Trading & Options · Profile from Trading and Options Research Companion

Kidder Peabody and Joseph Jett

The Boston-founded investment bank (1865), 80%-owned by General Electric from 1986, whose government-bond desk under Orlando Joseph Jett reported profits for two and a half years that its own accounting system had invented. Jett joined Kidder in July 1991 on the zero-coupon (STRIPS) desk at a $75,000 salary; by 1993 he ran the government desk, was paid a $9.3m bonus and was named Kidder's "Man of the Year" (SEC opinion, 5 Mar 2004). His "edge" was a quirk in Kidder's Government Trader system: a forward reconstitution of Treasury strips — a non-cash exchange with the Federal Reserve — was booked as a sale that produced an immediate trade-date "profit" roughly equal to the interest that would accrue before settlement. By entering ever larger and longer forward exchanges, Jett kept new paper profits ahead of the old ones' reversal; new Fed exchanges grew from about $2bn a month (Dec 1991) to $664bn (Mar 1994) (SEC). From July 1991 to 29 Mar 1994 the desk's ledger showed over $264m of profit that included ~$338.7m of illusory profit — a true loss of ~$74.7m (SEC). Kidder fired Jett on 17 Apr 1994; GE took a $350m pre-tax ($210m after-tax) first-quarter charge (SEC). The press figure "$350m of phantom profits" (Harvard Crimson, Apr 1994) is the charge and Kidder's first estimate; the SEC's audited reconstruction is $338.7m of illusory profit. GE sold Kidder's assets to PaineWebber in a deal valued at ~$670m (agreement 17 Oct 1994). The SEC's administrative law judge cleared Jett of fraud in 1998; the full Commission reversed in 2004, finding securities fraud and recordkeeping violations, and ordered $8.21m disgorgement and a $200,000 penalty. For the edge equation, Kidder is the purest case in this KB of an accounting artefact presented as edge: the market paid nothing; the system printed the profit.

At a glance

Founded: Kidder, Peabody & Co.: April 1865, Boston, by Henry P. Kidder, Francis H. Peabody and Oliver W. Peabody (Wikipedia, citing WSJ and Chicago Tribune)
Headquarters: New York (from memory, verify); government desk in New York
Ownership / structure: Private partnership-style firm until 1986, when GE announced it would buy 80% for an estimated $600m (Christian Science Monitor, 28 Apr 1986); later wholly GE-owned (from memory, verify); Kidder, Peabody & Co. Inc. a registered broker-dealer; assets sold to PaineWebber (closing Jan 1995)
Type: Bank trading desk / control failure; this profile is a single-event entity, 6 moves (rule 6)
The trader: Orlando Joseph Jett, hired Jul 1991 aged 33 (Wikipedia); MIT chemical-engineering degrees, Harvard MBA, GE Plastics, Morgan Stanley and First Boston (SEC; Wikipedia); managing director of the government desk from Feb 1993, reporting to Edward Cerullo (SEC)
Scale (dated): Reported STRIPS profit $32.5m (1992) including ~$40.4m illusory; $150.7m (1993) including ~$198.2m illusory against a real loss of ~$47.5m; ledger > $264m profit Jul 1991–29 Mar 1994 including ~$338.7m illusory (true loss ~$74.7m) (SEC opinion)
Cost to the owner: GE Q1 1994 charge $350m pre-tax / $210m after-tax (SEC opinion); bonuses paid to Jett $11.4m for 1992–93, $8.21m after withholding (SEC)
Regulators: SEC (administrative proceeding 3-8919); NYSE (barred Jett, Dec 1994 — NYT via Wikipedia); NASD (arbitration); US Attorney (investigated; no criminal charges — Wikipedia)
Moves in this profile: Six — the GE purchase, Jett's hiring, the forward-reconstitution engine, discovery and firing, the Lynch report and sale to PaineWebber, and the SEC and arbitration cases. Compare Barings (concealment by a trader) and Long-Term Capital Management (real edge, wrong funding)
Signature moves (incl. failures): GE buys Kidder (1986); Jett hired to the STRIPS desk (1991); forward reconstitutions and the phantom-profit engine (1992–94); discovery, firing and GE's charge (Apr 1994); the Lynch report and sale to PaineWebber (Aug 1994–Jan 1995); SEC proceedings, arbitration and the 2004 opinion (1996–2007)

6 strategic moves analysed

Each one gets a full strategy file in the companion: context, the decision, the financing, what happened, and the lesson.

1986
GE Buys Kidder Peabody
Acquisition, merger or IPO
1991
Jett Hired to the STRIPS Desk
Hiring, spin-out or partner departure
1992
Forward Reconstitutions and the Phantom Profit Engine
Rogue trade or control failure
1994
Discovery Firing and GE Charge
Loss, drawdown or blow-up response
1994
Lynch Report and Sale to PaineWebber
Restructuring / acquisition (exit by sale)
1996
SEC Proceedings Arbitration and the 2004 Opinion
Regulatory, enforcement or legal action

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