Institution History for NORTH SHORE BANK, A CO-OPERATIVE BANK
5 institution history record(s) found. < Previous Page 1 Next >
Event Date Historical Event
1888-01-01 GEORGE PEABODY CO-OPERATIVE BANK, THE located at 32 MAIN
STR, PEABODY, MA was established as a Cooperative Bank.
1986-01-10 GEORGE PEABODY CO-OPERATIVE BANK, THE was renamed to
GEORGE PEABODY CO-OPERATIVE BANK and moved to 32 MAIN STREET
1996-10-01 GEORGE PEABODY CO-OPERATIVE BANK was renamed to NORTH
1998-04-02 NORTH SHORE BANK was renamed to NORTH SHORE BANK, A
2014-04-09 NORTH SHORE BANK, A CO-OPERATIVE BANK moved to 248
ANDOVER STREET PEABODY, MA.
Page 1 of 1
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Institution History for NORTH SHORE BANK, A CO-OPERATIVE BANK
5 institution history record(s) found. < Previous Page 1 Next >
Event Date Historical Event
1888-01-01 GEORGE PEABODY CO-OPERATIVE BANK, THE located at 32 MAIN
STR, PEABODY, MA was established as a Cooperative Bank.
1986-01-10 GEORGE PEABODY CO-OPERATIVE BANK, THE was renamed to
GEORGE PEABODY CO-OPERATIVE BANK and moved to 32 MAIN STREET
1996-10-01 GEORGE PEABODY CO-OPERATIVE BANK was renamed to NORTH
1998-04-02 NORTH SHORE BANK was renamed to NORTH SHORE BANK, A
2014-04-09 NORTH SHORE BANK, A CO-OPERATIVE BANK moved to 248
ANDOVER STREET PEABODY, MA.
Page 1 of 1
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|Institutions Acquired by NORTH SHORE BANK, A CO-OPERATIVE BANK
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4 Institution(s) Found < Previous Page 1 Next>
Name (RSSD ID) Acquisition Date
MERRIMAC SAVINGS BANK (875909) 2015-11-01 The acquired institution
sold its assets to the acquiring institution.
SAUGUSBANK A CO-OPERATIVE BANK (158974) 2014-09-01 The acquired
institution sold its assets to the acquiring institution.
NEWBURYPORT CO-OPERATIVE BANK (1009176) 1992-06-01 The acquired
institution sold its assets to the acquiring institution.
ROGER CONANT CO-OPERATIVE BANK (160771) 1982-12-16 The acquired
institution sold its assets to the acquiring institution.
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Initial Decision of an SEC Administrative Law Judge
In the Matter of
Orlando Joseph Jett
INITIAL DECISION RELEASE NO. 127
FILE NO. 3-8919
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
In the Matter of
ORLANDO JOSEPH JETT
July 21, 1998
APPEARANCES: Jonathan A. Gottlieb, Petra T. Tasheff, and Herbert J.
Willcox for the Division of Enforcement, Securities and Exchange
Kenneth E. Warner, John R. Cuti, and Richard A. Greenberg for
Respondent Orlando Joseph Jett
BEFORE: Carol Fox Foelak, Administrative Law Judge
Bond trader Joseph Jett was charged with violating the antifraud
provisions of the securities laws and with causing and "aiding and
abetting" violations by his employer, Kidder, Peabody & Co., of
"books and records" provisions. 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. As a result Kidder paid him multimillion
dollar bonuses for 1992 and 1993. No customers or counterparties
were affected by the scheme as there were no purchases or sales of
The Decision concludes that Mr. Jett’s actions did not violate the
antifraud provisions because they were not "in connection with the
purchase or sale of any security" within the meaning of the
securities laws. It further concludes that he caused and aided and
abetted Kidder’s books and records violations when his illusory
profits were reflected in its ledgers and in its FOCUS reports filed
with the New York Stock Exchange and the Securities and Exchange
The Decision orders him to cease and desist from books and records
violations, bars him from association with a broker-dealer, and
orders disgorgement of $8.21 million in gains resulting from his
violations and a $200,000 penalty.
A. Procedural Background
The Securities and Exchange Commission (Commission) initiated this
proceeding by an Order Instituting Proceedings (OIP) on January 9,
1996, pursuant to Section 8A of the Securities Act of 1933
(Securities Act) and Sections 15(b), 19(h), and 21C of the
Securities Exchange Act of 1934 (Exchange Act). 1 The OIP alleged
that from July 1991 until April 1994 Respondent Jett willfully
aided, abetted, and caused Kidder, Peabody & Co.’s (Kidder)
violations of Section 17(a) of the Exchange Act and Rules
17a-3(a)(1), 17a-3(a)(2), 17a-3(a)(7), and 17a-5 thereunder,
willfully violated Section 17(a) of the Securities Act, and
willfully violated Section 10(b) of the Exchange Act and Rule 10b-5
I held a hearing in New York City on May 20, 21, 22, 23, 24, 28, 29,
30, 31, and June 3, 4, 5, 10, 11, 12, 13, 18, 19, and 20, 1996. The
Division of Enforcement (Division) called 16 witnesses from whom
testimony was taken, including Respondent Jett. Respondent’s counsel
called six witnesses, including the Respondent. A vast number of
exhibits were received into evidence. 3
My findings and conclusions are based on the record. I applied
preponderance of the evidence as the standard of proof. 4 Pursuant
to the Administrative Procedure Act, 5 I considered the following
post hearing pleadings: (a) the Division’s October 17, 1996,
Post-Hearing Brief and Proposed Findings and Conclusions; (b) the
Respondent’s February 21, 1997, Post-Hearing Memorandum and Proposed
Findings and Conclusions; and (c) the Division’s April 22, 1997,
Reply Brief and Appendix. I considered and rejected all arguments
and proposed findings and conclusions that are inconsistent with
B. Allegations and Arguments of the Parties
The OIP alleged that from July 1991 until about April 17, 1994,
Respondent Jett exploited an anomaly in Kidder’s trading and
accounting systems to create the appearance of $348 million in
profits. He did this, the OIP alleged, by entering instructions on
Kidder’s systems for the exchange, at future dates, of U.S. Treasury
bonds and their zero coupon components with the Federal Reserve Bank
of New York (Fed) in transactions known as STRIPS and
reconstitutions (recons). Thus, the OIP alleged, Respondent Jett
willfully aided, abetted, and caused books and records violations by
Kidder of Section 17(a) of the Exchange Act and Rules 17a-3(a)(1),
17a-3(a)(2), 17a-3(a)(7), and 17a-5 thereunder -- by failing to make
and keep current and accurate transaction journals (blotters),
ledgers, and order tickets, and filing materially inaccurate FOCUS
Reports. 6 Additionally, the OIP alleged that Respondent Jett
willfully violated the antifraud provisions of the securities laws,
Section 17(a) of the Securities Act and Section 10(b) of the
Exchange Act and Rule 10b-5 thereunder.
The Division argues that the evidence shows that the Respondent
engaged in fraud by exploiting an anomaly in Kidder’s trading and
accounting systems to book over $300 million in fictitious profits
and then misrepresented and omitted to state material facts to
Kidder employees in furtherance of the fraud. As a result, it
states, he received $11.4 million in bonuses. Additionally, it
argues that by these actions he willfully aided and abetted and
caused books and records violations by Kidder. The Respondent claims
there was no fraud in that he was open about his actions, that
Kidder knew and approved his actions, and that his actions were part
of a legitimate trading strategy. Additionally, he claims that much
of his forward activity resulted from Kidder’s efforts to window
dress 7 its balance sheet for the quarter ending in September 1993
and thereafter. In reply the Division argues that the records that
Jett asserts disclosed his actions provided insufficient information
to disclose his actions and their profit and loss (P&L) effect on
Kidder’s books and records, and that Kidder did not in fact know of
The Division seeks an order to cease and desist, disgorgement of
$11.4 million plus prejudgment interest, civil penalties of $11.4
million, and a bar from association with any broker or dealer,
without a right to reapply. The Respondent contends that the
proceeding should be dismissed because the Division did not prove
its fraud allegations or that the Respondent knew of Kidder’s books
and records violations.
II. Findings of Fact
A. Kidder, Peabody and Its Employees
Kidder was, until it ceased to exist in 1994-95, a registered
broker-dealer with offices in New York City and was ultimately a
subsidiary of General Electric Company (GE). 8 Div. Ex. 50 at B03.
Kidder’s Fixed Income Division (Fixed Income or FI) had 12 trading
desks, one of which was the Government Securities Trading Desk
(Government Desk). Respondent’s Answer (Feb. 7, 1996). The
Government Desk did proprietary and customer market-making trades in
Treasury bills, notes, bonds, STRIPS, government agency securities,
and money market instruments. 9 Tr. 827. The Zero Coupon Trading
Desk, also referred to as the Zero Desk or STRIPS Desk, was part of
the Government Desk. Tr. passim; Respondent’s Answer.
The Respondent was born in 1958. Div. Exs. 52, 55, 56, 57. After
receiving graduate and undergraduate degrees in chemical engineering
from the Massachusetts Institute of Technology and working as an
engineer for several years, he completed the M.B.A. program at
Harvard University. 10 Div. Ex. 52, 55. He worked in mortgage-backed
securities in the New York offices of Morgan Stanley for about two
years and at CS First Boston for about one year, but was let go by
both firms. Tr. 470, 472-73, 643; Div. Exs. 41, 43, 44, 56, 57. He
started work as a trader on Kidder’s Zero Desk in July 1991 at a
salary of $75,000 per year. Tr. 470-71. He received a disappointing
evaluation and bonus at the end of 1991, but showed dramatically
increasing profits and rewards from early 1992 until the events that
led to his termination in April 1994, as shown in the chart below.
Tr. 471, 481-82, 489-94, 838-51, 869-72; Div. Exs. 86, 87, 88, 89,
Hired at $75,000 as Vice President
1991 Total Reported Profit (7/91-12/91)
Raise to $150,000
Promoted to Senior Vice President
1992 Total Reported Profit
$2.1 million bonus
Promoted to head of Gov’t Desk
1993 Total Reported Profit
$9.3 million bonus
Named Kidder’s Man of the Year
1994 Total Reported Profit (1/94-3/94) )only)
Melvin Mullin, head of the Government Desk, was Mr. Jett’s first
supervisor. Tr. 477, 826-27, 830. Mr. Mullin’s supervisor was Edward
Cerullo, head of Fixed Income. Tr. 916, 918-19. In February 1993,
Mr. Mullin moved to a different position and Mr. Jett was appointed
head of the Government Desk, reporting directly to Mr. Cerullo. 11
Tr. 489-93, 850-51, 916-17. His hard work, drive, and discipline
attracted favorable notice. Tr. 868-72, 921, 967; Div. Exs. 87, 88,
89. On Mr. Cerullo’s recommendation, he was given Kidder’s Man of
the Year Award. Tr. 493-94, 923-24; Div. Ex. 118. His January 8,
1994, acceptance speech showed his thorough knowledge of
bond-trading concepts. Div. Ex. 118 (transcribed at Tr. 641-56).
In the first quarter of 1994, Kidder examined Mr. Jett’s trading
more closely than before. On April 17, 1994, Kidder fired him and
announced that it had recorded about $350 million of nonexistent
profits as the result of his fraudulent trading and would take a
$210 million charge to its first quarter earnings. 12 Tr. 596, 939;
Div. Ex. 50 at B01, B03; Resp. Ex. 600. Kidder hired the Davis, Polk
& Wardwell law firm to investigate the situation with the help of
the GE Corporate Audit Staff (GE CAS); this effort resulted in an
August 4, 1994, report, known as the Lynch report, which was made
public. Tr. 1815-2428, 2525-2650; Div. Ex. 50 at B03; Div. Ex. 153;
Resp. Ex. 600. Several legal proceedings, including this
administrative proceeding, ensued. See In re Kidder Peabody
Securities Litigation, 94 Civ. 3954 (S.D.N.Y.); In re General
Electric Securities Litigation, 94 Civ. 4024 (S.D.N.Y.); Arbitration
Between Joseph Jett and Kidder, Peabody & Co., Case No. 94-01696
(NASD Regulation, Inc.).
B. The Fixed Income Government Desk
1. Zero Coupon Bonds, Stripping and Reconning
U.S. Treasury securities are debt obligations of the United States
on which interest is paid. Div. Ex. 119 at A1; see also Tr. 116.
There are two categories of Treasury securities, coupon securities
and zero coupon securities (also known as discount securities or
zeros); they differ in the form in which the holder receives
interest and, correspondingly, in the price at which they are
issued. Div. Ex. 119 at A1. Coupon securities are issued at
approximately their redemption value (also known as par, principal
or face value); the interest is fixed as a percentage of the face
value, and is paid periodically (usually every six months) during
the life of the security. Div. Ex. 119 at A1, B1. Zero coupon
securities are issued at a discount to their redemption value; the
interest is paid at maturity when the security is redeemed and the
Treasury remits the full face value; the interest is the difference
between the face value received at maturity and the purchase price.
Div. Ex. 119 at A1, B2. Treasury securities with original maturities
of ten years or more are called bonds and are issued as coupon
securities. 13 Div. Ex. 119 at A1-A2.
There is a secondary market for Treasury securities; it is the most
liquid and the most actively traded financial market in the world.
Div. Ex. 119 at A2; see also Div. Ex. 118 (Tr. 642-43). The standard
or "regular way" settlement date for transactions in U.S. Treasury
securities is one business day after trade date. (Regular way
settlement for corporate stocks and bonds (corporate settlement),
now three days, was five business days at the time of the events in
question.) Tr. 537; Div. Ex. 119 at B10; John Downes & Jordon Elliot
Goodman, Barron’s Dictionary of Finance and Investment Terms 527
(4th ed. 1995); see also Tr. 891, 2472.
Coupon bonds and zeros are priced differently in the secondary
market as well, because of the difference in the way the holder
receives interest. Div. Ex. 119 at B1-B9. Prices of coupon
securities are commonly quoted as a percentage of par. Div. Ex. 119
at B2. Additionally, if a bond is sold in the middle of a coupon
period, the buyer, who will receive the next coupon, pays the seller
for the pro-rated portion of the coupon period during which the
seller held the bond, up to settlement date; this adjustment to the
price of the bond is called accrued interest. Div. Ex. 119 at B3;
Marcia L. Stigum & Franklin L. Robinson, Money Market and Bond
Calculations 76 (1996). Accrued interest is accounted for separately
from the price paid for the bond principal on books and records,
such as confirms. Marcia L. Stigum, After the Trade: Dealer and
Clearing Bank Operations in Money Market and Government Securities
133-36 (1988). In the case of zero coupon bonds, there is no accrued
interest since there are no periodic coupon payments. Div. Ex. 119
Various factors affect the market prices of Treasury securities.
Div. Ex. 199 at B1-B22. The prices of Treasury securities have an
inverse relationship to the movement of U.S. Government interest
rates. Div. Ex. 119 at B1-B2, B8-B9. Because zeros pay no interest,
they tend to rise in value over time ("accrete") such that they
approach their face value as they near maturity. Tr. 507-08, 1873;
Div. Ex. 119 at 7-8, B7-B8. The price of zeros is also affected by
supply and demand and other market conditions. Tr. 507; Div. Ex. 119
at 7-8, B7-B9. The farther the time to maturity, the more likely
market factors such as interest rates will dominate the effect of
accretion on prices. Div. Ex. 119 at 7-8, B9.
The U.S. Treasury has programs administered largely by the Federal
Reserve Bank of New York (Fed) whereby the coupons and principal
payments of certain U.S. Treasury bonds can be separated
("stripped") or reconstituted ("reconned") after being stripped. Tr.
509, 783-86, Div. Ex. 119 at 7, A3-A4. "STRIPS" 14 are the zero
coupon securities created from the interest payments and principal
piece of a stripped bond, and these STRIPS are traded in the
secondary market for U.S. Treasury securities. Tr. 506-07; Div. Ex.
119 at 7, A3.
The Fed plays a clerical role and is not a true counterparty in
stripping and reconning; they are "exchanges," not "trades" or
"transactions." Div. Ex. 119 at 15-16. The Fed does not make advance
commitments to make the exchanges; it charges a standard processing
fee and does not otherwise profit or lose from the exchanges. Tr.
784-88; Div. Ex. 119 at 8-9, 15-16, A5-A7; Div. Ex. 153. The actual
exchanges are via the FedWire connection between the Fed and a
clearing bank; Kidder’s clearing bank was the Bank of New York
(BONY). Tr. 784-85, 1901-02, 2045. At the time at issue the Fed
required delivery by 11:30, and the turn-around time was about three
hours. Tr. 786-87, 2487; Div. Ex. 100 at 9.
An arbitrage opportunity may be created for traders when the value
of the component parts is greater or less than the value of the bond
as a whole. Tr. 538, 836, 2958; Div. Ex. 119 at D2-D9. The
government securities market is highly liquid with virtually no
bid-offer spread. Tr. 687-88, 3062-65; Div. Ex. 118 (Tr. 643).
Correspondingly, profits that can be made from arbitrage between
STRIPS and bonds are limited; in the 1991-92 time frame, profit
opportunities varied from time to time and issue to issue but it was
not unusual to find profit opportunities in the range of $2,000 per
million, or about 6/32nds. Tr. 837-38, 874-75; see also Div. Ex. 119
at 18, D8; Tr. 550; cf. Resp. Ex. 1000 at 22-26; Tr. 875-76,
2779-89, 3048-56. It is axiomatic that high risk is usually
associated with high profit potential; low risk, with low profit
potential. Tr. 473; Div. Ex. 119 at 30-32. Generally when traders
believe they can create substantial profit at low risk from a
trading strategy, they do as much of the trade as they can because
low risk, high profit, opportunities in highly liquid and monitored
markets do not persist; others exploit the opportunity, the price of
the securities changes, and the opportunity disappears. Tr. 1645-46,
3061-65; Div. Ex. 96; Div. Ex. 96A at 25; Div. Ex. 119 at 32-33.
2. Kidder Systems
The Government Desk’s trades flowed through three computer systems
at Kidder: Government Trader (GT), used directly by traders; Tandem,
which maintained and processed information concerning GT’s trades
during the day as they occurred; and the IBM mainframe, into which
Tandem’s data was moved at the end of the day and maintained. Tr.
324-48; see generally Div. Ex. 153.
GT was a stand-alone computerized analytical system with multiple
touch screen menus which facilitated trading in Treasury notes,
bonds, STRIPS and options. Tr. 533-35, 1832, 1865-68; Div. Ex. 153
at 5-6. GT was designed by Mr. Mullin and Mike Benatar, a computer
programmer at Kidder, to help traders to identify and track relative
values among similar securities and identify market opportunities,
manage risk, and monitor profits and losses and trade date
positions. Div. Ex. 153 at 5-7; Tr. 533, 827-28, 834, 1059, 1832-33,
1862-63, 1875-76. Thus, a trader used GT to identify profitable
STRIP and recon arbitrage opportunities. Tr. 1048, 1865-68. A trader
also used GT to enter his instructions for trades, STRIPS and
recons. Tr. 535, 1831; Div. Ex. 153 at 5-7. GT contained prices,
which were either updated by the trader as to a particular security
or based on their assumed relationship to another security that had
been updated (matrix pricing). Tr. 1602, 1837-39, 3092-93; Div. Ex.
153 at 5-8 & nn.2, 4. There is no suggestion in the record that the
Respondent entered inappropriate price marks.
Tandem was a real-time on-line processor that captured and
maintained transactions as they occurred; it kept positions on a
real-time basis; it posted positions and kept current during the
day. Tr. 326-27, 338. Data from trade tickets, which were prepared
manually or generated by GT, was entered manually into Tandem. Tr.
329-33, 828, 1831, 1881-84. Additionally, end-of-day price data from
GT was downloaded automatically into Tandem at the end of each day.
Tr. 828, 1838-39, 1884-85. Tandem moved data from each day’s
activities onto the IBM at the end of that day; it also saved
certain files to tape. Tr. 333-34.
The IBM, a batch processor, received data from Tandem starting about
6:30 p.m. each day; the data resided on the IBM, which processed it
in various ways. Tr. 333, 336-49, 1831, 1896.
Information fed from GT into Tandem and IBM was incorporated into
financial and accounting reports generated by the two systems. Tr.
1831. Tandem generated the Daily Profit/Position Report #2 (PPR-2
Report), 15 which showed profit and loss (P&L) by CUSIP number, 16
and the Daily Transaction Journal, 17 which recorded every
transaction by ledger and CUSIP number. Tr. 1831, 1885-86, 1894. The
IBM maintained all of the firm’s trading information. Tr. 336-37. It
generated the FI 12 Trade Date Inventory Report 18 and the FI 10
Settlement Date Inventory Report; these autonymous reports of firm
inventory were by ledger and CUSIP number. Tr. 343-44, 380, 1831,
1896-98. It generated the KPPS-98 Report and the FI STAT Report. Tr.
342-44, 344, 391, 1831. The FI STAT Report was a transaction history
file that broke down transactions in the greatest detail. Tr.
344-45, 1831, 1901. The KPPS-98 Report 19 was a month-end exception
report developed in September 1993 that captured unsettled forward
transactions, including forward exchanges with the Fed. Tr. 1900-01.
Government Desk trade information was fed to order tickets,
transaction journals, ledgers, income statements, and FOCUS Reports.
20 Tr. 147-66, 533-35, 1831, 1885-86, 2296-97; Div. Exs. 23-37.
transct. flow process
See Div. Ex. 155.
Rule 17a-3(1), which the OIP alleges the Respondent violated,
pertains to blotters. The Daily Transaction Journal was the blotter
for trades entered in GT. Tr. 135, 191, 1831; see, e.g., Div. Ex.
3. Execution of STRIPS and Recons on Government Trader
After a trader on the Government Desk negotiated a purchase or sale
of a security with a counterparty, he entered the trade on GT,
indicating the security to be bought or sold, quantity, price and
counterparty. Tr. 534-35, 1865-69; Div. Ex. 153 at 6-7. To initiate
a STRIP or recon, a trader entered the bond, quantity and whether it
was a STRIP or recon; no price or counterparty was entered because
these are non-negotiated exchanges for which there is no
counterparty; GT automatically defaulted to house accounts that
recorded STRIP (08708910) and recon (08708909) activities. Tr.
534-35, 1865-69; Div. Ex. 153 at 6-7.
After a trader entered a trade, STRIP, or recon, GT immediately
updated his P&L for the day and his inventory. Tr. 1875-76, 2374-75;
Div. Ex. 153 at 6-7. Thus, he could see the immediate effect of a
trade or entry on his gross P&L position. Tr. 540-42, 1875-76,
2999-3003, 3015-16; Div. Ex. 92; Div. Ex. 92A at 1-2, 4, 7. Traders
understand and watch their P&L closely since their compensation is
largely based on P&L. Tr. 3059-61. The process of selecting a bond
to be reconned, entering instructions for the recon, and then
checking the P&L effect took about 10 to 14 seconds. Tr. 1875-76. GT
did not show net interest or cost of carry. Tr. 2683-84. This could,
however, be estimated. 21 See, e.g., Div. Ex. 92; Div. Ex. 92A at 1.
GT defaulted to next-day (regular way) settlement for trades,
STRIPS, and recons. 22 Tr. 537-38, 1865-69; Div. Ex. 153 at 6. Until
November 1992, a trader was limited to changing the settlement date
for a trade or exchange to same day, skip day, or corporate (five
day) settlement; then an upgrade was introduced that permitted a
trader to select any future date. Tr. 536-38. There is no economic
reason to enter an exchange greater than one day forward. 23 Tr.
853-54, 877-78; Div. Ex. 119 at 32-33.
GT treated a recon as the purchase of a bond and the sale of a group
of STRIPS, and vice versa, and created theoretical prices such that
the bond plus interest that would accrue on it as of settlement date
equaled the sum of all the STRIPS (TINTs plus corpus). Tr. 1533,
1868-69, 1881, 2316, 2904; Div. Ex. 119 at 16. GT created the prices
based on the spot price (price for next day settlement) of the bond
and STRIPS and assumed the current yield held constant. Thus GT
recorded the purchase of a bond priced for next-day settlement, but
the sale of a group of STRIPS theoretically priced for forward
settlement. The difference between the (spot) price of the bond plus
accrued interest and the sum of the forward priced STRIPS was added
to the principal piece (corpus). Since interest is built into the
purchase price of a STRIP, a zero coupon bond, and is not part of
the principal price of a coupon bond, such an exchange for forward
settlement would appear to show a profit on the trade date. A profit
appeared on the trade date because the forward price assigned to a
STRIP was higher than the price of the STRIP for next day
settlement; a profit was recorded on GT and Tandem when the position
was marked to market each day. Tr. 1869-71, 1884-85; Div. Ex. 119 at
Conversely, a forward STRIP entered into GT was treated as the sale
of a bond and the purchase of a group of STRIPS. Tr. 1868-69. In
that case the higher forward price for the STRIPS as compared with
the price of the bond would cause a loss to appear on trade date and
gradually disappear as settlement date approached. Tr. 1869-71.
Because GT calculated the forward price of the STRIPS by adding
accrued interest to the price of the bond principal, the apparent
profit when the forward recon was booked would be higher the larger
the bond value, the higher the bond coupon, and the greater the
number of days to settlement; Mr. Jett knew this. Tr. 546-47; Div.
Ex. 96; Div. Ex. 96A at 19; Div. Ex. 100 at 8. The profit
deteriorated as settlement date approached, because of the accretion
effect, as the STRIPS were marked to market each day. Tr. 1872-73;
Div. Ex. 119 at 18-19, F4-F8; see also Div. Ex. 153 at 7-9. Mr. Jett
knew this. Tr. 532, 541; Div. Ex. 78 at Bates 04674-78.
A profit discrepancy resulting from entry of a forward exchange on
GT -- the difference between the theoretical forward price of STRIPS
recorded in GT and Tandem, and the lower current market price of
STRIPS -- was recorded daily by Kidder’s P&L accounting system in
marking to market. Tr. 1869-71, 1884-85, 2323. Thus, profits and
losses which had not yet accrued were recorded in the firm’s books
and records. Tr. 533-34, 2296-97. Such forward booking of planned
but unexecuted exchanges required an accounting adjustment to be in
accordance with Generally Accepted Accounting Principles (GAAP). Tr.
2728, 2735-38, 2747; Resp. Ex. 1000 at 7.
It was against a trader’s self interest to request such an
adjustment that reduced his reported profits, 24 but the record does
not show that Kidder had a policy requiring a trader to do so. There
was no written policy. Tr. 873. Although Mr. Mullin recalled,
generally, instructing traders in department meetings to advise the
accounting department of forward transactions, he could not recall
any specifics, including who was present at such meetings. Tr. 830,
873-74. He did not discuss the issue with Mr. Jett. Tr. 874. Mr.
Mullin and Mr. Cerullo’s assistant David Bernstein adverted to a
general understanding that an accounting adjustment was necessary to
correct P&L distortion arising from a forward transaction, but Mr.
Bernstein waffled on whether it was a trader’s responsibility to
come forward or the accounting group’s responsibility to notice
forward settling trades. Tr. 830, 874, 1430-35, 1466-67, 1470-74.
The existence of a compliance officer was noted briefly on the
record, but there was no evidence that she addressed the adjustment
issue while the Respondent worked at Kidder. Tr. 2955. Kidder staff,
however, in May 1993, had discussions with him related to this
issue, as addressed below. Kidder later discovered unrealized
profits requiring adjustment in the Respondent’s ledger, resulting
in a large write-off for the first quarter of 1994. Tr. 1972-74,
2262, 2412-16; Div. Ex. 50 at B01, B03; Div. Ex. 121.
C. Jett’s Trading Strategy
Respondent Jett traded and booked exchanges with the Fed in the G-1
ledger at Kidder, along with other traders whom he supervised. Tr.
485, 534-35, 693, 988-89, 1328, 1476, 1983-84, 3001-05; Div. Exs.
92, 92A. He entered many thousands of forward recons and STRIPS. Tr.
580-82. Because he traveled frequently, he also instructed traders
under him, such as Kevin McLaughlin, Jeff Unger, and Joe Ossman, to
enter transactions or book exchanges with the Fed in his absence.
Tr. 485, 534-35, 693, 988-89, 1328, 1476, 1983-84, 3001-05; Div. Exs.
In addition to trades with counterparties, beginning in November
1991, Mr. Jett also booked forward recons and STRIPS with the Fed,
which generated apparent profits as described above. Tr. 533-35,
538-39, 2101-05; Div. Exs. 58-73, 121, 122, 152; Div. Ex. 153 at J.
About 90% of G-1 ledger activity from July 1991 through March 1994
was recons and STRIPS. Div. Ex. 153 at 11-12. The P&L effects of the
forward exchanges were reflected on Kidder’s books and records,
including the Daily Transaction Journal, ledgers, order tickets, and
FOCUS Reports. The effects were also reflected on the PPR-2 Report,
the FI-10 and FI-12 Reports, the KPPS-98 Report, the FI STAT Report,
the FISEQ file, the Fixed Income Daily Report, P&L in trial
balances, income statements, and statements of financial condition,
the BONY Clearance Report, and the Inventory Control/Haircut
Estimate Report. Tr. 125-66, 202, 207-08, 224-25, 269, 533-34,
2009-12; see generally testimony of Jeffrey Bornstein, Tr.
1815-2428; Div. Exs. 1-37, 58-73, 75, 121-24, 130, 135, 152, 154-56;
Div. Ex. 153 at 10-11.
Before the November 1992 upgrade to GT, Mr. Jett was limited to
changing the default, regular way, settlement date to five days
forward. Tr. 536-38. Thereafter, he entered forward recons for
settlement up to 203 days in the future. Tr. 537; Resp. Ex. 604.
The Respondent claims that his execution of this strategy on GT
merely involved an accelerated recognition of profit for internal
management reporting purposes only, described as "Trade Date Early
Recognition of Profit" or "TDERP," when Kidder estimated unaccrued
interest as profit in advance, and recognized it up front. Tr.
2797-2800, 2909-10; Resp. Ex. 1000 at 3-4, 7-8.
Indeed, since the initial profit recognized from a forward recon
rolled off, approaching zero on settlement date, a single forward
recon by itself had a minimal effect on the accuracy of Kidder’s
books and records. The Respondent, however, entered an increasing
number of forward recons in a pyramid-like manner that prevented an
overall loss in his portfolio; the amount of unrealized profit from
forward recons in his ledger grew over time. Tr. 1971-72; Div. Ex.
153 at F. He increased the quantity, dollar amount and number of
days forward, thus hiding losses from settling positions. 25 Tr.
2112-13, 2118-21; Div. Ex. 119; Div. Ex. 153 at D, H. Additionally,
he used higher coupon bonds, thus generating higher paper profits,
than for trades with customers; during his tenure at Kidder the
average coupon of his customer trades was 8.03%, of his STRIP/recon
exchanges, 10.25%. Tr. 2114-17; Div. Ex. 153 at G. This pyramid also
masked real trading losses in the Respondent’s ledger. Tr. 2148-49;
Div. Exs. 121, 124, 153.
This chart shows the P&L effect of a series of hypothetical forward
recons; negative accretion of profit from existing recons is offset
by adding new recons:
effect of hypo. fwd recons
Mr. Jett did not advise the accounting group to adjust for forward
recons. Tr. 542-45. He knew that the P&L effects of his forward
exchanges would affect Kidder’s books and records. Tr. 533-34. His
bonuses also showed him that the P&L effects were on Kidder’s books
and records and were otherwise considered by Kidder to be real.
Mr. Jett stated that the forward recons were just one part of a
three part arbitrage strategy: 26 1) the purchase of a collection of
STRIPS, 2) the sale of bond futures, and 3) a forward
reconstitution. Tr. 524, 529-30; Div. Ex. 78; Div. Ex. 119 at 10-11,
G. Arbitrage is profiting on price differences between the bond and
the sum of its parts. Tr. 538-39, 836-38, 860, 2720, 3050. The
Respondent defines "arbitrage" in an unusual way. Tr. 2958-60. He
adds to the "instantaneous" price differences "a time-related
element," described as "accretion" (of STRIPS) or "accrual (of
interest) on the bond" between trade and settlement date. Tr. 2959.
He refers to "early recognition of profit" by saying "the forward
reconstitutions had a time value of money embedded in them." Tr.
Mr. Jett also claims that a forward recon "hedged" with the purchase
of underlying STRIPS locked in the profit from a forward recon,
preventing negative accretion. Tr. 532, 2904-05, 2907-08. However,
any profit from owning STRIPS for a period and then reconning them
would occur with or without a forward recon, since the Fed does not
agree to make exchanges in the future. Further, a long position in
STRIPS must be financed and hedged. Mr. Jett acknowledged but
disregarded the significant costs of futures hedging and repo
financing in explaining his trading strategy. Tr. 2917-18; Div. Ex.
78 at Bates 04685; Div. Ex. 119. Nor did he purchase all the STRIPS
necessary to settle his forward recons. Tr. 2114-30; Div. Ex. 153 at
29-31, C, D, E, G. In fact, from July 1993 to March 1994, the amount
of reconstitutions open at month-end in the G-1 ledger for the 11¾%
bond maturing 11/15/2014 equaled or were up to 3.8 times greater
than the amount of stripped principal pieces that were outstanding
on a global scale as reported by the U.S. Treasury Department. Tr.
2117-20; Div. Ex. 153 at 30-31, D. Mr. Jett demonstrated his
in-depth understanding of the market in U.S. Treasury securities in
his January 1994 Man of the Year Award speech. Div. Ex. 118.
1. Early Trading Under Mullin
Mr. Mullin supervised Mr. Jett from the time he was hired in July
1991 until he became head of the Government Desk in February 1993.
Tr. 477, 830-31. Until GT’s November 1992 upgrade Mr. Jett could not
enter STRIPS or recons for more than five days forward. Tr. 536-39,
889. Mr. Jett characterized himself as becoming aware at that point
in late 1992 that "forward reconstitutions had a time value of money
embedded in them." Tr. 538. However, his trading behavior throughout
1992 already showed an increased tendency to use forward recons and
STRIPS, and not counterparty trades, to generate profit. Tr.
2092-94; Div. Exs. 121, 122; Div. Ex. 153 at 29-30, 35-36, C, F, J.
Out of $27.8 million in reported profits through October 1992,
before the upgrade, he recorded over $17 million in unrealized
profits from forward exchanges. Tr. 1972-74; Div. Exs. 121, 122.
Mr. Mullin and Respondent Jett discussed his trading strategy
frequently; they discussed such topics as the uses of GT’s various
screens, the firm’s risk policy that trades be hedged, the choice of
products for hedging, stripping and reconning, and customer
business. Tr. 834-37, 852-54, 878-79. He understood Mr. Jett’s
profitability to be derived from increased customer business and
increased STRIPS and recon activity to take advantage of
opportunities discovered on the screens of GT; he did not realize
the effect of the Respondent’s forward recons on profitability. Tr.
852-54. Mr. Mullin did not know that Mr. Jett entered forward recons
for more than five days forward after November 1992. Tr. 830-31,
853-54, 866. They did not discuss settlement date at all. Tr. 853.
Mr. Mullin did not review trade tickets, which indicated unusual
trading activity, particularly after Mr. Jett began trading for
greater than five-day settlement in November 1992. Tr. 329-31,
861-62. Mr. Mullin did review the Fixed Income Daily Report, the
Inventory Control Report, and the Daily Transaction Journal as
supervisor of the Government Desk, but did not notice significant
irregularity in the Respondent’s trading. Tr. 829-31, 876-77. The
Daily Transaction Journal showed trade and settlement date. See,
e.g., Div. Ex. 1D. For most of the time Mr. Mullin supervised him,
Mr. Jett’s profit levels were not out of line with what was expected
of him; for 1992 he was expected to generate $1 million in profits
per month, which he exceeded in 1992 and greatly exceeded in 1993
and 1994. Tr. 483-84, 840; Div. Ex. 121.
2. Head of the Government Desk Under Cerullo
Mr. Jett was made head of the Government Desk in February 1993 when
Mr. Mullin moved to a different area. Tr. 492-93, 850-51. About this
time Mr. Jett’s forward exchanges and reported profits, including
profits derived from forward exchanges, increased greatly. Tr.
491-94, 999-1000, 1020-23, 1631-34; Div. Exs. 121, 122; Div. Ex. 153
at F; Resp. Ex. 120. In 1992, he reported about $32.5 million in
profits, including $40.4 million of profits from forward exchanges;
in 1993, $150 million in profits, including about $198.2 million of
profits from forward exchanges. Div. Exs. 121, 122. In 1993 Mr. Jett
was responsible for a significant portion of the reported income of
FI. Tr. 493-94, 715-16, 1113-14.
Mr. Cerullo supervised Mr. Jett from February 1993 until he was
fired. Tr. 850-51, 916-17, 2944. Mr. Cerullo was in charge of Fixed
Income, a billion dollar business with 750 employees throughout the
world. Tr. 916, 960. He had conversations of a general nature with
Mr. Jett and others concerning his strategies and the source of his
profits. Tr. 1023-27, 1056-59. He delegated responsibility to
investigate specific questions to David Bernstein, his assistant;
Barry Finer, the FI Division Risk Manager; and others. Tr. 684-86,
694-96, 716-20, 924-29, 1025-28, 1056-58, 1341-42, 1353-54, 1358-60,
1627-29, 1677-78, 1769. Mr. Bernstein was Mr. Cerullo’s right-hand
man. Tr. 675, 1308-09, 2459-60, 2915. He kept Mr. Cerullo au
courant. Tr. 1418.
Information that raised questions about Mr. Jett’s trading was known
to Mr. Cerullo as early as the middle of 1993. He knew that Kidder
was doing a larger volume of STRIPS and recons during 1993 than
before. Tr. 1030. The reported profitability of the G-1 ledger,
which had increased greatly in 1992, continued to increase
dramatically each month in 1993, such that by April 1993 Mr. Jett’s
earnings had surpassed all of 1992. Tr. 999-1000, 1020-23. There was
talk around the firm about his enormous profitability. Tr. 715-16,
1632-34, 1645-46, 2462. Mr. Cerullo acknowledged that there was no
market-driven explanation for the dramatic increase in Mr. Jett’s
profits from 1992 to 1993, Tr. 1048-49, and thought that the profits
came from trading STRIPS and bonds, market making and STRIP and
recon arbitrage. Tr. 917-18.
Mr. Cerullo reviewed reports which gave indications of the
Respondent’s profitability, trading limits, position risk exposure,
and asset consumption, including the PPR-2 Report, the Daily
Transaction Journal, the Government Daily P&L/Inventory Report, the
Fixed Income Daily Report, the Risk Management Report, and the
Inventory Control/Haircut Estimate. Tr. 706-07, 923, 985-86,
1033-35, 1043, 1055-56; Resp. Exs. 120, 121, 122, 123. These reports
showed a dramatic, more than five-fold, increase in trading profits
during the year 1993 for Mr. Jett’s G1 ledger. Resp. Ex. 123. Mr.
Cerullo did not review Mr. Jett’s order tickets; the tickets
disclosed trade and settlement dates; the account numbers on them
showed the orders were STRIPS and recons. Tr. 957-59. When Mr. Jett
exceeded capital limits in the spring and summer of 1993, Mr.
Cerullo approved higher limits for him and did not question in depth
the source of his profits. Tr. 706-09, 1033-35, 1041-47, 1060-61;
Resp. Ex. 121.
Mr. Cerullo’s assistant Mr. Bernstein was alerted during the spring
of 1993 that Kidder’s Repo Desk was having problems processing the
Respondent’s exchanges, Tr. 2459, 2508-10, and that the accounting
department was concerned about the P&L effects of the Respondent’s
exchanges on Kidder’s balance sheet. Tr. 1314-16. Mr. Cerullo was
involved in the balance sheet reduction program at Kidder beginning
in September 1993, as discussed below. Mr. Bernstein specifically
told Mr. Cerullo about the Respondent’s forward recons with the Fed
in March 1994. Tr. 918, 924-25, 1769.
D. Revelation of the Problem
Mr. Jett’s "outrageously high numbers" were the subject of
conversation around the firm during 1993. Tr. 715-16, 1632-34,
1645-46, 2462. The Respondent points to several factors that
highlighted his activities to argue that knowledge of his activities
was widespread and that Kidder approved his strategy to book profits
from forward recons.
1. The Repo Desk—The Red Books
Kidder’s Repo Desk financed FI’s long positions and borrowed
securities to cover FI’s short positions. Tr. 960-61, 2444-45. Brian
Finkelstein managed the desk; Jim Rizzi dealt directly with Mr.
Jett. Tr. 2444-45, 2480-81.
In late 1992 the number of forward recons increased, and Mr. Rizzi
sometimes had difficulty keeping up; at times he could not obtain
the necessary STRIPS, and it was necessary, in effect, to cancel a
recon by pairing it off with an equal and opposite STRIP. Tr. 2484,
2486-87. Mr. Rizzi usually learned of trades due to settle on a
particular day by a Settlement Location Report provided to him that
same day; to solve the problem caused by Mr. Jett’s volume, he
suggested advance notice. Tr. 2483-87. Beginning in 1993, Mr. Jett
and his staff noted his STRIP and recon requirements in advance in
large notebook calendars kept on Mr. Rizzi’s desk and known, from
their red covers, as Red Books. 27 Tr. 612-14, 617-23, 2446-48,
2486-92; Resp. Exs. 102A (1993), 102B (1994). A STRIP or recon was
listed on the page of its settlement date; the information included
trade date, whether the entry was a STRIP or recon, the dollar
amount, the coupon and maturity of the bond, and the number of
STRIPS needed. Tr. 618-23, 2488-89; Resp. Exs. 102A, 102B. The P&L
effects were not shown. Tr. 628-31. Not all STRIPS and recons were
in fact noted in the Red Books, but they assisted the repo desk in
preparing for settlement date. Tr. 2037-38, 2486-88, 2519; Div. Ex.
153 at 13-14 n.11.
In spring 1993 Mr. Rizzi complained to Mr. Finkelstein that: 1) the
volume of Mr. Jett’s recons was tremendous, 2) forward settlements
would stay on the books until settlement date but often would not
settle, even though Mr. Rizzi had obtained STRIPS in preparation for
settlement, and 3) the desk would gather a large volume of STRIPS
for a recon, only to have the same bond stripped a few days later.
Tr. 2456-59, 2507-09, 2514-15. About this time, Mr. Rizzi also
questioned whether Mr. Jett’s trades were merely paper trades which
did not settle with actual customers. Tr. 2509-10. Mr. Rizzi and Mr.
Finkelstein met with Mr. Bernstein, who looked into the matter and
later assured them that Mr. Jett’s trades and customers were real.
Tr. 2459, 2508-10. Apart from this inquiry, in 1993 Mr. Finkelstein
frequently expressed concern to Mr. Bernstein, discussing
operational issues and wondering how Mr. Jett achieved such high P&L
trading figures. Tr. 2459-67. Mr. Bernstein alleviated his concern
by saying that he had looked into the situation and was satisfied,
and that Mr. Cerullo knew about Mr. Jett’s trading. Tr. 1644-45,
The Red Books were kept open and available on the desk of Jim Rizzi.
Tr. 617-20, 2446-48, 2491-92. Neither Mr. Mullin nor Mr. Cerullo
knew about them. Tr. 855, 961. The Respondent’s claim at Tr. 2944-45
that he and Mr. Cerullo reviewed every STRIP and recon in the Red
Book for May and June 1993 in connection with a contemporaneous
inquiry from the Fed is not consistent with the record evidence that
Mr. Cerullo as a manager delegated such specific tasks to others.
Mr. Bernstein claimed that he was not aware of their use before
1994. Tr. 1518. However, the record shows that Mr. Bernstein
reviewed the Red Books in his 1993 inquiries regarding the repo desk
and in the May 1993 inquiry discussed below. Tr. 2510, 2910-11,
2914. Mr. Rizzi’s recollection to this effect is more persuasive
than Mr. Bernstein’s denial. The Red Books were important to Mr.
Rizzi, so he would likely notice their use, and they would have been
an obvious source to help Mr. Bernstein in his investigations.
Information contained in the Red Books—especially the far forward
recons—was unusual and could have raised questions that would have
revealed the facts associated with the Respondent’s trading. By May
1993, a glance at the Red Book showed forward recons of increasing
length and size. Examples of entries made by then show an 18 week
forward recon of $200 million of a 12% bond for May 11 settlement; a
25 week forward recon of $200 million of a 12% bond for May 18
settlement; a 29 week forward recon of $200 million of an 11 5/8%
bond for June 8 settlement; and five to eight week forward recons
totaling $900 million for July 2 settlement. Resp. Ex. 102A at May
11, May 18, June 8, July 2.
2. The May 1993 Inquiry
In May 1993, Mr. Jett told Mr. Bernstein that the forward positions
in his ledger were forward reconstitutions with the Fed. Tr. 1317,
1425. Kidder accountant Charles Fiumefreddo was working on a project
to identify forward, unsettled, positions, so that they would not be
reported on the balance sheet; the KPPS-98 exception report was
developed as a result of this project. Tr. 1314, 1427. He realized
that Mr. Jett had forward positions and notified Mr. Bernstein. Tr.
1314-15, 1425-35, 1624. They questioned Mr. Jett about how trade
prices were arrived at and whether there was a P&L effect to his
trading in several conversations in May and June 1993. 28 Tr.
542-45, 563, 1316-23, 1475-78, 1624, 2903-05, 2909-10.
The Respondent and Mr. Bernstein testified concerning the meetings.
29 Tr. 542-44, 1475-1585, 1601-43, 1767-74, 2903-05, 2908-28,
2930-34. I evaluated the credibility of the testimony of each in
light of his self interest. Mr. Jett’s testimony was to the effect
that Kidder management approved his booking unrealized profits from
forward recons, which he characterized as "early revenue
recognition." Mr. Bernstein’s self interest was to show that he did
not uncover improper recording of profits because Mr. Jett misled
him. Nonetheless, his testimony avoided attributing affirmative
misrepresentations to Mr. Jett. As he characterized it, he could
have discovered the P&L distortion in May/June 1993 if he had asked
different questions. Tr. 1491, 1496, 1780-81.
The result of the meetings was that Mr. Bernstein believed that
there was no P&L effect from entering a forward recon. He relied on
this May 1993 belief until March 1994. Tr. 1327-28, 1336-43,
Mr. Jett told him that GT would use the spot price of the bond and
construct a price for the STRIPS such that "the sum of the dollar
prices of all of the STRIPS would equal the dollar price of the bond
plus accrued interest." Tr. 1318. This statement, which Mr.
Bernstein attributed to Mr. Jett, is true. The statement discloses
that the trade prices for STRIPS are higher than trade date prices
because interest accrued up to settlement date on the bond is
included in constructing the prices. Nonetheless, Mr. Bernstein left
with the understanding that there would be no up-front automatic P&L
effect of booking a forward recon. Tr. 1320. He did not attribute a
specific affirmative statement to that effect to Mr. Jett. Tr.
Mr. Bernstein explained that his mistaken understanding arose from
failure to recognize that "accrued interest" was accrued up to
settlement date; instead he believed the reference was to interest
accrued up to trade date. Tr. 1477-82, 1489, 1491. Such a
misunderstanding is surprising, since "accrued interest" in a bond
transaction always refers to interest accrued up to settlement date.
Resp. Ex. 210 and Div. Ex. 79 support a finding that his
understanding was that "accrued interest" was used in the normal
way, that is, up to settlement date. Assuming, arguendo, that he did
misunderstand, Mr. Jett cannot be faulted for not adding the phrase
"up to settlement date" when he described how GT constructed the
Mr. Bernstein summarized his understanding of the effects of a
forward recon in Div. Ex. 79, a one page memo containing a few
sentences of narrative and some T accounts. Tr. 1322. He claimed
that he showed it to Mr. Jett, especially directing his attention to
the T accounts and the absence of an entry for P&L on trade date,
and that Mr. Jett agreed it recorded their conversations accurately.
Tr. 1325. Mr. Jett denies having seen it then and states he first
saw it in 1995 at a session at the U.S. Attorney’s office. Tr. 2902.
Assuming, arguendo, that Mr. Bernstein did discuss Div. Ex. 79 with
Mr. Jett, this does not show that Mr. Jett made any affirmative
misrepresentations concerning the P&L effect of entering a forward
recon. While Mr. Bernstein stated that Mr. Jett seemed sure that he
understood the P&L impact of the trades, he conceded that they did
not discuss T accounting in detail and that the T accounts were his
own creation. Tr. 1325-26. Further, other statements on Div. Ex. 79,
while susceptible of more than one interpretation, are not
inconsistent with the fact that GT used the price of the bond and
constructed a price for the STRIPS that equaled the price of the
bond plus accrued interest.
Mr. Jett describes the meetings differently. According to him Mr.
Bernstein raised the issue of false profits resulting from forward
recons and he addressed it by explaining that the forward recons
were hedged by owning STRIPS so there could be no negative
accretion. 30 Tr. 2903-05, 2909-10. Hedging and risk are, however,
different subjects from accounting for P&L. Mr. Jett stated that the
result of the inquiry was a determination that profits and losses
from forward transactions should be posted on day one. Tr. 542-43.
According to him, "the consensus (among Mr. Bernstein, Mr.
Fiumefreddo, and himself) was that since I had ownership of the
underlying STRIPS, there was no negative accretion. Rather it was .
. . early revenue recognition from a forward reconstitution." Tr.
Mr. Jett argues that Resp. Ex. 214A, in conjunction with other
evidence, including Resp. Ex. 211, shows that he and Mr. Bernstein
discussed using dummy CUSIPs 31 to enter a different price that
included cost of carry. Tr. 2924-28. Such a price would combine the
P&L effects of a long position in STRIPS and a forward recon. Resp.
Ex. 214A, an undated, handwritten note on the letterhead of Robert
J. Chersi, Assistant Controller of Kidder, reads in its entirety:
"‘Non-Regular Way Settlement’ = off B/S (balance sheet) -- Been
approached By Bernstein to develop a LT (long term) approach to
creating dummy CUSIPs for forward settling STRIPS (today use regular
CUSIP #) Could, in ST (short term), manually remove them based on
trader pointing them out (non-regular way settlement) OK." Mr. Jett
claims that Mr. Chersi rejected the idea on the basis that he did
not have the resources to implement it. Tr. 2927-28. Yet both he and
Mr. Bernstein, who testified that he did not recall discussing dummy
CUSIPs, recognized that using dummy CUSIPs in GT would affect
Kidder’s books and records and make it impossible to reconcile them.
Tr. 1609-10, 2928.
Mr. Chersi was not called as a witness. On its face Resp. Ex. 214A
indicates that the writer understood dummy CUSIPs were being
suggested as a way to remove forward settling STRIPS from the
balance sheet and "OK’ed" a plan of manually removing them based on
the trader pointing them out. In short, Resp. Ex. 214A does not
support the Respondent’s claim that he, Bernstein and Chersi
discussed using dummy CUSIPs to adjust the P&L effect of forward
settling recons, and his testimony to this effect is undercut by his
own recognition of the obvious: using dummy CUSIPs in GT would
affect the books and records and make it impossible to reconcile
them. Mr. Jett also claims that, because of the rejection of the
dummy CUSIP plan at this time, Mr. Bernstein and Mr. Fiumefreddo
told him to limit his forward trades to ninety days and that he
abided by this limit through March 1994. Tr. 609-12, 2930-33. Other
than his testimony at the hearing, there is no evidence to support a
finding that this instruction occurred. See Tr. 1761-64. The
Respondent’s connection of the ninety day limitation with the dummy
CUSIP plan further supports the finding that there was no such
During 1993 Mr. Bernstein reported periodically on the Respondent’s
trading to Mr. Cerullo, who had questions about the Respondent’s
profitability because of a concern that he might be taking risk and
because of a desire to duplicate his performance should he leave.
Tr. 1025-28, 1056-59. Mr. Cerullo was not informed in any specific
detail of the May/June investigation or alerted to possible P&L
distortion; at most Mr. Bernstein mentioned P&L distortion in
passing in a dismissive way. Tr. 1028, 1627-29. He did not show him
Div. Ex. 79, his one-page memo. Tr. 1628. He told Mr. Cerullo in May
1993 that Mr. Jett had forward positions, but did not tell him they
were reconstitutions with the Fed until March 1994. Tr. 1769. Mr.
Jett’s testimony that the May/June meetings included Mr. Cerullo,
Tr. 2909, 2915, is not supported elsewhere in the record and is
inconsistent with the record evidence that Mr. Cerullo as a manager
delegated detail to others.
I find that Mr. Bernstein failed to understand and confront Mr. Jett
with the fact that he was booking unrealized profits and that Mr.
Jett failed to disabuse him of his misunderstandings. Mr. Jett knew
that he was booking unrealized profits from forward recons and
overcoming negative accretion by adding further unrealized profits
in a pyramid like manner, but he did not make affirmative
misrepresentations about this in the May/June meetings. He did know
that Mr. Bernstein, and Mr. Fiumefreddo, to the extent he was
involved, did not understand he was booking unrealized profits, and
he omitted to disabuse Mr. Bernstein, or Mr. Fiumefreddo, of this
misunderstanding. It is inconceivable that Mr. Fiumefreddo, if not
Mr. Bernstein, would have agreed to "early revenue recognition" not
in accordance with GAAP and approved his continuing to book
enormous, increasing, unrealized profits that would, sooner or
later, be unmasked. In sum, the result of the May/June inquiries was
not approval by Kidder to recognize profit up front on forward
recons as Mr. Jett claims. Nor was Mr. Cerullo sufficiently informed
so that his inaction could be taken as approval of Mr. Jett’s course
3. Fed Inquiry
In 1993, Kidder was one of about 40 Primary Dealers of Treasury
securities designated by the Fed. Tr. 410, 789-90, 2945. It reported
its government securities activity to the Fed on Form 2004. Tr. 410,
2945-46. Mr. Cerullo knew Kidder had a larger volume than previously
of STRIPS and recons during 1993. Tr. 1030. In May or June 1993 the
Fed contacted him to question reporting procedures for the STRIPS
and recons. 32 Tr. 1030-31, 2942-44. Mr. Cerullo spoke with
Respondent Jett about this and set up a committee to resolve the
issues. Tr. 1031-32, 2942-47, 2955. Kidder eventually engaged
Coopers & Lybrand to audit its Fed reporting procedures in general;
Coopers & Lybrand’s November 22, 1993, Report addressed a number of
reporting and control issues. Tr. 2954-56; Resp. Exs. 14, 20. In
January 1994, Kidder’s Legal Department reported on the status of
corrective measures. 33 Resp. Ex. 39. There is no evidence to
support the Respondent’s claim, Tr. 2942-45, 2951-53, that the Fed’s
inquiry was prompted by the volume of his exchanges. Neither the
volume of exchanges nor booking unrealized profits were issues
addressed in the reports of Coopers & Lybrand and the Legal
4. Internal Audit
In August and September 1993, Kidder’s Internal Audit Department
performed a standard desk audit of the Zero Desk. Tr. 1166-68, 1210.
The final report was issued in January 1994. Tr. 1167, 1182-83. The
goal of the audit was to review overall control mechanisms and to
identify risks. Tr. 1211, 1215-17, 1221-22; Resp. Ex. 79. P&L
distortion was not a focus of the audit. Tr. 1219-20. Nor was
trading strategy; there was a brief discussion with Mr. Jett for
background only. Tr. 1169-71, 1212-14, 1258-59.
As to risk, Mr. Jett advised the auditors that forward transactions
of one to three months comprised about 30% of his trading activity.
34 Tr. 1176-77, 1214-15; Resp. Ex. 90. Accordingly, the auditors
identified risks associated with forward transactions—credit risk
and comparison risk—as risks that management should address. Tr.
1215. These are risks that a trade does not settle, leaving the firm
with market risk from market movement between trade and settlement
date. Tr. 1215-17. Credit risk is the risk that the counterparty has
insufficient capital to settle the trade. Tr. 1215. Comparison risk
is the risk that a trade on Kidder’s books and records is not on the
counterparty’s; thus there should be a comparison with a
counterparty to make sure both parties agree on the trade
information. 35 Tr. 1217.
As to controls, the auditors checked to ensure there was a mechanism
to monitor P&L; they did not themselves check on the accuracy of the
desk’s P&L or on how its positions were marked to market. Tr.
1219-20. GT was password protected by one password used by all the
traders; for practical reasons, Mr. Jett rejected the auditors’
recommendation that each trader have an individual password. Tr.
1245-47; Resp. Exs. 85, 95.
In short, the audit was completely irrelevant to an understanding of
Mr. Jett’s strategy or his booking unrealized profits.
Barry Finer, the FI Division Risk Manager, was charged with
monitoring potential P&L impact from the market exposure of FI’s
positions to changes in interest rates. Tr. 684-87. He collected
summary information daily from the several trading desks, amounting
to 50 to 100 ledgers, and prepared a summary report for Mr. Cerullo
daily. Tr. 684-86, 689-93. Based on the numbers appearing on GT’s
risk summary screen, Mr. Jett’s trading positions were virtually
always within his market exposure limits. Tr. 690-94. Mr. Finer
monitored the overall risk of positions, not individual trades; he
did not consider settlement dates; because market risk arises at
trade date, settlement date is not an issue. Tr. 684-86, 691-92. Nor
did he ever review the Respondent’s individual trades or settlement
dates. Tr. 693. In the second half of 1993, Mr. Cerullo told Mr.
Finer to ask Mr. Jett about the sources of his profits; Mr. Cerullo
was concerned that he might be taking market risk. Tr. 694-96, 716,
718-20, 1025-26. Mr. Finer did so, and Mr. Jett told him he had
three roughly equal sources of profit: trading with customers and
profiting on the bid/offer spread; arbitrage between STRIPS and
bonds; and basis and yield curve trades. Tr. 695-96. Mr. Finer
reported Mr. Jett’s response to Mr. Cerullo. Tr. 718-20. This
response did not identify forward recons with the Fed as the source
of his profits. Mr. Finer’s inquiry did not advance Kidder’s
knowledge of Mr. Jett’s strategy or his booking unrealized profits.
6. The Balance Sheet Reduction Program
From September 1993 through March 1994, FI made a substantial effort
to reduce its assets on Kidder’s balance sheet. Tr. 713-14, 1326-27;
Resp. Exs. 128-39. The purpose of Kidder’s "window dressing" was to
meet quarterly balance sheet targets for total assets -- $80 billion
in September 1993, and to improve Kidder’s financial statements in
connection with negotiations in 1994 with the Union Bank of
Switzerland for a line of credit. Tr. 1061-63, 1068-76, 1096-98,
1730-31; Div. Ex. 96; Div. Ex. 96A at 17-18; Resp. Ex. 128 at Bates
42016; Resp. Ex. 218 at 2-3; Resp. Ex. 218A. The Respondent argues
that his forward activity was part of the window dressing and had
Kidder’s approval until it secured the line of credit. He also
argues that Kidder’s reaction to balance sheet spikes that he caused
during this period showed that it was aware of his forward recon
Mr. Jett’s involvement in the program started in September 1993 when
Mr. Cerullo’s plan to reduce FI assets included reducing STRIPS by
$5.3 billion. Tr. 1680, 2960; Resp. Ex. 129 at Bates 42116. The
reductions were to be achieved by moving assets off the balance
sheet by such means as trades for forward settlement and reducing
outstanding repos. Tr. 713, 1075-76; Resp. Ex. 129 at Bates 42116.
Mr. Bernstein was responsible for coordinating the balance sheet
reduction efforts and was the liaison between Mr. Cerullo and FI
traders. Tr. 713-14, 1646-49, 1668. He directed Mr. Jett to focus on
settlement date inventory in order to achieve targets set for the
third and fourth quarters of 1993, and in the first quarter of 1994.
Tr. 1326-27, 1646-49, 1680-83, 1691-95, 2498-2500, 2961.
For balance sheet purposes, the assets captured as of the reporting
date included settled transactions and pending regular way
transactions. Resp. Exs. 215, 215A, 216, 216A. A transaction
originally entered as a forward transaction remained forward
throughout its life, including during the day before settlement
date. Resp. Ex. 216 at 4; Resp. Ex. 216A.
a. Pair-Off Roll-Forwards -- Spikes
During the balance sheet reduction efforts, Mr. Jett engaged in
"pair-off roll-forwards," which occurred when:
1) an existing exchange, such as a STRIP, was negated by inputting
an equal and opposite exchange, such as a recon, to settle for the
same amount on the same date; or, similarly, a settled position,
such as a long settled STRIPS position, was exchanged for the
opposite position, such as a long settled bond position
2) the position was re-established to settle after the quarter end
so that it did not appear as an asset on the quarterly balance sheet
Tr. 1328-29, 1677-79, 2961-62. Spikes, or sudden increases, in the
firm’s balance sheet were caused when the pair-off transaction was
regular way, so that it appeared on the balance sheet, while the
equal and opposite forward transactions did not. Tr. 1678-79; Resp.
Exs. 215, 215A, 216, 216A. Mr. Bernstein and the accounting
department observed spikes in December 1993. Tr. 1677-80. He
discussed the spikes with Mr. Cerullo in December or January. Tr.
1110-13, 1678. Since a spike would be caused by pairing any regular
way and non-regular way transactions, the existence of spikes in
themselves did not reveal anything new about the source of the
Respondent’s profits, although they focused attention on him.
According to the Respondent, Mr. Bernstein told him to engage in
pair-off roll-forwards beginning in September 1993, when he had
trouble meeting the balance sheet target set for him. 36 Tr.
2961-62. Mr. Bernstein claims not to have known of the practice
until he and the accounting department investigated the source of
spikes in the balance sheet beginning in December 1993. Tr. 1332-33,
1677-82, 1692-93. Whoever originated the pair-off roll-forward idea,
Mr. Bernstein was clearly familiar with the practice throughout the
fourth quarter of 1993 and encouraged its use during the balance
sheet reduction effort. Tr. 1329; Resp. Exs. 215-18A. Mr. Cerullo
knew that the Respondent was using forward trades, but not that they
were exchanges with the Fed. Tr. 1075-76, 1644-45, 1769.
b. Inventory Committee
Mr. Cerullo and Kidder’s CFO, Richard O’Donnell, were on an
Inventory Committee which met weekly to monitor Kidder’s balance
sheet asset reduction. Tr. 1064-76; Resp. Exs. 128-29, 131-37, 139.
Mr. Bernstein sometimes briefed Mr. Cerullo prior to the meetings,
particularly towards the ends of the quarters. Tr. 1676-77.
Participants received information packages that were an inch or two
thick in advance of the meetings. Tr. 1066-67. Resp. Exs. 128-29,
131-37, and 139 are excerpts of a few pages from the packages. Tr.
1066-67, 1070-73, 1095. Starting January 17, 1994, notations in the
packages referred to multibillion dollar "Disallowance of ‘non
regular way’ sales (strips)." Resp. Exs. 133-36. Mr. Cerullo did not
know that this referred to forward exchanges with the Fed. Tr.
c. Forward Recons Continue
The Respondent complained about the balance sheet reduction effort
but was required to continue through March 1994. Tr. 2982-84; Resp.
Exs. 216-18A. He conceded that he entered a 90 day forward recon of
relatively small size, avowedly to offset loss which he sustained to
assist the firm’s window dressing. 37 Div. Ex. 96; Div. Ex. 96A at
18-19; Div. Ex. 100 at 8. The record, however, shows a large volume
of forward recons during the balance sheet reduction period between
September 1993 and March 1994 that is consistent with a continuation
of a strategy of booking profits from such exchanges and with the
necessity of an ever increasing volume to maintain the pyramid
effect of the strategy. See Div. Ex. 152; Resp. Exs. 102A, 102B.
Between September 1993 and March 1994 the Respondent had a pattern
of entering long-dated recons, for example, for 90 days, and
successive short-dated STRIPS, for example, for seven days at a
time, in equal amounts of the same bond. Tr. 2095-97, 2100-01; Div.
Exs. 153-54. Because reverse positions were entered, trade date
inventory would appear flat, but the remaining days, for example, 83
days, of accrued interest after the STRIP settled would be captured
on the books and records of the firm. Tr. 2095-97, 2100-01; Div. Exs.
153-54. After September 1993, the volume of the Respondent’s
exchanges increased greatly and 97% were paired off. Tr. 2105-08,
2112; Div. Ex. 153 at 34, H.
During the period of the balance sheet reduction Mr. Cerullo knew
that Mr. Jett was engaging in a large volume of forward settling
trades, and Mr. Bernstein knew that he had a high volume of forward
exchanges. Kidder’s understanding that Mr. Jett’s profits were
unrealized and based on forward exchanges was not, however,
7. The Diary
The record contains two versions of a computerized diary Mr. Jett
kept while employed at Kidder: the Jett version, Resp. Ex. 900, and
the Kidder version, Div. Ex. 161. The Jett version was kept by him
on his personal computer (PC); the Kidder version was an abbreviated
version, kept on Kidder’s computer, that he uploaded to his
secretary. Tr. 585-609, 2860-2901, 2988-89. He claimed that he
omitted from the upload entries containing personal information,
personnel matters or scandalous material. Tr. 595-96, 601-04,
2862-64, 2870-75. He had possession of his PC for a few weeks after
his discharge. Tr. 607, 2865-2868, 2891-92. Many entries which
support his testimony concerning various events and which are
contrary to other credible record evidence appear only in the Jett
version, yet pertain to business matters and do not fall within the
criteria for the material that he claimed was omitted from the
Kidder version. Tr. 2989-99; Div. Ex. 161; Resp. Ex. 900. While
notations in a diary would be expected to reflect the viewpoint of
the diarist, these facts indicate additional spin, whether the
entries were made contemporaneously with the events they purport to
describe or at a later time. Accordingly, no weight has been given
to such entries in the findings of fact insofar as they support the
Respondent’s version of disputed facts.
8. Transparency of Reporting
As discussed above, unusual facts amounting to red flags occurred in
1993. The Respondent’s high and ever increasing profits were widely
known, including by Mr. Cerullo. Additionally, the fact that he was
engaging in a high and ever increasing volume of forward exchanges
with the Fed was known outside the Zero Desk, including by Mr.
Bernstein. A general idea of this was easily accessible through the
Red Books. Detail concerning these matters could be researched
through reports generated and distributed by the firm, for example,
the Daily Transaction Journal, the KPPS-98 Report, and the trade
tickets. However, to discover the effect of the Respondent’s
activity required more than a cursory glance at the reports.
Tandem’s Daily Transaction Journal (DTJ) recorded every transaction
by ledger and CUSIP number. Tr. 1831, 1885-86, 1892-94; Div. Exs.
1D-8D, 9E-17E, 18F-22F, 130. It was distributed on the trading floor
daily and made available to Mr. Mullin and Mr. Cerullo. Tr. 779,
876-77, 1055. It showed trade date and settlement date, identified
STRIP and recon account transactions by the offset account number,
and showed beginning quantity and ending quantity by CUSIP. Tr. 777,
1886, 1890-93, 2283. While it is possible to calculate the profit
from a forward recon from the DTJ, the necessary analysis of the
report and calculations are cumbersome. Tr. 1893-94. The component
purchase and sale for each recon is recorded and posted separately
by CUSIP, and thus in as many as 62 sections of the DTJ (i.e., for
the recon of a recently issued 30 year bond, the buy of the bond and
the sale of 60 TINTS and the principal piece). Tr. 1883-84, 1888-92;
Div. Ex. 130. Thus, calculating profit requires identification of up
to 62 entries followed by multi-step calculations for each. Tr.
By September 1993 the KPPS-98 (Version 1) report was in existence;
it listed the forward trades that were open on a given date at month
end, and was developed as a result of Mr. Fiumefreddo’s May 1993
project. Tr. 1723-25, 1900-01, 1970-71. It did not give P&L
information. Tr. 1900-01, 1970-71. It listed every transaction by
CUSIP, that is up to 62 entries for one forward recon. Tr. 1334-35.
What is referred to as KPPS-98 Version 2 calculated unrealized P&L
for each CUSIP. Tr. 1970-71. Version 2 was used by GE CAS after Mr.
Jett was fired. Tr. 1970-71, 2043, 2051; Div. Exs. 1B-17B, 18C-22C.
It was not in use during Mr. Jett’s employment; Mr. Bernstein used
the original version in March 1994. Tr. 1334-38. Thus the KPPS-98
available during Mr. Jett’s employment did indicate a large volume
of forward exchanges to the reader, but would in itself be only a
step in research into uncovering unrealized profits.
The trade tickets, from which information was transferred to Tandem,
listed trade date, settlement date, and STRIP or recon account
number. Tr. 329-31, 828, 862, 958, 1831, 1881-84, 2490. For a recon
they reflected the purchase of a bond and the sale of STRIPS, and
priced the STRIPS at forward settlement date. Tr. 1883-85; Div. Ex.
135; Div. Ex. 153 at 7-8, 11-12. However, like the Red Books, the
trade tickets did show a large volume of exchanges with the Fed with
unusual settlement dates. Mr. Mullin did not review trade tickets,
nor did Mr. Cerullo. Tr. 861-62, 955-59.
Other available reports included the:
Profit and Position Report No. 2, which showed settled and unsettled
positions, including STRIPS and recons, but from which forward STRIP
and recon P&L could not be identified. Tr. 385-90, 1894-95.
Fixed Income Daily Report, which showed profitability, gross
positions, and consumption of financial resources, but did not
identify individual transactions, or forward recons with the Fed as
the profit source. Tr. 845-46, 923.
FI-12, which was a daily trade date inventory report by ledger, but
did not reflect which trade date positions were from forward STRIPS
or recons. Tr. 343-44, 375-81, 1896-98.
FI-10, which reported settled positions by CUSIP, and thus did not
reflect forward STRIPS and recons. Tr. 343, 379-80, 1897-99.
The data residing on the IBM could be sorted and retrieved in
various ways. Tr. 338-42, 1896. For example, the pending file saved
records of trades that were unsettled as of the month-end. Tr. 342,
FISEQ (also referred to as FI SEEK), an IBM file, which was a
month-end listing of transactions not canceled prior to settlement.
Tr. 401, 1901; Div. Ex. 153 at 16 n.14 & 20 n.20.
FI STAT, which broke down FI SEQ information by settlement date
within each CUSIP. Tr. 344-45, 1901; Div. Ex. 153 at 10.
Inventory Control/Haircut Estimate Report, Risk Management Report,
Government Daily P&L/Inventory Report, Balance Sheet Assets which,
in addition to the Fixed Income Daily, recorded inventory,
profitability, trading limits, risk exposure, and asset consumption.
Tr. 705-09, 829-30, 923, 985, 1033-35, 1043, 1046-47.
BONY Clearance Report, which contained information given to Kidder
by BONY regarding their clearing of trades, which was organized by
CUSIP, and which identified only settled STRIPS and recons. Tr.
See generally Div. Exs. 1-37. Given the lack of results from the May
1993 inquiry, which focused on the P&L effect of forward
transactions and on the fact that the Respondent’s forwards were
exchanges with the Fed, it is not clear that reviewing the DTJ,
trade tickets, or the KPPS-98 would have caused a speedier unmasking
of the problem.
E. The Beginning of the End
Mr. Jett’s reported profits for 1993 were over $150 million, and he
was awarded a bonus of $9.3 million and the Man of the Year Award.
Tr. 493-94, 923-24; Div. Ex. 118. On January 8, 1994, Mr. Jett gave
an acceptance speech about his trading philosophy to Kidder’s
Management Council at a conference in Florida. Tr. 2984-85; Div. Ex.
118. He reviewed the speech in advance with Mr. Cerullo, who warned
him against discussing municipal defeasances 38 (which Mr. Jett has
analogized to forward recons in arguing that it is appropriate to
book the profit from a transaction in advance of settlement date).
Tr. 924, 971-72, 2984-85. The speech focused on the idea that he had
broadened Kidder’s market share by expanding its customer base, a
factor which was not related to his exchanges with the Fed. Div. Ex.
In late February, Mr. Cerullo again asked Mr. Bernstein to
investigate the source and risk of Mr. Jett’s ever-increasing
profits. Tr. 926. Mr. Bernstein finally did a thorough
investigation, and by the end of March understood the size, nature,
and negative P&L consequences of the Respondent’s forward recons,
and told Mr. Cerullo. Tr. 924-29, 1328, 1333-78; Div. Exs. 80, 81,
83, 93, 94. He quantified unrealized profit associated with Mr.
Jett’s forward positions as exceeding $300 million. Tr. 1358-59. Mr.
Cerullo notified Michael Carpenter, the CEO of the firm, who engaged
substantial accounting and other staff to investigate the
Respondent’s trading. Tr. 928-30.
In late March, Mr. Cerullo questioned Mr. Jett who offered a series
of explanations regarding the alleged false profits, including that:
1) he rolled trades forward because the back office was unable to
keep up with his volume of business;
2) Mr. Bernstein told him to do this to reduce the balance sheet;
3) because of the balance sheet reduction effort he lost money and
recouped profits by entering forward recons with the Fed.
Mr. Cerullo concluded that Mr. Jett’s entire trading performance was
an accounting illusion with no economic substance. Tr. 934, 938-89.
He directed Mr. Jett to settle or pair-off his forward positions.
Tr. 930-31, 935-36. When Mr. Jett agreed to comply but did not, Mr.
Cerullo directed Mr. Bernstein and Mr. Finer to eliminate the
positions. Tr. 935-36. The total loss recorded in the trading ledger
was over $300 million. Tr. 936.
Similarly conflicting explanations were given in the next several
On April 1, 1994, CFO Richard O’Donnell questioned Mr. Jett about
his strategy; Mr. Jett referenced the hedging component of his
strategy; he stated that at the time of the May 1993 discussions
with Mr. Bernstein he was entering two week forward recons to allow
time to collect the pieces; he correctly noted that there was no
danger of the firm having to make a huge cash payment to the Fed
when his positions were collapsed, while sidestepping the question
of Kidder’s having to take a write-off. Tr. 1589-91; Div. Exs. 96,
96A. He drafted three memos on April 11 explaining his arbitrage
strategy (which he now claims was only in effect from late 1992 to
October 1993) and downplaying any P&L effects. Tr. 530-32; Div. Ex.
On April 14, Mr. Jett met with Mr. O’Donnell, Mr. Cerullo and
others. Div. Ex. 100. Again he blamed the window dressing effort,
stating that the problem arose when settled STRIPS positions were
turned into forward STRIPS. Div. Ex. 100 at 2, 8-11. He stated that
he felt he should not be penalized for the negative P&L effect of
the window dressing, implying that he knowingly entered forward
recons to counteract that effect. Div. Ex. 100 at 12. He referenced
the May 1993 meetings and Mr. Bernstein’s alleged approval of
forward recons up to 90 days forward. Div. Ex. 100 at 5-6. He stated
that the reason for the pair-offs was that his volume overwhelmed
the back office in the September and December quarter end months.
Div. Ex. 100 at 9. He conceded that the only opportunity for profit
in his strategy is from positive carry derived from the hedge
component. Div. Ex. 100 at 10-11. This, however, could not account
for the huge profits that were booked. Div. Ex. 119 at 10-34. He
also implied that his exchanges with the Fed were in furtherance of
customer trades. Div. Ex. 100 at 11-12.
On April 15, members of the GE CAS were asked to analyze the
situation. Tr. 1824-30. GE retained Davis, Polk as outside counsel.
Tr. 1828. On April 17, the Respondent was fired and his account at
Kidder was frozen. Tr. 939; Arbitration Between Joseph Jett and
Kidder, Peabody & Co., Final Award, Case No. 94-01696 at 2, 6 (NASD
Regulation, Inc., Jan. 28, 1998).
While Mr. Jett admitted that he knew that the profits which
initially appeared at trade date rolled off each day and were
ephemeral, Tr. 532, 541; Div. Ex. 78, he maintains that he never
committed fraud or tried to hide anything from Kidder staff, Tr.
2985-86, and that he did nothing wrong given the information which
was provided to him. Tr. 580-82. He wants to trade government
securities again, but will not engage in forward reconstitutions.
F. Jett’s State of Mind
1. What Jett knew
Mr. Jett was aware of the P&L effect of forward recon and STRIP
instructions entered on GT. Tr. 532, 541-42, 545-47, 933-34, 938-39;
Div. Ex. 78; Div. Exs. 96, 96A; Div. Ex. 100 at 8, 12. He knew the
P&L was reflected on Kidder’s books and records. Tr. 533-34.
Further, despite extensive, rather convoluted testimony at the
hearing and discussion in phone conversations and meetings with
Kidder staff concerning the "time value of money" and "hedging," Tr.
517-47, 563-64, 575-80, 2903-05, 2909-10, 2917-18, 2958-60; Div. Exs.
90-100, he knew that the only real profit opportunity derived from
financing and interest, and, therefore, was rather small. Tr.
530-32, 545-47, 2909-10, 2915-17, 2923-28, 3013-15; Div. Exs. 78,
96, 96A, 100. He knew he was credited by Kidder with high profits;
it was easy to check the P&L effect of an individual instruction on
GT and keep track of his P&L during the day. Tr. 540-42, 1875-76,
2999-3000, 3016; Div. Exs. 92, 92A. The high bonuses and Man of the
Year Award confirmed that Kidder credited him with high profits.
Mr. Jett entered many thousands of trades into the G-1 ledger
personally, and instructed subordinates to do so when he was away.
Tr. 534-36, 582, 988-89, 1476, 3001-05; Div. Exs. 92, 92A, 152. He
admits that he deliberately pursued profits booked through entering
forward recons. Tr. 533-42, 580-82. The increase of forward recon
profits over time, the use of higher coupon bonds for forward recons
than for customer trades, and pyramiding corroborate this. Tr.
1971-73, 2095-2101, 2112-21, 2143-50; Div. Exs. 119, 121, 122, 124,
152, 154; Div. Ex. 153 at 31-32, D, F, G, H. There is no evidence to
suggest that the high volume of exchanges with the Fed was in
furtherance of customer trades. There was only a small percentage of
customer trades, especially as time went on. Tr. 2101-04; Div. Ex.
153 at J.
Mr. Jett acknowledged that he knew the P&L effect of entering
forward recons by November 1992, when he "became aware of the fact
that the forward reconstitutions had a time value of money embedded
in them." Tr. 538-39. This roundabout acknowledgment was borne out
by his activity in 1993 when he was no longer constrained to
corporate settlement. Tr. 536-39, 889; Div. Ex. 152. His discussions
with Kidder staff in May 1993 and in 1994 as the profit scheme
unfolded also show that he knew the P&L effect throughout 1993. The
evidence also shows that he knew during 1992, when he was limited to
entering forward recons to five business days forward. Tr. 1971-74,
2092-94, 2101-03; Div. Exs. 121, 122, 152; Div. Ex. 153 at 29-30,
35-36, C, J.
The Respondent argues that Kidder knew and approved of his strategy,
then discarded him after his usefulness in obtaining bank financing
ended, changed its accounting theories, and pilloried him for the
resulting charge against earnings.
2. What Kidder knew
I find that Kidder management did not affirmatively approve the
forward recon scheme and the associated unrealized profits. Nor did
it know that Mr. Jett was booking unrealized profits through
exchanges with the Fed that were recorded by exploiting an anomaly
Some factors to which the Respondent points were irrelevant to
Kidder’s knowledge of his strategy or his booking unrealized
profits: the 1993 Fed inquiry, Coopers & Lybrand audit, and Legal
Department report; the 1993 audit by Kidder’s Internal Audit
Department; and the 1993 risk inquiry by Barry Finer.
Additional factors which the Respondent argues show Kidder knew and
approved require closer evaluation. The secondary market for U.S.
Treasury securities is the most liquid and actively traded financial
market in the world. Only limited profits can be made from trading
U.S. Treasury bonds and STRIPS. Yet Kidder knew that Mr. Jett was
posting enormous, record-breaking profits, purportedly from such
trading. Further, Mr. Jett exploited an opportunity created by the
operations of Kidder’s GT; he did not enter false marks into GT. The
Red Books were out in the open and available and contained an easily
understandable record of a sizable number of large and unusual
recons -- dated weeks forward. Mr. Jett’s volume of forward
exchanges with the Fed was less widely known than his reported
profits, but still well known outside the Zero Desk, including by
Bernstein, Rizzi and Finkelstein as of May 1993. Mr. Cerullo knew he
had forward settling trades of some kind. Mr. Jett’s managers had a
financial interest in his high profits. Mr. Cerullo’s compensation
was largely based on performance. Tr. 1115-16. Kidder’s negotiations
with the Union Bank of Switzerland during 1994 heightened the
importance of high profits and attractive financial statements.
It is doubtful that Kidder would have knowingly allowed hundreds of
millions of dollars in unrealized profits to build up and continue
to grow over time until, inevitably, they were revealed, with
predictably negative consequences for those involved. Yet,
superficially these factors by themselves could suggest that Kidder
management approved or at least knew that Mr. Jett was booking
unrealized profits through forward recons. A closer look shows the
contrary. The evidence shows only that Kidder failed to follow up on
questions that were raised.
The only record or report that disclosed the existence of the
forward exchanges at a glance were the Red Books, informal records
kept in 1993 and 1994 calendar notebooks at the Repo Desk. The Red
Books did not show P&L. Mr. Mullin and Mr. Cerullo did not know
about the Red Books.
When Mr. Mullin supervised the Respondent, his profits were not out
of line with his expected performance. When Mr. Cerullo supervised
the Respondent, his profits attracted notice. During this period a
glance at the Red Books showed a large number of exchanges with the
Fed with unusual settlement dates weeks forward. However, Mr.
Cerullo did not know about the Red Books. His assistant Mr.
Bernstein learned about the forward exchanges and actually inquired
into their P&L impact in May 1993. He failed to ask the right
questions, and the Respondent did not disabuse him of his
understanding that the forward exchanges were P&L neutral.
Thereafter, neither Mr. Bernstein nor anyone else inquired into the
P&L impact of the forward exchanges until 1994. During the balance
sheet reduction program, from September 1993 to the end of the
Respondent’s employment, Mr. Cerullo knew he was engaging in forward
transactions, and Mr. Bernstein knew he was engaging in massive
forward exchanges with the Fed. However, he continued to rely on his
May 1993 understanding that they were P&L neutral, and neither he,
nor anyone else, inquired into their P&L impact until late February
Kidder deployed substantial resources in discovering and
investigating the profits when it finally discovered the problem.
Tr. 1333-78; 1815-2428; Div. Exs. 1-37, 58-73. The magnitude of
these efforts is consistent with the finding that Kidder did not
previously approve or know of the forward recon scheme.
The Respondent, who is black, alluded obliquely to problematic race
relations at Kidder, but did not otherwise make any allegations or
arguments related to this. Tr. 472, 487, 496, 603, 2881-82; Div. Ex.
118. Nonetheless, because Wall Street has been described as lacking
diversity, 39 I examined the record for, and did not find, evidence
of discriminatory treatment in the firm’s dealings with him that
would bear on its approval or knowledge of the forward recon
3. Jett knew Kidder did not know
Mr. Jett knew that Kidder had not approved and did not know the
source of his profits. He knew that Mr. Bernstein was persuaded in
the May 1993 inquiry that unrealized profits were not being booked.
The issue of unrealized profits did not come up again until 1994.
His explanations to Mr. Cerullo, Mr. O’Donnell and others in March
and April 1994 were evasive and conflicting, and he ultimately
admitted that the only real source of profit was positive carry on a
long position in STRIPS, the so-called hedge. This also shows that
he knew previously that management did not approve or understand his
G. Missing Witnesses
The Respondent argues that an adverse inference should be drawn from
the fact that the Division did not call what he denominates critical
witnesses, Kidder employees Benatar, Fiumefreddo, Ossman,
McLaughlin, Unger, and Chersi. He describes Messrs. Benatar and
Fiumefreddo as particularly important, stating that the former
designed GT, the latter personally investigated the forward recons
for P&L distortion, and both were in discussions with Mr. Bernstein
in which Mr. Benatar confirmed that Mr. Jett’s explanation of how GT
recorded profits on forward recons was accurate. Mr. Jett claims
that they were unavailable to him as witnesses because the Division
had a close relationship with Kidder, and because Kidder caused its
employees to refuse to speak with his counsel. He states that they
were "peculiarly available" to the Division because of this and that
the Division interviewed each one and deposed each one except
Messrs. Benatar and Chersi. Additionally, he asserts that Kidder
enforced a directive of cooperation with the Division and
noncooperation with him by paying legal fees associated with the
Jett matter for its employees except him. In support of this
argument the Respondent cites a number of cases discussing the
"missing witness" jury instruction.
I have not drawn any inference adverse to the Division’s case, or to
the Respondent’s, from the absence of the named witnesses.
Additionally, as a matter of law, they were not unavailable to the
Respondent as witnesses. United States v. Torres, 845 F.2d 1165,
1170 (2d Cir. 1988). He could have subpoenaed them pursuant to Rule
232 of the Commission’s Rules of Practice, 17 C.F.R. § 201.232.
Their investigative testimony and Commission interview notes were
available to him long in advance of the hearing (unlike the
situation in federal criminal cases 40 such as Torres), and he also
obtained notes of interviews of Kidder employees conducted by the
Davis, Polk law firm in its investigation of the Jett matter. See In
re Kidder Peabody Securities Litigation, 168 F.R.D. 459 (S.D.N.Y.
1996). 41 Thus the possibility of surprise in their testimony would
have been minimal. Further, when a party calls a hostile witness or
a witness identified with an adverse party, interrogation may be by
leading questions. Cf. Federal Rules of Evidence, Rule 611(c); 1
Charles T. McCormick, McCormick on Evidence § 6 (John W. Strong ed.,
4th ed. 1992).
H. Harm Caused
1. Bonuses of Jett, Cerullo and Mullin
As shown previously, Respondent Jett received larger bonuses from
Kidder as his reported profits increased. After a $5,000 bonus in
1991, he was awarded $2.1 million in 1992, and $9.3 million in 1993.
There was a deferred component to Kidder’s bonuses. Tr. 1122-24,
1133; Resp. Ex. 127. Kidder did not, and will not in the future, pay
Mr. Jett the deferred portions of the bonuses; it paid to him
directly, or on his behalf as tax withholding, $1.54 million of the
1992 bonus and $6.67 million of the 1993 bonus. Arbitration Between
Joseph Jett and Kidder, Peabody & Co., Inc., Final Award, Case No.
94-01696, at 4, 6 (NASD Regulation, Inc., Jan. 28, 1998). Of these
sums, it paid him directly $950,000 in 1992 and $4.6 million in
1993. Tr. 500.
Mr. Jett’s supervisors also received bonuses based in part on his
performance. Mr. Mullin’s 1992 bonus was based in part on his
profitability. Tr. 888-89. Mr. Cerullo’s bonuses were $11.4 million
in 1992 and $15.4 million in 1993. Tr. 1115-16; Resp. Ex. 127; cf.
Tr. 1135-36, 1153. However, when he resigned from Kidder, his
severance payment of deferred compensation was reduced to offset any
compensation based on Mr. Jett’s activity that he had previously
been awarded. Tr. 1118, 1141, 1151, 1154.
2. Damage to Kidder’s Reputation -- $210 Million Charge
As a result of the Respondent’s activities Kidder took a $210
million charge ($350 million before taxes) for the first quarter of
1994 to correct the erroneous accounting of the forward recon
scheme. Tr. 1972-74, 2262, 2412-16; Div. Exs. 50 at B01, B03; Div.
Exs. 121, 122. The charge and the events leading up to it were
widely reported in the financial press as a "bond trading scandal."
III. Conclusions of Law
In this section it is concluded that Mr. Jett did not violate the
antifraud provisions, Section 17(a) of the Securities Act and
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, but did
aid and abet and cause Kidder’s books and records violations. He
acted with scienter and made material misrepresentations, but his
activities were not "in the offer or sale of any securities" or "in
connection with the purchase or sale of any security" within the
meaning of the antifraud provisions. He aided and abetted and caused
Kidder’s books and records violations in that its ledgers and FOCUS
Reports reflected his nonexistent profits.
A. Antifraud Provisions
The OIP charged Mr. Jett with violating Section 17(a) of the
Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5
thereunder, commonly referred to as the antifraud provisions.
Sections 17(a)(1) and (2) of the Securities Act make it unlawful "in
the offer or sale of" securities, by jurisdictional means, to:
1) employ any device, scheme, or artifice to defraud, or
2) obtain money or property by means of any untrue statement of a
material fact or any omission to state a material fact necessary to
make the statement made not misleading. 43
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder
proscribe similar practices "in connection with" the purchase or
sale of securities.
Scienter is required to establish violations of Section 17(a)(1) of
the Securities Act and Section 10(b) of the Exchange Act and Rule
10b-5 thereunder; it is "a mental state embracing intent to deceive,
manipulate, or defraud." See Aaron v. SEC, 446 U.S. 680, 686 & n.5,
695-97 (1980); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185,
194 n.12 (1976). 44
Recklessness can satisfy the scienter requirement under Securities
Act Section 17(a)(1) and Exchange Act Section 10(b) and Rule 10b-5
thereunder. David Disner, 63 SEC Docket 2246, 2254 & n.20 (Feb. 4,
1997); SEC v. Steadman, 967 F.2d 636, 641-42 (D.C. Cir. 1992);
Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir.
1990), cert. denied, 499 U.S. 976 (1991). Reckless conduct is
conduct which is "‘highly unreasonable’ and which represents ‘an
extreme departure from the standards of ordinary care . . . to the
extent that the danger was either known to the defendant or so
obvious that the defendant must have been aware of it.’" Rolf v.
Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir.), cert.
denied, 439 U.S. 1039 (1978) (quoting Sanders v. John Nuveen & Co.,
554 F.2d 790, 793 (7th Cir. 1977)).
The record shows the Respondent’s scienter; his intent was to
deceive and defraud. He entered a series of forward recons in a
pyramid like manner, in order to book profits which were in fact
nonexistent and receive large bonuses based on the profits. He
engaged in this activity for more than two years, until he was
fired. To enter a forward recon and check the resulting status of
his P&L for the day took only a few seconds. He knew that the P&L
effect of his forward recons was unrealized and required adjustment.
When questioned by Kidder management and accountants during his
employment at Kidder, he did not fully disclose the details of his
strategy and misled them as to the P&L consequences. He knew that
Kidder did not understand the source of his profits. When the fraud
was finally discovered, he denied wrongdoing and gave misleading and
conflicting explanations. Only at the very end of his employment at
Kidder did he concede that the only profit opportunity in his
purported strategy was from positive carry in owning STRIPS and thus
minuscule in comparison with the profits which he had booked.
The Respondent could not have believed that his profits were
anything but nonexistent. He completed the M.B.A. program at Harvard
University and worked in mortgage-backed securities for three years
before coming to Kidder. His Man of the Year Award speech shows
clearly that he understood the dynamics of the Government market and
that such high profits are unheard of in STRIPS and bond trading.
Any bond trader would have understood that a low risk high profit
opportunity does not persist and that his purported three part
strategy has costs which minimize profits.
In conclusion, the Respondent acted with scienter; his intent was to
deceive and defraud. His large bonuses, which provide a motive, and
his misleading Kidder staff seeking to investigate his profitability
support this conclusion.
In the alternative, the Respondent was reckless in not knowing that
his strategy was a "device, scheme, or artifice to defraud."
Assuming arguendo that he did not intend to defraud Kidder, the
unreal size of his profits was so obvious that he must have been
aware that his strategy was questionable. Thus, he was reckless in
relying on Kidder’s failing to stop him or to conduct a meaningful
investigation into the source of his profits.
2. Material Misrepresentations
The record also shows material misrepresentations within the meaning
of Securities Act Section 17(a)(2) and Exchange Act Section 10(b)
and Rule 10b-5(2) thereunder. For the reasons stated above these
were made with scienter.
Kidder’s financial statements included nonexistent, unrealized
profits resulting from the Respondent’s forward recons. The record
shows that these inaccuracies resulted from the intentional acts of
the Respondent in entering a series of forward recons so as to book
large profits and receive large bonuses as a result. Accordingly,
his actions implementing the recon strategy were misrepresentations
within the meaning of Securities Act Section 17(a)(2) and Exchange
Act Section 10(b) and Rule 10b-5(2) thereunder.
The Respondent did not disclose his false profit strategy to Kidder
management and accountants when asked. He did not fully disclose the
details of his strategy, and misled them as to the P&L consequences.
These dealings with Kidder staff also constituted intentional
misstatements and omissions within the meaning of Securities Act
Section 17(a)(2) and Exchange Act Rule 10b-5(2).
The standard of materiality is whether or not a reasonable investor
or prospective investor would have considered the information
important in deciding whether or not to invest in Kidder. See SEC v.
Steadman, 967 F.2d at 643; see also Basic Inc. v. Levinson, 485 U.S.
224, 231-32, 240 (1988); TSC Industries, Inc. v. Northway, Inc., 426
U.S. 438, 449 (1976).
The reasonable investor would consider a $300 million inaccuracy in
a broker-dealer’s financial statements to be material, whether he
were a potential investor in the broker-dealer or a customer making
investments through the broker-dealer and relying on the accuracy of
its accounting in handling his account. Accordingly, the
Respondent’s misrepresentations in implementing the forward recon
strategy and in his dealings with Kidder’s questions about it were
3. "In Connection With"
The Respondent’s fraudulent activities were not "in the offer or
sale of any securities" or "in connection with the purchase or sale
of any security" within the meaning of the antifraud provisions. 45
The actions of an employee of a broker-dealer are not "in connection
with the purchase or sale of any security" merely because he
defrauded his employer.
While the antifraud provisions are most often applied in cases of
fraud against the investing public, they can also apply to fraud
against broker-dealers. U.S. v. Naftalin, 441 U.S. 768, 774-77
(1979) (Section 17(a)); A. T. Brod & Co. v. Perlow, 375 F.2d 393,
396-97 (2d Cir. 1967) (Section 10(b) and Rule 10b-5). In those cases
customers defrauded broker-dealers with "heads I win, tails you
lose" schemes. 46 There is not, however, any precedent case that
held fraudulent practices by an employee against his broker-dealer
employer, in itself and not otherwise "in connection with the
purchase or sale of any security," to violate the antifraud
The Division argues that the Respondent’s activities were in
connection with the purchase or sale of securities. Its argument
rests on broad, general, statements made in cases in which courts
concluded fraud was "in connection with" specific purchases and
sales of securities. It cites the well-known "touching" language
from Superintendent of Insurance of New York v. Bankers Life &
Casualty Co., 404 U.S. 6 (1971): "The crux of the present case is
that (the fraud victim) suffered an injury as a result of deceptive
practices touching its sale of securities as an investor." Id. at
12-13. 47 In that case the seller of securities was duped into
thinking it would receive the proceeds of its sale but was deprived
of the proceeds by a deceptive device. The Division further cites
United States v. Newman to argue that the "in connection with"
requirement is satisfied where accomplishment of a fraudulent scheme
is "‘directly related to the trading process.’" United States v.
Newman, 664 F.2d 12, 18 (2d Cir. 1981) (quoting Competitive
Associates, Inc. v. Laventhol, Krekstein, Horwath & Horwath, 516
F.2d 811, 815 (2d Cir. 1975)). In the Newman case the court ruled
favorably on the misappropriation theory of insider trading; the
defendant had traded based on material, non-public information
obtained by other individuals who misappropriated confidential
information from their investment banker employers concerning
planned mergers and acquisitions.
In opposition the Respondent cites the leading case of Chemical Bank
v. Arthur Andersen & Co., 726 F.2d 930 (2d Cir. 1984), cert. denied,
469 U.S. 884 (1984) and other cases from courts within the Second
Circuit. 48 In Chemical Bank the court held that misrepresentations
concerning the financial condition of a borrower were not made "in
connection with" by the fact that stock, concerning which there was
no misrepresentation, was pledged as security for the loan. The
opinion by Judge Friendly examined "in connection with" at some
length. Chemical Bank, 726 F.2d at 939-45. The court opined that
"touching" was merely a variation of "in connection with" as a
matter of literary style and urged that cases near the borderline be
decided on a cautious case-by-case approach. Id. at 942-43.
b. Exchanges Were Not Purchases or Sales
In the cited cases, purchases or sales occurred. The issue was the
connection of the fraud to the transactions. In the instant case
there were no purchases or sales. Kidder’s internal recordkeeping
created the opportunity for nonexistent profits by treating STRIP
and recon exchanges with the Fed as a buy of one side of the
exchange and a sell of the other. The exchanges were not, however,
purchases and sales within the meaning of the antifraud provisions.
A STRIP or recon exchange is not a "disposition of a security or
interest in a security" within the meaning of the Securities Act and
Exchange Act. See Section 2(a)(3) of the Securities Act and Section
3(a)(13) and (14) of the Exchange Act. As to those exchanges that
were "settled," the record establishes that the Fed’s role was
essentially clerical in converting securities from one form to
another and that the exchanges were economic nullities. 49 After
September 1993 almost none of the forward exchanges entered into GT
even "settled." They were paired off and existed only in Kidder’s
recordkeeping systems. Therefore the Respondent’s profits from
forward recons were not "in the offer or sale" or "in connection
with the purchase or sale" of securities within the meaning of the
c. "Directly related to the trading process"
The Division argues that the Respondent’s fraud was "directly
related" to his real trading of STRIPS and bonds, referencing the
phrase, quoted supra, from the (pre-Chemical Bank) Newman case. The
Division reasons that the forward recons covered up losses in real
trading and therefore were in connection with the real trading. 50
The profits from forward recons induced Kidder to continue allowing
the Respondent to buy and sell bonds; without them, the Division
implies, the Respondent would have been fired. The Division also
points out that, for a time, netting with real purchases of STRIPS
on the Respondent’s trade date inventory tended to mask his short
STRIPS position caused by the forward recons. Indeed, the Division
points out, the Respondent claimed (not altogether accurately) that
part of his strategy was to purchase STRIPS.
Factually, rather than showing the forward recons were "directly
related" to purchases and sales, the record shows a tenuous,
indirect, relationship. The enormous, record-breaking, profits
resulting from the forward recons dwarfed any losses from real
trading. If some indications of the Respondent’s activities were
masked by netting with real trading, other indications remained. The
Respondent could have ceased real trading altogether without
affecting his ability to create profits and obfuscate their source.
The forward recon scheme existed independently from real trading and
was not "in connection with" actual purchases and sales in which the
Legal analysis of the relationship of the Respondent’s forward recon
scheme to his actual trading of STRIPS and bonds is aided by Judge
Friendly’s oft-quoted language from Chemical Bank:
The purpose of § 10(b) and Rule 10b-5 is to protect persons who are
deceived in securities transactions -- to make sure that buyers of
securities get what they think they are getting and that sellers of
securities are not tricked into parting with something for a price
known to the buyer to be inadequate or for a consideration known to
the buyer not to be what it purports to be.
726 F.2d at 943. There is no evidence whatever to suggest that the
parties to the Respondent’s real trading were deceived in those
transactions by the Respondent’s forward recon scheme.
The Division’s quote of a general statement taken out of context
does not support a conclusion that the Respondent’s forward recon
activities were "in connection with." In the Newman case the
fraudulent scheme enabled Newman to profit from purchases and sales
of securities. It could also be said that Newman’s counterparties
were deceived as to the prices paid in the securities transactions.
In any event, subsequent to the Chemical Bank case, reliance on
"directly related to the trading process" as a standard is
ill-advised because of its breadth and generality. In the instant
case, the fraud was not directly related to purchases and sales; the
only relationship to purchases and sales is that Respondent was in a
position to engage in the fraud because he was employed to engage in
the purchase and sale of Treasury securities.
B. Books and Records Violations
The OIP charged Mr. Jett with aiding and abetting and causing
violations of Exchange Act Section 17(a) and Rules 17a-3(a)(1),
17a-3(a)(2), 17a-3(a)(7), and 17a-5 thereunder. Section 17(a)(1)
provides that brokers and dealers "shall make and keep for
prescribed periods such records, furnish such copies thereof, and
make and disseminate such reports as the Commission, by rule,
prescribes as necessary or appropriate in the public interest." The
requirement that records be kept embodies the requirement that they
be accurate. James F. Novak, 47 S.E.C. 892, 897 (1983).
The Commission has emphasized the importance of the records required
by the recordkeeping rules as "the basic source documents and
transaction records of a broker-dealer." Statement Regarding the
Maintenance of Current Books and Records by Brokers and Dealers,
Exchange Act Release No. 10756, 1974 SEC LEXIS 3290 (Apr. 26, 1974).
The recordkeeping rules are "a keystone of the surveillance of
brokers and dealers by our staff and by the security industry’s
self-regulatory bodies." Edward J. Mawod & Co., 46 S.E.C. 865, 873
n.39 (1977) (citations omitted), aff’d, 591 F.2d 588 (10th Cir.
1979). Scienter is not required to prove a violation of Section
17(a)(1) of the Exchange Act and the rules thereunder. SEC v. Drexel
Burnham Lambert Inc., 837 F. Supp. 587, 610 (S.D.N.Y. 1993), aff’d
sub nom. SEC v. Posner, 16 F.3d 520 (2d Cir. 1994), cert. denied,
513 U.S. 1077 (1995); Stead v. SEC, 444 F.2d 713, 716-17 (10th Cir.
1971), cert. denied, 404 U.S. 1059 (1972).
1. Rules 17a-3(a)(1), 17a-3(a)(2) and 17a-3(a)(7)
Rule 17a-3 requires brokers and dealers to make and keep current
certain books and records, including:
1) blotters containing an itemized daily record of all purchases and
sales of securities, all receipts and deliveries, all receipts and
disbursements of cash and all other debits and credits (Rule
2) ledgers reflecting all assets and liabilities, income and expense
and capital accounts (Rule 17a-3(a)(2)); and
3) memoranda of each purchase and sale of securities for the account
of the member, broker, or dealer showing the price and, to the
extent feasible, the time of execution (Rule 17a-3(a)(7)).
Kidder violated Section 17(a) of the Exchange Act and Rule
17a-3(a)(2) because its ledgers reflected Respondent Jett’s
nonexistent, unrealized, profits.
There was no violation of Rules 17a-3(a)(1) and 17a-(3)(a)(7). The
blotters and order tickets accurately reflected the exchanges that
the Respondent entered. 51
2. Rule 17a-5
Exchange Act Rule 17a-5(a)(2)(ii) requires brokers and dealers who
clear transactions or carry customer accounts to file accurate
quarterly FOCUS Reports, which contain statements of financial
condition and income. Kidder filed inaccurate FOCUS Reports when it
included Respondent Jett’s nonexistent, unrealized, profits in the
statement of income portion of the reports.
3. Aiding and Abetting; Cause
For aiding and abetting violations of the federal securities laws,
three elements must be present: i) a primary or independent
securities law violation that has been committed by some other
party; ii) awareness or knowledge by the aider and abettor that his
or her role was part of an overall activity that was improper; and
iii) that the aider and abettor knowingly and substantially assisted
the conduct that constitutes the violation. Woods v. Barnett Bank of
Fort Lauderdale, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors
Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir.), cert. denied,
449 U.S. 919 (1980); IIT v. Cornfield, 619 F.2d 909, 922 (2d Cir.
1980); Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94-97 (5th
Cir. 1975); SEC v. Coffey, 493 F.2d 1304, 1316 (6th Cir. 1974),
cert. denied, 420 U.S. 908 (1975); William R. Carter, 47 S.E.C. 471,
The knowledge or awareness requirement can be satisfied by
recklessness when the alleged aider and abettor is a fiduciary or
active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir.
1990); Cornfield, 619 F.2d at 923, 925; Rolf, 570 F.2d at 45-48;
Woodward, 522 F.2d at 97.
The first and third elements, that a primary violation was committed
by Kidder and that Mr. Jett knowingly and substantially assisted the
conduct that constitutes the violation, are clearly present. 52 The
second element, awareness or knowledge that his role was part of an
overall activity that was improper, is present as well. He was well
aware of the P&L effect of booking forward recons. He knew that the
P&L effect of his forward recons required adjustment to be accounted
for legitimately. He knew that his forward recons and the associated
nonexistent profits were reflected on the books and records of the
firm. Because of his education and work experience he was aware of
the importance of a broker-dealer’s recordkeeping and that the P&L
effect of his forward recons would affect financial records such as
ledgers and FOCUS reports and thus cause them to be inaccurate.
Based on the same reasoning, Mr. Jett was also a "cause," within the
meaning of Exchange Act Section 21C, of Kidder’s violation of
Section 17(a)(1) and Rules 17a-3(a)(2) and 17a-5(a)(2)(ii).
The Division requests sanctions pursuant to Sections 8A of the
Securities Act and 15(b)(6), 21B, and 21C of the Exchange Act. The
Commission must find willful violations to impose sanctions under
Sections 15(b)(6) and 21B of the Exchange Act. It is well settled
that a finding of willfulness does not require an intent to violate,
but merely an intent to do the act which constitutes a violation.
Steadman v. SEC, 603 F.2d 1126, 1135 (5th Cir. 1979), aff’d on other
grounds, 450 U.S. 91 (1981); Arthur Lipper Corp. v. SEC, 547 F.2d
171, 180 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978); Tager
v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). The acts which constituted the
Respondent’s violations were, as described above, clearly
intentional. The acts included a series of entries into GT made by
the Respondent or under his direction to carry out his forward recon
strategy and his material misrepresentations and omissions. His
violations were thus willful.
The Division requests a cease and desist order; a bar from
association with any broker or dealer, without a right to reapply;
disgorgement of $11.4 million plus prejudgment interest; and
third-tier civil penalties of $11.4 million. The Respondent urges
that this proceeding be dismissed and does not address possible
For the reasons discussed below, these sanctions will be ordered: a
cease and desist order; a bar from association with any broker or
dealer; $8.21 million in disgorgement plus prejudgment interest; and
$200,000 in third-tier civil penalties.
A. Sanction Considerations
When the Commission determines administrative sanctions, it
the egregiousness of the defendant's actions, the isolated or
recurrent nature of the infraction, the degree of scienter involved,
the sincerity of the defendant's assurances against future
violations, the defendant's recognition of the wrongful nature of
his conduct, and the likelihood that the defendant's occupation will
present opportunities for future violations.
Steadman v. SEC, 603 F.2d at 1140 (quoting SEC v. Blatt, 583 F.2d
1325, 1334 n.29 (5th Cir. 1978)).
The Commission determines sanctions pursuant to a public interest
standard. 53 Thus, in addition to issues related to the violator, it
"weigh(s) the effect of (its) action or inaction on the welfare of
investors as a class and on standards of conduct in the securities
business generally." Arthur Lipper Corp., 46 S.E.C. 78, 100 (1975);
Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976).
I reviewed Commission opinions imposing sanctions in litigated 54
administrative proceedings that arose after the effective date of
the Securities Enforcement Remedies and Penny Stock Reform Act of
1990 (Remedies Act) 55 as precedent for the appropriate sanction or
combination of sanctions in the instant case. 56 The Commission has,
however, "stated on numerous occasions that sanctions are determined
on a case-by-case, facts and circumstances basis and ‘cannot be
precisely determined by comparison with action taken in other
cases.’" Consolidated Investment Services, Inc., 61 SEC Docket 20,
32 (Jan. 5, 1996) (citing and quoting Frank J. Custable, Jr., 51
S.E.C. 855, 863-64 (1993); Richard R. Perkins, 51 S.E.C. 380, 388
(1993); Butz v. Glover Livestock Commission Co., 411 U.S. 182, 187
(1973); Hiller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970)). The
amount of a sanction depends on the facts of each case and the value
of the sanction in preventing a recurrence. Berko v. SEC, 316 F.2d
137, 141 (2d Cir. 1963); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
Most Commission opinions imposing severe sanctions such as the
Division requests involved respondents who violated the antifraud
provisions. No Commission opinion in a litigated case imposed such
sanctions for aiding and abetting books and records violations. 57
The Commission has, however, imposed severe sanctions in cases where
there were no violations of the antifraud provisions but where there
was a lack of honesty and candor. See Ahmed Mohamed Soliman, 59 SEC
Docket 356 (Apr. 17, 1995); 58 First Securities Transfer Systems,
Inc., 60 SEC Docket 441 (Sept. 1, 1995). 59 Opportunities for
dishonesty recur constantly in the securities business, and this
necessitates special legal treatment. Richard C. Spangler, Inc., 46
S.E.C. at 252 (citing Arthur Lipper Corp., 46 S.E.C. at 101 n.7;
Archer v. SEC, 133 F.2d 795, 803 (8th Cir.), cert. denied, 319 U.S.
767 (1943); Hughes v. SEC, 174 F.2d 969, 975 (D.C. Cir. 1949)); see
also Benjamin G. Sprecher, 64 SEC Docket 720, 730 n.36 (April 8,
1997). The Respondent’s violative actions involved dishonesty and
fraudulent intent. Thus, more severe sanctions are appropriate in
the public interest than might usually be associated with books and
1. Cease and Desist
Section 21C of the Exchange Act authorizes the Commission to issue
cease and desist orders if it finds that any person "is violating,
has violated, or is about to violate" any provision of the Act or
rule thereunder. It may enter a cease and desist order against "such
person, and any other person that is, was, or would be a cause of
the violation, due to an act or omission the person knew or should
have known would contribute to such violation."
As concluded above, Respondent Jett was a cause, within the meaning
of Exchange Act Section 21C, of Kidder’s violations of Exchange Act
Section 17(a) and Rules 17a-3 and 17a-5 thereunder. Further, the
record shows a reasonable likelihood of such violations in the
future. 60 The relevant factors to consider when assessing the
likelihood of recurrent violation include "‘whether a defendant’s
violation was isolated or part of a pattern, whether the violation
was flagrant and deliberate or merely technical in nature, and
whether the defendant’s business will present opportunities to
violate the law in the future.’" SEC v. Steadman, 967 F.2d at 648
(quoting SEC v. First City Fin. Corp., 890 F.2d 1215, 1228 (D.C.
The Respondent’s actions in furtherance of his forward recon scheme
that caused the books and records violations extended over more than
two years; thus his violation was not isolated but was part of a
pattern. Also, the violation was closer to "flagrant and deliberate"
than "merely technical." His business will present opportunities to
violate the law in the future. A lack of recognition of the wrongful
nature of his conduct adds to the likelihood of future violation.
Accordingly, it is appropriate to order him to cease to cease and
desist from committing or causing any violations or future
violations of Exchange Act Section 17(a) and Rules 17a-3 and 17a-5
The Division requests that the Respondent be barred from association
with any broker or dealer, without a right to reapply for such
association. Based on the factors discussed in Steadman v. SEC, 603
F.2d at 1140, it is appropriate to bar the Respondent from
association with a broker-dealer. The Respondent’s violations were
egregious, as shown by the multimillion dollar bonuses that resulted
from them and that were the purpose of his course of action. The
violative activity was recurring, in that it continued for more than
two years. A high degree of scienter is indicated by his education,
experience in the securities business, drive, and work ethic, as
well as the bonuses. Moreover, he knew that Kidder did not
understand the source of his profits. There is a likelihood that his
occupation will present opportunities for future violations. The
Respondent has credibly disavowed any intent to engage in activities
precisely like those at issue in the future. Consistent with his
vigorous defense to the charges against him, he has not otherwise,
in this proceeding, recognized the wrongful nature of his conduct.
Nor did he do so in the course of his employment at Kidder; even
when the fraud was finally discovered, he denied wrongdoing and gave
misleading and conflicting explanations.
The phrase "without a right to reapply" will not be added to the
bar. It does not appear in the authorizing statute, Exchange Act
Section 15(b). Nor is there precedent for a bar "without a right to
reapply." For example, the phrase does not appear in the bar imposed
on Meyer Blinder, an unusually egregious securities law violator.
Meyer Blinder, 65 SEC Docket 1970 (Oct. 1, 1997). Finally, such a
phrase could never be more than hortatory.
Occasionally the Commission imposes a bar with a proviso that a
respondent can reapply within a specified period of time. 62 The few
litigated cases in which this has occurred since the Remedies Act
provided the Commission with alternative sanctions do not establish
standards for adding such a proviso to a bar. 63 Accordingly, none
will be added in this case.
Exchange Act Section 21C(e) authorizes disgorgement in this
proceeding. While that section refers to "payments to investors" in
connection with disgorgement, "(t)he purpose of disgorgement is to
force ‘a defendant to give up the amount by which he was unjustly
enriched’ rather than to compensate the victims of fraud." SEC v.
Blavin, 760 F.2d 706, 713 (6th Cir. 1985) (quoting SEC v.
Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir.
1978)). See also SEC v. Tome, 833 F.2d 1086, 1096 (2d Cir. 1987),
cert. denied, 486 U.S. 1014 (1988); H. Rep. 101-616 (1990); Rule 600
of the Commission’s Rules of Practice, 17 C.F.R. § 201.600, Comment;
Rule 620, Comment. While the Commission has authority to provide for
return of ill-gotten gains to investors, there is no requirement
that it do so. Rule 611, Comment (c).
Disgorgement is an equitable remedy that requires a violator to give
up wrongfully obtained profits. It returns him to where he would
have been absent the violative activity. Mr. Jett booked over $300
million in illusory profits, and, as a consequence, was awarded
$11.4 million in bonuses -- $2.1 million at the end of 1992, and
$9.3 million at the end of 1993. 64 Mr. Jett would not have received
such bonuses but for the forward recon scheme. The presence of the
illusory profits in Kidder’s books and records caused Kidder to pay
the bonuses; thus they are causally related to the proven
wrongdoing. First City Fin. Corp., 890 F.2d at 1230-31; see also
Hateley v. SEC, 8 F.3d 653, 655-56 (9th Cir. 1993). Accordingly,
disgorgement is appropriate in this case.
Kidder actually paid $8.21 million of the $11.4 million; it held the
remainder as deferred compensation and did not pay it after firing
Mr. Jett. The $8.21 million was paid to Mr. Jett directly ($5.5
million) or on his behalf as tax withholding. Accordingly, $8.21
million is the appropriate disgorgement amount.
Kidder’s inaction increased the amount of the ill-gotten gains by
the approximate amount of the 1993 bonus that it paid ($6.67
million). Mr. Jett’s reported profits were not out of line with
expectations in 1992, but they skyrocketed during 1993, and, even
after being alerted by red flags, Kidder’s attempts to understand
and investigate them were incomplete. Kidder did not, however,
knowingly encourage the Respondent to pursue the forward recon
scheme and book illusory profits. Thus the disgorgement amount will
not be reduced from $8.21 million.
4. Civil Penalties
Exchange Act Section 21B authorizes the Commission to impose civil
money penalties for willfully aiding and abetting violations of the
Exchange Act or rules thereunder. In considering whether a penalty
is in the public interest, the Commission may consider six factors:
(1) fraud, (2) harm to others, (3) unjust enrichment, (4) previous
violations, (5) deterrence, and (6) such other matters as justice
may require. Section 21B(c).
The 1990 Remedies Act authorized civil money penalties (in addition
to disgorgement) in proceedings by the Commission in the federal
courts as well as penalties and disgorgement in administrative
proceedings. There have been relatively few published opinions in
litigated cases in any forum which quantified penalties or discussed
the choice of penalties and/or disgorgement as sanctions. 65
As concluded above, Mr. Jett willfully aided and abetted Kidder’s
violations of Exchange Act 17(a) and Rules 17a-3(a)(2) and 17a-5.
His acts or omissions which constituted aiding and abetting Kidder’s
books and records violations "involved fraud, deceit . . . or
deliberate or reckless disregard of a regulatory requirement" within
the meaning of Exchange Act Section 21B(c)(1). The harm to Kidder
and his unjust enrichment are quantified in the $8.21 million in
bonuses he received as a result of his course of action. Mr. Jett
has no previous violations or disciplinary record. Nor is there any
indication in the record of harm to customers or counterparties.
With reference to "such other matters as justice may require,"
Kidder’s initial hesitant response to red flags is again noted. A
more aggressive investigation of questions raised by the
Respondent’s high profits would have reduced unjust enrichment and
the harm to Kidder.
A penalty is appropriate in this case. Although the disgorgement
amount is significant, it is the amount which the Respondent
received as a result of his violative activity. Merely returning his
gains with interest leaves him no worse off financially than if he
had not violated the law. A penalty in addition to disgorgement is
necessary for the purpose of deterrence. See Exchange Act Section
21B(c)(5); H. Rep. 101-616 (1990). A third tier penalty is
appropriate because the violative acts involved deceit and resulted
in substantial pecuniary gain to the Respondent. See Section
The maximum third tier penalty for a natural person for "each act or
omission" is $100,000 for the violations in this proceeding. 66 The
statute, like most civil penalty statutes, leaves the precise unit
of violation undefined. See Colin S. Diver, The Assessment and
Mitigation of Civil Money Penalties by Federal Administrative
Agencies, 79 Colum. L. Rev. 1435, 1440-41 (1979). In the instant
case the unit could be each forward recon, which would result in an
astronomical maximum penalty. Alternatively, the Respondent’s entire
course of action could be considered as one violation, which would
result in a maximum penalty of $100,000. The Division has requested
a penalty approximating the bonuses Mr. Jett was awarded as a result
of the forward recon scheme, that is, $11.4 million. A penalty of
this size is excessive because there was no violation of the
antifraud provisions and because of the mitigating factors. I
conclude that two courses of action form the basis for two
violations and for penalties: his forward recons through 1992, which
resulted in a $2.1 million bonus, and his 1993 and 1994 forward
recons, which were bolder and far more profitable to him.
Accordingly, a third-tier penalty of $200,000 is appropriate.
V. Certification of Record
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17
C.F.R. § 201.351(b), I hereby certify that the record includes the
items set forth as of the record index issued by the Secretary of
the Commission on November 21, 1997, as well as those items noted in
my Order Directing Corrections to Record Index, dated January 2,
Based on the findings and conclusions set forth above:
IT IS ORDERED that, pursuant to Section 21C of the Exchange Act, 15
U.S.C. § 78u-3, Orlando Joseph Jett cease and desist from committing
or causing any violations or future violations of Exchange Act
Section 17(a), 15 U.S.C. § 78q(a), and Rules 17a-3 and 17a-5
thereunder, 17 C.F.R. §§ 240.17a-3, .17a-5.
IT IS FURTHER ORDERED that, pursuant to Sections 15(b) and 19(h) of
the Exchange Act, 15 U.S.C. §§ 78o(b) and 78s(h), Orlando Joseph
Jett be, and hereby is, barred from association with any broker or
IT IS FURTHER ORDERED that, pursuant to Section 21C of the Exchange
Act, 15 U.S.C. § 78u-3, Orlando Joseph Jett disgorge $8.21 million
plus prejudgment interest at the rate established under Section
6621(a)(2) of the Internal Revenue Code, 26 U.S.C. § 6621(a)(2),
compounded quarterly, pursuant to Rule 600 of the Commission’s Rules
of Practice, 17 C.F.R. § 201.600. Pursuant to Rule 600(a),
prejudgment interest is due on $6.67 million from January 1, 1994,
and on $1.54 million from January 1, 1993, through the last day of
the month preceding which payment is made.
IT IS FURTHER ORDERED that, pursuant to Section 21B of the Exchange
Act, 15 U.S.C. § 78u-2, Orlando Joseph Jett pay a civil penalty in
the amount of $200,000.
Payment shall be made on the first day after this decision becomes
final. Such payment shall be: (i) made by United States postal money
order, certified check, bank cashier's check or bank money order;
(ii) made payable to the Securities and Exchange Commission; (iii)
delivered by hand or courier to the Office of the Secretary,
Securities and Exchange Commission, 450 Fifth St., N.W., Washington,
D.C. 20549; and (iv) submitted under cover letter which identifies
Orlando Joseph Jett as the Respondent in these proceedings, and the
file number of these proceedings. The Division shall submit a plan
of disgorgement no later than sixty (60) days after Respondent Jett
has paid any or all of the disgorgement amount and interest.
This order shall become effective in accordance with and subject to
the provisions of Rule 360, 17 C.F.R. § 201.360. Pursuant to that
rule, a petition for review of this initial decision may be filed
within twenty-one (21) days after service of the decision. It shall
become the final decision of the Commission as to each party who has
not filed a petition for review pursuant to Rule 360(d)(1) within
twenty-one (21) days after service of the initial decision upon him,
unless the Commission, pursuant to Rule 360(b)(1), determines on its
own initiative to review this initial decision as to any party. If a
party timely files a petition for review, or the Commission acts to
review as to a party, the initial decision shall not become final as
to that party.
Carol Fox Foelak
Administrative Law Judge
-- The OIP was amended by Order of February 2, 1996, to correct
errors in internal references.
-- Additionally, the OIP alleged that Melvin Mullin failed
reasonably to supervise Respondent Jett. Respondent Mullin's portion
of these proceedings was settled. Orlando Joseph Jett and Melvin
Mullin , Order Making Findings and Imposing Remedial Sanctions
Against Melvin Mullin, 61 SEC Docket 2852 (May 20, 1996).
-- Citations to exhibits offered by the Division and the
Respondent and to the transcript of the hearing will be noted as
"Div. Ex. __," "Resp. Ex. __," and "Tr. __," respectively.
-- The Respondent argues that the Due Process Clause of the U.S.
Constitution requires the Division to prove its case by clear and
convincing evidence. As stated in my Order Ruling on Motion for
Summary Disposition, 61 SEC Docket 2949, 2951 (May 17, 1996),
preponderance of the evidence is the standard of proof in Commission
administrative proceedings. See Steadman v. SEC , 450 U.S. 91
(1981). See also Seaton v. SEC , 670 F.2d 309, 311 (D.C. Cir. 1982).
-- See 5 U.S.C. § 557(c).
-- FOCUS is an acronym for Financial and Operational Combined
Uniform Single (Report). Pursuant to Rule 17a-5, Kidder filed its
FOCUS Reports with the New York Stock Exchange, which transmitted
them to the Commission. See, e.g. , Div. Ex. 23H.
-- Window dressing has been defined as "accounting gimmickry
designed to make a financial statement show a more favorable
condition than actually exists -- for example by omitting certain
expenses, by concealing liabilities, by delaying write-offs, by
anticipating sales, or by such other actions, which may or may not
be fraudulent." John Downes & Jordon Elliot Goodman, Barron's
Dictionary of Finance and Investment Terms 657-58 (4th ed. 1995).
See also Resp. Ex. 130 at 1.
-- In December 1994, PaineWebber Group, Inc. issued $670 million
in securities in exchange for key assets of Kidder. PaineWebber
Closes Kidder, Peabody Purchase Ahead of Schedule , Business Wire
(Dec. 16, 1994). In upholding the dismissal of a class action
against GE that resulted from the matters at issue in this
proceeding, the court of appeals noted: "GE had acquired 80 percent
of Kidder for $620 million in 1986. Shortly thereafter, an insider
trading scandal was exposed at Kidder, resulting in a $26 million
fine paid to the (Commission) and the implementation of a compliance
system at Kidder to detect fraudulent trading. Kidder's business
declined, with losses of $53 million posted in 1989, and $54 million
in 1990. In 1990, GE acquired the remaining 20 percent of Kidder in
a $550 million bailout transaction. Following this transaction,
Kidder began turning a profit, and did so throughout 1991, 1992 and
1993." Chill v. General Electric Company , 101 F.3d 263, 265 (2d
Cir. 1996). The 1987 sanction against Kidder is reported at SEC v.
Kidder, Peabody & Co. , 1987 U.S. Dist. LEXIS 15884 (S.D.N.Y. 1987);
Kidder was enjoined from antifraud and other violations and ordered
to disgorge $13.7 million and pay a civil penalty of $11.7 million.
-- Market making is making bids and offers to customers, both
institutional and retail. Tr. 827. In proprietary trading for the
firm's own account, trade is initiated by the trader rather than in
response to a customer order. Tr. 827.
-- The courses he took included Finance, Capital Markets,
Corporate Financial Management, Management of Financial Service
Organizations, and New Financial Instruments in the Capital Markets.
Div. Ex. 55 at Bates 000041.
-- Mr. Cerullo submitted an Offer of Settlement, which the
Commission accepted, in anticipation of the institution of
administrative proceedings against him in this matter. Edward A.
Cerullo , Order Instituting Public Administrative Proceedings,
Making Findings, and Imposing Remedial Sanctions, 61 SEC Docket 82
(Jan. 9, 1996).
-- GE's 10-Q for the first quarter of 1994 stated that the
write-off was $210 million ($350 million before tax), and that $139
million of the write-off related to periods prior to 1994. Div. Ex.
50 at B01, B03. The Division's estimate of false profits was $338
million. Tr. 1972-74, 2262, 2412-16 ; Div. Ex. 121 .
-- "Notes" are Treasury securities with original maturities of
between two and ten years and are issued as coupon securities;
"bills" are those with original maturities of one year or less and
are issued as zero coupon securities. Div. Ex. 119 at A1. See also
Downes & Goodman, supra , at 617.
-- STRIPS is an acronym of Separate Trading of Registered
Interest and Principal of Securities. TINTs (Treasury Interest
Securities) are the coupon payments, and TPRN or corpus refers to
the principal piece. Tr. 783-84, 1881; Div. Ex. 119 at A3-A4.
-- See, e.g. , Div. Ex. 1F; Tr. 385-90.
-- Every stock or registered bond is identified by a CUSIP
number, using the Committee of Uniform Securities Identification
Procedures. Tr. 393; Downes & Goodman, supra , at 122-23.
-- See, e.g. , Div. Ex. 1D; Tr. 775-77, 1831.
-- See, e.g. , Div. Ex. 1E; Tr. 375-79.
-- See, e.g. , Div. Ex. 1B; Tr. 391-98.
-- Profits from the Respondent's activities that are at issue in
this proceeding were recorded in the quarterly FOCUS Reports from
March 1992 through March 1994. Tr. 165-66.
-- The Fixed Income or Government Daily P&L/Inventory Report
included a "Net Interest" value. Tr. 988-91, 1977; Resp. Ex. 120.
Likewise the PPR-2 Report included a "carry" value. See, e.g. , Div.
Ex. 1F. The net interest or net cost of carry figure includes income
in minus the cost of financing. Tr. 989-90. All settled positions,
long or short, had a net interest value. Tr. 990, 1976-77. For a
long position in a bond, it would include the coupon interest earned
on the bond less the cost of financing -- repo interest or carry; on
a short position it would include the coupon interest Kidder paid on
the bond to the purchaser and the reverse repo interest earned from
lending cash and borrowing the security involved. Tr. 1976-77.
-- The Division's calculations of what it characterized as false
profits included even next-day settlement STRIPS and recons as
forward trades. Tr. 1972-74, 2262, 2313-14, 2412-16. This method
reduced the Division's false profit figure from $350 million to $338
-- A reason for corporate or greater settlement would be to
accommodate a customer or to have time to gather STRIPS. Tr. 877-78,
-- As Mr. Jett observed, "(when traders) lost money (they) would
seek to make an adjustment. When they made money, no adjustment was
ever requested." Tr. 545. See also Tr. 3060.
-- From November 1993 to March 1994 the quantity of STRIPS
required to settle open recons exceeded the available supply. Div.
Tr. 2117-20; Div. Ex. 153 at 30, D.
-- For example, Mr. Jett attributed profits, in part, to an
arbitrage strategy when questioned by Barry Finer, the FI Division
Risk Manager, in 1993, Tr. 694-96, and by Claudia Sonz, a Kidder
accountant, in December 1993. Tr. 561-62, 2431; Div. Exs. 90, 90A.
-- The Red Book concept had been used at Kidder prior to Mr.
Jett's arrival. Tr. 2484-85.
-- Mike Benatar and Kevin McLaughlin also participated in some
conversations. Tr. 1475-76, 1493-94, 1496, 2909.
-- Resp. Exs. 702A, 702B, 704, 705, 706, 707, and 707A are notes
taken by Davis, Polk staff of interviews of Mr. Bernstein in April,
May, and June 1994 concerning these and other conversations. The
notes were the impressions of the notetaker, were not verbatim
transcripts of the interviews, and were not affirmed by Mr.
Bernstein. Tr. 2533-86, 2643-45. The undersigned gave no evidentiary
weight to the notes, which were used during cross examination to
attempt to refresh recollection.
-- Mr. Jett also stated that he showed Mr. Bernstein the daily
report of his inventory (FI 12), which indicated that his positions
were flat, to show that he owned or was purchasing STRIPS. Tr. 2905.
Such an apparently flat trade date position could, however, be
achieved by a long dated recon matched with a shorter dated STRIP.
-- Dummy CUSIPs had been used at Kidder to track a security that
for some reason did not have its own CUSIP number. Tr. 1601-02.
-- Mr. Jett stated that Mr. Cerullo told him the Fed had called
in May; Mr. Cerullo stated it was during 1993. Tr. 1030-32, 2942.
The record shows a June 14, 1993, implementation date for a
correction in reporting STRIPS and recons on Schedule B of the Fed's
Form 2004 (to move them from the "Primary Broker" category to "All
Other"). Resp. Ex. 22 at Bates CA0023840; Resp. Ex. 29 at CA035902;
Resp. Ex. 39 at CA0023544. An internal Fed memo references a June
24, 1993, meeting with Kidder and revisions to past Schedule B
reports to change stripping from "Customer" to "All Other." Resp.
Ex. 6 at Bates 000000093. Mr. Cerullo set up a committee to deal
with the Fed reporting problem in July 1993. Tr. 1031, 2942; Resp.
Ex. 7 at Bates KJ04990; Resp. Ex. 30.
-- The actions to be taken included correct reporting of settled
and unsettled positions on Form 2004 Schedule A to remove unsettled
positions. Resp. Ex. 39 at CA0023564; Resp. Ex. 43.
-- The 30% figure was an understatement. See Div. Ex. 152; Div.
Ex. 153 at J.
-- Confirmations were not sent to the Fed until the day before
settlement; the exchanges were not compared trades. Tr. 1218, 2957.
-- The Respondent claims that the strategy gained the attention
of the Fed in September 1993 such that it questioned the high
numbers of STRIPS and recons reported on Kidder's Fed Form 2004. Tr.
2950-53; Resp. Ex. 48. As evidence of this he points to a
handwritten notation on the Form 2004 dated September 22, "as per
Joseph Jett Massive Strip + Reconstitution Activity - Several times
normal activity." Tr. 2951-53; Resp. Ex. 48. According to his
account a Fed official called him to query the numbers reported,
which he verified. Tr. 2943, 2952. There is no evidence that such a
query, which is otherwise unsubstantiated in the record, was brought
to the attention of Kidder managers, such as Mr. Cerullo.
-- It was the Respondent's explanation of this action at an
April 14, 1994, meeting, that caused Mr. Cerullo to understand that
the Respondent "knew what he was doing and why he was doing it" and
to become "flabbergasted, devastated . . . nauseous." Tr. 933-34;
Div. Ex. 100 at 8.
-- Municipal defeasances occur when a municipality has a payment
schedule spread over time and invests in a manner that matches the
payments; the municipality might purchase STRIPS whose maturities
matched the dates of the payments. Tr. 975. During 1993 it was
possible to make high profits from a small number of unsophisticated
municipalities which purchased STRIPS for defeasance by selling them
STRIPS at today's yield for forward settlement (typically one to
four weeks forward). Tr. 2933; Div. Ex. 119 at F8-F9.
-- See, e.g. , Race Study to Criticize Wall Street , Wall St.
J., Jan. 23, 1998, at C1; Congeniality and Unease as Wall St.
Addresses Race , N.Y. Times, Jan. 17, 1998, at D1; Addressing Racial
Issues on Wall St. , N.Y. Times, Jan. 14, 1998, at D4; Smith Barney
Diversity Plan Represents a Major Leap for Women on Wall Street ,
Wall St. J., Nov. 11, 1997, at B2; Commission Chairman Arthur
Levitt, Remarks at the Trinity Church Tercentenary (Mar. 18, 1997).
-- See 18 U.S.C. § 3500, commonly known as the Jencks Act.
-- See also Tr. 1297.
-- In November 1994 the Washington Post described Kidder as "the
scandal-ridden brokerage house that has been an albatross for parent
company General Electric." Daniel Gross, Barbarians Adjust Their
Gait; Shrinking Profits Take the Swagger Out of Wall Street's Walk
Wash. Post, Nov. 13, 1994, at C2. By late 1994 to early 1995 the
bulk of Kidder's assets were sold to PaineWebber, and losses for
1994 were attributed to the "bond trading scandal" related to the
Respondent, reduced underwriting, the slump in the mortgage-backed
market, operating results, and the costs of transferring ownership
to PaineWebber. G.E. Sees Kidder Loss of Up to $900 Million , N.Y.
Times, Nov. 4, 1994, at D15. The discovery of the Respondent's
scheme led not only to the firing of the Respondent, but also of top
managers at Kidder. Sylvia Nasar, More Kidder Resignations Are
Expected in Jett Case , N.Y. Times, Oct. 7, 1994, at D1. Jack Welch,
the Chairman of GE, was reported as shrugging off the sale of
Kidder, given its small size in comparison with the assets of GE as
a whole. Tony Jackson & Andrew Gowers, Big Enough to Make Mistakes ,
Financial Times, Dec. 21, 1995, at 13.
-- Section 17(a)(3) proscribes "any transaction, practice, or
course of business which operates or would operate as a fraud or
deceit upon the purchaser." It does not apply in this case because
the allegations focus on the culpability of the Respondent rather
than on the effect of particular conduct on members of the investing
public. Aaron v. SEC , 446 U.S. 680, 696-97 (1980).
-- Scienter is not required to establish a Section 17(a)(2)
violation; a finding of negligence is adequate. Jay Houston Meadows
, 61 SEC Docket 2444, 2453 n.16 (May 1, 1996), aff'd , 119 F.3d 1219
(5th Cir. 1997); SEC v. Steadman , 967 F.2d 636, 643 & n.5 (D.C.
Cir. 1992) (citing Aaron , 446 U.S. at 701-02; Newcome v. Esrey ,
862 F.2d 1099, 1102 n.7 (4th Cir. 1988)).
-- The "in the offer or sale of securities" standard of
Securities Act Section 17(a) is at least as high as the "in
connection with the purchase or sale of any security" standard of
Exchange Act Section 10(b) and Rule 10b-5. Chemical Bank v. Arthur
Anderson & Co. , 726 F.2d 930, 944-45 (2d Cir. 1984), cert. denied ,
469 U.S. 884 (1984). "In" and "in connection with" are sometimes
used interchangeably. U.S. v. Naftalin , 441 U.S. 768, 773 n.4
-- In Naftalin , the customer's fraudulent short sale scheme was
to place sell orders with broker-dealers and not deliver the
securities when the price moved against him. In Perlow , the
customers placed buy orders with broker-dealers with the fraudulent
intent of paying only if the price moved in their favor by the
-- The Division also quoted, in addition to the "touching"
language, from Bankers Life in a May 7, 1996, prehearing pleading:
"Section 10(b) must be read flexibly, not technically and
restrictively." Bankers Life , 404 U.S. at 12. The Supreme Court,
however, has not continued to use such expansive language in more
recent decisions concerning the scope of conduct proscribed by the
antifraud provisions. The Court has emphasized the statutory
language rather than expanding it by reference to the broad
congressional purposes behind it. See Central Bank of Denver v.
First Interstate Bank of Denver , 511 U.S. 164, 169, 173-74 (1994);
Santa Fe Indus., Inc. v. Green , 430 U.S. 462, 470-73 (1977);
Hochfelder , 425 U.S. at 197-99. But see United States v. O'Hagan ,
117 S. Ct. 2199, 2206-14 (1997).
-- Prior to the Chemical Bank case, after Superintendent v.
Bankers Life , "the 'in connection with' requirement was not
generally viewed as posing a significant obstacle in establishing a
securities fraud case." Barbara Black, The Second Circuit's Approach
to the "In Connection with" Requirement of Rule 10b-5 , 53 Brooklyn
L. Rev. 539, 539-40 (1987). See also Daniel A. McLaughlin, The "In
Connection With" Requirement of Rule 10b-5 as an Expectation
Standard , 26 Sec. Reg. L.J. 3, 5, 11-14 (1998).
-- Courts have examined other situations where purchases and
sales in the context of the antifraud provisions did not exist. See,
e.g. , International Controls Corp. v. Vesco , 490 F.2d 1334,
1342-44 (2d Cir.), cert. denied , 417 U.S. 932 (1974) (transfer of
ownership of subsidiary to another subsidiary not a sale since
complete control retained over transferee); Penn Central Securities
Litigation , 494 F.2d 528, 532-39 (3rd Cir. 1974) (formation of
holding company not a sale when little change in shareholders'
rights); Abrahamson v. Fleschner , 568 F.2d 862, 868 (2d Cir. 1977),
cert. denied , 436 U.S. 913 (1978) (internal corporate management
decision, without significant change in the nature of the investment
or in the investment risks so as to amount to a new investment, not
a sale); Gelles v. TDA Industries, Inc. , 44 F.3d 102, 104-06 (2d
Cir. 1994); Troyer v. Karcagi , 488 F. Supp. 1200, 1204-05 (S.D.N.Y.
1980) (transfer of accounts and custody of stock from one broker to
another not a sale); Sacks v. Reynolds Securities, Inc. , 593 F.2d
1234, 1239-41 (D.C. Cir. 1978). In Sacks the court observed, "lower
federal court interpretations of purchase and sale, although
encompassing many transactions that bear little overt resemblance to
conventional cash sales, require some surrendering of control,
change in ownership, or change in the fundamental nature of an
investment before a transfer will be deemed within the ambit of Rule
10b-5." 593 F.2d at 1240 (footnotes omitted).
-- The Respondent argues that the losses were derived from
futures trading, which is not within the Commission's jurisdiction,
and that his trading in treasury securities by itself was
profitable. The futures trading was required by Kidder's policy to
hedge risk arising from trading in securities. There is a closer
nexus between the Respondent's securities and futures trading than
between such trading and forward recons.
-- The only recent reported Commission cases that specifically
rule on blotter and order ticket violations are settlements. Even
these rulings would not support a conclusion that Rules 17a-3(a)(1)
and 17a-(3)(a)(7) were violated. In contrast to the instant case, in
which blotters and order tickets revealed the Respondent's
activities accurately, the blotter and order ticket irregularities
in these cases were for the purpose of concealing wrongdoing. Howard
A. Rubin , 45 SEC Docket 1530, 1531 (Mar. 20, 1990) (absence of
entry for transaction); PaineWebber Incorporated , 61 SEC Docket
179, 205-06 (Jan. 17, 1996); Goldman, Sachs & Co. , 55 SEC Docket
3208, 3214-16 (Feb. 3, 1994) (failure to record side agreements,
such as parking agreements); Cantor Fitzgerald & Co. , 56 SEC Docket
812, 816-17 (Mar. 17, 1994); Howe Barnes Investments, Inc. , 62 SEC
Docket 2627, 2633 (Sept. 23, 1996) (inaccurate or no time stamp and
unclear customer, security or buy/sell information); Lehman Brothers
Inc. , 59 SEC Docket 3135, 3140 (Aug. 15, 1995) (failure to record
customer names accurately); James W. Adams , 63 SEC Docket 964, 965
(Dec. 2, 1996); Carroll McEntee & McGinley Securities, Inc. , 54 SEC
Docket 2407, 2410-11 (Sept. 2, 1993); First Fidelity Securities
Group , 61 SEC Docket 68, 79 (Jan. 9, 1996) (inaccurate prices -
failing to reveal kick-backs or hidden fees); Refco Securities, Inc.
, 62 SEC Docket 1330, 1332-33 (Aug. 6, 1996); Gruntal & Co. , 61 SEC
Docket 1994, 2005-06 (Apr. 9, 1996) (blotters that did not reflect
theft of customer securities and funds); M. Rimson & Co., Inc. , 63
SEC Docket 2707, 2716-17 (Feb. 21, 1997) (tickets naming registered
representatives who were not involved in the transactions).
-- Kidder has not been charged as the primary violator. However,
as the Commission has stated, even in a criminal context it is not
necessary to indict, try or convict a principal wrongdoer in order
to convict an aider and abettor. Swartwood, Hesse, Inc. , 50 S.E.C.
1301, 1304 n.8 (1992) (citing United States v. Mann , 811 F.2d 495,
497 (9th Cir. 1987)).
-- See, e.g. , Exchange Act Sections 15(b)(6)(A) and 21B(a),
(c), and (d).
-- While far more administrative proceedings are settled than
litigated, it goes without saying that settled cases are
questionable precedent, particularly on the issue of sanctions,
since parties to a settlement may be motivated by pragmatic
considerations. See Richard J. Puccio , 63 SEC Docket 158, 163 (Oct.
22, 1996) (citing David A. Gingras , 50 S.E.C. 1286, 1294 (1992),
and cases cited therein); Robert F. Lynch , 46 S.E.C. 5, 10 n.17
(1975) (citing Samuel H. Sloan , 45 S.E.C. 734, 739 n.24 (1975);
Haight & Co. , 44 S.E.C. 481, 512-13 (1971), aff'd without opinion ,
(D.C. Cir. 1971), cert. denied , 404 U.S. 1058 (1972); Security
Planners Associates, Inc. , 44 S.E.C. 738, 743-44 (1971)).
-- The Commission's authority to impose the bar sanction is
long-standing. The cease and desist, disgorgement, and civil money
penalty sanctions, authorized in Securities Act Section 8A and
Exchange Act Sections 21B and 21C, were added to the securities laws
by the Remedies Act. The Congressional intent in authorizing the
Commission to impose these sanctions was to give it increased
flexibility in its choice of remedies. See H. Rep. 101-616 (1990);
Sen. Rep. 101-337 (1990).
-- The precedential Commission opinions on appeal from
Administrative Law Judges' Initial Decisions that concerned
violators in the securities business are: Terry T. Steen , Exchange
Act Rel. No. 40055, 1998 SEC LEXIS 1033 (June 2, 1998); L.C. Wegard
& Co. , Exchange Act Rel. No. 40046, 1998 SEC LEXIS 1130 (May 29,
1998); Victor Teicher , Exchange Act Rel. No. 40010, 1998 SEC LEXIS
980 (May 20, 1998); William F. Lincoln , 66 SEC Docket 1433 (Feb. 9,
1998); John Francis D'Acquisto , 66 SEC Docket 1094 (Jan. 21, 1998);
Meyer Blinder , 65 SEC Docket 1970 (Oct. 1, 1997); Samuel O. Forson
, 65 SEC Docket 24 (July 21, 1997); Donald A. Roche , 64 SEC Docket
2042 (June 17, 1997); Russell G. Koch , 64 SEC Docket 1616 (May 20,
1997), appeal pending , No. 97-70834 (9th Cir.); Benjamin G.
Sprecher , 64 SEC Docket 720 (Apr. 8, 1997); Demitrios Julius Shiva
, 64 SEC Docket 157 (Mar. 12, 1997); Martin B. Sloate , 64 SEC
Docket 117 (Mar. 7, 1997); David Disner , 63 SEC Docket 2246 (Feb.
4, 1997); New Allied Development Corp. , 63 SEC Docket 807 (Nov. 26,
1996); Richard J. Puccio , 63 SEC Docket 158 (Oct. 22, 1996); Robert
I. Moses , 62 SEC Docket 3046 (Oct. 8, 1996); Jay Houston Meadows ,
61 SEC Docket 2444 (May 1, 1996), aff'd , 119 F.3d 1219 (5th Cir.
1997); Timothy Mobley , 61 SEC Docket 42 (Jan. 5, 1996);
Consolidated Investment Services, Inc. , 61 SEC Docket 20 (Jan. 5,
1996); Ivan D. Jones, Jr. , 60 SEC Docket 1377 (Oct. 10, 1995),
aff'd , 115 F.3d 1173 (4th Cir. 1997), cert. denied , 118 S. Ct.
1512 (1998); First Securities Transfer Systems, Inc. , 60 SEC Docket
441 (Sept. 1, 1995); Martin Herer Engelman , 59 SEC Docket 1038 (May
18, 1995), aff'd , 87 F.3d 1319 (9th Cir. 1996); Ahmed Mohamed
Soliman , 59 SEC Docket 356 (Apr. 17, 1995); David M. Haber , 59 SEC
Docket 59 (Apr. 5, 1995); Albert Vincent O'Neal , 51 S.E.C. 1128
-- In Ivan D. Jones, Jr. , a respondent was sanctioned solely
for aiding and abetting books and records violations. Required books
and records were not being kept or were in a shambles. The
Commission imposed a limited suspension and a cease and desist
order. The NASD had also censured him, required him to requalify as
a principal and fined him $5,000.
-- In Ahmed Mohamed Soliman , the Commission imposed a bar and
revocation of registration, based on a respondent's misdemeanor
conviction for submitting false and fraudulent documents (to support
deductions related to his rental property) to the Internal Revenue
Service and on his failure to keep required books and records. He
had argued that there was no precedent for a bar based on books and
records violations, that his conviction for submitting false
documents was not related to the securities industry, and that no
member of the investing public was harmed. The Commission, however,
stated that the conviction showed a lack of honesty and that the
respondent failed to recognize the wrongfulness of his conduct. Thus
the sanctions were appropriate because opportunities for dishonesty
recur constantly in the securities industry. 59 SEC Docket at
-- In First Securities Transfer Systems, Inc. , the Commission
imposed a bar, revocation, and penalties totaling $75,000. A
transfer agent's owner, who had an extensive disciplinary history,
had willfully caused it to file with the Commission a form which
falsely omitted to disclose his relationship with it. The Commission
noted, as aggravating factors, his disciplinary history and the
failure of past sanctions to halt his violations and, as mitigating
factors, the lack of harm to others or of unjust enrichment. 60 SEC
Docket at 446-48.
-- Neither the Commission nor any court of appeals has ruled on
whether the Commission must find a likelihood of future violation to
issue a cease and desist order. The courts have, however, ruled that
a likelihood of future violation is required when considering the
cease and desist authority of other administrative agencies. See
Precious Metals Associates, Inc. v. CFTC , 620 F.2d 900, 912 (1st
Cir. 1980); Borg-Warner Corp. v. FTC , 746 F.2d 108, 110-11 (2d Cir.
1984); NLRB v. Savin Business Machines Corp. , 649 F.2d 89, 93 (1st
Cir. 1981); Citizens State Bank v. FDIC , 751 F.2d 209, 214-15 & n.9
(8th Cir. 1984). Cease and desist authority was added to the
sanctions available to the Commission in administrative proceedings
by the Remedies Act. As noted in the House Report on the
legislation, other federal agencies, for example, the Commodity
Futures Trading Commission (CFTC), Federal Trade Commission (FTC),
National Labor Relations Board (NLRB), and each of the federal bank
regulatory agencies, are empowered to issue cease and desist orders;
a cease and desist order was described as an administrative remedy
comparable to an injunction. H. Rep. 101-616, at 23-24 (1990). A
likelihood of future violation is required for an injunction. SEC v.
Steadman , 967 F.2d at 647-48; United States v. W.T. Grant Co. , 345
U.S. 629, 633 (1953).
-- The Division also requested a cease and desist order
concerning the antifraud provisions, Securities Act Section 17(a)
and Exchange Act 10(b) and Rule 10b-5 thereunder. Mr. Jett, however,
did not violate the antifraud provisions, so there is no basis for
such an order.
-- Six litigated cases that arose after the effective date of
the Remedies Act included such a proviso. Martin B. Sloate , 64 SEC
Docket 117 (Mar. 7, 1997); David Disner , 63 SEC Docket 2246 (Feb.
4, 1997); Richard J. Puccio , 63 SEC Docket 158 (Oct. 22, 1996); Jay
Houston Meadows , 61 SEC Docket 2444 (May 1, 1996); Consolidated
Investment Services, Inc. , 61 SEC Docket 20 (Jan. 5, 1996); Albert
Vincent O'Neal , 51 S.E.C. 1128 (1994). Additionally, the Commission
ordered the lesser sanction of a suspension in Ivan D. Jones, Jr. ,
60 SEC Docket 1377 (Oct. 10, 1995) and in Terry T. Steen , 1998 SEC
LEXIS 1033 (June 2, 1998).
-- See, e.g. , David Disner , 63 SEC Docket at 2257; Jay Houston
Meadows , 61 SEC Docket at 2456-58; Consolidated Investment
Services, Inc. , 61 SEC Docket at 32-34. Compare Martin B. Sloate ,
64 SEC Docket at 120-21 with Jay Houston Meadows , 61 SEC Docket at
2456-58, and Richard J. Puccio , 63 SEC Docket at 162.
-- Mr. Cerullo also was awarded multimillion dollar bonuses
based in part on the Respondent's profits. When he left Kidder his
severance payment was reduced to offset the compensation he received
that was based on Mr. Jett's activity so that he did not profit from
-- There have been a number of settled cases in which
disgorgement and/or penalty amounts were provided. Even these have
little in the way of clues as to why disgorgement and/or penalties
were selected or a particular penalty amount was assessed. An
exhaustive review of these issues is contained in Arthur B. Laby &
W. Hardy Callcott, Patterns of SEC Enforcement Under the 1990
Remedies Act: Civil Money Penalties , 58 Alb. L. Rev. 5 (1994). The
authors conclude that "it is hard to find any pattern in the amounts
assessed as civil money penalties, either in court or
administratively; this seems to be . . . negotiated on a
case-by-case basis, often taking into account penalties in similar
cases." Id. at 53. A review of cases and settlements since 1994
provides no further guidance.
-- The Commission increased the amounts for violations occurring
after December 9, 1996. Adjustment to Civil Monetary Penalty Amounts
, 61 Fed. Reg. 57773 (Nov. 8, 1996).
Home | Previous Page
PUBLIC PaineWebber Incorporated;
Mitchell Hutchins Asset
RESPONSE OF THE OFFICE OF
Management Inc.; the
INVESTMNT COMPAN REGULATION
Kidder Peabody family of
(Ref. No. 95-3- ICR) AN , funds; and Kidder, Peabody
THE OFFICE OF CHIEF COUNSEL
Investment Trust (File Nos.
(Ref. No. 95-27-CC) 812-8026 and 812-7714;
DIVISION OF INVESTMNT MAAGEMENT
Ref. No. 93-117-CC)
In your letter of January 17, 1995, you state that on
. October 17, 1994, Paine Webber Group Inc. ( "PWG"), the parent of
PaineWebber Incorporated ("PaineWebber") and Mitchell Hutchins'
Asset Management Inc. ("Mitchell Hutchins"), entered into an
asset purchase agreement wi th Kidder Peabody Group Inc. ( "KPG" )
and its parent, General Electric Company ("GE"). The agreement
provides for the purchase by PWG and certain of its subsidiaries
of certain assets of KPG and its subsidiaries (the
"Transaction"). The closing of the Transaction was divided into
several phases . The phase of the closing relating to the
investment management business (the "Closing") is scheduled to
take place on or about January 30, 1995, at which time most of
the assets of the subsidiaries providing investment advisory and
distribution services to the Kidder Peabody family of funds (the
"KP Funds") are.expected to be
transferred to PWG and its
You state that the KP Funds have been granted orders
exempting them from sections 2 (a) (32), 2 (a) (35), 18 (f), 18 (g)
18 (i), 22 (c), and 22 (d) of the Investment Company Act of
1940 (the "Actn) and rule 22c-1 thereunder (the "Exemptive
Orders"). 2/ The Exemptive Orders permit the KP Funds to
establish a multiple class distribution system and assess and
waive a contingent deferred sales charge. Kidder, Peabody & Co.
Incorporated ("KP&Co."), a wholly-owned .subsidiary of KPG, is the
distributor of the KP Funds. Kidder Peabody Asset Management,
1/ The KP Funds are Kidder, Peabody Investment Trust;
Kidder ,Peabody Investment Trust II ; Kidder, Peabody Investment
Trust III; Kidder, Peabody Municipal Money Market Series; Kidder,
Peabody California Tax Exempt Money Fund; Kidder, Peabody Premium
Account Fund; Kidder, Peabody Equity Income Fund, Inc.; Kidder,
Peabody Government Income Fund, Inc.; Kidder, Peabody Government
Money Fund, Inc.; Kidder, Peabody Cash Reserve Fund, Inc.;
Kidder, Peabody Tax Exempt Money Fund, Inc.; Institutional Series
Trust; and Liquid Institutional Reserves.
2/ Kidder Peabody California Tax Exempt Money Fund,
Investment Company Act Release Nos. 19226 (Jan. 22, 1993)
(notice) and 19269 (Feb. 17, 1993) (order); Liquid Institutional
Reserves, Investment Company Act Release Nos. 18409 (Nov. 15,
1991) (notice) and 18435 (Dec. 10, 1991) (order).
- 2 -
Inc. ( "KPAM"), a wholly- owned subsidiary of KPG, is the adviser
to the KP Funds. KP&Co. and KPAM are subj ect to certain
conditions imposed by the Exemptive Orders in their respective
capacities as distributor and adviser. After consumation of the
Transaction, PaineWebber or Mitchell Hutchins, rather than KP&Co.
and KPAM, wiii serve as distributor and adviser of the KP Funds.
You also state that Kidder Peabody Asset Allocation Fund
(the "Fund"), a series of Kidder, Peabody Investment Trust (the
"Trust"), has received assurances from the Division that the
staff would not recommend any enforcement action to the
Commission under section 12 (d) (3) of the Act if the Fund
purchased shares of common stock of GE, an affiliated person of
the KP Funds, under the conditions of the Trust's letter of
March 8, 1993. ~/
You state that PWG will not acquire the entities to which
the Exemptive Orders were issued. In addition, PaineWebber and
Mitchell Hutchins are not parties to the Exemptive Orders, and
therefore those orders 'are not applicable to them. You state,
however, that the Exemptive Orders are essential to the continued
operations of the KP Funds. You further state that PaineWebber
and Mitchell Hutchins have filed an application with the
Commission in which they request an exemptive order (the "Renewal
Order") that would effectively continue the relief previously
granted in the Exemptive Orders. 4/
You request assurance that the Division of Investment
Management will not recommend that the Commission take
enforcement action if the KP Funds, PaineWebber and Mitchell
Hutchins rely on the Exemptive Orders pending receipt by
PaineWebber and Mitchell Hutchins of the Renewal Order.
PaineWebber and Mitchell Hutchins specifically agree that,
pending receipt of the Renewal Order, they will comply with the
terms and conditions of the Exemptive Orders as though such terms
and conditions were imposed directly on them. 2/
~/ Kidder, Peabody Investment Trust (pub. avail. May 14,
1993) (the "May 14, 1993 Letter").
~/ PaineWebber America Fund, File No. 812-9394.
5/ In footnote 7 of your letter, you state that "because the
Exemptive Orders apply to registered investment companies
organized in the future that are in the same 'group of investment
companies' (as defined in Rule 11a-3) as the KP Funds, it is
proposed that any such new registered investment companies could
(continued. . .)
- 3 -
Based on the facts and representations in your letter, we
would not recommend that the Commission take enforcement action
against the KP Funds, PaineWebber or Mitchell Hutchins if,
pending the issuance of the Renewal Order the KP Funds,
PaineWebber and Mitchell Hutchins rely on the Exemptive Orders.
In particular, we base our position upon your representation that
PaineWebber and Mitchell Hutchins will comply with the terms and
condi tions of the Exemptive Orders as though such terms and
conditions were imposed directly on them. This assurance,
however, is not a substitute for exemptive relief. Accordingly,
with respect to the Exemptive Orders, this assurance shall be
effective until the earlier of final action by the Commission on
the application for the Renewal Order or one year from the date
of this letter.
Previous No-Action Letter
You request assurance that the Division will not recommend
Commission take enforcement action under section
12 (d) (3) of the Act if the Fund purchases common stock of GE as
described in your letter of January 17, 1995. In particular, you
ask that we concur in your opinion that the Fund may continue to
rely on the May 14, 1993 Letter.
You state that after the consumation of the Transaction,
PWG, the parent of PaineWebber and Mitchell Hutchins, will be an
affiliated person of GE as defined in section 2 (a) (3) (B) of the
Act as a result of GE's ownership of more than 5% of PWG's common
stock. You represent that, except for the change of identity of
the Fund's investment adviser and distributor, and the different
affiliation between GE and PWG and its subsidiaries relative to
GE's affiliation with KP&Co., the representations in the May 14,
1993 Letter remain unchanged in all material respects.
Based on the facts and representations in your letter, we
would not recommend that the Commission take any enforcement
5/ ( . . . continued)
rely on the Exemptive Orders, subj ect to those orders' terms and
conditions, pending receipt of the order sought under the
(p) ending (a) pplication." We believe that any investment companies
created after the Closing that wish to implement a
multi-class distribution system should do so based on existing
multi-class orders granted to PaineWebber and Mitchell Hutchins.
Accordingly, the assurance we express herein is limited to the KP
Funds in existence as of the Closing.
action under section 12 (d) (3) of the Act if the Fund purchases
common stock of GE as described in your letter.
This response expresses the Division's position on
enforcement action only, and does not purport to express any
legal conclusions on the questions presented. Facts or
conditions different from those presented in your letter might
require a different conclusion. Moreover, this letter provides
no assurance that the Commission will issue the Renewal Order.
Office of Investment Company
¡Janice M. Bis op
¡J . . h IÁttorney
Office of the Chief Counsel
January 27, 1995