S&P court loss in Australia unlikely to spark rival claims

Standard & Poor's found to owe duty of care with CDO ratings

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The decision by Australia's federal court to uphold a November 2012 ruling that found rating agency Standard & Poor's liable for losses on triple-A rated structured notes will set a precedent for subsequent cases in Australia and other common law jurisdictions but is unlikely to lead to a flood of similar cases, say lawyers.

On June 6 the full bench of the federal court rejected an appeal by S&P, ABN Amro (now a division of RBS) and Australian firm Local Government Financial Services (LGFS) and ruled that each party was fully liable for losses of A$25 million ($24 million) sustained by councils that had purchased synthetic collateralised debt obligations (CDOs).

The significance of the initial ruling and subsequent appeal is that this is the first time a credit rating agency has been found to owe a duty of care to investors with whom the agency has no direct relationship and adds weight to similar claims ongoing in the Netherlands and US. Other common law jurisdictions – defined as legal systems based on precedent and often but not always associated with the UK and its former colonies – are also likely to reference the case in future proceedings.

"Because this is the first case and we have gone all the way to an appellate judgement, it does assist globally all other proceedings that are under way in the US and Europe. It shows that S&P got too close to ABN Amro and not only were they negligent but knew they had no reasonable basis for the ratings," says John Walker, executive director of litigation funder Bentham IMF which provided cash for the lawsuit.

In Europe, a similar case is currently under way on behalf of 15 institutions in the Netherlands for around €200 million ($270 million) over CDO losses. In the US, the Department of Justice has filed a $5 billion civil lawsuit against S&P challenging 2007 CDO ratings and the underlying residential mortgage-backed security models.

The precedence value in this case is that the full court held that each party was wholly liable rather than liable for 33% of the losses as in the original judgement.

"This means that if you are able to prove liability you can go to one party and get the full payment rather than going to each and getting a share as was the case in the original judgement," says Walker.

This has implications such that if one party is insolvent, for example Lehman Brothers, you can go to other parties involved and get full payment, adds Walker.

In a statement, S&P said it was disappointed with the ruling. "We continue to believe that it is bad policy, and inconsistent with well-established laws outside Australia, 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," the rating agency said.

In Australia, while there are not believed to be any similar cases in the pipeline, the ruling may lead to large institutional investors who suffered losses from similar investments to think about lodging a case, says Rommel Harding-Farrenberg, partner at law firm Corrs Chambers Westgarth in Sydney.

"Perhaps rating agencies will be more likely to settle certain actions as a result of this ruling. However, in the first instance and the appeal the case turned on its specific facts, so there would need to be very similar facts to be fairly sure of a similar result. A key point was that the duty of care will only exist where the analysis underpinning a rating is unreasonable. A court won't impute responsibility for a rating just because a product doesn't perform or investors suffer a loss," says Harding-Farrenberg.

"Investors would have to carefully consider the facts and be in similar circumstances to have some confidence of a win, so I don't think it will open the floodgates," he adds.

In terms of implications for other cases, Harding-Farrenberg says this ruling is unlikely to influence cases in US courts.

"The Australian ruling is at odds with the current landscape in the US and is less likely to have significance there. To date, it appears to have been very difficult for a plaintiff to argue successfully that a rating agency ought to be liable for or has a duty of care to investors for the ratings it issues. This has ordinarily been the result of the strength of the First Amendment protection of free speech and the right to expression of opinions," he says.

Whereas English courts have not delineated between whether the rating is advice or an opinion, the American courts have comfortably formed the view that a rating is an opinion, and thus subject to protection under the First Amendment, says Harding-Farrenberg.

In other common law jurisdictions such as Hong Kong, the regulators and banks have worked together to create a system where a large portion of the losses that arose in CDOs were reimbursed by banks. That was not the case in Australia, says Walker at Bentham IMF.

"In Hong Kong the banks were required to compensate a large degree of the losses so there wasn't a need for civil proceedings. In order to make these claims proceed it is very rare for one person to do it alone as often their claim isn't big enough and they don't have the resources to see it through," says Walker.

"In Australia the claims are a product of litigation funding and a reasonably quick civil justice system," he adds.

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