Federal Audit of Lottery System Shows Serious Deficiencies

June 17, 2007 — A lengthy audit of the territory's video lottery system has turned up some serious deficiencies, including a lack of adequate financial documents and failure to implement proper controls over VLT operations, according to a federal Inspector General's audit report. Other findings listed in the 37-page document also explore the "flawed" contract executed in July 2003 between the local government and Southland Gaming of the Virgin Islands. According to the report, the company responsible for overseeing VLT operations in the territory is not required to submit annual audited financial reports to the lottery system, a practice which may have resulted in the loss of millions of dollars to the local government.
"Without audited financial statements, the Lottery cannot determine whether its share of net-gaming proceeds is based on actual revenues collected by SGVI (Southland Gaming)," the audit states. "The Lottery allows SGVI to control every aspect of video gaming from equipment installation to revenue collection and remittance but has no records to show whether VLT-related revenues or appropriate taxes have been paid to the government."
Estimated revenues included in the report put VLT earnings — taken for calendar years 2003, 2004 and 2005 — at $87 million in cash. Of that amount, about 70 percent, or $61 million, was paid out in prizes, while the remaining $26.1 million in net-gaming proceeds were distributed among VLT retailers (about $5.7 million, or 22 percent), the lottery system (about $8.3 million, or 32 percent) and Southland Gaming itself (about $12.1 million, or 46 percent).
Due to the lottery system's failure to obtain or maintain audited financials, however, auditors were not able to verify the figures. "The lack of any working system of checks and balances over VLT operations significantly increases the risk of fraud, waste and abuse of VLT revenues and undermines public trust in VLT operations," the audit states, adding the resulting loss of revenues to the local government "may be in the millions."
The absence of such documents additionally prevents the lottery system from determining whether Southland Gaming does in fact withhold 25 percent of winnings that exceed $5,000 for remittance to the Internal Revenue Bureau.
"As the oversight agency, however, the Lottery also has no mechanism in place to determine whether SGVI actually withheld or remitted the correct amounts," the audit states.
While the V.I. Code does require corporations conducting business in the territory to file annual income tax returns, no returns from SGVI have turned up at the bureau during fiscal years 2003- 2005, according to the report.
"And, because Southland Gaming is not required to submit audited financial statements to the Lottery, neither we nor the Lottery could determine the amount of corporate income tax that should have been paid," the audit states.
While findings related to the system's financials span a number of pages, the report also cites other concerns about a lack of operational control over local VLT machines, including unmonitored cash collections, a lack of security and the "inadequate" testing of the machines.
In these instances, the lottery system itself is held culpable, according to the report, as it "neither participated in nor monitored the removal of cash receipts, betting and payout data from VLT machines."
The lottery system’s failure to reconcile weekly VLT revenue statements provided by Southland Gaming also kept lottery officials unaware of any errors that may have occurred when computing the system's share of net-gaming proceeds, according to the report. "At the majority of retail locations, retailers removed cash receipts from VLTs at the end of each business day and deposited the funds into their individual business accounts," the audit states, adding that the lottery system's reliance upon data provided by Southland Gaming hindered the system’s ability to verify or properly monitor cash collected by the lottery.
In addition to concerns raised about VLT testing and security, the audit also states that the lottery system did not, among other things:
— keep in compliance with certain contract requirements, including one which stipulates that at least 65 percent of the system's goods and services be purchased from local companies;
— provide documentation showing that Southland Gaming, during 2004 and 2006, had paid license fees to operate VLTs in the Virgin Islands;
— remit a certain percentage of VLT revenues to two special government funds, as required by local law (according to the audit report, the lottery system owes $807,983 to the Educational Initiative Fund and Pharmaceutical Assistance to the Aged Program); and
— maintain complete and up-to-date files for VLT retailers (the lottery could only provide auditors with 35 out of 42 of its active retailer files, which were, according to the audit, incomplete and missing information).
In order to combat these deficiencies, the audit recommends that the lottery begins to: a) ensure that Southland Gaming remits its share of VLT prize winnings to the Bureau of Internal Revenue, file corporate income taxes and pay any outstanding tax amounts due; b) update its retailer records; c) establish and implement procedures to make sure that Southland Gaming payments are accurate; and d) revise the existing contract with Southland Gaming.
The audit also suggests the lottery properly test and secure VLT machines and begin to obtain audited financials for video gaming operations in the territory.
According to a five-page response letter attached to the end of the report, lottery officials stated that they "do not concur" with many of the audit's findings, claiming that certain policies and procedures designed to verify financial information, implement proper security protocols and reconcile revenue statements have already been done.
However, auditors found that many of these corrective actions had not been implemented during the time at which the audit was conducted.
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