Article 5.7 S&P loses Australia appeal over misleading investors
By Jamie Smyth and Sam Fleming
Financial Times June 6, 2014
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.'
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.
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 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.
FT
Source: Smyth, J. and Fleming, S. (2014) S&P loses Australia appeal over misleading investors, Financial Times, 6 June.
Regulators around the world have tried to keep closer tabs on the CRAs in recent years. The European Union set up a new regulator, the European Securities and Markets Authority, in part to scrutinise the CRAs' conduct. The Federal Reserve and the Securities and Exchange Commission in the US tightened regulation, e.g. by prohibiting the agencies from also advising the issuers (for a fee) on how to structure a bond issue to obtain a favourable rating. The fear was that the CRAs would lower standards in order to generate business for their consultancy wing. In addition, the agency's fee negotiator (for the rating exercise) has to be someone who is not involved in the rating assessment. Also, more disclosure on how ratings are determined, and disclosure of historical ratings performance, are required. One of the tools regulators are employing is the encouragement of rival CRAs to criticise and give alternative unsolicited opinions on ratings - see Article 5.8. Structured bonds, discussed in the article, have special individualised features to attract particular investors, usually with derivative features, e.g. an option to gain from a rise in the stock market, or bonds whose value derives from a collection of loans or other bonds (for more on securitisation see Chapters 15 and 16).