Takeaways

• The first-of-its-kind indictment for insider trading based on the use of Rule 10b5-1 plans comes one week after U.S. Securities and Exchange Commission (SEC) amendments to the rule came into effect.
• The amendments to Rule 10b5-1 include a new cooling-off period for officers and directors, a requirement that directors and officers certify that they are adopting the plan in good faith, and enhanced disclosure requirements.
• The indictment and the parallel SEC enforcement action are consistent with increased scrutiny from regulators and federal law enforcement on potential abuses related to Rule 10b5-1 plans and insider trading more generally.

Background

On Wednesday, March 1 the Department of Justice (DOJ) announced its first-ever prosecution of an individual for insider trading based on an executive’s use of 10b5-1 trading plans. Terren Peizer, the executive chairman of healthcare treatment company Ontrak Inc., was charged with one count of engaging in a securities fraud scheme and two counts of securities fraud for insider trading. The DOJ’s press release noted that “[t]he investigation is part of a data-driven initiative led by the Fraud Section to identify executive abuses of 10b5-1 trading plans.”[1]

A Rule 10b5-1 plan allows corporate insiders of publicly traded companies to establish a trading plan to purchase and sell stock in the company in the future. Rule 10b5-1(c)(1) provides an affirmative defense to insider trading liability where transactions were executed pursuant to the Rule 10b5-1 plan. Critically, the plan must have been adopted at a time when the person or entity was not aware of any material nonpublic information.

According to the indictment, Cigna, Ontrak’s biggest customer at the time, notified Ontrack on or about May 18, 2021, that it planned to terminate its contract with Ontrak by the end of the year. On or about August 18, 2021, Cigna formally notified Ontrak that it would terminate the contract. On August 19, 2021, Ontrak filed a Form 8-K with the SEC in which it disclosed that an unidentified customer was terminating its contract. Following the announcement, Ontrak’s stock price declined by more than 44 percent. Due to Peizer’s position as executive chairman and pursuant to communications with Ontrak employees, the DOJ alleged that Peizer was aware of these developments with Cigna.

The DOJ further alleged that Peizer entered into two 10b5-1 trading plans to avoid $12.069 million in losses by selling Cigna stock prior to the announcement of the termination of the Cigna contract. According to the indictment, in early May 2021, Peizer set up the first Rule 10b5-1 plan when he knew the contract was at serious risk of being terminated. The broker Peizer initially approached to set up the plan (Broker A) informed him that a “cooling-off” period[2] was required before he could trade stock – i.e., that Peizer could not engage in trading while in possession of material nonpublic information. Upon learning of Broker A’s cooling-off policy, Peizer contacted another broker who did not require a cooling-off period (Broker B), although Broker B warned Peizer that a 30-day cooling-off period is industry practice. Peizer entered into a second 10b5-1 plan in August 2021, approximately one hour after Ontrak’s chief negotiator informed him that Cigna confirmed that the contract would likely be terminated. Accordingly, to obtain approval for the second plan, Peizer allegedly falsely certified that he did not possess material nonpublic information, even though he knew of the high likelihood that Cigna would terminate its contract with Ontrak.

The SEC’s Parallel Enforcement Action

The SEC also filed a complaint against Peizer in the Central District of California, alleging a violation of Rule 10b5-1.[3] This complaint follows efforts to amend Rule 10b5-1. Addressing the issue of insider trading through 10b5-1 plans in 2021, Gary Gensler, chairman of the SEC, announced that the SEC would consider amending the rule and remarked that “these plans have led to real cracks in our insider trading regime.”[4] Gensler has continued to express concerns over trading through Rule 10b5-1 plans; “[W]e’ve heard from courts, commenters, and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information.”[5]

On Dec. 14, 2022, the SEC adopted several amendments updating Rule 10b5-1. The rule now requires a cooling-off period for directors and officers, which is the later of (i) 90 days following plan adoption or modification or (ii) two business days following the disclosure in certain periodic reports of an issuer’s financial results for the fiscal quarter in which the plan was adopted or modified. Officers and directors are also now required to certify at the time of adoption that they are not aware of material nonpublic information about the issuer or its securities and that they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5-1. The amendments also created enhanced disclosure requirements for 10b5-1 plans. The new amendments became effective Feb. 27, 2023.

Conclusion

The DOJ’s and the SEC’s cases against Peizer make it clear that they are focused on pursuing executives who attempt to evade the requirements of insider trader laws by abusively using Rule 10b5-1 plans. During his keynote address at the ABA National Institute on White Collar Crime on March 3 DOJ Assistant Attorney General Kenneth Polite Jr. noted that the case against Peizer “is remarkable” and alerted his listeners to expect additional such cases. And as has been demonstrated by countless prosecutions and enforcement actions, insider trading penalties can be harsh. Companies should ensure that they review the Rule 10b5-1 amendments and update relevant policies and procedures to comply with the amended rule. Officers, directors and other individuals should be vigilant in making sure they are complying with the new rules when executing Rule 10b5-1 plans and when they are buying or selling company stock.

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