Fraud Examination – Bre-X Mineral Case Study

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Summary of the Key Points

Bre-X Minerals was supposedly among the most valuable companies in Canada. The company convinced many of the mining experts by then that they owned one of the biggest gold mines ever discovered (Ro, 2012). Hailed as the mining of the century, the gold mine located on an island in Indonesia was said to have too much gold and this caused the price of gold on the market to drop very significantly because of an anticipated increase in the supply of gold from the mine. Within a very short period, many kinds of Canadian investors got interested in the Bre-X company as it looked very promising to the investors who rushed to buy the company’s shares. As a result of the rush, the share price shoot to as high as $250 as many investors believed it was their time to make huge returns from their investments.

The hopes and pessimistic nature of the investors took an instant turn when the chief geologist of the company took his life. The suicide took place a few days after a consulting firm reported that the gold samples from the mine were tempered with to fabricate the quality of the samples and make them much appealing to the investors. After it was clear that the allegations were true and the project by Bre-X was a scam, it was still not clear the mastermind behind the tempering of the gold samples to lure investors. Several lawsuits were filed against the Bre-X executives for misleading shareholders. Many of the company officials made huge profits from selling their stock one year before the tempering of the gold samples was disclosed. Many investors lost their money from this scam.

Analysis of the Case Using the Fraud Triangle Model

The fraud triangle model is used to explain the factors that cause a person to commit a corporate fraud. The model has three components which collectively constitute a fraudulent behavior. The components are; perceived financial need which is usually unshared, perceived opportunity and rationalization (Schuchter, & Levi, 2013). The components are summarized as pressure, opportunity, and rationalization. These are the three legs of the fraud triangle.

Pressure

Pressure is the first factor in the triangle that drives one to commit a fraudulent act. It is the main motivator of the crime. This factor involves an individual having some financial needs that one need to meet. They may be basic needs such as paying bills or secondary needs such as accumulating large amounts of money for oneself. In this case, somebody who was behind the tempering of the samples of gold must have had the pressure of making huge profits for the company to attract many investors to buy shares that had increased in share price. To attract many investors and win their trust in the company, the people behind the tempering of the gold samples wanted to lure investors that the company was dealing in gold of high quality by fabricating the gold samples from the mine.

Investors in this category of business must have been making their investment decisions depending on the quality of the gold that a company deals. After realizing that the quality of the gold from the mine was of low quality, the people in charge were under pressure to keep the trust of investors through gold of high quality. Therefore, they decided to temper with samples of the gold that is given to investors to convince them that indeed they were making credible choices of investing in the company. The pressure to meet the financial earnings through large sales to sustain the confidence of the investors is what must have prompted the people in charge to make such an arrangement of tampering with the samples.

Opportunity

Opportunity is the second leg of the fraud triangle. Opportunity, in this case, refers to the method that is plotted to be used in committing the crime. A person planning to commit a fraudulent activity identifies an opportunity through which one abuses his position to commit the fraud with a low probability of getting caught. The opportunity is ceased by the perpetrator to commit the crime with a high level of secrecy. The intention for the high level of secrecy is because of the consequences that may arise if the fraudulent activity is brought to light. In this particular case of Bre-X, the perpetrators identified that they could temper with the quality of the samples to make them look of higher quality to lure investors into making financial investments in the company. The perpetrators in the scandal did it with a high level of secrecy that it was very difficult to identify the people responsible for the tempering. The incidence of the chief geologist committing suicide may have diverted the attention of the people to see him as the person behind the whole scandal and conceal the other perpetrators in the scandal.

Rationalization

Rationalization is the third leg of the triangle.  In most cases, fraudsters are usually first-offenders without any criminal charges in the past. This scenario is used by the fraudsters to gain the trust of the people before they con them. Bre-X had no criminal activities in the past, and it was among the best mining companies in Canada. Investors trusted the company very easily with their investment. The perpetrators ceased this opportunity to tamper with the samples with the hope that it would remain undetected because of their clean background. Most investors must have seen the company as a clean corporate with nothing to fear. Along the way, the company must have realized the low quality of their gold, but because of the high demand for their shares, the people in charge probably forged a way to make sure that investors do not leave the company. It is possible that the company had no intention of committing the crime, but because of the situations along the way, they decided to engage in a fraudulent activity to save the company from losing investors.

Analysis of Financial Statements and Data

The data provided in the case study is only on the liquidity ratios of the company. The current ratio of the company stood at 1.21 which is a small ratio. The ratio implies that the current assets were only slightly higher than the current liabilities. A slight “mistake” such as letting the shareholders know the real quality of the gold the company was dealing with could land the company into big financial problems. It is, therefore, possible that the executives of the company realized it and decided not to let the truth about the quality of the gold be known to the shareholders and instead tempered with the samples of the gold to make it much more appealing to the investors. The inventory turnover stood at 1.29. This turnover was very high, and it implies that the cost of the sales was high than the average inventory. Therefore the company was likely facing some financial difficulties in which it could meet through all necessary means including duping the shareholders.

Case Study Questions

Assume you are a financial analyst who works for a major brokerage company that is heavily invested in Bre-X Minerals

In what ways would be investigating management and directors help determine the value of Bre-X’s gold prospects?

The management and the board of directors usually have much information about the financial performance of the company. The compensations given to the executive management team and the directors is usually proportional to the earnings of the company. The bonuses that are given to these individuals are usually a certain percentage of the earnings of the company. Therefore, an investigation into the compensation packages given to the management and the directors would help shed some light on the value of the prospects of the company.

In what ways would investigating the company’s relationships with other entities help determine the value of Bre-X’s gold prospects?

The relationships that an organization has with other entities can help to find the financial transactions between the organization and the entities. Entities such as the tax institutions, financial institutions such as banks, and other entities including the suppliers to Bre-X Mining would help in calculating and estimating the amounts of the transactions. These transactions amounts can help to estimate the amount of prospects that Bre-X Mining might have made from gold. The transaction costs can be used directly or as percentages of the transactions to add up the total prospects of the company from gold.

In what ways would be investigating the organization and its industry help determine the value of Bre-X’s gold prospects?

The industry is usually made up of firms that have different market shares for their products. Each organization has a proportion of the transactions that the company makes as part of the whole percentage of the entire market transactions. The supply of gold that Bre-X contributed to the industry can directly be used to estimate the value of the company’s prospects for gold. The organization's market share in the industry for the past and the very years when the fraud was committed can help a lot in estimating the value of the prospects that the company made from the sale of gold.

In what ways would investigating the financial results and operating characteristics help determine the value of Bre-X’s gold prospects?

The financial results and characteristics of operations have firsthand information regarding the value of the prospects of the company made from gold. Information on the value of sales and the cost of production can help determine the value of the gold that the company transacted. The financial results of the company both from within and outside the company such as external audit reports give much more reliable information regarding the value of the prospects and any other financial transactions by the company.

How were the gold industry and Canadian stock markets affected by this fraud?

Both the gold industry and the stock market in Canada were negatively affected. The gold industry had a negative image of possibly dealing with the gold of fabricated quality on a large scale in the local and international markets. The share prices for companies in the industry must have possibly dropped following the negative image about the entire industry. A fall in the share prices is because Bre-X had received higher preference for its shares before the issue of tampering with the quality of the sample came to light.

Some of the aspects of the perfect fraud storm that were discussed in the chapter were also present in the Bre-X scandal. Which elements were common to both the perfect fraud storm and the Bre-X scandal?

The common elements in the two scandals included the occurrence of the fraud when the firms were at the peak of their progress in the market. The frauds in the two cases came at the time when the companies had won the trust of the investors and other stakeholders. The two frauds in the two cases were also committed partially by influential people in the organizations. The frauds also involved the fabrication of quality of information and product respectively.

What were some of the perpetrators’ motivations to commit fraud?

Some of the motivations of the perpetrators to commit fraud included the desire to attract many investors into buying the company shares. The other motivation was to raise the share prices for the company so that those who owned shares could sell them at very prices to new prospective and unsuspecting shareholders.

Solutions to Preventing Fraud

Corporate frauds are very common, and they negatively affect corporates when they occur. It is important for the firm to set standards and measures that can be used to prevent these menaces from occurring since they are not healthy for corporates’ stakeholders. It is the duty of all the stakeholders to take part in preventing such frauds from happening (Cannon, Godwin, & Goldberg, 2006). The following are possible measures or alternatives that corporates can employ to prevent cases of fraud from happening.

Setting Moral Standards

There should be some moral standards that in place to monitor the activities of the employees in executing their various duties. Such moral standards should ensure that employees do not engage in illegal activities at the workplace (Dimoff, 2017). To ensure that moral standards are adhered to, there should be checks on how the employees behave at their workplaces. The setting of moral standards can also be effective if they are strictly monitored and followed from the top of the corporation. The executive management should spearhead the moral standards at the firm.

Doing Background Checks On the Employees

All employees should be subjected to a thorough background check on their behavior regardless of their positions at the firm. Criminal offenders have a tendency to repeat their illegal activities, and therefore anybody linked to any illegal activity in the past is not supposed to be offered a chance to work with the firm. The ill-at-ease feeling that an employee may have at the time of hiring can be used to determine the involvement in criminal activities of the past. Background checks are meant to ensure that people who are associated with criminal activities are kept off from a corporate.

Separation of Functions and Duties

Functions and duties should be separated so that they are not performed by one or only a few individuals at the firm. Frauds are done with a lot of secrecy which does not require many people to be involved. When functions and duties are performed by various individuals in the firm, it helps to reduce the level of secrecy that is needed to carry out fraudulent activities. This is one of the internal control measures that can be used by the management in preventing any fraudulent activities from happening.

Forced Vacations

Forced vacations on employees can help to access the activities of an employee in a firm. It is only when an employee is given unexpected vacation that those charged with the responsibility of overseeing the activities of an employee in the firm can access one’s work activities and identify any questionable activities.

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