‘I Smell Cash’: How the A.T.F. Spent Millions Unchecked

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.

Thomas Lesnak, a retired A.T.F. agent, was an expert on tobacco smuggling.

Mr. Lesnak specialized in investigating tobacco smuggling, one of the A.T.F.’s core missions. Though 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 of New York’s cigarettes come from the black market.

The A.T.F. 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. Mr. Lesnak had a solution: Rather than pose as a real company, go into business with an existing one.

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

“The idea was, ‘If you build it, they will come,’” Mr. 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. Mr. 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,” Mr. Lesnak said.

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

Christopher Small, one of the tobacco company employees involved in the operation.

Normally, undercover operations run entirely on government money, from a government account that is reviewed by government auditors. But Mr. 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 A.T.F. DEVISED A SOLUTION: When it was unclear where the money belonged, it went into a private account that Mr. Carpenter controlled. That kept the money outside the reach of Congress. Mr. Lesnak dictated all the spending and said he expected the government to balance the books at the end of the investigation. That never happened.

Mr. 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 A.T.F. agents that if you needed something, Mr. Lesnak could get it without red tape.

As Mr. 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,” Mr. Small said in a deposition.

Agents relied on the management account for routine expenses, and Mr. 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,” Mr. Small said.

Mr. Carpenter’s and Mr. Small’s company, Big South Wholesale, quickly became the national warehouse for all of A.T.F.’s smuggling investigations, records show.

Jason Carpenter, a small-time Alabama tobacco distributor, was one of the informants.

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 Mr. Carpenter and Mr. Small two of the A.T.F.’s most valuable informants. Their work helped lead agents to more than 100 arrests, Mr. Lesnak said. Records show they aided the F.B.I., the Drug Enforcement Administration, even British intelligence.

In appreciation for years of work, the A.T.F. awarded Mr. Carpenter and Mr. 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.

The A.T.F. wanted Tabesa’s tobacco in a “place that they could control,” Mr. Carpenter said. So he said he struck up a relationship with Mr. 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 A.T.F.’s partnership with Big South.

An advertisement for Palermo cigarettes in Asunción, Paraguay. The Big South warehouse in Virginia became a major distributor of the brand. CreditDado Galdieri/Bloomberg

IN EARLY 2011, the operation moved into a new, more expansive phase. Mr. Carpenter and Mr. 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 Mr. Carpenter and Mr. Small making money in ways that have no obvious connection to A.T.F. 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. Mr. Carpenter and Mr. Small were both buyers and sellers, making nearly $600,000 for the A.T.F. management account.

“I smell cash??” Mr. Small wrote in an email.

“Ka-Ching!” Mr. Carpenter replied.

More complicated transactions produced the same result. Court records show that, to keep up the ruse in Paraguay, Mr. Carpenter and Mr. 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 A.T.F. account.

Mr. Lesnak said he set the prices, allowing his informants “customary and reasonable” profits. Mr. Carpenter and Mr. 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 A.T.F. officially paid them nothing.

Those around Mr. 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 Mr. Lesnak’s children’s school. Mr. Lesnak handed out Blu-ray players and Xboxes to his son’s baseball teammates, one player recalled. The donations, Mr. Small said, were made at Mr. Lesnak’s insistence.

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

A portion of a sworn deposition in which a tobacco executive describes Mr. Lesnak’s practice of handing out money and gifts.

Most of the defendants investigated by Mr. 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, Mr. Lesnak arranged for Mr. Small to buy his Porsche, he said.

Once Mr. Spears was behind bars, he said, Mr. 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.” Mr. 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,” Mr. 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 Manhattan 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.

Stuart Thompson, then the chief financial officer of U.S. Tobacco Cooperative.CreditJeremy M. Lange for The New York Times

On March 8, 2013, the warehouse manager called Mr. Thompson. “He started telling me that A.T.F. was doing operations in our warehouse,” Mr. Thompson recalled.

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

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.

Mr. Carpenter, Mr. Small and Ms. Davis were fired. U.S. Tobacco is suing Mr. Carpenter and Mr. Small, accusing them of a $24 million fraud. The informants say they are being unfairly blamed for the A.T.F.’s actions.

The Tabesa investigation fizzled. Mr. 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 A.T.F. tobacco investigations. But investigators never audited Mr. Lesnak’s management account. The Justice Department now acknowledges that the only person who did was Ms. Davis, with her QuickBooks file.

Court documents show no record that the A.T.F. punished anyone. Mr. Kaye was promoted. Mr. Lesnak retired with his pension — “never an oral reprimand, never a written reprimand, never a suspension,” he said.