WASHINGTON — Working from an office suite behind a Burger King in southern Virginia, operatives used a web of shadowy cigarette sales to funnel tens of millions of dollars into a secret bank account. They weren’t known smugglers, but rather agents from the Bureau of Alcohol, Tobacco, Firearms and Explosives.
The operation, not authorized under Justice Department rules, gave agents an off-the-books way to finance undercover investigations and pay informants without the usual cumbersome paperwork and close oversight, according to court records and people close to the operation.
The secret account is at the heart of a federal racketeering lawsuit brought by a collective of tobacco farmers who say they were swindled out of $24 million. A pair of ATF informants received at least $1 million each from that sum, records show.
The scheme relied on phony shipments of snack food disguised as tobacco. The agents were experts: Their job was to catch cigarette smugglers, so they knew exactly how it was done.
Government records and interviews with people involved reveal an operation that existed on a murky frontier — between investigating smuggling and being complicit in it. After The New York Times began asking about the operation last summer, the Justice Department disclosed it to the department’s inspector general’s office, which is investigating. The inspector general “expressed serious concerns,” court records show.
It is unclear how broadly the ATF adopted this practice, at what level it was approved, and whether it continues. Nearly all references to the ATF have been blacked out of public court records, and most documents are entirely sealed.
The investigation and the looming racketeering trial will bring renewed scrutiny to the ATF, which has been buffeted in recent years by the botched gun-tracking operation known as Fast and Furious and its mismanagement of undercover investigations. Members of Congress, particularly Republicans, have heaped criticism on the agency for decades, and the National Rifle Association has lobbied to limit the agency’s authority and funding.
While government auditors have previously cited problems with ATF’s tobacco investigations, this operation went beyond what was identified in that audit, released in 2013. The ATF and the Justice Department declined to comment.
Documents in the racketeering lawsuit outline the ATF operation. The tobacco cooperative is suing a former employee and a consultant who, according to court documents, both worked as ATF informants. The informants have denied all wrongdoing.
Part of their defense, records show, is that they acted on behalf of the government. In response, a judge recently added the U.S. government as a defendant.
Since last summer, The Times has fought to make all the documents public, but the Justice Department has argued successfully in court to keep them secret. Crucial details, however, have been revealed through poor redaction, documents that were filed publicly by mistake and the sheer difficulty of keeping so much a secret for so long.
In spring 2011, U.S. Tobacco Cooperative was looking to expand its distribution network. The co-op is made up of about 700 tobacco farmers — from Virginia to Florida — who pool their crops and share the profits. Based in Raleigh, North Carolina, the company is a major exporter to China and produces discount-brand cigarettes including Wildhorse, Traffic and 1839.
“These are really, really good people,” said Stuart D. Thompson, the cooperative’s chief executive. “Every year, they take all their chips. They put them on the table, and they hope they get them all back.”
The company began negotiating to buy a tobacco distributor in Bristol, Virginia, Big South Wholesale. Big South’s owners, Jason Carpenter and Christopher Small, had a network of customers and owned a warehouse.
They also had an existing secret relationship with the ATF, records show.
The two men have filed court documents acknowledging “participation in undercover law enforcement activities.” And a judge’s sealed order, which is publicly available online, revealed that the two men worked “on behalf of various government agencies, primarily the Bureau of Alcohol, Tobacco, Firearms and Explosives.”
The basics of cigarette smuggling are simple. Each state sets its tobacco taxes. Buying cigarettes in low-tax states, like Virginia, and secretly selling them in higher-tax states, like New York, generates large profits. More complicated schemes have shipped cigarettes to Indian reservations, where they are not taxed, then rerouted them for sale on the black market.
ATF agents try to disrupt these networks. Often that means working with informants to buy and sell tobacco on the black market, much the way agents pose as drug dealers to investigate cartels.
Because so much of the case remains sealed, Carpenter and Small are prohibited from answering questions about nearly every aspect of the case. “Everything we did that is being attacked now in litigation, we did in good faith,” they said in a statement.
Exactly who at U.S. Tobacco knew about their ATF ties and what they knew are a matter of dispute. But there were signs that Big South was not a simple tobacco distributor. Its assets included more than two dozen vehicles, including expensive SUVs and a fleet of Mercedes, BMW, Audi, Lexus and Jaguar sports cars.
Early 2011 was a time of intense pressure inside the ATF. The agency was under fire from Congress over the Fast and Furious operation, in which agents allowed gun traffickers to buy weapons and ship them to Mexico, hoping the shipments could lead them to major weapons dealers. Justice Department auditors began scrutinizing how ATF agents managed their tobacco smuggling investigations.
With that audit continuing, the ATF issued new rules to tightly monitor undercover investigations. Soon after those rules went into effect, U.S. Tobacco completed its purchase of Big South for $5.5 million, a deal that gave Big South the authority to buy and sell cigarettes on behalf of the cooperative. Almost immediately, the farmers say, Carpenter and Small began defrauding them.
It worked like this: An export company working with the ATF placed an order for cigarettes to be shipped internationally — thus not subject to U.S. taxes. Big South would instead ship bottled water and potato chips, making it look as if cigarettes had been exported. Carpenter and Small would then buy the tobacco at a slight markup through a private bank account. Lastly, they would sell the tobacco to Big South, again at a markup.
Because they had the authority to buy on behalf of the tobacco cooperative, “Carpenter and Small simply sold products to themselves,” the farmers wrote in court documents. All of these transactions occurred on paper. The cigarettes never left the Virginia warehouse.
“It’s what I saw with my own eyes,” said Brandon Moore, the warehouse manager and one of the people who discussed the transactions in the case. Their accounts fit with descriptions in court records.
Moore said he was aware of the ATF operation but became troubled by it as he learned more. “It shouldn’t be going on, even if it is the ATF,” he said.
In one deal described in the lawsuit, the informants bought tobacco at $15 a carton and sold it to U.S. Tobacco at $17.50. The profit, about $519,000, went into what was known as a “management account.” That account, while controlled by Carpenter and Small, helped pay for ATF investigations.
Moore, the warehouse manager, said agents often told him what to buy on the company’s credit card. For instance, he recalled spending tens of thousands of dollars at Best Buy on iPads, televisions and other gifts to curry favor with potential criminal targets.
Carpenter and Small have also acknowledged in court documents receiving more than $1 million each, though it is not clear from public documents whether that was profit or reimbursement for expenses paid on behalf of the government.
How that arrangement began is unclear. Ryan Kaye, an ATF supervisor, testified that the management account was created “as a result of verbal directives from the ATF program office and other headquarters officials.” Kaye’s full statement is sealed, but excerpts are cited in one publicly available document.
The defendants in the lawsuit contend that U.S. Tobacco got a good deal on the cigarettes, even at the prices they paid. The farmers tell a different story, saying they never would have purchased Big South if they understood that Carpenter and Small had a side arrangement that involved selling them tobacco at inflated values.
Thomas Lesnak, a retired ATF agent who was involved in the operation, dismissed suggestions that anything was done improperly. He said he could not discuss Big South because the Justice Department was still conducting investigations based on information developed during operations based at the warehouse.
The arrangement began to break down in late 2012, when Thompson joined U.S. Tobacco as the chief financial officer. He was curious why his warehouse was placing so many orders for a brand of cigarette that competes against U.S. Tobacco. He could not get a straight answer, the company said in court documents.
In March 2013, Moore picked up the phone, called Thompson and explained what was happening. “I did what I did because of the ethics of it,” Moore said recently. “What was happening there was wrong.”
Once U.S. Tobacco discovered the bookkeeping irregularities, it reported them to the Justice Department, which investigates white-collar crime and government misconduct. Records show that the Justice Department, which includes the ATF, investigated some aspects of the case but no charges were filed.
“We voted unanimously to give everything we had to the government,” said Charlie Batten, a U.S. Tobacco board member whose family has worked the same North Carolina soil for generations. “We thought they would take it and run with it. What happened was, they’ve fought us tooth and nail.”
Because of the sealing order, Thompson, Batten and others are prohibited from discussing what happened to the money — even with their own farmers.
Three years into its lawsuit, U.S. Tobacco still cannot disentangle itself from the government. The cooperative recently told a judge that it was under investigation by the Treasury Department.
All those secret tobacco sales, it turns out, should have been taxed. And the government wants its money.