Feds Lay Out Case Against Martha Stewart

Testimony is under way in the Martha Stewart trial, with the government laying the groundwork for its case that her ex-stockbroker passed her an inside tip that the two later lied to cover up.

One of the first government witnesses was a Merrill Lynch & Co. (MER) official who testified that the broker, Peter Bacanovic, signed an agreement that requires firm employees not to discuss one client's transactions with another.

"It's important for us," the official, Luciano Moschetta, said of the Merrill rule in testimony Tuesday. "Because the relationship we have with our investors is based on trust."

Superseding Indictment (U.S. v. Stewart and Bacanovic) (pdf)

Prosecutors say Bacanovic tipped Stewart on Dec. 27, 2001, that ImClone Systems (IMCL) founder Sam Waksal was trying to dump his shares of the stock. Waksal later admitted he had early word of a negative government report about ImClone.

Stewart sold that day as well, and the stock plummeted when the government report became public. The government says Stewart and Bacanovic repeatedly lied to investors about the circumstances of the sale.

The two claim they had struck a deal earlier in December to sell Stewart's 3,928 shares of ImClone when it fell to $60 per share.

The other government witness who testified Tuesday was Daniel Lynch, acting CEO of ImClone, who told jurors about the mechanics of the company's application for government approval of the drug Erbitux (search) in 2001.

U.S. District Judge Miriam Goldman Cedarbaum (search) ordered the trial suspended for Wednesday because of heavy snow forecast for the New York area.

Testimony will resume Thursday — probably including Douglas Faneuil, a former Merrill assistant and the government's star witness against Stewart and Bacanovic.

Faneuil is expected to testify that he passed the Waksal tip from Bacanovic to Stewart — testimony that, if jurors believe it, would poke holes in the Stewart-Bacanovic $60 agreement.

Lawyers for both defendants have already hinted they will attack Faneuil's credibility, portraying him as a repeated liar who was willing to tell the government anything it wanted to hear in exchange for a plea deal.

The testimony comes after attorneys for all three parties in the trial — the government, Stewart and Bacanovic — presented impassioned opening statements.

Assistant U.S. Attorney Karen Patton Seymour said Stewart had sold ImClone on "a secret tip" that no one else had, then told an avalanche of lies to save her reputation and enormous fortune.

And she said Bacanovic made sure that word of Waksal's sale was passed along to Stewart.

"He knew he couldn't do it," she said. "But he didn't want his friend Martha Stewart sitting on a stock that was about to be obliterated by bad news."

Stewart attorney Robert Morvillo, meanwhile, suggested the government's pursuit of the domestic style-setter was reminiscent of George Orwell's Big Brother novel "1984."

He lashed out at Congress for leaking in the summer of 2002 that Waksal had directly tipped Stewart about the Erbitux decision, suggesting it was the work of politicians hungry for attention in the midterm election.

"Same government — leak it on one side, prosecute it on the other," Morvillo said disdainfully. "I think that George Orwell was just about 20 years too early," he said, alluding to the novel "1984" that described an all-intrusive government.

Morvillo never flatly denied that Stewart was tipped to the Waksal sale. But he described Stewart in December 2001 as weary from the holidays, and finally willing to follow Bacanovic's repeated suggestions to get rid of ImClone

He also said Stewart was telling the truth in an April 2002 interview with investigators in which she said she did not recall such a tip.

The prosecutor told jurors they would hear evidence that Stewart tried to pump up the stock of her own company, Martha Stewart Living Omnimedia (MSO), with false accounts of the ImClone investigation in 2002.

Seymour noted that the company depended on Stewart's image, and that for every dollar the media company's stock fell, Stewart stood to lose $30 million. Denying that she was tipped, Seymour said, was "another pure and simple lie."

"Martha Stewart was determined to put her own interests ahead of her own investors," the prosecutor said. "And so she lied over and over during a key period, to try to keep the price of MSLO from falling."

That charge, securities fraud, is one of five against Stewart in a federal indictment. Bacanovic is also charged with five counts. The charges carry potential prison terms of 30 years for Stewart and 25 for Bacanovic.