E.F. Hutton

EF Hutton was an American stock brokerage firm founded in 1904 by Edward Francis Hutton and his brother, Franklyn Laws Hutton. Later, it was led by well known Wall Street trader Gerald M. Loeb. Under their leadership, EF Hutton became one of the most respected financial firms in the United States and for several decades was the second largest brokerage firm in the country.

History

Founding through the 1970s

E.F. Hutton & Co. was founded in San Francisco in 1904 by namesake Edward Francis Hutton and his brother, Franklyn Laws Hutton. EF Hutton was one of the first brokerages to open offices in California. In 1906, two years after the firm was founded, its offices were destroyed in the San Francisco earthquake of 1906. In 1924, famed Wall Street trader Gerald M. Loeb joined the firm, ultimately rising to chairman. The firm developed a nationwide retail brokerage network to market its debt and equity securities. It also operated seasonal offices in Palm Beach, Florida (winter) and Saratoga Springs, New York (summer) to cater to its customers. Morrie Cohen opened Hutton's first one-man office on Maui in December 1969.

Hutton, an entrepreneur who later also became chairman of the General Foods Corporation and for years wrote a newspaper column, led the firm until his death in 1962. In 1970, Robert M. Fomon was appointed Hutton's Chief Executive Officer. In or around 1972, the firm hired Carole Brookins, making her one of the few women stockbrokers on the Chicago futures exchange floors at the time. Despite the failure or takeover of many of its peers in the 1960s and 1970s, Hutton retained its independence under Fomon's leadership. By the early 1980s, the original E.F. Hutton & Co. had become the principal component of what grew into a group of companies owned by E.F. Hutton Group Inc., listed on the New York Stock Exchange. Other subsidiaries of that Delaware-chartered holding company were E.F. Hutton Trust Company (now "Smith Barney Corporate Trust Company" and owned by Citigroup), E.F. Hutton Life Insurance Company, and E.F. Hutton Bank. The Hutton companies also managed many mutual funds and other investment vehicles, some of which were separately incorporated and/or registered, and participated actively in corporate mergers and public offerings of securities. In 1976, Western Union partnered with E. F. Hutton & Co.

1980s check scandal

In 1980, several Hutton branches began writing checks which were greater than the cash they had on hand at the bank, then making a deposit in another bank equal to the amount it wrote at the first bank. This strategy, known as "chaining", is a form of check kiting. "Chaining" gave Hutton the use of money in both accounts until the checks cleared. In effect, Hutton was giving itself a free loan that also did not carry any interest. Thomas Morley, who was in charge of getting the firm to better manage its cash, wrote a memo to Hutton's president, George Ball, saying that this practice netted one branch an extra $30,000 per month. Ball sent the memo out across Hutton's network of regional sales managers, with the note, "A point well remembered—and acted on." Over the years, Hutton shuffled money in this manner between 400 banks (mostly small rural banks), gaining the use of an estimated $250 million a day without paying a penny in interest. Whenever something was amiss, Hutton questioned the bank's procedures.

The scheme worked for almost three years until officials at the Genesee County Bank in Batavia, New York, discovered that the large deposits made by Hutton's four-person office there were far more than the office's banking requirements. They also discovered that the checks Hutton was using to make the deposits were drawn on two Pennsylvania banks. When Genesee officials learned that Hutton did not have enough money in the Pennsylvania bank accounts to cover the checks, they stopped honoring Hutton checks. One of the banks involved, United Penn Bank (now part of Citizens Financial Group), asked the Federal Deposit Insurance Corporation to investigate. In 1984, the matter was forwarded to the United States Attorney for the Middle District of Pennsylvania, who opened a federal criminal probe.

Hutton retained Tom Curnin, a respected defense attorney who was inclined to fight the government. However, in February 1985, Curnin discovered a memo from a Hutton regional vice president for the Washington, D.C., area which stated that his offices drew on "bogus deposits". The memo—tantamount to a smoking gun—led Curnin to change tactics and begin negotiations for a plea agreement. In the spring of 1985, Curnin told Hutton's board that it faced two choices: plead guilty to a massive list of felonies or face a trial that would likely see three senior Hutton executives convicted and drive Hutton out of business. Curnin advised settling with the government to avoid years of bad publicity.

On May 2, Hutton agreed to plead guilty to 2,000 counts of mail and wire fraud, as well as pay a $2 million fine plus $750,000 for the cost of the investigation. This is equivalent to approximately $ and $, respectively, in . Hutton also agreed to pay $8 million in restitution—the estimated extra income earned from the fraud. This is equivalent to approximately $ in . In return, Curnin wrung two major concessions. First, no Hutton executives would be prosecuted (even though the government determined that 25 senior officers masterminded the scheme). Second, the Securities and Exchange Commission allowed Hutton to stay in business; offenses of this magnitude usually result in an individual or firm being permanently barred from the securities industry.

An internal review conducted by former Attorney General Griffin Bell concluded that the scam occurred due to inadequate internal controls. For example, no one admitted to being Morley's immediate supervisor. However, a wide perception that Hutton had not been punished enough (for example, ''The New York Times'' William Safire claimed that the $2.75 million fine amounted to "putting a parking ticket on the Brink's getaway car"), led several customers to pull their accounts with Hutton, and many of the firm's star performers fled to other firms. Several public agencies also took their business elsewhere. Although Fomon was not implicated in the scandal, the board fired him in 1987.

1987 market crash and 1990s mergers

In early 1987, an internal probe revealed that brokers at an office in Providence, Rhode Island, laundered money for the Patriarca crime family. Although Hutton reported the investigation to the SEC, it was not enough to stop prosecutors from all but announcing that Hutton would be indicted.

In a case of especially bad timing, this came only a week before the 1987 stock market crash. By the end of November, Hutton had lost $76 million, largely due to massive trading losses and margin calls that its customers could not meet. It also had its commercial paper rating cut from A-2 to A-3, effectively losing $1.3 million in financing. Hutton was now weeks—perhaps days, according to some board members—from collapse. On December 3, Hutton agreed to a merger with Shearson Lehman/American Express. The merger took effect in 1988, and the merged firm was named Shearson Lehman Hutton, Inc.

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