thereto from the viewpoint of the minority.101 However, it should be remembered that the majority, after all, have a strong interest to produce the best results for the bonds; and instances wherein such committees do not use their honest efforts to produce such results are rare. Minority bondholders are excluded from the benefit of a plan only after long delay, and not even then in proceedings under Section 77 or Section 77B which, when consummated through reorganization by force of the statutes themselves, enure to the benefit of, and bind, all bondholders. Therefore, it is entirely proper that a trustee in most cases should be guided by the views of the majority.

Existing conditions, and the criticisms thereof in the Report, have been discussed at length because the recommendations contained therein cannot be intelligently considered without an understanding of the present situation. Suppose, therefore, that the Report had described correctly this situation and that it did not contain statements, implications or suggestions that corporate trustees fail in the performance of existing obligations (whether or not legally enforceable duties) to supervise the performance by issuers generally of their obligations, to protect investors against the terms of the indentures under which their securities are issued, to notify investors as to the possibility of change of their collateral, to precipitate principal or institute foreclosure proceedings or take other action ruinous to the credit of issuers without having the views of their bondholders and without financial protection; that it is the usual practice of these trustees to accept financial statements without scrutiny, to ignore defaults unless formally notified thereof, and to employ counsel representing conflicting interests; that maladministration is common; and that the trustees are mere stakeholders doing little to earn even their present moderate compensation. We are then in a position properly to consider the recommendations.

3. RECOMMENDATIONS TO CONGRESS AS TO CHANGES IN CORPORATE TRUSTEE DUTIES

The Report contains recommendations as follows:102

"1. That trustees should be charged with active duties and commensurate responsibilities.

"2. That the trustee be responsible for failure to record, file, or refile the mortgage in the proper recording office and for failure to use reasonable care and diligence in certifying the securities.

"3. That the trustee be responsible for the exercise of such reasonable care as the circumstances permit in checking the application of proceeds of security issues to their avowed purposes.

"4. That the trustee be responsible for the use of reasonable care and diligence in enforcing compliance with negative pledge clauses and provisions for substitution and release of security and in taking appropriate steps to protect the security holders in case the issuer violates or threatens to violate them.

"5. That the trustee be responsible for use of reasonable care and diligence in ascertaining the occurrence of defaults under the indenture and in giving notice thereof to the security holders where such notice is necessary for their protection. "6. That, when default occurs, the trustee be responsible for failure to take such action, in protection or enforcement of the security; in collection of principal or interest; or in representation of their beneficiaries in legal proceedings, as is reasonable necessary for protection of the investors.

"7. That all exculpatory clauses in indentures incompatible with the foregoing standards of conduct be outlawed.

"As stated, the foregoing recommendations are merely exemplary of the specific reform measures which we think are essential. They do not include all provisions of trust indentures which should be refashioned in light of the 'legislative determination' of the requirements of the public interest. But they indicate the quality and degree of a thoroughgoing reform of the present system."

As to the result which would follow from the adoption of the recommendations, the Report concludes:103

66

... The result would be that investors would have an active guardian of their interests throughout the entire life of the security. There would be carried over into the corporate field the standards of fiduciary relationships which have long obtained in personal trusts and with which these professional trustees have had a long and rich experience."

The Report further states 104 that "Certain exemptions from such regulation doubtless can be provided where the character or amount of such security issues are not of true national concern."

In making these recommendations, the Report recognizes that corporate trustees are not presently paid for the performance of the duties suggested and that the increase in their duties and responsibilities would "probably" require an increase in their compensation, but states that an informed judgment as to the extent of the increase should be based upon further investigation and study.105

The main and comprehensive recommendation, which is hereafter termed the Main Recommendation, is that corporate trustees be transformed into fully active trustecs like personal trustees. This recommendation in the author's opinion is unnecessary, impracticable, and contrary to the public interest. The reasons for this opinion follow:

(a) While revolutionary changes are not unwise merely because they are revolutionary, the present system, and the rights, duties and responsibilities arising therefrom, are well understood in the financial world and represent the product of extensive study by, among others, issuers, underwriters and large investors. The Commission cannot intend to imply that all of these persons, by reason of some self-interest, have permitted the long continuance of the present system regardless of its effect upon investors. Even upon the assumption that issuers, as the Commission seems to feel, 106 are generally disposed to give as little security as possible for their issues, the interests of underwriters and of large investors are directly to the contrary. After all, the securities must be marketed. The underwriters desire to sell them. The largest investors are insurance companies, savings banks, and other institutions. 107 It is scarcely to be assumed that, if dissatisfied with present conditions, underwriters and large investors would have failed to express their dissatisfaction most vigorously and effectively because, if losses suffered had resulted substantially from lack of the additional protection now suggested for investors, the sellers (whose business depends upon the quality of issues sold) and the purchasers would be the greatest sufferers. No system is perfect; but it seems plain, in view of the vital importance of stability to the financing of the business of the country,108 that the present system should not be scrapped, and a new and untried one substituted, in the absence of most sound and powerful reasons.

(b) The Report completely fails to set forth such reasons. The general criticisms of the present system are, as has been stated above, too largely incorrect or, where correct, are too largely based upon exceptional cases.

Disregarding cases of individual and controlled trustees "real estate" indentures which cases, for the reasons above stated, have no proper place in the Report, it fails to demonstrate the necessity for the recommended change because it fails to show any such extensive investor losses from the present limitations of the trustee duties as distinguished from losses arising out of poor management or adverse business conditions, or due to ineffective negative pledge clauses, over liberal rights to substitute collateral, and other weak indenture provisions which can be eliminated or improved without radical changes.

Even though it properly may be said that investors need additional protection, it is certainly possible, and far wiser, to give it to them without jeopardizing the entire system of corporate trusteeships. The recommendation that investors, instead of having a reasonable degree of further protection, should have a general guardian of their interests, and that corporate trustees should be compelled to accept the guardianship, is impracticable and contrary to the public interest because, even if the compensation of such trustees could be so increased as to be commensurate with the increased duties, it would be difficult, if not impossible, to find responsible corporate trustees which would feel justified in agreeing to act as general guardians of investors.

The new standards, so far as presently proposed, are extremely indefinite and could never be made definite. While the principal general proposed standard is that which now governs personal trustees (the exercise of the same degree of care and diligence which prudent men employ in their own affairs) the duties and

105 Id. at 69, 70.

106 Id. at 10.

107 Sunderland, op. cit., supra, note 43, at 22, estimates that insurance companies and savings banks represent over sixty millions, or over 50%, of the population of this country, holding either insurance policies or savings bank deposits; and that the insurance companies alone have invested in railroad securities something over four billions of dollars, and the savings banks, approximately two billions; other banks, educational institutions and foundations, approximately one billion, making a total of seven billicns out of a total bonded indebtedness of the railroads of approximately twelve billions. Willis and Bogen, op. cit. supra note 57, say it has been estimated that "well over one-third of all outstanding railroad bonds are held directly by financial institutions."

109 Moody's Manual of Investments (1936) 9, estimates that the total debt outstanding under indentures of Railroads, Utilities and Industrials at the end of 1935 was $33,390,000,000 (Railroads $11,445,000,000, Utili ties $12,023,000,000, Industrials $9,922,000,000). These figures do not include "financial and real estate" corporate bonds.

responsibilities of a corporate trustee could never be known except in a most general way until after a new body of law had been built up. This is particularly true since the trustee would not have control of the trust estate.

It does not appear from the Report that investigation has been made as to whether responsible institutions could act as corporate trustees if the recommendation should be adopted. It seems certain that they could not, except possibly in the event of greatly increased compensation or other financial protection. Responsible banking institutions would not be justified in thus risking their funds which it is their paramount duty to safeguard. Many corporations could not afford to pay such compensation or furnish such financial protection, so that the wealthier corporations might obtain desirable trustees which other corporations now, but could not in the future, obtain; and even if the compensation or financial protection of the trustees were greatly increased, there is strong reason to believe that responsible banking institutions would not feel justified in acting as corporate trustees. It would be impossible to calculate the extent of the risks taken or to have any reasoned assurance that the increased compensation or financial protection would be adequate. The amounts involved in the performance of corporate trust duties are often very great.

The Commission considers that it would be "in the public interest" for corporate trustees to be required to undertake the new duties, but it also feels that it is essential to investors that the corporate trustees be institutions having resources commensurate with the responsibilities.109 If the belief that institutions having such resources could not accept the proposed duties be correct, the result of the adoption of the legislation imposing such responsibilities would be that investors could not have the essential financial protection.110 Instances have already occurred, since the passage of the Streit Law, of declinations by responsible trustees of trusts under "real estate" mortgages, as to which the responsibilities required to be incurred are much smaller than those which would be undertaken if, for example, a trustee were to act as proposed under the mortgage of a railroad or other large business enterprise.

The Report does not attempt to demonstrate that the Main Recommendation is practicable from the viewpoint of expense. In fact, the Report does not concern itself with expense, although the cost of corporate trustee administration might be so greatly increased as to make the remedy far worse than any evil which has been shown to exist. The expenses which would result from the carrying out of the Main Recommendation would be tremendous. Reference has been made above to the necessarily large increase in trustees' compensation or other financial protection. Furthermore, if trustees could accept under any circumstances the responsibilities suggested, they manifestly could not accept such responsibilities unless they were authorized, at the expense of the issuers or of the trust estates, to employ legal, engineering, and accounting experts and were permitted to rely upon such experts in discharging the responsibilities. Among the subjects as to which expert advice might be required are the properties securing the issue, the titles to said properties, the prior liens thereon, the recording requirements of the localities in which the properties are situated, the financial condition of the issuer, the truth of its statements furnished as the basis for certification of bonds, substitution of collateral or release of property, the application by the issuer of the proceeds of the issue, the performance by the issuer of its various covenants, the seriousness of defaults and the advisability of publicizing or enforcing them, and the proper treatment of the securities in reorganization depending upon their merits, under the conditions then existing, as compared with other securities of the issuer. To illustrate, suppose that a trustee were required to investigate the truth of the various financial statements furnished by a large corporation which, in the usual course of business, would spend very substantial amounts in keeping its, voluminous records and in having them regularly audited by independent accountants.111 Unless it is to be assumed that corporate bookkeeping and finan

109 The Report states, at 111: "The protection of investors will require not only that conflicts of interest of trustees be eliminated but also that some safeguards against impecunious and irresponsible trustees be established. This is essential lest the safety of funds be jeopardized and the administration of these vast trusteeships fall into irresponsible hands. Toward that end provisions should be made that the trustee should be a bank or trust company, organized under state or federal laws, with resources commensurate with the responsibilities of the proposed trusteeship."

110 See Marshall & Ilsley Bank case, 213 Wis. 415, 250 N. W. 862, 864 (1933): "The courts have an obligation to keep pace with the business world, and the imposition of duties and obilgations upon a trustee that are more severe than called for will lead to difficulty in securing trustees who will accept the responsibility, and may even destroy the utility of the trust deed as an investment device."

111 Reports casually selected from among those made under the Securities Exchange Act of 1934 show the following payments to accounting firms:

Remington Rand, Inc., to Price Waterhouse & Co., Inc., $80,736.38 for the fiscal year ending March 31, 1936;

General Motors Corporation to Haskins & Sells $203,961.30 for the year ending December 31, 1935; Pacific Gas & Electric Company to Haskins & Sells $53,495.12 for the year ending December 31, 1935.

cial statements are generally erroneous or dishonest, it seems highly probable that most of the holders of an issue would feel that the moneys of their issuer were being wasted if the corporate trustee also were to employ its accountants to go over the books and records. In this respect, as in other similar respects, the Report, in its desire to protect small investors, does not consider whether recommendations of greatly increased expenses would be favored by large investors whose views are also of importance.

The Main Recommendation is based to a substantial extent upon an erroneous assumption that, because some investors mistakenly believe that the corporate trustee has the same active duties as a personal trustee, the proper remedy is to change the entire prevailing system and to require corporate trustees to assume such duties rather than to try to remove the misunderstanding. While it is doubtless true that some investors do not understand the duties of corporate trustees, the Report contains no evidence that purchasers ordinarily buy securities in reliance upon the performance by corporate trustees of personal trustee duties. Even so, small investors should be protected against the possibility of loss through deception. But is there any sound reason why the method of removing the misunderstanding should be to throw the corporate trustee system into chaos? If investors now misunderstand the duties of corporate trustees and believe them to be fully "active" trustees, the Commission under the existing Securities Act could require registration statements and prospectuses to contain such statements as the Commission should consider adequate to remove the misunderstanding. This would throw the burden of informing investors as to the limited nature of corporate trustee duties upon the persons who should have the burden, that is, the persons who profit from the sale of the securities. If necessary, the Securities Act could be appropriately amended. If, which seems unlikely, the misunderstanding cannot be adequately cleared away by the use of the Securities Act, then the term "trustee" can be modified. It certainly is not wise to scrap the long established system of corporate trusts in order to remove the misunderstanding.

While the Main Recommendation appears to be entirely unnecessary, impracticable, and contrary to the public interest, it may nevertheless be true that there are particular respects in which the existing system of corporate trusts should be improved. As to the specific recommendations the Report states, as above quoted, that such recommendations are "merely exemplary"; and it appears from the letter transmitting the Report to Congress that the Commission proposes to make further recommendations "for appropriate legislation."112 However, it is appropriate to consider the specific recommendations so far as they are presently indicated.

At the outset, and before considering separately each of the specific recommendations, it may be said with reference to them generally that, while the Report apparently contemplates employment of experts by trustees, it does not appear to permit to trustees the express right to rely upon experts selected with reasonable care. Unless trustees were thus permitted, it seems apparent that they could not undertake the responsibilities proposed because, if they were to do so, the funds of their depositors and stockholders might be subject to heavy losses if the experts should make mistakes. If the trustees should be allowed to rely upon such experts, they would be undertaking principally the duty to select experts with reasonable care. Trustees, of course, could make such selection; but we should then have the situation that, in addition to extensive investigation by the experts of the borrowing corporations and of the underwriting houses,113 the trustee would have its experts in the field. After this duplication by the trustee and the building up of large additional costs the situation still would be that the trustee relied upon experts, the only difference being that the trustee had selected another set of experts.

Recommendation (2) above quoted, proposes that the trustee be made responsible for failure to record, file or refile the mortgage (recording, filing and refiling being hereinafter included in the term "recording"). While in some instances, for example, in the case of a mortgage upon a hotel, recording by the trustee would not involve substantial labor or expense, the Report is attempting to prescribe rules of general application. The situation changes completely when the recommendation is applied to mortgages of large railroads, public utility companies, or indus

112 See supra note 2.

113 See Willis and Bogen, op. cit. supra note 57, c. 8. The examination made by investment bankers before bringing out a security issue involves the use of its buying department, its statistical department, the employment of engineering experts, of legal experts, and of accountants. It has been estimated that the examination thus made in the case of an issue covering large properties is likely to take from three to six months. If these functions were to be performed by corporate trustees also, it is apparent that much delay would necessarily result and expenses would be heavily increased.

trial companies. In such cases, the trustee would be required to make an extensive study of the properties covered and of the recording requirements in many jurisdictions. This would involve substantial expense and much delay unless it were proposed that the trustees' experts should go into the field with the other experts and incur and be paid expenses involved in the proposed bringing out of issues which might never be brought out. If the trustee were not to make its investigations until after the underwriting houses had finished with their investigations, the element of delay would be an important one. Large companies have capable employees who are thoroughly familiar with the mortgaged property, and competent counsel in the local jurisdictions involved. As has been seen above, the underwriting houses also study the properties and the essentials of the security. They necessarily are required to check the recording and the instances wherein investors in fact have suffered losses from failure to record have not been shown to be more than infinitesimal. With regard to this recommendation, therefore, it seems probable that the complaints against the increased expense and delay of corporate trustee administration would greatly exceed in quantity and in merit any complaints against the existing practice.

Recommendation (2) also proposes that the trustee be responsible for failure to use reasonable care and diligence in certifying the securities. They are already under the legal duty not to exceed their powers; and their powers depend upon the showing to them of the existence of the conditions, provided for by the indenture, permitting the certification. However, the intent of this recommendation is that trustees be required to investigate the truth of the documents supplied to them as the basis for certification. In the body of the Report it is stated: 114

"The conclusion is irresistible that in certifying the bonds, notes or debentures the trustees should be under an obligation to use reasonable care and diligence in ascertaining the truth of the representations of the issuer as to the existence of the conditions on which certification properly can be made. This will in the normal case mean appointment of independent engineers, appraisers or accountants by the trustee to examine the properties or accounts of the issuer." This recommendation is subject to the same comment: That the expense and delay of such procedure would be completely out of proportion to any losses which have resulted under the present system.

Recommendation (3) proposes that the trustees be responsible for the exercise of reasonable care in checking the application of the proceeds of the securities. In this respect, the Report fails to demonstrate,115 that the additional expense and delay would be justified by losses to investors under present practice.

Recommendation (4) suggests that the trustee be responsible for reasonable care in enforcing compliance with negative pledge clauses. How could it do so? It is recognized in the body of the Report 116 that this "problem is primarily one of control over the issuer rather than the trustee"; and that perhaps "negative pledge clauses in securities should be outlawed" as deceptive and as affording no real protection to investors. The Report also states 117 that issuers should not be permitted "to whisk away from the reach of investors assets to which they have properly looked for protection of their investment" and that "it is properly the function of corporate trustees to prevent this, as far as possible." Just how corporate trustees could prevent issuers from whisking away their assets does not appear. The Report suggests 118 that trustees "can make measurable progress in eliminating negative pledge clauses which are misleading and deceptive"; and that "trustees should require that they be drafted so as to prevent easy circumvention." In the case of negative pledge clauses, as in other cases to which the Report refers, the main fault in the present situation is in the contents of the indentures. It is reasonable to believe that the corporate trustees would welcome an invitation to consider with the Commission the insertion in indentures of language which would improve them, and that standard provisions might be adopted upon which the principal trustees would insist as a condition of accepting the trusts. However, it is quite a different thing to suggest that trustees should undertake the duty to enforce compliance with negative pledge clauses. The Report also states 119 that trustees "should require information of actions pertinent to performance of the issuer's obligations under the clause; and they should take action promptly to remedy any violation." The suggestion, recently repeated,120 that trustees should take action to enjoin or remedy violations may be

114 Report, at 29.

115 Id. at 30.

116 Id. at 15.

117 Id. at 15.

118 Id. at 15-16.

119 Id. at 16.

120 See Comment, Protection for Debenture Holders (1936) 46 Yale L. J. 97.