There are growing calls for the Financial Conduct Authority to drop plans to name firms under investigation.
Robin Henry, head of dispute resolution at law firm Collyer Bristow, said the proposals have "set alarm bells ringing" at City firms.
It comes after the regulator responded to calls from the the House of Lords Financial Services Regulation Committee to pause consultation on the plans.
In the letter, published on Friday (April 26), the FCA said: "We recognise these proposals represent a change in our established practice. We think it is important and timely to open the debate.
"We know that firms benefit hugely from understanding the issues that lead us to investigate and that they use that understanding to drive higher standards of conduct.
"We know that consumers benefit significantly from knowing when the regulator is on the case. And we know that a number of those to whom we are accountable have frequently and forcefully expressed their frustration at our lack of transparency hitherto."
Henry said naming firms which may later turn out to be innocent could cause unnecessary damage.
He said: "This proposal has quite rightly set alarm bells ringing at City firms who are concerned that they may be named if they are investigated by the FCA.
"These investigations can often be lengthy but can sometimes be dropped by the FCA without further action being taken for reasons which are not transparent.
"The FCA says that they want to increase the deterrent effect of their enforcement process by publishing information at the start as well as the conclusion of cases.
"Their stated aim of wanting to 'amplify the deterrent impact' by letting firms know what failings can lead to an investigation is sensible enough but naming firms which may turn out to be innocent seems likely to cause unnecessary damage."
In the letter, the FCA disputed its approach would amount to 'naming and shaming' firms.
It added, the numbers of firms which could be named are relatively small and said, in general, it had not seen evidence of share prices being impacted by being named as being investigated.
Harvey Knight, UK head of the financial services regulatory group at Withers, added: "There is a growing political and industry consensus that the FCA is exceeding its statutory objectives in pursuit of what it considers to be its best interests without any balancing considerations.
"From an international perspective it is becoming an outlier regulator, out of kilter with its international competition.
"We have moved beyond the 'shoot first and ask questions later' approach of the 2010s to a 'publish and be dammed', whatever the consequences to the UK's financial services industry and the UK's wider economy and tax receipts, approach to the UK firms and individuals it regulates"
Earlier today, FT Adviser reported 16 trade associations asked chancellor Jeremy Hunt to intervene over the FCA's 'name and shame' proposals, saying they would "have an unduly negative impact on the reputation on firms".
Consultation on the plans is set to close on Tuesday (April 30).
tara.o'connor@ft.com
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