A recently filed federal lawsuit accuses the publicly traded company K12 Inc. of misleading investors by putting forward overly positive public statements during much of last year, only later to reveal that it had missed key operational and financial targets.

The lawsuit also alleges that former K12 CEO Ronald J. Packard “reaped the rewards” of the bullish company projections by selling millions of dollars worth of stock in the months before an October announcement of disappointing news sent its stock price plummeting.

The legal action, filed in January in the U.S. District Court for the Eastern District of Virginia, is seeking class-action status. It says that Packard sold 43 percent of his personally held K12 common stock, for gross proceeds of $6.4 million, during those months, when the plaintiffs contend that the stock price was “artificially inflated.”

Lawsuits alleging that companies mislead investors prior to a sharp fall in stock prices, and that corporate executives benefit before those losses, are not uncommon. K12 officials and Packard declined an interview request, but in statements to Education Week, they strongly denied the claims laid out in the legal action.

“It is an unfortunate, but not unusual, practice for plaintiffs’ law firms to file class-action lawsuits against publicly traded companies who experience a drop in their stock price, and then attempt to solicit potential clients to join the class,” company spokesman Jeff Kwitowski said. “We remain focused on our mission to provide high-quality education products and services to the students, parents, teachers, and schools we serve.”

He also said that Packard had been forthright about his trading through his creation of a rule 10b5-1 plan, a type of document established by the U.S. Securities and Exchange Commission. Those plans establish a legal process through which a company executive makes stock trades in circumstances where inside information “was not a factor in the decision” to make transactions, by the SEC’s description.

Packard’s plan was designed to set the timing of his sales in advance and eliminate his discretion as to when shares were bought or sold, Kwitowski said, in keeping with SEC rules.

Kwitowski also said that the value of Packard’s stock sales was “significantly less” than the lawsuit claims, and that the idea that it represented 43 percent of his personally held common stock was off the mark, too. In addition, all of the shares Packard traded during that period and spelled out in the 10b5-1 plan were older options set to expire, he said.

In July, K12 settled a lawsuit brought by a group of investors, including the Arkansas Teacher Retirement System, for $6.75 million, a legal action that had claimed the company misled them about its academic results and business practices. K12 agreed to the settlement but denied the allegations.

A lawyer representing the plaintiffs in the new lawsuit, Stefanie J. Sundel, said the new legal filing was unconnected to the earlier case. She declined further comment on the lawsuit.

K12 is one of the biggest and most controversial names in for-profit education in the United States. The company, based in Herndon, Va., manages schools in 30 states with a combined enrollment of about 125,000 students, and it has lobbied aggressively over the years in state legislatures for policies allowing for expansion of online programs.

Packard’s resignation as CEO was announced by K12 in January of this year, according to a statement by the company.

But Trace A. Urdan, a senior analyst for Wells Fargo Securities in San Francisco, said that among professional investors, it was widely anticipated by mid-2013—the period targeted in the lawsuit—that management changes at the company were coming and that Packard was expected to be leaving the post.

In that context, Packard’s sale of stock was not unusual, and fit the profile of an executive leaving a top corporate position, said the analyst, who is asked to make independent evaluations of K12 on behalf of Wells Fargo’s investor clients.

In all likelihood, “his stock sale was more related to his impending departure from the company and the management team,” Urdan argued, rather than a desire to sell stock before bad news came to light.

Urdan did not think investors were likely to be rattled by the legal action—and that they would most likely expect it to get settled. Investors are likely to pay closer attention to K12’s performance, he argued, as judged by its ability increase student enrollment, and other factors.

October Disappointment

The new lawsuit has been brought by the Oklahoma Firefighters Pension and Retirement System. It cites a series of statements made throughout 2013 by company officials, including Packard and Nathaniel A. Davis, K12’s current CEO, voicing optimism about the company’s ability to grow.

For instance, Packard said in March 2013 that the “business-development environment” for K12 was “as good as we’ve ever had it,” according to the lawsuit. In August, Davis touted “significant marketing efforts” to enroll more students, according to the legal complaint.

But in an Oct. 8 statement filed with the SEC, K12 said that its fiscal 2014 revenue guidance was between $905 million and $925 million—lower than expectations—and that enrollment of students was also lower than expected.

Following those revelations, the company’s stock fell by 38 percent, to an eight-month low of $17.60, on Oct. 9, according to the lawsuit. As a result, the plaintiffs say they absorbed “significant investor losses.”

The plaintiffs claim that K12’s explanations that inadequate promotional efforts were partly to blame for underwhelming enrollment were at odds with earlier claims that strong marketing was underway. The lawsuit also contends that the company ignored other factors that should have indicated that it would miss its financial goals.

It is not unusual to see lawsuits filed by investors who allege misleading information was put forward by companies before a sharp drop in stock prices, said Jesse M. Fried, a professor at Harvard University’s law school. And in those cases, it helps the plaintiffs if they can show a major selling of stock by company executives before the stock price fell, he said.

The SEC instituted rule 10b5-1 plans in 2000 to establish policies that would deter insider trading while also giving company officials the right to prearrange trades that are not based on insider information.

Simply creating a 10b5-1 plan does not provide an absolute defense for company officials against insider trading, the SEC has said in explaining the policy. Those who file the forms must still meet various standards to show they acted properly. As the SEC has stated, the policy “permits persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith.”

But rule 10b5-1 plans have drawn criticism from those who say the process of creating and following them lacks transparency and does not offer adequate safeguards to prevent corporate executives from benefiting from inside information.

Critics note that 10b5-1 plans are not required to be filed with the SEC, and so the details of those plans often remain hidden.

K12 company documents filed with the SEC reference Packard’s 10b5-1 plan, and say that Packard’s sales transactions follow it. Kwitowski, the company spokesman, said K12 and Packard would not disclose details of Packard’s 10b5-1, which would amount to revealing “future trading plans.” Keeping that information private is consistent with practices of other companies, he added.

 Available Options

Many 10b5-1 plans are created for legitimate reasons, said Fried, the Harvard law professor, such as when an executive owns a lot of stock and wants to sell it, but is afraid of essentially becoming “locked up” with stock because of fears of being accused of insider trading.

But it is difficult to know whether executives build their plans to sell based upon knowing of negative inside information, he said. And in many situations, there is a good chance the details of 10b5-1 plans will never come to light, Fried said.

In and of itself, “the mere fact that stock sales are executed pursuant to a 10b-5-1 plan means absolutely nothing,” Fried said.

In lawsuits such as the one brought against K12 by the Oklahoma pension system, Fried added, the plaintiffs will typically try to get the details of the 10b5-1 entered into the record, to try to prove their case that investors were misled.

Kwitowski, in a statement, also said that all of the shares Packard traded during that period and detailed in his 10b5-1 plan were older options awarded to him years earlier that were set to expire, and that non-option K12 shares he owned were not sold, and not part of his plan.

Additionally, Kwitowski said that the value that Packard received from the stock sale were much less than the $6.4 million stated in the lawsuit, because of the cost of exercising the options.

Upon facing the expiration of stock options, stockholders typically have a number of alternatives that carry a variety of potential financial costs, said Barbara Baksa, the executive director of the National Association of Stock Plan Professionals, a membership association based in Concord, Calif.

It’s true that when the options expire, a stockholder would lose the right, or the option, to buy and then sell that stock, and the options would have no value, said Baksa. So an executive could go ahead and exercise the right to buy, and then sell the stock, as Packard has done.

Or, a shareholder could choose to exercise the options on the stock to keep a portion or all of it, Baksa said.

In either case, exercising the options “is a fairly expensive proposition,” she said, because of the costs of taxes, fees, and the price of purchasing the options.