give notice to the bondholders of any default.116 He believed that whether or not, apart from the indenture, a corporate trustee should give such notice "depends upon the circumstances." 117

As a matter of fact Guaranty, the trustee, never advised the bondholders of the default. The directors of the Hoe company formally voted on March 17 to notify the trustee of its inability to make the interest payments on April 1st. Guaranty Trust Company was then "officially" notified. Mr. Hibbard testified:

"Q. Then what did Guaranty Trust Company do? Did it forthwith communicate with the bondholders?

A. Not to my knowledge.

Q. There was further delay in Guaranty Trust Company's announcement to the bondholders of the default?

A. I don't know; I don't think the Guaranty Trust Company ever made such an announcement, nor do I feel that they should have.

Q. Now that announcement was made in what manner?

A. By the bondholders committee, to the best of my recollection.

Q. Now when was that bondholders committee formed?

A. I think it was about a week after that meeting."

"Q. That would make it about March 25th or 24th?

A. That is my recollection.

Q. Do you recall when the bondholders committee announced the default? A. Somewhere about that time, I should think March 25th or 26th

118

But there were reasons in addition to conventional inertia which led Guaranty Trust Co., the corporate trustee, to leave the matter to the protective committee and to lull the "bondholders into quiescence about the situation." 119 In February of 1932, two months prior to public announcement of default, the Guaranty Trust Company and other bankers of the Hoe company were planning the formation of various protective committees.120 Guaranty was heavily interested in Hoe in capacities other than as trustees for the bondholders. It was a creditor;121 it held securities junior to the bonds; 122 its securities affiliate was underwriter of Hoe securities;123 and it was in control of the company.124 When default appeared inevitable, the management began to arrange a friendly receivership,125 and Guaranty began to form protective committees so that it could dominate and control the reorganization. If it attained this position of dominance in the

reorganization, it would of course be in a position to control or influence the treatment of various claimants and interested parties, including itself in its many capacities. To this end the news of the impending default was suppressed until the stage was set and all the machinery prepared for reorganization. So testified Mr. Hibbard:

“Q. Well, I am wondering then, Mr. Hibbard, if all of this delay in making the announcement of the default was conceived for the purpose of getting the reorganization procedure and the reorganization units, the committees, organized, so that immediate action could be taken to assume a dominant, controlling position in the reorganization?

A. Yes." "

Our conclusion is that to relieve the trustee of all obligation to give notice of defaults is undesirable. Rather it should have the affirmative obligation to take such steps towards 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. Had such standard of conduct been exercised in the Hoe case the probabilities are that the reorganization which ensued would not have been so exclusively in the hands of insiders with conflicting interests to serve.

F. CONDITIONS PRECEDENT TO ACTION

The Guaranty Trust Company, in the case just recited, failed to notify bondholders of the impending default not because it lacked knowledge or power, but because it did not desire to do so. The corporate trustee is generally adequately equipped with powers; its inactivity is the product of its own desires coupled with provisions in the indentures which relieve it of any duty to act. The lack is not of power, but of duty and responsibility.

For example, the trustee generally is given ample powers in indentures to bring suit, in its own name, to collect principal and to foreclose and enforce rights under the indenture against the pledged property. 76 percent (324 out of 423) of the indentures studied, contained the express provision that the trustee possessed the power to sue in its own name and to recover the entire principal unpaid, in the event of default by the issuer in the payment of principal when due, whether on the due date of the securities or upon their accelerated maturity. And the more general provision, that on the happening of these same conditions the trustee could in its own name

120 Id., at 132.

enforce the rights under the indenture against the property, was contained in 91 percent (377 out of 415) of the cases. In all but 5 of these indentures (98 percent) it was expressly provided that the trustee was vested with the exclusive power to enforce such rights.

But instances of trustees taking such action, unless and until they are forced to do so by bondholders, are not common. Trust indentures normally contain express provisions that, despite the happening of specified defaults, the trustee has no duty to foreclose or to initiate other judicial proceedings or any other action specified in the indenture, unless the bondholders holding a stated percentage of the principal amount of securities then outstanding make a demand upon it. Ninety-three percent (391 out of 420 cases) of the indentures examined by this Commission contained such provision.127 In 57 percent (226 out of 391) of these, even after the necessary request had been made, the trustee retained by express provision the power to elect the remedy to be pursued. It can be compelled to take that particular type of action which bondholders desire only if a specified and higher percentage demand it.128 Trustees have even denied any duty to exercise their power to declare maturity of the securities accelerated. In 93 percent (396 out of 424) of the indentures, the trustee had no duty to accelerate prior to demand by a substantial percentage of security holders.129

Even this does not tell the whole story. It is not enough that the required percentages of security holders, having in some manner been assembled, shall give notice of default and make the demand upon the trustee. Almost uniformly there is this further barrier; the indenture expressly provides that the trustee has no obligation to take any action which in its opinion is likely to involve it in expense or liability unless the security holders furnish it with indemnity.

127 The percentage required to make demand upon the trustee varied as follows: 1 to 10%

11 to 20%

21 to 30%

31 to 40%.

41 to 50%.

Majority----

12

18

239

8

7

107

128 In 234 indentures this provision appeared. But the percentage required to direct the remedy to be pursued is usually higher than that required to compel unspecified action. The distribution was as follows:

Of 424 indentures examined by this Commission, 405 (96 percent) contained this provision.

These provisions are regarded as a matter of law, as parts of a "contract" between the trustee and security holders. For most securities there is no restraint upon the number of such provisions which can be inserted, or upon the percentage of security holders whose demand is necessary to require the trustee to act. For the comparatively few issues listed on the exchange, there is an exceedingly limited prohibition. The New York Stock Exchange and the New York Curb Exchange both specify that the Committee on Stock List "will object to any provision in an indenture whereby the consent of more than 30 percent of the outstanding bonds is necessary to initiate any action by the Trustees which may appear necessary for the protection of bondholders, subject, however, to the limitation that there is no objection to a provision by which the action of a majority in amount of such bonds will rescind any minority action."

It is obvious that this requirement affords investors no real protection against inert trustees; it merely places a liberal top-limit upon the conditions to action which the trustee may impose upon security holders. But the result of these conditions is definitely detrimental to investors. When the necessity for action arises, every bit of delay is hazardous and may be definitely injurious.

In order to obtain the necessary amount of security holders to make these demands and thus force the trustee to act or to mature their own right to do so, security holders normally will have to form a protective committee. To form such a committee they must communicate with their fellow security holders. In order to communicate with them, they need their names and addresses. Without such list they must resort to general advertising which is costly and ineffective. At best this method is a poor substitute for a list, for scattered security holders are difficult to reach through such a medium. Thus without a list of security holders, united effort is thwarted in its inception. The result is that they do not organize and matters drift along or the organization is perfected slowly and expensively. But such lists are difficult to obtain for, as elsewhere mentioned, they are usually in the exclusive possession of interested groups, i. e., the underwriter and the issuer. The latters' interests frequently are opposed to those of the security holders. In any event the history of reorganization demonstrates that those who possess the lists maintain their monopoly on them, giving access only to the favored few whose friendship and sympathy are known quantities. But whether the security holders obtain a list or not, the steps necessary to marshall a sufficient percentage of security holders to make the demand on the

trustee are time-consuming. Irreparable loss to security holders may occur in the interval-such loss being clearly traceable to the trustee's inaction. The situation has been graphically described by one trust officer as follows:

"If an event of default happen, the responsibilities and difficulties accumulate around the trustee's devoted head. Suppose one occurs and the required number of bondholders do not get together and form a protective committee, and there is no one to make request of the trustee to proceed under the foreclosure clauses of the indenture: What shall the trustee do? He can sit back with folded hands and say that the proper number of bondholders have not called his attention to the default and he has not been indemnified under the terms of the agreement, therefore he will do nothing. This may be strictly within the letter of the indenture, but, as Scripture has it, "The letter killeth, the spirit maketh alive'. Is it not a reproach against any issue of bonds that the trustee has so wrapped himself up in nonresponsibility clauses that his signature on the back of a bond is mere waste of ink?"

9 130

An example of the present impossibility of obtaining action by the trustee, appears in the reorganization of the Cuban Cane Products Company, which was studied and investigated by this Commission. When sale of the Cuban Cane properties to satisfy bank creditors' first mortgage was imminent in January 1934, the committee for the outstanding Cuban Cane debentures desperately sought, for the protection of the debenture holders, to have the sale deferred. 131 The sale was scheduled for January 30.132 Demand was made by the committee January 17 on Manufacturers Trust Co. as trustee for the debentures requesting that it take some action to defer the sale. Counsel to the committee testified:

"Q. You were attempting, as a committee, to get the corporate trustee to take effective steps to protect the debenture holders against an event that was about to happen, namely, the foreclosure sale?

A. I felt, that, as counsel for the committee the danger was so real it was the duty of the committee to leave no stone unturned to prevent that danger from becoming a reality."

99 133

On January 29, the day before the sale, the trustee replied 134 stating it was willing "to take any reasonable steps for the purpose of protecting the debenture holders." It added, however, that it had no funds as trustee available for the purpose and stated "we must ask that the debenture holders either arrange to put us in funds or adequately indemnify us against expense and liability before we can

150 W. G. Littleton, vice-president, Fidelity-Philadelphia Trust Co., 56 Trust Companies 335, 337-338 (1933).

131 Proceedings before the Securities and Exchange Commission In the Matter of Cuba Cane Sugar Corporation (1935), at 783-784.

1 Id., at 786.

13 Id., at 784.

134 Id., Commission's Exhibit No. 211. (For practices of trustees in demanding indemnity before acting, see Appendix A, Section IV, Table 2, infra.)