Last week’s Securities and Exchange Commission [3] (SEC) action against Goldman Sachs [4] landed like a bombshell on Wall Street. To the titans of Wall Street it must have seemed like the nice little kitty they had been stroking and cuddling over the years, viciously sank in teeth and claws.

The SEC has faced intense criticism from the public and media regarding the way it loosened leveraging rules, a key cause of the implosion of major investment banks and the meltdown as a whole. The SEC also took a pounding over its handling of the Bernie Madoff [5] fiasco. SEC officials chose to ignore explicit warnings from whistleblowers that Madoff was running a Ponzi scheme [6]. The SEC also mishandled its first major case related to the crisis, being roundly scolded [7] by a federal judge for not being tough enough on Bank of America’s secret bonus and salary deal with Merrill Lynch.

As one New York Times [8] article aptly put it: "In the last few years, the Securities and Exchange Commission seemed like the cop in the doughnut shop, sitting idly by while the likes of Lehman Brothers [9] and Bernard L. Madoff ran amok."

But last week, the SEC picked itself up, brushed itself off and launched back into the fray. It accused Goldman Sachs [4] of failing to disclose that an investment vehicle it created was commissioned and designed to fail by a hedge fund manager with an adverse interest. With this new case, which only advanced after an unusual partisan vote of the SEC the board, top SEC investigators are sending the strong message that they are back on the beat and not afraid to tackle the biggest institutions on Wall Street. Goldman [10], it should be noted, denies any wrongdoing.

Huge Implications

The implications of this case are huge for both Goldman and the SEC. First, many of the investors who were harmed by the deal were foreign banks. As a result, the British and German governments are contemplating suing Goldman for losses suffered by banks in their respective countries. Combined with the controversy over Goldman’s role in the Greek debt crisis [11], the SEC case deals another hard blow to Goldman's global reputation. Goldman's stock dropped significantly Friday after news of the SEC action broke. As more details are revealed about the case, Goldman stock may continue to take a pounding. Goldman’s inept press team will no doubt try to cook up more silly greed-washing schemes [12].

But Goldman’s loss could be the SEC’s gain. If successful, the SEC action could repair its tarnished reputation. This case is one of the first to be brought by the SEC's newly structured-products group and new enforcement chief Robert Khuzami [13], a former federal prosecutor. The case is a gamble as the basic transaction being investigated is a common one. But as Christopher Whalen of Institutional Risk Analytics remarked: "The SEC’s move marks an escalation in the battle to expose conflicts of interest on Wall Street and exposes a ‘cynical, savage culture’ that allows dealers to deceive one customer to benefit another."

The SEC has said it is looking into other deals like this one at other Wall Street firms. Stay tuned. Apparently this kitty now has claws.