Watchdog barks up wrong tree on Vincent and Robert Tchenguiz

The SFO has been looking at how millions were extracted from an Icelandic bank before it collapsed. But now it's the investigators who are under scrutiny

The Serious Fraud Office seriously considered putting undercover agents into Annabel's, the upmarket nightclub in London's Mayfair favoured by the rich and minor royals, to keep an eye on Vincent and Robert Tchenguiz, the millionaire property tycoons. The idea was for police officers to pose as staff and try to ingratiate themselves with the brothers and collect evidence.

The bizarre plan, which was rejected amid arguments within the agency, came just a couple of months before the SFO and dozens of police officers launched a series of dawn raids on the brothers' homes and offices. The pair were held in Bishopsgate police station in the City of London for most of the day and hundreds of documents and several computers were seized.

The raid in March 2011 came just 24 hours before the Tchenguizes were due to host their annual party on their yacht at the Mipim world property jamboree in Cannes. The party was always one of the highlights of the festival, with the best food and drink and plenty of attractive young women on board.

But a year on and neither of the Tchenguizes has been charged. The SFO's case, certainly against Vincent, appears to be crumbling and the agency, which is meant to be the pinnacle of fraud investigation in the UK, is fighting to save its reputation.

The judicial review of the case against the Tchenguiz brothers began yesterday at the Royal Courts of Justice in London. It is being heard by Lord Justice Thomas, who has already accused the SFO of acting with "sheer incompetence" in its handling of the case.

The SFO's investigation into the Tchenguiz brothers began after the collapse of Icelandic bank Kaupthing in November 2008. Vincent Tchenguiz had borrowed £100m – known as the Pennyrock Loan – from the bank, secured against part of his portfolio of 250,000 residential properties across the UK. Robert borrowed £80m from Kaupthing, and was also a shareholder in the bank.

Following the collapse, the SFO joined Iceland's Special Prosecutor Office in investigating how hundreds of millions of pounds was extracted from the bank only months before it went under.

But as the case has crawled through the courts, the SFO has had to concede that it made many mistakes. At the end of last year, an independent review of the case against Vincent concluded that "there had been factual errors" in its applications for the arrest and search warrants surrounding the Pennyrock Loan and asked the court to quash the search warrants against Vincent.

The SFO went a huge step further yesterday, admitting it may have no case against Vincent. Under its new director David Green – his predecessor Richard Alderman left last month – the agency has reviewed the case again.

Having drafted in Mark Ellison QC last Friday to replace Andrew Edis QC, who was "stuck in a murder trial", the SFO admitted that the case of Vincent "as a suspect in the SFO's investigation must be, and will be, reviewed – as a matter of urgency".

This means the action against him could be dropped entirely within the next month. But the FSA is less likely to withdraw from its case against Robert, which it believes is on a firmer footing.

Lord Goldsmith, Vincent Tchenguiz's lawyer, said: "That's as close as I have ever seen to a prosecuting authority saying that 'We may need to stop this investigation altogether'."

The court also heard the SFO apologise because its handling of part of the dawn raids on Vincent was "flawed and thus unlawful". In his opening briefing to the court, Lord Goldsmith said: "Taken as whole, the evidence in this case demonstrates myopia on the part of the SFO, a tendency to prevaricate before acknowledging its failings and a dogged unwillingness, even now, to accept the full extent and implications of the evidence it has overlooked in the course of this investigation." The Tchenguizes are seeking damages of at least £100m over the "wrongful arrest" but believe the sum could go much higher if they were to be awarded exemplary damages.

They have put forward a long list of losses they suffered, including losses with Kaupthing, the failure of the refinancing of Vincent's residential property management company Peverel, which collapsed, withdrawal of credit lines and losses on sales of secondary investments.

In a hearing last month to ask for extra time to prepare its case, the SFO admitted that it was "aware that if faces massive claims for damages, and indemnity costs, arising out of the events it is now considering so carefully". Both brothers deny any wrongdoing. If they end up collecting millions from the SFO, it will be the taxpayer who foots the bill.

Power pair: Brothers worth a fortune

Flamboyant and tycoon are words that could almost have been created for the Tchenguiz brothers.

Although their family background is Iraqi-Jewish, they were born in Teheran and came to the UK after the fall of the Shah of Iran in 1979.

Vincent went into investment banking in London and Robert joined him in 1988 to set up their first commercial property business, backed by their wealthy father.

They set up separate companies but remained close associates. Their partying and clubbing lifestyle saw them regularly featured with beautiful women on their arms, but Robert has been less often in the gossip columns since he married.

Vincent established his company Consensus Business as an advisory arm to the family trusts. He fought and won a battle with City superwoman Nicola Horlick over funds she ran.

Robert took his own line, with his company R20 taking stakes in pub and supermarket companies ranging from Marston's to Sainsbury's in attempts to unlock their property assets.

Vincent, who is unmarried but no bachelor, has homes in London, St Tropez and Cape Town. He owns the motor cruiser Veni Vidi Vici (I came, I saw, I conquered).