Lottery’s Oversight of Firm Called Lax

For years the California Lottery has given “special treatment” to its biggest contractor, allowing it to operate with little oversight and permitting the company to escape penalties when its gaming system malfunctioned, a state audit reported Tuesday.

State Controller Kathleen Connell said the state’s lax enforcement of its $400-million contract with GTECH Corp. has allowed the company to “exercise an unwarranted and improper degree of control over areas that should be more closely monitored.”

In a 23-page audit, Connell said she reached those conclusions after her auditors examined the lottery’s handling of GTECH’s contract over a two-year period, from Oct. 14, 1993, to Aug. 31, 1995.

Most troubling, she said, was an incident in May 1995 when the lottery should have assessed GTECH more than $600,000 in penalties for a breakdown in its ticket-buying system. Instead, Connell said, the lottery agreed to a settlement that allowed GTECH to avoid penalties.

“It’s this very close relationship between GTECH and the lottery that concerns us, quite honestly,” she said.

“I do not feel that we have an arms-length relationship here between [GTECH] and the lottery, and the fact they were able to negotiate what is clearly an attractive resolution to their problems is just another indication of that,” she said.

Lottery officials reacted angrily to the report, accusing Connell of attempting to “grab headlines” by releasing the final version of the audit to the news media before she gave it to the lottery.

Interim Director Maryanne Gilliard, who did not head the lottery during the period covered by the audit, said that the controller’s conclusions were not accurate and that they were based on a misinterpretation of the contract between the lottery and GTECH. The Rhode Island company has operated California’s online games since 1986.

She accused Connell of using the report as a diversionary tactic to draw attention away from an earlier finding by the controller that her office had overcharged the lottery for its audit work.

“The real issue here is not do we exercise sufficient control over GTECH . . . the real issue is nobody controls the state controller,” she said.

GTECH officials could not be reached for comment. But they have complained about the lottery’s “vendor-as-adversary mind-set” and fought the $600,000-plus penalty, saying it was excessive.

The squabble over the new audit is another indication of the tense relationship that has developed between the lottery, under the direction of Republican Gov. Pete Wilson, and the controller’s office headed by Democrat Connell.

The Lottery Act, approved by voters in 1984, requires Connell’s office to audit all the agency’s accounts and transactions and permits the office to charge the lottery for its costs.

Connell’s conclusion about the lottery’s relationship with GTECH has a historical basis.

Several times, the agency’s relationship with the company has been the subject of audits and legislative hearings.

The lottery’s last contract with GTECH was renewed without competitive bids. The state auditor later found that specifications had been written in a way so favorable to GTECH that other companies were discouraged from competing.

But under Gilliard, a former prosecutor, the lottery’s relationship with GTECH has soured in recent months.

Shortly after taking office, Gilliard announced that she would not exercise an option to renew GTECH’s contract when it expires in 1998 and instead would seek competitive bids.

Later, she accused the company of attempting to intimidate her for that decision by releasing an unsolicited report by the company that criticized lottery management.

The report charged that mismanagement had driven away potential customers, costing the state schools--the chief recipient of lottery profits--billions of dollars in potential revenues.

The report was written by former legislative analyst William Hamm, who is related to one of GTECH’s lawyers.

In the latest audit, the controller said the lottery should have penalized GTECH for revenue lost when one of its technicians inadvertently shut down three games May 13, 1995.

Although the GTECH contract required the assessment of damages, the audit said the lottery permitted the company to reach a settlement in which it agreed instead to supply the lottery with 75 new self-service terminals.

Gilliard defended the decision, saying the lottery had determined that the settlement was a better deal because the terminals would provide more than $2 million in annual revenue.

She said the assessment of damages was in dispute and by reaching a settlement, the lottery avoided a long and costly legal battle. “Last time I checked, $2 million is more than $600,000,” she said.

But Connell said that as of September, only nine terminals had been installed. Moreover, she said it was not appropriate for the lottery to acquire the terminals by the settlement and therefore avoid competitive bidding.

“More importantly, I think it’s another way to allow GTECH to avoid disclosing, at some point in the future, the fact that they had paid liquidated damages,” she said. “What it does is enable them to look as if they have been guilt-proof.”