OSC brings charges against Felderhof

Two years after Bre-X Minerals’ Busang gold deposit in Indonesia was revealed to be a fraud, securities regulators are laying charges against the company’s former vice-chairman, while police have ceased active investigation of the case.

The Ontario Securities Commission announced it was bringing eight charges against geologist and vice-chairman John Felderhof, citing offences under the insider-trading and disclosure provisions of the Securities Act. The Commission alleges that Felderhof sold Bre-X shares while knowing undisclosed and unfavourable material facts about the company, and permitted the company to release misleading resource estimates for its project.

At the same time, the Economic Crime Unit of the Royal Canadian Mounted Police announced it would not be laying Criminal Code charges over the salting fraud. Tampering with a mineral sample is an indictable offence under section 396 of the Criminal Code, but the Crown would have to prove both that the accused acted with a fraudulent intent, and that he either tampered with the samples personally or conspired with others to tamper with them.

Now that the police have decided not to lay any charges, there will be no grounds for extradition proceedings against Felderhof, who has remained in the Cayman Islands since the collapse of Bre-X in May 1997. Extradition would require that the Caymans government revoke Felderhof’s permanent residency on the islands.

Extradition is an internal matter in the Caymans, a British colony that is self-governing in internal affairs. There is no formal extradition treaty, but the government can respond to specific extradition requests from other countries.

Four of the charges laid by the OSC stem from the insider-trading provisions of the Securities Act; Felderhof, as a director and officer of Bre-X, was subject to the Act’s insider-trading rules. Anyone convicted under these charges is subject to a minimum fine equal to the profit he made or the loss he avoided by trading the shares. The maxiumum fine can be three times the profit made or loss avoided.

The OSC alleges that during four periods between late April and mid-September 1996, Felderhof sold Bre-X shares with a total value of $83.9 million while knowing “a material fact . . . that had not been generally disclosed.”

The other four charges were made under the Act’s Section 122, which contains its provisions for misleading disclosure. Section 122 provides for a maximum fine of $1 million or a maximum prison term of two years, or both.

The OSC’s information alleges that Felderhof “did authorize, permit or acquiesce” in Bre-X’s publication of four news releases containing resource estimates for the Busang project. The releases, signed by David Walsh, then chairman of the company, reported resources that ranged from 514 million tonnes grading 2.4 grams gold per tonne in June 1996 to 889 million tonnes grading 2.5 grams per tonne by February 1997 — Busang’s infamous “70 million ounces.”

A company officer or director charged under Section 122 has a “reasonable diligence” defence, under which he can argue that there was no reasonable way to know that the disclosure was misleading. The offence is, however, a strict-liability offence in which the intent to defraud need not be proved.

The four periods during which Felderhof was selling shares all were in the spring and summer of 1996, when the Busang “resource” was growing by leaps and bounds. The OSC’s information alleges that in all four cases the sales were made with knowledge of material facts that were not available to the public.

During the first stretch, April 24 to May 16, Felderhof sold 100,000 shares of Bre-X for $21.1 million; the first news disseminated after the end of that period was a resource estimate dated June 20.

Between June 24 and July 26, after a 10-for-1 stock split by Bre-X, Felderhof sold 991,800 shares for $22.6 million. The next news item released by Bre-X was that the company had resolved an ownership dispute with the former property-holder, Montague Gold of Australia.

Between Aug. 1 and 16, Felderhof sold 714,900 shares for $17.4 million, but news releases in the period immediately following Aug. 16 dealt with relatively inconsequential developments, such as a new listing on the Montreal Exchange and the spinoff of affiliate Bro-X Minerals.

The last period, Aug. 26 to Sept. 10, during which Felderhof sold 913,800 shares for $22.9 million, culminated with a release stating that Bre-X would “pursue all available opportunities” for the development of Busang.

The lack of specific news immediately following the four periods in the OSC’s information suggests the Commission will argue that Felderhof had more general knowledge that the Busang property was worthless. On the other hand, the four charges of misleading disclosure all arise from specific resource estimates that proved to be false. The Commission argues that Felderhof either knew, or ought to have known, that the estimates were incorrect.

The OSC announced the charges on May 11, two years and one week after an independent technical audit by Strathcona Mineral Services hammered the last nail into Bre-X’s coffin (T.N.M., May 12/97). Strathcona’s report at the time said “the magnitude of the tampering with core samples that we believe has occurred, and resulting falsification of assay values at Busang, is of a scale and over a period of time and with a precision that, to our knowledge, is without precedent in the history of mining anywhere in the world.”

The Royal Canadian Mounted Police said it had abandoned the investigation after it became apparent that witnesses outside the country — presumably including geologist Cesar Puspos and metallurgist Jerome Alo, both of whom were implicated in the salting operation — could not be compelled to testify. The police reviewed their evidence with prosecutors in Alberta and concluded that there would be no reasonable chance of getting a conviction.