California Congressman Edward Royce is interested in how activist hedge fund manager Bill Ackman plies his trade. In June, press reports noted Royce planned on “grilling” Securities and Exchange Commission Corporation Finance Director Keith Higgins at a House Financial Services hearing on insider trading issues related to Ackman’s acquisition of Allergan, Inc. (NYSE:AGN) stock in advance of a publically announced deal to acquire the company.

Bill Ackman Pershing Square Allergan

Today on Capital Hill Royce had his advertised opportunity, but the “grilling” that was promised at times appeared my like a picnic but nonetheless cleared the air on the issue to a degree.

“I’m very interested in the commission’s process for looking at novel and creative deals to ensure they are robustly reviewed to ensure strong investor protections and market transparency,” Royce said in his opening statement.

Edward Royce on the unusual nature of the Ackman / Allergan situation

Royce opened his comments by noting that people can understand insider trading when information is passed from one friend to another on the golf course, hinting at the unusual nature of the Ackman / Allergan, Inc. (NYSE:AGN) situation.  Ackman’s involvement in the Allergan acquisition was considered unique because he approached the purchaser, Valeant Pharmaceuticals Intl Inc (NYSE:VRX), helping orchestrate the acquisition while acquiring an interest in Allergan.

“In the last five years the SEC has been very active in perusing insider trading cases, charging over 507 defendants,” Royce said.  Insider trading cases could become “murkier” when the “exchange of information is shrouded in contracts and doesn’t look like something you have seen before.”

Royce hypothetical question directed reference to the Ackman Allergan deal

Royce then posed a “hypothetical” question to Higgens that appeared to be a direct reference to the Ackman Allergan, Inc. (NYSE:AGN) deal.

“The company (assumed to be Valiant Pharmaceuticals) enters into a contractual relationship with a hedge fund (assumed to be Ackman’s Pershing Square) to purchase the shares of the target (assumed to be Allergan) for the benefit of the company before the announcement of the intent to acquire the target,” Royce said, outlining the Valeant Pharmaceuticals Intl Inc (NYSE:VRX), Ackman, Allergan, Inc. (NYSE:AGN) deal without using those names.  “They call this agreement a joint venture, a partnership. Does the existence of the contract somehow make what would be otherwise considered illegal insider trading legal?”

While Higgins said he could not speak to any particular situations, he responded by citing two SEC rules.

Citing Rule 10B5, Higgins said there must be a breach of some duty owed by the person trading to the source of the information, such as a betrayal of a confidence.  In the instance Royce cited were the parties said “let’s work together to take this company over, Higgins said this would not be a breach of duty.

Higgins then appeared to tred on a gray area when discussing rule 14E3 which deals with tender offers. “When a bidder has taken substantial steps to commence a tender offer anyone who gets material non-public information from that bidder who trades on it is liable for insider trading irrespective of any breach of a duty,” Higgins said.

Royce later asked “does labeling the takeover offer a joint bid insulate the firm from insider trading charges?”

“That’s a question I don’t think the commission or the courts has answered on weather two parties getting together constitutes insider trading,” Higgins responded.