Question

In April 1997, Bre-X Minerals, a Canadian company, was supposedly one of the most valuable
companies in the world. Bre-X had convinced numerous mining experts that they had rights to one of
the largest gold deposits ever discovered. It was hailed as the mining find of the century. The
gold mine, located on a remote island in the East Kalimantan Province of Indonesia, supposedly had
so much gold that the actual price of gold on the open market dropped significantly due to the
anticipation of an increased gold supply. Within a few months, thousands of Canadians—big-time
investors, pension and mutual fund, managers and many small investors, including factory
workers—got caught up in “Bre-X fever.” The company’s stock price shot from pennies to more than
$250 per share before a 10-for-1 stock split was announced. Thousands of investors believed they
were on the verge of becoming millionaires.
The story took a sudden turn for the worse when Michael de Guzman, Bre-X’s chief geologist and one
of only a handful of company insiders entrusted with the mine’s core samples, apparently committed
suicide by jumping out the back of a helicopter. Guzman’s suicide was reported around the time that
an independent consulting firm reported that samples from the
mine had been tampered with. The firm concluded that the core samples were made to appear to be
rich in gold by adding a relatively small amount of gold to the samples. In essence, the firm
concluded that Bre-X was a scam of epic proportions!

As the scam came to light, it was unclear who was behind the tampering. While fingers were pointed
at senior Bre-X personnel, others blamed geologists in the field. Bre-X’s President, David Walsh,
was shocked at the news of the tampering and vowed to conduct an investigation. As is the case with
many frauds of this type, numerous class-action lawsuits were filed against Walsh and other Bre-X
executives, alleging that they misled shareholders. Walsh and other company officials received
profits of over $50 million from selling some of their Bre-X stock the year before the tampering
came to light. In the end, many people lost money as the gold find of the century turned out to be
a massive hoax.

You’re a fraud examiner working for the law firm Knight, Enshine, Ing & Armour representing investors in a class-action lawsuit against Bre-X and others including the CPA firm Knotluk, Eisschut & Ahsleap that performed the annual financial audits for BreX. The law partner handling the lawsuit wants your opinion, as an anti-fraud professional, about this case. She’s concerned that the defense will want to “blame the victim” saying that investments are always a risk and there are no guaranteed returns. She wants to make the case that investors were duped by BreX either by intentional design or utter irresponsibility.

Your task is to prepare a memo outlining:

1) the key actions that could have been taken, by any party (including the Canadian government), to prevent or detect the alleged Bre-X fraud,

2) why should have those actions been taken (how could that have prevented or detected fraud)

3) who should have been responsible for taking these actions.

You should be fair and honest in your assessment. In addition to the information you have from the law firm (pg. 376 in the textbook),

a recent Canadian government report provides the following information: • A number of senior Bre-X officials had been investigated previously by U.S. law enforcement and Interpol for a variety of questionable business dealings. • The geologists hired by Bre-X worked for firms with close ties to a former Indonesian government official with ties to organized crime. • The Canadian Stock Exchange listed Bre-X after waiving certain requirements and standards. Canadian securities regulators had not reviewed this because of a case backlog. • Bre-X had refused to share any laboratory, geological, metallurgical or other reports with anyone except for the ones performed on the samples held by Guzman. • Bre-X had not entered into any long-term contracts with mining firms. • This was one in a series of mining scandals in Canada during the past 30 years. • Knotluk, Eisschut & Ahsleap only sent two staffers to Indonesia during the financial audit. Due to the location of the mine, they did make a site visit. Instead, they performed the audit at their hotel. Bre-X provided documentation to them at the hotel and arranged for staff interviews via SKYPE. Neither auditor had any experience in the mining industry, with international projects, did not understand of speak Indonesian (some documents were in Indonesian and English was not the first language for some employees) and had no training in fraud examination. Note: Keep in mind the Fraud Exposure Rectangle on pg.361 and the Fraud Triangle. (I know, fraud examiners love describing things in shapes!)

Answer 1

Fraud Examination : BRE-X CASE STUDY

Bre-X minerals Ltd, a Canadian mining company  was found by David Walsh in 1989. The company purchased a property in Borneo , Indonesia, after following the advise of the company geologist John Felderhof. The company initiated drilling the plot. However the project manager Micheal De Guzman manipulated the samples by filling gold from his wedding ring. By this time the share prices went from 30 cents per share to more than $250 per share. Guzman, Felderhoff and Walsh sold their options at these high prices over the next two years. In the january of 1997, a fire destroyed all the samples collected from the plot. In the same year, Guzman falls 600 ft from the helicopted while on his way to meet the due didligence team. The share prices of Bre-X took a huge fall.

Lets outline the key actions that could have have been taken inorder to prevent the Bre-X scandal. The fraud triangle can be used to analyse the situation.

(Picture source: Google)

Pressure: It is the main motivator of a crime. The offiials behind the scandal must have had the pressure to increase the share prices so as to attract more and more investers to invest in the share of the company. It may be due to this pressure that they kept manupulating the shares. Like in most cases, we can conclude that financial gain was the main motive behind this scandal.

Opportunity: Opportuniy, the second leg of the fraud trinangle refers to the plot that lead to the scandal. One of the major highlights of this case is the fact that the officials kept the gold samples in high secrecy. It is concludable that this was done to prevent getting caught. However it should also be noted that, had the independent auditors asked for more evidence, huge losses could have been prevented to a large extent. It is also notable that since the company had no criminal records, it was easy for the perpertrators to gain the trust of the investors.

Rationalization: Rationalization refers to justifying the crime done by the perpetrator in an attractive manner. the perpetrators can pass the blame on to the victim saying that , markets are subject to risk.

This scandal could have been prevented in a number of ways. It is clear that the auditors have not properly exercised professional skepticism. Evidence from the recent reports from the canadian Government shows corruption in the Indonasian system. However it is not quite possible to point one single person to take the responsibility of this case. Like we have discussed , many of these factors led to this scandal bringing huge losses to the investors.