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Martha Stewart Scandal

Accounting ISU
by

Simran Saroya

on 11 November 2012

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Transcript of Martha Stewart Scandal

Simran Saroya Martha Stewart Martha Stewart is the founder and former CEO of Martha Stewart Living Omnimedia Inc. and owned four thousand stocks of ImClone System, a biopharmaceutical company. She was accused of insider trading after she sold four thousand ImClone shares on December 27th. This was a day before the Food and Drug Administration refused to review ImClone System’s cancer drug Erbitux which resulted in the firm’s stock price to drop dramatically. Other than Stewart, four other company executives cashed in shares before the announcement which was too coincidental to be ignored.

Investigations revealed that the CEO of ImClone and a friend of Martha Stewart, Sam Waksal, instructed his broker Peter Bacanovic to sell $7.4 million of his and his daughter’s stocks when he found out the FDA would refuse to review Erbitux. Phone records showed that Bacanovic, also Stewart’s broker, called her office the same day and Stewart’s portion of the stocks were sold minutes later. The Scandal Another ethical issue faced during this case was Martha Stewart’s “false statements” about the stop loss order. Even though she was punished with only a few months in jail and a few years of probation, I feel that the additional loss in brand equity of her company, MSO, can be viewed as supplementary punishment. Does the Punishment
Fit the Crime? The action of Martha Stewart selling her stocks on December 27th was illegal since the information related to the FDA’s decisions was still non-public. The trading was also an ethical issue because it was unfair to all the other investors who never had access to the information. Ethical Issue 4. Martha Stewart Living Omnimedia Inc. branded products viewers- Other than MSO customers, the damage to the company had pushed away advertisers as well as many readers and viewers from her media business.

5. “The Early Show” - Martha Stewart was an “Early Show” contributor in which she would discuss recipes and share other topics in the kitchen. She later cancelled her appearance because of the scandal and refused to take questions about the investigation. Not only did this have an effect on the audience, but on the overall effectiveness and routine of the show. Stakeholders Martha Stewart’s case was handed over to the U.S. Justice Department to investigate whether Stewart had lied to the House Energy and Commerce Committee. Stewart stated she was flying in her private jet to Mexico on December 27th and the only reason she sold the ImClone stocks was because she claimed she had issued a “stop-loss” order to sell the stock if it fell below $60/share. However, her explanation collapsed when Douglas Faneuil, the broker’s assistant who handled the sale of the stocks for Stewart, told lawyers his boss had pressured him to lie about the stop-loss.

The jury later found Martha Stewart guilty of four counts of obstruction of justice and lying to investigators. On June 17, 2004, Stewart was sentenced to five months of prison, five months of house arrest, two years of probation and a fine of $30,000. She later resigned as chairwomen and CEO of her company. Result of the Scandal 1. Martha Stewart Living Omnimedia Inc. (MSO) - When a brand is tied to one individual, the individual’s decisions and reputation impacts the whole company because the company is dependent on them. When Martha Stewart was accused and charged of taking part in illegal and unethical conduct, MSO was similarly labelled and directly affected.

2. MSO’s shareholders- Martha Stewart’s company stock price fell about 35 percent within a month of the scandal on the New York Stock Exchange. MSO shareholders lost thousands of dollars and many of them even sued Martha Stewart.

3. Kmart Corporation- Kmart is one of the main retailers that carried MSO products. Due to the scandal, the Martha Stewart brand lost its distinctive edge and image of perfection. This drove away many customers, decreasing sales for Kmart. Stakeholders Does the Punishment Fit the Crime? From an ethical perspective, I feel that the punishment fits the crime. This is because Martha Stewart lost thousands of dollars after the scandal and her company lost brand equity. One of the main ethical issues in this case was that Martha Stewart used information about the FDA to make a decision that gave her a direct advantage over other investors. By selling her stocks based on that information, she avoided a loss of $51000 while all the other ImClone investors suffered due to the decrease in share price. This was unfair for all the other investors, which is why she was reasonably punished with a fine of $30000. On top of that, investors sued Martha Stewart which led to a loss of thousands of more dollars for Stewart. Avoiding the Issue Many things can be done to keep insider trading from arising again. Even though the government has criminal and securities laws on insider trading, companies should make their own insider trading policies. To begin with, companies should make sure that the policy they enforce clearly states the definition of an insider as well as insider information, ensures everyone in the company understands the conditions under which they would become temporary insiders, and how they should approach the situation. Avoiding the Issue Another way to minimize the risk of insider trading is to keep watch on external parties including consultants and advisors. In this case, Martha Stewart was fed information by her broker, Peter Bacanovic, about ImClone which prompted her to sell her stocks.

Similarly, it’s a good idea to keep an internal watchdog or to form an investigation group to monitor the company’s stock trades and look into suspicious trading activities.
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