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Kidder's Jett Is Sanctioned but Cleared of Fraud

By Michael Siconolfi Staff Reporter of The Wall Street Journal


The Wall Street Journal C1 (Copyright (c) 1998, Dow Jones & Company, Inc.)

NEW YORK -- Joseph Jett, the central figure in one of Wall Street's most high-profile trading scandals, has been cleared of the most serious charge against him.

A Securities and Exchange Commission administrative law judge yesterday ruled that Mr. Jett, the former Kidder, Peabody & Co. government-bond chief, didn't commit securities fraud in the 1994 bond-trading scandal that ultimately brought down Kidder. That was the most significant charge in the SEC's civil case; Mr. Jett has never been charged in a separate criminal investigation of the scandal.

The judge, Carol Fox Foelak, said Mr. Jett's actions didn't constitute fraud because they weren't "in connection with the purchase or sale of any security." But she concluded that Mr. Jett had an "intent to defraud" Kidder and sanctioned the former trader on a lesser books-and-records violations charge. Mr. Jett also was barred from associating with any brokerage firm, fined $200,000 and ordered to disgorge $8.21 million in allegedly false profits.

The 54-page decision caps one of the final chapters in Mr. Jett's long-running saga. Kidder fired Mr. Jett in April 1994 and accused him of creating $348 million in fake profit on government-strips trades that masked losses of nearly $100 million over 2 1/2 years, allegedly to boost his performance-based bonus. Strips are created by splitting the interest and principal portions of bonds into two separately traded issues.

The ruling, if it stands, means that nobody at Kidder will be held legally accountable for securities fraud in the Wall Street scandal, though Mr. Jett's two superiors lost their jobs and Kidder itself was sold in the wake of the scandal to PaineWebber Group Inc. in 1994.

Mr. Jett's superiors, Edward Cerullo and Melvin Mullin, in 1996 separately settled SEC civil charges of failing to supervise Mr. Jett and were temporarily suspended from supervisory positions on Wall Street and fined. No criminal charges have been brought against anyone by the Manhattan U.S. Attorney's office in a separate investigation of the Kidder case.

The decision surprised some executives on Wall Street. It was widely expected that Judge Foelak would accept the SEC's allegations against Mr. Jett after 19 hearings held more than two years ago. Indeed, the ruling underscores how SEC administrative law judges, once viewed as rubber stamps in SEC civil cases, increasingly are ruling against the commission's enforcement staff. Though there are no current statistics on the propensity of administrative law judges to rule in favor of the SEC, "the world has certainly changed," says Richard Walker, the SEC's enforcement chief.

Neither the SEC nor Mr. Jett, 40 years old, was totally satisfied with the split ruling. "The decision correctly clears Mr. Jett of fraud charges, but it is illogical and wrong to sanction him for a books-and-records violation when he scrupulously followed all of Kidder's record-keeping procedures and Kidder itself was never even charged with a books-and-records violation," Kenneth E. Warner, Mr. Jett's lawyer, said in a statement. "We will definitely appeal."

The SEC, for its part, called Judge Foelak's ruling on the securities-fraud charge a technicality and is considering appealing. "She imposed serious sanctions against Jett, but more extreme sanctions are appropriate," said Carmen Lawrence, the SEC's Northeast regional director. Finding no securities fraud "was obviously not adequate in the commission's opinion," she said.

Despite the fact that the SEC sought a total of more than $22 million in penalties and disgorgement, Ms. Lawrence said the commission "for the most part was pleased" with the decision.

Mr. Walker, the SEC's enforcement chief, called the ruling "a resounding rejection of [Mr. Jett's] defense." As for Mr. Jett being cleared of securities-fraud charges, Mr. Walker said: "What's implicated here is a very narrow legal issue." He said the SEC "could" appeal; it has 21 days to do so. "The issue is up for grabs at the appellate level," he added.

In her decision, Judge Foelak said "Mr. Jett's actions did not violate the antifraud provisions because they were not `in connection with the purchase or sale of any security' within the meaning of the securities laws." But the judge concluded that Mr. Jett "exploited an anomaly in Kidder's software, in the manner of a pyramid scheme, that credited him on Kidder's books with enormous, but illusory, profits. He did this with an intent to defraud."

The judge rejected Mr. Jett's claims during the five-week hearing that his superiors directed his trading, and that his woes stemmed from Kidder's move in 1993 to change its accounting system on how the firm calculated its trading profit.

"I find that Kidder management did not affirmatively approve" the allegedly fraudulent bond-trading scheme "and the associated unrealized profits," Judge Foelak wrote. "The evidence shows only that Kidder failed to follow up on questions that were raised" on the allegedly bogus profit.

Mr. Cerullo and Mr. Mullin have denied any knowledge of Mr. Jett's actions. The two executives settled the SEC failure-to-supervise charges without admitting or denying wrongdoing.

An arbitration panel of the National Association of Securities Dealers in 1996 dismissed $82.8 million in claims that Kidder had filed against Mr. Jett.

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