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Regulation
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Of Note:


The Globe and Mail that indicates a pattern of suspicious trading on Canadian markets, despite the efforts of regulators.

The striking trading pattern suggests either that some players possess inside information about imminent deals, and
are making illegal profits at the expense of others, or that there are savvy investors unusually prescient in figuring out
just ahead of time which companies are going to be acquired

Most of the takeovers in the mining sector have been of junior gold explorers.

Canadian regulators, stung by criticism that they don't take insider trading as seriously as the U.S. Securities and
Exchange Commission does, have stepped up investigations of suspicious market activity...




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Trading patterns point to leaks in takeover deals




Saturday, November 27, 2010
Globe and Mail investigation shows share prices often rise before mining bids are made public

MARTIN MITTELSTAEDT

The shares of every mining company targeted for a takeover in Canada during the past year experienced run-ups, many of them significant, in the days just before the deals were publicly announced, according to an investigation by The Globe and Mail that indicates a pattern of suspicious trading on Canadian markets, despite the efforts of regulators.

The review covered 14 bids. Each targeted firm had a rise in its share price over the five-trading-day period preceding the acquisition becoming public knowledge.

The striking trading pattern suggests either that some players possess inside information about imminent deals, and are making illegal profits at the expense of others, or that there are savvy investors unusually prescient in figuring out just ahead of time which companies are going to be acquired. The biggest weekly gain was a 38-per-cent advance in the shares of Brazauro Resources Corp. before the public announcement of its takeover by Eldorado Gold Corp.

The question is whether the increase just before deals "is leakage of information or clever people spotting takeover targets," says Laurence Booth, professor at the Rotman School of Management at the University of Toronto. "You can't really distinguish between the two until somebody comes out and prosecutes somebody for leaking information."

Eldorado vice-president Nancy Woo said the company noted the share increase, but said investor speculation on its intentions for Brazauro wouldn't be surprising because it had previously taken a major equity stake in the firm.

But the consistency of the pattern does raise the troubling issue of whether investors on Canadian markets are being had by those with inside information, which is once again in the spotlight because of a number of investigations. The Ontario Securities Commission alleged earlier this month that Mitchell Finkelstein, a rising star at prominent Bay Street law firm Davies Ward Phillips & Vineberg LLP, tipped a fraternity chum who worked at the CIBC about a number of pending takeover deals.

And in the United States, federal agents raided the offices of three hedge funds this week as part of what appears to be a major insider-trading probe.

Canadian regulators, stung by criticism that they don't take insider trading as seriously as the U.S. Securities and Exchange Commission does, have stepped up investigations of suspicious market activity, according to annual summaries on the number of their enforcement activities.

Enforcement actions concluded against illegal insider trading rose to 16 in Canada last year, at least double the pace of each of the preceding two years.

"The OSC takes insider trading very seriously and has a dedicated team in enforcement that specializes in insider trading and market manipulation," said Jill Homenuk, a spokesperson with the commission.

Securities watchdogs declined to comment on whether any cases reviewed by The Globe, which began with the November, 2009, acquisition of Canplats Resources by Goldcorp and ended with the pending deal for Antares Minerals by First Quantum Minerals announced in October, are the subject of ongoing investigations.

To quantify the extent of the suspicious trading, The Globe had Fatma Sonmez, a finance professor at the Queen's University School of Business, analyze the market action in the 14 target companies in the 30 days before the bids were announced, using a capital asset pricing model.

It's a sophisticated formula that determines whether movements in prices are out of line with what would be expected, given the movements in the broader market. The model calculates the cumulative excess return in a stock, compared to the movement in the market as a whole, adjusted for the volatility of the shares, a factor known formally as its beta. Dr. Sonmez's model also compared the stocks' movements to that of similar mining stocks.

A 5-per-cent gain in a firm in advance of a takeover wouldn't raise eyebrows if it matched a market rally and the shares move in line with stocks generally, but it would be if returns streaked well ahead of a moribund or falling market.

According to Dr. Sonmez, there was a pattern of abnormal returns just before nine of the takeovers, or about two-thirds of the deals. Two cases were indeterminate, and three moved in line with what would be expected, given the overall action of the market in the days ahead of their deals.

On average, there was an abnormal return of 8.8 per cent in the deals compared to the gold index. In other words, the stocks gained 8.8 per cent more than would have been expected, given what was happening in the market at the time. (This calculation excludes the Potash Corp. deal, because its peer group is fertilizer producers, not gold miners.) The abnormal return for all the shares in the investigation, including Potash, was 9.4 per cent, compared to the TSX as a whole.

The excess gains started appearing 11 trading days before the bids became public and then grew steadily larger until the takeover announcement, when compared to the TSX. Most of the takeovers in the mining sector have been of junior gold explorers.

A gain of about 9 per cent over 11 trading days may seem modest, but it is more than an equity investor typically gains in a year. The S&P/TSX composite index has risen about 6 per cent annually over the past 30 years.

"On average, there is some sort of market move before announcements," Dr. Sonmez concluded, although she cautioned the analysis doesn't confirm anything untoward - just that there was an unexpected rise in the target's stock price, relative to other stocks.

The shares having abnormal returns before announcements (with the acquirer or potential acquirer in brackets) were: Andean Resources (Goldcorp); Antares Minerals (First Quantum); Brett Resources (Osisko); Brazauro Resources (Eldorado); Capital Gold (Timmins Gold); Red Back Mining (Kinross); Corriente Resources (CRCC-Tongguan Investment); Chariot Resources (China Sci-Tech); and AuEx (Fronteer Gold).

Acquisition targets typically surge on the day that news of a deal comes out, but in the Chariot case, most of the juicy gains happened before the announcement. The shares rose 28 per cent in the week before the deal became public, but only 5 per cent in the session after executives formally revealed they'd inked a deal.

Those without abnormal returns were Marathon PGM (Stillwater Mining); Comaplex (Agnico-Eagle) and Canplats (Goldcorp). The trend couldn't be determined for Underworld Resources (Kinross) and Potash Corp. (BHP Billiton).

The review looked at all mining takeovers, except cases where pre-deal share prices were being skewed upward by a logical explanation: open market purchases in targets by the acquiring firms.

The Globe sought comments from participants in each takeover. Generally, officials who responded said they detected nothing exceptional in the pre-deal trading patterns.

"Our corporate development people are confident that there was nothing unusual," said Jeff Wilhoit, vice-president at Goldcorp. Goldcorp has been approached by regulators looking at trading after each of its takeovers in the past three years, but Mr. Wilhoit characterized the inquiries as "matter of course" reviews.

Shares of Capital Gold rose 7.2 per cent in the week before it received a merger bid from Timmins Gold in late September. But Timmins CEO Bruce Bragagnolo said he didn't view the rise as unusual because it occurred around the time of the Denver Gold Show, an annual event that draws speculators to junior gold miners.

A spokesman for Potash Corp. said the 9.6-per-cent rise in its shares in the two weeks before BHP's takeover bid reflected market interest in fertilizer producers because shares in competitors also rose. BHP did not respond to requests for comment.

While regulators are supposed to be watchdogs, one company, Brett Resources, itself took action to protect shareholders.

Officials at Brett Resources worried that word of the company's impending takeover by Osisko might have leaked out in the middle of confidential negotiations on the deal. The shares closed at $1.98 on March 16, and then the next day they suddenly jumped to $2.09, at which point trading was halted in the early afternoon at Brett's request. The halt lasted until March 22.

Ronald Netolitzky, Brett's chairman, said the "little wobble" in the share price made him nervous. "It could have been just a normal pattern. We could have waited it out, but I consider it unfair to shareholders that sell," Mr. Netolitzky said.

He said the exchange initially balked at the request for a trading halt. "We actually had to call them and kind of push them," Mr. Netolitzky said. "We basically said: 'This is critical. We can't do this with a one-hour halt because we don't have the deal.'" The shares rose to $2.82 when trading resumed after the two sides completed the transaction. (TSX spokesperson Carolyn Quick said it doesn't comment on listed company matters.)

It is standard practice on deals to require all those involved, from boards to lawyers and investment bankers, to be aware of confidentiality requirements about material, non-public information and to sign non-disclosure agreements. Trading in advance of important information or tipping others is a violation of securities law, a fact well known throughout the investment community.

But some of those involved in takeovers suggested it becomes increasingly difficult to keep deals secret as the circle of those in the know expands from a handful of senior executives and board members to include the phalanx of investment bankers, securities lawyers, and other hired help swarming each of two separate corporate teams working on typical transactions.

Ulli Rath, Chariot's president at the time of the acquisition, said he kept a tally of everyone working on the deal for his company but "stopped counting above 50."

"It's initially a pretty small group but at some point there is an ever-widening circle of individuals that seem to be involved one way or the other," he says.

He says he still has no idea why the shares of the company surged during confidential talks. "If I knew, then I would be able to tell market surveillance. I really don't know."

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BEFORE THE NEWS, BIG GAINS

Is it good luck, insight, or suspicious trading? A review of the moves in 14 share prices before mining industry takeovers shows a consistent pattern of increases just before deals are publicly announced. While some of the increases are small, others are huge, with the biggest amounting to a 38 per cent gain in the week before the announcement.


BRAZAURO RESOURCES (BZO-TSX)

Shares rise 38 per cent in the week before its acquisition by Eldorado:

May 7

Eldorado presents Brazauro with a non-binding proposal for a takeover.

Saturday, May 8

Brazauro's board meets to consider the proposal.

May 8-11

The two companies and their advisors negotiate and finalize a deal.

May 12

The companies announce a takeover.

Close on week before deal (May 4): 50 cents

Last close before deal (May 11): 69 cents

Last close (May 12): $1.29

******

CHARIOT RESOURCES (CHD-TSX)

Shares rise 28 per cent in the week before its acquisition by China Sci-Tech:

Feb. 8

Chariot begins a period of exclusive negotiations with China Sci-Tech about a takeover.

Feb. 22

In response to unusual trading activity, Chariot Resources issues a press release at the request of regulators announcing that it is in talks with a third party about a possible deal.

Feb. 26

Chariot's board reviews the status of the deal with its legal advisors and RBC Capital Markets.

March 1

The companies announce a takeover.

Close one week before deal (Feb. 19): 49 cents

Last close before deal (Feb. 26): 62 cents

Last close (March 1): 65 cents

******

AUEX VENTURES INC. (XAU-TSX)

Shares rise 15 per cent in the week before its acquisition by Fronteer:

Aug. 12

AuEX board establishes a special committee to oversee a transaction with Fronteer.

Aug. 18

AuEX managers and Dundee Securities end a two-week effort to shop the company to other potential bidders.

Aug. 26, 27

AuEX and Fronteer and their legal and financial advisors engage in intensive negotiations on the pricing and structure of a deal.

Aug. 30

The companies announce a takeover.

Close one week before deal (Aug. 20): $3.91

Last close before deal (Aug. 27): $4.50

Last close (Augl 30): $5.69

******

A RUN OF TRADING LUCK

Acquisition targets and their share price moves in the week before public announcements of takeovers.

Brazauro Resources.........+38%

Chariot Resources............+28%

AuEX Ventures..................+15%

Andean Resources...........+13%

Brett Resources.................+10%

Underworld Resources.....+7.8%

Capital Gold.......................+7.1%

Canplats Resources.........+6.3%

Marathon PGM.....................+5%

Corriente Resources........+3.7%

Comaplex Minerals...........+3.2%

Antares Minerals...............+1.8%

Red Back Mining..............+0.7%

Potash Corp......................+0.6%

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCES: BLOOMBERG; DATELINES FROM SHAREHOLDER INFORMATION CIRCULARS ON THE DEALS




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