Federal investigators are negotiating an agreement with a Merrill Lynch & Co. trading assistant in which he could receive immunity from prosecution in exchange for testimony against Martha Stewart in the ImClone Systems Inc. insider-trading case, said people familiar with the matter.

The negotiations come as another major shoe dropped in the ImClone inquiry. On Wednesday, a federal grand jury indicted ImClone founder Samuel Waksal on insider-trading charges for trying to sell his ImClone shares -- and tipping off family members to sell their stock -- before the company's Dec. 28 announcement that the Food and Drug Administration wouldn't review the biotechnology company's cancer drug. The indictment also includes additional counts of perjury, obstruction of justice and bank fraud, a more serious charge that carries a maximum 30-year prison term. Mr. Waksal's lawyer said that his client is "presumed to be innocent, and he will respond to these charges as required."

Prosecutors haven't struck a deal with the Merrill trading assistant, Douglas Faneuil. But if a pact is reached, it could be bad news for Ms. Stewart, who sold nearly 4,000 ImClone shares on Dec. 27. Ms. Stewart has said that she sold her shares because of a previously arranged agreement with her broker and Mr. Faneuil's boss, Peter Bacanovic, to sell when the price of ImClone fell below $60 a share.

Federal investigators now have their doubts about her story. First, there was no official record at Merrill showing that an agreement existed, just some notes from Mr. Bacanovic. Moreover, prosecutors recently widened their investigation of Ms. Stewart beyond insider trading to include possible obstruction of justice and making false statements about why she sold, after hearing Mr. Faneuil's account of the events.

Mr. Faneuil, 26 years old, has told Merrill executives and federal investigators that Ms. Stewart sold her shares after he advised her, at the behest of Mr. Bacanovic, to take the action because Mr. Waksal and members of his family also were selling their stock, people close to the matter said.

Some outside legal specialists say Mr. Faneuil's role as a potential witness shows that prosecutors are escalating their probe and could be seeking to file charges soon. "If they reach a deal with Faneuil, it means that the Justice Department is likely to push for charges because it believes her story lacks credibility," says securities lawyer Jacob Zamansky, who is uninvolved in the ImClone case. "This means they think his testimony could be the smoking gun because there is no written stop-loss agreement."

Ms. Stewart's lawyer, Robert Morvillo, didn't return a call for comment. Mr. Faneuil's attorney, Marc Powers, had no comment. Mr. Bacanovic's lawyer didn't return a call.

Mr. Faneuil has emerged as a key witness in the government's wide-ranging investigation of Ms. Stewart's ImClone sale, which was just before the stock dropped on the FDA news. Mr. Faneuil initially supported Ms. Stewart's version of the events, telling federal investigators that she had a previously arranged "stop-loss agreement" to sell the stock when it fell in value.