Virginia state Sen. Peter K. Babalas, one of the legislature's senior Democrats, "willfully" violated the state's conflict-of-interest law by voting to kill legislation that would have imposed restrictions on one of his legal clients, a legislative ethics panel said yesterday.

The panel's report, the first under a new Virginia law, was forwarded to the state attorney general to determine whether there is enough evidence to prosecute the 63-year-old Babalas, the fourth-ranking member of the Senate. If convicted of violating the ethics law, Babalas could be fined up to $1,000, sentenced to a year in jail, and be expelled from the legislature.

Babalas, a Norfolk lawyer who accepted more than $61,000 from a second-mortgage company that would have been affected by the legislation, could not be reached for comment. His attorney, Wayne Lustig, said the panel's conclusion "is not supported by the facts. This appears to be a conclusion arising out of a giant leap from unsupported innuendo."

The legislator has contended that his actions in killing legislation that would have regulated his client, the now-bankrupt Landbank Equity Corp., and other second-mortgage firms were proper and separate from his role as a lawyer for the Virginia Beach firm.

The bipartisan Senate ethics panel, which included two former governors, said yesterday it found "not credible" Babalas' contention that he "did not know" the legislation he helped kill Feb. 11 "would have an adverse impact on his client's loan practices." The senator advised Landbank's officers "on the specific issue involved . . . not once, but in many instances," the panel said.

After his vote Babalas' law firm received a $3,000 payment from Landbank. According to records filed in a federal bankruptcy court, a Landbank official wrote on the invoice covering that payment: "This was one we agreed to pay after he stopped legislation in Richmond."

Landbank, the subject of a federal criminal investigation and scores of lawsuits, had been charging up to 40 "points" for securing mortgages for largely poor and uneducated clients in a half-dozen states. The proposed bill would have placed the transactions under Virginia regulation for the first time, imposing an eight-point limit on such transactions. (A point is one percent of the total cost of a mortgage.)

A spokesman for Acting State Attorney General William Broaddus said a "special team" has been assigned to review the Babalas report, but added that unless that team acts before Friday the case will likely be handled by Attorney General-elect Mary Sue Terry. A Democratic colleague of Babalas in the General Assembly, Terry will be sworn in Saturday as the state's top lawyer. She had no comment on the issue yesterday.

Lustig called for the attorney general to allow the Senate Privileges and Elections Committee to "judge the qualifications and acts of Sen. Babalas," an idea the ethics panel rejected in its 32-page report.

The panel said that evidence of legal services Babalas gave Landbank during 1984 and 1985 was vague. "Beginning in April 1984, however, it is clear that the work done by Sen. Babalas for Landbank focused in numerous instances on this precise issue -- the limitation on charges which Landbank could make," the panel said.

Most politicians in Richmond, including Gov. Charles S. Robb and Gov.-elect Gerald L. Baliles, declined to comment on the report, saying either they wanted time to study the report and its accompanying documents, or that comment would be inappropriate at this time.

House Speaker A.L. Philpott, who pushed the legislation that Babalas helped kill, said "It sure puts a cloud on him."

Some Republicans were outspoken. Jim Turpin, executive director of the Republican legislative caucus, said he hopes the attorney general will "deal with these obviously grave charges in a prompt and diligent manner."

Former Republican attorney general J. Marshall Coleman of McLean, who had called for Babalas to step down pending resolution of the matter, said the report will provide "the first test of the new attorney general. It will give us a chance to find out if she has all the prosecutorial vigor her paid television ads said she did."

No member of the Virginia legislature has been expelled in recent years, according to the Division of Legislative Services. A check of records there indicated that a delegate was expelled in 1926, shortly after he was elected and it was learned he had been convicted of a felony under a different name. Another delegate was dismissed in 1876 on charges that he stole another delegate's per diem allowances.

If the attorney general decides not to refer the case for prosecution, the issue will go to the Privileges and Elections Committee. State Sen. Joseph V. Gartlan Jr. (D-Fairfax), who is expected to assume chairmanship of the committee when the 1986 session of the legislature begins Wednesday, said the law "still leaves up to the Senate the matter of what should be done as far as the member's status with the body, what sanctions if any should be imposed."

Babalas set in motion the investigation, the first under the new conflict-of-interest law that established nonlegislative ethics advisory panels for both houses of the Assembly, on Nov. 12, after his actions were questioned by an editiorial in The Norfolk Virginian-Pilot newspaper.

The panel, composed of Chairman Rayner V. Snead, a retired state judge from Rappahannock County, and former governors Albertis S. Harrison Jr., a Democrat, and Linwood Holton, a Republican, gathered most of its evidence from sworn testimony and public records of the bankruptcy proceeding, and through legislative records. On Dec. 23, it conducted a hearing in Richmond, but allowed Babalas to submit an affidavit, which was made public for the first time yesterday.

In it, Babalas said he "was not aware of how Landbank charged its customers" and "did not know nor care whether an eight-point cap on discount points would affect Landbank or any second mortgage lender."

Landbank "never paid me nor were they ever charged for anything I ever did as a legislator . . . and there was never any agreement to that effect," he said.

But the panel found that "at least as early as April 30, 1984, Senator Babalas kept Landbank advised on legislative activities regarding Virginia's usury laws, when he wrote to Landbank owner William Runnells concerning those statues and said: 'I will keep you advised since there is going to be a study.' "

The committee found that in October 1984 Babalas wrote to Landbank's insurers on behalf of Landbank, "referred to his role in chairing the interest rate laws study, described the course of the study, used his Senate stationery to emphasize his legislative position, and used his position as senator to assist his client. Sen. Babalas charged Landbank $10,000 in connection with his work on Landbank's dispute with its insurers . . . . "

The panel said it found that, as of January 1985, Babalas was a registered agent for more than 10 Landbank entities and was "involved with Landbank to a substantial degree."

Babalas' lawyers argued that their client "did not view attorney's fees, regardless of the amount, as a personal financial interest that legally affected his abilty to vote on House Bill 1655," the report said.

The panel went on to say that "the record is clear that Landbank, which was an unregulated lender and which depended on loan fees and discount points for its profits, would be harmed by the cap on fees and discount points proposed in House Bill 1655."

Babalas contended the legislation was not specifically aimed at Landbank, and therefore his vote was not covered by the conflict-of-interest law. But the panel said "almost all legislation adopted by the General Assembly must be stated in general terms."