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Martha Stewart: Organization Ethics of Insider Trading

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On December 27, 2001, Martha Stewart made a decision that changed her life, and the decision jeopardized the livelihood of her stakeholders. Ms. Stewart received a call from her stockbroker’s assistant letting her know that Dr. Samuel Waksal was trying to sell his holdings in ImClone. Dr. Waksal was the chief executive officer and founder of ImClone, and he had just received notice from the Food and Drug Administration that the drug Erbitux did not receive approval to be used as a cancer drug.

Stock in ImClone was at a high due to expectations of Erbitux getting approval, and once the news of it not getting it reached the public, Dr. Waksal knew that the price of its stock was going to decline. (Carroll & Buchholtz, 2009, p. 814) This is an example of insider trading. “Anytime a company executive or employee buys or sells stock in the company that person works for, an inside trade has occurred. ” (Newkirk, 1998) In this essay I will explore who the ‘insiders’ were that knew that the stock was in danger, and the people who did not know. I will examine how Martha Stewart’s decision affected her company, Martha Stewart Living Omnimedia, and what she could have done differently.

The concept of insider trading is when a person has knowledge, positive or negative, that can impact a company’s stock price and a trade is made based on that knowledge. Insider trading is illegal. Martha Stewart “acted on inside information when she sold 3,928 shares in biotechnology company ImClone Systems”. (White, 2006) The Securities and Exchange Commission (SEC), the federal agency that has the responsibility of regulating stock trading in the United States, alleged in its case against Ms. Stewart that she received an illegal tip from her broker Peter Bacanovic.

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The tip was that Dr. Waksal and his family members were selling their shares of ImClone stock. Bacanovic was the broker for Dr. Waksal and for Ms. Stewart. (White, 2006) When insider trading takes place, there is a select group of privileged people who have information about the stock’s possible rise or fall. In the case of ImClone, Dr. Waksal let certain individuals, his father, his daughter and his broker’s assistant, know that a change was about to take place with ImCone stock by attempting to sell his shares. These are the people that the investigation revealed did ImClone stock trading on the day before the news become public.

Martha Stewart found out about the news when Bacanovic’s assistant, Douglas Faneuil, notified her that Dr. Waksal was selling his holdings. (Hurtado, 2004) Each person who sold their holding in ImClone on December 27, 2001 with knowledge of the possible decline participated in insider trading. The other individuals that owned holdings in ImClone were not privileged to that information, they did not have an inside advantage. The two parties who knew ImClone’s stock was going down and the people who did not know have several things in common.

They all felt that ImClone’s stock was a good investment and they were all about to loose money once the FDA’s decision was made public. The difference between the two parties is one had a closer connection to the executives of ImClone and the other did not. High level employees of an organization are privileged to insider information. The spouses, friends, bankers and lawyers are connected to individuals who have “awareness of material information that’s not publicly available” to everyone. (Clark, 2009) Martha Stewart and Dr. Waksal were close friends at the time of the ImClone scandal.

This allowed her to have an inside advantage. When Dr. Waksal received the news that the FDA was not going to accept Erbitux’s application for approval, he had an ethical dilemma. He knew that he could not control what was about to happen to ImClone, but he wanted to “minimize his losses, and maybe the losses of some family members and close friends”. (Carroll & Buchholtz, 2009, p. 814) Dr Waksal; his father, Jack; his daughter Aliza; and a number of close friends had significant investments in ImClone…Of course, elling his stock and advising his father, daughter, and friends to sell their stock would reduce their loses… Dr. Waksal was faced with a tough decision.

On one hand, he could refrain from engaging in questionable trading practice and thereby incur a significant amount of losses in his investment. On the other hand, he could choose to sell his stock based on the information he received, reducing his investment losses, but violating the law and ethics of fair trade. (Carroll & Buchhlotz, 2009, p. 814) Dr. Waksal influenced each person he told about the FDA’s decision and each person who knew he was trying to sell his holdings.

When the head of an organization decides to sell his/her holdings in the organization, knowledge of this greatly influences others to do the same. Once Martha Stewart became aware of the possible decline in ImClone stock, she had a decision to make too. Her decision was whether to do nothing or to sell her stock. The decision she made affected more people than just herself. It affected every stakeholder she was associated with at that time.

This included her employees at Martha Stewart Living Omnimedia (MSO), customers and competitors of MSO products, the Kmart Corporation, CBS’s “The Early Show” where Ms. Stewart was a style contributor, and other business leaders and the public. Employees of MSO were left wondering if their jobs were in jeopardy, customers and competitors of MSO did not know the fate of the company, Kmart’s revenues suffered, Ms. Stewart was no longer needed at CBS, and the public was left with mixed views. The ethical thing that Ms. Stewart should have done that would have spared her company’s reputation and prevented the public scrutiny that each company and person close to her had to endure would have been to not act on the tip she received about ImClone’s stock.

The company’s reputation would have been saved and Ms. Stewart would have saved money. She avoided a loss of $47,673 by selling her stock in ImClone before the news of the FDA’s decision was made public. (White, 2006). “The cost to her of selling that stock, factoring in penalties, restitution, and legal cost has been estimated to be about $300 to $400 million. Furthermore, had she held on to her shares of ImClone rather than selling them, she would have made a nice profit”. (Carroll & Buchholtz, 2009, p. 17)

In February 2004, after a new clinical trial and refilling by ImClone’s partner, the FDA approved the use of Erbitux for colon cancer and the price of its stock soared again. (Carroll & Buchholtz, 2009, p. 816) Dr. Waksal’s punishment for his actions was the maximum sentence of seven years in prison and he was asked to leave his position at Stanford University, the National Cancer Institute of the National Institutes of Health, Tufts University School of Medicine and Mount Sinai School of Medicine. He also lost his position of CEO with ImClone and he had to pay a fine to the SEC.

His plea agreement with the government and his admittance that “he tipped undisclosed individuals to dump their stock before the FDA decision was made public” spared his father and daughter from facing charges. (Carroll & Buchholtz, 2009, p. 815-816) Dr. Waksal’s and Martha Stewart’s stockbroker, Peter Bacanovic, was sentenced to five months in prison, five months of house arrest, and fined $4,000. Bacanovic’s assistant, Douglas Faneuil was fined $2,000. (Hurtado, 2004) The original investigation of Martha Stewart was for insider trading, but she was not indicted for insider trading.

A spokesperson for Ms. Stewart denied the allegations and insisted that Ms. Stewart had a prearranged agreement with her broker, Mr. Bacanovic, to sell ImClone stock if it fell below $60…Her assistant broker, Mr. Douglas Faneuil, however, claimed that such an agreement never existed and that Ms. Stewart sold her four thousand shares of ImClone after she learned that Dr. Waksal and other family members had dumped their stock. (Carroll & Buchholtz, 2009, p. 815)

Ms. Stewart was indicted on nine federal counts. The nine-count indictment alleged that Stewart altered evidence that she traded on inside information about the biotech company ImCone Systems, conspired with her stockbroker to lie to federal officials investigating the trade, and defrauded shareholders in her company, Martha Stewart Living Omnimedia, by misleading them about why she had sold the stock”. (Carroll & Buchholtz, 2009, p. 815) Martha Stewart was found “guilty on four counts: obstruction of justice, conspiracy, and two counts of making false statements”. (Carroll & Buchholtz, 2009, p. 816)

Ms. Stewart’s punishment for her crime was five months in prison, five months in home confinement, and two years of probation. The fines she had to pay included $30,000, and $195,00 that included the $47,673 she saved by selling her shares in ImClone plus $137,019 in penalties that represent three times the loss avoided amount. (White, 2006) “In addition to the fine, Ms Stewart agreed to a five-year ban on serving as a director of a public company and to limitations during those five years on the extent of her service as an officer or employee of a public company”. (White, 2006) Ms. Stewart resigned as CEO and chairman of Martha Stewart Living Omnimedia on the same day she was indicted, but remained on the company's board. She also “resigned her position as board member for Revlon and the New York Stock Exchange. ” (Carroll & Buchholtz, 2009. p. 816) Some think Ms. Stewart was justly tried and convicted, while others think she was a scapegoat for larger corporate scandals. My opinion is that the punishment given to Ms. Stewart was fair. The maximum amount of time the crime she was convicted for can be unto 20 years in prison. (Hoffman, 2007) Regardless of whom you are, consequences should follow when the law is broken.

Martha Stewart broke the law in a minimal way, so her punishment fits the crime. When shareholders invest in a corporation, they do so to make a profit. The money they invest is used in several ways by the corporation. It is used for product research and development, improvements, overseas expansion, and to keep the company afloat in tough times. If the company is not successful, the investors loose money. If the company is a success, the investors are rewarded with higher values of their stock shares in the company. (Clark, 2006) Martha Stewart’s action brought an initial loss for her investors.

Advertising sales plunged at MSO’s magazine when the incident began. “MSO stock plummeted by 60 percent after the charges were made public”. (Carroll & Buchholtz, 2009, p. 815) However, “when Ms. Stewart received the minimum sentence, the stock price of her company rose by 37 percent”. (Carroll & Buchholtz, 2009, p. 816) Before the ImClone scandal in 2001, Martha Stewart’s products were sold in Kmart and she was the CEO of MSO. During the ordeal, her magazine Martha Stewart Living loss advertising sponsors and pictures of Ms. Stewart were removed from the magazine.

Less than three years after she got out of prison, the magazine showed an increase in advertising pages, pictures of Ms. Stewart are back in the magazine, she has a channel on Sirius satellite radio, she has a new magazine called Blueprint for younger people, and she has a line of homes with KB Homes. “In 2006, she published Martha Stewart’s Home-keeping Handbook, a 744-page guide to all things domestic”. (Carroll & Buchholtz, 2009, p. 817) As of today, MSO is a thriving organization. Martha Stewart has a line of products at The Home Depot, PetSmart and Macy’s, along with The Martha Stewart Show on the Hallmark Channel.

The company reported $49. 7 million for its third quarter earnings in 2010. (“Martha Stewart,” 2010) Prior to the ImClone scandal, Martha Stewart owned a magazine, her products were in Kmart and she worked for “The Early Show”; after coming out of prison, she still owns the magazine, her products are with more prominent companies, she has her own show on television and her organization is still making profits. The relationship she had with her stockholders may have suffered during the scandal, but today the relationship is mended.

Ethical and public issues must be considered in a stockholder relationship. Decisions made by executives can have enormous effects on a company which can then cause negative and/or positive changes in a stockholder’s shares depending on how the public receives a brand or corporation once it has gone through a scandal. Loyalty to the Martha Stewart brand has helped the company to endure through the storm of the scandal. (Carroll & Buchholtz, 2009, p. 816) Shareholders should be considered when decisions are made that are unethical or that could be harmful to the company’s public image.

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