Liverpool City Council v McGraw-Hill Financial Inc

[2018] FCA 685

FEDERAL COURT OF AUSTRALIA

Liverpool City Council v McGraw-Hill Financial Inc

[2018] FCA 685

File number:

NSD 1018 of 2014
NSD 957 of 2015
NSD 414 of 2016

Judge:

RARES J

Date of judgment:

26 April 2018

Legislation:

Evidence Act 1995 (Cth) s 136

Cases cited:

Dasreef Pty Limited v Hawchar (2011) 243 CLR 588

HG v The Queen (1999) 197 CLR 414

Date of hearing:

26 April 2018

Registry:

New South Wales

Division:

General Division

National Practice Area:

Commercial and Corporations

Sub-area:

Corporations and Corporate Insolvency

Category:

No Catchwords

Number of paragraphs:

18

Counsel for the Applicants:

Mr C Withers with Ms A Lyons

Solicitor for the Applicants:

Squire Patton Boggs

Counsel for the Respondents:

Mr J Hewitt with Ms R Gall

Solicitor for the Respondents:

Clifford Chance

ORDERS

NSD 1018 of 2014

BETWEEN:

LIVERPOOL CITY COUNCIL (ABN 84 181 182 471)

Applicant

AND:

MCGRAW-HILL FINANCIAL, INC (NOW KNOWN AS S&P GLOBAL, INC) (A COMPANY INCORPORATED IN NEW YORK)

First Respondent

STANDARD & POOR’S INTERNATIONAL, LLC (A COMPANY INCORPORATED IN DELAWARE)

Second Respondent

NSD 957 of 2015

BETWEEN:

CLURNAME PTY LTD (ABN 66 002 898 231)
First Applicant

GOULBURN MULWAREE COUNCIL
Second Applicant

CIRCULAR HEAD COUNCIL
Third Applicant

AND:

MCGRAW-HILL FINANCIAL, INC (FORMERLY MCGRAW-HILL COMPANIES, INC) (A COMPANY INCORPORATED IN NEW YORK)

First Respondent

STANDARD & POOR’S INTERNATIONAL, LLC (A COMPANY INCORPORATED IN DELAWARE)

Second Respondent

S&P GLOBAL UK LTD (FORMERLY MCGRAW-HILL INTERNATIONAL (UK) LIMITED) (A COMPANY INCORPORATED IN THE UNITED KINGDOM)

Third Respondent

NSD 414 of 2016

BETWEEN:

MDA NATIONAL INSURANCE PTY LIMITED (ABN 56 058 271 417)

First Applicant

MITSUB PTY LTD, AS TRUSTEE FOR THE CHRIS CAROLL SUPERANNUATION FUND (ACN 130 784 333)
Second Applicant

AND:

MCGRAW-HILL FINANCIAL, INC (FORMERLY MCGRAW-HILL COMPANIES, INC (A COMPANY INCORPORATED IN NEW YORK)

First Respondent

STANDARD & POOR’S INTERNATIONAL, LLC (A COMPANY INCORPORATED IN DELAWARE)

Second Respondent

JUDGE:	RARES J
DATE OF ORDER:	26 APRIL 2018

THE COURT RULES THAT:

1.The report of John Deacon dated 30 October 2017 be rejected.

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

REASONS FOR JUDGMENT
(REVISED FROM THE TRANSCRIPT)

RARES J:

1. The respondents (S&P) seek to rely on the evidence of John Deacon as an expert in relation to, first, how he would assess whether to invest in a synthetic collateralised debt obligation (SCDO) and, secondly, how an investment adviser would advise a person in respect of making an investment in an SCDO.

2. In my opinion, Mr Deacon’s evidence is not admissible.  First, he was asked to outline his experience in investing in SCDOs as an investor, including to outline the matters that he would look at and take into account in making such an investment.  None of those questions dealt with what he understood to be, or his experience of, the way in which an ordinary reasonable person who invested, or considered investing, in those products in the period 2005 to 2007 did consider or ought to have considered whether to invest in them.

3. Secondly, he was asked to identify:

   matters I would expect other investors of [SCDOs] would take into account when making investment decisions.  (emphasis added)

   That question did not deal with how his experience bore on or was derived from his knowledge of what other investors did, so as to identify what particular standard ought be applied to such persons in making a decision about investing in an SCDO.

4. Thirdly, Mr Deacon was asked to outline his experience in working and dealing with arrangers of transactions such as SCDOs, to provide his views as to the “processes that arrangers follow in structuring such transactions”, as well as possible outcomes and considerations for an arranger where a credit ratings agency’s preliminary rating for a proposed SCDO were not what the arranger sought.

5. Mr Deacon clearly has very significant expertise in conducting financial analyses of transactions.  But his evidence did not identify any training, study or experience that he had as to what persons who were investors in products like the SCDOs the subject of these proceedings, such as local government bodies in Australia, that had to act to the standard of a trustee in making investments, or others, such as a medical indemnity insurer or an individual investor, did or ought to have done, including to comply with legislative requirements, their investment policies and guidelines.

6. Mr Deacon made no reference in his report to any of those matters.  Rather, he made assertions about what he or his team did.  He did not differentiate his team from himself and used the word “we” when he referred to work that he or they performed at major banks, in making investments in financial products or in structuring and selling them.  However, he did not refer to what the person of ordinary skill and care in the industry did in that regard or to his having any awareness of that.  If what his evidence were designed to do was to express an opinion as to what persons, in the position of the applicants, or their advisers, ought to have done, he did not identify any experience or expertise that he had in that field.  Rather, Mr Deacon described his own personal experience which, clearly, is of a high level.  Moreover, as he said of his and his team’s experience, when working at UBS and its subsidiary, Dillon Read Capital Management, in par 5.4 of his report:

   we bought cash CDOs and Synthetic CDOs, and static and dynamic CDOs, including cash CDOs of leveraged loans, cash CDOs of ABS, Synthetic CDOs of corporate loans and Synthetic CDOs of ABS. Whilst we also periodically reviewed Synthetic CDOs of corporate bonds / CDS, we did not buy these for the following reasons:

   …

   b)Certain features of single tranche Synthetic CDOs did not fit with our investing style. For example, our preference when investing in CDOs was to invest in CDOs where the underlying corporate names had been selected on the basis of fundamental credit analysis. In my experience, portfolios for single tranche Synthetic CDOs were instead typically selected on the basis of the ratings and credit spread levels of the underlying corporate names. Similarly, we preferred there to be an alignment of interests between ourselves and those managing the transactions we entered into, which the structure of single tranche Synthetic CDOs did not always facilitate. Specifically, the banks constructing single tranche Synthetic CDOs would not necessarily be required by the terms of the deal to own any of the assets in the reference portfolio, meaning that the COO tranche itself was (for the bank) a short position against the names in the reference portfolio and therefore the bank’s interests were opposite to the interests of investors. If we had wanted to, we could have approached an arranger to design a single tranche Synthetic CDO to our specification, which would have given us the control over the assets and the choice of manager that we preferred but as indicated above, we were able to source the underlying assets ourselves directly without the need to take that approach.  (emphasis added)

7. That evidence does not suggest that what Mr Deacon had to say had any particular relevance to the issues that he, as an expert, could express in three of the five representative proceedings that I am now hearing.  In Dasreef Pty Limited v Hawchar (2011) 243 CLR 588 at 604 [37] French CJ, Gummow, Hayne, Crennan, Kiefel and Bell JJ said that:

   The admissibility of opinion evidence is to be determined by application of the requirements of the Evidence Act rather than by any attempt to parse and analyse particular statements in decided cases divorced from the context in which those statements were made. Accepting that to be so, it remains useful to record that it is ordinarily the case, as Heydon JA said in Makita [(Australia) Pty Ltd v Sprowles (2001) 52 NSWLR 705 at 744 [85]] , that “the expert’s evidence must explain how the field of ‘specialised knowledge’ in which the witness is expert by reason of ‘training, study or experience’, and on which the opinion is ‘wholly or substantially based’, applies to the facts assumed or observed so as to produce the opinion propounded”. The way in which s 79(1) is drafted necessarily makes the description of these requirements very long. But that is not to say that the requirements cannot be met in many, perhaps most, cases very quickly and easily.  (emphasis added)

8. What Mr Deacon sought to do was to give evidence based on his personal experience of what he (or his former employers) did and to apply that, as a general standard, to what persons in the position of the applicants or their advisers ought to have done in assessing whether to enter into a transaction, for the acquisition of a claim SCDO except, significantly, in the two representative proceedings in which his evidence is not pressed, namely, the proceedings in respect of the Credit Sail II constant proportion portfolio insurance (CPPI) product.

9. Mr Deacon did not give evidence about what a person of ordinary prudence or reasonable skill and care ought to have done in analysing a corporate credit or SCDO transaction for his or her personal investment or as a trustee or as an investment adviser.  Rather, he said that:

   In analysing a synthetic corporate credit CDO transaction for potential investment, we would consider a range of areas. As with the investment process, this could be simplified / curtailed if we already knew the CDO manager / underlying assets in question.

   …

   (i)        Static portfolios would be diligenced in a number of respects.

   (A)Portfolio selection process. As noted at paragraph 5.4 above, in our experience the portfolios for single tranche Synthetic CDOs were typically selected by the banks on the basis of credit spread levels and ratings of the underlying corporate names without undertaking a fundamental credit analysis of the names.  ...

   (C)Company financials (published accounts / reports) in respect of the reference portfolio.

   (D)       Other public news (company website, news websites).

   …         (emphasis added)

10. Mr Deacon’s list of “diligencing” activity continued over the next six closely typed pages of his report.  However, he did not give any evidence of his ever interacting with any person in the position of any of the applicants or of investment advisers for such persons, more generally, so as to qualify him as able to express an opinion as to how any of them could, or ought reasonably to, have acted in accordance with any standard of care (including that of a trustee) that a person in their position ought to have followed when considering making an investment.  Accordingly, his evidence did not comply with what the majority held in Dasreef 243 CLR at 604 [37]. Secondly, Mr Deacon did not identify what experience, if any, he had had as an investment adviser or in dealing with investment advisers.  Rather, he merely pronounced as to what, in his view, he would have done working in a specialised context (as opposed to the circumstances of the applicants or their investment advisers) based on his own or his employer’s activities.

11. While there is no doubt that Mr Deacon has a great deal of experience, his report amounted to putting from the witness box the inferences and hypotheses on which S&P wished to rely:  see HG v The Queen (1999) 197 CLR 414 at 428 [43] per Gleeson CJ.

12. The way in which persons in the position of the applicants or their advisers ought to have approached the analysis of the transactions the subject of these proceedings cannot be examined in a vacuum.  Expert evidence is admissible to explain what persons of ordinary skill and care acting in accordance with accepted standards, as at 2005, 2006 and 2007, ought to have done in assessing particular transactions for proposed investments in SCDOs. 

13. Mr Deacon advanced no reasoning process relevant to assessing what persons ought to have done in the position of the applicants or their advisers, when they were offered products of the complexity of the claim SCDOs that had or, were expected to have a particular S&P credit rating, by reason of the ordinary application of the CDO Evaluator.  He did not identify why such persons ought to have gone behind that rating as to creditworthiness of the product.  He did not explain any reason why, for example, such an investor or adviser should examine each of the 100 or more reference entities in a portfolio for the purpose of assessing their creditworthiness for themselves by looking at their published accounts or reports or individual company websites to go behind a ratings agency’s credit rating of each such company.  Nor did Mr Deacon describe any training, study or experience to equip him to opine that investors in the position of the applicants, or their investment advisers, exercising ordinary skill and care ought then to have determined whether or not any particular reference entities were risks to which they should or should not be exposed.

14. What Mr Deacon or his team did was not evidence of what the ordinary person or a professional investment adviser ought to have done.  Mr Deacon gave no evidence that he had any training, study or experience in respect of, or of ever dealing with, persons in the position of the applicants as ultimate investors in products such as the Claim SCDOs.

15. I would also observe that the fact that S&P did not press his evidence in relation to the two Coffs Harbour proceedings (where the CPPI transaction was even more complex than investment in an SCDO), could make the assessment of evidence and the standards to which persons in the position of the other applicants are to be held capable of producing different results in the five representative proceedings that I am hearing. In my opinion, it would be likely to be both misleading or confusing and unfairly prejudicial to the applicants (under s 136 of the Evidence Act 1995 (Cth)) to apply different standards to the assessment of the conduct of the various applicants based on Mr Deacon’s specific and particular expertise for investment in SCDO products in some proceedings, but not others, although, it is, of course, readily possible for me to segregate my use of his evidence as a judge, as opposed to a jury, in such a case. However, I have not used this as a reason for my rejecting Mr Deacon’s evidence.

16. The questions on which Mr Deacon was asked to opine on are not relevant to the issues in the proceedings in which his report is tendered.  Rather, those questions (and his evidence in response) were confined to his own training, study or experience as to his own behaviours, or those of the organisations for which he worked.  The evidence did not deal with the areas of practical engagement that the applicants or their advisers had with the market for products in the class of the SCDOs the subject of these proceedings.  Mr Deacon gave no evidence that he ever acted as an investment adviser, or interacted with such advisers of the class who advised persons such as the applicants, or was familiar with what, in the ordinary course, such advisers did or ought to have done as at 2005 to 2007, when the transactions complained of occurred.  His evidence was not limited or referenced to that period of time or the standards that then applied.

17. While he adumbrated a very careful approach and demonstrated that he had significant experience in analysing details and risks of SCDOs and corporate credit transactions, he did not give any evidence of his experience in dealing with persons in the position of the applicants or their advisers in 2005 to 2007 (or at all), in relation to what such persons did in considering investments in products like the claim SCDOs.

    Conclusion

18. In my opinion, Mr Deacon’s evidence was at a level that did not engage with the issues relevant for decision in these proceedings.  I, therefore, reject his evidence.

I certify that the preceding eighteen (18) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Rares.

Associate:

Dated:        15 May 2018