In the first known decision of its type in the common law world,
the Federal Court of Australia has held that a ratings agency owes
a duty of care to potential investors. On November 5, 2012, the
Federal Court of Australia handed down its landmark decision in the
matter of Bathurst Regional Council v Local Government
Financial Services Pty Ltd (No 5)  FCA 12001
("Bathurst"). The court ruled that global ratings agency
Standard & Poor's ("S&P") had misled or
deceived investors and was negligent by assigning S&P's
highest rating of AAA to a volatile structured finance product
arranged by investment bank ABN Amro Bank NV ("Amro"),
known as Constant Proportion Debt Obligations ("CPDO").
As a result of the decision, investors who relied upon that rating
could recover losses from S&P.
Bathurst involved a claim made by 12 Local Councils in
the State of New South Wales (the "Investors") against
S&P, Amro, and municipal financial advisor Local Government
Financial Services ("LGFS") for losses suffered by the
Investors as a result of their investment in the CPDO. It was
submitted by the Investors, and accepted by the Federal Court, that
they had been induced to invest in the CPDO in reliance upon, among
other things, the AAA rating that S&P had assigned to the CPDO.
Given the high volatility of the CPDO, the court held that any
reasonably competent ratings agency in the position of S&P
could not have rated the CPDO with such a high rating on any
"rational or reasonable basis," 2 and that as
a result of S&P's negligence, the investors suffered loss
and damage by relying upon S&P's AAA rating in forming
their decision to invest.
In attributing blame to S&P, the court went on to note that
the investors were particularly vulnerable in that they could not
reasonably protect themselves from any lack of reasonable care by
S&P in the assigning of the rating.3 Indeed, less
than two years after purchasing the securities in late 2006, during
the global financial crisis, the Local Councils lost more than 90
percent of their original A$17 million invested in the CPDO due to
its inherent volatility in the market. The court was also critical
of Amro, which it found to have inappropriately influenced S&P
and misrepresented information that S&P then relied upon in
formulating its incorrect AAA rating of the CPDO. Moreover, the
court also ruled that Amro and LGFS had themselves engaged in
misleading and deceptive conduct and had breached various other
fiduciary and contractual duties owed by them.
Bathurst is a first instance judgment from a single
judge in the Federal Court of Australia. Given the serious
implications of the judgment for rating agencies, it is likely that
the decision will be scrutinized by appellate courts. If the
decision stands, it can be expected to encourage other investors in
other jurisdictions to pursue ratings agencies. The decision could
also lead to significant reforms by financial services regulators
in order to "crack down" on the inherent conflicts that
presently exist between investment banks and ratings agencies in
the arrangement and rating of financial services products.
1. Bathurst Regional Council v Local Government
Financial Services Pty Ltd (No 5)  FCA 1200 per Justice
2. Federal Court of Australia Summary of Bathurst
Regional Council v Local Government Financial Services Pty Ltd
(No 5)  FCA 1200 at .
3. Bathurst, n 1 at .
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guide to the subject matter. Specialist advice should be sought
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