Martha Stewart's Insider Trading Case: A Practical Application of Rule 2.1 by Hoffman, Drew INTRODUCTION "Arrogance." That seems to be the public perception of why Martha Stewart received significant criminal penalties and suffered major setbacks in her business ventures for her role in the ImClone Systems, Incorporated ("ImClone") insider trading scandal. However, public perception is often misguided, if not completely wrong, and thus, further research is required to determine where the blame should be placed. After examining the factual circumstances surrounding the insider trading scandal, it becomes clear that Stewart's arrogance did play a considerable role in her convictions and setbacks. Nonetheless, there is one individual who could have, and should have, attempted to stop Stewart from lying about her actions: Stewart's pretrial counsel John Savarese. This note contains three sections. The first two sections provide a background for Stewart's case. Part I lays out the facts of the case, and Part II presents a synopsis of insider trading law in order to lay the foundation for how Savarese should have advised Stewart in light of the penalties she faced. Finally, Part III focuses on a lawyer's role as an advisor as stated in Rule 2.1 of the Model Rules of Professional Conduct ("Model Rules"). In Part III, Rule 2.1 is broken into two components in order to identify the choices Savarese could have made based on his role as a legal advisor and to demonstrate how Rule 2.1, if followed closely, would have allowed Savarese to have been an effective advisor. I. WHAT HAPPENED . . . In December 2001, Martha Stewart's friend Sam Waksal, CEO of a biotech company called ImClone, learned that the FDA was going to reject ImClone's application for approval of its cancer drug, Erbitux.1 Waksal attempted to call his stock broker, Peter Bacanovic at Merrill Lynch, but Bacanovic was on vacation.2 However, Waksal did speak with Doug Faneuil, Bacanovic's assistant, and told him to sell Waksal's stock in ImClone.3 Following this exchange, Faneuil called Bacanovic and explained the situation.4 Bacanovic, who also served as Stewart's broker, told Faneuil to call Stewart and give her the story.5 Faneuil spoke with Stewart telling her that he thought ImClone's share price was going to drop because Waksal was trying to cash out.6 Upon learning this, Stewart decided to sell all 3,928 of her shares in ImClone, giving this order on December 27, 2001. 7 The sale occurred one day prior to the announcement concerning Erbitax's rejection.8 Stewart avoided losses of $45,673 by selling her 3,928 shares of ImClone.9 At the time, Martha Stewart claimed that she was worth $750 million, and thus, this loss would have been equivalent to approximately .006% of her total net worth, beyond miniscule from a business perspective.10 Therefore, her business risk in not performing this trade was next to nothing. Not only were Stewart's fines about four times greater than what she saved by selhng when she did but her many business ventures incurred significant losses.11 Had Stewart stopped to do a risk-reward analysis, she probably would have realized that the sale was a bad move, particularly with the shadow of pervasive corporate corruption that the Enron fraud had cast upon the business community at that time.12 Following the trade, botii Merrill Lynch and the SEC began investigating Stewart's trade, leading to the questioning of Bacanovic and Faneuil.13 It is at this critical juncture where Savarese should have stepped in and explained the possible implications of lying about this trade. Savarese accompanied Stewart to her first interview with the SEC, but nonetheless, Stewart, in conjunction with Bacanovic and Faneuil, fabricated a story to explain the remarkably coincidental sale of stock.14 Faneuil, at Bacanovic's suggestion, told the investigators that Stewart sold her stock in order to offset other tax gains.15 Both Bacanovic and Stewart claimed that they were in agreement to sell ImClone if it fell below $60. 16 Further, Stewart's assistant witnessed Stewart erase Bacanovic's message concerning ImClone's impending downward turn though Stewart later told investigators that she did not know if there ever was a message.17 Following the erasing of the message, Bacanovic produced a worksheet with an "@ $60" entry that referred to the alleged agreement between Stewart and Bacanovic to sell ImClone if it fell below $60.18 It is worth noting that the only entry on the worksheet that was in different ink was the "@ $60" entry.19 There were a number of charges brought against Stewart, who continues to claim that she did nothing wrong.20 These charges included, inter alia, conspiracy to obstruct the SECs investigation, making false statements, and perjury.21 The insider trading charges for the actual trade, however, were stayed until the completion of Stewart's criminal trial regarding lying about the trade.22 Eventually the insider trading charges were settled. Under the terms of the settlement, Stewart agreed to pay $195,081 and did not have to admit or deny any wrongdoing.23 Thus, the most significant penalties Stewart received, such as jail time, arose from the cover-up. The likelihood of charges being brought, while not an absolute certainty, should have been recognized as probable by Savarese. If the potential charges and the severity of the liability that Stewart potentially faced were brought to Stewart's attention, she may have refrained from lying. However, pursuant to the Model Rules, if Stewart did not listen to Savarese's advice, he could have and should have withdrawn from the case, an issue that will be discussed in Part III.24 II. INSIDER TRADING In order to evaluate the decision Stewart faced, it is appropriate to examine the likelihood of conviction on the insider trading charges and the potential punishment that would accompany such a conviction. Insider trading refers to the buying or selling of securities by a person who has obtained nonpublic information that is likely to be important to a reasonable investor and who employs that nonpublic information in breach of an obligation of confidence or trust.25 The term used to describe the "importance to a reasonable investor" is "material."26 This explanation of insider trading can be applied to Stewart's sale of her ImClone shares. First, Stewart sold securities, a factual issue that is not in question.27 Second, she obtained nonpublic information. The pubhc was not aware that ImClone's CEO was selhng his shares of ImClone because of the impending drop of ImClone's share price and, as a result, this was nonpublic. Third, the information was material. Everyone who had an interest in ImClone knew that the FDA was soon to make a decision on Erbitux. In that context, a reasonable investor would want to know that the CEO was selling stock. Fourth, Stewart may have breached a duty of obligation or trust, though this element is not altogether clear. Stewart was not an officer, a director, or a majority shareholder of ImClone; accordingly, she owed the shareholders no fiduciary duty.28 Therefore, there seems to be no breach of confidence or trust. As a result, this does not seem to be an inside trade. However, there is a tipper/tippee section included in the insider trading regulations which provides that an individual is liable for securities fraud if he/she receives a piece of information originating from an insider and purchases or sells a security based upon this information.29 In such circumstances, the receiver becomes a tippee.30 Moreover, if the tippee passes this insider information along, the new receiver also becomes a tippee.31 Accordingly, in an extenuated manner, Stewart could be considered an insider and subject to securities fraud liability. Nonetheless, this is an incredibly litigious issue and it certainly is not cut-and-dry that the trade Stewart made constituted insider trading. Therefore, there is no guarantee that if Stewart had come clean and been honest about what transpired that she would have been found guilty of insider trading. Savarese should have advised her in a manner that made this clear. This point will be dealt with in greater detail in Part III. It is important to further understand the possible legal consequences Stewart faced from the insider trading charges in order to effectively critique Savarese's role as an advisor. A person is subject to Rule 10(b)(5) of the Securities Exchange Act when one intentionally performs an inside trade.32 The maximum penalty for a violation of Rule 10(b)(5) includes imprisonment for up to 25 years and/or $5 million in fines.33 Stewart was a stockbroker for seven years in the 1960s and was on the Board of Directors for New York Stock Exchange,34 which suggests that she is a very savvy business person. Accordingly, a court may have found that she acted intentionally.35 It is incredibly unlikely, however, that she would have received jail time and millions in fines for completing a trade which was not clearly an inside trade and that only netted her approximately $45,000. It is more likely that the penalties described in Section 21(A) of the Securities Exchange Act of 1934 would have been imposed.36 This section provides that "The amount of the penalty . . . shall be determined … in hght of the facts and circumstances, but shall not exceed tiiree times the profit gained or loss avoided."37 In order to determine the "facts and circumstances" courts usually perform a six factor analysis focusing on 1) the egregiousness of the violations; 2) whether the violation was an isolated incident; 3) the degree of scienter involved; 4) the defendant's economic stake in the violation; 5) the defendant's role or position when engaged in the fraud; and 6) the likelihood that the misconduct will recur.38 In Stewart's case, the violation 1) was not very egregious;39 2) was completely isolated; 3) arguably involved a low level of scienter because it was not clear whether the trade she performed was an inside trade; 4) involved a very low economic stake relative to her total net worth; 5) did not involve a company in which she was an officer, director, or majority shareholder; and 6) will arguably not be repeated because the other five factors fall heavily in her favor.40 This relevant information should have been disclosed to Stewart by Savarese, so she could best weigh her options. Given this information, it would have been evident that her best option was, beyond any reasonable doubt, to come clean and admit the trade. III. ATTORNEYS AS ADVISORS: RULE 2.1 AND ITS APPLICATION TO STEWART'S CASE There are two major components of Rule 2. 1.41 The first is the exercise of independent professional judgment and the candid advice that should come from such judgment.42 The second is the lawyer's application of factors beyond purely legal ones as they are relevant to the client's situation.43 The two components will be addressed separately, using Stewart's story as a case study for how Rule 2.1 should be utilized. Many professionals, in many different professions, take on the role of advisor within their practice. In education, teachers advise students concerning school matters as well as on vocational matters; in medicine, doctors serve as advisors to patients and their families concerning medical decisions; and in the pastorate, ministers and the like counsel people regarding their relationships with a higher power. In each of these disciplines, the counseling mentioned concerns the professional's area of expertise. The scope of these professionals' counseling duties does not necessarily end there. For instance, a student may come to a teacher for advice about how to deal with a tough family situation. Similarly, when a doctor speaks with a family member about their loved one's condition and options, she takes on a role of confidante. She is someone who can be trusted and is there to help the family understand the benefit of each option not just regarding the health of the ill party but also concerning the effect of a decision on the life of the family generally. Pastors also find themselves advising members of their congregation about more than their relationship with God. Professionals in each of the areas discussed must be capable of advising those whom they come into contact with in their professional lives beyond the basics of their profession. In this regard, lawyers are no different.44 Lawyers should be willing to advise their clients in a manner that goes beyond purely technical legal advice.45 They should also be capable of advising in this manner. In fact, Rule 2. 1 of the Model Rules speaks to this issue exactly. Rule 2. 1 states that "In rendering advice, a lawyer may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the client's situation."46 As Rule 2. 1 indicates, a lawyer must be prepared to advise his/her clients using aspects outside the realm of legal issues.47 Thus, it is imperative that lawyers see themselves as advisors in a general sense. This is not to say, however, that a lawyer should pretend to know everything.48 Rather, a lawyer should call upon all of his relevant knowledge and experience, in the law and otherwise, when advising a client concerning his or her case.49 In this mode, a lawyer will be able to assist clients more meaningfully and, most likely, lead the client to make the best choices regarding their legal matter. Along these same lines, a lawyer must realize that in order to fulfill his duties as an advisor under Rule 2.1, he must give his client both professional and commonsense advice.50 A client may want an attorney to draft a contract for a business deal, but at the same time may want the lawyer's own opinion as to whether the deal is a good one or not. Thus, lawyers, in this day and age, must be willing to give both kinds of advice to their clients. In order to do so effectively, the lawyer will often have to look beyond technical legal issues. Stewart's story demonstrates this well. Stewart's plan to deny all culpability was misguided for two major reasons, both of which should have been brought to Stewart's attention by Savarese. First, there were too many people who knew about the cover-up. There was Stewart's assistant who Stewart asked to erase the message concerning the impending drop of ImClone's share price,51 Faneuil, and Bacanovic himself. As Stewart's advisor, Savarese should have helped her recognize a very common-sensical, yet vital, point: the truth will come out. The second major reason was the fact that corporate scandal was an incredibly hot topic at that time. Enron was the biggest name of a number of big corporations that created a gigantic cloud of suspicion over any and all big businesses and business leaders, and Stewart's alleged insider trade came to light at the peak of the big business scandals.52 The public was inundated every day with stories of the rich lying, cheating, and stealing to get richer and the public was fed up.53 Seemingly every newscast included video of CEOs, CFOs, and the like being handcuffed and led to police cars, followed each time by some middle class employee talking about how their life savings were lost when Enron, for example, went bankrupt. As a result, there could not have been a worse time for Stewart to become involved in a scandal of her own. Of course, Stewart's insider trading issues had nothing to do with her company, but she was a well-known business mogul caught up in a financial scandal. Thus, her public persona could take a mighty hit. She, as well as Savarese, should have been even more wary of what the illegal sale of the ImClone shares would do to her image because of the corporate atmosphere. Notice here that the second component of Rule 2.1 is implicated.54 Savarese, in discussing these issues with Stewart, should have been looking to relevant issues beyond just the law involved. Their discussion should have covered business aspects as well as moral concerns, both of which were relevant to Stewart's case. The Model Rules give further advice concerning the lawyer's role as an advisor in Comment Two of Rule 2.1. The Comment states that "Advice couched in narrow legal terms may be of little value to the client. . . . Purely technical legal advice, therefore, can sometimes be inadequate."55 Thus, the Model Rules make it clear that legal advice is not the only concern of the lawyer. Certainly, it is the number one priority, as one comes to a lawyer for legal advice, but as Comment Two notes, technical legal advice, on its own, can be inadequate.56 This fits with the business and moral aspects that Savarese needed to point out to Stewart. Savarese's role as an advisor should not have ended with the non-legal issues, however. He also should have explained the legal implications involved with insider trading and the consequences that could arise from being found guilty of lying about the trade.57 He should have made it clear that denying culpability was not really an option, and he should have done this regardless what Stewart's opinion on the matter was. This point brings us to the first component of Rule 2.1.58 When a client comes to an attorney, the attorney must "abide by a client's decisions concerning the objectives of representation. . . ."59 Thus, the attorney must listen to and respect the client's decisions concerning the characteristics of the representation. As Rule 2.1 states, however, the lawyer must also exercise independent judgment regarding the means to achieve the client's objectives.60 The lawyer, while serving as an advisor, must be candid about his thoughts regarding the client's decisions concerning the representation.61 Otherwise, the lawyer will not serve the client properly. Similarly, a lawyer must be able to speak his mind, regardless of whether his opinion might upset his client and thus cause harm to their personal or business relationship. Application of these principles to Stewart's case allows for a closer examination of Rule 2. 1 . Martha Stewart is intelligent, strong-willed, unshakably confident, and independent, and, as a result, saying no to her regarding anything would probably be difficult. When she has made a decision that will greatly affect her own life, however, saying no regarding the decision would most likely be even more difficult. Nonetheless, a lawyer, Savarese in this case, needs to exercise independent judgment and give candid advice.62 This is true regardless of whether the person on the other end is receptive or not.63 In fact, Rule 1.16(b)(4) allows a lawyer to withdraw when there is a fundamental disagreement with the client.64 In this instance, there should have been a fundamental disagreement between Savarese and Stewart once Stewart decided to claim that she did nothing wrong. As previously mentioned, Savarese needed to explain the legal implications involved with insider trading and the consequences that could arise from being found guilty of lying about the trade. Had he done this, it would have been clear that Stewart could have walked away with significantly less severe penalties had she come forward with the truth. In fact, it is possible that it would have been determined that she did not complete an insider trade. As a result, if Stewart had come clean with exactly what happened and argued that her role did not constitute insider trading, she could have walked away scot-free. It was imperative that Savarese make this clear to Stewart, and if Stewart would not listen to reason, Savarese should have withdrawn pursuant to Model Rule 1.16(b)(4).65 To take this one step further, had Savarese been aware that Stewart was acting fraudulently, then he had even more reason to withdraw.66 Either way, Savarese should have done one of two things: 1) demonstrate to Stewart why her plan was so incredibly misguided and compel her to change her plan or, if this was not possible, 2) withdraw. CONCLUSION Model Rule 2.1, coupled with Stewart's story, demonstrates a couple of very important lessons. First, it should be clear that a lawyer must, at times, be able to give his client something more than technical legal advice. This means a lawyer must take an objective point of view weighing the costs and benefits of a decision and give advice accordingly. In many instances, a lawyer must call on such far-ranging concepts as moral and economic consequences in order to weigh the costs and benefits of a decision and, in turn, effectively advise his client. Second, it should be clear that a lawyer must give his client independent and candid advice. This is so even if the client takes issue with the advice. When a lawyer recognizes that the client is taking a path with which the lawyer fundamentally disagrees, it is imperative that the lawyer point this out. At times, this may compel the client to fire the lawyer or might compel the lawyer to withdraw if the client does not change paths. Even in the face of these difficult situations, however, a lawyer must stay the course. Armed with the capability of calling on concepts outside the legal realm and with the ability to give independent, candid advice, a lawyer will be best suited to serve the interests of the client.
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