Phantom profits on Wall Street

THERE are some troubling parallels in the mercurial careers of Joseph Jett, the Kidder Peabody treasuries trader, and Paul Mozer, the Salomon Brothers treasuries trader.

Both men, at 36, rose to become head of the government securities desks at their firms from relatively humble origins. Both were also intensely competitive, bristling whenever their judgement was challenged. Mr Jett would literally roar at subordinates who displeased him, while Mr Mozer once told a deputy assistant US Treasury secretary he was going to have him sacked.

And in the tough, post- 1980s regulatory climate on Wall Street, both men wound up being accused of engineering schemes that cost their employers hundreds of millions of dollars.

Mr Jett was dismissed last week after allegedly booking some dollars 350m-worth of illusory profits. He has yet to tell his side of the story - apparently because his bank accounts have been frozen and he has been unable to retain a lawyer.

Mr Mozer, for his part, recently pleaded guilty to criminal charges of lying to regulators about his 1990 attempt to corner the market in US Treasury securities. He is to go on trial in June on separate charges filed by the US Securities and Exchange Commission.

The fact that both scandals have implicated young professionals is no coincidence, securities enforcement officials say. A Master's degree in business administration has become indispensable for taking on the hi-tech markets where big money is being made.

Derivative debt instruments such as the Treasury 'strips' Mr Jett allegedly manipulated - the interest-paying portion of a bond that has temporarily been divorced from its principal - represent ripe ground for a clever and opportunistic trader. Not only regulators have trouble monitoring these markets; George Soros, the best-known hedge fund manager, conceded last week that not even he understands some of the more arcane products.

US regulators say the complexity of the bond market is leading to a rash of new frauds. 'Hi-tech and computers make it easier to move money, easier to hide it, easier to steal it,' says James Dudine, a former enforcement chief with the US Federal Deposit Insurance Corporation.

What stands out about both the Kidder and Salomon episodes, however, is that they involved relatively straight- forward deception. In both cases, a lack of supervision would have been a key factor in allowing such schemes to work.

The alleged scheme at Kidder exploited a shortcoming of the company's computer accounting system, which carries the value of 'forward' trades - agreements to sell a security at a future date - at their eventual sale price. Typically, this is higher than current value. The difference between the prices, which normally narrows as the sale date approaches, is treated by the system as a profit - essentially ignoring the cost of carrying the strip in the meantime.

The 'profit' would normally disappear once the security was sold. But by 'rolling over' the trade - in this case, allegedly re-selling the strip to a non-existent buyer - the system maintained a profit on the account.

But as was the case with the Salomon ploy - which involved overbidding at US Treasury auctions to ensure Salomon controlled a huge share of the issue - the Kidder scheme was curiously flawed. To keep reporting profits, one would be condemned to keep rolling over the same trades with ever-longer maturities and for ever-bigger amounts.

Sooner or later, the game would have to come to an end, according to bond traders from rival firms. 'The mystery,' said a compliance officer at another Wall Street firm, 'is that in neither case did anyone seem to have prepared for that eventuality.'

(Photograph omitted)