When you're accused of insider trading, etiquette demands that you present some alternative explanation of why you just happened to do exactly the right thing at exactly the wrong time. Saying you were lucky doesn't cut it. (The standard response these days is to claim that you heard the stock mentioned on CNBC. Ivan Boesky fended off the SEC for more than a decade by claiming he got his takeover ideas from reading the newspaper.)
Martha Stewart knows nothing if not etiquette, so when it came out that she had sold her nearly 4,000 shares of ImClone on Dec. 27, the day before the company announced the FDA would deny approval to its cancer drug, Stewart had a ready explanation: She claimed that she had arranged with her broker in November to sell the stock if it dipped below $60.
Stewart denies she had any secret stock-moving information on ImClone, and many of the facts uncovered so far jibe with her story. The stock did dip below $60 the day she sold. Phone records back up that her broker first called her; she returned the call and then, after the trade was executed, called her friend Samuel Waksal, ImClone's CEO.
Still, Merrill Lynch announced Friday it suspended her broker, Peter Bacanovic, who happens to be a former ImClone employee and who helped Waksal's daughter sell her ImClone stock the day before. One theory is that Bacanovic could just as easily have tipped off Stewart as Waksal.
And Stewart's account of how and why she sold at $60 is puzzling for some who trade stocks regularly. Normally an arrangement to sell at a set price has a formal name, a stop-loss order, and a highly formal procedure that results in a customer getting receipts in the mail. No paperwork for a stop-loss order has been produced so far. If that order had been in place, there would have been no need for Stewart and her broker to talk at all.
"What she said was not understood by the broker as a formal stop-loss," says Jack Coffee, a securities law professor at Columbia. "He seems to have treated this much more as a conversation, a reminder to call her at 60."
There is some confusion about stop-loss orders for Nasdaq stocks. Policies vary from firm to firm. Not every firm accepts stop-loss orders for a particular stock. But Merrill was a dealer in ImClone, so it could have handled such an order. According to the Wall Street Journal, Merrill's policy did not require Bacanovic to enter the order in Merrill's computer.
Other evidence suggests that Stewart didn't have a formal stop-loss order. The whole point of a stop-loss order is to sell a stock as it slides, not after. But the sale of her stock was delayed: She unloaded it at $58, not $60, costing her nearly $8,000. A client with an official stop-loss would be upset if her broker didn't sell when he was supposed to.
Then there's the matter of the $60 price target. A price target is not something a trader whips up informally out of scraps of dryer lint and taffeta. People who set price targets normally see stocks through the lens of technical analysis. Their main technique is drawing two lines on a stock chart to pen in the range where a stock tends to trade. If the stock breaks through the top "resistance" line, they think something good is up, so they buy. If it drops below "support," they sell because it's going to drop further. Perhaps the freakiest thing about technical analysis is that it actually works.
Whether Stewart, a former broker herself, or Bacanovic used technical analysis is unknown, but it's something they would be familiar with. Would $60 have been a reasonable target to set for ImClone? It all depends on how far back in the stock chart you look and whether you are a short-term or long-term trader. (Stewart said in her statement that she bought the stock "several years ago," probably for less than $20, since that was its range before 2000.)
Richard Dickson, a technical analyst at Hilliard, Lyons, thinks $60 would have been a legitimate target for someone who looked at the performance of the stock in the last month before Stewart's order. Checking the chart back 11 months to January, Dickson would have set the target just under $57. Former day trader Eve Seligson-Mor reads the charts differently. She thinks the real support was around $45 when Stewart gave her order. She would also have taken into consideration the 50-day and 200-day moving averages. By late November, the 50-day was around $60, but the longer-term 200-day average was in the high 40s.
What Dickson finds peculiar is the roundness of the $60 number. "One of the old saws of Wall Street is that you never set a stop-loss order on a round number," Dickson says. The reasons are complex but basically involve trying to avoid getting swept up by meaningless trading activity on the exact dollar amount.
And the informal stop-loss order was a clumsy set up, Seligson-Mor says, considering how long Stewart was in the stock. "If you've already made so much money and you want to get out, why are you fooling around?" Seligson-Mor asks. A more logical course of action would have been for Stewart to simply sell the stock in November or, if she wanted to hang on but protect her gains, to buy a put option. For a small fee, Stewart could have bought a put option that would have given her the right, but not the obligation, to sell the stock at a set price.
All of that is not to say that Stewart didn't make some informal, prescient arrangement with Bacanovic in November. But the squishier the arrangement, the less effective the story is as an excuse. Sick of hearing of people who claimed that they were planning all along to sell the stock for, say, their kid's college tuition, the SEC came up with a new insider-trading rule in August 2000. If you knew inside information, the SEC is no longer going to get into a metaphysical discussion with you over whether it was part of your decision process. They just assume it was. The only exceptions are for people who set up irrevocable trading plans in advance, Coffee says, and Martha's doesn't come close.
No matter how messy all of this looks, it still doesn't amount to an insider-trading case. What that would take is someone coming forward to prove that Martha actually knew information from inside ImClone. If Bacanovic told her that it simply looked like a good time to trade but didn't say why, for example, she did nothing wrong. It may turn out that Stewart is as good at picking when to sell stocks as she is at everything else.