November 14, 2008 -- A federal grand jury in North Carolina is investigating allegations the controversial private security firm Blackwater illegally shipped assault weapons and silencers to Iraq, hidden in large sacks of dog food, ABCNews.com has learned.

Under State Department rules, Blackwater is prohibited from using certain assault weapons and silencers in Iraq because they are considered "offensive" weapons inappropriate for Blackwater's role as a private security firm protecting US diplomatic missions.

"The only reason you need a silencer is if you want to assassinate someone," said former CIA intelligence officer John Kiriakou, an ABC News consultant.

Six Blackwater employees are under investigation by another federal grand jury, in Washington, D.C., in connection with the shooting deaths of at least 17 civilians in September 2007 at a Baghdad traffic circle. Prosecutors are expected to return indictments in the next few weeks, according to people familiar with the case.

The investigation of the alleged dog food smuggling scheme began last year after two Blackwater employees were caught trying to sell stolen weapons in North Carolina. The two, Kenneth Cashwell and William "Max" Grumiaux pleaded guilty in February and became government witnesses, according to court documents.

Two other former employees tell ABCNews.com they also witnessed the dog food smuggling operation. They say the weapons were actually hidden inside large sacks of dog food, packaged at company headquarters in North Carolina and sent to Iraq for the company's 20 bomb-sniffing dogs.

Larger items, including M-4 assault weapons, were secreted on shipping pallets surrounded by stacks of dog food bags, the former employees said. The entire pallet would be wrapped in cellophane shrink wrap, the former employees said, making it less likely US Customs inspectors would look too closely.

In a statement, Blackwater did not address directly the allegations involving silencers but says "all firearms shipped to Iraq by Blackwater were given proper US government license." The statement denied Blackwater owned or possessed any M4 weapons in Iraq.

US Army officials told ABCNews.com earlier this year, at least one Blackwater M4 weapon was discovered during a raid on an suspected insurgent location in Iraq.

Last year, a US Department of Commerce inspector at JFK airport in New York discovered a two-way radio hidden in a dog food sack being shipped by Blackwater to Iraq, according to people familiar with the incident.

Blackwater says the radio did not need a license and was hidden among the dog food sacks, not inside the dog food.

The company says it is a common practice "to prevent corrupt foreign customs agents and shipping workers from stealing the valuables."

In addition to the grand jury investigation, Blackwater sources say the company is facing a multi-million dollar fine for some 900 instances in which it violated State Department licensing requirements for the export of certain weapons and technical know-how.

Blackwater acknowledged in its statements "numerous mistakes in complex and demanding area of export compliance," saying most of the violations were failures of paperwork not "nefarious smuggling."

Of the 900 cases, about 100 of them have been referred to the Department of Justice for possible criminal prosecution, according to lawyers briefed on the case.

Last month, Blackwater hired a team of former federal law enforcement officials and defense experts that it said would review the company's compliance with export laws.

Andrew Howell, Blackwater's general counsel, said, "Ongoing reviews by the Department of Justice, State and Commerce have highlighted the need for a significant and systems-wide initiative."

Another former Blackwater insider who talked with ABCNews.com said company executives made the decision to smuggle the weapons and silencers in the dog food "because it's a war over there and our guys need them."

Despite four separate federal grand jury investigations of its operations, Blackwater's contract to provide security services for the US State Department was renewed earlier this year. The contract pays Blackwater $250 million a year and runs for five years.

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