Friedman Billings Ramsey ( FBR) investors are piping hot over the latest twist at the investment firm.

FBR shares plunged 13% early Tuesday after the company stunned Wall Street with a Monday evening earnings warning.

The Virginia-based firm said first-quarter earnings likely will be cut in half, in part due to the cost of settling a regulatory investigation into Friedman's role as the placement agent for a 2001 private stock sale, or so-called PIPE.

In the quarter, Friedman Billings said it plans to set aside $7.5million to cover the cost of the expected settlement with the Securities and Exchange Commission and the NASD. The investment firm said the legal reserve is one reason it now expects to earn between 13 cents and 15 cents a share in the quarter, compared to the 30 cents that most analysts were expecting.

Friedman Billings offered no details on the investigation in the press release.

But the firm's woes go beyond the investigation into the PIPE deal. FBR also said that net revenue will tumble 26% from a year ago to $163million. The firm attributed the revenue weakness to the impact of rising interest rates on its big portfolio of mortgage-backed securities.

In premarket trading, shares of Friedman dropped $1.91 to $12.48.

The firm first disclosed last November that regulators were investigating the firm's role in finding hedge funds to invest in the deal, which was a kind of financing known on Wall Street as private investment in public equity, or PIPE.

Three weeks ago, in a surprise move, Emanuel Friedman, one of thefirm's founders, announced he would retire in June as co-chairman andco-chief executive. The investment firm offered no explanation forFriedman's decision, but sources say it may be connected to the falloutfrom the regulatory investigation.

The investigation of Friedman Billings is part of a broad inquiry by securities regulators into manipulative trading in the $14-billion-a-year PIPEs market. A year ago, the SEC issued subpoenas and requests for documents to 20 brokerages that have arranged PIPE deals for cash-strapped companies. Regulators subsequently issued subpoenas to about 10 hedge funds. The SEC is working in tandem with a parallel inquiry by the NASD.

The probe is focusing on allegations of stock manipulation by hedgefunds, which tend to be the biggest investors in these shadowy stock sales, and allegations of wrongdoing by the Wall Street firms that round upbuyers. PIPEs are popular with hedge funds because the buyers can getpreferred stock or bonds that convert into common shares at a discount to market prices.

The investigation of a 2001 PIPE deal for Compudyne ( CDCY) already has resulted in securities charges against hedge fund manager Hilary Shane.

The NASD complaint alleges Shane improperly bet against shares ofCompudyne in advance of the stock sale, for both her own account and thehedge fund she formerly managed, First New York's FNY Millennium Partners fund. The NASD's complaint against Shane is still pending, although sources say the parties are close to reaching a settlement.

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