[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
ROYALTIES AT RISK
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OVERSIGHT HEARING
before the
COMMITTEE ON NATURAL RESOURCES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
Wednesday, March 28, 2007
__________
Serial No. 110-9
__________
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COMMITTEE ON NATURAL RESOURCES
NICK J. RAHALL II, West Virginia, Chairman
DON YOUNG, Alaska, Ranking Republican Member
Dale E. Kildee, Michigan Jim Saxton, New Jersey
Eni F.H. Faleomavaega, American Elton Gallegly, California
Samoa John J. Duncan, Jr., Tennessee
Neil Abercrombie, Hawaii Wayne T. Gilchrest, Maryland
Solomon P. Ortiz, Texas Ken Calvert, California
Frank Pallone, Jr., New Jersey Chris Cannon, Utah
Donna M. Christensen, Virgin Thomas G. Tancredo, Colorado
Islands Jeff Flake, Arizona
Grace F. Napolitano, California Stevan Pearce, New Mexico
Rush D. Holt, New Jersey Henry E. Brown, Jr., South
Raul M. Grijalva, Arizona Carolina
Madeleine Z. Bordallo, Guam Luis G. Fortuno, Puerto Rico
Jim Costa, California Cathy McMorris Rodgers, Washington
Dan Boren, Oklahoma Bobby Jindal, Louisiana
John P. Sarbanes, Maryland Louie Gohmert, Texas
George Miller, California Tom Cole, Oklahoma
Edward J. Markey, Massachusetts Rob Bishop, Utah
Peter A. DeFazio, Oregon Bill Shuster, Pennsylvania
Maurice D. Hinchey, New York Dean Heller, Nevada
Patrick J. Kennedy, Rhode Island Bill Sali, Idaho
Ron Kind, Wisconsin Doug Lamborn, Colorado
Lois Capps, California Vacancy
Jay Inslee, Washington
Mark Udall, Colorado
Joe Baca, California
Hilda L. Solis, California
Stephanie Herseth, South Dakota
Heath Shuler, North Carolina
James H. Zoia, Chief of Staff
Jeffrey P. Petrich, Chief Counsel
Lloyd Jones, Republican Staff Director
Lisa Pittman, Republican Chief Counsel
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CONTENTS
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Page
Hearing held on Wednesday, March 28, 2007........................ 1
Statement of Members:
Pearce, Hon. Stevan, a Representative in Congress from the
State of New Mexico........................................ 2
Rahall, Hon. Nick J., II, a Representative in Congress from
the State of West Virginia................................. 1
Statement of Witnesses:
Alexander, Ryan, President, Taxpayers for Common Sense....... 49
Prepared statement of.................................... 50
Allred, Hon. C. Stephen, Assistant Secretary, Land and
Minerals Management, U.S. Department of the Interior....... 12
Prepared statement of.................................... 15
Bucy, Pamela, Frank M. Bainbridge Professor of Law,
University of Alabama School of Law........................ 71
Prepared statement of.................................... 73
Gaffigan, Mark, Acting Director, Natural Resources and
Environment, Government Accountability Office.............. 4
Prepared statement of.................................... 5
Response to questions submitted for the record........... 11
Gambrell, Kevin L., Indian Land Working Group................ 37
Prepared statement of.................................... 39
Response to questions submitted for the record........... 43
Geesey, Michael, Director, Wyoming Department of Audit....... 69
Prepared statement of.................................... 70
Lester, A. David, Executive Director, Council of Energy
Resource Tribes............................................ 63
Prepared statement of.................................... 65
Maxwell, Bobby L., Former Auditor, Minerals Management
Service.................................................... 33
Prepared statement of.................................... 34
Roller, Dennis, Audit Manager, North Dakota State Auditor's
Office, Royalty Audit Section.............................. 58
Prepared statement of.................................... 60
Additional materials supplied:
Pica, Erich G., Director of Domestic Programs, Friends of the
Earth, Statement submitted for the record.................. 89
OVERSIGHT HEARING ON
``ROYALTIES AT RISK''
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Wednesday, March 28, 2007
U.S. House of Representatives
Committee on Natural Resources
Washington, D.C.
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The Committee met, pursuant to call, at 11:00 a.m. in Room
1324, Longworth House Office Building, Hon. Nick J. Rahall, II
[Chairman of the Committee] presiding.
Present: Representatives Rahall, Christensen, Grijalva,
Bordallo, Costa, Kind, Inslee, Baca, Flake, Pearce, Brown,
McMorris Rodgers and Lamborn.
STATEMENT OF THE HONORABLE NICK J. RAHALL, II, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF WEST VIRGINIA
The Chairman. The Committee on Natural Resources will come
to order and is convening today to conduct a hearing on
Royalties at Risk.
In recent years, many of us have witnessed a sorry pattern
across the spectrum of Federal agencies. At every henhouse a
fox is stationed. The well-connected few are rewarded at the
expense of the common folk, and all the while the people's
branch has been looking the other way.
The Minerals Management Service exemplifies this troubling
pattern. Throughout the last several years, the MMS seems to
have drifted further and further into the grasp of the oil and
gas industry. No doubt this occurred in part because of the
agency's dual and conflicting roles.
On the one hand the MMS is charged with developing energy
resources on our public lands. On the other hand, it is
supposed to collect at a fair value payment owed to people for
the development of the resources they own. But something has
gone wrong. Development has been thriving. Oil and gas drilling
has dramatically increased. It is obvious by the sheer number
of rigs that are sprouting up all over the West and drilling
platforms in the Gulf of Mexico.
The energy development function at the MMS has been running
at full throttle, but when it comes to collecting the payment
due to the people, the agency has stalled. At best its
performance might be described as slipshod, but some argue it
is something more sinister.
Further complicating the collection capability of the MMS
is the Royalty-in-Kind program, a program over which I have
consistently in my years in Congress raised concerns. The RIK
program was designed to allow energy companies to pay the
government in product rather than in cash, but it has become an
elusive mess.
For the MMS, tracking money was hard enough, but following
the flow of oil has proven to be a slippery business indeed. By
some accounts the Royalty-in-Kind program has served as a giant
loophole, allowing wealthy companies to forego fair payment to
the public.
To make matters worse, in 2000 the agency further watered
down its audit function through a process known as compliance
review. Under this regime, fewer and fewer audits are being
conducted even as more and more energy is being produced.
Some seasoned auditors tried to raise red flags, but they
were ignored or they were pushed aside. As a result, the people
back home who are struggling to pay the mortgage, buy the
groceries and pay their annual tax bill have been getting
tougher treatment from Uncle Sam than do wealthy multinational
oil conglomerates.
The MMS by necessity works closely with representatives of
the oil and gas industry, but in far too many cases that
closeness has taken on the distasteful appearance of coziness.
It is becoming clear that the agency has acted to the benefit
of the industry and to the detriment of the public.
The recurring questions are: To what extent did it do so
deliberately? How can it be fixed? What can be done to prevent
it from happening again?
This committee has long neglected its duty to explore these
questions. That ends now. From the moment I took over this
chairmanship, I said that we would exercise vigorously and
fully our constitutional responsibilities of oversight. That is
what we begin today.
I thank the witnesses for taking the time to be with us,
and I look forward to hearing their testimony. Before I do, I
will recognize the acting Ranking Member, the gentleman from
New Mexico, Mr. Pearce.
STATEMENT OF STEVAN PEARCE, A REPRESENTATIVE IN CONGRESS FROM
THE STATE OF NEW MEXICO
Mr. Pearce. Thank you, Mr. Chairman. I am excited to join
you at today's hearing, Royalties at Risk. Like yesterday's
hearing, I must say that the title gives me pause because of
the perception that it creates.
We learned yesterday that of the 262 million acres of BLM
land, less than five percent of that land is being used for oil
and gas production. The other 95 percent of BLM lands has no
oil, no gas production, even though treasured resources are
there.
Similarly, only 15 percent of the National Wildlife Refuge
System has oil and gas activities. Furthermore, not a drop--
zero percent--of our parklands permit oil and gas activities.
We learned last Congress that less than three percent of our
Outer Continental Shelf is being leased for oil and gas
production.
The Outer Continental Shelf and our Federal lands aren't
generating any royalties, any of the royalties that it could
be, because most of it is off limits. Those are the royalties
at risk. If we continue to follow the San Francisco energy
policy, those are the royalties at risk we should be
discussing.
This hearing is a classic example of penny wise and pound
foolish. There are billions of dollars of Federal royalties
left on the table because more and more of our Federal lands
where much of the energy is remains off limits.
For example, a recent Congressional Research Service study
regarding the Arctic National Wildlife Refuge, ANWR, estimated
the prospective royalty revenue at $36 billion. In addition,
corporate income tax revenue from ANWR was estimated at $75
billion.
I don't mean to suggest that we must not demand that the
American taxpayer is fairly compensated for existing oil and
gas production, but it is a great shame that the truth of our
tremendous energy resource and the associated royalties are
being hidden from the American public.
I know that today's testimony will include a discussion of
the MMS Royalty-in-Kind program. I have been a supporter of
collecting royalties in kind because it is simpler to take a
straight percentage of a meter reading rather than to work in a
system of dueling auditors over oil's production value. Any
time you have money involved, you will attract lawyers and
auditors like regulations to bureaucrats.
Every grade school child understands the concept of one for
me and one for you. Royalty-in-Kind is much simpler than all of
this production value dueling and fighting. Simply put, the
more plumbing you have, the more ways there are to clog up the
drain.
I worked in the oil and gas industry, and the truth is the
matter of trying to value oil is not a simple task. It is a
commodity whose price is different every day, depending on
where you are. The price for our West Texas crude in eastern
New Mexico was always valued at less because it had a lesser
quality and a higher cost at the refinery.
When prices were low, oil servicemen like me hurt, and when
prices were high you knew that you could make your house
payment. That price changes daily and by location. To this end,
I look forward to hearing from Assistant Secretary Allred
regarding MMS' Royalty-in-Kind program and the progress you
have made so that we may put an end to dueling auditors.
Again, I look forward to the testimony and discussions.
Welcome to all of you, and thank you again, Mr. Chairman.
The Chairman. Do any other Members have opening statements?
[No response.]
The Chairman. OK. If not, we will proceed with the panel.
Panel I is The Honorable C. Stephen Allred, Assistant
Secretary, Department of Interior, and Mr. Mark Gaffigan,
Acting Director, National Resource and Environment, Government
Accountability Office.
Gentlemen, we thank you for being with us today. We have
your written testimony. It will be made part of the record as
if actually read, and you may proceed as you wish.
STATEMENT OF MARK GAFFIGAN, ACTING DIRECTOR, NATIONAL RESOURCE
AND ENVIRONMENT, GOVERNMENT ACCOUNTABILITY OFFICE
Mr. Gaffigan. Mr. Chairman, Mr. Pearce, Members of the
Committee, good morning. I am pleased to be here to discuss the
Minerals Management Service's management of Federal royalty
revenues collected from energy resources produced from Federal
lands and waters.
Federal lands and waters provide a significant amount of
revenue and energy to the American people. Most notably, about
$10 billion in annual oil and gas royalty revenue is generated
from Federal production that supplies about one-third of all
the oil and one-quarter of all the natural gas produced in the
United States. In addition, Federal lands and waters also
provide increasingly important renewable resources such as
geothermal energy.
M.M.S. has strived to meet the challenging responsibility
of managing these resources, but our oversight work has
highlighted some problems that require attention. In my
testimony today, I would like to touch upon three areas of our
royalties work that point to the need for ongoing attention:
Royalty relief, royalties-in-kind and geothermal energy
royalties.
First, royalty relief. The waiver or reduction of royalties
in order to encourage the development of oil and natural gas
has been fraught with problems. Specifically, a series of
mistakes and legal challenges in implementing relief under the
1995 Deep Water Royalty Relief Act will likely add billions in
unanticipated cost for taxpayers.
As has been widely reported, price thresholds, provisions
designed to limit royalty relief in the event of the high
prices we are experiencing today, were left off of over 1,000
leases issued in 1998 and 1999. Today, the lack of these
thresholds has already cost about $1 billion in foregone
royalty revenue.
In addition, current estimates by MMS indicate a range of
future foregone royalties of between $6.4 and $9.8 billion.
Adding to this problem, a current lawsuit is questioning
whether MMS even has the authority to establish price
thresholds for any of the leases issued under the 1995 Act,
thus bringing into question over 2,000 more leases issued in
1996, 1997 and 2000. If the case is lost, this could add
billions more in foregone revenue.
However, not every Federal lease provides royalty free oil
and gas to producers. In fact, on most leases royalties are
actually paid by producers and collected by the Federal
government. Unfortunately, determining proper royalty cash
payments has a history of costly, administratively difficult
problems resulting from disputes and litigation over the value
of oil and gas.
As an alternative to collecting royalties and cash, MMS can
choose to accept a portion of the actual oil and gas produced
to sell itself, known as taking royalties-in-kind or RIK. We
reviewed the RIK program in 2003 and 2004 and found shortfalls
in data and information systems that limited the ability to
determine how well RIK was doing.
We made recommendations to improve RIK, and MMS was very
responsive in implementing them. However, the RIK program has
grown significantly, with MMS receiving one-third of its
revenue from RIK in Fiscal Year 2005. This raises questions
about the ability to effectively manage RIK at these much
higher levels. At the request of Congress, we are about to
begin an updated look at RIK, ensuring that this important
program has continued oversight.
Finally, while MMS has faced significant challenges in
managing oil and gas royalties, other energy resources also
demand attention. For example, our 2006 review of geothermal
royalties found that about 40 percent of MMS royalty data for
the geothermal projects we looked at was either missing or
erroneous. As with oil and gas, the lack of good data and
information limits the ability of MMS to fulfill its royalty
management responsibilities.
M.M.S. is charged with an important responsibility in
balancing the goals of developing Federal energy resources
while ensuring a fair return for the American people.
Unfortunately, royalty management problems have created a sea
of uncertainty about future development and a crisis of
confidence for the American taxpayer that overshadows both
goals.
As we continue our work, GAO looks forward to assisting the
Congress and MMS to ensure that royalty management continues to
have oversight attention.
This concludes my opening remarks. I have submitted a
written statement for the record, and I welcome any questions
you might have. Thank you.
[The prepared statement of Mr. Gaffigan follows:]
Statement of Mark Gaffigan, Acting Director, Natural Resources &
Environment, U.S. Government Accountability Office
Mr. Chairman and Members of the Committee:
We are pleased to be here today to discuss our recent work on the
administration of revenues collected from the production of fossil and
renewable energy resources on federal lands and within federal waters.
Companies that develop these resources do so under leases which
generally require the payment of royalties on the resources extracted
and produced. These leases are administered by the Minerals Management
Service (MMS), an agency within the Department of the Interior
(Interior). These resources include geothermal, coal, and, most
notably, oil and natural gas (hereafter oil and gas).
In particular, fossil energy resources from federal lands and
waters are a critical component of the nation's energy portfolio,
supplying more than a third of all the oil and nearly a quarter of all
the natural gas produced in the United States in Fiscal Year 2005. Oil
and gas companies received over $77 billion from the sale of oil and
gas produced from federal lands and waters in Fiscal Year 2006, and
these companies paid the federal government about $10 billion in
royalties.
In order to promote oil and gas production, the federal government
has at times and in specific cases provided ``royalty relief''--the
waiver or reduction of royalties that companies would otherwise be
obligated to pay. When the government grants royalty relief, it
typically specifies the amounts of oil and gas production that will be
exempt from royalties and may also specify that royalty relief is
applicable only if oil and gas prices remain below certain levels,
known as ``price thresholds.'' For example, the Outer Continental Shelf
Deep Water Royalty Relief Act of 1995, also known as the Deep Water
Royalty Relief Act (DWRRA), mandated royalty relief for oil and gas
leases issued in the deep waters of the Gulf of Mexico from 1996 to
2000. These deep water regions are particularly costly to explore and
develop. However, as production from these leases has grown, and as oil
and gas prices have risen dramatically in recent years, serious
questions have been raised about the extent to which royalty relief has
been in the interest of taxpayers. These concerns were brought into
stark relief when it was learned that MMS issued leases in 1998 and
1999 that failed to include the price thresholds above which royalty
relief would no longer be applicable, making large volumes of oil and
natural gas exempt from royalties and significantly affecting the
amount of royalty revenues collected by the federal government. Further
royalty relief is currently available under other legislation and
programs, raising the prospect that the federal government may be
forgoing additional royalty revenues. Recently, congressional
committees, Interior's Inspector General, 1 public interest
groups, and the press have questioned whether our nation's oil and gas
royalties are being properly managed and whether the oil and gas
industry is paying a fair share of revenue to the public resource
owners, especially in light of high oil and gas prices, record industry
profits, and the daunting current and long-range fiscal challenges
facing our nation. GAO has expressed similar concerns, and the U.S.
Comptroller General has highlighted royalty relief as an area needing
additional oversight by the 110th Congress. 2
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\1\ Minerals Management Service's Compliance Review Process,
Department of the Interior Office of the Inspector General, Report No.
C-IN-MMS-0006-2006 (Washington, D.C.: Dec. 2006).
\2\ GAO, Suggested Areas for Oversight for the 110th Congress, GAO-
07-235R (Washington, D.C.: Nov. 17, 2006).
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The MMS is authorized by Congress to collect royalties ``in
value,'' as a fraction of the revenues companies receive from sale of
oil and gas produced on federal leases, or ``in kind,'' as a fraction
of the oil and gas that the MMS then sells to recover the government's
share of oil and gas revenue. With regard to oil, while MMS has long
received relatively small amounts of oil in kind for specific purposes,
such as in a past program that provided royalty oil to small refiners
at subsidized prices, the bulk of royalties have historically been
collected in value. In recent years, however, MMS has taken a growing
proportion of oil royalties in kind. Much of this oil was then
exchanged for other oil that was put into the nation's Strategic
Petroleum Reserve, over 700 million barrels of publicly held crude oil
that is stored to ensure emergency supplies in the event of a
significant disruption in the normal oil supply. Under the Energy
Policy Act of 2005, MMS is charged with ensuring that the revenues it
receives when it sells oil taken in kind are at least as great as the
revenues it would have received had it taken the royalties in value.
The recent expansion of the royalties in kind (RIK) program has raised
the obvious question of whether or not this condition is being met.
While fossil energy resources are significant, the federal
government also manages royalties from renewable sources such as
geothermal energy. Geothermal energy is a unique renewable energy
resource in that it can provide a consistent and uninterrupted supply
of heat and electricity. Companies drill wells to bring the geothermal
fluids and steam to the surface, separate the steam from the fluids as
their pressure drops, and use the steam to spin the blades of a turbine
that generates electricity. The electricity is then sold to utilities
in a manner similar to sales of electricity generated by hydroelectric,
coal-fired, and gas-fired power plants, and the companies pay royalties
based on the electricity sold.
Due, in part, to increasing demand for electricity, interest is
increasing in developing geothermal energy resources as an alternative
form of generation. Because many areas that have the potential to
produce additional geothermal energy are located on federal lands, the
federal government will continue to be a major participant in the
future development of geothermal energy. MMS collects the federal
geothermal royalties and disburses to the state and local governments
its share of these royalties. In 2005, the most recent year for which
data are available, MMS collected $12.3 million in geothermal
royalties, almost all of which was derived from the production of
electricity.
You asked us to provide information from our recent work on the
administration of federal royalty revenues at MMS. My testimony today
(1) updates our work regarding the fiscal impacts of royalty relief for
leases issued under the Deep Water Royalty Relief Act of 1995; (2)
describes our recent work regarding the administration of the royalties
in kind program, as well as ongoing work on this and related issues we
have undertaken for congressional requesters; and (3) provides
information on the challenges to collecting and managing geothermal
royalties that we identified in recent work.
To address these issues, we relied on recent GAO reports related to
MMS's royalty collection systems for oil, gas, and geothermal
resources. As part of our ongoing work, we also reviewed the
methodology and assumptions used by MMS to produce their February 2007
estimate of foregone oil and gas royalties. Our work follows the
issuance of our report last year explaining why oil and gas royalties
have not risen at the same pace as rising oil and gas prices.
3 Our work was conducted in accordance with generally
accepted government auditing standards.
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\3\ GAO, Royalty Revenues: Total Revenues Have Not Increased at the
Same Pace as Rising Natural Gas Prices due to Decreasing Production
Sold, GAO-06-786R (Washington, D.C.: June 21, 2006).
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In summary we found:
The absence of price thresholds in leases issued in 1998
and 1999 has already cost the government about $1 billion and MMS's
most recent estimate indicates a range of future foregone royalties of
between $6.4 billion and $9.8 billion over the lifetime of the leases.
However, because there is considerable uncertainty about future oil and
natural gas prices and production levels, actual foregone royalties
could end up being higher or lower than MMS's estimates. MMS is
currently negotiating with oil and gas companies to apply price
thresholds to future production from the 1998 and 1999 leases. To date,
the results of these negotiations have been mixed--only 6 of the 45
companies involved have agreed to terms. Moreover, a pending legal
challenge to Interior's authority to include price thresholds on any
leases issued under the DWRRA could, if successful, cost the government
billions more in refunded and foregone revenue.
In our most recent audit of the RIK program, conducted in
2004, we found that MMS had not collected the necessary information to
determine whether or not the revenues received from its sales of
royalty oil were equivalent to receiving royalties in value, largely
because it had not developed information systems to rapidly and
efficiently collect this information. We made recommendations to the
Secretary of the Interior that the agency has implemented and that have
improved the administration of the program as it existed at the time.
However, the continued expansion of the program raises additional
questions about the adequacy of the agency's overall management
practices and internal controls to meet the increasing demands of the
program. Accordingly, at the request of Congress, we are undertaking a
follow-on review assessing, among other things, the agency's ability to
quantify and compare administrative costs and revenues of the RIK and
royalties in value programs and the extent to which the revenues
collected under the RIK program are equal to or greater than what would
have been received had they been taken in value.
In a 2006 report on geothermal royalties, we found that
MMS had erroneous and missing historical geothermal royalty data and
did not collect sufficient data from royalty payors to accurately asses
whether MMS was collecting the amount of royalties required by statute.
The Energy Policy Act of 2005 included provisions that significantly
changed how geothermal royalties are calculated but also instructed the
Secretary of the Interior to seek to maintain the same aggregate level
of royalties over the next ten years that would have been collected
prior to the Act's passage. We found that in order to compare royalties
collected under the provisions of the Act with what would have been
collected under the old system would require historical data on gross
revenues from geothermal electricity sales as well as accurate royalty
data. However, we found that MMS did not have sufficient historical
gross revenue data with which to establish a baseline for past
royalties paid as a percentage of electricity revenues. Further, about
40 percent of MMS's royalty data was either missing or erroneous for
the projects we reviewed. In our report we recommended that the
Secretary of the Interior direct MMS to correct these deficiencies and
the agency agreed with our findings and recommendations. We are
continuing to monitor the agency's efforts to address these
shortcomings.
Background
Interior oversees and manages the nation's publicly owned natural
resources, including parks, wildlife habitat, and crude oil and natural
gas resources on over 500 million acres onshore and in the waters of
the Outer Continental Shelf (OCS). In this capacity, Interior is
authorized to lease federal fossil and renewable energy resources and
to collect the royalties associated with their production. These
substantial revenues are disbursed to 38 States, 41 Indian Tribes,
Interior's Office of Trust Funds Management on behalf of some 30,000
individual Indian royalty owners, and to U.S. Treasury accounts.
Royalties paid for fossil and renewable resources extracted from
leased lands represent the principal source of the $12.6 billion in
revenues managed by MMS' $10.7 billion, more than 85 percent of
revenues received in Fiscal Year 2006. 4 Of these, oil and
natural gas leases are the most significant component of royalties,
composing on average nearly 90 percent of the royalties received over
the past five years. For oil and gas, production royalties are paid
either in value or in kind. The OCS Lands Act of 1953, as amended, and
the Mineral Leasing Act of 1920, as amended, authorize the collection
of production royalties either in value or in kind for federal lands
leased for development onshore and on the OCS. Furthermore, according
to MMS, the terms of virtually all federal oil and gas leases provide
for royalties to be paid in value or in kind at the discretion of the
lessor. The Energy Policy Act of 2005 provides additional statutory
requirements to support the operation and funding of a program for
managing federal oil and gas royalties in kind.
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\4\ The remaining $1.9 billion consist of other revenues received
from rent payments and bonuses paid by companies for successful bids on
leases.
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Additionally, MMS also collects revenue generated by exploration
and development of geothermal energy resources commonly used to
generate electricity. 5 Until recently, the Geothermal Steam
Act of 1970, as amended, directed MMS to disburse royalties collected
from geothermal energy development such that 50 percent of geothermal
royalties be retained by the federal government and the other 50
percent be disbursed to the states in which the federal leases are
located. 6 A provision of the Energy Policy Act of 2005
changed the distribution of the royalties collected from geothermal
resources. While 50 percent of federal geothermal royalties must still
be disbursed to the states in which the federal leases are located, an
additional 25 percent must be disbursed to the counties in which the
leases are located, leaving only 25 percent to the federal government.
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\5\ Geothermal energy is literally the heat of the earth. This heat
is abnormally high where hot and molten rocks exist at shallow depths
below the earth's surface. Water, brines, and steam circulating within
these hot rocks are collectively referred to as geothermal resources.
\6\ 30 U.S.C. Sec. 191(a). The State of Alaska is an exception to
this provision, receiving 90 percent.
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Billions of Dollars of Royalty Revenue Will be Foregone Because of
Problems Associated with Royalty Relief
As Assistant Secretary Allred of Interior recently testified before
the Congress, the absence of price thresholds in leases issued in 1998
and 1999 has already cost the government almost $1 billion and MMS has
estimated a range of potential future foregone revenue for these leases
of between $6.4 billion and $9.8 billion. MMS calculated these
estimates under a range of assumptions about oil and natural gas prices
and future production levels. We reviewed MMS's assumptions and
methodology for estimating the potential foregone revenue from 1998 and
1999 leases and found them to be reasonable. However, because there is
considerable uncertainty about future oil and natural gas prices and
production levels, actual foregone royalties could end up being higher
or lower than MMS's estimates.
MMS is currently negotiating with oil and gas companies to apply
price thresholds to future production from the 1998 and 1999 leases. If
successful, this approach would partially undo the omission of price
thresholds for future production, thereby implementing the royalty
relief as though price thresholds had been included in the leases.
However, the results of the negotiation have been mixed so far--as of
late February 2007, only 6 of 45 companies have agreed to terms, and a
current legal challenge to Interior's authority to set price thresholds
on any DWRRA leases may further deter or complicate a negotiated
settlement.
In addition to forgone royalty revenues from leases issued in 1998
and 1999, royalty revenues on leases issued under DWRRA in 1996, 1997,
and 2000 are also threatened pending the outcome of a legal challenge
regarding price thresholds. Specifically, Kerr-McGee filed suit against
the Department of the Interior in early 2006, challenging its authority
to place price thresholds on any of the leases issued under the DWRRA.
In effect, this suit seeks to remove price thresholds from the leases
in question. In June 2006, Kerr-McGee agreed to enter into mediation
with Interior in an attempt to resolve the issue; however, the
mediation was unsuccessful and litigation has resumed. As of March
2007, the leases in question have generated approximately $1 billion in
royalties. If the government loses this legal challenge, it may be
required to refund these royalties--perhaps with interest penalties--
and to forego any future royalties on these leases, and perhaps any
lease issued during 1996, 1997, and 2000. As a result, the government
could stand to lose billions of additional dollars.
The RIK Program Has Been Unable to Demonstrate Its Effectiveness Due to
Data Limitations
We reviewed the RIK pilot program for this committee in two
separate reports in 2003 and 2004 and found that MMS did not collect
the necessary information to effectively monitor and evaluate the
program. 7 This information includes the administrative
costs of the RIK program and the revenue impacts of all sales. We found
that MMS lacked this information largely because it had not developed
information systems to rapidly and efficiently collect this
information.
---------------------------------------------------------------------------
\7\ GAO, Mineral Revenues: A More Systematic Evaluation of the
Royalty-in-Kind Pilots is Needed, GAO-03-296 (Washington, D.C.: Jan. 9,
2003) and GAO, Mineral Revenues: Cost and Revenue Information Needed to
Compare Different Approaches for Collecting Federal Oil and Gas
Royalties, GAO-04-448 (Washington, D.C.: Apr. 16, 2004).
---------------------------------------------------------------------------
We made several recommendations in our 2003 and 2004 reports to
address the shortcomings we identified. Specifically, to further the
development of management controls for MMS's RIK program, we
recommended that the Secretary of the Interior instruct the appropriate
managers within MMS to identify and acquire key information needed to
monitor and evaluate performance prior to expanding the RIK program. We
specified that such information should include the revenue impacts of
all RIK sales, administrative costs of the RIK program, and expected
savings in auditing revenues. We also recommended that MMS clarify the
RIK program's strategic objectives to explicitly state that the goals
of RIK include obtaining fair market value and collecting at least as
much revenue as MMS would have collected in cash royalty payments. MMS
agreed with both recommendations and has taken several steps to address
these shortcomings.
We acknowledge the agency's efforts and, within the context of the
program's scope at the time of our report, consider our recommendations
implemented by the agency. However, the expansion of use of RIK since
our last review raises an additional concern. The RIK program has
actively expanded the scope of its operations as MMS has increasingly
opted to take royalties in kind rather than in cash. As MMS reported in
its September 2006 Report to Congress, today's RIK operation manages a
significant portfolio of the nation's oil and gas royalty assets
collected primarily from federal leases in the Gulf of Mexico. This
portfolio has expanded more than three-fold from 1999 to present--some
82 million barrels of oil equivalent were exchanged in kind in Fiscal
Year 2005--and is expected to continue to grow for the foreseeable
future. The Energy Policy Act of 2005 permanently established an RIK
operation with administrative and business costs to be paid from
royalty revenues generated by RIK sales, effectively transitioning the
program from pilot status to a steady-state business operation and
potentially enabling a further expansion of the RIK program. The Act
restricts the use of RIK to those situations where the benefit is
determined to equal or exceed the benefit from royalties in value prior
to the sale. However, the larger scale of the RIK program at present
makes it unclear that MMS can effectively and accurately make this
determination going forward.
Noting this issue, we are undertaking work for the Congress.
Specifically, we have several ongoing reviews assessing, among other
things, MMS's ability to quantify and compare administrative costs and
revenues of the RIK and royalties in value programs; the effectiveness
of the systems used to collect, account for, and disburse royalties;
and the accuracy of royalty revenue collection, including evaluating
whether the value of RIK payments equal or exceed the value of
royalties that would have been received in value for oil and gas as
required by statute.
MMS Does Not Collect the Data Necessary to Assess Whether Geothermal
Royalties Remain Constant as Required by Law
In a 2006 report on geothermal royalties, we found that MMS had
erroneous and missing historical geothermal electricity revenue data
and did not collect sufficient data from royalty payors to accurately
asses whether MMS was collecting the amount of royalties required by
statute. 8 Specifically, about 40 percent of the royalty
revenue data for royalty payors was either missing or erroneous in the
projects we reviewed. In addition, MMS did not have sufficient
historical gross revenue data for geothermal electricity sales.
---------------------------------------------------------------------------
\8\ GAO, Renewable Energy: Increased Geothermal Development Will
Depend on Overcoming Many Challenges, GAO-06-629 (Washington, D.C.: May
24, 2006), 34-38.
---------------------------------------------------------------------------
MMS is charged with collecting and distributing royalties collected
from the development of geothermal resources used to generate
electricity. The Energy Policy Act of 2005 included provisions that
significantly changed how geothermal royalties are calculated but also
instructed the Secretary of the Interior to seek to maintain the same
level of royalties over the next ten years that would have been
collected prior to the Act's passage. We found that to meet the
statutory requirements, MMS will need to calculate the percentage of
gross sales revenues that lessees will pay in future royalties from
electricity sales and compare this to what lessees would have paid
prior to the Act. In order to compare royalties collected under the
provisions of the Act with what would have been collected under the old
system would require historical data on gross revenues from geothermal
electricity sales as well as accurate royalty data on those sales.
As a result of the insufficient gross revenue data and missing or
erroneous royalty revenue data, MMS is unable to determine if it is
collecting the amount of royalties on geothermal electricity production
as required in statute. In our report we recommended that the Secretary
of the Interior direct MMS to correct these deficiencies and the agency
agreed with our findings and recommendations. We will continue to
monitor the agency's efforts to address these shortcomings.
Conclusions
As seen by all the attention royalties management has received in
the Congress and the media, Interior's performance in managing this
effort is a cause for concern. Billions of dollars have been lost
already and potentially billions more are at risk. In a time of dire
long-term national fiscal challenges it is urgent that this problem be
fixed and the confidence of the American public that the sale of its
national resources is generating a fair return be restored. Our work on
this issue is continuing on multiple levels, including comparing the
value of royalties taken in kind to the value of royalties taken as
cash, reviewing the diligence of resource development, and evaluating
the accuracy of the agency's cost, revenue, and production data.
We look forward to this continued work, and to helping this
committee and the Congress as a whole exercise oversight of this
important issue. Mr. Chairman, this concludes my prepared statement. I
would be pleased to respond to any questions that you or other members
of the Committee may have at this time.
GAO Contact and Staff Acknowledgments
For further information about this testimony, please contact me,
Mark Gaffigan, at 202-512-3841 or [email protected]. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this statement. Contributors to this testimony
include Frank Rusco, Assistant Director; Robert Baney; Ron Belak;
Philip Farah; Doreen Feldman; Glenn Fischer; Dan Haas; Chase Huntley;
Dawn Shorey; Barbara Timmerman; Maria Vargas; and Jacqueline Wade.
Related GAO Products
Oil and Gas Royalties: Royalty Relief Will Likely Cost
the Government Billions, but the Final Costs Have Yet to Be Determined,
GAO-07-369T (Washington, D.C.: Jan. 18, 2007).
Suggested Areas for Oversight for the 110th Congress,
GAO-07-235R (Washington, D.C.: Nov. 17, 2006).
Department of Interior: Royalty-in-Kind Oil and Gas
Preferences, B-307767 (Washington, D.C.: Nov. 13, 2006).
Royalty Revenues: Total Revenues Have Not Increased at
the Same Pace as Rising Natural Gas Prices due to Decreasing Production
Sold, GAO-06-786BR (Washington, D.C.: June 21, 2006).
Renewable Energy: Increased Geothermal Development Will
Depend on Overcoming Many Challenges, GAO-06-629 (Washington, D.C.: May
24, 2006).
Mineral Revenues: Cost and Revenue Information Needed to
Compare Different Approaches for Collecting Federal Oil and Gas
Royalties, GAO-04-448 (Washington, D.C.: Apr. 16, 2004).
Mineral Revenues: A More Systematic Evaluation of the
Royalty-in-Kind Pilots is Needed, GAO-03-296 (Washington, D.C.: Jan. 9,
2003).
ROYALTIES COLLECTION
ongoing problems with interior's efforts to ensure a fair return for
taxpayers require attention
What GAO Found
The absence of price thresholds in oil and gas leases issued by MMS
in 1998 and 1999 has already cost the government about $1 billion and
the agency has recently estimated that future foregone royalties would
be $6.4 billion to $9.8 billion over the lives of the leases. Precise
estimates of the actual foregone royalties, however, are not possible
at this time because future projections are sensitive to price and
production levels, both of which are subject to change. MMS is
currently negotiating with oil and gas companies to apply price
thresholds to future production from these leases, with mixed results--
only 6 of the 45 companies involved have agreed to terms. Moreover, a
pending legal challenge to Interior's authority to include price
thresholds on any leases issued under the Deep Water Royalty Relief Act
could, if successful, cost the government billions more in refunded and
foregone revenue.
In our most recent review of the royalty in kind (RIK) program,
conducted in 2004, we found that MMS was unable to determine whether
the revenues received from its sales of oil taken in kind were
equivalent to receiving royalties in value, largely because it had not
developed systems to rapidly and efficiently collect this information.
We made recommendations that the agency has implemented that have
improved the administration of the program as it existed at the time of
our report. However, the continued expansion of the program raises a
new question about the adequacy of the agency's overall management
practices and internal controls to meet the increasing demands placed
on the RIK program. Accordingly, we are undertaking follow-on reviews
assessing, among other things, the agency's ability to quantify and
compare administrative costs and revenues of the RIK and royalties in
value programs and the extent to which the revenues collected under the
RIK program are equal to or greater than what would have been received
had they been taken in value.
In a 2006 report on geothermal royalties, we found that missing and
erroneous historical data, as well as insufficient data on electricity
sales, meant that MMS is unable to accurately determine whether it was
collecting royalties as directed by statute. The Energy Policy Act of
2005 included provisions that significantly changed how geothermal
royalties are calculated but also directed Interior to maintain the
same level of royalties over the next ten years that would have been
collected prior to the Act's passage. We found that making this
determination requires historical data on sales of electricity produced
from geothermal resources as well as accurate royalty data. However,
MMS did not have sufficient historical gross revenue data with which to
establish a baseline for past royalties paid as a percentage of
electricity revenues. Further, about 40 percent of MMS's royalty data
was either missing or erroneous for the projects we reviewed. We
recommended that MMS correct these deficiencies and the agency agreed.
We are continuing to monitor the agency's efforts.
Why GAO Did This Study
The Department of the Interior's Minerals Management Service (MMS)
is charged with collecting and administering royalties paid by
companies developing fossil and renewable energy resources on federal
lands and within federal waters. To promote development of oil and
natural gas, fossil resources vital to meeting the nation's energy
needs, the federal government at times has provided ``royalty relief''
waiving or reducing the royalties that companies must pay. In these
cases, relief is typically applicable only if prices remain below
certain threshold levels. Oil and gas royalties can be taken at MMS's
discretion either ``in value'' as cash or ``in kind'' as a share of the
product itself. Additionally, MMS also collects royalties on the
development of geothermal energy resources--a renewable source of heat
and electricity--on federal lands.
This statement provides (1) an update of our work regarding the
fiscal impacts of royalty relief for leases issued under the Deep Water
Royalty Relief Act of 1995; (2) a description of our recent work on the
administration of the royalties in kind program, as well as ongoing
work on related issues; and (3) information on the challenges to
collecting geothermal royalties identified in our recent work.
To address these issues we relied on recent GAO reports on oil,
gas, and geothermal royalty collection systems. We are also reviewing
key MMS estimates and data.
______
[The response to questions submitted for the record by Mr. Gaffigan
follows:]
April 27, 2007
The Honorable Nick J. Rahall
Chairman
Committee on Natural Resources
House of Representative
Dear Representative Rahall:
This letter acknowledges the questions submitted by the Committee
concerning our testimony on royalties at risk before the House
Committee on Natural Resources on March 28, 2007. Please see the
enclosure for our responses.
Sincerely yours,
Mark Gaffigan
Acting Director
Natural Resources and Environment
Enclosure
Qu estion 1: Benefits of Deep Water Royalty Relief Act--What benefits
did the country receive by encouraging exploration and development of
oil and gas in deep water through enactment of the Deep Water Royalty
Relief Act of 1995 during a time of very low commodity prices? In your
answer, can you quantify corporate and individual income tax revenue as
well as job impacts?
GAO Response--A number of Congressional members asked GAO to
examine the costs of royalty relief--in light of rapidly rising oil and
gas prices, press reports, and questions by other interested parties as
to whether the oil and gas industry was paying its fair share of
royalties. These members did not ask us to examine the benefits.
However, GAO has indicated in past testimony that benefits are an
important part of an overall assessment of royalty relief. These
benefits may include increased bonus bids, greater production,
increased oil and gas exploration, greater employment in the oil and
gas industry, and increased tax revenues. An accurate estimate of these
benefits arising from royalty relief would be difficult to achieve
because one would need to determine how much of the oil production,
exploration, and employment that has occurred is the result of, rather
than simply coincident with, royalty relief. Higher oil prices since
passage of the act have likely led to increased production, more
exploration, and greater employment, even in the absence of royalty
relief.
Qu estion 2: Geothermal Recommendations--You indicated that MMS agreed
with your recommendation included in your 2006 geothermal study. Are
you satisfied that they followed up on your recommendation?
GAO Response--Shortly after release of our report, MMS indicated
plans to implement our two recommendations. These recommendations
involved requiring payors to report gross sales revenues and requiring
MMS to correct erroneous or missing data as necessary. In July 2006,
MMS published revised geothermal valuation regulations, in accordance
with the Energy Policy Act, which was necessary prior to establishing
reporting requirements. MMS reported that it incorporated stakeholder
comments into the final regulations and that it will publish these
regulations soon. MMS is also revising the geothermal payor handbook to
reflect new reporting requirements, including our recommendation to
report gross sales revenues. With regards to correcting erroneous and
missing data, MMS reports that it completed one full audit and sent an
order to the payor to submit royalty underpayments for past years. MMS
reports that it is conducting compliance reviews on other leases that
we identified as having monetarily insignificant underpayments. GAO
will continue to monitor and assess the adequacy of MMS efforts to
implement these recommendations until MMS completes its work.
______
The Chairman. Secretary Allred?
STATEMENT OF THE HONORABLE C. STEPHEN ALLRED,
ASSISTANT SECRETARY, DEPARTMENT OF THE INTERIOR
Mr. Allred. Thank you, Mr. Chairman, Mr. Pearce, Members of
the Committee. I appreciate the opportunity to meet with you
today to discuss these issues that are facing the Department of
Interior and the Minerals Management Service.
This is my first opportunity to come before the House
before I was confirmed six months ago. I thought it was
important for us to give you an insight into my background and
perhaps will explain some of the actions that I am taking and
planning to take.
By way of background, I grew up on a potato farm and ranch
in Idaho. This is my first Federal experience. I have over 20
years of experience in state government. Most recently I
assisted then Governor Kempthorne in the creation of Idaho's
Department of Environmental Quality and became its first
director.
In addition, I have spent 20 years in the private sector,
and in fact that is the largest continuous portion of my
career, where I was involved in engineering and construction.
The organization that I ran as a chief executive of that
organization did over $600 million a year in business.
At the outset of my testimony I want to state my belief
that government employees have an obligation to protect the
public interest of the United States, and they need to be
perceived as doing so. If the public believes that we somehow
have failed in this obligation, whether in fact or perception,
that damage is to the detriment of all of us.
As you know, Secretary Kempthorne places great importance
on the Department, its agencies and its employees acting in a
highly ethical manner both in fact and perception.
What I want to do in the next couple of minutes is tell you
what the Secretary and I are doing to deal with the issues that
are the subject of this hearing. After the Senate confirmed me
as assistant secretary some six months ago, Secretary
Kempthorne asked me to review and manage the issues involving
the absence of price thresholds in the deep water leases issued
in 1998 and 1999 in the Gulf of Mexico and the other royalty
management issues.
Regarding royalty management, the Department has reviewed
the Inspector General's report of December 2006 concerning the
collection of oil and gas revenues. The Department is actively
implementing the recommendations and findings of the IG's
review.
In addition, I have traveled to the Minerals Management
Service's Denver Operations Center where these activities take
place and have reviewed their royalty collection process.
Earlier this month in fact I personally observed a royalty-in-
kind sale.
We have formed a high level panel to look at these
processes and procedures. That panel is chaired by two
extremely capable individuals, former Senators Bob Kerrey and
Jack Garn. Other members include individuals experienced in
Federal revenue collection and those of the state and tribal
governments.
As with any large organization with complex operations,
there are going to be many opportunities to improve those
operations. We look forward to receiving the Committee's
recommendations and to further improving our activities.
I find a lot of confusion. In fact, I had a lot when I
first got involved in the question of royalties. I would like
to take just a short period of time to review how royalties are
determined.
The first chart that I would like to put up is the Royalty-
in-Value program. What I would like to do is to direct your
attention to the left-hand part of that chart. The Minerals
Management Service supervises the meters on every source of oil
and gas and receives reports with regard to the production of
those commodities. They also receive reports from the left-hand
side of that chart from those who buy the oil and so we have
two sources of independent confirmation as to the amount of oil
that is produced.
In between we have two actions which cause most of the
argument having to do with the royalty-in-value type of
royalty. The first is transportation by the producer to the
buyer. The second is the processing of that oil since much of
the oil contains both oil and water.
Under the system that Congress has determined that we
should use, the producers are allowed to deduct that
transportation and that processing from the value of the oil
that they produce and upon which they have to pay royalties. It
is pretty clear what they produce.
It is generally unclear as to what the costs and whether
they are at arm's length relationships for the transportation
and the processing of those oils. That is where much of the
dispute comes about and the reason that we have to audit and
review their compliance.
The second type of royalty that I would like to discuss is
the royalty-in-kind. Again, I would direct your attention to
the left side of that chart because again we have the same
meters which are supervised by the Minerals Management Service
and which are reported in actually a couple of different forms
to the Minerals Management Service to determine the amount of
product, oil or gas, that is produced from that source.
In addition, since we now take our share of that oil or gas
and we transport it and process it and sell that on a
competitive basis, we know what has been produced. We know what
it costs. We do not have the arguments that we have with the
producers as to what those deductions should be so the
advantage to us in the royalty-in-kind over royalty-in-value is
that it removes most of the arguments that we have to resolve
with the producers with regard to those.
Incidentally, in 2005 the RIK version of royalties
generated $32 million more to the Federal treasury than it
would if we had taken the same amount of royalties in the
traditional Royalty-in-Value program. Because of the reduced
need for the detailed audits, we also believe that we avoided
almost $4 million in costs that we would have otherwise
incurred if we had managed that under the Royalty-in-Value
program.
Now also, as you are probably aware, we will begin in July
delivering most of the royalty-in-kind oil to the Strategic
Petroleum Reserve to fill its existing capacity. We will
maintain a small amount of sales to the Small Refiner program
and a small amount in the market so that in 2009 when the
repository is filled we will still have the capability to take
that and deal with that oil.
I want to emphasize. We have the choice of whether we take
it in royalty-in-value or royalty-in-kind, and we make that
decision based upon an analysis of what is in the best interest
of the government.
I am convinced after my reviews that MMS is collecting the
royalties that are set forth by the legislation that Congress
has enacted. Again, as with any large and complex operation,
there are opportunities to do better and to improve our
operation. I and the Minerals Management Service intend to do
that.
Just some quick statistics I thought you might be
interested in with regard to royalty management. In 2006, we
collected $12.8 billion. That involved some 380,000 production
sources per month, and we collected royalty from approximately
264,000 royalty-bearing points each month. That is from about
29,000 different leases. We have 530 employees involved in
that, of which 118 are compliance staff, 135 are auditors, 120
are contract personnel, and 108 are state and tribal audit
partners.
Another interesting statistic is in the 2000-2005 period we
completed 1,572 audits resulting in the collection of an
additional $98 million, 495 compliance reviews collecting an
additional $94 million in revenue.
An interesting statistic I think that is important that our
audits returned an average of $2.06 per audit dollar spent.
Compliance reviews returned an average of $3.27 per dollar
spent in those compliance reviews. MMS enforcement actions in
the period 2002-2006 have resulted in the collection of over
$52 million in penalties.
Regarding the price thresholds in 1998 and 1999, we have
reviewed the Inspector General's report of January 2007 and
have I believe gained a fairly complete understanding of the
information that is available there.
I have also traveled to the New Orleans Regional Office
where the oil and gas operations are regulated. I have asked
the Minerals Management Service to form a group, including
members of the Inspector General's staff, to conduct a lessons
learned review of the information that he has and to apply
those to our leases.
The Chairman. Mr. Assistant Secretary, can you wrap up here
in the next 30 seconds?
Mr. Allred. I sure can. I want to make the point that since
2001 all of the leases that we have issued have included the
price thresholds.
I would be most happy to answer any questions that you
have.
[The prepared statement of Mr. Allred follows:]
Statement of C. Stephen Allred, Assistant Secretary, Land and Minerals
Management, United States Department of the Interior
Mr. Chairman, thank you for the opportunity to appear here today to
discuss with you the Department of the Interior's role in managing
energy production on the Outer Continental Shelf and revenue from all
Federal and Indian mineral leases. I know this Committee has been
instrumental in shaping our domestic energy program, particularly with
regard to encouraging environmentally sound development of our domestic
oil and gas resources on the Outer Continental Shelf.
The Department and its agencies, including the Minerals Management
Service (MMS), serve the public through careful stewardship of our
nation's natural resources. The Department also plays an important role
in domestic energy development. One third of all energy produced in the
United States comes from resources managed by the Interior Department.
As energy demand continues to increase, these resources are all the
more important to our national security and to our economy. The Energy
Information Administration estimates that, despite increased
efficiencies and conservation, over the next 20 years energy
consumption is expected to grow more than 25 percent. Even with more
renewable energy production expected, oil and natural gas will continue
to account for a majority of energy use through 2030. Interior's
domestic energy programs, particularly offshore oil and gas production,
will remain vital to our national energy portfolio for some time to
come, as evidenced in Figure A attached at the end of my statement.
Since assuming the duties of Assistant Secretary of Land and
Minerals Management six months ago, I have developed a deeper
appreciation for the complexities involved in managing federal energy
production. I also am committed to ensuring that we provide an accurate
and transparent accounting of the revenue this production generates for
the American people.
At the direction of Secretary Kempthorne, two important topics have
been my major focus over the past six months--the deep water leases
issued without price thresholds for royalty relief in 1998 and 1999,
and the management of royalty revenues.
I would like to begin by providing some background on MMS's role in
Federal energy production and revenue collection. I then will discuss
in greater detail the two primary issues I am focusing on with MMS.
Background
The MMS has two significant missions related to energy: managing
access to offshore federal energy resources and managing revenues
generated by federal and Indian mineral leases, on and offshore. Both
of these functions are important to the nation's economic health and
are key to meeting the nation's energy needs.
The Federal Outer Continental Shelf (OCS) covers 1.76 billion acres
and is a major source of crude oil and natural gas for the domestic
market. In fact, according to the Energy Information Administration, if
the Federal OCS were treated as a separate country, it would rank among
the top five nations in the world in terms of the amount of crude oil
and second in natural gas it supplies for annual U.S. consumption.
1
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\1\ EIA U.S. Imports by Country of Origin, 12-21-2006.
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Since 1982, MMS has overseen OCS production of 11 billion barrels
of oil and more than 116 trillion cubic feet of natural gas.
Since 1982, OCS leasing has increased by 200 percent and oil
production has increased by 185 percent. According to MMS's
calculations, within the next 5 years, offshore production will likely
account for more than 40 percent of oil and 20 percent of U.S. natural
gas production, primarily due to deep water discoveries in the Gulf of
Mexico.
Attached Figure B shows the Energy Information Administration's
2007 forecast for total domestic oil and gas production and illustrates
what the significance of the OCS contribution is to the Nation's energy
security.
To support increased production offshore, MMS's Proposed 5-Year OCS
Oil and Gas Leasing Program for 2007-2012 proposes a total of 21 lease
sales.
We are closer to achieving the goals of this proposed program since
January, when the President modified a Presidential withdrawal in order
to allow leasing in two areas previously closed--the North Aleutian
Basin in Alaska and an area in the central Gulf of Mexico. The
President modified the leasing status of these two areas in response to
Congressional action and the request of Alaska State leaders. In
addition, this Administration has increased the royalty rate from 12.5
percent to 16.7 percent for any new deep water leases offered in the
Gulf of Mexico.
In implementing the mandates of the Gulf of Mexico Energy Security
Act, MMS will offer deep-water acreage in the ``181 South'' area and in
a portion of the Sale 181 area remaining in the Eastern Gulf of Mexico.
Our analysis indicates that implementing the new program would
result in a mean estimate of an additional 10 billion barrels of oil,
45 trillion cubic feet of gas, and $170 billion in net benefits for the
nation over a 40-year time span.
In addition to providing and managing access to the OCS, MMS
administers and enforces the financial terms for all Federal mineral
leases, both onshore and offshore and on Indian lands.
These activities have generated an average of more than $9 billion
in revenue per year over the past five years, representing one of the
largest sources of non-tax revenue to the Federal Government. (In FY
2006, $12.6 billion was collected, and 60 percent of that was from
offshore activities).
Since 1982, the MMS has distributed approximately $164.9 billion to
Federal, State, and Indian accounts and special funds, including
approximately:
$101.1 billion to the General Fund of the U.S. Treasury;
$20.4 billion to 38 states;
$5.2 billion to the Department's Office of Trust Funds
Management on behalf of 41 Indian tribes and 30,000 individual Indian
mineral owners; and
$38.2 billion to the Land and Water Conservation Fund,
the National Historic Preservation Fund, and the Reclamation Fund.
MMS carries out these responsibilities under statutory mandates and
ongoing oversight by Congress, the Government Accountability Office
(GAO) and the Department's Office of Inspector General.
I am happy to point out that for the past five years, as part of
its annual CFO audit, MMS consistently has received clean audit
opinions from the Office of the Inspector General's contracted
independent auditing firm.
1998-1999 OCS Leases without Price Thresholds for Royalty Relief
This January, the Department's Office of Inspector General
announced its findings on the 1998 -1999 deep water leases issued
without price thresholds. The MMS requested this independent review
last year. We appreciate the Inspector General's work and would note
that the Department and the MMS have undertaken some procedural and
organizational changes regarding lease sale packages and instruments in
order to strengthen our leasing procedures.
The Department of the Interior shares Congress's frustration that
during the previous Administration price thresholds were not included
in the 1998--1999 deep water leases. This Administration has included
price thresholds in all deep water leases it has issued with royalty
relief. The American people own these resources and are entitled to
receive a fair return.
The Deep Water Royalty Relief Act of 1995 required deep water
leases issued from 1996 - 2000 to include a royalty incentive to allow
companies to produce a set volume of oil and gas before they began
paying royalties. Since enactment, the deep waters of the Gulf of
Mexico have become one of the Nation's most important sources of oil
and natural gas. Price thresholds limit royalty relief when oil and gas
prices are high. Price thresholds were included in leases before 1998
and after 1999. They were not included in the 1998--1999 leases.
This matter has been a focus of mine since I assumed this position
last fall. In an attempt to address the missing price thresholds, we
are continuing to discuss this issue with companies in order to obtain
agreements to apply price thresholds to the deep water leases issued in
1998 - 1999. To date our efforts have focused on obtaining the much
larger royalty amounts to be realized from future production, estimated
to be about $9 billion.
To date we have reached agreements with six companies. This is a
significant but we need more companies to sign agreements.
I have adopted three basic principles to guide my actions in
seeking to resolve this matter. First, our focus will be to negotiate
price thresholds in leases prospectively; second, we will not give
economic advantage to one company over another; and finally, we will
strive to amend these agreements in a way that will minimize litigation
risk.
To achieve these principles, the Administration and the Congress
must work together. We cannot do this alone.
We know that the House has already addressed this issue
legislatively. We appreciate Congress's efforts to encourage companies
to agree to pay additional royalties. However, we must be mindful of
potential unintended consequences. H.R. 6 could conceivably result in
litigation. If legislation addressed future lease sales, and if a judge
were to enjoin future lease issuance for a period of time, the
resulting impacts would be significant. Litigation could take years to
resolve. The MMS has attempted to project what the potential loss of
production, revenue and royalties if lease sales were delayed for a
three-year period could look like.
Attached Figure C shows for example, for a 3-year delay, production
over 10 years would be reduced 1.6 billion barrels of oil equivalent
(boe).
Attached Figure D shows for example, the expected cumulative
revenue decline over a 10 year period of $13 billion for a 3-year
delay.
We all can agree this would not be in the Nation's best interest.
The OCS is a significant supplier of oil and gas. We cannot afford
major delays in offshore energy production due to unintended
consequences.
We look forward to working with Congress on resolving this issue of
national interest.
Management of Royalty Revenue
My second focus is the management of royalty revenue collected from
Federal and Indian mineral leases. In FY 2006, about 2,600 companies
reported and paid royalties totaling $12.6 billion from approximately
27,800 producing Federal and Indian leases.
MMS's mineral revenue processes and procedures are complex and
involve implementing myriad statutory authorities and regulations, as
well as a complex set of case law from over 50 years of administrative
and judicial decisions on Federal royalty matters.
The process begins when companies calculate their payments for
royalties owed the Federal government. Royalties are calculated based
upon four components: the volume of oil and gas produced from the
lease, which is verified by BLM or MMS officials during regular on-site
inspections; the royalty rate, which is specified in the lease
document; the value of the oil and gas as determined by regulations;
and any deductions for the costs of transporting and/or processing the
oil and gas production, which are also determined by regulations.
Companies are required to report this information and submit their
royalty payments to MMS on a monthly basis.
MMS receives reports and payments from payors and accepts them into
the accounting system, similar to filings with the Internal Revenue
Service. Fundamental accounting processes identify revenue sources, and
funds are distributed to recipients as prescribed by law. Interest is
assessed on late and/or under payments.
MMS's audit and compliance program assesses whether royalty
payments are correct. The types of questions that arise during
compliance activities include whether the company reported and paid its
royalty on the right volume, royalty rate, and value and whether the
company correctly calculated allowable transportation and processing
costs. Findings of underpayments are followed by collection of the
payment plus interest. Enforcement proceedings range from alternative
dispute resolution to orders to pay and penalty actions.
The current compliance strategy uses a combination of targeted and
random audits, compliance reviews, and royalty-in-kind property
reconciliations. The strategy calls for completion of the compliance
cycle within three years of the royalty due date. In Fiscal Year 2006,
this strategy resulted in compliance reviews on $5.8 billion in Federal
and Indian mineral lease revenues, 72.5 percent of total mineral
revenues paid for calendar year 2003.
In recent years, MMS has completed an increased number of audits,
doubling the number of audits in the most recent four-year period over
the previous four years. From 1998--2001, MMS, State, and Tribal
auditors completed 784 audits compared to the 1,572 audits completed
from 2002-2005. This increase is partially the result of the effort in
2005 on the part of MMS to close a significant number of old audits as
a result of a recommendation from an external peer review of our audit
activities. Collections based on audit work fluctuate from year to
year. The apparent reductions in collections resulting from compliance
efforts from 2001 through 2004 stand in contrast with very large
collections in the 1998-2001 period. This anomaly is due to resolution
of numerous lawsuits on undervaluation of crude oil and natural gas
during the 1998-2001 period. The result of the resolution of these
issues was large payments of additional royalties. Because these issues
were resolved, no additional large payments were owed in 2002-2005.
The MMS compliance and enforcement program has generated an annual
average of more than $125 million for each of the last 24 years. In
other words, MMS has collected a total of more than $3 billion dollars
in additional mineral revenues since program inception in 1982.
From FY 2003 through FY 2005, for every dollar spent on compliance
reviews, MMS has collected $3.27. For every dollar spent on audits, MMS
has collected $2.06.
MMS aggressively pursues interest owed on late payments as required
by law. In Fiscal Year 2006, MMS issued over 3,800 late payment
interest bills and collected a net amount of $7 million.
MMS has authority to use civil penalties in situations where
routine compliance efforts have been unsuccessful. During the last 5
years MMS has collected over $23 million in civil penalties resulting
from MRM enforcement actions. So far in FY 2007 MMS has issued over $2
million in civil penalty notices that are now in the administrative
process. When combined with other MMS enforcement actions during the
same time frame, MMS collected a total of $52.4 million.
Last year, while performing reconciliation of volume imbalances,
the MMS promptly identified that the Kerr McGee Oil and Gas Corporation
had under-delivered royalty gas volumes to MMS's Royalty-In-Kind (RIK)
program--at a time of very high gas prices. MMS pursued the issue and
collected $8.1 million--based on these high price periods--to resolve
the issue.
In December, MMS announced that a bill for over $32 million had
been issued to BP America Production Company for additional royalties
and interest due identified through audit work of BP's coalbed methane
production that occurred in the state of New Mexico.
These day-to-day efforts are just part of MMS's normal course of
business. These efforts are not only effective at ensuring compliance,
but also beneficial in bringing the appropriate revenues to the states,
Indians, and the American public.
I would like to emphasize, however, that although this work is
important, our focus is not on numbers of audits or amounts obtained in
collections. The real goal is to increase upfront compliance. We
measure success in having higher levels of upfront compliance so that
companies are making correct payments the first time. Audits act as a
deterrent, but we hope that audits will reveal fewer problems as
companies increase voluntary compliance.
MMS has taken steps to improve compliance rates in order to achieve
this goal. They include the following:
Clearer regulations--MMS has made significant progress in
developing and implementing clearer regulations, eliminating much
uncertainty and ambiguity that previously resulted in major findings.
RIK--MMS is receiving an increasing percentage of
revenues through its RIK program and has eliminated many valuation
issues for the RIK volumes. During FY 2005, for example, MMS received
about one-third of its revenues through RIK.
More effective compliance strategies--Compliance reviews
have allowed MMS to cover more properties than were possible using
audits alone, thereby increasing the deterrent effect. This increased
presence encourages companies to be more vigilant about proper
reporting and payment.
We appreciate the recent report of the Office of Inspector General
concerning the audit and compliance program. The results are similar in
substance to audits I have reviewed in State government or in the
private sector. My experience is that in any organization with such
large and complex operations, I would expect any performance audit to
find opportunities for improvement. MMS has embraced the findings, and
has an action plan to address them.
We note the Inspector General's major conclusion that compliance
reviews are a useful tool in our program, and we look forward to
implementing recommendations to further improve our application of
compliance reviews. We submit for the Committee's attention our
``Action Plan to Strengthen Minerals Management Service's Compliance
Program Operations'' which documents improvement actions taken and
planned in this area.
MMS does not work alone in its efforts to ensure the proper
collection of royalties; MMS collaborates with the States and tribes on
our compliance and audit activities. In addition, every three years,
the federal audit function of MMS is peer-reviewed by an outside
independent certified public accounting firm. Most recently, in 2005,
the MMS audit program was found to meet all applicable government
auditing standards. I am also happy to point out that for the past five
years, as part of its annual Chief Financial Officer audit, MMS
consistently has received clean audit opinions from the Office of the
Inspector General's contracted independent auditing firm.
Having said that, it also is true MMS continues to look for ways to
improve its programs, practices and performance. We welcome input from
this Committee, the full Congress, the Office of the Inspector General,
GAO and the public.
In response to the recent interest regarding the accuracy and
effectiveness of the MMS's royalty management program, Secretary
Kempthorne and I determined that an independent panel should be
convened to review the procedures and processes surrounding MMS's
management of mineral revenue. We are committed to ensuring our
processes are effective and transparent, and we welcome advice and
counsel.
The new panel will operate as a Subcommittee under the auspices of
the Royalty Policy Committee, an independent advisory board appointed
by the Interior Secretary to advise on royalty management issues and
other mineral-related policies.
The Subcommittee on Royalty Management has been asked to review
prospectively:
The extent to which existing procedures and processes for
reporting and accounting for federal and Indian mineral revenues are
sufficient to ensure that the MMS receives the correct amount.
The audit, compliance and enforcement procedures and
processes of the MMS to determine if they are adequate to ensure that
mineral companies are complying with existing statutes, lease terms,
and regulations as they pertain to payment of royalties.
The operations of the Royalty-in-Kind program to ensure
that adequate policies, procedures and controls are in place to ensure
that decisions to take federal oil and gas royalties in kind result in
net benefits to the American people.
Appointments to the Subcommittee were made on March 21, 2007. We
are pleased that former Senators Bob Kerrey and Jake Garn have agreed
to serve as co-chairs of this oversight. Secretary Kempthorne served
with them in the Senate and knows firsthand of their highest integrity.
The other members of the committee bring a wealth of knowledge to this
process. They include representatives from state and tribal
governments, industry, academia and revenue collection for the
government. We are grateful for their service and look forward to their
recommendations.
The Subcommittee will conduct its review over a six-month period
and then provide its final findings and recommendations to the full
Royalty Policy Committee and the Secretary of the Interior. We will be
happy to share the recommendations with you when they are available.
State and Tribal Royalty Audits
As part of its compliance assurance activities, the MMS administers
delegated and cooperative audit agreements with eleven States and seven
Indian Tribes. The States and Tribes are working partners and an
integral aspect of the overall onshore compliance efforts. Tribes
perform audits on tribal mineral royalties within their reservation and
the States perform audits on Federal leases within their boundaries.
The MMS conducts compliance reviews and audits to provide compliance
coverage over properties not covered by the States and Tribes.
The Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA)
tasks the Department of the Interior with ``utilizing the capabilities
of the states and Indian tribes in developing and maintaining an
efficient and effective Federal royalty management system.'' Title II
of this same statute enabled the Secretary of the Interior to enter
into cooperative agreements with states and Indian tribes to carry out
inspections and audits on Federal and Indian mineral leases within
their respective state or reservation. Under Title II, Section 202, we
have the Tribal Cooperative Audit Program; and under Section 205, the
State Delegated Audit Program).
Since the first agreement was signed with the State of Wyoming in
1981, MMS has held regular meetings with state and tribal
representatives to discuss issues of mutual importance. The
relationship among MMS and states and tribes has highlighted
partnerships as well as contractual obligations.
Funding for States and Tribes participating in the Section 202 and
Section 205 programs was around $9.1 million in FY 2006 and remains
level for FY 2007. The MMS continues to explore how to best allocate
available budget resources for the 202/205 Program. We have analyzed
cost, workload, and risk data to apply ``best business case'' criteria
to the funding of this program. The mineral revenues at risk and number
of producing leases are used to establish funding allocations among
States and Tribes. Other factors, such as program effectiveness and
anticipated increases and decreases in revenue activity, are also
considered.
To manage compliance coverage of the onshore Federal lease universe
within available funds, MMS developed a ``business case'' that uses the
number of producing leases and total royalty revenues received by
states to allocate resources beginning in FY 2006. The attached table
reflects the number of leases and revenues received by states and the
MMS funding allocation for FY 2004 through 2007. You will notice that
the total amount of funds devoted to the audit function of states has
not decreased. However, it is apparent from this analysis that some
states were significantly over-funded or under-funded in comparison to
others. MMS designed the business case to correct such inequities while
maintaining overall program funding.
The MMS had several briefings on this methodology with the
Congressional delegations representing impacted states, the Department
of the Interior's Office of the Inspector General and the Government
Accountability Office. During these briefings, the majority of
participants seemed satisfied that our methodology was fair and
reasonable.
At an August 2006 meeting in Alaska, MMS announced to its state and
tribal compliance partners that we will be working on improving the
effectiveness of our joint meetings and that MMS will fund one national
meeting annually at a central location, as well as regional and topical
meetings as needed. The national meeting will address issues common to
all states and tribes. Regional and topical meetings will focus on
issues specific to a given region of the country. These meetings will
provide additional benefits to all parties and enhance communication
among MMS and the delegations. States and tribes have also requested
training on specific issues which are difficult to address in a
national meeting, but will be an integral part of our regional
sessions. For example, once the final rule implementing the geothermal
provisions of the Energy Policy Act of 2005 is published, MMS will hold
a topical meeting with those states that have Federal geothermal
production to provide training on the rule and to coordinate our
compliance efforts. Discussing this topic at a national meeting is not
productive when very few states and no tribes are affected.
The MMS will continue its practice of coordinating with state and
tribal delegations in preparing the agenda. For many years,
representatives from the Office of the Inspector General have regularly
attended the STRAC meetings, and they will continue to be invited.
Conclusion
In the six months since I was confirmed to this position, I have
been working closely with the MMS to understand the complex processes
associated with accounting for the revenues generated from oil and gas
development on Federal lands, including the Outer Continental Shelf. In
an effort to gain a greater understanding of this work, I have traveled
to MMS's Denver office where I reviewed the procedures and controls
used to ensure that minerals revenues are properly reported and
accounted for and most recently I attended a sale of Royalty-in Kind
oil and gas. I also have visited offices and reviewed operations in the
Gulf of Mexico Regional Office.
This work is very important and must be undertaken carefully.
Equally important, and very important to Secretary Kempthorne and me,
is that we conduct business with the highest standards of ethics
possible. Making sure we can live up to that standard has been a high
priority of mine. I have stressed, and will continue to stress, our
obligation to conduct ourselves in accordance with the highest ethical
standards and to be accountable for our actions. Moreover, our conduct
must be ethical both in fact as well as in perception.
To summarize my remarks today, I want to reiterate I will continue
to focus on several key areas of oversight to the Minerals Management
Service.
We will issue our 5-year proposed OCS leasing program on time. This
is an important plan that addresses national energy security and
facilitates the development of critical energy resources now and in the
future.
I will continue to seek prospective royalty agreements with the
companies that entered into leases issued in 1998 and 1999 that lack
price thresholds in order to capture the majority of the revenues the
government would have received.
I am pleased at the results of our efforts thus far, but recognize
that there is much more work to be done. I look forward to continuing
to work with you, the Members of Congress, to address this important
issue.
In addition, I will continue to work with MMS to review and improve
our royalty management programs. I have every confidence that MMS will
successfully implement appropriate Inspector General's recommendations
and that the review by the soon-to-be finalized royalty policy
subcommittee will provide a fresh perspective on royalty management
issues and challenges.
I welcome your input on all of these initiatives, and I look
forward to working with you.
Mr. Chairman, this concludes my remarks. I would be happy to answer
any questions you have.
[NOTE: Attachments to Mr. Allred's statement have been retained in
the Committee's official files.]
______
The Chairman. Thank you both for your testimony this
morning.
Let me begin with you, Assistant Secretary Allred. I
appreciate the facts and the figures that you have given in
your testimony this morning, but, as I referred in my opening
statement, it is a fact that since the year 2000 there has been
a dramatic decline in the auditing function in favor of
compliance reviews.
The IG reported last December that MMS is now using
traditional audits on less than 10 percent of leases. The IG
also noted that compliance reviews did not provide the same
level of assurance as an audit. As I said earlier, in my view
there is a dysfunctional situation here ripe for the type of
abuses that are repeatedly reported.
So it does appear that we are getting ripped off, plain and
simple. You have said here today that you propose additional
audits to fix it. I believe that is what you said, and that is
my question. Are you going to increase the number of audits
that you undertake?
Mr. Allred. Mr. Chairman, one of the advantages we have
with the compliance reviews, and incidentally this is not
different than what the IRS does as well, is it allows us to
look at a much broader spectrum of those who are responsible
for providing the royalties.
With the compliance review program, we were able to review
about 72 percent. If we were to----
The Chairman. My question is will you increase the number
of audits? Yes or no.
Mr. Allred. What we are doing with regard to the audit
program is based upon the recommendations of the Inspector
General is we are changing our compliance review program to
make our audits more risk-based. That may result in more
audits, depending upon what comes out of the compliance review.
We are going to have to use both if we are going to have to
cover the majority of the royalties that we----
The Chairman. I am not agreeing that both need to be used,
but you are saying only that you may increase the number of
audits?
Mr. Allred. Mr. Chairman, we haven't finished the risk-
based management criteria yet that we are working with the IG
on.
The problem here is we have limited resources, as does
everyone else. Given the resources we have, we need to try to
cover the largest population of royalty payers that we possibly
can.
If we do just audits we will cover a much smaller portion
of that population, so given both resources what we hope to do,
and again I would refer you to the returns per dollar spent. We
need to use both. My belief if we need to use both in the
appropriate relationships.
The Chairman. Let me ask Mr. Gaffigan. In your testimony
you basically state that the MMS is unable to determine whether
the royalties it receives in kind are equivalent to receiving
those royalties by cash payments. Is that accurate?
Mr. Gaffigan. Yes. When we looked at the program in 2003-
2004, and again it was a much smaller program, they were having
some difficulty with finding the right information to make that
judgment.
We made recommendations to improve the information. We feel
that they were responsive to those recommendations. The
question is whether today at this larger scale they are
implementing those recommendations and making those
determinations as we go forward. That is what we are going to
look at in our work for you as we go forward.
The Chairman. So we are basically at a point where it has
expanded so rapidly that we need to decide whether it should be
eliminated?
Mr. Gaffigan. Well, it is at a good size. I mean, it is
one-third of the royalties they took in Fiscal Year 2005. I
don't know. Obviously whether you eliminate or not is a policy
decision that you guys will make, but it provides an
opportunity for them to understand the market.
When we looked at this, we looked at RIK going back to 1999
when it was first talked about. We said at the time there were
certain conditions which you needed to look to where RIK may
make some sense, and those were sort of the ability to have
access to pipelines, processing for gas, large volumes and
market expertise.
If you can combine those factors it may make sense to go
with an RIK. I think what we will try to do in looking at the
RIK program, as well as the RIV program because you can't look
at one without the other, is to address those questions.
The Chairman. Thank you.
The gentleman from New Mexico?
Mr. Pearce. I thank the Chairman.
Mr. Allred, on the compliance review process, now the IRS
uses compliance reviews and the SEC uses compliance reviews,
and yet we are given the impression today that compliance
reviews are a complete abomination, that they are something
that has only been seen by the robber barons that are currently
running the White House.
If you took the full amount of production, and you have
that number available to you, don't you? You may not have it
today. We know that the amount of percent that the government
is supposed to take is about 12.5 percent generally on
royalties, but it is creeping up in some places because,
frankly, the economics are better.
When you do the calculation, the total number of barrels
produced times the royalty rate, you get a number over here at
the right-hand side of the page that is some number. Now, I
think Johnnie Burton testified that we are getting almost 98
percent or 99 percent. Can you verify that number?
In other words, I am trying to remember the hearing from a
couple weeks ago. How much percent of the royalties are we
actually collecting if you just do a straight mathematical
calculation?
Mr. Allred. Mr. Pearce, I don't have those numbers with me,
but as we look through the compliance program what we look to
see, and the reason that that number is difficult is, you will
remember, you have allowed in the process for the companies to
deduct, just like in the income tax----
Mr. Pearce. We are getting way too complex, sir. I
appreciate that.
You have made a statement that you are convinced that your
agency is collecting what it should set out to collect. If you
could get that total number of barrels times the percentage
rates on the different blocks because some are different rates,
show me the calculation and then show me you said you collect
$12.8 billion, show me what it should be because I don't think
we are risking much using the compliance review process. Will
you get me that?
Mr. Allred. Yes, I will, Mr. Pearce.
Mr. Pearce. OK. All right. Thanks.
In our last hearing about the Clinton leases the IG
concluded that this whole business was a mistake by the Clinton
Administration, and they based that on several factors, but
when we went through that factor the IG himself said that there
is no evidence that omission was deliberate, but then on page 7
of his own report says that the Gulf of Mexico supervisor in
charge of leases was called by D.C. headquarters and directed
to remove the price triggers.
That to me seems deliberate. Does it appear that it was a
deliberate act to you?
Mr. Allred. Mr. Pearce, yes, it does.
Mr. Pearce. In the IG report he concluded that the omission
was a mistake because there was a policy to include price
thresholds. However, are we looked through thousands of emails
from that whole period of time we didn't find one instruction
to direct people to take. There wasn't one piece of evidence
directing that the price thresholds would be included.
He declared then when we made that point, he said well, it
was more of an innuendo policy. What do you think about
innuendo policies? This is our IG. This is the ranger, the
Texas Ranger. What about innuendo policies?
Mr. Allred. Well, Mr. Pearce, I can tell you that in the
Department of Interior now we do not have innuendo policies.
Mr. Pearce. All right.
Mr. Allred. We will specify what they are.
Mr. Pearce. The IG also admitted after we began to draw his
attention to letters that we held up in front of him and said
you say there is no smoking gun, but you happened to leave the
smoking guns out. Here are the letters from the Clinton
Administration employees that were excluded from his big
report, and they all said that the exclusion of price
thresholds was intentional.
We are trying to unravel a pretty messy deal here. I don't
know. What do you think about the government? Your agency has
offered incentives, has even gone beyond, to try to get the
companies to kind of voluntarily come into compliance.
I worry about that. I think you all are fair-minded. I
don't always agree, but I worry about this one step. Would you
talk about that policy where you are encouraging people to
change the parameters which they had previously in place?
Mr. Allred. I would be glad to, Mr. Pearce. You know, we
believe these are contracts between the Federal government and
these companies, and as with any contract you have to have the
agreement of both parties to change it.
We are encouraging the companies to come in voluntarily,
and six have done so. They represent a little over 20 percent
of what we believe will be future production. We are continuing
to talk to others to add the price threshold to their leases.
We do not believe we can force them, but there are a number of
them that believe they need to do so as well.
Those discussions continue. I think though that we will not
make further progress in that until Congress decides what role
it wants to play because I think currently there is a bit of
confusion about what will happen, and the companies are not
willing to come in until that is decided.
Mr. Pearce. Thank you.
Mr. Chairman, I have other questions, but I see my time has
expired. If we get a second round, I would appreciate it.
The Chairman. OK. The Chair is going to recognize Members
by the order in which they came in the hearing this morning.
Ms. Bordallo would be next, the gentlelady from Guam.
Ms. Bordallo. Thank you, Mr. Chairman, but I have no
questions.
The Chairman. OK. The gentleman from Arizona, Mr. Grijalva.
Do you have questions?
Mr. Grijalva. No, sir.
The Chairman. Yes. The Chair will recognize the gentleman
from Colorado.
Mr. Lamborn. Thank you, Mr. Chairman. I have no questions,
but I would be happy to yield my time to the Ranking Member in
case he had any last follow-up questions.
Mr. Pearce. I thank the gentleman.
Mr. Allred, in your testimony you give us some views on
H.R. 6. One of the things that legal scholars have talked about
is that it appears that H.R. 6 is a takings, a constitutional
abridgement; that is, that is offends the Constitution of the
United States in taking things without due process or whatever
is required.
What do your legal advisors tell you the strength of the
Fifth Amendment or the breach of contract claims are on H.R. 6?
In other words, what are you expecting if that passes for your
challenge to be to implement it?
Mr. Allred. Mr. Pearce, the advice as I understand it is
that we believe that that would be challenged in court, and our
fear is that that challenge would result in a prohibition or an
injunction against going forth with lease sales.
I have some graphs if anyone wants to get more detail, but
our concern is that a three-year delay in leasing could well
mean about 1.6 billion barrels of oil would not go into the
U.S. economy and that about $13 billion over 10 years would not
come into the Federal Treasury.
Mr. Pearce. OK. On our next panel we have a witness. Tell
me a little bit about the government employees who obtain
information in the course and scope of their duties and then
their ability to file a claim under the False Claims Act.
What about an MMS auditor that received information from a
company in the course of an audit? Should they be able to go
under the False Claims Act and file? Can you explain your
agency's position on that?
Mr. Allred. I would be glad to, Mr. Pearce. We believe that
those auditors should not be able to use information that is
available to them through their official course of duties.
There are two different mechanisms if they have concern
that they can raise either with management or with the
Inspector General. As we have asked the Inspector General to
review these issues, and I think you will see a report from him
within the next few weeks. I anticipate that that report will
indicate that those individuals did not afford themselves
either one of those routes to bring their concerns forward.
So I am concerned that auditors within the Department of
Interior should not be able to use information derived from
their responsibilities as public employees for their own
personal gain.
Mr. Pearce. In other words, they have access to data that
as a private citizen they could not have access to and so the
government requires people to open up their books to show the
most sensitive pieces of their company, and then the person who
used the government key to unlock that door that would normally
be closed then uses data to go out and file a claim in which
they personally stand to make a large sum of money.
Now you are just saying that you would disagree with that
particular intent. Would you say it crosses an ethical line?
Mr. Allred. Yes, sir, I believe it does.
Mr. Pearce. OK. Talk a little bit about the Tribal
Cooperative Audit Program, specific examples compared to what
we see in New Mexico or California or North Dakota, if you
would. We have just about a minute left, so if you would make
it tight.
Mr. Allred. Yes, I will. As you are aware, we contract with
states and tribal auditors to assist us in auditing. What we
have done recently, and it has caused some consternation, is we
have looked at the workload specifically with regard to those
states or tribes, and as a result of that we have reallocated
some of the funds. We have reduced the funds.
Mr. Pearce. Let me interrupt for just a second. I mean,
some of the states are complaining they are not getting enough
money, but their amount per lease is tremendously higher than
New Mexico at $155 per lease.
You provide a chart of that, and I appreciate that, in your
testimony. New Mexico gets $155 per lease. North Dakota, for
instance, is up in the $700 range, California above $2,500 per
well in this audit process, and yet they are complaining.
We will get into this a little bit later. I see my time has
expired. I do appreciate the gentleman.
The Chairman. The gentleman from California, Mr. Costa.
Mr. Costa. Yes. Thank you very much, Mr. Chairman. As a
continuation of the hearing we held last month, I thank you for
continuing this effort. I think it is very important. This
relates to the Committee and the subcommittees' efforts in this
110th Congress.
Mr. Allred, you spoke I guess in your testimony to the
Senate Policy Committee on Energy, if I understand it
correctly, that there was nothing drastically wrong, and I know
you have only been kind of on the job for six months here, but
with the Minerals Management Service's bureau, and yet it is my
understanding that you also have taken steps toward impaneling
a commission to study the Minerals Management Service.
I am trying to understand more clearly the two statements
if there is nothing drastically wrong. I mean, we have put
together panels when we asked former Secretary Baker and former
Congressman Hamilton to make recommendations on the Iraq Study
Commission. We have had a similar panel put together when we
were looking with Shalala and Dole on issues involving
veterans' health care just recently.
If there is nothing drastically wrong, what is the need for
the panel?
Mr. Allred. Mr. Costa, I think there is always a need for
outside review, and sometimes we get so involved in our day-to-
day activities that it is very beneficial to have those outside
reviews.
That is why I have supported the Inspector General doing
the performance audits. I have had those throughout my career.
I think they are very valuable to identify areas where we can
continue to improve.
One of my concerns when I asked that panel to be formed by
the Secretary was to make sure that we not only deal with the
issues and how can we improve, but that we also make sure as we
go forth with that that we deal with the perception and the
perception that it might not be as well, so in addition to the
Inspector General I wanted another group to come in to give us
their impression.
Mr. Costa. I appreciate that. So you have appointed the
panel, as I understand it. Do you have timelines in terms of
when you would like them to report back to the Secretary?
We hope that you will be able to share that with the
Committee.
Mr. Allred. Mr. Costa, we would be most happy to. It will
be reported to what is called the Royalty Policy Committee,
which is a FACA committee. It will be public in that thing, and
we would be most happy to brief you.
Mr. Costa. Do you have timelines for them?
Mr. Allred. I have asked them to do it in a six month time
period.
Mr. Costa. Good. We will follow up with that.
You made a comment at the end of your first line of
questioning to the gentleman from New Mexico, Mr. Pearce, when
you were talking about I believe the six out of the 45 that had
worked with you, but you said that there was some uncertainty I
think--these are my words, not your words--as to the
determination as to what would be determined here by the
Congress.
Could you explain further? I wasn't clear as to where you
were going with that.
Mr. Allred. I would be very happy to. In my continuing
discussions with the companies who have 1998 and 1999 leases
they are uncertain as to what Congress might do, and because of
that they are very reluctant to enter into any further
agreements with us until they know what that----
The Chairman. In terms of what, changing the pattern in
terms of the royalty? What uncertainty specifically? Can you
put your finger on that?
Mr. Allred. I think the questions they have as to whether
or not there would be additional costs that might be incurred
as a result of what Congress would do.
Mr. Costa. All right. Let me, Mr. Gaffigan, because my time
is almost expired.
On the issue of compliance review versus audits, in terms
of standard procedure for investigation and accounting
practices is there a random sampling or a level in which you
think you can best get to the determination as to what in fact
is being done appropriately and what is not being done, and do
you think in this case we have reached whatever that
appropriate randomness is with regard to Minerals Management
Service?
Mr. Gaffigan. I would commend to you the IG's report
recently in December that looked at this issue. We have been
focusing lately on the fiscal impact, but in general when you
are doing an audit one of the things, the criteria, you try to
look at is materiality; in other words, where are the big
dollars, no matter whether it is an audit of royalties or any
other issue.
You have to constantly be looking at that. You cannot sort
of go with one program and then change as things change. As
they move from RIK to RIV or using more RIK, there are also
issues to think about. What kind of audit steps do we need to
change? What kind of things do we need to look at in RIK?
That doesn't mean, you know, that the audit function goes
away just because you have RIK. It is a range of issues. There
is no one number that is out there. They should constantly be
looking at it, and one of the criteria they should be applying
is sort of the materiality of what they are looking at.
Mr. Costa. OK. My time has expired, but I would like to
pursue that line of questioning. I may have to submit those
questions to you.
I yield back to the Chairman.
The Chairman. The Chair will note the absence of any Member
on the Minority side at this time, but will ask unanimous
consent that all Members be allowed to submit questions for the
record, and we would ask the witnesses to follow up on those
written questions at a later time.
The gentleman from Wisconsin, Mr. Kind, is recognized.
Mr. Kind. Thank you, Mr. Chairman, and thank you for
holding this very important hearing.
As a former Ranking Member on the subcommittee, a lot of us
on the Committee have been disturbed in recent years in regards
to some of the reports coming out of MMS and Department of
Interior in regards to royalty collections.
I think this hearing is very pertinent and very relevant to
the type of work that we need to do in this committee in the
coming year, and I appreciate the witnesses' testimony. We are
going to have a couple of panels coming before us.
Mr. Allred, let us start with you. Obviously you have heard
reports in the media. We have heard reports too in regards to
possible retaliation of some auditors in relation to royalty
relief and how it is being conducted
If you take a look at those auditors in question, and we
are going to have a couple of them testifying in a little bit.
If you look at their resume and their background and
experience, and they do seem to be eminently qualified, and yet
when they were trying to highlight issues and problems at MMS
it certainly smacks of retaliation, which is very disturbing.
There may be a very perfect, logical explanation of what
took place. Maybe if you can illuminate us a little bit in
regards to the cases specifically that would be helpful to the
Committee.
Mr. Allred. I would be glad to. First of all, a couple of
issues. The first is that there was a process by which those
concerns could have been brought forward. They were not.
As I indicated earlier, we have asked the Inspector General
to investigate, and I am informed that his report is just about
done. That will be available to both you and to us.
Second, the question of retaliation. He has also I believe
looked at that, so that information will be available as well.
What some are calling retaliation is the issue of whether or
not we should continue those auditors to let them audit those
accounts for which they would personally benefit from.
The Government Accounting rules prohibit that. They require
an independence and so those auditors were removed from that
audit function. It was not retaliation. It was done to make
sure that we comply with ethics, ethical questions and with the
Government Accounting Standards.
Mr. Kind. We will have an opportunity to question them in a
little bit in regards to what took place in the individual
instances and that, but, getting back to what Mr. Costa was
raising, you have testified here today that your Department has
been successful in renegotiating six of the deep water leases
out of a potential 45 contracts that exist.
Are there any legal challenges right now prohibiting
further negotiations with these companies? What is the
stalemate with the remaining companies at this point? You
indicated there is uncertainty in regards to future
congressional action, but is there any other obstacles that MMS
is facing right now?
Mr. Allred. There really are none, and we continue those
sorts of discussions, but there is a reluctance on their part
to agree until they know what the whole playing field is.
As Mr. Gaffigan testified, there is a challenge to the
basis of the law that you passed as to whether or not we can
apply thresholds, and certainly that is a real question. We
believe we are on sound ground in defending your law, but that
is a challenge.
Mr. Kind. So that may be freezing the good faith efforts to
try to reach an agreement outside of legislative action I
assume.
Mr. Gaffigan, let me turn to you. We are just trying to
understand the culture at MMS. I have had a chance to briefly
review the report that you submitted before the Committee.
In your opinion, what is really the heart of the problem
here? Is it just insufficient personnel or resources in data
collection there, or is there a greater culture at MMS making
it more difficult to collect proper royalty in these
circumstances?
It certainly seems in your report that you are concerned
about data collection processes and the lack of information in
order to make good determinations, but in your opinion that is
the real obstacle?
Mr. Gaffigan. I think the challenge comes down to two
things: People and the information. MMS is an environment where
the kind of people they would hire to do the sorts of things
can also get jobs in industry, and when prices are high in the
industry and things are going well it is harder and harder to
draw the kind of expertise that you need to bring in to do
things like royalties-in-kind.
The other piece of the puzzle is information. Consistently
as we have looked at it as auditors, we have consistently been
sort of frustrated by the lack of the ability to get good,
timely information.
You know, just in preparing for this hearing we were trying
to get a sense of well, how much has gone into RIK lately? You
know, right now the best current information is based on Fiscal
Year 2005. Here we are in the middle of Fiscal Year 2007. We
have seen this theme over and over as we try to look for good
information.
Mr. Kind. I see. Thank you. Thank you both for your
testimony.
Thank you, Mr. Chairman.
The Chairman. The gentleman from Massachusetts, Mr. Markey.
Mr. Markey. I thank the Chair very much. I am trying to be
the winner of the Nick Rahall sound alike contest today. I
think I am doing a pretty good job.
The Chairman. You have a long way to go.
Mr. Markey. This pollen is unbelievable today.
Has the Administration, Mr. Allred, reversed its position
and now agrees that the language in H.R. 6 would not constitute
a takings and would not violate the Equal Protection Clause?
Mr. Allred. Sir, I am not an attorney and I am not aware of
any change in our position, nor do I have enough expertise to
really comment on whether it would or would not.
Mr. Markey. Well, the testimony from the Administration is
that it would constitute a takings and would violate the Equal
Protection Clause, so you are saying that hasn't changed.
In your testimony you cite the prospect of litigation as
the result of the Administration's opposition to the provisions
of H.R. 6. Our committee, Mr. Rahall, I and Mr. Miller and
others, we got some of the nation's most respected
constitutional scholars to actually help us write the language
which is in H.R. 6.
As you know, anyone can bring a lawsuit, but constitutional
scholars indicate that this language is in fact going to be
upheld so it doesn't really stop obviously an oil company from
suing. We assume some will, although it will be on weak
constitutional arguments.
Why do you continue to make that case, Mr. Allred, given
constitutional experts' views that the language in H.R. 6 is
strong and would be upheld if challenged?
Mr. Allred. Congressman, my concern is perhaps a more
strategic one from a standpoint of what might happen to the
leasing program and what might happen with regard to the amount
of oil or the revenues to the United States if there were a
challenge and if a company were to be able to get an injunction
against the leasing program.
Our analysis has indicated that if we had a three year
hiatus as a result of an injunction that it would cost the
United States about 1.6 billion barrels of oil and about $13
billion over 10 years to the U.S. Treasury. That is my
practical concern.
Mr. Markey. I understand your view on it, but I think that
you should understand that that could be the case for any law
that this committee passes.
Any law that the National Resources Committee passes that
is then signed into law could be brought to court. It is not a
reason I think for you to say we shouldn't be passing any laws
because oil companies, gas companies, coal companies might take
that law to court.
I don't think you should put yourself in the place of the
oil industry filing a frivolous lawsuit against an obviously
constitutional law which we have already passed through the
House. I think you are siding with the wrong party in this
case. I think you should be siding with this Congress and with
the American people seeking to reclaim lost revenues rather
than with the oil and gas industry.
Now, you stated in your testimony that the Administration
will focus on negotiation price thresholds on the leases
prospectively. When the companies holding these leases have
already received the windfall profit estimated at between $1
and $2 billion from past production, don't you think it makes
sense, Mr. Allred, to simultaneously attempt to recover this
massive lost revenue as well?
Mr. Allred. Congressman, I believe we should have price
thresholds that recover both past and future royalties.
Mr. Markey. What is the Administration doing to recover the
already lost royalty payments?
Mr. Allred. One of the things, as I indicated, is that I
have tried to look at where I can get the biggest recovery
first, and that has been on the future. I have been a little
bit handicapped in my discussions.
Mr. Markey. Why is it a mutually exclusive strategy to go
after future and not past revenues simultaneously? Why? Are you
hamstrung at your agency that you don't have enough personnel?
Should we pass an emergency appropriations to get you some more
lawyers?
It would be a very small investment for us to have to make
to get you another half a dozen lawyers over there to claim $2
billion. I think we would be willing to do it for you. Would
you make that request to us?
Mr. Allred. Congressman, my biggest problem has been when I
have talked to them and they have said why should we do it
because H.R. 6 does not require it prior to October 1.
Mr. Markey. So at that point would you do so?
Mr. Allred. I am sorry. At what point?
Mr. Markey. I know it doesn't require it. Why don't you do
it prior to that deadline? I mean, do you need a statutory
mandate to do it?
Mr. Allred. I am sorry, but I don't understand. You are
saying should we do it irregardless of H.R. 6?
Mr. Markey. Let me just move on to the next question, Mr.
Allred.
As part of the renegotiated terms that Interior reached
with six of the 45 companies holding these faulty leases, the
agreement states that it will terminate if Kerr-McGee prevails
in its lawsuit.
What kind of deal is that to agree on a renegotiated
contract that still lets the oil companies have the full
freedom to sue for more taxpayer money later on?
Mr. Allred. Congressman, I think that is a reality of the
legal system. They are challenging your law and whether or not
it included the ability for the Department of Interior to place
price thresholds.
If the courts find that your law did not include that then
we could not prevail in any case to force price thresholds.
Mr. Markey. Did you attempt to get those six companies to
waive their rights to file a Kerr-McGee style lawsuit as part
of the renegotiation?
Mr. Allred. Congressman, I believe none of those six
companies are part of that Kerr-McGee lawsuit.
Mr. Markey. No. As part of your negotiation with them, did
you ask them to waive their rights to file a Kerr-McGee style
lawsuit?
Mr. Allred. Congressman, no, I did not.
Mr. Markey. You did not. Looking back now, do you think
perhaps that should have been something that you had looked at?
Mr. Allred. Congressman, I don't believe they have ever
threatened to or have been part of that. I have discussed the
Kerr-McGee issue with Anadarko, and I have sought to try to
resolve that. I have been unable to do so.
Mr. Markey. Mr. Chairman, thank you. I yield back the
balance of my time.
The Chairman. The gentleman from Arizona, Mr. Flake?
Mr. Flake. Thank you, Mr. Chairman.
Mr. Allred, Senator Bingaman in the Senate has said that he
doesn't plan to move H.R. 6 because of constitutional
questions.
Do you want to comment on that? Does he share the same
concerns that you have or that have been expressed by the oil
companies?
Mr. Allred. Congressman, I have not had a specific
discussion with Senator Bingaman about H.R. 6 so I really can't
comment on what his beliefs are.
My concerns have to do with the practical impact of a
potential litigation that might deprive us of about 1.6 billion
barrels of oil and about $13 billion of income to the Federal
Treasury.
What I have sought to do is I have negotiated with these
companies to minimize their opportunity to challenge in court
what we are doing. I believe they should be paying royalties
and the Department of Interior believes they should be paying
royalties, but as I have gone forth, and I have learned this
through vast experience and a lot of gray hair, is I don't want
to do it in a way that might give anybody an opportunity to
challenge in court.
What my advice to the Senate and my advice to the House is
to however we resolve this issue let us try to do it, and we
are most willing to work with all of you. Let us try to do it
in a way that does not open the U.S. Government to a challenge
of what we do.
Mr. Flake. Do you have any specific recommendations on how
to proceed in that regard?
Mr. Allred. Congressman, the Senate asked me that question,
and my response was that I believe there is a way, without
direct use of subsidies, to encourage more companies to sign by
providing the tool to the Department of Interior that would
allow us to extend the deep water leases for three years in
return for their agreement to include price thresholds. I
believe that would bring a number of other companies.
Mr. Flake. Thank you. No further questions.
The Chairman. The gentleman from California, Mr. Costa?
Mr. Costa. Thank you.
I appreciate your patience, Mr Allred. Obviously this is
something that concerns the Committee. You have appointed--not
you but within the Department there was an appointment as it
relates to the Interior's Royalty Policy Committee.
As we all know, whether we like it or not in government
perceptions are often times challenging. Specifically
referencing Mr. Deal, who has been appointed as I guess the
vice chair of the Subcommittee on Royalty Management, his
previous employment of course with the American Petroleum
Institute is one which some would argue might create potential
conflicts.
It is important I think for all of us that the Royalty
Management Subcommittee and the panel be viewed as independent
and that the perception be seen that way. Would you care to
comment?
Mr. Allred. Congressman Costa, I would like the opportunity
to do so.
The Royalty Review Subcommittee is a subcommittee of the
Royalty Policy Committee, which is a FACA committee, and as
such it has to have a Royalty Policy Committee member on it.
Mr. Deal was the Royalty Policy Committee's choice to be on our
subcommittee that we have asked for.
I have little concern, given the other people that are on
that, that anybody will bias their report. If you look at
Senator Garn or Senator Kerrey or you look at the other people
who have been appointed, they do not have backgrounds primarily
with business and so I think that what we will get is a very
open and a very independent report, and that is what we sought.
Mr. Costa. All right. Thank you.
Mr. Gaffigan, back to the issue of the audits versus the
compliance reviews. You spoke about a number of factors that
had to be included when Minerals Management Services made those
choices.
It is my understanding that the Government Accountability
Office is to complete and release an updated report on the
Royalty-in-Kind program. Is that correct?
Mr. Gaffigan. We are just beginning that work.
Mr. Costa. OK. So would it be premature then for you to
comment or elaborate on some of the findings that are taking
place?
Mr. Gaffigan. Yes, because we don't have any findings, but
I would say the things we will look at are some of the things
we have looked at from the beginning of this program. It goes
back to 1999 when we talked about what sort of things need to
be out there? What conditions need to be out there to look at
RIK?
We identified four remaining factors. We talked about
access to pipelines, we talked about access to the processing
of natural gas, we talked about having large volumes so the
government is in a position of a strong sales position and also
market expertise. Those are the sorts of things we will look
at.
Following up on that, in our 2003 and 2004 work we asked
two basic questions. How do you sort of measure how you would
have done against royalties-in-value, and how also have you
done in sort of your administrative costs? Do you track
litigation costs, and have you any savings there?
When we looked at that in the pilot stage there were some
problems in terms of the kind of information that was available
to make those judgments. We made recommendations, and we are
going to pursue and see how they are doing on a much larger
scale.
Mr. Costa. Well, we will want you to keep us updated.
Mr. Gaffigan. Absolutely.
Mr. Costa. I will yield the balance of my time back, Mr.
Chairman.
The Chairman. Thank you.
Gentlemen, thank you for being with us today. We appreciate
it.
Mr. Allred. Thank you very much.
The Chairman. Thank you, Mr. Assistant Secretary.
Our next panel is composed of Mr. Bobby Maxwell, Former
Auditor, Minerals Management Service, Mr. Kevin L. Gambrell,
Indian Land Working Group, and Ms. Ryan Alexander, President,
Taxpayers for Common Sense.
The Committee welcomes our panel members, and we will
proceed as we normally do. We do have your written testimonies,
and they will be made part of the record as if actually read.
You may proceed in your individual testimonies as you desire.
Mr. Maxwell?
STATEMENT OF BOBBY MAXWELL, FORMER AUDITOR,
MINERALS MANAGEMENT SERVICE
Mr. Maxwell. Mr. Chairman and subcommittee Members, thank
you for the privilege and opportunity to be here today.
I have 26 years' experience auditing oil and gas companies.
The Chairman. Mr. Maxwell, let me ask you to bring the
microphone a little closer to you, please.
Mr. Maxwell. OK. Is that better?
The Chairman. Yes, sir. Thank you.
Mr. Maxwell. OK. Thank you.
Mr. Chairman and subcommittee Members, thank you for the
opportunity and privilege to be here today.
I have 26 years' experience auditing oil and gas companies.
Twenty-two of those years were at Minerals Management Service.
I am an expert in auditing sales contracts, revenue and
production systems.
I have also received many of the highest awards at MMS for
the work I have done. One of those awards included the
Meritorious Service Award. I understand auditing and how to
protect the assets of the American taxpayer.
M.M.S. has changed over the years. Less auditing is being
performed. Less underpaid royalties are being collected. The
qualifications of audit staff have decreased. Certain royalty
areas are not being audited at all.
Valid orders for royalty payments are sometimes not issued.
I personally was not allowed to issue a valid order to Kerr-
McGee Corporation for $10 million. I was not allowed to audit
royalty-in-kind contracts. I was not allowed to order companies
to pay interest on late payments.
On the Kerr-McGee issue, I personally filed a false claims
lawsuit on behalf of the Federal government. The Department of
Justice did not intervene in the lawsuit because it has become
a political issue.
On January 23, 2007, a courageous jury in the district
court of Colorado found Kerr-McGee Worldwide Corporation guilty
of underpaying the Federal government $7.6 million in royalties
and also that Kerr-McGee had withheld vital information from
the Federal government. With an impartial judge and jury,
deliberations only lasted for several hours. The American
public has spoken, but now Kerr-McGee is trying for a technical
win to not pay the American taxpayer.
Unfortunately, even today MMS states that Kerr-McGee owes
no additional royalties. MMS never attended the trial. MMS
never reviewed the 60,000 trial documents I received under
discovery. MMS never received the thousands of pages of
depositions or reviewed them. MMS never reviewed the trial
transcripts. MMS really just doesn't know. MMS is the
proverbial ostrich that has its head in the sand, sees nothing,
knows nothing, but states no royalties are due.
Kerr-McGee personnel's testimony at trial clearly showed
they had knowledge that the additional royalty was due MMS.
However, their final defense was that MMS never demanded the
payment.
M.M.S. must be required to maintain a highly professional
and aggressive audit program to collect all the royalties that
are due the government. MMS has many qualified auditors, very
highly qualified, many with MBAs, CPAs and industry experience.
However, many of them are more in clerical or technical
positions where they are not using that experience right now.
I think you have reviewed my written testimony, so I thank
you for the opportunity to be here and your time and attention,
and I will answer any questions you may have.
[The prepared statement of Mr. Maxwell follows:]
Statement of Bobby L. Maxwell, Former Auditor,
Minerals Management Service
Mr. Chairman and subcommittee members, thank you for the privilege
and opportunity to be here today. This is an opportunity for me to
participate in a hearing that will hopefully make the Mineral
Management Service (MMS) a better servant of the U.S. taxpayer. MMS is
responsible for collecting royalty payments for the U.S. Government and
brings in revenue only second to the Internal Revenue Service.
I served the American taxpayer with over thirty years of service,
including three years in the U.S. Army. I believe one of the greatest
joys in life was the opportunity to work for the government as a
citizen of this great country. My only regret is that my career was cut
short due to exposing the Federal government's current cozy
relationship with the oil and gas industry and its unwillingness to
consistently enforce laws and regulations requiring the industry to pay
royalties due on Federal oil and gas leases.
I audited the oil & gas industry for over 25 years. I became an
expert in reviewing industry contracts, revenue accounting and
production systems. I understand professional auditing, industry
contracts and how to determine what monies are owed the Federal
government under oil and gas leases.
I have a Bachelor of Business Administration degree in accounting
from Chaminade University of Honolulu, a Master's in Business
Administration from Texas A & M University, and I am a certified public
accountant in the states of Oklahoma and Hawaii. I received many awards
from MMS for being highly effective as a manager and for audit results.
In June 2003, I received the Department of the Interior Meritorious
Service Award from the Secretary of Interior, Gail A. Norton.
Around the year 2000, MMS began to change. The auditing function
began to be de-emphasized and the enforcement of the lease terms and
regulations seemed to become less important. To replace professional
audits, top management advocated a new system. This system was called a
``compliance review'' and often resulted in professional auditors being
replaced with other staff. The new staff often did not have an
educational background containing college level accounting or auditing
courses. All senior managers were ``directed'' that they would support
the new process as part of their jobs. It was clearly stated that no
dissent would be tolerated. I do believe that there is an appropriate
need and use for compliance reviews, but they should never be used as a
replacement for professional audits.
With the new compliance system we were told not to bother the oil
companies. We were told not to be requesting documents as we formerly
had with audits. Audit staff was reduced. Many auditors stopped
traveling to companies for audits, stopped interviewing oil company
staff, stopped visiting marketing departments and field personnel.
Audits were marginalized, and accounting and auditing degrees were no
longer required. For four years, MMS received a qualified audit report
reflecting substandard audit work. In 1992 audits covered 90% of all
royalty payments, currently audits and compliance reviews are only
covering 72% of royalty payments. Remember that the compliance review
is not an audit and does not provide the same level of assurance that
royalties were correctly paid. Further, royalty underpayment
collections have decreased by over $100 million per year.
By the year 2002, we were no longer allowed to audit certain areas.
For example, we were not allowed to review or audit many Royalty-in-
Kind contracts. In an attempt to review the contracts and
transportation agreements, I was ordered not to get any information
from the Royalty-in-Kind division of MMS, or review their contracts for
sales of the oil and gas. In an attempt to overcome this major scope
limitation on our audits, a meeting was schedule with the Office of the
Inspector General and Royalty-in-Kind personnel in Lakewood, Colorado.
Audit staff traveled from Oklahoma City, Oklahoma, for the meeting.
Neither the Office of Inspector General nor the Royalty-in-Kind
personnel showed up for the meeting. I was told not to pursue the issue
any further.
This was reminiscent of being directed to not pursue an issue many
years earlier. In the early 1990's, I was directed not pursue the issue
of oil companies exchanging crude oil by contracts using artificially
low exchange values. This resulted in MMS receiving royalties based on
a value far below the fair market value of the crude oil. A former
employee of ARCO Oil & Gas Corporation filed a False Claims Act lawsuit
against the oil companies based on this issue and collected over $400
million for MMS. This was over $400 million that MMS would never have
collected on its own initiative.
In 2003, I was chastised for attempting to bill a corporation for
interest due on millions of dollars it paid as a result of an audit.
However, the audit staff convinced the company to voluntarily remit the
interest payment without a bill from MMS. I was told that a system was
in place for billing interest and the audit staff should never issue
bills for interest relating to royalty underpayments we collected.
However, everyone in MMS knew that the system wasn't working and the
government was behind many years in the billings and apparently
millions of dollars in interest would never be collected. The fact that
many millions of dollars in interest would be years late being
collected--if ever collected at all--was of no concern to senior
management. The Jicarilla Apache Nation complained directly to the
Director of MMS and I was allowed to bill all companies for interest
due the Jicarilla Apache Tribe.
Every year we were pressured to do less auditing and state that
royalties were accurately reported and paid by the oil companies using
the compliance review process. In some cases the compliance reviews
were adequate and useful in determining if royalties were correctly
reported and paid. In other situations, it was only used as a method of
smoke and mirrors to state that royalties were in compliance. I was
told that finding and collecting royalty underpayments wasn't
important, but meeting our Government Performance Results Act standards
was what mattered, our operating budget depended upon it. Further, we
were directed that MMS would not issue any subpoenas to oil and gas
companies for records.
Pressure continued to mount in 2002 & 2003 to not pursue royalty
underpayments to the U.S. government by the oil and gas industry. The
most well known case is the Kerr-McGee Corporation (Kerr-McGee) royalty
underpayments. I developed an order requiring Kerr-McGee to pay MMS an
additional $10 million. I was pressured not to issue the order even
though it was fully supported by the lease terms and regulations. The
pressure came down from the Director of MMS not to pursue these
underpayments against Kerr-McGee. I was never told that the order was
not supported by the MMS regulations or justified--just not to issue
the order. No criteria was ever provided to me stating why the
additional royalty should not be collected from Kerr-McGee.
As you know, I filed a False Claims Act lawsuit against Kerr-McGee
on behalf on the U.S. government to collect the royalty underpayments
by Kerr-McGee. Within days of the lawsuit becoming public, I was
notified that I was being terminated from employment with MMS. MMS was
determined not to require Kerr-McGee to pay the royalty underpayments.
The Department of Justice did not intervene in the lawsuit, but allowed
me to take the lawsuit forward on behalf of the American public. This
has become a political issue within the Department of Justice.
I personally continued the lawsuit against Kerr-McGee Worldwide
Corporation on my own time and at my own expense. It has been a long
and difficult road, with absolutely no assistance from the Federal
government. On January 23, 2007, a jury in the United States District
Court for the District of Colorado found Kerr-McGee guilty of
underpaying the Federal government $7,555,886.28, and that Kerr-McGee
had failed to disclose to the United States Government all relevant
information to determine the value of royalties due. Kerr-McGee's guilt
of underpaying royalties and withholding vital information from MMS was
quickly determined when the evidence was presented before an impartial
judge and jury.
It is important to note that these twelve courageous citizens had
no hesitation in finding Kerr-McGee guilty. The overall deliberations
were less than four hours, and all indications are that the jurors
determined Kerr-McGee was liable in less than two hours into their
deliberations. Kerr-McGee's trial evidence did not seriously question
the royalty underpayments I had calculated, did not dispute the fact
that it had not engaged in reasonable and prudent marketing of this
Federal oil, and did not dispute that the buyer, Texon Corporation,
L.P. (Texon), had provided other significant consideration, including
the assumption of essentially, all of Kerr-McGee's transportation
responsibilities. No, Kerr-McGee's primary defense was that MMS had
decided not to issue an order to pay.
Kerr-McGee clearly lost in district court, but now is trying for a
technical win as a way of not paying its royalties due the American
taxpayer.
Not withstanding the fact that the American public has spoken on
this issue, even today MMS still states that Kerr-McGee owes no
additional royalty. However, MMS never attended the trial; MMS never
reviewed the almost 60,000 documents I received under the trial
discovery process; MMS never read the thousands of pages of
depositions; MMS never listened to the trial testimony or reviewed the
trial transcripts. In essence, MMS is the proverbial ostrich with its
head in the sand. It sees nothing and hears nothing, but is sure no
additional royalty is due. With this type of behavior, it is scary to
know that MMS is responsible for protecting the American public's
assets and collecting royalties due.
Kerr-McGee's testimony at trial clearly stated that its personnel
knew additional royalty was due, but elected not to pay the U.S.
Government. Kerr-McGee's accounting and marketing personnel stated that
they knew Kerr-McGee received additional value for the oil in the form
of services provided by Texon. Further, they testified that they knew
royalty was due on this additional value. However, no attempt was ever
made to pay MMS the full royalty value. The manager of revenue
accounting at Kerr-McGee, Mr. Terry Kyle, even directed an employee to
not provide answers to MMS for questions about additional incentives or
consideration that Kerr-McGee received in exchange for its sale of the
Federal oil to Texon.
Kerr McGee's attorney, Mr. Gorenson, provided an affidavit with
respect to one of Kerr-McGee's district court motions indicating that
he had full knowledge of the Texon contract terms many years ago. As a
Kerr-McGee attorney he made no attempt to have Kerr-McGee pay the
proper value of royalties. Rather, he worked to increase Kerr-McGee's
profitability at the expense of the American taxpayer.
I personally believe that the knowledge of the contracts and
royalty underpayments by Mr. Gorenson and Mr. Kyle are sufficient to
show that they knowingly and willfully filed false Federal royalty
reports and underpaid the royalties due the American taxpayers.
Further, the Director of MMS by stopping a valid order for royalty
underpayments makes one wonder if collusion between MMS and Kerr-McGee
took place. It is a matter that I personally believe should be closely
evaluated. In this instance, a career senior manager, myself, was
instructed not to issue a valid order for payment of the additional
royalty. Kerr-McGee knew the royalty was underpaid and the Director of
MMS personally stopped the order from being issued.
Kerr-McGee has taken a stand that it owes no royalty on the deep-
water leases that were issued without threshold values for royalty
payments. These leases were issued by MMS in error by not including a
threshold value for determining royalties due the Federal government.
Some companies have renegotiated similar leases in an attempt to
correct the error and bring an element of fairness to the American
taxpayer. However, Kerr-McGee is aggressively pursuing the issue
indicating that it will not pay any royalties to the American taxpayers
on its deep-water leases with the missing threshold dollar value.
However, Kerr-McGee will receive billions of dollars in revenue from
the sales of oil and gas from these assets that belong to the American
public.
I sincerely hope that this Congress will hold Kerr-McGee
responsible for paying all royalties that it owes. I believe, and a
jury of 12 American citizens agreed, that Kerr-McGee filed false
royalty reports with MMS and did not pay its full royalty obligation.
Further, I believe that behind closed doors in Washington D.C. the
decision was made that Kerr-McGee would be let off the hook and not
required to pay the royalties it owed. It was totally inappropriate for
the Director of MMS, as a political appointee, to intervene and revoke
my authority to issue a legal order to Kerr-McGee to pay the additional
$10 million. Also, I hope Congress will review MMS' compliance program
and encourage them to have a highly professional workforce and a truly
professional audit program independent of political pressure.
This concludes my formal testimony. Thank you for the opportunity
to appear here before this Subcommittee. I will be happy to answer any
question you may have.
______
The Chairman. Thank you, Mr. Maxwell.
Mr. Gambrell?
STATEMENT OF KEVIN L. GAMBRELL,
INDIAN LAND WORKING GROUP
Mr. Gambrell. Mr. Chairman and subcommittee Members, thank
you for the opportunity to be here today. I see this as an
opening to correct the course, encourage changes within MMS to
act as a fiduciary and honor the treaty obligations with the
tribes and individual Indians.
I have 16 years' experience in mineral industry work. My
background is a Master of Science, Mineral Economics. I work as
a practitioner for Alternative Dispute Resolution with the
Morris Udall Foundation. I am connected with the Rocky Mountain
Mineral Law Foundation. I have 280 hours of accounting auditing
of law, and I have worked as a Navajo Nation mining financial
analyst, as well as working for industry.
I came to the Federal government back in 1996, November 18,
to run an office that managed Indian trust assets, oil and gas,
on Navajo allotted lands. The reason the office was created was
because the Federal government had breached the trust with
Indian landowners, and many were not getting paid and were
losing their homes, cars, livestock.
When I took over the office I was delegated the authorities
of a BIA regional director, an MMS audit chief and a BLM field
manager, so in my office I saw basically everything from the
beginning of a lease, auctioning the leases, getting leases
developed, to counseling leases and collected bonds. I have
seen the whole process from end to end.
When I took over this organization, I ran into many areas
of departmental resistance within the bureaus. Many of the
bureaus were not willing to give up their authority, and I had
to fight tooth and nail to get any authority within my office.
I had to contact the deputy solicitor of Interior, as well as
the deputy commissioner of Indian Affairs, to get action within
the departmental agencies at the bureau level in the field.
At the end of the life of the pilot program, and it was a
pilot project under Reinventing Government, Vice President Al
Gore's pilot project, we were considered a success in 2002.
During that time up until 2002, I had reported to a court and
discussed what was happening within the Federal Indian Minerals
Office (FIMO), explaining how we were in compliance with the
consent decree that had orders to look at zero production, do
audits, look at transportation, look at other issues, hire
auditors, hire inspections, do everything from volumetrics to
valuation.
In 2002 it was a success. We became departmentalized, and
Gale Norton decided to extend this project to other locations
in Indian Country. Also we had been nominated for the Hammer
Award and other awards.
The things that have changed since I took the office and
after 2002 when I stopped reporting to the court to me are a
travesty. I saw a system called the compliance review system
that did nothing in terms of really getting at the issues of
valuation. I had an audit team that worked for seven years, and
in five years of that seven years we always collected on back
audit issues. Always. The compliance review process resulted in
very little collection.
I also had situations where the system was shut down in
2001 in November, the MMS royalty system. Soon after, when that
system came on line it was a new system that was created by
Accenture, and it was to increase the compliance review process
and make it a more contemporaneous, real-time audit process
similar to an audit process. It is not quite. It is more of a
compliance review.
When that system came on it failed miserably. I think over
50 percent of the royalty did not pay out in November 2001. In
December 2001, Cobell litigation. Judge Lamberth issued an
order to shut down the system, and that in a sense saved MMS
from being exposed for the problems that were occurring within
that system in November 2001.
The system did not come back on until 2002, April 2002.
When that system came back on, many people had already lost
their homes, cars, houses in Indian Country, but in addition to
that the system still did not pay out correctly. MMS changed
the error-checking system on volumetrics in order to let the
data flow through the system and pay out.
That is just one example of the many problems within MMS
and the compliance review system after I had stopped reporting
to the court.
I thank you for hearing my testimony. If you have any
questions, I would be glad to answer.
[The prepared statement of Mr. Gambrell follows:]
Statement of Kevin L. Gambrell for Indian Land Working Group
Mr. Chairman and subcommittee members, thank you for the
opportunity to be here today. I see this as an opening to correct the
course, encouraging change within Mineral Management Service (MMS) to
act as a fiduciary and honor the treaty obligations with tribes and
individual Indians.
I served and continue to serve Indian nations and the American
taxpayer for sixteen years. I look back at my experience and recognize
that it is one of the greatest joys of my life to see tribal people get
what they are entitled to. However, I also recognize that MMS and other
bureaus have forgotten their responsibility and now place industries
desires and wants above their trust responsibility to maximize the
benefit of oil and gas development to tribes and the American public.
I have a Bachelor's degree in International Trade and Relations and
a Master's in Mineral Economics from the Colorado School of Mines.
Further, I am a practitioner for Alternative Dispute Resolution with
the Morris Udall Foundation and I am a whistleblower.
I started my career in oil and gas management with Navajo Nation as
their Mining Financial Analyst and later went to work for the U.S.
Government as the Director of the Federal Indian Minerals Office
(FIMO).
The creation of FIMO was a result of Navajo individual Indian
mineral owners, known as the Shi Shikeyah (roughly translates to,
``This is My Land'') Allottee Association, filing a lawsuit against the
Department of the Interior in 1983 claiming that the federal government
mismanaged their resources. After years of litigation, the U.S.
District Court ordered Interior to establish FIMO.
FIMO was established in the early 1990s, however the employees
mirrored the bureaus, in that they had few common goals, struggled over
turf issues, handed off responsibility to other staff based on their
bureau functions, and performed little to no asset management. The
office failed to become the seamless, efficient and effective office
the Department committed to, thus the Shi Shikeyah Allottee Association
requested the court intervene.
In 1994, the Department established a National Performance Review
Laboratory under Vice President Al Gore's reinventing government
initiative. The laboratory is known as the FIMO Pilot project. Part of
the initiative was to establish a FIMO Director that would navigate the
staff from Bureau of Indian Affairs (BIA), Bureau of Land Management
(BLM) and MMS and the mission. This would require delegated authorities
to operate as a trustee for individual Indians in the Four Corners
Area. The goal was to perform proper lease management, and accurately
collect, disburse, and verify all royalties and volumes due from the
severance of minerals. In addition, FIMO would be placed near the
beneficiaries of these royalties so as to work with the beneficiaries
directly.
In November of 1996, I was hired as the FIMO Pilot Director. Over
the next six months, I changed the reporting relationship of the FIMO
staff from the three bureaus to me, reported to a DC level Interior
committee and acquired delegations of authority to act in the capacity
of a BIA Area Office, a BLM District Office, and a MMS Compliance
Division with regard to mineral issues.
Although FIMO was better equipped to act as the primary source for
fulfilling the trust responsibility, the agencies maintained control,
continued old practices and engaged in battles with me anytime I
questioned their trust management practices. To counter this defiance,
during the Pilot phase I found safety in reporting to the District
Court, the allottee association, and the committee. I overcame most of
the organizational resistance and turned around a negligent approach to
managing mineral assets on Indian lands to providing services that met
or exceeded the requirements of a Federal District Court consent
decree. In one example, we annually collected 7 times the underreported
royalty than MMS did for 20 years prior to my management. FIMO had the
highest underpayment collection to audit cost in comparison to other
MMS audit groups.
After a thorough evaluation of FIMO, it was considered a success
and made permanent in October 2001. The Secretary of the Interior gave
the green light to the committee to implement the FIMO concept
throughout Indian country and I and my staff were nominated for two
National Hammer Awards and numerous Spot Awards for excellent
performance.
Once the pilot phase ended, the court reporting requirements
stopped, and I reported to and took direction from line managers, I
lost the shield and became challenged with managing the trust assets
under the direction of management that made contrary decisions to
maximizing the benefit to the Indian allottees.
Over time, I exhausted all efforts in attempting to protect the
beneficiaries' interest against my superior's unethical decisions and
decided to communicate with the Special Master of Cobell litigation who
had the responsibility to ensure that information vital to the
interests of individual Indians be safeguarded. I have experienced the
following:
2000 Indian Gas Rule
In 2000, MMS changed the Gas Rules on Indian lands allowing
companies to use index prices versus doing the full accounting in
accordance with the lease requirements. As the Director of FIMO, I
opted out of the pricing method because I did not believe I had the
right to change lease terms without the consent of the Indian
landowners and the method appeared to negatively impact royalties. When
I voiced my concerns and decision, I was chastised by management and
told that my decision was wrong and burdensome to industry.
When MMS implemented the regulation, the tribes and MMS made the
decision for individual Indians, except Navajo allottees, to follow the
new rule. At the start, the Navajo allottees were ahead of the index
pricing by 25 to 45 cents per mcf every month. I reported this to
management and they ignored the evidence that the New Rule potentially
resulted in losses to the tribes and individual Indians. Soon after, DC
management told me that I was not to attend the quarterly meetings with
tribes and states.
They did nothing to inform other Indian groups that index pricing
was producing negative results in the San Juan Basin and tribes had no
way to benchmark the method without having gross value information.
Although MMS had conflicting data, MMS failed to act and protect the
interest of tribes and individual Indians. MMS management behavior
violated the requirement to maximize revenues to the beneficiaries as
stated in the regulations and law.
Undervaluation of trust assets, a violation of 64 C.F.R.
Sec. 43506, as the Minerals Management Service explicitly acknowledged
with regard to valuation of gas production from Indian leases, it is
responsible, ``[t]o ensure that Indian mineral lessors receive the
maximum revenues from mineral resources on their lands consistent with
the Secretary of the Interior's (Secretary) trust responsibility and
lease terms.''; see also Federal Oil & Gas Royalty Management Act--
1982--Title I, Section 101, Duties of the Secretary ``The Secretary
shall establish a comprehensive inspection, collection and fiscal and
production accounting and, auditing system to provide the capability to
accurately determine oil and gas royalties, interest, fines, penalties,
fees, deposits, and other payments owed and to collect and account for
such amounts in a timely manner; and 30 U.S.C. Sec. 1711 Comprehensive
Accounting and Auditing.
2001 New Computer Compliance System and the Shut-down
In November of 2001, MMS shut down the old computer compliance
system and turned on the new system created by the Bermuda based
Accenture, previously Arthur Anderson. MMS did not parallel test the
new system against the old system and the new system systematically
failed halting royalty payments to more than half of the federal and
Indian leases. In December, the problems were masked or decoyed by the
court ordered shut-down resulting from Interior's failure to protect
Indian data from internet hackers. Tribes and Indian individual stopped
receiving royalties for almost five months and MMS management was able
to save themselves from a congressional and public flogging.
The system came back on line at the end of April, 2002 and MMS
still could not determine where to allocate monies placed in escrow. In
desperation, MMS reduced their error controls and allowed erroneous
data to pass through the system in order to get payments out. Only part
the payment made it to the correct accounts. During the process, I made
a request for the raw data to do my own reconciliation and management
told me that their internet contractor had the data, but could not
provide it because it was proprietary.
The claim by Interior that they were not able to pay tribes because
they were off the internet was false. About five years before, Interior
paid tribes using a manual system. During the entire shut-down, MMS and
other bureaus blamed the Cobell litigation for the problem.
Consequently, many Indian people lost their homes, automobiles and
livestock.
In reality, this was a multi-million system not suitable for
compliance, as required by Inspector General Act of 1978, as amended,
(5 U.S.C. App. 3), which establishes as goals:
1. Promoting economy, efficiency, and effectiveness within the
agency.
2. Preventing and detecting fraud, waste, and abuse in agency
programs and operations.
3. Keeping the agency head and the Congress fully and currently
informed of problems in agency programs and operations and of the
necessity for and progress of corrective actions.
To this day, there are still monies sitting in escrow and the new
system does not live-up to the compliance system that Accenture told
MMS they would create. Accenture's contract was to end once the system
was on-line, but their million dollar contract continues. Many tribes
and state outright reject using the system for any serious analysis and
resort back to the prudent and thorough audit approach. Lastly, how
many times has the MMS Director and staff mislead congress on how well
the compliance system works?
2000 to 2002 Closing Legacy Audits
In 2000, MMS made a decision to close all back-logged audits. To
fully and diligently complete the audits, MMS would have to reverse
their compliance review course and hire and train additional auditors
with oil and gas accounting backgrounds. MMS decided not to change
their course and made the deliberate decision to fast track all past
audits with inappropriate and illegal valuation methods such as the
``bump method'' and other questionable practices. I blew the whistle on
the actions management was directing me to do that I knew based on past
audits would result in 1/8 the collections of underpaid royalties.
On January 31, 2003, my audit staff and I had a manager meeting in
Denver regarding audit goals. We talked with MMS Managers about
accounting requirements and we were directed to:
bypass the negotiated settlement approval process,
ignore third party verification,
classify rudimentary reviews as ``Yellow Book Audits,''
not document discussions with industry,
use a compliance system that did not work, and
perform duties and meet goals without adequate resources.
I raised concerns continually and provided evidence that their
method would loose millions of dollars. MMS management ignored my
arguments and used the fast-track approach throughout Indian country.
While the ``Bump method'' was casually used in the past through a
settlement negotiation process with Indian nations, it had never been
lawful before 2000 as an alternative method without the required
negotiated settlement process. The negotiated settlement process, as
defined in Royalty Management Program, Audit Manual 2.0, 2.1.5,
requires that if the company is unable to perform requirements under
the Order to Perform, they may use the negotiated/settlement process
with the approval of the Director of MMS and Assistant Secretary of
Indian Affairs. MMS management willfully violated these rules and
continued to implement their ``fast track'' procedures to meet their
unreasonable goals.
As a result of my unwillingness to comply with such outrageous
demands I feel that my superiors placed me in a situation with only
three alternatives: (1) blatantly breach the trust of the
beneficiaries, (2) act against management in insubordinate manner, or
(3) leave. I chose to leave.
It is difficult to assess how many millions of dollars were lost
because of this decision. Under any fiduciary system, this deception
and corrupt practices would be considered malfeasance and negligence
and somebody would go to jail. Even after I reported this problem to
the Office of Special Council and the Office of the Inspector General,
they did nothing to investigate or correct this problem.
2002 Trespass Issue
In 2002, I encountered a trespass issue where a company was
operating a cancelled lease. The company produced for almost a year
without reporting to MMS. The company received checks for production
and cashed them monthly at a liquor store in Louisiana. We discovered
the trespass when one of my inspectors visited the well site and found
that it was producing and selling through the transporter. We contacted
the transporter, told them that the producing company was trespassing
and that we wanted all sales information. I contacted the trespassing
company and told them we would collect 100% of the gross proceeds. They
were upset, contacted their attorney and debated about how unfairly
they were being treated. I told them that I would not tolerate this
violation and would consider filling criminal charges against them.
The trespassing company contacted MMS management. Then an MMS
Manager contacted me and told me that I could no longer talk with the
company and scrutinized my evidence and my approach to the trespass. I
asked management did they understand that they work for the American
taxpayer. In order to circumvent ``Friends of the Company'' MMS
management, I passed the responsibility to my auditor and forced the
company to comply.
This case revealed how easily a company could circumvent the
reporting system and produce and collect revenue without anyone's
knowledge. This further emphasized the need for third party
verification and field inspections. It also revealed that management
considered industry complaints credible to the extent that they were
willing to violate the beneficiary's interest, court orders and attack
an MMS subordinate's position.
2003 Zero Production
After I left federal service, MMS and the Solicitor in Albuquerque,
NM reversed my decision to collect additional value from companies
violating lease terms of shutting in production without approval, known
as ``Zero Production.'' The Solicitor wrongfully believed that
liability did not transfer with change in lease ownership. The
Solicitor decision is false based on private land oil and gas cases and
general property law.
Before I left, I had already collected more than a million dollars
and had about million dollars in cases still pending. Even though I was
able to collect on past violations, the Solicitor ignored the results
of my collections and arguments and reversed my decisions. I believe
that MMS and the Solicitors lost more than a million dollars to Indian
landowners. Their actions again violated court orders and MMS and the
solicitors never looked anywhere else in Indian country to investigate
``zero production.''
Compliance Audit Tracking System
During 2000, MMS management discussed what systems they would
continue with and remove. The Compliance Audit Tracking System (CATS)
was marked to be removed and when I discussed what the system did--
track all orders, issue letters and follow-up of compliance work over
time--management stated that they had no idea that the system contained
this data. This lead me to conclude that the MMS management was not
consulting with auditors and were willing discard anything they did not
understand or they intentionally wanted to remove historical
information. Discarding this system was in fact a removal of the tool
that helped the auditors track ``records of decision.'' In talking with
auditors today, I have been told that MMS has a new system, but it does
not cover tribes and states and I am concerned that past audit
``records of decision'' have not been included.
Conclusion
The problems of mismanagement of the public and Indian trust go far
beyond the MMS royalty issues. I experienced the broad failures in
protecting trust asset from BLM's expedited drilling and development
approvals to BIA's right-of-way undervaluation. In today's environment,
the actions of government executives represent an extension of
industry, in which the federal managers fail to understand who they
work for. Most federal executives have a company job waiting for them
once the administration changes. The revolving door to industry has
created a management team that is loyal to industry and the honest and
diligent government worker is oppressed and pushed out of the way, thus
violating and discounting the public trust. This is a travesty.
Recommendations
1. There is evidence that some oil and gas companies have not
reported and paid royalties, therefore indicating that the system is
still somewhat of an honor system. There must be third party
verification through transporter and plant information.
2. Although MMS makes claims that regulation changes will benefit
the American public, tribes and industry, it often benefits industry
more. Once the regulation is implemented, there is often it is
difficult to evaluate if the regulation changes actually benefit the
tribes and the American public and MMS usually neglects this
evaluation. Needless to say, industry tracks benefit to the penny for
any regulation change. MMS needs to reevaluate the regulation changes
and if they do no work, report this to the public and change course.
The method of evaluating the regulations effectiveness must be
emphasized and clear in public registrar at the outset of any proposed
regulation change.
3. MMS's regulation changes that modify lease terms are a
violation of contractual arrangements between lessees and lessors. MMS
uses regulations to modify lease terms and inadvertently damages the
interest of the landowner. MMS does not ask the landowner if they would
sign a new agreement to clarify or improve lease terms, they simply
make changes forcing the Indian landowners to comply. This violates
contractual and property law. MMS and other agencies must consult and
obtain approval to change lease terms.
4. MMS needs to be accountable to the states, tribes, and federal
government. As it is now, MMS reports and is accountable only to
federal politically appointed executives. The federal government has a
50% stake in state leases and a 0% stake in Indian leases. As such, MMS
should be guided, assessed, and managed by all government stake
holders. A board of governors representing the states, tribes and
federal government would do more to force MMS to be responsive to their
concerns than the current UNILATERAL approach that is often politically
manipulated with the industry stakeholders having the largest
influence.
5. Although, MMS has limited resources, expediting settlements,
compliance and collection at the loss of accountability makes them a
``simple paper processor'' with little to no concern for maximizing the
benefit to the American public and enforcing lease compliance. MMS
needs to change their objective from reporting false compliance
information to maximizing revenue to the tribes and the public.
6. Everything MMS does must be made transparent and trackable.
Any meetings with industry must be recorded and documented. Every
action should be recorded in a system that can be queried by any state,
tribal and MMS employee working on compliance. The IG should be able
review these documented discussions and events at any time.
7. IG audits must go beyond the Yellow Book standards or
Government Auditing Standards (GAS) in reviewing oil and gas audit
work. Although, the GAS covers important issues such as transparency,
accountability and peer reviews, it does not review the intricacies of
valuation and volumetrics. For example, an IG auditor will look at the
scope of work, internal controls such as signatures by managers, proper
indexing and spreadsheets that add up in the total column, but they
rarely review methodology of valuation and compliance with regard to
court orders and other legal instruments. The IG must support positions
that are well versed in mineral and energy accounting, as well energy
law.
8. MMS must use the full extent of the lease terms to force
compliance. MMS currently uses a penalty process to enforce royalty
collection that is rarely collected and gets few if any results. Under
royalty violation, I have used the cancellation clause to enforce the
lease terms and companies have immediately taken action to comply.
9. With regard to whistle blowers, the staff within the Office of
Special Counsel must be diligent and knowledgeable. They must follow-up
on issues and hold management accountable. Retaliation laws need to be
stronger, the investigative process needs to be thorough, and
management needs to be accountable and punished when violating the
public trust and employee rights.
10. MMS needs to restore the audit function. Determining
underpayment is not an engineering calculation and requires an
experienced oil and gas auditor that can look a vast array of data that
is not only quantitative, but qualitative. The compliance review that
MMS claims is an audit, is not and should be reported as only a review.
MMS uses the misinformation and other false data to hype the compliance
work that MMS claims they do annually. Many tribes and states have
purposely removed themselves from relying on only compliance reviews as
a realistic approach to lease compliance. These mineral assets belong
to the public and Indians and once exploited, are gone forever. Every
penny owed to the public and tribes should be acquired with the most
diligent and reasonable approach.
11. MMS must follow not only the laws and regulations, but also
the court orders.
This concludes my formal testimony. Thank you for the opportunity
to appear here before this Subcommittee. I will be happy to answer any
question you may have.
______
Responses to Questions submitted for the record by Mr. Kevin Gambrell
Would you explain the ``Bump method'' to the committee?
The ``Bump Method'' is a fast track approach for the dual
accounting requirement (Refer to MMS Audit Manual, Chapter 17, Section
17.5). This method usually results in fewer dollars collected for
Indian allottees. In the following I will provide a written summary of
the method and show the calculations at the end.
DUAL ACCOUNTING DEFINITION
Dual accounting is sometimes referred to as accounting for
comparison and it is found in many, if not most Indian leases, both
allotted and tribal. The purpose is to protect the royalty interest
owner by comparing two values and using the higher of the two for
royalty purposes. More specifically, a company acquiring a lease on
Indian lands must pay gas royalty on a value which is the higher of the
value of gas before processing less applicable allowances,(well head
value), to processed less applicable allowances (the combined value of
drip condensate, residue gas, and other gas plant products, less
applicable allowances like transportation and processing). To determine
the reasonableness of the company's reported value, the auditor must
determine the gross revenue the company received for the gas and if it
was based on the comparison for processed and unprocessed gas. This
requires an audit of the company's records and systems, in which we
look for purchasing contracts, allowance notifications, deductions,
spreadsheets showing the comparison, and systematic problem due to
internal controls and systems. Often, we go to third parties, such as
gas plants and transportation companies to determine if deductions were
reasonable. This requires an auditor with very specialized skill who
understands the ``ins and outs'' of gas transactions.
``BUMP METHOD'' DEFINITION
An alternative approach to the dual accounting comparison is a
method known as the ``Bump Method'' and also referred to as the
alternative methodology and the fast track approach. The method was
questionably approved under the Amendments to the Gas Valuation
Regulations for Indian Leases, effective January 1, 2000. The reason I
say questionably is that rule changes lease terms without the consent
of the Indian lease holder. The concept behind the ``Bump Method'' is
that the company will adjust the value of gas with regard to quality
before processing to determine a value after processing, thereby
bypassing the dual accounting comparison. More specifically, a company
will take the quality of the gas and if it is greater than 1000 British
Thermal Unit (BTU) the company will adjust the unprocessed value based
on table of increments found in 30 CFR Sec. 206.173. For example,
company A has unprocessed gas quality of 1506 BTU. The company will
refer to the table and find the adjustment under ``non-ownership in gas
plant'' is in BTU range of 1501 to 1550, requiring an increment of
.1600. If the company received $1.00 per thousand cubic feet of gas,
the company would multiply $1.00 times the increment of .1600 plus 1.
This means the company will pay royalty on $1.16. Theoretically, this
approach captures the value of the additional products in the gas
stream that increases the BTU quality. The caveat is that the auditor
assumes the price is correctly reported and bulletin prices in the area
are not manipulated. We know from the 1999 Qui Tam on crude oil,
Benjamin Johnson versus Unocal, that companies collude and manipulate
price indices. The companies essentially received value above the index
price, but never paid royalty or taxes on the higher actual value they
received. In addition, any audits pending for periods before 2000 had a
much greater risk of falsified prices because of the market changes,
deregulations, and vague and questionable practices of transportation,
measurement and reporting.
The equation:
Adjusted Value = ($1.00 X .1600) + 1
And
Adjusted Value = $1.16
The logic behind this method is that value for unprocessed gas
adjusted with the increment will capture additional value in processed
gas, therefore giving royalty the higher value. The caveat is that the
company's reported price and/or the index price may or may not be
reasonable, and requires verification.
This method was used in the past through a settlement negotiation
process with Indian Tribes, but was not sanctioned as alternative
method outside of the required negotiated settlement process. The
negotiated settlement process, as defined in Royalty Management
Program, Audit Manual 2.0 states in general that if the company is
unable to perform requirements under the Order to Perform, they may use
the negotiated/settlement process. The Manual than refers to the
process which requires a settlement team, and once in final form, the
practice has always been on Indian allotted land, to acquire approval
of the Director of MMS, Deputy Commissioner of Indian Affairs, and the
company.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
This method was approved as the ``alternative methodology'' on
January 1, 2000 (Attachment 3) and 25 CFR 206.173. If used prior to
Janaury 1, 2000 it required the ``settlement negotiation'' process
because it was not legally available. Further supporting this position,
it states in the Audit Manual Chapter 2, 2.2.5 ``...Always use
applicable regulations for the period under audit...'' To understand
why this is a fast-track approach, you must understand the ``Dual
Accounting'' method approved prior to January 1, 2000. I will present
it on the following page:
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Processed Gas Method (Actual)
I will not go through the calculations because it varies depending
on the gas purchasing, transportation and processing contracts. I have
several settlement statements between the purchaser and seller that
show cost associated with processing and transportation and the values
of methane and liquid by-products. Often we find companies taking
improper deductions, such as marketing cost, or gathering cost. Without
attempting to obtain the data, we cannot determine what deductions were
taken.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
This method is generally referred to as the wellhead approach or
the BTU method.
In what ways has this impacted Indian Country?
The ``Bump Method'' has wide and negative impact on Indian Country. I
have bench-marked the method against actual dual accounting and
have found (8) eight times the amount of underpaid royalty.
Why did MMS exclude the Navajo Allottees?
I was delegated as the BIA Regional Director with authority over
the Navajo Allotted leases and I opted out of the 2000 Gas Rule for two
reasons: (1) the new method violated lease terms, and (2) the new
method resulted in less recovery of underpaid royalties than the lease
defined method of royalty valuation. I worked with my audit staff to
determine this and tracked the value against the 2000 Gas Rule prices
on a monthly basis. The Navajo Allottees realized a 25 to 45 cents per
thousand cubic feet gain over MMS determined prices every month. The 25
to 45 cent gains adds up to hundreds of thousand dollars in realized
royalty for Navajo allottees. This was before audit and audit would
recover additional monies.
The ``Bump Method'' was applied to all other allottees or
Individual Indians across Indian Country, except the Navajo that I
excluded. MMS did not evaluate the benefits to this method.
Mr. Gambrell. You testified that while you were acting as Director
of the pilot project of the Federal Indian Minerals Office you
collected 7 times the underreported royalty than the MMS had for the 20
years before you took the position. Yet once this program became
permanent you were stymied from aggressively going after underpaid
royalties due.
Was this due to inertia and turf battles among the agencies at DOI? Do
you see any way to change the attitude or throw some light onto
it?
The past under performance of MMS was due to negligence and
incompetence. Industry knows that MMS's upper management will fold
almost anytime they are threatened with litigation. MMS has and has had
an incestuous relationship with industry. Most managers over MMS walk
through the revolving door to industry and back again. These executive
are inherently serving their own self-interest above and beyond Indian
and Public trust. The only way to change this attitude is to:
1. Limit the ability for Senior Executive Service managers to work
for Industry in the area that they had influence over.
2. Limit the ability for politically appointed officials to
recruit Executives from industry.
3. Use the existing ethic laws on the ``Appearance of Conflict of
Interest'' more aggressively.
4. Change MMS's oversight and reporting requirement from a Federal
Executive to a Board of Directors composed of Federal Executives, State
Audit Managers, and Indian Audit Managers. The State and Indian Nations
have a higher vested interest in assuring that their royalty interests
are collected 100%.
Mr. Gambrell. You refer in your testimony to MMS problems with the
computer system purchased by a Bermuda company which allowed
erroneous data to pass through the system and eventually cause
the shut down of the system.
Is it true that this shut down was falsely blamed on the Cobell
litigation?
Were Indian lease holders directly hurt by the shut down?
How was the system fixed to ensure the correct data was in the system?
Throughout Indian Country, MMS, BIA and OST management blamed the
shut down on the Cobell litigation, rarely referring to the hacker
penetrable conditions of their network, which enabled any hacker on the
street to access Indian data and manipulate it. During the same time,
the MMS system was upgraded and it failed to account for collections
and disbursements of Indian Royalties. We noticed the problems with the
MMS system one month before the shut-down ordered by Judge Lambreth of
the Cobell litigation. In addition, the Department of the Interior was
able to pay Indian lease holder by shipping digital tapes from Denver,
Colorado to Anadarko, Oklahoma. After the shut-down, the agencies would
not exercise this method, for it would expose MMS system failures not
related to Cobell.
Indian lease holders were hurt by the shut-down. Many lost
automobiles, homes, live-stock and their credit was severely damaged.
The system was never fixed, but instead MMS changed the filtering
of data to be less stringent, thus allowing garbage data and reporting
to pass through the system without any scrutiny.
Mr. Gambrell. When you went to the Special Trustee for Indian Trust
Funds with your concerns about the manner in which the trust
responsibility was being carried out, what kind of a response
did you receive?
When I speak of talking with the Special Trustee, I am referring to
the Indian Minerals Steering Committee which includes Executives from
BIA, BLM, MMS, Solicitors Office and OST (all have primary trust
responsibility). When I would refer to issues, often the Executives
would battle over turf issues, do as little as required by law, and
interpret law to reduce their agency legal risk even if it meant
damaging the benefit to the Indian individuals or tribes.
I also met with the Special Master under the Cobell Litigation, who
had responsibility to oversee the retention of records and information.
He was deeply concerned and found that what I had reported as egregious
acts were in fact true. He reviewed the issue concerning audit records
held in MMS Dallas office and found them to be missing, incomplete, and
misfiled. He looked into the right-of-way issues and found the
appraisal records were missing and destroyed. During his investigations
he was obstructed by the Department Interior Executives and Secretary
Interior's hired legal counsel.
Mr. Gambrell. You testified about a 2002 trespass issue which you
found a company stealing the resource of an Indian lease and
tried to bring the culprit to justice only to be stymied by
MMS. Do you know if the Indian allottee was ever paid for his
stolen trust asset?
The allottees were paid because I delegated the resolution and
tracking of this issue to my auditors. I was prevented from meeting
with the company and so I delegated my audit staff to act on my behalf
in dealing with the company.
Mr. Gambrell. Would you please speak to what is considered the
revolving door scenario at the Department which leads to
employees more loyal to industry then to those for whom they
are trustee? How prevalent a problem is this and can it be
stopped?
I will provide names of those walking through the revolving door.
MMS Director Cynthia Quarterman, MMS Director Jonny Burton, Deputy
Secretary of Interior Griles, Secretary of Interior Gale Norton, and so
on...
The Executive Branch should:
1. Limit the ability for Senior Executive Service managers to work
for Industry in the area that they had influence over.
2. Limit the ability for politically appointed officials to
recruit Executives from industry.
3. Use the existing ethic laws on the ``Appearance of Conflict of
Interest'' more aggressively.
4. Change the oversight and reporting requirements of MMS from a
Federal Executive to a Board of Directors composed of Federal
Executives, State Audit Managers, and Indian Audit Managers. The State
and Indian Nations have a higher vested interest in assuring that their
royalty interests are collected 100% and will not be as likely to be
politically manipulated by an Executives political party affiliation.
Questions for Kevin Gambrell from Minority
1. You written statements is replete with accusations of unethical and
illegal behavior by MMS, the Department of the Interior, and
oil and gas companies. Are you and auditor or an attorney?
I was delegated with the trust authority to audit, inspect and
enforce, and lease Indian allotted leases. I supervised and managed
auditors, inspectors and lease administrators. I issued subpoenas,
orders of non-compliance, orders to pay, negotiated settlements, and
made all trust decisions with regard to oil and gas leasing on Indian
allotted leases. My title equivalent was a Bureau of Indian Affairs
Regional Director, Minerals Management Service Chief Compliance
Officer, and a Bureau of Land Management Field Office Manager. My
audit, inspection and enforcement and leasing authorities were
delegated to me by the MMS Director, BLM Director, and BIA Deputy
Commissioner. I had the authority to enforce all laws and regulations
that pertained to the Code of Federal Regulations 25, 30 and 43 with
regard to mineral development on Indian Allotted lands.
The question as to auditor and attorney is irrelevant with regard
to upper management positions within the MMS, BLM and BIA. The Director
of MMS, Johnnie Burton has a Bachelors degree in Education, while I
have a Master of Science in Mineral Economics and have taken more than
280 hours of GAAP, FASB, and valuation/auditing training. In addition,
I was required to take auditing continuation credits annually, where as
the current Director does not take auditing continuation courses.
Did the auditors in your office or solicitors with the Department
agree with you?
The auditors in my office fully agreed with me and the solicitors,
although often they lacked any significant experience, usually agreed
with me. The solicitors' agreement depended on the issue. I only
considered the Solicitor's advice as a legal opinion that I would
consider in making my decision, but would not always go with.
Did the Inspector General of Interior or Office of Special Counsel
agree with you when you brought it to their attention?
The two organizations are not staffed with professionals to address
valuation, trust and other technical issues. The IG often reviews only
the surface issues that pertain to ``Yellow Book'' standards, but do
not consider actual methods of determining value and bench marking. The
OSC did not comment on my issues and did not follow-up with questions
or concerns.
2. You say MMS willingly ``violated'' court orders in the 2002
trespass case and the 2003 Zero Production case (page 5 and 6).
Which Court's Order were violated, and what did the Court do
about it?
Shii Shi Keyah Association v. Hodel, No. Civ-84-1622M D.N.M.
l984)Hon. E.L. Mechem). A class action on behalf of all Navajo
allottees with oil and gas leases on their lands alleging that the
Secretary of Interior was not in compliance with the Federal Oil and
Gas Royalty Management Act of 1982. A consent decree was entered in
March of 1989 requiring numerous changes on the part of the Secretary
to bring the Secretary into compliance with FOGRMA. This was after
several key summary judgment rulings in Plaintiff's favor on
interpretations of key provision of FOGRMA. An award was also entered
for the Plaintiff under the Equal Access to Justice Act which was, at
that time, one of the largest such awards yet to be entered. The court
retained superintendent jurisdiction over implementation of the consent
decree for five years.
The Department of Interior reporting requirement ended in 2001.
Consequently, the court is not aware of these violations, but will be
notified through additional lawsuits.
I also met with the Special Master under the Cobell Litigation, who
had responsibility to oversee the retention of records and information.
He was deeply concerned with violations of records retention and found
that what I had reported as egregious acts were in fact true. He
reviewed the issue concerning audit records held in MMS Dallas office
and found them to be missing, incomplete, and misfiled. He looked into
the right-of-way issues and found the appraisal records were missing
and destroyed. During his investigations he was obstructed by the
Department Interior Executives and Secretary Interior's hired legal
counsel.
______
The Chairman. Thank you.
Ms. Alexander?
STATEMENT OF RYAN ALEXANDER, PRESIDENT,
TAXPAYERS FOR COMMON SENSE
Ms. Alexander. Good morning, Chairman Rahall, Ranking
Member Flake and Representative Costa. Thank you for the
opportunity to testify today.
Taxpayers for Common Sense is a national, nonpartisan
budget watchdog organization. We believe in transparency,
competitive and clean contracting and accurate and independent
auditing. In short, we believe that taxpayers have a right to
demand excellence in accountability from our government.
For more than a decade, TCS has worked actively to ensure
that taxpayers receive a fair return on the resources extracted
from Federal lands and waters. In recent years, numerous
management failures at the Minerals Management Service have
cost taxpayers billions of dollars in waste and lost revenue.
TCS urges the Committee to reform the revenue collection
process, to improve contracting practices and to increase
accounting accuracy at MMS. We also urge the Committee to hold
the oil and gas industry accountable for accurate reporting of
minerals extracted from Federal lands and to eliminate royalty
relief programs. We look forward to working with the Committee
to effect these changes.
My focus today will be on three areas of primary concern to
Taxpayers for Common Sense: The risks presented by the reliance
on compliance review and industry self-reporting, the risk to
taxpayers the Royalty-in-Kind program presents and the failure
of MMS to remedy known problems.
It is the responsibility of MMS to ensure fair calculation,
collection and distribution of royalties on behalf of the
American taxpayer. In decades past, the MMS Auditing and
Compliance Division collected over $100 million annually
through the audit process. In recent years, this amount has
declined to less than half that number.
In the last decade, MMS began transitioning from a
traditional audit process to a new automated royalty
verification process known as compliance review. This system
relies substantially on self-reported data from the oil and gas
industry.
A recent report from the Inspector General concluded that
the compliance review process may not detect underreporting and
underpayment of royalties, particularly because anomalies
detected in the compliance review process rarely trigger a
traditional audit. The combination of self-reporting and
superficial data reviews provides companies with an incentive
to underreport and underpay royalties owed.
The Royalty-in-Kind program usually puts the Federal
government in the position of marketing oil and gas directly.
We have concerns about putting the government in this position.
Industry has proved itself very capable of bringing oil and gas
to the marketplace. Putting the government in that role is
potentially costly and inefficient.
Reports from the Inspector General raise questions about
the ability of MMS to track royalties collected, to track the
volume of production on Federal lands, and earlier this morning
we heard Mr. Gaffigan raise questions about MMS' ability to
determine whether or not the sales from royalty-in-kind
payments equal or exceed cash royalty payments as required by
statute.
Given these concerns, we have little confidence that MMS is
equipped to get the best deal for taxpayers through direct
sales. At the very least, the royalty-in-kind system should be
thoroughly evaluated, and if found not to benefit the taxpayer
we believe the program should be scrapped.
As the Committee well knows, the error of omitting price
threshold language from leases executed in 1998 and 1999 has
already cost the taxpayer over $1 billion. Recent reports
suggest that Director Johnnie Burton was aware of this error in
2004, and it was brought to wide public attention by the New
York Times expose last year, and yet MMS has only recently
begun to remedy this problem.
We are pleased to see that they have started to remedy this
problem, but every single delay costs the taxpayers more money.
Moreover, the current leadership at MMS has shown little
appetite for pursuing underpayments discovered by their own
staff. Worse, employees who have attempted to remedy
underpayment collection have been dismissed.
It is clear that several actions at MMS must occur to
remedy the current situation. Compliance review based on self-
reported data cannot be relied upon to ensure adequate
collection of royalty revenue. Steps must be taken to ensure
independent audits occur and royalty underpayments cease. The
system has to be reformed so it is more transparent and can
easily account for royalty payments.
For example, when Assistant Secretary Allred was testifying
earlier he couldn't give the numbers that you wanted. Those
numbers should be very easily accessible. Furthermore, the
system should be publicly accessible via the internet.
It is the Federal government's responsibility to protect
the taxpayers' resources and ensure that they are adequately
compensated for their sales. It is clear that the agency
responsible for the taxpayer protection is in need of an
accountability overhaul.
We are pleased to see such rigorous oversight by Congress.
The absence of the checks and balances inherent in the
oversight process invariably leads to problems, particularly in
agencies that by the nature of their missions have close ties
to the industries they regulate.
We are pleased the Committee has begun to address these
issues, and we look forward to working with you to see the
Minerals Management Service reformed.
[The prepared statement of Ms. Alexander follows:]
Statement of Ryan Alexander, President,
Taxpayers for Common Sense
Good morning Chairman Rahall and members of the committee. Thank
you for the opportunity to testify today. My name is Ryan Alexander and
I am the President of Taxpayers for Common Sense (TCS), a national,
non-partisan budget watchdog organization. The mission of Taxpayers for
Common Sense is to fight wasteful government spending and subsidies to
achieve an efficient and responsible government that lives within its
means. We believe in competitive and clean contracting--from the Iraq
war, to Katrina, to DOD procurement, to MMS contracts. We believe in
transparency: taxpayers should be able to easily see how their tax
dollars are spent, whether in the $460 billion defense budget or $300
million MMS budget. We believe in accurate and independent auditing. In
short, we believe that taxpayers have a right to demand excellence and
accountability from our government.
For more than a decade, TCS has actively worked to ensure that
taxpayers receive a fair return on minerals and resources extracted
from federal lands and waters. The mismanagement at the Mineral
Management Service (MMS) offends all our core values and in the absence
of corrective action will continue to waste tax dollars. TCS is
committed to reforming our revenue collection process, ensuring fair
contracting, and increasing accounting accuracy at MMS. TCS is also
committed to holding the oil and gas industry accountable for fair and
accurate reporting of minerals extracted from federal lands and
supporting efforts to eliminate royalty relief provisions. We will
continue to actively pursue each of these goals and look forward to
working with the committee on other efforts to achieve these ends.
In addition to the mismanagement and enforcement problems at MMS,
we believe there are structural problems with the current royalty
system that subsidize the oil and gas industry at the expense of the
taxpayer.
As you know, oil and gas companies that drill on federal and Indian
lands or off-shore pay royalties for the oil, gas and some other
minerals they remove. Generally, this payment is a percentage of the
total value of the oil or gas extracted. It is the responsibility of
MMS to ensure fair collection, calculation and distribution of
royalties on behalf of the American taxpayer. The collection of
royalties is a significant source of revenue for the federal
government: In Fiscal Year 2006, the Minerals Management Service
reported more than $10 billion in royalty revenue.
Royalty Relief
With the oil and gas industry continuing to experience record
profits, there is little need for taxpayers to continue to subsidize
it.
Given the current fiscal climate, we commend the House for
recognizing the need to reel in royalty relief provisions. Earlier this
Congress, the House passed legislation requiring the repeal of royalty
relief provisions included in the Energy Policy Act of 2005. We also
applaud the MMS for proposing the repeal of sections 344 and 345 of the
Energy Policy Act in their FY08 budget request. Taxpayers for Common
Sense opposed the inclusion of these provisions in the Energy Policy
Act and looks forward to working with Congress and MMS to see these
sections repealed.
Royalty-In-Kind Program
Another area which Taxpayers for Common Sense fears is ripe for
abuse is the Royalty-In-Kind program. From our standpoint, ``in kind''
contributions across government programs almost always end up being a
bad deal for taxpayers. We saw a red flag when MMS began pursing an
expansion of their in-kind program in the mid-1990s. The Royalty-In-
Kind program allows oil and gas companies to pay their royalty dues in
the form of oil or gas instead of cash. This forces the federal
government to market the oil and gas themselves. The burden of
marketing and selling oil and gas complicates government bureaucracy
and leads to a lack of transparency.
It may be true that the Royalty-In-Kind program makes it easier for
MMS and the industry to calculate the royalties that are due because
they need only determine a percentage of the amount of oil produced and
do not need to be concerned with the sale price. But the benefit for
the government ends there. In effect, the process adds layers of
complication and inefficiency by requiring the federal government to
resell oil and gas. Involving the government in the sale of oil can
easily lead to abuse. Given the current track record of MMS, we have
little faith that this system can operate efficiently and for the
benefit of taxpayers.
Auditing and Compliance
To ensure the adequate collection of royalties, MMS has an auditing
and compliance division whose goal is to oversee leases and complete
audits. In decades past, this division collected over $100 million
annually through the audit process. However, in recent years this
amount has significantly declined to less than half of that number. In
fact, a more than twenty percent decrease in the number of audits was
reported in the last five years. Not only has the collection of
revenues dropped dramatically in recent years, MMS has clearly shown
less commitment to this division, as demonstrated by shrinking budgets
and significant cutbacks in staffing.
In the last decade, MMS began transitioning from a traditional
audit process to a new, automated royalty verification process, known
as compliance review. This shift has not been cost-effective and is an
important contributing factor in the drop in revenues collected by MMS.
Further, relying on self-reported data from the oil and gas industry is
not an accurate way to monitor royalty collection.
Proponents of compliance review correctly point out that the
process allows MMS to check data pertaining to more transactions than
the traditional audit process; however, the superficial review does not
allow for an in-depth analysis or encourage improved accounting
procedures. As the Department of Interior Inspector General Earl
Devaney testified before the committee in February, the compliance
review process does not provide the same level of detail or accuracy a
traditional audit provides.
The IG audit report released in December 2006 detailed many
weaknesses in this program. The report highlighted MMS's inability to
access accurate and complete information on the program and the
inability to use it for daily management and reporting purposes.
Further, the current system does not provide states, tribes and
Congress with accurate information on the Compliance and Asset
Management Program.
The report went on to conclude that MMS could not establish the
true cost and benefit of compliance reviews and audits. When
considering the impact on federal taxpayers, one of the most egregious
findings of the IG report was that anomalies rarely lead to a full
audit. The report concluded that ``MMS may not detect underpaid
royalties.''
Additionally, the fact that the data relied on for this process is
self-reported by the companies should be of grave concern. The
combination of self-reporting and superficial data reviews provides
companies with an incentive to under-report and under-pay royalties
owed.
As demonstrated in the case brought forth by our fellow witness,
Mr. Bobby Maxwell, as well as other auditors at the agency, a negligent
MMS appears to be serving the interests of the oil and gas industry
over those of the taxpayer. In a glaring example of mismanagement
within the agency, these auditors were prohibited by the MMS from
collecting gross underpayments of royalties they had uncovered in their
investigations.
Contracting and 1998 and 1999 Leases
Perhaps the best-known example of mismanagement at the MMS is the
errors made in the leasing contracts of 1998 and 1999. In 1995,
Congress passed the Outer Continental Shelf Deep Water Royalty Relief
Act which awarded the oil and gas industry a waiver of royalty payments
for leases issued from 1996-2000. These leases were all intended to
include price thresholds that would trigger the collection of royalties
when the price of oil reached above $36/barrel.
A little more than a year ago it came to light that a gross error
had occurred in more than 1,000 leases issued in 1998 and 1999.
Contracts had omitted the price threshold language, unlike those for
leases issued in 1996, 1997 and 2000. When this error was uncovered in
a New York Times expose, a series of congressionally driven
investigations determined it was merely a clerical error. This clerical
error has already cost taxpayers at least $1 billion in lost revenue.
Adding insult to injury, Johnnie Burton, Director of MMS, was made
aware of the error as early as 2004, despite congressional testimony
she had given late last year to the contrary. The information was
uncovered by the Interior Inspector General and documented in a series
of emails sent to Ms. Burton.
While the original omission of the price threshold language was
obviously a very serious error, MMS's failure to devise and implement a
fair remedy in the nearly three years the agency has been aware of the
problem is emblematic of the lack of accountability and culture of
mismanagement at MMS.
On the subject of price thresholds, we would like to call one
additional matter to the Committee's request. MMS finalized the
``Shallow Water, Deep Natural Gas'' rule in 2004. The rule is designed
to spur development of natural gas far below ground in shallow waters.
Unlike the 1998 and 1999 leases, this rule does include a price
threshold. Unfortunately, MMS set the price threshold at the sky high
level of $9.34 per thousand cubic feet of natural gas. The threshold is
indexed to inflation and rose to $9.91 for 2006. MMS data show that
this threshold is so high that companies would have avoided royalties
even in 2005 and 2006, in a time of record high prices following the
Gulf Coast hurricanes. A threshold this high is no better than no
threshold at all.
We would also note that the threshold increased dramatically as the
shallow water deep gas rule moved forward--from $5.00 in the proposed
rule to $9.34 in the final version. The result will be billions in
foregone revenues for the federal taxpayer. We encourage the Committee
to look into this matter in greater depth.
Culture of Mismanagement at the MMS
Federal taxpayers continue to bear the burden of these multi-
billion dollar errors. The problem will only be compounded in the
coming years. Director Burton has shown little initiative to remedy the
problems within the agency. In addition to failing to correct the
missing lease language when it was first brought to her attention,
several employees who have attempted to remedy the under-collection of
royalties have been dismissed on her watch.
The Department of Interior estimates in the next five years that
energy companies will likely extract $65 billion in oil and gas from
federal lands and pay little or no royalties for it. This will cost
taxpayers $7-$9 billion in lost revenue. The problem will only escalate
as more oil comes online. By 2011, the Department of Interior estimates
that royalty-free oil will quadruple and natural gas will see a 50%
increase. Taxpayers cannot afford to have a grossly mismanaged agency
overseeing this important source of revenue.
Remedies and Solutions
It is clear that several actions at the MMS must occur to remedy
the current situation. Senior employees must be held accountable for
their actions and committed to the mission of the agency, not the
pocketbooks of Big Oil. Too many examples of close connections with the
oil industry have surfaced to ignore this problem. We encourage the
committee to continue rigorous oversight to ensure MMS is operating in
the interest of federal taxpayers.
Furthermore, compliance review cannot be relied upon to ensure
adequate collection of royalty revenues. Steps must be taken to ensure
independent audits occur and royalty underpayments cease. The current
system heavily relies on self-reporting, which can only lead to abuse.
The system has to be reformed so that it is more transparent and can
easily account for royalty payments. Furthermore this system needs to
be publicly accessible via the Internet.
Past errors must also be corrected. Contracts that omitted the
price threshold language must be renegotiated. We applaud Congress for
beginning to take steps in this direction. It is clear in testimony
provided by several of the oil companies involved with leases that the
industry was aware of the error and was also fully aware of Congress's
intent to keep the price thresholds in the contracts. Contracts are
renegotiated all the time, and this situation must be addressed or
taxpayers stand to lose billions more. Gross negligence on the part of
government employees is an unacceptable reason to allow the oil and gas
companies to exploit congressional intent and avoid the dues that are
rightfully owed to taxpayers. These oversight hearings will help reveal
to the general public any companies that refuse to pay. As we have
already mentioned, it is outrageous to imagine giveaways to oil and gas
companies while they are experiencing such enormous profits.
It is the federal government's responsibility to protect taxpayers'
resources and ensure they are adequately compensated for their sale. It
is clear the agency responsible for this taxpayer protection is in need
of an accountability overhaul.
MMS's Royalty-In-Kind system has fundamental flaws that make it
hard for taxpayers to be sure they are getting their money's worth from
their resources. Under the best conditions, this type of system would
be prone to abuse, particularly at an agency as flawed as MMS. At the
very least the Royalty-In-Kind system should be thoroughly evaluated,
and, if not found to benefit the taxpayer, scrapped.
The oil and gas industry runs on a boom and bust cycle. While
seductive, the offer of royalty relief to stimulate production can skew
the marketplace and have long-term unintended consequences of
diminished returns for taxpayers. We urge Congress to be very judicious
before pursuing royalty relief in the future.
Again, we are pleased to see such rigorous oversight by this
Congress. The absence of energetic oversight or the checks and balances
inherent in the oversight process invariably leads to problems,
particularly in agencies that by the very nature of their missions have
close ties with the industries they regulate. We are pleased the
committee has begun to address this issue and look forward to working
more to see this embattled agency reformed.
______
The Chairman. The Chair thanks the panel for your
testimony.
Let me begin my questions with Mr. Maxwell if I might. I do
thank you for traveling as far as you have to stand up and be
counted. The root of your testimony, it seems to me, is that
since the year 2000 a dramatic different philosophy has taken
root at MMS, and it appears that that philosophy is do not
bother the oil companies. I believe you put it that way in your
testimony.
It just boggles the mind. It is incredible. It is
incredible that such a philosophy would take hold when it comes
to the American people's lands. It is something the American
people must know, and they are deserving of a true record.
Government auditors are told not to bother those whom they
are lawfully entrusted to audit. If this system was in place at
the IRS, I really fear that this country would be broke today.
My question is what possible gain do you guesstimate, Mr.
Maxwell, that could be had by those who promoted this
philosophy? Is there a benefit that you see they might derive
from such a philosophy of just hands off the oil companies?
Mr. Maxwell. Sir, I don't understand the political
ramifications or how these things change, but the whole culture
has changed. Changed dramatically.
I believe in the years preceding I was very aggressive in
pursuing the oil companies. If we put an order out and we are
pursuing something, I don't care if the oil companies sue us.
If we are right and we need to establish a principle or enforce
a regulation or a law or to find out if something is, let us
litigate it. There are hundreds of millions of dollars or
billions, and I think to be scared that we are going to be sued
by an oil company is ridiculous.
The culture changed, and it changed in such a broad scale
it was almost unbelievable because there were statements made.
Don't bother the oil companies. Let us go to this new
compliance system. We do not want you to be getting records
like you did before, you know, getting massive amounts of
records.
So it changed drastically, and a lot of the people we were
hiring and putting in positions for compliance reviews had
different backgrounds. The basic requirement used to be to be
an auditor or an accountant you had 24 hours in accounting,
which could include business law, statistics, et cetera.
We quit pursuing that type of background, and we would move
different people in maybe from administrative areas or
different areas. I am not opposed to doing that, but I think
the basic requirement should have been if you move into those
positions go get your 24 hours of college level courses because
when we audit oil and gas companies they have some of the best
and brightest, and any gray area they are not going to pay
royalties on if they don't have to.
I don't blame them. If I was on their side, any gray areas
I would interpret to my benefit. However, you need people that
can realize what the accounting records are, different methods
of depreciation, transportation, and to be able to apply the
regulations, laws and lease terms. You have to have people that
can think, can work diligently and would be on site at the oil
companies.
And so when we started pulling away from that back to a
compliance review to where people would work in the office and
try to review without going on site to the companies, without
talking to the marketing personnel, the field personnel, you
really lose a lot of expertise in that culture.
I think that is why we saw the huge drop in royalty
collections. I don't think it was because the oil companies
just turned honest one year. I think it is because we stopped
auditing.
I might add, when we have talked about compliance reviews
there is a definite place for compliance reviews, but I think
you don't start with a compliance review and then see what you
need to audit. I think you start with the detailed audits, and
then you back off into what compliance reviews are sufficient
to monitor on an ongoing basis.
The Chairman. Was there any time that you conducted an
audit and you found that money was not owed?
Mr. Maxwell. I don't believe I ever had an audit that we
didn't collect anything.
The Chairman. The answer is no?
Mr. Maxwell. The answer is no, sir. That is right.
The Chairman. Mr. Gambrell, would you answer the same
question?
Mr. Gambrell. Yes. No.
The Chairman. The answer is no as well.
Let me explore with you just a bit more, Mr. Maxwell. Was
this a philosophy that you would say started at the grassroots
within the MMS and percolated up, or was it something that
started at the top and flowed downward?
Mr. Maxwell. Definitely started at the top and flowed down.
We were directed that we would support this new reengineered
method, the compliance. We would. We were directed at senior
manager meetings that dissent would not be tolerated. They said
we are making the change. We are making the transition, and it
is your job to go out and sell it and enforce it.
The Chairman. So it was a trickle down philosophy then?
Mr. Maxwell. Yes, sir.
The Chairman. Mr. Flake?
Mr. Flake. Thank you.
Mr. Maxwell, I am interested in you were at MMS until? When
did you leave?
Mr. Maxwell. 2005 the last time.
Mr. Flake. 2005?
Mr. Maxwell. Yes, sir.
Mr. Flake. What is the appropriate balance where somebody
works and gets official information and then decides to go out
on their own and file under the False Claims Act? Why wouldn't
more people do that using information that way, and where is
the proper balance between recouping money for the taxpayer or
somebody's private interest doing that?
Mr. Maxwell. I think that is a great question because I
looked at that, thought about it and struggled with it also.
In your employment situation, our responsibility is to the
American taxpayer and also to MMS, our employer. I think that
our job is to bill and the underpayments, to pursue them, to
litigate them, through the MMS or the government when it will
do it.
I think the False Claims Act only seems applicable to me
when the agency refuses to do its job, and I think there could
be three reasons that happens. One could just be corruption.
Two could be just ignorance. You could have people that are
incompetent. Three, you could have not enough personnel to do
the job.
I think there has to be extraordinary circumstances for an
employee to file a false claims on their own.
Mr. Flake. And you felt that that test was met here in this
case?
Mr. Maxwell. I do, sir, for a couple of reasons. Number one
is the director was aware of the issue, the Office of the
Solicitor. I discussed it with the Office of Enforcement, so I
believe it was well known. I was told the order would not go
out.
Mr. Flake. Is there a protocol? Is there an order that you
have to go through, and did you follow that?
Mr. Maxwell. I believe I did. I discussed it with the
Office of Enforcement, and at one time in 2003 I had an
interview with the Inspector General on another matter, which
was the matter of not being able to audit royalty-in-kind.
It wasn't set up for this specific reason of this Kerr-
McGee because I didn't know for sure at that time, but on the
other meeting that was set up, the meeting never took place.
Mr. Flake. MMS disputes some of these meetings or the
follow-up. Do you have any comment on that?
Mr. Maxwell. I don't doubt that. No, I have no comment, but
it doesn't surprise me.
Mr. Flake. Ms. Alexander, what is your feeling on that
balance? Should a former employee be able to file under the
False Claims Act using information that was gathered when the
person was an employee? Where do you strike the best balance
for the taxpayer in this regard?
Ms. Alexander. You know, I am not an expert in the False
Claims Act so I don't know the legal and technical requirements
under the Act. I think from our perspective we are happy that
anybody is pursuing royalties on behalf of the taxpayers, and
it would obviously be the best situation if there weren't a
need, if there was no need for a False Claims Act.
I think it is difficult for me to really testify in general
about a balance without knowing more about the law.
Mr. Flake. In your opinion, has MMS straightened up over
the past year or so?
Ms. Alexander. It is hard to tell, but I certainly liked
some of what I heard this morning. It sounds like they are
making efforts to be more aggressive about collecting
royalties, but, given their track record, you know, we are
going to look at that with a great deal of skepticism.
Mr. Flake. Under the False Claims Act, Mr. Maxwell, how
much do you stand to gain if the current numbers carry forward?
Mr. Maxwell. We currently have no judgment entered in the
record by the judge so we don't have any dollars, but when the
judgment is and if we eventually win, 100 percent of that money
goes to the Federal government. Then we deal with the Federal
government, but the percentage could range from 25 to 30
percent of the gross amount.
Mr. Flake. With regard, going back again to MMS and your
time there, are there the proper protocols in place right now
for an employee to say I have exhausted my remedy within the
organization before it goes out, or do we need to change those?
Mr. Maxwell. I have been gone for several years and so I am
not sure, but I think it should be well in place and very well
communicated, but I really don't know what they have right now
at this point.
Mr. Flake. You have been gone since 2005?
Mr. Maxwell. Yes. I have been gone for over two years.
Mr. Flake. All right. Thank you, Mr. Chairman.
The Chairman. Ms. Alexander, let me ask you. Do you agree
with the statement I made that if the IRS were run like this
agency was that our country would be broke?
Ms. Alexander. It seems like a kind of broad statement. I
don't have enough knowledge, but I will agree with it.
The Chairman. Mr. Gambrell, let me ask you. Mr. Lester will
state in a few moments in his testimony that Federal offshore
mineral leasing laws do not allow tribes to prohibit oil
companies from reducing payments by claiming overpayment in
previous years.
You claim, and I quote, ``Unilateral adjustments are often
made without the tribe's knowledge and lack review or oversight
by MMS.'' If that is accurate, this seems quite egregious to
me, and I would ask you if you would concur with Mr. Lester.
Mr. Gambrell. I am not quite sure what is meant by the
offshore as an offset to Indian leases. I don't understand what
that means.
The Chairman. Is there no statute of limitations, I guess
is my question, for companies to claim overpayment?
Mr. Gambrell. My understanding is there is a statute of
limitations to claim certain adjustments.
I also am aware that there are adjustments made in very
small amounts that add up to the millions of lines of
adjustments that go back quite some time to the 1990s, maybe
even into the 1980s. I have looked at royalty reports where I
have seen adjustments back in the 1980s.
The Chairman. Are companies required to provide proof of
overpayment to the Department of Interior?
Mr. Gambrell. Yes, if they want to recoup. Well, within my
office--I can't speak for the entire MMS, but within my
office--we required some type of documentation to recoup.
The Chairman. And who would have authority over these
issues?
Mr. Gambrell. Us.
The Chairman. And do you have any recourse?
Mr. Gambrell. If the company claimed an overpayment without
justification, we could collect. We might collect a bond. We
may issue a notice of noncompliance. We may cancel the lease.
The Chairman. OK. That ends my questions.
Do you have any further questions, Mr. Flake?
Mr. Flake. Not at this time. Votes are starting up in a
minute. Will this panel be finished, or will they be held over
until we are done?
The Chairman. They will be finished if there are no further
questions at this point. You may proceed, or we can submit in
writing at a later time.
Mr. Flake. I will conclude at this time.
The Chairman. Once again, we want to thank the panel for
being with us today.
Mr. Flake. Thank you.
The Chairman. We will proceed with our third panel with the
caveat that there are roll call votes expected on the Floor
momentarily, and we may have to recess and come back, but I
will call the panel to the table at this time.
Mr. Dennis Roller, Audit Manager, North Dakota State
Auditors Office, Royalty Audit Section; Mr. A. David Lester,
Executive Director, Council of Energy Resource Tribes; Mr.
Michael Geesey, Director, Wyoming Department of Audit; and
Professor Pamela Bucy, Frank M. Bainbridge Professor of Law,
University of Alabama School of Law.
As the votes are now starting, I would suggest that the
Committee take a half hour recess, and we will come back and
start at the top of the list I just announced. The Committee
stands in recess.
[Recess.]
The Chairman. The Committee will resume its sitting, and
the panel will proceed with Mr. Roller going first.
We do have your prepared testimony. It will be made part of
the record as if actually read, and you are encouraged to
summarize and stay within the five minute limit.
STATEMENT OF DENNIS ROLLER, AUDIT MANAGER, NORTH DAKOTA STATE
AUDITOR'S OFFICE, ROYALTY AUDIT SECTION
Mr. Roller. Mr. Chairman and Members of the Committee, I
want to thank you for the opportunity to comment and share my
views on some of the challenges faced by the Minerals
Management Service and the North Dakota delegation.
Let me begin with a quick history of the North Dakota
delegation. The North Dakota delegation was created in 1982
under the authority of Section 205 of the Federal Oil and Gas
Royalty Management Act of 1982. For the past 25 years, the
North Dakota delegation has performed compliance work on
Federal mineral royalties paid in North Dakota with some very
successful results.
As shown on Exhibit 1 of my written testimony, the North
Dakota delegation from 1982 through 2001 collected over $26.6
million. During that same period, the costs of the North Dakota
delegation were less than $4.2 million. That is almost $6 of
revenue for every $1 spent.
Given the North Dakota delegation's success in the past, I
now would like to discuss some of the challenges the MMS and
the North Dakota delegation are facing. The first area is a
state of misreporting for the MMS 2014s or the payment
reporting document and the oil and gas operations report, the
OGOR, or the production reporting document.
With the MMS reengineered system that went on line November
1, 2001, the MMS stopped doing any automated comparison of
these two documents. Without any automated check, company
reporting accuracy has deteriorated. This OGOR 2014 comparison
process was a recommendation of the fiscal accountability of
the nation's Energy Resources Committee of January 1982,
commonly referred to as the Linowes Commission, which was a
driving force for the creation of MMS.
Recommendation No. 5 of the Internal Control section of the
Linowes Commission report states that the Federal royalty
managers incorporate production data into the royalty
management system in order to cross check the data with sales
and royalty data for all leases each payment period.
The MMS did this comparison, commonly known as the AFS/PAAS
comparison, prior to the implementation of the new system, and
per the 2001 MMS budget justification document the AFS/PAAS
comparison process collected $56.2 million in additional Fiscal
Year 1998 royalties.
Because of the level of misreporting, the North Dakota
delegation requested the authority to perform volume and
royalty rate automated verifications using a North Dakota
developed tool. We have been performing these reviews using our
tools since October 1, 2006.
Using this tool which compares the 2014s and OGORs, the
North Dakota delegation has discovered countless reporting
issues, nonpayment issues, missing document issues,
nonreporting issues, two companies that just quit paying their
Federal royalty obligation in North Dakota and well over
$100,000 in additional royalties, not including the two
companies that just quit paying their Federal royalties, all at
a cost of less than $10,000.
The North Dakota delegation has taken on this comparison
process, a process the MMS used to perform, at a time when
North Dakota's funding has went from six FTEs and 4.5 FTE. The
reporting issue goes to the core of having an effective royalty
management program. Without correct reporting, the MMS does not
know what their universe of receivables is and consequently
cannot compare that universe to what was actually received, a
basically principle for any business.
A second major area is the collection and information
management system or CIMS. CIMS is the most current MMS
collection tracking system that was made available to the North
Dakota delegation in January of 2006. The previous collection
tracking system was shut down in late 2001. The North Dakota
collection information in the old MMS system was complete and
accurate, and the North Dakota collection information in CIMS
is incomplete and inaccurate.
A third area is the MMS reengineered system was not capable
of calculating and billing late payment and collection interest
until May 2003. Today the MMS says they are finally caught up
on the backlog of interest. However, the North Dakota
delegation has not received a report of the interest that has
been billed from November 2001 through September 2006.
Finally, over the last five years what used to feel like a
partnership of equals between the MMS and the delegations has
now developed into something else. The MMS is increasingly
issuing directives, requirements and mandates to delegations on
almost every aspect of our delegation of authority with no
negotiation or consultation.
In closing, the North Dakota delegation has been very
successful in the past at collecting additional royalties owed
from Federal lands. The level of misreporting and nonreporting
has drastically increased. The collection information, CIMS, is
incomplete and inaccurate. Interest since November 2001 is
still an unknown, and, finally, the MMS has moved away from a
partnership with the delegations.
This concludes my formal testimony. Thank you for the
opportunity to appear before the Committee today, and I will be
happy to answer any questions you may have on my oral or
written testimony.
[The prepared statement of Mr. Roller follows:]
Statement of Dennis Roller, Audit Manager,
North Dakota State Auditor's Office
Mr. Chairman and members of the committee, I want to thank you for
the opportunity for me to comment and share my views concerning the
wide array of challenges faced by the Minerals Management Service and
State and Tribal delegations.
Let me begin with a quick history of the North Dakota State
Auditor's Office Royalty Audit Section (ND delegation). The ND
delegation was created in 1982 under the authority of section 205 of
the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA). For
the past 25 years, the ND delegation has performed compliance work on
Federal mineral royalties paid in North Dakota, with some very
successful results. I was an auditor for the ND delegation for over ten
of those years and have been the audit manager for the ND delegation
for the last three years.
As shown at Exhibit 1, the ND delegation from 1982 through 2001
collected over $26.6 million in additional Federal royalties. During
that same period, the costs of the ND delegation were less than $4.2
million as shown at page 2 of Exhibit 1. That's almost $6 of revenue
for every $1 spent. For all State's that had a 205 delegation for 1982
through 2001 the total additional royalty collections were over $296.5
million, while costs were under $58.5 million. Exhibit 1 does not
include any 202 Tribal delegation collections or costs as several
Tribes prefer not to share that information. However, the ND delegation
believes that 202 Tribal delegations have had similar success. Exhibit
1 is only through 2001 as that is the last date through which the MMS
has accurate collection information. I will go into greater detail on
the Collections and Information Management System (CIMS) later. These
successful collection figures represent only the direct collections.
For example, the ND delegation findings often have a residual financial
effect due to future royalty payments being calculated correctly.
Given the ND delegation's success in the past, I now would like to
discuss some of the challenges the MMS is facing that are recently
limiting the efficiency of the ND delegation.
The first area is the state of misreporting for the MMS 2014s, the
payment reporting document, and the Oil and Gas Operations Report
(OGOR), the production reporting document. With the re-engineered
system that was put in place on November 1, 2001, the MMS changed the
property numbering system used by companies to report the 2014s. The
MMS also stopped doing any automated comparison of these two documents.
Without any automated check, company reporting accuracy has
deteriorated. Our audits now often entail a reconciliation of every
single payment made by a company for the review period in order to
determine what the company intended to report and pay.
This OGOR-2014 comparison process also was a recommendation of the
Fiscal Accountability of the Nation's Energy Resources Committee of
January 1982, commonly referred to as the Linowes Commission, which was
the driving force for the creation of the MMS. Recommendation #5 of the
internal controls section (Chapter 3) of the Linowes Commission report
states ``That the Federal royalty managers incorporate production data
into the royalty management system in order to cross check the data
with sales and royalty data for all leases each payment period.''
(emphasis added) The MMS did this comparison prior to implementation of
the re-engineered system and per the 2001 MMS budget justification
document, this comparison process collected $56.2 million in additional
FY98 royalties.
The deterioration of reporting has added a tremendous amount of
hours to our audits. In order to combat this, the ND delegation
requested the authority to perform volume and royalty rate automated
verifications on October 1, 2005, as allowed for under the Federal Oil
and Gas Royalty Simplification and Fairness Act of 1996 (FOGRSFA), see
exerts from the request at Exhibit 2. The ND delegation was denied that
request on January 20, 2006. However, the ND delegation was later
granted the ability to perform limited scope compliance reviews using
the comparison tool the ND delegation developed. The ND delegation tool
uses the OGOR reported sales and the two known factors in the royalty
equation, the Federal Governments allocation percentage and the royalty
rate, to compare to what the company reported as owed on the 2014. The
only remaining royalty equation factor is the unit value, which
includes allowances and transportation. The ND delegation has been
performing these limited scope oil volume and royalty rate compliance
reviews since October 1, 2006. Using this comparison, the ND delegation
has discovered countless reporting issues, non payment issues, missing
documents issues, two companies that just quit paying their Federal
royalty obligation in ND and well over $100,000 in additional
royalties, not including the amount owed by the two companies that just
quit paying, all at a cost of less than $10,000. The ND delegation has
taken on this comparison process at a time when funding has been
reduced from 6 FTE to 4.5 FTE and for FY08 the MMS has stated they will
only fund the ND delegation at 4 FTE.
What the ND delegation has been finding with our comparison process
is that companies are willing to correct their reporting when it is
brought to their attention. MMS is no longer bringing it to the
companies' attention and in fact we have had a company tell us that it
can't be reported wrong because the MMS hasn't notified them that it's
wrong.
This issue goes to the core of having an effective royalty
management program. Without correct reporting, the MMS does not know
what their universe of receivables is and consequently cannot compare
that universe to what was actually received. This is a basic principle
for any business.
A second major area is CIMS as I mentioned earlier. CIMS is the
current MMS collection tracking system that was brought online January,
2006. The previous collection tracking system, CTS, was shut down in
late 2001. The information in CTS agreed with the ND delegation's
collection data. Four years later when CIMS comes online the data is
inaccurate and incomplete. The MMS, on more than one occasion, has
asked the delegations for help in correcting and reconciling CIMS. The
ND delegation decided to use some of our limited resources to reconcile
the CIMS information to our state data. After performing this
reconciliation in mid 2006, it was determined that the reports that the
ND delegation can generate from CIMS are not accurate. The reports do
not reflect all the collections in CIMS for the ND delegation and there
is no way for the ND delegation to generate a correct report.
Thirdly, the MMS re-engineered system did not have an interest
module to bill late payment and additional royalty collection interest
until May 2003. Today MMS says they are finally caught up on the back
log of interest. However, the ND delegation has not received a correct
report of the interest that has been billed from November 2001 through
September 2006. The ND delegation did receive a report for interest
from November 2001 through April 2006, but the report information was
incorrect due to an error in the query.
On January 9, 2007, the MMS provided a report of interest for the
quarter of October 1, 2006 through December 31, 2006. The ND delegation
randomly reviewed two late payment interest billings from that report.
For the first case, no late payment interest was actually owed. MMS
billed late payment interest because the company misreported the sales
month. The company reported the May 2002 sales month royalties as
February 2002. So if the royalties were reported correctly, there would
not have been interest owed.
The second case the ND delegation looked at was one for which the
company claims they paid the royalty amount and MMS claims they didn't.
This dispute centers on the matching or bookkeeping process the MMS
has, a fourth area of concern. If a company reports on a 2014, that
they owe $100,000, but pays only $90,000 the MMS matches the money as
best they can. Normally the MMS would apply 90% to each of the detail
lines of the $100,000 report. In this case, the MMS determined that one
sales month for one property for one product was not paid and thus
billed the company interest for that one property, product, sales
month. Putting aside the dispute over whether the amount initially was
paid or not, the interest bill incorrectly calculated interest starting
February 1, 2000 when the royalty was not due until March 1, 2000.
Interest remains a concern for the ND delegation as the ND delegation
has no report of interest billings from November 2001 through September
2006 and is concerned with the accuracy of the billings for October
2006 through December 2006.
Once again, the Linowes Commission provided a useful guideline for
the MMS matching problem. In the summary section of the report, the
commission stated ``The Federal government should perform an oversight
role. It must not waste its limited resources on tasks that are the
industry's responsibility. In managing royalty collection, it should
not remain mired in bookkeeping details that rightly belong to the
lessee.'' The commission went on to state ``The oil and gas industry
should carry out its obligation, as lessee, to pay royalties in full
and on time. The industry, not the government, has primary
responsibility for the detailed record keeping needed to assure that
all royalties are paid.''
To further demonstrate the extent of how MMS has moved away from
putting the accounting responsibility on the companies, the ND
delegation has not issued an order to perform restructured accounting
in over 5 years. In the past, whenever the ND delegation encountered a
systemic problem, a problem for every test month or every property
covered by a contract, the ND delegation requested the company to pay
the additional royalties for the test months and then to perform
restructured accounting (recalculate) the royalties for all the non
test months. The MMS no longer is willing to sign orders to perform
restructured accounting so instead the ND delegation has to test all
months or project the non tested months. Unfortunately, if a projection
is used, the dispute becomes the projection method rather than if
additional royalties are actually owed.
The ND delegation concerns surrounding the financial system don't
end with the matching or bookkeeping issue. Within the last year, the
ND delegation has identified where an audit collection of $5,665 was
distributed to ND at 50% of $5,640. An immaterial difference, but no
explanation has been provided by the MMS for the difference. Another
issue identified in the last six months is the MMS effectively borrowed
ND's 50% share of the royalties for a property for up to three years
and no explanation has been given. This issue is that several payments
for ND's share of 2001 royalties for a property were backed out in
October 2003, even though the company did not change their royalty
reporting. Some of the amounts backed out were paid back three months
later, some 12 months later and the final amounts were paid back 36
months later. Was the ND delegation paid late disbursement interest and
how often has this occurred? Additional questions the ND delegation has
not been provided answers for. Ideally the MMS financial system should
be an automated process, but as MMS has recently stated to the
delegations, there are way too many manual processes.
A fifth area that the ND delegation has found to be ineffective is
MMS' Government Performance Result Act (GPRA) goals. The MMS goals are
tied solely to reviewing a certain percentage of the revenue
voluntarily paid by the companies. As the recent IG report points out,
this goal results in only large companies being reviewed while there
are hundreds of smaller companies that are never looked at. In fact,
the ND delegation has found that it encourages the delegation to not
look at companies that are severely underpaid. For example, the ND
delegation put a company on our work plan that paid $0 in Federal
royalties during the review period. The ND delegation got 0% credit
towards the goal. However, the ND delegation knew this company owed
over $100,000 of Federal royalties and had just failed to pay it.
Finally, the ND delegation has concerns about the working
relationship between the MMS and the State and Tribal delegations. The
delegation that has supported the MMS the most recently, has stated
during STRAC (State and Tribal Royalty Audit Committee) only meetings
that the limiting of the STRAC meetings to one a year by the MMS is in
retaliation to STRAC going to congress with letters about MMS. At the
last such STRAC only meeting, this delegation stated that it is a fact
that the MMS is looking at legal ways of getting rid of STRAC. As you
may be aware the MMS has reduced the number of STRAC meetings from
quarterly to one a year and has eliminated the STRAC only portion of
those meetings. See Exhibits 3 through Exhibit 13 for individual
delegation letters written to MMS in support of keeping the STRAC
meetings. This is a great concern to the ND delegation as the State and
Tribal delegations have had great success in collecting additional
Federal royalties and protecting the United States Citizens mineral
interests.
In closing, the delegations have been very successful in the past
at collecting additional royalties owed from Federal lands. The ND
delegation concurs with the recent IG report finding that the MMS
management lacks reliable information to manage the compliance program.
The collection information, CIMS is incomplete and inaccurate. The
level of misreporting and non-reporting has drastically increased.
Interest since November 2001 is still an unknown. The MMS is mired down
in detailed bookkeeping which should be the responsibility of the
industry. Goals encourage looking at high dollars and away from where
it is likely that there is a significant percentage of additional
royalties owed by a company. Finally, over the last five years the ND
delegation has noticed a disturbing trend of the MMS in moving away
from a partnership to a dictatorship in dealing with the delegations.
Thank you for the opportunity to provide written testimony to the
Committee today. I will be happy to answer any questions you may have
or provide further details and explanations surrounding any of these
issues. My contact information is:
NOTE: The exhibits attached to Mr. Roller's statement have been
retained in the Committee's official files.
______
The Chairman. Mr. Lester?
STATEMENT OF A. DAVID LESTER, EXECUTIVE DIRECTOR, COUNCIL OF
ENERGY RESOURCE TRIBES
Mr. Lester. Thank you, Mr. Chairman. The Council of Energy
Resource Tribes is honored to be invited to present its views
to the Committee on this subject. I am David Lester, Executive
Director for the Council of Energy Resource Tribes.
I have with me, who has helped the tribes since the
enactment of FOGRMA in 1982, Mr. David Harrison and Virginia
Boylan, attorneys who work with Indian tribes on these matters.
C.E.R.T., the Council on Energy Resource Tribes, was formed
in 1975, and one of its first objectives was to get reform of
how Indian royalty payments to tribes was handled by the
Department of Interior. As a result of scandals, as Mr. Roller
indicated, in 1982, Congress passed and the President signed
into law the Federal Oil and Gas Royalty Management Act to
reform, to correct the problems that were found in the late
1970s of the system as it existed then.
There are over 8,000 Indian leases, but there is no
official way of finding out how many wells are drilled because
the reporting is not at the well level. It is at the lease
level. A lease can cover as little as 160 acres or as much as
250,000 acres, as little as a small handful of wells or
thousands of wells. Compounding the data collection problem is
that the numbers for Indian wells do not correspond to the
numbering system used by the states and so we can't go and
cross check well data from state records to Interior records.
I am going to try to highlight some of the major problems
that the tribes have asked me to do, but also to request, if
possible, that the Committee consider coming out to the field,
perhaps allowing more detailed information to be gathered from
tribes and individual Indian allottees. We would like to work
with the Committee in gathering that information for you.
Compounding the urgency for the tribes in this matter is
that Indian leases can be held past their primary term if the
company or the operator continues to produce in the major
portion paying quantities. In the sense the data is gathered at
the lease level rather than at the well level, we have no way
of performing that analysis to determine whether those leases
that are being held in perpetuity are actually in compliance
with the terms of the lease.
In short, even if everyone did their job, the system is not
designed to fulfill its trust responsibilities to Indian
individuals or to Indian tribes, a responsibility that is
distinct in nature from its responsibility to public lands.
The FOGRMA was passed in 1982, but the final rules were not
issued until 1990. That is because there was a tremendous
attempt we believe, from our participation in the rulemaking
process, of the agency to water down FOGRMA and to in effect
reestablish the system that previously existed.
In short, the problems that FOGRMA sought to cure are with
us today in the agency. Among those are the posted price
problem. In many fields, the industry establishes a posted
price which it uses to calculate royalties. Ten years ago the
MMS abandoned the posted price on Federal leases, but continues
to allow companies and operators to use posted price in
calculating royalties owed to Indians and Indian tribes.
As far as we can see, in abandoning the posted price for
Federal leases they have collected over $480 million more than
they would have under the old system. We don't understand why
they don't make the rule applicable to Indian tribes as well.
The internal presumption within the agency is that the
operators and the royalty interest owners have common, in fact
coterminous, interests. In fact, we have a number of cases of
well defined adverse interests.
Major portion analysis. The leases require a major portion
analysis; that is, that the operators are to pay royalties
based on the highest price paid in the field on the majority or
the major portion of that field. Unfortunately, MMS does not
collect the data to do the analysis and so it is impossible for
us to know whether the companies are complying with those terms
of the lease.
In addition, as I said, we are getting lease level
reporting rather than well reports and so we don't know what
the paying quantities are on a well-by-well basis. Companies
also take their standard deductions, which often result in the
inability of the tribes to collect payment on liquids taken
from natural gas, liquids that have market value.
Audit compliance versus compliance review. Indian audits
that we have seen collect as much as 30 percent more than what
has been paid. We have no confidence at all in compliance
review and collecting what is owed to Indian tribes and Indian
individuals.
Advice from the State Tribal Royalty Advisory Committee is
often ignored. The agency seems to be in denial that there is
any real problem that exists in the agency. They continue to
use the honor system. When there is an overpayment claimed by a
company it is automatically deducted from the payments.
When a tribe discovers an underpayment, it takes a
procedure, an onerous procedure, for the tribe to collect the
underpayment. When we do, the government requires us to sign a
form that releases any claim that the tribe may have against
the government, even when it is only about the company's
payments, which leads us to believe that the government intends
on reducing our ability to have our grievances rectified in
Federal courts.
We want to say that this is not a partisan issue. This is
not Democrats or liberals versus conservatives. This is about
living up to the honor--the country and the tribes created the
trust--about living up to the contractual agreements the
parties have signed.
There are some things that are being done right. The lock
box system seems to be working. The cooperative agreements,
that is within MMS and BLM, bring tribal participation in. That
is working and should be expanded rather than reduced, which is
now the pressure to reduce the amount of money spent to cover
the field inspections and audits.
That Farmington office that was earlier referred to, it was
an example of what can be done when you bring all the agencies
together, so the coordination and turf problems can be reduced.
Unfortunately, the progress that was made is now dissipating
because it no longer is held feet to the fire by the courts.
The decision making around separating all these Indian
duties was made in 1982 by James Watt, which the tribes at that
time opposed, but I want to make sure that we understand. It is
not about where the boxes are. It is about getting the mission
right and correcting the culture in the agency that seems to
put us as adversaries; that the trustee and the beneficiary of
the trust are inherently adversarial when in fact that should
not be the case. The trustee should be our advocate and pushing
for full payment, full reporting, full disclosure, complete
transparency.
Free markets depend on transparency, and we are not given
that opportunity for transparent transactions with respect to
money owed us and production from our lands. I want to make
sure that we know that.
I will finish with this statement. It is about family
income. It is about capital for economic diversification and
building a local economy. It is about funding essential
governmental services at the tribal level. When we lose the
revenues on nonrecoverable, nonrenewable resources we have
cheated future generations.
It is not just about money. It is about what America stands
for, and that is serving the people, and gaining the trust and
confidence of the people. That is our government.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Lester follows:]
Statement of A. David Lester, Executive Director,
Council of Energy Resource Tribes, Denver, Colorado
Good Morning Chairman Rahall, Ranking Member Young and
distinguished members of the House Committee on Natural Resources.
Thank you, Mr. Chairman and Congressman Young for convening this
hearing and the strong support you have shown for Indian Tribes and
Native people over the years. I am David Lester, the Executive Director
of the Council of Energy Resource Tribes (CERT) and an enrolled member
of the Creek Nation of Oklahoma.
CERT was formed in 1975 in response to the energy crisis then
gripping the United States and our national need to increase domestic
production of oil, gas and hard rock mineral resources. CERT is an
organization formed by Indian Tribes to work for Indian Tribes and is a
true Inter-Tribal organization. CERT's membership includes 53 Federally
recognized Tribes and three First Nations from Canada.
Thirty-two years after its formation, CERT's mission remains the
same: to support its member Tribes in their efforts to develop
management capabilities and use their energy resources to help build
stable, diversified, self-governing economies according to each Tribe's
own values and priorities. CERT's programs include policy advocacy,
technical assistance, education and capacity-building partnerships. As
part of capacity-building and information sharing, CERT disseminates
knowledge through www.certredearth.com and other media.
I very much appreciate the opportunity to present testimony to the
Committee on a matter of great concern to our member Tribes. Because
CERT is a tribal organization, my testimony will focus on mineral
activity on tribal trust lands and transactions involving leases
between Indian Tribes and their private sector partners. Individual
Indians whose lands are leased for mineral activity, and to whom the
Minerals Management Service (MMS) also owes a trust responsibility,
have a related but distinct set of issues that I trust the Committee
will explore through the testimony of other witnesses. Similarly, my
testimony is related primarily to oil and gas leases, rather than
issues related to royalties from coal production even though MMS also
collects royalties from tribal coal leases. We do understand there are
myriad problems with undervaluation and underreporting on hard rock
mineral leases that are similar to oil and gas development.
I am pleased to be accompanied today by David Harrison, an attorney
from Albuquerque, New Mexico. Mr. Harrison is a former director of the
Bureau of Indian Affairs trust office and has long experience in
dealing with MMS and the issues facing Tribes in the area of royalty
accounting. Mr. Harrison is here to assist me in answering questions of
a technical nature that the members may have.
ROLE OF THE FEDERAL MINERAL MANAGEMENT SERVICE
At the outset, it is important to note that because the United
States (U.S.) holds legal title to the vast mineral estate that lies
below Indian tribal lands, the U.S. is bound to act as trustee for the
benefit of the Tribes and tribal members.
Federal laws such as the Indian Mineral Leasing Act and the Indian
Mineral Development Act require Federal approval of the terms and
conditions under which Indian energy resources are developed. The
Federal government invariably has some role in monitoring such
development and in overseeing the payment of royalties to the Indian
resource owner.
In this situation, Indian Tribes are often dependent on the MMS in
the Department of the Interior to provide accurate and timely
accounting and collection of royalties from gas, coal, and oil
companies engaged in mineral activity on tribal trust lands. However,
the Federal Oil and Gas Royalty Management Act also provides a
mechanism that allows Tribes to enter into contracts with the MMS to
perform audits of their own leases under MMS supervision. A number of
energy producing Tribes have entered into cooperative audit agreements
with the MMS and have been conducting royalty audits for many years.
Just as participation in audit review reflects greater tribal
involvement in resource management, other recent developments further
illustrate the evolving nature of Federal Indian law and policy
regarding tribal energy resource development. The Energy Policy Act of
2005 includes as Title V the Indian Tribal Energy Development and Self-
Determination Act, which authorized Indian Tribes to negotiate and
enter into with the Secretary of the Interior ``Tribal Energy Resource
Agreements'' (TERAs) for purposes of energy development, land
management, and environmental regulation on tribal lands. The major
element of such a TERA, once approved by the Secretary, is that the
Indian Tribes themselves will have the decision-making authority over a
host of energy and related matters that are currently relegated to the
U.S.
Indian tribal regulatory capacity is ever-increasing and that,
coupled with the Tribes' business sophistication, will bring a new day
in the near future when the advances in tribal authority made possible
by Title V might be expanded to include lease monitoring and royalty
verification functions that are currently relegated in large measure to
the MMS.
THE STATE AND TRIBAL ROYALTY AUDIT COMMITTEE EXPERIENCE
CERT believes this hearing is not just timely, it is, in truth,
long overdue. Some of the Tribes from whom CERT solicited input for
today's hearing have reported long and sometimes very difficult tales
about their dealings with the MMS. Although issues of concern to Tribes
are well known to the officials at MMS, the resolution of these
concerns has never been a priority of that agency and these concerns
continue to reside in the never-never land of the Federal bureaucracy.
The experience of the State and Tribal Royalty Audit Committee
(STRAC) is illustrative. STRAC was established in 1986 as an
association of royalty auditors for states and Tribes, who had entered
into delegation agreements or cooperative agreements with the MMS to
perform royalty audits. Members of STRAC have long been committed to
excellence in auditing, and the STRAC organization has provided a forum
for discussion of common audit issues, peer review, and development of
policy recommendations for improvements in valuation and auditing
policies and practices. In recent years, many members of STRAC have
expressed concern about emerging MMS policies and practices that may
adversely affect the collection of royalties by the Federal government,
states, and Tribes under Federal and tribal leases. Some Members of
Congress have also expressed concern about these matters.
Following up on a February 2006 letter from STRAC to the MMS, in
April 2006, seven Members of Congress, Representatives Carolyn Mahoney,
Henry Waxman, George Miller, Raul Grijalva, Edward Markey, Maurice
Hinchey, and Rahm Emanuel, wrote to MMS Director R.M. ``Johnnie''
Burton requesting information about MMS's compliance review program. In
particular, the letter sought information and analysis from MMS about
the cost and effectiveness of ``compliance reviews'' (CRs) compared to
more traditional audits covering leases of Federal and Indian tribal
lands. See attached April 3, 2006 letter. Compliance reviews are a
short-cut method of reviewing unverified company reports to determine
company compliance with royalty payment obligations.
In May 2006, Director Burton responded and indicated that, among
other things, in the five-year period between 2000 and 2005, CRs grew
from 34% of agency costs to 63% of agency costs as compared to more
traditional audits. Director Burton stated that ``[w]ith over 27,000
producing Federal and Indian mineral leases under our jurisdiction,
there are simply too many properties to rely on the traditional audit
approach alone.'' See attached May 17, 2006 letter. Director Burton
defended the agency shift to CRs by comparing historical audit
collections with the collections obtained under CRs.
The Southern Ute Indian Tribe, a member of the STRAC, received a
copy of Director Burton's May 2006 response and, in turn, sent a letter
to Director Burton taking exception to the inaccurate information and
representations contained in Burton's response. The Tribe was very
concerned that, in defending the shift away from audits to CRs,
Director Burton had significantly understated the amounts actually
collected by states and Tribes through audits. The Tribe requested that
Director Burton and MMS dedicate additional staff and initiate
corrective action and communications with the congressional recipients
of the erroneous information. See attached June 21, 2006, letter.
CERT was encouraged to learn that in July 2006 the Southern Ute
Indian Tribe was notified that additional MMS staff would be dedicated
to rectify the erroneous collections information. We hope that
Congress, as well as the states and Tribes that received the May 2006
letter from Director Burton will soon receive correspondence informing
them of the agency's corrective action, along with updated information.
Because this information appears to be a key justification for the
shift from traditional audits to CRs, its accuracy is important in any
meaningful discussion of the relative merits of CRs and audits.
CERT trusts that this Committee will provide the guidance that is
needed to the MMS to inspire Tribes to ensure that the degree of
monitoring, audits and accountings and royalty payments owed them are,
without question, accurate and will be paid in a timely manner.
In addition to the need for accurate accountings and disbursements,
Indian Tribes need assurance that when disputes inevitably arise
between Tribes and their private sector partners, the Department of the
Interior will act to fulfill its obligations to the Tribes and will not
be an active impediment to settlements between Tribes and the
companies. Tribal officials have asked that CERT bring to the
Committee's attention the following issues of concern. Many of these
matters are interrelated but I have tried to organize them so that the
potential solutions to each are clear.
THE HONOR SYSTEM FOR OIL VALUATION
At the outset, I want to impress upon the Committee that the
current legal framework and business model under which companies report
their own production, and therefore the royalties owed tribal resource
owners, can only be described as ``the honor system'', and it remains a
major problem for Tribes. The reality is that the conclusions of the
Linowes Commission in 1982 that companies were on an ``honor system''
is still true today, at least with regard to royalties payable on
tribal leases. You will recall that the Linowes Commission was
established to investigate allegations of Federal mismanagement of oil
and gas royalties. Its findings led the Congress to enact the Federal
Oil and Gas Royalty Management Act (FOGRMA).
FOGRMA, in turn, led the Department of the Interior to engage in
what we in Indian Country have grown accustomed to witnessing over the
years in the face of malfeasance or nonfeasance from our Federal
trustee: an internal ``reorganization'' that resulted in no substantial
improvement in MMS performance. Consequently, hundreds of millions of
dollars were spent on computer systems and automated reporting regimes,
scores of pages of fine print regulations were promulgated to deal with
valuation and accounting issues. Sadly, if the Linowes Commission were
reconstituted, it would report that the minerals industry is still
operating on the honor system, at least with respect to tribal mineral
leases.
Since 1998, the Navajo Nation and other Indian Tribes have been
urging the MMS to issue regulations governing oil royalty valuation for
Indian tribal mineral leases. MMS has issued regulations on oil royalty
valuation for Federal leases, but the regulation governing Indian
tribal mineral leases has been withdrawn. The result is that oil
production on tribal leases is still valued under rules that went into
effect on March 1, 1988. As the Committee might guess, the oil
marketing practices of the industry were vastly different 19 years ago
than they are today but Indian Tribes and Indian allottees still have
to rely on ``posted oil prices'' that are set by the industry itself.
These prices do not represent fair market value, and the Committee
should understand this as it moves ahead with its oversight efforts.
The honor system unfailingly results in underpayment of amounts
owed, and sometimes the underpayments are huge. In the 1980s, MMS
proposed as a conclusive presumption that an operator in an arms-length
transaction with an Indian Tribe was dealing in the best interest of
the royalty owner as well as himself. The royalty owners, including
Tribes, were successful in persuading the MMS to reject the idea of a
conclusive presumption. The MMS abandoned the notion that the interests
of producers and royalty owners are co-terminus, and it also abandoned
the notion that posted prices represent the true value of crude oil.
The MMS changed the regulation with respect to production of oil from
Federal leases, but has not acted with respect to Indian tribal royalty
owners. Thus, the honor system persists, but only to the detriment of
Indian royalty owners. We believe the Committee will agree that this is
unconscionable and needs to be revisited.
RELEASE OF CLAIMS AGAINST THE UNITED STATES
Because the U.S. holds title to Indian-owned energy resources such
as oil, gas, and coal, when either the U.S. or the Tribe discovers that
a company has underpaid significant amounts of royalties, the MMS makes
demands for compensation against the company. When settlements are
reached, MMS lawyers routinely insist that settlements contain hold
harmless provisions protecting the U.S. from any other claims relating
to that same production that are not covered by the particular
settlement agreement.
In all cases, it is the task of the MMS to value and collect
royalties accurately. Only when it fails to do so and the underpayment
is discovered, usually by the Tribe, does this issue arise. While the
U.S. retains responsibility for the enforcing the terms of the leases,
it does not accept any liability for failure to do its job. Claims may
be unknown to the Tribe at the time of settlement and it is an onerous
burden to require Tribes to pursue and prosecute these issues. CERT
recommends that the Committee direct the MMS to accept settlement
agreements without also requiring release by Tribes of collateral
claims against the U.S.
MAJOR PORTION PRICING
Standard Bureau of Indian Affairs Indian tribal mineral leases
require that royalties be paid on not less than the highest price paid
for a ``major portion'' of like quality production on the same field or
area during the production period. In trying to apply this requirement
over the years, it has been agreed to apply it only to arms-length
agreements. The problem is that the MMS has never collected the
information necessary to perform any analysis of either ``major
portion'' or what constitutes an ``arms-length'' agreement. Whether
this failure to act is caused by understaffing or by simple neglect,
the fact is that Indian tribal leases continue to be significantly
undervalued and thus underpaid.
The data collected by the MMS regarding production under Indian
tribal leases is not sufficient to support or fulfill the trust
obligation of the U.S. Revenue collected by the MMS from Indian leases
is only about two percent (2%) of the total production income from all
leases on Federal or tribal lands. It is our view, however, that this
is the most important percentage of collections because it represents
only a fraction of the true value of the tribal resources that, once
extracted, are lost forever. CERT respectfully suggests that this
Committee take the necessary steps, whether in the form of additional
funding for the MMS or in clarifying the law, to ensure that Indian
Tribes (and individual Indians) are paid accurately and fully for the
value of their resources. Once the resources are extracted, they cannot
be replaced.
NEGATIVE PAYMENTS
Federal offshore mineral leasing laws prohibit companies from
claiming recoupment of overpayments for a prescribed number of years.
This is not the case with leases on Indian lands. Thus, if a company
decides in 2007 that it overpaid for minerals extracted in 2006, it can
simply reduce currently owed payments by the amount it claims it
overpaid the year before. These unilateral adjustments are often made
without the Tribes' knowledge and, more important, without review or
oversight by the MMS. Similarly, a recoupment might occur at any time
because a mineral lessee might seek to recoup overpayments against 2007
production from years ago. If an Indian Tribe is not in a position to
know about these calculations and private company decisions, negative
payments just happen. The current system, if left untouched, will
continue to fail tribal resource owners.
COOPERATIVE AGREEMENTS AND LOCKBOXES
On a positive note, the MMS has entered into cooperative agreements
with several Indian Tribes under which companies simultaneously issue
production reports to the U.S. and to the Indian tribal mineral owner.
In these situations, royalty payments are sent directly to the Tribe's
financial institution. At one time, it took some Tribes years to get
duplicates of lease payment reports, and, consequently money transfers
and confirmations were not made in a timely fashion, which resulted in
confusing and often wildly inaccurate bookkeeping on the underlying
production.
Not all Tribes have cooperative agreements, but those that do seem
genuinely pleased with the timeliness of the payments and the lockbox
system. CERT recommends that the Committee encourage these types of
cooperative agreements and expand their use.
RESISTANCE TO WELL-BY-WELL REPORTING
A mineral operator can keep a lease in force in perpetuity, even
after the primary lease term has expired, as long as the lease is
producing ``in paying quantities'' on a major part of the lease. This
is true whether the lease is for 160 acres or 250,000 acres, and
regardless of the number of wells. If the operator does not report on a
well-by-well basis, however, there is no accurate way to know whether
the production is ``in paying quantities.'' When the ``major part'' of
the lease is not producing ``in paying quantities,'' the wells must be
shut in and the lease expires. Once wells are shut in, the only way to
resume production is to negotiate a new lease. To ensure correct
pricing, the mineral operator's production on a well-by-well basis
should be recorded.
AUDIT COMPLIANCE
The MMS has established an audit compliance and review program
related to its royalty accounting system. At the outset, most Tribes
believe that the MMS's reliance on voluntary submission by the company
of their respective oil and gas sales contracts is misplaced. CERT
Tribes agree with such an assessment, based on the past and present
performance of the industry. Further, technical compliance tools that
are being used successfully by Onshore and Indian Compliance Asset
Management organizations at the Minerals Revenue Management offices
simply do not work from the desk stations of auditors in remote tribal
headquarters. In these cases, Tribes rightly place little faith in data
generated by MMS' system to perform audits.
CONCLUSION
At least one person who audits company-reported oil and gas
payments for a Tribe in the Southwest routinely reports a 30%
underpayment for natural gas produced on tribal lands. Any system that
allows such underpayments, especially underpayments of this magnitude,
is immoral and untenable. As with so many other activities and
functions in other areas that are supposed to be performed by the U.S.,
the only way some Indian Tribes have been able to monitor the payments
is by doing it themselves.
Some Tribes actually monitor payments under contracts with the MMS.
However, monitoring is an MMS responsibility. If Tribes are routinely
finding these kinds of underpayments, it makes one seriously question
the ability or willingness of the MMS to account for the other 98% of
mineral leases where royalty payments are supposed to go to the U.S.
Treasury.
On behalf of the member Tribes of CERT, I again thank you for the
opportunity to appear before you today on this very important matter
and am happy to answer any questions you might have.
NOTE: Attachments to Mr. Lester's statement have been retained in
the Committee's official files.
______
The Chairman. Mr. Geesey?
STATEMENT OF MICHAEL GEESEY, DIRECTOR,
WYOMING DEPARTMENT OF AUDIT
Mr. Geesey. Mr. Chairman, Members of the Committee, I would
like to thank you for the opportunity to talk about the Federal
royalty management program. I am Mike Geesey with the State of
Wyoming, Department of Audit.
I am here today at the Chairman's invitation. As the
Chairman is well aware, Wyoming has a large amount of onshore
mineral production where Federal royalties are paid. Wyoming's
Department of Audit contracts with the Federal government to
audit royalty payments from that production.
I offer the following comments from a state's point of
view. In 1998, KPMG Peat Marwick presented an independent
report titled Cost Allocation of Royalty Management Program, A
Function Performed by the Minerals Management Service. The role
of KPMG was to present, among other analysis, an independent
report on the allocation of existing Federal and state audit
resources.
The conclusion in short was that the state audit programs
are resource effective and cost efficient. However, some states
were underfunded and other states were overfunded, thus
necessitating the need for a reallocation of the resources.
Wyoming has worked with the Minerals Management Service to
allocate those limited resources to match the risk and
oversight needed to ensure a proper onshore Federal royalty
payment compliance. In 2000, we received about 20 percent of
the funds budgeted for all state audit programs with over 40
percent of the onshore royalty payments being made from Federal
leases in Wyoming.
Last year, 2006, Wyoming received 30 percent of the state
audit funding with over 50 percent of the onshore payments
being made from leases in Wyoming. I believe there still needs
to make additional reallocation of the present budgeted funds
to balance the funding of royalties at risk. Given Wyoming's
current Federal production, the reduction in any funding could
potentially place some of the Federal royalty payments at risk.
The Department of Audit is proud of the role that we have
played in helping the Minerals Management Service with its
onshore royalty management program. We have consistently
strived to improve our audit program. Likewise, the Minerals
Management Service's efforts to do the same includes the
implementation of a compliance review program.
The State of Wyoming Department of Audit has always had a
professional working partnership with the Minerals Management
Service and sees the compliance review program as an additional
tool in the audit process. Wyoming acknowledges that this
program complements the current onshore royalty audit program
by enhancing the risk assessment process and providing early
detection of noncompliant Federal royalty payments.
This process has not and will not reduce the number of full
audits we plan to undertake. It only helps focus our limited
resources toward Federal royalty payments at risk.
Wyoming is disappointed to read that the Minerals
Management Service's 2008 budget is considering amending
Section 35 of the Mineral Leasing Act to syphon off
administrative costs for the singular act of calculating 50
percent of the total royalties paid in a state and writing a
check for that statutory payment. Those costs, using 2006
onshore royalties, would amount to over $44 million in reduced
Federal royalty payments to the states.
Presently this is in conflict with Section 503 of the
Mineral Payment Clarification Act of 2000. Wyoming sees no
reason to return to the controversial net receipt policy.
I thank you for giving me the opportunity to make some
comments. Thank you.
[The prepared statement of Mr. Geesey follows:]
Statement of Mike Geesey, Director,
Wyoming Department of Audit, Cheyenne, Wyoming
Mr. Chairman and members of this committee, I would like to thank
you for the opportunity to talk about the federal royalty management
program. I am Mike Geesey, with the State of Wyoming, Department of
Audit. I am here today at the Chairman's invitation. As the Chairman is
well aware, Wyoming has a large amount of onshore mineral production
where federal royalties are paid. Wyoming's Department of Audit
contracts with the Federal Government to audit royalty payments from
that production. I offer the following comments from a State's point of
view.
State funding of Federal Royalty Audits
On January 23, 1998 KPMG Peat Marwick LLP (KPMG) presented an
independent report ``Cost Allocation for Royalty Management Program
(RMP) Functions Performed by Minerals Management Service (MMS).'' The
role of KPMG was to present, among other analysis, an independent
report on the appropriate allocation of existing federal and state
audit resources. The conclusion, in short, was that state audit
programs are resource effective and cost efficient. However some states
were over funded and other states were under funded, thus necessitating
the need for a reallocation of audit resources. Wyoming worked with the
MMS to allocate those limited resources to match the risk and oversight
needed to ensure proper onshore federal royalty payment compliance. In
2000, we received about 20% of the funds budgeted for all the state
audit programs, with over 40% of the onshore royalty payments being
made from federal leases in Wyoming. Last year 2006 Wyoming received
30% of the state audit funding with over 50% of the onshore payments
being made from leases in Wyoming. I believe their still needs to be an
additional reallocation of the present budgeted funds, to balance audit
funding with royalties at risk. Given Wyoming's current federal
production, any reduction in funding could potentially place some
federal royalty payments at risk.
Compliance Review program
The Wyoming Audit Department is proud of the role we have played in
helping MMS with its onshore Royalty Management Program. We are
constantly striving to improve our audit program. Likewise, Mineral
Management Service's efforts to do the same, includes the
implementation of a compliance review program. The State of Wyoming,
Department of Audit has always had a professional working partnership
with the MMS and sees the compliance review program as an additional
tool in the audit process. Wyoming acknowledges that this program,
compliments the current onshore royalty audit program, by enhancing the
risk assessment process and providing early detection of noncompliant
federal royalty payments. This process has not and will not reduce the
number of full audits we plan to undertake. It only helps focus limited
resources towards federal royalty payments at risk.
MMS budget concerns
Wyoming is disappointed to read MMS's 2008 budget is considering
amending Section 35 of the Mineral Leasing Act (30 U.S.C. 191) to
siphoned off administrative costs for the singular act of calculating
50% of total royalties paid in a state, and writing a check for that
statutory payment. Those cost using 2006 onshore royalties would amount
to over $44 million in reduced federal royalty payments to the states.
Presently this would conflict with section 503 of the Mineral Payments
Clarification Act of 2000. Wyoming cannot see any reason to return to a
controversial policy of ``net receipt sharing.''
______
STATEMENT OF PROFESSOR PAMELA BUCY, FRANK M. BAINBRIDGE
PROFESSOR OF LAW, UNIVERSITY OF ALABAMA SCHOOL OF LAW
Ms. Bucy. I would like to thank the Committee for the
invitation to appear before the Committee. I am a law
professor. I was a Federal prosecutor prosecuting almost
exclusively white collar crime, and now I teach, publish and
speak on the Civil False Claims Act.
In my statement I would like to address four points. First,
the goal of the False Claims Act; second, how that goal is
affected when government employees who get the information
through their employment bring lawsuits under the statute;
Third, how the statute could be amended to remedy the
problems that are created when such employees bring lawsuits;
and, fourth, how to better remedy the problem that Mr. Maxwell
and other government employees run into when the agency that
they work for is not responsive to the problems. There is a
better solution for doing that rather than going through the
False Claims Act.
Whether you like the False Claims Act, which the Department
of Justice does, or you hate it, which most industry does,
there is no controversy at all that it is effective. It is
recognized as the premiere fraud fighting tool of the Federal
government. Last year, of course, Congress passed legislation
requiring all of the states to pass their own Civil False
Claims Act that mirrored the Federal statute.
The statute is unusual in that it allows a private person
known as a qui tam relator to bring the lawsuit, as well as the
Federal government. This private person need not be damaged or
affected at all by the fraud. All they have to have is
information that someone else has filed false claims with the
government, and that allows them to bring the lawsuit.
That person, the relator, is guaranteed a percentage of the
judgment, so, for example, even though Mr. Maxwell does not
know what percentage he will get, he is guaranteed 15 percent
under the statute. The False Claims Act after the 1986
amendments is now silent on the question that this committee
has raised, and that is whether government employees can serve
as qui tam relators.
The courts have weighed in on this, and there is a split in
the Circuits. Two of the Circuits say government employees do
qualify, and two of the Circuits say they do not. On each side
there is an en banc opinion, so clearly this is ripe for the
U.S. Supreme Court to take.
All of the courts that have addressed it, even the ones
that say that the statute does not allow the court to preclude
the government employees from serving as relators, all of the
courts agree that allowing government employees who get the
information through their employment frustrates the goal of the
statutes, so that is the point that I would like to cover is
how that does frustrate the goal.
I think it is also worth noting that every single court
that has addressed it has asked that Congress remedy this
problem because it is an ambiguity in the statute.
The major goal of the Civil False Claims Act is to bring
information of fraud to the Federal government. Fraud is hard
to investigate. You need an insider. You need somebody who can
tell you who did it, where the documents are and how it
happened. The False Claims Act incentivizes insiders to come
forward.
But, to allow a government employee who gets that
information through their government duties is parasitic, and
that is not the goal of the False Claims Act, which is to bring
information the government otherwise cannot get.
It also creates seven perverse incentives, and this is how
the courts talk about it, even the ones that say they don't
have the authority and Congress has to do it. The first
incentive is that it is going to give a government employee who
is going to be allowed to bring a lawsuit under the Civil False
Claims Act, the first incentive is to conceal information, to
conceal information about the fraud from their superiors, from
their co-workers and from government prosecutors so that they
can bring the lawsuit themselves.
The second incentive is to race to the courthouse to beat
the government in filing the house. The third incentive is to
prematurely disclose information which could cause the parties
that are being investigated to destroy documents or to get
their stories together.
The fourth incentive, contractors will be deterred from
being honest with auditors because they have to wonder am I
providing this confidential proprietary information to this
person so they can go file a lawsuit on their own behalf or so
that we can get this problem remedied to help the taxpayers.
Fifth incentive, the auditors who are often going to be in
the position to become these qui tam relators are also the key
government witnesses in any prosecution. Those witnesses'
credibility is destroyed once they become a plaintiff in a
case.
Sixth, the public confidence is destroyed whenever you have
to worry about your government official taking care of
themselves rather than their fiduciary duty to the public.
Seventh, of course it is inconsistent with all of the conflict
of interest requirements for government officials that they not
use their public position for private gain.
How to fix this. It is easy to fix. Congress passed a qui
tam provision to prevent bank fraud that is actually mirrored
after the False Claims Act and in that did what needs to be
done here. It is 15 words that disqualify a current or former
government employee who discovered or gathered the information
in the qui tam lawsuit in whole or part while acting within the
course of their government employment. That is all it would
take to fix this problem.
There is still the issue of what to do if you are working
for an agency that has not responded, and I would suggest that
that has already been taken care of in the context of public
companies. The Sarbanes-Oxley statute gave the impetus to the
SEC and to the ABA for lawyers to pass reporting up and
reporting out requirements.
That would require that there be an established protocol to
report within your agency, to report to the IG and report to a
fraud expert in the Civil Division at Department of Justice.
Those reportings would need to be legitimate reportings, not a
canceled appointment with the IG as in Mr. Maxwell's case.
This concludes my opening remarks. I have all of this in my
written statement, and I will be more than happy to answer any
questions.
[The prepared statement of Ms. Bucy follows:]
Statement of Pamela H. Bucy, 1 Frank M. Bainbridge Professor
of Law, University of Alabama School of Law
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\1\ Bainbridge Professor of Law, University of Alabama School of
Law (law faculty at UA School of Law, 1987 to present); Assistant
United States Attorney, E.D. MD., 1980-1987; Law Clerk, The Honorable
Theordore McMillian, United States Court of Appeals for the Eighth
Circuit, 1978-1979; J.D., Washington University, 1978.
I am most appreciative to Daniel Everett and to the following
students in my course on White Collar Practice who helped me prepare
this testimony: Bob Elliott, Prim Formby, Clay Gunn, Matthew Harris,
Emily Hines, Glenn Jones, Emily Kornegay, Mike Kuffner, Will McComb,
Monique Nelson, Robert Pitman, Oscar Price, Scott Sanders, Sirena
Saunders, Matt Shelby, Joseph Sherman, Harrison Smith, Derrick
Williams.
I am also greatly appreciative to Creighton Miller and Penny Gibson
at the University of Alabama School of Law Library, and to Erica
Nicholson, my assistant.
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Part One of this Statement provides an overview of the civil False
Claims Act. Part Two discusses court decisions and policy issues in
allowing government employees to qualify as ``relators'' under the
civil False Claims Act. 2 Part Two also addresses the recent
case of United States ex rel. Bobby Maxwell v. Kerr McGee Oil & Gas
Corporation. 3 Part Three proposes an amendment to the False
Claims Act to clarify when government employees should qualify to serve
as relators under the civil False Claims Act.
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\2\ 31 U.S.C. Sec. 3729 et seq.
\3\ Case 1:04-CV-01224-PSF-CBS (D.Colo., March 30, 2007).
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I. Overview of the Civil False Claims Act
The False Claims Act, 4 first passed in 1863,
5 and amended several times since, 6 most
dramatically in 1986, 7 is recognized by the United States
Department of Justice as its ``primary'' civil enforcement tool.
8 The Act grows out of a long tradition of using private
parties to supplement law enforcement efforts. 9
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\4\ 31 U.S.C. Sec. 3729 et. seq.
\5\ Act of March 2, 1863 at ch. 67, 12 Stat. 696-98.
\6\ Rev. Stat. 3490-94 and 5438 (1875); 89 Cong. Rec. S7606 (Sept.
17, 1943); Pub. L. 99-562, 100 Stat. 3153 (1986); Pub. L. 103-272, 108
Stat. 1362 (1994).
\7\ Pub. L. 99-562, 100 Stat. 3153 (1986).
\8\ Hearings Before House Comm. On Judiciary, Subcomm. on
Immigration and Claims, 105thCong., 2d Sess.14 (1998) [hereinafter
Subcomm. on Claims Hearings] (Testimony of Donald K. Stern, U.S.
Attorney, Dist. Mass. and Chair, Attorney General's Advisory Comm.,
U.S. Dept. of Justice).
For example, in FY 2000 the United States collected $1.5 billion in
civil fraud recoveries, most of which, $1.2 billion, was collected
through a private justice action, the qui tam provisions of the False
Claims Act (FCA). Press Release, United States Department of Justice,
November 2, 2000 at www.USDOJ.Gov, 21 TAF Qtrly. Rev. 18 (Jan. 2001)
[hereinafter Press Release, DOJ, Nov. 3, 2000].
As one Department of Justice official explained in 1996: ``The
recovery of over $1 billion demonstrates that the public-private
partnership encouraged by the Statute [the FCA] works and is an
effective tool in our continuing fight against fraudulent use of public
funds.'' Taxpayers Against Fraud, The 1986 False Claims Act Amendments,
Tenth Anniversary Report 15 (1986) (quoting Frank W. Hunger, Assistant
Attorney General, Civil Division, U.S. Dept. of Justice).
See also, Hearings Before House Comm. On Judiciary, Subcomm. on
Immigration and Claims, 105thCong., 2d Sess.14 (1998) [hereinafter
Subcomm. on Claims Hearings] (Testimony of Donald K. Stern, U.S.
Attorney, Dist. Mass. and Chair, Attorney General's Advisory Comm.,
DOJ) (``[T]he False Claims Act...has been the Department's primary
civil enforcement tool to combat fraud...''); Id. at15 (Testimony of
Lewis Morris, Assistant Inspector General, Dept. of HHS) (``The False
Claims Act has been an essential tool to protect the integrity of the
Medicare program.'' ``To achieve this goal...of ``zero tolerance'' of
Medicare fraud and abuse...the Government relies on a number of
enforcement options--criminal, civil, and administrative, as well as
educational outreach efforts. Chief among the enforcement tools has
been the False Claims Act.''); Id. at 25. (Testimony of Robert A.
Berenson, Director for Health Care Plans and Provides Administration,
Health Care Financing Administration, Dept of HHS)(``[T]he False Claims
Act is an important tool for...law enforcement...to pursue fraud and
abuse.''); Id. at 63. (Statement of Ruth Blacker, National Legislative
Counsel, American Association of Retired Persons) (``...Congress in
recent years [has] expand[ed] statutory authority and income resources
to deal with the problem [of heath care fraud and abuse]. However, none
of these things are likely to play a more important role in recovering
improper payments to in acting as a deterrent than the False Claims
Act. Use of the FCA by Federal authorities has become an important tool
for fighting fraud and abuse in many programs, including the Medicare
program.'')
\9\ Bucy, Private Justice, 75 S.C.L. Rev. 1, 13-54 (2002); Pamela
H. Bucy, Information as a Commodity in the Regulatory World, 39 Hous.
L. Rev. 905, 909-917 (2002) [hereinafter Bucy, Information as a
Commodity]; J. Randy Beck, The False Claims Act and the English
Eradication of Qui Tam Legislation, 78 N.C.L.Rev.539 (2000)
[hereinafter Beck, English Eradication]; Note, The History and
Developments of Qui Tam, 1972 Wash U. L. Q. 81 [hereinafter History and
Developments].
---------------------------------------------------------------------------
In American jurisprudence today there are a number of actions that
private parties may bring alleging that a defendant has violated some
federal or state law. 10 To the extent these actions
supplement the efforts of law enforcement in detecting, proving and
deterring lawbreaking, the private parties who bring them serve as
``private attorney generals.'' In almost all of these actions, the
private party who brings the action has been personally injured by the
defendant's conduct. The False Claims Act is unique among these actions
because it allows a private party who has not been personally injured
to bring the FCA action alleging violation of public laws by the
defendant.
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\10\ See, e.g., The Economic Communications Privacy Act, 18 U.S.C.
Sec. 2520 et seq.(2000 & Supp. 2001); American Disabilities Act, 42
U.S.C. Sec. 12188 (a)(1) (1995); The Civil Rights Act of 1964, 42
U.S.C. 1981 et seq (1994) (implied under Title VI, Guardian Assn. v.
Civil Service Comm'n of the City of New York, 463 U.S. 582, 594 (1983)
and Title IX, Cannon v. University of Chicago, 441 U.S. 677, 717
(1970).
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The FCA provides that a person who believes that he has information
and evidence that someone else (individual or company) has filed false
claims against the federal government, may file a lawsuit making such
allegations (termed a ``qui tam action). 11 This plaintiff
(termed a ``relator'') is required to file his lawsuit under seal (not
even serving it on the defendant). The relator is also required to give
a copy of the lawsuit to the United States Department of Justice, along
with a written report of ``all material evidence and information'' the
relator possesses. 12 The lawsuit stays under seal, often
for two years or more, to allow DOJ to fully investigate the charges
made by the relator. The secrecy provided by sealing the complaint not
only protects a defendant's reputation if the relator's information
amounts to nothing, but also facilitates DOJ's further investigation of
the relator's information.
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\11\ 31 U.S.C. Sec. 3730(b)(1).
\12\ Id. at Sec. 3730(b)(2).
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At the conclusion of its investigation, DOJ decides whether it will
intervene in the lawsuit as an additional plaintiff. If it does, DOJ
assumes ``primary responsibility'' for the case although the relator
remains as a plaintiff and is guaranteed a participatory role.
13 In some cases, DOJ handles the entire case after
intervening; in others, relators work hand-in-hand with government
prosecutors. In some cases, relators and their attorneys assume the
bulk of the investigative and litigative duties. 14
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\13\ 31 U.S.C. Sec. 3730(b)(2)(2002).
\14\ For other examples of FCA qui tam cases where the relator and
relator's counsel assumed large amounts of responsibility for the
preparation of the case, see United States ex rel. Alderson v. Quorum
Health Group, Inc., 171 F. Supp.2d 1323 (M.D. Fla. 2001); United States
ex rel. Merena v. SmithKline Beecham Corp., 114 F. Supp. 2d 352
(E.D.Pa. 2000)(facts more fully discussed in Merena, 52 F.Supp. 2d 420
(E.D.Pa. 1998) rev'd 205 F.3d 97 (3rd Cir. 2000))
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If DOJ does not join the lawsuit, the relator may continue pursuing
the case, litigating it alone. 15 Even if DOJ does not join
a relator's case, it retains authority over the relator's lawsuit in
several ways: DOJ monitors the case and may join it at any time, even
for limited purposes, such as appeal; 16 DOJ may settle or
dismiss a relator's suit over the relator's objections as long as the
relator has been given an opportunity in court to be heard;
17 DOJ may seek limitations on the relator's involvement in
the case, 18 or seek alternative remedies (such as
administrative sanctions ) in lieu of the relator's lawsuit.
19
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\15\ Id. at Sec. 3730(c)(3)(2002).
\16\ Id. at Sec. 3730(c)(3)(2002).
\17\ 31 U.S.C. Sec. 3730(c)(2)(A) and (B).
\18\ 31 U.S.C. Sec. 3730(c)(2)(C).
\19\ Id. at Sec. 3730(c)(5).
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If the government joins the relator's case, the relator is
guaranteed at least 15% of any judgment or settlement and the court can
award more--up to 25%. If the government does not join the lawsuit, the
relator is guaranteed 25% and could receive up to 30%. 20
The amount within the statutory award depends upon the relator's
helpfulness to the government. Because the FCA's damages and penalty
provisions tend to generate exceptionally large judgments, relators'
percentages involve substantial sums. 21
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\20\ 31 U.S.C. Sec. 3730(c)(3).
\21\ Recent relators' awards include $95 million, $44.8 million,
$28.9 million, and $18.1 million. 21 TAF Q. Rev. 20-21 (Jan. 2001).
---------------------------------------------------------------------------
The case of United States ex rel. Alderson v. Quorum Health Group,
22 demonstrates how the FCA works. It is typical in that it
shows the steps of a FCA qui tam action. It is atypical because of the
unusual contribution made by the relator to pursuing the case; in this
respect, Alderson exemplifies the FCA working to its fullest potential.
---------------------------------------------------------------------------
\22\ 171 F. Supp.2d 1323 (M.D. Fla. 2001).
---------------------------------------------------------------------------
In the 1980s, Alderson was the Chief Financial Officer at North
Valley Hospital in Whitefish Montana. He had been so employed for six
and one-half years. 23 In August, 1990, Quorum Health Group
took over as the management company for the hospital. Soon thereafter a
Quorum representative instructed Alderson to prepare two Medicare cost
reports. Hospitals that participate in the Medicare program by treating
Medicare patients must submit annual cost reports. These are lengthy,
detailed reports that provide extensive information about a hospital's
costs. 24 Alderson was told to prepare an ``aggressive''
cost report to submit to Medicare, and a ``reserve'' report to be used
internally. 25
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\23\ Id. at 1325.
\24\ Form HCFA 2552, Cost Reports for Hospitals. Cost reports are
lengthy and complex, consisting of hundreds of worksheets and requiring
detailed information about the facility, its staff and operation.
Providers are required to allocate various costs, including capital
expenditures, medical education costs, travel, malpractice insurance
premiums and payments, and every type of patient care costs to various
centers, designated by whether the patient was a Medicare patient and
whether the expense is properly reimbursable to the Medicare program.
Robert Fabrikant, Paul E. Kalb, mark D. Hopson & Pamela H. Bucy, Health
Care Fraud, Enforcement and Compliance Sec. 2.02[4] (LJSP 2003)
[hereinafter Fabrikant et al, Health Care Fraud].
\25\ Id.
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Alderson refused to prepare the two inconsistent reports. He was
terminated four days later. 26 Within months Alderson filed
a wrongful termination suit. 27 During depositions regarding
his termination, Alderson learned of additional irregularities in
Quorum's cost-reporting practices. He sought documents that would shed
further light on such practices and engaged a forensic accounting
expert. 28 In 1992, two years after his termination by
Quorum, Alderson filed a pro se FCA qui tam complaint alleging that
Quorum's cost reporting practice defrauded the Medicare program. As
required by the FCA, Alderson provided the federal government with a
copy of his complaint and a written statement of the information and
evidence he had gathered supporting the charges in his complaint.
29
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\26\ 171 F. Supp. 2d at 1325.
\27\ Id.
\28\ Id.
\29\ Id. at 1325.
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Unable to find another job after being fired from North Valley
Hospital, Alderson and his family suffered financially for years after
his termination. His family was forced to move from its comfortable
home to a cramped apartment in another town. They used the college
savings they had accumulated for their two teenage children.
30
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\30\ Kurt Eichenwald, He Blew the Whistle, and Health Giants
Quaked, N.Y.Times, Oct. 18, 1998, at Sec. 3, Page 1.
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For nine years after he filed his pro se FCA complaint, Alderson
spent thousands of hours working on his FCA case, 31
retained two different law firms to represent him in the action,
32 and either by himself or with his attorneys, met often
with DOJ attorneys and/or investigators, mostly in Washington D.C., and
at his own expense. 33 At these meetings, Alderson explained
how Quorum's reserve cost report practice defrauded the Medicare
Program. 34 When DOJ attorneys expressed concern about a
legal theory to support an FCA case, or what they viewed as weak
evidence or minimal damage, 35 Alderson addressed their
concerns. 36 The forensic accountant Alderson retained, and
continued to pay, met with DOJ officials in Washington D.C. to assist
Alderson in explaining the fraud to DOJ attorneys. 37
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\31\ 171 F. Supp. 2d at 1330.
\32\ Approximately one year after filing his pro se qui tam
complaint, Alderson retained a law firm that specialized in health care
law to handle his qui tam case. 171 F. Supp. 2d at1325. In 1995,
Alderson changed to a law firm that specialized in FCA qui tam cases.
Id. at 1327. This firm represented Alderson until the case was
resolved.
\33\ 171 F. Supp. 2d at 1325-1329.
\34\ Id.
\35\ DOJ attorneys believed the fraud to be $10 million or less,
too low to consider. Id. at 1325 -1331.
\36\ Id.
\37\ Id. at 1325.
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Working with the DOJ attorneys and investigators, Alderson
identified voluminous documents that government investigators should
subpoena from Quorum. 38 At DOJ's request, he reviewed the
documents obtained by subpoena. 39 These were extensive:
eight boxes of more than 11,000 records from 197 hospitals for seven
years. For one year, working alone, Alderson analyzed the records and
prepared a spread sheet summary of relevant cost reserve information.
He culled a set of 2,500 documents that corroborated specific reserve
information and presented his summary, spreadsheet and relevant
documents to DOJ. 40
---------------------------------------------------------------------------
\38\ Id.
\39\ Id.
\40\ Id. at 1326.
---------------------------------------------------------------------------
Seven years after Alderson filed his action 41 DOJ
agreed to intervene in Alderson's lawsuit, but only after receiving
``assurances from Alderson's counsel of their ability and willingness
to commit the necessary resources to the case and to undertake the
principal role in prosecuting the litigation.'' 42
---------------------------------------------------------------------------
\41\ Id.
\42\ Id.
---------------------------------------------------------------------------
The case ultimately settled for $85.7 million. Alderson's share was
$20.6. 43 The average relator's award, when the government
intervenes, is 16 % of judgment recovered. 44 When awarding
Alderson an unusually large award of 24 %, the Court looked to the FCA,
its legislative history, DOJ Guidelines for Relator's Award,
45 Alderson's persistence, 46 expertise, the
personal sacrifices he made to help the government, 47 and
the significant contribution of Alderson's counsel in pursuing the
case. 48 Alderson's attorneys were awarded $2.7 million in
attorneys fees pursuant to the FCA's requirement that culpable
defendants should pay ``reasonable attorneys' fees and costs.''
49
---------------------------------------------------------------------------
\43\ Id. at 1339.
\44\ Panel: FCA Enforcement in the Post-Stevens World, ABA Nat'l
Inst. On The Civil False Claims Act and Qui Tam Enforcement, Nov., 2000
(Discussion with Michael Hertz, Director, Commercial Litigation Branch,
Civil Division, U.S. Dept. of Justice).
\45\ 171 F. Supp. 2d at 1331-34.
\46\ According to the court, ``Only [Alderson's] dogged resolution,
eventually supported by competent professionals and an occasionally
reluctant government, resulted in the millions now available for
distribution.'' Id. at 1337.
\47\ Id. at 1337-1338.
\48\ According to the court, ``The record establishes that
Alderson's counsel contributed significantly (in both quality and
quantity) and at certain moments crucially to this case. That
contribution deserves manifest and telling weight in determining the
proper relator's award.'' Id. at 1335. The award of attorneys fees and
costs was in addition to the contingency portion of his award that
Alderson agreed to pay to his attorneys. Id.
\49\ 31 U.S.C. Sec. 3730(d)(1)(2002).
---------------------------------------------------------------------------
The court that determined Alderson's share described Alderson's
contribution to the case: ``[t]he record graphically demonstrates
Alderson's profound personal and professional commitment to success in
this litigation. His commitment manifested itself in his persistent
labors and those of his attorneys and accountants, all of whom
contributed mightily both before and after the United States
intervened.'' 50
---------------------------------------------------------------------------
\50\ Id. at 1338.
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II. Government Employees as Relators Under the Civil False Claims Act
A. Policy Reasons and Court Decisions
Because the civil False Claims Act (FCA) is widely recognized as
the most powerful tool available for pursuing fraudulent government
contractors and because government employees often learn of such fraud
in the course of their duties, the issue of whether government
employees qualify to sue under the FCA is significant, arises often,
and needs to be clarified by Congress.
Given the consensus by courts and policy makers that allowing
government employees to bring FCA actions creates serious enforcement
and fairness problems, and courts expressed frustration in their
ability to address these problems vis a vis Congress's authority to do
so, Congressional attention is needed. The FCA is an outstanding fraud-
fighting tool but to remain effective it needs clarification on the
issue of whether government employees qualify as FCA plaintiffs.
The courts that have addressed this issue disagree on the question
whether the FCA, in its current form, permits government employees to
bring suit under the FCA. The First 51 and Ninth Circuits
have held that government employees who obtain information in the
course of their official duties do not qualify to sue under the FCA.
52 The Tenth and Eleventh Circuits have held that government
employees do qualify. 53 All of these courts, however,
uniformly agree that it is poor public policy to allow government
employees to bring lawsuits under the FCA. The only point on which they
disagree is whether the courts, or Congress, should remedy the problem.
As the Tenth Circuit noted in reluctantly holding that government
employees were eligible to bring FCA lawsuits: ``Although there may be
sound public policy reasons for limiting government employees' ability
to file qui tam actions, that is Congress' prerogative, not ours.''
54
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\51\ view is more nuanced that simply holding, as the court did,
that the FCA as currently constructed does not bar all government
employees from bringing FCA actions. The Court went on to hold that the
relator in the case before it, an attorney with the United States
Department of Defense whose job was to review defense contracts for
fraud, was barred from bringing an FCA action. In so holding, the court
reasoned that the relator's ``responsibility, a condition of his
employment [was] to uncover fraud. The fruits of his effort belong to
his employer--the government.'' LeBlanc, 913 F.2d at 20.
\52\ United States ex rel. Fine v. Chevron, 72 F.3d 740, 745 (9th
Cir. 1995); United States ex rel. LeBlanc V. Raytheon Co., 913 F.2d 17,
20 (1st Cir. 1990).
\53\ United States ex rel. Holmes v. Consumer Ins. Group, 318 F.3d
1199, 1214 (10th Cir. 2003); cf. United States ex rel. Williams v. NEC
Corp., 931 F.2d 1493, 1501 (11th Cir. 1991).
\54\ Holmes, 318 F.3d at 1214. See also, Williams, 931 F.2d at
1503. (``We recognize that the concerns articulated by the United
States may be legitimate ones, and that the application of the False
Claims Act since its 1986 amendment may have revealed difficulties in
the administration of qui tam suits, particularly those brought by
government employees. Notwithstanding this recognition, however, we are
charged only with interpreting the statute before us and not with
amending it to eliminate administrative difficulties.'')
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The courts are right. There are significant policy reasons that
government employees who obtain information about fraud in the exercise
of their official duties, should not qualify to bring FCA lawsuits.
Termed ``perverse incentives'' by the U.S. Department of Justice,
55 these policy considerations are as follows:
---------------------------------------------------------------------------
\55\ As described by the Department of Justice, Holmes, 318 F.3d at
1212.
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(1) Access to confidential information. This may be the most
fundamental problem created when government employees who learn of
fraud in the course of their official duties are allowed to file suit
under the FCA. By virtue of their official position, government
auditors, investigators, attorneys and employees whose duty is to
investigate fraud by government contractors, obtain access to
confidential, proprietary, and privileged information of companies that
serve as government contractors. These government officials also have
access to internal governmental information including confidential and
non-public records and experts. Access to all of this information is
granted only because of the government employees' public position. It
is wrong for a government employee to use this access for his personal
benefit, rather than to serve the public interest. 56
---------------------------------------------------------------------------
\56\ See discussion of this problem at Holmes, 318 F.3d at 1217
(Tacha, dissenting); Fine, 72 F.3d at 745 (citing with approval
arguments made by the government).
---------------------------------------------------------------------------
(2) Conceal information. An FCA private plaintiff (``relator'')
qualifies to serve as a relator only if the information in the
relator's FCA lawsuit is non-public. 57 This is a wise
limitation for it helps ensure that the relator brings something of
value to law enforcement before the government has to share its
recovery with the relator. However, when the relator is a government
employee who obtained information about fraud in the course of his
official duties, this provision of the FCA encourages the government
employee to conceal information about fraud from his superiors, co-
workers and government prosecutors. By concealing such information, the
relator can investigate and develop the case for himself and preserve
his eligibility to bring an FCA suit. 58
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\57\ Section 3730(e)(4) of the FCA specifies the type of public
information that bars a private plaintiff from bringing suit.
``Public'' for these purposes is only: ``public disclosure of
allegations or transactions in a criminal, civil, or administrative
hearing, in a congressional, administrative of Government Accounting
office report, hearing, audit, or investigation, or from the news
media...'' If the information is ``public,'' the private plaintiff must
prove that he is the ``original source'' of the information. Id.
\58\ See Fine, 72 F.3d at 745 (citing with approval this argument
made by the government).
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(3) Race to the courthouse. The FCA provides that only the first
relator to file may bring an FCA lawsuit. Again, this provision is wise
policy for this helps ensure that the information the relator brings to
the government is not repetitive and justifies DOJ's sharing of its
judgment with the relator. This provision also limits, appropriately
so, the number of private individuals who share in the government's
recovery. However, this provision creates three temptations for the
government employee who wants to file his own FCA action.
First, it gives the government employee an incentive to delay the
official investigation of the fraud so that the employee has time to
prepare and file his FCA lawsuit before another potential relator files
suit.
Second, this provision encourages the government employee to steer
the official investigation in an unproductive or otherwise inefficient
direction so as to obfuscate for other potential relators key facts
that would enable those persons to file a FCA action and thus beat the
government employee in the first-to-file race. For example, if a
government employee who is investigating fraud by a government
contractor is planning to file his own FCA lawsuit and is concerned
that interviewing a particular witness may cause that witness to file
his own FCA action, the employee may be tempted to delay the interview
until after the employee has filed his own FCA action.
Third, the first-to-file requirement may encourage a government
employee to file his FCA lawsuit too early, thereby short-circuiting or
derailing other productive avenues of official investigation such as
grand jury investigations.
While some of these ``race to the courthouse'' problems may arise
with any relator, they are exacerbated when the relator is a government
employee because of the unusual access to information and ability to
derail the investigation by a government employee who investigates the
fraud as part of his duties.
(4) Premature disclosure. Although FCA lawsuits filed by relators
are filed under seal, and thus presumably unknown to the outside world
including defendants, the government's deadline for reviewing and
investigating the case, and deciding whether to join in the case, will
begin to run as soon as the relator files suit. In this sense relators
drive DOJ's agenda. This is, of course, true whether or not the relator
is a government employee. However, because the government employee has
access to information not available to other relators, the government
employee can file her FCA action even earlier than most other relators.
(5) Damaged credibility. Often the government auditor or agent who
investigated fraud by a contractor is a key witness at any civil or
criminal trial or administrative hearing. These persons often testify
as summary expert witnesses, explaining billing requirements and
tracing how the defendant's conduct violated these requirements. When
this individual has filed a lawsuit under the FCA in his own name and
stands to profit personally by doing so, his credibility as a witness
is ruined. This cripples the government's case. 59
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\59\ See Fine, 72 F.3d at 745 (citing with approval this argument
made by the government).
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(6) Conflict of interest. There are specific prohibitions against
federal employees using ``nonpublic government information...to further
any private interest, 60 participating in a government
matter in which the employee has a financial interest, 61
using public office for private gain, 62 using government
property or time for personal purposes, 63 and holding a
financial interest that may conflict with the impartial performance of
government duties.'' 64 There are also criminal penalties
for federal government employees who participate in matters in which
they have financial interests. 65
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\60\ 5 C.F.R. Sec. Sec. 2635.101(b)(3), 2635.703(a).
\61\ 5 C.F.R. Sec. Sec. 2635.402, 2635.501, 2635.502
\62\ 5 C.F.R. Sec. Sec. 2635.101(b)(7), 2635.702
\63\ 5 C.F.R. Sec. Sec. 2635.704, 2635.705.
\64\ 5 C.F.R. Sec. 2635.403; Holmes, 318 F.3d at 1225 (Tacha,
dissenting); cf. Fine, 72 F.3d at 746 (Kozinski, concurring) and at 747
(Trott, concurring).
\65\ 18 U.S.C. Sec. 208.
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When a government employee who obtains information of fraud by a
government contractor in the course of the employee's duties, files an
FCA action in his own name, all of the above regulations and statutes
are violated. They are violated when the government employee reviews
documents, interviews witnesses, and discusses strategy and
investigative direction with other government employees with expertise
in such matters. Access to such information and expertise would not be
available to the government employee if anyone knew that the employee
was going to use it to reap private gain. 66
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\66\ For discussions of this conflict of interest issue see Holmes,
318 F.3d at 1212 (citing arguments made by the government); 318 F.3d at
1224-1225 (Tacha, dissenting); Williams, 931 F.2d at 1503 (citing
arguments made by the government).
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(7) Erosion of public confidence. When potential defendants or
witnesses know that the government employee who is investigating fraud
may be working for himself and his own profit, they are less likely to
come forward to voluntarily cooperate, or to be fully forthcoming.
67
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\67\ See Fine, 72 F.3d at 745 (citing with approval this argument
made by the government).
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B. United States ex rel. Bobby Maxwell v. Kerr McGee Oil & Gas
Corporation
On June 14, 2004, Bobby Maxwell filed a qui tam action under the
civil False Claims Act. He filed his FCA action as a private person
even though Maxwell was at the time employed as a senior auditor with
the Minerals Management Service (``MMS''), 68 of the United
States Department of Interior. In his FCA action, Maxwell alleged that
Kerr-McGee underpaid royalties it owed to the federal government
pursuant to fifty-seven leases under which Kerr-McGee produced oil
offshore in the Gulf of Mexico. 69
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\68\ Case 1:04-CV-01224-PSF-CBS (Order of Dismissal for Lack of
Subject Matter Jurisdiction) at p. 4 (D.Colo., March 30, 2007).
\69\ Id. at 2 and 5.
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The federal government declined to join in Maxwell's FCA action.
70 Kerr-McGee filed a motion for summary judgment prior to
trial arguing that Maxwell, as a government employee who obtained
information of Kerr-McGee's alleged fraud in the performance of his
official duties, was precluded from bringing suit under the FCA. The
court deferred ruling on Kerr-McGee's motion until after trial. A jury
trial was held from January 16, 2007, to January 23, 2007. The jury
returned a verdict in favor of Maxwell and found damages of $7.5
million. 71 On March 30, 2007, the District Court granted
Kerr-McGee's motion for summary judgement, holding that Maxwell did not
qualify as an FCA relator. 72
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\70\ Id. at 11.
\71\ Id. at 1 and 6. This amount would be trebled according to the
FCA.
\72\ Id. at 28.
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In granting Kerr-McGee's motion for summary judgment, the District
Court noted that it was bound by Tenth Circuit precedent in United
States ex rel. Holmes v. Consumer Insurance Group, 73 in
which the Tenth Circuit held that ``[a]lthough there may be sound
public policy reasons for limiting government employees' ability to
file qui tam actions [under the FCA], that is Congress' prerogative,
not ours.'' 74 For this reason, the District Court reasoned,
it could not hold that Maxwell was precluded from filing suit solely by
virtue of his status as a government auditor who discovered the alleged
fraud in the regular course of his duties.
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\73\ 318 F.3d 1199 (10th Cir. 2003).
\74\ Id. at 10 citing Holmes, 318 F.3d at 1214.
---------------------------------------------------------------------------
The District Court noted, however, that Maxwell obtained the
information in his FCA suit as part of his official duties.
Specifically, the court noted that as the senior auditor charged with
determining whether Kerr-McGee's conduct was ``correct...and not
fraudulent,'' Maxwell: 75
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\75\ Id. at 2.
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``...frequently was on site at Kerr-McGee and took
documents back to his office to review ``whenever possible.''
76
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\76\ Id. at 3.
---------------------------------------------------------------------------
``...designed the subject audit of Kerr-McGee.''
77
---------------------------------------------------------------------------
\77\ Id. at 9.
---------------------------------------------------------------------------
requested documents from the field auditors which they
obtained pursuant to his requests. 78
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\78\ Id. at 9.
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``...personally conducted a comparison of the Texon sales
price data 79 to fair market value and to the values
reported by other companies, and discovered a vast difference.''
80
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\79\ Texon was a subcontractor Kerr-McGee dealt with. Id. at 3.
\80\ Id. at 9.
---------------------------------------------------------------------------
``...discovered two internal Kerr-McGee memorandums that
would later be used to show that Kerr-McGee considered the Texon
arrangement to be to its economic advantage.'' 81
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\81\ Id. at 10.
---------------------------------------------------------------------------
``...signed the letter from MMS to Kerr-McGee determining
that Kerr-McGee had underreported its royalties, 82 and
drafted follow-up responses.'' 83
---------------------------------------------------------------------------
\82\ Id. at 3.
\83\ Id. at 4.
---------------------------------------------------------------------------
Procedural provisions unique to the FCA require that all relators
must qualify as an ``original source'' before they may file an FCA
action if the information in the action has been ``publicly
disclosed.'' The District Court found that there had been public
disclosure of the information in Maxwell's FCA action. The court then
held that because of Maxwell's duties as a government employee, he
failed to qualify as an ``original source'' and thus, was ineligible to
bring his action under the FCA.
The Maxwell case aptly demonstrates the unfairness in allowing a
government employee who has access to a company's confidential,
proprietary and non-public information and access to governmental
records and experts, to use the FCA for his personal gain rather than
for the public interest. Every bit of the information Maxwell gathered
about Kerr-McGee's alleged fraud was because of his status as a
government auditor.
Although the District Court of Colorado ultimately held that
Maxwell failed to qualify to bring an FCA lawsuit, and thus reached the
``right'' conclusion, it was precluded, by Tenth Circuit precedent,
from doing so on the ground that Maxwell was ineligible to bring suit
under the FCA because he was a government employee who obtained the
information in his FCA action in the course of his official duties. The
court reached the same conclusion but had to labor through the ``public
disclosure'' and ``original source'' analysis to do so. It would have
made more sense from a policy perspective if the District Court could
have dismissed Maxwell's lawsuit at the beginning of the case simply
because he was a government employee who obtained information in the
course of his duties.
In addition and significantly, the resolution in the Maxwell case
was highly fact-specific. It was fortuitous that the court was able to
resolve the matter on grounds unrelated to Maxwell's status as a
government employee. Other instances of government employees who
capitalize on their access as government officials for personal gain,
may present different facts and may not be subject to dismissal. An
amendment to the FCA clarifying that government employees who discover
alleged fraud in the course of their official duties should not qualify
to bring FCA lawsuits is needed.
III. Proposed Amendment
There is no question that government employees who do not obtain
information of fraud in the usual course of their duties should
qualify, just like anyone else, to file private actions as relators
under the False Claims Act. Thus, for example, a government employee
who discovers fraud through friends or social connections in her
community should qualify as a relator. The problem arises only when
government employees who discover fraud in the course of their
governmental duties use that knowledge to profit personally by filing
an FCA action. The following proposed amendment to the FCA achieves
this balance. Significantly, Congress had recognized and addressed this
issue when creating private causes of action for those who know of bank
fraud. Congress did so by including the following language in the
Financial Institutions Anti-Fraud Enforcement Act of 1990.
84 This statute contains a qui tam provision similar to that
in the FCA.
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\84\ PL 101-647 (Nov. 29, 1990).
---------------------------------------------------------------------------
``the declaration is filed by a current or former officer or
employee of the Federal or State government agency or
instrumentality who discovered or gathered the information in
the declaration, in whole or in part, while acting within the
course of the declarant's government employment.''
85
---------------------------------------------------------------------------
\85\ 12 U.S.C. Sec. 4204(a)(1).
---------------------------------------------------------------------------
Such an amendment to the FCA would address the problem of
government employees who seek to profit by filing suit under the FCA
using information they obtained in their official capacity. It would
also appropriately and fairly allow government employees who obtain
information of fraud independently of their official duties, to qualify
as relators under the FCA.
______
The Chairman. The Chair thanks the panel for being with us
today.
I want to begin my questions with Mr. Roller. I am quite
impressed that North Dakota collects almost $6 for every $1 you
spend on audits, increasing Federal royalty collections in
North Dakota alone during the period of 1982 through 2001 by
$26.6 million. According to your testimony, this experience is
multiplied and seen across a spectrum of states and tribes that
participate in the MMS delegated audit program.
Mr. Geesey, does the Wyoming program enjoy the same level
of success? I am at a loss, therefore, to understand. Well, let
me ask you that question first.
Mr. Geesey. Mr. Chairman, I don't have the exact numbers,
but I can give you our total collections, which would include
Federals, because we do audits for both the Federal and our
state side, and right now we stand at about last year we
collected about $68 million in additional assessments at a cost
of around $3 million.
The Chairman. Let me turn it over to Mr. Costa in my
absence.
I am sorry. Let me go ahead and recognize the Ranking
Member, Mr. Pearce.
Mr. Pearce. Thank you, Mr. Chairman. I really am sorry I
missed the second panel. We had another obligation.
I was looking forward to hearing Mr. Maxwell. He has been
honored on the Floor of the House of Representatives as the one
guy who accomplished what the Administration would not and
could not do prior to that, bringing up possible negligence,
lost his job, standing up. It just sounds like the Paul Revere
of royalties.
Out in our area we have the Texas Rangers. They enforce the
law. It sounds like Mr. Maxwell was really a Texas Ranger.
Maybe we could call him a Royalty Ranger at this point for his
great service.
I would like to submit a couple of documents. Mr. Maxwell
testified that he reported his concerns regarding the Kerr-
McGee litigation to both the Office of Enforcement and the IG,
so first of all, Mr. Chairman, I would like to have unanimous
consent to submit the MMS procedure that requires auditors to
report their concerns regarding illegal acts to the Office of
Enforcement or IG.
Second, I would like to submit a statement from the MMS
stating that Bobby Maxwell never, never bubbled this
information up to the IG or the Office of Enforcement and that
he then carried it out and used it to apply in court for
something that possibly could bring him up to 10 million. I
think we have significant concerns about why he did not bubble
these things up through the system the way the law requires.
The next thing I would like to have introduced is the
opinion of MMS's third party auditors, people who say they are
doing a fairly good job, and that is from Thompson, Cobb,
Brazilio & Associates.
With your consent, Mr. Chairman, we will enter those into
the record.
Mr. Costa [presiding]. With no objection I would be willing
to do that.
Mr. Pearce. OK. Thank you.
Mr. Costa. I, as a point, would like to note that with your
references Mr. Maxwell was completely exonerated of the
charges.
You know, I understand the point you made, but the fact is
that the real problem of mismanagement at the Minerals
Management Service has existed. Mr. Maxwell took the matter to
court.
Mr. Pearce. Mr. Chairman, am I yielding back my time?
Mr. Costa. Let me finish my point, and I will be happy to
yield back.
Mr. Pearce. If I could stop the timer. That is the point.
Mr. Costa. No. I am very generous with the time, the
gentleman from New Mexico.
Mr. Pearce. OK. Thank you.
Mr. Costa. I have proven that in the previous hearings we
have held.
I think it is important, and without objection we will
submit the information that you provided. I think it is
important to note that he was totally exonerated by the courts,
and the documentation is there to prove that.
Without objection, we will submit that as well.
[NOTE: The information submitted for the record by Mr.
Pearce has been retained in the Committee's official files.]
Mr. Costa. I will allow you to continue. The gentleman from
New Mexico?
Mr. Pearce. Thank you. I thank the Chairman for his
indulgence.
I would point out that the case with Kerr-McGee is still in
process, so I am not sure exactly which court exonerated.
Additionally, Mr Chairman, I would point out that the Code,
5 C.F.R. 2635.101(b)(3), 2635.703(a), they prohibit a Federal
employee from using nonpublic government information to further
their private interests and so I have serious concerns about
Mr. Maxwell's legitimacy and in fact his standing whether or
not these cross the line at being criminal acts.
Also I would refer to C.F.R. 2635.402, 2635.501, 2635.502,
which prohibit a government employee from participating in a
government matter in which the employee has a financial
interest. Additionally I would point out 2635.101(b)(7),
2635.702, which prohibits a person from using public office for
private gain.
I would also point out C.F.R. 2635.704, 2635.705, which
prohibits a government employee from using government property
or government time for gain, and finally in fact 18 U.S.C.
1905, which in fact it is a crime for government employees to
disclose information gathered in the course of their
employment.
These are all things which raise grave concerns on the part
of the Minority about the testimony and in fact the actions by
Mr. Maxwell.
I would go next to a question that--well, I see my time has
elapsed. If we get a second round, I will gladly take a second
round. I yield back.
Mr. Costa. Thank you very much, the gentleman from New
Mexico.
As all of us are certainly entitled to our point of view, I
am not an attorney and that is a point I will make throughout
the 110th Congress as I chair this subcommittee. I certainly
appreciate everybody's perception.
Cases that are pending or cases that have been rendered on
we can certainly comment here on the Committee, but I would
like to focus back on this third panel. I want to apologize for
not having listened to your testimony. I had read it last
night. Unfortunately, this is one of those days.
Mr. Geesey, I heard one of the previous witnesses I did
catch on the second panel talk about his experience on tribal
lands both in the sector in his service to government and
beyond.
Do you have the experience to comment on communication and
cooperation between states and tribes with the Minerals
Management Service and give us a flavor from your own vantage
point?
Mr. Geesey. Mr. Chairman, no, I don't.
Mr. Costa. OK. Well, as I would not give you legal advice,
I am pleased that you are not going to give us advice in an
area that you don't feel comfortable with.
Mr. Roller, how about yourself?
Mr. Roller. As for communication between states and tribes
within the MMS are you talking?
Mr. Costa. Yes.
Mr. Roller. It mainly is at STRAC meetings. Other than
that, I don't know. I guess I don't have any experience to
comment other than that.
Mr. Costa. Mr. Lester looks like the gentleman who is
nodding his head in great fashion, so maybe you are the best
person to ask that question to.
Mr. Lester. I was agreeing with Mr. Roller that the
principal communication and interaction between tribes and
states is through the State Tribal Royalty Advisory Committee,
and that was formed because so many different Federal agencies
of the Department of Interior and so many of the stakeholders
needed a forum in which to communicate with one another.
In addition, the Department has an intradepartment, an
interagency committee, a steering committee on Indian minerals
because there is perhaps as many as 12 Interior agencies
involved with respect to the development, production and
payment to tribes and individuals from Indian lands. The
coordination within the Department and with the stakeholders is
a serious problem, Mr. Chairman.
Mr. Costa. Are any efforts being done, to your knowledge,
to try to address that?
Mr. Lester. I know that there are individuals who are
trying to address it within their scope of work, but there is
no one in the Department whose job it is to see that the
Department fulfills its responsibilities to Indian lands in the
mineral development, production and payment arena.
Mr. Costa. Mr. Lester, quickly because I have about a
minute and 20 left. Do you think that the current Federal laws
on the Indian Mineral Leasing Act and the Mineral Development
Act are sufficient today to ensure that Indian energy resources
are properly developed and monitored?
Mr. Lester. I think if they were properly implemented, sir,
they are except with respect to the interests of the individual
Indian landowner whose land is held in trust or is restricted.
They have little voice in the process, and that aspect needs to
be strengthened.
How to do it? I would turn to the Indian Lands Working
Group to provide the information on how best to do that.
Mr. Costa. All right. I thank you for the suggestion.
Mr. Geesey, before my time expires, please explain why the
State of Wyoming and private parties deduct fewer costs from
royalties on the transportation of coalbed methane than
Minerals Management Service does. Would you recommend that
Minerals Management Service adopt the Wyoming method?
Mr. Geesey. Mr. Chairman, we have been in discussion with
the Minerals Management Service regarding the coalbed methane
issue, and it is a simple matter of we think the marketable
condition is in a different place than the Minerals Management
Service believes it is.
The company thinks it is in another different place. All of
that is being litigated, as a matter of fact, because of the
complications of the statutes and stuff. I mean, every one of
them has a legitimate reason why it ought to be there.
We think ours is the most legitimate, but that is just our
feeling.
Mr. Costa. And it raises the most money for the public.
Mr. Geesey. In our mind, and of course for the State of
Wyoming, which is who we are trying to look out for.
Mr. Costa. Well, that is your job.
My time has expired. The gentleman from New Mexico?
Mr. Pearce. I thank the Chairman.
Mr. Geesey, tell me a little bit about what you think about
STRAC and its relationship with MMS and very shortly. We have a
lot of questions. Does it work or not? That is all I want to
know.
Mr. Geesey. Mr. Chairman, I don't think it works all that
well.
Mr. Pearce. OK.
Mr. Geesey. I think it is a good place where we can talk
some issues over. I have had this job now for 12 years, and----
Mr. Pearce. All right. You bet. That is good enough. I
appreciate it. I have heard it doesn't work all that well. I
mean, we don't cut with a very fine tooth blade up here.
Tell me, Mr. Roller. You get you said $6 for every $1 you
spend on audits. When I look at the chart over here, if I can
get my staffer to hold that up, I wonder why you get more
dollars per audit than some of the other states.
In other words, why don't you just contract out with New
Mexico? We do a pretty good job. We collect pretty good
revenues. It costs you about seven times what it does in New
Mexico. Why is that?
Mr. Roller. I can't answer why New Mexico doesn't contract
for our services in North Dakota. I can just tell you those are
the statistics. They are MMS statistics. They are not my
statistics.
Mr. Pearce. OK. And you all do great work?
Mr. Roller. Yes.
Mr. Pearce. OK. Now, what I am reading down through here,
when I read the amount of dollars that you collect for what you
spend, I read that North Dakota only collects $60 for every $1
that you spend to audit. Louisiana gets $1,400 for every $1
they spend. New Mexico gets $711 for every $1 they spend.
Wyoming, who I have heard criticism of their program today,
gets $628.
When I look at the way we overcompensate you and the very
paltry returns you get, I am not sure I can verify with dollars
on a piece of paper that your service works quite as well as
what I have heard in testimony today.
Mr. Geesey, tell me what you feel about the compliance
reviews versus straight out audits.
Mr. Geesey. We believe that it is a tool to be used. We
have some matching tools and so we used that tool. We were glad
that the Minerals Management Service gave us some additional
resources to do that.
We have already found some additional funds through that
process, and we are glad to do it. It is any kind of
enhancement of the audit process itself. I mean, as I stated in
my testimony, it doesn't slow down the number of audits we do.
In fact, it focuses us a little bit better than we were
able to before because of course it enhances our risk
assessment model by going through there and seeing those
anomalies that do exist when you look at the entire database
using the compliance review process.
Mr. Pearce. OK. Ms. Bucy, in your testimony you gave
several things about really allowing Federal employees to take
very privileged information and take that information and go
into court as private citizens and collect money.
You itemized a series of things. Do you think that that is
a circumstance that exists? Are you familiar with Mr. Maxwell's
case against Kerr-McGee?
Ms. Bucy. I have read the court opinions, yes.
Mr. Pearce. You have read the court opinions? From your
experience as a prosecutor, is that something you would be
concerned about?
In other words, that Federal employee who took privileged
information and then went into the courts and filed a lawsuit
as if he were a private citizen. Did that cross that threshold
that you as a prosecutor would have been concerned about?
Ms. Bucy. Yes. Yes, sir, it does in two respects. First of
all, I am not so sure that what Mr. Maxwell has identified is
fraud. It may just be accounting differences.
I am not so sure that a jury is really capable of telling
the difference, so I would feel better if a prosecutor had
signed off on it, somebody who knows fraud, and in fact the
Department of Justice had the chance to review his case and
turned it down because they said it was not fraud; it was just
accounting differences.
First of all, I don't know that it is fair to a defendant
to have people going around saying that stuff is fraud when it
is not. Second, if it is fraud and I as a prosecutor was going
to have to prosecute it one of the key witnesses would be the
government auditor who reviewed it, and if that person becomes
a qui tam relator their credibility is shot and so they have
ruined any chance of the government using them as a witness to
prosecute that case.
So it is unfair to the government and it is also unfair to
the defendant to have government employees pursuing these qui
tam cases.
Mr. Pearce. Thank you. I yield back.
Mr. Costa. Mr. Lester, as I read and I believe you
testified that you think in terms of as we look at the review
that the Committee should provide guidance to the Minerals
Management Service as it relates to the degree of monitoring
the audits, as well as the royalty payments, so that they are
accurate and timely. You also state that there needs to be
greater assurances I guess from the Department of Interior that
they won't serve as an impediment.
I am wondering on the settlements between the tribes and
the private sector parties. Would you please provide examples
of how the U.S. Government, which is bound under the Federal
law to act as the trustee for the benefit of the tribes, has
hindered these dispute settlements?
Mr. Lester. They have hindered in the sense that the data
that the tribes depend on often is late and inaccurate, and the
tribes' access to company records often is very difficult to
obtain.
Often tribes will have to go and dig into reports companies
have made to states and compare data on production from the
wells because the states also collect taxes from those wells
and so they are able to go to the state for information that
they can't get from MMS or BLM relative to production.
When the company and the tribe does reach agreement on the
settlement of what is owed then MMS or the Federal government
requires the tribe to release the government as trustee from
any claims; not just about the settlement, but any claims that
the tribe may have.
Mr. Costa. That is helpful, Mr. Lester. What I would ask
you to do is to submit some suggestions to the Committee on how
we might improve this process.
Mr. Lester. Thank you. I would be happy to do that.
Mr. Costa. Yes.
Mr. Geesey, a couple quick questions to you and Mr. Roller
before my time expires. In 2006, I understand that the State of
Wyoming voiced its opposition to a plan by Minerals Management
Service to curtail meetings held between state and tribal
auditors.
Despite Wyoming's opposition and others', MMS went ahead
with the plan. Can you explain why you opposed this plan?
Mr. Geesey. Mr. Chairman, I am not sure I understand what
the question is in terms of a plan.
Mr. Costa. The plan that we were told was meetings between
the state and tribal auditors that limited the numbers that
Minerals Management Service conducted.
Mr. Geesey. I don't know of any time when we would oppose a
meeting with STRAC. We probably think that the number of STRAC
meetings is too many, but I don't know that.
Mr. Costa. That is fine. Mr. Geesey and Mr. Roller,
according to the whistleblowers, Minerals Management Service
moved forward on a plan in 2002 to close hundreds of pending
audits so that it could receive a clean audit opinion after
four years of unqualified audit opinions.
Were the findings of these audits collected, or did MMS
simply walk away from, in your opinion, money that may have
been owed to the taxpayer?
Mr. Roller. From North Dakota's perspective, those audits,
if they were a North Dakota audit, we followed up on them, but
I believe the majority of those audits that were closed were
Minerals Management Service audits, which I wouldn't have any
information on.
Mr. Costa. Mr. Geesey?
Mr. Geesey. I would echo the same thing.
Mr. Costa. All right. Very good. I will yield back the
balance of my time.
This will be the last round. Following the gentleman from
New Mexico's questions or comments we will adjourn the hearing,
and we want to thank you for your time and your testimony.
Mr. Pearce. Thank you, Mr. Chairman. Again, a great
hearing.
Mr. Lester, you stated some concern about the MMS. You talk
about some of the tribes doing the monitoring themselves, and I
will tell you that I am always talking to the tribes in my
district about more self-determination.
Why don't you pick it up and do it? Why don't more tribes
just pick this up and do it themselves rather than depending on
MMS or whoever?
Mr. Lester. Our ability to enforce contracts and to enforce
the law against non-Indians is very limited by Federal law.
We do require the backing, in fact the enforcement
authority, from the Federal government as trustee because of
that very limited amount of jurisdiction we have over non-
Indians.
Mr. Pearce. OK. I appreciate that. That is something that I
am sensitive to.
Professor Bucy, if I understand the case, and we are going
back to Maxwell one more time. If I understand the case, what
happened is that Kerr-McGee were contracting with Texon to sell
their production, and Mr. Maxwell said no, that is not
appropriate. You could have made more money if you had done
this.
Now, each one of us, and I have never sold a house on my
own. I have sold lots of houses. We contract with a realtor to
get the best we can. We don't know the process. So basically
what Kerr-McGee did is contract with the realtor to sell some
property. They contracted with Texon to sell their oil. Mr.
Maxwell said in his professional opinion they could have made
more money. They paid $110 million, and he said now if you had
done it this way you could have made $120 million.
Talk a little bit about the legal implications. If this
case goes through and Mr. Maxwell is allowed to profit by this
private information that he got while he was a public employee,
but furthermore if he can direct someone.
Can the IRS come back and tell every American? Can every
IRS agent then go into American homes and say you used a
realtor to sell your property. If you had sold it yourself, you
would have been better off.
Talk a little bit about the risks throughout the system,
the shockwaves.
Ms. Bucy. What is at heart in the case against Kerr-McGee
is whether or not it got fair market value. You know, that is
in the eye of the beholder what is fair market value.
I think it is significant to note that whatever might be
the problems with MMS, MMS said this was not fraud. This was a
difference in opinion of fair market value. Then it went up to
the Department of Justice, and the Department of Justice looked
at it for fraud and said no, there is not fraud here. This is a
difference in opinion of fair market value.
The ramifications of that judgment standing are significant
because not only do you have all of these problems of a
government employee having access to confidential proprietary
information, but using it to say that there is fraud when it is
just a difference of opinion is going to completely undercut
the effectiveness of the False Claims Act.
Mr. Pearce. And that undercutting would then generate these
perverse incentives that cause good government employees to act
in a parasitic way. I think that is a very disconcerting
possibility.
Would you outline the legislative fix that you had
suggested in your testimony just briefly? How would it be fair
to government employees and yet be fair to the people and not
incentivize people to act like parasites?
Ms. Bucy. The language would only prevent government
employees from serving as qui tam relators if they got that
information acting in the course of their government
employment, so obviously it would apply to attorneys, auditors,
anybody who is getting confidential proprietary information in
the course of their employment from turning around and using it
for private gain.
It would still allow, and I think appropriately so,
government employees to be qui tam relators if they get the
information totally aside from their government duties.
Mr. Pearce. So it would give fairness, but also not
incentivize with perverse incentives this parasitic behavior?
Ms. Bucy. Exactly. Exactly.
Mr. Pearce. OK.
Ms. Bucy. I should note this is something that Congress
passed. I mean, that language is not my own. It is something
that Congress has already passed, but with regard to qui tam
provisions in bank fraud.
Mr. Pearce. In your opinion, was there court shopping going
on here? In other words, it should have been filed in the
Fifth, but it was instead in the Tenth.
Ms. Bucy. Absolutely. Well, forum shopping in the sense
that that is what plaintiffs' attorneys do and are allowed to
do, properly so, according to the courts.
The contract was in the Gulf of Mexico. That is the Fifth
Circuit. The Tenth Circuit is where it was filed, and that is
because the Tenth Circuit allows these parasitic lawsuits by
the government employees to go forward whereas other Circuits
would not.
The Fifth has not yet ruled on it, but the Tenth has, and
it is favorable to the government employees.
Mr. Pearce. Thank you.
Ms. Bucy. The First Circuit and the Ninth Circuit are the
ones that have clearly ruled that these are inappropriate
lawsuits.
Mr. Pearce. Thank you, Mr. Chairman. A great hearing. I
appreciate it.`
Mr. Costa. All right. I want to thank those who testified
on the third panel, the second panel and the first panel on
behalf of Chairman Rahall and all those who participated today.
I thank the Members of the Committee. This hearing is now
adjourned.
[Whereupon, at 2:28 p.m. the Committee was adjourned.]
[Additional material submitted for the record follows:]
[A statement submitted for the record by Erich G. Pica,
Director of Domestic Programs, Friends of the Earth, follows:]
Statement submitted for the record by Erich G. Pica,
Director of Domestic Programs, Friends of the Earth
On behalf of Friends of the Earth, I would like to thank the
Committee on Natural Resources for the opportunity to offer testimony
for the record on the Department of the Interior's collection and
management of oil and gas royalties. Friends of the Earth is a national
non-profit environmental advocacy organization and is a member of
Friends of the Earth International, the world's largest grassroots
environmental federation with more than one million members in 71
countries.
Last year the New York Times began publishing a series of
investigative articles that exposed gross mismanagement of the
Department's royalty program which could cost taxpayers billions. These
articles spurred welcomed congressional oversight and attention to the
issue of royalties paid by oil and gas companies for the privilege of
drilling on federal lands and waters. The articles and subsequent
congressional investigations have uncovered a pervasive culture of
ineptitude that has put at risk tens of billions of royalty dollars.
The failure to collect royalties means that millions of acres of public
lands and waters are being put at environmental risk without fair
taxpayer return. These royalties provide needed funding to the Land and
Water Conservation Fund, the Historic Preservation Trust Fund, the oil-
producing states and the general treasury.
The Interior Department itself first revealed the problem in last
year's budget, which noted that ``royalty relief'' would allow
companies to avoid paying royalties on more than $65 billion worth of
revenues from oil and gas drilled in the deep waters of the Gulf of
Mexico over the next five years, costing the federal government
approximately $9.5 billion over that period 1. It was later
discovered that a large share of the losses resulted from the failure
to include price thresholds capping royalty relief in leases issued in
1998 and 1999 2. According to a draft report by the
Government Accountability Office, losses to the treasury over 25 years
could reach a staggering $20 billion due to a combination of the
missing price thresholds and a recent federal court decision that
changed the methodology by which royalty relief is calculated. If the
oil industry is successful in a recent legal challenge, these losses
could balloon to $80 billion over the same period. 3
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\1\ Mineral Management Service. Fiscal Year 2007 Budget
Justifications and Performance Information, page 169. http://
www.mms.gov/PDFs/2007Budget/FY2007BudgetJustification.pdf
\2\ Andrews, Edmund L. ``U.S. Has Royalty Plan to Give Windfall to
Oil Companies.'' New York Times. Feb. 14, 2006. http://www.nytimes.com/
2006/02/14/business/14oil.html?pagewanted=
1&ei=5088&en=87dc413fa6add582&ex=1297573200&partner=rssnyt&emc=r
\3\ Government Accountability Office Draft Briefing on Oil and Gas
Royalties. March 27, 2006. http://www.nytimes.com/packages/pdf/
business/29lease.pdf
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Unfortunately, the missing price thresholds are only the tip of the
iceberg. Following the discovery the erroneous 1998 and 1999 leases,
media, congressional, and departmental investigations and whistleblower
actions have highlighted the failure of the Minerals Management Service
(MMS) to audit royalty payments or to seek payment of underpaid
royalties and interest on the royalties. Now that MMS's failures are
well-documented, it's time for Congress to insist on badly-needed
reforms to the agency. Friends of the Earth proposes the following
reforms that we believe will make oil and gas companies more accounted
to the American taxpayer.
Establish Independent Auditing
MMS has lost the confidence of Friends of the Earth, Members of
Congress and the American public, and cannot be trusted to fully and
fairly collect royalties from oil and gas companies on behalf of the
American public. Indeed, MMS is plagued by a culture of ineptitude that
makes it unfit to manage the nation's royalty collection program.
Friends of the Earth recommends that MMS's royalty collection and
auditing functions be either put into receivership with an outside
auditing firm, or placed under the direct guidance of the Department's
Inspector General. If these recommendations appear insufficient,
Friends of the Earth would recommend evaluating the potential of
housing the royalty collection and enforcement with the Internal
Revenue Service.
Increase Transparency
As investigations by the Department's Inspector General and the
Government Accountability Office have progressed, one common theme
continues to reappear: the lack of readily available and verifiable
information regarding oil and gas royalty payments. As a founding
member of the Publish What You Pay Coalition-US, a coalition of more
than 300 non-governmental government organizations worldwide helping
citizens of resource -rich countries hold their governments accountable
for the management of oil revenues, Friends of the Earth is keenly
interested in the full, timely and verifiable disclosure of royalty
payments made to the federal government. Royalty payments, contracts
between the federal government and companies, must be accessible and
understood by the general public. In addition, the public must be
notified about when a company is being audited, the results of the
audits, and any penalties/rewards levied after the completion of an
audit.
Increase the Royalty Rates
Currently, oil and gas companies typically pay a 12 to 16 percent
royalty on oil and gas they extract from federally owned waters and
lands. According to the New York Times (Incentives on Oil Barely Help
U.S., Study Suggests 4), the United States imposes
significantly lower royalty and tax rates on oil and gas companies than
other countries. According to the article:
---------------------------------------------------------------------------
\4\ Andrews, Edmund L. ``Incentives on Oil Barely Help U.S., Study
Suggests.'' New York Times. December 22, 2006. http://www.nytimes.com/
2006/12/22/washington/22royalty.html?ei=5088&en
=3c13b8d3062224f4&ex=1324443600&adxnnl=1&partner=rssnyt&emc=rss&adxnnlx=
117509
8448-K1vw88CiZYOjyxBNKgCuwg
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In the United States, the federal government's take--royalties as
well as corporate taxes--is about 40 percent of revenue from oil and
gas produced on federal property, according to Van Meurs Associates, an
industry consulting firm that compares the taxes of all oil-producing
countries.
By contrast, according to Van Meurs, the worldwide average
``government take'' is about 60 to 65 percent. And that figure,
of course, excludes countries that do not allow any private
ownership in oil production.
With annual profits of the big five oil and gas companies exceeding
more than $110 billion last year, it is time that Congress reevaluates
the royalties in place for current and future production.
In addition to the low tax and royalty rates, the impact of royalty
relief to spur domestic production is dubious. An MMS report entitled
``Effects of Royalty Incentives for Gulf of Mexico Oil and Gas Leases''
5 demonstrates this point. Table 5-9 of Volume 1 reviews
various royalty relief scenarios and estimates their impact over the
next 40 years. Under the current royalty relief regime, MMS is
estimating that 57,281 mmBoE in new reserves will be discovered, they
estimate that 56,644 mmBoE will be discovered without royalty relief.
This is a difference of approximately 1.1 percent. This additional 1.1
percent in discovery will cost taxpayers approximately $48 billion in
royalty revenues, the difference between the total royalty revenue from
the current royalty regime and no relief.
---------------------------------------------------------------------------
\5\ Mineral Management Service Economic Division. ``Effects of
Royalty Incentives for Gulf of Mexico Oil and Gas Leases.'' Volume 1.
OCS Study MMS 2004-077.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Eliminate Oil Royalty Relief Programs
For more than a decade, Friends of the Earth has opposed various
schemes to provide oil and gas companies with royalty relief. We have
consistently opposed bills such as the Deepwater Royalty Relief Act of
1996, royalty relief provisions in the Energy Policy Act of 2005, as
well as other schemes to help oil companies avoid paying royalties.
Particularly at a time of record oil and gas prices, it is clear that
companies do not need these incentives. Friends of the Earth was
pleased that H.R. 6, the CLEAN Energy Act of 2007, repealed royalty
relief provisions enacted in the 2005 energy bill. We are hopeful that
the Senate will follow suit, and we urge Congress to repeal additional
royalty relief provisions such as sections 343 and 353 of the Energy
Policy Act of 2005 dealing with royalty relief for marginal well
production and methane gas hydrates.
Collect Royalties from the 1998 and 1999 leases
Friends of the Earth remains concerned that MMS is not doing enough
to recapture the royalty revenue lost as a result of the 1998 and 1999
leases in the Gulf of Mexico. We remain disheartened by statements made
by Interior officials regarding their ability to renegotiate the
existing leases, as well as the terms of leases that have been
renegotiated to date. Members of this Committee played a lead role in
passing legislation last year that provided a strong incentive to
companies benefiting from unlimited royalty relief to sit down at the
negotiating table and agree to begin paying royalties. As Congress
sought to strengthen the Department of the Interior's hand with these
measures, administration officials such as MMS Director Burton
undermined them every step of the way by opposing the congressional
actions and publicly stating that ``I don't like to say `negotiate'
because I really don't have anything to trade.'' 6
---------------------------------------------------------------------------
\6\ Andrews , Edmund L. ``Interior Official Says She Will Not Try
to Recoup Lease Money.'' New York Times. September 22, 2006. ``http://
www.nytimes.com/2006/09/22/business/22oil.html?ei=
5090&en=cf1f7de8c9d7d739&ex=1316577600&partner=rssuserland&emc=rss&pagew
anted=
print
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The terms of the renegotiated leases that six companies have now
signed are highly unfavorable to the government and illustrate the
result of MMS's weak attempts to address the problem. Among other
things, the leases fail to recoup royalties on past production that
occurred on the 1998 and 1999 leases prior to October, 2006--nearly $1
billion in lost royalties. The leases also contain a variety of escape
hatches for the companies, allowing them to terminate the leases if the
Department reaches ``more favorable'' terms with another company in the
future or loses a lawsuit filed by Kerr Mc-Gee challenging its
authority to collect royalties, or if Congress enacts legislation
intended to address the faulty leases. Rep. Hinchey has drawn attention
to these flaws, and we share his concern.
In addition to the favorable renegotiated contracts, the Department
of the Interior is now asking for authority from Congress to offer
lease extensions as a means to entice companies to renegotiate. In
testimony before the Senate Energy and Natural Resources Committee, the
Assistant Secretary for Lands and Management, Stephen Allred, requested
additional authority from Congress to allow the Department of the
Interior to extend leases for companies that choose to renegotiate
their 1998 and 1999 leases. After opposing legislation to strengthen
their negotiating stance, and making public statements that weakened
it, MMS is now asking Congress for authority to give yet another
giveaway to the oil and gas industry. Needless to say, Friends of the
Earth would oppose these incentives.
Conclusion
The oil royalty collections system in the United States is broken.
The Department of the Interior and the MMS have lost the ability to
enforce the laws passed by Congress and protect the environment and
taxpayer interests. I thank the Committee on Natural Resources for
allowing Friends of the Earth to offer testimony, and hope our
recommendations will be considered in further debate.