Rule 10b5-1 Trading Plans Are Not a Free Pass for Insider Trading Schemes
Client Alerts | March 14, 2023 | Commercial and Corporate Litigation | Regulatory Defense | Risk Management
The U.S. Department of Justice (the “DOJ”) and the U.S. Securities and Exchange Commission (the “SEC”) recently brought criminal charges and civil claims for insider trading against Terren S. Peizer (“Peizer”), the Chief Executive Officer and Chairman of the Board of Directors of Ontrak Inc., a publicly traded healthcare company, despite Peizer’s use of a Rule 10b5-1 trading plan.
This prosecution is the first insider trading case predicated on the misuse of a Rule 10b5-1 plan, and reflects the government’s heightened scrutiny concerning potential abuses of these trading plans.
Rule 10b5-1 Trading Plans
Rule 10b5-1 trading plans permit corporate executives to buy and sell company stock safely by setting up a plan that specifies the share price, amount and transaction date in advance of the trades. Provided the insider is acting in good faith and is not in possession of material non-public information, the executive can use the trading plan as an affirmative defense to claims of insider trading, in accordance with Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934.
Between May and August 2021, Peizer allegedly avoided more than $12.5 million in losses by entering into two Rule 10b5-1 trading plans while in possession of material non-public information.
Peizer, in May 2021, allegedly established his first 10b5-1 trading plan shortly after learning that the relationship between Ontrak and its then-largest customer was deteriorating and that the customer had expressed serious reservations about continuing its contract with Ontrak. Peizer allegedly entered into his second 10b5-1 trading plan in August 2021 approximately one hour after Ontrak’s chief negotiator confirmed to him that the contract likely would be terminated.
The SEC and DOJ alleged that in establishing his 10b5-1 plans, Peizer refused to engage in any “cooling off” period – the time between when he entered into the plans and when he sold stock – despite warnings from two different brokers. Peizer instead allegedly began selling Ontrak shares on the next trading day after setting up each plan.
On August 19, 2021, six days following Peizer’s adoption of his second 10b5-1 trading plan, Ontrak announced that the customer had terminated its contract. Ontrak’s stock price declined by more than 44%.
The DOJ charged Peizer with securities fraud and insider trading, and the SEC asserted in a parallel proceeding that Peizer violated the anti-fraud provisions of the federal securities laws. These claims are based on the allegation that Peizer traded securities opportunistically and wrongfully on the basis of material non-public information concerning the customer’s likely and impending termination of its contract with Ontrak.
10b5-1 trading plans should not be considered a “get out of jail free” card. Notably, Peizer filed his trading plans as exhibits to his Schedule 13Ds and included “clean hands” representations. The government is using these representations as the basis for its position that Peizer has fraud-on-the-market liability.
The DOJ’s prosecution and the SEC’s related civil enforcement action demonstrate that the government is committed to enforcing the nation’s insider trading laws, and pursuing those executives that allegedly trade on material non-public information. These cases against Peizer should be a warning to those seeking to misuse 10b5-1 trading plans to evade the insider trading prohibitions of the Exchange Act and Rule 10b-5.
It is imperative that companies and traders review Rule 10b5-1 and its recent amendments, which include disclosure obligations, a cooling-off period, and a certification requirement that the individual is not trading on material non-public information and is acting in good faith. Traders cannot circumvent the insider trading rules without serious risk of exposure – disgorgement of profits, significant fines and penalties, injunctive relief and potentially lengthy jail sentences.
The Peizer case illustrates that a Rule 10b5-1 trading plan will not insulate anyone from a claim of insider trading if that person acted in bad faith and possessed material non-public information when setting up and implementing the plan.