If Michael Lewis is looking for a sequel to his best-selling “Flash Boys,” about the fairness of high-frequency trading shaving off pennies a share, he could find it this week in the actions of two “brazen men” who made billions in the canyons of Wall Street in a day by skating along the edge of conventional rules.
No fiber-optic lines required and apparently no laws gone broken. The news that hedge fund activist Bill Ackman had teamed up with pharmaceutical giant Valeant and its CEO, J. Michael Pearson , to launch a hostile takeover of Botox maker Allergan made headlines.
Along with the news came word that Ackman’s fund, Pershing Square Capital, had accumulated a 9.7 percent stake in Allergan, knowing that a bid was imminent. The Easter Monday news sent the stock soaring more than 22 percent from its previous close, a pretty nice profit when you own almost 10 percent of what is now a $50 billion company.
Was this front-running or insider trading? Ackman, no dummy, has it on good authority that it isn’t. Indeed, he hired the SEC’s former head of enforcement, Robert Khuzami — now a lawyer at Kirkland & Ellis — to specifically assure him of this. Other legal heavyweights seem to concur. It doesn’t seem to matter that the sellers of the stock and options that eventually put almost 10 percent of the company into Ackman’s hands unwittingly made a bad trade.
As Ackman tried to explain on Wednesday, “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 confidentiality].
It makes one wonder why there are insider-trading laws on the books in the first place.
Yet as bold as Ackman’s Allergan antics have been, the onus is on the SEC and its chief, Mary Jo White, to clean up the murky laws. In recent months, I’ve heard several big investors and hedge-fund managers complaining loudly that the options markets have become the Wild West of inside information, with blatant action in options preceding takeover announcements. Options expert Jon Najarian noted that trading was extremely suspicious ahead of Valeant’s bid for Allergan, even if you take out the Ackman factor.
The SEC could also crack down on Ackman’s claim that his trading gains in Allergan are justified as payback in lieu of investment advice under the assumption that Valeant had to “outsource” this takeover to Ackman’s fund in order to get the deal done. If that’s the case, Ackman’s windfall should be treated as ordinary income by the IRS, not an investment gain, shouldn’t it?
All in all, I have to hand it to Ackman for a brilliant move. But while his stealth moves enrich him and his investors, they slowly undermine investor confidence. What better time than a run on the company that famously removes wrinkles to take the wrinkles out of our insider-trading laws?