Black Eye For A Blue Chip Exchange

Toronto reels from the Bre-X scandal, and reform is afoot

Canada is no stranger to mining-stock scandals. In the late 1980s, the Vancouver Stock Exchange--home to many highly speculative "junior," or small, mining companies--was dubbed "the scam capital of the world" because of its many shady promoters. Just last December, investors in Timbuktu Gold Corp.--a highflier on the equally speculative Alberta Stock Exchange--saw their shares plunge more than 90% after the company's claimed gold strike in West Africa turned out to be a fraud. Through it all, the Toronto Stock Exchange has cultivated its image as a blue-chip exchange above such shenanigans.

Not anymore. The spectacular meltdown of Bre-X Minerals Ltd. has cast a harsh spotlight on Canada's premier exchange. Bre-X has lost some 90% of its value since its partner Freeport-McMoRan Copper & Gold on Mar. 26 reported finding "insignificant" amounts of gold at the Indonesian site Bre-X had billed as this century's largest gold find. "The TSE is coming out of this looking awfully bad," says Robert Bishop, editor of the Gold Mining Stock Report. On Wall Street, the TSE became the butt of jokes after its computer system crashed under the weight of surging Bre-X orders for four consecutive trading sessions, ending on Apr. 3.

Now, the Bre-X affair is raising far more troubling questions about the ability of the TSE--and Canada--to protect investors from potential fraud. Critics are finding fault with virtually every step of the process: from the review of new listings to the adequacy of corporate disclosure to Canada's patchwork system for catching scofflaws. "Everyone in the investment community is appalled" by the Bre-X affair, says Robert Sillcox, retired chief investment officer for the Ontario Municipal Employees Retirement System, a major institutional investor, who warns that it will "hurt Canada's reputation."

TSE officials defend their efforts. "It's awfully difficult to legislate against fraud," says former TSE Chairman Fred Ketchen. Adds TSE CEO Roland Fleming: "I don't know of a market that hasn't had the occasional shock," and despite Bre-X, "the TSE compares to the best markets in the world." Maybe so. But Bre-X seems certain to spark a major overhaul of securities regulation in Canada--even though Bre-X CEO David G. Walsh asserts: "I'm 120% confident that the gold is there."

SCATHING. Fleming, who concedes the TSE has limited regulatory authority, advocates big reforms. Indeed, Bre-X exploded less than 10 days after the TSE issued a scathing report on the relative impunity with which some companies violate disclosure laws.

Critics point to other lapses in the Bre-X affair. While Bre-X had issued a prospectus when it listed on the Alberta exchange in 1989, critics say a new prospectus should have been required when it joined the TSE last year. "We have very high standards," responds Fleming, who says the TSE used its own mining consultants to review Bre-X and other junior mining applicants, "60% of whom were denied a listing." Still, "it's fair to suggest the TSE will now be reviewing its listing requirements," admits Ketchen.

Angry shareholders charge, in several class actions, that Bre-X is a textbook example of a company using misleading statements to perpetrate a huge fraud. If so, that would be a clear violation of Canadian securities law, which, like U.S. law, requires full and accurate disclosure, says Toronto attorney Thomas I.A. Allen, who chaired the TSE's corporate-disclosure committee.

But in a damning report released days before Bre-X exploded, the Allen committee found there aren't enough teeth behind the Canadian disclosure laws to scare companies into compliance. Unlike the U.S., Canada doesn't have a national securities regulator. And the Allen committee found that the Ontario Securities Commission, which oversees the TSE, has had "patently inadequate funding to perform [its] tasks." In the Bre-X case, the OSE has launched a probe of possible insider-trading violations.

FIRST LAWSUIT. Even worse, Canadian law makes it difficult for shareholders to successfully sue companies for fraudulent misrepresentation--the key deterrent to fraud in U.S. markets. On Apr. 3, Windsor (Ont.) law firm Gignac, Sutts filed a $2.2 billion class action against Bre-X. But attorney Harvey T. Strosberg, who brought the suit, admits it's "the first such class action" ever filed in Canada. Until Canadian laws are changed to give shareholders an explicit right to sue--something the Allen committee recommended--the action faces an uphill battle.

Some shareholders complain that the TSE's biggest failure was not halting trading on Mar. 27 after the bombshell announcement from Freeport. But Fleming rebuffed Walsh's request to halt the stock. "We would have been doing a huge disservice to market participants had we followed his request," says Fleming. Problem is, once trading resumed on Mar. 27, the volume of orders forced the TSE to shut early that day and to stop accepting orders for Bre-X on the next three trading days. It was an enormous embarrassment for an exchange that once billed itself as a high-tech leader.

The software problem that caused this snafu has now been fixed, and the TSE expects finally to replace its 20-year-old computer system this fall. But no Canadian politician will be able to duck what Fleming calls "the true tragedy--the many retail investors who gambled [on Bre-X] and lost, without understanding the real risks." For now, the Canadian system "does not adequately protect" investors from such risks, says Allen. If Bre-X turns out to involve fraud, they may finally get the protection they deserve.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE