Shooting Fish in a Barrel: Investor Protection in the Aftermath of the Global Financial Crisis

‘How was it that relatively unsophisticated Council officers came to invest many millions of ratepayers’ funds in these specialised financial instruments? That is the fundamental question at the heart of these proceedings,' reflected Rares J, before pronouncing judgment in a case that has far-reaching implications for the regulation of financial services.¹ Wingecarribee Shire Council v Lehman Brothers Australia addressed directly a critical issue: what specific duty of care does a financial services provider owe to its clients and can these be voided by contractual terms or legislative exceptions? The Rares judgment provides the first definitive affirmative answer to the former and a negative to the latter. It held that a critical bifurcation in the Australian financial services legislation between sophisticated and unsophisticated investors cannot be used to evade responsibility of financial services providers to act in the best interest of clients. It found that Grange Securities, a wholly owned subsidiary of Lehman Brothers, had breached its fiduciary duty in facilitating individual transactions for complex products to sophisticated clients without explaining the risks. Of potentially greater significance, in what is a robust indictment of financial engineering and the methods used by its leading practitioners, it found that the placing of highly complex collateralised debt obligations in the investment portfolios of local councils constituted misleading and deceptive conduct.

The litigation's ongoing significance focuses on the interplay between two inter-connected factors. First, the judgment revealed a serious and still unresolved conflict over policy implementation of legislative intention in determining how complex securities instruments can and should be marketed. Second, it derived from rather than spawns a class action. That the testing of obligation was left to commercial funders, listed on the Australian Stock Exchange for profit, rather than the regulator funded by the taxpayer to uphold the public interest is even more surprising given that the entities represented in that action are themselves an arm of government. The Federal Court found that Wingecarribee was entitled to a $9 m payout. A confidential settlement has meant that the councils have been made whole but the story is a salutatory one of naivety and risk.

Lehman Brothers had entered the Australian market through its acquisition of Grange Securities and Grange Asset Management in March 2007.² In so doing, it took responsibility for the management of ongoing and prior relationships. These included the provision of transactional services and asset management for a number of local councils, each governed by a specific Individual Management Protocol (IMP). The Federal Court found that ‘the improvidence, and commercial naivety, of Grange’s Council clients in entering into these transactions that were highly advantageous to Grange’³ could only have occurred because the financial services firm was dealing with individual officials variously described as ‘financially quite unsophisticated and completely out of his depth’,⁴ ‘uninformed’⁵ and ‘careless’.⁶ Notwithstanding the carelessness, the Federal Court did not find grounds to reduce liability through contributory negligence. It did so because it found that the financial services firm had used a deliberate strategy to take advantage of its asymmetrical knowledge of product and regulatory complexity.⁷

‘The contrast between the actual, and patent, lack of financial acumen of the various Council officers at each of Swan, Parkes and Wingecarribee [each of which are local councils representing the class action] and the intelligent, shrewd and financially astute persons at Grange was striking’, noted Rares J.⁸ ‘Generally, risk-averse people do not take bets with substantial assets held for public purposes’, he concluded.⁹ That they did so could, the court found, be rendered explainable by the fact that they were victims of an elaborate deception. ‘Grange financed itself when it required cash by borrowing from its Council clients at a rate of interest or on terms as to security that Grange was not likely to achieve in an informed, arms length transaction with a commercial financier’.¹⁰ The clients had no ‘real appreciation of the true risks of SCDOS [Synthetic Collateralized Debt Obligations] or the financial wisdom of its [i.e. Grange’s recommendation’.¹¹ Rares J is, disarmingly, forthright as to how and why this could happen:

The nature and risks of a SCDO are concepts that are beyond the grasp of most people. Indeed, after the benefit of expert reports, concurrent expert evidence and the addresses of counsel, I am not sure that I understand fully how SCDOs work or their risks. Nonetheless, Grange portrayed itself as an expert in these investments. Most certainly, none of the seven Council officers who gave evidence had any expertise in these financial products. And, Grange knew and preyed on that lack of expertise and the trust the Councils placed in its expert advice.¹²

The 445-page judgment highlights again and again how Grange actively circumvented the stated objection of its clients to investing in illiquid complex instruments through a combination of deception and obfuscation. This is made manifest in the evaluation of specific dealings with Wingecarribee Council, a rural shire in New South Wales. ‘Grange tested the water’ and when the official ‘bit’ he was ‘reeled in’ by ‘words of comfort’.¹³ According to the Court, the council believed that it ‘had the best of both worlds: principal protection and increased interest. For Grange, this manner of allaying risk averse, financially unsophisticated council officers’ fears of CDOs, was as easy as shooting fish in a barrel'.¹⁴

There can be no doubting the level of judicial disquiet at corporate interpretation of the bifurcation between sophisticated and unsophisticated investors ‘given the subject matter involved, the prudent investment of public money’.¹⁵ The severity of the misconduct and the robustness of the judgment calls into question the sufficiency of a range of options canvassed by the Australian Department of Treasury on how complex financial products were systematically sold to mid-market participants (i.e. those that were deemed sophisticated or professional in legal terms but were, arguably, nothing of the sort).¹⁶ The still unresolved policy question focused on whether the conduct complained of in relation to Grange derived from a suboptimal culture within an individual firm. Although a significant actor in the Australian marketplace, Grange was not the sole facilitator of the placing of complex instruments in investor portfolios. In this crucial respect the judgment in Wingecarribee Shire Council v Lehman Brothers Australia raises more questions than it answers.

The ability to contract out of investor protection mechanisms is central to the rationale behind the bifurcation between sophisticated (i.e. wholesale or professional) and unsophisticated (i.e. retail) investors. In most developed markets much greater disclosure is required when products or financial advice are offered to retail clients.¹⁷Australia is no different, although the extent of compulsory superannuation further blurs the dividing line between investor classes.¹⁸ These restraints are designed to protect the naïve and the unwary from unscrupulous action by those with asymmetrical advantage. Sophisticated or professional investors, by contrast, have traditionally been assumed to have the resources to make informed decisions.¹⁹ The bifurcation has been justified, in part, on the need to facilitate financial services innovation and generate economic prosperity through the development of capital markets. These objectives can and often have had positive effects on the broader economy. Securitisation, for example, was once lauded as the primary mechanism for expanding home ownership. The dispersal of risk did, in fact, facilitate the advancement of credit to those imperfect credit histories.²⁰ The apparent success of securitization, however, was measured by short-term efficiency criteria. These retrospectively justified and legitimated the innovation. The potential negative externalities were traditionally glossed over or ignored.²¹ Following the implosion of the securitisation market, the individual corporate and societal consequences of this myopia became clear. The fallout impacted negatively the responsibility and legitimacy as well as long-term efficiency dimensions. Investment losses triggered an enormous erosion of private wealth. Housing and capital markets went into a downward spiral and credit stopped flowing. Emergency funding to the banking and financial services sector solved neither the underlying liquidity nor solvency problems. It merely transferred the risk. Sloganeering about the inherent unfairness of ‘privatized profits and socialized losses’ became more than a worn-out cliché. Nowhere was this more apparent than in the sorry tale of Lehman's Australian adventure.

In December 2007, four months after the problems in the US securitisation market became apparent, the Grange was rebranded as Lehman Brothers Australia and Lehman Brothers Asset Management, respectively. The incoming chief executive was Jim Ballentine, formerly head of Risk Strategy at the Fixed Income Division in New York, who was described as ‘a very senior credentialled Lehman resource’ whose appointment was designed to ‘provide connectivity to the Australian business and the global business’.²² The new CEO was acutely aware of the risks associated with complex derivatives (as indeed would the firm have been of Grange Securities role in developing this lucrative business through the due diligence process prior to its acquisition). He was interviewed, for example, for a BusinessWeek article as early as 2005 on the risk associated with credit defaults and defective modelling in credit derivivatives.²³ In 2005 Ballentine, as Head of Structured Credit was partly responsible for Lehman receiving the Euromoney Award for Excellence as ‘best derivatives house’, an award that the magazine claimed was based on the fact that ‘Lehman Brothers has been one of the more conservative credit derivatives houses. It has focused on doing the right thing for its credit derivatives clients. If that has meant missing out on a few extra cents per share over the years, so be it. And it has protected the bank from the reputational risk that the likes of Barclays Capital and Bank of America have run selling structured credit products’.²⁴ It was a reputation that was not to last in either the United States or in Australia.

The CDO market in Australia had experienced enormous growth in the early years of the millennium. In a survey conducted in 2007, updating previous research, the Reserve Bank of Australia noted demand was driven by what it described as middle-level rather than institutional investors, particularly local councils.²⁵ It also noted that that quality of the collateral shifted progressively downward as the rise of SCDOs offered investors capacity to include international credit exposure, particularly the United States. As early as 2004, the risk associated with SCDOs had been modeled by the Federal Reserve in Washington, D.C., with particular reference to potential time lags between a credit event happening and a ratings downgrade.²⁶ The Reserve Bank of Australia was much more sanguine. It did, however, highlight that the increasing complexity of some deals has made it difficult for issuers and investors to properly price risk.²⁷ It also noted that the ‘secondary market trading of CDOs is much less developed in Australia than in other markets. At present there are very few market-makers for these securities, though a number of institutions are prepared to transact on a best-endeavour basis’.²⁸

It would have been prudent for a manufacturer or supplier of these products to document both these trends and incorporate them into internal risk management and compliance procedures (i.e. it would have been prudent to ensure that the potential conflicts of interest in cases where the supplier was also underwriting the issue were identified, controlled, managed or avoided). It would also have been prudent to ensure that these risks were communicated to the client so that informed consent could be provided. In the provision of execution services, the presentation of material would need to ensure that there could be no suggestion that the relationship was advisory and that (with cause) the client was not considered a retail investor. A prudent supplier, mindful of its obligations to provide financial services ‘efficiently, fairly and honestly’,²⁹ would not engage in a deliberate strategy to obfuscate risk. While this would ensure flexibility to provide tailored services to those deemed capable of investing in complex products, at a purposive level, the sophisticated investor provisions of the Corporations Act are not designed to trap the unwary. But that is precisely what Rares J found had occurred in this case as a consequence of how Grange marketed its services and executed transactions.³⁰

“Grange knew that its business depended on winning and maintaining the trust and confidence of the financially unsophisticated and uninformed local government officers … with whom it dealt in order to effect transactions that would have been unachievable were the other party an informed investor’.³¹ The majority of the CDOs offered by Grange to Parkes Council, for example, were designed largely to exceed the minimum $500,000 threshold. The contract notes offered in evidence gave no indication of the true risks associated with the SCDO market, as highlighted in Reserve Bank of Australia research. According to the council officials they were transacted on the basis of misplaced confidence and trust and disconnect between standard disclaimers and the text in the body of an email.³² Grange ensured emails offering particular products carried a standard disclaimer:

In preparing this document the licencee did not take into account the investment objectives, financial situation and particular needs of any particular person. Before making an investment decision on the basis of this document the investor needs to consider, with or without the assistance of an advisor, whether the advice is appropriate in light of the particular needs, objectives and financial circumstances of the investor.³³

According to Rares J the fact that Parkes council continued to invest in these instruments from 2005 until 2007, ‘it follows that they continued to lack, and Grange continued to be aware that they lacked, any appreciation of the nature or risks of investing in each of the claim SCDOs. Had [they] become aware of the risks of capital loss that might be substantive, illiquidity, price volatility, the lack of a secondary market and the lack of Parkes’ investor suitability at any stage before the commencement of the global financial crisis in 2007 they would not have continued with investment of Council funds in SCDOs'.³⁴ Rares J noted that the disclaimers could not evade a prior fiduciary duty as a consequence of Grange assuming the position of trusted financial advisor.³⁵ ‘Its disclaimers told their readers not to act on a recommendation or opinion without first consulting the reader’s financial adviser. There is no doubt that the Council officers did exactly this … .A reasonable person in the circumstances of each Council would have understood that Grange was acting as its financial adviser and that the disclaimers did not apply to Grange’s advice and recommendations’.³⁶

The accountability deficit was heightened precisely because the clients were representatives of elected government. They had authority to invest surplus funds through the operation of the Local Government Act 1993 (NSW). The legislation specifies that investments can only be made in a form approved by the Minister for Local Government.³⁷ These two councils, Wingecarribbee and Parkes Shire, also had a responsibility to ensure that at all times investments were monitored in compliance with the Trustee Act 1925 (NSW) (TA Act). The third council, the City of Swan, a local council in Western Australia, was mandated to ensure its investment portfolio was administered in compliance with the Local Government Act 1995 (WA).³⁸ Throughout the period in which the New South Wales councils transacted with Grange Securities, the extant ministerial order allowed acquisition of securities that had been designated investment grade by Moody's Investor Services or Standard & Poors.³⁹ The accompanying guidelines specified the need to at ‘a minimum consider the desirability of diversifying investments and the nature and risks associated with the investments.’⁴⁰ These were further updated in July 2005, without restriction on the range of instruments chosen.⁴¹ The TA Act mandates ‘a council or entity acting on its behalf should exercise the care, diligence and skill that a prudent person would exercise in investing council funds. A prudent person is expected to act with considerable duty of care, not as an average person would act, but as a wise, cautious and judicious person would.’⁴² This standard, therefore, applies to the Parkes transactions and the Federal Court found they had acted prudently in taking the advice provided by Grange.

In the event that that responsibility is transferred to an external manager then the trustee must, in exercising a power of investment if the trustee's profession, business or employment is or includes acting as a trustee or investing money on behalf of other persons, exercise the care, diligence and skill that a prudent person engaged in that profession, business or employment would exercise in managing the affairs of other persons.⁴³ It is, therefore, appropriate that the provision of portfolio management services, be consistent with all of the terms of the relevant ministerial order and the TA Act. The TA Act states, in s 14C (1) ‘Without limiting the matters that a trustee may take into account when exercising a power of investment, a trustee must, so far as they are appropriate to the circumstances of the trust, if any, have regard to the following matters:

1. the purposes of the trust and the needs and circumstances of the beneficiaries.

2. the desirability of diversifying trust investments.

3. the nature of, and the risk associated with, existing trust investments and other trust property.

4. the need to maintain the real value of the capital or income of the trust.

5. the risk of capital or income loss or depreciation, the potential for capital appreciation.

6. the likely income return and the timing of income return.

7. the length of the term of the proposed investment.

8. the probable duration of the trust.

9. the liquidity and marketability of the proposed investment during, and on the determination of, the term of the proposed investment.

10. the aggregate value of the trust estate.

11. the effect of the proposed investment in relation to the tax liability of the trust.

12. the likelihood of inflation affecting the value of the proposed investment or other trust property.

13. the costs (including commissions, fees, charges and duties payable) of making the proposed investment.

The responsible officers had a duty to ensure that the portfolio was managed according to these objectives.⁴⁴ Counsel for Lehman Brothers Australia disavowed responsibility in favor of the technical issue of whether the inclusion of specific investments was consistent with the relevant order (i.e. were they permissible). It was a claim comprehensively rejected by Rares J, who deemed the insertion of SCDOs into the portfolios unwarranted.⁴⁵

Apart from the question of permissibility a second issue pivoted on who benefited most from the risk-benefit calculus (i.e. the extent to which these securities represented an appropriate investment strategy for the local councils given the relatively modest returns over the bank rate set against the downside risk in the event of default). Given the glaring conflicts of interest involved between Grange's vested interest in growing the CDO market and steering unsuspecting investors towards these products, it would have been necessary to document how these were addressed if the company was to remain in compliance with regulatory guidance.⁴⁶ No evidence was provided to court that this was done. Instead counsel for Lehman Brothers Australia stressed the sanctity of contract and the transference of responsibility to the council.

The Wingecarribbee IMP outlines the scope of the contract and outlines the scope of Grange's discretion.⁴⁷ The agreement provided Grange with wide discretion to deal, exercise any rights, establish operate or access any accounts, reinvest distribution and ‘do anything else in connection with the Portfolio which Grange considers proper or necessary.’⁴⁸ The client was permitted to vary the Guidelines and request disinvestment of specific assets if requests were made in writing. Critically, however, the agreement specifies that notwithstanding the commitment to provide the services in accordance with the Guidelines, ‘the Client acknowledges that the Portfolio may, for whatever reason, depart in a way which is not material from the Guidelines from time to time (but shall not be inconsistent with the Local Government Act (NSW) as amended’.⁴⁹ Moreover, Grange was provided authority to act on the instructions of any named authorised representative ‘without the need to check authority’.⁵⁰ The City of Swan IMP allowed for similar discretion both in terms of the scope of the agreement and authority to act on the instructions of any authorised individual without checking further authority.⁵¹

The contractual wording reinforced the asymmetrical disadvantage the councils voluntarily conceded. The critical issue for the court related to contractual wording.⁵² The Federal Court makes clear its belief that the results of such limited reasoning have been debilitating for corporate morality, corporate purpose and public order. ‘The last thing Grange wanted the Councils to think was that the investment in SCDOs had higher risk than the classes of investments with which the Councils were familiar and comfortable’.⁵³ Of equal importance, Rares J suggested that this was systematic.⁵⁴ ‘One thing is certain. Grange did not draw the disclaimers to the attention of any of the Councils. Nor did it tell any of them that it was not acting as the Council’s financial adviser. Importantly, Grange never suggested that it might be in a position of conflict, as the Council’s financial adviser for the transaction it was proposing and that the Council should obtain independent financial advice about what Grange was proposing, so that Grange could be released from any fiduciary obligation it owed’, he held.⁵⁵ As a direct consequence he found it only fair and reasonable that “Grange is liable to the Councils for their claims in contract, in negligence, for misleading and deceptive conduct, as well as for breach of fiduciary duty’.⁵⁶

The Wingecarribee Shire Council v Lehman Brothers Australia decision highlights the sub-optimal effect of a prior retreat to technicalities in dealing with substantive ethical considerations. The critical issue is how to respond. Tackling ethical deficiencies requires we may much more attention to the moral dimension of market conduct, which is at the core of the disclosure paradigm. It is essential to once again stress the ethical component of corporate and professional obligation. For the product manufacturer it demonstrates corporate responsibility, which can then be evaluated. For the regulator it offers an opportunity to engage in pro-active strategies that prevent systemic risk from developing. Ultimately, for the consumer and the sophisticated investor alike it provides a basis to trust.

Notes

1 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 14.

2 In December 2007, four months after the problems in the US securitisation market became apparent, the business was rebranded as Lehman Brothers Australia and Lehman Brothers Asset Management, respectively.

3 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 266.

4 Ibid, 483.

5 Ibid, 491.

6 Ibid, 462.

7 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 (“Grange was a person who, unlike each of the Council officers had the necessary financial acumen and expertise to be categorized as a “sophisticated investor” in the English ordinary usage of that expression. That is the capacity in which each Council engaged Grange to act on its behalf:’ at 913.)

8 Ibid, 752.

9 Ibid, 895.

10 Ibid, 264.

11 Ibid, 265.

12 Ibid, 410.

13 Ibid, 662.

14 Ibid.

15 Ibid, 790.

16 Department of Treasury, Wholesale and Retail Clients: The Future of Financial Advice (Canberra: January 2011) 8-10.

17 See Dimity Kingsford Smith, ‘Regulating Investment Risk: Individuals and the Global Financial Crisis’ (2009) 32 UNSW Law Journal 514 (questioning whether retail investors have the capacity or capability to evaluate risk and calling for a recalibration ‘between market efficiency and market protection:’ at 515); see also Joanna Grey and Jenny Hamilton, Implementing Financial Regulation (2006) 224 (noting that increased participation by retail investors, through self-investment and through defined contribution superannuation schemes leave unanswered questions of responsibility).

18 Kingsford Smith, above n 17, at 519.

19 See Securities and Exchange Commission v Capital Gains Research Bureau 375 US 180 (Goldberg J) (1963) (‘A fundamental purpose common to these statues, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry’: at 186). This necessitates, however, balancing valid and spurious claims, see Justin O’Brien, Redesigning Financial Regulation: The Politics of Enforcement (2007) 66-67 (citing Judge Milton Pollack’s argument that the federal securities laws are not meant ‘to underwrite, subsidize and encourage … rash speculation in joining a free-wheeling casino that lured thousands obsessed with the fantasy of Olympian riches but which delivered such riches to only a scant handful of lucky winners’). See generally, C. Edward Fletcher, ‘Sophisticated Investors Under the Federal Securities Laws’ (1998) 1998 Duke Law Journal 1081 at 1100 (noting US Eighth Circuit precedent that ‘there is no duty to disclose information to one who reasonably should already be aware of it’ beyond the basic facts so that outsiders may draw upon their own evaluative expertise in reaching their own investment decisions’). Increasingly, however, there are suggestions that the SEC should be given the power to ban either specific products or limit access to them, see Saule Omarova, ‘From Reaction to Prevention: Product Approval as a Model of Derivatives Regulation (2013) 3 Harvard Business Law Review 98; License to Deal: Mandatory Approval of Complex Financial Products’ (2012) 90 Washington University Law Review 63. For comparative review of how this is achieved with pharmaceutical products, see Daniel Carpenter, Reputation and Power: Organizational Image and Pharmaceutical Regulation at the FDA (2010).

20 See Stephen Schwartz, ‘The Alchemy of Securitisation’ (1994) 1 Stanford Journal of Law, Business and Finance 133.

21 Claudio Borio, ‘The Financial Crisis of 2007-? Macroeconomic and Policy Lessons’ (G20 Workshop on the Global Economy, Mumbai, 24-26 May 2009) 13 (‘to varying degrees, policymakers, just like everyone else, underestimated the threat. They were caught up in what, in retrospect, has partly turned out to be a Great Illusion. And even had the threat been fully recognized – and some no doubt did – the political economy pressures not to change policies would have been enormous. On the face of it, the regimes in place had proved to be extremely successful. A lot of reputational capital was at stake’) <http://www.g20.org/Documents/g20_workshop_causes_of_the_crisis.pdf>; see also Raghuram Rajan, Faultines: How Hidden Fractures Still Threaten the World Economy (2010) 1 (‘The problem was not that no one warned about the dangers; it was that those who benefited from an over­ heated economy—which included a lot of people—had little incentive to listen’).

22 Vishal Teckchandani, ‘Lehman Rebrands Australian Business,’ Investor Daily, 4 December 2007 <http://www.investordaily.com/cps/rde/xchg/id/style/3511.htm?rdeCOQ=SID-0A3D9633-D01480BA>.

23 See Mara Der Hovanesian, ‘Taking Risk to Extremes,’ Businessweek, 23 May 2005 <http://www.businessweek.com/magazine/content/05_21/b3934099_mz020.htm>. Moreover, the article cited an International Monetary Fund annual report, see International Monetary Fund, Global Stability Report (Washington, D.C. April 2005) 1 (‘If history is any guide, the single most important risk factor for financial markets in good times is complacency … .The combination of low risk premiums, complacency, and untested elements of risk management systems dealing with complex financial instruments could ultimately become hazardous to financial markets’). The report is prescient. It further warns, ‘An increasingly relevant contributor to this liquidity risk is the recent proliferation of complex and leveraged financial instruments, including credit derivatives and structured products such as collateralized debt obligations (CDOs). While secondary trading for these products exists, these instruments still rely on quantitative models for relative value assessment, investment decisions, and pricing. Therefore, there is a risk that models that are overly similar in their construction could cause investors to rush to exit at the same time, leading to market liquidity shortages. While risk management at many financial institutions has been strengthened and become more sophisticated in recent years, the risk management process still hinges, to a crucial extent, on the ability of market participants, in times of market stresses, to execute trades quickly without having prices move too much against them. However, most recent risk management models dealing with the new and complex credit instruments have not yet been put to a live test, that is, whether in time of need, the anticipated counterparties will stand ready to absorb the additional market and credit risks from those who would like to shed it’: at 3).

24 Euromoney Awards For Excellence 2005 <http://www.euromoney.com/Article/1000868/Awards-for-excellence-Best-credit-derivatives-house.html>.

25 Reserve Bank of Australia, ‘Recent Developments in Collateralised Debt Obligations in Australia,’ Bulletin, November 2007 <http://www.rba.gov.au/publications/bulletin/2007/nov/pdf/bu-1107-1.pdf> (‘Just over a third of NSW local governments had an investment in CDOS. Of those identified as holding CDOs, the average holding was 15 per cent of their investment portfolio, although the dispersion around this number is wide’: at 7).

26 See Michael Gibson, ‘Understanding the Risk of Synthetic CDOS,’ Federal Reserve Board, Finance and Economics Discussion Series (2004-36, Washington D.C. November 2004) <http://www.federalreserve.gov/pubs/feds/2004/200436/200436pap.pdf> 1 (‘Even though mezzanine tranches are typically rated investment-grade, the leverage they possess implies their risk (and expected return) can be many times that of an investment-grade corporate bond’).

27 Reserve Bank of Australia, above n 25, 1.

28 Ibid, 4.

29 Corporations Act 2001 (Cth) s. 912A(1)(a).

30 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 (noting presentation materials in which Grange presented itself as a an ‘unique advisor to Councils,’ that ‘always advocates prudent investments’ on the basis of rigorous research and due diligence’ and claimed that ‘Councils who have invested directly on Grange's advice have consistently outperformed those that invested in managed funds:’ at 469).

31 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 736.

32 Sue Lanin, ‘Lehman Hits Back at Council Claims,’ ABC Online (Sydney), 7 March 2011 <http://www.abc.net.au/news/2011-03-03/lehman-hits-back-at-councils-claims/1966490>.

33 Email from Grange Securities to Parkes Council (Second Amended Statement of Claim, PRK.500.001.0049).

34 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 492. Although the court found that ‘this is not to diminish the significance of [Parkes Council investment manager] Mr Bokeyar's inattention to even the simplest written material dealing with each proposed investment of large amounts of public money. However, this trait must have become obvious over a short time to [Grange officials] Ms May and Mr Clout as they dealt with Mr Bokeyar and certainly, no later than February 2005:’ at 493.

35 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 (Grange was, and held itself out as, an expert on financial products and in the giving of financial advice to local government councils. The Council officers were, in contrast, not expert in either field. Rather they were reliant on Grange for information and advice about the SCDO products it was seeking to sell or buy. Grange chose to give an explanation of FRNs and each SCDO product to Swan. Each occasion was a serious one involving the possible investment of significant sums of public money by a person that Grange appreciated, or ought to have realised, was financially uninformed or, at the very least, far less informed than it about the nature of those products’: at 786).

36 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 788. This built from previous argument that ‘the reason that the Grange representatives never mentioned the disclaimers in any oral dealings they had with Councils was patent. It had offered its services as, and acted as, a financial adviser to each of the Councils in respect of, among others, the particular transaction or dealing it was recommending to the Council and advising the Council to effect. As I explained in [585] the last thing Grange wanted was for the Councils to seek someone else's advice, given that it had positioned itself as a trusted financial adviser on investments for them’: at 726.

37 Local Government Act 1993 (NSW), s. 625 (2).

38 Local Government Act 1995 (WA), s. 614.

39 See Harry Woods, Local Government Act 1993 – Order (16 November 2000) (l); David Campbell MP, Local Government Act 1993 – Order (15 July 2005). The capacity to hold products that held investment grade ratings was rescinded in July 2008, see Paul Lynch, Local Government Act 1993 – Order (31 July 2008).

40 NSW Department of Local Government Circular to Councils, ‘Forms of Investment – Ministers Order’ (29 November 2000) and accompanying Investment Guidelines 1; these were amended in 2005 (noting also that ‘Ratings in no way guarantee the investment or protect an investor against loss. Prescribed ratings should not be misinterpreted by councils as an implicit guarantee of investments or entities that have such ratings. Even given this challenge, ratings provide the best independent information available’: at 2.). The Guidelines further note that in the event that a security falls below the required minimum, ‘a council must make all the necessary arrangements to withdraw the deposit as soon as practicable’: at 2. Moreover, although the guidance states that ‘funds required in the short-term must be invested with a short-term profile rather than with exposure to more volatile asset classes’ there is no further explicit restriction placed on asset class or concentration.

41 See Campbell, above n 39.

42 Trustee Act 1925 (NSW) s. 14A (2) (b)).

43 Ibid, s. 14A (2) (a).

44 For discussion of the prudent person test, see W. A. Lee, ‘Trustee Investing: Homes and Hedges’ (2001) 1 Queensland University of Technology Law and Justice Journal 3.

45 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 891.

46 See ASIC RG181.54 (Disclosure should also specify ‘the extent (if any) to which the licensee (or any associated person) has a legal or beneficial interest in the financial products that are the subject of the financial product advice; the extent (if any) to which the licensee (or any associated person) is related to or associated with the issuer or provider of the financial products that are the subject of the financial product advice; and the extent (if any) to which the licensee (or any associated person) is likely to receive financial or other benefits depending on whether the advice is followed’).

47 Wingecarribee Council IMP (Second Amended Statement of Claim, document in evidence: WNG.004.001.0045, section 2.1).

48 Ibid, s. 2.2(e).

49 Ibid, s. 2.3(d).

50 Ibid, s. 4.3(c).

51 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 (noting, ‘There was no evidence that Grange ever suggested to any of the three Councils that they should seek “professional advice”. That is because Grange had assumed the role of being the Councils’ financial adviser and provided the very advice to them that the disclaimers exhorted them to seek’: at 585).

52 See Lee above n 102 (‘It is the contract that governs the relationship. It is unwise, particularly in Australia, to assume that financial advisers undertake fiduciary duties unless they are prescribed within the context of an enforceable relationship … .So in employing financial advisers to advise them or financial services providers to invest for them trustees must take great care in framing the terms of the contract between them:’ at 16). It is a formulation that Rares J rejects, see Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 727.

53 Wingecarribee Shire Council v Lehman Brothers Australia (in liq) [2012] FCA 1028 at 975.

54 Ibid, There was no evidence that Grange ever suggested to any of the three Councils that they should seek “professional advice”. That is because Grange had assumed the role of being the Councils’ financial adviser and provided the very advice to them that the disclaimers exhorted them to seek’: at 585.

55 Ibid, 727.

56 Ibid, 984.