Lottery firm hangs on after firing, getting millions more in fees

When Illinois lawmakers voted in 2009 to hire a private company to run the state’s $2 billion-a-year lottery, they had high hopes of making more money that could be funneled into education and construction projects.

Then the company missed sales goals, and two governors tried to fire Northstar Lottery Group. But Northstar remains on the job more than two years later, and the firm is now able to collect millions of dollars more in fees than under its original contract, an Associated Press review found.

“It shouldn’t be this hard to fire somebody,” said former state Rep. Jack Franks, a Democrat who opposed the private management system and wants the state to resume running the lottery.

Republican Gov. Bruce Rauner’s administration said the delay reflects the challenges Illinois and other states have faced since turning some lottery operations over to the private sector. Indiana and New Jersey also hired private managers after Illinois in 2010 became the first state to do so. All three states have lowered revenue projections or restructured contracts because of disappointing sales.

A replacement firm for Illinois was supposed to have been hired by Jan. 1 under a termination agreement negotiated by Rauner in 2015 — roughly one year after his predecessor, Democratic Gov. Pat Quinn, tried to end the contract.

But a new manager has yet to be hired. Instead, Illinois has extended Northstar’s contract once and is working on another extension that could keep the company in place through 2017. Just one company submitted a bid to replace Northstar.

Lottery spokesman Jason Schaumburg said the transition — including ensuring there’s no disruption at the roughly 8,000 locations where lottery tickets are sold — is complicated.

“While getting a new manager in place in a timely manner is of great importance to the state, our priority is to ensure we are getting the best deal for taxpayers and that the new manager performs at a level taxpayers deserve,” Schaumburg said.

Meanwhile, under the termination agreement Rauner’s office negotiated with Northstar, the company may receive up to $17 million per year in “disentanglement fees” in addition to management fees of up to $14 million annually.

Unlike under the original contract, which paid a flat management fee of roughly $14 million, the payments reflect actual costs as determined by a third-party auditor. In the fiscal year that ended July 1, the company was paid a combined total of $13.5 million in fees.

Also, after making a final $10 million payment for missing revenue expectations, Northstar no longer has to pay additional penalties as it did under its original contract.

The Rauner administration says the agreement remains a better deal than what Quinn negotiated.

Critics cite the situation as further evidence that Illinois never should have hired a private manager. They say the costs associated with the decision are particularly troubling given Illinois’ massive financial problems. Illinois has more than $12 billion in unpaid bills, and funding for social services, higher education and other programs has been slashed because lawmakers have gone two years without passing a budget.

When they voted to privatize the lottery, lawmakers said annual contributions to the state schools fund would increase each year. Additional proceeds were to go toward a plan that would build roads, schools and other public projects.

After initially reporting record sales, Northstar fell far short of its goals in subsequent years. The company and the state went to arbitration following a disagreement over its revenue goals and how performance was calculated.

Company officials, while acknowledging some shortcomings, argued that the state made Northstar’s job more difficult, including canceling games it wanted to launch.

Quinn moved to end Northstar’s 10-year contract in 2014, after the lottery recorded its first loss in a decade. Rauner — a businessman making his first bid for office — made the handling of the lottery an issue in their bruising campaign for governor.

Attorney General Lisa Madigan blocked Quinn’s termination agreement in January 2015, saying it could obligate the state to pay more fees and expenses than in prior years.

Nine months later, Rauner’s new lottery director announced another agreement, calling it “a new day for the Illinois Lottery” and a better deal for taxpayers. The agreement assumed a transition period in which Northstar would continue to work alongside the new manager.

However, a request for proposals formally seeking a new manager was not issued until July 2016 — 10 months after the second termination agreement was signed. The only firm that submitted a bid was Camelot, which runs the British lottery and was among the companies that bid for the original Illinois contract.

Lottery sales have remained essentially flat in recent years. The lottery saw its second smallest increase in sales since 2003 in the fiscal year that ended June 30, according to a legislative report that cited preliminary, unaudited numbers.

In that same fiscal year, the lottery transferred $691.6 million to the school fund. No money was transferred to the capital fund “due to poor overall results by the lottery,” the report from the state Commission on Government Forecasting and Accountability stated.

Those have not been the only troubles. Last month, a group of lottery players sued Northstar after a Chicago Tribune investigation found that the lottery did not award many of the biggest prizes in some of its largest scratch-off, instant games.