Standard & Poor’s Misled Investors By Giving Synthetic Derivatives Its Highest Ratings, Rules Australian Federal Court

A ruling by the Australian Federal Court against Standard & Poor’s could give 13 NSW councils about A$30M in compensation for their about A$16M in synthetic derivative losses. According to the court, the ratings firm misled investors by giving its highest ratings to complex investment instruments that ended up failing during the worldwide economic crisis. The councils can now claim compensation from S & P and co-defendants Royal Bank of Scotland (RBS)– owned ABN Amro Bank and the Local Government Financial Services, Ltd. The three had sold the councils constant proportion debt obligation notes, promoted as Rembrandt notes, six years ago.

Specifically to this case, Australian Federal Court Justice Jayne Jagot said that Standard & Poor’s took part in conduct that was “deceptive” when it gave AAA ratings to constant proportion debt obligations that were created by ABN Amro Bank NV. The Australian townships were among those that invested what amounted to trillions of dollars in the CPDOs, as well as in collateralized debt obligations.

The projected A$30M in compensation includes not just councils’ losses, but also interest and costs. The councils are also entitled to receive compensation for breach of fiduciary duty from LGFS, which succeeded in its own claim against Standard and Poor’s and ABN Amro for Rembrandt notes that it sold to its parent company after the notes were downgraded from their triple-A rating to triple-B+.

This ruling, issued on Monday, is considered a landmark one in that it is the first judgment to be issued against a ratings firm since the worldwide financial crisis over the way it rated complex securities. The decline of synthetic derivatives during the economic collapse played a huge role in the collapse of Lehman Brothers. The decision could be an opening for similar cases elsewhere around the globe.

Yesterday, back in the United States, Illinois Attorney General Lisa Madigan won a ruling in circuit court allowing her to move forward with litigation against Standard & Poor’s Ratings Services. She is also accusing the rating firm of misleading investors while the economic meltdown was happening. Madigan claims that S & P sought to favor banker clients and up profits through the assignation to MBS of its highest ratings. The securities later failed. Madigan said that this ruling was key in that it was the first obstacle to pursuing the case and it has now been overcome. She said that this is a statement that S & P isn’t going to be able to use legal measures to escape the “fact that they committed fraud.”

For years, rating firms have overcome lawsuits in the US by claiming that the ratings they issue are opinions and have First Amendment protection. This Illinois lawsuit, however, appears to get around this by concentrating not on the actual ratings but on public statements S & P made about how its ratings process is autonomous and objective. Circuit Court Judge Mary Anne Mason said that First Amendment protections aren’t applicable to this case, because constitutions, both state and federal, don’t protect practices that are “false, misleading, or deceptive.”

A Casino Strategy, Rated AAA, The New York Times, November 8, 2012

Illinois Clears Legal Hurdle in Suit Against S&P, The Wall Street Journal, November 7, 2012

More Blog Posts:

Moody’s, Fitch, and Standard and Poor’s Were Exercising Their 1st Amendment Rights When They Gave Inaccurate Subprime Ratings to SIVs, Says Court, Institutional Investor Securities Blog, December 30, 2010

Standard & Poors Receives SEC Wells Notice Over CDO Rating, Institutional Investor Securities Blog, September 30, 2011

Make Credit Rating Agencies Collectively Liable for Inaccuracies, Proposes Lawmaker, Stockbroker Fraud Blog, October 7, 2009