What A Tobacco Racketeering Case, Possible ATF Involvement Means For Tobacco Stocks

The Bureau of Alcohol, Tobacco, Firearms and Explosives has been dragged into a hushed racketeering lawsuit involving fake cigarettes, a secret bank account and alleged sting operations.

According to the U.S. Tobacco Cooperative Inc., one former employee and contractor cheated nearly 700 coop farmers out of about $24 million. The two defendants claim to have secretly worked as ATF informants during their illicit transactions.

The New York Times Co NYT exposed the ongoing, four-year-old lawsuit Wednesday despite the Justice Department’s efforts to keep the issue private.

The Case Particulars

U.S. Tobacco — whose farmers split the profits of their consolidated products — acquired distributor Big South Wholesale in 2011 to buy and sell cigarettes on the cooperative’s behalf. But the Big South owners allegedly began defrauding the farmers by making “sales” to themselves or exporting “tobacco” that really turned out to be snack foods.

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According to certain case documents, the profits from the fraudulent deals went into a secret account that helped finance ATF investigations. Although officially managed by the Big South owners, who admitted to having received more than $1 million each, the fund’s application was purportedly directed by ATF agents.

The ATF, an organization under the Department of Justice, had an unknown level of participation in the alleged racketeering case, and the New York Times questioned whether the group was merely investigating the smuggling or complicit in it. Most relevant court documents, the Times noted, had been scrubbed of ATF mentions.

So What?

Stefanie Miller of Height Securities speculated that the circumstances discussed in the lawsuit mattered more to publicly traded tobacco companies than will any potential settlements.

“The lawsuit is less important than the reason for the lawsuit, itself,” Miller said.

It basically comes down to the “end” of the purported “means.” If the federal government succeeded in curbing illegal cigarette trade by its activities, then any events advancing the process ultimately contributed to a positive storyline for tobacco investors.

“If the federal government’s involvement basically opened up a way for certain individuals to game the system and make a bunch of money off of this, and basically be illicit cigarette dealers condoned by the federal government, then it’s less certain what the end of these means will be,” Miller said.

“Either way, while this is going on, there would have been impact in the market.”

Retroactive Pain

As a player in the deep discount market, U.S. Tobacco Cooperative is not considered a significant competitor of Reynolds American, Inc. RAI, Philip Morris International Inc. PM, Altria Group Inc MO or Vector Group Ltd VGR, which are more focused on the premium cigarette space.

However, its products do rival certain, less expensive segments of the big companies’ lines, and the illicit activities that hurt U.S. tobacco would have also heightened competition for the publicly traded companies.

“There could have been a little bit of a bite taken out of these companies’ revenues of their discount/deep-discount cigarettes, should consumers have switched to a deeper discounted, lower-priced cigarette that stems from the black market sales,” Miller said.

But those are the worst possible effects of the lawsuit and its surrounding circumstances. Miller said any damage has already been done, and shareholders should not expect the lawsuit or future discoveries of ATF’s involvement to in any way affect tobacco stock performance.

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