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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

) ) ) Plaintiff, ) ) ) ) v. ) ) THE UNITED STATES OF AMERICA, ) ) Defendant. ) __________________________________________)

THE OSAGE NATION AND/OR TRIBE OF INDIANS OF OKLAHOMA,

Electronically Filed January 12, 2006 Nos. 99-550 L & 00-169 L Judge Emily C. Hewitt

PLAINTIFF OSAGE NATION'S MEMORANDUM OF CONTENTIONS OF FACTS AND LAW

WILSON K. PIPESTEM Pipestem Law Firm, P.C. 1333 New Hampshire Avenue, N.W. Washington, D.C. 20036 Telephone: (202) 419-3526 Fax: (202) 659-4931 [email protected] Attorney for Plaintiff Osage Nation

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TABLE OF CONTENTS TABLE OF AUTHORITIES.............................................................................................................. STATEMENTS OF FACTS ............................................................................................................... I. BACKGROUND .................................................................................................................1 A. B. C. II. The Osage Tribe and Its Multiple Forced Relocations ............................................1 The 1906 Act............................................................................................................4 The Osage Agency ...................................................................................................7

THE OSAGE LEASES AND REGULATIONS..................................................................8 A. B. C. D. The Regulations and Form Leases Issued by the United States ..............................8 The Tranche One Leases..........................................................................................9 The Osage Regulations ..........................................................................................11 The Government Must Determine and Verify a Number of Variables Under the Royalty Formula ...................................................................................15

III.

THE GOVERNMENT'S GENERAL ADMINISTRATION OF ROYALTY COLLECTION AND VERIFICATION FOR FEDERAL AND INDIAN MINERALS LEASES .......................................................................................................16 A. B. C. Lack of Auditing ....................................................................................................17 Lack of Independent Verification of Production Volume ......................................19 Inadequate Staffing ................................................................................................20

IV.

THE OSAGE AGENCY'S ADMINISTRATION OF ROYALTY COLLECTION AND VERIFICATION ......................................................................................................20 A. B. C. General Systemic Flaws.........................................................................................20 Specific Flaws........................................................................................................22 Lack of Sufficient Records to Substantiate Royalty Collections...........................25

V.

THE OSAGE AGENCY'S MANAGEMENT OF FUNDS COLLECTED ......................27 A. B. The Process for Depositing Royalty Payments......................................................27 Investment of Osage Minerals Trust Funds ...........................................................28

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C. D. VI.

Distribution of Funds to Headright Owners...........................................................30 The Government's Mishandling of Trust Funds ....................................................30

THE GOVERNMENT'S ADMINISTRATION OF THE OSAGE MINERALS ESTATE HAS HARMED THE TRUST AND THE OSAGE NATION ...........................31 A. Harms Caused by the Government's Failure to Collect All Moneys Due Under the Tranche One Leases ..............................................................................32 1. Systemic Losses Due to Failure to Audit and Police .................................36 2. Penalties .....................................................................................................37 Harms Caused by the Government's Failure to Invest Trust Funds Efficiently and Prudently .......................................................................................37

B.

STATEMENT OF ISSUES OF FACT AND LAW ............................................................................ APPLICABLE LEGAL PRINCIPLES.............................................................................................. I. AS TRUSTEE OF THE OSAGE MINERAL ESTATE, THE UNITED STATES OWES THE OSAGE NATION THE HIGHEST FIDUCIARY DUTY ............................45 A. The United States' General Trust Duties Toward Dependent Indian Nations Impose a Heightened Standard of Care for Specific Statutory Trust Duties............................................................................................................45 Any Ambiguities in Statutes or Regulations Meant to Benefit Indian Tribes Must Be Construed in the Indians' Favor ..............................................................47 The United States Must Administer the Osage Trust Without Regard to the United States' Own Interests, Irrespective of the United States' Own Convenience, and at the United States' Own Expense ..........................................48 In the Absence of a Proper Accounting, the United States as Trustee Bears the Burden of Proving That It Has Properly Discharged Its Duties, and All Doubts Must Be Resolved Against the Trustee......................................................49

B. C.

D.

II.

CLAIM 1: THE UNITED STATES BREACHED ITS DUTY TO COLLECT "ALL MONEYS DUE" UNDER THE TRANCHE ONE LEASES .................................50 A. The United States Had a Duty to Collect "All Moneys Due" Under The Tranche One Leases ...............................................................................................51 1. 2. 3. The United States Was Required to Determine Accurately the Volumes of Oil Subject to Royalty ............................................................52 The United States Was Required to Calculate Royalties Correctly ...........53 The United States Was Required to Collect Late Fees Owed Under the Tranche One Leases .............................................................................55

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4. B.

The United States Had a Duty to Keep Clear, Detailed, and Accurate Accounts Showing What Moneys Were Due and What Moneys Were Collected .............................................................................55 The United States Committed Multiple Breaches of its Duty to Collect "All Moneys Due" Under the Osage Leases..........................................................56 1. 2. 3. 4. 5. 6. 7. 8. 9. The United States Breached Its Duty to Collect All Moneys Due by Failing Accurately to Determine Volumes of Oil Subject to Royalty........56 The United States Breached Its Duty to Collect All Moneys Due by Failing to Ensure the Accuracy of Sales Prices Used to Calculate Royalties ....................................................................................................57 The United States Breached Its Duty to Collect All Moneys Due by Failing Accurately to Determine Major Purchasers and Their Posted Prices ..............................................................................................59 The United States Breached Its Duty to Collect All Moneys Due by Failing to Include in Royalty Calculations the Highest Prices Offered by Major Purchasers .....................................................................59 The United States Breached Its Duty to Collect All Moneys Due by Improperly Excluding from Consideration Prices Posted, Offered, or Paid in Excess of Price Caps Applicable in Regulated Markets............62 The United States Breached Its Duty to Collect All Moneys Due by Applying Gravity Adjustments to Posted Prices When Calculating Royalties ....................................................................................................67 The United States Breached Its Duty to Collect All Moneys Due by Failing to Take into Account Higher Prices Paid on the Same Lease........68 The United States Breached Its Duty to Collect All Moneys Due by Failing to Identify Underpayments Subject to Late Fees...........................69 The United States Has Breached Its Duty to Account for Trust Moneys.......................................................................................................69

III.

CLAIM 2: THE UNITED STATES HAS BREACHED ITS DUTY TO INVEST TRUST FUNDS PRUDENTLY ........................................................................................69 A. The United States Has a Duty to Manage Trust Funds Prudently .........................69 1. The United States Had a Duty to Deposit Trust Funds Within 24 Hours of Receipt ........................................................................................71 2. The United States Has a Duty to Obtain a Reasonable Return on Investments ................................................................................................72 3. The United States Has a Duty to Obtain Interest on Funds Awaiting Disbursement After Checks Are Cut..........................................................73 4. The Government Has a Fiduciary Duty to Pay Interest on Funds It Failed to Collect Due to Breach.................................................................75 The United States Has Committed Multiple Breaches of Its Duty to Invest Prudently ................................................................................................................76

B.

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1.

A.

The United States Breached Its Duty to Invest Trust Funds Prudently by Taking an Unreasonable Amount of Time to Deposit Trust Funds Into Interest-Bearing Accounts ..............................................76 2. The United States Breached Its Duty to Invest Trust Funds Prudently by Obtaining an Unreasonably Low Yield ................................77 3. The United States Breached Its Duty to Invest Trust Funds Prudently by Failing to Earn Any Interest on Trust Funds Awaiting Disbursal ....................................................................................................77 IV. DAMAGES................................................................................................78 Moneys Due Under the Tranche One Leases That Were Not Collected and Deposited in Trust Accounts ..................................................................................79 1. Royalties Not Collected or Accounted For ................................................79 2. Late Fees Not Assessed for Underpayment of Royalties...........................80 Interest that the United States Had a Duty to Earn But Did Not Earn...................80 1. 2. 3. 4. Interest Lost Due to Unreasonable Delays in Depositing Trust Funds..........................................................................................................80 Interest Lost Due to Mismanagement of Funds on Deposit ......................81 Interest That Could Have Been Earned on Funds Awaiting Disbursal ....................................................................................................81 Interest on Moneys Due Under the Leases That Were Not Collected ....................................................................................................81

B.

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TABLE OF AUTHORITIES FEDERAL CASES Agurs v. Amoco Prod. Co., 480 F. Supp. 737 (W.D. La. 1979)....................................66, 67 Albuquerque Indian Rights v. Lujan, 930 F.2d 49 (D.C. Cir. 1991) ............................47, 48 Amoco Prod. Co. v. United States, 17 Cl. Ct. 590 (1989)............................................55, 66 Bigelow v. RKO Radio Pictures, Inc., 327 U.S. 251 (1946) ........................................50, 81 Blackman v. Hustler Magazine, Inc., 800 F.2d 1160 (D.C. Cir. 1986) ..............................50 Brent v. Natural Gas Pipeline Co., 457 F. Supp. 155 (N.D. Tex. 1978), aff'd 626 F.2d 1261 (5th Cir. 1980) ............................................................................................64 California v. Southland Royalty Co., 436 U.S. 519 (1978) ...............................................64 Cheyenne-Arapaho Tribes of Indians v. United States, 512 F.2d 1390 (Ct. Cl. 1975) ..........................................................................................................71, 72, 73, 75 Cheyenne-Arapaho Tribes of Oklahoma v. United States, 33 Fed. Cl. 464 (1995) ...........71 Coast Indian Cmty. v. United States, 213 Ct. Cl. 129 (1977).............................................66 Cobell v. Norton, 240 F.3d 1081 (D.C. Cir. 2001) .................................................45, 48, 60 Confederated Tribes of the Warm Spring Reservation v. United States, 248 F.3d 1365 (Fed. Cir. 2001) .......................................................................................50, 79, 80 In re Consupak, 87 B.R. 529 (N.D. Ill. 1988)..............................................................74, 75 County of Oneida v. Oneida Indian Nation, 470 U.S. 226 (1985).....................................47 Exxon Corp. & Subs. v. United States, 88 F.3d 968 (Fed. Cir. 1996) ................................67 Fletcher v. United States, 116 F.3d 1315 (10th Cir. 1997)...............................................3, 4 HRI, Inc. v. EPA, 198 F.3d 1224 (10th Cir. 2000)........................................................47, 61 Hemus & Co. v. Hawkins, 452 F. Supp. 861 (S.D. Tex. 1978) ..........................................64 Imperial Colliery Co. v. OXY USA, Inc., 912 F.2d 696 (4th Cir. 1990) .............................66 Jicarilla Apache Tribe v. Andrus, 687 F.2d 1324 (10th Cir. 1982) ....................................48 Jicarilla Apache Tribe v. Supron Energy Corp., 728 F.2d 1555 (10th Cir. 1984)..48, 60, 68 Kingery v. Continental Oil Co., 626 F.2d 1261 (5th Cir. 1980).........................................65 Manchester Band of Pomo Indians, Inc. v. United States, 363 F. Supp. 1238 (N.D. Cal. 1973)...............................................................................................................73, 75 Minnesota Chippewa Tribe v. United States, 14 Cl. Ct. 116 (1987) ............................46, 71 Mitchell v. United States, 664 F.2d 265 (Ct. Cl. 1981), aff'd 463 U.S. 206 (1983)............46 Mobil Oil Corp. v. FPC, , 463 F.2d 256 (D.C. Cir. 1972)..................................................63 Montana v. Blackfeet Tribe, 471 U.S. 759 (1985)........................................................47, 61 In re Morgan, 106 B.R. 573 (Bankr. D. Ark. 1989)...........................................................50 Okie Crude Co. v. Muskogee Area Director, 23 IBIA 174 (1993) .........................60, 61 ,62 Osage Tribe of Indians v. United States, 68 Fed. Cl. 322 (2005)............................... passim Phillips Petroleum Co. v. Wisconsin, 347 U.S. 672 (1954) ...............................................63 Placid Oil Co. v. FPC, 483 F.2d 880 (5th Cir. 1973).........................................................67 Pueblo of Laguna v. United States, 60 Fed. Cl. 133 (2004)...............................................50 Pyramid Lake Paiute Tribe of Indians v. Morton, 354 F. Supp. 252 (D.D.C. 1972) .........49 Ramah Navajo Chapter v. Lujan, 112 F.3d 1455 (10th Cir. 1997) ....................................47 Red Lake Band v. United States, 17 Cl. Ct. 362 (1989) ...............................................49, 55 Sac & Fox Tribe of Indians v. United States, 340 F.2d 368 (Ct. Cl. 1964) ........................71 Seminole Nation v. United States, 316 U.S. 286 (1942) ....................................................46

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Shapiro, Bernstein & Co. v. Remington Records, Inc., 265 F.2d 263 (2d Cir. 1959).........50 Shoshone Indian Tribe v. United States, 364 F.3d 1339 (Fed. Cir. 2004) .................. passim Sowell v. Natural Gas Pipeline Co., 789 F.2d 1151 (5th Cir. 1986) ............................65, 66 United States ex rel. Willoughby v. Howard, 302 U.S. 445 (1938) ....................................70 United States v. Mason, 412 U.S. 391 (1973) ....................................................4, 45, 46, 52 United States v. White Mountain Apache, 537 U.S. 465 (2003) ........................................53 West v. Oklahoma Tax Comm'n, 334 U.S. 717 (1948) .....................................................2, 3 Yankton Sioux Tribe v. United States, 623 F.2d 159 (Ct. Cl. 1980)............................ passim STATE CASES In re D'Espinay-Durtal's Will, 4 A.D.2d 141 (N.Y. App. Div. 1957).................................75 In re Doyle's Will, 191 Misc. 860, 79 N.Y.S.2d 695 (1948)...............................................73 Lightcap v. Mobil Oil Corp., 562 P.2d 1 (Kan. 1977)..................................................66, 67 Lynch v. John M. Redfield Found., 88 Cal. Rptr. 86 (2d Dist. 1970).................................72 Maryland Nat'l Bank v. Cummins, 588 A.2d 1205 (Md. 1991) ...................................75, 81 Estate of Pelton ex rel. Wells Fargo Bank v. Pelton, 132 Cal. App. 3d 496 (1982)...........73 Shell Oil Co. v. Williams, Inc., 428 So. 2d 798 (La. 1983) ................................................65 Vest. v. Bialson, 365 Mo. 1103, 293 S.W.2d 369 (1956)....................................................74 STATUTES AND REGULATIONS 15 U.S.C. § 751..................................................................................................................63 25 U.S.C. §§ 161....................................................................................................70, 71, 73 25 U.S.C. § 162............................................................................................................71, 73 25 U.S.C. § 331....................................................................................................................3 30 U.S.C. § 1701................................................................................................................19 30 U.S.C. § 1702................................................................................................................19 Federal Oil and Gas Royalty Management Act of 1982, 30 U.S.C. § 1711 (2003) ("FOGRMA") ........................................................................................................18, 20 31 U.S.C. § 1321................................................................................................................70 12 C.F.R. § 9 ......................................................................................................................75 25 C.F.R. § 183 (1975)............................................................................................... passim 25 C.F.R. § 226 (1983).....................................................................................11, 12, 13, 14 25 C.F.R. § 226 (1991)............................................................................................... passim 25 C.F.R. § 226.(2005).............................................................................................9, 11, 12 43 C.F.R. § 3162 ................................................................................................................57 43 C.F.R. § 4 ......................................................................................................................60 39 Fed. Reg. 22,254, (June 21, 1974) ..........................................................................12, 13 46 Fed. Reg. 9909 (Jan. 31, 1981) .....................................................................................63 55 Fed. Reg. 33,112 (Aug. 14, 1990).................................................................................13 Act of June 28, 1906, Chapter 3572, 34 Stat. 539 ..................................................... passim Act of March 3, 1921, Chapter 120, 41 Stat. 1249 ..............................................................6 Act of February 27, 1925, Chapter 359, 43 Stat. 1008 ........................................................6 Act of March 2, 1929, Chapter 493, 45 Stat. 1478 ..............................................................6 Act of June 24, 1938, Chapter 645, 52 Stat. 1034 ...............................................................6 Act of July 25, 1947, Chapter 334, 61 Stat. 459..................................................................6 vi

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Act of June 15, 1950, Chapter 248, 64 Stat. 215 .................................................................6 Act of October 6, 1964, 78 Stat. 1008 .................................................................................6 Act of October 21, 1978, Pub. L. No. 95-496, 92 Stat. 1660 ..........................................4, 6 H.R. Rep. No. 92-963 (1972)...........................................................................................3, 4 S. Rep. No. 97-512 (1982) .................................................................................................17 MISCELLANEOUS Garrick A. Bailey, Osage, in 13 Handbook of North American Indians 476...........1, 2, 3, 4 Bureau of Indian Affairs, Osage Agency, Policies and Procedures Guide (May 2004) ..............................................................................................................................7 Cohen's Handbook of Federal Indian Law (1982) ......................................................49, 64 Coopers & Lybrand, Osage Agency ­ Minerals Branch Organizational Review Report (Jan. 15, 1992)..................................................................................................21 Deed from the Cherokee Nation in Trust for the Use and Benefit of the Osage and Kansas Tribe, as reprinted in The Constitution and Laws of the American Indians, Vol. 4 (Nov. 26, 1890); .....................................................................................3 Federal Leasing and Disposal Policies: Hearings Pursuant to S. Res. 45, A National Fuels and Energy Policy Study Before the Senate Comm. on Interior and Insular Affairs, 92d Cong., 2d Sess., 652 (1972) .................................................49 Galvin, "Developing an Oil and Gas Jurisprudence in Michigan," 7 Wayne L. 64Rev. 403, 425 n.99 (1961), cited in 3 Williams & Meyers Oil and Gas Law § 644.............................................................................................................................64 Report of the Commission on Fiscal Accountability of the Nation's Energy Resources, Preface (1982) ................................................................................... passim Report of Royalty Management and Delinquent Account Collection Activities Fiscal Year 2000 (Aug. 23, 2002). ...............................................................................19 Restatement of Trusts, Second (1957)....................................................................... passim Restatement of Trusts, Third (1992)............................................................................72, 74 IIA Austin Wakeman Scott & William Franklin Fratcher, The Law of Trusts, (4th Ed. 1987).............................................................................................................. passim U.S. Gen. Accounting Office, Oil and Gas Royalty Collections ­ Longstanding Problems Costing Millions (Oct. 29, 1981) ....................................................16, 17, 18 Terry P. Wilson, The Underground Reservation: Osage 7-9 .......................................2, 3, 5

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Plaintiff, the Osage Tribe of Indians of Oklahoma ("Osage Nation" or "Tribe"), brings this action to recover damages from Defendant United States of America ("United States" or "Government") for its failure, as trustee, to manage the Osage Mineral Estate properly. The United States has breached its trust duty to the Osage Nation to (1) collect and verify the full amount of royalties and penalties due and (2) invest prudently those funds that it did collect. The Court has divided Plaintiff's claims into two tranches. Tranche One covers "those of plaintiff's trust fund mismanagement claims falling within the parameters described in Shoshone Indian Tribe v. United States, 364 F.3d 1339, 1350-51 (Fed. Cir. 2004), for five oil and gas leases for the following six months: January 1976, May 1979, November 1980, February 1986, July 1989, and October 1990." Order at 1 (Apr. 15, 2005). The five Tranche One Leases are commonly referred to as the North Burbank Lease, the North Avant Lease, the Stanley Stringer Lease, the Osage Hominy Lease, and the East Hardy Lease. All but one of the Tranche One Leases are oil leases only, and Plaintiff's claims with respect to Tranche One relate solely to the Osage Mineral Estate's oil.1 STATEMENT OF FACTS I. BACKGROUND A. The Osage Tribe and Its Multiple Forced Relocations

When first encountered by French traders in the late 17th century, the Osage Tribe lived along the Osage River in an area that is today southwestern Missouri. Garrick A. Bailey, Osage, in 13 Handbook of North American Indians 476 (Smithsonian Institution 2001). The Tribe's hunting ranges extended into southeastern Kansas, northeastern Oklahoma, and northwestern
1

The lease for the Osage Hominy Unit contains a royalty provision requiring royalty on natural gas. The Tribe is not asserting any damages with respect to what appears to have been a de minimis amount of gas production during the Tranche One months.

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Arkansas. Id. at 477. As a result of three treaties in the early 1800s, the Osage ceded substantial territory to the United States. See Terry P. Wilson, The Underground Reservation: Osage 7-9 (Univ. of Nebr. Press 1985). The treaties left the Osage with a reservation, established in 1825, measuring approximately 50 miles by 125 miles in what is now southern Kansas. Although many Osages initially refused to move onto the reservation, that soon changed. "Short of both food and trade items," off-reservation Osages came under substantial pressure to move because of the influx of white settlers and members of eastern tribes who resettled to the Osage's traditional hunting areas after passage of the Indian Removal Act of 1830. Bailey, supra, at 478. "In 1839 the last off-reservation Osage villages were finally forced to move to the reservation in Kansas." Id. It was not long, however, before the Osage were forced to relocate again. The Homestead Act of 1862 launched a wave of settlers into Kansas, and the Government sought Osage land to accommodate them. In 1866, the United States and the Cherokee Nation executed a treaty that, among other things, permitted the Government to settle "friendly" Indians in certain areas of Cherokee territory, including what is now northern Oklahoma. West v. Oklahoma Tax Comm'n, 334 U.S. 717, 720 (1948) (citing 14 Stat. 799). In 1870, the Osage leaders "reluctantly accepted legislation stipulating that the Kansas reservation would be sold for $1.25 an acre, and the money deposited for the tribe in the United States Treasury, where it would draw five percent interest." Wilson, supra, at 14. Comforted by the words of spiritual leader Wa-ti-an-ka, who declared that there was something in the ground that would protect their children and elders from starvation, most of the Osages moved in 1871 to a newly established reservation on a portion of the Cherokee territory covered by the 1866 treaty. See id. at 15. In 1881, the Osage adopted a constitution creating a

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tribal government modeled loosely on the government of the United States. Fletcher v. United States, 116 F.3d 1315, 1319 (10th Cir. 1997), (citing H. R. Rep. No. 92-963 at 7 (1972)). In 1883, proceeds from the sale of the Kansas lands were used to purchase from the Cherokees, at a cost of $.50 an acre, the 1.47 million acre territory that is now the Osage Reservation. The Cherokee conveyed the land to the United States "in trust nevertheless and for the use and benefit of the said Osage and Kansas Indians." See Deed from the Cherokee Nation in Trust for the Use and Benefit of the Osage and Kansas Tribe, as reprinted in The Constitution and Laws of the American Indians, Vol. 4 (Nov. 26, 1890); West v. Oklahoma Tax Comm'n, 334 U.S. at 720. This conveyance included both the land and the rights to minerals underneath the land. Id. In 1887, in response to pressure to open Indian Territory to white settlers, Congress passed the General Allotment Act, 24 Stat. 388, 25 U.S.C. § 331, which empowered the President to distribute or "allot" reservation lands to individual Indians. The Osage resisted allotment and were excluded from the 1887 Allotment Act. Wilson, supra, at 36. Allotment remained a contentious issue among the Osage, with some factions favoring allotment and others opposing it. See id. at 38-41. In 1897, oil was discovered on the new Osage Reservation. In 1900, in frustration over the Osage National Council's refusal to agree to allotment, the Secretary of the Interior, at the urging of the Commissioner of Indian Affairs, abolished the tribal government created by the Osage's 1881 constitution. See Bailey, supra, at 488; Wilson, supra, at 37-42. In 1904 the federal Indian Service created the Osage Business Committee, and, in a subsequent election, a pro-allotment faction won control of the Committee. Bailey, supra, at 488.

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B.

The 1906 Act

In 1906, Congress enacted a statute allotting the surface rights to tribal lands to individual members of the Osage Tribe. Act of June 28, 1906, Chapter 3572, 34 Stat. 539 ("1906 Act"). The 1906 Act required the creation of a tribal membership roll. Id. Each enrolled tribal member was to be allotted a pro rata share of the tribal lands not reserved for other uses.2 Id. at § 540-41. The final roll was approved on April 11, 1908,3 and consisted of 2,229 enrolled members of the tribe, each of whom received approximately 658 acres of land. Bailey, supra, at 488. Under Section 7 of the 1906 Act, these lands were set aside "for the sole use and benefit of the individual members of the tribe entitled thereto, or to their heirs, as herein provided." 4 34 Stat. at 545. Unlike the surface land, title to all minerals, oil, natural gas, sand, and gravel ("Mineral Estate") was not allotted. Bailey, supra, at 488. Instead, Section 3 of the 1906 Act reserved these resources to the Osage Tribe for a period of 25 years.5 34 Stat. at 543. The Act created "headrights," "which are each tribal member's individual share of the income derived from the minerals located on the land." United States v. Mason, 412 U.S. 391, 393 (1973). Each Osage whose name appeared on the 1908 roll received one "headright." Fletcher, 116 F.3d at 1319.

Town sites, railroad right of ways, agency buildings, three Indian village sites, and Roman Catholic school lands were to be withheld from the allotment. 1906 Act § 2(8)-(11), 34 Stat. at 542. 3 See H.R. Rep. No. 92-923 at 8. 4 The Government, as trustee, has numerous trust duties with respect to the allotted lands and the Osage Mineral Estate that are outside the scope of Tranche One. Accordingly, we do not address them in this memorandum. 5 Ultimately, Congress made the trust containing the Osage Mineral Estate permanent. Act of October 21, 1978, Pub. L. No. 95-496, 92 Stat. 1660.

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Section 9 of the Act establishes the Osage Tribal Council, comprised of a Principal Chief, an Assistant Principal Chief, and High-council members, to act on behalf of the Tribe. 34 Stat. at 545. The 1906 Act includes important provisions addressing the responsibilities of the United States to the Tribe and its members. Section 4 of the Act states: "[A]ll funds belonging to the Osage tribe, and all moneys due, and all moneys that may become due, or may hereafter be found to be due the said Osage tribe of Indians, shall be held in trust by the United States . . . ." 34 Stat. at 544 (emphasis added). Section 4(2) of the Act specifies that "the royalty received from oil, gas, coal, and other mineral leases . . . shall be placed in the Treasury of the United States to the credit of the members of the Osage tribe." Id. That section of the Act also provides that money derived from leases of the Tribe's mineral interests "shall be distributed to the individual members of said Osage tribe according to the roll provided for herein, in the manner and at the same time that payments are made on interest on other moneys held in trust for the Osages by the United States, except as herein provided." Id. (emphasis added). Under the Act, the remaining proceeds from the sale of the Kansas property also were placed in trust for the Osage, as well as grazing-rights revenues. 34 Stat. at 544; see also Wilson, supra, at 92-93. Section 4(1) of the Act acknowledges that claims can be made against the Government for recovery of money due the Osage Nation and provides that recoveries for such claims should be placed in trust. Section 3 of the 1906 Act provides that only the Government, as trustee, can issue a lease for the Osage Minerals Estate. 34 Stat. at 543. Thus, in accordance with this and the other provisions of the 1906 Act described above, the Government, as trustee, exercises complete and

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plenary control over every aspect of the management and operation of the Osage Minerals Estate and over the funds derived from that Minerals Estate. Congress has amended the 1906 Act on several occasions.6 The amendments reinforce the Government's obligation to administer the Osage Minerals Estate "as may be deemed for the best interest of the Osage Nation." Act of March 2, 1929, Chapter 493, 45 Stat. 1478; Act of June 24, 1938, Chapter 645, 52 Stat. 1034. Moreover, through the amendments Congress exercised further control over the Osage Minerals Estate by mandating that the Government and the Osage Nation must lease no less than 25,000 acres of the Osage Reservation for mining each year. Id. None of the amendments to the 1906 Act, however, changed in any material way the Government's trust duties described above, including the duties to collect and hold in trust all payments due or that may become due to the Osage Nation, to invest those funds prudently, and to distribute trust funds in accordance with statutory requirements. Under the 1906 Act, the Osage Tribe is the beneficiary of the trust containing the Osage Minerals Estate. Osage Tribe of Indians v. United States, 68 Fed. Cl. 322, 330 (2005). Some of the funds from the trust are used to cover expenses of the Osage Tribal Council, the governmental authority for the Osage Nation. The Council's expenses include the administrative costs of the tribal government, such as salaries, travel, and supplies, and costs related to administration of the Minerals Estate. The balance of the tribal funds, after payment of Tribal Council expenses, are distributed pro rata to "headright" owners on a quarterly basis. The 1906 Act was amended and modified by: Act of March 3, 1921, Chapter 120, 41 Stat. 1249; Act of February 27, 1925, Chapter 359, 43 Stat. 1008; Act of March 2, 1929, Chapter 493, 45 Stat. 1478; Act of June 24, 1938, Chapter 645, 52 Stat. 1034; Act of July 25, 1947, Chapter 334, 61 Stat. 459; Act of June 15, 1950, Chapter 248, 64 Stat. 215; Act of October 6, 1964, 78 Stat. 1008; and Act of October 21, 1978, 92 Stat. 1660. (Copies of these statutes are included in the Joint Appendix submitted by parties on Sept. 12, 2005.) As used herein, the term "1906 Act" refers to the 1906 Act as amended, unless specified otherwise.
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C.

The Osage Agency

To fulfill its treaty and other responsibilities to the Osage Nation, the Government established the Osage Agency. The Osage Agency is a sub-agency of the Department of the Interior, Bureau of Indian Affairs ("BIA"), located in Pawhuska, Oklahoma, on the Osage Reservation. The Reservation covers roughly 1.47 million acres and thus is larger than Delaware or Rhode Island. More than half of that acreage is covered by oil leases and oil and gas combination leases. According to the 1989 Osage Agency Annual Status Report, there were 1,601 producing oil leases on the Reservation at that time. In its employee position descriptions, the Osage Agency describes its purpose in the following way: The Osage Agency will uphold and strive to accomplish the Bureau of Indian Affairs mission within the boundaries of the Osage Nation Reservation in Oklahoma. Through the Branch of Minerals, we are to serve and promote the daily operations of the Osage Mineral Estate and the welfare of the Osage Tribe. The Branch of Minerals will prudently uphold the Bureau and Osage Agency mission by managing the Osage Minerals Estate for the Osage Tribe, which includes, but is not limited to, verifying volume and value of royalties of the Minerals Estate. Insuring that all monies are received in compliance with the Code of Federal Regulations and properly recorded in accordance with generally accepted accounting principles and generally accepted auditing standards. The duties that Osage Agency employees discharge include the collection of revenue from the Osage Minerals Estate for the benefit of the Osage Nation. "As the Osage Agency is the representative royalty collector," it is the responsibility of "the oil and gas accounting sections within the [Agency's] Branch of Minerals" to account for "all royalties due the Osage Tribe." Bureau of Indian Affairs, Osage Agency, Policies and Procedures Guide Ch. 1 (May 2004) ("Osage Policy Guide").

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The testimony of Osage Agency employees and governmental manuals describing the Osage Agency's duties leave no doubt that the United States exercises plenary control over Osage oil and gas leasing operations, including in particular the calculation and collection of royalties, for the purpose of fulfilling the trust obligations of the United States to the Osage Nation. The Osage Agency may - and sometimes does - consider the Osage Nation's wishes and may consult with the Osage Nation. Nevertheless, the evidence will show that the Osage Agency makes all decisions about Osage oil and gas leases based on the Government's determination of the proper course of action, even if that means disagreeing with the Osage Tribal Council. In fact, the Government understands that it must exercise this independent "high fiduciary responsibility" to discharge its obligations as trustee, even if that means denying the Osage Nation's requests with respect to management of the Minerals Estate. For example, in 1996 the Agency denied an Osage Nation request for a division order, stating: We agreed with your line of thinking that a high fiduciary responsibility does exist as defined in the 1906 Osage Allotment Act which offers specific guidance in the management of oil and gas trust resources. We place considerable weight on protecting the interests of the Osage mineral owners or annuitants as provided in the 1906 Act as amended. Letter from Gordon Jackson, Superintendent, Osage Agency, to Principal Chief Charles O. Tillman, Jr., Osage Tribal Council at 2 (October 18, 1996). II. THE OSAGE LEASES AND REGULATIONS A. The Regulations and Form Leases Issued by the United States

To implement its trust responsibilities under the 1906 Act, the United States has issued comprehensive regulations ("Osage Regulations") covering all aspects of oil and gas production

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from the Osage Minerals Estate.7 25 C.F.R. Part 226. Those regulations include form leases that must be used by all lessees. 25 C.F.R. § 226.7. Unless approved by the United States, as trustee for the Osage Nation, no oil and gas lease is valid and binding. 34 Stat. at 543. Since the first Osage Regulations under the 1906 Act were promulgated in 1912, the form oil and gas leases have incorporated by reference the Osage Regulations in effect at the time as well as all future changes in those regulations. The regulations, however, do not override royalty-rate, rental-rate, or term-of-lease provisions in the leases. 25 C.F.R. § 226.5. B. The Tranche One Leases

The Tranche One Leases permit the lessee to explore for and produce crude oil in defined areas of the Osage Reservation in exchange for specified payments to the United States, as trustee. The lessee pays royalties each month crude oil is produced from the leased premises.8 Each Tranche One Lease contains various provisions specifying how to compute the monthly royalty payment on crude oil. In basic terms, that computation involves three elements: royalty rate, volume, and value. It can be expressed as a Royalty Formula: Royalty = Royalty Rate x Royalty Volume x Royalty Value The Tranche One Leases define all three elements of the Royalty Formula. The first element ­ the Royalty Rate the lessee must pay ­ is a fraction (often 1/8 or 1/6) and is usually expressed as a percentage. The Tranche One royalty rates typically vary depending on the pool of oil (referred to in the lease as "sands" or "reservoirs") or area of the Copies of each version of these regulations are included in the Joint Appendix that the parties jointly submitted to the Court on Sept. 12, 2005. 8 The Tranche One Leases give the Osage Nation the option, subject to the trustee's approval, of taking the monthly royalty payment "in kind" ­ that is, taking physical delivery of a fractional share of the monthly crude oil production in lieu of a financial payment. During the Tranche One period, there were no in-kind takings by the Osage Nation from the Tranche One Leases.
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lease from which the crude oil was produced. In some cases, the rate varies with the per well production from the relevant portion of the lease. For example, the Stanley Stringer Lease establishes different royalty rates for three different portions of the leased premises: · · For oil produced from the Burbank Sand, the royalty rate is 16 2/3% on the first 850,000 barrels of oil produced and 12 1/2% on any additional oil produced. For oil produced from sands other than the Burbank Sand, the royalty rate is 16 2/3% unless oil production from those sands averages 100 or more barrels per well per day, in which case the royalty rate is 20%. For oil produced from a specified 520-acre portion of the lease, the royalty rate is 16 2/3% unless oil production from those sands averages 100 or more barrels per well per day, in which case the royalty rate is 20%.

·

Stanley Stringer Lease at 3-5. The other Tranche One Leases contain similar provisions. The Royalty Formula's second element ­ Royalty Volume ­ is expressed in barrels. The Tranche One Leases require that the royalty payment be based on all crude oil produced from the lease minus crude oil used as fuel to operate the lease. Under the leases, the third element ­ Royalty Value ­ is the higher of two prices: (1) the actual sales price of the oil (see, e.g., North Burbank Lease § 2(a)-(b)) or (2) the "highest market posted price" on the "day of sale or removal" for crude oil "in the Mid-Continent Field," which includes Oklahoma, Kansas, Colorado, and parts of Texas.9 North Burbank Lease § 2(c). The leases require the lessee to pay royalties based on the higher of those two alternative valuations. Id. at § 4. These lease provisions create a methodology for determining Royalty Value that is unique to the Osage. Under most oil and gas leases, Royalty Value is based exclusively on the market Named for the sheet that was literally posted in a producing field, "posted prices" indicate how much a potential buyer (usually a refiner) might be willing to pay for a crude oil or blend of oils of standardized quality (e.g., Oklahoma Sweet, West Texas Intermediate, Louisiana Light).
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value of the crude oil produced from the lease itself, not the market value of other crude oil sold at other, distant locations. By contrast, under the Tranche One Leases, the Royalty Value analysis includes posted prices for all types of crude oil throughout a large, multi-state geographical area. In short, the Royalty Value of crude oil produced from the Osage Mineral Estate is not limited to the market value of that oil at or near the lease. Instead, it may be based on the highest posted price for crude oil produced at locations many miles from the lease. The federal regulations relating to the Osage Minerals Estate ("Osage Regulations") apply to, and can modify many terms of, the lease, including the determination of Royalty Value. For example, the North Burbank lease provides: This lease is subject to the regulations now or hereafter prescribed by the Secretary of the Interior, relative to such leases, all of which are made a part of this lease; PROVIDED, that no regulations made after the approval of this lease shall operate to affect the term of lease, rate of royalty, rental or acreage, unless agreed to by both parties. North Burbank Unit Lease at ¶ 16. See also 25 C.F.R. § 226.5 (making leases subject to the then-current Osage Regulations). As explained below, the Government's 1974 and 1990 regulations modified the methodology for determining Royalty Value during the Tranche One Months. C. The Osage Regulations

The Department of the Interior, through the BIA, has promulgated comprehensive regulations governing the leasing of the Osage Mineral Estate.10 The Osage Regulations cover virtually every aspect of the oil leasing process, from the selection of lessees, to the operation of the wells, to the payment of royalties, to the shutting down and eventual abandonment of wells. For the first three Tranche One Months, until March 30, 1982, those regulations were codified at 25 C.F.R. Part 183. Effective March 30, 1982, the regulations were recodified at 25 C.F.R. Part 226.
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Consistent with the Government's collection duties under the 1906 Act, the Osage Regulations require that all royalties and other payments due under the leases be made to the Government as trustee. 25 C.F.R. §§ 226.4, 226.11(a)(1). As the Court has found, the pervasive nature of the Osage Regulations establishes that "the government has taken on not only the principal, but the sole, responsibility for managing lease revenues." Osage Tribe, 68 Fed. Cl. at 333. In 1974, the BIA adopted a new set of regulations, which remained in effect through the first five Tranche One Months (January 1976, May 1979, November 1980, February 1986, and July 1989). 25 C.F.R. § 183; 39 Fed. Reg. 22,254-62 (June 21, 1974). With respect to Royalty Value, the new regulations provided that the two types of prices mentioned in the Tranche One Leases ­ actual selling prices and posted prices ­ should continue to be part of the analysis. But the regulations also added two new dimensions to the analysis. First, the 1974 regulations directed that Royalty Value was to be based on the "highest ... offered price by a major purchaser" in the relevant geographic area, if that price was higher than either the actual selling price or the highest major-purchaser posted price in the area.11 39 Fed. Reg. at 22,256. Second, the 1974 regulations provided that, if different actual prices were "paid simultaneously for oil from a lease[,] and the highest such price exceed[ed]" the posted and
11

The complete text of the 1974 royalty regulation is: Unless the Osage Tribal Council, with the approval of the Secretary, shall elect to take the royalty in kind, payment shall be made at the time of sale or removal of the oil, except where payments are made on division orders, and settlement shall be based on the actual selling price, or the highest posted or offered price by a major purchaser in the Kansas-Oklahoma area, whichever is higher on the day of sale or removal. Where different prices are paid simultaneously for oil from a lease and the highest such price exceeds the higher of the aforementioned prices, then that price shall be the basis of royalty on all oil from said lease.

39 Fed. Reg. 22,254, 22,256 (June 21, 1974) codified at 25 C.F.R. § 183.11(a)(2) (1975), recodified at 25 C.F.R. § 226.11(a)(2) (1983).

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offered prices, then the highest actual selling price "shall be" the Royalty Value "on all oil from" the lease. 25 C.F.R. § 183.11(a)(2) (1975). The 1974 regulations also reduced the geographic area that the lessee and the Osage Agency must consider in determining Royalty Value. While the leases require consideration of posted prices of major purchasers in the entire Mid-Continent region, the 1974 regulations limited the major purchaser analysis for posted and offered prices to only two states in that region ­ Kansas and Oklahoma. 25 C.F.R. § 183.1(h) (1975). In 1990, the BIA adopted regulations further narrowing the relevant geographic area to a single county in Oklahoma ­ Osage County. 55 Fed. Reg. 33,112-114 (Aug. 14, 1990), codified at 25 C.F.R. § 226.1(h) (1991). The 1990 regulations, which apply to the sixth Tranche One Month (October 1990), also changed the 1974 definition of "Major Purchasers." While the 1974 regulations defined major purchasers as the "minimum number of purchasers taking 80 percent of the oil in the KansasOklahoma area," 25 C.F.R. § 183.1(h), the 1990 regulations provided that the definition covered the purchasers of 95 percent of the oil in Osage County only. 25 C.F.R. § 226.1(h). In addition, the 1990 regulations deleted the simultaneous actual selling price provision added to the Royalty Value analysis by the 1974 regulations. 55 Fed. Reg. at 33,114. The Osage Regulations make the lessee responsible for the accurate measurement of all crude oil produced from a lease of the Osage Minerals Estate. 25 C.F.R. § 183.11(a); 25 C.F.R. § 226.11(a). In addition, the lessee must file a monthly report with the Osage Agency providing the total volume of crude oil subject to royalty for each lease. 25 C.F.R. § 183.13(b); 25 C.F.R. § 226.13(b). If the purchaser (as lessee's agent) is responsible for paying the royalty, it must also file a monthly report setting forth relevant royalty and volume information. 25 C.F.R. § 183.14(b); 25 C.F.R. § 226.14(b).

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Lessees owe royalties on all crude oil produced from the Tranche One Leases, with the exception of oil used as fuel to develop and operate the lease from which the oil was produced. Thus, a lessee must report and "pay royalty on the value of all oil ... used off the premises for development and operating purposes." 25 C.F.R. § 183.14(a) (emphasis added); 25 C.F.R. § 226.14(a). In addition, the regulations provide the Osage Agency with broad authority to prevent waste, including the loss of crude oil subject to royalty. 25 C.F.R. § 183.37; 25 C.F.R. § 226.37. The Osage Regulations specify the timing and manner of royalty payments and the sanctions that apply when timely, correct payments are not made. The regulations direct the lessee to pay the royalty due on oil sold in a given month by the 25th day of the following month.12 25 C.F.R. § 183.13; 25 C.F.R. § 226.13. Payment must be made directly to the Osage Agency for the benefit of the Osage Nation. 25 C.F.R. § 183.11(a); 25 C.F.R. § 226.11(h). The regulations in multiple places make clear that tardy royalty payments trigger mandatory late fees of one and one-half percent per month. For example, 25 C.F.R. § 226.13(a) provides: "Failure to make such payments shall subject Lessee or purchaser, whoever is responsible for royalty payment, to a late charge at the rate of 1½ percent for each month or fraction thereof until paid." (Emphasis added.) See also 25 C.F.R. § 183.13(a) (one and one-half percent late fee); 25 C.F.R. § 183.11(c) ("Payment for any underpayment not made within the time specified shall be subject

Both the 1974 and 1990 regulations permit the purchaser of the crude oil to remit the royalty payment on behalf of the lessee. 25 C.F.R. § 183.14(a); 25 C.F.R. § 226.14(a). In that event, however, the lessee remains liable for the royalty payment. During the Tranche One period, both lessees and purchasers made royalty payments. In some cases, the lessee was a vertically integrated oil company that also "purchased" the oil produced from a Tranche One Lease.

12

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to a late charge at the rate of not less than 1½ percent for each month or fraction thereof until paid.") (emphasis added); 25 C.F.R. § 226.11(c) (same). D. The Government Must Determine and Verify a Number of Variables Under the Royalty Formula

As already noted, to compute and collect the full amount of royalties owed the Osage Nation, the Government must calculate the correct Royalty Rate, Royalty Volume, and Royalty Value. The Tranche One Leases, as modified by the Osage Regulations, require that the following items be determined each month in quantifying each of those elements: Royalty Volume · · · Royalty Rate · · · Royalty Value · The identity of each "major purchaser" in the relevant geographic area (KansasOklahoma or Osage County, depending on the Tranche One Month) during the month in which the crude oil was sold or removed from the leased premises. To determine the major purchasers, the Osage Agency must know o the total volume of oil purchased in the relevant geographic area during the relevant month; The rate in the lease for each portion of the leased premises. For leases (or portions thereof) with different royalty rates depending on levels of historical production, the cumulative volume of such production. For leases (or portions thereof) with different royalty rates based on the rate of production, the average rate of production per well. The total volume of oil produced and sold from each lease or from each portion of the lease having a separate royalty rate. The volume of oil produced from each lease that was used for operation and development of the lease from which it was produced. The total volume of oil produced from each lease and used for development and operation of a lease other than the lease from which it was produced.

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o

the identity of each purchaser in the relevant geographic area during the relevant month; and the volume bought by each such purchaser. Actual prices for all crude oil sales from each lease on a daily basis. The amount of each offer to buy oil by each major purchaser for each day of each month. The posted price bulletins issued by each major purchaser for each day of each month. Whether different prices are paid simultaneously for crude oil from a lease, and, if so, the actual prices paid by each purchaser.

o · · · · III.

THE GOVERNMENT'S GENERAL ADMINISTRATION OF ROYALTY COLLECTION AND VERIFICATION FOR FEDERAL AND INDIAN MINERALS LEASES The United States has long managed extensive oil and other mineral resources for its own

benefit and as trustee for a number of Indian tribes, including the Osage Nation. Over the past several decades, Congress and other governmental entities have analyzed the Government's managerial effectiveness. Those assessments have been disheartening. For example, the Comptroller General of the General Accounting Office has written: Since 1959, numerous GAO and Department of the Interior audit reports have pointed out the need for improved management of the Geological Survey's royalty accounting system. In our April 1979 report, we recommended both short and long range alternatives. Our follow up work shows that the problems discussed in our 1979 report not only persist, but have become worse. U.S. Gen. Accounting Office, Oil and Gas Royalty Collections ­ Longstanding Problems Costing Millions 2 (Oct. 29, 1981) ("1981 GAO Report"). In 1981, in recognition of extensive problems with the collection of royalties from federal and Indian oil leases, the United States created the Commission on Fiscal Accountability of the Nation's Energy Resources, referred to as the Linowes Commission after its Chairman, David F. Linowes. The United States asked the Commission to:

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·

examine the allegations of massive irregularities in royalties on the Nation's energy resources that are owed to the Federal government, Indian tribes, and States; investigate the allegations of theft of oil from Federal and Indian lands; and make recommendations for improving fiscal accountability of the Nation's energy resources.

· ·

Report of the Commission on Fiscal Accountability of the Nation's Energy Resources, Preface (1982) ("Linowes Report"). After months of investigation and work, the Commission concluded: Management of royalties for the Nation's energy resources has been a failure for more than 20 years. Because the Federal government has not adequately managed this multibillion dollar enterprise, the oil and gas industry is not paying all the royalties it rightly owes. The government's royalty recordkeeping for Federal and Indian oil and gas leases is in disarray. For this reason, the exact amount of underpayment is unknown. The results of individual audits, which have often uncovered large underpayments, suggest that hundreds of millions of dollars due the U.S. Treasury, the States, and Indian tribes are going uncollected every year. In addition, oil thefts are occurring on Federal and Indian leases. The extent of theft and the amount of royalty losses are unknown, but it is well-documented that security at many Federal and Indian lease sites is lax and is an open invitation to theft. Id. at xv. The GAO, the Linowes Report, and other various governmental studies have identified certain systemic flaws that have prevented the United States from fulfilling its responsibilities, both as owner of federal lands and as the trustee of Indian natural resources, to collect the full amount of royalty due. A. Lack of Auditing

The GAO has acknowledged that auditing oil and gas lease records is a critical component of effective royalty management. "[W]ithout sufficient lease account audits the

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Geological Survey must rely on unverified data reported by the oil and gas companies to compute and collect royalties due." 1981 GAO Report at 9. According to the Linowes Report, the "major shortcomings" of the federal royalty management system include the failure to "verify data reported by the oil and gas companies" and to "audit[] or critically review[]" lessee records on a regular basis. Linowes Report at 15; cf. id. at 44. The Government has acknowledged that, given the absence of independent verification, the oil industry has been on the "honor system." S. Rep. No. 97-512 at 9 (1982). The studies have uniformly concluded that the Government's failure regularly to conduct audits and check accounts has cost the federal treasury and Indian tribes hundreds of millions of dollars in uncollected royalties. 1981 GAO Report at 1. Although the lack of adequate records prevents a precise estimate, audits and other independent verification procedures alone can reasonably be expected to reveal significant underpayments ranging from two to ten percent of the amounts due. Linowes Report at 13, 16-18. The GAO has urged the Department of the Interior to "increase its auditing and monitoring of lease accounts." 1981 GAO Report at 3. The GAO also has recommended that the Department of the Interior adopt a "comprehensive, systematic plan for monitoring, reconciling, and auditing lease account records; inspecting leases; and verifying production and sales data." Id. at 5. The Linowes Report similarly recognized that "auditing [of oil royalty payments] should take its place as just another of the controls used by the system." Linowes Report at 74. In accordance with Congress's directives in the Federal Oil and Gas Royalty Management Act of 1982, 30 U.S.C. § 1711(c) (2003) ("FOGRMA"), the Department of the Interior's Minerals Management Service ("MMS") has undertaken in recent years, for leases on

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federal lands and all Indian lands other than the Osage Minerals Estate, an intensive audit program that relies on sampling techniques similar to those employed by the Internal Revenue Service.13 MMS's audit procedures require verification of lessee reports and purchaser statements by reference to original source documents. Recent reports of the Minerals Management Services have highlighted the agency's success in finding oil royalty underpayments through the use of inspection and detection programs. According to MMS, such programs have resulted in the collection of nearly $2.6 billion since the early 1980s. Report of Royalty Management and Delinquent Account Collection Activities Fiscal Year 2000 at 33 (Aug. 23, 2002). B. Lack of Independent Verification of Production Volume

The Government has repeatedly recognized that, to fulfill its fiduciary obligations, it must verify the volume of oil produced from Indian leases. For example, the Linowes Commission observed: The government has a legal responsibility to collect all the royalties due on oil removed from the public and Indian lands. As a trustee of Indian natural resources, it also has a fiduciary responsibility to fulfill. The Federal government can best meet its site security responsibilities by monitoring the industry's lease site security performance. Linowes Report at 86. The Linowes Commission determined that, in addition to the "real problem" of oil theft, under-measurement and under-reporting of oil production volumes require remedial action. Id. at 55, 85. That means more than simply reviewing the oil companies' paperwork. Rather, Congress has concluded that it is "essential" to provide for "routine inspection" of wells and to engage in other direct, hands-on efforts to verify production volumes. 30 U.S.C. § 1701(a)(3). By its terms, FOGRMA excludes the Osage Nation from its coverage. 30 U.S.C. § 1702(3).
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That is why Congress in FOGRMA directed the Department of the Interior to conduct annual inspections of leases that have "significant" production or that have a history of regulatory noncompliance. 30 U.S.C. § 1711(b) (2003). C. Inadequate Staffing

The Government has recognized that it needs well-trained, professional staff in sufficient numbers to manage mineral resources effectively. The Linowes Commission strongly urged an expansion of the Department of the Interior's minerals management staff, and described additional staff training in the oil and gas business as "essential." Linowes Report at 78. Such training is especially important to the effective execution of critical functions such as royalty collection and field inspection. Id. at 77-78, 148 (royalty management staff), 101-103 (field inspectors). The Linowes Commission urged federal royalty managers to commence comprehensive training of their staffs immediately. Id. at 79. IV. THE OSAGE AGENCY'S ADMINISTRATION OF ROYALTY COLLECTION AND VERIFICATION A. General Systemic Flaws

No Auditing. The evidence at trial will show that, notwithstanding the recognition in numerous governmental studies of the need to conduct regular audits to verify the accuracy of information provided by the royalty payor, the Osage Agency did not audit royalty payments, oil production volume, or any other aspect of the royalty process. The Agency had no system or procedure for doing so. Nor were there regular audits of the Osage Agency itself to test its procedures. In short, other than limited checks by a handful of gaugers, the Osage Agency did not independently verify any of the price, volume, or other data reported by lessees and purchasers. During the Tranche One period, the Osage Agency's royalty-collection process was

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organized to run as precisely the kind of "honor sys