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From: email@example.com (Kevin Reilly)
Subject: The Fallout from the Jett-Kidder Trading Scandal
Date: 29 Apr 1998 16:42:10 GMT
Organization: Duke's Fuqua School of Business
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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
(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
(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
(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
(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
(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.
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
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