For those keeping score in the hostile battle for control over the Botox maker Allergan, the latest court ruling is a mixed bag.
This week, a federal court ruling went in favor of Valeant Pharmaceuticals and William A. Ackman’s hedge fund firm, Pershing Square Capital Management. A court decided against Allergan’s efforts to prevent them from voting at a special shareholder meeting on Dec. 18 over whether to remove Allergan’s directors.
But the decision may open up a new line of attack against Mr. Ackman. This one could come from shareholders who sold their Allergan stock in the weeks leading up to the disclosure of Valeant’s bid for the company in April.
Back then, Valeant and Pershing Square rocked the capital markets by simultaneously announcing that Pershing Square had taken a 9.4 percent position in Allergan and that Valeant was making an unsolicited offer to acquire the company. This significant stake had been accumulated in the weeks before the announcement, leading Allergan to accuse the bidders of abusing the securities laws by taking advantage of confidential information about the offer.
Every hostile takeover effort unleashes a tidal wave of litigation, and this one is no different. Allergan, Valeant and Pershing Square have already settled litigation in Delaware over whether Allergan inappropriately adopted onerous bylaws intended to halt Valeant and Pershing Square from nominating replacement directors to the Allergan board. The settlement came after the judge in the matter made some skeptical remarks about Allergan’s conduct, indicating he was prepared to strike down the bylaw.
Unable to stop Valeant and Pershing Square’s bid in Delaware, Allergan, based in Irvine, Calif., tried another trick: suing in its home jurisdiction, the Federal District Court for the Central District of California. In this litigation, Allergan asked the court to stop Pershing Square from voting its 9.4 percent stake in the company in order to replace Allergan’s directors.
Here is where it gets technical.
Allergan premised its claim on showing that the shares were acquired in violation of Rule 14e-3, a rule adopted by the Securities and Exchange Commission in the 1980s to stop insider trading in connection with hostile offers. As the court put it:
Under Rule 14e-3(a), once an “offering person” “has taken a substantial step or steps to commence . . . a tender offer,” “any other person who is in possession of material information relating to such tender offer” that he knows or has reason to know is nonpublic and that he received directly or indirectly from the offering person must either abstain from trading or disclose the information to the public before trading.
Allergan argued that the share purchases violated the rule because Valeant and Pershing Square were already contemplating a hostile offer. Thus, Mr. Ackman should be prohibited from using shares acquired in violation of the law for his own benefit. More specifically, Allergan argued that Pershing Square was not an “offering person” making a tender offer, and therefore was barred from purchasing Allergan stock once it learned from Valeant about the possibility of a hostile bid. The bid only became a tender offer a few months later in June.
But Judge David O. Carter of the United States District Court found that Allergan could not sue for a violation because it did not sell any of its shares during the period when Pershing Square was buying its stake. Under Section 20A of the Securities Exchange Act of 1934, only a “contemporaneous trader” can sue for insider trading, not the company whose shares were traded.
That does not mean Mr. Ackman’s conduct got a clean bill of health from the court. Allergan recruited one of its employees who did sell shares to serve as a co-plaintiff, and the judge found that she could pursue an insider trading claim.
The case raises interesting issues about whether the insider trading rules were violated. Valeant and Pershing Square knew about the Rule 14e-3 problem. They tried to paint a picture in their initial agreement that they had not taken “substantial steps” to start a tender offer. Their agreement prohibited an offer until each agreed to make one, and then they would be treated as “co-bidders” in the transaction.
The S.E.C. rule in question also only applies to passing information to someone outside the circle of those making the tender offer. Valeant and Pershing Square argued that they should be considered as a single “offering person” under the rule because Mr. Ackman’s firm should be viewed as a “co-bidder.” If they are one entity, then there was no illegal tipping of information, even if a substantial step toward undertaking a tender offer had occurred. Here, it was undisputed that Pershing Square and Valeant were co-bidders for purposes of taking responsibility if they initiated a tender offer for Allergan .
In his decision, however, Judge Carter noted that “stating in a contract that they had not taken any steps toward a tender offer does not necessarily make it so.” He instead found that the fact that the parties had referred to themselves as co-bidders raised “serious questions” that needed to be decided by a jury as to whether the two had taken “substantial steps” for a tender offer.
It’s at this point that things got better for Pershing Square and Valeant. Even though shareholders might have a case here, the judge still decided to follow the tendency of courts to refuse to use the federal securities laws to stop shareholders from voting on transactions (that’s what happened in 2007 in the battle between the Children’s Investment Fund and CSX).
Instead, the judge declined Allergan’s request to prevent Pershing Square from voting its stake at the upcoming Allergan meeting. This is what we had expected – that the litigation was noise.
So where does that leave the parties?
Allergan is appealing Judge Carter’s decision. It is an uphill battle for the company, but it has nothing to lose except more money spent on lawyers.
Wording in the judge’s opinion about an acquisition of the company being too tentative to support an injunction at this time could give it some standing. So Allergan may try for a second bite of the apple as it gets closer to the Dec. 18 meeting by renewing its request, although Judge Carter made it clear that issues about the bid was something better left to a jury.
Still, even if Allergan loses the appeal, the decision allows the Allergan employee who sold shares during the time Pershing Square took its stake to continue a suit. Others who sold Allergan shares may also have this claim.
After the announcement of Valeant’s bid for Allergan, Mr. Ackman had a paper profit of more than $1 billion from his share purchases because Allergan’s stock soared on the news of the unsolicited offer. That means shareholders selling shares contemporaneously are out that much money. That’s more than enough to entice an enterprising law firm to file a class action lawsuit seeking to recoup those profits. Judge Carter’s decision provides a good first step to making out that case, which may also prod the Securities and Exchange Commission to open an investigation into the purchases.
Though Allergan didn’t win this round of the litigation, it has succeeded in doing some damage to the bidders. Pershing Square and Valeant were ordered to make corrective disclosures about their potential violations of the securities laws, which will happen by the end of the week.
Judge Carter’s decision to let a jury decide certain facts on the insider trading question seemed to rely a lot on the agreement of Pershing Square and Valeant governing their conduct. If this lawsuit proceeds, other information is likely to come out.
The most likely outcome is the shareholder vote will occur in December, but this suit may linger on in some way.
Valeant could have avoided all of this by simply not moving to a tender offer for Allegan. If it would have just kept its bid open while seeking to remove the directors, then it would not have raised the insider trading question. The lesson is that if a company wants a hedge fund to serve as a co-bidder in the future, it will just pursue the deal without making a tender offer. That would avoid having to deal with a problem of its own making, as Pershing Square and Valeant are doing right now.
An earlier version of this column misstated the timing of a court ruling on whether Pershing Square Capital Management and Valeant Pharmaceuticals can vote at a coming special shareholder meeting of Allergan. It was this week, not last week.