Insider Trading and Tender Offers

Christopher E. Austin and Victor Lewkow are partners focusing on public and private merger and acquisition transactions at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum.

Valeant’s hostile bid for Allergan was one of 2014’s most discussed takeover battles. The situation, which ultimately resulted in the acquisition of Allergan by Actavis plc, included a novel structure that involved a “partnership” between Valeant and the investment fund Pershing Square. In particular, a Pershing Square-controlled entity having a small minority interest owned by Valeant, acquired shares and options to acquire shares constituting more than nine percent of Allergan’s common stock. Such purchases were made by Pershing Square with Valeant’s consent and with full knowledge of Valeant’s intentions to announce a proposal to acquire Allergan. Pershing Square and Valeant then filed a Schedule 13D and Pershing Square then supported Valeant’s proposed acquisition. Ultimately Pershing Square made a very substantial profit on its investment when Allergan was sold to Actavis.

The structure attracted much commentary, including questions as to whether Pershing Square’s acquisition of Allergan shares while in possession of the non-public information regarding Valeant’s planned bid constituted improper insider trading. The general consensus was that the structure did not appear to implicate traditional 10b-5 insider trading concerns since Pershing Square acted with Valeant’s consent and no breach of duty was involved. Commentators also noted, however, that Rule 14e-3, which is a special insider trading rule relating to tender offers, could be implicated if at the time of Pershing Square’s purchases there had been “substantial … steps to commence a tender offer.” We discussed these issues in a post at the time.

The 14e-3 issues were considered last year by a federal court in connection with Allergan’s motion for a preliminary injunction against Valeant’s bid by Allergan and certain shareholders who sold Allergan shares at the time Pershing Square was purchasing Allergan shares and options. The court noted that the 14e-3 claims raised “serious questions” (part of the applicable standard for granting a preliminary injunction), but declined to issue an injunction on the basis that damages would be an adequate remedy for the persons who sold Allergan shares at the time of Valeant’s purchases [1]. After the Actavis acquisition of Allergan was completed, Allergan withdrew as a party but the litigation continued on behalf of the selling shareholders seeking damages from Pershing Square and Valeant. Earlier this year Pershing Square and Valeant moved to dismiss the action. On November 9, 2015 the court issued an order denying the motion [2], which means that the action will proceed (unless earlier settled).

The court’s order confirmed its analysis of certain of the issues addressed in its 2014 preliminary injunction motion. These included the court’s view that, at least when using the plaintiff-friendly basis for evaluating motions to dismiss, there were adequate allegations that (1) Valeant had taken substantial steps to commence a tender offer prior to Pershing Square’s purchases and (2) Pershing Square was not entitled to the exemption from Rule 14e-3 for purchases made by the “offering person.” The court also confirmed its earlier holding that there was a private right of action under Rule 14e-3.

The court also considered, however, several new arguments raised by the defendants in their motion to dismiss. In particular:

  • Defendants argued that the plaintiffs did not have standing to pursue the claim, relying on the fact that at the relevant time the plaintiffs sold common stock while most of Pershing Square’s purchases were in the form of options on Allergan shares acquired from Nomura International. And, defendants argued, any purchases by Nomura to hedge its exposure to Pershing Square from the sale of the options, were at Nomura’s discretion and could not be attributable to Pershing Square. The court discussed this argument in some detail, but ultimately concluded—again using the plaintiff-friendly standard required when considering a motion to dismiss—that there were sufficient facts alleged to support the argument that Pershing Square “used Nomura to acquire [Allergan] shares on its behalf” and that the options acquired from Nomura were, for these purposes, the “same class” as the underlying common shares. The court also noted that under Rule 14e-3 a party with certain material nonpublic information regarding a tender offer may not purchase or “cause to be purchased” the relevant shares and, as a result, “there is little basis for excluding Nomura’s open market purchases” from the analysis.
  • Defendants also argued that they did not act with the necessary scienter to establish liability—i.e., that they did not have “a mental state embracing intent to deceive, manipulate or defraud”—and in particular that the plaintiff’s needed to allege that each defendant “knew or was deliberately reckless in not knowing that Valeant had taken substantial steps to commence a tender offer.” The court rejected this position and noted that the plaintiffs need only allege that defendants knew “they were in possession of material nonpublic information … and that they acted with the intent to deceive, manipulate or defraud.” And the court concluded that the allegations that the purchases (including via Nomura) were “intentionally designed … to avoid disclosure” were sufficient to meet the “deceive” element of the scienter requirement.

The implications of the court’s decision include the following:

  • The 14e-3 risk from structures such as these is real and is likely to deter use of these types of arrangements going forward except if a tender offer is never commenced (or, at least in theory, even seriously discussed).
  • The court’s discussion of Pershing Square’s relationship with Nomura, if confirmed and expanded beyond the particular facts, could have implications for dealers and other participants in the options and other derivatives markets. For example, if a dealer selling an option to a client is characterized as that client’s agent, and the dealer’s resulting hedging activity is viewed as being undertaken on behalf of the client, numerous reporting and other obligations under securities law and contractual triggers based on share ownership (e.g., rights plans) could be implicated. The Second Circuit considered similar issues in 2011 in the CSX v . TCI matter [3]. Although the majority opinion in that case did not directly resolve the question of whether a holder of cash-settled total return swaps should be deemed to beneficially own the shares underlying the swaps, Judge Winter, in a concurring opinion, concluded that should not be the case absent the swap holder having rights in the underlying shares (e.g., the right to direct the voting or require the sale of the shares).

Endnotes:

[1] Allergan v. Valeant Pharmaceuticals Int’l, Inc., Case No. SACV-1214 DOC (C.D. Cal. November 4, 2014).
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[2] Basile v. Valeant Pharmaceuticals, 14-cv-02004, U.S. District Court, Central District of California (Santa Ana).
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[3] CSX Corp. v. The Children’s Inv. Fund Mgmt., No. 08-2899-cv, slip op. (2d Cir. July 18, 2011).
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