Professionalism/Michael de Guzman and the Bre-X Scandal

Introduction This chapter explores the 1997 Bre-X gold mining fraud. We examine the enabling forces around the scandal and analyze Michael De Guzman's specific cover-up strategy. Participants include Bre-X management, investors, the Indonesian Government, Freeport-McMoRan, Busang villagers and the Ontario Securities Commission. We discuss evident decision traps that are applicable across industries and professionals. thumb|Scandal that shook the Gold Mining industry thumb|Bre-X mine located on Borneo __TOC__ Timeline of Events Team Formation In 1988, David Walsh founded Bre-X Minerals Ltd out of his basement in Calgary, Canada.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf Initially focused on diamond expeditions in the Northwest Territories, Bre-X found little success in its first years of operations. After several failed expeditions, Walsh filed for personal bankruptcy in 1991.Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm To "put some romance into Bre-X," Walsh shifted his company's focus to foreign gold expeditions. He reached out to John Felderhof, a geologist famous for discovering the largest gold mine in Papua New Guinea, and together they targeted the jungles of Indonesia.Stephenson, A. and Seskus, T. (2017, January 26) Behind ‘Gold’: The real story of Bre-X proves life is stranger than fiction. Retrieved May 8th from http://www.calgarysun.com/2017/01/26/behind-gold-the-real-life-story-of-bre-x-proves-life-is-stranger-than-fiction Felderhof was named General Manager of Bre-X's Indonesian exploration and brought in Michael De Guzman, a Filipino geologist and long-time friend. Following De Guzman's and Felderhof's guidance, Walsh purchased land in Busang on the island of Borneo. R. v. Felderhof (2007, July 31) Ontario Court of Justice. Retrieved May 8th from http://www.groiaco.com/pdf/Judgment.pdf thumb|Lehman Brothers endorsed Bre-X Striking Gold Although over twelve mining companies labeled the land as "worthless", De Guzman and Felderhof were confident they would strike gold. This optimism faded, however, after failing on their first two attempts. "We almost closed the property," said De Guzman, claiming that Felderhof said "close the property" just before their initial hit.Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm After finally striking gold in 1995, Bre-X estimated over 30 million ounces of gold on the property.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf De Guzman and Felderhof continued to survey the land, and their estimates rose with each newly discovered sample.Henchek, C. (1998 June) Bre-X: The Lure of False Gold. Engineering and Mining Journal. By 1997, Bre-X's estimate eclipsed 71 million ounces of gold. R. v. Felderhof (2007, July 31) Ontario Court of Justice. Retrieved May 8th from http://www.groiaco.com/pdf/Judgment.pdf Felderhof believed the valuations could eventually exceed 200 million ounces, more than the Californian gold rush. When asked about the find, Walsh said "We all find it hard to believe that we're responsible for the largest gold discovery probably in the history of the world."Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm Stock Price Soars As word of the discovery spread, investors flocked to Bre-X. J.P. Morgan made public statements endorsing the Busang site and Lehman Brothers labeled it "the gold discovery of the century."Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf In 1996, Walsh began trading the once penny-stock on the Toronto Stock Exchange. The stock price soared from 30 cents to $170 in just two years.Dolphin, R. (1996, March 3) Stock of the century: Investors hit jackpot with gold mining. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold Local investors saw immediate gains, with one Canadian woman claiming to know "about five new millionaires."Crowe, K. (1996, March 11) Gold fever sweeps investors after Bre-X discovery. Retrieved May 8th from http://www.cbc.ca/archives/entry/bre-x-gold-fever thumb|Indonesian President Suharto played active role in negotiation Indonesian Government Intervention As gold estimates soared, the Indonesian government and President Suharto intervened. R. v. Felderhof (2007, July 31) Ontario Court of Justice. Retrieved May 8th from http://www.groiaco.com/pdf/Judgment.pdf Fearful that Bre-X lacked the resources necessary to handle the growing gold mine, President Suharto forced Bre-X to enter a partnership with a larger gold mining company. Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf Suharto also did not realize that his country was sitting on such a large reserve of gold and wanted to make sure that he had a piece of the pie. By the end of negotiations, Bre-X held 45% of the land, the Indonesian government owned 40% and Freeport-McMoRan claimed the remaining 15%.McNamara v. Bre-X Minerals Ltd., 197 F. Supp. 2d 622 (2001, March 30) U.S. District Court for the Eastern District of Texas. Retrieved May 8th from http://law.justia.com/cases/federal/district-courts/FSupp2/197/622/2430937/ Collapse Six weeks after closing the deal, Freeport-McMoRan began due diligence testing in Busang by completing core holes 1-2m away from the four Bre-X drill-holes that contained the highest gold grades. After failing to strike gold in any of these holes, Freeport requested to meet with De Guzman to discuss their findings. On his way to the meeting, De Guzman committed suicide, jumping out of his helicopter.Wilton, S. (2007, May 26) The mystery of Michael de Guzman. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold As news spread of De Guzman's death, fearful investors sold over nine million Bre-X shares.Calgary Herald and Herald wire services (1997, March 22) Nervous investors pound Bre-X shares. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold Walsh urged investors to ignore the rumors and launched an independent investigation.Ewart, S. (1997, March 20) Bre-X geologist plunges to his death from helicopter in Borneo. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold To Walsh's dismay, the investigation determined that "the estimated size of the Busang reserve was based on falsified data." Bre-X Minerals LTD. (1997, May 4) News Release. Retrieved May 8th from http://www.infomine.com/press_releases/bxm/pr050497bxm.html Bre-X lost $583 million dollars as the stock fell 80 percent, crashing the Toronto Stock Exchange's computerized trading system.CNN Money. (1997, May 5) No gold at Bre-X site. Retrieved May 8th from http://money.cnn.com/1997/05/05/companies/brex/ In November of 1997, Bre-X filed for bankruptcy.Deloitte & Touche Inc. (1997, November 5) Bre-X Minerals LTD., In Bankruptcy. Retrieved May 8th from http://www.insolvencies.deloitte.ca/en-ca/Pages/BRE-X%20MINERALS%20LTD__%20IN%20BANKRUPTCY%20.aspx?searchpage=Search-Insolvencies.aspx The Cover-up Salted Samples In the aftermath of the scandal, Strathcona Mineral Services conducted an independent audit of Bre-X. They discovered that Bre-X had tampered with the core samples, adding gold from an external source.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf In their report, they commented on the historical significance of the tampering, astounded by the length, scale and accuracy of the tampering operation.Historica Canada. (1997) Bre-X Collapses. Retrieved May 8th from http://www.thecanadianencyclopedia.ca/en/article/bre-x-collapses/ The report concluded that a member of the Bre-X team most likely engaged in "salting", sprinkling gold onto samples before shipping them to the lab for testing.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf Interviews with on-site workers revealed suspect operational procedures. The testing labs were "very downstream" from the mining facility, giving De Guzman privacy to prepare the samples.Scheider, H. (1997, May 18) A Lode of Lies: How Bre-X Fooled Everyone. Retrieved May 8th, 2017 from http://www.washingtonpost.com/wp-srv/inatl/longterm/canada/stories/brex051897.htm Workers reported De Guzman leaving open bags of rock samples in his office and often "blend[ing] pulverized rock samples with reddish, white and gold-colored powders" into the samples.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf Some journalists speculate that initial salting was simply to extend the project, but the salting continued after the enormous estimates returned from the lab.Henchek, C. (1998 June) Bre-X: The Lure of False Gold. Engineering and Mining Journal. thumb|De Guzman used Volcanic Pool Theory to rationalize unorthodox procedures Volcanic Pool Theory Prior to joining the Bre-X operation, De Guzman developed the "Volcanic Pool Theory." De Guzman believed that when a volcano "collapse[s] back onto itself," gold is created from the "massive buildup of heat and pressure." Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm The "Volcanic Pool Theory" motivated Bre-X's selection of Busang and justified their unorthodox mining practices. Busang's proximity to volcanoes made it the ideal location to test De Guzman's life work and potentially prove his Theory. Under typical mining conditions, after extracting a core sample from the ground, half is sent to the lab for testing and the other half is stored for future audits.Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf De Guzman argued that volcanic pressure causes a non-uniform distribution of gold across the core sample. For this reason, the entire sample must be tested to accurately measure the gold content.Lawrence, M. (1998, March 26) Expert Witness Deposition in Lane McNamara, et al. v. Bre-X Minerals Ltd. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1998326_o20x_Lawrence.pdf This procedure resulted in minimal core sample storage, preventing future auditors from accurately assessing the valuations. Henchek, C. (1998 June) Bre-X: The Lure of False Gold. Engineering and Mining Journal. Traps in Decision Making De Guzman surrounded himself with young geologists that recently graduated from college. Their inexperience resulted in minimal questioning of management, despite De Guzman's unorthodox practices. An observer likened the Bre-X team to "the geological equivalent of the batboys for the World Champion Yankees." While they were excited to partake in the gold rush, their inexperience limited their role in the operation.Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm This limited role allowed De Guzman's tactics to go unchecked. During the due diligence process, several investors questioned Bre-X's testing of the entire core sample. Felderhof responded by asserting De Guzman's expertise, arguing he does "not have time to educate them on the various grade determination methods for gold commonly used on a global basis in the mining industry."Lane McNamara, et al. v. Bre-X Minerals Ltd. (1997, July) Civil Action No. 597CV159. United States District Court for the Eastern District of Texas. Retrieved May 8th from http://securities.stanford.edu/filings-documents/1012/BXMNF97/1997725_r05c_97159.pdf Because most investors lacked experience in the mining industry, many blindly trusted the "Volcanic Pool Theory" justification, leading to high valuations and minimal further questioning.Henchek, C. (1998 June) Bre-X: The Lure of False Gold. Engineering and Mining Journal. Normalization deviance has also plagued investors in the mining industry. Investors have fallen for similar scandals in the past including a Uranium scandal in Utah in 1954, a Nickel scandal in Australia in 1969 and most recently, a gold mining scandal in China in 2007. Overconfident market expectations caused the stock prices of these companies to soar.Walker, S.(2016, October 5) Exposing Bubbles, Shysters and Out-and-out Scams. Retrieved May 8th from http://www.e-mj.com/features/6468-exposing-bubbles-shysters-and-out-and-out-scams.html#.WRHQFNLys2y Although skepticism of reported findings increases after a scandal like Bre-X is uncovered, decision fatigue eventually settles in and investors fall for similar traps over time. Aftermath Busang Community Members At the height of Bre-X's valuations, many local villagers moved their families to Busang. Much like the gold rush of California, most of these villagers left everything behind in hope of finding gold. Bre-X encouraged settlement, electrifying local villages and building a new church and kindergarten.Behar, R. (1997, June 9) Jungle Fever: The Bre-X Saga is the Greatest Gold Scam Ever. But to Understand the Enormity of the Fraud, You Had to Be There. Our Man in Borneo Tells his Story. Retrieved May 8th from http://archive.fortune.com/magazines/fortune/fortune_archive/1997/06/09/227519/index.htm Local villagers have remained in the area in hopes of striking gold. Said one villager who pans for gold each day, "There is gold here. If there is someone who was interested to continue the Busang project, please come to Indonesia."Wilton, S. (2007, May 29) Back to Busang. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold thumb|Canadian Government increased regulations, passing NI 43-101 No Criminal Charges Many investors accused Walsh and Felderhof of colluding with De Guzman, citing instances of suspicious behavior. When Bre-X filed for the U.S. Securities and Exchange Commission, they announced they "prepared, reviewed or verified [their findings] with independent mining experts," but failed to disclose that the samples were always drawn and controlled by Bre-X. Felderhof and Walsh also raised suspicion when they each sold $25 million in Bre-X stock prior to De Guzman's suicide. The courts ruled in favor of Felderhof and Walsh, claiming they "acted with their normal professionalism, which by its very nature bestows credibility."Scheider, H. (1997, May 18) A Lode of Lies: How Bre-X Fooled Everyone. Retrieved May 8th, 2017 from http://www.washingtonpost.com/wp-srv/inatl/longterm/canada/stories/brex051897.htm The Judge further believed "Felderhof has proven that he took all reasonable care."Stephenson, A. and Seskus, T. (2017, January 26) Behind ‘Gold’: The real story of Bre-X proves life is stranger than fiction. Retrieved May 8th from http://www.calgarysun.com/2017/01/26/behind-gold-the-real-life-story-of-bre-x-proves-life-is-stranger-than-fiction The Nasdaq also released a statement claiming that Bre-X passed the SEC's filing and financial requirements.Scheider, H. (1997, May 18) A Lode of Lies: How Bre-X Fooled Everyone. Retrieved May 8th, 2017 from http://www.washingtonpost.com/wp-srv/inatl/longterm/canada/stories/brex051897.htm New Regulations A spokesperson for Nesbitt Burns, an investment company that endorsed Bre-X, argued under the current reglatory climate, "our analysts rely on publicly available information...our experts are not experts in uncovering fraud." He further claimed, "our industry and our clients have been victimized." In the late 1990s, Canadian gold mining companies were not liable for the accuracy of their gold estimates. Because Bre-X did not publicly offer their shares, standardized due diligence was not required.Scheider, H. (1997, May 18) A Lode of Lies: How Bre-X Fooled Everyone. Retrieved May 8th, 2017 from http://www.washingtonpost.com/wp-srv/inatl/longterm/canada/stories/brex051897.htm The Ontario Securities Commission passed the NI 43-101 in response to the Bre-X scandal, "prohibit[ing] misleading disclosure" and requiring the "involvement of a qualified person."Ontario Securities Commission (2008, February 8) Mineral Project Disclosure Standards: Understanding NI 43-101. Retrieved May 8th from http://www.osc.gov.on.ca/documents/en/Securities-Category4/rule_20080229_43-101_1day-workshop.pdf Conspiracy Theories Several conspiracy theories have surfaced around the Bre-X scandal. Many people, including the doctor who performed De Guzman's autopsy, believe De Guzman faked his suicide and is still alive today.Dolphin, R. (1996, March 3) Stock of the century: Investors hit jackpot with gold mining. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold Workers on site the day Guzman disappeared claimed he was carrying large duffel bags of cash. Some say he ran to South America with a few hundred thousand dollars, while others say it was upwards of hundreds of millions. With this amount of money he could have bribed his way to freedom.Historica Candanada (2005) Bre-X Geologist Mike de Guzman Rumoured to be Alive. Retrieved May 9th from http://www.thecanadianencyclopedia.ca/en/article/bre-x-geologist-mike-de-guzman-rumoured-to-be-alive/ Genie De Guzman, his widowed wife, fueled the controversy when she claimed she mysteriously received a payment of $25,000 from Brazil.Canadian Press (2005, May 25) De Guzman Lives? Singapore Report Cites Cheque from Fallen Bre-X Geologist. Retrieved May 8th from http://www.resourceinvestor.com/2005/05/24/de-guzman-lives-singapore-report-cites-cheque-fallen-bre-x-geologist Another independent investigation found that De Guzman was pushed from the helicopter and served as the "fall guy" for the entire company.Dolphin, R. (1996, March 3) Stock of the century: Investors hit jackpot with gold mining. Retrieved May 8th from http://calgaryherald.com/news/local-news/bre-x-the-real-story-and-scandal-that-inspired-the-movie-gold It is also possible that De Guzman orchestrated the entire scandal, developing his "Volcanic Pool Theory" and then using it to convince successful prospectors who had fallen on rough times to invest without questioning. Conclusion Michael De Guzman convinced experienced investors, expert auditors and even Bre-X management that a dry mine was worth over $6 billion. In David Walsh's words, "four and a half years of hard work and the pot at the end of the rainbow is a bucket of slop."Stephenson, A. and Seskus, T. (2017, January 26) Behind ‘Gold’: The real story of Bre-X proves life is stranger than fiction. Retrieved May 8th from http://www.calgarysun.com/2017/01/26/behind-gold-the-real-life-story-of-bre-x-proves-life-is-stranger-than-fiction De Guzman leveraged his perceived expertise to justify suspect behavior and created a work environment where he could operate unchecked. These tactics to garner trust and seize control are illustrated across cases on ethics. It is a professional's responsibility to identify these red flags and thwart the fraud before it impacts thousands of stakeholders. We focused primarily on the specifics of the Bre-X scandal in this chapter and further analysis on the broader implications would strengthen this case study. A closer look at Freeport-McMoRan or the Indonesian Government as a stakeholder would improve this chapter as well. References