FEDERAL COURT OF AUSTRALIA

ABN AMRO Bank NV v Bathurst Regional Council [2014] FCAFC 65

Citation:

ABN AMRO Bank NV v Bathurst Regional Council [2014] FCAFC 65

Appeal from:

Bathurst Regional Council v Local Government Financial Services Pty Ltd (No 5) [2012] FCA 1200

Parties:

ABN AMRO BANK NV (ARBN 84 079 478 612), McGRAW-HILL INTERNATIONAL (UK) LIMITED, LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741), AMERICAN HOME ASSURANCE COMPANY (ABN 007 483 267753) v BATHURST REGIONAL COUNCIL, COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100), COROWA SHIRE COUNCIL (ABN 43 874 223 315), DENILIQUIN COUNCIL (ABN 41 992 919 200), EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945), MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582), MURRAY SHIRE COUNCIL (ABN 77 334 235 304), NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569), NARROMINE SHIRE COUNCIL (ABN 99 352 328 504), OBERON COUNCIL (ABN 13 632 416 736), ORANGE CITY COUNCIL (ABN 85 985 402 386), PARKES SHIRE COUNCIL (ABN 96 299 629 630), CITY OF RYDE (ABN 81 627 292 610), ABN AMRO BANK NV (ARBN 84 079 478 612), MCGRAW-HILL INTERNATIONAL (UK) LIMITED, LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) and AMERICAN HOME ASSURANCE COMPANY (ABN 007 483 267753)

BATHURST REGIONAL COUNCIL v LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100), COROWA SHIRE COUNCIL (ABN 43 874 223 315), DENILIQUIN COUNCIL (ABN 41 992 919 200), EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945), MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582), MURRAY SHIRE COUNCIL (ABN 77 334 235 304), NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569), NARROMINE SHIRE COUNCIL (ABN 99 352 328 504), OBERON COUNCIL (ABN 13 632 416 736), ORANGE CITY COUNCIL (ABN 85 985 402 386), PARKES SHIRE COUNCIL (ABN 96 299 629 630) and CITY OF RYDE (ABN 81 627 292 610) v LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

MCGRAW-HILL INTERNATIONAL (UK) LIMITED v BATHURST REGIONAL COUNCIL, LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) and ABN AMRO BANK NV (ARBN 84 079 478 612)

MCGRAW-HILL INTERNATIONAL (UK) LIMITED v COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100), COROWA SHIRE COUNCIL (ABN 43 874 223 315), DENILIQUIN COUNCIL (ABN 41 992 919 200), EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945), MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582), MURRAY SHIRE COUNCIL (ABN 77 334 235 304), NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569), NARROMINE SHIRE COUNCIL (ABN 99 352 328 504), OBERON COUNCIL (ABN 13 632 416 736), ORANGE CITY COUNCIL (ABN 85 985 402 386), PARKES SHIRE COUNCIL (ABN 96 299 629 630), CITY OF RYDE (ABN 81 627 292 610), LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) and ABN AMRO BANK NV (ARBN 84 079 478 612)

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) v BATHURST REGIONAL COUNCIL, COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100), COROWA SHIRE COUNCIL (ABN 43 874 223 315), DENILIQUIN COUNCIL (ABN 41 992 919 200), EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945), MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582), MURRAY SHIRE COUNCIL (ABN 77 334 235 304), NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569), NARROMINE SHIRE COUNCIL (ABN 99 352 328 504), OBERON COUNCIL (ABN 13 632 416 736), ORANGE CITY COUNCIL (ABN 85 985 402 386), PARKES SHIRE COUNCIL (ABN 96 299 629 630), CITY OF RYDE (ABN 81 627 292 610), ABN AMRO BANK NV (ARBN 84 079 478 612), MCGRAW-HILL INTERNATIONAL (UK) LIMITED and AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

MCGRAW-HILL INTERNATIONAL (UK) LIMITED v LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) and ABN AMRO BANK NV (ARBN 84 079 478 612)

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267) v BATHURST REGIONAL COUNCIL, LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741), ABN AMRO BANK NV (ARBN 84 079 478 612) and MCGRAW-HILL INTERNATIONAL (UK) LIMITED

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267) v COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100), COROWA SHIRE COUNCIL (ABN 43 874 223 315), DENILIQUIN COUNCIL (ABN 41 992 919 200), EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945), MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582), MURRAY SHIRE COUNCIL (ABN 77 334 235 304), NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569), NARROMINE SHIRE COUNCIL (ABN 99 352 328 504), OBERON COUNCIL (ABN 13 632 416 736), ORANGE CITY COUNCIL (ABN 85 985 402 386), PARKES SHIRE COUNCIL (ABN 96 299 629 630), CITY OF RYDE (ABN 81 627 292 610), LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741), ABN AMRO BANK NV (ARBN 84 079 478 612) and MCGRAW-HILL INTERNATIONAL (UK) LIMITED

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267) v LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741), ABN AMRO BANK NV (ARBN 84 079 478 612) and MCGRAW-HILL INTERNATIONAL (UK) LIMITED

File numbers:

NSD 501 of 2013 NSD 502 of 2013 NSD 503 of 2013 NSD 504 of 2013 NSD 505 of 2013 NSD 507 of 2013 NSD 508 of 2013 NSD 522 of 2013 NSD 523 of 2013 NSD 524 of 2013

Judges:

JACOBSON, GILMOUR AND GORDON JJ

Date of judgment:

6 June 2014

Catchwords:

CONTRACT - breach of contract - contract for provision of financial services - implied warranties in s 12ED of Australian Securities and Investments Commission Act 2001 (Cth) - damages for breach of contract

CORPORATIONS - financial products - breach of Australian financial services licence under s 912A of Corporations Act 2001 (Cth) - meaning of derivative in s 761D(1) of Corporations Act 2001 (Cth) - meaning of debenture in s 9 of Corporations Act 2001 (Cth)

CORPORATIONS - misleading and deceptive statements - whether statements based on reasonable grounds and result of exercise of reasonable care and skill - effect of disclaimers - proportionate liability provisions

CORPORATIONS - rescission - requirements of s 924A of Corporations Act 2001 (Cth) - notice under s 925A of Corporations Act 2001 (Cth) - whether notice given within a "reasonable period"

DAMAGES - causation - remoteness - "rule" in Potts v Miller (1940) 64 CLR 282 - contributory negligence - statutory damages - measure for damages - apportionment - proportionate liability

EQUITY - fiduciary obligations - informal advisory relationship arising from conduct - whether breach of fiduciary duty - equitable compensation - equitable contribution

INSURANCE - whether insured entity a party to contract of insurance - effect of s 48 of Insurance Contracts Act 1984 (Cth) - duty of disclosure - construction of terms

PRACTICE AND PROCEDURE - entitlement to raise new matters on appeal

STATUTORY INTERPRETATION - whether investment permissible under s 625 of Local Government Act 1993 (NSW) - whether product a security within the meaning of relevant Ministerial order

TORT - whether duty of care owed - negligent misstatement - indeterminate liability - vulnerability - causation - unlawful conduct - effect of disclaimers - contributory negligence

TRADE PRACTICES - misleading and deceptive conduct - whether conduct engaged in "in this jurisdiction" - whether conduct in relation to financial product or financial services - "mere conduit"

Legislation:

Acts Interpretation Act 1901 (Cth)

Australian Securities and Investments Commission Act 2001 (Cth)

Competition and Consumer Act 2010 (Cth)

Corporations Act 2001 (Cth)

Evidence Act 1995 (Cth)

Civil Liability Act 2002 (NSW)

Law Reform (Miscellaneous Provisions) Act 1965 (NSW)

Local Government Act 1993 (NSW)

Trustee Act 1925 (NSW)

Wrongs Act 1958 (Vic)

Cases cited:

Abigroup Contractors Pty Ltd v Sydney Catchment Authority (No 3) (2006) 67 NSWLR 341

Advance (NSW) Insurance Agencies Pty Limited v Matthews (1989) 166 CLR 606

Aiken v Stewart Wrightson Members Agency Limited [1995] 1 WLR 1281

Al Saudi Banque v Clark Pixley [1990] Ch 313

Astley v Austrust Ltd (1999) 197 CLR 1

Austral Mining Construction Pty Ltd v NZI Capital Corp Ltd (1991) 4 ACSR 57

Australian Broadcasting Corporation v XIVth Commonwealth Games (1988) 18 NSWLR 540

Australian Securities and Investments Commission v Australian Lending Centre Pty Limited (No 3) (2012) 213 FCR 380

Australian Securities and Investments Commission v Citigroup Global Markets Australia Pty Ltd (No 4) (2007) 160 FCR 35

Australian Securities and Investments Commission v Healey (2011) 196 FCR 291

Australian Securities and Investments Commission v Narain (2008) 169 FCR 211

Australian Securities and Investments Commission v Stone Assets Management Pty Ltd (2012) 205 FCR 120

Australian Securities Commission v Macleod (2000) 22 WAR 255

Avoca Consultants Pty Ltd v Millenium3 Financial Services Pty Ltd (2009) 179 FCR 46

Banque Bruxelles Lambert S.A. v Eagle Star Insurance Co Ltd [1997] AC 191

Barcelo v Electrolytic Zinc Co of Australasia Ltd (1932) 48 CLR 391

Beach Petroleum NL v Kennedy (1999) 48 NSWLR 1

BHPB Freight Pty Ltd v Cosco Oceania Chartering Pty Ltd (No 2) [2008] FCA 1656

Branir Pty Ltd v Owston Nominees (No 2) Pty Ltd (2001) 117 FCR 424

Breen v Williams (1996) 186 CLR 71

Broadlands Properties Limited v Guardian Assurance Company Limited (1984) 3 ANZ Insurance Cases 60-552

Bryan v Maloney (1995) 182 CLR 609

BT Australia Limited v Raine & Horne Pty Limited [1983] 3 NSWLR 221

Brickenden v London Loan & Savings Co [1934] 3 DLR 465

Burke v LFOT Pty Ltd (2002) 209 CLR 282

Butcher v Lachlan Elder Realty Pty Limited (2004) 218 CLR 592

Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304

Caltex Australia Petroleum Pty Ltd v Charben Haulage Pty Ltd [2005] FCAFC 271

Caltex Oil (Australia) Pty Ltd v The Dredge "Willemstad" (1976) 136 CLR 529

Campomar Sociedad Limitada v Nike International Ltd (2000) 202 CLR 45

Canson Enterprises Ltd v Boughton & Co [1991] 3 SCR 534

Caparo Industries Plc v Dickman [1990] 2 AC 605

CE Heath Casualty & General Insurance Ltd v Grey (1993) 32 NSWLR 25

CGU Insurance Limited v Porthouse (2008) 235 CLR 103

Chubb Insurance Co of Australia Ltd v Moore (2013) 302 ALR 101

CIC Insurance Ltd v Bankstown Football Club Ltd (1997) 187 CLR 384

City Centre Cold Store Pty Ltd v Preservatrice Skandia Insurance Ltd (1985) 3 NSWLR 739 at 744-745

Commercial Union Assurance Co of Australia Ltd v Beard (1999) 47 NSWLR 735

Commissioner of Taxation v Firth (2002) 120 FCR 450

Commonwealth v Amann Aviation Pty Ltd (1991) 174 CLR 64

Coulton v Holcombe (1986) 162 CLR 1

Dartberg Pty Ltd v Wealthcare Financial Planning Pty Ltd (2007) 164 FCR 450

Demagogue Pty Limited v Ramensky (1992) 39 FCR 31

Derring Lane Pty Limited v Fitzgibbon (2007) 16 VR 563

Devries v Australian National Railways Commission (1993) 177 CLR 472

Digi-Tech (Australia) Pty Ltd v Brand (2004) 62 IPR 184

Dovuro Pty Ltd v Wilkins (2003) 215 CLR 317

Dow Jones & Co Inc v Gutnick (2002) 210 CLR 575

Eastern Express Pty Ltd v General Newspapers Pty Ltd (1992) 35 FCR 43

Ellison v Lutre Pty Ltd (1999) 88 FCR 116

Elna Australia Pty Ltd v International Computers (Aust) Pty Ltd (No 2) (1987) 16 FCR 410

Environment Agency v Empress Car Co (Abertillery) Ltd [1999] 2 AC 22

Esanda Finance Corporation Limited v Peat Marwick Hungerfords (1997) 188 CLR 241

Fitzgerald v FJ Leonhardt Pty Ltd (1997) 189 CLR 215

Fitzgerald v Masters (1956) 95 CLR 420

Fox v Percy (2003) 214 CLR 118

Furs Ltd v Tomkies (1936) 54 CLR 583

Ganson Enterprises Ltd v Boughton & Co (1991) 85 DLR (4th) 129

Gates v City Mutual Life Assurance Society Limited (1986) 160 CLR 1

Godfrey Spowers (Victoria) Pty Ltd v Lincolne Scott Australia Pty Ltd (2008) 21 VR 84

Green in his capacity as liquidator of Arimco Mining Pty Ltd (in liq) v CGU Insurance Ltd (2008) 67 ACSR 398

Grey v Australian Motorists and General Insurance Co Pty Ltd [1976] 1 NSWLR 669

Handevel Pty Ltd v Comptroller of Stamps (Vic) (1985) 157 CLR 177

Hampic Pty Ltd v Adams (2000) ATPR 41-737

Hawkins v Bank of China (1992) 26 NSWLR 562

Hedley Byrne & Co Limited v Heller & Partners Limited [1964] AC 465

Henderson v Merrett Syndicates Limited [1995] 2 AC 145

Henville v Walker (2001) 206 CLR 459

HIH Claims Support Limited v Insurance Australia Limited (2011) 244 CLR 72

Hospital Products Pty Ltd v United States Surgical Corp (1984) 156 CLR 41

HTW Valuers (Central Qld) Pty Limited v Astonland Pty Limited (2004) 217 CLR 640

Humes Ltd v Comptroller of Stamps (Vic) (1989) 89 ATC 4646

Hydrocool v Hepburn (No 4) (2011) 279 ALR 646

I & L Securities Pty Ltd v HTW Valuers (Brisbane) Pty Ltd (2002) 210 CLR 109

Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd (2008) 73 NSWLR 653

Ingot Capital Investments Pty Ltd v Macquarie Equity Capital Markets Ltd (No 6) (2007) 63 ACSR 1

In Re Coomber [1911] 1 Ch 723

Janssen-Cilag Pty Ltd v Pfizer Pty Ltd (1992) 37 FCR 526

Jumbunna Coal Mine NL v Victorian Coal Miners' Association (1908) 6 CLR 309

Kelly v R (2004) 218 CLR 216

Kenny & Good Pty Limited v MGICA (1992) Limited (1999) 199 CLR 413

Kestrel Holdings Pty Limited v APF Properties Pty Limited (2009) 260 ALR 418

Kizbeau Pty Ltd v WG & B Pty Ltd (1995) 184 CLR 281

Learoyd and Whiteley (1887) 12 AC 727

Lemon v Austin Friars Investment Trust [1926] 1 Ch 1

Levy v Abercorris Slate and Slab Co (1887) 37 Ch D 260

Lym International Pty Ltd v Marcolongo [2011] NSWCA 303

Maguire v Makaronis (1997) 188 CLR 449

Marks v GIO Australia Holdings Ltd (1998) 196 CLR 494

Masters v Cameron (1954) 91 CLR 353

Meyer Heine Pty Ltd v China Navigation Co Ltd (1966) 115 CLR 10

Miller v Miller (2011) 242 CLR 446

Mutual Life & Citizens' Assurance Co Limited v Evatt (1968) 122 CLR 556

National Exchange Pty Limited v Australian Securities and Investments Commission (2004) 49 ACSR 369

Nelson v Nelson (1995) 184 CLR 538

Niboyet v Niboyet (1878) 4 PD 1

NMFM Property Pty Ltd v Citibank Ltd (No 10) (2000) 107 FCR 270

O'Halloran v R T Thomas & Family Pty Ltd (1998) 45 NSWLR 262

Orb Holdings Pty Ltd v Lombard Insurance Company (Australia) Limited [1995] 2 Qd R 51

Origin Energy LPG Ltd v Bestcare Foods Ltd [2012] NSWCA 407

Parker, In the matter of Purcom No 34 Pty Limited (In Liq) (No 2) [2010] FCA 624

Perre v Apand Pty Ltd (1999) 198 CLR 180

Permanent Trustee Australia Limited v FAI General Insurance Company Limited (in liquidation) (2003) 214 CLR 514

Perpetual Trustee Co Ltd v BNY Corporate Trustee Services Ltd [2010] Ch 347; [2012] 1 AC 383

Pilmer v Duke Group Ltd (2001) 207 CLR 165

Podrebersek v Australian Iron and Steel Pty Ltd (1985) 59 ALJR 492

Prime Forme Cutting Pty Ltd v Baltica General Insurance Co Ltd (1991) 6 ANZ Insurance Cases 61-028

Project Blue Sky Inc v Australian Broadcasting Authority (1998) 194 CLR 355

R v Scott (1990) 20 NSWLR 72

Re Bauer Securities Pty Ltd; Austral Mining Construction Pty Ltd v NZI Capital Corp Ltd (1990) 4 ACSR 328

Reinhold v New South Wales Lotteries Corporation (No 2) (2008) 82 NSWLR 762

Rosenberg v Percival (2001) 205 CLR 434

San Sebastian Pty Limited v The Minister (1986) 162 CLR 340

Selected Seeds Pty Ltd v QBEMM Pty Ltd (2010) 242 CLR 336

Selig v Wealthsure Pty Ltd (2013) 94 ACSR 308

Singer v Williams [1921] 1 AC 41

Smith New Court Securities Ltd v Citibank NA [1997] AC 254

Solomons v District Court of New South Wales (2002) 211 CLR 119

South Australia Asset Management Corp v York Montague Ltd

Sullivan v Moody (2001) 207 CLR 562

Suttor v Gundowda Pty Ltd (1950) 81 CLR 418

Taco Company of Australia Inc v Taco Bell Pty Ltd (1982) 42 ALR 177

Tame v New South Wales (2002) 211 CLR 317

Target Holdings Ltd v Redferns [1996] 1 AC 421

Tepko Pty Limited v Water Board (2001) 206 CLR 1

The Owners - Strata Plan 61288 v Brookfield Australia Investments Limited [2013] NSWCA 317

Tipperary Developments Pty Ltd v State of Western Australia (2009) 38 WAR 488

Tonkin v Cooma-Monaro Shire Council (2006) 145 LGERA 48

Trade Practices Commission v Australian Iron & Steel Ltd (1990) 22 FCR 305

Travel Compensation Fund v Tambree (2005) 224 CLR 627

Unity Insurance Brokers Pty Limited v Rocco Pezzano Pty Limited (1998) 192 CLR 603

Voth v Manildra Flour Mills Pty Ltd (1990) 171 CLR 538

Watson v Ebsworth & Ebsworth (a firm) (2010) 31 VR 123

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Wealthsure Pty Ltd v Selig [2014] FCAFC 64

Wenham v Ella (1972) 127 CLR 454

Wingecarribee Shire Council v Lehman Brothers Aust Ltd (2012) 301 ALR 1

Woolcock Street Investments Pty Limited v CDG Pty Limited (2004) 216 CLR 515

Wyong Shire Council v Shirt (1980) 146 CLR 40

X (Minors) v Bedfordshire County Council [1995] 2 AC 633

Yango Pastoral Co Pty Ltd v First Chicago Australia Limited (1978) 139 CLR 410

Yorke v Lucas (1985) 158 CLR 661

Youyang Pty Ltd v Minter Ellison Morris Fletcher (2003) 212 CLR 484

YZ Finance Co Pty Ltd v Cummings (1964) 109 CLR 395

Explanatory Memorandum to the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003 (Cth)

Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998 (Cth)

Explanatory Memorandum to the Insurance Contracts Bill 1984 (Cth)

Donnan J, "Debentures, Derivatives and Managed Investment Schemes - the Characterisation and Regulation of Investment Instruments" (2002) 13 Journal of Banking and Finance Law and Practice 28

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Date of hearing:

3, 4, 5, 6, 7, 10, 11, 12, 13 and 14 March 2014

Date of last submissions:

26 March 2014

Place:

Sydney

Division:

GENERAL DIVISION

Category:

Catchwords

Number of paragraphs:

1,859

Counsel for ABN AMRO Bank NV:

I Jackman SC with M Darke

Solicitor for ABN AMRO Bank NV:

Allens

Counsel for McGraw-Hill International (UK) Limited:

SG Finch SC with KH Barrett and IJM Ahmed

Solicitor for McGraw-Hill International (UK) Limited:

Clayton Utz

Counsel for Local Government Financial Services Pty Ltd:

G Parker SC with J Giles

Solicitor for Local Government Financial Services Pty Ltd:

Norton Rose Australia

Counsel for American Home Assurance Company:

S Couper QC with J Gooley

Solicitor for American Home Assurance Company:

Wotton Kearney

Counsel for Bathurst Regional Council:

J Thomson

Solicitor for Bathurst Regional Council:

McIntosh McPhillamy & Co

Counsel for PA Councils:

N Hutley SC with A Coleman SC and C Withers

Solicitor for PA Councils:

Piper Alderman

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 501 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612)

First Appellant    

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Second Appellant

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Third Appellant

AMERICAN HOME ASSURANCE COMPANY (ABN 007 483 267753)

Fourth Appellant

AND:

BATHURST REGIONAL COUNCIL

First Respondent

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

Second Respondent

COROWA SHIRE COUNCIL (ABN 43 874 223 315)

Third Respondent

DENILIQUIN COUNCIL (ABN 41 992 919 200)

Fourth Respondent

EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945)

Fifth Respondent

MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582)

Sixth Respondent

MURRAY SHIRE COUNCIL (ABN 77 334 235 304)

Seventh Respondent

NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569)

Eighth Respondent

NARROMINE SHIRE COUNCIL (ABN 99 352 328 504)

Ninth Respondent

OBERON COUNCIL (ABN 13 632 416 736)

Tenth Respondent

ORANGE CITY COUNCIL (ABN 85 985 402 386)

Eleventh Respondent

PARKES SHIRE COUNCIL (ABN 96 299 629 630)

Twelfth Respondent

CITY OF RYDE (ABN 81 627 292 610)

Thirteenth Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Fourteenth Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Fifteenth Respondent

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Sixteenth Respondent

AMERICAN HOME ASSURANCE COMPANY (ABN 007 483 267753)

Seventeenth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 502 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

BATHURST REGIONAL COUNCIL

First Respondent

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Second Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Third Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 503 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612)

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

First Respondent

COROWA SHIRE COUNCIL (ABN 43 874 223 315)

Second Respondent

DENILIQUIN COUNCIL (ABN 41 992 919 200)

Third Respondent

EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945)

Fourth Respondent

MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582)

Fifth Respondent

MURRAY SHIRE COUNCIL (ABN 77 334 235 304)

Sixth Respondent

NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569)

Seventh Respondent

NARROMINE SHIRE COUNCIL (ABN 99 352 328 504)

Eighth Respondent

OBERON COUNCIL (ABN 13 632 416 736)

Ninth Respondent

ORANGE CITY COUNCIL (ABN 85 985 402 386)

Tenth Respondent

PARKES SHIRE COUNCIL (ABN 96 299 629 630)

Eleventh Respondent

CITY OF RYDE (ABN 81 627 292 610)

Twelfth Cross Appellant

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Thirteenth Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Fourteenth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth)

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 504 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

First Respondent

COROWA SHIRE COUNCIL (ABN 43 874 223 315)

Second Respondent

DENILIQUIN COUNCIL (ABN 41 992 919 200)

Third Respondent

EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945)

Fourth Respondent

MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582)

Fifth Respondent

MURRAY SHIRE COUNCIL (ABN 77 334 235 304)

Sixth Respondent

NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569)

Seventh Respondent

NARROMINE SHIRE COUNCIL (ABN 99 352 328 504)

Eighth Respondent

OBERON COUNCIL (ABN 13 632 416 736)

Ninth Respondent

ORANGE CITY COUNCIL (ABN 85 985 402 386)

Tenth Respondent

PARKES SHIRE COUNCIL (ABN 96 299 629 630)

Eleventh Respondent

CITY OF RYDE (ABN 81 627 292 610)

Twelfth Cross Appellant

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Thirteenth Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Fourteenth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 505 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Appellant

AND:

BATHURST REGIONAL COUNCIL

First Respondent

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

Second Respondent

COROWA SHIRE COUNCIL (ABN 43 874 223 315)

Third Respondent

DENILIQUIN COUNCIL (ABN 41 992 919 200)

Fourth Respondent

EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945)

Fifth Respondent

MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582)

Sixth Respondent

MURRAY SHIRE COUNCIL (ABN 77 334 235 304)

Seventh Respondent

NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569)

Eighth Respondent

NARROMINE SHIRE COUNCIL (ABN 99 352 328 504)

Ninth Respondent

OBERON COUNCIL (ABN 13 632 416 736)

Tenth Respondent

ORANGE CITY COUNCIL (ABN 85 985 402 386)

Eleventh Respondent

PARKES SHIRE COUNCIL (ABN 96 299 629 630)

Twelfth Respondent

CITY OF RYDE (ABN 81 627 292 610)

Thirteenth Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Fourteenth Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Fifteenth Respondent

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Sixteenth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 507 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612)

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

First Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Second Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 508 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

First Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Second Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 JUNE 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 522 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

BATHURST REGIONAL COUNCIL

First Respondent

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Second Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Third Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Fourth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 JUNE 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 523 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

First Respondent

COROWA SHIRE COUNCIL (ABN 43 874 223 315)

Second Respondent

DENILIQUIN COUNCIL (ABN 41 992 919 200)

Third Respondent

EUROBODALLA SHIRE COUNCIL (ABN 47 504 455 945)

Fourth Respondent

MOREE PLAINS SHIRE COUNCIL (ABN 46 566 790 582)

Fifth Respondent

MURRAY SHIRE COUNCIL (ABN 77 334 235 304)

Sixth Respondent

NARRANDERA SHIRE COUNCIL (ABN 96 547 765 569)

Seventh Respondent

NARROMINE SHIRE COUNCIL (ABN 99 352 328 504)

Eighth Respondent

OBERON COUNCIL (ABN 13 632 416 736)

Ninth Respondent

ORANGE CITY COUNCIL (ABN 85 985 402 386)

Tenth Respondent

PARKES SHIRE COUNCIL (ABN 96 299 629 630)

Eleventh Respondent

CITY OF RYDE (ABN 81 627 292 610)

Twelfth Respondent

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Thirteenth Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Fourteenth Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Fifteenth Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 JUNE 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 524 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

First Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Second Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Third Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE OF ORDER:

6 june 2014

WHERE MADE:

SYDNEY

THE COURT ORDERS THAT:

1.    The parties are directed to confer and bring in agreed orders to give effect to these reasons for judgment including the question of costs by 4:00pm on 13 June 2014. If the orders cannot be agreed, then the parties are to file a joint document which identifies the areas of agreement, the areas of disagreement and, for the areas of disagreement, the reason or reasons for that disagreement by 4:00pm on 13 June 2014.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth).

INDEX

PART 1: INTRODUCTION

[1]

PART 2: THE FACTS

[17]

1.    THE COUNCILS

[18]

1.1    Introduction

[18]

1.2    Ministerial Order and s 625 of the Local Government Act

[19]

1.3    Investment Guidelines

[21]

1.4    NSW Local Government Investments Best Practice Guide

[25]

2.    LGFS

[26]

3.    CPDOS AND STRUCTURED FINANCE PRODUCTS

[32]

4.    ABN AMRO

[37]

5.    S&P

[40]

5.1    S&P's Ratings Business and General Practice

[40]

5.2    Rembrandt 2006-2 and 2006-3

[45]

5.3    Rating of Rembrandt 2006-2 and 2006-3

[46]

6.    SALE OF NOTES TO LGFS

[59]

7.    SALE OF NOTES TO THE COUNCILS

[98]

8.    DECLINE OF THE REMBRANDT NOTES

[142]

PART 3: S&P'S RATING AND ABN AMRO'S KNOWLEDGE THAT THE RATING LACKED REASONABLE GROUNDS AND WAS MISLEADING

[145]

1.    CHRONOLOGY OF EVENTS RELATING TO THE VOLATILITY ISSUE

[145]

1.1    Introduction

[145]

1.2    Background to the development of the CPDO

[157]

1.3    The anti-DPN (or CPDO) is introduced to S&P

[179]

1.4    ABN Amro communicates with S&P's rating committee

[196]

1.5    ABN Amro provide S&P with more analysis

[204]

1.6    S&P conducts further analysis

[207]

1.7    The launch of the CPDO

[220]

1.8    Some issues raised within ABN Amro about roll costs

[222]

1.9    The CPDO in AUD

[227]

1.10    Tightening spreads

[240]

1.11    The ABN Amro Surf Presentation

[246]

1.12    Further correspondence on tightening spreads

[248]

1.13    Further emails about the rating

[251]

1.14    S&P issues rating letter

[259]

1.15    Mr Martorell's comparative table

[262]

1.16    S&P realises 15% volatility not justifiable

[265]

1.17    Mr Ding detects starting spread problem

[269]

1.18    Further discussion of the parameters

[273]

1.19    Rembrandt 2006-3

[283]

1.20    The stability analysis

[289]

1.21    "A crisis in CPDO land"

[305]

1.22    The ratings letter for Rembrandt 2006-3

[318]

1.23    More discussion about tightening spreads

[320]

1.24    Some further problems emerge

[329]

1.25    Further consideration of the rating

[334]

1.26    Further development of S&P's model

[363]

1.27    ABN Amro's "additional insertions" to the chronology

[371]

2.    CONSIDERATION OF THE VOLATILITY ISSUE

[374]

2.1    The rebalancing issue

[374]

2.1.1    Entitlement to raise rebalancing issue

[374]

2.1.2    Reasons why ABN Amro is not entitled to raise rebalancing issue

[387]

2.2    The 25% volatility argument

[425]

2.2.1    The primary judge's findings on the volatility parameter

[432]

2.2.2    The primary judge's three key findings on volatility

[464]

2.2.3    The primary judge's rejection of Mr Ding's evidence

[466]

2.2.4    The primary judge's rejection of Mr Chandler's evidence

[470]

2.2.5    The primary judge's rejection of ABN Amro's "reasonable grounds" submission

[472]

2.2.6    The primary judge's findings about the effect of tightening spreads and its relationship to volatility

[486]

2.2.7    The primary judge's finding about the "new" volatility assumption

[492]

2.2.8    ABN Amro's "unexplained error" influences the primary judge's finding

[501]

2.2.9    Other reasons why ABN Amro did not have reasonable grounds

[504]

3.    CONSIDERATION OF THE PRIMARY JUDGE'S FINDINGS ON VOLATILITY

[508]

4.    CONCLUSION

[563]

PART 4: LGFS' PURCHASE OF REMBRANDT 2006-3 NOTES: S&P

[564]

1.    TORT CLAIMS

[566]

1.1.    Duty of care owed by S&P to LGFS?

[566]

1.1.1    Facts

[569]

1.1.2    Applicable legal principles

[573]

1.1.3     Application of principles to facts

[579]

1.1.4    No reasonable foreseeability / risk of harm insignificant?

[585]

1.1.4.1    S&P's liability indeterminate and S&P not know identity of LGFS

[587]

1.1.4.2    LGFS was not vulnerable and, even if it was, S&P did not know of its vulnerability

[596]

1.1.4.2.1    Disclaimers

[602]

1.1.4.2.2    Pre-Sale Report

[605]

1.1.4.2.3    Ratings Letters

[611]

1.1.4.3    S&P did not have direct dealings with or control LGFS

[614]

1.1.4.4    LGFS contravened s 912A of the Corporations Act?

[617]

1.1.4.4.1    Introduction

[617]

1.1.4.4.2    Relevant Facts

[624]

1.1.4.4.3    The statutory definition of a debenture

[642]

1.1.4.4.4    The relevant provisions of the Corporations Act

[651]

1.1.4.4.5    Discussion

[661]

1.1.4.4.6    The legal consequences of LGFS selling and advising in relation to the Rembrandt notes in contravention of its AFSLs and s 912A of the Corporations Act

[701]

1.2    Breach of duty

[721]

2.    STATUTORY CLAIMS - APPLICATION OF SS 1041H, 1041E OF THE CORPORATIONS ACT 1041E AND S 12DA OF THE ASIC ACT

[723]

2.1    S&P's challenge to the primary judge's finding of liability under s 1041H of the Corporations Act

[724]

2.2    Was the conduct "in this jurisdiction"?

[729]

2.3    Section 1041E of the Corporations Act

[746]

2.4    Section 12DA of the ASIC Act

[754]

2.5    Was S&P's conduct misleading or deceptive?

[765]

3.    CAUSATION, RELIANCE AND REMOTENESS

[774]

3.1    Introduction

[774]

3.2    S&P's contentions on appeal

[785]

3.2.1    Alternative Universe Contention

[786]

3.2.2    Disclaimers Contention

[791]

3.2.3    Real Cause of Loss Contention

[795]

3.2.4    Indirect Causation Contention

[797]

3.2.5    Remoteness Contention

[799]

PART 5: LGFS' PURCHASE OF 2006-3 NOTES: ABN AMRO

[801]

1.    TORT CLAIMS

[803]

1.1    Introduction

[803]

1.2    First duty - to exercise reasonable care and skill in providing to LGFS information and advice about the Rembrandt notes

[805]

1.2.1    Introduction

[805]

1.2.2    Applicable principles

[808]

1.2.3    Evidentiary issues on appeal

[813]

1.2.4    Findings and Appeal Grounds

[815]

1.2.4.1    LGFS financially sophisticated and not vulnerable

[817]

1.2.4.2    LGFS' precondition to acquisition of Rembrandt 2006-3 notes was that S&P (not ABN Amro) assign AAA rating

[834]

1.2.4.3    Mandate Letter

[839]

1.2.4.4    Disclaimers in Surf Presentation and Rembrandt 2006-3 term sheet

[852]

1.3    Second Duty - to exercise reasonable care to arrange and cause to be issued to LGFS a financial product which had a degree of security commensurate with its AAA rating

[861]

1.3.1    Mandate Letter

[864]

1.3.2    Warranty?

[868]

1.3.3    S&P should have detected lack of creditworthiness in the notes

[869]

1.3.4    Vulnerability

[875]

1.3.5    Unlawfulness

[876]

1.4    Were these duties breached?

[877]

1.4.1    First Duty - negligent misstatement

[878]

1.4.1.1    Introduction

[878]

1.4.1.2    Representations made?

[881]

1.4.1.3    Representations misleading?

[906]

1.4.2    Second Duty - duty as structurer

[907]

2.    STATUTORY CLAIMS

[911]

2.1    Introduction

[911]

2.2    Section 1041H of the Corporations Act and s 12DA of the ASIC Act

[912]

2.3    Section 1041E of the Corporations Act

[915]

3.    CAUSATION

[916]

3.1    Introduction

[916]

3.2    Reliance Contention - First Duty and LGFS' misleading conduct case

[919]

3.2.1    Finding LGFS proved reliance

[923]

3.2.2    Finding that LGFS did not need to prove reliance on any of the ABN Representations

[930]

3.3    Alternative Universe Contention

[934]

4.    CONTRACTUAL CLAIMS OF LGFS AGAINST ABN AMRO

[936]

4.1    Introduction

[936]

4.2    Legislation

[939]

4.3    ABN Amro's contentions on appeal and analysis

[941]

4.4    Breach of contractual obligations

[946]

4.5    Loss and Damage

[948]

PART 6: LGFS AGAINST ABN AMRO AND S&P FOR LOSSES ON LGFS' RETAINED NOTES

[954]

1.    INTRODUCTION

[954]

2.    APPEAL GROUNDS

[955]

3.    POTTS v MILLER

[958]

3.1    Introduction

[958]

3.2    Analysis

[960]

3.3    Extreme spread widening accompanying the GFC

[974]

3.4    LGFS effectively "locked in"?

[978]

3.5    Impugned conduct did not continue to operate

[980]

3.6    LGFS able to sell to ABN Amro

[987]

4.    CREDIT FOR INTEREST OR COUPON PAYMENTS?

[989]

5.    NOTICES OF CONTENTION - LGFS AND COUNCILS

[990]

6.    LGFS CONTRIBUTORILY NEGLIGENT?

[992]

PART 7: LGFS' CLAIMS AGAINST ABN AMRO AND S&P IN RELATION TO SETTLEMENT WITH STATECOVER

[993]

1.    INTRODUCTION

[993]

2.    LIABILITY OF ABN AMRO TO LGFS

[997]

2.1    Tort Claims

[997]

2.2    Statutory Claims

[1000]

2.3    Causation

[1001]

3.    LIABILITY OF S&P TO LGFS

[1003]

3.1    Tort Claims

[1003]

3.2    Statutory Claims

[1006]

3.3    Causation

[1007]

3.4    Loss and Damage

[1008]

4.    EQUITABLE CONTRIBUTION

[1009]

5.    LGFS CONTRIBUTORILY NEGLIGENT?

[1016]

PART 8: PA COUNCILS' PURCHASE OF 2006-3 NOTES: LGFS

[1017]

1.    INTRODUCTION

[1017]

2.    TORT AND EQUITABLE CLAIMS

[1018]

2.1    Introduction

[1018]

2.2    Factual Analysis

[1019]

2.2.1    Nature of the relationship

[1021]

2.2.2    Representations made by LGFS to PA Councils

[1025]

2.2.3    The context in which the representations were made

[1027]

2.2.4    Distinction between RB and NRB Councils?

[1033]

2.2.5    LGFS' challenges to factual findings

[1035]

2.2.5.1    Challenge 1: Whether the witnesses were the decision makers and the availability of other potential advisers

[1037]

2.2.5.2    Challenge 2: Relevance of Right Balance Agreements

[1045]

2.2.5.3    Challenge 3: Whether the Councils would have understood that LGFS would prefer its own interests over those of the Councils

[1048]

2.2.5.4    Challenge 4: Whether the Councils were reliant on LGFS

[1050]

2.2.5.5    Challenge 5: Findings concerning LGFS' beliefs in J[1371]

[1052]

2.2.5.6    Challenge 6: Relevance of the speed of the Councils' decision to acquire the Rembrandt notes

[1056]

2.2.5.7    Challenge 7: Price volatility and whether the Rembrandt notes were suitable for any Council at any time

[1060]

2.2.6    Conclusion

[1062]

2.3    Fiduciary duty claim

[1063]

2.3.1    Introduction

[1063]

2.3.2    Applicable legal principles - fiduciary relationship

[1066]

2.3.3    LGFS' submission on appeal

[1067]

2.3.4    Did a fiduciary relationship exist between LGFS and the NRB Councils?

[1068]

2.3.5    Conflict of interest and therefore disclosures required by LGFS?

[1072]

2.3.5.1    Failure to disclose potential risks and ramifications faced by LGFS in holding $40 million of notes

[1074]

2.3.5.2    LGFS information

[1082]

2.3.6    Factual causation

[1085]

2.3.7.    Contributory negligence / indemnity / apportionment in relation to fiduciary duty claim

[1099]

2.4    Negligence and negligent misstatement

[1100]

2.4.1    Introduction

[1100]

2.4.2    Factual analysis

[1104]

2.4.3    Duty of care

[1105]

2.4.3.1    Conflict with LGFS' statutory duties as investment advisor?

[1108]

2.4.3.2    LGFS undertook, or was to be taken to have undertaken, to perform those obligations to each of the NRB Councils?

[1119]

2.4.4    Breach of duty

[1121]

2.4.4.1    LGFS' commercial objectives

[1132]

2.4.4.2    Suitability of Rembrandt for local councils

[1136]

2.4.5    Other representations and non-disclosures

[1153]

3.    STATUTORY CLAIMS

[1154]

3.1    Introduction

[1154]

3.2    Section 1041H of the Corporations Act

[1155]

3.2.1    'Conservatism' of Councils

[1162]

3.2.2    LGFS' perception of the Councils' understanding of structured products

[1167]

3.2.2.1    Previous investment in structured products and therefore necessary knowledge

[1169]

3.2.2.2    Councils as institutions

[1174]

3.2.2.3    Contents of documents provided by LGFS to PA Councils and their response

[1175]

3.2.2.4    Eurobodalla

[1178]

3.2.2.5    Oral Presentations to PA Councils

[1180]

3.2.2.6    Nature of product

[1186]

3.2.3    Specific representations

[1189]

3.2.3.1    Role of LGFS

[1190]

3.2.3.2    The highly volatile nature of the Rembrandt notes

[1197]

3.2.3.3    The meaning of "market value" for purpose of sale back to LGFS

[1203]

3.2.4.    The modelling disclaimer

[1207]

3.2.5    The March 2007 rating review by S&P

[1212]

3.2.6    The cash out and cash in features of the Rembrandt notes

[1217]

3.3    Section 1041E of the Corporations Act

[1222]

3.4    Section 12DA of the ASIC Act

[1223]

4.    CONTRACT CLAIMS IN RELATION TO COOMA AND COROWA

[1224]

5.    CAUSATION

[1225]

5.1    The 'But For' Test - the first step

[1226]

5.1.1    Role of LGFS

[1228]

5.1.2    NAV volatility and evolution of credit spreads

[1231]

5.1.3    Calculation of market value

[1235]

5.1.4    Modelling disclaimer

[1236]

5.1.5    March 2007 S&P CPDO Evaluator

[1237]

5.1.6    Likelihood of cash out

[1238]

5.1.7    Prospects of cash in

[1239]

5.2    The Scope of Liability - the second step

[1240]

5.3    Contributory negligence of the Councils?

[1243]

6.    LOSS AND DAMAGE

[1244]

7.    SECTION 1041E CLAIMS APPORTIONABLE?

[1245]

8.    UNLICENSED TO DEAL CLAIM

[1246]

9.    RESCISSION CLAIM BY COUNCILS

[1247]

PART 9: PA COUNCILS' PURCHASE OF 2006-3 NOTES: S&P

[1248]

1.    INTRODUCTION

[1248]

2.    TORT CLAIMS

[1250]

2.1    Negligence

[1250]

2.2    Facts

[1253]

2.3    Applicable legal principles

[1254]

2.4    Application of principles to facts

[1255]

2.5    S&P's Appeal Grounds

[1256]

2.5.1    No reasonable foreseeability / risk of harm insignificant?

[1257]

2.5.2    S&P's liability indeterminate and S&P did not know identity of the PA Councils

[1259]

2.5.3    PA Councils not vulnerable

[1263]

2.5.4    S&P did not control the PA Councils or have any direct dealings with them

[1270]

2.5.5    Councils acted unlawfully: s 625 of the Local Government Act

[1272]

2.5.6    Bathurst's concession

[1298]

2.5.7    Conclusion

[1302]

2.6    Breach of duty

[1303]

3.    STATUTORY CLAIMS

[1304]

3.1    Introduction

[1304]

3.2    Section 1041H of the Corporations Act

[1305]

3.3    Section 1041E of the Corporations Act

[1306]

3.4    Section 12DA of the ASIC Act

[1307]

3.5    Conduct of S&P misleading or deceptive

[1308]

3.6    Causation

[1309]

4.    CONTRIBUTORY NEGLIGENCE

[1310]

5.    LOSS AND DAMAGE

[1311]

PART 10: PA COUNCILS' PURCHASE OF 2006-3 NOTES: ABN AMRO

[1313]

1.    INTRODUCTION

[1313]

2.    FACTUAL FINDINGS

[1315]

3.    TORT CLAIMS

[1318]

3.1    Introduction

[1318]

3.2    Did a duty of care exist?

[1321]

3.2.1    Introduction

[1321]

3.2.2    Applicable principles

[1323]

3.3.3    Findings

[1325]

3.2.4    Appeal Grounds

[1326]

3.2.4.1    ABN Amro did not know that LGFS intended to market the Rembrandt 2006-3 notes to the PA Councils or any specific matter which might have enabled it to assess the type of information which should be provided to the PA Councils

[1328]

3.2.4.2    ABN Amro had no control over what (if any) information LGFS provided to the PA Councils

[1332]

3.2.4.3    ABN Amro did not assume responsibility for the provision of information to the PA Councils

[1334]

3.2.4.4    ABN Amro did not assume responsibility to LGFS "for modelling and structuring" the Rembrandt 2006-3 notes

[1337]

3.2.4.5    The PA Councils were not vulnerable to a breach of the alleged duty by ABN Amro

[1338]

3.2.4.6    The alleged duty was incompatible with the contractual relationship between ABN Amro and LGFS

[1341]

3.2.4.7    The alleged duty would leave ABN Amro exposed to liability in an indeterminate amount to an indeterminate class

[1342]

3.2.4.8    The alleged duty would require ABN Amro to review and assess the adequacy of S&P's rating of the Rembrandt 2006-3 notes in circumstances where it was inappropriate or impossible

[1343]

3.3    ABN Amro breached the duty?

[1347]

4.    STATUTORY CLAIMS

[1349]

4.1    Introduction

[1349]

4.2    Section 1041H of the Corporations Act and s 12DA of the ASIC Act

[1350]

4.2.1    ABN Amro's conduct

[1353]

4.2.2    Was ABN Amro's conduct misleading?

[1361]

4.3    Section 1041E of the Corporations Act

[1366]

4.4    Accessorial liability claims

[1368]

5.    CAUSATION, RELIANCE AND REMOTENESS

[1370]

5.1    Introduction

[1370]

5.2    Indirect Causation Contention

[1374]

5.3    Alternative Universe Contention

[1381]

5.4    Unlawfulness Contention

[1382]

6.    LOSS AND DAMAGE

[1383]

7.    COUNCILS' FAILURE TO TAKE REASONABLE CARE AND CONTRIBUTORY NEGLIGENCE

[1386]

8.    NO DEDUCTION FOR COUPONS

[1387]

PART 11: BATHURST PURCHASE OF 2006-3 NOTES

[1388]

1.    ABN AMRO'S CLAIMS AGAINST BATHURST

[1388]

1.1    Tort claims

[1388]

1.2    Statutory claims

[1392]

1.3    Loss and damage

[1395]

1.4    Contributory negligence

[1396]

2.    S&P'S CLAIMS AGAINST BATHURST

[1397]

2.1    Tort claims

[1397]

2.2    Statutory claims

[1398]

2.3    Causation

[1399]

2.4    Loss and damage

[1400]

2.5    Contributory negligence

[1401]

3.    LGFS' CLAIMS AGAINST BATHURST

[1402]

4.    RESCISSION CLAIMS - SECTION 925A OF THE CORPORATIONS ACT

[1403]

4.1    The trial judgment

[1409]

4.2    The appeal

[1419]

4.3    Consideration

[1422]

PART 12: CROSS CLAIMS

[1446]

1.    ABN AMRO CLAIM AGAINST S&P

[1446]

2.    S&P CLAIM AGAINST ABN AMRO

[1453]

PART 13: CONTRIBUTORY NEGLIGENCE, APPORTIONMENT, PREJUDGMENT INTEREST AND COSTS

[1457]

1.    CONTRIBUTORY NEGLIGENCE

[1457]

1.1    Introduction

[1457]

1.2    Rembrandt 2006-3 - LGFS contributorily negligent?

[1458]

1.2.1    Statutory framework

[1459]

1.2.2    Appeal Grounds

[1467]

1.2.2.1    Purchased notes for on-sale to councils

[1469]

1.2.2.2    The notes were not suitable for on-selling

[1471]

1.2.3    Conclusion

[1473]

1.3    Rembrandt 2006-2 - LGFS contributorily negligent?

[1474]

1.3.1    Appeal Grounds

[1474]

1.3.2    Analysis

[1475]

1.4    Councils contributorily negligent?

[1478]

1.4.1    Introduction

[1478]

1.4.2    Standard by which Councils' conduct to be assessed

[1482]

1.4.3    Councils' reliance on LGFS

[1484]

1.4.4    Councils' consideration of the Pre-Sale Report and the Post-Sale Report and other documents

[1489]

1.4.5    Council Officers' understanding of the Rembrandt notes

[1494]

1.4.6    Hindsight evidence as to what the Councils would have done

[1498]

1.4.7    Councils breached the Local Government Act

[1502]

1.4.8    LGFS' Appeal Grounds

[1503]

1.4.9    Conclusion

[1505]

2.    APPORTIONMENT

[1506]

2.1    Introduction

[1506]

2.2    Apportionment of the losses

[1508]

2.2.1    Applicable Principles

[1508]

2.2.2    Councils' losses

[1512]

2.2.3    LGFS' losses

[1513]

2.3    AHAC's submissions

[1514]

3.    PROPORTIONATE LIABILITY UNDER THE CORPORATIONS ACT AND THE ASIC ACT

[1517]

3.1    Introduction

[1517]

3.2    Proportionate liability

[1528]

3.3    Statutory framework

[1533]

3.4    The proportionate liability provisions under Div 2A of the Corporations Act

[1544]

3.5    The cross-appeal by LGFS, S&P and ABN Amro

[1553]

3.6    Consideration

[1555]

3.6.1    What facts established contraventions of s 1041E and s 1041H

[1591]

3.6.2    Joint and several or apportioned damages awards

[1608]

4.    PRE-JUDGMENT INTEREST

[1612]

5.    COSTS

[1615]

PART 14: INSURANCE ISSUES - APPEALS BY AHAC AGAINST LGFS

[1618]

1.    INTRODUCTION

[1618]

2.    LGFS' NOTICE OF CONTENTION

[1627]

2.1    Did LGFS owe the s 21 of the ICA duty of disclosure

[1627]

2.2    Discussion

[1631]

2.3    Were the Rembrandt notes a debenture

[1653]

3.    AHAC'S APPEALS

[1654]

3.1    Did LGFS breach its s 21 duty of disclosure

[1654]

3.2    LGFS' knowledge

[1677]

3.3    Was the duty of disclosure waived?

[1699]

3.4    Did any non-disclosure have a causative effect?

[1714]

3.5    Exclusion in Endorsement 17

[1739]

3.5.1    Introduction

[1739]

3.5.2    Was Endorsement 17 engaged?

[1742]

3.5.3    Does the insuring clause apply only to conduct within LGFS' AFSL?

[1758]

3.5.4    Conflict of interest

[1772]

3.6    Exclusion in Endorsement 16

[1776]

3.7    Exclusion clause 3.3

[1796]

3.8    Was an excluded cause a proximate cause?

[1817]

3.9    Whether the settlement of the StateCover proceedings was reasonable?

[1828]

PART 15: ORDERS

[1859]

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 501 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612) and others named in the attached Schedule of Parties

Appellant    

AND:

BATHURST REGIONAL COUNCIL and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 502 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

BATHURST REGIONAL COUNCIL and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 503 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612)

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100)

First Respondent and others named in the attached Schedule of Parties

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 504 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100) and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 505 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

Appellant

AND:

BATHURST REGIONAL COUNCIL and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 507 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

ABN AMRO BANK NV (ARBN 84 079 478 612)

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

First Respondent

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Second Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 508 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

MCGRAW-HILL INTERNATIONAL (UK) LIMITED

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741)

First Respondent

ABN AMRO BANK NV (ARBN 84 079 478 612)

Second Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 522 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

BATHURST REGIONAL COUNCIL and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 523 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

COOMA MONARO SHIRE COUNCIL (ABN 19 204 741 100) and others named in the attached Schedule of Parties

First Respondent

IN THE FEDERAL COURT OF AUSTRALIA

NEW SOUTH WALES DISTRICT REGISTRY

GENERAL DIVISION

NSD 524 of 2013

ON APPEAL FROM THE FEDERAL COURT OF AUSTRALIA

BETWEEN:

AMERICAN HOME ASSURANCE COMPANY (ABN 67 007 483 267)

Appellant

AND:

LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED (ACN 001 681 741) and others named in the attached Schedule of Parties

First Respondent

JUDGES:

JACOBSON, GILMOUR AND GORDON JJ

DATE:

6 JUNE 2014

PLACE:

SYDNEY

REASONS FOR JUDGMENT

PART 1: INTRODUCTION

1    ABN AMRO Bank NV (ABN Amro) is an investment bank. In 2006, it created a "CPDO" (a form of financial instrument or "structured financial product"), which it proposed to sell in AUD under the name "Rembrandt notes". Standard & Poors (S&P) was a division of McGraw-Hill Companies Inc. At the request of the issuer of a financial instrument, S&P would assign a rating to the instrument. The rating was intended to describe the likelihood that principal and interest due under the instrument would be paid in accordance with its terms. ABN Amro asked S&P to rate the Rembrandt notes. S&P rated them AAA (the highest rating assigned by S&P). S&P accepted on appeal that the rating was flawed.

2    ABN Amro marketed and sold the Rembrandt notes to Local Government Financial Services Pty Ltd (LGFS). The two Australian dollar issues were known as the Rembrandt 2006-2 and Rembrandt 2006-3 notes (collectively, the Rembrandt notes). As its name suggests, LGFS dealt with local government authorities. LGFS purchased $10 million of the Rembrandt 2006-2 notes ($6 million on behalf of StateCover Mutual Limited (StateCover) and $4 million which it purchased in its own name and subsequently transferred to StateCover). LGFS then purchased $45 million of the Rembrandt 2006-3 notes. LGFS sold a substantial portion of the Rembrandt 2006-3 notes to 13 municipal councils in New South Wales (the Councils). StateCover and the Councils lost much of the amounts they invested in the Rembrandt notes. StateCover and the Councils sued ABN Amro, S&P and LGFS for damages.

3    After a trial occupying 53 days, judgment was entered for the Councils against ABN Amro, S&P and LGFS and orders were made apportioning liability between them. LGFS also established an entitlement to equitable contribution from ABN Amro and S&P including on account of LGFS' payment to StateCover to discharge StateCover's claims against LGFS, S&P and ABN Amro (the StateCover settlement). The primary judge dealt also with other claims which are described in more detail below.

4    Ten separate proceedings were brought in the appellate jurisdiction of this Court and have been heard together. There are appeals and cross appeals. In their appeals, ABN Amro, S&P and LGFS advanced so many different appeal grounds that it was necessary to tabulate those grounds in tables comprising 306 entries set out over more than 120 pages. To assist the parties, and to the extent that it is feasible, we have endeavoured to note these tabulated appeal grounds in the course of our reasons. The grounds are identified in the following way "[Party Name] Appeal Grounds Matrix Row [##]". By their appeal grounds, ABN Amro, S&P and LGFS put in issue just about every finding of fact and conclusion of law made by the primary judge and for the most part pursued each allegation of error with undiscriminating vigour. As a result, these reasons for judgment must be, and are, very long and very complex. But, subject to some qualifications, the attacks made on the findings made, and conclusions reached, by the primary judge fail. The qualifications have only a limited effect on the primary judge's final orders. Defined terms are used throughout these reasons for judgment. For the assistance of the reader, a glossary of those terms is set out in Attachment A. Paragraphs of the trial judgment are identified by the prefix J[***]. On appeal, the parties also filed a statement of agreed facts. That statement was not comprehensive. Paragraphs of that statement are identified by the prefix [SAF***].

5    At trial, three proceedings were heard together ([SAF2]):

1.    Proceedings commenced by Corowa Shire Council and 11 other New South Wales regional councils (the PA Councils) against LGFS, ABN Amro and S&P, in which cross claims were made between those parties and American Home Assurance Company (AHAC) (Corowa Proceedings);

2.    Proceedings commenced by Bathurst Regional Council (Bathurst) against LGFS, ABN Amro and S&P, in which cross claims were made between those parties and AHAC (Bathurst Proceedings); and

3.    Proceedings commenced by StateCover against LGFS, ABN Amro and S&P, in which cross claims were made between those parties and AHAC (StateCover Proceedings).

6    LGFS also sued both ABN Amro and S&P: (1) on account of LGFS' payment under the StateCover settlement; (2) LGFS' own losses incurred on the sale of the Rembrandt 2006-3 notes to its parent company, Local Government Superannuation Scheme (LGSS) and (3) any liability that LGFS might be found to have to the Councils in respect of their claims against LGFS. In addition, because LGFS' insurer, AHAC, denied LGFS cover for the StateCover settlement and the claims of the Councils, LGFS sued AHAC for indemnity under its insurance policy: [SAF1].

7    LGFS, ABN Amro, S&P and AHAC all denied liability and raised various defences and cross-claims to the claims against them. The cross-claims included not only those of LGFS against S&P and ABN Amro but also those of S&P and ABN Amro against each other and of AHAC against LGFS for the repayment of defence costs already paid. Issues of contributory negligence were raised against the Councils and LGFS by S&P and ABN Amro. Issues of proportionate liability were raised between LGFS, S&P and ABN Amro in respect of claims against and between them other than the claims of AHAC which were separate: [SAF1].

8    The PA Councils were commonly represented: [SAF4]. Bathurst was separately represented. Despite some differences in the formulation of the claims made by Bathurst and the PA Councils (including an unconscionable conduct claim by Bathurst against LGFS), the claims may be described together: [SAF1].

9    The Councils' and LGFS' claims may be described as follows:

1.    The Councils against LGFS: (i) misleading and deceptive conduct; (ii) negligence; (iii) in respect of two of the councils, Cooma and Corowa, breach of contract; (iv) an unlicensed to deal claim and (v) breach of fiduciary duty. Bathurst also brought a claim for restitution based on an allegation that councils were not permitted to invest in the Rembrandt notes, a claim which the PA Councils made in the alternative only to their primary case that the Councils were permitted to invest in the Rembrandt notes. The remedies sought for the unlicensed to deal claim and the fiduciary duty claim included rescission of the Councils' agreements to purchase the Rembrandt notes with associated restitution and equitable compensation. The remedies sought for the other claims were damages: [SAF1]. On appeal, the PA Councils did not pursue their rescission claim.

2.    The Councils against S&P: (i) misleading and deceptive conduct and (ii)  negligence. The remedies sought were damages: [SAF1].

3.    The Councils against ABN Amro: (i) misleading and deceptive conduct; (ii) knowing involvement in S&P's misleading and deceptive conduct and (iii) negligence. The remedies sought were damages: [SAF1].

4.    LGFS against S&P: (i) misleading and deceptive conduct and (ii) negligence. The remedies sought were damages: [SAF1].

5.    LGFS against ABN Amro: (i) misleading and deceptive conduct; (ii) negligence and (iii) a contract claim in respect of the Rembrandt 2006-3 notes. The remedies sought were damages: [SAF1].

10    S&P's claims against ABN Amro only arose if S&P was found liable to LGFS and / or the Councils. In that event, S&P brought proportionate liability claims against ABN Amro as a concurrent wrongdoer: [SAF1]. ABN Amro's claims against S&P only arose if ABN Amro was found liable to LGFS and/or the Councils. In that event, ABN Amro brought proportionate liability claims against S&P as a concurrent wrongdoer: [SAF1].

11    LGFS claimed that AHAC was liable to indemnify LGFS for any liability it had in respect of the claims of the Councils and in respect of the StateCover settlement and its defence costs in connection with each. AHAC denied that LGFS has any right to indemnity under the contract of insurance on various grounds and sought repayment from LGFS of the defence costs already paid: [SAF1].

12    The primary judge held, and we would uphold on appeal, that:

1.    S&P's assignment of a AAA rating to the Rembrandt notes was misleading and deceptive and involved the publication of information or statements false in material particulars and otherwise involved negligent misrepresentations to the class of potential investors in Australia, which included LGFS and the Councils, because by the AAA rating there was conveyed a representation that in S&P's opinion the capacity of the notes to meet all financial obligations was "extremely strong" and a representation that S&P had reached this opinion based on reasonable grounds and as the result of an exercise of reasonable care and skill when neither was true and S&P also knew them not to be true when they were made;

2.    ABN Amro was knowingly concerned in S&P's contraventions of the various statutory provisions proscribing such misleading and deceptive conduct, and also itself engaged in conduct that was misleading and deceptive and published information or statements false in material particulars and otherwise involved negligent misrepresentations to LGFS specifically and the class of potential investors with which ABN Amro knew LGFS intended to deal, being the Councils, by reason of ABN Amro's deployment of the AAA rating and its own representations as to the meaning and reliability of the AAA rating which also were not true and ABN Amro knew them not to be true when they were made;

3.    ABN Amro breached its contract with LGFS under which ABN Amro was to model and structure the transaction by which LGFS would purchase the notes having a degree of security commensurate with a rating of AAA assigned by S&P; and

4.    LGFS engaged in misleading and deceptive conduct and in one respect the publication of information or a statement false in material particulars and otherwise made negligent misrepresentations to the Councils about the Rembrandt 2006-3 notes and, in addition, breached its Australian Financial Services Licence (AFSL) in advising the Councils about and selling to them the notes because the notes were not a debenture and thus not a security but a derivative under the Corporations Act 2001 (Cth) (Corporations Act) in which LGFS was not licensed to deal.

13    The primary judge also held that LGFS was in a fiduciary relationship with each Council and, in its dealings with the Councils, LGFS breached its fiduciary obligations to avoid conflicts of interest in respect of the notes, or to disclose and obtain fully informed consent to such conflicts. The relationship between LGFS and each Council was of a fiduciary nature. LGFS breached its fiduciary obligations by failing to avoid conflicts of interest in respect of the notes although the conflict (and therefore the nature of the breach) we would describe differently.

14    In relation to the damages, contributory negligence and apportionment, the primary judge held:

1.    The arguments made by:

1.1    LGFS, S&P and ABN Amro of contributory negligence or the equivalent by the Councils; and

1.2    S&P and ABN Amro of contributory negligence or the equivalent by LGFS in respect of, relevantly, the Rembrandt notes,

were rejected.

2.    LGFS established its entitlement to damages against S&P and ABN Amro (which were held to be proportionally liable as to 50% each) for LGFS' loss incurred on the sale of the downgraded Rembrandt 2006-3 notes to its parent company LGSS ($15,970,184.72).

3.    LGFS established its entitlement to damages or equitable contribution from S&P and ABN Amro (which were proportionally liable as to 331/3% each with LGFS liable for the other 331/3%) in respect of the settlement LGFS made of the StateCover proceedings against LGFS, S&P and ABN Amro ($3.175 million).

4.    The Councils established their entitlement to damages from S&P, ABN Amro and LGFS (which were held to be proportionally liable as to 331/3% each) being the difference between the principal amount each paid and the payment they received on the cash out of the notes.

5.    The Councils also established their entitlement to equitable compensation from LGFS for breach of fiduciary duty but the measure of equitable compensation was held to be the same as the damages otherwise payable by S&P, ABN Amro and LGFS as to 331/3% each.

6.    LGFS established it was entitled to indemnity under the contract of insurance between FuturePlus Financial Services Pty Ltd (FuturePlus) and AHAC.

15    On appeal, we would uphold these findings in relation to damages, contributory negligence and apportionment except that we would hold that the damages assessed in relation to the claim under s 1041E of the Corporations Act are not apportionable.

16    The balance of the judgment is divided into Parts as follows:

1.    The Facts: Part 2;

2.    S&P's Rating and ABN Amro's knowledge that the rating lacked reasonable grounds and was misleading: Part 3;

3.    LGFS' purchase of the Rembrandt 2006-3 notes:

3.1    As against S&P: Part 4;

3.2    As against ABN Amro: Part 5;

3.3    As against ABN Amro and S&P for losses on LGFS' Retained Notes: Part 6;

4.    LGFS' claim against ABN Amro and S&P in relation to StateCover: Part 7;

5.    The PA Councils' purchase of the Rembrandt 2006-3 notes:

5.1    As against LGFS: Part 8;

5.2    As against S&P: Part 9;

5.3    As against ABN Amro: Part 10;

6.    Bathurst's purchase of the Rembrandt 2006-3 notes: Part 11;

7.    The Cross-Claims: Part 12;

8.    Contributory negligence, apportionment, pre-judgment interest and costs: Part 13;

9.    Insurance Claim between LGFS and AHAC: Part 14;

10.    The Orders: Part 15.

PART 2: THE FACTS

17    This part of the judgment is divided into the following sections:

1.    The Councils;

2.    LGFS;

3.    CPDOs and Structured Finance Products;

4.    ABN Amro;

5.    S&P;

6.    Sale of Rembrandt notes to LGFS;

7.    Sale of Rembrandt notes to the Councils; and

8.    Decline of the Rembrandt notes.

1.    THE COUNCILS

1.1    Introduction

18    The Councils are bodies corporate constituted under the Local Government Act 1993 (NSW) (Local Government Act) and are the local government authorities for various shires in New South Wales: [SAF5].

1.2    Ministerial Order and s 625 of the Local Government Act

19    In making investments with council funds, the Councils were required to comply with s 625(1) of the Local Government Act which provides that a council "may invest money that is not, for the time being, required by the council for any other purpose": [SAF8]. Under s 625(2), "[m]oney may be invested only in a form of investment notified by order of the Minister published in the Gazette": [SAF8]. Ministerial orders were published in the Gazette in 2000 and 2005: [SAF8].

20    The Ministerial order of 15 July 2005 (Ministerial Order) permitted investments in nominated assets. The Ministerial Order relevantly stated that investment was permitted in (see [SAF8] and J[2214]):

(a)    any public funds or Government stock or Government securities of the Commonwealth or any State of the Commonwealth;

(b)    any debentures or securities guaranteed by the Government of New South Wales;

(c)    any debentures or securities, issued by a public or local authority, or a statutory body representing the Crown, constituted by or under any law of the Commonwealth, of any State of the Commonwealth or of the Northern Territory or of the Australian Capital Territory and guaranteed by the Commonwealth, any State of the Commonwealth or a Territory;

(d)    any debentures or securities issued by a Territory and guaranteed by the Commonwealth;

(e)    any debentures or securities issued by a council (within the meaning of the Local Government Act 1993);

(f)    mortgage of land in any State or Territory of the Commonwealth;

(g)    purchase of land (including any lot within the meaning of the Strata Schemes Management Act 1996) in any State or Territory of the Commonwealth;

(h)    interest bearing deposits in a bank authorised to carry on the business of banking under any law of the Commonwealth or of a State or Territory of the Commonwealth;

(i)    interest bearing deposits with a building society or credit union.

(j)    any bill of exchange which has a maturity date of not more than 200 days; and if purchased for value confers on the holder in due course a right of recourse against a bank, building society or credit union as the acceptor or endorser of the bill for an amount equal to the face value of the bill;

(k)    any securities which are issued by a body or company (or controlled parent entity either immediate or ultimate) with a Moody's Investors Service, Inc. credit rating of "Aaa", "Aa1", "a2", "Aa3", "A1" or "A2" or a Standard & Poor's Investors Service, Inc credit rating of "AAA'', "AA+", "AA", "AA-"; "A+", or "A" or a Fitch Rating credit rating of "AAA", "AA+", "AA", "AA-", "A+" or "A";

(l)    any securities which are given a Moody's Investors Service Inc credit rating of "Aaa", "Aa1", "Aa2", "Aa3", "A1"; "A2" or "Prime-1" or a Standard and Poor's Investors Service, Inc credit rating of "AAA", "AA+", "AA", "AA-", "A+"; "A"; "A1+" or "A1" or a Fitch Rating credit rating of "AAA", "AA+", "AA", "AA-", "A+" or "A";

(m)    any debentures or securities issued by a bank, building society or credit union;

(n)    a deposit with the Local Government Investment Service Pty Ltd;

(o)    a deposit with the New South Wales Treasury Corporation or investments in an Hour-Glass investment facility of the New South Wales Treasury Corporation.

(Emphasis added.)

1.3    Investment Guidelines

21    On 29 November 2000, the Director-General of the Department of Local Government issued a circular (DLG 2000 Circular) to all councils attaching a copy of the relevant ministerial order as then in force: [SAF 11] and J[27]. The last two paragraphs of the circular stated:

In addition, Councils (sic) attention is drawn to Update 8 of the Code of Accounting Practice and Financial Reporting that contains a policy direction that states "councils must maintain an investment policy". That investment policy must comply with the legislation and investment guidelines.

In keeping with existing arrangements it is the responsibility of each individual council to determine that its investments are authorised in terms of the listed securities. Note that the Guidelines issued with the previous Order remain unchanged.

Those paragraphs of the DLG 2000 Circular provided that: (1) the councils must maintain an investment policy; (2) the investment policy must comply with the legislation and investment guidelines and (3) it is the responsibility of each individual council to determine that its investments are authorised in terms of the listed securities: [SAF 11] and J[27].

22    Under s 23A of the Local Government Act, the Director-General was authorised to issue guidelines to councils about the exercise of their functions: [SAF12] and J[28]. By s 23A(3), "a council must take any relevant guidelines issued under [s 23A] into consideration before exercising any of its functions". [SAF12] and J[28].

23    The investment guidelines referred to in the DLG 2000 Circular (Investment Guidelines) stated that ratings were an independent assessment of the capacity of an instrument to meet its obligations and, whilst ratings were in no way a guarantee against loss, "ratings provide the best independent information available": [SAF13], J[30] and J[2524].

24    On 27 November 2006, a date which is after Corowa, Eurobodalla, Parkes and Orange invested in Rembrandt 2006-3 but before the other Councils did so (although only by a few days in some cases), the Director-General of the Department of Local Government issued a further circular to all councils (DLG 2006 Circular): [SAF14] and J[31]. Part of the DLG 2006 Circular ([SAF14] and J[31]) stated:

Following a recent survey it is apparent that some councils are not adhering to the current Ministerial Investment Order regarding the investment of funds. As a consequence, this circular replaces Circular 00/71 and should be read in conjunction with Circular 05/53 to further remind councils of their responsibilities.

Councils must comply with the Ministerial Investment Order, section 625 of the Local Government Act 1993 and clause 212 of the Local Government (General) Regulation 2005.

...

Councils must consider the following when considering an investment:

    the purpose of the investment

    the desirability of investment diversification

    the nature and risks associated with the investments

    the likely income return and timing of any income return

    the length of the proposed investment

    the costs involved in making the investment

    other matters as appropriate

Councils need to be aware of their obligation to be transparent when reporting changes of value in investments. The onus for investments is to be on preservation of capital rather than the rate of return.

As part of its overall financial plan, each council should develop and maintain an investment strategy/policy. The strategy/policy should, as a minimum, consider the desirability of diversifying investments and the nature and risk associated with the investments.

...

1.4    NSW Local Government Investments Best Practice Guide

25    The NSW Local Government Investments Best Practice Guide, referred to in the DLG 2006 Circular, was a draft document prepared by two industry bodies, Local Government Financial Professionals and Local Government Managers' Association: [SAF15] and J[32]. A number of the Councils were aware of, and had regard to, this document in preparing their investment policies and otherwise when undertaking investments: [SAF15] and J[32]. The draft document, which was initially issued in 2000 and re-issued in April 2006, included the following statements ([SAF15] and J[32]):

2.    The Requirement for a 'Prudent Person' Approach to Funds Management

Section 11.3.5 of the Local Government (Financial Management) Regulation requires council to ensure

'it or its representatives exercise care, diligence and skill that a prudent person would exercise in investing council funds.'

Based on the above a prudent person is one who exercises the key elements of care, diligence and skill.

Whilst not exhaustive the following is a list of the matters a prudent person would be expected to consider:

i)    read and understand the legislative framework around which council is to exercise its powers of investment

ii)    adopt an investment policy and strategy (see examples in Appendix (4) to this guide)

iii)    confirm who has the authority to place investments on council's behalf

iv)    identify any internal gaps in knowledge required to adequately manage council's investments

v)    ensure a suitably skilled member of staff is given day to day responsibility for the management of councils (sic) investments

vi)    ensure staff involved in managing council's investments receive adequate training to undertake their role(s)

vii)    consider the use of advisers (appropriately licenced (sic) by ASIC) to fill any knowledge gaps and to provide expert advice on individual investments and portfolio design and construction. Refer to Appendix 7 for suggested evaluation criteria for selecting an adviser.

viii)    invest only in accordance with the legislation, investment policy and strategy

ix)    determine the purpose of the investment (e.g. future needs of funds invested)

x)    do not invest in products you do not understand and take the time to learn/understand available products

xi)    consider how any proposed investment compliments other investments in the portfolio as part of ensuring appropriate diversification of investment style, issuer/manager and maturity profile.

xii)    review investment performance and portfolio mix at least monthly with reference to a set market benchmark and council objectives

xiii)    request investment institutions/managers/advisers/brokers to provide immediate feedback when significant and/or adverse events occur that relate to your investments

xiv)    ensure council maintains title to funds invested

xv)    report to council monthly in accordance with the legislation

xvi)    reconcile investments held to general ledger at least monthly

xvii)    review investment strategy at least annually

xviii)    seek independent research and advice before investing in sophisticated investment types (eg. managed funds, floating rate notes - FRN's or collateralised debt obligations - CDO's)

xix)    refer to Appendix 6 of this guide - 'CDO Checklist' before placing CDO investments

xx)    Refer to Appendix 8 of this guide - 'General Investments Checklist' before placing general investments (ie. cash funds, enhanced cash funds, fixed interest funds, bank bills/NCD's, floating rate notes, asset backed securities and bonds.

3.    Development of an Investment Policy and Strategy

The Local Government Code of Accounting Practice & Financial Reporting requires council to maintain an investment policy and strategy and to review the strategy at least annually as part of its overall financial plan.

Example Investment Policy and Strategy documents are attached to this guide as Appendix (4).

In addition to the matters referred to in the example documents, in putting an Investment Policy and Strategy together you should consider the following:

i)    are council's objectives and philosophy in relation to desired investment outcomes clear eg. is council seeking to maximise returns within regulatory investment boundaries, or to generate reasonable (nominated by council) returns with lowest risk exposure to achieve that return

ii)    have you assessed your council's tolerance to risk (eg. to what levels is council willing to accept capital losses or significant fluctuations in returns)

iii)    are council's objectives in relation to return and risk reconcilable

iv)    have you assessed your council's expectations regards (sic) investment returns

v)    does council have any environmental/ethical investment policies

vi)    does council have any existing specific future uses for invested funds that would impact on the manner funds should be invested

vii)    have you assessed the maximum and minimum terms over which investments should be placed

viii)    does council have the systems in place to record and report on the investments it makes

ix)    has council provided a commitment to staff training in relation to council's investing activities

x)    does council have a formal process for determining what funds should be invested (eg. daily cash-flow analysis)

xi)    what are the benchmarks against which you will measure the performance of council's portfolio.

2.    LGFS

26    LGFS was established in 1979 as the financial services arm of the Local Government and Shires Associations, which operated as peak industry bodies for local government in New South Wales: [SAF40] and J[960]. In October 2004, LGFS was purchased by LGSS, a division of FuturePlus: [SAF40] and J[961].

27    Prior to its purchase by LGSS, all LGFS board members were councillors from New South Wales councils. After its purchase by LGSS, the LGFS board had six directors: three representatives of LGSS (who were also councillors) and three representatives of "various [l]ocal [g]overnment affiliated trade unions". The board later came to include a seventh member - a nominee of the Local Government Professionals Association: [SAF120] and J[1139].

28    Between 1986 and 1997, LGFS operated a deposit-taking institution for councils: [SAF121]. In 1997 or 1998, it launched its own funds management service, which involved accepting deposits from councils which were then deposited in a nominated LGFS facility (usually a short-term cash facility): [SAF123] and J[961]. LGFS would then aggregate the deposits for a particular facility and re-invest them with external fund managers: [SAF123] and J[961]. Mr Warwick Hilder was appointed as LGFS' Chief Executive Officer (CEO) in 1998: [SAF41] and J[1140]. One of his functions at the time of his appointment was to expand LGFS' operations to include a funds management service: [SAF41] and J[1140]. Subsequent initiatives included the development of a "Local Government Facility", which was a managed cash facility providing "socially responsible investment options for councils" and a "Committed Rolling Investment", which provided a floating rate of return and constituted "a series of term deposits joined together to provide an investment with a longer term": J[961]. By 2006, LGFS' "key business activity" was (as described by Mr Hilder) providing management services and facilities for local government entities in New South Wales: J[1140].

29    LGFS had a lengthy history of interactions with councils in New South Wales: [SAF42] and J[963]. LGFS presented its role to councils as helping councils to get the most out of financial markets: J[1141]. LGFS wanted the councils to "feel a strong relationship" with LGFS, acting as a sounding board by providing financial advice on an ongoing but informal (i.e., unpaid) basis: J[1141] and J[1147]. Both Mr Hilder and Mr Mark Tischler, a financial markets specialist with LGFS (who reported to Mr Hilder) agreed that LGFS wanted to be perceived by the councils as their confidant: J[1147] and J[1148]. The councils could only make investments in accordance with the relevant Ministerial Order, the relevant terms of which are set out at [20] above. Under the terms of the Ministerial Order in force at the relevant times, the councils could invest with LGFS regardless of whether LGFS carried a credit rating: J[962]. Nonetheless, LGFS sought and obtained a credit rating. At all material times, LGFS' rating was A/A1: [SAF122] and J[962].

30    During the relevant period, LGFS held two AFSLs: [SAF47] and J[2939]. The first was effective in the period from 5 November 2004 to 17 January 2007 (First AFSL). The second was effective in the period from 18 January 2007 until 30 June 2007 (Second AFSL): J[2939]. The First AFSL relevantly provided:

AUTHORISATION

This licence authorises the licensee to carry on a financial services business to:

(a)    provide financial product advice for the following classes of financial products:

(i)    deposit and payment products limited to:

A.    basic deposit products;

B.    deposit products other than basic deposit products;

(ii)    debentures, stocks or bonds issued or proposed to be issued by a government;

(iv)    securities; and

(b)    deal in a financial product by:

(i)    issuing, applying for, acquiring, varying or disposing of a financial product in respect of the following classes of financial products:

A.    securities limited to:

1)    debentures of a body corporate or unincorporated body only; and

(ii)    applying for, acquiring, varying or disposing of a financial product on behalf of another person in respect of the following classes of products:

A.    deposit and payment products limited to:

1)    basic deposit products;

2)    deposit products other than basic deposit products;

B.    debentures, stocks or bonds issued or proposed to be issued by a government;

D.    securities;

to wholesale clients.

(Emphasis added.)

31    In the Second AFSL, sub-paragraph (b) was altered to read as follows (emphasis added):

(b)    deal in a financial product by:

(i)    issuing, applying for, acquiring, varying or disposing of a financial product in respect of the following classes of financial products:

B.    securities limited to:

1)    debentures of a body corporate or unincorporated body only.

3.    CPDOS AND STRUCTURED FINANCE PRODUCTS

32    The CPDO is a form of structured finance product: [SAF82] and J[55]. Structured finance products use mechanisms and instruments to transfer and allocate cash flows and risks associated with a pool or portfolio of assets. A mechanism commonly used in structured finance products is leverage. An instrument commonly used in structured finance products is the credit default swap (CDS): [SAF82] and J[55].

33    A CDS is a contract relating to credit default risk: [SAF83] and J[56]. A typical CDS involves one party (the protection seller) selling to another party (the protection buyer) protection against the risk of a credit event. The credit event, for example, may be a default (such as failure to pay or bankruptcy) by a single entity or a pool of entities. The protection buyer pays the protection seller a fee for the protection against the risk of the credit event (the CDS premium fee). In return, the protection seller pays a sum to the protection buyer on the occurrence of the credit event (the CDS default payment). The CDS premium fee is usually fixed at the outset and paid quarterly. The method of calculating the CDS default payment is also fixed at the outset and is paid only after the occurrence of a credit event. In other words, the CDS premium fee is certain (or subject only to the risk of default by the protection buyer under the CDS) whereas the CDS default payment is contingent on an event which may or may not occur in the future (the credit event in respect of the referenced entity or entities): [SAF83] and J[56].

34    The mechanisms which apply to an actual CDS can also be applied to a notional or synthetic CDS: [SAF84] and J[58]. A notional or synthetic CDS still involves a contract but the contract need not involve any actual CDS: [SAF84] and J[58]. Instead the contractual provisions create an arrangement which mirrors the cash flows that would occur if an actual CDS had been executed: [SAF84] and J[58].

35    The pool or portfolio which a CDS can reference is also flexible. Instead of referring to a single entity (or obligor) a CDS can refer to a pool of entities (or obligors). The entities are obligors because they are subject to credit obligations. In or about late 2003 and early 2004, the CDX North America Investment Grade Index (the CDX) and the iTraxx Europe Index (iTraxx) were created. The CDX lists 125 US investment grade obligors and the iTraxx lists 125 European investment grade obligors. Investment grade means the obligor is rated BBB or above by S&P (or its equivalent by other ratings agencies). The obligors are included in the list by reference to a process which takes into account investment grade, liquidity and diversification across industry sectors. Both of these indices are rolled every six months in March and September of each year. On each roll, the identity of the obligors in the indices is reviewed. Obligors who have become sub-investment grade or illiquid (by reference to the index criteria) are removed from the index and replaced with investment grade obligors with the object of maintaining the index as one containing the most liquid 125 investment grade obligors across the diversified industry sectors: [SAF85] and J[59].

36    Together, if weighted 50% each, the CDX and iTraxx are referred to as the Globoxx Index (Globoxx): [SAF86] and J[60]. Globoxx consists of 250 obligors made up of the 125 US investment grade obligors on the CDX and the 125 European investment grade obligors on the iTraxx: [SAF86] and J[60]. The background to the development of the CDOs is described further in Part 3, Section 1.2 below.

4.    ABN AMRO

37    Purchased by the Royal Bank of Scotland in 2007, ABN Amro is an investment bank with its headquarters in London: [SAF52] and J[678]. It created the CPDO in early 2006: [SAF53] and J[1].

38    The first tranche of CPDOs were issued in Euros, US dollars and Yen: [SAF53] and J[390]. Later in 2006, ABN Amro decided to market the CPDOs in other currencies, including the Australian dollar: [SAF53] and J[1]. The two Australian dollar issues were known as the Rembrandt 2006-2 and Rembrandt 2006-3 notes: [SAF53] and J[1]. The Rembrandt notes aimed to pay high periodic coupons by taking leveraged exposure to a notional portfolio of credit indices: [SAF88] and J[41]. The notional CDS index contract referred to the CDX and iTraxx indices (which were known as the Globoxx index when weighted 50% each): [SAF87] and J[61]. Under the notional CDS contracts, the investors were the notional sellers of protection against default by entities listed on the indices and the counterparty was the notional buyer of such protection: J[5] and [SAF87]. Although the CPDO evolved out of other structured financial products which ABN Amro and other financial institutions had developed (such as collateral debt obligations (CDOs) and constant proportion principal insurance (CPPI) and variants thereof), ABN Amro's CPDO was a new structured financial product which the market had not previously seen and which no ratings agency had previously rated: [SAF87] and J[61].

39    In early May 2006, ABN Amro approached S&P for the purposes of obtaining a credit rating for the CPDO: [SAF104] and J[95]-J[99]. ABN Amro obtained the rating because many potential investors would not have the resources or expertise to assess the creditworthiness of the CPDO or to second-guess the rating of a structured financial product and many institutional investors could only invest in products with an investment grade rating: J[2759] and J[2816]. ABN Amro's role is further explained below.

5.    S&P

5.1    S&P's Ratings Business and General Practice

40    S&P, at the relevant time a division of the McGraw-Hill Companies, Inc., carried on a business of providing credit ratings, including through McGraw Hill International (UK) Limited, at the request of the issuer of an instrument to be rated: [SAF63], J[23] and J[381]. S&P's business model for rating structured financial products depended on potential investors requiring banks and financial institutions to obtain ratings from internationally recognised credit rating agencies such as S&P: J[2524].

41    S&P was paid a substantial fee to assign a rating "knowing that the only purpose of its rating is to facilitate the marketing of the product": J[2787].

42    S&P described the meaning of its credit ratings in a document entitled "Issue Credit Ratings Definitions" which was available, amongst other places, on its public website: J[34], J[35] and J[1463(1)]. This publication does not suggest that the ratings scale can be understood only in the context of a report by S&P explaining the particular rating. It is a stand-alone document which assumes that the reader will correlate a rating to the definition. Relevantly, it described a AAA rating in the following way ([SAF103] and J[35]):

An obligation rated 'AAA' has the highest rating assigned by [S&P]. The obligor's [the instrument's] capacity to meet its financial commitment on the obligation is extremely strong.

(Emphasis added.)

S&P's default probability criterion for a 10 year financial instrument or product rated AAA was 0.728%: J[65]-J[66].

43    In its public statements, S&P explained that "an S&P rating of a financial instrument or product concerns only the likelihood that the principal and interest will be paid in accordance with the terms of the instrument or product being rated. An S&P rating of a financial instrument or product is not concerned with the nature, magnitude or consequences of default": [SAF102], J[35], J[63] and J[381]. Once a rating is assigned by S&P, S&P generally publishes the rating, including on its website: J[383]. It did so in this case.

44    S&P had specialised skills and knowledge relevant to forming an opinion as to the creditworthiness of obligors in general and of complex structured products in particular: J[68]-J[69].

5.2    Rembrandt 2006-2 and 2006-3

45    Rembrandt 2006-2 was issued on 5 September 2006: [SAF95] and J[670]. It was denominated in Australian dollars and had a subscription amount of AUD $50 million: [SAF95], J[670] and J[2754]. Rembrandt 2006-3 was issued on 2 November 2006: [SAF96] and J[670]. It was denominated in Australian dollars and had an initial subscription amount of AUD $40 million: [SAF96], J[670] and J[2754]. In January 2007, the subscription for Rembrandt 2006-3 was increased by $5 million: [SAF96], J[670] and J[2754]. S&P knew the Rembrandt notes were to be marketed by ABN Amro in Australia: J[227], J[229]-J[231], J[260] and J[290]. S&P knew that the notes could only be dealt with in tranches with a minimum issue price of $500,000 ([SAF98] and J[2754]) and consequently knew that the class of purchasers of Rembrandt 2006-2 was not more than 100 buyers and that the class of purchasers of Rembrandt 2006-3 was limited to not more than 80 buyers: J[495].

5.3    Rating of Rembrandt 2006-2 and 2006-3

46    S&P assigned ratings of AAA to the Rembrandt 2006-2 and 2006-3 notes: [SAF64], J[1], J[267], J[268] and J[318]. The sequence of events leading up to those ratings may be summarised as follows.

47    In early May 2006, ABN Amro retained S&P to rate the "anti-DPN" or Surf CPDO: [SAF104] and J[95]-J[99]. The anti-DPN is described at [164] below. On 6 June 2006, S&P informed ABN Amro that it was comfortable that the CPDO structure could be rated: [SAF105] and J[200].

48    S&P had access to substantial amounts of data, historical knowledge, complex modelling and the resources and personnel of ABN Amro's London office necessary to model the initial CPDO notes, a process which took well over a month and the expertise of a number of S&P skilled employees: J[76]-J[376], J[385]-J[388], J[498]-J[501] and J[691]-J[959].

49    S&P prepared and issued reports about Rembrandt 2006-2 (the Pre-Sale Report) and Rembrandt 2006-3 (the Post-Sale Report) (collectively, the S&P Reports): [SAF65] and J[43]-J[46]. The Pre-Sale Report prepared and issued by S&P on 11 August 2006 assigned a preliminary 'AAA' rating to Rembrandt 2006-2 and included the statement that (J[2530]):

Information has been obtained by Standard & Poor's from sources believed to be reliable. However, because of the possibility of human or mechanical error by our sources, Standard & Poor's does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or the result obtained from the use of such information. Ratings are statements of opinion, not statements of fact or recommendations to buy, hold or sell any securities.

Analytic services provided by Standard & Poor's Ratings Services (Ratings Services) are the result of separate activities designed to preserve the independence and objectivity of ratings opinions. Ratings are statements of opinion, not statements of fact or recommendations to buy, hold, or sell any securities. Ratings are based on information received by Ratings Services.

(Emphasis added.)

50    The Pre-Sale Report included the following (J[45]):

Constant Proportion Debt Obligation Synthetic Presale Report

Rembrandt Australia Trust No. 2006-2

A$100 Million Floating-Rate Notes

This presale report is based on information as of Aug 11, 2006. The credit rating shown is preliminary. This report does not constitute a recommendation to buy, hold or sell securities. Subsequent information may result in the assignment of a final credit rating that differs from the preliminary credit rating. …

Class

Prelim rating*

Prelim amount (Mil A$)

Interest

Average life

Legal final maturity

A

AAA

100

Three-month BBSW plus a margin

August 2013

August 2016

*The rating on each class of securities is preliminary as of Aug. 11, 2006 and subject to change at any time. Final credit ratings are expected to be assigned on the closing date subject to a satisfactory review of the transaction documents and legal opinion, and completion of a corporate overview. Standard & Poor's ratings address timely interest and principal on the notes.

Transaction Participants

Transaction Key Features

Arranger

ABN AMRO Bank NV

Expected closing date

August 2006

Issuer

Rembrandt Australia Trust No 2006-2

Structure type

Synthetic debt obligation

Credit index portfolio administrator

ABN AMRO Bank NV

Portfolio composition

Corporate credit indices

Reserve account provider

ABN AMRO Bank NV

Purpose of transaction

Arbitrage

Swap counter party

ABN AMRO Bank NV

Portfolio management type

Rules based rebalancing

  

Reinvestment period (years)

10

Weighted-average maturity of assets (years)

5

Supporting Ratings

Institution/role

Rating

ABN AMRO Bank NV as swap counterparty and reserve account provider

AA-/Stable/A-1*

Transaction Summary

Preliminary credit ratings have been assigned to the constant proportion debt obligations (CPDOs) to be issued by Rembrandt Australia Trust No. 2006-2.

Notable Features

This is the second CPDO structure rated by Standard & Poor's that addresses the timely payment of interest and payment of principal. Previously, Standard & Poor's has rated other credit CPPI transactions that have principal protection, and CDO transactions that have timely payment of interest and principal.

For this transaction, Standard & Poor's assessed the possibility of the returns on the risky portfolio, plus the interest received on the risk-less deposit covering the full interest due on the note and principal at maturity. The analysis models the spreads on the credit indices, the default probability of constituents of these indices, the interest rate curve, and the effect of these on the returns earned through the structure.

The CPDO is a fixed-income instrument. It targets the payment of the stated coupons by taking variable leveraged exposure to a credit portfolio to generate sufficient returns to enable the coupon payments to be made.

The credit portfolio comprises two credit indexes (the credit index portfolio). The risk of these indexes will be passed on to investors, potentially until September 2016, through CDSs. The leveraged exposure will change over time. The arranger will calculate this exposure using a transparent and contractually agreed dynamic leverage control formula.

In addition, a CPDO differs from a standard single-tranche synthetic CDO in the following two ways:

    Under a standard single-tranche synthetic CDO, leverage is achieved by selling protection only on a specified tranche of a portfolio's theoretical capital structure. Under the CPDO, protection will be sold on the full theoretical capital structure of the portfolio, on a non-tranched basis. In other words, investors will be exposed to the full loss risk on the index portfolios subject to a maximum loss equal to their investment. Mark-to-market gains, or losses on the sold protection do not depend on correlation, as the protection is sold on a non-tranched basis. However, leverage is created by the fact that the amount of protection sold can be a multiple of the total note notional amount.

    There is possibility of "cashing-in" to a risk-free coupon-paying bond before maturity. This would mean that credit risk is not taken for the full life of the note, as the credit portfolio will be unwound after a "cash-in" event.

Mechanics Of The Structure

Under a swap agreement, the proceeds of the notes will be deposited with ABN AMRO Bank N.V. (AA-/Stable/A-1+). At the same time, CDS protection will be sold on the credit-index portfolio (see chart 1).

The total notional amount of protection sold on the credit index portfolio will be such that the present value of the expected income from the credit index portfolio will sufficiently cover the difference between: (i) the present value of the coupons and the principal due under the note, and (ii) the net asset value (NAV) of the note.

The total notional amount is referred to as the target portfolio size. The NAV of the notes is calculated as the sum of the deposit value and the mark-to-market of the credit-index portfolio.

In addition, the target credit portfolio size has certain maximum size constraints. If the actual credit portfolio size differs from the target credit portfolio size by more than 25%, then the actual credit portfolio size is adjusted to equal the target credit portfolio size, subject to the maximum size constraints.

In other words, the CPDO only uses the leverage it needs to make the scheduled principal and interest payments. If the NAV increases, the target portfolio size will generally decrease as the portfolio needs to generate less income to meet coupon and principal payments. This mechanic constitutes the dynamic leverage control formula.

Once the current note NAV equals the present value of the payments under the note, the credit-index portfolio will be unwound and no further credit exposure will be taken (a cash-in event). If this occurs, all future payments due under the notes will be made, and no more exposure to a credit portfolio will be taken.

Conversely, if the current note NAV is equal to or lower than 10% of par, the credit-index portfolio will be unwound and no further credit exposure will be taken (a "cash-out" event). If this occurs, all coupon payments under the note will cease and the proceeds of the cash deposit will be returned to the noteholder (see chart 2 for the CPDO process).

image

Strengths, Concerns, And Mitigating Factors

Strengths

    CPDOs are designed with a high likelihood of cashing-in to a risk-free investment that pays the stated coupons and principal at maturity.

    A highly rated bank will hold the note proceeds.

    When compared with a static portfolio comprised of identical underlying reference entities, rolling the indices acts as a defensive mechanism that limits negative credit migration and default risk.

    There is a high degree of transparency and liquidity in the on-the-run Dow Jones CDX, and the iTraxx European indices, which comprise the index portfolio.

    The index credit portfolio is untranched. Therefore, correlation is unnecessary for the calculation of the CPDO NAV.

Concerns

    A cash-out event will negatively affect interest payments and principal payment to investors.

    Credit risk and marked-to-market losses associated with the index investments and the rules governing them, may negatively affect interest payments and principal payments to investors.

    The extent of the portfolio's unfunded leverage is a source of risk.

   Forward interest rate risk movements will affect the target portfolio size and leverage adjustments.

Mitigating factors

    Standard & Poor's has analyzed the impact of the cash-out risk on interest and principal and has deemed it consistent with a 'AAA' rating.

    Standard & Poor's has analyzed the various risks associated with the transaction, particularly expected marked-to-market losses (and gains), interest rate movements, credit losses due to defaults, and has concluded that the net impact on the probability of paying timely interest and full principal is consistent with a 'AAA' rating.

    Spread widening, attended by no corresponding defaults, is beneficial to the structure.

    The structure's leverage decreases with the net present value (NPV) of future coupons promised on the structure. Consequently, the cash-in time of the structure is modelled to be less than the actual maturity of the note.

Credit Portfolio Characteristics And Management

The credit portfolio is initially invested in two credit indexes - the Dow Jones CDX 6 and the iTraxx Europe 5. Dow Jones and iTraxx Ltd, publish a new series of indices at six-month intervals. The index rules determine which credits are discarded and which are added. Generally, these rules seek to maximize the liquidity of the names in the indexes, and to substitute out credits that are no longer eligible credits. One aspect of eligibility in the Dow Jones CDX 6 and iTraxx Europe 5, is that all credits must be investment-grade. This serves to limit the credit risk in the transaction. Under the terms of this issuance, the transaction will be rolled out of the old and into the new indexes with the index roll dates. The marked-to-market gains or losses incurred due to this rolling feature will be deducted or added to the deposit.

Redemption Of The Notes

The notes will be redeemed at maturity using the balance of the deposit account.

General Modelling Framework

Modelling of this CPDO transaction broadly falls into five categories: credit spread dynamics, interest rate movements, default correlation and timing, cashflow mechanics, and trading rules.

Spread dynamics

A logged "Ornstein-Uehlenbeck" spread process is employed to model the portfolio spread with the specifications of:

    A long-term mean (Α), a mean reversion speed (?), and volatility (Δ).

This spread process represents the weighed-average spread of the pool at any given time. The mean reversion speed and volatility are calibrated from historical indices data. For the long-term mean, instead of applying it as a constant throughout the life of the transaction in our modelling, Standard & Poor's uses a slightly lower number for the first year because of the benign spread environment. Standard & Poor's then increases the long-term mean at year two, and keeps it constant until the maturity.

This spread determines the yield received on CDSs held in the credit-risk portfolio. Referencing the duration of assets in the index and a credit DV01, spread changes translate directly into mark-to-market changes in credit-risky holdings. Naturally, spread changes also determine rebalancing events, or in extreme circumstances, cash-out events.

Interest rate movement

Standard & Poor's uses two separate interest rate processes to model the short-time rate and the full-term structure: (i) a mean reverting interest rate process used to model the short-term three-month bank bill swap rate accrued by the cash deposit account, and (ii) a single-factor mean reverting interest rate process used to model the full-term structure of the interest rate movement, and applied in the present value calculation. This "parametization" is consistent with Standard & Poor's interest rate criteria.

Default correlation and timing

The default times are generated by Standard & Poor's CDO Evaluator, and loss paths are computed. Recovery rates on any default are taken to be the average portfolio recovery at trade inception.

Depending on the notional value of protection sold and size of the reserve, losses may imply rebalancings or - in more extreme scenarios - cash-out events. Correlated defaults may cause shortfalls between the NPV of future promised cash flows, and the current portfolio value that exceeds the structure's ability to rebalance.

Cash flow mechanics

The treatment of index rolls, bid-offer spread effects, running fees reflecting transaction costs, and payment of coupons are a critical component of the model.

Trading rules

The enforcement of trade rebalancing rules determines the evolution of the size of the credit portfolio. These rules are based on monetary ratios, and are therefore dependent on the cash flow mechanics outlined in "Cash Flow Mechanics".

All criteria and related articles are available on RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com. The criteria can also be found on Standard & Poor's Web site at www.standardpoors.com.

51    On 5 September 2006, S&P issued a ratings letter to ABN Amro confirming that it had assigned a public credit rating of AAA to Rembrandt 2006-2 (R-2 Ratings Letter): [SAF68], [SAF110], J[268] and J[2528]. The R-2 Ratings Letter relevantly stated:

Pursuant to your request that Standard & Poor's assign public ratings to the above-mentioned Notes, we have reviewed the information submitted to us and can confirm that we have assigned a public rating of 'AAA' to the Notes. If you have any questions concerning our approach to the assignment of the ratings, we will be pleased to answer them for you.

The rating is not investment, financial, or other advice and you should not and cannot rely upon the rating as such. The rating is based on information supplied to us by you or by your agents but does not represent an audit. We undertake no duty of due diligence or independent verification of any information. The assignment of a rating does not create a fiduciary relationship between you and us or between us and other recipients of the rating. We have not consented to and will not consent to being named an "expert" under any applicable securities laws. The rating is not a "market rating" nor is it a recommendation to buy, hold, or sell any obligations.

Standard & Poor's relies on the issuer and its counsel, accountants, and other experts for the accuracy and completeness of the information submitted in connection with the rating. This rating is based on financial information and documents we received prior to the issuance of this letter. Standard & Poor's assumes that the documents you have provided to us are final. If any subsequent changes were made in the final documents, you must notify us of such changes by sending us the revised final documents with the changes clearly marked. If the documents were not final, please be sure to send us black lined copies of the executed final documentation as soon as it becomes available along with a letter indicating that all changes have been so marked. In the event that we do not receive final papers within a reasonable amount of time, we reserve the right to withdraw our rating.

We will maintain continuous rating surveillance until the above-named securities mature or are otherwise retired. To maintain the rating, Standard & Poor's must receive all relevant financial information as soon as such information is available. You must promptly notify us of all material changes in the financial information and the documents. In order to maintain our rating surveillance, we must receive all reports submitted to the Trustee in regard to the above captioned issue and all publicly distributed financial information, the absence of which may result in withdrawal of the ratings. Placing us on a distribution list for this information would facilitate the process. Standard & Poor's may change, suspend, withdraw, or place on Credit Watch the rating as a result of changes in, or unavailability of, such information. Standard & Poor's reserves the right to request additional information, if necessary, to maintain the rating. Please send all information to European CDO Surveillance, at Standard & Poor's Ratings Services, 20 Canada Square, Canary Wharf, London, United Kingdom, E14 5LH, email: europeansurveillance@sandp.com.

This letter constitutes Standard & Poor's permission to you to disseminate the above-assigned rating to interested parties. Standard & Poor's reserves the right to inform its own clients, subscribers, and the public of the rating.

We're pleased to have had the opportunity to be of service to you. Our bill for the analytical work performed on this financing will be sent to you in due course. For more information pleases visit our website at www.standardandpoors.com. If we can be of help in any other way, please do not hesitate to call upon us. Thank you for choosing Standard & Poor's, and we look forward to working with you.

(Emphasis added.)

52    On 16 October 2006, before assigning the rating to Rembrandt 2006-3, S&P was told by ABN Amro that there was to be a single subscriber or "bespoke investor" for Rembrandt 2006-3: [SAF186], J[290], J[495] and J[2755].

53    On 31 October 2006, S&P issued a ratings letter to ABN Amro confirming that it had assigned a public credit rating of AAA to Rembrandt 2006-3 (R-3 Ratings Letter): [SAF68], [SAF112], J[318], J[1077] and J[2528]. The letter contained the same statements as the R-2 Ratings Letter: see [51] above. The same day, S&P informed ABN Amro's Australian office that it had assigned a AAA rating to Rembrandt 2006-3: [SAF112].

54    The terms of the Ratings Letters for the Rembrandt notes are significant: J[268] and J[318]. Each rating is described as a "public rating": see [51] and [53] above. S&P expressly authorised ABN Amro to disseminate each rating to potential investors, without restriction or limitation, and reserved the right to disseminate the rating itself: see [51] and [53] above and J[1027]. S&P undertook to maintain "continuous rating surveillance" and expressly reserved the right to alter the rating. S&P also described what the rating was not. Each rating confirmed S&P's public statements that the rating was a statement of S&P's opinion as to the notes' creditworthiness. The Ratings Letters did not say that S&P may not have a reasonable basis for its opinion as to creditworthiness or disclaim the reliability of S&P's opinion.

55    The Post-Sale Report was published by S&P on 15 November 2006: J[357]. It confirmed that S&P had assigned a public credit rating of AAA to Rembrandt 2006-3. The Post-Sale Report was distributed in Australia and a copy was provided to ABN Amro. The report available on the internet (from Ratings Direct) contained a different disclaimer from that in the Pre-Sale Report sourced from S&P: J[2520]-J[2521]. The Post-Sale Report included the statement extracted at [49] above as well as a statement that (see [SAF 67], J[47], J[2519], J[2530], J[2532], J[2534] and J[2536]):

The credit ratings and observations contained herein are solely statements of opinion and not statements of fact or recommendations to purchase, hold or sell any securities or make any investment decisions. Accordingly, any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision.

The Post-Sale Report was in the same relevant terms as the Pre-Sale Report (see [50] above) except for the publication date, the fact that the report was described as Post-Sale rather than Pre-Sale and the statements that the report was preliminary had been deleted: J[46].

56    S&P was paid a substantial fee by ABN Amro for providing the rating for the Rembrandt notes. An annual fee was also payable by ABN Amro to S&P while S&P maintained the rating as current through its "rating surveillance": J[62], J[268] and J[384].

57    ABN Amro's purpose in obtaining the rating was to disseminate the rating to potential investors so that those persons could rely on the rating as S&P's expert opinion as to the creditworthiness of the Rembrandt notes: J[2480] and J[2781]. S&P knew that was the purpose for which the rating was obtained, and that it was paid to assign the rating, so that ABN Amro could carry out that purpose: J[2816]. In fact, S&P spoke to potential investors about the rating of the CPDOs: J[222], J[233]-J[235], J[253]-J[254] and [49]ff above.

58    This analysis is to no ultimate different effect from the analysis which can be distilled from the primary judge's reasons. It will be necessary to return to consider these facts later in the reasons for judgment.

6.    SALE OF NOTES TO LGFS

59    The Australian branch of ABN Amro marketed Rembrandt 2006-2 to a number of institutional investors: [SAF54], J[1], J[267] and J[318]. These investors included FuturePlus (LGFS' ultimate parent company), which was introduced to the notes in early July 2006 when Mr Elliot Levick of ABN Amro contacted Mr Brad Storey of FuturePlus to inform him about the creation of Rembrandt 2006-2: [SAF107] and J[680]. Mr Storey and other representatives of FuturePlus attended a presentation on the notes on around 14 July 2006: [SAF107] and J[680]. The presentation was delivered by Mr Bevan Silvester, ABN Amro's local specialist for the CPDO: [SAF107] and J[680]. Mr Levick and Mr Hilder of LGFS also attended: [SAF107] and J[680].

60    This was not the first time that ABN Amro and LGFS had met to discuss LGFS' potential investment in structured financial products. On 6 March 2006, Mr Tischler of LGFS had met with Mr Paul Cordeiro, ABN Amro's Director, Head of Structured Credit Products, to discuss the ways in which ABN Amro "could assist in the repackaging of a disparate assortment of Council held CDOs into a securitised structure to produce a superior security for resale to councils": J[1011]. This was part of LGFS' desire to become a player in the structured financial products market, the details of which are set out at [98]-[109] below. In April 2006, Mr Cordeiro sent an email to Mr Hilder in which he proposed a meeting between ABN Amro and LGFS to discuss the possibility of "ABN Amro working with LGFS to create a high quality CDO investment which would meet the objectives of NSW councils (that is, return above BBSW) plus a high degree of security and rating stability of the structure" (emphasis added): J[1022] and J[2997(1)]. ABN Amro knew that, despite its apparent interest in exploring new products, LGFS would only be interested in a product with a high degree of security: J[3088]. It is unclear whether or when the proposed meeting took place, but in any event it appears that no real progress was made until ABN Amro commenced its marketing of the Rembrandt notes.

61    ABN Amro had prepared a presentation for the purposes of marketing the notes to its clients (the Surf Presentation). The Surf Presentation had been under preparation from relatively early in the development of the CPDO: J[36]. A version of the presentation was finalised for the first version of the CPDO (known as Chess), and subsequent versions were prepared in similar terms for later iterations of the CPDO, including for the Rembrandt notes: J[36]. Mr Silvester presented to the attendees at the meeting in July 2006 using the Surf Presentation: [SAF107] and J[3095].

62    The AAA rating was an important feature of the Surf Presentation: J[2997(4)]. With its knowledge that LGFS would only be interested in a product with a high degree of security, ABN Amro highlighted and explained the rating in the presentation to encourage interest in the Rembrandt notes: J[2997(4)]-J[2997(5)] and J[3088]. The contents of the Surf Presentation (excluding the disclaimers which were included in small print at the bottom of each page and at the end of the presentation) were set out by the primary judge at J[37]:

1    SURF - The First CPDO

 

A Breakthrough in Synthetic Credit Investments

FOR INSTITUTIONAL INVESTORS ONLY

August, 2006

Table of Contents

    Executive Summary

    Surf Structural Mechanics

    Note Performance

    Relative Value

    Rating Criteria & Stability

    Sensitivity Analysis

    Conclusion

    Key Risks Factors

    Appendices

    - Modelling Assumptions

    - Post Execution Servicing

    - Reference Portfolio

Executive Summary

    ABN AMRO is pleased to present Surf - the first Constant Proportion Debt Obligation (CPDO)

    Surf is a new form of synthetic credit investment that carries a full AAA rating from S&P on both principal and coupons and pays a coupon of BBSW+[190]bps pa

    Surf is designed to have a stable rating with a high likelihood of "cashing-in". After cash-in the CDS portfolio is unwound and no further CDS exposure is taken and all scheduled coupons and principal will be paid until maturity

    Surf aims to pay high coupons by taking leveraged exposure to a basket of credit indices. Surf utilises variable leverage in order to control risk

    The CPDO is suitable for investors who:

-    Seek to take high grade exposure in a form that has not had value eroded by movements in correlation as has occurred in the CDO market

-    Require high rating of principal and coupon payments, but without the necessity of principal protection

-    Wish to diversify their current structured credit portfolio

-    Require liquidity for structured products

Structured Credit - Recent History

    The theme for structured credit investments linked to Investment Grade credit portfolios, has been one of consistent spread tightening over the past 3 years

    While a portion of this spread compression can be accounted for by tighter corporate credit spreads due to the strong bid for credit, the impact of correlation has played a very significant part

    The credit correlation market of May 2005 highlighted the volatility of correlation - since then it has steadily declined

    This movement in correlation has led to a large amount of the value in mezzanine and senior tranches of CDOs to be eroded away, shifting value into the far riskier equity portion of the capital structure

    The CPDO is a new form of high quality structured credit investment which does not rely on the level of correlation for pricing

    While the CPDO will display some similar characteristics to a traditional CDO, such as highly rated principal and coupon payments, the price of the CPDO is not directly impacted by movements in correlation

Summary Terms & Conditions

Issuer

Rembrandt Australia Trust

Issue Price

100%

Swap Counterparty

ABN AMRO NV.

Issue Amount

AUD [100,000,000]

Rating

[AAA] by Standard & Poors*

Scheduled Redemption Amount

100%**

Scheduled Coupon

BBSW+[190]BPS pa**

Maturity

10 years after issue date

Credit Portfolio

Linked to highly liquid credit indices. Size determined by transparent non-discretionary rules

Liquidity

Daily, provided by ABN AMRO

Credit Indices

50% iTraxx Europe, 50% DJ CDX IG

Fees

1% arrangement fee 20 bppa administration fee, 4 bppa Leverage Facility Fee

 

 

What is the CPDO?

    A CPDO is a fixed income instrument with cashflows that have a high and rated likelihood of payment

    A CPDO aims to pay the stated coupons by taking leveraged exposure to a notional portfolio of credit indices. It comprises of exposure to a Credit Index Portfolio and a cash deposit

    The Credit Index Portfolio aims to generate sufficient returns to enable the coupon payments to be made

    The Target Portfolio Size of the Credit Index Portfolio is set such that the present value of the expected income from the Credit Index Portfolio is linked to the difference between the present value of the coupons and principal due under the Note and Note NAV

    Once the current Note NAV equals the present value of the payments due under the Note, the Credit Index Portfolio will be unwound and no further credit exposure taken …

    

Dynamic Leverage Control

    The Portfolio Size is dynamically adjusted in order to actively target payment of the stated coupon (BBSW+190bps pa) and repayment of the principal at maturity

    The Current Portfolio Size is adjusted to equal the Target Portfolio Size on each roll date

    In addition, if at any time the Current Portfolio Size differs from the Target Portfolio Size by more than 25%, then the Current Portfolio Size is adjusted to equal the Target Portfolio Size

    The Current Portfolio Size cannot be larger than the Maximum Portfolio Size

    Taking leverage in this controlled manner mans that there is no potential upside from over-leveraging, however investors are rewarded with a very tight distribution of returns and the potential to reduce the risk in the later years of the transaction …

Behaviour of the Target Portfolio Size

    The Target Portfolio Size is a dynamic measure designed to increase and decrease risk in a controlled manner

    The Target Portfolio Size calculation has been designed such that the coupon and principal can achieve a high and stable rating, comparable to a CDO. In essence, the CPDO only uses the leverage it needs to make the scheduled principal and interest payments

Behaviour of the Maximum Portfolio Size

    The Maximum Portfolio Size is a dynamic measure designed to limit the risk of the note

    The Maximum Portfolio size is capped at an absolute value of 15 times note notional to control maximum risk

    The Maximum Portfolio size is limited such that the maximum assumed 1 day loss on the Credit Portfolio cannot be more than the Note NAV, subject to the application of the Cap which is normally expected to cap the portfolio size

   Forced unwinding of credit portfolio positions due to a reduction in the Maximum Portfolio Size is unlikely due to the expected application of the Maximum Portfolio Cap

image

Portfolio Characteristics

    The credit portfolio is comprised of credit swaps on 5 year DJ CDX and iTraxx indices

-    DJ CDX and iTraxx are liquid indices and provide broad diversified exposure to the credit market

    Every six months, current index positions are unwound and new index swaps are entered into. This has 3 key benefits

-    The credit indices are rolled over each 6 months into new series of indices. Rolling the index swaps ensures that the credit portfolio always references the latest index series and benefits from the index selection rules, i.e. entities downgraded to below investment grade and less liquid credits are removed and replaced by investment grade and more liquid entities

-    Older series become illiquid quickly. Rolling the index swaps each 6 months ensures greater liquidity in the credit portfolio and help to keep rebalancing costs low

-    Under normal market conditions income from extra premium and mark-to-market gains may be generated by extending the maturity of the index swaps to 5.25 yrs from 4.75yrs at each index roll date

    When compared to a static portfolio comprised of 50% DJ CDX Series 2 and 50% iTraxx series 1, rolling the indices acts as a defensive mechanism that limits negative credit migration and default risk

"Cashing-In"

    If the Note NAV rises above the value of a AAA bond paying BBSW + 190bps pa plus administration expenses, a "cash-in" event will be triggered and the credit index portfolio and deposit will be fully unwound

    Under the base case scenario(1), a cash-in is expected to occur on average after 6.8 years. This means that there is no further credit risk for the investor until maturity and all scheduled coupons and principal will be paid until maturity

    Under a stable credit environment(2) a cash-in is expected to occur on average after 3.8 years

Hypothetical historical Cash-In Analysis

    A hypothetical CPDO issued on any date between Feb 1996 and Aug 2003 should have already cashed in - investors would have no exposure to further credit risk

Why "CPDO"?

    "CP" stands for Constant Proportion and offer the following advantages over traditional CPPI

-    The CPDO is the first product utilising Variable Leverage technology to structure a note for credit investors who require a full rating for both principal and coupons

-    Normal CPPI technology on fixed income assets takes a fixed income underlying and repackages it to produce equity like return distributions by always running at maximum leverage. The CPDO only leverages sufficiently to pay the stated coupon and principal at maturity

-    Unlike traditional CPPI, the CPDO is more likely to sell protection at higher levels and buy protection back at lower levels

-    Unlike traditional CPPI, there is much less likelihood of forced unwinding of portfolio positions due to risk limit breaches

-    Unlike traditional CPPI, there is no principal protection, but both coupon and principal are rated, making the CPDO ideal for investors who are comfortable with the risks in structured credit but do not wish to pay for principal protection

        "DO" stands for Debt Obligation and offers the following advantages over CDOs

-    Unlike CDOs, there is a possibility of cashing-in, where the CDS portfolio is unwound and no further CDS exposure is taken. This means that credit risk need not be taken for the full life of the note

-    The CPDO has no direct price exposure to correlation

-    Like CDOs, both the coupon and principal are rated

-    The CPDO does not suffer from adverse portfolio selection as the credit portfolio is linked to the on-the-run credit default swap indices

S&P Rating Methodology

    S&P has determined that Surf will earn sufficient returns to pay timely coupon of BBSW+[190]bps pa and principal at maturity to achieve a AAA rating

    The probability of receiving the rated coupons and principal at maturity is benchmarked to the default probability of an S&P bond with the same rating and tenor

   There are three issues that are paramount in assessing the risks at a given rating level

-    Credit Spread Movements

-    The quantitative analysis of the rated return must assess the income and mark-to-market gains and losses due to the reconfiguring and rebalancing of the CDS indices over the life of the transaction. Spread changes may also trigger a cash-out event

-    Credit spreads are modelled using a modified Leverage Super Senior framework

-    Credit Defaults

-    Credit defaults are generated by S&P's CDO Evaluator

-    Structural Considerations

-    Rebalancing rules, treatment of index rolls, bid/offer spread effects, running fees, payment of coupons, in addition to the market and credit risk of the index portfolio, are taken into account in the rating modelling process

AAA Rating

    Target rated return is BBSW+[190] bps pa

    The S&P 10 year AAA cumulative default probability is [0.728]% (emphasis added)

    The total numbers of paths in which the BBSW+[190]bps pa is not achieved must be lower than the target probability commensurate with a AAA rating and tenor

    A return of at least BBSW+[190]bps is achieved in at least [99.272]% of the simulations, which is consistent with a 10 year AAA rating

 

 

image

Rating Sensitivity

    The performance and rating of the CPDO is sensitive to the evolution of credit spreads, defaults over time, and roll costs

    The rating of the CPDO appears to be stable under a range of simulated default, credit spread scenarios, and roll costs as illustrated below

In the above analysis, the rating model was run from the issue date to the forward rating simulation point using the default end spread paths illustrated in order to model the note performance to the rating simulation point. The spread starts from an initial spread of 36bps and increases linearly at the rate shown per annum until the rating simulation point with S&P base case assumption for curve shape in all scenarios and roll cost for scenarios 1 and 2. The rating model is then re-run using the current S&P base case modelling assumptions at that future point in time to determine a potential rating. No assurance can be given with respect to future performance or future ratings. The assumptions underlying the analysis illustrated above are unlikely to be consistent with actual experience. In addition, S&P can change their rating assumptions, rating models and the way they monitor the rating at any time.

Conclusion

    Surf is a unique assets class and is the first fully rated product in the credit market that uses an alternative leverage technology to traditional CDOs

   Surf notes offer the opportunity for traditional fixed income investors to achieve stable, rated regular coupons with a tight fixed income like distribution of returns and will expand the universe of investors who can participate in the credit product space

   As the value of AAA CDO and LSS tranches eroded over the past year largely because of correlation sensitivity, Surf can achieve superior returns in the form of a highly rated leveraged product where pricing is not dependent on correlation risk

    When compared to similar fixed income synthetic credit products, Surf exhibits strong relative value

    Surf references highly liquid credit indices which are transparent, rules based and non-proprietary. Exposure to these indices ensure liquidity, no adverse selection and relative WARF stability    

Key Risk Factors

    

Credit Risk

    Investors are exposed to the credit risk of the underlying credit portfolio

    In case of defaults or spread widening, the Note NAV will be negatively affected and the size of the credit portfolio may be increased or reduced

    Leverage may increase the magnitude of losses

    The Note is not guaranteed by ABN AMRO. CPDO is not a principal protected note. Actual amounts of interest and principal paid on the notes are subject to the investment strategy performance

Correlation Risk

    As Surf references index swaps, moves in correlation will not directly affect the NAV of the notes

Price Volatility

    The NAV of the note is sensitive to credit spreads of the underlying portfolio of index swaps

    The price of the notes may be lower than the initial purchase price

    The traded price may be different from the NAV of the notes due to supply and demand issues

    Leverage may increase the magnitude of price volatility

Cash-Out Event

    If the NAV falls to 10% or lower, a "cash-out" event will be triggered and the credit portfolio is fully unwound

    No coupon will be paid after a cash-out event and any recovered value will be paid to noteholders

Performance and modelling risk

    Past performance may not be representative of future performance

    Current modelling assumptions are unlikely to be consistent with actual performance of CPDO

    Key modelling assumptions are set out in S&P base case assumption

63    The primary judge emphasised the following features of the Surf Presentation and how it described the CPDO (J[3095]):

1.    It represented the CPDO as a breakthrough in synthetic credit investments, such breakthrough being the result of the combination of coupon at 190 bps and the rating of AAA on coupon and principal.

2.    The product was "designed to have a stable rating", which the primary judge found could "mean only that it [was] designed to have a stable rating of AAA on both principal and coupon".

3.    The product was suitable for investors who "require high rating of principal and coupon payments".

4.    The target portfolio size calculations of the product had been "designed such that the coupon and principal can achieve a high and stable rating".

5.    The product offered investors higher coupons than many other fixed income instruments with similar ratings.

6.    It contained a detailed discussion of S&P's rating methodology, including the statement that the "probability of receiving the rated coupons and principal at maturity is benchmarked to the default probability of an S&P bond with the same rating and tenor" and that the "S&P 10 year AAA cumulative default probability is [0.728]%".

7.    It stated that the "total number of paths in which the BBSW + [190] bps pa is not achieved must be lower than the target probability commensurate with a AAA rating and tenor" and a "rating of at least BBSW + [190] bps pa is achieved in at least [99.272]% of the simulations, which is consistent with a 10 year AAA rating".

8.    It contained an extract from S&P's target probabilities or ratings quantiles tables.

9.    It contained a section on rating sensitivity based on ABN Amro's modelling.

10.    It repeated references to the product being the "first fully rated" product of its kind, with "stable, rated regulated coupons", and "superior returns in the form of a highly rated leveraged product".

64    In the course of oral submissions, counsel for LGFS identified particular aspects of the Surf Presentation. There is a degree of overlap between the aspects of the presentation we were taken to and those emphasised by the primary judge in her reasons but it is nonetheless necessary to consider these aspects of the Surf Presentation in some detail.

65    Page 3 of the Surf Presentation contained an executive summary of the presentation. It stated that the CPDO was "designed to have a stable rating with a high likelihood of 'cashing-in'". It further stated that:

The CPDO is suitable for investors who:

-    Seek to take high grade exposure in a form that has not had value eroded by movements in correlation as has occurred in the CDO market

-    Require high rating of principal and coupon payments, but without the necessity of principal protection

-    Wish to diversify their current structured credit portfolio

-    Require liquidity for structured products

66    Page 6 of the presentation comprised a single heading - "Surf Structural Mechanics". What followed this page was a number of diagrams which described how the actual structure of the CPDO worked and how the relevant formula was supposed to work. Page 9, for instance, set out how the coupon reacted with various movements in the market. It stated that the "calculation [had] been designed such that the coupon and principal can achieve a high and stable rating, comparable to a CDO. In essence, the CPDO only uses the leverage it needs to make the scheduled principal and interest payments".

67    Page 17 of the presentation provided a favourable comparison of the CPDO with traditional CPPI. Notably, it stated that "[u]nlike the traditional CPPI, the CPDO is more likely to sell protection at high levels and buy back at lower levels".

68    Immediately preceding page 17 was a page headed "Hypothetical historical Cash-In Analysis". It set out a pro-forma spread history in graphical form and, importantly, showed that the CPDO retained the ability to cash-in despite an increase in spreads and defaults. There was a series of statements at the bottom of the page. One of these statements clarified that the parameters used for the production of the graph were "run through the CPDO model (which has certain other modelling assumptions, including roll cost and curve shape as per S&P base case assumptions)". The natural implication was that the graph had been produced by ABN Amro using its own model, albeit with certain assumptions that were consistent with the assumptions adopted by S&P. There was, however, no suggestion that S&P was responsible for the information being conveyed by the graph.

69    The last three pages of the Surf Presentation contained a disclaimer, the key aspects of which were as follows:

No representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein. ABN [Amro] accepts no obligation to any recipient to update or correct any such information. No act or omission of ABN [Amro] or any of its directors, officers, employees or agents in relation to the information contained herein shall constitute, or be deemed to constitute, a representation, warranty or undertaking of or by ABN [Amro] or any such person. This presentation may contain forward-looking information. Such information may include, among other things, projections, forecasts or estimates of cashflows, returns, scenario analyses and proposed or expected portfolio composition.

Further, the information in this presentation reflects ABN [Amro's] opinions or views prevailing as of this date, which are accordingly subject to change without prior notice to you. The information in this presentation does not take into account the effects of a possible transaction or transactions or any other event, including with limitation an actual or potential change of control in the relevant entity, which may have significant valuation and/or other effects on the proposed transaction or transactions.

By accessing this presentation and before entering into any transaction each recipient represents, warrants and agrees that (i) they are considering this investment for their own account, (ii) they are a professional/institutional/accredited/expert investor with sufficient knowledge, experience and professional advice to make their own evaluation of the merits and risks of making a complex investment of this type, (iii) they shall, at all times, be solely responsible for making their own independent appraisal of the reference entity(ies) and investigation into the business, financial condition and creditworthiness thereof, (iv) they are fully aware that they may lose a significant amount or all of their investment, (v) they are responsible for making their own independent investigation and appraisal of the risks, benefits and suitability of any investments envisaged by this document, and for obtaining their own independent financial advice, and (vi) ABN [Amro] shall not incur any responsibility or liability whatsoever to any recipient in respect thereof.

70    The primary judge held that the parts of the disclaimer which might be relevant were "not prominent" and there were no "headings or other signposts leading the reader to the statements which might be relevant": J[3101]. Her Honour found that the disclaimer as to the existence of any representation, warranty or assurance said "nothing about the reliability of the AAA rating and no reasonable reader would read it as saying anything about the rating": J[3101]. Further, the statement that the Surf Presentation reflected ABN Amro's "opinions or views prevailing as of this date" undermined ABN Amro's argument that it was merely passing on the rating: J[3102]. The primary judge held that the disclaimers were, therefore, ineffective.

71    On 18 July 2006, Mr Levick of ABN Amro emailed the draft term sheet for Rembrandt 2006-2 to Mr Storey of FuturePlus: [SAF152] and J[680]. Mr Storey forwarded that draft term sheet to Mr Hilder of LGFS on the same day: [SAF152] and J[1025]. In July or August 2006, Mr Hilder and Mr Tischler (from LGFS), who also attended the meeting on 14 July 2006, met with representatives of ABN Amro, at which they were given, and taken through, the Surf Presentation: [SAF155], J[1028], J[1164], J[1166], J[3095], J[3097] and J[3189]. Mr Hilder could not recall what was said at the meeting but remembered that either at the meeting or shortly thereafter both he and Mr Tischler were informed that it was expected that the CPDO would carry a AAA rating: J[1164]. Mr Hilder recalled that Mr Tischler asked a number of questions at the meeting that lead him to believe that Mr Tischler had a better understanding of structured products generally and the CPDO specifically: J[1164]. But nonetheless Mr Hilder understood from the Surf Presentation that S&P had undertaken over 10,000 Monte Carlo modelling simulations to test the performance of the Rembrandt notes under different market conditions, and that S&P had estimated the 10 year cumulative default probability of the Rembrandt notes at "less than 1%": J[1167]. Mr Hilder understood from what he had read that the Rembrandt notes' AAA rating meant that they had a "0.76% chance of default": J[1167]. The only evidence of an explanation of the rating in terms of a percentage or numerical possibility of default was the explanation ABN Amro gave LGFS in and by speaking to the Surf Presentation: J[1167]. In the weeks following the meeting, Mr Hilder spent a lot of time "reading and re-reading" the Surf Presentation and the relevant term sheets in order to develop a level of understanding of the product to enable him to assess whether LGFS should purchase the Rembrandt notes for sale to the Councils: [SAF156] and J[1164]. At some point in August 2006, Mr Hilder believed that he had reached the point where he understood how the Rembrandt notes worked and each component of the notes: J[1172].

72    On 4 August 2006, Mr Levick emailed the draft of the Pre-Sale Report to Mr Storey: [SAF154] and J[231]. On 22 August 2006, Mr Tischler received a copy of the Pre-Sale Report: see [49] above and J[1173]. He considered the report to be "overall supportive of the Rembrandt notes" and that S&P considered the risk of loss involved to be "very low": J[1175]. Mr Hilder also read the Pre-Sale Report and, while he considered that it did not contain any information that was new to him, he noted the following aspects of the Pre-Sale Report: J[1173]:

• Rembrandt was a "fixed-income instrument" which targeted the payment of coupons by "taking variable leveraged exposure to a credit portfolio to generate sufficient returns to enable the coupon payments to be made";

• Rembrandt's credit portfolio comprised two credit indices, the risk of which would be "passed on to investors" through credit default swaps, with the leveraged exposure changing over time according to a "transparent and contractually agreed dynamic leverage control formula";

• S&P had analysed "the various risks associated with the transaction" (particularly mark-to-market losses, interest rate movements, and the risk of credit defaults), and had concluded that "the net impact on the probability of paying timely interest and full principal" was "consistent with a AAA rating"; and

• the statement that "spread widening, attended by no corresponding defaults, is beneficial to the structure".

LGFS did not know that ABN Amro had participated in the drafting of the Pre-Sale Report: J[3098].

73    On 11 August 2006, Mr Simon Michell, a financial markets dealer with LGFS, received an email from ratingsdirect@standardandpoors.com which contained a "research update" indicating that S&P had assigned a preliminary credit rating to Rembrandt 2006-2: [SAF157] and J[1027].

74    On 21 August 2006, Mr Hilder sent an email to Mr Levick stating that he "would like to progress the evaluation of this possible transaction" and that he also wanted to discuss white badging the product: [SAF160] and J[1178]. By this stage, Mr Hilder had effectively delegated to Mr Tischler the responsibility of dealing with ABN Amro: [SAF161] and J[1172]. Mr Tischler met with Mr Levick on or after 21 August 2006 to discuss the possibility of white badging the notes: [SAF162] and J[1178]. Mr Tischler accepted that LGFS was interested in white badging the notes so that councils would perceive LGFS to be "associated with" the product: J[1178]. This association would make the products more attractive to councils by giving it a local government "feel" and would assist LGFS to leverage off its rapport with councils: J[1178] and J[1278].

75    Mr Levick was subsequently involved in various email communications with LGFS. With some exceptions, he could not recall any specific dealings with LGFS. The extent of his recall was set out by the primary judge at J[682] (see also [SAF166]):

Mr Levick was involved in various email communications with LGFS but had no specific recollection of other direct dealings with LGFS apart from: - (i) ABN Amro informing LGFS of its expectation, and then the fact, of S&P giving the Rembrandt CPDOs a rating of AAA, (ii) Mr Hilder proposing that an issue of the Rembrandt CPDO be "white-badged" for issue by LGFS to its clients, (iii) Mr Hilder saying to him that LGFS had to be "very thorough and make sure [we] understood the details of the CPDO before selling it to" LGFS's clients, (iv) Mr Hilder and Mr Tischler asking Mr Levick and Mr Silvester a lot of questions about the CPDO during LGFS's due diligence process, and (v) Mr Hilder and Mr Tischler never said anything to suggest that they did not understand the nature of, or risks associated with, the Rembrandt CPDOs.

Mr Levick's recollection of his communications with LGFS discloses that ABN Amro emphasised its expectation that the CPDO would receive a AAA rating. The AAA rating was extremely important to LGFS: J[1293]. The evidence before the primary judge disclosed that both Mr Hilder and Mr Tischler considered that a AAA rating was "essential" for any product which was to be marketed by LGFS: J[1293]. ABN Amro knew that it was a pre-condition of LGFS' purchase of the Rembrandt notes that they obtain a rating of AAA. This was especially so given LGFS' relative inexperience in dealing in structured financial products (J[1293]) and its inability to verify the reliability of the rating: J[3197].

76    On 31 August 2006, Mr Hilder and Mr Tischler met with representatives of ABN Amro: [SAF168] and J[1040]. Later that day, Mr Tischler sent an email to Mr Brandon Lewis, a member of ABN Amro's structured credit team in Australia, which stated that StateCover had authorised LGFS to transact on its behalf in relation to Rembrandt 2006-2: J[1040]. Mr Tischler's email also stated that LGFS would purchase $4 million of Rembrandt 2006-2 and confirmed that StateCover would purchase $6 million: J[1040]. LGFS subsequently transferred the notes it purchased in its own name to StateCover: J[2982]. On 1 September 2006, Mr Levick sent an email to Mr Tischler which confirmed LGFS' and StateCover's purchase of Rembrandt 2006-2 and which attached the final term sheet for the transaction: [SAF170] and J[1041]. The final term sheet mistakenly recorded the issue date: J[1041]. On the same day Mr Levick sent to Mr Tischler an amended version of the final term sheet: J[1041]. Mr Tischler forwarded the final term sheet to Mr Hilder: J[1041].

77    On 4 September 2006, Mr Levick sent an email to Mr Tischler which attached a transfer and acceptance form for LGFS' investment in Rembrandt 2006-2. On 5 September 2006, a StateCover Authorisation and Dealing Docket was completed for StateCover's purchase of Rembrandt 2006-2. Mr Hilder signed the transfer and acceptance form on behalf of StateCover on that day: J[1044]. S&P issued the R-2 Ratings Letter the same day and it was provided to LGFS before LGFS caused StateCover to purchase the Rembrandt 2006-2 notes: see [50] above.

78    LGFS purchased the Rembrandt 2006-2 notes on behalf of StateCover in its capacity as a fund management service provider: J[1176]. The terms of the parties' relationship were set out in an agreement embodied in a letter dated 14 September 2004 between LGFS and StateCover: [SAF221] and J[3681]. After Rembrandt 2006-2 cashed out, StateCover commenced proceedings against LGFS seeking in excess of $9 million (together with interest and costs): [SAF236], J[2400] and J[2980]. StateCover also claimed against ABN Amro and S&P: [SAF236], J[2400], J[2980] and J[1180]. On 29 August 2011, LGFS settled StateCover's claim as against all parties for a sum in excess of $3.1 million (including costs): [SAF236], J[2400] and J[2980].

79    On 7 September 2006, Mr Levick sent an email to Mr Tischler and Mr Hilder which outlined possible fee structures for the next issue of the CPDO, which became the Rembrandt 2006-3 issue: [SAF175], J[1045] and J[1046]. On the same day Mr Tischler sent an email to Mr Hilder indicating his preference with respect to the fee structures suggested by Mr Levick: [SAF175], J[1045] and J[1046].

80    In September 2006, Mr Hilder prepared a document entitled "ABN's SURF CPDO Product" which listed the pros and cons of CPDOs: [SAF173] and J[1049]. On 28 September 2006, Mr Tischler sent Mr Levick and Mr Lewis a marked-up term sheet which set out a number of further questions by Mr Tischler about the CPDO: [SAF177], J[1048] and J[1303]. Mr Silvester provided responses to Mr Tischler on 4 October and 6 October 2006, the former response in relation to the adjustment to the cash deposit value following a credit event and the latter response in relation to the Maximum Index Portfolio Amount: [SAF178] and [SAF180]. On 9 October 2006, Mr Silvester sent Mr Tischler a further email which provided some "additional scenarios" from Rembrandt 2006-2: [SAF181] and J[1054]. These additional scenarios covered "extreme movements in spread" which showed "the robustness of the structure": [SAF181] and J[1054]. Mr Tischler and Mr Hilder were also assisted by Mr Lewis, who attended a meeting with Mr Tischler and Mr Hilder at which a private placement of the notes to LGFS was discussed and who answered questions asked by Mr Tischler from time to time: [SAF187] and J[672]. When a question related to a matter outside his area of responsibility, Mr Lewis would refer Mr Tischler to Mr Silvester or Mr Levick: [SAF187] and J[672].

81    By October 2006, Mr Tischler considered that he "generally understood how the mechanics of [the Rembrandt notes] worked" and believed he had "taken [his] investigation of the [Rembrandt] notes as far as [he] could". Mr Tischler recalled a conversation with Mr Silvester in or about mid October 2006 during which Mr Silvester said words to the following effect (J[1181]):

1.    As the spread movement in the indices was over par, LGFS should settle the purchase of Rembrandt 2006-3 in order to take advantage of spread tightening;

2.    This would result in LGFS making a capital gain;

3.    If spreads widened again, the value of Rembrandt 2006-3 would decrease as demonstrated by the scenarios ABN Amro had sent to Mr Tischler;

4.    Rembrandt 2006-3 was a robust structure which could withstand even significant spread widening; and

5.    Mr Silvester would send Mr Tischler further information on the current movement of credit spreads.

82    On 11 October 2006, Mr Tischler emailed Mr Silvester requesting a soft copy of what was termed a Mandate Letter which it was proposed would be executed by LGFS and ABN Amro: [SAF183] and J[1058]. The purpose of the Mandate Letter was to set out the "terms upon which [LGFS was] invited to appoint ABN Amro as structurer in relation to [LGFS'] firm order [of Rembrandt 2006-3]": J[1061]. Mr Silvester complied with Mr Tischler's request: [SAF183] and J[1058].

83    On 13 October 2006, Mr Tischler once again wrote to Mr Silvester, informing him that LGFS had provided the Mandate Letter to its solicitors, Mallesons Stephen Jaques, for review and they had identified certain issues which were contained in a single-page document headed "Issues with ABN Mandate Letter": [SAF184] and J[1059]. On 16 October 2006, Mr Silvester replied to Mr Tischler indicating that ABN Amro had amended the Mandate Letter to address the issues raised by LGFS' solicitors and that a signed copy would be sent to LGFS once it had agreed to the changes: [SAF184] and J[1059]. The Mandate Letter relevantly stated (at J[1061]):

Dear Sirs,

MANDATE FOR STRUCTURING A SURF CPDO NOTE THAT LOCAL GOVERNMENT FINANCIAL SERVICES PTY LIMITED WILL PURCHASE.

ABN AMRO Bank NV ("ABN [Amro]") is pleased to set out in this mandate letter ("Mandate Letter") the terms upon which Local Government Financial Services Pty Limited (the "Company") (each of ABN [Amro] and the Company a "Party" and together the "Parties") is invited to appoint ABN [Amro] as a structurer in relation to their firm order to purchase of AUD 40 million of SURF, a CPDO Note linked to a portfolio of Credit Indices managed by ABN [Amro] (as described in the attached indicative termsheet). Such proposed purchase is referred to in this Mandate Letter as the "Transaction".

1.    SERVICES

1.1     The Company hereby appoints ABN [Amro] to use all reasonable endeavours to perform such services as both ABN [Amro] and the Company agree to be necessary to successfully close the Transaction (the "Services"). The Company agrees that ABN [Amro] shall be the only party appointed to carry out the Services and it will not engage (directly or indirectly) any other party in connection with the Services without ABN [Amro's] prior written approval.

1.2    The Services will include, but are not limited to, the following:

1.2.1    to model and structure the Transaction;

1.2.2     to prepare a termsheet which will detail, inter alia, the following items: (i) the structure of the Transaction, and (ii) the size and characteristics in respect of the Transaction;

1.2.3    to perform such other services as may be mutually agreed in writing between the Company and ABN [Amro] as necessary to successfully Close the Transaction.

1.3    The obligations of ABN [Amro] in respect of the Transaction are several and not joint vis-À-vis the obligations of any third party appointed in respect of the Transaction.

1.4     The Company hereby authorises ABN [Amro] to do all such things that are reasonably necessary for the proper performance of its engagement as sole structurer in respect of the Transaction.

3     PARAMETERS OF ABN AMRO'S ROLE

3.1    Until Close of the Transaction or termination of ABN Amro's engagement pursuant to clause 7 below, neither the Company nor any of the Company's Associates will initiate discussions with or respond to proposals from third parties other than its own independent legal or accounting advisors regarding the Transaction … except with the prior consent of ABN Amro. …

3.2     ABN [Amro] will have no responsibility for providing or obtaining on the Company's behalf any legal, regulatory, accounting, taxation or other specialist advice in connection with the Transaction. The Company shall be responsible for obtaining any such advice from independent advisors which the Company has chosen and may not rely on ABN [Amro] for any such advice. Any such advice provided to the Company shall be the direct legal responsibility of the provider of such advice and not of ABN [Amro].

3.4     The Company acknowledges that ABN [Amro] is not acting as fiduciary but is an independent contractor retained solely for this Transaction. Defining the scope of any due diligence exercise, conducting any due diligence, analysis of any due diligence results, and the prudence, desirability and commercial merits of the Transaction are all entirely decisions for and ultimately the sole responsibility of the Company. Any valuation or other analysis undertaken by ABN [Amro] is provided on the understanding that ABN [Amro] does not accept responsibility for the accounting or other data (including commercial or technical assumptions) on which such analysis is based and it is the Company's sole responsibility to assess and evaluate such analysis, advice, data and assumptions. Advice, communications and services provided by ABN [Amro] under this Mandate Letter are intended solely for the benefit of the Company in relation to this Transaction and shall not be used for any other purpose and may not be disclosed to, used or relied upon by any other person without ABN [Amro's] prior written consent. No opinion or advice rendered by ABN [Amro] or any of its Associates may be construed as a recommendation to any person as to what action they should take in relation to the Transaction.

(Emphasis added.)

84    The indicative draft term sheet relevantly stated:

The Notes are expected to receive a full AAA rating from S&P.

Issuer

Rembrandt Australia Trust

Arranger

ABN AMRO Bank NV

Issue Price

100%

Issue Date

[27 October] 2006

Maturity Date

[27 October] 2016 (10 years after the Issue Date, subject to the Early Redemption Provisions (which include following a Strategy Unwind Event))

Note Type

Unsecured Floating Rate Notes

Expected Rating

The Notes are expected to be rated AAA by Standard & Poor's ("S&P") on the Issue Date as to the timely payment of their coupons and principal.

Currency of Issue

Australian Dollars (A$)

Series Face Value

[A$40,000,000.00]

Secondary Market Repurchase

The Dealer intends to make secondary markets in the Notes subject to normal market conditions. The price paid by the Dealer for any repurchase of Notes will be the price determined by the Dealer (the price determined by the Dealer will reflect supply and demand and therefore not necessarily be equal to the Net Transaction Value).

ABN AMRO make (sic) no representation and give (sic) no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. Each recipient represents, warrants and agrees that (i) they are considering this investment for their own account, (ii) they are a professional investor with sufficient knowledge, experience and professional advice to make their own evaluation of the merits and risks of making a complex investment of this type … (iv) they are fully aware that they may lose a significant amount or all of their investment, (v) they are responsible for making their own independent investigation and appraisal of the risks, benefits and suitability of any investments envisaged by this document, and (vi) ABN AMRO shall not incur any responsibility or liability whatsoever to any recipients in respect thereof.

The securities described in this termsheet may be assigned a credit rating by one or more rating agencies. A credit rating is not a recommendation to buy, sell or hold securities and may be revised or withdrawn by the relevant rating agency at any time. Each rating agency has its own methodology and modelling assumptions for rating transactions; ratings are sensitive to the methodology and modelling assumptions used and different methodologies, models and/or assumptions may, and in all likelihood will, produce different ratings. Any rating assigned to the securities represents the relevant rating agency's opinions regarding the credit quality of such securities; it is not a guarantee of quality or performance, nor is it an evaluation or indication of the likelihood or risks of fluctuations in market value. Any rating assigned to the securities may not fully reflect the true risks of an investment therein and may, in the event, be subject to qualifications. The risks, returns and performance of the securities described in this presentation may differ from those of an equivalently-rated corporate bond.

85    On 16 October 2006, LGFS confirmed that it was "happy to sign" the Mandate Letter: [SAF185] and J[1060]. ABN Amro replied by providing a signed copy of the Mandate Letter and by stating that once the letter was signed it (ABN Amro) could "execute the hedge" which would protect LGFS from further spread tightening: [SAF185] and J[1060]. On 18 October 2006, Mr Tischler confirmed by email to Mr Silvester (with a copy to Mr Hilder) that LGFS was happy for ABN Amro to execute the hedge: [SAF189] and J[1063].

86    In the present circumstances, ABN Amro knew that LGFS would only purchase the Rembrandt notes if they carried a rating of AAA: J[3199] and J[3272]. ABN Amro wanted the AAA rating: J[3089]. It made sure S&P was in no doubt as to its desire: J[3089]. ABN Amro would not accept anything less.

87    On 17 October 2006, Mr Silvester emailed a document to Mr Tischler which set out information regarding the credit spreads on a range of credit default swap indices, including the iTraxx and CDX indices: [SAF188] and J[1062]. Mr Silvester said that he would provide that information to Mr Tischler on a daily basis so that Mr Tischler could "monitor what the spreads [were] doing": [SAF188] and J[1062]. A subsequent email from Mr Silvester to Mr Tischler on 20 October 2006 stated that "[s]preads continue[d] to grind lower": [SAF192] and J[1066].

88    On 24 October 2006, Mr Silvester sent Mr Tischler an email about the price of Rembrandt 2006-2 and Mr Tischler sent an email to Mr Hilder conveying, among other things, his view that the price of Rembrandt 2006-3 should not be published until the "pricing [was] above 100": [SAF193] and J[1067]. Mr Tischler conveyed this view a short time later by email to Mr Silvester: [SAF193] and J[1068]. Mr Tischler also informed Mr Silvester that LGFS, as part of its white badging of the notes, had elected to rename Rembrandt 2006-3 as the "Community Income CPDO Notes" and requested a draft of the term sheet, updated to include this information: J[1069]. On that same day, Mr Lewis sent the draft term sheet to Mr Tischler (with a copy to Mr Silvester and Mr Levick) which incorporated the name change to "Community Income CPDO Notes" and the new issue and maturity dates: [SAF194] and J[1069].

89    On 25 October 2006, LGFS held a board meeting at which the proposed purchase of the Rembrandt 2006-3 notes (which were described as having a AAA rating) was discussed. Mr Hilder gave a presentation entitled "Community Income CPDO Notes" outlining the key features of the product. By this time, Mr Hilder said that he was "generally satisfied" with the additional information he had obtained about the Rembrandt notes, and that he would have decided not to proceed only if "something had arisen during [his] consideration of the product which caused [him] to believe it had any problems": J[1182]. But the information provided by ABN Amro to LGFS did not give Mr Hilder cause to reconsider. On the contrary, ABN Amro's marketing of the Rembrandt notes (including its emphasis on the robustness of the product's structure and its AAA rating), and its minimisation of any potential difficulty as set out in [91] below, indicated that all was well with the product. LGFS resolved to "approve the release" of the notes: [SAF195], J[1071] and J[1074].

90    The board papers for the board meeting of 25 October 2006 (at J[1071]-J[1072]) disclosed LGFS' concerns about the risk of its proposed purchase and on-sale to councils of the Rembrandt 2006-3 notes. Relevantly, the papers disclosed that a reason for a delay in the purchase of the notes was that credit spreads "had recently moved adversely from the point of view of launching the transaction in the near future". They also disclosed that the fact that LGFS would "have to purchase the issue [of the Rembrandt 2006-3 notes] from [ABN Amro] and progressively sell parcels to [councils]" would have a "number of ramifications for LGFS" including that "LGFS could end up holding inventory with no available purchaser". Part of the problem with such a scenario would be that while "the asset would be suitable for LGFS' balance sheet operations" it "would prevent new issues as there would be no room for holding long term assets". LGFS' ability to on-sell the Rembrandt notes to councils was thus of paramount importance to it. Indeed, one of LGFS' stated concerns was to ensure that "when [it acquired] the product for a price of $100" it was able to "present it to councils for $100 despite the reality that the market price for the product [would] be close to $98.80". LGFS noted that the "grotesquely complicated" nature of the product did "not help the selling process". Thus, rather than inform councils about its concerns and the fact that there was no secondary market for the notes, LGFS elected to focus on simplifying the information it provided to councils to "facilitate" its sale of the Rembrandt notes. LGFS' sales of the Rembrandt notes to the councils are addressed separately in Part 2, Section 7 and Part 7 below.

91    On that same day, Mr Tischler received an email from Mr Silvester noting that S&P had "changed the vol [volatility] from 15% to 25% in their modelling assumptions" observing that this "has had just a minor effect on the table (2 differences highlighted in yellow)": [SAF196] and J[1075]. Mr Silvester also noted that "in general, small changes to fees or spreads don't affect the rating stability": [SAF196] and J[1075]. Mr Tischler had understood Mr Silvester's email to be stating that "the change to the volatility was unlikely to change the AAA rating": J[1183]. This was not true and, as the primary judge observed, LGFS had no "real idea of the events within S&P and ABN Amro relating to the volatility assumption" or any other aspect of how the CPDO was rated: J[1183]. Mr Silvester's advice was at its best a mistake and at its worst a lie. This issue is addressed in detail in Part 3 below.

92    On 31 October 2006, S&P issued the R-3 Ratings Letter (see [53] above) to Mr Lewis which stated that S&P had "assigned a public rating of 'AAA' to [Rembrandt 2006-3]": [SAF197] and J[318]. On 2 November 2006, Mr Lewis informed Mr Tischler by telephone that ABN Amro had received the R-3 Ratings Letter from S&P for Rembrandt 2006-3: [SAF200] and J[1184]. Mr Tischler requested that LGFS be sent a copy of the R-3 Ratings Letter, which Mr Lewis duly sent to Mr Tischler, who then forwarded the letter to Mr Hilder: [SAF200], J[1184] and J[1077]. Aside from expressing that Rembrandt 2006-3 had been assigned a AAA rating, the R-3 Ratings Letter also stated that (J[1077]):

ƒnthe rating did not constitute investment, financial or other advice and could not be relied upon as such;

• S&P undertook no independent verification of the information provided to it by ABN Amro;

• the rating did not constitute a recommendation to buy, hold or sell any obligations; and

• the ratings letter constituted S&P's "permission… to disseminate the above-assigned rating to interested parties".

93    In the days immediately preceding LGFS' receipt of the R-3 Ratings Letter (31 October and 1 November 2006), Mr Tischler and Mr Silvester exchanged emails about the value of the notes and settlement, including that the price of Rembrandt 2006-2 had dropped below par: [SAF198] and J[1076]. The Rembrandt 2006-3 notes, with a face value of $40 million, were issued to LGFS on 2 November 2006 and LGFS completed its purchase of those notes on the same day: [SAF201], J[325] and J[670].

94    On 16 November 2006, Mr Lewis sent Mr Tischler (with a copy to Mr Silvester) a copy of the Post-Sale Report for Rembrandt 2006-3 (see [49] and [55] above), which had been issued by S&P the previous day: [SAF204-205], J[357] and J[1091]. As with the Pre-Sale Report, ABN Amro had participated in the drafting of the Post-Sale Report, a fact that was unknown to LGFS: J[3089].

95    On 14 December 2006, Mr Tischler sent an email to Mr Silvester (with a copy to Mr Michell) which confirmed LGFS' desire to purchase an additional $5 million of Rembrandt 2006-3 provided that the price remained at par or less: [SAF211] and J[1105]. On 4 January 2007, Mr Lewis advised Mr Cian Chandler, the primary credit analyst at S&P for rating the CPDO, that ABN Amro had received an order to increase the issue of Rembrandt 2006-3 by $5 million and requested a letter from S&P confirming that the increase would not affect the rating of the existing notes as well as confirming the rating of the new notes: [SAF212] and J[362]. S&P issued that letter on 5 January 2007: [SAF213] and J[362].

96    On 9 January 2007, Mr Lewis sent an email to Mr Tischler and Mr Michell attaching the ABN Amro final term sheet for Rembrandt 2006-3 (which showed the volume of the notes as $45 million, an adjustment to include the additional issue of $5 million): [SAF214] and J[1112]. On the same day, the additional Rembrandt 2006-3 notes, with a face value of $5 million, were issued to LGFS: [SAF215] and J[1228]. Mr Hilder stated that the reason for the purchase was to have an additional amount on LGFS' books for its own use and as a "reserve for potential future sales" given the popularity of the notes amongst councils: J[1228]. Mr Hilder was not involved in the purchase of the additional notes but he understood Mr Tischler to be dealing with ABN Amro with respect to the proposed purchase: J[1228].

97    On 20 February 2007, Mr Silvester sent Mr Tischler a number of transaction documents which related to the Rembrandt 2006-3 transaction, including the Notice of Creation of Trust, the Master Trust Deed and the Supplemental Deed: [SAF216] and J[1114].

7.    SALE OF NOTES TO THE COUNCILS

98    By 2003, structured financial products - particularly CDOs - had begun appearing in the local government investment market: J[990]. LGFS initially opposed investments by councils in CDOs, but by 2004 CDOs were making such substantial inroads into LGFS' traditional deposit-taking business that LGFS reconsidered its position: J[991]. In late 2004 and early 2005, LGFS began to investigate the possibilities of expanding its role as a provider of financial services to councils and expanding the range of investments options it offered to include structured financial products: J[991]. Market conditions were particularly trying for deposit-taking institutions like LGFS and diversification to offer more "exotic" products was an attractive option: J[994].

99    LGFS set about investigating the viability of structured financial products. In December 2004, it prepared an internal report entitled "LGFS and CDOs". The report identified "issues for LGFS in purchasing or recommending CDOs", including (J[992]):

1.    The questionable reliability of ratings - the report noted that "the correlation between names in a portfolio has a significant effect on the performance of tranches of a CDO" and that it was difficult to make accurate assumptions regarding default correlation;

2.    The lack of a "well-established secondary market", which posed "a problem for liquidity and market valuations";

3.    The impact of changing economic circumstances on movements in the price of CDOs, noting that at that time "credit spreads [were] historically low" and that "should economic conditions deteriorate the price of CDOs will decline"; and

4.    That "in the absence of price movements arising from the maturing of the CDO market, the probability of price falls appears to be greater than the probability of price rises".

The report recommended that, if LGFS were "satisfied at a theoretical level that CDOs may be an appropriate investment", its next step would be to build knowledge of the issues. The report concluded that it was possible that "a single-tranche synthetic CDO" would prove to be the most appropriate form of investment for LGFS: J[993].

100    On 17 February 2005, LGFS held a board meeting. The papers for that meeting noted that "financial market conditions are probably at their worst ever for a deposit taking business such as LGFS". The papers also included "a broad overview of the draft strategic framework that [was] being explored to develop a detailed strategy for LGFS" and identified possible strategies which included adding an advisory operation and improving returns by, among other things, exploring LGFS' possible role as "a broker for specialised products (long term bonds, FRNs and CDOs) for councils". A table appended to the papers, next to the action "develop a strategy for possible use of CDO products", noted "several discussions with market players. Internal paper produced. Staff member to attend a CDO conference in February": J[994].

101    LGFS held a further board meeting on 6 July 2005, the papers for which included LGFS' 2005/2006 Business Plan (Business Plan). Under the heading "2005/06 Operating Environment", the Business Plan recorded that LGFS' balance sheet had suffered an $80 million fall in deposits from a peak of just over $500 million to $420 million. Under that same heading, it was also noted that (as extracted at J[995]):

Managed Cash Funds have not matched the earning rates on longer term Floating Rate Notes and leveraged Collateralised Deposit Obligations, and with the ready availability of those products, there has been a significant shift of council funds into the longer term floating rate securities [T]here has been a similar shift away from traditional deposit products and in the absence of a crisis of confidence in such products it is likely that LGFS's Balance Sheet will continue to fall …

The Business Plan observed that a consequence of this environment was that "there [was] an opportunity to win business because councils have experienced difficulty in assessing the new products and traditional advisors to councils have been primarily focussed on funds management as the appropriate form of investment". To that end, the Business Plan opined that LGFS presented "a credible alternative approach".

102    Under the heading "Strategic Plan for 2005/2006", LGFS set out its intention to "[e]xplore product structures that could be used in a local government context that adds value or represents an alternative to CDOs for councils". It also identified that it would "[l]everage off the rapport with the councils to encourage the resultant products as viable alternatives for them" (emphasis added). This leveraging was important because, as the Business Plan noted, the councils were "very slow to change from existing practices".

103    The papers for the 6 July 2005 board meeting also included a research presentation entitled "Investigation of Local Government Investment Market" dated May 2005. The presentation had been created by Woolcott Research Pty Ltd at the commission of LGFS. The minutes of the board meeting disclosed that Mr David Elliot and Mr Matthew Toohey of Woolcott Research joined the meeting at 1:00 pm to present their findings. Relevantly, the presentation slides indicated that: (a) councils "tended to have a conservative approach in their investing philosophy"; (b) councils "were aware that they were investing public money, and thus had an obligation not to invest in anything too high risk"; (c) financial controllers at councils had "an accountancy background", and investment was "not their area of expertise"; (d) CDOs "were seen as a riskier investment" - nobody at the councils "felt they 'really' knew how a CDO works" and councils tended to "rely on [adviser's] for making investment decisions"; (e) the majority of councils were using an advisory service as they felt they did not have "the expertise or time to make the best investment choices": and (f) while councils retained "the final right on all investment decisions", it was "rare for them not to take the [adviser's] recommendations": J[998].

104    In September 2005, Mr Michell visited a number of the Councils, including Eurobodalla, Cooma, Corowa, Narrandera, Murray and Oberon, recording their appetite for CDOs and his perception of their approach to investments, particularly CDOs: [SAF254] and J[1006]. Mr Michell's notes record that appetite for CDOs was mixed but that most of the Councils were happy with LGFS' services: [SAF254] and J[1006]. His notes included the following:

Eurobodalla

John Murphy & Miles Craighead

20% CDO's

Current policy restricts amount invested in A1 category (inc LGFS) both individually and combined. Will be expanding this category in policy. Restrictions inhibiting returns - forcing them to A1+ level.

Miles interested in ECF - Mark to phone to discuss structure of FM.

Cooma Monaro

Darryl Hagger & Kate

Very happy LGFS. Very conservative. LGFS + two others. No CDO's. No FRN's.

Corowa

Ian Rich

CDO's through Grange - not happy with portfolio manager. Looking to sell portfolio.

Send letter of offer on "Right Balance" - very keen.

Total about $15-18 mill.

Send info on training.

Narrandera

Robert Brown

Very happy with LGFS. Send info on training.

LGFS plus two others (local bank and other)

Very conservative. No CDO's

Murray

Nathan Quinlan

Very conservative. Grange want to portfolio manage their funds.

Not comfortable with CDO's - don't understand them.

Send letter of offer "right balance".

Send details on training.

Oberon

Amanda McGrath

Send letter of offer "right balance"

Reviewing investment policy in November after auditors

Buying first CDO $500k - could be "beech" - "just dipping their toes" opportunity for monitoring

Send info on training

(Emphasis added.)

105    Mr Michell would make further marketing trips throughout LGFS' course of marketing the Rembrandt notes. After one of these trips, he noted in an email to Mr Tischler that "the positive image of LGFS is certainly something that comes out as providing a level of comfort for people and this acts to allay any concerns that (sic) about the ten year term or the fact that it is a new product": J[1094] and J[1377(6)]. Mr Michell's reference to "ten year term" was to the term of the Rembrandt notes, a term which he had identified was an "eyebrow raiser" for the councils: J[1094] and J[1377(6)].

106    In October 2005, Mr Hilder presented an Activity Report to the Board of LGFS prepared in the previous month. The report stated that:

Most if not all council holders of CDO's (sic) do not understand these products; Councils do not have the resources to monitor CDO's (sic) in an appropriate fashion; The high credit ratings on CDO's (sic) do not truly represent the inherent risks; CDO's (sic) are constantly evolving, there is no standard structure, complexity is increasing; Should credit markets suffer a significant blow-out, there will be losses.

(Emphasis added.)

107    A further board meeting was held on 12 October 2005. The minutes of that meeting recorded that FuturePlus' CEO expressed concern that "funds under management continued to fall and that CDO's (sic) continue to have a detrimental impact on market share" and that the company (being, presumably, LGFS) "would struggle to become profitable under its current business model, given the low margins available": J[1007].

108    Between June 2005 and November 2005, LGFS' term deposits suffered a reduction of around $95 million. By November 2005 over sixty councils in New South Wales had engaged external fund managers in respect of their portfolios: [SAF139].

109    In late 2005, LGFS developed a new service it intended to provide to councils, entitled 'Right Balance' (Right Balance Service): J[1153]. This new service was part of LGFS' plan to strategically position itself as an investment adviser to councils as opposed to its historical role as a deposit-taking institution: J[1153]. LGFS marketed the Right Balance Service to councils through a brochure (Right Balance Brochure), which included the following statements (emphasis in original) (J[982]):

Local Government Financial Services Pty Limited (LGFS) and FuturePlus Financial Services Pty Limited (FuturePlus) have joined forces to provide the foundation for a unique financial advisory service developed exclusively to assist Local Government Councils.

How can we help you?

Combining forces with FuturePlus places an extensive range of financial market and advisory capacities at LGFS's disposal. This means that LGFS can provide you with:

    Financial expertise - from highly experienced market specialists.

    Market intelligence - using our extensive in-house and external research capacities.

    Effective investment decision making - backed by an experienced team with highly successful processes for managing active portfolios in financial markets.

    Major buying power - combined with FuturePlus, having $7.5 billion in funds under management, LGFS can demand particularly competitive prices from the market.

With these capabilities and resources behind us, LGFS is extremely well equipped to provide Councils with a competitive edge to maximise returns on their funds.

What benefits can we bring you?

Having LGFS on your side means you will benefit from:

    An effective strategy developed by experts.

    Current market intelligence provided by experienced professionals with impressive track records.

    Sound product analysis drawn from successful in-house portfolio managers.

    Sharp prices garnered from the group's buying power in financial markets.

Supporting this is the superior client service offered by LGFS and FuturePlus. The core business of both LGFS and FuturePlus is to provide the best possible financial solutions and services to Councils, whether focused on investment needs or the superannuation needs of staff.

A partnership within Local Government

The Local Government Superannuation Scheme, together with its service provider, FuturePlus, has delivered very good financial outcomes for Councils for 8 years. Further, LGFS has a 30 year track record of successfully providing a range of financial services for Councils.

By partnering with LGFS, Councils can harness the extensive skills, experience and resources of both LGFS and FuturePlus to achieve better financial outcomes for Councils' own funds.

The "Right Balance"

At LGFS we believe that successful investment management is about getting the "Right Balance".

We have the skills and experience to help you achieve the difficult task of getting a balance of risk and return, a balance of credit and concentration, a balance of funds management and direct investments, a balance of fixed and floating rate exposures and a balance of exposure to various possible outcomes.

The Right Balance can only be achieved through a disciplined and logical process, such as the one developed by LGFS specifically for Local Government Council clients.

Based on key principles, this process develops a framework for setting a broad strategy to maximise a Council's investment returns and then for measuring the success of that strategy.

The process is all about getting the "Right Balance". Its key components are described over.

The "Right Balance" principles

The key principles of the LGFS Right Balance process are to:

    match the strategy to the nature of Councils' funds

    relate the Balance principles to the purpose for which Councils' funds are held

    assess and define Councils' risk tolerance and balance the strategy with this risk preference

    develop and articulate a preferred economic scenario that is directly related to financial market movements

    identify the main risks to this preferred scenario and assess the impact of a contrary outcome

    analyse the various market segments to identify "value"

    work within Councils' preferred market segments (direct investments, funds management or a combination of both)

    monitor economic and investment market developments in the context of Councils' strategy and within the assumptions that the strategy is built upon. (This is done in consultation with Councils to ensure the strategy remains relevant.)

LGFS also provides tactical advice on the products that can be used to implement each Council's strategy.

From time to time assets can trade at a price which is well above an appropriate price for the nature of the product and its attendant risks. LGFS will monitor these prices with a view to adding value to Councils by identifying "cheap" assets that fit with their strategies.

LGFS can also provide Councils with formal reporting on a regular basis which details the performance of the portfolio and enables a review the strategy.

LGFS will monitor these prices with a view to adding value to Councils by identifying "cheap" assets that fit with their strategies.

110    The Right Balance Brochure indicated that Messrs Hilder, Tischler and Michell had been appointed as the councils' primary contacts to "ensure effective delivery of advisory services and the timely flow of information to [c]ouncils": J[983]. It also specified the following information in respect of regulatory requirements (J[984]):

    LGFS is an Australian Financial Services Licensee (AFSL 245642).

    FuturePlus is an Australian Financial Services Licensee (AFSL 238445).

    LGFS holds a credit rating of "A,A1" by Standard & Poor's Ratings Agency.

    LGFS is an authorised investment under Local Government Act 1993 - Investment Order dated 16th November 2000 section (n).

    Local Government Financial Services Pty Limited (LGFS) is wholly owned by the Local Government Superannuation Scheme (LGSS).

    FuturePlus Financial Services Limited (FuturePlus) is owned by the Local Government Superannuation Scheme and the Energy Industries Superannuation Scheme.

111    LGFS had also prepared a standard-form letter which it sent to the councils with the Right Balance Brochure. That letter (the Right Balance letter) said (J[985]):

Investment markets have become extremely complicated with Brokers pushing increasingly complex and involved products that require extensive evaluation and legal due diligence. It has never been more difficult to manage financial assets.

In response to this, LGFS has joined forces with the Local Government Superannuation Scheme to develop the "Right Balance", a service to help councils extract the best returns from financial markets for the risks taken.

In using the "Right Balance" service council will not only benefit from the research and market resources of LGFS but will also benefit from the extensive resources and capacities of the staff managing the Local Government Superannuation Scheme. With an organisation of over $8 billion behind you, the complexities of the market can readily be mastered and the finest prices can be extracted.

The "Right Balance" service is a structured and logical strategic process for councils, to assist in managing and monitoring investment portfolios and to provide input into investment choices away from a sales context.

The process is structured to capture all the relevant elements important to council. The objective is to achieve the "Right Balance" between risk and return, credit concentration, funds management and direct investment exposures for council. A detailed explanation is set out in the attached brochure.

We would like to invite you to consider engaging LGFS to provide the "Right Balance" service for your council. …

112    LGFS also prepared an agreement which it was intended would be executed as between LGFS and those councils that wished to subscribe for the Right Balance Service (Right Balance Agreement). The Right Balance Agreement contained the following two recitals (J[986]):

A     LGFS has represented to the Council that it has the skill, facilities, capacity and staff to carry out the terms of this Agreement.

B     The Council wishes to appoint LGFS to provide Services in respect of its Portfolio and LGFS has agreed to accept that appointment on the terms and conditions set out in this Agreement.

113    The Right Balance Agreement also contained the following provisions (J[987]):

2.1 Appointment

The Council appoints LGFS to provide the Services in respect of the Portfolio on the terms and conditions of this Agreement.

2.2 Acceptance

In consideration of the Service Fees, LGFS accepts its appointment as service provider on the terms and conditions of this Agreement.

3.1 Performance

LGFS shall provide the Services diligently, accurately and efficiently and to meet the Performance Criteria set out in Schedule 1. If the Agreement, including Schedule 1, does not expressly specify the date by which a particular Service must be provided at the latest, the Service is required to be performed by a date which will reasonably enable the Council to comply with any Relevant Law.

3.3 Capacity

LGFS must maintain access to sufficient Resources to ensure the provision of Services and Additional Services.

3.8 Accuracy

LGFS is at all times responsible for ensuring that the information delivered (such as monthly performance reports) and the processes undertaken by virtue of the Services provided are accurate and complete. This means that the information supplied has been processed correctly in accordance with Council's Investment Policy and Relevant Law.

4.7 Commitment as to Resources

LGFS must have, or have access to, all the Resources necessary to provide the Services in accordance with this Agreement. LGFS represents that it:

(a)     will not seek to recover fees for the provision of the Services on an hourly rate basis; and

(b)     will maintain adequate and appropriate staff levels to provide the Services in accordance with the Performance Criteria.

5.1 Liability of and Indemnity by LGFS

LGFS is liable to the Council for each claim, action, proceeding, judgment, damage, loss, expense or liability incurred or suffered by or brought or made or recovered against the Council (Council Loss) to the extent that it arises as a result of or in connection with any breach of this Agreement by, or negligent act or omission of, or fraud or dishonesty on the part of, LGFS (or any of its officers, employees or agents) but not if the breach, act or omission is based on the direction of or information provided by the Council. LGFS agrees to indemnify the Council for all direct Council Losses but not for any indirect, economic, consequential or special Council Losses.

5.2 Liability and Indemnity by Council

The Council is liable to LGFS for each claim, action, proceeding, judgment, damage, loss, expense or liability incurred or suffered by or brought or made or recovered against LGFS (LGFS Loss) to the extent that it arises as a result of or in connection with any Proper Instruction, or any breach of this Agreement by, or negligent act or omission of, or fraud or dishonesty on the part of, the Council (or any of its officers, employees or agents (other than LGFS)). The Council agrees to indemnify LGFS for all direct LGFS Losses but not for any indirect, economic, consequential or special LGFS Losses.

6.1 Compliance generally

LGFS will, at all times, comply with the:

(a)     the Relevant Law;

(b)    the provisions of this Agreement; and

(c)     any compliance procedures established by the Council in respect of the Portfolio, and advised to LGFS from time to time.

9.1 LGFS' representations and warranties

LGFS represents and warrants to the Council, as at the date of this Agreement and for the Term and it is a condition of this Agreement, that:

(a)     it has and will maintain within Australia the power, skill, capacity and resources necessary to perform its obligations under this Agreement;

(b)     it will exercise all due diligence and vigilance in carrying out its obligations under this Agreement;

(c)     it will ensure that sufficient competent employees will at all times have the conduct of, and will maintain close supervision of, the Services and any Additional Services and any Additional Services to be provided under this Agreement;

(e)     it holds all licences, permits, authorisations, approvals and consents necessary to perform its obligations under this Agreement and will comply with all applicable laws in the performance of its obligations under this Agreement;

114    Schedule 1 to the Right Balance Agreement identified the "Service" in these terms (J[988]):

This Service Delivery Schedule (SDS) sets out the agreed service commitment between the Council and LGFS. The SDS forms part of Schedule 1 of the Services Agreement between the parties.

The purpose of the SDS is to:

    Clearly outline the Services to be provided to the Council by LGFS under the Agreement;

    Establish the responsibilities of each party in delivering these services; and

    Formulate a system to measure the accuracy, completeness and timeliness of LGFS as a service provider.

Phase

Service

Performance Criteria

Initial Action

    Develop reference investment that reflects the underlying purpose of funds

    Assessment of current portfolio

    Review Council's Investment Policy

    Cash flow analysis

Within 30 days after signing of agreement

Strategy

    Assess strategic orientation of portfolio

    Establish trigger points that would initiate a re-consideration of strategy

    Evaluation of the implications of alternative scenarios

    Agree process for regular portfolio review and reporting

Within 30 days after signing of agreement

Strategy Execution

    Assess the short term influences that could impact on the tactical timing of investments

    Assessment of assets within the risk parameters specific to council's investment policy

    Review approach to complex structured products

Within 5 business days of authorisation

Reporting

Monthly reporting

    Economic and Market report

    Portfolio performance report

    Compliance report

Within 7 business days of end of month

Quarterly reporting

    Review against implement Strategy

    Review of investment strategy

Within 7 business days of end of quarter (being three month anniversary of signing of agreement)

Annual reporting

    Annual assessment of investment strategy

    Presentation of annual results to Council

Within 30 days of one year anniversary of signing of agreement

115    The Right Balance Agreement defined the Relevant Law as the Local Government Act, the Corporations Act, the Income Tax Assessment Act 1997 (Cth), regulations and regulatory policy made under those Acts, and other Australian laws applicable to the councils as notified to them by LGFS: J[989].

116    The Right Balance Service was not successful and only had a marginal effect on LGFS' continuing loss of market share: J[1035]. Of the Councils to whom LGFS marketed the service, only Corowa and Cooma subscribed for the service and entered into the Right Balance Agreement with LGFS (the RB Councils): [SAF19], [SAF21] and J[1153]. The other councils will be referred to as the NRB Councils.

117    On 30 November 2005, Mr Hilder sent an email to Mr Peter Lambert, who was the CEO of LGSS and the CEO and Company Secretary of LGFS since 5 December 2007, attaching board papers including an "Activity Report December 2005 Quarter" which observed that:

[T]he strongest demand [for the Right Balance Service] is from councils that have portfolios of CDO's (sic) that are being approached by brokers wishing to trade them. These councils are unsure as to the brokers' motivation and do not have the tools or knowledge to evaluate the proposed trades. These councils have expressed a need for expert independent assistance and see LGFS as a natural fit to fill this roll (sic).

(Emphasis added.)

118    LGFS held further board meetings on 7 December 2005 and 22 February 2006. The papers for the 7 December 2005 meeting included reports about the marketing of the Right Balance Service and the impact of CDOs on LGFS' balance sheet. Mr Hilder presented the "Business Situation Review" which proposed a number of alternatives to "address the balance sheet reduction" including developing a new deposit product, using managed fund investments as assets against short-term council deposits, and maximising opportunities associated with the Right Balance Service: [SAF140]. The minutes of the meeting on 22 February 2006 record that in response to the confirmation of the minutes of the meeting held on 7 December 2005, FuturePlus' CEO "outlined that the underlying profitability of the business would continue to be difficult given that the providers of products utilising CDOs were eroding market share of those products with higher margins": [SAF141].

119    It was also in late 2005 that Mr Tischler had commenced purchasing CDOs for LGFS' own books in a tentative step into the market: J[1163]. Nonetheless, LGFS had not found a suitable alternative product and its market share continued to decline: J[1292]. LGFS' interest, by this time, was to establish itself as a player in the financial products market in order to overcome the "substantially deleterious effect that the sale of CDOs" by its competitors had had on LGFS' profitability: J[2311]. The CPDO provided LGFS with an opportunity.

120    On 6 March 2006, Mr Cordeiro published a paper entitled "Implications for structured credit for Local Government Authorities" which was discovered by LGFS, stating:

CDO's (sic) as an investment are probably a reasonably conservative investment for a local government investor when used in the right way, with sufficient understanding of the limitations and possible extreme (but unlikely scenarios) that can occur with this product type…It is clear from feedback from many of these investors are (sic) not fully briefed on limitations of the product and it would probably be fair to say that many investors in these products should not be invested (sic) in the way that they are.

(Emphasis added.)

121    On the same day, Mr Tischler met with representatives of ABN Amro, including Mr Cordeiro. Mr Tischler's notes of that meeting recorded that "[s]ome CDOs held by councils may not be suitable for inclusion because of excessive risk or unusual structural elements". His notes also recorded the following (J[1011]-J[1012]):

Meeting with ABN-Amro 6th March 2006

Summary

Meeting arranged to discuss ways ABN-AMRO could assist in the repackaging (sic) a disparate assortment of Council held CDOs into a securitised structure to produce a superior security(s) for resale to councils.

    Recognition of potential "time bomb" investors in CDOs may face if market moves against them.

    Significant portion of product (sic) in the market poorly structured and vulnerable

     Combining large volume of separate CDO issues held by councils into a common pool and securitising that pool to produce a superior AA rated security for resale …

    […]

    Purchase issues back from council at par, so no loss from initial purchase on issue and reissue new AA rated securitisation product at around 100 bps over bill. This may mean capital losses and gains against mark to mark values - which could present weakness to those running a counter campaign

    […]

    Some CDOs held by councils may not be suitable for inclusion because of excessive risk or unusual structural elements

122    On 5 April 2006, Mr Cordeiro emailed Mr Hilder regarding developing "[f]urther options for NSW Councils" stating:

Elliott [Levick] has asked me to think further about the options that may suit the requirements of NSW councils for high quality investments.

I am conscious of the difficulty to organise each individual council as they are independently managed, however, I am also conscious of the limited level of knowledge of complex financial products such as CDOs and similar products. I have been trying to identify a strategy which would be achievable and sensible for yourselves and the NSW councils in general.

Firstly, you would we (sic) aware that CDOs themselves aren't bad products, really, it's the contrary, they are good products. The problem with many of the transactions sold to NSW councils is [that] the distribution fees that are deducted from the value of the transactions forces the originators to create structures which are less robust than can otherwise be achieved. Furthermore, there is no independent specialist reviewing the transactions making it difficult for the council to truly understand the level of risk associated with the investment.

I would like to propose a discussion with that (sic) would involve ABN AMRO working with LGFS to create a high quality CDO investment which would meet the objectives of NSW councils (i.e. return above BBSW) plus a high degree of security and rating stability of the structure. There are a number of possible options for LGFS but some of the roles could include:

    Distribution agent

    Portfolio manager

    Structural adviser

    Asset consultant

In addition to the roles above, subject to a sufficiently acceptable volume, we could arrange for a third party, experienced, specialist portfolio manager to manage the transaction on the investors and your behalf.

What we would be trying to achieve is a transaction that pays a satisfactory margin over BBSW, but has a credit quality that would be satisfactory to the asset consultant. We could engage the services of an independent agency to assess the credit worthiness of the structure.

Please think about this line of discussion and feel free to call or email me back with your thoughts.

(Emphasis added.)

123    The circumstances in which LGFS purchased the Rembrandt 2006-2 and Rembrandt 2006-3 notes from ABN Amro are set out at [59]-[97] above.

124    At around the time that LGFS was considering investing in the Rembrandt notes, it was also in the process of a setting up its Fixed Out-Performance Cash Fund. That fund was to operate as a managed investment scheme and LGFS required an amendment to its AFSL to operate the fund; an amendment it was in the process of obtaining: [SAF464] and J[3594]. At trial, LGFS submitted that the Rembrandt notes were a "sideshow" to its real interest in marketing its Fixed Out-Performance Cash Fund. The primary judge rejected this submission on, among other things, the basis that it was "defeated by [LGFS'] own documents": J[2166].

125    LGFS began the process of marketing Rembrandt 2006-3 to councils soon after its purchase of the notes. In early November 2006, LGFS prepared a brochure entitled "LGFS Community Income Notes Brochure" to be provided to some of the councils (LGFS Community Income Notes Brochure): J[48]. It included the following information on the first page (as set out by the primary judge at J[49]):

Community Income CPDO Notes

Arranged by Local Government Financial Services Pty Ltd

The Offer:

AAA Rating

CPDO is a new form of synthetic credit investment that carried a AAA rating on both the principal and the interest.

High Return

Community Income CPDO Notes have a AAA rated quarterly coupon rate of BBSW + 190 bps pa.

Diversification

This new form of synthetic credit investment offers diversification as an alternative to existing forms of structured investments such as CDOs and CPPIs.

Liquidity

LGFS will provide liquidity by repurchasing notes at market value.

Key Features:

Credit indices: represent an implicit "self cleansing" feature.

The credit portfolio is comprised of credit swaps against international credit indices. The credit indices are rolled over every six months into a new set of indices providing a "self-cleansing" effect, i.e. entities downgraded to below investment grade are removed and replaced by investment grade entities.

Credit indices: spread widening can potentially be beneficial.

A widening in credit spreads, with no corresponding defaults, may be beneficial to the structure increasing the value of the leveraging.

Controlled leverage.

The Community Income CPDO Notes aim to pay stated coupons by taking leveraged exposure that is governed by a fixed set of rules.

Potential early de-leveraging/cash-in.

If the Note value rises above the value of a AAA bond paying BBSW + 190 bps pa plus administration expenses, a "cash-in" event will be triggered and the credit index portfolio will be fully unwound.

Investors continue to receive coupon payments for the remainder of the term without any further exposure to leveraged credit risk or can sell the CPDO, potentially for a profit.

LGFS support.

LGFS will continue to provide support to investors including next day liquidity and daily pricing as required throughout the term of the investment.

126    At the bottom of the first page appeared the following statement:

This document and the Term Sheet are for wholesale investors only. Retail investors cannot hold the Notes. This material is for information purposes only and should not be distributed to any person or entity in any jurisdiction or country where such distribution would be contrary to local law or regulation. This document is not an offer, nor invitation to offer, nor a solicitation or advice or recommendation to buy, subscribe for, issue or sell securities. No representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information in this document or the Term Sheet. This document is not intended to set out the final terms and conditions of the Notes and it may be amended, superseded or replaced in its entirety by the Term Sheet or other summaries of the terms and conditions. The final terms and conditions are set out in the Issue Notice. Investments such as the Notes involve a degree of leverage risk, and the value of such instruments may be highly volatile. Such risks may include the loss of a significant amount or all of your investment. This brief statement does not disclose all of the risks and other significant aspects in connection with the Notes and, before purchasing the Notes, you should ensure that you fully understand the terms of the Notes, including relevant risk factors and any legal, tax and accounting considerations applicable to the Notes. Neither Local Government Financial Services Pty Ltd nor any of its officers or employees accepts any liability whatsoever for any loss arising from the use of this document or the Term Sheet. This material may not be reproduced, distributed or transmitted to any other person without the prior written consent of Local Government Financial Services Pty Ltd. Please note that the information contained herein is of a general nature only. It is has not been prepared taking into account your particular investment objectives, financial situation and particular needs. This document is provided by Local Government Financial Services Pty Ltd (ABN 12 001 681 741), an Australian Financial Services Licensee (AFSL No 245642). Local Government Financial Services is owned by Local Government Superannuation Scheme (ABN 68 078 003 497).

127    The second page of the brochure contained the following diagram:

Community Income CPDO Notes

image

128    Mr Hilder intended the brochure to be a "plain-English explanation of the features of the Rembrandt notes" although he accepted that while it identified the advantages of the product, it did not identify any disadvantages or risks: J[1202] and J[1337]. Mr Hilder agreed that the brochure did not acknowledge that spread widening could be potentially detrimental to the structure of the CPDO, or that leveraging could increase the magnitude of the loss: J[1202]. Mr Hilder had made a decision "only to show the key features which were positive, not those that presented risks": J[1204]. For instance, while the brochure emphasised the liquidity of Rembrandt 2006-3 in the body of its text, it only discussed volatility in the fine print contained at the bottom of the first page. Mr Hilder said that he nonetheless approved the brochure on the basis that it was a mere "agenda for discussing the product" to "entice interest" and facilitate the sale of the product by outlining the "rewards or benefits or returns of the product": J[1337]. Mr Tischler's evidence was to the contrary; he considered the brochure to be the "marketing script" for the product: J[1338].

129    LGFS' decision to highlight the liquidity of the Rembrandt 2006-3 notes while minimising their volatility was deliberate. LGFS was aware that the Rembrandt 2006-3 notes were highly volatile. The Surf Presentation (set out at [61]-[69] above) disclosed as much on page 29 under the heading "price volatility". The presentation stated that: the "NAV of the note is sensitive to credit spreads of the underlying portfolio of index swaps"; the "price of the notes may be lower than the initial purchase price"; the "traded price may be different from the NAV of the notes due to supply and demand issues; and "[l]everage may increase the magnitude of price volatility". ABN Amro had mentioned price volatility as an issue at the oral presentation attended by Mr Hilder. At trial, Mr Hilder gave evidence that he understood that "the design of the Rembrandt notes meant that the price was liable to fluctuations which depended on the value of the indices": J[1357]. Yet, despite the Surf Presentation disclosing that the "price of the notes may be lower than the initial purchase price" and both Mr Hilder and Mr Tischler being aware that the Rembrandt 2006-2 notes had experienced a decline in market value to less than the issue price (see [87]-[93] above), LGFS did not inform the Councils that the market value of the notes may not be their face value. Rather, as the next paragraph sets out, LGFS chose to focus on the liquidity of the Rembrandt 2006-3 notes in its marketing.

130    Presumably to avoid the issue of volatility hindering its ability to on-sell the notes, LGFS emphasised the liquidity of the notes. The brochure stated that LGFS would "provide liquidity by repurchasing notes at market value" and that LGFS would "continue to provide support to investors including next day liquidity and daily pricing as required throughout the term of the investment": see [125] above. The liquidity of the notes was also important in ameliorating the ten year term of the Rembrandt notes which Mr Michell had identified as an "eyebrow raiser": see [105] above. Indeed, Mr Michell's email to Mr Tischler in which this issue was raised stated that the "eyebrow raiser" became "largely irrelevant when they [saw] the written commitment from LGFS to buy back at 24 hours (sic) notice": J[1094]. But, despite knowing that the Councils were relying on the liquidity of the notes to mitigate against the length of their term, LGFS did not inform the Councils that the market value at which LGFS promised to repurchase the notes from the Councils would be whatever price ABN Amro determined having regard to supply and demand at the time: J[1363]. In the event, liquidity was an important factor in the Councils' decision to purchase the Rembrandt 2006-3 notes. The primary judge found that there was evidence to establish, or to support an inference, that the promised liquidity of the Rembrandt 2006-3 notes was a factor which the Councils (except for Ryde) relied on in deciding to invest in the notes: see J[1552] (Parkes), J[1641] (Orange), J[1730] (Oberon), J[1955] (Murray), J[2012] Cooma and J[2050] (Narromine).

131    In addition to the brochure, LGFS marketed the notes by providing a copy of either the Pre-Sale Report or the Post-Sale Report to some of the Councils, by sending a letter entitled "CPDO - The Next Generation" to two Councils (Narromine and Ryde) (the CPDO letter), and by holding discussions with various representatives of the Councils: [SAF260] and J[1306]. The primary judge found that the discussions LGFS held with representatives of the Councils conveyed the impression that the CPDO, marketed as "Community Income CPDO Notes", were specifically tailored or designed for local councils: J[1370]. This impression was also conveyed by the terms of the CPDO letter sent to Narromine and Ryde, which was set out by the primary judge (at J[1125]) and which stated as follows (the version sent to Ryde contained a difference in the opening paragraph which is not material):

AAA Rated Principal & Coupon

AAA Rated Principal & Coupon

CPDO - The next generation.

As you discussed recently with Simon Michell, LGFS has introduced Constant Proportion Debt Obligation (CPDO) technology. This is a new AAA rated structure type which pays a AAA rated coupon of 190 basis points above the 90 day BBSW rate.

This new form of synthetic credit investment offers very high liquidity and represents a diversification alternative to existing forms of structured investments such as CDO's and CPPI's, some of which have struggled to maintain their credit rating and projected coupons.

The CPDO is a rules based structure that uses two investment grade credit indices (DJ CDX.IG and (iTraxx) rather than a static portfolio of credit default spreads to earn coupon. The indices roll every six months into a new series and entities downgraded to below investment grade are removed and replaced by investment grade entities, this serves to limit the credit risk in the transaction.

When compared with a static portfolio comprising identical underlying reference entities, rolling the indices acts as a defensive mechanism that limits negative credit migration and default risk. - Standard & Poor's Ratings Agency

Once the notes earn enough to pay the BBSW +190 bps coupon and expenses for the remainder of the term an early cash-in occurs and the credit index portfolio will be fully unwound. Investors continue to receive coupon payments for the remainder of the term without any further exposure to leveraged credit risk. In addition the option exists to sell the CPDO, potentially for a profit.

Spread widening, attended by no corresponding defaults, is beneficial to the structure. - Standard & Poor's Ratings Agency

Since issuance in November 2006, the notes have paid an initial coupon of 8.22% to the 20/12/06. Then 8.31% to the 20/3/07. The current coupon rate is 8.36% with the next roll (sic) 20/6/07. The rating has remained at AAA since issuance.

LGFS is proud to be the first to tailor this robust structure to Local Government which we believe provides Councils with the opportunity to improve the liquidity, credit quality and performance profile of longer dated portfolios.

We have a limited amount of notes remaining and we would be happy to discuss the characteristics of this offering in more detail with you.

(Emphasis added.)

132    Further, seven of the Councils were provided with either a draft or final version of the ABN Amro term sheet for the Rembrandt notes (Bathurst, Moree, Deniliquin, Murray, Narrandera, Oberon and Orange): [SAF260] and J[1307].

133    Mr Tischler and Mr Michell discussed ways of selling the product to council representatives: J[1205]. They agreed to (J[1205]):

    focus on the product's AAA rating, as this meant Rembrandt fell "clearly" within the terms of the Ministerial [O]rder;

    provide [C]ouncils with the [Pre-Sale Report or Post-Sale Report] and the ABN Amro draft term sheet, as well as the LGFS [C]ommunity [I]ncome [N]otes [B]rochure; and

    strongly encourage council representatives to read those documents for themselves.

134    The marketing documents used by LGFS (i.e., the LGFS Community Income Notes Brochure and the CPDO letter) emphasised the following features of the product (J[1308]):

(a)    the AAA rating assigned to the Rembrandt notes by S&P;

(b)    the high return and liquidity of the Rembrandt notes;

(c)    LGFS's "support" for the product (also reinforced by the renaming of the product as "community income notes"), plainly intended by LGFS to communicate a connection with the functions of councils;

(d)    the likelihood of a "cash-in" event occurring through which the credit index portfolio would be unwound and investors would continue to receive coupon payments for the remainder of the term of the investment, without any further exposure to leveraged credit risk, and

(e)    that the Rembrandt notes offered diversification as an alternative to existing structured credit investments such as CDOs.

135    On 16 November 2006, Grove Research and Advisory prepared a report about the Rembrandt 2006-3 notes (the Grove Report). A council (not involved in these proceedings) emailed the report to Mr Tischler on 30 November 2006 and Mr Hilder saw the report soon thereafter: [SAF209]. Relevant aspects of the report were set out by the primary judge at J[53]:

Features

Issuer

Rembrandt Australia Trust Series 2006-3

Books Close / Settlement

[November 17] 2006

Distributor

Local Government Financial Services (LGFS)

Arranger / Swap Counterparty

ABN Amro

Calculation Agent / Index Dealer

ABN Amro

Term

10 years

Rating

AAA (Standard & Poor's)

Structure

Credit-linked capital-protected notes

Releverage Triggers

75% / 125% of target

Quarterly Contingent Coupons

BBSW + 1.9% p.a.

Leverage Limit

15x

Liquidity

ABN Amro intend to make a market (1% bid offer spread currently indicated)

Currency

$A

Early Redemption Trigger

Cash-out (deleverage) event: NAV below 10c in the dollar

Underlying Assets

Investment grade CDS swap indices

The investment, less a 1% arrangement fee, will be invested in a cash deposit. This deposit can be leveraged into (long) index positions in a "dynamic leverage" manner. Leverage is limited by a complex formula to constrain the "value-at-risk" to a level that is unlikely to trigger a cash-out event - the factors affecting permissible leverage are discussed further below. The underlying investments are:

    50% "Dow Jones CDX.NA.IG" index - the 125 most liquid investment-grade North American CDS contracts

    50% "iTraxx Europe" index - the 125 most liquid investment-grade European CDS contracts

These are rolled every 6 months into new investment grade contracts, minimising (but not eliminating) the risk of default. This is contrasted to a CDO, in which names downgraded to sub-investment grade are not replenished and the investor remains exposed to them.

Since 1996, 8 credits have defaulted while still in their investment-grade indices (i.e. within 6 months of last index rollover, at which point they were still investment-grade). Accounting frauds such as Enron and Parmalat feature prominently in this list; however, other operational shocks can also be the cause. For example, the grounding of flights, additional security costs and reduced passenger numbers that followed "September 11" tipped Swiss Air into sudden default.

The issue is not managed; selection of indices and changes in leverage are based on pre-determined formulas. The target amount of value at risk is based on the combination of:

    Fixed interest curve (i.e. the theoretical value of the capital guarantee at maturity, plus coupons and fees).

    The credit duration of the indices (currently around 4.5 years), applied to a spread gap of 30% widening. Where the index spread is less than 67bp, a minimum spread gap of 20bp applies.

    1.4% of the index face value to cover default risk.

Note that a series of severe losses could result in "cash-out" and termination. This would result in a near total loss, unlike a standard CPPI credit note.

Although coupons are rated AAA, there remains a significant risk that, particularly in the later years, coupons may not be payable. The expectation is that unpaid coupons in response to a late "cash-out" event would not overly disadvantage investors, on the basis that they had been paid BBSW +190bp for a number of years. However, it is possible for adverse conditions to result in a poor overall return.

Key Features - CPDO

    Compared to previous CPPI credit notes, CPDOs are typically longer-dated. The longer term reduces the risk of "cash-out" events and enables greater leverage to be employed. It can take a "full cycle" view compared to a 5-year credit product that could capture a "bear market" only.

    However, unlike CPPI, "cash-out" of a CPDO results in early termination, and loss of at least 90% of the investment. (By contrast, in a CPPI investment "cashing out" results in deleverage, but ultimately a return of capital at maturity).

    As a result of this leverage, and the longer term to 'ride out" market cycles, Standard and Poor's modelling suggests that target coupons are very unlikely to be missed, and therefore that income can be rated AAA, not just collateralised principal as in CPPI.

    Unlike conventional CPPI, the fixed interest curve used is the cost of collateralising both maturity proceeds and coupons. Leverage is based on the size of the shortfall to fixed interest curve, rather than excess above fixed interest curve as in a CPPI investment.

    CPDOs introduce the concept of a "cash-in" event: If sufficient profits are made, the issuer will collateralise not just the maturity proceeds but also the coupons (and fees). The note will therefore stop taking trading risks, and effectively become a AAA FRN.

    In contrast to CPPI, leverage is increased as NAV falls, on the basis that more leverage is required to produce the targeted return. A CPDO is therefore a somewhat "contrarian" design, as opposed to CPPI which is "momentum-following".

Conceptually, the key difference between a CPDO and a CPPI credit investment is this: In the face of losses, the CPPI "gives up" - it deleverages, and ultimately "cashes out" to fixed interest, thereby ensuring the investor at least gets capital back at maturity. The CPDO "fights to the death" to earn the targeted coupon, taking on more risk in the face of losses and only "cashes out" if the NAV falls to under 10% of initial investment.

Key Risks

    CPDOs are a brand new product type, and while S&P have been convinced that risks to coupon and capital are relatively low this has not been tested across a credit market cycle.

    This makes them prone to re-evaluation by rating agencies as rating methodology evolves (particularly if new, unanticipated risks emerge). Conceivably, a change of heart could see an issue previously rated "AAA" downgraded due to a new approach.

    In particular, we have seen reports of a new CPDO rating matrix circulating internally in S&P that would not be consistent with a AAA rating for a product of this yield.

    Also, falls in the NAV due to realised losses in the index trades could result in ratings downgrade (at least of interest rating). It is not clear whether the rating could split if the security of capital and income diverged substantially.

    The note is exposed to mark-to-market risks from the trading positions. Buyback quotes from the market maker are likely to be based primarily on the NAV which could be substantially below par, and therefore result in realised losses should they have to sell.

    For example, the arranger's simulations project a 1% chance of NAV falling to the low 70's, and a 5% chance of bottoming in the low 80's. Such scenarios may also result in target coupons not being paid in full.

    10 years is a long time and circumstances can change - it may not be possible for investors to reliably forecast their liquidity requirements over that period.

    In the extreme, a cash-out (deleverage) event would result in early redemption - investors would receive a major enforced realised capital loss, and not have the opportunity to "save face" by holding to maturity to receive their capital back in full.

    Defaults within 6 months of inclusion or retention in rolling investment grade indices still occur from time to time, particularly during periods of economic weakness. Defaults have a direct impact on the NAV.

    Credit spreads widening, with large discontinuities, could reduce NAV substantially, and place coupons at risk. In particular, unlike conventional CDOs, CPDOs directly participate in market value risks. A CDO's pricing is locked in, and cannot be affected by changes in market spread levels.

    Purchasing a leverage position in CDS indices is less compelling in periods (such as the present) of historically low spreads.

Risk Mitigation and Benefits

1.    The inventors of CPDOs have applied sufficient rigour to demonstrate to S&P's satisfaction that risks to capital and coupon are commensurate with a very high credit rating.

2.    The targeted returns are higher than available for similarly rated synthetic CDOs of long terms, and arguably no riskier. They are somewhat lower than targeted from equity or similar growth assets over that timeframe, but with relatively low correlation to equity returns.

3.    In the arranger's simulations, even the low probability outcomes with very large falls in NAV still resulted in the bulk of coupons being paid at BBSW + 190, and therefore a commercial return was achieved from holding the product to full-term.

4.    The arranger indicates that in the event of a cash-in, the issue would likely be discounted at roughly BBSW. This would generate capital profits of approximately 1.9% per year of remaining term. For illustration purposes only, a cash-in event after 7 years would result in a capital profit of around $5, for a realised return approximately BBSW+ 245bp at current interest rates.

5.    The economic environment remains relatively benign, and corporate balance sheets in good shape (despite recent moves towards increasing leverage).

6.    The arranger has performed back-testing on the performance of such a structure invested through the credit cycle of 1996-2002 and found it to be surprisingly robust. 1996 was, like the present, a period of extremely tight credit spreads. Index positions would have suffered early as spreads widened, and several defaults occurred during the recession. However, the higher reinvestment rates on index rolls ultimately exceeded the cost of the early mark-to-market losses.

7.    The arranger has put in place hedging on the credit indices at the time of an earlier CPDO issue. This locked in a coupon / rating combination that (reportedly) would not be possible under today's market conditions. Moreover, the value of the hedging positions is such that initial NAV will be $101 (effective a negative arranging cost up-front).

8.    The CPDO leverages more as markets fall - an intuitively more pleasing response for a "contrarian" investor than in CPPI.

Indicative Investor Profile

This product is likely to suit investors:

    Looking for very long-dated and high-return structured credit product;

    Needing a strong principal rating and capital guarantee, including rated income;

    Able to invest for a 10-year period - while intended liquidity arrangements through making a market appear reasonable, there is no guarantee of liquidity in all market conditions.

    Able to cope with a high level of potential volatility in NAV, especially as this will be a primary driver of secondary market pricing.

It offers potential for a higher return than available on other high-rated, high-income products such as conventional CDOs but is likely to yield less than pure equity plays over its 10-year horizon. While it is possible to achieve these sorts of returns from equity / property linked notes, it is difficult to replicate the stability of coupon in such structures.

Investors likely to want such an investment should seriously contemplate buying this issue. At current market conditions, the yield and rating combination cannot be replicated. The investor benefits from hedging put in place by the arranger prior to issue, and to some extent would be buying investments at "last month's price". This makes it particularly good relative value in the long-only structured credit space for clients who have Policy that would permit investments of this term.

Term sheet and issue summary are available on request. Your Grove advisor can recommend whether these notes fit into your portfolio strategy.

(Emphasis in original.)

136    On 27 November 2006, Mr Michell emailed Mr Tischler a document which contained a summary of the visits he had made to local councils in New South Wales between 20 November and 24 November 2006: J[1093]. Mr Tischler forwarded the document to Mr Hilder on 29 November 2006. Mr Michell's summary contained the following notes:

Oberon Council

Committed to purchase $500k-$1mill of CPDO

Bathurst City

Happy with CDO - will present to his boss for approval for $1mill

Forbes Shire

Never previously bought CDO or CPPI products. Positive response to CPDO.

Believe they will purchase CPDO largely on our recommendation.

Narromine Shire

Very positive response to CPDO. Short of funds at the moment. Unable to make commitment until cash flow improves…

Moree Plains Shire

Liked the product. Will buy $2mill of CPDO. Asked for a regular economic update.

137    It also contained the following "overview" (at J[1093]):

Generally the response to the product has been very positive both by Councils who have a good understanding of CDO & CPPI and others who are having a structured product explained to them for the first time.

The main "eye-brow raiser" is the ten year terms but this soon becomes largely irrelevant when they see the written commitment from LGFS to buy back at 24 hours notice.

The coupon definitely works as most have a maximum of only 110 to 120 bps on any current holding.

The positive image of LGFS is certainly something that comes out as providing a level of comfort for people and this acts to allay any concerns about the ten year term or the fact that it is a new product.

138    On 1 December 2006, Mr Tischler forwarded the Grove Report to Mr Lewis who himself forwarded it to others within ABN Amro. Later on that same day, Mr Tischler emailed Mr Silvester to the effect that LGFS was happy for ABN Amro to meet with Grove Research and Advisory but wanted an LGFS staff member to be present. What happened with respect to the Grove Report after this is of no present relevance, except to note that Grove Research and Advisory subsequently contacted LGFS to arrange a sale of the Rembrandt 2006-3 notes to three of their clients: J[1113].

139    Prior to their purchase of the notes, some of the Councils sought advice from advisers other than LGFS. Moree, for example, sought advice from Grange Securities Ltd. On 27 November 2011, Mr Stewart Calderwood of Grange Securities Ltd forwarded an email to Mr Mitchell Johnson and Mr Simon Hearn of Moree which stated that "at AAA investor (sic) won't lose money as even if the rating agency assumptions are way wrong you build in such huge margins for error at AAA that you should be alright". The email also noted that the "current market rally has reduced spreads so it is far more likely now that the instrument will go the full term rather than being called early and there is considerable uncertainty over the instruments going forward as to a) whether they truly are going to work (sic) b) what will the rating agencies do going forward and what they will do for existing deals".

140    Each Council invested in Rembrandt 2006-3. The following table, extracted from the trial judgment, summarises the primary judge's findings about the amount invested by each Council in Rembrandt 2006-3, the date or dates on which each Council communicated to LGFS its decision to invest, the date each Council (excluding Bathurst) signed a transfer and acceptance form and the amount each Council received after the investment cashed out: [SAF6].

Council

Investment in Rembrandt

Communication of decision to invest to LGFS

Date Transfer and Acceptance Form Signed

Redemption Amount

Eurobodalla

$500,000

3.11.06

6.11.06

$33,387.08

Parkes

$3,000,000

3 or 4.11.06

8.11.06

$200,322.50

Corowa

$1,000,000

2.11.06

9.11.06

$66,774.17

Orange

$1,500,000

13.11.06

23.11.06

$100,161.25

Moree

$2,000,000

27.11.06

29.11.06

$133,548.33

Oberon

$1,000,000

13.11.06

5.12.06

$66,774.17

Deniliquin

$500,000

24.11.06

11.12.06

$33,387.08

Bathurst

$1,000,000

28.11.06

21.12.06 (transaction completed via Austclear)

$67,043.10

Narrandera

$2,000,000

13.02.07

3.04.07

$133,548.33

Murray

$1,000,000

17.01.07

17.04.07

$66,774.17

Cooma

$2,000,000

17.05.07

23.05.07

$133,548.33

Narromine

$500,000

24.05.07

20.06.07

$33,387.08

Ryde

$1,000,000

24.05.07

27.06.07

$66,774.17

These notes will be referred to as the LGFS Sold Notes.

141    LGFS retained some $26 million of the Rembrandt 2006-3 notes (the LGFS Retained Notes).

8.    DECLINE OF THE REMBRANDT NOTES

142    On 21 March 2007, LGFS held a board meeting at which it was noted that the sale of structured financial products had slowed in financial markets and that while LGFS had sold 50% of its issue of Rembrandt 2006-3, of "the other six issues announced, four were cancelled, one was postponed and another raised only $1 million": J[1116]. On 22 March 2007, S&P published a CPDO Evaluator which set out its intended approach for modelling future CPDO structures: see [366] and [368] below. Mr Hilder considered that the CPDO Evaluator, although ostensibly applying to only future CPDO structures (a matter which was stressed by ABN Amro), would impact on perceptions of the Rembrandt notes: J[1369]. Nonetheless, LGFS did not bring the CPDO Evaluator to the attention of the relevant Councils, including Narromine and Ryde who were yet to subscribe for the notes: J[1369]. Between 2 April and 29 May 2007, Rembrandt 2006-3 was priced at between 99.34 (98.44 in ABN Amro's ledger) and 101.99 (101.33 in ABN Amro's ledger) cents in the dollar: [SAF290] and J[2210]. By June 2007, the Rembrandt 2006-3 notes held by LGFS had reduced in price by $500,000: [SAF291] and J[1361]. On 20 December 2007, S&P placed the Rembrandt notes on "CreditWatch Negative" status, meaning that it was possible that the rating of the notes would be downgraded in the next three months: [SAF218] and J[1131]. On 20 February 2008, S&P announced that it had downgraded the rating of the Rembrandt notes to BBB+ status, at which point the notes had a value of about 35% of par: [SAF219] and J[1132].

143    On 7 March 2008, LGFS circulated a letter to each of the Councils, suggesting options that might avoid the Councils having to incur a realised loss on the notes. Four of the five proposed options required the Councils to invest further funds. The remaining option was to continue holding the notes. None of the options which required the investment of further funds were acceptable to any of the Councils: [SAF294] and J[1132].

144    LGFS sold the LGFS Retained Notes to LGSS on 20 March 2008. On 9 October 2008, LGFS sent a letter to each of the Councils stating that they could no longer advise them about what to do about the Rembrandt notes: [SAF295] and J[1133]. It was also in October 2008 that the Rembrandt notes cashed out: J[2275].

PART 3: S&P'S RATING AND ABN AMRO'S KNOWLEDGE THAT THE RATING LACKED REASONABLE GROUNDS AND WAS MISLEADING: ABN AMRO aPPEAL GROUNDS MATRIX ROWS 61 AND 62

1.    CHRONOLOGY OF EVENTS RELATING TO THE VOLATILITY ISSUE

1.1    Introduction

145    ABN Amro challenges the finding made by the primary judge that it knew that S&P's rating of the Rembrandt notes lacked reasonable grounds and was misleading.

146    An essential part of this challenge is that ABN Amro claims that it had reasonable grounds to believe that S&P rated the Rembrandt notes using an assumed 25% volatility (together with S&P's other base case parameters) and that the notes could be rated AAA using 25% volatility.

147    The primary judge's findings contrary to ABN Amro's claims are stated at J[3143], J[3148]-J[3149] and J[3162(3)]. A critical part of her Honour's findings, which is challenged by ABN Amro, is that when each series of the Rembrandt notes was issued, ABN Amro knew that S&P was using a 15% volatility assumption which it knew from at least early October 2006 to be flawed. This issue is referred to as the "volatility" issue.

148    As part of its challenge to her Honour's finding that ABN Amro knew or ought to have known that the notes could not be rated AAA using 25% volatility, ABN Amro submits that the modelling of the notes, then described as the Surf CPDO, in the period from May to June 2006 was not applicable to Rembrandt 2006-2 or Rembrandt 2006-3 because the structure of those notes had been adjusted in about late July 2006 to include "rebalancing on the rolls".

149    ABN Amro accepts that it did not put this submission at the trial but it submits that, for reasons to which we will refer later, it should be permitted to put the submission on appeal.

150    The PA Councils, whose submissions on this question were adopted by Bathurst and LGFS, submitted that it was not open to ABN Amro to put this argument, which was described as the "rebalancing" issue for the first time on appeal.

151    ABN Amro's contentions on the "volatility" issue and the "rebalancing" issue rely, in large measure, upon an examination of the documentary evidence.

152    Much of the documentary evidence comprised emails, some of which passed between ABN Amro and S&P, but many of the emails were internal to either ABN Amro or S&P.

153    Since the issue sought to be raised by ABN Amro depends upon whether it had reasonable grounds to believe that the AAA rating was justified, it is important to distinguish between the communications which were internal to S&P and those which were sent to ABN Amro or were internal to it.

154    Nevertheless, the parties accepted that a consideration of ABN Amro's contentions should be determined in light of the documentary material, considered in its full context.

155    The context is voluminous and consists of documents, some of which are referred to in the trial judgment, although not always in their full terms or in chronological order, and others which are found in various places in the appeal books.

156    In order to assist us in considering this issue we asked the parties to produce what was in effect an agreed chronology, prepared by counsel for the PA Councils and annotated by ABN Amro. We have drawn the chronological narrative set out below substantially from that document.

1.2    Background to the development of the CPDO

157    The background to the development of the CPDO can be traced to the period commencing in late 2005 and early 2006: see Part 2, Section 3 above and J[79].

158    At that time two groups of employees within ABN Amro were working on the development of structured credit products which would be designed to obtain high credit ratings from S&P notwithstanding changes which were then emerging in market conditions for such products: J[79]-J[81].

159    One of the employee groups was the London-based Exotic Credit Derivatives Group or ECD Group. It was responsible within ABN Amro for structuring, trading and marketing structured credit products: J[79].

160    The members of the ECD Group included Mr Richard Whittle, Mr Jamie Cole, Mr Paul Silcox, Mr Dave Poet and Ms Caroline Bosch. The positions they held in the ECD Group are described by the primary judge at J[72].

161    The other relevant employee group within ABN Amro was the Structured Credit Marketing Group or SCM Group: J[79].

162    The relevant members of the SCM Group were Mr Michael Drexler, Mr Juan-Carlos Martorell and Mr Chris Hodgeman. Mr Drexler and Mr Martorell were based in ABN Amro's New York office. Both were former employees of S&P. Mr Hodgeman was based in Hong Kong. The positions they held within ABN Amro are described by the primary judge at J[72].

163    One of the products on which ABN Amro's ECD Group and SCM Group were working was a new Dynamic Participation Note or DPN. ABN Amro had been working with S&P on the model for the DPN to ascertain the credit default risk, and hence the indicative rating for that product: J[80].

164    At about the same time, ABN Amro was working on another product which adopted the general framework of the DPN but with a number of alterations. A major alteration was the way in which leverage was employed. The alteration was to invert the way in which leverage was used so that leverage was increased when the product performed poorly and decreased when it performed well. For that reason the product was called the anti-DPN. Later, the anti-DPN model became the CPDO: J[81].

165    Another major alteration to the DPN which was made in the anti-DPN was a capping feature. It capped the return on the product by providing a cash in mechanism so that the risk associated with trading in the underlying indices to which the product was linked, ceased when the product earned enough to pay the coupon throughout the term and the principal on maturity: J[81].

166    On 11 March 2006 Mr Poet circulated an email within ABN Amro to a number of senior personnel including Mr Whittle, Mr Drexler, Mr Cole and Mr Silcox. The email attached some notes which outlined ratings achievable with S&P for DPNs. It also set out some parameters for modelling anti-DPNs and their rating implications. The anti-DPN section of the paper was followed by a note stating that (see also J [782]):

S&P have indicated that they would accept the use of [volatility] of 20% in the spread process…

167    On 12 March 2006 Mr Poet sent a further email to the same ABN Amro employees attaching a paper explaining the anti-DPN structure: J[83]-J[84]. The email observed that S&P held a presentation on rated CPPIs (a form of structured product which preceded the CPDO, and included the DPN) with 20 banks. This suggested some urgency for ABN Amro if it was to compete with the other banks.

168    Mr Poet's paper attached to the email considered the results of the anti-DPN using volatility parameters of 35% and 20% (noting that lower volatility should be helpful to the anti-DPN's performance): J[84].

169    Mr Poet's paper also explained the use of leveraging in the anti-DPN. He illustrated this by comparing it with a "casino strategy" involving the doubling and re-doubling of losing bets. The paper included the following remarks (J[84]):

… the value between the beginning and the end of the game is volatile, if you hit a losing streak your net worth can become very low, however most of the time you will be able to "bet yourself out of the hole".

… given the volatility of the product we should ensure that investors know that it will likely trade way below par, however if they are willing to "stick it out" to maturity they may receive a good return.

The spread process is crucial to the anti DPN's performance.

170    On 4 April 2006 Mr Drexler sent an email to a number of S&P employees in New York including Mr Derek Ding and Mr Sriram Rajan. Mr Ding and Mr Rajan were employed as quantitative analysts in S&P's New York office. They were responsible for the modelling of the DPN and anti-DPN (and later the CPDO) for rating by S&P: J[85] and J[74].

171    Mr Drexler's email attached an explanation of the problems and "our fixes" to the DPN model. He proposed a "spread vol", that is to say volatility, of "from 35% to 25%". He said both were justifiable given the historical data. He went on to say (J[85]):

Also, the spread vol of 25% seems to be reasonable in against the data which shows vol to be more in the sub 20% range.

172    Mr Norbert Jobst of S&P, who was one of the addresses of Mr Drexler's email of 4 April 2006 sent it on to other S&P employees including Mr Chandler. Mr Chandler was based in S&P's London office and was responsible for liaising with ABN Amro as well as certain employees of S&P, including S&P's quantitative analysts: J[86] and J[74].

173    Mr Chandler then emailed Mr Drexler on 6 April 2006 (with copies to S&P employees including Mr Jobst, Mr Ding and Mr Rajan) addressing, inter alia, Mr Drexler's arguments for reducing some of the parameters for the model, including the volatility and stating (J[86]):

… can you provide some evidence for coming away from these inputs?

174    Mr Drexler replied on 6 April 2006, attaching data from the relevant United States and European credit default swap indices (namely CDX and iTraxx). Mr Drexler stated that the observed LT mean (presumably a reference to long term spreads) and volatility were considerably below current assumptions: J[87].

175    Mr Chandler then sent a further email to Mr Drexler on 6 April 2006 (with copies to inter alia Mr Ding and Mr Rajan). The email was to the effect that S&P wanted evidence "over and above" the two year period of the indices: J[89].

176    Mr Drexler replied on 7 April 2006. His email included an observation on the volatility issue. As to that issue, Mr Drexler stated that the volatility on both the CDX and iTraxx indices was below 20% and that this was confirmed by an analysis of bond spreads: J[89].

177    On 26 April 2006 Mr Silcox sent to Mr Cole his analysis of the rating stability of the anti-DPN. Mr Silcox's modelling showed that the anti-DPN should be capable of achieving better ratings than the DPN, using the same parameters for the anti-DPN as had been used for the DPN: J[91].

178    However, Mr Silcox's modelling also showed that the rating which could be achieved was sensitive to various inputs including initial spread and assumed long term spread. As the primary judge observed at J[91], if the assumed initial spread was reduced from 36 bps to 26 bps the rating fell from AAA to A+, and if the assumed long term spread decreased below the assumed rate of between 80 and 100 bps, the rating fell to levels as low as BB+.

1.3    The anti-DPN (or CPDO) is introduced to S&P

179    The primary judge said (at J[95]) that the first written communication between ABN Amro and S&P about the anti-DPN appears to be an email from Mr Drexler to Mr Rajan and Mr Ding on 2 May 2006. Mr Drexler's follow up email to Mr Ding stated that the "corporate traditional DPNs" did not work anymore and that 5 year spreads had fallen: J[95].

180    On 9 May 2006 ABN Amro provided S&P with a sensitivity analysis on anti-DPN stability for a 10 year note at LIBOR + 200. The parameters included a volatility rate of 25%.

181    On 16 May 2006 there was a telephone conference between S&P and ABN Amro. Mr Chandler made a file note of it. One of the issues that was recorded in the file note was volatility. Mr Chandler noted that ABN Amro wanted volatility to be assumed to be 25% for the purposes of modelling the CPDO: J[112].

182    Very shortly after the telephone conference Mr Drexler and Mr Ding had an email exchange: J[147]. As the primary judge explained at J[115], the effect of what took place was that S&P's assumed volatility for the product was 35% whereas ABN Amro sought 25%.

183    ABN Amro continued to press for the 25% volatility assumption in an email from Mr Drexler to Mr Chandler and others from S&P (including Mr Ding and Mr Rajan). Mr Drexler's email stated that a 25% volatility assumption was justified because (J[116]):

… historically the credit indexes have shown 15% vol …

184    Mr Drexler also said that "we always roll into the 5 yr index" which limits the volatility and that the structure should have a lower volatility than an LSS (a structured financial product developed by ABN Amro and rated by S&P prior to the CPDO): see J[116] and definition J[23].

185    On 22 May 2006 Mr Silcox informed Mr Ding that in its modelling ABN Amro had assumed 25% volatility, a long term average spread of 100 and a mean reversion speed of 40%: J[120].

186    On 25 May 2006 Mr Drexler and Mr Martorell of ABN Amro had a conference call with Mr Chandler and others from S&P including Mr Ding and Mr Rajan. Mr Chandler's notes of the call record that (J[134]):

when we use 35% vol. and S&P defaults we still get BBB?

187    On 26 May 2006 Mr Chandler sent an email to Mr Martorell requesting further modelling from ABN Amro. The email requested the results of modelling based on a number of scenarios including (J[138]):

(1) Scenarios by Volatility; 15%, 25%, 30%, 35%

188    On the same day, 26 May 2006, Mr Cole (rather than Mr Martorell) responded to Mr Chandler's request. Mr Cole said (J[140]):

We had (I understand) agreed to use 25% vols - using 35% is overkill…

189    Later in the day on 26 May 2006 Mr Cole sent an email to Mr Chandler (and to the other main members of the S&P and ABN Amro "teams") attaching a matrix of modelling results which is reproduced in the trial judgment: J[145] and J[146].

190    The matrix was based upon a coupon of around 2% above LIBOR and included a range of inputs for a specified number of defaults, evenly distributed over the 10 year period as requested by S&P: J[145]. It comprised a range of assumptions including four different assumptions for volatility, namely 15%, 25%, 30% and 35% and LTAS ranging from 40 bps to 80 bps: J[146].

191    As the primary judge observed at J[3118], from the results of this modelling, Mr Cole knew that based on the number of defaults assumed by S&P, the CPDO could not achieve a rating of AAA if LTAS was assumed to be 80 bps or less at a volatility of 25%.

192    However, Mr Cole's matrix did show that upon those assumptions, but with a volatility of 15%, the model produced a AAA rating: J[146].

193    ABN Amro contends in the appeal that the modelling which was conducted on 26 May 2006 was an early version of the Surf CPDO which did not take into account "rebalancing on the rolls". Senior Counsel for ABN Amro points in this regard to the primary judge's observations at J[244] in which she referred to an amendment to the Australian CPDO made in August 2006 to rebalance on the rolls of the indices.

194    Later in the evening on 26 May 2006, Mr Martorell sent an email to Mr Chandler (with a copy to Mr Drexler) stating that (J[148]):

Our quants have been working with your quantitative team for this last 3 months on the basis that the base case scenario assumes 25% spread vol.

195    Mr Martorell's email of 26 May 2006 included a statement that the historical volatility of the portfolio was less than 15% for its 2½ year history: J[148(c)].

1.4    ABN Amro communicates with S&P's rating committee

196    S&P's rating committee was due to meet on 31 May 2006. Mr Chandler was a voting member of the committee. Mr Ding and Mr Rajan were not voting members but they attended the meeting by telephone: J[157].

197    Shortly before the meeting of S&P's rating committee Mr Chandler sent to the members a rating analysis meeting paper or RAMP: J[157]. Under the heading "Results", the RAMP set out the results and different sensitivities of the results to the inputs chosen for the model: J[157].

198    The model for the base case scenario referred to in the RAMP was volatility 25%, LTAS 100 bps and MR of 40%. This produced a rating of AAA for a coupon of 2% above LIBOR. However, the RAMP went on to say that this was not the full story and the results varied for different sensitivities: J[157].

199    One of the sensitivities to which the RAMP then referred was volatility. The author stated that over the previous two years, the iTraxx and CDX indices had a volatility of 15%. A table was then set out based on volatility assumptions ranging from 15% to 35% and an LTAS ranging from 40 to 80: J[157].

200    The table showed that at a volatility of 25% with an LTAS of 80 or less the model did not produce a AAA rating but it did produce AAA at an LTAS of 80 with an assumed volatility of 15%: J[157].

201    The author of the RAMP went on to say that volatility was not the main dependent variable and that the rating was heavily dependent on the LTAS. The author then said (J[157]):

Maybe the most valid result here is the 15% volatility table …

202    After the S&P rating committee meeting Mr Chandler sent an email to Mr Martorell, with a copy to Mr Drexler, and copies to S&P employees including Mr Ding and Mr Rajan. The email stated that the S&P committee could not ignore a scenario where low spreads continued into the future. This was a reference to LTAS below 80 bps at a volatility of 15%. The effect of the email was to ask ABN Amro whether the CPDO could justify a coupon of LIBOR + 2% at a AAA rating. Mr Chandler stated that (J[159]):

The current view is that L + 200 bps is not giving a AAA rating.

203    Mr Cole sent an email to the ABN Amro team on 31 May 2006 about Mr Chandler's approach. He said that ABN Amro "are completely screwed" if they took this approach" and it was completely unrealistic if they (S&P) were assuming their AAA default vector because, if so, spreads would not remain "at these levels": J[166].

1.5    ABN Amro provide S&P with more analysis

204    On 1 June 2006 Mr Martorell sent an email to Mr Perry Inglis and Mr Chandler of S&P (copying the ABN Amro "team"). The email set out details of the sensitivity analysis that had been requested by S&P. It concluded by requesting that S&P review the additional analyses (J[172]):

… with a view to confirm that the base case of 25% vol LTM = 100 is sensible. We want to launch this product asap …

205    The primary judge observed at J[175] that the modelling results contained in the attachments to Mr Martorell's email on 1 June 2006 showed that if S&P default rates were assumed (which ABN Amro did not consider they should be):

… the CPDO did not achieve a rating of AAA other than at an assumed volatility of 15% and an assumed LTAS of 80 bps.

206    ABN Amro contends that, in view of the subsequent amendment to the model to take account of rebalancing on the rolls (J[244]), the analysis dated 1 June 2006 was an early version of the CPDO which did not take account of that factor.

1.6    S&P conducts further analysis

207    On 2 June 2006 Mr Ding distributed to the members of S&P's credit committee the results of further modelling which he had conducted: J[183]-J[184].

208    As the primary judge observed at J[185], it was apparent from the modelling results prepared by Mr Ding that they involved an assumed volatility of 15%. Moreover, as her Honour went on to say at J[185], the modelling contained assumptions as to LTAS and:

… if the spread of 40 bps remained for one year only before rising to 90 bps the indicative rating was AAA but if the spread of 40 bps lasted for two years before rising to 90 bps [for the remaining 8 years] the indicative rating was only A.

209    Her Honour also found at J[186] that Mr Chandler emailed the results of the modelling to the ABN Amro team.

210    Several days later, on 5 June 2006, Mr Chandler emailed Mr Ding and Mr Rajan requesting that Mr Ding run the model for one year with an LTAS of 40 bps and the next nine years at a spread of 80 bps: J[190] and J[192].

211    On the same day, 5 June 2006 Mr Chandler sent an email to the S&P credit committee members (including Mr Ding and Mr Rajan). The email stated that the committee wished to be comfortable with a structure that reflected the current sentiment where spread levels remained relatively flat for the start of the transaction with some mean reversion to historic levels thereafter: J[191].

212    Mr Chandler's second email of 5 June 2006 continued by stating (J[191]):

The run that we feel replicates this is a scenario where 1st year Long Term Mean = 40, 1-10 year, LTM = 80, spread vol = 15% …

213    Also on 5 June 2006, Mr Martorell sent an email to the main members of the ABN Amro "team". The email stated that Mr Martorell had just spoken to Mr Chandler who was trying to arrange a meeting of the S&P committee and that "it should be OK". Mr Martorell's email stated that S&P were most concerned with the scenario involving an LTAS of 40 bps for the first year and 80 bps for the following nine years: J[194].

214    Mr Martorell's email and Mr Cole's reply as set out in the trial judgment at J[194] do not make reference to the assumed volatility ratio.

215    Mr Ding conducted further model runs and distributed the results to the S&P committee using an adjusted model. A note attached to the results refers to a volatility of 15%: J[197].

216    The primary judge observed at J[199] that Mr Ding's results were based on an assumed volatility of 15%. Her Honour also observed that Mr Ding's results at an assumed LTAS of 40 bps for one year and 80 bps for nine years produced an indicative rating of AAA. But her Honour also noted that the indicative rating was adversely affected by assuming 40 bps for any period longer than one year: J[199].

217    On 6 June 2006 Mr Chandler informed Mr Martorell that S&P was comfortable that the structure could be rated AAA and he said that S&P were still considering the base case for surveillance of the rating: J[200].

218    On 7 June 2006 Mr Chandler sent an email to Mr Martorell and Mr Drexler about the relevant scenarios for surveillance of the rating. He set out the main scenarios, the first of which was for a volatility of 15%, mean reversion speed of 40%, LTAS of 40 bps for one year and 80 bps for the remaining term: J[203].

219    Her Honour made the following critical finding at J[204] about the communications referred to above:

From the ABN Amro internal communication it is apparent that ABN Amro understood that S&P was comfortable to rate the CPDO AAA on the basis of modelling assumptions as set out in para (1) of Mr Chandler's email about ongoing surveillance - that is, starting at the current spread levels at that time, applying S&P default levels, volatility = 15%, mean reversion speed = 40%, LTM 1 = 40 bps for 1 year, LTM 2 = 80 bps for remaining term.

1.7    The launch of the CPDO

220    On 9 June 2006 ABN Amro prepared an announcement to its marketing team about the launch of the CPDO, which was called, at that time, the "Surf": J[206].

221    The primary judge observed at J[207] that the announcement attached the current version of the Surf Presentation which contained modelling assumptions consistent with ABN Amro internal communications about the details received from S&P: see [61]ff above. In particular, the assumptions included an initial portfolio spread of 36 bps, a volatility of 15%, and a spread of 40 bps for one year with 80 bps for the remaining term: J[207].

1.8    Some issues raised within ABN Amro about roll costs

222    On 19 June 2006, an ABN Amro employee who had been involved in the presentation of the CPDO to clients raised a number of questions with the ABN Amro team that had been raised by clients. One question was the cost of index rolls: J[210].

223    On, or shortly before, 3 July 2006 Mr Silcox carried out some modelling on the effect of roll costs. He then sent an email to other members of the ABN Amro team (and to others including Mr Hodgeman in Hong Kong) stating that "S&P do not model roll costs but do stress the number of defaults": J[216].

224    On the same day, 3 July 2006, Mr Silcox sent an email addressed only to members of the ABN Amro team. He said that they needed to think about the best approach to the subject of roll costs and how to raise it with S&P without S&P becoming "hung up on the roll cost and the modelling of it": J[217].

225    Mr Cole responded to Mr Silcox's email suggesting that ABN Amro should "get" S&P to emphasise the "highly stressed" default vector and not to get them [S&P] "thinking too much about it": J[218].

226    Mr Martorell replied on 4 July 2006 (J[219]) stating:

We should avoid S&P to overthink [the roll costs question] and open a can of worms.

1.9    The CPDO in AUD

227    The primary judge said at J[227] that the first mention to S&P of the CPDO in Australia occurred on 21 July 2006 in an internal S&P email referring to ABN Amro's marketing of the product in Australia with a coupon of 190 bps and a rating of AAA.

228    On 25 July 2006 Mr Silcox sent an email to Mr Ding and Mr Rajan on which ABN Amro relies. The email does not address the rating of CPDOs denominated in Australian dollars but refers instead to ratings for notes denominated in Canadian dollars: J[227].

229    Mr Silcox's email of 25 July 2006 is set out at J[227]. It states, relevantly, that "we are thinking about making a tweak to the leverage rules" which involves unwinding the trade on the roll dates instead of, as previously, rolling over the "full notional" on those dates.

230    Mr Ding referred to this email in his affidavit, in the part which is reproduced at J[526] of the trial judgment. Mr Ding said in his affidavit that he communicated with Mr Silcox or Mr Drexler in late July 2006 about modelling a structure for a proposed new transaction that was similar to the Canadian dollar CPDO which was referred to in Mr Silcox's email of 25 July 2006: J[526].

231    Mr Ding went on to say in his affidavit that he recalled that one of the proposed transactions was similar to the Chess CPDO except that it was to be issued in Australian dollars with a coupon of "Australian LIBOR" plus 190 bps. He also said in his affidavit that he understood that the new transaction was to have re-balancing on the roll dates. Mr Ding said that the Australian dollar transaction subsequently became known as Rembrandt 2006-2: J[526].

232    In addition, Mr Ding said in the portion of his affidavit reproduced by the primary judge at J[526]:

I used a base case volatility of 25%, a base case MR of 40% and a base case LTAS of 40 (for the first year) and 80 (for the remaining 9 years of the transactions).

I ran 100,000 simulations on the version of the Internal Model that provided for re-balancing on the roll date.

The indicative rating yielded by the Internal Model for those runs was 'AAA'.

233    However, importantly, the primary judge said at J[527] that she did not "accept aspects of this evidence", that is to say, in particular, Mr Ding's statement that he used a 25% volatility base case.

234    The primary judge went on to say at J[528] that Mr Ding's evidence was that he had sent the results of the modelling to Mr Silcox on 2 August 2006, but that after this, Mr Silcox queried the rebalancing on the roll dates assumption and Mr Ding then re-ran the model without rebalances on the roll dates: J[528].

235    The primary judge completed her narrative on this exercise by stating that the results (apparently without rebalancing) yielded an indicative rating of AAA and that Mr Ding sent the results to Mr Silcox on 3 August 2006 as well as reporting the results to Mr Chandler: J[528].

236    There are two other paragraphs of Mr Ding's affidavit to which the primary judge did not refer but which are important in understanding the evidence of the rebalancing issue. The first is paragraph [55] in which Mr Ding explained that when he became aware of the Chess CPDO in about May 2006, he commenced work on a model to analyse the transaction. He described this model as the "Internal Model".

237    The second was paragraph [56] which we reproduce in part as follows:

Initially I created one version of the Internal Model. That version did not automatically provide for rebalancing of the leverage notional on the roll date because this was not a feature of the CHESS CPDO as proposed at that time. …

After rating the CHESS CPDO I created a second version of the Internal Model which provided for automatic rebalancing on the roll date. The reason for two models was that not all transactions were structured by the arranger to automatically rebalance at the roll date. …

I used the rebalancing model for transactions that were structured to automatically rebalance on the roll date. By contrast, I used a model that did not provide for rebalancing for transactions that only rebalanced on the roll date upon the occurrence of pre-specified conditions (usually identified in the termsheet). Each version of the Internal Model was coded, and ran, in exactly the same way except for the rebalancing feature described above. In this affidavit I have generally not distinguished between each version of the model and I refer to them together, and separately, as the "Internal Model".

238    On 8 August 2006 S&P published a presale report for the "first CPDO structure" rated by S&P. The product was described as "Chess II Ltd" and the denominations were said to be in Euros, US dollars and Japanese yen, for a series of floating rate notes due in 2016. The presale report contained an explanation of the mechanics of the structure but it did not address assumptions in the model such as the volatility rate of the notional credit index portfolio. It contained an indicative preliminary rating of AAA.

239    On 11 August 2006 S&P published the Pre-Sale Report for Rembrandt 2006-2 rated by S&P: see [49]ff above. It also contained an explanation of the mechanics of the structure and contained an indicative preliminary rating of AAA: see [49]ff above. It did not address assumptions in the model such as the volatility rate of the notional credit risk portfolio.

1.10    Tightening spreads

240    On 14 August 2006 Mr Cole sent an email to the ABN Amro team, and to Mr Hodgeman in Hong Kong. The email stated (J[238]):

Gulp … see average spreads have tightened in again and today average (cdx/itrax now 35 bps … This is now below the cushion level of 36 bps we did all our runs/sims on.

Caroline [Bosch] - can you please check to see that ratings are still OK for all currencies based on current spreads. I imagine that we are still OK for deals with new rebalancing, but we need to definitely check the AUD/NZD ones based on this as they don't use new rebalancing method

241    Also on 14 August 2006 Mr Cole sent an email to Mr Silcox to ask whether he had run ABN Amro's model for the AUD and NZD transactions. Mr Cole said he knew S&P had confirmed the ratings but wanted to know if ABN Amro had done so as Ms Bosch "was having trouble getting the correct results". Mr Silcox said he had not done so using S&P's parameters: J[239].

242    On 14 August 2006 Mr Cole sent a further email to the ABN Amro team, and to Mr Hodgeman in Hong Kong about the tightening of spreads. The email included the following (J[240]):

Further to this, the EUR/USD/JPY are still comfortable (with rebalancing on rolls). The AUD and NZD deals were both OK for 36 bps. However, on 35 bps they are really borderline (AUD passes, NZD fails) … Both should pass comfortably if you used rebalancing on the rolls.

Something to seriously consider for AUD/NZD deals is still whether to switch

243    A further email on 14 August 2006 addressed the volatility issue. It was from Mr Hodgeman to Mr Cole and the ABN Amro team. The email asked how S&P had come up with the assumption of 15% for their base case assumption: J[241].

244    Mr Martorell replied on 15 August 2006 (J[241]) stating that:

Although in LSS S&P used 25%, LSS is very sensitive to spread process.

Remember that the "AAA" rating of CPDO was not really sensitive to the vol parameter. I think rating levels were almost identical with 15%, 25% and 35% … Since the CPDO rating is more sensitive to defaults than spread process S&P was fine to use their internal estimate of 15% for this product.

245    The primary judge observed at J[242] that, notwithstanding Mr Martorell's email, ABN Amro's own modelling showed that different volatilities had a material effect on the ratings. Her Honour went on to reiterate the finding she had made at J[175] (which we have referred to above at [205]) that, if S&P default rates were assumed, at an assumed volatility of 25%, with an assumed LTAS of less than 80 bps, the CPDO did not rate AAA: J[242].

1.11    The ABN Amro Surf Presentation

246    The content of the Surf Presentation has been referred to at [61]-[69] above. The document is dated August 2006 but it appears to have been made on 15 August 2006.

247    Importantly, as the primary judge said at J[38], the S&P base case is identified in the Surf Presentation as including an initial portfolio spread of 36 bps with a volatility of 15% and an LTAS of 40 bps for the first year with 80 bps for the balance of the term.

1.12    Further correspondence on tightening spreads

248    On 15 August 2006 Ms Bosch sent a further email to Mr Cole following up on his "Gulp" email of 14 August 2006 (see [240] above) and his reference in the later email of 14 August 2006 to the failure of the NZD transaction to attain a AAA rating: see [242] above. Ms Bosch appears to have re-run the simulation with a larger number of runs (50,000) but her email stated that the NZD transaction rated AA+ at an initial spread of 35 bps "without rebalancings on roll".

249    On the same date, 15 August 2006 Mr Hodgeman informed Mr Cole that the Australian CPDO would be amended to rebalance on the rolls of the indices: J[244]. The primary judge made that finding at J[244] but she did not refer to the evidence on which it is based. Her Honour went on to find at J[244] that the transaction documents for the Rembrandt transactions were amended to reflect this change.

250    The finding as to Mr Hodgeman's communication to Mr Cole on 15 August 2006 about rebalancing on the rolls appears to be supported by Mr Cole's next email in the "Gulp" email chain on 15 August 2006 in which he said:

glad you did change -NZD still didn't pass with more sims.

1.13    Further emails about the rating

251    Later that day on 15 August 2006 Ms Bosch sent an email to Mr Ding following up on several points relating to the CPDO. She informed Mr Ding that she had obtained default probabilities for the AUD/NZ CPDOs of 0.44% and 0.54% respectively (that is to say, results giving a AAA rating) based on 15,000 simulations with no rebalances.

252    That number of runs appears to be small when compared with the 50,000 referred to in her earlier email and full details of the parameters which she used were not set out.

253    On 25 August 2006 Mr Rajan sent a lengthy email responding to questions raised by a client of ABN Amro. The email is lengthy and is set out in full in the trial judgment at J[253]. The email stated relevantly that:

Our parameterisation for volatility (25%) is higher than has been historically realized

254    Mr Rajan's email of 25 August 2006 also stated that S&P did not estimate historical parameters for the specific portfolio referenced in the CPDO. He said that theoretically, all parameters could be referenced via Merrill Lynch but the most useful reference was the JP Morgan index. He also said that S&P used that index, rather than the historical one because of its short history: J[253].

255    Mr Rajan's email concluded with a statement that S&P did not yet have a model for the CPDO (J[253]) and:

For this trade, we had access to ABN Amro's source code.

256    On 28 August 2006, Mr Hodgeman forwarded Mr Rajan's email on to members of the ABN Amro team including Mr Cole, Mr Martorell and Mr Silcox. The message merely stated "FYI".

257    On 29 August 2006, Mr Cole forwarded Mr Rajan's email on to Mr Silcox, Mr Whittle, Mr Drexler and Ms Bosch (but not Mr Martorell). Mr Cole's email included an observation that S&P seemed to be saying that they were now using 25% volatility rather than 15%: J[256].

258    On 2 September 2006, Mr Lewis of ABN Amro in Australia asked whether his office could be given the rating model used for the CPDO as, without the model, they would be "flying blind": J[265]. There was no evidence that the model was ever provided.

1.14    S&P issues rating letter

259    On 5 September 2006, S&P issued the R-2 Ratings Letter to Mr Lewis. The R-2 Ratings Letter rated the Rembrandt 2006-2 notes AAA. On the same day Mr Ding sent an email to ABN Amro in London confirming that the AAA rating had been issued: J[267]-J[268].

260    Mr Ding was cross-examined about his email of 5 September 2006 confirming the rating. The transcript of the relevant part of the cross-examination is set out in the trial judgment at J[575]. The transcript amply supports the finding made by her Honour at J[576] that there was no document recording the results of any modelling runs of the Rembrandt 2006-2 notes as at 5 September 2006 when the R-2 Ratings Letter was issued.

261    The primary judge went on to say at J[576] that she was satisfied that there was no such modelling of the Rembrandt 2006-2 notes and that Mr Ding did not run any model for the CPDO using actual starting spreads until 10 October 2006. Her Honour said at J[576] that until 10 October 2006:

I consider that Mr Ding used an assumed average starting spread of about 36 bps just as ABN Amro had done before spreads started to tighten …

1.15    Mr Martorell's comparative table

262    It appears that by September 2006 another well-established ratings agency, Moody's, was also involved in rating other ABN Amro CPDO transactions. On 28 September 2006 Moody's confirmed to ABN Amro that it had assigned a rating of Aaa (the equivalent of S&P's AAA rating) to an ABN Amro CPDO known as "Castle": J[279].

263    On 2 October 2006 Mr Martorell provided a client of ABN Amro with a table comparing the assumptions used by S&P and Moody's to rate the CPDO. The table which Mr Martorell provided is of some significance because it stated that S&P's assumption for "spreads" was mean reversion speed of 40%, volatility of 15% and LTAS (described as LMR in the table) of 40 bps for the first year with 80 bps for the remaining nine years. The table is reproduced in full in the trial judgment at J[281].

264    Mr Martorell's table also shows that S&P's AAA rating of the CPDO assumed default rates in accordance with its internal evaluator: J[281].

1.16    S&P realises 15% volatility not justifiable

265    The primary judge found that by 3 October 2006 S&P had decided that 15% volatility could no longer be justified for use in rating the CPDO and that 25% volatility had to be used. Her Honour also found that by 3 October 2006 ABN Amro was aware that S&P no longer considered 15% volatility to be an appropriate assumption and that 25% would be used for new CPDOs. Her Honour's findings are stated at J[2615], J[2655] and J[3139].

266    In making that finding the primary judge referred to an email from Mr Martorell dated 10 November 2006 to which we will refer later: see [356] below.

267    The primary judge also relied upon the fact that ABN Amro had been advocating a 25% volatility assumption to S&P based upon what was said to be an actual historical figure of 15%: J[3139]. She considered it was unlikely that S&P "botched" such a basic calculation by employing a 15% figure. Instead, her Honour reasoned that the more likely explanation was that S&P accepted the representations made by ABN Amro that the historical volatility of the indices was 15% and made no calculation itself: J[2615].

268    The evidence given by Mr Chandler at T2215.40 to T2216.3 that throughout 2006 he believed the historical volatility of the iTraxx/CDX indices to have been 15% does not detract from the primary judge's finding.

1.17    Mr Ding detects starting spread problem

269    On 10 October 2006 Mr Ding sent an email to a number of people in S&P including Mr Rajan and Mr Chandler stating that there was a potential problem with the initial spread used in S&P's calculations. The email is set out in the trial judgment at J[284].

270    Mr Ding's email went on to say that for most of the CPDOs, deal arrangers were using starting spreads of 35 or 36 bps. However, he stated that spreads had tightened in the past week and were then at 31 bps. He then said (J[284]):

The note's performance is sensitive to the initial spread to an extent that if initial S = 32, it will not pass AAA test.

271    Mr Ding was cross-examined about his email of 10 October 2006. The relevant part of the transcript is reproduced in the trial judgment at J[581]. Mr Ding accepted in cross-examination that he had been modelling the CPDO for the two months preceding the email at a starting spread of 35 or 36 bps.

272    The primary judge found at J[582] that, based upon Mr Ding's concession in cross-examination, Rembrandt 2006-2 was never modelled at actual starting spreads. She made the same finding about Rembrandt 2006-3 at J[582].

1.18    Further discussion of the parameters

273    On 11 October 2006 Mr Cole sent an email to the ABN Amro team requesting them to ignore his earlier suggestion about additional fees which made the deal "very cuspy AAA/AA+". Mr Cole's email went on to say that:

the effect of the extra fee combined with the tightening of spreads since we last looked at this last week was more than our gut feeling, plus we have re-run with the new revised S&P spread vol.

274    This email was not referred to in the trial judgment, or in ABN Amro's written or oral submissions but it was inserted in the agreed chronology at ABN Amro's request.

275    By 12 October 2006 Mr Rajan said that S&P were receiving daily calls on quantitative issues relating to the criteria used in the CPDO. He said that, as a result, the quantitative analysts at S&P were considering quantitative issues about modelling CPDOs: J[285]. Mr Rajan made that statement in an email response to a request from Mr Stephen McCabe, a senior quantitative analyst at S&P's London office, (J[285]) that the S&P team:

… put together a document with all of the parameters we needed to model a CPDO.

276    The primary judge referred to Mr Rajan's email of 12 October 2006 in finding (at J[2565]) that Mr Rajan held serious concerns about the validity of S&P's modelling of the CPDO from no later than August 2006.

277    On 12 October 2006 Ms Bosch sent an email to Mr Cole and Mr Martorell about some modelling requests. She said in the email that she had carried out some analysis of iTraxx and CDX data which showed an average volatility of 29%. However, she said that this figure was "not that much different" from the 25% volatility used by S&P: J[286].

278    The primary judge seems to have explained the reference to 25% in this email at J[2629]. She found that by 12 October 2006 ABN Amro knew that S&P had discovered the error it had made about volatility and had let ABN Amro know that it would be using an assumed 25% volatility for future CPDOs: J[2629]. Her Honour's findings at J[3135] and J[3136] are to similar effect.

279    The primary judge found at J[646] that ABN Amro knew that S&P realised "by early to mid-October 2006" that the 15% volatility assumption was not justifiable and was intending to use 25% volatility for future deals.

280    The early to mid-October date to which the primary judge referred at J[646] is to be contrasted with her finding at J[2639], J[2655] and J[3139] that ABN Amro was aware of that information by 3 October 2006.

281    The "early to mid-October date" is also referred to in an important finding made by the primary judge at J[649]. She found that S&P proved itself willing not to correct the 15% volatility error for existing CPDO deals "in the pipeline" as at early to mid-October 2006. Her Honour found at J[649] that:

Those existing deals included Rembrandt 2006-3, as S&P was willing to treat that as a carbon copy of Rembrandt 2006-2 despite recognising that 15% volatility was unjustifiable.

282    This finding is not inconsistent with the finding made by the primary judge at J[320], based upon an S&P document published in October 2006 to which she referred at J[319], that S&P expected prospective arrangers of CPDOs to model their products on the basis of an LTAS of 40 bps for one year and 80 bps for the balance, a mean reversion speed of 40% and an assumed volatility of 25%.

1.19    Rembrandt 2006-3

283    On 16 October 2006 Mr Lewis notified Mr Chandler of S&P, and the ABN Amro team in London that ABN Amro's lawyers were drafting documents for the Rembrandt 2006-3 transaction involving the sale of $40 million of notes "to a bespoke investor": J[290].

284    Mr Lewis described the Rembrandt 2006-3 transaction as a carbon copy of Rembrandt 2006-2, except for an increase in expense fees to allow for a fee ABN Amro would be paying to the bespoke investor: J[290].

285    Initially, Mr Lewis indicated that ABN Amro wished to settle Rembrandt 2006-3 on 27 October 2006 but S&P was later informed that the transaction date had been deferred until 2 November 2006: J[290].

286    On 17 October 2006 Mr Lewis sent Mr Chandler the Rembrandt 2006-3 draft documents and a swap confirmation seeking his response on the same day, as Rembrandt 2006-3 was "a simple mark-up" from Rembrandt 2006-2: J[290].

287    The swap confirmation that Mr Lewis sent to Mr Chandler seems to have been the subject of an email communication the previous day, 16 October 2006, between Mr Silvester of ABN Amro's Sydney office and Mr Tischler of LGFS. Mr Silvester said in the email (J[1060]):

We can lock in the terms of the deal as soon as you give us the go ahead. This will mean that ABN Amro will execute the hedge and protect LGFS from further spread tightening.

288    Rembrandt 2006-3 was hedged at 32.05 bps on 18 October 2006: J[316] and J[3143].

1.20    The stability analysis

289    On 24 October 2006 Ms Bosch sent an email to Mr Hodgeman setting out a rating stability analysis for the CPDO based on an initial spread of 32 bps, but not using S&P's assumed defaults. Ms Bosch's email stated:

… this one is still run with 15% vol for the spread process. SP (sic) changed in the meantime to 25% vol.

290    Ms Bosch's email of 24 October 2006 went on to note that the trade with LGFS was hedged at 31.8 bps, and:

[i]n general, such small changes to fees or spreads don't affect the rating stability.

291    In his oral submissions, Mr Jackman SC submitted on behalf of ABN Amro, that the effect of Ms Bosch's email was that small changes in fees or spreads did not affect the rating stability which was the subject matter of the tables contained in the email.

292    ABN Amro also submitted that the purpose of the stability analysis was to show what effect different scenarios would have on the AAA rating.

293    However, Mr Hutley SC, for the PA Councils, submitted that this email should not be taken to be cogent evidence that S&P (to ABN Amro's knowledge) was modelling the product at 25% volatility. This is because the email was merely a stability analysis conducted by Ms Bosch, who did not give evidence, so that the reason for her comment about S&P's change to the volatility was not explained. In particular, there was no suggestion that Ms Bosch was involved in the direct dealings between S&P and ABN Amro about deals in the "pipeline".

294    On 25 October 2006 Mr Hodgeman extracted the content of Ms Bosch's email of the previous day and emailed it to Mr Silvester in Australia, without acknowledging Ms Bosch as the source of the information.

295    Mr Hodgeman's email of 25 October 2006 contains the statement originally made in Ms Bosch's email that "SP (sic) changed in the meantime to 25% vol".

296    Mr Hodgeman's email to Mr Silvester of 25 October 2006 appears to be the source of statements made by Mr Silvester in an email sent by him to LGFS on 25 October 2006. The relevant part of the email is extracted in the trial judgment at J[294] as follows:

S&P have changed the vol from 15% to 25% in their modelling assumptions. This has had just a minor effect on the table …

297    The primary judge made two relevant observations about the email at J[296]-J[297]. First, she said that none of the results in the table were based on S&P's assumed defaults. Second, she said that Mr Silvester's statement about the change in the volatility assumption must have been wrong. This was because, as she said at J[297]:

If S&P had changed the volatility assumption from 15% to 25% for the modelling of the Rembrandt CPDO all of the earlier modelling indicates that, without changes to S&P's other assumptions, the Rembrandt CPDO would not rate AAA.

298    The primary judge went on to say at J[298] that this finding was not to suggest that Mr Silvester knew the information to be wrong. Rather, ABN Amro in Australia did not have access to the model and thus was "flying blind": see [258] above. The Sydney office was dependent upon Mr Cole and Mr Martorell, in particular, to provide accurate information about issues raised by LGFS as to the stability of the rating: J[298].

299    The primary judge also said at J[3141] that, if Mr Silvester had the modelling results which Mr Cole and Mr Martorell had in London (which it appears he did not) he would have known that S&P did not change its assumption about volatility from 15% to 25%.

300    One other email on 25 October 2006 referred to the topic of rating stability. It was from Mr Cole to Ms Bosch with copies to a number of other ABN Amro employees including Mr Martorell and Mr Silcox: J[240].

301    Mr Cole's email of 25 October 2006 noted that spreads had tightened again to around 30 bps. He said that, at a minimum, ABN Amro should circulate an update to all sales persons who had live deals to give them "some colour" on where the market was and how it was affecting pending trades, saying "we can still get AAA but stability getting hit and will get worse if spreads tighten". Mr Cole also said that ABN Amro would have to consider "chopping coupons": J[293].

302    As the primary judge went on to say at J[293], Mr Martorell agreed that this would have to be considered (that is, cutting coupons) if spreads stayed where they were.

303    It is not clear whether the discussion about this topic between Mr Cole and Mr Martorell is relevant to the issue of volatility of the Rembrandt notes because the discussion within ABN Amro in this email chain focusses upon a product with a coupon of 100.

304    So much can be seen from the primary judge's remarks at J[299] and J[351] that by 26 October 2006 ABN Amro had at least six CPDO transactions which were required to be rated shortl