I am having the same problem, but using ftp without a proxy (we have
proxy authentication problems using http/apt here):

Reading package lists... Done
W: GPG error: ftp://au.archive.ubuntu.com jaunty-updates Release: The following 
signatures were invalid: BADSIG 40976EAF437D05B5 Ubuntu Archive Automatic 
Signing Key <[email protected]>
W: You may want to run apt-get update to correct these problems

So, at least for this case it is not a matter of apt working around
truly broken proxies. Pointing to other repos
(ftp://mirror.internode.on.net/) results in no error.

-- 
GPG error with apt-get (BADSIG 40976EAF437D05B5)
https://bugs.launchpad.net/bugs/24061
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