(Article from Securities Law Alert, November 2015)
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Section 14(e) of the Securities Exchange Act and corresponding SEC Rule 14e-3 “prohibit[ ] trading while in possession of nonpublic information in connection with a tender offer.” Basile v. Valeant Pharmaceutical Int’l, Inc., 2015 WL 7352005 (C.D. Cal. 2015) (Carter, J.). “Private plaintiffs may bring an insider suit only if they traded ‘contemporaneously’ with the defendant” (quoting § 20A of the Exchange Act).
On November 9, 2015, the Central District of California held that the contemporaneous trading requirement for insider trading claims brought under Rule 14e-3 can be met even if defendants caused a third party to purchase stock and then traded with that third party, rather than buying stock in the market directly. The court further held that stock options are part of the “same class” of security as common stock for purposes of § 20A’s contemporaneous trading requirement.
Background
On February 25, 2014, Valeant Pharmaceuticals International and hedge fund management company Pershing Square Capital Management, L.P., entered into a relationship agreement to pursue a merger between Valeant and Allergan. Over the next several months, a newly-created Pershing Square-owned entity, PS Fund 1, acquired 9.7% of Allergan’s shares through a series of transactions, including over-the-counter call options executed through Nomura International plc, as well as through an equity forward contract between PS Fund 1 and Nomura.
On April 21, 2014, PS Fund 1 publicly disclosed its 9.7% stake in Allergan through a Schedule 13D filing. The following day, Valeant submitted an unsolicited merger offer to Allergan. On June 17, 2014, Valeant announced a tender offer for Allergan.
On December 16, 2014, plaintiffs who had sold Allergan common stock between February 25 and April 21, 2014 brought a securities fraud class action against various defendants, including Valeant, Pershing Square, and PS Fund 1. Among other claims, plaintiffs alleged that defendants had engaged in insider trading in violation of § 14(e) of the Securities Exchange Act and Rule 14(e)-3. Defendants moved to dismiss plaintiffs’ claims on the grounds that, inter alia, plaintiffs could not meet § 20A’s contemporaneous trading requirement for insider trading claims.[1]
Court Finds PS Fund 1’s Private Trades with Nomura May Be Considered for Purposes of the Contemporaneous Trading Analysis Because PS Fund 1 Caused Nomura to Purchase Allergan Stock within the Meaning of Rule 14e-3
Defendants contended that PS Fund 1’s trades with Nomura could not be considered for purposes of the contemporaneous trading analysis. The court found that the “limited authority on this issue suggest[ed] otherwise.”
The court explained that “Rule 14e-3 prohibits an insider with nonpublic information related to a tender offer from purchasing ‘or caus[ing] to be purchased . . . 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’” (quoting Rule 14e-3 (emphasis added)). The court determined that “under the plain language of Rule 14e-3 and the accompanying regulations, entities can be held liable for causing others to purchase securities on their behalf.”
Here, the court found that plaintiffs alleged that “[d]efendants, using nonpublic information relating to a tender offer, deliberately caused Nomura to purchase Allergan stock on their behalf.” While “[p]laintiffs may not have traded face-to-face with [d]efendants on the open market,” the court explained that plaintiffs “could have traded directly with Nomura, who allegedly purchased Allergan stock at [d]efendants’ behest.” The court concluded that “[d]efendants’ private trades with Nomura involving Allergan stock should be considered as part of the contemporaneous trading analysis.”
In so holding, the court found persuasive the Central District of California’s reasoning in Johnson v. Aljian, 257 F.R.D. 587 (C.D. Cal. 2009). The Johnson court rejected defendants’ argument that their private stock sales with a bank should be excluded from the contemporaneous trading analysis for purposes of § 20A. The Johnson court reasoned that “if [d]efendants’ argument were adopted as law, then all a person would need to do to avoid liability under § 20A would be to funnel sales of shares through a broker.” The Valeant court found “the logic of Johnson directly applicable here,” and emphasized that “individuals and entities should not be permitted to use third parties in order to avoid liability under the insider trading laws.”
The Valeant court also deemed meritless defendants’ contention that PS Fund 1’s trades with Nomura should be excluded from the contemporaneous trading analysis because plaintiffs did “not allege a formal broker relationship between PS Fund 1 and Nomura.” The court explained that Rule 14e-3 does not “require a formal agency relationship between the insider and the person or entity caused to purchase securities” on the insider’s behalf.
The court found the allegations in the complaint sufficient for purposes of Rule 14e-3 to “establish [that] PS Fund 1 [had] used Nomura to acquire shares on its behalf.” The court pointed to allegations that “PS Fund 1 [had] solely traded with Nomura to minimize its risk; Nomura [had] acted ‘just like a broker’ for PS Fund 1; and that [Pershing Square’s CEO had] referred to these trades as ‘our purchases.’” The court therefore determined that it could and should consider PS Fund 1’s trades with Nomura for purposes of the contemporaneous trading analysis.
Court Finds the “Same Class” Element of the Contemporaneous Trading Requirement Met Even Though Plaintiffs Sold Common Stock While Defendants Purchased Stock Options
Defendants further argued that the contemporaneous trading requirement was not met because plaintiffs did not sell securities of the “same class” that defendants purchased, as required under § 20A. Defendants claimed that “since [p]laintiffs traded only in [Allergan] common stock, they [could not] establish standing based on PS Fund 1’s purchase of [over the counter] options and equity forward contracts.”
Rejecting this “narrow interpretation of the insider trading laws,” the court found that “the correct reading of § 20(A) . . . is that plaintiffs who trade in common stock have standing to pursue insider trading claims against insiders who trade in stock options.” The court noted that in Clay v. Riverwood International Corp., 157 F.3d 1259 (11th Cir. 1998), the Eleventh Circuit explained that “[i]nsider trading in options could have a damaging effect on common stock” because “after exercising [a stock option], the investor must still sell his shares through the market in order to realize his profit.” The Valeant court found that the Eleventh Circuit’s analysis “[bore] directly” on the question of whether “stock options . . . should be considered part of the ‘same class’ as common stock.” The Valeant court concluded that claims involving an insider’s purchase or sale of stock options “should not be dismissed ‘absent some evidence that the stock and options markets . . . [were] not part of interdependent markets.’”
Moreover, the court explained that even if it were to “[a]dopt[ ] [d]efendants’ distinction between common stocks and options,” it would still conclude that plaintiffs had standing based on allegations that “[d]efendants caused Nomura to purchase common stocks of Allergan on the open market.”
The court therefore denied defendants’ motion to dismiss plaintiffs’ claims under § 14(e) and Rule 14(e)-3.
[1] Section 20(A) provides that “[a]ny person who violates any provision of this chapter or the rules or regulations thereunder by purchasing or selling a security while in possession of material, nonpublic information shall be liable . . . to any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased . . . or sold . . . securities of the same class” (emphasis added).