Commentary

Martha Stewart: Obstructing Injustice

Martha Stewart and her stock broker Peter Bacanovic have been indicted for “conspiracy to obstruct justice” and, what amounts to the same thing, to “make false statements.” In Ms. Stewart’s case, those same false statements also amount to “securities fraud,” since they supposedly kept her company’s stock from falling even further than it did in June 2002.

The name of the alleged criminal is the same as it was a year ago — Martha Stewart — but the alleged crimes are now entirely different. It used to be about insider trading. Now it’s about felonious fibbing.

The original accusation began as an Associated Press story the evening of June 6, and another in The New York Times on June 7, 2002. The story was leaked or planted by “people close to a Congressional investigation.” That story said “Martha Stewart, a close friend of the former chief executive of ImClone Systems, sold all her shares in the biotechnology company a day or two before ImClone announced an unfavorable ruling by the Food and Drug Administration.” This anonymous insinuation that Martha Stewart had been tipped-off by ImClone founder Sam Waksal appeared a week before Waksal was arrested and the House Energy and Commerce Committee held hearings on the subject.

The June 6 accusations of insider trading have now been officially repudiated, yet magically transformed into the basis for Martha Stewart’s indictment for securities fraud. She held 62.6 percent of the Class A shares in Martha Stewart Living Omnimedia (MSLO) on June 6, and still holds 61.4 percent. The government says she spent the rest of that month making “false and misleading statements” to prop up the price of her own stock. But what Martha Stewart was publicly accused of on June 6 was trading on information from a genuine insider, Sam Waksal. Today she is no longer charged with insider trading.

Her statements about having made a December 20 agreement with her broker to sell at $60 may or may not have been true. But they were not nearly as misleading to MSLO stockholders as the false accusations of insider trading by “people close to a Congressional investigation.” The fact that MSLO fell from $19.01 on June 6 to $11.47 on June 28 shows that congressional slander on June 6 really did mislead the markets while Martha Stewart’s countervailing efforts did not.

The whole idea that an ImClone outsider like Martha Stewart could be guilty of insider trading was always a stretch. Consider the facts. ImClone stock closed at $71.94 on December 6 and $70 on December 14, then started to slip. By December 15, short interest in ImClone reached 77 million shares — presumably bets that the company’s cancer drug Erbitux would not get FDA approval by the year-end deadline. It helps to keep those 77 million short sales in mind when contemplating the Feds’ monomaniacal obsession with Martha Stewart’s 3928 shares.

On December 27, ImClone stock opened at $63.49 and closed at $58.30. At 3:13 that afternoon, Bloomberg News cited an earlier CNBC report regarding ImClone falling sharply “on concern about whether or not the Food and Drug Administration will approve the company’s Erbitux cancer drug.” At the market’s close, CNBC’s Carl Qunitilla explained there had been “a lot of rumors that perhaps the FDS would return a refuse-to-file letter” (rumors confirmed the following day). ImClone investors didn’t need inside information to be worried by the afternoon of December 27. All they needed was a TV.

Martha Stewart was flying to Mexico that day but her plane stopped to refuel in Texas from 1:26 to 2:01pm eastern time. A brief call to her stockbroker’s assistant Douglas Faneuil at 1:39 resulted in the sale of her remaining 3928 shares for $58.43 — close to the low for the day. At 1:43 - after her stock had been sold — she left a phone message for Sam Waksal: “Something is going on with ImClone and she [Martha] wants to know what.” Phone records prove the call was not returned. The fact that she was trying to find out what was “going on” with ImClone after she sold her shares suggests she had not been told about the FDA problem by Waksal (the original leak) or by Faneuil (the latest charge). Faneuil now says he did tell her the Waksal family was selling, but he got off with a wrist slap for switching to that story. We all know Faneuil lied at least once; we just don’t know when.

On January 18, the Chairman of the House Committee on Energy and Commerce, Louisiana Republican Billy Tauzin, sent a letter to Waksal and others claiming, “many observers were stunned to learn that on December 28, 2001 the FDA had issued a ‘refuse to file’ (RTF) letter in response to the ImClone submission.” Actually, the market was already stunned by the very public anxieties and rumors reported by CNBC on December 27. ImClone stock dropped 8 percent on December 27, 5 percent on the 28th and 18 percent on the 31st. ImClone’s steepest drops occurred in early January as more details about the FDA letter were disclosed. Ironically, the stock has soared lately because of new evidence that the FDA made a literally fatal error by thwarting Erbitux in December 2001.

A year ago, it was easy to accuse Martha Stewart of insider trading through anonymous press leaks. It would be much more difficult to prove such charges to a jury. Regardless of continued press rumblings about this indictment being part of some “insider trading scandal,” it is not. Martha Stewart is simply charged with not telling the truth about the reason why she conducted a perfectly legal sale of ImClone stock.

The bulk of the indictment rests on the deal Mr. Faneuil made to get off the hook by changing his testimony. He now says his boss Peter Bacanovic instructed him to tell Martha Stewart that the Waksal family tried to sell nearly 120,000 shares at the market’s opening on December 27. If so, that was a violation of Merrill Lynch policy about the privacy of client information. The “crime” here is that because Martha Stewart was a stock broker thirty years ago she should have known that the sales of Waksal shares had been” communicated to her in violation of the duties of trust and confidence owed to Merrill Lynch and its clients.” Bacanovic and Faneuil are accused of doing something unethical. But what is merely unethical for them can scarcely be illegal for Stewart.

Bacanovic had testified that Stewart told him in a phone call on December 20 to sell if ImClone dropped to $60 (the low between the 20th and 27th was $61.20 on the 20th). The indictment asserts, “this statement is false,” apparently because Faneuil says it is false. Other supposedly misleading statements have to do with Stewart and Bacanovic suggesting they had talked on December 27 when the conversation was actually with Faneuil. So what? Failure to disclose the motives for a perfectly legal transaction does not automatically convert legal into illegal.

Obstruction of justice surely suggests obstructing the SEC from charging someone (other than Waksal) with insider trading. But neither Bacanovic nor Stewart are charged with insider trading, so for whom was justice obstructed?

The charge of misleading information just repackages the same story. The idea of abusing this particular statute first appeared in a September 22, 2002 letter to Attorney General Ashcroft from Rep. Tauzin and three ranking committee members. The four congressmen felt misled by the fact that “Ms. Stewart repeatedly has refused to be interviewed by Committee staff and her attorneys have stated that would invoke her Fifth Amendment right not to testify.” Perhaps the indictment will now make them feel better about such uppity constitutional defiance.

Martha Stewart says she sold ImClone because the stock had dropped from $72 to $58 in a couple of weeks rather than because of Mr. Faneuil’s misdemeanor tip. The indictment says she did get a lukewarm tip, but there was not insider trading involved. On this and this alone the government has managed to accuse Martha Stewart of three victimless “crimes,” not one of which has anything to do with the original, fraudulent accusation that she traded on inside information from Sam Waksal. This looks more like a desperate way for her original accusers to save face than a serious effort to protect any real people from any real crimes.

Alan Reynolds is a senior fellow at the Cato Institute.