He wasn't worried.

Pershing Square Gets to Vote on Its Valeant Deal

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
Read More.
a | A

A while back, Pershing Square and Valeant teamed up to try to take over Allergan. Loosely speaking, the division of labor was that Pershing Square quickly and quietly bought up 9.7 percent of Allergan's shares in the open market, because it is an activist hedge fund and does that, and then Valeant offered to acquire Allergan via a merger, because it is an acquisitive drug company and does that. This entirely sensible division of labor made some people angry, on the theory that Pershing Square's buying of shares was insider trading, even though it pretty straightforwardly wasn't. Normally, it's only illegal to trade on nonpublic information if you misappropriated it from someone, and Pershing was trading on Valeant's information with Valeant's blessing and encouragement.

Anyway, Allergan said no to the deal, battle was engaged, and a few months later Pershing and Valeant did a dumb thing, which is that they launched a tender offer. The tender offer retroactively turned Pershing's share buying from "straightforwardly not insider trading" into "mmmmmmaybe insider trading?" And Allergan, not one to sleep on a reason to fight with Valeant and Pershing, promptly sued them for insider trading. The idea was that, if it could persuade a judge that their share buying was insider trading, then the judge might prevent them from voting their shares at Allergan's upcoming shareholder meeting, which would make it harder for Valeant to take over Allergan.

Today the judge in that lawsuit ruled with rather delightful ambivalence. Basically he concluded that Valeant and Pershing maybe insider traded, but not enough to block them from voting. Instead, their punishment for maybe insider trading is that they have to tell all of Allergan's shareholders that they maybe insider traded. That is a pretty silly punishment, no? I mean, the judge phrases it not as a punishment but rather as "corrective disclosures" to prevent "an uninformed shareholder vote," but honestly that is even sillier. The result is that Allergan gets a bit of a moral victory -- it gets to continue complaining about Pershing Square's insider trading -- but Valeant and Pershing get an actual victory, in that they get to vote the shares they own.

This is a strange case, and I think that the root of the strangeness is that the securities laws, and investors, still don't really appreciate the power of the poison pill. My stylized theory is that, back in the olden days, there were two ways to acquire a company:

  • You could call up its management, negotiate with its board of directors, agree on a deal, sign a merger agreement and do a friendly merger.
  • Or, you could ignore management, offer money directly to the company's shareholders and try to gain control through a hostile tender offer.

Tender offers were scary: They were a way for hostile bidders to gain control of a company without its board's permission. Managements did not like this, and they got the ear of regulators. So much of, like, mid-century corporate and securities law was about making tender offers harder and keeping boards in power.

One example of this is Rule 14e-3 under the Exchange Act, adopted in 1980. That's the rule that Pershing Square and Valeant mmmmmmaybe violated when buying Allergan stock. Rule 14e-3 says that, if anyone "has taken a substantial step or steps to commence, or has commenced, a tender offer" for a company, then it's illegal for anyone else to trade in that company's stock while in possession of material nonpublic information about the tender offer. So, if Valeant had taken substantial steps to commence a tender offer for Allergan as of February, when Pershing started buying shares, it would be illegal for Pershing to buy Allergan stock, unless Pershing was also acting as a bidder in the tender offer. The dispute in this case is over that question -- is Pershing a "co-bidder" -- and over whether Valeant had taken those substantial steps.

Here's what the court gives as the reason for this rule:

In promulgating Rule 14e-3, the SEC was concerned about the practice of “warehousing” (the practice of the tender offeror intentionally leaking information to institutional investors to allow those other entities to make early trades before other investors heard about the tender offer) because such a practice is unfair to investors who are trading at an informational disadvantage

That sounds pretty reasonable at first. Pershing Square did its buying of Allergan stock at an average price of around $129. When Valeant announced its bid, the price went to $163.65. It closed at $195.12 today. The investors who sold to Pershing Square missed out on almost $35 a share of profits, measured against the announcement price, or even more if you use today's price.

But: When Valeant announced its bid, it wasn't a tender offer. It only became a tender offer months later, after basically Allergan shareholders demanded that Valeant switch to a tender offer. The rationale that Pershing Square's trading was "unfair to investors who are trading at an informational disadvantage" was true both of the merger and the tender offer. But the rule applies only in the latter case, not the former. Why?

The answer, I think, is that Rule 14e-3 is not about protecting investors from informational disadvantages. It's about protecting companies from tender offers. The "warehousing" problem is not that some people might sell to Pershing Square at too low a price and then be sad. It's that Pershing Square might acquire a lot of shares and then tender them in the offer, making Allergan's management sad.

The idea is that, if you are a corporate raider in 1980, and you want to buy a company, you can announce a tender offer, but this will give the company time to make its case that shareholders shouldn't sell you their shares. But if you instead tell a few big institutional buddies that you're planning to launch a tender offer, they can go buy up a lot of shares in advance. That doesn't just cheat some people out of the tender premium. It also leaves more shares in friendly hands -- the hands of your institutional buddies, who've made a quick risk-free profit by buying shares to flip them to you in the tender offer. This in turn reduces the price you have to pay in the tender, since some of the shares are in the hands of people making a quick risk-free profit so they don't need much premium. That's scary to management, because it makes it easier for a raider to throw out management. None of this was really relevant to mergers, since mergers were cozy and friendly and uncontested and not really the province of raiders.

So that was I guess the rule for about five years. But then in 1985 the poison pill became a thing. The poison pill made hostile tender offers impossible. I mean, you can still announce a hostile tender offer. Valeant and Pershing Square did just that in this case. But it's a meaningless announcement. You can't close a tender offer -- you can't actually buy shares from shareholders -- without the permission of the board of directors. In the post-1985 world, the only practical way to do a hostile acquisition is to vote out the board of directors and replace it with new, friendlier directors. And that is of course what Valeant and Pershing Square are trying to do to Allergan, in the shadow of their otherwise ineffectual tender offer.

The poison pill had two relevant effects. One is: It made Rule 14e-3 obsolete. You can no longer take over a company by surprise by launching a tender offer. So the idea of tipping off your buddies, so they can accumulate shares and flip them to you in a tender and make your tender easier, is just dumb now. Your buddies can't flip shares to you because your tender offer can't close. Doing the thing forbidden by Rule 14e-3 doesn't make sense any more. In fact, Pershing Square argued as much in this case:

This was not some smoke screen -- everyone, including Allergan and its bankers, fully understood that a tender offer was not a viable vehicle to complete an acquisition because Allergan would put in place a poison pill preventing additional stock purchases.

The second effect that it made a case for, like, Bizarro Rule 14e-3. That is, now, if you want to launch a hostile takeover, you don't need people to tender into your offer, because that's now impossible. You need votes, for the inevitable proxy fight. So rather than the circa-1980 thing of getting investors on board by tipping them off to your tender offer, you can get them on board by tipping them off to your merger proposal. And then they hold the shares through the vote, are grateful to you for the price increase, are less price-sensitive than longer-term holders, vote for your board slate and your merger, and make a quick(ish) profit on the deal. If that's the evil that Rule 14e-3 was meant to prevent -- and that's a little speculative, and anyway I'm not at all convinced that it's actually a bad thing -- then these days it should really be aimed at mergers, not tender offers.

In any case, that's not quite what happened here: Pershing Square is more of a "real" co-bidder with Valeant than it is just a supportive voter rewarded with an insider tip. (It's putting up money, taking stock price risk, helping plan the offering strategy, etc.) But it's kind of what happened here: The main benefits of the Pershing Square toehold are to reduce the overall cost of the deal and to get a chunk of votes into friendly hands.

And in any case it's a thing that is totally allowed under insider-trading law. If you do exactly what Pershing Square and Valeant did here -- plan in advance, build a toehold, announce a hostile offer, wage a proxy fight -- but never launch a tender offer, then you're fine. Even if you involve several toehold buyers whose only role is to accumulate shares on the cheap, lowering your cost and gaining friendly votes for you. All you have to do is not launch a tender offer. And the tender offer is meaningless!

The weird thing is that this is the world we live in, a world where hostile takeovers are conducted via proxy fights, not tender offers. And it's the world we've lived in for almost 30 years. And yet! And yet the securities laws are still set up for the early 1980s, when tender offers were how hostile deals happened, and so the rules limit toeholds in tender offers while ignoring toeholds in mergers.

And, even more strangely, Valeant launched a tender offer, even though that tender offer could have no actual effect, and predictably landed Valeant and Pershing in this soup. Valeant did this not because it's dumb, necessarily, but because Allergan shareholders demanded it. (Because they're dumb, possibly.) A tender offer is still how you signal that you're serious about your hostile bid. Even though doing a hostile tender offer is impossible, and has been for 30 years.

  1. I mean, really, this is what they have to disclose:

    Defendants must make corrective disclosures to their September 24, 2014 proxy solicitation statement in compliance with Section 14(a) of the Securities Exchange Act and Rule 14a-9 promulgated thereunder, including disclosure of the facts underlying Defendants’ exposure to liability under Section 14(e) of the Securities Exchange Act and Rule 14e-3 promulgated thereunder. Specifically, Defendants must disclose that:

    a. Pershing Square and Valeant’s February 25 Relationship Agreement included an agreement that Pershing Square and Valeant agreed to be called “co-bidders” if the Allergan-Valeant transaction occurred by way of tender offer.

    b. Allergan and Karah M. Parschauer’s federal lawsuit against Pershing Square, Valeant, and PS Fund 1 alleged that they violated Rule 14e-3 by causing PS Fund 1 to acquire Allergan shares between February and April 2014 without publicly disclosing information about Valeant’s plans for a tender offer.

    c. The Court found that Plaintiff Parschauer raised serious questions as to whether Defendants’ conduct between February and April 2014 violated Rule 14e-3.

    That is nice for their lawyers, who will be paid to write that disclosure, but is it at all conceivable that this will change how any shareholder thinks about anything? Especially since:

    Given the publicity surrounding the Allergan-Valeant takeover, Allergan’s shareholders likely are at least generally aware of this lawsuit. In fact, Allergan attached its motion for preliminary injunction to Amendment No. 23 to its Schedule 14D-9, filed on October 7. However, the law requires Defendants to make material disclosure themselves.
  2. It's as interesting as it sounds. I wrote about it here, and you can just read the opinion, it's reasonably clear as these things go.

  3. Why would you though? More fundamentally, there's an argument that Valeant would not have done this deal without Pershing Square's help, partnership, etc. If that's the case, then the people who sold didn't miss out on anything -- in fact, they made out like bandits versus the sub-$125 "unaffected price" of Allergan's stock.

  4. From the opinion:

    On May 12, Allergan’s board rejected the merger proposal. In late May, officers of Pershing Square and Valeant attended the Sanford Bernstein investor conference in New York where they spoke with many Allergan shareholders. Responding to feedback from those shareholders, on May 30, Valeant announced a new, higher offer for Allergan’s shares. Around this time, Valeant’s board formally authorized management to pursue a tender offer. Valeant also secured financing for a tender offer, asked its legal counsel to draft documents for the tender offer, and contacted an exchange agent and dealer manager.

    Valeant and Pershing Square had an adorable plan to hold a shareholder "referendum," which I liked, but which shareholders apparently found a bit too cute. To shareholders, a tender offer signals seriousness. A referendum, not so much.

  5. A thing invented and popularized by the law firm of Wachtell, Lipton, Rosen & Katz, where I used to work.

  6. I mean, besides the moral power of persuasion, etc. Some directors want what's best for shareholders, even if it involves kicking out management, though in hostile deals it's useful not to assume that in your model.

  7. In the hostile context. The straightforward insider-trading-to-make-some-money-for-your-buddies thing is still available (and illegal).

  8. Not legal advice!

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net