Fed Ready to Approve Limits on ‘Junk Bonds’

The Federal Reserve Board is ready to approve a measure today that will restrict the use of risky, high-yielding securities, known as “junk bonds,” in corporate takeovers.

The controversial proposal, which has been criticized by the Reagan Administration, is expected to be approved by a vote of 3 to 2, with Chairman Paul A. Volcker and governors J. Charles Partee and Emmett J. Rice supporting the measure, Fed and Wall Street sources said.

Fed Vice Chairman Preston Martin and governor Martha R. Seger are expected to oppose the proposal, as they did on Dec. 6 when the Fed voted 3 to 2 for the restriction but allowed a period for public comment.

Fed governor Henry C. Wallich, who recently returned to work after an illness, is not planning to vote, Fed sources said. The seventh seat on the board is vacant.

Today’s vote is expected to be a showdown between Volcker and the Reagan Administration over whether the government should restrict financing for corporate takeovers.

Despite the White House opposition, Volcker has the votes to win, both supporters and opponents of the restrictions said Tuesday.

The Fed proposal comes at a time of growing concern over the extensive use of borrowed money to finance takeovers.

The narrow proposal on the Fed’s agenda today would not affect most takeovers, but it is designed to restrict the ability of what are known as “shell” companies to borrow more than 50% of the money needed to acquire a firm.

Several recent highly publicized takeover bids have included heavy borrowing by shell companies--companies with no material assets--that sell junk bonds that are backed only by the assets and stock of the takeover target.

Junk bonds are risky, high-yielding securities that are rated “below investment grade” by bond rating agencies.

Their use has permitted billion-dollar takeovers to be launched by individual raiders who borrow most of the money to finance their acquisition campaigns.

The Fed has the potential to regulate this kind of takeover activity by using its margin rules, which limit borrowing to buy stocks. Margin rules give the Fed regulatory potential.

The Fed’s margin rules generally restrict to 50% the amount of money that can be borrowed to finance stock purchases.

While the Fed had been discussing eliminating the margin rules altogether, it issued this new, broader interpretation after requests from Unocal and other companies that recently became targets of junk-bond financed hostile takeover bids.

At issue are the margin rules contained in Regulation G, which applies to lenders other than banks and brokers.

Fed sources said the governors privately have considered, and rejected, narrowing the new proposal by creating an exception for shell companies that indirectly have the backing of assets other than those of the acquisition target.

Other requests for changes, including a special exemption for operating companies with significant assets that create shells to make acquisitions, are not expected to lead to major revisions in the proposal.

On Dec. 23, the Fed proposal erupted into a major Washington political fight when the Justice Department, speaking on behalf of the Reagan Administration, said the Fed had exceeded its authority in proposing the restriction.

The Reagan Administration consistently has opposed additional regulation of takeovers, arguing that takeovers have a healthy and positive influence on the nation’s economy.