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Story Publication logo April 21, 2014

Zambia: The End of Vulture Funds?


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Investors have made millions suing the world's poorest countries over bad debts—but these so-called...

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Image by Mackson Wasamuni/Reuters, Zambia.

LUSAKA, Zambia — In his spare bungalow in central Lusaka, Fisho Mwale wears a pastel, plaid button-down and sleek, rectangular glasses. He is warm and soft-spoken. But his easy manner is camouflage; Mwale is calculating, as any man who has been both distinguished and underestimated might be.

The son of a soccer star who became foreign minister, Mwale was, for a few years, mayor of Lusaka, Zambia's capital. One of his early business ventures was buying a London-based trade-financing company. "It was an Anglo-American corporation," he says. "And here were these small, cheeky Africans." The acquisition reversed the usual flow of purchasing power, from global north to south. Which is to say, Mwale is proud.

Mwale keeps his facial hair narrow and closely cropped. He wears the same goatee in a favorite old photograph, in which he and several associates revel in the high-rolling lifestyle of the early debt-swapping business, a small slice of global financing that would bring Mwale fortune and frustration.

Twenty years after the photo was taken, outrage over a deal Mwale executed for (or with, depending on whom you ask) American financier Michael Sheehan drove Mwale out of Zambia. Allegations swirled that Mwale had bribed officials to push the deal through.

The deal that Mwale helped execute made Sheehan the best-known of a small group of men who head "vulture funds" — or, as the industry prefers to call them, distressed-debt investments. These are purchases, by private investors, of sovereign debt that's gone long unpaid. Investors say they want to "swap" that debt for local investment; critics say vultures buy debt cheaply only to sue later for much more money.

Activists and human-rights crusaders see this, essentially, as stealing from the poor to get rich, and using courts to do it. But financiers who deal in vulture funds argue that their lawsuits force accountability for national borrowing, without which credit markets would shrivel, and that their pursuit of unpaid commercial debt uncovers public corruption.

A man, a plan, humble origins

Michael Sheehan is in his mid-50s and lives in McLean, Va., a wealthy suburb of Washington, D.C. His company's office is only blocks from the White House. But he never works there, his assistant says, even when he's in the country, which is only about half the year.

While Mwale is tall and debonair, Sheehan is short and unassuming, even a bit skittish. He seems dressed not to impress but to blend in — a black trench coat, polished black leather shoes, black slacks and a sweater. The only thing that sets him apart from other middling bureaucrats is his jewelry: a thin, plain wedding ring on his left hand and a thick, yellow-gold band, with a gem embedded in the middle, on his right. Mwale says Sheehan is partial to this bauble, an emblem of his first working days in Africa.

Sheehan won't speak for attribution, but most of what he said can be pieced together with public records and interviews. His first private-debt purchase, in Zambia, made him the poster boy of vulture-fund operators. But Sheehan lacks the pedigree of most vulture power players, who went to Ivy League law schools and worked with each other on Wall Street in the 1980s and early 1990s.

After graduating from law school at American University, in Washington, D.C., he joined a law firm in the Democratic Republic of Congo, led by Patrick Mitchell, whom Mwale calls "the old grand man of our organization" and who today is general counsel for the company Sheehan owns.

After a few years in Kinshasa, Sheehan returned to Washington, where he joined the Debt for Development Coalition (DDC), a nonprofit funded by USAID, the international-aid arm of the State Department. The DDC was a key player in one of development's latest financing fads – cajoling creditors to sell, on the cheap, the old debt of poor countries that aid agencies were trying to help. The DDC then negotiated with local governments to convert the debt into cash for local development projects.

By the time Sheehan came on board, the DDC had already completed 25 of these deals in sub-Saharan Africa. In 1994, Sheehan and the DDC brokered one of the biggest development swaps in history. Contracted by the government of Zambia, a southern African country frequently on "world's poorest" lists, Sheehan and the DDC set up a deal that canceled debt and brought in cash for social services. For just $32 million, funded by the World Bank and nongovernmental organizations (NGOs), Zambia cleared $200 million of its commercial debt. In turn, Zambia gave $5.1 million in local currency to participating NGOs to fund development projects. The deal erased nearly 50 percent of Zambia's commercial debt.

After this deal, Sheehan did something curious: He quit his job. He left the nonprofit DDC to start his own private company, Debt Advisory International (DAI), where he bought another debt on the cheap. This time, though, the point wasn't to turn debt into a school or a hospital. This time, the point was to make Sheehan — and, as he later insisted, Zambia — money. But debts don't always trade hands easily, and Sheehan would need Mwale's help.

How to shop for debt

Buying a country's unpaid debt isn't a straightforward thing. For starters, you have to know where to look. In many cases, these debts go back so far, and record keeping is so bad, that the debtor country may not know whom it owes money to, says Stephen Karangizi, who runs the African Legal Support Facility, which the African Development Bank set up in 2010 to help African countries fight vulture lawsuits.

Once you find the debt, you have to convince the creditor to sell it to you. That, too, is no easy thing. When Sheehan left the DDC and struck out on his own, the first debt he tried to buy came from a country whose portfolio he already knew well: Zambia. Sheehan wanted to buy an old debt Zambia owed Romania, and he found an unexpected — and controversial — point of leverage: Zambia's poverty.

"Zambia's economic situation remains dire, and the country's unsustainable debt burden makes it one of the countries likely to benefit from the Highly (sic) Indebted Poor Countries (HIPC) initiative," Sheehan wrote to Romania's finance ministry in 1997, invoking (incorrectly) the formal name of a global debt-relief plan formalized just one year earlier.

Sheehan explained in the letter that once Zambia qualified for debt relief, it wouldn't be allowed to pay Romania any more than it paid anyone else. Debt-relief rules set strict terms: Commercial creditors get only 10 percent of what they were owed, in payments that could be spread over 23 years. Sheehan, on the other hand, was offering Romania 11 percent, and he was offering to pay it immediately.

Sheehan concluded with a dry bit of cost-benefit analysis: "We believe that there is very little chance that Romania can expect to obtain more in net present value terms than we are presently offering."

Poor countries make good bets

In the commercial market in unpaid debt, information about ripe loans is closely guarded; debts may change hands in moments, and sales are often surprises, if they get noticed at all. As Sheehan later told the London court where he sued, in "the exotic debt business … we are buying and selling debts every day, every week(;) most of these deals are done on a phone call, on a handshake, with perhaps an exchange of faxes." Until they happen, the details are kept confidential.

But international debt relief, on the other hand, happens transparently and slowly: The World Bank issues a list of debtor countries eligible for help. To win debt relief, they have to find and negotiate with their creditors, just as Sheehan described. They also have to implement a series of economic reforms.

The latter process can take years and, some critics say, brings in an unintended consequence: It gives vulture investors the advantage of knowing where debt prices will, eventually, be capped — or, put differently, where creditors stand to lose the most. That puts countries benefiting from debt relief in a precarious position, says Karangizi, of the African Development Bank: "Immediately after they write off the debt, they have more revenue than they previously had."

In other words, for the first time in decades, there is money on the books — money that courts can freeze to pay late-coming creditors. The promise of that new money is effectively announced when a country becomes eligible, and years before it hits the books; Karangizi says this makes debt-ridden countries attractive ground for vulture funds.

Not everyone agrees that preying on debt relief is part of the vulture-fund strategy. Vulture funds can only buy commercial debts, which are a small slice of what relief-eligible countries owe. Besides, debt is slated for forgiveness because no one has paid it back. Buying it and hoping that a delinquent debtor will suddenly pay a new creditor is, in one vulture investor's words, "the worst investment plan you could think of." The point, he says, is to turn the old debt into new investment.

Confusion, or corruption?

When he was first negotiating with Romania, Sheehan was optimistic that he'd win and swap the debt smoothly — confident enough, even, that he incorporated a special-purpose shell company called Donegal, in the British Virgin Islands, to hold the Zambian debt. (This strategy is more common than cunning: A creditor can sell the company instead of selling the debt itself, which is administratively cumbersome.)

While setting terms with Sheehan, Romania was simultaneously negotiating with Zambia. Three months after Sheehan formalized his proposal, a team from the Zambian finance ministry formalized its own proposal and took it to Bucharest.

David Ndopu, Zambia's economist in charge of the account, remembers feeling proud of his negotiating stamina and of the deal he brokered for his country.

"We negotiated hard," he told me. "It took about three days — three long days, from 9 in the morning going sometimes to 9 at night."

The team did not start out in the strongest position — Zambia had underestimated what it owed. But Ndopu played the debt-relief card, reciting the basic repayment terms and wooing his counterparts with a special brand of peer pressure that flattered their emerging European pride.

He played on something he, as a bureaucrat, understood well, the "desire of compliance with international norms," he said, by countries looking to move up in the world. He wanted Romania to think, "You know, everybody is doing it — Britain, Italy — and we're neighbors, so maybe we should do it as well."

Ndopu is an imposing man with a thick mustache, a round belly and a severity beneath his quiet words. He is also a religious man.

"It was not that David Ndopu was very convincing," he said of winning over the Romanians. "I was just fulfilling the Scriptures."

Ndopu's gospel took a nasty turn back home. He thought his boss, Stella Chibanda, would be elated that they'd gotten the price down to 12 cents on the dollar, or $3.5 million. Instead, she was furious. She scolded him repeatedly, he said, even denying that he'd had the authority to go to Romania to negotiate, and then she suspended him.

Later, lawyers for Zambia would allege that her bizarre reaction — turning down savings, letting the debt linger — suggested she'd been promised a cut of Sheehan's deal. Chibanda knew Sheehan's group was considering a donation to the Presidential Housing Initiative, a shelter program later exposed as a money-laundering ruse.

Though a judge would reject allegations that Chibanda was bribed in this case, Ndopu feels he was sacrificed in the process. Chibanda, he says sadly, "was like Judas Iscariot. The one who betrays you is the one you eat food with at the table."

A vulture lands in court

Ndopu's authority, or lack of it, would become a key point at a commercial court in London, where hearings opened in May 2006, presided over by Justice Andrew Smith. There, Zambia's lawyer, Michael Sullivan, "led an assault, if you like, on Michael Sheehan," remembers Mutembo Nchito, a Zambian anti-corruption lawyer who worked with Sullivan to prepare Zambia's case. "It was Michael versus Michael — one angelic, and one demonic." But the matter would turn, too, on what Mwale would — or wouldn't — say. The precise role he played in helping Sheehan set up the debt purchase would be critical to the court's decision about the legitimacy of Sheehan's claim to own the debt.

Zambia argued that the debt was acquired illegally, because its existence was privileged information and because Romania breached its agreement with Ndopu by selling to Sheehan.

Sheehan's legal team countered that there was no agreement between Romania and Zambia, because Ndopu didn't have the authority to make one, and therefore the sale to Sheehan was legitimate. It had another persuasive point on its side: Zambia had at one time acknowledged the debt to Donegal in a letter signed by Mwale's brother-in-law, who worked for Stella Chibanda in the Finance Ministry. Zambia also made some payments to Donegal as the two parties discussed investment possibilities. Eventually those talks broke down, and Sheehan sued.

Sullivan also sought to prove that Sheehan had acquired the debt nefariously, using a series of shell companies to disguise payments that Zambia suggested were bribes. Technically, Donegal owned the debt, not Sheehan. But Sheehan worked with a series of other companies and individuals, including Mwale, that attached to Donegal and its debt like barnacles to a ship.

Of the companies linked to Donegal, the most important to the corruption allegations was called Moreno, and it was owned by a man named Philip O'Rourke. Moreno appeared to be set up as a kind of firewall between Mwale and Sheehan: Mwale told the court he worked for Moreno and with O'Rourke — not for Donegal or Sheehan, who was Donegal's sole owner. Mwale and Sheehan both said in court that Mwale had rarely had any direct dealings with Sheehan.

In practice at least, Moreno overlapped with O'Rourke's other company, called Somerset Investments. At the time of the Zambia deal, Somerset was incorporated in Delaware and shared a mailing address with Sheehan's American company, DAI. In court, Sheehan insisted O'Rourke was only a contractor who also leased office space, but by 2004 — two years before the case began — Sheehan himself was listed as a director and senior partner at Somerset Trade Finance, another of O'Rourke's Delaware-incorporated companies, which also had an agent in Romania. Today, the latter Somerset is a wholly owned subsidiary of DAI.

The firewall didn't hold. In court, Mwale represented himself as an agent of Moreno, but on paper, during the Zambia deal, he represented himself sometimes as an agent (or even "executive director, Lusaka office") of Somerset, sometimes as a representative of Donegal. Mwale signed a consultancy arrangement with Somerset in January 1998 — while he was still mayor of Lusaka, in the same month that Sheehan and Romania agreed to a sale, with terms requiring that someone in Zambia verify the legitimacy of the debt.

Court records indicate Mwale sent memos and faxes to Sheehan and invoiced Donegal directly for consulting services. In records that Sheehan and O'Rourke wouldn't disclose until ordered to do so by the judge, Donegal also made payments directly to O'Rourke's personal account in Maryland. Donegal also made payments directly to Mwale and to Mwale's company. Even with these paper trails, the court never did establish where exactly Donegal's first payment, for $372,000, ended up.

The confusion became a critical point. Zambia alleged that Mwale had bribed government officials into sharing confidential information about the Romanian debt. Sheehan denied any but the most cursory knowledge of Mwale or his work.

The stakes were high: If the debt purchase was tainted by bribery, the court could rule that it had been acquired illegally, leaving Sheehan with nothing to collect. Zambia's lawyers also dangled another unpleasant possibility: whether Sheehan had run afoul of the Foreign Corrupt Practices Act. (Though the debt was held by a company Sheehan had registered abroad, it was managed by Sheehan's companies registered in the U.S.)

"He looks like a pirate"

In his 2007 judgment, Justice Smith wrote that he found Sheehan "deliberately evasive, even dishonest." He also recognized, and rejected, the Moreno firewall. "I am driven to conclude that Mr. Sheehan and Mr. O'Rourke deliberately gave false evidence in order to distance Donegal from the activities of Mr. Mwale," Smith wrote.

Suspicious though he was, Smith found no solid evidence of corruption. The debt sale, he ruled, was legitimate, and Sheehan was entitled to collect against Zambia. Because of his suspicions, and a dispute over the legality of some interest, Smith reduced the judgment, awarding Sheehan $15 million of the $55 million he'd asked for — but five times the price he'd paid for the debt nearly a decade before.

Years later, the experience still makes Ndopu emotional. The money Zambia paid Sheehan should have gone for social needs, he says: "water, health, education, all those pro-poor projects" in the plans that won Zambia debt relief.

"We paid back the vulture funds instead of developing our country," he says, a hint of helplessness in his voice. "The opportunity cost is quite immense."

When asked about Michael Sheehan, soft regret turns hard-edged and bitter. "He looks like those people who rob ships." Ndopu searches his anger for the right word. "A pirate! He looks like a pirate to me. I don't want to meet him again. I would shoot him on sight."

Across town, Fisho Mwale has kinder things to say about Michael Sheehan. "He is a nice man," Mwale insists, "but he has been harassed." Mwale knows something about harassment: The global dustup over the case pushed him to move to South Africa, a period of his life he refers to as being "in exile."

Four years after the case ended and not long after his return from South Africa, Mwale's version of this story, told over the course of a five-hour interview, is filled with nostalgia. It's also different from the version that came out in court.

Mwale says that he and Sheehan met in Lusaka in 1990, seven years before Sheehan bought the debt that made him infamous. They were introduced by O'Rourke, whom Mwale says he met in the late 1980s. Mwale talked about the Romania deal as a sequel to previous collaborations that began in the early 1990s.

"We started working together in this entity which Michael Sheehan had set up," Mwale explained, later identifying the organization as DAI. "He employed all of us. We came together as a group."

Mwale thinks the corruption allegations in the London court were rooted in envy and rivalries from his position here in Lusaka: Here again were the "small, cheeky Africans," daring to play in the global economy. That boldness, he says, earned him the jealousy of colleagues. He imagines them wondering, "How could this Mwale buy the debt?'"

But Mwale adjusted his story in the midst of its telling. Though he had described setting up Donegal to buy the Zambian debt as a collaborative endeavor with Sheehan, Mwale's role morphed as his story continued.

"I was not Donegal. I was an agent of Donegal," he says. In court, he had flatly denied this, insisting, "I have never been an agent of or authorized to represent Donegal or any other related company."

Not once, in a five-hour interview, did Mwale mention Moreno, although everyone involved — Sheehan, O'Rourke and Mwale — had insisted in court that that was the company Mwale worked for on this deal.

Toward the end of the interview, when asked about personal profit, Mwale demurred. "The point is the opportunity cost," he says. He meant that litigation is expensive, which cuts into earnings, and it is slow, which erodes the value of the debt collected.

When asked how much of the $15 million award to Donegal remained after those opportunity costs, he paused and fine-tuned his gaze.

"What you ask is — you're not trying to be rude," he relented. "But it's 'How much did you get?'" He said that there was "no money" for a long time, that he had had bills, that he'd been borrowing money to live, that he'd been so harassed that he'd had to leave Zambia. By the time there was any money to be had, he says, he was given $2 million. After the work expenses, the bills and the "exile," he says, "the cash which finally came to me was, like, $700,000."

Seven hundred thousand American dollars is about 3.5 billion Zambian kwacha (undiscounted, at a 2012 exchange rate). That's seven times what Zambia spent in 2012 on subsidizing maize for the poorest of its 13.5 million citizens, a third of whom can't afford to feed themselves.

The $15 million judgment won in the London court would be worth about 75 billion kwacha. That's half of the 2012 national agricultural budget in a county where farming accounts for one-fifth of the gross domestic product and the majority of the population are subsistence farmers. Fifteen million dollars is also nearly 2,000 times what it costs to feed an average Zambian family for a year.

Debt, poverty and corruption

From another perspective, it's hard to know just how much Sheehan's lawsuit really cost the Zambian people. Yes, $15 million could have gone a long way inside Zambia, at a time when the country was just beginning to benefit from its debt relief.

On the other hand, debt relief doesn't actually create money, despite our economic fictions. "In essence, it's just potential. It's money you're going to have," says Sydney Mwansa, formerly the economic-equity and development-program officer at the Jesuit Center for Theological Reflection, which spearheaded anti-vulture activism in Zambia during the Donegal trial.

The money Zambia did have to pay Sheehan came from assets it already had in London. In fact, Zambia kept quite a bit of money in London: In the same high court that heard Sheehan's case, Zambia's president was found guilty of embezzling $46 million, much of it stashed in or routed through London accounts. Sheehan's award, for a legitimate debt, was modest compared with what had been stolen from the Zambians by their own president.

Stella Chibanda, whom Zambia's lawyers alleged was on the take in Sheehan's case, and whose de-authorization of Ndopu's negotiation was critical to the legitimacy of Sheehan's debt purchase, was also found guilty, in London in 2007 and, in a different case, in Lusaka in 2010, of corruption. Her boss, a Zambian finance official and a key figure in the Sheehan debt sale, was also found guilty of corruption in Lusaka in 2010.

In fact, the laundry list of countries targeted by vulture funds is also a pretty good list of the world's most corrupt countries — and, in an irony Western narratives often overlook, Africa's richest countries. Sierra Leone, Liberia, Nigeria, Republic of Congo and the Democratic Republic of the Congo — all have been targeted by vulture funds; all have copious natural wealth; and none is a paragon of transparency.

In fact, vulture funds have long argued — and now there is some evidence — that their own lawsuits expose corruption that organizations like the World Bank (which has taken an active stance against vulture funds) say they want to curb.

A New York investment firm uncovered $5.5 billion in likely corruption in the Democratic Republic of the Congo, in the course of suing Congo for a debt that went back to the 1980s. The firm, FG Hemispheres, discovered a series of suspicious sales of publicly held mines and documented the pattern in an 87-page confidential memo it sent to the International Monetary Fund in November 2012, which sources inside the IMF later leaked to members of the press.

Congo's corruption has been an open secret for generations, but no one had been able to put a number on it. Last year, citing the Congolese government's failure to disclose details of some mining deals, the IMF canceled a $225 million loan to Congo.

The future of vulture funds

Following an activist push inspired by the Donegal case, the United Kingdom permanently banned the use of its courts for vulture suits in 2011. Similar legislation in the U.S. was derailed in 2009 when it was revealed that the bill was heavily shaped by lobbyists from the Republic of the Congo, whose first family was simultaneously fighting a vulture-fund lawsuit and spending lavishly on fashion in Paris and real estate in California. The U.S. Supreme Court in October deferred action on the first vulture-fund case appealed to its chambers. As courts around the world turn away from vulture funds, America is one of the few places investors are likely to find returns through litigation. By 2007, the year Sheehan's case was decided, 46 creditors had sued 11 debt-relief-eligible countries. Seven of those countries had lost their case, with judgments against them totaling nearly $1 billion.

Technically, however, there's nothing stopping Zambia's bad luck from repeating itself. A single government minister's signature is all that's needed to borrow billions, and the details of those debts are confidential. Mutembo Nchito, Zambia's director of public prosecutions, believes deals like Sheehan's require this kind of confidentiality. "This business couldn't operate in the light of day," he says.

Zambia isn't alone. Karangizi, of the African Legal Support Facility, says there's always the risk that new loans will pop up for vultures to buy. "Remember, these countries don't have accurate records of their creditors," Karangizi says. "It becomes very difficult to know when the vulture funds can strike, and one vulture fund alone can become quite significant."

Secrecy may shroud business, but international aid is supposed to be transparent. And yet the world's most powerful lenders, public and private, have long neglected red flags for corruption. After all, when Congo's President Mobutu Sese Seko borrowed millions for the national power grid — a debt that would end up as a $100 million claim owned by FG Hemispheres — he was already known as a dictator more interested in tipping back pink champagne than in making timely debt payments.

One lesson embedded in the story of vulture funds, then, is something of an embarrassment to Western economic powers: They should have known better than to have lent to these countries in the first place.

In fact, it's the deep roots of irresponsible lending, ironically, that make vulture funds possible. Forty and more years ago, banks loaned too much money to poor countries. By the 1980s, those countries couldn't even pay interest without taking out yet another loan, and American banks were saddled with toxic Third World debt. In 1982, if only half of the world's indebted poor countries had defaulted, according to the "University of Pennsylvania Journal of Business Law," America's six largest banks would have gone belly-up.

What vulture investors do today isn't all that different from what banks did to end that debt crisis. The terms were different, but the practice was, essentially, the same: take the debt that poor countries can't pay, buy it cheap and convert it into something that makes money in — and, ostensibly, for — those countries.

If that sounds like sleight of an invisible hand, it's for good reason. Third World debt is not just a problem for the debtor nation and its impoverished citizens. Like unpaid mortgages, repackaged and resold, unpaid Third World debt is also a problem for American banks. Bloated balance sheets make banks vulnerable, but debt doesn't disappear just because you know no one will ever pay it back. Last year, as debates over America's own debt limits paralyzed Washington, the U.S. government spent $175 million relieving the unsustainable debt of other countries. Since 1996, the American government has spent $2.63 billion doing the same, according to figures from the U.S. Treasury.

Even Zambians convicted of corruption see a problem with this.

"Debt write-off is immoral," Stella Chibanda insisted in an interview in 2011. "Somebody is paying tax there to subsidize this economy, here."

Of course, by the first commandment of capitalism — all money is fungible — the Zambian economy isn't the only beneficiary of another country's taxpayers.

So, too, were the winners in the Donegal case.


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