LONDON, June 7 (Reuters) - Deutsche Bank (DBKGn.DE) has become embroiled in a UK probe into market manipulation at the time of the collapse of Icelandic bank Kaupthing, sources familiar with the matter said. Britain's Serious Fraud Office (SFO) said in December it was investigating suspected offences against the Fraud Act prior to Kaupthing's demise in October 2008.
The suspicion was that Kaupthing tried to prop up the price of its debt through a number of investment vehicles that the bank was financing itself, the sources said.
"Generally speaking, we're looking at potential market manipulation," one of the sources said.
The vehicles were buying Credit Default Swaps (CDS) -- instruments used to insure Kaupthing's debt against default -- sending a positive signal to markets in the hope that Kaupthing's debt prices would rise.
Kaupthing was effectively buying the CDS itself, because it was financing the investment through a loan.
"We are cooperating with the authorities in seeking to establish the facts in this matter," Deutsche Bank said when asked about the story, which was first reported by UK newspaper The Guardian on Monday.
The German bank declined to provide further detail, while the SFO declined to comment altogether.
Deutsche issued credit-linked notes on behalf of the investment vehicles set up by Kaupthing, one of the sources said. But that did not mean it would necessarily have known about the way the vehicles were financed.
Last month, an Icelandic court ordered the former head of Kaupthing, Hreidar Sigurdsson, to be held for 12 days pending further investigation for suspected embezzlement, market manipulation and forgery. [ID:nLDE6460Q8]
Another former Kaupthing executive who now runs a privately held bank in Luxembourg, was also arrested. (Reporting by Douwe Miedema; Editing by Louise Heavens)