Following our update in June, it was reported in July that the Midcoast Council and Division CCFM vs Fitch Ratings Agency legal dispute regarding Fitch’s rating of the Palladin SCDOs settled out of court, prior to the scheduled trial date in September. Despite Fitch seeking a suppression order over the settlement amount, arguing it was a “tripartite agreement struck between Applicants, Fitch and Commonwealth Bank of Australia (the issuer of the Palladin notes)” that would not give “investors the full picture”, Justice Lee decided otherwise. He said “[it is] not only the group members who are protected by the need for the court to give primary objective to the public interest in open justice” as he disclosed investors received back 95% of their claim amount with Fitch agreeing to a settlement sum of $27 million in total.
Justice Lee however heavily criticised Squire Patton Boggs (SPB) and Fitch Ratings Agency saying he would never have made orders to reconvene the latest mediation if he was aware the “soft closure” from the adjourned October mediation meant that five Group Members who were Palladin holders but did not sign up with SPB and their funder were excluded from the latest settlement and therefore received no monies under the agreement.
Justice Lee said “I don’t think I should have to interrogate people who know what the full story is, but I certainly didn’t appreciate the significance of this adjourned mediation… someone must have known there was a significance in adjournment rather than terminated, I really should have been told that.” Justice Lee said as a result he was “In two minds” whether to approve the settlement in light of this information that had only become apparent to him on the morning of the settlement hearing. However he was persuaded to approve the settlement after SPB lawyers provided evidence of the extensive efforts they made to contact the five excluded Group Members and give them the opportunity to participate. Justice Lee said that a 95% recovery for investors clearly passed the test of being “fair and reasonable”
There are a number of points Amicus believes are significant for holders of other Fitch rated CDO’s in the reporting of this settlement. Amicus opinions are as follows:
- While the headline was that investors received back 95% of their claim, reported statements from Justice Lee shows the claim comprised more than simply principal losses, but also interest, costs and compensatory damages. From Amicus experience of similar cases, interest claims can be significant and far exceed those of net principal losses. This means SCDO holders who only believe they have a small principal loss (particularly after recoveries from other sources) can have quite large claims and the overall compensation they can receive from a settlement may cover all forms of losses.
- The case was initially based on accusations of Fitch assigning false or misleading AAA and AA ratings to the Palladin SCDO’s but SPB was able to add to their original claim additional accusations of fraud and deceit in July 2018 regarding Fitch’s use of a hidden table to map probabilities of default from its model to favourable ratings for the SCDO’s. It is the efficacy of these latter arguments that will give rise to whether claims against Fitch for other SCDO’s they rated in a similar manner can now be pursued.
- It is unknown as to what extent these additional claims alleging “Tort of Deceit” encouraged Fitch to settle the case and affected the settlement amount as opposed to the proximity of the trial date and the strength of the original claim. As the Palladin case was settled no legal precedent has been set as to whether a court may find against Fitch based purely on the “Tort of Deceit” claims or whether Fitch is likely to settle any case brought against it purely on these arguments. However a settlement for 95% of the claim amount (when the theoretical maximum that could be won in the court is 100%) suggests Fitch either believed their case was entirely hopeless or the risk of an unfavourable judgement against them for Dishonest Concealment would be so reputationally damaging to their business Fitch felt it could not take the risk (or a combination of both reasons).
- The settlement amount of 95% of the claim, Amicus believes is inclusive of the funder’s fee paid to International Litigation Capital Partners. Therefore as a percentage of the total claim amount, Group members will receive significantly less than this amount. It is for this reason Amicus believes the quantum of funding fees are important, particularly for strong claims, as settlements will likely be for a high percentage of the claim amount, but this can be reduced materially by the funder’s fee where the funder has taken little risk because the case is strong. In theory no court is going to award more than 100% of the claim amount and settlements even of a strong case will be for less than 100% of the claim amount. Often the biggest economic loss to investors from their total claim amount for strong cases is the funder’s fee.
- In terms of options for investors in relation to potential claims they may have in relation to holdings in Henley, Kakadu and other Fitch rated SCDO’s, Amicus is not aware SPB has filed a claim as yet against Fitch in relation to these SCDO’s and our understanding is an alternative law firm is currently assessing the available claims and progressing the issue with a potential lead applicant
- The issue of the exclusion of five of the twenty two Group members in the Palladin case from any settlement amounts and Justice Lee’s extensive comments regarding how he was not best pleased they had effectively missed out on compensation these five Group members would otherwise have been entitled to receive shows the value of engagement with the issues. Without knowing the specific details of why management at the five Group Members chose not to participate, the likely reality is that by not engaging they effectively forwent receiving a cheque that, even after funding costs, would have more than covered any principal losses their organisations incurred on Palladin had management chosen to participate.
Amicus’ recommendations based on this latest news is for investors to continue to wait to see if either SPB or an alternative law firm files a case in relation to other Fitch rated SCDO’s and depending on which law firm offers the best alternative to sign up with one or the other. We make this general recommendation on the premise that both legal actions will likely be externally funded and there is effectively no material downside risk to participating. As is demonstrated by the five Group members excluded from the Palladin settlement, there are material economic downsides to non-engagement and non-participation. Any investor with questions on the subject matter raised in this article should contact Amicus before following any of its general recommendations above as each claimant’s specific circumstances may mean our general recommendations above may not be applicable to each potential claimant specifically.