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The Securities and Exchange Commission on Friday charged Wall Street's most gilded firm, Goldman Sachs, with defrauding investors in a sale of securities tied to subprime mortgages.

The SEC said it charged New York-based Goldman (GS, Fortune 500) and a vice president, Fabrice Tourre, for their failure to disclose conflicts in a 2007 sale of a so-called collateralized debt obligation. Investors in the CDO ultimately lost $1 billion, the SEC said.

The SEC's civil fraud complaint alleges that Goldman allowed hedge fund Paulson & Co. -- run by John Paulson, who made billions of dollars betting on the subprime collapse -- to help select securities in the CDO.

Goldman didn't tell investors that Paulson was shorting the CDO, or betting its value would fall. When the CDO's value plunged within months of its issuance, Paulson walked off with $1 billion, the SEC said.

"The product was new and complex but the deception and conflicts are old and simple," said Robert Khuzami, director of the Division of Enforcement for the SEC.

A Goldman spokesman didn't immediately return a call seeking comment, but in a statement the bank said that "the SEC's charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation."

Goldman shares tumbled 13% following the midmorning announcement, wiping out $12 billion of shareholder value. Shares of Deutsche Bank (DB), another big player in the structured securities markets of the bubble era, slid 8%.

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The sheer spectacle of the U.S. Government charging Wall Street titan Goldman Sachs with civil fraud has been enough to rattle the financial markets and send Goldman's shares reeling. At midday, the investment bank's stock was down more than 12% and the price of put options on Goldman shares (bets that the stock will keep declining) were up dramatically. But beyond the organizational earthquake that has just been unleashed at Goldman— possibly damaging its reputation for years to come— how much money might it actually have to fork over?

Whether the case goes to trial or is settled out of court, the fines and penalties could be steep if Goldman is found at fault. At first blush it's just pocket change for the giant investment bank, which had revenues of $51 billion last year. The $15 million fee that Goldman earned for putting together the now infamous CDO security known as ABACUS 2007-AC1 (ABACUS) will surely be disgorged if it loses at trial or reaches a settlement, and it could easily be tripled as part of the penalty.

But the SEC could also cast a wider net when considering what Goldman should pay, and if the case goes to trial the discovery process could reach far and wide in tallying damages.

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