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Men in Suits
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MARTHA STEWART CASE

Background

Martha Stewart was an esteemed corporate maven in America. She served as the founder and CEO of Martha Stewart Living Omnimedia Inc. This company was engaged in the fields of publication (of books, magazines, newspaper columns), television programmes, merchandise, electronics etc. Martha Stewart was known to be a very popular and loved homemaker in the country and therefore when her name popped up in the involvement of insider trading, it sent ripples of disbelief throughout the United States.


Understanding Insider Trading

Insider trading, as the name itself suggests, is trading in the securities of the company by an insider. In a general sense, insiders are understood as people who by virtue of their position in relation to the company have access to the confidential information of the company. Insider trading is when these company insiders purchase or sell the stocks of their corporate entities, depending upon the unpublished private information that they have received due to the position that they enjoy in relation to the company. This kind of trading is illegal in many countries as it is unethical and shakes and dents the confidence and trust of the investors. The investors are gripped with a feeling about the market being unfair, and profitable only to those who trade on the basis of insider information. Therefore criminalising this type of activity was essential to maintain fairness in the capital market as well as to provide an equal platform to all people in the securities market. The happening of insider trading implies a weak corporate governance structure.


Below is the case study of Martha Stewart in the background of Insider Trading.


Imclone Systems, Inc connection

Imclone Systems Inc was a biotech company whose CEO was Samuel Waksal. The company had developed a drug named ‘Erbitrux’ to fight cancer. The company then forwarded an application to the appropriate authority for the purpose of introducing the medicine into the market. Samuel Waksal, being the CEO, had received a piece of prior material information from the Food and Drug Administration (FDA) on 27th December, 2001, that the application for the drug had been cancelled.


Waksal held stocks of Imclone and he could foresee the losses he would make on publication of the news of drug cancellation. Therefore in furtherance of his intention to run away from the future losses that he was going to incur by putting the hidden non-public information to misuse, he asked his appointed stock broker named Peter Bacanovic to sell off his stocks. His shares in the company were immediately sold by the broker. In this manner, Waksal engaged in the offence of insider trading. He wanted to extend the benefit of his unethical trading to his family too. As a consequence of which his daughter too sold her stocks worth $2.5 million in the company before the public announcement was made in relation to the drug.


Martha Stewart’s association with the above scenario comes into the picture in three ways. The first association is that Stewart had purchased around 4000 shares of ImClone. The second connection is the common stock broker Peter employed by her as well as Waksal and the third connection is Martha’s friendship with Waksal. The broker who received information from Waksal about the potential price drop in the near future passed on the same to Stewart and also informed her about the sales made by Samuel and advised her to sell the Imclone shares that she held. Within a span of merely two minutes, Stewart followed her broker’s suggestion. A significant fact here is that neither the broker nor Martha Stewart was aware of the confidential unpublished information. The broker acted upon the instructions of Waksal and depending upon such instructions, he further suggested Martha do the same. Martha merely acted upon the suggestion provided by the broker, not knowing about any confidential non-public information.


When the material news was officially made public by the FDA, there was an expected price drop in the shares of Imclone immediately amounting to a fall of nearly $12 per share. The share price of Imclone before the announcement by the FDA was 58 Dollars and after the announcement slipped to 46.48 Dollars. Both Stewart and Waksal saved huge sums which they would not have, had they not engaged in the impugned securities crime. Martha Stewart avoided a loss of around $45000.


However, the suspicious activities of massive trading in the shares of Imclone by Stewart and the CEO himself within minutes only a day before the news was made public grabbed the eye of the SEC (Securities Exchange Commission). This prompted the SEC to initiate investigations against both individuals. Samuel Waksal accepted his wrongdoing of engaging in securities fraud during the investigation and was sentenced to 7 years imprisonment by the SEC.


When Stewart was interrogated by SEC regarding her involvement in the concerned securities fraud, she defended herself by offering certain reasoning for her trading activity in the shares of Imclone which were later found to be false. Stewart along with her broker and the broker’s assistant instead of spilling out the truth decided to make up a fake story. The fictitious story that they put forth was that a prior agreement existed between them (Stewart and Peter) according to which they agreed to sell the shares of ImClone if its price value decreased below the figure of $60. In order to authenticate this fictitious story, a document was provided to the SEC by the broker which consisted of the expression “@$60”. Stewart and Peter termed the document as the concerned agreement and utilised the above expression present in it to their benefit in order to prove the genuineness of their made-up story. The investigation proceedings started by the SEC against Stewart lasted for around 2 years from 2002-2004.


As a founder and CEO, when enquiries against Stewart made headlines for her alleged involvement in the deceptive conduct of insider trading, her company Omnimedia suffered a lot of negative repercussions. The great success and popularity of Omnimedia Inc was all due to the brand name “Martha Stewart”. This is the reason that despite she having breached no fiduciary duty towards Omnimedia, her company had to face consequences when charges of improper transactions cropped up against her with respect to the stocks of some other company. Some of the ramifications that her company had to deal with were a 17% dip in the overall revenues, a downfall of 68.5% in incomes earned by the company through publications and a negative impact on the goodwill that her brand carried. These ramifications ipso facto decreased the price value of the shares of Omnimedia.


In her defence, Stewart published her story of innocence but it hardly carried any effect. The situation was already bad but it further went on to become worse. The assistant of her broker named Douglas Faneuil turned hostile and consented to provide evidence against Stewart. Thirteen civil suits were instituted against her and Omnimedia by the shareholders. The price value of Omnimedia’s shares was constantly on a roll of depreciation. The quarterly income figures of the company went below expectations. Further, in order to examine the truthfulness of her statements provided to the SEC during investigations, a second investigation on her by the office of Department of Justice (DOJ) was ordered by the House Energy and Commerce Committee. Stewart had become the cynosure of the SEC, shareholders, committees, media and the general public. Her reputation was harmed in various ways even before her guilt was proven. These ramifications show that the stigma of conviction begins long before a finding of guilt.


Due to such prevailing circumstances, she resigned as the chairperson of Omnimedia. On the completion of investigations, Stewart was acquitted of the charge of insider trading but was held guilty of conspiracy, for providing false statements to the investigators, for disrespecting justice and for one count of securities fraud. It was due to these convictions that she underwent a criminal sanction of imprisonment in addition to a civil penalty. On 17th June, 2004, she was sentenced to 5 months imprisonment, another 5 months of house arrest and two years of supervised release; and a monetary penalty of $30,000 was imposed on her. Her appeal on the sanction of imprisonment was rejected in 2006 by the US Court of Appeals for the Second Circuit.


Exemption from the charge of insider trading

An established fact, in this case, is that Martha traded in the ImClone securities on the basis of non-public information about the sales made by Samuel Waksal due to a potential price drop. However, this does not constitute a direct case of insider trading by itself as there are many angles that need to be looked from.


The failure in establishing insider trading charges on Stewart can be understood by looking into the observations made by the Supreme Court of the US in a few significant cases. The first significant case which develops the popular classic theory in the US is the Chiarella case. The Apex Court in this case had made an observation that only that person could be a potential insider trader who trades in breach of his or her fiduciary obligation towards the company and its shareholders. In the impugned case, Stewart was free of any such fiduciary obligation towards the shareholders of ImClone as she was no officer or majority shareholder of the corporate entity.


Looking at the jurisprudence on tipper-tippee liability on insider trading in the US, a tippee could be punished only if he or she is aware that the tipper has acted contrary to his or her fiduciary duty to gain certain benefits. The original tipper and tippee in the case are Waksal and Bacanovic, respectively. But if this tippee further forwards the insider information to another individual, that recipient too comes in the category of tippee. Thus, Martha Stewart in this case appears to be a tippee. However, this theory too does not fit the case as the tipper, who in this case could be the broker Bacanovic or his assistant, had no such fiduciary obligations towards the concerned shareholders.


But the year 1997 witnessed the genesis of the Misappropriation theory in the O’Hagan case. Going by this theory, any person whether or not he or she is bound by any fiduciary duties could be punished for engaging in the act of insider trading if he or she trades in the securities of the company by misusing a piece of confidential information about the company. The theory gave the least significance to any fiduciary obligation towards the investors but made the liability of the outsider contingent on one requirement. The requirement calls for the infringement of a confidential relationship towards the source from which the information was received. Here the source accounts for either the broker or the employer of the broker, who in this case is Merrill Lynch. Here even though Peter Bacanovic had misappropriated information, Stewart did not infringe any confidential relationship towards him or Lynch and she could not clearly be said to have committed the offence of insider trading for having traded on a piece of information misappropriated by some other individual. Thus, owing to a lack of jurisprudence on tippee liability, a lot of confusion existed while dealing with this issue.


Stewart was however the tippee of a misappropriator. Forming this position of Stewart as the foundation, the SEC proceeded in bringing a suit for insider trading against Stewart. The settlement of insider trading allegations through a civil claim by the SEC was concluded by an agreement through which Stewart was ready to pay $195,081 though she did not confess to the charge. The basic principle underlying a criminal conviction is that the guilt needs to be proved beyond reasonable doubt, which did not occur in the impugned case, as a result of which Stewart was exempted from the insider trading charge by the Trial Court.


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-off. It's worse still when the individual engaging in insider trading is the chairperson and CEO of a public company."


Conclusion

By participating in the improper ImClone transaction, Stewart lost a lot more than what she saved. She was not only charged a penalty of four times the amount saved due to the sale of ImClone stocks but her business entity suffered huge monetary as well as reputational losses. The investigation into this white-collar crime lasted for a lengthy period of two years. Even though she was freed from the insider trading allegation, the indictment of the rich and popular Martha Stewart of other wrongdoings assured the faith of the public in the principle of the Rule of Law and carried a greater deterrent effect. Though Stewart was not a classical insider trader or a classical tippee, her deceptive conduct accounted for a different kind of insider trading.



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