Goldman Gets Served; Street Justice Overdue

NEW YORK (TheStreet) -- Goldman Sachs'(GS) fraud charge on Friday stunned investors, not only because the investment bank has been untouchable, but also because the Securities and Exchange Commission's lawsuit could serve as the opening salvo in a campaign against corruption on Wall Street. It's been a long time coming.

The allegations center around a deal the New York-based bank made with hedge-fund firm Paulson & Co. in which Goldman Sachs would create and sell a collateralized debt obligation (CDO) comprising securities that Paulson picked. The hedge fund was simultaneously betting against the same CDO by purchasing credit default swaps (CDSs) from Goldman that would pay off if the security failed. Eventually, 99% of the underlying securities dropped in value.

>>Gary Weiss Says Bring Back Eliot Spitzer

Goldman is in trouble for failing to disclose that conflict of interest. Goldman told investors the securities were selected by an impartial third party rather than the hedge fund, essentially lying about the source of the deal to ensure the sale of the securities, the SEC says.

Investors on Friday dumped stocks, fearing fallout from the scandal. The biggest question in the stock market is whether the Goldman case was isolated.

All signs point to further action by the SEC. ProPublica recently released a story on a hedge fund named Magnetar, which was involved in trades similar to those of Goldman. Magnetar would sponsor a CDO by purchasing the riskiest equity portion of the security and pick assets included in the package, while simultaneously shorting the CDS contracts on a higher tranche. The net result would be a small loss on the equity portion paired with a gigantic gain on the CDS contract, effectively making a profit at the expense of investors betting on an increase.

Magnetar is reportedly linked to investment banks ranging from Citigroup(C) to JPMorgan(JPM) to Merrill Lynch (now owned by Bank of America(BAC)), through these trades. If the allegations prove to be true, the pain of Friday's stock-market drop will only be a prelude.

The SEC's enforcement chief, Robert Khuzami, indicated Friday the commission is reviewing other deals, saying "we're looking at a wide range of products," according to the New York Times. "If we see securities with similar profiles, we'll look at them closely."