March 3, 2023

Rule 10b5-1 Plans: SEC & DOJ Bring First-Ever Criminal Charges

Big news on the “insider trading” front. Earlier this week, the SEC announced that it had filed a civil complaint against the CEO & Chair of a healthcare company for his allegedly improper use of a Rule 10b5-1 trading plan. The SEC is seeking a jury trial in California. In addition, the DOJ announced parallel criminal charges and unsealed a grand jury’s indictment. Whoa! From the DOJ’s press release:

According to court documents, between May and August 2021, Peizer, 63, a resident of Puerto Rico and Santa Monica, California, allegedly avoided more than $12.5 million in losses by entering into two Rule 10b5-1 trading plans while in possession of material, nonpublic information concerning the serious risk that Ontrak’s then-largest customer would terminate its contract.

In May 2021, Peizer allegedly entered into his first 10b5-1 trading plan shortly after learning that the relationship between Ontrak and the customer was deteriorating and that the customer had expressed serious reservations about continuing its contract with Ontrak. The indictment alleges that Peizer later learned that the customer informed Ontrak of its intent to terminate the contract. Then, in August 2021, Peizer allegedly entered into his second 10b5-1 trading plan approximately one hour after Ontrak’s chief negotiator for the contract confirmed to Peizer that the contract likely would be terminated.

In establishing his 10b5-1 plans, Peizer allegedly refused to engage in any “cooling-off” period – the time between when he entered into the plan and when he sold stock – despite warnings from two brokers. Instead, Peizer allegedly began selling shares of Ontrak on the next trading day after establishing each plan. On Aug. 19, 2021, just six days after Peizer adopted his August 10b5-1 plan, Ontrak announced that the customer had terminated its contract and Ontrak’s stock price declined by more than 44%.

If convicted, the CEO faces a maximum penalty of 25 years in prison on the securities fraud scheme charge and 20 years in prison on each of the insider trading charges.

These are the first-ever criminal allegations that relate exclusively to the use of a Rule 10b5-1 plan – and only the second SEC enforcement action. Hold on to your hats, though, because there are likely more to come. As I blogged a few months ago, the SEC’s Enforcement Division has been on the lookout for problematic Rule 10b5-1 plans, after notching its first settlement last September. Like the SEC, the DOJ also says that it has a “data-driven initiative” to identify executive abuses of 10b5-1 trading plans.

While this case – on its face – seems to afford some pretty useful facts for the regulators, it also serves as a giant red flag for any insiders who want to throw caution to the wind and quickly sell shares outside of the as-amended Rule 10b5-1 plan requirements. In this article, the defendant’s lawyer complains that the SEC & DOJ filed their cases without notice, following some “good faith” discussions. So, this initiative appears to be a “full steam ahead” endeavor – which is not a promising environment for anyone whose trades fall in a grey area.

Liz Dunshee