I think as a matter of practice at the end of the 6 months' interlude between the enactment of the bill and the time it becomes effective, the Commission, with the cooperation of the industry, can cover large areas of this subject by rules and regulations. I doubt very much, against the background of our experience under the Securities Act and under the Securities Exchange Act, that it would be possible to cover 100 percent of the situations in that way. We think that it would be very undesirable if we did attempt by rule and regulation to cover 100 percent of the situations. We think it might actually result in stepping in front of some of these movements and slowing them up if we were to throw them into a legislative or administrative strait jacket. I think that the representatives of trust institutions and institutional investors by and large agree that such flexibility is a necessary, desirable, feature of the bill and that we should have power to act by order.

INDENTURES CAN BE AMENDED IF BILL IS AMENDED

There is one other criticism, Mr. Chairman, that raises somewhat of a bogey, I think. It has been said that the bill, by its terms, would impose an impossible requirement of the consent of 100 percent of the bondholders in order to amend it.

It has been urged that this deplorable situation would obtain if any particular provision of the bill should be found unworkable and should itself be amended.

There is absolutely no basis for that contention. There is absolutely nothing in the bill to prevent the inclusion in the indenture of a provision permitting an amendment of the indenture in this situation by the vote, say, of 50 percent, or 75 percent, of the security holders.

Under section 7 (m) (3), there may be included in the indenture provisions authorizing the holders of a majority of the outstanding bonds to consent to the postponement of any interest payments for a period not exceeding 1 year or to the waiver of defaults and their consequences.

The permission thus granted is subject to an exception, however, and the criticism I have been discussing may be the result of confusion as to the effect of this exception. The effect of this exception is merely to prohibit provisions authorizing such a majority to force a nonassenting security holder to accept a reduction or postponement of his claim for principal, or a reduction of his claim for interest or a postponement thereof for more than 1 year. In other words, this provision merely restricts the power of the majority to change those particular phases of the contract.

Evasion of judicial scrutiny of the fairness of debt-readjustment plans is prevented by this exception. Until comparatively recently, a prohibition of this sort was perfectly standard in note and bond indentures. In many States it is necessary in order to preserve the negotiability of the notes or bonds; in others it is necessary if the notes or bonds are to be legal investments for insurance companies, savings banks, and the like.

As we said in part VI, Trustees Under Identures, at page 150:

Hence, although these indentures which provide for reorganization by contract may solve some of the reorganization difficulties inherent in equity receivership or bankruptcy, it must be admitted that they give rise to abuses and problems which

must be faced if the interests of security holders are not to be made subordinate to the desires and conveniences of the dominant group. The risk is that if these provisions come into vogue and no controls are set up over them, the next cycle of reorganizations will take place on a voluntary basis without supervision of any court or administrative agency. * * *

If less than all the bondholders are to be given the power to effect reorganizations by virtue of the contract contained in the indenture, the use of proxies will doubtless be common. In case of indentures which provide for bondholders' meetings, it will not be practical to expect large numbers to attend in person. Rather, if the history of stockholders' meetings teaches us anything, we may expect that the bulk of bondholders, if they are represented, will be represented by proxy holders. If those proxies come into hands with interests adverse to those of the bondholders the latter will not only be inadequately represented; they may be exploited in the fashion in which protective committees in other situations have exploited security holders.

If the management or the junior security holders of a corporation can obtain proxies from bondholders to vote in their place and stead for changes in the bonds and in the indenture, grave injustices may result. The interests of such parties normally will not lie with the bondholders. Similar conflicts of interest may exist as respects other proxy holders.

In other words, the bill does place a check or control over the majority forcing on the minorities a debt-readjustment plan. It does go that far; but it does not prohibit any other restriction or appropriate amendments of the indenture by the consent of the parties.

This prohibition does not prevent the majority from binding the dissenters by other changes in the indenture or by waiving defaults and the majority may, of course, consent to the alteration of its own rights.

That covers, I think, for the most part, Mr. Chairman, the various points of criticism that have come to me.

BRIEF OUTLINE OF THE BILL

Now, for a few of the high spots in the bill, if the committee desires. They center, for the most part, around section 7, which is the keystone of this bill.

PERSONS ELIGIBLE FOR APPOINTMENT AS TRUSTEE

Section 7 (a) on page 18 requires the indenture trustee be an institution which is subject to governmental supervision or examination; an institution with resources commensurate with its responsibilities. That is the normal practice to have an institution today-there have been exceptions. Those exceptions largely have been in the real-estate field where you have had an individual trustee and the very damaging consequences as the result of that are shown very vividly, I think, in our reports on real estate bonds. (See Pt. III, Committees for the Holders of Real Estate Bonds, pp. 12 to 22.)

CONFLICTING INTERESTS

In section 7 (b), on page 20, we have a prohibition, to which I referred earlier, dealing with the problem of conflicts of interest possessed by the indenture trustee; conflicts between the trustee and the persons being represented by the trustee. There is little dissent and can be little dissent from the proposition that the trustee should not have interest materially conflicting with those of the security holders. The only questions are, first, what is a conflict; second, what should be the method of treatment. There are several possible methods of treat

ment. In the interest of uniformity and ease of administration, our Commission is strongly of the opinion that rules of thumb should be applied; that the Congress should not give the Commission continuing jurisdiction over the problem as some critics have suggested.

The interests which the trustee has may change from week to week or month to month, or day to day, over the life of a 20-year bond issue. It seems to us to be better to set-up rules of thumb fully covering such interests. They have the advantage of uniformity. They have the advantage of certainty. The trustee can know at all times precisely where he stands.

Mr. EICHER. The bill would include all issues regardless of size? Commissioner DOUGLAS. The bill has a provision on pages 10 and 11, section 3 (c), which eliminates from the bill certain small issues where the aggregate amount of the issue is under $250,000, where you are not so apt to get your widespread holdings; where your holdings are more apt to be locally held, and so on. The Commission has that exemptive power.

Mr. EICHER. Do you consider that is a sufficient safety valve to prevent any hardships under the provisions of section 7 (a) requiring a recognized institution always to be one of the trustees? In other words, might there be individual cases of hardship arising out of the fact that individuals are not permitted under any circumstances to be the trustee?

Commissioner DOUGLAS. There might possibly be in connection with some of the small issues. That was one of the reasons, I believe, that the $250,000 limit was put in rather than the $100,000 limit that is in the Securities Act. It was the feeling that the $250,000 top limit would take care of those situations.

Now, section 7 (b) treats with conflicts of interest. It imposes disqualifications upon trustees who are trustees under more than one indenture of the same obligor. That is, where the X company has a first-mortgage bond issue outstanding and a second-mortgage bond issue outstanding, the trustee cannot serve as trustee under both of those issues. The section places limitations upon too close affiliations with the obligor or with underwriters of its outstanding securities, and upon the ownership by the trustee of substantial amounts of other securities of the obligor.

In the case I mentioned, Mr. Chairman, which was before our Commission informally last Saturday morning, the trustee had a substantial block of stock of the issuer and at the same time proposed to act as trustee under a first-mortgage bond issue. He would be disqualified under section 7 (b) of this bill.

I should point out in this connection that the fundamentals of this conflict of interest sections are not too strange. The New York Stock Exchange will not accept as a trustee, for a listed bond issue, an institution which is trustee under other indentures of the same obligor, or in which an officer of the obligor is an executive officer, or which controls, or is controlled by the issuer. Affiliations with underwriters are now largely proscribed by the Banking Act of 1933. The bill embodies a logical extension of those principles into other fields. It is designed to lay down definite, concrete, specific rules covering the relationship of the trustee to the issuer and to the underwriter.

As we said in Part VI, Trustees Under Indentures, at page 106:

To recapitulate, if the trustee is affiliated with the issuer or with the underwriting bankers, it is all too likely to be sympathetic with their concerns. It is under constant pressure to protect them and their interests, instead of conducting itself with an eye single to the interests of its cestuis. And if it is a creditor of the issuer, the temptation to sacrifice their interests is redoubled. It is in a position to salvage its own interests at their expense; whether or not it is affiliated with management or bankers, it is able to move rapidly and effectively to protect its claims, before the interests of security holders are safeguarded. And in the reorganization process, if it is affiliated with management or bankers it is all too likely to accept, without careful scrutiny, plans which they propose, and to aid and abet majorities which they have marshalled while the interests of minorities go unrepresented. Certainly if trustees are to be expected to live up to the standard of conduct before and during reorganization which we have outlined, they cannot be allowed to incur antagonistic duties and loyalties to themselves as creditors or holders or representatives of conflicting securities, or to the management or its bankers.

PREFERENTIAL COLLECTION OF CLAIMS AGAINST OBLIGOR

There is nothing in the bill to prevent a trustee from becoming a creditor, a short term creditor, of the obligor. This is a matter dealt with in subsections (c) and (d) of section 7 on page 27. Under those sections, however, if within 4 months prior to a principal or interest default under the indenture the trustee effects a preferential collection upon its own claim, to the disadvantage of the bondholders which it represents, it must share the proceeds of such collection with the bondholders.

I do not understand that there is any real objection to that principle. That is to say, if X company is trustee for bondholders under an indenture and is likewise a short-term creditor of the obligor, within the period of 4 months prior to a default, if he collects money from the obligor during that 4 months' period, he collects it not only for himself but also for the bondholders.

Some have pointed out that these requirements might have the collateral effect of discouraging so-called rescue loans by the indenture trustee within 4 months of the default. It has been said, I believe, that in such cases the trustee should be permitted to retain the security even where it had knowledge of impending default at the time the loan was made.

The Commission has given careful consideration to those arguments and has concluded that since the trustee moves into a directly competitive position as soon as it makes such a loan, the apportionment provision should be applied, unless the trustee establishes it had no reasonable cause to believe that the rescue would be unsuccessful, that is, no reasonable cause to believe that the rescue would be unsuccessful.

Mr. EICHER. Is there possibly another answer to that objection, that the mechanics of this bill if and when it becomes law would permit flexibility of action among the bondholders for their own protection which under the existing law the bondholders do not have as a practical matter, so that for the purpose of rescue loans, if that should be indicated as desirable, the bondholders can jointly take any necessary action?

BONDHOLDERS' LISTS

Commissioner DOUGLAS. They can much more easily mobilize for action. That is indicated in section 7 (f) on page 34, requiring the obligor to supply the trustee with information as to names and addresses of bondholders.

In the past obligors have had a practical monopoly on such information derived from their records of persons to whom interest was paid. The monopoly has been shared partially by the underwriters. (See pt. I, Strategy and Techniques of Protective and Reorganization Committees, pp. 436-446.)

Mr. EICHER. That is, the bondholder lists would be available as public records?

Commissioner DOUGLAS. They would be available in the hands of the trustees for legitimate use by the security holders in getting tcgether to protect their own interests.

Mr. EICHER. Well, they are on file, under the requirements of the bill, with the Securities and Exchange Commission, are they not? Commissioner DOUGLAS. Under this proposed bill they are not filed with the Commission. They are filed with the trustee. Under section 7 (e)

Mr. EICHER. Well, would the Commission have the power under the bill to require the trustee to disclose the bondholders?

Commissioner DOUGLAS. Under the bill the Commission has control only over the indenture provisions. Once an indenture becomes qualified under the bill the Commission thereafter has no power to intercede, to step in, to force the trustee to do anything. The role of the Commission would be to see to it that the particular provisions of the indenture meet the standards of this statute.

REPORTS BY OBLIGOR AND INDENTURE TRUSTEE

Under the bill, section 7 (e) on page 33, the obligors will be required by the indenture to make reasonably informative periodic reports to the trustee. The better companies make such reports to their stockholders. The bill takes what seems to us to be the logical step of requiring such reports, and similar reports by the trustee concerning the trustee, to be made available to the bondholders.

The other phases of the bill relate largely to the duties of the trustee and the powers of the bondholders prior to default and after default.

DUTIES OF TRUSTEE PRIOR TO DEFAULT

Few will deny that in the case of national distribution of securities the obligor shou d be required to provide the trustee with the necessary tools for making an effective check on the performance of the undertakings of the obligor.

With respect to the more important undertakings, the obligor should provide, and its trustee should be required to obtain, certificates or opinions of independent attorneys, accountants, or other experts to see to it that the obligor is performing its obligations. If such opinions are not required, I think that trust officers will agree that the best trust institutions in the country cannot do a real job. The imposition of such requirement in no sense involves an interference with the management of the business. With respect to the less important