studies show to have been the source of the difficulties and evils theretofore encountered.

It would seem to me that that is a very broad power to give to it, and goes very far toward remedying the situations thus far disclosed: The power to regulate clauses, the power of virtual prohibition of the issue unless the security indenture conforms to provisions satisfactory to the Securities and Exchange Commission, and, thirdly, the power to compel lists of bondholders to be produced upon necessity, so that they may be quickly foregathered.

What are the additional features which this bill provides? In the main, and for this purpose, there are two fields or divisions with which the act deals. One relates to the degree of care which the trustee shall exercise before and after default, the other to conflicts of interest in which the trustee may find itself.

I am afraid that there may not be time for me to do it, although I have devoted a little more than one page to the background of indenture trusteeships, but, I believe, a few words about that might here be in order as perhaps helpful in considering these two main divisions of proposed remedy.

The first instance of a trustee device in the United States goes back to about a hundred years ago. The term "trustee" was a misnomer; the trustee was a mere stakeholder. Usually an individual was appointed for this purpose, often an officer of the obligor. He held nominal title to the security; if the obligations were satisfied, he returned the security to the obligor; if not, he held it for the benefit of the investors. But for the convenience of a single representative to hold the security for a large body of investors, shifting in number and person, the indenture could have been executed directly to them, as indeed was the case in one instance where a dozen bondholders who took a railroad issue were named in the indenture.

In modern financing such a single representative has become, of course, indispensable. Thirty years elapsed before the nature of such a trusteeship came before the courts for decision. It was an important railroad case. The court observed that "trusts of this complicated and public character are so entirely new that very little light can be gained from any analogy to other trusts"; and concluded that it was a trusteeship in the full sense of the private trust. Undoubtedly this decision gave impetus to the inclusion in the trust indenture, to a greater degree than before, of provisions, now common in all indentures that the trustee shall be exonerated from all liability except for willful negligence or bad faith. It was not until about 1880 that the institutional trustee, the modern trust company or financial institution, as we know it, came into the field. These institutions rapidly replaced the individuals who had theretofore served as indenture trustees. Of course the idea of a trust is very old; that of a mortgage is even more ancient; but although the modern trust indenture is a descendant of both, and ancient in lineage, it is really modern in its form as developed and currently used. So rapidly did the use of this device grow, at first as a matter of convenience and later as a matter of necessity, that, as I have stated, the security issues represented in the United States by such trustees are estimated at the close of the year 1934 to have reached the huge total of 37 billion dollars.

Courts have wrestled with various phases of the indenture trustee problem from time to time; but as a matter of fact, the cases which

reached the court, until the last decade, were surprisingly few in number when you consider the huge proportions the business has attained. With the past 10 years, however, there came a flood of legal decisions. Indeed, in that time there have been twice as many court decisions in this field of the law as in the preceding 50 years. The clause exempting the trustee from all liability except for gross negligence or bad faith commanded frequent attention. Some courts recognized that with the vast sums involved it was not to be expected that a trustee should subject itself to any greater measure of responsibility. However that may be, I am not at all sure that the enormous industrial and financial developments of the country would have been possible or as rapid under a much severer rule of trustee liability, and from that standpoint something may be said for the propriety of these exculpatory clauses in the past. The indenture trustee is now a vital and indispensable instrument. Legislation should not, I believe, interfere with this instrument to a point beyond the adequate control of the evils disclosed. In applying remedies great care is imperative, and one must be very careful lest the swing of the pendulum go too far in the opposite direction. And I think that is what, in some respects, appears here in this proposed act.

The proposed act abolishes the exculpatory clause. Further, it places upon the trustee the duty of reasonable care before as well as after default. I believe that regulative control must recognize the fundamental differences between conditions which precede default and those which follow. Courts have recognized this distinction and in a number of instances have declared the duties of the indenture trustee to be passive before default and active only after default occurs. Appropriate certifications from time to time filed before default with the trustee and, if desired, with the Securities Commission, emanating from approved and dependable sources, would establish compliance or noncompliance of the obligor with the requirements of the indenture. They can control the terms of the indenture and, in that way, can enforce compliance with the terms of the indenture.

Frequently complicated indenture conditions, or at least conditions difficult of accurate ascertainment, may exist which the indenture trustee in the ordinary course of events cannot ascertain, or which could be ascertained by it only at great expense and by the assumption of supervision over the business of the company, which would amount almost to a degree of suzerainty. This would constitute an unnecessary, impracticable, and undue interference with business, particularly where, as is often the case, large industrial institutions maintain offices scattered throughout the country. It is normally sufficient to require that the obligor furnish to the trustee properly certified statements establishing compliance. Indenture provisions and regulations could and should be strengthened to accomplish this adequately and satisfactorily. Such certificates are common in the business world, and the trustee should be enabled conclusively to rely upon them. The proposed act so provides. The trustee should be required to use reasonable prudence and care in the study of these certificates. In the narrow field beyond this, and before default, it seems to me the new statute should not impose upon the trustee any measure of duty greater than that heretofore commonly imposed.

Other conditions of default not disclosed by such statements are unlikely to be of moment and in any event, not being obvious, would

require for discovery a degree of participation in the detailed affairs of the obligor coextensive with its business, a duty hardly to be demanded of the trustee, and normally needless. If the trustee be not protected by the usual immunity in this narrow remaining field before default, it is likely, with the best of faith on its part, to be faced by claims and demands that might involve it in tremendous losses and perhaps serious consequences to its depositors.

In that field I believe the trustee should be protected with the same immunity which it now enjoys. I am holding no brief for banks or trust companies, but it must be remembered that when we talk of liabilities of indenture trustees we speak of claims that might reach enormously large sums, with the result depending upon a court's technical decision of the difference between care that is reasonable and care that falls just short of that standard.

What I say, I say without suggestion from any source; because I think it is my duty to speak. I believe that in the effort to remedy conditions, there may be too great an interference entirely unintentional-with the normal, safe channels. My opinion is the result of a long and full study of indenture financing, of court decisions, and of my own experience as a lawyer in the field of financing. By comprehensive regulations the S. E. Č. can require appropriate certificates for all reasonably foreseeable conditions. No more can be asked or expected beyond this, until default, either from the Securities Commission or from the indenture trustee.

Senator SMATHERS. What is your suggestion, right there, on the question of this narrow field and the degree of care?

Mr. POSNER. The degree which has heretofore existed: There must be something in the nature of gross negligence or bad faith or willful default. Because, unless you do that, you have a very narrow field which requires a most extensive entrance of the trustee into the business of an obligor to determine whether or not a default exists. Certificates ought to cover that situation, it seems to me.

Senator SMATHERS. Would you not be in the same situation that we are in today, where the courts may hold technically that the degree of care was gross, and the same loss will occur to the investors?

Mr. POSNER. Well, that is so with regard to all human relationships, and there must be some fixed measure of duty, of course. Because that is necessary for human intercourse, social and business. But that at least is the measure of duty before default under which they have acted for 50 or more years, and that does not constitute a new field.

Once a condition of actual default comes to the knowledge of the trustee, what shall be the measure of its duty? I am in complete accord with the views of Senator Barkley and of the Securities Commission in this regard: That these exculpatory clauses should at once disappear, and that a full measure of good faith and prudence should apply. Whether the default be technical or otherwise, the time has come when the general immunity clause should disappear at this point and reasonable care and prudence become at once the measure of the trustee's duty. In this regard I note the language of subsection (h) of section 7, that in case of default the indenture trustee shall in exercising its powers

use the same degree of care and skill in their exercise as a prudent man would exercise under the circumstances if he were a fiduciary and had the degree of skill which the indenture trustee has, or which the indenture trustee represents itself

as having, as indenture trustee, at the time of the offering of the indenture securities, whichever is the higher.

I am wondering only whether these provisions lend uncertainty to the measure of duties which should be made clear and certain. Indenture trustees are usually institutions of highest skill and experience. New institutions that may come into the field if the presently acting trustees are forced to abandon the field because of the provisions of the act or because regulations adopted by the Commission are too highly restrictive or onerous, will certainly not possess an equal degree of skill. They certainly will not have such a degree of skill, because such skill is the development only of many years of experience. Are we not thus creating differing standards and injecting uncertainty and perhaps confusion as to the measure of the trustee's liability? It seems to me it would be sufficient if the paragraph were to end after the words "under the circumstances", or, at most, after the words "if he were a fiduciary." And I would stop there. It seems to me that that covers it. I am only concerned about making it clear so that there will be no escape from responsibility.

The other division of activities with which the act deals-the subject of conflicts-calls for much more detailed discussion than I can permit myself, for I believe it is here that the pendulum swings too far, that conditions are imposed which are much too rigid and of doubtful value, and that in some instances the security holder is more likely to be hurt than helped. The conflicts with which the act deals are fourfold: Those which provide that the trustee may act under only a single indenture of a given obligor; those aimed at the prevention of common officership; those which deal with stock control of the obligor, the trustee, and the underwriter; and finally, those which concern the creditor position of the trustee. It is with this last that I am most concerned, and I shall say only a word as to the others, important as they are.

As a matter of fact, I believe it will be found that few difficulties have arisen, if indeed any, in spite of the exceedingly comprehensive report of the Securities and Exchange Commission, in situations where the trustee has acted under more than one indenture. I can see no good reason why the same trustee cannot act, for example, in refunding issues or in secured issues, especially where the securities are altogether separate and do not overlap. A common trustee, even in the case of first and second mortgages, does not necessarily create a conflict, if the instruments be capably drawn.

You must see that the difficulties of investors disappear materially with the high fiduciary duty thus placed on the trustee. You can well leave it to the fiduciary to take care of the situation and to protect the investors, when that high fiduciary duty is placed upon it. As to the case of trustees under more than one mortgage of the same obligor, my position is that the burden under the act should be the other way, and the attitude should be reversed.

Senator BARKLEY. Are there not certain conditions where the control would not be automatic?

Mr. POSNER. Undoubtedly. In the flagrant cases there would be no doubt. But the holding of two trust indenture issues by the same company in itself does not create that conflict, but the Securities and Exchange Commission bill takes the position that the rule is to be that there will not be more than one trusteeship by the same trustee

of the same obligor, unless the trustee establishes there is no conflict. There are types, here, where no conflict necessarily arises. But of course no grown-up person-21 years of age or older-let alone a trustee under high fiduciary responsibility, would accept more than one of the trusts if the conflict exists at the outset.

Senator SMATHERS. In other words, you think the Commission ought not to require the trustee to prove that the interest is dual or incompatible?

Mr. POSNER. But the Securities and Exchange Commission, with all the facts before it, can so declare, and the burden of proof should be that way. After all, the trustee institutions and the trust companies, of themselves, are not anathema. They hold an important place in the financial structure of the country. They know what their duties require, and I do not think they need any guardianship. Senator SMATHERS. Unless the investigation shows dual conditions do exist, it ought to be permitted as a matter of course?

Mr. POSNER. Yes; it ought to be permitted as a matter of course. Senator SMATHERS. Without requiring the trustee to produce proof that it does not exist?

Mr. POSNER. Yes; and without having to argue the point that the situation does not create a conflict.

In other words, it is upon the honor and the high fiduciary responsibility of the trustee to determine whether it will accept it. And this is no unimportant phase of the matter, either; because, with the enormous number of security issues in the offing and I hope that number will be extremely large, with the return and rise of business-there are not so many trustees of the highest responsibility which will be found. And the moment you appoint one, he is inoculated and is out, so to speak. So I think it is a mistake, and would retard the financial progress of the country.

The common practice is for the trustee who acts under more than one indenture of an obligor to resign from all but one whenever a default occurs under any. The indenture could make the practice obligatory. It is true that the act grants discretion to the Commission to permit a trustee to act under more than one issue of an obligor if the trustee satisfies the Commission that to do so is not likely to involve a material conflict of interest. But that does not cure the objection, for it is apparent that such permission is to be treated as the exception. In my judgment, the proper policy requires the direct reverse of this.

A trustee who is or permits himself to be in a position of conflict is subject to removal and must resign within 90 days. What constitutes a conflict of interest is rarely susceptible of clear definition in the ordinary affairs of life and is certainly less readily determinable by nice mathematical calculation. Looked at realistically, there is. little difference between the position of a trustee which appoints 2 of its 9 directors to the board of the obligor and becomes thereby immediately disqualified on the ground of conflict of interest, and one which, by increasing its board of directors to 10 from 9, is no longer in a position of conflict. What creates or cancels such a conflict if the second director, by owning eleven-tenths of 1 percent of the voting trust and other securities of the obligor, other than its indenture securities, disqualifies the trustee and forces its removal, whereas by owning only ten-tenths of 1 percent, removes the trustee's