More 'Ridiculousness'

Wielding a big knife and a look of determination, Martha Stewart kept her head down while chopping cabbage on CBS's "The Early Show" last week. But even in her weekly cooking segment, Martha couldn't escape the insider-trading scandal that's tarnished her homemaking empire. CBS brass warned her beforehand that she had to address the growing controversy if she wanted to come on "The Early Show" to whip up her summer salads. Stewart, after consulting her lawyers, agreed to take questions, but only if she didn't have to leave her kitchen to sit for a separate interview. So with Martha whacking away at the chopping block, anchor Jane Clayson laid out the worsening crisis and attempted to get the domestic diva to explain herself. "This will all be resolved in the very near future and I will be exonerated of any ridiculousness," Martha said, rolling her eyes and resuming her cabbage shredding. But Clayson, usually Martha's kitchen helper, continued to grill her. Exasperated, Martha huffed: "I want to focus on my salad."

But Martha's kitchen is getting a lot hotter. The widening probe into her sale of ImClone stock is now focusing on whether she fabricated a cover-up. And we're not talking about a chintz duvet. Federal prosecutors are now investigating the queen of perfection for obstruction of justice, in addition to insider trading. Stewart's alibi that she unloaded her ImClone stock because of a prearranged sell order with her broker may be collapsing. The broker's assistant, Douglas Faneuil, told Merrill Lynch lawyers that he was pressured by his boss to lie about a "stop loss" order that Martha insists proves her innocence. But congressional investigators tell NEWSWEEK that Merrill documents they reviewed last week show no credible record of a stop-loss order between Stewart and her broker, Peter Bacanovic, to sell her shares when they fell below $60. Stewart cashed out her shares for $227,824 on Dec. 27, one day before federal regulators rejected ImClone's cancer drug and the stock tumbled. Depending on what Bacanovic tells them, congressional investigators are considering calling Martha to Capitol Hill to testify about whether she made false statements to the panel investigating ImClone. Says one investigator: "We're going to keep dogging her."

Martha is also being hounded by federal prosecutors. The Feds intend to squeeze her friend Sam Waksal, the former ImClone CEO arrested on insider trading last month. A source close to the investigation tells NEWSWEEK prosecutors are trying to gain leverage on Waksal by going after his daughter Aliza, who dumped $2.5 million in ImClone stock on Dec. 27. Aliza Waksal's lawyer declined to comment, but a source close to the family says: "Squeezing Sam is not going to get Martha."

Bacanovic, who is under scrutiny also for being Aliza's broker, has plenty of motivation to cut a deal with the Feds, too. Merrill records and Faneuil's flip are poking holes in his story. Investigators have now learned that Bacanovic was on vacation in Florida on Dec. 27 when he spoke to Stewart, who was jetting to a Mexican holiday herself when she returned her broker's call. Bacanovic phoned in Stewart's sell order to Faneuil, who actually executed the trade. E-mail between the broker and his assistant before and after the trade never mentions a stop-loss order. Congressional investigators still want to interview both men, whom Merrill suspended. But Bacanovic's lawyers indicated he will not appear willingly, and he's expected to take the Fifth if he's subpoenaed, congressional sources tell NEWSWEEK. Lawyers for Bacanovic and Faneuil declined to comment.

Wall Street isn't buying Martha's story, either. Despite its strong business performance, Martha Stewart Living Omnimedia stock has fallen 40 percent since this scandal erupted in early June. (Martha's personal loss: $235 million.) "We've bounced back from all kinds of problems," Martha Stewart's president, Sharon Patrick, told NEWSWEEK. "Through all these problems, all we do is perform." Maybe so, but even advertisers are getting squeamish. "Her brand identity is about perfection," says ad exec George Fertitta, whose client Godiva Chocolates advertises in Martha's magazine. "If what she's accused of is true, it demonstrates a potential flaw." But perhaps the cruelest indignity comes from Martha's old pal David Letterman, who skewers her nightly. "I was watching her show and she had to accept a subpoena wearing an oven mitt," he joked last week. She might find a subpoena harder to shred than a head of cabbage.