The Center for Public Integrity

For New York Governor David Paterson, there was no good option.

Faced with a crushing state deficit, angry American Indians, and uncooperative tobacco companies, Paterson on December 15 signed into law a bill designed to take on one of America’s most lucrative black markets: the underground trade in cigarettes flowing through the state’s 10 Indian reservations.

New York’s 70-year-old tobacco black market exploded after 2002, as cigarette tax hikes encouraged smuggling from out of state and through reservations. The traffic is part of a nationwide boom in smuggled cigarettes, but the trade has reached a peak in New York. In 2007, one in three cigarettes sold in New York was channeled untaxed through Indian smoke shops, robbing the state and New York City of nearly $1 billion in tax revenue.

Ironically, this illicit trade has been protected in part by the state’s own reluctance to enforce cigarette tax collection on reservations, a policy known as forbearance. Indians protested violently at the state’s last attempt at collecting the tax in 1997, briefly shutting down the New York State Thruway. Since then, New York governors have vowed to end the black market, but ultimately have shied away from enforcing cigarette tax laws on reservation sales.

It remains unclear whether Paterson will be any different from his predecessors. If implemented, the new law will require manufacturers to supply only wholesalers that can certify that cigarettes won’t be re-sold tax-free to reservations.

The stakes are high. The law moves enforcement up the supply chain to the wholesale and manufacturing level, charging tobacco companies with ensuring that their products are not smuggled. “This means cutting off cigarettes at the factory door,” said Russell Sciandra, director of the Center for a Tobacco Free New York.

There’s something odd about PO Box 365, Irving, New York. Located on the Seneca Nation — nestled just at the Empire State’s southwestern tip — the box is the mailing address for at least 10 online vendors registered in far-flung locations, from New York City to Ankara, Turkey. Boasting names like BigChiefCigarettes.com, Smoke2U.com, and EZTobacco.com, the sites bear no apparent affiliation to one another, except that they all sell one product: untaxed cigarettes.

For years, tax-free cigarette sales on New York reservations have made the state among the country’s top destinations for discount smokes — and not surprisingly, either. With New York City home to the nation’s highest cigarette taxes, the tax-free trade offers a prodigious payoff for the enterprising cigarette vendor. (Between state and city taxes, a carton of cigarettes in New York City can cost up to $80; that same carton, untaxed, costs just $40.) There’s one problem, though: The trade is illegal.

In 2007, New York’s reservations — home to fewer than 17,000 people — sold a towering 6.4 billion cigarettes, leaving state revenue officials scrambling. Every year, the state loses nearly $1 billion in city and state taxes from reservation sales. While the Supreme Court has ruled that states can collect taxes on tribal sales to non-natives, ever since a violent Seneca protest beat back then-Governor Pataki’s attempt to enforce such taxes in 1997, successive governors have been loath to entangle themselves in the issue.

In his more than 30 years in law enforcement, John W. Colledge investigated cigarette smuggling, narcotics, money laundering, and arms trafficking. At the U.S. Customs Service, Colledge developed the International Tobacco Smuggling Program, which he oversaw between 1999 and 2002. In this interview, he talks about the tobacco industry’s complicity in cigarette smuggling; the massive profits that prop up criminal organizations; and the new tobacco black market now booming on the U.S.-Canada border.

Tom Zyckowski was one of four FBI agents who went undercover in parallel cigarette smuggling cases, Operation Royal Charm and Operation Smoking Dragon. The veteran special agent spent 25 years working for the FBI — 20 of them undercover — until he retired from the bureau in 2004. Posing as a Mafia “wise guy,” Zyckowski befriended an unlikely middle-aged couple — Charles and May Liu — who led the FBI through a dizzying world of counterfeit cigarettes and arms trafficking that spanned both U.S. coasts and reached as far as North Korea and China.

The illicit trafficking of tobacco is a multibillion-dollar business today, fueling organized crime and corruption, robbing governments of needed tax money, and spurring addiction to a deadly product. So profitable is the trade that tobacco is the world’s most widely smuggled legal substance. This booming business now stretches from counterfeiters in China and renegade factories in Russia to Indian reservations in New York and warlords in Pakistan and North Africa.

It began with a basic mathematical equation: In 1995 two scholars in Europe found that almost one-third of the world’s cigarette exports had simply vanished. Somehow, billions of cigarettes, once exported, had mysteriously gotten lost in transit.

Only it wasn’t that mysterious. Starting in 1999, a team of reporters from the International Consortium of Investigative Journalists pored over thousands of internal industry documents and uncovered how leading tobacco companies were colluding with criminal networks to divert cigarettes to the world’s black markets. Big Tobacco was doing it for profit — to boost sales and gain market share — as it avoided billions of dollars in taxes while recruiting growing numbers of smokers around the globe. The tobacco industry, as it turned out, did not merely turn a blind eye to the smuggling — it managed the trade at the highest corporate levels.

Here in California, it’s possible to pass within a mile of the Los Angeles-Long Beach port complex and never once suspect it’s there. East of the Palos Verdes Hills, the port’s surrounding warehouses easily obscure the mass of steamers that daily arrive studded with stacks of containers bearing international cargo.

Yet the complex is the busiest in America, the arrival point for nearly half the volume of all U.S. imports. And it’s here that, like so many other smugglers, Charles and May Liu first struck gold.

By all accounts, the Lius were not extraordinary. After emigrating from China around 1980, the pair settled into the Washington, D.C., suburb of Gaithersburg, Maryland. Charles was quiet, a student in political science at New Jersey’s Seton Hall University, where he received a master’s degree. At age 67, he had a professorial look, with chinos and sweaters his preferred attire. May was a romantic, someone the agents who arrested her would later describe as a “true lady,” one who loved ballroom dancing, wore pantsuits, and fastidiously watched her weight.

But the pair wasn’t quite what they appeared. By the time the FBI arrested them in August 2005, the Lius had led a team of agents straight into the heart of a vast Chinese smuggling network — one that sold, among other goods, counterfeit pharmaceuticals, fake $100 bills, and weapons from North Korea. And then there was their real gold mine: cigarettes. Low-grade, brand-name counterfeits. Over a billion of them, all told — more than enough to supply every man, woman, and child in America’s 50 largest cities with a pack.

Since a series of press exposés in 2000-2001 documented the tobacco industry’s extensive history of smuggling, the industry has seemingly retreated from the practice. Yet for Britain’s largest cigarette manufacturer, Gallaher Tobacco, the smuggling may have continued. According to lawsuits brought by former Gallaher distributor Ptolomeos Tlais, the company used companies like his to funnel large quantities of cigarettes to developing countries with no real market — and then smuggle them back into the European Union.

Here are some of the key documents related to the lawsuits:

The Affidavit — Former Gallaher executive Norman Jack reveals how the company set up its smuggling strategy.

The Verdict — A British judge rejected Tlais’s breach of contract suit against Gallaher, but found the company’s practices “gave rise to a risk of smuggling.”

The Dirty Deal — Gallaher arranged with Tlais to dump tons of moldy cigarettes overseas, while U.K. customs officials signed off on the deal.

The Moratorium — When Japan Tobacco International bought Gallaher in 2007, it also got a two-year moratorium on European Union enforcement of smuggling laws against Gallaher.

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