Fed Acts to Curb ‘Junk Bond’ Takeovers

The Federal Reserve Board has issued proposed rules that would place restrictions on the use of so-called “junk bonds” to finance corporate takeovers.

The board approved the proposed rules Friday by a 3-2 vote. The effect of the provision, which would take effect Jan. 1, would be to curtail takeovers in which the buyer puts up little or no cash.

A number of recent mergers and acquisitions among giant U.S. corporations have been financed heavily by borrowing.

Focus on ‘Shell’ Firms

Federal Reserve Board Chairman Paul A. Volcker, in a letter explaining the board’s proposal, said that it would be narrowly focused on so-called “shell” corporations, companies set up for the sole purpose of acquiring another company.

The proposal would apply margin, or credit, requirements to the use of junk bonds by the shell corporations. Current margin rules prohibit investors from financing more than 50% of a stock purchase with loans secured by that stock.

The proposed regulation would extend these margin requirements to prohibit a shell company from selling junk bonds to finance more than 50% of the cost of taking over another company if the only security behind the bonds is, in effect, the stock of the target company.

‘Limited Class’ Involved

Volcker stressed that the proposed rule “will impact only a limited class of borrowing transactions--those involving shell companies--that appear quite clearly to come within the scope of the present regulations.”

He said that the more common type of takeover effort, which involves an established company’s trying to buy controlling interest in a corporation through the purchase of stock, would not be covered by the proposed rule because those companies have “substantial assets other than margin stock” to back the sale of securities used in their takeover efforts.