Martha Stewart: The Irony Maiden Hates to Lose

By Janet Tavakoli
The Yearbook July 18, 2004

Martha Stewart’s crime is the financial equivalent of lying to police about her whereabouts after being told she is suspected of denting the fender of a parked car. Contrast that with alleged financial miscreants at Enron, Adelphia, Tyco, and WorldCom. They did the financial equivalent of revving their motors and intentionally running down baby carriages occupied by helpless infants, and they did it for years.

The securities fraud charge against Martha Stewart, 62, was thrown out. She was found guilty on March 5 of conspiracy, obstruction, and two counts of making false statements to federal investigators about what led her to decide to sell nearly 4,000 (3,928 shares) of her ImClone Systems, Inc. shares on Dec. 27, 2001. She received a lenient sentence within the federal guidelines: 5 months in prison, 5 months of home confinement, two years of supervised probation, and a $30,000 fine.

The Psychology of Loss Aversion
Martha Stewart was never charged with insider trading. Martha Stewart was a wealthy woman. Why would Martha Stewart even risk the appearance of insider trading by selling her shares through the same broker as Sam Waksal, the head of ImClone?

The answer is that Martha Stewart is human, and many investors would behave in the same way. Daniel Kahneman and Amos Tversky did studies on the financial psychology of judgment and decision making. They found that people feel more strongly about the pain that comes with loss than they do about the pleasure that comes with an equal gain. In fact, most people feel about twice as strongly according to their study. If you really hate to lose, you may feel even more strongly about it than that. Surprisingly, people will take much more risk to avoid a loss than they will to earn a gain, even when the economic results are the same. If you don’t believe it, try the following game.

Imagine that I have given you $100,000, and I have also given you two choices. I will either guarantee you an additional $50,000 or I will allow you to flip a coin. If it’s heads you get another $100,000; if it’s tails you get nothing additional. If you choose to take my guarantee, you are certain to walk away with $150,000. If you choose to flip the coin, you get either $100,000 or $200,000. Which option do you choose? Most people choose to take the certainty and walk away with $150,000.

But suppose instead I have given you $200,000, and I have given you the following two choices. I will either guarantee a loss of $50,000, or you can flip a coin. If it’s heads you lose $100,000; if it’s tails you lose nothing. Now which option do you choose? Most people will choose to flip the coin.

In both situations, you wind up with $150,000 if you choose the guarantee. In both cases if you choose the coin flip, you have a 50/50 chance of ending up with either $200,000 or $100,000.


Most people choose the sure $150,000 when they stand to gain. It is a very different story when they stand to lose. Most people will choose to flip the coin, because they will take more risk to avoid losing money, even if that means they will potentially be worse off than if they just took their loss. The feeling seems to be that they should at least try to avoid the loss. They shouldn’t stand by, do nothing, and just let it happen to them.

Appealing Ironies
The key witness against Martha Stewart was a broker’s assistant, Douglas Faneuil, who changed his story after being told he’d be charged with conspiracy. Federal prosecutors accused Larry F. Stewart (no relation to Martha Stewart) of lying repeatedly in his trial testimony about his role in testing the ink on a stock record worksheet. One juror was accused of lying about an arrest record so that he would be eligible to serve as a juror.

Victimless Crime
Even if insider trading had occurred, in this instance, it is the closest thing to a victimless financial crime. The nature of the information determines a stock’s gain or loss; the act of inside trading didn’t affect ImClone’s price. ImClone’s shareholders lost $900 million because the FDA arbitrarily decided – and later reversed that decision - to not approve the company’s cancer-fighting drug, Erbitux. Martha Stewart sold her shares at $58 and avoided a loss of $51,000 when the share price plummeted the next day on news of the FDA’s initial decision. Today those shares trade at about $78.

Martha Stewart’s name is often lumped into the same news items with Enron’s Ken Lay, Jeff Skilling, and Andy Fastow; the Rigas officers of Adelphia; Bernie Ebbers of WorldCom, and Dennis Kozlowski of Tyco. Yet her behavior is no where near what they are alleged to have done in either psychology or consequences.

The collapse of Enron and WorldCom led to billions of dollars in losses for investors and cost thousands of people their jobs. Adelphia’s former CEO, John Rigas, and his son, Timothy Rigas, the chief financial officer, were found guilty of fraud and conspiracy against the company. They were accused of treating the company like their personal enormous ATM and face 30 years for bank fraud. They were convicted of hiding $2.3 billion in debt, deceiving investors, and lining their own pockets from the company coffers. Tyco’s Dennis Kozlowski and Mark Swartz were charged with stealing $600 million in unapproved compensation and illicit share deals. A mistrial was declared in April when a juror was named and received letters and phone calls. The new trial may be more difficult for prosecutors, since meanwhile, Tyco chief attorney Mark Belnick was acquitted.

Penalizing the Wealthy
Usually Americans are concerned that the justice system may be unfair to the poor who have fewer resources to defend themselves. In the Martha Stewart case, her wealth worked against a fair outcome.

The Federal sentencing guidelines only attempt to make the prison sentences equal. Martha Stewart’s financial penalties – the fines - depend on her wealth. While the fine imposed by the court was only $30,000 out of a maximum of $250,000 for each count, this was nothing compared to her actual financial penalties.

Martha Stewart will never again serve as president of Martha Stewart Living. She gave up the $1.5 million annual salary she received as president. She lost her board seats, but that isn’t the end of it. She also faces restitution and penalties from civil actions, both from the Securities and Exchange Commission and shareholder suits.

On March 5, the day she was convicted, her stock soared from $13.70 to $17 on rumors of a light prison term deal, but plunged to $10.50 by the end of the day. Her conviction changed the company’s value by more than $203 million on that day. Ms. Stewart owns 63% of the company, but the other shareholders bore the rest of the loss, and may file civil suits forcing her to cover their losses - if they sold - once the criminal case is concluded.

Martha Stewart’s total financial hit could amount to $300-$400 million when you add potential penalties, restitution, and legal costs.

A drug dealer with no discernible assets would be sentenced along the same guidelines to prison, but would escape all of the financial penalties Martha Stewart faces. A drug dealer rarely has to worry about loss of prestige, much less loss of the top job in corporate America.

Some Justice
Whether you love her or hate her, whether you think she’s been unfairly punished or unfairly freed on bond, one can’t help admiring her presence of mind. Just after being handed a sentence she thought she’d never get, she stood on the courthouse stairs, apologized to the 200 Martha Stewart Living employees who lost their jobs, and made a pitch for her products and her magazine. After all, even if she isn’t president, she is still editorial director.

Martha Stewart knows how to take advantage of free publicity, and Wall Street rewarded her enterprising spirit. Her stock jumped 37 percent on Friday, the day she was sentenced, and closed up $3.17 at $11.81.