The US Securities and Exchange Commission?s (SEC) job is to regulate the securities industry and investigate wrongdoing, if any. However, it has managed to sleep through every bubble and bust in recent memory and has done virtually nothing by way of enforcement for years. It woke up from a long slumber this month and announced a civil fraud lawsuit against Goldman Sachs. The entire business world, including the stock markets, has gone hammer and tongs about Goldman because it is a done thing to call names, when the mighty falls. Its stock price has come down from $185 on April 14 to $153 as of April 28. It is not as if Goldman hasn?t done anything wrong. It has. However, it isn?t a blood-sucking greedy Dracula that it is being made out to be. Before we get on with Goldman bashing, let?s understand the facts of the case that the SEC has filed against the investment bank.

The SEC on April 16 brought securities fraud action against Goldman and a Goldman employee, Fabrice Tourre, a 31-year-old vice-president working at the structured product correlation trading desk. This desk was created in early 2005. One of the services it provided was the structuring and marketing of a series of CDOs called Abacus whose performance was tied to residential mortgage-backed security (RMBS), which are the collateral used in Abacus. The RMBS does well if house owners are paying their EMIs. If the homeowners default on their home loans, the RMBS?s price goes down. If the collateral value goes down, the CDO price, too, goes downhill. Let?s say, I bought a house for Rs 90 lakh by taking a loan for Rs 80 lakh from a bank. If my house is worth only Rs 30 lakh now, I would rather want that the bank takes possession of the house and suffer the loss, than me suffering the loss by repaying the loan of Rs 80 lakh.

In the case filed by SEC, Goldman is supposed to have misled their clients into buying CDOs linked to subprime RMBS. The reason they purportedly did it was that another client of Goldman?a hedge fund?wanted to sell those CDOs. This hedge fund called ?Paulson Credit Opportunity Fund? was run by John Paulson (not to be confused with Henry Paulson, the former treasury secretary and CEO of Goldman). Paulson wanted to take a bearish view of subprime mortgage loans. He was betting that the subprime loans would go bad. He needed somebody with whom he could play this bet, so that if his view turned out to be right, he could make money. It was a zero sum game like any other bet. And he got Goldman to get the other party who would bet the other way round by taking a view in 2007 that subprime assets were good. He got the bet bang on?the consequent subprime meltdown, as they say, is history. And did he make some money! He became a multi-billionaire by getting his bets right and is now the 45th richest man on earth with a net worth of $12 billion.

Although the jury is out and Goldman, for its part, is trying to say all the right things, I think that Goldman did intentionally mislead its investors by not disclosing that they were structuring this transaction because another client wanted to bet against the subprime loans. Is it a normal market practice among investment banks? Surprise: yes it is. Were these investors to whom they were peddling this stuff na?ve. No, they were not. It wasn?t as if Goldman was selling this to grandpas and grandmas who had no clue about CDOs. The investors were financial institutions, albeit not as smart and sophisticated as a Goldman or a John Paulson. True, it is unlikely that the investors would have bought CDOs had Goldman disclosed the information that another hedge fund was shorting it. If investment banks were as squeaky clean and honest, they would not be able to do a very large portion of the business they do right now. This is not to suggest that such behaviour should be condoned. Just that, that?s how the financial markets are, or for that matter all markets are. It is similar to a vegetable vendor palming off rotten stuff to you because somebody else wants to sell it and the vendor is getting paid well to do the selling. Paulson paid Goldman about $15 million to structure and market Abacus. As an investor, it does hurt that you bought financial instruments from the market leader with an enviable reputation and the stuff turned out to be rotten. It is unethical for sure, but I suppose Goldman would be upbeat about defending itself.

The SEC had been sleeping all this while, impervious to such practices. Now that it has woken up, it might be a good idea to focus on regulations that would help clean the stables. The easy thing to do, however, would be to investigate this case and then put the blame for everything on Goldman and go back to sleep again.

The author, formerly with JPMorganChase, is CEO, Quantum Phinance