AUDITING AND

CORPORATE GOVERNANCE
GROUP NO. -6
JUNK BOND SCAM AND TYCO CASE STUDY

 Roll no. 953- Sonali Chauhan  Roll no. 932- Srishti Arora
 Roll no. 940- Vaishali Mehandiratta  Roll no. 956- Barkha Arora.
WHAT ARE JUNK BONDS ?

Junk bonds are bonds that carry higher risk of default than most issued by
corporations and government. It represents bonds issued by companies that
are struggling financially and have higher risk of defaulting or not paying
interest or not repaying principal amount to investors. Companies that issue
junk bond are mostly start-ups or that are struggling financially. It pays
higher yield than their safer counterparts to compensate for high level of
risk.
Junks bond serve as a risk indicator of when
investors are willing to take on risk or avoid risk
in the market.
Junk bond prices can exhibit volatility due to
uncertainty surrounding the issuer’s financial
performance.
Active junk bond markets can indicate an
overbought market meaning investors are too
complacent with risk and may lead to market
downturns.
ENVIRONMENT IN THE 1980S

 1980s witnessed one of the most dramatic turnarounds in US stock market.

 The junk bond grew from a meager US$ 0.5 Billion in 1977 to around US$ 40
Billion in 1986.
 Junk bond was no longer seen as sign of financial difficulty but it was seen as
attractive investment opportunity.
 The reason for such a tremendous increase in junk bond was primarily the
introduction of concept of leveraged buyout.
LEVERAGED BUYOUT

A leveraged buyout is acquisition of another company using a

significant amount of borrowed money to meet the costs of acquisition.
The purpose of LBOs is to allow companies to make large acquisitions
without having to commit a lot of capital.
In LBOs, there is usually a ratio of 90% debt to 10% equity.
JUNK BOND KING – MICHAEL MILKEN

 Michael Milken is a philanthropist and current chair of non-profit think

tank called Milken institute.
 He joined Drexel Burnham Lambert in 1969 and started trading in high
yield bonds which earned him the nickname of JUNK BOND KING in
1980s.
 At the height of his success, he earned between $200 million and $550
million a year.
 He indicted and spent nearly 2 years in prison after pleading guilty to
charges of securities fraud.
 He was banned for life from the securities industry.
FRAUDULENT ACTIVITIES

 Investigating a number of once great blue-chip corporations fallen on hard times, he find something extraordinary.
The big wall street credit agencies has downgraded the bonds of these ‘Fallen Angels’ from AAA to C grade i.e.
junk status.
 They were dirt- cheap and the prospective profit earned from them would be colossal that’s why who traded in it
preferred to call it as high yield bonds.
 As Milken saw it, the ratings agencies were blinkered, too willing to play it safe and investors too short sighted to
defy their influence and scared of being tainted with indignity of such a gamble. Milken realized that all that was
holding the existing order in place was snobbery. Here onwards he developed unique ability to sense changes in
financial world.
After excelling at Wharton, he began to work as a trader at an old-guard investment bank called Drexel firestone,
where he was charged with researching low-grade bonds. The company merged several times in 1970s, becoming first
Drexel Burnham and then lambert.
These changes allowed him to exploit more and then he approached superiors to let him create a designated high yield
bond department and because of his obvious intelligence they allowed him for that by giving small amount of capital.
They could have no idea what they would let themselves in for : by 1976, he was earning 100% on the capital provided
him for bond operations.
From his new HQ at 9560 Wilshire Boulevard, Beverly hills, Milken began targeting struggling money managers who
invested in pension fund and life insurers. Soon, Milken was delivering them $50 million for every billion they had in
their company portfolio by buying bonds from companies with low credit standing having huge risk. As Michael jewis
writes ‘junk bonds behave much more like equity, or shares, than old fashioned bonds’.
In 1980s, America hit recession. Due to economic terms and elections, situations were in favor of Milken and it was the
beginning of his phase.
BEGINNING OF THE END

 In 1980, America hit recession due to economic terms and elections, situations were in favour of Milken and it
was the beginning of his phase.
 Milken began bankrolling the “Corporte raiders” to buy out large corporations, thereby creating new Junk bonds.
 By 1986, small stream of money Milken had diverted turned into a river of funds.
 Milken himself reportedly made $296 million in 1986 and $550 million in 1987.
 Wall street may have been booming but since 1980, the US’s deficit has shot up from $900 billion to $3trillion.
 Due to this the American industry was in death stage and unemployment was worse than ever.
 In 1986, Ivan Boesky was found to be one of the men with Milken as a part of a larger insider trading
investigation.
 Then the SEC started investigating against Drexel and Milken , as told by Boesky.
 In October 1987, the global stock millionaire were driven to automatic bankruptcy and turned inside out.
 In September 1988, SEC sued Milken and Drexel for a multitude and violations including insiders trading ,
manipulation of stock price and inaccurate record keeping.
 Drexel entered a guilty plea to 6 charges of stock manipulation.
 And, the game was up in April 1990, Milken was sentenced to three and half years in prison , fine of 200 million
and forced to accept a lifetime ban from dealing in securities.
LESSON LEARNED

 After a number of hearings and considerable debate in the 100 th Congress the President signed the Insider Trading
and Securities Fraud Enforcement Act of 1988.The provisions of the same are as follows:
• Expanded the scope of civil penalties
• Increase the maximum jail terms for criminal securities law violations from 5 to 10 years.
• Maximum criminal fines for individuals to be increased from $100000 to $1000000 and for non natural persons
from $500000 to $2500000.
• Reward informants who provide assistance to agency.
 On April 12 , 1989 the Executive Order 12674 was passed Prohibiting Executive Branch Employee Use of
Nonpublic Government Information for Private Gain.