Did Bill Ackman Trip over Allergan?

In amassing his huge stake, he may have stepped into insider trading territory  

If his death threat against Herbalife wasn’t risky enough, Bill Ackman’s recent hook-up with Michael Pearson of Valeant Pharmaceuticals has turned into an even more precarious campaign.  It’s Ackman’s first foray – and perhaps the first ever by a hedge fund activist — into 1980’s-style corporate raiding.

For the past several months, Ackman and Pearson have been cooking up an unsolicited — and now hostile — takeover bid for Allergan Inc., the California-based manufacturer of Botox and other cosmetic drugs.  

Pearson’s modus operandi has been to grow his Canadian pharmaceutical company without investing heavily in R&D by acquiring more than 40 smaller manufacturers with well-developed drugs.   Ackman agreed to finance Pearson’s quest for Allergan by having his $15 billion hedge fund – Pershing Square Capital Management — accumulate a substantial position in Allergan stock which Pearson could then use to sway Allergan’s board and entice its other stockholders. 

oops

Ackman presumed his legal position was nicely tied up

Ackman started acquiring Allergan stock and options in February of this year and, by April, exercised control over more than 25 million Allergan shares or 9.7% of its outstanding float (then valued at over $3.2 billion).  Later in April, Valeant made an unsolicited bid for Allergan for $51 billion, a bid openly supported by Ackman with his substantial stock position.  The initial (friendly) bid was summarily rejected by Allergan’s board and, in June, Valeant went hostile with a tender offer for all of Allergan’s shares.

Last week, that initiative was met with an Allergan lawsuit filed in a California federal court alleging that, in pursuing its joint venture with Valeant to acquire Allergan, Pershing Square tripped over the insider trading rules regarding tender offers.     

Under US law, a tender offer toward which any “substantial step” has been taken is treated as material, non-public information for insider trading purposes.  Tender offers are assumed to move market prices and, presumably, give anyone who knows of one in advance an unfair trading advantage over the investing public.  So, anyone tipped by an offeror of an impending tender offer is prohibited from trading in the securities of the target company unless and until the offer has been publicly disclosed1.  Public disclosure puts the tippee and target company shareholders on a level playing field.   

The key to the case will be whether Ackman bought any of the Allergan stock knowing that a tender offer was in the offing.

The key to the case will be whether Ackman bought any of the Allergan stock knowing that a tender offer was in the offing.   According to Allergan’s complaint, Pearson always expected his unsolicited bid for Allergan to be rebuffed and devolve into a tender offer and took several steps toward preparing that offer before disclosing it to the public.  Pearson hired both counsel and an investment banker to assist him in preparing the offer and, most importantly, engaged Pershing to support him by acquiring Allergan stock from unsuspecting Allergan stockholders.  That might just be enough to convince a court that Pershing’s purchases were, in effect, insider trades.  

Allergan claims that, in making those purchases while in possession of insider information, Pershing defrauded the selling Allergan stockholders of approximately $1.2 billion, the total amount by which its Allergan securities spiked at the time Valeant announced its initial bid for the company2.  The complaint demands that Pershing Square’s purchases of Allergan shares and options therefore be rescinded. 

Besides being a substantively colorable argument, the Allergan complaint is at the very least a roadblock in any move Valeant may now take.  Because the case is so factually-based, Allergan believes that the special meeting of stockholders that Valeant and Ackman have been pressing for since the announcement of the tender offer won’t take place until the lawsuit is resolved, probably sometime next year.  The special meeting was intended to enlist a shareholder vote on replacing the Allergan board with Ackman/Pearson nominees.

Allergan’s claim could not have come as a surprise to Ackman and Pearson who reportedly consulted outside counsel on the insider trading issue before undertaking the tender offer.

Allergan’s claim could not have come as a surprise to Ackman and Pearson who reportedly consulted outside counsel on the insider trading issue before undertaking the tender offer.  Apparently, there is some question, however, as to whether their counsel was aware of the imminence of the tender offer when they were consulted on the trading issue.  That fact may be critical in resolving the case.

This situation appears to be the first time on record that a hedge fund activist like Bill Ackman and a corporate buyer like Mike Pearson have teamed up to go after a fish as big as Allergan.  So there may not be any precedent on the legal issue at the heart of the case.  If Ackman really pursued his purchases in reliance on well-informed legal advice, or if the notion of a tender offer really didn’t arise until after Ackman completed his buying campaign, he may have an out.  If not, he’s going to have to disgorge a lot of money, but the blow to the brash and outspoken billionnaire’s ego will probably cause him even greater pain. 

1 SEC Rule 14e-3 is based on the premise that neither bidders nor their tippees owe fiduciary duties to target companies or their shareholders and are therefore not covered under classical insider trading laws.  In this case also, Ackman did not breach any fiduciary duty to Valeant since his purchases of Allergan stock and options were at Pearson’s request.

2 Allergan’s shares surged 15% upon the announcement of Valeant’s acquisition offer.