Report of the

DABC REVIEW COMMITTEE

Appointed by the Minority Leadership of the Utah Legislature
DABC Review Committee Members Peter S. Cooke, Co-Chair Jeff Hatch, Co-Chair Stephen Schubach, Co-Chair Brett Birt Kris Bodeen David Cole Dave DeSeelhorst Peter Erickson Scott Evans Tamara Gibo

DABC Review Committee Consultant Matthew Weinstein

Released January 27, 2012

Report of the DABC Review Committee

Introduction With the growing public outcry over waste, fraud, and abuse in Utahs system of alcoholic beverage control, the DABC Review Committee was appointed in late 2011 by the Democratic legislative leadership to bring a business perspective to bear on the issues facing the Utah State Legislature. Over the past several weeks, the DABC Review Committee has heard comments from a broad spectrum of interested parties, including hundreds of customers, businesses, citizens concerned with the social consequences of improper use of alcohol, government officials, and DABC present and former employees. Our dialogue touched many consumer and provider complaints with regulations, but policy considerations centered around three overarching topics: 1. How can the business of alcohol distribution be run better and provide the State with greater net income? 2. Do current liquor laws, rules and regulations properly align with the DABC mission and purpose of discouraging excessive drinking and preventing underage drinking and driving under the influence of alcohol? 3. Can our laws and regulations promote greater engagement of business providers in supporting the DABC mission and purpose, while at the same time providing accessible, customer-friendly service to visitors and local residents alike? DABC Generally and in the National Context The 21st Amendment to the US Constitution ended Prohibition and turned most regulation of alcohol over to the states, which deal with this responsibility either through a licensing system or a control regime. Thirty-two states are license states that do not participate in the sale of alcohol beverages but regulate alcohol by issuing licenses to private businesses to sell alcohol. The other 18 states are control states, like Utah, where the state acts as the sole wholesaler of alcoholic beverages, as well as the retailer in various ways in half of these states (one of the 18, Washington State, is set to transition from control to license in 2012). In Utah, the Department of Alcoholic Beverage Control (DABC) purchases for and oversees a mixed public-private system consisting of: 44 state stores 104 privately owned package agency stores of five different types over 2,500 clubs, bars, restaurants, and other licensed establishments that sell alcohol for on-premises consumption oversight of distribution of beer that is up to 4% alcohol by volume (3.2% by weight) to grocers and convenience stores. By statute, one state store is permitted for every 48,000 citizens, which would appear to allow a total of 58 state stores. In its FY2011 annual report, the DABC reported gross revenues and fees of $298 million and the following net state and local revenues from alcohol sales:

June 30, 2010. Comparative Gallonage for Utah Wine Spirits Heavy Beer Flavored Malt Beverages TOTAL GALLONS FY 2011 2,895,167 2,464,136 1,344,505 118,133 6,821,941 FY 2010 DABC Review Committee Report 2,777,208 January 27, 2012 2,363,527 Page 2 of 9 1,300,064 100,854 6,541,653

Total Funds to State and Local Governments from Liquor Sales

Funds School Lunch Transfer Sales Tax Net Profit FY 2011 29,555,158 15,752,918 62,313,707 FY 2010 27,921,283 14,688,985 58,359,774

Net Operating Income

107,621,783

100,970,042

Summary of DABC Problems Brought to Light in 2011 In recent years and dating back as far as 1995, state and legislative audits have revealed corruption and mismanagement at the Department of Alcoholic Beverage Control. An October 2011 legislative audit documents decades of improprieties that violated state laws and regulations and cost the taxpayers hundreds of thousands of dollars, including: a. Corruption i. Nepotism a mother supervising her own daughter ii. DABC paying a premium to purchase from Flexpak, a company owned by the DABC directors own son iii. Splitting of invoices to keep them under the $1,000 threshold that triggers competitive bidding iv. The DABC has been rigging bids and falsifying financial data for years in order to bypass procurement requirements. The DABCs routine practice has been to make purchases and then document higher bids after a purchase has already been made in order to pass financial audits conducted by the state. (page 3 of October 2011 audit) v. Post-retirement re-employment pattern revealed in December 2006 legislative audit vi. Special perks for senior management and Commission members: 1. Custom furniture for the DABC director 2. Expensive iMacs and iPads for senior staff 3. Use of $20,000 Jeep Liberty as an executive vehicle 4. Fancy gifts (an iPad and two netbooks) to three Commissioners b. Poor financial controls allowing money to go missing i. $300,000 loss at a package agency in Eden, Utah that was never reported to the Attorney General or the Commission revealed in May 2011 legislative audit ii. On January 24, 2011, $37,122 in liquor was picked up from the DABC and never paid for in violation of DABC Commission rule. (page 20 of October 2011 audit) iii. Failure to obtain documentation for invoices c. Failure to report and false reporting to the Commission d. Poor judgment in closing profitable stores rather than finding savings elsewhere in DABC administrative and warehouse operations, as is now being done by the new DABC director.

 The October 2011 legislative audit recommends that the Legislature consider whether it is time to revisit the current oversight structure of the DABC and goes on to state: Some of the potential restructuring areas could include any of the following: Reducing some responsibilities over the day-to-day operations of the department Moving appointment authority of the director from the commission to the Governor Changing [the commission] from part- to full-time

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In November 2011, Bonneville Research released a $100,000 state-funded review of DABC retail operations intended as a Business Plan for Minimizing Costs While Maximizing Profits of the DABC Stores and Package Agencies. The study was focused on the DABCs 44 stateowned and -operated stores and 42 of the state-licensed package agency retail stores. This report raised additional concerns not addressed in the state and legislative audits, primarily that the lack of retail expertise at the DABC has cost the taxpayers money by inflating costs and reducing revenues, for example by: a. Building new stores rather than leasing existing retail space. b. Rather than working from a store model prototype, DABC and DFCM paid five different architects to design the five most recent new market stores, which differ in size by less than 5%. c. Exercising poor judgment in choice of locations and size of stores, resulting in an inefficient and cost-ineffective distribution of retail outlets d. Allocating 40-50% of store space to storage, a wasteful choice in high-rent prime-retail locations such as the new Holladay store. e. Not evaluating existing stores for remodeling or replacement every 10-15 years f. Failure to develop a store operations manual or adopt best practices and measures to assess and improve individual store performance. g. Failure to retain employees at state stores, resulting in an average turnover rate of 61.5% between 2007 and 2011 and nearly a quarter million dollars of new-hire training costs in 2011. [Legislative testimony in recent years has attributed this problem to the unusually low pay even by public sector standards that prevails at the DABC, including hiring employees part-time instead of full-time to avoid paying benefits. Research has found that higher wages can actually save money by reducing the hiring and training costs that result from high turnover.] In addition, the Bonneville Research report proposed structural changes to the DABC including transferring DABC compliance functions to the Utah State Department of Commerce and having the Alcoholic Beverage Control Commission focus on retail operations. Public Input Provided to the DABC Review Committee The public input provided to the DABC Review Committee in recent weeks raised numerous additional concerns, particularly about the burden of certain aspects of alcohol regulation on private businesses and the general public as well as on the states image and whether they truly serve the publics interest in combating the social ills associated with alcohol consumption, particularly excessive drinking, underage drinking, and driving under the influence. Those concerns included the following list, which we present without necessarily endorsing them or prescribing any specific response:

 a. License issues i. Confusing, arbitrary, and inconsistently enforced license rules ii. Imbalance of licenses glut for restaurants, shortage for bars/clubs. iii. Limiting the availability of licenses based on Utahs resident population fails to account for either growth in visitors or changes in the consumption patterns of local residents. iv. Exacerbating iii. above, resorts and hotels are required to have a separate license for each food & beverage outlet, using up a growing number of scarce licenses to serve a growing number of non-resident visitors, whose increasing numbers are by law, and as noted above, not allowed to lead to an increase in the number of available licenses. v. Unintended consequences in transferring ownership of the state-issued license to the licensees and thereby allowing private sale of licenses in a new unregulated and undefined marketplace expectation of harm to smaller and locally based businesses by driving up the price of licenses, creating an additional barrier to entry into the market, promoting consolidation and benefitting large chains that are mostly based out of state. b. Public safety i. DABC does not focus enough on education about underage drinking and drunk driving, mostly leaving enforcement to local police ii. DABC has too few compliance officers enforcing overly complex rules. iii. DABC has not successfully engaged licensees in the policy making process on public safety issues. c. Transparency issues i. The Alcoholic Beverage Control Commission holds too many closed meetings d. Outdated and counterproductive rules for restaurants/bars/clubs that, among other effects, bring unwelcome national attention to Utahs unique alcohol regulatory environment, to the detriment of the states tourism industry i. Zion Curtain 1. Inconsistencies: Why is it okay to pour wine and beer where customers can see, but not liquor? 2. Consumer protection: How can customers be sure they are getting what they are paying for when the drink is being poured out of sight? 3. Burden on business: This regulation imposes a significant financial cost on restaurants and acts as a deterrent factor to out-of-state businesses considering locating in Utah. ii. Prohibition on drink specials and sales (though DABC is allowed to have specials and sales at state liquor stores). iii. Prohibition on many classic cocktails that commonly include more than 1.5 oz. of a primary alcohol and/or more than 2.5 oz. of total spirits according to the recipes required by the International Bartenders Association, such as 1. Black Russian 2. Cuba Libre 3. Long Island Iced Tea 4. Manhattan

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iv. v.

vi. vii. viii. ix. x. xi.

xii. xiii.

xiv. xv. xvi. xvii.

xviii.

5. Martini whether dry, dirty, vodka, or vesper, James Bond could not enjoy his favorite drink in Utah, either shaken or stirred 6. Mint Julep 7. Negroni 8. Screwdriver 9. Sidecar Prohibition on serving beer over 3.2% alcohol on tap or selling it in grocery stores. Prohibition on house-made bitters and infused spirits, meaning that Utah is cut off from recent national trends and innovations. Last summer California enacted legislation lifting its state ban on infusion of alcohol with fruit and herbs and other flavorings. DABC could accommodate public demand for flights/tastings by allowing the splitting into multiple glasses of the 2.5 ounce single-serving alcohol limit. Bars and clubs are required to lock up alcohol at night even though the establishment itself is already locked and alarmed. Wine, heavy beer, and liquor sales prohibited in grocery stores in spite of their interest and proven ability in other states to handle such sales responsibly Mail order purchase of wine and beer prohibited. DABCs system for special ordering is limited to full-case orders and can take months, and many wineries best offerings are only available through mail order. Prohibition on serving alcohol before 11:30 am means no bloody marys or mimosas with brunch on weekends if you eat at 10 or 11, as many people commonly do. Restaurants difficulties in complying with the 70-30 rule requiring that revenues for alcoholic beverages cannot exceed 30% of total sales, even though a single bottle of wine can easily cost more than the rest of the meal. Restaurants may address this problem by securing a club license, which has no 70-30 rule; however, there are currently no club licenses available and based on the current quota system, the state has issued more club licenses than are allowed. Breweries should be allowed to provide free tastings of beer, including heavy beer, just as wineries are allowed to under current law. Utahs definition of small wineries should match the federal standard of up to 100,000 gallons annually rather than just 20,000, and the small winery reduced markup credit should be applied accordingly. This would better enable small producers to grow and achieve critical mass, creating jobs and benefiting the state. Arbitrary and unpredictable enforcement by DABC, perhaps at times due to the odd and difficult-to-justify nature of some of the rules. A brewerys package agency can only sell products produced on site, not products produced at the brewerys other locations. DABC recently fined Brewvies for showing The Hangover Part 2, an R-rated film, and the penalty was higher than for not scanning IDs or serving minors. DABC cutting staff to save money, with the result that the employees are overworked, morale is suffering, and brokers have to stock shelves themselves because of understaffing (though the committee also heard ample praise for the many dedicated DABC staff who help businesses get through the maze of regulations). DABC reportedly directed to reduce wines by 1,000 SKUs, reducing the quality and variety of wines available to the public.

 xix. xx. xxi.

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Brokers prohibited from providing free samples to potential buyers such as restaurants. Club stores currently require licensees to pay with cash, check, or ACH only while consumers can pay with credit card. There is no wholesale discount for alcohol purchases by restaurants, clubs, and bars.

The impact of many of these rules on Utahs image and ability to attract visitors should not be underestimated. In just the last year, news stories have appeared about them around the nation. For example, in July there was a New York Times article Utah Liquor Laws, as Mixed Up as Some Drinks that referred to Utahs laws as peculiar, unusual, famously strict, capricious, and among the most complex in the country. The states new ban on drink specials has featured in stories from CBS News to Business Week as well as in a year-end AP roundup of the most significant new state laws in 2011 that appeared in media outlets across the nation. The well-known libertarian magazine Reason ran an article last summer with the title Utah's Liquor Laws: Still Crazy, but Less So (I Think). Last year an animated movie on YouTube mocking Utahs alcohol laws was viewed by tens of thousands of people. Even though this media attention often exaggerates the issues and fails to appreciate the progress that has been made, the unfortunate impression created for the rest of the nation about Utah just puts additional obstacles in the way of the hard-working professionals in both government and the private sector who devote their days to boosting Utahs tourism and convention business and convincing employers to move here from out of state. DABC Review Committee Recommendations The clear message from the public and from business is that alcohol is over-regulated. The clear message from the recent official reports is that Utahs alcohol regulatory system needs to be managed with greater competence and integrity. The two messages are complementary, and the conclusions we draw are intended to address both sets of problems. Structural Recommendations 1) The DABC Review Committee does not recommend that Utah abandon the control model and move toward being a license state because it is not clear that the states overall interests and general fund revenue would benefit from such a change. 2) The DABC Review Committee does not recommend that Utah disband the Alcoholic Beverage Control Commission because its independent and nonpolitical nature clearly benefits the state by limiting political interference in alcohol licensing and regulatory matters. 3) The DABC Review Committee recommends that policymakers give serious consideration to dividing alcohol-related responsibilities, with the Commission retaining control of the awarding and rescinding of licenses and of DABC rulemaking and regulation but giving up oversight of the DABCs wholesale and retail operations. The awarding and rescinding of licenses and oversight of rulemaking and regulation are the DABC function most susceptible to political interference and which therefore lend themselves most naturally to oversight by

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an independent commission. Indeed, it is in this area that the Commission has performed best in recent years, working diligently and effectively. But a part-time commission of volunteers cannot effectively oversee a large and complex business operation and should not try to do so. The states wholesale and retail operations should be overseen by professionals with much greater retail experience than we have seen in recent years at the top of the DABC, and those professionals must be directly accountable to the Governor. Only such a direct line of accountability will guarantee effective oversight. Moreover, such a direct line of accountability will make Utahs Governors personally responsible in the future for corruption and mismanagement in the states retail alcohol business, whereas under the status quo, such accountability is missing because it rests with a commission that is not really accountable to anyone. In fact, such a reorganization of the DABC may well be Utahs last resort for those who seek to avoid complete privatization of retail alcohol sales in Utah. A new accountability structure that makes the states leading elected official personally responsible for ending the corruption and mismanagement at the DABC is the most effective response to the rising tide of voices from across the political spectrum calling for getting the state out of the retail alcohol business completely, as many other control states have already done. In the absence of such reorganization, privatization will more and more come to be seen as the only way to protect the states interest in maintaining a well-functioning and well-regulated retail alcohol business in Utah. Thus, the director of DABC should be appointed by and serve at the pleasure of the Governor. The members of the Commission should be appointed as they are now, by the Governor for fixed terms with approval of the Senate. The Commission should be located and staffed where many other independent commissions currently are, within the Department of Commerce. The proposed restructuring is illustrated in the following chart: Current Structure ABC Commission DABC Retail and Wholesale Operations Licensing Rule-making Enforcement New Proposed Structure Governor DABC Retail and Wholesale Operation Dept. of Commerce ABC Commission Licensing Rule-making Enforcement

 Functional Recommendations

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1) The DABC Review Committee supports the general thrust of the recommendations of the Bonneville Research enhanced business plan that calls for putting private sector retail experts in charge of the states retail alcohol operations so as to effectively address the many deficiencies identified in their report. The DABC warehousing and distribution through retail stores, package agencies, restaurants, taverns and private clubs bears a strong resemblance to the grocery business, but traditionally it has been run by experts in warehousing rather than retail sales. The Bonneville Research report provides valuable advice for turning this business operation around to a strong customer focus, using marketing and management tools employed by leading retailers in store location, supply chain management, merchandising, signage, and so on to maximize net income and customer satisfaction while maintaining the DABCs commitment to avoid promotion of the sale and use of alcohol. 2) The DABC Review Committee calls for greater transparency in the functioning of the DABC and an immediate review of the many outdated, counterproductive, inconsistent, and difficult-to-justify rules that continue, in spite of the progress that has been made since just before the 2002 Olympics, to make Utah a national laughing-stock. Whether by legislation or regulation, many of these rules must be changed just as Utah has in recent years with private clubs and drink sizes and can be changed without jeopardizing the states interest in combating overconsumption of alcohol, underage drinking, and drunk driving. 3) The DABC Review Committee calls for expanding the DABCs alcohol education efforts, on which the DABC reported spending just $1.5 million last year. The Legislature should also investigate recent reports that local governments are not properly expending the beer tax revenues available to them for alcohol education and enforcement programs. All Utahns are proud of our distinction as having the lowest rates of alcohol abuse in the nation, but maintaining that distinction in the face of demographic changes and population growth and diversification will be a great challenge in the decades to come. DABC should work with advertising agencies as well as with licensees to develop the most effective programs in the nation to combat alcohol abuse and its attendant social ills. 4) The DABC Review Committee calls on the legislature to revisit the decision last year to allow private sale of all retail alcohol licenses, a provision contained in the Chapter 8a: Transfer of Retail License Act section of SB 314. This provision represents a direct threat to Utahs longstanding tradition of support for locally owned businesses. Especially in the context of a very limited supply of licenses and a quota system that is not keeping up with evolving public demand, including from the growing number of tourists and visitors, allowing the virtually unlimited sale of licenses will add a significant new barrier to entry in the market and give an unwarranted advantage to large chains, most of which are based out of state. In addition, this new law will create a new and powerful constituency lobbying in favor of new restrictions on the availability of licenses so as to protect and enhance the value of their newfound property right.

 Conclusion

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Utah state government has been recognized in the past as one of the best-run in the nation, most recently earning high marks in 2008 from Governing Magazines State Management Report Card. But the ongoing problems at the DABC and the failure of state government to effectively address them threaten to tarnish Utahs sterling reputation. The challenges that Utah faces in its system of alcoholic beverage regulation demand a complicated and sensitive balancing of competing interests and constituencies. Drinkers and non-drinkers, consumers and businesses, state and local government budgets all are impacted directly and indirectly by the well-documented problems in the current system. The status quo cannot stand. Fundamental changes in both structure and functioning are the only way to serve the fundamental values that have been undermined in recent years. We encourage the State Legislature to address comprehensive DABC and alcohol regulatory reform in this years legislative session with continuing critical input from the public and business representatives.