FSA abandons inquiry into HBOS short selling for lack of evidence

The UK financial markets watchdog has been unable to prove that short sellers deliberately trashed HBOS shares to profit illegally from the falling price, but said there is "no doubt" that false rumours were spread through the market in March.

The Financial Services Authority (FSA) has called off its investigation into the sharp fall in HBOS's share price, saying it was "extremely difficult" to prove individuals had profited from market manipulation.

It said in a statement yesterday: "The investigation has now concluded," bringing to a close a probe that had lasting almost five months.

"There is no doubt that false and damaging rumours were circulating about HBOS on 19 March 2008 and these would have had some impact on HBOS's share price. It is difficult, however, to say how much impact," the regulator said.

The FSA said that while the rumours probably contributed to the fall in HBOS's share price, it "has not uncovered evidence that they were spread as part of a concerted attempt by individuals to profit by manipulating the share price."

Hedge funds and proprietary traders at investment banks had come under suspicion, as they are significant users of the short-selling strategy.

The regulator pledged to follow up on some of the points highlighted by the investigation, and will launch a review of firms' systems and controls for dealing with rumours. It will report on its findings in the autumn.

This is part of the FSA's plan to get tough on market manipulation. This month, it has charged three people and arrested eight more over cases of alleged insider dealing, unconnected to the HBOS shares inquiry.

The FSA took the unusual step of announcing it was to launch an investigation into trading in HBOS shares on 19 March, after they plummeted 17 per cent in half an hour.

The dramatic price fall followed a slew of rumours in London that the UK bank faced funding difficulties. The regulator pledged to continue to scrutinise the markets intensely, and threatened market manipulators with criminal action.

As the furore grew, the role of short sellers came into focus. There were fears that a cabal of unscrupulous traders had deliberately contrived to hammer the stock with emails and messages giving a false impression of the bank's financial position in the hope they could "trash and cash" the shares.

Short sellers profit from a fall in a company's share price. Traders borrow shares from a long-term investor and immediately sell them, with an agreement to buy them back at a set date, hoping the price will have fallen so they can pocket the difference.

The FSA's investigation included 40 staff trawling through transactions in HBOS shares in search of suspect trades, and also scrutinising emails and message boards.

Traders, managers and compliance staff at various City firms were also questioned by the investigators.