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board, agency, or officer of the United States or of any State or political subdivision of any State, over any person or security, insofar as such jurisdiction does not conflict with any provision of this Act or any rule, regulation, or order thereunder.

CONTRARY STIPULATIONS VOID

SEC. 16. Any condition, stipulation, or provision binding any person to waive compliance with any provision of this Act or with any rule, regulation, or order thereunder shall be void.

SEPARABILITY OF PROVISIONS

SEC. 17. If any provision of this Act or the application of such provision to any person or circumstance shall be held invalid, the remainder of the Act and the application of such provision to persons or circumstances other than those as to which it is held invalid shall not be affected thereby.

STATEMENT OF WILLIAM O. DOUGLAS, CHAIRMAN, SECURITIES AND EXCHANGE COMMISSION, AND EDMUND BURKE, JR., ATTORNEY

Mr. EICHER. Commissioner Douglas is here. If you are ready to start, Mr. Commissioner, we will let you open the hearings. I may say for the record that Mr. Reece of Tennessee, a member of the subcommittee, indicated Friday that he would not be able to be with us this morning, but asked us to proceed with the hearings notwithstanding his absence.

You may proceed, Mr. Douglas.

HISTORY OF THE BILL

Commissioner DOUGLAS. Mr. Chairman and members of the committee: This bill is the outgrowth of studies that the Securities and Exchange Commission and others have made in the field of corporate trusteeships.

The Commission made a study and investigation pursuant to section 211 of the Securities Exchange Act of 1934, and the enumeration of the defects contained in section 1 of the bill is based upon the records of the public hearings conducted by the Commission in that investigation and upon an examination by the Commission of more than 400 trust indentures of issuers of all types, most of them made after 1920.

The Commission submitted to the Congress a report on Trustees Under Indentures in June of 1936. Following that time, the Commission assisted in the preparation of legislation to recommend to the Congress, and the bill which was worked out was, as you know, introduced by Senator Barkley in the Senate.

In the preparation of that measure for Senator Barkley, the Commission had the assistance and cooperation of various groups. I am very glad to be able to report that this measure was, from its incepiton, worked out in close cooperation with those who would be most affected by it.

I think the history of that might be of interest to the committee. In January, I believe it was, 1937, Tom K. Smith, then president of the American Bankers' Association, came into my office and said that he had heard that some legislation was being worked upon and asked whether it would be possible to collaborate in that endeavor. I assured him, on behalf of the Commission, that the Commission would

welcome such collaboration, and a very close cooperative set-up was the result.

Some members of the committee which Tom K. Smith appointed are here, I believe, this morning. There is one who is not here, Mr. Blaine B. Coles, vice president, First National Bank of Portland, Oreg. Mr. Coles, under date of April 16, 1938, gave me a letter on this matter which I would like to offer for the record, Mr. Chairman.

Mr. EICHER. Without objection, it may be put in the record.

Mr. DOUGLAS. I will not read the entire letter. There are one or two sentences which I would like merely to mention in passing. Mr. Coles says:

I should like to say to you that while I do not now speak as an official of the American Bankers' Association, yet I know that for the most part the bill has the approval of the great majority of trust institutions in the country, especially those located in cities west of the Mississippi River. Most trust men who have given serious consideration to the bill are in accord with the aims and objectives of the bill. Most of us also feel that the bill as now drafted is entirely workable and that regulations can easily be prepared that will provide for a simple, speedy, and direct administration.

(The letter above referred to is as follows:)

Hon. WILLIAM O. DOUGLAS,

PORTLAND, OREG., April 16, 1938.

Chairman, Securities and Exchange Commission,

Washington, D. C.

MY DEAR MR. CHAIRMAN: As you know, while I was president of the trust division of the American Bankers' Association during the last year, I have spent a good deal of time and have given much thought to Senate bill No. 2344 which, if passed, will be known as the Trust Indenture Act of 1938, and which is now before a committee of the House of Representatives for consideration. I have not seen the draft of the House bill but assume that it is in the same form as the Senate bill now stands.

I should like to say to you that while I do not now speak as an official of the American Bankers' Association, yet I know that for the most part the bill has the approval of the great majority of trust institutions in the country, especially those located in cities west of the Mississippi River. Most trust men who have given serious consideration to the bill are in accord with the aims and objectives of the bill. Most of us also feel that the bill as now drafted is entirely workable and that regulations can easily be prepared that will provide for a simple, speedy, and direct administration.

If it should prove in practice that amendments are necessary, you may count upon my assistance in helping to work out such changes as experience indicates will be desirable. Speaking personally and at the same time reflecting what I believe is the attitude of trust men in the West and Middle West, may I say that I hope the bill will pass in nearly as possible its present form. With every good wish, I am, Sincerely and respectfully,

BLAINE B. COLES,

Vice President, First National Bank of Portland, Oreg. Commissioner DOUGLAS. I think, Mr. Chairman, that the excellency of the measure is due in no small part to the close cooperation and collaboration which has been received from those who are vitally interested in this problem.

In addition to the committee of the American Bankers' Association, the Securities and Exchange Commission consulted throughout the spring of 1937, on numerous occasions, with informal committees representing various life-insurance companies and mutual savings banks.

The bill, as it was originally introduced in the Senate, had, I believe, certain features which the committee of the American Bankers' Association found objectionable. I believe that those provisions which

were at the early stages of this measure found objectionable by them have been eliminated. Every draft of the bill was scrutinized, not only by the special committee on mortgage trusteeships of the American Bankers' Association, but also by an informal committee of the executives of 17 New York City banks. I understand that those committees do not oppose adoption of the bill in its present form. So far as the measure now stands, Mr. Chairman, it does have the full endorsement of the Securities and Exchange Commission.

Mr. EICHER. For the record, Mr. Douglas, right there: Is H. R. 10292 identical with amended S. 2344 as reported by the Senate Committee on Banking and Currency?

Commissioner DOUGLAS. I have had it checked very carefully, Mr. Chairman, and it is identical except for a comma here and there. The substantive provisions of the bill are precisely identical.

OBJECTIVES OF THE BILL

Now, the general scope of the bill and the reasons which support it, and a section by section analysis of it are set forth in the report of the Senate Banking and Currency Committee, accompanying the Senate bill, copies of which are available to this committee. In view of that fact, I do not know that it would be desirable or necessary to go into all of the minutiae of this bill. I shall be glad to do so to the extent that the committee desires.

For the purposes of the record, however, I think it might be well for me to make a brief statement as to the nature of the trust indenture and the reasons for its widespread use.

Where bonds are to be nationally distributed, particularly if they are to be secured by the mortgage or pledge of property, the use of the trust indenture device has been found to be a practical necessity. The bondholders are generally widely scattered through many States. Their individual holdings are likely to be small. Even if the average bondholder had the necessary initiative and, knowledge, an attempt by him to enforce his rights by individual action, or to keep reasonably well informed as to the performance of the obligations assumed by the obligor, would require a disproportionate expenditure of time and money. By the adoption of the trust indenture device, and by vesting in the indenture trustee powers with respect to the enforcement of the rights of the bondholders, including their rights in any property mortgaged or pledged under the indenture, much duplication of effort and expense can be avoided. These facts, coupled with the increasing complexity of corporate financial transactions, have led to the extension of the trust indenture device to unsecured bonds as well as mortgage bonds. The desire of borrowers to place limitations and restrictions upon the bondholders' right of individual action has also played a part in this development.

The bond itself is merely one sheet of paper. The indenture is an elaborate legal document from 50 to 200 pages long. Although the bondholder rarely sees it, and could not understand it if he did see it, the indenture legally constitutes part of his contract to the borrower, that is, the obligor. The increasing complexity of corporate financial transactions has made it inevitable that important provisions with respect to the rights of the bondholders will be found only in the indenture, and will be incorporated in the bonds themselves only by reference to the indenture.

To the extent that the types of trust indenture now in common use are inadequate, it is clear that such inadequacy presents a national problem which cannot be dealt with effectively by the States, for it is conservatively estimated that more than $40,000,000,000 of securities which have been nationally distributed are now outstanding under trust indentures, and in the 12 months ended April 30, 1937, nearly 21⁄2 billions of additional securities which would have been affected by this bill were registered under the Securities Act, for sale by use of the mails or in interstate commerce.

At a later point in my statement, I shall be glad to discuss in some detail the deficiencies which, in the course of its study of the subject, the Commission found to exist in the forms of trust indenture in common use. I shall also discuss the manner in which the trust indenture is customarily prepared.

At this time I will, if the committee desires, touch merely upon what I think are the more salient points of the bill and its most important objectives. The primary purpose of the bill is twofold:

First, to bring all indenture trustees, which are usually national banks or State banks or trust companies, up to the high level of diligence and loyalty now maintained by the more conscientious trust institutions.

Second, to remedy the defects in indentures which now handicap those institutions in their efforts to render the vigilant and effective service which the protection and enforcement of the rights of investors require.

These objectives are to be accomplished by the establishment of statutory standards to which these trusts indenture must conform.

In our opinion, the bill has the same constitutional basis as the Securities Act of 1933, namely, the public offering of securities by the use of the mails or agencies of interstate commerce. In general, the bill applies only to indentures which must now, under the Securities Act, be submitted to the Securities and Exchange Commission as part of a Securities Act registration statement covering the bonds to be issued thereunder. All indentures so filed at the present time under the Securities Act are examined by our staff in order to determine whether their terms have been fairly and adequately disclosed in the registration statement and the prospectus.

The bill would merely require the Commission to determine also whether the terms of the indentures conform to the standards prescribed by the bill. I mention that, Mr. Chairman, because I do not think that, so far as the administrative load is concerned, the increase in work by the Securities and Exchange Commission, in the period after this bill gets in full operation, will be materially greater than the work which the Commission at the present time does under the Securities Act on trust indentures.

I would like to say at this point, Mr. Chairman, that the bill does not give the Commission any jurisdiction whatsoever over such matters as the wisdom of the issue, or the amount of security to be given for the issue, or the offering price, the maturity dateMr. BOREN. May I interrupt there, Mr. Douglas. Commissioner DOUGLAS. Yes; Mr. Boren.

The

Mr. BOREN. I think I understand this, but I want to be sure. difference between an underwriter and an ordinary broker is that the underwriter simply is an agent of the originating company? I mean

that he does not have any investment in the securities whatever. Is that right?

Commissioner DOUGLAS. He usually does not. He may, but that would be wholly incidental. He usually makes a commitment with the issuer to sell or to dispose of the particular security in question. Mr. BOREN. Then he is in a sense a commission merchant? Commissioner DOUGLAS. He is a merchant; yes.

Mr. BOREN. Well, do you not think that the term "commission merchant" fits him in that he draws a commission on the sale of securities which he takes?

Commissioner DOUGLAS. He gets his commission or his "spread." He commonly purchases the issue from the issuer or agrees to find purchasers for that issue; or he may merely agree to take all of the issue that remains unsold after the issuer has completed its offer.

Mr. BOREN. I think that answers my question, Mr. Chairman.

(The following summary of the deficiencies found by the Securities and Exchange Commission to exist in the present-day trust indenture was submitted by Commissioner Douglas, at the request of the subcommittee, for inclusion at this point in the record.)

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SUMMARY OF DEFECTS IN TRUST INDENTURES

In the course of its studies made pursuant to section 211 of the Securities Exchange Act of 1934, the Commission examined more than 400 indentures of issuers of all types. There follows a brief summary of the deficiencies found by the Commission to exist in the forms of trust indenture now in common use. Page references are to the various parts of the Commission's report of this study. 1. Trust indentures frequently fail to provide the trustee with the necessary tools for making an effective check on the performance of even the more important obligations assumed by the obligor in the indenture.

Where property is mortgaged or pledged under the indenture, the first essential is to see that the indenture is properly recorded. Failure to do so may mean disaster for the bondholders. Nevertheless, in 86 percent of the indentures examined, there was an express provision to the effect that the trustee was to be under no obligation to see that such recording was effected. (See pt. VI, Trustees Under Indentures, p. 24.)

In many cases it is not only proper, but essential, that the trustee make some check upon the disposition of the proceeds of the bonds issued under the indenture. The trustee received and disbursed the proceeds in the case of one-fourth of the indentures examined by the Commission. In practically none of the remaining indentures was any machinery established for a check by the trustee upon the disposition of the proceeds. (See pt. VI, p. 127.)

It is also essential, in many cases, that proper machinery be established whereby the trustee may make an effective check upon the performance of the conditions precedent to the issuance of additional securities. The failure to make such a check may be definitely prejudicial to the bondholders. (See pt. VI, pp. 26–29.) If the indenture fails to establish adequate restrictions and conditions upon the release and substitution of property mortgaged or pledged under the indenture, the bondholders may find, when trouble arises, that the assets upon which they have relied for security have been whisked away out of their reach. (See pt. VI, pp. 16-23.)

2. Indentures commonly failed to require the obligor to make reasonably informative periodic reports to the trustee. More than one-third of the indentures examined made no provision whatsoever even for annual reports by the obligor. (See pt. VI, p. 125.)

3. None of the indentures examined contained provisions requiring the obligor to file with the trustee information as to the names and addresses of the bondholders, or provisions requiring the trustee to make such information or the use thereof available to the bondholders themselves. Such provisions are an essential part of the necessary machinery for the transmission of information to the bondholders, and for the organization of the bondholders for the protection of their own interests.

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