Friday, May 26, 2006

Martha Stewart, Part Deux: The SEC Inisder Trading Case

Along with the criminal indictment on false statement, perjury, obstruction, and conspiracy charges filed on June 4, 2003, Martha Stewart and Peter Bacanovic were sued the same day by the SEC for insider trading (complaint here) arising from her sales of ImClone Systems, Inc. stock on December 27, 2001.  The Commission alleged that Stewart sold her shares (and avoided approximately $45,000 in losses) based on information about stock sales by ImClone's CEO, Dr. Sam Waksal, that was passed on to her by Bacanovic, her broker at Merrill Lynch.  The complaint does not allege that Waksal -- who is serving a 7-year prison term after pleading guilty to insider trading and tax charges -- tipped either Stewart or Bacanovic about problems ImClone was having in obtaining FDA approval for its main drug, Erbitux.  Instead, the SEC alleges that Bacanovic violated his fiduciary duty to Merrill Lynch by tipping Stewart about customer information: "As of December 27, 2001, the Waksals' efforts and instructions to sell their ImClone stock were not public and Merrill Lynch policies specifically required employees to keep information about those transactions confidential. Indeed, Merrill Lynch had in place at least four policies that prohibited employees, such as Bacanovic and [his assistant Douglas] Faneuil, from disclosing client transactions to others or effecting trades on information about client securities transactions."  The alleged insider trading is a step removed from the confidential information, and concerns market information rather than corporate information, raising questions of materiality and causation.  Federal prosecutors did not charge Stewart and Bacanovic with securities fraud, most likely because it would have been too difficult to establish guilt beyond a reasonable doubt.  The SEC suit operates under the more relaxed civil standard of preponderance of the evidence, although the case is certainly not an easy one.

The parties agreed to stay the civil case until the criminal case was over, and now that Stewart will not pursue any further appeals from the affirmance of her conviction by the Second Circuit in January 2006, the SEC suit can move forward.  An AP story (here) states that Stewart and Bacanovic must now file an answer to the complaint.  The civil case involves a fairly trivial amount of money for someone of Stewart's wealth, and could probably be settled for not much more than $200,000 with interest and a triple penalty, at the most.  The problem in settling the case most likely is a possible director and officer bar that could be imposed on Stewart if there is a finding that she engaged in a violation of the antifraud provisions of the federal securities laws.  The complaint seeks the following relief: "Order[] that Stewart be barred from acting as a director of, and limiting her activities as an officer of, any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act, 15 U.S.C. § 781, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, 15 U.S.C. § 78o(d) . . . ."  A D&O bar would prevent Stewart from exercising control of Martha Stewart Omnimedia Inc. as a senior executive, barring a move to take it private so that it would not be subject to the registration and reporting provisions of the Securities Exchange Act of 1934.  If the Commission is insisting on a bar, that may be too high a price to pay, especially in a case that Stewart stands a reasonable chance of winning, although at the cost of another round of negative publicity.  Then again, having appeared on a version of The Apprentice, there may be no such thing as too much bad publicity. (ph)

                                                                                    

UPDATE:  An AP story (here) states that Martha Stewart filed an answer to the SEC complaint asserting that she acted in "good faith," which is a defense to a fraud charge under Section10(b) and Rule 10b-5, the legal basis for the insider trading prohibition.  At this point, discovery will move forward, which means deposition notices are likely to go out to Stewart and Peter Bacanovic, her co-defendant and former broker.  Unlike the criminal case, in which neither testified, as civil defendants the opposing party has the right to compel them to testify.  While either can assert the Fifth Amendment privilege at the deposition, that can be used as evidence to infer that the person had the requisite intent to violate the antifraud provisions.  Settlement is certainly not precluded at this point, and as discovery proceeds the sides may move closer to resolving the issues. (ph)

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Civil Enforcement, Insider Trading, Martha Stewart, Securities | Permalink

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