Martha Stewart is in trouble with the Man today because, nearly two years ago, she learned the answer to a perfectly reasonable question a few weeks too early: Is the chief executive of the company in which I own shares selling his stock?
Why didn’t she have the right to know?
Stewart, if she is as micromaniacally diligent about her stock portfolio as she is about frosting cakes, had good reason to be suspicious. In the two weeks between Dec. 5th and Dec. 19, 2001, ImClone’s share price fell from $73 to $61.
It was public knowledge that ImClone’s future rested on the FDA’s approval or denial of an application for cancer drug Erbitux. No news was forthcoming, but the shares were clearly trading on negative rumors.
ImClone CEO Sam Waksal, a good friend of Stewart, started selling his shares on Dec. 26. Stewart sold hers on Dec. 27. ImClone finally announced the FDA’s rejection of its cancer drug on Dec. 28; the price fell an additional $9 the day after the announcement.
Waksal was wrong to sell out early, in a clear (and now closed) case of trading on insider information. But why didn’t Stewart, and other outside ImClone investors who weren’t
friends of Waksal, have the right to know that the CEO was dumping his stake?
According to the Securities and Exchange Commission, they did have the right to know — up to 41 days after the fact.
Prior to last year’s passage of the Sarbanes-Oxley Act (long after Stewart’s trade), corporate directors and officers had until ten days after the end of a calendar month during which to report insider purchases and sales to the public.
Sarbanes-Oxley sped up this leisurely process. Now, insiders have until before the end of the second business day following the day on which the transaction is executed to disclose stock purchases and sales.
So Stewart and the feds agree: A lot can happen in a couple of weeks.
Stewart didn’t have to wait. According to prosecutors, her Merrill Lynch broker, who was also Waksal’s broker, told his assistant to tell Stewart that Waksal was selling his ImClone shares. Sensibly, she sold as well.
Did Stewart act on an insider tip?
Insider trading is a murky affair (and the insider-trading charge against Stewart is civil, not criminal). The private Association for Investment Management and Research (AIMR), which administers the rigorous Chartered Financial Analyst (CFA) exam, suggests that investment professionals who receive material non-public information “shall not trade or cause others to trade in that security if such trading would breach a duty or if the information was misappropriated or relates to a tender offer.”
Stewart had no clear duty to ImClone (unlike Waksal, she wasn’t a corporate insider there). No tender offer applied. But, was Stewart’s trade based on misappropriated information?
It doesn’t seem so. Stewart wasn’t privy to any material non-public information on ImClone when she sold her stake, save for the obvious negative clue that the CEO was selling his. She didn’t peek at confidential company files or eavesdrop on cell-phone conversations.
Instead, a gift was handed to her: Her broker told her that Waksal was selling. Prosecutors don’t allege that he told her why.
Did Stewart act honorably? Not really. As the director of her own public corporation, she could, and should, have called Merrill Lynch’s corporate compliance department and reported that Merrill brokers were encouraging customers to trade on the basis of other customers’ trades. As the SEC notes, this was a clear violation of confidentiality rules. She didn’t.
But when Stewart sold, she acted on her interpretation of an insider’s behavior, not on a real insider tip. As the SEC puts it: “had information about the Waksals’ efforts to sell been known publicly, it would have signaled insider pessimism at ImClone about the FDA decision, the prospects for Erbitux, and the future of the company.”
Stewart already knew what her broker told her. So how could she help being pessimistic?
The SEC knows that the world of corporate insiders, investment professionals, and wealthy private investors is a small one. That’s why the government has strengthened its insider-trading disclosure requirements from 41 days to two.
If the SEC were to close the last loophole and force disclosure from two business days to one, Stewart wouldn’t have to rely on her broker in the same situation today. She could look on the Internet like everyone else.
— Nicole Gelinas is a financial journalist. Her interpretation of the AIMR standard is her own.