By Angela Dorizas
Councils that have lost funds through high-risk investments in structured instruments, including collaterised debt obligations (CDOs), may have a litigation case against financial advisers and rating agencies, says IMF.
The litigation funder has agreed to back a $25 million claim by Melbourne-based clean energy company Ceramic Fuel Cells (CFCL) against “various parties” to recover lost investment funds suffered through investment in structured financial products.
The company raised $90 million in a UK listing in 2006 and invested some of the proceeds into CDOs linked to the US sub-prime market. The synthetic investments were sold with a AAA rating, but in the end they proved to be worthless. CFC’s investments have now been written down to $7 million.
Potential targets in the lawsuit include security issuers, rating agency Standard & Poor’s and CFC’s investment adviser, Oakvale Capital – an advisory firm that has been used by a number of councils across Australia.
IMF general manager Hugh McLernon said litigation would include claims of negligence, breach of contract and misleading conduct under the Trade Practices Act.
“CFC may have heard the word CDO, but they had no idea of what it was. For instance, they didn’t get the product disclosure statement,” McLernon told GovernmentNews.
“The bottom line so far as we’re concerned is that Oakvale mis-sold them.
“These were people who raised money or had money – the councils raised it through rates, the companies raised it through fundraising from shareholders – they were looking for an extra one per cent risk free, liquid, non-exotic type investment for their money, but it was put into what is essentially a bet.
“None of these things ever had a liquid market from day one.”
Legal actions are yet to be formalised, but if they proceed CFC will become the first Australian corporation to sue advisory firms and rating agencies over failed investments.
McLernon said the case was likely to prompt further legal action from public and private sector organisations that have lost money on CDOs, mortgage-backed securities and credit-linked notes.
“I would be amazed if it doesn’t,” he said.
“There are a whole lot of people whose advisers have purchased these investments where the only real reason they purchased them was because they were issued by Royal Bank of Scotland or Barclays and they had a AA or AAA rating.
“Now they’re worth ten cents in the dollar if you can find anyone who wants to buy them. AAA-rated products aren’t supposed to do that.”
A number of councils across Australia still hold CDOs in their investment portfolios in the hope that they will mature, but according to McLernon that may be an unlikely outcome.
“They’re still getting paid interest, although they don’t realise they’re getting interest on their own money, so they live in hope that maybe defaults won’t happen,” he said.
“I think it is a forlorn hope.”
Over the past 14 months, IMF has called on councils who believe they may have been misadvised over their investments to join with CFC in taking legal action against financial advisory firms and rating agencies.
“We’d welcome them with open arms, but they’ve got to make the hard call,” McLernon said.
“We brought these problems and the solution to the notice of the councils from February 2008 onwards.
“We would welcome them into our group of people who want to sue the rating agencies. All they need to do is make the hard decision to do it.”
It would not be the first case involving local government. Wingecarribbee Shire Council in the New South Wales southern highlands is involved in an ongoing Federal Court case against collapsed US investment bank Lehman Brothers and its Australian subsidiary, Grange Securities, over a $2.5 million loss from investing in Federation CDO.
About 35 councils in Australia invested $25 million in Federaltion, which was a long-term, synthetic instrument based upon a list of 40 residential mortgage backed securities linked to the US sub-prime market.
A spokesperson for the NSW Local Government Minister, Barbara Perry, told GovernmentNews that councils had an obligation to their constituents to “always seek independent financial advice when dealing with investments”.
“They have also been regularly reminded about the importance of having a diversified investment portfolio,” the spokesperson said.
“The current unpredictable economic climate has served to reinforce the importance of this advice.”
Oakvale chief operating officer Paul Travers was unable to comment on the case due to client confidentiality, but said the company was in regular contact with its client base, including local councils.
“We maintain regular client contact with all of our clients and keep them appraised of any information that they need that will impact their portfolio,” Travers told GovernmentNews.
“That’s the way we do business, we keep our clients up to speed with what’s going on.”
Councils lost in a world of risk
A GovernmentNews investigation
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