In Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200, the Federal Court found that ratings agency Standard & Poors (S&P) and ABN Amro Bank NV (ABN Amro) misled investors and were negligent in marketing highly complex derivative products with a “AAA” rating.  The decision, the first of its kind worldwide, found that the credit assessment process lacked independent oversight was flawed and no reasonably competent ratings agency could have come to such a conclusion.  


In April 2006, ABN Amro created a new financial product known as a constant proportion debt obligation or CPDO.  The CPDOs were highly leveraged products which were described in court as “grotesquely complicated”. 

ABN Amro retained S&P to rate the CPDO for the market.  Naturally, ABN Amro sought to obtain the highest rating possible for the CPDO, which would indicate to potential investors that there was an extremely strong likelihood of achieving the stated return on the product.  S&P ultimately gave the CPDO a “AAA” rating, the highest rating achievable.

The CPDO products marketed in Australia were known as Rembrandt 2006-2 and Rembrandt 2006-3 notes (Notes).

The Local Government Financial Services (LGFS), an authorised deposit taking institution for councils in NSW, purchased the AAA rated Notes for the purpose of on-sale to councils in NSW.  $17,000,000 of those Notes were ultimately sold to 13 councils in NSW (the councils).

In October 2008, the net asset value of the Australian CPDOs fell below 10%.  In this event, the terms of the instruments creating the Notes provided for the Notes to be cashed-out.  The cash out payment to the note holders amounted to about 6% of the initial investment.  The councils consequently suffered losses totalling nearly $16,000,000.


The councils commenced proceedings against LGFS, S&P and ABN Amro, alleging inter alia misleading and deceptive conduct in contravention of s1041E and s1041H of the Corporations Act 2001 (Cth) and s12DA of the Australian Securities and Investments Commission Act 2001 (Cth) and negligence. 


The Federal Court found as a matter of fact that:

  • ABN Amro had pressed S&P on numerous occasions to adopt as the basis for the rating ABN Amro’s model inputs, which would produce a AAA rating;
  • S&P accepted a number of these inputs and assumptions at face value, which were found by the court to be unjustifiable and resulted in AAA rating being given when it should not have;
  • ABN Amro was aware of the inadequacies in S&P’s modelling of the CPDO and that they would benefit from the AAA rating;
  • S&P authorised ABN Amro to disseminate its rating of AAA of the CPDO to potential investors and ABN Amro did so; and
  • After ABN Amro released the CPDO to the market on the basis of the AAA rating, it failed to alert S&P to a number of issues with the CPDO because it was worried that it would open “a can of worms” and send S&P back to the “drawing board”.

The Court found that S&P’s rating was misleading and deceptive because it 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.

Further, the Court rejected the argument that S&P and ABN Amro had not contracted or dealt with the councils, such that they could not be held to owe a duty of care to the councils (or other investors).  The Court held that there is no inconsistency between recognising the contractual arrangements between S&P and ABN Amro and the existence of a duty of care by them to the third parties for whom the rating was intended. 

The Court also found that ABN Amro was “knowingly concerned” in S&P’s misleading and deceptive conduct and engaged in misleading and deceptive conduct itself.


The decision marks the first occasion on which a credit rating agency has been held accountable for its rating.  The previous modus operandi had been that credit ratings are merely opinions or indications which are subject to disclaimers and are not guarantees of a return.  The Federal Court’s decision, in finding that ratings agencies have a duty of care to investors, sets a new standard and could give rise to a sea of litigation against credit rating agencies that have previously “got it wrong”.

Having said this, it is important to note that the Court was concerned in this case with the process which S&P applied in determining its rating, and did not simply consider the fact that the products did not perform according to the rating.  As a consequence, credit rating agencies can protect themselves by ensuring that all assumptions, inputs and modelling process can be justified and are reasonable.

The judgment also warns investments banks and financial product manufacturers of the consequences of not allowing a credit rating agency to independently determine the rating for its product and not advising the credit rating agency of potential issues with their product.

S&P have announced their intention to appeal the decision.