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Availability of bondholders' lists (sec. 312).

Periodic reports by trustee and obligor (secs. 313 and 314).
Notices of default (sec. 315 (b)).

Prohibition of provisions relieving the trustee from liability even for its own negligence (sec. 315 (d)).

Prohibition of impairment of the individual bondholder's right to payment, without his consent (sec. 317).

Disclosure of the effect of release and substitution provisions, additional issue provisions, and so forth (sec. 318).

The only indenture provisions which would be affected by the proposal are those designed to enable the trustee (if it is a national bank) to ascertain that the covenants of the issuer are performed and to prevent impairment of the security, if any, for the bonds. As to these provisions, it is required merely that the prospective trustee "examine" them "for the purpose of determining that reasonable provision is made" to enable the bank to perform those functions. Presumably the trustee is not merely to "examine," but is to be under an affirmative duty to see that the provisions in question are in fact "reasonable." But if one national bank insists on a provision to which the issuer objects, the issuer need only go to another national bank with different views as to "reasonableness," or to a State bank or trust company.

For the requirement of section 315 (a) that the indenture impose upon the trustee, in the period prior to default, specific duties which a prudent man would assume and perform, and requirement of section 315 (c) that the trustee conform to the "prudent man" standard after default, the proposed amendment substitutes a direction to the trustee (if it is a national bank) to perform faithfully such of its powers and duties as shall be reasonably necessary to effect the objects of the trust. And for the requirement that the indenture prohibit the possession by the trustee of certain specified conflicting interests, the proposed amendment contains, in general terms, a statutory prohibition of "material conflicts."

Under the proposed amendment it would be for the individual national bank to judge whether it was conforming to these requirements, except as its judgment might be affected by the fear that the Board of Governors would examine, discover an "habitual" failure to conform, and deem such failure of sufficient importance to justify the exercise of the drastic remedy of withdrawal or restriction of trust powers. The amendment would therefore operate unequally, not only as between national banks and State institutions, but also as among national banks themselves.

(c) Type of regulation and adequacy thereof.-The proposal provides punitive, rather than corrective, machinery. The following observations should be made with respect to the type of regulation contemplated by this proposal:

(i) This type of regulation, if it is to be effective at all, would require detailed periodic examination by the supervisory agency of the trustee's actual performance of its obligations under all of its trust indentures;

(ii) It would cover only about 25 percent of the field-that is, trust indentures under which the trustees are national banks;

(iii) The supervisory agency would be confronted by the fact that many of the objectionable conditions disclosed in its examination

would be in strict accordance with provisions of the indenture which are left unregulated by the proposed amendment;

(iv) This type of regulation would be of an ex post facto nature; it would come into operation only after the improper action had occurred and the resulting loss been sustained by the bondholders, a loss which in many cases would have been prevented or at least minimized if the indenture itself had been corrected; and

(v) The only sanction would be the drastic remedy of withdrawal or restriction of trust powers in the event of "habitual" noncompliance by the trustee.

CORRECTION OF INDENTURE ITSELF

The philosophy of the present bill, on the other hand, is that the deficiencies in corporate-trust practice are in large part due to deficiencies in the trust indenture itself. The proper remedy is to correct the deficiencies in the trust indenture, which constitutes part of the bondholder's contract with the issuer. The appropriate time to correct the deficiencies in the nonbusiness features of these securities is before they are publicly offered in interstate commerce or through the mails. That is also the point of impact of the disclosure requirements of the Securities Act of 1933. If these deficiencies are corrected, it is the view of the Commission that the enforcement of the provisions of the indenture (that is, of the bonds issued thereunder) may appropriately be left to the bondholders themselves without continuing supervision by any governmental agency.

EXEMPTIONS (SEC. 304)

As I have already pointed out, the bill applies almost exclusively to securities which are now required to be registered under the Securities Act. Paragraph (4) of section 304 (a) carries over all of the Security Act exemptions, except the exemption for securities issued in reorganizations, which is provided by paragraphs (9) and (10) and section 3 (a) of the Securities Act. The suggestion has been made that the bill would apply to issues sold wholly within one State, if the mails were used in the sale of such issue. I would like to point out that the exemption provided by paragraph (11) of section 3 (a) of the Securities Act is also carried over. The effect of this exemption is to exempt intrastate issues even though the mails are used.

The application of the bill is restricted to public offerings of securities, by virtue of subsection 304 (b). That section carries over the exemption of private transactions which is provided by section 4 of the Securities Act.

Paragraphs (1) and (2) of Section 304 (a) limit the scope of the bill to notes, bonds, debentures, and similar securities.

Under paragraph (3) the effective date of the bill is postponed until 6 months after its enactment.

I do not think I need discuss paragraphs (5), (6), and (7) of section 304 (a) in any detail. They are explained in the sectional analysis which has already been inserted in the record (p. 210).

Subsection (c) authorizes the Commission to exempt indentures which are limited in size to $1,000,000 or less. In the Senate bill as

reported this "discretionary exemption" is eliminated and a flat exemption provided by the addition of a new paragraph, paragraph (8) of section 304 (a). This paragraph of the Senate bill is as follows:

Any security to which the provisions of section 305 would otherwise have been applicable and which has been or is to be issued (A) otherwise than under an indenture or (B) under an indenture which limits the aggregate principal amount of securities at any time outstanding thereunder to $1,000,000 or less; but, in the case of any such securities of the same issuer, the maximum aggregate principal amount of such securities to which the exemption provided by this paragraph may be applied within any period of twelve consecutive months shall not exceed $1,000,000.

This committee might consider the desirability of making some such amendment in the present bill.

I assume that the principal reasons for selecting the $1,000,000 figure are the fact that the smaller issues are less likely to be the subject of national distribution, and that, by the same token, the bondholders themselves are more likely to be in a position to take action for the protection of their own interests. It may well be that this committee would like to give consideration to a reduction of this figure, particularly if the committee is successful in its efforts to eliminate discretion from the three remaining discretionary provisions of the bill, and to eliminate the necessity of any qualification procedure in addition to that now required under the Securities Act. If those efforts are successful, whatever validity there is in the arguments relating to expense and delay will be eliminated.

We have already mentioned the effect that the $1,000,000 exemption would have upon the impact of the bill (p. 274).

Subsection (d) relates to additional issues of securities under old indentures which are not qualified under the bill and subsection (e) relates to foreign issues. Both of these subsections are discussed in the sectional analysis which has already been presented (p. 212).

PROHIBITORY SECTION (SEC. 305)

Subsection (a) in effect requires that all securities, the public offering of which is subject to the bill, be issued under a "qualified” indenture. Its language is substantially similar to that of section 5 of the Securities Act.

Subsection (b) applies, only to securities which are not registered under the Securities Act-that is, reorganization securities which are exempted from the Securities Act by section 3 (a) (9) and 3 (a) (10). The purpose of this section is to make the provisions of section 318 applicable to prospectuses which relate to such securities.

QUALIFICATIONS OF INDENTURE (SECS. 306 TO 308),
AVOIDANCE OF EXPENSE AND DELAY

An application for qualification must be filed with the Commission and becomes effective 20 days after such filing unless the Commission institutes refusal order proceedings within that time. The requirement of an application for qualification is of importance primarily with respect to those comparatively few issues which are exempted from registration under the Securities Act. In the case of registered securities the only information which would ordinarily be required, in addition to that already required under the Securities Act, would be information relating to the trustee's freedom from those conflicting issues which will, in effect, be prohibited by section 310 (b). It

might well be possible to make the provisions of section 306(a) more specific in that respect. In any event, section 307 (b) authorizes the Commission to provide for the consolidation of applications, reports and proceedings under this bill with those required under the Securities Act or other acts, with the result that, where the issue must also be registered under the Securities Act, the issuer will in most cases be able to file a single statement complying with the requirements of both acts.

The procedure for the qualification of the indenture has been carefully geared to the registration procedure of the Securities Act in other respects as well, but it has been necessary to depart from the Securities Act procedure in a few respects. For example, once an application for qualification has become effective, the Commission has no power, under the bill, to issue a "stop order," analogous to that provided for in section 8 (d) of the Securities Act, barring further offerings of bonds to be issued under the indenture. Under the Securities Act the problem is merely one of disclosure of the material facts and any deficiencies can readily be corrected. Under the bill, the question is whether the indenture conforms to the statutory standards, and it would be difficult to correct inadequacies discovered after the indenture had been executed and some of the securities sold.

Since the Commission will not have the "second line of defense" provided by the stop-order machinery, it is considered unwise to impose a mandatory requirement that refusal order proceedings be instituted within a shorter period than the 20 days provided in section 306 (c) of the bill, although in many cases the Commission will undoubtedly be able to complete its examination and give the issuer an opportunity to correct any defects in the indenture within a considerably shorter time.

The 26 pages of nondiscretionary provisions will, of course, not involve any procedure additional to that already necessary under the Securities Act. So far as the trustee's freedom from conflicting interests is concerned, the data necessary for a determination should be contained in the application for qualification itself, and hearings would be necessary only in doubtful cases. With respect to the only three indenture provisions not covered by specific statutory prescriptioni. e., those relating to the duties of the trustee before default, the kind of default of which notice must be given, and the type of certificate or opinion upon which the trustee will be entitled to rely-it should be noted that it will undoubtedly be possible to cover large portions of the field by general rules and regulations in the 6 months' period before the bill becomes effective, and from time to time thereafter as administrative experience is accumulated.

In doubtful cases the issuer can avoid the possibility of delay by filing its application for qualification of the indenture before it files its registration statement under the Securities Act. Such an application will contain those portions of the indenture which are affected by the bill, together with the relevant portions of the Securities Act registration statement, and information as to possible conflicting interests of the trustee. The indenture provisions affected by the bill are more or less standard, and can easily be determined in advance. As to any missing information or documents, the Commission will have the power, under section 306 (a), to consent, in proper cases, to the fil

ing thereof by amendment, as under the Securities Act, and thus prevent delaying the effectiveness of the application. Where the application for qualification is filed before the registration statement, duplication of information and documents can be avoided by incorporating them by reference in the registration statement, pursuant to rules which the Commission is authorized to make under section 307 (a). The requirements of this bill are therefore not expected to add materially to the cost of flotation of indenture securities, or to encourage the alleged trend to so-called private placements of such securities.

In this connection it is interesting to note that the item of registration expense did not prevent the registration of a total of over 9 billions of securiies of all types during the 2 years ended June 30, 1937. Any "drying-up" of public financing must therefore be due to other causes, among which may well be lack of investor confidence, and it is believed that this bill will tend materially to restore such confidence. As shown by the summary which has been presented (pp. — and —), expense of registration represents a comparatively small proportion of the total expense of publicly distributing indenture securities. In fact, for issues of $1,000,000 or more, underwriters' commission and discount was from four to nine times as important a factor in total cost as was registration

expense.

Mr. COLE. Thank you.
Mr. BURKE. Thank you.

(The following references were submitted after the hearings were concluded.)

COURT REVIEW OF REFUSAL ORDERS

The fear was expressed at the hearings that refusal orders by the Commission might be regarded as "negative orders" and therefore not subject to court review under the so-called negative-order doctrine. The basis for this fear seems to have been completely destroyed by three opinions handed down by the Supreme Court on April 17, 1939, which expressly repudiated that doctrine. In Rochester Telephone Corporation v. The Federal Communications Commission, Mr. Justice Frankfurter said:

"We conclude, therefore, that any distinction, as such, between 'negative' and 'affirmative' orders, as a touchstone of jurisdiction to review the Commission's orders, serves no useful purpose, and insofar as earlier decisions have been controlled by this distinction, they can no longer be guiding."

Similar views were expressed in two other opinions handed down on the same day: Interstate Commerce Commission v. Dan E. Maher and Federal Power Commission v. Pacific Power & Light Co. and Inland Power & Light Co,

Mr. COLE. At this point in the record I want to note that I have received a number of statements, telegrams, and letters in opposition to the bill. Mr. Hinshaw, a member of the committee, has also received a number, a list of which he submits in a letter addressed to me. These are in opposition to the bill, and without inserting them I will simply note a list of the statements, telegrams, and statements sent to me, together with the letter from Mr. Hinshaw.

(The material referred to above is as follows:)

Letters and statements in opposition to the bill have been received from the following:

Mr. Park Fussell, O'Melvey, Tuller & Myers, Los Angeles, Calif.

R. W. Proudfit, Swanwick, Donnelly & Proudfit, Los Angeles, Calif.

Mr. Joseph G. Pyle, Hahn & Hahn, Pasadena, Calif.

Mr. Edward Elliott, vice president, Security-First National Bank of Los Angeles, Los Angeles, Calif.

Mr. Glenn Whitney, Moody & Whitney, Glendale, Calif.

Mr. J. C. Macfarland, Gibson, Dunn & Crutcher, Los Angeles, Calif.

Mr. Jacob M. Lashly, Lashly, Lashly, Miller & Clifford, St. Louis, Mo.

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