Delay Is a Blow to U.S.’ Stewart Case

In a stunning setback for the government in the Martha Stewart trial Thursday, the judge postponed the star witness’ testimony after ruling that prosecutors unfairly held back a potentially crucial FBI memo from the defense.

The memo calls into question whether the key prosecution witness, Douglas Faneuil, could remember who told him to phone Stewart with what the government claims was an illegal insider stock tip.

Faneuil had been scheduled to take the stand Thursday to lay the keystone of the fraud and obstruction-of-justice case against Stewart and her former stockbroker, Peter Bacanovic. Now he won’t testify until at least next Thursday, and his credibility could be damaged if defense lawyers can show that his story has changed.

The judge’s ruling forces the government to call its witnesses out of order. Chief prosecutor Karen Patton Seymour complained that would weaken her presentation.

But it would have been worse for the prosecution if the defense had gotten its way.

In an impassioned speech, Richard M. Strassberg, Bacanovic’s lawyer, told U.S. District Judge Miriam Goldman Cedarbaum that the government’s misbehavior was so serious that she ought to dismiss all charges against the stockbroker or declare a mistrial.

Cedarbaum refused. She also denied a request by Stewart’s lawyer, Robert G. Morvillo, to bar Faneuil from testifying at all. Instead, she gave Stewart’s lawyers a week to figure out how to deal with the new information and instructed Seymour to begin calling other government witnesses when the trial resumes Monday.

“This sounds to me like a huge problem for the structure of their case,” said Paul E. Summit, a former federal prosecutor now with the Boston firm of Sullivan & Worcester. “For a chief witness for the government to be prepped and ready to go, and then to be yanked away -- that’s really tough.”

The charges against Stewart stem from her sale of 3,928 shares of stock in ImClone Systems Inc. on Dec. 27, 2001, the day before an adverse regulatory ruling sent the biotech firm’s stock tumbling.

Faneuil, 28, was expected to testify that Bacanovic, 41, his boss at Merrill Lynch & Co., told him to pass along to Stewart a tip that her friend Samuel D. Waksal, then head of ImClone, was “desperately” trying to dump his shares.

The FBI memo -- turned over to defense lawyers by fax at 10:15 Wednesday night -- casts doubt on that scenario.

The late-night delivery sparked an angry protest from Strassberg, Bacanovic’s lawyer, Thursday morning. The fireworks came before the jury of eight women and four men was led into the courtroom.

The memo was an FBI agent’s account of a Jan. 15, 2003, interview in which officials of the FBI, the U.S. attorney’s office and the Securities and Exchange Commission questioned Jeremiah S. Gutman, Faneuil’s former lawyer. The topic was a conversation that Gutman had with Faneuil on Jan. 7, 2002, 11 days after Stewart’s stock sale.

According to the FBI account, “Faneuil told Gutman that he had been instructed by Bacanovic or Waksal to pass information on to Martha Stewart about ImClone.” The memo was not made public, but that section was read to reporters by a member of the defense team who asked not to be identified.

Seymour, the chief prosecutor, contended that the memo was ambiguous, noting that lower down, “it says Gutman cannot recall if Faneuil said he was instructed by Waksal, Bacanovic or someone else.”

Seymour added that Gutman, 80, acknowledged it was “conceivable his memory is bad, his recollection is inaccurate, that he misunderstood Faneuil.”

Gutman could not be reached for comment Thursday.

Strassberg said that Gutman’s initial statement was unequivocal; his doubts crept in only later, under questioning from investigators upset that his statement “didn’t fit their theory of the case.”

Strassberg called it “very disturbing” that this “clearly exculpatory material” was delivered to the defense after the trial already had begun.

“This is central to their entire case against my client,” he said, adding, “It suggests their entire case may be misplaced.”

Under federal trial rules, the prosecution is required to turn over evidence that may exonerate the defendant well in advance of trial. Seymour said the defense had long been aware of Gutman’s involvement in the case and could have interviewed him themselves. The prosecutor also said she didn’t consider the memo helpful to Stewart, because if she acted on an inside tip, it didn’t matter who provided it.

At that, Strassberg leapt to his feet. “The government seems to think this is a case against Martha Stewart,” he said. “We’re here too!”

“I do think the government should have turned this information over earlier,” Cedarbaum said.

The jury, having heard none of the wrangling, was called into the courtroom for about an hour to hear the last portion of testimony from a Merrill Lynch executive who explained the firm’s ethics and confidentiality rules.

Cedarbaum then called a lunch break and instructed Seymour to find a government witness to replace Faneuil for the afternoon session. When court convened, the prosecutor said she had tried eight witnesses but was unable to find one who could quickly come to the courthouse.

Cedarbaum brought back the jury, told them there had been “a bit of a mix-up” and sent them home for a long weekend.

Although the information concerning Gutman was more favorable to Bacanovic’s case, legal experts have said that anything calling Faneuil’s credibility into question was also a plus for Stewart, 62.

In his opening argument Tuesday, Morvillo hinted at why Faneuil might have had trouble recalling who asked him to do what on Dec. 27, 2001.

Morvillo said Faneuil “made and received in excess of 75 phone calls” that day, many from Waksal and his family members, as ImClone shares tumbled on heavy trading volume.