Occasional Oreo eater Bill Ackman.

Photographer: Chris Ratcliffe/Bloomberg

Shareholders Should Love Allergan Insider Trading

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.
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We talk from time to time about insider trading, and one pretty consistent theme is that it's not always illegal to trade on nonpublic information. There is another element to insider trading, which asks how you got the information. Insider trading, I like to say, is not about fairness; it is about theft. If the way you got the information violated some duty to someone -- if you bribed an employee to disclose secrets, say, or if you are a corporate executive trading against your own shareholders -- then you can't trade on it. If you came by it innocently -- on a call with investor relations, maybe, or in "premarketing" for an activist campaign -- then you are free to trade.  And if you created it yourself -- say, if you came up with a great plan for a company, bought stock and then announced your plan -- that's even better. Of course, the exact contours of the rule -- exactly what it means to come by information innocently as opposed to guiltily -- are vague, controversial and hotly debated. 

But there is one super important exception to this general rule. If you innocently get wind of a merger, or an earnings surprise, or an activist campaign, or a failed drug-safety test, you can trade. But the rules for tender offers are much stricter: There is a specific Securities and Exchange Commission rule, Rule 14e-3, that bans insider trading on "material information relating to" a tender offer that is acquired from anyone connected to that offer. (We have talked about this rule before.) This is a fairly arbitrary distinction. If Company X is planning a hostile merger with Company Y, and tells Hedge Fund Z about it in advance so that Hedge Fund Z can build a stake in Company Y and vote for the merger, that is totally legal. But if Company X is planning a hostile tender offer for Company Y, and tells Hedge Fund Z about it in advance so that hedge Fund Z can build a stake in Company Y and tender into the offer, that is totally illegal. (If Company X builds the stake itself, that's fine.) In modern U.S. corporate control battles, the difference between a hostile merger and a hostile tender offer is essentially nonexistent. But it makes a big difference for insider-trading law.

Last year Company X was Valeant, and Company Y was Allergan, and Hedge Fund Z was Pershing Square. Pershing Square secretly built a 9.7 percent stake in Allergan, and then Valeant announced a merger offer, and the stock went up, and people wondered if that was insider trading. And I said no, of course not, Valeant and Pershing Square had teamed up to buy Allergan, and they were free to trade on their own intentions however they wanted. And I was right. But then I was -- maybe -- rendered retroactively wrong when, two months later, Valeant and Pershing Square converted their merger proposal into a tender offer. Allergan sued, claiming that Pershing Square's pre-announcement purchases were really based on inside information about a tender offer and were therefore illegal insider trading under Rule 14e-3.

We talked about that lawsuit last August. It raised subtle questions of when Valeant took "substantial steps" toward a tender offer, and of whether Pershing Square was itself a bidder in the tender offer (in which case its trading was fine). It also made Valeant's and Pershing Square's decision to launch a tender offer look pretty silly, since the tender offer did no real good but made the lawsuit possible.  But the case eventually fizzled along with the rest of Valeant's bid for Allergan, which ended up being sold to Actavis for a higher price than Valeant was willing to pay. Allergan's purpose in the lawsuit was to fight off Valeant's offer every way it could think of; once the offer was gone, the lawsuit was unnecessary.

But Allergan's wasn't the only lawsuit, and this week a judge denied Pershing Square's and Valeant's motion to dismiss a similar insider-trading class action lawsuit brought by some (former) Allergan investors. Their purpose in the lawsuit, unlike Allergan's, survives Allergan's merger. They want money, which is timeless.

They want that money because, in their telling, they are that most elusive thing, identifiable victims of insider trading. As their complaint puts it, they "sold shares of Allergan common stock on the New York Stock Exchange (the 'NYSE') during the Class Period and suffered damages as a result of" Pershing Square's buying, and now they want Pershing Square and Valeant "to return their unjust profits to the innocent Allergan stockholders harmed by their misconduct."

So what was the harm? Pershing Square was buying Allergan stock from February 25 through April 21 of 2014. The lead plaintiffs were selling during that time. One of them, the State Teachers Retirement System of Ohio, sold 164,100 shares at an average price of about $124.97. Another, the Iowa Public Employees Retirement System, sold 111,820 shares at an average price of about $124.54. The third, Patrick Johnson, sold 1,250 shares at an average price of about $126.50. Here is the entire history of Allergan's stock price from its initial public offering through February 24, 2014, the day before Pershing Square started buying :

Source: Bloomberg

So the harm suffered by these plaintiffs is that they sold Allergan stock at prices higher than the highest price it had ever recorded before Pershing Square started buying. That ... does not sound too terrible?

Of course here is the subsequent history of Allergan's stock price:

Source: Also Bloomberg

As soon as Valeant and Pershing Square announced their bid for Allergan, the stock shot up to the $160s, and it never really looked back; it was at $240.22 when the Actavis takeover closed a year later. The people who sold to Pershing Square in early 2014 in the mid-$120s got the highest prices in Allergan's history up to that point, but they also would have nearly doubled their money if they had waited another year to sell to Actavis. 

Why is that Pershing Square's problem, though? Or Valeant's? These guys didn't wait to sell their shares. They were willing sellers, based on the information available to them at the time, which included the fact that Allergan's stock was at its all-time highs. They were happy to get $124.50+ per share, which is why they sold when they did. Of course, in hindsight, knowing what Valeant and Pershing Square were planning, they wish they'd held out for more. But what Valeant and Pershing Square were planning really seems like Valeant's and Pershing Square's business. If the plaintiffs get any more now, that seems like a pure windfall for them. 

More than that, though, what Valeant and Pershing Square were planning is what created all that value for Allergan's shareholders. Here's how the plaintiffs describe the insider trading:

The scheme began in February 2014 when William Ackman, hedge fund billionaire and fearsome “activist” investor, and Michael Pearson, the CEO of cash-strapped but acquisition hungry Valeant, struck a simple but unlawful bargain. In exchange for inside information regarding Valeant’s plans to launch a hostile takeover and tender offer for fellow pharmaceutical company Allergan, Ackman agreed to secretly acquire nearly 10% of Allergan’s stock and commit those shares to support Valeant’s bid.

Notice that the "scheme" is a real exchange: Pershing Square wasn't buying stock just for its own purposes, but as a necessary part of Valeant's bid. Valeant wouldn't have bid for Allergan without building a sympathetic stake first. And Valeant's bid is what pushed the stock into the $160s. It's also what led to the ultimate sale to Actavis:

As expected, Valeant’s takeover bid put Allergan “in play” for other competing acquisition proposals. Ultimately, another bidder, Actavis plc (“Actavis”), offered Allergan shareholders $219 per share – more than the $200 per share Valeant offered.

So Pershing Square's secret buying was a necessary step in a chain that led to billions of dollars of gains for Allergan shareholders.  If Pershing Square and Valeant had never hit on this "scheme," Allergan's stock would not have gone up, and the plaintiffs would have no reason to regret selling their stock at an all-time high. The only harm that they suffered was that they didn't get the benefits that Pershing Square and Valeant provided to other shareholders. It is very difficult to feel sorry for them. 

But the law is the law, and 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.

Again, though, this is the law only for tender offers. If Valeant had bought the 9.7 percent "toehold" itself, or if Pershing Square had bought a 9.7 percent stake and then announced a value-adding activist fight rather than a takeover attempt, there'd be no lawsuit. Obviously it is legal to "insider trade" on your own intentions. Or if Valeant and Pershing Square had just stuck to the original merger plan and not switched to a tender offer, there would still be no lawsuit: In most contexts, "insider trading" without misappropriation is legal. Most of the time, it would be fine for Pershing Square to trade on Valeant's intentions, if that's what Valeant wanted.

A lot of people do not like the fact that insider-trading law is mostly about theft, not fairness. They want insider-trading law to give everyone a level playing field and equal information. Since an appeals court reinvigorated the misappropriation requirement last year, prosecutors have complained and politicians have tried to gut that requirement. But this case -- where that requirement doesn't exist, and where the plaintiffs may be in line for an absurd windfall at the expense of defendants who created billions of dollars of value for Allergan shareholders -- is a good example of why the requirement is useful. Most of the time, trading on non-public information is good. It makes prices more efficient and creates incentives for people to seek out that information. So activists secretly buy stock so that they can profit from their own (nonpublic) plans to improve companies, and short-sellers dig up undisclosed frauds so that they can profit from exposing them. If no one could profit from private information, markets would not be informative. We should want investors to find and use and profit from and, sure, sometimes share nonpublic information. Usually, that is good for shareholders and markets broadly. It was good for shareholders here! It seems like a shame to punish Valeant and Pershing Square for it.

  1. You know what this footnote will say but it will say it anyway: Nothing here is ever legal advice. In particular, when I say "thing X is not a crime, but closely related thing Y is a crime," that is always going to be philosophical speculation and never advice for how to live your life. I personally prefer to live my life in a way that is never close to crime, though on the other hand I type things on the Internet for a living and typing anything on the Internet is probably a crime

    Anyway relevant prior discussions here, here, here, here and here

  2. In theory, a merger is a negotiated deal -- you need to get the board to agree to a merger -- while a tender offer cuts off the board and goes straight to the shareholders. In practice, though, a board can always block a tender offer with a poison pill, which means that the only way to succeed in a hostile deal, whether merger or tender, is to pressure the board into agreeing to it, or to win a proxy fight to vote in a new board. A tender offer can never just succeed on its own without board approval. 

  3. As I said at the time:

    So why launch the tender offer? It does nothing now -- shareholders can't actually tender into it because of the poison pill -- and if Valeant ever persuades or replaces Allergan's board, then it could just do a friendly merger and dispense with the tender offer. The existence of the tender offer is probably helpful in persuading Allergan shareholders to call for a special meeting and to vote for Pershing/Valeant's candidates, but it's also very unhelpful in opening the door to this lawsuit.

    This one too!

  4. A lot of this buying was in the form of low-strike call options and forwards, and the opinion has a lot of stuff about how those options and forwards are really equivalent to buying the stock, which is true so I will just talk about stock. Also the mechanics of exactly who was buying are a bit complicated; we talked more about them here

  5. The numbers for STRS Ohio and Iowa PERS come from their declarations here. The numbers for Johnson come from his declaration attached to the amended complaint.

  6. Since the Allergan/Actavis merger, old Actavis has been renamed Allergan and now uses the AGN ticker, so AGN will give you historical Actavis prices, not Allergan ones. This ticker -- 1284849D US Equity -- is the old Allergan, which went public in 1989.

  7. Here I pretend that these plaintiffs, who sold at around the time Pershing Square was buying, "sold to Pershing Square," since that is sort of the hypothesis of the insider-trading theory. Of course, really they sold on NYSE and Pershing Square bought (through dealers who bought) on NYSE, and no one knows who the actual counterparties were. Legally this doesn't matter.

  8. The complaint says:

    As Pearson later explained: “Getting to 10 percent was – or close to 10 percent without triggering any pill was important because in the end, we knew it would come down to, you know, voting the board off or not.” Valeant also knew that Ackman had expertise in waging the kind of hostile proxy contest that would be required to replace the Allergan Board – and would willingly support Valeant’s bid because doing so would only increase Ackman’s insider-trading profits. Similarly, Valeant’s CFO Schiller testified that “one factor” Valeant and Pershing discussed in their plans for Allergan in February 2014 was “Ackman’s ability to purchase 10% of Allergan stock, which would go a long way toward the 25% needed to call a special meeting.”

  9. As Bill Ackman pointed out. Again from the complaint:

    During a January 7, 2015 CNBC interview, Ackman was asked pointedly about the obvious unfairness of Pershing’s massive profit while so many less privileged Allergan investors sold their shares to Pershing without knowing Valeant’s plans. Ackman’s response was telling: “Allergan shareholders made a fortune . . . . 90% of people who didn’t sell to us when we were buying got the benefit of the [Actavis] transaction.” Of course, the Allergan shareholders who did sell during the period of Ackman’s insider trading – i.e., the members of the Class – did not get any “benefit” whatsoever, and suffered substantial damages as a result of Defendants’ scheme.

    The damages were just not getting the benefit.

  10. I mean, it might have, but not on deal news. Maybe Allergan, free from the Valeant distraction, would have discovered a miracle drug and tripled its value. But you can't give the plaintiffs any credit for that. They sold their stock! They were betting the price wouldn't go up any more!

  11. My general view of tender offer rules is that they are all intended to prevent tender offers and protect incumbent managers; one way of preventing tender offers is by making it harder to establish toeholds like this.

  12. Or, similarly, if Pershing Square was planning an activist fight, and tipped off some other investors so that they built up sympathetic stakes, that would again (probably) be fine. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

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