Story: Business failures and corporate fraud

Page 3. Government intervention, 1890–1940

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The crisis facing the Bank of New Zealand in the early 1890s led the government to take a greater role in regulating business to protect investors and creditors. It began a pattern of government response following notorious failures.

Bank of New Zealand

As a result of its reckless lending on over-valued property without proper security, the Bank of New Zealand was facing collapse by 1894. A bill was rushed through Parliament providing a state guarantee.

King of the castle no more

 

While Joseph Ward survived the collapse of the Colonial Bank, another heavy investor in the bank, William Larnach, was not so lucky. Laden with debt and personal problems, he committed suicide in a Parliament committee room in 1898. Larnach’s castle on Otago Peninsula is his lasting legacy.

 

The following year the bank acquired the Dunedin-based Colonial Bank which was also on the verge of collapse. Treasurer Joseph Ward drew up the legislation for this. He did not disclose that he and his stock and station agency in Bluff were heavily in debt to the Colonial Bank and had contributed to its fall. Ward became bankrupt in 1897 and was required to quit Parliament. However he recovered, repaid his creditors and returned to the House.

State action

From the 1890s the state showed a greater interest in both defending the rights of creditors and protecting small businesses and farmers from difficulties in obtaining credit. The Joint-Stock Companies Act 1860, modelled on earlier English legislation, was updated with a new Companies Act 1901, inspired by the collapse of the dredging companies. The act tightened regulations on the appointment of directors, auditing, and the writing of prospectuses.

Deteriorating business conditions in the 1920s led to a rise in business failures, which was exacerbated by the onset of the economic depression in 1929. In 1920 there had been 145 bankruptcies. By the late 1920s the figure hovered at around 800 each year. Some professional groups, notably lawyers, set up fidelity guarantee funds to give clients limited protection in the event of business failure (although lawyers had also offered trust accounts since 1892).

The ‘junk bond’ king

In the early 1930s the coalition government passed special legislation to wind up the businesses of John McArthur. This was the most direct intervention in company affairs by the government since the 1894 Bank of New Zealand bailout.

Canadian-born McArthur had formed Redwood Forests in 1925, funding the company by the sale of debentures or ‘junk bonds’ – each representing an acre (0.4 hectares) of exotic forest which the company promised to plant.

From 1929 investment trusts had been set up in New Zealand. These pooled the funds of small investors and invested them collectively. When McArthur’s ventures began failing in 1930, he established his own Investment Executive Trust. This sent out door-to-door salesmen to persuade people to buy debentures. Subsidiary companies were also set up, all with minimum governance and disclosure. The largest debenture-holders were directors who moved money from company to company at great personal profit. McArthur even established his own stock exchange.

Fast work

 

The report of the commission inquiring into trusts was presented to Parliament on the evening of 8 August 1934. As a result of its findings, the Companies (Special Investigations) Act was passed through both houses and became law before midnight.

 

In 1933 the government set up a commission to inquire into trusts. It also passed a new Companies Act to protect small investors, and made door-to-door hawking of shares illegal. The next year it passed the Companies (Special Investigations) Act to investigate McArthur’s businesses, and in 1935 passed an act to wind them up. McArthur himself was fined £500.

How to cite this page:

Graeme Hunt, 'Business failures and corporate fraud - Government intervention, 1890–1940', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/business-failures-and-corporate-fraud/page-3 (accessed 12 December 2019)

Story by Graeme Hunt, published 11 Mar 2010