There is a serious problem with the way data on structured finance securities is provided to investors. These securities should have the clarity of a clear plastic bag. Instead, they're about as see-through as a brown paper bag. In fact, Goldman Sachs' (GS, Fortune 500) exact alleged fraud was to misstate and omit key facts about a structured finance security (called ABACUS 2007-AC1) whose return was driven by the performance of several subprime mortgage backed securities.

    The way Goldman and John Paulson profited handsomely on their Abacus trades was to exploit the fact that they could see into the bag, but others, including Goldman's customers, could not.

    If investors had transparency, they wouldn't be stuck trying to determine the contents of a brown paper bag, and wouldn't be at a major disadvantage to firms saying the investments were sound, while filling them with subprime junk and only allowing themselves and savvy hedge funders like Paulson to know the truth.

    Goldman, like many financial firms, enjoys an information advantage because it gets loan-level performance data on a daily basis. However, standard practice for other market participants -- investors and customers -- is to have to wait for the accumulation of daily data to arrive in a once-per-month or less frequent report. Not only does the data come in a brown paper bag, it's weeks old, too. Using old data to figure out what's in the bag today is a guessing game at best.

    Goldman is currently claiming its customers are sophisticated investors and should have understood the risks they were taking. But should even sophisticated investors be allowed to buy, sight unseen, the contents of a brown paper bag, as if they were contestants on a game show? Further, the two main indicators of risk available to investors -- credit ratings and the role of the collateral manager -- were both misleading in this investment, and in many others.

    Providing loan-level performance data on a daily basis to all parties would give investors the clear plastic bag view of what they are buying, making the question of purchasing the hidden contents of a brown paper bag, as in the Abacus CDO created for Goldman, and bet against by John Paulson, irrelevant. In short, better information would make crimes like the one Goldman is accused of impossible to commit.

Seeing vs. pretending to see inside the bag

    To overcome their inability to see into the bag, structured finance investors relied on third parties, namely credit ratings agencies, who told them they could determine and value the bag's contents.

    The Goldman lawsuit shows that the ratings agency system actually drives investors away from doing their own homework in the first place. The rating agencies have long held their access to confidential data sets them apart from other analysts.

    Investors incorrectly thought this meant ratings agencies had more timely data than they did. They thought the agencies were looking inside the brown paper bag. They were not. The agencies did not tell the market that they could not see inside the brown paper bag either, as they were not privy to loan-level performance data on a daily basis.

    If the data gap didn't exist, investors would have been able to see for themselves, rather than rely on ratings agencies, that the underlying securities weren't properly valued and that a bet they would retain their current price was a sure loser. They would have steered well clear of buying the Goldman product.

    Not only did Goldman know what securities were going into the ill-fated Abacus CDO, it had its own window into the subprime mortgage world, with direct involvement in originating, billing and collecting other subprime mortgages: Goldman helped start and later solely owned a subprime mortgage originator and servicer named Senderra.