Last week, a jury in Los Angeles returned a verdict in United States v. Peizer, finding that a company executive engaged in insider trading when, after learning of the likely termination of the company’s most important customer relationship, he implemented two separate 10b5-1 plans and began selling the company’s securities shortly after entering into each plan.  DOJ has touted this verdict as the “first insider trading prosecution based exclusively on the use of a trading plan” and warned that “it will not be our last.”  Significantly, however, the trading in Peizer pre-dated the SEC’s amendments to Rule 10b5-1 (discussed here), which now require a 90-day minimum “cooling-off” period for directors and Section 16 officers following adoption of a 10b5-1 plan before trading may begin.  Although the current version of Rule
10b5-1 would not allow the conduct at issue in Peizer (i.e., trading immediately following the implementation of a plan), the Peizer verdict nevertheless serves as an important reminder of law enforcement’s increased scrutiny of trading conducted pursuant to 10b5-1 plans.

Terren Peizer was the Executive Chairman and Chairman of the Board of Directors of Ontrak Inc., a company providing behavioral health services to members of large health-insurance plans.  DOJ presented evidence at trial that, during the course of his role at Ontrak, Peizer learned that Ontrak’s largest customer, a major healthcare and insurance company, was likely to terminate its contract with Ontrak by the end of the year.  Shortly after learning this news, Peizer contacted two separate brokers to set up a 10b5-1 plan.  The first broker informed Peizer that the plan would need to include a “cooling-off” period.  At the time, a “cooling-off” period was included as a prudential matter in some companies’ policies and practices but was not mandated by the SEC.  Peizer declined to use this broker, and instead found a broker that did not require a “cooling-off” period.  Peizer entered into two separate 10b5-1 plans with this second broker, each time affirming to the broker that he was not in possession of material nonpublic information and certifying to Ontrak’s CFO that entering into the trading plan was not a result of Peizer’s access to material nonpublic information.  Pursuant to the plans, Peizer sold a total of 26,000 Ontrak shares.  When Ontrak ultimately disclosed the termination of the customer relationship, its stock price fell by 44%.  The government presented evidence at trial that Peizer avoided over $12 million in losses by selling stock prior to the disclosure.

In order to prevail, DOJ needed to prove that Peizer was in possession of material nonpublic information when he executed the trading plans and subsequently traded in Ontrak securities.  DOJ’s main focus was on the timing of Peizer’s conversations with company personnel about the status of Ontrak’s relationship with its largest customer, the close proximity of when he entered into the 10b5-1 plans and when he learned key information about the customer relationship, and Peizer’s decision to shop for a broker who would not require a “cooling-off” period.

The Peizer case is a reminder that a 10b5-1 plan can provide protection only when an executive does not possess material nonpublic information at the time of implementing the plan.  Moreover, a plan must be implemented and operated in good faith rather than as part of an effort to evade the prohibitions of Rule 10b5-1.  Although Peizer concerned the pre-amendment version of Rule 10b5-1, we expect the DOJ and the SEC to search for violations of the tightened standards.  Indeed, echoing previous comments by the SEC, DOJ has announced that the Peizer indictment was the result of deploying “a data-driven initiative led by the Criminal Division’s Fraud Section to identify executive abuses of 10b5-1 trading plans.”

This post comes to us from Wachtell, Lipton, Rosen & Katz. It is based on the firm’s memorandum, “DOJ Secures Insider Trading Verdict Based on Use of 10b5-1 Plans,” dated June 26, 2024.