E.F. Hutton Guilty in Bank Fraud : Fined $2 Million for Scheme Similar to ‘Check Kiting’

WASHINGTON â€”  E.F. Hutton & Co. Inc., one of the nation’s largest securities dealers, was charged Thursday with 2,000 counts of wire and mail fraud for using a scheme similar to “check kitingâ€� to fraudulently obtain as much as $250 million in interest-free funds a day from 400 banks across the country.

In a deal with the government, the company pleaded guilty in federal court in Scranton, Pa., where the fraud first came to light, and was fined the maximum $2 million and assessed investigative costs of $750,000. No individuals were charged.

Hutton also agreed to work out a means of paying restitution to the banks and other financial institutions that were cheated out of interest payments from 1980 to 1982--when interest rates ran as high as 20%. Hutton said it is confident that the $8 million it has set aside for restitution will be more than enough.

‘Tens of Millions’

However, Robert W. Ogren, chief of the fraud section of the Justice Department’s criminal division, said the restitution needed will be “in the tens of millions.�

The brokerage firm stressed that the crimes to which it pleaded guilty injured “certain commercial banks� but did not involve or threaten customer or client funds. But Robert Fomon, chairman of the parent E. F. Hutton Group, said it was “a sad and difficult day� for the company and for him personally.

Fomon said that “the company and its top management assume full responsibility� for failing to impose needed controls “in internal cash-concentration procedures.�

The New York Stock Exchange suspended trading in the Hutton Group’s stock at the beginning of Thursday’s trading, although it opened later and dropped $3.75 a share to $29.25. The company also postponed its annual meeting from today to May 17.

Excessive Withdrawals

According to court papers filed by the government in the case, Hutton’s scheme involved withdrawing arbitrary amounts that exceeded the amount of customer funds it had deposited. These excessive withdrawals were covered by depositing checks drawn on other Hutton accounts.

In a detailed statement, Hutton described this practice as “excessive drawdowns,� which it defined as “intentionally and persistently writing excessively large checks against deposits before the checks creating those deposits had cleared.� Similarly, under check kiting, money or credit is obtained by using checks written against deposits that do not exist.

In addition, Hutton transferred funds from bank accounts maintained by its branches to those of its regional offices and then to its prime depository banks, exploiting the opportunities this created in delayed clearing times of deposits, according to the government.

Any convicted felon--including a company--is barred by federal law from acting as an investment adviser, but Hutton requested a waiver so that it could continue to act as the adviser for the mutual funds it manages for about 500,000 customers.

The SEC agreed to a 180-day temporary waiver while it conducts an investigation to determine whether to grant a permanent exemption.

The waiver was granted, SEC spokeswoman Mary McCue said, to “avoid disruption of the securities market� and to avoid injuring Hutton’s customers.

At a news briefing, Atty. Gen. Edwin Meese III said the action served notice on the business community that the Justice Department intends to vigorously prosecute white-collar crime.

Meese defended the failure to charge any individuals on the grounds that the scheme was developed as a corporate enterprise and that no one profited individually. He also said that it was necessary to grant immunity from prosecution to certain individuals and that it would not have been fair to prosecute some, but not all, of those behind the scheme.

However, court papers filed by the government in a related civil action that bars Hutton from similar acts in the future indicated that some Hutton branch managers did benefit financially.

The company “provided financial inducements and incentives to its branch office managers that, among other things, encouraged them to be more ‘aggressive’ and ‘creative’ in the overdrafting of their . . . depository bank accounts,� the government’s request for a permanent injunction stated.

“The financial inducements and incentives included crediting the branch offices with any interest benefits inuring to defendant Hutton Co. arising out of the branch’s relationship to its depository banks,� the complaint said. “In general, 10% of the branch profits (which included interest charges and credits) were paid to the defendant Hutton Co.’s branch office managers as part of their compensation.�

Government estimates of Hutton employees granted immunity from prosecution ranged from 10 to 50, most of them cashiers or at similar levels in some of Hutton’s local and regional offices.

Meese emphasized that the scheme went far beyond taking advantage of “float,� the interval between the time a check is deposited in a bank and the time the depository bank collects funds from the institution on which the check was drawn.

An example given in the government’s complaint for a permanent injunction said that some Hutton branch personnel, when deciding on an amount of money to withdraw, would add a zero, “thereby increasing the amount of the withdrawal tenfold.�

Meese indicated that he does not think the practice is widespread in the brokerage industry.

“I’m not so sure that other brokerage firms are necessarily doing the same thing, because this was not just a matter of taking the normal float,� Meese said. “This was actually taking out of the banking system two and three times as much money as was secured by deposits or future deposits. It really was a scheme in which a multiplier effect was used.�

When a questioner suggested that the Hutton statement made it appear that its actions were “a normal commercial practice,� Meese said: “In that case, we’re going to have an awful lot of prosecutions.�

Last October, E. F. Hutton & Co. was accused by the President’s Commission on Organized Crime of cooperating with an alleged courier for a Mafia heroin trafficking organization by ignoring a warning about his transactions and by notifying an associate of the courier when a federal grand jury subpoenaed bank records in the case.

Thomas Rae, Hutton’s general counsel, said the commission was “very unfair to us.� He contended that notifying the courier’s associate “was an unfortunate misunderstanding by Hutton employees.�