When company executives sell their shares at inflated prices due to misrepresentations, it often suggests a motive to commit fraud. In securities fraud cases, defendants frequently use “trading plans” established under Rule 10b5-1 of the Securities Exchange Act to counter such accusations. These plans create predefined transaction schedules to deflect allegations of suspicious trading activity.
The validity of this defense came under scrutiny in light of a June jury verdict against Terren Peizer, the former CEO of Ontrak Inc., who was convicted for insider trading. The Securities and Exchange Commission’s recent regulatory updates also demand more detailed disclosures regarding trading plans, reflecting growing concerns over their potential misuse.
Rule 10b5-1 permits corporate insiders to set a schedule for selling shares, which is often used in private securities litigation to counter allegations that insiders manipulated share prices for profit. Defendants argue that sales under these plans are prescheduled and not suspicious. However, as recognized by courts, these plans can be strategically amended to exploit inflated stock prices or insider information, as evidenced by a 2021 ruling in the Southern District of New York.
The case of Peizer illustrates how insiders might misuse trading plans; according to a press release, Peizer set up Rule 10b5-1 trading plans to sell shares before adverse news became public, concealing that he was trading on insider information. This emphasizes the need for courts to closely examine these plans before dismissing allegations of fraudulent motive.
The SEC’s late 2022 rule changes demand enhanced transparency, including disclosing trading plans and their terms. This should empower securities fraud plaintiffs to examine whether a trading plan’s existence genuinely negates a fraudulent motive. Enhanced disclosures also facilitate scrutinizing whether trading plans were entered into or altered in proximity to alleged misrepresentations, suggesting possible fraud.
Existing case law, which predates the 2023 disclosure requirements, often treated the existence of a trading plan as a defense against motive. Plaintiffs’ counsel should now utilize the newly required disclosures to investigate whether trading plans were employed strategically to capitalize on inflated stock prices. For example, the US Court of Appeals for the Tenth Circuit noted in a 2022 case that knowledge of a trading plan’s schedule could still motivate executives to make misrepresentations to benefit from pre-scheduled sales.
Courts should consider these factors when assessing the defense of trading plans, given their potential for abuse, to ensure that the mere existence of such plans does not negate an inference of motive to commit fraud.
For the original detailed argument, you can refer to Bloomberg Law’s article: Judges Should Scrutinize Trading Plans’ Use as Fraud Defense.