In an opinion that could impact revenue-raising proposals from a number of states, the U.S. Justice Department has ruled that long-term leases of state lotteries would violate federal law.

The ruling comes in response to a request by Indiana and New Jersey, two of a handful of states that have floated the idea of privatizing their lotteries to generate large, up-front cash payments.

Officials in Illinois, California, Vermont, Puerto Rico, Texas, and New York have also expressed interest in long-term leases of their lotteries in order to fund projects ranging from capital projects to education. No state has yet inked a deal.

The 13-page opinion issued Oct. 16. can be found at www.usdoj.gov/olc/2008/state-conducted-lotteries101608.pdf. It said a state must “exercise actual control over all significant business decisions made by the lottery enterprise” in order to comply with the federal lottery statute exemption.

Federal law currently prohibits the promotion and advertising of lotteries in interstate commerce with an exemption for those that are operated by a state. In addition to maintaining control over business decisions, a state must retain a majority share in the profits and losses of a lottery, as well as the rights to the trade marks and other essential assets of the state lottery, the ruling stated.

While federal law does allow a state to contract with a private firm to “provide goods and services necessary to enable the state to conduct its lottery, including management services,” such a company cannot receive more than a minimal interest in the profits and losses of a state-run lottery.

The ruling surprised Indiana Gov. Mitch Daniels, who recently has pushed a proposal to lease the Hoosier Lottery to a private operator to fund a college scholarship program. Daniels revived the idea in August after a similar plan he promoted in 2007 failed due to lack of political support. In promoting the plan, Daniels suggested a private company would pay at least $1 billion in up-front cash as well as $200 million a year in payments — the amount that the lottery currently generates in annual profits.

“As one of a number of states considering the possible lease of their lotteries to private operators, we were surprised by the … decision,” Daniels said in a statement released late Friday. “The best legal advice available to us had suggested that the [Office of Legal Counsel] would not interpret federal lottery statutes as preventing the long-term lease of state lotteries.”

Daniels said he would drop the plan and pursue other financing options rather than challenge the opinion in federal court. 

Illinois was one of the first states to float a possible lottery lease after Goldman, Sachs & Co. floated the idea and offered up a valuation study. The governor last year in his fiscal 2008 budget proposed leasing the lottery for at least $10 billion and using its proceeds along with a $16 billion pension bond issue to help bring down the state’s $49 billion unfunded pension liability. Lawmakers rejected the proposal largely due to concerns over how the state would replace the $600 million in annual lottery profits that now goes fund education.

The governor resurrected the idea this year. Under the latest plan, the state would lease the lottery for a 50-to-60-year term to raise at least $10 billion with about $7 billion going to fund new capital program. Any transaction would need approval of the state comptroller and treasurer, and fees for financial firms that work on the deal would be capped.

The state would retain a 20% ownership stake in the lottery using its ongoing annual profits, along with interest from an endowment set up with the remaining $3 billion from the lease payment to provide an ongoing source of funding to replace the lottery profits that now go to education.

Illinois budget officials had not seen the DOJ opinion and did not have an immediate comment.

Meantime, New Jersey Department of Treasury spokesman Tom Vincz said the state’s interest in the federal opinion dates back to 2006 when officials were evaluating all of the state’s assets and how New Jersey could possibly generate additional funds through public-private partnerships.

“Our interests were related to the overall asset study that had been launched a couple of years ago in which the lottery was identified as a candidate for a public-private partnership,” Vincz said. “And this was part of our due diligence, but our interests were not as fervent as other states’ interest were in getting clarity on this.”

He added that because New Jersey’s lottery system already generates significant revenues for the state’s coffers, “there would need to be some extremely compelling proposal that would come from the private operator to improve upon what we are already getting to our general fund from the way New Jersey is running its lottery.”

Elsewhere, New York Gov. David Paterson had been considering a proposal floated by former Gov. Eliot Spitzer to raise $4 billion for a higher education endowment through leasing the state’s lottery.

Yvette Shields, Michelle Kaske, and Ted Phillips contributed to this story.

 

 

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