Allergan v. Valeant: California District Court Questions Whether Co-bidder Vehicle Avoids Insider Trading Liability

Practical Law Legal Update 0-587-3266 (Approx. 7 pages)

Allergan v. Valeant: California District Court Questions Whether Co-bidder Vehicle Avoids Insider Trading Liability

by Practical Law Corporate & Securities

Background

The California suit is only one of several proceedings currently or previously brought in the Allergan takeover battle. In this case, Allergan alleged that Pershing Square had committed insider trading by acquiring Allergan stock during the pendency of a tender offer launched by Valeant. Specifically, Allergan alleged that the acquisition had run afoul of Rule 14e-3 under Regulation 14E. Briefly, Rule 14e-3 establishes a "disclose or abstain" rule specifically with respect to tender offers. The rule provides that if any person has taken a substantial step to commence (or has commenced) a tender offer, any other person who is in possession of material information relating to that tender offer that he received directly or indirectly from the offering person and that he knows is non-public must either abstain from trading or disclose the information to the public before trading. The theory of Allergan's compaint was that Valeant was an "offering person" that had taken substantial steps to commencing a tender offer, while Pershing Square was the person in possession of material information relating to that tender offer (the information being that a tender offer would be formally launched) and nevertheless bought stock in Allergan.

The relationship between Valeant and Pershing Square began on February 4, 2014, when Valeant's chairman and CEO J. Michael Pearson met with William Ackman of Pershing Square. At that meeting, Pearson and Ackman discussed the pharmaceutical industry and hostile takeovers in general terms, but did not discuss Allergan specifically. After that meeting, Valeant scheduled a meeting with Allergan's CEO David Pyott to discuss a possible merger between Valeant and Allergan. Ahead of that meeting, Valeant began engaging legal and financial advisors to work on a potential deal. Some of the presentations that circulated among Valeant's board and its advisors included references to possibly launching a tender offer.

After hearing that Allergan would not be interested in a deal with Valeant, Pearson cancelled his meeting with Pyott and instead signed a confidentiality agreement with Pershing Square to discuss a bid for Allergan. As Valeant and Pershing Square held discussions over such a transaction, more slide decks and e-mails were exchanged that revealed an expectation on their part that a hostile bid would eventually become necessary.

On February 25, 2014, Pershing Square and Valeant entered into a relationship agreement that would govern a new co-bidder entity. Under the agreement, Pershing Square would manage the entity, including the manner and timing of buying Allergan stock, except that Valeant would have a consent right before any purchases that triggered HSR reporting requirements. Pershing Square would also control the entity's voting rights over the Allergan stock it had acquired, with conditions that it vote all of its shares in favor of Valeant's proposals and against any proposal that would undermine Valeant's proposals.

The agreement contained the following key financing terms:

Valeant agreed to contribute $75.9 million to the entity once the entity purchased 4% of Allergan stock.
Immediately before closing the anticipated Allergan-Valeant transaction, Valeant could require Pershing Square to buy $400 million of Valeant stock.
If the transaction was consummated in a way that allowed Allergan shareholders to receive either cash or Valeant shares, then Pershing Square agreed to have the entity receive stock.
Once the transaction was consummated, the entity would dissolve and its assets, including any net profits arising from the Allergan stock, would be divided pro rata between Valeant and Pershing Square.
A lock-up provision under which Pershing Square would hold $1.5 billion worth of Valeant stock for one year after closing.

The agreement also contained an acknowledgement by the parties that no steps had yet to be taken toward a tender offer, that Valeant would consult with Pershing Square and acquire its consent before taking any such steps, and that the parties would be identified as co-bidders in any such offer.

After signing that agreement, the co-bidder entity, PS Fund 1, LLC, began buying Allergan stock on the open market, reaching 4% on April 3. At that point, Valeant contributed its agreed-upon $75.9 million (the size of a purchase that triggers an HSR-notification requirement) and authorized the entity to move past the 5% reporting threshold. PS Fund 1 reached the 5% threshold and eventually acquired a 9.7% toehold before the Schedule 13D reporting deadline. On April 22, Valeant and Pershing Square publicly announced the existence of their holdings through PS Fund 1 and their desire to do a deal with Allergan.

Initially, Valeant did not launch a formal tender offer. Rather, the bidders hoped to hold a non-binding shareholder referendum to pressure Allergan's board to negotiate. (A suit brought in Delaware to invalidate that meeting was eventually settled.) However, in response to shareholder feedback, Valeant and Pershing Square dropped the idea for a referendum in favor of formally launching a tender offer. On August 1, the plaintiffs filed suit, alleging that the defendants' conduct constituted insider trading in violation of Section 14(e) of the Exchange Act and Rule 14e-3. The plaintiffs also alleged that the defendants violated Section 14(a) and Rule 14a-9 by not adequately disclosing the background and co-bidder arrangement to Allergan shareholders. They asked that the Court preliminarily enjoin PS Fund 1 from voting its 9.7% stake in Allergan at the December 18, 2014, shareholder meeting and preliminarily enjoin the defendants from voting any proxies solicited by them in violation of Section 14(a) or Rule 14a-9 until corrective disclosures are made.

Outcome

The Court analyzed the plaintiff's motion under the Ninth Circuit's "serious questions" test, in which the moving party must show:

A likelihood of success on the merits.
A likelihood of irreparable harm to the moving party in the absence of preliminary relief.
That the balance of equities tips in favor of the moving party.
That an injunction is in the public interest.

The merits of the Rule 14e-3 claim turned on two issues:

Whether substantial steps toward a tender offer had been taken by the time PS Fund 1 had begun accumulating a stake in Allergan (there being no dispute that Pershing Square had been in possession of material, non-public information during that time).
Even if those steps had been taken, whether Pershing Square was an "offering person" together with Valeant and not a separate person trading on insider information.

Serious Questions Whether Substantial Steps Taken

The Court analyzed the "substantial steps" question under a standard of reviewing the offering person's objective conduct. In doing so, the Court took note of the rule's Adopting Release, which provides examples of relevant steps such as a board resolution to launch a tender offer, formulating a plan to launch a tender offer, arranging financing and preparing tender offer materials. The courts have provided other examples, including signing a confidentiality agreement, holding confidential discussions and conducting a financial analysis, even when a tender offer has not yet been the chosen structure for the deal.

The Court pointed out several examples of the defendants' conduct that would appear to rise to these levels. They had begun working in February with legal and financial advisors, commencing due diligence and preparing financing, while several discussions made reference to a possible tender offer. The defendants argued that their conduct did not reach any of these levels. They pointed out the provisions in the relationship agreement stressing that a tender offer had not yet been launched and would require further consent. Rather, in their view, the tender offer had only begun in earnest after the late-May meetings with Allergan shareholders, by which time the toehold stake had already been amassed.

The Court, however, remained unconvinced that a tender offer had not already begun in February, explaining that "stating in a contract that they had not taken any steps toward a tender offer does not necessarily make it so." Indeed, the very fact that Pershing Square and Valeant referred to themselves as "co-bidders" and entered into the relationship agreement evidenced that they were already thinking about how regulators would respond to what appeared to be substantial steps taken toward a tender offer.

Serious Questions Regarding Co-bidder Status

The defendants argued in the alternative that even if substantial steps toward a tender offer had already been taken, Pershing Square and Valeant were collectively one "offering person" within the meaning of Rule 14e-3. To buttress their argument, the defendants pointed to the broad meaning of terms like "bidder" and "offeror" in the disclosure requirements of Regulation 14D. In that context, the SEC broadly considers four "bidder" status factors such as whether the co-party:

Played a significant role in the initiating and negotiating of the offer.
Acted together with the named bidder.
Provided or played a primary role in obtaining the financing.
Would beneficially own the securities purchased by the named bidder in the tender offer.

The Court lamented the dearth of SEC and common law guidance on the definition of "offering person" for purposes of Rule 14e-3, but found that one takeaway from the case law is that bankers who do no more than supply the tender offeror with money in return for an interest in the target company's stock do not qualify as co-bidders for Rule 14e-3 purposes. Beyond that, the Court found persuasive the plaintiffs' argument that the definition of "offeror" for disclosure purposes is not a useful guideline for the definition of "offering person" under Rule 14e-3. The Court agreed with the plaintiffs that the purpose of the Williams Act is to ensure that investors have access to the material information they need to decide how they will respond to a tender offer. This requires defining "offeror" broadly to ensure broad disclosures under Sections 13(d) and 14(d). On the other hand, for purposes of Rule 14e-3, "offering person" should be defined narrowly to restrict the number of persons allowed to trade on insider information about tender offers.

Rather than equating an "offering person" to an "offeror," the Court adopted the plaintiffs' proposed test for distinguishing them, under which an offering person should:

Be more than a financier.
Actually make an offer to purchase shares.
Have some degree of control over the terms of the tender offer and over the surviving entity.

By this standard, the Court found "serious questions" as to whether Pershing Square qualified as an offering person. In its favor, Pershing Square did play an active role from the beginning in helping Valeant craft its acquisition strategy. The Court acknowledged the likelihood that the tender offer could not have been launched without Pershing Square's assistance in strategizing the bid, financing it by acquiring a toehold through PS Fund 1, agreeing to accept Valeant shares if that were part of the consideration and agreeing to buy $400 million of Valeant shares at Valeant's request. However, the Court remained doubtful that the SEC meant for these factors to be sufficient to exempt an entity like Pershing Square from the "disclose or abstain" rule. Here, Pershing Square had no control over:

The price to be offered to Allergan's shareholders.
Whether the tender offer would involve cash and/or an exchange of stock.
Whether to call off the tender offer at some point.

There was also no evidence that Pershing Square would actually acquire any Allergan stock through the tender offer or be involved in the surviving entity beyond the one-year lock-up.

For these reasons, the Court held that the plaintiffs raised serious questions going to the merits of their Rule 14e-3 claim. The Court added that serious questions were also raised regarding the defendants' compliance with the disclosure rules. While acknowledging the notoriety of the takeover battle and the likelihood that Allergan shareholders knew all about Valeant and Pershing Square, the Court held that the defendants would still be required to disclose the background and particulars of their arrangement.

Irreparable Harm, Balance of Equities, Public Interest

Having found serious questions on the merits, the Court turned to adjudicating the remedy requested by the plaintiffs. Because of the irreparable harm of an uninformed vote, balanced against little more than the added cost of making additional disclosures, the Court ordered the defendants to make corrective disclosures or otherwise be enjoined from voting the shares and proxies they had collected. The required disclosures were that:

Pershing Square and Valeant's relationship agreement included an agreement that Pershing Square and Valeant agreed to be called "co-bidders" if the Allergan-Valeant transaction occurred by way of tender offer.
The federal lawsuit against Pershing Square, Valeant and PS Fund 1 alleged that they violated Rule 14e-3 by causing PS Fund 1 to acquire Allergan shares without publicly disclosing information about Valeant's plans for a tender offer.
The Court found that serious questions were raised as to whether the defendants' conduct violated Rule 14e-3.

However, the Court declined to grant an injunction to totally remove the defendant's voting power over PS Fund 1's shares and the proxies they had solicited. In the Court's view, the harm facing the plaintiffs was too remote to justify such a remedy, as it depends on:

PS Fund 1's votes tipping the scales at the meeting.
Replacement directors being nominated.
Allergan refusing to appoint those directors.
The Delaware Court of Chancery ordering their election.
A tender offer being successfully consummated that threatens Allergan's corporate existence.

A finding that this harm is imminent, in turn, would have to be made on the basis of a determination not reached by a jury on a novel legal issue of whether or not Pershing Square qualified as an offering person, against the backdrop of a corporate battle that seemingly changes every day. The Court decided instead to be mindful of the neutrality of the Williams Act and allow the shareholders to make the ultimate decision about Allergan's management.

Practical Implications

Although the Court did not enjoin the defendants from voting the proxies they have solicited, the decision is hardly an endorsement of the co-bidder arrangement as a method for qualifying as an offering person. To the extent that public M&A practitioners were looking to the Valeant-Pershing Square vehicle as a model for structuring joint activist-strategic buyer bids, the decision indicates (until the SEC or an appellate Court advises otherwise) that the vehicle is not a safe harbor from insider trading liability absent greater control for the party establishing a toehold in the target company. To have a greater chance of avoiding a violation under Rule 14e-3, the co-bidder agreement should grant the financing party such powers as:

Control (or at least a vote) over the price to be offered to the target shareholders.
Control (or at least a vote) over the decisions to offer cash, stock or a mix and whether to terminate the tender offer at any point.
Acquisition of the target company's stock through the tender offer.
Involvement in the surviving entity's governance beyond agreeing to a timed lock-up.

Alternatively, if the principal bidder does not wish to share control in this fashion, the parties can always avoid launching a tender offer altogether. The potential Rule 14e-3 violation only arose because Valeant and Pershing Square switched their strategy from pursuing a non-binding referendum to commencing a tender offer, months after the initial announcement of their bid. In a hostile setting, however, a tender offer is not necessary to gain control over the target company. Instead, the bidders can launch a proxy contest in the hopes that they will win enough seats on the target company's board to appoint a majority of directors who are amenable to a negotiated merger with the bidders. At that time, the parties can then negotiate a merger agreement, without ever having launched a tender offer and becoming subject to Regulation 14E.

Allergan v. Valeant: California District Court Questions Whether Co-bidder Vehicle Avoids Insider Trading Liability | Practical Law