Fordham Law

Icahn Investigation Highlights Gray Area Of Securities Law

Steve Thel in Law360, June 03, 2014

Media Source

Law360, New York (June 03, 2014, 6:43 PM ET) -- Activist private equity and hedge fund investors who take large stakes in companies to put pressure on management can provoke big stock swings with a simple holdings disclosure or a tweet, but since those managers aren't insiders, they fall into a gray area for securities suits under U.S. insider trading laws as highlighted by recent scrutiny of Carl Icahn and Bill Ackman.

"There is increased scrutiny on activity that some don't think passes the smell test, but when you look at the facts, it doesn't rise to the level of insider trading under" U.S. Securities and Exchange Commission rules, said Andrew Freedman, a partner in Olshan Frome Wolosky LLP's activist practice.

At a time when investor activism is on the rise, the investigation by U.S. regulators into billionaire investor Carl Icahn and professional golfer Phil Mickelson for alleged insider trading ahead of an Icahn bid for Clorox Co. and Bill Ackman's recent untraditional role in a bid for Allergan Inc. highlight this murky area where investors can share information to the benefit of a select few without running afoul of the law.

Experts say there is generally little legal risk of sharing that information before making an investment public, as the individuals don't owe a duty to the company and make their investment decisions based on public information.

"It looks unseemly and that's why people react badly," said Marc Weingarten, co-head of the shareholder activism practice at Schulte Roth & Zabel LLP. "But under the current law, I just don't see this as insider trading."

In the Icahn and Mickelson case, a letter to Clorox's chief executive just a few days after a series of stock and options trades in the company by Mickelson and golf course owner and sports bettor William T. Walters would bring an SEC rule regulating trading around a tender offer into play. But even that would be hard to prove, experts say.

That same rule led to questions about Ackman’s involvement in a Valeant Pharmaceuticals International Inc. cash-and-stock bid for Allergan first launched in April. But Weingarten says Ackman's Pershing Square Capital Management LP's role as a co-bidder for the company left him free to build a position, even with knowledge of the impending offer.

And in situations where an activist is simply buying shares with no intention to make a bid, the situation is even more clear-cut. There are no SEC regulations prohibiting the sharing of trade ideas based on public information, experts say. At that time, activists are no different from any other investor who might share an idea.

"A lot of people pay attention to what Warren Buffett is buying because they think he's a smart investor," said Jennifer H. Arlen, a professor at New York University School of Law.

Still, these investors have proven themselves capable of provoking big and profitable stock moves.

Last August, a simple tweet from Icahn that said he had bought a large position in Apple Inc. caused a $12 billion gain in that company's market capitalization in a matter of hours. And Ackman's stake in and co-bid for Allergan sent that company's stock soaring 22 percent.

As Icahn, Ackman and other high-profiled agitators have shown activism to be a significant moneymaker, more firms have picked up the strategy in recent years, including fledgling outfits and hedge funds that have traditionally favored other approaches. That expansion of the activist universe has helped increase the scrutiny around the sharing of information as it becomes more common, Freedman said.

"It's a small activist world out there, and it is becoming increasingly crowded," he said. "The sharing of ideas has become fairly commonplace."

Some argue that activist investors owe a confidentiality obligation to their own investors, which would require them not to share information with others, but Weingarten says that is often a weak argument.

"Nowhere does it say that an activist fund manager can't talk to someone else about his intentions," he said.

However, both Freedman and Weingarten emphasize that talking to other investors can raise other concerns relating to group issues. Any information sharing should be done so as to not unwittingly make the divergent investors a group as defined by Section 13D of the Securities Exchange Act. In that case, they could run afoul of securities law if they don't file a Schedule 13D when collective ownership of a company passes 5 percent.

Despite the public scrutiny of activist information, experts agree that the SEC is unlikely to make any changes to its insider trading regulators any time soon.

"The SEC has resisted making a clear rule because they don't want to give a road map to how to insider trade," said Steve Thel, a securities professor at the Fordham University School of Law. "The law is intentionally tough to understand."