Lehmans 'gave no warning' on CDOs

Lehmans 'gave no warning' on CDOs
Elisabeth Sexton
June 2, 2011

Lehman Brothers Australia breached its duty to its clients says Tony Meagher, SC.

COMMONWEALTH Bank warned its clients about relying on credit ratings when investing in complex financial products but Lehman Brothers Australia did not, the Federal Court heard yesterday.

Tony Meagher, SC, for a class action of 72 local councils, charities and churches, said Lehman breached its duty to its clients because unlike its rivals it failed to disclose that credit rating agencies did not measure all the risks of buying synthetic collateralised debt obligations, or CDOs.

The class action seeks $250 million in compensation from the liquidator of the collapsed investment bank for losses incurred on CDOs sold by Lehman and its forerunner, Grange Securities.
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A research report headed ''Understanding the risks of synthetic CDOs'' published by Commonwealth Bank in 2006 said these products were riskier than similarly rated corporate bonds.

The report said investors should be aware of the ''limitations of only relying on the credit rating''.

Synthetic CDOs offered higher returns than corporate bonds ''to compensate investors for the difficulties faced in selling in the secondary market'', it said.

A firm specialising in advising local government authorities, Grove Research and Advisory, also published warnings which Lehman failed to disclose to its clients, Mr Meagher said.

CDOs suffered from ''high illiquidity'', Grove said in a report circulated in 2004.

''In other words, forced sellers will find it very difficult to find a buyer.''

This week, Mr Meagher referred to evidence in February and March from officials from the three lead members of the class action, Wingecarribee Shire Council, City of Swan and Parkes Shire Council, which he said showed that the views of rating agencies were ''critical'', ''dominant'' and ''vital'' to their investment decisions.

Councils in New South Wales were also subject to a ministerial order restricting their investments to a defined list, which included products carrying specified ratings by Standard & Poor's, Moody's Investors Service or Fitch Ratings.

Queried by Justice Steven Rares yesterday about evidence that Swan had a copy of the bank report, Mr Meagher said it had arrived during a changeover of finance staff at the council ''and that's as far as [the evidence] goes''.

Reading from transcript of evidence given in March by Swan's outgoing finance manager in 2006, Rajah Senathirajah, Justice Rares said: ''He says he might have put it on the file, paid no attention to it.''

Mr Meagher said other documents proved that Lehman, and before it Grange, knew that credit rating agencies did not assess risks associated with price volatility and illiquidity.

Standard & Poor's and Fitch only assessed the risk of a default causing ''the first dollar of loss'' and did not measure the likelihood of an investor losing all its capital.

Closing submissions continue today.

Read more: http://www.smh.com.au/business/lehmans-gave-no-warning-on-cdos-20110601-1fglj.html#ixzz1O2AGV7sh