0001 1 * * * * * * * * * * * * * * * * * 2 3 4 TEXAS LOTTERY COMMISSION 5 MEETING 6 7 AUGUST 16, 2006 8 9 * * * * * * * * * * * * * * * * * 10 11 12 13 14 15 16 BE IT REMEMBERED that the TEXAS LOTTERY 17 COMMISSION meeting was held on the 16TH of AUGUST, 18 2006, from 9:00 a.m. to 2:20 p.m., before Brenda J. 19 Wright, RPR, CSR in and for the State of Texas, 20 reported by machine shorthand, at the Offices of the 21 Texas Lottery Commission, 611 East Sixth Street, 22 Austin, Texas, whereupon the following proceedings 23 were had: 24 25 0002 1 APPEARANCES 2 3 Chairman: Mr. C. Tom Clowe, Jr. 4 5 Commissioners: Mr. James A. Cox, Jr. 6 7 General Counsel: Ms. Kimberly L. Kiplin 8 9 Executive Director: Mr. Anthony J. Sadberry 10 11 Charitable Bingo Executive Director: Mr. Billy Atkins 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0003 1 INDEX - August 16, 2006 2 PAGE 3 Appearances.................................... 2 4 AGENDA ITEMS 5 Item Number I.................................. 6 6 The Texas Lottery Commission will call the meeting to order 7 Item Number II................................. 130 8 Consideration, possible discussion and/or action on a petition for rulemaking to amend 9 16 TAC 402.200, General Restrictions on the Conduct of Bingo 10 Item Number III................................ 130 11 Report, possible discussion and/or action on lottery sales and revenue, game performance, new game 12 opportunities, market research, and trends 13 Item Number IV................................. 144 Report, possible discussion and/or action on 14 transfers to the State 15 Item Number V.................................. 146 Consideration of and possible discussion and/or 16 action on the agency's legislative appropriation request 17 Item Number VI................................. 178 18 Consideration of and possible discussion and/or action on external and internal audits and/or 19 reviews relating to the Texas Lottery Commission and/or on the Internal Audit Department's activities 20 Item Number VII................................ 6 21 Report, possible discussion and/or action on GTECH Corporation, including proposed 22 acquisition of GTECH 23 24 25 0004 1 INDEX - CONTINUED - August 16, 2006 2 3 Item Number VIII............................... 179 Consideration of and possible discussion and/or 4 action on the lottery operator contract, including whether the negotiation of the lottery operator's 5 contract in an open meeting would have a detrimental effect on the Commission's position 6 in negotiations of the lottery operator contract 7 Item Number IX................................. 179 Report, possible discussion and/or action on the 8 procurement of advertising services 9 Item Number X.................................. 180 Report, possible discussion and/or action on the 10 drawings audit services contract 11 Item Number XI................................. 181 Report, possible discussion and/or action on the 12 instant ticket vending machine contract 13 Item Number XII................................ 181 Report, possible discussion and/or action on the 14 agency's contracts 15 Item Number XIII............................... 181 Report, possible discussion and/or action on the 16 79th Legislature 17 Item Number XIV................................ 183 Commission may meet in Executive Session 18 Item Number XV................................. 184 19 Return to open session for further deliberation and possible action on any matter discussed in 20 Executive Session 21 Item Number XVI................................. 185 Report by the Executive Director and/or 22 possible discussion and/or action on the agency's operational status, and FTE status 23 Item Number XVII............................... 187 24 Report by the Charitable Bingo Operations Director and possible discussion and/or action on the 25 Charitable Bingo Operations Division's activities 0005 1 INDEX - CONTINUED - August 16, 2006 2 3 Item Number XVIII.............................. 188 Public comment 4 Item Number XIX................................ 188 5 Adjournment 6 Reporter's Certificate......................... 189 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0006 1 AUGUST 16, 2006 2 3 CHAIRMAN CLOWE: We'll come to order. 4 Good morning. Today is August 16th, 2006. It's 5 9:00 a.m. Commissioner Cox is here. My name is Tom 6 Clowe. We'll call the Texas Lottery Commission to 7 order. 8 And we have individuals here from -- 9 from outside the city. We'll call on them and their 10 presentation first. Number seven on the agenda, 11 report, possible discussion and/or action on GTECH 12 Corporation, including proposed acquisition of GTECH. 13 Director Sadberry. 14 MR. SADBERRY: Chairman, Commissioner, 15 good morning. For the record, my name is Anthony 16 Sadberry, Executive Director. 17 Pursuant to the directions given to us 18 at the July 19th, 2006, meeting, Mr. Mattax and I have 19 conferred, at your direction, Chairman, and we have 20 also had the opportunity to meet with Mr. Turner and 21 his management team, who are present today. And I 22 would at this time like to ask David Mattax, Division 23 Chief of the Financial Litigation Division from the 24 Office of the Attorney General to come forward, and 25 Mr. Mattax will give the presentation on this agenda 0007 1 item at this time. 2 MR. MATTAX: Good morning, 3 Mr. Chairman. My name is David Mattax, Chief of the 4 Financial Litigation Division of the Office of the 5 Attorney General. 6 As Executive Director Sadberry said, we 7 met with members of the GTECH management team as a 8 follow-up to issues that had been raised in previous 9 meetings with regards to the operational issues that 10 have been -- arisen with GTECH over the years. And, 11 fundamentally, the purpose of those discussions was to 12 discuss the corporate governance that GTECH has in 13 place now, the issues that have come up in the past, 14 and what they have done as a corporation to try to 15 prevent such issues from occurring in the future. 16 Before I get into some of the generic 17 discussions we had with respect to that, it's also 18 important to note that once the transaction with 19 Lottomatica is complete, there will have to be an 20 integration of the corporate governance principles of 21 Lottomatica, the code of conduct of Lottomatica, with 22 that of GTECH. And it would be my suggestion that at 23 some time in the future, after that integration is 24 complete, that we follow up with both GTECH and 25 Lottomatica to see how they've meshed their procedures 0008 1 together. The purpose of which, then, is to get some 2 assurance that this Commission will be fully advised 3 of matters that may arise in the future before they 4 arise. And, secondly, to the extent that there are 5 any suggestions that I or the Commission would like to 6 make with respect to those, to make them better, if 7 possible, those -- the suggestions could be in -- and 8 we certainly have -- GTECH has just been receptive to 9 those discussions. 10 Let me briefly talk about the basic 11 fundamental concepts that GTECH has put into place to 12 supervise and, basically, to oversee things such as 13 the contracts with consultants that have been raised 14 before and some of the issues with regards to them. 15 The fundamental concept they have is, they have a 16 global business development and public affairs policy, 17 and they have a committee which oversees those 18 affairs. That committee -- all outside consulting 19 contracts go through that committee and have to be 20 approved by unanimous vote -- it's not written to be 21 unanimous, but it's unanimous -- but procedure has 22 developed that it requires unanimous vote. So, 23 basically, all consulting contracts will be reviewed 24 by that committee. 25 In addition, those corporate governance 0009 1 principles require that any contract which is for a 2 total of two million dollars or more than 500,000 3 dollars a year, has to also go before the Board of 4 Directors. 5 Now, with respect to that, currently, 6 the Lottery Commission receives reports with respect 7 to consultants contracts with consultants in Texas. 8 And we have discussed and GTECH has agreed to, in the 9 future, basically provide the Commission with a list 10 of all the contracts they have. And in that regards, 11 then, to the extent that we see anything or anything 12 raises some concern, we will have that information up 13 front. 14 In addition to that, if in fact -- now, 15 there aren't any -- there is only one current what we 16 call coterminous contracts still in existence. A 17 coterminous contract is a contract which runs for the 18 duration of -- a contract with a consultant or another 19 party that runs for the same amount of time as the 20 contract that GTECH has with various -- whatever 21 particular lottery that is. They currently only have 22 one of those. They have no intentions at this -- 23 current intentions to have any other such contracts in 24 the future but, of course, anything could happen. 25 It's not barred. But one of the other things we 0010 1 discussed is that with respect to anything like that 2 type of a contract or any other type of contract that 3 would require Board of Directors approval, that we be 4 notified immediately of those types of contracts as 5 well. And, again, GTECH has said there would be no 6 problem with doing that. 7 Now, the gist of that means that with 8 respect to these types of contracts in the future, the 9 plan would be that the Commission would up front be 10 aware of them, be able to monitor them, and then if 11 issues came up in the future, we would be aware of 12 them sooner. To the extent that any action that would 13 need to be taken by the Commission, they would be in a 14 position to do that. 15 As I mentioned, because of the merger 16 between GTECH and Lottomatica, I don't anticipate the 17 fundamental nature of the corporate governance 18 principles that were discussed with them will change, 19 but I do suggest that after that merger is complete 20 and after the integration is done that we revisit with 21 both GTECH and Lottomatica, what the integrated 22 procedures are going to be, and then perhaps report 23 back to the Commission sometime in the future, when 24 that integration is complete. 25 And that's basically what I wanted to 0011 1 say today. Now, I know the GTECH leadership team is 2 here, and I'm sure they would be happy to answer any 3 questions that you have, or if they intend to make a 4 presentation, but at this point, I would happy to 5 answer any questions you have, but that's essentially 6 my report right now. 7 COMMISSIONER COX: Mr. Mattax, thank 8 you, and please tell me if you think that these 9 questions would be better addressed to the folks from 10 GTECH. 11 The -- I think I heard you say that all 12 consulting contracts have to be reviewed by a board 13 committee. That would be this corporate compliance 14 and governance committee that Mr. Turner told us about 15 back in 2000. Do they have to be approved before 16 they're executed or are they ratified after they're 17 done? 18 MR. MATTAX: The general proposition 19 under the terms of the corporate governance rules is 20 that they are approved beforehand. Now, there is a 21 provision in here which allows them to be entered into 22 and then ratified afterwards, but if they're not 23 ratified -- and GTECH correct me if this has ever 24 happened before -- but the way I read it, it could be 25 done that way, but, again, if they're not ratified, 0012 1 they don't ever go into affect. So in other words, 2 you can't have a contract, is my -- in my reading of 3 these corporate governances -- someone at the local 4 level enters into, and then just goes back up to 5 Lottomatica's committee and just sort of rubber stamp. 6 That's not the way it's going to be. That committee 7 would then have to approve that contract, and if it 8 didn't approve it, it would never go into effect. But 9 my understanding is, the theory behind it and the 10 operational practice is that these contracts are 11 always approved beforehand. 12 COMMISSIONER COX: Okay. I think I 13 read -- help me remember -- in the report of the 14 Department of Public Safety that Mr. Turner generally 15 approved these contracts alone, and then once a year 16 submitted them to the board. 17 MR. MATTAX: I think they could 18 probably address that better, but that's not my 19 understanding. 20 COMMISSIONER COX: Okay. Thank you. 21 And then you indicated that a contract 22 over two million has to go to the board. 23 MR. MATTAX: A contract over 500,000 a 24 year, or over two million in total value. 25 COMMISSIONER COX: Okay. And would 0013 1 that be before they're executed or after they're 2 executed? 3 MR. MATTAX: Again, my understanding 4 is, it's before they're executed. And, again, they 5 can correct me if I'm wrong on that. 6 COMMISSIONER COX: And the only other 7 question I have is, do you have any indication how 8 long the integration of these two codes of conduct is 9 going to take before we might be able to take another 10 look? 11 MR. MATTAX: I don't know. My hope 12 would be -- and they can address that -- that we are 13 talking about maybe within three months after the 14 merger, but I really don't know. And that would be 15 speculative. But that would be what I would like to 16 put the time frame on it, but I don't know if that's 17 doable or not. I think that has to do with how GTECH 18 and Lottomatica, what their plans are, but it seems to 19 me that three months might be a reasonable amount of 20 time for them to get that together. 21 COMMISSIONER COX: Thank you, 22 Mr. Mattax. 23 CHAIRMAN CLOWE: Mr. Mattax, you head 24 up the Financial Litigation Division at the Office of 25 the Attorney General. Is that correct? 0014 1 MR. MATTAX: That's correct. 2 CHAIRMAN CLOWE: And, additionally, you 3 are the designated division for this agency in 4 contractual matters. 5 MR. MATTAX: That's correct. 6 CHAIRMAN CLOWE: And you have worked 7 with the Department of Public Safety and the outside 8 law firm that you employed in our behalf to do work on 9 this proposed transaction, so you have spent, in the 10 last four months maybe, more time than you probably 11 have spent with us in these types of matters for some 12 time. 13 MR. MATTAX: That's a fair assessment, 14 yes. 15 CHAIRMAN CLOWE: And what I would like 16 is an indication from you at this point -- I'm not 17 asking for a legal opinion, but an indication, based 18 on that experience and your position and your 19 knowledge, of what the value would be to this agency, 20 knowing what our internal resources are now as they 21 have been deployed to work with you in this matter, of 22 establishing, as long as the operator is an outside 23 firm for the conducting of the lottery operations, a 24 standing committee or a standing entity that would be 25 charged with the responsibility of oversight so that, 0015 1 as much as possible, all changes or surprises would be 2 eliminated and could be monitored on an ongoing basis? 3 MR. MATTAX: Well, I think that would 4 be an excellent methodology to impose. My suggestion 5 would be that someone in the Lottery Commission be 6 designated as the point contact with GTECH, or whoever 7 the outside lottery operator may be, but basically 8 have that structurally set up. In addition to that, 9 have the Department of Public Safety, maybe through an 10 outside agreement, interagency contract, be part of 11 that. And then, of course, my Office, the Attorney 12 General's office, could certainly work with that. And 13 then when we get these reports that are going to be 14 forthcoming from GTECH, and then obviously from 15 Lottomatica when that transaction is complete with 16 respect to what the contracts are, any unusual events 17 that may come up with respect to any large contracts 18 that may be approved by the board, then we would be in 19 a position to immediately vet them, and then if there 20 are any issues that gave us concern, then we would be 21 in a position to get back to GTECH or Lottomatica on a 22 short basis. So I think that formalizing the 23 structure there would be a good idea. I think -- I've 24 discussed that, I believe, and I think that Director 25 Sadberry agrees that there should be a point contact 0016 1 on these particular issues to work with GTECH in that 2 point contact. And then if anything looks unusual of 3 any concern, could then bring in other resources from 4 the Department of Public Safety and the Attorney 5 General's Office. 6 CHAIRMAN CLOWE: Well, you know, I 7 think we asked you and the law firm and the Department 8 of Public Safety to be available to our call in the 9 meeting where you made reports to us. But my concern 10 for the future, and this question is directed solely 11 to the future, as long as this agency employs an 12 outside corporate entity to be its lottery operator, 13 it would seem that we should add to the resources we 14 have internally with those which you bring, and 15 others, and the depth of experience and knowledge is 16 just much greater than anything we have here, so that 17 we constantly monitor issues such as we're going to be 18 talking about with Mr. Turner and his colleagues this 19 morning. I would like to get ahead of the curve and 20 be looking at issues as they develop and knowledgeable 21 about them so that we're right on top of anything that 22 comes to our attention. 23 MR. MATTAX: I would certainly agree 24 with that, and I think it's fundamentally important to 25 make sure that there is someone dedicated at the 0017 1 Lottery Commission level to have, basically, 2 continuous contact with GTECH about their contracts 3 and about their issues. And not just contracts, but 4 other issues that may arise or unusual transactions, 5 unusualness in the sense of -- not being nefarious 6 about them, but maybe just out of the ordinary, and so 7 that those could be brought to the attention of the 8 Lottery Commission so that we understand what they are 9 and so we're not in the situation where something 10 might look out of the ordinary and we go, well, now we 11 understand why that was done. And so I think that's 12 an excellent idea and I would certainly offer my 13 services to the extent to help in that regard. 14 CHAIRMAN CLOWE: Well, you and your 15 group have been most helpful. 16 And Director Sadberry, I know that you 17 have, I think, Mr. Jackson oversighting contracts as a 18 normal practice, but I think this contract and perhaps 19 others rise to a level beyond what normal oversight 20 Mr. Jackson is employing. And I would like to suggest 21 to you, with Commissioner Cox's concurrence, that you 22 explore this idea and determine if a standing group 23 could be established that can call on these resources 24 for the future and keep us advised currently on 25 anything that constitutes, within the contract, an 0018 1 issue for us. 2 MR. SADBERRY: Mr. Chairman, I fully 3 concur, I understand, and you can rest assured -- you 4 and Commissioner Cox can rest assured that that will 5 occur. I will report and advise you of that in due 6 course. 7 CHAIRMAN CLOWE: Thank you. 8 Anything further, Mr. Mattax? 9 MR. MATTAX: Not at this time. But I 10 would be happy to answer any further questions. I 11 think maybe the next step would be for Mr. Turner to 12 give his presentation, and I'll stay in the room and 13 would be happy to come back if there is any follow up. 14 CHAIRMAN CLOWE: Very good. Thank you, 15 sir. 16 Mr. Turner, will you come forward, sir. 17 MR. TURNER: Yes, sir. 18 COMMISSIONER COX: Mr. Chairman, do we 19 have Witness Affirmations on these people? 20 CHAIRMAN CLOWE: I don't know. Will we 21 have them or can we get them for everybody who is 22 going to testify this morning, please? 23 MS. KIPLIN: Sure, we certainly can. 24 MR. TURNER: Good morning, 25 Mr. Chairman. For the record, my name is Bruce 0019 1 Turner. I'm the CEO of GTECH. Commissioner Cox, how 2 are you. 3 Thank you for affording me the 4 opportunity to come before you today. You've heard 5 from Mr. Mattax, we have made a concerted effort to 6 address any issues of concern that you may have. 7 As I did last week, when we traveled 8 here to meet with lottery senior management, I brought 9 with me today my senior management team, effectively 10 in their entirety. And the bulk of these will also be 11 the senior management of the new Lottomatica once we 12 close that transaction, imminently. Today I'm joined 13 by Jaymin Patel, our Chief Financial Officer; Walter 14 DeSocio, our General Counsel -- I should point out 15 that Mr. Patel will be the Chief Financial Officer of 16 the new Lottomatica; Mr. DeSocio will be the Chief 17 Administrative Officer, which includes his duties as 18 General Counsel, of the new Lottomatica; Don Sweitzer, 19 our Senior Vice-President for Global Business 20 Development and Public Affairs; and Alan Eland, our 21 Senior Vice-President for the Americas. 22 With your permission, sir, I'll make 23 some remarks and then, obviously, I and my colleagues 24 will be happy to take any questions that you may have. 25 CHAIRMAN CLOWE: Certainly. 0020 1 MR. TURNER: When I last appeared 2 before you, it was actually six years ago, in 2000, I 3 started by providing you a brief summary of my 4 personal background. I told you of my early training 5 and having graduated from the United States Military 6 Academy at West Point, and I related the simple and 7 straightforward code of ethics and honor, which states 8 that you will not lie, cheat, steal, or tolerate those 9 who do. That code has remained a part of my value 10 system all of my life. It's certainly a good way to 11 start. 12 As I appear before you today, I want to 13 make it clear that I have steadfastly adhered to that 14 code. Any inference, either direct or otherwise, that 15 I have not followed those ethical principles is simply 16 wrong. 17 I can offer another observation that I 18 do believe is relevant and critical to your very 19 important review of these matters. GTECH has made 20 tremendous progress over the six years since I last 21 testified before you. We have improved governance, 22 we've improved security, we've improved oversight and 23 compliance. As you know yourself, running a large 24 company is a challenging task. It is a dynamic 25 process. It is one that requires continuous 0021 1 improvement. I understand how it would be human 2 nature to look at past events and assume that any new 3 developments are just more of the same. That is not 4 the case, and I appreciate the opportunity to tell you 5 why that is so. 6 As you have heard, my leadership team 7 and I have had the opportunity to provide the lottery 8 senior leadership, as well as representatives of the 9 Attorney General's Office, a full review of the wide 10 array of overlapping and interlocking control 11 mechanisms that we have in place today. Many of those 12 mechanisms have been developed and implemented in the 13 past six years. We review our policies and procedures 14 in areas of corporate governance, business evaluation, 15 internal and external auditing, global accounting, 16 code of conduct, training and awareness, government 17 relations activities and oversight. 18 We have also made them familiar with 19 the due diligence efforts of other jurisdictions 20 regarding the Lottomatica transaction. Because of its 21 20-year concession contract with GTECH, the Rhode 22 Island lottery and other Rhode Island reviewing 23 agencies, including the Rhode Island State Police, 24 created a dedicated team to review all aspects of this 25 very large transaction. A highly regarded law firm 0022 1 with offices in the United States and Europe was hired 2 to lead the due diligence review, along with Kroll 3 Associates, an internationally-recognized corporate 4 investigative firm. PriceWaterhouseCoopers was also 5 included in the team to evaluate all detailed 6 financial aspects of the transactions and any 7 implications that may flow from that. 8 GTECH, Lottomatica, and De Agostini 9 provided full access to all requested information and 10 key personnel. With the support the Rhode Island 11 State Police, the team also reached out to other 12 relevant law enforcement organizations worldwide. 13 The review process in Rhode Island 14 culminated in the preparation of a substantial written 15 report which was presented in a public meeting. I am 16 aware that the Texas Lottery staff has a copy of the 17 Rhode Island report, which is also currently available 18 on the Web site of the Rhode Island lottery. 19 Most other relevant lottery authorities 20 chose to conduct a due diligence review collectively 21 through the auspices of the North American Association 22 of State and Provincial Lotteries, or NASPL as it's 23 referred to. NASPL created an oversight committee 24 comprised of the representatives from each lottery, 25 and/or the Attorney General's Office of the respective 0023 1 states involved. They selected Grant Thornton, 2 L.L.P., an internationally-recognized accounting firm, 3 to lead the comprehensive review process. As well, 4 they focused on corporate information, key individual 5 investigations, and interviews, management 6 presentations and site visits. They also interacted 7 with relevant law enforcement and regulatory agencies 8 worldwide. 9 Given their report is not publicly 10 available nor has a copy been provided to GTECH, we 11 understand from discussions with a number of NASPL 12 members who were involved in the comprehensive process 13 that the final report is favorable in both its 14 findings and conclusions. That understanding is 15 reinforced by the fact that, at present, GTECH has 16 received consents or assurances to our proposed 17 transaction from, among others, the States of 18 California, Georgia, Michigan, Illinois, Ohio, New 19 York, and as we announced in an AK from -- filed with 20 the SEC this morning, the State of Florida. 21 It is important to note that the Texas 22 DPS testimony to the Commission was provided prior to 23 the publication of the final NASPL and Rhode Island 24 reports. Subsequent to that DPS testimony, each of 25 those respective due diligence teams took the time, as 0024 1 have you, to re-examine the matters raised by DPS 2 prior to publishing their final reports. Those final 3 reports were favorable to the transaction and, we 4 understand, complementary of GTECH's management 5 practices and corporate governance structure 6 worldwide. 7 We have a tremendous amount of respect 8 for the DPS team. Certainly, the enormity of the task 9 that they were given and the commitment and diligence 10 they brought to their work, it is admirable. While 11 the subjects highlighted in the DPS testimony to the 12 Commission have been previously disclosed by GTECH, we 13 appreciate why the DPS team would bring them to your 14 attention. I want to assure you that I take the DPS 15 comments very seriously. I am confident that the 16 several areas outlined and highlighted represent, in 17 some cases, misunderstandings. 18 Our disclosure of reports that were 19 actually given as oral presentations, not written 20 submissions, have led to a great deal of confusion and 21 consternation. That is unfortunate, regrettable, and 22 easily corrected. 23 Let me provide you, if I may, a broader 24 perspective on the issue of document disclosure. As a 25 result of our business strategy, GTECH has voluntarily 0025 1 opened the company to greater inspection and review, 2 which includes some of the most stringently regulated 3 gaming jurisdictions in the world, such as the states 4 of Nevada and New Jersey, just to provide two 5 examples. GTECH has received over 90 commercial 6 gaming licenses in the past several years. We are in 7 the process of applying for a hundred more. We are 8 accustomed to dealing with comprehensive and, at 9 times, intrusive due diligence, led by law enforcement 10 and other agencies around the world. That's simply 11 the business we're in. There is no other lottery 12 vendor in the world that has had the same depth of 13 scrutiny that we welcome on a continuous basis. I 14 hope you can appreciate that it would be quite 15 illogical for us to purposely withhold information 16 from a single jurisdiction when we're simultaneously 17 providing exactly that same information to almost 200 18 other investigative agencies worldwide. 19 It is important for you, I believe, to 20 understand that we have reached out to DPS 21 investigators to provide them with assurances in 22 writing that we have been forthcoming in responding to 23 their document requests. We will continue to 24 cooperate with them in providing any further 25 information they may require as they continue their 0026 1 work with the Texas Lottery Commission. 2 If I may, I would like to focus on how 3 GTECH has changed since my arrival six years ago. 4 I'll begin by highlighting our corporate governance 5 structure which, six years ago when I testified before 6 you, was in its very infancy. As you may be aware, 7 GTECH has an independent Board of Directors. I am the 8 only GTECH employee to serve on the board. We have an 9 independent Chairman of the Board. That has been in 10 place for the past six years. That remains a unique 11 structure in United States corporate governance; it is 12 more common in Europe. 13 There is a corporate governance and 14 compliance committee of the Board of Directors that 15 independently reviews matters such as those raised in 16 the DPS review. You should be aware as well that we 17 have a stringent code of conduct, which is supported 18 by training, annual certifications, and processes for 19 employees to contact our Board of Directors directly 20 and anonymously, if desired. We reviewed that code 21 and its interrelation with our business development 22 processes and procedures at great length during our 23 recent meeting with Mr. Sadberry and his team. Our 24 system of corporate governance and internal controls 25 within GTECH was instrumental in providing me, as the 0027 1 Chief Executive Officer of the company, and Jaymin 2 Patel, as our Chief Financial Officer, the comfort to 3 sign the certifications required under the newly 4 implemented Sarbanes-Oxley Act for our fiscal years 5 2005 and 2006. In fact, as a government services 6 company, we have always maintained a strong and 7 comprehensive system of financial controls, which 8 ultimately helped us to meet the rigorous requirements 9 of the Sarbanes-Oxley Act in an efficient and timely 10 manner. All of our operating managers around the 11 world, my senior staff, and supporting financial 12 personnel provide the appropriate representations that 13 ultimately support the company's certifications that 14 we sign. 15 I believe it's also noteworthy that the 16 GTECH Board of Directors has been named the top 17 performing board in the gaming industry by an 18 international consulting organization for the past two 19 years in a row. That is testimony, I believe, to the 20 robust nature of our corporate governance procedures 21 and policies and the diligent manner in which our 22 Board of Directors oversees those activities and the 23 management of our company. 24 An example that I believe is somewhat 25 illustrative of how the board operates when confronted 0028 1 with a compliance issue relates to events in Brazil. 2 As you have been made aware, GTECH was the target of a 3 well-organized extortion scheme led by high level 4 government officials that -- and senior members of the 5 ruling political party. The board and various 6 subcommittees of the board have been actively involved 7 in reviewing this matter. It has discussed and 8 discussed and been briefed on the situation in Brazil 9 over 40 times since the issues first arose. It has 10 conducted a comprehensive independent investigation of 11 our Brazilian operations, using the outside resources 12 of a highly-experienced international investigative 13 law firm, Williams & Connolly, which is based in 14 Washington, D.C. 15 Likewise, when we became aware of 16 concerns in Trinidad, which had its origins before my 17 arrival, in 1998, the board conducted an independent 18 review and audit. The outcomes of those reviews, 19 which determined that GTECH personnel had not violated 20 any laws, have been reported to all regulatory 21 agencies, including the United States Securities and 22 Exchange Commission. 23 GTECH also has policies in place today 24 that provide oversight in the form of a high level 25 internal government affairs committee, that Mr. Mattax 0029 1 referred to, that oversees background suitability 2 checks and approves all consulting agreements and 3 business partnerships. All of the activities of the 4 government affairs committee are reported to the GTECH 5 Board of Directors. In addition, the Board's approval 6 is required if contracts reach certain thresholds, 7 which Mr. Mattax has already referred to. 8 By example, the consultancy arrangement 9 in Poland that was brought to your attention had been 10 reviewed as part of our business evaluation process 11 conducted by the GTECH finance organization, and 12 separately by the government affairs committee. That 13 kind of overlapping and interlocking review is a 14 required procedure. The GTECH board had been -- has 15 been consulted on this matter as well. That 16 consultancy arrangement, while admittedly unique, 17 underwent rigorous review and was deemed appropriate 18 and necessary, as has been reported to numerous 19 regulatory agencies worldwide. 20 When it comes to investing shareholder 21 capital, one of the most important review areas for a 22 board of any type, of any company, GTECH has 23 instituted stringent policies and procedures that 24 guide the evaluation of investments, which are 25 specifically approved by the Board of Directors. In 0030 1 the Czech Republic, our lottery customer, which is an 2 agency owned by sports organizations and founded to 3 promote sports and athletic competition, wanted to 4 construct a sports stadium. As part of an overall 5 economic package, we were able to marshal the strength 6 of our financial resources and help them fulfill that 7 mission critical opportunity. That investment was 8 reviewed and approved by the GTECH Board of Directors. 9 The investment was also met with great 10 enthusiasm publicly when announced in the Czech 11 Republic. The arena has been constructed and is the 12 premier venue for sporting competition and 13 entertainment programs in Prague today. The loan 14 guarantees provided by GTECH are being repaid 15 according to a normal schedule. Not only were our 16 policies and procedures followed, we were able to 17 usher in a new business model that we believe 18 differentiates GTECH in the marketplace and helps our 19 customers achieve their unique objectives, which can 20 be different around the world. 21 As our global customers continue to 22 remain financially challenged to meet ever-expanding 23 requirements, I anticipate the lottery vendor 24 community will increasingly employ shareholder capital 25 in new and innovative ways to meet the changing 0031 1 requirement set of our customers. We stand prepared 2 to meet that challenge and will provide leadership to 3 do so. 4 As I have talked with you today, I hope 5 I have provided at least a bit of a sense that GTECH 6 has changed since I last visited you. Every business 7 encounters challenges. Our business operates at the 8 vortex of politics and gambling, which requires a 9 heightened sense of awareness and adherence to strict 10 compliance processes. It is not a landscape that we 11 see through clouds or shades of gray. We at GTECH 12 pursue our business in a manner which differentiates 13 right from wrong, in a way that is brightly 14 illuminated and clearly visible to all GTECH 15 employees. That is because we have made a practice of 16 doing the right things for the right reasons, as part 17 of our core philosophy of operating our company, and 18 our policies and procedures help to ensure that 19 outcome. 20 My ethical foundation was formed as a 21 young man, molded by a unique institution known simply 22 as West Point. I could have no better teacher, and 23 those lessons carry through to the company I now have 24 the distinction to lead. As our 4.8 billion dollar 25 merger transaction with Lottomatica nears its close, 0032 1 we will begin a new chapter in GTECH's history. I 2 have described it to my employees worldwide as chapter 3 two, page one. We will be larger, we will be more 4 international, we will be stronger, and, by 5 definition, we will also be more complex. This will 6 certainly not be an easy task, but we look forward to 7 the myriad of business opportunities that our future 8 holds. We also welcome the continued careful scrutiny 9 that comes in the regulated gaming world. I have 10 recently recommended to the NASPL leadership that the 11 global review we have just completed with various 12 jurisdictions worldwide should form the basis for a 13 new RFP standard surrounding vendor integrity and 14 transparency. This standard of scrutiny has been a 15 baseline serving the commercial gaming industry for 16 many, many years. It is my hope that it will become 17 the standard of transparency for the lottery industry 18 as well in the future. 19 Mr. Chairman, six years ago, outside 20 the corridors of this room, you personally made me 21 aware of your expectations of my leadership team and 22 of me. As I vividly recall, you told me that you 23 would not tolerate the kind of problems that have been 24 previously associated with GTECH, on my watch. That 25 resonated with me, and I remember it quite well. I 0033 1 considered it then, and I do today, my duty to fulfill 2 our obligations to you and to the people of Texas. It 3 is my responsibility to continue to lead this company 4 with integrity, with honor, and with trust. I assure 5 you that I will continue to do so. 6 I appreciate the opportunity to appear 7 before you today, and my colleagues and I would be 8 happy to answer any questions that you may have at 9 this time. 10 CHAIRMAN CLOWE: Thank you, Mr. Turner. 11 COMMISSIONER COX: Would you like me to 12 start? 13 CHAIRMAN CLOWE: Sure. 14 COMMISSIONER COX: Okay. Mr. Turner, 15 we appreciate your coming to this Commission and 16 making this report. 17 MR. TURNER: Yes, sir. 18 COMMISSIONER COX: You've told us a lot 19 about what you've done and what other jurisdictions 20 have done. These things can but provide us with cold 21 comforts. The only warm comfort that we can get is 22 from the work that's done by the Texas Attorney 23 General and Texas Department of Public Safety. So 24 many of the things that I will be asking you about 25 today will be related to those specific things, 0034 1 helping me understand in certain instances where -- 2 how apparent conflicts between what you said and what 3 they said can be reconciled. 4 MR. TURNER: Yes, sir. 5 COMMISSIONER COX: I have some 6 questions. I've got a lot of questions. And I want 7 to preface my questions with the statement that I 8 recognize that what you and your associates are trying 9 to do is very difficult. In today's world, and I 10 believe this is particularly true with international 11 government contracting, it is very hard to succeed and 12 at the same time conform to high ethical standards. 13 I've carefully reviewed a number of 14 documents, and based on that review, I believe that 15 you personally have high ethical standards and have 16 attempted and are attempting to ensure worldwide 17 compliance with GTECH's code of conduct. In no way 18 should any question I ask you be interpreted as 19 questioning your personal standards or your integrity. 20 Having said that, I believe the people 21 of Texas want to know more about some of the matters 22 you've addressed. This a due diligence process and, 23 as you've said, you're very accustomed to that 24 process. 25 The integrity of the Texas Lottery and 0035 1 GTECH as the lottery operator is very important to the 2 people of Texas and to their elected officers and 3 representatives, and those are the folks to whom this 4 Commission reports. My questions, again, do not go to 5 your personal integrity, they go to how successful you 6 have been in changing the culture of GTECH, given the 7 environment in which it operates. I intend that this 8 dialogue will be constructive. I have read and I hear 9 that you're committed to high ethical standards. What 10 I'm trying to discover is how effectively you have 11 manifested that commitment, how effective you have 12 been as an agent for change, and how perhaps you can 13 be more effective in the future. 14 You've referred to your appearance 15 before the -- this Commission in September of 2000. I 16 believe that was shortly after you were named Chairman 17 and I believe at that time you were acting CEO. Is 18 that correct? 19 MR. TURNER: That is correct, sir. 20 COMMISSIONER COX: And you appeared 21 before Chairman Clowe and Commissioner Whitaker and 22 Commissioner Sadberry, who of course is now our 23 executive director, you appeared to report on a matter 24 in the United Kingdom that it seems GTECH had quietly 25 corrected, a software malfunction, without notifying 0036 1 the National Lottery Commission. You told this 2 Commission what the GTECH Board of Directors did in 3 that case, and you said that those actions represent 4 the standards by which we would hope that you would 5 judge GTECH in the future. You reported that an 6 investigation was conducted because the integrity of 7 the lottery was in question. You reported that your 8 most important objective was, quote, to ensure that we 9 protect that integrity at all times. Once the facts 10 were fully known, you said, it was clear to the board 11 and to myself that the only course of action was a 12 radical change in the leadership of the company. So 13 you sought and received the resignations of the three 14 top executives involved in the incident, which 15 included the Chairman and CEO, the Chief Operating 16 Officer, and head of European operations. 17 You said, additionally, the structure 18 of the Board of Directors has been changed. The post 19 of Chairman and Chief Executive Officer has now been 20 separated. The membership of the Board of Directors 21 is in the process of being strengthened and expanded 22 with additional independent nonexecutive directors. 23 Further, the company created a new committee of the 24 Board, the Compliance and Corporate Governance 25 Committee, to oversee the proper handling and 0037 1 resolution of ethical issues. You reported that your 2 compliance officer, Paul Daly, a respected veteran of 3 the FBI, reports directly to the Board, any member at 4 any time. You reported that GTECH's board has been 5 vigilant and aggressive in making certain that its 6 code of conduct has become institutionalized within 7 the company. You said you believed that has taken 8 place. This was six years ago. 9 MR. TURNER: Yes, sir. 10 COMMISSIONER COX: Mr. Turner, did you 11 bring Mr. Daly with you, the corporate compliance 12 officer? 13 MR. TURNER: Mr. Daly does not work for 14 GTECH any more. 15 COMMISSIONER COX: Does he have a 16 counterpart, at this time, a corporate compliance 17 officer? 18 MR. TURNER: Walter DeSocio, the 19 General Counsel, serves in that capacity. 20 COMMISSIONER COX: I see. And does he 21 serve with exactly the same charter that Mr. Daly 22 does? 23 MR. TURNER: Yes, sir, he does. 24 COMMISSIONER COX: So any questions 25 that I might have wanted to ask Mr. Daly, it would be 0038 1 appropriate to ask Mr. DeSocio? 2 MR. TURNER: Yes, sir. 3 COMMISSIONER COX: Okay. And when did 4 Mr. Daly depart? 5 MR. TURNER: Commissioner Cox, I don't 6 remember the exact date. I believe it was sometime -- 7 do you guys remember? 8 MR. SWEITZER: 2003. 9 MR. TURNER: 2003. 10 COMMISSIONER COX: And do you recall 11 the circumstances under which he departed? 12 MR. TURNER: I do not recall the 13 specific circumstances, sir. At that time, I was not 14 the CEO of the company. 15 COMMISSIONER COX: Is there someone 16 here who might recall those circumstances? 17 MR. SWEITZER: Yes, sir. He retired. 18 COMMISSIONER COX: So he retired and 19 was not replaced as such, but his duties were shifted 20 over to your General Counsel? 21 MR. TURNER: Yes, sir. 22 COMMISSIONER COX: Okay. You further 23 stated at that time, the problems that occurred in the 24 United Kingdom were errors in judgment, primarily by a 25 single individual, that were clear violations of our 0039 1 code of conduct. That error cost three parties to 2 that decision their jobs. 3 Continuing, you said, quote, it is my 4 firm commitment, and that of the Board, to continue to 5 actively promote our code of conduct and emphasize the 6 need to comply with it at all times under all 7 circumstances. 8 You went on to say, let me reiterate, 9 however, the GTECH board acted definitely, with great 10 concern, and intentive purpose. Individuals in the 11 company acted improperly. They were removed. 12 Structures and processes have been changed and 13 strengthened to ensure that similar circumstances 14 would not occur in the future. That is the standard 15 by which we expect to be judged. 16 Now, the words I hear you saying today 17 are much like the words I heard -- I read that you 18 said to Chairman Clowe and Commissioners Whitaker and 19 Sadberry back in 2000. And yet, the Department of 20 Public Safety reported a number of instances that have 21 occurred on your watch that seem to fit the pattern of 22 the things that you told us were not going to occur. 23 So that's where I want to help -- want you to help me 24 understand whether they're distinguishable and, if so, 25 what further corrective action is indicated and what 0040 1 further corrective actions have been taken. We all 2 know that we can't write a code of ethics that's going 3 to anticipate everything that could possibly go wrong, 4 but as we learn lessons, we change things to try to 5 make them better. 6 So I want to look at this from the 7 standpoint of, do you believe that the DPS, Department 8 of Public Safety, properly characterized these things 9 and, if so, were there lessons learned that have been 10 taken into account so that you can further improve the 11 process that you brought to GTECH. 12 MR. TURNER: Well, to your direct 13 question -- 14 COMMISSIONER COX: And that really 15 wasn't a question at that point. That's an indication 16 of where I'm going to be going when I start asking 17 questions. 18 MR. TURNER: I'll wait for your 19 questions, then, Commissioner. 20 COMMISSIONER COX: In conclusion, you 21 stated, we have made the right decisions for the right 22 reasons and acted proper firmly and promptly to 23 protect the integrity of the Lottery and to protect 24 the public trust. We can have no greater mission. We 25 are now clearly focused on the future. 0041 1 I want to assure you personally that I 2 take our responsibilities to the citizens of the State 3 of Texas quite seriously. I started by telling you 4 briefly of my training at West Point -- and you did 5 that again today. The core values of honor and 6 integrity are very central to me and have been a 7 hallmark of my career. I recognize that we at GTECH 8 need to earn your trust by being true to the 9 responsibility and those values, which I do embody 10 personally, each and every day. That is our duty. 11 Now, this is a question. Before today, 12 over six years since you made that statement, what 13 have you personally and specifically done for the sole 14 purpose of earning the trust of this Commission and 15 the citizens of the State of Texas? 16 MR. TURNER: Well, I think that can be 17 answered in several ways, Commissioner Cox. 18 Obviously, we have continued to fulfill our duties and 19 obligations here in the State of Texas, working with 20 your staff of professionals and your lottery 21 professionals, to help you optimize your business 22 enterprise. I think the results in that regard speak 23 for themselves. You've been, obviously, actively 24 involved in that as well. 25 Additionally, we have, over this period 0042 1 of time, strengthened the various policies and 2 procedures that I've talked about and taken that 3 message worldwide. The level of transparency that we 4 have today, both with our Board of Directors and with 5 a variety of outside regulatory agencies that are 6 reviewing our company, based on our business strategy 7 to move more aggressively into the commercial gaming 8 industry, is light years ahead of where we were six 9 years ago. So I do believe that we are in a very 10 different place. 11 On a personal note, I and my senior 12 colleagues make it a point, as we go around the world 13 and we meet with employees of GTECH, who operate in 50 14 different countries and many different languages, to 15 try to make sure we reinforce the various elements of 16 integrity, of ethics, of an understanding that we must 17 operate our business with the utmost of transparency 18 at all times. We try to not only behave that way 19 personally, but take that message out to our various 20 people around the world as we have opportunity to do 21 so. So those are -- are many examples of the things 22 that we have done actively and that I have done 23 actively over the past six years. 24 COMMISSIONER COX: Well, that was 25 partially responsive. I asked what you had personally 0043 1 and specifically done for the sole purpose of earning 2 the trust of this Commission and the people of Texas, 3 but we'll get to that in a moment. 4 Later on in that meeting, in response 5 to a question from Commissioner Sadberry, you reported 6 that you were relaunching a worldwide ethical training 7 program to ensure that we keep that top of mind with 8 every associate in GTECH, anywhere we operate. We 9 actually have an individual designated within our 10 training function, which we have now funded with an 11 incremental 1.5 million. We will have a number of 12 support materials which identify the toll free number 13 that goes directly, not to GTECH, but to the Council 14 for Ethical Organizations, an external compliance 15 activity. Reported concerns will be funneled directly 16 to Paul Daly and directly, as a result, to the Board 17 of Directors. To make people aware of the phone 18 numbers, we'll provide simple things, like a mouse pad 19 that's right on your desk, which provides the phone 20 number. If it's top of mind, you'll ensure that you 21 do the right thing. So I'm confident, based on the 22 collection of these type of activities we are now 23 conducting, that a problem of this type is very 24 unlikely to occur again in the future. 25 Tell me a little bit about how this 0044 1 really came down. Did you actually end up setting up 2 this hotline to the Council for Ethical Organizations? 3 Did reported concerns go to Mr. Daly, and, in turn, to 4 Mr. DeSocio, and did you really print up the mouse 5 pads? How did this come out? 6 MR. TURNER: Yes, sir, we did those 7 things. We launched, in 2000, a worldwide training 8 plan. That training plan has evolved, obviously, over 9 the years to meet the needs of our respective 10 employees around the world. We launched an external 11 toll free number that would allow any of our employees 12 around the world to anonymously raise issues through 13 what we call our integrity line. We report any calls 14 in to that integrity line. It has been used over the 15 years. Generally speaking, Commissioner Cox, it's 16 used for HR related items. But that goes 17 independently to the Board. They review that, the 18 Corporate Governance Committee of the Board of 19 Directors and their chairman, review that report on a 20 quarterly basis and have continued to do so. 21 Where we have had areas of sensitivity 22 during the past six years that required a greater 23 sense of scrutiny and investigation, those activities 24 were also conducted by the Board of Directors. So the 25 things that I described to you as our plan of action 0045 1 six years ago have very much been put in place. It 2 has evolved over time, as you would expect it to. 3 COMMISSIONER COX: Sure. 4 MR. TURNER: And I expect it will 5 continue to evolve in the future. 6 COMMISSIONER COX: Excellent. Okay. 7 At that meeting Chairman Clowe said, you have given us 8 your personal assurance that you are in charge and 9 that you're going to operate in a totally ethical 10 manner throughout the entire company. That's very 11 important to us and we're going to depend on you to do 12 that. 13 And that's very consistent with what he 14 indicated -- you indicated he told you privately as 15 well. 16 MR. TURNER: Yes, sir. 17 COMMISSIONER COX: I have had that 18 personal assurance from the individuals that you 19 mentioned who are no longer with the company, however. 20 And that was a matter of concern for us, when the 21 events began to be discovered and we got information 22 about what was going on in your company. 23 And that goes, I think, to some of my 24 concern about, we have heard this before, but yet 25 these things keep happening. And we'll get to that in 0046 1 detail in a moment. 2 You know, in a sense -- this is 3 Chairman Clowe again -- we're partners here, and we 4 cannot go forward without the trust and the confidence 5 that is implicit in our relationship. Chairman Clowe 6 goes on to say, my view is, you have a tough job. 7 I certainly agree with that. You have 8 a tough job. 9 And I think that the person that you 10 select as CEO -- at the time you were not the CEO. I 11 think you were the Chairman and acting CEO. 12 MR. TURNER: That's correct. 13 COMMISSIONER COX: And I think that the 14 person that you select as the CEO is critical to your 15 policies being implemented in a very effective and 16 meaningful way. To that end, I think it's fair to ask 17 you to come back and to bring the CEO of the company 18 when that person is selected. Not immediately upon 19 that decision being made, but perhaps within about six 20 months, and tell us how you feel about the progress 21 that you have made and where you feel you are with the 22 CEO, and talk to us about your company. This -- and I 23 have this underlined. This is not a 24 one-time-it's-done kind of thing that you, I think, 25 should walk away from here and leave us feeling good. 0047 1 I want some further assurance. 2 If it isn't an imposition, on behalf of 3 the Commissioners, I would like to ask you to come 4 back and give us a progress report and let us know how 5 you're moving along with the goals and objectives that 6 you have set. 7 And this is your response. 8 Mr. Chairman, I would be happy to do that. I will 9 happily bring the new Chief Executive Officer back 10 with me and we can provide you with frequent -- as 11 with frequent progress reports as you'd like. 12 You would have my personal guarantee, 13 sir, that I take your comments to heart. I am 14 personally responsible for the actions of GTECH, all 15 that we do or do not do. That is my duty. You have 16 my word on that, and I can provide no stronger 17 guarantee. So I look forward to continuing a long 18 relationship with all of you. 19 Now, that ends the quotes that I'll be 20 bringing from the September 2000 Commission meeting. 21 That was the September 11th, 2000, meeting. 22 Now, did, after that meeting, GTECH 23 name a permanent CEO? 24 MR. TURNER: Yes, sir, we did. 25 COMMISSIONER COX: And who was that 0048 1 permanent CEO. 2 MR. TURNER: The permanent CEO was a 3 gentleman named Howard Cohen. 4 COMMISSIONER COX: And when was he 5 named CEO? 6 MR. TURNER: He was named CEO in early 7 2001. I believe it was March or April. 8 COMMISSIONER COX: April 26th. 9 MR. TURNER: Right. 10 COMMISSIONER COX: So to have met your 11 commitment to this Commission, you and Mr. Cohen would 12 have reported your progress on the implementation of 13 your new policies and programs by October or November 14 of 2000. Did you do that? 15 MR. TURNER: I did not attend the 16 Commission again. Mr. Cohen did come and report to 17 the Commission sometime after he was appointed as the 18 CEO. I don't remember what that date was, sir. 19 COMMISSIONER COX: How long did 20 Mr. Cohen serve? 21 MR. TURNER: He was the CEO of the 22 company for 16 months. 23 COMMISSIONER COX: For 16 months. 24 Until August of 2002. 25 MR. TURNER: Yes, sir. 0049 1 COMMISSIONER COX: And at that time, 2 you became the CEO. 3 MR. TURNER: That's correct. 4 COMMISSIONER COX: Under what 5 circumstances did Mr. Cohen cease to be the CEO? 6 MR. TURNER: The Board of Directors 7 determined that he was unsuitable for the company and 8 replaced him. 9 COMMISSIONER COX: So after an 10 extensive effort, led by Korn/Ferry and yourself to 11 recruit a CEO, then 16 months later, the Board 12 determined that you had failed. 13 MR. TURNER: The Board determined, sir, 14 that the selection was inappropriate. That is 15 correct. 16 COMMISSIONER COX: When you were named 17 CEO in August 2002, did you come before this 18 Commission to make any reports on progress of the 19 implementation of your new policies and programs? 20 MR. TURNER: No, sir, I did not. 21 COMMISSIONER COX: Before today, have 22 you come before this Commission for that or any other 23 purpose since September of 2000? 24 MR. TURNER: No, sir, I have not. 25 COMMISSIONER COX: Do you recall 0050 1 Chairman Clowe telling you, this is not a 2 one-time-it's-done kind of thing that you, I think, 3 should walk away from and leave us feeling good. I 4 want some further assurance? 5 MR. TURNER: Yes, sir, I do remember 6 that. 7 COMMISSIONER COX: That was almost six 8 years ago. Before today, have you done anything at 9 all to provide him and to provide this Commission with 10 that assurance? 11 MR. TURNER: Sir, I believe what we 12 have done directly to the Commission -- to be 13 responsive to your question, the answer is no. What 14 we have done, however, is keep in direct contact with 15 the Director -- there have been several, obviously, 16 over the years -- and their staff to keep them fully 17 apprised of -- and I have visited the Texas Lottery 18 staff on numerous occasions over the past several 19 years to do so. 20 COMMISSIONER COX: But the answer was, 21 as to this Commission, you have personally done 22 nothing since September of 2000? 23 MR. TURNER: In a formal Commission 24 setting such as this, that is correct, sir. 25 COMMISSIONER COX: Thank you. Okay. 0051 1 Now, looking at some specific matters 2 that the Department of Public Safety got into. Does 3 the GTECH code of conduct apply to consultants or only 4 to employees? 5 MR. TURNER: It applies to all parties, 6 including consultants. 7 COMMISSIONER COX: Okay. And your 8 transmittal letter with the code of conduct says, 9 these guidelines apply to all GTECH employees around 10 the world. We expect our representatives, 11 consultants, and contractors to be guided by these 12 principles as well. 13 What kind of orientation and training 14 are consultants given to know that they are aware of 15 the code of conduct and are expected to comply with it 16 in everything they do? 17 MR. TURNER: Commissioner Cox, if I 18 may, I think the -- to provide you the most 19 comprehensive answer to that question, I'll ask 20 Don Sweitzer, my Senior Vice-President of Global 21 Business Development and Public Affairs, to address 22 that. 23 COMMISSIONER COX: And would you and 24 Mr. -- would you and he sign your Witness Affirmation 25 Forms, please. 0052 1 MR. TURNER: Yes, sir. 2 MR. SWEITZER: Commissioner, in answer 3 to your question about specific training for 4 consultants. We go through a process with them when 5 we first identify an individual or a company that we 6 are considering to hire for a -- as a consultant. 7 Generally, the local person, our local person on the 8 ground, is the first person that meets with this 9 individual and, basically, in an informal way, walks 10 them through our policies and procedures. 11 When we get to a point where the local 12 person, in conjunction with the people that work in my 13 organization, which are the global business 14 development, basically, international sales people, 15 plus government relations employees, who also work in 16 my organization, when we get to a point where it -- 17 there have been a couple of interviews and it's clear 18 that we think we want to hire this individual or 19 company, generally, not in a hundred percent of the 20 cases, but pretty close to it, a -- I will conduct a 21 personal interview myself with the individuals. At 22 that time, we do a more formal walk-through. I have 23 the policies and procedures with me. I talk to them 24 about it. I talk through -- it usually takes several 25 hours, because in many cases we're talking to people 0053 1 in foreign countries, emerging economies, and so on 2 who are not -- sometimes not even familiar with 3 general business practices. And we walk them through 4 very clearly our policies and procedures. In the case 5 of international consultants, also the Foreign Corrupt 6 Practices Act and the things that are covered by the 7 laws of the United States, and we make it very clear 8 to them that we're serious about these rules and 9 so on, and we're -- and go through fairly extensive 10 discussion with them. 11 When we get to the formal aspect of 12 hiring them, they are required to review our policies 13 and procedures and sign a document that they 14 understand them and that they intend to comply with 15 them. They are then required, on a yearly basis, to 16 recertify that they understand the policies and 17 procedures. And from time to time, policies and 18 procedures get adjusted or changed. They're required 19 to review them, read them, and indicate that they are 20 familiar with them, and that not only are they 21 complying with our policies and procedures, but they 22 are complying with the policies and procedures in the 23 state or the country in which they operate. 24 Part of their contract also requires 25 them to inform us of developments or changes in their 0054 1 own state or government as it applies to consultants, 2 lobbyists, and so on. That's not the only way that we 3 monitor those things. Our own counsel monitors those 4 in every country that we -- and state that we operate 5 in. But that's the procedure when we first bring 6 someone on. 7 COMMISSIONER COX: That sounds like a 8 very thorough procedure. When did you put that 9 procedure in place? 10 MR. SWEITZER: That procedure has been 11 in place for several years. I have been with the 12 company for eight years and that's how we have done it 13 as long as I've been there. I think it was an 14 informal process several years ago, five or six years 15 ago, or when Bruce came on, and we -- we -- the 16 evolvement or tightening up of our procedures, now 17 it's required that all of these -- I have to say, I 18 think, years ago, consultants -- I also served as a 19 consultant to GTECH many years ago, and things were 20 done in a much more informal basis at that time. But 21 it -- but this type of procedure has been in place for 22 about six or eight years. 23 COMMISSIONER COX: I don't want to get 24 into the details right now of the Department of Public 25 Safety's report, but the sense of it with respect to 0055 1 what happened in Brazil and Trinidad and Tobago was 2 that the process was not like you've just described. 3 MR. SWEITZER: Was not what? 4 COMMISSIONER COX: Was not like you've 5 just described. 6 Did you personally go to Brazil and 7 meet with those folks down there? 8 MR. SWEITZER: Yes, I've been to Brazil 9 many times and -- 10 COMMISSIONER COX: Did you meet with 11 the consultants there before they were hired? 12 MR. SWEITZER: Yes. 13 COMMISSIONER COX: And you briefed them 14 on your ethics? 15 MR. SWEITZER: Yes. 16 COMMISSIONER COX: And did you meet 17 with the consultant in Trinidad and Tobago? 18 MR. SWEITZER: There was not a 19 consultant situation in Trinidad and Tobago. 20 COMMISSIONER COX: I thought I 21 understood that GTECH hired someone there to spread 22 some money to a program that you were required to 23 support under your contract. 24 MR. SWEITZER: No. We were required 25 under our contract, in Trinidad and Tobago, to support 0056 1 certain community activist groups and projects as part 2 of our contract. 3 COMMISSIONER COX: And I believe the 4 Department of Public Safety's report said that that 5 money ended up in the hands of a lottery commissioner? 6 MR. SWEITZER: There is an ongoing 7 investigation there now that, I believe, that one of 8 the firms that was doing this community service work, 9 that some money made its way to an individual who 10 eventually -- and then money eventually made it to 11 either a company or an individual who served as a 12 lottery commissioner. I think that's an ongoing 13 investigation. 14 COMMISSIONER COX: Okay. So Mr. 15 Turner, I think you've said that your board is 16 investigating that matter? 17 MR. TURNER: Yes, sir, they have. 18 COMMISSIONER COX: The Department of 19 Public Safety said that you also said that your 20 employee was not properly monitoring the activity 21 there. 22 MR. TURNER: That is correct. In the 23 context of that, sir, I -- as I described to them, as 24 you've asked me here, too, what can you do better. It 25 was my belief, after reviewing the facts of that 1998 0057 1 issue, that our individual on the ground should have 2 monitored contract performance better than they did. 3 COMMISSIONER COX: Were there any 4 personnel changes from that? 5 MR. TURNER: The people that were 6 involved at that time, in 1998, and then subsequent to 7 that, no longer work for the company. 8 COMMISSIONER COX: Was that your choice 9 or theirs? 10 MR. TURNER: Those departures were 11 before my time, sir, or during that time, but they 12 were not related to this recent -- 13 COMMISSIONER COX: So the Trinidad and 14 Tobago thing was not on your watch? 15 MR. TURNER: The initial part of that, 16 sir, in terms of the contract and the requirement for 17 community development activities, as designated by the 18 lottery commission there, was contracted originally in 19 1998, sir. 20 COMMISSIONER COX: Would you have been 21 suspicious of a contract with a provision like that? 22 MR. TURNER: I think, sir, that that is 23 something that we would review, and we do review as 24 part of our business evaluation process. That process 25 of very comprehensive review is led by many parties, 0058 1 including our Chief Financial Officer and General 2 Counsel, to review the entirety of the contract and 3 the terms and conditions under that. So by itself may 4 or may not have been something that -- that would have 5 caused anything other than a careful review of the 6 terms and conditions requested by the regulated body 7 itself. 8 COMMISSIONER COX: So right now, if 9 GTECH were to get a contract that required that some 10 nebulous kind of undertaking be funded by GTECH, 11 without the money going directly into the coffers of 12 the country, that might not pass muster today? 13 MR. TURNER: We would evaluate that 14 very carefully, and I believe that would be correct, 15 sir. When we look at these situations, obviously, 16 lotteries around the world have very different 17 mandates. They're not -- they're not all designed the 18 way they are here in the United States. And so, 19 consistent with the missions they may have, or the 20 specific social objectives they may be trying to 21 achieve, they may have different requirements. We 22 evaluate those requirements very carefully to 23 determine the appropriate -- what we believe are the 24 appropriateness of those requirements in the context 25 of that, understanding that it is very difficult for 0059 1 any vendor -- and we would be no exception -- to 2 regulate the regulator. 3 COMMISSIONER COX: Sure. Now, as to 4 the situation in Poland, there is a lot of money going 5 around in Poland. How much total was paid to that 6 consultant in Poland? 7 MR. SWEITZER: To date -- I think 8 the -- the total contract over ten years, is 18 -- 9 MR. PATEL: 20 million. 10 MR. SWEITZER: 20 million dollars. 11 COMMISSIONER COX: 20 million dollars. 12 And this was a case in which -- tell me the 13 circumstances about what this consultant was retained 14 to do, who retained him, what he tried to do, whether 15 he was successful, why he was terminated. Help me 16 with all of that. What kind of instruction he was 17 given in your ethical standards and policies. Just 18 kind of help me through Poland. 19 MR. SWEITZER: Well, first, the answer 20 to your last -- he was given the kind of advice, when 21 he was first hired on, on behavior that I just 22 described. So he received the same that I just 23 described. The circumstance at that time, 24 Commissioner, was that we had found ourselves in a 25 situation in Poland where our ten-year contract was 0060 1 coming up. We, for a variety of business reasons, 2 found out at a rather -- kind of the 11th hour, in our 3 relationship there, that we -- our contract was more 4 in danger than we might have thought it was. Part of 5 that was, unfortunately, because of -- our local 6 leadership on the ground were not doing as good a job 7 as we thought they should and we found ourselves, not 8 only with a relationship problem, but with individuals 9 at the top of the organization there who didn't even 10 have a good grasp of what was going on in the 11 government. And we found ourselves in danger in this 12 contract, which is one of the biggest contracts we 13 have in the world. 14 COMMISSIONER COX: If I could, how big 15 is it on an annual basis? Or was it? I don't know 16 whether you still have it or not. 17 MR. SWEITZER: The exact -- 18 MR. PATEL: Annual revenues are in the 19 area of 25 million dollars. 20 MR. SWEITZER: Annual revenues in the 21 area of 25 to 30 million dollars a year. 22 MR. TURNER: Well, we should -- if I 23 supplement that slightly, however. Our total business 24 in Poland is much more than our contract with the 25 Polish National Lottery, Totalizator Sportowy. We 0061 1 also own two companies in Poland. We are the largest 2 bill payment services company and debit and credit 3 card services company in Poland, through two 4 subsidiaries, and we also have one of our largest 5 worldwide software hubs, very similar to the software 6 HUB we have here in Austin, in the city of Warsaw in 7 Poland. So in aggregate today, Poland represents an 8 entire business enterprise that is approximately -- 9 and Jaymin, correct me if I'm wrong here -- 10 approximately 100 million dollars and is, outside of 11 the United States, I believe, our largest single 12 concentration of employees in the world. 13 MR. SWEITZER: And at that time, when 14 we found ourselves in this situation, Commissioner, it 15 coincided precisely with the troubles that we were 16 going through in the United Kingdom at that time. And 17 we suddenly find ourselves in -- with a problem in 18 Poland, and with little knowledge, even at the top our 19 company, with what was going on in the government and 20 an understanding of what was happening in Poland. 21 We turned to a retired co-chairman of 22 our company, a man named Victor Markowicz, who is a 23 Polish -- was a Polish national, and very much 24 involved with his country throughout his life and even 25 now. We called him and actually went and had a 0062 1 meeting with him and said, we find ourselves in this 2 situation in Poland and we need some help. Do you 3 have any ideas, can you help us out. He referred us 4 to an individual, who we subsequently had several 5 meetings with, to get to know and so on and so forth, 6 who was ultimately the individual who we retained in 7 Poland to -- to assist in this problem and to -- as we 8 were ultimately successful in retaining our contract, 9 another ten-year contract, which he was very helpful 10 on. That individual has continued to represent us 11 through -- through the beginning and until now, in 12 Poland, on a variety of advice as far as the -- the 13 government in government has changed many times in the 14 last year several years, it's a very complicated 15 place, as are most governments, and so he has provided 16 services to us throughout that, advising us on -- on 17 the government and political situation in the country 18 as well as helping us on marketing and the contracts 19 and negotiating the contracts and so on. 20 COMMISSIONER COX: I thought I recalled 21 from the DPS report that you had bought out his 22 contract. 23 MR. SWEITZER: We bought out -- he 24 still is on a retainer with us. We bought out a large 25 part of the contract, but he is still associated with 0063 1 us. He still represents us. 2 COMMISSIONER COX: So that was 3 partially true. 4 Where did the 20 million go? 5 MR. SWEITZER: Well -- 6 COMMISSIONER COX: Do you have a 7 detailed accounting for where the 20 million went? 8 MR. SWEITZER: Well, it went to this 9 individual's company. 10 COMMISSIONER COX: Yes. What did they 11 do with it? 12 MR. SWEITZER: Well -- 13 COMMISSIONER COX: Do you require your 14 consultants to account for the expenditure of the 15 money that you give them? 16 MR. SWEITZER: Well, I think -- I don't 17 know where you're going with this, but do we require 18 our consultants to tell us that they do with the money 19 that we pay them, you know, after we pay them? No. 20 What we do, as part of our due diligence in hiring 21 consultants is, we do a background check on all of 22 these individuals using a professional -- agencies 23 that do this, so that we become comfortable with the 24 kind of an individual that we're dealing with. And we 25 require them to show us their bank accounts, and we do 0064 1 a criminal background on them. We also require them 2 to show us their bank accounts and any businesses that 3 they're involved in and references and so on, so that 4 we're comfortable with all of the people who work for 5 us, including this individual, that they're not people 6 that are involved -- that either have a past, that are 7 involved in any kind of -- of certainly criminal 8 activity, but even unusual movement of monies and so 9 on. And because we work closely with these 10 individuals, we know them, we know their business 11 practices, we know how they conduct their lives, and 12 so if there is any suspicion, and especially in a case 13 like this where certainly is a large amount of money, 14 do -- are we vigilant in -- not only do we talk about 15 it directly, that no money that is paid to you in any 16 way from us makes its way anyplace else, either to 17 government officials or -- or anything else, in 18 relation to us, but we also monitor these individuals, 19 frankly, as human beings and citizens. And you -- you 20 can sometimes tell if somebody is conducting 21 themselves in an improper manner in their personal 22 lives and that would cause us suspicion. 23 COMMISSIONER COX: So I think that was 24 a, we don't audit it. 25 MR. SWEITZER: No, we don't audit 0065 1 their -- once we pay their fees, we don't audit their 2 companies, no. 3 COMMISSIONER COX: I bet it would be 4 fair to say that Mr. Turner is one of your most 5 trusted employees. 6 MR. SWEITZER: Mr. Turner? 7 COMMISSIONER COX: Uh-huh. 8 MR. SWEITZER: Of course. 9 COMMISSIONER COX: Would you give him 10 20 million and not ask him to account for it? 11 MR. SWEITZER: Well, sir, you're saying 12 a different thing now. 13 COMMISSIONER COX: No, I'm not. I'm 14 asking whether the same standards apply to employees 15 and consultants. 16 MR. SWEITZER: Well, then let me ask -- 17 let me answer the question in this fashion. Since 18 we've paid the individual in Poland, and we're talking 19 about such a large amount of money, have I and others 20 in this company had specific conversations with this 21 individual if -- in the beginning, and as time has 22 gone on, to become totally comfortable in direct eye 23 to eye contact that nothing -- no money, nothing, 24 favors or anything else, is going to anyone in the 25 Polish government or in Poland, or in any way, to 0066 1 assist in an improper way the work that you do for us. 2 Do we have those conversations with our consultants? 3 Have we had that conversation specifically with this 4 consultant? Yes, sir. 5 COMMISSIONER COX: And I know that 6 certain activities can't really be measured on an 7 hourly basis, but the Department of Public Safety was 8 very concerned about the undenied fact, if you will, 9 that he didn't do much work. What would you guess he 10 made on an hourly basis? 11 MR. SWEITZER: Well, I don't -- once 12 again, I don't know how to determine what he made on 13 an hourly basis. My colleagues and I are puzzled by 14 that aspect of the report because we're familiar with 15 the work that the individual does. A consultant of 16 this type, a large amount of their value is the wisdom 17 and knowledge that they're able to impart on us on 18 certain things that we don't understand, we wouldn't 19 naturally understand, and historical things, and 20 mind-sets and cultures. That kind of advice is 21 provided by this individual on a regular basis to us. 22 It's provided in telephone conversations, in meetings, 23 as things develop, the -- the finance minister 24 changes, there is a new government, a new -- please 25 explain this to me. What is the background here. 0067 1 Those types of -- that type of individual that -- who 2 has that kind of knowledge and understanding, that's 3 extremely valuable information. It is provided to us 4 sometimes in a five-minute telephone conversation. 5 There are other -- this individual and 6 his colleagues also provide us, because of their 7 expertise, advice on the nuts and bolts of our 8 contracts and so on. So there is a lot of that type 9 of advice. But to try to put an hourly -- this is an 10 individual and his colleagues who you call on the 11 phone, you do conference calls, they do work in the 12 country, they report things to you, that has 13 significant value. 14 COMMISSIONER COX: He doesn't bill by 15 the hour. 16 MR. SWEITZER: I'm sorry, sir? 17 COMMISSIONER COX: He doesn't bill by 18 the hour. 19 MR. SWEITZER: No, sir, he does not. 20 COMMISSIONER COX: Why did you 21 partially terminate his contract? 22 MR. SWEITZER: I think that's mostly a 23 financial -- 24 MR. TURNER: Yeah, I can address that, 25 Commissioner Cox. The -- the practical dimension is 0068 1 that any time you have a transaction of the type that 2 we are about to do with Lottomatica, you evaluate -- 3 and, Chairman Clowe, I think you're quite familiar 4 with this in your own personal business experience -- 5 and, Commissioner, I am sure you've had that as far as 6 your gaming experience as well -- you evaluate various 7 opportunities to consider the acceleration of costs 8 and expenses, all appropriately, all transparently, if 9 you believe that it would be the appropriate time to 10 do so. 11 In this particular case, we reviewed 12 that contract. Obviously, we had been quite aware of 13 it. Determined it would be appropriate to accelerate 14 that payment in an economic fashion that is 15 advantageous to our shareholders, since the discount 16 rate we negotiated for that acceleration on a net 17 present value basis was attractive. And as a result, 18 we executed that transaction; ultimately good for our 19 long-term shareholders. 20 COMMISSIONER COX: And this had nothing 21 to do with any scrutiny that this situation was being 22 brought under? 23 MR. TURNER: None at all, sir. None at 24 all. 25 COMMISSIONER COX: Okay. Mr. Turner, 0069 1 you stated, in September of 2003, that 80 percent of 2 your compensation is a risk stock-based trans -- 3 compensation. 4 MR. TURNER: Yes, sir. 5 COMMISSIONER COX: Is that still the 6 case? 7 MR. TURNER: That is no longer the 8 case, sir. After my first contract, which was the 9 Chairman and interim CEO contract for a two-year term, 10 when the board decided to engage me as the permanent 11 CEO, approximately four years ago, they determined 12 that they wanted to structure a more traditional 13 contract for Chief Executive Officer. 14 COMMISSIONER COX: And what would that 15 contract look like? 16 MR. TURNER: Today? 17 COMMISSIONER COX: Yes. 18 MR. TURNER: Today, my contract has a 19 base salary that is indexed relative to other 20 executives of comparable-sized companies. That review 21 is conducted by independent bodies that report to the 22 Board of Directors. I have the potential for a cash 23 bonus that can be up to two times that base salary, 24 and then I am annually awarded, at the discretion of 25 the Board of Directors of the compensation committee, 0070 1 stock options and restricted stock in levels that they 2 believe are appropriate. 3 COMMISSIONER COX: So it would still 4 seem to be the case that a very significant portion of 5 your compensation is performance related. 6 MR. TURNER: Yes, sir. 7 COMMISSIONER COX: And would that be 8 the case for the other executives at GTECH as well? 9 MR. TURNER: Yes, sir, that's correct. 10 COMMISSIONER COX: Would you agree that 11 gains of significant new accounts can increase the 12 company's stock price? 13 MR. TURNER: Yes, sir, I would. 14 COMMISSIONER COX: Would you agree that 15 losses of significant accounts can decrease a 16 company's stock price? 17 MR. TURNER: We've certainly had that 18 experience, sir. 19 COMMISSIONER COX: Does it seem to you 20 that your compensation program might lead you to a 21 certain course of action while your ethics program 22 might lead you to another? 23 MR. TURNER: No, sir, I do not believe 24 they are different. 25 COMMISSIONER COX: Okay. Would you -- 0071 1 can you give me a little more on that? Because, to 2 me, it seems that they kind of fight with each other. 3 MR. TURNER: I can understand your 4 thoughts -- your thoughts there. The compensation 5 programs that we have structured, over many years, are 6 designed to provide alignment of the management team's 7 interests with those of our shareholders. Obviously, 8 our public company mission, as you know, is to 9 optimize long-term value for our shareholders. Most 10 of the structure of those compensation elements are 11 things that will vest over long periods of time, so 12 impacts to the short-term stock price are really not 13 things that we consider. We have never run our 14 company with -- with an emphasis on short-term value 15 creation. Those, based on my ten years experience on 16 Wall Street, can be fleeting at times, particularly in 17 fickle markets. We do have a very close alignment 18 with long-term value creation. Our board has been 19 very clear in terms of our accountability. 20 I'll raise a case in point. We -- when 21 the initial challenge in Brazil were first -- first 22 came about, for a brief period of time, 30 percent of 23 our revenue was held back by the customer. That was 24 an unexpected event. Nonetheless, I went to the Board 25 of Directors and suggested that as a result of that 0072 1 action, we should not pay management bonuses, despite 2 the fact that we had earned one, because we were going 3 to have to take other actions within the company to 4 bring our costs down as a result of this unexpected 5 event, which was subsequently reversed. I think that 6 gives you a -- a very specific example of a situation 7 in which we behaved in a manner that did not -- was 8 not consistent with our own personal financial 9 interests. But it was very much consistent with the 10 philosophy that if we operate our company ethically, 11 if we provide products and services that are demanded 12 and valued by our customers, and we make the right 13 decisions for the right reasons, long-term value will 14 be enhanced. 15 I think when we look at the track 16 record since my last visit with you, one of the 17 questions at that time that I had was, what do you 18 think the outlook for the company is, and the stock 19 specifically. While I did not opine on the stock 20 potential, I did say very specifically, I thought the 21 outlook was good. Since that time, the stock is up 22 almost seven-fold, and most notably, in the last 12 23 months, I believe it was Forbes magazine named GTECH 24 the 28th best managed large company in America. I 25 don't think that our business actions in any way are 0073 1 inconsistent with the long-term requirements to 2 operate our company with the utmost of integrity. 3 They actually go together. 4 COMMISSIONER COX: Okay. GTECH's 5 corporate governance guidelines require that each 6 director, consistent with the responsibilities of the 7 directors to shareholders, should have a substantial 8 personal investment in the company. That's -- that's 9 from your corporate governance guidelines. I recall 10 that you characterized these directors as independent. 11 MR. TURNER: Yes, sir. 12 COMMISSIONER COX: Do you consider 13 directors also responsible to GTECH's other 14 stakeholders, creditors, employers, government 15 agencies, customers, such as the State of Texas? 16 MR. TURNER: Yes, sir. Very much. 17 They are responsible ultimately to all of our 18 stakeholders. 19 COMMISSIONER COX: Do you consider that 20 you're responsible to all of the stakeholders. 21 MR. TURNER: Absolutely, sir. 22 COMMISSIONER COX: I'm a certified 23 public accountant. 24 MR. TURNER: Yes, sir. 25 COMMISSIONER COX: My code of ethics 0074 1 requires that as to my audit clients, I remain 2 independent. And I think, if you think of 3 independence, at least I, perhaps it's because I'm an 4 accountant, think of that being a hallmark of 5 accountants -- the American Institute of CPA's has 6 chosen to require that auditors, in order to be 7 independent in reality and in perception, not have a 8 financial interest in their clients. Further, the 9 AICPA prohibits fees and compensation based on 10 outcomes. 11 Now, you have a situation where your 12 compensation is largely determined based on outcomes 13 and your -- as you call them, independent board of 14 directors hold stock in your company and must hold a 15 substantial amount of stock in your company. So on 16 the one hand, you see independence permitted -- or 17 fostered by compensation based on outcomes which 18 benefit the shareholder and not necessarily the other 19 stakeholders, and ownership in the company, whereas 20 the American Institute of CPAs, I think an expert on 21 independence, sees that those are incompatible. Can 22 you help me with that? 23 MR. TURNER: That's a tough one, sir. 24 I can say that a hallmark of our 25 company since, really, over the last six years, has 0075 1 been to align the various stakeholders' interests in a 2 way that will allow us to optimize value. Those 3 things work hand in hand. If I do not operate or if 4 we do not operate in a transparent way with full 5 integrity, then our ability to win and execute 6 business around the world is impaired. Our ability to 7 execute our services for our customers is impaired, 8 because that is the business in which we operate. 9 When I think about the level of independence, I can 10 provide you my own -- my own experience as an -- 11 originally, as an independent director, subsequently 12 as an executive of the company. There is no doubt in 13 my mind that -- that the Board of Directors of GTECH 14 exercises its independence quite regularly, as they 15 are required to do so. I don't believe that the fact 16 that they have chosen, in some cases, to take some of 17 their stock -- or some of their fees in stock 18 versus -- versus cash has impaired their independence 19 at all. 20 COMMISSIONER COX: Well, now, as I 21 understand your corporate governance guidelines, 22 whether they take their fee in stock or not, they have 23 to invest an amount equal to three times their annual 24 remuneration as directors. 25 MR. TURNER: I think -- 0076 1 COMMISSIONER COX: That's what it says 2 here. 3 MR. TURNER: Sir, I know that applies 4 to employees, senior employees of the company. I 5 would have to check -- 6 COMMISSIONER COX: Let me read it to 7 you. 8 MR. TURNER: Please do, sir. 9 COMMISSIONER COX: This is called Stock 10 Ownership by Directors. The Board believes that each 11 director, consistent with the responsibilities of the 12 directors to shareholders, should have a substantial 13 personal investment in the company. As a result, each 14 director is required to own shares of stock in the 15 company valued at a multiple of three times the 16 then-annual cash retainer paid to directors. This 17 requirement shall phase in proportionally over five 18 years. To achieve this requirement, directors may 19 include shares acquired in the open market, or 20 received by directors in lieu of cash compensation, as 21 well as any vested restricted shares or shares 22 received when exercise of options granted to directors 23 under applicable long-term incentive. 24 Is this an outdated document -- 25 MR. TURNER: No, I believe that is 0077 1 correct, sir. Now that you've -- I don't candidly pay 2 much attention to how my directors choose to invest. 3 That is more the responsibility of the Chairman of the 4 Board. But I -- now that you have refreshed my 5 memory, I do remember that they put that in place. I 6 could not tell you if they are in compliance with that 7 or not. I do not know. 8 COMMISSIONER COX: Okay. Mr. Chairman, 9 I think that's what I have for the time being. Thank 10 you. 11 Mr. Turner, thank you very much. 12 MR. TURNER: Thank you, sir. 13 CHAIRMAN CLOWE: Thank you, 14 Commissioner Cox, for your comprehensive questions 15 and, Mr. Turner, you for your substantive answers. 16 Let's take a short recess. 17 (RECESS.) 18 CHAIRMAN CLOWE: We'll come back to 19 order. 20 Again, Commissioner Cox, thank you and, 21 Mr. Turner, thank you as well for the questions and 22 answers given on the record to date, to this point. A 23 very thorough covering of a great many matters 24 relating to this subject and of benefit, I think, to 25 all of us. 0078 1 In order to clarify, Mr. Turner, I 2 would like to go back to a few areas that Commissioner 3 Cox and you have touched on and ascertain as to 4 whether or not my understanding of some of your 5 answers is correct. 6 MR. TURNER: Yes, sir. 7 CHAIRMAN CLOWE: I would characterize 8 the matter involving those activities in Brazil as 9 being ongoing and still not concluded at this time. 10 Would that be correct? 11 MR. TURNER: Well, that is correct, 12 sir. Now, I should point out that as of this week, we 13 have ceased operations in Brazil. The customer has 14 now taken the responsibility for their own networking 15 system and we are in the process of shutting that 16 operation down. 17 CHAIRMAN CLOWE: So you will no longer 18 conduct operations in the country of Brazil, the way 19 things stand at this time? 20 MR. TURNER: Other than a small 21 contract we have with the state lottery, Minas Gerais, 22 which is set to expire in October. We, obviously, 23 will continue to satisfactory our obligations under 24 that contract, but beyond that, it is not our 25 intention to continue business in Brazil. 0079 1 CHAIRMAN CLOWE: And my understanding 2 from the discussion that you and Commissioner Cox had 3 was that you clarified that these activities began 4 between your company and the country of Brazil prior 5 to your joining the company. 6 MR. TURNER: The -- the contract 7 started prior to my joining the company. The -- the 8 situation that unfolded was in 2003, that brought into 9 question some of the -- some of the scrutiny, and that 10 was considering my tenure. 11 CHAIRMAN CLOWE: And how would you 12 characterize the relationship between the beginning of 13 the contract and these activities as they developed, 14 time-wise? 15 MR. TURNER: I don't understand your 16 question, sir. 17 CHAIRMAN CLOWE: Did these issues that 18 came up, that you've described to Commissioner Cox in 19 talking about the business situation in Brazil, exist 20 from the outset when the contract was initiated or did 21 they come up in 2003? 22 MR. TURNER: The primary conditions 23 that -- that resulted in the situation that we 24 publicly disclosed and described, really manifested 25 themselves after the PT party assumed power in the 0080 1 fall of 2002. 2 CHAIRMAN CLOWE: In the fall of 2002. 3 MR. TURNER: Yes, sir. 4 CHAIRMAN CLOWE: Thank you. 5 Would it also be correct, in regard to 6 the matters that you and Commissioner Cox have 7 discussed in Trinidad and Tobago, would it be correct 8 to say those are ongoing as well? 9 MR. TURNER: There is an ongoing review 10 by the government in Trinidad surrounding, so we 11 understand we are cooperating with them in that review 12 to the extent that they need any assistance from us as 13 they focus on activities of the prior political party 14 and regime in power at that time. 15 CHAIRMAN CLOWE: I think your 16 discussion of the consultant in Poland was very 17 thorough, and I don't have any further questions for 18 clarification in regard to that matter. And I think 19 your statement in regard to the investment in 20 Czechoslovakia, or the Czech Republic, was thorough, 21 and I don't have any further questions in regard to 22 that matter. And I appreciate the fact that you and 23 Commissioner Cox covered those four items in the 24 detail that you did. 25 Have you received a copy of the 0081 1 Department of Public Safety report that they issued to 2 this Commission? 3 MR. TURNER: Yes, sir, I have seen the 4 eight-page statement that they provided. 5 CHAIRMAN CLOWE: That's the one I'm 6 referring to. It -- it was dated Wednesday, July the 7 19th, 2006, and was delivered verbally as well as in 8 writing to this Commission. 9 Do you have any further comments for us 10 in regard to the other more generic items that are 11 found in the summary? 12 MR. TURNER: I do -- I'm not sure how 13 to respond to that, Mr. Chairman. 14 CHAIRMAN CLOWE: Let me help you by 15 perhaps just reading to you a few that I would like 16 your comment on, but I wanted to give you an 17 opportunity, if you wanted to, to give us a statement. 18 GTECH's past management style indicates 19 their willingness to spend large amounts of money for 20 consultants with little or no audit process and no 21 accountability for the consultant's actions. 22 I think Commissioner Cox and you 23 covered that in some detail in regard to the situation 24 in the Czech Republic, but that's a general 25 observation that the DPS makes. What would your 0082 1 comment be in response to that? 2 MR. TURNER: Well, Mr. Chairman, I 3 certainly, you know, can't describe things that 4 happened before I joined the company. Those are a 5 matter of public record and I think they've been 6 reviewed before this body in the past. I am quite 7 confident that the processes and procedures that we 8 have put in place that we have shared in 9 Director Sadberry and his staff and the Attorney 10 General's Office have put together a -- a structure 11 that represents a -- a set of preventative actions and 12 measures that will -- that will help us to both 13 sensitize the company and its employees and in the -- 14 in the unlikely but possible event that there is a 15 problem, and we run a complex international business, 16 we will have the right response mechanisms in place to 17 ensure thorough evaluation, vetting, review, and, if 18 necessary, actions in those situations. 19 Those policies, procedures, and 20 techniques that are in place that are used, quite 21 actively, were not, generally speaking, things that 22 were in place in the 1990s. 23 CHAIRMAN CLOWE: And would you give us 24 any further statements in regard to their next item, 25 which is, GTECH's operating style is very aggressive 0083 1 and contracts will likely continue to be pursued by 2 the newly-planned company in the current GTECH manner 3 since GTECH will manage the new company. 4 MR. TURNER: I respectfully, sir, 5 disagree with the conclusion that our operating style 6 is aggressive, other than to note that we do operate 7 in a competitive business. We have -- you know, and 8 that competitive business is one that changes every 9 day around the world. I think that -- that we will 10 operate -- continue to operate in a way, as we have -- 11 I believe we have -- with transparency, with 12 integrity, with ethics, in a competitively changing 13 world that is dynamic. If we have opportunities in 14 appropriate ways that are transparent, with the full 15 oversight and review of the Board of Directors, to 16 drive innovative solutions to problems, to create new 17 business models that may change our industry paradigm 18 in ways that positively affect the public good, then 19 it is likely that we will consider doing so. 20 We have the advantage of -- as a result 21 of the Lottomatica transaction, of being the largest 22 diversified lottery services company in the world. 23 That brings with it responsibility. It also brings 24 with it capabilities. To the extent that we can 25 deploy those capabilities in appropriate ways, then we 0084 1 will do so. I don't believe that is -- I don't 2 believe that is aggressive. I do believe it is a 3 logical way to run a business in a competitively 4 changing market. 5 CHAIRMAN CLOWE: So a summation to that 6 might be that you intend to manage the company so that 7 it expands and grows and develops, but it'll be within 8 the legal and ethical and moral bounds that are those 9 which you have described to us as the policies that 10 you've established. 11 MR. TURNER: Absolutely, Mr. Chairman. 12 Without the ethical underpinning of our company, in 13 the business that we operate in, which is the vortex 14 of gaming and politics, without that foundation, we 15 don't have a company. So that the only thing that we 16 can do, which is the right thing to do, is make sure 17 that we do everything possible to operate our company 18 in a fashion that is transparent, that is with 19 integrity, that is with honor, that creates trust in 20 all of our customers around the world. And that is -- 21 that is certainly what we must do. 22 CHAIRMAN CLOWE: I would like to go 23 back now to the discussion that you had with 24 Commissioner Cox in regard to directors. And, 25 hopefully, by way of perhaps clarification, I would 0085 1 like to ask you if your definition of an independent 2 director, and I think you had some good exchange of 3 ideas there, to me -- and would you agree -- an 4 independent director is generally called that when 5 they are not an employee of the company? 6 MR. TURNER: That is the legal 7 definition, that is correct, sir. 8 CHAIRMAN CLOWE: So when you say to us 9 that you are the only employee of the company serving 10 on the board and all the directors are independent 11 directors, what you're saying is, they have no 12 commercial connection, there is no compensation 13 directly from the company, other than that which they 14 are paid for serving as directors? 15 MR. TURNER: Yes, sir. There are very 16 specific rules set by the New York Stock Exchange, set 17 by NASPL, and in some cases set by the U.S. Securities 18 and Exchange Commission that define very specifically 19 the elements that represent a standard of independence 20 for directors. And if those standards are not met, 21 then the director cannot be considered independent for 22 purposes of executing their fiduciary 23 responsibilities. That then flows to committees on 24 which they can serve and other activities. 25 For instance, I could give you a 0086 1 specific example. While those new rules that have 2 been promulgated since that time were not in place, 3 the Board considered the fact that -- that after my 4 role as interim CEO, while I was still under contract 5 to the company, that for that period of time I was not 6 independent, although I was no longer actively 7 involved for that 16-month period of time in the 8 day-to-day operations of the company. But there are 9 very specific rules that define director independence 10 for public companies, and today, GTECH has -- has 11 eight directors that are, I can assure you from my 12 personal experience, quite independent. 13 CHAIRMAN CLOWE: And then you all had a 14 discussion about the stock ownership requirement, and 15 I would like to tell you that I generally think of 16 that as an effort on the part of the company to make 17 independent shareholders stakeholders and to encourage 18 them -- and in some cases, they not only can either 19 take direct cash compensation or stock, but many 20 companies -- maybe not many -- some companies require 21 the directors to take their compensation in stock. 22 And then this requirement exists with your 23 organization that a multiple of compensation be held 24 in stock. That could be generally characterized, 25 could it not, as an attempt to draw the independent 0087 1 directors' attention to the value of the stock 2 relative to the public ownership, and to encourage 3 their diligence and efforts to make decisions that are 4 beneficial to the company in regard to its operation, 5 its profitability and, therefore, as a publicly held 6 company, it would be reflected in the price of their 7 stock. Is that a fair general characterization? 8 MR. TURNER: Sir, I think that is very 9 similar to the discussion that our independent Board 10 members had as they debated that topic and made a 11 decision that they believed that -- to use the simple 12 term, and I tend to be direct in my communications -- 13 that they believe that directors needed to have some 14 skin in the game if they were going to properly 15 represent all other affected parties. So there was -- 16 that was some of the discussion. But I think your 17 characterization is quite correct. 18 CHAIRMAN CLOWE: And, of course, you 19 report that on an annual basis, and that's out there 20 for anybody that's interested to look at, to see what 21 the directors' annual compensation is, what their 22 shareholdings are, what your compensation is, what 23 your shareholdings are, what your options values are, 24 that's all public information? 25 MR. TURNER: Yes, sir. That's publicly 0088 1 disclosed in our proxy statement annually. 2 CHAIRMAN CLOWE: Then let's go back to 3 another item in the DPS report which I was interested 4 in, and I think it's a -- I think it's an interesting 5 change in the director setup that I would like for you 6 to comment on. 7 GTECH's Board of Directors are 8 currently all independent with the exception of Turner 9 himself. And according to our interviews with each of 10 them, they're not familiar with the day-to-day 11 operations of the company. They rely upon and accept 12 Bruce Turner's explanation for business operations. 13 I don't find that terribly unusual. I 14 would have liked to have seen an indication of more 15 involvement on the part of the DPS observation, but 16 that is the way they put it. 17 Here is the part that is more 18 interesting to me, since we're talking about past, 19 present, and future. Under the newly-designed 20 company, that will not be the case. Lottomatica's 21 Board of Directors is expected to have De Agostini 22 Board members as a majority influence. Only three 23 current GTECH Board members will have a place on 24 Lottomatica's planned new board. 25 I think that is a substantial change to 0089 1 that which you have described to us that's in place 2 for GTECH. And you have indicated the continuation of 3 management, but talk to us now about this new board 4 that will have the oversight with only, I think, 5 three, what I would call, carryover directors 6 post-transaction. 7 MR. TURNER: Yes, sir. The -- the new 8 structure for the board, although the number of 9 directors I think is still being discussed, I would 10 expect it to be slightly larger than GTECH's current 11 board, which is nine, with eight independent 12 directors. I expect that the -- the Lottomatica board 13 will likely have, I would say, between 11 and 13 14 members. I don't -- please don't hold me to that 15 number. I'm not sure -- and I don't make that 16 decision. The majority of the Board members will be 17 appointed by the De Agostini group and largely have 18 already been appointed. There are several independent 19 members of the Lottomatica board today. And the 20 De Agostini group believed it was important, for 21 business continuity, but also, to ensure that -- that 22 we mesh very different cultures appropriately, that 23 several independent members of the GTECH board be 24 asked to join the Lottomatica board, and three of 25 those individuals have been defined. The current 0090 1 Chairman of the board of GTECH, Mr. Bob Dewey, will 2 become and has agreed to become the Vice Chairman of 3 the board of Lottomatica. And two other Board 4 members, Tony Ruys, who is the retired CEO of 5 Heineken, and Jim McCann, who is the current sitting 6 CEO of 1-800-Flowers, have agreed to join the 7 Lottomatica board as well. So the structure will be 8 somewhat different. 9 There will also be an executive 10 committee, very common in European companies. That 11 executive committee will meet ten times a year, and 12 the Board of Directors will meet four times a year. 13 CHAIRMAN CLOWE: And can you give us 14 any further information on the non-carryover 15 directors, as you see that group at this time? 16 MR. TURNER: The non-carryover 17 directors from -- 18 CHAIRMAN CLOWE: From GTECH. 19 MR. TURNER: GTECH. 20 CHAIRMAN CLOWE: The De Agostini 21 directors. And you may not know who they are at this 22 time or -- 23 MR. TURNER: I don't know all of -- I 24 don't know all of the directors. I think that my 25 opportunity to meet them was brief over a dinner. I 0091 1 do know the executive committee members, and those 2 include various people such as Lorenzo Pellicioli, who 3 has been here to meet with members of the Commission 4 and staff. He is the CEO of the De Agostini group. 5 It will also include Roberto Drago, who is the primary 6 representative of the -- of the ownership group and 7 the families. Then a variety of other members from 8 De Agostini and Lottomatica as well. 9 We can get that -- I don't have off the 10 top of my head that full list. I think we have 11 provided it to staff. I'm certain we have. We 12 could -- we could pull that out and provide that to 13 you yet again. 14 CHAIRMAN CLOWE: But that's not firm, 15 if I'm understanding your indication to us, in your 16 knowledge, at this time? 17 MR. TURNER: I think it's relatively 18 firm, sir, but I don't know that every specific slot 19 has been -- has been finalized, although I do believe 20 it's quite close. We can get back to you on that. 21 CHAIRMAN CLOWE: The impression I have 22 at this point is that the De Agostini entity will be 23 the control group. 24 MR. TURNER: Yes, sir. 25 CHAIRMAN CLOWE: If this transaction 0092 1 occurs. And therefore, by number of Board members, 2 and I assume by members a majority on the executive 3 committee, they will represent control, probably 4 through shareholdings. Is that a correct assumption? 5 MR. TURNER: That is correct, sir. 6 CHAIRMAN CLOWE: That has been an item 7 that Commissioner Cox and I have been very interested 8 in because it represents a real change in the control 9 structure of the company, from being a U.S. held 10 entity to -- with outside directors, to a foreign 11 controlled entity, with the control situation sitting, 12 I assume, not only on the board, but in the executive 13 committee, with the De Agostini corporate entity. We 14 have delved into that, as I'm sure you are aware, 15 through the Attorney General's Office and with the 16 outside law firm, to determine how we can continue to 17 observe the company's performance and its operation, 18 and I assume you have been made aware of those 19 discussions and are aware of our continuing interest 20 in that regard. And you heard my questions, I would 21 assume, to Mr. Mattax this morning about -- in regard 22 to the future, and any case where this Commission 23 employs an outside company as the lottery operator, 24 the establishment of an oversight entity, would you 25 have any objections to that if you were the person to 0093 1 make that agreement on behalf of the lottery operator? 2 MR. TURNER: I have no objections to 3 that at all, sir. By the way, I should point out that 4 we have already agreed with the various NASPL member 5 states, at their request, that Grant Thornton, their 6 designated review firm, will come back 12 months after 7 closing and do a comprehensive review of, in essence, 8 the fabric of overlapping and interlocking policies 9 and procedures to evaluate our progress on integration 10 of those activities. And we have committed to do that 11 and to pay for that activity. 12 CHAIRMAN CLOWE: Well, I think that's 13 good. You know, it's not just a plain vanilla-type 14 deal. You've got the entity in Luxembourg and it's 15 a -- not only an international deal, but it has its 16 complexities. And to a regulatory body, which this 17 agency is in the case of our relationship with you, 18 information is the thing, timely and accurate, that 19 gives us the opportunity to perform our jobs. 20 MR. TURNER: Yes, sir. We would 21 welcome the opportunity to -- to have some regular 22 vehicle for communication, whether that's with 23 Director Sadberry or a member of his staff. I think 24 that would go a long way, as you have suggested 25 earlier this morning, towards eliminating any areas 0094 1 that -- of misconception or identifying, earlier, 2 areas of concern, so that we -- we can have an open 3 and productive dialogue about that, because surprises 4 are never good. 5 CHAIRMAN CLOWE: And, you know, in my 6 view, it's not only these issues that we've talked 7 about that are in the past to some extent, but it's 8 the present, the transaction you're currently 9 pursuing, and then the future of the surviving entity 10 in whatever relationship it might have with this 11 agency. And so having the opportunity to visit with 12 you personally about this on the record, I would 13 like -- and I appreciate hearing from you -- what you 14 would give us in the way of a response. 15 In regard to that, you have come to 16 Texas and visited with the Commissioners individually 17 prior to this appearance since 2000, have you not? 18 MR. TURNER: Yes, sir, I have. I 19 couldn't recall the number of times that was, but I 20 have visited individually with the Commissioners, and 21 obviously I visited with the staff from time to time 22 as well. 23 CHAIRMAN CLOWE: My recollection is 24 that you met with me and you brought a principal in 25 the formation of this deal, initially, to answer on an 0095 1 informal basis, not in a public meeting, any questions 2 that I might have had after you explained what the 3 proposed transaction was, early on. Is that not 4 correct? 5 MR. TURNER: Yes, sir, that is correct. 6 I visited here with -- with you, and accompanying me 7 to Texas was Lorenzo Pellicioli, who is the CEO of the 8 De Agostini group and is now the Chairman of the Board 9 of Lottomatica. 10 CHAIRMAN CLOWE: And did you have a 11 similar meeting with Commissioner Cox? 12 MR. TURNER: Yes, sir, I believe that 13 we had a similar meeting later that same day. 14 CHAIRMAN CLOWE: I also want to thank 15 you, along with Commissioner Cox, for being here and 16 for bringing your executive staff. I hope that you 17 feel that these questions have been put to you with 18 dignity and respect. It is a Texas tradition to be 19 courteous and to treat people who appear before any 20 body -- and by that I mean, a governmental body -- in 21 a way that our business is conducted with courtesy and 22 with the respect that people who are doing the 23 people's business ought to have. 24 We are appreciative of the fact that 25 the State of Rhode Island has apparently given you, 0096 1 after an exhaustive investigation, an okay and 2 approval, and the other states that you mentioned. 3 But that stops at the border in this state. And you 4 know very well, Texans are different. And 5 Commissioner Cox and I, for the high compensation that 6 we receive, and it doesn't compare with yours, are 7 here to protect the people of Texas within the bounds 8 of the contract that we have with your company as the 9 lottery operator. And so while we're aware and we are 10 respectful of those entities giving you approvals, we 11 have to look at our business here. You have had the 12 contract -- when I say "you," I mean GTECH -- as the 13 lottery operator with this agency since this agency 14 was created and the lottery began in 1992. Are you 15 aware that in the last bid for this contract, your 16 company was the only entity that presented a bid? 17 MR. TURNER: Yes, sir, I am aware of 18 that. 19 CHAIRMAN CLOWE: Commissioner Cox, I 20 don't think that subject is proper with Mr. Turner 21 appearing before us, but under this item of the 22 agenda, if the General Counsel approves it, I want to 23 go into that subject and have a discussion on the 24 record about the position this agency is in. 25 COMMISSIONER COX: Mr. Chairman, I 0097 1 think that you may have it in the last statement in 2 the DPS report. 3 CHAIRMAN CLOWE: I think you're exactly 4 right. And I do want to get into that if you don't 5 have any objection. 6 COMMISSIONER COX: No, sir. 7 CHAIRMAN CLOWE: I don't want to 8 involve Mr. Turner in that because of commercial 9 reasons, but I do think it's something that you and I, 10 perhaps with Director Sadberry, need to discuss at 11 this time on this record. And as you know, because 12 you were present, I, appearing on behalf of the 13 agency, was asked questions about that in the 14 Licensing Committee two weeks ago, and I want to 15 review the answers I gave to you and see how you feel 16 about them in that discussion. 17 COMMISSIONER COX: Yes, sir. 18 CHAIRMAN CLOWE: Do you have any 19 further questions for Mr. Turner? 20 COMMISSIONER COX: A couple of mop up 21 questions. Nothing I don't think of great substance, 22 but as I look over my notes, there are a couple of 23 things that I wanted to ask you about. 24 MR. TURNER: Yes, sir. 25 COMMISSIONER COX: Back in July, I 0098 1 think, when the Department of Public Safety made this 2 report to us, there was some discussion about this 3 report and the lack thereof related to -- I think it 4 was Brazil. And was there an investigation or wasn't 5 there, and was there a written report or was there a 6 PowerPoint or was there not. And did you initially 7 tell them there wasn't one and later tell them there 8 was one. And did you propose to give it to them, but 9 wouldn't, and -- can you help us with all of that? 10 MR. TURNER: Yes, sir, I can. The -- 11 and if I may indulge for a moment. When the Board of 12 Directors was made aware by the management team of 13 the -- of the situation that was unfolding in Brazil, 14 they deemed at that point that they would engage 15 outside resources, Williams & Connolly, a very well 16 respected firm in Washington, D.C., to conduct a 17 comprehensive review. I should note that one of their 18 principals at that time was a fluent Portuguese 19 speaker, which made it certainly convenient for them 20 to go to Brazil. That review process began. 21 Management was, as it should be, excluded from that 22 process and excluded from the record. That was to be 23 done completely independently of all management. We 24 were to have no involvement whatsoever and we did not, 25 so -- 0099 1 COMMISSIONER COX: So it was 2 management, including you. 3 MR. TURNER: Including myself, yes, 4 sir. For purposes of that report, that was for the -- 5 done by the independent Board of Directors, without 6 our involvement. 7 They followed that process. All of the 8 corporate records associated with that are maintained 9 by Williams & Connolly, and I think that one of the 10 misunderstandings, I believe, that occurred with DPS, 11 as they were doing their diligent job and meeting 12 individually with people, is that -- that various 13 people simply didn't know what was in the record 14 because they were not involved in the process. That 15 was controlled externally by the Board of Directors. 16 We have since, as I noted in my earlier 17 statement, I believe we have closed with DPS over the 18 area of misunderstanding, and it is my understanding 19 at this point that they are satisfied that they have 20 been given access fully to Williams & Connolly, in a 21 fashion similar to what we have done with other 22 regulatory agencies, including the United States 23 Securities and Exchange Commission, and that at this 24 point they are satisfied. 25 COMMISSIONER COX: And so it sounds 0100 1 like it may be possible that they were asking you 2 questions that perhaps they should have been asking 3 the nonexecutive Chairman, since you were excluded 4 from these proceedings? 5 MR. TURNER: Well, I think, 6 Commissioner Cox, they were asking all of the 7 directors and all of the management questions, and 8 there seemed to have been some confusion over, you 9 know, discussion of whether a PowerPoint presentation 10 was a report. And they, I believe, based on a review 11 of various minutes, formed a conclusion that there was 12 another written report by Williams & Connolly that 13 they had not been provided, and I think that was just 14 a misunderstanding. 15 COMMISSIONER COX: So you believe at 16 this point that this is all cleared up? 17 MR. TURNER: Yes, sir. We have 18 confirmed to the professionals at DPS that they will 19 continue, to the extent they would like to have 20 access, to Williams & Connolly. Those are -- they are 21 the keeper of all of the records, including those in 22 Portuguese. We had spent substantial amounts of money 23 for the Securities and Exchange Commission, 24 translating all source documents from Brazil into 25 English. All of that is available for their 0101 1 inspection. My understanding is, they have spent time 2 in Washington, D.C., or had spent time in Washington, 3 D.C. They are welcome to have further access if they 4 desire that. 5 COMMISSIONER COX: Excellent. Thank 6 you. 7 Now, one other question with regard to 8 this contract with Mr. Blass. 9 MR. TURNER: Josef Blass. 10 COMMISSIONER COX: Blass, in Poland. 11 The Department of Public Safety says, Bruce Turner 12 admitted to Board members as written in the minutes, 13 and he also admitted to DPS personnel, that he alone 14 approved Blass's largest contract. 15 That doesn't seem consistent with what 16 I think I heard earlier. 17 MR. TURNER: Yes, sir. As you have 18 seen in my testimony, and as my employees will attest, 19 I'm pretty blunt in my communication. I don't mince 20 words and I don't quibble. 21 I had explained to them, as I explained 22 to my board when that issue was raised after it was 23 reviewed, that that had been brought to my attention 24 very early in my -- in my tenure, in the year 2000, 25 and that I had approved that transaction. That indeed 0102 1 is true and I confirmed that to others. Now, I think 2 Mr. Sweitzer has provided for you a broader context 3 than that which I provided DPS. But as I said, I am 4 usually pretty blunt, and if I'm aware of something 5 and I believe that I approved it, I don't -- I don't 6 pass that buck to somebody else. 7 COMMISSIONER COX: Okay. Well, help me 8 reconcile that with what Mr. Mattax told us about the 9 Board approving all contracts over X amount and the 10 committee approving all contracts with consultants, 11 and Mr. Sweitzer going down and vetting the 12 consultants before they're hired, and all of those 13 other things that we've heard along that line. 14 MR. TURNER: Right. Well, the process 15 that puts in place -- there are many elements of the 16 process. Don Sweitzer explained to you how the 17 government affairs committee works. It has various 18 members. I am not a member of the government affairs 19 committee. That is by design. The -- they provide 20 the review and, ultimately, call it the first stage 21 approval, if necessary. There are very few consultant 22 contracts that would come to me directly, in a real 23 time basis, for my review for approval. The situation 24 in 2000 in Poland was somewhat unique, and after the 25 government affairs committee reviewed, what they felt 0103 1 appropriate, to make me aware of that and they did. 2 The -- the corporate governance and 3 compliance committee of the Board of Directors reviews 4 annually, and has for several years, the -- the full 5 range of consultants we engage worldwide. We agreed 6 with Commission's -- with the staff and the Attorney 7 General to provide that information. 8 We're in the process of coordinating, 9 Director, with your staff on that at this time. On an 10 ongoing basis. 11 Now, we did put in place a policy 12 several years ago where we set threshold limits in 13 terms of what would require Board of Directors 14 approval. And those threshold limits were set at 15 contracts in excess of 500,000 dollars in any given 16 year or two million dollars over their life. That 17 process and that threshold approval level is in place 18 today. It was not in place six years ago. 19 COMMISSIONER COX: Okay. And so six 20 years ago, when you approved this contract by 21 yourself, did you brief this consultant on GTECH's 22 ethical requirements? 23 MR. TURNER: That was done by 24 Don Sweitzer, as he described earlier. 25 COMMISSIONER COX: So even though you 0104 1 approved it, Mr. Sweitzer was participating and he 2 briefed them on your ethical requirements that they 3 would need to comply with if they accepted your money? 4 MR. TURNER: Yes, sir. 5 COMMISSIONER COX: Mr. Chairman, I 6 think that that -- I have one question for 7 Mr. DeSocio, if I could, please. 8 And please introduce yourself so I'll 9 be sure that I'm pronouncing your name correctly, 10 Mr. DeSocio. 11 MR. DeSOCIO: I'll be happy to do that. 12 My name is Walter DeSocio. I'm the 13 General Counsel of GTECH. Happy to be here. 14 COMMISSIONER COX: This relates to your 15 assuming the role that Mr. Daly had, which Mr. Turner 16 described to the September 2000 meeting of this 17 Commission. Can you tell me how that -- at that time, 18 Mr. Turner stated that Mr. Daly was a former FBI 19 agent, I believe, of some tenure, and that he was 20 totally independent of management, and that he could 21 report to any member of the Board of Directors at any 22 time on any matter. And that he was well known to the 23 employees of GTECH to be available to them to report 24 matters of concern that they might have in the ethical 25 area. 0105 1 Now, clearly, you are not independent 2 of all reporting requirements. You report to 3 Mr. Turner. Is that correct? 4 MR. DeSOCIO: Yes, I do report to 5 Mr. Turner. I also, as the Chief Compliance Officer 6 of the company, report functionally to the Chairman of 7 the Board, and I interact on occasion with the 8 Chairman of the Board about matters typically, for 9 example, where e-mails come in to the Board of 10 Directors on certain matters, as mentioned earlier. I 11 will often have a brief conversation with the Chairman 12 about those. I also report functionally as well to 13 the Chairman of our Corporate Governance and 14 Compliance Committee, which is currently chaired by 15 one of our directors, the former SEC Commissioner. So 16 I really have two other, if you will, independent 17 board points of contact and oversight. During our 18 regular board meetings -- at every board meeting, it's 19 our practice not only to have, of course, full board 20 meetings, but have committee meetings. We have a 21 corporate governance and compliance committee meeting 22 at every board meeting. At every one of those 23 meetings, there is, typically, as there is at the 24 larger board meeting, an executive session. So I will 25 from time to time report out in executive session to 0106 1 the Chairman of that particular committee. 2 So you are correct, there is a -- there 3 is a reporting relationship with Mr. Turner, but there 4 is also a functional reporting relationship to other 5 members of the board, as I just described. 6 COMMISSIONER COX: So you have, in your 7 view, requisite independence of Mr. Turner because of 8 your other reporting relationships with the Chairman 9 of the board? 10 MR. DeSOCIO: Yes, I believe that, and 11 I leave that's by mutual design, yes. 12 COMMISSIONER COX: And are you 13 satisfied with the way the program, that Mr. Daly was 14 initially in charge of and you're now in charge of, 15 has worked and is working? 16 MR. DeSOCIO: I am. I should probably 17 give you a chronology, since I'm relatively new to 18 GTECH. I joined in January of 2005, so if I recall, 19 subsequent to Mr. Daly's departure -- and I won't get 20 all the names right -- but there were other 21 individuals who essentially filled the same function 22 as Mr. Daly. There was also a predecessor to me who 23 served as General Counsel of the company, Mark 24 Crisafulli, who at one point went over to the business 25 side of the company and it's at that point that I 0107 1 stepped in as general counsel of GTECH, having come 2 from the outside in January of 2005. 3 With regard to the compliance 4 ecosystem, as I refer to it, overall, I think it's -- 5 I think it's a very strong, very robust, very 6 resilient system. In my prior lives, I have worked at 7 some relatively large companies and had significant 8 roles in board matters and in compliance matters, 9 worked in regulated businesses as well, though not in 10 the gaming business, and I think I have a pretty good 11 appreciation for what a good compliance system and 12 governance system looks like. And, frankly, I think 13 the GTECH compliance and governance system is among 14 the strongest I have seen, not only at companies I 15 have worked at, but at companies I have come across in 16 my travels. And it is -- it is a system that is good 17 but can always be better. The gaming business is, by 18 nature, a very challenging business, and we are a very 19 complicated, geographically diverse company, so I -- I 20 sleep relatively well at night, but I don't sleep like 21 a baby. I don't think compliance officers are 22 supposed to sleep like babies. We're constantly 23 looking for ways to do things better. We -- we have 24 initiatives underway as a result of the pending merger 25 with Lottomatica where we think we have opportunities 0108 1 to do things even better, to -- to take our training 2 programs, for example, and spread them even more 3 effectively out to the furthest reaches of the 4 business, since at the end of the day, a compliance 5 and ethics program isn't good if everyone sitting at 6 the corporate center understands it and we all 7 violently agree with our policies and procedures. 8 It's got to be good out the furthest point of the 9 perimeter of your business. 10 So the Lottomatica transaction will 11 provide some, you know, opportunities for us to design 12 new and better systems, but overall, I think that the 13 GTECH system is a very, very strong system and has -- 14 has served the company well in situations like Brazil 15 and in situations subsequent to that, where we have 16 had early detection and early prevention programs in 17 place and have prevented the company from going down 18 the wrong road. 19 COMMISSIONER COX: Thank you. 20 Mr. Turner, as to your discussion with 21 Chairman Clowe about independence of directors, I 22 appreciate his clarifying the points that you and I 23 didn't get to in our discussion. And my point perhaps 24 wasn't crystal clear. My point was that not at all 25 that you're not in compliance with the requirements of 0109 1 the New York Stock Exchange or any other published 2 requirements that may be out there. My idea, and it 3 may just be that, and it may be idealistic, is that, 4 to quote you, I think, correctly, you operate in a 5 vortex of government and gaming. And Chairman Clowe 6 and I know as well as anyone in the world knows that 7 that is an uncomfortable vortex in which to operate. 8 And it may at times require nontraditional measures to 9 assure both the stockholders, on the one hand, and the 10 government customers, on the other side, that you have 11 governance that takes into account your unusual arena. 12 And it's different from Procter & Gamble, it's 13 different from companies that sell consumer products 14 to consumers. You're selling a controversial product 15 to government. And my suggestion is just that you and 16 your associates think about whether the traditional 17 model of high levels of incentive-based compensation 18 and stock ownership by Board members is the right one 19 in the environment that you operate. 20 MR. TURNER: Mr. Commissioner, we'll 21 take that -- take that on and obviously share it with 22 my respective new owners in the close -- which I think 23 is fairly imminent. I certainly -- it's a little 24 different in that -- that the new Lottomatica, many of 25 the members of the board are the largest shareholders 0110 1 of the company by design. But I think that -- I think 2 that you raise a very good point and it's certainly 3 worthy of careful reflection, and I actually want -- 4 the take away I have here that I think that would be 5 good for us to do is to reach out to many of the 6 leaders in the commercial gaming world, folks from -- 7 some of which are from your former professional 8 activities -- and find out what they are doing today, 9 if they're talking about some of these same issues. 10 Companies like Harrah's Entertainment International, 11 Game Technology, MGM-Mirage, these are companies, 12 candidly, that are either relatively larger than what 13 the new Lottomatica will be with GTECH, or comparably 14 sized, so we can maybe share some thoughts on -- on 15 this -- this very unique area in which we all operate 16 together. And maybe there will be some learnings that 17 come out of that. But I will certainly carry your 18 message to the De Agostini Board members. I expect 19 they're listening now, but I understand you. 20 COMMISSIONER COX: And let me assure 21 you that Chairman Clowe and I understand that the past 22 is dug up when you're in a business like we're in. 23 The past of this agency gets dug up a lot. We're in a 24 new day, under the leadership of Mr. Sadberry, and it 25 appears that GTECH is in a new day under your 0111 1 leadership, and we hope that we can all put our 2 present performance to the forefront and, ultimately, 3 maybe people will forget those things that happened in 4 the past. 5 MR. TURNER: Well, sir, that is 6 certainly my hope. I understand, as you do, that -- 7 that in the competitive world in which we operate, the 8 past remains your past. It's sort of like family. 9 They stay family whether you like it or not. 10 So -- but we understand those things 11 and we certainly appreciate the opportunity to serve 12 the people of Texas. This is a very important 13 contract for my company. I believe that we take it 14 very seriously, and I know the professionals we have 15 on the ground here are dedicated to help you achieve 16 your goals and objectives. 17 COMMISSIONER COX: Thank you very much 18 for being here. 19 Thank you, Mr. Chairman. 20 CHAIRMAN CLOWE: Thank you, 21 Commissioner Cox. 22 Gentlemen, the only thing I would add 23 is that, you know, the people that go to Las Vegas go 24 there and to Atlantic city on their own, and nobody 25 requires them to go, and they can leave when they want 0112 1 to. Texans pretty much stay here in this state. And 2 along the lines of the comments that Commissioner Cox 3 made, I want to remind you that there is between a 4 third and 40 some-odd percent of the people in this 5 state who I think don't like legalized gaming. And we 6 must be very respectful of them and their viewpoint, 7 and be aware that anything at any time can be 8 controversial. 9 The author of the gaming bill that 10 brought legalized gaming into this state is in this 11 room, and I wish I had all the history and the 12 knowledge that he has. It might help me better 13 understand some of the problems we're dealing with in 14 this state. But after eight years on this board, and 15 Commissioner -- or Director Sadberry predates me on 16 that, we understand some of the problems that we have 17 to deal with. And so when you talk to the Board, as 18 it evolves, if this transaction is approved, and they 19 say to you, you know, won't those guys in Texas ever 20 settle down? Your answer to them should be, no. We 21 will never stop asking questions, we will never stop 22 our inquiries, we will always be like we are, and the 23 board of Mega Millions doesn't understand us either. 24 But you've got to give us your best effort as the 25 lottery operator. You've got to give us a scrupulous, 0113 1 fair, and honest operation. We just won't accept 2 anything else. And no matter who the Commissioners 3 are or the Executive Director, that's the standard 4 that's set for this agency in the State of Texas. And 5 we're under the microscope every day, so we intend to 6 lead our lives that way. Our public lives. 7 Again, thanks to you, Mr. Turner, and 8 your executive staff for being here. I think at this 9 time we have no further questions. 10 MR. TURNER: Thank you, sir. 11 CHAIRMAN CLOWE: Mr. Mattax, will you 12 come up again, please. 13 Mr. Mattax, at the time of our meeting 14 where we had reports from you and from Graves, 15 Dougherty and from the Department of Public Safety, we 16 asked you if you had found anything that indicated 17 that any individuals or the proposed surviving entity 18 of this transaction would be unsuitable. You answered 19 that in the negative, if I recall correctly. 20 MR. MATTAX: That's correct. 21 CHAIRMAN CLOWE: Since that time, we 22 have received now a -- an additional formal report 23 from GTECH -- on GTECH from the Department of Public 24 Safety, as well I think you probably attended numerous 25 meetings informally that were not in the public and on 0114 1 this record. And now you've been present today for 2 all of the information that has been discussed between 3 Mr. Turner and his colleagues and the Commissioners. 4 Based on your knowledge of all of those appearances 5 and all of that information, including up to today, 6 is -- as our attorney, is there anything in your 7 opinion that deems this proposed transaction or the 8 individuals involved as being unsuitable within the 9 legal confines of our contract with GTECH? 10 MR. MATTAX: No. Let me further say 11 that I believe that, as we've discussed previously, 12 the thorough review of the Department of Public Safety 13 with respect to the vetting of the individuals at 14 Lottomatica and then the De Agostini group, who will 15 ultimately have control over this corporation after 16 the merger, has shown nothing that would reveal any 17 unsuitability with respect to the management there. I 18 don't believe any of the issues that have subsequently 19 been raised reveal any suitability issues with respect 20 to GTECH either and, therefore, I have not changed my 21 opinion that I gave that there is no reason for this 22 board to take any action with respect to the 23 Lottomatica transaction, because there is no 24 suitability issues there. 25 I would further comment, though, that 0115 1 as you've heard today, problems have arisen in the 2 past, and procedures are in place to try to prevent 3 those from happening in the future. It is my intent 4 to continue to work with GTECH and with the Executive 5 Director and his staff to follow through with these 6 procedures. As I mentioned, I think it might behoove 7 the board, after this transaction is consummated and 8 after there is some integration between Lottomatica 9 and GTECH, to perhaps have Mr. Turner and 10 Mr. Pellicioli come back to the Board -- excuse me, 11 back to the Commission after that integration to 12 discuss what they're going to continue to do as far as 13 corporate governance, as far as making sure that 14 contracts are properly vetted, as far as making sure 15 that they operate, as this Commission wants, in the 16 highest integrity possible. 17 But at this point, my view is that 18 there is nothing that should prevent this transaction 19 with Lottomatica going forward, but I do believe we 20 should continue to diligently investigate and 21 diligently work with Lottomatica so this Commission is 22 aware of any issues that may arise in the future that 23 need to be addressed. 24 CHAIRMAN CLOWE: Questions? 25 COMMISSIONER COX: No, sir. 0116 1 CHAIRMAN CLOWE: Thank you, Mr. Mattax. 2 Now, Commissioner Cox, thank you for 3 pointing out to me this last item on the DPS report 4 under this subject on the agenda. 5 When I appeared before the House 6 Licensing Committee, I was asked some questions by the 7 chair of that committee regarding this issue. I 8 responded that at the time of the request for 9 proposals for this current contract, there was only 10 one bidder, and that was GTECH. Mr. Turner has 11 confirmed that by his personal knowledge. 12 I also commented to the committee that 13 to my knowledge, I didn't know whether the statute 14 enabled us, but I did not believe we had the 15 authorizations for FTEs or we had the appropriations 16 to run the operation if -- and I didn't know whether 17 the statute authorized it or not. And I was giving 18 what I had as best knowledge of that situation. 19 I would invite Director Sadberry and 20 the General Counsel to help us understand just what 21 the facts are in that regard, because I have been 22 pointing out in my testimony numerous times that we 23 only have one bidder for this contract, that the State 24 of Texas has not positioned itself, to my knowledge, 25 to take over this operation and run it itself. We 0117 1 have a fully bundled operation which is one that I 2 think the legislature set us on the water with the 3 idea to sail the ship in that manner. And I think at 4 this time, if you're in agreement, I would like to 5 discuss this in the public and make it public, and 6 have it known for the benefit of any and all that are 7 interested in this situation. 8 COMMISSIONER COX: Okay. 9 CHAIRMAN CLOWE: Director Sadberry, 10 first of all, will you correct me in any misstatement 11 I've made and then add any comments you may wish to in 12 regard to this subject. 13 MR. SADBERRY: Mr. Chairman, thank you. 14 I will attempt to do so. 15 I, as you know, was in attendance at 16 the committee hearing at which time those questions 17 were posed to you, and heard the questions and your 18 responses. And in connection with that, have heard 19 your statements today, and I believe it would -- with 20 the assistance of Mr. Turner's testimony in that 21 regard, my estimation is, you are accurate in every 22 aspect of the statements and comments that you have 23 made regarding that matter, some of which occurred 24 even when I was a Commissioner, some that occurred 25 after I was no longer a Commissioner, and some which 0118 1 have occurred on my current watch. And as we are 2 currently in the process of a legislative -- process 3 of the budgeting for future years at the LAR process 4 that accompanies that, which is also an agenda item on 5 today's meeting, so it's quite timely to consider 6 these points. 7 I believe I can state, and again, I, as 8 you, would be subject to any clarification or 9 assistance to be provided by our General Counsel in 10 that respect, who has been here during all of this 11 time and will be in a position to know the state of 12 information. But to be specific, in my understanding, 13 were the Commission to undertake any approach of 14 conducting that aspect of the lottery that is now 15 undertaken by the lottery operator, by contract with 16 this agency, it would require legislative action. 17 That being the case, we today would not have that 18 authority nor capability. The legislature would be 19 the determining body to act, pursuant to their charge 20 and their authority in the State. So that -- we can 21 expand on that, but I think that's the direct and 22 specific answer. 23 With respect to the notion of a lottery 24 operator, that is part of the statute which tends to 25 acknowledge the authority of the Commission to operate 0119 1 in that fashion. I think believe, in our vetting and 2 review of that statutory language, that is what it 3 does. Whether it mandates that we have a lottery 4 operator is, of course, subject to interpretation. 5 And that is not necessarily the interpretation we were 6 given, but it certainly contemplates that there be a 7 lottery operator, which is our current mode, and has 8 been the mode since not only the creation of this 9 agency, but even prior to that time, at the inception 10 of the lottery in 1992, one year prior to the agency's 11 creation. 12 With respect to the contract in its 13 present form, bundled or unbundled or partially 14 bundled or unbundled, that is probably the function, 15 as we perceive it, of how it was set in motion at the 16 outset of the contract with -- as has been amended on 17 several occasions. But to in any way depart from that 18 mode, it would either, in our estimation, be a 19 function of mutual contractual negotiations and 20 agreements between the agency and our current 21 operator, or any subsequent operator, or again, it may 22 the subject of legislative action. 23 So I believe I can say -- and I sense 24 the -- the nature and intent of your testimony before 25 the committee, the House Committee, and your 0120 1 statements today, that what we are doing reflects what 2 has evolved as the -- for the time being, the feasible 3 options that we have as they currently exist. 4 We believe that we are tasked, from 5 several sources, with a consistent and continuing look 6 at the situation, and to use the resources available 7 to us to determine what, if any, recommendations or 8 options that may be available for discussion should we 9 be requested to engage in such discussions, or should 10 it be an appropriate function of the LAR process or 11 otherwise to see, on a going-forward basis, what may 12 be our options in the State of Texas with respect to 13 the lottery. 14 CHAIRMAN CLOWE: Thank you for that and 15 I want to continue on and establish some facts. I 16 think it's very important, when you have a discussion 17 like this, to get the facts before everyone. 18 The largest contract that this agency 19 has is with the lottery operator. 20 MR. SADBERRY: That's correct. 21 CHAIRMAN CLOWE: And, historically, my 22 recollection is, for the last four fiscal years, we 23 have paid GTECH -- and I recall it as being 95, 93, 87 24 and 83 million dollars a year. Is that close enough? 25 MR. SADBERRY: Close enough for me, and 0121 1 much to my greater comfort, we have the people present 2 in the meeting who could give us the actual numbers, 3 including our controller and others who are with us 4 today. 5 CHAIRMAN CLOWE: It's a large contract. 6 MR. SADBERRY: It's a large contract. 7 CHAIRMAN CLOWE: The second largest 8 contract is with the instant ticket printer, which is 9 primarily Scientific Games. 10 MR. SADBERRY: Primarily. 11 CHAIRMAN CLOWE: And although they 12 print the tickets, they are delivered to the warehouse 13 here, and then GTECH takes over the distribution and 14 the monitoring. 15 MR. SADBERRY: That's correct. 16 CHAIRMAN CLOWE: That's part of their 17 contract. 18 MR. SADBERRY: That is correct. 19 CHAIRMAN CLOWE: The third largest 20 contract is for advertising, and that is currently 21 with DDB, in Dallas, Texas. Those are the three 22 contracts that are of magnitude that I think is very, 23 very significant to any State agency. Although 24 they're all important, those are significant. 25 MR. SADBERRY: I would concur. 0122 1 CHAIRMAN CLOWE: Now, of those three 2 principal contracts -- I'll call them that for want of 3 a better name -- we have competition for the instant 4 ticket printing, we have competition for the 5 advertising, but we have already stated, for the 6 lottery operator, there has only been one bid this 7 last time. 8 MR. SADBERRY: The last time, one bid. 9 COMMISSIONER COX: Mr. Chairman, what 10 year -- it was before my tenure. What year was that 11 last contract? 12 CHAIRMAN CLOWE: Let's get it exactly 13 right. You weren't here Commission -- or 14 Director Sadberry. Is -- Deputy Director Grief in the 15 audience? 16 MR. SADBERRY: He is here. I think he 17 is now rising to come forward. 18 CHAIRMAN CLOWE: Gary, are you the 19 holder of that knowledge? 20 MR. GRIEF: Good morning, Mr. Chairman, 21 Commissioner Cox. For the record, my name is Gary 22 Grief, deputy executive director. 23 I could probably come up with a close 24 date, but I would defer to our General Counsel, who 25 would -- I can see she's probably looking that up 0123 1 right now on her computer, to give us an exact date. 2 CHAIRMAN CLOWE: That will be 3 satisfactory. 4 MS. KIPLIN: I'm looking. 5 COMMISSIONER COX: Don't let us put any 6 pressure on you. 7 MS. KIPLIN: Not at all. 8 I believe it was 2000, it went out to 9 bid. I'm just looking for that. 10 MR. GRIEF: Tom Jackson, our Contracts 11 Manager, has provided me with the initial start date 12 of the current contract, and this document indicates 13 it's October 10th, 2001. I believe we had a year 14 implementation time, the 365 days prior to that date, 15 where we had implementation for the contract. So the 16 initial term began on 10-10-01. 17 CHAIRMAN CLOWE: And that's a nine-year 18 contract. And the rate of compensation is 2.6999 19 cents per dollar? 20 MR. GRIEF: Actually, Mr. Chairman, the 21 compensation number is correct, but it runs through 22 August 31st, 2011, almost a ten-year contract. 23 CHAIRMAN CLOWE: Okay. That's the year 24 that -- that went in first to make it a ten-year 25 contract. 0124 1 MR. GRIEF: Yes, sir. 2 CHAIRMAN CLOWE: I remember that now. 3 Okay. I think it's important, 4 Commissioner, to get these facts out so that people 5 understand that you've got to look at the elephant. 6 You can't look at the tail, you can't look at the 7 trunk or at a foot, you've got to look at this whole 8 situation to see where we are in this state. 9 Our projected revenue for the current 10 fiscal year is what, Mr. Grief? 11 MR. GRIEF: Slightly over one billion 12 dollars in net revenue. 13 CHAIRMAN CLOWE: To the Foundation 14 School Fund, and our gross? 15 MR. GRIEF: About 3.75 billion? 16 MS. PYKA: Seven nine. 17 MR. GRIEF: 3.79 billion. 18 CHAIRMAN CLOWE: And we represent, my 19 recollection is, about eight percent of GTECH's 20 revenue. And Mr. Turner, could you nod your head and 21 I'll -- we're getting a nod from the GTECH official, 22 and I'll say on the record, that's been confirmed. 23 And that's the testimony I gave before the House 24 Licensing Committee. 25 This is the people's business and this 0125 1 is serious business. And for people who want to know 2 and want to be involved in it, they're fully entitled 3 and we need to start with the facts. 4 Anything further, Commissioner? 5 COMMISSIONER COX: Director Sadberry, 6 earlier, Mr. Turner referred to the Texas model, which 7 as I understand it is, we outsource more than anybody 8 else does of lottery services. 9 DIRECTOR SADBERRY: I think that's a 10 reasonable statement, Commissioner. I think that's 11 the reference that's intended when people refer to the 12 Texas model, and that's, I think, the same reference 13 the Chairman and I referred to, a bundled 14 configuration. 15 COMMISSIONER COX: Now, to your 16 knowledge, and I guess this was done initially by the 17 Comptroller's Office before you came -- became 18 Chairman of this Commission. 19 MR. SADBERRY: That's correct. 20 COMMISSIONER COX: Was that done as a 21 result of statute or was that done as a result of rule 22 or was that done as a result of an administrative 23 decision by the statewide elected officials who headed 24 this agency? 25 MR. SADBERRY: Commissioner, as you 0126 1 indicated, it was done prior to the formation of the 2 agency and prior to, therefore, the naming and the 3 serving of any Commissioners. In looking at that 4 point and then making an analysis of it, I don't 5 believe the statute requires it. I think the contract 6 certainly provided for it and the contract has been 7 the guiding administrative force throughout all of 8 those years, subject to the amendments that have 9 occurred. The amendments have not generally addressed 10 that aspect of the contract. So I would not say it's 11 statutory, but I think it's certainly contemplated by 12 the statute. And, again, the statute does refer to a 13 lottery operator. And we believe the bundling of the 14 service is certainly consistent with the statutory 15 enabling authority. 16 MR. GRIEF: Commissioner, if I could, I 17 would also offer -- and Executive Director Sadberry, 18 my recollection is that the legislation did cap the 19 number of FTEs of the Lottery Commission at the 20 Comptroller's Office at the time at 186. And by 21 virtue of that cap, that virtually ensures that you 22 can't do it all in-house. You've got to contract out 23 a large portion. 24 COMMISSIONER COX: So that would 25 indicate that the initial intent of the legislature 0127 1 was that this would be almost all contracted out and 2 there would be a small oversight agency here. 3 MR. GRIEF: That was my observation at 4 the time. 5 COMMISSIONER COX: So and -- from where 6 we are right now, and I know Ms. Pyka is going to give 7 us a presentation later on, on the LAR, but the -- the 8 way the -- our budget is allocated by line item and 9 the number of FTEs we are allocated, at this moment, 10 prevent our departing from our present strategy? 11 MR. GRIEF: That's correct. 12 CHAIRMAN CLOWE: Well, that's part of 13 it. There is another large part, which is the 14 appropriation for the hardware and the system. 15 COMMISSIONER COX: Sure. The -- 16 CHAIRMAN CLOWE: And although we have 17 rights to the code, for our contract with the 18 operator, we don't own the equipment, we don't have 19 the -- the hardware. 20 COMMISSIONER COX: Or the software. 21 CHAIRMAN CLOWE: Well, we can get the 22 software. But -- what is the word, Gary? 23 MR. GRIEF: Capital budget. 24 CHAIRMAN CLOWE: No, no. The word for 25 the code. 0128 1 MR. GRIEF: The source code. 2 CHAIRMAN CLOWE: The source code. We 3 have rights to that. 4 MR. GRIEF: Yes, we do. 5 CHAIRMAN CLOWE: But for anybody that 6 thinks the State can just throw the switch because 7 that's what it wants to do, you've got to understand 8 these requirements. And that is the reason I want us 9 to discuss this. And it's important and 10 Director Sadberry has said it requires statutory 11 change. 12 You know, let's just have this 13 discussion in the public and get everybody talking 14 about the correct facts. 15 MR. SADBERRY: I would certainly 16 adopt -- and thank you, Gary, for that supplemental 17 information regarding the initial cap on the FTEs, and 18 I guess that was at the agency creation stage, even 19 after the lottery was in existence and the contract 20 was in existence, where the legislature could have 21 provided a different scheme, if you will. It did not. 22 By -- and, in fact, it did the opposite by virtue of a 23 cap, included in all of that, and that includes 24 certainly the IP issues and hardware, is intended by 25 my statement that it would require a legislative 0129 1 action. And I think, to be specific, perhaps even 2 elaborate further, you need to look at every aspect of 3 the operation in terms of what legislative action 4 could be required. For example, the lifting or 5 increase of the cap on FTEs, the capital budget, the 6 rider, the appropriations, all aspects of what it 7 takes, if you will, to feasibly look at the whole 8 picture. But it all feeds into, generally, the 9 concept that it's a legislative action function, and 10 not the authority or decision in that regard of the 11 Lottery Commission, at the outset, moving in any other 12 direction. 13 CHAIRMAN CLOWE: Counselor, this 14 discussion is all properly included within this item 15 in the agenda, is it not? 16 MS. KIPLIN: I think so. I think, 17 particularly, the item seven that you're on, it's 18 possible discussion and/or action on GTECH 19 Corporation, and part of that has to do with, what is 20 the future. I think, as Commissioner Cox pointed out, 21 that is an observation in the report of the Department 22 of Public Safety. 23 CHAIRMAN CLOWE: Very good. 24 Anything further, Commissioner? 25 COMMISSIONER COX: No, sir. 0130 1 CHAIRMAN CLOWE: Then we'll move on to 2 item number two, consideration, possible discussion 3 and/or action on a petition for rulemaking to amend 4 16 TAC 402.200, General Restrictions on the Conduct of 5 Bingo. Ms. Joseph. 6 MS. JOSEPH: Good morning, 7 Commissioners. My name is Sandy Joseph, Assistant 8 General Counsel. 9 I would like to report to you that 10 yesterday the petitioner for this rulemaking withdrew 11 the request for rulemaking. Therefore, there is no 12 action required by the Commission at this time. 13 CHAIRMAN CLOWE: Thank you, ma'am. 14 Next, item three, report, possible 15 discussion, and/or action on lottery sales and 16 revenue, game performance, new game opportunities, 17 market research, and trends. Ms. Pyka. 18 MS. PYKA: Thank you, Commissioners, 19 and good morning. My name is Kathy Pyka, Controller 20 for the Texas Lottery Commission. With me to my right 21 this morning is Robert Tirloni, our Products Manager; 22 and David Sizemore, our Research Coordinator. 23 Our first chart that we have for you 24 this morning reflects revenue from sales and net 25 revenue to the State for the week ending August 5th, 0131 1 2006. Total sales through this 49-week period 2 amounted to 3.5 billion, while estimated net revenue 3 to the State for this period was 955.8 million. Our 4 fiscal year 2006 sales to date did reflect a 100.3 5 million dollar increase over fiscal year 2005 sales. 6 And net revenue to the State reflects a 4.3 percent 7 increase, as compared to the 916.1 figure for the same 8 period in fiscal year 2005. 9 Commissioners, I wanted to note, by the 10 end of this week, we will have exceeded our fiscal 11 year 2005 sales to date figure. 12 Our prize expense, as a percentage of 13 sales, is reflected as 62.7 percent for the current 14 period, a slight increase over the same period last 15 fiscal year. 16 The next slide includes our fiscal year 17 2006 year-to-date sales by game. As noted, 75.7 18 percent of sales or 2.7 billion was from instant 19 ticket sales, with 7.8 percent of sales or 275.4 20 million from Pick Three, followed by 6.4 percent of 21 sales or 225.8 million from Lotto Texas, and 5.2 22 percent of sales and 183.3 million from Mega Millions. 23 And this slide provides you the 24 graphical presentation of the 3.5 billion dollars in 25 sales by game. 0132 1 MR. TIRLONI: Good afternoon, 2 Commissioners. For the record, my name is Robert 3 Tirloni. I am the Products Manager for the 4 Commission. 5 This next slide shows the 2.7 billion 6 dollars in instant sales, fiscal year to date, broken 7 down by price point. We look at this monthly and 8 share it with you. And there have been no changes. 9 The five-dollar price point is our leading price 10 point, followed closely by our two-dollar price point 11 and then our ten-dollar price point. 12 Commissioners, Kathy just provided you 13 the percentage of sales that we're seeing from our 14 instant and on-line games, and a couple of meetings 15 back we had talked about what other states are 16 experiencing, and so I have some information to share 17 with you today. 18 COMMISSIONER COX: Robert, if I could. 19 MR. TIRLONI: Sure. Yes, sir. 20 COMMISSIONER COX: Let's go back to 21 that last slide. 22 MR. TIRLONI: This one? 23 COMMISSIONER COX: Yes. 24 MR. TIRLONI: The instants? 25 COMMISSIONER COX: I hear there is talk 0133 1 that the government is going to quit minting pennies 2 because it costs two cents to mint one. And so 3 they're just going to change the way we do business so 4 we don't do business with pennies anymore. 5 MR. TIRLONI: Okay. 6 COMMISSIONER COX: And there is no 7 longer a nickel coke, and there is no longer a 8 500-dollar automobile. Do you think there will come a 9 time when there is no longer a one-dollar ticket? 10 MR. TIRLONI: That may eventually 11 happen. I think the one-dollar price point is an 12 important price point still in the product mix for 13 maybe new players or casual players who may not want 14 to spend 5 or 10 or 20 dollars. But we have seen a 15 decrease in the one-dollar price point over time, and 16 we have seen progression up to the higher price point. 17 So that's -- that's possible. I don't know that we 18 would want to completely remove it from the product 19 mix as a whole because, as I said, I think it does -- 20 I think it does serve a niche for -- for some portion 21 of the playing population. 22 COMMISSIONER COX: Has -- to your 23 knowledge, has any state taken this step? 24 MR. TIRLONI: I don't believe so. 25 COMMISSIONER COX: Are the one-dollar 0134 1 games generally large runs so that the ticket printing 2 is -- is quite economical? I know they are smaller 3 tickets than the two-dollar tickets. 4 MR. TIRLONI: They -- they are. They 5 are larger runs. They're usually about 12 to 14 6 million runs, depending on the game. 7 COMMISSIONER COX: So they're a more 8 generic product. It costs us less to produce, change 9 less often, require less creative work, and are there 10 to fill a purpose in our portfolio? 11 MR. TIRLONI: I believe that's true. 12 Yes. 13 COMMISSIONER COX: Thank you, Robert. 14 MR. TIRLONI: So this slide is a 15 snapshot of fiscal year 2005 for the states 16 represented. The states that I've highlighted in red 17 are the states that both Commissioners asked me to 18 gather information on, and so I've highlighted those. 19 Texas, you can see is -- let me get my 20 pointer here. Texas is third down. For '05, we saw a 21 split between instant and on-line, instant sales 22 making up almost 74 percent; on-line, 26 percent. The 23 state that you all inquired about -- one of those 24 states, Massachusetts, saw a split of about 84 to 15, 25 instant to on-line. Now, I should say that this -- 0135 1 these percentages represent traditional -- in terms of 2 the on-line percentage, traditional on-line games. So 3 there is no kino or VLT sales figures in these 4 percentages so that we could provide you with an 5 apples-to-apples comparison to Texas. 6 For example, for Massachusetts, if we 7 put their kino sales in there, that percentage would 8 change to about 70 percent instant, 30 percent 9 on-line. 10 The other states that you asked about, 11 Georgia, is seeing, in '05 -- or saw in '05, about a 12 61-39 split between instant/on-line. California is 13 about 54-45 or 55-45; New York about the same. And 14 Florida is about 53-47. 15 I listed other states for you that are 16 more in the ballpark with Texas in -- in this 75-25, 17 74-26 range. And you see that those are Vermont, 18 Maine, New Hampshire. Idaho is almost at a 70-30 19 split, and Tennessee is -- is very close as well. 20 And then at the bottom I have shown you 21 what was experienced in the United States 22 jurisdictions for that time period. Now, this is a 23 snapshot. I have another slide that shows progression 24 from the year 2000 to 2005, which I think is very 25 informative, and it shows a movement and a trend. And 0136 1 that's my next slide. 2 CHAIRMAN CLOWE: So, you know, what he 3 told us about Massachusetts puts them out of this 4 chart. 5 COMMISSIONER COX: Or, looked at 6 another way, if you take out Vermont, Maine, New 7 Hampshire, Idaho, and Tennessee, and I'm going to take 8 them out because I'm betting that they either don't 9 have in-state lotto games or they're not very big, and 10 that would be a principal reason for their not having 11 much in on-line sales. Massachusetts, he said, I 12 think, if you take out kino, is 70-30. We're leading 13 the pack. 14 CHAIRMAN CLOWE: That's exactly right, 15 and we're the only state that has the population we do 16 that's up there. 17 COMMISSIONER COX: So what that starts 18 to say to me, Robert -- 19 MR. TIRLONI: Yes, sir. 20 COMMISSIONER COX: -- is that I would 21 like to see next time -- 22 MR. TIRLONI: Uh-huh. 23 COMMISSIONER COX: -- and maybe you 24 already have this chart -- I would like you to see -- 25 take the yellow ones out. 0137 1 MR. TIRLONI: Okay. 2 COMMISSIONER COX: Because I don't 3 think they're comparable. And take out from the other 4 states the stuff we don't have -- kino, whatever -- so 5 that they're all on a solid base. 6 MR. TIRLONI: Then that is the red -- 7 the red states that you're looking at are -- we did 8 take out the stuff that we don't have. 9 COMMISSIONER COX: Well, now, I thought 10 you said in Massachusetts, if you took out kino, it 11 would be 70-30. 12 MR. TIRLONI: If you -- I'm sorry. If 13 you added kino in to their on-line sales, then that 14 split would be 70-30. 15 COMMISSIONER COX: Oh, okay. I didn't 16 hear that. 17 CHAIRMAN CLOWE: And you might just 18 make an "other" column. 19 MR. TIRLONI: I can do that. We can do 20 that for you. 21 CHAIRMAN CLOWE: And -- and then add 22 another column and make that per capita sales. Don't 23 you think -- 24 COMMISSIONER COX: Good. And then the 25 other thing I'd like to see is contribution margin, if 0138 1 that's what Ms. Pyka calls it, the percentage of 2 revenue to sales. 3 MS. PYKA: Okay. 4 CHAIRMAN CLOWE: Yeah. 5 MR. TIRLONI: Okay. We can expand -- 6 we can expand that for you. Well, I -- we have -- we 7 have all of the data collected already. It's just -- 8 it'll just be a matter of us -- of presenting it in 9 a -- in a slide that will be easy for us all to look 10 at next month -- 11 CHAIRMAN CLOWE: Yeah. 12 MR. TIRLONI: -- but we can do that. 13 I think this next slide is very 14 interesting -- 15 CHAIRMAN CLOWE: And I think -- let me 16 just say this while we're on this subject. I think 17 what we're looking at here is the fact that our on -- 18 our instant tickets and their growth has kept us 19 enabled to make the billion dollar a year 20 contribution. If we didn't have that growth, even 21 though there is going to be a lower contribution to 22 the State, we wouldn't be where we are, and we will 23 probably still show a lower per capita participation. 24 COMMISSIONER COX: Certainly than 25 Massachusetts and Florida. 0139 1 CHAIRMAN CLOWE: And probably New York, 2 maybe California. Maybe not California. 3 Okay. We're just trying to talk about 4 where we think this is going to show we are. Thank 5 you, Robert. 6 MR. TIRLONI: This next chart, I have 7 just focused on this chart on the states that you 8 asked me to compile information on. And the -- the 9 yellow is the exact same percentages that you saw in 10 the previous slide for instant and on-line. What I've 11 done in green is illustrated what the percentages were 12 in the year 2000, so I've gone back about five years. 13 And I think the movement is interesting. For example, 14 in Massachusetts, in the year 2000, they had about 15 a -- 16 CHAIRMAN CLOWE: Yeah, we got it. We 17 got it. 18 MR. TIRLONI: -- 80-20 split. 19 CHAIRMAN CLOWE: We got it, Robert. 20 MR. TIRLONI: Okay. 21 CHAIRMAN CLOWE: There's no exception, 22 is there? 23 MR. TIRLONI: The Georgia, you know -- 24 no, there is no exception. The migration has, you 25 know, moved pretty much from on-line to instant. 0140 1 CHAIRMAN CLOWE: Yeah. That's good. 2 Thank you. 3 MR. TIRLONI: And we'll get that other 4 information for you for next month that you just 5 requested. 6 And I believe Director Sadberry is 7 going to update you on some research slides from Ipsos 8 Reid. 9 MR. SADBERRY: Commissioners, I have 10 for you this morning -- actually, now this afternoon, 11 the latest survey information from Ipsos Reid relating 12 to the public perception of the Texas Lottery. This 13 information was compiled in the month of July. 14 The first slide addresses the question, 15 how would you describe your overall opinion of the 16 Texas Lottery. As shown, the percentage of negative 17 responses to this question decreased, from June to 18 July, from 40 percent to 38 percent, and positive 19 responses decreased, from 41 percent to 37 percent, 20 over the same period. Neutral responses increased, 21 from 19 percent to 25 percent. 22 The second slide addresses the 23 statement, the Texas Lottery is operated fairly and 24 honestly. From June to July, the percentage of 25 respondents who disagreed with this statement 0141 1 increased, from 30 percent to 32 percent, while those 2 who agreed with the statement increased, from 50 3 percent to 53 percent. Those neutral with the 4 statement decreased, from 20 percent to 15 percent. 5 We will continue to track this 6 information on a monthly basis and will update you 7 periodically. I would be happy to answer any 8 questions. 9 COMMISSIONER COX: Director Sadberry, 10 on that chart I'm -- I'm having a little difficulty 11 focusing, but it looks like the agree has hit 53 12 percent three times and that's been the highest it's 13 been. Is that what you see? 14 MR. SADBERRY: That's what I'm seeing, 15 Commissioner. 16 COMMISSIONER COX: And is -- is this 17 the entire period -- does this chart show the entire 18 period we've been gathering this data? 19 MR. SADBERRY: We've looked into that, 20 Commissioner, and we've gathered the data consistently 21 over a number of years, is my understanding. I also 22 understand that it's been presented on a monthly basis 23 in Commissioner meetings, probably over a -- just 24 slightly less than a one-year period of time, 25 beginning sometime around last summer. And 0142 1 Doctor Sizemore is here. We talked about this, and he 2 can certainly be more specific about it than I can. 3 COMMISSIONER COX: And the -- I guess 4 what I would like to know, if you have the data, 5 David, is, was there a significant period before this 6 where comparable questions were asked, and we could 7 determine whether 53 percent is about as good as we've 8 ever done, or where there was a time when it was 70? 9 You know, what -- what kind of score card are we 10 getting here? 11 DOCTOR SIZEMORE: Well, as you recall 12 from previous presentations on the subject, the 13 question did change to not include "Commission" 14 anymore. So -- and I -- that was last -- off the top 15 of my head, I think it was sometime last year. And 16 once it changed, the responses seemed to move in a 17 positive direction. So people were moved -- we 18 removed the word, and people had a better opinion of 19 the lottery, or they reported better. 20 COMMISSIONER COX: So what I hear you 21 saying is that we really can't tell, because we have 22 changed the question, whether this is the best we've 23 ever been or not? 24 DOCTOR SIZEMORE: Well, in the last 25 year and a half or so, we could use a comparable 0143 1 measure -- maybe the last two years, it could be, 2 where the -- the question is consistent over time. 3 And whether 53 percent is the highest, I would have to 4 look back at the data. If you want to give me a 5 minute, I do have some of the material here. I could 6 give you a -- a reaction. 7 COMMISSIONER COX: Well, I think if the 8 question is different, probably the most relevant 9 period is what -- what do we know for the period that 10 the question has been the same. 11 DOCTOR SIZEMORE: Right. And, as 12 Mr. Sadberry pointed out, we've been presenting this 13 to you each month for about a year, a little over a 14 year, maybe. And I seem to recall that the highest 15 reported measure was in the 70s quite a long time ago, 16 when the question was originally produced -- or 17 presented; and then, since then, particularly, in 18 reference to where it's presented monthly to you, it's 19 been in this 45 to 52 percent area. 20 COMMISSIONER COX: So there was a time 21 when it was 70 percent? 22 DOCTOR SIZEMORE: Yes. 23 COMMISSIONER COX: And that was with 24 the question "Commission," rather than "Texas 25 Lottery" -- 0144 1 DOCTOR SIZEMORE: Well -- well, I would 2 have to look back at that. 3 COMMISSIONER COX: Okay. 4 DOCTOR SIZEMORE: Yes. 5 COMMISSIONER COX: Maybe next time you 6 could give us just a short history on what the 7 question has been and what the responses have been for 8 the period of time that the State has been giving -- 9 been gathering it. 10 DOCTOR SIZEMORE: Okay. 11 CHAIRMAN CLOWE: Thank you. 12 MR. TIRLONI: Commissioners, that 13 concludes our presentation for this morning. We'd be 14 happy to answer any other questions you may have. 15 CHAIRMAN CLOWE: Thank you. 16 Next, item four, report, possible 17 discussion and/or -- and/or action on transfers to the 18 State. Ms. Pyka. 19 MS. PYKA: Thank you, Mr. Chairman. 20 Again, for the record, Kathy Pyka, Controller for the 21 Lottery Commission. 22 And tab four does include information 23 on the agency's financial status. The first report in 24 your notebook reflects transfers and allocations to 25 the Foundation School Fund and the allocation of 0145 1 unclaimed prizes as of August 2006. Our total 2 transfers to the State amounted to 985.3 million, and 3 this represents a 2.6 percent increase in the total 4 amount transferred for the same period last year. 5 The second page of your notebook 6 reflects the detailed information for the monthly 7 transfers. Of the 985.3 million dollar transfer to 8 the State, 946.5 million was the amount transferred to 9 the Foundation School Fund, with a balance of 38.8 10 million transferred from unclaimed lottery prizes. 11 The third document in your notebook 12 simply provides the calculation of the transfer, with 13 the final document in your notebook providing a report 14 of lottery sales, expenditures, and transfers from 15 fiscal year 1992 to date. Total cash -- cash-based 16 transfers to the Foundation School Fund, through 17 August of this year, totaled 946.5 million, with a 18 cumulative transfer to the Foundation School Fund of 19 8.6 billion. 20 I would be happy to answer any 21 questions, Commissioners. 22 CHAIRMAN CLOWE: Kathy, what was that 23 percentage of increase that you quoted? 4 point -- 24 MS. PYKA: It's 2.6 percent increase on 25 total -- 0146 1 CHAIRMAN CLOWE: Okay. 2 MS. PYKA: -- which is unclaimed, plus 3 the transfers to the Foundation School Fund. 4 CHAIRMAN CLOWE: Very good. Thank you. 5 The next item is yours as well, number five, 6 consideration of and possible discussion and/or action 7 on the agency's legislative appropriation request. 8 COMMISSIONER COX: Mr. Chairman, before 9 we take this item up, can we take a short break? 10 CHAIRMAN CLOWE: Absolutely. We'll 11 take a short recess. 12 (RECESS.) 13 CHAIRMAN CLOWE: We will come back to 14 order. Ms. Pyka, item number five. 15 MS. PYKA: Thank you, Mr. Chairman. 16 Again, for the record, my name is Kathy Pyka, 17 Controller for -- 18 CHAIRMAN CLOWE: I don't think your 19 mike is on. 20 MS. PYKA: Again, for the record, Kathy 21 Pyka, Controller for the Lottery Commission. 22 This afternoon I'm seeking your 23 approval of the Commission's legislative 24 appropriations request for fiscal years 2008 and 2009. 25 Our Commission's legislative 0147 1 appropriation request was developed in accordance with 2 guidelines from the Leadership Offices, which stated 3 that each agency's baseline request for general 4 revenue related funds would be limited to 90 percent 5 of the sum of amounts expended in fiscal year 2006 and 6 budgeted in 2007, plus an amount equal to the general 7 revenue related salary increase, in accordance with 8 Section 13.17 of Article 9. Funding requests for 9 other purposes which succeed the baseline spending 10 level amount could not be submitted in the agency's 11 baseline but are allowed as exceptional items. 12 In accordance with these Commission 13 guidelines, the Commission's fiscal year 2008-2009 14 legislative appropriation request includes a baseline 15 request of $373,017,887, and the exceptional item 16 request in the amount of $31,401,088, for an overall 17 total request of $404,418,975. As compared to the 18 Commission's baseline budget levels for fiscal year 19 2006-2007, this total LAR reflects a 9.3 million 20 dollar reduction. 21 Regarding full-time equivalent 22 positions, the baseline request reflects 313.5 FTEs, 23 with an additional 5 FTEs requested within the 24 exceptional item request. 25 As noted earlier, we do have an 0148 1 exceptional item request. There are nine of those, 2 amounting to 31.4 million. Each of these exceptional 3 item requests has been prioritized in accordance with 4 the agency's goal structure, to allow us to continue 5 our regulatory and revenue generating functions, 6 provide essential services, and allow for potential 7 growth in lottery revenue. Of the nine exceptional 8 items, six of the items relate to the restoration of 9 the requested budget reductions, while the remaining 10 three items relate to capital acquisition. 11 The nine items, in prioritization order 12 as suggested by staff, include: 13 Exceptional item one, the restoration 14 of a lottery operator contract in the amount of 15 20,560,000; 16 Exceptional item two, restoration of 17 the budget reduction for instant ticket production 18 contract in the amount of $1,000,000; 19 Exceptional item three, the budget 20 restoration of the advertising contract in the amount 21 of 5.6 million; 22 Exceptional item four is a hardware and 23 software upgrade request for 395,000; 24 Exceptional item five is a computer 25 room air conditioning system in the amount of 157,500; 0149 1 Exceptional item six is a VCS system of 2 $84,845; 3 Exceptional item seven is the 4 restoration of a bingo administration budget 5 reduction, with -- including five FTEs in the amount 6 of $505,268; 7 Exceptional item eight is a budget 8 restoration for the bingo prize fee allocation in the 9 amount of $2,198,475; 10 And, finally, exceptional item nine is 11 the budget restoration for the marketing promotion 12 items in the amount of $900,000. 13 Commissioners, I'll provide now an 14 overview of each of these exceptional items. 15 Our first item related to the lottery 16 operator contract. We're seeking restoration of the 17 10 percent reduction in the amount 20,560,000. It is 18 estimated that a 20.6 million dollar reduction of this 19 contract will impact sales to the State of Texas by 20 762 million, with a reduced revenue transfer to the 21 Foundation School Fund of 206 million. 22 If the exceptional item funding is not 23 restored for this item, the Commission will be 24 required to take one of the two following actions: 25 One, suspend lottery sales in an interim period in 0150 1 each fiscal year when sales reach the level that 2 cannot be supported by a payment to the lottery 3 operator vendor; and then, second, negotiate with the 4 lottery operator vendor for a reduced contract rate 5 from 2.6999 percent of gross sales to 2.4299 percent 6 of gross sales. 7 The second exceptional item on the -- 8 COMMISSIONER COX: Ms. Pyka? 9 MS. PYKA: Yes, sir. 10 COMMISSIONER COX: Now, the -- tell me 11 what the impact you figured on cutting out that 20 12 million would be. 13 MS. PYKA: The impact to sales is 762 14 million. 15 COMMISSIONER COX: Okay. And is that 16 number a function of 2.699 percent of something? 17 MS. PYKA: Yes, it is. It's of the -- 18 it's a function of looking at the 20.6 million dollar 19 budget reduction. 20 COMMISSIONER COX: Okay. As -- so that 21 related to the first scenario, which was, when you 22 have paid GTECH everything you can, we shut her down. 23 MS. PYKA: Yes, sir. 24 COMMISSIONER COX: As to the second 25 one, where -- which will say that we would have to go 0151 1 in with GTECH and work out reductions in their 2 services, totaling 20 million, do you have any way of 3 estimating what the revenue reduction might be in that 4 instance? 5 MS. PYKA: We're not able to. 6 COMMISSIONER COX: Because you just 7 don't know what those negotiations would lead to? 8 MS. PYKA: That is correct. 9 COMMISSIONER COX: But it would 10 probably be reasonable to think that the reduction in 11 revenue would be pretty big? 12 MS. PYKA: Correct. 13 CHAIRMAN CLOWE: I -- I wonder just how 14 practical it is to offer up a reduction, along the 15 lines that Commissioner Cox defined, of -- of just -- 16 we sell so many tickets and then shut it down. I 17 mean, that's -- that's not really possible, is it? 18 MS. PYKA: It is not really possible, 19 but in looking at a budget reduction of this nature 20 and looking at the -- the overall budget of the 21 Commission, knowing that their contract represents 22 over 53 percent of our lottery dedicated account 23 budget, it -- it was one of the options that we had to 24 look at. And so, certainly, suspension of sales is 25 not practical, and we offer the second option of 0152 1 noting the negotiation of the contract. 2 CHAIRMAN CLOWE: Well, you know, one of 3 the things that Mr. Morrissey said, in the meeting I 4 attended on behalf of this board, was that they didn't 5 want proposals that involved shutting the Capitol down 6 and saving money by doing that. And I -- I'm a little 7 uneasy about this from that standpoint. Have you 8 discussed this with them and -- 9 MS. PYKA: They are certainly aware of 10 the issue and -- and the dollar amount -- the dollar 11 value that we're talking about on our overall 12 reduction. We had talked to them about the overall -- 13 if -- whether or not there could be maybe -- excuse 14 me -- exemptions on our contractual line items. 15 And -- and the response being that all budgets of all 16 agencies are to be reflected. That it's the agency's 17 requirement to clearly articulate what the impact -- I 18 mean, I clearly believe they understand the 19 reasonableness of that. But we -- we have a 20 responsibility to clarify for them what that impact to 21 sales or what that dollar value is. 22 CHAIRMAN CLOWE: Okay. Well, we're -- 23 we're in a lengthy process, and as you work through 24 this, keep us advised on the conversations back and 25 forth. 0153 1 MS. PYKA: I certainly will. 2 Exceptional item number two does relate 3 to our instant ticket production contract. And we're 4 seeking the restoration of the 10 percent reduction of 5 a million dollars. Our instant ticket vendors provide 6 both instant ticket development and manufacturing 7 services. 8 Restoration of funding for this one 9 million dollar exceptional item will allow the 10 Commission to continue on our aggressive game launch 11 strategy, with a goal of increasing both lottery sales 12 and transfers to the Foundation School Fund. 13 Exceptional item number three -- 14 COMMISSIONER COX: Kathy? 15 MS. PYKA: Yes, sir. 16 COMMISSIONER COX: There, the million 17 dollars that you're asking for would have what 18 estimated revenue impact? 19 MS. PYKA: On this particular item, we 20 have not estimated the revenue impact. I can -- I can 21 say that I know the dollar value that we can associate 22 with instant ticket printing, but in this case, the -- 23 the strategy includes both printing, as well as the 24 licensing fees. And to maintain our flexibility on 25 the strategy that we use, I've not quantified it in a 0154 1 revenue or a sales figure, but there definitely is. I 2 mean, we could do a straight print and say, that would 3 be 178 million in sales and transfers of 48 million to 4 the Foundation School Fund, if we want to focus just 5 on the print portion of that contract. 6 COMMISSIONER COX: Okay. Now, let's -- 7 let's go to Chairman Clowe's observation about the 8 first exceptional item you addressed, which was, reach 9 the point where we have paid GTECH everything we can 10 and shut her down. 11 MS. PYKA: Right. 12 COMMISSIONER COX: Isn't there a 13 similar scenario that we might be presenting, to be 14 consistent, that we sell all the tickets we can for 15 this million dollar reduction and we quit selling when 16 we run out of tickets? 17 MS. PYKA: It is a similar scenario, in 18 the fact that it is a fixed budget amount and then 19 preparation billed by line item. And when you've 20 reached that amount, we would be at the end of the 21 budget cycle. 22 COMMISSIONER COX: Okay. 23 MS. PYKA: Exceptional item number 24 three pertains to our mass media advertising contract. 25 This item includes the restoration of the 10 percent 0155 1 reduction in the amount of 5.6 million. 2 The advertising contract allows the 3 Commission to enhance the marketing effectiveness of 4 the Texas Lottery, effectively reaching and educating 5 the public to increase sales and enhance awareness of 6 Texas Lottery games. 7 We've consulted with professionals in 8 the field of advertising and business in an effort to 9 measure advertising's contribution to lottery sales. 10 We've received a recent study prepared by the McComb 11 School of Business at the University of Texas, and 12 that study concluded that an increase in one dollar in 13 advertising is accompanied by an additional 12 dollars 14 in sales. 15 The University of Texas report 16 referenced similar results from a study performed by 17 the State of Florida -- or for the State of Florida by 18 the Patel Institute. In their study -- excuse me -- 19 they concluded that a one dollar increase in 20 advertising would generate a 15 dollar increase in 21 sales. 22 The Commission has estimated that 23 restoration funding of this 5.6 million dollar item 24 would provide increased lottery sales of 67.2 million 25 and increase transfers to the Foundation School Fund 0156 1 of 18.1 million. If the exceptional item funding is 2 not restored for this item, it is expected that there 3 would be a negative impact, again, to sales and to 4 revenue transfers to the Foundation School Fund. 5 Exceptional item number -- 6 COMMISSIONER COX: Kathy? 7 MS. PYKA: Yes. 8 COMMISSIONER COX: Sorry. Now, you 9 asked for 5.6 million dollars restoration on the 10 advertising contract. That would restore it to what 11 number? 12 MS. PYKA: That would restore the -- 13 the value to 32 million, our current appropriation. 14 COMMISSIONER COX: Okay. And is that 15 the cap that results from that combination of prize 16 payouts on the instant tickets and an original number 17 of 40 million? 18 MS. PYKA: The -- the cap that we have 19 is a function today of appropriation. But there -- 20 in -- in -- in addition to that, there is also a 21 Government Code restriction. And that is where 22 they're looking at the prize payout percentage as a 23 comparison to the 52 percent that's outlined in the 24 Government Code. And any variable between the 52 25 percent prize payout cap in the Government Code and 0157 1 our prize payout percentage is then reduced on a 2 percent basis. For every percent over the 52 percent, 3 one million dollars is reduced from a 40 million 4 dollar cap that's in the Government Code. So as a 5 result, the current prize payout ratio today of 60 6 percent would limit the advertising budget strategy to 7 32 million, which would be the 60 percent, as compared 8 to the 52 percent, an 8 percent modification, with 9 that 8 percent resulting in an 8 million dollar 10 reduction from their 40 million dollar cap. 11 COMMISSIONER COX: Okay. So what you 12 are presenting is the evidence that Professor Huff and 13 Doctor Jarrett compiled and compared that a reduction 14 in advertising has significant detrimental impact? 15 MS. PYKA: Correct. 16 COMMISSIONER COX: Will you also be 17 presenting or offering to present the information they 18 have that increases in advertising dollars, within 19 limits, can produce significant positive additions to 20 revenue? 21 MS. PYKA: Certainly. I'll be happy to 22 share that. Professor Huff had hoped to stay with us 23 today but had another commitment, but I wanted to 24 provide information from his report related to the 25 increase. And I'll -- I'll just summarize it quickly. 0158 1 Based on findings from several states, 2 a reduction of one dollar in advertising resulted in a 3 reduction to the lottery of approximately 30 dollars 4 per year. And so then that's -- we -- we looked at 5 the reduction and then looked at the increase, and 6 that is summarized as, an increase in advertising 7 generates an increase of 12 dollars per year. 8 COMMISSIONER COX: Okay. So the line 9 doesn't have the same slope on the reduction side that 10 it has on the increase side? 11 MS. PYKA: That is correct. 12 COMMISSIONER COX: And is -- would it 13 be appropriate, as responsible folks, to let them know 14 that there is an upside opportunity here, should they 15 choose to avail themselves of it? 16 MS. PYKA: I think that would be 17 appropriate. 18 COMMISSIONER COX: And is that 19 something that we plan to do? 20 MS. PYKA: I think we can certainly do 21 that. Through our committee hearing process says as 22 there is additional questions on this area, to make 23 sure that they're aware of the results of these 24 studies, both this and the Patel Institute. 25 COMMISSIONER COX: Okay. So do you 0159 1 intend to take Professor Huff with you over to the 2 legislature and let him offer information about his 3 report? 4 MS. PYKA: I think that that's -- 5 that's certainly something that the Commission is 6 allowed to do, and we have certainly referenced his 7 report within our exceptional item request funding. 8 COMMISSIONER COX: So you have let them 9 know that it's out there so that -- 10 MS. PYKA: Yes, sir. 11 COMMISSIONER COX: -- at a very 12 minimum, he can respond if they ask him to? 13 MS. PYKA: Correct. 14 COMMISSIONER COX: Thank you. 15 MS. PYKA: Moving on to exceptional 16 item four, this is our first that does not relate to 17 budget restoration. And this is a request for 18 hardware and software infrastructure upgrade in the 19 amount of 395,000. We'll provide three separate 20 funding items -- the first to upgrade our 21 infrastructure software on our desktops of 100,000 22 dollars. This relates to our current Microsoft Office 23 platform that we're using, the fact that it's reaching 24 the end of its life cycle. 25 The second is an upgrade and/or 0160 1 replacement of existing wide area network and local 2 area network hardware and software of 250,000. 3 And the third item that's included in 4 this exceptional item is an upgrade to the 5 Commission's network security device of 45,000 6 dollars. 7 Exceptional item five, again, does not 8 relate to budget restoration, but is a capital 9 acquisition item for a computer room in our -- or air 10 conditioning units within our computer room. It's 11 157,500, and it will allow us to meet future heat 12 loads, do the additional drawing and infrastructure -- 13 information resources infrastructure equipment that we 14 have. 15 Exceptional item six is our third 16 capital item, not part of the budget restoration. 17 It's a VCS 5000 piece of equipment that would be used 18 in our in-house forensic laboratory that is currently 19 needing to be replaced. The current model was 20 purchased in 1998. It's no longer under warranty or 21 the operating system is no longer supported. 22 And then we move on to our next budget 23 restoration item, which is exceptional item seven. It 24 relates to our bingo compliance field operations area, 25 and it's $505,268. And we seek the restoration of 0161 1 five employees in the Bingo Division. 2 In looking at current performance 3 measure estimations for this particular strategy, if 4 the restoration funding is not provided, we believe 5 that there would be 25 fewer -- 25 percent fewer 6 audits, inspections, and investigations of license 7 holders in the bingo auditing area. 8 Exceptional item eight is another 9 budget restoration item. It's for the bingo prize fee 10 allocation, again, $2,198,475. The allocation of 11 bingo funds to local jurisdictions is currently based 12 on bingo prize fees collected at games conducted in 13 counties and municipalities. If restoration of 14 funding is not provided, these counties or local 15 jurisdictions would be negatively impacted by not 16 receiving their share of prize fees that are remitted 17 to the State. 18 And then, finally, exceptional item 19 nine relates to our -- 20 COMMISSIONER COX: I'm going to have to 21 stop you again, Kathy. 22 MS. PYKA: Uh-huh. 23 COMMISSIONER COX: Now, we're saying 24 that we don't want to reduce bingo administration by 25 five FTEs, which have been identified potentially as 0162 1 five auditors. 2 MS. PYKA: Correct. 3 COMMISSIONER COX: And yet Ms. Melvin 4 has recently given us -- given us a report that 5 indicated that those auditors need to be totally 6 relooking what they're doing -- whether they're doing 7 the right thing, whether they're doing enough of the 8 right thing, whether they're doing the wrong things, 9 whether they're doing compatible things. And so for 10 the period of time that we may be talking about, is it 11 reasonable to believe that we will need the same 12 complement of auditors that we need right now since 13 there seems to be so much unknown about what they may 14 be doing in the future? 15 MS. PYKA: Commissioner, there is no 16 doubt that there is an unknown about what they'll be 17 doing in the future. But at this point in time, we 18 believe it is the right thing, the prudent thing to do 19 to request the restoration of this funding because we 20 don't know what they'll be doing in the future. We 21 have to work through those plans. And so we believe 22 that there is going to be a need to ask for the 23 restoration of these particular FTEs at this point in 24 time. Billy is currently working on the Internal 25 Audit report and implementing those recommendations, 0163 1 but at this point in time, we don't have the answers 2 to those questions and, at this point, believe we -- 3 we should pursue the restoration. 4 COMMISSIONER COX: So I heard you use 5 the word "prudent" today. Do you believe that in the 6 absence of information, it would be imprudent to just 7 give up these resources and go through the difficulty, 8 if not impossibility, of regaining them, should they 9 be needed? 10 MS. PYKA: Correct. If at some point 11 down the road we find that we don't need the five 12 FTEs, we can certainly not budget, not fill those 13 FTEs, but since we don't know that right now, we 14 believe we should pursue the restoration. 15 COMMISSIONER COX: Now, again, to -- to 16 Chairman Clowe's point about let's don't do things 17 like talk about shutting down the Capitol. Isn't item 18 eight sort of in that category? 19 MS. PYKA: Item eight, I -- I agree, is 20 in that category, but, again, there were no exemptions 21 when we looked at the budget reduction. 22 COMMISSIONER COX: So what is your 23 choice? 24 MS. PYKA: What is our choice. And as 25 I looked at this, in looking at the bingo budget, when 0164 1 you look at the overall budget and you exclude the 2 prize fee allocation, 93 -- 93 percent of budget 3 relates to salaries. There was really no way to take 4 this bingo prize fee allocation reduction from the 5 operating portion of that budget. So, again, in our 6 eyes, this would be something normally that would be 7 considered an exemption. It was not because no 8 exemptions are being granted. And so we're doing a 9 fair 10 percent reduction, as outlined, and asking for 10 that to be restored. 11 COMMISSIONER COX: Okay. Thank you. 12 MS. PYKA: And then our last item, 13 again, is the exceptional item nine, relating to 14 marketing promotion items. This includes both direct 15 mail and promotional items in the amount of $900,000. 16 We do use these items, and marketing 17 promotion activities include both introducing lottery 18 products to adult Texans across the state, educating 19 our players, and providing opportunities to learn 20 about the lottery products and communicating game 21 information. 22 Restoration of the funding for this 23 item will allow the Commission to continue marketing 24 and promotional efforts with the supportive goal of 25 increasing lottery revenue to the State of Texas. 0165 1 COMMISSIONER COX: And this is one 2 that's not quantifiable? 3 MS. PYKA: Correct. It is difficult to 4 determine a return on investment with the procurement 5 of promotional items, so at this point in time -- 6 COMMISSIONER COX: Maybe -- 7 MS. PYKA: -- we -- we see a benefit, 8 but to -- to put a dollar amount to it is difficult. 9 COMMISSIONER COX: Maybe we'll be that 10 much better next year and we can do it. 11 MS. PYKA: I hope so. We'll continue 12 working on that. 13 That summarizes the nine exceptional 14 items. I would like to now visit on the rider request 15 that we've included in the document. The rider 16 revisions are reflected on page 3B of the LAR. It not 17 only includes revisions to the Commission's current 18 rider -- rider structure in the 2006-2007 General 19 Appropriations Act, but we've also asked for some 20 revisions to the riders that are -- 21 COMMISSIONER COX: What page? 22 MS. PYKA: 3B. 23 COMMISSIONER COX: Got it. 24 MS. PYKA: What I would like to do 25 is -- is highlight for you the major revisions on 0166 1 those riders. 2 We're seeking a revision to rider 3 three, which is the operate lottery rider. In this 4 revision, we've -- we've asked Leadership to provide 5 funding for certain bingo indirect and overhead 6 administrative expenses through the sale of lottery 7 tickets. This rider revision is also contingent upon 8 the passage of legislation to amend Chapter 466 of the 9 Texas Government Code. 10 We've asked for a revision to rider 11 seven that pertains to the limitation of 12 out-of-country and out-of-state travel. This revision 13 includes requesting out-of-country travel, if it is 14 reimbursable by a third party, for vendor 15 investigations and inspections. 16 We've included a revision on rider 15, 17 which is the appropriation of increased revenue. And 18 this revision includes a request to seek unexpended 19 appropriation authority between the fiscal years of 20 the biennium. 21 And then, last, we've asked for a new 22 rider. The new rider has been referenced as New Rider 23 701. It's on page 9 of 11 of Section 3B. And this is 24 a -- a rider seeking adjustment to appropriated 25 amounts. This rider would provide us a mechanism to 0167 1 request adjusted appropriation authority if the 2 current activities which have been previously 3 outsourced via the lottery operator contract were 4 performed by the agency. 5 Specifically, this rider, one, would 6 address seeking a revision to the number of FTEs, 7 seeking a revision on appropriation transfers, and 8 then, finally, seeking a revision on capital budget 9 authority. It outlines the mechanism that we would 10 use to seek a revision, and that includes the standard 11 of -- of going to both the Governor's Office and the 12 Legislative Budget Board to seek this revision. And 13 we would outline exactly how we would go about seeking 14 the revision to the appropriation bill. 15 COMMISSIONER COX: What -- what 16 would -- if this were approved, what would it give us 17 that we don't already have? 18 MS. PYKA: It would give us three 19 things. It would give us a mechanism to address the 20 FTE cap. It would give us a mechanism to address the 21 capital authority cap. And it would give us a 22 mechanism to address the capital budget authority cap. 23 And I wanted to note: Two of those three are 24 currently included in Article 9, but the appropriation 25 authority item is not included in Article 9. So it 0168 1 places it within our appropriation bill as a mechanism 2 to go forward to ask for all three of those revised 3 line items. 4 COMMISSIONER COX: Okay. So does this 5 give us -- is this asking for authorization to study 6 alternatives to the Texas model? 7 MS. PYKA: I wouldn't -- I wouldn't 8 focus on authorization to study, but I would focus on, 9 if there were a desire to move to a different model, a 10 mechanism to go forward with a request to modify our 11 current appropriation bill. 12 COMMISSIONER COX: So is it implicit in 13 that answer that we already have the authority to 14 investigate alternatives in preparation for 2011? 15 MS. PYKA: Yes, I believe we do. 16 COMMISSIONER COX: Okay. 17 MS. PYKA: Commissioners, our LAR is 18 due to the Leadership Offices on the 25th of this 19 month. And in addition to filing our hard copies of 20 the document, we're required to enter the document 21 electronically in the ABES system. And the ABES 22 system is -- let me back up -- the Automated Budget 23 Evaluation System of Texas that the LBB manages. Upon 24 completion of the document, we're required to provide 25 both the LBB and the Governor's Office certification 0169 1 of the integrity of the dual submissions and assurance 2 that the hard copy and the electronic copy are one and 3 the same. The signature certificate for this 4 particular requirement is on page 1C of your LAR. And 5 I wanted to note that the LAR before you is accurate 6 to the best of my knowledge, and the budget reflected 7 in the ABES system and this hard copy before you are 8 identical. 9 Before moving on, we do have two budget 10 hearings that are presently scheduled for this LAR. 11 We've received notice of our joint budget hearing 12 before the LBB and the Governor's Office on September 13 19th. And then we've also been notified by the Senate 14 Finance Committee of our LAR hearing, which is 15 scheduled for October the 3rd. 16 This completes my presentation. I 17 would be happy to answer any questions. 18 COMMISSIONER COX: Kathy, there is -- 19 somewhere in this big document I saw information 20 relating to the Executive Director's compensation. 21 MS. PYKA: Yes, sir. 22 COMMISSIONER COX: Can you direct us to 23 that page? 24 MS. PYKA: That is included in the 25 Administrator's Statement, which is reflected on page 0170 1 1A, page 2 of 4. It's about two-thirds of the way 2 down the page, under the heading, Change to Exempt 3 Position Salary Level. 4 COMMISSIONER COX: Okay. And this is a 5 request that we have talked about many times, to 6 increase the compensation of the Executive Director to 7 a number that makes sense, considering the complexity 8 of this agency and the requirements of that position. 9 MS. PYKA: Correct. 10 COMMISSIONER COX: And this was an 11 issue that the State Auditor weighed in on in his 12 review of our internal function, and indicated that 13 there had been a lack of continuity in the Executive 14 Director, and one of the things perhaps that should be 15 studied was the compensation. And I think he may have 16 even said stronger -- and I'll just read here from the 17 State Auditor's Office: It is noted that the agency 18 has not experienced stability in its executive 19 director position. The report stated, in part, the 20 executive director's lower than average salary may 21 hinder the agency's ability to attract and retain the 22 best qualified individual to lead the agency. 23 According to a survey of 42 other state lotteries that 24 the agency conducted, the salary of the agency's 25 executive director is not competitive with the 0171 1 salaries of lottery directors in other states. The 2 audit report further recommends that the Commission 3 should consider including a performance incentive for 4 the executive director through a salary increase or 5 bonus within its legislative appropriation request. 6 The agency is supportive of a base salary increase and 7 a performance incentive. 8 Now, Mr. Chairman, I want to go on the 9 record that, personally, I would need to hear an awful 10 lot of information and deliberate at length with you 11 before I could say that I support a performance 12 incentive. I certainly don't disagree with the idea 13 of studying that alternative. And I fully support the 14 idea that the Executive Director's salary is woefully 15 low. But on that one matter, I don't have enough 16 information to say that I concur with what the agency 17 is doing here. 18 CHAIRMAN CLOWE: I guess, Kathy, can 19 you respond to that as a beginning place? 20 MS. PYKA: I certainly can. 21 In response to this State Auditor's 22 report, we have included that we are supportive of 23 definitely a salary increase. Their specific 24 recommendation looked at the consideration of a 25 performance incentive. And at this point, we wanted 0172 1 to note our support of moving forward with that and 2 certainly wish to develop proposals that could be 3 shared, if requested. 4 If -- if it's the desire of the 5 Commission, we can certainly revise that paragraph to 6 maybe reflect that we'll study this further. We could 7 show the support and that we'll study the performance 8 incentive further, or we can remove the performance 9 incentive verbiage from this paragraph if that's the 10 desire of the Commission. 11 COMMISSIONER COX: Mr. Chairman, I 12 wasn't objecting to the inclusion. I think it is 13 broad enough to say that this is something we are 14 willing to study. I just wanted to put my own concern 15 about not having enough information to really concur 16 in this statement for the record. 17 CHAIRMAN CLOWE: Sure. And I share 18 in -- in exactly that feeling. I would suggest that 19 we leave it in because the State Auditor has shown the 20 light on the subject. 21 COMMISSIONER COX: Yes. 22 CHAIRMAN CLOWE: And although I think 23 it's highly unlikely that a bonus proposal is going to 24 be allowed by the legislature for this position, it -- 25 it's an item to be discussed and might help the 0173 1 legislature settle on what they would like to do, 2 which is more than likely, in my mind, based on my 3 experience, more a grade re-establishment for this 4 position rather than a bonus. 5 I have had conversations with members 6 of various committees, and, you know, the bonus thing 7 works very well in the private sector, but it's 8 difficult to implement in the public sector. But I 9 would suggest, just as you say, we leave it as it is 10 and -- and note the fact that we have to work on that 11 quite a bit to be a part of recommending it, but we 12 are getting the message, I think, across in this LAR 13 that we've been sending out for some time now, that we 14 need some more money for this position. 15 COMMISSIONER COX: Yes. 16 CHAIRMAN CLOWE: Any other questions, 17 Commissioner? 18 COMMISSIONER COX: No, sir. 19 CHAIRMAN CLOWE: Any comment, 20 Director Sadberry? 21 MR. SADBERRY: Mr. Chairman, 22 Commissioner, just on that, two things. On that 23 specific matter, I will note that I am aware of prior 24 discussions on this, and staff has discussed it. 25 We've had the benefit of Commissioner input, and I -- 0174 1 I would certainly, just so that it's clear from my 2 perspective, and then, in that regard, we're talking 3 about here a position, and that is for the benefit of 4 the agency. And it is, in fact, intended to be 5 consistent with the auditor's recommendation, and it's 6 in there for that reason. If you even had the 7 authority, and that's a big supposition, I would still 8 personally be on the record saying that I would think 9 you would carefully weigh the notion of an incentive 10 bonus. But that is also addressed to the auditor's 11 observation regarding recruitment and what your future 12 needs might be in that regard. So I'm certainly 13 appreciative and in agreement with your comments and 14 your general discussion in that regard. And I didn't 15 want the record to be silent on that. I'm aware of 16 that prior to this meeting and in agreement with and 17 in concurrence with it in this meeting. 18 Secondly, Kathy mentioned the 19 certification matter. And we have had discussions on 20 that, and I think General Counsel, if I may, 21 Mr. Chairman, we'll call on General Counsel to speak 22 to the certification. 23 CHAIRMAN CLOWE: And we'll do that, but 24 I just want to go back about this issue of leaving the 25 Texas model at some point in time. 0175 1 What -- what this agency is doing, by 2 virtue of considering the approval of this LAR, is 3 saying, if it's the desire of the legislature, and 4 I -- and I think we're looking to the legislature for 5 guidance in this matter -- here is the -- here is the 6 means to begin this process. 7 MS. PYKA: That is correct, 8 Mr. Chairman. 9 CHAIRMAN CLOWE: We're not just sitting 10 here with our hands over our eyes and ears and mouth. 11 We're saying, here is the vehicle, if you want to 12 start this process, based on the, I think, full and 13 complete record we made this morning. And then I 14 think, Commissioner, it kind of goes out of our hands. 15 Our job is to follow the statute and make the rules. 16 This is not our issue to deal with, in my mind. We 17 are a resource. We could be called on for 18 recommendation, and we could give projections. But 19 this is in the hands of those who are beyond us, in my 20 mind. But we're not sitting on our hands and -- 21 COMMISSIONER COX: And -- and that, for 22 us, I think is the important thing. One of the most 23 important things, I think, of the function -- function 24 of the board is succession planning. And this is a 25 form of succession planning. And I think we should be 0176 1 sure that it's going on. 2 CHAIRMAN CLOWE: That's right. And I 3 think that covers it. 4 Anything further? Counselor? 5 MS. KIPLIN: Commissioners, you heard 6 the issue of the certificate that is required to 7 accompany the LAR. And in there is a phrase and 8 it's -- it -- it applies to those that are signing, 9 which would be the Chair, the Executive Director, and 10 the Chief Financial Officer, which is Kathy Pyka. 11 There is a phrase that says that it's accurate and 12 it's identical to the best of my knowledge. And so 13 when you all sign that, I wanted to just put this on 14 the record, that for the Executive Director and for 15 the Chair, the "to the best of my knowledge" is based 16 on representations that have been made to y'all by 17 agency staff. In other words, you haven't compiled 18 it. You didn't prepare it. I just wanted to make 19 sure that we were -- we were clear on that. 20 CHAIRMAN CLOWE: Thank you for that 21 clarification. 22 I move the adoption of the 23 recommendation for the agency's budget for submission 24 to the LBB and the Governor's Office, if that's the 25 correct motion. 0177 1 MS. KIPLIN: Mr. Chairman, I think it's 2 broader. I think it's the legislative appropriations 3 request. 4 CHAIRMAN CLOWE: Well, that's what I 5 thought the staff had recommended. 6 MS. KIPLIN: I'm sorry. I heard 7 budget. 8 CHAIRMAN CLOWE: Well, that's the LAR, 9 isn't it? 10 MS. PYKA: This is the LAR. It's the 11 adoption of the legislative appropriation request for 12 fiscal years 2008 and 2009. 13 CHAIRMAN CLOWE: Okay. Well, I think 14 of that as one and the same. 15 MS. PYKA: I'm -- I'm with you. 16 CHAIRMAN CLOWE: Okay. 17 COMMISSIONER COX: Second. 18 CHAIRMAN CLOWE: All in favor, please 19 say aye. Opposed, no. The vote is two-zero in favor. 20 We'll sign it now. 21 MS. PYKA: Mr. Chairman, yes, I have 22 this. 23 CHAIRMAN CLOWE: And then when we have 24 done that, we will go to item number six, which is 25 your item, Ms. Melvin. 0178 1 Commissioner, do you want to break for 2 executive session? 3 COMMISSIONER COX: That's up to you, 4 Mr. Chairman. We need to consider the most efficient 5 use of the staff's time. 6 CHAIRMAN CLOWE: It's all right with 7 you, we'll just go ahead and try to finish this. 8 Item number six, consideration of and 9 possible discussion and/or action on external and 10 internal audits and/or reviews relating to the Texas 11 Lottery Commission and/or the Internal Audit 12 Department's activities. Ms. Melvin. 13 MS. MELVIN: Good afternoon, 14 Commissioners. For the record, my name is Catherine 15 Melvin, Director of the Internal Audit Division. 16 I have just a few items of update. 17 Each are related to -- each is related to external 18 audits of the agency. The State Auditor's Office is 19 on track to issue a report on the recently completed 20 audit of procurement practices of TLC, and that is 21 scheduled to be released by August 31st. 22 Secondly, the agency has recently 23 signed an interagency contract with the State 24 Auditor's Office to conduct the annual financial audit 25 and the Mega Millions agreed-upon procedures audit. 0179 1 And as you likely recall, the State Auditors performed 2 that audit last year, utilizing a third-party 3 contractor to actually perform the work. 4 And then finally -- 5 COMMISSIONER COX: Do you know, 6 Catherine, whether they intend to use a third-party 7 contractor this year as well? 8 MS. MELVIN: They do intend to, to my 9 knowledge. They have not yet signed that contract, 10 but they have indicated their intent to bring a third 11 party on board. 12 Lastly, an entrance conference is 13 scheduled tomorrow to discuss a required overpayment 14 recovery audit. The Texas Comptroller of Public 15 Accounts oversees these audits, and the Comptroller 16 also will be utilizing a third-party contractor to 17 actually conduct that audit work. 18 That concludes my presentation unless 19 you have any questions for me. 20 COMMISSIONER COX: No, sir. 21 CHAIRMAN CLOWE: Thank you, ma'am. 22 We'll pass on item number eight and go 23 to number nine, report, possible discussion and/or 24 action on the procurement of advertising services. 25 Mr. Jackson. 0180 1 MR. JACKSON: Good afternoon, 2 Commissioners. For the record, my name is Tom 3 Jackson. I'm the Purchasing and Contracts Manager for 4 the Commission. 5 Negotiations for the advertising 6 services contract should be completed by the end of 7 the week, and it is anticipated that the contract will 8 be signed within the next couple of weeks. 9 And I would be happy to answer any 10 questions. 11 COMMISSIONER COX: None. 12 CHAIRMAN CLOWE: Thank you, 13 Mr. Jackson. The next item, number ten, is yours, 14 report, possible discussion and/or action on the 15 drawings audit services contract. 16 MR. JACKSON: Commissioners, approval 17 was requested from the State Auditor's Office to 18 extend the drawings audit services contract through 19 August 31st, 2007. The State Auditor's Office agreed 20 and delegated the procurement back to the Texas 21 Lottery Commission. The current contract has been 22 extended for one year. 23 If you have any questions, I would be 24 happy to respond. 25 CHAIRMAN CLOWE: Any questions? 0181 1 Thank you, sir. 2 The next item is yours, number 11, 3 report, possible discussion and/or action on the 4 instant ticket vending machine contract. 5 MR. JACKSON: Commissioners, the 6 instant ticket vending machine contract expires on 7 August 31st, 2006, and it has two one-year extension 8 options. We will be exercising our option to extend 9 that contract. 10 CHAIRMAN CLOWE: Thank you, sir. 11 The next item, number 12, is yours, 12 report, possible discussion and/or action on the 13 agency's contracts. 14 MR. JACKSON: Commissioners, in your 15 notebooks, under tab number 12, is a report on prime 16 contracts that have been updated for your review. 17 Most of that basically we've already discussed. 18 I'll be happy to answer any questions. 19 COMMISSIONER COX: No, sir. 20 CHAIRMAN CLOWE: Thank you, sir. 21 Next, item number 13, report, possible 22 discussion and/or action on the 79th Legislature. 23 Ms. Trevino. 24 MS. TREVINO: Good afternoon, 25 Commissioners. For the record, I'm Nelda Trevino, the 0182 1 Director of Governmental Affairs. 2 I have a very brief report for you this 3 afternoon. First of all, we are preparing to schedule 4 our next agency legislative briefing for a date late 5 in September, and we intend to provide updates on 6 various matters, including fiscal year end lottery 7 sales and revenue, the agency's LAR submission, and 8 the status of various audit reports related to the 9 agency. 10 The Governmental Affairs staff 11 continues to monitor interim House and Senate 12 committee hearings, and it's our understanding that 13 interim committee reports with recommendation for the 14 80th Legislature to consider will be issued sometime 15 during the fall. We will keep you posted on 16 developments related to these activities, and that 17 concludes my report and I'll be happy to answer any 18 questions. 19 CHAIRMAN CLOWE: And, Nelda, my 20 understanding is that pursuant to our appearance 21 before the licensing committee, the House Licensing 22 Committee, Director Sadberry has been requested to 23 meet with Chairman Flores to give him an update on 24 this meeting today, as well as other matters relating 25 to the agency that he may have an interest in. Is 0183 1 that correct? 2 MS. TREVINO: That's correct, 3 Mr. Chairman, and actually, we're looking to have that 4 meeting scheduled for one day next week. 5 CHAIRMAN CLOWE: And, Director 6 Sadberry, you'll keep us advised of the results of 7 that meeting, please. 8 MR. SADBERRY: Yes, sir, I certainly 9 will. 10 CHAIRMAN CLOWE: Thank you, Nelda. 11 Commissioner, if you're ready, I'll 12 move we go into executive session. 13 COMMISSIONER COX: All right, sir. 14 CHAIRMAN CLOWE: At this time I move 15 the Texas Lottery Commission go into Executive 16 Session: 17 To deliberate the duties and evaluation 18 of the Executive Director, Deputy Executive Director, 19 Charitable Bingo Operations Director, and Internal 20 Audit Director, and to deliberate the duties of the 21 General Counsel pursuant to Section 551.074 of the 22 Texas Government Code. 23 To legal advice regarding pending or 24 contemplated litigation and/or to receive legal advice 25 pursuant to Section 551.071(1)(A) or (B) of the Texas 0184 1 Government Code and/or to receive legal advice 2 pursuant to Section 551.074(2) of the Texas Government 3 Code, including but not limited to: 4 Cynthia Suarez versus Texas Lottery Commission 5 Sheldon Charles versus Texas Lottery Commission and 6 Gary Grief 7 Stephen Martin versus Texas Lottery Commission 8 Employment law, personnel law, procurement and 9 contract law, evidentiary and procedural law, and 10 general government law. 11 Is there a second? 12 COMMISSIONER COX: Second. 13 CHAIRMAN CLOWE: All in favor, please 14 say aye. The vote is two-zero. The Texas Lottery 15 Commission will go into Executive Session. The time 16 is 1:19 p.m. Today is August the 16th, 2006. 17 MS. KIPLIN: Mr. Chairman, I think on 18 the last statutory cite -- and this really is required 19 by law -- I think you said 551.074, regarding legal 20 advice, and it's 551.071. 21 CHAIRMAN CLOWE: I stand corrected. 22 Thank you. 23 (EXECUTIVE SESSION.) 24 CHAIRMAN CLOWE: The Texas Lottery 25 Commission is out of Executive Session. The time is 0185 1 2:03 p.m. Is there any action to be taken as a result 2 of Executive Session? 3 If not, let's move to item 16, report 4 by the Executive Director and/or possible discussion 5 and/or action on the agency's operational status, and 6 FTE status. Director Sadberry. 7 MR. SADBERRY: Commissioners, there are 8 materials in your notebooks for your review regarding 9 status of positions as of August 8th, 2006. 10 I would like to take the opportunity 11 now to discuss one of the recommendations that has 12 been implemented here at our agency, which is the 13 establishment of a full-time ombudsman to identify 14 workplace issues, to conduct ongoing employee surveys, 15 and facilitate employee work groups and employee 16 discussions on workplace issues as needed. 17 In an effort to promptly implement the 18 establishment of the agency ombudsman, one of the 19 agency's internal auditors will serve in the ombudsman 20 position. 21 Earlier today, Dale Hernandez was 22 present and stayed in the meeting as long as possible. 23 She, along with another member of staff out of the HR 24 division, are attending the -- a seminar being 25 conducted at the Texas Law Center, and I encouraged 0186 1 her to attend that seminar, which directly relates to 2 ombudsman related issues, rather than be here for the 3 introduction. But she had hoped to be here, and I had 4 hoped to have her here to meet you in person. 5 But speaking of Dale Hernandez, who 6 will be serving in this position, I am confident that 7 she has a clear understanding of the importance of the 8 ombudsman's role. Dale brings a wealth of internal 9 audit experience and, with this experience, the 10 thoughtful insight of the value of remaining 11 independent of management. And I would be happy to 12 address that matter further with you, as well as 13 answer any questions at this time. 14 COMMISSIONER COX: Director Sadberry, I 15 think Dale is an excellent choice -- I think Dale is 16 an excellent choice, and I'm particularly glad to see 17 that you have already got her in training on what 18 she's doing. That was a question I asked her last 19 week. What -- what have you done? What can you do? 20 Is there an on-line course? Is there a cram course? 21 Is there something you can do to be sure that you're 22 doing this in a professional manner? So thank you for 23 doing that. 24 MR. SADBERRY: My pleasure, 25 Commissioner. Thank you. And -- and, specifically, 0187 1 that's -- the title of that program is Ombuds of 2 Texas, held today at the Texas Law Center, room 204. 3 And it has agenda items, including the ombudsman 4 position, Open Records requests, opinions update, and 5 related matters that I think will -- will fit directly 6 into your interests. 7 COMMISSIONER COX: Thank you. 8 CHAIRMAN CLOWE: Thank you. Anything 9 further, Mr. Sadberry? 10 MR. SADBERRY: That's all. 11 CHAIRMAN CLOWE: Next, item 17, report 12 by the Charitable Bingo Operations Director and 13 possible discussion and/or action on the -- on the 14 Charitable Bingo Operations Division's activities. 15 Mr. Atkins. 16 MR. ATKINS: Commissioners, the only 17 thing on my report I did want to confirm, we will be 18 making allocations to local jurisdictions this week 19 for the second quarter 2006. 20 And then, also, I just wanted to remind 21 the Commissioners, I will be out of the office from 22 Friday, August 18th, until Monday, August 28th. In my 23 absence, Phil Sanderson, Assistant Director, will be 24 available. 25 CHAIRMAN CLOWE: Very good. 0188 1 COMMISSIONER COX: Have a good 2 vacation. 3 MR. ATKINS: Thank you, sir. 4 COMMISSIONER COX: Where are you going? 5 MR. ATKINS: Cape Cod. 6 COMMISSIONER COX: Cool. 7 CHAIRMAN CLOWE: Thank you, Billy. 8 Item number 18, public comment. Is 9 there anyone wishing to make comment to the Commission 10 at this time? 11 Commissioner Cox, do you have anything 12 further? 13 COMMISSIONER COX: No, sir, I do not. 14 CHAIRMAN CLOWE: Shall we adjourn? 15 COMMISSIONER COX: Yes, sir. 16 CHAIRMAN CLOWE: The Texas Lottery 17 Commission is adjourned. Thank you all very much. 18 19 20 21 22 23 24 25 0189 1 REPORTER'S CERTIFICATION 2 3 STATE OF TEXAS ) 4 COUNTY OF TRAVIS ) 5 6 I, BRENDA J. WRIGHT, Certified Shorthand 7 Reporter for the State of Texas, do hereby certify 8 that the above-captioned matter came on for hearing 9 before the TEXAS LOTTERY COMMISSION as hereinafter set 10 out, that I did, in shorthand, report said 11 proceedings, and that the above and foregoing 12 typewritten pages contain a full, true, and correct 13 computer-aided transcription of my shorthand notes 14 taken on said occasion. 15 Witness my hand on this the 23RD day of 16 AUGUST, 2006. 17 18 19 BRENDA J. WRIGHT, RPR, 20 Texas CSR No. 1780 Expiration Date: 12-31-06 21 WRIGHT WATSON & ASSOCIATES Registration No. 225 22 Expiration Date: 12-31-07 1801 N. Lamar Boulevard 23 Mezzanine Level Austin, Texas 78701 24 (512) 474-4363 25 JOB NO. 060816BJW