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. 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 >>
  3. 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 >>
  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 is the difference between a zero-coupon bond and a regular bond?

    The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons, or interest ... Read Answer >>
Related Articles
  1. Small Business

    Wall Street History: GE, McDomination And J.P. Morgan

    From the formation of General Electric in 1892 to the dotcom crash of 2000, we'll look at what made financial history this week.
  2. Investing

    Coal's Weak, So Buy Peabody

    It takes a weak coal market to get Peabody shares cheap.
  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. Personal Finance

    Wall Street History: The Boesky And Siegel Deal

    Oil wells, sub sandwiches and foreclosures are all discussed this week in Wall Street history.
  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

    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.
  8. 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.
  9. Investing

    Why The GE Stock Is Falling Today (GE)

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

    A slang term meaning that a consumer who was previously defrauded ...
  5. Bottom-Dollar Scam

    Fraudulent claims by swindlers or con artists who prey on job ...
  6. Fixed-Rate Bond

    A bond that pays the same amount of interest for its entire duration. ...
Hot Definitions
  1. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  2. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
  3. Hard Fork

    A hard fork (or sometimes hardfork) is a radical change to the protocol that makes previously invalid blocks/transactions ...
  4. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Zero Day Attack

    Zero Day Attack is an attack that exploits a potentially serious software security weakness that the vendor or developer ...
Trading Center