Parkes Shire Council is taking legal action against Local Government Financial Services (LGFS) over the marketing of complex debt products which have lost most of their value.
The NSW municipality incurred a $2.7 million loss on its $3 million investment in Rembrandt constant proportion debt obligations (CPDOs).
Rembrandt is a highly leveraged synthetic derivative product created by ABN AMRO Holdings, now known as Royal Bank of Scotland. LGFS, owned by the Local Government Superannuation Scheme, is a product provider that predominantly services NSW councils.
The nature of Rembrandt was that once its price fell to 10 cents in the dollar it automatically cashed out, forcing its holders to incur deep losses, LGFS said.
About $45 million of Rembrandt was placed with LGFS, which sold approximately $18.5 million to municipalities marked as Rembrandt 2006-02 and Rembrandt 2006-03.
"This council, together with a small number of similarly affected other NSW councils, are taking legal advice on a number of inadequacies in the way that the LGFS marketed the product, represented the product and transacted in the product under their due diligence obligations and the requirements of their financial services licence," Parkes director of corporate services Les Finn said.
"A number of councils are acting in concert through the services of legal firm Piper Alderman to have the matter redressed. There are other NSW councils receiving independent advice on their position."
Despite the high levels of risk and the complicated nature of CPDOs, the instruments were given AAA ratings by a number of ratings agencies, Finn said.
The loss on Rembrandt affected some of Parkes' long-term projects and has dented the council's long-term financial plans, he said.
LGFS chief executive Peter Lambert denied the organisation ever misrepresented the product and said councils were made fully aware of the risks involved.
