Bear Stearns

(BSC)

and securities regulators are heading toward a showdown over the big Wall Street firm's role in the mutual fund trading scandal.

It's increasingly likely that the

Securities and Exchange Commission

will file formal civil charges against Bear Stearns for its role in processing and financing abusive mutual fund trades, say people familiar with the long-running investigation.

Nearly a year ago, the SEC notified Bear Stearns that it was considering bringing an enforcement action against the Wall Street brokerage and its big clearing operation. Late last year, the firm increased its litigation reserve by about $100 million to cover the cost of a potential settlement.

Since then, the regulators have turned up the pressure by threatening to file civil charges against at least eight current and former Bear Stearns employees, including four top executives in the clearing division -- one of the firm's core businesses.

But sources say settlement talks between Bear Stearns and the SEC are making little headway. If a deal is not reached within the next few weeks, the SEC could move to file charges against Bear as soon as the end of the month, sources say.

In fact, the regulatory case against Bear Stearns was briefly scheduled last month for a hearing before the full SEC commission, a step that's often a precursor to the filing of formal charges, people familiar with the inquiry say. But the matter was removed from the SEC calendar shortly after it was scheduled, to allow more time for the settlement talks to progress.

Now, time appears to be running out on those negotiations.

Officials with the SEC declined to comment. A Bear Stearns spokesman also would not comment.

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Regulators believe Bear played an important role in processing and financing abusive mutual fund trades for dozens of hedge funds and small brokerages that have been implicated in the far-reaching scandal. So far, mutual fund companies and brokerages have paid nearly $2.5 billion in fines and restitution in the investigation.

The filing of formal charges against Bear Stearns would be a relatively unprecedented event, given the propensity of SEC regulatory investigations involving Wall Street brokerages to end in a settlement. Terms of such deals usually allow the firm to avoid an admission of guilt.

But Bear Stearns appears reluctant to agree to any deal that would carry a stiff fine, plus a demand that the Wall Street firm divest the portion of its clearing operation that provides back-office services to 350 small brokerages, or "correspondent" firms.

Clearing is the arcane but crucial service on Wall Street in which a firm such as Bear Stearns acts as a middleman for small brokerages that lack the financial resources and back-office muscle to make sure big sales of securities go off smoothly.

For years, Bear Stearns has been one of the dominant players in the clearing market. The firm's clearing operation, which includes its hedge fund prime brokerage business, accounts for 13% of its annual revenue. The stocks held by the customers of the brokerages it clears for provide an asset base from which Bear Stearns borrows to make stock loans to hedge funds and other wealthy investors.

People familiar with the investigation say regulators view Bear Stearns' alleged misdeeds as similar to those committed by

Bank of America

(BAC) - Get Report

, which settled its case with the SEC by paying a $515 million fine and agreeing to sell its clearing business. Like Bank of America, regulators believe Bear Stearns created a trading platform in its clearing operation that made it too easy for rogue brokers and hedge funds to engage in market timing and late trading, the two main abuses the mutual fund investigation has zeroed in on.

Regulators believe Bear Stearns went a step further, taking advantage of its clearing muscle to maximize its profit from abusive mutual fund trading. The SEC contends, according to people familiar with the investigation, that Bear Stearns aggressively matched hedge funds that wanted to engage in abusive mutual fund trading with small brokerages that were willing to handle that kind of trading, and cleared their trades through Bear Stearns.

Additionally, Bear Stearns provided financing to the hedge funds, enabling them to make more profitable trades.

The four top executives in Bear Stearns clearing operation who have received so-called Wells Notices from the SEC were involved in overseeing a sales force that forged relationships with small brokerage firms and hedge funds that use Bear Stearns to either clear trades or provide back-office services.

The four Bear Stearns executives, three of whom are senior managing directors, continue to be employed by the firm, although one executive has been on leave for more than a year.