SETTING NEW STANDARDS — Investor protection key to new guidelines

Higher disclosure standards among several changes advocated It was the stated goal of the Mining Standards Task Force to “enhance investor protection.” The mineral industry has debated the new proposals from its perspective, but investors can be excused for not knowing just how the recommendations of the task force will help protect them.

The short answer is that the recommendations do not protect investors — they give investors the tools to protect themselves. And the investor who uses those tools will be the one to benefit from the new regulatory climate in the mineral industry.

Taking up those tools means realizing that the regulators cannot ensure that the investor will be prudent. They can only try to ensure that the rules are fair, and permit a diligent investor to make intelligent decisions and analyze the risks he is taking in investing.

Even now, some private investors show an astonishing incomprehension of equity investment. To judge from the howls of protest when a company’s shares plummet, many shareholders seem to expect that their shares should never lose value.

So it bears repeating that equity is not like debt: there is no promise to pay. The equity investor gives up his claim to a return, and his claim on the capital he invests, in exchange for a piece of the action.

If the company does well, the shareholder can reasonably expect to share in the bounty — that is what dividends and capital gains are about. But if the company does poorly, the investor can expect to lose money. The “floor” for his loss is provided by the laws that govern limited liability companies: he can lose no more than what he spent to buy the shares.

It also bears repeating that mining and exploration are two different things, and that investing in one is not like investing in the other. A mining company has a producing mine, and the cash flow that comes from operating it. An exploration company lives off its capital, and makes money only if it can increase the value of its assets by making a discovery, developing it, and turning it into a producing mine.

These facts are easy to forget in investment climates like the last bull market, where some investors did not want to be told they might lose money, and some brokers did not have the spine to tell them so.

The new regulatory policies will help the well-informed investor to become better-informed, but the burden of learning the basics of investing must still be borne by anyone looking for return on equity. Nuts-and-bolts knowledge like the difference between debt and equity cannot be ignored.

Still, for the responsible investor, the provisions for review by a qualified professional, guidelines for exploration practice and more complete requirements for corporate disclosure will make information easier to get and more reliable.

The recommendation that a “Qualified Person” (QP) should review the technical content of all corporate disclosure will not in itself prevent fraud or bad practices: there can be dishonest or incompetent QPs. But now the QP must bear professional responsibility for his work, through a self-regulating body enabled by law to take away his licence to practise. This, in itself, may sharpen the concentration of scientists and engineers involved in mineral exploration and development.

The last few months have seen misconceptions about who will be a QP, whether the regulators will keep a list of acceptable QPs, and just what the QP will have to do. What the investor should know is that companies are simply expected to employ professionally licensed scientists and engineers for any exploration work, and that the company must, before releasing news, check it with the same QP that supervised the work. At other times, the company must get an independent opinion on its projects, and that independent opinion must come from licensed professionals as well.

The individual investor should not expect to take a QP to court over faulty work, or regard the QP’s review as a kind of Good Housekeeping seal on the project, but he can at least assure himself that overexuberant disclosure from the company’s senior management will have to meet the approval of the QP, and that the QP can be made accountable for the quality of the review.

The technical minutiae of “exploration best practices” are probably lost on most private investors; for them, the distinction between diamond and reverse-circulation drilling is arcane enough without also going into the difference between an “analysis” and an “assay.”

An investor can and should understand from the best-practices issue that many recent stock scams in the mining industry have hinged on bad science, or on good science badly carried out. The best-practices guideline is meant to ensure that the project’s QP will stick to scientifically sound practices, done the right way, and will have to document clearly the exploration methods the company used.

In its interim report, the task force listed eight Canadian mining stock scandals between 1980 and 1997, yet only two — Bre-X and Timbuktu Gold — were “pure” salt frauds. Two (Cartaway and Golden Rule) grew out of careless or biased field practices, one (New Cinch) out of what may be charitably termed incompetent lab work, and three (International Platinum, Naxos and Delgratia) out of the mad-scientist school of geochemistry.

What the investor can expect from the adoption of a best-practices guideline is that if an exploration company follows poor field and laboratory practices, that fact will come to public notice sooner, and that if a project has originated on the nut fringe, there will be adequate cause for the regulators to get involved early in the project’s life.

Finally, it is the higher disclosure standards recommended by the task force that will enable investors to do their own homework. The detailed requirements for the content of news releases mean that the investor will have the chance to examine the results in greater — and often more intelligible — detail.