Can a Virginia city's police department run an undercover business to catch cigarette traffickers, and what happens to the money the operation generates?

Plain-English summary

The City of Hampton's police department, working with the federal Bureau of Alcohol, Tobacco, Firearms and Explosives, ran a long undercover operation against cigarette traffickers who bought cigarettes in low-tax Virginia and resold them in higher-tax states. ATF set up a fake business that sold cigarettes to the traffickers and then "churned" the proceeds (deposited them back into the operation's accounts) to fund continued investigation and to buy vehicles and equipment.

The operation ran into trouble. An ATF agent was arrested in 2010 on allegations he had personally benefited from the churning. ATF suspended its participation. Hampton continued running the operation on its own until January 2012, when the Hampton Police Chief halted it because of further alleged officer misconduct and asked the Virginia State Police to investigate.

By the end, the operation's account held roughly $750,000, and the equipment and vehicles bought with operation funds sat unused. The Hampton city attorney needed to know four things: Was the underlying operation lawful? Are the proceeds exempt from normal local-government finance rules? Does the city own the proceeds? When could the city spend them?

The AG answered:

1. The operation was lawful. Virginia is a Dillon Rule state, so cities possess only powers expressly granted by the General Assembly, fairly implied from those grants, or essential to municipal existence. Section 15.2-1102 gives cities broad police powers for the "safety, health, peace, good order, comfort, convenience, morals, trade, commerce and industry" of their inhabitants. The Virginia Supreme Court had repeatedly construed this grant broadly when public safety was at issue. A police-run churning operation against criminal cigarette trafficking fit comfortably within that grant. Hampton's city charter also independently empowered such activities.

2. The proceeds are not exempt from general fund rules. No special statute carves churning proceeds out of standard local-finance law. Hampton's city charter required all moneys "received or collected for the use of the city" to be paid over and held as council ordered. Va. Code § 15.2-2506 required an annual, semiannual, quarterly, or monthly appropriation before any money could be paid out. Those rules applied to churning proceeds once they became city money.

3. Ownership was the unresolved question. The AG would not opine on whether the funds and assets actually belonged to Hampton. Under the MOU, residual funds had to be distributed in accordance with DOJ guidelines "if any participating agency withdraws from the Task Force prior to its termination." No party had given written notice of termination. ATF had simply stopped participating. The AG declined to interpret the MOU between Hampton and the federal government, and noted that the issue might require negotiation among the parties or a court action (declaratory judgment, interpleader).

4. No spending until ownership is established. Because Hampton had not yet acquired a lawful ownership interest in the proceeds, it could not appropriate or expend them. The combination of § 15.2-2506 and the city charter required actual ownership before any disbursement.

Currency note

This opinion was issued in 2013. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

What is a "churning" operation?
An undercover investigation where law enforcement creates a front business that generates real revenue from criminal customers (here, cigarette traffickers), then reinvests ("churns") the proceeds back into the operation to fund continued investigation, buy equipment, and pay informants. ATF used the model widely in tobacco-trafficking cases.

Is a churning operation legal in Virginia?
For tobacco trafficking investigations conducted by a city police department, the AG concluded yes, under the broad police powers in § 15.2-1102 and the city's charter. The opinion does not address state-level approval requirements or limits in other contexts.

Do the proceeds belong automatically to the city?
No. They belong to whoever actually owns them under the MOU and federal guidelines. If a federal task force ran the operation under an MOU, residual assets get distributed according to the terms of that MOU and DOJ directives. Until the MOU is terminated and the distribution worked out, ownership is unsettled.

Can the city spend the money while ownership is being sorted out?
No. The AG was clear on this. The city must first acquire a lawful ownership interest. Until then, the money sits.

What is the Dillon Rule?
Virginia's strict rule of municipal authority: cities and counties can only exercise powers expressly granted by the General Assembly, fairly implied from those grants, or essential to their existence. Compare it to "home rule" states, where local governments presumptively have any power not denied. Dillon-Rule analysis is the first step in any question about whether a Virginia locality can do X.

Why the focus on § 15.2-1726?
That statute was the authority Hampton used to enter the MOU with ATF in the first place; the opinion notes the Hampton Police Division executed the memorandum of understanding with ATF pursuant to § 15.2-1726.

Background and statutory framework

The relevant statutes:

• Va. Code § 15.2-1102: general police-powers grant to cities and towns.
• Va. Code § 15.2-1726: authority for local police departments to enter agreements (used for the ATF MOU).
• Va. Code § 15.2-2506: requires an appropriation before any money can be paid out by a locality.
• Hampton City Charter: paralleled the statutory grants, requiring that all moneys "received or collected for the use of the city" be paid over, held, and disbursed as the council orders.

The interpretive moves:

• Dillon Rule analysis: the AG identified the express grant (§ 15.2-1102) and asked whether undercover business operations were "fairly implied" or "necessary or desirable." The opinion noted that the Supreme Court of Virginia has construed the general police-powers grant broadly when public safety and morals are involved, without naming a particular case, and concluded the churning operation fit.
• The "fund management" question turned on the absence of any special statute exempting churning proceeds. With no exemption, the default rules apply.
• The ownership question went unanswered because resolving it required interpreting a contract between the city and the federal government, plus federal guidelines neither party had supplied. AG opinions in Virginia generally do not interpret federal-state agreements.

Citations

• Va. Code § 2.2-505 (authority for the advisory opinion)
• Va. Code § 15.2-1102 (general police powers)
• Va. Code § 15.2-1726 (authority for the ATF MOU)
• Va. Code § 15.2-2506 (appropriation required before disbursement)

The opinion's Dillon Rule and police-powers discussion is quoted without naming any particular case.

Source

• Landing page: https://www.oag.state.va.us/annual-reports-opinions/official-opinions
• Original PDF: https://www.oag.state.va.us/files/Opinions/2013/13-007_Hudson.pdf

Original opinion text

COMMONWEALTH of VIRGINIA
Office of the Attorney General
Kenneth T. Cuccinelli, II
Attorney General

May 31, 2013

Cynthia E. Hudson, Esquire
City Attorney for the City of Hampton
Office of the City Attorney
22 Lincoln Street
Hampton, Virginia 23669

Dear Ms. Hudson:

I am responding to your request for an official advisory opinion in accordance with § 2.2-505 of the Code of Virginia.

Issues Presented

You pose four questions regarding the operation of "churning" activities in the City of Hampton. First, you ask whether the City of Hampton, through its police division, is authorized to conduct churning operations to detect crimes involving the diversion of tobacco products. You next ask whether funds derived from a churning operation are exempt from laws generally governing the use of local government funds. Third, you ask whether the operation's funds and other assets become the property of the City of Hampton at the conclusion of the churning operation. Finally, you ask at what point in time the City of Hampton may appropriate, or otherwise lawfully commence a process for expenditure of such funds.

Response

It is my opinion that the City of Hampton may lawfully conduct churning operations to detect crimes involving the diversion of tobacco products. It is further my opinion that funds derived from a churning operation, of which the city ultimately may obtain an ownership interest, are not exempt from general laws governing the use of local government funds. In addition, this Office cannot definitively opine on the ownership of the completed operation's residual funds and other assets. Finally, it is my opinion that the City of Hampton may not appropriate or expend such funds until it establishes a lawful ownership interest in them.

Background

You relate that, in June, 2010, the Hampton Police Department entered into an agreement with the Federal Bureau of Alcohol Tobacco, Firearms and Explosives (ATF) to combat illegal cigarette trafficking. Through this partnership, a Hampton-based undercover operation was formed to target individuals who purchased cigarettes in Virginia and then sold them in higher tax states in order to make a profit. Pursuant to § 15.2-1726 of the Code of Virginia, the Hampton Police Division executed a memorandum of understanding with ATF ("the MOU") detailing the methodology and respective responsibilities of the parties. ATF assumed operational control.

You state that ATF used federal money to create a fictitious business entity that sold tobacco products to cigarette traffickers. Through the fictitious entity, ATF and Hampton Police purchased cigarette inventory, opened bank accounts, secured credit cards and leased property to conduct the business. ATF "churned" the proceeds from these commercial transactions to offset expenses incurred during the undercover operation. Any additional moneys generated by the operation were deposited into the operation's bank accounts to fund future transactions.

You report that ATF suspended its participation in the operation in October, 2010, after an assigned ATF agent was arrested on allegations that he personally had benefited from the churning activities. By that time, the cigarette sales through the undercover enterprise had resulted in accumulation of several hundred thousands of dollars. These funds were deposited into the fictitious entity's bank account. Hampton Police chose to continue the operation without the participation of ATF and used churning proceeds to purchase vehicles, computer equipment, and other property; however, in late January, 2012, the Hampton Police Chief decided to halt the operation based on alleged officer misconduct and requested the Virginia Department of State Police conduct an independent criminal investigation.

You indicate that approximately $750,000 was generated through the churning operation and remains in the fictitious entity's account. The property purchased with churning operation funds (vehicles, electronic equipment, and other office equipment) is kept separate from other city properties and is not being used. You state that, other than budgeted salaries for Hampton police officers, no City funds were expended in support of the operation.

Applicable Law and Discussion

In determining the power of a local governing body, Virginia follows the Dillon Rule of strict construction, which provides that "municipal corporations possess and can exercise only those powers expressly granted by the General Assembly, those necessarily or fairly implied therefrom, and those that are essential and indispensable."

Section 15.2-1102 of the Code of Virginia confers general police powers on cities and towns that are not:

expressly prohibited by the Constitution and the general laws of the Commonwealth, and which are necessary or desirable to secure and promote the general welfare of the inhabitants of the municipality and the safety, health, peace, good order, comfort, convenience, morals, trade, commerce and industry of the municipality and the inhabitants thereof[.]

The Supreme Court of Virginia has construed broadly this general grant of police powers to localities when public safety and morals are involved.

Moreover, Hampton's participation in a churning operation through its police department is not expressly prohibited by the Constitution or the general laws of the Commonwealth. Thus, it is my view that employing a churning operation to combat tobacco trafficking in Hampton is fairly implied in and consistent with the legislative grant of police power set forth in § 15.2-1102. The Hampton City charter further utilizes similar language to confer powers to the city to promote the general welfare of the city and the safety, health, peace, good order, comfort, convenience, and morals of its inhabitants. The city, through its police force, may deem a churning operation proper to provide for the safety, health, peace, good order, comfort, convenience, and morals of its inhabitants and would be authorized to conduct such an operation to deter criminal activity, including the illegal trafficking of cigarette products. Thus, the city's police powers under § 15.2-1102 and its charter are broad enough to encompass the described churning operations.

The Hampton City Charter provides that "[a]ll moneys received or collected for the use of the city from any source shall be paid over, held and disbursed as the council may order or resolve, and in such depository or depositories as may be prescribed by the council, either by ordinance or resolution." In addition, § 15.2-2506 of the Code of Virginia prescribes that,

No money shall be paid out or become available to be paid out for any contemplated expenditure unless and until there has first been made an annual, semiannual, quarterly or monthly appropriation for such contemplated expenditure by the governing body[.]

I find no other law that otherwise would apply to govern how such proceeds from a churning operation are to be handled. Therefore, to the extent that the city ultimately may obtain a lawful ownership interest in such funds, and consistent with their accumulation through a public safety-related operation in Hampton, it is my view that the moneys collected from tobacco sales were "for the use of the city." In that instance, and in conformity with the above-cited provisions of Virginia law and the city's charter, the funds may be appropriated and expended as the council provides.

The MOU section entitled, "Duration," establishes how to effect termination of the agreement and sets forth the federal guidelines to which the parties must refer to govern the distribution of residual funds from task force operations:

This MOU shall remain in effect until it is terminated in writing (to include electronic mail and facsimile). If any participating agency withdraws from the Task Force prior to its termination, the remaining participating agencies shall determine the distributive share of assets for the withdrawing agency, in accordance with Department of Justice guidelines and directives.

Thus, a distribution of residual funds and other assets depends upon a written termination notice from a withdrawing participant in the MOU, and, upon a withdrawal from the task force created by it, adherence to the governing terms of the Department of Justice standards for such a "distributive share of assets." Based upon the information you provide, neither ATF nor the City of Hampton's police division have provided written notice of termination of the MOU or intent to withdraw from the task force created by it.

The issue whether "the proceeds of such a churning operation and goods purchased with churning funds become the property of the city" is beyond the scope of this opinion. You note that while ATF ceased its participation in and apparently abandoned the joint operation, and initiated no prosecutions based upon it, "there is no indication that the ATF terminated the MOU with Hampton in accordance with its terms which provide for termination by ATF in writing." Pursuant to the above-referenced specific termination-related provisions of the MOU, it is not possible to now opine on how residual funds and the proceeds from other assets might be divided between the City of Hampton, the federal government, and, perhaps, other law enforcement organizations participating in the MOU. Moreover, unless you were to present a specific legal question relating to the termination of the MOU, this Office would decline to interpret the provisions of such an agreement between a locality and other entities.

Finally, it is axiomatic that the City of Hampton may not make an appropriation or expenditure of residual funds or the proceeds from other assets derived from the churning operation unless and until it acquires a lawful ownership interest in them. It has not yet established such an ownership interest.

Conclusion

Accordingly, it is my opinion that the City of Hampton lawfully may conduct churning operations to detect crimes involving the diversion of tobacco products. It is further my opinion that funds derived from a churning operation, of which the city ultimately may obtain an ownership interest, are not exempt from general laws governing the use of local government funds. In addition, this Office cannot definitively opine on the ownership of the completed operation's residual funds and other assets. Finally, it is my opinion that the City of Hampton may not appropriate or expend such funds until it establishes a lawful ownership interest in them.

With kindest regards, I am

Kenneth T. Cuccinelli, II
Attorney General