Judge David Carter’s Valeant Decision: A Close Reading

carterFebruary and April 2014, Pershing Square acquired 9.7% of the shares of Allergan, a pharm company based in Irvine, California and best known for Botox. The circumstances under which it obtained this large chunk of the company’s equity have straightened some wrinkles and raised some eyebrows, and more important have raised a close legal question as to whether Pershing Square and related legal entities would be permitted to vote those shares in an upcoming special meeting.

The controversial opinion issued by Judge David Carter on this matter on November 4th is worth a careful look, and I propose to give it that here, with a minimum of editorializing.

Special Meeting Scheduled

In June, Valeant announced its tender offer for Allergan’s shares. Allergan’s board has resisted the attempted takeover, and Valeant, along with its ally, Pershing Square, have demanded a special shareholders meeting, at which they hope the shareholders will vote the resistant directors out, and vote in directors friendlier to the joinder.

Their demand has been met: a special meeting is scheduled for December 18th. But the Allergan board brought a lawsuit claiming that the hedge fund and the would-be acquirer have violated securities laws and regulations. Pursuant to that lawsuit, Allergan moved for a preliminary injunction that would prohibit PS Fund 1, the Ackman controlled entity that holds the 9.7%, from voting at the December 18th, and that would require collective disclosures before any of the proxies they have solicited could be voted.

The lawsuit, and the demand of the motion, is based on the allegedly underhanded relationship between Valeant’s CEO and chairman, J. Michael Pearson, on the one hand and Bill Ackman of Pershing on the other. According to a deposition the court cites, at a meeting on February 4th Pearson and Ackman discussed “unsolicited bids in the pharmaceutical industry generally” although they didn’t at this time discuss Allergan itself “in any detail.” Apparently Allergan was at least referenced. Immediately thereafter, Pershing Square started doing due diligence Allergan, with at least the idea of working with Valeant.

On February 9th, the alliance became more formal. Pearson told Ackman that Allergan was the target, and Pershing Square and Valeant entered into a confidentiality agreement. On February 11, Pershing Square formed PS Fund 1.

HSR Reporting Rules

By February 25th, things were moving more quickly. Valeant and Pershing Square lawyers drafted an acquisition plan according to which Pershing Square would manage PS Fund 1, described in the document as a “Co-Bidder Entity,” except that Valeant would have to consent before the purchases by that entity triggered the Hart-Scot-Rodino reporting rules. Also, the deal held that when the transaction was consummated the Co-Bidder Entity would dissolve, with Valeant and Pershing Square each taking any net profits pro rata.

On April 7th, with the fund’s purchases poised at the 5% reporting threshold under HSR, Valent’s board gave its consent to further purchases. On April 10th, Valeant contributed $75.9 million to the fund. Between April 11th and April 21st the entity acquired a lot of Allergan shares. As the court says in a footnote, this took advantage of 13d-1 of HSR, “under which a person has 10 days from the date he or she becomes a 5% shareholder to file 13D and disclose his or her ownership to the SEC.” This ownership was disclosed on the 21st, and this disclosure was elaborated upon in a Valeant press release on the 22d.

Allergan’s stock price immediately rose 22%, and Allergan’s board adopted a poison pill.

On June 11th, Valeant formed a new subsidiary, AGMS, to hold its Allergan shares.

So let’s skip to the key legal questions. Are Valeant and Pershing Square involved in insider trading as SEC rules understand it? Is there a “likelihood” that they are, in the sense that would support a preliminary injunction? If there is such likelihood, should Pershing Square be barred from voting the shares it purchased pursuant to this arrangement?

The court applied what is known as the Winter test for preliminary injunctions; named after a 2008 Supreme Court decision, Winter v. NRDC. The test involves four elements: a court will grant such an injunction if there is (1) a likelihood of success on the merits; (2) a likelihood of irreparable harm to the movant; (3) a balance of equities in favor of the movant; and (4) the interest of the public.

After working through each of those elements, the court granted the injunction “in part,” and in a way that allows each party to claim victory.

Inherently Appealing

The defendants have to make corrective disclosures to their proxy solicitation statement, disclosing the particulars of the February 25th agreement, and they shall disclose the court’s finding that there are “serious questions as to whether Defendants’ conduct between February and April 2014 violated Rule 14a-3.”

But the court has not enjoined the co-bidders from voting their stock, which is surely at or near the bottom line for Pershing Square itself.

The take-away for merger arbs is that this sort of co-purchasing tactic in the lead-up to a tender offer may well be suspect in the eyes of many federal judges, and ought to be initiated if at all, only with that caution in the front of one’s mind.

I’ll end with the following words from Carter’s November 4th decision: there is, he thought, “something inherently appealing about preventing someone who may have violated the securities laws from using their allegedly wrongfully-acquired shares to carry out their ultimate plan.” He didn’t act upon that temptation here, but he may have made it easier for others to do so.


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