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Ackman, Allergan and insider trading

Jeff Macke

This week a very rich man made about a billion dollars trading on material, non-public information.

The investor is Bill Ackman and what he knew was that Valeant Pharmaceuticals would be making an unsolicited bid for botox-maker Allergan. Ackman knew about the bid because he and his Pershing Square Capital Management were partners with Valeant in the bid.

Related: Ackman puts a new twist on activism with Allergan bid

In anticipation of this deal Ackman purchased 4.99% of Allergan stock over several weeks. Once that stake was built Ackman let the market settle for a few days before going for the kill. In what he called a "rapid accumulation program" of Allergan stock. (In English Ackman bought call options and "forward contracts" giving him the right to buy another 4.7% of the company at a set price and date to be named later).

With only about $15 billion in assets under management Ackman and Pershing Square have managed to take a 10% position in what is now an almost $50 billion corporation. With Allergan shares having moved from $116 to over $160 on the takeover Ackman and Pershing Square are up hundreds of millions of dollars at the very least.

Why Isn’t it Illegal?

What Ackman did is absolutely trading on “material non-public information,” (legalese for insider trading) but it’s not necessarily illegal. As discussed in my coverage of Treasury’s exceptionally well-timed sale of General Motor’s (GM) stock weeks before massive recalls, insider trading laws are murkily defined.

Related: Treasury’s GM stock sale would land a hedgie in prison: Macke

Here’s the law from the SEC’s website: “Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include 'tipping' such information, securities trading by the person 'tipped,' and securities trading by those who misappropriate such information.”

Ackman’s moves may rub you the wrong way, and the word “punchable” is often used to describe his countenance, but he didn’t break any laws. His fiduciary duty is to himself and his investors. The only specific group he could have been front-running, which is to the say the only plausible victims, were the people at Valeant. 

As Ackman explained to CNBC: "The way the rules work is you're actually permitted to trade on inside information...as long as you didn't receive the information from someone who breached…fiduciary duty or duty of confidentiality, et cetera. Valeant basically came to us and said, 'Look, if you can help us buy Allergan we can work with you.' We said, 'Great,' and we formed a partnership," he said. "The partnership has various terms. It gives us the right and permission from the company to go buy a stake in Allergan." 

The way Ackman explains the story, he and Pershing Square are basically taking trading gains in lieu of investment banking, private equity or so-called finders fees. 

Free Riders

The people who almost certainly were violating both the spirit and the letter of insider trading regulations were those buying the call options and shares of Allergan ahead of the deal based on rumors or second-hand information regarding the move. Jon Najarian of OptionMonster.com points out that the trading volumes were extremely suspicious ahead of the news. 

Were some of those people trading illegally?  There’s a Latin term, res ipsa loquitur that loosely means “the thing speaks for itself.”  Common sense and a glance at the volumes is all but per se evidence of illegal trading happening in Allergan, but let’s see you prove it. The government literally never loses insider trading cases but it only chooses to pursue violators when it’s in their public best interest.

Again referring to the SECs website "Because insider trading undermines investor confidence in the fairness and integrity of the securities markets, the SEC has treated the detection and prosecution of insider trading violations as one of its enforcement priorities.”  

Chasing down a bunch of options traders who have a friend of a friend who knew of Valeant and Ackman’s plan becoming a government priority seems like a long shot.

Ackman isn't alone in his tactics either. Also profiting are the bulls who were part of the 100% increase in the average volume of Allergan shares and call option activity immediately preceding the takeover bid.

None of this is illegal. It's brilliant. It's Wall Street.

For weeks there's been a debate over whether or not the stock market is Rigged. The answer is "yes" but not the way Main Stream Media thinks.

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