Litton Saudi Defense Project Is Target of IRS Inquiry : Probe: Focus is on allegations of improper payments linked to a Saudi prince and on subsequent tax deductions. Firm, royal family member deny allegations.

The Internal Revenue Service is investigating whether Litton Industries made millions of dollars in improper payments to a leading member of the Saudi royal family and whether the firm improperly claimed tax write-offs on the alleged payments, The Times has learned.

The IRS inquiry is focusing on a massive $1.7-billion Litton program to build an air defense system for Saudi Arabia, an effort started in the late 1970s and completed several years ago, according to court papers and IRS correspondence.

Litton, a defense electronics supplier and shipbuilder headquartered in Woodland Hills, strongly denies the allegations, saying: “We firmly believe this contract was conducted in a totally proper manner.”

Allegations that Litton paid at least $47 million in “bribes” to Prince Khaled ibn Sultan ibn Abdulaziz, who was then deputy commander of the Saudi Arabia Air Defense Command, are contained in a sealed lawsuit filed last year in Los Angeles federal court by former Litton manager Stephen Reddy.

The prince denied the allegations in Reddy’s suit through his attorney, Richard A. Anderman, a partner in the New York law firm Christy & Viener. In a letter to The Times, Anderman called Reddy’s allegations “defamatory.”

The prince, who was joint commander of allied forces during the Persian Gulf War and recently wrote a book on the war, declined to be interviewed for this story. His uncle is the Saudi king and his father is minister of defense.

Reddy voluntarily withdrew the suit in 1994 at the behest of the Justice Department, which concluded that the statute of limitations had expired on any civil or criminal laws that might apply, according to a federal prosecutor. But the IRS has pursued a tax investigation of its own, using the lawsuit as a road map.

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U.S. defense contractors have found business in the Middle East, their most important export market for high-technology weaponry, fraught with legal peril. Regardless of whether Litton did anything wrong, the case demonstrates the way U.S. firms often get entangled in complex foreign subcontracting arrangements as part of arms deals.

Earlier this year, Lockheed Martin Corp. pleaded guilty to federal charges that it paid a $1-million bribe to a member of the Egyptian parliament to help sell its C-130 cargo planes to the Egyptian military in 1989.

Litton and Reddy have been feuding for years, though their disputes have never surfaced publicly. Reddy first sued Litton in state court in the mid-1980s, charging the company had fired him for protesting the questionable payments. The suit was eventually dismissed.

The latest suit in federal court alleged that Litton set up a complicated scheme in which it passed money to the prince through an inflated subcontract to build housing in Saudi Arabia for Litton employees installing radar equipment. Included in the deal was an agreement by Litton to purchase land from the prince at inflated prices, the suit alleged.

Litton issued a subcontract worth $214 million to a small firm controlled by Wafic Said, who is the prince’s “personal business agent,” the suit alleged. The firm then assigned its own subcontract to Liechtenstein-based Tag Systems Construction, which Said and the prince also controlled, according to the suit.

Tag then issued yet another subcontract to a German construction firm to build the houses for $99 million, the suit said. By the end of the deal, Litton paid the equivalent of $1.3 million per house for 66 three-bedroom houses, the suit said.

Reddy, who was Litton’s manager in Woodland Hills for the Saudi housing program, said in his lawsuit that the excess payments received by Tag represented a formal kickback arrangement struck between Litton and the prince in the late 1970s.

“Everybody at Litton knew Prince Khaled was in charge of Tag,” Reddy, 44, said in an interview. “The prince made every decision on the job.”

But in the letter from his law firm, the prince denied that he ever held any “legal or beneficial interest” in Tag or that he was involved in any land transactions with Litton. Litton also denied that it purchased land from the prince.

“All of these allegations by Mr. Reddy are totally false,” said Litton spokesman Robert S. Knapp. He emphasized that “we know of no investigation of this program by the IRS or any other government agency.”

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Officials at Tag’s offices in Paris did not return calls seeking comment. A spokesman at the Saudi Arabian Embassy said he had no information about Tag or its owners. Wafic Said could not be located.

The existence of the IRS investigation was confirmed in a Feb. 22 letter to Reddy by IRS international tax examiner Robert Brown in Glendale, who wrote that he and IRS examiner Lou Barron would be investigating “the potential federal income tax consequences in connection with your allegations made against Litton Industries Inc. and subsidiaries.”

Until now, the merits of Reddy’s charges have never been investigated by the government. Steven Segretto, a federal prosecutor who examined Reddy’s case, said the statute of limitations had long expired when Reddy filed his sealed suit last year.

Segretto also said he had serious doubts about the legal theory under which a whistle-blower could sue a contractor for making foreign bribes and proving that the payments damaged the U.S. government. Prosecutors never made any judgment about the merits of the allegation, he added.

IRS officials in May took possession of five boxes of paperwork--containing more than 1,000 separate documents--from Reddy, according to his attorney, Phillip Benson of Newport Beach. In addition, IRS attorneys have drafted 13 pages of questions about the Litton deal and have sought answers from Reddy and Benson.

An IRS spokesman in Los Angeles declined comment. Under the Foreign Corrupt Practices Act of 1977, any bribes made to foreign officials are illegal and cannot be deducted from income in computing corporate tax liability, he said.

Sources close to the investigation said IRS officials have already audited Litton’s tax returns and determined that the housing subcontract payments were claimed as corporate tax deductions. It appears the IRS inquiry has gone beyond the purely preliminary stage, but much investigative work needs to be done, sources said.

Foreign bribery cases generally are tough to prove, according to lawyers and investigators. Among the most difficult tasks is showing that a U.S. firm’s payments actually end up in the pocket of a foreign government official.

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The prince, who holds a graduate degree in political science from Auburn University in Alabama, has retired from the military and is now in private business. He also owns the Arab-American newspaper Al Hayat, published in New York, according to Powell Tate, a Washington firm that is a publicist for his book.

In his book, entitled “Desert Warrior,” the prince called the Litton program “one of the biggest headaches of my military career,” because of technical problems and delays. In the end, those technical problems were fixed, the prince said.

The prince says he personally negotiated the broad outlines of the Litton air defense contract with the late Litton Chairman Charles (Tex) Thornton. The book contains a photograph of the prince, wearing a cowboy hat, shaking hands with Thornton, attired in Western wear and holding a cigarette.

In his book, the prince calls Wafic Said one of his “best friends,” saying Said traveled to Saudi Arabia from London during the Gulf War “to be on hand in Riyadh in case my family needed any help.” But Reddy in his suit alleged that Said was a so-called “personal business agent” for the prince, handling his complex business dealings through a number of shell corporations.

Reddy, a lawyer, is among the most experienced whistle-blowers in the nation. Before filing his federal suit last year, he sued Litton in Los Angeles County Superior Court in 1986, claiming that he was improperly fired for protesting the payments to Tag.

Litton contended that he was laid off along with others for business reasons. After lengthy legal maneuvering by the parties in both state and federal courts, the case was dismissed on a technicality for delays in reaching trial. In the meantime, Reddy and Litton sued each other for malicious prosecution. Litton lost its case; Reddy’s case against Litton is still pending.

After Reddy left Litton, he was hired by Teledyne as its program manager in Saudi Arabia. Reddy filed whistle-blower charges against Teledyne in 1992, alleging the firm sold defective equipment and bribed Egyptian officials.

The Justice Department joined the prosecution of that case and last October won a $5.6-million settlement against Teledyne, though Teledyne did not acknowledge any guilt. Reddy, who now lives on the East Coast and no longer works in the defense industry, received $869,000 of that settlement.

Steve Kantor, who worked at Litton as a subcontracts administrator in the Saudi Arabian program, said he attended several meetings in the 1980s when Reddy raised ethics concerns about the Tag relationship.

Kantor, who now lives in Santa Barbara, is not a party to any lawsuit. “He was ignored,” Kantor said of Reddy’s protests. “I believed him.”

But another former Litton official in the Saudi program, speaking on condition that he not be identified by name, contended that Reddy’s allegations are without merit, saying that the entire relationship between Litton and Tag was legitimate. “There was no payoff,” he said.