By Covering Business May 15, 2012
By Julia Leite
Columbia Journalism School ’12
On December 27, 2001, media mogul and celebrity homemaker Martha Stewart sold her stake in the biotech company ImClone. Two days later, the company’s stock dropped 16 percent when the Food and Drug Administration said it had rejected the ImClone’s main drug, Erbitux, for cancer treatment. Stewart had owned 4,000 shares of ImClone. By selling just before the FDA’s announcement, she avoided losses of $45,673, a tiny fraction of her net worth, which Forbes had estimated at $700 million just six months earlier. However, that trade would end up being one of the defining actions of her career – and the one that landed her in a federal prison.
Stewart was not the only ImClone investor who avoided heavy losses ahead of the FDA’s decision. On the same day she placed her trade, Sam Waksal, ImClone’s chief executive, had sold a $5 million stake, along with his daughters’ full holdings in the company.
For regulators, catching Waksal for insider trading was simple. A CEO selling a large block of his company’s stock just days before a significant regulatory announcement is an obvious red flag. Waksal himself said later in an interview with “Dateline” that his case was easy and that “the Securities and Exchange Commission had me.”
Stewart’s case was more complicated. She had made a timely sale, but that wasn’t enough to accuse her of insider trading. To do that, the government would have show Stewart traded while in possession of information that was nonpublic and material – something that is not widely known and that a regular investor would consider important in making a decision about a trade.
Of course, Stewart wasn’t exactly a regular investor. She was a friend of Waksal, which could have meant he had told her about the FDA’s decision and that she had sold her stock based on that information. But Waksal hadn’t told her about the decision. He hadn’t spoken to Stewart at all that day.
There was another link between Stewart and Waksal. They shared the same broker at Merrill Lynch, Peter Bacanovic. Although neither Bacanovic nor his assistant, Doug Faneuil, knew about the Erbitux decision, both knew that Waksal was trying to dump his stock. And they warned Stewart about it.
That Stewart knew Waksal was selling his stock but not the reason behind the sale complicated the insider trading case against her. Knowing about the FDA decision would qualify as nonpublic and material. Just knowing the CEO was trying to sell $5 million worth of his shares was nonpublic information, but on its own, would it have made a difference to a run-of-the-mill investor? For the SEC, the answer was yes. The agency requires insiders like CEOs to disclose trades of company’s stock to the public.
For the SEC to build an insider trading case against Stewart, it also would have to show that her transaction violated some duty to refrain from trading on the information in question. Stewart did not have such a duty herself. She wasn’t on the Imclone board of directors and had no official ties to other insiders like Waksal. She had merely traded on a tip. However, she knew Bacanovic had breached his duty as a broker when he told her about Waksal’s trades.
The nuances in Stewart’s case ultimately drove the government to back down from charging her with insider trading. Instead, it focused its case on the lies she told to cover the trade. When questioned by the SEC and the FBI in the months following her trade, Stewart said she had no knowledge of Waksal’s trade and that she had sold on a standing agreement with her broker to sell if shares traded below $60. Bacanovic corroborated the story, but his assistant Faneuil eventually came forward and revealed the truth, furthering the case against Stewart. Later, Stewart’s own assistant, Annie Armstrong, testified that Stewart had tried to change a record of Bacanovic’s phone message to her about ImClone.
To the jury in Stewart’s trial, it seemed clear she had lied. “This is a woman who pays attention to details… I mean that’s her life, to pay attention to a lot of details. And she knew what was going on with her portfolio,” jury member Rosemary McMahon said in an interview with “Dateline” in 2004.
The defense argued that Stewart was too rich to worry about a few thousand dollars and that she and Bacanovic were too smart and sophisticated to make such obvious mistakes and get caught, but that argument failed to convince the jury.
“We thought there was going to be more from the defense,” Jonathan Laskin, another jury member, told “Dateline.” “We almost were hoping they would put up more of a fight or something or give us more to chew on, but it wasn’t there.”
Stewart was sentenced to five months in prison, plus five months of house arrest and two years of probation for lying, obstruction of justice and conspiracy. Bacanovic was also found guilty on all charges, except forging a document as proof of the stop-loss agreement he had claimed to have with Stewart.
It could have been worse. The U.S. attorney had also charged Stewart with securities fraud, claiming she had defrauded investors in her own company by repeatedly stating she was innocent. Securities fraud carries penalties of up to 20 years in jail. Stewart was fortunate the judge dismissed those charges.
Insider trading, the charge ultimately dropped by the government, also carries a maximum penalty of 20 years in prison.
With so much evidence and a jury so convinced of the guilt of the defendants, it is not clear why the government did not charge Stewart with insider trading. The government had proven Stewart had material, nonpublic information about the company and that she had traded her Imclone shares based on that information.
The government had also made the case that Stewart knew she was doing something wrong. First, long before she became America’s most famous homemaker, Stewart had been a broker herself, so she knew Bacanovic couldn’t inform her about what his other clients were doing. Second, she would not have had a reason to lie if she thought it was a cookie-cutter trade.
One reason the government may have backed off is that the U.S. attorney’s office may not have wanted to risk setting a bad precedent for other insider trading cases based on tips. There was also no clear precedent for Stewart’s case, so charging her with insider trading would have meant testing new boundaries of the law.
The extra media attention also could have helped Stewart dodge the extra charge. Stewart was an A-list celebrity, and the trial would be highly publicized and scrutinized. The U.S. attorney may not have wanted to risk an unusual case under those conditions. One of the defense’s arguments was that Stewart was being prosecuted only because she was a celebrity and that the prosecutors wanted to make their careers by taking her down. In fact, Stewart’s celebrity may have worked to her advantage, leaving prosecutors and the U.S. attorney’s office more reticent in building their case.
Although the Justice Department decided not to charge Stewart with insider trading, the SEC pursued a case against her. At the time, Stephen M. Cutler, the SEC’s director of enforcement, said “it is fundamentally unfair for someone to have an edge on the market just because she has a stockbroker who is willing to break the rules and give her an illegal tip.”
Without admitting or denying the accusations, Stewart settled with the SEC in 2006, agreeing to pay a fine of $195,000 (four times the amount she had avoided in losses on ImClone’s stock, plus interest) and stepping down as director of her company for five years. Bacanovic also settled, paying a little more than $75,000 in penalties.
Lying to avoid losses of $50,000 – 0.007 percent of her estimate fortune – ended up costing Stewart much more. Although she made a comeback after her prison term, her incarceration remains a stain on her illustrious career. And had she been charged with insider trading and not just covering it up, the stain could have been much worse. For Sam Waksal, an insider trading conviction meant seven years in prison.
“Never break the law. Never lie to the U.S. government,” Waksal said on “Dateline.” “And if you’ve broken the law, don’t talk to the U.S. government.” That advice could have saved Martha Stewart from a forced hiatus. Instead, she had to learn from prison that even if the government doesn’t charge you for breaking securities laws, it does not appreciate being lied to.
This article was written for the Columbia Journalism School’s seminar on business journalism in the spring of 2012.