Joseph Jett
Encyclopedia
Joseph Jett is an American
former securities trader, known for his role in the Kidder Peabody trading loss in 1994. At the time of the loss it was the largest trading fraud in history.
. Jett was hired by Kidder, Peabody & Co in July 1991. At the time he was 33 years old. He had worked previously as a bond trader at Morgan Stanley
for two years and at First Boston
for eighteen months.
was owned by General Electric Corporation. In 1994, the firm was sold to Paine Webber. After the acquisition by Paine Webber
, the Kidder, Peabody name was dropped.
The trades used in constructing the phony profits were forward reconstitutions of US Treasury bonds. The transaction is executed when a trader buys a set of treasury strips sufficient to re-create the original bond that they were derived from.
Kidder's system incorrectly valued forward-dated transactions as if they were immediately settled, rather than taking into account the time value of money
for the period before settlement of the trade. The method Jett followed was facilitated by this error. By buying US Treasury bond strips (whose price increases each day due to accretion), hedged by a short treasury bond position (whose price remains relatively stable over the settlement period), Jett was able to book immediate, illusory profits. Once settlement of the trade happened, any false profits immediately were reversed as a loss. Therefore, in order to continue to appear profitable, Jett had to engage in more and more such trades, enough to both offset the losses on the settling trades plus additional trades to keep delivering profits. For the scheme to persist, the size had to continually grow, and this is what eventually brought the scheme's downfall—
Jett's trading size had become so large that General Electric, the owner of Kidder Peabody at the time, asked that he cut the size of his positions because of the bloating of GE's balance sheet. With no new trades to offset those settling and rolling off, the losses became apparent to Kidder senior management.
Jett, who was previously a marginally profitable trader, started earning large bonuses once he began executing the trades that exploited the system flaw. While in 1991 Jett was paid a bonus of $5000, in 1992 and 1993 he was paid $2.1 million and $9.3 million respectively. The board of General Electric, who had owned Kidder Peabody since 1986, had to approve the $9.3 million outsized bonus in 1993. Later, in his autobiography Straight from the Gut, Jack Welch
would lament not personally looking into how one of his employees could become so successful so quickly.
"Jett was provided the opportunity to generate false profits by trading and accounting systems," Mr. Lynch wrote. "It was his supervisors, however, who allowed Jett that opportunity for over two years because they never understood Jett's daily trading activity or the source of his apparent profitability. Instead, their focus was on profit and loss and risk-management data that provided no insight into the mechanics of Jett's trading."
The use of Gary Lynch to conduct the internal investigation was controversial, as he was also the lawyer hired by Kidder to represent the firm in its case against Jett.
all were involved in the various actions around the Jett case, since they all had some regulatory authority over Kidder Peabody.
The New York Stock Exchange acted first, by banishing Jett from trading securities or working for any employer affiliated with the exchange.
The NASD was involved in the dispute over Jett's bonuses, which were frozen in an account held by Kidder Peabody. In 1996, a NASD arbitration panel rejected Kidder Peabody's monetary claims against Jett and ordered the funds from Jett's personal accounts to be released. Kidder had sought $8.2 million for undeserved bonuses and $74.6 million for trading losses incurred by Kidder. The $74.6 million sought by Kidder was the amount of the actual losses, rather than the total false gains of $350 million. Although the bonuses from Jett's trading had totaled $11.4 million, the accounts contained approximately $5 million due to deduction of deferred compensation (which the panel ruled, did not have to be paid to Jett) and taxes due. In a Salon.com interview from 1999, Jett said that ultimately $4.5 million was returned to him in 1998.
The Securities and Exchange Commission investigated the losses from 1994 onward, and in 1998 released an initial ruling that Jett did not commit securities fraud, but charged him with a lesser record-keeping violation.
The SEC ordered Jett to forfeit his $8.2 million in bonuses associated with the false profits, fined him $200,000, and bars him from any future association with a securities broker or dealer.
Both Jett and the SEC's Enforcement Division appealed the decision. In March 2004 the Securities and Exchange Commission finally ruled on the appeal, and concluded that, in addition to upholding the record-keeping violation, Jett has also committed securities fraud. Specifically, they found that Jett committed fraud by deliberately exploiting weaknesses in Kidder Peabody's automated trading records system in order to book fake profits of about $264 million (when he had actually lost the firm about $75 million). The Commission re-affirmed the penalty that Jett forfeit $8.2 million in fraudulently-obtained bonuses, plus the fine of $200,000 and a lifetime bar from the industry.
Jett never appealed the 2004 SEC decision, even though he had the right to do so. In 2006, when the SEC was seeking an enforcement action against Jett in the United States District Court for the 2004 decision, Jett sent a memorandum to the court saying that he had never received notice from the SEC as to their 2004 decision since the order had been sent to his old address. He sent another filing saying he was unaware of the 2004 decision being made and therefore had no chance to appeal. The District Court rejected this when they found that Jett had been quoted in a New York Times article shortly after the 2004 decision was announced, saying that he was unconcerned with the SEC action since he was still legal to trade securities offshore.
The SEC released an enforcement action against Jett in 2007, ordering him to pay the fines due.
The US Attorney's office investigated Jett, but no criminal charges were ever filed.
Jett has claimed to operate a hedge fund called Cambridge Matrix Funds, domiciled in the British Virgin Islands. However, the BVI Financial Services Commission, the regulator of such funds, has no listing for Cambridge Matrix in its comprehensive list of funds domiciled in the BVI.
Jett told The New York Times in 2004 that he gets between $4,000 and $8,000 per appearance on the lecture circuit.
He currently operates a firm called Jett Capital Management LLC. According to its website, the firm offers asset management, advisory, and private equity services, though it is unclear how Jett is able to perform these functions while being permanently barred from the securities industry.
In July 2008, the French news channel France 24
televised a feature following the Jerome Kerviel
trading losses, which featured an extensive interview with Jett. In it, Jett said that because of legal costs he has no money left to pay the SEC fines, and that he was living in the basement of an ex-girlfriend's house in Princeton, New Jersey. The France24 reporter said that Jett is running a financial consultancy domiciled offshore, which conducts its business from hired conference suites in New Jersey. The show televised Jett meeting with a client who was trying to raise $9 million for a business venture. At the conclusion of the report, the commentator said she believed that Jett was trying to use the France 24 program to show the SEC that he has no money to pay the fines due.
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
former securities trader, known for his role in the Kidder Peabody trading loss in 1994. At the time of the loss it was the largest trading fraud in history.
Jett's background
Joseph Jett grew up near Cleveland, Ohio. He earned his bachelor's and master's degrees in Chemical Engineering at MIT and after working two years at GE Plastics went on to earn an MBA from Harvard Business SchoolHarvard Business School
Harvard Business School is the graduate business school of Harvard University in Boston, Massachusetts, United States and is widely recognized as one of the top business schools in the world. The school offers the world's largest full-time MBA program, doctoral programs, and many executive...
. Jett was hired by Kidder, Peabody & Co in July 1991. At the time he was 33 years old. He had worked previously as a bond trader at Morgan Stanley
Morgan Stanley
Morgan Stanley is a global financial services firm headquartered in New York City serving a diversified group of corporations, governments, financial institutions, and individuals. Morgan Stanley also operates in 36 countries around the world, with over 600 offices and a workforce of over 60,000....
for two years and at First Boston
First Boston
First Boston Corporation was a New York-based, bulge bracket, investment bank, founded in 1932 and acquired by Credit Suisse in 1990. Together with its sister investment banks, it was referred to as CS First Boston after 1993 and part of Credit Suisse First Boston after 1996, the First Boston part...
for eighteen months.
Kidder Peabody
At the time of Jett's employment, Kidder, Peabody & Co.Kidder, Peabody & Co.
Kidder, Peabody & Co. was a U.S.-based securities firm, established in Massachusetts in 1865. Its operations included investment banking, brokerage, and trading....
was owned by General Electric Corporation. In 1994, the firm was sold to Paine Webber. After the acquisition by Paine Webber
Paine Webber
Paine Webber and Company was an American stock brokerage and asset management firm that was acquired by the Swiss bank UBS AG in 2000. The company was founded in 1880 in Boston, Massachusetts, by William Alfred Paine and Wallace G. Webber. Operating with two employees, they leased premises at 48...
, the Kidder, Peabody name was dropped.
Jett’s trading strategy
Jett's primary strategy was to exploit a flaw in Kidder's computer systems that made unprofitable trades appear profitable.
"There were virtually no genuine profitable trades. Joseph Jett, Kidder, Peabody's former bond-trading star, simply made up trades and marked them down as having made money. In the meantime, his few real trades consistently lost money."
- Floyd Norris in the New York Times
The trades used in constructing the phony profits were forward reconstitutions of US Treasury bonds. The transaction is executed when a trader buys a set of treasury strips sufficient to re-create the original bond that they were derived from.
Kidder's system incorrectly valued forward-dated transactions as if they were immediately settled, rather than taking into account the time value of money
Time value of money
The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time. The time value of money is the central concept in finance theory....
for the period before settlement of the trade. The method Jett followed was facilitated by this error. By buying US Treasury bond strips (whose price increases each day due to accretion), hedged by a short treasury bond position (whose price remains relatively stable over the settlement period), Jett was able to book immediate, illusory profits. Once settlement of the trade happened, any false profits immediately were reversed as a loss. Therefore, in order to continue to appear profitable, Jett had to engage in more and more such trades, enough to both offset the losses on the settling trades plus additional trades to keep delivering profits. For the scheme to persist, the size had to continually grow, and this is what eventually brought the scheme's downfall—
Jett's trading size had become so large that General Electric, the owner of Kidder Peabody at the time, asked that he cut the size of his positions because of the bloating of GE's balance sheet. With no new trades to offset those settling and rolling off, the losses became apparent to Kidder senior management.
Jett, who was previously a marginally profitable trader, started earning large bonuses once he began executing the trades that exploited the system flaw. While in 1991 Jett was paid a bonus of $5000, in 1992 and 1993 he was paid $2.1 million and $9.3 million respectively. The board of General Electric, who had owned Kidder Peabody since 1986, had to approve the $9.3 million outsized bonus in 1993. Later, in his autobiography Straight from the Gut, Jack Welch
Jack Welch
John Francis "Jack" Welch, Jr. is an American chemical engineer, business executive, and author. He was Chairman and CEO of General Electric between 1981 and 2001...
would lament not personally looking into how one of his employees could become so successful so quickly.
The Lynch Report
As the scandal first came to light, Kidder Peabody hired lawyer Gary G. Lynch from the law firm of Davis, Polk & Wardwell, the former enforcement chief of the Securities and Exchange Commission, to conduct an internal investigation. The result was an 86 page document that became known as the Lynch Report. The report was released in August 1994 and concluded that Jett acted alone, but also blamed the losses on a complete breakdown of the system of supervision at Kidder, particularly with regard to Ed Cerullo and Melvin Mullin."Jett was provided the opportunity to generate false profits by trading and accounting systems," Mr. Lynch wrote. "It was his supervisors, however, who allowed Jett that opportunity for over two years because they never understood Jett's daily trading activity or the source of his apparent profitability. Instead, their focus was on profit and loss and risk-management data that provided no insight into the mechanics of Jett's trading."
The use of Gary Lynch to conduct the internal investigation was controversial, as he was also the lawyer hired by Kidder to represent the firm in its case against Jett.
Regulatory Organization Charges and Decisions
The Securities and Exchange Commission, the National Association of Securities Dealers, and the New York Stock ExchangeNew York Stock Exchange
The New York Stock Exchange is a stock exchange located at 11 Wall Street in Lower Manhattan, New York City, USA. It is by far the world's largest stock exchange by market capitalization of its listed companies at 13.39 trillion as of Dec 2010...
all were involved in the various actions around the Jett case, since they all had some regulatory authority over Kidder Peabody.
The New York Stock Exchange acted first, by banishing Jett from trading securities or working for any employer affiliated with the exchange.
The NASD was involved in the dispute over Jett's bonuses, which were frozen in an account held by Kidder Peabody. In 1996, a NASD arbitration panel rejected Kidder Peabody's monetary claims against Jett and ordered the funds from Jett's personal accounts to be released. Kidder had sought $8.2 million for undeserved bonuses and $74.6 million for trading losses incurred by Kidder. The $74.6 million sought by Kidder was the amount of the actual losses, rather than the total false gains of $350 million. Although the bonuses from Jett's trading had totaled $11.4 million, the accounts contained approximately $5 million due to deduction of deferred compensation (which the panel ruled, did not have to be paid to Jett) and taxes due. In a Salon.com interview from 1999, Jett said that ultimately $4.5 million was returned to him in 1998.
The Securities and Exchange Commission investigated the losses from 1994 onward, and in 1998 released an initial ruling that Jett did not commit securities fraud, but charged him with a lesser record-keeping violation.
"This Initial Decision finds that, for over two years, Mr. Jett exploited an anomaly in Kidder’s software, in the manner of a pyramid scheme, that credited him on Kidder’s books with enormous, but illusory, profits. He did this with intent to defraud."
The SEC ordered Jett to forfeit his $8.2 million in bonuses associated with the false profits, fined him $200,000, and bars him from any future association with a securities broker or dealer.
Both Jett and the SEC's Enforcement Division appealed the decision. In March 2004 the Securities and Exchange Commission finally ruled on the appeal, and concluded that, in addition to upholding the record-keeping violation, Jett has also committed securities fraud. Specifically, they found that Jett committed fraud by deliberately exploiting weaknesses in Kidder Peabody's automated trading records system in order to book fake profits of about $264 million (when he had actually lost the firm about $75 million). The Commission re-affirmed the penalty that Jett forfeit $8.2 million in fraudulently-obtained bonuses, plus the fine of $200,000 and a lifetime bar from the industry.
Jett never appealed the 2004 SEC decision, even though he had the right to do so. In 2006, when the SEC was seeking an enforcement action against Jett in the United States District Court for the 2004 decision, Jett sent a memorandum to the court saying that he had never received notice from the SEC as to their 2004 decision since the order had been sent to his old address. He sent another filing saying he was unaware of the 2004 decision being made and therefore had no chance to appeal. The District Court rejected this when they found that Jett had been quoted in a New York Times article shortly after the 2004 decision was announced, saying that he was unconcerned with the SEC action since he was still legal to trade securities offshore.
The SEC released an enforcement action against Jett in 2007, ordering him to pay the fines due.
The US Attorney's office investigated Jett, but no criminal charges were ever filed.
Jett's post-Kidder career
Jett has written two books about his life and experience at Kidder Peabody.Jett has claimed to operate a hedge fund called Cambridge Matrix Funds, domiciled in the British Virgin Islands. However, the BVI Financial Services Commission, the regulator of such funds, has no listing for Cambridge Matrix in its comprehensive list of funds domiciled in the BVI.
Jett told The New York Times in 2004 that he gets between $4,000 and $8,000 per appearance on the lecture circuit.
He currently operates a firm called Jett Capital Management LLC. According to its website, the firm offers asset management, advisory, and private equity services, though it is unclear how Jett is able to perform these functions while being permanently barred from the securities industry.
In July 2008, the French news channel France 24
France 24
France 24 is an international news and current affairs television channel. The service is aimed at the overseas market, similar to BBC World News, DW-TV, NHK World and RT, and broadcast through satellite and cable operators throughout the world. During 2010 the channel started broadcasting through...
televised a feature following the Jerome Kerviel
Jérôme Kerviel
Jérôme Kerviel is a French trader who has a pending appeal of his conviction in the January 2008 Société Générale trading loss incident for breach of trust, forgery and unauthorized use of the bank's computers, resulting in losses valued at €4.9 billion.Société Générale characterizes Kerviel...
trading losses, which featured an extensive interview with Jett. In it, Jett said that because of legal costs he has no money left to pay the SEC fines, and that he was living in the basement of an ex-girlfriend's house in Princeton, New Jersey. The France24 reporter said that Jett is running a financial consultancy domiciled offshore, which conducts its business from hired conference suites in New Jersey. The show televised Jett meeting with a client who was trying to raise $9 million for a business venture. At the conclusion of the report, the commentator said she believed that Jett was trying to use the France 24 program to show the SEC that he has no money to pay the fines due.