In September 2011, Arkansas Lottery Internal Auditor Michael Hyde told Lottery Commissioner Bruce Engstrom and Lottery Director Bishop Woosley, who at the time served as legal counsel, that he had uncovered some inconsistencies in a deal with the lottery's largest vendor, which could cost the lottery $20 million and possibly much more. According to Engstrom, when Hyde began discussing looking further into how the contract was awarded and if it should have gone to another vendor Woosley said, "If this gets out, we're all going to lose our jobs." (Woosley has said he doesn't remember saying that, but if he did, the context was, if an inaccurate report gets out, people could lose their jobs.)
Shortly thereafter, Hyde and Woosley met with former Lottery Director Ernie Passailaigue to discuss the contract and why a week after it was signed Passailaigue amended it to make the terms more favorable to the vendor. The day after the meeting, Passailaigue tendered his resignation.
For more than a year, whether Passailaigue adhered to the law when he amended the contract was a matter of fierce debate between lottery staff, the state legislative oversight committee of the lottery and the division of legislative audit. Ultimately, the three settled the matter by agreeing that the lottery would operate differently in the future. Hyde's investigation, which became public last month following a Freedom of Information request from the Arkansas Times, rehashed that argument but also considered a more salient question: Why did Passailaigue sign off on a contract that gained the lottery nothing and cost it millions?
It's a question no one has been able to answer satisfactorily, including Passailaigue. Reached at his home in Isle of Palms, S.C., last week, Passailaigue wouldn't discuss why he altered the contract. "If it comes to a court of law, I will set the record straight," he said. Pressed on why it would come to a court, he said, "Contracts are subject to dispute or misinterpretation."
"It doesn't take any legal analysis to see that what he did was wrong," Gov. Mike Beebe said of Passailaigue on the March 30 edition of "Arkansans Ask: Governor Mike Beebe" on AETN. "It was wrong for him to do that. That in and of itself would have amounted to a firing offense. Does that render the contract as changed illegal? I don't know the answer."
Pressed by host Steve Barnes as to his sense of the deal, Beebe said, "My initial sense is that if it was wrong to do it, then it's illegal."
Weeks later, after asking his in-house counsel to review the contract, Beebe said the contract is legal, but "not right." Like the speaker of the House and the Senate pro tempore, Beebe controls three appointments to the commission, but otherwise has no authority over the lottery.
On April 11, Hyde made his official recommendation to the lottery commission: seek outside legal counsel to determine the validity of the contract and, should it be deemed invalid, seek financial redress. Seven commissioners, including two appointed by Beebe — Chair Dianne Lamberth and Secretary Treasurer Ben Pickard — voted to ignore the auditor's advice and reaffirm their commitment to the vendor, Scientific Games International (SGI). Engstrom and George Hammons, another Beebe appointee, voted against reaffirming the deal. After the vote, the commission went into executive session for almost an hour to evaluate Woosley and Hyde. It reconvened without taking any formal action, promising to pick up the evaluation in May. Engstrom said after the meeting he feared the commission might vote to fire Hyde. "I've always thought his job is in jeopardy and there's nothing that happened today that changed that," he said.
Before the April 11 meeting, Engstrom said the issue boiled down to two questions, "Did we get screwed? And, if we got screwed, are we stuck with it?" The vote to reaffirm may mean that the lottery is stuck with the contract, though a citizen may yet file a lawsuit against the lottery. Engstrom's other question — whether the lottery got screwed in the deal — hints at a larger concern that's easily answered, but not so easily remedied.
When Ernie Passailaigue found himself in a tough spot as Arkansas Lottery director — which happened almost continuously during his two years at the job — he was always ready with one of two lines, which went something like this: "You don't understand gaming" and "Look at all this money we've made for kids to go to college." Both of which were fairly brilliant, as verbal sparring goes. The former, an easy cudgel to wield for a man with a decade of experience in an arcane world. The latter, an effective smokescreen to cover most management mistakes since Passailaigue could typically point to seven-figure numbers.
That, broadly speaking, Passailaigue screwed the lottery — that his decisions cost the state money that otherwise could have gone to gamblers and scholarships — has been well documented. He paid exorbitant salaries to people who were later demonstrated to be unqualified. (His successor makes half what he made; there have been no direct replacements for two $225,000 assistants Passailaigue brought with him, now departed.) He cost the lottery thousands in undocumented travel reimbursement (a case Pulaski County Prosecutor Larry Jegley is still investigating). Under his watch, the IRS fined the lottery $100,000 for non-payment of taxes.
But what kind of man was Passailaigue? A pretender, who knew nothing except how to talk the talk? Or a craftier sort?
What Hyde uncovered suggests the latter. While performing a scheduled audit last year on SGI, the vendor that provides the lottery with instant tickets, he discovered that in the bidding process SGI offered the lottery two pricing options — one rate based on a percentage of sales, or another based on a smaller percentage provided the lottery would agree to pay for a collection of extra services out of its prize fund. Despite initially agreeing to the discounted rate, lottery management ultimately signed a contract for the regular rate. Shortly thereafter, Passailaigue altered the terms of the contract — without approval from the Lottery Commission or the Lottery Legislative Oversight Committee — to pay more than either of the rates SGI initially offered, even though the altered terms included services that were included in the discounted offer.
"It's like going into Burger King and ordering a value meal, and then when they start ringing you up, saying, 'No, ring up everything separately, so I can pay more,' " said Engstrom. "It doesn't make sense."
In the meeting with Hyde and Woosley the day before he resigned, the only benefit to the lottery following the change that Passailaigue could name was Tel-Sell, a sales and customer service operation that SGI operates solely on behalf of the Arkansas Lottery to support retail outlets that sell instant tickets. The operation includes four people operating phones. In the meeting, Passailaigue's lieutenant David Barden, who would also soon resign, estimated that Tel-Sell would cost the lottery $750,000 to $800,000 to run in-house. With SGI running it, he said it would provide $3.21 million for scholarship recipients. Hyde contends that Tel-Sell should have been included in SGI's original discounted offer.
Passailaigue also changed the contract to make SGI the lottery's exclusive instant ticket vendor, an alteration that greatly benefited the vendor. Twenty-two state lotteries use multiple instant ticket vendors, according to the 2011 edition of La Fleur's World Lottery Almanac.
In his meeting with Hyde, Passailague said SGI would not protest if the lottery later negotiated with another instant ticket printer. In a March 16 email from Scientific Games Vice President and Corporate Counsel Philip J. Bauer to Woosley, Bauer offered the lottery a $2 million credit, "in order to avoid an unnecessary and unproductive dispute" and "not in the performance of any obligation or as an admission of any kind of liability." He also said that, among other considerations, SGI would be willing to amend the exclusivity contract clause with language suggested by SGI. On April 11, when the commission agreed to reaffirm the contract and accept the settlement, SGI had not agreed to change the exclusive term.
Most state lotteries have five major expenses. The prize fund through which winners are paid is always the largest. Commissions paid to retailers and vendor costs usually fall next, followed by money spent on advertising and marketing and salaries. Considered as a percentage of total sales, last year Arkansas spent less than or about the same as four other lotteries that started in the 2000s — North Carolina, Oklahoma, South Carolina and Tennessee — in all those categories except for one: vendor costs. In fact, a review of the annual reports from the 2011 fiscal year of more than half of the state lotteries in the country reveals that Arkansas pays considerably more, as a percentage of total sales, to its vendors than all other lotteries except for one (North Dakota, one of the smallest lotteries in the country and one that can't sell instant tickets according to its constitution). Where vendor expense represents less than 3 percent of sales in most lotteries, it's 5.19 percent in Arkansas. That means that the Arkansas Lottery, with total sales of $464 million last year, pays more to its vendors than lotteries with well over a billion dollars in sales. Take North Carolina, which sold almost $1.5 billion last year — more than three times Arkansas's sales. It paid its vendors $23.48 million. Arkansas paid its vendors $24.06 million.
As a consequence, despite the amount of money it has generated in its first two years — more than $800 million in sales and nearly $177 million to scholarship payments — the Arkansas Lottery grossly underperformed. In the last two fiscal years, considered as a percentage of sales, Arkansas netted less than any other lottery in the country save Massachusetts, according to figures provided by the North American Association of State and Provincial Lotteries. In other words, the lottery did what it was designed to do — in Arkansas's case, to fund scholarships — worse than all but one other lottery in the country.
It might be reasonable to assume that Arkansas is merely going through some growing pains associated with being a brand new lottery. But when compared to the first and second fiscal years of the other newer lotteries, the Arkansas Lottery looks pathetic. In the first fiscal year of five new state lotteries, Arkansas's net as a percentage of sales was nearly six percentage points lower than the second lowest-performing state lottery (North Dakota) and 15 percentage points lower than the best performing (Oklahoma). In the second fiscal year, the gap only widened. Arkansas was seven and a half percentage points behind the Tennessee Education Lottery and at least 10 percentage points behind the other four.
In his presentation to the lottery commission on March 27, Lottery Director Bishop Woosley contended that a document signed by officials from the lottery and Scientific Games that indicates that the lottery would pay the discounted rate was a mistake and not an actual contract. He argued that the commission had authorized Passailaigue's amendments to the contract through acquiescence, a legal term that means agreeing by not voicing objection. He asked the commission if it was prepared to lodge a multimillion-dollar lawsuit against Scientific Games based on the discounted rate, which he said was never formally approved or in force.
After the commission voted to reaffirm the contract, Woosley defended the pragmatism of the move. "You have to weigh, do you want to cancel a contract and invalidate a contract, and suspend sales for three or four months to six months, when we're making nine or $10 million or $11 million a month in scholarship money? If the allegation is that we should sue to collect $20 million dollars — which I disagree with — but if it's true, you invalidate the contract, it's going to take you four to six months to get a new instant ticket vendor, you're going to lose $40 million in the process and you're going to lose customers and sales and you're going to cost people sales. It's a business decision. It's not cut and dried. It's very grey."
"Anything that was questionable to me was done by our previous administration," said Commissioner Ben Pickard. "They are no longer here. We've been working under this contract for two and a half years. It is in my mind an ongoing contract. The ramifications for us not continuing are somewhat mind-boggling."
Asked why the commission did not follow Hyde's recommendation and seek outside counsel, Commission Chair Dianne Lamberth said, "This was not an outside counsel issue at the time. We just wanted to affirm because we knew that the contract we were under — we'd been paying them as they were supposed to be paid, they'd been performing as they were supposed to be performing."
Pressed further on the value of an internal auditor if the commission is going to ignore his recommendations, Lamberth said, "Sometimes you can agree to disagree about the audit. We don't have to always accept the audit. They bring things to us and at that point we made an educated decision on whether to accept it or not accept it. We do it very, very thoughtfully and very, very thoroughly."
The lottery commission does not pay its commissioners. Many live away from Little Rock, where the commission typically meets. Because of the money involved, the lottery is always in the news. When the news is negative, the commission sometimes bears the blame. That said, there is some indication that the commission has not always acted thoughtfully or thoroughly.
Take for instance the lottery's other major vendor contract with Intralot, a Greek company that provides and services the lottery with the technological infrastructure to administer both instant ticket and so-called draw games, like Mega-Millions and Powerball, where winners are selected after players purchase their tickets. Arkansas pays 2.45 percent of its total sales to Intralot. In the minutes to a legislative oversight committee hearing on Aug. 11, 2009, then Lottery Commission Chair Ray Thornton notes that Intralot's rate is "extremely low and beneficial to Arkansans." He cited the 2008 La Fleur's World Lottery Almanac listings of the rates paid by all of Arkansas's neighbors as higher — aside from the rate Tennessee pays — than Intralot's bid to the Arkansas Lottery. But apparently Thornton — and the lottery commission and legislative oversight committee — failed to read the fine print. Arkansas Lottery staff doesn't still have a copy of the 2008 almanac, but Freedom of Information requests and the 2011 edition of the almanac show that Arkansas, by virtue of paying a percentage of total sales, pays far more than its neighbors, which largely pay a percentage of only online draw game sales. For example, last year Louisiana had online sales of $236.38 million and paid Intralot a total of $10.65 million. Meanwhile, Arkansas had online sales of $73.9 million and paid Intralot $11.4 million. That's the cost difference of 4.5 percent and 15.43 percent of online sales, respectively.
That Louisiana runs one of the most successful lotteries in the country, when its net is considered as a percentage of sales, owes to its success in selling draw games, which cost less to run. The Arkansas Lottery, in its rush to start selling tickets as quickly as possible, didn't introduce online draw games until six weeks after the lottery began. Sales of online games have since greatly lagged those of instant games, though the lottery did enjoy record sales of draw games in March, following the excitement surrounding the record Mega-Millions jackpot. Woosley thinks that all the first-time players who were inspired to buy Mega-Millions tickets could now easily become regular players, providing a significant boon to sales.
But until 2016, when the contracts with SGI and Intralot expire, the Arkansas Lottery will be laden with high fees that will cost Arkansas students scholarships. Until then, there are questions not likely to be answered. Like, why Arkansas couldn't negotiate a flat-rate with Intralot as South Carolina did? Or why Arkansas couldn't structure contingencies into its vendor contracts, where certain sales figures trigger percentage reductions in the cost, as Louisiana did? Or why Arkansas signed seven-year contracts when many states signed much shorter terms? No doubt when the time for contract renegotiation comes, SGI and Intralot will have answers. They've got support from several connected lobbyists. Mitchell Berry, son of former congressman Marion Berry and a past hunting buddy of Attorney General Dustin McDaniel and Bishop Woosley, represents Scientific Games. And former state Rep. Robbie Wills, the lead sponsor and self-proclaimed architect of the Arkansas Lottery, now represents Intralot.
This story has been update to reflect Gov. Beebe's comments about the lottery on April 18.