At the beginning of 1994, business at General Electric appeared to be going swimmingly. Under the direction of Jack Welch, considered by many to be one of the world's top CEOs, it had reported 51 consecutive quarters of earnings and was widely regarded as one of the few truly successful conglomerates. All that was about to change. Trouble was brewing at Kidder, Peabody, the investment bank in which GE held an 80 percent stake. Kidder had already caused GE embarrassment in 1987—the year after it was acquired—when it was fined $25.3 million by the SEC for insider trading. This time the problem was much more complex and controversial. Kidder was about to take a $210 million charge after taxes against first-quarter earnings for 1994, resulting in a first-quarter loss of $140 million.

 

Kidder alleged that the loss was due to bogus profits recorded by Joseph

Jett, the 36-year-old managing director of the government-trading desk. Jett's basic strategy was to enter into forward contracts that involved the exchange of strips (interest-only government paper) for bonds. His employer claimed, however, that when the date of the exchange came, Jett would roll the loss-making contracts forward and log fictitious profits (as reported in The Wall Street Journal, 18 April 1994).

 

Jett recorded $350 million in profits in 1993—enough to earn him a

$9 million bonus. His $10 million compensation exceeded even that of Jack Welch. But according to Kidder, the profits were phony; Jett had allegedly concealed a $9.5 million loss in 1992, $45 million in 1993, and $29 million in the first few months of 1994. Jett claimed that he was made a scapegoat for Kidder's underperformance.

 

What really happened may never be known. Although the SEC subsequently found Jett guilty of books and records violations, no criminal charges were ever filed, and the National Association of Securities Dealers (NASD) cleared him of fraud. But the aftermath was nonetheless devastating. Jett was only the first to go, followed either through dismissal or resignation by at least five former colleagues, including the CEO and the head of brokerage. Kidder itself was sold later that year to a rival brokerage, Paine Webber, for a knockdown price of just $90 million.

Although the Jett affair was more opaque than many later trading fiascoes, many of its root causes—inadequate oversight of traders and understanding of trading strategies—have been repeated. Most notable was Barings, the venerable UK merchant bank which collapsed in 1995 after more than $1 billion of trading losses run up by rogue trader Nick Leeson. Kidder's tale, and the others like it, suggest that companies should not be so dazzled by the golden geese that they stop looking for the rotten eggs.

 

BASED OFF THE CASE STUDY, Answer the followings

a. What is the central issue the case is describing?

b. Based on your readings, what problem needs to be addressed?

c. Put yourself in the Chief Risk Officer's chair and describe the considerations you would identify.

d. Agree or disagree with the solution described in the case and provide support for your position.

e .Provide a concise summary of the items you considered and your conclusion.

Answer rating: 100% (QA)

a The central issue described in the case is the fraudulent activities and subsequent downfall of Kidder Peabody an investment bank in which General E... View the full answer