In December 2022, the Securities and Exchange Commission (SEC) amended Rule 10b5-1 (the “Rule”) under the Securities Exchange Act of 1934 to add new reporting and disclosure requirements for corporate insiders and companies. On March 1st, 2023, the SEC announced that it had charged the Executive Chairman of a healthcare treatment company with insider trading. Notably, a long-standing affirmative defense under the Rule covered the activity outlined in the complaint.
The Rule provides an affirmative defense from insider trading liability if the conditions within the Rule are met. The SEC’s amendments purport to address suspected abuses by adding new requirements and disclosure obligations on insiders and companies.
The SEC defines insider trading as generally “buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information about the security.”1
Since 2000, the SEC has permitted prearranged trading plans created under the Rule (a “10b5-1 Plan”) that are arranged with the company’s consent and reviewed by legal counsel—a process that acted as a shield from allegations of insider trading. These 10b5-1 Plans put the executives’ and officers’ sales of company stock on autopilot to avoid claims of insider trading, provided that the executive or officer did not have material, nonpublic information when the plan was established. These Plans, and the affirmative defenses provided by the Rule, appear to have been effective, as they resulted in only three insider trading cases involving a 10b5-1 Plan.2
New Investigations from the Justice Department and the SEC
On March 1st, 2023, the SEC announced charges for insider trading against the Executive Chairman of Ontrak Inc., a California-based healthcare treatment company, “for selling more than 20 million USD of Ontrak stock between May and August 2021 while in possession of material nonpublic, negative information related to the company’s largest customer.”3 In the press release, SEC Chair Gary Gensler stated: “Today’s action comes the week that updated amendments to Rule 10b5-1 become effective. These reforms to Rule 10b5-1 will further help prevent unlawful trading by executives based on nonpublic information and help build greater confidence in the market.”4
According to the SEC’s complaint, the Executive Chairman established a 10b5-1 Plan to sell Ontrak, Inc. stock after he learned that Ontrak’s relationship with its then-largest customer was tenuous. Nevertheless, the Executive Chairman “attested at the time that he was unaware of any material nonpublic information concerning the company, executed the 10b5-1 Plan, and sold nearly 600,000 of Ontrak shares, worth more than 19.2 million USD.”5
The complaint further alleges that when the Executive Chairman learned the customer contract was not only tenuous, but in fact on the verge of termination, he adopted a “second Rule 10b5-1 trading plan and [sold] 45,000 more shares of stock worth more than 1.9 million USD.”6 When the contract termination was announced, “Ontrack’s stock price fell more than 44 percent and, as a result…[the Executive Chairman] avoided more than 12.7 million USD in losses by executing the two trading plans.”7 Three lessons from the SEC’s actions are clear: (1) data obtained by the SEC is driving a new enforcement initiative; (2) the protections afforded by 10b5-1 Plans are at risk; and, (3) the SEC and Justice Department are pursuing a new kind of insider trading case.8
Considering the Risk Under Rule 10b5-1, Given the Recent Amendments
In its Press Release, the SEC revealed the investigation resulted from “a data-driven initiative into executive trading” under 10b5-1 Plans.9 Importantly, the SEC highlighted that individuals aware of material nonpublic information who use that information “as part of a scheme to evade insider trading prohibitions…cannot take advantage of any affirmative defenses available under Rule 10b5-1.”10
It is the first time the Justice Department has criminally charged an insider-trading defendant who used a 10b5-1 Plan,11 and this momentous occasion came the same week that updated amendments to the Rule became effective. The complaint, filed in the US District Court in the Central District of California, charges the Executive Chairman, and the company that served as his investment vehicle, with violating antifraud provisions of the federal securities laws and seeks permanent injunctive relief, disgorgement, civil penalties, and an officer and director bar.
The New Guidance
The Rule’s amendments and the subsequent prosecution represent a stark shift away from what many executives have considered business-as-usual. Further, the Justice Department’s appetite for pursuing additional prosecutions at this time under the Rule remains unclear.
In our continuing effort to inform Chief Executives and other officers of firms (including executives and officers of Internet infrastructure and data center companies) of developing risk profiles, you should follow our articles and information at www.whitefordlaw.com and contact the authors for emerging trends, details of the new guidance, and advice on the ways in which the Justice Department and SEC’s new data-driven enforcement initiative may affect you or your firm.
1 U.S. Securities and Exchange Commission, Insider Trading, https://www.investor.gov/introduction-investing/investing-basics/glossary/insider-trading.
2 Mark Maremount & Dave Michaels, Insider-Trading Cases Once Deemed Too Hard to Crack Are Now Targets of U.S. Government, Wall Street J. (Mar. 3, 2023), https://www.wsj.com/articles/insider-trading-cases-once-deemed-too-hard-to-crack-are-now-targets-of-u-s-government-c5320fac.
3 U.S. Securities and Exchange Commission, SEC Charges Ontrak Chairman Terren Peizer With Insider Trading (Mar. 1, 2023), https://www.sec.gov/news/press-release/2023-42.
4-7 Id. (Internal quotations omitted).
8 See Mark Maremount & Dave Michaels, Insider-Trading Cases Once Deemed Too Hard to Crack Are Now Targets of U.S. Government, Wall Street J. (Mar. 3, 2023), https://www.wsj.com/articles/insider-trading-cases-once-deemed-too-hard-to-crack-are-now-targets-of-u-s-government-c5320fac (noting that another public company, Los Angeles-based HyreCar Inc., disclosed investigations into stock trades involving 10b5-1 plans).
9 U.S. Securities and Exchange Commission, SEC Charges Ontrak Chairman Terren Peizer With Insider Trading (Mar. 1, 2023), https://www.sec.gov/news/press-release/2023-42.
11 Jessica Corso, DOJ Cautions Execs with Novel Insider Trading Case, Law360 (Mar. 6, 2023).