The former CEO of a Nevada-based healthcare company has been convicted of insider trading in a landmark case involving the executive’s use of a safe harbor that, in this case, could not shield him from a jury conviction.
A Los Angeles jury found Terren Peizer, who also served as the chair of the company’s board and was its largest shareholder, guilty of one count of securities fraud and two counts of insider trading. He avoided $12.5m in losses by selling stock before news came out that the company was losing its biggest customer, according to a news release from the US Attorney’s Office for the Central District of California.
The jurors deliberated for nine days, finding Peizer guilty of trading shares of stock based on confidential information he had about Ontrak’s likelihood to lose Cigna as a major customer.
What is most interesting, though, is that Peizer had used what is known as a 10b5-1 trading plan to make the trades – a pre-arranged plan to sell portions of his portfolio in the future, regardless of market events. Those pre-arranged executive trading plans have served as a safe harbor for executives who could otherwise have been found to trade based on their access to material nonpublic information.
This case shows that the safe harbor is not an unchecked and absolute cloak of immunity from conviction, as other factors need to be considered. It is the first insider trading prosecution based exclusively on the use of those trading plans.
Timing is key
Although Peizer was not in charge of dealing with Cigna, executives kept him apprised of efforts to save a $90m deal with the health insurer.
In May 2021, Peizer entered into his first 10b5-1 trading plan after learning that the customer relationship was deteriorating and the customer expressed serious reservations about continuing its contract with Ontrak. Peizer later learned that the customer intended to terminate the contract.
Then, in August 2021, Peizer entered into his second Rule 10b5-1 trading plan approximately five minutes after Ontrak’s chief negotiator for the contract informed Peizer that the contract likely would be terminated.
Peizer refused to engage in any “cooling-off” period – the time between when he entered into the trading plan and when he sold Ontrak stock – despite warnings from multiple brokers, Ontrak’s Insider Trading Compliance Officer, and several attorneys. Instead, Peizer began selling shares of Ontrak on the next trading day after establishing each plan.
“This is the Justice Department’s first insider trading prosecution based exclusively on the use of a trading plan, but it will not be our last.”
Nicole Argentieri, head of US Justice Department Criminal Division
On August 19, 2021, just six days after Peizer adopted his August 10b5-1 plan, Ontrak announced that the customer had terminated its contract and Ontrak’s stock price declined by more than 44%.
“As a CEO, Mr. Peizer abdicated his responsibilities by using his position to conceal trading on material non-public information in order to avoid the losses shareholders suffered,” said Acting Assistant Director in Charge Krysti Hawkins of the FBI Los Angeles Field Office. “The FBI is committed to investigating illegal trading practices and holding offenders accountable in order to ensure fairness and trust in the marketplace.”
10b5-1 trading plans
A Rule 10b5-1 trading plan allows a corporate insider of a publicly traded company to set up a prearranged and automatic plan for selling company stock, and it can offer an executive a defense to insider trading charges, since the trades are deemed to be prescheduled commitments.
However, the 10b5-1 trading plan safe harbor and defense is unavailable if the executive is in possession of material, nonpublic information at the time he or she enters into the 10b5-1 trading plan.
Additionally, a plan does not protect an executive if the trading plan was not entered into in good faith or was entered into as part of an effort or scheme to evade the prohibitions of Rule 10b5-1.
Prosecutors argued that Peizer created the plan knowing Ontrak was going to lose Cigna’s business. His defense attorneys argued that Ontrak’s chief financial officer had signed off on Peizer’s use of the trading plan and had certified Peizer did not have material nonpublic information.
DOJ issues statement
The head of the US Justice Department’s Criminal Division, Nicole Argentieri, said: “This is the Justice Department’s first insider trading prosecution based exclusively on the use of a trading plan, but it will not be our last. We will not let corporate executives who trade on insider information hide behind trading plans they established in bad faith.”
Peizer is scheduled to be sentenced on October 21, and he faces a maximum penalty of 25 years in prison on the securities fraud count and 20 years in prison on each of the insider trading counts.
GRIP Comment
An eye-catching number of insider trading cases have been pursued, made public, and discussed at length in speeches made by officials at US regulatory agencies in the last couple of years.
In December 2022, the SEC adopted amendments to Rule 10b5-1 and new disclosure requirements to enhance investor protections against insider trading.
The amendments provide an affirmative defense to insider trading liability and require more comprehensive disclosure about an issuers’ policies and procedures related to insider trading, including quarterly disclosure by issuers regarding the use of Rule 10b5-1 plans and certain other trading arrangements by its directors and officers for the trading of its securities.
This case proves the plans alone will not serve as a total cloak of immunity; law enforcement and, ultimately a judge or jury, decide a 10b5-1 plan was used as cover for criminal conduct, insider trading charges can apply.
