BULL STREET - The art of the Con

When E. F. Hutton Talked You Were In Trouble

 

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-law’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, Hutton’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.. 

 

Hutton’s management remained aggressive even after their leader’s death in 1962.  This aggression manifested itself in an awesome rejection rate of Hutton checks from Bank of America’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 wasn’t all, Hutton’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 Hutton’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 complied. 

 

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 Hutton’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, Hutton’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 firm’s bottom line was eroding. Hutton had become a money-eating machine. One possible solution to this problem discussed by Hutton’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, Hutton’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 Hutton’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 company’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 didn’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 manager’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 Hutton’s primary bank. 

 

The New York State Corporation officials  told the Genessee Bank to bounce the Hutton check[45]. 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 superior’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.[46] 

 

As though Hutton didn’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 didn’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 Hutton’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 firm’s bottom line was that illicit interest income accounted for 75 percent of the retail brokerage division’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 nation’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 competitors[47].  

 

Congressional investigators were particularly galled in the way Hutton’s auditors mischaracterized the overdrafts on in Hutton’s financial statements.  There was no overdraft item on Hutton’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 accountant’s audit partner regarding this matter:

Mr. 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. Hutton’s reputation had become so damaged by the terrible publicity that several years later they were merged out of business. 

 

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