In Australia, an Ominous Ruling for Ratings Firms

McGraw-Hill's headquarters in New York Photograph by Scott Eells/Bloomberg

Ten thousand miles from Wall Street, a federal judge in Australia has issued what appears to be the first ruling of its kind, holding a ratings agency liable for the “misleading and deceptive” seals of approval it stamped on complicated investment products in the years leading up to the financial crisis.

While banks and other institutions have been fined for behavior contributing to the crisis, this is the first time that a ratings house—whose  “AAA” grades provided essential cover to those selling dross-laden assets as gold—has been found legally accountable, too.

Standard & Poor’s gave AAA ratings to two complex products known as constant proportion debt obligations in 2006, indicating that they were highly reliable. Twelve local Australian councils that claimed they lost more than 90 percent of their roughly $17 million (U.S.) investment when the products collapsed are now entitled to damages, Justice Jayne Jagot ruled from Sydney’s Federal Court.

In a statement, S&P said it would fight the ruling. “We are disappointed with the Court’s decision, we reject any suggestion our opinions were inappropriate, and we will appeal the Australian ruling, which relates to a specific CPDO rating,” S&P said.

The case could have broad implications for similar litigation around the world. “It’s a surprise,” says Lawrence White, an economics professor at New York University’s Stern School of Business. “It may well be that we will see more of these types of things.”

In the United States, ratings agencies have long used the First Amendment to protect their work from litigation, arguing that their grades of AAA, BB+, CC, and so on are opinions. “The credit-rating agencies describe their pronouncements as opinions,” says White. “There’s always language saying—and I’m paraphrasing—nobody should take investment actions on the basis of these opinions.” That defense has been weakening, and the 2010 Dodd-Frank reforms established a new Office of Credit Ratings to oversee the industry.

S&P is a division of McGraw-Hill. The company announced in September that it will separate into two independent parts by the end of this year: McGraw-Hill Financial and McGraw-Hill Education. In the third quarter, S&P brought in about 25 percent of McGraw-Hill’s revenue and almost 40 percent of its operating income. Shares of the company fell by as much as 7 percent on Monday morning before closing down 4 percent.

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