Southwestern ex Paterson pleads guilty
From Stockwatch. For those that say that Canada's National Instrument 43-101 is always better than US or other foreign standards, remember that this was a very simple yet very expensive, high-profile and embarrassing fraud conducted under NI 43-101. The stock traded over $30 a share, and raised over $40 million in a secondary offering at $35.50 a share led by Raymond James, who also led a prior secondary for over $15 million at $10 a share.
The basic rules of mineral exploration and reporting apply everywhere, regardless of country or reporting régime. Sampling and assays need to be conducted by independent third-parties under specific QA/QC programs that are fully disclosed to both investors and regulators.
2012-09-17 20:21 ET - Street Wire
by Mike Caswell
Geologist John Paterson has pleaded guilty to criminal fraud charges in the Provincial Court of British Columbia that stemmed from a four-year scheme to inflate assay results from Southwestern Resources Corp.'s Boka project in China. He entered the plea Monday morning in an appearance before Judge Harbans Dhillon on what was supposed to be the first day of a lengthy criminal trial.
The charges he faced stemmed from a fraud in which he altered assay results for Boka from 2003 to 2007, overstating as many as 443 figures in 25 news releases. As he was doing so, he earned $5.6-million trading the stock, the prosecution claimed. His scheme only came to an end when an outside firm tried to verify the company's assays as part of a prefeasibility study, and Mr. Paterson resigned as the company's president. Southwestern subsequently had to retract all results from the property, with the resulting sell-off dropping the stock to $2.90 from $6.34.
His trial on the charges was scheduled to start Monday and to run for as long as five months. At the outset of Monday's hearing, however, defence lawyer Rod Anderson summoned Mr. Paterson to the front of the court room and advised the judge that his client had agreed to change his plea to guilty. After verifying that Mr. Paterson understood the consequences of pleading guilty, the judge accepted the plea.
The focus of Monday's hearing then turned to Mr. Paterson's sentence. Crown counsel Ian Hay submitted that a 10-year jail term would be appropriate, given the substantial damage Mr. Paterson inflicted on the market. The Crown estimates investor losses to be $260.1-million, and the cost to Southwestern Gold to be $45-million.
One of the factors Mr. Hay asked the judge to consider is the personal gains that Mr. Paterson made during the scheme. According to the prosecution's calculations, he personally earned $5.6-million trading the stock. At the same time he collected $705,000 in salary over four years plus a $246,000 severance payment when he resigned. Mr. Hay also asked that the judge consider that Southwestern raised $78-million with prospectus offerings while the inflated results were public. Subscribers to those offerings paid as much as $38 for their shares, he said.
In support of his sentencing recommendation, Mr. Hay outlined the mechanics of the fraud. He explained that the scheme took place as the company was drilling on Boka, with Mr. Paterson overseeing much of the work. At the time there was much interest in the stock based on an "initial buzz."
The fraud, as described by Mr. Hay, centred around the treatment of the assay certificates from the drilling. As with all certificates, access to those from Boka was very restricted to prevent leakage of the information. Mr. Paterson alone received the certificates from the assay labs and transcribed them into press releases. The problem, according to the Crown, was that when he wrote the releases (which he did by hand), the figures that he used for drill results were not those that the assay lab supplied.
Mr. Hay said the fraud starting falling apart in 2005, when the company was looking at a prefeasibility study for the Boka project. Such a study would require an independent verification of the company's drilling. The market was initially excited by the news, but the "problem of course for Mr. Paterson is he must be caught," the court heard. A proper study would uncover the fabricated drill results.
At first, Mr. Paterson attempted to defeat the sampling process used for the study, Mr. Hay said. He instructed the project manager in China, John Zhang, to "frustrate" some work. The prosecution did not say exactly how Mr. Zhang did this, but did say that some drill core went missing, only to be later found in a warehouse. Mr. Hay also explained that in September, 2006, Mr. Paterson made a $200,000 personal payment to Mr. Zhang. He did this by transferring money between accounts at a Bermuda brokerage, LOM Securities. (The same brokerage was one of five that Mr. Paterson used for trading Southwestern, the court heard later in the day. There was no suggestion LOM did anything wrong.)
The delays with the study continued until June, 2007, when Mr. Paterson suddenly resigned all roles with Southwestern (and collected a $246,000 severance payment). With the exception of some sporadic contact, nobody at the company ever heard from him again, Mr. Hay said. Around the same time, Mr. Zhang disappeared.
By this time others at the company had become suspicious of the assay results from Boka. Results from new samples had come back considerably lower in value than prior results. This prompted the company to order copies of the original certificates that Mr. Paterson had received over the prior four years.
Comparing the data quickly revealed that many of the company's prior news releases had overstated the results at a magnitude far greater than human error could have caused, Mr. Hay told the court. Southwestern immediately retracted the results and contacted the RCMP and the B.C. Securities Commission.
The effect on Southwestern, as described by Mr. Hay, was significant. The stock fell to 90 cents, and the company had to write Boka down to $10-million. By that point it had invested $38-million in the project. (The company ultimately sold the property for $9.4-million.)
In the wake of the discovery Southwestern and Mr. Paterson were named in a class action lawsuit, which they eventually settled by paying $15.5-million. (Of that money, Mr. Paterson and his wife paid $7.2-million and Southwestern paid the remainder.)
Mr. Paterson had faced a nine-count indictment, which charged him with five counts of fraud over $5,000, two counts of fraud on the stock market, one count of publishing false statements to induce persons to become shareholders of a company and one count of publishing false statements to deceive shareholders of a company. He pleaded guilty to four counts on Monday, and the prosecution dropped the remaining five.
The sentencing hearing is scheduled to last approximately two months.
