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Jett Aftermath

Path: socrates.fsb.duke.edu!usenet From: kpr2@mail.duke.edu (Kevin Reilly) Newsgroups: mba.1997_98.term4.ba341.Managerial_Acctg.Huddart.Closed Subject: The Fallout from the Jett-Kidder Trading Scandal Date: 29 Apr 1998 16:42:10 GMT Organization: Duke's Fuqua School of Business Lines: 200 Message-ID: <6i7l92$3t52@socrates.fsb.duke.edu> NNTP-Posting-Host: 152.3.251.52 Mime-Version: 1.0 Content-Type: Text/Plain; charset=ISO-8859-1 X-Newsreader: WinVN 0.99.8 (beta 2)

The following is a description of the fallout (legal and otherwise) from the Jett-Kidder Peabody bond trading scandal.

First a brief summary. Numerous individuals connected with this scandal were investigated and/or sued. The SEC launched a probe into this matter and filed civil administration charges against many of the parties involved. The New York Stock Exchange conducted its own investigation and levied its own sanctions. Jett and Kidder went to arbitration. Jett sought the return of the money in his trading account. Kidder asked for just shy of one hundred million dollars in damages from Jett. If all that were not enough, the shareholders of GE brought an action against Kidder, Carpenter, O'Donnell, Cerullo and Jett seeking a fortune in damages for fraud and deceit in connection with Jett's trading scheme.

GE sold Kidder for approximately $600 million dollars (after investing $1.4 billion in Kidder). The individuals involved were investigated, sued, and spent the better part of their lives for years with attorneys trying to minimize the fallout. In Jett's case, it appears as if he is personally responsible for millions in legal fees associated with defending himself against the SEC, the NYSE and GE shareholders.

The following gives a more detailed description of the events described above:

(1) SEC Investigations and Actions:

(a) Melvin R. Mullin: Mullin hired Jett in 1991 and supervised him during the early stages of his alleged fraud. Mullin ran Kidder's government bond desk from 1988 until early 1993. Mullin settled civil administration charges brought by the SEC accusing him of failing to supervise Jett. Pursuant to the terms of the settlement, Mullin was banned from the securities industry for three months, after which time he was barred from working as a supervisor for three months. Additionally, he was fined $25,000.

(b) Edward Cerullo: Cerullo was Kidder's bond chief and Jett's immediate supervisor while most of the alleged fraud occurred. Cerullo settled civil administration charges brought by the SEC accusing him of failing to supervise Jett. Cerullo agreed to a one-year supervisory suspension and a fine of $50,000.

(c) Joseph Jett: As of April 1, 1997, SEC civil administration charges were still pending against Jett. The charges concern allegations that Jett created false profits to hide losses.

(2) The New York Stock Exchange Proceedings:

(a) Melvin R. Mullin: It appears that (as of 2/2/96) Mullin's lawyer wasn't too confident that his motion to dismiss the charges against Mullin would be granted. I don't have any subsequent information on Mullin regarding the Big Board proceedings (Big Board and NYSE are used interchangeably); however, one year later, Mullin's "I'll fight this to the end" attitude softened as he (as mentioned above in part (1)) settled charges with the SEC.

(b) Edward Cerullo: The Big Board found that "Cerullo failed to make a reasonable inquiry into the increase in profits resulting from Jett's trading until February 1994," and Cerullo "failed to reasonably discharge his duties and obligations in connection with the supervision and control of Jett's activities." The Big Board suspended Cerullo for one year from any supervisory positions in the brokerage business (this suspension was served concurrently with his SEC suspension). The Big Board imposed no fine as they felt it would have been redundant given the SEC fine.

(c) Joseph Jett: In a decision dated August 4, 1994 (subsequently upheld on appeal November 4, 1994), the Big Board barred Jett from trading securities until he testifies before the NYSE hearing panel. The NYSE hearing panel stated that Jett failed to show up or refused to testify in enforcement division hearings from April to August of 1994. Jett alleged that his requests for postponement of these hearings were unfairly denied. I have no data as to whether Jett's bar from trading was subsequently lifted (if he decided to testify).

(3) Arbitration between Jett and Kidder Peabody: After the scandal was uncovered, Kidder froze Jett's cash management account of $4.8 million and his vested executive compensation account of $130,000. Jett brought a claim to recover these funds. Kidder Peabody counterclaimed for $82.81 million in damages resulting from Jett's actions.

(a) Arbitration Panel Ruling: In April 1997, the arbitration panel ordered Kidder to release $1 million from Jett's personal trading account. The panel further rejected Kidder's counterclaims for damages totaling $82.81 million.

(b) Why Arbitration and not a New York State or Federal Court Proceeding?

(1) Why is an Employee Forced to Arbitrate? Individuals working in the securities industry are generally required to sign a standard "U-4" agreement (the name of this agreement may vary from industry to industry) which (among many other things) compels an employee to arbitrate any and all claims arising out of his or her employment.

(2) Why do Employers Want to Compel Arbitration? Arbitration is generally a quicker and easier way to resolve disputes than seeking redress in state or federal court. Arbitration is also generally more informal (procedural rules that are mandated in state and federal court are relaxed in arbitration). Further, arbitration is generally a less expensive way for an employer to have an employee's dispute resolved. Finally, arbitration is a nice way for an employer to avoid a jury trial. If an employee's case were heard in state court, the employee's case (depending on the matter) would most likely be heard by a jury. Most employers want to avoid jury trials because juries are generally more sympathetic to the plaintiff and are more likely (than an arbitrator) to award large damages. Further, juries may not possess the expertise to decipher the difficult issues that arise in securities cases, exacerbating the risk of a plaintiff-friendly outcome. In sum, employers have a predisposition to having employee's claims heard by arbitrators (again, this is a general statement - employer preferences will vary).

From the employee's perspective, arbitration does offer some advantages. As mentioned above, arbitration is generally faster and less costly than pursuing a matter in state or federal court. Accordingly, for a plaintiff that does not have a lot of money or time for litigation, arbitration can be a quick and easy way (relatively speaking) for her to have a dispute resolved. Finally, the procedural rules normally binding in state or federal court are relaxed for arbitration. Relaxing these rules can make it easier for a plaintiff to offer evidence to establish her case.

(4) Shareholder Litigation: GE shareholders brought two shareholder derivative actions seeking damages suffered as a result of fraud and deceit associated with this trading scandal. (a) What is a shareholder derivative action? Basically, a shareholder (or group of shareholders) sues on behalf of the company. It is a bit different than the company (in this case GE) sending out their attack dogs to sue the alleged wrongdoer. Here, the shareholder "steps into the shoes of the company" and sues on behalf of his or her fellow shareholders for damages they suffered as shareholders.

(b) In re General Electric Securities Litigation. GE shareholders brought an action against Kidder's parent, General Electric, essentially contending that "GE committed securities fraud by reporting earnings which it knew included Jett's false profits." The court dismissed this case stating that Plaintiffs failed to "plead" or allege (in their Complaint) that GE, with respect to Jett's profits and cover-up, had an "intent to deceive, manipulate, or defraud" or was engaged in "knowing or intentional misconduct." Essentially, the case was "bounced-out" before it ever began.

(c) In re Kidder Peabody Securities Litigation. Not dissuaded by the aforementioned ruling, GE shareholders filed an action (alleging essentially the same fraud and deceit) against Kidder, Michael Carpenter (Kidder's former Chairman, CEO and President), Richard O'Donnell (Kidder's CFO), Edward Cerullo (Jett's Supervisor) and - you guessed it - Orlando Joseph Jett. These Defendants attempted to dismiss the case arguing that Plaintiffs failed to state a claim upon which relief could be granted. The court denied Defendants' motion finding that Plaintiffs' sufficiently alleged a pattern of conduct that met the legal elements of fraud (in this case Section 10(b) of the Securities and Exchange Act of 1934).

Specifically, the court found that "Kidder arguably had a motive to either hide Jett's trading scheme or to recklessly disregard the warning signs of that scheme." Further, as to Carpenter, "Plaintiffs have established a sufficient motive to either hide Jett's trading scheme or to recklessly disregard the warning signs of that scheme." Cerullo did not escape either: "[t]he criticisms of Cerullo in the Lynch Report, coupled with the various red flags and instances in which Kidder Management, including Cerullo, should have discovered the fraud, are sufficient to state a claim for securities fraud." Finally, the court found that "Jett owed a duty not to participate in the making of material misrepresentations and by generating the false profits on which all the other misrepresentations were based, Jett so participated[sigma] Moreover, Jett had a clear motive to misrepresent his profits - the $9 million performance-based bonus he received founded on the fictitious huge profits generated by his scheme."

(d) What this Ruling Means. By surviving Defendants' motion to dismiss, Plaintiffs did not "win" the case by any means. The court merely found that Plaintiffs' allegations, if proven true at trial, would constitute a violation of Section 10(b) of the Securities and Exchange Act of 1934. Now the Plaintiffs have to prove the truth of their allegations (contained in their Complaint) and prove that they suffered damages as a result of Defendants' fraud and deceit. In sum, consider Plaintiffs' "victory" as clearing one hurdle of many they will need to clear in order to recover damages in this matter.

(e) Kidder Refused to Pay for Jett's Attorney's Fees. In a case where the employer and employee find themselves on the same side of the table (here, Defendants), the employer generally foots the legal bill for its employees (or former employees). Kidder did so for Carpenter, Cerullo and Mullin. However, Kidder denied Jett's petition for $600,000 in legal fees stating that Jett "acted at all times in his own interest rather than Kidder's and is not entitled to have Kidder, the victim of his fraud, advance defense costs which he will never be able to repay." This refusal by Kidder is especially painful for Jett as the costs of defending his interests in the shareholder litigation suit described above could run into the millions.

(5) Who Won? The Lawyers. In all this mess, no one went to jail. The fines imposed by the SEC and NYSE were minimal (relative to the amount of money involved). The GE shareholders may get (or may have gotten) some money. But the real "winners", if you want to call them that, were the lawyers, who received millions making sure no one went to jail and trying to allocate blame in a myriad of legal proceedings.

**** The aforementioned information was gathered from various articles retrieved from the Dow Jones News/Retrieval Service or reported cases. In the interests of time, the writer did not cite specific sources or give specific legal citations. In the event you have a question as to the legal nature of anything described above, please feel free to contact me - I will do my best to answer your questions. I did my best to recount accurately the events subsequent to the Jett trading scandal. However, in the interests of disclaiming myself of any and all liability (what liability, who knows? But you can never be too careful) - I take no responsibility for the accuracy or inaccuracy of the information contained herein. Finally, this summary in no way conveys any legal advice upon which you should rely.

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Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 865-3271
(814) 863-8393 fax
huddart@psu.edu
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