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Joseph Jett is an African American businessman, best known for his role in the Kidder Peabody trading loss in 1994.

He currently operates a firm called Jett Capital Management LLC. The French Television network, France24, televised Jett meeting with several of his clients and the commentator speaks of Jett meeting clients in an expensive Manhattan skyscraper. The commentator went on to say that there was significant evidence in her opinion that Jett had considerable wealth but wanted the world to believe otherwise.

The Jett model seems to make for a solid rogue road map -- cause a disaster, blame it on the firm and walk away a free man.

Like British rogue trader, Nick Leeson, Jett has written two books, one of which was pulled from the shelves amid threats of litigation. He told the New York Times in 2004 that he gets between $4,000 and $8,000 a pop on the lecture circuit. With a career like this, what's not to like about getting in trouble with a little off-the-books trading?

On Edge

A rogue with a future, of course, needs to have a little edge. Jett wouldn't be so interesting if he'd been let off the hook by everyone. He keeps his bad-boy image because the SEC hit him with a $200,000 fine, $8 million in restitution, and a lifetime bar from the securities industry.

He hasn't paid the SEC, and is running an investment business anyway. Jett didn't return telephone calls or e-mail seeking comment.

Jett's Background

Having previously attended MIT and Harvard Business School, Joseph Jett was hired by Kidder, Peadbody & 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. In one of them he was laid off, in the other one he was fired.

Kidder Peabody

In 1994 the investment bank Kidder, Peabody & Co. was sold to Paine Webber after losses of over $1.4 billion in Mortgage Derivatives. The losses in CMO’s (Collateralized Mortage Obligations) were caused by the bankruptcy of Askin Capital , one of five “satellite firms” with whom Kidder had parked the high risk “toxic waste” (Principal Only) equity portion of nearly all their industry leading CMO deals.

On April 17 1994, GE CEO Jack Welch identified Jett on the GE-owned TV network CNBC as a “rogue trader” who had singlehandedly caused $250 million in losses.

Jett’s Trading Strategy

The transactions at issue 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 moderately 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 million and $9 million respectively. The board of General Electric, who had owned Kidder Peabody since 1986, had to approve the $9 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.

The Lynch Notes

On the eve of the SEC trial against Jett, Jett's attorneys and Class-action plaintiffs won a ruling by Second District Judge Dollinger. The court determined that interview notes of Jett's co-workers taken by the law firm Davis Polk were not protected by the work-product rule because General Electric failed to sustain its burden of demonstrating that the documents were created principally to assist in contemplated or ongoing litigation. Davis Polk's lead attorney on the Jett case was former SEC Enforcement Chief Gary Lynch. The revelation of the Lynch notes raise ethical issues and conflict of interest issues concerning Lynch.

The ruling was a landmark decision in Attorney Client Privilege and is studied in case law to this day. So what did the Lynch Notes reveal? What was said by Jett's co-workers to Gary Lynch that failed to make it into the much publicized Lynch Report that concluded that Jett acted alone?

Handwritten notes by Davis Polk law firm partner Larry Portnoy, written after interviewing numerous Kidder executives, stated: “Not really false profits. Rather advanced profits. We didn’t view it as false. Just accelerated. So CF (Lead Accountant Charles Fiumefreddo) didn’t see it as a phony profit issue.

David Bernstein was assistant to Edward A. Cerullo, Kidder’s fixed-income chief. According to notes from an interview with lawyers for Kidder, Bernstein said that “Kidder can’t deny that 100-plus people knew that forward trades with Fed took place. Issue is it had P&L effect.” Other notes record him saying they were “not really false profits.”

Aftermath

After the scheme was discovered in 1994, Kidder reversed over $340 million in trading profits from Jett's trading. Kidder Peabody fired Jett and froze the funds in his personal accounts, which he had kept with the securities firm. GE's decision to get out of the investment banking business was brought about by the losses on Kidder's CMO desk that were over $1.4 billion. The losses on the CMO desk were more than the desk earned in the previous three years. Curiously, no one on the CMO desk was accused of fraud. Kidder Peabody was ultimately sold for a nominal price to Paine Webber.

Also in 1996, a NASD arbitration panel rejected Kidder Peabody's monetary claims against him 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 as a result of Mr. Jett's alleged misconduct. It is remarkable that the $74.6 million sought was starkly different amount than the original allegation of a loss of $350 million.

"This is about as clean a bill of health they could have given Jett," said Alan Bromberg, a securities-law professor at Southern Methodist University. By rejecting the monetary claims, he added, the panel is saying "all of the things that he is accused of doing wrong, he either didn't do or it didn't hurt Kidder."

Although the bonuses from the alleged fraud had totaled $11 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 interview from 1999, Jett said that ultimately $4.5 million was returned to him in 1998. Also in July, 1998, the SEC ruled that Jett did not commit securities fraud, but charged him with a lesser record-keeping violation.

In 2004, the Securities and Exchange Commission concluded that Jett had exploited 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 ordered Jett to forfeit $8.2 million in fraudulently-obtained bonuses, fined him $200,000 and barred him from any future association with financial trading.

In September 2007 the SEC released an enforcement action against Jett , ordering him to pay the fines due.

In July 2008, the French news channel France 24 televised an interview with Jett, where he said he has no money to pay the SEC fines, and was living in the basement of a friend's house in Princeton, New Jersey. He also claimed he is running an offshore financial consultancy from short-term rental office space.

References

1. ^ http://www.sec.gov/litigation/opinions/33-8395.htm
2. http://www.france24.com/en/20080718-reporters-banking-crime-trader-joe-jett-kerviel-wall-street
3. See http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a4nMEjBE5c5k
4. "Did He or Didn't He", 60 Minutes aired 2-19-95
5. http://www.nytimes.com/1995/05/24/business/founder-of-askin-capital-agrees-to-settlement-of-sec-charges.html
6. http://hf-implode.com/imploded/fund_AskinCapitalManagement_1994.html
7. http://www.personal.psu.edu/sjh11/Courses/BA521/Jett/JettNYTimes97.shtml
8. in Fed R. Civ. P. 23(b)(3)
9. http://studentlaw.blogspot.com/
10. Paul Tharp, “Jett: Looks Like He's in the Clear”, The New York Post, June 20, 1996
11. http://www.businessweek.com/archives/1996/b3482091.arc.htm Gary Weiss, “The Flimsy Case Against Joseph Jett”, Business Week, July 1, 1996
12. Jett Scores Against Kidder Peabody as Panel Rejects Firm's Money Claims, Anita Raghavan, The Wall Street Journal, December 20, 1996
13. Jett Scores Against Kidder Peabody as Panel Rejects Firm's Money Claims, Anita Raghavan, The Wall Street Journal, December 20, 1996
14. "Judge to Joe Jett: Pay Up," Portfolio.com, September 11, 2007
15. In the Matter of Orlando Joseph Jett, U.S. Securities and Exchange Commission, March 5, 2004
16. See http://www.sec.gov/litigation/litreleases/2007/lr20273.htm
17. http://www.france24.com/en/20080718-reporters-banking-crime-trader-joe-jett-kerviel-wall-street

Also see List of Trading Losses

• American chief executives
• Massachusetts Institute of Technology alumni
• Harvard Business School alumni