In 2012, the Federal Court of Australia delivered judgment in favour of the applicants inWingecarribee Shire Council v Lehman Brothers Australia Ltd (in liq) [2012] FCA 1028 (the Lehman Brothers case). This case was a class action brought by three city councils (the Councils).

Summary of Lehman Brothers case

The Court found that, in an attempt to attract investors, Lehman Brothers had misdescribed very complex and high-risk financial products to councils and charities around Australia as “safer than the four major Australian banks”1 when they were not.

The products Lehmans was selling were synthetic collateralised debt obligations (CDOs) that were so complex they were beyond comprehension for most people. The Court found these CDOs were only suitable for ‘sophisticated investors’, in the ordinary meaning of the words.

Important findings

  1. The Councils were held to be unsophisticated investors even though they could technically be qualified as “sophisticated” under statute because they control large amounts of tax-payers’ money2.  An investor may be considered unsophisticated if they do not have the capacity to understand the product and its risks even if the investor would be classified as “sophisticated” under statute.    
  2. As a result of the lack of sophistication, Lehman Brothers held the Councils’ trust. This trust meant that Lehman Brothers was the Councils’ financial advisor and a fiduciary, despite disclaimers to the contrary3.  If the relationship between the bank and the investor is one where the bank is the investor’s trusted advisor, banks will not be saved by disclaimers in product documentation. 
  3. The Councils acted on the advisor’s recommendations, not on the documents containing the disclaimers4. If document disclaimers are irrelevant to the relationship formed with the investor, or not given prominence because they are hidden in large bundles of documents without attention being drawn to them, they may be ineffective. A client cannot be expected to read every circular or other document that an adviser sends the client about the product5
  4. Phrases such as ‘the bank “may be on the opposite side of a transaction, may earn placement fees, may be a conflict of interest”’ do not amount to full and frank disclosure6.  Conflicts must be disclosed in terms of the amount of profits earned and the precise ways this is done. 
  5. Rating agencies were not concurrent wrongdoers by publishing its ratings of the CDOs7. The bank misused the ratings to convey that the product was equivalent to products of the same rating, not the rating agency.

Status post-judgment and new claim against Standard & Poor’s

The Councils are still awaiting compensation from Lehman Brothers. Voting on the latest scheme of company arrangement proposed by the liquidator of Lehman Brothers was adjourned after the holding company blockaded the meeting.

The investors of a subset of the CDOs launched a new claim against Standard & Poor’s for the balance of their losses. This claim is founded on an allegation that the credit ratings given by Standard & Poor’s were made without reasonable basis and falsely represented that its ratings were independent and made without conflicts of interest.

In late 2012, the Federal Court of Australia ruled in favour of the councils and held they were deceived by Standard & Poor’s AAA credit rating. The Court awarded nearly $30 million in compensation.

Standard & Poor’s is appealing this decision to the Full Court of the Federal Court.