A number of Australian councils, charities and other community groups tasted victory last week in a long-running court battle with the reviled Lehman Brothers investment bank.

The ruling in the Australian Federal Court slated the Australian subsidiary of Lehman's, formerly known as Grange Securities, for selling sophisticated, risky collateralised debt obligations (CDOs) to a range of investors who were above all seeking conservative, interest-bearing investments.

Justice Steven Rares accused Grange/Lehman of being "engaged in misleading and deceptive conduct", opening the way for the various aggrieved parties to recover almost $250 million from the carcass of Lehman Brothers.

It's easy to conjure up a vision here of a bunch of innocent, hick-town councils being hoodwinked out of $1 billion by a band of sleazy, city-dwelling salesmen.


But the image isn't quite true-to-life.

In the first place it wasn't just rural outposts such as Wingecarribee and Parkes that fell for the CDO story. As I recall some big-city Australian councils, such as the inner-Sydney, high-net worth suburb of Waverly, also bought CDOs on behalf of their ratepayers.

Interestingly, most of the soon-to-be-worthless CDOs were sold to councils in NSW and Western Australia (and to a certain extent, Tasmania), regions where councils had more discretion in their investment decisions. Victoria and Queensland state governments managed council investments centrally and shied away from anything outside the conservative fixed income norm.

The disparate NSW, WA and Tasmania councils, then, were easier pickings for the CDO-sellers. However, the councils were also supposed to have rigorous investment selection processes in place - processes that appear to have failed in many cases.

A NSW government investigation into the CDO catastrophe, the Cole Report, found a fundamental error of the councils involved was to not seek out independent investment advice.

Many NSW councils, the Cole Report states, were unable to "clearly separate the advisory role from product distribution role". In short, the councils couldn't distinguish between a salesman and an adviser.

But not all councils bought the story. Some years ago Chris Russell, head of the South Australian Local Government Association (SALGA), recounted the memory of a Grange sales pitch to me.

According to Russell, he asked the Grange guy how CDOs were secured.


"[The Grange rep] gave a vague and fluffy answer," he said, effectively killing off the Grange CDO sales campaign in South Australia.

New Zealand has its own CDO scandals, of course. Famously, OnePath (nee ING) eventually shelling out of hundreds of millions of dollars to defend its honour. The PINs offerings, working their way towards a capital-guaranteed finale, and the now-settled Macquarie Fortress Notes, also come to mind.

However, with the Credit Sails issue still unresolved, some New Zealand investors may be heartened by the Australian Federal Court Lehman/Grange decision.

According to the most recent communique from the Credit Sails Community group (spear-headed by Wanaka-based hedge fund manager, Greg Marshall) awaits a final report from the Commerce Commission before proceeding further.

If the Commission comes up short of a solution, the Credit Sails group would inevitably head to the courts.

"... litigation funders continue to contact [Marshall's firm] seeking to represent Credit Sails in this case and we are aware of at least one other extensive filing against the issuer in the High Court over negligence and breach of contract," Marshall says in the note.