If you, like me, wonder just what the heck went on from 2001 to 2008, this article from today’s AUSTRALIAN© , by Leo Shanahan, may give you a wee bit of a head’s up. Fannie Mae and Freddie Mac in the United States is where the rot started – these folks (and others mentioned and in some cases yet to be ‘proved’ I suppose) propped it up and kept the lie alive. We all paid and are still paying…
GLOBAL ratings agency Standard & Poor’s faces a wave of potential litigation after being slammed for engaging in “misleading and deceptive conduct” by assigning its coveted AAA rating to complex and risky financial instruments that contributed to the global financial crisis.
In a world-first, the Federal Court of Australia has exposed the misuse of S&P’s AAA ratings in the lead-up to the crisis by finding that the ratings agency and investment bank ABN Amro – now owned by Royal Bank of Scotland – were liable for advice and distribution of complex financial products called constant proportion debt obligations to 13 NSW councils.
The court’s ruling could cost S&P, the bank and a subsidiary of the NSW Local Government Superannuation Scheme $30 million in damages, although the ratings agency immediately said it would appeal against the decision.
The Australian can also reveal that for the first time, one of Australia’s major banks – the Commonwealth Bank – will be pursued for its role in advising and selling a series of complex products called synthetic collateralised debt obligations. The bank denies wrongdoing.
S&P and fellow ratings agency Moody’s have been heavily criticised in the wake of the global financial crisis for assigning their AAA ratings, which usually denote the safest investments, to high-risk financial products such as some CDOs, in return for fees from banks. CDOs are a financial instrument backed by a pool of bonds, loans or other assets that pay a rate of interest based on their level of risk.
S&P has denied wrongdoing but since the GFC, the agency has overhauled the practice of assigning ratings to products structured by banking clients.
Federal Court judge Jayne Jagot found that S&P’s decision to give its AAA rating to the financial product named “Rembrandt notes” was “misleading and deceptive” and involved “negligent misrepresentation”, particularly given its role as a client of ABN Amro in assigning the rating.
Justice Jagot said S&P had been “sandbagged” and ABN Amro had “simply bulldozed the rating through”.
“The very purpose of a rating is to provide investors with independent information by persons expert in assessing the creditworthiness of an investment so that, by a simple system of letters, an investor can know and compare the creditworthiness of investments,” Justice Jagot said.
“S&P knew the nature of the product and that it was being paid to assign a rating that ABN Amro could distribute to potential investors of tranches of $500,000 in the CPDO notes.
“Given the nature of the product and the task of rating, S&P ought reasonably to have known that the ordinary and reasonable members of the class of potential investors would be vulnerable to acts and omissions by S&P in the assigning of the rating.”
Justice Jagot went on to criticise ABN Amro for using the faulty rating to sell the products, which would later turn toxic and cost the NSW councils more than 90 per cent of their investments.
“ABN Amro was knowingly concerned in S&P’s contraventions of the various statutory provisions proscribing such misleading and deceptive conduct, and also itself engaged in conduct that was misleading and deceptive and published information or statements false in material particulars.”
Justice Jagot found the Local Government Financial Services, a subsidiary of the NSW Local Government Superannuation Scheme, would also be liable for damages but would be able to claim damages back from S&P and ABN Amro given their reliance on the two organisations.
The case was bankrolled by litigation funder IMF. IMF executive director John Walker said the ruling would have significant implications for a case that will be run in the Netherlands by major banks and superannuation funds that lost up to E2 billion ($2.5bn) on the complex CPDOs and CDOs in the global financial crisis.
“If a reasonable portion of those claims are successful then the damages potentially to be awarded would be greater than their (ratings agencies’) balance sheets,” Mr Walker said.
“We are looking at around 20 or so clients, banks and pension funds involved in CPDOs, with what used to be ABN Amro, now Royal Bank of Scotland . . . We are talking to eight to 10 of them whose average investments were E50m-E100m each. At least half that money was lost.”
IMF has already filed further proceedings against ABN and S&P for further losses on more CPDO notes, known as the “Rembrandt 2”. Mr Walker said the firm would also be pursing cases in Britain, New Zealand and another in Australia, with Moody’s also set to become the target of legal action.
Yesterday’s decision follows a ruling last month in the Federal Court which found the Australian arm of failed US institution Lehman Brothers liable for investment advice to councils regarding other complex financial instruments.
Law firm Piper Alderman ran the Lehman case and that brought against S&P, and partner Amanda Banton said more cases were likely to be brought against ratings agencies in Australia and overseas as result of yesterday’s decision.
She said the potential for further litigation against S&P and Moody’s was even greater given their role in ratings of CDOs, a much larger market than the CPDO notes at the centre of yesterday’s decision.
“The key issue now is whether everyone will now seek to attack the ratings of the CDOs, which are a $2 trillion business,” Ms Banton said. “In Lehman’s they may only get 30c in the dollar because Lehman’s is in liquidation. But now they may also go after the arranger in Standard and Poor’s . . . a lot of our clients may be having a look at ratings agencies in terms of those claims.”
S&P issued a statement saying it would 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.”
A spokesman for Royal Bank of Scotland said the group was “studying this long and complex judgment”.
LGFS has since wound up its operations as a result of the investments but its lawyer, Norton Rose’s Stephen Klotz, said his client felt “vindicated” by the judgment.
Yesterday’s ruling means the councils will recover about $30m in losses, with IMF expected to take at least a 30 per cent of the damages in fees.