Running the numbers 

It's been a rocky two years at the Arkansas Lottery office.

On Friday, Arkansas Lottery Director Ernie Passailaigue tendered his resignation to Lottery Commission Chair Dianne Lamberth. In a little over two years, Passailaigue took the lottery from an idea contained within a piece of legislation to a $460 million a year business. The Arkansas Department of Higher Education doesn't have a final tally of scholarship recipients for this fall just yet, but over 31,000 Arkansas students received scholarships to attend state colleges and universities during the 2010-2011 school year. That's an outcome universally seen as a good end. But it was the means to that end that led to continued pressure on Passailaigue, and, ultimately, his resignation.

Rumors had been swirling around for some time that the director was on his way out. Passailaigue told reporters just over a week ago that he would be leaving within the next three years. When pushed for a firm date, he said, "It might be tomorrow, it might be three years from now." Turns out it was only eight days later.

In a brief filed with the U.S. District Court, former Arkansas Lottery staff attorney Bridgette Frazier, who was forced to resign her post in November 2009, describes her tenure at the Arkansas Lottery as "falling down a rabbit hole into a bizarre wonderland populated by peculiar individuals with no use or love for state law, state regulations or native employees."

Frazier sued the lottery for wrongful discharge, violation of her First Amendment rights, deprivation of due process, infliction of emotional distress and defamation of character. The lottery has filed a motion to dismiss the case. Frazier's colorful legal writing tells the story of an organization that repeatedly failed to follow state laws, of administrators whose actions were "willful, wanton, reckless and malicious," and of state actors who "run roughshod over [Arkansas] citizens with impunity." Lottery officials have, of course, disagreed formally in court filings.

Sept. 28 marks the two-year anniversary of lottery ticket sales. In those two years, Arkansans have spent $900,646,436 on tickets (according to the latest figures available). Because of that, students started out the 2010-2011 school year with a combined $123,024,759 in scholarship funds.

But the lottery has been plagued by what former Lt. Gov. Bill Halter has charitably called "administrative hiccups" — a chief financial officer unfamiliar with generally accepted accounting principles, punitive IRS fines totaling nearly $100,000, unfavorable legislative audit findings and two attempts to oust an executive director who eventually decided to deprive lottery commissioners of the opportunity to give it a third try.

Once the Arkansas Lottery has had a few years to mature, it will be easier to look back on Passailaigue's tenure and come to a conclusion as to whether or not the decisions he made on behalf of the state were beneficial or somewhere short of that mark. One thing is for certain: two years ago things were much brighter for the lottery director.

Early media scrutiny was mostly limited to his hefty salary of $324,000 a year, a sum that lured him away from the same position in South Carolina. Passailaigue was charged with getting the lottery up and running quickly, and he did — some might say with undue haste. To hear him tell it, Arkansas's lottery enjoyed a quicker startup than any other lottery in American history.

Shortly before midnight on Sept. 27, 2009, people took their place in convenience store queues to throw money down on shiny new scratch-off tickets while visions of dollar signs danced in their heads. That first day, the lottery sold an estimated $1.2 million worth of tickets and handed out over $725,000 in prizes. At a launch ceremony held at a Murphy Oil station in Little Rock, Passailaigue handed a cigar to Halter, the man who will likely go down in history as the father of the Arkansas Lottery, and said, "We just birthed the lottery." Times were good.

Not even two months would pass before the lottery's attorney, Frazier, was fired. She alleged she was terminated for expressing concerns about lottery personnel practices to the attorney general's office. She claims she was denied due process in her forced termination. Officially not much was said, by either Frazier or the lottery, at the time of her departure. But it was the first indication that things might not be running so smoothly at lottery headquarters.

Taking stock

The night the lottery began, Halter bought a few lottery tickets to give out as mementos and souvenirs to some of the people who helped him take the lottery from an idea, to a ballot initiative, through the legislative process and into a $460,000,000 a year enterprise. He says that since that time he's probably only purchased a couple of tickets.

"Any time that I do, I realize that win or lose, there's a student in Arkansas that's winning," Halter says.

Two years in, Halter says he doesn't have any regrets and thinks the lottery has done exactly what it set out to accomplish.

"Ultimately this is about improving access to higher education in Arkansas," he says. "That was the reason that we put so much at stake here. I think we can say that that has absolutely been a success. The number of those applying to colleges has gone up dramatically as has the number of those admitted. Certainly in the first year there were over 31,000 scholarship recipients; the second year will be a comparable number. Freshman admission to the University of Arkansas is up by 53 percent over the last two years. It's hard to argue with those numbers."

During the campaign for the ballot initiative, Halter would tell questioning crowds that the lottery would triple the amount of state-funded financial aid. And it did.

For the 2009-2010 school year, Arkansas Department of Higher Education statistics show the state spent $54,217,865 on financial aid. In 2010-2011, the total was $157,000,324.

It's also important to remember another thing Halter said in 2009: The lottery is "not a silver bullet" that will cure all that ails the educational system in Arkansas. Halter says one major problem facing the state, and the nation, is the cost of higher education.

A recent report from the Arkansas Division of Legislative Audit found the average cost of tuition and fees at four-year universities in the state has gone up 26.3 percent since 2006, more than doubling the growth of the Consumer Price Index over roughly the same period.

"I don't think you could ever expect, in a world of inflation, that tuition is not going to go up," Halter says. "I do think we've seen a disturbing trend, and it's been happening for decades, where the cost of tuition and the cost of higher education has exceeded, in its growth, the cost of living. I find that very troublesome and it's something we need to continue to work on both here in Arkansas and across the country. This is not an Arkansas-specific problem. It's an unsustainable trend."

Halter cites statistics on increases in admission to colleges and universities as proof of the lottery scholarships' success. But the aforementioned legislative audit report says that an influx in students is a contributing factor to rising costs.

From the report: "State colleges and universities are significantly funded through state appropriations. As a result, added programs or rising enrollment at an institution not correspondingly supported by a state appropriation will disproportionately increase tuition and mandatory fees."

But Halter says that's a good problem to have. He hopes that rising tuition rates, or increases in the number of students attending college, won't negatively impact lottery scholarship award amounts in the future. An act passed by the state legislature has already reduced the scholarship amounts for new recipients. Beginning in 2011, new students at four-year institutions received a $4,500 per year scholarship, down from $5,000 the year before. Students at two-year institutions received $2,250, not the $2,500 given to initial recipients.

"If there is pressure on the dollars available and we've got more students going into college and that's what's causing the pressure on the pot of funds, then that's a great problem to have. It's saying we've got more students going in, there's more students eligible for the scholarship. Then, in the context of a multi-billion state budget, you look at whether there are some areas that we can dedicate to scholarship funding that would be a better investment for the long-term future of Arkansas than some other area where those funds are currently being spent."

But when you talk about the lottery, you're really talking about two different things: the scholarships and the business of selling tickets. Passailaigue came under constant fire for his management of the lottery.

In September 2010, two lottery commissioners voted to fire him for doling out comp time to exempt high-paid lottery employees, including himself. Passailaigue and others, including Vice Presidents Ernestine Middleton and David Barden (both of whom draw $225,000 salaries) eventually repaid the money. Other exempt employees who had accrued comp time were not allowed to take it.

Passailaigue also took responsibility for and defended hiring CFO Philip Miley, who indicated on his resume that he was a certified public accountant although his license had expired. In 2010 a legislative audit found that lottery financial statements were not prepared using generally accepted accounting principles. Miley made bigger headlines in August when the lottery was fined nearly $100,000 by the IRS for failure to make tax withholding payments on time.

Passailaigue accepted responsibility for the blame in each instance, telling commissioners that the buck stopped with him.

Halter defends the lottery chief.

"There's certainly been a lot of sound and fury about different things that have happened and they're quite specific things that have happened that have been viewed as bobbles or missteps or mistakes," Halter says. "But I think it's important to put those in the context of going from a starting point of zero to an approximately $500 million worth of sales annually, and you're doing it very rapidly. It is inevitable because this organization is made up of human beings, who are fallible, that they weren't going to get every part of it right 100 percent of the time right out of the gate.

"Having said that, let me make it really clear: Every time that I see one of the missteps, I say, 'Boy, I wish that hadn't happened and I hope they move quickly to fix that.' "

New blood

One person trying to fix some of those missteps is newly-appointed Lottery Commissioner Bruce Engstrom of North Little Rock. Engstrom, who was appointed by Speaker of the House Robert Moore, opposed the lottery act presented to voters in 2008. Another new commissioner who has shown he's not afraid to ask questions is former state Sen. Steve Faris of Malvern. Faris was a co-sponsor of the lottery's enabling legislation as a senator. Both he and Engstrom seem to have come on board with a sense of purpose: To find out more about how the lottery operates and keep it out of the headlines.

"The speaker urged me to go on the commission," Engstrom says. "I told him on the front end that I didn't like what I was reading in the paper. It sounded like they had some problems. He asked me to go on and serve with an open mind. I told him later that I was surprised and disappointed to find that the problems looked to be much worse and more persistent and systemic than I had anticipated."

Since joining the commission, Engstrom has raised questions about everything from where the lottery stores data on retailers to the qualifications of the chief financial officer. He recently began looking into a decision that happened before the lottery even started: the decision to award gaming contracts to Intralot and Scientific Games.

Under the contracts, which were approved by the Lottery Commission and reviewed by a legislative oversight committee, the lottery pays both companies a dollar amount based on a percentage of ticket sales, not a fixed amount. Intralot is paid 2.45 percent of total lottery ticket sales (that includes online games like Cash 3 and Cash 4, along with instant scratch-off tickets). Scientific Games is paid 1.75 percent of instant ticket sales. However, the lottery paid Scientific Games 3.27 percent of instant ticket sales in 2011, a total of $12.7 million. A payment of 1.75 percent would have been $6.8 million. That's a difference of $5.9 million. We did not get a clear answer from the lottery as to why a higher payment was made. Engstrom says he hasn't either.

Each state handles vendor contracts differently. For example, South Carolina, where Passailaigue headed the lottery before moving to Arkansas, pays a flat fee to their vendors, not a percentage. As a result, South Carolina's Lottery pays much less.

In 2011, total sales for the Arkansas Lottery reached $464,019,351 million. As a result, payments to Intralot totaled $11,370,557. By comparison, South Carolina had total sales of $1.05 billion and paid only $7,898,208 to their vendor. So South Carolina paid less money to their vendors and had more than twice the sales.

In terms of instant tickets, the numbers don't look any better. The Arkansas Lottery sold $387,478,608 in instant tickets and paid $12,658,623 for the contract that enabled them to do so. South Carolina again had much higher sales, at $698,258,816, and paid only $7,410,860 for their contract.

When you consider South Carolina's contract costs as a percentage of sales and apply that same percentage to Arkansas's total sales, Arkansas pays over $16 million more per year than South Carolina. Each Arkansas contract is set for seven years, which comes to a total of more than $112 million over the life of the contract.

Engstrom can't figure it out.

"I'm trying desperately to understand why we bid those big vendor contracts the way we did on the front end and I'm not satisfied with Ernie's response to that because it looks like to me, if you compare what we're spending on those vendors and what South Carolina is spending on those very same vendors, then we're paying way more than South Carolina is paying. We're totally backwards from South Carolina. I can't get an answer as to why that happened other than the generic, 'Well, we were trying to get up and running real quick.' "

The Request for Proposals for both contracts asked for bids to be submitted only on a percentage of sales basis. The RFPs did not ask for fixed-rate bids even though Passailaigue, while visiting Arkansas to offer advice to legislators and commissioners before he was hired, said that the commission should consider asking for both. Engstrom questioned Passailaigue about the decision to only ask for percentage bids at a July commission meeting. Here's the exchange:

Passailague: I said that was a consideration that I would look at.

Engstrom: Did you do that?

Passailague: No.

Engstrom: Why?

Passailague: Several reasons. The first reason is that the only way you're going to get a competitive bid on an early start-up date is to get the percentage of sales contract awarded.

Engstrom: So how much did we gain by doing that?

Passailague: Well we got $30 million dollars net in the bank between Sept. 28 and the end of the year [when the lottery was originally scheduled to begin].

"That math just didn't work," Engstrom says. "If in fact he didn't sit down with a pencil and paper and figure that out before he signed those contracts, that would be strong evidence that he lacks the skill sets to keep doing what he's doing, in my mind. But I'm still looking into that."

Passailaigue said in an e-mail to the Times that he still believes he made the right decision. He maintains that the contracts were prepared according to state law, approved by the Lottery Commission and the legislative oversight committee and awarded to the lowest bidder.

"Yes, it was the right business decision," Passailaigue wrote, "because the Lottery more than doubled revenue estimates (Arkansas sales estimates were around $200 million in sales before I was employed); since the Lottery doubled the revenue estimates ($465 million in FYE 6/30/11), the payment to vendors were [sic] higher in total dollar terms."

In further support of his position, Passailaigue cited a comment by former Lottery Commission Chair Ray Thornton, who touted the efficacy of the Intralot contract at a commission meeting in 2009. Thornton said surrounding lotteries paid higher percentages.

"In my rough-hewn business sense, when you have a bid that comes in at a more advantageous level than any of the states surrounding Arkansas, except for Tennessee, then that is a pretty clear assurance that the bid is in the ballpark and reasonable," Thornton said.

Engstrom says he doesn't think the contracts can be changed, but it's important to look at managers' past decisions to evaluate whether their decisions are beneficial to an organization or not.

"Big question marks started to appear in my mind," he says. "And they have not been erased."

Looking ahead

Passailaigue's supporters declined in numbers throughout the last two years. He faced (and survived) two firing attempts by the commission and his presence at recent legislative oversight hearings drew tough questions from even the most mild-mannered of lawmakers.

One person, though, has always defended Passailaigue: Lottery Commission Chair Dianne Lamberth of Batesville. Lamberth has served on the commission from the very beginning and took over as chair after the commission's first leader, Ray Thornton, stepped down in 2010. Lamberth is quick to defend Passailaigue's management of the organization.

"Ernie takes responsibility for anything that goes wrong," Lamberth says. "He always gives credit to his team and the employees when things go right. So he's taken responsibility for many of these missteps — in fact all of these missteps. He had the expertise to get us where we are. He's done a very good job for us at this point."

Passailaigue told the Times in an e-mail, before he resigned, that he hopes the lottery will continue "to be a relevant option for consumers to spend their disposable entertainment dollar."

Lamberth says that's one thing she's focused on, and she'd like to see it happen "without bumps in the road."

"I like to look at the big picture," Lamberth says. "I want to see us maintain and increase the number of students that we're able to give scholarships to. We may end up getting a very successful CEO, we may get another president of the United States out of this. We might get another philanthropist that will really help our state. You never know what these students will become. But we do know that will help with economic development. The smaller picture is I want to make sure that we're still in tune to be able to give Arkansans the games they want to play, that we know what they want to do and that we can do it in a way to maximize our revenue."

Halter believes lottery administrators have worked to correct mistakes that have come up along the way. What's needed now, he says, is a rigorous analysis of who is taking advantage of the scholarship funds, how successful the program has been in helping families afford higher education and the impact it will ultimately have on graduation rates.

"This is not over," Halter says. "We need to continually look at what we need to do to improve financial aid for Arkansas families and what we need to do to improve educational achievement in K-12 education. How do we help students and families make that transition from high school to college? How do we make sure that more and more folks have the opportunity to participate in some kind of higher education? It doesn't have to be a formal program. There are a number of different ways that we need to focus on helping those families. That's a key part of this equation. What comes next? How do we improve what we have?"

While Engstrom has been critical of how the lottery operates, he still believes, on balance, the lottery has been a good thing for the state.

"If you ignore the fact that a lot of the money coming from the lottery is probably coming from people that can ill afford to pay it — and I have to sometimes force myself not to think about that — then the good is outweighing the bad. What I was not taking into account when I was against it was the good that comes from the money, and that's scholarships. That's the part that has really opened my eyes."

Engstrom is not so sure the lottery's troubles are over. His biggest fear, every time he sees a headline with the word "lottery" in it, is that Arkansans are losing confidence in the enterprise.

"People are losing confidence in what's going on and I keep telling them it's going to get worse before it gets better," he says. "I don't blame people for being mad; they ought to be mad. I just hope they don't get so mad that they want to take these scholarships away from the kids. I don't want that to happen."

After Passailaigue announced his resignation, Halter had this to say: "You've got to assess this from a big picture and longer-term perspective. I think going forward, we need to make sure we have a professional that's becomes the head of this. Because it's a $500 million dollar a year competitive enterprise. It is subject to competitive pressures and you don't want this to be a place for a political appointment. You want a professional appointment. It's not a place for political cronyism and it's not a place for political has-beens. I think it's important to note, too, that the average Arkansan does not care about the day to day machinations of the lottery. They just care if they're going to be able to get a scholarship for their kids."

When asked if he had any regrets about his time at the lottery so far, Passailaigue said simply, "Life is a learning process and successful people both learn from their mistakes and build on their positive decisions."


Speaking of Arkansas Lottery, Ernie Passailaigue

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