Case Study: Bre-X Scandal – The $6 Billion Gold Fraud

The Bre-X scandal is the perfect example of a true fraud that results from dishonest and deceitful business ethics, morals, and principles. 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.

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.

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.

Aftermath of  Bre-X Scandal

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. 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.