S&P sued over rating on notes

Standard & Poor's credibility has come under legal attack in a A$40 million (NZ$57m) action by a Australian investment firm over a AAA-rated debt investment that subsequently turned toxic.

The credit rating agency has been challenged to defend the rating it subscribed to "constant proportion debt obligation" notes created by investment bank ABN Amro and bought by Local Government Financial Services (LFGS), which sold them to district councils. In a counter-claim lodged in Australia's Federal Court last week in response to legal action taken against it by 12 NSW councils, LGFS has alleged S&P breached the Corporations Act by giving the notes the status of a top-rated bond.

LGFS bought $45m in the notes between November 2006 and January 2007, of which $18.5m was sold to local authorities, such as Bathurst, Parkes, Orange, Eurobodalla and Ryde.

They are now suing LGFS for the return of the money, after the value of the notes fell sharply and ended in returning just 6.6 per cent of their original purchase price.

In its action against ABN and McGraw-Hill International (the owners of S&P), LGFS has claimed:

S&P was negligent in assigning its highest rating to an investment with a risk of default far higher than a AAA-rated bond.

S&P disregarded or inadequately considered the risks involved in its credit checks.

Its financial modelling was not sufficiently rigorous.

Just over a year after it bought its last block of the notes, and as the global financial crisis sent debt markets into freefall, S&P downgraded its rating of their value to BBB, one of its lowest grades.

Such a rating ran contrary to LGFS's credit policies that banned it from holding risky investments and required it to sell the notes at market value.

But the fall in their value to under 10 per cent of their purchase price also activated a sell clause in the original deal with ABN, requiring the bank to pay the noteholders what they were worth at the trigger point.

- © Fairfax NZ News