Why Is Martha Smiling?

Aft

er months of agonized waiting for her high-profile trial to begin, Martha Stewart looked almost upbeat last week as she finally had her first days in court. Sporting clean-line pantsuits and clutching a Hermes Birkin handbag (starting price: $6,000), she looked — for once — perfectly out of place in an otherwise musty courtroom in downtown Manhattan. And when the judge unexpectedly delayed for a week testimony from Douglas Faneuil, a key government witness, Stewart left the courthouse with a smile on her face.

The smile may not last long. The charges against Stewart of federal securities fraud and obstructing a government investigation relating to her December 2001 sale of 4,000 shares in ImClone Systems could bring her 30 years in jail if she is convicted. But experts are scoring Round 1 in the legal battle to the defense.

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The complex case hinges on the testimony of Faneuil. As an assistant at Merrill Lynch, he was covering for his boss Peter Bacanovic, Stewart's stockbroker, on the day the controversial shares were sold. Bacanovic, also a defendant at the trial, was on vacation in Florida when Faneuil called to say that ImClone CEO Sam Waksal intended to dump his shares — which seemed to suggest the share price was set to fall. Prosecutors say Bacanovic told Faneuil to alert Stewart. The defendants have repeatedly denied that this exchange took place, which could be construed as leading to insider trading.

Faneuil, 28, was preparing to take the stand on day two of the trial and was expected to tell this version of the events to the jury, when Bacanovic's lawyer, Richard Strassberg, stunned the courtroom by calling for a mistrial. Strassberg said that at 10:15 the previous night the prosecution had belatedly faxed him a copy of an interview the FBI had conducted with Faneuil's former lawyer, Jeremiah Gutman, 80, which hinted at a different version of events. Gutman said he couldn't remember whom Faneuil had identified — Bacanovic or Waksal — as the one who had instructed him to pass on the tip to Stewart. Gutman's confusion raised doubts, at least temporarily, about the basis of the prosecution's case. Faneuil will have a chance to address them when he testifies this week, but the defense is already questioning his reliability and charging the government with trying to shield him. "It is very disturbing that we are here, in trial, after openings, and all of a sudden this clearly exculpatory material is provided to us," said Strassberg.

The judge declined to drop any charges but chastised the prosecution for withholding the Gutman document when it should have showed it to the defense several months ago, as required by law. The crucial issue going forward, says Robert Mintz, an attorney with McCarter & English who specializes in white-collar crime, is whose memory appears to be at fault — Faneuil's or Gutman's. "If Faneuil craters on the stand, this could be the end of the government's case," he says. For Stewart, smile or no smile, the agonizing wait goes on.