How Bre-X Holders Ignored
Warnings, Got Lost in Glitter
By SUZANNE MCGEE and MARK HEINZL
Staff Reporters of THE WALL STREET JOURNAL
TORONTO -- As gold-fever outbreaks go, the Bre-X
fiasco is among the worst. And angry investors are
still steaming that their promised El Dorado turned
out to be filled with fool's gold.
By May, when independent tests finally disclosed
that there didn't appear to be gold in any of the 268
holes drilled over the past three years by
Calgary-based Bre-X Minerals Ltd. in the Borneo,
Indonesia, forests, billions of dollars of wealth had
disappeared from the stock market. What only
weeks earlier had seemed to be the largest gold find
ever had become the biggest mining fraud in
history.
What is still striking about the whole thing is how
nearly no one suspected that the Bre-X glitter wasn't
real. And some of those who did -- a retired couple
in Calgary, a Bay Street banker, a consulting
geologist -- didn't speak of their doubts at the time
and were slow to act.
"No one looks good in this," says John Embry, who
oversees the Canadian stock investing activities for
Royal Bank of Canada's $32 billion mutual fund
family. He says the two forces that usually keep
markets in balance got seriously out of whack.
"There was no fear, and greed got to crazy levels."
The Gustavsens Pull Out
Some investors did manage to escape with hefty
profits. Lilian and Aksel Gustavsen, retirees in
Calgary, bought 2,500 Bre-X shares in 1994 when
the first drilling results were propelling the stock to
two Canadian dollars a share (US$1.44). After
Bre-X shares soared to C$47, they decided to grab
some profits, selling 80% of their holdings. By late
1996, their remaining holding had become 5,000
shares, thanks to a 10-for-1 stock split, worth some
C$100,000 (US$71,940). That's when they first
heard rumblings that the big find might not be all it
was cracked up to be.
"We heard there might not be gold there," says Mrs.
Gustavsen. Their broker, who she won't name, told
them firmly, "I want you out," she recalls. The broker
didn't explain why, other than to mention suspicions
about the find, but the Gustavsens sold 4,000
shares, stubbornly clinging to their final 1,000. "I still
had faith in [Bre-X's founder and chairman, David]
Walsh," says Mr. Gustavsen, who emerged with a
profit of over US$100,000.
In only two years, Bre-X had mushroomed from just
one of Canada's thousands of speculative mining
firms, run by a former bankrupt mining promoter out
of the basement of his Calgary home, into Canada's
30th largest corporation. It was courted by
companies eager for a piece of its glittering
discovery, as investment analysts competed to
produce the most glowing description of its
prospects; its shareholder list included names like
Fidelity Investments and Quebec's Caisse de depot
et placement, a giant pension fund.
The Collective Mindset
Some investors were lucky enough to sell because
of their concern over the mounting political risk in
Indonesia, which was leaving Bre-X's exact status as
owner and operator of the Busang project unclear.
Yet they're still angry at being duped by Busang
officials, and at their own failure to follow up on some
of the warning flags that emerged at key turning
points in the Bre-X saga.
"The collective mindset was that this was a
wonderful discovery, and anything that contradicted
this belief could be somehow rationalized or
explained away, including the company's geologist
falling out of a helicopter," says Margot Naudie, a
money manager with Jones Heward in Toronto, and
an early Bre-X supporter. "After a certain point, the
stock became harder to avoid than to invest in, and
no one was even willing to look at the risks." Jones
Heward, a unit of the Bank of Montreal that manages
the bank's family of mutual funds, had a net profit on
its overall investment in Bre-X, though it did endure
some losses as the stock plunged.
Many Canadian investors were primed to jump into
Bre-X because they had missed two earlier big
resource finds by Diamond Fields Resources Inc.
and Arequipa Resources Inc., one-time penny
stocks that ultimately were bought out by major
mining firms for billions of dollars. Bre-X brought on
board executives with credibility in an investment
industry already prowling in search of the next
Diamond Fields, and ready to listen to Bre-X's story.
The geological tale was a plausible one, and
whoever laced the core samples with gold didn't go
overboard. And as the company continued to deliver
good results and its stock continued to climb,
skepticism fell.
String of Red Flags
All but ignored were warning signs: a mysterious fire
at the Busang site; heavy insider selling even as
executives withheld news the Indonesian government
had yanked key permits; the fact that the firm's most
recent prospectus was eight years old; Bre-X's
apparent reluctance to reach an acquisition deal with
one of its many suitors; the firm's policy of refusing to
talk to analysts or others expressing doubts about
the venture.
Indeed, even as the string of red flags grew, so did
the list of Bre-X believers. Swelling the ranks of the
original individual investors, who had heard about
the company by word-of-mouth or through specialist
newsletters, were the first institutional investors, a
handful of North American precious metals mutual
funds. As the company's drilling results remained
consistent, analysts at blue-chip trading firms were
taken on tours of the Indonesian site, and returned
with glowing comments and "buy"
recommendations. Giant mining firms like Barrick
Gold Corp., Newmont Mining Co., Placer Dome Inc.
and Teck Corp. were sniffing around, enhancing the
view that the find had to be not only real, but even
bigger than originally thought. As the firm listed its
stock on the Toronto Stock Exchange, the last
handful of skeptics disappeared, buying in as the
stock peaked last September, reassured by the
august presence of J.P. Morgan & Co. as Bre-X's
adviser on a possible sale.
"Can you blame the poor Joe retail investor for
getting taken when only a month earlier Peter Munk
[Barrick Gold's chairman] was making statements
that he wanted Busang?" says one trader on Bay
Street, Canada's equivalent of Wall Street.
"Everything that happened, the arrival of Fidelity, of
J.P. Morgan, just enhanced the credibility of the
whole phenomenon."
Caisse de depot et placement, Canada's largest
pension fund with C$57 billion in assets, lost C$70
million on Bre-X. It bought last December after the
stock was added to the TSE 300-stock index only
seven months after listing on the exchange. The
index listing made a purchase all but inevitable, say
officials at the pension fund, which managed to
unload only a million of its shares early this year at a
profit. So did the universal recommendations by
brokers at blue-chip Canadian investment dealers
like Nesbitt Burns Inc. (owned by the Bank of
Montreal).
"To opt not to participate in the discovery of the
century is a decision that's hard to claim as being
the act of a good fiduciary," says Thomas Gunn,
chief investment officer of the Ontario Municipal
Employees Retirement System, a pension fund that
lost C$45 million in Bre-X.
The Greater Fool Theory
The fear of losing out on the next Diamond Fields
drove some funds like Toronto Dominion Bank's
Precious Metals Fund into Bre-X. The fund ended up
losing about C$10 million of its C$12.7 million
investment in the firm in late March. But last summer,
when the stock soared, split 10-for-1, was listed on
the TSE, and the mining giants were circling Bre-X,
it seemed that it was the right bet to make.
"The 'greater fool' theory really did apply to the
trading in Bre-X by this point," says William
McKenzie, vice president at Fairvest Securities
Corp., a Toronto firm which represents the interests
of institutional shareholders. "Everyone was buying
the stock sure that someone else like a takeover
bidder would drive it higher."
Unknown to the vast majority of shareholders,
however, by mid-1996 enough concern was already
circulating in the inner circles of these mining firms
that a multibillion dollar takeover was looking less
likely. Barrick had relinquished the idea of a hostile
bid, in part because it couldn't have imposed any
conditions -- such as proof that the gold really did
exist.
Richard Warden, manager of American Express
Co's American Express IDS Precious Metals Fund,
began selling in the final months of 1995, as the
stock approached C$100 a share.
"It just gets so large that you have to question the
valuation, especially as a percentage of your
portfolio," he explains. He netted US$10 million on
his investment, even though he'd started buying
some again as a takeover play in 1996 and failed to
get out in time to avoid the crash. Royal Bank's Mr.
Embry, one of the earliest investors, also sold his
much of his five million-share position, acquired for
the equivalent of 21 Canadian cents, for an average
of C$20 a share. He declined to give the total profit.
Some of the biggest profits were being recorded by
Bre-X's corporate insiders. While opting not to tell
the world about the cancellation of the preliminary
drilling permit, Mr. Walsh, John Felderhof, then
Bre-X vice chairman and chief geologist, and two
other executives sold a total of C$37.6 million of
stock. When the news trickled out months later,
infuriated investors were told Bre-X didn't consider
the cancellation material, and that the sales were
"incidental" and "unimportant."
'Managers Should Have Known'
Some professionals managed to steer completely
clear of Bre-X. Robertson Stephens, the San
Francisco investment firm known for its interest in
speculative mining ventures and an early player in
Diamond Fields, firmly passed on Bre-X after its
geologist reviewed the project's details. The
company declined to discuss its decision further.
FMR Corp.'s Fidelity Investments pared its holdings
of Bre-X substantially in the months preceding the
revelations by Freeport-McMoRan Copper & Gold
Inc. that it had found only traces of gold in some of
Bre-X's test drill holes. At the end of 1996, some 15
Fidelity funds held 7.62% of Bre-X, a position that
had slumped to only 2% by late March. By the time
the stock was suspended on the TSE and Nasdaq,
market sources say Fidelity had unloaded its
remaining holdings. Other than saying that over the
entire time frame in which its 15 funds owned Bre-X,
they as a group made a profit, Fidelity spokesman
declined to comment on holdings of individual
securities.
Greg Chorny, who bought the stock early in its
meteoric rise and made tens of millions of dollars on
it, is nevertheless angry.
"Had this been what they promised us it was, I would
have made 10 times what I did," says the Aurora,
Ontario, investor, who has made enough by investing
in speculative mining stocks to stop practicing law
and concentrate on investing and golf. "Managers
should have known investors were relying on
incomplete information. Anyone who got out of this
giant fraud did so only out of luck." |
