As E. F. Hutton tries to restore its image, regulators looking at it even more closely

They're slinging mud at one of Wall Street's darlings. Even as it drips and oozes over E. F. Hutton & Co.'s pristine reputation, observers say it may be Thanksgiving before the mess is cleaned up, and perhaps a year before the firm can regain a semblance of credibility.

In May, Hutton pleaded guilty to 2,000 counts of fraud. But a general admission of corporate guilt wasn't enough. Now, the quest for a guilty person or persons is again tarnishing Hutton's name.

Just months ago, E. F. Hutton had an unsullied reputation as one of the best-managed, most-respected brokerage firms in the business. When Hutton spoke, its mouthpiece of some 6,700 brokers made sure people listened.

Until May 2. That is when the firm pleaded guilty to a massive check-overdraft scheme involving some 23 branch offices and 400 banks. Between 1980 and 1982, Hutton made millions of dollars in interest through a complex checking operation that shifted funds between banks to cash in on the ``float'' -- the delay in crediting account balances.

Hutton quickly agreed to pay a $2.75 million fine. It set aside $8 million to pay back the banks for lost interest. Management did what the public relations textbooks say is the best way to avoid a drawn-out scandal -- make a clean breast of things.

To clear its name, Hutton hired former Attorney General Griffin Bell to do an internal investigation. A new president was hired away from Merrill Lynch. And former deputy secretary of state Warren Christopher was recently retained to for ``strategic guidance.''

But the controversy has escalated. Two congressional subcommittees, the Securities and Exchange Commission, and a group of 50 state regulators are all investigating Hutton now. And it's possible the Justice Department may reopen its case.

Wall Street analysts rail that the government and the press have blown the whole thing out of proportion. Controversy can be a tremendous liability for a firm whose sales depend on the trust of the public.

``I'm amazed by the attention it's gotten,'' says Brenda Davis, a brokerage analyst at Mabon, Nugent & Co. in New York. ``[The bankruptcy of] Baldwin-United was a bigger scandal in terms of dollars and cents.'' Ms. Davis and others note that Hutton's practice of taking advantage of check-float delays is not unusual -- albeit often on a smaller, much less aggressive scale -- among other brokerage houses, banks, and corporations.

But the admission of guilt has triggered a series of investigations that has kept the company in the news.

For instance, federal securities laws indicate Hutton's guilty plea should be grounds for debarment as an investment adviser. The Securities and Exchange Commission has temporarily waived debarment while it conducts an investigation. SEC auditors are also now reviewing the cash management practices of most major brokerage firms, analysts say.

Punitive SEC action is expected by November. ``For political face-saving purposes, the SEC will have to fine Hutton,'' says Perrin Long, brokerage analyst at Lipper Analytical Services, New York.

But the SEC may be the least of Hutton's worries. Almost every state in the country has laws prohibiting anyone with a criminal record to sell securities. The magnitude of Hutton's offense and its client base has left state regulators unsure of what steps to take.

``We're in a quandary,'' says Patricia Whalen, staff attorney at the Massachusetts Securities Commission. ``We're here to protect the investors. But if Hutton's license is revoked or suspended, its doors are closed. And where does that leave E. F. Hutton investors?

``And we could suspend Hutton from taking in new clients,'' Ms. Whalen says. ``But then, are you hurting the company or John Smith, an honest broker working for E. F. Hutton but who is not guilty of anything? Finally, we have to uphold the provisions of the statute [which can bar someone with a felony conviction from selling securities] uniformly,'' whether it be E. F. Hutton or someone else.

The North American Securities Administrators Association (consisting of securities regulators from 50 states) has formed a committee to study the Hutton case. The group plans to make recommendations to state securities regulators by October.

Some states, such as Connecticut, are conducting their own investigation. Today, the Connecticut banking commissioner will announce whether hearings into the Hutton case will reopen because of newly discovered documents that may contradict previous testimony.

Many states, including Massachusetts, are awaiting the finding's of Mr. Bell, a senior partner in the Atlanta law firm King & Spalding. If his inquiry pinpoints the individuals and specific branch offices involved in the checking scheme, then state regulators may have a clearer course of action.

``My job is to determine who's responsible,'' Bell says. ``And who had knowledge but didn't do anything about it at the corporate office level. And to make recommendations so it won't happen again.''

Earlier this month, Bell's investigation turned up 18 documents the Justice Department subpoenaed but never received. And that put the Hutton scandal back on Page 1. The documents indicated that perhaps some corporate officials knew and encouraged the overdrafting going on at regional offices.

``I am confident there are going to be some disciplinary actions and some terminations,'' Hutton chairman Robert Fomon said recently. Bell says he plans to have a report ready by Labor Day.

How will this affect Hutton's business?

``I can't, and Hutton can't, quantify what the domino effect might be,'' says Mr. Long at Lipper. ``Who knows how many other states will follow if Connecticut suspends their license for a period of time or gives their profits to charity?''

To date, the cloud hanging over Hutton has rained on only a few deals. One Massachusetts and one New York state agency have dropped Hutton from future financings. New York City banned Hutton from underwriting one deal, then reinstated the firm.

While Hutton's checking abuses did not endanger its clients' money, calls to brokers in regional offices show that a few customers have pulled their accounts. One broker said, ``People that are astute applaud us for our aggressive money management. Those that aren't astute or are older, more conservative, are appalled.''

Long doesn't see one or two lost accounts per broker as too detrimental. ``What is hurting is a sizable slowdown in the rate of new accounts opened,'' he says. Hutton has stopped advertising and has seen a drop in invitations to investment seminars.

Productivity suffers too, says Ms. Davis at Mabon, Nugent: ``Brokers talk about what's happening to Hutton and wonder, `Should I be looking for a new job,' rather than prospecting for new accounts or executing trades.''

In Washington, the controversy is being fed by an investigation by the House Judiciary subcommittee on crime led by US Rep. William J. Hughes (D) of New Jersey. That inquiry has been slowed by difficulties in obtaining documents from the Justice Department, which says its hands are tied by privacy laws governing grand jury investigations.

On Friday, hearings did reveal that as early as March 1980, a Hutton executive had asked for a legal opinion about the firm's banking practices. But at the time, Hutton's general counsel Thomas Rae said he told Hutton officials those practices were not illegal.

Congress jumped into this case because some members are concerned the Justice Department let E. F. Hutton off too easily: A major crime and no criminals? Surely, congressmen feel, someone among Hutton's higher-ups knew what was going on.

But the Justice Department didn't think it had a strong enough case to prosecute individuals at Hutton. ``We ultimately viewed our choice as one between an uncertain prospect of convicting two mid-level individuals who did not gain from the fraud, against the certainty of a broad-based enforcement stroke that could immediately wipe out cash management abuses throughout the business community,'' stated the Justice Department.

Analysts say it's possible that top E. F. Hutton executives knew too little about how the scheme worked to discern that it was illegal. Congressional investigators have said privately that not all bank overdrafting procedures are illegal and it may be difficult to pin down which references in the Hutton documents apply to illegal activity.

But apparently, there is a strong desire -- by Congress and now by Hutton management -- to see someone take the blame. ``What every one is waiting for is Griffin Bell's report and Hutton's response to it. To end this thing, there seems to be a need for blood, for heads to roll,'' says Joel Rosenthal, an analyst at Jesup & Lamont Securities in New York.

The end result of the Hutton scandal is likely to be either legislated or voluntary revamping of corporate cash-management methods. A code of ethics for cash-management officers has been suggested. Banks may set up a different set of check-clearing policies for corporate clients. Undoubtedly, banks are now paying closer attention to corporate account balances.

For Hutton, the dark smear on its reputation will take time to remove. ``There's no question, we face a rough road,'' concedes newly-hired Hutton president Robert Ritereiser. He says, in the future he hopes the public will judge Hutton on its investment performance and not on past ``aberrations.''