Since 1999, energy companies have more than doubled the number of wells that drain natural gas in Southwest Virginia, producing 128 billion cubic feet of gas last year - a quantity that would fetch $1.2 billion for gas producers at average regional prices for 2008.

Members of Virginia’s Gas and Oil Board, shown in a public session, have clashed for a year over how thorough of an audit they wanted. (Earl Neikirk/Bristol Herald Courier)

---

As natural gas profits have soared, so has the balance of an obscure state-run escrow fund, which holds royalties belonging to thousands of landowners whose ownership is in dispute or whose whereabouts are unknown. In 10 years, the total funds in escrow have ballooned from $3.6 million to more than $24 million – all without a single audit to determine if energy companies are making the legally required deposits into escrow.

For the past year, members of the state regulatory board charged with overseeing the escrow fund have been locked in debate over how deeply to probe gas corporations’ compliance with making royalty payments into the fund. Some on the board have called for a forensic audit, while another member strenuously objected that such an audit “will be opening a door that I do not think we want to or need to go through,” according to interviews and internal communications obtained by the Bristol Herald Courier through a Freedom of Information Act request.

The documents shine a light on the board’s private deliberations, and the deep division among members that discussion of an audit has provoked. They also reveal that board members actually voted to award a contract for an audit nine months ago.

On March 5, David Asbury, the main state official responsible for managing the Virginia Gas and Oil Board’s business, announced to board members that they had voted 4-3 to hire a Colorado accountant to perform the audit. The accountant, Mary Ellen Denomy, came with a string of letters attached to her name, including abbreviations for “Certified Fraud Deterrent Analyst” and “Certified Forensic Financial Analyst.” Her price tag for the audit: $106,000.

At 11:57 a.m., Asbury e-mailed board members that they had selected Denomy and that all bidders would be notified of the board’s decision that afternoon.

It never happened.

At 12:25 p.m., Sharon Pigeon, the senior assistant attorney general who advises the board, sent an urgent reply to Asbury, voicing a concern that he was about to take action “in an illegal closed session.”

“Board action is not official until taken in an open meeting, so I assume you plan to call for a vote on this on the 17th,” she wrote, referring to the board’s hearing later in March. “I also assume there is reason to support the decision in the event there is a challenge to accepting the highest bid, so someone needs to be prepared to offer that information at the meeting.”

Butch Lambert, the board chairman who Pigeon copied on her e-mail, responded at 1:06 p.m.

“Just so that we are above board with this, I think that we should follow Sharon’s recommendation. We can do this first thing.”

At the March 17 hearing, the board members went into a closed session to discuss the audit. When they re-emerged, public board member Mary Quillen moved to “drop those proposals that were received as not meeting the guidelines.”

Bruce Prather, the board member who represents the gas and oil industry, seconded the motion, and the board voted to readvertise the contract.

“We’re not auditing it”

Whenever gas companies make payments into escrow, they attach statements that show the volume of gas that a well produced, what it sold for and whatever deductions the company made in getting the gas to market. But bankers at Wachovia, which has managed the account since 2001, don’t look at these statements.

“I will tell you that the information is on there,” Patrick Dixon, a senior vice president for Wachovia, told Gas and Oil Board members at a July hearing. “We’re just not doing anything with that information. We’re not auditing it. We’re not in any way proving whether it’s right or wrong.”

It’s unclear how long board members knew they had access to this information; Asbury in April asked Wachovia for a “sample of the checks and the accounting that they receive [from gas operators] month over month,” which he said he provided to board members.

The last audit of the escrow fund was in 1999. It cost $4,000. In their report, accountants at the Central Virginia firm of Robinson, Farmer, Cox Associates wrote that though they performed compliance tests with state laws and board regulations, “providing an opinion on compliance with those provisions was not an objective of our audit and, accordingly, we do not express such an opinion.”

Asbury, in an e-mailed response to Herald Courier inquiries, wrote: “We balance the need to audit against the need to keep management fees charged to the account to a minimum.” Meaning: The people whose royalties are in escrow will foot the bill for any audit, not the agency in charge of ensuring the integrity of the fund.

Only two state employees are responsible for monitoring payments into about 950 sub-accounts in escrow – active and inactive – and ensuring that companies file the required paperwork: Asbury, the director of the Division of Gas and Oil, and Diane Davis, the DGO’s programs administrator.

Asbury said that the DGO’s parent agency is expanding its electronic reporting system with “automated quality checks” to include the escrow fund. Currently, the DGO has no such system in place.

Perhaps out of necessity, Asbury has outsourced part of his watchdog function to the companies he watches.

Asked if it was anyone’s job to review operators’ monthly accounting statements sent to Wachovia, Asbury sidestepped the question in a written response, noting that “major gas producers are publicly held companies” and that “payments into escrow [. . .] are internally and externally ‘audited’ transactions.”

The Herald Courier, in comparing escrow deposits with gas production during 2008 and 2009, found that hundreds of individual accounts did not receive royalty payments for months when the corresponding wells produced gas.

The analysis also revealed 20 duplicate sub-accounts that appear to receive payments from the same gas wells, underpayments and overpayments, accounts that should have been closed out years ago – and one account that was closed out, only to reappear months later with a negative 37 cents.

There is a cost to extraneous accounts: Wachovia charges $8 per account each month. The bank’s servicing fees have exceeded the amount of interest earned on the fund’s deposits for most of 2009, resulting in a loss of nearly $17,000 for the first 10 months of the year.

Board divisions

On March 6, the day after Asbury notified board members the results of their votes on who would audit the escrow fund, an agitated Bruce Prather phoned the DGO director.

At 3:50 p.m., Asbury e-mailed Lambert about the conversation. “Board member Prather called and was upset about the pending decision for the [request for proposal] Escrow Audit,” he wrote.

“Do you know what he is upset about?” Lambert replied.

“He had done research regarding the chosen candidate/proposal,” Asbury wrote, referring to Mary Ellen Denomy, the Colorado CPA. “He has concerns about the candidate’s testimony against certain gas companies and their interests out west in state court.”

In his research, Prather may have seen a March 2007 article in the now-defunct Rocky Mountain News, in which western royalty owners christened Denomy “Erin Brockovich” – a reference to a tenacious woman who took on an energy giant in a pollution case and was lionized on the big screen by actress Julia Roberts.

When asked about his concerns in November, Prather said, “Me? I don’t know where that came from.” Asked if he denied making the comments Asbury referenced, Prather said, “I’m not saying anything.”

In a phone interview, Denomy said, “There should be no reason for a company to feel threatened by an accountant. I’m trying to make sure monies are not being misappropriated. I’m just a bean-counter.”

For a year, board members have clashed over how thorough of an audit they wanted.

In February, public member Peggy Barber, without having seen the bids from would-be auditors, informed Asbury, “I would like to choose the lowest bidder for this project as the end result should ultimately be the same.” Barber, dean of workforce development and continuing education at Southwest Virginia Community College, did not return phone calls or an e-mail seeking comment.

Katie Dye, a public member from Buchanan County, has called for a “forensic audit,” and Bill Harris, a public member from Wise County, has supported a more thorough audit.

On the other side, Mary Quillen, another public member, voiced a strong objection to auditing the financial records of gas operators. On Aug. 10, Quillen e-mailed Asbury with her comments on the pending escrow audit.

“I do not want this to be misinterpretated (sic) to mean we are going to audit each operators financial records,” Quillen wrote. “This will be opening a door that I do not think we want to or need to go through. There are some on The Board and members of the public (regular attendees of the meetings) who will take this opportunity to jump on this as a means of addressing their own agendas.”

Quillen, director of programs for the University of Virginia’s Southwest Center in Abingdon, did not return phone messages or an e-mail seeking comment. When approached by a reporter during a break at the Nov. 17 board hearing, Quillen said, “This is not an appropriate time to have a discussion with you.”

Asked to suggest an appropriate time, Quillen said, “I have no comment at this time. No comment.”

Prather seems to share Quillen’s view on the scope of the audit. When asked to verify his position, Prather said, “It sounds to me like you have access to our closed meetings.”

When pressed, he said that Pigeon, the board’s attorney, advised them against a forensic audit.

“Ms. Pigeon told us that this was our legal position,” Prather said. “She told us we couldn’t, we can’t take this thing outside the board and allow a forensic audit of these companies.

“That’s absurd,” he added. “Do you know how much that would cost?”

The upshot

On Sept. 21, the board published a revised request for bids for the audit, adopting much of Dye’s proposed language. The successful bidder will randomly audit 35 individual accounts in the escrow fund and compare actual payments against expected payments based on the board’s files, which detail how much production in a gas unit is subject to escrow.

The auditor’s task could be significantly complicated by missing supplemental orders – the crucial document that shows what percentage of royalties should be escrowed. The Herald Courier, in reviewing 12 Gas and Oil Board files with large percentages of owners who did not agree to lease, found that six of them were missing supplemental orders. When confronted with this, the Department of Mines, Minerals and Energy – DGO’s parent agency – acknowledged a “backlog of incomplete supplemental board orders.”

Without a supplemental order, it is impossible to determine what should be in an individual account in escrow.

Some board members are still unsatisfied with the audit’s scope.

“We would like for it to have taken a different direction,” Harris, the public member from Wise County, said in an interview. He described the published proposal as a “verification process rather than a forensic process.”

“I’m still not sure we’ll get some of the answers to the questions you’re raising,” Harris said. “We’re going to sort of wait and see what comes out of this.”