The director of British-based company ATSC, Jim McCormick, 53, was arrested on suspicion of fraud by misrepresentation and bailed pending further investigation, police said.
At the same time, the British government announced it will ban the export of the ADE651, an ATSC product marketed as a bomb detector and reportedly bought in large numbers by the Iraqi military to use at security checkpoints.
"Tests have shown that the technology used in the ADE651 and similar devices is not suitable for bomb detection," the Department for Business, Innovation and Skills said in a statement.
"As soon as it was brought to the attention of the Export Control Organisation and (business secretary) Lord (Peter) Mandelson we acted urgently to put in place export restrictions which will come into force next week," it added.
While ATSC did not need an export licence because the ADE651 is not officially military technology, the department said "it is clearly of concern that it is being used as bomb detection equipment."
The ban will be limited to Iraq and Afghanistan, the department said, because "our legal power to control these goods is based on the risk that they could cause harm to UK and other friendly forces."
It added: "The British Embassy Baghdad has raised our concerns about the ADE651 with the Iraqi authorities.
"We have offered co-operation with any investigation they may wish to make into the how the device came to be bought for their military as bomb detection equipment."