Bill Ackmans Allergan Insider-Trading Dispute Doesnt Look Bad

Insider trading, I like to say, is not about fairness, it is about theft. It's not illegal to trade when you have information that no one else has. The financial industry employs thousands of people whose job is to find out things about companies and then trade their stocks. That job is well compensated and at least a little bit socially useful: It makes prices accurate, makes markets efficient, allocates resources properly, etc. It's not illegal. What is illegal is trading on information that belongs to somebody else: a chief executive officer trading her company's stock based on news she hasn't told shareholders, a lawyer trading on takeover news he learns about under an obligation of confidentiality. The problem is not that insider traders have an advantage in the market -- any informed professional trader has an advantage over uninformed amateurs -- but that they obtained that advantage by taking it from people who owned the information.

That is, I think, a good general approach to U.S. insider trading law, but there is a weird exception called Rule 14e-3. Rule 14e-3 says that if you have material nonpublic information about a tender offer, and you got that information from someone involved in the tender offer, then you can't trade on it, unless you are the person doing the tender offer. Even if -- and this is the weird part -- even if the person doing the tender offer wants you to trade on it.

This rule does not make much conceptual sense. If, say, Company A wants to acquire Company B in a merger, Company A can buy some Company B shares before announcing its merger proposal, to try to lower its average cost and lock up some votes for the deal. Or it can team up with Activist Fund C to do the same thing: Activist Fund C can buy a "toehold" before the merger is publicly proposed, which can lower the overall cost of the deal and lock up some votes. That's not illegal insider trading, because Activist Fund C didn't misappropriate the information from Company A. Company A wanted it to trade on the information, and Company A owned that information. 

But if Company A wants to acquire Company B in a tender offer -- which in modern U.S. practice looks pretty similar to a merger -- then it can also buy some Company B shares first. But it can't enlist Activist Fund C to do it, because of Rule 14e-3: Even if Company A and Activist Fund C want to team up to buy Company B stock, which they could perfectly legally do before proposing a merger, they can't legally do it before proposing a tender offer.

As you may know, Company A was Valeant Pharmaceuticals International Inc., Company B was Allergan Inc., Activist Fund C was Bill Ackman's Pershing Square Holdings Ltd., and last week Pershing Square and Valeant agreed to pay 0 million to settle an investor insider-trading lawsuit over their (failed) effort to acquire Allergan back in 2014. They had some decent defenses: When Valeant and Pershing Square teamed up to buy Allergan shares before announcing Valeant's takeover offer, they were proposing a merger, not a tender offer, so arguably they didn't trigger Rule 14e-3. (Later they switched to a tender offer, so arguably they did.) Also the tender offer documents said that both Valeant and Pershing Square were offering to buy Allergan, arguably making them both exempt from Rule 14e-3. But these were debatable points, and so they settled a lawsuit that Ackman still says has "absolutely no merit." 

When I talk to people about this case, their reaction is often "Well, it may not be technically insider trading, but it sure looks bad." My reaction is exactly the opposite. Ackman's trading in Allergan stock ahead of Valeant's takeover offer might technically have been illegal insider trading under Rule 14e-3 (thus the settlement), but it doesn't look bad. It's how markets are supposed to work. No shareholders were harmed, and in fact they were helped: Ackman and Valeant teaming up is what got them a higher price for their shares. Ackman and Valeant had the advantage of being able to trade knowing their own takeover plans, but knowing your own plans is not an unfair advantage. Warren Buffett frequently buys stocks, then announces that he's bought them, and then they go up. For that matter, Bill Ackman frequently buys stocks, then announces that he's bought them, and then they go up. He buys them knowing that he has plans for them, and then he announces the purchases and the plans, and the market reacts by pushing the stock price up. The people who sold to him not knowing about his plans didn't get the benefit of his information, but why should they? It was his information, his own plans. If you think it should be illegal to buy up shares before announcing your own plans to change a company, then you might be missing the point of insider trading law, and of activist investing, and really of financial markets generally.