A confidential memo sent to more than 200 private security companies (PSCs) in Iraq last May warned of the "serious risk" of armed exchanges between foreign guards and local security forces.

Lawrence Peter, director of the Private Security Company Association of Iraq (PSCAI), responded to the kidnapping of four British bodyguards by calling for a new standard operating procedure to offer private guards better protection.

The official concern over the fear that potentially tense encounters could escalate into lethal exchanges emerged amid a bitter row over the conduct of the American PSC Blackwater after 11 Iraqis were killed when its guards opened fire in a busy Baghdad square last Sunday. Yesterday the firm's problems were compounded when it emerged that US federal prosecutors are investigating whether Blackwater employees smuggled weapons into Iraq and sold them on the black market.

Last Sunday's shooting incident revived concerns over the conduct of the tens of thousands of mercenaries providing bodyguarding services for officials and companies involved in the lucrative reconstruction of Iraq.

Blackwater insisted its staff acted in self-defence, although this claim was disputed by Iraqi eyewitnesses. The company was ordered to suspend operations while a joint US-Iraqi inquiry was held, but it has now resumed in a limited way in the Iraqi capital.

In his memo, Peter asked PSCs for help in developing new tactics for guards operating on the streets of Iraq following the kidnapping of four British guards after they were approached by a group of bogus Iraqi police.

He said: "I am concerned that there is now a serious risk of a PSC detail opening fire on a police detail, should the situation not 'feel right'.

"At a minimum it seems that PSC details must keep in mind the rules for the use of force. In so doing, PSCs must also be mindful of the rule of law and appropriate response to legitimate authority.

"I would like to develop a list of (nonbinding) recommendations, an SOP [Standard Operating Procedure], which PSCs could consider when planning their operations.

"The alternative . . . dead policemen, dead ex-pats, or ex-pats in prison on trial for murder etc . . . is something we should seek to avoid."