Court Raises Serious Questions About the Legality of the Tactics Employed but Declines to Enjoin Hostile Bidders from Voting Shares
On November 4, 2014, the district court in Allergan, Inc. v. Valeant Pharmaceuticals Int’l, Inc., Case No. SACV 14-1214 (C.D. Cal.) ruled on Allergan’s claims that Pershing Square Capital Management, L.P., a hedge fund that teamed up with Valeant in its battle for control of Allergan, committed insider trading in violation of Securities Exchange Act Section 14(e) and Rule 14e-3 when it caused a jointly funded special purpose entity (the JV entity) to purchase a 9.7 percent stake in Allergan prior to Valeant’s commencement of a tender offer for all outstanding Allergan shares. In ruling on Allergan’s motion for a preliminary injunction, the court found that Allergan had raised serious questions going to the merits of the insider trading claim. However, the court declined to enjoin the JV entity from voting the shares at an upcoming special meeting of shareholders because Allergan failed to show that it would suffer irreparable harm.
In February 2014, Valeant and Pershing Square entered into a letter agreement that outlined a plan for acquiring control of Allergan. Between February and April, Pershing Square acquired 9.7 percent of Allergan’s shares through the JV entity at a cost of more than $3 billion, $75.9 million of which was contributed by Valeant. In June 2014, Valeant publicly announced a tender offer for all outstanding Allergan shares. Valeant and Pershing Square also commenced a consent solicitation to call a special meeting of stockholders in order to remove six directors from Allergan’s nine-person board as part of a plan to gain control of the Allergan board. Allergan agreed to hold a special meeting on December 18, 2014. Among the litigation brought in connection with the hostile offer, Allergan filed an action in the District Court for the Central District of California alleging various violations of federal law by Pershing Square and Valeant in connection with their tender offer and proxy solicitation. Allergan sought a court order that would preliminarily enjoin the JV entity from voting or exercising any ownership privilege over its 9.7 percent stake in Allergan, and preliminarily enjoin Valeant and Pershing Square from voting any proxies at the special meeting until corrective disclosures were made to their proxy materials.
The main issue before the court was whether the purchase of the 9.7 percent stake constituted insider trading in violation of Section 14(e) and Rule 14e-3. Section 14(e) is an anti-fraud rule applicable to tender offers. Rule 14e-3(a) provides, in relevant part, that once an “offering person” has taken “a substantial step or steps” to commence a tender offer, any other person who is in possession of material nonpublic information relating to the tender offer which the person acquired from the offering person must abstain from trading or disclose the information prior to trading. The court first found that plaintiffs had raised serious questions as to whether Valeant had taken substantial steps to commence the tender offer prior to the JV entity’s acquisition of shares. The court based its finding on factors such as: the Valeant board having met multiple times to discuss a combination with Allergan with the understanding (evidenced by board materials) that there was a high likelihood that a transaction would involve a hostile tender offer; Valeant having hired three law firms and contacted bankers to begin due diligence; Valeant representatives having executed a confidentiality agreement and a letter agreement with Pershing Square, the latter contemplating a detailed plan by which the acquisition would be accomplished; and Valeant and Pershing Square having formed a JV entity and referred to themselves as co-bidders. All of these steps preceded the date of the acquisition of the shares by the JV entity.
The court then considered whether Pershing Square could be considered a co-offering person, so that its conduct falls outside the prohibition of Rule 14e-3. The court held that the term “offering person” in Rule 14e-3 encompassed the possibility that two or more persons may act together as one “offering person.” The court noted the absence of legal authority addressing the difference between a co-offering person and any other person for purposes of Rule 14e-3. Looking in part to the SEC’s multi-factored test for “bidder” and “offeror” for Regulation 14D purposes and prior case law, the court stated that an offeror “should be more than a financier, and should actually make an offer to purchase shares and should have some degree of control over the terms of the tender offer and over the surviving entity. ” In addition, the designation “offering person” should also further Rule 14e-3’s purpose of “limiting the universe of persons permitted to trade on insider information only to the person making the tender offer,” and thus the court emphasized factors such as control over the terms of the offer, the surviving entity and the named bidder. In applying the test to Pershing Square, the court recognized that Pershing Square played an active role in helping Valeant craft its strategy and finance its offer. However, it noted that Pershing Square had no control over the offer price or consideration mix, the bidding entity or withdrawal of the offer, did not appear likely itself to ever hold any Allergan shares, and was not seen by Valeant as a co-bidder other than for SEC purposes. Given these facts, the court found that plaintiffs had raised serious questions regarding whether Pershing Square was a co-offeror exempt from Rule 14e-3’s “disclose or abstain” rule, and therefore also serious questions going to the merits of plaintiffs’ Rule 14e-3 claim.
In considering plaintiffs’ requests that the JV entity be enjoined from exercising any voting or other ownership privileges over the 9.7 percent stake at the December shareholders meeting, the court noted the absence of any final determination of facts, the novel issues of law, and the speculative nature of irreparable harm. The court found that plaintiffs had not demonstrated a likelihood of harm given the large number of intervening events that would have to occur, including defendants prevailing at the shareholder meeting to remove directors and in connection with a subsequent Delaware court proceeding to force an election at which their nominees would be eligible to join the board. As a result, the court declined plaintiffs’ request for a preliminary injunction. The court did, however, require defendants to make corrective disclosures in their proxy materials pursuant to various disclosure claims also made by plaintiffs.
The court’s decision leaves Valeant free to continue its hostile bid for Allergan. However, continuation of the bid is not without risks. The court left open the possibility that Pershing Square may be found liable for insider trading in violation of Rule 14e-3 in connection with the JV entity’s acquisition of a 9.7 percent stake. If Pershing Square is ultimately found liable, damages could be in the hundreds of millions, or possibly billions, of dollars. Valeant’s increasing the offer price and completing the offer is likely to only increase the potential damages, given that it will increase the disparity between what former shareholders received from the JV entity for their shares and what they could have received in the tender offer. Valeant has significant indemnification obligations to Pershing Square under their letter agreement, and will need to factor in the potential damages as an additional cost to the deal.
In addition, the court noted defendants’ statements in their proxy statement that if they are successful in removing the Allergan directors and if the remaining Allergan directors do not put the Valeant nominees on the Allergan board, the defendants will file a lawsuit in the Delaware Court of Chancery to force an election. Section 223(c) of the Delaware General Corporation Law provides that if at the time of filling a board vacancy the directors then in office constitute less than a majority of the whole board, holders of at least 10 percent of the voting stock can petition the Court of Chancery to order an election to fill the vacancies. However, Allergan can raise the potential violation of Rule 14e-3 in any such case in an argument that Valeant should not be permitted to avail itself of Section 223(c) because it would be profiting from its own violation of law. Delaware courts have recognized that “inequitable action does not become permissible because it is legally possible.” See, e.g., Schnell v. Chris-Craft Industries, 285 A.2d 437, 439 (Del. 1971).
As the Allergan court noted in denying a preliminary injunction, the court’s decision falls far short of determining the outcome of the Pershing Square/Valeant takeover attempt. However, the decision provides a cautionary note to any hedge funds or strategic acquirers contemplating similar partnerships. (See our earlier article for other reasons for caution.) The decision also serves as a reminder to boards of directors that they have possible defenses through assertion of the federal securities laws when faced with an activist attack. Boards of directors continue to have a duty to take action that they believe serves the best long-term interests of the corporation and its stockholders.
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