One trading day after announcing the news that the huge hedge fund he runs, Pershing Square Capital Management, had partnered with Valeant Pharmaceuticals International to make an unsolicited $45.6 billion cash and stock takeover bid for Allergan, William A. Ackman is sitting on a paper profit of more than $1 billion on the Allergan shares and options he had been secretly buying over the past two months.
But the question arises: Is this a just reward for a clever takeover strategy devised in February by Mr. Ackman and Valeant’s chief executive, J. Michael Pearson? Or does Mr. Ackman’s extraordinary windfall come as result of what feels like insider trading: Using material, nonpublic information - knowing that Mr. Pearson wanted to buy Allergan and would make an offer for it at a substantial premium to the market price â€" to scoop up 28.9 million Allergan shares from selling shareholders not privy to the plan?
What constitutes the legal definition of insider trading is a messy, murky business, and always has been. There is no law that defines “insider trading†per se, only a few rules promulgated by the Securities and Exchange Commission (and that only a securities lawyer could love) that define insider trading as the buying or selling of securities knowing you have “material nonpublic information†about them, obtained from someone who breached a duty of confidentiality or trust. Then it is left to prosecutors, like the undefeated Preet Bharara, the United States attorney in Manhattan, to bring cases before juries based, simplistically, on the old saw about pornography: You know it when you see it.
Mr. Ackman is no fool. Rather, he is brazenly intelligent â€" he once volunteered to me, unsolicited, his breathtaking SAT scores - and before leaping into this particular abyss he consulted, deliberately, with Robert Khuzami, the former head of enforcement at the S.E.C., who is now a $5 million-a-year-man at Kirkland & Ellis, the Wall Street law firm. Mr. Khuzami assured Mr. Ackman that buying nearly $4 billion of Allergan’s shares knowing that Valeant intended to start a hostile takeover at a premium to market did not violate the S.E.C.’s rule 10b5-1 about insider trading.
Indeed, the onetime regulator told Mr. Ackman that he was so sure of his legal advice that he would welcome his former S.E.C. colleagues to call him and discuss it with him. (For its part, Valeant obtained legal advice from two other Wall Street heavyweights, Sullivan & Cromwell and Skadden Arps.)
Needless to say, Mr. Ackman does not think his deal with Valeant crossed any lines. “The way the rules work is, you’re actually permitted to trade on inside information as long as you didn’t receive the information from someone who breached a fiduciary duty or a duty of confidentiality, et cetera,†he told CNBC on Wednesday morning. (He told me virtually the same thing Tuesday afternoon but then thought better of being quoted. “I want to focus the discussion on the fundamental merits of the transaction,†he wrote in an email to me.)
He likened his buying Allergan options â€" while armed with the nonpublic knowledge of Valeant’s desire to own Allergan and that its previous entreaties had been rebuffed â€" to the decision of his hero Warren E. Buffett to take a 10 percent stake in Coca-Cola without telling anyone. Mr. Buffett does not, of course, have any obligation to tell the world that he intends to buy shares in a company before he buys them.
Mr. Ackman allows that the investors who sold stock to him before his announcement of the deal lost out after the deal was announced, but he is not particularly sympathetic to them. They are mere short-term investors and the spoils of this particular battle belong to the long-term investors who are willing to stick with him while he does the hard activist-type work of changing a company’s chief executive, its strategy or its mix of business lines. Shareholders are of course allowed to go along for the ride - free of charge - while the Bill Ackmans of the world perform their magic.
What makes the alchemy appealing is that the high-profile activist investors - who seem to be able to get on TV on a moment’s notice â€" are allowed to buy stakes in companies in advance of doing the things that make the target companies more valuable. In the case of Mr. Ackman and Valeant, the value that the investor added was to give Valeant’s management the backbone to go after Allergan after its earlier bids had been rebuffed. Taking up Mr. Ackman’s cause, Matt Levine at BloombergView wrote on Tuesday that these shareholders “will be sad†about selling too early to Mr. Ackman “but that’s how markets work.â€
In fact, they are likely to be considerably more than sad and just may initiate a lawsuit against Mr. Ackman and Valeant, claiming they had been harmed financially. Allergan’s lawyers are probably getting ready to file a lawsuit, too.
So if the duped Allergan shareholders are supposedly not the victims here â€" although I believe that they are â€" who then has paid a price? Valeant shareholders are the ones who are probably scratching their heads this morning, wondering why the company’s chief executive agreed to pay Mr. Ackman $1 billion in nearly risk-free vig to rent his capital, to get his expertise in accumulating stock on the sly and for adding some legitimacy to Valeant’s bid for Allergan. Mr. Pearson, the chief executive, also won Mr. Ackman’s pledge to vote his 9.7 percent stake in Allergan for the Valeant takeover. But Mr. Pearson did not need to pay this windfall to Mr. Ackman; he could have started the takeover on his own after accumulating a stake in Allergan and then tossed out a so-called bear hug letter as many chief executives have done before him in pursuit of hostile takeovers. The $1 billion that went to Mr. Ackman could have gone to Valeant’s shareholders instead. (As it is, Valeant stock is up about 11 percent â€" adding some $4 billion in market cap - in the last week. Mr. Pearson told CNBC on Wednesday that teaming up with Mr. Ackman would help Valeant get the deal done. “Bill never gives up and either do we,†he said.)
The S.E.C. itself appears to be sending mixed signals about all this. In January, according to The Wall Street Journal, the agency’s exam manager, Ashish Ward, told attendees at an annual seminar for compliance officers, “We understand common practice in the hedge fund business is to share investment ideas about companies but you want to make sure those conversations don’t go so far as to actually discuss what you are actually doing right now…that would be information that’s nonpublic,†and presumably a violation of the insider trading rules.
So if it’s not kosher for hedge funds to share material, nonpublic information privately with one another about their investment ideas - and that seems intuitively correct - how can it be acceptable for Mr. Pearson to tell Mr. Ackman that he intends to make a takeover bid for Allergan before Mr. Ackman does his buying and then makes $1 billion in profit?
If the two have exploited a loophole in the rules, more power to them. But it’s a loophole that Mary Jo White, the S.E.C. chairwoman, may want to look very seriously at closing, and fast, before what Mr. Ackman has cleverly hatched becomes the new way of doing business on Wall Street.
