Commentary: NI 43-101 gives false sense of security

We read with considerable interest your editorial entitled “Crimes and rumours of crime” (T. N. M., July 6-12/09) and the front page story “NI 43-101 to get an Overhaul” (T. N. M., July 20-26/09) — particularly as our firm had the privilege of acting as co-counsel for John Felderhof in the Bre-X Minerals case and as co-counsel with Sangra Moller in the Southwestern Resources case. Given our lengthy involvement in these cases we hope that your readers will find this short note to be a helpful addition to this discussion.

First, we do not share the general view expressed in the editorial and story about the value or effectiveness of National Instrument 43-101. As is well known, NI 43-101 is a set of rules and procedures that deals with public disclosure for mining projects. In our view, the Bre-X case would have, in all likelihood, unfolded without significant or material differences had NI 43-101 been in place back in 1997. While no doubt NI 43-101 has improved practices, we are concerned that the policy is leaving investors with a false sense of security and we hope that this brief comment will help bring them back to cold hard reality.

Secondly, one of the major differences between Bre-X and Southwestern was the level of recovery for investors. In the case of Bre-X, there was little or no financial recovery for thousands of investors and the company was delisted and cease-traded in almost record time. With Southwestern, the stock continued to trade after the fraud was uncovered, the properties were later sold and eventually the company was taken over. If you were a Bre-X shareholder during the winter of 1997 your shares were trading around $25 prior to the first announcement of trouble by Freeport-McMoRan Copper & Gold and at about $4 the day before the announcement of Strathcona Mineral Services’ first set of findings. This quickly went to zero. On the other hand, if you were a shareholder of Southwestern on the day prior to the first announcement, your shares were worth $6.34. If you held on until the takeover, you recovered 50¢, which, while still a significant loss, is still a far cry better than zero.

NI 43-101 contains a set of rules and policies for the public disclosure of information relating to mining projects. It was implemented by the Canadian Securities Administrators in February 2001. This system was brought forward to regulate publicly traded companies disclosing scientific and technical data about their mineral projects. After numerous incidents of falsified press releases within the mining industry, the guidelines of the NI 43-101 system were introduced in the hope that they would ensure validity and accuracy of mineral discoveries.

NI 43-101 mandates that a mining company issuing disclosure (the issuer) only release information that has been prepared by, or under, the supervision of a qualified person (QP). A QP is an individual who: a) is an engineer or geoscientist with at least five years of experience in mineral exploration, mine development or operation or mineral project assessment, or any combination of these; b) has experience relevant to the subject matter of the mineral project and the technical report; and c) is a member in good standing of a recognized professional association.

In order to help limit fraud, qualified persons should be independent of the issuer that they are working for. This is intended to prevent any circumstance that could interfere with the qualified person’s judgment regarding the preparation of the technical report. A test to determine if the QP is independent of an issuer is whether the majority of the QP’s annual income from the previous three years has come from the issuer.

John Paterson was the CEO of Southwestern Resources and somewhat surprisingly also acted as the company’s qualified person on their mineral project in Boka, China. Paterson tampered with the company’s assay results from the Boka project prior to their being published in company press releases, boosting the value of the company’s stock while at the same time profiting from the sale of some of his shares. Paterson was later found guilty of misusing his AusIMM membership as a qualified person and he has received a lifetime ban from that organization. As CEO of the Australasian Institute of Mining & Metallurgy, Michael Catchpole told Mining Daily: “The offence that most concerned the AusIMM was Paterson working in his professional capacity as the competent person and altering assay results before they were published to the stock exchange.”

The Bre-X fraud was arguably the largest mining scandal in history. Someone, still unknown but suspected by many, although not all, to be Michael de Guzman, salted Bre-X’s core samples before they were shipped off to be assayed. It was alleged that the samples were salted at the Samarinda office where samples were stored.

The magnitude of tampering that is believed to have occurred in the Bre-X Minerals case is unprecedented in the history of gold exploration. Over a three-and-a-half-year period, 25,000 to 30,000 two-metre interval samples were salted, which would have required incredible technical ability. Because of the sophistication of this tampering, in our view, the NI 43-101 requirements would not have detected salting in the Bre-X case any more than they did in Southwestern. The assay results for the Busang region deposit were consistent with the geology and numerous experts were also deceived into believing Bre-X’s results.

In our experience, most cases of fraudulent results occur in laboratories or by tampering with their results — not with the company’s samples. Because of this, we believe the focus of supervision should be on the quality of lab results and procedures, including independent auditing of those procedures. In order to try to confirm high-grade results, perhaps sample audits of scissor or twin holes of high-grade core intervals should be carried out and taken directly to the labs under independent third-party supervision in a manner similar to the role that independent auditors play in reviewing and testing financial statements. Once in the lab, the process of assaying the core should be closely monitored by the same independent third party supervising personnel to authenticate the results.

By one simple addition to Item 16 in NI 43-101 report requirements, adding the requirement for independent third-party sampling and assaying, it would supplement the role of independent qualified persons and hopefully reduce the number of cases where actual results fail to live up to resource estimates. Having unimpeachable and independent third-party resource audits would provide investors in mining companies with a much stronger sense of security when reading press releases containing resource or reserve calculations.

The second problem is that of avoiding a rush to judgment when a fraud is suspected. Upon discovering that there was overwhelming evidence that tampering had occurred in the Bre-X results and that there was much less gold than had been previously announced at Busang, Bre-X immediately wrote off the Busang property and ended exploration in the region. The company made no real effort to determine exactly how much gold was at Busang notwithstanding the overwhelming evidence that there was at least a modest deposit in the Busang Central zone and numerous positive indicators for porphyry copper-style mineralization in the Busang South East zone.

Southwestern Resources took a much different and we would say better approach once it was evident that tampering had likely occurred. Hours after CEO John Paterson suddenly resigned, the company announced the withdrawal of all previously announced results for the Boka project and advised that such results should not be relied upon. Southwestern then continued to keep its investors informed throughout the procedures that followed, which included hiring independent consultants to carefully review the results to determine the prospectivity of the project. Four
hundred and thirty-three discrepancies in gold grades were subsequently identified in a public statement but work continued, and eventually the Boka project was sold to Hong Kong East China Non-Ferrous International Mineral Development Co. for $9.4 million in May 2008. Southwestern successfully changed the focus of the Boka project to salvaging some value for its shareholders and eventually was taken over in March 2009 by Hochschild Mining.

— Joseph Groia is a lawyer and principal of Groia & Company Professional Corp. ( www.groiaco.com). James MacNeil is a summer intern at Groia & Company, and is entering his second year of studies in Mining Engineering at McGill University.