the x files The X-filesThe truth is out there, write Michael...

the x files The X-files
The truth is out there, write Michael West and Kevin Andrusiak, but separating the gold dust from the bulldust is no easy task
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July 22, 2006
SPECULATORS were taught a big lesson last week: don't believe everything you read on the Australian Stock Exchange company announcements service.
Whoever it was that snapped up shares in CuDeco - formerly Australian Mining Investments - when the stock peaked at $10 will be nursing deep pocket wounds. Ditto Frontier Resources, whose stock was suspended after a bullish drilling report.

Shares in both companies collapsed this week after they were forced to admit gilding the lily on their exploration results.

The events of the past few weeks have thrown into stark relief the job the ASX does in monitoring the torrent of information that spews out of its market announcements system, and aroused debate once more about the conflict of the profit-driven exchange regulating itself and the companies that pay its fees.

Surveillance costs money, and the investment community is again asking whether the ASX is spending enough on checking the accuracy of the information that companies release to investors.

Many believe that the ASX is undergunned on supervision and vulnerable to another Bre-X scandal. Bre-X, a Canadian minnow whose shares shot from a few cents to $C286.50 on a 200 million ounce gold discovery in the jungles of Borneo, crashed in 1997 when it was found to be salting gold samples. It was a scam that sapped market confidence for years.

As the ASX does not vet the company releases that flood through its system, critics believe it lacks the money and the staff to spot the bulldust before it reaches the investing public.

"The problem for the ASX is that there is nobody on board within the company that can quickly wave a flag and say this is right or this is wrong," says a consulting engineer and former member of the body that sets the standards for resource estimates, the Joint Ore Reserves Code (JORC) committee. "They have to go outside. This has been one of the big worries, that some cowboy will come along and do another Bre-X."

Hugh Robertson, a director of ASX's tiny rival, and customer, the Newcastle Stock Exchange, and director of broking house Bell Potter, says the ASX conflict has never been properly resolved.

"They do a good job, but equally I don't think it's good public policy when you have the gatekeeper in effect in the company. It's supposed to act as the guardian."

Indeed, the AMI-CuDeco episode was a big miss, with investors trading on inflated resource estimates for five days before the ASX was goaded into action.

Colourful CuDeco chairman Wayne McCrae had put out an ASX release on June 29 boasting that the company's drilling program had found a 59 million tonne inferred copper resource near Cloncurry in Queensland. Grading 2.04 per cent copper, the numbers indicated a rich orebody, perhaps the biggest mineral discovery in Australia this decade.

A penny dreadful, wallowing at only 29c six weeks before, CuDeco shares closed at $1.78 on June 28, the night before the big announcement.

The Australian reported the find and the stock went crazy. One week later, CuDeco touched $10 a share. Only that day did the ASX step in, suspending trading with the stock at $7.11.

Without the necessary geological or metallurgical expertise at hand - and no doubt praying this discovery was real - the ASX hired external consultants to assess CuDeco's data.

When the stock began trading again, after a two-week suspension - and amid a rash of negative press about McCrae's former stock market exploits - CuDeco's resource had been radically wound back from 59 million tonnes to 25 million tonnes. This was still a rich and potentially large resource, but a lot more work was needed to satisfy JORC requirements for a larger orebody.

It was not so much a scam as the amateur work of an exuberant junior explorer. Non-JORC-compliant disclosures are frequent.

Despite a number of complaints to the ASX, West Australian miner Ashburton still has photographs of tailings dams up on the ASX wire from 2004. The tailings dams, purportedly from its project in Brazil, do not belong to Ashburton, though they are in a company presentation that helped raise money from investors.

Meanwhile, another junior, Frontier Resources, had declared to the exchange it had discovered a "hypothetical reserve" of copper in Papua New Guinea. Frontier shares bolted from 12c to 48c. Under the JORC code, as in life generally, there is no such thing as a "hypothetical reserve". This time, though, the ASX was not so tardy. Frontier was promptly suspended, chastened for sloppy reporting and the shares were reinstated at 25c - its stock price halved.

ASX market supervision head Eric Mayne maintains that the exchange's supervision is well funded. He says the "perception of conflict" is well managed by a restructuring that has hived off the supervision into a separate vehicle reporting to a separate board of directors.

But he concedes that you cannot necessarily believe what you read on the ASX wires. "We could never say that each announcement is 100 per cent accurate. It is not right for you to say this statement goes out and therefore we are testament to the accuracy of this statement."

Mayne has a daunting task. The exchange is the biggest financial publisher in the nation. It sends out 110,000 announcements a year - that's 2000 a week, and many run to tens of pages.

And the job is getting bigger. In the past two years the number of listed companies has jumped by almost a third to 1930, each of them jostling for the attention of investors and battling a growing list of compliance requirements that add pages to each document.

The ASX has seven people sitting in front of the screens watching the markets, including two specialists targeting insider trading. There are 31 company advisers nationally who concentrate on disclosure issues.

While Mayne admits there is no vetting of the announcements that go out, he says it is absurd to say the ASX is responsible for investors buying stock on faulty information. "It is not right for you to say that this statement goes out and then therefore the share price rises (and) we are testament to the accuracy of the statement. The price goes to $10 and the ASX is responsible for the price going to $10. That's absurd. The media made a good contribution."

Both former insiders and junior mining executives say the regulatory spending has simply not kept pace with the ASX workload, either in head count, expertise or resources.

Is the ASX doing enough to protect itself and its investors? The 300-odd junior miners, not to mention a host of biotech and other hi-tech companies, require expertise in surveillance.

"If you cannot rely on every announcement that is made, your credibility is on the line," says the principal of one broking house. "In surveillance, they got rid of the expensive guys and hired young cheap ones. For all the money it gets paid to provide a regulatory service it should get the information right. A loss of credibility to the market is worth a fortune."

Mayne, a former colleague of recently departed ASX chief Tony D'Aloisio, says the resources in surveillance have been added to, in line with the growth in the number of companies and announcements.

One former insider at the exchange says there has been an exodus of experienced staff who have been replaced with younger and cheaper people who lack the hard experience to spot a scam.

And there is no guarantee despite the increase in companies' announcements that consumers are any better protected or market integrity guarded.

The ASX has just agreed to a $2.3 billion merger deal with the Sydney Futures Exchange. As part of the deal, D'Aloisio was squeezed out at the behest of major institutional shareholders wanting SFE boss Robert Elstone in charge for his impressive record as a cost cutter.

His track record is brutal on costs. And not only are surveillance and trading, listing and execution under one roof, so are settlements and depositary functions.

"It is trying to be all things to all people," says Robertson.

Many others declined to comment on the record but the message from investors and company executives is generally cautious as to whether the model can be sustained.

"I don't think it's good public policy when you have the gatekeeper in effect in the company," says Robertson.

Combating the "perception of conflict of interest", as Eric Mayne puts it, the ASX has hived off its surveillance division into a separate entity where Mayne reports to a separate board.

Besides the conflict of monitoring market ramps, scams and insider trading the ASX's integrity depends on its standing up to its big customers.

"The structure we have in place is about as close as you will get to separation," says Mayne. Still, the board of ASX Market Supervision could hardly be considered independent itself.

Three of its directors, Maurice Newman, Michael Sharpe and Jillian Segal, are directors of ASX and Sharpe is a director of aggressive investment bank Babc ock & Brown, which regularly spins off floats on the ASX.

Another director, Dr Thomas Parry, is an adviser to Macquarie Bank, which has a similar conflict to Babc ock & Brown. That leaves Peter Jollie and Mayne himself.

One leading fund manager believes the conflict of interest measure is "unsustainable. If you started with a blank sheet of paper would you really have supervision under the one roof with the commercial business".

Above all though, a commitment to rigorous and well-funded supervision is regarded by almost all market participants - the exchange included - as essential to the integrity of the ASX and therefore its reputation, liquidity and cost of capital for all clients.

Too many AMI-CuDecos cannot be afforded, especially by those who paid $10 a share.