The Full Federal Court in Australia has confirmed that a ratings agency can owe a duty of care to potential investors.


The claim concerned a complicated structured financial product known as a constant proportion debt obligation (CPDO) which was sold using the name ‘Rembrandt notes’.  The issuing bank (from their previous dealings with Standard & Poor’s) had a good idea how S&P would model the performance of the CPDO to assess the creditworthiness and the rating.  The bank therefore modelled the CPDO in a way to ensure an AAA rating for the Rembrandt notes, which they were duly given by S&P.   The notes were sold to a funds management company, LGFS, and LGFS sold a substantial number of notes to local councils in Australia.  The councils subsequently lost most of the money they had invested and issued proceedings against Standard & Poor’s, the issuing bank and LGFS.  LGFS had retained some of the notes and also issued claims against Standard & Poor’s and the bank.

The court at first instance ruled in favour of the councils against S&P, the issuing bank and LGFS and in favour of LGFS in respect of the losses it suffered on the notes it retained.  S&P owed a duty of care to investors to exercise reasonable care in forming, and to have reasonable grounds for, the opinion expressed by the rating.  In breach of duty, S&P’s rating of AAA was misleading and deceptive and S&P along with the issuing bank had been involved in the publication of information and statements that were false in material particulars and involved negligent misrepresentations being made to potential investors.  The bank had been “knowingly concerned” in S&P’s misleading and deceptive conduct and had itself engaged in conduct that was misleading and deceptive.  LGFS had also engaged in misleading and deceptive conduct and had breached its fiduciary obligations to the councils.

S&P, the issuing bank and LGFS appealed the judge’s findings.

Appeal decision

The appeal court upheld the findings of the first instance judge (with the qualification that it found that a claim for damages under the Australian Corporations Act was not apportionable).  Importantly, the appeal court upheld the finding that S&P owed a duty of care to potential investors.

On appeal, S&P accepted that the rating of the notes had been flawed.  It argued, however, that the first instance judge had been wrong to hold that it owed a duty of care.  Central to S&P’s case that it did not owe a duty of care was that the risk of harm was not reasonably foreseeable because its liability was indeterminate and, in particular, it did not know the identity of the investors.  The Federal Court rejected that argument, finding that the class of potential investors was known and identified.  To establish that the ratings agency owed a duty of care to investors it was not necessary to show that it knew the precise identity and number of members of the class of investors or the exact loss. It was sufficient that S&P knew the characteristics of the class (that each was an investor in the notes) and knew the foreseeable type of loss that would be suffered if its rating of a product was negligent.

The Federal Court also dismissed the argument that the investors were not vulnerable and were capable of protecting themselves from the loss suffered.  The court found that S&P knew that an ascertainable class of persons (the investors) would be reliant on S&P’s conduct, that its function in rating the notes was specialised and that the members of the ascertainable class were likely to rely on S&P. The investors could not replicate or second-guess S&P’s rating.

S&P had no direct dealings or contractual relationship with the investors.  The agency’s contract with the issuing bank identified, however, that S&P had responsibilities to other parties (S&P gave permission to the bank, for example, to disseminate the rating to interested parties) and S&P were aware that the reason why the bank obtained and paid for the rating was so that it could be communicated to interested parties.

The court also upheld the findings that the issuing bank breached the duty of care it owed to LGFS and that LGFS was in breach of the duty of care it owed to the councils.  The bank owed a duty of care to LGFS to exercise reasonable skill and care in providing information and advice about the notes, and to exercise reasonable care to ensure that LGFS was issued with a financial product that had a degree of certainty commensurate with the AAA rating.


Although an Australian decision, it is interesting to note that a key part of the appeal court’s finding was based on the sheer complexity of the products and the inability of an end purchaser to conduct any meaningful assessment of the rating.  This certainly suggests that where investors were sophisticated (in the sense they can assess the risk for themselves/or can afford to pay advisers to help them understand the risks), or where the products are not overly complex, it is much more difficult for claimants to establish a duty of care on common law principles alone.  It will also be interesting to see whether claimants seek to rely on this decision in this jurisdiction in the future, and it will be interesting to see how many (if any) claims are made against rating agencies under the new European Regulation Credit Rating Agencies, which applies to ratings issued after June 2013.

Further reading: ABN Amro Bank NV v Barthurst Regional Council [2014] FCAFC 65