On March 1, 2023, the U.S. Department of Justice (“DOJ”) unsealed an indictment charging Terren S. Peizer, the CEO and Chairman of the Board of Directors of Ontrak Inc., a publicly traded health care company, with engaging in an insider trading scheme involving his fraudulent use of Rule 10b5-1 trading plans to trade Ontrak stock. The Securities and Exchange Commission (“SEC”) announced a parallel civil insider trading action the same day.

According to the DOJ press release, the indictment represents the first criminal insider trading case based exclusively on an executive’s use of 10b5-1 trading plans. A Rule 10b5-1 trading plan can provide an affirmative defense to insider trading charges; however, the defense applies only if the executive entered into the plan in good faith and was unaware of any material nonpublic information.

The Allegations

The indictment alleges that between May and August 2021, Peizer sold more than $20 million of Ontrack stock and avoided more than $12.5 million in losses by entering into two Rule 10b5-1 trading plans while possessing material, nonpublic, information concerning the risk that Ontrak would lose its then-largest customer.

Peizer allegedly entered into the first 10b5-1 trading plan in May 2021, shortly after learning that the relationship between Ontrak and its customer was deteriorating as the customer expressed reservations about continuing its contract. Peizer allegedly entered into his second 10b5-1 trading plan in August 2021, just after Ontrak’s chief negotiator informed Peizer that the contract would likely be terminated.

The indictment further alleges that Peizer refused to engage in any “cooling off period”—the time between entering the plan and selling stock—despite warnings from two brokers. Instead, Peizer allegedly began selling Ontrak shares the next trading day after establishing each plan. Six days after Peizer adopted his second 10b5-1 plan, Ontrak announced that the customer had terminated its contract and Ontrak’s stock price declined by more than 44%.

The Charges

Peizer is charged criminally with one count of engaging in a securities fraud scheme and two counts of securities fraud for insider trading. The SEC’s complaint charges Peizer with violating anti-fraud provisions of the federal securities laws and seeks permanent injunctive relief, disgorgement of ill-gotten gains, civil penalties, and an officer and director bar for Peizer. The cases were brought in the U.S. District Court in the Central District of California.

SK Takeaway

Although Rule 10b5-1 plans provide a way to safely trade without insider trading concerns, an executive who fails to follow the rules governing those plans could appear to be attempting an end run around insider trading prohibitions, risking significant exposure.