Britain rebuked for dropping bribe inquiry

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Tony Blair suffered a humiliating rebuke from an international financial watchdog after it condemned the Government's decision to abandon a fraud inquiry into a £40bn arms deal with Saudi Arabia.

The Organisation of Economic Co-operation and Development (OECD) expressed alarm that Britain could have breached its promise to combat corruption in the developing world.

Lord Goldsmith, the Attorney General, also confessed to his unease with the scrapping of the Saudi investigation.

BAE Systems was accused of setting up a secret slush fund to smooth the deal, which dates back to the late 1980s, to supply the Saudi government with Tornado and Hawk fighter jets. The defence giant strenuously denied the allegations, which the Serious Fraud Office (SFO) started investigating in 2004. The inquiry into the so-called Al-Yamamah deal was dropped last month amid claims that the bribery inquiry was blighting BAE's chances of landing another lucrative contract with the Saudis. The Government also warned that security co-operation with Saudi Arabia, a key partner in the fight against terrorism, was being affected by the controversy.

The Prime Minister has said he takes full responsibility for the decision to end the SFO inquiry. But he was rebuffed by the OECD yesterday, which said it had "serious concerns as to whether the decision was consistent with the OECD anti-bribery convention".

Angel Gurria, its secretary general, warned that "appropriate action" would be considered after its working group on bribery reports in March on Britain's compliance with the convention. The OECD, which could send a mission to Britain to investigate the case, warned that the convention's credibility depended on industrialised nations demonstrating the "political will" to abide by it.

Sir Menzies Campbell, the Liberal Democrat leader, said the episode had done serious damage to the country's reputation. He said: "Any government other than Mr Blair's would be deeply embarrassed by this criticism. Whenever British ministers argue the case for a hard line on corruption elsewhere, for example in developing countries, they will be rightly accused of double standards."

Following the OECD statement, Lord Goldsmith told the Lords: "It is very important to make it clear that dropping the investigation into alleged bribes paid by BAE Systems - and it was not an entirely comfortable decision - doesn't mean we are backing off in any way from our commitment to tackling international corruption.

"On the contrary, I am clear we should re-double our efforts. I have told the director of the Serious Fraud Office that he should vigorously pursue current investigations, which include a number of other cases against BAE, and that we need to do all we can to make sure that he has the resources to do so."

The Al-Yamamah arms deal is said to be the biggest sale of British goods in the nation's history. As well as dozens of fighter jets, it also included naval vessels, missiles and the construction of an air base.

The contract was said to have been clinched by the lobbying of former prime minister Margaret Thatcher, with her Defence Secretary Michael Heseltine signing its first phase in 1985. Delivery continued until the late-1990s and BAE then began negotiations to supply Eurofighter aircraft to Saudi Arabia.

In 2004, allegations surfaced that BAE had paid £60m into a secret fund set up for the Saudi royal family and other government officials. The SFO confirmed it was investigating the claims.

Last month, the company said the Eurofighter negotiations had slowed down and it emerged that the Saudis were holding talks with a rival French defence contractor. On 14 December, Lord Goldsmith announced the SFO investigation was being discontinued. He said: "This decision has been taken following representations that have been made both to the Attorney General and the Director concerning the need to safeguard national and international security. It has been necessary to balance the need to maintain the rule of law against the wider public interest."

This week Mr Blair argued that pressing ahead with the SFO inquiry would have been "devastating for our relationship with an important country with whom we co-operate closely on terrorism, on security, on the Middle East peace process".

He added: "That is leaving aside the thousands of jobs which would have been lost, which is not the consideration in this case, but I just point it out."

The Labour MP Roger Berry welcomed the warning from the OECD, which he said would "have to be taken seriously" by the Government.

He predicted that a Commons select committee would investigate the Government's decision once the OECD had issued its official written report in March. "There's deep unease about this decision," he said, " but sadly I don't think this issue is going to go away because I don't think the Government is going to reverse its decision."

The BAE deal with Saudi Arabia

1985 First phase of Al-Yamamah arms deal with the Saudi government is signed by Michael Heseltine on behalf of UK Government

1987 First aircraft delivered by British Aerospace (later BAE Systems)

1988 Second stage of deal signed

1991 Saudi Tornado jets fly alongside RAF Tornado bombers in Gulf War

1992 National Audit Office investigates contract. Its report is never published

2003 Newspaper allegations about a secret slush fund into which BAE paid bribes. It strongly denied the claims

2004 BAE Systems confirms it is being investigated by the Serious Fraud Office

2005 BAE announces provisional agreement to supply Saudi Arabia with Eurofighter jets. Talks to finalise the deal continue throughout 2006

1 December 2006 BAE Systems admits that negotiations over the Eurofighter have slowed. The French planemaker Dassault says it is in talks to sell a rival jet, the Rafale, to Saudi Arabia

14 December 2006 Lord Goldsmith, the Attorney General, announces that the SFO is dropping its investigation because of the "need to safeguard national and international security"

6 January 2007 Saudi Defence Minister says the country is looking forward to receiving 72 Eurofighter jets "very soon"