Bloomberg News

S&P Faces Australia Trial Over Ratings of CDOs Sold to Towns

October 03, 2011

(Updates with S&P comment in ninth paragraph.)

Oct. 3 (Bloomberg) -- Standard & Poor’s, the rating company being investigated by U.S. regulators over the nation’s credit downgrade, will face trial in an Australian court to defend allegations it misled investors with ratings of collateralized debt obligations, in the first case of its kind.

Two Australian towns and an insurer sued the U.K. arm of S&P’s owner McGraw-Hill Cos., along with financial services firms including the Royal Bank of Scotland Group Plc, who were involved in the sale of AAA-rated securities that plummeted in value during the global economic crisis in 2008.

“It is my understanding that this is the first trial globally, focusing on a rating agency’s involvement in the CDO debacle that materially contributed” to the global downturn, John Walker, executive director of litigation funder IMF (Australia) Ltd., which is paying for the lawsuit, said in an e- mail. Walker declined to comment further until the start of the trial tomorrow.

Statecover Mutual Ltd., a workers’ compensation insurer of local governments in New South Wales, Bathurst regional council and Corowa Shire Council seek to recoup the losses they incurred from the purchase of securities in 2006.

The Bathurst council paid A$1 million ($963,000) to acquire a so-called Community Income Constant Proportion Debt Obligation Note, or a CPDO, on Dec. 20, 2006, and was advised less than two years later that the note was being unwound and the council would receive a repayment on the note of A$67,043, according to the statement of claim.

Note Rating

The CPDO note was rated as AAA by S&P, and a financial market specialist at Local Government Financial Services Ltd. assured Bathurst’s accountants that the CPDO wasn’t like a CDO, in which the council had a specific policy not to invest, the plaintiff said.

“The Standard & Poor’s report was misleading and in material ways misdescribed the characteristics and operations of the CPDO note,” according to the filing.

The trial in Sydney Federal Court before Justice Jayne Jagot is scheduled for 10 weeks.

“We believe the case brought by LGFS and others against McGraw-Hill UK lacks merit,” S&P said in an e-mailed statement today. “Because the action is before the Australian courts it is not appropriate to discuss it.”

Standard & Poor’s, based in New York, on Aug. 5 cut the U.S. credit rating to AA+ from AAA. The downgrade contributed to an equity rout that erased about $6.8 trillion of global stocks value from late July to mid August.

Flawed Analysis

U.S. government officials have said the downgrade was based on a flawed analysis that overstated the nation’s debt by about $2 trillion. The Securities and Exchange Commission is scrutinizing the method S&P used to cut the rating and whether the firm properly protected confidential information, according to a person with direct knowledge of the probe, who declined to be identified because the inquiry isn’t public.

Standard & Poor’s, along with Moody’s Corp. and Fitch Inc., last week won the dismissal of a lawsuit alleging their ratings of mortgage-backed securities were faulty in the U.S. state of Ohio.

Ohio’s Police & Fire Pension Fund, the Public Employees Retirement System, State Teachers Retirement System of Ohio and two other public pension plans claimed they lost $457 million on more than 300 mortgage-backed security investments made from January 2005 to July 2008.

U.S. District Judge James L. Graham in Columbus threw out the case Sept. 26, agreeing with the firms that the ratings were “predictive opinions.” Without specific allegations that the ratings services intended to defraud investors, the companies couldn’t be held liable, he said.

Second Lawsuit

The lawsuit involving S&P is the second in Australia to focus on the sale of collateralized debt obligations as investments for towns and other groups, ahead of the global economic downturn.

The Wingecarribee Shire Council and two other municipalities sued Lehman Brothers Holdings Inc.’s Australian unit claiming it failed to advise of the risks of collateralized debt obligations and ignored town policies that required conservative investments, in pushing risky synthetic CDOs beginning in 2003.

Justice Steven Rares hasn’t ruled on the case, following a trial that began March 2 and ended June 7.

Lehman Brothers’ $613 billion bankruptcy in September 2008 triggered a contraction in global credit markets.

The case is: Statecover Mutual Ltd. v. Local Government Financial Services Ltd. NSD1268/2010. Federal Court of Australia (Sydney).

--Editors: Paul Tighe, Jim McDonald

To contact the reporter on this story: Joe Schneider in Sydney at jschneider5@bloomberg.net

To contact the editor responsible for this story: Paul Tighe at ptighe@bloomberg.net


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