By court reporter Jamelle Wells and staff, ABC Radio and TV – September 22, 2012
A group of Australian councils, charities and churches has won a Federal Court case against defunct investment bank Lehman Brothers in a case which could have global ramifications.
The judgment is considered a test case as it is the first in the world to look at the conduct of an investment bank, on both legal and ethical grounds, in the lead-up to the global financial crisis and how they behaved in the aftermath.
The class action involved 72 councils, churches and charities who sued Lehman Brothers for around $250 million, claiming it breached contracts and engaged in misleading and negligent conduct.
Justice Steven Rares has ruled that the parties are entitled to compensation but the amount has yet to be finalised.
They had sought compensation for losses incurred on investments they made on advice from Grange Securities, which was bought by Lehman Brothers Australia in 2007.
The investments had exposure to the housing market collapse in the United States.
Members of the group were advised by Lehman’s Australian arm before buying subprime mortgage-related derivatives or collateralised debt obligations (CDOs) branded locally as federation notes.
This was prior to 2007 when America’s housing sector began to crash, sparking a meltdown on Wall Street.
Justice Rares found the investors were not properly advised of the risks involved in highly complex financial products.
He said councils were often targeted by Grange Securities because they had ready access to large sums of money for investment, but the the “high risk” nature of the investments made them unsuitable for local councils.
“I have found that Grange engaged in misleading and deceptive conduct in breach of [the act] when it promoted the SCDOs to the councils in terms of suitable investments,” he said.
Because Grange is in liquidation, it cannot be ordered to make any compensation payments at this time.
Wingecarribee Shire Council, south-west of Sydney, led the class action seeking to recover $21.4 million in losses.
Held to account
Those involved in the class action appear set to get back about 33 cents in the dollar.
John Walker, executive director of IMF which helped fund the litigation, says the ruling paves the way for significant recoveries from the estate of Lehman Australia.
“So what this judgment means in divvying up around $230 million in assets in Lehman Australia, is if this finding holds, and it holds for every person in the class (action), then they’re looking at around three or four times what was proposed by the liquidators about three years ago,” he said.
“What we dealt with in these proceedings is to see whether or not we could make it accountable – an investment bank which actually sought to target not-for-profit organisations and make profit from selling derivatives to them in circumstances where they certainly should not have sold these products to those targets.”
Economics correspondent Stephen Long says the representative action paves the way for compensation to a large class of claimants who invested in the CDOs:
There’s a separate case being run in Australia which is targeting Standard and Poor’s – the ratings agency which rated these products as triple A – and that action will involve investors worldwide.
There’s a class action, a book being built of investors right now all around the globe. This case was being keenly watched in the United States, in Europe and elsewhere.
It’s significant on a number of fronts. One, that it opens up the possibility for further litigation; secondly, that it’s the first time, as I understand it, that a court anywhere has looked at the substantive issues in this case.
There are policy implications from this too.
One of the possible policy implications of this is that churches and charities aren’t really treated as being like say your ordinary retail investors, your mum and dad. They’re treated as being akin to a sophisticated investor where clearly they’re not and maybe there’s a need for reform of the Corporations Law on that front.
Secondly, the judge has made quite critical comments about the legislation. Justice Steven Rares said that there is a mind-boggling complexity in the definition of misleading and deceiving conduct now.
We used to have one simple test under the Trades Practices Act. Now there are separate definitions for financial services and financial products, definitions in different acts.
He says it should be simplified and all brought together in a very simple and easily administered test; that’s something for government to think about.
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