The term "associate" is used in section 5 and in schedules A and B, all of which relate to the information which is to be contained in the declaration required to be filed. A person filing it has to file information about himself and his associates.

The term also appears in section 7, which authorizes the Commission to refuse to permit a declaration to become effective if it finds that the declarant or any member of the declarant is an associate of a person who would be disqualified from being a declarant. One example would be this: Suppose that A is disqualified from being a declarant that is, from forming a committee by the terms of this bill. B seeks to become a member of the committee. B is owned and controlled, lock, stock, and barrel, by A. Since A is disqualified, B likewise should be disqualified, because he is nothing more nor less than an al ter ego of A.

Now, the definition of "associate" is designed to embrace those relationships which are so close and intimate as to give rise to a strong inference that the person who has that relationship carries the disabilities and disqualifications of the other person. I am disqualified; my partner should likewise be disqualified. A corporation is disqualified, for instance, and I am president of the corporation. There again, I should be disqualified.

I do not know that I need to go down through all of these variations on the definition of an associate. It is just a concept to make impossible or less likely that the provisions of this bill would be evaded and that persons who are disqualified would nevertheless have other sympathetic persons with close relationships to them in there, doing their essential work.

Mr. MARTIN. Is there a definition of "declarant" in the bill? Commissioner DOUGLAS. Yes; declarant-no, not of declarant. "Declaration."

Mr. MARTIN. Declaration is defined?
Commissioner DOUGLAS. Yes.

Mr. MARTIN. Let me ask another question here.

Is the underwriter usually an investment banker?

Commissioner DOUGLAS. Oh, yes, sir; almost without exception. Disqualification of Investment Bankers and Management.

Mr. MARTIN. Now, the investment bankers are excluded or disqualified?

Commissioner DOUGLAS. That is correct, with the one exception, where the Commission, under the definition of underwriter on page 11 (sec. 2 (a) (18)), would have the power to say that A or B or X would not be an underwriter for the purposes of the disqualification section where the Commission determined that the exclusion of A, B, or X from that definition would not be detrimental to the public interest or the interest of the investors.

Mr. MARTIN. Is that paragraph (18) on page 11?

Commissioner DOUGLAS. That is correct; but with that exception, the underwriter falls within the disqualified class.

Mr. MARTIN. And the management of a corporation in reorganization is disqualified?

Commissioner DOUGLAS. The management is in the case of reorganization; it is not in the case of a voluntary readjustment. Mr. MARTIN. I mean in reorganization.

Commissioner DOUGLAS. And may I say on your question as to to investment bankers, it does not mean, as I read the Lea bill, that no investment banker may become a member of a protective committee. It means this: If I am an investment banker and I have underwritten and sold to the public the first mortgage bonds of X company, which bonds are in default, I cannot go on any committee for the securities of X company. But if I have underwritten bonds of X company which are in default and the securities of Y company go into default, I am not disqualified by reason of being an underwriter of securities of X company from becoming a member of the committee for the securities of Y company.

Mr. MARTIN. Has it been considered as to whether any particition or representation could be given to the underwriter or management?

Commissioner DOUGLAS. Any participation?

Mr. MARTIN. Yes.

Commissioner DOUGLAS. That is a problem to which we have given great thought. And, the best judgment that we have on it at the present time, sir, is that it would be extremely difficult to put that on any discretionary or administrative basis whereby the Commission would be faced with the problem of selecting the good ones from the bad ones; where the Commission would be under the necessity of making an appraisal of a particular situation and saying there is or there is not a material conflict of interest here.

Our best judgment at the present time is that the only satisfactory or workable way to handle it would be to provide a rule of thumb. The rule of thumb indicated and the rule of thumb which the Commission does recommend to the committee at this time is that one provided in section 6, namely, a disqualification.

Mr. MARTIN. How is the size of protective committees determined? Commissioner DOUGLAS. I beg your pardon.

Mr. MARTIN. How is the size of protective committees determined? Is there any limitation as to the number of persons who may be represented on a protective committee?

Commissioner DOUGLAS. The Lea bill, as I read it, is designed to control what might generally be called public solicitation. There is an exemption in line 14, page 17, section 3 (c), for action by small groups. I and 11 of my fellow security holders can get together. So long as there is no group larger than 12, we can get together and give proxies to each other and make deposit agreements willy-nilly, without let or hindrance, because we are dealing with a small group and presumably that group knows what it is about and does not need the arm of Congress to protect it. But at some point along there the distinction between a private solicitation and a public solicitation becomes clear. Twelve may not be the right figure. I hold no brief for 12. I think that in section 77 of the Bankruptcy Act dealing with the reorganization of railroads the Congress intended to provide that groups of 25 or less could solicit without let or hindrance, without coming under the control of the Interstate Commerce Commission. Perhaps 25 is the more adequate figure. I think 12 or 25, or some such figure, is suggestive of the correct policy and is sound, namely, that the solicitation which should be subjected to the conditioning influence of any such legislation as this should be a public solicitation. Mr. MARTIN. Are those protective committees, as they have operated so far, are they very large groups, or are they limited?

Commissioner DOUGLAS. They usually have a membership of not less than three. Occasionally you will find a corporation forming a protective committee, being a protective committee itself. In the early stages of the reorganization of the real-estate issues of the Commonwealth Bond Corporation-I think it was up in New Yorkthe Commonwealth Bond Corporation, the house of issue, was the committee.

Mr. MARTIN. What?

Commissioner DOUGLAS. It was the committee. It was a house of issue and it was the committee. That is a little unusual. Normally, committees are composed of individuals, usually three, or five or seven.

EXEMPTIONS

The exemptions beginning on page 14, section 3, are to some extent comparable to the exemptions under the Securities Act. The first one on line 16, page 14, section 3 (a) (1), is an attempt, as I read it, to make the bill a flexible bill to some extent, as to reorganizations which are pending at the effective date of the statute.

Existing Committees.

I am not at all sure that section 3 (a) (1) beginning on line 18 is adequate. I feel, however, that if the bill became a law that it would be desirable to apply it so far as practicable to pending reorganizations; that is, to reorganizations not consummated at the time of the enactment of the bill.

Now, obviously, the bill could not reach back and undo reorganizations that had been done. But suppose A, B, and C form a committee, and the day before the bill becomes effective they announce its formation. Since they are just under way, there is no reason why they should not come in under the bill.

The standard suggested in 3 (a) (1) is that any committee comes in under the bill, unless it has obtained proxies or deposits in support of the adoption or approval of a plan from 50 percent or more of the amount of any class of securities outstanding. That is indicative of the fact that when a committee gets such a substantial percentage back of it, the reorganization is well along and in an advanced, mature stage.

Solicitation, like the public offering of securities for sale is a continuing process. Where at the effective date of the act solicitation has barely gotten under way, the general policy of the bill requires that it be made applicable to any further solicitation. But, as I have said, practical as well as theoretical considerations are against applying the bill to reorganizations which are substantially completed on its effective date.

Some more or less arbitrary line must be drawn. Wherever it is drawn, the distinction should, of course, be based upon the stage reached at the time the act became effective.

Mr. MARTIN. Let me ask you a question there.

if

Is it the situation now that any person, or any group of persons, they move first and are successful, may get the control of reorgani

zation?

Commissioner DOUGLAS. There is not any doubt about that. Mr. MARTIN. Can the first man, without any relation of law, who jumps into the breach, if he is successful, get control of reorganization? Commissioner DOUGLAS. There is no doubt about that, sir.

Mr. MARTIN. And, he can do that without regard to his own financial responsibility or rating. Is that so?

Commissioner DOUGLAS. Yes; that certainly is true.

He may be, as has certainly not been uncommon, the substantial stockholder, or the owner of a substantial junior interest in the company. Yet he may set himself up as a first mortgage bondholder protective committee. But it is to the interest of the first-mortgage bondholders not to get into the hands of the second-mortgage bondholders.

Mr. MARTIN. Then if he gets control of the reorganization he could control primarily in his own interest, could he?

There is no
That is

Commissioner DOUGLAS. There is no doubt about it. doubt about it. And the fact is that that has been done. not just an academic observation or a guess, or a theoretical supposition. That is a reality, sir.

The reorganization processes in the last 4 or 5 years have been rife with such practices. There is no doubt about it that great oppression and damage to the security holders has been done as a consequence. Mr. MARTIN. If such interests had advance information they would be in a position to have and they could have their plans already to

move.

Commissioner DOUGLAS. Yes. Take the case of real estate reorganizations, which I think are adequately covered in our report on real estate committees. There you find most of these reorganization problems in miniature form. In essence the larger reorganizations are merely embellishments on the procedure and strategy followed in the smaller real estate cases, where you get relatively simple situations. There, for example, Straus (not always, but in the vast majority of cases) was heavily interested in the junior securities. It was forming first-mortgage bondholders' committees, and it worked out reorganization plans which made it almost certain that the junior and equity interest of Straus would not be wiped out. And they rationalized that procedure on a lot of different grounds.

Now, as to the solicitation of assents in a pending case, as I indicated, section 3 (a) (1) is merely suggestive. I hold no particular brief for that particular provision. Perhaps it goes too far. I merely want to indicate to the committee that I think it would be too bad if this bill were passed and had no application whatsoever to pending cases. Certainly there are many pending cases to which the bill should be applicable.

Railroad Committees.

The exemption in line 4, page 15 (sec. 3 (a) (2)), is deemed necessary, I think, by reason of the fact that such solicitation comes under the jurisdiction of the Interstate Commerce Commission by reason of section 77 of the Bankruptcy Act governing railroad reorganizations. There is no attempt here to impair the jurisdiction of the Interstate Commerce Commission. It keeps precisely what it has

under that statute.

Banking and Insurance.

The other exemption, line 8 (sec. 3 (a) (3)), is also designed to avoid interference with existing supervision over reorganizations in the hands of agencies like the Comptroller of the Currency, bank commissioners, insurance commissioners and other agencies of States or Territories.

The CHAIRMAN. Is the control under those agencies fairly comparable to the control that would be granted by this bill in other cases? Commissioner DOUGLAS. I do not think it is quite that. But nevertheless, these commissioners and commissions, and agencies, have worked out a reorganization technique for handling the job which a local statute or a Federal statute has placed upon them. It seems to us undesirable to superimpose over that regulation another administrative regulation. If the present jurisdiction which any of those other agencies have is not adequate, I think that it should be built up, not through this measure, but through the other statutes granting those agencies power and jurisdiction.

The CHAIRMAN. Suppose those agencies fall into the control of selfish interests. That much probably could be said about these existing schemes of control.

Commissioner DOUGLAS. Yes; that is true, sir.

Existing Committees.

Mr. EICHER. Mr. Chairman

The CHAIRMAN. Mr. Eicher.

Mr. EICHER. Mr. Douglas, going back to section 3 (a) (1) for a moment, to what extent do you think that sections 16 and 23 with their inhibitions against untrue statements or misleading statements would be considered as being effective retroactively against solicitations that have been made prior to the effective date of the act?

Commissioner DOUGLAS. I do not think that they should apply to solicitations made prior to the effective date of the act. I do think that if the committee gets exemption by reason of the provisions of 3 (a) (1) so that it can solicit without qualifying under the bill, it should not be free from the provisions of sections 16 and 23.

If, in the case of future solicitations, it makes misrepresentations, engages in fraudulent practices, I should think that committee should be subjected to the provisions of section 16 and section 23. That technique is carried over from the Securities Act where even though particular issuers do not have to register under the Securities Act, nevertheless if they engage in fraudulent practices, they run afoul of section 17 of the Securities Act dealing with misleading statements and section 24 dealing with criminal penalties.

I do not think, in precise answer to your question, sir, that this bill should be retroactive. I think the penalties of sections 16 and 23 should apply only to future solicitations.

Mr. EICHER. One of the questions that comes to my mind is whether or not a dissenting security holder might, under the language of the bill, come in to Court later on and attempt to invalidate the reorganization on the ground that prior solicitations had occurred in violation of sections 16 and 23.

Commissioner DOUGLAS. If that is a possible interpretation, I think that section 3 (a) (1) should certainly be clarified. And, I think that perhaps

Mr. EICHER. 23 is the penalty section?

Commissioner DOUGLAS. Yes; that is the criminal penalty section. Mr. EICHER. Yes.

Commissioner DOUGLAS. Section 16, as I see it, would primarily embrace the powers of the Commission to get an injunction.