Trading Places: The SEC’s Crackdown on Insider Trading Continues
By Jeff Johnston and Tom Mitsch
Over the last several weeks, federal regulators and prosecutors have sent a strong signal to company executives that they will be using every tool in their arsenal to combat insider trading. The government’s crackdown has targeted a variety of trading activities, including those done through a Rule 10b5-1 trading plan, which many have traditionally considered to be a safeguard against insider trading claims.
As part of this push against insider trading, the Securities and Exchange Commission (“SEC”) announced charges against three different sets of insiders under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
First, on February 23, 2023, the SEC announced charges against two cousins, Andrew and Gary Stiles for trading in the stocks of Eastman Kodak Company (“Kodak”) and Novavax Inc. (“Novavax”) based on nonpublic information related to both companies’ planned government partnerships to assist in the fight against COVID-19 at the height of the pandemic. The SEC alleges that Andrew Stiles obtained material, nonpublic information about Kodak’s efforts to obtain funding from the federal government to produce supplies necessary to respond to the COVID-19 pandemic through his employment with a third party medical supply chain company that was assisting Kodak. Stiles obtained the material, nonpublic information before the government’s consideration of funding Kodak’s efforts became public. Based on this material, nonpublic information, Andrew Stiles allegedly purchased more than 95,000 shares of Kodak stock and tipped his cousin, Gray Stiles, who purchased more than 45,000 shares ahead of the public announcement in July 2020. After the announcement of the loan, Andrew Stiles and Gray Stiles sold their Kodak shares for more than $1.5 million in total profits.
Similarly, the SEC alleges that, while working as a consultant to Novavax, Andrew Stiles purchased 1,844 shares in Novavax while possessing material non-public information regarding the company’s efforts to secure funding to manufacture a COVID-19 vaccine. Based on this trading, the SEC alleges Andrew Stiles received more than $45,000 in profits.
On the same day, the SEC also announced charges against two other individuals, Kevin Van de Grift and Gil Friedman, based on allegations that they had traded on material, nonpublic information prior to the April 9, 2018 public announcement that private equity firm Francisco Partners Management, L.P. (“FPM”) agreed to acquire payment systems company Verifone Systems, Inc. (“Verifone”). Specifically, the SEC alleges that, Friedman, a former FPM consultant, tipped his friend and day-trader Van de Grift off to the impending acquisition of Verifone. Van de Grift then allegedly purchased 60,000 shares of Verifone and sold them for a profit of around $300,000 the day after the announcement.
And, on March 1, 2023, the SEC announced insider trading charges against Terren S. Peizer, Executive Chairman of the Santa Monica, California-based healthcare treatment company Ontrak Inc. (“Ontrak”) for allegedly trading in Ontrak stock based on material nonpublic information related to the company’s largest customer. As with the charges levied by the SEC against executives of Cheetah Mobile Inc. last September, the SEC found Peizer engaged in insider trading even though all of the trades in question were supposedly made pursuant to a Rule 10b5-1 trading plan.
The SEC alleges that, in March 2021, Ontrak’s then-largest customer had notified Ontrak that it would be terminating its contract effective June 26, 2021. Around the same time it also learned that its next largest customer was also dissatisfied with Ontrak’s service and considering terminating its contract With this knowledge, the SEC claims that Peizer established a Rule 10b5-1 trading plan in May 2021 and sold nearly 600,000 of Ontrak shares worth more than $19.2 million. The SEC’s complaint further claims that, when Peizer learned that the second customer was, in fact, going to terminate its contract, he proceeded to adopt a second Rule 10b5-1 trading plan and sell another 45,000 shares of stock worth more than $1.9 million.
When Ontrak announced on August 19, 2021 that the customer had terminated the contract, Ontrak’s stock price predictably fell more than 44 percent and, as a result, the SEC complaint alleges, Peizer avoided more than $12.7 million in losses by executing the two trading plans. SEC Director of Enforcement Gurbir S. Grewal explained that “Peizer, armed with inside knowledge, avoided millions in losses that ordinary investors suffered. That’s insider trading, even when the trading is done through a 10b5-1 trading plan.” The SEC specifically alleged that Peizer hired a broker to implement the 10b5-1 plan and execute the trades based on the fact that the broker would not require a cooling-off period — a period of time between the date that a trading plan is adopted and the date of the first transaction to be executed under the plan.
In addition to the permanent injunctions, civil penalties, and officer-and-director bars which the SEC is seeking in all three cases, Andrew Stiles, Gary Stiles, and Peizer have also been indicted by the United States Department of Justice (“DOJ”) for the same allegedly fraudulent insider trading schemes. If convicted, they face maximum penalties of 25 years in federal prison
Assistant Attorney General Kenneth A. Polite, Jr. explained that the DOJ’s “groundbreaking insider trading indictment demonstrates that the Department of Justice, together with our law enforcement partners, will not allow corrupt executives to misuse 10b5-1 plans as a shield for insider trading.” Assistant Director in Charge Donald Alway of the FBI Los Angeles Field Office added that “The FBI and our partners are committed to holding insiders accountable at all levels, including those who act in bad faith when establishing trading plans in order to evade regulations,” because “Americans must have trust in the marketplace and that can only be achieved when offenders who violate their obligations are held responsible.”
These charges come at the same time as new SEC rules became effective further restricting insiders ability to use Rule 10b5-1 trading plans by imposing a cooling-off period of 90-120 days before insiders may trade company stock. SEC Chair Gary Gensler has explained that these reforms were enacted to “help build greater confidence in the market” because “[a]cademic research has identified abnormal returns for company insiders trading under 10b5-1 plans, particularly when those trades are close in time to the adoption of the plan.” Grewal further explained that “the SEC remains committed to investigating such abuse and holding bad actors accountable” because “[f]ew things undermine trust in the markets more than insiders abusing their positions for personal advantage.” As a result, it is clear the SEC and DOJ have placed an emphasis on cracking down on insider trading moving forward and any insiders considering trading in company stock must be certain that they do not possess material nonpublic information.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.