Standard & Poor’s and a Royal Bank of Scotland Group Plc unit are liable for investment losses on securities bought by Australian towns, an appeal court judge ruled today, upholding a 2012 verdict they misled investors.
S&P’s rating of the securities was “unreasonable, unjustified and misleading,” Justice Peter Jacobson, who dismissed the appeal at the Federal Court of Australia in Sydney, wrote in a 473-page judgment.
The ruling is another setback for S&P, a unit of McGraw-Hill Cos., which faces more lawsuits in the U.S. and Europe over ratings it issued on residential mortgage-backed securities and collateralized debt obligations before their value plunged during the global financial crisis. The U.S. government has said it may seek as much as $5 billion.
“This is a landmark decision that changes the legal landscape,” Amanda Banton, a partner with Piper Alderman lawyers who represented the councils, said in a statement. “The implications for other claims currently in the court are enormous.”
The repackaging of debt into securities with top rankings from S&P and other rating companies contributed to more than $2 trillion in losses and writedowns after Lehman Brothers Holdings Inc. collapsed in 2008 and the world fell into recession.
Australia Federal Court Justice Jayne Jagot in November 2012 found S&P, ABN Amro Bank NV and Local Government Financial Services Pty liable for misleading towns in New South Wales state with descriptions and ratings that gave the impression of safe investments. She awarded the towns A$20.2 million ($18.8 million) plus costs incurred in the litigation in March 2013.
The 13 councils affected included Parkes, a farming area about five hours’ drive west of Sydney whose radio telescope received television signals of the Apollo 11 moon landings, and Corowa, a town on the Murray River north of Melbourne that’s home to the country’s biggest hog farm.
Moree Plains Shire, part of a cotton and wheat-growing region in the north of the state, lost about A$1.9 million on the notes, according to today’s judgment, compared to A$6.4 million the council spent on roads in 2012.
“It was devastating. We still have about 2,000 kilometers of gravel roads in our shire because we can’t afford to seal them,” Katrina Humphries, the shire’s mayor, said by phone today. “There has to be people somewhere that have profited from this. Money doesn’t just disappear.”
ABN Amro Bank’s Australian business had arranged the creation of so-called Rembrandt notes, which were linked to credit-default swaps on investment-grade companies. They were given the highest investment rating by S&P in 2006 and sold to Australian councils by LGFS.
The securities were unwound less than two years after the towns bought them because credit spreads kept increasing, exhausting their cash value, according to court filings. Twelve of the councils said they lost more than 90 percent of the A$16 million they invested in the notes.
“For ratings agencies to deny that they should be responsible for opinions, that they do not need to have a reasonable basis for their opinions, is farcical,” John Walker, executive director of litigation funder Bentham IMF Ltd., told reporters outside the court. “People rely on these ratings.”
ABN Amro, S&P and LGFS criticised 306 aspects of Justice Jagot’s original judgment, according to today’s ruling.
The appelants “put in issue just about every finding of fact and conclusion of law made by the primary judge and for the most part pursued each allegation of error with undiscriminating vigour,” the judges wrote. “Subject to some qualifications,” all those attacks failed.
Today’s judgment upheld the findings that S&P’s assignment of a AAA rating to the notes was “misleading and deceptive.”
The ratings company said it was disappointed by the decision.
“It’s clear that the law in Australia relating to duty of care is at odds with well-established laws elsewhere,” S&P said in a statement e-mailed by spokesman Richard Noonan. “It is bad policy to enforce a legal duty against a party like S&P, which has no relationship with investors who use rating opinions, yet impose no responsibility on those investors to conduct their own due diligence.”
ABN Amro is now a unit of RBS and no longer affiliated with the Dutch lender of the same name. Ronald Wong, a spokesman for RBS, declined to comment. Both Wong and Noonan declined to comment on whether they’d appeal.
The case is Between ABN Amro Bank NV and Bathurst Regional Council. NSD501/2013. Federal Court of Australia (Full Court) Sydney.