Ratings agencies' damage minimised in CDO ruling

The damage to the credit ratings agencies in the judgement on the class actions between three local councils and Lehman Brothers Australia over the investments in toxic debt instruments is merely reputational.

Justice Stephen Rares rejected one line of defence advanced by Lehman Brothers, namely that its responsibility should be reduced by 50 per cent, partly on the grounds that the ratings agencies must share the blame for the near wipe out of their investments in securities that carried AAA or AA ratings.

Lehman - which traded under the name of Grange Securities at the time it advised the councils - argued that it was actually the ratings agencies, and not Grange, that were responsible for the representations over credit quality that the firm pitched to the councils.

However, Rares wrote that "representations are not conveyed in a vacuum. They are communicated in a context. The mere publication of ratings by the rating agencies in association… did not of itself make the representation about material risks or risk profile of one product, such as the CDO, as compared to another class of product with the same rating, such as [a bank] issued FRN.

"Grange encouraged the council officers to use their existing understanding of what a credit rating signified in respect of products they were familiar with as the basis for them inferring that CDO products with similar ratings, that Grange promoted to them, involved similar risks.

"But, Grange knew (and a reasonable investment adviser or vendor in its position would have known) when it was promoting to the councils the CDOs that this inference was not correct."