The Saga of Bre-X Is a Cautionary Tale : Canadian Exchanges: Both Small and Volatile

Originally published Saturday June 27, 1998 in the International Herald Tribune

By Ann Brocklehurst

LIKE Canada itself, the Toronto Stock Exchange is often regarded as little more than a less-exciting version of its neighbor to the south. Many foreign investors simply do not see any reason to buy into a mar ket like Toronto when they believe similar products are available in New York.

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“They tend to throw us in with the U.S. market when the markets are really quite distinct,” said John Carson, senior vice president for market regulation at the Toronto exchange. “But those who view the U.S. market as a virtual proxy for Canada are quite mistaken.”

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Unfortunately for Toronto, its most important distinguishing feature as of late has been the role it played in the Bre-X Minerals Ltd. gold scam. By the time the extent of the fraud was revealed in May 1997, the company’s stock lost 6 billion Canadian dollars ($9 billion) in value.

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The panic selling caused the exchange’s electronic-trading systems to crash, and it faced criticism for including Bre-X in its 300 index, meaning that mutual funds that recreated the index would have purchased it.

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“To varying degrees, everyone in Canada’s investment industry was hurt by the collapse of the company: investors who lost their holdings, mining companies who suffered from an erosion of confidence, and all of us who work in the Canadian capital markets who have suffered negative impact on our hard-won credibility,” the exchange president, Rowland Fleming, told the annual meeting in May.

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Just a few weeks later, the exchange and the Ontario Securities Commission proposed regulations that would require mining companies to increase their disclosures about properties and drilling standards.

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Although Mr. Carson admitted it would take time for Canada to regain its credibility in the prospecting business, Toronto is still billing itself as the world’s leading mining exchange and trying to persuade foreign companies to list there. In 1997, 3.2 billion Canadian dollars in mining capital was raised on the exchange, representing more than a third of the world’s total.

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Mr. Carson also emphasized that, despite Bre-X, the exchange broke a number of records in 1997. Its 300 index hit several all-time highs, trading volume was the largest ever at an average of 1.68 billion dollars a day and new issues reached a peak of 102, up from 79 in 1996.

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At the same time however, the exchange is feeling the effects of globalization and electronic trading. Even when it can convince foreign investors that Canadian stocks have something unique to offer, Toronto faces direct competition from the New York and American stock exchanges and the Nasdaq market, which list 34 of the stocks in the Toronto Stock Exchange 35 and 40 percent of those in the 300 index.

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At the annual meeting, Mr. Fleming noted that the number of interlisted stocks was increasing and competition for trading was intensifying. “We now execute less than 60 percent of the trading volume in Canadian securities, as markets fragment and trading in upstairs markets and proprietary trading systems increases,” he said.

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The Montreal Exchange , Canada’s second-largest, knows how it feels to lose business to bigger markets. Once the most important bourse in the country, Montreal ceded that position to Toronto in the 1950s. It now contents itself with being No. 2 and draws much of its business from pension funds and institutional investors who trade in Montreal, mainly to support the city’s financial industry.

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All the major Quebec companies are listed in both Montreal and Toronto, including some of the best performing small-cap stocks in the country. For example, A.L. Van Houtte Ltd. of Montreal — a coffee maker and distributor recommended to Money Report readers on Sept. 6 by Christine Decarie, vice president of the Montreal money-management firm Montrusco & Associates Inc. — has returned nearly 40 percent since that time. The share price of Fonorola Inc., another Money Report pick, is up 79 percent, reflecting a takeover bid by Call-Net Enterprises Inc. – WHILE equity analysts no longer agree that Quebec stocks are undervalued because of fears that the French-speaking province may choose to secede from the rest of Canada, they still say there is value to be had in Quebec. ”It is a sad truth that companies only really learn to compete during tough times. In Quebec, capital and population flight have so suppressed economic growth that any management whose company has been able to grow and prosper really must know its stuff,” according to a recent report by the Toronto money manager Burgundy Asset Management Ltd. ”The result is a tough, pragmatic group of entrepreneurs who can be relied upon to make money in just about any circumstances.” Among the Quebec companies currently recommended by Burgundy are the grocer Metro-Richelieu Ltd., the auto parts distributor Uni-Select Inc. and the radio and billboard company, Radiomutuel Inc., all of which trade in Montreal and Toronto. Canada’s two other markets, the Alberta Stock Exchange and the Vancouver Stock Exchange, are niche markets completely different from Toronto and Montreal. Alberta specializes in startup mining and energy stocks while Vancouver is known chiefly for penny mining stocks. Although Bre-X was originally listed in Alberta, Vancouver has a nastier overall reputation for listing companies involved in scams and scandals. Both markets are only for speculators. For example, Downing & Co., a small financial-services firm in Olivenhain, California, is recommending Anvil Resources Ltd. to the ”risk oriented.” Anvil is based in Vancouver, trades in Calgary and its primary focus is to discover and develop resource rich properties. Richard Coates of Downing said the potential of Anvil’s oil and gas properties make it a strong buy at its current price of about 1.43 dollars a share, even though the price has nearly quintupled so far this year. Much of the gain came after the company reported positive results at a gas well drilling.