Your broker calls to suggest that you sell some stock. So what's the harm in that? For Martha Stewart, the elements of such a fateful conversation now threaten to unravel her media and retail empire.
Since the Oct. 2 guilty plea of her broker's assistant, Douglas Faneuil, who executed what prosecutors allege was an insider trade of ImClone Systems stock (IMCL), things are looking worse for America's most celebrated homemaker. Shares in Martha Stewart Living Omnimedia (MSO), now trading at around $6, have lost about two-thirds of their value since the scandal became public on June 6. No wonder analysts such as Jeff Klinefelter of U.S. Bancorp Piper Jaffray this week gave up even trying to put a price target on MSO reports.
The recent developments prompted Stewart to resign from the board of the New York Stock Exchange on Oct. 3. Meanwhile, the House Energy & Commerce Committee is pursuing a broader investigation into the sale of more than $70 million stock by directors and officers of ImClone a month before Food & Drug Administration concerns about the company's cancer drug, Erbitux, became public.
Confused? Here are the answers to some questions surrounding the latest twists in the Martha mess:
Q: Why is Faneuil's testimony so critical?
A: He now disputes the existence of a so-called stop-loss order, which both Stewart and Merrill Lynch broker Peter Bacanovic said was behind the fortuitous timing of Stewart's sale. He says the "tippee" (the word used to refer to Stewart in the complaint against Faneuil) was told that CEO Samuel Waksal was trying to sell his stock. At issue: whether Stewart knew only that Waksal was getting out, or if she also learned that Waksal was dumping his shares because the Food & Drug Administration was about to reject the application of ImClone's cancer drug.
Q: If Stewart's knowledge was limited to the fact that Waksal was trying to dump his shares, is that enough to constitute insider trading?
A: Investigators need to prove that Stewart knew -- or had reason to know -- of the impending FDA announcement, according to securities-law experts. The fact that she tried to call Waksal later that day could suggest that she wanted more details on what was going on. But it doesn't prove that she already knew some nonpublic information, or even that she knew Waksal himself was selling stock.
Bacanovic is apparently not cooperating with investigators, although that may change if charges are filed. Stewart continues to maintain that she did nothing wrong because she had a standing agreement to sell her 3,928 ImClone shares, once the stock fell below 60. Representatives for Stewart were unavailable for comment.
Q: So how can Faneuil's guilty plea really hurt her?
A: His version of events suggests that Stewart may have lied to federal investigators and congressional investigators. That could leave her open to charges of possible perjury and obstruction of justice, which would be far easier to prove than the more damning allegation of insider trading. Charging her with lying could make her appear guilty of insider trading in the eyes of the public.
Q: Was Stewart forced to resign from the NYSE Board?
A: Technically, no. But there's little question that her position on the board would appear inappropriate in light of new developments in the case. Although she has not been charged with any crime, the accusations being lobbed at Stewart are serious enough that they could harm the perceived integrity of the board. With investor confidence already eroded to such a low point, exchange officials are especially sensitive to the whiff of scandal these days.
Stewart herself issued a press release stating that she did not want "the media attention currently surrounding me to distract from the important work of the NYSE, and thus I felt it was appropriate to resign."
Q: Is Stewart likely to resign from her company's board, or step down as chief executive?
A: Don't count on it. While Stewart is the head of a public company, she still owns about 63% of Martha Stewart Living's shares. And her alleged behavior, while distasteful, hardly ranks high on the abuse scale compared to the actions allegedly taken by officials at Enron or Tyco. Nobody has accused her of mismanaging her own company, or engaging in corruption.
Even if she were to be found guilty of lying to prosecutors, the question for investors is whether the company will fare worse if she's gone or if she stays at the helm. Chances are they will decide that the latter is preferable. If not, she can always try to take the company private.
Q: How much will her brand really suffer because of this?
A: To some extent, of course, that depends on the final outcome. It's highly unlikely that beleaguered Kmart (KM), now under Chapter 11 protection, will pull all those Martha Stewart Everyday products off the shelves. Some consumers -- perhaps in sizeable numbers -- may now boycott those Martha-approved bed sheets. Still, MSO is going ahead with plans to launch a holiday line of products in Kmart this fall.
Another influential group is watching this drama -- advertisers, who may decide to steer clear of anything Martha. With the loss of her weekly appearance on CBS's The Early Show and her need to maintain a low profile until the charges are resolved, MSO has lost a potent one-person publicity machine. Unlike other companies that bear the name of their founders, Martha Stewart is truly the personification of her brand. She hosts its TV show, handles the radio spots, and is the face that's plastered across its publications.
The company can't just reach for a substitute if she's no longer a desirable spokesperson. Advertisers will likely want a resolution of this case before considering a return to their association with Stewart.
Q: Will she be charged?
A: That could depend on whether broker Bacanovic is willing to strike a deal to testify against his former client. This much is clear: Even with Faneuil's testimony, investigators probably don't have enough to prove insider trading beyond a reasonable doubt. While they could push ahead with lesser charges like perjury, they may try to hold out for a bigger catch. They probably won't let the case drag beyond the end of the year, however. With so many other CEOs doing perp walks this fall, prosecutors are mindful that the public could soon tire of the spectacle. By Diane Brady in New York, with Mike McNamee and Amy Borrus in Washington