Jan. 9 (Bloomberg) -- U.S. prosecutors dismissed charges against David Stockman, a former budget director in the Reagan Administration who was later accused of misleading investors in Collins & Aikman Corp. when he served as its chief executive.

Acting U.S. Attorney Lev Dassin in Manhattan announced the dismissal today in a statement. Charges were also dropped against J. Michael Stepp, the former chief financial officer of the now-bankrupt auto-parts maker, David Cosgrove, a former controller, and Paul Barnaba, ex-director of financial analysis.

“Further prosecution of this case would not in the interests of justice,” Dassin said.

Elkan Abramowitz, the lawyer for Stockman, said in an interview that a “fast, rushed” investigation by the New York law firm Davis Polk & Wardwell, which represented the Collins & Aikman board after the company’s collapse, led to the filing of criminal charges in 2007. New York-based Davis Polk took the results of its probe to the prior U.S. Attorney, who filed charges without thoroughly investigating the case, he alleged.

“They didn’t spend the time to look through the evidence,” Abramowitz said, criticizing the government’s practice of relying on private lawyers to conduct government investigations. “It’s a perfect example of what’s happening with the outsourcing of prosecutions.”

Yusill Scribner, a spokeswoman for Dassin, declined to comment.

Davis Polk

A telephone call to Davis Polk wasn’t returned.

It’s unusual for prosecutors to dismiss cases. The Manhattan U.S. attorney did so last year in an international bribery prosecution of former American International Group Inc. director David Pinkerton and in 2007 against ex-Credit Suisse Group banker Frank Quattrone, who was accused of obstructing justice.

Stockman, 62, and his three codefendants were charged with defrauding company investors by issuing false financial reports and engaging in a phony rebate scheme to raise capital and avoid defaulting on credit agreements.

Four former Collins & Aikman executives, including then- Treasurer John Galante, pleaded guilty to charges in the case and were cooperating with prosecutors.

Abramowitz said the dismissal followed his discovery of evidence that he brought to the attention of prosecutors.

‘Renewed Assessment’

“All indications were that no one at Collins & Aikman thought they were doing anything illegal,” the lawyer said. “They were doing everything in the open.”

Abramowitz added that prosecutors today may be more aware of troubles afflicting the automotive industry than they were three years ago.

In papers filed in Manhattan federal court today, prosecutors cited their “renewed assessment of the evidence, including evidence and information acquired after the filing of the indictment.”

Stockman, who declined to comment in an e-mail, has spent 3 1/2 years trying to clear his name, Abramowitz said. In a 2007 interview, Stockman blamed the company’s bankruptcy on his sudden firing in May 2005 by the Collins & Aikman board. The company sought bankruptcy protection five days after Stockman left the company.

Cabinet Officer

“I was the youngest Cabinet officer of the century,” Stockman said in a 2007 interview with Bloomberg News. “How did I get through all these stages of life and manage to get to age 57, and then go on a crime spree?”

Stockman became chairman and chief executive officer of Collins & Aikman in 2002, after the private equity fund he founded, Heartland Industrial Partners LP, became the majority investor in the Southfield, Michigan-based company. He said he lost $13 million from the Collins & Aikman collapse.

Stockman served as director of the Office of Management and Budget from 1981 to 1985, successfully helping convince Congress that deep tax and spending cuts would revive the economy.

Regarded as brainy and brash in Washington political circles, Stockman, a former Harvard divinity student, came under fire in late 1981 after he told the Atlantic magazine that billions of dollars in congressional budget cuts were “artificial” and that lawmakers lacked courage to truly slash government spending.

‘Nolle Prosequi’

“None of us really understands” the federal budget, Stockman told the Atlantic. He apologized for his remarks, told the press he’d been taken “to the woodshed” by an angered President Reagan and remained on the job another four years.

U.S. District Judge Barbara Jones today approved the government’s request for a “nolle prosequi,” as the dismissal is called. Defense lawyers learned of the decision today.

“Being charged is a terrible thing,” Cosgrove’s lawyer, Craig Stewart, said in an interview. “It’s such a cloud hanging over your head.”

Stepp’s lawyer, Karen Seymour, said the case “should never have been filed” in the first place. Sol Wisenberg, Barnaba’s lawyer, said the indictment had a “devastating effect” on his client and called the dismissal a “great victory.”

The case is U.S. v. Stockman, 07-cr-220, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: David Glovin in U.S. District Court in New York at dglovin@bloomberg.net.

Last Updated: January 9, 2009 15:01 EST