The New York Inspector General finally released her report on the incorrect takeout rate by the New York Racing Association over a 15-month period ending in late 2011.  Her report concluded that many were to blame for the error, including one of the state agencies with oversight responsibility for NYRA.

While media reports focused on her conclusion that former CEO Charles Hayward and General Counsel Patrick Kehoe were “derelict” in not discovering the error, if one goes beyond the executive summary and reads the entire 122-page report, it becomes apparent this conclusion was unwarranted concerning Hayward.  Indeed, a fair reading of the report, coupled with a familiarity with the government culture in Albany, would lead to a conclusion that it was politics  –  not malfeasance  –  that led to Governor Andrew Cuomo’s remarkable seizure of  NYRA.

The takeout issue was identified when the State Comptroller uncovered it while reviewing another matter.  (“Takeout” refers to the amount retained by the track from wagers.  The percentage varies depending on the type of wager.  In New York, for example, the track’s current takeout on win wagers is 16% while it is currently 24% on exotic wagers such as the Pick 6.)

A 2008 statute raising the takeout in order to provide additional money to New York City Off Track Betting facilities had a sunset provision, meaning the higher rate expired in September, 2010.  When NYRA realized its mistake at the end of 2011, it took corrective steps, including returning excess money it had retained to winning bettors it could identify.  It provided further relief by lowering the illegal 26% rate to 24%  –  below the 25% it could have retained  –  as a way of making good with its customers.  NYRA also directed its Integrity Counsel to investigate the failure to lower the takeout to determine how it occurred.

In addition to the NYRA review, a separate investigation was undertaken by the Racing and Wagering Board, one of four state agencies that had oversight responsibility for NYRA.  (The Board no longer exists, with its functions being taken over by the State Gaming Commission.)  The Board issued an “Interim Report” on April 26, 2012, in which it identified “serious concerns” and concluded:  “While it is clear NYRA knew they were collecting an inappropriate rate based on an August 2011 email, they decided to continue to collect the excess takeout in violation of the Racing Law….”

Although the Board had not reviewed the numerous documents it had requested but not yet received, and did not interview a single person, the Interim Report set in motion a chain of events that led to the termination of NYRA CEO Charles Hayward and General Counsel Patrick Kehoe by NYRA’s Board, and an agreement on legislation placing NYRA under state control  –  all within a matter of four weeks.

Robert Megna, then the Chair of the Franchise Oversight Board, asked the Inspector General to investigate the takeout issue on April 29, 2012.  On Monday of this week, following an examination of “over 800,000 document pages” and interviews of 60 individuals, Inspector General Catherine Leahy Scott released her report.  There was no one mentioned in the report who had any responsibility for takeout rates that was left unscathed.  Those who were found to have some level of culpability included low-level staff at NYRA, outside auditors for NYRA and its totalisator company, the Racing and Wagering Board, members of the NYRA Board and NYRA senior executives.

For a project that consumed more than two years and obviously entailed a substantial amount of work  —  22 people from the IG staff are identified  –  there is remarkably little that is new in terms of significant findings.  Indeed, NYRA’s Integrity Counsel reached much of the same conclusions in early 2012.   That the takeout rate created in 2008 should have reverted to its prior level in September 2010 is well known.  It is surprising, however, that NYRA’s two top attorneys not only missed the expiration date of the takeout increase, but more remarkably did not interpret the law correctly, despite several opportunities to reexamine their assumptions.

What I think is new and significant is the involvement of Hayward and his explanations for why he did not address the erroneous takeout earlier.  Also significant is the complete lack of any discussion by the Inspector General on the political environment.  While she may not think that is her role as an Inspector General, it is certainly a topic that should be addressed by the media.

Central to Hayward’s involvement is the “August 2011 email” that was mentioned so prominently in the Racing and Wagering Board’s Interim Report that triggered the cascade of dramatic changes for New York racing.  Because it is so significant, it will be discussed fully.  Here is the relevant text of the email from an unidentified bettor that was sent to the Daily Racing Form‘s Steven Crist, who the IG Report describes as a friend of Hayward’s:

The 2008 NYCOTB takeout increase legislation included a sunset provision that went into effect on September 15, 2010. … The takeout limits allowed by law are now 12-17% for w/p/s, 14-21% for exacta/double wager 15-25% for tris/super and P3/4 and 15-36% for P6 with no separate rates for carryover and non-carryover pools.  (Please note that the tri/super/P3/P4 takeout is currently at 26% which is currently outside the parameters of the law.)

NYRA may be waiting for the VLT money before they lower any takeouts, but if NYRA wanted to lower takeout all they have to do is make a request to the NYSRWB, which would most likely to [sic] approve the request.

Crist asked Hayward if this was true, to which Hayward responded:

This gentleman is correct.  Off the record, we have been working on this for some time.  We originally had thought that we would announce this for Saratoga but political forces intervened.  Since we are showing substantial losses in 2010 and 2011 and we have been smacked around by Cuomo (and he could check the SRWB from approving), we decided to wait.  Also, the regional OTBs who collectively lost money in 2010 will scream like stuck pigs and that would provoke Skelos who is very tight with the guys who run Nassau OTB to introduce anti-NYRA legislation for the benefit of the OTBs.  Finally, we are quietly working on a plan to open 10 or so restaurant/bars in the city and we did not want the politicos to block this effort.

We have had some internal debates on how much to lower each pool and how we would present this to our simo customers, the consumers and the politicos.  I would appreciate it if you could keep these details confidential.  I would also welcome a further discussion on this topic with you before the meet is over.

Before we look at what Hayward said to the the IG regarding this exchange, let’s look at what he said in the response.  After saying, “[t]his gentleman is correct,” he immediately moves into NYRA’s hope that all takeout rates can be lowered.  This is not only consistent with his personal views, but also conforms to NYRA’s opposition to increasing the takeout rates when the 2008 legislation was enacted.  The IG Reports confirms this has been NYRA’s consistent position during this period.

The IG, recognizing the centrality of this exchange to the conclusions of the Racing Board’s Interim Report,  is implicitly critical of the Board’s failure to conduct any interviews.  Noting that the IG’s interview of Hayward on this email exchange required 15 pages of transcript, the Report states that their actually speaking with Hayward provided “greater insight.”

Hayward said his response addressed only the second paragraph of the bettor’s email, not the first:

And in my response, I say we’ve been smacked around by Cuomo, and he could check the Racing and Wagering Board from approving.  Now if I knew we were outside the statutory law.  Would I suggest that Cuomo might not approve that by the Racing and Wagering Board?  I don’t think I would.

(Quotation is as it appears in the IG Report.)

The IG’s Report acknowledges that Hayward’s statements are consistent with what he told NYRA”s Integrity Counsel in March, 2012.  The Report also documents that Hayward was involved in discussions within NYRA in June, 2011, regarding his goal of reducing takeout rates for all wagers.

There is simply no reason to believe that Hayward thought the increased takeout on exotic wagers had expired at the time of the “August 2011 email.”  NYRA’s lawyers did not think so.  As the IG Report amply demonstrates, NYRA’s top two attorneys not only were oblivious to the statutory sunset provision, but thought the statute permitted an ongoing rate of 26%.  Why would the CEO have a different view?  (I place little stock in the fact that being aware of something in 2008 means you will remember it two years later  –  the basis of the IG’s criticism of many mentioned in her Report.)  As the Report states:

Hayward added, “I believe when I ask a legal question of my general counsel and he gives me an answer, I believe it.”  Indeed, Kehoe summed up the problem in this way to the Inspector General:       “[U]nfortunately, I gave bad advice.”

Given that a CEO relied on consistent  – albeit erroneous  –  advice from a General Counsel with long experience at the business, why would the Inspector General then conclude that Hayward “questionably testified”  –  under oath  –  and that he was “derelict in his duties in failing to take note of NYRA’s noncompliance with the statutory takeout rate for exotic wagers  –  a fact plainly stated in the email?”

I think the answer to that question gets to the second significant aspect of the IG’s Report  –  the effect of New York’s political environment on this matter.  Even though both Hayward and Kehoe raised political considerations in explaining what they were thinking during the period under review, the Report does nothing more than quote them.  Now the Inspector General may feel constrained from discussing such realities, but I feel no such limitations.

The plain fact is that almost every aspect of this event has been deeply infused with politics.  Start with the fact that Off Track Betting facilities in New York are laced with political influence and patronage.  Why else would a horse race betting franchise in New York City be unable to operate at a profit?  Why would other OTB’s in the state be facing similar troubles?  The 2008 legislation increasing takeout rates had as its express purpose bailing out the bankrupt New York City OTB’s.

So Hayward’s (and Kehoe’s) view that political considerations were in play when they wanted to lower all takeout rates, and that opposition was expected from the “politicos” was not some kind of paranoid delusion  It’s the same with Hayward’s anticipated resistance to bringing betting terminals to restaurants and bars so residents of the nation’s largest city could make an occasional wager on a horse race.  (As the IG Report notes, wagering handle is the most significant part of NYRA’s revenue stream.  Before NYCOTB closed in 2011, simulcasting revenue accounted for 60 per cent of NYRA’s total revenue.  It dropped to 43 per cent in 2011.  But three years later there has been no progress in restoring such a vital part of NYRA’s business.)

The long knives came out at the end of 2011 when it was revealed that NYRA had mistakenly failed to decrease one takeout rate, even though Hayward acknowledged the mistake and NYRA took immediate corrective action.  Robert Megna, whose day job is as Cuomo’s Budget Director, has also served as the Administration’s point person on racing issues.  He was Chair of the Franchise Oversight Board when the takeout error was discovered, and directed the Racing and Wagering Board to conduct a review.

When the Interim Report was released, Megna referred the matter to the Inspector General to investigate further.  Megna’s choice of the IG is interesting.  While many may assume that an Inspector General is an independent person not subject to political influence, that is not the case in New York.  Instead, the IG is appointed by the Governor, and her term in office ends when the Governor’s does.  If Megna were interested in a truly independent review, he would have sent it to the Comptroller.  But he got what he wanted.

Inspector General Scott thus ignored the overwhelming evidence and concluded that Hayward was “derelict” in fulfilling his responsibilities.  I understand that the leader of an organization is the one ultimately accountable for what happens on his watch, but I do not think relying on the advice of two seasoned attorneys with experience in the organization makes one “derelict.”  It is usually the ignoring of legal advice that leds to that accusation.

Scott also fails to mention one of the central documents in this whole matter  –  and, once again, Megna is at the center of it.  On May 15, 2012, Megna and John Sabini, then head of the Racing and Wagering Board, sent a remarkable letter to the Chairman of the NYRA Board in which they impugned the integrity, character and fitness of Board members and threatened to rescind their licenses to participate in racing.  What was the offense?  It wasn’t the failure to catch the incorrect takeout rate.  Rather, it was their temerity in selecting replacements for Hayward and Kehoe.

While the newly selected CEO and General Counsel continued to serve, the threats and intimidation by Megna and Sabini served its purpose.  It cowed the old NYRA Board into an agreement in which the Board ceded power and control to the Governor.  Legislation was soon enacted to make the Cuomo coup official.  There is, of course, nothing positive the IG could say about these tactics of the Cuomo Administration, so we can presume that explains why there is no mention of this letter.  (A similar reticence did not prevent her from identifying Board members who failed to disclose their ownership of horses, even though this tidbit had no connection to the takeout issue.  I mean, who knew that Ogden Mills Phipps owned race horses?)

It’s not surprising that the Inspector General, as an appointee of the Governor, tiptoed around behavior by top officials that embarrass the Governor  –  perhaps I should say, “should embarrass the Governor.”  She is to be given credit, however, for including in her Report the evidence upon which a reasonable person would conclude that former CEO Hayward  acted appropriately.  But she did not reach that conclusion.

After all, we could not have a determination by the Governor’s Inspector General that the Governor’s basis for taking control of New York’s racing was based on a falsehood  –   that Charles Hayward was deliberately violating the law.  Had the Racing and Wagering Board simply taken the step of interviewing him  –  an action required by basic decency if not good government  –  they would have heard the same explanation he had given NYRA’s Integrity Counsel a month earlier.  But decency, good government and the truth were apparently not considerations for the Governor and his men who were determined to get their hands on NYRA  –  no matter who had to be trampled in the process.