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Kaiser Blog: The Bre-X Decision - Justice Not Served


Kaiser Blog: The Bre-X Decision - Justice Not Served

August 3, 2007

I have now had a chance to read much of the 594 page Bre-X judgement released July 31, 2007, in particular the 277 page portion that deals with the OSC's allegation that there were numerous "red flags" which should have caused John Felderhof to recognize that something was wrong with the Busang project.

First of all I have to declare that Defence lawyer Joseph Groia is definitely not a contender for the crown General Tommy Franks bestowed on Douglas Feith, for it is absolutely amazing how he was able to use testimony from two expert witnesses for the defence to transform this trial about John Felderhof's credibility into one that put on trial the credibility of Graham Farquharson and Strathcona Mineral Services, and to bamboozle Justice Peter Hryn into concluding that everybody who had anything to do with Busang was completely competent and only Graham Farquharson was incompetent for imagining non-existent "red flags" from the biased standpoint of "hindsight". Yes Mr Groia, you did chew up and spit out Mr Farquharson in a manner that would indeed discredit him in the eyes of somebody profoundly ignorant about geology, exploration and mining as was Justice Hryn. You earned your fee well and a lot of deep-pocketed parties owe you a deep well of gratitude. But as far as the rest of the mining industry which was not monetarily impacted by this outcome is concerned, you are just a lawyer specialized in the letter of the law, not an upholder of justice as you claim.

Mr Groia and Justice Hryn are dead wrong in their argument that there were no red flags visible without the benefit of hindsight, and the logic by which Peter Hryn arrives at his conclusion that this fraud was so sophisticated that nobody, including John Felderhof, could be expected to see a red flag is deeply flawed.

Without the exhibits to which Justice Hryn refers to in his decision it is very difficult to evaluate his conclusions, but based on an initial read I suspect that with enough time, which I do not have, I could demonstrate that the arguments of expert witnesses Phillip Hellman and Terry Leach, one of whom still thinks there is gold at the Southeast Zone, fall apart when you put them back into a proper context. Groia's defence strategy was to ignore the elephant and focus on the parts, treating each red flag in isolation from its context.

In effect he used the professional status of all parties which handled data and samples supplied by Bre-X, and their failure to voice any complaints, as an argument that there were no visible red flags. He then demonstrated how Graham Farquharson made small errors, confused things, couldn't remember certain things, contradicted himself, appeared to have double standards, and couldn't come up with comebacks to super-specialized assertions by Groia's expert witnesses. By the time Groia was done Justice Hryn was left facing somebody who looked like a fool that had dreamed up red flags in hindsight after it had been demonstrated that Busang was a salt job. It was the usual legal hack job on a witness that magnifies human foibles to the point that these are all that anybody can see. The Ontario Securities Commission appears to have left their expert witness flapping in the wind, and did not mount a similar attack on Hellman and Leach. By the time I was done reading the decision I had forgotten that it was John Felderhof who was on trial. And that is no surprise, because what is conspicuously absent from this trial is any analysis of how the fraud was carried out, and any testimony by and cross-examination of the real subject of this trial, John Felderhof, who did not bother to show up and testify.

Not only did Groia successfully impugn the credibility and integrity of Farquharson the messenger, but he also successfully distracted the attention of Justice Hryn from the fact that Bre-X carefully ensured that each professional only dealt with a trunk, an ear, a toe or a tusk of the elephant, while holding the threat of "we can give the job to countless others banging on the door" like a hammer over their heads. Nobody ever handled the entire elephant, nobody ever had independent control of a chain of custody of bedrock core to assay results until Freeport McMoran and Strathcona conducted their confirmation and audit twin drilling.

Project Operations Manager John Felderof made sure that no independent professionals ever handled Busang sample material that had not first been prepped by his Filipino team and their to this day unidentified associates in the Samarinda warehouse. And, with the exception of the petrologist whose mandate was just to describe the minerals, nobody ever dealt with anything but information. In the odd case where untampered samples slipped into the possession of outsiders and returned negative results, it was always "explained" as an error, getting unlucky with that sample, or, in one bizarre case, as "duds" deliberately supplied by Bre-X to discourage unwelcome suitors. Based on the assay results published by Bre-X in its news releases, the equivalent of elephant dung, everybody "knew" an elephant was present, but nobody ever got to interact with the elephant itself.

The Southeast Zone discovery unfolded in 1995 on the heels of confirmation that the Voisey's Bay nickel-copper discovery by Robert Friedland's Diamondfields was for real. The initial Voisey's Bay discovery hole in November 1994 was drilled into a dyke whose tonnage implications made the early market response look like a typical hype job that valued the stock far more than the footprint of the discovery justified. It was not until the first hole into the Ovoid, a target represented by a large EM anomaly, that the market began to take Voisey's Bay seriously. That occurred in early 1995, and thanks to the magmatic segregation style of the near surface massive sulphide nickel-copper mineralization and its relationship to the EM anomaly, anticipating the results of stepout holes within this anomaly was something people familiar with this type of deposit were able to do with an abnormal degree of accuracy. The rapid drilling off of the Ovoid and the accompanying rocket launch of Diamondfields to a pre-split equivalent price of $160 eventually leading to a buyout offer by Inco valued at $4 billion turned into a template for the Southeast Zone discovery when the first holes were announced in July 1995. The market saw history repeating itself in rapid succession, and rushed into Bre-X with such gusto that observers and shareholders alike were left gaping and all technical participants were congratulating themselves over having the privilege to be part of this incredible phenomenon. By switching the focus from the Central Zone to the Southeast Zone, Bre-X scaled the story so fast and so big it bowled everybody ever. This was no accident, as Mr Groia and Justice Hryn readily concede, for the Southeast Zone was a salt job from start to finish.

Graham Farquharson testified that people "were apparently carried away by the excitement of being part of the Busang story" as his explanation why third party professionals like Kilborn Engineering did not see any red flags. In dismissing Farquharson's explanation Justice Hryn not only displays profound ignorance of the psychology of a discovery play, but reveals a perverse understanding of how the mining industry works. On Page 383 he declares "Kilborn would not ignore evident concerns when it also wanted to invest in Busang and develop the property with Bre-X". Whoa, I thought Kilborn was an independent third party conducting resource calculations for its client Bre-X!

Yes, every service provider is eager to get a bigger contract from a client, which carries the perennial risk that a professional entity will end up ignoring a red flag whose subsequent determination as false would constitute the end of further business. But that Kilborn's agenda included making an investment in Busang is a serious allegation that calls into question the professional integrity of Kilborn as an independent service provider. Did not Kilborn's desire to invest in Busang create a high risk that its handling of the information provided by Bre-X might be compromised? Surely Justice Hryn's statement by implication that Kilborn had a conflict of interest in its dealings with Bre-X was just a silly error of the sort Graham Farquharson was caught making! No, for Justice Hryn repeats this statement on Page 387.

But where is the evidence that Kilborn "wanted to invest in Busang"? If it exists, then Kilborn has a problem. I don't think it exists. I think Kilborn was simply sucking up to Bre-X when it allowed Bre-X to repeatedly put in its news releases language that suggested Kilborn was actually conducting independent verification work on Busang like is normally requested by clients eager to develop a real mine which will eventually require debt financing. Kilborn did not publicly protest and clarify that it only worked with data supplied by Bre-X until after Freeport-McMoran's confirmation drilling called into question the veracity of results published by Bre-X. This sort of inattention to accuracy is by itself enough to call into question the confidence Justice Hryn has in Kilborn's professional inability to see any red flags. But why is Justice Hryn also making such a libelous statement which would seem to paint a red bulls eye on Kilborn for class action litigators? Is it because he is hopelessly unqualified to render a meaningful judgement on this case?

I stated earlier that Justice Hryn is dead wrong in his conclusion that because a bunch of professional organizations did not report any red flags there were none to see, and that consequently the red flags identified by Graham Farquharson were visible only with the benefit of hindsight. Part of my argument is that the circumstances of the Busang play were so unusual that all professional service providers were naturally inclined to reduce their normal critical judgement. A second part of my argument is that access to the elephant was so fragmented that the various parties were unlikely to see more than one red flag in their professional capacity. A full set of red flags was only possible if somebody had complete control of the chain of custody of sample from bedrock to assay sheet. A single red flag is not definitive. It is the confluence of red flags which spurs people to action and engage in self-protecting behavior. The third part of my argument is that it is simply false that multiple red flags were not visible with regard to Busang, and I speak from personal experience.

In February 1997 I had discussions with several geologists in the course of my activity researching junior exploration companies that were very disturbing. I belonged to that group of people who had followed Bre-X largely by reading material published by the company, and, given the intensive coverage this company had received from others, I did not think to question the validity of the geological data. As Justice Hryn declares, "drill results trump geological puzzles". I understood that Bre-X was a powerful Cinderella story which inspired both retail and institutional investors to take the Canadian exploration juniors seriously, and this interest was beneficial to my business as a newsletter writer which involved identifying other juniors with "prospective projects".

What these geologists, who had no axe to grind except perhaps preservation of the integrity of their profession, had to say was that there were a number of red flags that made them suspicious about Busang. Some of these were later listed by Strathcona, one of them was the active prevention of independent chain of custody based verification work, which circulated as unpublished scuttlebutt that nevertheless by its specificity it was reasonable to view as true, and others belonged more in the category of "what would a geologist do if he or she had a discovery like Busang on his or her hands, and which was not being done by John Felderhof". These red flags were being fretted about before Freeport started drilling its confirmation holes, and well before Strathcona started its audit.

One can perhaps say that I am fabricating this in hindsight, that if I had really heard serious talk about red flags I might have written about them in my newsletter. I did indeed think about publishing the list of red flags, but thought to myself, there may be valid explanations for them, I have no power to force definitive validation or elimination of the red flags, the stock might in the interim go down, a lot of people would be very unhappy with me, the company and who knows who else would probably sue me, and if the red flags proved to not be red flags at all, my budding career as a newsletter writer would be finished. So I kept my mouth shut, but during the Tuesday night of PDAC in the lobby of the Royal York while John Felderhof was collecting his Prospector of the Year Award and grandstanding about the 200 million ounce potential of Busang, I told the red flag story to an individual who is highly regarded in the resource calculation business. He thought this very interesting, but was aghast to hear that Kilborn was not actually collecting its own samples and validating the grade of the Southeast Zone with its own chain of custody.

A "red flag" is anything out of the ordinary, a definition which in geology applies equally to "green flags". An orebody is an abnormality, and a gigantic orebody like Busang is an extraordinary abnormality. Red and green flags by themselves serve no other purpose than to heighten one's alertness for other red or green flags. A world class deposit hosts a startling preponderance of green flags which the exploration process naturally aspires to identify. The first green flag is that a project is "geologically prospective", which means it has potential for gold. In his decision Justice Hryn makes a big deal about Farquharson's statement that Busang is "geologically prospective", but does not seem to understand that such a statement is a conditional that refers to "potential" and not actuality. Exploration involves generating additional green flags that justify pushing a project through the exploration cycle at an increasingly higher information gathering cost. As a project moves from target generation through target drilling to discovery delineation, the project geologists work to visualize the discovery.

How do these "green flags" geologically and mineralogically hang together becomes a question that burns hotter the bigger the discovery. Visualizing an emerging deposit requires access to detailed information. One type of information involves detailed grade intervals which allows people like Paul Kavanagh to visualize 3-dimensional grade shaped bodies. At a more sophisticated level drill logs are added to the equation which allows really good geologists to visualize the orebody not just in terms of grade defined shape but also in terms of structure and host geology. It helps to walk actual core, which is one reason core is split and only half sent away for assaying. At another level the deposit is visualized in genetic terms. How did the deposit form? To some degree the answer is academic, but in an important degree it helps the visualizer "see" where more of the same might be waiting to be found.

All these green flags needed to visualize the deposit come from information. The deposit itself is invisible, partly because it is underground, partly because the economic metals are not visible, and often because even the surface expression of a deposit not buried beneath un-mineralized rock is obscured by dirt, swamp, water, bushes, and, in the case of the Southeast Zone, jungle. When somebody visits a property you do not go there to see the deposit. You go there to see the geological setting, the lay of the land, the various mineralized rock types in so far as they are exposed, and the drill core shack. You look at drill logs and sections, ask countless questions of the project geologists to help you visualize the deposit, while all the time listening for incoherence, stuff that does not make sense, things that entitle you to ask further questions. You are the visitor seeking to visualize, the host is the vision keeper who must try to share that vision with you. By the time you go home you may have a very good visualization of what is already known about the deposit, and what it is hoped upcoming exploration work will further demonstrate, but you never actually see an orebody. As far as physical due diligence is concerned the most you can do is collect samples from outcrop which you can get assayed at home. In the case of Busang all outcrop was "depleted" so it was impossible for anybody to bring home mineralized samples unless the project manager allowed you take actual core. Unless you saw the core come out of the ground, you have to trust information about where the hole was drilled. With regard to procedures all a visitor sees is fragments of the process. The most you can do is interview workers and listen for things that seem strange, which you will only hear if the worker does not understand that what he or she is describing is "strange". And if there is something wrong with the process, the project tour guide will endeavor to hustle along and give that worker some instructions that require immediate attention away from your proximity. That, in itself, is a red flag, but a fleeting one that only becomes problematic when it appears systematically.

No matter who you are your ability to visualize a deposit depends on your access to the "elephant", and there is only one person who has absolute control over access to all the "green flags" that constitute the elephant. That person is the project manager, and at Busang that person was John Felderhof. He may have delegated almost everything to Michael de Guzman and his crew, but he had the power and funds to request and inspect anything on his own behalf.

Until Suharto forced Freeport-McMoran onto Bre-X, Felderhof denied everybody unrestricted physical access to the Busang deposit. He did not allow any outsiders to independently control the chain of custody from rock in the ground to results in the lab. This can be partly attributed to competitive paranoia, or even to a self-centered desire by Felderhof to hog all the scientific glory for himself. But what is very strange is that Felderhof avoided the quest for green flags. He did not try to load Busang into his head like just about every project geologist would, studying the data in detail, ordering thin sections, trying to visualize and understand what makes this fabulous discovery tick. This is odd, because Felderhof did not hesitate to describe himself as discoverer of OK Tedi and several other deposits, all of which had numerous other co-discoverers who could dispute how much Felderhof actually contributed to the discovery. De Guzman may have been the person who figured out that the rock to the southeast of the Central Zone was a worthy drill target, but the entire Busang project was still Felderhof's idea. He had every right to claim the glory of the Southeast Zone as definitive confirmation of his genius as a geologist.

But the closest Felderhof came to loading Busang into his head was when he added his name to the infamous Maar-Diatreme paper which includes the statement "gold dominantly occurs in free native form, and as submicroscopic particles in pyrite - arsenopyrite and as minor amount in electrum occluded in sphalerite". How did he know that? Because de Guzman told him so? Visible gold in core was apparently observed in the Central Zone, but only rarely noted in core logs in the Southeast Zone, without any display samples retained or even photgraphed. Based on the assay results the orebody taking shape in the Southeast Zone was a thing of beauty that had the entire world mesmerized, and for the discoverer, and indeed everybody looking over his shoulder, the deposit's most spectacular green flag would have been the physical relationship of gold grains with a "fineness in the order of 600-900" to the surrounding minerals.

The biggest green flag should have been a thin section photo revealing how the gold grains spatially related to the surrounding minerals, a photo which every proud geologist would have on hand, especially in the absence of visible-gold-in-core photos such as those provided by Aurelian for its very real epithermal gold deposit. They say a winner has a thousand fathers but a loser is an orphan. Nobody but Felderhof could claim to be the father of Busang, but he did not behave like a proud father. Why not?

How did Bre-X know that the gold in the Southeast Zone was nuggetty in a manner similar to the Kelian deposit, where, incidentally, only the Northeast Lobe is treated as the analogue whose recovery characteristics applies to the entire Southeast Zone? In his decision Justice Hryn completely ignores the fact that the only gold evidence supported information possessed by Bre-X pertained to the Central Zone whose nature is acknowledged as different from that of the Southeast Zone. It appears that the understanding about the nature of the Southeast gold was inferred from the assays generated by samples taken from the bags of crushed core that floated down the Busang River through the warehouse in Samarinda where all the ones marked as "mineralization" had to be systematically opened to make sure humidity had not destroyed the numbers inside and outside the bags. In a kimberlite where the grade is very low and the target mineral constitutes an extreme nugget effect it is hopeless to try to find a diamond through thin sections of kimberlite. It is pointless because the diamond did not form in the matrix, and thus the thin section with diamond in it would convey no information. But in a gold deposit the gold grains did form in the matrix. How it formed is relevant to the formation of the entire deposit. It is part of the deposit visualization that every good geologist aspires to achieve for his or her pet project, especially when it is the richest deposit ever found. John Felderhof knew there was no gold in the Southeast Zone because he could not produce the biggest green flag which was within his power to produce.

A big red flag is that John Felderhof did not authorize or commission any third party to conduct verification work on the Central or Southeast Zones. When Freeport-McMoran and Strathcona did this it became immediately clear that no gold was present. Another red flag is the decision to destroy the entire core, which made it impossible to verify drill logs by having somebody independently relog the remaining core half. But the biggest red flag is the absence of the biggest green flag Felderhof needed to properly draw the conclusion that the gold at Busang was similar to that of the Kelian deposit and needed special handling to deliver reproducible grades. None of the third parties involved with Bre-X were in a position to vouch for the green flag in the form of physical in situ evidence of the presence of gold. It is perhaps understandable that nobody was in a position to accumulate enough red flags to feel comfortable about sounding the alarm. But Felderhof had possession of all the red flags, and was missing the ultimate green flag. By the time he signed his name to the Maar-Diatreme paper released for PDAC 1996, for which thin section photos of the gold would have been a triumphant inclusion, he knew there was no such thin section to be had.

 
 

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