Standard & Poor's is facing a class action worth more than $100 million over its decision to stamp top-notch credit ratings on complex products that inflicted hefty losses on local councils.
In a move tipped to pave the way for similar actions overseas, a group of 90 councils, churches and charities filed a legal claim against the credit rating agency in the Federal Court on Tuesday.
IMF (Australia), which is funding the action, will allege S&P misled the small investors when it said its ratings were independent. It will also say S&P did not have "reasonable grounds" to rate so highly what were toxic debts.
Many councils bought the products from Lehman Brothers Australia.
They had names such as Glenelg, Scarborough and Blue Gum and received ratings of AA or AAA but plunged in value during the global financial crisis.
The claim, being led by Western Australia's City of Swan and Moree Plains Shire Council in NSW, will allege councils would never have invested in the products if staff had known all the risks.
The executive director of IMF, John Walker, said the suit would make similar arguments to a claim from the US Department of Justice, which has alleged S&P misled investors when it said its ratings were independent.
Credit rating agencies have suffered a backlash since the financial crisis over claims they were conflicted by payments from investment banks issuing the products.
"The ratings agencies got too close to the banks and were not being objective when giving their opinions," Mr Walker said.
Some of the same councils who had invested with Lehman Brothers were told on Monday they could get almost half their money back, under a proposal from liquidators.
The latest suit is targeting the remaining losses.
It comes after the Federal Court last year ruled in a separate case that a group of councils were entitled to $30 million damages in a similar case against ABN Amro, S&P and finance company Local Government Financial Services.
The previous suit related to products called constant proportion debt obligations, or CPDOs, but Tuesday's class action centres on more widely held products called collateralised debt obligations, or CDOs.
S&P's Australian office did not comment on the action, but it is challenging last year's court ruling.