Last week, in Allergan, Inc. v. Valeant Pharma. Intl.,Inc., Judge David O. Carter of the United States District Court for the Central District of California issued a significant ruling in the ongoing takeover battle between Valeant and Pershing Square and target Allergan, the maker of Botox. Judge Carter held that an Allergan shareholder had raised serious questions going to the merits of her claim that Valeant and Pershing Square had run afoul of Rule 14e-3, a rule of the Securities and Exchange Commission designed to eliminate insider trading in connection with tender offers. Nevertheless, he denied the plaintiffs’ request for an injunction that would have barred the defendants from voting shares at Allergan's December 18, 2014 shareholders meeting.

On August 1, 2014, co-plaintiffs Allergan and Karah Parschauer filed suit, alleging that Valeant and Pershing Square violated Sections 14(a) and 14(e) of the Securities Exchange Act of 1934 and SEC Rules 14a-9 and 14e-3. The underlying dispute surrounds the steps that Valeant and Pershing Square had undertaken earlier this year towards the takeover of Allergan. In brief, in late February 2014, Valeant and Pershing Square agreed on an acquisition plan involving the creation of a "Co-bidder Entity" to be managed by Pershing Square. Pershing Square would fund the Co-bidder Entity’s toehold purchase of Allergan shares. Valeant would contribute $75.9 million once the Co-bidder Entity acquired a 4% stake in Allergan. Upon consummation of Valeant’s takeover of Allergan, the Co-bidder Entity would be dissolved and the proceeds from the Allergan stock held by the Co-bidder Entity would be divided by Valeant and Pershing Square in accordance with their respective contributions to the Co- bidder Entity. Indeed by April 21, the Co-bidder Entity had acquired a 9.7 percent stake in Allergan; on June 2, Pershing Square announced that it would be seeking to call a special meeting of Allergan shareholders (for the purpose of voting out Allergan's directors); and on June 17 Valeant announced that it was launching a tender offer for Allergan stock. A special shareholders meeting is now scheduled for December 18, 2014 to vote on proposals to remove six current Allergan directors and recommend replacements.

Much of Judge Carter's opinion surrounds the implications of Rule 14e-3 for the activities of Pershing Square. The rule, in relevant part, provides that

[i]f any person has taken a substantial step or steps to commence, or has commenced a tender offer (the ‘offering person’), it shall constitute a fraudulent, deceptive or manipulative act or practice . . . for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from . . . the offering person . . . to purchase or sell . . any of such securities . . . unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.

The rule also prohibits an offering person from communicating "material, nonpublic information relating to a tender offer to any other person under circumstances in which it is reasonably foreseeable that such communication is likely to result in a violation" of the rule.

Holding that Allergan, as a target entity, lacked standing to pursue a Rule 14e-3 claim, Judge Carter focused on the claims of Parschauer, an Allergan employee, who had standing on the ground that she was allegedly a "contemporaneous trader" with Pershing Square’s alleged acts of trading in violation of Rule 14e-3.

Parschauer’s claim challenged the Co-bidder Entity's accumulation of Allergan stock between February 25 and April 21, 2014. Pershing Square admitted that it had possessed nonpublic information regarding a possible acquisition of Allergan that it did not publicly disclose before trading. It maintained, however, that its trades were not subject to Rule 14e-3 because Valeant had not yet taken substantial steps to commence a tender offer. Further, Pershing Square argued that, assuming substantial steps had been taken, it should be viewed as the offering person itself since it was working in tandem with Valeant. Judge Carter expressed doubt with respect to both of these contentions.

On the issue of whether Valeant had taken substantial steps towards a tender offer, Judge Carter concluded that Parschauer's evidence raised serious questions. He cited Valeant's multiple board meetings concerning a combination with Allergan; the hiring of law firms and arrangements with banks to perform due diligence and set up financing; meetings with Pershing Square, an outfit "known for their experience in handling unsolicited bids"; and the confidentiality agreement and acquisition plan that Valeant signed with Pershing Square. In particular, Judge Carter noted aspects of the acquisition plan suggested “at least a strong possibility at that time that their actions would lead toward and facilitate a tender offer."

Judge Carter then addressed whether  Pershing Square should be viewed as  an offering person working in concert with Valeant rather than an unlawful recipient of insider information from an offering person. Judge Carter conceded "from [his] review of the relevant statutory and regulatory text that the term 'offering person' can include multiple persons." But he also recognized that the concept of a "co- offering person" could, if too broadly defined, "swallow the general rule" that discourages disclosure of material, nonpublic information by offering persons to outsiders. Judge Carter therefore struggled -- in the absence of "any legal authority directly addressing" the issue -- to identify characteristics that distinguish co-offerers from other persons. Ultimately, he suggested that the distinction "may involve emphasizing control factors, such as control over the terms of the offer, control over the surviving entity, and control over and identity with the named bidder."

Taking Pershing Square's measure against this ill-defined standard, Judge Carter again concluded that Parschauer "raised serious questions,” this time “as to whether Pershing Square was a co-offering person." Judge Carter acknowledged that Pershing Square was "active as a strategist and financier to Valeant." But he also noted that under the acquisition plan Pershing Square had no control over the price or structure of Valeant's tender offer. Moreover, Pershing Square would neither acquire stock in the tender offer, nor would it have any obligation to be involved in the entity that survived the tender offer beyond a one year commitment to hold a certain amount of equity in the surviving corporation. Given these characteristics, the court was "doubtful that Congress and the SEC meant . . . to exempt an entity like Pershing Square from the 'disclose or abstain' rule."

Nevertheless, the court denied Parschauer’s request to enjoin the Co-bidder Entity from voting its shares at Allergan's December 18, 2014 special shareholders meeting. Judge Carter reasoned that, in the event that final judgment was rendered in favor of Parschauer, she could be adequately compensated by a damages award keyed to the injury she suffered from Co-bidder Entity's failure to disclose or abstain. Parschauer's argument that the Co-bidder Entity's accumulation of shares would permit it to take control of Allergan to the detriment of shareholders was, in Judge Carter’s view, too speculative.

As to the alleged proxy solicitation violation under SEC Rule 14a-9 (prohibiting materially misleading proxy solicitations), Judge Carter conceded that "a shareholder would have to be 'living under a rock' not to know about Plaintiffs' insider trading claims from the news or from Allergan's own disclosures." But, he admonished, "that does not change Defendants' obligation to make their own required disclosures." He ordered the defendants to make appropriate corrective disclosures and to refrain from voting any proxies submitted on the basis of the misleading solicitation until the corrective disclosures were made.

Judge Carter's opinion suggests that future bidders and activist investors acting in concert on a hostile tender offer may face uncertainty in connection with the application of Rule 14e-3 to their efforts. As Judge Carter himself noted, "the SEC may one day issue a clarifying interpretation or even promulgate an amended rule that imposes a different one." In the meantime, the courts will "do [their] best to interpret existing laws and regulations and to apply them to the cases before [them] in a manner faithful to their text and purpose."