Finance and fraud: Serious shortcomings SFO investigation of Tchenguiz brothers crystallises concern about UK's leading anti-fraud body Lord Justice Thomas had heard enough. One of Britain's most senior judges had sat through two hours of excuses from the country's leading fraud-busting agency about mistakes in a case involving a pair of London's most flamboyant property entrepreneurs, the Tchenguiz brothers. Key documents had disappeared, financial reports had been overlooked and senior investigators who best knew the case had quit, the Serious Fraud Office's barristers said as they pleaded last month for an extension to prepare a legal challenge in one of its most high-profile cases. Begrudgingly, Lord Justice Thomas approved the extension into May, tossing in this rebuke: "There is only one explanation for this: sheer incompetence." He gave the SFO until April 29 to explain its side of the story to the court. His pronouncement was the latest embarrassment for a two-and-a-half year probe started in the wake of the 2008 global credit crisis. An effort to unravel the rot in Iceland's bloated banking system led to suspicions about Vincent and Robert Tchenguiz, symbols of a frothy easy-money decade in Britain. But the investigation has come under pressure - in part because the SFO, meant to enforce rigour in business practices, misread its own files. In this case, the Tchenguizes allege a level of incompetence that crystallises wider concerns about the SFO's abilities to keep up with both the fast pace of modern finance and the sophisticated fraud that flourishes alongside it. An investigation into the Tchenguizes was never going to be a quiet affair. They had amassed multibillion-pound fortunes through a string of business deals spanning property, hotels, supermarkets and pubs. Their love of fast living and lavish parties, whether in their Chelsea mansions or cruising along the Côte d'Azur, made them tabloid supernovas. Their stars had dimmed by the end of 2008. They were left with losses running into hundreds of millions of pounds as stock markets around the world went into free fall. But it was their relationship with Kaupthing, an Icelandic bank at the centre of that country's financial crisis, that soon attracted regulators. Robert, 52, had sat on the board of Kaupthing's largest shareholder, Icelandic financial services group Exista, and the brothers had borrowed hundreds of millions of pounds from the bank shortly before it collapsed in October 2008. Kaupthing's demise, which helped push Iceland to the brink of bankruptcy, drained millions from UK retail depositors. The SFO, working with authorities in Reykjavik, launched an investigation in 2009. This was just the kind of flagship case that Richard Alderman, then the agency's media-savvy director, believed it was important to pursue to show the agency would crack down on potential wrongdoers, no matter how wealthy or well connected. The probe, centred on the processes that allowed large loans to be made by Kaupthing in the run-up to its failure, resulted in the brothers grabbing headlines for all the wrong reasons. On March 9 2011, 135 police and financial investigators raided the London homes and offices of the Tchenguizes. UK media - some of which had been tipped off, dispatching journalists to stake out the properties before police arrived at 7.15am - splashed accounts of the search on their front pages. Both brothers were taken into custody and questioned for hours at a City of London police station. The timing was particularly inconvenient for 56-year-old Vincent. He was due to fly to Cannes that day to host a party aboard his 130ft yacht, Veni Vidi Vici - an annual event usually widely covered by the press. Nearly 14 months later, much hangs on the outcome of those raids for both the SFO and for the Tchenguizes. The brothers say the raids damaged their businesses. Vincent has questioned the legality of the raid and the credibility of the evidence used to authorise the search in a challenge that brought the SFO before Lord Justice Thomas. The agency's already delicate reputation is riding on what happens next, as it admitted in a recent court filing. These proceedings are of the utmost seriousness to the director and the SFO. They involve a wholesale challenge to the SFO's competence and the good faith of its staff," it said. It added that it faced "a massive claim for damages." The "wholesale challenge"" could not come at a worse point in the 24-year history of the SFO. The agency's investigations budget has been slashed by 10 per cent since 2010 to about £32m this fiscal year. Meanwhile the cost of fraud to the UK economy is expected to spiral to £73bn a year, according to recent National Fraud Authority data. While the agency has faced credibility questions in the past - earning it the sobriquet from satirists at Private Eye magazine of the "Serious Farce Office" - it endured the very real prospect last summer of being split up and absorbed into a wider crime agency. After internal debate the government backed down, but uncertainty over the SFO's future was followed by the departure of key personnel there. Among the recently departed officials are Mick Randall and Wayil Eisa. Back in March 2011, the middle-ranking investigators, who declined to discuss the case with the Financial Times, presented allegations in court against the brothers to gain search warrants. Their first hearing did not go smoothly. They had to return three times with additional facts to include in their sworn statement before the judge granted 11 warrants allowing the SFO to seize computers and files, according to court documents. The 147-page SFO statement seen by the Financial Times set out wide-ranging and separate allegations of financial fraud against each brother. Vincent faced a three-prong allegation that he had duped Kaupthing into issuing him and Robert loans of £80m and £100m in March 2008, six months before it went bust. In using his portfolio of 250,000 residential property freeholds - the largest business of its kind in the UK - to secure both loans, it was alleged, Vincent had pledged the same collateral for each. He was also accused of having "widely and materially overstated" the worth of the freeholds by accounting for them using a 150-year rather than a 50-year basis, which the SFO contended was standard accounting practice. Lastly, he was said to have failed to disclose to Kaupthing the existence of "substantial" other lenders with senior ranking claims over the collateral. Vincent immediately denied wrongdoing, claiming his accounting followed the industry standard. He filed a £100m damages claim against the SFO and requested a judicial review into aspects of the case. Future strategy: New director looks to get tough The Serious Fraud Office is being legally challenged by the Tchenguiz brothers at a sensitive time. Its new director, David Green - former head of Revenue & Customs Prosecution Office - only took up his tenure last week, writes Caroline Binham. His arrival comes as the SFO is being surveyed by the Crown Prosecution Service Inspectorate. Mr Green told the FT last week that the inspection, announced in February, was not a review of the viability of the 24-year-old agency. Instead he likened it to a property survey before purchase. It is monitoring how the SFO chooses cases and develops them, he explained. The inspector, Mike Fuller, has met with lawyers on the Tchenguiz case, say people familiar with the survey. The survey has also fuelled staff concerns about the agency's future - just eight months after Theresa May, the home secretary, pledged that the "SFO is staying as it is" after she ditched plans to bundle it into a wider National Crime Agency. Mr Green said that he wants a more aggressive crime-fighting strategy at the SFO and to move away from a "perception of compromise." At the RCPO he oversaw a 92 per cent conviction rate; the SFO has one of about 70 per cent. While declining to comment on the Tchenguiz case, he acknowledged a need to "constantly improve the quality of our work." Nine months after the raid, the SFO retreated. In December 2011, it notified Vincent that it was asking for the warrants to be quashed and that it would return the seized material. The agency offered to pay his costs if he abandoned his request for a judicial review. Vincent refused. Claiming his business had languished because of the investigation, and that the SFO had generated publicity that hurt his reputation, he demanded a full account of the agency's actions. In recent weeks, the SFO has said it still has "serious suspicions" about the brothers" involvement with Kaupthing's collapse. However it has also revealed flaws in its investigation in a letter to Vincent and in a court filing. In the letter, dated February 21 2012, almost a year after the brothers" arrest, the SFO admitted to failures in interpreting the information used to build its case against him. It revealed another misstep, too: it "inadvertently" gave incorrect information to the courts in its efforts to secure warrants. The SFO said in the letter that it had relied on a number of sources to put together its case. The source for its most serious allegations was Grant Thornton, the independent agency that had been hired by Kaupthing's resolution committee to investigate the bank's failure. The accountancy firm informed the agency in late 2010 that it had "uncovered material suggesting that VT's companies had produced fraudulent UK accounts," according to the letter. The SFO then issued what is known as a Section 2 notice, a legally binding request for Grant Thornton to supply information relevant to the case. The firm handed over more than 200 documents, according to the same letter. Among them was the agreement for the £100m that Kaupthing lent to Vincent's trust. The agreement for the loan, known as Pennyrock, detailed the structure and terms of the debt, clearly outlining the valuation of Vincent's collateral. It also referred more than 400 times to the existence of more senior lenders with calls on the freeholds portfolio. Kaupthing, the agreement shows, was fully apprised of the terms of the loan. The agency said in the letter that the agreement had been read by three staff members who did not spot the information in question. "The fact that the SFO was in possession of material which showed disclosure to the bank and the basis of the valuation and the senior lending was overlooked," the letter explained. In particular the allegation concerning the financial statements was inadvertently miscast so as to include the additional and unwarranted suggestion that senior lending had not been disclosed and that in general terms matters material to the lending had been misrepresented to the bank and personnel involved. The SFO did not say how the oversight occurred. In response to requests for comment, Grant Thornton told the FT it had acted "in accordance with its professional responsibilities and legal obligations." It added that: "It is the responsibility of the investigating agency to review and interpret any information provided to it, and to act as it sees fit." Mr Alderman, 60, retired in April after four years at the SFO. Contacted through an intermediary yesterday, he said he would not comment and that the case was "a matter for the SFO." An agency representative said yesterday that it has acknowledged mistakes with the warrants and that "the important thing now is to deal with this at the judicial review." Further complicating matters is the fact that the SFO failed to read other documents - available at the time from civil court cases unfolding in the middle of last year, which would have made clear the errors with its evidence. Vincent was pursuing Kaupthing in civil proceedings in London in a £2bn claim in losses related to the collapse of the bank. The bank confirmed in evidence that it knew both the accounting methodology and the existence of senior lenders in the Pennyrock loan. A copy of Kaupthing's defence was supplied to the agency on June 30. "However regrettably, it was not read" until August 5, according to the SFO letter. By then, Vincent had obtained a copy of the bank's defence. In a bid to uncover what went wrong, the SFO has assured Lord Justice Thomas that it has been "burning the midnight oil" as it prepares for the critical judicial review hearing in three weeks. The agency has a new director, David Green - former head of the Revenue & Customs Prosecutions Office - who has made prosecutions a priority. Even so, the UK's leading fraud fighters said they had come up against stiff challenges. The SFO told the judge that its staff were struggling because many of the investigators involved in the case had left. In addition, some former staff have moved out of London "and/or did not have access to any form of secure email communication." This week, the SFO is scheduled to produce a witness statement detailing its actions in the run-up to the raids. It is as yet unclear whether this document will shed new light on a case that has raised more questions than it has answered.