In a landmark legal test case, a Federal Court judge has declared Lehman Brothers liable for millions of dollars in losses incurred by Australian investors through the bank's "misleading and deceptive conduct".
A group of 72 councils, charities, churches and private investors sued the Australian arm of the bankrupt American investment bank for $248 million, claiming it had breached contracts.
The judgment is the first in the world to rule an investment bank liable for its conduct in the lead up to the global financial crisis and its behaviour afterwards, said John Walker, executive director of litigation funder IMF, which helped fund the case.
While Justice Steven Rares ruled on Friday that the bank is liable, he did not make an order on damages and instead will hear submissions on the matter in November.
Investment advisory firm Grange Securities, which Lehman Brothers took over in March 2007, had cold-called non-profit groups, selling complex financial instruments known as synthetic collateralised debt obligations (SCDOs).
While the products were AAA rated, Justice Rares said Grange had failed to tell local councils it was making "very large fees" and profits from the sale of these products between 2003 and 2008.
He also found the junk derivatives had no secondary market, and that Grange knew the SCDOs were risky and would fetch a lower value if sold.
"I have found that Grange engaged in misleading and deceptive conduct," Justice Rares said in his judgment against Lehman Brothers Australia.
"For these reasons Grange is liable to compensate the councils for their losses incurred as a result of these investments."
Leading the action against Lehman Brothers, which filed for bankruptcy in 2008, was Wingecarribee Shire Council, southwest of Sydney, which sought $21.4 million in losses, along with Parkes Shire Council in western NSW and City of Swan Council in Perth.
Mr Walker said the ruling was a first-world judgment against an investment advisory firm selling synthetic SCDOs.
"It's the first time there's been a hearing and we expect the first time there's been a judgment addressing not only investment banks but also the rating agencies," Mr Walker told reporters on Friday.
He added that the Australian court case could lead to action in The Netherlands against financial services giant ABN Amro and ratings agency Standard and Poor's.
Australian creditors were likely to get back 33 cents in the dollar for losses, depending on liquidators settling, Mr Walker said.
Amanda Banton, the partner of commercial law firm Piper Alderman which handled the case, said Grange had deceived conservative council investors.
"The products were likely to be illiquid and there was no guarantee on the return of capital," she told reporters.
Darrel Bourke, the chief executive of Brisbane-based child disabilities charity Montrose Access, said it would take 20 years to recover an investment of $3 million.
"Although we're very happy with the decision today it will take us quite a number of years to recover," he said.
Colin Cameron, City of Swan's executive manager of corporate services, said the $8 million it had invested with Lehman Brothers would be the equivalent of a 12 to 15 per cent rates increase.