Shareholders of Southwestern Resources Corp. have found out the hard way that the mineral disclosure regime brought in by Canadian securities regulators after the Bre-X Minerals Ltd. scandal does not necessarily protect them against assay fraud.

National Instrument 43-101, approved by the Canadian Securities Administrators after the Bre-X salting scandal, prescribes the form and content of all technical disclosure by exploration issuers. It also requires issuers to designate a professional geologist as a “qualified person”; this geologist is responsible for the accuracy of technical information provided in news releases and other disclosure documents.

In the case of Southwestern, a Toronto Stock Exchange-listed company based in Vancouver, the designated person was John Paterson, also of Vancouver. He was also the company’s president, CEO and largest shareholder. Although these multiple roles created a potential conflict of interest, it is quite permissible under NI 43-101.

In December 2002, Paterson announced dazzling assay results from Southwestern’s Boka gold project in China’s Yunnan province. “This may be the discovery that injects new life into the junior Canadian resources sector,” resources stock analyst John Kaiser told reporters at the time.

What nobody knew then was that Southwestern would become a Bre-X-like scandal.

Upon news of the initial assay results, the stock immediately doubled to $5.35 a share. Over the next year, the company issued many more impressive assay results. By January 2004, the stock had peaked at $21.30 a share, giving Southwestern a total stock market capitalization of more than $800 million.

It was a giddy time, not only for investors but also for Paterson and the company’s co-founders. In 2004, Paterson earned $5.2 million in salary and options, making him the eighth most highly compensated public-company executive in British Columbia that year. Chairman George Plewes, who left the company in 2004, ranked ninth with $4.9 million; Dan Innes, vice president of exploration, who left in early 2006, placed 19th with $3.4 million in salary and options.

Although early assay results were promising, later results were erratic. Investor hopes that Boka could be a bulk tonnage play began to diminish; by mid-June 2007, the stock had declined to the $6-a-share level.

David Black, a lawyer in Vancouver who took over as chairman when Plewes left, says Paterson had been telling investors that a feasibility study would be completed by the end of that month. “But,” he says, “it was obvious that was not going to happen.”

On June 18, 2007, when South-western announced that the study would be delayed until the end of the year, “investors started to scream at me,” Black recalls. “I contacted Paterson and told him I was getting a lot of criticism. He said: ‘I guess my credibility is gone, too.’ I said: ‘That’s what I’m hearing, too’.”

The next morning, Paterson resigned. South-western’s board then struck a special committee to investigate the delay. Tim Jauristo, who replaced Paterson as CEO, went to China and discovered that the numbers reported in Paterson’s news releases did not correspond with the numbers in the assay database. Somebody had juiced up the figures — in some cases, by moving the decimal point one digit to the right, increasing the grades by a factor of 10.

For Black, it was a “eureka” moment — only in reverse. The stock price plunged by 80%, to $1.25.

At that point, Paterson disappeared from view. He did not answer telephone or e-mail messages. His wife issued a statement saying that, on his doctor’s advice, he had been admitted to hospital for clinical depression and would co-operate only “when he is well enough to do so.”

Then in August, Southwestern filed a lawsuit in B.C. Supreme Court against Paterson, alleging he had altered assay results and cashed in stock during the ensuing share price run-up. How much stock is not stated, but it is believed to be several million dollars’ worth.

To ensure that Paterson did not liquidate any more assets, Southwestern obtained an injunction freezing all his assets — other than $100,000 for legal fees and $9,000 a month for living expenses.

His wife, Joan, in consideration for not being enjoined in the action, agreed to a similar injunction, and was similarly permitted to draw $100,000 for legal fees and $15,500 a month for living expenses.

Paterson’s scheme, although generating only a few million dollars in illicit profits, caused immense damage to shareholders. The stock is now trading at 57¢ a share; and Southwestern’s market cap has fallen to a mere $25 million from its $800-million peak.

@page_break@Two law firms in Ontario and a law firm in B.C. have filed prospective class actions, claiming some $320 million in damages.

“We are still gathering information, weighing our next course of action and how best tactically to pursue the litigation,” says lead counsel Dimitri Lascaris of Siskinds LLP in London, Ont. “It seems relatively clear who was at the centre of the scandal. But the extent to which others may have knowingly or negligently permitted this to happen is something that remains to be determined.”

When the altered assay numbers were discovered, Southwestern immediately fired the project manager in China, John Zhang, who, according to Black, was “in on the scheme.” The company is pursuing legal action against him in China.

“This situation proves that when you have two geologists in cahoots, NI 43-101 doesn’t really work,” Black says. “If somebody is professional and clever, it is very hard to protect against fraud.”

Paterson has gone into mitigation mode and is negotiating a settlement with Southwestern. The company, in turn, is working to settle the class-action lawsuits. Paterson also has to deal with the B.C. Securities Commission and will almost certainly agree to a lifetime ban from the B.C. securities market.

Any fine imposed by the BCSC will be postponed until investor claims are resolved, which is the commission’s usual practice.

The big wild card is the criminal proceedings. The RCMP’s integrated market enforcement team in Vancouver is putting together a brief for Crown prosecutors, who almost certainly will lay charges. It is also clear that a scheme of this magnitude, duration and premeditation will attract a jail sentence. The only question is: how long?

Another wild card is Paterson’s status as a professional geologist. Although he has lived and worked in Vancouver for well over a decade, he is not registered with the Association of Professional Engineers and Geoscientists of B.C. Rather, he is registered with the Australasian Institute of Mining and Metallurgy in Australia.

Apparently, Paterson once worked in Australia and became a member of the AIMM in 1989. Even though he returned to Vancouver a long time ago, he was able to maintain his registration in Australia.

Other professional bodies, such as those governing chartered accountants and lawyers, require their members to register in the jurisdiction in which they are working, but this is not the case with geologists. There are practical reasons for this. Geologists, generally speaking, are a nomadic species who take on assignments all over the world. So, the profession permits them to be registered in one jurisdiction and work in another.

By the same token, the CSA permits geologists registered in other jurisdictions to act as qualified persons in Canada, as long as they belong to a recognized self-regulatory organization. AIMM is one of those recognized SROs.

Although all of this makes perfect sense, the implications for investors in this case are daunting. Southwestern shareholders in B.C. have been duped out of millions of dollars by Paterson’s skulduggery and should be able to look to APEGBC to deal with the matter. Instead, they have to rely on an SRO in a foreign jurisdiction located some 12,500 kilometres away to take appropriate action.

So, are the Australians on the case? All Michael Catchpole, the executive director of AIMM, will say is there has been “considerable correspondence between professional bodies and ourselves, and we are very aware of the events that involved Paterson and his company.”

By all accounts, Paterson is not claiming innocence. On the contrary, he and his lawyer, Rod Anderson of Harper Grey LLP in Vancouver, are trying to settle the matter with Southwestern, its shareholders, Crown prosecutors, the BCSC and, in all likelihood, AIMM.

So, the jurisdictional issue with respect to his professional status may not matter in this case. IE