of the investor rather than of the committee. Too long have they been employed as instruments of oppression. The Lea bill does provide for curtailing the broad scope of these deposit agreements. PERVERSION OF COMMITTEE FUNCTIONS Such conditions as I have enumerated have not been isolated and infrequent-they have been persistent and widespread and of a truly national nature. They have permeated the whole reorganization field from real-estate cases to foreign-debt rearrangements. They have meant that the functions of protective committees have been perverted if not destroyed. As a result, the investor has been at the mercy of self-constituted and self-appointed committees whose objectives are frequently incompatible with the objectives of investors. These committees are interested in concealing claims for fraud or mismanagement; investors are interested in collecting on those claims. These committees are interested in keeping the past a closed book; investors are interested in examining the past to determine whether or not the management has been so incompetent or faithless as to be discharged rather than restored to power. These committees have frequently been interested in reorganization profits; investors are interested in economy and fairness. They are interested in effecting a reorganization which will "save face" for them; investors are interested in thoroughgoing reorganizations. For such reasons, the interests of reorganizers and the interests of investors are often incompatible. As the Chairman well stated in his remarks in the House concerning this bill: Investors require protection against "protective" committees more interested in enriching themselves from the fees, commissions, and other emoluments incident to the reorganization than in honestly and competently representing the security holders whom they purport to protect. They require protection against reorganization committees whose primary interest is in retaining or gaining control of the reorganized enterprise for the sake of the profits which may accrue to them by reason of that control. They require assurance that committees will have as their major objective the rebuilding of the enterprise, on a sound business basis, for the benefit of stockholders, bondholders, and employees. And they require that this be done expeditiously, efficiently, and economically. INADEQUACY OF EXISTING LAW Existing law is not adequate to deal with these situations. Large numbers of protective committees do not come under any regulation or control. So far as the States are concerned, few adequate controls exist; and in view of the interstate complexion of most protective committee activities, intrastate control is of necessity limited in effectiveness. The solicitation of proxies, deposits, and assents, by use of the mails and of agencies of interstate commerce is likewise free of regulation to a great degree. Existing Federal control and supervision over such solicitation are both limited and inadequate. At the present time some committees are required to register under the Securities Act of 1933, as amended, but such registration requirements are applicable, by and large, only to committees seeking deposits of securities. Committees which seek powers of attorney or proxies are, by and large, exempt from that act. This result flows from the fact that only in some circumstances are proxies so constituted as to come within the definition of "security" under the Securities Act. Nor is the application of the registration requirements at all pervasive in the case of committees seeking deposit of securities, by reason of the many exemptions of which protective committees may avail themselves under the act. For example, under section 3 (a) (2) of the Securities Act there is included within the category of exempted securities certificates of deposit for any security issued or guaranteed by any State or by any political subdivision of a State. This means that the act cannot be brought to bear upon committees acting for the holders of municipal obligations, committees which, as indicated in part IV of our report to the Congress, are sorely in need of regulation. Similarly, the disclosure of full and material information by many other types of committees has been inhibited by the exemptions provided in section 3 (a) (10) of the Securities Act. Under this provision certificates of deposit receive an exemption where the terms and conditions of their issuance and exchange for outstanding securities are approved by any court, or official or agency of the United States, or other governmental authority expressly authorized by law to give such approval. My observation is that too frequently such approval by such agency has been pro forma. Courts overburdened and unacquainted with technical details of these situations have not afforded the measure of scrutiny to be desired. They have not been given a sufficiently specific and adequate standard against which to apply the legislative mandate. Further, under section 3 (a) (9) of the act, solicitation activities on the part of corporate managements seeking to effectuate so-called voluntary plans or reorganization may be free of the desirable requirements for full and adequate disclosures. The power of the Securities and Exchange Commission under the Securities Exchange Act of 1934 over the solicitation of proxies, consents, and authorizations is applicable only to certain securities registered on national securities exchanges, while the powers of the Commission over committees under sections 11 and 12 of the Public Utility Act of 1935 extend only to securities and reorganizations of registered holding companies and subsidiaries thereof. This brief examination of the narrow scope of existing Federal regulation over the solicitation of proxies, deposits and assents indicates the first conclusion to which the Commission was led in its study and investigation of protective and reorganization committees under section 211 of the Securities Exchange Act of 1934. KIND OF LEGISLATION NEEDED In the first place, the present controls must be given a broader base. Methods must be designed to bring within the Federal system of regulation and control the many committees presently exempt and immune from any supervision. In practical operation, it is our belief that this can be best achieved by an extension of the presently limited supervisory power of the Securities and Exchange Commission. But this step alone will not suffice. In the second place, even where the Commission today possesses jurisdiction over the solicitation activities of committees, its powers need to be strengthened materially. This will be equally true in the event of the extension of the Commission's present jurisdiction. Its administrative control and supervision needs to be implemented so that more effective and pervasive supervision over those who are engaged in such solicitation may be had. This is necessary because if committees are made to meet merely registration requirements they will be forced to disclose only the truth as to their organization, and affiliations and their plans. But in reorganization situations mere disclosure is hardly sufficient for the protection of investors. To the ordinary prospective purchaser of securities disclosure of the pertinent facts surrounding an offering is of great value, since by and large he may buy or not as his whim or judgment indicates. But upon default investors in these reorganization situations are locked in, so to speak, They are for the most part unorganized, and to a great extent incapable of self-help. They have little freedom of choice. Their only choice, and it is not a real one, in my judgment, is on the one hand to go along with those who by virtue of long tradition and practice in corporate reorganizations have come to possess dominance over the organization and operation of protective committees, or on the other hand to proceed by themselves. The latter course is obviously a futile one in most instances. Hence the investor is in effect forced to throw his lot in with those who, self-constituted and self-appointed, announce themselves as his protectors. Disclosure of all the pertinent facts concerning the committee will be of small comfort to him; his choice is hardly expanded though he knows that those who control the destiny of his investment are incompetent or faithless fiduciaries. In other words, the basis for administrative regulation must be broadened so as to require not only the disclosure of relevant facts, but also to permit some restraint on the conduct and activities of committees and some check on their personnel at the time of their formation and during their existence. There is required, for example, the power to refuse to qualify as committees those who have palpably conflicting and adverse interests. There is need to curtail and restrict in the public interest and for the protection of investors the powers which committees may take unto themselves, and the unconscionable practices which may persist in spite of full disclosure. EVOLUTIONARY NATURE OF PROPOSED LEGISLATION This is not a wholly new departure for Congressional action. The beginnings of such type of control over committees are to be found in sections 11 and 12 of the Public Utility Holding Company Act of 1935 where the Commission is given power to make rules and regulations governing the solicitations by committees and others in case of registered holding companies and subsidiaries thereof. With the benefit of the rich experience born of the depression and of the experience under the present statutes, a broader program should be undertaken. Such a program should be built on the firm foundations of the other acts which the Commission administers. It should be envisaged as an evolutionary development of present controls, not as a radical or revolutionary development. It entails a separate statute dealing with solicitation of proxies and deposits and assents. Such a statute is conceived as an extension and evolution of the regulatory acts presently administered by the Commission. Committees acting in reorganizations would be required to qualify under such statute, in lieu of registration under the Securities Act of 1933, as amended, or compliance with the pertinent provisions of the proxy rules of the Commission under the Securities Exchange Act of 1934 or comparable rules under the Utility Act. Furthermore, exemptions presently provided committees under the Securities Act of 1933, as amended, would be restricted in their application to the new statute. This system of control must be sufficiently broad to cover committees operating in connection with voluntary reorganizations, foreign debt rearrangements, municipal debt readjustments, and the solicitation of proxies, deposits, and assents by use of the mails or agencies of interstate commerce in connection with reorganizations in State or Federal courts. OBJECTIVES OF PROPOSED REGULATION OF COMMITTEES Such administrative control would provide a greater degree of assurance that those who are acting in a fiduciary or representative capacity will be free from adverse interests and will take unto themselves only those discretionary powers necessary or appropriate for protection of investors. But in view of the fact that committees are not always an essential or necessary part of reorganization paraphernalia, some minimum control over the solicitation of assents to, or acceptances of, plans should be devised. Otherwise, groups or individuals not soliciting discretionary powers but only assents to, or acceptances of plans might do all the essential work of reorganization without subjecting themselves to the conditioning influences of such new regulation. This would not be desirable since conflicts of interest may be as important in connection with solicitation of assents as in case of solicitation of proxies or deposits. This condition is apt to be particularly acute in case of voluntary reorganization plans which are free from scrutiny or supervision by any agency. Furthermore, committees are not a customary or usual part of voluntary reorganization procedures. In such cases, the management commonly solicits assents to plans directly. In view of the frequent appearance of conflicts of interest in such solicitors, a minimum degree of control over solicitation of such assents is necessary. Accordingly, at least in the voluntary reorganization, the same degree of control over solicitation of assents or acceptances should be provided as in case of solicitation of proxies or deposits. Furthermore, assents to and acceptances of a plan subject to the jurisdiction of a court or other agency which has power to pass on the fairness of the plan should in general not be allowed until the plan has been carefully scrutinized by the court or agency and its submission to investors authorized. In summary, such a statute would give renewed emphasis to the fact that representatives of security holders in reorganizations occupy a fiduciary position. The standards of fiduciaries require that neither they nor their lawyers should possess dual or multiple interests. Likewise, they require that neither committees nor their lawyers should be permitted to be the sole arbiters of the value of their services to security holders. Such a statute would eliminate the abuses which have characterized the strategy and techniques of reorganization. It would not permit the use of deposit agreements in oppressive and undesirable ways. It would break the virtual monopoly which the inside groups made up of investment bankers and managements have over lists of security holders. It would control high-pressure salesmen, so that security holders would be assured of an honest and complete portrayal of all material facts affecting their investment. In other words, it would give investors protection on a national scale against the abuses which the recent depression has portrayed in such flagrant fashion. That is the first basic essential part of the Lea Bill, in general terms, control over protective committees. And, that is embraced in the first 12 sections of the Lea bill. Mr. WOLVERTON. Mr. Chairman- Mr. WOLVERTON. Would it be proper to ask you a question now? Mr. WOLVERTON. Mr. Douglas, what is the underlying theory or policy that prompts the drawing of this bill? It would seem to me from what you have said that there are two thoughts in your mind: First the investor is unable to take care of himself, and secondly, that reorganization committees, generally speaking, are dishonest, and cannot be relied upon. Is that the theory that prompts the necessity for this bill? Commissioner DOUGLAS. I would not state it precisely that way, sir, and I did not intend to so state it. Mr. WOLVERTON. That is the inference that you have left with me as a result of your well-prepared statement. Commissioner DOUGLAS. Perhaps I can clarify it in this way: Investors in these reorganization situations, the average investor commonly needs a representative, somebody to look out for his interests. Mr. WOLVERTON. Then, you agree with my first thought that the investors are unable to take care of themselves and need a governmental agency to protect them. Commissioner DOUGLAS. It is not precisely the idea to have a governmental agency to protect them in the sense of representing them; but it is thought that the law should provide that those people who do undertake or purport to protect them, should live up to, measure up to, certain minimum standards for those in a fiduciary position, for the reason that the investor is so much at the mercy of those individuals. Mr. WOLVERTON. Then it is necessary to protect them from reorganization committees who are dishonest and you assume that the investors without the help of a governmental agency, would not be able to do so. Commissioner DOUGLAS. That is, just by reason of self-help, the investors would not be able to get the type and quality of leadership that they need. Any person can pop up and announce himself as their representative, and their leader, and by virtue of his strategic position force the investors to accept him. Mr. WOLVERTON. In other words, you assume that the investor has no alternative except to comply with a demand of reorganizing agree ment. Commissioner DOUGLAS. That is by and large, I think, a very accurate generalization. |