A Lode of Lies: How Bre-X Fooled
By Howard Schneider
As it progressed from stock exchange to stock exchange in North America, Alberta-based Bre-X Minerals Ltd. acquired fans among the elite of the continent's investment community, enlisting top brokerage firms such as Canada's Nesbitt Burns Ltd. to finance its activity and enrolling New York's J.P. Morgan Co. as a financial adviser.
Along the way, it cleared regulatory hurdles from Calgary to Washington, satisfying officials at each step that its claim about finding the world's biggest gold deposit, in the distant jungles of Indonesia, was sincere.
It wasn't, and billions of dollars in losses later, market regulators and analysts in Canada and the United States are wondering how such a comparatively primitive scam foreign gold dust "salted" into otherwise worthless chunks of jungle rock, according to an independent consultant hoodwinked experts who are supposed to use their skepticism and insight to protect investors.
Toronto Stock Exchange President Rowland W. Fleming refers to Bre-X as a "comet," a once-in-a-lifetime scam that shows how even the most rigorous systems can be deceived by a big enough lie.
"If someone is simply lying, in a huge and stupendous fashion, as appears to be the case with Bre-X, all the disclosure rules in the world will not protect either the gullible investor or, it seems, even the most sophisticated one," Fleming said in a speech to a conference of corporate officials last week.
The Bre-X saga also shows how those same rules, while portrayed as adequate to protect investors, can require little independent verification of company claims.
The Bre-X scheme is the subject of criminal investigations in Canada and Indonesia, though no one has been charged or arrested. Its stock is worthless, and there is a growing file of civil litigation brought by shareholders against the company and others, such as Nesbitt Burns, who were involved in its financing. There are calls for an overhaul of Canada's market rules, and an attempt by everyone involved in the venture Bre-X officials, consulting engineers and stockbrokers alike to distance themselves from the embarrassment.
Bre-X Chairman David Walsh said the company, delisted by the exchanges where it once found favor, is doing its own "forensic" probe and has sought bankruptcy protection; John Felderhof, former vice president in charge of exploration, said in a statement released from his Cayman Islands home that he was unaware of the tampering.
Between April and September 1996, Felderhof sold $26.5 million in Bre-X stock; Walsh sold $5.5 million, and his wife, Jeannette, sold $20.6 million, according to insider trading records.
A spokesman for Nesbitt Burns, whose gold analyst visited a Bre-X site in Indonesia and endorsed the company's claims until late in the process, said the brokerage house is as much a victim as anyone else.
"Our analysts rely on publicly available information that is released by reputable companies, but in this case there is fraud. Our experts are not experts in uncovering fraud," said Paul Gammal, a spokesman for the brokerage, a subsidiary of the Bank of Montreal. "Our industry and our clients have been victimized."
Because it relied mostly on private placements of stock, Bre-X's public disclosure requirements were less rigorous than they would have been if the company sold its stock directly to the public. The only prospectus the company was required to file, for example, was an original one in 1989, the year Walsh listed the firm on the Alberta Stock Exchange to finance a hunt for minerals in Canada's Northwest Territories. That document contains no mention of Bre-X's later efforts in Indonesia.
The investors who originally bought Bre-X's private placements ultimately began selling their shares on the open market. The disclosure requirements, however, remained the same as those for the private offering. Meanwhile, the company was making increasingly optimistic statements, which pushed the estimated size of the gold find from a few million ounces to more than 70 million ounces, the largest deposit ever.
Under Canadian law, company officers are not liable for the accuracy of such statements, as they would have been with projections included in a formal prospectus, said Brenda Eprile, executive director of the Ontario Securities Commission. A recent report has recommended changes in those rules, recognizing that stocks initially sold through private placements eventually migrate to the public market.
"When a company like a Bre-X does not do public offerings, there is not the due diligence and not the liability" associated with direct sales to the public, Eprile said. "Yet the company got up to $6 billion" in market capitalization as its stock circulated among both market-wise investors and less-experienced individuals who bet their savings on the presumed pot of gold.
Bre-X's public statements and official filings frequently noted that estimates of the size of the find had been prepared by a respected engineering firm, Montreal-based SNC Lavalin. Not as publicized was the fact that the engineering company had been hired only to make its calculations based on samples of earth extracted and processed by Bre-X.
Bre-X's filing with the U.S. Securities and Exchange Commission, for example, includes several sections cautioning investors about the risks of mining in general and the risks of Indonesia particularly, but it also says the estimate of a gold find "in excess of 30 million ounces" had been "prepared, reviewed or verified by independent mining experts" without stating that the samples always were drawn and controlled by the company.
After those samples were doctored probably, officials feel, at a riverside warehouse en route to an Indonesian testing lab the engineers also thought they were looking at a sizable gold find.
"We were very downstream" from the company-controlled drilling program, said Robert Racine, a spokesman for SNC Lavalin, whose Indonesian subsidiary, PT Kilborn, worked with Bre-X.
In fact, it was more than two years from Bre-X's initial public statements about a major gold find on the Indonesian island of Borneo before someone outside the company independently tested the site for gold.
When mining giant Freeport McMoRan Inc. conducted its own drilling as part of negotiations over a possible partnership with Bre-X, the scheme unraveled.
The Louisiana-based company found no gold at the site; a second independent drilling program, by Strathcona Mineral Services Ltd. of Toronto, went even further, declaring that Bre-X's claims were the product of a tampering operation "without precedent in the history of mining anywhere in the world."
Called to Freeport's field office to explain the discrepancy, Bre-X's chief geologist, Michael de Guzman, fell from a helicopter en route, an apparent suicide. In statements to the Canadian media, his family members insist that he, too, was a man of integrity who would not have participated in the salting scheme.
A Track Record
Before Freeport's testing, Bre-X was able to build a store of credibility that began with success on the Alberta Stock Exchange and continued with listings last year on the Toronto Stock Exchange and in the United States on the Nasdaq Stock Market, where a total of 111 million shares changed hands over 10 months beginning in August 1996.
From initial private offerings at 30 cents a share, Bre-X stock climbed to more than $250 on the open market before a 10-for-1 split a year ago.
Institutional investors, including mutual fund companies, the Ontario Teachers' Pension Plan and Quebec's huge cooperative Caisse de Depot, flocked to the high returns, helping to inflate Bre-X's value. The cycle of support for Bre-X also included a press corps eager to tout what looked like a true Canadian worldbeater. The fact that Canadian prospectors had uncovered some stunning mineral finds in recent years added to the hype.
In the end, each investment decision, each positive news story, each company statement gave Bre-X a tougher veneer of legitimacy and made it less likely for the next person in line to question the underlying facts, said Toronto Stock Exchange President Fleming and others who followed the company.
"As a general matter . . . the various participants in this saga acted with their normal professionalism, which by its very nature bestows credibility," Fleming said. "There was normal behavior on the part of professionals, and we now know it was all based on the most dreadful deceptions."
In hindsight, there were early warning signs, but the information either never got outside the company or was dismissed as irrelevant to the ongoing Bre-X boom.
Standard industry procedures, for example, were ignored when Bre-X crushed the full contents of each drilling sample rather than splitting them in half and securing a portion for future partners or others to test. Studies by an Australian company as early as 1995 also included information that raised doubts about the find: The gold flakes extracted by Bre-X seemed to fall too easily from the sample and looked more like alluvial gold panned from a river rather than volcanic gold leached from bedrock.
Even a January fire at Bre-X's field office, which destroyed many of the sampling records, should have caused more concern than it did, said John Woods, editor of the Vancouver, B.C.-based market journal Stockwatch.
"Everything came together" to sustain the Bre-X myth, Woods said, not least the willingness of investment pros to accept what the company's management told them.
Along with years of litigation and the potential for criminal indictments, Bre-X will likely trigger some changes in Canada's market oversight and disclosure rules.
As for Nasdaq, "from our perspective, they passed the [SEC's filing requirements], they passed the financial requirements," said spokesman Reid A. Walker. "There are no policy changes as far as I know."
How extensive Canada's changes will be remains uncertain. Fleming and officials at the Alberta exchange say overreaction would kill what the market is there for to help companies raise money. It would, for example, be difficult to force small, speculative mining firms to independently verify any finds because of the expense.
Christopher Armstrong, a historian at Toronto's York University who is finishing a book on Canada's financial markets, said the country's resource-driven economy goes through cycles of tougher and looser regulation, as scandals like Bre-X's encourage a tougher attitude until concern about overregulation and lost profits pushes the pendulum back.
"Put yourself in [a broker's] shoes. Here is a stock that is going up like crazy. . . . All the officials are eager to have it traded. That is their business," Armstrong said of Bre-X. "When we fake a resume and get one person to accept it, they go easier the next time around, and pretty soon you're a neurosurgeon performing surgery with a degree from the Garage University."
© Copyright 1997 The Washington Post Company