Reply Brief — Shalala v. Guernsey Memorial Hospital

FIT FED

No. 93-1251 MAR 2 1 1994

. 2

In the Supreme Court of the United States

OcTOBER TERM, 1993

DONNA E. SHALALA. SECRETARY OF HEALTH

AND HUMAN SERVICES, PETITIONER

v.

GUERNSEY MEMORIAL HOSPITAL

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

REPLY BRIEF FOR THE PETITIONER

DreW S. DAYs, IT]

Nolicitor General

Le partie nt of Justice

Washington, DC. 20520

(202) 1S 2217

TABLE OF AUTHORITIES

Cases: Page

American Medical Int'l, Inc. v. Secretary of HEW, 466

F. Sapp. GBS (D.D.C.. 88D) ..cccccccccvecssccccecccevcecsecscsssosces 2

Bethesda Hosp. Ass'n v. Bowen, 485 U.S. 399 (1988) .... 4

Good Samaritan Hosp. v. Shalala, 113 8. Ct. 2151

Sl iiidisddichdidnddgdnidasmecdndncnddakerietncensupdisnssinansiorvenseteieectes 4,7

HCA Health Services of Midwest, Inc. v. Bowen, 869

or Bi | bt nT eee 3

Martin v. OSHRC, 499 US. 144 (1991) ................00eeeeee. 10

Methodist Hospital of Indiana, Inc. vy. United States,

SR ee EE GEE, Gs IID pncnencnnccnadcddsacscancevecsensccuncqasors 8

Mother Frances Hosp. v. Shalala, No. 93-4388 (5th Cir.

TE Gi, TE cscdvscccccssvedeccesensoscsscsecconvassscoossovsunqesocessonses 9

National Medical Enterprises, Inc. v. Sullivan, 916 F.2d

542 (9th Cir. 1990), cert. denied, 500 U.S. 917 (1991) .... ss]

Research Medical Center v. Schweiker, 684 F.2d 599 (8th

Ea. . SEIU aceutiinacincncecinssiasninitbedenpaveinbesnneenducionoceuntenacupensees 4

Richey Manor, Inc. v. Schweiker, 684 F.2d 130 (D.C.

Eee - TIRED ccntccnccecenesesccssisccecsntdavensonscabecszensenoesesessoosscoseces a

St. Francis Hosp. Ctr. v. Heckler, 714 F.2d 872 (7th

EIU. TRMIOID ctececiiciibisjibiemstanenidnshpnddzesninsmeannremnsguseéssovinessensesenee 10

Stinson v. United States, 113 8. Ct. 1913 (1993) ............ 3

Sun Towers, Inc. v. Heckler, 725 F.2d 315 (5th Cir.),

cert. denied, 469 U.S. 823 (1984) 2...............ccccccsscccceseeees 9, 10

Statute and regulations:

I~ s cnscuabmbpnebedsonaenesnatinnseden 6

42 C.F.R.:

Section 413.5(b)(1) ............... EAT re ae TI EDO 7

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Regulations—Continued:

Section 413.24(D)MZ) .....ccccccccsscccccsceccscsossoosessocsssusonsnns

Section 418.246d) .....cccccccsscossssscssscenscesseubeesaeneeeenenenaen

Section 418.2408) ..:..c.ccorcoseccoscecssessssessadsesuensesenseeneneenn

Section 413.50 ..cccccccsccocccsscescsscscosccosessonsensennsssssensennene

Section 413.58 .....ccccccccccccsoscsccccccccssesccosesssscsscsssnenennens

Section 418.60 ...cccccocccsesessisosessocsseccsnssnssesenseneeeseneaaaan

RL ) ee aa

Section 418.64 ..<..ccccccccsscessssecorepscessenssesannsnsseetennnnaaaee

Section 413.64(D) ...ccccccccccoscsssssevescsessesencssesesenenneeeeeenn

Miscellaneous:

Early Extinguishment of Debt, Accounting Principles

Board Opinion No. 26 (Accounting Principles Bd.

OTB) ..coccoscessascescccoceesscboccsccssducssssnsenenennninnneannnn=nnE

“ Dascohoe Applying Government Accounting Prin-

CiPlEs (199O) ...ccccccceseereceeesseeeeetereseerenresssereeseeseerneees onan

41 Fed. Reg. 46,292 (1976) ......cccccccssseeeeeeeeeeererseeeseeerennees

R. Kay & D. Searfoss, Handbook of Accounting and

Auditing (2d €d. 1989) .....cccccceeeeeseeeeeeeeeennnenneneenesesseennees

D. Keller, J. Bulloch & R. Shultis, Management Accoun-

tants’ Handbook (Ath ed. 1992) .......cccccccccceeeeeeeeeeeeeeeeeees

United States Department of Health & Human Services,

Health Care Financing Administration, Medicare Pro-

vider Reimbursement Manual (1987) ......cccccccseseeseeeeeeees

2, 6

In the Supreme Court of the United States

OCTOBER TERM, 1993

No. 93-1251

DONNA E. SHALALA, SECRETARY OF HEALTH

AND HUMAN SERVICES, PETITIONER

v.

GUERNSEY MEMORIAL HOSPITAL

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

REPLY BRIEF FOR THE PETITIONER

1. Respondent attempts to defend the court of appeals’

broad holding that the Secretary’s regulations require

application of generally accepted accounting principles

(GAAP) to resolve every reimbursement issue, in the

absence of a specific regulation to the contrary with

respect to a particular issue. See Br. in Opp. 12-21. As we

explain in the certiorari petition (Pet. 14-22), however,

nothing in the text or background of the pertinent regula-

tions supports that rule. The purpose of the reimburse-

ment principles set forth in the Secretary’s Provider

Reimbursement Manual! (PRM) (including PRM Section

233, which addresses advance refunding transactions) is to

' United States Department of Health & Human Services, Health

Care Financing Admi. istration, Medicare Provider Reimbursement

Manual (1987).

(1)

2

resolve reimbursement disputes arising under those long-

standing regulations. The very existence of (and pervasive

reliance on) the PRM in the day-to-day administration of

the Medicare Program demonstrates the fallacy of

respondent’s and the court of appeals’ view that the

Secretary has effectively delegated to the accounting

profession the power to prescr’»e and revise reimburse-

ment principles, and thereby to dictate the outcome of

reimbursement disputes under the massive and costly

Medicare program.’ See Pet. 15.

If the Secretary had intended that GAAP would trump

even express provisions of the PRM, surely the reg-

ulations or the PRM itself would have said so. In fact,

however, the foreword to the PRM states (at I) that GAAP

should normally be applied in determining reimbursable

costs where the Secretary's guidelines and policies do not

supply a contrary rule. See also American Medical Int'l,

Inc. v. Secretary of HEW, 466 F. Supp. 605, 624 n.21

(D.D.C. 1979). Moreover, the Commissioner of Social

Security formally explained the operation of the regula-

tory scheme in this manner in 1976 when he promulgated

certain reimbursement rules relating to equity capital,

stating (41 Fed. Reg. 46,292 (emphasis added)):

[Gjenerally accepted accounting principles are

applicable to Medicare cost determinations only when

a cost situation is not covered by 20 C.F.R. Part 405

{now 42 C.F.R. Part 413] or the Provider Reimburse-

* The Medicare regulations were promulgated before the accounting

profession had adopted an exclusive GAAP standard for accounting for

advance refunding transactions. See Early Extinguishment of Debt,

Accounting Principles Board Opinion No. 26 (APB 26) 4% 4-10

(Accounting Principles Bd. 1972) (describing alternate methods in gen-

eral use before adoption of exclusive method by APB 26). Respondent's

thesis must therefore be that although the Secretary’s method of

accounting for such transactions was permissible under her regulations

at the time they were issued, it ceased to be permissible at the moment

the Accounting Principles Board promulgated APB 26. See Br. in Opp.

17 n.6.

0 ee ee ee

3

ment Manual. It is only in the absence of health

insurance program policy that generally accepted

accounting principles should be followed.

That reasonable interpretation of the Secretary’s own

regulations is entitled to “controlling weight.”* See

Stinson v. United States, 113 S. Ct. 1913, 1919 (1993).

2. In the alternative, respondent attempts to defend the

court of appeals’ decision by asserting that the longstand-

ing regulatory scheme implementing the Medicare

program distinguishes for present purposes between

whether and when particular costs incurred by a provider

will be reimbursed. In respondent’s view, the regulations

do not require use of GAAP in determining whether costs

will be reimbursed, but generally do require use of GAAP

with respect to timing. The regulations on which respon-

dent relies draw no such distinction. They speak only of

“[s|tandardized * * * accounting *** and reporting

practices,” 42 C.F.2. 413.20(a), and of “the accrual basis of

accounting,” 42 C.F.R. 413.24(a). If, as respondent claims,

those regulations require the Secretary to apply GAAP in

determining Medicare reimbursements, they provide no

basis for her to distinguish, in doing so, between “charac-

terization” and “timing” issues.

Moreover, even a proper cost of care is “allowable”

under Medicare only with respect to the particular period

* Respondent cites (Br. in Opp. 18) a court’s passing characteriza -

tion of the Secretary's position in HCA Health Services of Midwest, Inc.

v. Bowen, 869 F.2d 1179, 1181 (9th Cir. 1989), for the proposition that

the Secretary has switched her position depending on which interpreta-

tion of the regulations helped her cause in particular litigation. That is

incorrect. The Secretary has never disputed that GAAP provides

standard accounting rules that may be useful in determining proper

Medicare reimbursement (as well as for general recordkeeping and

financial reporting purposes) where the regulations and the PRM do not

prescribe a particular rule. So far as we are aware, however, the

Secretary has never taken the position that her regulations require

application of GAAP for reimbursement purposes where, as here, she

has prescribed a contrary interpretation. We have reviewed the gov-

ernment’s brief in HCA, and it is fully consistent with that position.

4

in which the provider rendered the care to which the cost

relates; and the determination of when a cost relates to

the provision of patient care is as fundamental as the

determination of whether it relates to patient care at all.

See generally 42 C.F.R. 413.9 (cost determination);

413.24(d) and (f), 413.50, 413.53 (apportionment); 413.60(b),

413.64(b) (estimated and final payments); see also Research

Medical Center v. Schweiker, 684 F.2d 599, 603 (8th Cir.

1982) (deferring to PRM capitalization requirement for

interest on construction loans because spreading costs

over several years best reflects benefit of constructed

facility to Medicare beneficiaries). Medicare reimburse -

ment is made on an annual basis, following review of the

provider's annual cost report. See Good Samaritan Hosp.

v. Shalala, 113 S. Ct. 2151, 2157 (1993); Bethesda Hosp.

Ass'n v. Bowen, 485 U.S. 399, 400-401 (1988). It is based on

“the actual cost of services furnished to beneficiaries

during the year.” 42 C.F.R. 413.9(b) (emphasis added).

Accordingly, the central issue in reviewing a provider's

report is what costs may properly be reimbursed by

Medicare for that cost year. The reason why costs might

not be reimbursable for the particular cost year has no

bearing on whether the Secretary is obligated to look

outside her own policy directives under the Medicare

Program—to GAAP—in order to resolve that issue.

3. Respondent repeatedly refers to “the accrual basis

of accounting” as though that term were synonymous with

GAAP. See, e.g., Br. in Opp. 14, 16, 20-21. It is not. Both

as a matter of normal usage and as defined in the relevant

regulation itself, accrual accounting describes any system

under which “revenue is reported in the period when it is

4 Indeed, as pointed out in the petition, the apportionment of a

provider's otherwise allowable costs between Medicare and non-Medi-

care patients may vary substantially from period to period (because, for

example, of fluctuations in the provider's patient mix). Shifting such

costs between periods may therefore have an equally substantial effect

on the amount that is actually reimbursable under Medicare. See Pet.

21, 26 n.15.

5

earned, regardless of when it is collected, and expenses are

reported in the period in which they are incurred,

regardless of when they are paid.” 42 C.F.R. 413.24(b)(2).

That definition is broad, and excludes primarily “cash-

basis” accounting, under which revenues are reported

when collected, and expenses when paid.

Respondent’s bald assertion that “[t]here are no

‘versions’ of accrual accounting” (Br. in Opp. 17) is simply

wrong. “Cost” or “management” accounting, for example

—that is, accounting that is designed to provide current

and often specialized financial information for management

purposes—is generally based on accrual principles, but is

not governed by GAAP. See generally D. Keller, J.

Bulloch & R. Shultis, Management Accountants’ Hand-

book 1.2-1.3 (4th ed. 1992). Accrual (not cash-basis, com-

pare Br. in Opp. 20-21) accounting for state and local

governments and their proprietary activities may be

governed by the standards of the Governmental Account -

ing Standards Board (GASB), which differs from the

GAAP applicable to private entities—but which in fact

constitutes “GAAP” for those entities to which it applies.®

See generally R. Kay & D. Searfoss, Handbook of

Accounting and Auditing 31-4 to 31-10 (2d ed. 1989); M.

Dittenhofer, Applying Government Accounting Princi-

ples § 1.03[2] (1990) (“only the standards promulgated by

the GASB have the status of GAAP for state and local

governments”); id. at §§ 9.03-9.04 (discussing “accrual”

and “modified accrual” accounting); A. Afterman & R.

Jones, Governmental Accounting and Auditing Dis-

closure Manual § 1 (1992). And in areas where a particular

GAAP standard has not been established, or where GAAP

recognizes more than one approach, a variety of quite

different approaches may be recognized as legitimate

® As noted in the petition (at 18 n.11), the GASB’s Statement of

Governmental Accounting Standards No. 23 requires covered entities to

report gains and losses on advance refunding transactions on a deferred

basis very similar to that required by the Secretary for purposes of

Medicare reimbursement.

6

methods of accrual-basis accounting. See, e.g., APB 26, 14

4-10; see also note 2, supra. Thus, even if the regulations’

requirement that providers keep financial data “on the

accrual basis of accounting” (42 C.F.R. 413.24(a)) were

interpreted to constrain the Secretary's discretion in

making use of those data in determining appropriate

Medicare reimbursements, it could not be read to require

her to defer specifically to GAAP in making those

determinations. °®

4. Respondent argues (Br. in Opp. 17-18) that the “cost

finding” provisions of 42 C.F.R. 413.24 demonstrate that

the same Section’s references to “the accrual basis of

accounting” apply to the Secretary’s reimbursement

determinations, rather than simply to the way in which a

provider’s records must be maintained. The “cost finding”

required by the regulations refers to the process of

apportioning general and indirect costs (such as many

administrative costs) to recognized cost centers for

purposes of Medicare reimbursement. See generally 42

C.F.R. 413.24(d). That process merely requires the

provider to reorganize some of its normal finz.ncial data in

a way specifically designed to help identify which of its

costs for the relevant period—all of which are presumably

6 Respondent’s defense of the court of appeals’ holding that PRM

Section 233, which prescribes non-GAAP treatment for advance refund-

ing gains and losses, is a “substantive” rather than an “interpretative

rule (Br. in Opp. 21-24) makes clear that the argument rests entirely on

the proposition that the Medicare regulations require application of

GAAP in the absence of a specific statute or regulation to the contrary.

Respondent’s argument (Br. in Opp. 24) based on 42 U.S.C. 1395hh(a)(2)

rests on the same proposition—that PRM Section 233 “changes a

substantive legal standard governing * * * the payment for services,

because (in respondent’s view) the general regulations “establish, is a

baseline, that reimbursement determinations will be made in accor-

dance with GAAP. Both arguments thus depend in turn on the equation

that respondent posits between GAAP and “the accrual basis of

accounting” within the meaning of 42 C.F.R. 413.24(a). See, e.g., Br. in

Opp. 21, 23. As discussed above and in the petition, however, that

equation is fallacious.

~ a

7

legitimate under GAAP—are allowable under the special

standards of the Medicare program. If the requirement

that providers “recast” their basic financial data in that

way in preparing their Medicare cost reports has any

larger significance, it is to refute respondent’s simplistic

assertion (Br. in Opp. 15) that -ction 413.20(a) of the

regulations somehow guarantees that in order to be

entitled to reimbursement, providers need do no more than

present the Secretary with their “basic accounts, as

usually maintained.”?

5. a. The court of appeals’ erroneous ruling warrants

review by this Court. In attempting to distinguish the

conflicting cases cited in the petition (Pet. 11-14), respon-

dent contends that those decisions “address whether or

not a certain type of cost is allowable” (Br. in Opp. 9), and

accuses the Secretary of “confus[ing] the issue of cost

allowability with the issue of the timing of reimbursement

for allowable costs.” /d. at 8. It is of course true that in

* Respondent also notes (Br. in Opp. 14) that the certiorari petition

does not discuss 42 C.F.R. 413.5(b)(1). The court below did not cite that

Section in support of its holding, and it is without relevance. Section

413.5(b)(1) states a general principle of current payment for expenses as

they are incurred, which is implemented by specific interim payment

and retroactive adjustment provisions. See 42 C.F.R. 413.60, 413.64;

Good Samaritan Hosp. v. Shalala, 113 8. Ct. at 2155-2156. It has

nothing to do with determining when expenses are incurred (a central

question of accrual accounting), so that “current payment” becomes

appropriate. Indeed, read in isolation, the “current payment” language

would suggest a rule of cash-basis reimbursement —that is, payment

shortly after the provider is forced to “put up money for the purchase of

goods and services.” 42 C.F.R. 413.5(b)(1). As respondent itself points

out, however, the cash outlays relevant to this case took place

primarily in 1972 and 1982. Br. in Opp. 4. Respondent and the

Secretary agree that Medicare reimbursement with respect to those

cash expenditures is appropriately spread out over many years after

they took place. The only question at the time of refunding is whether

the original costs that remain unrecovered (as well as certain costs of

the refunding itself) should continue to be recognized on the original

schedule, or be accelerated into the year of the refunding. Section

413.5(b)(1) provides no guidance on that question.

8

most advance refunding cases, including this one, there is

no dispute as to the overall refunding loss (or gain)

realized by a Medicare provider, the question 1s, instead, in

which accounting period or periods that loss should be

taken into account (or “allowed”) for purposes of Medicare

reimbursement. See Pet. 25. As we have just explained

(see pages 3-5 supra), however, there is no relevant

distinction between that question of “timing” and the

question of “reimbursability vel non” (Br. in Opp. 10 (cita-

tion omitted)). Both are aspects of the same question

presented by this case: whether the Secretary's regula-

tions require that a provider's costs be reimbursed in all

respects—including timing--in accordance with GAAP.

In any event, respondent’s attempt to deny the existence

of a circuit conflict on the basis of its timing/allowability

distinction is unconvincing. To begin with, there was no

dispute in Methodist Hospital of Indiana, Inc. v. United

States, 626 F.2d 823 (Ct. Cl. 1980) (see Br. in Opp. 9) that

the pension costs at issue in that case were both (i)

reimbursable if properly accrued and (ii) properly accrued

for purposes of the provider's financial accounting. 626

F.2d at 824, 826. The decision stands cleanly for the

proposition that the Secretary need not defer to a financial

accounting determination of the proper timing of an

otherwise reimbursable cost.

Similarly, the issue in Richey Manor, Inc. v.

Schweiker, 684 F.2d 130 (D.C. Cir. 1982), was whether a

stock purchase should be treated as a purchase of assets

for Medicare purposes, thus allowing the purchaser to

allocate the stock price to the assets and recover it over

time through increased depreciation. Although the court

disposed of the case on other grounds, it made clear that

even if the transaction were properly characterized as an

asset acquisition for accounting purposes, that would not

determine the proper Medicare treatment. /d. at 135. And

the issue of accounting or reimbursement “symmetry on

ae ttt OD at.

.

Ld OE Ne es OR el he SO =

9

which that conclusion turned was as much one of “timing”

as one of “reimbursability vel non.”®

To be sure, some cases holding that GAAP does not

automatically govern the Secretary’s reimbursement

decisions deal with issues of characterization, rather than

timing. The courts in National Medical Enterprises, Inc.

v. Sullivan, 916 F.2d 542, 547 (9th Cir. 1990), cert. denied,

500 U.S. 917 (1991), and Sun Towers, Inc. v. Heckler, 725

F.2d 315, 328-329 (5th Cir.), cert. denied, 469 U.S. 823

(1984), rejected the contention that because “stock mainte-

nance” costs were recognized as legitimate administrative

expenses under GAAP, the Secretary was required to

treat them as reimbursable costs of patient care. As

explained above, however, the regulations on which

respondent relies draw no distinction between “characteri-

zation” and “timing” issues, and that distinction therefore

cannot detract from the conflict that exists over whether

the regulations require the use of GAAP in resolving

reimbursement questions.®

* As the court explained, allowing the buyer’s accounting treatment

to dictate reimbursement would “destroy the symmetry of the regula-

tory scheme” by allowing increased depreciation deductions to the

buyer in years after the purchase, without a corresponding recapture, in

the year of the sale, of depreciation deductions previously taken by the

seller. 684 F.2d at 135. The fundamental point is to allow only one

reimbursement for the original cost of the assets, either by denying

duplicative depreciation deductions (and corresponding cost reim-

bursements) to the buyer, or by balancing such future deductions (and

reimbursements) against a lump-sum recapture amount recognized as

income to the seller in the year of the sale. Either system must be

followed with respect to both buyer and seller in order to achieve

proper overall timing of depreciation reimbursements for the acquired

assets. The court indicated that it would defer to the Secretary's

resolution of that “timing” issue for Medicare reimbursement purposes,

without regard to the accounting treatment adopted by either party to

the transaction. Jbid. & n.5.

* A panel of the Fifth Circuit recently accepted the distinction of

Sun Towers proposed by respondent in this case, and reversed a

decision in favor of the Secretary on the advance refunding issue.

Mother Frances Hosp. v. Shalala, No. 93-4388 (5th Cir. Mar. 3, 1994),

10

b. Respondent does not seriously attempt to refute our

submission (Pet. 24-27) that this case presents an issue of

substantial practical and legal importance. Indeed, re-

spondent concedes (Br. in Opp. 25) that the petition

“conclusively demonstrates” the importance of the issue

to providers—and, by the same token, to the Secretary.

Beyond that concession, respondent merely restates the

premise that Section 233 of the PRM works a substantive

change in reimbursement rules established by the general

Medicare regulations, and on that basis argues that the

decision below is unremarkable in requiring compliance

with the notice-and-comment requirements of the Admin-

istrative Procedure Act. Br. in Opp. 25-26. It is precisely

by adopting that false premise, however, that the court of

appeals has threatened both normal principles of deference

to the Secretary’s interpretation of her own regulations

implementing a complex benefits program, and the impo-

sition of substantial unjustified monetary liability on the

federal government. As set forth in the petition, those

threats warrant review by this Court, especially in view of

the continuing circuit conflict on the basic question

presented.

For the foregoing reasons and those stated in the peti-

tion, the petition for a writ of certiorari should be granted.

Respectfuliy submitted.

Drew S. Days, Ill

Solicitor General

MARCH 1994

slip op. 2838-2839; compare Pet. 14 n.9. We obviously disagree with the

panel’s reading of Sun Towers, as well as with its decision on the

merits. We also note that respondent’s reliance (Br. in Opp. 10-11, 16)

on decisions of the Provider Reimbursement Review Board is

misplaced. Each of the Board’s advance refunding decisions has been

reversed by the Secretary’s designate; and it is the Secretary, not the

Board, to whose expertise deference is due. E.g., Sun Towers, 725 F.2d

at 326; St. Francis Hosp. Ctr. v. Heckler, 714 F.2d 872, 874 (7th Cir.

1983); ef. Martin v. OSHRC, 499 U.S. 144, 152-153 (1991).