British PR firm Bell Pottinger was reportedly paid $540m (£417m) by the US to create campaign material in Iraq to portray al-Qaeda in a negative light and track suspected sympathisers.

A recent report by the Bureau of Investigative Journalism (TBIJ) indicates that the London-headquartered company, which is known for its roster of controversial clients – such as the Saudi government and Chilean dictator Augusto Pinochet's foundation – made fake terror and news-style videos, which would then be used to track those accessing them.

Created by Margaret Thatcher's PR advisor Lord Timothy Bell in 1989, staff from the company moved to US base Camp Victory in Baghdad, where they worked alongside high-ranking military officers.

Bell, the company's former chairman, confirmed the same to The Sunday Times and said that the "covert" team reported to the Pentagon, the CIA and the National Security Council.

"It was a covert military operation. It was covered by various secrecy documents. We were very proud of it. We did a lot to help resolve the situation. Not enough. We did not stop the mess which emerged, but it was part of the American propaganda machinery," Bell said.

Former video editor of Bell Pottinger, Martin Wells, who worked with the public relations house from 2006 to 2008 has appeared on video to explain the "psychological operations" conducted for the US government and his own role in Iraq.

"When I first started working, I didn't know how big a project this was. I just assumed it was news gathering. We would do the news items which would go out on the various channels locally," he said, explaining that they were most often stories about bomb blasts and attacks. "We would have people out there filming it. It would come back, we would then edit it... and we were to make it, as best we could... look as if it was Arabic... as if it was created by Arabic TV almost."

The firm's output was signed off by former General David Petraeus – then commander of the coalition forces in Iraq – and on occasion by the White House, Wells added.

He spoke about TV commercials that promoted anti al-Qaeda messages and video CDs featuring the terror group's propaganda footage. He was reportedly told by his boss that the videos were going to be tracked via Google Analytics.

As part of its investigation, TBIJ, a UK-based independent and not-for-profit organisation, also interviewed former officials and contractors and traced the operations through US army contracting censuses, federal procurement transaction records and reports by the Department of Defense (DoD) inspector general, as well as Bell Pottinger's corporate filings and specialist publications on military propaganda.

"White is attributed, it says who produced it on the label," one contractor involved with the work explained of the three types of media operations carried out in Iraq. "Grey is unattributed and black is falsely attributed. These types of black ops, used for tracking who is watching a certain thing, were a pretty standard part of the industry toolkit."

According to TBIJ, "It identified transactions worth $540m between the Pentagon and Bell Pottinger for information operations and psychological operations on a series of contracts issued from May 2007 to December 2011. A similar contract at around the same annual rate – $120m – was in force in 2006."

The Pentagon has reportedly confirmed contracting Bell Pottinger for work in Iraq under the Information Operations Task Force (IOTF). The firm was expected to produce material, some of which was openly sourced to coalition forces and some which was not. They insisted that all material put out by IOTF was "truthful".

Since shifting ownership in 2012, Bell Pottinger has had no connections with the unit that operated in Iraq – which was shut down in 2011. The key people who worked in the 'psychological operations' unit deny any involvement with tracking software as described by Wells.