Legal Memo Defends Ackman’s Actions in Allergan Bid

In the wake of this week’s unusual hostile bid for Allergan, one of the most pressing questions has been whether William A. Ackman, the activist investor who runs Pershing Square Capital Management, engaged in insider trading.

By accumulating a large stake in Allergan while knowing a bid was imminent, Mr. Ackman clearly had an advantage over other investors. And when Pershing Square and Valeant Pharmaceuticals announced its plans, the value of Mr. Ackman’s $4 billion stake quickly rose by about $1 billion.

But because Mr. Ackman is part of the buying group, it appears he was well within his legal rights. The fact that the tactic was legal, however, does not mean it is not drawing scrutiny.

In a memorandum issued Thursday, lawyers at the firm Cleary Gottlieb Steen & Hamilton, who are not involved in the bid, reaffirmed the legality of Mr. Ackman’s actions, which resulted in his firm acquiring a 9.7 percent stake in Allergan.

“Based on public information, there is nothing to suggest insider trading,” they said. “First, it appears that neither Valeant nor Pershing Square had obtained any material non-public information from Allergan. Second, it has been long established that a prospective bidder can accumulate a stake in a target without disclosure of its own plans.”

They also said Mr. Ackman and Valeant likely did not run afoul of a special Securities and Exchange Commission rule that pertains to tender offers. That rule, Rule 14 e-3, stipulates that once a potential bidder has “taken a substantial step or steps to commence a tender offer,” no one who knows about the pending bid can buy shares in the target.

The bidders likely are safe here for two reasons. For one, the Pershing Square fund that bought the Allergan shares was associated with the buying group. And moreover, Mr. Ackman and Valeant may not actually begin a tender offer any time soon.

“It is highly likely that Valeant has been careful to avoid any actions that could be characterized as steps towards commencement of a
tender offer,” the Cleary lawyers write in the memo. “Instead, Valeant is likely to pursue the acquisition by making public merger proposals (‘bear hugs’) together with a proxy contest to change the board of directors.”

(The lawyers say that the S.E.C. rule pertains to tender offers only, instead of other acquisition structures, because “the Williams Act gave the S.E.C. authority to adopt rules regulating tender offers and this rule was adopted in 1980, at a time when tender offers were the principal means of acquisitions and there were concerns about people trading based on advanced knowledge of tender offers. This was during the era of ‘raiders,’ who often made tender offers, and well before the current era of ‘activists.’”)

Another issue receiving scrutiny in the wake of the bid for Allergan is whether or not Pershing Square and Valeant should have been forced to disclose the stake they were amassing sooner.

The S.E.C.’s so-called Schedule 13D window stipulates that investors who accumulate 5 percent of a company’s stock must publicly report their position within 10 days of crossing that threshold, but allows the stake to grow within those 10 days.

“For many years numerous market participants have urged Congress to shorten the window, noting that almost every other developed market
has a much shorter period to make filings disclosing large positions,” the Cleary lawyers write. And while the Dodd-Frank regulation in 2010 authorized the S.E.C. to close or shorten the 10-day window, it has not yet acted.

“While many commentators assumed that the S.E.C. would move quickly to do so, activist hedge funds and their supporters argued that
encouraging activism was good public policy (since it was a counterweight to ‘entrenched’ boards of directors) and that the ten-day window encouraged activism by permitting acquisitions of larger stakes without disclosure (and the resulting run-up in share price),” the memo says.

Finally, there is the question of whether Valeant and Pershing Square should have filed antitrust pre-notification under the Hart-Scott-Rodino Act, notifying regulators of a potential merger of rivals. But because Pershing Square mostly bought options, they did not have to report holding underlying shares. Therefore, the Cleary attorneys write, “it appears that no filing had been required.”

Though Pershing Square and Valeant appear to have stayed well within their legal rights in accumulating their 9.7 percent stake in Allergan, “this week’s high-profile events regarding Allergan may put pressure on the S.E.C. (and potentially Congress) to address a number of important policy questions,” the memo states.

Among them are whether the 13D window should be closed or shortened, whether substantial derivative positions should require additional disclosure, and whether the rule around limits on trading around tender offers should extend to other deal structures.

So far regulators in Washington have been quiet on the issue, but that may not be the case for long if corporations start lobbying for more protection against hostile bids and activists.

“These issues are part of a growing debate as to whether there are cases of ‘illegitimate’ imbalances of information beyond classic ‘insider trading’ that regulators should address,” the memo said.