such as giving notice, trustees exercise their descretion under all of the circumstances. Often, where the taking of such action might have a seriously detrimental effect upon the security, they await the instructions of the specified percentage. There may be forceful arguments on both sides of the question whether they should give such notice. The giving of notice may adversely affect the issuer and through it the security holders; it may lead to application for receivership, or to the institution of reorganization or other proceedings in bankruptcy, when such proceedings are unwise. On the other hand, the failure to give notice may result in the non-institution of such proceedings when they should have been instituted. No general rule can properly be stated, nor does the Report attempt to do so.84 The Report criticizes the employment by some trustees of counsel who also are counsel for interests conflicting with the trust or are counsel for a group of the bondholders, such as a bondholders' committee; and indicates that such employment is not unusual.85 In the author's experience the employment of the counsel for conflicting interests is decidedly rare. Various instances might be cited wherein trustees have declined to employ their regular counsel, whom naturally they would prefer to employ, because such counsel appeared to have a possibly conflicting representation. The experience of the writer is that when trustees are considering the employment of counsel they rarely fail to require, as a necessary condition of the employment, that counsel do not represent conflicting interests. It is a fact that the same trustee is sometimes the trustee under different indentures of the same corporation and that prior to default the same counsel normally would act for the trustee in different capacities. This was particularly true as to old railroad mortgages, such as those of the Missouri, Kansas & Texas Railway Company, and of the Chicago and Northwestern Railway Company,86 usually covering branches of a large system. In recent years it is much more likely to be the case that there are different trustees under different indentures of the same corporation. However, in some cases the same trustee does act under the different indentures. The listing requirements of the New York Stock Exchange do not prevent a trustee from so acting, provided that it shall file with the Stock Exchange an agreement to resign from any conflicting position which shall thus develop.87 It may be very desirable, from the viewpoint of expense, familiarity with the property and other practical considerations, that the same trustee should act under different indentures of the same company. The likelihood of any conflict before default is very small; and the employment of the same counsel under several indentures presents a situation only of remote possible future conflict, not of actual conflict with which this portion of the Report is concerned. Where, however, by reason of default or otherwise, the possibility of substantial conflict has become real, the trustee and its counsel usually resign under one or the other of the indentures; and this has long been true, as in the Missouri, Kansas and Texas case and the Chicago and North Western case,88 entirely without consideration of Stock Exchange requirements. While the employment of the counsel for conflicting interests is very unusual, it has been less uncommon in the past for the trustee to employ counsel who also act for the bondholders' committee.89 In some cases this works well and saves expense; but, because the trustee represents all bondholders, the better view would seem to be that it should not retain counsel who also represent a particular group; and in one case such practice has been judicially disapproved.90 As the Report 74 The Report states, at 42: "Our conclusion is that to relieve the trustee of all obligation to give notice of defaults is undersirable. Rather it should have the affirmative obligation to take such steps toward advising security holders of impending or actual defaults as are, in view of all the circumstances, reasonable and necessary for their protection. To publicize transient and technical defaults might do irreparable damage to security holders and issuer alike. No rigid and inflexible rule can be prescribed. What is needed is a standard of conduct prescribed by law which requires the trustee to take the same action it would take were it the investor." This, with its context, amounts to a suggestion not that trustees be required to give notice in all cases, but that they be compelled to exercise their discretion honestly and intelligently, which, beyond any ques tion, they presently do in the great majority of cases. 85 Report, at 60. 86 See printed record, Central Trust Co. v. Missouri, Kansas & Teras Ry. (E. D. Mo. 1933-1936), Vol. I, 287, 463, 695; printed record, In the Matter of Chicago and North Western Ry. (N. D. Ill. 1935–1936), Vol. I, 151, 259. 8f Stock Listing Requirements, New York Stock Exchange, C. C. H. Stock Exchange Regulation Service Supp., 11617, provides after making certain "recommendations": "Each mortgage, indenture, or deed of trust should be represented by a separate trustee" (italics added). The Exchange interprets (although not in published form) this language as a general recommendation; and, where no likelihood of harm appears, it will list securities, although the same trustee is acting under the different indentures, upon the agreement of the trustee to resign in case that conflict shall appear. 88 See printed record, Central Trust Co. v. Missouri, Kansas & Texas Ry. (E. D. Mo. 1933-1936), Vol. I, 390: printed record, In the Matter of Chicago and North Western Ry. (N. D. Ill., 1935-1936), Vol. I, 475. 69 The Report states, at 80, that in 16% of the cases investigated counsel to the committee was counsel to the trustee. 90 See U. S. & Mexican Trust Co. v. U. S. & Mexican Trust Co. as Trustee, 250 Fed. 377, 382 (C. C. A. 8th, 1918). states, there is "respectable authority among trust companies and their counsel that the employment by the trustee of counsel to the committee is undesirable." On the other hand, some trustees feel that they best serve the interests of security holders by avoiding the expense of duplicating counsel, where no real conflict between the committee and the nondepositors is at all probable.92 The Report suggests 93 that trustees should promptly intervene in receivership or bankruptcy proceedings of the issuer and should move expeditiously to impound rents and profits. Combined with subsequent references to general "intertia" of corporate trustees and the statement that trustees "normally will not act❞ unless requested by the specified percentage, the suggestion apparently implies that trustees usually do not intervene or impound income without such request. The author's observation of railroad reorganizations under Section_77, such as the proceedings involving the Missouri Pacific Railroad Company, The New York, New Haven and Hartford Railroad Company, and the Chicago and North Western Railway Company,95 leads to the belief that it is now the usual practice for trustees, without request or indemnity, to intervene and make demand for the income. In these cases, almost all of the trustees have intervened in the court proceedings, and also before the Interstate Commerce Commission when a reorganization plan has been presented. The court records of reorganization proceedings under Section 77B generally show that the practice is also prevalent therein.96 The characterizations by the Report of present trustee duties are not accurate. For example, it states that the trustee is presently nothing more than "a stakeholder and an amanuensis of the group which happens to be dominant." 97 The preceding portion of this article will demonstrate that trustees, even prior to default, undertake very serious responsibilities and perform very substantial services, and that a trustee is not properly described as a mere stakeholder. One court has stated that such a trustee "would seem to occupy middle ground between a mere stakeholder or depositary, on the one hand, and a testamentary trustee, on the other." 98 This is a fair characterization. Nor is the trustee merely an amanuensis of the dominant group. It is true that in most cases the trustee will follow the views of the holders of a majority of the bonds. Certainly there is no impropriety in so doing, even where the indenture does not provide, as frequently it does, that the trustee is bound by the instructions of the majority. A general statement, however, that trustees follow as a matter of course the instructions of the majority, would not be correct. It is not the practice of competent trustees to accept blindly the suggestions or requests of the majority where improperly prejudicial, by reason of illegality or otherwise, to the minority.99 The respect in which the interest of the majority most frequently conflicts with that of the minority is with reference to the upset price to be fixed by the court in the decree of sale, the upset price being the minimum bid which the court will consider. 100 As a rule, the courts themselves look throughly into the propriety of the proposed upset price; and trustees also give careful consideration 91 Report, at 78. 92 The Report also comments, at 80, upon the fact that in 36% of the cases investigated by the Commission the trustee was represented directly on the committee, and states that the trustee is thus prevented from being an effective representative of all security holders. It has been held that there is no impropriety in the trustee being represented on, or being the depositary for, the bondholders committee [Fidelity Trust Co. v. Washington-Oregon Corp., 217 Fed. 588, 600-601 (W. D. Wash., 1914); Guaranty Trust Co. of New York v. Chicago, M. & St. P. Ry., 15 F. (2d) 434, 440, 441 (N. D. Ill., 1925 and 1926); Palmer v. Bankers Trust Co., 12 F. (2d) 747, 753 (C. Č. A. 8th, 1926)] although minority bondholders were permitted to intervene in a case in which the president of the trustees was chairman of the committee, the same counsel acted both for the trustee and for the committee, the trustee institution was also the depositary for the committee, and (this being probably the controlling fact) an actual conflict of interest between the committee and the minority had developed after the formation of the committee. Central Trust Company of New York v. Chicago, Rock Island and Pacific R. R. 218 Fed. 336 (C. C. A. 2d, 1914). The mere fact that one of the members of the committee is an officer of the trustee does not mean that the committee will dominate the trustee. The depositary is merely a mechanical agency. 93 Report, at 47. 94 Id. at 61. 95 See printed records, In the Matter of Missouri Pacific R. R. (E. D. Mo. 1933-1936) 269, 1129, 165, 2063, 2221, 3259, 3357, 3401; In the Matter of New York, New Haven & Hartford R. R. (D. Conn. 1935-1936) 35, 89, 95, 111, 1113, 47, 141, 227, 315; In the Matter of Chicago and North Western Ry. (N. D. Ill. 1935-1936) 151, 259, 775, 783, 835, 841, 935, 991, 431, 511. 96 See, generally, Israels, op. cit. supra note 45, at 411. 97 Report, at 70. 98 See Marshall & Ilsley Bank v. Guaranty Investment Co., 213 Wis. 415, 422, 250 N. W. 862, 864 (1933). 99 Corporate trustees are thoroughly familiar with the rule stated in Hollister v. Stewart, 111 N. Y. 644; 19 N. E. 782 (1899) that they are "not at liberty to follow the advice or wishes of the majority" without also being responsible to the "minority" for "faithful administration." 100 See Weiner, Conflicting Functions of the Upset Price in a Corporate Reorganization (1927) 27 Columbia Law Rev. 132. 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 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." 101 See Israels, supra, note 45, at 409. 102 Report, at 70. 103 Id. at 112. 104 Id. at 112. 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." 108 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, Utilities $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 |