Brokerages’ role in sub-prime collapse probed

U.S. regulators, concerned that Wall Street firms might have concealed the extent of the rout in bonds backed by sub-prime mortgages, plan to examine how the biggest brokerages accounted for the securities as they plummeted in value, people with knowledge of the inquiry said.

The Securities and Exchange Commission wants to learn whether the firms inaccurately valued their own sub-prime investments or those held by clients, one of the sources said.

The Financial Industry Regulatory Authority, a brokerage regulator formed by the merger of the NASD and the New York Stock Exchange’s former enforcement unit, is collaborating with the SEC.

The firms to be examined are Goldman Sachs Group Inc., and Merrill Lynch & Co., Morgan Stanley, Lehman Bros. Holdings Inc. and Bear Stearns Cos. All are based in New York.

The agencies and the firms declined to comment.

The probe was prompted by market turmoil after two Bear Stearns hedge funds that invested in sub-prime securities collapsed, triggering a broad decline in credit markets in July.

Meanwhile, the audit committee of Bear Stearns’ board has hired law firm Davis Polk & Wardwell to conduct an inquiry into the two failed funds, a person at the law firm said Friday.

A Bear Stearns representative couldn’t be reached for comment about the law firm’s probe.

The SEC started monitoring how Wall Street firms price thinly traded, mortgage-linked securities last year. Because they rarely trade, investors often rely on the brokerages that sold them to estimate their market value.

Lawrence White, an economics professor at New York University, said investigators might ask whether the firms’ valuations amounted to “shading the results to benefit themselves.”