NEW YORK -The judge in the Martha Stewart trial dealt a setback to the government's stock fraud case yesterday, barring prosecutors from having securities analysts testify on how investors reacted to public statements by Stewart about her sale of ImClone Systems Inc. stock.
Stewart, founder and former chief executive of Martha Stewart Living Omnimedia Inc. is charged with securities fraud.
Prosecutors say she misled her company's shareholders about the ImClone sale, waging a public campaign to minimize the trading scandal and prevent it from hurting Martha Stewart Living stock.
The government wanted to call expert witnesses to testify about whether investors were swayed by her statements.
The fraud count, which carries a sentence of up to 10 years in prison, requires prosecutors to prove that Martha Stewart Living investors made decisions on their stock based on her comments. Stewart also is charged with obstruction of justice.
"It's probably a setback for the government," said Howard Schiffman, who heads the securities practice at Dickstein Shapiro Morin & Oshinsky in Washington.
But prosecutors might still prove the effect her statements had on investors by showing that Martha Stewart Living shares rose after she made them, he said.
"The government must prove that she made the statement and it impacted the stock price," Schiffman said.
U.S. District Judge Miriam Goldman Cedarbaum granted a defense motion precluding "expert testimony regarding questions of the materiality of Ms. Stewart's public statements" about her Dec. 27, 2001, sale of about 4,000 ImClone shares. Though the ruling makes it tougher for prosecutors to prove stock fraud, the government can still do so through other means.
Cedarbaum barred prosecutors from offering expert testimony "on whether a reasonable investor would have considered Ms. Stewart's statements important in making investing decisions." Prosecutors had planned to use securities analysts as experts.
Stewart's lawyer, Robert Morvillo, said outside court that the ruling means the government may not call analysts to testify about whether Stewart's statements were "material" to shareholders' investment decisions. He called it "an important aspect" of the government's case.
Stewart, 62, and Bacanovic, 41, are on trial in federal court in Manhattan. They're charged with plotting to deceive investigators about the motive for her ImClone stock sale.
Bacanovic's former assistant, Douglas Faneuil, testified last week that he passed on a tip from his boss to Stewart that her friend, ImClone founder Samuel D. Waksal, was selling his family's stock in the company.
On hearing the news, Faneuil said, Stewart told him to sell her ImClone shares.
He said he later gave in to pressure from Bacanovic to adopt a cover story that Stewart had a prior agreement to sell when ImClone fell below $60.
The stock fraud count accuses Stewart of lying to Martha Stewart Living investors in June 2002, when she publicly offered the same explanation for her sale of ImClone shares.
Stewart avoided a loss of $51,000 by selling her ImClone stock a day before the U.S. Food and Drug Administration rejected an application for Erbitux, the company's cancer drug.
Waksal is serving an 87-month sentence for insider trading. Erbitux was approved by the FDA Thursday.
Martha Stewart Living shares fell 12 cents yesterday to close at $11.65 on the New York Stock Exchange.