Sen. says Bear trades before rescue need scrutiny

WASHINGTON (Reuters) - A senior lawmaker and the chief of Bear Stearns Cos urged the Securities and Exchange Commission on Thursday to investigate whether short sellers and market speculators contributed to Bear Stearns' collapse.

SEC Chairman Christopher Cox stopped short of confirming an agency probe, but pledged that any necessary enforcement action would be taken.

"The rumors surrounding the activity you described are too big to miss," Cox said in response to Senate Banking Committee Chairman Christopher Dodd's questioning. The panel met to learn more about the rapid downfall of Bear Stearns and its unprecedented rescue by the Federal Reserve and JPMorgan Chase.

Cox also told lawmakers that their hopes the agency will investigate rumors of illegal trading will be "met and exceeded."

Trading in Bear Stearns spiked in the days leading up to the investment bank's collapse last month, Dodd said.

Dodd said he asked experts to crunch some numbers and found that if someone had invested $600 in Bear Stearns put options on Thursday, March 13, the investment would have swelled in value to $37,000 by the following Monday.

Equity puts give the right to sell the underlying shares at a given price and time. They can be used to speculate on potential stock price weakness or to insure an investor's stock holdings against adverse stock moves.

Bear Stearns, once the fifth-largest U.S. investment bank, notified the Fed and other regulators on March 13 that it would have to file for bankruptcy the next day unless it could secure financing. On March 14, the Fed and JPMorgan announced emergency financing, and two days later, JPMorgan agreed to buy Bear for just $2 a share.

"I would hope that you're looking at this," Dodd told Cox. "This is going beyond rumors."

Bear Stearns Chief Executive Alan Schwartz echoed the concerns in his testimony to lawmakers, saying market manipulation occurred.

"I would just say as an observer of the markets, it looked like more than just fear," Schwartz said.

"It looked like people wanted to induce a panic. A lot of the trading would point to that."

Cox said the SEC investigates rumors of illegal trading, adding that he was prohibited by law from revealing a specific investigation before civil charges are filed.

"The SEC very aggressively pursues insider trading, market manipulation and the kinds of illegal naked short-selling that has been very publicly alleged in this case," Cox said.

Short-selling, or betting that a stock will fall, is not itself illegal. Short-sellers borrow shares they consider overvalued and sell them. If the price drops, they repurchase the shares, return them and pocket the difference.

In a naked short sale, which is a securities law violation, the investor sells stock that has not yet been borrowed.

It is also illegal to engage in insider trading if the investor trades on inside information that is material and not publicly available.

The SEC has said such cases are notoriously difficult to prosecute because it can be hard to prove intent and that an investor possessed material, non-public information.

Trading volume in Bear Stearns shares was under 10 million shares a day prior to the week the bank collapsed. But volume grew to 32 million shares a day on March 10 and culminated with 186 million shares traded on Friday, March 14, when the emergency financing was announced.

"This raises bells and whistles in my mind," Dodd said.

(Reporting by Karey Wutkowski; Editing by Dan Grebler)