California Lottery officials shortchanged schools by millions, state audit says

SACRAMENTO —  The management of the California Lottery was sharply criticized Tuesday by state officials, who released a scathing audit alleging that the agency shortchanged schools by millions of dollars over the last four years, and recommended that most of the money be repaid. Separately, the state controller has launched an investigation into a gift of 30,000 Scratchers tickets to “The Ellen DeGeneres Show,” first reported by the Los Angeles Times.

The audit released Tuesday said California schools have suffered as a result of problematic management and contracting at the lottery agency.

“The Lottery has not followed state law, which requires it to increase its funding for education in proportion to its increases in net revenue,” State Auditor Elaine Howle wrote in a letter to Gov. Gavin Newsom and the Legislature.

Howle said the California Lottery failed to provide $36 million that should have gone to education in the fiscal year that ended June 30, 2018.

The audit also said the lottery agency was unable to demonstrate that its prize payout rate is “optimal for maximizing funding for education, leaving it unable to know whether it is diverting too much funding to prize payments.” In addition, the lottery agency too often uses noncompetitive contracts for purchasing, so it may not be getting the best value for its money, the audit said.

California voters created the state lottery in 1984 by approving a ballot measure that required 34% of sales revenue to go to schools and capped administrative expenses at 16%. But the state Legislature acted in 2010 to allow a smaller percentage to go to education as long as lottery managers used “best practices.”

Lottery Director Alva V. Johnson disputed that the agency has shortchanged schools, saying he and the auditors have a “fundamental difference of opinion” over how to interpret the California State Lottery Act and the 2010 change in the law.

Howle said state law requires the lottery to increase its annual education funding in proportion to the increases in its net revenues, which she defines as total sales revenue minus the lottery’s administrative and operational expenses.

Since the 2010 amendments to the Lottery Act, the lottery’s total operating revenue has increased by 115% and its funding to education has increased by 66%, the audit said.

But Johnson countered that the auditor’s interpretation would have required school funding to be artificially decreased in some years. He said the funding formula used by his agency has provided $6.7 billion to education during the last four years, which he said is an increase of more than $1.3 billion from the previous four years.

The auditor originally determined that the lottery should have provided $69 million more to education but reduced the amount to $36 million after hearing an explanation from lottery officials.

“The Lottery strongly disagrees with CSA’s findings that it owes $69 million to education because compliance with a year-over-year proportionality requirement would be inconsistent with the Lottery’s mission to maximize funding for education,” Johnson wrote in response to the audit.

The newly launched review by State Controller Betty T. Yee, the state’s chief fiscal officer, comes after The Times reported this month that the lottery gave $212,500 worth of Scratchers tickets to DeGeneres’ talk show to be handed out to the studio audience.

Each member of the audience was given a $500 bundle of 72 Scratchers tickets as a way to promote the games, but a whistleblower complaint filed by lottery workers said the giveaway was a “misuse of funds” and noted some of the 425 packets were not properly accounted for.

The audit drew calls for reform at the lottery from state Sen. Ling Ling Chang (R-Diamond Bar), who requested the financial review last year.

“The findings today demonstrate what we suspected all along. That the California Lottery has a culture of profits first and schools last,” Chang said Tuesday. “They owe our schools millions of dollars and I will be introducing legislation to ensure our schools get what they are owed.”

Lottery spokesman Russ Lopez confirmed the controller “began a review of the California Lottery’s ‘Ellen Show’ promotion as part of their oversight responsibilities.” He declined further comment this week but earlier this month defended the promotional giveaway as a cost-effective way to boost Scratchers sales, which he said reached record levels during the holiday season.

“‘The Ellen DeGeneres Show’ was one of many marketing efforts that provided increased product awareness and appeal of Lottery products during the holiday giving season,” Lopez said.

The new probe and the audit findings Tuesday are just the latest in a series of controversies to hit the California Lottery, including an audit last year by Yee that found more than $305,000 in improper or questionable spending that included travel, food, gifts to employees and entertainment expenses.

Last year’s report, which cited improper expenses including $21,666 in T-shirts, backpacks, lip balm and iPad cases for employees, was followed by the resignation of the lottery’s director at the time, Hugo Lopez.

Howle’s new audit released Tuesday said the state controller’s office “has not effectively carried out its responsibility to oversee the Lottery’s performance,” which it does through audits.

“Notably, the SCO inappropriately removed a finding from an April 2019 audit report, which questioned costs of $720,000 related to trade shows, after the Lottery requested changes to this finding,” Howle wrote to the governor.

Howle also said the controller’s office has not sufficiently reviewed the efficiency of lottery operations and didn’t adequately assess its performance after the law was changed in 2010.

The controller’s office said Howle’s auditors disregarded reasonable auditing practices.

Newsom’s office did not immediately respond to a request for comment on the new audit and the controller’s review.

Chang said the giveaways and the other spending controversies put a cloud over the lottery.

“The lottery was created to fund schools. Period,” she said. “But it has a history of controversy so this comes as no surprise to me. Every dollar wasted at the lottery is a dollar that won’t go to the classroom — this behavior has to stop.”