Lehman Unit Liable for Failed CDOs Sold in Australia

Lehman Brothers Holdings Inc.’s Australian unit is liable for losses three towns incurred from buying failed securities, a judge ruled. The lawsuit’s sponsor said the case is the first of its kind to complete a trial.

Lehman’s unit “engaged in misleading and deceptive conduct,” Federal Court Justice Steven Rares said issuing his decision in Sydney yesterday.

Grange Securities Ltd., which was bought by Lehman, invested the towns’ money in securities whose value collapsed along with the U.S. housing market. The synthetic collateralized debt obligations, or SCDOs, in 2008 played a role in the worst financial crisis since the Great Depression, as world-wide credit froze and the $330 billion market for auction-rate securities collapsed.

Damage from the failures of complex derivatives extended from Wingecarribee, a town southwest of Sydney, to Alabama’s Jefferson County, which filed for bankruptcy last year and Harvard University, which paid hundreds of millions of dollars to cancel interest rate swaps.

“An SCDO is a sophisticated bet,” Rares said in his judgment. “They have many risks.”

The three Australian towns that invested A$37.3 million ($39 million) in the securities sold by Grange sued in 2009 to recover their losses. Yesterday’s decision signals that about 70 councils, church groups and charities in Australia which made similar investments may be more likely to recover about A$200 million.

Creditors Plan

The towns’ suit was opposed by PPB Advisory, liquidators of the Lehman unit.

“We may, or may not, appeal,” Marcus Ayres, a partner at PPB, said in a phone interview following the ruling.

The liquidators plan to propose a settlement to creditors in the first quarter of 2013, Ayres said, and will use the judge’s decision as guidance in developing the repayment plan.

PPB has reached an agreement in principle to settle a dispute over $300 million of collateral related to Lehman Brothers Holding’s so-called Dante program of credit-linked notes, Ayres said.

U.K. courts ruled investors who bought the notes, including Lehman Australia’s customers, must be paid, rather than the money going to the parent company. A U.S. Bankruptcy Court judge disagreed and froze the assets.

The settlement, once completed, will mean Lehman creditors in Australia, will get “substantially” more back, Ayers said. He declined to be more specific.

AAA Rating

The towns and organizations have claimed the securities were sold with the safest credit rating, AAA, which didn’t reflect their actual risk.

Australian towns have also sued Standard & Poor’s Corp. for giving its highest rating to derivative-linked notes and claiming the ratings company misled investors. A decision in the case is pending.

Yesterday’s ruling is seen as a step forward in the S&P litigation and may result in more lawsuits in Europe, John Walker, executive director of IMF (Australia) Ltd. which paid for the lawsuits, told reporters in Sydney.

He said IMF has agreed to fund a claim against S&P in the Netherlands and is looking at lawsuits in Germany and France. No lawsuits have been filed in Europe yet, Walker said.

Wingecarribee, about 140 kilometers (90 miles) southwest of Sydney, sued to recover A$21.4 million, claiming Grange ignored explicit instructions to avoid CDOs. Two other towns, the West Australian city of Swan and Parkes Shire Council, northwest of Sydney, claimed to have lost A$15.9 million on their investments.

Fees, Commissions

“This is the first occasion that there has been a judge that has dealt with the issue substantially,” Walker said.

Grange, which became Lehman Brothers Australia, bought synthetic collateralized debt obligations on behalf of clients to collect fees and commissions that were greater than it would have earned from investing in term deposits for the customers, the towns have claimed.

Lehman Brothers Australia appointed a voluntary administrator under the country’s bankruptcy laws on Sept. 26, 2008, nine days after Lehman Brothers Holdings, the fourth-biggest investment bank in the world, filed for the biggest bankruptcy in U.S. history.

Rares said because Grange is in liquidation, he can’t order it to make any payments.

The ruling means the towns will probably recoup three or four times more than PPB had offered as a settlement, Walker said.

Floating Rate

Douglas Neville, financial services manager at Wingecarribee’s shire council, testified in March, 2011, that he received assurances the council’s money would only be invested in floating rate notes and felt “betrayed” when he found out in July 2007 much of the money was put into CDOs.

Grange “had very wide powers” under an agreement signed by Wingecarribee’s council for investment decisions, the company’s lawyer John Sheahan said at the trial. The Lehman unit followed the agreement in buying the CDOs, he said.

The synthetic collateralized debt obligations, which invest in credit default swaps or other non-cash assets linked to pools of mortgages, car loans or credit card receivables, weren’t the type of investments municipalities were allowed to make by law, Tony Meagher, the lawyer for the towns, said before the ruling.

The case is Between Wingecarribee Shire Council and Lehman Brothers Australia Ltd. NSD 2492/2007. Federal Court of Australia (Sydney).

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