January 01, 2016

The Office of Natural Resources Revenue: There’s a New Sheriff in Town!

Kathleen C. Schroder and Peter J. Schaumberg

Since the minerals revenue management functions of the Department of the Interior were relocated to the Office of Natural Resources Revenue (ONRR) in 2010, federal and Indian oil and gas lessees have endured a dramatic increase in enforcement actions relating to their royalty reporting and payment obligations. Press releases published by ONRR reveal that, over the last five years, the agency has sought to assess oil and gas companies at least $37 million in civil penalties, an amount that far exceeds the civil penalties assessed prior to 2010.

This article examines the shift in ONRR’s enforcement of reporting and payment obligations of federal and Indian oil and gas lessees through civil penalty assessments, including the possible reasons for ONRR’s stepped-up enforcement efforts. We also review the recent statutory and regulatory interpretations that ONRR is relying upon to dramatically increase its assessment of civil penalties. What is not yet known is whether this new enforcement landscape will diminish future interest in leasing and development of federal and Indian oil and gas resources.

At the outset, we note that few details are known about ONRR’s justifications for its recently assessed civil penalties. The ONRR does not publish the notices of civil penalty that are issued to companies and only announces their assessments in news releases or cryptic descriptions on their website at www.onrr.gov/About/NewsReleases.htm. Similarly, administrative appeal filings are not readily available, and only a handful of civil penalties have been the subject of published administrative decisions. However, some observable common threads in the civil penalties illuminate the bases for the agency’s aggressive new enforcement policy.

The ONRR’s increased enforcement reflects the convergence of several factors: an emphasis by the agency to improve its management systems, a secretarial directive to demand more stringent accounting from oil and gas companies, and a series of reports scrutinizing the government’s ability to ensure accurate payment and reporting of federal and Indian lease royalty revenues.

ONRR collected over $13 billion in federal and Indian lease revenues in fiscal year 2014 and is the second-largest revenue collector for the U.S. government after the Treasury Department. Before 2010, the Minerals Management Service (MMS) handled the collection of royalties for production of oil and natural gas and other minerals from federal and Indian leases. In 2007, a subcommittee of the Royalty Policy Committee, which provides advice to the secretary of the interior on royalty management issues, released a report identifying more than 100 recommendations related to MMS’s royalty management. Many of these recommendations related to MMS’s own internal procedures and processes to improve its royalty management. MMS began implementing these recommendations shortly after the report was released. MMS, and then ONRR, have expanded the audit program and undertaken significant data mining efforts aimed at early detection of missing or inaccurate production and royalty reports and payments.

In 2008, a scandal rocked MMS after the Department of the Interior’s inspector general released a report identifying a series of improprieties between MMS employees and oil and gas company representatives relating to the Royalty-in-Kind Program. When Secretary Ken Salazar took office the following year, he vowed to reform the agency. The reorganization of MMS following the Deepwater Horizon incident in 2010 provided the opportunity to assign the minerals revenue management function to the newly created ONRR for both offshore and onshore leases.

Secretary Salazar’s declaration of a “new sheriff in town” came amid the release of a series of reports by the U.S. Government Accountability Office (GAO) criticizing MMS’s ability to ensure the accurate collection of oil and gas royalties. GAO found that MMS, and later ONRR, lacked reasonable assurance that they were properly collecting the United States’ and Indian lessors’ share of oil and gas royalty because the agencies lacked adequate management systems and sufficient internal controls to verify the accuracy and completeness of royalty payments. In particular, GAO observed that companies often did not timely file production and royalty reports and that MMS could not quickly detect these and other deficiencies. These reports culminated in GAO’s inclusion of Interior’s management of federal oil and gas resources on its 2011 list of “high-risk” areas within the U.S. government “due to their greater vulnerabilities to fraud, waste, abuse, and mismanagement or the need for transformation to address economic, efficiency, or effectiveness challenges.” GAO, High-Risk Series: An Update, No. GAO-11-278 (2011).

The secretary’s emphasis on enforcement, GAO’s criticisms of MMS’s ability to ensure accurate reporting and payment, and ONRR’s internal efforts to improve its own management systems catalyzed ONRR to pursue payment and reporting violations aggressively. As ONRR improves its own management systems, it can more quickly identify when companies have failed to file required reports or have submitted reports with erroneous information.

ONRR’s enforcement philosophy is captured by the agency’s strategic outcomes, as identified by its director. First, ONRR seeks to collect “every dollar due” from companies and ensure timely compliance with laws, regulations, and lease terms. Second, ONRR aims to disburse and distribute accurate data to recipients of federal and Indian lease royalties. Finally, ONRR seeks to restore its “credibility with the public.” Statement of Gregory J. Gould, Director, ONRR, before the Committee on Appropriations, Subcommittee on Interior, Environment and Related Agencies, House of Representatives (Mar. 17, 2011). In ONRR’s view, increased assessment of substantial civil penalties furthers these outcomes.

ONRR’s Emphasis on Enforcement and Increased Civil Penalties

ONRR’s emphasis on enforcement is most evident in its increased assessment of civil penalties for “knowing or willful” violations under the Federal Oil and Gas Royalty Management Act of 1982 (FOGRMA). In FOGRMA, Congress directed Interior to improve its “archaic and inadequate” accounting methods and develop enforcement practices to ensure “the prompt and proper” collection of royalty. 30 U.S.C. § 1701(a)(1), (b)(3). To enable the agency to enforce royalty reporting and payment obligations, Congress established a tiered system of civil penalties, with the amount of penalties escalating with the severity of violations. FOGRMA allows ONRR to impose the highest civil penalties for limited types of “knowing or willful” conduct amounting to physical or paper theft of oil and gas. Criminal penalties also may be sought for these same, most egregious violations.

At one end of the spectrum, subsections (a) and (b) of 30 U.S.C. § 1719 authorize ONRR to impose civil penalties ranging between $500 and $5,000 per day for any violation of FOGRMA, the mineral leasing laws, or lease terms or regulations, including the obligation to report and pay federal royalties correctly. However, ONRR may not assess such penalties until it has first provided the lessee formal notice and the opportunity to cure the violation. Id. § 1719(b). Second, subsection (c) of 30 U.S.C. § 1719 allows ONRR to assess civil penalties of up to $10,000 per day per violation to anyone who “knowingly or willfully” fails to pay royalties at all or fails to permit an inspection or audit. Id. § 1719(c)(1) and (2). Finally, for a limited set of the most egregious violations, subsection (d) of 30 U.S.C. § 1719 authorizes ONRR to assess civil penalties of up to $25,000 per day per violation to anyone who “knowingly or willfully prepares, maintains, or submits false, inaccurate, or misleading reports, notices, affidavits, records, or data to the agency,” or who steals oil or gas. Id. § 1719(d)(1) and (2). In addition to these civil penalties, FOGRMA authorizes criminal fines of not more than $50,000 or imprisonment for not more than two years, or both, for anyone who is subject to the most significant civil penalty under § 1719(d). Id. § 1720. ONRR need not provide notice or an opportunity to cure “knowing or willful” violations before assessing penalties. FOGRMA also prescribes that no civil penalty may be assessed before the lessee has an opportunity for a hearing on the record. Id. § 1719(e).

Before 2010, MMS/ONRR assessed very few knowing or willful civil penalties. That has changed. Of the forty-six civil penalties ONRR has announced since 2010, seventeen (37 percent) were for alleged “knowing or willful” violations. These seventeen penalties totaled $23.5 million—nearly two-thirds of the total penalties assessed since 2010.

Although the sheer size of civil penalties should not be ignored, ONRR’s reasons for imposing them warrant more attention. ONRR’s newly crafted interpretations of the terms in 30 U.S.C. § 1719(d)(1) signal a shift in the agency’s decades-old interpretations of FOGRMA and reflect that the agency will not tolerate what it views as repeated or passive reporting mistakes.

ONRR’s Expansion of “Knowing or Willful”

ONRR’s increased assessment of knowing or willful civil penalties reflects the agency’s reinterpretation of FOGRMA’s hierarchical statutory scheme. Subsections (a) and (b) of 30 U.S.C. § 1719 give ONRR the authority to pursue the broadest possible range of penalties, but because the agency first must provide the lessee notice and an opportunity to correct the violation, penalties often are never assessed. Therefore, by broadening the scope of knowing or willful civil penalties under subsections (c) and (d) of 30 U.S.C. § 1719 that begin to accrue on the date of the violation without prior notice, ONRR has created more circumstances in which substantial civil penalties may be assessed.

ONRR’s enhanced effort to pursue knowing or willful civil penalties is founded on recent interpretations of FOGRMA that the agency had never pursued during the first thirty years following the statute’s enactment. ONRR’s existing regulations implementing FOGRMA do not define “knowing or willful,” and little judicial and administrative guidance exists on how this language should be applied in FOGRMA enforcement actions. Informally, ONRR has recently stated that it has interpreted “knowing or willful” in its recent enforcement actions as actual knowledge, reckless disregard, or deliberate ignorance of the truth or falsity of information. ONRR, Enforcement Operations Overview (Feb. 6, 2013), available at www.onrr.gov/compliance/PDFDocs/Enforcement_Operations_Overview.pdf. Furthermore, ONRR has suggested that it will apply a standard of “known or should have known” to establish knowing or willful violations. For example, ONRR has informally stated that the submission of contradictory documents can demonstrate a knowing or willful violation. Id. Indeed, press releases suggest that ONRR has assessed knowing or willful civil penalties to companies when, after an audit identifies errors, they continue to submit reports with the same errors, even if the erroneous reports may have been attributable to automated systems.

In May 2014, ONRR proposed to amend its civil penalty regulations at 30 C.F.R. part 1241 to codify its new interpretations of FOGRMA that ONRR had applied in recent civil penalty assessments. See 79 Fed. Reg. 28,862, 28,865 (May 20, 2014). Among the proposed revisions, ONRR would define the term “knowing or willful” for the first time. ONRR is proposing to lower the mental state necessary to establish a knowing or willful violation beyond reckless disregard or deliberate ignorance, to now include acting with “gross negligence.” Id. at 28,873. ONRR reasoned that this standard is “appropriate given Congressional intent in FOGRMA to establish a robust enforcement system and to ensure the integrity of the royalty accounting system.” Id. at 28,863.

This standard, however, arguably departs from Congress’ stated intent behind the coverage of subsection (d) of 30 U.S.C. § 1719. Although Congress sought to establish a robust enforcement system, Congress distinguished between violations that require large civil penalties and those with lesser liability. FOGRMA’s authors reasoned that “a balance must be struck between the need to deter violations of the Act and the need to avoid a situation in which exposure to very severe penalty liability for relatively minor or inadvertent violations of necessarily complex regulations becomes a major disincentive to produce oil or gas from lease sites on federal or Indian lands.” S. Rep. No. 97-512, at 17 (1982). Congress also indicated that knowing or willful violations are “usually considered to be acts for which criminal sanctions are warranted.” H. Rep. No. 97-859, at 34–35 (1982).

When presented with alleged knowing or willful violations, the Interior Board of Land Appeals (IBLA), an administrative appeals board within the department’s Office of Hearings and Appeals, similarly has applied a higher threshold. See, e.g., Marathon Oil Co. v. Minerals Management Service, 106 IBLA 104 (1989) (construing knowing or willful as used in 30 U.S.C. § 1719(c) to mean that the actor “knew or showed reckless disregard” for whether its conduct was prohibited); Meridian Oil, Inc., 147 IBLA 211 (1999) (company’s knowledge that conduct is regulated does not necessarily cause an action at odds with those regulations to be willfully committed); Cabot Oil & Gas Corp. v. Office of Natural Res. Revenue, No. CP-11-016 (June 5, 2015) (addressing the mens rea standard for knowing or willful behavior under 30 U.S.C. § 1719(d)(1)). The board may soon face this issue again in one or more pending appeals.

Perhaps even more significant to companies paying federal and Indian royalties, under ONRR’s proposed definition of knowing or willful, ONRR will impose liability on a company “even if the managers, principals, or owners may not have actual knowledge of specific prohibited acts their agents or employees commit.” 79 Fed. Reg., supra, at 28,873. Although federal court case law is mixed on the issue of whether knowledge of lower-level employees can be imputed to the company, Department of the Interior decisions suggest that a lower-level employee’s actions may not always be attributed to the company and that the issue depends on a fact-specific determination. See Marathon Oil, 106 IBLA at 104; Cabot, No. CP-11-016 at 17.

The recent penalties ONRR assessed, together with ONRR’s proposed amendments to its civil penalty regulations, reflect that the agency is seeking to lower the mental state necessary for a knowing or willful violation. This significant change, when coupled with ONRR’s new interpretations of “submission” and “maintenance,” has wide-reaching consequences. 

ONRR’s Recent Interpretations of “Submission” and “Maintenance” of False or Inaccurate Records

The burden on oil and gas companies to avoid knowing or willful penalties is further heightened when ONRR’s new definition of knowing or willful is applied together with the agency’s interpretations of other FOGRMA terms. ONRR’s civil penalties imposed in recent years reflect that the agency is seeking to impose knowing or willful penalties for repeated reporting errors, regardless of whether they occurred through active or passive conduct by companies, or even at the same leases. Based on available information, most of the knowing or willful penalties appear to have been assessed for two general types of alleged violations. First, penalties were assessed for the alleged knowing or willful “submission” of false information to ONRR under 30 U.S.C. § 1719(d). In those cases, after an order or audit identified errors, companies allegedly continued to file reports with the ONRR that contained the same or “similar” errors. Second, penalties were assessed for the alleged “maintenance” of false information. In these cases, the agency advised the companies that reports previously filed with ONRR contained errors, but the companies did not timely correct the errors.

In its recently proposed regulations, ONRR would define the “submission of false, inaccurate, or misleading information” as when “you provide information to an ONRR data system, or otherwise to us for our official records, and you knew, or should have known, the information that you provided was false, inaccurate, or misleading at the time you provided the information.” Id. at 28,874. Thus, submission of false records requires action by a company. In contrast, ONRR proposed to define the “maintenance of false, inaccurate, or misleading information” as when “you provided information to an ONRR data system, or otherwise to us for our official records, and you later learn the information you provided to us was false, inaccurate, or misleading, and you do not correct that information or other information you provided to us that you know contains the same false, inaccurate, or misleading information.” Id. at 28,873. The latter definition thus creates the risk of a knowing or willful civil penalty for a company’s passive failure to correct reports it previously filed with ONRR. To be clear, the civil penalty in this circumstance is not based on the lessee’s originally filed royalty report, but the lessee’s failure to correct the allegedly incorrect report purportedly maintained on ONRR’s database.

Oil and gas companies and trade associations strenuously opposed ONRR’s proposed definition of maintenance. In comments filed on the proposed rule, they explained that FOGRMA’s provision penalizing maintenance of false or inaccurate records arguably contemplates only a company’s internal retention of intentionally falsified records in the company’s custody and not records in ONRR’s custody. In other words, FOGRMA only penalizes a company for intentionally fabricating or falsifying records. Consistent with this view of the statute, FOGRMA’s recordkeeping requirements contemplate that companies must maintain records for audit by ONRR by keeping records in their custody. 30 U.S.C. § 1713(b). Under the commenters’ reasoning, FOGRMA was not intended to penalize a company’s passive failure to correct reports previously filed with ONRR under the knowing or willful provision of the statute. Rather, these types of violations were intended to be covered only by the nonknowing or willful penalty provisions in subsections (a) and (b) of 30 U.S.C. § 1719 where, following formal notice from the agency that reports are erroneous, the lessee fails to correct them despite the risk of substantial civil penalties of $500 to $5,000 per day per violation. Otherwise, ONRR could turn every situation where it notifies a lessee of an erroneous report into a knowing or willful penalty, and never again use subsections (a) and (b) of 30 U.S.C. § 1719.

At the time of this writing, ONRR has not published final revisions to its civil penalty regulations. Yet, these issues are currently being contested at the administrative appeal level. In particular, a recent IBLA decision on an interlocutory appeal may embolden ONRR in its proposed definition of “maintenance.” In Statoil USA E&P, Inc. v. Office of Natural Res. Revenue, 185 IBLA 302 (2015), the appellant received an order to correct previously filed royalty reports but allegedly did not do so within the required timeframe. ONRR issued a notice of civil penalty, but never sought civil penalties under 30 U.S.C. § 1719(a) and (b) despite conceding they are readily applicable. Rather, ONRR defaulted to subsection (d) of 30 U.S.C. § 1719, alleging that by failing to correct the reports, the appellant knowingly or willfully maintained incorrect information in ONRR’s database. On appeal, the appellant argued that FOGRMA’s provision for civil penalties for maintaining inaccurate records was intended to penalize lessees who falsified records within their custody with the intention of misleading ONRR—not to penalize a company’s failure, after notice, to correct inadvertent errors in records on file with the ONRR. The IBLA disagreed on this threshold legal issue. The case is now on interlocutory appeal before the director of the Office of Hearings and Appeals.

The ONRR’s proposed definition of maintenance, when combined with its interpretation of knowing and willful, may create significant liability for operators that fail to reexamine records previously filed with ONRR, even if those leases have never been the subject of an ONRR inquiry. The ONRR’s interpretation of submission and maintenance, together with its proposed definition of knowing or willful, essentially charges oil and gas operators with constructive knowledge of all like reporting errors after one such error has been identified and obligates operators to detect and correct such errors promptly. 

What Does the Recent Enforcement Shift Mean for Oil and Gas Operators and Other Agencies?

The slew of civil penalties ONRR has assessed since 2010, coupled with ONRR’s statements in the preamble to its proposed amendments to the civil penalty regulations, reflect that ONRR holds accurate payment of royalties and reporting of production as its highest priority and, further, that ONRR has little tolerance for errors by oil and gas companies. Indeed, ONRR has justified its aggressive approach as a means to “incentivize corporations and other persons to take all necessary steps to ensure that their employees and agents are not engaging in prohibited acts.” 79 Fed. Reg., supra, at 28,864. However, ONRR’s approach raises a policy question of whether it quells a necessary dialogue with operators. Because royalty reporting is complex, with few clear answers or bright lines, operators may need the assistance and cooperation of the government rather than the threat of a heavy hammer.

ONRR has also made clear that civil penalties may be warranted even for those errors that have no royalty consequence to the United States or Indian lessor—in other words, revenue neutral or net zero errors that do not result in underpayments of royalty. In ONRR’s view, accurate reporting is just as essential as proper payment of royalties because the agency needs to be able to audit and detect incorrect royalty payments.

Arguably, however, ONRR’s standard of perfect reporting—particularly when there are no royalty consequences—may be the exacting management that Congress sought to avoid when enacting FOGRMA. Congress expressly intended not to create such onerous compliance standards that “exposure to very severe penalty liability for relatively minor or inadvertent violations of necessarily complex regulations becomes a major disincentive to produce oil or gas from lease sites on federal or Indian lands.” S. Rep. No. 97-512, supra, at 17. The fact that Congress equipped ONRR with the authority to impose lesser penalties and assessments for mistaken and even repeated errors suggests that knowing or willful civil penalties should be unusual, not the norm for reporting errors. 30 U.S.C. §§ 1719(a), 1725. Ultimately, challenges to civil penalties may put the legal question of whether ONRR’s aggressive enforcement actions are consistent with its statutory authority in the hands of the federal courts.

Although FOGRMA principally addresses reporting and payment of federal and Indian lease royalties, FOGRMA also obligates companies to keep records relating to the production, transportation, and sale of oil and natural gas from federal onshore and offshore leases and Indian leases. As a result, the Bureau of Land Management (BLM), the Bureau of Safety and Environmental Enforcement (BSEE), and the Bureau of Ocean Energy Management (BOEM) may impose penalties for failure to comply with these obligations. 30 U.S.C. §§ 1713, 1719(a); 43 C.F.R. §§ 3162.4 (2014); 30 C.F.R. §§ 250.1450 et seq. and 550.1450 et seq. Like the ONRR, BLM, BSEE, and BOEM may attempt to impose heightened civil penalties and criminal penalties for the knowing or willful preparation, maintenance, or submission of false, inaccurate, or misleading reports, notices, affidavits, records, data, or other written information to these agencies. Id. §§ 1719(c), (d), 1720. FOGRMA’s application to onshore and offshore production records creates a question of whether BLM, BSEE, or BOEM could adopt ONRR’s expansive interpretation of its statutory authority. For instance, in recently proposed revisions to Onshore Order No. 3, BLM proposes to increase the recordkeeping obligations associated with the production, transport, purchase, sale, or measurement of federal oil and natural gas. See 80 Fed. Reg. 40,768, 40,804 (July 13, 2015). Accordingly, there is a potential that BLM could increase its recordkeeping enforcement efforts, perhaps in line with ONRR or perhaps not. 

Watch Out for the New Sheriff!

ONRR has been under increasing pressure to ensure that production from federal and Indian oil and gas leases is properly reported and that royalties from such production are properly paid. The substantial civil penalties ONRR has assessed in recent years, together with ONRR’s proposed amendments to its civil penalty regulations, signal the agency’s aggressive interpretation of its statutory authority to enforce oil and gas companies’ obligations to report and pay royalties properly. For companies with hundreds or thousands of producing federal and Indian oil and gas leases, the administrative burden can be overwhelming. But the legal issues are still unsettled. Ultimately, the limits of ONRR’s knowing and willful civil penalty authority under FOGRMA will be resolved as appeals of civil penalties are reviewed by the Department of the Interior and the federal courts.

Kathleen C. Schroder and Peter J. Schaumberg

Ms. Schroder is a shareholder at Bjork Lindley Little LC in Denver, Colorado, and may be reached at kschroder@bjorklindley.com. Mr. Schaumberg is a principal at Beveridge & Diamond PC in Washington, D.C., and may be reached at pschaumberg@bdlaw.com. The authors are grateful for the valuable input and insights of James M. Auslander at Beveridge & Diamond PC.