S&P Liable for “Misleading and Deceptive” AAA Ratings for the First Time
New York [November 5, 2012] – An Australian Court has become the first in the world to find a ratings agency liable for AAA ratings on junk derivatives, paving the way for many new possible claims in the United States and elsewhere.
Australia’s Federal Court yesterday found against Standard & Poor’s (S&P) and investment bank ABN AMRO (now Royal Bank of Scotland) in a claim brought by a handful of local government authorities that lost more than $30 million in complex securities that turned to junk when the housing market crashed.
The claim against S&P and ABN AMRO was backed by Australia’s largest litigation funder IMF (Australia), parent company of US-based funder Bentham Capital.
The securities - complex synthetic derivatives known as constant proportion debt obligations, or CPDOs - were arranged by ABN AMRO, rated AAA by S&P and sold to local government authorities by an intermediary firm in 2006. Billions of dollars worth of similar securities packaged by ABN AMRO were sold to institutional investors in the US and Europe over the same period.
Bentham Capital Chief Investment Officer, Ralph Sutton, said the Australian judgment, coupled with new findings that challenge the ratings agencies’ First Amendment defense, could spell trouble in US courts for Moody’s and S&P, among others.
“A recent ruling from Judge Shira Scheindlin in federal court here in New York
suggests the rating agencies are in serious trouble relying on an ‘opinion’ defense,” Mr. Sutton said.
Last August, United States District Judge Shira Scheindlin denied Moody and S&P’s motions for summary judgment in a similar action, holding:
While ratings are not objectively measurable statements of fact, neither are they mere puffery or unsupportable statements of belief akin to the opinion that one type of cuisine is preferable to another…If a rating agency knowingly issues a rating that is either unsupported by reasoned analysis or without a factual foundation it is stating a fact-based opinion that it does not believe to be true. Ratings are actionable if (they) both misstated the opinions or beliefs held by the rating agencies and were false or misleading with respect to the underlying subject matter they address.
In the Australian case, 12 local government authorities alleged that ABN AMRO exercised real and substantial influence over S&P’s rating process in order to obtain the desired ratings for the securities, known as Rembrandt Notes (sold as Castle Finance or Chess globally). Plaintiffs also alleged that S&P negligently and misleadingly granted a AAA rating to the CPDOs when a junk bond rating would have been more appropriate.
In her judgment, Australian Federal Court Justice Jayne Jagot found, in part:
As explained in the reasons for judgment, I am satisfied that:
S&P’s rating of AAA of the Rembrandt 2006-2 and 2006-3 CPDO notes was misleading and deceptive and involved the publication of information or statements false in material particulars and otherwise involved negligent misrepresentations to the class of potential investors in Australia, which included LGFS and the councils, because by the AAA rating there was conveyed a representation that in S&P’s opinion the capacity of the notes to meet all financial obligations was “extremely strong” and a representation that S&P had reached this opinion based on reasonable grounds and as the result of an exercise of reasonable care when neither was true and S&P also knew not to be true at the time made.
In the US, litigation finance has recently come under attack by the US Chamber of Commerce, the largest lobbying group in America. The majority of the US Chamber’s funding is reported to come from just 16 large US companies. The Chamber last week proposed regulating the litigation finance industry, but would prefer to eliminate it entirely.
Litigation finance, however, is a critical mechanism to enable cases to be brought and litigated against large corporations, banks and other powerful institutions, often by small and mid-sized companies and entities.
The Australian Federal Court’s finding yesterday -- in favor of local municipalities -- that S&P’s AAA ratings were “misleading and deceptive” could never have been achieved without litigation funding support from IMF (Australia), Bentham’s parent.