We appreciate the work that the Securities and Exchange Commission has done in this investigation. We think it has been helpful. We think it has even pointed out to trustees some pitfalls that they ought to avoid. But it is evident from the report of the Commission that its study is not based upon a full consideration of the problem of financing industry; it is only a study of a relatively few cases, in which bondholders lost money partly through the failure of trustees to do their duty or to perform their duties properly.

Nevertheless, we believe that the Commission has shown a need for greater supervision over the trusteeships. We feel, however, that all parties will agree that in any remedial legislation consideration of the good to be accomplished must bear some relation to the harm that may be done. It is from that standpoint that we approach this proposition.

We have given this thing very careful study. We started with a predilection in favor of the idea of the Commission before we had seen their bill. We have given a lot of thought to it. After careful consideration, we are convinced that the whole theory of the bill is

wrong.

Trust companies and banks exercising trust powers are not fly-by-night concerns; however, some of them may abuse their powers or fail to perform their duties as trustees. They are creations of the state, and they exist at the will of the state. If there are some trust companies which by reason of incompetency or lack of integrity do not perform their duties properly, it would seem to us that the proper remedy is to take away their right to act as trustees.

This brings us to our objections to this particular bill. I am not going to discuss it in detail, as I would if I were proposing amendments to it; I am going to discuss it from the standpoint of the theory of this manner of accomplishing what the Commission feels should be accomplished.

Section 7 of the bill sets up certain standards by which to determine whether a trust company is disqualified to act as trustee. Some of these standards are harmless; some are very serious. There is no attempt to eliminate the incompetent or dishonest trustee but only to eliminate certain artificial situations, which at some time, and under certain conditions, may tend to dissuade the trustee from performing its functions properly. A trustee could be free from all the disqualifications that are mentioned in the bill and still be a very unsatisfactory trustee; and, on the other hand, it could have practically all the disqualifications mentioned in the bill and still be a very excellent trustee. The real qualifications of a trustee are integrity, experience, good business judgment, and a high sense of moral responsibility. If a trust company has these qualifications, it will see that it does not have relationships that are actually conflicting; or if by change of situation or conditions inconsistent releationships should develop, it will take prompt steps to prevent them, whenever that situation arises. The real test of whether a trustee measures up to its responsibilities is how it performs its job, and that cannot be determined by any set of arbitrary standards or by rule of thumb.

Section 7 (b) of the bill provides an indenture trustee shall be deemed to have a conflicting interest if

(6) such trustee shall be or become a creditor, directly or indirectly, secured or unsecured, of an obligor, except as authorized pursuant to subsection (d) of this section, if the indenture to be qualified is not secured by the pledge or mort

gage of property or if any indenture securities outstanding had a maturity at the time of issuance of less than five years;

As was pointed out this morning, there is nothing inherently inconsistent in a bank's loaning money to a corporation when it is acting as trustee under one of its indentures. For example, a company in good financial condition, well managed, with good earnings, has an issue of debentures outstanding. It comes into the bank with whom it has customarily done business and which is trustee under that indenture, and says, "We should like to borrow $100,000 for our seasonal purposes, for our normal operations."

There is no reason in the world why the bank should not lend money to that company simply because it is trustee under its indenture. Naturally, the bank is not going to lend money if it does not expect that it is going to be repaid. It is not going to lend money if it thinks the company is going to default under its debenture issue. Nobody wants to lend money and later be dragged into a creditors' action or a bankruptcy court. Banks lend money only when they have reasonable expectation that those to whom they lend are going to continue to do business and not get into financial difficulties.

Senator TOWNSEND. Under the provisions of this bill could the bank lend to the company?

Mr. CANRIGHT. Only as permitted by the provision I have just read. That provides that if you are trustee under a secured indenture-that is, where there is a pledge of property or a mortgage of property-then the bank can lend to the obligor on the indenture. securities, if the securities issued under that indenture have a maturity in excess of 5 years; otherwise, it cannot.

There is another exception, but it does not bear upon the point I have in mind.

There may come a time, if the borrower gets into financial difficulties and the bank is still a creditor of the corporation, when there may arise a conflicting interest. If that situation should arise, that is the time when the bank could either sell its note that it had taken from the corporation, or resign as trustee and eliminate that conflict.

Frankly, we are and have been for years trustee under indentures of a great many corporations. Those corporations are customers of the bank. I have no doubt that we lend money to them from time to time, but it has never affected our operations. In the corporate trust division we have never known whether they borrowed money from us or not. Certainly, not knowing whether they borrowed money, our judgment could not have been affected as to what we should do as trustees, and it has not.

We have had two or three cases—not more than three-in which the companies did get into financial difficulties, and the bank was a creditor. There we resigned as trustee, because we felt that there might be some conflict when we came to the enforcement of the obligations. We resigned as trustee, and another trustee was appointed in our place.

It

Furthermore, a bank likes to be trustee for its own customers. would rather lend money to a man whom it knew paid his bills and who it knew had a proper regard for his obligations. No bank wants to take over a trusteeship if it feels that it is not going to succeed. A bank does not like to have bondholders lose money by it. Its good name is at stake. But when you have a customer who has been

doing business with you for many years who wants you to act as trustee, and you know he has always paid his debts promptly, you know how he manages his business, and you know what his whole history has been, you accept his trusteeship with a great deal more confidence than you do the trusteeship of some stranger who comes to you, because you cannot know the facts with respect to a stranger in the same way you can of a man or a company with whom you have been dealing over a period of years.

A corporation also has an interest in who is going to be its trustee. It is the most natural thing in the world that it should want the bank with whom it has been doing business for years to be trustee, and that is a perfectly legitimate relationship. It is going to deposit money with the bank for the payment of interest. It is going to deposit money with the bank for the payment of installments of principal or for the redemption of its bonds or debentures. It wants to know that when those bonds or coupons or debentures, or whatever else they may be, are presented for payment, they are going to be paid. The money has got to be there to pay them. A corporation has an interest in keeping its credit good, whether it is credit at the bank or long-time credit. It is money in its pocket.

The way in which a trustee manages its corporate trust matters has a great deal to do with whether or not its customers are satisfied. This bill disturbs all of those normal relations. It casts great burdens on banks and trust companies. It entirely upsets the whole credit structure.

A bank may have had customers for years, and it has got to decide whether it is going to continue in the future to do a commercial banking business with them or whether it is going to act as trustee for them, and all unnecessarily.

If those interests were really conflicting, that would be a different proposition; but in the great majority of cases they never become conflicting. Most of our corporate trust indentures do not go into default; and some of them, where we have lent money to them, were not creditors at the time they did go into default, or have not been for years. Those things are not fixed situations.

Paragraphs (7) to (10) of the same subsection (b) of section 7 of the bill sets out with great particularity the disqualifications of the trustee because of the ownership by the trustee of a specified percentage of stock or other securities of the obligor.

I have discussed the matter of credit relationship. I shall confine this to the matter of stock. The percentages are purely arbitrary, as was pointed out by Mr. Posner here this morning, and of necessity they must be. But they are not only arbitrary; they are more or less artificial. They bear very little relation to the object they are attempting to accomplish.

Take this as an illustration: Section 7 (b) provides that an indenture trustee shall be deemed to have a conflicting interest if such trustee is the beneficial owner of 5 percent or more of the voting securities or 10 percent or more of any other class of security of an obligor. I shall not refer to the whole section; it is only that part that bears upon what I have to say.

You will note that it says "5 percent of the voting securities" and 10 percent of others. Why that distinction?

If approximately 50 percent of the other stockholders of the corporation felt it was to the interest of the stockholders to pay the obligations and perform their duties and covenants under their debenture issue, is it conceivable that the trust company is going to be so much more interested in fleecing its own security holders than other people who have no interest in them whatever? If the majority of the other stockholders wanted to pay it, is it at all probable that the trustee is going in to say, "No, don't pay them, even though we are trustee under that obligation?" If a majority of the stockholders do not want to pay, it does not make any difference whether the bank has 5 percent or not.

Consider this also: After all, if a shyster lawyer is going to deliberately lose a case and risk his reputation for winning cases, or if a jockey is going to lose a horse race, it is not the percentage of something that he is interested in; it is what amount be is going to get out of it. So it is with the trustee. It is not a question of whether it owns 5 percent of the stock, but what that 5 percent represents to it as an investment, if it can protect it, and what it is going to get out of the stock.

Conceivably, an unscrupulous trustee might have $100,000 or $500,000 and fail to do its duty by its debenture holders or bondholders, when the same trustee would not do it if its interest were only $500. It might violate its duty if that $500,000 were only 1 percent of the stock, if it were that kind of trustee. If $500 represented 10 percent of the stock, it still would not have any interest in violating it. It could not afford to risk its reputation.

Why did they not put some standard of that kind in there? I will tell you why they did not. It could not be put in because what affected one bank would not affect another. What would affect a bank with a capital and surplus of, say, $75,000,000 would not affect the bank that is a little bank. In other words, they could not put in standards that were real standards, so that they had to put in the best they could and make an artificial standard, and they put it in on percentages which could be applied to all trustees.

Coming a little further to this matter of stock, the stockholders' relation normally is not adverse to that of the bondholders. You have held bonds and stock in the same corporation, and you have never thought you were at war with yourself. The interests of the stockholders and bondholders, at least until the time the company gets into financial difficulties, are practically one. They are interested in good management and in good profits. What is good for one is good for the other one. It is only when the company gets into financial difficulties that you have a real conflict of interest.

Then, consider this, too: Banks do not invest their own assets in stock of a corporation, as a general thing. They get this stock in order to realize on some note or through some obligation. They accept it in payment of some obligation that cannot be paid otherwise, intending to dispose of it as soon as the market permits and whenever they can dispose of it without too great a sacrifice. In other words, this thing is in a state of flux. We might own 10 percent of the stock of a corporation today and not own any tomorrow. We might be qualified as a trustee today and tomorrow be disqualified, depending upon a thing that has no relationship to our ability or desire to carry out our duties as trustee.

Someone may say, "You admit that this may be conflicting at some time. Therefore, is it not better to eliminate the possibility of such a situation ever arising?"

My answer to that would be this: That if the only thing we were interested in were to prevent trustees-I mean that if all that society were interested in were to prevent trustees from ever getting into a conflicting situation, the prohibitions of the bill might have some justification, even though under those circumstances it would be unjust to the trustees and borrowers.

But that is not the only interest of society. The interests of society are many. As I said before, this affects society all along the line. It affects the whole credit structure. It affects the whole business relationship. It affects, indirectly, matters of employment, because if cannot make proper provision for the borrowing of money, you cannot employ people.

you

No one can conceive of all the ways in which this thing will operate, except that we know that every day we will be confronted by some question arising under this bill which will impede us in our normal course of doing business, by reason of the restrictions that are placed upon us and which, as I say, is unnecessary.

Take this little instance, just to show how this affects us: For example, a man comes into a trust company and says, "I have always been a customer of your bank. I like the way you do business. I want you to be executor and trustee under my will which I am having drawn up."

We say, "Our relations have always been very pleasant, and we will be very glad to act as executor and trustee under your will."

The years roll by, and the man dies. We get the inventory of his estate. We look it over. We check the securities of all the companies for which we are trustee under corporate trust indentures. Then we add those shares in each company to the shares we already hold as guardian, executor, administrator, trustee, conservator, and all the other representative capacities. When we have gone over all these things, we find that unfortunately we have got a half percent more of the stock of one corporation than we are authorized to have under this bill.

Then we are confronted with the case of saying to the heirs, "We are sorry we did not know and the testator did not know at the time he drew the will and appointed us as executor what shares he would own at the time of his death, but under the Trust Indenture Act of 1937 we cannot act as executor and trustee under the will."

It just unfortunately happens that his stock added to what we then have is more than we can have. The bill makes one provision for that. It says that we can be trustee under this identure issue, notwithstanding the ownership of this stock, provided we sell it in 18 months. The trouble with that is that we cannot be sure we are going to sell it in 18 months. After all, we cannot sell the stock of a deceased's estate in order to do away with the conflict. If it is not the proper time to sell the stock, we must continue to hold it, and we do not know what the situation will be in 18 months. Therefore, the only thing we could properly do would be to refuse to act as executor or to resign under the trust indenture, neither of which would be desirable.

I now come to another feature of the bill that is entirely different, and that is the control of the Securities and Exchange Commission