Australian Court on Rating Complex Financial Instruments

Federal Court of Australia has delivered an important ruling that pertains to
the liability of credit rating agencies. In Bathurst
Regional Council v. Local Government Financial Services Pty Ltd
, the
court found that Standard & Poors (S&P) was liable to several local
councils in Australia for a AAA rating provided in connection with their
investment in complex financial instruments known as constant proportion debt
obligations (CPDOs). Along with S&P, ABN Amro which structured these
instruments was also held liable.
The court
found that S&P’s AAA rating was “misleading and deceptive and involved the
publication of information or statements false in material particulars and
otherwise involved negligent misrepresentations to the class of potential
investors in Australia …” Furthermore, it was found that S&P, in arriving
at its conclusions, heavily relied upon inputs provided by ABN Amro without
independently verifying them. In effect, this ruling no longer allows rating
agencies to disown responsibility to investors who relied on their opinions to
make investment decisions.
judgment is interesting for several reasons. It involves a rare instance where
rating agencies have been found to be liable. As the Economist notes,
it is unlikely that other courts would adopt a similar stance. S&P is in
any event said to be appealing this decision.
It is an
unusual instance where the court has not shown any hesitation in delving into
the technical aspects of complex financial instruments in minute detail. Jagot,
J’s decision is 1,500 pages and 3,723 paragraphs long. The summary itself is 9
pages and 56 paragraphs long! Although the court was aided by expert evidence,
the fact that these complex instruments have been stripped down to their
essentials in determining the outcome of the liability of S&P and ABN Amro
is remarkable.
judgment would certainly call attention to the risk profile of rating agencies
in terms of legal liability.

A further discussion of this judgment is
contained in
(which links to other coverage as well) and
Jayanth R. Varma’s Financial Markets Blog
(arguing from a financial
modelling perspective that these instruments should not have been rated at

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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