Martha's New Ruffle

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Speaking to Wall Street analysts last week, Martha Stewart forcefully stated that her controversial $228,000 sale of ImClone stock last December--a day before the company announced bad news about its promising cancer drug--was "proper and lawful." Her company also announced a 26% jump in ad pages for the July issue of Martha Stewart Living. Say this for the woman who turns old drawer pulls into fancy wine corks: She knows her audience. Shares of Martha Stewart Living Omnimedia, in which she has a 63% stake worth nearly $500 million, recovered to $15.97 Friday after a two-week slide that had taken it down to $14.40 amid fears that her brand would be sullied by connection to insider-trading allegations at ImClone.

But Stewart's troubles aren't over. Sources close to the congressional investigation of Stewart tell TIME that a new line of inquiry is focusing on a close friend of hers, Dr. Bart Pasternak, who sold 10,000 shares of ImClone at about the same time she made her sale. Meanwhile, Merrill Lynch broker Peter Bacanovic--whose clients included Stewart as well as her friend Sam Waksal, the former ImClone CEO recently arrested on insider-trading charges--was placed on leave along with his assistant. Merrill, which earlier praised Bacanovic, said an internal investigation "raised factual issues regarding a client transaction."

That transaction, sources say, was the sale of Stewart's ImClone stock. Stewart and Bacanovic have denied insider trading, saying they had an oral agreement to sell ImClone if it fell to $60; her shares were sold at $58. But Merrill has found no evidence to support claims of such an agreement. Stewart and her lawyers declined to comment on this development, and Bacanovic was unavailable. Bacanovic gave Merrill executives an undated printout of Stewart's holdings with "$60" penciled in by the ImClone entry, but Merrill, according to one source, has evidence that something other than the price triggered the trade. Merrill reported its findings to the House Energy and Commerce Committee, the Securities and Exchange Commission and the U.S. Attorney.

The sale by Pasternak, a vascular surgeon who practices in Westport, Conn., came on Dec. 27 or 28, according to a source close to the congressional investigation. It was on Dec. 27 that Stewart sold her nearly 4,000 shares. What has caught the attention of investigators is that on Dec. 27, Stewart was traveling with Pasternak's estranged wife Mariana, a real estate broker. While she and Stewart were on the ground in San Antonio, Texas, en route to Mexico on Stewart's private jet, Stewart phoned Bacanovic to sell her shares and then tried to reach Waksal. Investigators are trying to learn whether Mariana Pasternak had contact that day with her husband, also a friend of Waksal's. Neither of the Pasternaks returned calls.

Investigators want to know whom else Bacanovic spoke with that day, and they have sent a letter to Merrill asking for Bacanovic's client list, phone log, e-mail and records of trades of ImClone. Dr. Pasternak held 100,000 shares at the time of his sale; he told investigators he sold his remaining 90,000 shares in January, a source said.