Trust Indenture Act Of 1939

Posted in Markets Compliance on May 2, 2024
Trust Indenture Act Of 1939

The Trust Indenture Act of 1939 applies to the debt securities such as bonds, debentures, and notes that are offered for public sale. Such securities may be registered under the Securities Act, they may not be offered for sale to the public unless a formal agreement between the issuer of bonds and the bondholder, known as the trust indenture, conforms to the standards of this Act.

Trust Indenture Act Of 1939

The Trust Indenture Act Of 1939

The Trust Indenture Act (TIA) prohibits bond issues valued over $10 million from being offered for sale without a formal written indenture agreement. Both the bond issuer, and the bondholder must sign the agreement, and the signed agreement must fully disclose the particulars of the bond issue. The Act also requires a trustee to be appointed for all bond issues, so that the rights of the bondholders are defined, and not compromised.

The Act was intended to address the loopholes in the trustee system. The bondholders could theoretically force action but often only if they could identify other bondholders who would act with them. Collective action was frequently impractical given the wide geographical distribution of bondholders. Trustees are required to make a list of the investors to communicate with each other.
The Act gave investors more substantive rights, including the right for bondholders to independently pursue legal action for their due payment.

The Act requires that the trustee must be free of issues. The trustees are required to make appropriate disclosures, to the securities holders. If a bond issuer becomes insolvent, the trustee may have the right to seize the bond issuer’s assets and he may sell the assets to recoup the investments.

The debt issuers are expected to disclose the terms in the indenture agreement. A trust indenture is a contract entered into by a bond issuer. The purpose is to protect the interests of the bondholders. The trust indenture mentions the terms and conditions that the issuer, lender, and trustee must abide by during the tenure of the bond. Securities registration requirements do not apply to the bonds issued during the reorganization of a company.

Raising the interest rate on outstanding convertible bonds is not allowed by the SEC. However, bonds of reorganized companies and convertible bonds with increased interest rates continue to fall under the provisions of the Trust Indenture Act.

Understanding The Trust Indenture Act Of 1939

To protect bond investors, Congress passed the Trust Indenture Act of 1939. It forbids the sale of debt securities in a public offering unless they are issued under a qualified indenture.1 The TIA is overseen by the Securities and Exchange Commission (SEC).

To make indenture trustees more proactive in their roles, the Trust Indenture Act was introduced as an amendment to the Securities Act of 1933. It imposes some direct obligations on them, such as reporting requirements.

The purpose of TIA was to address flaws in the trustee system. Trustees’ passive actions, for example, prevented collective bondholder action before the TIA. Individual bondholders could theoretically force action, but only if they could identify other bondholders willing to act alongside them. Given the wide geographical distribution of an issue’s bondholders, collective action was frequently impractical. The act requires trustees to make a list of investors available so that they can communicate with one another.

The TIA of 1939 gave investors more substantive rights, including the ability for an individual bondholder to pursue legal action independently to receive payment. The TIA requires that the appointed trustee have no conflicts of interest with the issuer.

The trustee must also provide relevant information to security holders on a semiannual basis. If a bond issuer goes bankrupt, the appointed trustee may be able to seize the bond issuer’s assets. The assets can then be sold by the trustee to recoup the bondholders’ investments.

Final Thoughts

The Trust Indenture Act (TIA) of 1939 prohibited the sale of bond issues worth more than $10 million without a formal written agreement (an indenture). The indenture must be signed by both the bond issuer and the bondholder, and it must fully disclose the details of the bond issue. It also requires that a trustee be appointed for all bond issues in order to protect bondholders’ rights. The SEC finalized a rule change in 2015 that raised the reporting threshold to $50 million for issues.