Mr. FEIGHAN. You are stating, then, for the record, to your knowledge misencoding checks was not a deliberate policy of Hutton?

Mr. FOMON. Absolutely not.

Mr. FEIGHAN. In May 1985, the Bank of America, in their internal memo, if I might quote for the record, stated that: "Hutton has admitted to deliberately seeking to take advantage of check clearing delays. The prosecutor told me"-"me" being an individual at the Bank of America-"that this included deliberately tampering with MICR"-that is the coding ink at the bottom of the check"on their checks, in order to obstruct presentation."

"These problems"-this is a memo dated May 7, 1985-"these problems, that is the deliberate miscoding of checks, have recently intensified. Hutton's checks are increasingly unreadable and must be manually recorded and manually interfiled."

Mr. FOMON. Who said that?

Mr. FEIGHAN. Mr. Christopher T. Mahoney, vice president of Bank of America, a copy of which document I would be happy to provide for you.

Mr. FOMON. Yes, I would like that very much.

Mr. HUGHES. The document will be received without objection in the record. You will be provided with a copy.

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Due to the Hutton case, we now have an opportunity to establish strict policies regarding the operation of E.F. Hutton's and Dean Witter's DDA accounts. Their cash management practices are under judicial and regulatory scrutiny, and they are on the defensive. We, along with the rest of the banks, have been pressing them on a number of issues without much success. I think that we are now in a position to dictate how ve expect their accounts to be managed, especially in view of the fact that Hutton was convicted for certain practices which have been common in the industry.

Below are the main issues and my recommendations with respect to new policies: Uncollected Balance Positions:

1.

We currently analyze collected balances on a month-average basis, which has the unintended effected of allowing the depositor to borrow intra-month at his own option in any amount, and to repay by returning the principal for a like period. Wells Fargo and Crocker are on the verge of instituting the practice, with brokerage customers, of charging interest on daily uncollected positions at the posted broker rate and crediting positive collected balances at the Earnings Allowance Rate, thus earning a spread on the involuntary loans resulting from uncollected balances. This approach appears to be logical, since these are loans and do involve credit risk. I think we should adopt this policy, to be applied on a quarterly basis. For the time being, we will have to do this manually which will be time-consuming, but it strikes me as the best way to protect the bank, short of disallowing uncollected positions altogether, which is unrealistic. We won't be able to do this for Hutton until its accounts go on CDA, which will occur when they are migrated. Until that time, we should bill for average deficiencies on a monthly basis.

The Hutton injunction specifically prohibits Hutton from "causing uncollected funds in bank accounts to be withdrawn without the written consent of the banks." I would expect Hutton to ask us to consent to this and would agree to it on the basis of the foregoing arrangement.

some of

This is a more intractable problem since it has so many causes, which are legitimate, such as concentration activity. There arте three basic approaches we could take: (1) Prohibit certain float-causing practices, such as the deposit of large flost items drawn on New York; (2) set a float lizitetion, such as a 1:1 ratio to collected balances; or (3) charge for float above a certain level (such as 100% of collected balances). I think that, of these options, the third is probably the best and most flexible. As to what ve should charge, I would think that between 5 and 10 basis points per ancus would be appropriate. Morgan is charging $150 per million on float in excess

-2

of $10 million as of statement date, which translates into 6 basis points per annum ($150 x 44 $600). inclination yould be to charge 7.5 basis points per annum for float in excess of 100% of collected balances (or total float if collected balances are negative). This translates into $750 per million per

year.

3.

This is a low amount, but it will incent the customers to reduce float.

Service Charges:

In order to clearly seperate the issue of activity expense from the issue of collected balances, I think that we should bill service charges separately.

that

These

read

Hutton has admitted to deliberately seeking to take advantage of checkclearing delays. The prosecutor told де this included deliberately tampering with the MICR on their checks in order to obstruct presentation. Account Rec. has had problems with Hitton's checks since the 1970's. problems have recently intensified; Hutton's checks are increasingly able and must be manually re-MICRed and manually interfiled. This has now been picked up by NAD Audit Division in its audit of the Brea Account Rec, Center. Although we are billing Hitton for these coats, the solution is better checks. We have conveyed to them in detail what is wrong with their checks (on 4/25) but so far nothing has been done. Therefore, I think that the tice has come for us to require that Hutton select a vendor acceptable to us; that the specs be acceptable to us; and that random samples of each batch be submitted to us for testing. This parallels Audit's recommendations. (We will also bill Hittor for past processing costs caused by poor quality checks.)

Dean Witter is the only customer to whom we still lend on a clearinghouse basis. This system creates float at disbursement and repayment; is troublesome in that we have to keep track of Friday paydowns and borrowings because of the three-day clearing delay. Ultimately the auditors are going to pick this up and require us to terminate the practice since it creates float and potentially exposes the bank to float due to the repayment by check. In view of these problems, I think we should terminate this arrangement and offer only Fed Funds loans to Witter. This will cause them some problems and pay reduce their borrowings from us, but I an convinced that we will be better off in the long run if we eliminate this unorthodox arrangement. Furthermore, if we are ever going to do this, DOW is the best time, in the yake of the Hutton scandal. (With respect to Friday peydowns/borrowings, I think ve should calculate the interest on their net position and bill them.)

We should proceed to migrate Hutton's accounts into #1235 without further delay.

Anitely

Christopher T. Mahoney, VP

Mr. FEIGHAN. In light of that memorandum, Mr. Fomon, do you have a comment on the policy that E.F. Hutton has in terms of coding or misencoding of checks and what problems might still exist?

Mr. LYNCH. I might comment on that.

Mr. Morley and I met with Mr. Mahoney▬▬

Mr. FEIGHAN. In May?

Mr. MORLEY. I believe so.

Mr. LYNCH. And he told us at that time that there was still a problem with the printing and the quality of the checks that were being provided. He made no indication that this was being done deliberately, and we assured him that we would go back to the printer and try to get the quality improved. But I have met with

Mr. FEIGHAN. Excuse me, Mr. Lynch, if I might just respectfully interrupt.

I'm not concerned at this point, any more, with the problems that you've had with your printer. I am talking about what is alleged to be deliberate miscoding of checks in order to delay the process.

Mr. FOMON. Who does that gentleman say, whom does he quote as saying that we were deliberately misencoding?

Mr. FEIGHAN. He stated-Mr. Christopher Mahoney states in his May 7 memo of this year: "Hutton has admitted to deliberately seeking to take advantage of check clearing delays. The prosecutor told me that this included deliberately tampering with the MICR❞—that means the coding at the bottom of the check-"on their checks, in order to obstruct presentation."

Mr. FOMON. Well, I frankly think that is a bad rap. I know who told that gentleman that, and I don't think there is any evidence. There may be, but I don't think there is any evidence of willfully tampering with the coding on checks.

Mr. FEIGHAN. It certainly must concern you that one of your major banking customers has that idea of your practices.

Mr. FOMON. Had we been tampering with coding on checks I would think we would have been charged with that.

Mr. FEIGHAN. That is the point of these hearings.

Mr. FOMON. No, but by the Justice Department. That seems to me a rather serious charge.

Mr. HUGHES. The gentleman's time is up.

The gentleman from Kentucky.

Mr. MAZZOLI. I thank the chairman, and I will just follow up for a second on what my friend from Ohio has gone into here.

Can you give me just-or maybe Mr. Castellano-just about how much, roughly, would a printing bill from this bank printer be for Hutton for 1 month or 1 year? Any idea how much loot that guy is carrying away, that printer that can't get it right?

Mr. CASTELLANO. I have no idea.

Mr. Mazzoli. $1 million a year, do you think, the printing bill? Mr. CASTELLANO. I have absolutely no idea.

Mr. MAZZOLI. $2 million? $3?

Mr. FOMON. I would doubt if it's a big amount, because I would think that check printing is a specialty, and a typical check printer would not be getting regular printing business from E.F. Hutton.

Mr. MAZZOLI. Well, it seems to me-and I listened to what the gentleman said, and I'm sure he said it from his heart but it just wasn't very convincing to me-that you've got to get two, and three, and four runs of checks before they get the consecutive numbers right. I mean, to me, you'd have a case in court against a bank printer for being incompetent, materially involved in a swindle, or fraud. I can't believe you just simply bring the checks back and say, "Hey, Mister, we love you; would you print it right?"

Mr. FOMON. I'd be glad to get you the numbers on how much business we do with this printer.

Mr. Mazzoli. I would love it.

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