SYDNEY - In a major blow to the ratings industry, the Federal Court of Australia ruled on Monday that Standard & Poor’s had misled investors by giving its most trusted rating to instruments that S&P knew to be faulty, the Australian reports.
The court also ruled that the Netherlands bank ABN Amro had misled investors by selling the faulty instruments.
The Sydney judge ordered S&P and ABN Amro to pay damages to several New South Wales municipalities, which lost 93 % of their 16 million Australian dollar investment ($16.6 million), according to the Sydney Morning Herald.
The instruments, marketed as Rembrandt notes by ABN Amro, had been rated AAA by Standard and Poor’s. The verdict, which will be appealed, could open S&P to a further $200 billion in claims worldwide, reports the Sydney Morning Herald.
S&P defense attorneys argued that the ratings system is “an art, not a science,” and claimed that S&P was not responsible for mistakes caused by misinformation provided to the ratings companies by the banks who made the original loans or bought them. In the U.S., the ratings agencies affirm that their ratings are “opinions,” protected by freedom of speech, the Wall Street Journal says.
The judge also condemned ABN Amro Bank, which was acquired by the Royal Bank of Scotland in 2007, and investment advisors Local Government Financial Services Ltd (LGFS) for “misleading and deceptive” conduct, and ordered them to repay the money the municipalities had lost.
The ratings agency said in a statement, “We reject any suggestion our opinions were inappropriate, and we will appeal the Australian ruling,” the Wall Street Journalsaid. The judgment is the first in a case against the firm since the crisis began.
The legal firm that sued S&P in Australia plans to conduct further legal action in the U.K., the Netherlands and New Zealand, reports Les Echos.
The three major ratings agencies, S&P, Moody’s and Fitch, are responsible for giving credit ratings to investment products, and also to issuers of bonds, including cities and nations. The ratings in turn strongly influence the amount of interest required for a loan: a trusted nation can receive a loan at a much lower interest rate because lenders are more certain of being repaid. The ratings are critical because many government-run institutions are not legally allowed to invest in products that have less than a top rating of AAA.
One of the main causes of the economic crisis was that sub-prime loans, in other words extremely risky loans, permitted by U.S. deregulation of the banking industry, were sold on from the lending banks to other financial institutions and repackaged into complicated “derivatives” which few understood, but which were given AAA ratings by the ratings agencies.
The risk of the bad loans was thus passed along to the final buyers, often non-U.S. banks, pension funds, and government agencies. When the original borrowers massively defaulted on the loans in 2007 when their mortgage rates increased, many of the final buyers were unprepared because they had thought their holdings were AAA. Their huge losses led to a domino effect in the world financial system.