Where Financial Reform and SEC v Goldman Collide

Financial reform advocates were practically shaking with excitement to utter their I-told-you-so's over the weekend after the SEC filed a lawsuit (.pdf - brief synopsis here) against Goldman Sachs for fraud. One example of a reformer with a triumphant tone came this morning as House Financial Services Chairman Barney Frank (D-MA) said that the case helps reinforce the need for more regulation of financial markets. Should it?

Political Perfection

To be sure, having a major investment bank sued by the SEC strengthens anti-Wall Street rhetoric. In that way, it will enhance public support for measures to crack down on banks and discourage politicians from looking the other way -- and the timing couldn't have been better. So politically, the event is extremely helpful. But that's different from saying that the content of the SEC complaint assists regulation proponents in defending the more controversial reform proposals.

If the SEC Wins

An SEC win might seem like it would strengthen the case for reform. It shouldn't. If the SEC succeeds in showing that Goldman committed fraud, then that means current law already forbid Goldman's alleged bad behavior. In other words, no further regulation would be necessary to right the wrongs committed by the investment bank in this case.

If the SEC Loses

A Goldman win, however, should help reform's appeal. If it's widely perceived that the deal at the center of the SEC case was sleazy but Goldman gets away with it, then reforms everywhere will be vindicated in their view of the necessity of changes to the system.

Yet the corrections needed to fix the system according to the Goldman example are relatively benign. The SEC says that Goldman misled investors by not providing all of the relevant information for a security it sold. This is merely a call for greater disclosure. Virtually no one -- whether Republican, Democrat, banker, or consumer -- has much trouble with additional disclosure requirements. All of the more controversial measures, like the non-bank resolution authority, the consumer financial protection agency and putting derivatives on an exchange, wouldn't be necessary to have prevented the fraud the SEC believes occurred. Investors would have just needed a little more disclosure.

What Reforms Should Argue

However, this could provide some additional ammo for reformers' war if they highlight the uniqueness of this case. After a historic financial crisis, this marks the first -- and potentially last -- legal action related to wrongdoing against a major Wall Street bank the SEC has managed to take. That revelation shows how little regulators could have done to lessen the severity of the crisis in the current framework. Good reform should help to create an environment where investors don't as easily buy securities that will one day be toxic.

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