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.