A $2 Million Fine for Kited Checks

By Spencer Davidson.

"This is a sad and difficult day for E.F. Hutton and for me personally," said a subdued Robert Fomon, chairman and chief executive of Wall Street's fifth-largest brokerage firm. Hours before Fomon appeared at a press conference in New York City last week, Hutton President Scott Pierce had pleaded guilty on behalf of the firm to 2,000 separate criminal charges of mail and wire fraud. After accepting Pierce's pleas in a Scranton, Pa., courtroom, Federal Judge William Nealon fined Hutton the maximum $1,000 on each charge, or a total of $2 million. Never before had a prestigious Wall Street investment group acknowledged such a major fraud.

The charge made last week by Attorney General Edwin Meese was that Hutton had used a sophisticated method of check kiting to avoid high interest rates. Kiting is a procedure in which two or more checking accounts are played off against each other to stay one step ahead of a bounced check. After overdrawing an account at one bank, a person or institution pays the overdraft by writing another check, which overdraws an account on another bank. With some quick moves, it is possible to stay just ahead of the bankers and in effect obtain an interest-free, short-term loan.

In the case of E.F. Hutton, executives deposited funds in local banks and then wrote checks for sums greater than the amounts in the accounts. Those were then covered a few days later by checks from other Hutton branches. In addition, 83 Hutton offices were involved in multiple transfers that moved money among a series of banks on its way between Hutton offices. As much as $10 billion was involved over a 20-month period starting in July 1980, during which time short-term interest rates rose to more than 20%. Thus the practices provided E.F. Hutton with interest-free loans of as much as $250 million a day.

At least 400 commercial banks were affected by the transactions, some of them small rural banks so eager for Hutton deposits that they might have been inclined to ignore doubtful practices. In addition to the $2 million fine and $750,000 in court costs, Hutton has had to set aside a reserve to pay the banks the missing interest, which could amount to $8 million or more.

No individuals were named in last week's charges or identified by the company, even though the Hutton branch managers benefited because they were given bonuses equal to 10% of their branch profits. That immediately raised charges of Justice Department favoritism toward Big Business. Meese lamely attempted to explain his decision not to go after any Hutton employees, saying it was necessary to give immunity "to push the investigation along." He added, "It didn't seem fair to subsequently charge other individuals for doing identical acts."

Hutton's Fomon last week stressed that no customer or client lost any money as a result of the illegal transactions. Even so, a brokerage house that gathered considerable eminence with its "When E.F. Hutton talks, people listen" advertising campaigns had swiftly lost some prestige.

The person perhaps most embarrassed by last week's disclosures was John Shad, who was Hutton vice chairman during part of the time the fraud occurred and is now head of the Securities and Exchange Commission. The SEC, under the Investment Company Act of 1940, must now rule on whether Hutton, after being found guilty of criminal misconduct, will be allowed to continue acting as an investment adviser. The SEC will not make a decision in the case for at least six months, and Shad has already exempted himself from participating in the deliberations.

With reporting by David Beckwith/Washington and Thomas McCarroll/New York