By Julian Bajkowski

Global financial ratings agency Standard & Poors has vowed to fight fresh legal action against it to recover millions of dollars lost by dozens of Australian councils after the local governments bought into junk, sub-prime instruments graded by the firm as AAA and AA quality investment products.

The confirmation by S&P that it will now contest the new claim against it sets the stage for another courtroom battle certain to be closely watched by the government, finance and legal sectors for potential precedents that could influence other damages cases related to the GFC around the world.

“The lawsuit is without merit and we will vigorously defend ourselves against it,” S&P said in a statement provideded to Government News.

“Our ratings were based on the good faith judgment of our analysts and reflect what they knew at the time,” the ratings agency said.

The legal spotlight turned to S&P following two Federal Court decisions in Australia in 2012 that found those pushing so-called ‘toxic debt’ products – synthetic collateralised debt obligations (SCDOs) and collateralised debt obligations (CDOs) – could be held liable for damages incurred through losses stemming from them in the wake of the GFC.

At the crux of those decisions was whether or not councils, churches and charities were essentially misled over the quality of the financial instruments – as denoted by their investment grade rating –by those selling products on behalf of now collapsed investment bank Lehman Bros.

In November 2012, a decision handed down by Federal Court Justice Jayne Jagot found that the local governments were entitled to claim damages from S&P, investment bank ABN Amro and financial services provider Local Government Financial Services Pty Ltd (LGFS).

“LGFS’s marketing was hopelessly deficient in alerting the councils to the risks of this investment. But … S&P’s rating was hopelessly deficient too,” Justice Jagot wrote in her decision.

Importantly, S&P are appealing that decision as well as contesting the latest claim against it that is being run as a class action by publicly listed litigation funder IMF Ltd.

“We are disappointed with the Court’s decision, we reject any suggestion our opinions were inappropriate, and we will appeal the Australian ruling, which relates to a specific CPDO rating,” S&P said at the time the decision was made public.

Justice Jagot was withering in her criticism of the CPDO, a term that refers to products known as Constant Proportion Debt Obligations, a form of synthetic derivative, that were sold under the label of Rembrandt notes.

“The CPDO was described in part of the evidence as a “grotesquely complicated” instrument. This is accurate,” Justice Jagot wrote.

While there is plenty at stake in the latest claim against S&P, the big question for the financial services industry and government investors alike is what liabilities may flow from investment and debt ratings and gradings that are an essential part of the business that agencies like S&P engage in.

Litigation funder IMF has made clear that it is unlikely to stop at Australia and S&P in its pursuit of the recovery of damages suffered by its clients during the global financial crisis.

On announcing the latest action against S&P this week, John Walker, executive director of IMF (Australia) Ltd said that the new filing “will pave the way for further filings in Europe funded by IMF, on behalf of European pension funds, banks and other investors, seeking compensation for losses after investing in complex financial products.”

“These filings are expected to include a claim in the Netherlands against Royal Bank of Scotland NV and S&P and a claim in the UK against Moody’s,” Mr Walker said.

The scenario of burned investors being able to successfully pursue ratings agencies for damages is not a particularly inviting scenario for those businesses grading investments given the potential for legal and financial exposure.

In Australia IMF is pursuing S&P on behalf of 90 local governments, churches and charities on the back of two separate landmark decisions handed down by the Federal Court that found against Lehman and the ratings agency.

IMF has said that the councils it is representing will allege that “the ratings given to the CDOs, the value of which plummeted during the global financial crisis of 2007 and 2008, were made without a reasonable basis.”

The City of Swan (Western Australia) and Moree Plains Council (New South Wales) are at the forefront of the claim as representatives of other investors.

Statements from IMF have said that the councils will allege that “S&P falsely represented that its credit ratings of the CDOs were objective, independent, uninfluenced by any conflicts of interest and reflected S&P’s true opinion regarding the credit risks that the CDOs posed to investors.”