Charge against Stewart grew out of her defense

Fraud: If she's convicted, executives fear that public protestations of innocence could become a crime.

February 06, 2004|By Robert Little and Bill Atkinson | Robert Little and Bill Atkinson,SUN STAFF

Hidden behind the public spectacle of the Martha Stewart trial is a legal struggle that could fundamentally change the rules governing how publicly owned companies communicate with investors. That possibility is sending shivers down the spines of corporate America.

If Stewart is convicted of the most serious charge against her - that she lied about her role in an illegal stock trade to protect the share price of the publicly traded corporation that bears her name - then some legal scholars say the ruling could muzzle CEOs throughout the country, who would worry that defending any accusation in public could lead to a securities fraud charge.

And the consequence, those legal experts say, could run deeper than simply denying free speech to some celebrity executives. It could shut down the flow of information that the nation's securities laws are designed to lay bare.

"I expect that it will have a chilling effect on corporate executives who publicly proclaim their innocence," said Eugene I. Goldman, a Washington attorney and former Securities and Exchange Commission prosecutor.

"Whether or not [prosecutors] win against Stewart, the charges will cause chief executive officers to huddle very closely with their counsel, on what, if anything, they can say publicly about charges that have been disseminated by the prosecutors."

"The SEC is definitely treading on new ground here, pushing the boundaries of the securities laws to see how far they will go," said Thomas R. Ajamie, a Houston-based lawyer who has represented shareholders in several high-profile securities cases.

"But that could be a good thing for people who are saving their money or people with 401k's - the people who the securities laws are there to protect.

"The idea is for you and me to have the same amount of information about a stock that the company executives have. And if the founder of the company like Martha Stewart Living is in a position where she might be criminally charged - something that really could have an impact on the value of the company - that's information we should have had."

Stewart's attorneys cross-examined the star witness against their client yesterday, trying to cast a haze of skepticism into the courtroom by suggesting that former Merrill Lynch & Co. employee Douglas Faneuil used recreational drugs and testified against Stewart only to avoid being prosecuted himself.

Faneuil told the court Wednesday that he passed Stewart a tip from her Merrill Lynch broker, Peter Bacanovic, in December 2001, informing her that the founder of drug manufacturer ImClone Systems Inc. - a personal friend of Stewart's named Samuel D. Waksal - was dumping his personal shares of the company's stock.

The claim is at the heart of the case against Stewart, who sold her own 3,928 shares of ImClone the same day and avoided a $51,000 trading loss when the shares soon plunged, amid a negative federal assessment of a highly touted anti-cancer drug the company was developing.

Waksal pleaded guilty to securities fraud and is serving a seven-year prison term.

The charges against Stewart don't directly involve claims of insider trading but rather that she lied about her sale of ImClone shares to protect her image, and thus avoid a run-down of the share price of Martha Stewart Living Omnimedia Inc.

In two publicly released statements and one that her lawyer sent to The Wall Street Journal, Stewart claimed that she didn't know of Waksal's actions and that she sold her ImClone shares because the price fell below a pre-determined threshold of $60 a share.

She also claimed publicly to be cooperating with federal investigators.

Prosecutors contend that all of those statements are untrue and were made solely to shore up the stock of Stewart's company, which traffics heavily in the celebrity CEO's public image and would likely have suffered if shareholders knew of her involvement in illegal trade.

Many securities law specialists say that by charging Stewart with securities fraud for, in effect, publicly proclaiming her innocence, federal prosecutors have stretched the laws to new limits.

"They are taking a denial of guilt and trying to bootstrap that into a federal crime," said Andrew C. White, a criminal defense attorney in Baltimore who specializes in white-collar crime. "At best, it is a novel theory. I think it is wholly inappropriate."

"That sounds like stretch," said Andrew Jay Graham, a white-collar criminal defense attorney in Baltimore and a former federal prosecutor. "They have stood the traditional notion of the presumption of innocence on its head."

No one knows just how Stewart's case might affect other corporate executives, mostly because the linkage between Stewart's public image and the stock in her company is virtually without peer on Wall Street. The connection between Berkshire Hathaway Inc. and founder Warren Buffett is often offered as an analogy, but few other stocks can claim to be so dependent on the image of their associated CEOs.

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