Officials of Arthur Andersen & Co., the independent auditor of E. F. Hutton & Co., testified yesterday that they repeatedly raised questions with senior officers of the broker-dealer firm about aggressive overdrafting and other possibly illegal cash-management practices.
The testimony, before the House Judiciary subcommittee on crime, runs counter to earlier testimony to the subcommittee by Thomas W. Rae, Hutton's executive vice president and general counsel.
Andersen, the nation's largest accounting firm, was itself a target as well at yesterday's day-long hearing, drawing sharp criticism from several subcommittee members and from Abraham J. Briloff, of the Emanuel Saxe Distinguished Professor of Accountancy at the City University of New York and a critic of the accounting profession.
On July 19, Rae testified that he had not known of aggressive overdrafting practices until late February or March 1982. It was around this time that Hutton learned of the federal grand jury investigation that led last May to its plea of guilty to 2,000 felony counts of mail and wire fraud in a check-kiting scheme.
Another exchange yesterday involved a memo in which Joel E. Miller, the Andersen partner who had Hutton as his client, discussed a three-hour meeting on March 5, 1980, at which he and other Andersen officials told Rae that they were concerned about Hutton's money-management procedures in connection with the 1979 audit of the broker-dealer.
The meeting ended with Miller asking for a written legal opinion on the propriety of the procedures. Rae refused, saying, according to the memo, that "there is no question as to the propriety" of his company's cash-management methods.
At the July hearing, subcommittee Chairman William J. Hughes (D-N.J.) told Rae that Andersen "expressed concerns because there were a lot of overdrafts," but the Hutton attorney replied: "Arthur Andersen expressed no concerns whatsoever at that time."
Yesterday, Andersen's Miller and Philip R. Peller, an Andersen partner and a regional director of accounting and audit practice, both disputed Rae.
Under persistent questioning by Hughes, Miller acknowledged that Hutton's top management knew early on of aggressive overdrafting and disputed Rae's denial that he had not known of it.
Peller said that Andersen "independently focused on the legality of the overdrafting practice in connection with our 1979 audit, and promptly brought the issue to the attention of" Rae and Thomas P. Lynch, managing director, executive vice president, and chief financial officer of Hutton, and, like Rae, a board member of the firm.
Peller said that in February 1980, Andersen expressed concern to Lynch about possible similarities in the cash-management procedures of a California corporation that had been indicted and pleaded no-contest. At the March 5 meeting, which was attended by Rae and Hutton controller Michael Castellano, Peller said, Andersen tried "to resolve the legal issue we had raised. In particular, we wished to understand better the procedure of writing checks against certain individual bank accounts even though the balance in those accounts, per Hutton's books, was zero or sometimes even negative."
Subcommittee members said they couldn't understand why the independent auditor had accepted at face value Rae's assurances that everything was legal -- despite his "vested interest," and without making inquiries of banks or running the matter by Andersen's own lawyers.
The answer from Miller and Peller was, first, that Andersen trusted Rae; and second, it agreed with him that excessive overdrafting is legal under what they called "the means principle." Under it, an overdrafter can write checks amounting to interest-free bank loans so long as he has separate, unbanked assets sufficient to cover the checks.
"I had confidence in Mr. Rae," Miller said.
Had Andersen "really fulfilled its responsibilities," Professor Briloff charged, Hutton's "money management excesses would have been 'stopped dead' no later than 1980 or 1981."
Peller rejected the charge. "We put our responsibilities to the public first," he testified. "We've never condoned illegal behavior."
He also said that "the accounting treatment and disclosure we recommended starting in 1979 was proper and in accordance with generally accepted accounting principles."
Briloff also faulted the report by former U.S. attorney general Griffin B. Bell, which Hutton commissioned. Briloff labeled it a "greywash," partly because Bell, agreeing with Andersen that its responsibilities were limited, granted it "apparent absolution."
The hearing, the fourth in a continuing series, was called as a result of a Sept. 4 Washington Post story, committee aides said. The article quoted experts as saying that a seemingly innocuous, unexplained change in Hutton's annual financial statement could have been a screen for excessive overdrafting.
In the liabilities column, the phrase "drafts payable" became, in 1979: "drafts and checks payable." Peller said that Andersen had proposed the change for sound accounting reasons, and he defended it vigorously against protests by the subcommittee that investors were not informed why the change was made.
Hughes produced an Andersen memo showing, from Hutton's records, that as of Dec. 31, 1981, Hutton balances in accounts in numerous banks, including three in the Washington area, far exceeded its outstanding checks. At Riggs National Bank, for example, the balance was $45,170 and the outstanding checks $5 million. At First American Bank, the balance was $2.5 million, the checks $11.5 million; at United Virginia Bank the balance was $350,000 and the checks $9.7 million.
"Shouldn't that have put you, a seasoned, veteran auditor, on notice" that Hutton's cash-management was out of line, Hughes asked.
Hughes also produced a "strictly confidential" Andersen memo on a Feb. 25, 1982, meeting with Rae, Lynch and a Hutton outside counsel on a new development: the Genesee Country Bank in upper New York State had discovered that it was making inadvertent interest-free loans to Hutton, bounced its checks, and notified state banking regulators.
The Andersen memo, signed by Miller and a colleague, John Tesoro, said Rae reported that the bank "desires to continue doing business with Hutton . . . " Rep. Romano L. Mazzoli (D-Ky.) charged that Rae was later shown "to have lied" about this. Miller did not dispute him.
The Andersen memo also reported that the Hutton spokesmen said "that there were no claims asserted or unasserted, that EFH would suffer no financial loss, and that the only exposure might be unfavorable publicity."
Again, Miller said, his trust in Rae was controlling. Perhaps ironically, the Justice Department has said that it was the Genesee case that caused the whole Hutton check-kiting scheme to unravel.