WASHINGTON (AP) _ A former E.F. Hutton branch manager has dropped a lawsuit claiming he was libeled in the brokerage firm's 1985 report about its elaborate check-kiting scheme, according to court papers filed Monday.

The out-of-court settlement negotiated in July by attorneys for John M. Pearce and Hutton was approved in an order by U.S. District Judge Thomas Flannery.

According to court papers, each side will pay its own expenses in the case, which was to be submitted first to arbitration by the New York Stock Exchange before any proceedings in federal court.

The settlement was negotiated shortly after Pearce had lost his suit against former Attorney General Griffin Bell, who had been hired by Hutton to investigate the check-kiting scheme and produce a report.

A federal court jury on June 20 absolved Bell of any civil liability, ruling that none of the statements about Pearce in the report was false or defamatory.

The terms of the settlement were not made public and attorneys for both sides refused to comment on it. ''The matter stands resolved,'' said Stephen G. Milliken, Pearce's lawyer.

Hutton, now part of Shearson Lehman Hutton Inc., pleaded guilty in 1985 to 2,000 counts of mail and wire fraud and agreed to pay a $2 million fine after admitting that branch employees participated in the overdrafting scheme.

The company also agreed to reimburse banks for the millions of dollars in interest that was lost when branch officers wrote checks against funds that had not been deposited in their company accounts.

Bell and his Atlanta law firm, King & Spalding, were hired to conduct an internal investigation and write a report about the check-kiting scheme. The report blamed Pearce, who managed Hutton branches in Bethesda, Md., and St. Louis, as one of six officials responsible for the scheme.

Pearce, now a businessman in Sarasota, Fla., claimed that Bell and Hutton conspired to absolve top company managers by placing the blame on mid-level executives.

His parallel claim against Hutton was to be submitted to arbitration under NYSE rules.

Bell, whose report exonerated top officials of wrongdoing, said he couldn't find any evidence of illegal conduct by the company's ranking officials. The report only blamed these executives for failure to properly manage employees and detect improprieties.