(FORTUNE Magazine) – A HINT that something new was amiss at E.F. Hutton popped up in the fall of 1985 when the big investment firm revealed that it faced a bad loan and was setting aside $1.3 million in reserves. The news was vague and little noticed. But last July, Hutton filed a suit charging that it had been the victim of an elaborate stock and commodity trading scam. Hutton raised its reserves to $34 million; the pretax loss, $48 million, amounted to $13 million more than first-half earnings. The mastermind of the fraud, charged Hutton in its lawsuit, is George Aubin, a 42-year-old Houstonian who ran up huge trading losses in 1984 and 1985. He hid the losses from Hutton for months, says the suit, covered them with millions of dollars of bad checks, and then stuck the brokerage firm with worthless collateral. Aubin's side of the story, spelled out in a suit against the firm and two of its brokers, is that Hutton took advantage of him by churning his accounts. Aubin also charges that Hutton schemed to knock down the value of a savings and loan institution it took as collateral against his debts. He claims Hutton did so by colluding with state and federal regulators. Finally, Aubin says, Hutton slandered him in an attempt to ''crush and destroy'' him and a business partner in hopes of hiding its own misdeeds. No one involved in the suits would talk to FORTUNE for this story. Two of Hutton's top brokers are at the center of the fracas. Don Sanders, 50, and his sidekick, John Mundy, 49, handled Aubin's accounts. For years Sanders has been Hutton's superstar securities broker, pulling in commissions of $2 million to $3 million a year. He cuts a wide swath through Houston society -- he is part owner of the Astros and is on the board of the University of Houston. Sanders and Mundy are members of Hutton's ''Directors' Advisory Council,'' made up of the firm's most successful brokers. The Aubin scandal is yet another large embarrassment for Hutton. Last year the firm pleaded guilty to criminal charges in a check overdrafting scheme; it paid a $2-million fine and returned $4 million to the banks involved. Hutton is alleging fraud by a Baltimore mortgage company that collapsed last year, and has set up a $16-million reserve. The Texas fraud started, Hutton says in its suit, when Aubin opened 37 different accounts with the company, mostly in 1984. The volume of trades in the accounts grew furiously. Hundreds of contracts for Treasury bond futures and stock index futures, along with thousands of shares of stock, were bought and sold almost daily. Sanders and Mundy were the envy of E.F. Hutton. Aubin says in his suit that Hutton's commissions on his trades came to $16.5 million over 18 months. Typically, brokers like Sanders and Mundy keep almost half the commissions they earn. According to Hutton's suit, Aubin's arrangement with the firm helped him hide huge trading losses. If he lost on a trade, he didn't have to pay for a week. But if he made money, he could demand payment the following day. That is not an uncommon arrangement between a brokerage house and a big margin customer. But Hutton says Aubin was using it to play an enormous ''float'' game, funding losses by buying and selling the same securities or commodity contracts on margin in his different accounts. Up to a point, Aubin agrees. After his losses began to mount toward the end of 1984, he says in his suit, Hutton began to execute simultaneous buy-sell trades in stock accounts. The five-day float on the proceeds was used to fund margin requirements in his commodity accounts. But Aubin says the activity was suggested by Hutton's brokers to maintain their commissions. Early last year Hutton called a halt to the arrangement and demanded that the accounts be paid up. In February, Aubin produced 28 checks made out to Hutton totaling $46 million. They bounced -- in part, Aubin says, because Hutton stopped payment on more than $11 million of his trading earnings. A few days later a friend and business associate of Aubin's, J. B. Haralson, offered his stock in a Texas thrift, Mercury Savings Association of Wichita Falls, to cover the trading losses and bounced checks. Haralson also owned a far smaller thrift, Ben Milam Savings & Loan Association of Cameron; both were up for sale, and Hutton figured they were worth more than $100 million altogether. RBI Inc., a company owned by Haralson, signed a one-year note to Hutton pledging the proceeds of the Mercury sale against the losses. Aubin's suit charges that Hutton was eager to make the agreement as a preemptive step: It was already under investigation for overdrafting and did not want another scandal. In its internal correspondence, the suit says, Hutton referred to the matter as ''Transaction 'X.' ''

Hutton accepted the note (paying interest on it, according to Aubin's suit, out of the commissions Sanders and Mundy had earned) and not only wiped out Aubin's losses but provided him $4 million so he could meet margin requirements and resume commodity trading. There were apparently no hard feelings. Sanders -- who Aubin says had been doing business with him and Haralson since the early 1970s -- continued to handle the trades, along with Mundy; Aubin and Mundy were even photographed together at a race track in New Mexico that summer. Before the one-year note from RBI came due, Aubin had largely emptied his accounts, withdrawing some $40 million according to Hutton. Hutton protested at first, but Aubin replied that he was not a party to the note RBI signed, and so owed Hutton nothing. Hutton never collected on the thrift: It was a mess. Aubin may be partly responsible. Hutton charges that though Haralson was the nominal owner of Mercury and Milam, Aubin secretly controlled both and ran them as one institution through Haralson and others. One vivid account of Aubin's relationship with Mercury and Milam comes from a former executive of the thrifts. (It is contained in a sworn statement he offered in another suit against Aubin.) The executive says Aubin got the S&Ls to buy four airplanes, among them a Learjet, and spent as much as $80,000 on demonstration flights of a Gulfstream II. He adds that Aubin invested millions of the thrifts' dollars in horses, including $750,000 for a prizewinning quarter horse. Mercury's parlous condition should have come as no surprise. Hutton had been working with it since 1983, when it sold the thrift some of Baldwin-United Corp.'s mortgage operations. A Hutton memo presented in Aubin's suit says the firm was worried about the thrift's deferred obligations to Baldwin-United, which ''Hutton will be liable for if Mercury failed or chose not to pay.'' Moreover Haralson hired Hutton to find a buyer for Mercury and Milam in 1984 after the Texas savings and loan commissioner said Mercury was engaged in ''unsafe or unsound practices,'' and got his agreement to sell it. By the time Hutton took RBI's note, the commissioner was warning of ''extremely dangerous and questionable practices'' at the thrifts. Among them: ''major loans to insiders,'' including George Aubin, and speculation on securities in a secret E.F. Hutton margin account. Aubin puts the blame for the thrifts' woes on Hutton. He says the firm persuaded state and federal regulators to unnecessarily declare the thrifts insolvent. Among other things, he says, the regulators tried to keep the thrifts from selling assets in order to bring their net worth up to standards. In any case, just days after Hutton's note was due, state and federal thrift officials put Mercury and Milam under a conservator. The thrifts, said the Federal Home Loan Bank, had ''substantially dissipated their assets and earnings.'' Hutton was left empty-handed. When reports of the situation spread through Hutton, many employees were outraged at the firm's management. ''These chimpanzees are putting us out of business,'' says one top Hutton broker. He adds that at a New York meeting ! late last year between Hutton Chairman Robert Fomon and many top producers, several brokers threatened to quit if the firm did not stop what appeared to be an endless string of blunders. ''It was almost a revolt,'' he says. Since 1970 Aubin has been sued at least 50 times in Houston alone, and has done plenty of suing. Why did Hutton get so involved with him? To many of its brokers, the problem is -- or was -- the firm's management style. Before Robert Rittereiser became president in mid-1985, Hutton typically gave big moneymakers lots of autonomy and asked few questions. Says a former Hutton broker: ''If you were a big producer they'd almost turn their back on what was going on. This couldn't have happened at Merrill Lynch.'' In fact, it didn't. In 1982 Merrill Lynch's credit department investigated a commodity account George Aubin had opened, and closed it down after two months.