I entertain no doubt but that the Commission was motivated by the best of intentions, but am somewhat fearful that some of the provisions of the bill which theoretically may benefit the security holders might in reality have very little effect upon them.

For example, premature or untimely default action on the part of the trustee prompted solely by the desire to free itself of possible liability under the rigid requirements of the bill, might well be detrimental to the interests of the security holders.

Likewise, it seems unreasonable to expect that credit will be extended by indenture trustees to an obligor if there is imposed on the bank the burden of proving that it had no reasonable cause to believe that the obligor would default on the indenture security within 4 months, and this might adversely affect the interests of the security holders, particularly if the obligor is unable to obtain credit elsewhere, which well might be the case.

Another matter which merits careful thought and consideration of this bill is the result which might be produced from the unwillingness of financially responsible and ably staffed trust companies to assume the burdens and liabilities imposed upon the trustee in the probable diversion of indenture trusteeships to weaker and less competent institutions. And in this connection, also, the matter of how much the bill might conflict or interfere with the control and supervision of the Federal Reserve Board which should be vitally interested in any liabilities assumed by member banks of the Federal Reserve System.

Indenture securities issued under corporate trust indentures in most cases have maturities extending over many years, during which time economic conditions will be constantly changing. Unless some flexibility is permissible under the terms of the indentures by which such securities are secured to meet these changing conditions, the security holders may in many cases be harmed by the rigid restrictions which were designed to protect them. Such flexibility should be provided by vesting discretionary powers in the trustee without exacting further responsibility than the exercise of good faith in the light of circumstances existing at the time the power was exercised.

Our counsel in matters of corporate trust administration has repeatedly stated to us that the elaborate exculpatory provisions which commonly appear in trust indentures are not as effective as they might seem and has advised that the indenture trustee is bound to act in good faith and exercise reasonable care. The provisions of the bill in this regard should not go further than to require from the trustee good faith and reasonable diligence.

The conflicting interest provisions are entirely too complicated to be strictly complied with by a trust company of any size. It would perhaps be preferable from the standpoint of all concerned simply to provide that the indenture trustee shall be liable for losses suffered by the security holders to the extent that advantage was gained by it at the expense of the security holders.

In its present form the bill vests in the Securities and Exchange Commission powers which are so broad, if legal, as to practically permit the Commission to write the indenture, thus taking out of the hands of the real parties to the transaction the privilege of making their own contract, a condition which seems to be entirely unjustified

under the circumstances, and in all probability a dangerous undertaking insofar as the Government itself is concerned.

I have two general recommendations to make.

1. No legislation on the subject matter of this bill at a time like the present when numerous other obstacles stand in the way of orderly functioning of the capital markets.

2. Constructive efforts to approach the matter of framing a bill of this nature, for presentation at an opportune time, from the standpoint, essentially, of simplicity, flexibility, and not imposing too drastic liability on the trustee in respect of the trust estate which is not under its direct control and supervision.

(a) Providing that indentures covering securities required to be registered with the Securities Exchange Commission must have as one of the trustees thereunder an institution, authorized to exercise corporate trust powers, which is subject to Federal or State supervision. or examination.

(b) Providing that the same institution shall not be eligible to act as trustee under more than one indenture of the same obligor.

(c) Providing some reasonable penalty for advantage gained by the indenture trustee, individually, at the expense of security holders.

(d) Restricting exculpatory provisions in indentures to the extent of exacting from the trustee good faith and reasonable diligence in the administration of its trust functions.

3. Further impartial investigation by the Government, either through the Securities Exchange Commission or available banking channels of the general practice and policies of trust companies in matters of indenture trustee administration by member banks of the Federal Reserve System. It is suggested pertinent data laong these lines might be obtained at very little expense to the Government by utilitizing the facilities of bank examination.

Mr. EICHER. Don't you feel, Mr. Helffrich, that there is a probability of increased investor confidence which would result in greater mobility in distribution of securities if there can be accomplished the standardization that this bill contemplates?

Mr. HELFFRICH. I do not so understand. I have not heard any investors complain outside perhaps of this real estate situation-there were a few no doubt in the Commission's report which I understand was made on the basis of an examination not only of banks and trust companies which may be members of it and you understand subject to national supervision, but was made of this whole situation generally which included individual trustees and special banking houses in some cases which had the whole thing in their own shop. They acted as trustees; they sold the bonds and were perhaps affiliated with the obligor.

Mr. EICHER. On all four sides of the same table?

Mr. HELFFRICH. There is no question about it; but those situations I think existed largely in the real estate field, so-called real estate mortgages, and goodness knows when the time will come again that will be possible to float these so-called real estate issues.

Mr. EICHER. Thank you.

Mr. HELFFRICH. Thank you.

STATEMENT OF F. E. FROTHINGHAM, PRESIDENT, INVESTMENT BANKERS' ASSOCIATION, BOSTON, MASS.

Mr. EICHER. Mr. Frothingham.

Mr. FROTHINGHAM. Mr. Chairman and gentlemen of the committee, my name is F. E. Frothingham. I am president of the Investment Bankers' Association.

Mr. Chairman, the time is running very short and so I will say but a few words, because I desire that some of my associates may say what they more particularly like to.

Mr. EICHER. The clerk has an allocation of an hour and a quarter for the remaining witnesses. That would be 15 minutes for each. Mr. FROTHINGHAM. I will be short, nevertheless.

So much has been said here that is in support of our general views to which I want to refer particularly, but I think they corroborate the feeling of the governing board of the Investment Bankers' Association, which is unanimous that fundamentally the approach to this bill is not along lines that will be productive of the best results and that especially this is not a time to engage in further legislation of this sort.

I know of the careful study that Mr. Douglas has made of this subject since before he was Commissioner. I have read his reports and no sensible man can other than be condemnatory of the practices that were there outlined.

All of my business experience has been more or less in contact with mortgages, in contact with these affairs, and I am appreciative of the faults that need correction, but I cannot yield even to Mr. Douglas in my desire to see those faults corrected and the conduct of business brought to a high plane.

Neverthless, the fundamental approach to this subject in this bill seems to us a mistaken one. It is on the theory primarily of approval by the Commission. The full disclosure theory has been widely departed from in this suggestion.

If I understand the approval theory it is that over and above all other rules which the Commission might make, they are largely, if not entirely, controlled by their independent and unregulated judgment of what they believe to be for the public interest and for the protection of investors. That clause appears I think some 22 times in the bill.

Mr. EICHER. You understand, of course, that is to meet the requirements of the Supreme Court.

Mr. FROTHINGHAM. Well, under that clause, rules and regulations can be made, among other things, as to title for the issue, method of handling debentures, maintenance of certain ratios of assets; terms for issues of additional bonds, or for the release of property; substitution of property or collateral; use of proceeds of released property; in the event of default, methods of foreclosure duties of trustees and in connection with other provisions of the indenture.

Now, the objection to that theory, gentlemen, is this: That it substitutes the judgment of a commission, which unfortunately must be made up of changing personnel as time goes on, for the judgment of both the borrower and the lender. It sets the Commission at the counsel table and gives the Commission final decision with regard to these various items.

That has the effect of dulling independence and the eagerness of both the borrower and lender to do their best with the situation. Their responsibilities automatically take an instinctive shift to the Commission. The Commission, as we see it, does, in fact, define in a very large measure the provisions of the mortgage. True, it cannot touch such matters as the amount of the issue. It can touch the maturity items and things of that sort, but those are not major considerations.

As time goes on conditions change. Nobody can tell what will be the judgment of the Commission. The whole subject remains indeterminate and unfinished and leads to a quality of confusion that we do not believe can be productive of the most desirable results. Further than that, we cannot see from a reading of the bill carefully, or as carefully as we can, from the point of view and objective study which we always want to make, that the objective sought by the bill will, in fact, be reached.

My associates will speak more particularly on the details of that, but, in general, that would be my judgment and it is the judgment of the Investment Bankers' Association.

The application of the rules under this bill will surely result in developing almost immediately another series of corrections that will be required.

I realize that the corrective processes must be more or less a cut and dried one. Mistakes will be made and corrections will be made, but in our judgment this bill approaches the subject from so fundamentally an unfortunate angle in itself and one we feel so confidently will not cure the evils involved, that for those reasons we think the bill should have further study. We would like to give it further study. We would like to see, and I personally would like to see, a group of men get together with the Commission, a lender, a borrower, and someone representing industry-a banker-to study this situation. I know that it may be felt by you and by others that the interest of the investment banker is a purely selfish one. That perhaps is not an unnatural feeling. But I would like to call your attention to the fact that the success of the investment banker, the profitableness of his business, depends primarily upon the free flow of the capital markets, the constant borrowing and lending, and the constant investments by security holders. There is where our selfish interest lies. So that we want to see all these various interests, so far as we can and in accordance with our good judgment, protected, as they can be.

It has been pointed out how the bankers might be injured. We are interested in the banking situation, that it may remain solvent; that it shall perform its duties; that it will always be healthy. We are also interested in the borrower's situation, that he will gradually come forward and try to get money, and that undue restraint be not placed upon the machinery for getting it.

We are interested in the purchaser. The purchaser is usually a group of investment banking houses who buy with their own money and hold in their own accounts.

My experience has been, and I have had a good deal of it, that in the overwhelming majority of cases their effort is to protect the people to whom they are going to sell securities. If they cannot succeed in

protecting those people and so devise as good an instrument as may be possible, they injure themselves in the long run.

Now, I understand that the remote customer is not a party to the decision. He cannot be. I understand that the borrower may lay down certain terms and say to the purchaser, if you do not want this "piece of goods" we will sell it to somebody else. Some conditions are more or less inevitable at all times in whatever occupation we are engaged.

I will not pursue that further, but I would like to emphasize those two points, that the fundamental approach to this bill, we think, is not a wholesome one, that there is danger in legislative procedure, and that this is not the time to put through legislation of this sort.

May I refer for instance to the right of appeal which Mr. Douglas said that, of course, was available; but consider how attenuated is the right of that appeal? What are you going to appeal from, and if you are successful in making an appeal, how long is it going to be before the appeal is settled and you know where you stand? In the meantime a market has gone by; the need of a situation has gone by. You are thrown into a confusion as a result of unnecessary delay.

With regard to the provisions that require that the nonassenting bondholder shall be able to maintain his rights, let me say there again over the long experience that there has been a constant evolution in the method of writing mortgages. In the old days the terms were explicit. There were a lot of protective features injected for the benefit of the ultimate purchaser and there was no provision provided, no modification clauses, as they are called in mortgages.

As time went on occasions came up which developed the mistakes, made clear many of the mistakes of the restrictive provisions in mortgages, and the inclusion of clauses allowing for the modification of the mortgage were inserted.

As a rule that provision presented modification either of the due. date, the interest rate, or the nature of the lien, but as time has gone on, as we have seen the experience in other countries, it is beginning to look very much as though the greatest interest of the bondholders would lie in a more expanded clause which prior to the default or prior to receivership or bankruptcy proceedings would enable such a majority of the bondholders as would unquestionably represent the best interests of the whole group of bondholders to override the desires of a small minority.

We would all at once say that if 99 percent of the bondholders agreed to something, 1 percent ought not to be able to hold them up. Between that and some lower figure, there is an opportunity for judgment, but the direction of the tendency of writing these mortgages is to enlarge those provisions so that the incidents coming up, innumerable as time goes on and innumerable unforeseen circumstances make it possible to create conditions not rigid, but on a more flexible basis. Now, with regard to the limitations that are put on the action of the trustees: It seems to me that has been very well explained here. Many of them result in unhappy results. The definitions of what constitutes conflicting interests are so meticulous and to such refined limits that they do not, it seems to me, accomplish the objects in mind. They simply cannot. One has got to depend on a certain amount of discretion, on a certain amount of ability and good will.