The Dow Jones Industrial Average traded 167 points lower and dropped nearly 200 points, while the S&P 500 fell 0.3 percent. The Nasdaq Composite traded around the flatline, however, as Netflix shares jumped nearly 3 percent.
Axios reported, citing a source with direct knowledge of the matter, that Rosenstein would step down from the role. "He's expecting to be fired," according to Axios' source. Bloomberg News later reported the White House accepted Rosenstein's resignation. NBC News cannot yet report that he has been fired or that his resignation has been accepted.
The White House later said in a statement Rosenstein and President Donald Trump will meet on Thursday amid the conflicting reports.
"Certainly the fact that you have such contention within the administration is not the sort of stability markets like to see. To have a such a high-level official resign is a part of that," said Bruce McCain, chief investment strategist at Key Private Bank.
Larry McDonald, founder of the Bear Traps Report, said Rosenstein's resignation could lead to more trouble for the Republicans in the upcoming midterm elections.
"I can't see this helping the midterms for the Republicans and the Trump agenda will be frozen in ice and possibly reversed," he said. "If Rosenstein is gone, it emboldens Trump's base, but it's not going to help him with Democrats as well as middle-of-the-road voter that wants to give the Mueller investigation the benefit of the doubt."
An NBC-Wall Street Journal poll showed Democrats leading Republicans by 12 points for control of Congress heading into the election.
Equities had already been under pressure earlier as new tariffs on U.S. and Chinese goods took effect while both countries also cancelled trade talks.
The Wall Street Journal first reported late Friday that China had cancelled talks with the U.S. on trade as both countries impose tariffs on billions of dollars worth of their goods. The two sides were set to meet in order to dial back tensions, but the Journal reported that China rescinded a proposal to send two delegations to Washington. Other news outlets matched The Journal's reporting throughout the weekend.
Kevin Lamarque | Reuters
Deputy Attorney General Rod Rosenstein appears with U.S. President Donald Trump at a roundtable on immigration and the gang MS-13 at the Morrelly Homeland Security Center in Bethpage, New York, May 23, 2018.
Tim Courtney, chief investment officer at Exencial Wealth Advisors, said the risk of a full-blown trade war between the U.S. and China is not being completely priced in by the market. "I think the market has expected trade disputes to get resolved. That's been the case for the most part, except for China," he said.
The move lower on Monday comes after the Dow and S&P 500 posted record highs on Friday and notched solid weekly gains.
"They did it in a very healthy way," said Art Hogan, chief market strategist at B. Riley FBR. He noted that money rotated out of defensive stocks and some of the high-flying tech shares into financials. "I think we can see another bid in financials if the 10-year can hold above 3 percent."
The benchmark 10-year Treasury note yield traded at 3.08 percent on Monday.
Energy shares rose, meanwhile, as Brent crude broke above $80 per barrel to hit its highest level since 2014 after OPEC leaders signaled they would not be boosting output immediately. The Energy Select Sector SPDR ETF (XLF) rose 1.4 percent.
"It's clear that the OPEC meeting didn't have a lot of talk about new supply coming," said Hogan. The boost is coming more from "the supply side, but demand is still strong, which is a positive" for oil and energy stocks.
Comcast outbid Twenty-First Century Fox on Saturday in a $39 billion takeover of U.K. broadcaster Sky, submitting a much higher bid in a three-round auction. On Monday, the U.K. broadcaster recommended its shareholders to accept an offer from Comcast. Comcast shares fell 6.8 percent while Fox's stock rose 1.4 percent.
Meanwhile, SiriusXM announced it would buy Pandora in a stock deal worth $3.5 billion. The deal initially sent Pandora shares ripping nearly 20 percent higher in the premarket but rose just 0.3 percent in regular trading.
—CNBC's Michael Sheetz and John Melloy contributed to this report.