DOJ Prevails in Insider Trading Trial Based Solely on Stock Sales Under 10b5-1 Trading Plans
The U.S. Department of Justice ("DOJ") won at trial in its first insider trading prosecution against an executive based exclusively on his sales of stock under 10b5-1 trading plans.
On June 21, 2024, a federal jury in California returned a guilty verdict against Terren Peizer, the founder and former chairman and CEO of a publicly traded health care company, for insider trading in a novel case brought by the DOJ based solely on Peizer's sales of stock under 10b5-1 trading plans. These plans are governed by Rule 10b5-1 of the Securities Exchange Act of 1934 ("Exchange Act"), which provides corporate insiders with an affirmative defense to insider trading claims if the insider trades are subject to certain conditions.
According to DOJ, Peizer avoided more than $12.5 million in losses by allegedly misusing two 10b5-1 trading plans to sell stock while he possessed material nonpublic information ("MNPI") that the company's then-largest customer might end its contract. Peizer entered into the first plan after learning that the customer had raised issues concerning its relationship with the company and was considering terminating its contract. Peizer entered into the second plan after learning that the customer intended to terminate its relationship with the company. Although not required by Rule 10b5-1 at the time, Peizer did not allow a "cooling-off" period, wherein an executive waits a certain number of days to begin trading after establishing a trading plan, despite being advised by two brokers that he should. DOJ also alleged that Peizer falsely certified that each trading plan was not entered into as a result of access to or the receipt of MNPI.
When the company ultimately announced that the customer had terminated its contract, just days after Peizer adopted the second plan, the company's stock price declined more than 44%. After a nine-day trial, the jury deliberated for six hours and returned a verdict finding Peizer guilty of one count of securities fraud and two counts of insider trading.
As we previously reported, 10b5-1 plans have recently faced scrutiny, leading the U.S. Securities and Exchange Commission in 2022 to adopt new rules for reliance on the affirmative defense that were not in place at the time of Peizer's actions. The new conditions include mandatory cooling-off periods and that directors and officers must certify, when adopting a plan, that they are not aware of any MNPI about the issuer or its securities and that they are adopting the plan in good faith. For persons other than the issuer, the rules also restrict the use of multiple overlapping trading plans and limit the use of single-trade plans in a 12-month period.
Companies and executives should expect more criminal prosecutions based on the alleged misuse of 10b5-1 plans as DOJ has already signaled it plans to pursue such cases. The head of DOJ's Criminal Division, Nicole M. Argentieri, stated, "[t]his 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."
