“In the wake of this week’s unusual hostile bid for Allergan, one of the most pressing questions has been whether William A. Ackman, the activist investor who runs Pershing Square Capital Management, engaged in insider trading.”

“By accumulating a large stake in Allergan while knowing a bid was imminent, Mr. Ackman clearly had an advantage over other investors. And when Pershing Square and Valeant Pharmaceuticals announced its plans, the value of Mr. Ackman’s $4 billion stake quickly rose by about $1 billion.”

“But because Mr. Ackman is part of the buying group, it appears he was well within his legal rights. The fact that the tactic was legal, however, does not mean it is not drawing scrutiny.”

“In a memorandum issued Thursday, lawyers at the firm Cleary Gottlieb Steen & Hamilton, who are not involved in the bid, reaffirmed the legality of Mr. Ackman’s actions, which resulted in his firm acquiring a 9.7 percent stake in Allergan.”

“Based on public information, there is nothing to suggest insider trading,” they said. “First, it appears that neither Valeant nor Pershing Square had obtained any material nonpublic information from Allergan. Second, it has been long established that a prospective bidder can accumulate a stake in a target without disclosure of its own plans.”

“They also said Mr. Ackman and Valeant probably did not run afoul of a special Securities and Exchange Commission rule that pertains to tender offers. That rule, Rule 14 e-3, stipulates that once a potential bidder has “taken a substantial step or steps to commence a tender offer,” no one who knows about the pending bid can buy shares in the target.”

“The bidders are most likely safe here for two reasons. For one, the Pershing Square fund that bought the Allergan shares was associated with the buying group. And moreover, Mr. Ackman and Valeant may not actually begin a tender offer any time soon.”

“It is highly likely that Valeant has been careful to avoid any actions that could be characterized as steps towards commencement of a tender offer,” the Cleary lawyers wrote in the memo. “Instead, Valeant is likely to pursue the acquisition by making public merger proposals (‘bear hugs’) together with a proxy contest to change the board of directors.”

“(The lawyers said that the S.E.C. rule pertained to tender offers only, instead of other acquisition structures, because “the Williams Act gave the S.E.C. authority to adopt rules regulating tender offers and this rule was adopted in 1980, at a time when tender offers were the principal means of acquisitions and there were concerns about people trading based on advanced knowledge of tender offers. This was during the era of ‘raiders,’ who often made tender offers, and well before the current era of ‘activists.’”)”

“Another issue receiving scrutiny in the wake of the bid for Allergan is whether Pershing Square and Valeant should have been forced to disclose the stake they were amassing sooner.”

***

Read full New York Times DealBook article here.