Stewart Consent Decree Leaves Key Insider Trading Questions in Flux

The Martha Stewart insider trading saga finally ended on August 7. According to the SEC’s release, Ms. Stewart entered into a consent degree pursuant to which she is enjoined from future violations of the antifraud provisions, ordered to disgorge the losses avoided by her trading and required to pay prejudgment interest and a civil penalty equal to three times her avoided losses. Ms. Stewart is also barred for five years from serving as a director of a public company and is limited in the type of services she can render as and officer or employee of a public company. See Litigation Relapse No. 19794 (Aug. 7, 2006).

The consent decree ends Ms. Stewart’s entanglement with the SEC just as her business activities seem to be on the rise. Presumably this is a good business decision for Ms. Stewart. At the same time, however, the settlement leaves important legal issues unresolved. The insider trading allegations in the complaint are on the fringes of the misappropriation theory upheld by the Supreme Court in U.S. v. O’Hagan, 521 U.S. 642 (1997). Presumably it was recognition of this fact that led the government to omit insider trading charges in the criminal case, although there is wide spread public perception that the criminal case was in fact based on insider trading.

The allegations in the civil complaint suggest reasons for omitting the insider trading claims. While, for example, the SEC complaint spent several paragraphs explaining the Merrill Lynch confidentiality policies allegedly breached by Mr. Bacanovic by telling Ms. Stewart that Imclone Chairman Sam Waskal and his daughter were attempting to sell all of the Imclone shares they held at Merrill Lynch, there is little information about her knowledge of Mr. Bacanovic’s duty and his breach other than Ms. Stewart’s receipt of a policy mass mailed to all clients outlining Merrill Lynch’s “Privacy Pledge.” Indeed, the allegations on this point appear flimsy, relying on a mailing months before the trades in question of a Pledge stating that brokers promised to keep “personal financial information” restricted. Likewise, whether the inside information was in fact material is far from clear based on the conclusory allegations in the complaint. Indeed, at one point after her stock sales the complaint claims that Ms. Stewart attempted but apparently failed to determine the significance of the information she had received. Further, the share price was declining at the time of her trade which raises further questions.

Finally, the SEC’s recitation that Ms. Stewart invoked her Fifth Amendment privilege during an interview after being informed she had a right to do so, presumably in an inappropriate effort to obtain an adverse inference or at least engender public skepticism toward Ms. Stewart, is heavy-handed and contrary to the spirit of the Fifth Amendment and the U.S. justice system. The resolution of the key insider trading questions presented by the case will have to await another day.