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Case Analysis

Kidder, Peabody & Co.

7/18/2013

Submitted By :-

| Navneet |

| 2012180 |


Kidder, Peabody & Co.

April 17, 1994, Kidder, Peabody & Co. announced a $ 350 million charge against
earnings as a result of the detection of false trading profits. On the same day of
termination of employment with the company, Joseph Jett was promulgated. By
illustrating the mechanics of communication records, this case describes a trading
strategy that led to the creation of false profits. Failure of internal control are also
discussed.

Based on the facts a 7s analysis are as follows.


1. Strategy
Jetts trading strategy, to generate profits was based on the mark-to-market valuation of
unsettled positions.
A forward recon which was to be settled several months into the future generated huge
profit on the transaction date. This profit was offset over time by small daily losses as the
settlement date approached. But these losses could be swamped by the illusory profit
generated by entering a new forward recon.
Jett compensated his large unsettled positions in forward recons with settled positions in
the same bonds and STRIPS, to keep his balance sheet exposure down,
Jett had unsettled positions greater than the actual market for the bond. It was impossible
to settle these positions at settlement date. Hence, Jett made next-day settlement
transactions on the same instrument to pair-off strips or recons to solve this problem.

2. System
The government desk grouped together all the traders involved with government-related
instruments. It was part of the Fixed Income Division which employed over 700 people,
accounted for the majority of Kidders earning.
The operations department or back office was under Richard O Donnells control and
included the government clearance area which processed all transactions at settlement
date.
Kidder traders in the STRIPS market used a proprietary expert computer system, the
Government Trader System, to record transactions in the market.
The GTS allowed the trader to scan market prices to detect arbitrage opportunities.
Kidder, Peabody & Co. Had a full accounting and control department to maintain the
formal reporting systems and audit the activity of the various desks.


3. Skill
Michael A. Carpenter, CEO of Kidder, had no experience in brokerage, further he had
little experience in securities trading. He also had a strained relationship with head of
GECS, Gary Wendt.
David Bernstein, manager of business development was respected for his intelligence and
familiarity with financial and administrative issues.
Jett was harsh, dominating & cunning film fare artist. He had a well deserved reputation
for firing anyone who questioned his trading methods.
Edward Cerrullo, head of Fixed Income Division, was a skilled and knowledgeable
trader. He supervised the management tasks of various desk heads.
The skills of top level managers in Kidder is questionable as no one took any initiative to
find how Jett was making profits which was not generating cash.


4. Staffing
Michael A Carpenter, a GE executive was appointed as a CEO of kidder Peabody. He
held the number two position at GECS and had managed leveraged buyout loans and
takeover deals. Although he had no experience in brokerage.
Joseph Jett was trained at MIT and Harvard Business School. Before joining Kidder, he
had work experience as a bond trader at Morgan Stanley for two years and at First Boston
for eighteen months. In one of them he floundered and was laid off and in the other he
was fired.
David Bernstein, manager of business development, had work experience of twelve years
at GE in different financial analysis positions.
Edward Cerrullo, a skilled and knowledgeable trader, had headed the fixed income
division. He was also a member of kidders board and several other committees.
The position of Business unit controller was left vacant because of no available good
candidate.
The audits teams consisted of inexperienced auditors, who relied on Jetts account of his
trading strategy without verifying its statements.


5. Structure
Jett was harsh and domineering with subordinates, many of whom were afraid of him. He
had a well-deserved reputation for firing anyone who questioned his trading methods.
The reporting system within the company was not up to the mark as the Lynch report
concluded that no one provided knowing assistance to Jetts trading abuses and that the
Jetts activity remaining undetected was primarily because of lax supervision.


6. Style
At Kidder, managers had a lot of trust and confidence on there workers.
Employees had all the flexibility to work & were not monitored.
The management decision making style of the company is basically top to bottom. The
top management decides about the policies and middle, lower management use to follow
it. We can see in the case when there was top line and bottom line was given to the
company when Carpenter was appointed CEO of the Kidder, Peabody.
Initial when GE acquired Kidder, the control was given to Kidder management. So that
GE could actually understand the business
Later it was decided that a manager with strategic and general management skills would
be better suited to take on the tremendously difficult task of straightening out Kidders
many problems.
The basic decision making is through analytical reasoning by traders and managers. They
emphasize a lot on numbers and their significance.


7. Shared values
All employees at Kidder as well as at GE were extremely skilled at masters in their
profession.
Employees at both the firms thrived hard to work towards their goal and achieve their
goals. They shared values of commitment, hard word and sincerity.
Although they dint shared any organization culture as they were dissatisfied when GE
took control over them. They felt like outsiders in their own firm. That was the reason
why many left after Carpenter came in. Also their bonus was also reduced in order to
make the company more competitive, this dissatisfied many employees.