Contrary to what some have suggested, the securities fraud charge is not based on
Stewart's denial that she committed insider trading. It is based on her having gone
beyond a denial to offer what the prosecution regards as a false explanation for the
trade. Still, as Judge Miriam Cedarbaum observed in the Nov. 18 hearing, the charge
is, at the very least, a "novel" application of securities law. Typical securities
fraud cases are based on false statements about a company's business, financial
performance, or products. In this case, Stewart's statements were not about her company
but about her personal sale of stock in another company. The prosecutors argue that,
because Stewart's reputation is (or was) critical to the business of her company,
reasonable investors would have viewed her explanation as having altered the "total mix"
of available information about the company's stock, and, therefore, because it was
allegedly false, it would have defrauded them.
What Martha Stewart won't be tried for (in January) is the crime that she was originally
assumed to be guilty of: insider trading. The indictment repeatedly implies that Stewart
committed this offense--she is said to have possessed "material nonpublic information"
when she sold her stock and to have known that this information had been
"misappropriated" (the two prerequisites)-- but she is not charged with insider trading,
perhaps because the prosecutors do not believe they can prove it beyond a reasonable
doubt. Stewart has, in fact, been charged with insider trading, but by the SEC, not the
U.S. attorney, and in a civil case, not a criminal one. (Civil charges require a lower
burden of proof: "more likely than not" or "by clear and convincing evidence," instead
of "beyond a reasonable doubt.") As explained in my first dispatch, the SEC will likely
face a challenge in proving the charge because the type of "material nonpublic
information" that Stewart allegedly possessed has not, in the past, been treated as
illegal to trade on (and, arguably, was neither material nor nonpublic, according to the
technical definitions of those terms).
...Stewart will also be tried for a more serious and controversial charge: criminal
securities fraud (Count 9). In June 2002, amid widespread speculation that Stewart had
been tipped off about the Food and Drug Administration's impending refusal to review
ImClone's cancer drug Erbitux--speculation that hit the stock of Stewart's company,
Martha Stewart Living Omnimedia, like a pipe to the forehead--Stewart issued publicly
the same "predetermined price" explanation that she had already given the U.S. attorney,
the FBI, the Securities and Exchange Commission, and a congressional subcommittee.
Because the prosecutors believe this explanation is hogwash, they charge that, by
issuing it, Stewart swindled investors in her company.
As I said in class, if the prosecutor's theory is valid, then it would also be
securities fraud if Martha Stewart were charged with murder and denied the charge even
though she was actually guilty so as to avoid a drop in the price of her company. Going
further, under this theory it seems to me it would be illegal for any key employee--
that is, one whose future is important to the company-- to lie about parts of his
personal life that affect his value to the company. A CEO could not falsely deny that
he was guilty of drunk driving. A CFO could not falsely deny that he had been diagnosed
with cancer. A key research scientist could not falsely deny that he was thinking of
retiring early and going to live in Tahiti. This seems absurd.
The missing connection might be in the lie's motivation. If someone lies only to manipulate the price of a stock he is selling, that does seem like securities fraud, even if the lie is about his personal life. But if he lies for an entirely separate reason, that should not be securities fraud. In mixed cases, I'd put the burden of proof on the prosecutor that the securities sale was the main reason for the lie.
I don't see how the prosecutors can win this case. Professor Bainbridge discusses how even if this is treated as lying to influence the price of Martha Stewart Living Omnimedia stock, there are still problems, because for it to be fraud, the lie has to be material (even if she lied, which is not altogether clear). If she lied by saying that she was innocent, but nobody believed her, since defendants pleading guilty often are lying, then the lie is not material.
Still another defense argument for Stewart is that even if she did lie, it might be to protect shareholders rather than defraud them. Suppose she did X, but claimed she didn't do X. Suppose, furthermore, that doing X really will have no effect on the present and future profits and dividends of Martha Stewart Living Omnimedia stock (for example, prosecutors are falsely claiming that X is insider trading, but she knows that the courts will eventually agree with her that it is not). Then lying about X is a way to protect investors from their own wrong reaction to what ought to be irrelevant news. Under this theory--- a plausible one-- it is the prosecutors who are manipulating the stock prices by their irresponsible charges, and Martha Stewart was just protecting the integrity of the securities markets.
Of course, all this is separate from the question of whether Martha Stewart deserves to go to jail for something else. She may well have engaged in insider trading, or perjury-- or even murder or making atrocious cakes, for all I know. I'm just talking about the charge of securities fraud here.
[ http://php.indiana.edu/~erasmuse/w/04.01.23a.htm . Erasmusen@yahoo.com. ]
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