Cover Charges

The mystery of Martha Stewart's crimes

When I first heard Martha Stewart was in legal trouble, I did not understand what she was supposed to have done that was so bad she might go to prison for it. After reading about the investigation, the indictment, and the trial that's wrapping up in New York, I still don't get it.

To begin with, the charges against Stewart are all based on an offense, insider trading, with which she is not charged. The government accuses her of plotting with her Merrill Lynch broker, Peter Bacanovic, to cover up an insider trade (conspiracy); lying to investigators about it (false statements to federal agents and obstruction of justice); and misleading investors by falsely proclaiming her innocence (securities fraud).

But Stewart is not charged with the act she allegedly covered up and lied about: the sale of 4,000 ImClone shares on December 27, 2001, shortly before the company announced that it had failed to get the Food and Drug Administration's approval for a new cancer medicine. The government says Stewart sold her ImClone shares because she knew ImClone CEO Sam Waksal and his daughter were selling theirs.

The prosecution's main witness was Bacanovic's assistant, Douglas Faneuil, who testified that he passed on the tip about Waksal (also one of Bacanovic's clients and a friend of Stewart) under his boss's instructions. Stewart and Bacanovic, who is being tried with her, insist she sold the stock because they had agreed she should once the price dropped to $60.

Stewart's attorneys have done a pretty good job of discrediting Faneuil, noting that he's an admitted liar, pointing out inconsistencies in his statements, arguing that aspects of his account are implausible, and suggesting that he is lying in exchange for the government's leniency. Still, I'm inclined to believe him, mainly because two of his friends testified that in January and April 2002 he told them essentially the same story: that Stewart sold her stock because she knew the Waksals were selling theirs, and that his boss was pressuring him to lie about it.

But it really shouldn't matter who is telling the truth. Let's say Faneuil did tell Stewart about the Waksals' panicked selling before she dumped her stock. Then she knew two important facts: The price of ImClone stock was going down, and the company's CEO was eager to unload it. The government's position seems to be that under these circumstances the law required her to keep the stock and take a bath.

In other words, the tip should have prevented Stewart from selling her stock, even if she would have done so without the "nonpublic information" about the Waksals. If benefiting from such a tip does not seem fair, neither does losing money because your broker is indiscreet.

Before the Stewart case, as Michael McMenamin pointed out in the October issue of Reason, "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 fact that such action is unprecedented helps explain the government's otherwise puzzling decision to allege insider trading in a civil suit against Stewart but not in her criminal trial.

In any case, as McMenamin also noted, the very concept of insider trading as a crime is suspect. Companies and exchanges may have good reasons for prohibiting officers such as Sam Waksal from trading stock based on privileged information and for punishing those who break that rule. Likewise, brokerages that want to keep their customers' trust will (like Merrill Lynch) have policies against revealing confidential information about them. But the need for criminal prosecution in such cases is not obvious.

That's all the more true of Stewart, who was at least two steps removed from the true corporate insider in this case and who, even by Faneuil's account, neither sought information about the Waksals nor told him to lie about the trade. Especially troubling is the charge of securities fraud, which Judge Miriam Goldman Cedarbaum dismissed on Friday. The charge was based on the premise that Stewart falsely claimed her ImClone sale was legal as a way of bucking up the stock of her own company, Martha Stewart Living Omnimedia.

Had this novel definition of securities fraud been accepted by the courts, any corporate officer charged with a crime would have risked additional charges if he were bold enough to deny the government's allegations. Such a threat could transform the right to remain silent into an obligation.