“The Purloined Letter” is one of Edgar Allen Poe’s most famous crime stories. A woman had her letter stolen by an unnamed minister. It contained information that could have been damaging and the thief used such contents to blackmail the owner. Though detectives searched the minister’s person and rigorously searched his hotel, they could not find it. It was amateur detective C. Auguste Dupin who discovered the letter. The blackmailer knew the detectives would suspect he would use an elaborate hiding place to conceal the letter. Instead, he hid it in plain sight.
The moral of the story is if you want your crime to go undetected then commit it in plain sight. Next month Valeant (VRX) and Bill Ackman of Pershing Square (OTCPK:PSHZF) could face a jury trial for insider trading in Allergan (AGN) shares. The plaintiffs’ argument suggest the insider trading activities occurred in plain sight of regulators and the media.
By early 2014 Valeant had grown a reputation for acquiring pharmaceutical companies, hiking prices and rationalizing expenses to quickly grow earnings. With a $37 billion market capitalization Allergan was much bigger than Valeant, and the company had indicated it had no interest in being acquired. In February 2014 Ackman signed an agreement with Valeant with the goal of pressuring Allergan into a merger agreement. According to Bloomberg the move was virtually unheard of:
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.
The fact pattern suggests Ackman took a $3.2 billion stake in AGN shares (9.7%) shortly after inking its agreement with Valeant. In mid-April AGN spiked after Ackman and Valeant publicly divulged the plan, creating a $1 billion paper profit for Ackman. Two months later Valeant launched a $53 billion tender offer for Allergan, putting the company in play. Actavis won the bidding war in November with a $70 billion takeover; Pershing Square netted a profit of over $2 billion on its AGN stake.
We Have A Legal Memo!
Ackman’s hostile bid drew scrutiny from the media and the investment community. By accumulating a large stake in AGN prior to Valeant’s hostile bid Ackman gained an advantage over other investors, so the logic went. In April 2014 The law firm of Cleary Gottlieb Steen & Hamilton reaffirmed the legality of Ackman’s bid:
“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 nonpublic 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 probably 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 are most likely 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.
The legal memo may have brought Ackman’s “Edgar Allan Poe” routine full circle. Not only was the potential insider trading scheme perfected in plain sight, but it was legal; a reputable law firm reaffirmed it. Cleary Gottlieb’s memo states various facts, some of which may or may not relate to Valeant and Ackman. Cleary Gottlieb’s argument was that Pershing Square was part of a “buying group.” However, just because they put it into a legal memo does not make it true.
Cleary Gottlieb also emphasizes Rule 14 e-3, and implies Ackman could build his 9.7% stake since Pershing and Valeant may not have taken a substantial step to commence a tender offer. That alleged fact pattern might also become a point of contention in a court of law.
Insider Trading In Plain Sight?
My main question is “Why would Ackman need to enjoin Valeant in the scheme?” What gives me pause is Ackman started building a sizeable position only after knowing Valeant was on board with his play. Pershing Square had billions in assets under management (“AUM”). Ackman could have purchased a stake and used his public relations machine to get the word out about how the “smart money” was invested in AGN, and how undervalued it was. That sounds like activism at its finest.
I have read practically every book about Wall Street that matters. I am aware of investors buying enough shares of a company to threaten a takeover with the hopes the target would buy them out at a higher price to make them go away. This is known as “greenmail” and it was a very popular tactic during the 1980s leverage buyout craze. If all Ackman wanted was greenmail then why would he need to enjoin Valeant? He simply could have took a sizeable stake and raised enough capital to make a run at Allergan on his own. This all begs another question, “If the trading scheme is not activism or greenmail then what is it?”
The case could hinge on the buying group’s original intentions. Did Ackman and Valeant contemplate a merger or tender offer? Apparently, trading on inside information is allowed if a merger is contemplated, but illegal if a tender offer is being planned. Per Bloomberg, the plaintiffs claim Valeant’s intentions were to make a hostile bid all along:
The judge seems to be siding with the Allergan shareholders on the question of whether Ackman and Valeant took “substantial steps” toward a tender offer, a necessary condition for illegal insider trading, before Ackman started quietly acquiring Allergan shares in late February 2014.
Likewise, the judge in his tentative decision appeared to agree with the shareholders that Ackman wasn’t a co-offeror in the Allergan bid and as such exempt from prohibitions against insider trading.
Ackman might have convinced Clearly Gottlieb he and Valeant had no plans for a tender offer, but can they convince a jury?
The Play For Investors
The lawsuit amounts to $2 billion, which is close to Ackman’s gain on his AGN stake. If Ackman and Valeant simply had to reimburse the plaintiffs it could cost Pershing Square $1.7 billion and Valeant $300 million – the split represents the 15% of trading gains Ackman shared with Valeant. Per Institutional Investor the hedge fund had over $18 billion in AUM in 2015. After redemptions and losses the fund now has about $9.5 billion in AUM. Ackman might have to liquidate certain of his holdings to fund potential pay outs until the lawsuit.
Through year-to-date November 14, 2017 the performance of Pershing Square Holdings, Ackman’s publicly-traded hedge fund, was down 4.2% net of fees. This compares negatively to the S&P 500 (SPY) and Dow Jones (DIA) which were up 17.2% and 20.9%, respectively. The following chart highlights the performance of certain of Pershing Square Holdings’s large investments:
Ackman is known for taking large stakes in a few holdings. If he has to liquidate certain holdings to help fund a payout then shares of certain holdings could decline. There could be selling pressure in certain of these stocks once the trial (expected to start next month) comes to a close.
Valeant has $1.9 billion in cash on hand. It could fund its share of the AGN trading gains. Valeant’s ultimate exposure to a legal settlement remains to be seen. A protracted case could tarnish the company’s brand and pressure its stock as investors ponder its ultimate legal exposure.
Reputational risks and potential legal exposures from the AGN insider trading case make VRX and PSHZF a sell.
On Trump And The Global Economy
Trump And The Global Economy Town Hall took place October 24th in Fort Greene. It Featured Professor Lance Brofman, Coconut Rob (Coconut Rob Smoothies), Wuyi Jacobs (AfroBeats Radio) and Ralph Baker, author of Shock Exchange: How Inner-City Kids From Brooklyn Predicted the Great Recession and the Pain Ahead.
The event was well-received by the community. We parsed through President Trump’s proposed tax plan and [i] how it was pure economic folly and [ii] high net worth individuals could potentially game the system by shifting income around. Apparently, Kansas Coach Bill Self did this when the state of Kansas cut taxes in the past. We discussed the pros and cons of technology on workers and the economy. How will the economy and country prosper under Trump’s leadership vis-a-vis Obama? What’s behind the verbal sparring with black athletes, ESPN’s Jemele Hill and North Korea’s Kim Jong Un?