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give rise, in our mind, to the necessity for some such measure as the Lea bill.
The Chairman. We will be very glad to have you do so, Ir. Douglas.
I might say for the benefit of the committee that I believe a statement by Mr. Douglas will be perhaps the primary statement in exposition of this bill.
So, Mr. Douglas, you are at liberty to proceed in your own way and explain the bill.
Commissioner Douglas. Mr. Chairman: There is at present the problem and the necessity of affording to the individual investors of this country protection against a type of abuse and exploitation with which existing legislation cannot cope.
The CHAIRMAN. Will you state your full name and your relation to the Commission, Mr. Douglas?
Commissioner Douglas. My name is William 0. Douglas and I am a member of the Securities and Exchange Commission.
Mr. Eicher. Mr. Chairman, I think it would be better to defer any questions until after Mr. Douglas has presented the Commission's views of the bill.
The CHAIRMAN. Do you prefer that, Mr. Douglas, rather than for the committee to engage in questioning at any time?
Commissioner Douglas. I think it might be preferable, until I get down to the specific provisions of the bill.
The CHAIRMAN. Very well, then; we will proceed in that manner, if there is no objection.
Mr. MAPES. Mr. Chairman, may I ask a question? The CHAIRMAN. Mr. Mapes. Mr. MAPES. Mr. Douglas, are you going to give a general outline of the reasons for these suggested amendments?
The CHAIRMAN. I understand that that is so.
NEED FOR REGULATION
Commissioner Douglas. There is at the present time, Mr. Chairman,' the problem and the necessity of affording to the individual investors of this country protection against a type of abuse and exploitation with which existing legislation cannot cope--the abuses on the part of protective committees in reorganization. That problem is not precisely a new one; but its importance, in my judgment, has been given renewed emphasis as a result of the vast reorganization experience born of the recent depression. The present need for regulation has been more than amply disclosed by recent governmental investigations, including those by the Select Committee of the House, a special committee of the Senate, and by the reports of the Securities and Exchange Commission, which, by section 211 of the Securities and Exchange Act, was directed by the Congress to undertake a study and investigation of work, activities, personnel, and functions of protective and reorganization committees. At the direction of Congress the Commission submitted in its recent reports a series of recommendations with respect to the regulation of such committees. The facts enumerated in those public records afford a firm foundation for the desirability of and need for the Lea bill.
The years just past have seen thousands upon thousands of corporate debtors-issuers of millions in securities purchased by every segment of the American public-arrive at the stage where they have been unable to meet their obligations. Often in these cases, liquidation and a distribution of assets to security holders have been impracticable if only for lack of buyers. Often, too, it has been unwise, where sound business judgment pointed out that a hope of greater salvage lay in restoring the distressed corporation to the status of a going concern. This could be accomplished only if its creditors agreed to a moratorium on its debts, or consented to an extensive scaling down of its obligations. And in a thoroughgoing readjustment of its financial structure, fairness and equity required of stockholders that they give up at least as much as the sacrifices called for from creditors. It is this process of extensive financial readjustment, commonly called reorganization, which has given rise to the problems with which the Lea bill deals.
HELPLESSNESS OF INVESTORS In these reorganizations the individual investor has come to play an anomalous and insignificant role. In every case it is his investment which is at stake, yet the processes of reorganization have so evolved, or have consciously been so fashioned, that he is usually given recognition only when his consent is necessary to the consummation of a plan, whether it be a voluntary plan or otherwise. Even then this recognition has at times been of the most perfunctory kind. In other respects the security holder is largely helpless to help himself, or to join with others in his position in an effort at joint action. The impact of this is felt when we consider the existing obstacles in the way of individual action by the investor. Merely by reason of the fact that he is one of many security holders involved in an intricate, difficult situation, and the fact that his average holdings are small, he cannot undertake the burdensome expense of active participation in court proceedings for reorganization or in the negotiations that lead to a completed reorganization. Apart from the question of expense, which might well cost him more than the value of his investment, the average investor does not possess training, the experience, or the skill which these complicated problems demand.
The problem of protection of investors in these situations has many angles to it. Part of it relates to the adequacy of the reorganization machinery in the Federal courts to protect investors against the reorganizers. This phase of the program-insofar as reorganizations under section 77-B of the Bankruptcy Act are concerned-is in my judgment adequately covered by the Chandler bill (H. R. 6349) presently before the House Committee on the Judiciary. Another phase of the problem concerns the representative role of the corporate trustee who, all agree, should assume more active duties in defending and promoting the interests of bondholders, noteholders, and debenture holders in these default situations. That phase of the problem is, in my judgment, adequately covered by the Barkley bill (S. 2344) presently before the Senate Committee on Banking and Currency. Other phases of the problem are covered by the Lea bill which in conjunction with the Chandler and Barkley bills present an integrated and persuasive treatment of the whole, though each bill is independent of the others. The two phases of the Lea bill which should be noted involve (1) protective committees; and (2) a limited participation by an administrative agency-the Securities and Exchange Commissiomin certain types of reorganization proceedings. I will deal with these two phases of the problem in that order.
First as to protective committees:
Mr. MAPES. Has a bill similar to the Barkley bill been introduced on the House side?
Mr. Douglas. I am not aware, sir, that that has been done.
Mr. MAPES. Would the Barkley bill be germane to the bill which we are considering—the Lea bill?
Mr. Douglas. It is a complementary measure, in a sense; but it is wholly independent of the Lea bill and has no direct tie-up with the Lea bill.
Mr. EICHER. Is the Barkley bill an amendment to the Securities Act also ?
Mr. Douglas. The Barkley bill is in effect, though perhaps not technically, an amendment to the Securities Act. It broadens the basis of administrative supervision over bonds, notes, and debentures issued under trust indentures.
FORMATION OF COMMITTEES
Coming back to the problem of protective committees which I first mentioned: The helplessness of the average investor to help himself has led to the necessity or at least the desirability of some kind of group action. This need has been supplied usually by protective committees. These committees, as you know, are usually composed of three or more individuals, though occasionally a corporation has served as a committee. These committees may be formed as a result of meetings of security holders. This is rather uncommon. They usually have come into being, self-constituted and self-appointed, with an announcement of program and purpose and with a plea to security holders for support. Their sponsors are usually the management of the debtor company and its investment bankers, not security holders or their authorized representatives. These committees may merely communicate with security holders without attempting to obtain powers of attorney from them. Customarily, 'however, they seek a power of attorney. This may be in the form of a revocable proxy or in the form of an irrevocable deposit agreement. The proxy is a simple instrument listing such specific or general powers as the committee desires or deems useful or necessary; the deposit agreement is a more complicated instrument. Usually deposit under the deposit agreement means loss by the security holder of effective control over his securities as well as a grant of broad powers from him to the committee.
FUNCTIONS OF COMMITTEES Within this broad framework committees have operated. They have had important functions to perform, although committees are, in many situations at least, not necessary parts of the reorganization paraphernalia.
These functions can be outlined briefly. For one, united action on the part of investors is sometimes necessary, under the provisions of trust indentures, in order to induce action, such as foreclosure, by indenture trustees for the protection of bondholders. Experience and investigation have shown that recalcitrant, inactive trustees need the spur of a vigilant committee, representing substantial numbers of bondholders, if such trustees are to be made to take steps for their protection. And those indentures, as you know, usually provide that the trustees need not act unless certain persons make demand upon them, or a certain percentage of the stockholders, make demand upon them, 25 percent usually.
Again, the mobilization of security holders is necessary if they are to exercise a continued and careful scrutiny over the administration of the debtor in those cases where receivership or bankruptcy occur. Another function is the investigation and enforcement of claims against the management and their affiliates, with the consequence that assets may be added to the estate and all security holders aided. There may also be claims running to security holders individually which result from misrepresentations in the original sale of the securities. Committees may perform a signal function at much smaller cost than could individual investors by thoroughly investigating these claims, and by laying the basis at least for their enforcement. Or there may be certain types of class suits which committees can bring and which they occasionally do bring.
Further, in the negotiations and compromises over the terms of the readjustment (an indispensable part of all reorganizations) committees have in the past been able to supply a service which scattered, disorganized security holders could not undertake, because of its complexity, difficulty, and time-consuming nature. In these negotiations the aid of experts, such as engineers, attorneys and the like, may be needed; only group action made it possible in many cases to put such facilities within the reach of the average security holder.
It is the function, also, of committees, able to commandeer expert knowledge, to subject all plans to critical appraisal and examination, from the point of view and in the interests of the security holders whom they ostensibly represent. And, since the accomplishing of reorganization, in the last analysis, depends on the consent of the creditors and stockholders, it is the function of committees to marshal consents to proper plans, and lead opposition to those believed to be unfavorable to the class of security holders for whom they are acting.
Mr. WOLVERTON. Mr, Chairman
Mr. WOLVERTON. I think, generally speaking, everybody is in accord with the statement that you are making.
Will you refer to the section of the bill to which that has particular application?
The CHAIRMAN. Mr. Wolverton, Mr. Douglas plans to take it up section by section after he has made his general statement.
Mr. WOLVERTON. Well, it would help me a whole lot if I could have my eye on the section which he is talking about.
Commissioner Douglas. I will endeavor, as I go along, sir, to indicate the particular section or portion of the Lea bill where the general points that I indicate are covered.
DOMINATION BY MANAGEMENTS AND INVESTMENT BANKERS
I mentioned before the fact that customarily committees have been sponsored by the management of the debtor company or by the investment bankers, not by security holders or their authorized representatives. This has been due to several circumstances. Over and above the inertia and lack of leadership among investors is the fact that if the individual security holder attempts to organize his fellow investors, he will find himself faced at the outset with an insuperable obstacle. He does not know who are his fellow investors, nor can he find out. The lists of security holders are the exclusive possession of the debtor or of the investment bankers for the debtor, and in the main they will deny access to these lists or their use by the individual security holder. Furthermore they have had inside kncr ledge of impending default and so have prepared, in advance of public announcement of default, a solicitation campaign in support of their own committees. The result has been that they have been first in the field with all of the advantages which that means. consequence the debtors—which, in any realistic sense, means the corporate management-together with the investment bankers for the corporation, have been able to control the effective formation and operation of protective committees. The individual investor has had little choice but to throw in his lot with committees sanctioned and sponsored by banker-management groups. These groups have been able to prevent the effective operation of committees by others, by denying them lists of security holders; and they have been able, out of motives and for purposes on which I shall enlarge, to set up their own committees and in practical effect to dominate the vehicles supposedly representing the security holders.
COMMITTEES AS FIDUCIARIES
I cannot emphasize too strong y that, in the reorganization field, as a matter of law, committee members are fiduciaries. As such they owe exclusive loyalty to the class of investors they represent. They owe that class diligence, efficiency, and single minded devotion. But these fiduciary standards have been frequently flouted to the ultimate detriment and distress of countless numbers of investors. This condition has prevailed, not exclusively, to be sure, in case of managementinvestment banker committees, but conspicuously in such cases. In the welter of conflicting interests, ulterior objectives and self-serving actions which flow from investment banker-management dominance over committees, these committees have frequently lost sight of their essential functions which they can perform to advance the interests of investors.
There are two aspects of the manner in which committees have violated these fiduciary standards. The first relates to conflicts of interests; the second, to the exercise of the fulsome powers which committees have taken unto themselves in these proxies and in these deposits agreements which they have used.
Now, as to conflicting interests, the Lea bill supplies an effective check to the conditions described in our reports. And I might add