Fraudulent Oil and Gas Royalties

United States of America ex. rel. Johnson v. Shell Oil Company, et al

Using the qui tam provision of the False Claims Act, a group of whistleblowers revealed a nationwide conspiracy by more than a dozen oil and gas companies to systematically defraud the government by underpaying leasing royalties.

When oil and gas companies lease federal or Indian-owned lands, they are required to pay a fee, known as a royalty, to the federal government. Companies are required to report the market value of the oil they extract and to pay the royalty based on a percentage of that market value. Funds collected from royalty payments are given to Native American tribes, educational and environmental funds, and national parks. However, in the 1980s and 1990s, Native American tribes, government whistleblowers, and several industry insiders began to suspect that companies were systematically underpaying their royalties, a type of fraud that could potentially violate the False Claims Act.

The False Claims Act is a critically important whistleblower law which regulates fraud in connection with those receiving compensation or other benefits from the government. Created by Abraham Lincoln, the law was originally applied to cases in which a contractor defrauded the government by submitting bills to the government for poorly performed or nonexistent work. However, the False Claims Act also applies to instances in which entities prevent the government from collecting what taxes or fees that is owed, a concept referred to as reverse false claims.

The False Claims Act contains a powerful whistleblower provision, known as qui tam, which allows any individual or non-governmental organization with knowledge of fraud against federal programs or contracts to file a lawsuit in U.S. District Courts on behalf of the United States. In qui tam actions, the government has the right to intervene and join the action. If the government declines, the relator may also proceed on their own. Whistleblowers who provide original information that results in a successful prosecution are awarded a mandatory reward of between 15% and 30% of the collected proceeds. These rewards are often substantial, since under the False Claims Act, the criminal activity is liable for a civil penalty as well as treble damages.

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United States of America ex. rel. Johnson v. Shell Oil Company, et al.

Before 1996, no one had ever used the False Claims Act to address oil and gas royalties. However, a qui tam filed by two industry whistleblowers set a new precedent that the False Claims Act as a powerful tool for holding oil and gas companies accountable.

Prior to blowing the whistle on the oil and gas industry, the two primary relators, J. Benjamin Johnson Jr., a petroleum engineer, and John M. Martineck, an accountant, were employed as crude oil marketing specialists at Atlantic Richfield Company (ARCO). Their daily communication and negotiation with representatives of other companies allowed them to observe how the industry calculated royalty payments to private parties and the government.

Royalty payments are required to be paid as a set percentage of the true fair market value of the oil, equivalent to the price companies can charge for the oil at the time. What Johnson and Martineck uncovered was a scheme by which major companies were creating an artificially low price by selling equal amounts of oil to affiliated entities, such as parent or subsidiary companies, and charging one another low prices. These swap prices were recorded as the first “sale” to determine the market price. By claiming these artificial prices as the value of the oil, the companies were able to pay royalties on a substantially smaller value.

Johnson and Martineck left ARCO to form a consulting firm, Summit Resources, where they used their expertise to help oil producers and royalty owners recover the full value of their oil. As consultants, Johnson and Martineck reviewed thousands of confidential royalty payments for their clients, giving them unique access to information on royalty payments. In this position, the two found that the underpayment of royalties was “systematic and widespread but also extremely well disguised.”

Because many of the contracts they analyzed involved portions of federal land, they realized that the largest victim of royalty underpayment was the federal government. After failing to draw sufficient attention to their concerns in meetings with the Mineral Management Service, the agency previously responsible for overseeing royalty payments, they turned to the False Claims Act.

In 1996, Johnson and Martineck filed a False Claims qui tam case in the U.S. District Court for the Eastern District of Texas. The two whistleblowers alleged that 18 major oil companies, including Shell, Exxon, and BP, were involved in a “nationwide conspiracy” to defraud the federal government by underpaying royalties on 27 million acres of federal and Indian land in 21 states.

A year and a half later, a non-government organization representing government whistleblowers, the Project on Government Oversight (POGO), filed a similar qui tam case. For four years prior, the organization had been investigating and reporting on royalty underpayment schemes and a lack of oversight by the Mineral Management Service, and they had identified a similar pattern of fraud.

A third case was also filed by another oil and gas industry whistleblower, Harold Wright, a private royalty owner and the former chairman of the Natural Gas Supply Association. Wright had become suspicious after overhearing an oil executive claiming royalty owners had no idea what they were receiving. After investigating the underpayment of his own private royalties, he was able to use his knowledge of the industry to uncover a series of additional underpayment schemes employed by the defendants to underpay federal royalties.

The three parties agreed to consolidate the suits into one suit and, in 1998, the Justice Department also joined the suit, which became United States of America ex. rel. Johnson v. Shell Oil Company, et al. After attempting without success to dismiss the cases, fifteen of the companies ultimately settled for nearly half a billion dollars. As whistleblowers whose original information led to a successful prosecution, Johnson and Martineck received $30 million. The Project on Government Oversight received $1.2 million from Exxon Mobil’s settlement, which was shared with two government whistleblowers. Although Wright passed away before the cases were settled, his heirs ultimately received more than $15 million from his role in the settlements.

Key Takeaways

Johnson v. Shell established the False Claims Act as a powerful method for whistleblowers to hold oil and gas companies accountable for defrauding the government. By revealing both a widespread pattern of fraud and a tool to report it, this initial case helped to set off a cascade of similar suits against companies from state government and private royalty owners. By 2002, the settlements from these suits had reached more $10 billion.

Whistleblower suits under the False Claims Act have continued to play a powerful role in identifying fraud in oil and gas royalties. For example, Kerr-McGee and its parent company, Anadarko Petroleum, paid $26 million to settle allegations that it had engaged in a similar swapping scheme to underpay royalties owed from oil lease in the Gulf of Mexico. The whistleblower, Bobby Maxwell, a former auditor in the Interior Department, was awarded $7.5 million for his role in the case.

These cases illustrate the necessity of whistleblowers and strong whistleblower reward laws in identifying widespread fraud. Through their unique knowledge of the industry, the whistleblowers in Johnson v. Shell were able to confirm long-held suspicions about royalty underpayments by providing detailed knowledge of the elaborate scheme that companies were using to defraud the government. Today, journalists and regulators continue to probe other long-time suspicions about potential fraud in the industry, asking difficult questions about how oil and gas companies estimate oil and gas reserves or disclose climate risks, but many questions remain – that perhaps only a whistleblower can answer. The impact of whistleblowers in the Johnson v. Shell suggests that, where widespread fraud is suspected but difficult to detect, industry insiders with knowledge of fraud could play a transformative role.

To learn about the False Claims Act in more depth, read The New Whistleblower’s Handbook, the first-ever guide to whistleblowing, by the nation’s leading whistleblower attorney. The Handbook is a step-by-step guide to the essential tools for successfully blowing the whistle, qualifying for financial rewards, and protecting yourself.  

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