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standard that would be exceedingly difficult for any administrative agency to apply. That would involve almost the trial of a lawsuit. In view of the difficulty of selection and classification, it seems to us that complete disqualification, as a rule of thumb, is the only sensible, practical proposition.

The CHAIRMAN. Speaking broadly, Mr. Douglas, what obligations do underwriters ordinarily assume as affecting the security holders? Commissioner DOUGLAS. The underwriter professes to assume, and certainly the most reputable ones endeavor faithfully to assume, the task of getting a committee organized; going on the committee; getting other people to go on the committee; drafting the deposit agreement; perhaps loaning the committee money; perhaps giving the committee the facilities of its office; making detailed engineering analyses or accounting analyses or financial analyses of the company; actually writing a plan; getting counsel for the house of issue to be counsel to the committee, and carrying the burden of the work of reorganization on their shoulders.

I mean, they are normally right in the center of the whole picture. The CHAIRMAN. What I really had in mind was the obligation assumed by the underwriter prior to the existence of any committee. Commissioner DOUGLAS. Well, that varies from case to case. They commonly profess to have a moral obligation to watch out for any defaults, to watch the developments in the company prior to default and the formation of a committee to see whether or not that company should reorganized and to advise security holders of plans for reoganization.

At that stage it is one of watchfulness to see to it that security holders are properly advised of developments in the business that may adversely affect their interests.

Now, coming down to subdivision (4) on page 25

Mr. MAPES. Mr. Chairman.

The CHAIRMAN. Mr. Mapes.

Basic theory of bill.

Mr. MAPES. Have you seen a copy of a memorandum dated June 16, 1937, by Jacob K. Javits, a member of the New York bar, which was sent to me, and, I assume, to the other members of the committee, criticizing this bill?

Commissioner DOUGLAS. What is the author's name?

Mr. MAPES. Javits.

Commissioner DOUGLAS. I may have seen it, sir. I do not recall. Mr. MAPES. He describes himself as a member of the New York bar, 165 Broadway, New York City.

Commissioner DOUGLAS. I do not recall it. It may have come to the office.

Mr. MAPES. In the brief there is this statement:

The firm of which I am a member has for some years represented independent protective committees in various reorganizations. We have not represented "company" or "bankers" committees.

On this question of allowing underwriters to be members of protective committees, there is this paragraph:

Enactment of the bill would, I believe, favor action in person or through their personal representatives by individual holders of large amounts of securities in corporations undergoing reorganization or debt adjustment. This type of action

is often not motivated by the same objectives which should motivate the independent security holder or his committee representatives and often involves conflicting interests on persons or personal considerations.

And the following sentence is underlined:

Rather than discourage participation in recrganizations by underwriters and management, who are most often the largest individual security holders, the bill would encourage it and aid in removing the only effective "opposition" (independent protective committees) which now exists.

What do you say to that?

Commissioner DOUGLAS. Why, the logic of that does not impress me, as I read this bill. The underwriters form and set up a strawman committee. The fact that this committee was a nominee of the underwriters, would be grounds for issuance of a refusal order or stop order by the Commission.

As to the second point, as I understand his memorandum, the independent committees would not be disqualified or even discouraged, in my judgment, unless they happen to run afoul of one of these provisions.

Independent committees have not always been of the purest variety. Our investigation indicates that. Frequently they have been trading in the securities. Frequently they have been representing preferred stock, owning nothing but common stock, and so on.

The bill would not prevent the formation of committees that were representative of the owners of the securities. It certainly would prevent and to this extent the author of that memorandum is correct-it would certainly prevent the formation of certain types of committees that have roved this field in recent years, and some of those have been so-called independent committees, sailing under false colors.

We review those at great length in this report.

Mr. MAPES. I looked this memorandum over when it came in a month or so ago and put it in my desk here; but I know nothing about the author of it.

As I recall, the sense of it was that the bill was so stringent that it would be apt to make it impossible for men who knew about a business to have anything to do with a reorganization of it. That, perhaps, is too broad a statement, but it is along that line.

Commissioner DOUGLAS. I should think that the bill, if enacted into law, in substantially this form, ought to encourage the formation of proper committees rather than discourage them.

Mr. MAPES. What do you say as to the criticism about the difficulty of getting men of experience and standing who understand the business to qualify under this bill?

Commissioner DOUGLAS. Why, many committees at the present time have to register under the Securities Act of 1933. There are liabilities under that act, and this committee heard, several years ago, the cries which went up over the so-called terrific responsibility and so on. That liability is not light.

We have not observed, however, that that has terrified people into not forming committees. They come in in considerable numbers and assume the responsibilities under that statute.

Mr. MAPES. This bill differs somewhat, does it not, from the Securities Act, in that the Securities Act requires complete disclosure? Commissioner DOUGLAS. Plus liability.

Mr. MAPES. Plus liabilities?

Commissioner DOUGLAS. And it emphasizes that.

Mr. MAPES. But this, in addition to requiring complete disclosure, gives the Commission a great deal of power in determining as to the conflicting interests and other qualifications of men to serve on the committee, does it not?

Commissioner DOUGLAS. That is true, sir. It is quite different from the Securities Act. My point is this: If the committees will operate under the Securities Act, where there is a possibility of liability, they would be even more apt to act under a statute which is a disqualifying statute rather than a liability statute. I mean, the committee would submit its papers to the Commission, and the Commission either would say "you are disqualified"; or "you are, in our judgment, not disqualified"; and, in the latter case, the committee would then go ahead. The honest, upright, open, and aboveboard committee would lay its cards on the table and get a confirmation on this point of conflict of interests before it started operations.

Mr. MAPES. Do you think the Commission ought to have that final power to determine who shall serve on the committees rather than the parties in interest themselves, if they know all the facts?

Commissioner DOUGLAS. I do not think so, if we were dealing with a simple situation where there were groups no larger than those in this room, who could make their own bargain. But in these reorganization situations, the investors do not have a chance to make their own bargain.

A committee is announced and the security holder has a thousanddollar investment or a $5,000 investment or a $10,000 investment. What can he do? For all practical purposes, he can do very little except to follow the leadership of that committee. He can hire a lawyer. Perhaps he can form another committee; but once he starts doing that, he starts running into money, and for him to start on a national basis and organize a group that will represent him, he is up against a very, very difficult proposition. For all practical purposes, he cannot do it.

He has to have a list of the security holders, to begin with. He has to have some financial resources, in the second place.

The history of reorganization shows, I think, that the fate of investors is in the hands of one or two committees; that they are subject to the leadership of one or two; that they have little choice but to go along with that committee. As some of the reorganization experts testifying before our Commission said, they have nothing but a Hobson's choice. If they do not go along, they are apt to be frozen If they do go along, they are apt to pay a heavy, heavy price. I think, on a strictly logical basis, sir, you are quite sound in your observation that the parties should be able to make their own bargain on the basis of disclosure; but as we have observed the situationlooking at it from a national point of view, with security holders scattered all over the country-they are not in a position to make their own bargain.

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Mr. MAPES. This, of course, puts the Commission in what some people term "management.'

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Commissioner DOUGLAS. I do not think so, sir. I would disagree with that.

Mr. MAPES. Well, perhaps that is not the right word. But, instead of requiring disclosure and regulation and stopping there, it would give the Commission discretion to exercise its judgment, superimpose its judgment, upon those interested, from your own statement, would it not?

Commissioner DOUGLAS. Yes, it would.

Mr. MAPES. Is there some reason why this should be done with regard to this particular problem that does not apply to business generally?

Commissioner DOUGLAS. That is why the Commission should be given power to say "No, Mr. X, you cannot go on a protective committee because you have a conflict of interests."

Mr. MAPES. Yes; if all of the interested parties know of this conflict of interests, is there some reason why the Securities and Exchange Commission should be given control over these reorganization matters to that extent? That goes further it seems to me than most regulatory bodies are allowed to go.

Commissioner DOUGLAS. Well, I think it is the realization of the fact that merely telling the security holders, in a registration statement under the Securities Act, the truth, the whole truth, and nothing but the truth, is of little help to the security holders in these reorganization situations, in view of the fact that they are at the mercy, the rather complete mercy, of the dominant group in the reorganization. And, for me, a security holder, to know that the person at whose hands I am subjected is a faithless fiduciary is small comfort. The fact that he can trade in the securities and is trading in them; the fact that he owns stock rather than bonds; the fact that he has sold me the securities under questionable circumstances; to know all of that and still be forced to follow his leadership and be under his domination, is no real protection.

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Mr. MAPES. If the people financially interested, know all of those things, and they prefer to have him under those conditions, think he is the best qualified to reorganize the property; notwithstanding that, you think the Commission should have the power to say that he should not be allowed to do so?

Commissioner DOUGLAS. I do not say "notwithstanding that", sir; I say that is a situation that is very unlikely to exist.

I say, if those in this room got together and wanted to designate X, Y, and Z as a committee, knowing that X, Y, Z had all sorts of conflicts of interest, but, knowing that, said, "Well, let us go ahead anyway, because we believe in these men"; that is one thing. But, that is not the situation that we are dealing with. That is not, in my judgment, the real situation existing in the reorganization field. The investors are scattered throughout 48 States. They have no real voice in the selection of the committees. These committees spring up, self-constituted, self-appointed, self-anointed, and they announce themselves and ask for proxies and deposits.

Mr. MAPES. I think it can be assumed that everybody in this room, at least, is in favor of the objective which you have in mind, namely, the protection of the security holders.

I have been impressed with the criticism, however, that if you get men who are not interested in the company to reorganize it you may not get the best kind of a man to do the job.

Commissioner DOUGLAS. Well, that is, of course, a difficult thing to pass judgment upon. That is a matter of predicting.

But, I merely submit to you for consideration the fact that those who have appeared so far, in opposition to this bill, certainly have something more than mere altruism at stake. They have an economic, vested interest there to protect.

Mr. MAPES. Oh, yes, that is true.

Provisions of proxies and deposits.

Commissioner DOUGLAS. Coming down, Mr. Chairman, to subdivision (4) on page 25; subdivision (4) of section 6 (a): We reach there another phase of this broad problem of conflicts of interest.

I indicated earlier that this bill was not concerned merely with disclosure and with the disqualification for membership on committees of those who had conflicts of interests; but also the protection of security holders against the assumption by committees of unwarranted powers.

Subdivision (4) of section 6 (a) would require the Commission to look at the proxies and deposit agreements proposed to be employed by committees and say these proxies and these deposit agreements meet the requirements of this statute.

What are the requirements of this bill? Well, section 10 (a)-and I think it might be desirable to touch on 10 (a) at this point, because it involves one of the required findings as respects proxies and deposit agreements under section 6. Section 10 (a) begins on page 35.

Fees and expenses.

The first thing that the Commission would have to determine under section 6 (a) (4) would be that the particular proxy or the particular deposit agreement that the committee proposes to use contains adequate provision for review and determination of fees and expenses of the committee, by a person who is independent of the committee, or by some governmental agency. It has been the common practice, as revealed in our reports, for committees to be the sole arbiters of the reasonableness of their own fees; to determine, themselves, by themselves, how much their services were worth.

It has been the common practice of committees to determine the propriety, the reasonableness, of their own expenses. This bill would put a halt to that. This bill would require each committee to make a provision to provide by contract-in the deposit agreement or proxy that some other person would sit as a board or as a reviewing agency on its fees and on its expenses. That one single thing in this bill would put an end to some of the unconscionable practices which, as revealed at length in our reports, have prevailed. The requirement that that provision be in each such agreement is not a theoretical matter. There has been a broad experience in that connection. We review it at length in our real-estate report, where we show the practice instituted by Judge Mack in connection with the G. L. Miller reorganization and carried over to some other real-estate reorganizations. Under that system the committees themselves selected a person and designated that person in the deposit agreement, or they designated the machinery whereby such a person should be chosen as the person to pass upon the reasonableness of the fees and expenses of the committee. This would be required under this bill for every committee, so that no longer would you have a committee sitting in solemn judgment on the worth of its own services.

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