* Bank stocks fall; gold prices, VIX shoot up
* Dow, S&P below 50-day DMA for first time since April
* S&P suffers largest gap down since March 2009
* Indexes down: Dow 1.24 pct, S&P 1.12 pct, Nasdaq 1.61 pct (Updates to early afternoon)
By Yashaswini Swamynathan
May 17 (Reuters) - U.S. stocks braced for their worst day in at least two months as reports of a memo by former FBI chief James Comey suggested that President Donald Trump tried to interfere with a federal investigation, setting off alarm bells on Wall Street.
Trump had asked Comey to end a probe into former National Security Adviser Michael Flynn's ties with Russia, the reports said.
The news comes on the heels of a tumultuous week at the White House when Trump unexpectedly fired Comey and then disclosed classified information to Russia's foreign minister about a planned Islamic State operation.
The latest developments cast a shadow over Trump's proposed business-friendly policies such as tax cuts and simpler bank regulations, which have underpinned a record-setting rally on Wall Street.
"I think the biggest issue right now is what does this mean for the plan that we thought we were on," said Jeremy Bryan portfolio manager at Gradient Investments in Arden Hills, Minnesota. "Is it delayed or is it dead?"
Bank stocks, which outperformed in the post-election rally, were the worst hit. The S&P 500 financial sector sank 2.5 percent, led by losses in Bank of America and JPMorgan.
Goldman Sachs was the biggest drag among the 25 decliners on the Dow.
Both the Dow and the S&P 500 fell below their 50-day moving average for first time since late April. The S&P began the session by opening 0.74 percent lower, the largest gap down since March 30, 2009, when the index suffered a 0.84 percent drop at the start of trading.
At 12:07 p.m. ET (1607 GMT), the Dow Jones Industrial Average was down 260.91 points, or 1.24 percent, at 20,718.84, the S&P 500 was down 26.85 points, or 1.12 percent, at6 percent, at 2,373.82 and the Nasdaq Composite was down 99.13 points, or 1.61 percent, at 6,070.74.
The dollar index sank on Wednesday, erasing all of the gains since Trump's election victory in November.
The VIX, Wall Street's "fear gauge", shot up to 13.72, its highest level in nearly one month.
"We're largely through the earnings season, so political uncertainty is probably going to be the largest source of risk in the next three to six months." Bryan said.
Nine of the 11 major S&P 500 sectors were lower.
Utilities and real estate sectors - preferred investment options in times of uncertainty due to their slow but predictable growth - were higher.
Target was up 2.8 percent at $56.06 after the big-box retailer reported a smaller-than-expected drop in comparable sales.
AbbVie slipped 2.4 percent to $65.25 after Coherus BioSciences received a favorable patent ruling against AbbVie's Humira drug. Coherus shares rose nearly 7 percent to $23.55.
Declining issues outnumbered advancers on the NYSE by 2,224 to 665. On the Nasdaq, 2,313 issues fell and 474 advanced.
The S&P 500 index showed six new 52-week highs and 17 new lows, while the Nasdaq recorded 21 new highs and 66 new lows. (Reporting by Yashaswini Swamynathan in Bengaluru; Editing by Saumyadeb Chakrabarty)