By Chris Baltimore and David Brinkerhoff

WASHINGTON/NEW YORK (Reuters) - DuPont Co., the No. 2 U.S. chemicals maker, failed for more than 20 years to report potential health risks caused by a key ingredient in the manufacture of Teflon, the Environmental Protection Agency said on Thursday.

The Wilmington, Delaware, company violated the Toxic Substances Control Act from June 1981 to March 2001 by not reporting dangers associated with perfluorooctanoic acid or C-8, EPA said.

The chemical is crucial in the process of making the well-known coating used in a wide range of consumer products, including nonstick cookware and stain-resistant carpets.

Tests by 3M, the original manufacturer of C-8, have shown that high levels of exposure may cause liver damage and reproductive problems in rats.

Traces of C-8 were found as early as the 1980s by DuPont in water supplies near DuPont's West Virginia plant and in a pregnant employee, the EPA said.

In an administrative complaint, EPA accused DuPont of "multiple failures to report information to EPA about substantial risk of injury to human health or the environment" from C-8.

Shares of DuPont fell 32 cents, or 0.74 percent, to $42.77 on Thursday afternoon amid a fall in the broader stock market.

DuPont dismissed the EPA's allegations as baseless and said it would file a formal denial with the agency within 30 days.

"The evidence from over 50 years of experience and extensive scientific studies supports our conclusion that (C-8) does not harm human health or the environment," DuPont said in a statement.

C-8 can remain in humans for up to 4 years, according to the EPA. Small amounts of the chemical are found in a large proportion of the general U.S. public.

The EPA is trying to determine how C-8 finds its way into the general population, DuPont said, adding that it supports the EPA's efforts.

Tom Skinner, head of EPA's enforcement office, said the agency would seek penalties "in the millions of dollars." DuPont could face penalties of $25,000 per day for violations before Jan. 30, 1997, rising to $27,500 per day after that, the EPA said.

A straight calculation could mean fines in the range of $300 million, but "that is not what we would be seeking," Skinner said, although he would not disclose the exact amount.

As early as 1981, blood samples from at least one pregnant worker at DuPont's West Virginia plant showed that C-8 had been transferred to her fetus, the EPA said.

DuPont also detected traces of the chemical in water supplies in West Virginia and Ohio communities near the plant that exceeded its own exposure guidelines in 1991, the EPA said.

Some investors had anticipated the EPA's action on Thursday and said the chemical maker could absorb any legal costs.

"I wouldn't overreact," said Earl Gaskins, managing director at Brandywine Asset Management Inc. in Wilmington, Delaware, which owns DuPont shares.

"There still is no clear-cut evidence, or even overwhelming or substantial evidence, that C-8 is injurious to humans," he said, adding "there's a fair amount of insurance that would protect DuPont."

Since C-8 is used to manufacture Teflon and not in the coating itself, it may have only contaminated people near its production, Gaskins said.

Nonetheless, the chemical's link with Teflon could affect DuPont's reputation with consumers, sources said.

"At bare minimum, it's a public relations issue for the company, and at worse, the full extent of the law could be implemented," said Heather Langsner, a senior analyst with Innovest Strategic Value Advisors. Innovest, based in New York, analyzes companies based on risk factors like environmental concerns and social impact.

DuPont is facing Teflon problems on other fronts.

A suit, filed by residents near DuPont's West Virginia plant and due to go to trial in September, seeks medical testing, clean water supplies and property and personal injury damages, an attorney familiar with the case said.

In 2000, 3M pulled its stain repellent Scotchgard from the market after the EPA expressed concern that a sister chemical to C-8 posed serious health risks. 3M has since stopped making all C-8-related chemicals.

DuPont said it had no plans to stop using C-8.