Performance audit, Lottery Commission

              PERFORMANCE AUDIT
LOrCERY COMMISSION
Report to the Arizona Legislature
By the Auditor General
February 1987
87- 3
DOUGLAS R NORTON. CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
February 6, 1987
Members of the Arizona Legislature
The Honorable Evan Mecham, Governor
Bill Henry, Executive Director
Arizona State Lottery Commission
Transmitted herewith is a report of the Auditor General, A Performance Audit
of the Lottery Commission. This report is in response to a July 26, 1985,
resolution of the Joint Legislative Oversight Committee.
The report indicates that a greater proportion of Lottery revenues could be set
aside for prizes and/ or the designated revenue funds. In addition, the report
addresses the need to strengthen legislative and executive budgetary control
over Lottery operations.
My staff and I will be pleased to discuss or clarify items in the report.
Respectfully submitted,
~ ou$( as R. Norton
Auditor General
CC: William Thomson
Peter Francis
Art Heikkila
Greg Halemba
Dennis Murphy
Dan Summers
2700 NORTH CENTRAL AVE. SUITE 700 PHOENIX, ARIZONA 85004 ( 602) 255- 4385
The Office of the Auditor General has conducted a perfor~ cnce audit of the
Arizona Lottery Commission in response to a July 26, 15185, resolution of
the Joint Legi sl ative Oversight Commi ttee. This performance audi t was
conducted as part of the Sunset Review set forth in Arizona Revised
Statutes ( A. R. S. ) SS41- 2351 throuch 41 - 2373.
The Arizona Lottery was proposed by initiative petition anc! approved by
voters in the 1960 ge~ eral election. The Lottery's purpose i s " to produce
the maxirnum amount of net revenue consonant with the dignity of the
State." To do this, the Lottery operates an i ~ s t a n t ticket game and a
computerized on- line game. From i t s f i r s t game in 1981 through June 1986,
the Lottery transferred $ 145,40O, OCO into the several statutorily
designated funds, including the local Transportation Assistance Fund, ttie
County Assistance Fund and the Generzl Fund.
The Lottery Has More Administrative
Funds Availzble Than I t Heeds ( see pages 13 through 19)
A greater portion of Lottery revenues could be allocated t o prizes and
ear~ arked for designated revenue funds. Pl though the Lottery has 25
percent of total revenues available fcr reneral admini stration, i t has
spent less than 20 percent of total revenues to operate during i t s first.
five years. Stztes with lotteries most comparable t. o Arizo~ a's also spene
less than 20 percent of revenues for aeministration. The percentaae of
Lottery gross revenues allowed for administrative expenses should be
reduced from 25 percent to no more than 20 percent. This would allow
increases in the percentaae of revenL1es allccated for prizes and the
percentage of revenues transferred t o the General Fund an4 other
designated revenue funds.
Even a relatively small increase in the revenue percentace allccated to
prizes waul d produce noticeable effects. For example, d~~ rintgh e recent
Double Your Treasure instant game, increasing the prize a l l o c a t i o ~ by 2.5
percent \~ ould hsve prouic'ed an additional $ 130,179 in prize money, for an
additional 32,828 winners. Similarly, if the Pick same had received an
additional 2.5 percent from i t s inception, i t woul d have paid two more $ 3+
mil 1 ion jackpots.
Budgetary Control Over Lottery
Operations Needs To Be Strengthened ( see pages 21 through 25)
The Lottery statutes should be revised to increase budgetary control over
Lottery functions. The Lottery operates more autonomously than most
agencies within State c~ overnment. The Lottery i s not subject t o an annual
appropriation of i t s operating funds by the Legislature, nor i s i t subject
to executive control over i t s procurement anc! contracting activities. Ry
contrast, 16 of 22 other states appropriate their lottery operating
budgets. Further, although the initiative establishin? the Lottery may
have intended that the Commission provide oversight, the Commission has
never been active i n reviewing operating or construction budgets, or
staffing levels. Establ i shing executive and legislative oversight waul+
strengthen control over Lottery expenditures.
The Lottery Needs To Better Maintain The Appearance
Of Im~ artialitv And Fairness In Its Contract Selection
process ( see Gages 2i through 3/ 1
The Lottery's contract selection process could be strengthened tc better
ensure i t s integrity and fairness. E? aintaining intecrity and fairness i s
essential due to the nature of the Lottery's activities, i t s potential
vulnerability t o the influence of organized crime, and i t s need to
maintain puhl ic confidence. Aggressive camin? co~ panies further
underscore this need. For example, i n one instance a gaming company
threatened to expose how t o compromise the security of a competitor's
ticket.
Some Lottery contracts appear t o have been awarded c ~ i t h o u t appropriate
competitive safeguards. For example, a series of four electronic data
processing contracts worth an estimated $ 1.5 million were awarded to the
same vendor. The vendor received the initial award t o do a feasibility
study and was allowed to b i d on subsequent related work. This 9ave the
vendor a considerable advantage over other bidders. In contrast, State
Purchasing Cff ice pol icy discourages permitting vendors who kave conducted
a f e a s i b i l i t y study to bid on subsequent related work, hecause of
potential conflicts of interest. In three other cases, the competitive
bidding process was circumvented through the use of subcontracts worth a t
least $ 450,000. Six other state l o t t e r i e s use a central procurement
office for contract selections and awards. Repeal ing the Lottery's
exemption from the State procurement statutes and making the State
Purchasing Office responsible for Lottery procurement would hecter
insulate the Lottery from acgressive gaming companies and strengthen the
Lottery ' s procurement procedures.
The Lottery Has E! ot Sufficiently
Control 1 ed I t s New Buil dinc Costs [ see caaes 39 throuah 43)
The Lottery has not sufficiently controlled costs for i t s new building.
Based on square foot costs, the Lottery building will cost over $ 440,000
more than other State buildings under ccnstruction. More elaborate
interior and exterior features as an exterior brick facade, brick
planter walls and a cut stone walkway contribute to the hioher cost.
During the course of the audit, the Lottery rescinded i t s decision to
replace its furniture. Replacement of most of i t s furniture i s
unnecessary and woul d have ccst $ 600,000.
The Lottery Ha. s Exceeded I t s Authority
To Investiaate Lottery Violations ( see naces 4? 5 throuoh 481
Lottery investigators do not have statutory authority to conduct
investigations. A. R. S. $ 5- 510. C. 1 imits the Lottery's law enforcement
status to receiving investigstive information pertaining t o investieations
of Lottery a c t i v i t i e s from law enforcement agencies. The Department cf
Public Safety, rather than the Lcttery, i s empowered by statutes to
investigate Lcttery violations. Despite t h i s , Lottery personnel have
conducted numerous investicztions c f svcti matters as fraud and ticket
theft.
Lottery investigators have also violated State statutes by carrying
concealed firearms. The Lottery's 1 imi ted 1 aw enforcement status
precludes carrying concealed firearms. According t. o the Legislative a
Council, only officials designated as peace officers can legally carry
conceal ed firearms.
YMLE OF CONTENTS
Page
INTRODUCTION AND BACKGROUND. . . . . . . . . . . . . . . . . . . . . 1
SUNSET FACTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
FINDING I: THE LOTTERY HAS HORE ADMINISTRATIVE
FUlJDS AVAILABLE THAN I T NEEDS . . . . . . . . . . . . . . .
Administrative Portion I s
Hi gher Than Necessary . . . . . . . . . . . . . . . . . . .
More Could Be Set Aside For
Prizes And The General Fund . . . . . . . . . . . . . . . .
Recommendations . . . . . . . . . . . . . . . . . . . . . . 19
FINDING I I : BUCGETARY OVERSIGHT AND CONTROL OVER LOTTERY
OPERATIONS NEEDS TO BE STRENGTHENED . . . . . . . . . . . . 2 1
Budgetary Oversight Over The L o t t e r y I s Keak. . . . . . . . 2 1
Revising Lottery Statutes
Woul a Increase Oversight. . . . . . . . . . . . . . . . . . 24
Recomendati on . . . . . . . . . . . . . . . . . . . . . . 2 5
FINDING I I I: THE LOTTERY NEEDS TO BETTER MAIfJTAIN
THE APPEARANCE OF IMPARTIALITY AND FAIRNESS
IN ITS CCNTWCT SELECTION PROCESS . . . . . . . . . . . . .
Gaming Envi ronmen t Requi res That
I n t e g r i t y Be Mai n t a i ned . . . . . . . . . . . . . . . . . .
Some Contract Awards Made Without
Adequate Competitive Safeguards . . . . . . . . . . . . . .
P u t t i n g L o t t e r y Under State Purchasing
O f f i c e Iiould Improve Controls . . . . . . . . . . . . . . .
Recommendations . . . . . . . . . . . . . . . . . . . . . .
TABLE OF CONTENTS
FINDING IVC: O NTTHREO LLLEODT TEIRTYS HNAEWS BNOUTI LDSUINFGF ICCIOESNTTSL. Y . . . . . . . . . . . . .
Page
3 9
Lottery Building Expensive Compared
With Other State C o n s t r ~ c t i o n . . . . . . . . . . . . . . . . 39
Lottery Planned To Replace Furniture . . . . . . . . . . . . 42
FINDING V: THE LOTTERY HAS EXCEEDED ITS AUTHORITY
TO INVESTIGATE LOTTERY VIOLATIONS. . . . . . . . . . . . . . 45
Lottery Has Exceeded Authority . . . . . . . . . . . . . . . 45
Investi( jators Should blot
Carry Concealed Firearms . . . . . . . . . . . . . . . . . . A6
Recommendations. . . . . . . . . . . . . . . . . . . . . . . 47
OTHER PERTINENT I NFORPATI ON
Organization Of Pub1 i c Gaming Regulation . . . . . . . . . . 49
AREAS FCR FURTHER AUDIT WORK. . . . . . . . . . . . . . . . . . . . . 57
AGENCYRESPOMSE . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
APPENDIX
Legislative Council Memoranda
LIST OF TABLES
TABLE 1
TABLE 2
TABLE 3
TABLE 4
TABLE 5
TABLE 6
TABLE 7
TABLE 8
TABLE 9
TABLE 10
Lottery Revenues Transferred To Designated
1R9e8v5e- n8u6e F. un. ds. F. o. r F. is. ca. l . Y. ea. rs .19.81.- 8.2 . T. hrc. ug. h . . . . . . .
Arizona Lottery Revenues And Expenses
Fiscal Years 1981 - 82 Throuah 1985- 86. . . . . . . . . . . .
Administrative Expenses
Fiscal Years 1981 - 82 Through 1985- 86. . . . . . . . . . . .
Lottery Administrative Apportionment And Expenditures
( In Millions Of Dollars)
Fiscal Years 1981- 82 Through 1985- 86. . . . . . . . . . . .
Cumulative Retained Revenues
For Fiscal Years 1981 - 82 Through 1985- 86. . . . . . . . . .
Percentage Of Total Lottery Revenues
Spent On Administrative Expenditures
Among Small To Medium Population States
That Have I n s t i t u t e d Lotteries Since 1382 . . . . . . . . .
Comparison Of Estimated Building Costs
For Lottery, DOR And DPS Bui 1 d i nps. . . . . . . . . . . . .
Comparison Of Licensing Work Load, Staffing And Procedures . . . . . . . . . . . . . . . . . .
Comparison Of Racing, Bingo
And Lottery Investigative Staff . . . . . . . . . . . . . .
Consol idation Of Gaming
Re~ ulaticn In Four States . . . . . . . . . . . . . . . . .
INTRODUCTION AND BACKGROUND
The Office of the Auditor General has conducted a performance audit of the
Arizona Lottery Commission i n response to a July 26, 1985, resolution of
the Joint Legislative Oversight Cornmi ttee. T h i s performance audit was
conducted as part of the Sunset Review s e t forth i n Arizona Revised
Statutes ( A. R. S. ) § S41- 2351 through 41 - 2379.
The Arizona Lottery was proposed by i n i t i a t i v e petition ( Proposition 200 1
and approved by voters i n the 1980 general election. During its 1981
session, the Legislature enacted House Bill 2366 ( Laws of 1981, Chapter
245) which established the Lottery i n s t a t u t e . The Lottery's purpose i s
" to produce the maximum amount of net revenue consonant w i t h the dignity
of the State."
Lottery Games
The Lottery currently operates an instant game and a computerized on- line
game. The instant game involves purchasing a ticket and scratching off
the coating to determine i f i t is a winning ticket. Prizes usually range
from $ 2 to $ 100,000. Approximately six instant games are held per year.
The instant game was the ~ n l yL ottery garre until the Legislature approved
an on- 1 i ne game that began i n 1984.
The on- line game i s played weekly and involves selecting six unique
numbers between 1 and 39. A t the end of the week a drawing determines the
six winning numbers and the bonus number. Players selecting winning
combinations share the prize money. If no player selects a l l six winning
numbers, the grand prize i s carried over l; nt. il there is a winner. Grand
prize winnings have ranged from $ 150,000 to $ 8.7 million.
Lottery tickets are sold by agents licensed by the Lottery. Each t i c k e t
sell s for $ 1. Agents receive 6 percent of 1 ottery ticket sales revenues.
Tickets are warehoused and distributed t o r e t a i l e r s by Lottery personnel.
Lottery Revenues And Distribution
A. R. S. SS5- 505. B and 5- 522 specify how Lottery revenues are distributed. II
Forty- five percent of revenues are paid out i n prizes, a t l e a s t 30 percent
must be apportioned to the local Transportation Assistance Fund, the
County Assistance Fund or the State General Fund, and the remaining 25
percent can be apportioned for payment o f costs incurred in the operation 0
and administration of the Lottery. Designated revenue fund distribution
for fiscal years 1981 - 82 through 1985- 86 is shown in Tab1 e 1.
TABLE 1
LOTTERY REVEtIUES TRANSFERRED TO
DESIGNATED REVENUE FUNDS FOR FISCAL( 1)
YEARS 1981 - 82 THROUGH 1985- 86
Local Transportation General
Fiscal Year Assistance Fund Fund
( 1 ) Transfers to the County Assistance Fund will begin ir; fiscal
year 1 8 6 - 8 7 .
Source: Arizona Lottery Commission Annual Reports for fiscal years
1581 - 82 through 1985- 86.
For the f i r s t year the Arizona Lottery's instant game sales were
relatively high, b u t have decl ined and stabil ized a t approximately $ 5 to
$ 6 mil lion per game. lleekly on- 1 ine game sales have ran9ed from $ 300,000
to $ 6 mill ion per week, and account for the significant upsurge i n Lottery
sales i n the past two years. Annual Lottery revenues since fiscal year 0
1381 - 82 are shown in Table 2.
TABLE 2
ARIZONA LOTTERY REVENUES AND EXPEKSES
FISCAL YEARS 1981- 82 THROUGH 1985- 86
Fiscal Year Fiscal Year Fiscal Year Fiscal Year Fiscal Year
1981 - 82 1982- 83 1983- 84 1984- 85 1985- 86
REVENUES
T i c k e t s a l e s
i n s t a n t $ 114,143,431 $ 74,892,648 $ 59,275,035 $ 46,217,404 $ 34,578,266
Ticket s a l e s
on- 1 i ne 26,657,995 86,374,157
R e t a i l e r 1 icense
fees 61,699 9,788 7,375 8,700
Other revenue 53,708 34,005 35,984
Total revenues 114,205,130 74,902,436 59,328,743 72,916,779 120,997,108
EXPENSES
Prizes 51,441,369 36,370,619 25,987,156 33,467,842 55,135,210
Administrative 16,327,767 15,562,016 13,432,630 16,804,780 23,591,845
exoenses ( see
Total Expenses 67,769,136 51,932,635 39,419,786 50,272,622 78,257,182
Net income 46,435,994 22,969,801 19,908,957 22,644,157 42,270,053
before t r a n s f e r s
Unusual item -
forgiveness of debt 1,400,551
Net income before
t r a n s f e r s to other
S t a t e of Arizona
funds 46,435,994 22,969,801 21,309,508 22,644,157 42,270,053
Transfers to other
S t a t e of Arizona
funds ( 36,600,000) ( 31,800,000) ( 18,000,000)
Income before
cumulative e f f e c t
of change i n
accounting
p r i n c i p l e 9,835,994
Cumulative e f f e c t
of change i n
accounting
p r i n c i p l e 654,883
Net Income 10,490,877 ( 8,830,199) 3,309,508 644,157 5,270,053
Retained revenues
( d e f i c i t ) besinning
of year ( 1,472,032) 9.018,845 188,646 3,098,154 d, 147,211
Retained revenues,
end of year $ Q. 018.845 1 8 8 , 6 4 6 _ 1 3,498,154 -$ A. 147-, 311 -$ 3,417,264
Source: Arizona Lottery Commission Annual Reports, f i s c a l years 1981 - 82 throu? h 1385- 86.
Organization And Budget
The State Lottery Act established a Commission consisting of five members
appointed by the Governor to five- year terms. Two members of the
Conimission must have a t least five years' experience i n law enforcement,
and one must be a certified public accountant. The Lottery Commission is
autl~ orized to make recommendations to the Lottery Director and to set
pol icy.
The Executive Director is also appointed by the Governor, to exercise
immediate supervision over the Lottery and promul gate ru1 es under
authorization from the Commission. The Executive Director currently
supervises approximately 120 staff working i n five divisions. The
Executive Director a1 so acts as the secretary and executive officer of the
Commission.
As shown i n Table 3 ( page 5 ) , the Lottery spent more than $ 23 million t o
support i t s operations in fiscal year 1985- 86. The Lottery initiative
exempted the Lottery from the State budget and appropriations processes
for determining State acency operating budgets. The Lottery deterrvines
i t s own operating budget within the parameters set by statute. A1 though
the Lottery can expend up to 25 percent of revenues for administrative
expenses, n o t more than 4 percent may be spent on advertising.
A u d i t Scope And Purpose
Our audit focused on the Lottery's sbility t o perform i t s functions
effectively and efficiently. The report presents findings anc!
recornniendations in five areas.
e Whether the Lottery has more administrative funds available than i t
needs.
a Ilhether additional 1 cgisl ative and executive oversight of the Lottery
is needed.
e The adequacy of the Lottery's contract selection process.
TABLE 3
CATEGORY
ADMIIIIISTRATIVE EXPENSES
FISCAL YEARS 1381 - 82 THROUGH 1985- 86
Fiscal Year Fiscal Year Fiscal Year Fiscel Year Fiscal Year
1981 - 82 1982- 83 1983- 84 1984- 85 1985- 86
R e t a i l e r
c o n ~ i s s i o n s $ 6,127,019 $ 4,679,135 $ 3,931,696 $ 4,553,037 $ 7,316,728
Advertising
& promotion 4,432,372 3,310,135 2,377,539 2,688,849 3,931,143
Tickets
purchased 3,097,973 2,596,098 2,582,771 2,594,817 1,748,9! 1
On- 1 ine
sys tern
Wages &
enpl oyee
re1 ated 1,406,861 2,260,297 72,869,202 3,243,303 3,174,722
Contract
s e r v i c e s 438,998 261,571 321,494 637,537 807,145,
Unusual i tern ( 1 1 1,529,323
Other
admi ni s-t
r a t i v e 824,544 925,457 1 ,279, S2t? 1,951,949 2,094,759
TOTAL $ 1 6,327,767 $ 1 5,562,016 $ 1 3,432,630 $ 1 6 .€? 04., 780 $ 23,591 ,845
Reimb1; rsement t o vendor f o r on- line gace expenses incurred p r i o r
t o o r i g i n a l c o n t r a c t beins adjudged nu1 1 and void.
Source: Ari zona Lottery Commi ssi on Annual Repcrts, f i scal years 19231 - 82
through 1985- 36.
a Whether the Lottery has sufficiently control led i t s new buil ding costs.
0 Whether Lottery Security Staff shoul d be conducting investigations and
carrying concealed firearms.
In addition, we developed other pertinent information concerning combining
gambl ing regul atory functions ( see page 49).
Our audit scope was limited to the extent we could not review lottery
commission executive session meeting minutes. The Lottery could not
locate any of these meeting minutes from i t s f i r s t executive session
through June 1986.
Due t o time constraints we were unable to address all potential issues
identified during our audit. The section Areas for Further Work ( page 57)
describes these potenti a1 issues.
Our audit was conducted i n accordance with general 1 y accepted governmental
auditing standards.
The Auditor General and staff express their appreciation to the Lottery
Commission, Executive Director and staff for their cooperation and
assistance during the audit.
SUNSET FACTORS
In accordance with Arizona Revised Statutes ( A. R. S. ) S41- 2354, the
Legislature should consider the fo1 lowing 12 factors in determining
whether the Arizona Lottery Commission should be continued or terminated.
1. The objective and purpose i n establishing the Lottery
The Arizona Lottery Commission was proposed by initiative petition
( Proposition 200) and approved by voters i n the November 1980 general
election. The Lottery Commission's purpose i s " to produce the
maximum amount of net revenue consonant w i t h the dignity of the
state." This i s currently accomplished by offering the public an
instant ticket game and an on- line Game.
2. The effectiveness w i t h which the Lottery has met. i t s ob. iective and
purpose and the efficiency w i t h which it has operated
The Lottery has producea a significant amount of net revenue since i t
began operations in 1981. The Lottery is required by statute t o
distribute a t least 30 percent of wagers to three designated fcnds,
wtlich are the Local Transportation Assistance Fund, the State General
Fund and the County Assistance Fund. Curing i t s f i r s t five years of
operation, ending June 30, 1986, the Lottery distributed $ 1 45,400,000
into these funds.
Although the Lottery has produced much net revenue, i t s operstions in
some cases have not been efficient. Efficiency of operations i s
especially critical for the Lottery because any monies saved can be
distributed t o the designated funds. Our audit found that the
Lottery's building costs are excessive. Eased on square foot costs,
the Lottery building will cost over $ 440,000 more than other State
buildings under construction, according t o construction estimates.
The Lottery f e l t a more elaborate building was necessary t o project a
proper Lottery image.
3. The extent to which the Lottery has operated w i t h i n the public
interest
The Lottery has operated within the public interest by generating
substantial net revenues which are apportioned to the State and to
1 ocal governments.
4. The extent to which rules and regulations promulgated by the Lottery
are consistent w i t h the 1 egi sl ative mandate
The Lottery has promulgated rules and regulations that are consistent
w i t h i t s legislative mandate. The Attorney General ' s Office reviews
and certifies all proposed rules.
The extent to which the Lottery has encourased i n p u t from the public
before promulgating i t s rules and regulations and the extent to which
i t has informed the pub1 ic as to i t s actions and t, heir expected
impact on the public
The Commission has adequately encouraged input from the public before
promu1 gating i t s rules and regulations. Proposed rules are
summarized i n the Administrative Digest. Any proposed rule is placed
on a regular Commission meeting agenda for consideration. Fleeting
notices are posted a t the Lottery and in the Senate Press Room. In
addition, the Department of Administration i s notified. The Lottery
a1 so notifies industry and retai 1 er representatives of proposed rules
and regulations affecting them.
The Lottery has not complied w i t h the statutory requirement t o keep
Commission executive session meeting minutes. State boards and
commissions are required by stat. irte t o keep records at all meet. inss,
including executive sessions. During the course of the audit the
Lottery could not locate any of i t s executive session minutes from
the Lottery's f i r s t meeting through June 1986.
6. The extent t o which the Lottery has been able t o investigate anc:
resolve complaints that are within i t s jurisdiction
Since the Lottery i s not a regulatory agency, per se, i t s enabling
legislation d i d not incl ude a formal conpl aint process. Statutes
authorize the Department of Pub1 ic Safety to conduct investigations
into any violations of statutes pertaining to the conduct of the
Lottery. However, we found that the Lottery has excee6ed i t s
a ~ ~ t h o r i ttyc investisate Lottery viol ations ( See Finding V, pages 45
through 48).
7. The extent t o which the Attornev General or anv other a ~ ~ l i c a b l e
agency of State government has the authority to prosecute actions
under i ts enabl i ng 1 egi sl ation
A. R. S. 55- 51 2 . O1 provides both the Attorney General and county
attorneys concurrent prosecution authority for any offense arising
out of or i n connection with the formation, management, operation or
conduct of the State Lottery.
8. The extent to which the Lottery has addressed deficiencies in i t s
enabl i ng statutes which prevent i t from ful f i l l i ng i t s statutory
mandate
Since i t s inception i n 1981, the Lottery has been active i n
submitting 1 egis1 ation t o increase i t s effectiveness. Legislation
addressed:
a Percentage of revenues a1 1 owed for adverti sing,
a Limited peace officer status for the Assistant Director of
Security and Licensing,
c Authorizing on- line games,
a Confidentiality in procurements,
a A1 lowing redemption centers,
0 Authorizing f a c i l i t i e s construction, and
e Clarifying various items relatins t o Lottery games.
In addition, according to the Lottery Director, statutes limiting the
number of drawings for on- line games should he repealed to permit
additional drawings and the introduction of new games. The Lcttery
proposed l e g i s l a t i o n t o t h i s effect i n the l a s t legislative session
b u t i t did not pass.
9. The extent to which chanses are necessary in the lavs of t, he Lottery
to adequately comply w i t h the factors l i s t e d i n the sunset law
Based on our audit work, we recommend that the Legislature consicier
the following changes to the Lottery Commission's statutes.
o Amend A. R. S. S5- 505. B, reducing the percentage of v~ agers allowed
for Lcttery administrative expenses from 25 percent to no more
than 20 percent, and increasing the percentage of wagers t. o he
transferred to the designated revenue funds and/ or the prize
fund. ( Efficiency of Operations - Sunset Factor 2).
o Amend A. R. S. $ 5- 503, repealing Lottery's exemption from the
State procurement statutes and making ttre Department of
Administration- State Purchasing Office, responsible for all
Lottery procurement. ( Effectiveness of Operations - Sunset
Factor 2 )
In addition, v: e recommend that confl icting statutes r e l a t i n s t o
revenue distribution be amended. I t appears that when A. R. S. S5- 522
idas anended i n 1986 to establish a County Assistance Fund, A. R. S.
$ 5- 505. B was not similarly amendec' to reflect this change. Further,
according to Leci sl ctive Council , these s t d t ~ t e s a1 so appesr to
conflict i n term o f revenue distribution avoufits. A. R. S. S5- V5. E
requires that " not less than 3C percent" of revenues be transferred,
whereas A. R. S. 55- 522 does not indicate a minimum percentage.
10. The extent to r; hicl~ the terminaticn o f the Lottery k! oulc'
significantly harp the ~ l i b l i c health, safety cr welfare
Ter~ inating the Lottery would not have a deleterious effect on the
pub1 ic health, safety or we1 fare. However, t e r v i n a t i n ~ the Lottery
would el iminate a sicjnificant an? ount of revenue made available to the
State. Since i t s inception i n 1981, t, he Arizona Lottery has raised
more than $ 145 mil 1 ion i n net revenues distributed to the Local
Transportation Assistance Fund, the Highway User Revenue Fund, the
County Assistance Fund and the State General Fund.
11. The extent to which the level of reaul ation exercised bv the Lottery
i s appropriate and whether less or more stringent levels of
regul ation woul d be appropriate
The Arizona Lottery i s not a regulatory agency. However, the agency
must ensure that Lottery retailers comply w i t h Lottery statutes, and
rules and regulations promul gated thereunder. According t o the
Lottery Director, the level of regulation currently provided i n this
regard i s appropriate and requires no change.
12. The extent to which the Lottery has used private contractors in the
performance of i t s duties and how effective use of private
contractors could be accomplished
The Arizona Lottery makes extensive use of private contractors in the
performance of i t s duties. Private contractors provide instant game
tickets; on- 1 ine game systems, services and tickets; drawing
equipment; and annuities to fund grand prizes. In addition, the
Lottery uses private contractors for advertising and promotion,
auditing, overseeing drawings, and dat. a processing. We did not
identify any other areas for the Lottery's use of private contractors.
THE LOTTERY HAS !! ORE ADFIINISTFATIVE
FUNDS AVAILABLE THAN IT b! EEDS
The Lottery's administrative portion of revenues coul d be reduced. I t s
cL! rrent apportion~ ent is more than ample t o meet all i t s needs and i s nore
than most other state 1 otteries spend. If the Lottery's administrative
portior; were reduced, more funds would be available for prizes and for
remittance to the General Fund.
Administrative Portion Is
Higher Than Necessary
The Lottery's percentage of total revenues allowed for operatin9 expenses
i s hisher than i s necessary t o ~ e e ti t s needs. The Lottery has never
expended all of the 25 percent of revenues allowed and has carried forwar4
1 arge amounts annually . Further, as the Lottery natures, 1 arge initial
expenditures for capital improvements and electronic data processin9 ( EDP)
systems development should decrease. Post other states spend considerably
less than 25 percent of their total revenues to operate their lotteries.
Portion available not needed - Although the Lottery has 25 percent of
total revenues avai 1 able for oeneral adrni ni s t r a t i on, i t has needed
considerably less t o operate during i t s f i r s t five years. As shown in
Table 4 ( page 14), the Lottery has actually spent less than 20 percent of
i t s total revenues on administrative expenditures. In fiscal year
1985- 86, for example, the Lottery spent approximately $ 23 mi7 1 ion a1 though
more than $ 30 million \: as available for Lottery operations.
If Lottery revenues continue to increase, the percentage of revenues
required to cover administrative expenditures can be expected t c
decrease. Dcri~ g the three fiscal years ir: which Lottery revenues were
less than $ 75 million ( fiscal years 1982- 83, 1983- 84 and 1384- 85), the
percentage of revenues spent on Lottery administration has ranned from
20.8 percent to 23.0 percent, with an average of 22.1 percent. For the
two years i n which total revenues were greater than $ 110 million, *
administrative expenditures constituted 14.3 percent and 19.1 percent of
total sales, respectively. T h i s indicates that as revenues increase, a
smaller percentage of revenues is needed for administration.
TABLE 4
LOTTERY ADMINISTRATIVE APPORTIONMENT FRD EXPENDITURES
( IN MILLIONS OF DOLLARS)
FISCAL YEARS 1981 - 82 THROUGH 1385- 16
Admi n.
Total Portion
Fiscal Year Revenues 25% of Total
TOTAL
Expenditures As
Admi n . Percentage Of
Expenditures Total Revenue
19.3% ( Average)
) This was the f i r s t full year the Lotto ( Pick) game was i n
operation. The addition of the Pick game i s p r i ~ a r i l y
responsible for the sharp increase i n administrative expenditures.
0
Source: Arizona State Lottery Annual Reports
A1 tllough some of the excess administrative monies have been remitted to •
the Genera1 Fund, monies carried forward each year have been substantial.
As shown in Table 5 ( page 15), for example, approximately $ 10 million of
revenues have been accumulated through fiscal year 1985- 86 and are being
carried forward to the current fiscal year. Carry forvards c f t h i s ill
magnitude indicate that revenues earmarked for administrative expenditures
are more than adequate to meet the Lottery's needs.
TABLE 5
CUMULATIVE RETAIFJED REVENUES
FCR FISCAL YEARS 1381 - 82 THROUGH 1985- 8h
Fiscal Year
1981 - 82
1982- 83
1983- 84
1984- 85
1985- 86
Retained Revenues
) Because of the severe fiscal crisis experienced by the State
during fiscal year 1982- 83, the Lottery transferred a1 1 possible
monies ( including all retained revenues from the previous fiscal
year) to the General Fund.
( 2 ) The fiscal year 1985- 86 retained revenues figures are based upon
the Lottery's fiscal year- end income statement. Included in this
estimate i s $ 4,733,500 that has been placed in an obliaated
capital expenditures fund t o cover construction costs of the new
bui 1 ding.
Source: Arizona State Lottery Annual Reports.
Capital improvement and EDP systems development costs should decrease - As
the Lottery matures, administrative expenditures may decline. Large
initial expenditures for capital improvements and EDP development should
decrease. Land acquisition and construction of the Lottery's building,
estimated to cost $ 5.2 million, will be fully paid for w i t h retainer!
revenues from fiscal years 1985- 86 and 1986- 87. The Lottery's main frame
computer, purchased in fiscal year 1985- 86 at a cost of $ 85,000, should be
sufficient t o meet i t s needs for the foreseeable future.* Most system
development and conversion work - totaling approximately $ 1.5 million -
shoul d be compl eted during 1987.
Other states spend less - Other states spend considerably less than 25
percent of their total revenues for administration. On the average, the
percentage of total revenues spent by other s t a t e l c t t e r i e s for
administrative costs during fiscal year 1984- 85 i s 14 percent.** Of the
* The Lottery recently purchased a used maintrame computer from the
Department of Revenue.
** This figure includes the District of Columbia lottery.
18 ot. her s t a t e l o t t e r i e s in operation during fiscal year 1984- 85, only
Vermont spent more than 25 percent of i t s revenues on lottery
On the average, states with lctteries most comparable to Arizona's spend
or will expect to spend less than 20 percent on administration.** Since
1982, six states with populations comparable to or smaller than Arizona
have instituted 1 otteries. In the aggregate, these state 1 otteries, as
shown in Table 6 ( see page 1 7 ) , spend or will expect to spend 18.3 percent
of their revenues on lottery administration.
More Could Be Set Aside For
Prizes And The General Fund
If the Lottery's administrative portion were reduced by 5 percent, more
monies - an estimated $ 6.2 million in fiscal year 1986- 87 - would be
available for other purposes.*** These additional monies could be used to
increase the prize pools and/ or t. rcinsferred to desicnated Revenue or
General Funds.
F/ iore prize money - Increasing the percentage of revenues designzted for
prizes by 2.5 percent for the instant and Pick games would p u t the Lottery
more in line with other state lotteries.**** Arizona ranks low in the
percentage of revenues allotted to player prizes. In Arizona, 45 percent
of instant and Lotto ( Pick) revenues are allocated for prizes. An Auditor
* The Ver~ ont lottery is the 1o~: est revenue producing lottery in the
nation. During fiscal year 1984- 85 Vermont's 1 ottery revenues
totaled $ 5.2 million.
** These lotteries were cllosen for two reasons. First, given their
infancy, one can expect then t o be incurring development costs
similar t o that of the Arizcna State Lottery. Seccnd, actlral or
projected revenues for these lotteries are comparable to or smaller
t h a n the Arizona State Lottery.
*** LIe estimate fiscal year 1986- 87 revenues will be approxi~ ately $ 123
million based on actual revenues of $ 61.5 million for the f i r s t six
months of the fiscal year.
**** The following analysis asscmes that the 5 percent reduction would be
divided evenly between the prize and revenue fun6. s. IJor! this money
i s actually allocated is a l e ~ i s l a t i v ep olicy 6ecision.
General s t a f f survey of other state l o t t e r i e s indicates that, on the
average, 49.1 percent of revenues are allocated for prizes.
PERCENTAGE OF TOTAL LOTTERY REVERUES SPE!; T ON
ADEIMISTRATIVE EXPEI! DITURES AMONG SMALL TO FED1 Ubl POPULATION
STATES THAT MAVE INSTITUTED LOTTERIES SIfJCE 1982
Year Annual Revenue Percentage
State Instituted Population ( in Mill ions) of ~ evenues( 1)
ARIZONA 1981 2,718,215 7 ~ . 9 ( ~ ) 23.0
Washington 1982 4,132,156 150.0 17.6
District of
Col urnbia 1982 633,333 112.7 17.2
Colorado 1983 2,& 89,964 105.3 18.6
Iowa 1985 2,913,808 82.5 20.0( 3)
Orecjon 1985 2,633,105 42.2 15.3
West Virginia 1986 1,949,644 24.0 21.0( 4)
Average percentage of revenues excltidinc Arizcna set aside for
administrative expenditures - 18.3 percent.
I1 ) For fiscal year 1524- 25 unless otherwise noted.
( 2 ) Arizona Lottery revenue for fiscal year 1935- 86 was approxiaately
$ 121 million.
( 3 ) Percentage of revenues to be spent on Lottery achinistration
duri n~ fiscal year 1985- 86.
( 4 ) U e s t V i r g i n i a i r i n i t s f i r s t y e a r o f l o t t e r y o p e r a t i o n . During
the f i r s t three years, t h i s lottery is permitted to spend up to
21 percent of revenues for adnini s t r a t i v e expendi tures. After
three years, t h i s will drop to 15 percent.
Source: State Lottery Annual Reports and Auditor Generzl survey of s t a t e
1 o t t e r i e s .
Increasing the percentage of revenues allocated for prizes would have a
significant impact on the number and size of purses awarded. An increase
in the prize zllocaticn by 2.5 percent would have meant an additional
$ 130,179 in prize money for the Double Your Treasure instant came
conducted frcm Flay to June, 19c" 6. fissuming no changes in the prize
structure, t h i s could have translated into approximately 32,786 additional
l o w t i e r winners ($ 2-$ 20), 40 medium t i e r winners ($ 50-$ 1 G O ) , znd two
additional high t i e r winners ($ 5,000).
An increased a1 location to the Pick prize fund of 2.5 percent would have
also had a an irxpact on the number of big jackpots won. This would have
resulted i n two more $ 3+ million jackpots since the game's inception in
October 1 984.
Furthermore, research indicates that i ncreasi n~ the percentage of Lottery
revenues desicnated for prizes may increase interest in the Lottery among
Ari mona residents. Surveys conducted by Behavior Research Center and
Arizona State University's Survey Research Laboratory i n 1984 and 1985,
respectively, found that reasons given by Arizona resi eents for not
playing the Lottery include a perception that there are too few winners,
that odds are too heavily weighted against the players, and that not
enough revenue i s allocated for prizes.
Designated revenue and General Funds - F4ore revenues c o ~ l d be transferred
tc the designated Revenue and General Funds. Durin~ i t s five- year
existence, the Lottery has transferred almost 33 percent of i t s revenues
to the Local Transportation Assistance, County Assistance or General
Funds. However, in the past three years the Lottery has transferred
slightly more than the minimum 30 percent required by statute. In
contrast, other s t a t e l o t t e r i e s transferred approximately 36 percent of
lottery revenues t o s t a t e coffers during fiscal year 1935. If 2.5 percent
more were reni tted t o these funds i n fiscal year 1986- 37, $ 3.1 mil 1 ion in
additional funds would be available t o support public programs and
projects.
CONCLUSION
The percentage of Lottery revenues set aside for administrative
expenditures shc~ rla be reduced. This percentage i s higher than
necessary. Eeducirrg the perce~ tage of tot21 revepues earnarked fcr
administrative costs woul d permit the Legislature to corxmi t more revenues
for prizes, designated revenue funds and the General Fund.
RECOMKENDATI CMS
1 . The Legi sl atlare shoul d consider reducing the percentase of Lottery
revenues earmarked for administrative expenditures from 25 percent to
no nore than 20 percent.
2. The perce~ tage of revenues allocated to prizes and transferred to the
State Treasury shogld be increased as the State Legislature deems
appropriate to reflect changes i n the allocation of revenue for
Lottery administration.
BUDGETARY OVERS1 GHT AND COFlTROL OVER LOTTERY
CPERATIONS NEEDS TO BE STRENGTHENED
Arizona Lottery Commission statutes should be revised to increase control
over Lottery functions. Under the Lottery's current autonomcus structure,
budgetary oversight of Lottery operations i s weak. Revising Lottery
statutes woul d improve both 1 egi sl ative and executive oversight.
Budgetary Oversight Over
The Lottery Is \, leak
The Lottery operates more autonomously than most a~ encies within State
government. Both the Legislature and the executive branch are limited
statutorily i n the amount and nature of oversight they can exercise over
the Lottery. Moreover, the Lottery Commission has exercised a limited
role and cannot effectively oversee the Lottery's adrnini stratitie
operations. As a result, the Lottery Director has broad discretion end
authority t o operate independently.
Legislative and executive oversisht 1 imited - The 1980 initiative that
established the Lottery 1 imi ted oversight of Lottery operations. IJn1 ike
most State agencies, the Lottery is n o t subject to an annual appropriation
of i t s operating funds by the Legislature, nor i s i t subject t o executive
control over i t s procurement and contracting activities.
The Lottery Act ( H. B. 2366 Laws 1981, Ch. 245) enacted i n 1981 established
the Lottery pursuant t o an initiative approved by the voters in F! ovemher
1980. A private gaming company, which later becane a wajor Lottery
contractor, financed the drafting of the Lottery initiative." The
framework for the Lottery's autonomous structure was establ i shed i n the
initiative and so \: as - not a legislative policy decision.
* The same private gaming conpany supporting the Arizona Lcttery
initiative later supported similar initiatives for California and
Oregon. These initiatives a1 so 1 imi ted 1 egi sl ative and executive
oversight.
Under the provisions of the Lottery Act, the Lottery has a statutory
exemption from the State appropriations process. Unlike most State
agencies, i t sets i t s own budget and staffing levels. The Attorney
General, in Cpinion 181- 022 dated January 13, 1981, ruled that the Lottery
Act:
. . . read as a whole, clearly expresses a direction to
the Commission and Executive Director to spend or
dispose of all the monies raised from the sale of
lottery tickets for the purposes described in the Act,
and that i t does not contemplate that any further
legislative action will be necessary for the
expenditure or disposition of those monies.
The Attorney General, in the same opinion, also ruled t h a t the continuing
appropriation so stipulated i s constitutional . This exemption from the
annual appropriation process essential ly prohibits the Legislature from
exercising one of i t s strongest oversight powers over the 1 ottery.
Further, the Lottery i s exempt from executive budget oversight. The
Lottery is not required to submit i t s budget to the Executive Budget
Office for review.
Commission's role - The Lottery Comission also has a limited role in
overseeing the Lottery's operations. The initiative establ ishing the
Lottery may have intended for the Commission t o provide oversight.
I- lowever, the Commission has not been sble t o f u l f i l l this function
effectively.
According t o a Legislative Council Cpinion dated Auaust 29, 1986, i t
appears that the Lottery Act intended for the Commission t o " exercise
general and cverall control" over the Lottery's operations. The
Commission has the authority t o approve or disapprove the Lottery
Director's actions. Accordin9 t o the Lecislative Counci7, this appears to
give the Commission authority over the Lcttery's budget anc! staffing
levels, a1 thoush the lznguage of the Lottery P. ct i s not clear on this
point.
In practice, the Commission i s limited in i t s oversight role. First, it
has never been active in reviewing the Lottery's operating or capital
construction budgets and staffing levels, even though it appears to have
oversight authority in this area. Second, the Commission has 1 imited
statutory authority in other areas. For example, i t only has the power to
disapprove contracts within 14 days of the Director's order awarding the
contract. I t cannot award contracts t o the bidder i t feels i s most
qua1 ified.
The nature of the Commission further inhibits i t s ability to oversee the
Lottery. Gne Commission member stated that being part time and unpaic!
provides the Corrmissioners with 1 i t t l e opportunity or motivation t o
closely monitor Lottery operations. A t i t s monthly meetings, the
Commi ssion i s dependent on information provided by Lottery empl oyees.
Another Commissioner stated that the Com~ ission i s l i t t l e more than " a
rubber stamp for the Director's decisions."
Limited in i t s role, the Co~ mission has become less involved in Lottery
operations in recent years. From 1981 throuch 1983, the Commission
averaged 18 meetings per year. For 1984 and 1985 the average meetings per
year dropped to 13. As of August, the Commissicn tiad met only four tines
i n 1986. Further, the Cammi ssion subcornmi ttees, original ly formed to
prcvide close scrutiny of specific functional areas within the Lottery,
are almost inactive. According to two Commissioners interviewed, the
subcommittees have met only once i n the past year.
Director authority - Because oversight i s lacking from the legislative and
executive branches, and from the Commission, the Director has extensive
authority t o operate the Lottery independently . The Director prepared and
had final approval over a budget of approxircately $ 23 million for fiscal
year 1985- 86. The Lottery budget was n o t required t o be reviewed by the
Executive Budget Office ( EEO) or the Joint Lcgi sl ative Budget Comi ttee
( JLBC), yet 80 agencies with equal or lesser budgets were required to
subinit to this budget review process.
Lottery statutes could be revised t o increase control over and
accountabil i ty for i t s operations. Establ ishins executive and legislative
oversight would strengthen control over Lottery expenditures.
The Legislature has the authority to restructure the Lottery if i t
chooses. According to a Legislative Council Opinion dated August 29,
1986, the Legislature may amend the Lottery Act and modify the structure
and authority of the Lottery Comission, because the Lottery initiative
did not receive a majority of the vote of qual ified electors.
Article IVY part 1, section 1, subsection ( 61,
Constitution sf Arizona, prohibits the legislature from
amendi r; g or repeal i ng initiated or referred measures
which receive a majority vote of the qualified
electors. The phrase ' majority of qual i fied electors'
means the majority of those eligible to vote, not those
actually v o t i n g . Adam v. Bolin, 74 Ariz. 269, 247
P. 2d 017 ( 1952).
According to the Secretary of State's Office, 41 2,992 pecple voted i n
favor of the Lottery initiative; enough to pass the measure, b u t not a
majority of nore than 1.1 mill ion qualified voters.
Greater control over expenditures - Establishing legislative oversight and
ED0 review of Lottery budsets would provide grreater control over Lottery
expenditures . Currently, the Lottery determines i t s operating budgets
w i t h o u t any outside review. Requiring the Lottery to participate in the
executive budget and 1 egis1 ative apprcpriations processes woul d provide
increased control over expenditures. Under the budget and appropriations
process, a1 1 i terns, incl udi ng furniture purchases and professional and
outside services, would be reviewed by EBO and JLBC staff and would
require 1 egi sl ative approval .
Revising Lottery statutes t o improve central oversight v~ oudl be consistent
with practices in other states. Currently, 16 of the 22 states ( excluding
Arizona) operating 1 otteries appropriate their 1 otteries' cpersting
budgets.* Of the 12 states that have established their lotteries as
stand- alone acencies, eight appropriate the l o t t e r i e s ' operating budgets
through 1 egi sl ative action. The other ten states that operate 1 otteries
have rcade the lottery subordinate to a larger agency, such as the
Department of Revenue.
CGMCLUSI ONS
The Lottery could be restructured to i~ prove control over Lottery
operations. A t present, the Lottery i s free from the restrictions under
which most State agencies must operate. Subjecting the Lottery to the
executive budget and legislative appropriations processes would provide
increased oversight over Lottery expendi tures.
The Legislature stioul d consider revising Lottery statutes to require the
Lottery to participate in the executive budget and legislative
appropriations processes.
* Some states appropriate personnel and administrative costs, b u t not
those costs which are a fixed percentage of revenues, such as
retailer commissions, vendor commissions and advertising. However,
blichigan a1 so appropriat- es i t s 1 ottery's advertising budget.
Regardless of the form of inple~ entation, all of the states
interviewed a1 1 ow access tc supplemental and emergency funding i f
there i s a budget shortfall.
THE LOTTERY rlEEDS TO BETTER. NAItJTAIN TI-{€ APPEAP. A! ICE OF
IPiPARTIALITY AND FAIRNESS 114 ITS CONTRACT SELECTIOEJ PROCESS
The Lottery's contract selection process could be strengthened to better
ensure i t s integrity a ~ df airness. The gamin9 environment requires
diligence in maintaining the integrity of the Lottery's contracting
process. Some contract selections appear t o have been made \ vitho~ rt
adequate safeguards to ensure fair and open competition. Placin~ the
Lottery under the authority of the State Purchasing Office ( SPO) would
help ensure impartiality and fairness in the contract selection process.
Gaming Environment Requires
That Inteari t v Be Maintained
Plai ntai ni ng the integrity and fairness of the contract selection precess
i s essential due to the nature of the Lottery's activities and i t s
potential vul nerabil i ty to the influence of organizec! crime. The
aggressiveness of some vendors providing gaming services further
demonstrates the need t o vicil antly ouard the Lottery's integrity a ~ d
impartial i ty in selecting contractors.
Maintaining Integrity - Maintaining procedures to ensure fairness and
integrity of governmental agencies involved in ga~ ing or wa~ erina i s
especially important due t o the nature of their activities. While
discussing the need for carefui control cf legalized gzming, the Nevada
Supreme Court* found that the gaming industry i s susceptible to corrupticn
by organized crime. The Court further concl~ lded thst since y m b l in9 i s
often considered a vice, a government must strive to promote and operate
i t s garxin9 venture in a \ Jay that i s inoffensive t o i t s constituents.
Finally, t o ensure the scccess and c~ rowth of i t s garnbl ing organization, a
government nust maintain the appearance as xell as the fact of honesty an(:
fairness with respect t o i t s gamins operations.
* Plevada Tax Commission vs. Flarion 8. Hicks, 73 Nev. 115, 119, 310 P. 2d
852 ( 1957).
Maintaining the integrity of the Lottery's contract selection and award
process is especially c r i t i c a l to maintain public confidence i n the
Lottery. Lottery contracts involve mil 1 ions of do1 lars i n pub1 ic funds
which need to be safeguarded. Moreover, the nature of the Lottery's
a c t i v i t i e s make i t a particularly sensitive and visible public entity. I n
f a c t , the special need to maintain the integrity of the Lottery's
contracting process was recognized i n the Lottery's enabl i ng 1 egi s1 ation.
Arizona Revised Statutes ( A. R. S.) $ 5- 509, subsection D, states:
. . . In all awards of contracts pursuant to this
section, the director shall take particular account of
the sensitive and responsible nature of the
commission's functions and the paramount considerations
of security and integrity.
Aggressive Vendors - The aggressiveness of some gaming companies that
serve the lottery industry further underscores the need to maintain
integrity and impartial ity in selecting contractors. The foll owing
incident i l l u s t r a t e s t h i s aggressiveness.
e A single vendor has produced tickets for 31 of 33 instant games
offered by the Lottery. This vendor was instrumental i n the
passage of the Lottery i n i t i a t i v e , expending approximately $ 2C@, COO
for wri tins the i n i t i a t i v e , establ i s h i n ~ support groups and
petition signature gatherers, 2nd media advertisement. According
to the vendor's Chief Executive Officer, i n 1980 his company
financed pub1 ic opinion surveys in several states, identified
Arizona as a likely market for a l o t t e r y , and began the i n i t i a t i v e
e f f o r t . This ve~ dor was subsequently awarded the f i r s t contract to
produce lottery t i c k e t s f o r Arizona.
In February 1382 the Lottery akjarded its second contract for
instant game t i c k e t s t o a competitor of the vendor behind the
i n i t i a t i v e . Howver, before production began on the f i r s t game
under the second contract, the vendor behind the i n i t i a t i v e sent a
l e t t e r to Lottery o f f i c i z l s s t a t i n g t h a t i t had found a way to
compromise the security of the tickets offered by the vendor
selected. Later, the Lottery Cosmission vcted to cancel the
winning vendor's contract and issue a new request for proposals
( RFP). The vendor behind the i n i t i a t i v e was awrded the contract
under the second RFP.*
* This vendor has ensaged in sirnilar conduct in other l o t t e r y s t a t e s
a f t e r 1 osing contracts, incl uding Connecticut and I1 1 inois. The
vendor aroused public concern over the " security" of the tickets to
be supplied by a competing vendor.
Lottery's responsi bil i ty - The Lottery bears responsibility for
maintaining the integrity and impartial i ty of i t s contracting process
because i t is exempt from the State Procurement Code. Of all State
governmental units, only ten were given exemptions from these
regulations. A. R. S. $ 41 - 2501 . F stipulates:
The Arizona state lottery commission i s exempt from the
provisions of this chapter for procurement relating to
the design and operation of the lottery or purchase of
lottery equipment, tickets and related materials.
The former Director interpreted t h i s t o mean that any procurement, other
than for office supplies, i s exempt from Procurement Code requirements
because all such purchases relate t o the operation of the Lottery. The
Lottery makes purchases t. hrough the State Procurement Office only when
the Director feels i t has a greater expertise than Lottery staff i n
acquiring a certain item.
Although the Lottery i s exempt frcm the State Procurement Code, A. R. S.
$ 41 - 2501 . F ( as amended 1985 requires the Lottery Director to promul gate
procurement rules and regulations " substantially equivalent'' t o the
Code. Prior to this enactnent, tile Lotter~ y did not have rules and
regulations governing i t s procurement process. The Lottery adopted
procurement rules i n June 1985.
Some Contract Awards Made Without
Adeouate Com~ ettii ve Safeauards
Some Lottery contracts appear t o have been awarded without appropriate
safeguards to ensure competition because poor procedures were followed.* A
series of electrcnic data processing contracts have been awarded to the
same contractor who conducted the feasibility study on which subsequent
work has based. In addition, a vendor questioned the fairness of some
instant same contract awards. Finally, some subcontract awards were made
w i t h o u t sdequate procedures to ensure a fair and competitive selection.
* Our review of this area was 1 imited by the fact that the L0tter. Y was
unable to provide any of i t s executive session minutes fron! the
Lottery's f i r s t meeting through June 1986. According t o regular
meeting minutes, issues concernin9 suits filed over gamin? contract
disputes were discussed during executive sessions.
2 9
Electronic Data Processing ( E C P ) contracts - The Lottery awarded a series
of four EDP contracts worth an estimated $ 1.5 million to the same vendor
over the past three years. The f i r s t contract was to perform a
f e a s i b i l i t y study for an auto~ ated accounting system. Two additional
contracts were awarded tc implement portions of the f e a s i b i l i t y study. A
fourth contract was awarded to convert the Lottery's accounting and
management systems to a new computer system. These contracts were awarded
by the Lottery Director because he believed the vendor was the best
qua1 ified conpany to perform the work.
e In December 1983 the vendor was awarded a contract for approximately
$ 21 5,000 to begin work imp1 ementi ng the Lottery's new automated
system. The Lottery attached to its RFP a brief management overview of
the f e a s i b i l i t y study, b u t not the study i t s e l f , which included
detailed information required by prospective vendors. One potential
bidder wrote to Lottery o f f i c i a l s indicating i t could not respond to
the RFP because the scope of work was too broad and loosely defined.
The only respcnsz to the 9FP was from the vendor v; ho corductec! and
wrote the feasibil i ty study.
Comment: A clause in the request for proposals stated the fir11
- cations would be made availzble to the winning vendor. Thus,
the vendor selected had an advantage over other bidders since i t was
the only firm w i t h an advance copy of the full f e a s i b i l i t y study. A
current SPC policy recognizes the potential conflict of interest and
fairness issues 14ihich may arise i n situations such as this. IP i t s
own procure~ ents, SPO will not permit venders who do a f e a s i b i l i t y
study to bid on subsequent related work. SPO encourages other state
agencies to f o l l o ~ th e same rule.
8 A second contract to implement the f e a s i b i l i t y study bias acarded in
July 1G84 to the same vendor. This contract was worth i: pproximatefy
$ 750,000 to $ 1 million. A1 though the Director d i d not establish a.
formal evaluation committee, he asked two Assistant Directors to
evaluate the proposals informally. However, one of the tb: o, the ECP
Director a t the time, did not review the proposals.
Comr? ent: Again, the vendor selected had an advantage over other
vendors because of i t s involvement i n the f e a s i b i l i t y study. In
addition, a1 thouch not required a t the time by law or rule, a formal
technical eval uation of proposal s was not conducted. Given the size
of t h i s contract, a formal evaluation of the proposal would have heen
appropriate and beneficial . Such an evaluation could have provic'ed
documentation that each proposal etas given f a i r considerati on.
Instant game contracts - A vendor questioned the fairness of some instant
game contract awards. Allegations made by an unsuccessful instant game
bidder were investigated by the Department of Public Safety ( DPS) and
found t o have merit. However, the Lottery took 1 i t t l e or no action as a
result of the DPS investigation.
o In April 1981 the Lottery awarded i t s f i r s t contract for instant
game tickets. A major evaluation criterion was the security of
tickets produced. However, official bid samples were not sol ici ted
i n the Lottery's RFP. Instead, the Lottery's Director of Secr~ rity
traveled to states in which various vendors' tickets were beinn used
and purchased samples for testing by the Cepartment of Public
Safety. However, sample tickets purchased for one vendor were
actually produced by a predecessor company and were printed by a
different method than the method presented in the vendor's
proposal. The vendor d i d not receive the contract and protested the
Lottery's decision.
Comment: The Lottery's proposal evaluation process was flawed i n
that the Lottery did not purchase and test the same quality ticket
the vendor specified in i t s proposal. In addition, the Lottery did
not formally respond to the vendor's protest.
o As mentioced previously, in 1982 the Commission canceled a vendor's
instant ticket contract because i t s tickets were compromised by a
competing vendor. As a res~ rtl , a second RFP was issued. The
proposals submitted by the vendors in respcnse t o the second RFP
differed l i t t l e from the proposals submitted to the f i r s t RFP except
in the area of pricing. The vendor originally awarded the contract
submitted a bid considerably lower than the competing vendor. In
addition, DPS evaluated the vendors' tickets and found them to be of
simi 1 ar qua1 ity and resistant to compromise. However, the Lottery
awarded the contract t o the competing vendor.
Comment: I t i s unclear why the Lottery changed i t s original
decision and awarded the contract to the competing vendor. Although
there was no requirement t o do so a t the time, there bdas no written
justification of the Lottery's decision.
o In October 1984 the Lottery hired an independent evaluator to review
instant same contract proposals. A vendor complained that the
eva1uai; or had a prior business relationship with the conpany that
had been producing lottery tickets for Arizona. Lottery officials
d i d not agree with the vendor. Tbe vendor, trhicb file< the
complaint, k~ ithdrew i t s proposal and the contract was awarder' to t h ~
company that had been producing Arizona's tickets.
Comment: A t the request of the governor's office and the Lottery,
DPS conducted an investigation i n t o allegations made by the losing
vendor. The DPS investigator responsi bl e for the investigation
concluded that the available documentation tended to support the
1 osing vendor's contention of an ongoing business re1 ationship
between the individual actine as the independent evaluator and the
winning vendor. The DPS investigator stated that the independent
eval uator ' s role was " highly questionabl e. "
Subcontracts - The Lottery's practice of entering i ntc subcontracts
through i t s main advertising contract, a1 though not i l l egal , has been
carried out without adequate procedures to ensure f a i r and open
competition. According to the Director of SPO, such use of subcontracts
violates the s p i r i t and intent of the State Procurement Code and is not
good procurement practice.
a In April 1985 the Lottery Director instructed the Lottery's
advertisins agency to subcontract for the services of a particular
eastern lottery consulting firm and b i l l the Lottery for the
services. A competitive bidding process was not used. According to
the former Director, this was done because the recently hired
advertising agency had no lottery experience and he wanted them " up
to speed" as quickly as possible. Furthermore, according to the
former Director, there were few firms that had the experience
necessary to provide assi stance to the Lottery's zdverti sing
agency. The contract terms between the advertising agency and the
consultants were for a f l a t fee of $ 10,000 per month, plus travel
expenses. The ccntract ran for a period of approximately one year,
totaling more than $ 120,000. For t h i s fee, the consultants woul l be
available for consul tation and would develop marketing- plans. On
June 1, 1 W G , the contract w i t h the consul tin? firm was extended for
an additional seven months, making the total estimated cost of
consulting services more than $ 190,000.
Comment: By subcontracting through i t s advertising agency, the
Lottery was able to bypass a competitive bidding prscess, thereby
f a i l i n g t o ensure f a i r and open competition for a consulting
contract val wed a t over $ 1 90,000. Furthermore, subcontracting
resulted in additional charges to the Lottery. The advertising
agency charged a 13.24 percent commission on the subcontract,
resulting in a payment of over $ 25,000 to the agency.
@ Eased on the recorcmendations of the subcontracted consulting firm,
the Girector instructed the advertising ageccy to subcontract for a
survey of lottery players ( market segmentation study). In February
1986 a s~~ bcontracwt orth $ 200,000 was awarded to another eastern
firm to conduct the survey.
Comment: As in the previous example, the Lottery bypassed a
competitive biddin9 process and failed to ensure open and
competitive bidding for a $ 200,000 market segmentation study.
A1 though proposals were sol icited frcm selected vendors, an RFP was
not advertised i n any newspapers or trade journals. P, dc! i tional ly,
the consulting firm had a previous working relationship w i t h the
firm hired to conduct the survey. Moreover, Lottery official s
instructed that a reputable local firm be excluded from the
competition. Lottery official s disagreed with the firm's findings
on the Lottery as reported i n a 1984 news a r t i c l e .
o A $ 00,000 subcontract was awarded to a film production company to
produce a speaker's film. Competitive proposal s were not
solicited. The Lottery Director a t the time instruct. ed the
advertising agency to subcontract with the film company.
Comnent: By subcontracting through the advertising agency, the
Lottery was able to bypass s competitive bidding process and award a
$ 60,000 contract without f a i r and open conpetition.
Putting Lottery Under State Purchasing
Off ice Woul d Imnrove Control s
Placing the Lottery under the authority of the State Purchasing Office
would better ensure the integrity of the contracting process. The
Lottery's current exemption from the State Procurement Code i s not
necessary. SPO involvement would better insul ate the Lottery from
potential outside influence. In addition, i t b! oul d strengthen procurement
procedures and provide for an independent appeals process.
Exempticn Unnecessary - The Lottery's existing exemption from the State
Procurement Code i s unnecessary. The extensive procurement independence
granted to the Lottery has resulted i n problems i n the past and does not
sufficiently insul ate the Lottery from potential outside infl uence. \/ hi1 e
Lottery official s contend that procurement independence is necessary fcr
the Lottery to function, a recent procurement of instant tickets indicates
that Lottery procurement under SPO supervision can be successful.
The Lottery i s not sufficiently insulated from potential out. side pressures
and influence. As a result of the Lottery's exemption from t. he State
Procurement Code, statutory authority i s granted to the Director to
s o l i c i t bids and award contracts. A.. f?. S 35- 509 empo\; ers the Director to
s o l i c i t b i d s and contract for the desipn and operatien of the Lottery and
the purchase of Lottery equipment, tickets and re1 atec! materi a1 s. This
authority gives the Director a great deal of discretion i n soliciting bids
and awarding contracts, including the following areas.
o Determining whether a competitive sealed b i d i s not practical and
calling for the use of an RFP process.
o Determining the methods by which proposals will be evaluated. For
example, whether an evaluation committee will be used and who will s i t
on the committee.
o Determining whether cost or pricing data should be included in the RFP.
o Determining the relative importance of the individual criteria used to
evaluate the proposal s.
o Determining whether an administrative hearing officer will be used i f
a protest i s filed.
o Making the final determination as t o who will receive a contract.
o Making the final determination if a protest i s filed by a vendor.
Currently, only the Commission serves as a buffer between the Direct. or and
Lottery vendors, b u t i t s role i s weak. A. R. S. 55- 509. C. stipulates that
any award made by the Director becomes effective unless the Commission
rejects the award within 14 days of receiving notification of the award.
The Commission has exercised this authority only once i n the last five
years, during which time 58 contracts were awarded.
Lottery officials contend that procurement independence i s necessary for
the Lottery t o function properly. According t o Lottery officials,
changing market forces within the 1 ottery industry coul c' require immediate
response through the procurement process. However, since 1984, the
Lottery has l e t two 2nd three year contracts for i t s gaming services. In
addition, according to the Director of SPO, emergency procedures exist
that ~ o udl a1 low the Lottery immediate, yet lepal , response t o a crisis
situation.
The recent award of a contract for Lottery instant game tickets
illustrated the benefit of SPO involvement in the procurement process. A t
the request of the Lottery Director at the time, SPO was askee to
supervise the procurement process for the instant ticket contract. SPO
issued the RFP, received the responses and appointed a committee t o
evaluate the bidder's responses. The committee was made up of two Lottery
Assistant Directors and three official s from other state 1 otteries. The
committee conducted i t s eval uation and made i t s recommendation to the
Lottery Director, who accepted the recommendation and awarded the
contract. P. ccording to a SPO official , Lottery official s were heavily
involved thrcughout the process, while SPO acted to ensure compliance with
the Lottery's procurement regulations.
SPO Involvement Would Insulate the Lottery - Six lottery states utilize a
central procurement office for contract selection and award, thus more
effectively buffering the 1 ottery itsel f from outside influence.*
The Connecticut and Massachusetts l o t t e r i e s , for example, rely on their
state purchasing offices for contract selection and award, including
gaixing contracts. In both states, 1 ottery official s are heavily involved
in drafting RFPs, establishing evaluation criteria and determining
qua1 i fied vendors. However, state pvrchasino official s oversee the
process, thereby ensuring compl iance, and make the final sward decision.
Further, state purchasing hears and rules on any protests filed by
vendors. According to a Connecticut lottery official, his agrency feels i t
has had fewer problems with major gaming vendors because of the third
party insulation provided by the state purchasing office.
As a third party in the procurement process, SPO would be less susceptible
to the influences of the large vendors who tend to dominate the lottery
industry, particularly gaming vendors. For this reason, SPC's involvement
in contract awards would help ensure that selection decisions are based on
the vendors' compliance w i t h the criteria expressed i n the RFP.
- k These states are Nc\ v Jersey, Connecticut, Col orildo, Massachusetts,
West Virginia and Flissouri .
SPO would strengthen procedures and provide appeals process - The
involvement of SPO ~ ~ odu lst rengthen the Lottery's procurement procedures
and provide an independent appeals process. Involving SPO would ensure:
1 ) the use of an RFP process, including the developvent of relevant
evaluation c r i t e r i a , 2 ) tire use of an evaluation process, including the
establ ishment of a commi ttee to evaluate proposal s submitted i n response
to RFPs and the selection of ccmmittee members, and 3) the written
documentation of the rationale used t o award contracts.
SPO's participation i n Lottery's procurement process woul d a1 so provide a
third party to hear appeals filed by losing vendors. Currently, the
Director of Lottery has decision authority over appeal s. However, most
vendor appeals to the Director over his decisions have received 1 i t t l e or
no response. As previously mentioned, i n one specific case a vendor's
protest over the use of a particular independent evaluator was found not
to have merit by the Director, a1 though a CPS investigator 1 ater concluded
that the vendor had sufficient grounds for a protest.
CONCLUSIONS
The Lottery's contract selection process should be strengthened t o ensure
integrity and fairness. Some contract selections were made without
adequate procedures to ensure a fair and open ccrnpetitive selection.
RECCIIMENDATI ONS
1 . The Legi sl ature shoul d consider:
a. Repealing the Lottery's exempticn from the State procurement
statutes, and
b. Iiaking the Department of Advini stration- State Purchasino Office
responsible for a1 1 Lottery procurement.
2. If the Lottery retains its procurement responsibility, i t should:
a. Fol low State Purchasing Office pol icy excluding vendors
conducting feasi bil i ty studies from bidding on subsequent re1 ated
work, and
b. Follow State Purchasing Office Guidelines concerning the use of
subcontracts.
THE LOTTERY HAS NOT SUFFICIENTLY
CONTROLLED ITS NEW EUILDIKG COSTS
The Lottery has not sufficiently control 1 ed costs for i t s new building.
Based on square foot costs, the Lcttery building will cost over $@ t40, OCO
more than other State buildings under construction. In addition, the
Lottery had planned to replace its furniture, a t an estimated cost of
$ 600,000.
Lottery Building Expensive Compared
Ni t h Oti~ er State Construction
The Lottery building i s expensive compared w i t h other current State
building construction. Several design features contribute to increasec!
costs. In addition, the Lottery incurred unnecessary communications
consultant expenses for the new building.
The Lottery is constructing a 38,650 square foot building or: a three- acre
s i t e near the intersection of the Hohokam Expressway and University Drive
i n Phoenix. The constrcction began i n mid- 1986 and is estimated to be
completed i n April 1987. The buildins will house the Lottery's
administration, warehouse and prize redemption functions i n Phoenix, which
are currently separated and housed in leased commercial space. The total
cost for the Lottery building and furnishings i s estimated a t
approximately $ 5.2 million. The Lottery is paying for the building w i t h
excess monies retained from the percentage of wagers allowed for
administrative expenses. Building plans are not subject to review by the
Depzrtment of Administration's Facil i t i e s Planning and Construction Office
( DOA- FPC). In contrast to most State agencies, the Lottery is exempt from
appropriations and review processes for capital construction. However,
statutes d i d require the Lottery obtain legislative approval for any
capital construction.
Lottery building cost high - Nhen compared w i t h current State building
construction, the Lottery building i s expensive. We compared Lottery
building cost estimates w i t h two State buildings currently under
construction by the Departnent of Public Safety ( DPS) and the Departnent
of Revenue ( DOR). Our analysis found that the Lottery building will ccst
a t least $ 16 per square foot more than either the DPS or the DOR
buildings.* If built for $ 16 per square foot less, the Lottery could have
saved more than $ 440,000. Tab1 e 7 ( see Page 41 ) compares Lottery, DOP and
DPS bui 1 ding costs.
Reasons for increased cost - Design fact. ors may contribute to the Lott. ery
bui 1 ding ' s higher costs. The Lottery desired a more el aborately desi oned
building, feeling s ~ ~ ca hb uilding would project a more positive image of
the Lottery to the public. More elaborate exterior and interior
appointments help contribute to increased costs. The building \: ill have a
brick facade applied to the exterior concrete block walls. A1 though this
feature adds aesthetically to the motif, i t has 1 i t t l e functional value.
* " Finished shell cost" was used as the basis for comparing costs
between buildings because i t excludes costs of special systems or
requirements unique to any of the buildings. These include security
systems, cafeteria equipment, emergency generators and other items.
In addition, several other costs were nct included because of
differences in the building sites, designs and special needs. These
incl ude costs for 1 and, architectural and engineering fees, other
administrative costs, s i t e development, and parking and warehouse
f a c i l i t i e s . Another buil ding recently under construction, the Capitcl
Center, was also analyzed to determine finished shell cost. The
Capitol Center construction vias a private venture, purchased by the
State Epon completion. The Capitol Center's finished she1 1 cost was
$ 58 per square fcot, or at least $ 9 per souare fcot lower than tbe
Lottery building. The Capitol Center's finished she1 1 per square foot
cost may be even lower than $ 58. However, rbe were unable t o verify
this because detailed cost information was not available. Some
special systems and features costs colrld not be deleted as was done
with the other buildings.
TABLE 7
COPPARISON OF ESTIMATED BUILDING COSTS
FOR LGTTERY, DOR AND DPS BUILDINGS
Finished She1 1 Cost Building Square ~ e e t ( 1 ) Cost/ Square Foot
Lottery $ 1,854,826 27,650 ~ 6 7 . 0 8)( ~
DOR 9,645,187 1 91,992 50.23
DPS 3,142,217 61,730 50.9@
( 1 ) Warehouse space was excluded because of lower costs as compared
to office building construction. The Lottery's project manager
estimated the Lottery's 11,000 square foot warehouse cost a t $ 35
per square foot.
( 2 ) Total bui 1 ding costs, including warehouse space, are 658.37.
Office building costs, the focus of our analysis, are $ 67.08.
Source: Lottery, DOA, construction and architect documents, and
interviews with staff.
Other exterior items planned are brick planter walls and a cut stone
walkway. Although aesthetically pleasing, these features are not
necessary. The building's interior will have higher grade carpet,
ceilings, doors and floor t i l e . In contrast, both the DPS and DOR
bui 1 dings will have standard interior finishes except for the publ ic areas
and some offices. Two other states' lotteries contacted indicated that a
more elaborate public and media area within a building i s beneficial for
publ ic relations purposes. Ho~ rever, an elaborate building and furnishings
are not needed to operate successfully.
We did not find that special security needs, a factor cited by the Lottery
Director in testimony before the Joint Committee on Capital Review ( JCCR),
accounted for the increased costs of the Lottery's finished shell.
Special security systems were factored o u t of our analysis. P. ioreover,
specifications do not indicate that the building structure i s different
t h a n other office building construction using masonry walls.
Some comunicati ons consul tan t expenses unnecessary - The Lottery has a1 so
incurred some unnecessary comunications expenses for i t s building. The
Lottery retained a communications consul tant t o analyze cornmunica tions
needs i n the new building, write the request for proposals for the phone
system, and oversee and a s s i s t i n the bidding and review process i n
selecting a phone system. The Lottery will pay approximately $ 13,750 for
these services. Communications consul ting, however, i s provided as a
service free of charge to State agencies by the Department of
Adrni ni s t r a t i o n . In addition, the State Procurement Office will oversee
the acquisition of the system, minimizing the consultant's role i n this
area.
Lottery Pl anned
70 Re~ alc e Furniture
The Lottery had planned furniture replacement to coincide w i t h the move tc
its new building. The State Purchasing office issued a request for
proposals i n December 1986 for the major portion of the new furniture,
According to the construction project manager, furniture rep1 acement was
estimated to cost about $ 600,000, and included 110 workstations and other
i terns.
\ de found that the Lottery d i d not need to replace its furniture.
According to an analysis done for our Office by DOA s t a f f , the Lottery's
furniture i s i n good condition, requiring 1 i t t l e repair.
e None of the wood furniture showed more than minor wear.
a Metal desks, f i l e cabinets and tables were sound.
Panels were i n exceptionally good condition.
0 The rrrajority of the chairs sjere excellent quality, needing only sore
reuphol stering.
DOA s t a f f also noted that Lottery's furciture i s only five years old and
probably s t i l l under a 12- year warrznty. Other State agencies contacted
stctcd that they usually replace furniture after 15 t o 20 years.
During the course of tile audit, the Lottery rescinded i t s decision t o
replace i t s furniture. The Lottery will now continue to use i t s existing
furniture and supplement as necessary from existing State purchasing
contracts. The request for proposals issued by the State Ptirchasin?
Office was cancel 1 ed.
42
CONCLUSIONS
The Lottery has not sufficiently controlled costs for i t s building. Based
on square foot costs, the Lottery's new building will cost a t least
$ 440,000 more than other State buildings that are under construction.
RECOMF1ENDATI ONS
1. The Lottery should determine ways to minimize i t s building
construction costs, e l i ~ i n a t i n ga ny unnecessary design features.
2. The Lottery shoul d consider using State provided services whenever
possible rather than retaining consultants.
THE LOTTERY HAS EXCEEDED ITS AUTHORITY
TO INVESTIGATE LOTTERY VIOLATIO/, JS
The L o t t e r y has exceeded i t s a u t h o r i t y t o conduct investigations.
Although the L o t t e r y ' s Security and L i c e n s i n ~ D i v i s i o n has conducted
extensive i n v e s t i g a t i o n s o f L o t t e r y r e l a t e d v i o l a t i o n s , it does not have
s t a t u t o r y a u t h o r i t y to do so. I n addition, L o t t e r y i n v e s t i g a t o r s have
v i o l a t e d State statutes by c a r r y i n g concealed firearms.
The Security and Licensing D i v i s i c n has c~ nducted extensive i n v e s t i g a t i o n s
o f L o t t e r y v i o l ations. According t o L o t t e r y records, the D i v i s i o n
conducted more than 170 i n v e s t i g a t i o n s during 1385.* These i n v e s t i g a t i o n s
involved t i c k e t fraud and t i c k e t s stolen from r e t a i l e r s . The D i v i s i o n
c u r r e n t l y empl clys ten i n v e s t i g a t o r s t o conduct such i n v e s t i p a t i o n s anci
other security and l i c e n s i n g functions.**
Lottery Has Exceeded Authority
The L o t t e r y does not have s t a t u t o r y a u t h o r i t y t o conduct i n v e s t i g a t i o n s s f
L o t t e r y v i o l a t i o n s . Rather, the Department o f P L Ii~ c~ S afety ( DPS) i s
responsible f o r such investigations.
Although i n v e s t i g a t i o n s are being conducted, the L o t t e r y does not have
s t a t u t o r y a u t h o r i t y t o do so. Arizona Revised Statues ( A. R. S. ) $ 5- 510
authorizes the L o t t e r y t o create a Security and Licensing D i v i s i o n under
the supervision o f an Assistant D i r e c t o r appointed by the L o t t e r y
Director. The s t a t u t e further designates the Security and Licensing
D i v i s i o n t o be a law enforcement agency and the D i r e c t o r of the D i v i s i o n a
peace o f f i c e r . Hcwever, these designations a r e 1 i m i tec! by A. E. S.
§ 5- 510. C, which states, i n part:
* 1985 i s the l a t e s t year f o r kihich data are available.
** Other r e s p o n s i b i l i t i e s o f t h e S e c u r i t y and Licensing D i v i s i o n
i n c l ude: issuing 1 icenses, condiicting criminal and f i n a n c i a l
background ctiecks, conducti ng conpl iance v i s i t s o f 1 icensees, and
p r o v i d i n g s e c u r i t y ever L o t t e r y f a c i l i t i e s , t i c k e t s and drawings.
Such law enforcement agency and peace officer status
shall be for the 1 imited purpose of receiving
investigative information from law enforcement agencies
pertaining to investigations of l o t t e r y a c t i v i t i e s .
According to a Legi sl ative Counci 1 memorandum dated Clovember 26, 1986,
this limitation means the Lottery does not have statutory authority to
conduct investigations of Lottery violations.* The Lottery attempted to
gain statutory authority to conduct investigations and peace officer
status for investigators through 1 egis1 ation i t proposed i n 1% 2.
However, the legislation failed to pass.
According to Legislative Council, DPS, rather than the Lottery, is
empowered and required by statute to conduct lottery investigations.
A. R. S. $ 5- 571 states, i n part:
The director of the department of public safety shall
order an investigation into any violation of a statute
of t h i s s t a t e which pertains to the conduct of the
state 1 ottery. [ emphasis added1
Accordir~ g to a Security and Licensing Division o f f i c i a l , \ p: hen the Lottery
f i r s t began, DPS conducted investigations of Lottery violations. However,
Lottery officials were unhappy viith the quality and costs of the
investigations being conducted 2nd unilaterally establ ished their own
investigative s t a f f w i t h i n the Security and Licensing Civi sion.*
According to the Director of DPS, he removed his investigators from
Lottery investigations because Lottery o f f i c i a l s told him they were no
1 onger needed.
Investigators Should Not
' Carry Concealed Firearms
Lottery investigators have violated State statutes by carrying concealed
firearms. The Security and Licensing Division's 1 imi ted 1 aw enforcement
afid limited peace o f f i c e r s t a t u s precludes carrying concealed firearms.
* See Appendix for f u l l t e x t of the opinion.
** As noted i n Finding I1 ( page 21 ), current la^ allows the Lottery
authority to establish i t s own budget and staffing levels as long ss
i t s administrative budget does not exceed 25 percent of gross
revenues.
Lottery investigators have been observed By Auditor General staff carryins
concealed firearms while conducting Lottery business. According to the
Division Director, investigators carry conceal ed firearms when
accompanying daily cash deposits, for security of Lottery facil i t i e s , and
i n the event of potentially dangerous situations. However, according to
the Legislative Council, only officials designated as peace officers can
1e gal 1y carry co~ ceaeld firearms.
The Director of the Security and Licensing Division contends that he csn
delegate his peace officer status to Division investigators, tlov: ever, the
Division Director's peace officer status i s limited by A. R. S. 555- 510 to
receiving investigative information from law enforcepent agencies
conducting Lottery investigations. According t o the Legisl ative Council ,
this authority cannot be deleaated.
The Lottery's Security and Licensing Division has exceeded i t s statutory
authority t o conduct investigations. Accordins t o the Legislative
Couccil, the Division's law enforcenent powrs are lirrited t o receivina
information from law enforcement a~ encies conducting investigations of
Lottery violations. As a result, the Division lacks the authority t o
conduct Lottery investigations. Further~ ore, because Division
investigators lack peace officer status, they have violated State statutes
by carrying concealed firearms while conductin9 Lottery business.
RECOtl" ll4ENDATI ONS
1. If the Lottery wants to conduct investi~ ations, i t should petition the
Legislature to amend the statutes t o grznt Lottery investigators peace
officer status.
2. Until Lottery investigators are s t a t u t o r i l y granted peace officer
status, the Lottery shcul d:
a. Comply w i t h A. R. S. § 5- 510 and discontinue conducting
investigations of 1 ottery violations.
b. Direct Security and Licensing Division investigatcrs to stop
carrying concealed firearms.
c. Reduce Security and Licensing Division staffing level s
appropriate to its remaining work load.
3. The Department of Public Safety should resume conducting
investigations of a1 1 Lottery re1 ated viol ations until Lottery
investigators are granted peace o f f i c e r s t a t u s .
OTHER PERTIEIENT INFORMATICt!
During the course of our audit, and in response to legislative interest,
we examinee! the feasibil i ty of combining State gaming re1 ated reoul ation
in a single agency. The follob! ing section presents information we
gathered during this audit and during prior audits of the Department of
Racing and Departnent of Revenue- Bingo Section.
Organization Of Pub1 ic Gamin2 Regulation
CJe are unable to clearly determine whether coclbining gaming r e y l ation
into a single agency would result in a more efficient or effective
regul atory program. A1 1 three agencies responsi bl e for publ ic gaming
regulation perform 1 icensing and i nvestigative functions; however,
according to officials of the three agencies, there i s currently no
overlap in the types of licensees. Also, the type of investi~ ations
conducted differ . A1 though publ ic gaming regulation involves sone common
activities, only a f e s~ ta tes have ccmbined the regulation of t\ llo or li: cre
gaming functions. The Department of Public Safety ( DPS) has proposed
consol idating gaming investigative staff in Arizona; hoviever, ~ aminq
officials have identified potential problenls with this plan.
Reflulation of Public Gamina in Arizona
Three separate agencies are responsible for the regulation of public
gaming in Arizona. They include the Department of Racing, the Departnent
of Revenue and the State Lottery. All three agencies perform licensing
and investigative activities as part of their reoulatory duties. However,
the v~ lume and nature of these activities differ. The acencies issue
licenses t o different types of licensees, and vary t o some degree in
licensing unit staffing and procedures. Investigative staff, on the other
hand, are comparable among these agencies, a1 t h o u g h the types of
investigative duties reflect the particular needs of each agency.
Licensing - The Department of Racing issues the most licenses each year
and has the most extensive category of licensees compared to Bingo and
Lottery. According t o Department of Racing records, i n fiscal year
1985- 86, 9,308 licenses were issued in 26 licensure categories.* These
categories i ncl ude stab1 es or kennel s, owners, trainers, jockeys, agents,
grooms, exercise riders, veterinarians, mutile1 clerks, concession workers,
maintenance workers and security officers. According to a Department
official, almost everyone connected w i t h the operation of a horse or dog
track i s 1 icensed.
o The Department sf Revenue- Bingo Section i s responsible for issuing
bingo licenses. Presently, the two categories of licensure are larae and
small game licenses. As of October 1986 there were approximately 675
1 icensees, sl i ghtly more than one- ha1 f hol ding srrial 1 game 1 icenses. Large
game licenses are l i ~ i t e dt o qualified organizations such as churches or
nonprofit organizations, as defined by Arizona Revised Statutes ( A. R. S. )
$ 5- 401. Small game licenses can be issued t o any organization or
individual who has the approval of the local governing body and i s deemed
of good moral character.
o The Lottery licenses retailers t o sell lottery tickets, both instant
game and Pick tickets, issued by the Lottery. As of August 1986 there
were approximately 2, OUU 1 icensed Lottery retailers. A. R. S. $ 5- 512. A
states that before issuing a license to sell lottery tickets, the Lottery
must take i n t o consideration such factors as the applicant's financizl
responsibility, nature of business, community background and reputation,
business accessibility, and expected sales volume.
According to officials of the three agencies, there i s currently no
over1 ap in 1 icensees. A1 though the possi b i l i t. y ex1 sts that an individual
could hold multiple gaming related licenses, officials were unable t o
identify any common 1 icensees.
* Racing i ssues 1 icenses va l i d for three- year periods, and fiscal year
1985- 86 was a renewal year.
Tab1 e 8 summarizes the simil ari ties and differences between the 1 icensino
activities of the three agencies.
TABLE 8
COMPARISON OF LICElJSIt~ lG NORK LOAD,
STAFFING AND PROCEDURES
RAC I NG B I FirGO LOTTERY
Number of licensees 9,308 G75 2,000
Number of licensing
categories 26
Types of 1 icensees primarily qua1 ified commercial
individual s individual s & retai 1 ers
organizations
Number of licensing
staff G 5 (*
Type of staff exam technicians, clerks, rnarketi r; g
investigators investigators representatives,
i nvesti gators
Nature of background f i n ~ e r p r i n t none current1 y HCIC/ ACIC/ RCCL. i
ci~ ecks checks through done name checks
DPS 8 FBI through DPS
Unique aspects racino rul ings
checks through
national data base
credit
checks
(*) Lottery involves numerous marketing and investigative staff in
the licensing process.
Source: Data compiled by Auditor General staff from Department of Racing,
COR- Bingo Section and State Lottery records, fiscal year 1985- 86.
Investiaations
All three a~ encies also conduct investigations to enforce compliance with
statutory requirements. Investigative staff are similar in classification
and stztbs; however, the vclume and type of investisations differ znr!
ref1 ect each agency's particul ar enfcrcenent needs. A1 1 three
investigative staffs do receive support from DPS and the Attorney
General ' s Office.
0 The Department of Racing has a staff of six investigators ( Investigator
I11 and Investigator 11). All have prior law enforcement experience and
have 1 i ~ i t e dp eace officer status. The staff i s currently in the process
of being certified by the Arizona Law Enforcement Officers Advisory
Cocncil ( ALEOAC).*
In fiscal year 1986, the Racing Department cpened 404 cases. Most
investigations involved fa1 se appl ications. Other investigations focuset!
on criminal background, criminal activity , possession of drugs and other
matters.
The Bingo Section has seven investigators, most of whom are classified
as Investigator 111s. All have limited peace officer status and are
ALEOAC certified. Thus, they are similar to the t? acins Department
investigative staff. Three of the Bingo Section investigators have ten or
more years of prior law enforcement experience.
Bingo investigators perform a variety of functions related t o regulation
of the bingo industry. Investigators review new license applications and
conduct desk revievis of quarterly financial reports submitted by
licensees. Investigators also conduct co~ pliance checks. Investigators
v i s i t licensees while games are in progress and assess whether they are
being operated in compl i ance with resul atcry requirements. Approximately
200 compliance checks were made in fiscal year 1985- 80.
Investigators also conduct extensive investigations of crininal activity
in the bingo industry, usually in conjunction with DPS. The Bingo Section
opened 95 such investigations durinc fiscal year 1985- 80.
* ALECAC i s a body of law e~ forcetxent officials created t o establisl?
minimum qualifications and training for law enforcement officers.
a Lottery's investi~ ators, 1 ike their counterparts in Racinc and Bingo,
are in a similar classificztion series. Several investigators have
extensive prior 1 aw enforcement experience. However, Lottery
investigators have more limited authority than Racing and Bin90
investisators in that they are statutorily restricted t o licensing and
employment investigations. As a result, the Lottery's investigative staff
are - not ALEOAC certified and do pot have peace cfficer status.
Lottery investigators conduct criminal background checks supporting the
licensins function and compliance checks to determi~ e if retailers are
complying with applicable requirements in selling instant Same and Pick
tickets. In addition, although not authorized by statute, the Lottery has
conducted investigations invol vins questionable tickets, or ticket fraud,
and stolen tickets.
Tzble S summarizes the similarities and differences between the
investigative staff o f the three agencies.
TABLE 9
COI4PAKISOQI CF RACING, BINGO AblD LOTTERY IIIVESTIGATIVE STAFF
LOTTERY
Number of investigators 6 7 10
Principal classification Investigator Investigator Investigator
of staff 11s and 111s 111s 111s
Peace officer status yes Yes no
ALEOAC certification i n progress Yes no
Source: Bata cc~ piled by Auditor General staff from Department of Facing,
DOR- Bingo Section ana State Lottery records.
Beyond these three agencies, DPS and the Attorney General's Office provide
support for the enforcement of public gaming in Arizona. DPS assists
Racin~ and Lottery in conducting criminal history background checks for
1 icensure. DPS has a1 so assisted these agencies or independently
conducted criminal investigations of potential publ ic gamin9 violations.
For example, through an agreement w i t h DORY DPS has two investigators
assigned to assist in bingo investigations. One recent bingo case
assisted by DPS investigators resulted in 69 felony counts against ten
individual s. DPS 1 aboratory facil i ties are continuously used by the
Lottery to evaluate instant ticket security, and occasionally used by the
Department of Racing to conduct drug screening tests.
The Attorney General's Office provides assistance to all three agencies in
t h e i r efforts t o reaulate public gaming. The Office's Organized Crime and
Racketeering Division has prosecuted criminal cases involving public
gaming. In the last three years, the Division has been irivolved in the
prosecution of two Bingo cases involving fraudulent activities of bingo
operators, and one Lottery case involving the fraudulent redemption of a
1 ottery ticket. The Attorney General ' s Office has a1 so conducted
investigations and intell i gence gathering activities in the areas of
publ ic gaming.
Gaming Regulation i n Other States
A1 ttlougti ~, aming a~ encies perform some sinil ar activities, few other states
have combined the regulation of two or more gaming functions. However,
there is some reported benefit among those states consolidating regulatory
functions.
Only four of 33 states respondir;~ t o the lC8E survey cf the tiatic~ al
Associati on of Gambl i ng Regul atory Agencies ( NAGRA) have consol idated the
regulation cf t ~ oor rcore gaming activities under a single acency. As
shown in Tab1 e 10, Connecticut, Flassachusetts and Michigan regulate
lottery and bingo under the same asency. In addition, Coilnecticut's
Department of Revenue Services also resulates pari- mutuel wagering. New
York regulates both racing and bingo tkroush i t s State Pacing and Wagering
Board.
TABLE 10
CONSOLIDATION OF GAMING REGl! LATION I I! FOUR STATES
STATE GAMIFG ACTIVITIES RESPOMSI BLE AGEIlCY
Connecticut 1 ottery, binso , ( l ) pari- rutuel Departcent of
wagering, off- track betting Revenue Services
Massachusetts l o t t e r y , bingo State Lottery Commission
Michigan l o t t e r y , bingo Bureau of State Lottery
Mew York pari- mutuel wagering,
binso
Mew Ycrk State Racing
and Kaoering Board
Bingo l i c e n s i n ~ a nd enforcement authority effective October 1987.
Source: Data compiled by Auditor General s t a f f from NAGRA survey.
States that have combined aami ng regulatory agencies may s t i l l maintain
separate regulatory units for each gaming activity; thus, the actual
amount of functional consolidation and coordination may be limited. In
New York, for example, the Racing and Wagering Board maintains separate
racing and bingo licensing and reculatory units. Furthermore, the
Michigan and Massachusetts l o t t e r i e s maintain separate licensing and
r e y l a t c r y units. Lottery o f f i c i a l s i n Michigan feel i t i s easier to
regulate and license the two a c t i v i t i e s w i t h separate s t a f f , each with
personnel who are familiar w i t h the particular garni~ g function. As a
result, only certain administrative functions such as personnel, payroll
and purchasing are corisolidated and shared bet:.! eer! ilichic, nls lottery and
bingo functions.
Connecticut, by contrast, has been able to achieve some functional
consolidation w i t h reported benefits. According to a Division cf Special
Revenue o f f i c i a l , ~ aming enforcement a c t i v i t i e s have been combined under a
single security section. T h i s has el irninatecl over1 ap of some a c t i v i t i e s
associated wi ti] separate 1 icensing and resul atory u n i ts. Fcr example,
according to the Connecticut official , security staff can conduct
enforcenent and 1 icensing duties for all forms of caming regulated by the
division. As a r e s u l t , s t a f f nembers' time can be ut, ilizcci i n whatever
gaming area has the greatest need.
55
Feasibility of Consolidation Needs Further Strid\/
Because gaming agencies in Arizoria perform some common functions such as
criminal background checks and have somewhat comparable investigative
staff, consolidation of some activities may be feasible. However,
objections to such consol idation by some gaming official s need further
study and consideration.
DPS has proposed consol idati ng gaming entorcernent activities w i t h i n DPS.
Current efforts involve transferring the bingo licensing authority from
DOR to DPS. Studies conducted by both agencies conclude that DPS i s
better suited t o 1 icense and regulate bingo operators. In the future, the
Director of DPS envisions the possible establishment of separate bingo,
lottery and racing sections w i t h permanently assigned positions under a
single enforcenent u n i t within DPS. According to the DPS Director, this
organizational arrangement would have several benefits. First, DPS has
the manpower and equipment necessary t o conduct statewide gaming
enforcenent. For example, EPS has investigative staff assigned throughout
the State. The current regulatory agencies have staff only in Phoenix and
Tucson. Second, DPS can enhance career paths for investi~ ators.
Investigators would be part of a larger 7i; w entorcement agemy that coulg
offer more career opportunities. Finally, DPS has access t o several
background investigative sources not avai 1 able t o the current regulatory
agencies.
Official s of two gaming asencies, ho~ ever, point o u t potential problems
with consol idating 9arning enforcement within DPS. For example, DPS
investigators may tend t o focus on criminal i nvesti cat1 on and prosecution
rather than administrative actions. According to an Attorney General
official, taking administrative action such as suspending or revoking a
license can be a more effective enforcement action than a criminal
sanction, while less d i t t i c u l t and costly to achieve.
I n addition, DPS investigatcrs assigned t o the agency would have two
bosses, according to one c r i t i c . This raises the concern cn the part of
the agency directors that the investioatcrs would be wore responsive t o
DPS than t o the Oirector of their assigned agency.
AREAS FOR FURTHER AUDIT WORK
During the course of the audit, we identified several potential issues
that we were unable to pursue because they were beyond the scope of our
audit or we lacked sufficient time.
a Should r e t a i l e r commissions be restrcctured?
Retailers s e l l i n g l o t t e r y tickets receive a 6 percent commission on tkeir
ticket sales. Most other s t a t e s provide r e t a i l e r s w i t h a 5 percent
commission, and only a few s t a t e s give higher commissions. Reducing
r e t a i l e r commissions by 1 percent of revenue ksould have provided an
additional $ 1.2 million to the Lottery during fiscal year 1985- 86. Thest!
monies could be transferred to the designated revenue funds. Further
audit work i s needed to determine whether r e t a i l e r commission amounts
shoul d be restructured.
Should the Lottery be allowed to conduct additicnal aames?
Currently, the Lottery is allowed by statute to conduct an instant ticket
game and an on- line Lotto game. Several other states have added
additional games to their product mix as their l o t t e r i e s have matured. In
fact, the Arizona Lottery was not able to reverse declining sales until i t
began the on- line game. To increase player i n t e r e s t , other states have
introduced a variety of on- 1 ine games. Further audit work i s needed to
determine whether the Lottery should be authorized by law to condcct
additional games.
8 Should the Lottery use government securities to better insure grand
prize payments over time?
Many s t a t e 1 o t t e r i e s , incl uding Arizona's, finance grancl prizes through
annuities purchased from private insurance cotxpanies. Using annuities
gives the appezrance cf a larger prize. The Ari~ ona Lottery has conpanics
bid so the most beneficial annuity can be obtained. Some states O! ew
York, Rhode Island and [ laryl and), hov: ever, are turning to sovernment
securities rather than private company annuities because rates are similar
and provide more security. Some insurance companies have either cone
bankrupt or have shown significant financial losses. One firm with
significant financial 1 osses he1 d annuities for several state 1 otteries
( not Arizofia). Al thoush the question has n o t been addressed legally, i t
may be possible that the Lottery could be held liable for any remaining
monies on annuities held by companies thst writ out of business. Further
audit work i s needed to determine whether the Lottery should annuitize
grand prizes using government securities.
e Should the Arizona Lottery award instant aame ticket contracts more
frequently and use different vendors?
The Lottery has used the same instant game ticket vendor for 30 of the 32
instant games played since the Lottery's inception. In addition, the
Lottery has not awarded an instant game contract since 1984. Sotre other
states' lotteries l e t contracts for one- year periods only. Other states
have l e t contracts to more than one vendor over the same time period.
Officials from some of these states have indicated that shorter
contracting periods and mardins concurrent contracts t o more than one
vendor help promote competition and lower ticket costs. According t o sope
other states' officials, there are nov: several instant game ticket vendors
that can provide secure, quality tickets. This was not true a few years
ago. Further audit work i s needed to determine whether the Arizona
Lottery should use shorter contract periods and different vendors t o lower
instant game ticket costs.
a Is the amount of revenue a1 lowed for advertisina excessive?
The Lottery is allok! ed 4 percent of total wasers for advertising
expenditures. Previously, the Legi sl ature reduced and then increased the
advertising a1 1 ocance as the popularity of the gams fluctuated. With the
advent of the on- line game, which dramatically increased Lottery revenues,
the Lottery's potential advertising budget has pro\ vn proportionately.
However, the Lottery s t i l l runs the same number o f instant games in a
year. Further, the on- line game is less advertising intensive than the
instant gaixes. Further audit work is needed t o determine whether the
Lottery's advertising allowance could be reduced.
301 E. Virginia
Suite 1200
Phoenix, Arizona 85004
ARIZONA I# ITERY
( 602) 255- 1470
Bill Henry
Executive Director
Douglas R. Norton, Auditor General
Office of t h e Auditor General
HAND DELIVERED
2700 North Central Avenue, S u i t e 700
Phoenix, AZ 85004
Re: Response Of The Arizona S t a t e Lottery Commission
To The Auditor General's Performance Audit
Dear M r . Norton:
The Response of t h e Arizona S t a t e Lottery Commission as
d r a f t e d by Charles E. Buri, Executive D i r e c t o r March 14, 1983 t o
January 5 , 1987, a r e enclosed f o r i n c l u s i o n i n t h e published
r e p o r t of t h e Performance Audit you conducted on t h i s agency.
As you know, I was appointed t o t h e p o s i t i o n of
Executive Director of t h e Arizona Lottery on January 8 , 1987 and
assume f u l l r e s p o n s i b i l i t y f o r what we do o r f a i l t o do as an
agency. However, as your a u d i t was conducted p r i o r t o my
appointment, I b e l i e v e it is important and f a i r t h a t t h e
Commission's response, as d r a f t e d by M r . Buri, be forwarded t o
you i n t a c t and unedited by me.
I have noted with i n t e r e s t t h e f u l l t e x t of your
Performance Audit and as I become more f i r m l y f a m i l i a r with t h e
f a c t s and i s s u e s p e r t i n e n t t o the s u c c e s s f u l management of t h i s
agency over the next s e v e r a l months, I w i l l be reviewing your
recommendations again f o r a p p r o p r i a t e a c t i o n where merited.
Your Finding ( V) concerning t h e i n v e s t i g a t i v e a u t h o r i t y
of t h e Lottery is of such compelling importance t o me, as
Executive D i r e c t o r , t h a t some immediate a c t i o n was deemed
necessary. My opinion is t h a t t h e Lottery has not exceeded i t s
s t a t u t o r y a u t h o r i t y . However, I agree with your recommendation
t h a t the L e g i s l a t u r e amend t h e s t a t u t e s t o more s p e c i f i c a l l y and
c l e a r l y d e f i n e o u r i n v e s t i g a t i v e r e s p o n s i b i l i t i e s . Accordingly,
I have asked t h e Senate Finance Committee t o introduce such
c l a r i f y i n g language.
Executive Direc t o r v
RH : nh
Enc l o s u r e s
cc: Members of t h e Commission
Charles E. Buri
RESPONSE OF THE ARIZONA STATE LOTTERY CO1IMISSION
TO THE AUDITOR GENERAL' S PERFORllANCE AUDIT
Drafted by
Charles E. Buri, Executive Director
March 14, 1983 - January 5, 1987
INTRODUCTION
The following memorandum represents the response of the
Arizona S t a t e Lottery Commission t o the Auditor General's
Performance Audit.
PURPOSE
The Arizona L o t t e r y , a s established by voter i n i t i a t i v e
i n the general e l e c t i o n of November, 1980, has a singular purpose
and t h a t i s " to produce the maximum amount of net revenue
consonant with t h e d i g n i t y of the s t a t e . "
EFFECTIVENESS AND EFFICIEVCY
Given t h i s purpose, the effectiveness and efficiency of
the Arizona Lottery are best measured by net revenues, and,
judged accordingly, the Arizona Lottery has proven exceedingly
successful.
In i t s f i r s t f i v e Years ( July 1 , 1981 through June 30,
1986), the Lottery accrued S442,350,196 i n gross revenues. From
t h a t t o t a l , it r e a l i z e d $ 156,284,407 i n net revenues. That
amounts to a r e t u r n on s a l e s of b e t t e r than t h i r t y - f i v e percent
( 3 5%) .
Impressive i n t h e i r own r i g h t , t h e s e f i g u r e s take on
special s i g n i f i c a n c e when contrasted with the performance of
others. For example, i f ranked among Business Week's Top 1 ,000
Companies f o r calendar year 1985, the Arizona Lottery would be
980 i n terms of gross revenues. In terms of net revenues,
however, it would climb dramatically ... t o 656. In other words,
the Arizona Lottery has Seen able t o r e a l i z e a s u b s t a n t i a l l y
greater r e t u r n on s a l e s than most businesses.
This r e s u l t i s underscored by the f a c t t h a t , i f measured
against the Fortune 500 Companies for calendar year 1985, the
Arizona Lottery would rank f i r s t in terms of r e t u r n on s a l e s a t
t h i r t y - f i v e percent ( 35%) . I f measured by s a l e s per employee f o r
calendar year 1985, t h e Arizona Lottery would a l s o prove
exceptional with s a l e s of n e a r l y $ 887,000 per employee; making it
eighth b e s t among t h e Fortune 500 Companies. S i m i l a r l y , i f
considered from t h e vantage o f change i n s a l e s , between c a l e n d a r
years 1984 and 1985, t h e Arizona Lottery would be e i g h t among t h e
Fortune 500 Companies with an i n c r e a s e of over s e v e n t y p e r c e n t
( 70%). And, during t h e same period of time, net revenues
increased by an even g r e a t e r margin -- namely, e i g h t y - t h r e e
percent ( 83%). To say t h e l e a s t , t h e Arizona L o t t e r y has proven
exceedingly e f f i c i e n t and economical i n i t s o p e r a t i o n s .
PUBLIC INTERESTS SERVED
The primary b e n e f i c i a r i e s of net revenues produc ed by
t h e Arizona L o t t e r y a r e Arizona's incorporated c i t i e s and towns,
which r e c e i v e t h e s e monies through t h e Local T r a n s p o r t a t i o n
Assistance Fund. As of June 30, 1986, t h e Local T r a n s p o r t a t i o n
Assistance Fund had received $ 88,500,000 i n L o t t e r y revenues; t h e
d i s t r i b u t i o n and use of which was overseen by t h e Department of
T r a n s p o r t a t i o n .
In a d d i t i o n , p r i o r t o t h e c r e a t i o n of t h e Local
T r a n s p o r t a t i o n Assistance Fund, $ 22,600,000 i n Lottery revenues
were t r a n s f e r r e d t o t h e S t a t e ' s General Fund, and, by Session
Law, another 511 ,300,000 was t r a n s f e r r e d t o t h e General Fund i n
F i s c a l Year 1982- 1983. A more r e c e n t change i n t h e Lottery Act
r e s u l t e d i n an a d d i t i o n a l $ 1 4,000,000 of L o t t e r y revenues going
t o t h e General Fund i n F i s c a l Year 1985- 1 986. A l l t o t a l e d , t h e
S t a t e ' s General Fund h a s r e c e i v e d $ 47,900,000 i n Lottery
revenues.
When combined, Lottery monies flowing t o t h e Tdocal
T r a n s p o r t a t i o n Assistance Fund and t h e General Fund amount t o
$ 145,400,000 o r about $ 1 2,700,000 above and beyond t h a t required
by law ... f o r t h e Lottery was o n l y r e q u i r e d t o apportion t h i r t y
percent ( 30%) of gross revenues f o r t r a n s f e r t o t h e Local
T r a n s p o r t a t i o n Assistance Fund and t h e General Fund. Yet, by
focusing on " t h e bottom l i n e , " it has heen a b l e t o do much, much
b e t t e r .
Moreover, t h i s F i s c a l Year should be t h e L o t t e r y ' s b e s t
ever. When a l l is s a i d and done, t h e Lottery w i l l gross
approximately $ 1 30,000,000 and, from those revenues, remit
$ 23,000,000 ( t h e maximum permitted by law) t o t h e Local
T r a n s p o r t a t i o n Assistance Fund, $ 7,650,000 t o t h e County
Assistance Fund ( a g a i n , t h e maximum permitted by law) , and about
$ 1 5,000,000 t o t h e General Fund. Obviously, t h e L o t t e r y s e r v e s
t h e p u b l i c ' s i n t e r e s t s well.
PUBLIC'S PEKCEPTION
Rut, how do Arizonan's f e e l about t h e i r L o t t e r y ? The
answer is v e r y f a v o r a b l y .
Last y e a r , as a p a r t of t h e L o t t e r y ' s ongoing market
r e s e a r c h e f f o r t s , Arizona S t a t e University ' s Opinion Research
T, aboratory completed a survey o f Arizona r e s i d e n t s , concerning
t h e i r a t t i t u d e s toward and opinions about t h e L o t t e r y . I n t h e
course of t h a t survey t h e following questions were asked with t h e
noted r e s u l t s .
" Overall, do you think t h e Lottery is a good
t h i n g , a bad t h i n g , o r a r e you not sure?"
Good Thing . . . . . . . . . . 784
Bad Thing . . . . . . . . . . 1 1 %
Not Sure . . . . . . . . . . 11%
" If an e l e c t i o n were t o be held today, do you
t h i n k you would vote t o continue t h e
L o t t e r y ? "
Yes . . . . . . . . . . . . . 80%
NO . . . . . . . . . . . . . 15%
Not Sure . . . . . . . . . . . 5%
" In g e n e r a l , how b e n e f i c i a l is t h e Lottery t o
t h e S t a t e ? "
Very B e n e f i c i a l . . . . . . 27X
NSoomt eAwth aAt lBl eBneenf iecfiiacli a l . .. .. .. .. 577%%
Don't Know . . . . . . . . . . 9%
C l e a r l y , Arizonan's regard t h e i r Zottery with extreme
favor.
SUNSET FINDINGS
Even t h e Auditor General ... i n e v a l u a t i n g t h e L o t t e r y
a g a i n s t t h e twelve " sunset" f a c t o r s p r e s c r i b e d by A. R. S. 541 - 235- 1 . . . recognizes t h a t t h e Lottery is a s u c c e s s f u l o r g a n i z a t i o n .
He w r i t e s t h a t ( 1) " The Lottery Commission's purpose is
t o produce t h e maximum amount of net revenue consonant with t h e
d i g n i t y of t h e s t a t e " and t h a t ( 2) " The L o t t e r y has produced a
s i g n i f i c a n t amount of net revenue s i n c e it began o p e r a t i o n s i n
1981 ." Accordingly, t h e Auditor General f i n d s t h a t ( 3) " The
Lottery has operated w i t h i n t h e public i n t e r e s t . . . . 11
I n terms of o p e r a t i o n s , t h e Auditor General s t a t e s ( 4)
" The Lottery has promulgated r u l e s and r e g u l a t i o n s t h a t a r e
c o n s i s t e n t with i t s l e g i s l a t i v e mandate" and t h a t ( 5) " The
Commission has adequately encouraged input from t h e public bef o r e
promulgating i t s r u l e s and r e g u l a t i o n s . " He a l s o remarks t h a t
( 6) " Since t h e L o t t e r y is not a r e g u l a t o r y agency, i t s enabling
l e g i s l a t i o n did not include a formal complaint p r o c e s s , " but t h a t
( 7) " A. R. S. 55- 512.01 provides both t h e Attorney General and
County Attorneys with concurrent prosecution a u t h o r i t y f o r any
offense a r i s i n g out of o r i n connection with t h e formation,
management, o p e r a t i o n o r conduct of t h e S t a t e Lottery."
Regarding l e g i s l a t i o n , t h e Auditor General notes t h a t
( 8) " Since i t s i n c e p t i o n i n 1981, the Lottery has been a c t i v e i n
submitting l e g i s l a t i o n t o i n c r e a s e i t s e f f e c t i v e n e s s , I1 but
recoinmends t h a t ( 9) " [ Tlhe 1, egislature c o n s i d e r reducing t h e
percentage of [ revenue1 allowed f o r L o t t e r y a d m i n i s t r a t i v e
expenses . . . and r e p e a l i n g t h e J , o t t e r y l s exemption from t h e S t a t e
procurement s t a t u t e s . "
As f o r t e r m i n a t i o n , t h e Auditor General opines t h a t ( 1 0)
" Terminating t h e Tdottery would e l i m i n a t e a s i g n i f i c a n t amount of
revenue made a v a i l a b l e t o the S t a t e . " And, i n response t o t h e
f i n a l two c r i t e r i a , t h e Aaditor General simply r e p o r t s t h a t ( 11)
" The Arizona L o t t e r y is not a r e g u l a t o r y agency" and t h a t ( 12)
" The Arizona Lottery makes extensive use of p r i v a t e c o n t r a c t o r s
i n t h e performance of i t s duties" and t h a t " no o t h e r areas f o r
t h e L o t t e r y ' s use of p r i v a t e c o n t r a c t o r s " were i d e n t i f i e d .
C l e a r l y , t h e Lottery passes muster under t h e " sunset"
c r i t e r i a .
AUDITOR GENERAL'S RECOMPIENDATIONS
Yet, having s a i d a l l t h i s , the Auditor General then goes
on t o make f i v e recommendations, to w i t : ( 1 ) The percentage of
Lottery revenues s e t aside f o r administrative expenditures should
be reduced, permitting more revenues to be earmarked for p r i z e s ,
designated revenue funds and the General Fund; ( 2) The Lottery
should be subjected t o the executive budget and l e g i s l a t i v e
appropriation process to provide increased oversight; ( 3) The
Department of A d n i n i s t r a t i o n ' s Purchasing Off i c e should be made
responsible for Lottery procurements ; ( 4) The Lottery should
determine ways to minimize i t s building construction c o s t s ; and
( 5) The Lottery should seek peace o f f i c e r s t a t u s f o r i t s
i n v e s t i g a t o r s .
In support of these recommendations, the Auditor General
attempts t o f a u l t the Lottery on a number of grounds.
Nevertheless, t h i s t a c t was not wholly unexpected, as h i s s t a f f
were q u i t e open i n defining t h e i r charge as " finding something
wrong" ( See, Appendix One). \ h a t is s u r p r i s i n g , however, i s the
minutiae and inexpert analyses ( See, Appendix Two) t h a t the
Auditor General uses i n pursuing t h i s goal.
Understandably, the Auditor General does not mention h i s
e d i t o r i a l b i a s o r the i n t e l l e c t u a l shortcuts used i n preparing
h i s Report . . . but the Lottery must. In a d d i t i o n , the Lottery i s
compelled t o respond t o each of the Auditor General's f i v e
recommendat_ ions -- not because it disagrees with a l l of the
recommendations ( i t does not) -- b u t , r a t h e r , t o provide the
balance and symmetry needed t o form a f a i r and o b j e c t i v e opinion.
ADMINISTRATIVE FUNDS
The Auditor General f i r s t a s s e r t s t h a t the Lottery h a s
25X of t o t a l revenues a v a i l a b l e for general administrative
expenses and t h a t t h i s i s more than needed. Unfortunately, the
Auditor General's figures are i n e r r o r .
The expenditure of Lottery revenues i s governed in l a r g e
measure by s t a t u t e and regulation. S p e c i f i c a l l y , s t a t u t e d i r e c t s
t h a t 454 of the revenues accruing from the s a l e of l o t t e r y
t i c k e t s be returned t o players i n the form of p r i z e s , t h a t no
l e s s than 30% go t o t h e S t a t e of Arizona, and t h a t no more than
4% be used f o r a d v e r t i s i n g and promotion. I n a d d i t i o n ,
r e g u l a t i o n s p e c i f i e s t h a t r e t a i l e r s r e c e i v e a commission of 6%.
Totaled, 85X of a l l L o t t e r y revenue has been s p e c i f i c a l l y
a l l o c a t e d by s t a t u t e and r e g u l a t i o n .
T h i s l e a v e s 15X of revenue over which t h e Lottery has
some d i s c r e t i o n ; t h e q u a l i f i c a t i o n being t h a t market p r i c e s , f o r
such things as t i c k e t s and o n - l i n e game processing systems,
d i c t a t e t o a degree how t h i s money i s s p e n t . I n f a c t , t h i s p a s t
year, t h e c o s t of those two items ( i . e . , i n s t a n t t i c k e t s and the
o n - l i n e game processing system) amounted t o almost 6% of revenue,
which l e f t only 9% of revenue with which t o administer t h e
Lottery -- not 254 as t h e Auditor General a s s e r t s .
It a l s o bears mentioning t h a t t h e L o t t e r y did not spend
t h e f u l l 94 on a d m i n i s t r a t i v e expenses. Charged with t h e
r e s p o n s i b i l i t y t o produce t h e maximum amount of net revenue, t h e
Lottery was a b l e t o hold t h e s e expenses t o only 4% of revenue.
This allowed it t o r e a l i z e an a d d i t i o n a l 5% i n net revenue ...
bring in^ t h e t o t a l t o 35%.
So, although h i s f i g u r e s a r e wrong, the Auditor General
is c o r r e c t i n saying t h a t t h e L o t t e r y , through e f f i c i e n t
management, has r e a l i z e d savings i n i t s a d m i n i s t r a t i v e expenses
and t h a t t h e s e savings might be used f o r o t h e r purposes.
It i s t h e Auditor General's recolnmendation t h a t these
savings be s p l i t between t h e S t a t e and Tdottery p l a y e r s . However,
i f t h i s money is to be r e a l l . o c a t e d , the Lottery recommends t ! ~ a t
it be a l l o c a t e d e n t i r e l y f o r t h e payment of p r i z e s ; b r i n g i n g t h e
p l a y e r s ' s h a r e of Lottery revenues up t o 50%. Why . . . because it
would allow t h e Lottery t o produce even g r e a t e r net revenues f o r
t h e S t a t e .
Additional p r i z e money would allow f o r more p r i z e s
which, i n t u r n , would b e t t e r the odds of winning. B e t t e r odds of
winning t r a n s l a t e i n t o more winners and t h e more people win, the
more people p l a y . I n o t h e r words, with more p r i z e money, t h e
Lottery could enhance i t s games, which would r e s u l t i n more
t i c k e t s being s o l d . And, s i n c e the S t a t e r e c e i v e s not l e s s than
30% of every d o l l a r spent on Lottery t i c k e t s , t h i s means more
money f o r t h e S t a t e .
BUDGETARY CONTROL AND OVERSIGHT
The Auditor General's second recommendation i s t h a t
L e g i s l a t i v e c o n t r o l and oversight be increased by subjecting the
Lottery t o the appropriation process.
Again, however, it must be noted t h a t s t a t u t e ,
regulation and market forces d i c t a t e how 91Xoof a l l Lottery
revenues are expanded. This f a c t , coupled with the suggestion
t h a t the Lottery Act be amended to a l l o c a t e an additional 5% of
revenue f o r the payment of p r i z e s , leaves only 44 t h a t would be
sub j ec t t o the appropriation process.
Given t h i s small percentage and the f r u g a l i t y exercised
by the Lottery in its operations, there i s l i t t l e reason t o go
through the appropriation process. It would be absolutely f u t i l e
to a l l o c a t e t h i s money on a lump sum b a s i s , f o r s t a t u t e ,
regulation and ruarket forces already do exactly t h a t . On the
other hand, t o appropriate t h i s money on a l i n e item basis would
be unduly r e s t r i c t i v e a