Joseph Jett

Joseph Jett is the Managing Partner of Jett Capital Management. Jett is a recognized industry leader and expert in Private Equity and Alternative Investments. Jett has made numerous television appearances providing market commentary on such influential business shows as CNN Moneyline, Your World with Neil Cavuto and Geraldo at Large with Geraldo Rivera.

Jett is an acclaimed public speaker appearing at such finance industry venues as Kingpins of Wall Street hosted by noted lawyer, Raul Felder, and famed comedian, Jackie Mason; Global Summit for Private Equity Conference and has spoken at several of the nation's top business schools including Harvard, NYU, Wharton and Stanford.

Jett has authored two books about his life and experience in the financial markets. The first, "Black and White on Wall Street", was published by William Morrow & Company. The second, "Broken Bonds" was published by Cambridge Matrix Publications Kft.

In the early 1990's Jett was perhaps best known for his role in the Kidder Peabody trading loss in 1994. At the time of the loss it was the largest alleged trading fraud in history.

Jett's background

Joseph Jett grew up near Cleveland, Ohio. At age of 8, he began working as a paperboy. During high school he worked as a dishwasher and short order cook at a steakhouse. The son of a conservative businessman, Jett was a fan of Richard Nixon, worked in Ronald Reagan’s 1980 Presidential campaign and disdained affirmative action programs so much that he refused to identify his race on his application to the Harvard Graduate School of Business Administration. He was picked on by fellow blacks whom he constantly challenged to do better. In ninth grade, Jett stepped onto a basketball court at a city park and stole the ball proclaiming, "It's time that we as a people stop making baskets and start making A's!" He was beaten up for his efforts. To defend himself, he became a dedicated disciple of weightlifting and the martial arts.

Jett earned bachelor's and master's degrees in Chemical Engineering at MIT and after working two years at GE Plastics went on to Harvard Business School. In his book Black and White, Joseph Jett states that his Harvard MBA degree was not awarded due to his failure to pay final college tuition, which he was not aware of, and which the New York Times reported in 1994. He finally paid for his tuition and was awarded his MBA degree in 1987. A confirmation from Emily Hayden, a Harvard MBA representative and the Harvard MBA school confirmed that Joseph Jett was indeed awarded a Harvard MBA in 1987. 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.

Kidder Peabody

In 1994, following a number of scandals and losses in the fixed income department, the investment bank Kidder, Peabody & Co. was hurriedly sold to Paine Webber. 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

In his book "Black and White on Wall Street" Jett explained that his primary trading strategy was to trade massively to exploit an anomaly in the relation of cash bonds to their derivative futures market. Jett's trading position approached a staggering $50 Billion. The anomaly was caused by the Clinton administration's abrupt decision to have semi-annual rather than quarterly issues of the long bond.

For nine months, scarcity of the cash bond created a situation where the cheapest to deliver security into the futures market was a callable security with a duration of merely 9 years. Jett purchased the STRIP components of the cash bond with a 30 year duration and sold short futures against his cash holdings.

Due to the difference in duration, Jett had on a massive yield curve play in a basis trade. Jett's supervisor Ed Cerullo was a recognized expert in basis trading. Jett argued successfully to the NASD that his long cash profit's outweighed any loss from the shorter duration futures position and that his trades were profitable. Jett claimed that Kidder had forced the appearance of losses by redefining "unrealized profits" common to both Jett's forward trades and Kidder's massive CMO operation as "unrealizable profits" only for those trades in Jett's position.

Jett's STRIP trading was in fact quite profitable. The SEC ruled that as all of Jett's alleged losses were from the short futures position, which are not securities per se, that Jett was not guilty of securities fraud.

Kidder held that Jett's primary strategy was to exploit a flaw in Kidder's computer systems that made unprofitable trades appear profitable. 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 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 management approved accounting method. By buying US Treasury bond strips (whose price increases each day due to accretion), hedged by a short futures 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 $2.1 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.

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, which raises questions about the impartiality of the investigation.

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 [if] it had P&L [profit and loss] effect.” Other notes record him saying they were “not really false profits.”

April 1994: Jett Fired

Scheme is discovered. Kidder reverses over $340 million in trading profits from Jett's trading. Kidder fires Jett and freezes the funds in his personal accounts, which he had kept with the securities firm. Kidder's Chairman, Michael A. Carpenter, indicated that Jett, a weightlifter and martial artist, was too fear inspiring to even be questioned by Kidder's management, "The power of the man is hard to ignore!"

May 1994: Jett and Nietzsche

In two lengthy pieces Jett's personal beliefs were examined. Jett was known for his peculiar fascination with the symphonies of Gustav Mahler, the poetry of Lord Byron, and the philosophy of Friedrich Nietzsche. Barron's carried an editorial by Joe Queenan who blamed Jett's fascination with Nietzsche as what separated Jett from more moral traders. Queenan ridiculed Jett's insidious appreciation of European culture: "Accused Kidder trader was a fan of Nietzsche, for goodness sake." The Harvard Crimson in a piece entitled "The Human Piranha" examined Nietzsche's influence on the derivatives trader opining that if Jett followed Nietzsche he would be a proponent of brutal honesty.

June 1994: Kidder Chairman Fired

Kidder's CEO Michael Carpenter is fired in the wake of the scandal. He retains all his earnings from Jett's alleged false profits.

February 1995: GE Flexes Media Muscle

GE-owned NBC releases Law & Order Episode "Rage" based on the Jett - Kidder Peabody Scandal. The episode portrays a Nietzsche quoting African-American who murders his boss after his "phantom trades" are discovered. The Jett charactar portrayed by actor Courtney Vance presents a "black rage" defense to excuse his actions.

January 1996: FBI Exoneration

The F.B.I. exonerates Jett after a lengthy investigation that included 25 interviews of Jett. The U.S. Attorney Attorney for the Southern District, Mary Jo White, refused to indict Jett on criminal charges and in an unusual show of support invited the SEC to FBI offices to interview Jett for themselves. Jett's supervisor, Ed Cerullo, agrees to a settlement with the SEC for failing to supervise Jett. He agrees to a fine of $50,000 and a suspension from the industry for one year.

June 1996: The SEC Trial

The Securities and Exchange Commission investigative files show a curious fascination with Jett's relation ships with white female coworkers. The inquisitions soon turned to allegations about Mr. Jett's sex life. The S.E.C. files on the case read like a G-rated Starr Report. Instead of fellatio and sex-toy cigars, the files chronicle "rumors" heard by a group of white male Kidder employees about Mr. Jett's alleged affairs with white Kidder females. In a typically sizzling incident, while watching a movie with a blond colleague–outside the office–Mr. Jett "placed his hand on her knee."

August 1996: Jett Boss Fined

Another former boss of Jett's, Melvin Mullin, is fined $25,000 with a three month suspension, also for failing to supervise. He retains all of his earnings from Jett's alleged false profits.

December 1996: NASD Exoneration

A NASD arbitration panel rejects Kidder Peabody's monetary claims against him and orders 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. The $74.6 million sought by Kidder was the amount of the actual losses, rather than the total false gains 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 $11.4 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 interview from 1999, Jett said that ultimately $5.6 million was returned to him in 1998.

July 1998: The SEC Decision

Two years after the Securities and Exchange Commission trial was held the Administrative Law Judge rules that Jett did not commit securities fraud, but charges him with a lesser record-keeping violation. The SEC refused to allow Jett a jury trial.

"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 Commission orders Jett to forfeit his $8.2 million in bonuses associated with the false profits, fines him $200,000, and bars him from any future association with a securities broker or dealer. Both Jett and the SEC's Enforcement Division appeal the decision.

March 2004: SEC Appeal Heard Ten Years Later

Securities and Exchange Commission rules on the appeal. The SEC concludes that, in addition to upholding the record-keeping violation, Jett has also committed securities fraud. Specifically, 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-affirms 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.

The SEC finding must be viewed in perspective. The SEC has by its own records a 94% conviction ratio. Meaning if you appeared on trial before the SEC, you stood a 94% chance of being found guilty.

DESCRIPTION: A case is considered “successfully resolved” if it results in a favorable judgment for the SEC, a settlement, or the issuance of a default judgment. In general, the SEC strives to resolve successfully as many cases as possible, but at the same time, it aims to file large, difficult, or precedent-setting cases when appropriate, even if success is not assured.

Fiscal Year	2004	2005	2006
SEC Conviction Ratio	90%	91%	94%

ANALYSIS of RESULTS: The SEC exceeded its target, although a continued high success ratio depends on numerous factors, including the complexity of cases, the extent to which parties contest actions, and the availability of litigation and investigation resources. Note: The percentages for FY 2004 through FY 2006 have been recalculated to reflect a change in categorization; consequently, these numbers are slightly lower than reported previously. FY 2006 previously reported a 98% conviction ratio.

Jett never appealed the 2004 SEC decision, even though he had the right to do so. In the longest running case in SEC history, Jett had moved from his 1996 address to which the decision and avenues of appeal were sent. Jett stated that he simply failed to receive them.

August 2006: Madoff Context

In 2006, the SEC was focused on an enforcement action against Jett in the United States District Court for the SEC decision in 2004. Jett's prosecution did not occur in a vacuum. As the SEC focused on Jett, SEC investigators interviewed one Bernie Madoff, who didn't bring along a lawyer. When asked how he consistently beat the market, he told the investigators, "Some people feel the market," the report recounts.

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.

September 2007: Jett Defense Crippled

Jett appeared before the District and Appeals Court without counsel because his assets including a home value at $1.1 Million were tied up by his former girlfriend, Melissa Leonardo, a former lapdancer now a Director at Merrill Lynch. Jett accused Leonardo of dissipating over $250,000 in his assets pursuing a coercive relationship with her Merrill Lynch supervisor currently head of Barclay's Wealth Management.

The merits of Jett's case, whether he was guilty or innocent, were thus never heard by the Federal Courts which exist to keep the SEC in check. The SEC had a 94% conviction ratio. SEC releases an enforcement action against Jett, ordering him to pay the fines due.

Jett's post-Kidder career

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.

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, but this may have been Jett trying to manipulate France24 and the SEC.

References

Also see List of Trading Losses