A:

The 1980s for Kidder, Peabody & Co. ended on a very sour note. Its star banker, Marty Siegel, was at the center of the Ivan Boesky scandal that blew up in 1987. General Electric (NYSE:GE), parent company to Kidder, Peabody & Co., acquired the bank and was required to pay $26 million in fines as part of a settlement with then-U.S. attorney Rudy Giuliani. Slowly, GE built itself back into profitability under the management of Si Cathcart and his successor Mike Carpenter.

Unfortunately for Kidder, Peabody & Co., the internal problems were not over. Joseph Jett was a bond trader on GE's government bond desk. His job was to skin a profit from price differences in plain vanilla government bonds and zero-coupon bonds. Jett's job involved stripping and/or reconstituting bonds in order to take advantage of arbitrage. Jett had discovered a glitch in Kidder's computer system; it would record profits on a forward reconstitution daily, even if the trades would be worthless upon settlement.

Kidder, Peabody & Co.'s system was designed to tally profits while allowing time for trades to settle. By moving his trades forward again and again, Joseph Jett was able to keep profits building while delaying the final transaction that would necessarily cause a loss equal to the false profits. An upgrade of the system on the same faulty grounds allowed him to enter more false trades, which kept them floating longer. GE noticed Kidder's portfolio was becoming extremely heavy and over-extended in bonds. GE told Kidder to reduce its stake, whereupon Jett's scam was revealed.

Around $350 million in false trades were made and $8 million in performance bonuses on false trades were paid to Jett. Jett's bonuses made him the prime target of a SEC investigation. Interestingly, Jett denied concealing the trades and put the blame on Kidder, Peabody & Co. management, stating that the company knowingly engaged in fraud in an attempt to wrest control of Kidder, Peabody & Co. back from GE. His most serious charges were overturned on appeal. Kidder, Peabody & Co. untangled from GE when the parent company sold the investment bank to Paine Webber, presumably out of anger at having to deal with two high profile trading scandals during the short time they owned it.

To read more about stock scams, see The Biggest Stock Scams Of All Time.

This question was answered by Andrew Beattie.

RELATED FAQS
  1. What recognized CEO earned the moniker "Neutron Jack"?

    When it was announced that Jack Welch would be taking over as head of General Electric (NYSE:GE), skeptics wondered how much ... Read Answer >>
  2. What is a stripped bond?

    The quick answer to this question is that a stripped bond is a bond that has had its main components broken up into a zero-coupon ... Read Answer >>
  3. How does an investor make money on a zero coupon bond?

    Learn about investing in zero-coupon bonds, exactly how they work as an investment vehicle, and their advantages and disadvantages ... Read Answer >>
  4. Why do interest rates tend to have an inverse relationship with bond prices?

    At first glance, the inverse relationship between interest rates and bond prices seems somewhat illogical, but upon closer ... Read Answer >>
  5. What are the best ways to protect trade positions against false signals?

    Find out why it is important that traders learn to protect themselves against false signals, and read about some of the most ... Read Answer >>
Related Articles
  1. Small Business

    Peabody Chapter 11: Is This Only the Beginning?

    Gain insight into why Peabody Energy ended up in bankruptcy after the coal mine sale to Bowie failed, and discover if Peabody’s bankruptcy marks the beginning of a sector-wide trend.
  2. Investing

    Is This the End of the Line for Peabody Energy?

    It feels like such a long time ago that Peabody Energy's (NYSE: BTU) then-chairman and CEO Gregory Boyce proclaimed the coal industry was in the early stages of a "supercycle" as India and China ...
  3. Financial Advisor

    What's Behind GE's $32 Billion Deal With Wells Fargo

    GE is a 123-year-old blue chip mainstay, with some radical plans for the future--as evidenced by Wells Fargo's $32 billion purchase of several of GE's finance-related businesses.
  4. Investing

    Is Peabody the Canary in the Coal Mine? (BTU)

    Peabody Energy became the latest coal company to file for bankruptcy this morning. It is a sign of the times for the coal industry.
  5. Investing

    Peabody Energy May Declare Bankruptcy (BTU)

    Peabody Energy Corp., the U.S.'s largest coal miner, announced Wednesday that it may declare bankruptcy in the next thirty days.
  6. Retirement

    Is General Electric Stock Suitable for Your IRA or Roth IRA? (GE)

    Learn about the history of General Electric's business, the troubles that arose from GE Capital and if GE still makes an appropriate IRA investment.
  7. Investing

    Top 5 Companies Owned by General Electric (GE)

    Learn how General Electric is no longer the company it used to be. With the divestiture of GE Capital and NBC Universal, it is focusing on its industrial roots.
  8. Investing

    Should GE Be Part of Your Portfolio?

    Here's what you need to consider if you are thinking of adding GE to your portfolio.
  9. Investing

    The Biggest Risks of Investing in General Electric Stock

    Read about the biggest risks facing General Electric Company, an international conglomerate that is undergoing unprecedented restructuring.
  10. Investing

    Why The GE Stock Is Falling Today (GE)

    GE reported positive earnings this morning. But its stock is down. Why?
RELATED TERMS
  1. Julian Robertson

    A former hedge fund manager and investor, Julian Robertson founded ...
  2. Ivan Boesky

    An American stock trader known for his role in a 1986 Wall Street ...
  3. Coupon Stripping

    The separation of a bond's periodic interest payments from its ...
  4. Settlement Period

    The period of time between the settlement date and the transaction ...
  5. Total Debt To Total Assets

    Total Debt To Total Assets is a measure of financial risk that ...
  6. Bond

    A debt investment in which an investor loans money to an entity ...
Hot Definitions
  1. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  2. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  3. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  4. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  5. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  6. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
Trading Center