- The art of the Con
Edward F. Hutton, the investment
banker that founded the brokerage firm that bore the name was born in New York
City in 1877. His family was poor and his father dies when he was just ten.
He was forced to drop out of school to help support his family and started
his working career as a mail boy. Eventually, Hutton became a stockbroker, married
well, and founded a small brokerage house with his father-in-lawâ€™s help. His
big break came when he opened up an office in San Francisco at the time of the
1906 earthquake. Interestingly enough, at that time Hutton had just about the
only direct telegraph line to New York and when the quake hit, he was able to
rack up big profits before anyone else even knew what had happened.
Hutton ran an open shop at the
brokerage house and encouraged all of his employees to let him know directly
if they had any solid ideas for enhancing the firm. Paradoxically, Huttonâ€™s
shop was almost anarchistic; if you were not mature enough to make your own
decisions, you really were not made of the stuff that Hutton was looking for.
Whatever the logic, E. F. Hutton the brokerage company grew until it was the
second largest firm of its kind in the United States next to Merrill Lynch.
Hutton had worked himself up
through the ranks, ultimately becoming the Chairman of General Foods as well
as the Chief Executive Officer of the brokerage company. E.F. Hutton &
Company was merged into Shearson Lehman Brothers in 1987, and today that
firm is called Salomon Smith Barney (part of Citigroup). The brokerage house
became widely known for the slogan: .When E. F. Hutton speaks, people listen..
Huttonâ€™s management remained
aggressive even after their leaderâ€™s death in 1962. This aggression manifested
itself in an awesome rejection rate of Hutton checks from Bank of Americaâ€™s
data processing equipment. Bank of America noticed that easily 50% of the checks
that Hutton wrote could not be processed by computer, fully 50 times the national
average, moreover, all of the checks that bounced out of the electronic system
had to be individually re-entered. The bottom line was that this kiting scam
allowed Hutton to profit from a much longer than average float on their checks.
This little magic trick was
accomplished in a number of ways. The “chemists” at Hutton had discovered that
when a greasy substance was rubbed into the check, it would bounce more often
than not. They had also discovered that when a staple was placed into the bar
coding area, the check would not clear the system the majority of the time,
and they learned in their research that when an edge of the check was folded,
the check could not make it through the data processing equipment. They used
every single one of these innovations to steal the float from their banks.
But that wasnâ€™t all, Huttonâ€™s
shenanigans were causing a severe backup at Bank of America, and after a careful
evaluation of what was happening, the bank voiced its suspicions that Huttonâ€™s
checks were being deliberately doctored in no uncertain terms. Bank of America
gave Hutton two choices: either they would stop playing with the checks, or
the Bank would close their account and report them to the Treasury. Hutton
However the slim at Hutton had
already found a new way to beat the system. This time they were going to do
it with brains and not brain. They created a .use of funds system that predicted
almost to the penny how much money E. F. Hutton would need at a particular branch
on any given day. Whatever was in excess would be bundled up and wired out
by 1:00 P:M so that it hit Huttonâ€™s money center account the same day
and started to pay interest immediately. Hutton felt that in order for the system
to work properly, they needed the total co-operation of their branch managers;
thus they created an incentive system where 10% of the interest received was
compensated to the office managers as a bonus for their assistance in aiding
the defrauding of their local banking institutions.
This was not a bad idea as far
as managing money was concerned, but it created a lot of problems as soon as
the managers realized that the systems could easily be rigged in their favor.
By drawing down excessive amounts of money, the manager created excess in the
interest account against uncollected funds in his local account. Small town
banks did not have the oversight systems in place to figure out what was happening;
indirectly they were being robbed blind by greedy Hutton managers who were selling
their souls to the Devil for 10% of the action.
By 1978, Huttonâ€™s brokerage
business had become only a subterfuge that allowed them to commit bank fraud
With money literally only being made from criminal activities, excesses in management
spending had come with the criminality and the firmâ€™s bottom line was eroding.
Hutton had become a money-eating machine. One possible solution to this problem
discussed by Huttonâ€™s senior officials was that the firm go into an .overdraft
mode. and subsist on the float. Even if they were caught, the banking regulators
had no oversight over a brokerage firm, and Hutton would get off Scott-free.
However, Huttonâ€™s legal analysis was fatally flawed. When regulators finally
got wind of the scheme, they concluded that it actually constituted a radically
illegal mail fraud.
By 1980, in place of checks
that heretofore had been written for a thousand dollars or more were being
replaced with multi-million dollar overdrafts, an act of theft against the banks
that were clearing the transactions. From Huttonâ€™s point of view the plan was
a startling success, and in that year, Hutton was able to cut its bank borrowings
on a daily basis from almost $400 million to a more manageable $200 million
per day. Assuming that Hutton was paying 10% interest on the money, a figure
that would probably have been conservative for that time of high rates, they
would have saved almost $20 million in 1980 alone, a very pretty penny.
However, even with this, the
companyâ€™s executives believd that more could be accomplished. Branch managers
were pushed to increase their illegal activities by extortion oriented senior
management. Those managers that didnâ€™t perform up to expectations were given
a written memorandum showing in detail the difference between the monthly commission
that they actually received and the what they could have gotten for being more
productively involved in the conspiracy. The Hutton public relations department
even went as far as to put into the managerâ€™s pay envelopes, monopoly money
showing how much more they could be making.
The New York State Corporation
owned the Genessee County Bank, a small upstate bank at which E. F. Hutton had
just opened an account. The management at the bank soon noticed that Hutton
was writing checks for millions of dollars that it was unable to cover. Hutton
was depositing uncollected funds from the United Penn Bank in Wilkes-Barre,
Pennsylvania. New York State Corporation officials called the United Penn Bank
asking whether or not there were good funds behind the checks. The response
went, something like, .Hutton never has good funds. United Penn Bank told the
caller that the check that they had issued to Genessee was indirectly backed
by a third bank-check probably issued by Manufacturers Hanover, at this point
Huttonâ€™s primary bank.
The New York State Corporation
officials told the Genessee Bank to bounce the Hutton check. They then called upon the manager responsible for issuing the
check at Hutton. He indicated that his orders were coming from higher up and
he was only a small cog in the chain. He gave them his superiorâ€™s phone number
and up the daisy chain they went. The buck stopped at a very senior level,
and the seriousness of what had just transpired was firmly impressed upon the
executive with whom they spoke. Hutton offered to deposit $30 million to its
Genessee Bank account to cover any inconvenience that Hutton may have put them
through. Genessee officials accepted the funds an hour later, and promptly froze
the account. Thus, $30 million of Hutton funds was tied up in the small bank
for over 90 days.
In late December of 1991 Genessee
officials wrote to .the state and federal banking regulators, the FBI, and the
Secret Service describing everything Hutton had done. A few days earlier, United
Penn had notified the Federal Deposit Insurance Corporation, a federal banking
regulator about their problems with Hutton. As the complaints flowed in, the
banking regulators realized they had a highly significant problem on their hands.
As though Hutton didnâ€™t already
have enough problems, a new Hutton account began depositing astronomical amounts
of money into the firm on a daily basis. An examination was commenced by the
U. S. Government as to the source of these funds, after all, Hutton had already
offered cooperate. However, not only didnâ€™t Hutton cooperate but just as the
Government was about to close in for the kill, they found out that the accounts
in question had been closed and the money had been removed based on the advise
of Hutton management. Government investigators, which included FBI chief Louis
Freeh, were incensed with Huttonâ€™s backstabbing. They had unquestionably made
a very bad enemy.
In 1983, Hutton overdrafts totaled
one-half billion dollars and the effect this had on the brokerage firmâ€™s bottom
line was that illicit interest income accounted for 75 percent of the retail
brokerage divisionâ€™s profits pre-tax profits. The Justice Department of the
U. S. Government soon discovered this intricate system and began a massive
investigation. Their conclusion was released in 1985 when Hutton .pled guilty
to 2,000 counts of mail and wire fraud; charges stemming from the use of the
nationâ€™s postal service and telecommunications networks by the firm to defraud
its banks via the draw down system. The firm teetered on the brink of insolvency
until 1988, when it was bought by Shearson Lehman Brothers, one of its major
were particularly galled in the way Huttonâ€™s auditors mischaracterized the overdrafts
on in Huttonâ€™s financial statements. There was no overdraft item on Huttonâ€™s
balance sheet; Hutton accountants used the term .Drafts & checks payable
instead. The two terms mean entirely different things, and Congress correctly
concluded that this was merely a smokescreen. They were also not to happy with
the fact that Arthur Andersen & Co., the accountants had sent a memorandum
for the files to Hutton regarding their management procedures relative
to this matter, nothing was completed and Arthur Andersen never followed it
up. Congressman Hughes had a little discussion with the accountantâ€™s audit partner
regarding this matter:
Hutton would have turned over in his grave had he been aware that of his bunch
of shyster employees had brought such shame to his good name. These folks admittedly
were unable to profitably run a brokerage firm and were obliged to steal from
other financial companies to make end meet. If they had been a little more sophisticated
and not pushed so hard for their employees to break the law, we would have called
their exercise, excellent money management techniques. However, one caught,
they became social pariahs. Huttonâ€™s reputation had become so damaged by the
terrible publicity that several years later they were merged out of business.