The U.S. justice department has launched a corruption probe into Britain's BAE Systems, a potential headache for Gordon Brown just hours before he succeeds Tony Blair as British Prime Minister.
BAE, Europe's biggest military contractor, said on Tuesday the probe would include its dealings with Saudi Arabia under a state-to-state deal that led to Britain's biggest ever export deal, worth an estimated 43 billion pounds ($86 billion) stretching back to the 1980s.
Shares in BAE, which makes Typhoon jet fighters, Nimrod reconnaissance planes and nuclear-powered submarines, fell as much as 11% on fears the probe could lead to fines, hit its U.S. business and disrupt a new deal with Saudi Arabia.
The probe will also pose an immediate challenge for Gordon Brown, who succeeds Tony Blair as prime minister on Wednesday.
Blair has been criticised by anti-bribery campaigners and the British media after he stepped in to halt a probe of BAE by the UK's Serious Fraud Office last December, citing risks to national security and relations with the Gulf kingdom.
"Our position on the investigation in this country hasn't changed and we have no comment to make on what happens in the States," Blair's spokesman said. He declined to comment on whether the government would cooperate with the U.S. probe.
BAE said in a brief statemnent that it had been notified by the DoJ that a formal investigation had been started and that it would include an examination of the Saudi deal.
BAE has denied making wrongful payments in its dealings with Saudi Arabia under the government arms deal, known as al-Yamamah. The UK also has a new agreement, known as al-Salam, to supply Saudi Arabia with 72 Eurofighter Typhoon jets.
"This is bad for sentiment and could delay the signing of the Salam deal," said analyst Nick Cunningham at brokers Panmure Gordon. "But it is unlikely to have a material financial impact and could ultimately cauterise the seeping wound of Saudi-related allegations."
British media reports have accused BAE of paying 1 billion pounds over a decade to Saudi Prince Bandar bin Sultan in connection with the al-Yamamah deal.
Bandar, a former Saudi ambassador to the United States and like Blair a close friend of the U.S. president, has denied the sums involved represented secret commissions to him.
The U.S. investigation centres on alleged violations of the Foreign Corrupt Practices Act, which prohibits bribes of foreign officials, said two sources familiar with the matter.
The U.S. government would have jurisdiction to investigate the matter if any payments made to Bandar were routed through U.S. bank accounts.
Solicitors for Bandar have said the U.S. accounts at Riggs Bank into which funds were paid as part of the al-Yamanah deal, were in the name of the Saudi Arabian Ministry of Defence and Aviation, and any monies paid were exclusively for ministry purposes.
A Justice Department spokeswoman declined to comment.
BAE is the biggest foreign arms company in the U.S. market and has made two multi-billion dollar acquisitions in the United States in as many years.
The U.S. Committee on Foreign Investment last week approved the most recent deal, BAE's $4.1 billion takeover of army truck maker Armor Holdings.
"We believe that the U.S. Defense Department will likely continue awarding contracts on the basis of merit," said UBS analyst Colin Crook, though he warned there was considerable uncertainty over the DoJ probe and it could last for years.
Lehman Brothers analysts also said they expected the Armor deal to close on time, and that BAE's North American businesses would be unaffected, given that the investigation did not involve BAE North America, a separate legal entity.
BAE shares closed down 7.8 percent at 407-3/4 pence their lowest level since December.