Placing the Blame At E.F. Hutton

By Stephen Koepp

When E.F. Hutton Chairman Robert Fomon gave a 30-minute talk over the company's public-address system last week, everybody listened. His 17,000 employees and the rest of Wall Street had been waiting four anxious months for the results of an internal probe into the check-kiting scheme for which Hutton paid a $2 million fine in May. "It won't make pleasant reading," Fomon advised as he gave a preview of the 183-page report issued last week by former Attorney General Griffin Bell, whom Hutton had hired for the job.

No specific Hutton employees had been singled out for blame back in May, when the company pleaded guilty to 2,000 counts of wire and mail fraud. The Justice Department's failure to charge any of Hutton's executives raised howls of criticism that cast further harsh light on the company's operations. But, as expected, Bell's report did single out offenders and called for changes in the way Hutton does business. "I think we got the facts," declared Bell, whose team of 14 lawyers interviewed more than 370 current and former Hutton employees. Says James Hanbury, who studies Hutton for the investment firm Wertheim & Co.: "Bell was tougher on Hutton than I expected. You can't call this a whitewash."

Bell's report criticized 15 executives in particular, and Hutton promptly announced plans to discipline 14 of them. Three senior officials will leave the company: Thomas Lynch, a vice chairman; Thomas Rae, chief legal counsel; and Thomas Morley, a senior vice president in charge of cash management. Lynch, however, will keep his director's post and continue to receive full pay; Rae will retire early. Two mid-level executives will be officially reprimanded, three regional managers will be suspended for 30 days without pay, and six branch managers will be fined between $25,000 and $50,000. The payments from the officials, all of whom earn at least $100,000 a year, will be turned over to charity.

While many large companies today manage their money by aggressively moving it among various accounts, some of Hutton's branch managers went much too far. They issued a flurry of overdraft checks in order to obtain no- interest loans at a time when rates were about 20%. For 20 months beginning in July 1980, the company obtained as much as $250 million a day in freebie loans on which it could earn interest. Bell termed the overdrafts "so excessive and + egregious" that "no reasonable person could have believed that (their) conduct was proper."

Bell's report concludes that Hutton's upper officers put excessive pressure on branch managers to boost their cash-management income and then failed to monitor how it was being done. One senior vice president gave underlings envelopes containing play money equal to how much extra profit he thought they could be bringing in. But in attempting to trace the blame for the check-kiting scheme as high as possible on the corporate ladder, Bell discovered a "peculiar management structure" at Hutton with fuzzy personal responsibilities. No one, for example, was willing to admit being the immediate boss of Morley, the cash manager. Wrote Bell: "Morley is now an orphan, seemingly lost or at least in limbo along with his corporate function." Even so, the investigator found fault with Lynch because "he should have been aware of potential abuses of overdrafting."

The very top officers at Hutton, though, escaped any charges of wrongdoing in Bell's report. These include Fomon and former President George L. Ball, who is now head of Prudential-Bache. While the investigator deemed that Ball contributed to Hutton's "overdraft culture" because he "constantly exhorted" branch managers to boost their earnings, the president's job description made him responsible largely for sales performance rather than banking or legal questions. As for Fomon, Bell did not hold him accountable because the chief executive had hired qualified underlings and "was entitled to rely on the decisions, judgments and performance of these persons."

Hutton pledged to take all the remedies that Bell prescribed to prevent recurrences. Until now, Hutton has been largely run by insiders; only four of its 27 directors are from outside the company. But to provide additional controls, the firm's board will be recast to include a majority of outsiders in place of corporate officers. Hutton will restructure its management chart so that diverse number-crunching departments will answer to a single top financial executive.

In some aspects, Bell's report contained heartening news for Hutton. He disagreed with earlier estimates that Hutton's scheme had cost banks as much as $30 million. Instead, the investigator contends that the $8 million that Hutton has set aside to compensate the banks will be more than enough. Hutton's culpability, though, will be further scrutinized in probes by a House subcommittee and the Securities and Exchange Commission, among others.

The upheaval at Hutton creates uncertainty about the future of the firm started in 1904 by Edward F. Hutton. Since Fomon took over as chief executive in 1970, he has managed to turn Hutton into one of Wall Street's most dynamic performers while at the same time eluding takeover bids by other financial companies. But its independence is growing tenuous. Hutton's shake-up could prompt some senior executives and other large stockholders to welcome a takeover offer. That could make Hutton an easier acquisition target for such firms as Phibro-Salomon, the investment company, or Chrysler, which has been seeking to buy a financial subsidiary. While Hutton executives hope that Bell's report will be the end of the overdraft episode, the story may not be over.

With reporting by Anne Constable/Washington