April 7 (Bloomberg) -- A U.S. judge set aside the political corruption verdict that probably cost ex-Alaska Senator Ted Stevens re-election and ordered an investigation into whether prosecutors’ “shocking” conduct was criminal.

U.S. District Judge Emmet Sullivan said he had a duty to determine the “potential for obstruction of justice” by six federal prosecutors. He granted a U.S. government motion to set aside the verdict and dismiss the case against Stevens.

The Justice Department abandoned the case after Attorney General Eric Holder, who took office in February, discovered the prosecutors had withheld evidence that would have helped Stevens contest the charges he omitted $250,000 worth of gifts on his financial disclosure reports.

“In nearly 25 years on the bench, I’ve never seen anything approaching the mishandling, the misconduct, I’ve seen in this case,” Sullivan said in Washington at the outset of what he called “a dramatic day.”

Sullivan appointed a special prosecutor, Washington lawyer Henry Schuelke, to conduct the probe of the government lawyers. He ordered the Justice Department to share files with Schuelke to help him determine whether the prosecutors are guilty of criminal contempt.

The instances of misconduct are too serious and too numerous to be left to a Justice Department investigation that has “no outside accountability,” the judge said.

Public Integrity Section

Those to be investigated are William Welch II, chief of the Justice Department’s public integrity section, Brenda Morris, the principal deputy director, and four other members of the trial team. The section prosecutes public officials and government employees for corruption.

“We will review the order regarding an investigation of prosecutors’ conduct and will continue to cooperate with the court on this matter,” the Justice Department said in a statement. The department said it will review the judge’s comments about evidence disclosure “for possible future actions.”

Schuelke, formerly a U.S. prosecutor and military judge, was seated in the front row of the spectators’ gallery during today’s two-hour proceeding.

The judge may conduct a trial of any criminal contempt citations that carry up to a six-month jail term, legal experts said. A jury trial would be required if Sullivan contemplated a longer sentence, said E. Lawrence Barcella, a Washington defense lawyer and former federal prosecutor.

Balanced Temperament

He described Schuelke as having a “very balanced temperament” who won’t “be a hatchet man or a cover-up guy.”

If Schuelke found evidence of more serious criminal wrongdoing, he would have to refer it to the Justice Department for prosecution, Barcella said.

Washington defense lawyer Michael Madigan called the judge’s appointment of a special prosecutor “an extraordinary action” he has never seen in his 30-year career.

The 85-year-old Stevens, a Republican, thanked Sullivan for his vigilance. “Until recently, my faith in the judicial system was unwavering,” Stevens said in court.

The prosecutors’ conduct “has consequences for me that they will never realize and that cannot be reversed,” he said. “Today, through your persistence, your honor, my faith has been restored.”

End of Career

The voters ended Stevens’s 40-year Senate career in November, just days after a Washington jury delivered its verdict. Stevens lost to Democrat Mark Begich by 3,700 votes out of just more than 300,000 ballots.

“We deeply, deeply regret that this occurred,” Justice Department lawyer Paul O’Brien said of the government’s handling of the case. O’Brien was part of a team of three Justice Department lawyers who replaced the original prosecutors after Sullivan found them in contempt of court in February.

Alaska Governor Sarah Palin and other Republicans have called for Begich, a Democrat, to step aside and permit a special election. Begich, 47, has said he does not intend to resign.

Brendan Sullivan, Stevens’s lawyer, conceded that probably won’t happen. “Nothing can be done to give the citizens of Alaska the senator they surely would have elected,” he said.

“We’re no match for corrupt prosecutors,” the lawyer said. “They abandoned all decency to win a conviction.”

Justice Department lawyers offered no rebuttal.

Chief Witness

Holder abandoned the case against Stevens after concluding prosecutors should have turned over their notes of an interview with the government’s chief witness, Bill Allen. The witness testified that his oil-services company, Veco Corp., renovated the senator’s house in Girdwood, a town near Alaska’s largest city of Anchorage.

The notes taken by two prosecutors showed that Allen made statements that contradicted his own trial testimony on how much the renovations to Stevens’s home cost.

The judge called the suppression of those interview notes the “most shocking and serious” government failing in the trial.

In an April 15, 2008, interview with five prosecutors and an FBI agent, Allen estimated the renovations were worth about $80,000. Prosecutors had submitted into evidence Veco workers’ time sheets indicating the renovations cost $188,000.

Allen also told prosecutors a different story about a note he received from Stevens requesting a bill for “all the work on the chalet,” referring to Stevens’s home, according to April 1 court papers filed by the government.

Summing Up

At the trial, Allen testified that a friend, Bob Persons, had told him to disregard Stevens’s request for a bill, saying “that’s just Ted covering his ass.”

“That was false” and prosecutors sitting in court when Allen testified “knew it was false,” Sullivan, the defense lawyer, told the judge. In their summations, two of the prosecutors vouched for the reliability of Allen’s testimony, Sullivan said.

During the interview with prosecutors, Allen “did not recall talking to Bob Persons regarding giving a bill” to Stevens, the government said in court papers filed last week.

The defense lawyer said prosecutors tried to shape Allen’s testimony, citing an e-mail from one prosecutor to another.

“We may want to talk to” an unidentified person “to get him to push Bill Allen on this,” Sullivan said, reading from the document.

Signaling to Client

Besides ordering the investigation of the prosecutors, the judge also asked the U.S. attorney’s office in Washington to investigate why Allen’s lawyer, Robert Bundy, signaled to his client while he was on the witness stand.

The judge had expelled Bundy from the courtroom despite the lawyer’s insistence that he was not trying to signal to Allen.

During the trial, Stevens’s lawyers repeatedly accused prosecutors of failing to turn over evidence they were required to share with defense lawyers because it might help their client. Defense lawyers said prosecutors belatedly turned over copies of a Federal Bureau of Investigation interview in which Allen had told investigators he “believed Stevens would have paid an invoice if he had received one.”

Last week, Holder said in an interview that “certainly mistakes were made” by prosecutors. Their failure to turn over the interview notes might have had a “substantial impact on the case,” the attorney general said.

Holder has declined to say whether the prosecutors committed any wrongdoing, saying he wants to await the results of an internal investigation.

The judge said he was frustrated with the apparent lack of progress in that investigation, saying, “to date, the silence has been deafening.”

He also said he found it “shocking, but not surprising” that Holder’s predecessor, Attorney General Michael Mukasey, never responded to the defense lawyers’ letters complaining about the prosecutors.

To contact the reporters on this story: James Rowley at jarowley@bloomberg.net; Cary O’Reilly at caryoreilly@bloomberg.net

Last Updated: April 7, 2009 18:03 EDT