WHEN DEPUTY DEFENSE Secretary W. Paul Thayer was chief executive of the conglomerate LTV Inc., before President Reagan nominated him late last year to be the number two man at the Pentagon, a Texas grand jury indicted his firm for conspiring to defraud the federal government.

The grand jury accused LTV of creating a subsidiary in 1969 called LTV-Education Systems Inc., (LTV-ESI) in an illegal scheme to use vocational schools to get access to millions of dollars of federal student loan funds. At the time, LTV was near bankruptcy.

In 1978, LTV settled that criminal case by pleading no contest and paying a $500,000 fine. But a multimillion dollar civil suit between the Justice Department and the conglomerate still is pending. LTV denies any civil liability.

Thayer personally was not charged with any wrongdoing in either of these cases.

In May, the government filed a 36-page brief that outlined its civil case. The brief does not focus on Thayer, but it mentions him in passing. It claims that Thayer, as a company executive, asked LTV officials to put LTV-ESI under his control, hired its top management, received a memo about the profitability of one of the schools, actively sought financing for LTV-ESI and, when the schools came under investigation, approved a staff recommendation to refund student loans that had been delayed but rejected a recommendation that LTV tell the government that it might have paid excessive interest to LTV in the past.

Charles L. Bucy, counsel at LTV Corporation, said Thayer's actions as an executive of the company were proper.

"His (Thayer's) attitude always has been, from the very start, if we owe any money to the government we shall pay it immediately," Bucy said.

"I have no recollection of any civil suit," Thayer said. "Everything you are talking about happened 10 years ago. I was never indicted or deposed on this. I don't understand the newsworthiness of this all, except for the fact that I was elevated to my present position and that is news in Washington."

Regarding the grand jury indictment, Thayer said: "As I recall, a judge in Dallas went on record saying the present management of LTV had no part in it (alleged wrongdoing) and he knew more about the case than you or anyone else."

When told that the government had alleged that LTV started its subsidiary to abuse a federal loan program, Thayer said: "That's a damn lie."

The extent of Thayer's personal involvement in LTV-ESI could be ascertained from several thousand documents generated by the grand jury. But, those documents are under court seal and would be made public only if they were introduced at the civil trial. That trial, however, may never take place because LTV and the government currently are negotiating an out-of-court settlement.

In the meantime, a telephone caller has tipped several news organizations, including The Washington Post, to the civil suit. Recently, The Cleveland Plain Dealer published a story about it.

Bucy called the story "inaccurate" and "untrue."

"The company (LTV) was going down the tubes," when Thayer took control in 1970, Bucy said. "He simply didn't have time to know what was happpening at 43 individual schools in a subsidiary of a subsidary. He had much bigger fish to fry," Bucy said.

LTV was on the brink of bankruptcy when Thayer took over. It's founder, James J. Ling, had been borrowing heavily since 1968 to keep LTV solvent.

After two months of internal fighting and what Fortune magazine later described as "anarchy at LTV headquarters," Ling's creditors forced him out and put Thayer in charge in June 1970.

It was later described by the press as "an unwittingly brilliant choice."

Thayer had led an incredible career. As a World War II Navy fighter, he personally destroyed 19 enemy aircraft, including six in dogfights. After the war, he married to-na stewardess and became a test pilot for Chance Vought, later part of LTV.

During his first eight months on the job, three test pilots were killed and three others quit, but Thayer stayed. In all, he walked away from six wrecked planes and bailed out of one, breaking his coccyx. "So far as I know," he jokingly told Fortune magazine in 1973, "I'm the only man around here who can really say he busted his ass for this outfit."

Thayer's rise in management was as stunning as the barrel rolls that he used to perform in company jets. (Ling reportedly once grounded him for barrel rolling a jet while Mrs. Ling was aboard.)

A fierce competitor, he quickly moved up the corporate ladder. He was colorful, too. A big game hunter, former part-owner of a stable of racehorses, inveterate poker player and crapshooter, Thayer once sold $24,000 worth of his LTV shares to pay a gambling debt, Fortune reported.

Taking charge of LTV was one of the biggest gambles Thayer ever took. Fortune magazine described the situation in 1970 at LTV like this: "With its cash running down, LTV was surviving on borrowings, but the investment houses and the banks were refusing more credit. When Thayer took over, $75 million remained of a bank loan that was 14 months overdue. An additional $2 million of long-term debt would come due the next year and no cash was coming in to meet either payment. As Thayer sums it up: 'The fortunes of LTV were damn dismal.' "

The government contends in court papers that in June 1968, H.M. Butler asked LTV to buy three vocational schools that he owned. (Butler refused comment for this story.) LTV declined Butler's proposal at first, the government alleges, but Butler "rekindled LTV's interest" after he told management that they could "double current revenues" by "using the Federal Insured Student Loan (FISL) program."

Vocational schools in Texas had been barred frommparticipating in the program, but the state legislature had recently changed that. Under the FISL program, a student could receive a loan regardless of his credit rating. The loan was made through a private lender or a qualified school to the student who was required to immediately pay it to the school. The loan covered a full year's tuition which meant the school got its money up front and all at one time. Students didn't have to repay the loan until nine months after they stopped attending classes. In the meantime, the goverment paid interest to the lender and, if the student defaulted, Uncle Sam covered the loss.

"With the FISL program firmly in its sights, LTV purchased the schools . . . " the government alleged. At the time, Thayer was president of LTV-Aerospace Corporation, which was a subsidiary of LTV. "Thayer . . . convinced Ling (LTV's president) to include the schools in Aerospace's commercial diversification," the government said in its brief filed in the civil case.

Bucy, LTV's attorney, said Aerospace, which is a major defense contractor, wanted the new subsidiary under its control because the Defense Department had been pressuring it to diversify and "Aerospace saw an opportunity to improve its corporate image during the Vietnam era."

Thayer then hired M.L. Chandler to manage LTV-ESI, according to the government brief which said that "Chandler was an aerospace expert who had no experience in education and had little enthusiasm for students." Chandler declined comment.

Bucy said Thayer hired Chandler because of he needed a manager, not an educator, to run LTV-ESI.

Then, according to government documents in the criminal case against LTV, the president of Aerospace (Thayer) "advised" Chandler to put Butler in charge of the newly- formed college division to find more schools to buy. Within two years LTV acquired 43 vocational schools.

"From the outset, LTV-ESI's plans focused on the aggressive sale of Federal Insured Student Loan program loans and largely ignored education . . . " the government claims. "Using this approach, ESI obtained more than $40 million in -ntuition through FISL loans in less than five years. Many students were cheated and serious damage was done to the Federal Insured Student Loan program."

In its brief, the government describes depositions which it had taken from former LTV- ESI employes. "ESI executives have described their sale practices as 'hucksterism' and 'snake oil peddler sales policy'; their salesmen as 'fast talking, quick close artists', and their sales techniques as 'cold turkey prospecting,' " the government said.

"In one particularly flagrant case, LTV- ESI enrolled 150 students in its unaccredited Dallas school and represented to the Education Department that they were attending an accredited school in Dallas," the government said in its court papers. "Many LTV-ESI students did not stay in school long enough for FISL applications to be processed. When the student was no longer in school, LTV-ESI instructed salesmen to locate the students to endorse the checks. LTV-ESI then would obtain the full amount of the FISL loan," the government said.

Students were allegedly enrolled in computer courses when the schools did not have computers, the government claimed in its criminal indictment. "When the schools would receive advance notice of inspections to be made by the accrediting commissions, equipment would be sent to the school by bus to make it appear the school was adequately furnished and equipped."

In a deposition, Chandler described LTV- ESI as "a profit-gold mine" during its first two years of operation, according to the goverment. The government's court papers said Butler's three schools made $225,000 in pre-tax profit before he sold them to LTV. The next year, the same three schools earned a pre-tax profit of $1 million, the government alleged. Overall, in its first year, the rapidly- expanding college division generated "$1,898,000 of cash over expenditures," the government said.

The government said 80 percent of all students attending LTV-ESI schools during that first year had received federal loans.

"FISL loans almost immediately delivered a 50 percent increase of gross income," the govenment said, "the results exceeded LTV's highest hopes."

In 1969, Chandler was ordered by "Aerospace management" to "increase LTV-ESI's sales forecast from $91 to $120 million" by 1974, the government alleged. Thayer was president of Aerospace at that time.

That same year, Chandler wrote a memo to Thayer which the government claims showed that "an education was a low priority" at LTV schools. The government, however, only quotes one abbreviated sentence from that memo: "Indications are . . . profitability is reduced by lack of energetic marketing and an excessive roster of instructors." LTV says the government has taken Chandler's memo out of context.

In 1971, LTV-ESI was experiencing financial problems.

"Emphasizing sales over instruction led to the enrollment of large numbers of students who withdrew quickly," the government alleged. Some 56.8 percent of LTV-ESI students dropped out before the 1971 school year ended.

That high dropout rate had a drastic effect on LTV-ESI's profitability because LTV was required to refund a portion of a student's loan if he dropped out before the school year ended. The high dropout rate also made banks reluctant to make FISL loans, the government said.

"As LTV-ESI's financial condition worsened in 1971, officials throughout LTV and Aerospace joined in the search for funds, including Paul Thayer, LTV's new chief executive officer," the government said in its civil brief.

LTV began paying $35 to $50 fees to banks for each loan they made, the government said, contending such fees were "patently illegal" and LTV had been warned not to make them. (Not all the loans to students in these schools came from banks;;some of LTV-ESI's schools were also approved as lenders, so they could give credit to students directly.)

The company also delayed paying student refunds, sometimes up to two years, and did not tell the government when -n some students had dropped out of school, the government claims in its brief. As a result, the government contends it overpaid interest.

In 1974, Thayer's staff recommended that LTV-ESI pay student refunds that it owed and notify the government that the Education Department may have paid excessive interest on some loans, the government contends in its civil brief. Thayer approved the repayment, but "rejected (his staff's) proposal to notify the Education Department about prior-inflated interest claims," the government claims. One paragraph of the criminal indictment also says that this incident involving Thayer took place, but he was identified by his title, not name.

When told about the paragraph, Thayer said, "I still don't know what you are talking about."

LTV shut-down its educational subsidiary in 1975.

In 1977, LTV filed a $3.5 million civil suit against the Education Department because it had refused to reimburse it for defaulted FISL loans. The Justice Department filed a countersuit for $70 million "upon the theory of pervasive abuse, fraud and unjust enrichment."

In 1978, the Texas grand jury issued an indictment against LTV, Aerospace and LTV- ESI. It accused unnamed executives of conspiracy to defraud the government by abusing FISL. LTV pleaded no contest and paid a $500,000 fine.

In accepting the out-of-court settlement, U.S. District Judge Patrick E. Higginbotham wrote in an order: "There are executives that escaped indictment in this case. If they were guilty, they should be aware how fortunate they are . . . these are jail time offenses."

The next day, Higginbotham issued a one- paragraph amendment to his previous order: "The word 'executives' as used in the order . . . does not refer to present management of LTV. Most of the acts charged in the indictment occurred at least five years ago."

Bucy said Higginbotham's order was specifically written to clear Thayer of any involvement in the grand jury charges. Higginbotham declined to comment on why he issued the second order.

Bucy said LTV pleaded no contest to the grand jury charges only because it was afraid that a court fight would have jeopardized negotiations for a $450 million line of credit which the company needed in 1978 for the merger of LTV and the Lykes Corp. He said the company never did anything wrong.

Stuart F. Pierson, a Washington attorney who represents LTV in LTV-ESI matters, "wanted to fight the accusations," Bucy said, "because he felt he could prove they were untrue, but it came down to being a business decision."

According to LTV's civil brief, the government's theory that LTV bought the schools "as a calculated scheme to drain the FISL program of cash" may "make interesting reading, but it lacks a necessary basis in truth."

"LTV-ESI did not, indeed, it could not have served as an abusive cash source. Only the first of LTV-ESI's four active years was even slightly profitable; the last three were a constant and nagging hemorrhage.

"Through ESI's four years of active operations, Aerospace supplied more than $24 million in support for its subsidiary," according to the brief. "After acquisition, the schools were upgraded in equipment, facilities and new buildings. . . . For a large group of companies struggling to restructure and to stabliize, ESI's minuscule revenue could never justify its constant cash drain."

Pierson wrote in the brief that LTV-ESI eventually paid $15.3 million in refunds and almost $800,000 in "unrequired refunds and interest to the Education department alone." It also set up a voluntary systemwide refund project which paid students more than $5 million in additional refunds.

The government is now trying to make LTV meet standards for the student-loan program that were not in effect at the time, LTV contends.

"It (the government) cannot obiterate four years of approvals, assurances, conflicting interpretations, uncertain and informal program management and construct in their place a regulatory scheme which did not exist when ESI participated in the FISL," he said.

In preparation for Thayer's Dec. 14 confirmation hearings, the Senate Armed Services Committee asked for a written explanation from LTV of this criminal and civil litigation. Bucy sent the committee a two page explanation, and Judge Higginbotham's order. Thayer was not questioned about LTV-ESI's troubles at his confirmation hearing.