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Commissioner DOUGLAS. I will see that that is done, Mr. Chairman, and I will endeavor in doing so not only to make reference to the parts of the Commission's public records, but indicate some of the experiences of the Commission since its investigations and studies of this subject ended, because we have these cases of trust indentures and corporate trustees before us every day, either under the Securities Act or under the Public Utility Holding Company Act.

Mr. BOREN. It is important in presenting the case in precise form to this full committee, and to the Congress, assuming we get that far with it.

Mr. EICHER. I think it would be very fine to have that.

ADEQUATE PROTECTION IS NOT PROVIDED BY UNDERWRITERS PARTICIPATION IN DRAFTING INDENTURE, OR BY DISCLOSURE OF ITS TERMS

Commissioner DOUGLAS. Mr. Chairman, some critics of the bill have made the argument that the interests of the investors now receive adequate protection through participation of the underwriters in the preparation of the indenture, and through the disclosure requirements of the Securities Act.

Now, there is no doubt but what the underwriters have, in the drafting of these indentures, performed in the past a very important function. It is certainly true that the underwriters, and very largely the underwriters alone, have been in a position to correct deficiencies in the indenture, for, as I have said, it is obvious that the investing public can have no share in its preparation; but the fact remains that the deficiencies at which the bill is directed persist in the indentures currently filed with the Commission under the Securities Act, and the fundamental fact remains that if the underwriters had discharged their obligation we would have no need to be here today.

What we are dealing with is a competitive situation where if one underwriter does not touch it another will, or may; or if one corporate trustee does not take an issue on another will or may. And it is not without significance that, as I have said, the correction of the deficiencies in indentures, at which this bill is directed, will largely impair management-underwriter control of the destinies of the bondholders, and restore such control to the bondholders themselves.

Mr. EICHER. In other words, the borrower can shop around and find the fellow who will take it on his terms.

Commissioner DOUGLAS. The borrower can shop around. The borrower can shop around and the borrower does. We know from our experience at the Commission that they do. We have seen the borrower shopping around for a trustee.

Now, if it were merely a question of dealing with the top, the cream of the profession, again we would not be here today; but as I say, we have in the trust indenture field as in almost any other field, variations in efficiency and integrity.

The types of corporate trust institutions vary very much.

All that this bill is designed to do is to make more standardized and uniform the best practices in the field.

Mr. Boren, in connection with your recent question, perhaps this would be of interest: On Saturday morning last we had informally before the Commission a situation where a trustee was about to accept a trusteeship under a first-mortgage bond issue. At the same

time the trustee was heavily interested in the stock of the issuer of those bonds. That was last Saturday. Now, that happens to be a case under the Public Utility Holding Co. Act and I think that if the issuer persists in retaining that particular corporate trustee, that the Commission might well refuse to issue the order permitting the sale of those securities.

That does not happen to be one of the top-flight trustees in the country and the underwriter in that particular situation did not happen to be a top-flight underwriter.

Mr. EICHER. Under the illustration you have just given then as I understand it, the trustee himself would be a borrower, at least to the extent of his common-stock holdings.

Commissioner DOUGLAS. He would. That is correct.

We have seen that situation develop in practice. It is not a healthy situation from the point of view of the bondholders. Top-flight trustees will not get into that situation. But as I say, we are not dealing with top-flight trustees throughout this whole field. There are varying degrees of competency and varying degrees of integrity, as there are in any field. In view of such current situations that we run across in our work at the Commission, it is our conviction that there is only one way to deal with the problem, and that is in a uniform way; not by trying to throw the whole thing into a legislative straitjacket, but by setting up minimum standards so that security holders will know that they are dealing with a real trustee; so that the security holders will be protected against the dilution of the loyalty of the trustee to them by reason of pecuniary self-interest with the obligor.

The theory of the bill is that the trustee should be in a better and in a more strategic position to protect the security holders than it is at the present time.

Its broad aim is a revitalization of the trusteeship, a step which the underwriter and the obligors have long delayed.

(Discussion of the inadequacy of disclosure as a corrective is resumed at p. —.)

BILL WILL NOT HINDER OR DELAY FINANCING

Mr. EICHER. Mr. Douglas, I do not want to inferfere with your own order of presentation, but before you conclude your statement, it would be helpful to me personally, at least, if you would discuss some of the objections that have been coming to me in the last 2 or 3 days, the burden of which have been that the enactment of this bill at the present time would restrict the free flow of funds from the capital markets into industry. I believe that one of the telegrams stated, and most of the others, that it would tend to be another handicap to the revival of business that we are all hoping for.

Will you speak of that now or later on in your statement, as you please.

Commissioner DOUGLAS. Mr. Chairman, I can assure you that if the Commission felt that that was true-and that objection has been urged on us we would be here today opposing this bill rather than favoring this bill.

The argument has been made that the necessity of qualification of indentures under the bill will cause additional expense and delay in the flotation of bond issues.

Now, as I have said, the bill applies generally only to those indentures submitted to the Securities and Exchange Commission as part of the securities' registration statement covering a proposed bond issue. As I think I have already said, at the present time the Commission must examine such trust indentures in order to determine whether there has been a full disclosure of their terms in the registration and prospectus.

We have that chore to do at the present time and we do it. We read the trust indentures from cover to cover.

Under the bill the Commission would have to determine whether the terms of such indentures conform to the standards established by the bill.

The machinery for qualification of the indenture is carefully geared into the registration machinery of the act in order to avoid expense and delay.

I assure you, Mr. Chairman, that our Commission is very much alive to the importance of not interfering with the flotation of legitimate securities. We are very much alive to the great importance of getting private capital moving into industry and we would not, for a minute, approve this bill if we believed that its passage would interfere with a proper functioning of the capital markets or would not aid in the restoration of investors' confidence.

Now, our Commission is vitally interested in the restoration of the capital markets. We are anxious to do everything that we can. Only the other day, we took steps toward simplifying some of our rules and regulations respecting small established business.

I think this matter should not be overlooked, that the keystone of all of the capital markets is the confidence of investors. Now, that confidence, in my opinion, has never recovered from the blow it received in 1929. Of all of the financial abuses against which the country became aroused in recent years, perhaps none has shocked the morals or destroyed confidence as greatly as the absence of adequate fiduciary responsibilities in large areas of the field of finance.

The trustee in our legal and financial system must be a symbol of confidence and protection, and I think the higher standards set by the bill will tend to restore confidence, on the part of investors, in the integrity of the financial processes.

I have every reason to believe, as a result of our administrative experience today, that there will not be the expense and delay of which the opponents of this measure have voiced fear. In that connection, let me point out that the bill becomes operative 6 months after it is passed. That provision is in there because it was realized that it would take some time to work out rules and regulations trying to standardize, to the greatest extent possible, the various types of covenants that would be required in an indenture. That provision will eliminate any delay which might otherwise result, on the passage of the bill, merely from the difficulty of getting out the necessary rules and regulations.

So, the bill as presently drafted provides a 6 months' period within which the Commission, working with the committees of the American Bankers' Association and working with such other committees as elements in the industry may provide, can proceed forthwith to set up practical, workable rules and regulations, so that, when the bill does go into effect, it will operate smoothly and without interruption to the normal processes of finance.

ADEQUATE PROTECTION IS NOT PROVIDED BY DISCLOSURE

(Discussion continued from p. -.)

In summary of all of this, Mr. Chairman, I might merely indicate this: It is our confident belief, and we believe the informed judgment, that requirements which look only to the disclosure of what is in the indenture are not an adequate solution of the problem.

Mr. EICHER. That is all of the authority you have under the existing law?

Commissioner DOUGLAS. That is all the authority we have under the existing law-that is, under the Securities Act. We do have peculiar problems under the Public Utility Holding Co. Act; but in finance generally that is all the authority we have, and we see its inadequacy. We saw it last Saturday in the case I mentioned in which the trustee was in effect the obligor.

The average investor rarely sees the indenture which constitutes part of his contract. He could not understand it if he did see it. A great deal of explaining would be necessary in order to make him realize why the deficiencies to which I have referred operate to his great disadvantage. And when trouble comes, he is unlikely to attribute his difficulties in the enforcement of his rights to deficiencies in the indenture itself. Any investment banker will agree that when you are trying to sell a security, you do not say much about the possibility of default. That is perfectly natural. It is also perfectly natural that the average investor, when he purchases a bond, thinks more about the price, the interest rate, the maturity date, and the security therefor than he does about the adequacy of the provisions relating to the protection and enforcement of his rights. In any event, it is clear from 2 years of experience under the Securities Act since the publication of our report on "Trustees under indentures" that even the fullest disclosure of the terms of an indenture is not sufficient to bring about the necessary improvements, and that the desired objectives will not be attained so long as the form of the indenture is determined exclusively by the conventions of the obligor and its underwriters.

We come down to the situation, Mr. Chairman, closely analogous to the insurance situation some 30 years ago, when for the benefit of insurance buyers the States found it necessary to take steps to protect them.

Mr. EICHER. You are referring to the Hughes investigation?

Commissioner DOUGLAS. Well, I am referring to the efforts made by the States to standardize certain types of clauses in insurance policies; to eliminate some clauses that history had shown were very bad, from the point of view of the insurance buyers. The States at that time, as you know better than I, found it necessary to take steps to see to it that insurance policies were more fairly drawn, against certain uniform standards. Such regulation is now accepted as a matter of course, and I think insurance company officials would practically all agree that the resulting improvement in the forms of insurance policies has been an excellent thing, not only for the purchasers of such policies, but for the insurance companies themselves.

This situation provides a close analogy. Here we are concerned not with the protection of insurance buyers, but with the protection of security buyers. The bill does not involve an attempt to say this

issue is sound and that issue is unsound; that this issue is of investment grade and that that issue is speculative. But in the light of the bargain which the parties have made, the bill says to the trustee or to the obligor, "If you want to do this, you have to do it in a certain way. For example, suppose there is a provision in an indenture which comes up for consideration under this bill, allowing a substitution of collateral held as security for the bonds. The bonds, at the time of the issuance, are secured by other bonds, and those other bonds, we will say, are first-mortgage bonds.

Is it not important that the buyer of the security is protected against negligent or wilful dissipation of the security underlying his security? If common stock is to be substituted for those firstmortgage bonds underlying the bonds that are sold, should not some protection be provided to see to it that adequate standards are applied and adequate diligence employed in the substitution?

There is no attempt in this bill to say you cannot substitute X for Y; but machinery is provided in this bill so that there will be a check on the substitution of X for Y, so that an independent auditor or independent engineer, say, will pass on the substitution, so that the obligor will not be able to play with the portfolio, to the great disadvantage of the security holders.

That is the type of technique employed, not the technique of saying you cannot make the type of bargain which will permit substitution; but the technique which says when you make a bargain which permits substitution, then certain safeguards must be set up around its exercise.

I think I have covered in general, Mr. Chairman, the mechanics.

NECESSITY FOR FLEXIBILITY

There is one other point that has been raised by some of the critics. I believe some have objected that each indenture under this bill was to be the subject of separate and independent substantive rulings by the Commission, and that that was bad.

Now, the bill does permit the Commission to act by order as well as by rule and regulation.

Mr. EICHER. With an appeal from the order?

Commissioner DOUGLAS. Yes, sir; with an appeal from the order, as under the Securities Act.

There are several ways in which one could go about accomplishing the objectives of this proposed legislation. There are several methods he could employ. First, he could attempt to standardize everything"Thou shalt not," or "Thou shalt," so to speak-and put it right in the statute. We think that would be a bad way of doing it.

The problems exist with respect to all types of securities issued under indentures-real estate bonds on the one hand, and industrials on the other, and so on.

We are careful of trying to put rigid rules right in the statute. That would be a legislative strait jacket, injurious, I think, really injurious to finance. What this bill seeks to provide is flexibility, and the maximum protection to finance. That protection is afforded by this flexibility, in my opinion. We can act by rule or regulation, or by order. The bill does permit a case by case treatment of each indenture and that, I think, is one of its strongest points.

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