Joseph Jett

Orlando Joseph Jett (born 1958) 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.

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 School.

At the time of Jett's employment, Kidder, Peabody & Co. was owned by General Electric Corporation, who had purchased the firm in 1986.

The board of General Electric, who had owned Kidder Peabody since 1986, had to approve the outsized $9.3 million bonus in 1993.

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.

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.

In 1994, after numerous losses including those related to Jett, the firm was hurriedly sold to Paine Webber.

After the acquisition, the Kidder Peabody name was dropped.

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 from which they were derived.

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.

In the first quarter of 1994, Jett was "trading" so frequently that Kidder's computer systems couldn't keep up, and his "profits" had grown to $350 million, large enough that Kidder management feared he was taking unacceptable risks.

Computer specialists began noticing that none of Jett's supposed "trades" were ever consummated.

It eventually emerged that Jett rolled trades over two to three days before he was due to settle up, but kept the profits on the books.

Kidder halted Jett's trading and summoned Jett to a meeting.

When his explanations proved unsatisfactory, he was fired.

The losses were large enough that parent GE had to take a $210 million charge to its first-quarter earnings.

Later, in his autobiography Straight from the Gut, longtime GE chairman Jack Welch would lament not following his normal practice of personally looking into how one of his employees could become so successful so quickly.

He also recalled GE business leaders were so shaken by the size of the loss that they were willing to dip into the coffers of their own divisions to close the gap.

In contrast, Welch said, no one at Kidder was willing to take responsibility for the debacle; most Kidder staffers were concerned about the effect on their bonuses.

This convinced Welch that Kidder's culture did not fit with that of GE, and led him to sell off Kidder later that year.

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."