The Billion-Dollar Fall of the House of Espirito Santo Was There Unlawful Activity Behind the Spectacular Collapse of the Espirito Santo Empire?

PORTUGAL

UNDER PRESSURE: Ricardo Salgado, here at a news conference in early 2012, led the family empire for decades. REUTERS/JOSE MANUEL RIBEIRO The billion-dollar fall of the house of Espirito Santo Was there unlawful activity behind the spectacular collapse of the Espirito Santo empire?

BY SERGIO GONCALVES, LAURA NOONAN, ANDREI KHALIP

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CLEAN UP: Banco Espirito Santo had grown to become the second biggest lender in Portugal. REUTERS/HUGO CORREIA

LISBON, AUGUST 29, 2014 directive from Portugal’s central bank that The two letters, whose existence was Salgado stop mixing the lender’s affairs made public last month but whose de- n June 9, with his 150-year-old with the family business. The guarantees tails are revealed here for the first time, Portuguese corporate dynasty were also not recorded in the bank’s ac- are a key part of an investigation into the Oclose to collapse, patriarch Ricardo counts at the time, which is required by spectacular fall of one of Europe’s most Espirito Santo Salgado made a desperate Portuguese law. prominent family businesses. Portuguese attempt to save it. The following week, after intense pres- regulators and prosecutors are examining Salgado signed two letters to Venezuela’s sure from regulators, Salgado resigned. them along with the bank’s accounts and state oil company, which had bought $365 Within a month, the holding company, other evidence to determine whether there million in bonds from his family’s hold- Espirito Santo International, filed for was unlawful activity behind the fall of the ing company. The holding company was bankruptcy, crumbling under 6.4 billion Espirito Santo empire. in financial trouble. But the letters, accord- euros ($8.4 billion) in debt. In August, So far, shareholders and investors in ing to copies seen by Reuters, assured the Banco Espirito Santo was rescued by the the family companies and Banco Espirito Venezuelans that their investment was safe. Portuguese state, after reporting 3.6 billion Santo have lost more than 10 billion euros, The “cartas-conforto” – letters of comfort euros in losses. making this one of Europe’s biggest corpo- – were written on the letterhead of Banco rate collapses ever. Espirito Santo, a large lender controlled by The letters offer a glimpse into how the family. They were co-signed by Salgado, Salgado ran the Espirito Santo empire who was both the bank’s chief executive and and its crown jewel, the bank, virtually head of the family holding company. unhindered. In addition, interviews with “Banco Espirito Santo guarantees ... it family members, company officials and 87% Collapse in value of Banco will provide the necessary funds to allow Portuguese regulators, as well as financial reimbursement at maturity,” said the letters. Espirito Santo shares between documents, show how the 70-year-old There were problems, though: By prom- May and August patriarch consistently blurred the lines be- ising that the bank stood behind the hold- tween the bank’s interests and those of his ing company’s debt, the letters ignored a Source: Thomson Reuters Text continues on page 4

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The Family Businesses The collapse of the Espirito Santo empire shines a light on the gaps that can open up when companies span di erent jurisdictions. The Espirito Santo family companies were mostly registered in Luxembourg, while their main asset – Banco Espirito Santo – was in Lisbon.

Main players: who owns what Banco Espirito Espirito Santo Espirito Santo Espirito Santo International (ESI) Financial Group Santo Control based in Luxembourg Rioforte (ESFG) (BES)

Espirito Santo family Financial Owns Owns Owns assets Owns Owns stake stake stake stake stake 88.4% 57.2% 100% 49.3% 20.1%

Non financial assets Rioforte owns assets around the world, from hotels to energy, hospitals and real estate.

Market cap of bank and its main owner €8 billion 8

6 6

4 4

LAST TRADING DAY 2 BES €674.99 million AUG. 1, 2014 0 ESFG 2008 2009 2010 2011 2012 2013 2014 €259.46 million JULY 9, 2014

Sources: Thomson Reuters; Rioforte; Banco Espirito Santo M. Ulmanu/Reuters Graphics

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family and even his country. Around the time he signed the letters, Salgado sought public funds to save the family empire, arguing that it was impor- tant for Portugal. “This is not just my problem, it’s a national problem,” he told officials at Portugal’s central bank, according to people at a meeting they held. Salgado declined to comment for this story. One person close to him said Salgado had asked Portuguese authorities to help him fix the family business in 2013. The bank’s collapse, the source said, could have been avoided. The corporate meltdown also shines a light on Portuguese and Luxembourg regulators and the gaps that can open up when companies span different jurisdictions. The Espirito Santo family companies were mostly registered in Luxembourg, while HEADLINES: News of the collapse of Espirito Santo empire rattled markets in Portugal, and around their main asset – Banco Espirito Santo Europe. REUTERS/HUGO CORREIA – was in Lisbon. Little information was exchanged between regulators in the two countries. That helped hide the true state of wrongdoing after finding “signs of abuse of stable shareholder base and long-term plan- the family companies’ affairs. insider information” and a “possible crime ning as a recipe for growth. But Europe’s Portuguese financial regulators knew in of abuse of confidence.” debt and financial crisis, which has left one January about deep financial problems at Portugal’s prosecutor general says there in five out of work across the continent’s Espirito Santo International, the family’s are now several investigations under way southern rim, has changed things. Luxembourg-based umbrella holding. ESI, regarding the Espirito Santo empire, but The Espirito Santo business was found- though, continued to borrow heavily in the has given no details. ed in 1869 by lottery dealer and currency months that followed, with deepening con- Antonio Roldan, an analyst for Portugal exchange broker Jose Maria do Espirito sequences for the Lisbon-based bank. and Spain at Eurasia Group in London, Santo e Silva. The family guided its bank- Luxembourg’s regulator CSSF said it says the European Union, the European ing empire through World War Two by did not supervise any holding companies of Central Bank and the International helping finance Europe’s trade in tungsten, the Espirito Santo family, while the coun- Monetary Fund, who arranged the 78 bil- a crucial ore found in Portugal and used to try’s central bank said it had no responsibil- lion euro bailout of the Portuguese state in make weapons. ity for supervising Espirito Santo entities. 2011, should also have spotted problems. By the early 1970s, Portugal was in the Portugal’s central bank and its markets “Portugal was supposed to be under very last years of the Antonio Salazar regime, a watchdog CMVM both say they acted close supervision” by international authori- dictatorship that looked favourably upon the promptly and efficiently. Portugal’s central ties as a condition of the bailout, he said. Espirito Santos and their glamorous con- bank says Banco Espirito Santo former nections. After 1974’s peaceful “Carnation” A EUROPEAN TALE managers repeatedly violated its directives. revolution, the country’s left-wing gov- CMVM chief Carlos Tavares told a par- In many ways, the rise of the Espirito Santo ernment nationalised the banks and the liamentary committee earlier this year that empire is a quintessentially European tale. Espirito Santo clan lost the business. the watchdog had examined Espirito Santo Family dynasties such as the Agnellis in Italy The following year members from the companies various times over the past six or Germany’s Quandts have helped define family’s five branches decided to rebuild years and alerted prosecutors about possible the continent’s corporate history using their their empire with $20,000 (around $90,000

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at today’s value) of their own money and loans from several international banks. The move offered a chance to shine for Ricardo Espirito Santo Salgado, great- grandson of the bank’s founder. He had joined the family business a few years earlier as a mild-mannered 31-year-old to head Banco Espirito Santo’s economic studies unit. Once the family set out to rebuild he opened a bank in Brazil, together with French lender Credit Agricole. In the mid- 1980s, when Portugal began to encourage private investment again, Salgado returned to Lisbon and set up a new bank, again with Credit Agricole. He bought back an insurance firm, called Tranquilidade, that the family had once owned. The family business grew. So did its ownership structure. At the top was Espirito Santo Control, a non-listed holding company that owned Espirito Santo HISTORY: Bank of Portugal Governor Carlos Costa on August 3, the day he announced the central International, the umbrella for businesses bank would rescue Banco Espirito Santo in a 4.9 billion euro recapitalisation. REUTERS/HUGO CORREIA spanning hotels, property and finance. Luxembourg-registered ESI was 57 percent owned by the family, with the rest held This is not just my problem, Luz, a traditional wood-panelled restaurant by friends and Portuguese executives who it’s a national problem near Lisbon. wanted “a seat at the Espirito Santo table,” FAMILY TENSIONS according to a person close to the family. Ricardo Salgado Through an intermediary company, ESI Espirito Santo patriarch Portugal fell into recession after seeking owned Espirito Santo Financial Group its international bailout in 2011. As part (ESFG) which in turn owned Banco department bosses. At family company board of the bailout terms, Banco Espirito Santo, Espirito Santo. meetings, he rarely faced dissent. “People like other Portuguese banks, was no longer A family council, with representatives of never turned around and said, ‘no, you can’t’,” allowed to pay dividends to its sharehold- the five branches, ran the shop. said a person who attended the meetings. ers, including the Espirito Santo clan, who Salgado’s big break came in 1991 when The Espirito Santos lived in style. Isabel at that time owned a majority stake in the the Portuguese state sold Banco Espirito de Melo, matriarch of one family branch, lender. That meant a big source of the fam- Santo back to the family and Credit hosted grand parties in her country estate ily’s income was gone. Agricole. Salgado became chief executive. outside Lisbon, a mansion whose dining The stock market value of Banco Under his leadership the bank more than room comfortably seats 75. On her piano Espirito Santo fell to 1.97 billion euros at doubled its share of the Portuguese lend- sat silver-framed photos of the family with the beginning of 2012 from 3.5 billion a ing market to 20 percent in 2013, becom- Richard Nixon, the Rockefellers and the year earlier – costing the family 420 million ing Portugal’s second-largest lender after a King and Queen of Spain. euros on paper. Most banks sought state- state-run bank. Salgado himself built a holiday home in backed loans. Banco Espirito Santo did According to people who worked with the coastal estate of Comporta, a sprawling not. Salgado boasted the bank had main- him, Salgado was courteous but distant. estate larger than Lisbon that the family has tained “strategic independence.” Every year, at a meeting with senior staff in been developing into an up-market tourist Turnover at the family’s hotel, property a Lisbon hotel, he would sit in the middle spot. Every Christmas Eve he gathers 50 and other businesses suffered. To avoid selling of the room, shooting detailed questions to family members for lunch at Visconde da assets or losing their controlling stake in the

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bank, the family companies, led by Salgado, its assets, and had scant evidence for its re- Salgado decided that ESFG would pro- simply borrowed more – including from the ported transactions. The 6.4 billion euros of vide guarantees to Banco Espirito Santo’s bank, and from the bank’s customers. debt it held at the end of September 2013 retail clients who had invested in family For the first time, though, not every- was an “atomic bomb,” according to a per- bonds, according to a person familiar with one agreed with the patriarch’s approach. son close to ESI, because most of it had to the decision. Salgado had previously argued Among the dissenters was Jose Maria be paid back within one year. within ESFG that it was in ESFG’s inter- Ricciardi, a cousin of Salgado’s who head- KPMG would not comment for this story. est to guarantee bank clients, because the ed the bank’s investment arm. In early After the audit, the Bank of Portugal lender was its most valuable asset. November of 2013, Ricciardi organised a moved to protect Banco Espirito Santo Some at ESFG, however, thought this small gathering of family members at his from its founding family. was unfair to the company’s other share- father’s house. It ordered the bank to make sure any holders and creditors, the person with According to a source with knowledge loans it had made or would make to fam- knowledge of the board meeting said. of the meeting, Ricciardi said he was wor- ily businesses were secured by assets, in case Parent company ESI set out to repay the ried about the family empire’s debt. In par- the family could not repay its debts. The bonds it had sold to Banco Espirito Santo ticular, Ricciardi was concerned about the central bank also ordered that any of the retail clients. There was a problem, though: way the empire was financing itself by sell- bank’s retail clients who had bought bonds The reimbursements didn’t come from new ing bonds of the family businesses to clients from the family business be given guaran- revenue. Instead, ESI and other family of Banco Espirito Santo. He argued that tees that their money was safe. companies issued even more debt. Salgado should step down. The companies issued bonds through Ricciardi went public with his criticism an opaque transatlantic ping pong, involv- of “practices” at the group but did not give ing an ESFG holding company in Panama details. He urged Portuguese financial reg- and another family-linked firm, according ulators to order an overhaul. billion to people familiar with the family company But at another family meeting on €10 accounts. Many of the bonds – whose value Estimated total losses in Espirito November 7, he was overruled. Even his could reach five billion euros – ended up own father voted to keep Salgado on. “I did Santo family companies and back in the hands of Banco Espirito Santo not support my son ... to avoid an imme- Banco Espirito Santo clients. That opened up the prospect that diate institutional break” within the family, the bank would have to compensate cli- said Ricciardi’s father, Antonio Ricciardi, in Source: Reuters ents in the event that the holding company an email to Reuters at the time. could not repay the bonds. The reason for the family tensions soon The existence of the audit was not made The problems at ESI were publicly dis- became clear to Portuguese regulators. The public at the time. But Reuters has learned closed on May 20, as Banco Espirito Santo Bank of Portugal had earlier reviewed the that four months later, in April, the board told investors that it would raise more capi- top borrowers at the country’s largest banks of ESFG – the family company that owned tal. The empire kept up a brave face. Earlier and discovered Banco Espirito Santo’s a 27.4 percent stake in Banco Espirito that month, the bank had prepared a slide heavy loans to Espirito Santo family com- Santo – was alerted to the problems at its show for investors titled “Wisdomland,” panies. The central bank asked auditors parent company ESI. playing up the family’s history and repu- KPMG to go through ESI’s accounts and During a teleconference meeting, some tation. “Wisdom is something that needs the results were shocking: ESI’s accounting directors argued that they should publicly time to grow.” had “materially relevant” irregularities that disclose the problems, because ESFG’s Now, though, in addition to disclosing put into question the “veracity and com- other shareholders and creditors had a right the financial problems at ESI, the bank pleteness of accounting records,” accord- to know. But Salgado, who was both CEO told investors that it had sold debt in fam- ing to a copy of the KPMG report seen of ESI and ESFG chairman, argued for si- ily parent company ESI to its customers. by Reuters. The report’s contents have not lence. “He recommended the board let him It said this posed a “reputational risk” for been detailed before. deal with the situation. The board believed the bank. If ESI defaulted, customers KPMG found that ESI had either not in him and that his recommendations were could start asking questions about how recorded or had under-reported financial the right things to follow,” said a person the debt was sold, and the bank’s brand liabilities and risks, had grossly overvalued with knowledge of the board meeting. could suffer, especially if there was any

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hint it knew the bonds were risky. Salgado told a Portuguese business newspaper that the extent of ESI’s problems hadn’t previously been known. “We didn’t know that there was such sickness as we have subsequently found inside ESI,” said Salgado, ESI’s chief executive at the time. “There was serious negligence. I don’t think there was wilful misconduct.” These assurances helped the bank com- plete its one billion euro capital increase. In the weeks that followed, the true extent of the bank’s links with its troubled founding family began to emerge. Investors panicked. Shares in Banco Espirito Santo would dive 87 percent in the following two and a half months. In early June, Salgado made his move to ANGER: Protesters hold up posters with the image of Salgado during an August demonstration save the business, and his name. outside Banco Espirito Santo’s headquarters in Lisbon. REUTERS/HUGO CORREIA He first visited members of the Portuguese government and central bank governor Carlos Costa. Salgado asked both In late June, Portugal’s central bank chief fight for honour and dignity, mine and for loans worth 2.5 billion euros to avoid organised a meeting with representatives of my family’s.” the collapse of the family company. He said the five Espirito Santo family branches. At Quoting Pope Francis, he added: “Don’t an implosion of the Espirito Santo group the meeting, Costa ordered family mem- cry for what you have lost; fight for what would reverberate throughout the economy. bers, including Salgado, to step down from you have.” The officials refused. “We will not use top management of the bank. New execu- public instruments to solve problems of a tives would be named. With additional reporting by Axel Bugge private nature,” Prime Minister Pedro Passos Weeks later, Espirito Santo International Writing by Alessandra Galloni Coelho said. “When private companies do filed for creditor protection in Luxembourg, Edited by Simon Robinson bad business they have to bear the costs.” and most of the other family firms followed Salgado and his cousin, Jose Manuel suit. Salgado presided over a July 18 meet- FOR MORE INFORMATION Espirito Santo, signed the letters for the ing to discuss the bankruptcies. “He was Sergio Goncalves, Editor, bank to guarantee the family debt bought cerebral and polite, but imperial as always,” Portuguese Service by PDVSA, Venezuela’s state oil company. said a person who saw him at that time. [email protected] PDVSA and a Venezuelan state-owned A few days after Banco Espirito Santo Laura Noonan, European Banking fund, to whom one of the letters was ad- reported a record loss of 3.6 billion euros Correspondent dressed as a proxy of the state oil firm, de- for the first half of 2014, Portugal bailed [email protected] clined to comment on the correspondence. it out. The state formed a new bank, called Andrei Khalip, Senior Correspondent, It is unclear whether PDVSA will get its Novo Banco from the healthy parts of the Portugal money back. old lender. [email protected] The letters were not shown to the Salgado has now set up an office at a Alessandra Galloni, Bureau Chief bank’s internal audit committee and were high-end hotel in the coastal resort town Southern Europe not recorded at the time in the bank’s ac- of Estoril. He has mostly stayed silent [email protected] counts. The Bank of Portugal later said throughout the affair. In a brief interview Michael Williams, Global Enterprise Editor this violated the law. with a local newspaper, he said: “I will [email protected]

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