Funds Diverted, Defense Firms Allege

The nation’s two largest defense contractors allege in a secret portion of a lawsuit that the government diverted funds from the now-canceled A-12 attack-jet program--and possibly used the money for intelligence activities during the Reagan Administration, sources close to the case say.

Known cryptically as “Count 2” of the $1.3-billion suit filed against the federal government last year by General Dynamics and McDonnell Douglas, the allegation could become a political bombshell if it were made public, according to officials familiar with its contents.

When the suit was filed, senior Navy officers immediately classified the allegation “top secret.” Defense Secretary Dick Cheney, asked about the allegation last November, said he was not aware of the contractors’ charges, adding that the assertion was “ludicrous on its face.”

Added Cheney: “We don’t go around taking money out of those kinds of programs to finance (intelligence.)” It remains unclear how the companies say the alleged diversion occurred, how the alleged diversion damaged them and what use may have been made of the funds.

General Dynamics spokesman Alvin Spivak said Tuesday that he had no information about Count 2. McDonnell Douglas officials could not be reached for comment.

Last week, the Department of Justice agreed to begin negotiations to settle the civil suit, believed to be the largest case brought by a defense contractor against the government. Government officials have denied that their aim in settling was to prevent a public airing of the dispute.

Separately Tuesday, it was learned that the U.S. attorney in St. Louis has dropped a federal criminal investigation examining whether the two companies obtained excessive payments on the A-12, a Stealth attack jet canceled last January after the program--with a $1-billion cost overrun--had fallen a year behind schedule.

The civil case, however, is bound to drag on for some time.

The matter of Count 2 is considered so sensitive that the government’s Information Security Oversight Office, a part of the General Services Administration, last week blocked an attempt by the two companies to declassify the allegation.

Steven Garfinkel, director of the office, said he was “satisfied that the information sought to be protected by the Navy . . . (is) legitimately classified,” according to a Jan. 8 letter obtained by The Times on Tuesday under the Freedom of Information Act.

In a request seeking the declassification last November, General Dynamics and McDonnell officials disclosed that the original allegation was ordered classified by the deputy chief of naval operations, the Navy’s second-ranking officer.

The declassification request was signed by R. D. Hancock, McDonnell’s director for business management on the A-12, and G. P. Hogan, General Dynamics’ manager of contracts.

Asked about the allegations that funds were diverted from the program, Hogan, who has since retired, said: “It may make sense, and it may not make sense. I am out of the picture.”

Although the request did not disclose the contents of Count 2, it shows that the matter revolves around budgetary information on the A-12 program--a seemingly unusual matter to keep secret on a defunct program.

At issue are certain budgetary codes contained in Count 2 and other classified sections of the lawsuit that apparently would have disclosed the origin of the contested funds, the “specific government department responsible for administering the appropriation, the fiscal year for which an appropriation was made and the congressional budget from which the funds were appropriated,” according to the letter.

The Navy was so concerned about the sensitivity of the codes that when the labor unions at McDonnell and General Dynamics sued the two firms and requested government documents to support their cases, the Navy demanded that the unions sign a non-disclosure agreement, according to Jerome Diekemper, a St. Louis attorney representing the unions.

“If we had these codes, they didn’t seem significant to us,” he said.

The unions sued the two firms for laying off workers without providing 60 days’ advance notice required by federal law.

The decision by the U.S. attorney’s office to drop its criminal probe follows lengthy grand jury hearings in St. Louis. The allegation under investigation was that the firms collected excessive progress payments on the A-12 by providing the government with an overly optimistic cost estimate for completing the project.

“Obviously, we are extremely pleased with the decision to terminate the grand jury investigation,” General Dynamics spokesman Spivak said.