not of having the Commission pass upon the securities, but merely having it look at the terms of the trust indenture itself to see to it that the members of the general public who buy the securities either will be in a position to protect themselves or will have someone there who can protect them. To condition the use of the mails or agencies of interstate commerce in the sale of bonds secured by such indentures seems clearly constitutional.

On the question of interference with private contracts, there is no no question in my mind but that it does interfere, to that extent, and there is no question in my mind but that it is constitutional so to interfere, and necessary in the public interest so to interfere.

MEMBERS OF INVESTING PUBLIC ARE THE REAL LENDERS

Who are the parties to this contract? Not speaking as a lawyer, but speaking as a layman, the parties to the contract are the security holders on the one hand and the obligor on the other, the lender and the borrower.

INVESTING PUBLIC CANNOT PARTICIPATE IN DRAFTING INDENTURE

The investment bankers who underwrite an issue of bonds ordinarily have no intention whatsoever of making a permanent investment in those bonds. That is not their business. Their capital would ordinarily not be adequate for that purpose without the assistance of substantial bank loans. If the underwriter ever becomes the owner of the bonds, it is only with the intention of distributing those bonds to the public. Occasionally, of course, where the underwriters are unable to dispose of the issue, they find themselves in the position of involuntary investors, but realistically, where there is to be a public offering, the real "lenders" are the ultimate purchasers of the securities the members of the general public who buy them. Therefore, when we speak of the interference with the right of private contract between borrower and lender in this situation, we are speaking of the contract between the obligor and the ultimate purchasers of the securities. I think it is very important to bear that point in mind.

Who are the security holders? At the time of the issuance of the securities, they are unknown. The obligor may be in Delaware and the security holders may be in the other 47 States.

We all know, from our common knowledge, about the interstate mechanism which has been developed for the interstate distribution of securities. We all know that they flow in interstate commerce. We all know that they are sold nationally. We also know that the wide sale and distribution of the securities raises a very acute problem as to what those disorganized, scattered, security holders are going to be able to do to protect themselves, in case the particular issue gets into difficulty.

Mr. BOREN. The indenture is not a contract of sale?
Commissioner DOUGLAS. I beg your pardon.

Mr. BOREN. The indenture is not a contract of sale, but rather a contract to offer for sale. Is that not a layman's interpretation of it? Commissioner DOUGLAS. I think so.

Now, as I have said, the bond itself is merely one sheet of paper. The indenture is an elaborate legal document which, although the bondholder rarely sees it, legally constitutes part of his contract.

It is perfectly obvious that with certain exceptions this contract that is made is not made by the security holders on one side of the table and the obligor on the other side of the table. It is a contract that is made for them, not by them. Who makes it? We know that the security holders do not make it, with certain exceptions.

Mr. EICHER. It is a contract that the lender has the option to accept or reject later on?

Commissioner DOUGLAS. That is correct.

Mr. EICHER. It is only then that it becomes a contract.

Commissioner DOUGLAS. Legally, I suppose it is a contract between the trustee and the obligor. Actually, our statistics show that in the case of more than half of the indentures examined by the Commission in the course of its study of protective committees, the trustee had no participation whatsoever in the drafting of that contract. (See pt. VI of the report above referred to, entitled "Trustees Under Indentures," pp. 7-10.) That contract has, by and large, been drawn by the obligor on the one hand and the underwriter on the other. The traditional view is that, generally speaking, it is not the place of the trustee to make any suggestions except on two points: First, whether the provisions of the indenture will "work,' as a purely mechanical matter, and, second, whether the trustee is given adequate powers and immunities. A prospective trustee which made suggestions as to other points would be likely to find that its choice lay between accepting the indenture "as is," or declining to act as trustee. In the latter case, the borrower could shop around until it found a trust institution which would accept the indenture, notwithstanding the objectionable provisions.

It would be clear to me that the drawing of the contract should not be left to the borrower the obligor. Perhaps if we were dealing with an old-fashioned situation in which we had one prudent man dealing with another prudent man in a simple borrowing and lending situation, we could fully expect that the one prudent man could take care of himself, or we would not feel so badly if he did not take care of himself; but where we are reaching the masses of the people, different considerations apply.

They are not in a position, realistically, to look after their own interests.

Mr. EICHER. But it is known right from the beginning, is it not, Mr. Douglas, that the trustee is merely a straw man and he is set up there for the purpose of representing the ultimate hundreds, possibly thousands, of private investors whose money it is expected will be invested in that particular issue?

Commissioner DOUGLAS. Yes, sir.

Mr. EICHER. So it is the general public interest represented by these millions of investors that are expected to supply the funds that this bill seeks to serve?

Commissioner DOUGLAS. The trustee does not supply the funds. Mr. EICHER. No. It is these individuals who represent the public interest and it is their interest that this bill seeks to protect.

Commissioner DOUGLAS. That is right.

Mr. EICHER. And seeks to see to it that the kind of a contract that they think they are buying is the kind of a contract they are getting. Commissioner DOUGLAS. That is correct.

Mr. BOREN. As a practical matter, in the ordinary and average sense, in the trust indenture, who is the underwriter and who is the trustee?

Commissioner DOUGLAS. Well, that varies so much, Mr. Boren.

Mr. BOREN. I mean, to indicate, Mr. Commissioner, that we will say possibly the First National Bank & Trust Co. in Oklahoma City will be the trustee and may be the underwriter. Is that a practical application of the thing?

Commissioner DOUGLAS. No; not since the passage of the banking act, when the underwriting of securities was divorced from commercial banking. Your underwriter at the present time is a partnership or a corporation, or an individual, who is engaged either in the wholesaling or retailing of securities. The trustee, by and large, is a bank, a commercial bank, or a trust institution.

Mr. BOREN. That is the distinction I wanted to make, as to whether under the banking act the bank could act as an underwriter or a trustee.

Commissioner DOUGLAS. The banks in these situations are acting as trustees in most of the cases.

Now, we will find smaller issues where the bank does not act as trustee, but where an individual has been acting as trustee.

You take, Mr. Chairman, our report on real-estate bonds. That report shows that, in many real-estate situations, an individual, an officer of the underwriter, was the trustee a so-called vest-pocket trustee. (See pt. III of the report above referred to, entitled "Committees for the Holders of Real Estate Bonds," pp. 12-17.) This bill is, among other things, designed to see to it that in these issues of national importance the trustee is a responsible institution.

Mr. EICHER. In other words, that there be arm's-length representation.

Commissioner DOUGLAS. That there is arm's-length representation by a responsible institution.

Mr. BOREN. In the eventuality of an issue not being marketable as expected at the time of issue, does the underwriter then stand in the position of holding an obligation to assure to the obligor that its issue shall be taken up and funds will be furnished it?

Commissioner DOUGLAS. That depends entirely upon the contract the underwriter makes with the issuers. Normally it will be an agreement to take all that is not sold by the issuer, or an agreement to find purchasers for the issuer, which means a firm commitment that, if they do not find purchasers, the underwriter will take them. Sometimes you will find underwriters as defined in the Securities Act not taking a commitment, but merely selling as an agent without any firm commitment. That is not the usual case.

Mr. BOREN. If I might go a little afield from the point here under discussion, I was particularly interested in the exemption you mentioned under section 3 in reading the first provision under section 3.

Am I right in the assumption that you rather intended to define what securities were under the act rather than what securities were to be exempted?

Commissioner DOUGLAS. Well, under section 3 an attempt was made to eliminate from the bill certain types of securities which it did not seem necessary to subject to the bill. In other words, where the public interest was not so apparent or where the kind or type of security itself did not lend itself to the type of abuses that had arisen.

Mr. BOREN. It strikes me that in this section you have proceeded in the reverse of the ordinary approach by saying that all securities are exempted, except.

Commissioner DOUGLAS. That is the Securities Act approach, Mr. Boren, and this is drafted along the lines of the Securities Act in that respect. That is, the Securities Act sets out categories of securities exempt from the Securities Act. There are exceptions, but by and large this bill follows the Securities Act type of exemption. For example, as respects Government securities, municipal securities, and

so on.

Mr. BOREN. Well, I do not think it is fundamentally important, but I do want to be sure that I understand clearly your proposition here.

If I understand the Security Act properly, it sets out definite exemptions, say, for example, municipal securities are exempt. Commissioner DOUGLAS. That is right.

Mr. BOREN. And rather defines the exemptions, while apparently in section 3 here you said that all securities are exempted, "except," and then define those that are not exempt.

Commissioner DOUGLAS. That was not the intention, Mr. Boren. Mr. BOREN. I wanted to make it clear.

Commissioner DOUGLAS. Section 3 (a) reads:

The provisions of sections 4, 5, 12, 13, and 14 of this Act shall not apply to any of the following securities.

Mr. BOREN. Will not apply to any securities other than?

Commissioner DOUGLAS. No; shall not apply to any of the following securities. In other words, it is following the pattern of the Securities Act.

Mr. BOREN. I do not know whether I have the proper bill or not, but it reads:

(1) Any security other than (a) a note bond, debenture, or evidence of indebtedness, whether or not secured, or (b) a certificate of interest or participation in any such note, bond, debenture, or evidence of indebtedness, or (c) a temporary certificate for, or guarantee of, any such note, bond, debenture, evidence of indebtedness or certificate.

Mr. BURKE. That is right.

Commissioner DOUGLAS. You are thinking of 3 (a) (1).

Mr. BOREN. That is right.

Commissioner DOUGLAS (reading):

Any security other than a note, bond, debenture, or evidence of indebtedness, whether or not secured.

That is correct.

In other words, we are not dealing with all types of securities here. We are dealing with those securities which are customarily issued under an indenture.

Mr. BOREN. You have listed here specific securities which you are dealing in in this section 3 (a) (1), rather than in the specific securities which are exempt?

Commissioner DOUGLAS. That is true with respect to section 3 (a) (1), sir, but the remaining paragraphs of subsection 3 (a) specifically exempt certain additional classes of security. For example, 3 (a) (4) carries over all of the Securities Act exemptions.

Mr. BOREN. Yes.

Commissioner DOUGLAS. Other than those provided by paragraphs (9) and (10) of subsection 3 (a) of the Securities Act.

Mr. BOREN. I just wanted to be certain that I understood this differentiation.

Mr. BURKE. In section 3 (a) (1) you limit the application of the bill to notes, bonds, debentures, or evidence of indebtedness, and so forth, as specified in that paragraph.

Mr. BOREN. When you refer to a temporary certificate or guarantee, you mean a callable issue, for a temporary purpose?

Mr. BURKE. No, sir; not quite that. Where securities or bonds are to be issued, ordinarily, in the case of the larger issues at least, it is necessary to engrave those bonds. That takes some little time. It may not be possible to do that by the time that the underwriter wants to make an offering of the bonds, and actually to deliver them. In those situations the underwriter frequently gets up what is called a temporary bond, which is merely a printed bond and can be gotten up over night.

Now, the bill applies to those temporary bonds as well as to what are called the definitive, engraved bonds.

Mr. BOREN. I have finished, Mr. Chairman.

Commissioner DOUGLAS. Mr. Chairman, the philosophy of this bill is that in the drafting of these indentures the interests of the security holders have not been adequately represented.

Some critics of the bill make the argument that the interests of the investors do receive at the present time adequate protection through the participation of underwriters in the preparation of the indenture, and through the disclosure requirements of the Securities Act.

Mr. BOREN. Mr. Commissioner, I have five volumes that I have been looking over during the week end of reports that the Commission has made as a result of its studies on this subject; but I think it would be well for our record here to show a specific example, one or two, and give some illustrations of the extent of the studies that you have made to show the need for this sort of protection to the public.

Commissioner DOUGLAS. What would be the best way of treating the factual material, Mr. Chairman? We submitted to the Congress in June 1936, a report entitled "Trustees Under Indentures" covering this subject.

Should I offer for this record a copy of that?

Mr. BOREN. It is too long, I suspect, for printing in this record.
Commissioner DOUGLAS. It is rather voluminous.

Mr. BOREN. Perhaps I have made here an unnecessary request. Mr. EICHER. I believe it would be of value, for the purpose of these hearings, and would promote their educational features, if Mr. Douglas would incorporate with his statement a ready reference to those more formal hearings of such specific examples as Mr. Boren refers to.

Commissioner DOUGLAS. I should be very happy to do that. I can do that.

Mr. EICHER. It would help the committee very substantially if we had that ready reference available.

Commissioner DOUGLAS. And I can, as I go along, perhaps give in hypothetical terms the types of problem that the bill deals with. Mr. BOREN. I think that would be well.

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