PARIS (Reuters) - France's market regulator will seek the maximum possible fine against luxury giant LVMH for failing to disclose it was preparing to build a stake in rival Hermes initially revealed in 2010.

While the amount of the fine, 10 million euros ($13.05 million), would be a pittance for the group controlled by France's wealthiest man Bernard Arnault - LVMH's market value is 70 billion euros - the decision by regulator AMF is a public relations setback for the owner of some 60 luxury brands.

LVMH's dealings had been opaque and represented grave misconduct which could even be regarded as "fraudulent behavior", the regulator said on Friday.

The public hearing spills open a row which has run for more than two years between the makers of some of the world's best known top-end goods.

LVMH owns Louis Vuitton, the world's biggest luxury brand in terms of revenues, together with a string of fine wine and spirits makers including Hennessy cognac and Moet & Chandon champagne while Hermes is known for its iconic Kelly and Birkin leather hangbags.

Regulator AMF said LVMH should have disclosed the size of its exposure to Hermes shares through equity derivatives as well as the fact it had a Hermes stake of just under 5 percent acquired in 2001 and 2002.

It said evidence showed that LVMH had aimed as early as 2008 to further boost its stake in Hermes which cost around 12,000 euros and can take months to obtain.

LVMH, which now owns 22.6 percent of Hermes, surprised the market in October 2010 when it announced it had a 14 percent stake, gained partly via derivatives that allowed it to not declare its holding.

Hermes has fought LVMH's stakebuilding every step of the way and is also challenging it in a separate court procedure. The AMF finding will not have any impact on the court case, but still represents a boost to Hermes' case.

Hermes has argued that LVMH did not tell the market for many months it was a buyer of the shares, which would have boosted its shares if made public.

In France, companies are required to disclose when they take a stake worth more than 5, 10 and 15 percent of a another company's capital if the target is listed on the stock market.

Earlier on Friday, the AMF said it would look into LVMH's call for the judicial process to be made invalid and it would not halt the process.

LVMH shares closed down 1.23 percent while Hermes shares ended down 0.6 percent compared to a 1.2 percent fall for the Paris stock exchange's CAC 40 blue chip index.

($1 = 0.7660 euros)

(Reporting by Astrid Wendlandt and Pascale Denis; Editing by Christian Plumb and Patrick Graham)