A COMPARISON

Evening Post, Volume CXVIII, Issue 34, 9 August 1934, Page 8

A COMPARISON

BRITAIN AND NEW ZEALAND

"DANGEROUS PRACTICES"

The Commission' proceeds to mako a comparison of tho British and New Zealand types. .of trust companies.

"A comparison of the constitution and policy of the Investment Executive Trust of New Zealand, Ltd., which exemplifies tho contractual type of trust, with the British type, will serve to reveal tho structural weaknesses which have mads possible (or at least facilitated and encouraged) the dangerous and objectionable practices referred to in greater detail in other parts of this report," "tbe'donimission states. • '' (a) Capital Composition.—-The capital resources,of investment trusts are procured by means of ordinary shares, preference shares, and debentures. Tho ordinary rule in trusts of the British type is that at no time should the debenture capital exceed the share capital. The total capital of sixty-three such * trusts is distributed as follows: Ordinary' shares, ........ £34,530,000 Preference shares .. £36,334,000 Total share capital £70,884,000 Total debenturo capital . £45,192,000 "Prom this it will bo seen that, in practico, tho debenture liability is substantially less than the total share capital.. .-:..:•'. SIXTEEN TIMES SHAKE CAPITAL. " Tho capital composition of the Investment: Executive Trust of New Zealand, Ltd., is in marked contrast wifcii British practice. The nominal capital is £100,000, but prospectuses sp far; issued provido for debentures totalling £4,000,000. .The total nominal, capital is one-fortieth of the total nominal value of dqbentures.,:which maybe issued. Paid-up' share capital as at -October 17, 1933, totalled* approximately £30,000 (ordinary '£24,600, preference £5670)j' but th&, debenture; issue totalled £493,290,"0r over sixteen times the, share capita),, Of tho ordinary capital of £24,400, two individuals, Messrs. J. \V. P S. McArthur and. C. G. Alcorn, hold £22,575. The control of .-.debenture-funds totalling nearly £5,00,000, is in their'; hands! In the /same -'way, other contractual trusts operating.in New Zealand show a small ratio tof sharo capital to debenture; liability! '■■'; : ;"' ,' " '■..' '"(b) Security^—-In the'ease ol: trusts of. the,;. British type, the security to de-be'ntur.e-hojders consists of the total assets .'of .--.tho undertaking. The /.debenture capital is backed by the whole of tho,.;- paid-up share capital of the company, ;and this is normally in excess of thd,debenture capital. The ddbenturo carries a: fixed rate-of. interest,.and-is a mortgage secured against the whole of tho assets of the trust.-''.

"The debenturo of the Investment Executive' Trust of New Zealand, Ltd., is a contract to pay over a certain proportion of the net revenuti proceeds derived from the investments mado with the'debenture funds/ These appear to,-.bo 'reduced, before investment, ■by capital'/chargcs in respect of ;bvokerage: and administration costs which luiYO:.t.tftaHod:up'.lo 10 percent, of tho nominal value oJE tho debentures. De-

bentnro-holders: may require repayment of their: debentures if the average injtorest" oyerrany two successive years , falls; below 3 per cent, per annum, or lon winding-up of tho company; but i the assets of the company are not charged:by tho debentures of any series. The share capital of tho company is free from liability in respect of debentures. Hence, the security behind debentures in any series consists simply in tho securities and funds held to the credit of the-series, and arising from transactions with tho funds provided by debonture-holdoTS themselves; ."■. ... ""■. '.'■< NO TRUSTEE. "A further essential difference having relation to tho question of security is the appointment of trustees. Many if not all, British trusts appoint trustees with power to inspect security portfolios and power of audit. While the power of trustees will be circumscribed by the conditions of the trust deed, their appointment does provide an, additional safeguard against abuse. The Investment Executive Trust of New Zealand, Ltd., appoints no trustee, and debenture-holders "have no powers of audit. "The essential bearing, of the above on the facts which are disclosed in our report is this: By the provision of a small share capital, a small group of individuals has obtained control ovov a large volume of funds and used these, unhampered by trustees or by incurring any risk of loss of their own capital. '■■'•' ■ There is nothing to prevent'them from manipulating the funds to their fown advantage, but, even apart from such possible manipulation, they stand to gain a very high rate of return on their own capital,; while avoiding any loss which may result from using the debenture funds in speculative investments, la such circumstances it becomes all the more imperative that those who direct policy should be men of undoubted integrity.. "(e) Investment Policy.—Two basic canons of investment policy should be the diversification of investments and the avoidance of speculative investments. One authority states that a trust with a capital of £2,000,000 should not invest moro than £3000 in any oho enterprise. As a general principle^ securities should not bo purchased Bave in established undertakings with ample assets, and which have been proved by experience to be sound. The Investment Executive Trust of New Zealand, Ltd., violates botli these canons. WHITTLING AWAY SECTJEITIES. "Its debenture certificates provide that, on completion of an issue of debentiiresj not moro than 10 per cent, of the'funds contributed shall be in any. one security/ -.-;> but this provision does not apply until the issue is completed. Hence, it can bo deliberately evaded by refraining from completing an issue, and the appearance of security through diversification is illusory.' The existence of a largo number of subsidiary or related companies facilitates-, such "evasion; for it is possible to place'investments in several such concerns ~a!nd then divert them to a particular object, which may bo selected primarily because it furthers the interests of the directors themselves. The interests of debenture-holders aro subsidiary.*.. Investment trusts which are mindful of "the of those who invest with theni^ aiid< anxious for their own ■ reputation^ .should' refrain from tho establishment of subsidiary or interlocked companies,, oxcopt for such ancillary purposes as the marketing of their debentures. The Investment Executive Trust group,'hereinafter described .-.' in detail, .'comprises at least fifteen companies which are connected by common shareholders, or directors, sharoholdinfs. iii each-other, ;or other forms,of finaricialUnterdependence., No elaborate argument •is-raqii'u'ed' to demonstrate the openings which this fives to use the funds of debenture-holders to servo the personal ends of those in control, or to obtain profits by way of commission, or the danger that tho security of debenture-holders may be steadily whittled away. "The second basic canon, the avoid ance of speculative securities, has also been flagrantly violated; for it will be shown that a considerable proportion of j the fuiids of the debenture-holders lias been used in the purchase and renova-j

tion of ii; building. This is certainly neither an established concern nor a proven enterprise," but is definitely a speculative investment. It will be shown that the device of subsidiary or related comrjahies has been used to facilitate this investment. At the samo time, it has enabled the transaction to be. undertaken in such a way as to throw the burden of risk on the debenture-holders, while leaving it open to the directors to enjoy any exceptional profits which might conceivably .bo realised. Debenture-holders have no means of obtaining, knowledge of the transactions directed to the purchase of this building, becauso they have no powers in regard to inspection of tho portfolios of securities."