Pershing Square hedge fund manager Bill Ackman is known for his bold investing calls, both long and short, and is also known as an investor who will pull no punches in his efforts to promote his investments, including a willingness to push into legal grey areas.
The involvement of his hedge fund, Pershing Square Management, in the saga surrounding the buyout of pharma giant Allergan (and profiting handsomely despite being on the “losing” side), is an instructive case in point in how far Bill Ackman is willing to push the legal envelope.
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Background on possible insider trading by Pershing Square
As a recent blog post in the Harvard Law School Forum on Corporate Governance and Financial Regulation points out, the fight for Allergan was one of 2014’s most bruising corporate takeover battles. Despite Valeant initiating a hostile takeover offer, Allergan was ultimately taken over by Actavis.
Of particular interest, Valeant’s bid for Allergan included a novel structure involving a “partnership” between Valeant and Ackman’s Pershing Square. In specific, a Pershing Square-controlled holding company with a minority interest owned by Valeant acquired shares and options totaling over 9% of Allergan’s common stock. Keep in mind that these purchases were made by Pershing Square with Valeant’s consent and with knowledge of Valeant’s plans to announce a proposal to acquire Allergan. Pershing Square and Valeant filed a Schedule 13D and Pershing Square officially backed Valeant’s proposed acquisition.
As it turned out, Pershing Square ended up making a large profit when Allergan was eventually purchased by Actavis for a notably sweetened price.
Legal issues at hand in Valeant – Pershing takeover structure
The unusual takeover structure created by Pershing and Valeant drew a great deal of attention and scrutiny, including questions about Pershing Square’s acquisition of Allergan shares while in possession of non-public information regarding Valeant’s plans to make a bid being improper insider trading.
According to the blog post from Christopher E. Austin and Victor I. Lewkow, “The general consensus was that the structure did not appear to implicate traditional 10b-5 insider trading concerns since Pershing Square acted with Valeant’s consent and no breach of duty was involved. Commentators also noted, however, that Rule 14e-3, which is a special insider trading rule relating to tender offers, could be implicated if at the time of Pershing Square’s purchases there had been “substantial … steps to commence a tender offer.””
Not surprisingly, lawsuits were filed before the final sale of Allergan to Actavis and have been continued on behalf of the selling shareholders seeking damages from Pershing Square and Valeant. Pershing Square and Valeant moved to dismiss the action, but on November 9th of this year, the court issued an order denying the motion, so the lawsuit will move forward unless it is settled.
The order from the court confirmed the prior issues addressed in its 2014 preliminary injunction motion. For example, the order held there were “adequate allegations that (1) Valeant had taken substantial steps to commence a tender offer prior to Pershing Square’s purchases and (2) Pershing Square was not entitled to the exemption from Rule 14e-3 for purchases made by the “offering person.” The court also confirmed its earlier holding that there was a private right of action under Rule 14e-3.”
Austin and Lewkow highlight two important implications of the court’s decision:
First, the 14e-3 risk from structures like this one is real and may deter use of these types of arrangements going forward, except if a tender offer is never actually undertaken (or, in theory, even seriously discussed). But there is a big if in the 14e-3 issue.
Matt Levine of Bloomberg View notes:
Rule 14e-3 really was intended to prohibit these sorts of “unseemly ‘warehousing’ and ‘front-running’ practices,” as the plaintiffs put it. Those are just emotional descriptors, though. Is this “unseemly”? Some people sure think so! Is it “front-running”? I mean, obviously not, but people use “front-running” to mean any old thing these days. Is it illegal? I … don’t know? The judge’s opinion denying the motion to dismiss is not great for Pershing Square and Valeant; he takes pretty seriously the plaintiffs’ arguments (1) that Valeant had taken “substantial steps” toward a tender offer at the time and (2) that Pershing Square was not an “offering person” in the tender offer, so its buying was illegal. I tend to think Valeant and Pershing Square have very slightly the better of those arguments, but they are close questions, and certainly there are some bad facts for Valeant and Pershing Square. In any case, they are tough questions to go to trial on. On the other hand, paying a big settlement would be pretty unpleasant right now for Valeant and Pershing Square.
Second, the court’s discussion of Pershing Square’s relationship with Nomura, if confirmed, could have implications for broker dealers and others involved in the options and derivatives markets. Say a dealer selling an option to a client is characterized as that client’s agent, and the dealer’s hedging activity after selling the option is seen as undertaken on behalf of the client, a slew of reporting and other obligations under securities law and contractual triggers based on share ownership (rights plans) could be required