Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200


The Federal Court yesterday handed down its decision in a class action brought by thirteen Councils against McGraw Hill International (UK) Limited (known for the rating service it provides under the trading name “Standard and Poor’s” (S&P)),  ABN Amro Bank NV (“ABN Amro”) and Local Government Financial Services Pty Ltd (“LGFS”). 


The claims concerned the rating, sale and purchase of structured financial products known as constant proportion debt obligations (“CPDOs”).  LGFS purchased these CPDOs before on-selling them to the Councils.  At the time of acquisition, the relevant CPDOs had AAA credit ratings.


Jagot J has held that S&P:

  • engaged in misleading and deceptive conduct in breach of ss 1041E and 1041H of the Corporations Act and s12DA of the ASIC Act, and otherwise made negligent misstatements to the Councils and LGFS by assigning the rating of AAA to the CPDOs which conveyed the representation that S&P had reached this opinion based on reasonable grounds and as a result of an exercise of reasonable care.  Contrary to these representations, the CPDOs were rated by S&P on the basis of:
    • unjustifiably and unreasonably optimistic assumptions for at least two of the major inputs for the modelling of the CPDOs’ performance;
    • non-stressed assumptions for other inputs that, if eliminated, would have changed the modelled performance of the CPDOs from AAA to sub investment grade (below BBB));
    • there being no regard to the impact on the CPDOs of ratings migration; and
    • defects in relation to the modelling of defaults and long-term average spread; and
  • breached its duty of care to the Councils for the same reasons.

Jagot J also held that ABN Amro:

  • was knowingly concerned in S&P’s contraventions; and
  • engaged in conduct in breach of ss 1041E and 1041H of the Corporations Act and s12DA of the ASIC Act, and otherwise made negligent misstatements to the Councils and LGFS by using the AAA rating assigned by S&P.

LGFS was held liable for:

  • misleading and deceptive conduct and negligent misrepresentation in respect of the CPDOs;
  • breaching its Australian Financial Services Licence through dealing in derivatives with which it was not licensed to deal; and
  • breaching its fiduciary duties to each of the Councils (which it owed in its capacity as an investment adviser), by providing advice without first disclosing that it had a significant financial interest in selling the CPDOs to the Councils.  

Further, the defence of “contributory negligence” was held to be unavailable because:

  • the Councils believed they were receiving sound and reliable investment advice from LGFS, who in turn relied on the representations of ABN Amro and S&P;
  • the Councils relied on a AAA rating from the world-leading ratings agency S&P;
  • it was “beyond the capacity” of many, if not most, Councils to understand the mechanics of  the CPDOs and it was sufficient for them to rely on the investment recommendations, the AAA rating and a basic understanding as to what the CPDOs offered; and
  • any carelessness by the Councils in not reading material or understanding the risks did not materially contribute to the economic loss suffered as nothing they could have done would have led to an awareness that they had not been told of the material risks of the CPDOs by LGFS or that S&P’s rating was not in fact based on reasonable grounds or the product of the exercise of reasonable care.

By way of remedy, Jagot J held that S&P, ABN Amro and LGFS were proportionally liable in equal parts to compensate the Councils for their losses, assessed on the basis that damages amount to the difference between the principal amount paid for the CPDOs and the payment received on the cash-out of the CPDOs, without deduction for any coupon payments received by the Councils in the intermediate period.  Further, the Councils were also entitled to equitable compensation from LGFS for breach of fiduciary duty, however the measure of this compensation was the same as the damages recoverable from S&P, ABN Amro and LGFS, assessed proportionately.  S&P and ABN Amro were also equally liable for LGFS’ losses on its own investments in CPDOs.  The parties were ordered to make further submissions on the issue of interest at a later date. 

S&P has indicated in media reports that it intends to appeal the decision.

A copy of the full decision and a summary released by the Federal Court may be found here.