Adviser failed to check right to sell notes, court told

S&P did not 'step away' from the rating it gave the notes in 2006.

THE financial adviser that sold loss-making Rembrandt Notes to 13 local councils made no effort to work out whether its licence permitted it to do so, the Federal Court heard yesterday.

If Local Government Financial Services had disclosed the structured financial products it was selling, they would have been excluded from its liability insurance policy, the barrister for Chartis Australia Insurance, Simon Couper, QC, said.

LGFS, owned by the NSW local government superannuation scheme, holds an Australian Financial Services Licence that does not allow it to sell financial derivatives.

It is defending a $16 million claim by the councils, who lost 93 per cent of their capital when the Rembrandt Notes, a type of Constant Proportion Debt Obligations, failed in 2008.

LGFS is in turn suing the arranger of the notes, the investment bank ABN Amro, and the agency that assigned them a AAA rating, Standard & Poor's. The councils are also suing the bank and the agency for negligence and misleading and deceptive conduct.

In his opening address, Mr Couper said the point was not whether the Rembrandt Notes were derivatives, but whether LGFS ever considered they might be.

"The reasonable financial adviser would have said to himself, these notes look like they might be derivatives I should tell my insurer because it's obvious to me that my insurer will want to know whether I have been acting outside my licence," Mr Couper said.

LGFS's barrister, Guy Parker, SC, said in his opening submission last week there was no evidence that any LGFS employee "had any inkling that there was even a question as to the relevant scope of its licence at the time of the [insurance] renewal".

In any event, the legal definition for the licence said that if a financial instrument was "a security" it was not "a derivative", Mr Parker said.

The Rembrandt Notes were debt instruments that fell under the definition of debentures, which fell under the definition of securities, he said.

On Friday the barrister for S&P, Steven Finch, also said LGFS should never have sold the Rembrandt Notes to the councils. "If it's not suitable for their purposes, who's to blame? The person who didn't find out that it wasn't suitable for their purposes," Mr Finch said.

"There is no doubt at all that the councils should not have purchased these notes for reasons completely unrelated to its rating. They didn't comply with the guidelines [issued by the minister for Local Government] or their individual policies."

Mr Finch said S&P did not "step away" from the AAA rating it gave the Notes in 2006, which he said meant "the prospects were that the likelihood of the interest and capital being repaid in respect of this note were extremely strong".

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