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The Securities and Exchange Commission may be ready to file civil insider trading charges against Martha Stewart, but securities experts say the case could be a tough one to prove. The agency has been investigating Stewart for selling nearly 4,000 shares of ImClone Systems Inc. on Dec. 27, one day before the Food and Drug Administration announced it would not review the biotechnology firm’s experimental cancer drug, Erbitux. That announcement immediately sent ImClone’s stocks into a nose dive from which it never recovered. Last month, the SEC’s Enforcement Division reportedly sent the chief executive of Martha Stewart Living Omnimedia a Wells Notice informing her that it plans to recommend that the full commission press charges. Securities lawyers said the commission almost always follows its staff’s recommendations. At first glance, things might appear grim for Stewart. ImClone’s founder and chief executive, Samuel D. Waksal, has admitted to tipping off family members about the pending FDA announcement, pleading guilty to bank fraud, securities fraud, conspiracy and perjury. Waksal did not implicate Stewart, who is a personal friend (he dated her daughter), but that could change since he still faces other criminal charges. Stewart’s version of events — that she had a standing “stop-loss” order with her broker, Merrill Lynch & Co.’s Peter Bacanovic, to sell her shares if the stock dropped below $60 — has also been undermined in recent weeks. Although the stock price did dip to about $58 the day she sold, Stewart has been unable to produce documentation of the stop-loss order, which is typically in writing. To make matters worse, Bacanovic’s assistant, Douglas Faneuil, is expected to testify that Stewart sold her ImClone shares after Bacanovic, who was also Waksal’s broker, told her that Waksal family members were selling their own holdings. Stewart’s lawyer, Robert G. Morvillo, of Morvillo, Abramowitz, Grand, Iason & Silberberg, referred calls to her spokeswoman, Allyn Magrino, who declined to comment on the case. The SEC declined to comment as well. TOUGH CASE TO PROVE Yet securities experts say such developments do not even begin to add up to a finding that Stewart was guilty of insider trading. “I think it’s going to be a tough case,” said Robert E. Gooding, who heads the securities litigation practice of Howrey Simon Arnold & White. “It seems like the SEC is trying to stretch current law on insider trading.” Insider trading turns on the concept that investors may not trade stocks based on material, non-public information that is improperly obtained. The classic example is a company executive who trades based on information he has learned or tips someone else off who then trades on the information. But the tipper can also be someone who gets the information second- or third-hand, like Bacanovic, who as Waksal’s broker, most likely knew in confidence of the stock sales. Securities experts said the case against Stewart boils down to whether the SEC can prove scienter, or that Stewart knew or should have known that selling her stock was prohibited. “It all depends on her conversation with Mr. Bacanovic or whomever she talked to,” Gooding said. If Stewart can demonstrate that all her broker said was, “I think it may be a good time to sell ImClone,” she may be off the hook, he said, adding that this was the case even if Bacanovic knew about the Waksals’ sales. If the broker told her to sell because the Waksals were selling, then that is more problematic, said Robert G. Heim, a partner at New York’s Meyers & Heim and a former SEC officer. “Securities lawyers debate this question all the time,” he said. “It helps you appreciate Ms. Stewart’s predicament.” MOSAIC THEORY In such an event, the agency would probably pursue the case against Stewart on a so-called mosaic theory, said Donald. C. Langevoort, a securities professor at Georgetown University Law Center. Although the Waksals’ stock trades may not seem material to the world at large, he explained, the SEC will try to put it in a context in which the information gave Stewart an insider advantage. For instance, if Stewart was aware that there was a major drug trial at ImClone and that FDA approval was expected shortly, she might have viewed the news of the Waksals’ sales of shares less innocently. Pleading ignorance might also be hard for someone like Stewart, a former stockbroker, chief executive of a publicly traded company and until she resigned earlier this month, a board member of the New York Stock Exchange. It is not just what you knew, but what a reasonable person in your position should have known, Langevoort said. As a fallback theory, the SEC might focus on the urgency with which Bacanovic tracked Stewart down to tell her to sell her ImClone holdings (she apparently took the call on her private plane). “If it is not a normal conversation, you can argue there is at least a jury question as to materiality,” he said. In Stewart’s defense, Langevoort said, she has an argument that although it was a misuse to pass on the information about the Waksals’ sales, “it is the kind of stuff securities brokers always spread around, and in fact, is exactly what a well-placed broker is supposed to do.” MOST CASES SETTLE Most likely, however, all these interesting legal questions will go unanswered. Ninety-five percent of civil insider trading cases settle, and given the sanctions the SEC usually seeks — a fine — there is no reason this case should not settle as well, Langevoort said. He added that the agency was probably motivated to settle as well: “When they want to make law, they look for a case that is a little less gray.” Despite the legal uncertainties of the case, and the relatively small amount at stake — the sale netted Stewart about $228,000 — experts said they were not surprised that the agency was pursuing it. “They’re making a statement,” said Jeffrey Haas, a securities professor at New York Law School. “Everyone knows Martha Stewart and what better way to send a signal that no one is above the law.” Stewart’s woes do not end with the SEC. The U.S. Attorney’s Office for the Southern District of New York is also on the case, and could prosecute her criminally on insider trading charges. If the SEC sues, Stewart will probably learn that same day whether the government will also bring criminal charges, experts said. But such charges are very rare because of the difficulty of proving insider trading beyond a reasonable doubt, added Heim of Meyers & Heim. “That’s why the Southern District is so intent on going after her broker,” he said. Thus far, Bacanovic has refused to cooperate with the investigation. The U.S. Attorney could also pursue obstruction of justice charges against Stewart for allegedly lying about the stop-loss order, Howrey Simon’s Gooding said. “If there was no such order as she claims, she’s got a problem,” he said. But, he added, there is an issue whether Stewart personally told the government anything of the sort. Stewart has publicly stated that she had a stop-loss order in place with her broker. She has also said that she spoke with the SEC and the U.S. Attorney about the stock sales but declined to discuss the substance of those conversations. Even if Stewart manages to get off with a slap-on-the-wrist, she faces a long road to recovery, experts said. As a practical matter, if she settles the SEC’s charges, she is going to have a hard time keeping her chief executive post at her company, Gooding said. “Any officer or director who enters into a consent decree with the SEC involving fraud will have difficulty keeping that position,” he said. The scandal may prove most damaging to Stewart from a public relations standpoint, said New York Law School’s Haas. “She’s becoming a Leona Helmsley of the securities world,” he said.

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