FSA blames "naive" traders for rumour mongering

LONDON (Reuters) - The financial watchdog blamed traders for being "naive" in rapidly spreading market rumours that it said had caused hefty drops in share prices and undermined market confidence.

Adopting policies on how to deal with rumours and monitoring chat sessions, phone calls and emails from traders would help companies to avoid such practices, the Financial Services Authority said on Wednesday.

"Spreading false or misleading rumours about companies, particularly in volatile or fragile market conditions, can be a very damaging form of market abuse," the FSA's Alexander Justham said in a statement.

The FSA published its findings in a newsletter and stressed they were recommendations, not regulation.

Supervisors across the globe have expressed concern about the speed with which rumours can spread and cause funding markets to shut due to a loss of confidence and -- in a worst-case scenario -- bring down a bank.

Morgan Stanley (MS.N) and Goldman Sachs (GS.N) shares were hit by market rumours about their financial health around the time of Lehman Brothers' bankruptcy in September.

Several countries have curtailed short-selling of financial stocks, fearing that market players such as hedge funds cornered the market by betting on falling stocks and then spreading rumours that put pressure on the shares.

In a study based on cases it had recently looked at, the FSA found no intention to disseminate false information.

A trader had spread a piece of "hot news" to 10 to 12 of his friends over a messaging system without making clear that it was a rumour. One of his contacts then did not hesitate to spread the message on to 150 of his contacts.

"We are clearly unhappy with these events and would have expected that in both cases ... the traders would have recognised the unverified, speculative and damaging nature of this rumour," the FSA said.

The FSA said it had carried out the project to assess the policies and procedures that firms apply in dealing with rumours, and that it had meant to offer some practical suggestions on good practice to adopt to avoid market abuse.

(Reporting by Douwe Miedema; editing by Simon Jessop)