Standard & Poor’s can’t blame the 2008 global financial crisis for the collapse of notes it recommended because it rated the debt as a long-term investment, said a lawyer for an Australian financial adviser.
Local Government Financial Services Ltd. sued S&P in Federal Court in Sydney, accusing the company of breach of duty and negligence in giving the notes the highest investment rating. LGFS filed the lawsuit after it was sued by a dozen Australian towns that lost more than 90 percent of their investment.
S&P may face potentially unlimited, or so-called indeterminable, claims if it’s found liable for its ratings, the New York-based unit of McGraw-Hill Cos. (MHP) said in written submissions that it’s scheduled to present to the court this week. S&P blamed the global financial crisis, when credit markets froze following the 2008 bankruptcy of Lehman Brothers Holdings Inc., for the notes’ collapse.
“To say adverse economic conditions, even very adverse economic conditions” could be blamed for the collapse of a AAA- rated 10-year investment is “totally unreal,” Guy Parker, LGFS’s lawyer said in his closing statement today before Justice Jayne Jagot.
LGFS and the Australian townships also sued ABN Amro Bank NV, which became the Australian affiliate of the Royal Bank of Scotland Group Plc (RBS), and manufactured the investments, according to Parker. ABN Amro Bank in turn sued S&P, saying the ratings company failed to rate the notes “well and competently.”
S&P’s liability isn’t indeterminable, Parker said, because the financial adviser has a single claim.
LGFS sought to find new investments to sell to municipal councils as it competed for business in 2006 with Grange Securities Ltd., which later became a unit of Lehman.
Three townships sued Lehman in 2007, claiming its Australian unit failed to advise of the risks of investing in collateralized debt obligations. The verdict is pending.
LGFS purchased A$45 million ($47 million) of the notes from ABN Amro Bank, and resold A$18.5 million in 2006 and 2007, including A$17 million to Australian towns that sued in a bid to recoup their losses, according to court documents.
“LGFS relied on the rating,” Parker said today. “The complexity of the product made the rating all the more important.”
Extreme Financial Conditions
As credit spreads increased in the midst of the most extreme financial conditions since the Great Depression, the notes’ cash value was exhausted and they were unwound, ABN Amro Bank said in its written submissions, which it will also present to the judge later this week. About 6.7 percent of the investors’ principal was returned, the bank said.
U.S. lawmakers had accused ratings companies of mishandling their assessments of mortgage-backed securities, at the heart of the 2008 financial crisis, and Congress sought to reduce their influence as part of the Dodd-Frank Act of 2010.
S&P stripped the U.S. of its AAA credit rating on Aug. 5. Instead of eroding the value of U.S. government debt, the rating cut sparked financial market turmoil that made Treasuries and the world’s reserve currency favorites among investors, with 10- year note yields dropping to a record low of 1.6714 percent just seven weeks later.
The case is: Bathurst Regional Council v. Local Government Financial Services Ltd. NSD936/2009. Federal Court of Australia (Sydney).
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