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UPDATE 3-Goldman shares rise on false SEC settlement rumor

* Goldman shares up as much as 5.4 percent

* Shares rise on rumor of SEC settlement-analyst

* Goldman, SEC decline to comment

* Goldman, SEC have not settled -Washington sources

* KBW Banks index up 2.6 percent (Updates market activity)

NEW YORK, May 21 (Reuters) - Goldman Sachs Group Inc GS.N shares rose as much as 5.4 percent on Friday on rumors of a possible settlement with U.S. regulators and a feeling that the stock could be oversold.

The shares were up 3.5 percent at $140.80 in afternoon trading on the New York Stock Exchange, off an earlier high at $143.44. Goldman’s share rise came as bank stocks reversed losses and rose shortly after the open. [ID:nN21144360]

Goldman shares were further helped by a broader rally that sent the KBW Banks index .BKX up 2.6 percent. Goldman's rival Morgan Stanley MS.N was also up, gaining 4.84 percent.

Goldman Sachs and the SEC declined to comment.

But Washington sources familiar with the matter said the SEC and Goldman Sachs have not reached a settlement.

The SEC has accused Goldman of creating and marketing a debt product linked to subprime mortgages without telling investors that a prominent hedge fund helped choose the underlying securities and was betting against them.

Market sources confirmed that the early jump in Goldman shares -- following Thursday’s slump in U.S. stocks -- was based on rumors that the bank might be close to a settlement with the U.S. Securities and Exchange Commission and because the stock is oversold.

Zero Hedge first reported rumors of a Goldman-SEC settlement were spreading through Wall Street.

“We are seeing some signs that we may be close to a settlement. I think that the key here is conciliatory comments that we’ve been hearing from the CEO of Goldman, Lloyd Blankfein, where he’s taken a far more apologetic tone to what has happened,” said David Dietze, President and Chief Investment Strategist at Point View Financial Services in Summit, New Jersey.

Blankfein told India’s Economic Times on Friday that he regrets participating in transactions that “brought too much leverage into the world.” [ID:nSGE64K02U]

“He’s basically admitting that they didn’t do some things as well as they could have and that is suggesting that there is some posturing to be able to come to an accord with the SEC,” Dietze said.

Salem, Massachusetts-based Cabot Money Management fixed income manager William Larkin, who owns Goldman bonds, said Goldman stock has been oversold.

“Goldman has been oversold, and the bonds have been widening pretty substantially the last couple days,” he said. (Reporting by Clare Baldwin, Jonathan Spicer, Rachelle Younglai, Joe Rauch and Edward Krudy, editing by Matthew Lewis, Leslie Gevirtz)