Develop the argument that Martha Stewart was not really in possession of inside information that was disclosed in a breach of fiduciary duty. How does her case differ from the insiders at Texas Gulf Sulphur or from other outsiders who have been convicted of insider trading? What specific features of the information that she obtained make her case different from those of convicted insider traders? Review and comment on at least two classmates’ responses. 200 – 500 words
Case: Martha Stewart: Inside Trader?
On December 27, 2001, Martha Stewart was en route with a friend from her home in Connecticut to a post-Christmas holiday in Mexico when her private plane landed for refueling in San Antonio, Texas.802 While standing on the tarmac, she listened to a telephone message from her assistant, Ann Armstrong, reporting a call from Peter Bacanovic, her stockbroker at Merrill Lynch. The message relayed by her assistant was brief: “Peter Bacanovic thinks ImClone is going to start trading down.” Stewart immediately returned the call, and at some point during the 11-minute conversation was put through to her broker’s office at Merrill Lynch. Bacanovic was on vacation in Florida, and so she talked instead with his assistant, Douglas Faneuil. Faneuil later testified that, on orders from Bacanovic, he told Stewart that he had no information on the company but that the Waksal family was selling their shares in ImClone. Although Stewart denied being told this, she instructed Faneuil to sell all of her ImClone stock. Her 3,928 shares sold within the hour at an average price of $58.43 a share, netting her approximately $228,000. Stewart then made one more phone call, to Sam Waksal’s office, leaving a message that Waksal’s secretary scribbled as “Martha Stewart something is going on with ImClone and she wants to know what.” During her vacation in Mexico, she reportedly told her friend, “Isn’t it nice to have brokers who tell you those things?”
The ImClone Trade
Martha Stewart became a national celebrity and self-made billionaire through her print and television presence and the many household products bearing her brand name. After a brief career on Wall Street as a stockbroker, she started a successful catering business that led to a succession of books on cooking and household decorating. The magazine Martha Stewart Living followed, along with a television series and a partnership with Kmart. In 1999, her company, Martha Stewart Living Omnimedia (MSLO) went public, with Stewart as the CEO and chairman. MSLO was unique in that Martha Stewart herself was the company’s chief marketable asset.
Sam Waksal was the founder, president, and CEO of ImClone Systems, Inc., a biopharmaceutical company that sought to develop biologic compounds for the treatment of cancers. Martha Stewart and Sam Waksal were close friends, having been introduced in the early 1990s by Stewart’s daughter Alexis, who had dated Waksal for a number of years. It was also through Alexis that her mother and Waksal came to know Peter Bacanovic, who attended Columbia University in the mid-1980s while Alexis was enrolled at nearby Barnard College. Bacanovic worked briefly at ImClone before joining Merrill Lynch in 1993 as a broker, and Stewart and Waksal became two of his most important clients. Waksal helped Stewart achieve an advantageous split from her then-publisher Time Warner in 1997, and in gratitude, she invested an initial $80,000 in ImClone stock. With a net worth of over $1 billion, her investment in 2001 represented three hundredths of 1 percent of her total holdings.
In 2001, the future of ImClone rested on the uncertain prospects of a single drug, Erbitux, for the treatment of advanced colon cancer. Erbitux was a genetically engineered version of a mouse antibody that showed great promise in early tests. In October, ImClone submitted a preliminary application to the Food and Drug Administration (FDA) for approval of Erbitux. This application was merely the first step that allowed the FDA to determine whether the research submitted by the company was sufficiently complete to begin a full FDA review. A decision on the application was expected by the end of December. On December 28, 2001, ImClone announced that the FDA had found the application to be incomplete and would not proceed to the next stage. After the news was announced, ImClone stock dropped 16 percent to $46 a share.
The previous day, on the morning of December 27, Sam Waksal and his daughter asked Peter Bacanovic to sell all of their ImClone shares held at Merrill Lynch, which were worth over $7.3 million. Merrill Lynch sold the ImClone stock of the daughter for approximately $2.5 million but declined to sell Sam Waksal’s shares, citing concern about insider trading. An attempt by Waksal to have his shares transferred to his daughter so that they could be sold by her failed. Separately, Sam Waksal’s father sold shares worth more than $8 million, and smaller amounts were sold by another daughter and a sister of Sam Waksal.
The Aftermath
The Securities and Exchange Commission (SEC) quickly opened an investigation into suspected insider trading in ImClone stock. Faneuil later testified that Bacanovic initially told him that dumping Stewart’s stock was part of a tax-loss selling plan. After being informed by Faneuil that Stewart had made a profit, Bacanovic changed the story, explaining that Stewart had placed a stop-loss order to sell the stock if it dropped below $60 a share. Stewart affirmed to federal investigators that she had given this instruction to Bacanovic and gave as a reason that she did not want to be bothered about the stock during her vacation. This conversation, she claimed, was with Bacanovic, though she had in fact talked only with Faneuil. She also said that she was unable to recall whether Sam Waksal had been discussed in the December 27 telephone conversation or whether she had been informed about stock sales by the Waksal family.
Before meeting with investigators, Stewart accessed the phone message log on her assistant’s computer and changed the entry “Peter Bacanovic thinks ImClone is going to start trading downward” to “Peter Bacanovic re imclone,” but afterward told her assistant to restore the original wording. Meanwhile, Bacanovic altered a worksheet that contained a list of Stewart’s holdings at Merrill Lynch with notations in blue ballpoint ink to include “@$60” by the entry for ImClone. An expert later testified in court that the ink for this entry was different from that used in the other notations.
In March 2003, Sam Waksal pleaded guilty to charges of securities fraud for insider trading, obstruction of justice, and perjury. He was later sentenced to seven years and three months in prison and ordered to pay $4 million. The Department of Justice accepted a proposal from Martha Stewart’s attorneys that she plead guilty to a single felony count of making a false statement to federal investigators that would probably avoid any prison time. However, Stewart decided that she could not do this and would take her chances in court. A justice department official said, “We had no desire to prosecute this woman” but indicated that the lying was too egregious to ignore.803 Stewart and Bacanovic were charged with conspiracy, obstruction of justice, and perjury—but not insider trading. On March 5, 2004, a jury found both parties guilty. Stewart and Bacanovic were each sentenced to five months in prison, five months of home confinement, and two years of probation. Stewart was fined $30,000 and Bacanovic, $4,000. By selling her ImClone stock when she did, Stewart avoided a loss of approximately $46,000. She estimated the total loss from her legal troubles to be $400 million, including a drop in the value of MSLO stock and missed business opportunities.
In June 2003, the SEC brought a civil action for insider trading, which was separate from the criminal charges of which Stewart was found guilty. To convict Stewart of insider trading, the SEC would have to show that she had received material nonpublic information in violation of a fiduciary duty. The information that she received from Faneuil in the December 27 phone call was that the members of the Waksal family were selling their ImClone stock. Neither Faneuil nor Bacanovic had information about the FDA rejection of the Erbitux application that prompted the sell-off. Neither one had a fiduciary duty to ImClone. However, Bocanovic owed a fiduciary duty to Merrill Lynch that he breached in ordering that information about the Waksal’s sales be conveyed to Stewart.
Merrill Lynch had an insider trading policy that prohibited the disclosure of material nonpublic information to anyone who would use it to engage in stock trading. A confidentiality policy also prohibited employees from discussing information about a client with other employees except on a “strict need-to-know basis,” and further stated, “We do not release client information, except upon a client’s authorization or when permitted or required by law.”
Since the information that the Waksals were selling was obtained by Bacanovic in his role as their broker, he breached his duty to Merrill Lynch. However, Martha Stewart denied that she was aware that Bacanovic was their broker. Moreover, as a former stockbroker who understood the law on insider trading, she knew that she could not act on information received from an insider like Waksal. But could she trade on information provided by Bacanovic, even if he was violating a fiduciary duty to Merrill Lynch? Stewart was apparently unconcerned about her first interview with federal investigators because, according to a close associate, “All she thought they wanted to talk about was whether Waksal himself had tipped her about the F.D.A. decision. She knew she was in the clear on that one.”804
On August 7, 2007, the SEC announced a settlement with Martha Stewart and Peter Bacanovic.805 Stewart agreed to pay a $195,000 penalty and accept a five-year ban on serving as an officer or director of a public company. Bacanovic was ordered to pay $75,000; he had previously received a permanent bar from work in the securities industry. The SEC’s Director of Enforcement declared, “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. It’s worse still when the individual engaged in the insider trading is the Chairman and CEO of a public company.”806
