DOJ And SEC Charge Individual For Insider Trading Through Use Of 10b5-1 Trading Plans
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  • DOJ And SEC Charge Individual For Insider Trading Through Use Of 10b5-1 Trading Plans

    On March 1, 2023, the Department of Justice (“DOJ”) unsealed an indictment against the founder, CEO, and Chairman of a publicly traded health care company (the “Company”), alleging that he had illegally executed trades pursuant to Rule 10b5-1 trading plans while in possession of material nonpublic information.  The Securities and Exchange Commission (“SEC”) filed a concurrent civil suit against defendant for the same activity.  In each case, the government alleged that defendant improperly used his 10b5-1 plans by entering into them while in possession of material nonpublic information and triggering sales shortly thereafter, without any form of cooling-off period.

    Rule 10b5-1 allows corporate insiders to trade their own stock at a scheduled date without running afoul of insider trading laws.  When filing these 10b5-1 plans, the corporate insider is required to certify that they are not aware of any material, nonpublic information about the stock or issuing corporation, and that they are adopting the plan in good faith.  And historically, there has not been any formal cooling-off period required by Rule 10b5-1, meaning that an executive that enters a plan in good faith while not in possession of material nonpublic information could sell stock pursuant to such a plan promptly thereafter (even though best practice has generally been to wait a certain period between entering a 10b5-1 plan and selling stock).  While in December 2022 the SEC adopted new rules to amend 10b5-1 to require 90 to 120-day cooling-off periods (among other things, as discussed here), such rules were not in place when the defendant entered the trades at issue.

    According to the indictment, defendant allegedly avoided more than $12.5 million in losses by trading on material nonpublic negative information that the Company’s then-largest customer was planning to terminate its contract with the Company.  Defendant allegedly entered into his first 10b5-1 trading plan in May 2021 when the customer expressed concerns about continuing its contract, and then after defendant later learned that the customer informed the Company of its intent to terminate the contract, he allegedly entered into his second 10b5-1 trading plan in August 2021.  In each case, defendant allegedly began selling stock the next trading day, against the advice of two brokers who recommended that he wait for a cooling-off period.

    Defendant was charged with one count of engaging in a securities fraud scheme and two counts of securities fraud for insider trading by DOJ.  This is the first time the DOJ has charged an individual with insider trading based solely on the individual’s use of 10b5-1 trading plans, and it follows a series of news reports examining the extent to which executives trading pursuant to 10b5-1 plans timed sales effectively.  Assistant Attorney General Kenneth A. Polite, Jr. highlighted how DOJ analysts assessed trading data and SEC filings to detect “company insiders who greatly outperformed the market when trading pursuant to 10b5-1 plans.”  While the SEC’s recent rule amendments will likely further curb any risk of abuse, the DOJ’s action is a further reminder that the government will be analyzing trading patterns for any potential anomalies.
    Categories: 10b-5DOJInsider TradingSEC

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