Watchdog challenged over £2.4m donation to Lib Dems

Britain's elections watchdog is facing a damaging High Court challenge over its decision that the Liberal Democrats do not have to repay a £2.4m donation given by a fraudulent bond dealer who swindled £34m out of his investors.

Victims of Michael Brown, 43, who is on the run after being sentenced to seven years' imprisonment, are investigating applying for a judicial review of the decision by the Electoral Commission that the donation – the biggest ever received by the Lib Dems – was given legally. This was despite evidence it was funded entirely from stolen money.

The bond dealer was an unknown businessman when he offered Britain's third largest political party a series of large donations on the eve of the 2005 general election, despite not being registered to vote in Britain. His largesse extended to arranging for Charles Kennedy, the then party leader, to fly around Britain on his private jet at a cost of £30,000.

The flamboyant lifestyle of Brown came to an abrupt end in 2006 when doubts were raised about the source of his wealth and City of London Police moved to arrest him. He was convicted in his absence of fraud and theft at Southwark Crown Court last year after absconding before his trial.

The Electoral Commission last week announced that a four-year investigation into the donations from Brown, made through his British company 5th Avenue Partners Ltd, had found no evidence that election law was broken because the firm had met a test that it was "carrying on business" in Britain at the time of the gift. Under the Political Parties, Elections and Referendums Act 2000, a company can make a donation to a political party as long it can show it is trading at the time.

But lawyers representing Robert Mann, a Los Angeles-based tax lawyer who invested £5m with Brown, described the Commission's findings as a "disgrace" and a "whitewash" by failing to address earlier rulings by two High Court judges that 5th Avenue, which has never filed formal accounts, was set up solely to allow the bond trader to carry out his fraud and that its funds came from his duped investors.

Tony Brown, the solicitor representing Mr Mann and other victims of the fraudster, told The Independent: "What has happened is the equivalent of a drug dealer setting up an off-the-shelf company, employing a couple of cronies, hiring an office and then making a very big donation to a British political party. The Electoral Commission has basically said that is fine.

"The criminality of Brown's conduct has been completely ignored by the commission. The law is very clear – a company must be trading and carrying on business legally in order to make a political donation. All the commission has found is that 5th Avenue gave the appearance that it was trading, and left it at that."

Among those Brown succeeded in luring into shelling out large sums with apparently copper-bottomed guarantees of bank-banked funding were Martin Edwards, the former chairman of Manchester United, who invested nearly £8m after hearing Brown's boasts of his friendship with Prince Andrew and his status as the son of a peer.

Using the money from new investors to pay previous clients, Brown ensured a stream of cash to fund a lifestyle to match his boasts, spending £2.6m on a Raytheon private jet, £100,000 on improvements to the library at his Belgravia gentlemen's club and £327,000 on an entertainment system at his hilltop villa in Majorca.

The party has always insisted that it complied with electoral law and was under no obligation to return the money. In a statement, the Lib Dems said: "At all times the party acted in good faith in relation to the receipt and the expenditure of these donations in the 2005 general election campaign. All our donations and loans were properly declared to the Electoral Commission."

Outlining its reasons for finding that 5th Avenue was in business, the Commission said the company had opened accounts with a high street bank, deposited money in a trading account and spent "substantial sums" on office furniture and equipment. The Commission added that it was satisfied that it had satisfied its obligation to ensure electoral law is followed.

City of London Police said last night it was still actively seeking Brown. There have been no confirmed sightings of the Scotsman since he left his Hampstead flat at 6am in June last year.