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NATIONAL AUDIT OFFICE

REPORT BY THE

COMPTROLLER AND

AUDITOR GENERAL

Paymetis to the NationalLottery Distribution Fund

ORDERED BY

THE HOUSE OF COMMONS

TO BE PRINTEO

23 JULY 1996

LONDON:HMSOHC678 Session 1995-96Published30 August1996 E9.85

PAWENTS TO THE NATIONALLOTTERYDISTRIBUTIONFUND

This report has been prepared under Section 6 of the National Audit Act, 1983for presentation to the House of Commons in accordance tith Section 9 of theAct.

John BournComptroUer and Auditor General

National Audit Office23 Jdy 1996

The ComptroUer and Auditor General is the head of the National Audit Officeemploying some 750 staff. He, and the NAO, are tota~y independent ofGovernment,He certifiesthe accouts ofallGovernmentdepartmentsandatide range of other pubhc sector bodies; and he has statutory authority toreport to Parhament on the economy, efficiency and effectiveness with whichdepartments and other bodies have used their resources.

PAWENTS TO THE NATIONALLOTrERYDISTRIBUTIONFUND

Contents

Page

Executive sununary

IntroductionVeriRcation of Distribution Fund paymentsThe Players’ Trust and the prize shorffa~ paymentFrauds and irre@arities

Part 1: Introduction

The statutory frameworkResponsibilities, accountabRities and National AuditOffice access

Study scope

Part2: Lotte~revenues and Distflution Fund income

IntroductionTicket sales revenues

The target prize totalThe Distribution Fund

Other Distribution Fund incomeAnciRary activity paymentsInvestment eartigs generated by the Escrow AccountInvestment earnings generated by the Players’ Trust

Cash movements

Part 3: VerW1cation of Distribution Fund paymeuts

IntroductionVerification of wee~y ticket sales paymentsVerification of other Distribution Fund payments

Integrity of computer systemsUee of chec~stsResufts of Nationaf Audit Office examination

1

1245

7

78

10

14

141414161616171718

21

212123232936

PAWENTS TO THE NATIONALLO~ERY DISTRIBUTIONF~D

Part 4 The Players’ fiust ad the prize shortfti payment

IntroductionThe Players’ TrustPrize shortfall

SecurityThe Players’ TrustPrize shortfafl

Cash flowThe Players’ TrustPrize shortfaH

Part 5: Frauds, hre@tities and risks to the &strfiution fund

IntroductionInstitutional frameworkVtinertifity to fraud

41

414142454546474750

51

515152

1: Distribution Fund income 58

PAWENTS TO THE NATIONM LOTrERY DISTRIBUTIONFUND

Executive summary

Introduction

1 The National Audit Officehave examined the Director General of the NationalLottery’s (the “Director GeneraY) arrangements for satis~lng hlmse~ that aUlottery proceeds due to the National Lottery Distribution Fund (the “DistributionFund) are paid by the due dates, In doing this it was necessary to considervarious payments made between the lottery operators, Camelot Group plc~Camelot”), the Distribution Fund and a “Players’ Trust” which protectsplayers’ prize money and advanced sales payments,

2 The key findings arising from the National Audit Office examination are:

a) Vefication of Distribution Fund Payments. Camelot are re@red to payweekly a proportion of the income generated from sales of lottery tickets (the“weeMy ticket sales payment”) to the Secreta~ of State for National Heritage(the “Secretary of State”), for the benefit of the Distribution Fund. Thesepayments account for some 97 per cent of the Distribution Funds income. Inaddition to the weeMy ticket sales payments there are a number of otherpayments which can impact on the Distribution Fund. These tota~ed someE260 mi~on h respect of the year ended 31 March 1996. The National AuditOffice examination estabhshed that aU sums recorded as due to theDistribution Fund had been paid punctually and in fti, although there wasscope for some improvement in the Director Genera~s arrangements for thevefilcation of some of the (relatively) minor payments. The Director Generalhas stice taken action to address the opportunities identified. This issue isdlscusscd in Part 3 of the main body of tiis report.

b) The Players’ fiust and the Prize ShortfaU Payment. The Players’ Trust isdesigned to protect player< money in the event of the financial co~apse ofCamelot. In practice the Trust operates eight separate bank accounts and theNational Audit Ofice examined the way in which these accounts are runand, in particular, the disposition of the interest income they generate. TheNational Audit Ofice examination also addressed the issue of any annualprize shortfaU payment that maybe appropriate. Any such payment iscalcdated to reflect the extent to which the total value of prizes won in ayear fans short of the annual target specified in the Llcence issued underSection 5 of the National Lottery etc Act 1993 (the “Section 5 hcence”), Theseissues are discussed in Part 4 of the main body of this report.

1

PAWENTS TO THE NATIONM LO~ERY DISTRIBUTIONFUND

c) Frauds and Irre@arities. The National Audit Oilice sought to draw oninternational experience in an attempt to assess the vtierabihty of theUnited Kngdom National Lottery to fraud and other irre@arities. The keymessage emerging from this work was that lotteries using basicaUy the same

e@Pmentand systems as those in the United Kngdom have been inoperation for many years in many countries and have proved resistant tosignificant fraud. Further, untike most countries, in the United ~gdom theimpact of fraud is, in most cases, borne by the operator, ie Camelot. Thereare, however, two types of fraud, the frauddent cance~ation of tickets for theon fine game and the misappropriation of unclaimed prizes, which coufdimpact on the Distribution Fund. The Director General has recognised thesepossibihties, however, and has taken action to forestaU them. This issue isdiscussed in Part 5 of the main body of this report.

3 Because the relevant legislation does not give the National Audit Officerights ofaccess to a public limited company such as Camelot, or to the Players’ Trust,this report is based principally on an examination, undertaken in the Autumn of1995, of the work of the Director General and KISstaff, and of documents heldhy them. The National Audit Office asked Camelot for access to their records,hut they dectined. The National Audit Office were able to see those Camelotpapers held by the Director General, however, and Camelot were given anopportunity to comment on the draft report. Their comments are noted whereappropriate.

Verification of Distrhution Fund pa~ents

4 The National Audit Officefound that the payments recorded as due to theDistribution Fund had been made punctua~y and in ti. In the National AuditOffice’sview, however, there was scope for some improvements in the DirectorGenera~s arrangements for the verification of some of those payments (seeparaqaph 8) and in the work done to satisfy himself on the integri~ ofCamelot’s underlying computer systems (see paragraph 7).

5 The weetiy payments made by Camelot out of ticket sales revenue, tota~ng

11,402mihonin theyearended31March1996,accouted forsome97 per cent of the Distribution Fund’s income. The Director General obtainsdaily a copy of a tape from Camelot, on which are recorded au transactionsmade by retailers, processes Wls tape independently using hls own securecomputer insta~ation and draws on the information so generated to veri&Camelot’s weekly ticket sales payment, The Director General rehes on hls ownindependent reconcihation of the totals on the daily &ansaction tapes toCamelot’s bank account to gain an assurance that the tapes have not beentampered with prior to receipt hy him. Provided they have not, then this processenables hlm to verify the weekly ticket sales payment.


6 In addition to the wee~y ticket sales payments there are a number of otherpaymenti which can impact on the Distribution Fund. Nthough dwarfed by theticket sales payment, these are nevertheless si~ificant in absolute terms. Theyinclude:

. a payment e~al to the value of any shortfa~ between the annual target prizetotal specified in the Section 5 Llcence and the actual prize habih~ generatedin that year (El 35 mi~on in respect of 1995/96);

. unclaimed prizes, that is prizes which are not claimed by those who wonthem (S34 milhon in respect of 1995/96);

. payments made into an Escrow Account, the balance on which reverts to theDistribution Fund on termination of the Ecence (f90 miMon in respect of1995/96); and

. interest income generated by the Players’ Trust and the Escrow Account(S3 miltion in respect of 1995/96),

In assessing the work done by the Director General to verify these payments,the National Audit Office considered, among other things, the work heundertook to satisfy himsek on the integri~ of the Camelot computer andcommunications systems which provide hlm with some of the information onwhtch he rehes.

7 The National Audit Office confirm that, in addition to the risk assessment workand security evaluations done as part of the process of selecting the NationalLottery operator, the Director General received and considered appropriateprofessional advice and drew upon a substantial body of evidence relating to theintegrity of Camelot’s computer systems before approting hve running of thosesystems, but suggest that the ongoing rehance on tbe systems would be betterinformed if additional work was done in specific areas, The Director Generaltold the National Audit Office that undertaking the additional work identified bythem before launch wotid have been time consuming, and he had to balancethe risk of Eve running against the loss to the Distribution Fund restiting fromdelay to the launch of the lottery. The National Audit Office acknowledge thereasons for the Director Genera~s decision not to insist on more extensivepre-lamch testing before approving Eve running of the computer systems, butobsemed that additional work cmdd also have been undertaken after launch,The Director General is considering the benefits of the additional worksuggested, taking account of the assurance he had about the systems beforelaunch; subse~ent experience of the systems’ performance; and his continuingcontrol of changes. The key areas in which the National Audit Office considerextra work could be beneficial are in the determination of security standards, insystem testing and in reviewing computer code.

3

8 The key point emerging from the National Audit Office’sdetafled examination ofthe verification work undertaken by the Director General on the “otherpayments” referred to in para~aph 6 above, was that aUthe cash movementsexamined had been made punctuaUy and in fuU. In sti cases, however, theverification work undertaken by the Director General was not ftiy independentof tiformatimr supplied by Camelot. The two most material examples were:

. Camelot is reimbursed daily from the Players’ Trust, for au prize paymentcheques clearing its relevant bank account in that day. Thesereimbursements typica~y total S1O mi~rm to f 15 mi~mr a week. TheDirector General did not test directly that only vahd pfize payment che~eswere paid from this account.

. The Director General did not verify independently the value of advancedsales income surrendered hy Camelot to the Players’ Trust. ~icaUy tils wi~exceed f5 milhmr a week.

The Director General has since taken action to address the sk issues raised bythe National Audit Office.

The Players’ Trust and the prize shortfa~ pa~ent

9 The National Audit Office considered a number of points that arise out of theway in which the Players’ Trustis constituted:

. Sectity. The Director General has a statutory duty to protect players h theNational Lottery. The Players’ Trust is desi~ed to protect players’ money in theevent of the bacial co~apse of Camelot. It does not protide the sameprotection to the money due to the Distribution Fund. The Director General toldthe National Audit Officethat this was because to do so wmdd be inappropriateand contrq to the pohcy that money owed to the Government shotid odyexceptiondy rank ahead of other creditors in the event of insolvency.

. Cmh Ffow. As offered in Camelot’s successti apphcation to run the lottery,

Mterestgeneratedonpfizemoneyptid hto theTrustaccruestotheDlstrfiutionFund, There are, however, other sources of interest income tising born theoperation of tie Trust the disposition of which is not specfied in their

aPP~cation. and wfich ~ practice revert to Camelot. In addition, for tec~cdreasons, the total value of prizes won in a year is Wely to fa~ short of the annualtarget specified in the Section 5 hcence. This shotiti is csdctiated annuaUy and,uless othetise d~ected by the Director General, ptid to the Distiution Fund.In the fiterim the accumtiadng SW, S135 rniOionin the year to31 Mwch 1996, is m integral part of Camelot’s balances.

4

PA~ENTS TO THE NATIONM LOTrERYDISTRIB~ION FUND

10 The Director General told the National Audit Office that he dld not seek toimprove on Camelot’s successfd appEcation to run the National Lottery. Hestated that this was because any negotiations on elements such as thedisposition of interest income, for example, wmdd have led to the reopening ofother parts of their apphcation, possibly leading to legal cha~enge by other

applicants and delay to the launch of the National Lottery.

11 As to the prize shortfall arrangements, the Director General is reviewing thesebecause they are not working as expected. He has pointed out, however, that itis desirable that any revised arrangements shotid provide Camelot with theincentive to act as required. He said that if they agreed to pay interest on theprize shortfa~ to the Distribution Fund, they wmdd be given a greater incentiveto meet the prize payment target by paying more money to players, which mayprovide a worse overal restit for the Distribution Fund than simply receivingthe shortfaU. Camelot told the National Audit Office that the offer contained intheir apphcation for a Section 5 Hccncc was constructed to arrive at a balance ofadvantage between themselves and the Distribution Fund and if one componentwas changed, they would feel justified in opening other issues from which theDistribution Fund benefits,

12 The National Audit Office on the other hand note that the prize shortfaUpayment reflects the extent to which Camelot has faUen short of its Section 5Ecence target to pay a specified level of prizes. The Invitation to Apply, however,made it clear that apphcants’ Business Plans shmdd be consistent with tbetarget prize totals specified in their application,

Frauds and irregdarities

13 As part of its review, the National Audit Office afso sought to consider potentialrisks to the Distribution Fund income of possible frauds and irregdarities,drawing on experience gained tiom visiting overseas lotteries. The keymessages emerging from this work were that

. unhke most other lottery jurisdictions visited, most of which have state mlotteries, in the United Mngdom the impact of any fraud generaUy faHs on theprivate sector operator, Camelot, rather than the Distribution Fund;

. lotteries using basica~y the same equipment and systems as those in theUnited Kngdom have been operating for many years in many comtries.Experience has shown them to be robust and resistant to significant fraud.

5

PAWENTS TO THE NATIONALLO~ERY DISTRIBUTIONFUND

14 There are however two areas in which losses from frauds experienced in someoverseas lotteries codd, if repeated here, impact on the Distribution Fund:

.

.

Frauddent cmce~ation of tickets for the on he game. It is possfile for aretailer to cancel any ticket and retain the stake money, so depressingapparent sales.

Misappropriation of unclaimed Drizes, Were a claimant to obtain afl therelevant information on an authentic winning ticket, in some lotteryjurisdictions it wotid be possible to forge a ticket that wotdd satisfy the basicchecks designed to detect fraudtient claims.

15 The Director General bas told the National Audit Office that there have beenisolated instances of the first type of fraud in the United ~gdom, he is keepingthe matter under continuous review, and has approved recent changes to thecance~ation procedure which have made it less hkely that players ti fti todetect a fraudukmt cance~ation. Regarding the issue of misappropriation ofunclaimed National Lottery prizes, however, to minimise this risk in theUnited Mngdom the Director General bas approved additional independentchecks on selected tickets to estabhsh that the ticket was gemdnely printed atthe proper time, and on the terminal on which the winning wager was placed.Camelot have stated that they have procedures to safeguard against both ~esof fraud described shove. The National Audit Office have reviewed the writtendescriptions of the procedures available within the Director Genera~s officewhich detail the procedures concerned, hut have not been able to test theiroperation directly.

6

PA~ENTS TO THE NATIONALLOTTERYDISTRIBUTIONFUNO

Part 1: Introduction

The statutory framework

1.1 The National Lottery etc. Act 1993 ~the Act”) provides the statutory frameworkfor the United Kngdom National LotteW. Section 3 of the Act creates the officeof Director General of the National Lotte~ ~the Director Genera~) whileSection 4 charges the Director General with a duty to exercise his functionsonder the Act in the manner he considers most hkely to secure:

● that the lottery is run with aU due proprie@

. that the interests of every participant in the lottery are protected; and

● subject to the above, to maximise the net proceeds from the lotte~ paid tothe Secreta~ of State for National Heritage.

These proceeds are paid in turn to the National Lottery Distribution Fund ~theDistribution Fund”), dtimately for dlstributimr to the “Good Causes” specified inPart II of the Act.

1.2 The Director General heads the Office of the National Lottery which is anon-ministerial Government Department employing some 30 staff. Throughoutthis report aUreferences to the Director General shmdd be read as referfigeither to him persona~y, or to members of bis staff, as appropriate.

1.3 Section 5 of the Act provides for the Director General to hcense a bodycorporate to run the National Lottery and Section 6 empowers him to hcense abody (or bodies) corporate to promote lotteries as part of tbe National Lottery.The Act makes clear that the Director General is not himse~ appointed to runthe National Lottery, or to promote individual lotteries forming part of it, but heis appointed to grant hcences and to ensure comphance with those Ecences. TheDirector Genera~s statutory powers, including those relating to the grant andrevocation of hcences, imply a duty to monitor and regulate the National Lotteryin accordance with the objectives set out in the Act.

1.4 The Director Genera~s evaluation of apphcations leadlng to the award of theSection 5 Hcence to Camelot Group plc ~Camelot”) was the subject of a NationalAudit Office report pfihshed on 7 Jtiy 1995, “Evaluating the Apphcations torun the National Lottery”, HC569 Session 1994-95. This report foUows on fromthat work by examining how the Director General ensures that au lotteryproceeds due to the Distribution Fund, currently over El bi~on a year, are paidpunctna~y and in fd.

7

PA~ENTSTOTHENATIONALLO~ERYDISTRIBWIONFUND

1.5

1.6

Responsibilities, accountabfities and NationalAudit Office access

The scope of the work which the National Audit Officewere able to wdertake inexamining this subject was determined in accordance with tbe relevantlegislation. The National Lottery etc. Act 1993 provided for a private sectorcompany to run the lottery and the National Audit Office have no rights ofaccess to such companies under the legislation governing their work. Thevarious bodies involved in the lottery and the accountabihty framework titilnwhich they operate are described in paragraph 1.6 and Figure 1 opposite.

In addition to the Director General and the operator, Camelot, the other mainparties with responsibilities for the National Lottery are as fo~ows:

The Secretary of State for National Heritage is responsible for aUpohcymatters regarding the National Lottery, including making Re@ations andissuing Directions to the Director General deahng in particdar tith mattersthat the latter shodd take into account h deciding whether or not to granthcences and with the conditions that ficences shmdd contain. The DirectorGeneral reports annua~y to the Secretary of State, who lays hls report beforeParhament.

The Permanent Secretary of the Department of National Heritage is theAccounting Oticer for the Distribution Fund and is responsible for satisfyinghimself that five of the eleven Lottery distributing bodies meet theirresponsibihties to the Secretary of State.

The Accounting Officers for the Home Country Departments areresponsible for satisfying themselves that six of the eleven Lotterydistributing bodies meet their responsibihties to the relevant Secretary ofState.

Disttiuting Bodies are responsible for the distribution of lottery proceedsto the Good Causes. Each is headed by its own accounting officer titb

ministerialresponsiblhtybornebytbe relevantSecretaryofState.

Beneficiaries are the dtimate recipients of grants made from lotteryrevenues, Some of these are pubhc bodies to which the ComptroHer andAuditor General has right of access under existing arrangements, but themajority are private and charitable bodies to which the ComptroUer andAuditor General does not have automatic access. However, underarrangements agreed with the distributing bodies most lottery grants, otherthan the smallest, are offered subject to conditions that afford theComptroUer and Auditor General access to the recipient’s records to a~owhim to check the use made of the grant, although this is not universal.

It fo~ows from the statutory framework that the Distilbution Fmd itse~ is not

the responsibility of the Director General, nor does he have any involvementwith the disbursement of funds from the Distribution Fund to the Good Causes.

8

PA~ENTS TO THE NATIONALLO~ERY DISTRIBUTIONFUND

Figure .1: National lottery”- aceounlabilily; accesi.andlbltery cash’movernents’, ”

In total, 13 different accounting officers bear responsibility for the collection and disbursement of lottery funds, although many cashmovements do not involve pubflc sector bodies . . .

SecretaryofSlateforNational Heritage

&

Keys

-~ ,Cco,nting,ficera, ~ Direct accountability

Q R~~~&~~r~~~~~~~~Chth’ Comptro]’erand+ Reg”l~ryandmonitoring

respo sibihty only

-~ Private Sector Bodies to which the Comptroller and Audit General ,,.. ~...does not hsve acceas.

.._-> Lottery cash movements

~ Beneficiafie$. Some Beneficiatiesare publicsectorbodieawhile others are not. The question ofwhethertheComptroller and Auditor General has a right of access to those bodies depends on a variety of factors, includingwhether the distribution body concerned made such access a condition of ita grant in the first place.

Note: ‘f. There are 11 distribution bodies in total. The other six are responsible to the Home Country Depatiments

9


1.7

1.8

1.9

1.10

1.11

men considering how the Director General satisfies timse~ that the proceedsdue to the Distribution Fund have been paid iu fti and by the due dates, it isnecessary to consider various payments made be~een Camelot, theDistribution Fund and the Players’ fiust, which maintains secmity over ptizemoney and advance sales payments on hehaf of players. In due couse it wi~also be necessary to consider an Escrow Accouut tiom which a payment to theDistribution Fund wifl be due on termination of the Section 5 hcence. Wile theNational Audit Office have the power mder the relevant legislation to examineand report upon the economy, efficiency and effectiveness tith which theDirector General discharges his statutory fmctions, as explained in para~aph1.5, they have no rights of access to a pubhc fimited company such as Camelot,or to the Players’ Tmst.

In their 19th Report of Session 1994/95, the Committee of Pubhc Accomtsrecommended that the Department of National Heritage and the DirectorGeneral should make arrangements to provide the ComptroUer and AuditorGeneral with access to Camelot records relating to financial contiol of lotteryactivities. However, the Government rejected this recommendation in afieaswy Minute dated 4 October 1995, pointing to the access the DtiectorGeneral had to Camelot, and the Comp&oUer and Auditor Genera~s rights ofaccess in tmn to documents and records held by the Director General - seeFi~e 2 opposite.

rhe National Audit Office contacted Camelot in November 1995, to seek accessto their records, hut Camelot dechned tils re~est. They added that they weresubject to close”regulation hy the Director General and that any queries theNational Audit Office might have relating to the National Lotte~ and Camelot’spafi in it wodd be properly addressed to the Director General. Camelot alsoadded that they take great care to ensue they are very open iu theh repotingand follow aUthe best practices as recommended by the Cadbmy andGreenb~ Committees, although as a non quoted company they are not ohhgedto do SO.

This report is therefore based primarily on an examination, uudetiaken in theAutun of 1995, of the work of the Director General and his staff and

documentsheldbythem,includingdescriptionsofCamelot’sprocedwes.TheNational Audit Officehave not mdetiaken any examination within eitherCamelot or the Players’ Trust. Appropriate comments have been made h thetext where this limitation has impacted on the work undertaken.

Study scope

Some of the Director Genera~s re~atory responsibfities go beyond p~elyfinancial considerations. Mile th~ work-the Director Gen~ral &dertakes toconfmm the payment of sms due to the Distribution Fuod started immediatelyon the lauuch of the National Lotte~, work on the development of some of thecomphance programmed addressing other areas was sti~ in hand when tilsstudy was undetiaken.

10


The Committee of Pubfic Accounts recommended that the National Audit Office should have accesa to Camelofs financial records. TMs

recommendation was not accepted, however...

Committee of PubtiiAccmrnts Recommendation

In their 19th Repofl of Seaaion 1994-95 (paragraph 4) the Committee of Pubhc Accounts stated:

(Wii) “We are glad to note that the Natiorra/Audit Office have access to the records held by the Director Genem/ of the National Lotfe~ which

relate to his monitoring of the activities of the National Lottery operato( Camelot. These arrangements do not enable the National Audit

Ofice to provide Parliament with full and indeperrdentasarrrancea that all National Loffev income has been collected andaccourrted for

since the Comptro//erarrd Auditor General has no right of direct acceas to the books and records of Camelot. ”

(wiii) “We therefore recommend that the Depaflment (of National Heritage) and the DirectorGeneral of the National Lotferymake arrangements

to provide the Comptroller and Auditor Geneml with acceaa to Camelot records relating to financial control of lottery activities including

those relating to, and maintained at, retail mrtleta. ”

Treaaury Response

The TreasuW Mnute dated 4 October 1995, paragraph 38, (Cm 2990) stated:

“The Depaflment agrees with the Committee about the impotiance of the Comptro//erandAuditm General having access to the records

held by the Director General of the National Loftey Howevec the Depatiment does not agree that this is insufficient to enable the National

Audit Office to provide Parliament with an independent assurance in respect of the collection ofandaccomrting for National Lottery

income. The National Loffe~ etc Act lays down a atatuto~ framework that requires the Director General to ensure that the National

Lottery is run with all due proprie& that the interest ofparficipants areprotectedand that, subject to these, the National Lottery

m%imises the revenues to the Good Cauaes specified in the Act. The Iicence gmrrted to Camelot Group plc, the operator of the National

Lottery mrdersoction 5 of the Act, allows the Oirectorto call for such information and records as he considers necessary to allow him to

meet his statutory obligations and ensure that Camelot Group PICmeets its Iicence commitments. The Ohector Genersl has the power to

revoke Iicences if they are not comp6ed with. Camelo?s Iicence commitments include the payment to the Secretav of State of the monies

due to Good Causes andararrrgements foraccourrfirrg for those monies. The Oirector Geneml thus has the necesaavpowers to ensure

that the National Lottery is pmper~ run andaccmmted fo~ Under the powers granted by the National AuditAct f983, the Comptmllerand

Auditor Geneml will have access to the documents and records held by the O/rector Genera/and will be able irrdependent~toinvestigatethe Director GeneraPs exercise of his powers so as to assure Parliament in relation to the controls over the collection of and accounting

for Nationa/ Lotferyrevenue, and, general~ in relation to the Oirector Genera~s performance of his licensing and regulatory duties.

Further the income of the National Lottery is sales turnover in the books of the Camelot Group plc, which is a private sector company and

not a public body as defined in sections 6 and 7 of the Natiorra/Audit Act f 983. The Department therefore does not feel that it is

appropriate or neceasaw to e~end these arrangements to provide the Comptroller and Auditor Genersi with access to Came/o?s records. ”

1.12 In fact, building upon work undertaken initially by external consultants, theDirector Genera~s operational comphance team has finahsed a matrix in whicheve~ condition in the hcences and other relevant documentation is crossreferenced to a comphance work programme. The matrti identified arequirement for 21 such work progcammes which together wiU address,amongst other things, aUthe 36 conditions and 11 schedufes of the Section 5hcence. The Director General entisages that the majority of these programmedshotid be executed either quafierly or monthly, with a few more frequently thanthat, and three once per year. A snapshot showing the state of development ofthe total compliance work programme, at the time of the National Audit Office

11

PA~ENTSTOTHENATIONMLO~ERYDISTRIBUTIONFUND

fieldwork in Autumn 1995, is @ven in Figure 3 below. It shodd be noted,however, that the Director General has sought to confirm aU cash movementsdue to the Distribution Fund since the launch of the lottery.

....—eT. ,

!’m9ife3:oPeratinnalcornPiianceworkPwamm:s: ii;we&-~”m1995 ‘:’ ~ “ ‘:.,~~ ‘: ““ :1,...

As at 31 October 1995 much work had been done on the development of the comphance pmgramme, but this work waa not complete . . .

Progrsmme Topic Effective DatesDraff1

A. Retail Head Dffice Dperafions 4/95

B. Visits to Retailers Z95

C. Payments to Secretav of SWte etc 8/95

D, Verification of Salea Combined with A

E, Instant tickets 6/95E Mail subscriptions 8/95G. Regional office operations 9/95

H. Marketing 8/95

1. Advertising Combined with H

J. Management information 7/95

K. Protection of prize winners intereata 9/95L. Security arrangements 6/95

M. Change control procedures 6/95

N. IT SecurityO. Purchasing/contractors/creditors 7/95

P Internal Audit 7/95

Q. Yearend procedures 5/95

R. Oraw procedures 9/95

S. Protection of playera interests 9/95T. Ancillary activi~ 7/95

U. Warehouse Operations 8/95

Source: Information supplied by the Director General.

Draff 2

9/95

3/95

9/95

10/95

9/95

9/95

8/95

9/95

Proposed Programme

Frequency *1

QuatierlyM Annually

Weekly

Quarterly

Monthly

AnnuallyN Annually

N Annually

W Annually

Monthly

Quarterly

MonthlyMonthly

N Annually

MonthlyAnnually

Annually

N Annually

N Annually

Quarterly

N Annually

Dale ProgrammeHrsl Executed’2

21.4.95 and 31.7.95

‘3

10.8.95

26.10.95

20.10.95

31.3.95

31.7.95

31.7.95

7.8.95

10.10.95

Notes: ‘1. Some of the inditidualpmgrammes have sub elements which are intended to be applied less frequentv than the main pmgramme.

The frequency with which allprogrammes are applied is reviewed regulark

‘2, The ‘tiates first executefl quoted are the dates on which the first draffaudit report on that pmgramme topic was produced. As at

3f October 1995 one programme, ie Pmgmmme B: Wsita to Retiilers, had been executed twice.

“3. Much of the workerwisaged under this pmgmmme is on going and is discussed in Part3 of the main report

1.13 Given that work on the comphance programmed was continuing while the termsof reference for this study were being discussed, the National Audit Officedecided that it would be appropriate to restrict its scope to an examination ofthat part of the Director Genera~s comphance arrangements directed atsatisfying himself that all lottery proceeds due to the Distribution Fund werepaid by the due dates. Throughout tils report the term “verification” has beenused in this restricted sense, and the term “comphance” used to refer to thetotatity of the comphance work programmed, as set out in Figure 3.

12


1.14 In addition to this introduction this report contains five further elements.

Part 2: Lottery Revenues and Distribution Fund Income - outhnes theprinciples for the apportionment of Lottery revenues, which are based onCamelot’s apphcation, and explains the various types of paymente due to theDistribution Fund.

Part 3: Vetilcation of Distribution Fund Payments - examines theeffectiveness of the Director Genera~s procedures designed to enable him tobe satisfied that amounts due to the Distribution Fund have been paidpunctua~y and in fti.

Pati 4: The Players’ Trnst and the Prize ShortfaU - discusses a number ofpoints concerning the Players’ Trust and the Prize ShofiaU arrangements.

Part 5: Frands, hre@arities and Risk to the Distrihntion Fnnd -considers potential risks to the Distribution Fund income from possiblefrauds and irre@arities, drawing on experience in selected lotteries inEurope and North America. In doing so it has regard to actions taken by theDirector General to minimise these risks.

Appendix 1- summaries the latest available data on lottery ’revenues andDistribution Fund income, and examines how the apportionment of revenuesbe~een the Exche~er (through Lottery Duw), the Prize Winners, theDistribution Fund and the balance available to Camelot, changes over timeand at different sales volumes.

13

PAWENTS TO THE NATIONM LOTTERYDISTRIBUTIONFUND

2.1

2.2

2.3

2.4

Part 2: Lottery revenues andDistribution Fund income

Introduction

The Director Genera~s imphed statutory duties to re@ate and monitor thelottery are given substance by the 36 conditions md 11 supporting schedties ofthe Section 5 hcence, which incorporates the commitments made by Camelot inits hcence application. It is necessarily a complex document designed to securean unambiguous and legaUywatertight relationship between the DirectorGeneral and the operator, The financial conditions which dictate the a~ocationof lottery revenues are partictiarly detailed. The National Audit Office thereforereviewed the Ucence to provide a framework for this examination of the workdone by the Director General, and has summarised its key financial featuresbelow. In addition the Section 5 hcence confers upon the Director General tideranging powers of access to Camelot’s facihties and data, to help him in thedischarge of his re@atory duties.

Ticket sales revenues

Lottery duty, set at 12 per cent under the Finance Act 1993, is the fwst chargeagainst the proceeds of the National Lottery. The Section 5 ficence re@es thatafter alowance has been made for this duty, the revenue obtained from the saleof National Lottery tickets is to be apportioned initia~y bemeen the Target PrizeTotal and the Distribution Fund. The Ecence then a~ows the operator to retainthe balance of ticket sales revenue out of which it must meet its operating costs,including retailers’ commission, and ultimately derive its profit.

The principles on which the above apportionment is based are outined below.

ThelatestavailabledataonlotteryrevenuesandDlsktiutionFmtdincomearegiven in Appendix 1, together with calcdations shotig how Distribution Fundincome wil change over time and at different sales volumes,

The target prize total

Schedtie 2 to Condition 5 of the Section 5 ticence specfies for each year of thehcence the target percentage of ticket revenues, net of lottery duty, hat is to beearmarked for prizes as the target prize total - see Figure 4 opposite.

14

PA~ENTS TO THE NATIONAL LOTTERY DISTRIBUTION FUND

2.5

2.6

In practice, in any year the actual prizes won wi~ afrnost certaidy differ fromthe target because each individual game forming part of the National Lotteryhas its own prize structure and payout percentage. The operator must,therefore, try to manage the portfofio of games so that the total prize habih~ inthe year meets the target prize total incorporated in the Section 5 Ecence. It isdiffictit in practice, however, to actieve the exact target prize total specified, Todate for example the success of the on tine game, with a 45 per cent target prizepayout percentage, relative to instant games with target prize payoutpercentages averaging 55 per cent, has led to a si~ificant shortfall against thetarget prize total. To the extent tiat the actual prize Eabifi@ in respect of thegames m in the year faUs short of the target prize percentage specified in theficence, Camelot must, unless otherwise agreed by the Director General, pay thedifference to the Distribution Fund on or before 28 July in the followingfiancial year.

Apart from the first (part) year ended 31 March 1995, the Target Ptize Total expressed as a percentage ofticket revenue net of Lotfew Duty stays fairly constant at around 57 per cent...

YearEnding 31 March

19951996

1997

19981999

2000

2001

2002

TargetPrize Total as a parcantaga of

net ffckel revenue

53.6457.56

57.36

56.3656.32

56.71

56.71

56.68

Source: The Section 5 Iicence.

Note: Thepercerrtages in the above table are tiken direct~ from the Section 5/icence. The

Section 5/icence expresses all such numbers on the basis ofsalea net of LotfevDuW The

percentages quoted above are not direct~comparable, therefore, with those in flguresA2and

A3, which are based on gross sales revenue,

In addition, in any lottery there are prizes won which remain unclaimed. Ayprizes not claimed within 180 days of the draw date for the on tine game, or180 days of the closure of any instant game, fa~ to be paid to the DistributionFred.

PA~ENTS TO THE NATIONALLO~ERY DISTRIBUTIONFUND

The Distribution Fund

2,7 The Distribution Fund can share in ticket sales revenue in fom different ways,ie from the:

. ticket sales payment

. payments made into an Escrow Account;

. value of any shofifa~ between the target prize total and actual prize habti~(see para~aph 2.5); and

. value of any unclaimed prizes (see para~aph 2.6).

2.8 Schedde 1 to Condition 5 of the Section 5 hcence specifies for each year of thehcence the percentage of ticket revenue, net of lottery duty, to be paid to theDis&ibution Fund as the “ticket sales payment” - see Fi~e 5 opposite. Theschedde ftier provides that these percentages are to be subject to variousadjustments ticluding, for example, adjustments to reflect changes fi the RetailPtice Index since November 1993.

2.9 In addition to the ticket sales payment, Condition 31 of the Section 5 hcencere@res Camelot to maintain in an Escrow Account a balance eWal, in effect, to2.5 per cent of the value of the previous highest year’s ticket sales, lessS40 miUon. Upon termination of the ficence the Escrow balance revetis to theDistribution Fund, and if tie ticence is revoked an additional S40 miMon,guaranteed by Camelot’s shareholders, is paid.

Other Distribution Fund income

2.10 In addition to revenue from ticket sales, the Distribution Fund can receiveincome from:

. anc~ary activities;

. investment earnings generated by the Escrow Account balance; and

. investment earnings generated by the Players’ Rust.

hcillary activity payments

2.11 AnciHary activi~ payments arise from activities which are related to the lotte~but are not pafl of the lottery itself, for example income horn the sale ofbroadcasting rights, rights to exploit the logo etc.

16

PA~ENTS TO THE NATIONALLOTTERYDISTRIBUTIONFUND

2.12

2.13

~The marginal rate of Tcket Sales Payment increases sharply as ticket revenue increases. . .

Value of

sales (fro)

UptO660

661-1320

1321-1760

1761-2200

2201-3080

over 3080

Ticket Sales Payment as a

percentage of net ticket revenue

YearEnding 31 March . . . . . .

1995 1996 1997 1998 1999 200029.31 23.48 23.88 25,29 26.44 26.05

30,45 24,61 25.01 26.43 27.58 27.1833.5s 27.74 2S.14 29,56 30.70 30,31

36.42 32.50 32.70 33,70 33,74 33.35

38.41 34.49 34.69 35,69 35.73 35.34

38,69 34.77 34.97 35,97 36,01 35.62

Source: The Section 5 Licerrce.

2001 2002

26.05 26.27

27.19 27.41

30,31 30.54

33.35 33.3s

35.34 35.37

35.62 35.65

Notes: 1. ~ar one la a parfyearon~ie the lottery was launched on 14 November 1994. The percentage

contributions to the Distribution Fund for that first (pafl) yearare not typical of those for the

remainder of the Iicence period.

2. The percentages in the above @b/e are @ken direct~ from the Section 5 Iicence, The

Section 51icence expresses ailauch numbers on the basis ofsales net of LotferyDu& The

percentages quoted above are not direct~ comparable, therefore, with those in figuresA2

andA3, which are based on gross sales revenue.

3. The percentages in the above table are marginal rates ie each applies mdy to thatpati of the

sales revenue falling in the relevant revenue band, and not to total revenue. In other words

they are applied in the same way as income tm bands.

Investment earnings generated by the Escrow Account

As akeady noted, tie Section 5 hcence in effect rewires Camelot to maintain inan Escrow Account a balance e~al to 2.5 per cent of the value of the previoushighest year’s ticket sales, less E40 mimon. N monies standing to the credit ofthe Escrow Account may be invested as the Secretary of State sees fit and allincome generated by such investments accrues to the Distribution Fund.

Investment earnings generated by the Players’ Trust

The arrangements governing the payment of prizes are, in essence, that smauvalue prizes, up to a mmirnurn of f200, may be paid by a retailer, while largerpfies can only be claimed at one of Camelot’s re~onal centres or, in somecases, at certain desi~ated Post Offices.

17


2.14 &rangements estabhsbed under Condition 25 of the Section 5 hcence re@eCamelot to pay specified sums into an independent “Players’ Trust”, of whichLaw Debenture Trust Corporation is trustee and which is subject to audit byPrice Waterhouse. These sums are:

. on or before the on fine launch date the sum of E5 mtion intended to beavailable to winners, participants and beneficiaries if Camelot shotidbecome insolvent or go into receivership; and

. a sum e@valent to the value of all advanced sales income and outstandingprize money obhgations, from which it can then reclaim the appropriatesums (eg prizes paid) at the proper time, subject to a minimum balance ofS5 mi~on being maintained.

2.15 The trustee can, subject to the safeguards and restrictions specified by theDirector General, invest the funds held in the trust. The income from prizemoney invested is used first to cover the costs of the trust itself, tith thebalance going to the Distribution Fund. Investment earnings from otherelements in the trust are a~ocated to Camelot. This process is discussed furtherin Part 4 of this report.

Cash movements

2.16 In practice, 13 different @es of cash movements are necessa~ to give effect tothe principles outined above. These are summarised in Figure 6 opposite. Ofthe 13 potential payment types identified only ten had generated actualpayments as at 30 June 1996.

2.17 Taking a broad ovemiew, the Director General’s work on the vefication of cashmovements seeks:

. to verify re@ar payments from Camelot to the Distribution Fund, ie theweekly ticket sales payments, which accounted for some 97 per cent of theFund’s total income in the year ended 31 March 1996; and

. to verify the other types of payments identified in Figure 6 opposite, mostimportantly those made back and forth between Camelot and the Players’Trust. These include primarily payments relating to prize money obhgationsand advanced sales and arise from the Director Genera~s statutory obhgationto protect the interest of participants in the lottery. They can, however,impact also on payments to the Distribution Fund, ie through the UnclaimedPrizes Payment. In addition there is the Prize ShortfaU Payment and someother less significant payments, for example those arising from anciUa~income and the various types of investment income.

2.18 These payments are discussed further in Part 3 of this report

18

PA~ENTS TO THE NATIONALLO~ERY DISTRIBUTIONF~D

to give effect to these principles ...

Who paYS To Whom

Camelot Distribution Fund

Camelot Players’ Trust

What

Weekly Ticket Sales Payment

The relevant percentage of weekly ticket

sales (net of tin), amusted if necessay to

reflect changes in Lottery Duty and in RPI,

Ticket Salas Payment Annual A~usfment

The amount Of any) by wfdch the

aggregate of the weekly ticket sales

payments made in the year falls short of

the tots ticket salea payment required for

that year.

Prize Shortfall Payment

The amount Of any) by which the total

value of the ptize fiaMliV generated in the

year falls ahoti of the target for that year,

a~usted if necessa~ to reflect changes in

lotte~ dufy,

Interest Penalty

Interest penalties of 3 per cent above

Nat West Base rate on any payments not

made promptly in accordance with the

licence requirement.

Ancillary Income

Payments aflsing from ancillary activities

(Note - the probable value of such

payments and how they are to be divided

between the Distflbufion Fund and the

operator is not specified in the hcence).

Prize Payment etc

The total value of pflze HaMlify generated

in the previous week minus the aggregate

amount of pdzea properly paid by

ratilars plus tha full valua of all advancad

salea.

When

Weekly

Annually

Annually

If payment overdue

Weekly

Cross Reference

See figure 7.

See figure 8A (1),

See figure 8A (2).

Not applicable. No such payments

have been required to date.

See Hgure 8B

See Figure 8C

19

PA~ENTSTOTHE NATIONALLO~ERYDISTRIB~IONF~D

Who pays To Whom What

Camelot Escrow Eaarow Payment

Any payment necessary to msintain a

balsnce in the Escrow Account equivalent

to 2.5 Der cent of the aggregate value of

LofteW tickets sold in the previous highest

financial year, less f40 milhon.

Players’ Trust Camelot Prize Reimbursement

Reimbursement of pflze money properlypaid out by the hcensee, plus the value of

all advanced sales relating to the previous

wee~s draw.

Investment Insome

The hcensee maybe reimbursed out of the

Trus~s investment income for expenditure

it incurs on fees and expenses in

connection with operating the trust. It may

also receive interest on prize payments

made and for which reimbursement is due

but unpaid.

Players’ Trust

Escrow

Distribution Fund

Distribution Fund

When Cross Reference

Annually, if necessary Not apphcable. The first payment

necessary under Uris condition, for

f90,424,937, was made on

12 Amil 1996,

Not specified in See Hgure 8D,

Section 5 Iicence

Not specified in Not apphcable. In the early days of

Section 5 flcence the loftev there was insu~cient

investment income available tomeet

the opemting costs of the Trust,

These were funded initially by

Camelot who were subsequently

reimbursed by the Trust, in

April 1995, when suficient income

had been generated. Ttis was an

unusual set of circumstances.

See Figure 8E,

See figure 8E

Investment Income Quarterly

Investment income remaining in the Trust

after all other obligations have been met.

Unclaimad Prizes Weekly

Theaggregatevalueofalluncltimedprizes in every constituent LofteV for

which the claim period expired during the

week.

lnvastment Income Not specified in Not applicable. No such payments

All investment income generated in the Section 5 ticence have been made to date.

Escrow account.

Escrow Balance On termination of Not apphcable. No such payments

Accrues to the Distribution Fund at the end hcence have been required to date.

of the Iicence.

Source: National Audit Otice anaksis of the Section 5 Iicence.

20

PAWENTS TO THE NATIONWLO~ERYDISTRIBUTIONFUND

Part 3: Verification ofDistribution Fund payments

Introduction

3.1 Any assessment of the work done by the Director General in undertaking theverification of payments to the Distribution Fund needs to recognise the roles ofthe different parties involved. As has been noted in Part 1 of this report,Section 5 of the Act empowers the Director General to award a hcence to aprivate sector operator to run the National Lottery. mile the Director Generalhas an obhgation under the Act to select an operator capable of running theLottery, to set the framework for the operator, and subse~ently to ensure that itmeets au its obhgations under the Hcences he has granted, be is not empoweredto run the National Lottery. In particdar, under the Section 5 hcence he granted,the Director General must approve the functional specifications of au systemsnominated by hlm and obtain independent testing of tiem to ensure theyconform to the approved specifications. Responsibihty for lottery systems,however, rests with Camelot.

Verification of the weeMy ticket sales payments

3.2 The verification of the weetiy ticket sales payment is relatively straightforward.Tbe fmctional specifications reviewed by the National Audit Office re@e thatau data on sales, cance~ations and prize payments made by retailers arerelayed directly through the communications network to Camelot’s maincomputer centre where they are processed and simultaneously recorded on adaily transaction tape. A copy of this tape is then processed independently bythe Director Genera~s staff using their own secure computer installation. Theythen compare the output of their system with that of Camelot to ensure theaccuracy and completeness of the information produced by the latter. Thus theDirector General is in a position to determine independently the sales figuresachieved without relying on Camelot’s central computing systems.

3.3 It is theoretica~y possible for unauthorised amendments to be made to the tapesprior to them being handed to the Director Genera~s staff. However, theDirector Genera~s staff have direct on hne access to Camelot’s bank accountsand use this to check that the total of the cash co~ected weekly from theretailers is the sum of the total amounts recorded as due on the dailytransaction tapes. Mthough this check wiU not detect compensatingunauthorised amendments made, for example, to the sales and cance~ationsfigures, it is difficult to conceive how this cmdd be used to advantage by adishonest person because the vital figure is the cash balance due and, as notedabove, this is confirmed to an independent source, that is the bank.

21

PAWENTS TO THE NATIONM LO~ERY DISTRIB~ION FUND

The National Audit Office note that the Director General independentlyprocesses the daily transaction tapes and independently reconciles weeklycash collection porn the retailers with the result. This gives him an assurancethat Camelot k processing of the data and the data processed are both correct.Subject to the caueat that the National Audit Oflce have not been able toexamine the arrangements that exist within Camelot to protect the integrity ofthe daily transaction tapes, the process described in paragraph 3.2 providesan accurate figure for total sales. It is then a simple matter to calculatefiomthe Section 5 licence the appropriate percentage contribution and apply it tothe sales figure to confirm that the weekly ticket sales payment to theDistribution Fund is correct - see Figure 7.

Camelot must pay to the Distribution Fund the relevant percentage of weekly ticket sales (net of lotteW duLy), adjusted if neceaaary to reflectchanges in LotteW Duv and in the Retail Price Index . . .

TICKET SALES PAYMENT

SaleaLeas Lottery Duty @ 12%

Sales Net of duv

Payment Percentage

DUE TO DISTRIBUTION FUNO

f

93,098,28111,171,794

81,926,487

30.674

25,130,130

Source: Afatimra/Audif Otice ana~ais of the Oirector Genera~s working papers,

Notes: 1, The term ‘kalculateti means that the figure concerned ia dhect~ derivable from other numbers in the pro forma

2. The data incorporated in the pro forma relates to the weekending 9 September f995and has been included mr~ to give a general

indication of the materiali~ or othemise of the factor concerned,

Comment

a. The Oirector General informs the Distribution Fund of the amount they should expect to receive. It is then the responsib6iVof the Ustribufion Fund to monitor receiDt.

22

PA~ENTS TO THE NATIONAL LOTTERYDISTRIBUTIONFUND

Verification of other Distribution Fund payments

3.4 In addition to the weekly ticket sales payment there have been to date nineother types of payment required by the Section 5 hcence which can impact onthe Distribution Fund in one way or another. The Director General seeks tove@ these. Mthough their impotiance to the Distfiution Fund is dwarfed bythe ticket sales payments, they are nevetiheless significant in absolute terms -they codd exceed S260 mi~on in respect of the year ended 31 March 1996,although this is unfikely to be a typical year.

3.5 The verification of these payments is more comphcated than for ticket salespayments, since the necessa~ information is not available from the dailytransaction tapes processed independently by the Director General. This isbecause the daily transaction tapes record only transactions between retailersand Camelot, and transfers between the Players’ Trust and Camelot, forexample, do not involve retailers. Verification therefore requires the DirectorGeneral to rely on Camelot’s internal controls and other mechanisms. In orderto assess the significance of this rehance the National Audit Office haveconsidered in some detail:

. the work done by the Director General to satisfy Klmself on the integrity ofthe Camelot computer systems which provide him with some of theinformation on which he reties (see paragraphs 3.6 to 3.10) and

. the checkhsts used by the Dtiector General to verify the various cashpayments made, and the confirmations protided to hlm by the auditors ofCamelot and the Players’ Trust (see para~aphs 3.11 to 3.15).

Inte~ity of computer systems

3.6 The objective of the National Audit Office’swork in this area was to estabfishwhether the work done by the Dtiector General to satisfy himse~ on theinte@~ of the Camelot computer systems was we~ informed and considered.The work mdetiaken included a M review of documentation held by theDirector General but because the National Audit OffIcedid not have directaccess to Camelot’s offices or computer systems they were unable to test directlythe accuacy of the documentation they reviewed or the strength of Camelot’ssystems.

3.7 The D&ector General satisfied hlmseM on the inte@ty of Camelot’s computersystems before authorizing Eve runting. His continued rehance on theirintegri~ is based on the fact that Camelot cannot implement changes withouthis approval and that he can require changes if he beheves the systems aredefective. His decision to authorise Eve running was based on:

. reports produced by hls own evaluation team

. reports which he commissioned from PA Consdting Group, his systems andsectity advisers; and

23

. the reports of Deloitte and Touche, who undertook independent systemtesting which he had reqtired.

The work undertaken to date has included the following

Invitation to Apply -As part of the process of preparing the Invitation toApply for a Section 5 hcence, first the Department of National Hetitage andthen the Director General and his team of constants undertook a structuredindustry-specific risk assessment. The risk assessment included:

. a study of existing lottery systems, games and processes;

. tisits to overseas lottery operators to investigate, among other tilngs, actualoccurrences of security breacbes;

. input from PA Consulting Group on computer system securi~

. design and role playing rehearsals of as many potential security attacks anddefences as could be conceived.

The detailed questions and draft hcence requirements set out in theInvitation to Apply were drafted to reflect the resdts of this work.Apphcants’ were required to provide detailed proposals for addressing therisks identified in, and meeting the requirements of, the Invitation to Applyand any other risk identified by the apphcants themselves.

AppEcation Evaluation - PA Constiting Group analysed the security andgeneral information systems aspects of all apphcations received and assuredthe Director General that Camelot’s proposal was adeqnate. Camelot’s

aPphcation included the resuks of system load testing undertaken by anindependent test organisation which suggested that the capacity of theproposed system would exceed expected demand by a substantial margin.

Functional SpecMcatirms following Camelot’s selection, as required by theSection 5 licence, the Director General identified key fmctional specifications

relating to Camelot’s systems and reviewed them to ensure that they met hls

requirements and the specification promised in their apphcation. mereweaknesses were identified, these were resolved to the satisfaction ofPA Consulting Group before the Director General approved the specificationconcerned.

System Testtig - as re@red by the Section 5 Hcence, Camelot’s systemswere subjected to testing by independent testers, Deloitte and Touche,

approved hy the Director General. PA Consulting Group reviewed the workperformed by Deloitte and Touche and undertook their own security review.Both PA Consulting Group and Deloitte and Touche identified someweaknesses that needed to he rectified before the launch of the NationalLottery. The Director General made it a condition of approving tive runningthat au such weaknesses were rectified before launch and that Camelot drewup an action plan to deal with the remaining, lower priorim, weaknesses. In

24


addition, Camelot, with the assistance of G Tech, performed simdated loadtesting of wagers and prize validations prior to launch of both the on fineand instant games. The Director General told the National Audit Office thatCamelot also organised retafler “Playdays” prior to the lottery launch, usingthe nationwide base of terminals. These Playdays tested gaming systemtransaction processing, the network itse~ and terminals in retail outlets.

Live ru-g - the Director Genera~s approval for Eve running wasconditional upon Camelot undereating a comprehensive security audit withinthe first six months of five running. By April 1995 the Camelot security teamhad completed reviews of au lottery systems against the securi~ standardsdefined by Camelot and approved by the Director General. A prioritisedchectist of matters to be addressed was produced and agreed with theDirector General. The chec~st has subse~ently been used as the basis formonthly progress meetings between the Director Genera~s team andCamelot.

3.8 Based on their review of documentation supphed by the Director General, theNational Audit Ofice are satisfied that the work undertaken has been carriedout to an appropriate professional standard. Nevertheless, the National AuditOffIceconsider the Director Genera~s rehance on Camelot’s systems wotid bebetter informed and considered if more work was done in the fo~owing areas:

Security standards - Camelot’s security standards comply with those set outin the Department of Trade and Industry Code of Practice for InformationSecurity Management which has subsequently become British Standard7799. These standards are widely recognised as a good basefine for thesecurity of systems of normal sensitivi~. British Standard 7799 itsefrecognises, however, that its adoption shotid be supplemented by asystematic risk analysis of partictiarly sensitive systems to identi~ thoseareas where the security requirement exceeds the basehne to which thestandard apphes. The National Audit Office consider that the impact of abreach of the security of the lottery systems would be stilcient to justify aformal risk analysis using a method such as CCCWM”, which is widely usedin government, or an equivalent commercial methodology. The DirectorGeneral has commented that, in view of his risk assessment work and thatundertaken by Camelot, it is unhkely that the use of a non indust~ spec~lcmethod, such as CMM, wordd add significantly to the assurance on systemsecmity that he has akeady obtained. Camelot told the National Audit Officethat their standards supplement those set out in British Standard 7799 withsome additional measures recommended by their advisers, and that the riskof a significant breach of security is considered to be low in the Eght ofexisting controls which are some of the most rigorous in the indmtry.

Testhg Camelot’s apphcation included an independent report on systemload testing. Load testing was done prior to the launch by independenttesters to four times the expected load on the system, and by Camelot priorto launch to double the expected load. As akeady noted Camelot alsoorganised retailer “Playdays” to further test the system before launch. Theirwork did not, however, extend to trying to breach system integrity or

25

PA~ENTSTOTHENATIONM LO~ERY DISTRIBUTIONFUND

availabihty by overloading it, configuring it incorrectly or deWeratelyattacking it. In the National Audit Office’sview this is an important omission.In Wls context it is relevant to note that although the system genera~y

appears tO have held up weu to the demands placed on it, nevertheless,major parts have had to be closed down on three occasions:

. a sudden burst of actitity at the launch of the instants games in March 1995resdted in system overload and the subsequent closedown of the instantgame system for just over 8 hours;

. the system became overloaded again during the intense period of activityleading up to the first “double roffover” draw in January 1996, restiting inthe on fine system being closed down for approximately haE an how and

● a configuration error led to the live and both backup on he systems beinglocked into a search for a non-existent sateUite station for a Ettle over anhour and a hak.

The Director General has pointed out that, in the f~st 18 months fo~owingthe launch of the lottery, software errors led to only 18 hours system downtime and that none of these incidents put players’ money at risk when thesystem did have to be closed down. Camelot told the National Audit Officethat, in their opinion, tbe implementation of their securi~ standards made itunnecessary to simulate deliberate attacks on their systems and that thetesting by Deloitte and Touche was not designed to test beyond specifiedfimits. They doubted whether more stringent testing wmdd have discoveredthe deficiencies which led to the three incidents which were au untypical ofnormal consumer activity.

Code Review - Good practice suggests that, during the system developmentstage, quatity control and review processes shotid be used to reduce the riskof programming errors or the dehberate insertion of unauthorised codewhich cotid compromise system security. The National Audit Officerecognise that a fuUreview of aUprograms wmdd be time consuming, butwould expect the Director General at least to obtain code retiews of critical

modulesor evidencethat suchcodereviewswerecarriedoutdwingtheoriginal development stage. The Director General pointed to the age of thelottery systems most were developed some ten years ago and argued thatbecause unauthorised program code cotid be introduced into any modtde,only a fuUreview of au modties wotid be conclusive and that his own,independent, computer system wotid, in most cases, detect inaccurate ormanipulated code. The National Audit Office recognise the force of thesearguments but are not convinced that they are a justification for notobtaining evidence that any modties have been subject to code retiew.Camelot told the National Audit Officethat they beheve that in using triedand tested programs coupled with strong procedural and technical controls,the effects of unauthorised program code would be detected immediately.

These three issues are discussed further in National Audit Office comment 2.

26

PA~ENTS TO THE NATIONM LO~ERY DISTRIBUTIONFUND

3.9 The Director General has told the National Audit Office that the fo~mving factorstiuenced hls decision to authorise the launch of the National Lottery:

. the substantial work carried out on the computer systems (seepara~aph 3.7);

. the need to balance any residual risk of authorizing five running against theloss to the Distribution Fund that wmdd result from delay caused byre@ring more extensive pre-launch testing (the National Lottery paid someE13 miMon to the Distribution Fund in its first week of operation and salesincreased in subseWent weeks);

. the legal framework and hcence obligations provided Camelot with a directinterest in ensuring the integrity and pnbhc credlbihty of the National Lottery;

. the core design and security features of the lottery systems proposed byCamelot for the United Mngdom National Lottery were not significantlydifferent from those incorporated in similar lottery systems that had workedwe~ in other countries for some years: and

● the assurance given by the Director Genera~s computer system, run by hlsown staff, which uses independent software to reperform some of thefunctions of Camelot’s computer systems. This would, in most cases, help todetect inaccurate or manipdated code, whether caused by systemma~unction or a dehberate security breach.

The Director General has emphasised that carrying out the additional worksuggested by the National Audit Officebefore launch would, in his opinion, havedelayed the launch of the National Lottery tith conse~ent loss to theDistribution Fund.

3.10 The Director General is considering whether the additional work describedshonfd be carried out now. Now that he has authorised hve running, thesedecisions are properly for Camelot, unless changes are being made to thegaming software, or he is of the opinion that the computer systems are defective(which he is not). On the particular points:

Sectity stmdards: He accepts that Camelot shmdd be encouraged toreview security standards and poficy to ascertain whether the securi~re@rement has changed, although the form and timing of this reviewshmdd be left to them.

Testtig There wmdd be insignificant benefit now in trying to breach systemintegri~ by incorrect configuration testing since computer operationsprocedures and controls shmdd prevent this. The Director General thinksthere may be some benefit in asking Camelot to consider whether deliberateattempts shodd be made to attack system integrity, and this may form partof a wider security review in the future.

PA~ENTSTOTHENATIONWLO~ERY DISTRIBUTIONFUND

Code Retiew The Director General does not consider it is worthwtie to goback and undertake code retiew, although he wti consider whether it shotidbe done in future to new code, as part of the change control procedures setout in the Section 5 hcence.

The National Audit Office acknowledge that the Director General has receirredand considered appropriate professional advice and drawn on a substantialbody of evidence relating to the integrity of Camelotk computer systems. Theyacknowledge the reasons for the Director General> decision not to insist onmore extensiue pre-launch testing before approving live running of thecomputer systems and note his view on the need for further work now. In theNational Audit Oflce view, howeuec the Director Generalk continuing relianceon the integrity of Cameloth computer systems would be better informed ifmore work was done in the following areas:

. Security standards - the risk assessment carried out was not a formal riskanalysis of the type fauoured by the National Audit O@ce. The NationalAudit Office consider that such an analysis would provide additionalassurance that all significant risks had been identified and recommend thatCamelotk security standards be reuiewed within the first three years ofoperation of the lottery systems and that the Director General ensure that aformal risk analysis is carried out;

. Testing - the National Audit Office recognise the reported high leuels ofavailability of the lottery systems and accept that no testing regime couldguarantee to eliminate all risk of system failure but note that, despite therigour of the functional testing carried out, failures, albeit minor ones in thecontext of the size of the computer operation, have in fact occurred. Thesedemonstrate that the load and exception testing undertaken, whilstthorough, was not exhaustive. They also note that testing has not, to date,extended to trying to breach system integrity or availability by overloadingit, configuring it incorrectly or deliberately attacking it;

. Code review - the Director General has neither commissioned code reuiewsof Camelotk systems nor obtained evidence that such reuiews were carriedout during the development process. The National Audit O@ce recognisethat a full code review of all programs would be time consuming, but wouldexpect the Director General to at least obtain code reviews of criticalmodules or euidence that such code reviews were carried out during theoriginal development stage.

28

PAWE~S TO THE NATIONALLOTTERYDISTRIBUTIONFUNO

3.11

3.12

3.13

Use of checWsts

[n the course of their work to verify cash movements, the Director Genera~sstaff make use of various chec~sts. The one of most relevance to this reportdetails the tests to be completed which, between them, address both cashmovements around the Players’ Trust and also those involving the DistributionFund,

The chec~lst details 34 tests which must be completed every week, but is notarranged in a way that makes exphcit the logical relationships between thepayments to be veri~ed. This point is made to help explain the National AuditOffice’sapproach to this part of their work, which was:

●

✎

✎

✎

✎

✎

to take as their starting point a carefti analysis of the Section 5 hcence;

to isolate the Ecence conditions dictating revenue flows between the operator(Camelot), the Distribution Fund, the Players’ Trust and the Escrow Account(eee Figure 6);

to identify the factors dictating those revenue flows;

to produce pro formas in which the factors dictating actual payments werearranged in such a way as to make exphcit the logical relationships betweenthem

to record the tests conducted by the Director Genera~s staff against eachpayment (see Figures 8A to 8F); and then

to analyse the resuks.

Two conseWences flow from this approach. The proformas appearing inFigures 8A to 8F are National Audit Office creations and as such:

. are @te unlike the documentation used by the Director General’s staff; and

. provide an independent basis against which to measure the ade~acy of thetesting regime operated by the Director Genera~s Comphance Division.

Since the National Audit Office examination the Director General hasinitiated a review of the structure and content of the checklists used by hisstaffi The National Audit Ofice welcome this initiative, since the structure ofthe current checklist could exacerbate the danger that staff will not

appreciate the purpose of the checks being carried out,

29

PA~ENTSTOTHENATIONW LOTTERY DISTRIBUTION FUND

~~gure 8=rniiO~~ajrn-iifio~;ti”ibitiori Fund: ““’”’. }’~~ ~~:’: - ‘~:-~:~”~--”: .’::””:--:---:’ ~“. .’:’”::~~:~”;-;”j}:”

Al. TZckel Sales Payment-Annual A~uafmanl YE March 1995Camelot must pay to the Distribution Fund the amount of any) by which the aggregate of the weekly ticket sales payments made in the yearfalls ahoti of the total ticket sales payment required for that year . . .

AZ. PriZeShortfall Payment - Annual Adjustment YE 31 March 1995Camelot must pay to the Distribution Fund the amount of any) by which the aggregate of the prize payments made in the year falls short ofthe target for that year, adjusted if necessay to reflect changes in lottery duty . . .

NH SALES CALCULATION

Total Sales

Lottery Duty Charged (12Y.)

Sales net of duty

Al. TICKET SALES PAYMENT

Aggregate Tcket Sales Paymenta in yeal

Percentage Payment on net sales

up to f672,1 i 9,000 @29.31 “A’Balance up to fl ,047,751,DDD @30.45 ”/0* _

DUE TO DISTRIBUTION FUNO

AZ. PRIZE SHORTFALL PAYMENT

Aggregate Prize Total for year

Prize Percentage per S5 hcence 53.64°h

Target Prize Total (Sales less duty x 53.640A)

OUETO DISTRIBUTION FUNO

fooo

196,998

N

fooo

1,190,626

~

311,255

311,378

~

544,327

Source: Natimra/Audit Oflce ana~sis of the Director GeneraVs working papers.

Notes: 1. The term ‘calculated means that the figure concerned is directfy derivable from other numbers in the pro forma.

2. The percentages marked* areas per the Section 5 Iicence. The tranche limits are as per the Section 5 Iicence a~uated for an

increase in the RP/ from 141.6 to 144.2 in the relevant petiod. (cf first two columns in Rgure 5 of this report),

Comments

a. All of the numbers in this statement were vetified by Camelofs external auditors at the year end. They then wrote to theOirector General confirming the data concerned was in accordance with the underlying accounting records of Camelot and gave a fairand accurate view. The external auditors’ statement was then checked in turn by the Director Genera~s own staff.

b. The Director General informs the Distribution Fund of the amount they should expect to receive. [t is then the r,esponsibihty of theDistribution Fund to monitor receipt,

30

PA~ENTSTOTHENATIONALLOTTERYDISTRIBUTIONFUND

Camelot must pay to the Distribution Fund sums arising from ancillav activities (Note the probable value of such payments and how they are to bedivided beWeen the Distribution Fund and the operator is not specified in the ticence)

INCOME

f

DISTRIBUTION FUNO

PERCENTAGE AMOUNT

f

1. National Lottery

Enterprise

Ucensing

Programme (38,326) 50

2. Other 5,000 50

OUETO DISTRIBUTION FUNO ‘

Source: NatiorralAudit Office arra@ais of the OirectorGenera~s working papers

Notes: 1. “National LoftewEnterprises”is an operating division of Camelol

2. The term ‘calculated means that the figure concerned ia direct& derivable from other numbers in the pm forma

3. The data incorporatedin the pm forma relates to the quarter ending 30 September f995andhas been included onk to give a general

indication of the materialiv or othemiae of the factor concerned.

Comments

a. The Director General had no formal procedure for veri~ng the data in this pro forma (see paragraph 3.15 point 6).

b. The Director General informs the Distribution Fund of the amount they should expect to receive. It is then the responsiMfify of the~attibution Fund to monitor receiot.

31

PA~ENTS TO THE NATIONM LO~ERY DISTRIBWION FUND

Camelot must surrender to the Players’ Trust the percentage of the total value of the Lottery tickets sold which is to be paid out as ptizes minus the

a99re9ate amount Of P~zes paid by retailer$ PIUSthe full value of all advanced sales . . .

1. PRIZES

Calculated Ptize hab6tifya

Less

On tine Prizes paid by retailer

Instant Prizes paid by retailer

Rmrndings b

DUE TO TRUST

2. PRIZE RESERVE (ROUNDINGS) b

DUE TO TRUST

3. ADVANCED PAYMENTS c

Mu[Uidraw

Subscription

OUE TO TRUST

f f

44,913,472

15,734,803

15,259,657

28,647 31,023,107

13,890,365

w

5,463,194

~

~

Source: rVatiorra/Audit Otice ana~sis of the Ohector GeneraPs working papers,

a.

b.

c.

In the weekending 9 September 1995, the weekly sales total was vetified to a report produced by the Director Genera~s InformationTechnology Unit. In that week total sales were generated from ten different instant games, plus the on line game. Each game had a different

pflze s!ructure, The“CalculatedPtizeHaM[~ (E44,913,472- seeabove)is detivedbymultipl~ngthesalesfor eachgamebyits overallpercentage prize hability, as required by the Section 6 icence appmptiate to that game. The percentage prize Iiabihfies for the ten instantgamee available in the week examined ranged from 54.957 per cent to 55.924 percent. The analysis of total instant sales into the indvidualgames was provided to the Director General by Camelot. The data necessary to confirm this analysis was not routinely available from theDirector Genera~s own Information Technology Unit and so was not independently verified (see paragraph 3.15 point 4).

Higher tier pdzes in the on fine game are calculated as a percentage of the sales total, The actual prizes paid are however rounded down to thenearest fl. The total of all the roundings are transferred by Camelot to a prize reserve held in the Players’ Trust. In the week examined thedebO on Camelofs bank account generated by this transfer was not confirmed by the Director Genera~s staff. The credit payment de the receiptinto the Players’ Trust) was confirmed, however, and arguably this is much more important than the debit, Nevertheless, all other debits wereroutinely confirmed and it is unclear why this payment should have been treated differently.

Players have the option of paying in advance for their plays, Advanced sales receipts relating to all draws tating Dlace after the current onemust be surrendered by Camelot to the Players’ Trust. Camelot informs the Director Generaj of the transfer to be made each week, The

Mrector Genera~s staff then confhm the Cash Movement involved using on Ine “read only access to Camelofs bank accounts. The value of thepayment concerned was not verified to any independent source however. This was important since the sum involved was large - somef5.5 milhon (see paragraph 3.15 point 2).

32

PAWENTS TO THE NATIONALLOTTERYDISTRIBUTIONFLrND

,R@r&8N.FlJye?vitiustpaymentitot6am.elokPrize,re~Jursemy!e&*W~:g~;epprn:erlg95... ,:,,.,,,,.,.,,,,.,,,,,,,.~e~&., ~. ,. ., .- ,, . .,~;+>~,<cs,= .~,. V.=.Adi&&i&*&i;$k$

The Players’ Trust must reimburse Camelot for pflze money paid out, plus Camelo?s share of advanced payments for subscriptions when due...

1. PRIZES

Ontine Prizes paid by Camelot

Instant Pfizes paid by Camelot

OUE FROM TRUSTEES ‘

2. ADVANCED PAYMENTS

Utilsed Mulfidraw

Utilsed Subscflption b

OUE FROM TRUSTEES

E

5,216,300

~

5,587,943

19,664

~

Source: National Audit Ofice ana&sis of the Director Genem~s workirrgpapers.

Notes: 1. The term ‘tialcrdated means that the figure concerned is direct~ derivable from other numbers in the pro forma.

2. The data incorpomtedin the pro forma relates to the week ending 9 September 1995 and has been included Onh to give a general

indication of the materiali~ or othemise of the factor concerned.

Comments

a. Camelot claim daily reimbursement from the Players’ Trust of all ptizes paid out by them. The sum involved is large (although onlyf5.2 million in the weekended 9 September 1995 tMs was a rollover week-in a more normal week the figure would be 210 milflon to215 million), The Oirecfor General verified the prize total paid out by Camelot, but did not confirm that this total was made up only of vahdprizes (see paragraph 3.15 point 1).

b. Camelot reclaim from the Players’ Trust the value of all advanced sales made in previous weeks wtich relate to the current draw.The subscription sales figure reclaimed by Camelot for the weekending 9 September 1995 was some f20,000 - see above.TMs figure was not vetified by the Ohector General (see paragraph 3.15 point 5).

33


f~gure8E: ~layer< ~r”sl ~aymenl f. ~$,ribution;und ,nve~imentlncome:; ~”afier ‘Ended~o:september jgg~ ‘::; ,:} :’y:,,:::>:;:$’j

The Players’ Trust must pay to the Distribution Fund investment income generated by the Trust interest account, after the costs of running the Trusthave been met

Investment Balance on Trust Interest

Account

Amounts due under Trust Interest PriotiN of

Payments Schedule

Truafeek Fees

Soticitots FeesBanKs Fees

Auditor’s Fees

Camelot

DUE TO DISTRIBUTION FUNOa

source:

Notes:

f f

771,643

5,945

53910,164

~ m

Natimra/Audit Ofice ana~aia of the Oirector GeneraYs worMng papers.

1.

2.

Comments

The term ‘kalculatefl means that the figure concerned is dhect~ derivable from other numbers in the pro forma.

Jhe data incmpomted in the pm forma relates to the quarter endbrg 30 September 1995andhas been included on~ to give a geneml

indication of the materiali~ or otherwise of the factor concerned.

a. The costs associated with operating the Players’ Trust are recovered from the investment income earned by the Trust, and the balance is paidto the Distribution Fund. The Oirectm General does not check Law Oebenture Trust Corporation’s calculation of these amounts(see paragraph 3.15 point 3).

b. The Director General informs the Distribution Fund of the amount they should expect to receive. It ia then the responsibifify of theDistdbution Fund to monitor receipt.

34

PAWENTS TOTHE NATIONALLO~ERY DISTRIBUTIONFUND

~Figure8i:.playtifTr"5tjFaymentin,@:itfibuionFunti:;unclaimed ~tizej.iw~ ~5eptemher1g95 :, ?---::~.;.--;-=::-=::.-

The Players’ Trust must pay to the ~stflbutimr Fund the aggregate value of all unclaimed pflzes in eve~ constituent Lottery for which the claimperiod expired during the week . . .

fUNCWIMED PRIZES

Ontine 823,828Instant

OUETO DISTRIBUTION FUND m

Source: Nat/orralAudit Office anaksis of the Director Genera~s working papers.

Notes: 1. The term ‘kalctrlatedmeans that the figure corrcemedis direct~derivable from other rrumbers in the pro forma

2. The data incorporated in the pm forma relates to the weekending 9 September 1995 and has been included orrb to give a general

indication of the materiali~ or otherwise of the factor concerned.

Comment

a, The Director General informs the Distribution Fund of the amount they should expect to receive. It is then the responsibifiu of theDistribution Fund to monitor receipt,

35

PA~ENTSTOTHENATIONWLOTrERY DISTRIBUTION FUND

Resdts of National Au&t Office expatiation

3.14

3.15

The key points emerging from the National Audit Office’sanalysis of theDirector Genera~s testing programme, undertaken in Autumn 1995, were that

. W the cash movements examined had been made punctuaUy and in M;

● the testing used to verify the sums involved was genera~y comprehensive,although at that time there were four payments for which the DirectorGeneral placed considerable rehance on the functioning of controls operatigwithin Camelot, the operation of which is checked under his comphanceactivity (see Points 1,2,4 and 5 below); and

. there were a futher two payments for the cotilrmation of which the DirectorGeneral effectively reheal on statements supphed by Price Waterhouse inaccordance with the Section 5 ficence or the Trust Deed. However, theseformal arrangements were not supplemented by any exchange ofcorrespondence between the Director General and the auditors concerned,specifying the extent of the Director General’s rehance (see Points 3 and 6below).

The sti issues arising out of the payments referred to above are discussed in thenext paragraph, hsted according to their financial value.

In assessing the significance of the points made it is important to recognise thatthe Director Genera~s verification work does not function in isolation. As notedabove there are a number of other mechanisms which, although not an integralpart of the checkhst referred to in paragraphs 3.11 to 3.13, nevertheless help toconfirm the numbers in Westion or to provide assurance on the underlyingsystems. For that reason, the foUowing section is set out in three parts ie:

Findings in Autumn 1995- in which the key issues identiled at the time ofthe National Audit OffIcereview are set out.

Additiond Controls in which the role of other mechanisms outside the

routine checkhst testing programme is outhned.

National Audit Office comment in which the National Audit Officeassessment of the effectiveness of the conmols outined is discussed.

36


Poht 1 Hnrfings in Autumn 1995

Camelot claim reimbursement daily, from the Players’ Trust, of all prize cheques clearing their bank

account. In fact all Camelot prize payment cheques are drawn on a separate Camelot bank account used

only for that purpose. The balance on this account at the end of the day therefore represents the total of all

prize payments made in that day, and forms the basis for Camelofs reclaim. The Director General has

“read only acceas to all Camelo?s bank accounts and uses this to confirm that the balance on the Prize

Payment Account reverts to nil when reimbursement is received. In practice this approach aaaumes that

the additional controls (see below) prevent any cheque other than a vafid prize cheque being paid from the

account concerned, but this assumption had not been tested directly by the Director Genera~s staff at the

time, although there had been a hmited initial review of the integriW of the operator’s prize payment

system in November 1994, The value of the reimbursement payments is some fl Oto 15 million in a

Wpical week-see figure 8D, Comment a.

Additional controls

Camelofs prize payment arrangements are covered by functional specifications which describe their

systems. The Director General haa developed a Compliance Programme in pursuance of which Camelot’acompliance with these functional specification ia checked by his own staff. The Director General has toldthe National Audit Office that some sample checks were carried out in October 1995, as pafl of his

compliance activity undertaken in Camelo~s Regional Ofices. He alao obtained comfort fromPflce Waterhouse’a confirmation that the ptize payment total reported by Camelot for the year ended

31 March 1995 waa in accordance with their underlying records and gave a fair and accurate view. The

main compliance work on prize winners, however, the scope of which is to confirm that prizes have beenpaid in accordance with the Iicence, is programmed to be undertaken annually and the first such exercise

was carried out in Oecember 1995.

~.--.=:,--~:-=----~n:-~n ,.. ; .,. . ,..i=--- --.-~- -. -~:- -’-:~:-;.~ ::: ‘:’. .: , .....j“National:~udit:O flcecorn94 ,, ; ::’::,,’“ “.....

The National Audit ‘O@c2riote that”the Director General drew comfort fromPrice Waterhouse> confirmation of the annual prize payment total. They alsonote however that the Director General did not have any information on thedetailed work and testing on which the Price Waterhouse opinion was based.It is dificult therefore to assess the significance of this work to the issue ofwhether any cheque other than a valid prize cheque is eoer paidfrom thePrize Payment Account.

The National Audit O@ce welcome the involvement of the Director Generalkcompliance staff in overseeing the operation of Camelot 5 Prize PaymentAccount, but note that, apartfiom the limited initial reuiew and visits to theregional offices, their first work on this system took place in December 1995,a little over a year after the launch of the lotterg This work was undertakenas part of the Director Generalk overall programme of compliance activity.Although the National Audit Ofice have not been able to examine the relevantCamelot systems at first hand, they have examined the Director Generalkcompliance programme and the report produced following its execution. Onthe basis of this examination the National Audit Office can confirm that thework done appears to have been carefully planned and properly carried out.

PAWENTS TO THE NATIONAL LOTTERY DISTRIBUTION FUND

Petit 2

Poht 3

Hndings in Autumn 1995

~

Players have the option of paying in advance for their on tine game playa, either through the uae of a

“mulfidraw” faci~~ available at retailers or by payment via subsctipfion made direct to Camelot. Under the

Section 5 ticence Camelot are required to surrender all advanced sales income to the Players’ Trust

weekly. The Director General did not at the time, however, check that the transfers made were of the

correct amount. In the week examined, the aum involved was some S5.5 miltion - see figure 8C

Additional controls

The Director General has told the National Audit Office that the appropriate check on mulfidraw income

waa incorporated into the weekly verification program me in November 1995, and all such transfers madesince the launch of the Ioftey have now been confirmed. He also stated that Camelofs compliance with

the functional specification coveting the transfer of advanced sales income to the Players’ Trust waschecked in respect of au bscriptiona income in January 1996 and would be checked in respect of

multidraw income in July 1996.

National Audit Ofice comment 5

The National Audit Ofice welcome the retrospective verification of multidrawincome and the work done by the Director Generalk compliance staff onsubscriptions income, but note that, as at June 1996, they had not undertakenany work on the multidraw procedures.

Hndings in Autumn 1995

The balance of investment income generated by prize money held in the Playera’ Trust, afferthe deduction

of certain expenses, is paid to the Distribution Fund. Law Debenture Trust Corporation’s calculation of this

payment, wotih some 23 milflon gross a year, was not verified by the Director General - aee Figure 8E,

Comment a.

Additional controls

The management of the funds in the Players’ Trust is the responaitili~ of Law Debenture Trust

Corporation, under the terms of a Trust Deed approved by the Director General. Law Debenture are an

independent trustee, subject to trust legislation and regular audit. The Director General has told theNational Audit Office that he is currently confirming in writing with auditors Price Waterhouse the areaa

set out in the Trust Deed in which he ia paflicularly relying on their detailed audit work and testing, Thissuoolementa the reootino arrangements saecified in the Trust Oeed and will encapsulate the numerous-.,informal discussions that have already taken place between the Director General and Price Waterhouse anthis issue. The Director General has told the National Audit Office that his function is to check compliance

with the Iicences issued rather than to conduct an audit, and in his view only the latter would make it

aPPrOP~ate to review Price Waterhouse’s working papers.

38


Point 4

Point 5

~’”:-~:::=’””~:”’”~ TT “’:’”:~””::~-~z””’. ”’:””-~’~.’” ‘“’=” ~--”’-’”’’’’-”’”’ :: .:,.:: “ ‘ “’“’ ,’.. ~: :::’.:.~NationalAudit.O@tie, cornrnerit’k;: ~~~~”””:’. ‘

The National Audit Ofice agree that, where the Director General is placingreliance on the external auditors of the Players’ Trust, it is appropriate thatthe details of this reliance should be confirmed in writing. They also considerthat such reliance should be informed by a knowledge of the detailed auditwork and testing on which it is based and on an assessment of the relevant ofthis testing to the Director Generalk own requirements.

Finding in Autumn 1995

Different games have different tofa prize payouts. Camelot’s total ptize KaMtiw in any one week is therefore

determined by the sales mix achieved in that week. Although the Dhector General verified independently

the total weekly sales, he depended on Camelot for its analysis between games. Hewas therefore unable

to vetify independently the ptize payment tiabiliv claimed by Camelot when calculating the sum to be

surrendered each week to the Playera’ Trust - see Rgure 8C Comment a.

Additional controls

The Director General has told the National Audit Office that, since November 1995, the informationnecessary to verify the sales of instant games, by game, has been obtained from the Dhector General’s

independent computer system and has been used duflng the verification of Camelo~s weekly payment tothe Players’ Trust. He has also said that all such payments made since the launch of the lottery have been

verified retrospectively.

The National Audit Office welcome the re~ospectiue verification of the sales

figures for instant games. by game. and that they are now routinely ver@edby the Director General, but again note that the relevant checks wereinwoduced eight months afier the launch of the first instant game.

Hnding in Autumn 1995

Camelot can reclaim weekly from the Players’ Trust the value of any advanced sales. The Director General

did not veflfy that the correct amount of subscription income had been reclaimed. In the week emmined

this was some f20,00D - see Hgure 8D, Comment b.

39

PA~ENTSTOTHENATIONALLO~ERY DISTRIBUTION FUND

Petit 6

Additional controls

Camelofs subscription system is covered by its own functional specification. As sheady noted under thefirst point shove, the Director General has developed a Comphance Pmgramme addressing all such

functional specifications. This programme requires Camelofs comphance with the functional specificationgoverning the subscription system to be examined annually by the Director General, and the first such

exercise was carried out in Janua~ 1996.

National Audit Ofice comment 8

The National Audit Office welcome the involvement of the Director General>compliance staff in overseeing the operation ofCamelot k SubscriptionSystem, but note that their first work on this system took place inJanuary 1996. a year after the launch of the Subscription Scheme. Althoughthe National Audit Office have not been able to examine the relerrant Camelotsystems at first hand, they have examined the work done by theDirector Generalk compliance staff and can confirm that it appears to havebeen properly planned and executed.

Finding in Autumn 1995

Camelot are required to pay quarterly a proportion of any ancillary income generated to the Mstribution

Fund, All such payments were simple flat rate payments at the time of the National Audit Office review, but

no formal procedure was in place to vetify that the quarterly payment made equalled the sums due. The

Director General had no independent means of highlighting quarterly ancillary activities that had not been

drawn to his attention, m indeed of ensuring that all income generated quarterly by the ancillaW activities

of which the Director General was aware had been brought into account-see Figure 8B Comment a,

Additional controls

In July/August 1995 the Director General’s compliance program me first addressed the issue of incomefrom ancillaW activity and, the National Audit Office understand, will continue to do so quarterly in

recognition of the growing volume and complexi~ of such activi~. In addtion, Camelo~s ~rectors and

their eflernal auditors, Price Waterhouse, are required by the Section 5 Iicence to report on and cetify

annually income generated by ancillary activity, As noted in the “Additional Controls” under Point 3above, the Director General is currently seeking to confirm in wtiting with Price Waterhouse the nature

and extent of his reliance on their work.

National Audit Oflce comment 9

The National Audit Office welcome the involvement of the Director General>compliance staff in monitoring Ancillary income but note that thisinrroluement did not occur until some eight months after the launch of thelottery. The National Audit O@cefurther agree that it is appropriate that thedetails of his reliance on Price Waterhouse should be confirmed in writingand, as noted under comment 6, this reliance sfiould be informed by aknowledge of the work done by them.


4.1

4.2

4.3

Part 4: The Players’ Trust andthe prize shortfall payment

Introduction

Part 3 of this report has hig~ghted the key practical issues emerging from theNational Audit Office’sexamination of the Director Genera~s testing regime.Many of the points identified involve cash movements to or from the Players’Trust. In addition to these practical issues, however, there are a number ofpoints that arise in connection with the operation of the Players’ Trust and theprize shortfaU arrangements, and these are discussed below.

The Players’ Trust

One of the Director Genera~s statutory duties is to protect players. In order to~11 this obhgation he asked au apphcants for the Section 5 Ecence to makeproposals to protect prize winners, and stated in the Invitation to Apply thatdrafting to give effect to the proposals of the successful apphcant wotid beincorporated in the hcence issued. Camelot proposed a Players’ Trust, with LawDebenture Trust Corporation as Trustee. Key features of the proposals were:

.

.

.

the payment of a S5 mition reserve into the Trust

a weeUy payment on Wednesday of the prize habifity generated in theprevious week, less any prizes akeady paid out by retailers; and

the payment of the interest accruing on the prize money (net of Trustexpen~es) to the Distribution Fnnd.-

Camelot wotid claim reimbursement from the Trust, for prizes they had paid,provided that the S5 mi~on reserve was not depleted.

These proposals were incorporated in the Section 5 hcence with an additionalfeature, namely the inclusion of subscription and m~tidraw payments in theTrust arrangements. The Director General said that he insisted on this in orderto protect participants. He did not, however, seek to improve on Camelot’sfinancial offer, by, for example, asking for the interest on this money to be paidto the Distribution Fund. It was made clear in the Invitation to Apply that thefinancial content of apphcations would not be permi~ed to change and thatchanges to the Licence should be Emited to those needed to take account ofaspects of apphcations for which no provision had been made, and fornecessary detailed modtilcations. His view, therefore, was that any attempt byhim to improve on part of Camelot’s financial offer woufd have been expected tolead to the re-opening of discussion of other parts of Camelot’s bid, and he wasconcerned that such negotiations could have led to cha~enge by other

41

PAWENTS TO THE NATIONWLO~ERYDISTRIBUTIONFOND

4.4

4.5

4.6

4.7

aPP~cants thrOugh judicial review. He was also concerned that any negotiationswodd have been hkely to delay the granting of the hcence and the launch of thelottery, with a consequent loss to the Distribution Fund of revenue from ticketsales. The Director General also considered that any changes wotid havebrought the tender process adopted by hlm into disrepute, affecting any futurecompetitive processes in relation to the grant of hcences.

The Director General told the National Audit Officethat the detailedarrangements governing the Must were agreed between Camelot and theTrustee, within the overa~ framework set by the Section 5 hcence, after thedecision to appoint Camelot as the Section 5 hcensee, and were subject to his

approval. Law Debenture pointed out that they were not involved in negotiatingaspects of the Trust arrangements such as the timing of payments into theaccounts or the disposition of tbe interest generated, nor wmdd it have been

appropriate for them to do SO,

The Trust Deed itself defines eight bank accounts, five to be operated by theTrustee and three by Camelot. The deed also created charges over the monies inthe Camelot operated bank accounts and tbe monies receivable from theretailers. The advanced play and prize monies are therefore protected by theMst as soon as they are received by retailers, so that the Trustee can takecontrol over these funds in the event of insolvency, ticence revocation or similareventuahties. Thus while the monies in the Trust operated accounts are directlycontroUed by the Trustee, those in the Camelot accounts and with the retailersare not, although they are nevertheless sti~ under the protection of the Trust byvirtue of these charges. Throughout the remainder of Wls section the words“protection” and “contro~ have been used in these speciahst senses.

Ml the accounts created under the fiust Deed are hsted in Figure 9 opposite,which also includes a brief informal statement of the role of each. It shodd benoted however that the fiust Deed is a complex document which has beendrafted to anticipate a wide range of eventuahties, and Figure 9 must not betaken as giving any more than a broad view of bow these accounts interrelateday to day under normal operating circumstances.

Prize shortfall

The Director General told the National Audit Office that the Section 5 hcenceprovisions relating to the payment of the prize shortfaU to the Distribution Fundwere designed to give the operator an incentive to meet the prize paymenttarget, in order to stimdate sales and so generate more revenue for theDistribution Fund. He further explatied that the prize target was established asan annual figure, rather than a game by game or weekly figure, in order to givethe operator flexibih~ in managing a portfotio of games. It was alwaysacknowledged that it wotid be impossible to achieve the exact prize target eachyear, for the reasons set out in Part 2 of this report, but it was expected that anyshortfa~ would be small. The main reason for the unexpected size of theshortfa~ is, as explained previously, the success of the on Ene relative to theinstant games, coupled with the fact that the on Hne game has a lower prize payout percentage. In addition Camelot pointed out that their Apphcation for a

I

42

PA~ENTS TO THE NATIONWLO~ERY DISTRIBUTIONFUND

Trusf Accounts

Payments In

From

Payments Out hdereti Allocation

When

Daily 10O”h to Trust

Interest NC

What When To What

Account Name - Operational Trust Account

Camelors Retilem’

Collection NC

Weekly Trust Payment, ie theptize ob[gafions aritino on

Oames played in the previous

week less ptizes paid by

retailers.

Any amount of the security for

additional or increased ptize

payment announced whch

proves necessaw to increase

the ptize pool to the levelrequired.

Weekly, usually Came[OYs Prize Reimbursement of ptizes

Ilam Payment MC paid by Camelot

Wednesday

Trust Ptize Resewe

NcWeekly, usually ~sttibution Fund Unclaimed prizes

ham

Wednesday

Weekly,

usually Ftidzy

Account Name - Trust Interest Account

On the same day Per Pfloritv All monies in the

that the interest Schedule in the last account, inclutino anyis cretited to column interest earned on

the Operational authotised investment

Trust MC or on the balance.

Any interest earned on the

Operational Tust MC

Quafiedy 1 Trust Operatino

Cosb

2 Cetin paymen~to Camelot

3 Balance to

Qisttibution Fund

Operational Trust NC

Account Name - Resewe Trust Account

Camelo?s Geneml

Nc25m depostied by Camelot in

accordance with Condition 25

of the hcence.

Launch of Camelot f5 miltion

Lottev (Note: mis sum canbefotieit if there is a failureby Camelotofa typespecifiedin the secondschedule to the rustDeed.)

On expiW of fOO% to Camelot,hcence paid auatiedy

Account Name - Subsctipffon Trust Account

Weekly, usually Camelo?s Retilers’ All Subscflpflon and

ham Collection NC multidraw ticket sales

Wednesday income relatino to games

Camelors

Subscflption NC

Camelors ReMleE’

Collection MC

All subsctipflon sales income

relating to future draws.

Weekly, 1Oo”hto Camelot

usually 11 am paid Quaflerly

Wednesday

Weekly, usually

ham

played in the previous

week.All multidraw recdpts relatingto future dmws.

Wednesday

Account Name - Tru# Prize Resewe Account

Weekly, usually Camelors Gbneral Any amount of the

11 am Nc secutiv for addtional or

Wednesday increased ptize payment

announced which provessurplus to requiremen~

following the draw.

1 woddng day Operational Trust NC Any amount of the

priorto pubhc secutiv for additional or

announcement increased prize payment

announced w~ch proves

necessav to increase

the ptize pool to the level

required

Camelors RetileE’

COlletiOn MC

Sums afising from rountingdown the on hne game ptizes

to the nearest f.

Weekly, 100% to Camelot

usually 11 am paid auatierly

Wednesday

Camelors GenenlNc

Any amount needed to

provide security for additional

or increased ptize payments

wfdch Camelot may from timeto time announce.

Weekly,

usually 1f am

Wednesdav

continued...

43

Paymenb In

From

Retailers

Subscription Trust

NC

Paymenh Out Inte=ti Allocation

What When To What When

Account Name - CameloPs Retailers’ Collection Account

Icket Sales revenue

~ncluding multidmw sales)

net of cancellations, ptizes

paid by Etailers and retile~’commission.

All subscription and multidmw

ticket sales income relatino togames played in the previ;us

week.

Subscription Playem Subscription Sales Income

received

Opemtional Trust NC Reimbursement of prizes paid

by Camelot

Weekly, usually

Monday

(Multiple

Retilem) and

Wednesday(Independent

Retailers)

Weekly, usually

Ilam

Wednesday

Opemtional Trust NC Weekly Trust Payment ie Weekly, 100% to Camelot

the pfize obhoations usually 11 am

atising from games Wednesday

played in the previous

week, less prizes paid by

retailem

Subscription Trust All mulfidmw receipb Weekly,

Nc relating to future draws usually 11 am

Wednesday

Trust Pfize Resewe Sums atising from Weekly,

NC rounting down the on usually 11 am

hne game ptizes to the Wednesday

nearest f.

Camelot General MC Provided that there are Weekly,

su~cient funds available usually 11 amin the RetileK’ Wednesday

Collection NC then

1 A sum equal to the

weekly ticket sales

payment due to the

Mstdbution Fund,calculated in accordance

with the S5 hcence.

2 The balance remtinino

on the Rettilers’

Collection NC after

allowance has been

made for the abovepaymenb,

Account Name - CameloYs Subscription Account

Oaily Subscription Trust All subscription S8[eS

WC income relating to future

dmws

Account Name - Camelot’s Prize Payment Accounf

Oai[y Pti2ewinne6 Pti2eS paid tirectly by

Camelot

Soune: NationalAudit Ofice anafysisof Vust Oeedsupplementedby additional inhmation supplied by the Director Genem[

Weekly, 100% to Camelot

usually 11 amWednesday

Daily Not interest earning

Notes: 1. A should be nofed fhat the Tmst Oeed is a complex document which has been dmfted to anticipate a wide mnge of eventualities, and fhe tmnsfem shownabove must not be taken as giving anymore than a bread flavour of how fhese accounb interrelak under normal opemting cinumsbnces.

2. In pmctice fhe actual dap on which paymenk an made may change depending on the incidence of Bank Holidays.

3. The cash movemenfs shown beween Camelors G8n8mlMC, the Opemtional Rust W, and Cust Prize Reseme W, reflect fhe mefhod chosen to date byCamelot forprovfding securiv in advance of superdmw announcements.

44

PA~ENTSTOTHENATIONALLO~ERYDISTRIBUTIONFUND

Section 5 hcence was constructed to arrive at a balance of advantage betweenthemselves and the Distribution Fund and if one component was changed, theywotid feel justified in opening other issues from which the Distribution Fundbenefits,

Security


4.8 The Players’ Trust is designed to provide security for players so that, in theevent of revocation or suspension of the hcence, or the financial coUapse of theoperator, the players’ advanced sales payments and prize money entitlementsare protected, The National Audit Office note that the Trust does not extend thissame protection to the Distribution Fund, that is although the players’ moniesare protected by the Trust, the Distribution Fund’s income is not.

4.9 The Director General stated that to make the sums due to the Distribution Fundsubject to the security of tbe Players’ Trust wotid be contra~ to the pohcy thatmoney owed to the Government shodd only exceptiona~y rank ahead of othercreditors in the event of insolvency. The National Lottery etc Act gave theDirector General a statutory duty to protect participants. This justified givingplayers the protection of the Trust in such an eventuah~, The Director Generalsaid that he had no e~valent justification for giving the Distribution Fundexceptional treatment.

4.10 In addition to this general point, tbe National Audit Office also noted Wospec~lc bitations on the control exerted by the Trustee:

. CoUection of the ticket sales income due from retailers is initiated on aMonday. Money paid by major mtitiple retail chains is paid into Camelot’sRetailers’ CoUection Account the same day, that due from independentretailers does not clear until the Wednesday. However the relevant paymentto the Operational Trust Account to cover prize money obhgations is made ona Wednesday, In practice therefore advanced play and prize money arisingfrom ticket sales made by mdtiple retailers does not come under the directcontrol of the trustee mtil two days after it is received by Camelot. It ishowever protected as soon as received by retailers by charges over therelevant sums. The Director General has told the National Audit Office that in

a typical week the sum involved is hkely to be S11 m~on.

. Payments are made into Camelot’s Subscription Account daily. The balanceon this account is transferred to the Stiscription Trust Account only weekly,on a Wednesday, in accordance with the terms of Camelot’s offer. TheDirector General has told the National Audit OffIcethat the maximum sumout of the Trustee’s direct control in the intervening period could reach$20,000, although it too is protected by the Trust charges as soon as receivedso that the Trustee can take control if need be.

45


4.11

4.12

The Dticctor Gcnoral said that the fiust arrangements provided good secmityfor players, without involving the Trustee in Camelot’s day to day operations. Hestated that additional security cotid be achieved by changing the pa~entarrangements, so that Camelot made an initial pa~ent on accomt to the Truston Monday, paying the balance due on Wednesday when the remaiofig tidswere received from independent retailers. It should be noted however that anyextra secwity this provided would not be meat because Monday’s pawentcmdd not cover au the obhgations to players generated by wagers placed atmultiple retailers, without prejudicing the weekly ticket sales paysnent to theDistribution Fud. hy change to the existing payment arrangements wotidalso have cash flow imphcations for Camelot, so Section 8(3)(a) of the Act woddprevent the Director General from varying the Wednesday payment day withoutCamelot’s consent, leading to the re-opening of the whole fiancial framework.Mternatively, the Trustee cmdd be given fti day to day crmtiol over theRetailers’ CoUection Accomt, but this wotid mean their managing an tipofiantpafi of the day to day operations of the lotte~, which would be impractical,

Prize shortfall

The Section 5 hcence in effect a~ows any prize payment shotiaU to be held aspati of Camelot’s general balances mtil 28 July in the year fo~oting thefinancial year in which the shoflfa~ arose. The pfize pa~ent shotiau arisingin respect of the year ended 31 March 1996 was $135 m~on. The DirectorGeneral has pointed out that Wls money (unhke the money io the Players’ Rust)does not lega~y belong to the participants, and is not therefore an appropriatematter for a Trust setup to protect players in accordance with his statnto~ dutyto protect participants.

National Audit O&ce cornrnerit 10 ‘,.

The National Audit O@ce note that:

. advanced sales and prize money arisingfiom ticket sales made by mulh’pleretailers is not transferred into the Players’ Trust Accounts until two daysafter receipt, while subscription payments, although receiued daily byCamelot, are transferred to the ~ust only weeklg Although protected bycharges and by the bank mandates and payment instructions in themeantime, these monies do not fall under the control of the trust until theyare transferred; and

. the annual prize payment shortfall is held as part of Camelotk generalbalances until 28 July in the year following the financial year in which theshortfall arose.

46

Sales and prize money are protected by the ~ustfrom receipt by retailers orCamelot, but the National Audit Office believe security over these monieswould be enhanced if they were transferred under the direct control of theTrust more promptly following receipt. The Director General has said that theprize shortfall, specifically is not an appropriate subject for the >ust since,as pointed out previously, the Dust is designed to prouide security for players.

PA~ENTSTOTHENATIONMLO~ERYDISTRIBUTIONFUND

Cash flow


4.13 The National Audit Office note that, in response to the request in the Invitationto Apply for proposals to protect prize winners, Camelot’s Section 5 hcence

aPPhcation offered a Players’ Trust with, broadly, the interest generated by theTrust being used:

. firstly to meet the Trust costs;

. secondly to pay interest to Camelot om

a) any monies due but unpaid to it as reimbursement of prize payments made;

b) a sum of E5 milhon that Camelot was required to pay into the Trust on orbefore the launch of the lottery;

. fina~y, the balance to revert to the Distribution Fund

This offer was incorporated into the Section 5 hcence without speci~lng the

detail of how the Trust bank accounts were to be structured in the Trust Deedsince, in the Director Genera~s view, it was the hcensee’s responsibility to put inplace the arrangements required by the Section 5 hcence, subject to hisapproval.

4.14 In practice, however, as akeady noted, the Trust Deed specifies eight bankaccounts. The Deed provides that the investment income generated by theseaccounts is apportioned as fo~ows:

Operational Mst Account - holds prize money. N investment incomearising on this account is paid to the Trust Interest Account.

Trust bterest Account - holds investment income received from theOperational Trust Account, which is used firstly to meet the costs ofoperating the Trust and secondly to pay interest to Camelot on any moniesdue but unpaid to it as reimbursement of prize payments made. FinaUy thebalance is paid to the Distribution Fund. These arrangements are as offeredin Camelot’s Section 5 Ecence apphcation and consistent with the Hcence asissued. The Director General has told the National Audit Officethat, in tbeyear ended 31 March 1996, the gross income under these arrangements wasS3 miMon.

Reserve Trust Account - this holds the S5 milhon Camelot was required topay into the Trust on or before the launch of the lottery, au investmentincome arising from which accrues to Camelot. This is ae offered inCamelot’s apphcation and as incorporated in the Section 5 ticence issued -see paragraph 4.13 b above.

PA~ENTS TO THENATIONALLO~ERYDISTRIBUTIONFUND

Subscription must Account - all investment income generated on thisaccount accrues to Camelot. Akhough this is consistent with the Section 5Licence, in the National Audit OffIceview it is important to note thatCamelot’s Section 5 licence application itse~ did not mention the issue ofhow interest on Advanced Sales income was to be appofioned. The DirectorGeneral has told the National Audit Officethat the cost of operating thesubscription system is Weater than the retailer commission payable onnormal sales, and the investment benefit to Camelot of cash h advance hhis view goes some way to offset Wls extia cost. In addition, because au

apphcants for the Section 5 ficence were re@red to make clear in theiraPPhcatiOns the monies tiey would pay over to the Dis@ibution Fmd andthe hcence was awarded on that basis then, given Camelot did not offer topay interest on Subscription Income, his tiew is that there was no scope forhim to make them do so without opening negotiations on the Section 5hcence as a whole, risking possible judicial retiew and Wely si~flcantdelay to the lotte~ lamch. The Director General said that it wotid bedifficult to negotiate changes now, and that it wotid be hkely to lead tonegotiations on other aspects of the Section 5 Llcence; as a result it woutd beof uuceflain benefit to the Distribution Fund, See National Audit Officecomment 11.

fiust Prize Reserve Account - The Section 6 hcence for the on he gamerequires Camelot to allocate at least 45 per cent of sales revenue to prizes,subject to the rounding down of each prize to the nearest S1. The Trust Deedprotides that Camelot may from time to time elect to credit the fiust PrizeReseme Account with the whole or any pati of:

a) an amount payable to prize winners as additional prize payments, forexample superdraws;

b) monies which arise from the rmmding down to the nearest f 1 of the on Enegame prizes.

The balance on this accouut maybe apptied to meet additional prizepayments such as superdraws. N interest on the accomt accrues to

Camelot,as doesanybalanceexistingin tbeacco~t whentheSection5licence expires. The National Audit Office noted that neither Camelot’sApphcation nor the Section 5 hcence issued made any provision for anaccount of this type.

The Director General has told the National Audit Office that it is normalpractice for hlm to require Camelot to ensue the balance on the Trust PrizeReserve Accouut is sufficient to meet the prize habihty hkely to be generatedby any superdraw before the relevant draw takes place, to guarantee thesecurity of the sums concerned. He also stated that Camelot have alwayspaid all monies arising from rmmdings into the Rust Prize Reseme Acconut,although they are not obhged to do so.

4s


Camelotis Retders’ CoUection Account - aUinvestment income accrues toCamelot. It has akeady been noted that this account receives ticket salesincome from multiple retailers on a Monday and from independent retailerson a Wednesday. However, Camelot meet the full obfigatiou tu theDistribution Fund arising from sales via both types of outlet on a Tuesday,w~e prize money obhgations to the Players’ Trust are met on a Wednesday,as offered in Camelot’s apphcation - see National Audit Office comment 11.

Camelot’s Subscription Account - aUinvestment income accrues to Camelot- see National Audit Office comment 11.

Camelotis P&e Payment Account - this is effectively an imprest account,therefore it does not generate any investment income.


Although the National Audit O&ce note that the Director General does nothave the power to alter the financial provisions of the Section 5 licencewithout Camelotk consent. theg nevertheless wish to describe the way inwhich interest generated on two of the eight accounts described in the TrustDeed is allocated and to comment on a third. These are discussed below.

Subscription ~ust Account

All investment income generated on this account accrues to Camelot. Theapplication was silent on iffiow any advanced sales system should finction. TheDirector General told the National Audit O@ce that the idea for such an accountwas put to him during the course of dra&ng the final Section 5 Cicence.Aroundten per cent of advanced sales income will ultimately accrue to Camelot. themajority ultimately accruing to Prize Mnners and the Distribution Fund.

The Director General has told the National Audit Office that, in the yearended 31 March 1996, Camelot was paid E829,000 interestfiom this account.

Camelotk Subscription Account

The disbursement of interest on this Account is the same as for that on theSubscription Trust Account.

The Director General has told the National Audit Ofice that, in the yearended 31 March 1996, Camelot was paid E2.000 interestfiom this account.

Camelotk Retailers’ Collection Account

All the interest on this account accrues to Camelot. This is consistent withCamelotk original application and the Section 5 licence. Given sales as at31 March 1996 were 70 per cent ahead offorecast, Camelot will havebenefitedfiom a roughly proportional increase in interest incomeflom itsRetailers’ Collection Account ouer and above that envisaged at the time of itsapplication. The Director General told the National Audit Office that theannual cash value of the sum involved is E420,000.

49

Prize shortfall

4.15 In addition to the issues arising from the structure of the Trust accounts, thereis one further cash flow issue arising from the way the prize shortfa~ paymentis treated. The Section 5 Ucence requires the prize shortfaU payment to becalcdated annua~y and, unless so directed by the Director General, paid to theDistribution Fund. Nternatively the Director General can require it to be used tofund prizes in the subsequent year, although to date be has not done so. In theinterim the sum involved is an integral part of Camelot’s balances and is nottherefore identifiable as such in any particular account. Camelot receives thebenefit of interest earned on this money, estimated by the Director General to besome S6 milhon in the year ended 31 March 1996.

4.16 The Director General said that the prize shortfa~ arrangements were notworking as expected and he was reviewing them, but that the arrangementscould only he changed with Camelot’s consent. He added that it was desirablethat any changed arrangements should fit into the financial framework, andprovide the operator with incentives to act as desired, and pointed out that

a) if Camelot agreed to pay interest on the shortfaU to the Distribution Fund,they wotid be given a greater incentive to meet the prize payment target bypaying more money to players. This may produce a worse overa~ restit forthe Distribution Fund than simply receiving the sbortfa~.

b) the annual target encourages the operator to manage its game portfoho andsuperdraws, over the medium term, in such a way as to mmimise itsrevenue, and hence the revenue to the Distilbution Fund,


The prize shortfall payment reflects the extent to which Camelot has fallenshort of its Section 5 licence target to pay a specified level of prizes. TheIncitation to Apply for the Section 5 licence, howevec required all applicants’business plans to be consistent with the target prize totals specified in their

application.

As already noted Camelotk preliminary results record the prize paymentshortfall for the year ended 31 March 1996 as E135 million, and the DirectorGeneral has estimated that the interest earning potential of such a sum islikely to be of the order of E6 million, The National Audit O@ce note that theNational Heritage Committee Second Report Session 1995/96, recommendedthat Camelot should pay such interest to the Distribution Fund.

50

PAWENTS TO THENATIONWLOTrERY DISTRIBUTIONFUND

Part 5: Frauds, irregularitiesand risks to the DistributionFund

Introduction

5.1 As part of its retiew, the National Audit Office sought to consider potential riskto the Distribution Fmd income of frauds and irregtiarities, drawing onexperience gained from tisiting selected lotteries in Ewope and North fierica,and discussions held with both senior lottery employees and the relevantexternal auditors:

. to find out what frauds and other irre@arities the operators of thoselotteries had experienced; and

. to assess the relevance of their expedience to the United Ungdom lotte~ andto form a judgement on the risks this tiphed for the Distilbution Fun&sincome.

Throughout this part of their work the National Audit Office had regard to thefact that the lotteries visited operate Within a different institutional frameworkfrom that in the United Rngdom, and to the actions taken by theDirector General to tinimise the risks identified.

Institutional framework

5.2 One major dfierence in the insti~tional frameworks h ~estion was that mostother lotteries tisited were state run, operated by a ptihc sector institution,usua~y as a more or less independent mit uder the overa~ supemision of therelevant Finance Ministry. ~fle the lottery organisation in these jwisdictionsmay contract out part of its operations, it remains responsible for thoseelements that are contracted out (usuaUy hardware, central processing,terminals etc) as weU as for the elements that it carries out with its own etaff,for example, game design and development, marketing and retaihngarrangements, banking arrangements etc. This contrasts with theUnited Hngdom where all these matters are the responsibihty of a privatesector operator, subject to overaU re~ation by the Director General.

51

PA~ENTS TO THE NATIONALLO~ERY DISTRIROTIONFDND

5.3 The Director General has told the National Audit Office that a de~erate featureof the United Mngdom struct~e is that the private sector operator takes thecommercial risk, and the impact of frauds and other irre@arities fa~s as far aspossible on the operator, not the Distribution Fund, ie Camelot bear the lossesarising from frauds.

5.4 The Director General bas further explained that he meets hls statutoryobjectives in a variety of ways. The following are particdarly relevant to theprevention of fraud. He:

. exercises his right to approve the functional specifications of any systems henominates, to require indcpcndont systems testing, and stisequentiy toconduct tests to ensure the requirements of the functional specifications aremet, before giving approval to operation of the systems concerned;

. maintains a comphance programme,including independent computerprocessing of wagers and prizes, to satisfy himsef Camelot continue tooperate the systems approved by him in accordance with the relevantfunctional specifications; and

. requires Camelot to make re@ar reports of au security incidents impactingon the lottery. In the year ended 31 March 1996 there were some 4,000 suchincidents many of which involved criminal offences includlng, for example,burglaries committed against lottery retailers. The Director General has toldthe National Audit Office that these reports are reviewed by his staff and

appropriate follow up action discussed with Camelot.

Despite these mechanisms, the experiences obtained in the other lotteryjurisdictions do have some relevance to the United Rugdom, and areconsidered further below.

Vulnerability to fraud

5.5 In practice there was remarkable unanimity in the key message emerging horn

alloverseasIotieryoperatorsinterviewedbytheNationalAuditOfEce, This mayhe paraphrased as “Lotteries using basically the same equipment and systemsas those in the United Kngdom have been operating for many years in manycountries of the world. Experience has shown such lotteries to be robust andresistant to significant fraud or other irregdarities. They have withstood the testof time”,

52

PAWENTS TO THE NATIONWLOTrERYDISTRIBWIONFUND

5.6

5.7

That is not to say, however, that there are no vtierable areas. Mthough thelevel of fraud maybe low in relation to the total size of the lotteries concerned,tiauds nevertheless etist. Figure 10, overleaf, fists the frauds described toNational Audit Office staff during the course of their visits and provides:

.

.

.

.

a brief description of the fraud concerned;

an assessment of whether the fraud concerned, if perpetrated in theUnited Mngdom, could impact on the Distribution Fnn&s income;

a description of the preventative measure(s) available to combat thosefrauds; and

an assessment of the risk involved.

It must be emphasised that Figure 10 has been constructed on the baeie ofdiscussions with overseas lottery operators and with staff from the OffIceof theNational Lottery. Mthough National Audit Office staff have seen thedocumentation available from the Director Genera~s tests, they have not beenable to test for themselves Camelot’s security arrangements and for that reasontheir assessment of risk is ~a~fied.

It is important to note that many of the potential frauds outhned inFigure 10 are very un~kely to impact on the Distribution Fund, rather they tendto impact on the operator or the way in which the available prize pool isdistributed between prizewinners (both genuine and fraudulent). Twoexceptions to this general rule have been identified however.

. CanceUation of tickets for the on tie game. A retailer can cancel a ticketfor up to 15 minutes after it has been entered into the system. This facih@ isavailable for participants who have, for example, belatedly reahsed they haveforgofien their waUets or have chosen the “wrong” numbers etc. Theetistence of this facihty makes it possible, if the player does not notice, forthe retailer to cancel any ticket before giving it to the player and retain thestake money, thus in effect accepting the risk that the ticket might win aprize. To the extent that such frauddent cancellations depress sales they alsoreduce the Distribution Fund contribution. Provided the number of&audtient cancellations is held within reasonable hmits there is Ettleprospect of such frauds being detected unless and until a player complains ofdifficd~ in claiming a prize. Some lotteries visited (eg Republic of Ireland)do not have a cance~ation facihty, because of its vtierabih~ to abuse byretailers. The Director General has explained that the cancellation faciE~ is acustomer service, so this is an area where hls duty to protect players and tomaximise revenue to the Distribution Fund must be balanced. He added thatthe cancellation pohcy is continuously under review. The Director Generalhas also told the National Audit Officethat recent changes to the cance~ationprocedure have made it less hkely that players wiU fail to detect a frauddentcanceUation, and that Camelot systems facilitate the detection andinvestigation of unusual cance~ation patterns by retailers.

PA~ENTSTOTHENATIONWLO~ERYDISTRIBUTIONFUND

significant fmud. That is not to say there are no vulnemble areas however..

Fraud

ON LINE ~ME1. Interference with the Dmw Process

2.

3.

4.

5.

Addition of winning plays to themaster tape after the result ofthe draw is known, eitherdirectly or through “hacking”.

ForgeW of winning ficketa afterthe result is known.

Misappmptiation of unclaimedprizes, Wnners have up tosix months to claim their pdzes,The pmbabilty of a claim aftersay 25 weeks ia low, thereforeaccess to the winners vatidafionfile, either directly or through“hacking”, would allow anapparently authentic winningticket to be forged with little fiskof a dupficate claim,

Cancellation of a play ie a retailermay sell a ticket and then cancelit, retaining stake money forimelf.

Impact on ~stribufion Fund

No - Affects only the diatflbutionof the available ptize pool.

No - Affects only the distflbutienof the available ptize pool

Untikely. Unclaimed ptizes revertto the Distflbufion Fund. To theexent that any forged ticketscould sewe to reduce theapparent level of unclaimedptizas, they might in theoryimpact on the Oiatdbution Fund,but this ia unhkely (see“Assessed ris~ column)

Yes. Unclaimed pflzes reveti tothe Distflbution Fund. To theefient that any forged ticketswould acme to reduce theapparent level of unclaimedptizes, they will impact on theOisttibufion Fund.

Yes. The Diattibution Fundconttibufion is based on Iotfaryturnover. To the efient thatcancellations reduce salesrevenue they reduce theDisttibufion Fund conttibufion.

Preventative Measure

Physical Secutity of OrawEquipment

Close down the on line gamingsystems before the draw andkeep the transaction tapessecure.

Afferfhe draw all plays relating tothat draw are smnned and a file ofwinning plays produced. This isthen available on tine to all refsilemand Camalot Ragional Otices whoare required to uae t to confirmthe authenticity of all prize claimsbefore mating payments (but seealso”4 below).

Secutify of the WnnersValidation Rle, plus additionalchecks

Prize Wflfler Validation. If aretiler cancels a play thataubaequently pmvea to havebeen a winning selection, theplayer will be unable to claim hisprize becauae it will not berecorded in the winners file (see“3 above) - although of courseif the player claims the prizefrom the same outlet from whichthe ticket was pumhased, theretailer may choose to meet theclaim from its own funds.

Assessed Nsk*.’ ‘“: “‘

Minimal

Minimal (Note, the widerquestion of whether there ia afisk that a pe~on with malciousintent could hack into anddamage Camelot’s ayatems isdifficult to assess withoutdetailed knowledge of Camelo~saecuti~ armngemenfs),

Small. The operator i~elf isfinancially liable for any invalidpflze payment madfl thereshould be no impact on theDistdbufion Fund.

Risk minimised in theUnited Ungdom by additionalindependent check on the ticketsof selected prizewinners, Thisfraud has been perpetratedsuccessfully elsewhere, however.

Mgh. given the size of the retailnetwork k is inevtib[e thatsomeone somewhe~ willsuccumb to this temp~on.However such frxuda are [ke~tobecome apparent fah~ quickly, sorevenue losses are untikely to begreat. The key risk ia that fromadveme publc”~ should a play ofa major prizewinner provesubsequently to have beenfmudulently mncelled, aa hashappened in at least one otherlottery juflsdicfion.

54


Fraud

INSTANT GAMES6. Forgew of winning ticket,

7, Retailer “pricking” ie retailers“pricW the latex coveflng on thecards to reveal key informationand so identiti winning carda.The retailer can then choose tosell only Ioaing cards, retainingthe winning cards and claimingthe prizes on them.

8. Fraud on Players, Naive orelderly customers may bedefrauded by unscrupulousretailers who convince themtheir ticket was not a winningone and then appropriate theirprize.

Impact on Distribution Fund

Unhkely. Unclaimed prizes revetito the Distribution Fund. To theextent that any forged ticketscould serve to reduce theapparent level of unclaimedprizes, they might in theoryimpact on the Oistribufion Fund,but this is unhkely (see“Assessed risW column)

No - Affects only the distributionof the available ptize pool.

No - Affects only the distributionof the available prize pool.

Source: NatiorralAudit Ofice discussions wifh overseas lottery operatora.

Preventative Measure

At the same time as printing

instant tickets, the printer will

routinely produce a mastertape

holding the vahdation number ofevey winrdng ticket and arecord of the ptize involved. Thisis available on fine to all retailersand Camelot Regional Otices,who are required to use it toconfirm the authenficiv of prizeclaima before making payments.

Player vigilance - playera shouldnot buy damaged cards.

Player vigilance

AssessedRisk*

Small. When busy, individualretailera maybe tempted to payout small ptizes without firstvahdating the claim but theoperator itself is financially hablefor any invafld pdze paymentmadt there should be no impacton the Distribution Fund.

Hgh, given the size of the retailnetwork it is inevitable thatsomeone, somewhere willsuccumb to this temptation.

Medium, although the level ofsuch fraud is likely to be minimal.

Mote: * These assessments draw on the AratiorralAudit Officek review of documentation of Camelotk aecudfyarrangementa provided by

the Director General, and the Director Genera~s tests of such arrangement where appropriate. The National Audit Office has not tested

those armngemenfs at fhst hand.

55

PA~ENTSTOTHENATIONALLOTrERYDISTRIBUTIONFUND

. ~sappropriation of unclaimed prizes. Were a claimant able to obtain aUthe relevant information on an authentic winning ticket (validation number,place and time of issue etc), in some lotteries tisited it wmdd be possible toforge a ticket that would satisfy the basic checks designed to detectfraudufeut claims. To minimise this risk in the United Hngdom, theDirector General has approved additional, independent checks on selectedprize winners’ tickets, to estabhsh that the ticket was genuinely printed atthe time that, and on the terminal on which, the winning wager was placed.For securi@ reasons these checks are not described in this report. TheNational Audit Office have not been able to examine the operation of theprocedures concerned at first hand,

Camelot have also told the National Audit Officethat they have safeguardsagainst both types of fraud described above.

5.8 In addition to outhning opportunities for tiaud, the lottery operators constitedalso identified other activities which, although not frauddent as such,nevertheless codd bring the lottery concerned into disrepute. These aredescribed below.

● Cross Border Trading, in which tickets from one lotte~ are sold in theterritory of another lottery at above their face value. It was suggested to tbeNational Audit Office that such made can not only impact on the reputation ofthe lottery concerned, it can also provide an opening for criminal elements,Because of its size, the United ~ngdom lottery is able to offer much biggerprizes than those available in most other lotteries in the world, and it ispoptiarly a~eged that this has generated a significant trade in UnitedRngdom Lottery tickets outside the boundaries of the United ~ngdom itse~,although the total volme of this activity can only be guessed at. TheDirector General told the National Audit Officethat, in order to discouragesuch activity, Camelot are entitled to refuse to pay prizes on tickets resold byway of trade, although unless action is taken in the importing country to stopi~egal sales of United Ungdom lottery tickets the made ti~ be dlfficdt toprevent. Camelot told the National Audit Office that this issue had been we~recognised by them and a comprehensive file on the subject had recently

beenfomardedtotheDirectorGeneral,

. Money laundertig is a process through which some of the money obtainedthrough criminal activi~ can be given an appearance of legitimacy. Gambhngwith such money, for example, is rikely to resdt in at least some losses, butthe proceeds of au successfti wagers are available to the originator as“clean” money. Lotteries genera~y are concerned that they may be used as ameans of “laundering” money and that such activi~ may bring the lotteryinto disrepute through the association with criminal elements.

. Sales to Underage Persons, which are i~egal under Re@ations made underSection 13 of the Act. The Director General has told the National Audit Officethat he insists on Camelot removing the terminals of retailers who seU tickets

56


NegaUy. Camelot stated that they conducted regtiar spot checks andinvestigated allegations of underage seting, and that two retailers’ terminalshad been removed for this offence.

. Fmancid faflure by rettiers, that is the retailer does not remit the moneytaken from the sale of lottery tickets. In the United Kingdom this would haveno effect on the Distribution Fmd since, under the terms of the Section 5hcence, Camelot is responsible for au payments to the Fund and wotidtherefore be reWired to make good any shortfa~.

. Bribes offered in exchange for terminak. Retailers with lottery terminalsmay benefit from enhanced turnover through increased casual trade incomparison with their competitors who do not have a terminal. It is a~egedthis has encouraged some retailers in overseas lottery jurisdictions to offerbribes in exchange for a terminal. The Director General told us that hewotid take very seriously any evidence that this had occurred in theUnited Mngdom.

5.9 None of these irregularities wmdd impact directly on the income to theDistribution Fuud.

,_... . .,=...:-., ... . . . .. ..,._-...,..=.. ..7:....,—,...~,.,-..,-,-,,,.. . .,

iNational $udit;otice ‘c0rnrnent;13 :.:‘“.’,.:..””.; .“ ‘“... ,..

Mile the experience of overseas lotteries using basically the same equipmentand systems as those in the United Kingdom suggests these systems arerobust and resistant to significant fraud, there are nevertheless two areas inwhich losses fiomfiauds experienced in some ouerseas lotteries could, ifrepeated here, impact on the Distribution Fund:

● Fraudulent cancellation of tickets for the on line game. If not detected bythe playez it is possible for a retailer to cancel any ticket and retain thestake moneg so depressing apparent sales.

. Misappropriation of unclaimed prizes. Given the checks and safeguardscontained in the procedures approued by the Director General, it is mostunlikely that a person with dishonest intent could forge a ticket .that wouldsatisfy the checks designed to detect fraudulent claims.

The Director General has told the National Audit Office that. while there havebeen isolated instances of the first type offraud in the United Kingdom. therisk of the second type offraud is minimised by additional independent checkson selected tickets to establish that the ticket was genuinely printed at thetime that, and on the terminal on which, the winning wager was placed.

There are other irregularities which, fperpetrated, would not impact directlyon the income to the Distribution Fund, but could conceivable impactindirectly by adversely influencing the public k perception of the lottery andhence their propensity to buy tickets.

PA~ENTS TO THE NATIONAL LOTTERY DISTRIBUTION FUND

Appendix 1Distribution Fund income

Introduction

1 This Appendm incorporates the National Audit Office’scalctiation of the actuala~ocation of ticket sales revenues that occurred in the period horn the launch ofthe lottery in November 1994 to 31 March 1996, and compares it with thatenvisaged in Camelot’s Section 5 hcence apphcation. It also analyses the way inwhich the aUocation of ticket sales revenue between Lottery Duty, the TargetPrize Total, the Distribution Fund and Camelot changes over time and atdLfferent sales volumes,

Sales revenues and Distribution Fund income -actual

2 In Figure Al opposite, the a~ocation of ticket sales revenue as envisaged inCamelot’s ficence apphcation is compared with the actual restits achieved in theperiod from launch until 31 March 1996.

3 It should be noted that the values of payments to prizewinners and to theDis&ibution Fund quoted in Figure Al differ from those reported in Camelot’saccounts because the latter

● include under prize payments the fd target value of prizes. In fact, asrecorded by Camelot in the narrative accompanying its accounts, the actualprize total has been below target in both financial years since the lottery’slaunch. Therefore since, unless the Director General agrees otherwise, theshortfa~ wi~ he paid to the Distribution Fund, that shortfa~, worth

S153 milhon, is shown in Figure Al under the Distribution Fund and notunder prizes;

. include under prize payments the value of unclaimed prizes. Since aUunclaimed prizes titimately revert to the Distribution Fund, the value of suchprizes, estimated by the National Audit Office as Wely to be S74.8 mi~on, isincluded in Figure Al under the Distilbution Fund and not under prizes;

. include under Distribution Fund payments a provision for payments worthf 19.4 milhon to be made into the Escrow Account. As akeady noted,Camelot is required in effect to maintain in this account a balance equal to2.5 per cent of the previous highest year’s ticket sales, minus S40 mi~on. Infact, Camelot’s reported sales in the part year ended 31 March 1996 were~5,217 milfion. This triggered a payment into the Escrow Account of some

58

PA~E~S TO THENATIONALLOTTERYDISTRIBUTIONFUND

When other factore such aa the Shotill in Pflze Payment and the Unclaimed Prizes Payment are tiken into consideration, the overall Distflbution Fundcontdbtimr rate for the period from launch to 31 March 1996 was 30.3 percent, as against the 25.7 percent entisaged in Camelofs ticence application

PerMcence Application Actual Differencefm “/0 fm “/0 fm “/0

Distribution Fund

Tcket Sales Payment 939.3 24,7 1,713,7 26.7 774.4 82,4

Shortfall in Prize Payment’l 153,0 2.4 153,0 -

Unclaimed Prizes.z 38.0 1.0 74.8 1.2 36.8 96.8

Eacmw”3

Sub Total 977.3 m 1,941.5 30.3 964.2 98.7

Duty 456.0 12.0 768.9 12.0 312.9 68.6

Ptize Total ”1.2 1,857,5 48.9 2,976.8 46.5 1,119.3 60.3

Source: Afatiorra/Audif Office analsis of data @ken from Camelo?s Section 5 Iicence application anditapublished accmmts for theyeal

ended 31 March 1995, and their unaudited preliminav results for the year ended 3f March f996, supplemented by additional

information supplied by the Director General and by Camelot.

Notes: *f. In the period in 9uestion, the actual ptize totaiprovided for by Camelot fellf153 million short of the target prize total required

by the Section 5 Iicence. Since this shortfall will, unless othewise directed by the Director General, be paid into the Distribution Fund,

in the above table f f53 million has been deducted from the prize payment total as reported in Camelofs published accounts and

added to the Oistribudmr Fund payments.

*2. Camelot forecast in its application that prizes equating in value to one percent of sales would remain unclaimed. In fact Camelot

have repofled that the actual value of unclaimed prizes relating to theyearended3f March f995 waa ff3.9 million. If the proportion

of prizes unclaimed remains unchanged for the period from launch to 31 March f996, the value of the unclaimed prizes concerned

will be f74.8million. For this reaaon, in the above table, f74.8million ha; Beerr deducted from the actual prize payout total as

reported in Camelofa accounts and has been added to the Distribution Fund payments.

‘3. Because the Escrow Account balance onk becomes available to the Distribution Fund on termination of the Iicence, no allowance

has been made in the above table in respect of this, although CameloYs Profit and Loss accounts for the period concerned included

f 19.4 million shown as pafl of the sums accruing to the Distribution Fund, in recognition of their obligation. To that efient the figures

shown under “Came/ofs Retention” are overstated.

E90.4 million. Since, however, the balance of the Escrow Account is notexpected to be available to the Distribution Fund until 30 September 2001, ithas not been included in the Distribution Fund payments in figue Al; and

. ticlude the value of income to the Dishibution Fund generated by anci~a~activities (eg sale of broadcasting rights etc). Figme Al includes only incomearising directly from ticket sales.

59

PA~ENTSTOTHENATIONM LO~ERY DISTRIB~lON FUND

4 Over the period from lauuch uutil 31 March 1996, sales were 68.6 per centhigher than expected. The net effect of aUthe relevant Section 5 hcenceconditions was that the Distribution Fund received 30.3 per cent of ticket salesrevenue, against a forecast of 25.7 per cent. Both the prize total and Camelot,although receiving a reduced percentage share of total revenues, benefited inabsolute terms.

Sales revenues and Distribution Fund income -changes

5 The interaction of the relevant Section 5 Llcence conditions has imphcations forthe allocation of ticket sales revenues both:

● over time, and

. at different sales volumes

Changes over time

6 The way in which the allocation of ticket sales revenues changes over thehfetime of the Section 5 licence is illustrated in Figure AZ opposite, using thesales figures forecast by Camelot in its original Section 5 ficence apphcation. ASalready noted, as at 31 March 1996, actual sales were a httle under 70 per centahead of forecast. Mthough if this trend were to continue Figure AZ wmddrequire revision, the key messages drawn from tils analysis wodd remainunchanged. In compihng Figure AZ it has been assumed that lottery duty wi~remain at 12 per cent while any changes necessary to accommodatemovements in the Retail Price Index have been ignored.

7 The main point emerging from Figure A2 is that Camelot’s share of ticketrevenues dechnes sharply over time, Camelot budgeted to retain 14.9 per centof ticket sales income in the first (part) year of the hcence period reducing, otherthings being equal, to 9.4 per cent of revenue by the end of the Ecence period,with the Distribution Fund share increasing from 25,9 to 28.7 per cent.

Changes in sales volumes8 The propotilon of ticket sales revenue absorbed in lottery duty and the target

prize total are freed for each year of the hcence, irrespective of the total volumeof sales. In year one, for example, lottery duty was 12 per cent, w~e the targetfor prize payments was set at 53.64 per cent of net sales (see Figure 4 in mainbody of this report). However, the percentage of revenue paid to the DistributionFund via the ticket sales payment, varies with total sales volume, with theproportion accruing to the Distribution Fund increasing as sales increase, andthe percentage retained by Camelot reducing.

60

PA~ENTS TO THE NATIONAL LOTTERYDISTRIBUTIONFUND

The Ucence application envissged CameIors retention reducing by approximately one third over the hfe of the ticence, with the Oistflbufion Fundbeing the main beneticiay through increases in the Tcket Sales Payment,,,

Year-ending Forecast Sales Duty.f Target Prize Ticket Sales Camelot’s

31 March (gross) Total’2 Paymerr{s Reterrtiorr”4

1995

1996

i 997

1998

1999

200D

2001

2002

Total

Source:

Notes:

fm

S50.O

2,950.0

4,160.0

5,075.0

5,212.0

5,350.0

5,485.0

2,810.0

fm

102.0

354.0499.2

609.0625.4

642.0

658.2

337.2

Y.

12.0

12.0

12.012.012.012,0

12.0

12.0

fm

401.2

1,494,3

2,099,8

2,517.0

2,583,2

2,669.9

2,737.3

1.401.6

“/0

47,2

50,7

50,5

49.6

49.6

49.9

49.9

49.9

fm

220,3

719,0

1,098,8

1,432.3

1,497.0

1,522.3

1,564.7

805.9

“/0

25,9

24,4

26,4

28.2

2S.7

2S.5

2S.5

2S.7

fm

126.5

362.7

462.2

516.7

506.4

515.s

524.S

265.3

31,s92.0 3, S27.0 12.0 15,904.3 49.9 8,860.3 27.0 3,300.4

Natimra/Audit Office arraksis of data taken from Camelo?s Section 5 Iicence application and from the Section 5 Iicence.

‘1. Lottery Duty of f2percerrt assumed unchanged throughout Iicenceperiod.

“/0

14.9

13.0

11.1

10.2

9.7

9.6

9.6

9.4

10.3

*2. These percentages are expressed on gross sales revenue. They are not directk comparable therefore with the percentages in figure 4,

which are calculated from net sales revenue, but they can be derived from them.

*3. These percentages are expressed on gross sales revenue. They are not directk comparable therefore with the percentages in figure 5,

which are calculated from net sales revenue, but they can be derived from them.

‘4. Sales minus (Oufy+ Prizes+ Distribution Fund).

General: The amounts in the above table have been calculated byappving the relevant financial conditions in the Section 5 Iicerrce to the

sales figures in the left hand column, and rounding the results to the nearest decimal of f million. The percentages have been calculated from the

amounts in the columns and the relevant sales figure, rounded to the nearest decimal. Because of this method of calculation, the tible will not

always crosscast.

9 Over the whole licence period, the value of the ticket eales payment to theDistribution Fund forecast in Camelot’s apphcation equates to 27.8 per cent ofgross revenue. It has already been noted, however, that sales to 31 March 1996were some 70 per cent ahead of forecast. Sales at this level, maintained overthe whole Ucence period, wotid increase the Distribution Fund contribution to29.2 per cent, with a comesponding reduction in Camelot’s retention. This isillustrated in Figure A3 overleaf, which also shows the effect in cash terms; iewhile a 70 per cent increase in sales wotid generate a reduction in thepercentage retained by Camelot, it wotid nevertheless produce an overaUincrease in the cash value of that retention from E3,300.4 milfion toS4,851.7 milhmr over the hcence period.

61

PA~ENTS TO THE NATIONM LOTTERYDISTRIBUTIONFUND

Although Hgure 5 showed that the marginal rate of Tcket Sales Payment increased sharply as ticket sales increased, the sverage mte is much more

stable, with a 70”A increase in sales generating an increase in the Ticket Sales Payment from 27.8 percent of gross sales to 29.2 per cent...

Sales Level

forecast”1

+1o

+20

+30

+40+50

+60

+70 .2

+80

+90

+100

Sales

(gross)

Em

31,892.0

35,081.2

38,270.4

41,459.6

44,648a47,B3a.o

51,027.2

54,216.4

57,405.6

60,594.8

63,784.0

Duly

Em

3,827.0

4,209.7

4,592.4

4,975.2

5,357.95,740.6

6,123.3

6,506.0

6,888.7

7,271.4

7,654,1

“/0

12.0

12.0

12.0

12.0

12.012.0

12.0

12.0

12.0

12.0

12.0

Targel Prize

Total

fm “/0

15,904.3 49.9

17,494.7 49.9

19,085.1 49.9

20,675.6 49.9

22,266.0 49.923,856.4 49.9

25,446.8 49.9

27,037.3 49.9

28,627.7 49.9

30,218.1 49.9

31,808.6 49,9

~cket Sales

Paymant’3

8,860.3 27.8

9,854.2 28,1

10,848.2 28.3

11,842.9 28.6

12,837.5 28.813,832.2 28.9

14,826.8 29.1

15,621.4 29.2

16,a16.9 29.3

17,813.9 29.4

18,810,9 29.5

Camaloi’s Retenfion’3

fm

3,300.4

3,522.6

3,744.7

3,965.9

4.187.44,408.8

4,630.3

4,851.7

5,072.3

5,291.4

5,510.4

“/0

10.3

10.0

9.8

9.6

9.49.2

9.1

8.9

8.8

8.7

8.6

Sou~e: Nationa/Audit Ofice ana~sia of data taken from Came/otk Section 5 Iicence application and from the Section 5 Iicence.

Notes: ‘1. Based on the forecast incorporated in Came/oYs Iicence application.

*2. Actual/eve/ of sales achievedin period from launch to 31 March 1996,

*3. Camelot is required to maintain a balance in an EscrowAccount equivalent to 2,5per cent of the value oflotfery tickets sold

in the previous highestyea< less f40 million. The balance on this account reverts to the Distribution Fund on termination of the

iicence, No a~ustment has been made for this in the above table.

General:The amounts in the above table have been calculated byapp~hrg the relevant financial conditions in the Section 5 Iicence to the

sales figures in the left hand column, and rounding the results to the nearest decimal of f million. The percentages have been calculated from the

amounts in the columns and the relevant sales figure, rounded to the nearest decimal. Because of this method of calculation, the table will not

a/ways crosscast.

62

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