SEC Rule 10b5-1 provides an affirmative defense to corporate officers, directors, and companies for trading in their company’s stock. To be eligible for the defense, the officer, director or company must establish a public trading plan that sets forth predetermined dates, prices and amounts for buying, selling or hedging stock. Once the plan is created, stock transactions will occur automatically based on the details of the plan, and the plan will provide a defense against accusations of illegal insider trading.
But there is a catch. The 10b5-1 plan must be adopted at a time when the insider does not have possession of material nonpublic information about the company. The failure to adhere to this essential legal requirement resulted in the first criminal prosecution for insider trading based on the allegedly corrupt use of a 10b5-1 plan – charges that a federal judge recently refused to dismiss.
In March 2023, the U.S. Department of Justice brought criminal charges against Terren Peizer, the former Chief Executive Officer and Chairman of Ontrak, Inc., a Los Angeles-based company that uses artificial intelligence and telehealth to treat behavioral health conditions. The first-of-its kind indictment charged Peizer with entering into two 10b5-1 plans and then selling 600,000 shares of stock while knowing that Cigna Group, Ontrak’s leading customer, planned to terminate a major contract to provide health care for chronically ill patients. Peizer’s stock sales allegedly enabled him to avoid $12.7 million in market losses after the stock price fell by 44% after the announcement of the contract termination. In bringing the indictment, Assistant Attorney General Kenneth A. Polite, Jr., stated that “Today’s groundbreaking insider trading indictment demonstrates that the Department of Justice, together with our law enforcement partners, will not allow corrupt executives to misuse 10b5-1 plans as a shield for insider trading.”
After a superseding indictment was filed in January 2024, Peizer moved to dismiss, asserting that the government had not sufficiently alleged that he possessed and used nonpublic information. But U.S. District Judge Dale S. Fischer in Los Angeles held in a March 7, 2024, ruling that the indictment specified numerous nonpublic facts that a “reasonable investor would consider important in deciding whether or not to trade in Ontrak securities.”
The prosecution charged that in March 2021, Peizer stepped down as CEO of Ontrak and became the Executive Chairman and Chairman of the Board of Directors. But despite the change in title, Peizer still received nonpublic information about customer relationships, including the fact that Cigna was raising numerous issues concerning its relationship with Ontrak and that the Cigna contract was at serious risk of being terminated. Peizer allegedly knew that losing Cigna would seriously affect Ontrak’s stock price, particularly after the price plummeted by 46% in February 2021 when Ontrak announced the loss of Aetna, its then-largest customer. At a May 18, 2021meeting, Cigna informed Ontrak of its intent to terminate its contract by year-end.
On May 4, 2021, eight days before the meeting with Cigna, and when he allegedly had been expressing concern to Ontrak’s CEO and a consultant that the Cigna contract would be terminated, Peizer contacted a broker to establish a 10b5-1 plan to sell $19 million in stock, although he had sold stock only twice since 2003. After learning that the broker would require a “cooling-off period” before he could sell stock, Peizer allegedly went to a different broker, who although not requiring a cooling-off period, recommended that Peizer refrain from selling stock for 30 days, a proposal that Peizer rejected.
To enter into the 10b5-1 plan, Peizer allegedly falsely certified that he did not possess material nonpublic information. After the 10b5-1 plan was adopted on May 11, 2021, Peizer exercised 686,000 stock warrants and began selling those shares.
On August 13, 2021, Peizer allegedly learned from a senior executive that Cigna appeared ready to terminate its contract. One hour after this call, Peizer allegedly entered into a second 10b5-1 plan, again falsely stating that he did not possess material nonpublic information. Peizer sold approximately 45,000 shares of Ontrak stock over the next three days before Ontrak announced on August 19, 2021, that Cigna had terminated its contract, resulting in the steep stock price decline.
Peizer’s motion to dismiss argued that he did not enter into the 10b5-1 plans while possessing material nonpublic information about Cigna. He asserted that on May 6, 2021, and on August 5, 2021, prior to the implementation of his trading plans, Ontrak made filings with the SEC that disclosed all material information about the Cigna relationship. Peizer argued that these filings – a quarterly report and a Form 8-K report – publicly disclosed that Ontrak might not be able to keep key customers, that losing these customers would materially harm the company, and that it expected a smaller budget and more limited expansion. The August disclosure, Peizer argued, disclosed a reduced forecasted gross margin because the company had made a revised proposal to Cigna that would negatively impact Ontrak’s margins. Peizer also argued that Ontrak’s compliance professionals reviewed and approved his 10b5-1 plans.
Judge Fischer rejected these arguments. First, the court held that it could not take judicial notice of SEC filings and that only the face of the indictment could be considered (unlike in a civil case, where SEC filings might be incorporated by reference into the complaint). Second, the court held that the indictment “clearly and directly” alleged an intent to defraud, despite Peizer’s argument that intent was inadequately pled. Finally, in response to Peizer’s argument that the government had not showed how he “used” any nonpublic information, the court that “[T]his is obviously not true, as the [indictment] provided extensive detail regarding Defendant’s trades that were allegedly made based on his knowledge of nonpublic information.”
Peizer contended that the government had not clearly stated its theory of liability because its description of the material nonpublic information that he allegedly possessed was “ambiguous.” But the court held that “it should go without saying that [the information] is not ambiguous in context” and the government’s theory of liability was based on the specific information described in the indictment.
In December 2022, the SEC adopted amendments to Rule 10b5-1 that could have prevented Peizer’s trading. The most important amendment was to require a cooling-off period for officers and directors of the later of 90 days following the modification or adoption of the 10b5-1 plan or two days following disclosure in periodic reports for the quarter in which the plan was adopted or modified. Under the revised rule, if Peizer filed his 10b5-1 plan on May 11, 2021, he would have been able to sell stock prior to the August 19, 2021 announcement of the Cigna contract termination—but not until August 9, 2021, after the cooling-off period. In addition, because a cooling-off period would still be in place, he would not have been able to sell immediately after filing his August 13, 2021 10b5-1 plan. Of course, he could have still sold stock outside of a 10b5-1 plan, but that still would have been illegal insider trading if he was aware of Cigna’s plans. Also, the amendments restrict the use of multiple overlapping trading plans and limit the ability to rely on the affirmative defense for a single-trade plan to one single trade plan for all persons other than the company.
The SEC’s revised rule was intended to prevent the kind of abuse of 10b5-1 plans for which Peizer is being prosecuted. Nonetheless, officers and directors, and a company’s inside and outside counsel, must carefully monitor trading under 10b5-1 plans to ensure compliance with legal requirements and to avoid potential liability.
For more information regarding Alto Litigation’s litigation practice, please contact one of Alto Litigation’s partners: Bahram Seyedin-Noor, Bryan Ketroser, or Joshua Korr.
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