AN INDUSTRY LAWYER'S PERSPECTIVE ON THE MMS AUDIT PROCESS: NICE PEOPLE FINISH FIRST

• Jurisdiction: United States

Federal and Indian Oil and Gas Royalty Valuation and Management
(Feb 2007)
CHAPTER 6A
AN INDUSTRY LAWYER'S PERSPECTIVE ON THE MMS AUDIT PROCESS: NICE PEOPLE FINISH FIRST
Dimitri Lee Seletzky
Counsel, Headquarters - Law Department
Chevron North America Exploration & Production, a division of Chevron U.S.A. Inc. ¹
Houston, Texas

DIMITRI LEE SELETZKY

Dimitri Lee Seletzky joined the Houston office of Chevron's law department in August 2004. At Chevron, Mr. Seletzky primarily handles matters involving the Department of the Interior, focusing on federal and Indian royalty issues. His practice at Chevron includes counseling, royalty audits, and Department of the Interior administrative appeals. Mr. Seletzky is Chevron's representative on the American Petroleum Institute's Subcommittee on Exploration and Production Law.

Prior to working at Chevron, Mr. Seletzky practiced law at Fulbright & Jaworski L.L.P.'s Washington, D.C. office. At Fulbright, Mr. Seletzky's practice focused on federal and Indian lands matters including federal and Indian oil and gas royalty issues and onshore and offshore land access issues. Mr. Seletzky's practice at Fulbright encompassed counseling, royalty audits, administrative appeals, federal court challenges of agency decisions, and the defense of actions under the federal False Claims Act.

Mr. Seletzky is a member of the Texas, Washington, D.C., and Maryland bars. He graduated magna cum laude from the University of Baltimore School of Law in 1998.

"Nice guys finish first. Be one and win." Ben Stein, How Successful People Win 131 (2005).

I. INTRODUCTION: ATMOSPHERICS MATTER

Beginning early last year the federal and Indian oil and gas royalty collection and audit program managed by the Department of the Interior's Minerals Management Service ("MMS") came under intense scrutiny, thanks in part to a series of New York Times articles alleging that the MMS mismanaged the program. Coming at a time of perceived high gasoline prices, the articles fueled a storm of controversy on Capitol Hill and in the oil patch, even though major allegations made in the articles have been investigated and debunked.² One could attempt to write off the attention focused on royalties over the past year as sound and fury without significance or relevance to the daily work of oil and gas royalty auditors and auditees, but that is quickly becoming impossible. For better or worse, the atmospherics matter. As anyone who has been through an audit with the MMS recently knows, the criticism and heightened scrutiny placed on the agency by the recent media and Congressional attention has placed enormous new burdens on the auditors and their management. Many of them must now routinely devote a significant part of their time to responding to internal and external audits, reviews, and inquiries regarding their own work, in addition to handling their old job responsibilities with no new resources.

Further clouding the atmosphere for officials at the MMS, a recent trend has emerged of agency auditors filing their own qui tam False Claims Act³ actions regarding issues they identify in their audits.⁴ Most courts that have considered the question have held

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that government employees such as MMS auditors who file suits relying on information they are obliged by their job duties to disclose to the government do not meet the False Claims Act's jurisdictional requirements for private plaintiffs.⁵ Further, conflict-of-interest rules applicable to federal employees arguably should preclude MMS auditors from qualifying as False Claims Act plaintiffs.⁶ In the MMS audit process context, if every auditor has a significant financial incentive to bring his own suit, rather than simply audit on behalf of the government, the integrity of the process is brought into question. Despite the legal precedents and conflict-of-interest concerns, however, a federal district court in the Tenth Circuit is allowing an MMS auditor's False Claims Act case to proceed to trial.⁷ This decision will likely spawn the filing of many more such suits because the potential economic rewards for auditors filing them are great: successful False Claims Act qui tam plaintiffs are entitled to 15 to 30 percent of any recovery.⁸

The atmospherics surrounding the MMS audit process threaten to transform the relationship between the MMS and industry from one of "trust but verify" into one of simple distrust. That transformation would be an unfortunate turn of events not just for the MMS and industry, but also for the U.S., because the resultant lack of certainty and predictability in the audit process would be yet another disincentive for domestic exploration and production. The statistics regarding our reliance on foreign oil already tell a tale of declining domestic production and increasing reliance on imports.⁹ As new burdens and costs are placed on companies that have continued exploring for and producing oil and gas domestically, the trend of production declines will only continue, and our dependence on foreign oil will only increase.

Industry and the MMS must work together in their day-to-day business to mitigate the damage to their relationship. In the audit process arena, both sides can improve the relationship by recognizing that, contrary to the popular maxim that "nice guys finish last," in the long term the marketplace rewards not thieves and robber barons, but those who act with honesty and integrity, as well as skill and intelligence.¹⁰ This rule is particularly important in the oil and gas royalty audit arena because audits are, after all, about assuring the accuracy of financial reports. A reputation for honesty and integrity on both sides can only help both auditor and auditee during the audit process.

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This paper provides a basic overview of the audit process. It attempts to collect most of the pertinent legal authorities and guidance regarding the MMS's authority and duties in conducting royalty audits, as well as the rights and obligations of auditees. It also attempts to provide a basic tool kit of essential information to prepare for and conduct or undergo an audit. The paper incorporates practical tips for auditees derived from my experiences in handling numerous MMS audits and appeals. Please take them for whatever they are worth.¹¹

II. OVERVIEW OF THE MMS'S AUDIT PROCESS

A. Background Regarding Federal and Indian Oil and Gas Royalty Audits

The Federal Oil and Gas Royalty Management Act of 1982 ("FOGRMA" or "Act")¹² sets forth the duties and authority of the Department of the Interior ("Interior") regarding oil and gas royalty collections and enforcement. The Act was intended to respond to Congressional findings that "the system of accounting with respect to royalties and other payments due and owing on oil and gas produced from . . . [federal and Indian] lease[s] . . . is archaic and inadequate . . . ."¹³ To that end, a chief purpose of the Act was "to require the development of enforcement practices that ensure the prompt and proper collection and disbursement of oil and gas revenues owed to the United States and Indian lessors and those inuring to the benefit of States . . . ."¹⁴ The Act charged the Secretary of the Interior ("Secretary") with the establishment of "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."¹⁵ More specifically as to audits, the Act requires the Secretary to "audit and reconcile, to the extent practicable, all current and past lease accounts for leases of oil or gas and take appropriate actions to make additional collections or refunds as warranted."¹⁶

The Secretary has delegated his duties regarding the administration of the federal and Indian oil and gas royalty program, including his audit and reconciliation duties, to the MMS.¹⁷ Within the MMS, the various offices of the Compliance and Asset Management Program ("CAM") within the Minerals Revenue Management division ("MRM")¹⁸ are responsible for enforcement of the laws, regulations, and lease terms requiring the accurate

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calculation and payment of royalties.¹⁹ CAM is divided into four sections: Onshore Oil and Gas, Offshore Oil and Gas, Indian Oil and Gas, and Solids and Geothermal.²⁰ Additionally, FOGRMA empowered the Secretary to enter into cooperative agreements with states and Indian tribes allowing them to carry out royalty audits under the Act,²¹ and he has done so. (In this paper, unless otherwise stated, the terms "auditor" and "auditors" will be used interchangeably to describe MMS auditors within CAM's sections, state auditors conducting audits of federal royalties for lands within their states borders under delegated audit authority, and tribal auditors.)

For those who may be new to the oil and gas royalty arena, a brief word about royalties and royalty determinations may be in order before proceeding with the details of the MMS's oil and gas royalty process. "A royalty is a share of production [(royalty-in-kind)], or the value or proceeds of production [(royalty-in-value)], free of costs of production, when and if there is oil and gas production on . . . [a] property."²² In the case of federal properties, "[r]oyalties . . . are distributed to other . . . Interior bureaus, the Department of the Treasury, and other federal agencies. Additionally, state governments receive a portion of royalties from minerals produced within their state borders."²³ In the case of Indian properties, "[r]oyalties . . . are distributed to the applicable tribal governments or individual Indian owners."²⁴

In recent years, the MMS has taken an increasing amount of its royalties in-kind, but it still continues to take a significant portion of its royalties in value.²⁵...