Why First Nations Should Be Wary of Junior Miners

Southwestern collapse awakens ghosts of Bre-X; [Final Edition]
David Baines. The Vancouver Sun. Vancouver, B.C.: Feb 9, 2008. pg. G.1
Abstract (Summary)

In addition to being the company's most senior officer and largest shareholder, [John Paterson], a professional geologist licensed in Australia, was the company's "qualified person" -- the person responsible for ensuring the veracity of the company's news releases and technical reports. With such a heavy financial interest in the company, he obviously had a huge vested interest in the success of the Boka project, a potential conflict of interest.

"I contacted Paterson and told him I was getting a lot of criticism. He said, 'I guess my credibility is gone, too.' I said, 'That's what I'm hearing, too'."

"This situation proves that when you have two geologists in cahoots, 43-101 really doesn't work," [David Black] said. "If somebody is professional and clever, it is very hard to protect against fraud."


Southwestern Resources Corp. was one of the first exploration companies to jolt the investment community out of its Bre-X Minerals- induced slumber.

"This may be the discovery that injects new life into the junior Canadian resource sector," resource stock analyst John Kaiser said in December 2002, when Southwestern announced dazzling assay results from its Boka gold project in the Yunnan province of China.

The irony, which nobody knew at the time, was that Southwestern would become a Bre-X-like scandal.

Upon news of the initial assay results, the stock immediately doubled to $5.35, but as events unfolded, that was just the start. Over the next year, the company issued many more impressive assay results. By January 2004, the stock peaked at $21.30, giving Southwestern a total stock market value of more than $800 million.

It was a giddy time, not only for investors but also for the company's founders: president and CEO John Paterson, chairman George Plewes, and vice-president of exploration Dan Innes. In 2004, Paterson earned $5.2 million in salary and options, placing him eighth on The Vancouver Sun's list of most highly compensated B.C. public company executives. Plewes ranked ninth that year at $4.9 million, and Innes 19th with $3.4 million.

Despite his new-found wealth, Paterson did not live a flamboyant lifestyle. He and his wife, Joan, reside at 4311 Angus Drive in Vancouver, currently assessed at $2.62 million, a relatively modest price for that neighbourhood. In June of 2005, Joan acquired a home on Saltspring Island for $1.58 million. (It is currently assessed at $1.63 million.)

Paterson was the company's boss, not by virtue of his management style, which could be brusque, but because he controlled the largest block of shares. He didn't always see eye-to-eye with Plewes, who left the company in 2004, or with Innes, who left in early 2006.

In addition to being the company's most senior officer and largest shareholder, Paterson, a professional geologist licensed in Australia, was the company's "qualified person" -- the person responsible for ensuring the veracity of the company's news releases and technical reports. With such a heavy financial interest in the company, he obviously had a huge vested interest in the success of the Boka project, a potential conflict of interest.

While early assay results were promising, later results were erratic. Investor hopes that Boka could be a bulk tonnage play began to diminish. By mid-June 2007, the stock had declined to the $6 level.

David Black, a Vancouver lawyer who took over as chairman when Plewes left, said Paterson had been telling investors that a feasibility study would be completed by the end of June, "but it was obvious that was not going to happen."

On June 18, when the company announced the study would be delayed until the end of the year, "investors started to scream at me," Black recalled.

"I contacted Paterson and told him I was getting a lot of criticism. He said, 'I guess my credibility is gone, too.' I said, 'That's what I'm hearing, too'."

The next morning, Paterson resigned. The board then struck a special committee to investigate the delay. Tim Jauristo, who had replaced Paterson as CEO, went to China and discovered that the numbers reported in Paterson's news releases did not correspond with the numbers in the assay database.

Somebody had juiced up the figures, in some cases by moving the decimal point one digit to the right, increasing the grades by a factor of 10. For Black, it was a "eureka" moment, only in reverse. The stock price plunged by 80 per cent, to $1.25.

At that point, Paterson disappeared from view. He did not answer telephone or e-mail messages. His wife issued a statement saying that, on his doctor's advice, he had been admitted to hospital for clinical depression and would cooperate "when he is well enough to do so."

In August, the company filed a lawsuit against Paterson, alleging he had altered assay results and cashed in stock during the ensuing share price run-up. How much stock is not stated, but it is believed to be worth at least $2 million. While a substantial amount, it is a fraction of the illicit profits made by Bre-X geologist John Felderhof.

To ensure that Paterson did not liquidate any more assets, the company obtained an injunction freezing all his assets, other than $100,000 for legal fees and $9,000 per month for living expenses. His wife, in consideration for not being enjoined in the action, agreed to a similar injunction, and was similarly permitted to draw $100,000 for legal fees and $15,500 per month for living expenses.

Paterson's scheme, relative to the amount of his illicit profits, caused immense damage to investors. From a peak of $800 million, the company's market capitalization (with the stock now at 57 cents) has slid to a mere $25 million.

Two Ontario law firms and a B.C. firm have filed prospective class actions, claiming some $320 million in damages. "We are still gathering information, weighing our next course of action and how best tactically to pursue the litigation," lead counsel Dimitri Lascaris of Siskinds LLP in Toronto said in an interview this week.

"It seems relatively clear who was at the centre of the scandal, but the extent to which others may have knowingly or negligently permitted this to happen is something that remains to be determined."

When the altered assay numbers were discovered, the company immediately fired the project manager in China, John Zhang, who, according to Black, was "in on the scheme." The company is pursuing legal action against him in China.

In the wake of the Bre-X scandal, the securities industry implemented a new regime for formalizing and standardizing mineral disclosure, including the appointment of a professional geologist as a "qualified person" to supervise the disclosure (called National Instrument 43-101).

"This situation proves that when you have two geologists in cahoots, 43-101 really doesn't work," Black said. "If somebody is professional and clever, it is very hard to protect against fraud."

Paterson has gone into mitigation mode and is negotiating a settlement with the company. Southwestern, in turn, is working to settle the class-action lawsuits.

Paterson also has to deal with the B.C. Securities Commission and the RCMP. With regard to the commission, he will almost certainly agree to a lifetime ban from the B.C. securities market. Any fine would be postponed to investor claims, which is the commission's usual practice.

The big wild card is the criminal proceedings. The RCMP Integrated Market Enforcement Team is putting together a brief for Crown, which will almost certainly lay charges. It is clear that a scheme of this magnitude, duration and premeditation will attract a jail sentence. The only question is how long.

Paterson's lawyer, Rod Anderson of Harper Grey LLP in Vancouver, could not be reached for comment on Friday. Paterson is believed to be still living at his residence on Angus Drive. On Thursday, when I knocked on the door, nobody answered.

I returned to the street and about 10 minutes later, two women exited with two small dogs on leashes. They glanced briefly at me, turned and walked in the opposite direction.

dbaines@png.canwest.com