Sigrún Davíðsdóttir's Icelog

This is really the question Lord Justice Thomas and Justice Silber have to answer when they rule on the judicial review granted into the arrest of Vincent and Robert Tchenguiz, house searches and raids conducted by the Serious Fraud Office. The brothers are testing separate reviews – their cases are different – and the answer won’t necessarily be the same for both of them.

In the UK media much has been made of the SFO’s blunders in its investigation of the brothers’ connection with Kaupthing, which also touches key Kaupthing characters like the bank’s chairman Sigurdur Einarsson. The SFO has already acknowledged certain mistakes and excused to Vincent – the part concerning Robert hasn’t been touched upon. This hasn’t sheltered the SFO from being taunted by the media and rumours swirl that the investigation will be called off.

James Eadie QC, representing the SFO, introduced his skeleton last week by underlining the complex structure of the Robert Tchenguiz companies. There was R20, a counsel to the Tchenguiz Discretionary Trust and yet also somehow owned by the TDT and then there are companies administrating the TDT, also advised by R20. The Tchenguiz Family Trust, owned by Vincent, is a separate entity and yet somehow connected as well. When Kaupthing collapsed, Robert owed €2bn to Kaupthing – a staggering 25% of Kaupthing’s loan book had been lent to Robert.

Eadie pointed out that three fundamentals are a necessary prerequisite to normal banking:

1)    Loan-to-value ratio, ie the collaterals have to cover the lending

2)    Internal processes for proper lending; the lending has to be properly dealt with

3)    No lending to insolvent companies

In Kaupthing, Eadie claimed, all these three fundamentals were broken. Robert got an unsecured loan of €155m from Kaupthing. The bank put aside normal processes used in relation to other borrowers. Eadie said that Oscatello was insolvent in December 2007, the bank knew it and still it kept pouring loans into this Robert Tchenguiz company.

In addition, Eadie mentioned that Tchenguiz had removed valuable collaterals and replaced them with assets worth a whole lot less. – Incidentally, there are examples from other favoured clients of the Icelandic banks who got away with this, meaning that when certain companies went bust, the creditors got the junk and the favoured clients have kept their valuable assets.

Justice Thomas didn’t much want to accept that this was a complicated case under investigation. It could very well be seen as a case where a bank thought it was in its interest to keep lending, hoping for better times to come, because a bankruptcy would be too heavy for the bank to bear (though he didn’t mention that a bank shouldn’t get into such a situation in the first place). The key question was, according to Justice Thomas, whether the decisions were commercially legitimate and sound.

Eadie accepted Justice Thomas’ explication but stuck to his own version, pointing out that it was in no way in the bank’s interest to keep on lending, over the many months after December 2007, when nothing indicated that Oscatello could be saved – and when the normal fundamentals of banking were so completely set aside.

Eadie mentioned briefly that Kaupthing managers also had investments with Robert Tchenguiz. This point merits some attention. When the managers were dealing with Robert Tchenguiz investments they weren’t only dealing with a client with whom the bank had co-invested. They were dealing with a client with whom they personally had invested.

As the SIC report shows, the managers took out loans with Kaupthing, invested in at least one investment company, Kaupthing Capital Partners II. This company invested in Somerfield and Laurel, together with Tchenguiz, in Jane Norman, Mosaic Fashion and Booker with Baugur/Jon Asgeir Johannesson and in companies with Agust og Lydur Gudmundsson and Olafur Olafsson, respectively the bank’s largest and second largest shareholders.

As to how the key employees saw their participation in these investments there is this very illuminating email in the SIC report (vol. 3, p81), dated December 12 2006, from Kaupthing Luxembourg manager Magnus Gudmundsson and Kaupthing Singer & Friedlander manager Armann Thorvaldsson to Sigurdur (Siggi) Einarsson and Kaupthing’s CEO Hreidar Mar Sigurdsson:

“Hi Siggi and Hreidar

Since Armann has discussed this with you we (the association of loyal CEOs) have talked about it between us and came to the following conclusion about our shares in the bank:

1. We, each of us separately, set up a SPV where we put all of our shares and loans.

2. We take an additional loan up to 90% LTV which means we will immediately take out some cash.

3. We get permission to lend more if the KB shares go up to what amounts to 90% LTV up to course 1000. Meaning that if the share price goes above 1000 we won’t be able to borrow more.

4. The bank makes no margin calls against us and would shoulder any theoretical losses, if they occurred.

We are interested in using some of this money to put into Kaupthing Capital Partners.

Best regards,

Magnus and Armann”

This explains how the managers of the bank saw their own personal loans from the bank – no risk for them, all risk on the bank – and this money were partly used to invest, ‘risk-free,’ with the bank’s major clients – and in some cases, the bank’s major shareholders. This raises the question to whom these and other Kaupthing managers were loyal and if Eadie’s definition of normal banking fundamentals were entirely followed here.

The loans to Oscatello – one of the underlying reasons for the SFO investigation – follow the abnormal banking practices in Kaupthing. Looking at only one loan, one might think that yes, Kaupthing was hoping the tide would turn as it poured money into Oscatello – but there are certainly are questionable sides to this lending. Sides, which characterised Kaupthing’s relationship to all its favoured clients.

Another aspect of this interesting relationship comes to light when the favoured clients bought big stakes. In February 2007 much was made of Exista’s invasion into the Finnish insurance market as it starting buying into Sampo, where it ended up owning 20%. But there was a prelude to Exista’s Sampo acquisition, as explained in the SIC report (vol. 2, p. 175):

In March 2006 Kaupthing consented to a loan agreement to finance acquisition of just over 10% in the Finnish insurance company Sampo. The buyer was Exafin BV. It’s beneficial owner, behind a series of some companies, was the Tchenguiz Family Trust.* According to the agreement the American bank Citibank lent to buy shares in Sampo. Half of Exafin’s total capital contribution of EUR100m came from Tchenguiz Family Trust but the other half came from Kaupthing, through its subsidiary Isis, as participation lending. In addition, Kaupthing gave Citibank a mixture of options and a guarantee, which obliged Kaupthing to place a collateral if the value of the shares fell below a certain level. This guarantee had to be met at least once because in July 2006, after a fall in Sampo’s shares, Kaupthing agreed to an addition to the guarantee, which it then placed with Citibank. By then, the total guarantee placed by Kaupthing was EUR360m. In February 2007 Exista bought Exafin BV from companies owned by the Tchenguiz Family Trust. At the same time, the loan from Isis was paid back but the other part of the loan remained unchanged. This meant that Citibank kept financing the shares but it was still Kaupthing’s obligation to pay out the guarantees in case Citibank made a margin call due to a falling share price. To lessen the risk on Kaupthing, Exista placed a guarantee for the margin calls. In this way, Kaupthing could turn to Exista for the guarantee it had placed. 

As can be seen from this, Robert Tchenguiz had, quite extraordinarily bought Sampo shares before Exista started buying them. Quite handily, Exista just bought the Tchenguiz company which owned the shares. To complicate things further, it was also around this time that Robert Tchenguiz took place on the Exista board. And luckily for the instigators of these dealings it was Kaupthing – and not the clients – that, again, shouldered the risk.

The SFO picked a tiny little piece to investigate out of the whole Kaupthing story. But even this tiny bit raises some serious questions. The judicial review isn’t about the guilt of Vincent and Robert Tchenguiz but only if the SFO supplied the correct information when it got the warrant from a judge before the Tchenguiz brothers and seven others were arrested in March 2011 and their private premises and offices searched.

James Eadie kept emphasising that it was important to look at the whole picture, not just the tiny bits the Tchenguiz’ lawyers were complaining about to undermine SFO’s whole rationale. It will be interesting to see what conclusion the judges reach – and if the SFO sticks to its investigation or not.

*James Eadie presented the Tchenguiz Family Trust as belonging to Vincent Tchenguiz. According to the SIC report this company was however involved, on part of Robert, in the Sampo deal. This may indicate that the dividing lines between the brothers’ assets are more fluid than they present them – or that they have changed since this happened. Yet another possibility is that the SIC report got it wrong but it’s right to keep in mind that the SIC had access to Kaupthing documentation regarding these transactions. 

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