LITTLE ROCK — The auditor of the Arkansas Lottery Commission is questioning whether a contract that the lottery has had almost from its beginning is valid, which poses a multimillion-dollar potential problem for the lottery.
The matter involves an action that former Lottery Director Ernie Passailaigue took in 2009 regarding the lottery’s contract with game firm Scientific Games.
Lottery auditor Michael Hyde now estimates that an amendment to the contract has cost the state $7.29 million more than was in the initial deal approved by the commission and its Legislative Oversight Committee. He said that over the seven years of the contract, Scientific Games will receive an estimated $21.7 million more than it would have under the original deal.
Concerns about the amendment and how it was implemented were raised in a 2010 audit, and the committee subsequently took steps to address it, and considered the matter put to rest.
But Hyde, in his preliminary 2011 audit findings, questions whether the committee and commission ever formally approved the amended contract.
The fact that Hyde’s findings have revived the matter has some committee members exasperated, and the game firm looking to resolve it once and for all.
At a commission meeting Monday, Lottery Director Bishop Woosley made public an e-mail from an attorney for Scientific Games that listed several things that the company is willing to do “in consideration of and as a condition precedent for” the lottery resolving the Nov. 25, 2009, amended-contract matter. Hyde had earlier posed questions to Woosley and Scientific Games in regard to the contract.
The Lottery Commission is to meet at 1:30 p.m. Tuesday to discuss the situation in more depth.
At Monday’s meeting, Commission Chairman Dianne Lamberth of Batesville asked Hyde to analyze and prepare a report on his concerns.
Some of the nine lottery commissioners said they want to hear from Hyde before commenting to the news media.
“It’s all supposed to be based on something that is supposed to be cleared, and before I say anything that would be damning to the internal auditor, I need to hear what he has to say,” Commissioner Steve Faris of Central said.
Faris said he also wants to hear from Woosley, who was the lottery’s attorney from 2009 until being hired Feb. 11 as director.
“The director has a good grasp on the problem and seems to be on his way to finding a solution to the problem,” Faris said. “There’s some areas of concern, the magnitude of the problem has yet to be determined.”
Hyde’s concerns stem from a previously scheduled, routine audit that he is conducting on the instant-ticket contract. (Instant tickets are for scratch-off games). He plans to complete the audit before June 30 and said he would not comment further until it is complete.
Woosley cautioned that Hyde’s concerns are preliminary, and he wants the commission to discuss them.
“I don’t really have an opinion one way or another. I just want them to make a decision based on the correct information,” Woosley said of commissioners.
Lottery spokesman Julie Baldridge said it is too soon to know what the effect on the lottery would be if the contract is considered invalid. Baldridge served as interim lottery director before Woosley was hired.
“There is no way to find out the answer to that question,” she said, until the commission and the Legislative Oversight Committee weigh in on it.
She said if the commission decides that the issue is settled, “we’ll consider the matter closed unless there is action from outside the lottery.”
HISTORY
Arkansas’ lottery has provided about $238 million for college scholarships, but it has run into problems in the 21/2 years it has existed.
The fact that the contract change hadn’t gone through the proper approval process was uncovered in a 2010 audit along with about a dozen other findings, including that the lottery failed to follow state travel rules and regulations for reimbursements for several employees, including its director.
The audit found that on Aug. 5, 2009, the commission approved the original instantticket lottery game service contract with a stated cost of 1.75 percent of net sales. On Aug. 13, 2009, the oversight committee reviewed, and in essence approved, that contract.
But, the audit found that on Aug. 25, 2009, Passailaigue agreed to a “recital of selected options,” which is similar to a contract amendment, but did not ask the commission or oversight committee to consider it.
The recital raised the stated amount for Scientific Games to 1.92 percent of net sales, plus 1.5 percent of the prize pool. That amounts to an additional $3.9 million a year for Scientific Games, according to the 2010 audit.
Passailaigue resigned Oct. 3, 2011.
Arkansas lays out a process for how lottery contracts are to be approved.
Arkansas Code Annotated 23-115-205 (a)(20) states that the commission may enter into contracts as needed, but A.C.A. 23-115-1101 (d)(3)(A) states that the Legislative Oversight Committee reviews all contracts of $25,000 or more before the contracts go into effect.
In addition to the contract amendment, three other licensing agreements with the vendor were not reviewed by the oversight committee or approved by the commission. Those cost the lottery $671,861, according to an April 8, 2011, report on what the lottery commission was doing to resolve concerns that were raised in the 2010 audit.
“The subsequent Recital of Selected Options and three licensing agreements were not approved by the commission or reviewed by [the oversight committee]. Lack of appropriate review of contracts and modifications of contracts could lead to a lack of transparency to the [oversight committee] and public,” the 2010 audit states.
The audit’s recommendation for resolving the matter was that the “agency ensure compliance with state law by submitting appropriate documents for review by the Arkansas Lottery Commission Legislative Oversight Committee.”
In a Dec. 14, 2010, letter from the Legislative Oversight Committee to the commission, the committee said the commission should notify it of any changes made in a major procurement contract or in any ancillary agreement. The commission agreed to do that in the future, and on March 8, 2011, legislative auditors cleared the audit, and thus considered the matter resolved.
But Hyde said Monday that he has found no evidence that the commission ever approved the Scientific Games contract changes.
The lottery commission’s response to the 2010 audit indicated that it saw the amendment as being part of the original terms of the contract and thus didn’t need additional review by the oversight committee.
Woosley said the matter just keeps resurfacing.
“We thought it was resolved, and then my first day [as director] it came up again,” he said. “It’s cleared, we move on, and it comes back up.”
CONTRACT COSTS
Hyde’s analysis shows that the state has paid Scientific Games about $29 million since the contract began in 2009.
His analysis of the amendment shows that the change to 1.92 percent instead of 1.75 percent cost the lottery $7.29 million between Sept. 28, 2009, and Feb. 29, 2012. That means $1.95 million less for scholarships and $5.54 million less for lottery players.
His projection that over seven years the amendment will increase Scientific Games’ take by $21.7 million than what was in the original contract means $5.65 million less for scholarships and $16 million less for lottery players.
SCOPE
Early drafts of the report that Hyde plans to give commissioners Tuesday list two findings from his audit, but he says those findings could change.
One finding states that the contract modifications “were not approved by the Arkansas Lottery Commission or reviewed by the Arkansas Legislative Lottery Oversight Committee.”
“Internal audit could not identify any additional services provided by Scientific Games to justify the pricing modifications,” he said in a Wednesday e-mail.
The second finding concerns the recital that changed the pricing and terms of the original Aug. 13, 2009, contract.
Hyde wrote that changing the contract after is was approved “could put into question the integrity of the competitive procurement process.”
“The revisions substantially increased the cost of the contract with little or no benefits to the Arkansas Scholarship Lottery,” the e-mail states. (The lottery refers to itself as the Arkansas Scholarship Lottery, although that is not its official name under Arkansas law.)
Hyde wrote that the recital substantially changed the contract.
He wrote that a section of the original “request for proposal” states that the vendor chosen for the contract may be required, up to seven times a year, to package, warehouse and distribute up to seven instant-ticket games purchased by the lottery from other vendors.
But, the recital approved a few days later changed that to make Scientific Games the exclusive ticket provider for the entire term of the contract.
Hyde wrote that there was no apparent benefit or financial gain for the lottery to use the company as the exclusive ticket provider.
“This change guarantees Scientific Games millions of dollars of revenues over the life of the contract,” he wrote.
Hyde wrote that the original contract as bid without the exclusivity provision is a benefit that the state no longer receives.
For both findings, Hyde recommends in his report draft that lottery management seek legal guidance.
“If a determination is made that the contract pricing modifications are not binding, Internal Audit recommends Lottery Management seek recovery of the additional cost paid to the instant ticket game services vendor,” the e-mail states.
Co-chairman of the Lottery Commission Oversight Committee state Sen. Johnny Key, R-Mountain Home, said he thought the whole matter had been dealt with but that the committee would listen to Hyde’s concerns.
“If he has new issues or concerns, they need to be addressed,” Key said.
Key said the committee wouldn’t have a role in determining the validity of a contract.
“Whether something is legal or not, that is within their [the commission’s] arena to deal with as a contractual issue,” Key said.
NEGOTIATIONS
Hyde said in his Wednesday e-mail to commissioners that when he took his concerns to Woosley and Scientific Games, a meeting was scheduled to address them a few weeks ago.
“The meeting turned into a negotiation meeting, in which I was not invited to attend for obvious reasons,” Hyde wrote in his e-mail.
He wrote that he told Woosley and Commissioner Ben Pickard of Searcy that he was concerned that the negotiations were getting ahead of the audit, which he told reporters Thursday is in the beginning stages.
Philip Bauer, vice president and corporate counsel for Scientific Games, sent an e-mail March 16 to Woosley detailing the results of that meeting. The e-mail was made public Monday.
It states that the company wants to work with the lottery “to remedy the situation and put this issue behind us for good. We as a company take legal compliance very seriously and want to ensure that our business with the state of Arkansas complies with the rules in force.”
He told the Arkansas Democrat-Gazette on Monday that he too had thought the matter was resolved but that someone had brought it back up. He did not say who. Bauer referred further phone calls to a company spokesman, who said the company will not comment until after the meeting Tuesday.
The e-mail from Scientific Games states that in exchange for the lottery getting the proper approval for the Aug. 25, 2009, amendment to its contract, the company will give the state $2 million in cash over the course of the contract.
It also said it would allow an amendment to the contract’s exclusivity clause, provide a $200,000 credit to purchase merchandise for in-game prizes or the Points for Prizes store, and amend the contract to allow the lottery to purchase additional merchandise. In addition, it states that the rate that the lottery pays Scientific Games for Linked Games will be discounted.
Baldridge called the negotiations a normal part of doing business. However, she said Scientific Games isn’t renegotiating its contract, it is discussing possible concessions.
“They are satisfied with the contract. They think it is fair and square,” she said. “If they renegotiate our contract, they’re going to have lotteries all over America asking for it.”
Baldridge said the $2 million would go toward scholarships.
She said if any of the items listed in Bauer’s e-mail are approved by the commission and the committee, they will be an act of good will, not legally binding.
“The current contract is the contract, and anything we get from them going forward is a concession [by Scientific Games],” Baldridge said. “It’s not uncommon at all.”
Front Section, Pages 1 on 03/25/2012