Can Procurement funds be used to fund the Second Source contract, or must RDTE funds be used?
The Financial Management Regulation (FMR) 7000.14-R Volume 2A Chapter 1 Section 22.214.171.124 explains the use of RDT&E Appropriations: RDT&E will finance research, development, test and evaluation efforts performed by contractors and government installations, including procurement of end items, weapons, equipment, components, materials and services required for development of equipment, material, or computer application software; its Development Test and Evaluation (DT&E); and its Operational Test and Evaluation (OT&E) as provided for in paragraph 126.96.36.199 (Test Articles and Test Support) below.
If the second source contract will be used to develop the capability then RDT&E funding should be used; however, if the second source contract is to simply purchase the items, then Procurement funding can be used. In the question background, you stated "the PM wants to develop a Second Source for the system", which implies that the Second Source would have to develop the system. The use of an OTA does not drive the correct Appropriation type, the scope of the work drives the Appropriation type. You should check the budget exhibits to ensure you have requested funding for the second source effort, if not, you should update the budget exhibits soonest.
I strongly recommend you consult the Business Financial Manager, Contracting Officer and/or Legal Office for additional guidance and direction.