In what the agency says is the first prosecution of its type, the U.S. Department of Justice has brought criminal charges against Terren Peizer, the Executive Chairman of the healthcare company Ontrak, alleging that the executive improperly used Rule 10b5-1 trading plans to sell shares in the company ahead of the company’s disclosure of bad news. The SEC has separately brought a civil enforcement action against Peizer based on the same allegations. The government alleges that Peizer set up the plans while aware of the undisclosed bad news and that his stock sales allowed him to avoid more than $12.7 million in losses.
A copy of the U.S. Department of Justice’s March 1, 2023 press release about Peizer’s prosecution can be found here, and the February 24, 2023 grand jury indictment of Peizer can be found here. The SEC’s March 1, 2023, press release can be found here, and its complaint against Peizer can be found here.
Background
The government alleges that Peizer first established a Rule 10b5-1 trading plan for his investment vehicle, Acuitas Group Holdings LLC, in May 2021. The government alleges that Peizer established the plan shortly after learning that Ontrak’s relationship with its then-largest customer – representing more than half of its revenue – was deteriorating and that the customer had expressed serious reservations about its contract with Ontrak. The government alleges that after executing the trading plan, Peizer sold nearly 600,000 of his Ontrak shares worth more than $19.2 million.
The government alleges further that in August 2021, Peizer entered into a second Rule 10b5-1 trading plan approximately one hour after Ontrak’s chief negotiator for the troubled customer contract confirmed to Peizer that the contract likely would be terminated. On August 19, 2021, just six days after Peizer adopted his August 10b5-1 plan, Ontrak announced that the customer had terminated the contract, and Ontrak’s stock declined more than 44%.
The government specifically alleges that, contrary to the requirements of Rule 10b5-1, Peizer set up the trading plans while in possession of material non-public information. The government also alleges that in establishing the plans, Peizer allegedly refused to engage in any “cooling-off” period (that is, a time interval between when he entered into the plan and when he sold stock) despite warnings from two brokers. Peizer allegedly began selling Ontrak shares on the next trading day after establishing each plan. The government also alleges that at the time he established the plans, he attested that he was unaware of any material non-public information concerning the company.
The indictment charges Peizer with one count of engaging in a securities fraud scheme and two counts of securities fraud for insider trading. The SEC’s complaint against Peizer accuses him of violating the antifraud provisions of the federal securities laws and seeks permanent injunctive relief, disgorgement of ill-gotten gains with prejudgment interest, civil penalties, and an officer and director bar.
The Justice Department’s press release quotes the U.S. Attorney for the Central District of California as saying that Peizer is “accused of using his insider knowledge as CEO of a publicly traded company to line his own pockets in violation of his duty to his company and its shareholders.” The SEC press release quotes Gurbir Grewal, the agency’s head of enforcement as saying that Peizer’s misuse of the plans, set up while he was in possession of material information, allowed Peizer to avoid millions of dollars of losses, adding “That’s insider trading, even when the trading is done through a 10b5-1 trading plan.”
Discussion
The Justice Department’s press release calls its prosecution of Peizer as “groundbreaking,” noting in the very title of the press release that the criminal action against Peizer is the “first insider trading prosecution based exclusively on use of Rule 10b5-1 trading plans.”
The SEC’s separate enforcement action against Peizer is the agency’s second action brought against a corporate executive for misuse of a Rule 10b5-1 plan.
Long-time readers will recall the agency’s 2010 action against Countrywide Mortgage’s CEO Angelo Mozillo, in which the agency alleged alleged that Mozilo engaged in insider trading in the securities of Countrywide by establishing four 10b5-1 sales plans in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide’s increasing credit risk. In October 2010, Mozilo agreed to settle the SEC’s enforcement action for a payment of $67.5 million dollars, including a $22.5 million penalty and a disgorgement of $45 million. The financial penalty was at the time (and I believe still is) the largest ever paid by a public company’s senior executive in an SEC settlement.
The timing of the government’s actions against Peizer is interesting, as is noted in the SEC’s press release. The press release quotes SEC Chair Gary Gensler as saying that the action against Peizer “comes the same week that updates amendments to Rule 10b5-1 become effective.” As noted here, the SEC’s amendments to the Rule went into effect on February 27, 2023. The amendments were intended to address long-standing concerns that some executives had misused trading plans. Among other things, the amendments specifically required cooling off periods before trading can take place after a plan is established. The amendments also put in place restrictions on the use of multiple plans.
The enforcement action shows that, in addition to tightening up the Rule in order to curb perceived abuses, the government intends to go after executives that abuse trading plans. Both the Justice Department press release and the SEC’s press release contain statements that the respective agencies actions against Peizer arose from “a data-driven initiative into executive trading pursuant to 10b-1 plans.” The agencies’ actions against Peizer show not only that the government is scrutinizing executives’ trading but that they intend to hold executives accountable for alleged abuses; the fact that the government has brought a criminal action against Peizer shows that the initiative is serious.
However, amid all of the concerns about abuses of Rule 10b5-1 trading plans, there is another important point that needs to pointed out here. That is, used properly, 10b5-1 plans can provide an important affirmative defense to allegations of securities fraud – and this consideration remains true even after the agency’s recent amendments to the Rule. Specifically, corporate insiders who traded in their shares of company stock pursuant to a written trading plan have been able to rely on the Rule’s protection in order to defend themselves against alleged securities law violations.
For example, as discussed in greater detail here, in the Eighth Circuit’s 2008 opinion in the Centene securities class action lawsuit, the appellate court, in affirming the district court’s finding that the plaintiffs had not adequately pled scienter, specifically considered the fact that the individual defendants’ stock sales on which the plaintiffs sought to rely had been made pursuant to a Rule 10b5-1 trading plan. In another instance, discussed here, the defendants were able to rely on the fact that their trades in company securities had been made pursuant to a written trading plan in support of their motions to dismiss the securities class action lawsuit that had been filed against them.
My point is that while trading plans adopted pursuant to Rule 10b5-1 can be abused, the adoption of trading plans is still a good idea. Moreover, the concept behind rule – that is, to provide corporate insiders with a way to trade in their company securities – is still valid, as well. Nothing about the recent revisions to the Rule or even about the government’s actions against Peizer should take away from the fact that adopting a proper plan is a smart way for corporate executives to try to protect themselves from potential liability under the federal securities laws.
Indeed, a written trading plan is one of the important practical steps that companies and their executives can take as part of securities litigation loss prevention program. Well-advised companies and their executives that adopt plans that avoid the abuses will have an important tool in their arsenal if they are called upon to defend themselves in a securities suit. Nothing about the recent revisions to the Rule or even about Peizer’s prosecution changes any of that.