Not A Good Thing For Martha

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CONVICTED: Prosecutors made a clean sweep with Stewart, winning convictions on all four counts related to 2001 stock trades. The domestic doyenne faces up to 20 years in prison

The Martha Stewart jokes didn't seem as funny on Friday. You know, the ones about how black-and-white stripes are in this year and how a little lemon and seltzer can remove those pesky ink stains after you've been fingerprinted. As much as we revel in the failings of the famous, many folks figured she would never face prison. Such jests have the ring of tragedy now that she has been found guilty of obstructing justice and other crimes that all but guarantee she will end up behind bars.

Stewart was caught in a simple lie, the evidence so compelling and her attorney's 20-minute defense testimony so curt—Martha's too smart to do this—that after five weeks of testimony, a jury of eight women and four men needed less than three days to deliberate. And much of that time was spent weighing the case against her co-defendant and former Merrill Lynch stockbroker, Peter Bacanovic. He was found guilty as well on four of five counts and almost certainly will see prison time too.

U.S. Attorney David Kelley insisted that the government was not singling out Martha Stewart for prosecution to make an example of her in an era of spectacular corporate corruption. Take him at his word. But Stewart was no ordinary Jane who traded on inside information to make a quick buck. Her tabloid celebrity, her status as a walking, talking brand name, and her role as CEO of a publicly held corporation turned what would otherwise have been a simple case into a treacherous web of legal and corporate issues. And at almost every turn, she and her advisers made the wrong move, getting her deeper and deeper in trouble.

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In the world of criminal defense, where the first three rules are shut up, shut up, shut up, she talked to federal investigators twice. In the world of corporate public relations, where appearance is everything, she disappeared for too long. At trial, the jury seemed to resent her celebrity cheering section—sorry, Rosie—and the fact that her attorney, Robert Morvillo, never let her testify. That might have been proper legal strategy, but the jury had spent all that time in court with her and had never been properly introduced. That's not very Martha.

At the heart of the case was a stock tip that, the government alleged, allowed Stewart, once worth $1 billion, to net a measly $45,000. Prosecutors never filed criminal insider-trading charges, though, and Stewart handed her tormentors a comparatively easy obstruction case when, as the jury decided last week, she lied to cover up why she had sold 3,928 shares of ImClone Systems on the eve of an adverse ruling for its cancer drug Erbitux. Stewart could probably have come clean immediately and received a slap on the wrist from the Securities and Exchange Commission (SEC). But by sticking to a bogus story, she turned a civil case into a criminal one. "When we first indicted this case, we said it was about lies, all about lies," says Kelley. "And as you saw in the evidence, that's what it was. Lies to the FBI, lies to [the SEC] about very important matters."

Stewart suffered her first visible emotional breakdown last Wednesday evening, after the case was handed to jurors, says a source close to her. She might have had an inkling of what was to come on Friday inside a crammed but quiet courtroom in lower Manhattan. The most serious charge against her, securities fraud, had been thrown out the previous week. But four counts remained—obstruction, conspiracy and two charges of making false statements. Stewart, grim-faced and dressed in her ritual uniform, a dark pantsuit, sat and showed no emotion as Judge Miriam Goldman Cedarbaum repeated the word guilty four times. Her daughter Alexis, 38, who had sat behind her throughout the trial, dropped her head into her hands and remained motionless for several minutes. Stewart is likely to get up to two years in prison, say lawyers familiar with the sentencing guidelines. Shortly after leaving court, she posted on her website a statement vowing to "appeal the verdict and continue to fight to clear my name."

Where did Stewart go wrong? Trial lawyers say her attorney, Morvillo, took too big a risk in assuming that the government had not made its case. The defense presented a truncated case and never put Stewart or Bacanovic on the stand to offer a competing version of events. Howard Schiffman, head of securities litigation at Dickstein, Shapiro, Morin & Oshinsky in Washington, notes that the defense's main argument—that Stewart and Bacanovic had an oral agreement to sell ImClone at a preset price—was left unsubstantiated. "What was the evidence that there was a prior conversation if they didn't testify?" says Schiffman. "The defense didn't offer an alternative theory." But that was at the end of a long trail of missteps by Stewart and her handlers. Among the fateful errors:

Stewart got a hot tip. Her first mistake, clearly, was to sell the ImClone stock, given the impetus for doing so. The bio-tech firm that was then run by her friend Sam Waksal had been riding high on its promising cancer drug. But on Dec. 26, 2001, Waksal got wind that the FDA was going to reject his company's application to move forward with its drug. The Waksal family sent word to Bacanovic, their broker as well as Stewart's, and tried to sell $7.3 million of ImClone stock. Waksal has since pleaded guilty to securities fraud and other charges and is serving a seven-year prison sentence.

Bacanovic was on vacation in Florida on Dec. 27, but Douglas Faneuil, his assistant, relayed the message from Waksal to him, prompting Bacanovic, according to Faneuil, to exclaim, "Oh, my God, get Martha on the phone!" The amount of money at stake was trivial to someone as wealthy as Stewart, who had previously sold 20% of her ImClone holdings. Yet Martha is famously tightfisted and, as testimony showed, an extremely demanding client. She was traveling to a resort in Mexico with her friend Mariana Pasternak. But through a series of phone calls she learned what Waksal was up to. She called Faneuil, who told her Bacanovic thought she might like to act on the information, which she soon did. Pasternak testified that Stewart later said to her, "Isn't it nice to have brokers who tell you those things."

The FDA rejected Erbitux the next day, and ImClone shares promptly dropped 16%. The prescient ImClone sales immediately caught the attention of compliance officers at Merrill Lynch, who on Dec. 31 asked Bacanovic about it. He said it had something to do with tax-loss selling. Later he changed his story, saying he and Stewart had a pre-existing agreement to sell the stock if it dipped to $60, which it did that day. "On Monday, Dec. 31, he said nothing, nothing about any $60 price agreement," assistant U.S. Attorney Michael Schachter argued in his summation. "Four days after the sale, Peter Bacanovic didn't say a word about what is now the cornerstone of his defense." Unsatisfied with Bacanovic's account, Merrill Lynch reported the activity to the SEC, which opened an investigation.

Stewart was in a tough spot when the allegations first surfaced. She was the highly visible CEO and namesake of her publicly traded company, and if she said nothing, she risked having her name sullied, her stock trashed and shareholder suits filed. Yet speaking up was worse. Her statements could be used against her in court. Indeed, the whole case flowed from her ill-advised explanation to investigators that she had a stop-loss order at $60. "She and her lawyers violated the first rule of criminal defense, 'Don't talk to the cops,'" says Manhattan criminal-defense attorney Gerald Shargel. That assumes, of course, that the hands-on Stewart was following her lawyers' advice. The fact that she agreed to meet with investigators not once but twice leaves Shargel flabbergasted. "If she had just kept her mouth shut, nothing would have happened," he says. Stewart was initially solely represented by Wachtell, Lipton, Rosen, & Katz, a heavyweight corporate law firm. But by the time she was indicted, she had placed her bets with Morvillo, a white-collar-crime specialist.

Still, Stewart and Bacanovic had a story, and they were sticking to it. And so was Bacanovic's assistant, the 28-year-old Faneuil. At least until the feds got him isolated from his confederates and, as they famously do, squeezed this little fish until he gave up somebody bigger. At trial, Faneuil provided what seemed to be damning testimony about being part of the cover-up. After all, he had arranged Stewart's ImClone trades.

In cross-examination, the defense zeroed in on Faneuil, tarring him as a liar who smoked pot and had tried the drug ecstasy. That might have been a tactical error. Jurors said after the trial that the most damaging testimony came from Stewart's assistant, Ann Armstrong, who sobbed on the stand before describing how Stewart at one point altered part of a phone log showing she had heard from Bacanovic on the day in question. Armstrong convinced the jurors that Faneuil was believable. "That was one of the strongest things that showed there was some kind of cover-up," said juror Chappell Hartridge. When a witness for Bacanovic, Stewart's business manager Heidi DeLuca, seemed to corroborate the $60 agreement, assistant U.S. Attorney Schachter's brilliant cross-examination shot holes in her testimony.

A final courtroom gaffe, it seems, was the presence of celebrity friends—among them Rosie O'Donnell and Bill Cosby—who sat behind Stewart in a show of support. "If anything, we may have taken it as a little bit of an insult," Hartridge said.

There are ways to defend yourself in public without giving prosecutors ammunition—and reasons for doing so. After all, the jury pool is out there listening. But Stewart's longtime handlers at the Susan Magrino Agency seemed overwhelmed. For months the agency failed to put out any kind of message. Says Susan Magrino: "It wasn't a p.r. strategy. The lawyers were calling the shots at the time."

Before she was indicted last summer, Stewart handed the reins to Citigate Sard Verbinnen, the crisis-management firm that Hewlett-Packard's Carly Fiorina used to help win a brutal proxy battle to take over Compaq. Once Citigate took the helm, Stewart starting getting her message out with careful prime-time interviews and the Internet. Within hours of her indictment, Citigate launched, which posts notes from well-wishers and upbeat messages from Stewart. The site has received more than 16 million hits and 81,000 e-mails.

Martha Stewart Living Omnimedia went public amid great fanfare in 1999. But savvy investors have long worried about the proverbial question, "What happens if she gets run over by a bus?" The company is so dependent on her name, likeness and image that if they are not in good standing, the franchise is seriously degraded. After the verdict, shares of Stewart's company dropped nearly 23%.

Since the ImClone troubles first surfaced, the company has made efforts to play down Stewart's role, cutting back on photos of her in its flagship publication, Martha Stewart Living. But the vast majority of the business is still plastered with the name Martha Stewart, and the efforts to branch out are late in coming.

Even if she wins on appeal, a long shot in any criminal case, Martha Stewart's name and company have suffered phenomenal damage. Yet Americans love to rehab their celebrities after they have been trashed seemingly beyond repair, and brand names have proved to be nearly indestructible. Maybe Martha will be too.