Will Goldman Torpedo Your Portfolio?

The SEC's lawsuit against Goldman Sachs (NYSE: GS) is, for lack of a better word, gold for the news industry. Goldman is a financial giant, renowned for its smarts, and the suit smacks of conspiracy; it's a financial journalism softball of ridiculous proportions.

But many investors may be reading about this and scratching their heads, wondering whether it has any real significance beyond the delicious salaciousness.

Well, here's the deal: If you're steering clear of big banks and investment banks -- here we're talking about Goldman, along with Morgan Stanley (NYSE: MS), JPMorgan Chase (NYSE: JPM), and their ilk -- then you can let this go in one ear and out the other because it's unlikely that this is going to have much of an impact on your other investments.

However, if you do have your eye on the big bank cartel, then this could be one more reason to tread carefully or backpedal altogether.

The SEC ain't walking softly, but it has a big stick
There were no kid gloves involved when it came to announcing the suit, in which the SEC alleges that Goldman misrepresented the nature of a collateralized debt obligation (CDO) to buyers. The announcement came on a Friday, right in the middle of the trading day. If it were a missile, it would have been a satellite-guided cruise missile aimed right at Goldman's heart.

Unless you're Royal Bank of Scotland (NYSE: RBS) -- which ended up losing $840 million on the deal in question -- Goldman's alleged missteps really seem more smarmy than outright illegal.

That's the whole point. The charges aren't terribly damning, and yet the Securities and Exchange Commission, the Democrats, and the media are playing it up as if there were conclusive evidence that Lloyd Blankfein was beating third-graders up to take their lunch money. And that can only mean one thing: The SEC is on a war path.

It makes perfect sense. With egg still on its face from the whole Bernie Madoff debacle, the folks at the SEC want the commission's name to once again strike fear into the hearts of financial evildoers. The biggest and easiest targets are the major investment banks, and thanks to the bravado, hubris, and the general masters-of-the-universe idiocy that pervade Wall Street, finding fodder for the SEC's comeback tour shouldn't be all that challenging.

Reform food
But the potential for other banks to get roped in to the SEC's witch hunt isn't the only reason that the Goldman suit puts an overhang over the financial industry. The suit has also re-energized calls for financial reform.

The fact that the timing of the lawsuit seems almost too picture perfect is already the subject of an internal SEC investigation. But leaving aside the possibility that there was any SEC / Democrat collaboration here, this suit was exactly what reformers in Congress needed to help give new regulations a final push.

I happen to be an unabashed fan of financial reform (and actually think it should go a lot further than it's slated to), but there's little doubt that certain reforms will not be good news for big financial companies.

For one, reformers want to put as much of the derivatives market on open exchanges as possible. The problem is that investment banks like Goldman are able to charge an arm and a leg for structuring and selling derivatives right now precisely because there's no readily available market or standardized contracts. Put it all on open exchanges, and whammo!, profits start shrinking.

The Goldman suit may even create enough momentum so that more stringent limitations end up as law. Senators Sherrod Brown, D-Ohio, and Ted Kaufman, D-Del., have put together the cutely titled "SAFE Banking Act," which -- among other things -- would limit bank holding companies to non-deposit liabilities of no greater than 2% of U.S. gross domestic product. Based on the bill's definition of GDP, that would mean that currently, a bank holding company would be limited to $281 billion in non-deposit liabilities. And for most banks that would mean some serious downsizing.

Source: Capital IQ, a division of Standard & Poor's. All data except for Goldman and Morgan Stanley as of March 31. Goldman and Morgan Stanley data as of Dec. 31, 2009.

And these numbers actually understate how much size the banks would have to shed because the Brown-Kaufman bill includes off-balance-sheet items as part of non-deposit liabilities.

Not a big deal, but totally a big deal
The bottom line of the Goldman lawsuit is that while the charges aren't terribly egregious, it's a sure sign that lawmakers are on the hunt for banking scalps. There's always the possibility that this somehow blows over and leaves the financial system intact, but I doubt that'll be the case.

Think I'm off my rocker and that banks are the best stocks out there right now? Head down to the comments section and share your thoughts.

Fool co-founder Tom Gardner doesn't think you should sell. But then again, he's not talking about banks.