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Nightmare on Wall Street

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on October 18, 2000

Joseph Jett was a brilliant mathematician, a scholarship student at Harvard and MIT. In 1991 the prospect of working in an intellectually demanding environment lured him into the new profit-hungry Kidder Peabody, one of Wall Street's oldest and richest banks, which had been bought by General Electric in 1986. Jett's Kidder Peabody job was in government bonds, the buying and selling of government debt. It was a trading backwater where no-one had ever achieved high returns before. But Joseph Jett was about to change all that.

A government bond of security is a loan of money to government. Like a mortgage, the government repays its money in a series of interest payments over several years. Jett and his team were trading not only the full bond issued by the government, but also separating these bonds into their separate interest payments, or strips, and trading these.

Using this technique, Jett's reported profits for his first year at Kidder Peabody were $32 million, more than doubling the previous best performance of his desk.

By 1993 he was thought to have made the company approximately $150 million, and was promoted to head his department. By the end of '93 he was handling thirty billion dollars. Even during the Wall Street recession of 1994 Jett's profits continued to soar. The company accounts showed that Jett had made $350 million in two and a half years. These profits meant huge bonuses for Jett and his bosses. Jett alone took nine million dollars in a single year.

As more and more capital flowed into Jett's account, Jett and his team took their trading into a new and exciting arena known as 'forward transactions'. This meant that traders were no longer limited by deals they could strike on a particular day of trading. They booked into their computer screens trades that were only due to take place at some future date. Effectively this meant that Jett could now strip down and reconstitute bonds that he did not yet own. Nonetheless these acts brought about a surge in Kidder's reported profits.

But all was not well.

Kidder's management team had discovered what amounted to a shortfall of $350 million. Their response was to launch an investigation into the way Jett was stripping and reconstituting bonds.

Jett's forward trades, the much-acclaimed engine of his trading strategy, were often cancelled before they actually happened. Kidder Peabody's star trader, it suddenly appeared, had spent much of his time orchestrating a series of entirely pointless trading plans, or phantom trades.

Unable to fathom Jett's thinking, and intrigued to find out if it could explain the shortfall $350 million, some of Kidder's managers invited Jett to join them in a meeting to discuss the problem.

Kidder Peabody then appointed a top flight lawyer to investigate the case against Joseph Jett. Kidder felt that they could prove that the entire bank had been duped by its uniquely manipulative and charismatic head bond trader.

Stories appeared in the press casting doubts on Jett's academic achievements and personal integrity, and, most bizzarely, suggested that a succession of different women were regularly seen going in and out of his New York apartment.

With the press determined to vilify him, the entire might of General Electric against him, his colleagues refusing to return his calls and his money frozen in a Kidder Peabody account, Jett - with some difficulty, eventually found a defence attorney willing to represent him. And, as the story unfolded, it became increasingly clear that the evidence did not fit Kidder's version of events as neatly as they might have wished.

Jett and his lawyer tried to gather the evidence they needed to show that Kidder's managers were in fact behind his strategy of logging forward trades. Jett's lawyer claimed that Kidder was so anxious to impress General Electric - and to attract money from other banks - that they were directing Jett's trades in order to help them achieve this.

Tapes of phone calls between Jett and his managers about the forward trading at the centre of the crisis enabled Jett's lawyer to argue that Jett's bosses were in command of the situation, well aware of his trades, and even setting down the terms on which he was supposed to trade.

In July, 1996, Jett's case was put before a panel of three arbitrators. They had to decide whether Joseph Jett was a lone wolf who single-handedly hoodwinked one of Wall Street's most established investment banks, or was the puppet of an institution in which naked greed had got the better of proper management.

In the end, Jett won the arbitration. All of Jett's money has been returned to him, and Kidder Peabody has been sold off at a loss to General Electric. In August 1998 a second case brought by the SEC, the regulatory body responsible for the securities industry, again cleared Jett of fraud, but fined him over $8 million on the grounds of bookkeeping violations. Both Jett and the SEC are appealing against this decision.

Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
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