This was a scandal that plagued the later years of the Reagan administration. It was alleged that, despite an embargo, the American government traded arms to Iran. It was conjectured that Reagan was motivated by a desire to secure the release of American hostages in Lebanon, even though he publicly denied an arms-for-hostage agreement. In addition, it became known that some of the funds from the arms sales in Iran were funneled to an insurgent group in Nicaragua called the Contras, which the United States supported over the Communist Sandanista government despite the fact that further funding of the Contras had been prohibited by Congress. The plan was carried out by National Security Advisor John Poindexter and Lieutenant Colonel Oliver North.

Reagan appointed a commission headed by U.S. Senator John Tower to investigate. The Tower Commission found no evidence that Reagan knew of the diversion of the funds, but criticized him for failing to be more involved.