SYDNEY--Standard & Poor's lost a landmark case in Australia
Monday over top-flight ratings given to financial products that
collapsed in the build-up to the 2008 global economic crisis.
The Federal Court of Australia ruled that S&P's AAA rating
of constant proportion debt obligation notes created by banking
giant ABN AMRO and sold to the councils of 13 Australian towns, had
been "misleading and deceptive".
It is the first time a ratings agency has faced trial over
synthetic derivatives and the case could set an important precedent
for future litigation.
"(It is a) decision that is likely to have global implications,
and be felt hardest in Europe and the U.S. where similar products
were sold to banks and pension funds," said Piper Alderman, the law
firm representing the councils.
"No longer will rating agencies be able to hide behind
disclaimers to absolve themselves from liability."
IMF Australia, a publicly listed company that provides funding
for large legal claims and bankrolled the case, said it was already
mulling similar actions in New Zealand, Britain and the
Netherlands.
"We expect that investors, banks and regulatory authorities
around the world will be examining this judgment carefully to
determine the broader implications, said IMF director John
Walker.
S&P has already been warned by the U.S. Securities and
Exchange Commission that it could face a lawsuit over its rating of
a similar product, Delphinus CDO 2007-1, a package of
collateralized debt obligations.
The derivatives market, involving the trade of complex
instruments based on the risk of loans going bad -- from mortgages
to the debts of developing countries -- were a key driver of the
global financial meltdown in late 2008.
S&P said it was "disappointed" and would challenge the
ruling.
"We reject any suggestion our opinions were inappropriate, and
we will appeal the Australian ruling, which relates to a specific
CPDO rating," a spokesman said.
Within months of the councils buying the CPDOs from Australian
firm Local Government Financial Services (LGFS) in late 2006,
assured they had a less than one% chance of failing, the notes
defaulted.
The councils, from small, mostly mining and farming towns, lost
$16 million Australian (US$16.5 million) on the so-called
"Rembrandt notes", more than 90% of the original capital
invested.
Judge Jayne Jagot said S&P's assessment of the products as
"extremely strong" had been central to the loss.
"The CPDO could achieve a rating of AAA only on the basis of an
unreasonable combination of unreasonably optimistic inputs but not
otherwise," she said.
"S&P did not assess the CPDO notes by reference to
exceptional but plausible events in any way. To rate the CPDO notes
AAA without having done so was to act without reasonable care as a
ratings agency."
Ms. Jagot said S&P had claimed to have reached its opinion
"based on reasonable grounds and as the result of an exercise of
reasonable care when neither was true and S&P also knew not to
be true at the time made".
She described the Rembrandt as "grotesquely complicated,
potentially highly volatile and issued at a time when tightened
credit spreads were likely to be adverse to the product's
performance".
The judge ruled that ABN AMRO had also been "knowingly concerned
in S&P's contraventions of the various statutory provisions
proscribing such misleading and deceptive conduct" and had engaged
in such conduct itself.
She made a similar ruling on LGFS and rejected the three
financial agencies' arguments that the councils should bear a part
of the blame due to to their "contributory negligence".
Ms. Jagot ordered S&P, ABN AMRO and LGFS to each pay
one-third of the councils' losses plus interest, meaning the total
compensation would be around A$30 million.