Auditing the Auditors

Did a major energy company manipulate prices to get out of paying royalties to the Treasury Department when it pumped oil and gas from federal land? That's a question jurors are being asked to decide in a Denver courtroom right now. Bobby L. Maxwell, a former auditor with the Interior Department's Minerals Management Service, is suing energy giant Kerr-McGee Corp., saying the company bilked the federal government by selling oil pumped from the Gulf of Mexico between 1997 and 2002 at below-market prices to another company that absorbed marketing costs in exchange for the deal.

But the trial, which began Jan. 16, is unquestionably about more than the actions of one oil company in the highly inscrutable world of energy pricing. The Minerals Management Service, the Interior Department agency responsible for collecting a share of minerals produced on federal or tribal lands either as a portion of the product or its cash equivalent, is on trial, too, if only by inference.

Maxwell was a well-regarded supervisory auditor at MMS with a track record of recovering unpaid royalties. But when his analysis of Kerr-McGee's operations showed it had underpaid royalties of at least $50 million, he says he was prohibited by senior agency executives from going after the company, according to court papers filed in the case. So, in June 2004 Maxwell filed a lawsuit against the company under the Federal Civil False Claims Act, a Civil War-era law that allows private citizens acting on behalf of the government to sue contractors they believe have defrauded the government. After the suit became public in January 2005, MMS reorganized its audit operations and eliminated Maxwell's job. Maxwell then sued MMS for firing him in retaliation for going after Kerr-McGee on his own. That suit was settled out of court for an undisclosed sum, and Maxwell retired to Hawaii.

Kerr-McGee, bought by Anadarko Petroleum Corp. in 2006, denies any wrongdoing, and the Justice Department declined to join Maxwell's suit against the company. But if Maxwell prevails, as some industry watchers expect, both he and the government stand to gain millions (under the False Claims Act plaintiffs receive a percentage of any penalties collected), while MMS will suffer yet another blow to its reputation. Earlier this year, auditors in the Government Accountability Office and Interior's Office of the Inspector General found that officials at MMS and Interior, largely through ineptitude, failed to establish price thresholds for leases approved in 1998 and 1999, thus allowing companies to produce oil and gas under those leases without paying any royalties at a time when energy prices were at record highs.

The threshold requirement was developed in the 1990s, when prices were significantly lower, and was intended to create an incentive for companies to produce oil and gas in deep water, which is especially expensive and risky. Companies pay royalties only after oil prices reach a certain threshold, which would ensure profitability. But the leases from 1998 and 1999 contained no such thresholds; investigators estimate at least $2 billion has been lost in unrealized royalties as a result of the bollixed leases, and another $8 billion could be lost over the life of the remaining leases if they are not renegotiated.

While Interior's inspector general, Earl E. Devaney, continues to investigate the lease fiasco, in December he issued a report highlighting shortcomings with the agency's compliance review process, the method by which MMS evaluates the reasonableness of company-reported royalties. Auditors in Devaney's office found that MMS relied on incomplete and inaccurate data to conduct reviews, and that the agency overstated royalty collections it attributed to the program. For example, MMS cited $134 million in qui tam settlements (money recovered when private citizens initiated claims on behalf of the government under the False Claims Act), even though it collected that money inadvertently and not through any actions taken by the agency. Qui tam settlements represented 19 percent of the total collections MMS reported.

While compliance reviews generally are viewed as an asset to the auditing process, they are not an effective substitute for conventional audits that meet government standards, the IG reported. Unlike audits, compliance reviews do not require auditors to obtain and review company source records, systems or internal controls, or produce formal reports. MMS initiated the compliance review process in the late 1990s in part as a cost-saving measure.

Concurrent with introducing and using the compliance review process, MMS cut the number of agency auditors as well as state and tribal auditors it funded. Between 2000 and 2006, the number of MMS auditors fell from 169 to 134, or nearly 21 percent; state and tribal auditors decreased from 118 to 108, a cut of 8.5 percent. The total was reduced by more than 15 percent over that period, the IG found.

Audit output also fell about 22 percent between 2000 and 2005, although the IG noted that errors in MMS data made it impossible to compare audit initiation data on an annual basis.

In late December, MMS Director Johnnie Burton submitted to the IG a plan to strengthen compliance operations. Improving compliance is a top priority for agency executives, Burton told Devaney in a Dec. 28 letter accompanying the plan. "Each improvement action has a target completion date and a designated MMS official with implementation responsibility. We are confident this action plan will fully and effectively implement the OIG recommendations," Burton said.

Burton defended MMS' continued practice of counting qui tam settlement amounts in its compliance tracking system, however: "Most qui tam cases are the outgrowth of information developed by historical audits or compliance reviews of mineral lessees. Moreover, for qui tam cases that evolve to settlement stage, MMS, states and tribes perform significant work, typically over long periods of time, to determine and negotiate settlement amounts."

The pressure on MMS isn't likely to abate soon. As the Maxwell suit unfolds in Denver, Congress is planning hearings in Washington on royalty collection problems. Meanwhile, Interior might blunt some of the criticism through self-reform. Last November, C. Stephen Allred, Interior's assistant secretary for land and minerals management, announced the formation of an independent panel to review and make recommendations on mineral revenue collection from federal and tribal lands. "A review of the procedures and processes surrounding management of mineral revenue at the Department of Interior is in order," Allred wrote to Daniel Riemer, chairman of the Royalty Policy Committee, an independent advisory board appointed by the Interior secretary to advise on mineral- related policies. The new panel will operate under the auspices of the committee, Allred said. Among other things, it will review audit, compliance and enforcement efforts at MMS, he said. The panel is to report its findings in late spring.