Prosecuting Like Its 2007? New York Attorney General Brings Martin Act Insider Trading Action Against Former Public-Company CEO

Over the last several months, there have been a number of reports about a perceived drop-off in enforcement activity by the U.S. Securities and Exchange Commission, including in the area of insider trading. See, e.g., SEC Enforcement Actions Against Public Companies and Subsidiaries Drop by 30% in FY 2025 | Cornerstone Research. Some observers have speculated that state attorneys general may attempt to fill this perceived gap in enforcement.

Perhaps a sign of things to come, on January 15, the New York Attorney General filed insider trading charges against the former chief executive officer (the "CEO") of a biotechnology company. The NYAG alleged that, in early 2021, the CEO sold millions of dollars of company stock while he knew about non-public information concerning "serious and unresolved contamination issues" that his company was facing in manufacturing a COVID-19 vaccine. The NYAG simultaneously announced it had reached a resolution the biotechnology company itself based on the same facts.

As alleged, in October 2020, the CEO learned of the potential contamination issues and manufacturing problems with the vaccine. Around this same time, the CEO contacted his financial adviser and had his adviser develop a so-called "Rule 10b5-1" trading plan, which would allow the CEO to exercise stock options and simultaneously sell the acquired shares. The NYAG's complaint notes that, before this, the CEO had not implemented such a plan since 2016. Rule 10b5-1 plans are based on SEC Rule 10b5-1(c), which provides an affirmative defense to SEC insider trading charges where the trading at issue was pursuant to a pre-set "10b5-1" plan entered into by an executive. However, for the plan to be an effective defense, the executive must certify when entering into the plan (among other things) that he or she is entering into the plan in good faith and that he or she is not in possession of material non-public information ("MNPI").

After the CEO entered into the plan, in November 2020, the company continued to investigate the potential contamination issues but did not disclose them to the public. Following a 60-day "cooling off" period required by the trading plan, the CEO executed on the plan beginning in January 2021, and, as alleged by the NYAG, sold millions of dollars in company stock, all while the contamination issues remained under investigation and undisclosed. In February 2021, shortly after the CEO completed these sales, the company disclosed some information about the contamination problems, and its stock began a "steady decline from which," according to the NYAG's complaint, "it has not recovered."

The NYAG alleged the CEO violated New York's Martin Act, Section 352 of New York's General Business Law. The Martin Act forbids fraudulent practices in connection with the sale of securities, including, as alleged by the NYAG, trading of stock by company insiders in possession of MNPI.

Takeaways

• The NYAG's use of New York's Martin Act to prosecute insider trading is notable. On the books in New York since 1921, the Martin Act was used fairly sparsely until the 2000s and early 2010s, when it featured prominently in a number of major corporate investigations involving the NYAG during that era. Since then, it has (again) been used less frequently.
• Under the Martin Act, the NYAG need only allege (1) a misrepresentation or omission of material fact, and (2) falsity of that misrepresentation. Thus, unlike SEC Rule 10b-5, which the SEC uses to police insider trading, the Martin Act does not require intent, scienter, or reliance.
• It remains to be seen whether this case represents a harbinger of increased insider trading enforcement (and increased Martin Act enforcement more generally) by the NYAG.
• If the CEO chooses to litigate the charges, much of the action will presumably focus on when the information about the contamination, which developed over several months, became serious "enough" that it was "material" non-public information ("MNPI") and whether the representations the CEO made when he entered the 10b5-1 plan (such as he was not then in possession of MNPI) were false when made. Given that it also appears the company's in-house attorneys approved the CEO's 10b5-1 plan, the representations made and approvals given in those conversations (and related privilege) issues, will also likely be highly significant.
• At the same, from a compliance perspective, despite the different requirements of the Martin Act, the NYAG's action in this case involves a similar fact pattern to many SEC insider trading cases. In its resolution with the company, the NYAG required the company to amend its current insider trading policy to add a revised trading pre-clearance form, requiring that, before trading or entering a 10b5-1 plan, any board member or officer at the senior vice president above is certify that he or she is (i) aware of the company's insider trading policy, (ii) aware that it is unlawful to trade, or enter into a Rule 10b5-1 plan, while in possession of MNPI; (iii) is not in possession of or aware of any material information about the company that has not been publicly disclosed by the company in a widely disseminated press release or public filing with the SEC; and (iv) has considered whether they are aware of any material incident that has not been publicly disclosed.

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