By Dan Levine and David Ingram

SAN FRANCISCO/WASHINGTON (Reuters) - The U.S. Department of Justice has begun a rare internal examination of what went wrong in the prosecution of a controversial drug conspiracy case against delivery service Federal Express <FDX.N>, the department's top prosecutor in San Francisco told Reuters.

The review plays into a broader debate about how the government prosecutes suspected corporate wrongdoing and could influence its approach to such cases in the future.

Prosecutors obtained a grand jury indictment against FedEx in 2014 on charges the courier service had knowingly helped Internet pharmacies ship illegal pills. But four days into a trial in San Francisco last month, the Justice Department abruptly dropped all charges. The judge commended the decision, saying it was clear FedEx was "factually innocent."

The U.S. Attorney in San Francisco, Brian Stretch, said he has assigned the office's deputy criminal chief to a review that could take two months. It will examine why prosecutors brought the case, what oversight supervisors provided and what role officials in Washington D.C. played, Stretch said in an interview Wednesday.

"This is not a finger pointing exercise," he said. "This is an exercise with the singular purpose to find lessons learned, and apply them to current and future cases."

The outcome could hold lessons for government regulators, prosecutors and corporate defense lawyers, said Laurie Levenson, a professor at Loyola Law School in Los Angeles and a former assistant U.S. Attorney.

"It can impact policies not just on whether they go after individuals or organizations," Levenson said. "It can impact how aggressive you get with the use of criminal law, as opposed to civil law or regulatory actions."


The Justice Department's strategy in the FedEx case is one that had worked for it many times before: Call in a company suspected of wrongdoing, present it with the evidence and try to come to a settlement in exchange for not seeking criminal charges.

In October 2012, DOJ officials from Northern California and Washington met with FedEx attorneys in San Francisco and presented evidence the prosecutors said showed the company had knowingly shipped illegal Internet prescriptions, according to a person who attended.

The Justice Department already had wrung $500 million from Google <GOOGL.O> over ads it carried for online pharmacies, and the government was in negotiations with United Parcel Service <UPS.N> over drug deliveries that would lead to a $40 million settlement.

Key to the case against FedEx, prosecutors told company lawyers at the 2012 meeting, were internal corporate emails the government obtained by subpoena. In one, a FedEx executive wrote about online pharmacies: "It is becoming more apparent to us that many of these companies are fraudulent."

FedEx said the emails were taken out of context, according to the source at the meeting. Not only had it done no wrong, its lawyers said, the company had repeatedly told the Drug Enforcement Administration it would suspend deliveries from any pill distributor identified by investigators as engaging in illegal action.

FedEx refused to settle and opted to take the case to trial.

In accepting the government's decision to drop the case last month, U.S. District Judge Charles Breyer noted the company's cooperation and said FedEx "did not have criminal intent."


FedEx's trial lawyer, Cristina Arguedas, said a government review was essential because the Justice Department had repeatedly ignored evidence of the company's cooperation.

"This was an epic institutional failure on the part of the Department of Justice, and the department owes an explanation to the public on how this failure occurred," she said.

Stretch declined to respond. But he said he was proud of the effort, despite the result.

Critics have argued that non-prosecution agreements, the type of deal the government sought in the FedEx case, unfairly burden shareholders and are ineffective deterrents against individual wrongdoing.

Such settlements, which include deferred prosecution agreements, were rare in the 1990s. But after the indictment of audit firm Arthur Andersen led to its demise, companies and the government have sought to avoid trials. In recent years, the Department of Justice has negotiated 20 to 40 deferred and non-prosecution agreements annually, according to data compiled by the University of Virginia.

    Today, most government investigations into potential wrongdoing at large, publicly traded companies are resolved with agreements that involve fines but no criminal charges, said Brandon Garrett, a University of Virginia professor who has studied corporate prosecutions.

"Hardly any corporations risk a criminal trial," Garrett said. "The biggest companies tend to settle out of court and the small fry plead guilty."

When they are charged, most companies plead guilty and avoid trial. Of 1,795 companies sentenced in federal court between 2006 and 2014, only about 7 percent were the result of convictions at trial, according to U.S. Sentencing Commission data. The rest agreed to plea bargains.

    The case against FedEx grew out of a law enforcement campaign to shut down online pharmacies that supply pills to customers without verifying prescriptions. In recent years, the government broadened its scrutiny to companies that sell advertising to or deliver drugs for those pharmacies. The strategy resulted in the non-prosecution agreements with Google and United Parcel Service.

In a statement this week, UPS said it "made a business decision" in 2013 to end the government investigation. Google declined to comment. Neither company faced criminal charges.

After the 2014 FedEx indictment, Judge Breyer warned prosecutors in pretrial hearings that he viewed FedEx's intent as crucial and the company's claim that it cooperated with the DEA as an important consideration.

The judge ordered prosecutors to hand over notes taken by the DEA during meetings with FedEx. They corroborated the company's account that it had volunteered to help.

Still, prosecutors moved forward, arguing in an opening statement that they would prove FedEx was "no more than part-time drug dealers."

Arguedas, the lawyer for FedEx, responded by citing many meetings with the DEA at which the company offered assistance, and noted FedEx had no way of identifying valid shipments.

Ultimately, the judge said he was "critical of the decision to prosecute." But, he added, abandoning the case was "entirely consistent with the government's overarching obligation to seek justice even at the expense of some embarrassment."

(Editing by Sue Horton and Lisa Girion)