The failure and termination of several recent Canadian prospectus financings has highlighted the particular disclosure challenges that companies face in the mining sector, and in particular some recent confusion around the rules applicable to preliminary economic assessments (PEAs). It also suggests that regulators have recently been scrutinizing the technical disclosure of mining issuers with particular attention, raising the execution risk associated with public financings and other transactions in the sector.
On February 16, 2012 Extorre Gold Mines (Extorre) announced that it had terminated a $50 million offering of common shares. The offering, which was undertaken on a bought deal basis with a syndicate of underwriters led by TD Securities, had been previously announced on January 30, 2012. The termination of the offering resulted from the inability to clear a final prospectus through the Canadian securities commissions due to issues raised by the B.C. Securities Commission (BCSC) relating to Extorre's scientific and technical disclosure. More details of the issues involved came to light when the company put out a detailed clarification press release on February 24, 2012, which highlighted a number of disclosure issues identified by the BCSC, including in particular a number of concerns regarding the manner in which a preliminary economic assessment for its Cerro Morro project was characterized both in its current technical report and in other public disclosure documents. The disclosure in question appeared to characterize portions of the PEA as being to a higher preliminary feasibility study (PFS) standard, while retaining the PEA nomenclature for the stated purpose of allowing the inclusion of new inferred resources in a subsequent version of the PEA.
A second recent example of a broken bought deal in the mining space occurred when Rio Novo Gold announced on March 6, 2012 the termination of its previously announced $20 million equity offering. The company was unable to clear its prospectus with the Ontario Securities Commission (OSC), and announced at the time of the termination of the offering that a PEA would be forthcoming in respect of its Almas project in Brazil. The issue at hand appeared to be the use of economic analysis in the company's disclosure that was unsupported by an existing PEA or technical report.
Finally, a third issuer, Karnalyte Resources, also terminated a previously announced $115 million equity bought deal offering on December 13, 2011, indicating that it had received comments from the Alberta Securities Commission (ASC) on its technical report for the Wynyard Carnallite project that it was unable to resolve in a timeframe necessary to complete its financing. A subsequent press release on February 6, 2012 revealed that the company had not yet resolved the ASC's comments on the technical report.
One of the most common sources of regulatory issues for mining issuers is compliance with the rules governing the use of economic analysis relating to mineral projects in their public disclosure, particularly in the case of relatively early-stage projects. As a subset of these issues, the securities regulators have recently indicated that they believe there is some confusion in the marketplace regarding the use of PEAs. This confusion may have arisen as a result of the fact that the applicable definition was amended as part of the recent overhaul of National Instrument 43-101 so as to remove the requirement that a PEA had to be in respect of an early stage property and prior to the completion of a PFS. As a result, the new instrument provided additional flexibility with respect to the use of PEAs on properties that had previously advanced to a further stage (e.g., to assess alternative development options or allow for a possible project reset where a PFS or feasibility study (FS) had become obsolete), while perhaps inadvertently providing some room for behaviour that the regulators consider to be problematic.
One of the key attractions of a PEA under the current Canadian regulatory regime applicable to mining projects is the specific exemption for PEAs from the normal prohibition on economic analysis disclosure that includes or is based on inferred mineral resources, the weakest of the various CIM categories of mineralization. That exemption is subject to certain conditions, including the use of a prominent disclaimer and the inclusion of disclosure regarding the impact of the PEA on the results of any PFS or FS that exists in respect of the same project, but nonetheless provides an opportunity to provide a portrait of a project's potential based on inferred resources. That opportunity disappears once the project advances to a PFS, which must be based solely on higher categories of mineralization. As a result, there may be a temptation to retain what is nominally a PEA in place notwithstanding the progression of the project to a more advanced stage, in order to retain the ability to provide economic analysis based on inferred resources.
At recent conferences, staff of the BCSC and the OSC have cautioned that "calling something a PEA does not make it so if it is actually done to the level of a PFS or FS" – which appears to be exactly the concern they had with Extorre. In addition, staff have gone out of their way to clarify that a PEA is not in their view:
- a study done concurrently with or as part of a PFS or a FS;
- a way to include inferred resources in a PFS or a FS (which is otherwise prevented by operation of the CIM definitions); or
- a way to modify a PFS or a FS to include more optimistic assumptions.
We understand that a staff notice will be forthcoming later in 2012 that will further articulate the views of the staff at the Canadian securities commissions on the appropriate use of PEAs and attempt to remove some of the current confusion in this area.
The public financing failures have highlighted the particular regulatory hurdles and risks to which mining issuers are subject in the prospectus financing context, as NI 43-101 imposes a set of challenging compliance requirements that do not generally exist in other industry sectors. Potential pitfalls may be lurking within an issuer's prior public disclosure record, including its current technical reports, but not surface until such time as it is exposed to a higher level of regulatory scrutiny in the context of a public financing transaction, with potentially embarrassing or damaging results.
As a result, it is critical that issuers and underwriters consider these issues, review the existing disclosure record with care and evaluate possible risks and possible structuring alternatives well in advance of embarking on transaction in order to avoid similar problems. Particular attention should be paid in evaluating the level and form of support for any economic analysis (such as guidance related to a project) previously published by the issuer, in reviewing any existing PEAs and PEA-related disclosure, and in ensuring more generally that material scientific and technical information regarding material projects is supported by a current technical report.
Douglas Bryce's practice focuses on corporate and securities law matters, with an emphasis on mergers and acquisitions and corporate finance transactions. Jeremy Fraiberg is Co-Chair of Osler's Mining Group.
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