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Reliant Energy's response to the government, both before and after its indictment for criminal manipulation of the California energy market, was not typical of companies threatened with criminal prosecution. Its fight didn't end in outright vindication for the company. But it debunks the idea that jousting with the government is inevitably corporate suicide. Reliant ultimately admitted much of what the government alleged. But the company didn't plead guilty, a price it always considered too high.

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Reliant Energy insisted that they hadn't committed a crime during the California blackouts. Turns out they were right

Andrew Longstreth

The American Lawyer

November 8, 2007

William Jeffress Jr. was ticked off. On April 8, 2004, the Baker Botts partner had returned from a meeting to watch a press conference on his office computer. U.S. Attorney General John Ashcroft was announcing the indictment of Jeffress' client, Houston's Reliant Energy Services Inc. -- a subsidiary of Reliant Energy Inc. -- and four of its employees for criminal manipulation of the California energy market during the rolling blackouts of 2000 and 2001.

The indictment came as no surprise. Prosecutors in the San Francisco office had told the company a few weeks earlier that criminal charges were coming.

But what angered Jeffress was the way Kevin Ryan, the U.S. Attorney for the Northern District of California who accompanied Ashcroft at the press conference, described his client. "Faced with evidence of widespread fraud within the company, Reliant chose to be uncooperative during the federal investigation," Ryan said in a statement. "As a result, the grand jury and the Justice Department send an important message today to corporate America and consumers: Even a top-five energy company can and will face criminal prosecution if it engages in far-reaching criminal conduct and fails to take immediate steps to disclose and clean up its act."

"That greatly irritated me," says Jeffress.

Jeffress isn't the chest-pounding, blustery type. He's a small man, with reddish hair, a mustache, a hearty laugh, and the manners of a Virginia gentleman. And though he has 35 years of courtroom experience defending white-collar cases, he's not a former prosecutor -- which may help explain why he was so irked by the U.S. Department of Justice's characterization of Reliant. As Jeffress saw it, his client had cooperated with the government investigation, at least as much as it could. The problem was that the prosecution's idea of cooperation meant admitting a crime.

After hearing the comments by Ryan, Jeffress helped craft a statement for Reliant's general counsel, Michael Jines. "Any suggestion that Reliant did not fully cooperate with the Department of Justice is inaccurate and unfair," Jines said in a press release. "What Reliant did was not agree that the conduct constitutes a criminal offense."

Reliant's response to the government, both before and after its indictment, was not typical of companies threatened with criminal prosecution over the last five years. The mere specter of indictment and conviction spooked most targeted corporations into an unprecedented level of cooperation with the government: Companies waived attorney-client privilege, cut off the legal fees of suspected wrongdoers in their ranks, and plead for mercy. Among the 440 Corporate Fraud Task Force indictments tracked by The American Lawyer, 14 were filed against companies, most of which quickly reached deferred prosecution deals in which they paid fines, admitted wrongdoing, and pledged to stay out of trouble in exchange for a government promise that at the end of a specified time period, the corporation's record would be wiped clean.

Another five companies reached deals even before they were indicted.

Reliant had some good reasons to follow the typical defense playbook. It faced damning evidence and a charged political environment, the same combination that led to the post-indictment collapse of Arthur Andersen LLP.

But Reliant also had reasons to maintain a defiant stance. The case was not a bet-the-company matter -- the indictment concerned just two days of alleged market manipulation at a subsidiary. The government's theory was novel: The prosecution team, which would change no fewer than four times over the course of the case, based its case on the nearly 70-year-old Commodity Exchange Act, which had never been the basis of a criminal prosecution. And most importantly, Reliant's management and lawyers were convinced that the company hadn't committed a crime.

Reliant's three-year fight didn't end in outright vindication for the company. In March 2007, days before it was to stand trial, Reliant finally signed a deferred prosecution agreement and paid a $22.2 million fine. (The company also paid out more than $500 million in civil settlements and fines to resolve the affair.) But that result debunks the idea that jousting with the government is inevitably corporate suicide. Reliant ultimately admitted much of what the government alleged. But the company didn't plead guilty, a price it always considered too high.

The government's case against Reliant was all about the events of two days in June 2000, at the dawn of the California energy crisis. In California after deregulation, contracts for electricity could be bought and sold on the California Power Exchange Corp. every day. June 19, 2000, was a bad day for Reliant's energy trading division. Lisa Flowers, a Reliant trader, had entered into a long-term contract for the delivery of electricity, expecting that prices would go up. When market prices tanked instead, Reliant faced a multimillion-dollar loss.

But the company made sure it didn't lose any money, prosecutors would later allege. Reliant operated five power generators in California. According to the government's case, Reliant employees intentionally shut down the generators so that electricity prices would increase.

The allegations were supported in vivid detail on audiotapes. (Reliant traders were routinely taped.) During one conversation, a Reliant employee actually talks about "market manipulation attempts."

Reliant Plant Operator: Trying to shorten the supply, uh? That way the price on demand goes up.

Reliant Manager: Well, we'll see.

Reliant Plant Operator: I can understand. That's cool.

The shutdown worked. After prices went up, Reliant turned its power plants back on and proceeded to sell electricity for the maximum permitted price.

Reliant was also able to sell the contract that trader Flowers had entered into, which had become profitable with the sudden dip in electricity supply.

Lawyers from Baker Botts, who had been retained by Reliant to handle the regulatory investigations and civil suits stemming from the California energy crisis, found the audiotapes of the Reliant traders. According to Jeffress, after an internal investigation, Reliant turned the tapes over to regulators from the Federal Energy Regulatory Commission.

Reliant lawyers believed, then and now, that despite the cringe-inducing language on the audiotapes, the conduct they revealed was not criminal (though not exemplary, either). Jeffress and his colleagues homed in on the rules that governed California's energy market, concluding that they did not prohibit companies from shutting down their plants.

"The rules in effect permitted a generator to shut down its plant for any reason at all," says Jeffress. "Or no reason."

In January 2003 Reliant agreed to pay $13.8 million to settle FERC's investigation of market manipulation. It did not admit wrongdoing.

The tapes, however, fed a political firestorm. After they were made public as part of the FERC settlement, Reliant became a convenient target.

California state Attorney General Bill Lockyer, who filed a civil suit against the company (which the company ultimately paid $460 million to settle), would refer to Reliant as "one of the four horsemen of the apocalypse." Sen. Dianne Feinstein urged the Justice Department to investigate the manipulation. San Francisco Assistant U.S. Attorney Patrick Robbins, who was leading the federal criminal investigation into California's energy crisis, had already subpoenaed Reliant, Duke Energy Corp., and The Williams Cos. Inc., in the fall of 2002. But according to defense lawyers, that subpoena was not related to the two days in June 2000. It wasn't until after the audiotapes became public in early 2003 that prosecutors shifted the focus of their investigation to market manipulation.

During a late 2003 meeting hosted by the U.S. Attorney in San Francisco, Robbins and other prosecutors peppered Jeffress with questions about the tapes. How long had Reliant known about them before they were disclosed to FERC? Why did Reliant give the tapes to regulators and not to the Department of Justice? Had Reliant disciplined the employees on the tapes? They were the kind of questions that led Jeffress to believe that Reliant was in danger of being indicted.

"[Cooperation] was an issue," he says. "I think they thought that when we discovered the tapes, we should have considered them evidence of criminal wrongdoing and turned them over."

Jeffress and his co-counsel in San Francisco, William Goodman of Topel & Goodman (now part of Kasowitz, Benson, Torres & Friedman), knew that under the document known as the Thompson Memo -- the Justice Department's guidelines for prosecuting corporate fraud -- Reliant would have to show not only its willingness to cooperate with the criminal investigation that was now under way, but also the good faith of its actions before prosecutors found out about the tapes. Jeffress and Goodman pointed out that Reliant had handed over the damning evidence to FERC, and had made witnesses available to regulators and prosecutors without subpoena. They also assured prosecutors that as of March 2003, Reliant had had enough of volatility in the energy markets and had exited the business.

But Reliant, Jeffress says, drew the line at some of the Thompson Memo's other not-so-gentle suggestions. The company didn't waive the attorney-client privilege, for example. Nor did it stop paying the legal fees of Reliant employees who were under investigation. (It was not explicitly asked to do either by prosecutors.) And it refused to admit criminal wrongdoing.

"We were prepared to explore a resolution on a number of levels," says general counsel Jines. "What we were not prepared to do [was] plead guilty."

In March 2004, in a final attempt to stave off indictment. Jeffress and Goodman met with Christopher Wray, then the head of the Justice Department's criminal division in Washington, D.C. But when prosecutors were not receptive, Reliant decided not to budge. Jines says the company's reputation was the overwhelming factor in its decision to fight. An indictment could have meant suspension from government contracts, but so could a guilty plea.

Plus, Reliant had suffered plenty already. Its stock had tanked, and it was the subject of myriad civil suits and investigations. Reclaiming the public trust was going to be an expensive, uphill battle -- Reliant had recently paid $300 million for the naming rights to an entertainment complex in Houston -- but the company thought it could be done, as long as it didn't admit a crime. Reliant could fight an indictment. It couldn't fight a guilty plea.

On April 8, 2004, a federal grand jury sitting in San Francisco returned a six-count indictment against Reliant and four of its officers: Lisa Flowers, the energy trader; Jackie Thomas, a former vice president of Reliant's Power Trading Division; V. Reginald Howard II, a former director of Reliant's West Power Trading Division; and J. Kevin Frankeny, Reliant's manager of Western Operations. The indictment charged them with wire fraud, conspiracy, and commodities manipulation.

Over the last five years, at least 13 major companies targeted by the Corporate Fraud Task Force, including Computer Associates International Inc.; America Online Inc.; Symbol Technologies Inc.; and KPMG LLP, have negotiated deferred or nonprosecution agreements that spared them criminal convictions?but often left their employees exposed. Reliant's lawyers believed that neither the corporation nor its employees had committed crimes. So Reliant chose to stand with its executives, despite the pressure and expense of doing so. Nanci Clarence of Clarence & Dyer, who represented Reliant trader Flowers, calls Reliant's defiance "the anti-KPMG defense."

"There was no pressure [for my client] to plead guilty," says Clarence.

"Bill [Jeffress] set the tone from the beginning that there was going to be a trial. I don't think there was ever any sense that this was a case where the company was going to pull the plug."

Crowell & Moring partner Philip Inglima, who represented Reliant director Howard, says that an unusual degree of unity developed among the defense lawyers in the case. "There were no surprises between us," says Inglima.

The Reliant lawyers' solidarity stood in contrast to the prosecution's problems. U.S. Attorney Ryan ran an office that was widely reported to be in turmoil; assistants grumbled publicly about his management style, which was described in several San Francisco newspaper stories as aloof and insecure.

The Reliant prosecution suffered from the office's uproar. In August 2005, only four months after the indictment was returned, Patrick Robbins, the Assistant U.S. Attorney in charge of the case, announced his resignation.

According to a former San Francisco prosecutor, Robbins was dismayed that Ryan had driven out another young prosecutor, Lisa Tenorio-Kutzkey, because he heard that she had been interviewing for an outside job. Ryan denies the story. He says that Robbins and Tenorio-Kutzkey left of their own accord, and that their abrupt departures after a long investigation forced him to restaff the case quickly. (Tenorio-Kutzkey did not return calls seeking comment. Robbins declined to comment.) The switch in prosecutors seemed at first to be a breakthrough in the Reliant case. Shortly after taking over in mid-2004, Assistant U.S. Attorney Jeffrey Bornstein approached the company to discuss a deferred prosecution agreement that would not require Reliant to admit to a crime. Bornstein and his colleagues prepared a draft agreement, but according to Reliant's defense lawyers, before they could respond with a counterproposal, the deal was nixed by Bornstein's superiors. Jeffress says the higher-ups insisted that the deal include a guilty plea from the company. (The fate of the individuals, he says, had not come up at that point.) Reliant lawyers blamed Ryan for squelching negotiations. (Bornstein declined to comment.) "Ryan had decided that his prosecutors were going to try this, no matter what his prosecutors thought," says Jeffress.

Ryan's version of the story is different. He says that he, Bornstein, the San Francisco securities fraud unit chief, and officials at the Justice Department collaborated on the decision to withdraw the deferred prosecution deal. According to Ryan, they all concluded that the admissions that Reliant was willing to make were not strong enough. "Reliant wasn't willing to budge, and neither were we," Ryan says.

By the summer of 2005, leadership of the case had changed again. Bornstein had left the U.S. Attorney's Office for private practice, and a third lead prosecutor, Haywood Gilliam Jr., had taken over. That fall, Gilliam filed two superseding indictments against Reliant and its four employees. The new indictments tweaked theories in the original, but they didn't bring new charges. Defense lawyers for Reliant and the individuals, who had been collaborating on motions, interpreted Gilliam's efforts as weakness in the government's case. "They kept trying to recast the indictment," says Reliant counsel Goodman.

The case appeared to be headed for trial. In the last week of October 2005, San Francisco federal District Judge Vaughn Walker had about 80 potential jurors standing by for jury selection in the trial of Reliant and its four employees. But just days before the scheduled Oct. 31 start, prosecutor Gilliam appealed to the 9th U.S. Circuit Court of Appeals for a ruling on jury instructions. Walker had excluded evidence the government wanted to introduce to establish the definition of an artificial price, which would help prove that Reliant's actions distorted the market.

At a hearing the day before jurors were to be picked?with Jeffress and lawyers for the individual defendants asking the judge to let the trial proceed despite the government's appeal?Walker needled prosecutors.

"Presumably, you want a trial," the judge said. "You want to take this case to trial, although you keep changing the indictment and appealing evidentiary rulings and so forth. But I assume the government wants to go to trial."

Gilliam had argued that the appeal was critical to the government's case.

But Jeffress asserts that Gilliam simply didn't want to try the Reliant case. In a reversal of typical roles, it was the prosecution, not the defense, that was delaying the trial.

The government's appeal stalled the Reliant prosecution for more than a year. By the time a new trial date was set, custody had changed once again.

Michael Wang became the fourth prosecutor to lead the case, taking over just before U.S. Attorney Ryan, who had received negative evaluations from his superiors in Washington, D.C., was replaced by interim U.S. Attorney Scott Schools in February 2007.

With a March 2007 trial date, Wang was under pressure to get up to speed quickly. Jeffress' co-counsel, Bill Goodman, says he sensed that the new set of prosecutors might at last be ready to settle on terms Reliant could accept. Walker had ruled for the defense in some evidentiary matters.

And the case was getting stale. Federal Bureau of Investigation agents, Goodman heard, were out reinterviewing witnesses. "The government didn't like the way the case was shaping up," he recalls.

Less than two weeks before trial was scheduled to begin, the government cracked. Wang called Goodman about working out a settlement. (Goodman had taken the lead while Jeffress, who was part of the defense team of I. Lewis "Scooter" Libby, was in Washington, D.C., for Libby's trial.) Goodman told Wang that the company would only agree to a deal in which the government dropped criminal charges. Otherwise, he said, Reliant was ready to go to trial. He also insisted that any deal had to include all of the individual defendants as well. According to Goodman, Wang didn't show much resistance. He signaled to Goodman that both conditions were in the "realm of possibility."

After his first conversation with Wang, Goodman called Nanci Clarence, who represented one of the Reliant employees, to let her know about the settlement possibility. "We were preparing our opening statements," says Clarence.

From that point, negotiations for individuals and the company took parallel tracks. Wang pushed for and received admissions of wrongful conduct during those two days in June 2002. But there were no guilty pleas?not from the company and not from the individual defendants.

Wang explained the decision to settle the case in a statement e-mailed to The American Lawyer: "As Assistant United States Attorneys, our job -- indeed, our sworn obligation?is to do the right thing, based on the law and the facts as we understand them to be," he wrote. "That is exactly what we did here."

Privately, prosecutors say that the Reliant case offers a lesson about the perils of changing jockeys in the middle of a race. But Jeffress and Goodman like to think the outcome had more to do with the merits of the defense and a company's unique resolve.

"I think there are a lot of instances where companies go way too far in cooperating," says Jeffress. "The key is to make a decision early on and stick with it."

Actually, there are two lessons. One, battling the government may not be fatal. And two, energy companies should avoid turning the power on and off to preserve their market positions.