Recent disclosures of accounting irregularities at major public companies - including some that involved securities fraud lawsuits and investigations by the Securities and Exchange Commission - may put pressure on banks that act as indenture trustees representing bondholders to bring securities fraud actions themselves.
However, the general - though sometimes forgotten - rule is that indenture trustees do not have authority to bring such actions, no matter how much the companies' investors or other constituencies may clamor for them. These lawsuits are most typically brought on behalf of people who had bought the company's securities - usually when they were first issued. Trustees, on the other hand, brought in to collect past-due amounts under the bonds on behalf of current securities holders, whom indenture trustees are deemed to protect.
Over the years, those who have sought to defend the right of indenture trustees to bring securities fraud actions have generally relied on several arguments, or variations on them. Trustees are typically authorized under indentures to pursue "any available remedy," and their heightened post-default duties require them to bring legal action, some arguments go. To the extent that individual bondholders do not take legal action because indenture provisions require them to satisfy certain conditions first, implicitly, the right to pursue securities fraud lawsuits must reside with the trustee.
Responding to these arguments, courts have consistently distinguished between ordinary trustees, who exercise common law duties, and indenture trustees, whose duties and obligations are defined exclusively by the terms of the indenture. Banks that act as indenture trustees are more like stakeholders whose duties and obligations are defined by the indenture.
Courts have held that the "any available remedy" clause common among indentures only authorizes certain remedial actions. These actions must be aimed at collecting the principal, premium (if any), and interest on the bonds, and to enforce the terms and provisions of the indenture and the bonds. Only in some instances - in which indenture trustees have explicitly been given a broad grant of authority to protect and enforce the trustee's rights and the rights of the bondholders - have courts upheld the standing of trustees to bring outside tort and fraud claims.
Conversely, if trustees do have the right to assert fraud claims against bond issuers and others - such as the issuer's accountants and investment bankers - they may have to consider the extent to which they have an obligation to investigate, perhaps at considerable expense and with potential liability, whether such claims are valid.
It is generally recognized that indenture trustees have expanded post-default duties. These include the duty to use the same degree of care and skill in the exercise of their rights and powers as a prudent person would use under the circumstances in conducting his or her own affairs. That said, courts have been consistently unwilling to expand trustees' post-default powers beyond those duties specifically set forth in the indenture.
Another argument sometimes used to make the case for trustee lawsuits is that forbidding these suits leaves bondholders virtually powerless to remedy the fraud committed by issuers of public debt. The so-called "no action" clause in many indentures limits the ability of individual bondholders to pursue remedies until the holders have satisfied certain conditions. These conditions include: notice to the trustee that a default has occurred and is continuing; a written request to the trustee by a requisite percentage of holders to pursue a remedy or remedies; an offer of satisfactory indemnity to the trustee by the bondholders; and the failure of the trustee to comply with the bondholder's request within 60 days after receipt of the request and offer of indemnity.
But these limitations apply only to remedies expressly under the indenture and the bonds. The bondholders' right to pursue fraud claims derives not from the indenture, but from federal securities law and an individual bondholder may therefore bring such a claim - at its own expense.
Some legal commentators have argued that it would be both inappropriate and a conflict of interest for an indenture trustee of current bondholders to bring a securities fraud action. An American Bar Association committee, for example, summarized some of the various conflict-of-interest issues and other matters that have been used to argue against indenture trustees bringing securities fraud suits in an article in the May 2000 issue of the trade group's magazine, The Business Lawyer.
That summary names at least four ways in which pursuing a fraud claim could create a conflict for the trustee. One is that fraud claims may be brought by people who no longer hold the securities - and who sold their securities after the fraud was discovered - as well as by individuals who continue to hold the securities. And securities holders may have different rights, depending on when they purchased their securities and the extent to which they can prove reliance on the fraud.
Furthermore, recoveries by holders of fraud claims may prejudice collections by current holders. Finally, securities fraud claims may be subordinated to the claims on the securities by current holders, which would raise conflicting interests between fraud claimants and current holders over the desirability of, or distributions in, bankruptcy proceedings.
These factors, among others, have been viewed as limiting both the opportunity and the responsibility of banks acting as indenture trustees to bring securities fraud actions on behalf of bondholders.
These factors and relevant case law may be viewed also as protecting and vindicating indenture trustees from responsibility to investigate or bring potentially aggressive, expensive, and uncertain fraud actions - particularly when such actions might benefit only historical holders of bonds and not the current holders, whom the trustees represent directly.
