GENERAL SCOPE OF THE BILL

The major provisions of the measure and the required procedure thereunder are presented in an appendix to this report, page 15.

In brief, a commercial or industrial firm endeavoring to obtain capital funds through a public offering of bonds or other evidences of indebtedness to an amount of $250,000 or more would have to comply with the terms of both the Securities Act and the proposed measure and the rules, regulations, and orders under both. If the issue were smaller or if it were an additional issue under an existing indenture, the Commission could employ its discretion to deny exemption.

The Securities Act is a law which provides for the public disclosure of essential facts concerning a securities issue. The Barkley-Lea bill, however, in addition to providing for disclosure, would go very much further. It would give to the Securities and Exchange Commission extensive powers as to the form and contents of the indentures under which securities are issued, even as to provisions with respect to the rights and powers of the indenture security holders.

In effect, the Commission would be given power to pass upon so many of the terms of the indenture and securities that it would be difficult to distinguish between qualification and approval. There is support for this view in a number of the provisions of the bill and in the frank statement of the Chairman of the Commission that it, as the representative of the Government, should be "the fourth party at the contract table" with the debtor corporation, the corporate trustee and the underwriter. He freely admitted that the measure departs from the "adequate disclosure" concept of the Securities Act.

As a matter of public policy, we do not believe it is advisable to confer such broad powers upon any governmental agency.

CONFLICTS OF INTEREST

The trust indenture would be required to provide that if the bank as trustee has or acquires certain specified conflicts of interest, it must eliminate them or resign. The conflicts, which are defined in an arbitrary manner, are set forth in a number of complicated provisions.

The following will serve to illustrate some of the conflicts that would disqualify a trustee :

If the trustee holds as collateral for an obligation which is in default 5 percent of the voting securities of the obligor firm or 10 percent of any other class of securities not issued under the trustee indenture;

If the trustee holds 5 percent of the voting securities of the obligor, no matter what proportion such holding may bear to the assets of the bank;

If, during the life of the indenture, personal trusts under the administration of the trustee should come to hold 25 percent of any class of securities of the issuer ;

If the trustee does not have more than nine directors but has two common directors with the obligor;

If the trustee has 10 or more directors and 2 of them are common directors with the obligor, provided the Securities and Exchange Commission has not approved the additional common director, or provided he owns as much as 1 percent of the securities of the obligor other than those issued under the indenture.

There obviously could be tendencies to collusive action or conflict of interest if the interrelationships of the trustee and obligor were less than those defined and no such tendency nor conflict if overlapping interests were greater.

There would be danger that in some communities it would be impossible to find a responsible institutional trustee that would not be disqualified, and one would have to be sought in another community.

DISTRESS SITUATIONS

In practice, various provisions of the measure would operate to prevent the bank which is acting as a trustee from making to the commercial or industrial firm a so-called "rescue loan," namely, a loan made with knowledge that the firm is suffering or may encounter a financial embarrassment. The bill would prohibit the trustee from realizing upon property received as security for a claim created within the 4 months preceding a "default" unless the trustee sustains the burden of proof that it had no reasonable cause to believe that a default would occur within those 4 months.

In most cases of distress loans a trustee is doubtless apprehensive of the possibility of a default, and after the event had occurred would find it exceedingly difficult to sustain the burden of proof that it had no "reasonable cause" to believe that a default would occur within 4 months.

Such a distress loan frequently is necessary, before or after a default, to permit a firm to meet taxes, pay rolls, rentals, or other current expenses in order that it may avoid bankruptcy. Often the trustee institution is the only one in a position to make a secured "rescue" loan that may avert a disaster. The restrictions upon such loans could operate to the serious disadvantage of the security holders, quite contrary to the theory of the bill.

There are other provisions of the bill, as well as requirements that could be made by the Commission, which would make a trustee less inclined than at present to endeavor to save a commercial or industrial firm from receivership or bankruptcy. A trustee which attempted to act to this end, believing it to be in the best interests of the security holders, might be confronted later by a suit in which a jury would hold it liable for some action taken or omitted in good faith. It appears certain that a trustee would avoid taking helpful actions, which, because of the terms of the bill, might result in liabilities that would endanger its capital or surplus or even some of its deposits.

The section of the bill which outlaws indenture provisions permitting a stated percentage of security holders to consent to a default of interest for a period exceeding 1 year or to any default of principal is most unfortunate. Experience in England over a period of generations has established the soundness of such clauses which frequently permit expeditious reorganizations through the medium of bondholders' meetings without the necessity of court action. While perhaps it may be necessary to place restrictions upon the exercise of powers by less than 100 percent of bondholders at a bondholders' meeting, it seems to be a step backward to prohibit absolutely provisions of the type referred to. In brief, a number of features of the bill could operate to prevent many volun-tary reorganizations that would be in the interests of security holders.

POWERS OF THE COMMISSION

The exercise of the broad powers granted to the Commission to pass upon many provisions of the indenture, both as to form and substance, would mean - individual consideration of each indenture.

It has been observed that the grant of such powers is undesirable as a matter of public policy. Their exercise would constitute a serious interference with business and, in effect, would impose upon the Government an unwarranted degree of responsibility for the merit of the indenture and of the securities issued thereunder.

The Commission already has had frequent changes in its membership, subordinate personnel, and viewpoints. Nevertheless, the Commission of the day would be empowered to insist upon the insertion of provisions which would continue effective during the life of an indenture, that is for even a score or twoscore or more years.

These would be contract provisions and not merely governmental regulations. If later the law were amended or even repealed as being unsound, or the rules, regulations, or orders of the Commission were changed, that would not alter the provisions of the indenture. Its terms could be changed only by agreement of all or a prescribed high proportion of the securities outstanding under it. This agreement in practice is virtually impossible to obtain. It is uncertain that a clause in the indenture permitting modification under defined conditions would be approved or, even if approved, could be made effective because of mandatory provisions in the bill.

The grant of such discretionary powers is unnecessary. The end could be accomplished substantially by statutory requirement of specific duties to be placed upon corporate trustees and by limiting exculpatory clauses.

HEAVY EXPENSES

The measure would impose substantial additional burdens upon capital financing by commercial or industrial firms. This additional expense would I have to be incurred because of the governmental conferences and red tape that I would be connected with the qualifying of indentures, because of the increased fees that would have to be charged by trustees, and because of the increased necessity for the employment by the trustee of outside appraisers, engineers, and other experts.

The trustee fees would have to be higher because of the greatly increased active duties and risks a trustee would have to assume.

These costs would especially hamper small and medium-sized industrial and commercial firms and the smaller communities.

No testimony has been adduced before either the Senate or House committees as to the extent of the additional costs that would be placed upon commercial or industrial firms. Apparently, such a hindrance, which in our opinion would be substantial, was considered to be of little moment.

In our judgment, the measure would not result in sufficiently increased protection of investors to offset the expense and difficulties and the assumption. of risks which would be involved in complying with its provisions.

CORPORATE V. PERSONAL TRUSTS

The apparent effort in the reasoning of the Commission to draw an analogy between the duties and responsibilities of a trustee of a corporate trust and those of a trustee of a personal trust is palpably in error.

The value of the securities in the case of a corporate trust may exceed the capital and surplus of an institutional trustee. But, in a personal trust, which usually consists of a broad range of securities, the total normally would be a small proportion of the capital funds of a bank serving as trustee.

A trustee of a personal trust has little difficulty in filing periodic accountings and in obtaining instructions from the courts in a matter involving the exercise of business judgment. In other words, it can readily obtain protection. A trustee in a corporate trust, however, would experience great difficulty in obtaining instructions and could not obtain the protection which the trustee of a personal trust gets from periodic accountings.

ECONOMIC EFFECTS

A marked business recession is now in progress. There is widespread recognition of the imperative need of reactivation of private enterprise, and business is expected to develop greater initiative in the task of advancing recovery.

This recession has come despite low interest rates and liberal money and credit policies. The new expansionistic credit program of considerable proportion which has been initiated places particular emphasis upon the importance of supplying capital funds.

It is essential to the well-being of the entire country that the recession be retarded. In assistance to this there must be encouragement of new capital issues and stimulation of private investment in job-making enterprises.

There are capital needs of great magnitude to be supplied. The well-being of the less prosperous of our people can only be improved materially and permanently through increased employment and increased production. This new employment cannot be given without great additions to capital investment. Billions of dollars of new investments must be made.

The situation has been well described recently by an outstanding authority, who stated:

"The imperative requisite for recovery is a renewed flow of corporate financing for expanding enterprise. The degree of that expansion will determine how much unemployment we shall have, and that is our most important problem. Prospects for profits now depend on laws and regulations and the expectations concerning them."

The way must be found to obtain a transition from heavy governmental expenditures and deficits to more normal methods of recuperation through release of private energies and funds.

The great lag in private investment in commerce and industry is indicated by the fact that the volume of new capital funds obtained by business through the sale of securities during the past 7 years has averaged less than $750,000,000 per year, in contrast to more than $4,750,000,000 per year in the previous 7-year period.

Many factors are retarding private investment. Among them must be included present regulatory practices affecting the origination, underwriting, and distribution of securities. The present laws and regulations in regard to public offering: of securities require revision in encouragement of new capital financing.

The restraints upon such financing that would result from adoption of the Barkley-Lea bill would be additional factors of moment in hampering that degree of reopening of the capital markets which is indispensable to reemployment and recovery. This is no time to initiate actions which will retard economic rehabili

tation. All such steps as would delay the reopening of the capital markets and the removal of business barriers present the choice between recovery and a deeper slump.

ALTERNATIVE METHOD

The Federal Reserve Act empowers the Board of Governors of the Federal Reserve System to grant by special permit to a national bank the right to act as trustee or to act in any fiduciary capacity in which a State bank or trust company or other corporation in competition with the national bank is permitted to act under the laws of the State in which the national bank is located.

The Board is empowered to promulgate such regulations as it may deem necessary to enforce compliance with the pertinent provisions of the Federal Reserve Act and the proper exercise of the trust powers.

In regulation F, adopted by the Board of Governors in relation to trust powers of national banks, it is made clear that the Board gives special consideration to whether the bank has sufficient capital and surplus to receive permission to exercise fiduciary powers, to the needs of the community for the trust service, to the probable volume of trust business available to the bank, to the general condition of the bank in relation to the proposed exercise of trust powers, to the character and ability of the management of the bank, to the qualifications, experience, and character of the executive officers of the trust department, to the availability of competent legal counsel, and to other facts and circumstances that the Board may deem proper.

The regulation deals in some detail with the requirements upon the bank in acting as trustee in personal trusts but includes a statement of principles, from an independent source, applicable to corporate trust business.

Furthermore, the Board of Governors has broad powers over the conduct of the operations of all member banks of the Reserve System, including powers of examination of the banks, suspension of their privileges, dismissal of officers, etc. It is inadvisable to grant to the Securities and Exchange Commission, as does the Barkley-Lea bill, the authority to determine whether or not a bank should be permitted to act as a corporate trustee under an indenture and in effect to determine the degree of liability that may or must be assumed by a bank in so acting.

This decision should continue to rest with the Board of Governors of the Federal Reserve System as regards national banks and, if need be, should be broadened clearly to include corporate trustee operations of the State member banks. If this power were exercised by the Board of Governors of the Federal Reserve System, it could adopt suitable rules and regulations applicable to corporate trustee operations that would have regard to the position of a bank as a whole.

There is already complaint that there are too many Federal agencies supervising banking institutions and measures are being officially proposed to consolidate some of these agencies. The Barkley-Lea bill, however, would give to an entirely different agency, the Securities and Exchange Commission, which has had no relation to supervision of banks, a new and broad power affecting the duties, responsibilities, and liabilities of banks in a field of operations that should be subjected to the constant scrutiny of the established agencies of bank supervision.

If the point be raised that the Board of Governors of the Federal Reserve System has no powers in relation to State banks which are not in the membership of that System, it would be a simple enough matter to provide by law that nonmember banks might not serve as corporate trustees under indentures unless they agree specifically to abide by pertinent rules and regulations applicable to member banks so serving.

Rules and regulations concerning the discharge of corporate-trustee functions by banks might well impose specific duties upon corporate trustees, require avoidance of substantial conflicts of interest, and limit exculpatory clauses. No power, however, should extend to the point of permitting the Board of Governors of the Federal Reserve System or any agency of government to exercise a power, directly or indirectly, to dictate the substance of an indenture.

The procedure outlined, combined with the requirement of full disclosure of the essential terms of indentures when used in connection with new issues of securities, would provide, in a more practical and defensible manner than does. the Barkley-Lea bill, a method of dealing with any evils that fair-minded men may recognize as attaching to the issuance of securities by commercial and industrial firms under trust indentures.

126815-39-14

Senator ROBERT F. WAGNER,

THE LOUISVILLE TRUST Co., Louisville, Ky., February 11, 1939.

Chairman, Subcommittee, Senate Committee on Banking,

Washington, D. C.

DEAR SENATOR WAGNER: We have been carefully considering Senate bill 477 dealing with the subject of corporate trusteeships.

We are convinced that this bill is unnecessary as the authority of the Securities and Exchange Commission is sufficient to protect investors under corporate trusteeships. We are also convinced that both small borrowers and investors will be harmed rather than helped by the bill due to the greatly augmented expense of qualifying a bond issue and to the additional fees which the trustees will be required to charge to cover the additional work demanded of them and to justify the added responsibility of trusteeship. The drastic provisions of the bill as to foreclosure will have a tendency to depress rather than enhance the value of the bond issues in the hands of the public in the event the debtor should become embarrassed or even, in some cases, merely careless. During the depression many loans have been worked out by forebearance and issues which would have been liquidated at substantial losses under foreclosure have been paid in full.

In our opinion the bill, if it becomes law, will tend to drive the business of corporate trusteeships to New York and Chicago and to deprive the businessmen in the smaller communities of the services of local trustees. Such local trustees, necessarily, are in closer touch with the borrowers' affairs, and are in position to give better trust service, both to the debtors and the bondholders.

There are other objections to the bill, which apply more particularly to the corporate trustees, their rights and liabilities. In this letter, however, I have addressed myself particularly to the bondholders whose interests the bill seeks to safeguard, and to the businessman who finds it necessary to get additional capital for the expansion of his business. The best interests of both would, in our opinion, be defeated by permitting the bill to become law.

Will you kindly make this letter part of the record of proceedings before your committee?

DEAR SENATOR WAGNER: As an investment banker and broker with 38 years' experience, I have studied with some care the above bill.

I protest against its passage because first, it will have a detrimental affect on trustees located in moderate-sized cities like Louisville, driving such business to the larger centers of the North and East. Second, it will prevent the development of business of moderate size by making the costs of such financing unreasonable. Third, it will hurt the distribution of investments to small investors in territories such as this in which we operate.

I earnestly request that you make this letter a part of the record of hearings on this bill.

Yours very truly,

ISAAC HILLIARD.

Senator HUGHES (presiding). That will conclude the hearing. We shall notify you if there are to be further hearings on this matter. (At 12: 10 p.m. the hearing was concluded.)