disability so that the holders of, say 25 million dollars of an issue may breathe freely again because a complete break and interruption in the trusteeship is avoided.

Take one other phase, and then I have finished with the whole question of conflicts of this character. If the trustee and its directors and executive officers individually or collectively own 4.9 percent of the voting securities of the obligor, all is well; but if anyone of them acquires an additional one-tenth of 1 percent of this stock, or if the trustee bank happens to hold that small additional percentage as part of the security loan account of a customer who has been unable to meet his obligation, then all is lost, not only the two directorships but also the trusteeship itself.

The position I take is that it is no answer to say that the percentages must be fixed somewhere. Why must they be fixed at all? To do so is to set up misleading standards. In what laboratory, whether of law or alchemy, was the formula found for these percentages? They certainly could not have been drawn from the actualities of industry and finance. We know that conflicts of interest frequently exist where the percentages are much less, and are absent where the percentages are much, much greater. Our courts sitting in equity have been quick to find these conflicts and will disregard forms and percentages in order to reach the substance. Why confuse the situation and create a form of defense and I think, Judge, you realize how lawyers, drawing their points from analogous statutes, are quick to seek a defense based upon this; so why create a defense? Why establish a defense based upon statutory declaration of the standards and percentages that create conflict? However all-inclusive may be the definition of the act defining conflicts, it must still fall far short of the possibilities of human ingenuity. Why attempt to do by statute, with all its inescapable rigidity, that which courts of equity have long been able to achieve with all the necessary flexibility?

On the question of the creditor responsibility-and then I have finished-by this act the Government through its S. E. C. regulations will control the terms of the indenture and enforce certificates and standards that will insure compliance with those terms and protect the investor. On the happening of a default, the act enables the investors quickly to rally for their own protection. By the high duty of fiduciary care imposed upon the trustee, the investor is still further protected; and under its impetus there can be no doubt but that many of the trustee conflicts heretofore encountered will disappear, regardless of the remaining provisions of the act. What more need the Government propose?

You cannot hope, by an act, to cause to spring forth full panoplied a great body of the law. That calls for the development of the courts throughout the years; and there is danger, when one attempts to do that, of creating unnecessary conflicts and difficulties which may be destructive.

So, with all this, what else is there to be done? Well, instead of resting there, the Government goes farther. Here it might well rest and, having set up these full safeguards, allow the normal procedures of the courts of the land to operate in the normal way.

But the proposed act does not rest here, even with the inclusion of these provisions. It goes further forward and proposes formulas under which the trustee may or may not become a creditor of the

obligor; in one set of conditions the right to become such a creditor is absolutely prohibited; in another set of conditions it is permitted, although on terms which are onerous and harsh, if not prohibitive.

There are few businesses which do not require short-term loans, usually for 3 or 4 months, to meet seasonal needs or stock turnover, or where collections temporarily are slow. The indenture trustee of such a company, usually informed of its financing requirements and the nature of its seasonal and other needs, readily and customarily makes such a loan. Normally these loans are unsecured, and the total of such business aggregates billions of dollars a year. Such a loan by a bank, whether secured or unsecured, is absolutely prohibited if it is the trustee under a debenture issue of the obligor, and prohibited also if it is the trustee even under a secured issue whose maturity at the time of issuance was less than 5 years. So much for prohibited loans.

Permitted loans are those in which the bank is indenture trustee under a secured issue having an original maturity of 5 years or more. Then you would think the situation was cleared. Whatever virtue or magic there might be in the other situation, here at least you might think the indenture trustee could lend to its obligor. But not even there may that be done; because if, at any time within 4 months prior to an uncured default in the payment of principal or interest on the bonds, the trustee has received any payment or any additional security on its claim, it must account therefor to its bondholders, and this regardless of the fact that the loan may have been made long before the 4-month period.

The nature of the duty to account differs in prohibited and permitted loans. In those permitted the funds or property to be accounted for must be apportioned between the trustee and the bondholders pro rata on the net amounts of their deficiency claims. But in prohibited loans the funds and property must be accounted for subject to prior payment in full of the bonds.

An exception to the trustee's obligation to account exists in the case of permitted loans where the trustee succeeds in proving that at the time it received a payment or additional security within the 4-month period it had no reasonable cause to believe that default in payment of principal or interest on the bonds would occur within such 4 months. The third phase regarding which I wish to make a suggestion, and then I conclude with a suggested amendment, is this: It is settled law that I may safely lend money to an enterprise in concededly failing circumstances, and take security contemporaneously with such loan. This may be, indeed, the means of saving the enterprise from disaster, but if the business fails I may collect against the collateral which I received at the time of the loan; I may not, however, knowing the threatened conditions, improve my position beyond the value of that collateral. But not so with the indenture trustee; and even in the case of a "rescue loan" which may tide over the threatened trouble and give a chance to bondholders to be saved from serious loss, aid is denied to the bondholders by this special rule of the proposed law. These provisions, I submit to this committee, are much too harsh. The amount of loss which American corporation bondholders have suffered in the past from disloyal trustees bending their activities to collect their individual loans from the obligor on the bonds is insignificant compared to the losses of American corporation bondholders

generally. No evils exist that are commensurate with the harshness of the remedy. These provisions make it impossible for the trustee to help the obligor on loans just at the time when many an obligor needs help to save a situation that otherwise may result in a default on its bonds and where the obligor may not be able to find any other bank than the trustee to make the loan. Indeed, corporate trustees often make loans to help an obligor of their bonds where they would not make the loan if they had no trust relationship.

I have suggested various amendments; and if this committee will permit me, I should like to submit them for the record and for the committee. The point to be made here is clearly drawn. The mere making of the loan is not the thing that should be prohibited. The thing that should be prohibited is the improvement of the position of the creditor.

It is submitted that the above provisions would be much fairer if paragraph (6) above quoted were eliminated from the definition of "conflicting interest", so that the mere making of a loan by the trustee to the obligor of its bonds in itself is never a cause for the trustee's resignation; and then to recognize that the trustee should never be allowed within 4 months before an uncured default in principal or interest of the bonds to improve its net creditor position at the expense of its bondholders; but in every such case, regardless of its knowledge or suspicions of an impending default, it should share pro rata with its bondholders the amount by which its net creditor position has been improved during this 4-month period, subject to the burden of the trustee to show, as provided in the act, its lack of knowledge or grounds for believing that default in interest or principal was impending. That is the crux of the situation-the improvement of its position, not the making of the loan in itself. The advantage of this change will be that the trustee's loan business could still go on and that there would be less danger of the larger banks and trust companies now acting as corporate trustees gradually discontinuing this activity and leaving the business to smaller and less responsible banks and institutions.

To accomplish this change it would be necessary to eliminate paragraph (6), page 24, lines 12-18, and also to omit from page 29, line 12, through page 30, line 20, and insert at page 29, line 12, the following:

and provided, further, That the indenture to be qualified shall provide that the trustee's rights in the funds and property held in such special accounts and the proceeds thereof shall be apportioned between the trustee and the indenture security holders in such manner that the trustee realizes no greater percentage of its deficiency claim (after deducting therefrom all credits for which it is not required to account thereunder) than the security holders realize in respect of their deficiency claim against the obligor (after deducting therefrom all allowable credits).

I think that in that way you could have the loan still go on, and they may not improve their position in any way.

Then of course another amendment should be made-that they may, contemporaneously with the loan, take security. I could never understand why that could not be done, or why this should be singled out of the whole finances of the country and put upon the block, when it is so common and well recognized in equitable and proper practice throughout the country. This change would permit the trustee to make secured "rescue loans" within the 4-month

period, without any duty to account, so as to be able to help the company over a tight place. To accomplish this there can be inserted at page 29, line 6, after the word "period", the words "or any security for a claim received contemporaneously with the creation of such claim."

In conclusion I should like to add just this: Large temporary loans running into the millions of dollars, are from time to time required by important industrial institutions, and are usually taken by a half dozen or more banking institutions, as was the case not long ago. It can be readily understood that if such institutions are disenabled from lending to enterprises for which they act as indenture trustees, industrial managers with even ordinary foresight would immediately exclude these banks from trusteeships in order not to preclude them from making loans as seasonal requirements arise. A lucrative part of the business of banks and trust companies is in these short-term loans to the obligor; these loans, rediscounted at the Federal Reserve bank, form the basis of an appreciable fraction of the money issue of the country. Nor is it likely that trusteeships would be accepted by responsible banks if the resulting penalty were the prohibition of such loans. I believe this would be fraught with serious consequences; it is my firm belief that, with comparatively few exceptions and I say this firmly to this committee the banking interests of the country engaged in the field of indenture trusteeships have acquitted themselves well during the exceptionally difficult 10 years through which we have just passed.

Of course we may take our horrible examples, but they are the exceptions. Who knows of the billions upon billions of dollars which have been saved to security holders by the pertinacity and assiduity and alertness of the indenture trustees throughout the country?

Senator BARKLEY. Do you not have to legislate, on all matters, largely for the exceptions? Is not legislation designed to cover those situations where men are not willing or, for any reason, do not recognize what the great majority of people recognize as a duty and a moral obligation? Nearly all legislation which prevents someone from doing something is designed with regard to these exceptions.

Mr. POSNER. I think so, Senator; and that should be taken care of to the full extent necessary and adequate, but not beyond that. The CHAIRMAN. The 10 percent?

Senator BARKLEY. Yes.

Mr. POSNER. Yes. But I say you do it adequately when you fix the fiduciary control, when you see to it that the clauses of the indenture, which have been the source of so many difficulties, are checked and controlled, when you see that proper certificates are given, when you see that stockholders' lists are provided, when you see that the care which a trustee must exercise should be a high degree of fiduciary care. I think you are doing all that. But I think that when you go beyond that, you go way beyond the necessities of the case.

But even if you think this provision of one-tenth of 1 percent is all right, and even if you think it is proper to supersede the courts and leave it to the statute, with its rigidity, then certainly you have gone as far as you should and as far as the worst of the evils you have discovered would require.

Then to go beyond that also, and to begin to regulate these conditions under which one may not become a creditor, and to do what commonly is done throughout the country-and, as in this case,

often for the benefit of the investors of the country-I think is going too far. More than that, I think it is going to drive out of this business experienced institutions which I think should be induced by all the fair means possible to remain in it.

Now, Mr. Chairman and Senators, I conclude with this thought: Banks of sufficient financial responsibility to undertake trusteeships of important issues are not numerous, as compared with the needs of finance; and the difficulty would be aggravated if those to whom the obligor intends later to look for funds are precluded from becoming trustees. The consequence would be that such trusteeships would inevitably be forced into hands of questionable responsibility. Inpecunious or inexperienced trustees would, I believe, raise far more serious problems than those which arise when the indenture trustee becomes a banking creditor of the obligor, particularly when the trustee is under a high fiduciary responsibility toward the security holder, and when conflicts of interest will inevitably be considered and judged by the courts in the light of these higher standards.

There are some other matters which I cannot go into now. I think the security holders are unduly hampered by some of the provisions which appear in the statute. I think, particularly, that subdivision (h), with regard to the authority of holders to control what shall be the development of their situation in the way of default, is too greatly limited.

The CHAIRMAN. In what respect?

Mr. POSNER. You have a provision here by which a majority may ask concerning the remedy, here, but may not extend the time of payment of interest or principal, and the like. But there are very few reorganizations where that is not done; and it would seem to me that a study of that phase of it is called for here, and should be submitted with a view to the appropriate change in this statute, so that the bondholders themselves should not be hampered.

Senator TOWNSEND. Have you the amendments that you could leave with the committee, for remedying the bill in those respects?

Mr. POSNER. None, sir, in that respect. Frankly, I confess that when I finished preparing this statement, late last night, I thought I had gone as far as the patience of this committee would permit. I am very deeply interested in the subject, I need not tell this committee. I need not tell Professor Douglas how eager I am to cooperate and to help. It is only with that view that I have undertaken the trouble and the expense of coming here last week and this week.

Senator Townsend, I shall submit, as you suggest, one or two amendments with respect to what I have suggested.

The CHAIRMAN. I think that would help the committee, if you will do so.

Mr. POSNER. Thank you, sir. I am sorry if I have gone beyond the appropriate time limits.

The CHAIRMAN. You have spoken for an hour instead of half an hour; but we find no fault with you for that.

Mr. POSNER. Thank you very much, sir; I am very grateful to you all.

(The following are amendments submitted by Mr. Posner in accordance with the committee's request.)

Strike from section 7 the subsection (6), page 24, lines 12 through 18.

After the word "period," page 29, line 6, insert: "or any security for a claim received contemporaneously with the creation of such claim,”.