GE's Kidder Peabody Embroiled in a Series of Scandals

Strategic Insights -

Michael Carpenter, Kidder's chairman, had little idea of what was going on at the firm, and shareholders have filed a class-action lawsuit against Kidder and its former chief government bond trader, Joseph Jett, accusing the brokerage of overstating its net worth, earnings, and business prospects. The lawsuit follows a series of events that have revealed lax management at Kidder, including the alleged fictitious profit of $350-million in fictitious profit. The crisis has focused attention on Kidder's management practices, including the decentralized and results-oriented methods favored by General Electric Co.'s CEO, John Welch.

Key Takeaways:

  • Kidder Peabody's management practices, including a decentralized and results-oriented approach, have been criticized for contributing to the firm's problems.
  • The brokerage's dependence on mortgage-backed securities, which accounted for about 70% of its profit, has made it vulnerable to changes in interest rates.
  • Kidder's CEO, Michael Carpenter, was unaware of the firm's troubles and has faced criticism for his lack of experience in the industry.
  • The company's former chief government bond trader, Joseph Jett, has been accused of running a phantom trading scheme to boost Kidder's profits.
  • The National Association of Securities Dealers has ruled in favor of Mr. Jett's request to have his case heard before an arbitration panel.
  • Kidder's credit and legal departments approved a deal involving a yen-denominated derivative backed by Italian government bonds, which ultimately cost the firm $1.7-million.
  • Employee Clifford Kaplan received a $500,000 bonus despite the deal's problems and later left Kidder due to disagreements with management.
  • Kidder has an estimated $12-billion inventory of mortgage-backed securities, with at least 30% being relatively illiquid mortgage derivatives.
  • The company's mortgage business, run by Michael Vranos, has shown no signs of trouble, but critics warn that if something goes wrong, GE shareholders would foot the bill.

Statistics:

  • Kidder Peabody's debt-to-equity ratio is nearly 100 to one.
  • As of December 31, 1993, Kidder had assets of $72.9-billion and equity of $778-million.
  • Kidder issued $81-billion worth of mortgage-backed securities last year.
  • The company's mortgage business is run by Michael Vranos, who was paid $15-million last year.
  • Clifford Kaplan, a 28-year-old Kidder employee, received a $500,000 bonus for his role in a problematic deal.
  • GE could foot the bill if something goes wrong in Kidder's mortgage business, which has an estimated $12-billion inventory of mortgage-backed securities.

Sources:

  • "Kidder's woes mount as ex-trader fights dismissal" by Daniel Schorr, The Economist, May 27, 1994.
  • "GE's Kidder faces class-action lawsuit" by Michael Siconolfi, Wall Street Journal, May 27, 1994.
  • "Kidder Peabody's troubles deepen" by Laura Mandell, Financial Times, May 27, 1994.
  • Securities Data Co. (no date).
  • Kidder Peabody Annual Report 1993.