Dispatches From The Martha Stewart Trial

Some Preliminary Conclusions

The pre-trial forecast

Having now reviewed the allegations and available evidence in “mind-numbing” detail (as one reader put it), we are in a position to draw some preliminary conclusions. Again, only a fraction of the evidence has been released, so these conclusions may change radically during the trial.

First, it seems safe to say that no one will ever know why Martha Stewart sold her ImClone stock on Dec. 27, 2001; even Stewart herself is probably not certain what mix of factors triggered the decision. Stewart probably had many bits of information—sharp price decline, extreme volume, negative rumors, impending announcement, prior intention, etc.—and one of these might have been that Sam Waksal was trying to sell some stock. Depending on how the Waksal information was related and what weight Stewart gave it, this might have been anywhere from the sole reason for the sale to a minor data point. If the U.S. attorney had charged Stewart with insider trading, it wouldn’t matter whether the information contributed to the decision: The questions would be whether it was “material nonpublic information” and whether Stewart knew it had been “misappropriated,” and if the answers were determined to be “yes,” she would have broken the law merely by trading while in possession of it (unless she had previously instructed her broker to sell, in which case the trade would be legal no matter what she knew). But the U.S. attorney didn’t charge Stewart with insider trading.

What the U.S. attorney did charge Stewart with was obstructing an insider-trading investigation that determined, ironically, that she shouldn’t be charged with insider trading (not necessarily that she didn’t commit this offense, just that she shouldn’t be charged with it). Just as ironic, even though the trade’s legality or illegality will not be formally determined at the trial, it may still be one of the jury’s most important considerations.  From a moral perspective, if not a legal one, if the jury believes that Stewart’s trade was, in fact, “entirely lawful,” this will likely appeal to its sense of fairness: It may be illegal to escape from jail, but the crime feels more justifiable if the escapee was wrongly imprisoned in the first place. On the other hand, if the jury believes the trade was illegal, or even shady—an instance of an arrogant, rich person taking advantage of privilege—then the jury may feel Stewart deserves to be punished, even if what she’s punished for isn’t insider trading (it is no accident that the indictment often implies that Stewart committed this crime).  Even if the jury believes Stewart should be found guilty of something, however, its members may still grapple with whether charges of “conspiracy,” “obstruction of justice,” and “criminal securities fraud” are appropriate. These crimes are serious felonies; people convicted of them usually should go to jail. In this case, however, one can imagine that a reasonable person, having reviewed the circumstances and evidence, might feel that incarceration is neither appropriate nor deserved.

Next, with regard to the obstruction charges, unless Peter Bacanovic suddenly pleads guilty and testifies against Stewart (which seems highly unlikely—he presumably has already resisted intense pressure to do so), the case will likely boil down to the explanations for a couple of phone calls and a handful of oral statements that were neither recorded nor made under oath. Most of these statements concerned either the $60 understanding or the claim that Stewart gave her sell order to Bacanovic instead of Douglas Faneuil. In the first instance, unless Bacanovic or Stewart told someone (Faneuil? Ann Armstrong?) that the agreement was a lie, it is hard to imagine how the prosecution will prove that it didn’t exist. In the second, it seems clear that Stewart made inaccurate statements to investigators; whether the prosecution can prove she made them with the intention of obstructing justice, however, is another question. One observer, Judge John E. Sprizzo, who is handling some of the civil cases against Stewart, recently remarked, “This is not the strongest obstruction case I’ve ever seen.”

And then there is the most serious charge: securities fraud. Unlike some observers, I don’t think this charge is preposterous. If a key executive intentionally makes false statements about a subject relevant to his or her company’s stock price, this can be fairly viewed as a fraud on the shareholders, and Martha Stewart is not only Martha Stewart Living Omnimedia’s key executive, but also its brand and primary product, so her reputation is clearly relevant to the stock price. Because the alleged false statements were issued primarily to deny serious (and, in this case, false) allegations, however, I do think the charge is unfair. I also think it sets a dangerous precedent, one that places too much power in the hands of prosecutors, a group whose individual motives and incentives are often no better aligned with the “common good” than those of business executives (and, for that matter, most professionals).

The securities fraud charge was based not on Stewart’s public denial of guilt but her alternative (and allegedly false) explanation. The reason this is still problematic, in my opinion, is that it puts Stewart—and any other executive accused of wrongdoing—in a no-win situation: guilty or innocent, the accused cannot risk explaining his or her actions, even for the benefit of investors, for fear of getting slapped with the potentially more serious charge of securities fraud. As the following scenarios demonstrate, moreover, this precedent hurts not only falsely accused executives, but also investors—the people who the securities laws are supposed to protect.

  • If the accused executive is guilty and admits guilt, this is fair. The stock will justifiably get hammered.
  • If the accused executive is guilty, denies guilt, but doesn’t explain for fear of getting charged with securities fraud, this is also fair. With no explanation, investors will be skeptical of the denial, and the stock will justifiably get hammered (although, if one is going to consider false explanations a crime, it seems logically inconsistent that false denials are not considered a crime).
  • If the accused executive is innocent, denies guilt, and doesn’t explain for fear of getting charged with securities fraud, this is unfair. The lack of an explanation will be construed as guilt, and the stock will get hammered unjustifiably.
  • If the accused executive is innocent, denies guilt, explains, and then gets charged with securities fraud, this is awful, for both the executive and investors—the stock will get hammered even though no one committed a crime.

The last scenario is the closest to the Stewart case. The prosecution obviously believes that Stewart gave a false explanation instead of a true one, but given the extraordinary price that Stewart, Bacanovic, and the shareholders of Martha Stewart Living Omnimedia have already paid as a result of this belief, one hopes that the prosecution’s confidence is extremely high (and based on evidence more convincing than “we think she’s full of it”). Otherwise, the implication is that we live in a society in which a handful of us can legally declare what is or isn’t true and charge anyone who dares disagree with a felony—a situation that seems, if nothing else, distinctly un-American.

The final question is a broader one: whether the alleged actions (these specific actions, not the broader crimes) warrant the destruction of half-a-billion dollars of shareholder value, the expenditure of tens of millions of tax dollars, the dedication of months of effort by some of the most potent, talented investigators and prosecutors in the country, and the cost and wasted time that will accompany any jail sentences—or whether there wasn’t some other, more reasonable way the situation could have been resolved. If the only settlement offer from the prosecution was a felony guilty plea, one can understand why Martha Stewart and Peter Bacanovic would have refused it. Similarly, if the only offer from the defense was complete vindication, one can understand why the U.S. attorney’s office, if convinced Stewart and Bacanovic broke the law, would have walked. But if ever a case cried out for a mutually acceptable compromise, this is it.