THE chief executive of BAE Systems was enjoying the sun at the Paris air show a fortnight ago, watching flying displays from the veranda of the company chalet. Mike Turner was his normal ebullient self, thanks in part to his company’s improved prospects in America, the world’s largest defence market.

Intent on boosting its presence there, two months ago BAE bought Armor Holdings, the American vehicle maker that is famous for the Humvee. Turner also had high hopes that a big order from the Pentagon for armoured cars to protect troops in Iraq was heading his way –hopes that became real last week when the US Marine Corps placed a $212m contract for 441 vehicles.

But last week another arm of the American government put a cloud on Turner’s horizon. In a statement to the stock exchange, BAE said it was under investigation by the US Department of Justice. The investigation related to “the company’s compliance with anticorruption laws, including the company’s business concerning the Kingdom of Saudi Arabia”.

For years BAE has faced accusations over its dealings with Saudi Arabia, with allegations that a slush fund was used to bribe officials and members of the Saudi royal family as part of the Al-Yamamah deal, a 1989 government-to-government arrangement under which BAE supplied billions of pounds of weapons and training over nearly two decades. The company has consistently denied any wrongdoing, and last year a Serious Fraud Office investigation into the affair was called off on the grounds that it was threatening Britain’s security interests.

BACKGROUND

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• Eurofighters go to Saudi Arabia in £4.4bn order

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Investors had steadfastly ignored the allegations and the police investigation. Over the past three years BAE has been one of the best-performing big company shares on the London market, outperforming the FTSE 100 index by 65%.

The intervention of the Department of Justice, however, was enough to cause shareholders to take fright. The shares dropped 8% on the day of the announcement, and finished on Friday at 405p, down 7.7% on the week.

The change of heart in the City was prompted by the fearsome reputation of the Department of Justice, and the swingeing penalties it can impose under the Foreign Corrupt Practices Act (FCPA), the main piece of anticorruption law in America.

Over the past 18 months, investors have become aware of – and alarmed – at the American authorities’ appetite for pursuing foreign companies and executives, and the ruinous effect it can have on businesses.

There have been many examples. The NatWest Three, three former bankers, were extradited to America to stand trial for their part in the Enron affair. A clutch of British internet gaming groups saw their share prices tumble after an American crack-down on the sector, including the arrest of British executives. Ian Norris, former chief executive of Morgan Crucible, faces extradition to America over alleged price-fixing despite having retired from the ceramics group four years ago.

Under the FCPA, officials at the Department of Justice have recently investigated Statoil, the Norwegian oil group, and Vetco Gray, a British-based maker of engineering components for the oil industry. In February three Vetco subsidiaries pleaded guilty to paying $2.1m (£1m) to Nigerian customs officials. The company paid fines totalling £26m, and agreed to the appointment of a monitor to oversee its compliance with the FCPA.

Sam Eastwood, a partner at the City law firm Norton Rose, said: “I see this as part of a pattern of the United States continuing to extend its jurisdiction internationally – not just under the FCPA, but across the board. What is behind this is a view from American legislators that American companies should not be unfairly disadvantaged by the application of different legal standards – there should be a level playing field.”

The legislation the Department of Justice is using has its roots in the aerospace industry. In the 1970s, while investigating allegations of payments by large American companies to President Richard Nixon, the authorities stumbled across a web of offshore funds held by Lockheed Martin. The company had used these to bribe officials around the world, usually in connection with sales of its Tristar airliner.

The Lockheed scandal prompted a cleansing of the stables at American firms, with more than 400 confessing to some kind of bribery in the run-up to the FCPA legislation.

It has proved a fearsome weapon: when confronted with an FCPA investigation, American companies almost always choose to cooperate fully, said Kent Schmidt at Dorsey & Whit-ney, a California law firm. “The alternative to cooperation is much worse,” he said.

The law applies to companies that have some connection to America and there are two ways of establishing a connection: the foreign company must issue shares or bonds in America or there must be some territorial link to the alleged bribery. Lawyers say that in most cases this means an executive made a phone call from the United States, used an American bank account or the US mail service.

BAE should be in the clear on the first count. Although it issues an American Depositary Receipt – a form of share – these are not listed on an American exchange.

But the second is more problematic. BAE has big operations in America – BAE North America accounts for 36% of sales – meaning executives are in constant contact with American banking and communications systems. More important, recent allegations over the Saudi deals have centred on payments made through the now-defunct Riggs Bank, based in Washington.

The payments, alleged to have totalled more than £1 billion over a number of years, were reportedly destined for Prince Bandar, the former Saudi ambassador to America.

But defence-industry sources claim that the Riggs Bank payments were part of an arrangement in the Al-Yamamah deal that required BAE to pay Saudi officials receiving training in America. “There were payments through Riggs, but they were not bribes. Why would you send bribes through Washington when you can send them to a Swiss bank account?” said one source unconnected with BAE.

The investigation by the Department of Justice could also become a diplomatic nightmare for Britain. As the Al-Yamamah deal was government-to-govern-ment, awkward questions about the involvement of the Ministry of Defence and Deso, its export agency, might be asked.

For BAE, there may not be an immediate commercial fall-out, and City analysts last week said the reaction to the Department of Justice’s announcement was overblown. Most think it unlikely the deal to buy Armor Holdings will be blocked, and the order for new armoured vehicles went ahead as expected. Nor are the Saudis likely to walk away from a new deal to buy 72 Eurofighter Typhoons from BAE, a contract that could be worth £20 billion over two decades.

The Saudis may delay implementing the contract because of the American announcement, but they need to update their air defences. “They are getting nervous about Iran, and they do need the planes,” said one defence-industry executive, who also pointed out that America has high hopes of selling the Saudis the rival F-15 fighter, an early version of which the Royal Saudi Air Force already operates.

In the longer term, however, BAE is likely to feel the effects of scrutiny by the Department of Justice. “There is a difference in the enforcement culture in the United States and Europe. In America, it is a zero-tolerance regime. Prosecutors have a fantastic level of resources – and they are prepared to use them," said Eastwood.

Schmidt said: “Even if in the end they take no action, an investigation is a huge, huge hassle, and it can be quite devastating.”

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