Martha Stewart Pleads
Not Guilty to Charges

A federal grand jury in New York indicted Martha Stewart on five criminal counts of securities fraud, conspiracy and making false statements to federal agents, in a case that threatens her position in the media empire she created and could land her in prison.

The Securities and Exchange Commission, in a separate civil case filed in a New York federal court, accused the head of the homemaking and media company of insider trading in connection with her sale in December 2001 of ImClone Systems Inc. shares the day before ImClone announced a negative decision by the Food and Drug Administration.

Ms. Stewart's former stockbroker at Merrill Lynch & Co., Peter Bacanovic, was charged in the same indictment as Ms. Stewart.

The 61-year-old Ms. Stewart, dressed in a neat tan pants suit, and Mr. Bacanovic, clad in a dark- blue suit, both pleaded not guilty. They were released on their own recognizance, though Mr. Bacanovic was required to surrender his passport.

Amid the swirl of corporate-crime scandals, this case has stood out because of Ms. Stewart's celebrity status.

In the more than 20 years since the publication of "Entertaining," Ms. Stewart's first book, she turned herself into a national icon by creating an art form of what had previously been thought of as household drudgery. Yet even though her magazine, Martha Stewart Living, spawned a host of imitators, and her company was a success, Ms. Stewart never managed to shrug off the barbs slung at her, setting the scene for the media frenzy over her indictment.

Ms. Stewart resigned as the head of her company Wednesday and was succeeded by two others. (See related article⁶)

Martha Stewart arrived at the federal courthouse in Manhattan.

Mr. Bacanovic entered his own not guilty plea to charges of conspiracy, obstructing justice and making false statements. Mr. Bacanovic, 41, was also charged with perjury in testimony given to the SEC and with creating and using false documents to explain away Ms. Stewart's well-timed ImClone stock trade. Mr. Bacanovic was dismissed by Merrill last year, soon after the federal probe began.

Prosecutors, after a 16-month investigation, allege that Ms. Stewart's sale was based on material, nonpublic "insider" information that Samuel Waksal, ImClone's former chief executive, and a member of his family were trying to sell all of the ImClone stock they held at Merrill. They say Ms. Stewart received the information about the Waksals from Mr. Bacanovic's former assistant at Merrill, who is cooperating with the government. The government charges that Mr. Bacanovic then tried to conceal and cover up the reason for Ms. Stewart's stock sale by testifying that she had a sell order when the shares fell to $60 apiece.

Ms. Stewart's lawyers, Robert Morvillo and John Tigue, plan an aggressive counterattack. In a statement, they asserted that the indictment reveals that the basis for the entire investigation -- the accusation that Ms. Stewart sold her ImClone shares based on inside information -- has proved to be false. "It is most ironic that Ms. Stewart faces criminal charges for obstructing an investigation which established her innocence," they said. "This turn of events can only be characterized as bizarre and raises questions about the motivation for such peculiar charges."

Moreover, the lawyers said that the news releases her company issued in June 2002 about the reasons she sold ImClone stock don't constitute a fraud. "The press releases were issued in response to Congressional leaks that Ms. Stewart sold her ImClone shares because she was tipped that its cancer drug application was going to be denied -- another allegation that has proven to be absolutely false," they said. They added that prosecutors, by charging her with fraud in connection with these releases, are saying she wasn't free to proclaim her innocence without fear of being punished by the government.

Her lawyers added: "Martha Stewart has done nothing wrong," asserting that the government is making her the "subject of a criminal test case" in the securities law area because of her celebrity status.

RESOURCES Read about important developments7 in the Martha Stewart/ImClone scandal. Read Martha Stewart's letter8 following the indictment. Read documents related to the Martha Stewart case, by arrangement with Findlaw (http://www.findlaw.com/9): • Indictment10 of Martha Stewart and Peter Bacanovic   • SEC complaint11 against Martha Stewart and Peter Bacanovic   • U.S. House panel's investigation referral12 to the Department of Justice (09/10/02)   • Misdemeanor charges13 against Douglas Faneuil (10/02/02)   • Indictment14 of Samuel Waksal for securities fraud (08/07/02)

Responded James Comey, the Justice Department's U.S. attorney in Manhattan: "Martha Stewart is being prosecuted not because of who she is, but because of what she did." He contends that she had lied to federal officials "during two interviews" with the Federal Bureau of Investigation, the SEC and the U.S. attorney's office. "For the first four months of last year," she obstructed justice, he said.

Mr. Comey rejected defense-lawyer assertions that his office had overreached in charging Ms. Stewart. Indeed, he said he had considered -- but rejected -- criminal insider-trading charges, which potentially would have exposed Ms. Stewart to increased fines and prison time. "I concluded that criminal [insider trading] charges would be unprecedented," Mr. Comey said. The SEC's burden of proof for civil insider-trading charges is less than that of federal prosecutors. Moreover, even if found guilty of civil insider-trading charges, Ms. Stewart would face fines, but no prison time for them.

If convicted on the criminal charges, Ms. Stewart could be sentenced to a maximum of 10 years in prison and as much as $1 million in fines. Prosecutors also charged that Ms. Stewart defrauded investors in her own company through a series of false statements that they alleged were designed to curb the losses in Martha Stewart Living Omnimedia Inc.'s stock price. Ms. Stewart is a controlling shareholder in the company. Prosecutors say that after an article in The Wall Street Journal¹⁵ about her ImClone sales, Ms. Stewart "falsely stated that she did not have any nonpublic information regarding ImClone when she sold the shares."

Some criminal lawyers said Ms. Stewart may have a good shot at defending against this charge. "What she said seems to be literally correct," observes John K. Carroll, a New York defense lawyer who formerly headed the securities- fraud unit in the Manhattan U.S. attorney's office. "She knew Sam tried to trade, but she didn't know why he was trading," so she may not have violated any law. There isn't any evidence that Ms. Stewart knew of the FDA action in advance.

The SEC's insider-trading case appears to be stronger against Mr. Bacanovic than Ms. Stewart, some legal specialists said. "The SEC certainly alleges facts that Bacanovic breached a duty" by making sure Ms. Stewart knew about the Waksal stock sales, says Joseph Grundfest, a former SEC commissioner who teaches securities law at Stanford University in California. "But how should Martha Stewart have inferred that the information she was getting from Merrill was material or nonpublic?"

In a written statement, Mr. Bacanovic's lawyer, Richard Strassberg, said his client is "innocent of the charges that have been filed and intends to fight them."

In all, Ms. Stewart sold 3,928 shares of ImClone on Dec. 27, 2001, yielding proceeds of about $228,000. Prosecutors say that by selling the same day as the Waksals tried to sell their shares, Ms. Stewart avoided significant trading losses. On Dec. 30, the FDA rejected ImClone's application for its cancer drug, Erbitux. The next trading day after the FDA decision, ImClone's stock price immediately fell to $45.39, an 18% decline. In succeeding days, it slid even further. Wednesday, ImClone traded at $34.32, up 77 cents, in 4 p.m. Nasdaq Stock Market trading.

Prosecutors say Mr. Bacanovic directed his assistant, Douglas Faneuil, to inform Ms. Stewart about the Waksal transactions while she was on vacation. In October, Mr. Faneuil pleaded guilty to a misdemeanor charge and agreed to testify against Ms. Stewart and Mr. Bacanovic.

Once the federal investigation into the stock trades began, prosecutors say, she and Mr. Bacanovic conspired to concoct a cover story. Prosecutors say the two spoke on the phone before they were interviewed by government lawyers in the first few weeks of last year. Both spoke of the ImClone sell order and Mr. Bacanovic gave sworn testimony about it.

Prosecutors allege that Mr. Bacanovic covered up by altering a printed "worksheet" that listed stocks held by Ms. Stewart at Merrill.

After learning of the SEC's investigation of Ms. Stewart's sale of ImClone stock, the government said, Mr. Bacanovic "altered the worksheet, using ink that was blue ball point, but was scientifically distinguishable from the ink used elsewhere on the worksheet." They said the alteration reflected Ms. Stewart's cover story that she had sold her stock in accordance with an order to sell the shares if ImClone fell to $60 a share.

Meanwhile, with Ms. Stewart's departure, the company tapped Sharon Patrick, previously president and chief operating officer, as CEO and Jeffrey Ubben, a director and managing partner at ValueAct Capital Partners, as chairman. Arthur Martinez, a director and former chairman of Sears, Roebuck & Co., has been named lead director and will preside over all meetings of independent directors of the board. Ms. Stewart will remain a director and will also serve as chief creative officer.

Write to Kara Scannell at kara.scannell@wsj.com²¹and Laurie P. Cohen at laurie.cohen@wsj.com²²

Updated June 5, 2003 9:11 a.m.