Martha Stewart's Insider Trading Case Research Paper

Pages: 6 (2068 words)  ·  Bibliography Sources: 6  ·  File: .docx  ·  Level: College Senior  ·  Topic: Business - Law

Martha Stewart's Legal Troubles

As reported by Kevin Rawls (2009) Martha Stewart owned shares of a company called ImClone. In 2001 ImClone received notification that a new prescription drug, Erbitux, in which the company invested large amounts of money for research and development, would not receive approval by the Food and Drug Administration (FDA). Sam Waskal, the CEO of ImClone, made a call to his stock broker, Peter Bacanovic, and instructed him to sell his personal shares of the company stock in order to avoid financial losses. The Bacanovic also served as a broker for Martha Stewart, and notified her that the CEO was liquidating his stock in the company and that it would be in her financial interest to follow suit by selling off her own 3,928 shares. The Securities and Exchange Commission (SEC) noticed an unusual coincidence between the selling of mass amounts of shares by the CEO of ImClone and Martha Stewart and began an investigation to determine if Martha Stewart was guilty of insider trading.

Insider Trading

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The Security and Exchange Commission (SEC) defines insider trading as buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. At the beginning of the twentieth century insider trading was not considered illegal. In fact, a Supreme Court ruling once characterized insider trading as a perk of being an executive. However, after the excesses of the 1920's and the ensuing depression, there was an inevitable backlash and shift in public opinion. Consequently insider trading was banned and serious penalties imposed on those convicted in engaging in the practice (Kennon, NDI). The question of what constitutes insider trading is difficult to determine. For the SEC to prosecute and convict someone for insider trading, they must prove that the defendant had a "fiduciary duty" to the company and/or intended to personally gain from buying or selling shares based upon the insider information.

Research Paper on Martha Stewart's Insider Trading Case Assignment

In 1988 James O'Hagan, a lawyer at the firm of Dorsey & Whitney, which represented Grand Metropolitan PLC, when he learned Grand Met was planning to launch a tender offer for Pillsbury. Although O'Hagan never personally worked on the deal, he started buying up Pillsbury stock and call options. When Grand Met announced its tender offer for Pillsbury in early October, the value of O'Hagan's stock and options holdings skyrocketed. All told, O'Hagan pocketed more than $4 million in profits. O'Hagan was convicted on fifty-seven counts, but the conviction was overturned on appeal. Eventually the case ended up in front of the Supreme Court who reinstated O'Hagan's insider trading convictions. In doing so, the Court endorsed an expansive definition of "insider" which goes beyond traditional corporate insiders. The court found that while O'Hagan had no duty to Pillsbury or its shareholders, he did have a duty to the source of his information. O'Hagan's failure to disclose his personal trading to Grand Met and Dorsey, in breach of his duty to do so, made his conduct deceptive (Salceda & Rodda, 1998).

In another case Barry Switzer, who at the time was the Oklahoma football coach, faced prosecution by the SEC after he and some friends purchased shares in an oil company in 1981. Switzer was at an Oklahoma track meet when he overheard a conversation between executives concerning the liquidation of Phoenix Resources. He purchased stock in the company at around $42 per share, and later sold at $59, making around $98,000 in the process. The charges against him were later dismissed by a federal judge on a "lack of evidence." Based on legal precedence Switzer probably would have been fined and served jail time if one of his players was the son or daughter of the executives and had mentioned the tip to him off-handedly. One might say there is a fine line between lucky and criminal (Kennon, NDI).

The Case

Drew Hoffman (2007) explains the problems Stewart faced before the trial. First, she sold securities; this is a factual issue that is not in question. Next, she obtained nonpublic information. The public was not aware that ImClone's CEO was selling his shares of ImClone because of the impending drop of ImClone's share price and, as a result, this was nonpublic. In addition, the information was material. Everyone who had an interest in ImClone knew that the FDA was soon to make a decision on Erbitux. In that context, a reasonable investor would want to know that the CEO was selling stock. Finally, Stewart may have breached a duty of obligation or trust, though this element is not altogether clear. Stewart was not an officer, a director, or a majority shareholder of ImClone; accordingly, she owed the shareholders no fiduciary duty. Therefore, there seems to be no breach of confidence or trust. As a result, this does not seem to be an inside trade. However, there is a tipper/tippee section included in the insider trading regulations which provides that an individual is liable for securities fraud if he/she receives a piece of information originating from an insider and purchases or sells a security based upon this information. In such circumstances, the receiver becomes a tippee. Moreover, if the tippee passes this insider information along, the new receiver also becomes a tippee. Accordingly, in an extenuated manner, Stewart could be considered an insider and subject to securities fraud liability.

The Verdict

It is possible, since Martha Stewart was not an officer of the company and technically had no real responsibility to other investors and therefore did not have a fiduciary duty to them, that if Stewart had originally been forthright about her activities to the authorities she might not have been convicted of insider trading. Instead Stewart chose to conspire with her broker in an attempt to fabricate a story about how there was a standing order for to sell her shares if ImClone stock price fell below $60 per share. This development in the case represents an important ethical distinction in the decisions made by Stewart up until this point. When Stewart initially received the information about the potential drop in the stock price of the ImClone stock and subsequently asked her broker to sell her shares, it is possible that she did not knowingly engage in illegal behavior. However, once Stewart conspired with her broker to defraud the Securities and Exchange Commission and knowingly lie to federal investigators she engaged in illegal and unethical behavior for which no claim of ignorance would be credible (Rawls, 2009).

Sheldon Richman (2003) pointed out that after more than a year of associating Stewart with insider trading the U.S. Justice Department failed to indict her for that crime. In other words, after a year of investigation the U.S. attorney decided that he could not prove to a jury beyond a reasonable doubt that Martha Stewart had illegally traded stock on the basis of material nonpublic information about a publicly held company.

The case the U.S. Attorney filed against Stewart was about lying, lying to the FBI, lying to the SEC, and lying to investors. Specifically, the charges were obstruction of justice, conspiracy, and securities fraud. Charges of perjury were not filed because her statements to the government were not made under oath.

Although Stewart maintained her innocence, she was found guilty and sentenced on July 16, 2004 to five months in prison, five months of home confinement, and two years probation for lying about a stock sale, conspiracy, and obstruction of justice.

In August 2006, the Securities and Exchange Commission announced that it had agreed to settle the related civil case against Stewart. Under the settlement, Stewart paid disgorgement of $45,673, representing the losses avoided from her insider trading, plus prejudgment interest of $12,389, for a total of $58,062. A civil penalty of $137,019, representing three times the amount of the losses avoided was also imposed. Stewart agreed to a five-year bar from serving as a director of a public company, and a five-year limitation on her service as an officer or employee of a public company by prohibiting her from participating in certain activities, including financial reporting, financial disclosure, monitoring compliance with the federal securities laws, internal controls, audits or Commission filings (U.S. Securities and Exchange Commission, 2006).

Discussion

The high profile nature of the Martha Stewart insider trading case led to prolific research and writing by academic and media professionals. This prosecution has engendered a diversity of opinion about the law, its application, and Stewart's character.

According to the Center for Individual Freedom (NAI, 2004) this is an open and shut case. In the course of an insider trading investigation, the SEC and FBI questioned Martha Stewart and Peter Bacanovic, her stock broker, over Stewart's sale of ImClone stock. Stewart and Bacanovic conspired to lie to government investigators. Stewart lied to the investigators. Bacanovic lied to the investigators. Lying to government investigators is a free-standing felony, regardless of the presence or absence of any other criminal activity. To twelve jurors the sum… [END OF PREVIEW] . . . READ MORE

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