‘I smell cash’: How the ATF spent millions of dollars unchecked

BRISTOL, Va. — For seven years, agents at the Bureau of Alcohol, Tobacco, Firearms and Explosives followed an unwritten policy: If you needed to buy something for one of your cases, do not bother asking Washington. Talk to agents in Bristol who controlled a multimillion-dollar account unrestricted by Congress or the bureaucracy.

Need a flashy BMW for an undercover operation? Call Bristol.

A vending machine with a hidden camera? Bristol.

Travel expenses? Take this credit card. It's on Bristol.

When The New York Times revealed the existence of the secret account in February, publicly available documents made it seem like the work of a few agents run amok. But thousands of pages of newly unsealed records reveal a widespread scheme — a highly unorthodox merger of an undercover law enforcement operation and a legitimate business. What began as a way to catch black-market cigarette dealers quickly transformed into a nearly untraceable ATF slush fund that agents from around the country could tap.

[U.S. agents swindled farmers out of $24 million, suit says]

The spending was not limited to investigative expenses. Two informants made $6 million each. One agent steered hundreds of thousands of dollars in real estate, electronics and money to his church and his children's sports teams, records show.

Federal law prohibits mixing government and private money. The ATF now acknowledges it can point to no legal justification for the scheme. But far from reining in the spending, records show, supervisors at headquarters encouraged it by steering agents from around the country to Bristol.

Yet no one was ever prosecuted, Congress was only recently notified, and the Justice Department tried for years to keep the records secret. The Times intervened in an ongoing fraud lawsuit over the activity and successfully argued that a judge should unseal them. The documents tell a bizarre story of how federal agents set up shop inside a southern Virginia tobacco business and treated its bank account as their own.

At least tens of millions of dollars moved through the account before it was shut down in 2013, but no one can say for sure how much. The government never tracked it.

Thomas Lesnak, a veteran agent, operated out of a government office building tucked behind a Burger King in Bristol, a small city near the intersection of Virginia, North Carolina and Tennessee. Colleagues regarded him as fast-talking and likable. When he met suspects, he always came off as the good cop.

Lesnak specialized in investigating tobacco smuggling, one of the ATF's core missions. Although cigarettes are available at any corner store, they are extraordinarily profitable to smuggle. That's because taxes are high and every state sets its own rates. Virginia charges $3 per carton. New York charges $43.50. The simplest scheme — buying cigarettes in Virginia and selling them tax-free in New York — can generate tens of thousands of dollars in illicit cash. By some estimates, more than half New York's cigarettes come from the black market.

The ATF tried setting up front companies to infiltrate smuggling rings, but with limited success. Gangs and cartels were too smart to deal with companies that appeared out of thin air. Lesnak had a solution: Rather than pose as a real company, go into business with an existing one.

In late 2006, Lesnak persuaded Jason Carpenter, an established small-time Alabama tobacco distributor, to open a warehouse in Bristol, become an informant and let the ATF operate alongside him. "We basically merged ourselves with a tobacco business," Lesnak said last year in a confidential deposition.

"The idea was, 'If you build it, they will come,'" Carpenter said in a deposition. "And lo and behold," he said, "they came."

Would-be smugglers appeared, looking to buy untaxed cigarettes. Some offered cash. Others offered to trade stolen property or guns. Lesnak and Ryan Kaye, one of the agents involved in the operation, worked the floor. "It got to the point where we were, you know, warehouse workers as opposed to criminal investigators," Lesnak said.

The ATF allowed Carpenter and his business partner, Christopher Small, to conduct illicit tobacco sales in the hopes of catching criminals. Lesnak, Carpenter and Small declined repeated interview requests.

Normally, undercover operations run entirely on government money, from a government account that is reviewed by government auditors. But Carpenter was running a real company. Sometimes he worked for the government, sometimes for himself, and it was not always clear where the profits should go.

So the ATF devised a solution: When it was unclear where the money belonged, it went into a private account that Carpenter controlled. That kept the money outside the reach of Congress. Lesnak dictated all the spending and said he expected the government to balance the books at the end of the investigation. That never happened.

Kaye testified last year and was asked repeatedly who approved this arrangement and under what authority:

"I do not recall exactly who authorized that."

"I wouldn't call it 'authorization.' I would call it an 'understanding.'"

"No authorization was needed."

"I don't know of a specific law that authorizes those specific activities."

The secret fund became known as a "management account," and word spread quickly among ATF agents that if you needed something, Lesnak could get it without red tape.

As Lesnak described it, senior officials in Washington frequently sent agents to him for untraceable license plates, credit cards and more. Automobiles, particularly luxury cars, were hot items. "We had so many vehicles that we actually set up a company just for leasing," Small said in a deposition.

Agents relied on the management account for routine expenses, and Small said hotel bills and gas alone could run to $23,000 a month. "We had 14 or 15 agents carrying American Express cards that we paid the bill on," Small said.

Carpenter and Small's company, Big South Wholesale, quickly became the national warehouse for all of ATF's smuggling investigations, records show.

But nobody from the government ever audited the spending, the Justice Department acknowledges. The responsibility for that oversight fell to the Big South bookkeeper, Wendi H. Davis, who testified that she managed the government's secret account on a QuickBooks file on her computer. She did not respond to messages or a letter left at her home.

The unusual business arrangement and the secret account helped make Carpenter and Small two of the ATF's most valuable informants. Their work helped lead agents to more than 100 arrests, Lesnak said. Records show they aided the FBI, the Drug Enforcement Administration, even British intelligence.

In appreciation for years of work, the ATF awarded Carpenter and Small plaques in 2010 that read: "Your efforts have helped to revolutionize the way we do business."

Court records show they worked on one of the government's most sensitive cases — a money laundering and smuggling investigation into the Paraguayan tobacco magnate Horacio Cartes. His company, Tabesa, is a major cigarette producer.

That ATF wanted Tabesa's tobacco in a "place that they could control," Carpenter said. So he said he struck up a relationship with Cartes, posing as someone who could smuggle cigarettes into foreign countries. The Big South warehouse in Virginia became a major distributor for Palermo cigarettes, a Tabesa brand.

That deal with Tabesa would ultimately unravel the ATF's partnership with Big South.

In early 2011, the operation moved into a new, more expansive phase. Carpenter and Small sold their company to U.S. Tobacco Cooperative, a farmer-owned cigarette manufacturer. But they remained on the job, an arrangement that gave them the power to buy and sell on the cooperative's behalf.

U.S. Tobacco now accuses them of using that authority to defraud millions from the company. And documents from this period show Carpenter and Small making money in ways that have no obvious connection to ATF investigations.

In one such transaction, court records show, U.S. Tobacco sold cigarettes for $3 a carton, then bought back those same cigarettes at nearly $17. Carpenter and Small were both buyers and sellers, making nearly $600,000 for the ATF management account.

"I smell cash??" Small wrote in an email.

"Ka-Ching!" Carpenter replied.

More complicated transactions produced the same result. Court records show that, to keep up the ruse in Paraguay, Carpenter and Small bought large amounts of untaxed Palermo cigarettes, then sold them at a markup to their employer. One such sale made $519,000 for the secret ATF account.

Lesnak said he set the prices, allowing his informants "customary and reasonable" profits. Carpenter and Small were paid $6 million apiece in less than two years, according to court documents. Such huge sums would normally require special approval. But since the money came from the secret account, the ATF officially paid them nothing.

Those around Lesnak benefited, too. The old tobacco warehouse — a $410,000 repurposed candy factory — was given to his church, property records show. A half-million dollars from the secret account was donated to local law enforcement agencies. Thousands more went to Lesnak's children's school. Lesnak handed out Blu-ray players and Xboxes to his son's baseball teammates, one player recalled. The donations, Small said, were made at Lesnak's insistence.

To keep his warehouse workers happy, records show, Lesnak handed out envelopes of cash — $500 to $700 a month, tax free. On an office casino trip, Davis testified, he provided money for gambling. Employees were given DVD players, televisions or freezers that arrived in the warehouse, records show.

Most of the defendants investigated by Lesnak pleaded guilty without a trial, saving prosecutors from having to disclose Big South's cooperation. One defendant, Mark Spears, said in an interview that agents flew him first class from Florida to Virginia and said they would take care of him if he pleaded guilty. To make sure he had money, Lesnak arranged for Small to buy his Porsche, he said.

Once Spears was behind bars, he said, Lesnak deposited $100 a month in his prison commissary. He was unable to provide documentation, but transaction records from the management account do show a $2,000 check with the notation "Mark Spears." Spears said that represented two months of rent on his house while he was in prison.

"They said it was because they wanted to help me out, get me back on my feet," Spears said. "I think they were paying me the money basically to keep me quiet."

The prosecutor, Joseph W.H. Mott, declined to comment through a Justice Department spokesman.

The operation ran until Stuart Thompson, a bookish New York native, took over as chief financial officer at U.S. Tobacco. He repeatedly pressed the warehouse manager to explain the unusual supply of Palermos. No market existed for that many cigarettes, he said.

On March 8, 2013, the warehouse manager called Thompson. "He started telling me that ATF was doing operations in our warehouse," Thompson recalled.

Company lawyers descended on the warehouse, seizing everything. A tobacco company had just raided the ATF.

Agents were outraged. They believed the company had no right to search its own warehouse. "I was very, very upset about that," said William C. Duke, one of the agents involved.

Carpenter, Small and Davis were fired. U.S. Tobacco is suing Carpenter and Small, accusing them of a $24 million fraud. The informants say they are being unfairly blamed for the ATF's actions.

The Tabesa investigation fizzled. Cartes was elected president of Paraguay, and neither he nor Tabesa was charged. The company said it had "no involvement or participation" in smuggling or money laundering.

In September 2013, a Justice Department review found widespread problems with ATF tobacco investigations. But investigators never audited Lesnak's management account. The Justice Department now acknowledges that the only person who did was Davis, with her QuickBooks file.

Court documents show no record that the ATF punished anyone. Kaye was promoted. Lesnak retired with his pension — "never an oral reprimand, never a written reprimand, never a suspension," he said.

Kitty Bennett contributed research.