are continuing their probe of Republic New York Corp.'s role in an alleged scheme to defraud Japanese investors, a federal source said Tuesday.

The source said investigators are examining Republic's part in aiding Martin A. Armstrong, an investment manager who was arrested late Monday on federal securities fraud charges. Mr. Armstrong, 49, who controlled Princeton Global Management Ltd., is accused of using a Republic Securities account to try to hide losses of as much as $950 million, and of causing an officer at Republic to "issue false confirmation letters."

So far, Republic has not been accused of wrongdoing. The company said that its securities arm had "no discretion" over Mr. Armstrong's accounts and that it is cooperating with investigators. A spokeswoman said it is also conducting an internal investigation to determine if anyone in Republic had knowledge of criminal activity.

But in declining to close the Republic case now that an arrest has been made, federal investigators are leaving the door open to possible charges of misdeeds at the banking company. Meanwhile, questions about Republic's involvement could give HSBC Holdings leverage to alter or even scrap the $10.3 billion deal for Republic that it unveiled May 10.

"The key question is, How high up did it go?" said Thomas Burnett, a merger analyst with Merger Insight in New York. "Did it go beyond Republic Securities? Did it go to the boardroom? Right now, we just don't know."

William Baity, the Treasury Department's director for financial crimes enforcement, said Monday that law enforcement officials are likely to still be "sorting out" the Republic case a year from now.

When the scandal became public Sept. 2, HSBC said it was postponing the Republic transaction, which was expected to close Oct. 1, and that it might have to wait until yearend. On Tuesday the London-based company said its timetable has not changed further, and declined to comment on the developments.

Analysts believe the deal remains on target, despite the latest turn of events, but say the terms would be vulnerable if Republic is implicated or the investigation drags on.

Stephen Biggar, a bank analyst with Standard & Poor's Equity Group, said HSBC might be gaining leverage to drive down the deal price. Shares of Republic are trading at a 19% discount to the agreed merger price, and a renegotiation can't be ruled out, he said. "You would have to suppose that when HSBC was doing its due diligence this affair was hidden from them in some way."

However, he said, "I suspect what we have here is the case of one rogue employee. It appears to be isolated."

Merger Insight's Mr. Burnett said that the longer the investigation continues, the more pressure HSBC will face to recut its deal for Republic. "Right now, we know that both sides still want to do this deal."

Republic's shares closed down $1 Tuesday, at $59, faring better than bank stocks on average.

The U.S. Attorney's office in Manhattan is leading the probe that prompted Mr. Armstrong's arrest. According to court filings, as many as 200 letters from William H. Rogers, president of the futures division at Republic New York Securities, allegedly misrepresented the net asset value of a fund run by Mr. Armstrong. The letters, used to placate investors about the fund's holdings, were being mailed out as recently as August, according to the filing.

Though Mr. Rogers has not been charged in the case, he has been fired from the bank. James E. Sweeney, chief executive of the futures division, has been suspended.

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