(Recasts)

By Paul Tait

CAMP VICTORY, Iraq, May 1 (Reuters) - Classified information wrongly kept by the former head of a detention centre holding members of Saddam Hussein's regime could have been devastating to the U.S. army in Iraq, an investigation heard on Tuesday.

Special Agent Thomas Barnes, the U.S. military's senior fraud investigator for Iraq and Afghanistan, said he was shocked by the amount of classified material found in the living quarters of Lieutenant-Colonel William Steele.

Steele is the former commander of the 451st Military Police Detachment at Camp Cropper, the detention centre near Baghdad airport where "high-value detainees" are among 3,000 people held and where Saddam spent his last days before his execution.

He faces nine charges, including aiding the enemy by providing an unmonitored cell phone to detainees, at a military investigation to decide whether he should face a court-martial.

Barnes said he led a search of Steele's living quarters at Camp Cropper on Feb. 22. Up to 65 documents were found in a briefcase, as well as piles of CD-Roms.

"I'd never seen that amount of classified material not properly stored, not properly labeled and not properly protected," Barnes told the investigation by telephone from the United States.

"In my opinion the documents that were found were extremely sensitive to the army's mission in Iraq. I believe if those documents were compromised it could have been devastating."

Steele is also accused of fraternising with a detainee's daughter, having an improper relationship with a translator, unauthorised possession of classified information and keeping pornographic videos.

Chief Investigating Officer Colonel Elizabeth Fleming later adjourned the hearing after the second day of evidence and will decide whether to proceed with a court-martial.

SYMPATHY FOR DETAINEES

While the charge of aiding the enemy can carry a death sentence, U.S. military legal officials have said the maximum penalty Steele would likely face if convicted at a court-martial would be a life sentence.

An agent attached to the U.S. military counter-intelligence directorate in Baghdad told the investigation earlier on Tuesday that Steele went to his office in February and said he had spoken to legal counsel and admitted his guilt.

Special Agent John Nocella was asked by the prosecution about privileges given to detainees in "Compound Five" at Camp Cropper, where detainees regarded as strategically significant were held, including use of Steele's personal cell phone.

Asked if Steele expressed empathy with "high-value detainees" because he understood their "personal anguish" and wanted to make their lives better, Nocella said: "Yes, he did".

Steele had explained this was because the detainees had not been found guilty of any offences, the investigation at the U.S. military base Camp Victory heard.

Steele had been detained in Kuwait since last month.

He is charged under the Uniformed Code of Military Justice for offences alleged to have occurred between October 2005 and February 2007. The U.S. military says he is entitled to the presumption of innocence.

Steele is the highest-ranking U.S. officer to face a charge of aiding the enemy since Captain James Yee, a Muslim chaplain at Guantanamo Bay, was charged in September 2003 with mutiny, sedition, aiding the enemy, adultery and possession of pornography. The army eventually dropped his case.

(Baghdad newsroom, editing by Dominic Evans)

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