Does the lack of a Mineral Resource make a property immaterial for reporting under S-K 1300?
Scanning recent correspondence between the United States (US) Security Exchange Commission (SEC) and a minerals company, I was drawn to the discussion of materiality. New rule S-K 1300 requires minerals companies to provide details for mineral properties that are considered material to the company. Defining which properties are material is a little tricky as companies need to judge whether divulging additional property specific detail would be reasonably expected by an investor deciding whether to buy shares in the company.
Under the previous rules, Industry Guide 7, minerals companies were not permitted to submit reports detailing exploration results or estimates of exploration targets. Under the new rule, S-K 1300, minerals companies must report exploration results or estimates of exploration targets (a range of possible tonnes and grades of metal, for example) if those results or estimates are material to the company.
The SEC have queried the company’s submissions, which included details on some properties but excluded other properties that it deemed to be immaterial. The SEC were not satisfied that the basis for deciding the immateriality of those properties was clearly stated and asked for more information. The company responded to the effect that the excluded properties had not been explored to a degree sufficient to allow reporting of a Mineral Resource, and therefore they were not material to the company.
This case study prompted the question: does the absence of a Mineral Resource, as a sole criterion, satisfactorily demonstrate a property is immaterial to the company?
There are a few arguments each way on this question, which hinge on a very subjective fulcrum – the appetite for risk … and reward.
S-K 1300 states that a company must report exploration results or exploration targets if these are material to the company. It seems clear then, taking the rule at face value, that one cannot argue the absence of a Mineral Resource provides justification to determine immateriality.
In support of the argument that a Mineral Resource is required to consider a property as being material are other requirements in S-K 1300 relating to assessing the prospects for economic extraction. To report a new Mineral Resource, a company must perform and submit an Initial Assessment, which requires high level assumptions to be made about technical, economic and other factors to assess Reasonable Prospects for Economic Extraction (RPEE). A Mineral Resource cannot be reported for a property that does not have RPEE, so if you have not completed sufficient exploration work to enable an assessment of RPEE then the argument (presumably) goes that the company has no basis to evaluate the materiality of the property because they have no basis to predict future financial metrics. This argument has a hidden premise, which is that the financial metrics of the project are the sole criterion for determining materiality. However, the materiality criterion must include an assessment of whether potential investors have all the information reasonably required for them to make an investment decision, which could include information such as the company’s view of exploration potential.
In this case, the company presumably wanted to acquire the immaterial properties on the basis that they thought they would be valuable for the company to own at some point in time. That is, they must have formed a view that led them to believe an investment of company funds was justified. This gets to the heart of investment in exploration plays – potential investors who have an appetite for high risk (and high reward) will expect companies to provide information on why they thought investing funds in a property was justified and what the exploration potential is for that property. S-K 1300 provides guidance for properly reporting exploration results or exploration targets such that investors are not misled.
Even if there has been no exploration field work completed on the property, an exploration company will form a view of the exploration potential and will therefore have an exploration target. S-K 1300 allows reporting exploration targets in the absence of any exploration data as long as the basis of the exploration target (i.e. the conceptual geological model) is adequately described. That means there is no reason why the company in this case could not have provided more information on the properties it is claiming are immaterial. There could be valid reasons for considering those properties immaterial, but the absence of a Mineral Resource is not a valid criterion on its own.
This case possibly reflects a sense of unease with the new S-K 1300 rules, which require companies to expose substantially more information than they have ever had to in the past. Whilst we are starting to see how the SEC is responding to submissions, I can imagine some company CEO’s worrying that they may have some explaining to do in the future if they report an exploration target that turns out to be way off the mark. Reporting exploration targets as a range, as required by S-K 1300, does provide a mechanism for companies to mitigate the risk of getting it wrong, but still provide investors with relevant information.
Minerals companies always operate in a state of uncertainty and depending on their appetite for risk that uncertainty can be extreme. If a minerals company is betting big on an exploration property, then investors could reasonably expect to have information about that. That is, a declaration of an exploration target, reported and qualified as per S-K 1300 requirements, could influence the decision of an investor to buy shares in the company. Investors, like minerals companies, have their own appetite for risk. Investors buying into a company at the exploration stage can reap great rewards if that property progresses to an operating and profitable mine.
Regardless of a company’s appetite for risk, public reporting needs to include better justification of materiality judgement than simply stating there has not been enough exploration work completed to define a Mineral Resource.