The chances of jail time for Martha Stewart have been greatly reduced by the Judge dismissing a securities-fraud charge, the most serious offense in the indictment, saying the prosecutors didn’t offer enough evidence that she intended to mislead investors

Stewart, the founder and former chief executive of Martha Stewart Living Omnimedia Inc., was charged with securities fraud for making false statements to her company’s shareholders about her December 2001 sale of ImClone Systems Inc. stock. The government said she waged a public campaign to minimize the impact of a federal investigation of the sale on Martha Stewart Living stock.

Stewart had faced up to 10 years in prison if convicted. Four other conspiracy and obstruction of justice charges are still pending before U.S. District Judge Miriam Goldman Cedarbaum. They carry sentences of up to five years each.

“I have concluded that no reasonable juror can find beyond a reasonable doubt that the defendant lied for the purpose of influencing the market for the securities of her company,” Cedarbaum said.

At a hearing last week, Cedarbaum had called the stock fraud charge “the most problematic” in the indictment against Stewart.

Martha Stewart Living stock surged on news of the dismissal. Shares rose $1.80 to $14.90 at 12:38 p.m. in New York Stock Exchange composite trading. The stock hit a 52-week high of $15.25 at 12:09 p.m.

Stewart’s lawyer, Robert Morvillo, said he was pleased at the decision. Assistant U.S. Attorney Karen Seymour, the lead prosecutor in the case, declined to comment.

Former federal prosecutor Christopher Bebel called the decision “a major blow for the government. It raises the chance for acquittal on all counts.”

Though jurors won’t be told why the securities fraud charge was dropped, “they will surmise that either the government has dismissed or the judge has thrown it out” he said. “Jurors have been instructed to refrain from reading media reports, but this will in all likelihood filter down to at least some of the jurors, and it will cause them to view the government’s case in a different light.”

The judge’s decision also removes the threat of a 10-year sentence for Stewart had she been convicted, Bebel said. “It ratchets down her exposure to a significant prison term” he said.

Prosecutors said Stewart sought to deceive her company’s shareholders in a June 7, 2002, statement contained in a Wall Street Journal article; a June 12, 2002, statement to shareholders; and a June 18, 2002, release to investors.

Martha Stewart Living’s market value rose a total of $138.2 million after two of the three statements mentioned in the indictment.

The government offered evidence at the trial in Manhattan federal court that Martha Stewart Living shares rose after Stewart told investors she had a pre-existing agreement to sell her ImClone shares once they fell below $60.

Stewart, 62, and her former broker at Merrill Lynch & Co., Peter Bacanovic, 41, are also accused of conspiring to deceive investigators about the reason for her ImClone stock sale. The trade occurred a day before federal regulators denied an application for Erbitux, an ImClone cancer drug. The Food and Drug Administration approved Erbitux on Feb. 12.

Stewart alone was charged with stock fraud.

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