National Instrument 43-101: Pros and cons

National Instrument (NI) 43-101 is a rule developed by the Canadian Securities Administrators (CSA) and administered by the provincial securities commissions that governs how public companies disclose scientific and technical information about their mineral projects to investors.

It applies to oral, printed and electronic statements, and requires that all disclosure be based on advice by a “qualified person.”

A qualified person, as defined by NI 43-101, is an individual who:

* is an engineer or geoscientist with at least five years of experience in mineral exploration, mine development, operation or mineral project assessment, or any combination thereof;

* has experience relevant to the mineral project and the technical report; and

* is a member in good standing of a professional association.

The rule was first introduced in 2001 in response to a series of unfortunate scandals in the 1990s that culminated with the collapse of Bre-X Minerals, which vaporized $3 billion worth of invested capital. Its purpose was to enhance the accuracy and integrity of mineral data disclosed by mining companies to restore investor confidence in the Canadian exploration sector.

By many accounts, it has achieved just that. The guidelines for reporting enforce a level of objectivity that eliminates interpretive language that might be classified as promotional.

Investment bankers, fund managers, and sophisticated investors around the world have embraced the rule as the de facto industry standard by which the merits of mineral projects are evaluated.

But there are some unfortunate deficiencies in the regulation that will likely be rectified in time. Until then, active investors should bear these in mind when considering NI 43-101-compliant information, or the absence thereof.

For example, with the upward trend in mineral prices across the board over the last several years, mining operations that had been decommissioned in the ’90s when commodities were at the bottom of the price curve are being recommissioned. If the known mineral resource that originally resulted in the mine being built was calculated before 2001, the company that owns the mine cannot disclose the existence of known, economically viable orebodies, except on a limited basis.

This forces them to spend money on 43-101-compliant exploration to secure investor capital at acceptable prices. If the company tries to raise funds without the 43-101 resource/reserve calculations, it will invariably suffer a discount in the price at which it is able to finance, and excessive shareholder dilution results.

The company and its shareholders would have realized a more efficient use of capital if they could raise money to put the mine into production without the 43-101-compliant report, thereby generating cash flows and capital returns faster.

As another example, property seekers in developing nations use the existence of “informal” or non-mechanized subsistence mining to identify likely acquisition targets.

Century Mining (cmm-v, cmnzf-o) recently acquired the San Juan mine in Peru. A town of 5,000 people is located near the mine site, with no discernible source of livelihood except mining. A small-scale mill has been running for over a decade, and the mill has historically been fed by vein systems that outcrop in various locations worked by the locals.

A business plan commissioned by the previous owner and executed by a recognized German engineering firm, stipulated that an investment of US$10 million could bring mine and mill output up to 80,000 oz. gold each year.

The company included this information in a press release, but was ordered by the TSX Venture Exchange to issue a clarification the next day, because the source of the referenced information was not NI 43-101 compliant.

So the shareholders of the company must bear the delay and expense of the execution, documentation and filing of a 43-101-compliant exploration program with the exchange before the value of the mine can be built into the share price. Therefore, the company again is forced to finance at an unnecessarily dilutive price to satisfy the regulation.

While these are two examples of ways in which 43-101 can have a negative impact on shareholders, it is important to bear in mind that, thanks to NI 43-101, a situation like Bre-X, where drill core samples were tampered with to appear to be richer in gold than they actually were, is extremely unlikely.

Indeed, there have been no examples of “salting” by any companies that fall under the jurisdiction of 43-101 since it came into effect.

Investment banks tend to invest in either management or projects. If the company seeking financing has a stellar project, but management doesn’t have the track record corporate finance types look for, then they’d better have a comprehensive 43-101 report in hand if they hope to get support.

“We generally very much rely on 43-101 reports and especially any that document resources and or reserves as these reports are signed off by consultants with abundant experience who have reviewed much of the historical record (if present) and their documentation of that work and any recent exploration data does provide a very important access point,” says Jim Mustard, senior mining analyst and vice-president of Haywood Securities.

Once a project attracts Haywood’s interest and the company wants to review it more closely, Mustard says NI 43-101 reports are usually the first thing examined for further data.

“We will generally review most of the relevant sections focusing on project issues, metallurgy, geological setting and the proposed work plans to determine the merits of additional work,” he says.

The deficiencies of 43-101 are not something that stakeholders will necessarily have to contend with forever.

In December 2005, revisions to National Instrument 43-101 were published that were seen by most as modest in scope.

The modifications included an allowance for public companies to refer to “historical estimates,” defined as an estimate of mineral resources or reserves prepared prior to February 1, 2001 (the effective date of the previous instrument). Under the amended instrument, an issuer may still disclose historical estimates using the historical terminology if, among other things, the issuer comments on the relevance and reliability of the historical estimate.

The definition of “preliminary assessment” is now broader than the old definition; it now refers to a study that includes an economic analysis of the potential viability of mineral resources taken at an early stage of the project, before a preliminary feasibility study has been completed.

Also, the amended regulations no longer contain prescriptive tests for non-independence of a qualified person. Instead, a qualified person is independent if there are no circumstances that could, in the opinion of a reasonable person aware of all of the relevant facts, interfere with the qualified person’s judgment regarding the preparation of the technical report.

— The author writes an independent newsletter called the Resourcex Investor, where he identifies premium opportunities in resource exploration (www.resourcexinvestor.com).