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Martha Revisited: Why the Stewart Case Needs a Second Look

by , Editor Emeritus , Free Liberal

Martha Stewart. Say the name and it tends to evoke a wide range of reactions:

“Martha’s a greedy, rich woman who thought she was above the law. She got what she deserved.”

Or: “Martha’s a strong, independent woman who is the victim of sexist selective prosecution.”

Or: “Martha did nothing wrong. Insider trading is not a real crime. The SEC, Justice Department and Congress are all envious socialists who want to control entrepreneurs like Martha. They couldn’t even get her on ‘insider trading,’ that’s how weak their case was.”

Is it possible that, in some ways, all of these reactions are correct? Could it be that the law is inappropriate, the prosecution selective and disproportionate, and, yet … what Martha did was also a mistake, one which it is appropriate to forbid and penalize in some form? In a word, yes.

This author’s perspective on the Stewart case may be a bit different from most. At root, the situation she found herself in is one that I have great familiarity with. Prior to my current career as a private investor, I worked as an investor relations executive for publicly traded companies.

I was frequently in possession of what is called “material, nonpublic information.” That is, I knew about financial, operating or merger and acquisition (M&A) information before the public did, in the form of news releases or SEC filings. I knew about developments in the companies I worked for, and for other companies, as I was “in the loop” on potential M&A deals, for example.

As a matter of personal integrity, I never traded on this information even if I could have “gotten away” with it. For “getting away” with it meant that I put myself “above” the investing public, whom my job was to be a fair “information broker.” How can one— in good conscience— trade on material, nonpublic information on the one hand, and on the other fairly represent information to the public about my own company? In a sense, not trading on material, nonpublic information is a manifestation of the Golden Rule.

At the end of the day, that’s exactly what Martha appears to have done: Traded on material information the public did not have. Indeed, she traded on the information that Sam Waksal, then founder and CEO of Imclone, was selling some of his family’s stake in his own company.

Stewart, who was personal friends with Waksal, had the same stockbroker as Waksal did. Her Merrill Lynch broker Peter Bacanovic (through his assistant Douglas Faneuil) told her that Waksal was selling. Stewart asked if there was any news that would account for Waksal to be selling. There was none. Stewart called Waksal herself to find out if “Something is going on with Imclone and she wants to know what.”

Waksal was a classic abusive insider trader. Armed with the information that his product had flunked an FDA test, he sold. He “got while the getting was good.” While one is loathe passing judgment on Waksal, this appears to be the act of a coward. Rather than allow his stock to take its lumps in the marketplace, Waksal abused his position of having advance warning about negative news, and he sold. Perhaps he panicked, overriding what his conscience would otherwise have dictated.

In this writer’s opinion, what Waksal did was to effectively defraud other investors. Waksal was paid a handsome salary for his job. Part of his job was to ensure to his investors— the owners of his corporation— that the information in the public domain had integrity. His salary was NOT paid to him to manipulate the information flow for his personal gain. It’s a fundamental fiduciary responsibility of Waksal’s, and he failed.

Enter Martha. Waksal’s trading was brought to her attention. Let’s recall that Martha had not just fallen off a turnip truck. She was a highly sophisticated person in the ways of Wall Street. Not only was she Chairman and CEO of a publicly traded company, Martha Stewart Living Omnimedia, but she was on the Board of Directors of the New York Stock Exchange. And she was a former stockbroker to boot.

There is, quite simply, no credible way that she did not know the rules for material, nonpublic insider trading. Granted, she may well have panicked, and simply did not act according to her conscience.

To be fair, Stewart’s defense was that she and her broker had a pre-assigned price that she wished to sell Imclone at (a stop loss). Apparently the brokerage firm she used— Merrill Lynch— did not allow for stop-loss orders on NASDAQ-listed stocks. However, given the facts that her broker told her about Waksal trading; that she called Waksal at the time she was selling her Imclone shares to ask what was going on; and that— while there was a questionable “informal” stop loss arrangement for Imclone at $60— the Merrill Lynch broker assistant Faneuil called Martha with the news that Waksal was selling when the stock was $58. In other words, had there really been a stop loss, the broker should have simply sold the shares. There was no need to gain Stewart’s approval.

Further, there was certainly no need to inform Stewart that Waksal was selling. Faneuil testified that there in fact was no stop loss; that stop loss had been an after-the-fact fabrication by his boss Bacanovic to rationalize this unseemly trade on material, nonpublic information. To this observer, Faneuil’s testimony is highly plausible and credible. Apparently the prosecution and jury saw it that way, too.

Martha’s mistake was huge. She not only ended up in prison, but her own company’s value plummeted. With the spotlight on her, old bits of news about her were brought front-and-center: that she could be a vicious and vengeful employer, screaming at employees for performance that displeased her. That she was highly contentious with her neighbors in both Westport, CT and in her vacation home in the Hamptons, wrapped up in lawsuits and disputes over various subjects. And more. Could it be that the universal truth “what goes around, comes around,” approximated a rough justice for Martha?

Of course, “redemption” is always possible. As of February 2005, when this article is written, Martha’s company’s value has bounced back to its all-time highs after it had fallen roughly 75 percent on the news of the Imclone affair. And now Martha will have her own reality TV show, modeled on The Apprentice starring Donald Trump, another Phoenix-like businessperson.

In many ways, this writer has great compassion for Martha. Although very financially secure— she behaved, at least, in ways that suggest she was a deeply unhappy person. Of course, we cannot know what was going on in her head. One suspects that her widely reported “perfectionism” got the best of her, overriding her better judgment when presented with the Waksal Imclone stock sales information. In her heart, were she to able to do it all over again, one suspects that Martha would not have made that trade. In retrospect, she might have fired her broker for putting her in a compromising position in the first place.

What’s it all mean? What Sam Waksal did was beyond the pale. This author’s view is that sending him to jail was counterproductive. Surely stiff fines and disbarment from involvement in publicly traded companies would seem perfectly appropriate. Martha’s Merrill Lynch broker Bacanovic and his assistant Faneuil seem to have gotten their just desserts, more or less.

And Martha? It’s frankly absurd that she’s had to do jail time. Her “crime” was minor. By resisting justice, Martha brought on herself further (temporary) agony, including the negative effects on her own stock, Martha Stewart Living Omnimedia.

The “insider trading” laws as currently structured are nonsensical. From an economic point of view, actual financial damages are extremely difficult to prove. The damage is done to the system as a whole, as Stewart and Waksal took advantage of information that they ought not have either had (in Stewart’s case) or used (in Waksal’s). They made mistakes. We all make mistakes. They should rectify those mistakes, and there should be punitive penalties to dissuade future Stewarts and Waksals.

In a sense, Waksal is the thief. Bacanovic is the fence, trafficking in Waksal’s ill-gotten gains. Stewart is the buyer of stolen goods, apparently knowing, at least, that the property was “hot.”

While “theft” is directionally accurate, what Waksal did wasn’t exactly stealing. Instead, it was far more like a contract breach— a contract with his shareholders and with the general investing public. As a practical matter, of course, the general investing public simply could not know what Waksal did, or Bacanovic, or Stewart.

A more optimal solution for “insider trading” on material nonpublic information could be for it to be a matter for the public markets to enforce. The NYSE and NASDAQ could use their many private powers to ensure that trades likes Waksal’s, and then Bacanovic’s tipping of Stewart, and then Stewart’s, were not conducted without consequences. The investing public— and even non-investors— benefit from an information flow that has integrity. Rather than jail time, stiff penalties and disbarment from involvement in publicly traded companies seem far more appropriate and proportionate in these circumstances.

In the meantime, the SEC and Justice Department— with all their flaws— will have to suffice to deter the next Waksal/Bacanovic/Stewart case. One or two cheers for that. Free markets should not be built on fraud, or those who condone or benefit from fraud.


Free Liberal editor Robert Capozzi
Robert Capozzi is one of the stone-cold soldiers of hip-hop, and a private investor from New York.