Introduction
This is my seventh installment of an article, which covers a variety of mining industry and mineral economic topics. Please forward any criticism and/or feedback on any of the topics discussed to me via info@smallcappower.com. If you choose to read on, be aware that I am not providing any financial or legal advice!
Technical
This is the technical portion of the article in which I explore economic issues and provide analysis of mineral deposits. I apologize for taking a bit of an extended break from writing but have been busy with due diligence assignments in Colombia (metallurgical coal) and Chile (copper exploration).
Just a couple of months ago (June 30th, 2011) the Canadian Securities Administrators (CSA) adopted new versions of the National Instrument 43-101 Standards of Disclosure for Mineral projects (the New Instrument), Form 43-101F1 Technical Report (the New Form), and Companion Policy 43-101CP (the New Companion Policy) (together, the New Mining Rule).
The New Mining Rule replaces the previous versions of these documents, which came into effect in all CSA jurisdictions on December 30, 2005.
I’d like to discuss one of the sections of the New Companion Policy which is personally sensitive to me in light of a recent development involving an invitation I received to join the board of a junior gold exploration and development company. The section that I’d like to discuss is Part 4 of the New Companion Policy, which describes the obligation to file a technical report in connection with certain written disclosure about mineral projects on material properties. Specifically, the disclosure regarding a company’s decision to go in production is defined under Part 4.2 – (6) and is quoted as follows:
Production Decision – The Instrument does not require an issuer to file a technical report to support a production decision because the decision to put a mineral project into production is the responsibility of the issuer, based on information provided by qualified persons. The development of a mining operation typically involves large capital expenditures and a high degree of risk and uncertainty. To reduce this risk and uncertainty, the issuer typically makes its production decision based on a comprehensive feasibility study of established mineral reserves.
We recognize that there might be situations where the issuer decides to put a mineral project into production without first establishing mineral reserves supported by a technical report and completing a feasibility study. Historically, such projects have a much higher risk of economic or technical failure. To avoid making misleading disclosure, the issuer should disclose that it is not basing its production decision on a feasibility study of mineral reserves demonstrating economic and technical viability and should provide adequate disclosure of the increased uncertainty and the specific and technical risks of failure associated with its production decision.
Under paragraph 1.4(e) – Discussion of Operations of Form 51-102F1, an issuer must also disclose in its MD&A whether a production decision or other significant development is based on a technical report.
What the Ontario Securities Commission (OSC) is saying in this section is that an issuer is not required under current securities legislation to establish mineral reserves if it wants to put a mineral property into production. This of course means that an issuer also does not have to produce a feasibility study or even a pre-feasibility study to put a mineral property into production. Not needing a feasibility study is implied since mineral reserves can only be established at a minimum by a pre-feasibility or full feasibility study.
Personally, I don’t agree with this policy, as it is too soft and is very dangerous for investors and also shows how little the OSC really understands of the root cause of mining project failures. A feasibility study is essentially a business plan which demonstrates that you understand the business and industry you are engaged in and are proposing to risk a significant proportion of the company’s resources (shareholder’s money!) to place the project into production. Is it so much to ask that a feasibility study or “business plan” be written before building a mine? I could list a hundred cases where a junior company has by-passed the business plan phase and gone directly to building a mill or concentrator plant only to find out later that they did not have any ore to feed it. In the past, management and the board of such a failed company would disappear, leaving investors with nothing more than a pretty stock certificate. I naively thought this type of situation of companies making a production decision without mineral reserves and then failing miserably was in a thing of the past. On reflection it isn’t and still is practiced quite frequently. Therefore I believe very soon we will see the first case where a group of directors will be sued civilly and found liable for a failed mine after choosing to go into production in the absence of mineral reserves or effectively without a proper “business plan”.
I am pleased, though, that the policy at least requires that an issuer provide full disclosure that a production decision has been made without being based on a technical report (without mineral reserves and feasibility study) and with clear definition of the known risks. However, I ask why would directors put themselves in such a risky situation because the OSC says it is not required. Without a feasibility study demonstrating mineral reserves, a director really has no protection in the event the project fails (i.e. no basis for the due diligence defense). The main reason directors have independent feasibility studies prepared is to prevent personal liability since they will have the benefit of a due diligence defense if sued civilly. Boards do make mistakes, which is inevitable, but those who choose to make production decisions without mineral reserves may find themselves at serious risk in the very near future. I’m afraid that directors won’t be able to fall back on any wording found in the New Companion Policy to support their defense for not insisting that management provide a business plan before digging!
Quite frankly, if the Canadian Securities regulators really cared about shareholders they would mandate independent feasibility studies for all mining companies with less than $C50M of annual revenue annually over the last five years. Directors who don’t direct independent feasibility studies to be undertaken prior to being put into production should also be banned from acting as directors of public mining companies for life and hopefully also sued civilly by the companies shareholders.
The rest of the story
I mentioned earlier that the New Companion Policy has some immediate relevance to me as a result of an invitation to join the board of a junior gold exploration and development company. To avoid naming names, let’s just call the company ABC Exploration Co. As per the company’s website, The Company’s flagship project is the XYZ Gold and Silver Mine, ….(XYZ Mine). The XYZ is a bonanza style low-sulphidation epithermal gold and silver deposit with historic production of approximately one million ounces of gold equivalent. The mine has never been fully exploited or explored and material that was once considered waste is now potentially economic. In addition, the Company has discovered a series of entirely new high-grade gold and silver veins that remain open for expansion in three directions”.
A management information circular for the annual and special shareholders meeting was issued nominating me for election to the board of ABC Exploration Inc. (“ABC”). The circular provided the following summary of my employment history:
Wes Roberts holds a B.Sc. (Mining Engineering) and M.Sc. (Mining Engineering) from Queen’s University, and an M.B.A. (Finance) from the Schulich School of Business. Since April 2008, Mr. Roberts has been the Vice President Mining of Heenan Blaikie Global. From 2006 to 2008 Mr. Roberts was Vice President, Corporate Development of Breakwater Resources ltd. From 2001 to 2006 Mr. Roberts was a self-employed mining engineer, during which time he consulted on various projects for Inco Limited. From 1982 to 1999 Mr. Roberts held various senior operating and engineering consulting positions in Canada.
The circular also disclosed that I personally and directly own 45,000 voting securities in the company.
One week later a concerned shareholder proxy circular was issued (posted on SEDAR) to be used in connection with the ensuing annual and special meeting of holders of common shares of ABC. This second circular was issued and funded by a dissident group (essentially ABC management) consisting of two current and one recently dismissed officer of ABC. The following is a direct quote from this circular concerning my proposed nomination to the ABC Board by the current board members.
The Wrong Focus – Wes Roberts
Wes Roberts has been nominated by the current Board in its slate of proposed directors. While Mr. Roberts appears to us to have ample experience in prospecting, exploration and feasibility studies, we believe the Board requires directors who are focused on production. We believe that spending shareholder money on costly, time-consuming and distracting feasibility studies is entirely the wrong direction for the Company. It is critically important that the Company not lose its focus on production. We need the right directors on our team.
My response to being called the “Wrong Focus” is that the dissident group couldn’t have given me a better compliment. Without ever meeting me (but apparently reading my resume) the author of this statement is “spot on” in his/her assessment that as a director I would expect management to show the utmost professional discipline to insure best industry practices in mine safety and technical standards. Under my directorship there could be no production decision by the board without an independent assessment of mineral reserves, based on a feasibility study and a sound business plan including budgets, schedules, permitting approvals and real plans to mitigate project risk. Doing otherwise would simply be in violation of my code of ethics as a Professional Engineer of Ontario. The primary responsibility of a board is to protect the assets of shareholders and thus it cannot allow management to pursue objectives, which are counter to the interests of shareholders. Doing any less can expose a board to litigation by shareholders who claim board incompetence and negligence of duty has or could directly lead to a financial loss.
How can anyone of sound mind propose a production decision without a thorough and formal technical investigation of the project risks? What are your chances of success if not accurately knowing the location of, the size, density, geometric dimensions, grade, metal and mineral type and metallurgical characteristics of the product you intend to mine. What are your chances of success if not accurately knowing the competency of the rock you intend to mine as ore and also the rock which must be used to gain access to the ore. What about cost of mining, milling, administration, smelting and refining of these same ores and what is the probability of success if you don’t even know if there is a market or buyer for what you want to sell? Missing any one of these items or being just slightly off on several of these items could result in the directors making a faulty production decision. Are we as shareholders, board members or other project stakeholders expected to just accept on faith alone that a CEO has thought the problem through and simply has it all stored by memory, even though we know he/she has no technical basis to make such a decision? I have been exposed to those who feel they don’t have to justify their decisions and are threatened by questions posed only as part of basic due diligence. Eventually these situations come to a close but often not before the damage has been done and cost has been severe.
Is it now clear why a mining engineer should not be the preferred choice to act as a director of a mining company board! We’re just bad to the bone... or just prone to confusing the issues with facts!