STATE OF NEW YORK RACING AND WAGERING BOARD

INTERIM REPORT

INTO THE MATTER OF INCORRECT TAKEOUT RATES AT THE

NEW YORK RACING ASSOCIATION, INC.

Audits and Investigations Unit

April 26, 2012

NYRA Takeout-Interim Report Executive Summary

April 26, 2012

This is an interim report into the matter of incorrect takeout rates at the New York Racing Association, Inc. (NYRA) in effect from September 15, 2010 to December 21, 2011. The Board has decided to issue this report prior to the conclusion of its review because of the seriousness of the findings contained herein. The regulatory framework over pari-mutuel wagering in general and NYRA in particular is complex. The Franchise Oversight Board, Racing and Wagering Board, Office of the State Comptroller and Department of Taxation and Finance all have specific responsibilities enumerated in the Racing, Pari-Mutuel Wagering and Breeding Law (Racing Law). The Racing Law allows racetracks to set takeouts, subject to Board approval, within prescribed ranges. Chapter 115 of the Laws of 2008 (Chapter 115) prescribed new ranges for NYRAs takeout rates, effectively increasing the minimum rates. The Chapter 115 rates expired on September 15, 2010. NYRA did not change the rates at the time of expiration which resulted in the exotic rate being 1% above the legally permissible rate. In December 2011 the Board became aware that NYRAs exotic takeout rate was 1% above the limit authorized by the Racing Law. According to NYRA, the total dollar amount of the additional 1% withheld by NYRA on on-track wagers was $1,125,925. The total dollar amount of the additional 1% withheld by racetracks and off-track betting sites betting on NYRA was $7,361,722 for a total of $8,487,647 inappropriately withheld from bettors. NYRA has reported that it made an inadvertent error and a mistake. The Board commenced an investigation into the matter. The purpose of the investigation was to determine why NYRA did not change the takeout rates when they expired on September 15, 2010. It was also to determine why the issue was not detected by the relevant parties who may have been in a position to do so, including this Board. The Boards review thus far has found the following: Based on a review of NYRAs emails, several NYRA personnel, including CEO Charles Hayward, were notified and/or were aware that the exotic takeout rate had expired. NYRA may not have lowered the rates due to perceived political and financial reasons. In an email dated September 1, 2010 NYRA Vice-President Liz Bracken informed a NYRA Manager that, takeout legislation sunsets middle of September, but I have not heard that we intend to lower takeouts. The email was subsequently forwarded to two other NYRA employees. Mr. Hayward was notified via email by a concerned bettor on September 28, 2010 that the law had sunset and the rates had expired. Mr. Hayward notified the bettor that he was referring the issue to NYRAs General Counsel Patrick Kehoe. 1

NYRA Takeout-Interim Report

April 26, 2012

In August 2011 (almost a year after the rates had expired) the Daily Racing Form (DRF) publisher and columnist Steve Crist passed along an email from a DRF reader indicating the rates had expired and were outside the parameters of the Racing Law. Mr. Hayward emailed Mr. Crist on August 1, 2011 confirming that the reader was correct and requested that Mr. Crist keep the information confidential. Mr. Crist agreed. As part of its 2010 financial statement audit, NYRA provided the incorrect exotic takeout rate to its independent auditor, UHY, LLP. NYRA personnel reported to UHY that there were no statutory changes in takeouts for 2010. UHY attempted to verify the rates with statute. However, UHY verified the inappropriate 26% exotic rate by reconciling it to the expired section of statute containing the 26% exotic rate instead of the effective section of statute containing the 15-25% range. United Tote, NYRAs totalisator provider, failed to verify takeouts with the Racing Law and instead relied on information provided by NYRA. The Board requires annual independent audits of NYRAs tote system (provided by United Tote) which includes the verification of correct takeout rates. Berry, Dunn, McNeil & Parker (BDMP) performed the audit covering the period October 1, 2009 September 30, 2010. BDMP stated that it did not verify the takeout rates with statute. PriceWaterhouseCoopers (PWC) performed the audit for the period January 1, 2011 September 30, 2011. The Board found that PWC attempted to verify the takeout rates and identified the correct statutory range of 15-25% but failed to note that the exotic rate was in excess of the limit. NYRA has not properly updated its internal controls on file with the FOB and did not follow its system of internal controls on file with the FOB as required by law. NYRAs former integrity counsel Getnick & Getnick has written to the Board indicating that it has documents responsive to the Boards investigation but cannot provide them due to attorney-client privilege. NYRA has permitted the Board to review part of what NYRA asserts is the only document responsive to the Boards request. NYRAs current integrity counsel was to obtain verification that the referenced report is the only responsive document. This remains an open question. NYRAs current integrity counsel, Jonathan Sack of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C. has publically reported that he has reviewed the takeout matter and the evidence suggests that there is no indication of intentional wrongdoing, no one was trying to deceive anyone and that it does not appear that anyone saw the mistake and perpetuated it. In August 2010, the Office of the State Comptroller (OSC) was engaged in real-time monitoring of NYRAs financial condition. OSC found that NYRAs cash flow projections continue to be prepared accurately, based on valid assumptions that have been 2

NYRA Takeout-Interim Report

April 26, 2012

consistently applied and updated on a timely basis. The cash flows would have been prepared using revenue assumptions based on the incorrect takeout rates. It is unclear if OSC attempted to verify the takeout rates. The Franchise Oversight Board (FOB), with limited staff and budget, was not in a position to perform a meaningful review of NYRAs takeout. The Racing and Wagering Board (Board) did not audit the NYRA takeout rates, instead relying on the required independent audits, as it does with all racetracks. In conclusion, while the Board has not received all the requested documents from NYRA, the information received so far raises serious concerns necessitating bringing this information to the attention of the Franchise Oversight Board. The documentation received from NYRA indicates a knowledge of the violation, failure to report that information in a timely fashion and take corrective action. While it is clear NYRA knew they were collecting an inappropriate rate based on an August 2011 email, they decided to continue to collect the excess takeout in violation of the Racing Law without notifying any parties including the Board, the FOB, its tote company or its auditors. It is also believed, based on documents received, that NYRA had even earlier knowledge of the takeout expiration. Just prior to the rates expiring, internal NYRA emails discuss the impending expiration of the rates and in September 2010 NYRA was emailed by an outside party with notification of the takeout expiration. NYRA has yet to submit several thousand documents that NYRA has indicated are responsive to the Boards request. The Board will continue to conduct its review and pursue the information that NYRA has yet to provide as of the date of this interim report. The Board will continue to work with the Franchise Oversight Board in reviewing this matter fully and appreciates the cooperation of the FOB.

NYRA Takeout-Interim Report

April 26, 2012

Special Note This is an interim report into the matter of incorrect takeout rates at the New York Racing Association, Inc. (NYRA). The Board has decided to issue the report prior to the conclusion of its review because of the seriousness of the findings contained herein. It should be noted that the Board has requested thousands of pages of documents from NYRA, its auditors, United Tote Company and others. While many documents have been provided and reviewed there remains a significant amount of material that has not been submitted by NYRA. Therefore, this report is preliminary as of the cover date. Background Pursuant to Section 206 of the Racing Law and a franchise agreement with the State of New York, the New York Racing Association, Inc. (NYRA) operates Aqueduct Racetrack, Belmont Park and Saratoga Race course. The regulatory framework over pari-mutuel wagering in general and NYRA in particular is complex. Pursuant to Section 212 of the Racing Law, the New York State Franchise Oversight Board (FOB) provides general oversight of NYRAs finances, budgets, internal controls and compliance with the franchise agreement. Pursuant to Section 101 of the Racing Law, the New York State Racing and Wagering Board (Board) has general jurisdiction over all horse racing activities and all pari-mutuel betting activities. The New York State Office of the State Comptroller (OSC) is charged with auditing NYRA while the New York State Department of Taxation and Finance performs some functions such as testing the totalisator system. The Racing Law requires NYRAs financial statements and its system of internal controls to be audited by an independent certified public accounting firm. The Boards rules require NYRAs totalisator system to be audited annually for compliance with specific statutory requirements such as takeout. Pari-mutuel wagering is a form of gambling where bettors wager against themselves by pooling wagers together. A portion of the pool, known as takeout or commission (herein takeout), is retained by the racetrack and OTBs as its gross revenue. The remainder of the pool is returned to the winning bettors. The Racing Law allows racetracks to set takeouts, subject to Board approval, within prescribed ranges. Section 238 of the Racing Law prescribes the takeout range for NYRA. Chapter 115 of the Laws of 2008 (Chapter 115) was signed into law on June 17, 2008. Chapter 115 primarily dealt with the New York City Off-Track Betting Corporation (NYCOTB) which was in a precarious financial position. Among other things, Chapter 115 amended the takeout rates used by NYRA. The minimum takeout rates were raised with the hope that the additional gross revenue would help NYCOTB. Chapter 115 provided that the takeout provisions shall take effect on the ninetieth day after it shall have become a law and shall expire and be 4

NYRA Takeout-Interim Report

April 26, 2012

deemed repealed 2 years after such effective date. Therefore, the takeout became effective on September 15, 2008 and was set to expire on September 15, 2010. Consistent with Chapter 115, NYRA requested new takeouts on August 13, 2008. The Board approved the takeouts on September 12, 2008. The takeout rates were 16% for regular wagers, 18.5% for multiple wagers, 26% for exotic and 16% for super exotic wagers (26% on super exotic carryovers). On December 6, 2011 staff from the New York State Office of the Comptroller (OSC) requested from Board staff the current takeout rates for NYRA. OSC was auditing the New York State Thoroughbred Breeding & Development Fund (NYSTBDF) and was verifying certain statutory distributions. Board staff provided the Boards September 12, 2008 letter approving the takeout rates. On December 7, 2011 OSC staff requested the Board to review the relevant statutes and questioned if takeout rates that NYRA was using were still in effect. Board staff confirmed the actual takeout rates that were programmed into the NYRA totalisator system and began researching the issue. Board staff confirmed that the statutory takeout rates had reverted to pre-Chapter 115 ranges. The rates being used by NYRA for regular, multiple and super exotic wagers were still within the authorized ranges; however, the exotic rate of 26% exceeded the maximum authorized rate of 25%. The Board informed NYRA of the issue on December 8, 2011. Board staff contacted NYRA to solicit NYRAs comments on what the Board believed was an incorrect takeout rate. NYRA initially informed the Board that NYRA believed that it was in compliance. The Board subsequently discussed the issue with NYRA again and on December 16, 2011, NYRA agreed with the Boards findings. The Board directed NYRA to change the takeout rate. The effect of the error was that NYRA, and those sites betting into NYRA, retained from the pool an additional 1% that was not authorized by statute. Likewise, the bettors who won exotic wagers during this time period were shortchanged. According to NYRA, the total dollar amount of the additional 1% withheld by NYRA on on-track wagers was $1,125,925. The total dollar amount of the additional 1% withheld by racetracks and off-track betting sites betting on NYRA was $7,361,722 for a total of $8,487,647 inappropriately withheld from bettors. On December 21, 2011, the Board approved NYRAs request to change takeout rates to 24% for exotic and 15% for super exotic and 24% for super exotic with a carry over. The Board also directed NYRA to reimburse those bettors, under certain qualifying parameters, that were underpaid as a result of the additional 1% takeout withheld on exotic wagers. In order to be eligible for reimbursement a bettor needed to have won an exotic wager during the period the additional 1% was withheld and have made the wager through an account, had a winning exotic wager subject to IRS reporting requirements or had an unexpired winning exotic pari-mutuel ticket. NYRA was directed to make such payments by March 30, 2012 and file a report of the same with the Board by April 16, 2012. Other New York racetracks and OTBs were directed to 5

NYRA Takeout-Interim Report

April 26, 2012

perform similar procedures. NYRA subsequently reimbursed affected bettors $594,508. Therefore, NYRA realized a profit of $531,417 from the unauthorized takeout. Board staff also commenced an investigation into the matter. The purpose of the investigation was to determine why NYRA did not change the takeout rates when they expired on September 15, 2010. It was also to determine why the issue was not detected by the relevant parties who may have been in a position to do so, including this Board. The FOB became aware of the takeout issue about the same time the Board did. In a letter dated December 21, 2011 the FOB Chairman wrote, an outside investigation overseen by the Racing and Wagering Board must be commenced to determine responsibility for the overcharge and why audit standards and integrity controls established to insure compliance with the laws governing NYRA operations failed to function properly. The FOB Chairman immediately directed that NYRA comply with the Boards investigation. NYRA Staff has reviewed over 5,000 documents from NYRA including emails, accounting records, board of director minutes, budgets, internal audits and more. NYRA has yet to submit all of the documents requested by the Board. In addition, there are many documents for which NYRA has asserted legal privilege and refused access. NYRAs official explanation of this matter was that it was an inadvertent error and a mistake1. However, Board staffs review of NYRA records indicates that several individuals were well aware that the Chapter 115 takeout rates had expired. Board staff also found that outside parties notified NYRA of the expiration. An email provided by NYRA showed that on September 28, 2010 an individual notified Charles Hayward of the following:
This takeout increase was supposed to sunset on September 15, 2010. I cant find anywhere that it has been removed and am quite sure that it hasnt since NYRA didnt promote it. We had emailed back and forth about this back in 2008 and you told me that it would be removed, as scheduled, on the above date. Would you mind letting me know if it has or hasnt and if it hasnt, why?

Hayward emailed the individual on October 4, 2010 indicating that he was sending the inquiry to NYRAs General Counsel Patrick Kehoe. It should be noted that staff did not find an email from Hayward to Kehoe on this subject. However, NYRA has asserted legal privilege on communications with its legal department. The Board has requested a privilege log.

Letter dated December 22, 2011 from NYRA CEO Charles Hayward to Franchise Oversight Board Chairman Robert Megna.

NYRA Takeout-Interim Report

April 26, 2012

On August 1, 2011 Steve Crist, Daily Racing Form publisher and columnist, passed an email along from a reader. Crist asked Hayward if the reader was correct. The reader expressly indicated that NYRAs rates were not in compliance. The reader wrote:
The 2008 NYCOTB takeout increase legislation included a sunset provision that went into effect on September 15, 2010. (Article 2 Section 238 of the Racing, Pari-Mutuel and Breeding Law) The takeout limits allowed by law are now 12-17% for w/p/s, 14-21% for exacta/double wager 15-25% for tri/super and P3/P4 and 15-36% for P6 with no separate rates for carryover and noncarryover pools. (Please note that the tri/super/P3/P4 takeout is currently at 26% which is currently outside the parameters of the law) [emphasis added] NYRA may be waiting for the VTL money before they lower any takeouts, but if NYRA wanted to lower takeout all they have to do is make to request to NYSRWB, which would most likely to approve the request.

Later on August 1, 2011 Hayward responded to Crist:

This gentlemen is correct. [emphasis added] Off the record, we have been working on this for some time. We originally had thought that we would announce this for Saratoga but political forces intervened. Since we are showing substantial losses in 2010 and 2011 and we have been smacked around by Cuomo (and he could check the SRWB from approving), we decided to wait. Also, the regional OTBs who collectively lost money in 2010 will scream like stuck pigs and that would provoke Skelos who is very tight with the guys who run Nassau OTB to introduce antiNYRA legislation for the benefit of the OTBs. Finally, we are quietly working on a plan to open 10 or so restaurant/bars in the city and we did not want the politicos to block this effort. We have some internal debates on how much to lower each pool and how we would present this to our simo customers, the consumers and the politicos. I would appreciate it if you could keep these details confidential. I would also welcome a further discussion on this topic with you before the meet is over.

On August 1, 2011 Crist emailed Hayward:

Will keep it confidential and would love to discuss possible reduction schemes with you off the record whenever the time is right,

Hayward invited Crist to dinner to discuss. Staff does not know if Hayward met with Crist or, if so, what was discussed but Board staffs review of Crists columns from the date of the email until the issue became public revealed one December 30, 2011 column2 on the NYRA takeout where Crist referred to the issue as an honest mistake. It is clear that others at NYRA were aware of the sunset provision as well at a much earlier date. An email dated September 02, 2010 (prior to the expiration) from NYRA VP of Simulcasting Liz Bracken to NYRA Manager of Settlements Christopher Widmer stated:
2

http://www.drf.com/news/crist-nyras-response-takeout-fiasco-not-long-term-solution

NYRA Takeout-Interim Report

April 26, 2012

Current rates good until Belmont. Takeout legislation sunsets middle of September, but I have not heard that we intend to lower takeouts.

Widmer emailed Bracken back on September 2, 2010:

Ok, keep me posted on the takeout issue and Ill send you a Belmont rate sheet early next week.

On September 2, 2010 Widmer also forwarded Brackens email to Shuana DeFour, NYRA Revenue Analyst and Ingrid Jagrup, a NYRA employee. At the February 14, 2012 meeting of the FOB, various NYRA representatives including Charles Hayward commented on the takeout issue. The following are excerpts from draft transcripts of the meeting:
THAT LEGISLATION HAD A SUNSET ON IT. SO IN SEPTEMBER OF 2010, WHEN THAT LAW SUNSETED FOR EXOTICS WHICH THE LAW HAD MOVED OUTSIDE THE ALLOWED RANGE, OR STATUTORY RANGE, THERE SHOULD HAVE BEEN A REDUCTION FROM 26 TO 25. THAT REDUCTION DID NOT TAKE PLACE. I WILL POINT OUT TO YOU THAT DURING THE ENTIRE PERIOD IN QUESTION, NYRA PRINT [SIC] ALL OF ITS TAKEOUT RATES, AND WE CONTINUED TO PRINT A TAKEOUT RATE AT 26 PERCENT IN OUR PROGRAM, WE PRINTED IN THE DAILY RACING FORM THE 26 PERCENT, ALL OF OUR SIMULCAST CONTRACTS WHICH HAVE OUR TAKE OUT RATES WHICH ARE EXICUTED [SIC] IN THE PERIOD AND APPROVED BY THE STATE RACING AND WAGERING BOARD REFLECT THE 26 PERCENT. SO LOOK, WE DID NOT OBEY THE LAW, WE UNDERSTAND THAT, BUT WE WERE NOT TRYING TO MISLEAD ANYBODY AND IN FACT PUBLISHING INCORRENT INFORMATION AND WITHHOLDING INCORRECT INFORMATION

Hayward further commented, in part:

THE WHOLE ISSUE HERE IS THAT WE HAVE RANGES AND UNFORTUNATELY WHEN THE LAW, AND WE CAN APPEAL TO THE STATE RACING AND WAGERING BOARD AND MAKE A CHANGE EVERY QUARTER. WHAT THE LAW DID IS IT MOVED THE TAKE OUT OF THE RANGE. SO THAT'S WHY STATUTORALLY, THEY SET A LAW THAT SUNSETTED THAT TOOK IT OUTSIDE THE STATUE [SIC]. IN FACT THEY HARD CODED THAT 26 IN THE LAW. SO WHEN THAT WENT AWAY, AND BY THE WAY IT WAS ABOUT 3 MONTHS AFTER WE GOT THE LOAN THAT THE STATE GAVE US, WHICH BECAME EVENTUALLY GENTING LOAN, WE DID NOT FEEL POLITICALLY WAS THE RIGHT TIME TO GO TO THE STATE AND SAY WE WANT TO REDUCE THE TAKEOUTS, BUT WE SHOULD HAVE

Board staff reviewed several other documents that call into question NYRAs claim that this was an inadvertent error. NYRAs accounting department keeps a spreadsheet of relevant statutory rates. These spreadsheets clearly show that the statutory takeout rates along side the rates in effect at NYRA. The following is an excerpt from one of the spreadsheets:
NYRA On-Track Commission Type of Wager Regular Multiple Exotic Take-Out Range 12-17% 14-21% 15-25% Was Location Page 28, Section 228 Page 28, Section 228 Page 28, Section 228 Current Rates Refers to Pocket Part 16.0% 18.5% 26.0% Now Section 238 Section 238 Section 238

16.0% Non-carryover pick 6

NYRA Takeout-Interim Report

April 26, 2012

The spreadsheet indicates the current exotic rate of 26% while the takeout range is capped at 25%. The sections refer to the Racing Law. The spreadsheets reviewed by staff had an auto-fill date function thus the date always indicated the date the file is opened so it was impossible for staff to tell when this spreadsheet was used. However, the file modified date for the above spreadsheet indicated it was last modified on September 14, 2011, almost one year after the takeouts expired. According to NYRA Assistant General Counsel Pasquale Viscusi the spreadsheet was initially prepared by a NYRA Revenue Analyst in 2006 or 2007. The spreadsheet was updated on several occasions. It was used as an internal reference regarding provisions of the Racing Law. Several NYRA employees received the spreadsheet. The spreadsheet was also provided to UHY, NYRAs independent auditors (see UHY Section). The Chapter 115 takeouts were discussed in NYRAs 2009 budget narrative, dated November 24, 2008, submitted to the finance committee of its board of directors. The two primary determinants of NYRAs gross revenue are handle and takeout which are intrinsincly related. On page 2 of the document NYRA discussed the effect of declining handle and stated, this decrease in handle is offset by the 1% take-out increase in all pools (implemented September 15, 2008) resulting in a net 1.3% decrease in on-track gross revenue. According to minutes from a meeting of NYRAs Finance Committee held on August 12, 2009, NYRA discussed its year-to-date performance. NYRA reported, the positive difference between total handle and revenue earned is a result of an improved blended commission rate and is attributable to NYRAs ability to command higher simulcast host fees in the marketplace and the statutory increase in takeout enacted in 2008. In NYRAs 2010 budget submitted to the FOB NYRA again acknowledged the Chapter 115 takeout rates. NYRA indicated, however, that it believed the rates would be extended, Blended commission rates are budgeted to remain relatively flat year-overyear, and assume an extension of the 1% takeout increase enacted in September 2008 which is set to expire September 2010. It is unclear why NYRA made such an assumption but the takeout rates were not extened and expired in September 2010. On December 29, 2010, approximately three months after the rates expired, NYRA submitted its 2011 budget to the FOB. Despite NYRA discussing the rates in two previous budgets, staffs review of this specific budget found no mention of the Chapter 115 rates. It is also evident that NYRA discussed reducing takeout internally after the rates expired. Staff found several analyses prepared by NYRA regarding the potential impact of reducing takeout in 2011, during the time the rates had expired. Staff also found an email dated September 1, 2010 (just before the Chapter 115 rates expired) from Dan Silver, NYRA Director of Communications, to an unknown recipient requesting studies involving takeout. Silver wrote, One of the things we are going to investigate in the coming months is potential impact of lowering takeouts NYRA Internal Controls 9

NYRA Takeout-Interim Report

April 26, 2012

The FOB directed the Board to examine NYRAs internal controls. Pursuant to Section 240 of the Racing Law, NYRA must file, a report expressing the opinion of the independent certified public accountant that based on his examination of the financial statements the franchised corporation has followed, in all material respects, during the period covered by his examination, the system of accounting and internal controls as filed with the [FOB]. Therefore, NYRA is required by law to operate pursuant to the controls on file with the FOB. The Board examined the controls specifically as they relate to takeout and in general as they relate to NYRAs statutory obligation to follow the controls on file with the FOB. The Boards review found three areas of controls relevant to takeout: NYRAs Accounting Policies and Procedures, NYRAs Pari-Mutuel Operations Procedures and NYRAs Law Department Policy and Procedures. The Accounting policies detail the procedures for reconciling commission (i.e. revenue from takeout) received on a daily basis to reports produced by the tote system. The controls do not require the reconciliation of takeout to statute. The PariMutuel procedures state, the Pari-Mutuel Departments main objective is to protect the interest of the wagering public and ensure that the collection and distribution of funds is in accordance with New York State racing and wagering laws. The controls also state that, on a race meet basis or when the Mutuel Office requests a change, the Compliance Manager receives the group Configuration Report from United Tote reflecting all the changes made to the system. The Compliance Manager reviews the report and assesses the propriety of the changes. The controls also require a daily review of the User Configuration report. While not mentioned specifically in the controls, NYRA receives a daily Sever Configuration report which lists the takeouts. This report is discussed in the United Tote section of the report. NYRAs Law Department policy has no specific mention of takeout. However, the policy states, the General Counsel will make a diligent effort to identify those laws, rules, and regulations not specifically covered in this section, which pertain to NYRAs operations, and inform NYRA management of its responsibility to comply. It should be mentioned that, historically, NYRAs controls have been deficient in citing specific statutes and affixing responsibility for compliance. Prior to 2008, the Board was the repository for NYRAs controls. The Board frequently reviewed NYRAs controls and cited NYRA for not including such statutory references. This is illustrated by a November 21, 2006 letter from the Board to NYRA stating, in part, Board staff has criticized NYRA in the past for not including specific references in its internal controls to the applicable sections of the [Racing Law]. Board staff believes strongly that referencing specific statutes and enumerating procedures will effectuate NYRAs compliance with the Racing Law. The Boards general review of NYRAs controls found that NYRA is not following its system of internal controls as filed with the FOB. Further, NYRA has updated its controls but has not filed them with the FOB, thus not giving the FOB an accurate portrayal of its controls.

10

NYRA Takeout-Interim Report

April 26, 2012

Through a review of NYRAs internal audits and board/committee meeting minutes staff found several areas of controls that may have been updated but not filed with the FOB. These controls include accounting, pari-mutuel operations, NYRA Rewards, Travel and Entertainment, and Cash Cards. In particular, NYRA made material changes to its account wagering controls to allow customers to receive instant funding of wagering accounts. These procedures were approved by the Board in 2008. However, NYRA never filed these controls with the FOB. The controls on file with the FOB are dated March 2006 and do not allow instant funding. Therefore, NYRA is in material non-compliance with the controls on file. Staff also made NYRAs independent auditor, UHY, aware of this issue on February 10, 2012. (Staff notes that UHY issued an unqualified opinion with respect to NYRAs 2011 report issued March 28, 2012 as well as the 2010 report.) According to minutes from the August 2, 2010 meeting of NYRAs Audit Committee, Mr. Kehoe reported that staff from the NYRA Law Department was charged with instructing all departments to update their procedures, at which time he would file with the FOB. According to minutes from an February 28, 2011 meeting of NYRAs Audit Committee, under the heading of Material Non-Compliant Finance Issues, Ellen McClain reported that the Travel and Entertainment policy has been rewritten and issues relating to the same were resolved. Despite these apparent revisions to NYRAs controls, the schedule of controls included with NYRAs Report on Accounting and Internal Controls, listed no amendments to controls filed with the FOB in 2010 or 2011. It also appears that NYRA may not have filed the 2009 required accounting and internal control report with the FOB. Howard Foote of UHY presented the Accounting and Internal Control attestation report at the March 24, 2010 meeting of the Audit Committee. UHY found material non-compliance with the Accounting policies and the Travel & Entertainment policies. There was a discussion about whether the report had to be filed with the FOB. Mr. Kehoe stated that it was not clear that this report had to be filed with the FOB but would be distributed to the NYRA Board. Mr. Kehoe reiterated this at an August 2, 2010 Audit Committee meeting. According to the minutes, the UHY report on [internal controls] has not been furnished to the FOB for the past two years and they have not requested it. Staff found this peculiar since, prior to 2008, the statute designated the Board as the recipient of the report and NYRA annually filed the same. It appears NYRA began to file the report with the FOB for the 2010 year, the first year there were no material non-compliance findings. A similar report was filed with the FOB for the year 2011. Documents prepared by NYRAs former internal auditor, William Varvaro, found issues with its internal controls. The March 23, 2010 Accounting and Internal Control Compliance Review from Mr. Varvaro, former NYRA Internal Auditor to James Heffernan, Chairman of NYRAs Audit Committee and Patrick Kehoe, NYRA General Counsel, noted that the accounting and internal controls as filed with the Board have not been adhered to on a consistent basis for all attributes tested and We noted that several policies were not consistent with controls and procedures that are in place, and therefore they should be updated and filed with the Board. It also notes, regarding their scope, It did not include the accounting and 11

NYRA Takeout-Interim Report

April 26, 2012

internal control improvements which were implemented by NYRA but not submitted to the Board. There is a similar memo regarding the same dated April 6, 2009. UHY (NYRAs Independent Auditor) Pursuant to Secion 240 of the Racing Law NYRA is required annually to file audited financial statements and a report on its accounting and internal controls with the FOB. Note 18 of NYRAs 2010 financial statements is entitled Statutory Takeout and Distributions for NYRA Races. The Note states: the Racing Law provided for the following distributions as of December 31, 2010 and 2009. The Note provides a chart listing the exotic takeout rate at 26%. Obviously, this rate exceeded the statutory rate as of September 15, 2010. It is the responsibility of NYRA management to prepare the notes. It is the responsibility of NYRAs auditor to render an opinion on the financial statements which includes the notes. NYRAs independent auditor is UHY LLP (UHY). Staff reviewed UHYs workpapers from the audit. In a memo dated November 11, 2010 UHY documented its understanding of parimutuel commission. The auditor wrote, in part, the takeout rate is governed by New York State statute. See WP 7186.01. WP (Work Paper) 7186.01 is the same spreadsheet disclosed previously in this report in the NYRA section. The spreadsheet shows the current exotic takeout at 26% and the statutory range of 15-25%. The UHY auditor also noted, per inquiry of Ingrid Jagrup [a NYRA employee], the rates did not change during 2010 and wont change until the law changes as they are all statutory. This is, of course, incorrect. The law changed on September 15, 2010. In addition, NYRA can change the rate to any percentage within the range with Board approval. According to the work paper the auditor performed the following procedures, in order to place reliance on the rate schedule, UHY traced the rates to the published Pari-Mutuel Racing, Wagering and Breeding Law, found in table 7186.02-7186.06. Work paper 7186.02 was Section 238 of the Racing Law. The auditor highlighted a paragraph of the racing law pertaining to NYRAs takeout including, twenty-six per centum of the total deposits in pools resulting from on-track exotic bets. However, the particular paragraph contained an asterisk and at the end of the paragraph the asterisk disclosed, * NB Effective until September 15, 2010. Thus the auditor verified the takeout information to the expired paragraph. The work paper contained the paragraph that was in effect with the correct rates but it was not highlighted. UHY also verified the rates directly with NYRA. Staff found an email from a NYRA Revenue Analyst to a UHY auditor dated March 17, 2011. The email stated, There have not been any statute changes for the period of 2010 nor are there any current ones for 2011. The rates are the same. Totalisator System and Standards The totalisator system is the cash register at the racetrack; it processes all the wagers and calculates the payoffs. NYRA contracts with United Tote Company (UT) to perform these services. 12

NYRA Takeout-Interim Report

April 26, 2012

In 2008 the Board promulgated Part 5100 of Title 9(E) of the New York State Codes, Rules and Regulations (Rules) relating to totalisator standards. The Rules, which have the effect of statute, require that totalisator companies annually submit a Type II SAS 70 report (or other report approved by the Board) that demonstrates compliance with the tote standards. The SAS 70 refers to Statement on Auditing Standards 70, which is a pronouncement promulgated by the Auditing Standards Board, a techincal arm of the American Institute of Certified Public Accountants. The SAS 70 is an audit of service organizations, such as a totalisator company, and renders an opinion on the service organizations internal controls. Beginning with reporting periods after June 15, 2011 the standard was changed to SSAE 16 (Statement on Standards for Attestation Engagements). Anually, the Board establishes and provides minimum control objectives, required control descriptions and procedures that must be tested. The Boards control objective S-4 requires that the system controls provide reasonable assurance that transactions are completely and accurately processed, posted, and summarized for reporting purposes. The Board requires inclusion and testing for compliance of , commissions are calculated using appropriate statutory take-out rates (retention / takeout). This requirement is listed as control objective S-4 x. It is also a requirement that this control is tested at the actual site, as opposed to a wagering hub which may apply to several sites. These control objectives must be adopted and implemented by UT and are ultimately the reponsibility of UT. UT submitted audits for the years 2010 and 2011 which contained no findings related to the use of the expired takeout. Berry, Dunn, McNeil & Parker (BDMP) was UTs auditor in 2010 and PriceWaterhouseCoopers (PWC) was the auditor for 2011. Staff reviewed the audit work papers from both firms. BDMP (UTs SAS 70 Auditor) BDMP performed the audit covering the period October 1, 2009 September 30, 2010. According to the report, UT Control Activity 14 states that percentages for commissions, positive breakage, and negative breakage are set in the server configuration file in accordance with NY requirements. The report identifies Board requirement S-4 x. Listed under Tests Performed by BDMP the report states, inspected server configuration files to determine that percentages are properly set in files. The report found no exceptions relating to the control objective. Staff reviewed the work papers from the BDMP audit. Work paper Ops 6 was a NYRA system log dated September 15, 2010 (the first day the new rates came into effect). The configuration report listed the incorrect rates. The auditor noted, commissions can change based on events (like pick 6 carryover). No other notations were made. The other relevant work paper was ORPT 3. NYSRWB requires that this particular test be performed annually at each specific site / track, therefore the required testing should have been at a NYRA track for the NYRA tote. However, BDMP used a report for Batavia Downs. In addition, BDMP used a prior years report. 13

NYRA Takeout-Interim Report

April 26, 2012

The auditor also misidentified the takeout rates for Batavia as Belmont. The auditor used the rates to test if calculations were properly performed. The auditor noted percentages agree as required by NYSRWB standards. Staff interviewed the partner-in-charge of the audit. He stated that his interperation of the required control objective testing (commissions are calculated using appropriate statutory takeout rates) does not require actual verification of the legal rates. BDMP interprets this to mean that the system has a mechanism in place to input rates and the system properly calculates payoffs, etc., using the rates. Therefore, BDMP never checked the rates against the statute. BDMP checked the rates against configuration reports that were used by UT to verify the rates with NYRA. (see section on United Tote) PWC (UTs SSAE 16 Auditor) PriceWaterhouseCoopers (PWC) performed the SSAE 16 audit for the period January 1, 2011 September 30, 2011. According to the report, UT Control Objective S-4 #8 states that percentages for commissions, positive breakage, and negative breakage are set in the server configuration file in accordance with NY requirements. The report identifies Board requirement S-4 x. The report states, inspected server configuration files for evidence that percentages are properly set in files. The report found no exceptions relating to the control objective. Staff reviewed the work papers from the audit. According to work paper 108-11 PWC inspected the server configuration for Belmont and noted that the configuration appears reasonable based on the standards set out by NYS. The rates in the configuartion file were the expired Chapter 115 rates including the 26% exotic. The test was performed on September 15, 2011, one year after the rates had expired. The work paper also had a summary of Section 238 of the Racing Law. The auditor correctly identified the correct statutory rates including the exotic rate of 25%. Nevertheless, no exceptions were noted from the test.

United Tote United Tote Company (UT) is NYRAs totalisator vendor. UT provides the personnel, hardware and software for totalisator processing. In performing this function UT interacts and relies on certain NYRA controls and processes and personnel. For instance, NYRA tellers input wagers into the ticket issuing machines. UT personnel are responsible for configuring the takeout rates into the totalisator system. According to UT, they rely on NYRA to provide the proper rates; UT performs no independent verification of the rates. Ultimately, UT is responsible for ensuring it meets the control objectives required by the Board, including the verification of takeout rates. UT failed in this regard.

14

NYRA Takeout-Interim Report

April 26, 2012

UTs procedure is to provide a copy of the configuration report to NYRA Mutuel Management on a daily basis. NYRA Mutuel Management signs off on the report and returns it to UT. However, a UT manager stated that the focus of the configuration report is the Pick 6, which has a rate that can change from day to day depending on if it has a carryover or not. The UT manager stated the other rates are usually reviewed at the beginning at the meet and assumed not to change. Staff reviewed thousands of pages of documents from UT including emails and various operational documents such as checklists and configuration reports. When the Chapter 115 rates were implemented in September 2008 NYRA notified UT of the change and UT provided the configuration report verifying the changes. No similar notification was found when the rates expired. Staff also reviewed a sample of the daily configuration reports from the period approximately 1 week before until 1 week after the Chaper 115 rates expired. Staff also reviewed several days in 2011. In total staff reviewed configuration reports for 34 live NYRA racing days. Nearly all of the reports had an indication that the Pick 6 rate was reviewed (circled or checked near the Pick 6 rate). These were presumably marked by the NYRA manager although 25% of the reports were not initialed by NYRA management. Getnick & Getnick LLP Getnick & Getnick LLP (G&G) served as NYRAs court appointed monitor during NYRAs deferred prosecution agreement and later as NYRAs integrity counsel until March 2011. Section 206.5 of the Racing Law requires NYRA to comply with all applicable laws and regulations and retain an independent business integrity counsel, who, among other things, will act as an independent source to help ensure the integrity of the franchise corporation, its officers and employees, and its operations. The Board requested that G&G provide specified material that it may have relevant to the takeout issue. Hinshaw & Culbertson LLP (Hinshaw), counsel to G&G, advised the Board that it wanted to comply but NYRA has instructed G&G to refrain from communicating with the R&WB in response to [the Boards letter], citing attorney-client privilege. NYRA subsequently responded that G&G had a single document that was responsive and that NYRA believed that a contract dispute with G&G spilled over into NYRAs good faith effort to comply with the Boards request. Hinshaw stated that the single document is a 48-page report dated June 13, 2011 from G&G to NYRAs board of directors. The report has 65 attached exhibits. The Boards General Counsel independently verified that what NYRA asserted was the only responsive excerpt of the report offered no probative value to the investigation. Nevertheless, due to the legal privilege, G&G has not submitted the document it claimed is responsive to the Boards request. NYRAs current integrity counsel was to obtain verification from Hinshaw that the referenced report is the only responsive document. This remains an open question. 15

NYRA Takeout-Interim Report Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C.

April 26, 2012

Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C. (Morvillo) has served as NYRAs integrity counsel since June 2011. The Board requested that Morvillo specify material that it may have relevant to the takeout issue. Morvillo responded that it had several documents responsive to the request but could not be disclosed due to attorney-client privilege. It is the Boards understanding that Morvillo has undertaken an investigation into the takeout matter. To date, the Board has not received the report of this investigation. Pursuant to conversation between Board counsel and Mr. Sack, as of March 19, 2012, the investigation had not been completed but a preliminary report had been made to the NYRA Board of Directors Oversight Committee. As stated previously, Jonathan Sack, the Morvillo partner, spoke at the February 14, 2012 meeting of the FOB. During the meeting Sack made two statements about Morvillos review of the matter. The following are taken from the FOBs draft transcription of the meeting:
SACK>>AT THE REQUEST OF THE SPECIAL OVERSIGHT COMMITTEE OF THE BOARD OF NYRA, I INTERVIEW QUITE A FEW PEOPLE AND HAVE REVIEWED DOCUMENTS, THERE MAYBE BE SOME ADDITIONAL DOCUMENTS TO REVIEW AND PEOPLE TO TALK TO BUT I HAVE DONE QUITE A BIT OF WORK AND I SAW NO INDICATION OF INTENTINAL [SIC] WRONGDOING. WHICH I THINK IS VERY, AT LEAST CLEARLY INDICATED BY THE FACT THAT NYRA CORRECTLY PUBLISH IT'S TAKEOUT RATES. THEY WERE INCORRECTLY, IN THE CASE OF EXOTIC WAGES, THEY WERE 1% TOO HIGH, BUT IT PROVIDED CORRECT INFORMATION, AND IF ANYTHING INDICATED THAT THEY WERE 1 PERCENT ABOVE WHAT THE LAW WAS. SO, WHILE THAT'S NOT DEFINATIVE, IT 'S CERTAINLY HIGHLY SUGGESTIVE EVIDENCE THAT NO ONE WAS TRYING TO DECEIVE ANYONE AND NOONE [SIC] WAS INTENTIANLLY [SIC] TRYING TO IMPOSE A HIGHER TAKEOUT RATE. AND THAT'S WHAT MY REVIEW HAS SHOWN TOO. And, SACK>>WHAT I WOULD JUST ADD FROM MY REVIEW IS THAT IT DOES NOT APPEAR THAT ANYONE SAW THE MISTAKE AND PERPETUATED IT. SO WHAT IT INDICATES IS QUITE A NUMBER OF PEOPLE WHO WERE IN A POSITION TO SEE THE MISTAKE DID'T IDENTIFY IT IN REPORT. I WAS GOING TO ADD ONE OTHER THING THAT IS THE RACING AND WAGERING BOARD HAS REQUESTED MATERIAL, AS FOR AS I KNOW, FROM NYRA'S INDEPENDENT ACCOUNTANT, SO I THINK THE ISSUE WILL VETTED IN THAT MANNER.

Office of State Comptroller Pursuant to Section 209 of the Racing Law the New York State Office of the State Comptroller (OSC) is the primary governmental agency responsible for auditing NYRA. OSC has broad audit authority to examine NYRAs receipts, disbursements, contracts, leases, investments and any other matters relating to its financial operations including the calculation of the franchise fee. OSC is required to report the results to the Governor, Legislature, Attorney General, FOB and the Board. OSC issued NYRA audit report Financial Condition and Selected Governance Activities (Report 2009-S-89) on July 12, 2010. The report found that NYRA was in dire financial 16

NYRA Takeout-Interim Report

April 26, 2012

condition. The audit included a review of NYRAs handle and revenue, books and records, NYRA internal cash flow summaries and operating budgets. Takeout is instrumental in the compilation of these documents. Subsequent to the issuance of the report, OSC initiated an ongoing audit to provide ongoing, real-time monitoring of NYRAs fiscal condition and operating practices. According to OSCs first interim report (Report 2010-S-54) dated August 31, 2010 OSC began monitoring weekly cash flow projections detailing available cash and projected revenues and expenses for several weeks forward. OSC compared projected revenues for August and September 2010 (the month Chapter 115 expired) and verified the major assumptions supporting the projections are unchanged and continue to be applied consistently and accurately. OSC concluded that NYRAs cash flow projections continue to be prepared accurately, based on valid assumptions that have been consistently applied and updated on a timely basis. There was no mention if OSC had reviewed the takeout rates or if NYRA budgeted revenue based on the inappropriate exotic takeout rate. OSC issued its third interim report (Report 2011-F-16) on NYRA on January 24, 2012. The report noted that OSCs audit of the NYSTBDF found that NYRA had been underpaying its bettors by 1%. It also noted that the Board was requiring NYRA to pay back bettors which would result in a lower profit in 2012. The report did not indicate if OSC had ever reviewed the takeouts (in the previous audits) or if NYRA made any adjustments to its future cash flows accounting for the lower takeouts approved in December 2011. Other than OSCs initial inquiry during its NYSTBDF audit, the Board was never contacted by OSC about this issue. It is clear that OSC reviewed NYRAs detailed financial records, including future cash flow projections around the time Chapter 115 expired but the Board has not examined OSCs work papers to determine if OSC had reviewed the takeout rates. Franchise Oversight Board Pursuant to Section 212 of the Racing Law the Franchise Oversight Boards (FOB) duties and responsibilities include: Monitor and enforce compliance with the franchise agreement; Review and make recommendations concerning NYRAs budgets; Review and make recommendations concerning NYRAs revenues and financial plan; Review and make recommendations concerning NYRAs accounting and internal controls; Determine and enforce compliance with terms of the Racing Law. Section 212 of the Racing Law also states that the FOBs duties do not reduce, diminish or impede the Boards general authority granted by the Racing Law. The FOB has five part-time members serving without compensation. The FOB has no full time staff but has a Division of Budget employee serving as its secretary. As a practical matter 17

NYRA Takeout-Interim Report

April 26, 2012

the FOB operates as a global overseer with a limited budget that relies heavily on NYRAs representations, supported by NYRAs employees, consultants and auditors. Realistically, with its limited resources, the FOB was in no position to review or enforce compliance with the detailed takeout provisions of Chapter 115.

New York State Racing & Wagering Board The Board was directed to investigate all parties relevant to this issue, including itself. The Board has done so and acknowledges that any internal investigation may create a perception of bias. While the Board has taken steps to mitigate any bias and present only the facts, the Board welcomes any third party review of its findings. It is standard procedure for the Board to thoroughly review any Racing Law legislation. The Board provides an annual report containing a summary of legislation. The Boards 2008 Annual Report summarized Chapter 115 stating, in part, this Chapter also amended (for 2 years) the takeout rates applicable to wagers placed on races conducted by [NYRA]. Annually, the Board reviews the complete volume of the Racing Law for provisions that may sunset. The Board summarizes those provisions that may require an extender. Many of these provisions have been in existence for years. For instance, telephone and account wagering has been set to expire on a periodic basis (almost annually) since its inception. Any law that is extended is summarized in the aforementioned annual report. (Historically, the Board has not publically reported legislation that has expired.) The Board performed this review in 2010 but did not identify the relevant NYRA takeout section as expiring. However, it was not standard practice to identify expiring provisions of law when revering sections were in place. The Board detects compliance with the statutes through various means including audits and review of documents filed by regulated entities. Prior to this incident, the Board only verified statutory takeouts when regulated entities notified the Board of a software change in the totalisator system or a change in the takeout rates have been requested. Rates were verified through totalisator tests conducted in conjunction with the Department of Taxation and Finance (Tax) or through review of the configuration reports. A review of the Boards files (and Tax) showed that NYRAs totalisator vendor provided a configuration report in September 2008 when Chapter 115 went into effect. The review found that no totalisator tests were performed after that date. The review also found no evidence that the Board verified NYRAs actual takeout rates with statute after September 2008. As noted previously in the report the Board has been proactive with promulgating totalisator rules including the requirement for a specific audit that was to include verification of takeout rates. The Board has relied on these audits to ensure the takeout was correct. The reports are reviewed in depth on an annual basis by the Board. Simply put, the Board thought that takeout was being verified with statute, as required. This report previously documented the audit failures relating to those audits.

18

NYRA Takeout-Interim Report

April 26, 2012

The Board annually reviews certain wagering information provided by regulated entities. The Board performs limited procedures to check for reasonableness. The information is published in the Boards annual report. The Boards specific procedure for takeout is to verify the total takeout percentage (takeout by pool is not submitted) is reasonable based on total handle (known as the blended takeout rate). Actual takeout rates are not calculated nor verified with statute. Even if the Board had realized that Chapter 115 had expired, the 1% additional takeout rate for exotics in three months in 2010 would not have affected the blended takeout rate significantly enough to warrant notice (the 2011 reports were filed after the incident became known). In fact, the Board found that NYRAs initial 2010 reports had blended takeout rates for Saratoga and Belmont that were too low; 14% and 17% respectively. The error was due to NYRA not including takeout from some account wagering on the form and subsequently filed a revised form. As NYRA has publically pointed out it has filed dozens of its simulcast contracts listing the expired exotic takeout rate with the Board. The Interstate Horse Racing Act (IHRA) and the Racing Law requires Board approval of such agreements. However, the Boards review process of simulcast contracts does not include verification of takeout rates with statute. The Board reviews the contract for compliance with the IHRA and to ensure the contracts contain certain necessary clauses or requirements required by Board Rules or conditions of approval. The approval of the contracts is conditioned on compliance with the Racing Law, which includes takeout provisions. After the incident became public it was alleged that the someone emailed the Board on January 8, 2011 notifying the Board that the Chapter 115 rates had expired. The Board performed an exhaustive search of its email system searching for such an email. Nothing was found. The Board does provide an email address for the public to use for contact. However, if the Boards system identifies the email as potentially carrying a virus or being spam the email is not viewed and it is permanently deleted after two weeks. The Board has received no supportive evidence that such email was sent to or received by the Board. As a result of this issue the Board has implemented the following changes: The Board will include in its annual report a summary of statutes or provisions that have expired or reverted; The Board will annually review the qualifications of auditors performing SSAE 16 audits; The Board will require all racetracks to submit takeout configuration reports on a periodic basis and the Board will verify the takeouts with the Racing Law; The Board will require racetracks to publish the their takeout rates with a web link to the current statutory takeout sections of law;

19