Sigrún Davíðsdóttir's Icelog

The effect of punishment is a hotly debated topic in criminology. The fact that two Icelandic bankers were sentenced to 4 1/2 years in prison for breach of fiduciary duty in the so-called Byr case seems to have shaken others in a similar situation. In an interview with Ruv tonight, the head of the Office of the Special Prosecutor Olafur Hauksson said that the OSP clearly senses that the Byr sentence has had an effect.

“The judgment gives a clear indication how the courts are likely to view similar cases. Also, the judgment has in some ways clarified things for those we are questioning, which means that the testimonies are now more clear than earlier,” Hauksson said. Those questioned are more willing to tell the whole story than earlier, which means that witness statements are better.

Hauksson says that the heavy sentences have spelled out the gravity of these cases. Many other cases under investigation regard breach of fiduciary duty where the sums at stake are not only ISK1bn, like in the Byr case but amount to several billions or even tens of billions. The maximum punishment for breach of fiduciary duty is six years, which means that the Supreme Court judges who ruled on the Byr case must have seen this activity as a serious crime.

Again, the question is why so little seems to be done in other European countries to prosecute bankers. Breach of fiduciary duty is a crime in most if not all Western countries, it is a fairly clear-cut activity – and yes, at least in Iceland it’s actually a serious crime.

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One of Kaupthing’s celebrity clients, the Australian supermodel Elle Macpherson has won the right to appeal a judgment in her case in the Isle of Man. Macpherson took out a loan with Kaupthing’s Isle of Man branch. The liquidator insisted Macpherson should pay back £7.8m but she claimed she could offset her deposits with the bank of £2.5m to lower the outstanding loan and should only pay the difference, just over £5m. The case was further complicated because the deposit was in Macpherson’s name whereas the loan was in the name of a nominee company, Light House Living Ltd*. With Kaupthing’s full acceptance Macpherson chose to have a company as the owner of her property in order to guard her privacy and hinder that the address landed in the public domain.

Macpherson, who in her earlier modelling days was simply called “The Body,” now runs a successful lingerie business and lives in London. She took the liquidator to court, won the first instance but when the High Court in the island sided with the liquidator Macpherson turned to the highest court of appeal for the British Crown Dependencies, such as the Isle of Man, this highest court being one of these archaic English institutions the Queen’s Privy Council. The Council has now granted the model appeal, which means she still has the chance to a successful challenge. The administrator has been ordered to pay Macphersons’s legal bill, expected to be a six figure sum.

The final ruling will be of importance not only to Macpherson but to others in the same situation.

There are several issues at stake in this case and those who want to get to the bottom of this case and its consequences can read some legal views on it here, p 384 and also here.

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Since October 2008, debt-related recession has popped up one country to another. In Spain, like in Iceland, the recession has hit private mortgage-holders and other small borrowers very badly. The same counts for other countries. Part of the Icelandic solution is the so-called “110% way” for individuals and debt relief in general, in addition to changes in bankruptcy laws. The other European countries in recession need to consider if they can benefit from the same. 

Iceland suffered a banking collapse in October 2008. The Government at the time didn’t rescue the banks; they were too big to safe. Consequently, after the collapse the main focus wasn’t on the debt taken over by the Government because of the banks – though there was some – but on the sky-rocketing mortgages, in particular for those borrowers who had taken out forex-linked/forex mortgages. These mortgages shot up because the Icelandic krona collapsed.

The plight of home-owners became the main political issue in Iceland and a problem that had to be resolved. In addition, the loans themselves were legally challenged. It turned out that linking interest rates to a foreign currency was illegal – but lending in foreign currency was legal. The loan contracts came in various forms meaning that some forex loans were legal, others not. The latest judgment in a series of judgments related to these loans stipulated that the interest rates should be the foreign interest rates, which were very low.

This latest ruling created a huge unbalance between those who had borrowed in foreign currencies and those whose mortgages were indexed in Icelandic krona, tied to the high interest rates in Iceland. The banks have re-calculated the forex loans and are now doing it again, where appropriate, after the latest rulings.

Apart from all this uncertainty regarding the forex loans the Government, together with mortgage lenders, has eventually found a solution for those who were saddled with mortgages – no matter what type – they could no longer afford. The short version is that mortgages are brought down to 110% of the value of the property. This means that sums above the 110% are written off. This is now called the “110% way” in Icelandic. In addition, banks have been willing to negotiate write-offs for companies.

Ireland was hit by a banking crisis at the same time the Icelandic banks collapsed. Ireland, with very low public debt, took on the banking debt, didn’t properly clean up the banks until much later (and possibly still not enough) and wound up saddled with debt, which originated in a finance sector that lent too much to too few – as in Iceland – and lent too much into just one sector of the economy, construction. In Ireland, private debt migrated to the public sector. Losses that should have been born by the banking sector weren’t allowed to fall there, for fear of a financial meltdown spreading to other European countries.

Ireland is still not in a good place and might very well be forced to ask for more money from the European Union. Ireland, as Greece, has been forced to cut down on public service though the outlook in Greece is much more horrific. At least, Ireland is still attracting foreign investment, something so painfully lacking in Greece.

As in Iceland, home ownership is high in Spain. From mainly living in some sort of tenancy arrangements Spaniards took to home ownership in the latter part of last century like the Northern Europeans took to the Spanish beaches. With the housing boom and the Spanish Cajas focusing on mortgages there has been a fair bit of over-borrowing/over-lending to individuals in Spain as is clear from this insightful article in Der Spiegel, by Juan Moreno, a Spanish journalist who grew up and lives in Germany.

One of Moreno’s relatives in Spain profited from the boom, bought a truck and then several trucks. Now he is bankrupt. Bankruptcy in Spain is harsh – there is no end to it. In Iceland, bankruptcy laws have been changed and the debt period is now down to only two years. Theoretically, the debt can be kept alive longer but any creditor needs more than ordinarily good reasons for doing so. In Iceland, Moreno’s cousin Pepe would have the perspective of starting all over again after two years. And most likely, an Icelandic bank would have written most of the debt off and allowed Pepe to keep one truck, with which Pepe could make a living for himself and his family and the state would get some taxes.

At the core of Iceland’s best crisis recovery is debt relief. It certainly is true that the recession-hit euro countries need a growth plan – but they also need to look at such basic things as bankruptcy laws and writing off debt quite fiercely. Otherwise, no growth plan, however clever and well funded, will really help. If the Spaniards want a reason to go out and protest this is a good point to protest on: more write-offs on individuals and small companies and changes in the country’s bankruptcy law.

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The High Court (Sir John Thomas, President of the Queen’s Bench Division, and Mr Justice Silber) has today declared that search warrants issued to the Serious Fraud Office were unlawful as they were obtained by misrepresentation and non-disclosure of the judge. – This is the beginning of the Summary of the judgment July 31 regarding the judicial review sought by Vincent and Robert Tchenguiz.

The story is that when the SFO presented their reasons in March last year for requesting a permission for house searches at the home and offices of the Tchenguiz brothers the SFO mispresented their material very badly. Ergo, the ruling is a heavy criticism of the SFO. I would also read the ruling as a criticism of judge Paul Worsley, who heard the SFO in March last year, although the two judges tread very lightly on that issue. But how could the SFO be so sloppy/bad/imprecice in its presentation? The issues the two judges differ on with the SFO are dealt with in para 122-124, quoted in extenso below. The judges add some sweetener to their bitter pill to the SFO: at the end of the judgment they  go to some length in excusing/explaining SFO’s mistake by emphasising the SFO’s lack of human and financial resources.

Regarding Robert and his company R20 Lth, the Court concluded (comments in[] are mine; the “para” refers to paragraphs in the ruling):

“We regret to conclude that the Information did not properly present the transactions where criminality was suspected in the context of the financial markets in which they were undertaken. The background was straightforward, but it was never explained. The case that was made on the specific transactions was not in the respects we have identified accurately set out; it failed in the respects we have identified fairly to draw to the attention of the judge the points that weighed against the granting of the warrants.” (para 170)

“The failure to set out the background, lack of clarity in the presentation in the Information and in the oral evidence, the errors made and the failure to put the matters that weighed against the granting of the warrant have been set out by us in detail. At the hearing before the judge, the oral evidence given at the hearing was both unfair and inaccurate. The tone of that evidence was unjustified. We have no doubt that, if what was in the Information [submitted by the SFO to the judge in March 2011, when the permission for the searches was sought] had been presented in such a way that the background was properly explained, the errors were corrected and the matters that weighed against the grant of the warrant had been drawn to the judge’s attention, it would have made a real difference and he would not have granted the warrants. This is very far from the case where the failures only might have made a difference; they plainly did, as the warrants would not have been granted.” (para 175)

“… it is apparent from what we have set out after a detailed examination of the materials over three days in court and a study thereafter of the evidence presented to us that a case of reasonable suspicion might have been advanced and presented by the SFO to the judge, at least in relation to the making of the Oscatello loan facility and associated arrangements (see paragraph 124 above) and the Money Market loans (see paragraph 136). This would have been a task that did not require corrections or additions by way of disclosure, but it would have required starting again and putting the presentation in a coherent, fair and analytical manner. Whether there was or is such a case of reasonable suspicion, if a case had been made in that way, would then have been for the judge to determine.”

“Although we consider such a case might have been made, we cannot accept the submission that it would be just to refuse to quash the decision of the judge. What we would be doing would be permitting the SFO in effect to justify what it had done by adopting a proper and analytical approach in this court and doing what it had manifestly failed to do when it went to Judge Worsley.” (paras 176‐ 177)

This is yet another victory for Vincent against the SFO – the SFO has already dropped all investigations into his affairs with Kaupthing – and completes his vindication in his dealings with the SFO. In a press release yesterday, Vincent said: “I will be seeking damages from the SFO – and from any other parties who contributed to the Court being misled. My claims will reflect the substantial personal and business costs and losses that have directly resulted from the actions of these parties.” The comment leaves an open question as to who else, beside the SFO Vincent will sue. The fact that Grant Thornton, an international advisory firm, played a large part in this whole saga might indicate who Vincent has in mind – but it remains to be seen.

Though Robert, as well as his brother, won his legal challenge against the SFO he has less to celebrate. The SFO has reiterated that its investigation into his relationship with Kaupthing is still ongoing. However, Robert has stated the following: “I now intend to pursue my claim in respect of damages I have suffered as a result of the SFO’s (Serious Fraud Office’s) illegal actions.” He also intends to bring proceedings against the SFO in respect to his arrest.

The ruling itself offers some insight into the mistakes the SFO made in handling this investigation, as well as the issues being investigated.

First some facts regarding Kaupthing: “On 8/9 October 2008, Kaupthing collapsed. According to the Information presented by the SFO it had €8bn in debts, 25% of which was owed by companies within the TDT [Tchenguiz Discretionary Trust; related to Robert Tchenguiz] and 12% by Exista Hf [owned by the Icelandic brothers Agust and Lydur Gudmundsson, with Robert as a board member the last few years], its largest shareholder.” – Robert Tchenguiz owed Kaupthing £1.6bn when the bank collapsed. The fact that Kaupthing’s largest shareholders were also its largest borrowers follows a familiar pattern from the other two Icelandic banks, Landsbanki and Glitnir.

As to the allegations made by the SFO related to Robert and the TDT:

105. As we have set out, five specific transactions were relied on  as showing suspected criminality.  Listed in chronological order, they were:

i)              The Oscatello loan facility and the increases in lending under it

ii)              Money Market loans [in total, Kaupthing made 36 money market loans to Oscatello, in total £345m; £143 million was repaid, but £156m was outstanding at the time of the collapse of Kaupthing. Explained in para 132 and following.]

iii)              Pumpster [regarding Kaupthing loans to a company owned by TDT; the SFO alleges these loans concealed bad debt to Kaupthing at a time when Oscatello was insolvent. Explained para 138 and onwards.]

iv)              Thorson [a TDT company; Kaupthing transferred almost £62m to Thorson’s account with Kaupthing Luxembourg 3 October 2008; para 151.]

v)              Project Longboat and the PIK notes [transactions 13 November 208 related to Oscatello; para 157]

Here are some highlights from the judgment. The following refers to the allegation, see v) above, but as seen here these allegations were also a matter between the Kaupthing resolution committee and TDT:

After the collapse of Kaupthing, TDT companies entered into a series of transactions on 13 November 2008 through which the security previously pledged to Kaupthing for loans to Oscatello [structure owned by TDT with Kaupthing as a co-investor] were replaced by “Payment in Kind Notes”.  Immediately after the transaction had been effected, the lawyers acting for TDT notified the Resolution Committee of Kaupthing that the transactions had taken place.  The clear intention and effect of these transactions were to remove the assets, including interests in Somerfield Ltd, used as security for the loans by Kaupthing, to companies outside the Oscatello structure to prevent the liquidators of Kaupthing taking control of those assets and selling them in the then market conditions. [This is how the SFO presented these transfers.]

30. On 5 December 2008, the Resolution Committee began proceedings in the British Virgin Islands in respect of these transactions against Investec and the Oscatello companies.  The pleadings signed by Mr Steinfeld QC alleged fraud. Grant Thornton prepared a report on this transaction on 14 January 2009.  An interim application for the appointment of receivers was made to the courts of the BVI which was vigorously contested on grounds set out in an affidavit sworn by an officer of Investec.  The proceedings were subsequently settled for £137m in June 2010; we were told by Lord Macdonald QC who appeared for RT and  R20 [company belonging to Robert’s business sphere] that this payment represented the proceeds of the sale of the interests in Somerfield Ltd.  All allegations of fraud were withdrawn as part of the settlement.

On how the SFO presented its case to Judge Worsley in March last year:

After short submissions from the in-house advocate the judge authorised the issue of the warrants.  Nothing was asked or said as to whether the judge had been told matters that weighed against issuing the warrants. 

51. The judge gave no reasons for his decision. [This is ia what I take to be a criticism of the Judge.]  This is a matter of complaint which we consider as the second issue at paragraphs 202 and following.

The SFO has dropped its investigation not only into Vincent Tchenguiz but also into Kaupthing Singer & Friedlander manager Armann Thorvaldsson and another key Kaupthing employee Gudni Adalsteinsson. Former chairman Sigurdur Einarsson and CEO Hreidar Mar Sigurdsson are still under investigation. The following is an interesting indication of matters being investigated:

There was no allegation against RT or VT that they had tampered with or destroyed documents, though such an allegation was made in the Information against others.

The SFO greatly emphasised that Kaupthing kept on lending to Oscatello all through 2008 even if it seemed “under water,” as stated in an email from Gudni Adalsteinsson. However, the two judges felt this was a one-sided presentation – this is the core of their grave criticism of SFO’s presentation. The two judges take a different stance on the loans and that’s what they are pointing out here:

122. It was obvious that a forced liquidation of Oscatello at the time of the 19 December 2007 arrangements could, because of the nature of the security held by Kaupthing, in all probability have seriously damaged Kaupthing.  It is not uncommon that a bank exposed to a company with a balance sheet of the type exhibited by Oscatello might have therefore a commercial rationale for lending more money in those circumstances, even if the company was  insolvent; the bank would hope that the market would improve and that the loss that would result from a decision to terminate the lending and consequent insolvency would be averted.

123. In our judgment, the failure to set out these facts and to explain these matters in the Information and oral evidence, was a grave and material omission which resulted in the judge not being given a fair presentation of the key issue in the case – was this a case where Kaupthing made  a wrong commercial decision in December 2007 by continuing to lend to the TDT companies in the hope that their exposure would be reduced by an improvement in the market or was this dishonest and collusive lending?

124. The failure to explain that issue in these relatively simple terms is entirely consistent with the overall presentation  to the judge which did not  set the issues out in an analytical manner.  It is with deep regret that we have reached this conclusion on what was done. Properly understood and explained, the materials which we have had an opportunity of examining during a three-day hearing before us and thereafter, might have provided grounds for reasonable suspicion on the basis of the matters to which we have referred at paragraph 118 and the matter to which we refer in paragraph 126.

It would then have been for the judge to be personally satisfied that it did.  However that was not the way in which the matter was put before the judge.  He was given an account that was not only wholly inadequate, but unfair.

This is how the judges view the case – the judicial review was not about the merits of the investigation but about procedures in obtaining permission for house searches etc. Below, the judges spell this out quite clearly:

176. However, it is apparent from what we have set out after a detailed examination of the materials over three days in court and a study thereafter of the evidence presented to us that a case of reasonable suspicion might have been advanced and presented by the SFO to the judge, at least in relation to the making of the Oscatello loan facility and associated arrangements (see paragraph 124 above) and the Money Market loans (see paragraph 136). This would  have been a task that did  not require corrections or additions by way of disclosure, but it would have required starting again and putting the presentation in a coherent, fair and analytical manner.  Whether there was or is such a case of reasonable suspicion, if a case had been made in that way, would then have been for the judge to determine.

177. Although we consider such a case might  have been made, we cannot accept the submission that it would be just to refuse to quash the decision of the judge.  What we would be doing would be permitting the SFO in effect to justify what it had done by adopting a proper and analytical approach  in this court and doing what it had manifestly failed to do when it went to Judge Worsley.

178. In any event, as Lord Macdonald correctly submitted as we have set out at paragraph 76, the merits of the investigation and continuing the investigation are not an issue in these proceedings. It is very important that proceedings of this kind are confined to the issues that strictly arise and are not utilised as a means of indirectly seeking the court’s view on an investigation.  The question whether matters should be investigated is under our constitution the responsibility of the investigating and prosecuting authorities; the role of the courts is strictly limited.  There would be highly undesirable consequences if it were otherwise.

As the SFO has stated, its investigation regarding Kaupthing continues.

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Imagine you come home one evening to find the back door kicked in with the door and the doorframe completely destroyed. Inside, everything is in disarray, furniture badly damaged and plenty of valuables stolen. When the policemen arrive they are completely stoic. They have seen it all before, recognise the methodology and are more or less sure who did it. The friendly policeman in charge tells you that by the time they get around to arrest the culprits the stolen goods – your things – will have been sold off. Sorry, no chance of recovering any of it. The thieves move too quickly, the police too slowly though the thieves will no doubt eventually be caught.

“When can I expect to be called in as a witness,” you ask. “Well, not so sure the case will come court. We negotiate with the thieves. They will pay a fine and that’s it. Quite a hefty fine because there is a lot of damage, apart from the stolen goods, of course.” You can’t believe your own ears: the thieves have committed a criminal act – and they will sell your property to pay the fine. Dismayed, you point this out to the friendly policeman. He shrugs his shoulders. “This is the new order. Prison is only for petty street crime. The serious criminals, we negotiate with them.”

Shareholders in banks involved in LIBOR swindle, such as Barclays and others banks soon to be named, and in HSBC, which allowed itself to be used as a conduit for money laundering by Mexican drug lords, dodgy Russian and entities with ties to terrorist organisations (see earlier Icelog here), are more or less in the situation of the house-owner in the story above. This is what’s been going on for the last many years when it comes to certain actions of those who operate from the management suites of big banks. With ever rising salaries, no matter if the banks lose or not, top managers have been allowed to let the company pay the fines resulting from their lack of oversight, corrupt company culture and potential criminal acts.

HSBC has just set aside $2bn to cover potential money-laundering fines and mis-selling claims. Barclays has just paid £290m to UK and US authorities for the LIBOR rigging. In addition, Barclays is now under investigation related to its fund-raising in the Middle East in 2008. The bank has just announced its pre-tax profits, £759m – down 71% from last years £2.6bn and potentially more fines in sight for Barclays.

This might – just might – be changing though. Recently, the Serious Fraud Office announced that its new director, David Green, “is satisfied that existing criminal offences are capable of covering conduct in relation to the alleged manipulation of LIBOR and related interest rates. The investigation, announced on 6 July, involves a number of financial institutions.”

This means that the SFO is now investigating the LIBOR rigging as a potentially criminal act, in the belief laws have been broken. Part of the rigging involved portraying the bank stronger than it indeed was, in the financial turmoil of autumn 2008. If that isn’t market manipulation I find it difficult to understand that concept.

In the US, some senators have introduced a bipartisan bill to give US regulators the authority to seek tougher fines from the financial sector. The understanding is that although the fines posed on Barclays are record high it’s still decimal dust in the grand scheme of the bank’s balance sheet. The bill proposes raising the maximum penalty from up to $150,000 per violation for individuals and $725,000 per entity to respectively $1m and $10m. Crucially, the SEC could seek fines of three times the amount of ill-gotten gains – or investor losses.

Interestingly, last November, US District Judge Jed Rakoff refused to rubber-stamp a $285m settlement the SEC had posed on Citigroup. Rakoff’s reasoning was that the fine was “pocket change” and investors had been “short-changed.” To put the fines in perspective re ill-gotten gains and losses, the SEC alleged investors lost $700m from the underlying scheme while Citigroup had estimated its gain $160m. In 2009, Rakoff did the same and forced the SEC to increase its settlement with Bank of America.

None of the things that happened in banks now being fined happened because of some laws of nature but because of one decision after another, leading in the same direction. Decision taken by individuals with the power to make these things happen. If accountability is to be a word be counted on, the individuals who took the decisions have to be made accountable, instead of just using their power make shareholders pay.

Regulators still seem to believe that mild words of warning are enough. President Barack Obama says he’s in favour of making “penalties count.” If the penalties just count for the shareholders and not for those who actually condone – or carry out – what’s being penalised that’s just not enough. Seeing Raj Rajaratnam sentenced to eleven years in prison for insider trading might awake more fear of the law than letting the company pay fines and seeing shareholders lose out on dividends.

As I’ve pointed out earlier, the correlation between corruption and the recession is to my mind a clear one. Corrupt business practices played its part in the financial collapse in the autumn of 2008. Both European countries and the US are still smarting from the aftermath and the ensuing recession has led to job losses and expensive bail-outs, paid by tax payers in these countries. In that sense, tax payers are paying for potential financial crimes.

Apart from corrupt business practices and the bail-outs there are three issues at stake here. The fines are ridiculously low, compared to the balance sheets of these gigantic banks. Secondly, is it fair that managers, on whose watch these breaches occur, can just dry the losses off on shareholders? And thirdly, is it fair that those who break the law out of luxurious suites with perks such as private toilets and paid-for taxes are treated any differently than criminals operating on the high street?

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