Editor’s Note: Recently, both the DOJ and the SEC brought, for the first time ever, criminal and civil insider trading charges against a corporate executive for his alleged fraudulent misuse of a 10b5-1 trading plan, which typically allows corporate insiders to pre-schedule sales of company shares to avoid accusations of insider trading. In this post, several former federal prosecutors and white collar defense attorneys provide their reactions to this case and its implications for future insider trading cases.
Top row from left to right: Brian Jacobs, Gina Parlovecchio, Rachel Maimin, and Kathleen McGee.
Bottom row from left to right: Robert Johnston, Marc Rein, and Katherine Goldstein. (photos courtesy of authors’ respective firms)
Government’s First-of-Kind Criminal Prosecution Alleging Misuse of Rule 10b5-1 Plans May Open the Door for Court to Reassess Key Element
by Brian Jacobs
A person who engages in trading “on the basis of” material nonpublic information (“MNPI”) with intent to deceive and in breach of a duty commits a crime. Rule 10b5-1 says a trade is made “on the basis of” MNPI when a person trades while “aware of” that information. Some Courts of Appeals, however—including the Ninth Circuit in United States v. Smith, 155 F.3d 1051 (9th Cir. 1998), which would apply to the recent DOJ and SEC actions against Terren Peizer in California—have interpreted “on the basis of” to mean the trader “actually used” the MNPI to trade. Few cases since Rule 10b5-1 came into effect have addressed the tension between Rule 10b5-1’s “knowing possession” standard and the case law’s “actual use” standard.
Given this unsettled law, it is no surprise that the DOJ and SEC seem to have drafted the Peizer indictment and complaint, respectively, largely to emphasize the “knowing possession” of MNPI (their preferred standard), rather than the “use” of MNPI. In this regard, it is particularly intriguing that the government alleges that the defendant had not sold stock in his company for 10 years before the alleged trades. In the government’s view, the defendant’s sudden activity no doubt indicates “use” of MNPI. But the sudden activity could also indicate a personal event motivating the trades, or a long-held plan to sell that did not rely on MNPI at all. If the defendant can present a colorable defense that his trades were motivated by some factor other than MNPI, such that he did not “use” MNPI to trade, the government’s “knowing possession” standard may finally face a rare and overdue test.
Brian Jacobs is a Partner at Morvillo Abramowitz Grand Iason & Anello PC and a former federal prosecutor at the U.S. Attorney’s Office for the Southern District of New York (“SDNY”).
Groundbreaking Insider Trading Case Highlights DOJ’s Use of Advanced Data Analytics to Detect Crime
The DOJ’s case against Peizer has the hallmarks of a classic insider trading case, but it is remarkable for two reasons: (1) it marks the first time DOJ has brought criminal insider trading charges based exclusively upon a corporate insider’s use of 10b5-1 plans, which are designed to shield corporate insiders from insider trading charges; and (2) it highlights DOJ’s expanded use of data analytics in its investigations.
For more than twenty years, 10b5-1 plans have provided a mechanism for companies and corporate insiders to buy and sell securities of their own company while mitigating liability for insider trading. Under 10b5-1 plans, insider sales must be planned in advance, at a time when the company or corporate insider is unaware of any MNPI. In the Peizer case, however, DOJ has alleged that Peizer, the founder, CEO and Chairman of Ontrak, attempted to exploit the protection provided by 10b5-1 plans to carry out trades based on MNPI. Specifically, DOJ alleges that Peizer entered into one 10b5-1 plan shortly after learning that the relationship between Ontrak and its then-largest customer was deteriorating, and a second 10b5-1 plan just one hour after learning that the customer’s contract would be terminated. He then allegedly found a way to avoid waiting the “cooling off period” before selling his shares. The implication of the allegations is that Peizer abused the cover offered by his 10b5-1 plans. This case is likely DOJ’s warning to corporate insiders to ensure they are honestly complying with the requirements of their 10b5-1 plans.
Peizer’s case is also noteworthy because it highlights how DOJ is expanding its use of data analysis to investigate cases. During a speech on March 3, 2023, Assistant Attorney General Kenneth Polite cited the Peizer case as an example of how DOJ has worked with data analysts and scientists to develop algorithms that detect leads indicative of fraud and manipulation in the financial markets. Here, DOJ used data analytics to identify corporate insiders who greatly outperformed the market when trading pursuant to 10b5-1 plans, and found Peizer’s trades. Such a lead proved fruitful in this case, and the DOJ has warned that similar cases are expected to follow.
Gina M. Parlovecchio is a Partner at Mayer Brown LLP and a former federal prosecutor at the U.S. Attorney’s Office for the Eastern District of New York (“EDNY”).
10b5-1 Amendments and Peizer
by Rachel Maimin, Kathleen McGee, Robert Johnston, and Marc Rein
On December 14, 2022, the SEC amended Rule 10b5-1 in an attempt to provide investors with greater protection against insider trading. Meeting the requirements of 10b5-1 provides an affirmative defense to allegations of insider trading on the basis of material nonpublic information. However, studies have shown that 10b5-1 plans have been abnormally profitable.
The SEC’s amendments include:
- Cooling-off periods of at least 90-days for directors or officers (30-days for non-directors or officers) after plan adoption or modification during which one may not trade under the plan. The only exception is if the modification does not change the sale/purchase price, the amount to be sold/purchased, or the timing of trades;
- Required certifications from directors and officers that they (1) are not aware of material nonpublic information and (2) are adopting the plan in good faith, and not in an effort to evade insider trading prohibitions;
- An extended good faith requirement which now lasts for the duration of the plan; and
- A restriction on having multiple overlapping plans.
These amendments seek to curtail acts such as those alleged on March 1, 2023, by the SEC against Terren S. Peizer, CEO and Executive Chairman of Ontrak, Inc.. According to court documents, Peizer allegedly avoided over $12 million in losses by selling more than $20 million in stock in under four months through two separate 10b5-1 plans. The SEC alleges that Peizer was in possession of material nonpublic information regarding the imminent loss of his company’s largest customer when he entered into 10b5-1 plans in May and August 2021. Without engaging in any cooling-off period, Peizer sold off roughly 650,000 shares of Ontrak just days before its largest customer terminated their contract and Ontrak’s stock price fell more than 44 percent. The DOJ subsequently charged Peizer with one count of engaging in a securities fraud scheme and two counts of securities fraud.
The actions against Peizer come less than one week after the amendments to Rule 10b5-1 became effective. While the amendments will not have an effect on the case against Peizer, the SEC intends that they deter similar conduct in the future.
Rachel Maimin, Kathleen McGee, and Robert Johnston are Partners and Marc Rein is an Associate at Lowenstein Sandler LLP. Maimim was a former federal prosecutor at the SDNY; McGee was formerly the Bureau Chief of the Bureau of Internet & Technology for the New York State Attorney General’s Office; and Johnston formerly held senior in-house legal and compliance roles at Sculptor Capital Management.
The Government Takes Aim at 10b5-1 Plans
In one sense, the SEC and DOJ have charged a straightforward insider trading case, having alleged that the defendant, a public company executive, was in possession of material, non-public information before he made profitable trades in his company’s stock. But in other respects, these charges are quite significant. First, the government is clearly taking aim at trading pursuant to 10b5-1 plans, which market participants have relied on for 20 years. In addition, the government has repeatedly touted its use of data analytics in bringing this case, which means that there are more like it on the way. Finally, it seems clear that the SEC is going to be taking a hard look at 10b5-1 plans that pre-date the changes to the Rule, including whether those plans had a cooling off period, even though plans that pre-date the amendments were not required to have one.
Katherine Goldstein is a Partner at Akin Gump Strauss Hauer & Feld LLP. Formerly, she was a federal prosecutor at the SDNY.
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