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State Audit: lottery delis may violate Constitutional ban on casinos

TRIBUNE FILE PHOTO - Gamblers hit the video lottery terminals at one of the establishments at 'Lottery Row,' a strip center filled with lottery retailers in Jantzen Beach in North Portland. The Oregon State Lottery has failed to apply its own regulations designed to enforce the state Constitutional ban on non-tribal casinos, according to a state audit released Thursday.

The Secretary of State’s audit examined the financial records of 18 lottery-oriented cafes — bare-bones establishments modeled after Dotty’s Deli that revolve around six state lottery terminals — and found more than half of them derive the majority of their revenues from gambling. Eight years ago, the Oregon State Lottery Commission adopted administrative rules that deemed an establishment in violation of the Oregon Constitution if it gets more than half its gross revenues from gambling.

A 2000 state audit made similar findings.

The new audit, titled “Oregon State Lottery: Unclear Laws May Let Prohibited Casinos Operate in Oregon,” found that state lottery officials rarely terminate a retailer’s contract for violating the casino rules. And, auditors noted, lottery officials are backing away from enforcing those rules; instead, they’re now judging whether a business is a casino largely by the way it looks.

“It’s just a money machine that they really don’t want to dissect,” said Jeff Geisler, chairman of Hi-Noon, the neighborhood association for Hayden Island in North Portland. Hi-Noon had requested the audit last November due to concerns about crime and vice at “Lottery Row,” a cluster of lottery-oriented retailers in a tiny strip mall in Jantzen Beach. They were supported by House Speaker Tina Kotek, a North Portland Democrat whose district includes Hayden Island.

The state earned $578.6 million in revenue from lottery machines in 2014, money that is dedicated to schools, economic development, parks and other services.

Former Hi-Noon chairman Ron Schmidt said the audit shows that government has a conflict of interest between protecting neighborhoods and earning state revenue from gambling.

“It is clear the enforcement of the laws must be taken away from the same agencies whose goal is to maximize gambling profits,” Schmidt said.

Schmidt was scornful of the Oregon State Lottery’s new approach of evaluating whether one of the lottery-oriented delis is a casino by its outward appearance.

“Exterior ads for food, seating for food, menus for food and the ability to cook food does not make a restaurant,” he said. “It makes for an empty entrance to the gambling casino.”

State auditors suggested that the Oregon State Lottery work with the Oregon Legislature to adopt a legal definition of casino, to clarify compliance with the Oregon Constitution. And, auditors recommended, if retailers can’t comply with the Constitutional ban on non-tribal casinos, they should put fewer lottery terminals in their bars and restaurants.

When Oregon voters authorized the Oregon State Lottery in 1984 via a Constitutional amendment, they expressly barred casinos except for those operated by Native American tribes. A 1994 Oregon Supreme Court ruling decreed that an establishment is a casino when its “dominant use or dominant purpose” is gambling. But those terms have never been explicitly defined.

Jack Roberts, executive director of the Oregon State Lottery, said in response to the audit that he agreed with the recommendation to “develop a more clear and enforceable definition of a casino.”

However, Roberts said it’s too time-consuming and burdensome for lottery officials to be analyzing lottery retailers’ financial records to determine compliance with the state’s casino prohibition. “Going forward,” Roberts wrote in his formal response to the audit, “we hope to rely less upon a strict arithmetical calculation of lottery versus non-lottery income for these establishments and more upon the totality of circumstances indicating whether or not a lottery retailer is operating a “casino” and, beyond that, whether it is operated in accordance with the Oregon Lottery’s standards for a retailer offering our games.”

Lottery officials also cautioned auditors that “fewer gambling machines would reduce funding for schools, parks and economic development,” the audit states.

The casino definition has proved difficult for state officials ever since sales from earlier video poker machines vastly exceeded anyone’s expectations, said Bob Whelan, a senior economist for ECONorthwest in Portland who closely studies the gaming industry.

At one point, the lottery defined a business as a casino if it derived more than two-thirds of its gross revenues from gambling. Over the years, the standard was lowered to 60 percent and then 50 percent.

But economists say judging whether a business is a casino by its gross revenues is ludicrous, because many lottery retailers — just like casinos — sell food, drink and cigarettes at deep discounts to attract gamblers and, in Oregon’s case, to avoid going over the 50 percent threshold.

Of the lottery-oriented cafes audited by the state, cigarettes made up 32 percent to 97 percent of the non-gambling revenues. A former Dotty’s employee said it was common to see other retailers buying multiple cartons of cigarettes and then return to their shops to mark up the prices for resale. Auditors also found some retailers are giving free food to employees and counting those as sales to inflate their non-gambling revenues.

Nevada-based Oregon Restaurant Services pioneered the format of small delis geared to gamblers when it created the Dotty’s chain. Other companies followed suit, creating the Maddy’s, Purple Parrot, Jasper’s and Cooper’s chains. Oregon Restaurant Services helped create Lottery Row by subdividing some of its cafes into two smaller shops, in a blatant effort to site more state lottery terminals.

Auditors defined the lottery-oriented delis as “Limited Menu Retailers,” a sign that food is secondary to the main business of gambling. They found 234 such establishments in Oregon, which generated about 21 percent of state profits from lottery machines in 2014. Each of six state lottery terminals in such establishments averaged $26,111 in returns for the owners in 2014, according to auditors, compared to a $15,230 average for all Oregon lottery retailers.

Whelan said it’s clear that Dotty’s and similar chains are casinos. “They really are making all their money from gambling,” he said.

Nevada law defines what a casino is, Whelan said, and so can Oregon law.

However, he cautioned that it could have unintended impacts. While it’s misleading to determine a business is a casino based on its gross revenues, he said, if the state used the more rigorous definition of where a company’s profits come from, it may be surprised by the results. Many neighborhood bars and taverns across the state make the bulk of their profits from state lottery terminals, he said.

A vast number of Oregonians may not play lottery machines but they enjoy the benefits of cheap beer, cheap tavern food and hundreds of neighborhood bars and restaurants nourished by lottery profits.




Lottery machines plentiful in Oregon

• There are 2,274 retail sites in Oregon hosting a total of 11,911 Oregon State Lottery machines

• Lottery machines generated an average of $727 million a year after paying out prizes the past five years, split between the state and lottery retailers.

• In 2014, machines generated $565 million for the state and $178 million for retailers.

• There are 234 Dotty’s style lottery-oriented delis in Oregon. They operate 1,305 of the machines and generated $158 million in net profits to the state and retailers in 2014

• More than 900 other restaurants host lottery machines in Oregon, including 221 Asian restaurants, 118 pizzerias and 75 in Mexican restaurants.

• State lottery machines are found in 642 bars and taverns in Oregon plus 165 sports bars.

• State lottery machines are found in 125 fraternal organizations, 46 exotic dancing clubs and 55 bowling alleys.

Source: Oregon Secretary of State Audits Division

To read the full audit: sos.oregon.gov/audits/Documents/2015-21.pdf