The Office of Federal Procurement Policy is considering whether to modify an obscure federal regulation that guides millions of dollars worth of government contracts to small businesses each year.

This tinkering with the so-called "rule of two" has angered the Small Business Administration, the House and Senate Small Business Committees and small businesses that received preferential treatment under the regulation.

Meanwhile, other small firms -- primarily in the fields of architecture and engineering -- and members of Congress who last year pushed through legislation designed to eliminate the rule, complain that the OFPP is not moving forcefully enough to remove the provision from federal procurement regulations.

"This issue is likely to be the most critical small business procurement issue in 1985," said William J. (Bud) Maraist Jr., OFPP's acting associate administrator for policy development. "Perhaps there is room for some type of compromise -- but we haven't sorted out what that would be."

Under law, agencies are encouraged to give a certain amount of their business to small firms. The "rule of two" provides the basis under which procurement officials decide which contracts to set aside for bidding by small businesses. Put simply, the rule says that if the official can identify at least two small firms that could provide the service or product at a "reasonable cost," the contract will be set aside for small businesses.

The stakes involved are enormous. According to the SBA, small businesses won more than $24 billion worth of the $166 billion in goods and services purchased by the government in fiscal 1984. But small firms won only $4.2 billion of that under open bidding procedures, according to Donald P. Young, associate SBA administrator for procurement and technical assistance. The rest were contracts worth less than $25,000, which must go to small firms, or contracts that agencies decided to "set aside" for small businesses.

Young said the proportion of federal contracts awarded to small businesses has dropped from 30 percent in the last two years of the Carter administration to 18 percent.

OFPP officials say the confusion over the "rule of two" began two years ago, when the Federal Acquisition Council began writing a set of comprehensive procurement regulations. The council, made up of representatives of the Defense Department, the General Services Administration and the National Aeronautics and Space Administration, was supposed to come up with a single set of guidelines to replace the three sets of rules that the agencies followed when they made purchases for themselves or, in the case of GSA, for the rest of the government.

One of the issues that was discussed was whether to include a "rule of two." The DOD had used one for years, but only some of the civilian agencies had followed the guideline. Eventually the council agreed to include the "rule of two" as part of the new Federal Acquisition Regulations that went into effect last April.

But three months later Congress passed the Deficit Reduction Act, which instructed the OFPP to strive to "increase the use of full and open competition" in federal procurement. According to the bill's supporters, Congress intended the "rule of two" to be scrapped.

The council took up the issue again, but decided to keep the provision. William B. Ferguson, deputy assistant adminstrator of GSA for acquisition policy and a council official, said the panel decided that "full and open competition" could be achieved through "open competition among small businesses, as required under other laws that give some preferences to small business."

In October, as the issue continued to smolder, the OFPP, which is supposed to resolve such disputes, asked for public comments on whether the rule should continue to be used. At the time, OFPP Administrator Donald E. Sowle stated that he believed that the language of new Federal Acquisition Regulations "complies with the current law and reflects the will of the Congress . . . "

But that only seemed to exacerbate the situation.

James C. Sanders, head of the Small Business Administration and Frank S. Swain, the agency's chief advocacy counsel, both told the OFPP that it was meddling with a system that worked well.

"There had to be some standard that procurement agents could follow in determining if there was enough competition for a small business set-aside," said the SBA's Young. "The 'rule of two' did that."

But Rep. Jack Brooks (D-Tex.), chairman of the House Government Operations Committee, takes the opposite view. In early 1984, he fired off a letter to David A. Stockman, director of the Office of Management and Budget, of which the OFPP is a part.

Brooks wrote that continued use of the "rule of two" creates "a serious restriction on the government's ability to obtain goods and services from the maximum practicable number of vendors at the lowest cost." Brooks said it was "inherently unfair to turn over the federal marketplace to any single economic group. The major purpose of procurement is to serve agency missions in a cost-effective manner."

Since OFPP asked for comments, the battle lines have solidified. While most federal agencies said they liked using the rule, trade groups representing construction firms, architects and engineers have opposed it.

The Associated General Contractors of America, which opposes the concept of designating certain contracts for small businesses, said that in fiscal 1983, civilian agencies and the Defense Department awarded virtually the same share -- about 90 percent -- of their construction contracts to small businesses -- even though DOD set aside a much larger share. Using the "rule of two," DOD set aside 77 percent of those contracts, while the civilian agencies set aside 46 percent.

"This great disparity in the percent of construction contracts set aside highlights the inappropriateness of using the 'rule of two' to select contracts" for small businesses, said Hubert Beatty, the AGC's executive vice president.

Other trade groups, including the Committee on Federal Procurement of Architectural/Engineering Services, called on the OFPP to order the Federal Acquisition Council to bar the use of the rule.

"We still don't think we have to propose a change," said the OFPP's Maraist. "But we are looking at ways to make a compromise."

One alternative under consideration is to give contracting officials more authority to decide whether two small businesses amount to "sufficient competition" to set aside a contract for small businesses. But aides to Brooks and SBA officials say the compromise doesn't go far enough.

"It's going to be a couple more months, probably, before we decided what to do," Maraist said. "I want to give everyone a chance to comment who wants to."