The tactic was certainly novel. It was the first time a company had teamed up with an activist investor before a bid. Both Mr. Ackman and Valeant said the arrangement was reviewed by an army of lawyers, including Robert S. Khuzami, the former head of enforcement at the Securities and Exchange Commission, and was strictly within the law. Mr. Ackman and Valeant — as a well as a number of spectators — argued that the proposal adeptly skirted laws against insider trading because, in this instance, Valeant's chief executive, who would normally be considered the source of the tip in this situation, did not breach any fiduciary duty because Valeant was teaming up with Mr. Ackman as part of the takeover. Some even heralded the move as the next big innovation in activism.
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Still, something hasn't smelled right about these clever machinations. An analyst at Sanford C. Bernstein quite rightly titled a report "How Can It Be Legal?"
Late last week, Allergan, the maker of Botox, offered an argument for why the arrangement might not be legal after all. Most important, even if it were legal, it clearly undermines the public's confidence that all investors get to play on "a level playing field," the Bernstein analyst said.
Allergan sued Valeant and Mr. Ackman, contending that they did indeed engage in insider trading and that Mr. Ackman should be forced to disgorge the shares he controls.
While Mr. Pearson may not have breached a fiduciary duty to Valeant by sharing information about the planned takeover bid with Mr. Ackman — that's an S.E.C. rule known as 10b-5 — Allergan argues they violated another S.E.C. rule that makes it illegal to share information before a takeover bid when it is part of a tender offer, in which the suitor goes directly to shareholders, bypassing the board. Valeant, after being rejected by Allergan's board, began a tender offer for Allergan on June 18. (If you're asking why the S.E.C. prevents one kind of insider trading and not others, that's a good question.)
Read MoreI did not front-run Allergan stock, Ackman says
At the time that Valeant first came forward with its bid, those observers who said the maneuver was legal did so specifically because the company and Mr. Ackman said they did not plan to start a tender offer.
But Mr. Pearson recently acknowledged, in an unscripted moment during a conference call, that he anticipated pursuing a tender offer from the outset. "On April 22, we announced our offer for Allergan. We suspected at the time it would ultimately have to go directly to Allergan shareholders. We were correct."
That runs counter to what the company said initially. "Valeant and Pershing Square went so far as to claim in writing that they were not contemplating a tender offer — a feeble, self-serving attempt to circumvent the insider trading rules — yet then agreed in the same document on the procedures each would follow if a tender offer were to occur," Allergan said in its lawsuit, referring to Mr. Ackman's fund, Pershing Square Capital Management.
Of course, Valeant has long argued that it is impossible for it or for Mr. Ackman to have been involved in insider trading because they are effectively partners in the bid for Allergan. They described themselves as "co-bidders." (People close to Valeant also say that Mr. Pearson's unscripted words are being misconstrued and that he wasn't referring to making a tender offer, rather he was saying Valeant always planned to communicate with Allergan shareholders.)