DEFINITION of Trust Indenture Act of 1939
The Trust Indenture Act (TIA) of 1939 is a federal law passed in 1939 that prohibits bond issues valued over $5 million from being offered for sale without a formal written agreement (an indenture), signed by both the bond issuer and the bondholder, that fully discloses the particulars of the bond issue. The act also requires that a trustee be appointed for all bond issues, so that the rights of bondholders are not compromised.
BREAKING DOWN Trust Indenture Act of 1939
The Trust Indenture Act (TIA) of 1939 prohibits the sale of any debt securities in a public offering unless it has been issued under an indenture and is qualified under the TIA, which was passed for the protection of bond investors. The TIA was introduced as an amendment to the Securities Act of 1933 in order to make indenture trustees more proactive in their roles by putting some obligations directly on them, such as reporting requirements. The Trust Indenture Act, administered by the Securities and Exchange Commission (SEC), was intended to address flaws in the trustee system. Prior to the Act, for example, trustees’ passive actions blocked collective bondholder action. Individual bondholders could theoretically force action but often only if they could identify other bondholders who would act collectively with them, which was impractical given the wide geographical distribution of all bondholders of an issue. With the Act, trustees are required to make available a list of the investors so they can communicate with one another.
In effect, the indenture gave investors more substantive rights, requiring indentures to include provisions that, among other things, gave individual holders the independent right to bring certain legal actions and to be paid. The TIA requires that the hired trustee be free of conflict of interest with the issuer and make semi-annual disclosures of pertinent information to the securities holders. Debt issuers are expected to disclose terms and conditions under which a security is issued through the use of a formal written agreement known as a trust indenture.
A trust indenture is a legal and binding contract entered into by a bond issuer and an independent trustee in order to protect the interests of bondholders. The document must be approved by the SEC and highlights the terms and conditions that the issuer, lender, and trustee must adhere to during the life of the bond. In addition, any protective or restrictive covenants, such as call provisions must be included in the indenture. In the event that a bond issuer becomes insolvent, the appointed trustee may be given the right to seize the bond issuer's assets and sell them in order to recoup the bondholders' investments.
Securities, typically municipal bonds, that are not subject to regulation under the Securities Act of 1933 are exempt from the Trust Indenture Act. Securities registration requirements do not apply to bonds issued during a company reorganization or recapitalization; however, these bonds fall under the provisions of the Trust Indenture Act.