Myths About Martha

Investors may want to think twice about how issues in the high profile trial are playing out.
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A mythology has clouded the trial of Martha Stewart since it kicked off last week in Lower Manhattan. The spreading belief that the case is flimsy has helped boost

Martha Stewart Living Omnimedia

(MSO)

stock some 30% this year. Investors should approach the situation with more skepticism.

Whereas most celebrities on trial -- and this is a celebrity trial more akin to the Winona Ryder five-finger-discount courtroom-reality show in Beverly Hills than the trials of arch-villain CEOs gone wild of the Bernie Ebbers ilk --are presumed guilty in the court of public opinion, Martha seems to be getting more than just the benefit of the doubt.

Of more concern than the presumption of innocent until proven guilty -- which is a good thing -- is the misconceptions and folklore surrounding the case. This is particularly troubling for those who have recently purchased MSO stock in anticipation of business-as-usual at the company.

Here then is the definitive guide to the biggest myths about the princess of perfections problems:

1. It's just 3,928 shares -- for Martha that's nothing, what's the big deal?

Since when does the amount allegedly swindled have any bearing on the gravity of the charges? By this logic, if Bill Gates held up a convenience store at gunpoint he should go free because "what's $300 to a billionaire anyway?"

Doesn't the fact that she would consider bending or breaking the rules (if she's guilty) over so little say something about her character?

Does a crime's relative insignificance to bigger recent crimes matter? If you robbed a small-town bank of $20,000 and somebody else knocked over a Brinks truck for $20 million, should the government leave you alone and focus on the bigger fish?

Besides, the fact that the Ken Lays of the world are walking the streets does not mean they have been written off as untouchable by the government just yet.

2. They are going after poor Martha much harder than other, real criminals.

The government is probably going after Martha with more energy than most alleged white-collar criminals, and maybe even some regular criminals. There is sound reason for this. Wealthy celebrities fight back much harder and the government has to bring more resources to the table.

If the Justice Department charged you with obstruction of justice, would you hire several lawyers, image consultants and publicity experts? Would you hire Web designers to put together a vanity site promoting your side? Would you land a prime-time interview with Barbra Walters to help your image and claim your innocence?

There's a reason O.J. Simpson is playing golf in Florida. Celebrities fight back -- hard. And jurors -- no matter how prescreened they are -- have a natural tendency to believe celebrity's artfully crafted public images.

3. They aren't even charging Martha with insider trading -- what a sham trial.

Jails are full of people who committed bigger crimes after being prosecuted for smaller crimes. In almost every episode of the TV program

Cops

, somebody gets pulled over for speeding, swerving, running a red light, only to assault an officer, evade arrest, drive recklessly, or worse in an effort to stay out of trouble. When they catch these people and toss them in jail, nobody says: "They aren't even charging him with having a broken taillight!"

If the allegations are true, Martha committed a bigger no-no trying to cover up a smaller one. She's charged with lying and fabricating evidence to cover the fact that she was trading on non-public information. If so, she's just as foolish as the people on

Cops

.

Moreover, the government busted Al Capone for tax evasion. That doesn't mean Capone was an innocent man other than being a tax cheat. The government plays the best cards it is dealt.

4. Trading on non-public information is a victimless crime -- it shouldn't even be illegal.

What Paul Reubens (the actor who played Pee-Wee Herman) did in an adult movie theater was a victimless crime. Trading on privileged information is anything but. There are good reasons the

SEC

added rules barring certain types of insider trading half a century ago. (Neither Stewart nor her broker are charged with insider trading.)

Other "outside" investors get hurt. Imagine if you had an outstanding buy order on a few thousand shares of

ImClone Systems

(IMCL)

stock at $60 a share in late December 2001. Imclone stock may never have dipped below $60 in the days before the bad news broke about Imclone's Erbitux if not for selling by people with direct or indirect information that trouble was afoot.

Their selling drove the market down to a price you thought was a good entry point, not knowing the full story. On Dec. 31 2001, after the negative news on ImClone broke, the stock opened $10 lower than it closed the day before. This would have been the price your buy order executed -- assuming you didn't pull it on the bad news -- had savvy sellers not driven the price down before the bad news and triggered your buy.

Martha Stewart's sales, if they are found to be improper, cost one or more people about $40,000 when they bought her shares shortly before the stock tanked. For every dollar someone saves avoiding bad news, an outsider loses a dollar -- it's a zero sum game. Just because the victim is harder to identify doesn't mean there is no victim.

Would you rather have your car broken into and lose a radio (a crime punishable by jail), or lose $40,000 in a stock trade because you bought shares you never would have bought if there weren't allegedly improper selling?

5. Martha has friends in high places; we'd all do what she did it if we got that call.

Who wouldn't want to be tipped off about bad news before it happens? Wouldn't it be nice to be such an important client that your broker might risk his career for you? We all want to be Martha, taking those important calls on the tarmac while our personal jet refuels enroute to an exotic getaway. Most mortal investors can't get their broker to return their calls about a stock as they are refueling the minivan on a drive to Disney World.

One reason white-collar crime is treated with relative kid gloves is we can imagine doing it ourselves, unlike say, carjacking or crack dealing. People in lower rungs of society can imagine other "street" crimes. That's their world. The government throws them in the slammer for acting on the impulse.

If a different echelon of society ran the courts and government, we'd probably see white-collar crime come with severe penalties and knocking off a liquor store punishable for a fine worth three times the amount of what was stolen and a promise not to step into a liquor store with a gun for five years.

While we may want to be Martha, we really don't want to think the system is so rigged in the favor of the powerful that our chances of success as an investor are hopeless. Besides the very real costs to society of insider trading, the even bigger issue is confidence in the markets and corporate America.

One reason stock valuations were low for much of the 20th century was your average investor had little confidence in investing; Wall Street was an insider's game. Much of this mentality was carried along from the days when Wall Street really was an insider's game and the general public was at a distinct disadvantage. The playing field will never be level, and insiders and big clients will always get the best IPO allocations, the best service, advice, prices, etc. The average investor can accept that. Cheating is another story.

There was a time when Sam Waksal wouldn't be in jail for seven years for his trading behavior in ImClone -- insider knowledge, like a company jet, was just another perk for being a CEO.

Investor confidence in the system is a good thing; higher valuations mean more venture capital for new business start-ups (bigger payoffs for success) plus an easier time raising equity and debt financing, among other benefits.

Cracking down on corporate mischief and improper trading keeps Joe Mutual Fund Investor confident in the system, and everybody benefits from that.

6. Her stock trading wasn't illegal.

If Peter Bacanovic or his assistant Doug Faneuil (assuming he could dial, being so hopped up on drugs, as the defense asserts) called Martha and told her to sell her stock and she did, she clearly would not be making an illegal insider trade. Even if the broker based his decision by observing ImClone founders and family panic-sell, Martha would walk. The broker could get in trouble with the

NASD

, his firm, and possibly the SEC for using confidential client trading information as the basis for decision.

But if Bacanovic or Faneuil told Martha why they wanted her to sell, and that it was because ImClone founder Sam Waksal was selling, then she sold based on material nonpublic information.

Martha's strongest defense would have been to claim she didn't know such information was material and nonpublic. This is a tough angle given that Martha allegedly tried to cover up why she sold and that she was once a stockbroker and should know better.

7. The government is just going after Martha because she is Martha.

Don't confuse media coverage with the government's actions. Every day the SEC goes after people for securities violations. Check out www.sec.gov for near-daily updates. The government goes after a lot of people, we just never hear about it.

Martha gets ink because celebrities are our royalty. The only thing we love more than their rise is their fall. The media cover Martha because people want to know about her fall from grace more then Ken Lay's. There is no government conspiracy, nor is this story proof that people don't want to see a woman succeed in business.

8. None of this mess will hurt her business or her stock -- it didn't hurt Steve Madden.

Madden, the founder of the shoe company that bears his name, pleaded guilty to securities fraud and money laundering in 2001. He was later sentenced to jail. His company has done fine in his absence. This may not be a good case study for investors in Martha Stewart Omnimedia.

Steve Madden

(SHOO) - Get Report

is not a brand built around a personality, so much as a brand that happens to be a name. Customers don't buy Steve Madden shoes to be like Steve Madden. People don't know what kind of clothes Madden wore to court or what kind of car he drove. People don't even know what he looks like. He was never under the microscope that is celebrity worship in America. In fact, hardly anyone knew his story until the Martha Stewart case got everyone writing about it.

Madden is probably just a guy who wishes Martha's mess would go away so his name would stop being in the paper with the words "securities fraud" and "jail."

Martha is not rapper 50 Cent -- a criminal record would not help make her more "real" to her customers. People buy Martha Stewart merchandise because they want to be part of the image she crafts and embodies for the public. Without that premium value brand, her products have to compete in the cold, cruel world of low margins and high competition. Recent "Martha free" products launched from the company will face this harsh reality going forward.

9. Peter Bacanovic wouldn't break the rules for "a lousy" $450 in commissions.

This ridiculous point was presented by Bacanovic's defense in trial last week, along with efforts to paint his assistant-turned-state's-evidence as a lying drug kingpin who'll roll over for anyone.

The real question is: Why would Bacanovic risk breaking a serious

Merrill Lynch

policy and possible securities laws to help an already rich woman from losing a few thousand dollars? If he just told Martha to sell (directly or indirectly) and didn't say why, she wouldn't even be in hot water, only he would.

No, Bacanovic had to let Martha know that he was going out on a limb for Martha. Bacanovic put obsequious treatment of his celebrity-client and social climbing up so high on his to-do list that embarrassing his own employer and breaking the law paled in importance. Peter Bacanovic's logic defied reason, but that doesn't mean he didn't do it.

Jonas Max Ferris is co-founder of MAXfunds.com, a fund research and analysis company, and partner in an investment advisor offering managed accounts in mutual funds. He welcomes column critiques, comments or baseless accusations at jferris@maxfunds.com.