Federal Court judge Justice Jayne Jagot was scathing in her assessment of the process that led to the ratings agency, Standard & Poor's, giving a debt derivative devised by ABN Amro an AAA rating.Jagot handed down a judgement yesterday, ruling in favour of 12 local councils that brought a claim against S&P, ABN Amro and a fund manager, Local Government Financial Services, over their investment in the derivatives. She found that the respondents had misled the councils and failed to advise them of the significant risk involved in the investment.Jagot ruled that the councils were entitled to claw back the money they had invested and lost. With interest, the total amounts to around A$30 million. She rejected a counter-claim of contributory negligence by the councils.The judge accepted the description of the financial instrument in question, a constant proportion debt obligation (CPDO), as "grotesquely complicated".ABN Amro (now Royal Bank of Scotland) devised the CPDO, a highly leveraged credit derivative, in 2006. One of its features was that it increased its leverage in the event of losses. The CPDO could be seen as a version of a gambling strategy where you double your bets when you lose (up to a maximum leverage of 15 x capital invested).ABN Amro engaged Standard & Poor's to rate the creditworthiness of the CPDO. "In doing so, ABN Amro pressed S&P to adopt as the basis for the rating ABN Amro's model inputs," the judgement said.It did this in "numerous communications". These communications included "wrong assertions" about the volatility of the indices underlying the CPDO.The judgement said: "S&P believed ABN Amro's assertions [about the volatility of the index]. S&P did not calculate the volatility for itself, although it could easily have done so and, in my view, was required to do so as a reasonably competent ratings agency.""S&P thus modeled the CPDO thereafter for rating purposes on the basis of an incorrect assumption. This assumption as to volatility was unreasonably and unjustifiably low."Standard & Poor's rated the creditworthiness of the CPDO at AAA"I am satisfied that but for this error about volatility, the CPDO could not have been rated AAA by S&P on any rational or reasonable basis," the judgement said.The ratings process involved other "arbitrary, irrational and unreasonable distinctions".S&P assigned the AAA rating to the "first incarnation" of the CPDO, without assessing its performance having regard to ranges of inputs or market conditions. "Two of the major inputs were unjustifiably and unreasonably optimistic and had no proper rational foundation," said Justice Jagot.The judge found that ABN Amro "knew of all these matters and that they benefited from the modeled performance and thus [the] rating of the CPDO."