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Lottery Contract Snafu Costs State Millions


SACRAMENTO — The state's mishandling of a lottery computer contract has added $44 million to the price tag for a new customer-friendly ticketing system--and may have cost California's financially strapped schools as much as $113 million in anticipated revenue, legal documents and interviews show.

The computer snafu stems from a contract cancellation ordered by former Lottery Director Sharon Sharp that has resulted in a costly legal settlement and a two-year delay in the introduction of the new technology--now set for next June.

The contract was part of a long-range strategy to entice more people to play the lottery by making it more convenient. The idea was to create thousands of new ticketing outlets by developing low-volume terminals for mom and pop businesses that hadn't had the customer traffic to justify the high cost of ordinary on-line telephone hook-ups.

In addition, for Scratcher players, the contract would provide for computerized validation that would allow small winning tickets to be cashed at any outlet in the state. Scratcher tickets now can be cashed only at the places they were purchased.

Lottery officials estimated that the Scratcher changes alone will increase Scratcher sales by about 30%. Using that percentage, they calculated that California schools would have reaped an additional $113 million had the new system been in effect for the last two years, as originally planned. At least 34% of lottery revenues must go to public schools. Another 16% goes to administration and the remaining 50% to prizes.

But one year after the contract was awarded to the Sacramento-based High Integrity Systems Inc. in March, 1992, Sharp suddenly announced its cancellation, contending the company had failed to deliver the system as promised.

Company officials angrily denounced the decision, saying it was lottery foot-dragging and constant change orders that had prevented it from going into operation. Both sides sued each other.

Now, after spending $7.2 million on legal expenses, the lottery has settled the lawsuits and reinstated the contract in an agreement that several lawyers see as a resounding victory for the company.

Costs Shifted to State

An examination of the settlement shows that not only did it give more favorable terms to High Integrity Systems, it also forced the state to pay $36.8 million in costs that it had not been required to pick up under the original agreement.

Officials said the new agreement requires the lottery to make an immediate payment of $25 million to the company for hardware, software and terminals; purchase two mainframe computers estimated to cost a total of $2.3 million; pay telecommunications costs expected to run $130,000 a month--or $8.5 million over the life of the contract--and reimburse the company an estimated $1 million for upgrades needed because of the two-year delay.

Lottery administrators acknowledged that all of these costs were absorbed by the company in the original contract. The original five-year contract required High Integrity Systems to absorb all costs for the 6,700 terminals and other computer equipment needed to run the new system and the installation costs. The company would recoup the costs and make a profit by earning a percentage of the sales.

But the administrators said they believed they had been right in accepting the settlement because it freed them from a costly, time-consuming lawsuit that had prevented the lottery from moving forward with technological advances that would increase its revenues.

"This decision makes the best sense for the lottery to meet its business needs and to fulfill its role to maximize revenues for public schools," Interim Director Del Pierce said in a written statement. "We would rather spend our efforts on sales enhancements and providing better service and convenience to our players than on continuing to litigate this matter."

Officials would not discuss the possible damages that might have been assessed against the state had the case gone to trial, but documents show they could have been substantial. "As I stand here, the lottery faces a potential liability to High Integrity Systems exceeding $100 million," company President Tony Stefanis warned the lottery in May, 1994.

McGeorge School of Law professor Claude Rohwer, an expert in contracts, said the trial outcome would have been hard to predict because of the way the contract was written. He said it was impossible for him to determine the legal obligations of either side.

"This was the most poorly drafted document I have ever looked at in my professional career," said Rohwer, who examined it several years ago for High Integrity Systems. "If a student turned in that document as some work product . . . I'd flunk them."

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