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.

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References

http://financetrain.com/case-study-trading-scandal-at-kidder-peabody/

http://www.nytimes.com/1994/08/05/us/behind-kidder-scandal-overview-kidder-scandal-tied-failure-supervision.html

http://www.prenhall.com/divisions/bp/app/old_laudon2/exercises/case05.html

http://online.wsj.com/news/articles/SB901051553209433500

http://www.investopedia.com/ask/answers/08/kidder-peabody-joseph-jett.asp

http://en.wikipedia.org/wiki/Joseph_Jett