On March 1, 2023, the U.S. Department of Justice and the Securities and Exchange Commission announced insider trading charges against Terren Peizer, the CEO and Chairman of a California-based healthcare services company called Ontrak, Inc. (the “Company”) for allegedly selling Company securities while in possession of material, non-public information (“MNPI”) that one of the Company’s major customers was likely to cancel its contract.
When the news was disclosed, the Company’s stock dropped dramatically, and by trading ahead of the news, Peizer allegedly avoided more than $12.5 million in losses. This is the first time the DOJ has brought criminal charges for insider trading based solely on an executive’s use of a Rule 10b5-1 trading plan, which provides an affirmative defense to insider trading through the use of a trading plan adopted when the trader is not in possession of MNPI.
The SEC announced charges against Peizer and his personal investment vehicle, Acuitas Group Holdings, LLC (“Acuitas”), in a parallel civil action the same week that recent SEC amendments to Rule 10b5-1 became effective.
Customer Contracts. The DOJ’s indictment and the SEC’s complaint set forth substantively similar factual allegations, which Peizer is contesting.
- Peizer is the founder and long-time Chairman of the board of directors of Ontrak, a company that provides behavioral health services to members of insurance plans. He also served for many years as CEO, a post he resumed in August of 2022; during most of the period relevant to this case, Peizer served only as Chairman, not CEO.
- According to the charging documents, in late March of 2021, Peizer first came into possession of MNPI that the Company’s relationship with its then-largest customer, a health insurance provider, was deteriorating and that the customer was considering terminating the contract.
- Earlier that same month, the Company had announced the termination of a contract with another large customer, and the stock price fell 46%. The Company was allegedly relying on its contract with the remaining customer to replace the lost revenue from the departing customer.
- The SEC’s complaint alleges that throughout April 2021, Peizer was “fixated” on saving the Company’s relationship with the remaining customer and was aware that the customer had raised concerns about the relationship and its ability to continue under the terms of the current contract.
Disclosure and Rule 10b5-1 Plan. The Company disclosed in its May 6, 2021 Form 10-Q that its business depended on four large customers and “the loss of any one of such customers would have a material adverse effect on us.”
- On May 10, 2021, Peizer allegedly set up a Rule 10b5-1 trading plan to sell shares of Company stock through Acuitas and began sales the next day.
- According to the charging documents, the first broker Peizer approached to set up the plan told him that its policy required a 14-day cooling-off period.
- Peizer opted for another broker that did not require a cooling-off period—although that broker did inform him that the industry standard was 30 days—and sold shares from May 11, 2021 through July 20, 2021.
- The DOJ and SEC further allege that on May 18, 2021, the customer informed the Company of its intent to terminate the contract by the end of the year. The customer also had dramatically reduced the number of its insurance plan participants that it referred to the Company.
Continued Deterioration. From May to August 2021, the relationship with the customer continued to deteriorate, and on August 13, 2021 a Company sales employee allegedly informed Peizer that he thought the customer would terminate the contract.
- According to the government, on August 13, 2021, Peizer entered into a second Rule 10b5-1 plan and sold additional Company stock from August 16, 2021 through September 28, 2021.
- Prior to implementation of both plans, Peizer allegedly certified to the Company’s CFO, in accordance with Company policy, that he was not in possession of MNPI while entering into the plans.
- Several days later, on August 18, 2021, the customer informed the Company’s CEO that it would terminate its contract effective December 31, 2021, which the customer confirmed in a certified letter the next day.
- On August 19, 2021, the Company filed a Form 8-K with the SEC announcing that its customer had terminated the contract and its stock price fell more than 44%.
- By selling Company shares through his two Rule 10b5-1 plans, Peizer allegedly avoided losses of more than $12.5 million.
Rule 10b5-1 and Recent Amendments
In December 2022, the SEC adopted amendments to Rule 10b5-1 that became effective February 27, 2023. The amendments impose a cooling-off period on Rule 10b5-1 plans of officers and directors lasting until the later of:
- 90 days following adoption or modification of the plan; and
- two business days following disclosure of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification).
The amendments also require an officer or director to include a good-faith representation in a plan stating that they:
- are not aware of MNPI about the issuer or its securities; and
- are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5.
- Caution When Entering a Plan. Now more than ever in view of the new rule changes and the government’s appetite to advance a novel fraud charge, officers and directors should exercise caution when setting up 10b5-1 plans during periods in which they could even arguably be in possession of MNPI. This is particularly important given that the Rule 10b5-1 amendments now require officers and directors to certify that they were not aware of MNPI at the time of entering into the plan and are adopting the plan in good faith, which itself could form the basis of an independent violation.
- Aggressive View of MNPI. Such caution is particularly important because the SEC and the DOJ have taken in this litigation aggressive positions on what constitutes MNPI, particularly with respect to Peizer’s May 2021 trading. Although the government’s allegations, if true, would clearly establish that the loss of the customer would be material, the allegations do not clearly establish that the relationship actually had been lost when Peizer traded. At the time he traded in May 2021, Peizer allegedly knew that the customer was “not satisfied” and was “considering” terminating its contract, in part due to a “budget crunch” – but there had been no rupture in the relationship. Indeed, the allegations also detail months of back-and-forth communications between the companies as Ontrak tried to salvage the relationship.
- Peizer can be expected to argue that he did not know at the time he traded that the customer actually would terminate its contract, but rather that he thought the customer was taking a hard negotiating line. It was not until after Peizer traded that the customer informed Ontrak that the customer was terminating the contract, which Ontrak disclosed the next day as required by securities regulations.
- This argument is weaker as to the August trading, but by alleging that Peizer was in possession of MNPI all the way back in May, the government has taken an aggressive position with no clear limiting principle. Few businesses have any guarantees that they will retain their customers forever, and it is not at all clear how “likely” the loss of a key customer must be for DOJ and the SEC to claim that it constitutes MNPI.
- More Criminal Rule 10b5-1 Cases Expected. Now that the DOJ has brought its first criminal case for executive insider trading using Rule 10b5-1 plans, we can expect to see more. The DOJ’s case is aggressive in that Peizer will be expected to argue that the fact that he conducted the trades pursuant to Rule 10b5-1 plans, with the disclosure and visibility those entail, is proof that he lacked the requisite criminal intent. Peizer also likely will point out that he set up the plans in connection with warrants that were due to expire, and that his good faith is demonstrated by the fact that he sold fewer than 650,000 shares at a time when he was alleged to own more than 9 million, meaning that he would have suffered far greater losses after the August 2021 disclosure than he avoided through his plan trading.
- Deviation from Rule 10b5-1 Signaling Criminal Intent. The DOJ also alleged that Peizer demonstrated his criminal intent by shopping for a broker who would not force him to observe a cooling-off period. Although a cooling-off period may have been “best practice,” as one of the brokers put it, it was not a legal requirement at the time of the trades, and it is somewhat aggressive for DOJ to argue that his failure to do something he had no obligation to do demonstrates criminal intent. Now that Rule 10b5-1 has been amended, including with cooling-off periods, DOJ will be able to argue in future cases that any deviation from the stricter requirements of the rule demonstrates criminal intent.
- Data Analysis as an Enforcement Tool. According to both the DOJ’s and the SEC’s press releases, the allegedly unlawful trading was discovered through a data-driven initiative into executive trading. Companies and their executives should be mindful that data analysis is a powerful tool for detecting suspicious trading that government agencies will continue to leverage.
- Importance of an Insider Trading Policy. Finally, the SEC did not charge the Company with any wrongdoing, and the complaint provides that the Company had an insider trading policy that specifically prohibited trading or establishing a Rule 10b5-1 plan while in possession of MNPI. This underscores the importance of such policies in protecting companies themselves from liability.