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, the notes would have been excluded from its liability insurance policy, said the barrister for Chartis Australia Insurance, Simon Couper, QC.
LGFS, owned by the New South Wales local government superannuation scheme, holds an Australian Financial Services Licence, which 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 obligation, failed in 2008.
LGFS is in turn suing the arranger of the notes, investment bank ABN Amro, and the ratings agency that assigned them a AAA rating, Standard & Poor's.
The councils are also suing the bank and the rating 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, which fell under the definition of debentures, which fell under the definition of securities, he said.
On Friday the barrister for Standard & Poor's, Steven Finch, SC, 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."
Mr Finch said S&P did not "step away" from the AAA rating it gave the Rembrandt 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".
Frequently Asked Questions about this Article…
What were the Rembrandt notes and why did they lead to big losses for local councils?
The Rembrandt notes were structured products described in the article as a type of constant proportion debt obligation. They failed in 2008, and the councils that bought them lost about 93% of their capital, triggering legal claims and disputes over who was responsible for the losses.
Who sold the Rembrandt notes to the councils and what licence did that adviser hold?
Local Government Financial Services (LGFS) sold the Rembrandt notes to 13 local councils. LGFS holds an Australian Financial Services Licence (AFSL) and the court hearing discussed whether that licence permitted it to sell the structured notes.
Did LGFS have the legal right under its AFSL to sell the Rembrandt notes—were they derivatives or securities?
The article reports competing legal arguments. Chartis (the insurer) and others suggested LGFS made no effort to check whether its AFSL allowed sale of derivatives. LGFS's lawyers countered that under the legal definitions, the Rembrandt notes were debt instruments (debentures) and therefore 'securities' rather than 'derivatives,' and so outside a derivative prohibition.
Which parties are involved in the lawsuits over the Rembrandt notes losses?
The councils have made a roughly $16 million claim against LGFS. LGFS, in turn, is suing the arranger ABN Amro and the ratings agency Standard & Poor's. The councils are also suing ABN Amro and Standard & Poor's for negligence and misleading and deceptive conduct.
Could LGFS’s liability insurance cover claims arising from the sale of the Rembrandt notes?
According to the insurer Chartis Australia, if LGFS had disclosed that it was selling structured financial products the Rembrandt notes would likely have been excluded from its liability policy. Chartis argued LGFS made no effort to check whether its licence permitted the sales, which was relevant to the insurer’s position.
What did Standard & Poor’s say about giving the Rembrandt notes a AAA credit rating?
Standard & Poor's (through its barrister) said it did not 'step away' from the AAA rating it assigned in 2006, and that the AAA rating indicated the prospects that interest and capital would be repaid were 'extremely strong' at the time the rating was given.
What legal claims are being made against ABN Amro and Standard & Poor’s?
The councils (and LGFS in parts) are pursuing claims against ABN Amro and Standard & Poor’s for negligence and for misleading and deceptive conduct arising from the sale and arrangement of the Rembrandt notes and the ratings assigned to them.
What can everyday investors take away from the Rembrandt notes dispute about investment suitability and ratings?
The article highlights a few practical points: structured products can be complex and may not be suitable for all investors; an adviser’s licence and whether a product falls inside that licence can matter; and a high credit rating (like AAA) does not remove questions about a product’s suitability or the need for due diligence before investing.
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