Investment banking: Goldman probe spooks markets; but should be no surprise

There is little or no doubt that Goldman Sachs is being used as a test case by the USA's securities regulator the SEC. After two years of being accused of being "asleep at the wheel," regulators all over the world are trying to salvage their reputations.

A recent flurry of insider trading prosecutions has been, in part, a tool to demonstrate that regulators do have teeth.

What is different about the Goldman Sachs case is that most regulators have, so far, chosen relatively small institutions to chase.

The SEC needed some good news on Friday 16th April: it was about to be named in a damning report by the Office of the Inspector General - and it knew it had no effective defence, that it would have to put its hands up and say "we screwed up but things are better now." And that's exactly what it did with a statement by Chairman Mary Schapiro.

If you can't attack, divert: Sun Tzu didn't say it, but he might as well have done.

Knowing that there would be a media storm over allegations that it knew, in 2005, of suspicious activities by Allen Stanford and did nothing, allegations that have often been demonstrated to be true in relation to Bernie Madoff, the SEC knew that bucketfuls of brown, sticky, smelly stuff were coming its way in the weekend papers.

And therefore a big news story that would detract from that was a good idea.

But, the SEC says, it is investigating more cases at Goldman and at other financial institutions, heralding the chance of more actions.

There is no doubt that there is a need to investigate: but the SEC should investigate itself and other regulators and government departments. The SEC is having to tread a careful line: if it says that CDOs, per se, are a bad thing, that calls into question the judgment of both its own new products division and of Alan Greenspan. In 2002, as the US tried to come back from its 2001 / 2002 mini-crisis he personally promoted asset backed securities as a potential saviour of the US financial sector. For the SEC to turn on Greenspan - who as recently as this month was still trying to stave off criticism of the Fed's failure to identify the problems in the underlying housing loans market - would be akin to heresy.

Americans have a tendency to over-dramatise: they talk of "violations" - a word that in English has a much more severe meaning; in this case they talk of "fraud" but the facts alleged would not, at least so far as have been disclosed, meet the threshold necessary to sustain a civil case on that basis in the UK much less a criminal prosecution. And the USA is unusual, although not unique, in using the word "fraud" in regulatory cases: in non-US markets, the SEC's statement with its capital letters makes the word "fraud" stand out.

The USA is also unusual in using the word "charges" in relation to a civil action: elsewhere, that word is reserved for criminal trials. The SEC is not bringing criminal charges: that's the job of the Department of Justice or state authorities.

And so, in truth, the PR effect of the release far exceeds its actual importance and, even though other actions will follow, they will not risk the health of the financial sector and they will not put people in jail.

But it's done it's job: this morning hardly anyone is mentioning the OIG's Stanford Report.