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Nov 04, 2012

Australian court rules S&P liable for damages to municipalities for AAA rating on Rembrandt notes

Ruling cites ‘misleading and deceptive’ practices by Standard & Poor’s in relation to rating on notes, and implicates ABN Amro

An Australian court has ruled that rating agency Standard & Poor’s misled investors by granting triple-A ratings on so-called Rembrandt notes or constant proportion debt obligations (CPDOs), which plunged in value during the 2008 financial crisis.

The Federal Court of Australia says S&P’s practices were ‘misleading and deceptive’ in rating two Rembrandt notes issued in 2006 and ruled that the 12 Australian municipalities that sued S&P over the securities are eligible for damages. The ruling also implicates ABN Amro, which created the securities, and Local Government Financial Services, which sold them.

S&P’s AAA rating of the notes ‘was misleading and deceptive and involved the publication of information or statements false in material particulars and otherwise involved negligent misrepresentations to the class of potential investors in Australia,’ Federal Court Justice Jayne Jagot writes in her November 5 ruling. ‘By the AAA rating there was conveyed a representation that in S&P’s opinion the capacity of the notes to meet all financial obligations was ‘extremely strong’ and a representation that S&P had reached this opinion based on reasonable grounds.’

The judgment is thought to be the first such ruling against one of the ratings agencies for a specific rating and may have implications for the agencies in other jurisdictions, according to the lawyers acting on behalf of the municipalities.

Jagot says ABN Amro also ‘engaged in conduct that was misleading and deceptive and published information or statements false in material particulars’ and ‘was knowingly concerned in S&P’s contraventions.’

The 12 municipal councils in New South Wales bought a total of A$17 mn ($17.6 mn) worth of the 2006 Rembrandt notes, which then lost a combined total of A$15 mn in value in the 2008 financial crisis. A 13th council, which is suing separately, says it lost 90 percent of its A$1 mn investment. IMF (Australia) funded the class action suit on behalf of the municipalities.

‘We reject any suggestion our opinions were inappropriate, and we will appeal the Australian ruling, which relates to a specific CPDO rating,’ S&P says in a statement.

The ruling comes a little more than a month after Justice Steven Rares of the Federal Court of Australia ruled that Lehman Brothers, the now defunct investment bank at the heart of the financial collapse, was responsible for financial damages caused to 72 organizations, including charities, churches and town councils, for ‘misleading and deceptive conduct’.