JAY DAWDY
Johnny Lee was the son of a peasant farmer in Yunxiao County in the province of Fujian, China. Brett Sinclair was a hardworking, white-collar professional living in Manhattan's Upper East Side. Johnny was uneducated and poor but worked hard and made a decent living by Yunxiao's standards, even if the industry he worked in was a bit shady. Brett had an excellent education, a great job and made plenty of money, but he was known as a cheapskate by his friends. He tried to save a few bucks wherever he could.
These two 25-year-olds lived in different worlds, but they both had a secret, and, unbeknownst to them, they also had a connection. The twosome was linked together at opposite ends of a complex network of people, companies and technology involved in the counterfeit cigarette trade. Simply put, Johnny made counterfeit cigarettes and Brett bought them. But the larger story was a far more complicated tale of a global black-market industry that had exploded through the use of the Internet.
Johnny Lee's secret was that he went to work every day in an illegal operation inside a cave hidden by the thick forests in the Yunxiao countryside. Inside that cave was a fully operational cigarette-manufacturing facility that cranked out counterfeit cigarettes by the millions each year. These cigarettes were produced with well-known U.S. and European cigarette labels, but they were 100-percent counterfeit. Even though producing counterfeit cigarettes was illegal in China, it was a highly lucrative business for the locals, and it beat the hard labor and low pay that went along with peasant farming. In fact, hundreds of locals worked in the industry because they could earn a far better living as counterfeiters than in the other limited opportunities that were available. Additionally, the chances of getting caught were slim, and the punishment was light if that happened. In other words, the cost-benefit ratio for counterfeiting cigarettes made sense.
I came to understand that Johnny was just one small piece of a much larger network of production and trade in counterfeit cigarettes around the globe. Even though it was in an illegal industry, Johnny's employer, Shin Tao Exporters, was vertically integrated and sophisticated. In addition to making the cigarettes, Shin Tao grew their own tobacco in Southern China, Vietnam, Laos and throughout Southeast Asia. And Shin Tao had a robust and growing customer base. They exported to distribution channels across the world — principally to cities in Russia, Eastern Europe and more recently a number of African countries, including Kenya and Tanzania.
Of course Johnny didn't know much about the global trade in counterfeit cigarettes or the many layers of exporters and smugglers between him and Brett — who was buying his cigarettes on the Internet. Johnny was simply keeping his nose to the grindstone and trying to make a good living. In his mind, he was doing his job, providing for his family and trying to hide the secret of his illegal activities.
Brett, however, more than 10,000 miles away in a different environment completely, was attempting to do more than make a living. He was trying to make enough money to buy a co-op on the Upper East Side — not easy in Manhattan's hot real estate market. Brett was tech savvy, smart and driven. He worked hard, tried to save as much money as he could and did almost everything on the Internet. He shopped online, ordered his groceries online, traded stocks online and did his banking online. Hell, he even dated online. Another thing that Brett did online was buy his cigarettes. In Brett's mind, everything was cheaper and more efficient online — especially buying cigarettes. Cigarettes sold online were much cheaper, in part because there were no hefty local taxes assessed on them, unlike the cigarettes Brett sometimes purchased at the corner newsstand in his neighborhood.
Sometimes the smokes Brett bought online tasted a little funky, but overall, they weren't too bad. And they looked like the real thing, even though the packages they came in were from some faraway places, like Thailand, Russia and many of the old Soviet countries with names Brett couldn't pronounce. It was true; Brett was a cheapskate who bought his cigarettes online, but he did it for understandable reasons.
Brett and Johnny were linked indirectly because Brett was buying the cigarettes that Johnny was making for Shin Tao. What Brett didn't know, or for that matter, what Johnny didn't know, was that Shin Tao was just one small player in a worldwide industry. Counterfeit goods in general were a major export from China, and cigarettes were just one of the many black-market industries that had grown significantly in the past 20 years.
Shin Tao was one of hundreds of small counterfeit-cigarette entrepreneurs that had sprung up in the countryside of Yunxiao over the years. To get started, producers only needed a few cigarette machines, the raw materials to make the product, people to feed the machines, and a good place to hide the production facilities. The buyers were easy to find and the profit margins were great. There were hundreds of companies just like Shin Tao operating in and out of Yunxiao, combining to produce what some experts estimated at more than 450 billion counterfeit cigarettes per year.
Shin Tao was owned and operated by a few entrepreneurial locals who had several other production facilities around the Yunxiao countryside. Although this was big business, and the local officials knew what was going on (and were being paid to turn a blind eye), Shin Tao and the other counterfeiters were cutting into government revenues, so they had to operate in hidden locations — like caves, basements and other discrete spots located throughout the countryside.
But the Shin Tao founders were smart, careful and astute businessmen. As they grew, they established multiple covert operations. In the event that one location was discovered by the authorities, they could simply shut it down and continue their production elsewhere. And, in fact, the founders of Shin Tao were just one of many players on the lowest level of the massive production and distribution network in the counterfeit-cigarette trade. Shin Tao sold its cigarettes mainly to overseas buyers in Russia, Eastern Europe and Africa — the same places from where Brett's cigarettes were being shipped.
Over the years, Shin Tao had evolved from a local seller into a global wholesaler, producing a fake product at a far lower cost than the real thing and selling it at a profit to distributors around the globe. The products it sent to customers in Russia, Kenya and Tanzania tended to stay in-country; however, the cigarettes going to Eastern Europe were distributed to the United States and around the globe via the Internet. These Eastern European importers were more commonly referred to as smugglers. They were a new wave of entrepreneurs who made the big money in the counterfeit-cigarette business, selling to end consumers around the world.
The smugglers were based in Belarus, Georgia and Uzbekistan. In a short time, they had perfected the art, science and technology of trading black-market goods. These criminals had plenty of experience fencing counterfeit goods in the past, and they had developed a robust distribution network. They had perfected the use of one of the most efficient and cheapest distribution systems mankind had ever seen — the Internet.
The Eastern European middlemen hired a group of young programmers and Internet geniuses to develop Web sites to sell the illicit booty. The smugglers mainly bought from China and sold their products in the United States. Their Web sites, online ordering interfaces, shipping and logistics capabilities would have made Amazon, Google and Yahoo! proud. The sites were everywhere and the sellers were prodigious in their ability to fill orders and ship cigarettes. And it started with the massive supply of counterfeit cigarettes coming out of China, including those from Shin Tao Exporters.
What the counterfeiters and smugglers didn't count on was the victims — multiple types of victims — getting tired of being ripped off. The legitimate cigarette manufacturers were, of course, being victimized in the form of lost sales to the counterfeiters. Local municipalities, particularly in the United States, that collected heavy taxes on cigarettes sold in their jurisdictions were also victimized by the lost tax revenue. And last but not least, the end buyers, like Brett, were being victimized, and many of them didn't even realize it. Although they were buying cheaper smokes online, the counterfeit cigarettes were unregulated and contained much higher levels of nicotine, carbon monoxide and other toxins than the originals, creating serious additional health concerns (as if smoking wasn't bad enough already).
Victims were finally wising up, and they decided to do something about it. This was not a case in which there was an "aha moment" when a discovery was made that resulted in an investigation. The counterfeit market had been around a long time, but in the last few years, the counterfeiters had become much more sophisticated in mimicking the real product. As a result, they were able to sell more and more cigarettes. The supply increased rapidly as more counterfeiters popped up and realized the profit margins to be made by selling tobacco online.
As the Eastern European smugglers started exploiting the Internet as their distribution tool of choice, the trade in counterfeit cigarettes in New York and other U.S. cities exploded. With the perfection of the Internet as a distribution mechanism, the counterfeiters and smugglers began to seriously cut into the profit margins of the legitimate companies.
And as the counterfeiters multiplied, the established cigarette manufacturers around the world began to explore new ways of stopping them. The counterfeiters and smugglers were not only cutting into their profit margins, but the legit manufacturers were losing control of their brands, marketing and distribution networks.
Simply put, the genuine manufacturers were losing the battle to the counterfeiters and smugglers and they needed creative solutions to the problem. Other big players were also losing to the counterfeiters — state and local tax authorities. They were not collecting the taxes they were owed on the sale of counterfeit cigarettes, and cigarette taxes were a big source of tax revenue. As we know, the taxman doesn't like it when he doesn't get his cut. What resulted was a strange mix of bedfellows as clients, and some new and creative ideas for investigation. That's where my team came in.
During my investigative career, I had seen numerous frauds, worked on interesting and unique cases, and run into many nefarious characters. But when I received a call from a new client requesting that I run an undercover operation to buy cigarettes over the Internet, I remember thinking, "Wow, this is something different."
This case, in a nutshell, involved investigating the improper sale of counterfeit cigarettes over the Internet through a variety of Web sites, but no one knew who was behind the sites. Our client wanted to identify the responsible parties, go after them, and shutdown their networks. What we didn't know at the time was that, in addition to counterfeiters and their improper distribution methods, we would also uncover a vast network of questionable characters across the globe who were stealing products and selling them over the Internet. These schemes resulted in the selling of illegal and dangerous merchandise to unsuspecting consumers who usually thought they were simply getting a good deal.
After some research on my end and detailed briefings with the client, we realized that the Internet could be used as a powerful tool for the distribution of counterfeit goods. But we also came to understand that the Internet could be used as a superior investigative tool and a platform for conducting undercover operations.
Our assignment was relatively simple: Go online, identify the most prominent Web sites selling a certain brand of cigarettes, pose as consumers, and buy a predetermined amount of cigarettes to be delivered to addresses in New York City. We also carefully documented our purchases and receipts and engaged in dialog with the sellers whenever possible to gather information about their locations, modes of operation and any other background that might later be useful to our investigation.
I put together a team of mostly younger investigators who seemed to be online constantly. This team identified the Web sites in question and embarked on a very controlled and documented undercover-buy operation through the Internet. Working with the client, we developed a specific ordering protocol, documentation requirements (including capturing screen-shots of every relevant Internet page), and a purchasing method. After receiving the cigarettes, we followed a detailed chain-of-custody process, carefully cataloging the product receipts along with the ordering documents, taking video and still photos and packaging the evidence for delivery to outside counsel.
The sellers didn't know or care who we were. They didn't check age requirements or worry about local taxes that should have been levied. The sellers had been operating with impunity for years and had no apparent fear of being investigated or caught; they were just trying to sell as many counterfeit cigarettes as they could.
To do the buys, our investigators used their own credit cards designated solely for this case, and we had the cigarettes delivered via U.S. mail. We obtained new credit cards upfront for this purpose and then canceled them after the project to avoid any subsequent unwanted billing. We then examined the products received to identify the sellers and their locations when we could. The sellers included a variety of overseas smugglers, counterfeiters, gray-market dealers and sovereign groups that were selling goods in violation of several laws.
While attempting to investigate to the source of the counterfeiters and smugglers, we engaged in interesting chats over the Internet and collected some useful tidbits of intelligence about them, but for the most part they were wary of providing details about their locations and business activities.
My group of investigators — most in their twenties — loved this engagement. They were able to surf the Internet at work and rack up amazing bonus points and frequent-flier miles on their credit cards from the high volume of purchases we were making. They also had some funny stories about the reactions of their local post offices and neighbors, given the number of suspicious-looking boxes they were receiving from Eastern Europe. One of my investigator's neighbors wanted to stage an intervention because she thought his smoking habit had gotten out of control. "How could one boy smoke all those cigarettes?" his neighbor, Delores, asked him repeatedly.
Ultimately, we were successful in documenting the counterfeiters and identifying a plethora of groups that were assisting the smuggling and distribution operations in the United States. Our investigative work resulted in the shutdown of a number of illegal Web sites. I wish I could say that our investigation made a big dent in identifying and shutting down the vast network of smugglers in Eastern Europe and the producers in China, but that would be too good to be true.
The fact is that although our work was vital in terms of assisting counsel in closing a number of Web sites with U.S. ties, new Web sites popped up daily. Additionally, many of them operated outside the United States, so the legal jurisdiction and ability to impact their operations was complicated and difficult at best.
However, we had a number of successes, particularly in the United States and within New York City. One of them involved Brett Sinclair's local newsstand. You see, Brett was actually one of my undercover investigators. Much to his neighbor Delores's relief, he actually had a good excuse for buying so many cigarettes — and he wasn't smoking all of them! Brett was working for the good guys the whole time, purchasing cigarettes, documenting his buys and continuing to investigate the source of counterfeits, just like the rest of my team.
In one particular instance, after doing some online buys, receiving the cigarettes, and engaging the supplier in online chatting, Brett learned the products bought from this Web site were being distributed via a warehouse in Brooklyn, New York.
After obtaining permission from the client, we engaged in additional investigation of the storage facility in Brooklyn. We sent a surveillance team to the location, documented trucks coming and going, wrote down license plates, collected video evidence, and followed some of the outgoing trucks to their next destination for delivery. A few of them went right back across the river into Manhattan and delivered cigarettes to local newsstands and neighborhood bodegas, which were selling the counterfeit cigarettes and making great profit margins. Sure enough, one of the newsstands was right down the street from Brett's apartment; the investigation had really come full circle.
With the assistance and approval of the client, we presented our findings to local law enforcement, which subsequently raided both the warehouse and the retail locations; confiscated the counterfeit products; and closed a number of the warehouses, newsstands and bodegas that were selling counterfeit products.
Note
Lessons Learned
This case made me appreciate the reach and distributive power of the Internet for the dissemination of counterfeit goods. Although we were investigating counterfeit cigarettes, this could have been any other counterfeit merchandise. The Internet as the medium through which these products were sold provided cover for the individuals committing the fraud. The perpetrators were hard to trace because they hid behind their Web sites and offered little information about their identities or operations. However, we also learned that the Internet can be a powerful tool and a mechanism for launching online and undercover investigations; it was the primary investigative tool employed in this case. Through our undercover purchases and subsequent Internet-based investigation to isolate and identify the offenders, we were able to stop future sales, dismantle Web sites and confiscate counterfeited and stolen products.
By capitalizing on the anonymity of the Internet, we used the fraudsters' tools to catch them. This brought out another reinforcing lesson for any investigation, which was to think like the fraudster and use their tools and methods against them. In this case, the perpetrators were sophisticated Internet-based smugglers, so we used the Internet against them. By performing most of our investigation online, we were able to collect valuable evidence that helped shut down their operations. Had we tried to contact these smugglers on the phone or approach them in person, they would have run for the hills. Instead we approached them in the way they were most comfortable — through the Internet.
Another important focus in this investigation was to appeal to the criminals' sense of greed. They were in business to sell counterfeit cigarettes and make money, so they were gullible to our undercover operation — and willing to sell to almost anyone. That, of course, backfired. However, if fraudsters think there is something in it for them, they are usually more than willing to unwittingly succumb to undercover operations.
A key ingredient to the success of this case — including the ultimate seizure of counterfeit products and capture of local merchants trading counterfeit goods — was the support of local government authorities. They had a vested interest in the case, but it was important to get them on board from the start. The threat of being put out of business and the attention of the authorities were, in many ways, more powerful deterrents to the criminals than the civil remedies that our client could employ. This lesson can apply to any investigation. It's important to think about who your allies are: law enforcement, other victims who are willing to pay for your services or cooperation by a related party who may have relevant information. The more interested parties and allies you have on your side (and frankly the more authority figures and deeper pockets your side has), the stronger your chances of success will be.
This case also made me realize that, even though we were not able to stop each player involved, as investigators we can make progress in small increments. It's important to keep working hard, pushing back, and being aggressive. And even if you can't completely solve the problem — as in this engagement — achieving smaller successes, such as closing a group of Web sites and the identification of local merchants who were buying from these sites, was in fact progress. Our success was also a major deterrent to others trading in this space.
Jay Dawdy, CFE, CMA, is the president of Gryphon Investigations. He has more than twenty years of finance, accounting and investigative experience and concentrates on complex financial, litigation support, due diligence and fraud investigative cases. Mr. Dawdy served as an instructor in investigating financial fraud at Baruch College and presents and writes frequently on fraud investigation and prevention.