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In June 2024, a jury in a federal court in California convicted the former chief executive officer and chairman of Ontrak Inc. (Ontrak), a publicly traded company, of federal securities fraud and insider trading for sales of Ontrak stock pursuant to two 10b5-1 plans that he set up in May and August 2021 shortly after learning that Ontrak would be losing its largest customer, avoiding USD 12.5 million in losses. The trades were executed prior to the public disclosure of the loss of the customer.
Following the conviction, the DOJ's Principal Deputy Assistant Attorney General Nicole Argentieri gave the following warning to corporate insiders in a press release issued by the DOJ: "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 inside information hide behind trading plans they established in bad faith".
The conviction should serve as a reminder that 10b5-1 trading plans are not an absolute shield for insider trading, and a warning that the government is focusing on insider trading violations made through 10b5-1 trading plans.
We recommend that companies and insiders implement the following actions to ensure compliance:
Although Rule 10b5-1 trading plans can operate as an affirmative defense against insider trading for corporate insiders buying and selling company stock, such plans offer no protection if they do not comply with the requirements of Rule 10b5-1. These include two recent requirements adopted from the 2022 amendment to Rule 10b5-1 that we previously issued an alert on: that the plan be adopted in good faith before the insider possesses any material nonpublic information, and that no trades be executed until after a "cooling off period" – the time between entering a trading plan and the first trade – has lapsed. Rule 10b5-1 was not available to Ontrak's former CEO and chairman as an affirmative defense to insider trading because two of the rule's key requirements were violated: He set up his trading plans while in possession of material nonpublic information, and did not comply with the required "cooling-off period," instead executing trades shortly after establishing each of the plans.
Since implementation of the 2022 amendment to Rule 10b5-1, the terms of each trading plan are required to be disclosed to the SEC. Corporate insiders should expect the government to perform sophisticated data analytics using information disclosed to the SEC from each insider's 10b5-1 trading plan. Insiders should also be aware that this analysis enables the government to identify correlations between movements in a company's stock price and the establishment of, or trades under, an insider's Rule 10b5-1 plan, and should expect the SEC to investigate suspicious or abnormal activity.
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