Corruption and the FCO: Blue skies, white sands, dark clouds

Special report: Met police call for criminal inquiry into former diplomat's Cayman Islands rule

Haven: the Cayman Islands (Alamy)

Britain's former top diplomat on the Cayman Islands should face a criminal inquiry for allegedly lying to police investigating corruption in the notorious tax haven, a Scotland Yard review has concluded.

Former governor Stuart Jack has been cited for possible attempts to pervert the course of justice over a Watergate-style break-in at a newspaper office on the islands, according to documents seen by The Independent on Sunday.

In the latest twist of a tortuous dispute played out under the island's tropical blue skies and courtrooms thousands of miles apart, the Metropolitan Police says there are sufficient grounds for an investigation into Mr Jack and two other senior officials. The head of a police team sent in 2007 to investigate the allegations accuses them of misleading him and effectively scuppering his inquiry, according to the letters.

The claims against the three, which Mr Jack strongly denies, amount to possible "misconduct in public office, attempting to pervert the course of justice and possibly wasting police time", according to a letter from the Yard's Commander Allan Gibson to the island's current governor, Duncan Taylor. "It is my view the allegations are serious and contain sufficient detail to warrant a criminal investigation," he said.

The letter – copied to Simon Fraser, the head of the Diplomatic Service – poses awkward questions for the Foreign and Commonwealth Office (FCO): any inquiry is likely to inflame a long-running controversy and embarrass senior diplomats, the Cayman authorities – and the Met. If it does nothing, it faces accusations of hypocrisy after David Cameron last week called on the Cayman Islands and other British Overseas Territories to show greater transparency in their tax affairs.

The FCO is already fighting in the courts to block release of a document that could blow the lid off its attempts to avoid blame for the original bungled police inquiry. It began as a leaks investigation and ended as a multimillion-pound inquiry into alleged police wrong-doing. FCO officials have declined to release an inquiry report because its "disclosure could lead to a loss of confidence within the international community which could impact negatively on the Cayman Islands' reputation and, more directly, on its financial services industry".

Nicholas Shaxson, author of Treasure Islands, a critical study of tax havens, said: "The Cayman Islands' authorities are completely and utterly captured by the financial sector... I wouldn't trust them to do an independent investigation if the reputation of the Caymans is at stake."

The case is one of a string of embarrassing episodes involving British Overseas Territories, the 14 nations that represent a hangover from Britain's imperial past and which remain some of the world's most controversial tax havens, in receipt of billions in global cash.

They include the Turks and Caicos Islands, which were ruled directly from the UK for three years from 2009 because of a corruption scandal, and the tax havens of the Caymans, Bermuda and British Virgin Islands, which all retain the Queen as head of state. The territories stopped short of claiming full independence from the Empire but secured a status that includes British oversight and, in the Caymans' case, a career diplomat, appointed from London, to become the most powerful man on the island.

Mr Jack retired from the post in 2009 and moved back to Britain after a final two years dogged by controversy over the Scotland Yard inquiry which has cost an estimated £20m, in high salaries, costs and damages payouts.

Martin Bridger, a former senior Met detective, led the original investigation into alleged police leaks to the media. But the inquiry became much longer and larger after the team learned that the island's police leadership had authorised a potentially illegal search of the newspaper office that was receiving the alleged tips.

The investigation was a disaster and led to a £1m payout to a judge who was wrongly arrested, the ousting of the islands' British police chief, and major criticisms of the inquiry in a judge-led review. The 12-strong police team – dubbed the Sunshine Squad amid claims of drinking and hard partying – was sent home in 2009, damaging the reputations of those involved. A member of the team, who declined to be named, said: "This was a flawed investigation from the start. There was arguably never a substantive offence. It seemed some officers drew the investigation out for their own ends."

Mr Bridger claimed he learned, after his team was banished from the island, that the former governor had used his position to authorise the search but failed to tell him. If Mr Jack had done so, he said he would never have embarked on the two-year inquiry. "I am pleased that the Met has agreed that a criminal investigation is warranted and should be commenced against those named," he said. "My hope is that the FCO and the Governor, Duncan Taylor, will remain true to their public statements that good governance, transparency and integrity must at all times underpin the activities of those who hold high public office."

In a statement to the IoS, Mr Jack said. "I categorically deny the allegations made by Martin Bridger. Such baseless accusations are deeply upsetting to my family and harmful to my reputation. I look forward to giving evidence when those proceedings come for trial in the Cayman Islands Grand Court. I have no doubt the court will find Mr Bridger's remarks to be wholly unsubstantiated."

John Evans, the man who searched the newspaper office, has contacted Scotland Yard and said he would back the former governor in an inquiry, threatening more bad publicity for the Met. "It's generated a huge feeling of distrust. The people in the Cayman Islands aren't sure who to blame for it all," he said.

"It has left behind a feeling that, if anyone comes out from the UK to do a future investigation, they are untrustworthy. They are only in it for what they can get out of it."

Today, the Caymans is one of the world's biggest offshore trading centres, worth billions of pounds, based on zero taxation and banking secrecy. It comes second only behind Switzerland in the Tax Justice Network's financial secrecy index. Enron, the failed US energy giant, used hundreds of Cayman-registered subsidiaries to keep billions off its balance sheets.

David Marchant, the owner and editor of OffshoreAlert, was scathing about the authorities' efforts to close down the saga. "David Cameron talks tough about clamping down on offshore tax. But he already has the framework for the Turks and Caicos Islands; he could literally take over these jurisdictions overnight. Only in Britain could this nonsense happen. People are infected with this peculiar Fawlty Towers way of conducting business. It's breathtaking. They need to bury this 50ft under the ground and move on."

Although Scotland Yard has called for an inquiry, it said it could not carry it out because it was "conflicted" owing to its former officers' initial involvement. It indicated a non-British force should be brought in.

An FCO spokeswoman confirmed it was considering the Met's letter.