Wingecarribee Shire Council v Lehman [2012] FCA 1028 | Case summary

Federal Court of Australia|2012-07-01|Before: Rares J

For the reasons in section 6.2.3, the Claim SCDOs were not readily able to be liquidated for cash at short notice other than through Grange while it had the wherewithal and preparedness to do so. There was no other market or source of liquidity. As will appear when considering the difficulties in valuing the Claim SCDOs, the unmatured products are not liquid and it is difficult to realise them for

cash and more so for cash in the order of face value (see section 7 below). This

inherent characteristic was demonstrated by Mr Calderwood's note quoted in [698]

and [879] that these were hold to maturity investments.

Grange alone kept the products liquid for so long as it considered that this was in its financial interest and it had the financial ability to do so as Mr Rae and Mr Clout discussed in their emails of 14 and 15 September 2006 (see [366]-[368]). Often, this involved Grange buying a product from one client who needed funds, and then Grange making a sale of that product to another client as ad hoc individual transactions, or through use of an IMP agreement mandate or by Grange raising the cash price from another client through a "no haircut repo". None of that trading activity detracted from the accuracy of the issuers' offering memoranda's risk warning that the products were inherently not readily able to be liquidated for cash at short notice. And, of course, each of the inherent risks of lack of liquidity and market price volatility affect the price of an SCDO when an investor seeks to sell it, as has

happened to Swan and Parkes since Grange experienced financial problems in the

The issuers' offering memoranda correctly warned of the inherent risks that SCDOs were "suitable only for investors who can bear the risks associated with a lack of

liquidity" in those products ([123]). Swan and Parkes were not such investors.

Thus, Grange breached term (3) of its contracts with Swan (before the IMP

agreement) and Parkes by selling the SCDO's to the Councils.

Were the products suitable and appropriate for a risk averse local government council?

The Claim SCDOs sold by Grange were not suitable for risk averse local councils like Swan and Parkes. For each of the reasons that I have found that Grange was in breach of terms (1), (2) and (3) in sections 6.2.2-6.2.4, the product had features and risks that

were neither suitable nor appropriate for the Councils.

The complexities and risks of SCDOs were understood by experts. The SCDOs were

commercial derivatives (leaving to one side the issue about whether they were

"derivatives" as defined in the Corporations Act: see too section 9.3.3). They were synthetic financial products. Mr Finkel said, accurately, that an SCDO:

"is essentially a bet that the CDS portfolio will only have a limited amount of net

losses, which can be fully absorbed by others who have taken more junior slices [i.e.

tranches] of risk (up to a specified loss threshold) on the portfolio of CDS". (emphasis added)

Mr Finkel also described the Claim SCDOs as being "some of the most complex and high risk fixed income investments available in the marketplace". Mr Hattori said that a potential investor would normally carry out a thorough review, or due diligence evaluation, of a potential investment to identify issues for discussion with the vendor. He made the point that the investor had to be in a position to make use of the information available and that this would depend on the investor's general financial

training together with any steps the investor had taken to gain specialist knowledge.

As [have found at [95] the structure of Claim SCDOs inherently carried much more risk than the same or equivalently rated FRNs or corporate bonds of the kind with which the Council officers were familiar. That included the significantly greater risk

of market price volatility than in similarly rated investment products (see section

The Councils did not meet the investor suitability criteria in the risks explained in the offering memoranda ({122], [123]). The Councils were not sophisticated investors. They did not want to put their ratepayers' capital at risk. They could not depend on an undercapitalised company like Grange to provide liquidity or a secondary market if financial markets suffered extreme market events (see section 3.5.4). The products were susceptible to the risk of price volatility (see e.g. section 3.5.3, [241]-[243]).

And, as hold to maturity investment products, they were illiquid.

The apparently high credit ratings of the SCDOs sold to the Councils by Grange did not reveal the risks discussed in section 6.2.2. Thus, the seeming compliance of those products with the rating requirements in the Minister's Order (in Parkes' case) was also not sufficient to make the SCDOs suitable investments (see [416]). The products were far too complex for the Council officers to understand their nature or their risks

in a way that would have enabled them to make any informed decision whether or not

to purchase them ([410]). As I have found, had each of Mr Senathirajah, Mr Downing or Mr Bokeyar been made aware of some of those material risks, he would never have

caused the Council to purchase any of the products.

An investment in a Claim SCDO exposed the Council to having to hold the asset to its maturity if, for any reason, Grange could not honour its promise or assurance of there being a secondary market or liquidity provided by Grange available to realise the asset earlier. Moreover, the price for which it could be realised before its maturity was subject to substantial risks of market price volatility and dimunition because of the lack of liquidity (see sections 3.5.3 and 3.5.4). Those risks would be accentuated if extreme market events occurred making it desirable for the investor to realise its asset for cash either before those events affected it, or as they were affecting, the product. That is what happened when Wingecarribee became concerned about its holding of the Federation product. The price Grange was prepared to pay for it was

15%, a fraction of its face value ([718] see section 4.5.8).

Moreover, these products had an additional feature, as emerged when the flip clause in the Dante notes was asserted, namely, the difficulty for a noteholder to enforce its right to be repaid the capital due on maturity against a SPV or holder of collateral located in a foreign jurisdiction. This difficulty in enforcing repayment of capital of the Dante notes arose because each of those SCDOs contained the "flip clause". That has given rise to the current interjurisdictional stalemate in the ability of investors to

Generally, risk averse people do not take bets with substantial assets held for public purposes. The Claim SCDOs were not suitable or appropriate for a risk averse local government council. For these reasons Grange breached term (4) of its contracts with Swan (before the IMP agreement) and Parkes by selling the Claim SCDOs to the

Term (5) of the contracts between Grange and Swan (before the IMP agreement) and Parkes is inter-related to term (1). The income stream was only as secure as the

capital invested. If sufficient credit events eroded part or all of the SCDO's tranche,

then the interest receivable by the investor would be reducted or eliminated correspondingly. However, unlike in term (1), the promise in term (5) did not include the words "high level" to emphasise the extent of security of the income stream. I discussed in section 6.2.2 the particular suspectibility of SCDOs to extreme market events. The emphatic words "high level of security for protection" in term (1) did not except the occurrence of extreme or systemic market events as an ordinary part of

The promise in term (5) is not as emphatic as that in term (1). The income stream from the Claim SCDOs was relatively secure. The only substantive threat to that security was the occurrence of an extreme or systemic market event that could cause credit events to erode the investor's tranche in an SCDO's reference portfolio. The income stream did not depend on the SCDO being liquid or saleable in a secondary market. While I have found that the Claim SCDOs did not have a high level of security for the protection of their capital, I am not satisfied that they did not conform to the relatively less exacting promise that the income stream that they provided was secure. The SCDOs paid their coupon interest in accordance with their terms. That continued until some of the Claim SCDOs suffered from an erosion or wiping out of the tranche in which the Councils had invested, following the impact of the global

Accordingly, Swan (in respect of contracts before the IMP agreement) and Parkes

have failed to prove a breach of term (5) of their contracts with Grange.

Did Grange exercise reasonable skill and care in making each investment recommendation and giving that investment advice to Swan (before the IMP agreement) and Parkes?

It follows from my findings that Grange breached terms (1), (2), (3) and (4) that it did not exercise reasonable skill and care in making each investment recommendation and giving investment advice to act on it to Swan (before the IMP agreement) and Parkes. That conduct was a breach both of term (6) of the contracts and also of Grange's duty of care in tort to the respective standards I found in [790] and [807]. But for that conduct, Swan (before the IMP agreement) and Parkes would never have invested in

the Claim SCDOs. And, but for that conduct Swan would never have entered the IMP

agreement so as to enable Grange to make or continue making investments in those products. As I discuss in more detail in section 8.3.2, the provisions of s 5D of the Civil Liability Act 2002 (NSW) (set out at [1119] below) and its Western Australian analogue created a "but for" test of liability in negligence in contract and tort. Here, as Grange argued, s 5B has no relevance to its liability since the claims in negligence did not depend on Grange failing to take precautions against a risk of harm (GWSCL 6-11). In Roads and Traffic Authority (NSW) v Refrigerated Roadways Pty Ltd (2009) 77 NSWLR 360 at 397 [173]-[177] Campbell JA, with whom McColl JA agreed at 365 [1], as did Sackville AJA esp at 449 [443], held that s 5B(1) only modified the common law applicable to situations where the negligence alleged amounts to "failing to take precautions against a risk of harm". Both parties accepted that s SD(1) (s 5C(1) of the Western Australian Act) was relevant and introducted the "but for" test of factual causation (s 5D(1)(a)).

In general, the degree of care required under a contractual obligation to exercise reasonable skill and care is different from the reasonable prudence that a person in a fiduciary position must exercise: Austin v Austin (1906) 3 CLR 516 at 525 per Griffith CJ, Barton and O'Connor JJ. However, here, when acting for each of Swan and Parkes, Grange was their agent and was bound to act as a prudent person exercising the Council's powers in accordance with the provisions of s 18(1) of the Trustees Act 1962 (WA) and having regard to ss 14A and 14C of the Trustee Act 1925 (NSW) respectively (sections 5.1.5, 5.2.4 above). That standard is how an ordinary, prudent business person would have acted in making investments of public money for

a Council: Austin 3 CLR at 525; Jacobs' Law of Trusts (7" ed) at [18.09].

Investments in the Claim SCDOs and SCDOs generally had each of the inherent risks specified in sections 6.2.2 to 6.2.5 above. It was not open to the Councils to invest in products that carried one or more of those risks or to Grange to recommend or advise such investments as their investment adviser. It would have been a breach of trust for a trustee to invest in the Claim SCDOs because of their inherently hazardous nature created by the risks and matters referred to in each of sections 6.2.2 to 6.2.5: Fouche v Superannuation Fund Board (1952) 88 CLR 609 at 636-637 per Dixon, McTiernan and Fullagar JJ; Government Employees Superannuation Board v Martin (1997) 19

WAR 224 at 273E per Ipp J; Jacobs' Law of Trusts (7* ed) at [18.06], [18.10], [18.12].

Of course, the Councils did not hold their funds in the capacity of trustee. But their investment policies and (for Swan), s 6.14 of the Local Government Act 1995 (WA) and, (for the New South Wales Councils), the Minister's investment guidelines, specifically included the need to exercise the care, diligence and skill that a prudent person engaged in the investment of funds would exercise in managing the Council's public funds ([157], [175], [415], 417]). Lindley LJ explained why investment in an asset that is inherently hazardous is not prudent and so not open to a person bound to invest in accordance with the standard applicable to a trustee in Jn re Whiteley (1886) 33 Ch D 347 at 356-357 in the following passage, that was approved in Fouche 88 CLR at 637 and 641:

"A security of so hazardous a nature as this, though in one sense and to some extent a

real security, is not a proper security for trust money; it is not in truth a real security

for any sum beyond the value of the land as land. The security for more than this

value is the solvency of the borrower, and the trade carried on by him." (emphasis added)

The last sentence just quoted captured the imprudence of Grange's recommendations and advice that the Councils invest their money in products for which first, their invested capital did not have a high level of protection, secondly, the liquidity or secondary market was no better than Grange's own undercapitalised solvency and,

thirdly, they were not suitable and appropriate for a risk averse local council.

Swan alleged that Grange breached their IMP agreement in two ways by investing in SCDOs. First, Swan asserted that the Claim SCDOs did not provide it with ready access to funds for its day to day requirements without penalty, as the objective in cl 2.1 of the 2003 Swan Policy required ([175]). Schedule 2 required Grange to observe that Policy in making investments: [362], [770]. And, it argued that the Claim SCDOs were not prudent investments of the kind authorised by the Trustees Act. Secondly, Swan (and Wingecarribee) contended that Grange breached its contractual

obligation to exercise reasonable skill and care by investing in the Claim SCDOs.

In answer to the first of those arguments, Grange contended that the objectives in cl 2.1 of the 2003 Swan Policy had competing aims. Thus, it argued, it was necessary to balance the objective for ready access to funds with that of "enhancing the yield to

I reject Grange's argument on the first limb. The objective of enhancing the yield to Swan was qualified by the words "through prudent investment of funds". That reflected the Council's duty in cl 2.2 to invest in accordance with s 6.14 of the Local Government Act and Pt III of the Trustees Act: [175]. The other objectives, set out in [175] above, complimented that one, by seeking returns consistent with the 90 day BBSW or a bank bill index, a high level of security for the overall portfolio by using recognised ratings criteria and maintaining an adequate level of diversification. None of these objectives justified investment in products that lacked a high level of security. Nor was the last of those objectives qualified by the Council's addition in cl 2.1 of the 2003 Swan Policy of the words "using recognised ratings criteria". The ratings criteria, in themselves, did not provide a high level of security in the sense that a reasonable person in the position of the parties would have understood at the time of making the IMP agreement. For the reasons I have given in section 6.2.2, ratings for the Claim SCDOs had a significant deficiency because of their lack of comparability with ratings for other products. The "risk factors" set out in the offering memoranda for SCDOs, being the subject matter of the proposed investments would have altered a reasonable person in the position of the parties to real issues about the level of security of these products: see [92], [122]-[123]. Moreover, informed investors and investment advisers, such as Grange, knew or ought to have known that SCDO products were materially riskier and more susceptible to extreme market events than

similarly rated produdcts, such as ADI issued or corporate FRNs.

Investment in SCDOs was not prudent for Swan for the reasons I have given in sections 6.2.2-6.2.5 and 6.2.7. However much Grange sought to assert the need to balance the objectives in cl 2.1 in exercising its investment powers under the Swan IMP agreement, it failed to achieve such a balance consistent with those objectives when it invested in the Claim SCDOs. In any event, for the reasons I have given in

section 6.2.7, a prudent person could not have invested the Council's funds in the

Claim SCDOs by reason of s 6.14 of the Local Government Act and s 18(1) of the

Moreover, the Claim SCDOs did not meet the objective in cl 2.1 of the 2003 Swan Policy. This was because they did not provide Swan with ready access to funds for its day to day requirements without penalty. The Claim SCDOs were not easily tradeable on an established secondary market for the reasons in section 6.2.3, nor were they readily able to be liquidated for cash at short notice for the reasons in

In elaborating their second argument, the Councils contended that Grange was negligent by investing in SCDOs, including the Claim SCDOs, in breach of the IMP agreements. They asserted that Grange knew of that each of Swan and Wingecarribee had conservative investment histories, SCDOs were highly complex and designed for sophisticated investors, the Councils should have invested prudently and in products that were liquid, each was not in a position to tolerate any likelihood of price volatility in the Claim SCDOs, and those products had risk features that made them riskier than

Grange argued in response that the Swan IMP agreement did not require it to invest in accordance with a conservative investment strategy. It contended that the 2003 Swan Policy reflected the Council's motivation to invest in products with a higher yield. It argued that each Council was a sophisticated investor within the meaning of s 708(8) of the Corporations Act. Grange also argued that in any event, the Council was such an investor because Grange had those attributes and was managing the Council's investments under the IMP agreement on their behalves. Grange submitted that the Claim SCDOs were liquid because of its promise to provide liquidity and investment of the Councils' funds was not imprudent. It argued that Mr Senathirajah understood that the market price of CDOs might be affected by general market sentiment towards CDOs as a product or the affect of particular credit events or ratings downgrades on a particular CDO. Grange also relied on the fact that both he and Mr Downing understood that the market price could drop below par. Grange submitted that it had informed Swan that the SCDOs were leveraged but Mr Downing had relied on the rating as the determining factor as to the quality of the product. Grange argued that

the Claim SCDOs' risk of price volatility and lack of liquidity were not inconsistent with the Councils' conservative investment requirements. It also contended that the Claim SCDOs it invested in carried the highest ratings, indicating that each product

I do not accept Grange's arguments on the second limb. I am satisfied that Grange was in breach of its contractual obligation to exercise reasonable skill and care in performing its functions under the Swan IMP agreement by causing each Council to invest in the Claim SCDOs. Grange performed extensive research and gave detailed consideration before it decided to market each of the SCDOs it sold to its clients. It argued that this work demonstrated that it acted reasonably. However, this argument overlooked two critical matters, first, the failure of the Claim SCDOs (and other SCDOs) to meet the particular investment requirements of the Council and Western Australian law and, secondly, Grange's own appreciation of the significant degree of risks to which investment in the Claim SCDOs (and other SCDOs) exposed the Council as compared to the kinds of products that did not have the features that I have

found to have resulted in breaches of contractual terms (1), (2), (3) and (4).

Grange exercised the Council's powers of investment under cll 2.1 and 2.2 of the Swan IMP agreement. It had to do so in accordance with the Guidelines in Sch 2 that included the 2003 Swan Policy (see section 4.3.1). The 2003 Swan Policy sought to enhance the yield that the Council received. That objective, read in the context of the policy as a whole, did not amount to Swan abandoning its conservative investment strategy, as I have explained at [906]-[907] above. Grange was aware that each Council was a government body investing public money to earn a return during a period in which the money was not required for public purposes. It was aware that the Councils were not seeking or entitled to expose their constituents' money to any significant risk of loss. Grange was aware that investment in SCDOs exposed the holder to the risks that, for example, Mr Hagan, Mr Rae and Mr Vincent identified in their analyses in March 2006 ([98]-[100]), 14 and 15 September 2006 ([366]-[368]) and the "no haircut repos" email ([266]-[268]).

Grange, as manager of the Councils' portfolios under their IMP agreements, was the

agent of each of Swan and Wingecarribee. In that capacity, it was a person who,

unlike each of the Council officers had the necessary financial acumen and expertise to be categorised as a "sophisticated investor" in the English ordinary usage of that

expression. That is the capacity in which each Council engaged Grange to act on its

Division 6D.2 of the Corporations Act required a person offering securities, such as SCDOs, for sale in certain circumstances to make disclosure to investors in respect of such offers. However, s 708 created a number of exceptions to this requirement, including that provided in s 708(8). That exception applied to, among others, an investment where the minimum amount or amounts payable by an offeree for the particular security was, or totalled at least, $500,000 (s 708(8)(a) and (b)). The Councils did not allege any breach of Div 6D.2 as part of their case. As I have noted above, none of the terms sheets or other documents provided to the Councils explained to them what Grange referred to as a "sophisticated investor" was. Each Council made a number of investments for less than a total of $500,000 in SCDOs over the course of their relationships. For example, Grange bought for Swan $150,000 worth of the Henley AAA Claim SCDO on 23 April 2007 and $300,000 worth of the Lehman Bros Property Note on 13 June 2007. The issuers' offering memoranda did use the expression "sophisticated investor" in its natural and ordinary

meaning and not in the sense of a person meeting the test in s 708(8). As I have found, the Councils were not "sophisticated investors" ((218], [265]-[268], [407], [464], [483], [491], [557], [623], [662], [665], [686]).

Moreover, a sophisticated investor charged with the responsibility of managing a client's portfolio in accordance with its investment policy, must observe the client's policy, if known to it (as it was to Grange) when making investment decisions. Grange had an approach to its IMP agreement mandates that was accurately summarised by its director of business development, Alison Perrott, in a risk management overview she wrote on 19 August 2005. She noted that Grange had no formal procedures for portfolio management, including procedures for addressing any conflict of interest, compliance reviews or portfolio reviews. Pertinently, she observed:

"We are promising "individually managed & tailored" but this was always from the clients perception, internally we intended to produce "sausages" with cash

enhanced, local gov't and high yield with little variation. We are finding ourselves in a situation where for every 2 plain sausages we have | variation." (emphais added)

At the conclusion of her overview, Ms Perrott added an observation made by Mr O'Dea:

"Applying true porftolio management ... ie, it is tempting to use mandates as underwriting tools, & covering unsold positions in new issues, to the point where portfolio positions get too big ... a touchy subject but if we blow up we will get a

The purchase of the Federation SCDO for Wingecarribee was an example of the "sausage" approach Ms Perrott described. Grange failed to look at the prohibition in the Wingecarribee IMP agreement against the acquisition of a product for which there was no active secondary market, where its own slides stated that there was none for

the Federation SCDO: see [371]-[372], [638], [716].

In addition, Grange breached its contractual obligation to exercise reasonable skill and care in making investment decisions under the Swan IMP agreement because the Claim SCDOs did not have a high level of security for the protection of the capital invested by the Councils, there was no established secondary market for, and there was a lack of liquidity of, the products (see sections 6.2.2-6.2.5 above). Those matters meant that investment in the products for the Councils was also imprudent. Mr Senathirajah and Mr Downing understood that the market price of SCDOs was susceptible to general market sentiment and the impact of credit events or rating downgrades in particular products. However, neither understood how the risks of price volatility and extreme market events applied to this particular form of investment (see section 6.2.2 and [860] above). Mr Senathirajah understood, from what Grange had told him, that its monitoring of the performance of SCDOs would enable Swan to take prophylactic corrective action before any particular product became vulnerable to causing Swan a capital loss ([236]-[237]). Mr Downing regarded, as Grange submitted, SCDOs as being hold to maturity investments and so he was not concerned about fluctuations in market value, since these did not affect

repayment of capital by the issuer on the product's maturity: [406]-[410].

Grange's final argument, that the Claim SCDO's carried high ratings indicating that

each product carried a minimal risk of loss of capital, ignored the known limitation on

the use of ratings to assess risk for structured finance products in comparative terms with ADI issued FRN's or corporate bonds: [847] and see generally section 6.2.2. Additionally, I found in sections 4.3.2 and 4.3.3 that a number of Grange's investments in Claim SCDOs under the Swan IMP agreement were in breach of its

° the investments in the Coolangatta and Federation Claim SCDOs on 16 March 2007 and 8 May 2007 respectively, which had final maturity dates more than five years later, in breach of cl 2.6(a)(11) of the 2003 Swan Policy ([369]-[370], [376];

° the investment of $250,000 in the Flinders Claim SCDO on 6 July 2007 at a price greater than face value. At that time Grange was dumping its own holding of that product onto its clients in the belief, based on a valuation it had received from Credit Suisse that it was worth $8 (per $100 face value) below

Grange's undisclosed internal benchmark and materially less than face value

For these reasons, and those in [899], but for Grange's negligence, Swan would never have invested in the Claim SCDOs, either because it would never have entered into the IMP agreement at all, or, Grange would not have used its mandate to make these

Like Swan, Wingecarribee alleged that Grange breached its obligation in their IMP agreement to exercise reasonable care and skill (see section 6.2.8). Wingecarribee also alleged that Grange breached their IMP agreement in two further respects. Those were that investment in the Claim SCDOs was a breach because, first, there was no active secondary market for them and, secondly, they were "derivatives" within the meaning of s 761D of the Corporations Act: [812]-[813]. I will deal with the last issue in section 9. Grange argued that it had not breached its contractual obligation to exercise reasonable skill and care because Sch 2 to the Wingecarribee IMP agreement

expressly allowed investments in CDOs, credit linked notes and structured products

However, the mere fact that these were permitted investment classes did not mean that each and every product meeting the description "CDO" or "structured product" would fall within the investments permissible under the Wingecarribee IMP agreement. The other requirements in the IMP agreement governing investments also had to be met, such as the existence of an active secondary market for the products. Any CDO or structured product had to meet all of the relevant criteria for investment in the

Nonetheless, unlike what I have found in respect of the Swan IMP agreement, Grange did not breach the Wingecarribee IMP agreement simply because it invested in SCDOs including the Claim SCDOs. That form of investment was expressly authorised, subject to the two additional requirements that the products had to have an

The 2003 Wingecarribee Policy and the Minister's investment guidelines required the prudent person test to be applied to the consideration of the Council's investments (([415]-[417], [611]). The Wingearribee IMP agreement did not refer expressly to either of those matters. Both parties contracted by reference to the fact that Wingecarribee was a Council constituted and operating in accordance with the Local Government Act (NSW) (cl 2.3(d), [638], [811]). Grange acted as the Council's agent. The IMP agreement could not be construed to permit Granged to act, in its capacity as the agent of Wingecarribee in investing its funds, in a manner inconsistent with its principal's investment policies or guidelines set by the Minsiter for the

exercise of powers to invest by local government bodies.

It follows that Grange was still bound to act as a prudent person when exercising its power, as the Council's agent, under the Wingecarribee IMP agreement if it decided to select CDOs or structured products for investment. That is, Grange was entitled to consider investing in SCDOs for Wingecarribee despite their inherent properties that made these products unsuitable for Swan under the Swan IMP agreement as found in section 6.2.8. However, in making investments in CDOs and structured products

Grange was still required to act as a prudent person.

Critically, cl (c) of Sch 2 to the Wingecarribee IMP agreement required Grange to manage the portfolio to ensure that "all securities must have an active secondary market". In sections 6.2.3 and 6.2.4, I found that there was no established secondary market on which the Claim SCDOs were easily tradeable and that they were not readily able to be liquidated for cash at short notice. The only market was of the insubstantial nature described in the issuer's offering memoranda at [123] and Grange provided that facility only while doing so suited it and was within its limited capital resources: [881], [884]-[885]. Grange's investment for the Council of $3 million in the Federation Claim SCDO was a breach of this provision. Its own slide presentation for this product stated that "There is currently no market for the Notes". That went on to say that Grange might make a market for the product from time to time but was under no obligation to do so: see the risk factor quoted in full at [371]. Grange did this after concerns had been expressed in the international financial press about RMBS products (see [370]). This use of its power under the Wingecarribee IMP agreement made good Ms Perrott's analogy of Grange's use of the "individually managed portfolio" as being a "sausage". This investment indicated that Grange used

the trust of the Councils to do what suited Grange.

Grange's investment of Wingecarribee's funds in the Claim SCDOs was a breach of cl (c) of sch 2 of this IMP agreement. A corollary of that finding is that Grange was in breach of its obligation to exercise reasonable skill and care in making investments for Wingecarribee under their IMP agreement because the Claim SCDOs lacked

Grange argued that because each of Mr Hyde, Mr Dunn and Mr Neville understood that there may be fluctuations in the market price of the Claim SCDOs, it had not been in breach of its obligation to exercise reasonable skill and care by investing in products that had a likelihood of price volatility. It also relied on Mr Neville's stated intention that the products be held to maturity. It also contended, as it did in respect of the similar claim by Swan, that the same obligation had not been breached because the Claim SCDOs were not riskier than other fixed interest products. Grange asserted that the main concern of Wingecarribee was the risk of loss of even a dollar of capital. It submitted that the risk of such loss was measured by the ratings assigned by the

The answers given by Wingecarribee's witnesses must be understood in the context that they had no idea, when deciding to go ahead with the IMP agreement, that contrary to their express wishes (but not the signed agreement) the Councils would be investing in unfamiliar products and, in particular, SCDOs. As Mr Neville said, it was consistent with his understanding based on what Grange's representatives had said that the market price of FRNs might vary from time to time. However, when he referred in his evidence to FRNs, he was not describing the SCDO products that Mr Calderwood asserted were FRNs in the meeting of 16 February 2007. Rather, Mr Neville was speaking of ADI issued FRNs that he was familiar with from his past experience. That was also Mr Hyde's understanding. The market price of these could vary as interest rates changed over time. However, those variations in market value would have no bearing, on maturity of the product, on the return of the capital deposited with the ADI when it issued the FRN ([623], [632]-[636]). This understanding did not begin to envisage the risk of market price volatility and the

Wingecarribee sought both capital security and liquidity, since it would need access to substantial amounts of cash once it began the construction of its planned leisure centre. The Claim SCDOs were not a prudent form of investment for those purposes for the reasons I have given in sections 6.2.2 to 6.2.5 and 6.2.7. But for Grange's

negligence, Wingecarribee would never have invested in any of the Claim SCDOs:

Finally, Grange committed breaches of the Wingecarribee IMP agreement:

° between 16 and 19 February 2007 when it sold 9 SCDOs at face values or better totalling over $11.1 million when it had valued these at about $728,000 less in its own books and borrowed $2 million on a "repo" of the Scarborough

product at face value, when it had valued this at 92% of face value in its books

° on 6 July 2007 when it offloaded onto the Council at an over value $2,100,000 worth of the Flinders Claim SCDO (see [694] and [918]).

It follows from the above that Grange is liable to each Council for damages for breach of contract by causing the Council to invest in the Claim SCDOs. I will consider below the extent to which Grange's liability in damages is affected in conjunction

with considering this issue on the negligence and misleading conduct claims.

Was there a breach of fiduciary obligation by Grange?

Did Grange commit a breach of its fiduciary obligations owed to Swan before 9 February 2007?

Before they entered into their IMP agreement, Grange owed Swan the fiduciary obligations first, not to obtain any unauthorised benefit from their relationship and, secondly, not to be in a position where Grange's interests or duties conflicted, or there was a real or sensible possibility that they might conflict, with the interests of Swan: [732], [745]. However, Grange would be relieved of each obligation, if it obtained Swan's fully informed consent to obtain such a benefit or be in the position of actual or possible conflict. A similar position existed in respect of Grange's relationship

Swan and Parkes argued that Grange breached both obligations. The Councils contended that Grange earned substantial and undisclosed fees or profits in relation to the underwriting, structuring and selling of SCDOs that it advised or recommended them to buy. They contended that these fees or profits were significantly greater than Grange could have earned by selling or dealing in the more traditional FRN products that the Councils had been familiar with before Grange persuaded them to buy SCDOs. The Councils argued that, by selling SCDOs to them Grange was able to minimise or defray its own risks of underwriting and holding those SCDOs on its books. They contended that in presenting, advising and recommending SCDOs for purchase, Grange never squarely addressed with them how it benefitted from the

Grange argued that it disclosed to the Council in every contract note that it was either the buyer or seller on the other side of the transaction. It also repeated the argument

that I have rejected above, namely that it had disclosed in contract notes issues from

about late January 2005 that it earned fees, so as to obtain Swan's and Parkes'

As both sides accepted in argument, the first purchase by each of Swan and Parkes of an SCDO, being the Forum AAA, product was critical. Had the risks in such an investment been fully and properly explained, neither Council would have invested in

SCDOs at all ([206]-[207], [406]-[410] (as to Swan), [448], [456] (as to Parkes)).

Mr Senthirajah and Mr Bokeyer understood that Grange was the vendor of the Forum SCDO (and was the Council's counterparty in each subsequent transaction). Both understood that Grange made some money for itself in those transactions ([248], [449]). Mr Senathirajah also understood in a general way that when Grange was seeking to sell a new product that it was an underwriter of the issue and could earn fees in that capacity ([248]). Grange's representatives explained to Mr Downing that its source of income, when it sold a new issue, was a fee from the bank that had promoted the product. Mr O'Dea made him aware that Grange was the underwriter, or as Mr Downing said "marketing agent" for some new issues. Indeed, Mr Downing received a term sheet for the Glenelg product that identified Grange as its underwriter. However, he had no understanding, and Grange did not tell him, of the extent of the fees it earned (T506). Mr Bokeyar never asked and was never informed about what Grange earned in fees or other income from its dealings. Indeed, underwriting fees were never mentioned to him by Grange's representatives ([449]). There is no evidence that Grange disclosed to any of the three Councils the amount of fees or

profit it earned from selling any new or other SCDO or other product to the Councils.

I am of opinion that Grange's revelation of its being the counterparty in, and on occasion, the possibility that it might earn unspecified fees or profits from, trading with its clients did not amount to a sufficient disclosure from which it can be inferred that any of the Councils gave its fully informed consent to Grange obtaining such a benefit. Once Grange came to occupy a fiduciary position in relation to each Council, it had the onus of proving that it had obtained the Council's fully informed consent to its obtaining any benefit from, or acting when it had an actual, or potential conflict in, that relationship. A client in the position of the Councils would be likely to approach

consideration of Grange's advice and recommendations much more cautiously, if it

realised that Grange stood to gain very large underwriting fees or other profits, sometimes totalling over $1 million, from the sale of each new issue of SCDOs. Of course, this very consideration is irrelevant to the questions of whether Grange

breached its fiduciary obligations and, if so, what remedy should be given against it.

In Furs Ltd 54 CLR at 592-593, Rich, Dixon and Evatt JJ said:

"Tf, when it is his duty to safeguard and further the interests of the company, he uses the occasion as a means of profit to himself, he raises an opposition between the duty he has undertaken and his own self interest, beyond which it is neither wise nor practicable for the law to look for a criterion of liability. The consequences of such a conflict are not discoverable. Both justice and policy are against their investigation. With reference to a transaction arising out of another relation of confidence, Lord Eldon said: "The general interests of justice" require "it to be destroyed in every instance; as no Court is equal to the examination and ascertainment of the truth in much the greater number of cases" (Ex parte James (1803) 8 Ves. 337, at p. 345; 32 E.R. 385, at p. 388). His language has been applied to, and illustrated by, the case of a fiduciary agent making undisclosed profits (Panama and South Pacific Telegraph Co. v. India Rubber Gutta Percha and Telegraph Works Co. (1875) L.R. 10 Ch. 515 at pp. 523, 527)." (emphasis added)

Similarly Lord Radcliffe, delivering the advice of the Judicial Committee in Gray [1952] 3 DLR at 14 said:

"There is no precise formula that will determine the extent of detail that is called for when a director declares his interest or the nature of his interest. Rightly understood, the two things mean the same. The amount of detail required must depend in each case upon the nature of the contract or arrangement proposed and the context in which it arises. It can rarely be enough for a director to say "I must remind you that I am interested" and to leave it at that, unless there is some special provision in a company's articles that makes such a general warning sufficient. His declaration must make his colleagues "fully informed of the real state of things" (see /mperial Mercantile Credit Ass'n v. Coleman (1873), L.R. 6 H.L. 189 at p. 201, per Lord Chelmsford). If it is material to their judgment that they should know not merely that he has an interest, but what it is and how far it goes, then he must see to it

that they are informed (see Lord Cairns in the same case at p. 205)." (emphasis added)

In essence, all that Grange did was to let the Councils know that it was "interested", in the sense that it would make something out of dealing with them. That was not enough to put its clients into a position to make a fully informed choice whether to deal with Grange by acting on its advice or recommendation to purchase an SCDO. The more is this so given Grange's appreciation that the Councils had no real concept of some of the risks that they were assuming, and the scale of what Grange was earning, in dealing with these products. This is eloquently demonstrated by

considering the switches proposed in Mr Clout's email of 9 August 2004 , the email

exchange between Mr Clout and Mr Rae of 14 and 15 September 2006 and Mr Vincent's explanation of "no haircuts repos" ([300]-[307], [366]-[368], see too [266]- [268], [286]-307]). It follows that Grange, in selling the Claim, and other, SCDOs, was in breach of its fiduciary obligations owed to Swan and Parkes by obtaining

benefits from each relationship that had not been authorised by either client.

Grange was also in breach of the second proscriptive fiduciary obligation because it acted in effecting transactions with SCDOs with each of Swan and Parkes when its personal interest in the transactions conflicted with those of each Council. Once again, Grange failed to obtain its Council clients' fully informed consent to its participation in each transaction while in that position of conflict. Grange stood to benefit from each such dealing. There is no evidence of the precise extent to which Grange benefitted from purchases and sales of SCDOs that were not new issues, other than that these were substantial (e.g. [296]). There was no evidence that, apart from the generality of the disclosure of its being a counterparty and entitled to a profit or fee, Grange informed any of the Councils of how much it stood to make from any trade. But the evidence of the scale of its underwriting fees or profit on new issues demonstrated, first, why Grange was involved in advising and recommending SCDOs to its clients and, secondly, why it needed to provide, what it knew the products did

not independently have - a secondary market and liquidity.

If Grange had wished to obtain the Councils' fully informed consent to its acting in its

position of conflict, it had to give advice and make disclosures to the standard identified in Daly 160 CLR at 377, 384-385, see: [739]-[742]. Grange did not do so: [182], [192], [200], [207], see also section 4.2.14, [340], [350]-[354].

Did Grange commit a breach of its fiduciary duty owed to Parkes?

For the same reasons as I have given in respect of Swan in section 6.3.1, Grange breached each of its fiduciary obligations owed to Parkes (see section 4.4.3, [538]- [549], [568]-[574], [584]-[585]).

Did Grange commit a breach of its fiduciary duty owed to each of Swan and Wingecarribee in respect of their IMP agreements?

I discussed, in sections 5.1.5 and 5.3.1 esp at [782], how the provisions of Sch 3 of the Swan and Wingecarribee IMP agreements affected Grange's fiduciary relationships with each Council after it entered into its agreement. In substance, Grange continued to owe the two proscriptive fiduciary obligations to each of Swan and Wingecarribee after entry into the respective IMP agreements. Grange did not obtain the fully informed consent of either Council at any time to relieve it of those fiduciary

obligations for the reasons I have given in section 6.3.1.

Even if I were wrong to have found that Grange owed the particular fiduciary obligations above, it owed fiduciary duties, as each Council's agent, in making investments on its behalf under the IMP agreements. The specific breaches of the IMP agreements that I have found at [918] in respect of Swan and [930] in respect of Wingecarribee amount to conduct that was a misuse of Grange's agency, and hence,

Indeed, Grange's conduct in respect of Wingecarribee's inquiries as to how Grange was remunerated was, as I have found at [618]-[620], hardly candid and was calculated to mislead and deceive. And it succeeded. Far from making a full and frank disclosure, Grange hid the truth in answer to a direct enquiry from Wingecarribee. That conduct was unconscientious. It would not accord with the equitable obligations Grange had to make a full and frank disclosure of the benefits it sought to gain by entry into the Wingecarribee IMP agreement, by permitting these to be eschewed by a combination of its false pre-contractual assertions and Sch 3 of the

I am of opinion that Grange did not obtain any fully informed consent from either of Swan or Wingecarribee to relieve it from the two fiduciary obligations it owed each of

356 - Were the representations made by Grange misleading or deceptive?

The Councils relied on the various statutory provisions prohibiting corporations from engaging in misleading or deceptive conduct. For many years all one had to know was that the elegantly simple s 52(1) of the Trade Practices Act 1974 (Cth) prohibited a corporation from engaging in conduct, in trade or commerce, that was misleading or deceptive or likely to mislead or deceive. For some purpose that is not evident the Parliament decided to remove elegant simplicity in its statutory drafting some years ago. Now the community and the Courts must grapple with a labyrinth of statutes, all prohibiting such conduct, in relatively general fields (such as s 18 of Sch 2 of the Competition and Consumer Act 2010 (Cth) and see s 131A of that Act itself) and also in particular fields, such as s 1041H(1) of the Corporations Act and s 12DA(1) of the ASIC Act. The latter two provisions state:

1041H(1) A person must not, in this jurisdiction, engage in conduct, in relation

to a financial product or a financial service, that is misleading or deceptive or is likely to mislead or deceive.

12DA(1) A person must not, in trade or commerce, engage in conduct in relation to financial services that is misleading or deceptive or is likely to mislead or deceive. (emphasis added)

Of course, each Act has a myriad of complex definitions of what is a financial product or a financial service or are financial services. Each Act gives a person, who suffers loss or damage by conduct of another in contravention of the prohibition, the right to compensation (e.g. s 10411(1), s 12GF) coupled with substantively identical related exceptions and qualifications concerning proportionate liability. Since the end result of this legislative morass seems to be the same, it is difficult to discern why the public, their lawyers (if they can afford them) and the Courts must waste their time turning up and construing which of these statutes applies to the particular circumstance. Here, should it make any difference whether Grange was alleged to have engaged in conduct in relation to "financial services" (s 12DA(1)) or "'a financial product or a financial service" (s 1041H(1))? Why is there a difference? Why does a court have to waste its time wading through this legislative porridge to work out

which one or ones of these provisions apply even though it is likely that the end result

will be the same? As Edmund Davies LJ lamented in The "Putbus" [1969] P 136 at 152:

"Were bewilderment the legitimate aim of statutes, the Merchant Shipping (Liability

of Shipowners and Others) Act, 1958, would clearly be entitled to a high award.

Indeed, the deep gloom which its tortuousities induced in me has been lifted only by

the happy discovery that my attempt to construe them has led me to the same conclusion as my brethren."

For present purposes I will assume that it is sufficient to deal under the ASIC Act with the resolution of the issues concerning misleading or deceptive conduct. That provided, in s 12BAB(1)(a) that, relevantly a person provides a "financial service" if they "provide financial product advice". Next, s 12BAB(5) provided:

"(5) For the purposes of this section, financial product advice means a

recommendation or a statement of opinion, or a report of either of those things, that:

(a) is intended to influence a person or persons in making a decision in relation to a particular financial product or class of financial products, or an interest in a particular financial product or class of financial products; or

(b) could reasonably be regarded as being intended to have such an influence;

(c) a document prepared in accordance with requirements of Chapter 7 of the Corporations Act, other than a document of a kind prescribed by regulations made for the purposes of this paragraph; or

(d) any other document of a kind prescribed by regulations made for the purposes of this paragraph."

The parties did not suggest that any of the exceptions in s 12BAB(5)(c) and (d) was applicable. Thus, in providing the Councils with its recommendation, advice or opinion in respect of the Claim SCDOs and other SCDOs in evidence, Grange gave financial product advice within the meaning of s 12BAB(5). That was because when Grange gave a recommendation, advice or opinion it intended to influence the Council officer to buy or sell the product or products concerned. Therefore, Grange

provided a financial service on each such occasion within the meaning of s

When Grange recommended or advised each of Swan (before their IMP agreement) and Parkes to buy or sell an SCDO, or invest in SCDOs as a class, it gave financial product advice. That is because Grange intended to influence the Council to make a decision in relation to a "security", defined as a financial product in s 12BAA(7) but not otherwise defined in the ASIC Act. The SCDOs were notes issued by an SPV that evidenced the debt owed by it to the investors. An SCDO is a "security" in ordinary parlance. One sense of the word in the Oxford English Dictionary online is:

Se. Chiefly in p/. Originally: a document held by a creditor as a guarantee of the

right to payment, or attesting ownership of property, stock, bonds, etc.; (hence) the

financial asset represented by such a document. Also (orig. and chiefly U.S.): such a document issued to investors to finance a business venture.

And, the Macquarie Dictionary online gives these definitions:

Law a. something given or deposited as surety for the fulfilment of a promise or an obligation, the payment of a debt, etc. b. someone who becomes surety for another. c. an evidence of debt or of property, as a bond or a certificate of stock.
(usually plural) stocks and shares, etc. [Middle English, from Latin séciritas]

Grange also recommended to each of Swan and Wingecarribee, or advised each about, the characteristics of the classes of investments it would make under the IMP agreements if the Councils entered into them. That recommendation or advice was intended to influence the Councils in making a decision to allow Grange to include

securities in the form of SCDOs in their portfolios under the IMP agreements (see s

The Councils alleged that each of representations (1)-(4) that I have found in sections 5.1.3, 5.2.3 and 5.3.2 that Grange made to them was misleading or deceptive. They also alleged that representations (2), (3))(d)-(g) and (4) were made by Grange with respect to a future matter without it having reasonable grounds for doing so, for the

purposes of s 12BB of the ASIC Act. That section provided:

"12BB Misleading representations with respect to future matters qd) If:

(a) a person makes a representation with respect to any future matter (including the doing of, or the refusing to do, any act);

(b) the person does not have reasonable grounds for making the representation;

the representation is taken, for the purposes of Subdivision D (sections 12DA to 12DN), to be misleading.

(2) For the purposes of applying subsection (1) in relation to a proceeding concerning a representation made with respect to a future matter by:

(a) a party to the proceeding; or (b) any other person;

the party or other person is taken not to have had reasonable grounds for making the representation, unless evidence is adduced to the contrary.

(a) have the effect that, merely because such evidence to the contrary is adduced, the person who made the representation is taken to have had reasonable grounds for making the representation; or

(b) have the effect of placing on any person an onus of proving that the person who made the representation had reasonable grounds for making the representation.

(4) Subsection (1) does not by implication limit the meaning of a reference in this Division to:

(a) a misleading representation; or (b) a representation that is misleading in a material particular; or (c) conduct that is misleading or is likely or liable to mislead;

and, in particular, does not imply that a representation that a person makes with respect to any future matter is not misleading merely because the person has reasonable grounds for making the representation."

954 There was no issue that evidence had been adduced at the trial, within the meaning of s 12BB(2), of reasonable grounds for Grange making each of the representations as to future matters for Grange complained of. That cast the onus onto the Councils to

prove that Grange did not have reasonable grounds for making each of representations (2), (3)(d)-(g) and (4): North East Equity Pty Ltd v Proud Nominees Pty Ltd (2012) 285 ALR 217 at 224 [30] per Mansfield, Greenwood and Barker JJ.

Were representations (1)(a) and (2) misleading or deceptive?

Representation (1)(a) has considerable overlap with representation (2) in relation to whether the Claim SCDOs complied with a conservative investment strategy. Similarly representation (1)(b) has some overlap with representation (3)(g) in relation to whether the Claim SCDOs complied with the Councils' policies. I will deal with the latter two in section 6.4.3. Representations (1)(a) and (2) were:

"(1) investments, including the Claim SCDOs, that Grange recommended to, or made on behalf of, each Council:

(a) were suitable for investors with a conservative investment strategy

(2) Grange observed prudent, conservative income defensive, capital protective and pro-liquidity practices when investing on behalf of local government authorities or investing with conservative investment strategies."

Each Council had a conservative investment strategy before it began dealing with Grange. Grange promoted its SCDO products to both Parkes and Swan as "very attractive instruments for the more conservative investor, or for the defensive or capital-stable portion" of a portfolio, as Ms May wrote to Mr Bokeyar on 13 June 2003 ([478]), [479], see too [520]-[521] and, in respect of Swan: [178]-[179], [208]). Mr Hyde told Grange that Wingecarribee was a very risk-averse client at their initial presentation ([625]). Mr Rosenbaum and Mr Calderwood told Wingecarribee's finance committee, on 21 February 2007, of their understanding of Wingecarribee's conservative approach to investment of its funds ([680], [687]). On 12 March 2007 Mr Calderwood wrote to Mr Neville saying that "The current portfolio for

Wingecarribee has been constructed conservatively" ([687]).

Wingecarribee Shire Council v Lehman

At a glance

Court

Decision date

Before

Source

Judgment (1073 paragraphs)

Parties

Legislation Cited (16)

Cases Cited (127)

Cited By (23)