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A question of accountability: credit rating agencies, investments and councils

By Binoy Kampmark - posted Thursday, 6 March 2014

Can you really ever trust investment advice? In the New South Wales case of Tomasetti v Brailey [2011] NSWSC 1446, the court held that Mr Tomasetti could not hold his accountant liable for investment losses he suffered. Brailey was subjected to a range of allegations, including negligence, breach of contract, and breaches of the Corporations Act. The court did not accept the contention that Brailey had been negligent in his conduct. On the surface, there was nothing to suggest that the accountant had to go over and above what he was already doing.

In 2012, the legal, and in effect financial world, was rocked by the ruling of Federal Court Justice Jayne Jagot, who awarded 13 New South Wales councils damages to the tune of $30 million in compensation for losses incurred on Constant Proportion Debt Obligation notes (CPDOs). The problem there was that Standard and Poor's had given the complex investments an AAA credit rating, the equivalent of a gold star. ABN AMRO and Local Government Financial Services were also involved, the former having created the investments, the latter having sold the product. When the 2008 global financial crisis hit, the investments collapsed. All the parties are challenging the ruling before the Full Court of the Federal Court.

There may be good reasons why we can frown on the credit rating policies of S&P. Entire nations have either suffered or gained on the basis of whether such agencies grant the appropriate rating. Finances can be ruined in the wink of an eye. Investments can leave a state because a rating has fallen. And it also true that arriving at such a rating can itself be a flawed process without independent oversight.


A neat analogy for this is the cult of celebrity wine tasters – when a one pays a visit to a vineyard, a gold star rating will send sales soaring. Once word gets around that the rating is poor, sales plummet. It is questionable whether "oversight" ever played much of a role there.

The idea, however, of holding a credit rating agency liable for advice as if they were guarantees may well be a step to far. One can hardly sue a soothsayer for false predictions, even when those predictions were given on existing evidence. Financial advice and astrology share more things than are admitted, and those who practice the latter might well claim that the stars are far more reliable than stocks and bonds. Finance markets are, after all, notoriously fickle, and the CPDO was bound to have suffered a plunge at some point – the idea of councils actually running with such a scheme should have raised eyebrows to begin with.

For one, the decision assumes the proximity of relationship that is simply not there. Investment prospectuses are constantly done up by financial services. Ratings are made independently – those seeking to make an investment either accept the rating or do not. After all, caveat emptor remains the fundamental rule. There can hardly be a relationship of trust, what is otherwise termed a fiduciary relationship, in this case.

The statement from S&P argues that it is "bad policy to enforce a legal duty against a party like S&P, which has no relationship with investors who use rating opinions, yet impose no responsibility on those investors to conduct their own due diligence." They have a point. Had S&P actually asserted, unconditionally and unequivocally in the veracity of their judgment, and insisted that the councils rely on their judgment, the story on accountability might be seen differently. The clue lies in the nature of that relationship. All parties, to a degree, are responsible, but it can well be argued that councils should be more responsible than any of them.

The Judge was not convinced by that line of argument. For one thing, S&P came across badly – it had been "sandbagged" while ABN AMRO "bulldozed the rating through". That rating had proven to be "hopelessly deficient". In her eyes, all the parties had made negligent misrepresentations and had misled the councils. The same view was expressed against ABN AMRO and the LGFS.

The Councils have put much stock in the decision. Their investment plans are riding high on it. Bathurst Regional Council Mayor Gary Rush insists that paying back the money "would mean we have to curtail some of the maintenance opportunities or the development of infrastructure opportunities we are currently looking at." But surely, care should have been taken to consider CPDOs to begin with? The United States Federal Reserve famously termed them upon their creation in 2006 the "poster child for the excesses of financial engineering". The writing, in rather big print, was already on the wall.


Councils are public bodies, investing with the proceeds of the public purse. As part of their remit, they should be even more careful about the way they invest. Prudence rather than speculation should be the guiding rationale. The global financial crisis did its work not merely to show how irresponsible investment advice might be – but how irresponsible it was for those to follow it. The decision by Justice Jagot does have the effect of immunising councils from the need to undertake further checks. While S&P will, as it has done before, make poor judgments, councils should not be entitled to get away with their speculations with public money.

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About the Author

Binoy Kampmark was a Commonwealth Scholar at Selwyn College, Cambridge. He currently lectures at RMIT University, Melbourne and blogs at Oz Moses.

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