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Rating agency's duty of care to investors upheld in Australia
In a landmark decision in 2012, the Federal Court of Australia found, among other things, that rating agency Standard & Poor's (S&P) owed investors a duty of care in respect of a financial product it rated and S&P had engaged in misleading and deceptive conduct in giving the financial product an AAA rating. S&P challenged these findings, and after two years the Federal Court of Appeal in ABN AMRO Bank NV v Bathurst Regional Council [2014] FCAFC 65 (Bathurst) has handed down its decision. The finding on appeal is unequivocal: a rating agency can owe a duty of care to investors for the rating it gives a financial product and therefore must exercise reasonable care when formulating, and have reasonable grounds for, a financial product rating.
As one of the only examples (if not the only example) in the common law world of the finding of such a duty of care, the decision in Bathurst represents a rare occasion where the poor performance of a rated financial product during the global financial crisis has given rise to a successful cause of action against a rating agency.
Facts
In April 2006 ABN AMRO Bank NV ('ABN AMRO') created a financial product known as a 'constant proportion debt obligation' (CPDO). S&P was tasked with rating the CPDO. In rating the product, S&P did not seek out any more documentation or material than that which had been provided to it by ABN AMRO. S&P, based on the figures and information provided by ABN AMRO, assessed assumptions on volatility and spreads, non-stressed assumptions, calculations of likely default and account ratings migration. The end result was an AAA-rated financial product.
ABN AMRO then, for the purposes of marketing the product to potential investors, requested from S&P permission to publish its AAA rating. Some potential investors questioned why certain risks were not considered in the model that S&P used, and ABN AMRO opted not to pass this concern on to S&P1 - instead telling clients that the existing model 'directly or indirectly captures [those] risks'.2 3 S&P did at a later stage become aware of these concerns - but elected not to modify the existing model out of fear that it...