In a world first case, Standard & Poor’s (S&P), ABN Amro and Local Government Financial Services (LGFS) have each been found liable for misleading and deceptive conduct, and therefore liable for losses sustained by 13 local councils. The losses came about from the sale and purchase of a type of collateralised debt instrument known as a “constant proportion debt obligation” (the CPDOs) created by ABN Amro in 2006. The case is a world first in that it is the first time a rating agency has been held liable for the quality or reliability of its ratings. Accordingly, the most interesting part of the decision focuses on the claims against S&P and its rating of the Rembrandt 2006-3 CPDO notes.

Justice Jagot's judgment in Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200 (Bathurst v LGFS), handed down on 5 November 2012, comes in the wake of Wingecarribee Shire Council v Lehman Brothers Australia Ltd (in liq) [ 2012 ] FCA 1028 (see our other client update concerning this case). In Bathurst v LGFS the Federal Court handed down another decision on the sale of the synthetic collateralised debt instruments widely credited with playing a critical role in causing the global financial crisis.

ABN Amro retained S&P to rate the CPDOs and S&P issued a rating of AAA for the product. LGFS sold approximately $16 million of CPDO notes to the 13 plaintiff councils from November 2006 to June 2007. With the global financial crisis in mid-2007, the value of the CPDOs, held by both the Councils and LGFS, plummeted to less than 10% of the principal investment.

The claims against S&P

Both LGFS and the Councils brought claims against S&P for misleading and deceptive conduct and negligence. They contended that S&P, by its conduct in issuing and publishing in Australia the “AAA” ratings for the CPDOs, contravened ss 1041E and 1041H of the Corporations Act 2001 (Cth), and s 12DA of the Australian Securities and Investment Commission Act 2001 (Cth), prohibiting false or misleading conduct in relation to financial products.

S&P had defined its AAA rating as a statement of its opinion that the issuer of the bond’s capacity to meet its financial commitments to pay interest and repay principal was extremely strong.

LGFS and the Councils alleged that, as S&P is a ratings agency in the business of assigning ratings to financial instruments, the assignment of a AAA rating carried with it a representation that S&P had a genuine and reasonable basis for reaching the conclusions that it reached about the creditworthiness of the financial instrument.

Ultimately, Jagot J was satisfied that S&P’s rating was not based on reasonable grounds or as the result of an exercise of reasonable care, and that S&P also knew this not to be true at the time made, and hence S&P’s rating of AAA of the CPDO notes was misleading and deceptive.

Critically, her Honour found that the modelling inputs adopted by S&P, which were the inputs that ABN Amro itself used for its modelling and pressed S&P to adopt, were not inputs that any reasonable ratings agency would have used. Jagot J found that S&P based its rating of AAA on assumptions that were substantially more favourable to the performance of the CPDOs than the actual economic conditions existing at the time, and unreasonably so. Her Honour found that at least one person within S&P considered that ABN Amro, whether intentionally or not, had effectively “gamed” the model it knew S&P would apply to rate the CPDOs.

Other claims

The Court also found proved the claims against LGFS for misleading and deceptive conduct, negligence, breach of fiduciary duty, breach of Australian Financial Services Licence, breach of contract, and against ABN Amro for its role in the marketing of the CPDOs in misleading and deceptive conduct, negligence and breach of contract.


The ruling against ABN Amro and S&P exposes the flaws in a system in which ratings upon which investors rely for an independent evaluation of default risk are made by agencies which are themselves paid by the issuers to rate their products. Even more than Wingecarribee Shire Council v Lehman Brothers, the consequences of this decision are likely to reverberate around the globe. ABN Amro sold about €2 billion worth of similar products, rated by S&P, in Europe. Other credit rating agencies, such as Moody’s and Fitch, which also rated CPDOs and CDOs, could also be affected. 

Bathurst v LGFS reinforces the lesson from Lehman Brothers that it will now be far more difficult for financial service providers, investment banks and rating agencies to rely on disclaimers to absolve themselves from liability. 

For more detailed analysis of Bathurst v LGFS please click here.