Legislative auditors sharply criticized the State Lottery Agency yesterday for serious management and oversight failures, saying some of its findings were so significant that they have been sent to state prosecutors for criminal investigation.

The audit - made public yesterday - found such problems as the payment of at least $112,000 on instant tickets that hadn't been issued but had been improperly "activated" by a lottery employee, permitting them to be fraudulently cashed. That employee was dismissed.

Auditors also found the Maryland Lottery had paid $86,000 to people holding nonwinning lottery tickets because a contractor - on three occasions - entered incorrect numbers into an automated system that retail outlets use when they check for winning ticket numbers on games such as Pick 4.

And auditors found the lottery lost $1.4 million on a game called "Let It Ride." Independent analysts had warned the game was too complicated and confusing for players - and it was shut down six months after its launch in April 2001 because of poor sales.

The findings of generally poor oversight and other problems prompted auditors to give the lottery agency an "unsatisfactory" rating, which triggers an automatic follow-up audit in six months. State agencies are generally audited about every three years.

Legislative auditor Bruce A. Myers said such a rating is uncommon. The lottery was one of three state agencies to be rated unsatisfactory out of about 80 that underwent fiscal compliance audits this year, he said.

"We identified numerous serious matters," Myers said.

The audit is scheduled to be reviewed at a hearing Wednesday of the General Assembly's Joint Audit Committee.

Lottery Director Buddy Roogow said the agency acted quickly to deal with the case involving allegations of fraud by the former employee. He said the other problems cited by auditors are also being fixed.

"We have recognized the shortfalls in our system and have addressed, or are addressing, every item that [auditors] have identified," Roogow said.

He said the problems that auditors found are no reflection on the integrity of the lottery's operations. "This is the first bump in the road we've had in years," Roogow said.

The lottery generated gross revenues of $1.3 billion for the fiscal year that ended June 30. Of that amount, $733 million went to players as prize money and $416 million went to the state's general fund.

Tarnished image

The highly critical, 42-page audit report tarnishes the lottery agency at a time when Gov.-elect Robert L. Ehrlich Jr. is proposing that the lottery oversee slot machines at horse tracks in Maryland - if slots legislation wins Assembly approval in the coming session.

Perhaps the most serious incident cited by auditors was that involving an employee who improperly activated $232,000 worth of instant scratch-off tickets at a lottery warehouse over a period of 15 months.

"Winning tickets cashed from these improperly activated tickets were estimated to be at least $112,000," Myers wrote in a letter to the Assembly's audit committee chairmen.

Activating the tickets before they were issued allowed them to be scratched off and the winning tickets from the batch cashed in at retail sales outlets. Normally, the tickets are activated by vendors as they put them out for sale, according to lottery officials.

Myers wrote that the problem would not have occurred if the lottery had followed the recommendations of two previous audits to segregate certain employee duties. Employees with access to the instant ticket inventory were not supposed to be in a position to activate them, he said.

Roogow said he had told a subordinate, no longer with the lottery, to restrict access of those who could activate instant tickets after the previous audit findings. He said he was shocked when he discovered that it had not been done.

The lottery discovered the problem in August last year, Roogow said, when a sales agent who was visiting a retailer found a cashed, winning instant lottery ticket for a game that had not yet been released for sale to the public.

The ticket was traced to a retailer whose account had been charged for a batch of new tickets but who had never received them, Roogow said.

He said warehouse surveillance tapes showed an employee at a computer during "odd hours." Although the man denied it, lottery officials believed that he was possibly activating books of tickets, Roogow said.

"He was terminated almost immediately," Roogow said. "We reported it to the attorney general's office and turned everything over to them." He declined to identify the former employee.

Carolyn H. Henneman, who heads the attorney general's criminal investigations division, confirmed that a referral had been made to her office but declined to comment further.

Roogow said of the incident: "It pains me. It's something I feel puts the lottery in a bad light, but as soon as we found out about it we stopped it. We cured it, reported it to the proper authorities and we made sure it can't happen again."

Oversight faulted

Auditors also faulted the lottery for what they described as lax oversight of New Jersey-based Automated Wagering Inc., the contractor hired to run the state's online lottery games.

"The on-line contractor entered incorrect winning lottery numbers in the automated system on three occasions that resulted in payouts of $86,000 on non-winning tickets," the auditors found. "Although the contract stipulated that the contractor was liable for payments made as a result of its errors, the agency did not attempt to recover the non-winning ticket payouts."

Roogow said he chose not to penalize the company because it was entering the numbers at the lottery's request, even though it was not contractually obligated to do so.

He said he has assessed penalties in circumstances where the state lost sales because of computer problems or other errors by the company.

Roogow said AWI has paid more than $1 million in penalties since 1996 because of incidents in which the lottery has lost sales and revenue.

As a new administration prepares to take over in Annapolis, Roogow's future as lottery director is uncertain.

He said he has talked to representatives of Ehrlich's transition team about his desire to continue as lottery director but hasn't been advised of his status.

"I very much enjoy this job and would very much like to remain," he said.