Bill Ackman's Big Triumph Becomes His Big Problem

(Bloomberg View) -- Most of the time, securities class-action lawsuits are nothingburgers. A company’s stock price drops unexpectedly, some plaintiffs’ lawyers sue on behalf of supposedly aggrieved investors, and after a year or two of legal wrangling, the parties settle for what amounts to pocket change for the corporation.

But every once in a while, a securities class-action suit comes along that combines high stakes, serious legal issues and potentially astronomical damages. A case called “In Re Allergan Inc Proxy Violation Securities Litigation” is one such lawsuit. It should be getting a lot more attention than it is.

The central character in this legal drama is our old friend Bill Ackman, the billionaire activist investor who runs Pershing Square Capital Management, his $10.8 billion hedge fund. Ackman has been involved in his share of lawsuits over the years, but usually they’re tactical moves in some larger fight with a company he is trying to shake up; once the fight ends, the lawsuits get dropped. What makes this suit different is that it has one aim: to extract a very large sum of money from Ackman and his co-defendant, Valeant Pharmaceuticals International Inc.

Well, actually, there is a second aim. If the case makes it all the way to trial—it’s scheduled for late January, 2018—the plaintiffs hope to show that Ackman and Valeant defrauded them.

The lawsuit goes back to Valeant’s 2014 attempt to take over Botox-maker Allergan Inc. This was well before Valeant’s collapse, when it was still Wall Street’s favorite pharmaceutical company and its chief executive, Michael Pearson, was widely admired for his ability to create, you know, “shareholder value.” Pearson’s business model relied on continuous acquisitions; after each one, Valeant would reduce or eliminate the acquired company’s research and development division while ratcheting up the price of its drugs.

As a potential target, however, Allergan was a different kettle of fish. With a market cap of $37 billion, it was much larger than the companies Valeant had previously taken over. And its CEO, David Pyott, had already made it abundantly clear that he was not interested in a merger with Valeant.

Enter Ackman. In an unusual—nay, virtually unheard-of—move, the hedge fund manager signed an agreement in late February with Valeant; its goal was to pressure Allergan into agreeing to a merger. No sooner was the ink on the agreement dry than Pershing Square began quietly buying Allergan shares, until it had accumulated 9.7 percent of the stock, at a cost of $3.2 billion. (Valeant kicked in a scant $70 million towards the purchase.) In Wall Street parlance, Ackman had taken a “toehold” in Allergan.

On April 22, when Ackman and Valeant finally divulged their plan publicly, Allergan’s stock shot up, giving Ackman a paper profit of $1 billion. Two months later, after Allergan rebuffed Valeant’s entreaties, Valeant launched a $53 billion tender offer. The battle finally ended in November, when Allergan agreed to be bought by Activis PLC  for just over $70 billion. Pershing Square’s profit on its Allergan stake was a staggering $2.2 billion.

QuickTake Insider Trading

The legal question that has always hung over Ackman’s purchase of Allergan’s stock was whether it amounted to an improper use of inside information. After all, Ackman accumulated his stake knowing in advance that Valeant was likely to make a move that would lift the stock. This gave him a formidable informational edge over all the Allergan shareholders who sold their stock to him.

The day after Valeant’s merger proposal was announced, the business journalist William Cohan wrote an article in the New York Times asking whether Ackman’s “extraordinary windfall” was the result of using “material, non-public information—knowing that Mr. Pearson wanted to buy Allergan and would make an offer for it at a substantial premium to the market price.”  And when Ackman and Pearson went on CNBC to tout their merger plan, anchor Joe Kernen asked Ackman this question:

So you buy up to just under 10 percent. Now you’re in, and you’re buying from people who don’t know what you know. And they’re giving up their stock. Probably, they’re kicking themselves now obviously that they sold to you. But you had this knowledge that eventually Valeant was going to make an acquisition. Why is that not front-running?

Ackman responded with a reminder that inside information can be deployed legally, saying that he was legally allowed to trade on what he knew about Valeant’s plans because Pearson had not breached a fiduciary duty in sharing them with him. And he may well have been right about that. But that was never the problem. Rather, the legal issue centered around the fact that Valeant’s original merger offer morphed into a hostile tender offer.

Basically—and this gets a little complicated—Ackman was allowed under the law to buy Allergan shares based on Valeant’s inside information so long as a friendly merger was contemplated. But if it could be proven that Valeant took “significant steps” toward a hostile tender offer while he was accumulating his toehold, then Pershing Square’s purchase would have violated the law. Unless, that is, Ackman and Valeant were both “offering persons,” a legal term that means they were both going to be acquirers of Allergan. (I told you it gets complicated.)

You could certainly argue that the distinction between trading on inside information when a merger is contemplated (legal) versus trading on the same information when a tender offer is being planned (illegal) is, as my Bloomberg View colleague Matt Levine once put it, “weird.” Nonetheless, that’s the law. And the lawsuit brought by the plaintiffs, who are led by two big pension funds  that sold Allergan stock while Ackman was buying, revolves around this very question.

Ackman and Valeant, of course, insist that their intent was always to persuade Allergan to agree to a merger—and that they only moved to a tender offer after it became clear that Allergan would never agree. Though they don’t use the phrase “offering person,” they claim that the term they do use, “co-bidder,” is essentially the same thing. And, they say, the Securities and Exchange Commission vetted the Ackman-Valeant arrangement and it passed muster.

The plaintiffs allege just the opposite: that the defendants knew from Day One that they would have to go hostile, and that their early “friendly” offers were a ruse to make their inside track appear legal. They dispute the notion that a co-bidder is the same as a legally-defined “offering person.” And they scoff at the idea that the SEC looked closely at the deal. They are seeking $2.2 billion in damages—the entirety of Ackman’s profit on his Allergan stake.

I realize this all sounds pretty technical, and I suppose it is. But it has two elements that will catapult it into a significant business story should it go to trial, and maybe even if it doesn’t.

The first is the special status of insider trading when it comes to tender offers. What Valeant and Ackman are accused of is not the traditional kind of insider trading, with a tipper and a tippee and a breach of confidentiality. But it’s no easy matter to persuade casual onlookers, some of whom may end up on a jury, that they should be open-minded about fine distinctions between honest and crooked trading on inside information related to buyouts and takeovers.

The taint of wrongdoing is the last thing Ackman needs, coming after the $4 billion he lost investing in Valeant, not to mention his long, failed crusade against Herbalife. The press would be merciless, Wall Street would be thick with schadenfreude, and his investors would probably be very unhappy. It would put another large dent in a reputation that has taken a few too many hits of late.

QuickTake Hedge Funds

Indeed, Ackman’s very presence is the second element that would give a trial notoriety. He is, after all, the most polarizing investor of his generation, not just because of his tactics but because of his personality. He’s a billionaire who brags about paying $90 million for an apartment he never plans to live in (“I thought it would be fun,” he told the New York Times in 2014). He says things like, “I’m a change-the-world guy,” and “We don’t make an investment unless we think, one, it is good for our investors and two, it’s good for America.”

Imagine Ackman on the stand, trying to explain to a jury why what looks to the untrained eye like insider trading is actually perfectly legal! His instinctive cockiness and immense personal wealth are qualities lots of potential jurors won’t like. And there are also some documents that mention the possibility of a tender offer that Ackman’s side will have to explain away.

More generally, how persuasive will the argument be that Ackman and Valeant weren’t taking significant steps towards a tender offer given that they launched one only two months after Ackman bought his toehold?

All of this would suggest that Ackman and Valeant should be settling this suit instead of fighting it.  But that could hurt Ackman, too. Elizabeth Krutoholow, who covers Valeant for Bloomberg Intelligence, told me that a big damage award would cut into Valeant’s growth “and derail them further from recovery.” Ackman could afford to pay major damages but it would mean another reputational hit.

The plaintiffs, knowing all this, are unlikely to agree to a chump-change settlement. So Ackman and Valeant will have to decide: pay a lot of money to make the case go away, or go to trial and hope for the best.

Either way, it’s going to be a painful end to what Bill Ackman once considered one of the greatest triumphs of his career.

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

Joe Nocera is a Bloomberg View columnist. He has written business columns for Esquire, GQ and the New York Times, and is the former editorial director of Fortune. He is the co-author of "Indentured: The Inside Story of the Rebellion Against the NCAA."

  1. The company is now known as Allergan PLC.

  2. Pershing Square actually made billion, but it paid million of that to Valeant.

  3. My Bloomberg View colleague Matt Levine disagreed saying at the time that the Ackman-Valeant pact was not insider trading.

  4. “Front-running” usually refers to a broker or trader buying a stock in advance of a client who has placed a buy order for the same stock.

  5. Formally, this law is Rule 14e-3 of The Williams Act. Its purpose is to prevent a company from leaking inside information about a coming tender offer to investors who can then load up on the stock and serve as allies.

  6. The Iowa Public Employees Retirement System sold million worth of Allergan stock between late February and April while the State Teachers Retirement System of Ohio sold million worth.

  7. Valeant and Pershing Square have agreed to split any settlement or damages award

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