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A short introduction to what happened. Explain the fraud.
Fraud is defined as intentionally deceiving or causing damage to another individual or individuals in order to acquire personal gain. It is a misrepresentation of specific facts by a person aware of the falseness in order to persuade others, so the individual is able to achieve that personal gain.
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The Bre-X scandal is a perfect representation of fraud. It began in 1990 when a Canadian based company from Calgary, Alberta declared that they had made a discovery of a “world-class gold deposit” in Busang, Indonesia. The gold reserves kept on increasing until reportedly 200 million ounces of gold had been found. Along with this amazing discovery of gold, the share prices for the company increased drastically, leading to their listing on the Toronto Stock Exchange. With the success Bre-X had achieved, other powerful mining companies were interested in purchasing and buying them out. At this point, the insiders from Bre-X were multimillionaires.
When an investigation began in 1997, people soon discovered that there was actually hardly any gold in Busang. It was discovered that alluvial gold dust had been purchased from local Indonesian placer miners to “salt” the rock cores. It was reported that in 1996, the salting had increased to the point where the metallurgists of Bre-X hired laborers involved in a construction project to assist with the mixing. It was a complete scam, and there was no recoverable gold. With this horrendous discovery, the share prices plummeted, resulting in a drop of $6 billion in market value. The individuals who were owners of these shares suffered gigantic and significant losses.
Introduce the company involved, what industry, financial health (before the fraud) and history.
Bre-X was founded and created in 1988 by David Walsh. The initial objective of the company was to search for diamonds located in the North West Territories of Canada. The company was not able to achieve success in finding any significant deposits of diamonds in the Northwest Territories. During this time, Bre-X Minerals Ltd’s stock listing was on the Alberta Stock Exchange, obtaining an average price of 27 cents between 1989 and 1992.
David Walsh filed for personal bankruptcy in 1993 due to the accumulation of $60 000 in credit card bills. Financially, Walsh and his company were not finding much success, so he decided to sell part of his ownership in Bre-X for $10 000. Walsh realized that his company was not achieving much success and that he had to find different opportunities. He decided to go to Indonesia to look for opportunities with his friend, a geologist named John Felderhof. Felderhof, along with another geologist, believed there was a special opportunity in one of the sites in Indonesia. This site was 57, 571 hectares in Samarinda, East Kalimantan, Indonesia. It was also known as Busang. After being convinced by Felderhof, Walsh decided to take the risk. Bre-X purchased the site for $80, 100.
Bre-X was not financially sound, and received three different private placements. The first placement was initiated with Ondaatje McCutcheon, Ltd for $4.5 million in March 1994. More capital was needed for further drilling to continue, so that the exploration was funded. The second private placement, initiated in May 1995, was with Nesbit Burns, Scotia McLeod, and McLean McCarthy Ltd for $7.5 million in common shares. This was used towards working capital and to proceed with and fund exploration. The third private placement was by Nesbit, Scotia McLeod, Levesque Beaubien Geoffrion, and First Marathon Securities for $30 million in February 1996. Bre-X used these private placements to cover the expenses of their drilling and exploration for gold.
State the “players” or key personnel involved in the fraud.
Most Bre-X employees were involved with this gold mining fraud, but there are three main individuals who orchestrated it. David Walsh, John Felderhof and Michael de Guzman were the key personnel involved in the fraud.
David Walsh was known as the founder of the company and the CEO. While he did not ever admit of any wrongdoing, it is clear that he was very involved. When Freeport analyzed the gold, they realized that the gold was alluvial, meaning it had originated from rivers, and was not gold that originates from volcanic deposits. The tests taken by Freeport were not matching the results reported by Bre-X. At this point, Walsh was threatening legal action upon false allegations because he knew that the results from his company were accurate. A couple of days, Bre-X admitted that some of the results were in fact overstated due to invalid samples. David Walsh was clearly aware of the entire scandal, which helped him earn millions, but constantly denied any reports of fraud.
The other two major players involved in the fraud were the two geologists who established Busang as the mining site, John Felderhof and Michael de Guzman. They were both confident with the existent of gold in this area, but eventually realized that they were mistaken. The reason of the salting is thought to be due to the faith of these two geologists in the gold that they thought was located at Busang. Salting the rock cores was a method of ensuring enough capital to fund the exploration for it. Eventually, Bre-X shareholders’ expectains grew, but there was no actual gold being found. Instead, the salting operation continued leading to the biggest mining fraud in history. Felderhof and de Guzman did not want to accept that they were wrong, so they used this method to cover it up until gold was finally discovered.
What happened to the “players”? Jail time, fines, etc.
The Bre-X fraud led to billions of dollars being lost, but there weren’t any consequences for the people involved. The three men that schemed and generated this entire scandal were never met with any type of consequences laid upon them legally. Whether it was lack of evidence or the Canadian court system, but it seemed as if everyone involved got off very easily.
David Walsh made earnings of $35 million by selling shares in Bre-X. Going from filing for bankruptcy to making $35 million is a large difference, especially knowing this success was obtained through a fraud. Walsh would not be charged legally, meaning he had become a multimillionaire through this scandal. After the collapse of Bre-X, Walsh moved to the Bahamas with his earnings. Shortly after, David Walsh would die due to brain aneurysm at the age of 52.
John Feldorhof, the chief geologist of Bre-X, made $84 million by selling his Bre-X shares. He would eventually move to the Cayman Islands, and still resides there. Out of all the people involved in the fraud, he was the only one who was tried in Canada. Felderhof was being tried on the charges of insider trading and misleading investors. Many argued that he should have been charged with fraud and not these less disciplinary charges. Either way, in July 2007, the judge reached a not guilty verdict on this case. John Felderhof was found not guilty.
Michael de Guzman is the most interesting case out of these three men. He was not able to gain as much as his partners through this mining fraud. Freeport had demanded to know about the differing results they had received from their examination of the gold, so de Guzman was sent to deal with the Freeport representatives. He jumped out of the helicopter that was taking him to Indonesia. He would fall 240 meters to his death. It was claimed that it was a large part due to his fight with Hepatitis B. It was just a couple of days before the fraud was uncovered to the public, leaving many people to suspect that he couldn’t take the pressure and eventual allegations.
State details of the actual fraud – type of fraud, $$ involved
The Bre-X scandal is the perfect example of a true fraud that results from dishonest and deceitful business ethics, morals, and principals. The Bre-X scandal is considered to be the biggest mining and gold scandal of all time, and one of the biggest stock scandals in Canadian history. The Bre-X scandal significantly damaged the Canadian Financial Markets and caused substantial reductions in consumer buying and trading confidence, which caused a considerable amount of damage to the Canadian economy. Subsequent to the collapse of Bre-X in 1997, its stocks and shares became worthless and left investors with significant losses.
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The Bre-X scandal began in March 1993, subsequent to the company purchasing a large mining site in Busang, Indonesia (on Borneo). Subsequent to Bre-X purchasing the mining site in Busang, it boasted that it was sitting on the largest known gold deposit in the world. In October 1995, Bre-X announced that it had discovered significant amounts of gold on its mining site in Indonesia. Subsequent to this, the company had been followed and recommended by some of the best known gold analysts in both Canada and the United States. Consequently, there was a lot of optimism and sanguinity in the stock market, as investors and brokers wanted to invest into Bre-X in hopes that they will became instantly rich overnight. This led to Bre-X being added to the Toronto Stock Exchange’s TSE 300 index and traded on NASDAQ.
At its climax and peak, the market capitalization of Bre-X reached over 6 million Canadian dollars. This extremely high market capitalization is quite suspicious and apprehensive as Bre-X was a penny stock four years earlier and only had a peak market capitalization measured in the thousands. Bre-X’s massive growth and market capitalization expansion was all based on fraudulent claims and no real hard evidence and proof; the hype of the Bre-X stock from financial analysts coupled with the boastful comments made by Bre-X led to the skyrocketing and soaring prices and values of its stock, which, in turn, led to the increase in Bre-X’s market capitalization.
The Bre-X fraud began to quickly unravel on March 26, 1997 when the American firm Freeport-McMoRan, a forthcoming partner in excavating the Busang gold site, publicly announced that it conducted due-diligence core samples and found insignificant amounts of gold in the excavated samples. This public announcement caused the rapid selling of Bre-X stocks which, in turn, caused the postponing of a mining deal between Bre-X and Suharto. Bre-X blatantly denied the accusations by Freeport-McMoRan and demanded more reviews of the gold quantity at the site by other gold analyst companies. This led to a third-party independent company, Strathcona Minerals, being brought in to check the gold samples at Busang. When the report with the results from the Strathcona Mineral analysis was published on May 4, the Busang ore samples had been salted with gold dust. It was discovered that alluvial gold dust had been purchased from local Indonesian placer miners to “salt” the rock cores. It was reported that in 1996, the salting had increased to the point where the metallurgists of Bre-X hired laborers involved in a construction project to assist with the mixing. It was a complete scam, and there was no recoverable gold in the Busang mining site.
Subsequent to discovery of the gold scandal at Busang being revealed, Bre-X stocks plummeted in value and trading of the stock ceased and the stock was removed from the TSX and NASDAQ. Consequently, mutual funds, pension plans, and private investors all over North American took substantially heavy losses subsequent to the stock plummeting. Numerous class-action lawsuits were filed in Canada and the United States; some of these lawsuits were targeted towards Canadian and American investment firms because they had recommended the stock for so long.
State what GAAP principles were violated during the fraud and tell how the GAAPS were violated
The GAAP’s that were violated and contravened during the Bre-X scandal were: The Principle of Conservatism, The Objectivity Principle, and the Cost Principle. These GAAPs were all violated due to the fact that the accountants of Bre-X were refusing to undertake proper business ethics in their profession and create legible financial statements as they were personally involved in the fraud themselves.
The Principle of Conservatism states that the accounting for a business should be fair and reasonable so that the assets or profits of a business are neither overstated nor understated. In the Bre-X scandal, the Principle of Conservatism was violated because the accounting for the company, Bre-X, was not fair and reasonable as the assets of the company were blatantly overstated. The overstating of the assets affected the investing decisions of investors and brokers, as these individuals analyzed Bre-X’s financial statements and received an incorrect perception of the company’s strength and health. The overstating of the assets led to Bre-X being listed on the TSE and NASDAQ, which, in turn, led to the stock value sky rocketing and soaring to extreme highs that would’ve been something absolutely unprecedented to predict as the company was a penny stock only four years earlier. Overall, the Principle of Conservatism was violated by Bre-X in the fraud due to the overstating of its assets, which led to the massive expansion of Bre-X; in addition, this also led to significant losses to investors when the company crashed when the fraud was revealed.
The Objectivity Principle states that accounting will be recorded on the basis of objective evidence, which means that accountants have to base transactions on real factual evidence, rather than opinions, feelings, or falsified data. The Objectivity Principle was violated during the Bre-X scandal because falsified data was used to record the transaction for the purchase of the land in Busang, Indonesia. The price on the source document for the purchase of the land was not used by Bre-X accountants, as they used a falsified valuation of the land made by a Bre-X insider to record the transaction of the land. This fraudulent recording of the land asset led to the assets of Bre-X being overstated, which led investors to false and ambiguous conclusions when choosing where to invest; the higher asset valuation led more investors to investing into Bre-X, which only led to billions of dollars being lost by investors when the fraud was revealed. Overall, the Objectivity Principle was violated by Bre-X in the fraud due to the purchase of the land asset in Busang being blatantly overstated due to the use of a false asset valuation conducted by a Bre-X insider, rather than the use of the actual amount on the source document for the purchase of the land.
The Cost Principle states that the accounting for purchases must be at the cost price to the purchaser, which appears on the sources document for the transaction, in almost all cases, as there is no place for guesswork of wishful thinking when accounting for purchases. In addition, the Cost Principle states that when there is no source document for a purchase, the item has to be recorded at a fair market value that must be determined by some independent means (ex. third party auditor). The Cost Principle was violated during the Bre-X scandal, because the accountants for Bre-X did not state the value of the land asset that they bought in Busang, Indonesia at the price that they bought it at, as they conjured up falsified evidence and recorded the value of the land asset at a significantly higher asset price than what was paid for it. In addition, the Cost Principle was also because Bre-X should have consulted a third party auditor to evaluate their land asset, rather than using an insider from their own company to value the land. The company insider that evaluated the Busang land used falsified evidence from the Bre-X geologist, Michael de Guzman, to place an unfair market value on the land asset. Overall, the Cost Principle was violated by Bre-X in the fraud due to the value of the land asset in Busang not being recorded at cost price nor a fair market value, as inequitable and unwarranted asset valuation was done by a Bre-X insider.
Who were the auditors? What do auditors do? What role did they play in this fraud?
Auditors are independent certified public accounts that are responsible for examining the financial statements that a company’s accounting department prepares. Auditors are specialized in the testing of financial statements and accuracy within a company, hence, business hire auditors to perform audits to ensure that their financial statements comply with the laws laid out by the government and the Generally Accepted Accounting Principles (GAAPs). An audit is the examination of the accounting records and internal controls of a business to be able to express an opinion about the business’s financial position and results of operation. Subsequent to the audit, an auditor is responsible for providing a written report to the business that contains an opinion as to how the financial statements are prepared and if they comply with Government laws and GAAPs.
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