THE US government has criticised Lord Goldsmith, the attorney-general, for dropping a Serious Fraud Office (SFO) inquiry into allegations of corruption involving Britain’s biggest defence firm and the Saudi royal family.

In an embarrassing rebuke, officials from the US State Department told Goldsmith’s office that they have “serious concerns” about the decision to drop the BAE Systems fraud investigation.

The issue was raised at a private meeting of the Organisation for Economic Cooperation and Development (OECD) in Paris last month.

The defence company is alleged to have paid millions in bribes to at least one senior member of the Saudi royal family to win valuable defence contracts.

The SFO inquiry was dropped on “public interest” grounds in December following threats from the Saudi government that it would sever diplomatic and intelligence ties with Britain if the investigation continued.

At the OECD meeting, officials from more than 30 countries met British representatives seeking to explain their decision. Civil servants from Goldsmith’s office and the SFO were also present at the meeting. All the countries present, including Britain, are signatories of an antibribery convention.

A source said: “The British explained the position and the Americans were then first to take a bash. The US delegate expressed himself fairly forcibly and serious concerns were raised. It was a frank exchange. The French were also outspoken.”

The British government has to prepare a report in defence of its actions to present to a meeting of the OECD’s antibribery group next month.

Meanwhile, the Liberal Democrats are pressing the European commission to investigate whether the decision breached European Union competition rules.

Vince Cable, the party’s Treasury spokesman, said: “If it could be shown that the dropping of the SFO investigation gave BAE an unfair advantage, then this would constitute a serious breach of the law.”

The intervention of the American government has surprised some British officials as President George W Bush is close to the Saudi royal family.

Sources say the US action was driven by commercial interests. The Americans were among the first in the world to outlaw bribery abroad. They then led an international drive against such corruption which gave rise to the OECD’s antibribery convention.

US defence firms are said to be furious that they may now be at a disadvantage when competing with BAE.

Mark Pieth, a Swiss law professor who chairs the OECD’s working group on bribery in international business, says he is concerned that the potential breach of the antibribery convention may put the agreement “squarely at risk”.

“Britain is one of the key members of this convention and we are concerned because it seems as if there’s been a breach of article 5 by Britain,” he said.

“The only explanation for dropping the case has been that there’s been very strong political pressure.”

The British government has been keen to make it clear that corruption inquiries continue into BAE’s behaviour in six countries, including South Africa, Romania and Chile. BAE denies any wrongdoing.

Last week Goldsmith revealed plans for an external review of the SFO to ascertain whether “lessons can be learnt from other jurisdictions”. He also extended the contract of Robert Wardle, head of the SFO, for a further year.

Wardle is now expected to step down in April 2008. He has said that he had “no regrets” over having halted the inquiry.

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