1 1 2 3 4 5 6 ****************************************************** 7 8 TEXAS LOTTERY COMMISSION 9 EMERGENCY MEETING 10 AFTERNOON SESSION 11 12 January 31, 2001 13 14 ****************************************************** 15 16 17 18 BE IT REMEMBERED that the TEXAS LOTTERY 19 COMMISSION emergency meeting was held on the 31st of 20 January, 2001, from 4:43 p.m. to 5:15 p.m., whereupon 21 the following proceedings were had: 22 23 24 25 2 1 CHAIRMAN HEFLIN: -- invited guests. 2 We have a -- Commissioner? Chairman. Oh. We do have 3 a commissioner -- chair -- or, Mr. Chairman, we're 4 glad you are -- joined us today. 5 CHAIRMAN CLOWE: Thank you, 6 Chairman Heflin. If I may thank you for the 7 opportunity to appear today to you and the members of 8 the committee and the senator. My name is Tom Clowe. 9 Here with me are Executive Director Linda Cloud, 10 Deputy Executive Director Patsy Henry and director of 11 the Charitable Bingo Operations Division, Billy 12 Atkins. 13 And at this point, Mr. Chairman, I'd 14 like to ask your direction. Commissioner Anthony 15 Sadberry is standing by. We had an emergency meeting 16 this morning of the Commission, and we would like to 17 report to you on that meeting. I adjourned our 18 meeting this morning, recessed our meeting, and can 19 reconvene it at this time when you'd like to have that 20 report. 21 That would bring Commissioner Sadberry 22 into the room. He's prohibited, under the Open 23 Meetings Act, from being here during the time of our 24 report to you. So, if you'd like us to go forward 25 with our report at this time, we might convene that 3 1 meeting again and bring him in, if that meets your 2 pleasure. 3 CHAIRMAN HEFLIN: I would just as soon 4 go ahead and have that information presented now, if 5 that meets with your -- 6 CHAIRMAN CLOWE: Yes, sir. 7 CHAIRMAN HEFLIN: -- your schedule. 8 CHAIRMAN CLOWE: I'm going to ask that 9 Commissioner Sadberry be brought in. That will 10 constitute a quorum of the Commission. Commissioner 11 Betsy Whitaker is out of the country and otherwise 12 would be here with us. 13 CHAIRMAN HEFLIN: Okay. 14 (Commissioner Sadberry now present.) 15 CHAIRMAN CLOWE: And this is 16 Commissioner Anthony Sadberry, and I would -- then I 17 would reconvene the meeting of the Texas Lottery 18 Commission at 4:34 on January the 31st, as it was 19 recessed this morning, and ask Executive Director 20 Linda Cloud to give you -- the committee a report on 21 our emergency meeting this morning. 22 MS. CLOUD: Mr. Chairman, members. As 23 you know, protecting the integrity and security of our 24 games is the most important job any of us can do 25 working for the Lottery Commission. It is the part of 4 1 our business that requires vigilance and oversight, as 2 well as timeless dedication and perseverance. 3 I have given each of you and our 4 players a personal pledge to do my part to make sure 5 our games remain fair, that our accounting and 6 tracking systems are accurate, and that when issues 7 arise with the potential of causing problems for the 8 lottery, either real or perceived problems, that I 9 will take immediate steps to provide adequate 10 notification of those issues and to take immediate 11 action to correct and resolve them. 12 By some accounts, today's issue may be 13 considered more a current business practices concern 14 than anything else based on today's practices and 15 industry standards. Let me explain. For the past 16 several weeks, an internal audit has been underway 17 involving some of our instant ticket games. That 18 audit is not yet completed. However, I want to make 19 you aware of one preliminary finding that has been 20 brought to my attention. It involves game information 21 on some credit materials such as this selling sheet 22 which we provide our retailers for each instant game. 23 As you can see, the selling sheet 24 provides an approximate total number of prizes in this 25 block up top for each prize level for that particular 5 1 game based on an approximate number of total tickets 2 printed. This information comes from game specs or 3 working papers which we coordinate with our vendors. 4 It may be easier to visualize if you think of working 5 papers as a blueprint set of instructions for the 6 manufacturer in order for them to print our games. 7 On Friday evening at the close of 8 business, Texas Lottery Commission Internal Auditor 9 Debra McLeod brought a situation to my attention 10 involving what appears to be variances between the 11 information we are publishing on some of -- for some 12 of the instant games compared to the number of winning 13 tickets we're actually selling at the particular prize 14 levels or winning levels. This is happening because 15 the printed materials are produced before the tickets 16 arrive in Austin based on approximate data, not the 17 actual number of tickets received. 18 Since being made aware of this audit 19 finding, reviewing and understanding this issue has 20 become my number one priority, and I am making you 21 aware of all of it as quickly as I could. Based on 22 the internal auditors' preliminary findings, this is 23 what is happening: Information provided in the 24 selling sheets contained data we request in our 25 blueprint or working papers. However, this data is 6 1 based on hypothetical mathematical models that assumes 2 100 percent delivery of the tickets requested. Of 3 course, this would require error-free printing without 4 any glitches, dye problems or other manufacturing 5 defects which, of course, is inconceivable. In the 6 real world, this never happens. 7 To compensate, we build in variances or 8 acceptable tolerance levels to allow more or less of 9 whatever variable is being requested. In other words, 10 an acceptable limit may result in a few additional top 11 winning tickets being shipped to us than we requested 12 or a few less tickets. It may also result in a total 13 ticket shipment totaling more or less tickets than the 14 millions of tickets we requested be printed. 15 Where this becomes an issue for us and 16 may potentially confuse our players occurs as the 17 tickets are being sold. That's because every two 18 weeks, we also issue another document that is called 19 winning tickets remaining notification flyers that 20 comes directly off the system and is totally accurate 21 information. The data on the selling sheets and the 22 winning tickets remaining flyers for instant games 23 does not match because one uses approximate numbers 24 and the other uses actual numbers, and there's no room 25 in this lottery for fuzzy math. 7 1 As a result of this discrepancy in 2 information and during the duration of this ongoing 3 internal audit review, I am taking the following 4 immediate actions: Number one, in addition to calling 5 this meeting to inform you, I have also brought this 6 to the attention of our legislative leadership. 7 Number two, I have immediately instructed our sales 8 reps to remove any incorrect print materials from 9 retailer locations, and I have asked our marketing 10 department to suspend production of all instant game 11 information for new games that may be incorrect. 12 Number three, we will begin immediately adjusting any 13 confusing information that is out on our Web sites. 14 I am pleased to report, however, I have 15 also been informed by our internal auditor and want to 16 assure you and the public that the overall odds of 17 winning any prize for each instant ticket reviewed, 18 which is the number we print on the back of each 19 ticket, is correct and was unaffected. Audit findings 20 at this point also indicate the overall prize payout 21 percentage for each game was also unaffected. 22 In closing, let me add, based on the 23 audit information I have been given so far, in my 24 opinion, no player has been adversely affected either, 25 and the security and integrity of our instant games 8 1 has not been compromised. We have, of course, our 2 commissioners here as well as our internal auditor if 3 there's questions that you would like to ask of either 4 of them or myself concerning this. 5 CHAIRMAN HEFLIN: The question I would 6 have is, was this confined to multiple games or a 7 single game or is that information that you know yet? 8 MS. CLOUD: It is -- We have looked at 9 all the games that we have that are in an active 10 status and being sold at this time at our retailer 11 locations. There's 65 games, and it goes across the 12 board with every vendor we've done business with. 13 CHAIRMAN HEFLIN: Okay. So, this is 14 not a problem that's just occurred with your most -- 15 with your current vendor, then. Is that correct? 16 MS. CLOUD: That's correct. 17 CHAIRMAN HEFLIN: Okay. Are there 18 sanctions in -- contractual sanctions that can remedy 19 this situation with either your current printer and/or 20 your previous printers? 21 MS. CLOUD: Yes, there are -- 22 CHAIRMAN HEFLIN: In other words, 23 there -- 24 MS. CLOUD: There are sanctions, 25 Mr. Chairman, in the present contract. We put them in 9 1 this present contract. It was not in the prior 2 contract. 3 CHAIRMAN HEFLIN: Okay. 4 MS. CLOUD: But we do have the 5 sanctions there. 6 CHAIRMAN HEFLIN: The variance -- In 7 the previous contracts, were the variance stipulations 8 there? 9 MS. CLOUD: No, sir. 10 CHAIRMAN HEFLIN: Okay. So, there was 11 not -- So, was it expected that they -- the runs would 12 be perfect or that there were no variances or was 13 there just -- 14 MS. CLOUD: I have a difficult time 15 answering as to why there wasn't. I recognized, when 16 we put out the RFP for the present contract, that we 17 needed those variances in there, and we put them into 18 the contract we have. 19 CHAIRMAN HEFLIN: In the present 20 contract, was -- the RFP went out and the contract was 21 awarded within the last two years? Three years? 22 MS. CLOUD: Two years. 23 CHAIRMAN HEFLIN: Okay. And the 24 previous contract to that was -- or it went -- 25 MS. CLOUD: The previous contract to 10 1 that was an assumption of a buy-out. We initially 2 started doing business with Dittler Brothers in 3 Atlanta, Georgia, and Dittler Brothers was purchased 4 by BABN who now has a plant in San Antonio. 5 CHAIRMAN HEFLIN: And when was that 6 contract initially negotiated? 7 MS. CLOUD: Let's see. '96, '97. 8 CHAIRMAN HEFLIN: Okay. And then the 9 acquisition was made in -- by the other company. 10 MS. CLOUD: Of the one we have 11 presently? 12 CHAIRMAN HEFLIN: No. The acquisition. 13 MS. CLOUD: The acquisition was in '96. 14 I'm pretty sure -- Well, my general counsel said it 15 was before '99, the acquisition. 16 CHAIRMAN HEFLIN: Okay. And are there 17 actions that the Commission has under review to remedy 18 the current situation as far as sanctions or is it too 19 early to tell on that yet? 20 MS. CLOUD: It is too early to tell. 21 CHAIRMAN HEFLIN: Okay. 22 CHAIRMAN CLOWE: Chairman Heflin, if I 23 might -- 24 CHAIRMAN HEFLIN: Sure. 25 CHAIRMAN CLOWE: -- hope to clarify 11 1 something there. The audit is ongoing, and the reason 2 that I called for the emergency meeting this morning 3 was to report the results as it stands today. The 4 Commission was notified of this situation which is 5 underway Monday afternoon, and we feel very strongly 6 about the integrity of the Commission in dealing with 7 the players of these games in Texas and the 8 perception, and it was my opinion we had grounds -- 9 and the general counsel agreed -- to have the 10 emergency meeting. So, we're coming to you at some 11 point short of the finish of the internal audit. 12 In regards to the use of the word 13 sanctions, I don't believe there are any sanctions in 14 this contract. It is, in fact, more a provision for 15 liquidated damages and if there is a breach of the 16 contract, and we have yet to determine that and have 17 clarification of that issue as part of the completion 18 of the internal audit. 19 So, I wanted to expand on what the 20 executive director said to you, and hopefully that 21 clarifies it. We expect to have that conclusion of 22 the internal audit prior to our next meeting in 23 February or certainly a report at that time. 24 CHAIRMAN HEFLIN: The term sanction was 25 my term and certainly not that of -- 12 1 CHAIRMAN CLOWE: Yes, sir. 2 CHAIRMAN HEFLIN: -- the Commission or 3 the executive director. 4 So, if there -- If it is determined 5 when the audit is complete -- and by the way, what's 6 the schedule for the completion of that? Do we have 7 that yet? 8 MS. CLOUD: We think we need about two 9 to three more weeks on the audit. 10 CHAIRMAN HEFLIN: So, if it's 11 determined that the -- there has been damage incurred 12 by the printer, then there are provisions to recover 13 damages through the contract? 14 CHAIRMAN CLOWE: If there is a breach. 15 CHAIRMAN HEFLIN: Right. Right. 16 CHAIRMAN CLOWE: Yes, sir. 17 CHAIRMAN HEFLIN: Okay. 18 CHAIRMAN CLOWE: There are limitations, 19 and we have yet to determine what the end result is. 20 The audit reports at this point some overage in some 21 areas and some underage. So, we're not complete at 22 this point in time. 23 CHAIRMAN HEFLIN: Okay. Questions of 24 the members? Ms. Luna? Senator? 25 MADAM SENATOR: Thank you, 13 1 Mr. Chairman. I really appreciate the fact that as a 2 former member of this committee, you're allowing me to 3 sit in. I was not able to sit in on the Senate 4 finance side as we had a committee hearing that my 5 presence was requested at to make quorum, and, so, I 6 wasn't able to ask some of those questions. 7 CHAIRMAN HEFLIN: Well, we're allowing 8 you to sit in as a senator. 9 MADAM SENATOR: Thank you. We 10 appreciate it. 11 UNIDENTIFIED SPEAKER: Does she still 12 get vote? 13 MADAM SENATOR: Absolutely not. 14 CHAIRMAN HEFLIN: That's another issue. 15 MADAM SENATOR: Absolutely not. 16 Thank you, and let me say thank you to 17 Ms. Cloud and to the chairman and to the committee for 18 addressing this in an emergency fashion. I think that 19 the credibility of the games themselves and 20 perceptions can be just as real as what is actually 21 happening. 22 I wanted to ask some questions about 23 this, and the vendor for our scratch-off games is not 24 listed in the documents, I don't think, that -- on 25 Page 186 on major contracts. Can you tell me who the 14 1 vendor is? 2 MS. CLOUD: The vendor -- It's all of 3 our vendors. This audit is across the board. We've 4 got all the games on the street that we -- The 65 5 games we've audited go all the way back to our first 6 vendor. 7 We still have about seven games on the 8 street from Dittler Brothers. We have about four 9 games on the street with BABN. We have Scientific 10 Games which has the majority of the games that we have 11 on the street at this time, and we have some Pollard 12 who is our backup vendor for the present vendor. 13 MADAM SENATOR: Have you assessed from 14 your internal audit where the major problem has 15 occurred? 16 MS. CLOUD: The major problem is 17 occurring, like I said, in the prize levels. The 18 variance for each prize level is 2 percent over or 19 under. 20 MADAM SENATOR: Is that an overage or 21 an underage? 22 Can you tell me, is there any one 23 particular vendor that it seems to be a problem with? 24 I don't remember this discussion coming before this 25 committee or any House committee or Senate committee 15 1 the last time we were in legislation. 2 MS. CLOUD: The variances have been put 3 into the current contract. It was not in the previous 4 contracts. So, this was -- We did not -- We had not 5 audited this part, and we had not had -- didn't know 6 we had this issue until now, but it is a -- looks like 7 it's an industry standard where it's a problem with 8 all vendors, not just this one. 9 MADAM SENATOR: So, it's a problem 10 right now particularly with Scientific Games since 11 they have the majority of the games out there? 12 MS. CLOUD: Yes. 13 MADAM SENATOR: Okay. I wanted to ask 14 you, if it's an under-redemption, then it's clearly a 15 case where we are not meeting -- our folks who are 16 buying, our customers, we are not right -- If it's an 17 over-redemption, then the State loses the revenue. If 18 it's an under-redemption, it's clearly not meeting 19 what is printed or what the expectations are of the 20 consumers that buy the game. Is that true? 21 MS. CLOUD: No, ma'am. 22 MADAM SENATOR: Okay. Explain it -- 23 MS. CLOUD: If you'd like my internal 24 auditor -- I can explain it. 25 MADAM SENATOR: In other words, if 16 1 you -- 2 MS. CLOUD: Say you have shorter that's 3 on the print run which has caused the prize levels 4 within those print runs to be reduced as well. The 5 overall odds of the game and the overall prize payout 6 remained the same. This has not affected our players 7 at all. They have still got the same amount of prizes 8 in the game. It's not in the format that we put out 9 on the street, but it -- they still have the same 10 prize -- 11 MADAM SENATOR: So, there's a 12 disconnect between the information and what's actually 13 occurring? 14 MS. CLOUD: And that's what we're 15 concerned about. 16 MADAM SENATOR: Okay. Thank you. 17 REPRESENTATIVE LUNA: Mr. Chairman. 18 CHAIRMAN HEFLIN: Representative Luna. 19 REPRESENTATIVE LUNA: I'm just a low, 20 little old coastal girl, and I don't follow. I just 21 need to question that a little bit further. 22 How is it that the players are not 23 being affected? I just don't follow your argument. 24 MS. CLOUD: You have -- You -- When we 25 sent out the working papers, we tell the vendor how 17 1 many tickets we want printed, and in the printing 2 process, they have to pull any pack that has any 3 defects whatsoever. They all -- This is major 4 procedure for all of them. 5 When they get through with the printing 6 process, they end up with less -- in some cases, less 7 tickets than we put in our blueprint. We ask for 8 20 million tickets, we got 19. And that million 9 tickets had prizes in them, and because of that, the 10 prizes are also gone from the game. So, in checking 11 the inventory that we actually received and the number 12 of prizes that came with that inventory and coming 13 up -- you come up with the same prize payout, overall 14 prize payout that we had in the game, and the overall 15 odds of the tickets don't change. 16 REPRESENTATIVE LUNA: You're suggesting 17 that -- 18 MS. CLOUD: But -- 19 REPRESENTATIVE LUNA: -- if you 20 ordered -- How many millions, let's say, do you order 21 in a typical run? 22 MS. CLOUD: 20 million. 23 REPRESENTATIVE LUNA: So, if you order 24 20 million and you're shorted 1 million tickets, you 25 just didn't have any -- you're just certain you didn't 18 1 have any winners in that 1 million tickets -- 2 MS. CLOUD: No -- 3 REPRESENTATIVE LUNA: -- or the odds 4 aren't changed with the remaining 19 million that are 5 put into circulation? 6 MS. CLOUD: They did have winners in 7 the 1 million. 8 REPRESENTATIVE LUNA: But your -- Is 9 your argument, then, that the odds don't change? Is 10 that what you're suggesting, because you have 19 11 million out there and you still have the same 12 percentage of winners? 13 Again, I apologize. I'm just so slow. 14 MS. McLEOD: That's okay. That's okay. 15 My name's Debra McLeod. I'm the -- 16 REPRESENTATIVE LUNA: I hate to tell 17 you this right now. I'm just going to tell you, I 18 mean, whenever we have something like this occur, the 19 perceptions -- when we already have, I think, in many 20 instances, the public that questions the existence of 21 the Lottery, what are we really generating from the 22 lottery, this is, to me, a very serious problem, and, 23 so, I just have to tell you that's where I'm coming 24 from. 25 MS. McLEOD: To help you understand -- 19 1 I'm the internal auditor. My name is Debra McLeod. 2 What we've done is look at the volume 3 of tickets. For example, if you had a pool of 100 4 tickets that we were selling, 60 of those were 5 winners. So, you'd have a 60 percent prize payout. 6 If, in fact, the vendor had only shipped us 80 tickets 7 and we had 48 winners, you still have the same 60 8 percent variance, 60 percent prize payout. 9 So, that's exactly what has happened 10 here. When the vendor sells us or gives us less 11 tickets, they also give us less winners in that pool. 12 So, the percentage is a correlation between the 13 winners and the overall number of tickets delivered. 14 REPRESENTATIVE PUENTE: Mr. Chairman. 15 CHAIRMAN HEFLIN: Representative 16 Puente. 17 REPRESENTATIVE PUENTE: The numbers 18 we're talking about, 20 million and 1 million -- or 19 19 and 1 million, are those numbers that are actually 20 occurring in your sample? 21 MS. CLOUD: In the variances? 22 REPRESENTATIVE PUENTE: Yes. 23 MS. CLOUD: Yes. They're -- Each 24 one -- Each game is maybe a different number, of 25 course, but that's the correlation we're looking at. 20 1 REPRESENTATIVE PUENTE: People that 2 play the scratch-off versus people that play Lotto, am 3 I right in assuming that people that play scratch-off 4 play because they anticipate a better chance of 5 winning, for example here, $21,000? 6 MS. CLOUD: Yes, most of them play for 7 the top prize. 8 REPRESENTATIVE PUENTE: Okay. And as 9 opposed to the Lotto, it's just a home run or nothing? 10 MS. CLOUD: Right. Although our 11 players are pretty dedicated at just winning a prize 12 in our instant games, they're pretty happy when they 13 win $20. 14 REPRESENTATIVE PUENTE: So, these odds 15 that you're talking about that -- the 1 million that 16 are faulty or not, they have the same percentage of 17 winners and losers as the other batch. 18 MS. CLOUD: Yes. 19 REPRESENTATIVE PUENTE: But that's in 20 theory only. Correct? In other words -- 21 MS. CLOUD: No. That's actual. 22 REPRESENTATIVE PUENTE: But that, by 23 chance then -- say, by chance, the big pot, the big 24 prize may be in that batch, that 1 million ticket 25 batch? 21 1 MS. McLEOD: No. The answer to that is 2 no. The reason is because they randomly put the 3 number of winners throughout the whole print run. 4 Then they go back -- The instant ticket vendor goes 5 back and makes sure that you have "X" number of high 6 tier winners, what we call mid tier and low tier. 7 REPRESENTATIVE PUENTE: So, if we're 8 talking about 1 million and 19 million batches -- 9 MS. McLEOD: Right. 10 REPRESENTATIVE PUENTE: -- in the 11 1 million batch, there should be one or two 12 21,000-dollar winners, and in the other batch, the 13 rest of them? 14 MS. McLEOD: Right. Right. 15 REPRESENTATIVE PUENTE: There should 16 be, and they're supposed to be, or is that by chance? 17 MS. McLEOD: No. There is, because 18 somebody has gone back from the instant ticket 19 manufacturer and verified that, yes. 20 What we find, though, is -- For 21 example, this game, I believe, was -- 22 REPRESENTATIVE PUENTE: Well, I'm not 23 coastal, and I'm not a girl, but I'm confused, too. 24 REPRESENTATIVE LUNA: Excuse me, 25 Mr. Chairman. 22 1 CHAIRMAN HEFLIN: Ms. Luna. 2 REPRESENTATIVE LUNA: But I guess to 3 take it one step further, I guess I'm not convinced, 4 and if I'm not convinced, how is the general public 5 going to be convinced, at least from what I've heard 6 so far? And I have to echo the senator's remarks that 7 I'm -- I appreciate that y'all are treating this as an 8 emergency matter and that you convene in an emergency 9 meeting. Now we need the emergency recovery to 10 convince the public so that this doesn't further 11 affect the lottery sales which have been declining in 12 our state. 13 Actions taken by the Lottery Commission 14 in the past or by the executive director or whomever 15 has periodically caused some serious detriments to the 16 lottery in the public's eye. So, not -- I mean, I may 17 be silly up here and say I'm confused. It's further 18 than that. Maybe I'm just not convinced. 19 MS. McLEOD: If I might -- and I have a 20 two-person staff, myself and one other auditor. We're 21 working literally night and day to get to the end of 22 this by Friday so that we can quantify all the tickets 23 that we have currently out on the street. 24 Of the 45 we've reviewed of the 65 25 games that are open, we can honestly say at this point 23 1 of calculation that we have more prizes out there than 2 what we had advertised. So, we're not hurting the 3 players at this point. What we're trying to be is 4 more forthright in the information in saying if you're 5 relying on this piece of information, this is based on 6 an estimate. We would rather go with what we actually 7 get back from the instant ticket manufacturer and give 8 you more up-to-date and current information. 9 REPRESENTATIVE PUENTE: Does the 10 lottery -- do you have the ability to -- I'm -- Well, 11 let me just ask you. Do you have the ability to know 12 immediately if there's a drop-off in scratch ticket 13 sales and in what game it is and geographically where 14 it's occurring? 15 MS. CLOUD: We track our sales on a 16 daily basis. 17 REPRESENTATIVE PUENTE: In other words, 18 there's a reporter right back there (indicating). 19 He's just scribbling away. When the stories hit 20 tomorrow that there's a problem, can we see an 21 immediate drop-off in scratch ticket sales the next 22 day? 23 MS. CLOUD: I'm going to -- Well, I 24 don't know that it shows up quite that quickly, but we 25 would see it probably within the week. 24 1 REPRESENTATIVE PUENTE: And have y'all 2 decided as a -- in the meeting that we're in now, 3 what -- how you're going to correct this problem? Not 4 the actual auditing problem, but the perception 5 problem that's out there, to ensure the people that 6 participate in the lottery that we have a game that is 7 fair and that there is a true chance of winning? 8 CHAIRMAN CLOWE: I think that our first 9 step was to have the emergency meeting this morning 10 and to have the report that was forthcoming. The 11 media was at the meeting, and they were notified and 12 asked to be there, and I think Linda said what she was 13 taking in the ways of steps to correct the perception 14 of information that's going out in the sales slips and 15 information on our Web site. 16 MS. CLOUD: That's correct. 17 REPRESENTATIVE PUENTE: I mean, but 18 people that buy scratch-off tickets, I don't know if 19 they're going to run to the Web site to see what's 20 going on. It's a very -- to me, a very fickle player 21 that, if they see that it's happening, they might 22 choose to, you know, got to the Lotto, play the Lotto 23 or play some other game of chance that doesn't involve 24 the Texas Lottery. So, have y'all decided how you're 25 going to let the public know that it's still a good 25 1 game? 2 MS. CLOUD: We emphasized that in our 3 meeting this morning with the media there. Also, this 4 selling sheet goes to the retailers. It doesn't 5 really go to the players. It does go -- Some of the 6 retailers do put it in their play stations where the 7 player can see there's -- the makeup of the game, but, 8 you know, we're telling the truth when we say the odds 9 didn't change, the overall payout didn't change, and 10 it had to do with the correlation of the inventory 11 being over what we ordered or less than what we 12 ordered, and the prizes fell into that same -- Prizes 13 within that overage or shortage was the same. 14 REPRESENTATIVE PUENTE: Are you having 15 both problems, overage and shortage? 16 MS. CLOUD: Yes. 17 REPRESENTATIVE PUENTE: Randomly? 18 MS. CLOUD: Yes. 19 REPRESENTATIVE PUENTE: And within all 20 games? 21 MS. CLOUD: Yes. 22 REPRESENTATIVE PUENTE: And all 23 vendors? 24 MS. CLOUD: All vendors. 25 REPRESENTATIVE PUENTE: Okay. 26 1 CHAIRMAN HEFLIN: One question. This 2 information is the point of contention. Is that 3 correct? 4 MS. CLOUD: Yes. 5 CHAIRMAN HEFLIN: If I wanted to -- 6 Let's just say that the audit has been completed on 7 Game No. 210, The Hot Hand, and we knew what had 8 actually been delivered. Okay? Then would it be a 9 matter of altering the number of prizes by each 10 denomination here to make it accurate? 11 MS. CLOUD: Yes. 12 CHAIRMAN HEFLIN: Okay. And, so, I 13 might find that instead of having 515 hundred-dollar 14 tickets, there might be 503? 15 MS. CLOUD: That's correct. 16 CHAIRMAN HEFLIN: I might find that in 17 instead of 40,080, 25-dollar tickets, there might be 18 40,076 or something. 19 MS. CLOUD: That's correct. 20 CHAIRMAN HEFLIN: So, this is the kind 21 of information we're talking about? 22 MS. CLOUD: This is the document we're 23 pulling back from the retailer, and we're making the 24 correlation to the Web site of the actual prizes that 25 were shipped. 27 1 CHAIRMAN HEFLIN: Okay. When a run is 2 made, is the entire run delivered at the same time to 3 the Lottery Commission or is it done over a period of 4 time? 5 MS. CLOUD: With the present contract, 6 the runs have been slip shipments where they have sent 7 half the shipments in order for us -- because we've 8 been trying to get as many of the higher payout games 9 back on the street. So, we have allowed some slip 10 shipments up until August, but now the shipments are 11 coming in all at one time. 12 CHAIRMAN HEFLIN: Okay. So, in theory, 13 then, you would be able to, after the initial 14 promotion and after the initial sheet went out -- and 15 I take it this goes out before the retailer actually 16 gets the tickets in hand? 17 MS. CLOUD: Yes, sir. 18 CHAIRMAN HEFLIN: Okay. Then the 19 Commission -- the agency will have the ability to send 20 a second sheet with corrected information once all the 21 tickets have been delivered. Is that right? 22 MS. CLOUD: That's correct. That's the 23 intent, but what we intend to do with the initial 24 shipment of the selling sheet two weeks prior to the 25 game going out on the street is to leave out totally 28 1 the number of tickets in that prize level, just send 2 out to the retailer from this point forward the amount 3 of the prizes that are in the game, and then after the 4 game is received by us and we have the end of 5 production information, then we'll send out a new 6 selling sheet that will replace this one. 7 CHAIRMAN HEFLIN: And then as you send 8 out updates showing the remaining tickets in a 9 particular run, based on what's been cashed in -- 10 MS. CLOUD: Right. 11 CHAIRMAN HEFLIN: -- then that would 12 reflect accurate information? 13 MS. CLOUD: That's correct. And that 14 information is accurate. 15 CHAIRMAN HEFLIN: Okay. Any other 16 questions? Senator. 17 MADAM SENATOR: Thank you, 18 Mr. Chairman. I just wanted to make sure that what I 19 thought I heard you say when questioned by the 20 chairman was actually answered. 21 When you finish the audit, which I know 22 you're working very hard on, when you have determined 23 that there have been some variances -- and what you're 24 telling us today is that there are actually more 25 over-redemptions than under-redemptions. In the 29 1 over-redemption case, then the person who loses that 2 revenue during -- of the over-redemption is the State 3 of Texas, and in the -- 4 MS. CLOUD: I'm sorry. When we have an 5 over-redemption, we have more inventory than we have 6 ordered. So, we have more income from the game than 7 we intended. 8 MADAM SENATOR: Okay. If we have a 9 dollar amount that was either -- Oh, so, you're 10 telling me that there's no dollar amount over or under 11 than what we had anticipated so that the State is not 12 owed or that we still have the same payout, but you're 13 saying that we have received no monetary harm to our 14 revenue stream because of the errors or the 15 discrepancies in the printing of scratch-off tickets? 16 MS. CLOUD: At this point in the 17 audit -- and we have not seen that. We have not seen 18 that we've had any errors between what we give back to 19 the State or what we give to our players. 20 MS. McLEOD: Just to make a point of 21 clarification, I have not audited that portion yet. 22 So, that's the very next thing. We felt that the 23 players' perception issue was the most important. We 24 started there. Second to that is the vendor issue, 25 and then third, of course, will be the State revenue. 30 1 So, with each facet of this, we're working as 2 expeditiously as possible. 3 MS. CLOUD: You've looked at the 4 instant tickets received versus what the odds 5 information -- She's looked at the inventory we 6 received -- 7 MADAM SENATOR: Okay. 8 MS. CLOUD: -- compared to the prizes 9 we've received to make the overall prize payout. 10 MADAM SENATOR: But there is -- If I 11 understand what you said correctly, there are 12 provisions in the current contract with the current 13 vendor to have any damages or anything recouped. Is 14 that correct? 15 CHAIRMAN CLOWE: Senator, may we have 16 the general counsel speak to that? I think it's an 17 excellent question, and it's a legal question, and I 18 would be more comfortable if she may be allowed to 19 respond to that. Mr. Chairman? 20 CHAIRMAN HEFLIN: Absolutely. 21 MS. KIPLIN: My name's -- For the 22 record, my name's Kimberly Kiplin. I'm the general 23 counsel for the Commission, and I've heard those 24 questions, and I appreciate the opportunity to respond 25 to that. 31 1 It is going to be, first of all, is 2 there a breach. There are, pursuant to the contract, 3 allowable tolerances, if you will, plus or minuses for 4 each of the three issues that we're looking at. The 5 question is, if there's a breach, what are the 6 remedies. 7 I've heard the senator's questions 8 regarding the over-redemption. There are specifically 9 liquidated damages provisions in both the contracts we 10 have with Scientific Games and Pollard that the vendor 11 will be required of paying any prize claimed for a 12 prize that was not approved by the Lottery. So, that 13 will go to the issue of the payout -- or, pardon me, 14 the revenue stream to the State. That money will be 15 paid, and that will be the liquidated damages. 16 The other one has to do with actual 17 damages because there, in my view -- and it's real 18 preliminary. So, I'm going to qualify this right now 19 because I know I'm on the record. I don't see 20 liquidated damage provisions that are on point with 21 the other issues in terms of what happens if the 22 vendor is outside the tolerances. 23 So, if there are not liquidated 24 damages, the next step is to take a look at what 25 actual damages are, and that will be something I'll 32 1 have to work with my client on in terms of what those 2 actual damages are. The first question, of course, 3 is, is there a breach, and we're still, as I 4 understand it, in the fact-finding mode to determine 5 whether there has been a breach by the vendor or 6 whether it's more focused on the information that the 7 Lottery's providing pursuant to the selling sheets. 8 MADAM SENATOR: Can you tell me the 9 current value of -- thank you for that -- the value 10 for the contract for our scratch-offs? 11 MS. CLOUD: Senator, off the top of my 12 head, I can't, but I will get that information for 13 you. 14 MADAM SENATOR: Can you tell me if it's 15 over a million? 16 MS. CLOUD: Yes. Yes, ma'am. It's -- 17 Pardon me. I want to say -- I'm trying to think -- 18 Okay. Last year, we spent 15 million with the vendor. 19 MADAM SENATOR: With the vendor. And 20 maybe I'm asking the wrong person, but on the 21 documents, the LBB document that I have here, it says 22 major contracts, and we go from the GTech for lottery 23 operations at 90 million to 783,000 for 24 Pricewaterhouse. If there are other major contracts 25 that we should know about, it wasn't in this document. 33 1 I'm certain, if we have a contract with 2 a vendor that's at 16 million, the legislators really 3 need to know that because the problem that we're 4 seeing now is, with that particular vendor, there's no 5 way -- under major contracts, it was not listed that 6 this was a major contract. So, I would ask -- 7 MS. CLOUD: I'm sorry. That has been 8 reported as a major contract, but I don't know why 9 it's not in this document. 10 MADAM SENATOR: And is there any -- 11 LBB, is there any reason why we left off 16 million a 12 year as a major contractor for this agency? 13 MR. ATKINS: No, there shouldn't be any 14 reason we left it off. I'd have to go back and 15 double-check the database to see why it's not in 16 there. 17 MADAM SENATOR: It's a big step from 90 18 million down to less than a million, and this is a 19 major -- and I don't see any of it on here. So -- 20 MR. ATKINS: We can check that for you. 21 MADAM SENATOR: Thank you. I 22 appreciate that. 23 I guess general counsel needs to come 24 back to the table. So, what you said a moment ago is 25 that the contract called for -- 34 1 CHAIRMAN HEFLIN: Let me just -- 2 Kimberly, do we have a witness affirmation form? 3 MS. KIPLIN: No, sir, you do not. You 4 will before I leave. 5 CHAIRMAN HEFLIN: And the testimony 6 that you're giving is the truth, right, as you will 7 attest to when you sign this? 8 MS. KIPLIN: Yes, sir. 9 CHAIRMAN HEFLIN: Thank you very much. 10 MADAM SENATOR: Thank you, Kimberly. 11 The contract -- As you just stated, the 12 contract calls for the vendor to pay any prize which 13 the Lottery didn't authorize. So, in other words, 14 there would be -- that implies there would be no cost 15 to the State if, for example, additional prizes 16 because of this problem are awarded? 17 MS. KIPLIN: Yes, that's correct. I 18 will -- 19 MADAM SENATOR: Okay. So, it implies 20 that there will be a potential for a greater payout 21 than was intended. Is that a possibility? 22 MS. McLEOD: If the mic is being turned 23 towards me -- 24 MADAM SENATOR: I guess they wanted you 25 to answer it. 35 1 MS. McLEOD: -- auditors don't go 2 towards possibilities. We deal in black and white 3 facts. So, I'm going to pass on the question. That 4 second phase within -- by Friday afternoon, I can get 5 you definite concrete information. 6 MADAM SENATOR: The logical leap my 7 brain takes is that if there's a possibility for 8 greater payout, then -- again, I get back to my 9 point -- how is the public and how am I convinced that 10 there's no possibility for players to be affected? 11 And I guess I'll have to wait till Friday for that 12 answer, but, you know, that's what I want to know. 13 MS. CLOUD: We'll be glad to provide 14 you with that information. 15 MADAM SENATOR: I'm not trying to cut 16 you off, Kimberly. If you've got something -- some 17 way to respond -- I just saw Linda passing the mic 18 over to your auditor. 19 MS. KIPLIN: Sure. And the one -- 20 What's in my mind to who would be able to be 21 responsive to you is that there is a plus or minus 22 3 percent tolerance on the volume of tickets. For 23 example, you order 20 million, the Lottery orders 24 20 million, then we actually get up to 3 percent more. 25 So, we're selling more tickets than what we had 36 1 anticipated when the original prize payout was 2 calculated, and if -- Theoretically, if you have more 3 tickets, you'll have these more prizes, and my -- I 4 think that's what this provision's going to, but I'm 5 just trying to be responsive, and it may be that 6 that's just a hypothetical, and we'll have to see. 7 CHAIRMAN HEFLIN: For the benefit of 8 anyone in here or outside that's with the Texas 9 Workforce Commission, when we complete our hearing 10 with the Lottery Commission, we're going to adjourn 11 until in the morning. So, if you're waiting for the 12 Workforce Commission to present to the subcommittee 13 today, you may be released, unless you just like 14 hearing the testimony here. 15 UNIDENTIFIED SPEAKER: At what time, 16 Mr. Chairman? 17 CHAIRMAN HEFLIN: It's my intent that 18 we would meet at 8:00. If you -- the members twist my 19 arm and say we must come in at 7:00, we can do that, 20 but otherwise, it will be at 8:00 in the morning. So, 21 it's our intention that we take up the hearing, 22 rolling Workforce Commission over to tomorrow. 23 And I want to say, members, both to the 24 subcommittee and to the commissioners and Lottery 25 Commission employees, I realize that you could have 37 1 delayed making this information known until you had 2 your audit complete. It would have been sometime down 3 the road, but I want to tell you I appreciate the fact 4 that you took the risk of going ahead and going public 5 with this as soon as you knew something about it. I 6 think that's the responsible thing to do. 7 The fact that you can't answer all of 8 our questions now is part of the risk that you took by 9 bringing it to us early. I think it's better that 10 you've done this. I appreciate that and -- but we 11 will ask that when you have the information, you bring 12 it to us and share it with us so we'll have the full 13 picture and can either know that we're not going to 14 get a comfort level or either get to a comfort level 15 one way or the other. 16 So, I just wanted to say thanks for 17 going ahead and being forthright with the information. 18 It's not a -- It's something I would have rather not 19 happened, but the fact is, since it did, I think 20 you're being responsible by getting to us. So, let me 21 go ahead and say -- proceed with any further 22 questions, if y'all have any. 23 I would say, Commissioner, if you -- is 24 there further information you want -- I realize that 25 we're going to let you conclude your meeting before we 38 1 move on with our budget hearing. So, let me turn it 2 back over to you and -- 3 CHAIRMAN CLOWE: With your permission, 4 Mr. Chairman, then I will adjourn this meeting of the 5 Texas Lottery Commission at 5:15 p.m. on January the 6 31st and ask Commissioner Sadberry to leave the room. 7 MR. SADBERRY: Mr. Chairman and 8 members, I take it it's been explained why I've come 9 in and out -- 10 CHAIRMAN HEFLIN: Right. 11 MR. SADBERRY: -- that you don't take 12 it as anything disrespectful, but following the legal 13 rules. Thank you. 14 CHAIRMAN HEFLIN: Right. And we 15 appreciate your presence here. 16 CHAIRMAN CLOWE: Mr. Chairman and 17 members and Senator -- 18 19 20 21 22 23 24 25 39 1 REPORTER'S CERTIFICATION 2 3 STATE OF TEXAS ) 4 COUNTY OF TRAVIS ) 5 6 I, LEIGH ANNE WILLIAMS, Certified 7 Shorthand Reporter for the State of Texas, do hereby 8 certify that the above and foregoing pages constitute 9 a true and correct transcription of the statements 10 made on the recorded audiotape of the record at the 11 time indicated. 12 13 Witness my hand on this the 5th day of 14 February, 2001. 15 16 17 LEIGH ANNE WILLIAMS, Texas CSR 4446 18 Expiration Date: 12/31/02 1609 Shoal Creek Boulevard, Suite 202 19 Austin, Texas 78701 (512) 474-4363 20 21 JOB NO. 010201LAW 22 23 24 25