Hedge Funds Face Expansive Short-Selling Probe, Exciting Critics

The U.S. Justice Department has launched an expansive criminal investigation into short selling by hedge funds and research firms -- thrilling legions of small investors and other skeptics of the tactics that investigative firms use to bet on stock declines.

The probe, run by the department’s fraud section with federal prosecutors in Los Angeles, is digging into the symbiotic relationships between funds and researchers, hunting for signs that they improperly coordinated trades or broke other laws to profit, according to people familiar with the matter.

The government is examining how the investors handle information and set up their bets, especially ...