The Federal Reserve Board voted 3 to 2 yesterday to adopt a revised version of a controversial measure that restricts the use of junk bonds in certain corporate takeovers.
The proposal, which had the support of Fed Chairman Paul A. Volcker, was approved despite strong opposition from the Reagan administration. The administration has opposed additional regulation of takeovers, arguing that takeover activity exerts a healthy influence on the economy.
Most Wall Street merger experts predicted yesterday that the revised proposal will have little impact on the frenetic pace of merger activity. They said it will apply to only a small percentage of deals, adding that investment bankers and lawyers will easily find ways to comply with the new restrictions without really changing their practices.
Merger experts said that among the many ways bidders could get around the new restrictions are by selling preferred stock rather than debt to finance takeover bids, or by having companies with significant assets guarantee takeover financing.
The new Fed restrictions on borrowing come amid growing concern over the excessive use of debt to finance takeovers.
Despite the ease with which lawyers and investment bankers were suggesting ways to keep the booming takeover business alive yesterday, Drexel Burnham Lambert Inc., the Wall Street firm that has profited most from the dramatic growth of junk-bond financing, and T. Boone Pickens Jr., who has used junk bonds to finance hostile takover bids for major oil companies, attacked the Fed's decision.
Drexel said the decision is "unwise and unwarranted," and predicted that it "will cause disruption in the capital markets." Pickens charged that the Fed decision was the result of lobbying by executives of large companies who are eager to gain protection from takeover bids they oppose.
Felix Rohatyn, senior partner of Lazard, Freres & Co., said he supports the Fed proposal, although its impact is mostly symbolic.
"I think it is a limited ruling which deals only with the most extreme type of junk-bond takeovers," Rohatyn said. "I don't believe it is going to have a dramatic impact on takeover activity. It is an important symbolic step for the Fed to get involved at all, and I believe it was a fight Volcker had to win."
Under the proposal approved yesterday, shell companies -- those with no material assets -- will not be allowed to borrow more than 50 percent of the money needed to make certain acquisitions. However, in a narrowing of its earlier proposal, shell companies will not have their borrowing power limited by the Fed as long as a separate operating company with substantial assets guarantees the shell's borrowings.
In several takeover bids, shell companies have borrowed money by selling junk bonds that represented more than 50 percent of the value of the target firm. However, Volcker said yesterday that the Fed interpretation is not limited to junk bonds -- risky, high-yielding securities that are rated "below investment grade" -- but is aimed at any form of debt securities issued by shell companies that violate the new guidelines.
Merger experts said the Fed proposal discriminates against hostile takeover bids that are opposed by the management of the target companies. They were referring to a provision in the Fed proposal that says the new rules will not apply in friendly takeovers where a merger agreement has been signed.
The Fed has the power to regulate takeover activity by using its margin rules, which limit borrowing to buy stocks. These rules generally restrict to 50 percent the amount of money that can be borrowed to finance stock purchases. The Fed said that in deals where a merger agreement has been signed, the new rules do not apply, because in those cases lenders rely on the target company's assets, rather than its stock, when they agree to provide takeover financing.
Fed officials cited several recent deals that relied on junk-bond financing as examples of how its new policy will apply. It said that while Pickens' bid last year for Unocal Corp. violates its rules, GAF Corp.'s offer for Union Carbide Corp. would be legal because GAF, a company with significant assets, agreed to guarantee the borrowings.
The Fed cited Pantry Pride's recent bid for Revlon Inc. as an example of a another deal that would not violate its rules. In that deal, the rules would not be violated because Pantry Pride borrowed its funds through a public offering of debt that was registered with the Securities and Exchange Commission, the Fed said.
Assistant Attorney General Douglas H. Ginsburg said he was "gratified by the revisions" in the Fed proposal. He also said that despite the Justice Department's opposition to the proposal, its civil division would represent the Fed if any litigation arises.