Valeant insider trading ruling: Activists beware of hostile bidder hookups

November 12, 2015

(Reuters) – Back in April 2014, Wachtell Lipton Rosen & Katz put out a client alert warning of a scary new template for hostile bids: corporate raiders teaming up with activist investors for their mutual benefit and the corresponding doom of target companies. The alert was inspired, of course, by the pharmaceutical company Valeant’s partnership with Bill Ackman’s Pershing Square in a bid for Allergan.

As Wachtell explained, Ackman and Valeant seemed to have structured the bid with surpassing shrewdness. To steer clear of the Williams Act prohibition on insider trading in advance of a tender offer, they styled themselves as co-bidders and conspicuously said (in the early going) that they were not launching a tender offer. Pershing, which put up the money to acquire a toehold in Allergan stock, also, used derivative purchases to avoid disclosing its growing stake, at least in Wachtell’s recounting. The upshot, according to Wachtell, was a no-money-down toehold in the target for Valeant and a quick profit for Pershing when Valeant announced its bid. “Speculation and rumor abound,” the client alert said, “of other raider-activist pairings.”

But after a ruling Wednesday by U.S. District Judge David Carter of Santa Ana, California, those pairings must seem about as appealing as peanut butter and sardines.

Judge Carter held that Allergan shareholders can move ahead with a class action accusing Valeant and Pershing Square of insider trading. That wasn’t a big surprise. The same judge found last November that Allergan had raised “serious questions” about whether Valeant and Pershing violated the Williams Act in Allergan’s own insider trading suit against the hostile pair. (Allergan, as it happens, was represented by Wachtell.) In Wednesday’s decision, Judge Carter reiterated his previous conclusion that Pershing and Valeant hadn’t been quite clever enough to evade a deeper inquiry about the legality of their partnership structure.

But the judge also knocked down new defenses by Pershing’s lawyers at Kirkland & Ellis and Valeant’s counsel at Sullivan & Cromwell. The most intriguing was a novel argument that two of the name plaintiffs in the case did not have standing to sue because they weren’t selling Allergan stock when Pershing was buying shares, only when the hedge fund was executing futures contracts with Nomura.

To bring a private insider trading case, investors have to show they could have been injured by the alleged fraudster, which comes down to establishing that both were trading at roughly the same time. Two of the shareholders suing Valeant and Pershing didn’t trade late last February, when the hedge fund bought outright about 600,000 shares of Allergan. They were, however, in the market in March, when Pershing acquired millions more Allergan shares through call options transactions with Nomura.

The plaintiffs, represented by Bernstein Litowitz Berger & Grossmann and Kessler Topaz Meltzer & Check, argued that the Nomura futures deals were an elaborate cover for Pershing and Valeant. They said Pershing used the Nomura options deals to acquire an “economically identical” stake in Allergan without triggering federal disclosure obligations – which, in turn, permitted Pershing to win big when Valeant finally announced its hostile bid. According to their brief, they were injured when Nomura, acting at Pershing’s behest, went to the market and acquired Allergan shares to meet its call obligations.

Pershing and Valeant said that theory could have “dire, unprecedented regulatory consequences” for Nomura and other dealers. Nomura, according to defense lawyers, was not acting as Pershing’s broker when it bought Allergan shares. The bank was hedging its own risk. Holding Pershing and Valeant responsible for Nomura’s trades, they said, was tantamount to ruling that Nomura was part of the acquisition group – and that holding would mean that options trades would trigger disclosure obligations and perhaps poison pills.

Judge Carter didn’t seem too worried about that. He simply cited language in the Williams Act prohibiting insiders from “causing” the purchase of a target’s securities in advance of a tender offer. The complaint in this case adequately alleged that Pershing and Valeant caused Nomura to buy Allergan shares when name plaintiffs were selling, the judge said, so shareholders have standing to stay in the suit.

You can see why this ruling is a disincentive for activists thinking about partnering with strategic bidders for hostile acquisitions. Pershing’s Allergan profit was the product of the stealth it maintained by acquiring shares through options deals that carried the added benefit, under Pershing’s thinking, of insulating the hedge fund from insider trading liability to Nomura counterparties. Judge Carter’s decision strips away the insulation, putting Pershing’s profit at risk.

If hedge funds can’t count on short-term profits from stealth partnerships with hostile bidders, why team up with them? For the longer term? Just ask Ackman how that’s working out for him and Valeant.

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