Lyle Roberts makes an interesting point in his 10b-5 Daily Blog in a post titled The Outset of the Fraud, which summarizes a recent federal court decision that illustrates the value of a properly established Rule 10b5-1 plan. Harrington v. Tetraphase Pharma., Inc. was a typical strike suit that generally follows any significant drop in a company’s stock price. However, the plaintiffs also alleged insider trading by two executives who had sold stock pursuant to a 10b5-1 plan. I’ll let Mr. Roberts’s blog post tell the rest:
If an individual defendant’s stock trading took place pursuant to a pre-determined Rule 10b5-1 trading plan that was entered into before the outset of the alleged fraud, the use of the trading plan may undermine any inference that the trades were “suspicious” for purposes of assessing scienter (i.e., fraudulent intent). As part of this analysis, however, does a court have to accept that the beginning of the class period constitutes the outset of the alleged fraud?
In Harrington v. Tetraphase Pharma., Inc., 2017 WL 1946305 (D. Mass. May 9, 2017), the plaintiffs claimed that the company “knew that the drug they were testing would fail long before that information was released to the public.” The alleged timeline was that the class period began on March 5, 2015, two of the individual defendants entered into Rule 10b5-1 trading plans on March 13, 2015, and the company became aware of the results of its clinical testing as of late April or early May 2015. In assessing the impact of the Rule 10b5-1 trading plans on its scienter analysis, the court noted that the plans “were executed before even Plaintiffs argue that defendants possessed results from the pivotal portion of the [clinical trial].” Accordingly, the court rejected the idea that it was forced to accept, for purposes of analyzing the impact of the trading plans, that the alleged fraud began at the beginning of the class period. Instead, the court concluded that the “reasonable inference from the alleged facts” was that the fraud began after the two individual defendants entered into their trading plans and, as a result, their subsequent trading was not suspicious.
This holding is important because it illustrates how executives’ sales of stock made (or begun) prior to a period of adverse public information and declining stock price can still be protected. We don’t want to encourage adverse public information or declining stock price, but we are in favor of protecting executives and directors.