A:

For Kidder, Peabody & Co., the 1980s 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 Co. (GE), parent company to Kidder Peabody, 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, Kidder Peabody built itself back into profitability under the management of Si Cathcart and his successor Mike Carpenter.

Unfortunately for Kidder Peabody, the internal problems were not over. Joseph Jett was a bond trader on its government bond desk. His job was to make 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.

Kidding Nobody

Kidder Peabody'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 overextended 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 management, stating that the company knowingly engaged in fraud in an attempt to wrest control of the firm back from GE. His most serious charges were overturned on appeal. Kidder Peabody 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. (See also: 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"?

    The story of Jack Welch, former CEO of GE, has become the stuff of management legend. Read Answer >>
Related Articles
  1. 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 ...
  2. Investing

    Coal's Weak, So Buy Peabody

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

    General Electric Stock Could Rise More Than 30%

    GE stock has underperformed for nearly 10 years but may be poised to rise soon.
  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

    Why GE Will Never Break Up

    it's the oldest component of the Dow Jones Industrial Average, having joined the index in 1896, and long ago outlasting its then-contemporaries.
  6. Insights

    Lights Out! GE Considering Sale of Consumer Lighting Business

    Company thinking of pulling the plug on lightbulbs - its oldest business
  7. Investing

    GE Options Traders Bet Stock Will Fall 15% Further

    GE stock is on a dramatic downward slide, with few glimmers of hope. Can it turn the tide?
  8. Investing

    GE Cuts Its Dividend By 50% to $0.12

    GE announced it was slashing its quarterly dividend in an effort to align the payout with its cash flow generation.
  9. Investing

    Could Warren Buffett Save GE?

    General Electric's current situation makes it an ideal Buffett investment, says RBC Capital.
  10. Investing

    GE P/E Ratio: A Quick Analysis

    A quick calculation and analysis of GE's trailing and forward P/E ratios.
RELATED TERMS
  1. Bond Fund

    A bond fund is a fund invested primarily in bonds and other debt ...
  2. Bond Market

    The bond market is the environment in which the issuance and ...
  3. Discount Bond

    A discount bond is a bond that is issued for less than its par ...
  4. Bond ETF

    Bond ETFs are very much like bond mutual funds in that they hold ...
  5. Dollar Bond

    A dollar bond is a U.S. denominated bond that trades outside ...
  6. Put Bond

    A put bond is a bond that allows the bondholder to force the ...
Hot Definitions
  1. Inflation

    Inflation is the rate at which prices for goods and services is rising and the worth of currency is dropping.
  2. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  3. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  4. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  5. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  6. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
Trading Center