31/05/2013

In this the fourth and final article on Wingecarribee Shire Council v Lehman Brothers Australia Ltd (in liq) (2012) we look at the court’s findings in respect of the use by the adviser of the product ratings.

You might recall that Wingecarribee Shire Council lost a substantial amount of money by investing in so-called “Synthetic Collateralised Debt Obligations” (SCDO’s) and it and many other councils took a class action against their adviser, Grange Securities, who had been taken over by Lehman Brothers Australia.

Lehman argued that the major ratings agencies (Standard & Poors, Fitch and Moody’s) had given the SCDO’s high ratings and should be proportionately liable for the councils’ losses. The argument ran that the ratings were effectively a representation that the SCDO’s were equivalent, as regards risk profile, to other types of financial products carrying the same rating from the same ratings agency.

 The court would have none of it. It held that the ratings did not convey that message.  Rather it was how the adviser used the ratings that was the real concern.  In this case Grange used the ratings to suggest that the products with similar ratings had similar risk profiles.

Grange did not put the ratings, and the use to which they could be put, into context or explain to the client the limitations of the ratings in respect of identifying material risks of the product or its risk profile.

Advisers who want to use ratings to sell product must explain to the client the limitations of those ratings.  Given that the ratings agencies are under attack since the GFC for the questionable quality of their rating of various exotic products the use of ratings as a sales tool may be in decline.  Nonetheless, if ratings are discussed, then it is vital that the adviser make the client fully aware of what the ratings actually mean and how they can be used in assessing the product.

To do otherwise is to run a material risk of failing to fully meet the adviser’s duty to the client.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.