Column

The Bre-X fiasco and impotent trading laws

Diane Francis June 2 1997
Column

The Bre-X fiasco and impotent trading laws

Diane Francis June 2 1997

The Bre-X fiasco and impotent trading laws

Column

Diane Francis

The sexiest business story around these days is the Bre-X Minerals Ltd. swindle. Journalistically, it is truly the mother lode. After all, there’s suicide or murder, adultery, greed and conspiracy theories. There’s also the exotica of Indonesia’s jungle, frenzied stock market trading based on Internet rumors and the unabashed grab of assets by Indonesia’s First Family.

But Bre-X is a much more profound story than simply being the world’s biggest mining hoax. It is a penetrating look into the world’s changing financial system. More capital is now being invested in exotic locales where persons rarely play by the same rules. More importantly, the Bre-X situation calls into question the integrity of the world’s stock markets and financial regulatory agencies. That is because there is often no control over information that drives stocks up and down. Bre-X’s pre-demise trading frenzy was the result of hourly rumors posted on the Internet or scurrilous stories in foreign newspapers.

The $3-billion collapse of Bre-X stock on March 26 is the most high-profile stock disaster to date. Just days before the slide, an Internet item said that Bre-X’s main geologist in the field had killed himself because Bre-X’s partner, Freeport McMoRan Copper & Gold Inc., had been unable to confirm the existence of any gold in Bre-X’s Busang field.

It was rumored that the geologist had committed suicide because he had doped, or added gold to, Bre-X’s samples. That rumor was picked up as a news story in an Indonesian newspaper, quoting a source in an Indonesian company in partnership with Freeport who also said insignificant amounts of gold had been found by Freeport.

That source happened to be correct, which means the newspaper story represented a leak of information material to the value of Bre-X stock. As a result, regulators in Canada imposed a trading halt on Bre-X stock while they decided what to do about the situation. Bre-X pleaded to keep the trading halted, but a grey market had sprouted up. This meant that shares were trading outside the stock exchanges among sophisticated institutional investors. That constituted an unlevel playing field because small retail shareholders or would-be shareholders were unable to dump, or buy, Bre-X stock based on the leaked information since the trading had been halted.

And that’s why the regulatory authorities decided they had to force Freeport, and Bre-X, to release results earlier than they would otherwise have done. They also decided that they had to lift the trading halt. So after the dismal drilling results were revealed to all the world, some $3 billion in paper losses were sustained by Bre-X shareholders in a matter of minutes.

No one in Canada is protected from cyber short-sellers who post insider information or lies on the Internet

That capitalist carnage clearly underscored the fact that securities laws are virtually unenforceable. It also means that investor protection measures such as trading halts no longer work.

Freeport and Bre-X each had a responsibility to keep the lid on Freeport’s premature drilling results. Why someone blabbed or how the information was obtained remains a mystery. But the point is that if the leaks had not happened, Freeport would have been allowed to finish all its drilling and testing. And Bre-X would have been able to wait until the results of an independent audit by Toronto’s Strathcona Mineral Services Ltd. had been completed.

The result, as we now know, was exactly the same, because both Freeport and Strathcona were unable to confirm Bre-X’s spectacular reserves estimates. But that’s not the issue. The leak meant that securities laws had been broken by persons unknown. These laws require companies to issue full, fair and timely disclosure of material facts that would affect the price of their stock. The reasoning behind such laws is to level the playing field so that insiders cannot withhold information and buy or sell, based on what they know and what others do not know.

So here regulators were faced with a likely crime in the form of leaks, but were unable to prosecute the culprits. Instead, they were forced to ask Freeport, and Bre-X, to release publicly the same premature drilling results, which were obviously known to those who had already leaked the information. And that news brought about the collapse of the Bre-X stock.

Another lesson to be learned is that the Internet, as well as foreign newspapers, is beyond the protective libel and slander laws of Canada and other civilized countries. Such laws are designed to protect companies and their shareholders from irresponsible journalists, analysts or short-sellers who would spread misinformation to make a stock go down.

But no one in Canada is protected from cyber short-sellers who post insider information or lies on the Internet. No one in Canada can be protected from a Jakarta newspaper with scurrilous information.

Another example of the inability to regulate was what happened to Bre-X on April 23, a record-breaking day in which 17 million shares changed hands. That day, the stock nearly doubled in price on an Internet rumor that Freeport’s president, James Moffett, had resigned. This made Bre-X go up in value in frenzied trading because speculators reasoned that he quit because there was, indeed, gold in Busang despite his company’s test results. Alas, profits had already been taken when a Freeport spokesman said hours later that the rumor was patently untrue.

We have seen the future for stock markets, and it may be more Bre-Xs.