Professor Bainbridge...on law, politics, religion, culture & food

Was Martha Stewart’s Denial Material? The Problem with Count 9

Over at Slate, Henry Blodgett's continuing coverage of the Martha Stewart trial remains must-reading for anyone remotely interested in domestic divas in distress. In entry # 2 he correctly explains that the criminal indictment against Stewart does not allege insider trading. He also correctly explains that:

[T]he securities fraud charge is not based on Stewart's denial that she committed insider trading. It is based on her having gone beyond a denial to offer what the prosecution regards as a false explanation for the trade. Still, as Judge Miriam Cedarbaum observed in the Nov. 18 hearing, the charge is, at the very least, a "novel" application of securities law. Typical securities fraud cases are based on false statements about a company's business, financial performance, or products. In this case, Stewart's statements were not about her company but about her personal sale of stock in another company.

I agree with the Judge that the securities fraud charge is a bit of a stretch. Here's why.

As I explain in my book, Securities Fraud: Insider Trading, one can only be held liable for securities fraud if one has made a material misrepresentation or omitted to state a material fact that one had a duty to disclose.

In this case, the government is trying to prove that Martha's public defense of her transaction was a material misrepresentation. First, the government must prove that she lied when she claimed the transaction was executed pursuant to a pre-established trading plan. This going to be a battle of credibility, unless they have smoking gun physical evidence. UPDATE: On the physical evidence issue, compare the Media Cynic and Tung Yin. I don't find any of the items Prof. Yin cites to be "smoking guns," which is why I still think it will end up being a credibility contest. He may be right that the government is likely to win that contest, but after the Quattrone trial, I'm not so sure about that. (All of which tends to confirm my argument below that jury selection will matter a lot.)

Second, even if the government can prove Stewart lied, the government still must prove that her lie was material. In order for a misrepresentation to be material, the government will have to prove that there was a substantial likelihood that the reasonable investor would have considered it important in deciding whether to buy or sell Martha Stewart Omnimedia stock. This is the real stretch.

Would the reasonable investor be effected in his/her decision by Martha's explanation? I don't see how. The government is making a big deal about how critical Martha is to the company. But that's not the right question.

The right question is whether the reasonable investor would factor Martha's explanation for the trade into the investor's calculus of whether Martha will get off, which in turn would have to then be factored into the investor's calculus of whether to buy or sell MSO stock. In other words, they're either going to have to prove (1) a reasonable investor would have thought Martha was guilty of insider trading, would have changed his/her mind because of Martha's explanation for the trade, and therefore would have bought MSO stock or (2) a reasonable investor would have thought Martha was innocent of insider trading, would have had that belief confirmed by the explanation, and therefore would have bought MSO stock. Or maybe sold. Or maybe .... Well, you get the point.

I find the government's case implausible. My guess is most people either figure she didn't commit insider trading, in which case her allegedly false explanation for the trade is irrelevant, or (probably more likely) they figure she did do it but would give her a pass on the denial. Nobody would expect Martha to admit guilt. To the contrary, reasonable people would expect her to deny it, even if they think she did it. So I have a very hard time seeing how the government is going to prove that Martha's denial (even if false) would have been considered important by the reasonable investor in deciding whether to buy or sell MSO stock. (Whether they can get her on any of the other 8 counts is beyond the scope of this post!)

The government's best shot - maybe its only shot - on Count 9 is to get a jury that's really mad at rich corporate fatcats, but I assume Martha can afford a really good jury consultant.