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.

  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. 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 >>
  4. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... 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

    Coal's Weak, So Buy Peabody

    It takes a weak coal market to get Peabody shares cheap.
  3. 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.
  4. Investing

    Braver Buys 112,647 GE Shares in 2Q16 (GE)

    Braver Wealth Management purchased 112,647 shares of General Electric Co (GE) in the second quarter of 2016.
  5. Investing

    GE's CEO Eyes 'Next Age of Productivity' (GE)

    General Electric Co. (GE) may continue to explore innovative ways to drive revenue growth in the foreseeable future.
  6. 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.
  7. Investing

    General Electric Adds to Its Leadership Team (GE)

    General Electric Co (GE) has announced the appointment of four officers, a move that may help the company achieve its earnings goals.
  8. 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.
  9. Investing

    Why The GE Stock Is Falling Today (GE)

    GE reported positive earnings this morning. But its stock is down. Why?
  1. Coupon Stripping

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

    The period of time between the settlement date and the transaction ...
  3. Bond

    A debt investment in which an investor loans money to an entity ...
  4. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  5. Corporate Bond

    A debt security issued by a corporation and sold to investors. ...
  6. Bottom-Dollar Scam

    Fraudulent claims by swindlers or con artists who prey on job ...
Hot Definitions
  1. Perkins Loan

    A loan program that provides low-interest student loans to undergraduate and graduate students who demonstrate exceptional ...
  2. Wealth Management

    A high-level professional service that combines financial/investment advice, accounting/tax services, retirement planning ...
  3. Assets Under Management - AUM

    The market value of assets that an investment company manages on behalf of investors. Assets under management (AUM) is looked ...
  4. Subprime Auto Loan

    A type of auto loan approved for people with substandard credit scores or limited credit histories. There is no official ...
  5. Racketeering

    A fraudulent service built to serve a problem that wouldn't otherwise exist without the influence of the enterprise offering ...
  6. Federal Debt

    The total amount of money that the United States federal government owes to creditors. The government's creditors include ...
Trading Center