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Allergan Finds a Hole in Valeant & Ackman Partnership

Stocks in this article: VRX AGN

NEW YORK (TheStreet) -- There were no tips on the golf course, no secret meetings on a deal, just a telephone call from Valeant Pharmaceuticals' (VRX) CEO to William Ackman of the hedge fund Pershing Square. The call was to seek a partnership between Valeant and Pershing Square to help build a large position in Allergan (AGN) stock, win board seats and pressure the company to agree to a deal with Valeant.

Insider trading? Maybe. Against the law? Maybe not. The right way to do business? No way.

This is the first known instance of this tactic. But given the extra scrutiny and lawsuit now being filed it may be the last.

Read More: Johnson & Johnson Can Only Get Better When It Gets Cheaper

In a lawsuit, Botox maker Allergan alleges insider trading by Ackman and rival Valeant. In the civil case filed in California, Allergan states that Pershing Square and Valeant "hatched" an "improper and illicit insider-trading scheme" that allowed Ackman to purchase shares in Allergan ahead of the planned $51 billion buyout.

Pershing Square's 9.7% stake in Allergan, purchased between February and April in the form of call options, and a small $76 million worth of stock, gained $1.2 billion in value the day the buyout plan was announced.

Pershing Square and Valeant have a unique partnership agreement that was set up to skirt insider trading rules. That is the subject of the lawsuit.

Valeant and Ackman appear to have gone wrong, according to Allergan, in the documents they had drawn up by a legion of lawyers, including a former head of the Securities and Exchange Commission. The suitor companies laid out procedures that would be followed should their deal not be accepted by Allergan. In doing so, they possibly broke an SEC rule regarding tender offers.

In the lawsuit, Allergan is arguing Ackman and Valeant violated the S.E.C. rule 10b-5 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. After Allergan rejected the bid, Valeant and Pershing Square began a tender offer on June 18.

Read More: Exclusive: Target Sizing Up Digital Deals

"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." Valeant CEO Pearson stated in a conference call.

When it rains it pours for Bill Ackman. His billion dollar short bet on Herbalife stumbled a week ago when his Herbalife presentation sent shares higher, not lower. Now he's in the news because his Pershing Square fund is being sued for insider trading by Allergan.

Valeant and Pershing are fighting back and attempting to have the lawsuit thrown out.

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