Kathleen McReynolds MBA 5050: Business Law

Martha Stewart Insider Trading

Martha Stewart Living Omnimedia Martha Stewart was once best known as a high-profile business womanmore specifically, as the founder and front-woman of Martha Stewart Living. She formed the corporation in 1997, combining several business ventures into one entity that would eventually manage an impressive portfolio: four core magazines, an Emmy award-winning television show, a weekly segment on CBS, dozens of books, a newspaper column, a radio program, and a popular merchandising website. On October 19, 1999, Stewart became a billionaire when the IPO of Martha Stewart Living Omnimedia (ticker MSO) more than doubled her net worth overnight. Because Marthas personality was virtually synonymous with her brand, the companys rise to power sent the domestic diva into the spotlight. On December 27, 2001, however, Martha received interesting information from her Merrill Lynch broker, Peter Bacanovic, regarding a company in which Martha held stock. Martha Stewart would soon give journalists much more to talk about than cinnamon scones and doilies

ImClones FDA Rejection ImClone Systems, Inc., a bio-pharmaceutical firm, was founded in 1984 by Sam Waksal whose vision was to develop breakthrough medicines in the field of oncology. ImClone had a particularly promising colon cancer drug Erbitux under review by the FDA in 2001, but in December of that year confidence in the new drug began to waver. On December 4th following a meeting with the FDA, an employee of ImClone composed an internal memo implying that Erbitux might not be approved after all. Sam Waksals brother (and co-founder of ImClone) sold $50M in shares just two days later. On Christmas Day in 2001, Waksals brother learned that Erbituxs chances of FDA approval had dropped to about 1%. He quickly shared this news with Sam, who flew home to divest in the company. Sam informed several family members of the news and they scrambled to sell $15M in shares collectively. Waksal knew that ImClone planned to publicly announce the FDA rejection after trading ended on the following daya blackout day on which insiders could not trade. Desperate, he eventually had to forge a signature of the ImClone General Council to complete the transaction.

Marthas Tip That same day, Martha received her fateful phone call from Bacanovics assistant. The Merrill Lynch broker left a message with Martha explaining that the CEO of ImClone and his family (also clients of Bacanovics) had just sold all of their shares in the company. Martha returned the call as soon as her flight landed and spoke

Kathleen McReynolds MBA 5050: Business Law

Martha Stewart Insider Trading

to Douglas Faneuil from 1:30pm until 1:41 pm. Just two minutes after the phone call ended, Faneuil executed the transaction, selling Marthas 3,928 ImClone shares at $58 per share. On December 28th, the FDA publicly reported that it had rejected ImClones drug Erbitux. The next trading day saw ImClone stock value drop about 16%. Bacanovics tip had saved her $45,673.

The SEC Gets Involved Compliance officers at Merrill Lynch noticed the suspiciously well-timed sales and questioned Bacanovic on the matter, but his weak defense prompted them to report the incident to the SEC. In early 2002, the SEC began investigating the ImClone trades. Waksal was arrested and charged for insider trading in June, at which time Marthas investigation finally became more prominent. Although Stewart maintained her innocence throughout the investigation, she and her associates sold $79 million worth of MSO stock just before news of the investigation went public (some of her shareholders even sued her for doing this!). By late June 2002, MSO stock had fallen to a low of $13.60 per share, and by August it had fallen under $9 per share. During the investigations, Bacanovic and Stewart insisted that they had agreed upon a stop-loss order at $60 on December 20th regarding Stewarts ImClone shares. Martha claimed that she had no recollection of Bacanovics tip nor did she know that he was the broker for Waksal. On June 4, 2003, a federal grand jury indicted Stewart and Bacanovic. Stewart was accused of securities fraud, obstruction of justice, conspiracy, and making false statements. Bacanovic was charged with obstruction of justice, conspiracy, making false statements and perjury.

Conviction and Sentencing On March 5, 2004, Martha Stewart was found guilty on all counts and sentenced to five months in prison and five months of home confinement and was fined $30,000. Bacanovic was convicted of all counts except falsifying documents. He was sentenced to five months in prison, five months of home detention, two years of probation, and was fined $4,000. In a separate earlier trial (October 2002), Faneuil pled guilty to accepting a payoff to hush Marthas trade. He was fined $4,000 but served no jail time. Waksal also pled guilty to tipping off his family and selling his own stock illegally. He was sentenced to seven years in prison, the harshest penalty in the case.

Kathleen McReynolds MBA 5050: Business Law

Martha Stewart Insider Trading

Aftermath The MSO stock declined steadily throughout the investigations and trial. It was once worth more than $2 billion, and crumbled to about one-fourth of that after trial. Interestingly, the price jumped up 37% in July 2004 when Martha received a relatively light sentence (she could have been in prison for 20 years). Perhaps the worst punishment for Martha was the demolition of her formerly pristine image. She stepped down from the Board of Directors and was never able to fully recover to her position of wealth and business success. She became the object of ridicule in popular media and stepped down from many of her previous ventures. The company even took her face off of the Martha Stewart Living magazine temporarily. Although she has overcome much and regained a place in the business world, she may never be able to achieve her former levels of success. As of February 7, 2012, the MSO stock closed at $4.77 per share with a market capitalization of about $264 million, merely a shadow of what the company used to be.

Insider Trading at a Glance The SEC defines illegal insider trading as buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include tipping such information

Kathleen McReynolds MBA 5050: Business Law

Martha Stewart Insider Trading SOURCES CONSULTED

"Bacanovic's Life Ruined, His Lawyer Says at Sentencing." USATODAY.com. 16 July 2004. Web. 07 Feb. 2012. <http://www.usatoday.com/money/media/2004-07-16-bacanovic-sentencing_x.htm>. "Complaint: Martha Stewart and Peter Bacanovic." U.S. Securities and Exchange Commission (Home Page). Web. 07 Feb. 2012. <http://www.sec.gov/litigation/complaints/comp18169.htm>.

Farrell, Greg. "Martha Stewart Convicted of Four Felonies." USATODAY.com. 05 Mar. 2004. Web. 07 Feb. 2012. <http://www.usatoday.com/money/media/2004-03-05-stewart_x.htm>.

"Insider Trading." U.S. Securities and Exchange Commission (Home Page). Web. 07 Feb. 2012. <http://www.sec.gov/answers/insider.htm>. "MSO: Summary for Martha Stewart Living Omnimedia- Yahoo! Finance." Yahoo! Finance. Web. 07 Feb. 2012. <http://finance.yahoo.com/q?s=MSO>. "Seattle Times Newspaper." Community.seattletimes.nwsource.com. Web. 07 Feb. 2012. <http://community.seattletimes.nwsource.com/archive/?date=20040305>. "SEC Charges Martha Stewart, Broker Peter Bacanovic with Illegal Insider Trading." U.S. Securities and Exchange Commission (Home Page). Web. 07 Feb. 2012. <http://www.sec.gov/news/press/2003-69.htm>. ORourke, J. "Martha Stewart Living Omnimedia Inc.: The Fall of an American Icon." Public Relations Review 30.4 (2004): 447-57. Print.