The investigation centers on whether the Pentagon analyst passed secrets about U.S. policy on Iran to the main pro-Israeli lobbying group in Washington, the American Israel Public Affairs Committee, which then was said to have given the secrets to the Israeli government, one official said. Both AIPAC and Israel deny the allegations.
60 Minutes Correspondent Leslie Stahl was first to report the story, on Friday.
No arrests have been made, said two federal law enforcement officials, speaking to The Associated Press Saturday on condition of anonymity because of the continuing investigation. A third law enforcement official, also speaking anonymously, said an arrest in the case could come as early as next week.
Two of those officials raised the possibility the government might not bring espionage charges, but rather lesser ones that could include the mishandling of sensitive government material.
The officials refused to identify the Pentagon employee under investigation but said the person is an analyst in the office of Douglas J. Feith, undersecretary of defense for policy, the Pentagon's No. 3 official.
Late editions of Saturday's Washington Post say, "The name of the person under investigation was not officially released, but two sources identified him as Larry Franklin."
"He was described as a desk officer in the Pentagon's Near East and South Asia Bureau, one of six regional policy sections," the Post continued. "Franklin worked at the Defense Intelligence Agency before moving to the Pentagon's policy branch three years ago and is nearing retirement, the officials said."
The spying allegations threaten to create tensions between Israel and its closest ally at a sensitive time. After four years of fighting with the Palestinians, Israel faces growing international isolation and can ill afford a confrontation with Washington.
Israeli security sources said to the AP Saturday that the Mossad foreign espionage service, military intelligence and other intelligence branches had all been asked about possible involvement with the Pentagon analyst. All denied any connection to the affair, the sources said, speaking on condition of anonymity.
White House spokesman Scott McClellan, traveling with President Bush on a campaign visit in Dayton, Ohio Saturday, said he was not in a position to discuss a continuing investigation.
"Obviously, any time there is an allegation of this nature, it's a serious matter," he said.
The Pentagon said in a statement the investigation involves an employee at "the desk officer level, who was not in a position to have significant influence over U.S. policy. Nor could a foreign power be in a position to influence U.S. policy through this individual."
The Pentagon said Friday night it had cooperated with the Justice Department for "an extended period of time."
David Siegel, a spokesman for the Israeli Embassy in Washington, said, "We categorically deny these allegations. They are completely false and outrageous."
Feith is an influential aide to Defense Secretary Donald Rumsfeld who works on sensitive policy issues including U.S. policy toward Iraq and Iran. Feith's office includes a group assigned specifically to work on Iran.
He also oversaw the Pentagon's defunct Office of Special Plans, which critics said fed policy-makers uncorroborated prewar intelligence on President Saddam Hussein's Iraq, especially involving purported ties with the al-Qaida terror network. Pentagon officials have said the office was a small operation that provided fresh analysis on existing intelligence.
One of the law enforcement officials said the person was not in a policy-making position but had access to extremely sensitive information about U.S. policy toward Iran.
In Israel, the chairman of the Knesset's Foreign Affairs and Defense Committee said Saturday that Israel worries about Iran's nuclear policies. But Yuval Steinitz said he is confident the government has not abandoned a 20-year-old decision not to spy on the United States.
Mr. Bush has identified Iran as part of an "axis of evil," along with North Korea and the Iraqi government deposed by the U.S.-led invasion last year.
Yet his administration has battled internally over how hard a line to take toward Iran. The State Department generally has advocated more moderate positions. More conservative officials in the Defense Department and some at the White House's National Security Council have advocated tougher policies.
Israel, one of the United States' strongest allies, has worked behind its conservative prime minister, Ariel Sharon, to push the United States toward a tougher stance against Iran. The Israeli tactics have raised questions whether inside information may have been used to try to influence U.S. policy.
AIPAC said in a statement that the lobbying group was "fully cooperating with the governmental authorities and will continue to do so." It said any allegation of criminal conduct by the group or its employees was "baseless and false."
The Pentagon investigation has included wiretapping and surveillance and searches of the suspected Pentagon employee's computer, the law enforcement officials said.
Israel and Iran have been in an increasingly hostile war of words in recent months.
In 1981, Israel destroyed a nuclear facility in Iraq after becoming suspicious that Saddam was developing a nuclear weapons capability.
Despite the close U.S.-Israeli relations, this is not the first allegation of spying on Israel's behalf.
Jonathan Pollard, a former naval intelligence officer, was convicted of giving top-secret documents to Israel in the mid-1980s. He continues to be a point of contention in U.S.-Israeli relations. The Israeli government has repeatedly pressed for his release, but intelligence officials have called the information he passed to the Israelis highly damaging.
Pollard was caught in Washington in November 1985, and was arrested after unsuccessfully seeking refuge at the Israeli Embassy.
Separately, Iran said Saturday it would continue its nuclear program but provide "guarantees" not to build atomic weapons, and warned Washington it cannot stabilize neighboring Iraq and Afghanistan without Tehran's help.
In a wide-ranging news conference in Tehran, Iranian President Mohammad Khatami said the wall of mistrust separating Tehran and Washington had become thicker during the Bush administration, adding he hoped American casualties in Iraq would affect U.S. public opinion before the November election.
Washington claims the Iranian nuclear program is aimed at building atomic weapons, but Tehran says is directed at generating electricity.
"We are ready to do everything necessary to give guarantees that we won't seek nuclear weapons," Khatami said.
"As Muslims, we can't use nuclear weapons," he told reporters in Tehran. "One who can't use nuclear weapons won't produce them."
He did not elaborate on the nature of the guarantees, but Iran has already agreed to international inspections of its nuclear facilities and military sites. Khatami reiterated his country would not give up its nuclear program.
Khatami's statement marks the first time Tehran has so publicly said it would provide guarantees to ease international concerns about its nuclear program.