KIDDER PEABODY CASE A BRIEF ABOUT THEM PDF

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KIDDER PEABODY CASE A BRIEF ABOUT THEM...

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Case Study Kidder Peabody Trading Scandal 1994 An Overview of the Kidder Peabody Trading Scandal 1994 case study Issues of the Kidder Peabody Trading Scandal

The Kidder Peabody trading scandal of 1994 is described as one of the biggest trading scandals of all times to occur on Wall Street. This trading scandal happened when the bond trading star Joseph Jett recorded phantom profits for his employer, Kidder Peabody between 1991 and 1993. Background facts of the Trading Scandal

Joseph Jett was employed by Kidder Peabody in 1991. Before this, he had obtained both Bachelors and Masters Degrees in chemical engineering at Massachusetts Institute of Technology. He had studied on scholarship and went ahead to be employed at GE Plastics as an engineer. However, he felt dissatisfied with his career and quit his job. He later enrolled for an MBA at Harvard University. Having completed the MBA program, Jett got employed at Morgan Stanley for two years before being let go. He then found work at First Boston where he worked as a junior trader. After eighteen months this position was

scraped off and Jett was let go again. However in 1991, Jett was employed at Kidder Peabody as a trader in the zero coupon securities department. At the time of being hired, Kidder Peabody was a part of a bigger firm General Electric Inc. Jett was hired as an arbitrageur and was basically supposed to monitor the price of coupon securities or strips and trade in the profitable ones hence make profit for his company. How Joseph Jett’s Scandal worked

By the first year of his employment Jett earned a bonus of $5000 but this changed when he discovered a flaw in the software of Kidder Peabody. The software was structured such that any entries made by traders for forward or future securities would be recorded and considered as a done deal. There was no confirmation in the future as to whether or not the forward securities had actually been completed and neither was there any monetary exchange to confirm a closed transaction. Joseph Jett exploited this loophole by entering the trades but not finalizing the deals. Any incomplete deal led to losses for the company and Jett actually started making phantom profits. By 1992, he earned bonuses worth $2.1 million for the mega profits he had earned for his company. His profit-making streak went on to soar in 1993. In fact, out of the $439 million profit that Kidder Peabody made in 1993, Jett’s exploits constituted around $210 million. This is why his bonuses escalated to $9 million and he was named the trader of the year. By 1994, Joseph Jett had been promoted to the head of the zero coupon securities department and had other traders beneath him. However, his success was not to last because soon so much of the company’s money was held in phantom profits that the General Electric bosses

began to querying Jett’s trading deals. He was trading much more in order to make more profits and cover up the huge losses he had already made. By the time the managers discovered this problem in March 1994, Jett’s phantom profits for Kidder Peabody stood at $350 million and actual losses were $85 million. As a result Jett was fired and Kidder Peabody hired the famous trading lawyer, Gary Lynch to investigate the matter. Effects of the Scandal

Joseph Jett’s trading scandal resulted in Kidder Peabody’s 1993 profits being scaled down from $439 million to a mere $89 million. By the end of 1994, Kidder Peabody had made such huge losses that General Electric decided to do away with the company altogether. Over 2000 employees lost their jobs as a result of this. Joseph Jett was acquitted by Securities and Exchange Commission of the most serious charge brought against him by Kidder Peabody, securities fraud. However, he was found guilty of having the intent to defraud his former employer. He was thus banned from trading in the US and fined a sum of $200,000. Additionally, he was also ordered to disgorge $8.2 million for the fake profits he had made in Kidder Peabody.

Kidder and the 1980s insider trading scandal[edit] Gordon served as Kidder's chairman until selling it to General Electric in 1986. GE believed that Kidder would be a good fit for its financial services division, GE Capital. GE executives had felt chagrin at putting up money to finance leveraged buyouts, only to have to pay large fees to other investment banks. GE believed that it made sense to find a way to keep these fees for itself after taking such expensive risks. Thus, when Gordon concluded that Kidder could not stay independent, he found a receptive ear in GE chairman Jack Welch. GE initially left the firm in the hands of Gordon's longtime heir apparent, Ralph DeNunzio.[7][8] Soon after the GE purchase, a skein of insider trading scandals, which came to define the Street of the 1980s and were depicted in the James B. Stewart bestseller Den of Thieves, swept Wall Street. The firm was implicated when former Kidder Peabody executive and merger specialist Martin Siegel —who had since become head of mergers and acquisitions at Drexel Burnham Lambert—admitted to trading on inside information with super-arbitrageurs Ivan Boesky and Robert Freeman. Siegel also implicated Richard Wigton, Kidder's chief arbitrageur. Wigton was the only executive handcuffed in his office as part of the trading scandal, an act that was later depicted in the movie Wall Street. With Rudy Giuliani, then the United States Attorney for the Southern District of New York, threatening to indict the firm, Kidder was initially poised to fight the government. However, GE officials were somewhat less inclined to fight, given that Siegel had admitted wrongdoing. A GE internal review concluded that DeNunzio and other executives had not done enough to prevent the improper sharing of information. and also revealed glaring weaknesses in the firm's internal controls. Notably, Siegel was able to move about the trading floor as he pleased, and Wigton and Tabor did Siegel-requested trades with almost no questions asked. In response, GE fired DeNunzio and two other senior executives, stopped trading for its own account, and agreed to a $25.3 million settlement with the SEC.[7][8] Years later, in his autobiography, Jack: Straight from the Gut, Welch said that the aftermath of the insider trading scandal led him to conclude that buying Kidder had been a mistake. He was appalled by the firm's outsize bonus pool, which was $40 million greater than the GE corporate pool at the time even though Kidder accounted for only 0.05 percent of GE's income. He also didn't understand how "mediocre people" were garnering such high bonuses. Soon after Black Monday, Welch and other GE executives resolved to sell off Kidder at the first opportunity that they could do so "without losing our shirt."[8]

1994 bond trading scandal[edit] Kidder Peabody was later involved in a trading scandal related to false profits booked from 1990 to 1994. Joseph Jett, a trader on the government bond desk, was found to have systematically exploited a flaw in Kidder's computer systems, generating large false profits. When the fraud was discovered, it was determined that Jett's claimed profits of $275 million over four years had actually been a $75 million loss. The NYSE barred Jett from securities trading or working for any firm affiliated with the exchange, a move that effectively banned him from the securities industry. [9] The SEC subsequently formalized his ban from the industry, and ultimately concluded that Jett's actions amounted to securities fraud. [10] Jett's implosion forced GE to take a $210 million charge to its first-quarter earnings ($350 million before taxes). Years later, Welch recalled that GE business leaders were so shaken by the huge loss that they offered to dip into the coffers of their own divisions to close the gap. In contrast, Welch said, no one at Kidder was willing to take responsibility for the debacle. [8][11] Although Kidder had rebuilt itself with mortgage-backed bonds, negative media coverage following the disclosure of Jett's overstated profits led GE to sell most of Kidder Peabody's assets to PaineWebber for $670 million, in October 1994. The transaction closed in January 1995, and the Kidder Peabody name was retired.[12] Years later, Welch claimed that the Jett debacle was a reminder that Kidder had been "a headache and an embarrassment from the start" for GE. Earlier, several GE board members with experience in financial services, such as Walter Wriston of Citicorp and Lewis Preston of J.P. Morgan, had warned him that a securities firm was very different from other GE businesses; as Wriston put it, "all you're buying is the furniture." The experience led Welch to pass on numerous other acquisition opportunities for GE that made strategic sense on paper after he concluded that they didn't fit with GE's culture.[8]...