FBI Had Data on Iraq Loan, Panel Is Told : Gulf War: CIA witnesses reportedly said the bureau knew at 1989 meeting that Italian bankers were aware of funds funneled through Atlanta branch.

Reports indicating that executives in Rome of Italy’s largest bank knew about billions of dollars in loans to Iraq were discussed at secret 1989 meetings at the U.S. Embassy there in the presence of an FBI official, CIA witnesses have reportedly told Congress.

A senior government source said CIA officials made the assertion during recent testimony to the Senate Intelligence Committee.

Word that the FBI, which reports to the Justice Department, apparently knew about the reach of the loan scheme long before the department put the manager of the bank’s Atlanta branch on trial, charging him with orchestrating the loans, adds to doubts about the department’s conduct of the politically sensitive probe into the loans and threatens to widen the rift that has developed between the two agencies over the case.

The Justice Department has claimed it had no evidence until recently that bank officials in Italy may have known their Atlanta branch was making $5 billion worth of illegal loans. Some of the loans, made between 1985 and 1989, were used by Iraq to improve the Scud missiles that killed American soldiers and Israelis in the Gulf War.

Questions about the government’s handling of the investigation into loans made by Italy’s Banca Nazionale del Lavoro have been raised by U.S. District Judge Marvin H. Shoob, who conducted hearings on the bank case in Atlanta. Shoob has said he believed the U.S. government withheld intelligence information from him either to avoid disclosing embarrassing details of the Bush Administration’s pre-Gulf War tilt toward Iraq or to stop revelations that could damage the Italian government, which owns BNL.

The prosecution of the Atlanta bank case also has become a political issue. Democrats have charged the Bush Administration with intentionally limiting the criminal investigation into the illegal loans. Other questions have been raised about how the Justice Department’s investigation fits into an apparent pattern of widespread assistance to Saddam Hussein before his troops invaded Kuwait.

At a sentencing hearing in Atlanta last month, for instance, the attorney for the manager of the BNL branch there made reference to President Bush’s secret 1989 order mandating closer ties to Iraq. The lawyer described the order as part of a deliberate U.S. foreign policy that allowed the loan scheme to thrive and had the effect of restricting the federal investigation into it.

President Bush has defended his actions as a reasonable attempt to bring Hussein into the “family of nations.” Bush has denied that U.S. aid helped Iraq’s military.

When word emerged earlier this month that CIA officials had told a closed Senate hearing that the CIA had been pressured by Justice officials to withhold pertinent documents from Shoob’s court, a dispute between the CIA and FBI seemed to break out into the open.

In response, Atty. Gen. William P. Barr on Friday named a retired federal judge to investigate the conduct of the CIA, FBI and the Justice Department in the matter.

The CIA, in depositions to the Senate panel, said the FBI official may have sent his own reports about the information to the FBI in Washington, according to the government source who is familiar with the recent agency testimony to the Intelligence Committee.

Asked about the testimony, Paul McNulty, chief spokesman for Barr, noted that “the FBI said it would be doing a thorough review of all evidence it received.” But he said he could not comment because the matter could be part of the independent investigation by retired federal Judge Frederick B. Lacey, ordered by Barr Friday.

John Collingwood, chief of the FBI’s congressional and public affairs office, said: “We’re looking into every aspect of this to include any points where information and documentation may have changed hands between the agencies.” He declined to elaborate.

The FBI’s two top men in Rome at the time were James Frier, then the legal attache at the embassy, and his deputy, Robert Peter. Frier, now deputy assistant director of the FBI’s criminal investigative division, and Peter, now with the FBI in Alabama, declined comment through a spokesman.

Other sources said it has not been established yet whether either man saw all the CIA cables containing the classified information. The sources also said it would be a departure from usual practice for the men to have sent cables of their own to FBI headquarters.

Instead, the normal practice for handling such “shared” information that originated with the CIA was to allow the CIA station chief in Rome to relay the material by cable to CIA headquarters at Langley, Va., which then would send it on to FBI headquarters across the Potomac River in Washington, a source familiar with the procedure said.

The testimony about the FBI’s sharing the CIA reports appears to conflict with directions Frier reportedly gave the CIA in Rome about the BNL investigation. Frier has told colleagues that he urged the CIA to avoid getting involved with anything “evidentiary” about the BNL case and instead to refer it to the FBI, the agency responsible for criminal investigations.

The New York Times reported Saturday that the CIA also had uncovered a cable from its Rome station chief that suggested the possible payoff of government officials in the United States and Italy in the BNL case. The cable quoted a source of unknown reliability as stating that officials of both nations were bribed in connection with the loan scheme, the paper said.

The loans, which had not been reported to federal regulators, were discovered in an FBI raid in August, 1989. Internal Justice Department documents show that the prosecutor handling the case in Atlanta decided almost immediately that the illegal activity was isolated in the Atlanta branch and that BNL officials in Rome had been unaware of the loans.

But officials of the Justice Department’s criminal division instructed the Atlanta prosecutors to press further for any sign that the crime extended beyond BNL’s Atlanta branch, department officials said. Those instructions appear to contradict suspicions that the Justice Department wanted to ignore any evidence that BNL officials in Rome were involved.

The manager of the branch, Christopher P. Drogoul, pleaded guilty last June. Prosecutors in Atlanta have maintained no BNL officials outside Atlanta were aware of Drogoul’s activities and that U.S. intelligence agencies had no relevant information on the issue.

However, on Sept. 14, the first day of Drogoul’s sentencing hearing in Atlanta, Rep. Henry B. Gonzalez (D-Tex.) disclosed on the House floor that the CIA had sent him a letter saying BNL officials in Rome were aware of the loans.

In response, Shoob asked for CIA information related to the case. On Sept. 17, prosecutors produced a CIA letter which said it had only press reports in late 1989 indicating that Rome officials may have known of the loans.

But Senate Intelligence Committee investigators discovered that the CIA had four classified cables from its Rome station chief from September and October of 1989. The cables quoted reliable sources telling the agency that Rome officials knew about the loans, sources said.

One CIA source was identified as Navy Capt. Lawrence Ewert, then the defense attache at the embassy. Ewert, now retired, says he never discussed BNL with the CIA.

These cables are at the center of the CIA-Justice dispute. Sources have said the CIA witnesses told the committee the cables were discovered before the Sept. 17 letter was sent to Shoob and that Justice was alerted.

CIA analysts felt the cables were strong enough evidence to conclude that BNL officials in Rome knew of the Atlanta loans, a finding that complicated the case against Drogoul.

Shoob concluded on Oct. 1 that Administration officials had interfered in the BNL case. He said there were enough questions about whether bank officials in Rome knew about the loans to allow Drogoul to withdraw his guilty plea, setting the stage for a full trial next year.

Barr said Friday, however, that the Justice Department has never closed the door on possible complicity by BNL officials in Rome. “The prosecution of Drogoul is the logical step in the normal course for moving up the chain of a potential conspiracy,” he said.

In addition to naming the ex-judge to investigate the agencies’ conduct, Barr said he is replacing some of the Atlanta prosecution team with a new task force of prosecutors to review the BNL case and pursue further evidence.