S&P loses Australia appeal over misleading investors

Agency gave AAA ratings to toxic financial products

Standard & Poor’s has lost its appeal against a landmark court ruling in Australia, which found the credit rating agency misled investors by giving AAA ratings to toxic financial products that lost almost all their value.

The ruling by the Federal Court of Australia in a case that also involved ABN Amro, which is now owned by Royal Bank of Scotland, paves the way for similar court actions elsewhere from investors who lost billions of dollars during the financial crisis.

John Ahern, a partner at law firm Jones Day, said the judgment augured ill for rating agencies. “The position that the court took is logically the conclusion that courts in other jurisdictions could arrive at, given [there is] a good deal of similarity in the principles of negligence – at least in common law jurisdictions.”

The blow to S&P, a unit of McGraw Hill, comes just three days after the agency was rebuked by the EU securities watchdog, in the first use of the regulator’s enforcement powers over credit rating companies. That matter related to an incorrect announcement by S&P in 2011 of a downgrade to France’s credit rating.

S&P originally lost the Australian case in November 2012, when the court issued a scathing ruling that the rating agency was “misleading” and “deceptive” when it awarded a AAA credit rating to a complex debt instrument – constant proportion debt obligation notes (CPDOs), also known as Rembrandt notes.

The judgment was the first time a court found a credit-rating agency liable for losses incurred by investors on financial products, which it had erroneously awarded a gilt-edged credit rating. It also said that rating agencies have a duty of care to investors.

The court found that the Rembrandt notes were sold to local councils in Australia on the basis that the AAA rating was based on reasonable grounds, and as the result of an exercise in reasonable care and skill, while neither was true.

“S&P also knew them not to be true when they were made,” concluded the original ruling.

Local councils lost tens of millions of dollars on the collateralised debt instruments when the financial crisis struck.

ABN Amro, which created the toxic products, and Local Government Financial Services, which sold them to councils, also engaged in misleading and deceptive conduct, according to the original court judgment.

The dismissal of the appeal by Judge Peter Jacobson is a setback for S&P, which is fighting multiple legal actions in the US and Europe related to claims it issued misleading credit ratings before the 2008 financial crisis.

“On appeal, we would uphold these findings in relation to damages, contributory negligence and apportionment,” said the near 500-page appeal ruling delivered by Judge Jacobson on Friday.

S&P said it was disappointed by the ruling.

“It’s clear that the law in Australia relating to duty of care is at odds with well-established laws elsewhere, including in the US and Europe,” the rating agency said.

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