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DOJ and SEC Allege Insider Trading Based Exclusively on Use of Rule 10b5-1 Trading Plans
March 3, 2023 Download PDF
On March 1, 2023, the Department of Justice unsealed criminal insider trading charges, and the SEC filed a parallel civil complaint, against the Executive Chairman of a publicly-traded healthcare company based on stock sales made pursuant to Rule 10b5-1 trading plans. As highlighted by the DOJ in its press release, the case represents the first-ever insider trading prosecution based exclusively on the use of Rule 10b5-1 trading plans.[1] These actions are consistent with an increased government focus on and scrutiny of Rule 10b5-1 plans and come on the heels of recent SEC amendments to Rule 10b5-1.
Background on Rule 10b5-1
Rule 10b5-1 establishes an affirmative defense to insider trading for purchases or sales of stock made pursuant to a written plan adopted before the person became aware of material, nonpublic information (“MNPI”).[2] A Rule 10b5-1 plan thus allows a public company insider who may come into possession of MNPI to buy or sell shares at a predetermined time on a scheduled basis, provided that the plan satisfies certain conditions and is adopted at a time when the insider has no MNPI.
In December 2022, the SEC adopted certain amendments to Rule 10b5-1, which became effective on February 27, 2023.[3] The rule changes include cooling-off periods before trading can commence under a Rule 10b5-1 plan, a requirement that all persons entering into a Rule 10b5-1 plan must act in good faith with respect to the plan, and a condition that directors and officers include representations in their plans certifying at the time of the adoption of a new or modified Rule 10b5-1 plan that: (1) they are not aware of any MNPI about the issuer or its securities; and (2) 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 will also require more comprehensive disclosure about issuers’ policies and procedures related to insider trading, including quarterly disclosure by issuers regarding the use of Rule 10b5-1 plans and certain other trading arrangements by their directors and officers for the trading of their securities. For a further discussion of the amendments, please see the Paul, Weiss client memo available here.
The Government’s Allegations
Terren S. Peizer was the Executive Chairman of Ontrak, Inc., a company that provided behavioral health services to patients insured by Cigna.[4] The government alleges that through his position on the Board of Ontrak, Peizer learned that Cigna had raised several concerns about its relationship with Ontrak and that, as a result, Ontrak was in “serious danger of Cigna terminating its agreement . . . .”[5] Peizer allegedly contacted a broker to set up a Rule 10b5-1 plan to sell shares of Ontrak after learning this information, but the broker required that the Rule 10b5-1 plan have a cooling off period.[6] Peizer allegedly then contacted a second broker that did not require a cooling-off period and requested that his shares be sold as soon as possible.[7] According to the government, Peizer certified to Ontrak’s CFO, in seeking approval for the plan, that “this proposed dealing was not a result of access to, or receipt of Material Nonpublic Information as described in the Company’s Insider Trading Policy.”[8] Peizer entered into a Rule 10b5-1 plan with the second broker and sold shares that generated approximately $19 million in proceeds.[9]
Thereafter, Peizer allegedly entered into a second Rule 10b5-1 plan and again certified to Ontrak’s CFO that he did not possess MNPI.[10] Peizer sold approximately $900,000 of Ontrak shares pursuant to that plan.[11] When Ontrak later disclosed the termination of its relationship with Cigna, Ontrak’s stock price allegedly fell by approximately 44%.[12]
Takeaways
This first-ever insider trading prosecution based exclusively on the use of Rule 10b5-1 plans comes just a week after recent SEC amendments to Rule 10b5-1 became effective, and is consistent with an increased government and regulatory focus on and scrutiny of Rule 10b5-1 trading plans. The DOJ announced that the prosecution was part of its “data-driven initiative led by the Fraud Section to identify executive abuses of 10b5-1 trading plans,”[13] and SEC Chair Gary Gensler specifically referenced the recent amendments to Rule 10b5-1 in the SEC’s press release, stating that the amendments “will further help prevent unlawful trading by executives on the basis of non-public information and help build greater confidence in the market.”[14]
In light of the amendments to Rule 10b5-1 and the continued government and regulatory emphasis on Rule 10b5-1 plans, it is important not only that insiders with potential access to MNPI remain vigilant when adopting a Rule 10b5-1 plan, but that issuers carefully evaluate existing policies and controls and address any potential gaps.
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[1] Press Release, CEO of Publicly Traded Health Care Company Charged for Insider Trading Scheme, DOJ (Mar. 1, 2023), https://www.justice.gov/opa/pr/ceo-publicly-traded-health-care-company-charged-insider-trading-scheme.
[2] See generally 17 CFR § 240.10b5-1.
[3] Insider Trading Arrangements and Related Disclosures, Exchange Act Release Nos. 33-11138; 34-96492 (Dec. 14, 2022).
[4] United States v. Terren Scott Peizer, 2:23-cr-00089-DSF, Indictment at 2 (C.D. Cal. Feb. 24, 2023).
[5] Id. at 4-5.
[6] Id. at 8.
[7] Id. at 8-9.
[8] Id. at 9.
[9] Id. at 10.
[10] Id. at 11.
[11] Id. at 12.
[12] Id. at 12-13.
[13] Press Release, CEO of Publicly Traded Health Care Company Charged for Insider Trading Scheme, DOJ (Mar. 1, 2023), https://www.justice.gov/opa/pr/ceo-publicly-traded-health-care-company-charged-insider-trading-scheme.
[14] Press Release, SEC Charges Ontrak Chairman Terren Peizer with Insider Trading, SEC (Mar. 1, 2023), https://www.sec.gov/news/press-release/2023-42.