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The SEC Goes Out on a Legal Limb in Its Bid to Net Martha Stewart

Even the Justice Department avoided stretching insider-trading laws that far.

June 06, 2003|Stephen M. Bainbridge | Stephen M. Bainbridge is professor of corporate and securities law at UCLA.

On Wednesday, the Securities and Exchange Commission accused Martha Stewart of insider trading. That means the SEC is asking us to believe that Stewart -- TV show host, corporate president and multimillionaire -- risked her reputation, livelihood and fame to avoid losing a whopping $45,673.

But what Stewart allegedly did doesn't look much like classic insider trading. Classic insider trading looks like this: Suppose Jane is the chief executive of a big mining corporation. Jane learns the company has struck gold. Before the discovery is announced, Jane buys some more stock, knowing its value will rise.

Now suppose Jane tells her friend Don the good news. Don buys stock, also pre-announcement. That is known as tipping, and it can be another form of insider trading. According to the U.S. Supreme Court, the tip is illegal if Jane got a personal benefit from making the tip and Don knew (or should have known) that Jane's tip violated her fiduciary duty to the company.

A third kind of insider trading is called misappropriation. Suppose Jane's company plans a hostile takeover of a second company. She tells her attorney Anne about the plan. Anne then buys stock in the target company. Anne has committed illegal insider trading based on misappropriated information.

If Anne tips her friend Dave, that too would be illegal.

But here's what Stewart appears to have done: She spoke with her broker, who told her that another of his clients, Samuel Waksal, the head of ImClone, was selling off stock in his own company. She decided to dump hers as well.

It is as though Jane's broker thought her trade was unusual and told another client about it.

Stewart was a friend of Waksal's, but it's pretty clear that she didn't know what Waksal knew: The Food and Drug Administration was going to hold up a new drug his company wanted to release.

In fact, according to the SEC itself, after selling her ImClone stock, Stewart called Waksal and left the following message: "Martha Stewart -- something is going on with ImClone and she wants to know what."

Although the SEC's civil complaint makes much of the Stewart-Waksal friendship, the SEC nowhere alleges that Stewart had any advance knowledge of the problem with the FDA.

In other words, Stewart got a hot tip and she acted on it. So what?

As a society, we care about insider trading because it is a form of theft. Information about the gold discovery belonged to Jane's company, not to Jane. Information about the takeover bid belonged to the company, not to Anne. They stole that information from its owner and used it for personal gain. If the information leaked as a result, the company would be injured.

But what information did Stewart steal and from whom? The SEC alleges that she stole it not from ImClone but from Merrill Lynch, where her broker worked. Is this theft as we know it?

Tellingly, the Justice Department did not charge Stewart with insider trading. Only the SEC's civil complaint does so. Instead, the Justice Department went after Stewart for conspiring to obstruct justice by engaging in the great American pastime of lying to the cops.

According to published reports, the U.S. attorney decided that going after Stewart would be an "unprecedented" expansion of insider trading law.

I don't particularly like Martha Stewart's public persona. Like a lot of people, I get a vicarious thrill out of seeing the high and mighty brought low. But charging her with insider trading stretches that crime beyond where it was ever meant to go.

So what have we learned from all this? That Stewart apparently didn't pay much attention to the Watergate scandal. It wasn't the break-in that brought down Nixon's presidency; it was the cover-up.

It won't be insider trading that brings down Martha Stewart. It will be the cover-up.

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