St. Martha

Why Martha Stewart should go to heaven and the SEC should go to hell.

Michael McMenamin from the October 2003 issue

(Page 4 of 4)

According to the SEC, Douglas Faneuil, Bacanovic's assistant, who copped a plea in exchange for a misdemeanor slap on the wrist, advised Stewart, at the behest of Bacanovic, that the Waksals were selling their ImClone stock. In doing so, Faneuil (and allegedly Bacanovic) broke Merrill Lynch's customer confidentiality rule. Stewart asked Faneuil where the stock was trading. Faneuil said $58, and Stewart told Faneuil to sell her remaining ImClone shares (3,928 shares for close to $230,000). Stewart then left a message for Waksal at his office, subsequently summarized in a note from Waksal's secretary: "Martha Stewart. Something is going on with ImClone and she wants to know what."

The SEC started investigating ImClone within days of the FDA announcement on December 28, 2001. It first interviewed Bacanovic on January 7, 2002, and Stewart on February 4. Stewart and Bacanovic each told investigators that she unloaded her shares because of an oral arrangement they had to sell her ImClone shares at $60. Faneuil initially backed them up but later recanted, telling prosecutors there was no agreement. He said Bacanovic pressured and bribed him (with extra vacation and free airline tickets) to lie. As further proof of this cover-up, the Justice Department's indictment cites the fact that Bacanovic marked "@60" near the listing for Stewart's ImClone holdings in a blue ink different from the blue ink he used on a spreadsheet where he wrote down portfolio decisions for Martha's various holdings on December 20. The feds claim the different ink proves that he made the notation after December 27. Forensic experts say there is no way to tell when the "@60" notation was made.

The SEC also charges that prior to the initial February interview, Stewart temporarily changed an entry in her telephone log from "Peter Bacanovic thinks ImClone is going to start trading downward" to "Peter Bacanovic re: ImClone." Then she had second thoughts and changed the log back to its original form. This aborted tampering with evidence does not prove Stewart was guilty, but it does illustrate the uncertainty created by the government's murky insider trading rules.

The Real Insiders

A better approach would focus on actual wrongdoing rather than the perceived unfairness of unevenly distributed information. Insider trading should be regulated by existing criminal laws that prohibit industrial espionage and the theft of trade secrets and sensitive commercial information. Dennis Levine, for instance, could have been prosecuted for stealing proprietary information from his employer and selling it to Boesky. Ditto O'Hagan. At most, Foster Winans and Peter Bacanovic should have been fired for violating their employers' internal policies, not prosecuted or sued for insider trading.

Anything more should be left to the public companies and the stock exchanges on which their shares are traded. If companies want to permit or prohibit insider trading by their executives, let them say so publicly and let investors decide if they want to buy shares based on that policy. If a stock exchange believes insider trading damages investor confidence, it should require companies whose shares trade on the exchange to have rules against it.

The SEC does not want this to happen. Its prosecution of Ray Dirks for saving his clients from the Equity Funding fraud and its failure to sue Sam Waksal's daughter, father, and anonymous friends for their insider trading suggest why. The SEC does not care about protecting individual investors; insider trading has no effect on them anyway. It does not care about the integrity of the market or capital formation; insider trading has no effect on them either. The only people protected by SEC prosecution of the nebulous "crime" of insider trading are SEC lawyers and their allies, who can keep on inventing new definitions of the offense as they go along. Before suing Stewart, the SEC had never gone after the customer of a broker who offered his knowledge of what another customer had done as a reason to make a trade.

The Justice Department and the SEC don't care about the "fairness, efficiency, and integrity" of our capital markets. Letting Aliza Waksal keep her profits from insider trades proves that. The government lawyers want to enhance their own power and prestige. They don't care who they hurt in the process, such as the shareholders of Martha Stewart Living Omnimedia, who saw the company's value drop by over $400 million between December 2002 and August 2003.

What's worse, these government lawyers don't seriously expect to prevail at trial. Without a credible claim of insider trading against Stewart, the securities fraud charge based on her public (and truthful) denials of the government-leaked claims that she was guilty of insider trading will collapse. Martha will walk, and it will be a good thing. But she and her shareholders will have paid an unnecessary price. That's not a good thing. It's a disgrace. And a damn shame.