The Federal Reserve Board yesterday proposed a restriction on the use of borrowing to finance certain corporate takeovers.
Although it had been reported that the Fed was considering restrictions on all borrowing used in takeovers, the proposal issued yesterday does not go that far. Instead, it applies only to debt issued by shell corporations that are used to purchase the stock of takeover targets.
These shell corporations are companies with no assets or on-going businesses formed primarily for the purpose of making takeover bids and making acquisitions. Their use has become controversial recently as corporate raiders, including T. Boone Pickens Jr. and Carl Icahn, have used them to make hostile takeover bids heavily financed with high-yielding, risky securities known as "junk bonds."
The Fed said that although it could have adopted the proposal without public comment, it will solicit comments until Dec. 23 "in order to provide full assurance of no unintended effects." The Fed's decision to solicit comments reflects concerns about the unforseen impact that the new rules could have on the capital markets. Federal Reserve Chairman Paul A. Volcker said that subject to final review, the proposal would affect deals entered into after Dec. 31.
The Fed's proposal comes amid continuing controversy over the rapid pace of merger and acquisition activity. Fed officials and members of Congress recently have expressed concern that takeover activity is financed too heavily with debt, unnecessarily weakening corporate balance sheets.
Drexel Burnham Lambert Inc., the Wall Street investment banking firm that is the leader in issuing junk bonds, immediately issued a statement praising the Fed for seeking public comment before adopting the proposal. Drexel is the firm credited with first using shell corporations to issue junk bonds that are used in takeovers.
"Based on the quick reading of the proposed interpretive rule, it is clear that the Federal Reserve Board is sensitive to the importance and scope of any rulings in this area as they affect the capital markets," a Drexel spokesman said. "The major intent is toward the safety and soundness of the financial system. However, rule changes in this area can have intended and unintended affects on the capital markets, and we are undertaking study of both. We will submit appropriate comments to the Federal Reserve Board."
The Fed's proposal is actually an interpretation of an existing regulation known as Regulation G, which limits the amount of credit that can be extended by persons other than banks or brokers to purchase stock. Under Regulation G provisions known as margin rules, credit can be extended to purchase up to 50 percent of the value of the stock being acquired. But prior to yesterday's announcement, Regulation G had not been applied to shell corporations used to make takeover bids.