By Julian Bajkowski
A group of 12 New South Wales councils have scored a second vital win in the ongoing legal battle over how toxic financial instruments were deceptively marketed to them as safe investments, causing the loss of millions of ratepayer’s dollars during the global financial crisis.
A decision handed down on Monday by Federal Court Justice Jayne Jagot found that the local governments are entitled to claim damages from global ratings agency Standard & Poors, investment bank ABN Amro and financial services provider Local Government Financial Services Pty Ltd (LGFS).
“LGFS’s marketing was hopelessly deficient in alerting the councils to the risks of this investment. But … S&P’s rating was hopelessly deficient too,” Justice Jagot wrote in her decision.
“The CPDO was described in part of the evidence as a “grotesquely complicated” instrument. This is accurate,” she wrote.
Justice Jagot’s decision is highly significant because it is certain to be used as a precedent by other badly burned investors around the world – many of whom invested public funds held in trust – to legally force compensation out of the financial institutions and ratings agencies that sold them toxic debt dressed up as safe and conservative investments.
The latest matter, which follows a similar decision on the conduct of Lehman Brothers, is watershed for the global financial services industry because it goes to the heart of whether ratings agencies can be held liable for losses incurred by the buyers of so-called AAA rated products.
The AAA rating is supposed to be the highest possible quality rating for financial instruments and debt in terms of their likelihood to meet performance expectations.
However the use of the rating – and those issuing it – has repeatedly been drawn into question in the wake of the GFC because of serious deficiencies and potential conflicts of interest that emerged in how the ratings agencies and their classifications operate.
A specific concern is that ratings agencies are increasingly paid by banks and institutions to rate products, thus becoming financially reliant on the businesses and products they are supposed to be objectively assessing.
The role of ratings agencies in stamping junk investment products as a low risk remains one of the burning issues in the aftermath of the GFC that sent many national economies reeling backwards after 2008.
The decision against Standard & Poors represents a significant reputational blow to the company which also rates the credit risk of governments as lenders, including Australian state governments.
Along with its peers, the agency’s ratings are used by banks to calculate the terms, including interest, of loans to governments that routinely curtail their expenditure at the expense of public services to maintain their credit ratings.
In a statement issued shortly after the decision S&P said that it will appeal the decision.
“We are disappointed with the Court’s decision, we reject any suggestion our opinions were inappropriate, and we will appeal the Australian ruling, which relates to a specific CPDO rating,” S&P said.
The term CPDO refers to products known as Constant Proportion Debt Obligations, a form of synthetic derivative, that were sold under the label of Rembrandt notes.
The decision to appeal by S&P was widely expected in the event of a decision against the agency because the ruling provides legal ammunition for those seeking compensation in other jurisdictions, particularly Europe.
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