Question: In June 2002, Martha Stewart began to
In June 2002, Martha Stewart began to wrestle with allegations that she had improperly used inside information to sell a stock investment to an unsuspecting investing public. That was when her personal friend Sam Waksal was defending himself against SEC allegations that he had tipped off his family members so that they could sell their shares of ImClone Systems Inc. (ImClone) just before other investors learned that ImClone’s fortunes were about to take a dive. Observers presumed that Stewart was also tipped off, and even though she proclaimed her innocence, the rumors would not go away.
On TV daily as the reigning guru of homemaking, Stewart is the multimillionaire proprietor, president, and driving force of Martha Stewart Living Omnimedia Inc. (MSO), of which, on March 18, 2002, she owned 30,713,475 (62.6%1) of the class A and 30,619,375 (100%) of the class B shares. On December 27, 2001, Stewart’s class A and class B shares were worth approximately $17 each, so on paper the MSO class A shares alone were worth over $500 million. Class B shares are convertible into class A shares on a one-to-one basis.
Stewart’s personal life became public. The world did not know that she had sold 3,928 shares of ImClone for $58 each on December 27, 2001,2 until it surfaced in June 2002.3 The sale generated only $227,824 for Stewart, and she avoided losing $45,673 when the stock price dropped the next day,4 but it has caused her endless personal grief and humiliation and the loss of reputation as well as a significant drop to $5.26 in the MSO share price.
What Happened?
Stewart had made an investment in ImClone, a company that was trying to get the approval of the U.S. Food and Drug Administration (FDA) to bring to market an anti-colon cancer drug called Erbitux. Waksal, then the CEO of ImClone and a personal friend of Stewart’s, was apparently warned on or close to December 25, 2001, that the FDA was going to refuse5 to review Erbitux.6 According to SEC allegations, Waksal relayed the information to his family so that they could dump their ImClone shares on an unsuspecting public before the official announcement. Stewart claims that she did not get any inside information early from Waksal, but regulators believe that she may have, or from her broker or her broker’s aide. The activities of several of Waksal’s friends, including Waksal, are under investigation by the SEC.
Waksal was arrested on June 12, 2002, and charged with “nine criminal counts of conspiracy, securities fraud and perjury, and then freed on $10 million bail.â€7 In a related civil complaint, the SEC alleged that Waksal “tried to sell ImClone stock and tipped family members before ImClone’s official FDA announcement on Dec. 28.â€8
According to the SEC, two unidentified members of Waksal’s family sold about $10 million worth of ImClone stock in a two- day interval just before the announcement. Moreover, Waksal also tried for two days to sell nearly 80,000 ImClone shares for about $5 million, but two different brokers refused to process the trades.9
Stewart has denied any wrongdoing. She was quoted as saying, “In placing my trade I had no improper information.… My trans- action was entirely lawful.â€10 She admitted calling Waksal after selling her shares but claimed, “I did not reach Mr. Waksal, and he did not return my call.â€11 She maintained that she had an agreement with her broker to sell her remaining ImClone shares “if the stock dropped below $60 per share.â€12
Stewart’s public, however, was skeptical. She was asked embarrassing questions when she appeared on TV for a cooking segment, and she declined to answer, saying, “I am here to make my salad.†Stewart’s interac- tions with her broker, Peter Bacanovic, and his assistant, Douglas Faneuil, are also being scrutinized. Merrill Lynch & Co. suspended Bacanovic (who was also Waksal’s broker13) and Faneuil, with pay, in late June. Later, since all phone calls to brokerages are taped and emails kept, it appeared to be damning when Bacanovic initially refused to provide his cell phone records to the House Energy and Commerce Commission for their investigation.14 Moreover, on October 4, 2001, Faneuil “pleaded guilty to a charge that he accepted gifts from his superior in return for keeping quiet about circumstances surrounding Stewart’s controversial stock sale.â€15 Faneuil admitted that he received extra vacation time, including a free airline ticket from a Merrill Lynch employee in exchange for withholding information from SEC and FBI investigators.16
According to the Washington Post report of Faneuil’s appearance in court:
On the morning of Dec. 27, Faneuil received a telephone call from a Waksal family member who asked to sell 39,472 shares for almost $2.5 million, according to court records. Waksal’s accountant also called Faneuil in an unsuccessful attempt to sell a large bloc of shares, the records show.
Prosecutors allege that those orders “constituted material non- public information.†But they alleged that Faneuil violated his duty to Merrill Lynch by calling a “tippee†to relate that Waksal family members were attempting to liquidate their holdings in ImClone.
That person then sold “all the Tip-pee’s shares of ImClone stock, approximately 3,928 shares, yielding proceeds of approximately $228,000†the court papers said.17
One day later, on October 5, it was announced that Stewart resigned from her post as a director of the New York Stock Exchange (NYSE)—a post she held only four months—and the price of MSO shares declined more than 7% to $6.32 in afternoon trading.18 From June 12 to October 12, the share price of MSO had declined by approximately 61%.19
Stewart ’s future took a further interesting turn on October 15, when Waksal pleaded guilty to six counts of his indictment, including bank fraud, securities fraud, conspiracy to obstruct justice, and perjury. But he did not agree to cooperate with prosecutors and did not incriminate Stewart.20 Waksal’s sentencing was postponed until 2003 so that his lawyers could exchange information with U.S. District Judge William Pauley concerning Waksal’s financial records. 21
After October 15, the price of MSO shares rose, perhaps as the prospect of Stewart’s going to jail appeared to become more remote and/or people began to con- sider MSO to be more than just Stewart and her reputation. The gain from the low point of the MSO share price in October to December 9, 2002, was about 40%.22 Stewart still had a lot to think about, however. Apparently the SEC gave her notice in September of its intent to file civil securities fraud charges against her. Stewart’s lawyers responded, and the SEC deliberated. Even if Stewart were to get off with a fine, prosecutors could still bring a criminal case against her in the future. It is an interesting legal question, how, if Stewart were to plead guilty to the civil charges, she could avoid criminal liability.23
On June 4, 2003, Stewart was indicted on charges of obstructing justice and securities fraud. She then quit as chairman and CEO of her company but stayed on the board and served as chief creative officer. She appeared in court on January 20, 2004, and watched the proceedings throughout her trial. In addition to the testimony of Faneuil, Stewart’s personal friend Mariana Pasternak testified that Stewart told her that Waksal was trying to dump his shares shortly after selling her ImClone stock.24 Ultimately, the jury did not believe the counterclaim by Bacanovic, Stewart’s broker, that he and Stewart had a prior agreement to sell ImClone if it went below $60. Although Judge Cedarbaum dismissed the charge of securities fraud for insider trading, on March 5, 2004, the jury found Stewart guilty on one charge of conspiracy, one of obstruction of justice, and two of making false statements to investigators.25 The announcement caused the share price of her company to sink by $2.77 to $11.26 on the NYSE. 26
Stewart immediately posted the follow- ing on her website:
I am obviously distressed by the jury’s verdict, but I continue to take comfort in knowing that I have done nothing wrong and that I have the enduring support of my family and friends. I will appeal the verdict and continue to fight to clear my name. I believe in the fairness of the judicial system and remain confident that I will ultimately prevail.27
Stewart was subsequently sentenced to five months in prison and five months of home detention—a lower-than-maximum sentence under the U.S. Sentencing Guide- lines—and she did appeal. Although she could have remained free during the appeal, on September 15, 2004, she asked for her sentence to start28 so that she could be at home in time for the spring planting sea- son. Stewart’s appeal cited “prosecutorial misconduct, extraneous influences on the jury and erroneous evidentiary rulings and jury instructions,†but on January 6, 2006, her conviction was upheld. 29
Impact on Reputation
Stewart may still disagree with the verdict. But there is little doubt that the allegations and her convictions had a major impact on her personally and on the fortunes of MSO and the other shareholders that had faith in her and her company. Assuming a value per share of $13.50 on June 12, the decline to a low of $5.26 in early October 2003 represents a loss of market capitalization (i.e., reputation capital as defined by Charles Fombrun30) of approximately $250 million, or 61%. The value of MSO’s shares did return to close at $35.51 on February 7, 2005,31 but fell off to under $20 in early 2006. According to a New York brand-rating company, Brand Keys, the Martha Stewart brand reached a peak of 120 (the baseline is 100) in May 2002 and sank to a low of 63 in March 2004.32
What will the future hold? Stewart has returned to TV with a version of The Apprentice as well as her usual homemaking and design shows, and her products and magazines continue to be sold. Will she regain her earlier distinction? Would she do it again to avoid losing $45,673?
Questions
1. What was the basis of Stewart’s reputation?
2. Why did MSO’s stock price decline due to Stewart’s loss of reputation?
3. Who is Stewart’s target market?
4. What qualities were associated with the Martha Stewart brand before the controversy? Which of these were affected by the accusations of insider trading, and how? How would you find out for sure?
5. What level of sales and profits would MSO have reached if Stewart’s reputation had not been harmed? Refer to the SEC or MSO websites for information on financial trends.
6. What range would the stock price have been in at the end of 2002, based on your estimates?
7. Stewart’s overall net worth was huge relative to her investment in ImClone. Assuming she did not have inside information, was there any way she could have avoided the appearance of having it?
8. How could Stewart have handled this crisis better?
9. Why is insider trading considered harmful? Should insider trading be banned if it assists in moving a stock price to a new equilibrium quickly so that non-insiders are trading at appropriate prices sooner?
10. If you wished to sell an investment in a company where one of your friends is an insider or even a significant employee, should you call your friend to advise him that you are about to sell? Why or why not?
> How can a corporation show respect for its stakeholders?
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> BP has had a record of mishaps affecting life, the environment, and the property of the company and other stakeholders. On October 26, 2010, the Public Broadcasting System (PBS) in the United States aired a fifty-three-minute TV documentary titled The Sp
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> South Africa and the drug companies have changed forever,” say David Pilling and Nicol degli Innocenti.1 South Africa is to the drug pharmaceutical industry what Vietnam was to the U.S. military. Nothing will be quite the same again. That, at least, is t
> Harold Johns found himself in jail in Germany. He was a vice president of Baranca Industries Inc., a U.S. firm that constructs and installs factory equipment. Unfortunately, he was the highest-ranking Baranca official in Germany while he was in Germany o
> Walt1 Pavlo joined MCI in 1992 and rapidly became second in command at the company’s finance or long-distance collections unit, as is documented in the ethics case “Manipulation of MCI’s Allowance for Doubtful Accounts” in Chapter 5. Walt left MCI in 199
> A cryptocurrency, such as a Bitcoin, is a digital commodity that can be used in financial transactions. Unlike the U.S. or Canadian dollar, cryptocurrencies have no government backing. It is worth only what another person will pay for it. A crypto- curre
> Harry Potter is known to tens of millions of readers as a figment of J. K. Rowling’s imagination. One of the good guys, he is a gifted apprentice magician and budding wizard. Harry and his pals have bested evil wizards in tale after tale and many movies,
> Assume that you are a professional accountant who is CFO of a medium-sized manufacturing company that plans to do the following: • Misrepresent products that come from environmentally irresponsible sources as environmentally friendly. • Bribe officials o
> In 1984, twenty-three-year-old Wanda Liczyk received her designation as a chartered accountant. The following year, she left Coopers & Lybrand (now part of PricewaterhouseCoopers) to become a budget analyst for the City of North York. By 1991, she had be
> Martin Pilzmaker was a young, aggressive lawyer from Montreal who was invited in 1985 to join the law firm Lang Michener in Toronto. It was expected that his immigration law practice “could enrich the (firm’s) coffers by $1 million a year catering to the
> Livent, once the world’s premier live entertainment companies, was sold in 1998 to buyers who soon found that the value they had paid for was an illusion. Livent had thrilled audiences with performances of Phantom of the Opera, Ragtime, Kiss of the Spide
> On July 1, 2013, Scott London, a former KPMG audit partner, pleaded guilty to securities fraud. He had been passing information to his friend, Bryan Shaw, over a two-year period ending in 2012. He told his friend about earnings announcements by Herbalife
> Google is the world’s largest search engine. In 2009, it had approximately 400 million Web users, of which 200 million are located in the United States. Its global revenue from advertising amounted to $23.6 billion. China is the world’s third-largest eco
> The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB). The PCAOB reports to the U.S. Securities and Exchange Commission (SEC). One of the PCAOB’s responsibilities is to audit the accounting firms through practice in
> At the firm, we’ve got a new way of looking at tax issues. It’s called ‘risk management,’ and, in your case, John, it means that we can be more aggressive than in the past. In the past, when there was an issue open to interpretation, we advised you to ad
> Sophia and Maya were having a quiet afterwork drink at the Purple Pheasant around the corner from their office. Both are professional accountants in their late twenties and were talking about their futures in public accounting. “I want to concentrate on
> Before 2002, accounting firms would provide multiple services to the same firm. Hired by the shareholders, they would audit the financial statements that were prepared by management while also pro- viding consulting services to those same managers. Some
> As Bill Adams packed his briefcase on Friday, March 15, he could never remember being so glad to see a weekend. As a senior tax manager with a major accounting firm, Hay & Hay, on the fast track for partnership, he was worried that the events of the week
> The Italian federal corporate tax system has an official, legal tax structure and tax rates just as the U.S. system does. However, all similarity between the two systems ends there. The Italian tax authorities assume that no Italian corporation would eve
> The leak of the Panama Papers in 2016 revealed the existence of hundreds of thou- sands of offshore shell companies used by the world’s wealthy to avoid paying taxes, raised the public’s awareness of advantaged treatment of the wealthy, and led to renewe
> Multinationals are headquartered in one country but have operations worldwide. Generally, each multinational pays income taxes in the jurisdiction in which it generates its profits. For example, a German company with operations in the United States and S
> Multidisciplinary practices are probably an inevitable development. Clients want “one- stop shopping,” at a professional firm where they can go for all their needs, and where the partner responsible for their work can keep them briefed on new services th
> Stan Jones was an investor who had recently lost money on his investment in Fine Line Hotels, Inc., and he was anxious to discuss the problem with Janet Todd, a qualified accountant who was his friend and occasional advisor. “How can they justify this, J
> It’s legal, but is it ethical? For years, a nationally known doughnut chain only sold sugary drinks at its retail outlets on a prominent university campus. Sugar consumption is known to contribute to diseases such as heart disease, tooth decay, diabetes,
> At one time, a well-known communications firm measured all managers at all levels on return on net assets (RONA). Write a report to the firm’s CFO indicating why you believe that the use of a single performance measure for managers at all levels will not
> Consider the following jobs. Identify a nonfinancial performance measure that you would recommend. a. Flight attendant b. Hotel parking valet c. Sports venue ticket-taker d. Bank teller e. Restaurant wait-staff
> Kipling’s Taco Shop was the only establishment serving tacos and other quick bites in a small college town for more than 20 years. Service was limited to the walk-up window, with no delivery and no inside seating. The owner of Kipling’s focused on well-m
> Refer to the information in Exercise 17-43. Required Write a memo to the managers at Crescent Call Centers recommending which variances they should investigate this period along with your reasons. Exercise 17-43: The standard direct labor cost per call
> Refer to the information in Exercise 17-41. Required Write a memo to the senior manager of Oakman Accounting Partners recommending which variances from the past year the firm should investigate along with your reasons. Exercise 17-41:
> Gerisch Consolidated sold 21,150 units of its only product last period. It had budgeted sales of 24,300 units based on an expected market share of 25 percent. The sales activity variance for the period is $340,200 U. The industry volume variance was $194
> Refer to the information in Exercise 17-22. Assume that Fischer Fabrication had no beginning finished goods inventory and only produced one product. A count of inventory showed that 4,400 units remained in the warehouse. Required a. Assume Fischer writes
> The River Plant of Carlisle, Inc. produces a particular metal fixture used in aerospace and maritime industries. The following information is available for the last operating month: ∙ The plant produced and sold 27,600 fixtures for $72
> The (partial) cost sheet for the single product manufactured at Briarcliff Corporation follows: The master budget level of production is 45,000 direct labor-hours, which is also the production volume used to compute the fixed overhead application rate. O
> Refer to the information in Exercises 16-38 and 16-39. Required What are the fixed overhead price and production volume variances for Golden Food Products? Exercise 16-38: Exercise 16-39:
> When would you advise a firm to use direct intervention to set transfer prices? What are the disadvantages of such a practice?
> Annland Components applies fixed overhead at the rate of $5.10 per unit. For October, budgeted fixed overhead was $513,825. The production volume variance amounted to $3,825 favorable, and the price variance was $12,750 unfavorable. Required a. What was
> Coe Parts applies fixed overhead at the rate of $6.80 per unit. Budgeted fixed overhead was $197,200. This month 28,120 units were produced, and actual fixed overhead was $192,100. Required a. What are the fixed overhead price and production volume varia
> Rankin Fabrication reports the following information with respect to its direct materials: Rankin Fabrication holds no materials inventories. Required a. Prepare a short report for Rankin’s management showing direct materials price and
> Refer to the information in Exercises 16-38 and 16-39. During the year, the company purchased 320,000 pounds of material and employed 32,500 hours of direct labor. Required a. Compute the direct materials price and efficiency variances. b. Compute the di
> Golden Food Products produces special-formula pet food. The company carries no inventories. The master budget calls for the company to manufacture and sell 120,000 cases at a budgeted price of $60 per case this year. The standard direct cost sheet for on
> Engleside Components produces testing equipment for medical devices. Recently, one of the company’s usual suppliers was unable to fill an order, so the purchasing manager chose a supplier who had been approved. The price was significantly higher than the
> Selected data for March for Irvington, Inc. follow. The variable material sales activity variance is $21,600 U. Required a. How many units were budgeted for March in the master budget? b. Recreate the master budget for March.
> The following data are available for the most recent year of operations for Prest Products. The revenue portion of the sales activity variance is $225,000 U. Required a. How many units were actually sold in the most recent period? b. Prepare a sales acti
> The Main Street plant controller at Nowak Enterprises sends you the following graph to explain the plant’s costs. Required Given the data shown in the graph, determine the following: a. Budgeted fixed cost per period. b. Budgeted variab
> Burdeno Appliances has two divisions, Sales and Financing. Sales is responsible for selling Burdeno’s inventory and maintaining inventory for future sale. Financing Division takes loan applications, packages loans into pools, and sells them in the financ
> What are the limitations of market-based transfer prices? What are the limitations of cost based transfer prices?
> Refer to the information in Exercise 15-36. Suppose Manufacturing is located in Country X with a tax rate of 35 percent and Marketing in Country Y with a tax rate of 15 percent. All other facts remain the same. Required a. Current output in Manufacturing
> Refer to the information in Exercise 15-24. Assume there is no special order pending. Required a. What transfer price would you recommend for Hamlet Industries? b. Using your recommended transfer price, what will be the income of the two divisions, assum
> Anstell Corporation operates a Manufacturing Division and a Marketing Division. Both divisions are evaluated as profit centers. Marketing buys products from Manufacturing and packages them for sale. Manufacturing sells many components to third parties in
> Refer to the information in Exercise 15-34. Suppose Production is located in Country A with a tax rate of 30 percent and Distribution in Country B with a tax rate of 10 percent. All other facts remain the same. Required a. Current output in Production is
> Carol Components operates a Production Division and a Packaging Division. Both divisions are evaluated as profit centers. Packaging buys components from Production and assembles them for sale. Production sells many components to third parties in addition
> Cascade Containers is organized into two divisions—Manufacturing and Distribution. Manufacturing produces a product that can be sold immediately or transferred to Distribution for further processing and then sold. Distribution only buys from Manufacturin
> Refer to the data in Exercise 15–26. Suppose that Civic Division will charge the client interested in implementing a costing system by the hour based on cost plus a fixed fee, where the cost is primarily the consultant’s hourly pay. Assume also that Civi
> Whitehill Chemicals has two operating divisions. Its Formulation Division in the United States mixes, processes, and tests basic chemicals, and then ships them to Ireland, where the company’s Commercial Division uses the chemicals to produce and sell var
> Hardyke Group operates a local after-school recreation and activities program. The Education Department is a state governmental agency. Hardyke has an agreement with the Department to provide services to students in need for a nominal $1 per day, to be p
> Pilgrim Logistics operates a network of delivery vans. Pilgrim allows its decentralized units (divisions) to “rent” vans to another Pilgrim division. Commercial Division has leased some of its idle vans to Retail Division for $450 per month. Recently, Co
> How can ratios, such as ROI, be used for control as well as performance evaluation?
> Lola Metals has two decentralized divisions, Stamping and Finishing. Finishing always has purchased certain units from Stamping at $36 per unit. Stamping plans to raise the price to $48 per unit, the price it receives from outside customers. As a result,
> Lamothe Solutions is a management consulting firm. Its Business Division advises firms on the adoption and use of financial systems. Civic Division consults with state and local governments. Civic Division has a client that is interested in implementing
> Refer to the data in Exercise 15-24. Assume the transfer price is unchanged from the current transfer price. Required a. Does Hamlet Industries want to accept this order? b. Will the Distribution Division manager be willing to accept this order? c. Will
> Hamlet Industries is organized into two divisions, Fabrication and Finishing. Both divisions are considered to be profit centers, and the two division managers are evaluated in large part on divisional income. The company makes a single product. It is ma
> Refer to the data in Exercise 14-45. Assume that the division uses beginning-of-year asset values in the denominator for computing ROI. Required a. Compute ROI, using net book value. b. Compute ROI, using gross book value. c. If you worked Exercise 14-39
> Refer to the information in Exercises 14-40 and 14-41. Required a. What is the division’s residual income before considering the project? b. What is the division’s residual income if the asset is purchased? c. What is the division’s residual income if th
> Refer to the data in Exercise 14-37. Required Evaluate the performance of the two divisions assuming Houghton Chemicals uses economic value added (EVA). Exercise 14-37:
> Refer to the data in Exercises 14-24, 14-28, and 14-32. The individual regions are responsible for research and development (R&D) decisions and for current liabilities. Information on R&D expenditures (which are included in SG&A) for the year
> Refer to the data in Exercise 14-33. Required Evaluate the performance of the two divisions assuming Lasky Manufacturing uses economic value added (EVA). Exercise 14-33:
> The following data are available for two divisions of Ryan Enterprises: The cost of capital for the company is 7 percent. Ignore taxes. Required a. If Ryan measures performance using ROI, which division had the better performance? b. If Ryan measures per
> What is the coordinating role of budgeting?
> Refer to the information in Exercise 14-24. Information on the division assets in the three regions of Lauderdale Corporation follows: Required Compute the division ROI for each of the three regions. How have these regions performed? Exercise 14-24:
> The following partial financial information (in thousands of dollars) is available for Thole, Inc.: Corporate overhead costs at Thole are allocated to divisions based on relative sales. Required a. Complete the income statements for both divisions and th
> Refer to Exercise 14-25. The results for year 2 have just been posted: Required Compute divisional operating income for the two divisions. How have these divisions performed? Exercise 14-25:
> Owen Audio shows the following information for its two divisions for year 1. Required Compute divisional operating income for the two divisions. Ignore taxes. How have these divisions performed?
> Refer to the data in Exercise 13-54 and in Exhibits 13.20 and 13.21. Required To what level or levels would funding for Product Development Group have to drop such that one, but only one, of the PDG Areas received no funding? Explain. Exercise 13-54:
> Lauderdale Corporation is organized in three geographical divisions (regions) with managers responsible for revenues, costs, and assets in their respective regions. The firm is highly decentralized and managers are evaluated solely on divisional performa
