Government officials, especially those in SEC Enforcement, have been making noise about the potential for insider trading abuse of Rule 10b5-1 plans since at least 2007, when then-SEC Enforcement Chief Linda Thomsen expressed concern that “executives are taking advantage of a legal safe harbor to sell their stock and profit before their companies report bad news….[A]cademic studies suggest that the rule may be a cover for improper activity, Thomsen said. ‘We’re looking at this hard….If executives are in fact trading on inside information and using a plan for cover, they should expect the ‘safe harbor’ to provide no defense.’” (See this Cooley News Brief.) Now, in 2023, DOJ has unsealed an indictment against Terren Peizer, the executive chair of Ontrak, Inc., representing the first time, according to the press release, that DOJ has brought “criminal insider trading charges based exclusively on an executive’s use of 10b5-1 trading plans.” (Note, however, that the SEC did bring a case last year against executives of Cheetah Mobile related to sales under a purported 10b5-1 trading plan entered into while in possession of material nonpublic information. See this PubCo post.)  DOJ charged that Peizer entered into a fraudulent scheme using 10b5-1 plans and engaged in insider trading, both of which charges carry stiff criminal penalties.  DOJ said that the FBI is continuing to investigate this case. Not to be completely outdone—although it’s hard not to be outdone by the threat of serious jail time—the SEC has also filed a civil complaint against Peizer, charging that he engaged in insider trading in Ontrak shares using 10b5-1 plans as part of a scheme to evade insider trading prohibitions: when Peizer entered into the plans, the SEC alleged, he was aware of material nonpublic information about the company. As you probably know, to be effective in insulating an insider from potential insider trading liability, the 10b5-1 plan must be established when the insider is acting in good faith and not aware of MNPI. Creating the plan once the insider has learned of MNPI, as alleged in this case, would seem to defeat the whole purpose of the rule—to ensure an even playing field for all investors. The SEC alleged that Peizer sold more than $20 million of Ontrak stock, avoiding more than $12.7 million in losses.  At the end of last year, Bloomberg reported that the SEC and DOJ were using data analytics “in a sweeping examination of preplanned equity sales by C-suite officials.” (See this PubCo post.) That effort appears to have paid off in this case; DOJ advises that this investigation was “part of a data-driven initiative led by the Fraud Section to identify executive abuses of 10b5-1 trading plans,” suggesting perhaps that this may not be the last prosecution we will see for abuse of 10b5-1 plans.

According to the US Attorney for the Central District of California, “Peizer allegedly exploited material nonpublic information and tried to shield himself with a rule designed to ensure a fair and level playing field for all investors. With this indictment, we again affirm that the law applies equally to all and that corporate executives who unlawfully denigrate the integrity of our financial markets will be held accountable.” In the SEC’s press release, Gurbir Grewal, Director of  Enforcement, highlighted the SEC’s allegation “that Mr. Peizer, armed with inside knowledge, avoided millions in losses that ordinary investors suffered. That’s insider trading, even when the trading is done through a 10b5-1 trading plan….Few things undermine trust in the markets more than insiders abusing their positions for personal advantage; the SEC remains committed to investigating such abuse and holding bad actors accountable.”  SEC Chair Gary Gensler reminded us that the new Rule 10b5-1 amendments have just become effective: the “action comes the week that updated amendments to Rule 10b5-1 become effective. These reforms to Rule 10b5-1 will further help prevent unlawful trading by executives on the basis of non-public information and help build greater confidence in the market.”

Background (based on the SEC complaint as well as the DOJ indictment)

Ontrak is a publicly traded “behavioral health company that contracts with health plans to identify members whose chronic disease will improve with behavior change, and then provides those members with additional healthcare solutions. Ontrak earned revenue through fees it charged to its health plan customers.” Peizer is the founder, Executive Chair and Chair of the Board of Ontrak, and also served as CEO from Ontrak’s inception in 2003 through April 11, 2021, and again after August 12, 2022. In May through August 2021, Peizer adopted  two purported 10b5-1 trading plans in the name of his personal investment vehicle, Acuitas Group Holdings, LLC, under which he sold almost 650,000 shares of Ontrak stock.

The SEC alleged that, given his position as Executive Chair, Peizer owed Ontrak and its shareholders a duty to keep MNPI confidential.  Ontrak’s insider trading policy designated Peizer as a director subject to the policy (and  Acuitas as a “designated insider”).  The policy stated that “information should be regarded as material if there is a reasonable likelihood that it would be considered important to an investor in making an investment decision regarding the purchase or sale of the Company’s securities.” One example of MNPI expressly cited in the policy was a “[m]aterial agreement (or termination thereof).”

According to the SEC, the company had incurred significant net losses and negative operating cash flows since its inception in 2003 and had expressly stated that it was highly dependent on four key customers. On March 1, 2021, the company announced that it had been notified by its then-largest customer that the customer would be terminating its contract, after which Ontrak’s stock price closed down more than 46%.  Peizer, who, through Acuitas, at that time owned almost 10 million shares, lost over $265 million in value. As a result of that customer loss, the company’s contract with Customer A, its next largest customer—the members of which accounted for 67% of all remaining participants in the Ontrak program—assumed even greater importance; Ontrak indicated publicly that it anticipated  broader engagement with that customer’s members and did not expect more customer terminations. From April to September 2021, revenue from Customer A represented about half of Ontrak’s revenue.

However, toward the end of March 2021, “Peizer had learned that Customer A was not satisfied with Ontrak’s services and considering terminating its contract.” As DOJ noted, among other things, the customer had determined “that its contract with Ontrak did not result in the cost savings it had anticipated.”  The SEC alleged that Customer A communicated this information to Ontrak’s CEO, who regularly apprised Peizer of all events concerning the deterioration of Ontrak’s relationship with Customer A. Describing a number of these communications, the complaint alleged that, throughout April 2021, “Peizer communicated with numerous individuals at Ontrak about the importance of saving the Customer A relationship.” By the end of April 2021, “Customer A had informed Ontrak’s CEO that it would not be able to continue under the terms of the current contract.” The SEC believes that the “CEO informed Peizer of this fact at the time.” Customer A began to slow down its monthly patient enrollment and, in early May, negotiations began on concessions to alleviate Customer A’s dissatisfaction.   On May 10, Peizer asked Ontrak’s CEO for a reading of the tea leaves and, on the same day, established his first 10b5-1 plan.

In setting up his plan, the SEC alleged, Peizer advised his broker that he wanted to exercise warrants that expired in August and sell the shares under 10b5-1.  The broker recommended a 30-day cooling-off period, which was a brokerage firm rule, potentially negotiable, but only to 14 days. Peizer replied that a 30-day cooling-off period “would condense the sales and have a more negative share price impact”; he declined to establish a plan with that broker, and instead opted for a broker that did not mandate a cooling-off period, Nevertheless, even the second brokerage house advised that a 30-day cooling-off period was industry best practice.  What’s more, DOJ alleged, the broker advised Peizer that the absence of a cooling-off period “together with the ‘rapid transaction executions subsequent to plan adoption’ might ‘create an appearance of impropriety and call into question whether a plan adopter had MNPI…at the time of plan adoption.’’’  

In establishing the May plan, Peizer represented that he had no MNPI, which the SEC characterized as “false”: “[b]y the time he established the plan,” the SEC charged, “Peizer was aware that Ontrak’s contract with Customer A—its largest customer, representing over two-thirds of its business—was in serious jeopardy.”  In addition, the SEC alleged, this was Peizer’s first Rule 10b5-1 plan for Ontrak securities; DOJ alleged that his only previous sales of Ontrak shares occurred once in 2008 for approximately $220,000 and once in 2011 for approximately $118,000. In addition, the SEC alleged, he had retained all of the shares he acquired through prior warrant exercises. However, from May 11, 2021 through July 20, 2021, Peizer, through Acuitas, sold almost 600,000 shares under his 10b5-1 plan for proceeds of around $19 million.

On May 18, the SEC alleged, “Customer A notified Ontrak’s CEO of its intention to terminate its contract effective December 31, 2021. That same day, Ontrak’s CEO notified Peizer via text message: ‘Customer A is intending to end relationship at the end of the year 12-31-21….They are really firm with me. Decision has been made.’”  Ontrak continued to make various efforts to salvage the contract, and Peizer was kept apprised of these communications, the SEC alleged. Beginning in July 2021, Customer A sent no further members to Ontrak for enrollment.  On August 13, a sales employee, in response to Peizer’s question, told Peizer that he thought Customer A would terminate its contract. One hour later, DOJ alleged, Peizer established his second 10b5-1 plan.

The plan established in August provided for the sale of just over 450,000 shares, which were acquired through the exercise of all remaining warrants, set to expire between December 15, 2021 and April 13, 2022. Once again, there was no cooling-off period.  Although, in setting up the plan, Peizer represented that he had no MNPI, the SEC alleges that he was “aware, among other things, that Customer A had notified Ontrak that it intended to terminate the contract, that Customer A had not engaged in Ontrak’s attempts to renegotiate the contract, that Customer A had stopped sending any of its members for enrollment in Ontrak’s program, and that the Ontrak Sales Employee responsible for the relationship with Customer A believed Customer A would indeed formally terminate its contract with Ontrak.”

But Peizer was able to sell only 45,000 shares under the plan before Customer A notified Ontrak, on August 18, that it was terminating the contract effective December 31.  Ontrak announced the termination in a Form 8-K the next day, indicating that it did “not expect this decision to have a material negative impact on our previously stated revenue and margin expectations for FY 2021.” However, Ontrak estimated expected 2022 revenues at a level 57% below analysts’ estimates.  Ontrak’s stock price fell 44% on the day of the announcement, down to $11.68. On February 27, 2023, Ontrak’s stock closed at $0.6795.  By selling ahead of the announcement, the SEC and DOJ charged, Peizer avoided almost $13 million in losses.

The SEC alleged that Peizer had negative MNPI related to the company’s largest customer at the time he entered into each 10b5-1 plan.  According to the SEC, when he established the May plan, he knew, or was reckless in not knowing, that the situation regarding Customer A was “dire”: “Peizer was aware that Ontrak’s contract with its largest customer—representing over half of its business—was in serious jeopardy, by virtue of the fact that: (1) Customer A had expressed dissatisfaction with Ontrak’s program; (2) Customer A informed Ontrak that it could not continue under the current contract; (3) Customer A had drastically cut down the list of its members that could be enrolled in the Ontrak program; and (4) Ontrak’s CEO had sent proposed fee and other concessions to try to salvage the relationship.”  Similarly, with regard to the August plan, the SEC alleged, Peizer knew that Customer A had notified Ontrak of its intention to terminate the contract and that Customer A was not responding to efforts to revive the contract.  As a result, the SEC charged, he acted with scienter. He also knew, the SEC alleged, that the information was MNPI and that, in entering his plans, his representation was false. As result, the SEC claimed, 10b5-1 provided no affirmative defense. 

Charges

DOJ  charged Peizer with one count of engaging in a securities fraud scheme (if convicted, maximum term 25 years in prison) and two counts of securities fraud for insider trading (if convicted, 20 years possible in prison on each of the insider trading charges).  The SEC charged Peizer (and his investment vehicle) with violations of Exchange Act Section 10(b) and Rule 10b-5, control person liability under Section 20(a) (with regard to the investment vehicle) and fraud under Section 17(a).  The SEC asked for relief in the form of injunctions, disgorgement and civil penalties, as well as an officer and director bar.

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