Pershing Square (PSHZF) announced Friday it settled a lawsuit claiming it and Valeant (VRX) had profited from insider trading in shares of Allergan (AGN):

Pershing Square Holdings, Ltd. (PSHZF) (LN:PSH) (NA:PSH) today announced that it has reached an agreement in principle, subject to court approval, to settle lawsuits concerning the attempted acquisition of Allergan plc. (“Allergan”) by Pershing Square Capital Management, L.P. (“Pershing Square”) and Valeant Pharmaceuticals International, Inc. (“Valeant”) in 2014, which were filed in the Central District of California (Anthony Basile et al v. Valeant Pharmaceuticals International, Inc. et al. and Timber Hill LLC v. Pershing Square Capital Management, L.P. et al) ...

“We continue to believe the case had absolutely no merit,” said Pershing Square CEO Bill Ackman. “We decided, however, that it was in the best interest of our investors to settle the case now instead of continuing to spend substantial time and resources pursuing the litigation.”

The agreement ends a saga that began after hedge fund manager Bill Ackman's Pershing Share netted a paper gain of over $2 billion. VRX fell nearly 2% on the news while PSHZF rose nearly 2%.

The Situation

I assumed VRX could potentially succumb to its high debt load, and litigation related to AGN insider trading and its relationship with specialty pharma Philidor. A few large AGN shareholders claimed that Ackman traded on insider information pursuant to Valeant's hostile takeover attempt of Allergan. AGN investors claim that had they known about the pending offer they might have held onto their investments and earned more after AGN shares spiked on the bid. U.S. District Judge David Carter denied a request by Ackman and Valeant to discard the claims, setting up a potential jury trial in January.

The settlement calls for a payment of $290 million to the claimants. Pershing Square will pay $193.75 million and Valeant will pay $96.25 million. I understand that Pershing Square had reserved $75 million for the case. Though Pershing Square could experience a cash outflow, the hit to income would equate to the payout less the $75 million reserve. Valeant's cash outflow would be $96 million, but its hit to income would be net of any legal reserves pursuant to the settlement.

Valeant has cash of $1.9 billion, amassed largely from asset sales. The hit to cash is negligible compared to the other possible outcomes. Had the case gone to trial Valeant might have incurred additional legal fees to defend itself. Had Valeant and Ackman lost the case then it might have led to a disgorgement of profits and/or other costs. The settlement could be symbolic, however. The AGN insider trading lawsuit and Philidor exposure have been talked about, yet nothing has come of them. This payout symbolizes that these exposures could be real and there could be more to come. Valeant's debt/run-rate EBITDA exceeds 7x. Optically, a $96 million payout for past acts for a company this highly-indebted does not look good. The stock's reaction to the news likely reflects that sentiment.

Are There Other AGN Lawsuits Hiding In The Woodwork?

I understand that the recent lawsuit was brought on by a few large AGN shareholders. It could be naive to assume these are the only shareholders who sold AGN shares while Valeant and Ackman were planning their takeover of Allergan. The $64,000 question is, "Are there other insider trading lawsuits in the woodwork?" A commenter on my previous article posed such a question:

Commenter: @Shock Exchange, is $96.25 million immaterial? Also, based on this settlement, do you think any other AGN shareholders will sue now?

I believe the risk that other shareholders could come forward is a real one. Secondly, there is strong evidence that Ackman traded on material, non-public information. In denying Valeant and Ackman's attempt to dismiss prior claims, Judge Jackson implied that further investigation could be warranted. Cleary Gottlieb believes Ackman and Valeant did not break insider trading laws. That does not mean a jury would not disagree.

Additional lawsuits could create more distractions and more legal fees for the defendants. A loss in court could lead to additional payments. More importantly, it could lead to a disgorgement of the $2 billion in profits Ackman made from the trade and the approximately $390 million he shared with Valeant. These amounts would be material to both Valeant and Pershing Square, in my opinion. They might seek quick settlements with any additional plaintiffs in order to protect the profits previous made from the AGN trade.