Martha's Untidy Story

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As congressional investigators dug into the troubled biotech firm ImClone in June, they had a simple but explosive question for Martha Stewart, a friend of former ImClone CEO Samuel Waksal's: Did she receive inside information that prompted her to sell her ImClone stock just a day before the Food and Drug Administration (FDA) rejected ImClone's cancer drug and sent the share price tumbling?

Eager to keep Stewart from testifying at a House Energy and Commerce Committee hearing June 13, sources say, her lawyers agreed to respond in writing. The letter, which arrived the day before the hearing, explained that her $228,000 sale had been "prompted solely" by an earlier arrangement with her broker to sell ImClone's stock if it ever fell below $60 a share. Her attorneys stated that their information was "based on a thorough review of the circumstances."

Just hours before the hearing began, sources tell Time, Stewart's lawyers requested that committee chairman Representative Billy Tauzin, a Louisiana Republican, enter the letter into the committee record and issue a statement exonerating Stewart. "We were stunned," says Tauzin spokesman Ken Johnson. "We couldn't believe what they were asking us to do." Tauzin refused.

And that was when relations were good. Two months later, as new facts about her case have surfaced, Tauzin's patience with Stewart has worn thin. Congressional investigators increasingly see her as uncooperative, and that's usually enough to create bipartisan resolve. Sources told Time last week that Stewart has twice spoken to the FBI, which is investigating ImClone, and gave the account told in the letter.

Stewart faces issues far worse than congressional ire. Prosecutors are building a case against her on charges of insider trading, obstructing justice and making false statements. Sources say they are trying to gain the cooperation of Martha's friend Mariana Pasternak, who was with her on the day of the ImClone stock sale.

Tauzin is so frustrated by Stewart that he may subpoena her to appear in September despite the Justice Department investigation. He has been negotiating for weeks with Stewart's lawyers, who are trying to stave off a summons that would create a difficult choice for the Princess of Propriety: testify at the risk of contradicting herself under oath or assert her Fifth Amendment right against self-incrimination. The latter is her legal privilege, but would do nothing to help the stock of her company, Martha Stewart Living Omnimedia, which has fallen 65% since the ImClone news broke.

Tauzin and investigations-subcommittee chairman Jim Greenwood are annoyed in part because the evidence provided by Stewart's lawyers has continually "tweaked" her story, Johnson says. In the June 12 letter, they said Stewart's Merrill Lynch broker Peter Bacanovic called her on Dec. 27, informed her that ImClone's shares had dropped below $60 and sold at 1:43 p.m. The chronology helped bolster her claims of an earlier stop-loss order. But her story changed with new documents obtained from Stewart's office six days later. Instead of a single call from Bacanovic on the afternoon of Dec. 27—as ImClone's stock fell below $60—records revealed an urgent effort by the broker to reach her between 10 and 11 a.m. Sources tell Time that he even tried to be patched through to her on a corporate jet she had boarded for Mexico. The hour is significant because ImClone was still selling above the $60-a-share stop-loss price at that time. Why the urgency?

The committee disclosed more information last week, deepening suspicions that Bacanovic, who was also Waksal's broker, had advance knowledge of the FDA rejection. In a Dec. 27 e-mail sent to his assistant before the Stewart sale, Bacanovic asked, "Has news come out yet? Let me know, thx, P." The assistant replied, "Nothing yet. I'll let you know. No call from Martha, either." The FDA rejection was announced after the market close on Dec. 28. Bacanovic's assistant, Douglas Faneuil, at first backed Stewart's story. But published reports say he later recanted, telling prosecutors that Bacanovic prompted him to advise Stewart that Waksal family members were selling the stock and she should do likewise.

Tauzin now views the June 12 letter as an attempt to mislead the committee. "They tried to sandbag us," says Johnson. Stewart spokeswoman Allyn Magrino refused to comment on a possible Capitol Hill appearance. If Stewart comes in for a Tauzin meeting, it will be a return engagement. In 2000, he appeared on her show to promote his Cajun cookbook, Cook 'N Tell. This time he wants to swap more than recipes.