Mr. Mazzoli. Let me ask you this question. Are you satisfied enough with what you have done that if there was a check-kiting operation, or whatever you want to call this thing, procedure, process, that you'd know about it, and if you'd know about it, you should go to jail if somebody is performing some little dance down at the end of the string.

Mr. CASTELLANO. We have developed――

Mr. MAZZOLI. You would be prepared to say that the things are right enough that you'd go to jail if they weren't, right now-Mr. CASTELLANO. Well

Mr. MAZZOLI [continuing]. In 1985, June the

Mr. CASTELLANO. I don't like the term jail, but I would say that we have the▬▬

Mr. Mazzoli. Would you take responsibility for whatever would be civil or criminal, for what is going on right now in E.F. Hutton, this very moment?

Mr. CASTELLANO. I would take responsibility for the controls that are implemented to show us if this thing could ever happen again. Mr. MAZZOLI. Mr. Fomon, let me ask you that direct question. Are you satisfied enough with what you've done now, on your own, pending what Mr. Bell does, and what any of the other action, that you would not take full personal, even criminal, responsibility for anything which is going on down the line? Are you satisfied enough with what you have done?

Mr. FOMON. Well, I'm not satisfied in relation to what we will do in the future.

For example, we were wrong in leaving the bank relationships to each individual region. In the future, we will control-

Mr. MAZZOLI. In the future? I thought the future was now. It is now, according to Mr. Castellano.

Mr. FOMON. All right. The future is now.

We will-we are setting up a system to control all of theseMr. MAZZOLI. I thought it was setup. Excuse me "are setting" or "is set" up?

Mr. FOMON. It is not set up.

Mr. MAZZOLI. It is not set up?

Mr. FOMON. It is set up from Mr. Castellano's standpoint. Mr. MAZZOLI. I get the impression that there may not be complete accord at the table as to what has been done and what hasn't been done. I won't press the point, because you all may not have consulted, but you should have before today.

Mr. Lynch, are you satisfied, would you put your neck on the line for what E.F. Hutton has done?

Mr. LYNCH. Well, the changes in the reporting relationships, the new controls and procedures are not under my jurisdiction, either under Mr. Castellano's, or-

Mr. MAZZOLI. All right—

Mr. LYNCH [continuing]. Under Mr. Hines-

Mr. MAZZOLI. I appreciate that.

I'm sure that in a great success by E.F. Hutton you wouldn't divorce attention to, or you wouldn't claim to be a "bastard child," I think that, you know, concomitantly, if there is something wrong being done down below after all of this kind of attention, I would hope that you'd have some.

Anyway, Mr. Morley, you seem to be a guy on the spot here. How do you feel? Are you satisfied with what's been done, that you'd put your neck on the block right now?

Mr. MORLEY. I still-I think we are in the process of setting the controls up. I still think we have some more to do as far as centralizing the local relationships, but I am confident that we have in place now a mechanism to ensure everything is going on, and we will have an absolute foolproof in a very short period of time. Mr. MAZZOLI. I thank you, gentlemen.

I thank you, Mr. Chairman.

Mr. HUGHES. I just want to say to my colleagues, I appreciate your spending what is an inordinate amount of time on a very complicated matter, and I appreciate the forebearance and the patience of the witnesses and those that are hear today. We have been at it a long time. I see some colleagues yawning, so it is time either to put them to bed or eat, and before we break I want to make a couple observations.

First of all, Mr. Castellano, I don't buy your suggestions that your office was not aware of the excessive overdrafting. The documents which we have, which we will get to after lunch, suggest otherwise.

To you, Mr. Fomon, I want to say that the documents that we've examined to date suggest, and we're going to supply you with some of them so you can take a look at them over lunch, that in fact there were people in the senior management that were aware of these practices, that the practices were encouraged. There is a great deal of pressure on the part of regions to comply with-for the central region, in particular, which was involved in excessive overdrafting, so there is an explanation for much of it.

I am not suggesting that, in a company your size, every region knew what every other region was doing, but I do suggest to you that, once you read the documents, I think that you'll have to agree that there were people in high places in your company that were aware of the excessive overdrafting. Overdrafting, to me, suggests that you're taking funds that don't belong to you.

Mr. Castellano, you had to submit a number of reports to the SEC, and also to your stockholders, financial statements. You had to reconcile, from time to time, those figures, and when you have to reconcile $400 to $450 million in drafts and checks payable, and try to explain that to the SEC, you've got to be on notice that something's wrong. And that's precisely what happened throughout this entire period of time, and I might say that the overdrafting continued beyond the time that you've testified, and, in fact you stopped the practices. So we're going to furnish you with those documents. You can take a look at them, in particular the documents from Linda Curtiss that was referred to today, which I gather you had never heard of before.

So we'll furnish you with that. Take a look at that, because I think that's extremely relevant to the testimony you've given today.

With that, the subcommittee stands adjourned until 2:15.

[Whereupon, at 1:11 p.m., the subcommittee was recessed, to reconvene at 2:15 p.m., the same day.]

AFTERNOON SESSION

Mr. HUGHES. The Subcommittee on Crime will come to order. Before we broke for lunch, I made reference to a memorandum directed to Mr. Ball, Bob Eber, Paul Hines, and it looks like "Peter"—it's very difficult to read the last name "Maratote," perhaps――

Mr. LYNCH. Muratore.

Mr. HUGHES. M-a-r-a-t-o-t-e?

Mr. LYNCH. M-u-r-a-t-o-r-e.

Mr. HUGHES [continuing]. From Linda Curtiss, dated November 20, 1981. And I would like to offer this for the record.

E.F. HUTTON INTEROFFICE MEMORANDUM

To: George Ball, Bob Eber, Paul Hines, Peter Muratore.

From: Linda Curtiss.

Date: November 20, 1981.

Subject: Midwest region planning meeting.

Outlined below are the major issues, as I see them, surrounding the Midwest Region Planning Meeting to be held on Tuesday, November 24.

1. SALESFORCE, REVENUE AND PROFIT PROJECTIONS

Based on results through September of 1981, the retail offices of the Midwest Region are on track to finish the year with 437 AEs (5% higher than projected), $57.6 million in gross revenues (4% lower than projected) and $13.5 million in net profit (6% higher than projected). Thus, profits have the potential to increase by 4% over 1980 levels, despite a $1.5 million increase in the Midwest regional interbranch allocation to retail branches.

Attrition levels in the Midwest Region have increased dramatically during the first six months of 1981 to an annualized rate of 15%, up from an historical rate of only 10%, but still slightly below the firmwide 1981 rate of 16%. The region added 24 AEs from other firms during the first half of the year, an annualized affiliation rate of 11.5%, down from an historical level of 15%. Training slots are being filled as rapidly as they become available, with the region overfilling their first half year's allocation.

With affiliations, terminations and trainees at their recent historical rates, and with a similar market environment, the Midwest Region can expect to increase revenues by 16% in 1982.

Projected growth in the salesforce through 1985 (discussed at last year's meeting) is at an annually compounded rate of over 10%, slower than growth in the past five years, but nearly double the growth in the industry over the past five years.

In brief, the Midwest Region has slightly higher than average productivity, direct costs equal to the firmwide rate, significantly better than average indirect costs, and the lowest relative interest profits in the retail system. This combines to a location profit level ranking 5th in the firm, slightly lower than average when measured on a per AE basis, or as a percentage of gross revenue.

The overall productivity of the Midwest Region's AEs, while slightly higher than the firmwide average, is below the experience-weighted "expected" level for the region, for full-time, retail AEs. The region has a slightly more experienced salesforce than the national average, predominantly due to the small population of AEs registered less than 3 years.

DISTRIBUTION OF MIDWEST REGION PRODUCTIVITY BY EXPERIENCE LEVEL, 6 MO 1981

This below-expected productivity, given the experience levels of the salesforce, is evident in 12 of the region's 18 established offices (67%) and ranges from 1% below expected in Madison to 31% below expected in Rockford.

Product strength in the region covers such diverse products as tax shelters (where the region leads the firm in actual and average production), life insurance, corporate bonds, and commodities.

Net interest profits in the Midwest Region are at the lowest level in the firm through the first nine months of this year, at 14.9% of gross revenue versus a firmwide average of 16.8%. This lower-than-standard interest is evident both in the interest earned on general ledger balances (indicative of cashiering operations) and in interest earned on customer balances. Had interest levels been at the firm average for the first nine months of the year, the profits of the region could have been increased by $800,000 (an annualized $1.1 million). A one-month analysis of interest done in the month of October, 1980 (admittedly old information, but inciteful nonetheless) shows improvement potential in several areas: margin debit balances averaged 12% below the firm and the average spread charged on these balances was

10% below the firm; interest earned on overdrafting was 67% below average; interest earned from BOA checks and other general ledger balances was 20% below standard; interest from free credits was slightly better than average and interest on short sales only slightly below standard, but interest charged to the region because of cash debits was over 50% higher than average. In the past year, the region has made several attempts to remedy this interest situation, but current results versus the firm average (3rd quarter 1981) show a widening of the disparity in the cashiering-related interest on general ledger balances, while interest on customer balances has improved to the firmwide average.

The Midwest Region is the most under-brokered area of the country with 437 potential clients per NYSE registered representative, 43% more than the nationwide average of 306. However, the industry population is growing at nearly the slowest rate in the nation, with the number of NYSE RRS increasing by 2.2% from 1979 to 1980, and at an annual rate of 5.5% over the last 5 years. With Hutton's salesforce growing at 10%, our share of the NYSE RR population is steadily increasing. New offices in Flint, Janesville, LaCrosse, and St. Paul (expected to open next month) will extend over coverage.

IV. MANAGEMENT

Pages 24 through 28 of the attached package provide additional information on the branch managers in the Midwest Region.

I believe this memorandum and the attached schedules cover the major issues facing the Midwest Region.

Attachments.

cc: L. Broad

A. Dorec
R. Frugoli
P. Genin

[Signed] LINDA.

INTRODUCTION

During the analysis relating to the Midwest Regional Planning Meeting, interest profits for the Midwest Region versus those of other regions became an issue of great concern. Corporate Development, therefore, agreed to analyze the components of interest income and expense.

The objectives of this analysis are twofold. The first objective is to analyze the regional differences in the components of net interest income, primarily to determine, statistically, the causes of the Midwest Region's below average interest profits in 1981. The second objective is to develop a prototype for the periodic reporting of net interest income.

Prior analysis has shown a similarity of results for interest profit on an annual basis compared with the results of a single month. Based upon these results, and given the volume of clerical effort necessary to analyze the components of net interest income on a regional basis, the month of November, 1981, was selected as a representative sample. Interest revenues and expenses were examined for the interest