and the “equitable equivalent of the rights surrendered” require considerably more exposition.

The fairness and equity of the plan, under present law, depends at least on an implicit determination that "the plan will fully compensate the respective classes of creditors and equity security holders for their respective interest in the debtor or his property." Such a determination normally, although not in every case, involves a valuation of the property and business dealt with. Valuation involves judgment. "Since its application requires a prediction as to what will occur in the future, an estimate as distinguished from mathematical certitude, is all that can be made."

The Bankruptcy Commission (Pt. II, p. 254 n. 9(c)), states that the phrases "reasonable basis for the valuation" or "reasonable probability" are designed to modify the present law. As noted above and discussed more fully at pp. 49-55 of our report, valuation calls for a determination based on reasonable probabilities.

The terms "fair and equitable" have acquired a settled meaning. They may be confused by the changes proposed in both bills. To avoid misunderstanding, we recommend that Clause (B) be amended to require a finding that the plan is "fair and equitable" and that the remainder be deleted.

At pp. 47-51 of our report, we object to the proposed relaxation of the "fair and equitable" standard (C. 7-303(3) and (4), J 7V301(3) and (4)). These objections also extend to their incorporation as exceptions to the "fair and equitable" standard.

In reviewing proposed C. 7–310(d)(2) and J. 7–308(d) (2), we note a possible difficulty not discussed in our report. Findings would be made at confirmation unless the court "previously made findings upon approval of the plan." An order approving a plan as fair and equitable and feasible is based upon evidence developed at the plan hearing. Fairness and feasibility are not tried de novo at confirmation. Nevertheless, these findings, as under present law, should be affirmed in the order of confirmation. Intervening circumstances may require judicial review or notice prior to confirmation. Confirmation of a plan would be futile if, for example, the debtor's factory is destroyed by fire after approval. A change in circumstances between approval and confirmation is rare. But it may occur. An order confirming a plan, which reaffirms that the plan is fair and equitable and feasible, is an acknowledgment that nothing has occurred to warrant a change in the court's basic determination. We believe there are good reasons for retention of such findings in the order of confirmation. TESTIMONY OF PHILIP A. LOOMIS, JR., COMMISSIONER, SECURITIES AND EXCHANGE COMMISSION, ACCOMPANIED BY AARON LEVY, DIRECTOR, DIVISION OF CORPORATE REORGANIZATION, SECURITIES AND EXCHANGE COMMISSION; GRANT GUTHRIE, ASSOCIATE DIRECTOR, DIVISION OF CORPORATE REGULATION; AND PAUL GONSON, ASSOCIATE GENERAL COUNSEL, SECURITIES AND EXCHANGE COMMISSION

Mr. LOOMIS. Mr. Chairman, I am very pleased to be here.

Mr. EDWARDS. Can you introduce, in addition to Mr. Levy, who is with you today?

• Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 526 (1941).

Mr. Looмis. On my left is Mr. Guthrie, Associate Director of that Division; and on my right is Paul Gonson, Associate General Counsel, who handles our appellate work in corporate reorganizations, among other things.

I am pleased to appear before you today to express the Securities and Exchange Commission's view on the proposed bankruptcy legislation, H.R. 31 and H.R. 32.

I will only summarize the prepared testimony since it has been submitted for the record. In December, we submitted a fairly extensive report on this legislation to the Senate committee, a copy of which I believe has been provided to you.

We propose, as soon as possible, to make certain revisions and updating of that report, and submit to you a revised report.

My comments today will be wholly limited to the subject of reorganization or rehabilitation of corporations, particularly publicly owned corporations, which is provided for in chapter VII of the Bankruptcy Commission's bill. Our experience with, and knowledge of, ordinary bankruptcy proceedings is not sufficient to qualify us to make a contribution to that subject.

In that connection, I note that ordinary bankruptcy proceedings, including consumer bankruptcy, constitute the great bulk of the business of the bankruptcy courts, and naturally, these were the primary concerns of the Bankruptcy Commission.

On the other hand, corporate reorganizations have been a matter of concern to the SEC ever since 1934 when it was directed by the Congress in the Securities Exchange Act of that year to make a study, which, in turn, led to the enactment of chapter X of the Bankruptcy Act in 1938, under which the SEC has had significant responsibilities ever since.

Chapter X is not extraneous to the main thrust of SEC's work as the Bankruptcy Commission seems to have thought, since, as the Supreme Court has recognized, and indeed as the Bankruptcy Commission has recognized, chapter X is, in important part, an investor protection statute.

Chapter XI is designed to provide a quick and equitable way to adjust unsecured debts to trade creditors and banks or other commercial and institutional lenders.

In order to consolidate chapters X and XI, the Bankruptcy Commission had to work out a number of different compromises in order to try to provide a chapter which would work in both types of cases. We are concerned that in doing so we may have created a situation in which the protection for public investors provided in existing chapter X might be seriously compromised or eroded.

We do not entirely reject the idea of combination because we understand the Bankruptcy Commission's belief that it would be desirable to avoid unfruitful controversies and litigation as to which chapter

a corporation should elect to file under. But we do feel that the compromises proposed must be modified in order to preserve investor pro

tections.

One of the major reforms enacted by the Congress in 1938 was the provision for a mandatory appointment of the disinterested trustee whenever the debtor's liabilities exceeded $25,000. This trustee is a key person in the reorganization of a large organization.

On the other hand, a trustee is not needed in the average chapter XI case. So, what the bill does is to allow the court in some circumstances to dispense with the trustee in either kind of case.

We do not believe that should occur. We think that the trustee should continue to be mandatory in the case of a large publicly owned corporation, subject perhaps to a possible exception when they are not significantly reorganizing the company.

Turning now to the fair and equitable standard, a reorganization plan under existing chapter X is required to conform to the "fair and equitable" standard.

This, under applicable decisions of the Supreme Court, incorporates the "absolute priority role" which in general terms means-as the Bankruptcy Commission pointed out "that a junior interest may not be retained unless claims of senior interests are fully satisfied." Chapter XI, on the other hand, was amended in 1952 to eliminate the fair and equitable standard. This seems clearly required for the purposes of a typical composition with creditors in a chapter XI situation, since such a composition, by its very nature, contemplates that the equity interest will be retained even though the rights of creditors are to some degree modified. Such treatment is usually satisfactory to trade creditors who may look forward to future profitable business with the debtor, if the composition is successful.

Again, the Bankruptcy Commission had to try to compromise this successfully. The issue was a difficult one, and we think one of their compromises was an ingenious one having considerable merit. The absolute priority rule calls for a determination as to the future value of the reorganized business, which is very difficult to make with the precision that the absolute priority rule seems to contemplate.

Specifically, we agree, in principle, with the provisions in section 7-310 of the Bankruptcy Commission's bill, which allows for the elimination of the absolute priority rule whenever the creditors agree that there is no material effect on public investors.

This would allow the retention of the current chapter XI practice where trade creditors and banks, which usually expect to continue doing business with the rehabilitated company, are sometimes willing to forego some of their recovery. The section would require, however, the consent of all creditors to allow public stockholders to participate in the reorganization of an insolvent debtor. We see no reason to allow one creditor to block such a reorganization, and so we favor the retention of the current chapter XI requirement of approval by a majority of each class of creditors.

We oppose the two further modifications of the absolute priority rule. Section 7-303 authorizes a plan to provide for participation by

equity holders even when the company is insolvent if the court finds that they will make a contribution which is important to the operation of the reorganized debtor or the successor under the plan, a provision which would overrule a decision of the Supreme Court to the contrary. We do not believe particularly where the management runs the company that this kind of designation is justified.

Similarly, we do not support delayed contingent participation rights a person who would otherwise receive nothing under the fair and equitable standard would be given contingent participation rights in hopes that things would work out within 5 years.

We think that the burden of this overhanging contingency, particularly on subsequent public offerings of securities and on the market price of securities issued under the plan, outweighs any benefits to an excluded class.

We have a special concern with proposed section 4-406 which subordinates claims based on violations of the securities laws. The proposal is inconsistent with the Supreme Court's decision in Oppenheimer v. Harriman National Bank.

The same issue has also been raised in half a dozen or so cases of massive securities fraud, such as Westec, Four Seasons, and Equity Funding. In such a situation there is a conflict between the expectations of creditors that shareholder interests would be subordinated and the equities of investors who have been defrauded in violation of the securities laws, but we think that the legislative abolition of the latter type of claim is a Draconian solution.

Ever since 1938, the Commission has had significant functions and responsibilities with respect to reorganizations under chapter XI. The principal function is appearing in the case of large, publicly held corporations. There is participation with respect to all significant decisions as a representative of public investors and filing an advisory report with respect to plans of reorganization. The Bankruptcy Commission proposes to terminate this primarily because they think it is undesirable for both the administrator and other agencies to perform similar functions, and secondarily, that the SEC's work in reorganization proceedings is tangential to its major statutory duty and has not been adequately funded in the past.

We think these reasons lose sight of the importance of investor protection in such reorganization proceedings, and of the fact that not only the provisions for the SEC's participation, but many other provisions of chapter X are designed to provide protection for public investors. In that way chapter X is an important investor protection statute.

Consequently, we feel that it is not tangential to our investor protection responsibilities, and it might be equally tangential to the administrator who is concerned with consumer bankruptcy and ordinary bankruptcy.

Similarly, with respect to chapter X, it permits the participation of representatives of various classes of creditors and stockholders in order to assure fair representation. They can be compensated if they served a useful purpose.

In chapter XI, on the other hand, there is only one committee composed of major security creditors.

We think, particularly in the case of publicly owned corporations, an official committee composed of major creditors such as banks and suppliers would not provide adequate representation for public investors and the chapter X representation arrangement is preferable in the cases of large, public owned corporations.

I now come to some other matters. Departing from the present chapter X Bankruptcy Commission proposes that distribution under the reorganization plan not be made to the holders of record until the order confirming the plan becomes final.

In our view, this change appears to work an automatic stay which,. in the case of a frivolous appeal, would be detrimental to public investors. The bill should be changed to make stays of unconfirmed plans of reorganization pending appeal remain discretionary with the trial and the appellate court, which is the present tactic.

We propose to revise our reports to discuss this particular question.. In the foregoing discussion, I have necessarily concentrated on those provisions in the bill as to which we disagree with the Bankruptcy Commission.

However, I would not like to leave the impression, as a result of this emphasis, that we do not find improvements over the current law which would be made by the proposed legislation.

A few examples follow.

Section 7-203 codifies several court decisions that the SEC has supported, which held that a trustee might continue to utilize property of an estate subject to liens and its proceeds in the operation of a business of the debtor.

Section 7-204 provides that the filing of the petition for rehabilitation shall operate as a stay of any set-offs, codifying the case law and recognizing the practices in chapter X cases to that effect, a position which the SEC has supported in the courts.

We believe that these two sections, taken together, increase the potential for a successful reorganization by making clear that the trustee may utilize assets subject to security interests or set-off.

Another improvement is section 4-313, which corrects to a great extent the existing discrepancy between the law of immunity in bankruptcy proceedings and that applying to immunity generally.

Present section 7a (10) of the Bankruptcy Act provides for an automatic immunity to be conferred upon the testimony given by the persons who testify on behalf of the debtor and for any use which is made of that testimony.

Because many of the chapter X and XI proceedings in which the SEC has participated have involved conduct which may be an issue in future criminal cases, the automatic grant of immunity in the present Bankruptcy Act raises disturbing questions concerning possible prejudice to those cases.

Section 4-313 would delete the automatic immunity presently contained in section 7a (10) and substitute the requirement that the privilege against self-incrimination be properly invoked.

Accordingly, any person who would be required to testify before the administrator or the bankruptcy court would not be granted automatic immunity. If he objected to a question, he would have to claim his privilege against self-incrimination.