The Rittenhouse Review

A Philadelphia Journal of Politics, Finance, Ethics, and Culture

Monday, June 24, 2002  

Insider Trading Chatter Strains Logic

One of the biggest stories of the past two weeks has Martha Stewart, invariably termed “the doyenne of domesticity” or some other such nonsense, embroiled in an insider trading scandal at ImClone Systems Inc., a biotechnology firm that was headed by her friend Sam Waksal until he was arrested on insider trading charges on June 12.

This is the stuff tabloid editors dream of, and true to form, the New York Post and the Daily News (New York), among others, have been reporting even the most minor bits of new information while tracking and tailing Stewart’s every move. The Wall Street Journal also have been actively covering the story, albeit with considerable restraint. Stewart has strongly denied any wrongdoing.

There is scant evidence so far that would lead a reasonable person to reach the conclusion that Stewart’s sale of fewer than 5,000 shares of ImClone Systems on Dec. 27, 2001, was based on material non-public information, that being the basic definition of insider trading.

The facts so far

Let’s look at what we know. According to published reports, Stewart purchased 4,910 shares of ImClone on the open market at some unknown date “several years ago,” in a transaction that may represent a goodwill gesture (toward her friend Waksal) as much as it did an investment in the true sense of the term.

Stewart pared her holdings in ImClone in late October 2001 -- two months before the date in question -- when Bristol Myers-Squibb Co. conducted a tender offer for 20 percent of the outstanding shares of ImClone, a firm with which the beleaguered pharmaceutical company had signed a strategic agreement.

Stewart’s participation in the tender offer establishes an intent to sell that clearly precedes any exchange of information, by anyone, about the Food and Drug Administration’s pending decision regarding Erbitux, ImClone’s as yet unapproved cancer treatment.

Because the tender offer was oversubscribed, Stewart, like every other ImClone investor involved in the transaction, was able to sell only 20 percent of her stake in ImClone, or roughly 982 shares. Thereafter, in November according to Stewart, or in mid-December according to Peter Bacanovic, her broker at Merrill Lynch & Co., and never according to the Journal’s account of Bacanovic’s assistant Douglas Faneuil, Stewart placed a “stop-loss” order, apparently informally (that is, not in writing), directing that her shares be sold when the price of ImClone dropped below $60.

And indeed, Stewart’s remaining 3,928 shares were sold on Dec. 27, the first day on which the price of ImClone dipped below $60 since Nov. 12. (Both Bacanovic and Faneuil have been placed on leave from Merrill Lynch.)

We do not know, yet at least, the price at which Stewart purchased the shares of ImClone. However, Stewart tendered her shares to Bristol Myers at $70, implying that this price represented, to Stewart, an acceptable return on her initial investment. Thus, it doesn’t require too great a leap to conclude that four to six weeks later Stewart came to the conclusion that $60 also provided an acceptable return, taking into account the potential gain sacrificed when the volatile stock traded above that price and its recent decline.

Stewart’s reported proceeds from the December transaction totaled $227,824 before taxes. This is not an inconsequential sum of money, but we find it extremely difficult to believe that this is an amount for which Stewart would risk her career and her company, though certainly other people of similar means have done similar things.

A reasonable explanation

So what happened? We know only what is in the public record, which we note is growing by the day. However, we think there are many perfectly reasonable scenarios that could account for Stewart’s trade, though one could be forgiven for not knowing this given the newspaper coverage of the matter so far.

We outline one such scenario below:

After the Bristol Myers tender offer, during which she was unable to sell all of her ImClone shares as desired, Stewart instructed Bacanovic to sell her remaining holdings when the stock dropped below $60.

This apparently was not done in writing (though Stewart says she has written notes to this effect), nor was it in some way entered into Merrill Lynch’s records so that the trade would be made in Bacanovic’s absence or in the event he wasn’t watching the stock carefully. This would suggest that the directive from Stewart was issued in an off-hand way, as in, “Well, Peter, I think we should sell the stock if it drops below $60.” The $60 price target being almost 15 percent below what Stewart anticipated getting for all of her shares in the tender offer. To us, that represents a perfectly reasonable strategy for Stewart to employ for downside protection.

On the first day the stock dipped below $60, Bacanovic saw the trade or had his attention directed to it by an automated alert system, by Faneuil, or by someone else, possibly a member of the Waksal family. (Waksal and his daughter Aliza Waksal are among Bacanovic’s clients and Bacanovic previously worked for ImClone.)

Shortly thereafter, Bacanovic called Stewart to confirm that she wished to sell the shares, a call that would appear to confirm that the stop-loss order was not in writing or otherwise on file at Merrill Lynch. It would also demonstrate responsibility on Bacanovic’s part in the event that Stewart’s directive was in fact issued in an offhand manner.

After receiving confirmation from Stewart, Bacanovic placed the order to sell Stewart’s shares. Stewart, traveling in Texas at the time, subsequently called Waksal, and left a message saying, “Something’s going on at ImClone,” or words to that effect.

To us this is an entirely plausible chain of events, particularly if we consider what Bacanovic may have said to Stewart during their telephone conversation. Keep in mind that the dialogue below is entirely fictional and hypothetical, Noonanesque if you will.

Bacanovic: “Martha, I’m glad you called. ImClone has dropped below 60. You asked me to sell your shares when it crossed that level. I just wanted to confirm that you still would like to do that.”

Stewart: “Oh, it did? Well, what do you think? I noticed the stock has been declining for the past three weeks.”

Bacanovic: “Yes, it has. Down from 75 to 65. But the stock really has been sinking like a stone today. And on very heavy volume.”

Stewart: “Is there any news out on ImClone?”

Bacanovic: “Nothing on the wire so far.” (Or, alternatively, “Nothing on the wire so far, but the FDA’s decision on Erbitux could be announced at any time.” Or, alternatively, but we think unlikely, “Nothing on the wire but I heard from a source at ImClone that the FDA is going to reject the Erbitux application.”)

Stewart: “What does your analyst say?”

Bacanovic: “Eric Hecht says there’s speculation in the market that the FDA won’t approve Erbitux. The stock’s performance in the last few weeks seems to be signaling that.”

Stewart: “Any signs buyers are coming in to support the stock?”

Bacanovic: “No. The spread points to more weakness.”

Stewart: “Okay. Well…Let’s dump it.”

Even if we assume the stop-loss order is an invention at which both Stewart and Bacanovic independently arrived, one could just as easily presume -- and we emphasize this is not an accusation, only a hypothesis -- that Bacanovic, a scheming parvenu (at least according to the papers), sought to place himself in Stewart’s good graces by getting her out of ImClone in front of disastrous news about which he previously had been informed. If so, Stewart’s only offense was being taken by a less than entirely honest stockbroker, a type hardly unknown in the industry.

The call to Waksal

Stewart’s Dec. 27 telephone call to Waksal is telling. First, we note that Stewart called Waksal at 1:41 p.m., after giving Bacanovic the order to sell the stock. We have to assume this is true as Stewart surely is aware that the timing of events could readily be established through phone records, thereby eliminating any reason to lie.

Second, Stewart was telling Waksal something was going on at ImClone, not vice versa. This strikes us as the type of exchange two friendly CEOs might have with each other. Again, Noonanesquely entering Stewart’s brain, we hear: “Hmm. I wonder what’s going on at ImClone. I should call Sam. I’m sure he’s aware the stock is tanking. Maybe he could use some support. I’ve probably panicked. I hope he doesn’t take this personally.”

Much has been made of the fact that Waksal didn’t take Stewart’s call since he was in the office -- “writing letters” -- that day, the suggestion being that Stewart’s account of an unanswered phone call is implausible. Hardly. Waksal may have alerted others to the adverse decision coming from the FDA, and yes, it’s conceivable that he told Stewart this on Dec. 27 (or to Bacanovic who told Stewart). But it is at least equally plausible that Waksal, not knowing Stewart already had sold her shares, declined to take the call from his friend for fear of drawing her into the sordid mess he had created.

We are also confused by the unwillingness or inability of some commentators to recall that Stewart once worked as a stockbroker at the now departed Paine Webber, a position at which she presumably would have picked up the basic underpinnings of what constitutes insider trading.

Moreover, Stewart’s firm, Martha Stewart Living Omnimedia Inc., is a publicly traded corporation listed on the New York Stock Exchange. In exchange for her services, Stewart earned nearly $3 million last year, and Stewart owns 63 percent of the firm’s outstanding Class A shares and 100 percent of its Class B shares, giving her not only substantial paper wealth but 94 percent of the voting power concerning company affairs.

The notion that Stewart, having created this company and attained this position, was either unaware of securities law on this matter or willfully disregarded such law -- thereby jeopardizing herself and her eponymous firm -- is difficult for us to accept.

We emphasize that we have outlined only one of many alternative scenarios in the Stewart-ImClone matter and we concur that there many more that could be written casting Stewart in a bad light. Moreover, we concede that we may be thoroughly misguided in our hypothesis. Our point here is to demonstrate that rushing to judgment about Stewart’s actions in this matter is pointless and unfair, not least of all because insider trading, when it does occur, is extremely difficult to prove.

Until we see or hear more convincing evidence, we’re behind Stewart.

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