Martha Stewart’S How-To On Insider Trading

From being a very successful businesswoman to calling a prison cell home, Martha Stewart has definitely had an interesting past couple of years. She started her career about 30 years ago with a catering business and has since built from that becoming the CEO and Chairman of Martha Stewart Living Omnimedia, Inc. Her success also includes the publication of her magazine Everyday Living, being the commercial spokeswoman for K-Mart, and having her own popular television show, From Martha’s Kitchen. She had built the reputation of being a public figure with how-to advice on creations in the kitchen to gardening. Despite these accomplishments, Stewart managed to become entangled in some insider trading scheme that damaged not only parts of her career, but also her public image.

Insider trading is the act of purchasing or selling securities based on material, nonpublic information. Information is consider to be material if a reasonable person would use it in such a way that would persuade them to partake in an exchange of securities, or if it was reasonable to believe that it would affect the market price of a security once the information has become public (Carlin 2003). Information can only be acted upon once it has been made public, otherwise, unfair trades would take place that could negatively affect the general public and shareholders of the company. Those who are employees of the company upon employment have a signed agreement to put the interests of the shareholders first. Acting on tips from within the company or other sources could negatively affect the corporation’s success, resulting in a shareholders loss.

Martha Stewart became involved with an insider trading scandal back in December of 2001. Suspicion came about when Stewart and other executives of a company called ImClone made a timely sale of their stock. Soon after, an investigation was launched by the Securities and Exchange Commission (SEC), who then brought charges against them of committing securities fraud by engaging in illegal insider trading (Carlin 2003).

The investigation traced all the way back to Stewart’s earliest involvements with ImClone. It discovered that Stewart and Samuel Waksal, a co-founder and former CEO of ImClone, had become friendly in the early 1990s (Carlin 2003). ImClone is a biopharmaceutical company that specializes in the development of treatments for cancer. They are incorporated with their headquarters in New York City, and are publicly traded on The Nasdaq Stock Market under the symbol IMCL. Among several products they have Erbitux, which is their leading product.

Stewart and Waksal both had accounts through the brokerage firm Merrill Lynch, where they shared the same broker, Peter Bacanovic. Stewart also had history with Bacanovic as it was reported that they have known each other since the mid-1980s. Stewart had become a client of Bacanovic in the mid-1990s and soon was one of his high profile accounts. Stewart placed Bacanovic in charge of her pension, personal accounts, and Martha Stewart Living Omnimedia’s 401(k) plan. He also administered Omnimedia’s Employee Stock Option Program and through this became a financial advisor many of the employees. Through Stewart’s account with Bacanovic, she owned 3,928 shares of stock in ImClone.

Since 1992, ImClone had been focusing mainly on the development of Erbitux, their new promising anti-cancer drug. The last hurtle they had was to receive approval from the Food and Drug Administration (FDA). On October 31, 2001, ImClone submitted their final portion of their application for approval, called a Biologics License Application (BLA). Upon completion of turning in the final portion of the BLA, the FDA had 60 days (December 31, 2001) until it was required to decide whether to accept it or not for filling (Carlin 2003). Stewart was aware of the new drug that was being developed and awaiting approval from the FDA. As the date of when the FDA would make its decision approached, investors awaited the news. Somehow, on December 26, 2001, Waksal privately learned that the FDA was not going to accept the BLA from ImClone. Having obtained this nonpublic information, Waksal and his family sold their very substantial amounts of ImClone stock (Caillavet 2004).

Once Bacanovic discovered Waksal had placed an order to sell his stock, he decided to contact Stewart. At first he could not get a hold of Stewart, so Bacanovic left a message with Stewart’s assistant saying “Peter Bacanovic thinks ImClone is going to start trading downward” (Caillavet 2004). Later that day Bacanovic told his assistant to attempt to contact Stewart again and this time tell her that Waksal was selling his stock. Stewart was temporarily unreachable because she was in her airplane on her way to Mexico; however, she landed in Texas to refuel and checked her messages there. Stewart then contacted Bacanovic’s assistant at Merrill Lynch, who informed her that Waksal was selling his stock and that she may want to consider the same with her own. With that information, Stewart ordered that all 3,928 shares of ImClone stock be sold. They sold at an average price of $58.43 per share (Carlin 2003). Once the information of the FDA’s refusal of the ImClone’s Erbitux had been made public, the stock price per share dropped 16 percent. Stewart’s sale of stock prior to this saved her from losing $45,673.

The information that Waksal had acted on was considered material because it had not been publicly disclosed. Bacanovic knew that the information he was passing on to Stewart had not been released to the public. Also, Stewart knew that the information she had received was not known by the public, but yet decided to act on it. These actions make both Bacanovic and Stewart guilty of insider trading.

Once the SEC learned of this transaction, they began to investigate. Stewart and Bacanovic attempted to cover up their wrongdoing by lying