A New York manufacturer whose defective dehydration remedy allegedly caused the deaths of four Peruvian babies pleaded guilty last week to defrauding the U.S. agency that purchased the preparation for a foreign relief program.

Mohammad Haleem Khan, owner and director of U.S. Materials Co., acknowledged in U.S. District Court in Manhattan that he defrauded the Agency for International Development (AID) under a $266,000 contract for 2.8 million packets of oral rehydration salts, which are administered widely to infants suffering from diarrhea and malnutrition.

Federal prosecutors agreed to drop the remaining 31 charges against Khan, including four counts of involuntary manslaughter. He faces a maximum penalty of five years imprisonment and $250,000 fine.

The four March 1986 deaths in a Lima hospital called into question AID procurement procedures that resulted in the distribution of some salt doses containing too much potassium, according to investigators.

Jay Morris, acting AID administrator, said the agency did not have time to follow normal procurement procedures when Peru asked for an emergency stock of oral rehydration salts in late 1983. Morris said the agency has adopted stricter controls since the mishap, which he described as an isolated incident.

The May 1986 indictment of Khan said that he had never produced oral rehydration salts before winning the government contract, that he lacked equipment and materials to meet AID's urgent delivery schedule and that he knew his production methods were "grossly deficient."

AID officials said the agency's Lima mission had no way of knowing of a potential problem when it awarded Khan the contract in November 1983.

Khan represented his firm as a capable manufacturer of the salts and of "other more sophisticated pharmaceutical products," and "there was no reason to presume that this firm wouldn't meet {Peru's} need in a very timely and cost-effective way," Morris said.

Typically, AID awards contracts through the General Services Administration, Morris said. But in this instance, the Peru mission advertised for suppliers directly. Khan was the lowest valid bidder, Morris said.

Gene Richardson, AID assistant inspector general for criminal investigations, said an element of risk enters into any procedure that places a premium on the lowest bidder. "Sometimes we get what we pay for," Richardson said.

In this instance, government officials said, Khan employed youths in their early teens part-time to help prepare the mixture of glucose, potassium chloride, sodium chloride and other chemicals amid unsanitary conditions at his Garnerville, N.Y., plant.

Although Khan's contract required delivery of 1 million packets of the salts by Jan. 1, 1984, "U.S. Materials did not even acquire the raw materials, manufacturing equipment or production facility to produce oral rehydration salts until January 1984," the indictment said. AID granted Khan repeated extensions when he fell behind schedule, the indictment said.

The Food and Drug Administration made 17 contacts with the company while it was under contract with AID in an effort to ascertain whether it was manufacturing substances within FDA jurisdiction, according to William Schwemer, assistant associate commisioner for regulatory affairs.

Although FDA inspectors discovered empty packages of oral rehydration salts in a garbage bin on one visit to the site, they did not learn of Khan's AID operation until after his product was linked to fatalities in Peru, Schwemer said.

More than 2 million salt packets were eventually distributed, while officials were bracing for a possible repeat of weather that caused a dramatic increase in deaths from dehydration the previous summer. The Peruvian government recalled the packets after four babies treated with the remedy died in the same hospital.

Morris said it was never proved that the salts caused those deaths, and no other deaths were attributed to the treatment. Khan denied that he provided a lethal product, although his plea Friday acknowledged that the salts were not prepared according to set standards, Assistant U.S. Attorney Franklin Stone said.

The guilty plea applied to one count of wire fraud alleging that Khan made false representations in an October 1983 cable to AID's Lima mission.

Khan, 46, remains free on personal recognizance pending his sentencing Oct. 2.

He could not be reached for comment and did not respond to a request for an interview through his lawyer, Robert Ponzini. Ponzini would not respond to the government's account of Khan's business operation.

The prosecution had intended to bring 50 witnesses from Peru and other distant locales to testify at the trial, which was scheduled to begin next month, Richardson said.

As a result of the case, AID now requires that contractors be inspected by the FDA, which regulates oral rehydration salts, and AID missions abroad must obtain approval from Washington for purchases in the United States, Morris said.

A spokesman for the Peruvian embassy said Khan's plea absolved AID of responsibility in the matter, but he reiterated his government's long-standing assertion that the families of the four babies should be "properly compensated."

The Peruvian government reportedly demanded $20 million in compensation in 1986. That demand was not formally presented, however.

Oral rehydration salts, which pharmacies stock under the name pedialyte, remain a cornerstone of relief efforts in underdeveloped regions and are credited with saving millions of lives around the world, Morris said.