Insider-Trading Cases Once Deemed Too Hard to Crack Are Now Targets of U.S. Government
New enforcement actions focus on executives who used prearranged trading plans
The Justice Department and the Securities and Exchange Commission are hunting for a new type of insider-trading case, one that once seemed too daunting for regulators and prosecutors to touch.
What distinguishes the new targets is the use of prearranged trading plans, which chief executives and other officers of public companies have historically used to insulate themselves from accusations of insider trading. Executives set up the plans, often with the advice or approval of a company lawyer, and put their often lucrative sales of company stock on autopilot.
The plans provided a shield from regulatory or legal trouble as long as the executive didn’t have material nonpublic information when the plan was implemented. Regulators who wanted to question the trading would need to show that an executive had market-moving, undisclosed information and intended to trade on it at the time he or she set up the plan.
The SEC first permitted such plans through a regulation passed in 2000 and known as Rule 10b5-1. Over the next 20 years—in 2004, 2010 and 2012—regulators brought only three insider-trading cases involving a 10b5-1 plan.
The regulatory agency has now brought two in the past six months, including one on Wednesday accusing Ontrak Inc. chief executive Terren Peizer of trading illegally under 10b5-1 plans in 2021, when he was aware of negative news for his company involving the loss of a major customer, which hadn’t yet been divulged to shareholders. Another public company, Los Angeles-based HyreCar Inc., has disclosed criminal and SEC investigations into stock trades involving 10b5-1 plans.
A lawyer for Mr. Peizer said Wednesday that his client, who remains Ontrak’s largest shareholder, is innocent and that the government “has clearly overreached.” The lawyer, David Willingham of King & Spalding LLP, declined to comment further on Thursday.
The 10b5-1 regulation had loopholes, such as the ability of executives to create plans and immediately start selling, including before earnings announcements, according to academic research.
SEC Chair Gary Gensler has called the measure “antiquated, exposing real gaps in our insider-trading enforcement regime.” However, a lawyer for the company often signs off on a 10b5-1 plan, giving the executive a defense against claims that he or she was aware that trading could be deemed illegal. The lawyer’s involvement creates a hurdle for the SEC or Justice Department to acquire more evidence, since attorney-client privilege doctrine generally shields those communications from the government.
The inquiries “are difficult because there are a lot of thorny privilege issues and other issues that make these investigations more difficult than your typical investigation,” SEC Enforcement Director Gurbir Grewal said in an interview this week.
Mr. Grewal said that regulators had “seen a lot of abuse” of 10b5-1 plans, motivating their decision to update the rules last year. But the new rules, which include restrictions such as a “cooling off” period during which executives can’t trade, won’t stop regulators from looking backward for instances in which executives may have misused trading plans, he said.
The Justice Department also charged Mr. Peizer criminally. Assistant Attorney General Kenneth Polite Jr., head of the DOJ’s criminal division, said in a speech Friday in Miami that prosecutors discovered Mr. Peizer’s trades using data analysis. It is the first time the department has criminally charged an insider-trading defendant who used a 10b5-1 plan, officials said.
“So take note,” Mr. Polite said. “Because I expect other such cases will follow.”
A unit within the fraud section, known as Market Integrity and Major Frauds, has used advanced data analysis in the past to spot and prosecute manipulative trading in other markets, including commodity futures.
The SEC said on Wednesday that it found Mr. Peizer’s trades through its own data-driven initiative that examines executive trading pursuant to 10b5-1 plans.
Mr. Peizer, 63 years old, is a former trader at investment bank Drexel Burnham Lambert Inc., who received immunity from federal prosecutors in the late 1980s for cooperating with their investigation of junk-bond king Michael Milken.
Prosecutors and regulators said Mr. Peizer was aware at the time he set up two trading plans that Cigna Corp. , a customer of Ontrak, was about to end its relationship with the company.
Mr. Peizer’s trading under the plans allowed him to avoid losses of over $12 million, according to the federal grand jury indictment returned against him.
In September, the SEC sued Cheetah Mobile Inc.’s chief executive and its former president, claiming they jointly established a 10b5-1 plan after learning about a significant decline in advertising revenue from the company’s largest advertising partner.
HyreCar, which rents cars to drivers for ride-share and delivery services, said in December that it received a grand jury subpoena stemming from a federal criminal investigation into 10b5-1 plans and 2021 stock trades by company executives, including its then-CEO Joseph Furnari and his brother, Michael Furnari, its then-chief business development officer. HyreCar said it also received a subpoena from the SEC related to stock trades.
According to regulatory filings, the Furnari brothers each sold about $5.2 million of HyreCar stock at roughly $17 per share in July 2021, not long before the company’s stock fell about 50% in one day after it announced poor results for the quarter ended June 30, 2021.
The company said in January that it had terminated both Furnaris. This week it filed for bankruptcy protection. The Furnaris couldn’t be reached for comment. HyreCar said, “We are fully cooperating with the investigations, but we have a policy of not commenting on ongoing investigations.”
The Wall Street Journal in June 2022 published an investigation into stock sales by insiders who used 10b5-1 plans, showing that those who sold within 60 days of adopting such a plan often had good timing, on average selling before a downturn in the company’s stock price.