of a majority in amount of the outstanding debentures to waive a default or to rescind a declaration by the trustee accelerating the maturity of the bonds by reason of a default under the indenture. However, the indenture provision with respect to bondholders' meetings (art. XIV, sec. 2 (cc), p. 344) does not extend to requiring the exclusion of bonds owned by the company or persons standing in a control relationship with it, in determining whether the required majority have joined in such direction or waiver. Such exclusion would be required by section 316 (a) of the bill.

(b) Preservation of holder's right to payment:

This requirement is met by the last sentence of article IX, section 20 (p. 310), which preserves the right of the individual bondholders to enforce the payment of principal and interest at their respective due dates.

Section 317. Special powers of trustee; duties of paying agents

(a) Special powers of the trustee :

Article IX, section 14 (on p. 304) and article IX, section 22 (on p. 312) contain the provisions required by this subsection.

(b) Paying agents:

The indenture does not appear to contain the provisions required by this subsection.

ANALYSIS OF EXPENSE OF FLOTATION-MICHIGAN CONSOLIDATED GAS CO.

An excellent sample for an analysis of the expense of flotation of securities is provided by the registration statement covering $34,000,000 first-mortgage bonds and $8,000,000 serial notes of this company which was filed with the Commission on September 1, 1938.

It could truthfully be said that the total cost of registration and public distribution of the two issues was $1,663,408, or 3.90 percent of the aggregate principal amount of securities offered. But the following analysis of the items entering into such total cost makes clear that the really significant words are "and public distribution." Cost of registration constitutes a comparatively unimportant part of the total cost. This analysis is based upon the registrant's own estimates, as set forth in the registration statement.

In the first place, of the impressive total mentioned above, $216,082 (of which $45,751.95 was paid to underwriters for expenses) represents expenses incurred in connection with an earlier financing plan which was abandoned in March 1937. Deducting that amount, the total expense of flotation of these two issues was $1,447,326.

The total expenses for these two issues may be summarized as follows. Percentages represent percentages of the aggregate face amount of the two issues.

This summary is based on the assumption that two-thirds of the expenses (other than registration fee) listed in item (3) below were attributable to the necessity of registration, and that the remaining one-third would have been incurred even if registration had not been necessary. But even if all of those expenses were attributable solely to registration, registration expense would still represent only one-seventh of the total expense of distribution, and underwriters' commission and discount approximately two-thirds of that total. These figures are not put forward in an effort to show that the underwriters' commissions were unreasonable in this case, but, rather, to make clear that criticism of registration expense really raises a false issue.

Mr. COLE. Then, if you prefer, in the remaining time you have this morning, you may go into the controversial sections of the bill or use the next hour we have in such way as you started the other day. Mr. BURKE. Sir, in view of the fact that these case histories and these analyses of sample Securities Act indentures are in shape to go into the record, subject of course to a final check as to facts, I think it would probably be more helpful if I started going through the bill.

Mr. COLE. All right. You may do that.

I suggest that we want to conclude this morning, and we will use the next hour in any way you think desirable to close the hearings. Mr. BURKE. I will be very glad to do that, sir.

I think we had gotten as far as section 310 (b) on page 23.

PROHIBITION OF CONFLICTING INTERESTS (SEC. 310 (b))

That is the section which requires that there be spelled out in the indenture the types of conflicting relationships which the indenture trustee is not permitted to have.

Paragraph (1) relates to trusteeship under two or more indentures of the same issuer. The first case history, the Detroit International Bridge Co., I think, provides an illustration of the advantages which such a prohibition in the indenture would have. (See pp. 233 and 247).

Then there is a series of provisions which prohibit too close relationships with the issuer and its underwriters, or the ownership by the trustee of substantial amounts of conflicting securities.

As I have already pointed out, the prohibition of conflicting interests is not a novel idea. The New York Stock Exchange will not accept as trustee for a listed bond issue a bank which is trustee under other indentures of the same obligor. It will not accept as trustee a bank of which an officer of an obligor is an executive officer, or a bank which controls or is controlled by the obligor, and affiliations with underwriters are largely prohibited by the Banking Act of 1933. This subsection is in accordance with the policy behind those existing restrictions. At least three of the case histories presented to this committee (pp. 247, 248, and 249) show the soundness of that policy. Yet, far from prohibiting the possession of material con

flicts, many indentures include provisions which specifically permit the trustee to possess interests which involve an actual or potential conflict. Now, assuming that something should be done about it, there are a very limited number of ways to do it.

One method would be to establish a system of continuing supervision by a governmental agency, with authority to determine and eliminate conflicting interests. This method, if it were to be effective at all, would involve a tremendous and expensive administrative burden, because it would require perpetual detailed supervision of thousands of outstanding trust indentures. A second method would be to insert in the indenture a prohibition, in general terms, of "materially conflicting interests." Such a provision would involve a question of fact in each case, which it might very well require litigation to resolve. In fact, the very indefiniteness of the standard would invite litigation by "strikers," which is what the trust institutions themselves are anxious to avoid. The third method is to establish, in the indenture itself, "rules of thumb" specifying the types of conflicting interests which the trustee may not possess and continue to act as trustee.

The third method is the one which has been adopted in section 310 (b). It requires the inclusion in the indenture of "rules of thumb" establishing reasonable restrictions on the possession of conflicting interests. These restrictions become operative only when the trustee has ascertained that a prohibited conflict exists. Incidentally, after an indenture has been executed, the requirement of "ascertainment" should go far toward eliminating concern over the fact that paragraph (3) is based upon control in fact rather than ownership of a specified percentage of securities (as already pointed out, this problem also arises under the rules of the New York Stock Exchange). Within 90 days after ascertaining the existence of such a conflict, the trustee must either eliminate the conflict or resign as trustee. In the event of its failure to do so, removal proceedings may be instituted by the bondholders. In other words, after the indenture has been executed, these restrictions are to be policed by the trustee and the bondholders themselves. Section 309 (c) expressly deprives the Commission of any powers of enforcement, after the indenture has been qualified.

It is perfectly true that under section 306 (a), the Commission may require the inclusion in the application of information with respect to conflicting interests possessed by the trustee. It is also true that under section 308 (a) (3), the Commission may issue a refusal order if it finds, after notice and hearing, that the trustee possesses one of the conflicting interests specified in these "rules of thumb." Since, under the indenture provision itself, a trustee which possessed such a conflict would have to resign within 90 days after the indenture was qualified, there would seem to be little point in permitting it to act even for that period. Objection has been made to the fact that so far as section 310 (b) (3) is concerned, the Commission would be authorized to determine, before the indenture was qualified (but not afterward), whether the trustee in fact stood in a "control relationship" with respect to the obligor or its underwriters. Control is, under the bill, a question of fact, as to which reasonable men may differ. While reasonable men might differ with the Commission's finding in a particular case, the Commission certainly does not have "unlimited discretionary power" in this respect. There are plenty of precedents

under other statutes, and the Commission is faced with the necessity of making this very determination under the Holding Company Act. There is even room for argument that if the question of control is close enough to permit of a reasonable difference of opinion, the institution in question should not act as trustee.

IMPACT ON "LOCAL" INSTITUTIONS

It has been urged that some of the disqualification provisions would prevent local institutions from acting as trustee, and drive the business to the larger financial centers. The first answer, of course, is that that is where the business is already-at least the "milliondollar" business which would be affected by this bill. The statistics already presented (p. 97) with respect to the geographical distribution of trusteeships for issues which would have been affected by this bill during the 2 years and 8 months ended December 31, 1938, show that 95 percent in dollar amount, and 86.5 percent in number, of these trusteeships went to New York, Chicago, and seven other financial centers. The remaining 5 percent in dollar amount and 13.5 percent in number went to institutions located in only 21 other cities, such as Buffalo, Cincinnati, Los Angeles, St. Paul, Hartford, New Haven, Providence, Newark, Jersey City, Baltimore, and Washington. The remaining 10 cities contributed only $20,000,000 to the total. In fact, 23 of the trust institutions which communicated with the Senate committee, and a substantial number of the institutions which have communicated with this committee, have not had any indenture trusteeships which would have been affected by the bill during this period. Their suffering will, of course, be purely vicarious.

It seems to be assumed that, in the case of the larger financial centers, it would be possible for an issuer to find a local institution which would not be affected by the prohibitions against the possession of conflicting interests. It would be very surprising if in any of the 30 cities whose institutions do this type of business a local issuer could not find at least 1 local trust institution which would satisfy the conflicts requirements. If, in a very unusual case, an issuer had prohibited tie-ups with all of the local institutions, it is distinctly arguable that the indenture trusteeship should go elsewhere.

INTERLOCKING DIRECTORSHIPS, ETC.

Paragraph (4) prohibits too numerous interlocking directorships and officerships between the trustee and the issuer. This paragraph, however, permits, in common parlance, one director or executive officer "each way" between the trustee and the obligor, but no person may at the same time be an executive officer of both. The second common director is permitted only if the number of directors of the trustee is more than nine. Interlocking directorships with underwriters are also proscribed.

OWNERSHIP OF VOTING SECURITIES OF TRUSTEE

Paragraph (5) imposes restrictions on the beneficial ownership, by the obligor, its underwriters and their respective officials, of voting securities of the trustee. Neither the obligor nor any of its

officials may be the beneficial owner of more than 5 percent of such securities. The limitation upon their collective ownership is 10 percent, however. A 5-percent limit is placed upon the ownership of such securities, individually or collectively, by each underwriter and its officials.

SECURITY HOLDINGS BY THE TRUSTEE

Paragraphs (6), (7), and (8) deal with the matter of the beneficial ownership by the trustee of securities of an obligor or underwriter, and securities of persons who own substantial percentages of the voting securities of an obligor, or who stand in a control relationship with an obligor. The restrictions also apply to securities held as collateral security for an obligation which is in default as to principal.

SECURITY HOLDINGS BY THE TRUSTEE IN A FIDUCIARY CAPACITY

Ownership in a representative capacity-that is, as executor, trustee or in a similar capacity is given separate and more liberal treatment in paragraph (9), on the theory that such ownership does not involve as direct a conflict as beneficial ownership. If, on May 15 in any year, the trustee's holdings of such securities in a representative capacity exceed the prescribed 25-percent limit, the trustee is to be deemed to have a conflicting interest. But any such securities (in an amount not exceeding 25 percent for each estate) which were acquired through becoming executor, administrator, or testamentary trustee of an estate which included them may be excluded from this calculation for a 2-year period.

There seems to be some misunderstanding as to the effect of the latter provision. There was submitted for the record a telegram from a Denver trust institution expressing the fear that if it should unexpectedly become executor of an estate which included more than 25 percent of the voting securities of the obligor, it would have to decline the executorship or resign as trustee. But the 25-percent exemption for securities so acquired is in addition to the 25 percent normally allowed by this paragraph. The result is that holdings up to 50 percent would be permitted.

Mr. COLE. That is the language beginning in line 15?
Mr. BURKE. Line 15; yes, sir.

Mr. COLE. All right.

Mr. BURKE. As a matter of fact, nothing in the entire bill would hurt that particular Denver institution, because, according to our statistics, it did not have any indenture_trusteeships which would have been affected by the bill during the last 2 years and 8 months.

SECTION 310 (C)

The next subsection, subsection (c) on page 30, has already been touched on by Mr. Page, in submitting his proposed amendment to the present bill.

That subsection, of course, is designed to prevent the Commission from establishing, under the Holding Company Act, more stringent standards with respect to utility-company indentures filed under this bill than are prescribed by this bill itself.