number of conflicts which have existed throughout the trusteeship. One conflict, not uncommon, is the identity of interest between the trustee and owners of junior securities or equity interests. This has been conspicuous particularly in the real estate bond field, as we have pointed out in our report on Committees for the Holders of Real Estate Bonds. As discussed there, the trustees were usually officers, directors or affiliated corporations of the houses of issue. The house of issue, as a result of advances made by them to meet payments of taxes, principal and interest, had acquired junior securities or equities in the properties. As owner of the equity the house of issue would at times operate the property. It was to the obvious advantage and self-interest of these houses to preserve these junior securities and equities against being diluted or wiped out by the bondholders whom the trustee represented. It could hardly be expected that the trustee, so closely identified with the house of issue, would take adequate steps to preserve the bondholders' position against these adverse claims of the houses of issue. And it is a matter of record that the trustees did not. The many ways in which the inaction of these trustees served to protect the investments of the houses of issue need not be repeated here. One example will suffice. The bondholders after default were entitled to the benefit of earnings and income of the property. By reason of the active or passive connivance of the trustee, however, such covenants were violated to the detriment of the bondholders and to the advantage of the equity owner. One such case concerned a bond issue underwritten by American Bond & Mortgage Co. That underwriter owned the equity of a property which secured an issue of first mortgage bonds distributed by it. One of the company's officers was trustee of the bond issue. While the bondholders might have claimed segregation of the income for their benefit after default, nothing was done by the trustee to that end. As a result the property was "milked" by the underwriter in its capacity as equity owner. The minutes of a protective committee for American Bond & Mortgage Co. issues, including the bonds above discussed, contain an interesting discussion of this situation between certain members of the committee and Harold Moore, an official of the company. Mr. Moore testified concerning them before this Commission as follows: "Q. Perhaps Commission's Exhibit 431 will refresh your recollection. It is an excerpt from the minutes of the Hazlewood Committee of July 25th and 26th, 1930. On page 9, Mr. Rickaby is reported as having said: "That money that the 35 Clark Street Corporation has, while it legally belongs to the 35 Clark Street Corporation, it is really the first mortgage bondholders' money-it is accumulated risk. Mr. MOORE. That is correct. The CHAIRMAN. Do I understand the American Bond & Mortgage Company has common stock ownership in this now? Mr. RICKABY. They own all the common stock of the 35 Clark Street Corporation which took this property over last summer, before corporation was formed, and to use harsh language, they milked up $35,000 to $75,000 before they started depositing rents. Mr. MOORE. That is true; the same thing would be true in any number of properties where the owners have not paid all of the income on their mortgage indebtedness.' 39 249 Mr. Moore testified before this Commission in respect of the foregoing matter, as follows: "A. Well, it doesn't call to my memory those particular facts, except as they show in that particular statement, and as I said before, I have no reason to believe that is not accurate, but just at the moment I do not have any recollection of what did transpire in connection with that situation. Q. From that statement it would appear A. That I knew of that situation at the time. Q. That would appear, would it? A. Yes. Q. From that statement it would likewise appear that the rents collected between August 29th and January 30th were not used to pay back taxes? A. That is correct. Q. It would likewise appear from that statement that those funds were not applied on the first mortgage indebtedness? This is a gross example of abuse of the fiduciary responsibilities of a trustee; but it is an abuse not uncommon to the real estate field. And it is symptomatic of the disrepute into which trusteeship under indentures has fallen. The effect on the security holders of a trustee's identification or affiliation with owners of junior securities or equity interests may at times be more difficult to measure or ascertain than in the foregoing case. It may mean merely that the advocacy of the cause of the security holders is less aggressive and more timid than it otherwise would be. The mischief which ensues will more often be subtle than flagrant. Yet it is clear that it is incompatible with the fiduciary obligations of a trustee that it own or represent or be affiliated with those who own or represent securities which conflict with or are adverse to those of the beneficiaries of the trust. Divorce of the trustee from such adverse interest is essential. An excellent statement of this necessity may be found in Northampton Trust Co. v. Northampton Traction Co., where the Supreme Court of Pennsylvania, addressing itself to the argument that a trustee could represent both senior and junior mortgages, said: 251 "We can easily imagine many situations where a trustee might so act as to be a positive benefit to junior creditors, without infringing a particle on the first creditor's right; Op. cit. supra note 96, at 2248-2249 20 Id., at 2249. 270 Pa. 199, 203, 204, 112 Atl. 871. 872 (1921). but went on to say: "It is not necessary to determine what conflicting claims may arise, either with regard to the extent, validity, terms of the mortgage or application of income from the operation of the property; it is sufficient that they may well arise, and public policy requires where controversies are brought into court, that each party should be represented by someone whose single object it is to secure all to which each party is entitled, unhampered by personal relations to an adverse party, who is bound in conscience to be a loyal and vigorous champion without any obligation to a conflicting creditor or party.” 258 Frequently there appear multiple and manifold conflicts of interests of the trustee. Thus in the Hoe situation, Guaranty Trust Co. was interested not solely as trustee for the bondholders. Its securities affiliate, Guaranty Co., was represented on the Hoe directorate; with banker associates it had obtained control of the company in 1924 by common stock acquisition;254 and it controlled the voting trust for Hoe's common stock, two of its officers being trustees, and the third trustee being a partner of Edward B. Smith & Co., investment bankers.255 It had a 97 percent participation in the public issue in 1924 of $4,500,000 of Hoe bonds 256 for which Guaranty Trust Co. was trustee and coupon paying agent. As we shall develop later, Guaranty Trust became a bank creditor of Hoe and depositary of its funds.257 It was in reflection of these diverse interests that Guaranty participated in the Hoe reorganization as we have already described. With these many interests in the situation, obviously it could not regard its functions in the reorganization as solely on behalf of bondholders. It was identified with the management and with its bankers. It was itself a short-term creditor. Consequently, at every turn we found it serving its various proprietary rather than its fiduciary interests. As we have already described, its trust officers consulted with the management as to whether a bondholder should be informed of an impending default, and information was withheld at the suggestion and in accordance with the plans of the management. And, as Mr. Hibbard testified, it withheld this information in order that the management and its bankers, with both of whom Guaranty Trust was affiliated, might set the reorganization stage. These many interests of Guaranty Trust Co. in Hoe bore fruit in other ways which can be demonstrated directly to have injured bond It was also registrar for the Hoe Class A stock (Id., at 73), transfer agent for the voting trust certificates (Ibid.), depositary for the common stock (Id., at, 74), depositary for the three protective committees for Hoe securities formed in 1932 (Id., at 430), and, in large measure, was the committee for the Hoe bonds. Id., at 431. holders. As we have said, Guaranty Trust Co. became depositary of the company's funds,258 and it extended a line of credit to the company.259 In 1926 the Hoe company executed a loan agreement and deposited as security for its loans receivables "approximately equaling the amount of the loan" 260 from the Guaranty, then approximately $1,700,000.261 In 1928, this agreement was modified. The collateral was increased to 120 percent of the loan, and Hoe was privileged to withdraw any collateral in excess of that amount.262 Boudinot Atterbury, former officer of Guaranty Company, testified before this Commission that it was "very customary" to have the trustee extend lines of credit to the mortgagor and that in this case counsel did not advise against it: "Q. Do you recall any conversations respecting the desirability of the Guaranty Trust Company being trustee under the mortgage as well as the lender of funds to the company on a line of credit? A. No, I don't. Q. Do you know if that was ever discussed with any of your counsel or associates? A. So far as I can recall there was no conversation along that line. It was a very customary arrangement. Q. You say that was customary? A. Very customary. It seems to me a very customary arrangement that the same institution which is trustee of a bond issue should be available for banking support for the company. It is likely to know the situation more intimately than some outside institution, and would have a real interest in de veloping it and supporting it in every way possible. Q. In other words, it was an accepted procedure? A. I think it would be, as a matter of personal opinion, extremely unfortu nate if any question should be raised as to the right of a banking institution to loan to the company for which it acts as trustee, assuming always that it proceeds in good faith. * Q. Isn't there a possibility of essential conflict between a short term creditor and a long term creditor? A. I can conceive that a situation might arise where such a conflict would result, but on the other hand, wouldn't you be depriving a company of valuable banking support, and might you not be handicapping the financing of industry in general if you did make a definite and strict requirement along those lines? I say that the situation should be followed in good faith. Q. You will agree, though, that there are situations which occur where a certain amount of money is available which both short term and long term are after and that there might be a divergence of interest there, and consequently if they have the same person representing both interests, or even the same counsel representing both interests, there may not be fair treatment of either. A. I can easily see that where bad faith was shown there might be a real conflict of interest. 258 Id., at 70. 269 Id., at 69. 200 Id.. at 383. 201 Id., Commission's Exhibit No. 20, 302 Id., at 384-385. Q. To the best of your recollection you would say that your counsel did not advise you against acting in those two capacities? But what transpired makes clear that good faith to the security holders requires that the trustee be freed from such contradictory demands of loyalty. In January, 1932, the Hoe company appeared to be in difficulties. Guaranty proceeded to apply the proceeds of collections on the collateral to reduce the loans.264 Nevertheless, on January 30, 1932, there was $285,300.21 in pledged collateral in excess of 120 per cent of the loan, which Hoe might draw down under the loan agreement, thereby decreasing Guaranty's margin of security.265 So the loan agreement was modified and the right of Hoe to withdraw this collateral was taken away.20 266 Guaranty Company controlled the Hoe company. Consequently on March 17, 1932, the Hoe directors ratified this modification of the loan agreement which resulted in depriving Hoe of the possibilities of using over $200,000.267 On the same day the directors voted to default on the payment of interest due April 1, 1932, on the bonds, of which Guaranty Trust Co. was trustee. The record is clear that Guaranty acted to secure its own position as creditor with knowledge of Hoe's difficulties and the impending default and reorganization. The possibility of a default on the bonds was being discussed in May, 1931,268 and reorganization plans were being considered late in 1931.29 By February 1932, plans for creation of protective committees were under way.270 Apparently the Guaranty's trust officer by March 10, 1932, was aware that the company "has advised us that they will be unable to meet the April 1st interest payments",271 and Guaranty decided not to advise bondholders of this fact.2 272 If this collateral had not been appropriated by Guaranty Trust Co., it could have been withdrawn by Hoe and would have increased the assets to which the bondholders might resort for payment of their claims. But with knowledge of the default, Guaranty's only concern apparently was to protect its own position-collect on its oustanding loans. Guaranty not only withheld information of the 23 Id., at 71-73. There are at the present time restrictions on loans made by mem. ber banks of the Federal Reserve system to their affiliates. See U. S. C., Title 12, Secs. 371c. 221a. 24 Op. cit. supra note 107, at 390. Id., at 395. Id., at 139-140, 390-392. Id., at 392. 208 Id., at 106-107. Id., at 108-109. 270 Id., at 110-111. Id., at 118. Supra, at 39 et seq. |