CASE STUDY: The BRE-X Scandal, Misguided belief in the QRA

Bre-X Minerals Ltd was a company set up in Calgary by David Walsh and his wife, on May 30, 1988. It became defunct in 2003. The death of Bre-X came after its involvement in a major gold mining scandal. Qualitative analysis of an area in the jungles of Busang, Indonesia, revealed a gargantuan amount of gold: close to 200 million ounces. This was something unheard of in the mining industry as it represented 8% of the world's gold supply. The excitement of the find was feverish: at one point in May 1996, Bre-X was worth CAD $6 billion. Meticulous and expensive quantitative core sampling proved that the motherlode discovery was indeed true. So influential was the risk analysis that it received the backing of the head of Barrick Gold, Peter Munk: at that time, he was also the head of the Toronto Stock Exchange (TSE). Then, in 2003, a neighbouring mine could not comprehend the enormous wealth and requested an independent study. Before this study could be completed, Bre-X collapsed causing a loss totalling $3 billion. The truth was that there was not a spec of gold in Busang. Among the major losing investors were three Canadian public sector organizations: The Ontario Municipal Employees Retirement Board (loss of $45 million), the Caisse de dpt et placement du Qubec, the Quebec Public Sector Pension fund ($70 million), and the Ontario Teachers Pension Plan ($100 million). The Good Times begin On May 30, 1988, David Walsh incorporates Bre-X Minerals Ltd. in Calgary. He and his wife, Jeannette, are the only employees and they work out of their home. A year later, Bre-X goes public on the Alberta Stock Exchange at 30 cents a share. Its focus is looking for diamonds in the Northwest Territories, in Canada. April 2, 1993: David Walsh contacts Canadian geologist, John Felderhof, to inquire about opportunities in Indonesia. The men had met in 1983 in Indonesia where Mr. Felderhof was working for an Australian company. But both men are now down on their luck and running out of cash. May 3, 1993: Mr. Felderhof helps Bre-X acquire its first stake in the Busang property in Borneo for USD 80,000. Bre-X tells investors that, based on gut feeling, the site might contain 1 million ounces of gold. Mr. Felderhof assembles a crew to drill for samples to back this subjective analysis. He then recruits a friend from a previous venture, Michael De Guzman, a geologist from the Philippines. Gold-plating the evidence Oct. 19, 1995: Mineral exploration can be a very expensive project. By this time, Bre-X and all its subcontractors have sunk in a lot of money and need more investors. Bre-X tells investors that drilling has uncovered a deposit with about 2.7 million ounces of gold. Analysts believe the find might hold 30 million ounces. Mr. Felderhof says it could be 45 million and adds that the site "has the potential of becoming one of the world's great gold ore bodies." Bre-X's shares hit $59. Greed feeds into greed and the money starts rolling in. March 14, 1996: Mr. Felderhof tells shareholders at the Bre-X's annual meeting in Toronto that Busang holds at least 30 million ounces. "I think it's 30 million plus, plus, plus." Mr. De Guzman even hints at 2 | P a g e 100 million ounces. Bre-X's shares top $187. The company moves to the Toronto Stock Exchange in April and splits its shares ten to one in May. The new shares trade at TSE starting at $28.65. The natives get restless Aug. 15, 1996: A local businessman in Indonesia, Yusuf Merukh, realizes that he can get in on the action. He sues, claiming that he has a 40 per cent interest in the mining site. The Indonesian government cancels Bre-X's exploration permit citing this ownership dispute at the Busang property. Indonesian President Suharto refuses to renew Bre-X's exploration and production license until the dispute is settled. Oct. 28, 1996: Bre-X signs a strategic alliance with an Indonesian company controlled by Sigit Harjojudanto, President Suharto's eldest son. Mr. Harjojudanto's company gets a 10 per cent stake in the property plus USD 1 million, a month for 40 months and contracts to supply the mine with utilities, petroleum products and limestone. Nov. 29, 1996: The Indonesian government directs Bre-X to strike a deal with Barrick Gold Corp. to develop the property so that the gold can be mined. Barrick gets majority control of the development company, and the government says it "would appreciate it if the parties could consider a 10-per-cent participation being given to the Indonesian government." Feb. 27, 1997: Barrick Gold pulls out of the negotiation and suddenly, there's no one to mine the yellow metal. President Suharto's close friend Mohammed (Bob) Hasan steps in and helps Bre-X negotiate a new deal with Freeport McMoRan Copper & Gold Inc. of New Orleans. Bre-X gets the largest ownership stake, 45%, while Mr. Hasan gets 30%. The remainder is split between Freeport and the government. The machines start rolling in to start the dig. Before the first shovel hit the ground at Busang, a mysterious fire destroys the administration office and all geological exploration quantitative risk records. QRA restarts and the honeymoon ends March 12, 1997: Freeport decides to conduct its own Quantitative Risk Analysis (QRA) drill samplings. The geologists head-scratching starts when they find discrepancies between its due-diligence sampling and Bre-X's QRA results. Mr. De Guzman, in Toronto for a mining conference, is told to provide some answers to some pointed questions. At the same conference, Mr. Felderhof is named "Prospector of the Year." At the request of Freeport, Mr. De Guzman agrees to take an independent team to the site where he sampled the core. On the way to the site in the jungle, Guzman falls out of the helicopter in an unfortunate accident and is unable to keep to the appointment with the independent analysts. An unidentifiable body is found four days later in the river. Relatives claimed that it was indeed Guzman but there is no supporting evidence. March 26, 1997: Freeport's QRA says it has found "insignificant" amounts of gold at Busang, certainly not the "30 million ounces" touted the previous year. Bre-X acknowledges that its estimates may have been overstated. This news causes the investors to panic and to sell off so many shares of mining companies that the Toronto Stock Exchange's computers overload twice in one day. Bre-X's share price tumbles to $2.50, with roughly $3 billion in market cap disappearing within minutes. May 5, 1997: Strathcona Mineral Services Ltd, hired by Bre-X to investigate what happened, concludes that widespread tampering occurred at Busang. Strathcona calls it the biggest fraud in the history of mining. Strathcona discovers that Guzman had tainted the QRA sample drillings with gold from his own wedding ring and then, later, the gold rings from his wives. Lawsuits fly all over Toronto; the RCMP investigates but lays no charges. A year later, Bre-X announces the death of David Walsh of a brain aneurysm, at his home in the Bahamas. 3 | P a g e Case dismissed May 11, 1999: The Ontario Securities Commission files eight counts of illegal insider trading against Mr. Felderhof, alleging he pocketed $84 million by using non-disclosed information. Mr. Felderhof is the only Bre-X official ever charged. His trial begins in October 2000. The trial drags on until May 2018. On May 12, Ontario Superior Court Justice Paul Perrell dismisses a class action lawsuit as the prosecutors throw in the towel declaring that the case was hopeless and that they had run out of money to continue the legal fight. Felderhof and his wife Ingrid are acquitted. The whereabouts of De Guzman is still a mystery. "We are from Ottawa" This scandal came about despite the various standards for science based QRA in the industry. However, there was no publication then to protect the investors. To prevent investment fraud in the mining industry, the Canadian government asks for a new standard report from mining exploration companies trading in Canada. This document, the National Instrument - NI 43-101, overseen by the Canadian Securities Exchange is directed at the investors. It is reviewed and endorsed by qualified subject experts before the company can release information on mineral exploration to the public. However, it is still not perfect: the NI-43101 is a complex report inherent with technical jargon, such that it may not serve the interests of the average investor. It is, however, a deterrent that halts tampering with risk data in the mining industry which is funded by public investment.

QUESTION

Mineral exploration and production is a tremendously expensive venture. For this reason, companies have to be very prudent in minning projects. Alot of money is spent on risk analysis before a mine goes into production. It is standard practice to spend most of this analysis on QRA.

1)For this assessment, find out how the parties should have responded to 3 risks. Illustrate your answers with examples from the case. You will lose points if your answer is not clear or excessively verbose, you will also lose points for copy-and-paste answers