Amicus Curiae Brief — Shalala v. Guernsey Memorial Hospital

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_ No. 93-1251

Supreme Court of t the Hnited States

OCTOBER TERM, 1993

DONNA E. SHALALA,

Secretary of Health and Human Services,

Petitioner,

VS.

GUERNSEY MEMORIAL HOSPITAL,

Respondent.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

BRIEF AMICI CURIAE OF THE

AMERICAN HOSPITAL ASSOCIATION,

THE FEDERATION OF AMERICAN HEALTH

SYSTEMS, THE CALIFORNIA ASSOCIATION

OF HOSPITALS AND HEALTH SYSTEMS,

AND THE TEXAS HOSPITAL ASSOCIATION

IN SUPPORT OF RESPONDENT

ROBERT A. KLEIN

’ Counsel of Record

DENISE RIOS RODRIGUEZ

AMY B. HAFEY

WEISSBURG AND ARONSON, INC.

2049 Century Park East, Suite 3200

Los Angeles, California 90067 > —-—

(310) 277-2223

Lawyers Brief Service * Appellate Brief Printers * (213) 613-1013 * (714) 720-1510

eT ”

FREDRIC J. ENTIN

JOHN E. STEINER, JR.

Office of General Counsel

AMERICAN HOSPITAL ASSOCIATION

840 N. Lakeshore Drive

Chicago, Illinois 60611

(312) 280-6000

MARY R. GREALY

Deputy Director and

Executive Counsel

FEDERATION OF AMERICAN

HEALTH SYSTEMS

1111 19th Street, N.W., Suite 402

Washington, D.C. 20036

(202) 833-3090

CHRISTINE R. HALL

General Counsel

CALIFORNIA ASSOCIATION OF

HOSPITALS AND HEALTH SYSTEMS

1201 K Street, Suite 800

Sacramento, California 95814

(916) 443-7401

CHARLES W. BAILEY

General Counsel

TEXAS HOSPITAL ASSOCIATION

6225 Highway 290 East

Austin, Texas 78723

(512) 465-1038

af<

QUESTIONS PRESENTED

1. Whether the Secretary of Health and Human Ser-

vices’ denial of respondent's claim for its reasonable

costs incurred according to generally accepted account-

ing principles or GAAP conflicts with Medicare

regulations.

2. Whether, if Medicare regulations do not require

GAAP be used to determine Medicare allowable costs, a

guideline relied upon by the Secretary to deny reim-

bursement is invalid under the Medicare Act and the

Administrative Procedure Act.

QUESTIONS PRESENTED ...

TABLE OF CONTENTS

TABLE OF AUTHORITIES...........

INTEREST OF AMICICURIAE.........

SUMMARY OF ARGUMENT .........

PP as ee ee ee

THE SECRETARY'S MEDICARE REGU-

LATIONS REQUIRE GAAP AND AC-

CRUAL BASIS ACCOUNTING BE USED

IN DETERMINING MEDICARE COSTS

UNLESS OTHERWISE PROVIDED BY

RE ccc en eoeeees

A. The Secretary's Construction Of

Her Regulations Violates Their

ee eee

B. The Secretary's Agency Deci-

sions Are Inconsistent With Her

Present Construction Of The

ee ee

SECTION 233 OF THE PROVIDER

REIMBURSEMENT MANUAL IS _IN-

VALID FOR FAILURE TO COMPLY

WITH THE REQUIREMENTS OF THE

MEDICARE ACT AND THE ADMIN-

ISTRATIVE PROCEDURE ACT .....

CONCLUSION

The Medicare Statute And The

APA Require That Substantive

Rules Regarding Reimbursement

Be Established By Regulation. .. .

Section 233 Is Not An Interpre-

ED i a ee ean ee’

Failure to Comply With APA

Procedural Requirements Is Incon-

sistent With The Intent of Con-

Ss cwe es ee 0 6 8 Oe 8

Page

-iv-

TABLE OF AUTHORITIES

Page

Cases

Abington Memorial Hosp. v. Heckler,

576 F. Supp. 1081 (E.D. Pa. 1983), aff'd,

Abington Memorial Hosp. v. Heckler,

750 F.2d 242 (3d Cir. 1984), cert. denied,

sub nom. Heckler v. Abington Memorial

Hosp., 474 U.S. 863 (1985) ........... 29

American Mining Congress v. Mine Safety

and Health Administration,

995 F.2d 1106 (D.C. Cir. 1993) ....... 23, 24

Batterton v. Francis,

EE A a ee 19

Bowen v. Georgetown Univ. Hosp.,

ee eee ee 19

Charlotte Memorial Hosp. & Med. Center v. Bowen,

860 F.2d 595 (4th Cir. 1988)... ........ 5

Community Nutrition Inst. v. Young,

818 F.2d 943 (D.C. Cir. 1987)... ....... 25

General Motors Corp. v. Ruckelshaus,

742 F.2d 1561 (D.C. Cir. 1984),

cert. denied, 471 U.S. 1074(1985). ....... 22

Good Samaritan Hosp. v. Shalala,

fe & e 17, 19, 24

Guernsey Memorial Hosp. v. Sullivan,

796 F. Supp. 283 (S.D. Ohio 1992) ....... 11

ee

Page

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

869 F.2d 1179 (9th Cir. 1989). ....... 5, 16

K Mart Corp. v. Cartier, Inc.,

Ce a a ee 11

Lincoln v. Vigil,

2 c's 5 6 6 6-0 «9-08 18

Linoz v. Heckler,

800 F.2d 871 (9th Cir. 1986)... ...... 26, 28

McLouth Steel Prod. Corp. v. Thomas,

838 F.2d 1517 (D.C. Cir. 1988) ......... 27

Mercy Hospital v. Sullivan (D. Me. 1991),

Medicare & Medicaid Guide (CCH) 440,227 .. 7

Morton v. Ruiz,

rr re og rs ene 6S oe eee 18

Mother Frances Hosp. of Tyler, Texas v. Shalala,

15 F.3d 423 (Sth Cir. 1994) .... .... 5,28

Mt. Diablo Hosp. Dist. v. Bowen,

860 F.2d 951 (9th Cir. 1988)... ...... 25, 28

NLRB v. Wyman-Gordon Co.,

DE Pins « b's o 5 ¢ 0 2 0 0 #8 8 27

National Family Planning & Reproductive

Heaith Ass'n Inc. v. Sullivan,

979 F.2d 227 (D.C. Cir. 1992). ....... 26, 28

National Medical Enterprises v. Bowen,

851 F.2d 291 (9th Cir. 1988)... ...... 5, 16

- Vi -

Page

Natural Resources Defense Council v. U.S.

Envil. Protection Agency,

824 F.2d 1258 (Ist Cir. 1987)... ......., 29

OrNda HealthCorp v. Shalala (E.D. Ark. 1993),

Medicare & Medicaid Guide

eg ro 16

Rosetti v. Shalala,

12 F.3d 1216 (3rd Cir. 1993)... ........, 18

Samaritan Health Serv. v. Bowen,

811 F.2d 1524 (D.C. Cir. 1987) ........., 28

Schweiker v. Gray Panthers,

a 1 on i ok a 19

Sentara-Hampton Gen. Hosp. v. Sullivan,

980 F.2d 749 (D.C. Cir. 1992)... 2... . 22-23

State of Ohio Dep't of Human Serv. v. United

States Dep't of Health & Human Seryv.,

862 F.2d 1228 (6th Cir. 1988). ..... 25, 26, 28

United States v. Picciotto,

875 F.2d 345 (D.C. Cir. 1989)... ........, 21

Villa View Community Hosp., Inc. v. Heckler,

720 F.2d 1086 (9th Cir. 1983). ........ 5-6

W.C. v. Bowen,

807 F.2d 1502 (9th Cir. 1987)... ..... 25, 28

- Vii -

Page

Agency Decisions

Biscayne Medical Center v. Blue Cross

Association, et al.,

HCFA Admin. Dec. (1982),

Medicare & Medicaid Guide

SE os kk we 0 6 6 6 Woe Sees 15

Broadway Community Hosp. v. Blue Cross

Ass'n, et al.,

PRRB Dec. No. 82-D94 (1982),

Medicare & Medicaid Guide

EE ae ae a 15

Comprehensive Home Health Care, Inc. v.

Blue Cross and Blue Shield Ass'n, et al.,

PRRB Dec. No. 91-D21 (1991),

Medicare & Medicaid Guide

Cn + 6 bb 6 616 pe ws eee 8 4 16

Dr. David M. Brotman Memorial Hospital v.

Blue Cross Association, et al.,

HCFA Admin. Dec. (1980),

Medicare & Medicaid Guide

CI» «dtp eos tees eesv es 14

Greene County General Hosp. v. Blue Cross

and Blue Shield Ass'n, et al.,

PRRB Dec. No. 86-D38 (1985),

Medicare & Medicaid Guide

| RE ee ee 16

” HCA Home Office Stock Option Group Appeal v.

| Blue Cross and Blue Shield Association, et al.,

PRRB Dec. No. 85-D49 (1985),

Medicare & Medicaid Guide

ee) bY ee ee 15

- Vill -

Page

Methodist Hosp. of Lexington, Inc. v. Blue

Cross & Blue Shield Ass'n,

HCFA Admin. Dec. (1991),

Medicare & Medicaid Guide (CCH), ¥ 39,469

aff'd, Methodist Hosp. of Lexington, Inc.

v. Sullivan, C.V. No. 91-2684-HB

(W.D. Tenn. 1993)

National Medical Enterprises, Inc. Group Appeal,

PRRB Dec. No. 93-D2 (1992),

Medicare & Medicaid Guide

(CCH) { 40,933

Rapides General Hospital v. Blue Cross Ass'n,

et al., PRRB Dec. No. 82-D35 (1982),

Medicare & Medicaid Guide

Ee A 15-16

Republic Health Group Appeal - Favorable Leasing

v. Blue Cross and Blue Shield Ass'n, et al.,

PRRB Dec. No. 93-D11 (1993),

Medicare & Medicaid Guide

re Te Se 16

Woodland Park Hosp. v. Blue Cross and

Blue Shield Ass'n, et al.,

PRRB Dec. No. 91-D30 (1991),

Medicare & Medicaid Guide

(CCH) { 41,332

Woodruff Community Hospital v. The

Travelers Ins. Co..,

PRRB Dec. No. 91-D40 (1991),

Medicare & Medicaid Guide

(CCH) { 39,208

Page

Statutes

Administrative Procedure Act,

OD os 6c oe 6 90% ob 0 0 a we 18

ed ee ae ee ee 2

hn ee 0. ee ea ee 22

2 SS a a er ae ae 18

Social Security Act,

og Pa a ae ae ee ee ee 19

42 U.S.C.§§ 1395-1395ccc. .. .. 2 2 ee ee |

42 U.S.C. § 1395x(v)(1M A)... ----- passim

GOR we ee be oe ews 6 8 88 20-21, 28

42 U.S.C. § 1395hh(a)(2) ....--- ee ees 28

42 U.S.C. § 1395ww(g)(1)(A). . - . - - 2 ee 4

42 U.S.C. 6 190GeAMIT) . 0 ww ww ee we 25

42 U.S.C. § 1396a(aX(17)(B). ...--- +s: 19

Regulations

20 C.F.R. Pt. 405 (1968)

Sections 405.401-405.454 ......6-+ 2 eee 5

36 C.F.R. § 796(g)(S)(xili) . 2. ee 21

42 C.F.R. Pt. 405

Sections 405.401 et seg... . 2... 2 see ees 5

ie ee og 6k we 10, 14

Section 405.406(a). ........-++. 9, 14, 15

es a Sg 9 6 Cele ek ee 10

sg gee oe ows 10, 14, 15

Section 405.453(a) and(b). ........+.+.-s 15

= x -

Page

ee CS i al 4,5,10

er ee 20

eign S Cogs gma eee See 20, 24

kg a a a So ee 22

2 ee ae 24

ee se es Cae 5, 26

CE ee 5, 10, 11, 17

ee 6,7, 8,11, 14

I so Se 0 oe ee 12

I 5g a0 5 Oe 8

Section 413.20(d)(2)(vii). .. .....2.2.242.. 8

a ere 5,9, 10, 11, 14, 17

I gg ee 9

RR IE le ky Sp i)

ESL ae a a 7)

I oc ste cS a Tee 12

TS oe nen 5

ee tah 5

SE ES ae a ao br 20

ET ae 5, 26

Oe 26

EEE a a aA eS 20

Section 413.153(b)(2)(iii) . . . 2 2 26

WU a i uk cw we we se blk 5

Federal Registers

31 Fed. Reg. 14,808 (Nov. 22,1966). ........ 5

36 Fed. Reg. 2532 (Feb. 5,1971).......-¢-... 22

41 Fed. Reg. 46,291 (Oct. 20,1976) ....... 12, 27

42 Fed. Reg. 52,826 (Sept. 30,1977). ........, 5

51 Fed. Reg. 34,794 (Sept. 30,1986). ........ 5

56 Fed. Reg. 50,834 (Oct.9,1991).......... 27

59 Fed. Reg. 20,312, 20,388 (Apr. 25, 1994)... .. 27

- Xi -

Page

Manuals

Provider Reimbursement Manual, Foreword . . .11, 21

Provider Reimbursement Manual § 233... . . passim

Provider Reimbursement Manual, Part II, Ch. 28. . .12

Legislative History

Social Security Amendments of 1965,

S. Rep. No. 404, 89th Cong., Ist Sess. (1965)

reprinted in U.S.C.C.A.N. at1976........ 30

Social Security Amendments of 1983,

Pub. L. No. 98-21, §§ 601-607,

97 Stat. 149-172-(1963) . 0... 2 ee ew ee ee 4

Omnibus Budget Reconciliation Act of 1987,

H. Rep. No. 100-391(1), 100th Cong.,

Ist Sess. § 4073 (1987) reprinted in

if Fed od Sb 8. GU a 28

Miscellaneous

American Institute of Certified Public

Accountants, Audits of Providers of

Health Care Services, § 3.01 (1993)....... 7

Robert A. Anthony, Interpretive Rules,

Policy Statements, Guidance,

Manuals, And The Like — Should

Federal Agencies Use Them To Bind

The Public? 41 Duke L.J. 1311 (1992). ..... 28

~ Xii -

Attorney General’s Manual on the Adminis-

trative Procedure Act (1947). ........ 18,

Kenneth C. Davis, Administrative Law Treatise,

Sw Gees PD ks bes sk Kee ewe ek

HCFA Form 2552-92 (9/93), reprinted in

Medicare and Medicaid Guide (CCH),

Report No. 773 (Oct. 29, 1993)

© Sm A be i ee! Oo

INTEREST OF AMICI CURIAE

With the written consents of both parties, which have

been filed with the Court, amici curiae respectfully

submit this brief in support of respondent Guernsey

Memorial Hospital.

Amici curiae are four hospital associations. The

American Hospital Association (“AHA”), an Illinois

corporation, is the primary organization of hospitals in

the United States. AHA represents approximately 5,400

hospitals and other health care institutions. The Federa-

tion of American Health Systems, a New York corpora-

tion, represents approximately 1,400 investor-owned

hospitals and 350 managed hospitals throughout the

country. The California Association of Hospitals and

Health Systems and the Texas Hospital Association are

organized under the laws of their respective states and

are the statewide hospital organizations in their states.

Amici’s members include most of the nation’s hospitals.

The overwhelming majority of amici’s institutional

members participate as providers of services in the

Medicare program. 42 U.S.C. §§ 1395-1395ccc. Pay-

ments made to hospitals on behalf of beneficiaries of the

Medicare program account for approximately 40% of the

revenue of most member hospitals. Reimbursement for

services furnished to Medicare beneficiaries is a major

factor considered by such hospitals in their financial

planning, and can affect the continued ability of hospi-

tals to provide needed services to Medicare beneficiaries

and others in the community. Accordingly, amici have-

an immediate and continuing concern regarding the

consistent application of the Medicare statute and im-

plementing regulations, as well as the integrity and

reliability of the procedures used to implement changes

a

in the reimbursement rules applicable to Medicare

providers.

At issue in this case is an attempt by the Secretary of

Health and Human Services (“Secretary”) to avoid her

own regulations regarding accrual basis accounting and

generally accepted accounting principles (“GAAP”), as

well as her attempt to bypass the rulemaking require-

ments of the Administrative Procedure Act, 5 U.S.C.

§ 551 et seg. (“APA”), in her administration of the

Medicare program. Amici suggest that the Court reject

the Secretary’s efforts to reinterpret her rules regarding

the applicability of GAAP to Medicare cost determina-

tions. Moreover, the Court should reject the Secretary’s

attempt to issue legislative rules through the Provider

Reimbursement Manual (“PRM”) without regard to

rulemaking procedures. Instead, this Court should adopt

the reasoning of the court of appeals below, which prop-

erly applied the clear terms of the Secretary’s regula-

tions addressing GAAP, and which is consistent with the

APA and the critically important policy considerations

underlying it. ;

SUMMARY OF ARGUMENT

As the court of appeals found below, the Secretary

seeks to avoid the plain terms of her Medicare regula-

tions which provide that Medicare costs are to be deter-

mined in accordance with GAAP. These regulations do

not exist simply by reason of the Secretary’s general

rulemaking authority, but were specifically mandated by

the Medicare statute which requires the issuance of

regulations to establish the method or methods to be

used to determine Medicare costs.

In claiming that the regulations at issue here do not

provide for GAAP, neither the final agency decision

~ =

below, nor the Secretary’s brief here, addresses the

terms of her regulations. Read as a whole, the regula-

tions create a direct relationship between provider books

and records maintained in accordance with GAAP and

the determination of Medicare costs. They specifically

link provider records to the cost determination process.

For many years, final agency decisions have inter-

preted the regulations in question to require the appli-

cation of GAAP in determining Medicare costs. The

Secretary has argued before the courts that GAAP ap-

plies pursuant to her regulations, particularly where

GAAP would reduce Medicare costs. The Secretary has

taken inconsistent positions regarding the application of

GAAP under her regulations, however, depending on her

litigating strategy.

The Secretary’s current interpretation of the regula-

tion is designed to avoid the notice and comment

rulemaking requirements of the APA. If the regulations

do not establish GAAP as the primary basis for deter-

mining Medicare costs, the Secretary asserts that she

need not comply with the APA in issuing rules that are

inconsistent with GAAP. Because Congress has directed

the Secretary to exercise her legislative rulemaking

authority through regulations, however, she is not free to

establish a method of determining costs through a mere

interpretive rule. The rule at issue in this case is a sub-

stantive rule that can be adopted only in accordance with

the procedural requirements of the APA. Any other

result would seriously threaten the integrity of the

rulemaking process.

_

ARGUMENT

I. THE SECRETARY’S MEDICARE REGULA-

TIONS REQUIRE GAAP AND ACCRUAL

BASIS ACCOUNTING BE USED IN DETER-

MINING MEDICARE COSTS UNLESS OTHER-

WISE PROVIDED BY REGULATION.

A. The Secretary’s Construction Of Her

Regulations Violates Their Clear Terms.

The Medicare statute, 42 U.S.C. § 1395x(v)(1)(A),

requires that the actual reasonable costs incurred by

providers for services to beneficiaries “shall be deter-

mined in accordance with regulations establishing the

method or methods to be used... .”! Regulations im-

plementing this mandate appear at Title 42 C.F.R., Part

| Effective for cost reporting periods beginning on and after

October 1, 1983, Medicare directed that most hospitals in the

country be paid their operating costs, not on the basis of their

reasonable cost, but on the basis of prospectively determined rates.

However, the Secretary continued to pay certain costs, including

costs defined as capital-related costs, on the basis of reasonable

costs actually incurred. Social Security Amendments of 1983, Pub.

L. No. 98-21, §§ 601-607, 97 Stat. 149-172 (1983). The costs

involved in this case are deemed by the Secretary to be capital-

related costs and were paid on a reasonable cost basis. For cost

reports beginning on or after October 1, 1991, capital-related costs

are also paid on a prospectively determined basis. See 42 U.S.C.

§ 1395ww(g)(1)(A).

Because virtually all costs of hospital inpatient services are now

paid under Medicare's prospective payment system, the future

significance of the specific regulations at issue in this case is greatly

diminished. The issue of whether the Secretary is required to issue

regulations with respect to Medicare’s payment system remains of

extreme importance to amici and its members.

Becca eel he Ee et

of.

413, and are entitled “Principles of Reasonable Cost

Reimbursement.”

_ Although amended and supplemented, these principles

have been in place since the beginning of the Medicare

program. See 31 Fed. Reg. 14,808 (Nov. 22, 1966),

codified at 20 C.F.R. §§ 405.401-405.454 (1968).?_ The

reimbursement regulations address the specific treatment

of certain kinds of costs such as depreciation, interest,

costs associated with bad debts, costs involving trans-

actions between related organizations, and costs of edu-

cational facilities. See 42 C.F.R. §§ 413.134, 413.154.

413.80, 413.17 and 413.85 (1993), respectively. In

addition to the specific cost matters addressed, the regu-

lations have, since the program’s beginning, addressed

provider financial records and the application of accrual

basis accounting for purposes of determining allowable

costs. These latter regulations are found at 42 C.F.R.

§§ 413.20 and 413.24.

The Secretary claims that these sections by their terms

do not require the use of GAAP and accrual basis ac-

counting to determine Medicare costs.’ Brief for the

2 These regulations were recodified at 42 C.F.R. § 405.401 et seq. in

1977. See 42 Fed. Reg. 52,826 (Sept. 30, 1977). In 1986, the

regulations were redesignated at 42 C.F.R. Part 413. See 51 Fed.

Reg. 34,794 (Sept. 30, 1986).

> The overwhelming weight of authority, including the court of

appeals below and three other federal courts of appeals, have

disagreed with the Secretary and found that the regulations at

§§ 413.20 and 413.24 mandate the use of GAAP and accrual basis of

accounting in determining how Medicare costs are paid. See, e.g.,

Mother Frances Hosp. of Tyler, Texas v. Shalala, 15 F.3d 423 (Sth

Cir. 1994); HCA Health Services of Midwest, Inc. v. Bowen, 869

F.2d 1179, 1181 (9th Cir. 1989); Charlotte Memoria! Hosp. & Med.

Center v. Bowen, 860 F.2d 595, 600 (4th Cir. 1988); National

Medical Enterprises v. Bowen, 851 F.2d 291 (9th Cir. 1988); Villa

(continued)

ne

Petitioner (“Pt. Br.”) at 27. Instead, she claims these

regulations only impose record-keeping requirements on

hospitals. But her argument makes only passing refer-

ence to the actual terms of these regulations and ignores

their requirements in the context of the regulatory

scheme.

As the court of appeals in its decision below noted,

the language in 42 C.F.R. § 413.20(a) requiring that

hospitals follow standardized accounting practices that

are widely accepted in the hospital field, “does not exist

in a vacuum.” Appendix to Petitioner’s Brief (“Pet.

App.”) at lla. This requirement exists in the context of

the “principles of cost reimbursement” referred to in the

prior sentence of the regulation which requires “that

providers maintain sufficient financial records and statis-

tical data for proper determination of costs payable

under the program.” 42 C.F.R. § 413.20(a) (emphasis

added). The Secretary interprets this provision to re-

quire that financial records be maintained consistently

with widely accepted reporting practices, so that under

some other system-wide method of determining costs,

unstated in her regulations, the costs payable under the

program will be properly determined. Under the

Secretary’s construction, there is a vague relationship

between hospital financial records and the determination

of costs which does not appear in the regulations.

The district court in Maine dismissed the Secretary's

argument as requiring two separate accounting systems

to be maintained, stating:

(fn. continued)

View Community Hosp., Inc. v. Heckler, 720 F.2d 1086, 1093 n.18

(9th Cir. 1983).

~ Be

The [Secretary’s] argument is illogical. The

Secretary mandates certain record keeping

requirements precisely because the provider is

entitled to reimbursement of reasonable

costs.... To suggest that the Secretary re-

quired providers to seek reimbursement under

one accounting system while he intended to

make payment under another is contrary to the

structure of the regulations.

Mercy Hospital v. Sullivan, (D. Me. 1991), reported at

Medicare & Medicaid Guide (CCH) ¥ 40,227 at 30,603

(quoting St. Luke’s Hosp. v. Secretary of Health &

Human Serv., 632 F. Supp. 1387, 1391 (D. Mass. 1986),

vacated on other grounds, 810 F.2d 325 (1st Cir. 1987)).

Contrary to the Secretary’s position, her regulations

provide for a direct relationship between the mainte-

nance of hospital financial records and books of account

and the proper determination of costs payable under the

program. As noted, the first sentence of § 413.20(a)

addresses the principles of cost reimbursement which

require that sufficient data be maintained “for proper

determination of costs payable under the program.” This

sentence, standing alone, strongly suggests that the data

maintained by the provider is the basis for determining

costs. Next, according to the subsection, hospitals must

maintain their books and records in accordance with

standardized definitions, accounting, statistics and re-

porting practices that are widely accepted in the hospital

and related fields. Generally accepted accounting princi-

ples have always provided the standard definitions and

accounting practices applied by non-government hospi-

tals in maintaining their books and records. See, e.g.,

American Institute of Certified Public Accountants,

Audits of Providers of Health Care Services, § 3.01

(1993) (“Financial statements of health care entities

Should be prepared in conformity with generally ac-

cepted accounting principles.”) No other standardized

definitions exist for such hospitals or are widely ac-

cepted so far as is known to amici.

Immediately following the requirement that standard-

ized definitions, accounting, statistics, etc., be followed

is the provision that changes in hospital accounting

practices and systems will not be required “in order to

determine costs payable under the principles of reim-

bursement.” This sentence does not provide that a hos-

pital’s financial records will be adapted in some manner

to accommodate the methods to be announced by the

Secretary for determining costs. Instead, it reaffirms

that costs will be determined from the hospital’s finan-

cial records without requiring that those records be

modified.

The last sentence of § 413.20(a) states that “the meth-

ods of determining costs payable under Medicare in-

volve making use of data available from the institution’s

basic accounts, as usually maintained, to arrive at

equitable and proper payment for services to benefi-

ciaries.” The only natural reading of the sentence is that

the “basic accounts as usually maintained” form the

basis for determining costs payable under the program.”

Otherwise, how are the “basic accounts as usually main-

4

As the court of appeals below stated, the Secretary can, of course,

Sd from GAAP by validly issued regulations. See Pet. App. ai

a.

' Section 413.20(d) specifies provider record-keeping requirements

in some detail. It requires providers to furnish information to

intermediaries regarding several matters including costs of opera-

tion. 42 C.F.R. § 413.20(d)(2)(vii). Under the Secretary's construc-

tion, the record-keeping requirements of subsection (d) regarding

costs of operation are superfluous.

—

iBe

tained” involved in the methods of determining costs?®

The accrual accounting regulation at § 413.24 is even

more specific in its application to the determination of

costs to be paid by Medicare. Referring only to subsec-

tion (b) of this reguiation which defines the accrual basis

of accounting, the Secretary concludes that the regula-

tion addresses only the manner in which information

must be “reported” in a provider’s books, but not how it

is to be used in determining costs. See Pt. Br. at 24-25.

But the regulation is actually much more specific.

Subsection (a) refers to “cost data” which must be

provided to the Secretary to support payments to

providers for their reimbursable costs. The “cost data”

must be based on providers’ financial and statistical

records which can be verified by audit and must be

based on the accrual basis of accounting. See 42 C.F.R.

§ 413.24(a), (b). Subsection (e) of the regulation con-

firms that the cost data maintained in accordance with

the accrual basis of accounting is the basis on which

costs are determined. It provides that “[t}he cost data

submitted must be based on the accrual basis of account-

ing which is recognized as the most accurate basis for

determining costs.” (emphasis added). This statement,

coupled with the requirement that cost data must be

submitted on the accrual basis of accounting in order to

support payments to providers, leaves no doubt as to the

use of accrual basis accounting in the cost determination

© The Secretary answered this question in her brief to the court of

appeals for the ninth circuit by representing that “the regulations

provide that the essential methods of determining reimbursable costs

‘involve making use of data available from the institution's basic

accounts as usually maintained....’ 42 C.F.R. § 405.406(a).”

(emphasis added). See Brief for Appellee at 4-5 filed in HCA Health

Services of Midwest, Inc. v. Bowen, Secretary of Health and Human

Services, 869 F.2d 1179 (9th Cir. 1989).

«1.

process. Not even the Secretary’s reinterpretation can

avoid the regulation’s plain language which provides

that accrual basis accounting is the most accurate basis

for determining costs rather than merely a_ record-

keeping standard.

The claim that § 413.20 serves only a record-keeping

purpose is assertedly supported by reference to its origi-

nal placement at the end of what the Secretary considers

“prefatory sections” of the initial Medicare regulations.

Pt. Br. at 26. In fact, the Secretary has made clear that

this regulation is part of the reasonable cost reimburse-

ment rules. Prior to 1986, former § 405.406 (now

§ 413.20) was included with other regulations under a

center heading of “Reasonable Cost Reimbursement:

General Rules” and former § 405.453 (now § 413.24)

was grouped with other regulations under a center head-

ing of “Additional General Rules on Reasonable Cost

Reimbursement.” See 42 C.F.R. Part 413 (1984). The

center headings, while not a part of the regulations them-

selves, demonstrate that the Secretary considered these

regulations to be part of the general principles of reim-

bursement, and that they were intended to do more than

“provide general reassurance to providers” that their

accounting practices would not have to be changed. Prt.

Br. at 26.

Under the center headings, former §§ 405.406 and

405.453 were grouped with regulations which set forth

mandatory principles of reimbursement. For example,

immediately following former § 405.406, and under the

same center heading, was former § 405.414 which ex-

pressly limited the definition of, and reimbursement for,

capital-related costs in a manner which departed from

GAAP. See 42 C.F.R. § 405.414 (1984). Similarly, the

placement of § 405.453 with a group of regulations

under the center heading “Additional General Rules on

i a. ee en se ee wr |

ee ee eee

Oa 8 AE BIE yO a El AT wy

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~'-

Reasonable Cost Reimbursement” groups it with other

regulations which specify the manner in which costs are

to be determined. It was not until the regulations were

redesignated from Part 405 to Part 413 in 1986 that the

Secretary grouped §§ 413.20 and 413.24 together under

a center heading entitled “Accounting Records and Re-

ports.” See footnote 2, supra. Far from supporting the

Secretary’s claim that these regulations were intended as

record-keeping rules only, it is clear from the placement

of the regulations until 1986 that they were part of the

Secretary’s mandatory reimbursement principles which

were applied in determining Medicare costs.’

As the court of appeals stated below, the Secretary

cannot ignore the structure of her regulations in inter-

preting their terms. See Pet. App. at 11a. As this Court

noted in a case involving the construction of statutory

language, “the court must look to the particular ...

language at issue, as well as the language and design of

the statute as a whole.” K Mart Corp. v. Cartier, Inc.,

486 U.S. 281, 291 (1988).

If §§ 413.20(a) and 413.24 do not impose GAAP as

the basic method for determining costs, then no regula-

tion exists which specifies an overall methodology to be

applied in the cost determination process. This absence

not only violates the clear instructions of Congress con-

tained in 42 U.S.C. § 1395x(v)(1)(A), but leaves a void

in the method to be applied by hospitals in determining

their Medicare costs. The Secretary claims that this void

is filled by the Foreword to the PRM and/or by the

7 The district court below, apparently unaware that the Secretary

retitled these sections in 1986, concluded that § 413.20 did not deal

with cost reimbursement, in part, because it was titled “Financial

Data and Reports.” Guernsey Memorial Hosp. v. Sullivan, 796

F. Supp. 283, 290-91 (S.D. Ohio 1992).

=

Secretary’s Federal Register notice published at 41 Fed.

Reg. 46,291, 46,292 (Oct. 20, 1976), each of which

direct GAAP be used only when a cost situation is not

otherwise addressed. See Pt. Br. at 28, 30 n.17. But

these notices do not conform to the statute’s requirement

that regulations issue to establish the methods to be used

in determining costs. The Secretary seeks to minimize

the importance of GAAP by arguing that it is only a

“stop-gap” in the cost determination process because

GAAP is only applied for cost situations not otherwise

covered by her policies. Pt. Br. at 28. Even if this were

true, the use of GAAP as a comprehensive “stop-gap” to

Medicare cost determinations would surely be such a

fundamental element in the reimbursement system as to

constitute one of the methods to be used in cost deter-

minations; as such, it could only be implemented by

regulation as required by § 1395x(v)(1)(A).

But far from a “stop-gap,” it is clear that hospitals’

books and records, as maintained under GAAP, form the

primary basis on which Medicare costs are determined.

In fact, the Secretary’s cost reporting forms and instruc-

tions require that the cost report be completed from the

financial records and basic books of accounts of the

provider.® The cost report instructions require that the

initial schedule of the cost report, entitled “Worksheet

A,” incorporate the trial balance of expense accounts

from the provider’s accounting books and records.

PRM, Part II, Ch. 28, § 2807, reprinted in Medicare &

Medicaid Guide (CCH), Report No. 773, dated October

8 Cost reports are the forms used by providers to claim their

Medicare allowable costs. See 42 C.F.R. §§ 413.20(b), 413.24(f).

Cost reporting forms contain numerous schedules which incorporate

most categories of costs directly from a provider's books and

records. See PRM, Part II, Ch. 28, which sets out the provider cost

reporting forms and instructions.

«2B

29, 1993. The trial balance of expense accounts is a

summary of the various expense ledgers maintained by

the provider in accordance with GAAP. Moreover, the

provider is required to certify that the cost report “is a

true, correct and complete statement prepared from the

books and records of the provider in accordance with

applicable instructions, except as noted.” See HCFA

Form 2552-92 (9/93), reprinted in Medicare & Medicaid

Guide (CCH), Report No. 773, dated October 29, 1993.

Rather than specifically addressing the language of

her regulations, the Secretary, citing to her “broad

authority” to determine the method or methods of reim-

bursement, asserts that she is not obligated by statute to

apply GAAP and accrual accounting as the basis for her

cost reimbursement principles, and that GAAP and

Medicare have different objectives. Pt. Br. at 19-23.

However, there is no inconsistency between these asser-

tions and the conclusion that the regulations require

GAAP as the method of determining costs. The Secre-

tary, faced in 1966 with the need to develop a com-

prehensive system of cost reimbursement principles,

wisely adopted one which was already available, widely

recognized, in use, and fully comprehensible to pro-

viders. While it is possible to conceive of a system to

determine costs other than GAAP and accrual basis

accounting, none has been suggested by the Secretary.”

Nor does she refer to any interpretation, whether judicial

or administrative, which would reasonably provide an

alternative to the use of GAAP as the fundamental basis

for determining reasonable costs.

If, as the Secretary asserts, GAAP is not the frame of

reference in her regulations for determining allowable

9 The Secretary could, of course, have mandated cash basis account-

ing as the basis for determining costs.

-14-

costs, then the regulations are silent as to the relation-

ship between financial records and Medicare allowable

costs. More importantly, there would be no regulation

under which costs are uniformly and systematically

determined, leaving a “black hole” in the regulations

regarding the methods to be used in that determination.

B. The Secretary’s Agency Decisions Are

Inconsistent With Her Present Construc-

tion Of The Regulations.

The Secretary claims that her interpretation of the

regulations is supported by consistent and long-standing

agency practice and interpretation. Pt. Br. at 28. But

this claim is contradicted by the agency’s prior actions

in applying the same regulations. In numerous final

agency decisions, the Secretary concluded that her regu-

lations at §§ 413.20(a) and 413.24 (and their predecessor

regulations at 42 C.F.R. §§ 405.406(a) and 405.453

(1984)) specifically provide for the application of GAAP

and accrual basis accounting in determining costs. For

example, in Dr. David M. Brotman Memorial Hospital v.

Blue Cross Association, et al., HCFA Admin. Dec.

(1980), Medicare & Medicaid Guide (CCH) 4 30,922 at

9839, the Deputy Administrator not only held that

§ 405.406 requires that GAAP be followed, but applied

GAAP in lieu of a PRM provision which treated the

particular expense in a manner inconsistent with GAAP.

He held that: “Under 42 C.F.R. 405.406, the determina-

tion of costs payable under the program should follow

Standardized accounting practices.... In this regard,

under generally accepted accounting principles, credit

card sales would be recorded individually at the full

amount of the sale when the transaction occurred .. .”

and concluded that credit card costs should be treated as

ee eo er

se

an expense rather than a reduction of revenue as required

by a Medicare directive to the contrary.

Similarly, in Biscayne Medical Center v. Blue Cross

Association, et al., HCFA Admin. Dec. (1982), Medicare

& Medicaid Guide (CCH) { 32,304 at 9499, the Deputy

Administrator held that the costs in question could not

be recognized as reimbursable, stating, “[uJ]nder 42

C.F.R. 405.453, Medicare cost finding and reimburse-

ment is based on the accrual basis of accounting. Under

this method, a potential receivable would not be re-

corded as such in the provider’s financial statements

until it is definite and the amount can be reasonably

determined.... In this case, the Medicare receivable is

contingent upon the provider winning [another appeal

issue]. Until the final determination ... the provider

cannot reasonably expect to receive any additional

reimbursement.”

In another final agency decision, HCA Home Office

Stock Option Group Appeal v. Blue Cross and Blue

Shield Association, et al., PRRB Dec. No. 85-D49

(1985), Medicare & Medicaid Guide (CCH) 7 34,630 at

10,123, the Provider Reimbursement Review Board

(“Board”) upheld the intermediary’s decision disallow-

ing costs because it “implemented the requirements of 42

C.F.R. 405.406(a) that costs be defined .. . by following

GAAP, as set forth in APB 25....” The Board further

concluded that “42 C.F.R. 405.453(a) and (b) require

cost data [be maintained] on the accrual basis of ac-

counting ... [and] since 42 C.F.R. 405.453(a) requires

that the subject cost be accrued, the providers did not

fulfill that requirement... .” ;

10 To the same effect are: Broadway Community Hosp. v. Blue: .

Cross Ass'n, et al., PRRB Dec. No. 82-D94 (1982), Medicare &: -

Medicaid Guide (CCH) 7 32,001 at 9889; Rapides General Hosp. v.

(continued)

as

In litigation, the Secretary has also relied on GAAP to

deny reimbursement of costs based on her regulations.

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

F.2d at 1180-81. See also National Medical Enterprises

v. Bowen, 851 F.2d at 293. Moreover, there has been no

consistent agency practice to apply GAAP where Medi-

care program policies are silent. The Secretary has

refused to apply GAAP where there was no Medicare

directive to the contrary. For example, in OrNda

HealthCorp v. Shalala, (E.D. Ark. 1993), reported at

Medicare & Medicaid Guide (CCH) 41,975, appeal

withdrawn, the Secretary rejected GAAP as the basis to

determine the costs associated with a capital lease.

Neither the regulations nor the PRM addressed capital

lease costs and neither contained a provision for denying

such costs. The district court reversed the Secretary’s

decision and concluded that GAAP and accrual account-

ing apply to determine the costs of capital leases

(fn. continued)

Blue Cross Ass'n, et al., PRRB Dec. No. 82-D35 (1982), Medicare

& Medicaid Guide (CCH) 431,703 at 10,263; Greene County

General Hosp. v. Blue Cross and Blue Shield Ass'n, et al., PRRB

Dec. No. 86-D38 (1985), Medicare & Medicaid Guide (CCH)

q 35,353 at 10,857; Woodruff Community Hosp. v. The Travelers Ins.

Co., PRRB Dec. No. 91-D40 (1991), Medicare & Medicaid Guide

(CCH) ¥ 39,208 at 26,285; Comprehensive Home Health Care, Inc.

v. Blue Cross and Blue Shield Ass'n, et al., PRRB Dec. No. 91-D21

(1991), Medicare & Medicaid Guide (CCH) 4 39,084 at 25,466-67;

Woodland Park Hosp. v. Blue Cross and Blue Shield Ass'n, et al.,_

PRRB Dec. No. 91-D30 (1991), Medicare & Medicaid Guide (CCH)

441,332 at 35,134; National Medical Enterprises, Inc. Group

Appeal, PRRB Dec. No. 93-D2 (1992), Medicare & Medicaid Guide

(CCH) 4 40,933 at 33,849-50; Republic Health Group Appeal -

Favorable Leasing v. Blue Cross and Blue Shield Ass'n, et al.,

PRRB Dec. No. 93-D11 (1993), Medicare & Medicaid Guide (CCH)

{ 41,005 at 34,322.

+ 19

pursuant to §§ 413.20 and 413.24."!

Amici submit it is bad policy, as well as bad law, to

permit the Secretary to rely on her regulations to apply

GAAP when convenient, and to deny the applicability of

those same regulations when it is not. The agency’s

inconsistent action in applying GAAP to determine costs

substantially reduces any deference due the Secretary.

See discussion in Brief For The Respondent at 20-21.

Il. SECTION 233 OF THE PROVIDER REIM-

BURSEMENT MANUAL IS INVALID FOR

FAILURE TO COMPLY WITH THE REQUIRE-

MENTS OF THE MEDICARE ACT AND THE

ADMINISTRATIVE PROCEDURE ACT.

A. The Medicare Statute And The APA

Require That Substantive Rules Regard-

ing Reimbursement Be Established By

Regulation.

The Medicare statute at 42 U.S.C. § 1395x(v)(1)(A)

expressly delegates to the Secretary legislative authority

to give substantive meaning to the vague statutory con-

cept of “reasonable costs” through regulations. See

Good Samaritan Hosp. v. Shalala, 113 S. Ct. 2151, 2154

(1993). As noted, the statute directs that regulations

issue to establish the method or methods to be used in

'! The Secretary has also refused to apply GAAP in other cases

involving the cost of capital leases, although no Medicare directive

addressing such costs exists. See, e.g., Methodist Hosp. of

Lexington, Inc. v. Blue Cross & Blue Shield Ass'n, HCFA Admin.

Dec. (1991), Medicare & Medicaid Guide (CCH), { 39,469, aff'd,

Methodist Hosp. of Lexington, Inc. v. Sullivan, C.V. No. 91-2684-

HB, (W.D. Tenn. 1993) (unreported).

- 18 -

determining costs. If, as the Secretary asserts, her regu-

lations are silent as to a systematic methodology for

determining reasonable costs, PRM § 233 (which repre-

sents the Secretary’s attempt to address one category of

costs, those incurred in a bond defeasance) stands alone

as a substantive rule which must be issued in accordance

with the notice and comment rulemaking requirements of

the APA. 5 U.S.C. § 553(b).'?

There is no dispute that § 233 constitutes a “rule” as

that term is defined in the APA. See 5 U.S.C. § 551(4). -

Nor is there any question that if § 233 is a “substantive”

or “legislative” rule, it is subject to the requirements of

the APA. See Lincoln v. Vigil, 113 S. Ct. 2024, 2033

(1993). While the term “substantive rule” is not defined

in the APA, the Attorney General’s Manual on the Ad-

ministrative Procedure Act (1947) describes substantive

rules as those “issued by an agency pursuant to statutory

authority and which implement the statute....” /d. at

30 n.3. The Court has characterized such rules as those

“affecting individual rights and obligations.” Morton v.

Ruiz, 415 U.S. 199, 232 (1974). Such rules are deemed

to “grant rights, impose obligations, or produce other

significant effects on private interests.” Rosetti v.

Shalala, 12 F.3d 1216, 1222 n.15 (3rd Cir. 1993), citing

American Ambulance Serv. v. Sullivan, 911 F.2d 901,

907 (3rd Cir. 1990) (quoting Batterton v. Marshall, 648

F.2d 694, 701-02 (D.C. Cir. 1980)).

The Court has recognized that § 1395x(v)(1)(A) does

not merely authorize the Secretary to issue regulations

but, in fact, “directs” the Secretary to promulgate regula-

tions establishing methods to be used in determining

12 The Secretary apparently concedes that if Medicare regulations

require the application of GAAP in the determination of reasonable

costs, § 233 of the PRM is invalid. See Pt. Br. at (1).

-19-

reasonable costs. Bowen v. Georgetown Univ. Hosp.,

488 U.S. 204, 210 (1988). “Rather than attempt to de-

fine ‘reasonable cost’ with precision, Congress em-

powered the Secretary to issue appropriate regulations

setting forth the methods to be used in computing such

costs.” Good Samaritan Hosp. v. Shalala, 113 S. Ct. at

2154. As the Court noted in Good Samaritan Hospital,

aside from the agency’s determination made pursuant to

its regulations, there is no available standard of reason-

ableness. 113 S. Ct. at 2158. Therefore, in establishing

methods for determining reasonable costs, the Secretary

is not merely interpreting a statutory term. Instead, such

rules implement the statute and grant rights, impose

obligations and significantly affect private interests.

Applying the definitions discussed above, they are sub-

stantive rules subject to the procedural requirements of

the APA.

The Court has also recognized that where an express

delegation is made by Congress, “[iJn exercising that

responsibility, the Secretary adopts regulations with

legislative effect.” Batterton v. Francis, 432 U.S. 416,

425 (1977). The statutory delegation in that case ap-

peared in Title IV of the Social Security Act, granting

the Secretary the power to prescribe standards for deter-

mining when a father is unemployed for purposes of

eligibility for benefits under the Aid to Families with

Dependent Children Program. 42 U.S.C. § 607(a).

Again in Schweiker v. Gray Panthers, 453 U.S. 34, 44

(1981), the Court recognized that the language of the

Medicaid statute, 42 U.S.C. § 1396a(a)(17)(B), directing

the Secretary to prescribe standards for determining the

availability of income and resources, constituted an

“explicit delegation of substantive authority” to define

the term “available.” In exercising her authority to

define reasonable costs pursuant to the directive of

- 2%.

§ 1395x(v)(1)(A), the Secretary similarly exercises

substantive authority and issues legislative rules.

Although the Secretary asserts that the regulations

“already provide ample ‘legislative authority’ for reim-

bursement of bond issuance costs” (Pt. Br. at 39), the

provisions relied on by the Secretary indicate to the con-

trary. The reader will search in vain among the regula-

tions cited by the Secretary for any indication whatso-

ever regarding the methods (other than GAAP) to be ap-

plied in determining either the amount of, or the timing

of, the bond defeasance costs incurred by a provider.'*

The Secretary argues further that nothing in the APA

or the Social Security Act “requires the agency to adopt

every minute and detailed reimbursement policy and

guideline as a ‘substantive rule’ with the force of law.”

Pt. Br. at 37. If the Court accepts her characterization of

the regulations, however, not only has the Secretary

issued § 233 (which she describes as a minute detail)

without public participation, but GAAP as a basic princi-

ple of Medicare reimbursement has been adopted with-

out the benefit of rulemaking. '*

'3 Aside from the application of GAAP, none of the cited regula-

tions sets forth a method for determining such costs. Section

413.5(a) distinguishes the cost-based payment system from a

fixed-rate system or prior cost system and sets forth basic principles

of allocation of costs among payors; Section 413.9 establishes the

principle that costs must be related to patient care, but refers the

reader to other regulations for the methods of determining the cost

on items included; Sections 413.130 and 413.153 establish that bond

defeasance costs are among the types of costs allowable under

Medicare, but provide no methodology by which the amount of cost

recognized as allowable will be determined.

14 As the Secretary noted in her Brief to this Court filed on March

24, 1994 in Thomas Jefferson University v. Shalala, No. 93-120, the

Secretary has “an explicit mandate to formulate regulations to define

what reimbursement is due under the Medicare Program,” citing 42

(continued)

Acknowledging that Medicare costs are determined by

GAAP absent a contrary rule, the Secretary cites not her

legally binding regulations, but introductory language in

the Foreword to the PRM and a brief statement in the

1976 Federal Register publication. Pt. Br. at 28, 30

n.17. But this approach is an unprincipled one because

the Secretary seeks to impose GAAP without a regula-

tion so that she can depart from GAAP, not through

properly adopted regulations, but through mere policy

statements and manual provisions. Pt. Br. at 28, 30 n.17.

Moreover, the Secretary attempts to exercise unfet-

tered discretion by virtue of an open-ended rule similar

to that adopted by the Park Service in United States v.

Picciotto, 875 F.2d 345 (D.C. Cir. 1989). In its regula-

tions, the Park Service retained authority to impose

“additional reasonable conditions” in issuing park per-

mits for demonstrations and special events. See 36

C.F.R. § 796(g)(5)(xiii)(1988). The court concluded that

the Park Service could not impose additional uniform

restrictions without engaging in APA notice and com-

ment rulemaking, and concluded that the Park Service's

open-ended rule was an attempt by the agency to “grant

itself a valid exemption to the APA for all future regula-

tions and be free of APA’s troublesome rulemaking

procedures forever after, simply by announcing its inde-

pendence in a general rule.” Jd. at 346-47.

Here, the Secretary goes one step further. Not only

does she attempt to grant the agency an exemption to the

APA, she attempts to establish the exemption through a

(fn. continued

U.S.C. §§ 1395hh, 1395x(v)(1)(A). In that case, the Secretary

addressed by regulation a “minute detail” of reimbursement involv-

ing community support of educational services which is far less

significant than either § 233 or the application of GAAP. See Brief

for ReSpondent, Thomas Jefferson University v. Shalala, at 21.

- 22.

mere introductory statement in a Manual and a brief

statement buried in a preamble accompanying the publi-

cation of a regulation. Under the Secretary’s view, she

need only adopt one basic regulation, such as 42 C.F.R.

§ 413.9(b), stating that all costs must relate to patient

care, and all of the remaining details can be filled in

through the PRM, bypassing the APA entirely. Such an

approach was clearly not contemplated by Congress and

is directly contrary to the APA.

B. Section 233 Is Not An Interpretive Rule.

The Secretary characterizes § 233 as an interpretive

rule or policy statement. !° Interpretative rules are de-

fined in the Attorney General’s Manual on the Admin-

istrative Procedure Act (1947) as “rules or statements

issued by an agency to advise the public of the agency’s

construction of the statutes and rules which it admin-

isters ....” Generally, “[aJn interpretative rule simply

States what the administrative agency thinks the statute

means, and only ‘reminds’ affected parties of existing

duties. On the other hand, if by its action the agency

intends to create new law, rights or duties, the rule is

properly considered to be a legislative rule.” General

Motors Corp. v. Ruckelshaus, 742 F.2d 1561, 1565 (D.C.

Cir. 1984), cert. denied, 471 U.S. 1074 (1985) (citations

omitted). Like all exceptions to the notice and comment

requirement of the APA, the exception for interpretive

rules is to be narrowly construed. See Sentara-Hampton

Gen. Hosp. v. Sullivan, 980 F.2d 749, 759 (D.C. Cir.

iS Recognizing the prudence of allowing public input in the

rulemaking. process, the Secretary waived the grants and benefits

exception of 5 U.S.C. § 553(a)(2) in 1971. 36 Fed. Reg. 2532 (Feb.

5, 1971).

- 23.

1992) and cases cited therein. A rule is not interpretive

merely because it sets forth the agency’s interpretation

of a statutory term. “A rule that performs [an] interpre-

tative function is a legislative rule rather than an inter-

pretative rule if the agency has the statutory authority to

promulgate a legislative ule and if the agency intends to

exercise that power.” Kenneth C. Davis, Administrative

Law Treatise § 6.3 at 235 (3rd Ed. 1994).

In this case, the Secretary cannot “remind” pro-

viders of the existing reasonable cost reimbursement

methodology since, under the Secretary’s construction,

the regulations do not provide for such a methodology.

Accordingly, § 233 does more than merely advise the

public of the agency’s construction of its rules; it creates

new law regarding Medicare reimbursement for bond

defeasance costs.

While various factors are considered in determining

whether a rule is interpretive, the courts have looked to

agency intent, as well as to the source and nature of the

authority exercised, to distinguish between substantive

and interpretive rules. Last year, the court in American

Mining Congress v. Mine Safety and Health Administra-

tion, 995 F.2d 1106, 1112 (D.C. Cir. 1993), adopted a

test which looks to the agency’s intent to exercise dele-

gated power in order to make such a distinction. The

court stated that if any of the following four questions is

answered in the affirmative, the rule is legislative, not

interpretive: (1) whether in the absence of the rule there

would not be an adequate legislative basis for enforce-

ment action or other agency action to confer benefits or

insure the performance of duties, (2) whether the agency

has published the rule in the Code of Federal Regula-

tions, (3) whether the agency has explicitly invoked its

general legislative authority, or (4) whether the rule

effectively amends a prior legislative rule. In this case,

- 24

the first and fourth tests must be answered in the affirm-

ative.

Applying the first test, there is no legislative basis in

the regulations for § 233. Congress expressly left to the

Secretary the responsibility for developing a payment

methodology by regulation, since the term “reasonable

costs” provided an inadequate basis for determining

provider reimbursement. See Good Samaritan Hosp. v.

Shalala, 113 S. Ct. at 2154. The Medicare regulation the

Secretary purports to interpret by § 233 is 42 C.F.R.

§ 413.9. This regulation is simply a broad statement of

the principles of reasonable cost reimbursement which

provides no substantive guidance in determining when

costs are to be recognized. In fact, the very regulation

on which the Secretary relies states that reasonable costs

“must be determined in accordance with regulations

establishing the method or methods to be used, and the

items to be included.” 42 C.F.R. § 413.9(b)(1) (1993)

(emphasis added). The only regulations establishing the

basic method for determining bond defeasance costs, and

most other costs, are now disavowed by the Secretary.

Therefore, in the absence of § 233, there would be no

basis for the Secretary’s denial of costs in this case.'’

The fourth test of American Mining Congress is also

met, since the Secretary has consistently applied GAAP

as the underlying substantive methodology for determin-

ing Medicare reimbursement. As discussed in Section I

above, GAAP has been the primary basis for determining

16 In faci, the third factor is also arguably met here, since the

Secretary has cited 42 U.S.C. § 1395x(v)(1)(A) in support of § 233.

Pt. Br. at 39.

M7 In this regard, § 233 is similar to the many substantive rules the

Secretary attempted to adopt without compliance with the APA

which have been invalidated by the courts. See footnote 19, infra.

- 25 -

Medicare costs. Thus, whatever the source of authority

to apply GAAP, it has been the only system-wide

method applied by the Secretary. Section 233, requiring

a determination in direct conflict with GAAP, effectively

amends that prior legislative rule.

The court of appeals for the ninth circuit has adopted

a similar analysis looking to “the source of the rule” in

determining whether a rule can properly be characterized

as interpretive. In W.C. v. Bowen, 807 F.2d 1502, 1504

(9th Cir. 1987), the court stated, “[i]f it is promulgated

pursuant to statutory directive or under statutory auth-

ority, it is a substantive rule.” (citation omitted). In

W.C. v. Bowen, the Secretary was acting pursuant to a

congressional directive to implement a program of re-

viewing decisions rendered by administrative law

judges. There, as here, “[iJn exercising that discretion,

the Secretary enacted a substantive rule.” Jd. at 1505.'°

See also Mt. Diablo Hosp. Dist. v. Bowen, 860 F.2d 951

(9th Cir. 1988) (rejecting the Secretary’s purportedly

interpretive rule regarding the timing of certain Medi-

care bonus payments).

Similarly, the sixth circuit in State of Ohio Depart-

ment of Human Services v. United States Department of

Health and Human Services, 862 F.2d 1228, 1234 (6th

Cir. 1988) found no existing regulatory authority for an

eligibility ceiling the Secretary attempted to impose on

the Ohio Medicaid program. The court concluded that

the ceiling was in no way compelled by the regulation or

the underlying statute at 42 U.S.C. § 1396a(a)(17). Id.

18 Where, as in this case, Congress directly commands an agency to

issue regulations, such a duty “would not be satisfied with issuance

of an humble interpretative rule.” Community Nutrition Inst. v.

Young, 818 F.2d 943, 953 (D.C. Cir. 1987) (Starr, J. concurring in

part and dissenting in part).

- 26 -

Because the court concluded that the ceiling was not

implicit in the regulation from the beginning, it could

not be imposed later without compliance with the notice

and comment requirements of the APA. /d. at 1236.

In this case, there is nothing explicit or implicit in the

existing regulations on which to conclude that the

method for determining bond defeasance costs imposed

by § 233 would be applied. On the contrary, as dis-

cussed in Section! above, the regulations lead to the

Opposite conclusion. Where a rule results in a change in

existing law or policy it is substantive in nature and, as a

result, must be promulgated in accordance with the

rulemaking requirements of the APA. Nat’! Family

Planning & Reproductive Health Ass'n, Inc. v. Sullivan,

979 F.2d 227, 240 (D.C. Cir. 1992); Linoz v. Heckler,

800 F.2d 871 (9th Cir. 1986).

Moreover, the Secretary’s decision to adopt a method-

ology contrary to GAAP through a mere interpretive rule

or policy statement is inconsistent with her prior actions.

The Medicare reasonable cost regulations reflect numer-

Ous instances in which the Secretary defined costs in a

manner contrary to GAAP only after compliance with

the APA rulemaking requirements. For example, 42

C.F.R. § 413.134, which addresses depreciation costs, is

contrary to GAAP in that it modifies the determination

of historical costs, limits the methodology for prorating

costs over the useful life of an asset, and provides for

the recapture of depreciation by the program upon a

gain on the sale of an asset. See also 42 C.F.R.

§ 413.153(b)(2)(iii) (providing for an investment income

offset to interest expense); 42 C.F.R. § 413.17

(providing for the recognition of costs relating to items

or services obtained from related organizations); 42

C.F.R. § 413.134(h) (special treatment for sale and

leaseback transactions).

. 29.

The regulation adopted in the 1976 Federal Register

publication cited by the Secretary here is another exam-

ple of the Secretary’s deviation from GAAP only after

compliance with the APA. Following the APA’s notice

and comment rulemaking procedures, the agency

adopted an approach to limit the amount of goodwill to

be included in a provider’s equity capital which was

inconsistent with GAAP. 41 Fed. Reg. 46,291 (Oct. 20,

1976). Moreover, the Secretary continues to adopt rules

contrary to GAAP through the APA rulemaking process.

See, e.g., 56 Fed. Reg. 50,834 (Oct. 9, 1991) (proposed

rule modifying accrual basis accounting). In fact, ac-

cording to the Secretary’s regulatory agenda, she intends

to issue a regulation regarding the application of GAAP

to Medicare reimbursement determinations generally,

presumably to adopt her litigating position in this case.

59 Fed. Reg. 20,312, 20,388 (Apr. 25, 1994).

C. Failure to Comply With APA Proce-

dural Requirements Is_ Inconsistent

With The Intent of Congress.

The APA rulemaking requirements which ‘the Secre-

tary seeks to avoid in this case, were designed to ensure

fairness and mature consideration of rules of general

application. NLRB v. Wyman-Gordon Co., 394 U.S. 759,

764 (1960), citing H.R. Rep. No. 1980, 79th Cong., 2d

Sess. 21-26 (1946); S. Rep. No. 752, 79th Cong., Ist

Sess. 13-16 (1945). The procedures serve the dual func-

tions of allowing the agency to benefit from the exper-

tise and input of parties who file comments to the

proposed rules and to see that the agency maintains a

flexible and open minded attitude towards its own rules.

McLouth Steel Prod. Corp. v. Thomas, 838 F.2d 1317,

1325 (D.C. Cir. 1988).

- 98.

The Health Care Financing Administration has been

among the federal agencies criticized for its frequent

nonobservance of the APA in administering the Medi-

care and Medicaid programs. '? Robert A. Anthony,

Interpretive Rules, Policy Statements, Guidance,

Manuals, And The Like — Should Federal Agencies Use

Them To Bind The Public? 41 Duke L.J. 1311, 1316

n.15 (1992). Congress was also concerned that “impor-

tant [Medicare] policies are being developed without

benefit of the public notice and comment period and,

with growing frequency, are being transmitted, if at

all, through manual instructions and other informal

means.” H. Rep. No. 100-391(1), 100th Cong., Ist Sess.

§ 4073 (1987), reprinted in U.S.C.C.A.N. at 2313-250.

Accordingly, in 1987, Congress adopted 42 U.S.C.

§ 1395hh(a)(2), which mandates that “[nJo rule, require-

ment, or other statement of policy ... that establishes or

changes a substantive legal standard governing .. . pay-

ment for services ... shall take effect unless it is

promulgated by the Secretary by regulation.” Section

233, which clearly changes a substantive legal standard

regarding payment, is precisely the type of rule that

concerned Congress when it amended § 1395hh.

The Secretary’s extra-record comment indicating that

she attempted to comply with the spirit of the APA by

19 ,

Numerous attempts by the agency to impose substantive rules

through manuals and policy statements have been invalidated by the

courts. See, e.g., Mother Frances Hosp. of Tyler, Texas v. Shalala,

15 F.3d 423 (Sth Cir. 1994); National Family Planning & Reproduc-

tive Health Ass'n, Inc. v. Sullivan, 979 F.2d 227 (D.C. Cir. 1992);

State of Ohio Dep't of Human Serv. v. U.S. Dep't of Health &

Human Serv., 862 F.2d 1228 (6th Cir. 1988); Mt. Diablo Hosp. Dist.

v. Bowen, 860 F.2d 951 (9th Cir. 1988); W.C. v. Bowen, 807 F.2d

1502 (9th Cir. 1987); Samaritan Health Serv. v. Bowen, 811 F.2d

1524 (D.C. Cir. 1987); Linoz v. Heckler, 800 F.2d 871 (9th Cir

1986).

- 29 -

discussing § 233 with a select group of interested parties

illustrates the problems that result from failure to

comply with the APA. Pt. Br. at 36 n.21. Such an infor-

mal procedure fails to assure the public participation

required under the APA. Moreover, the Secretary’s

approach denies the public, as well as the courts, an

adequate explanation of the basis and purpose of the

rule. As a result of the Secretary’s informal approach in

this case, the Court is denied a complete and contem-

poraneous explanation of why the rule was promulgated.

Such an explanation is essential to the Court’s review of

a rule in the face of a substantive challenge. See Natural

Resources Defense Council v. U.S. Envtl. Protection

Agency, 824 F.2d 1258, 1286 (1st Cir. 1987). Moreover,

absent a rulemaking record, the Court cannot determine

whether the agency fully considered those comments it

received. “An agency decision may not be reasoned if

the agency ignores vital comments regarding relevant

factors, rather than providing an adequate rebuttal.”

Abington Memorial Hosp. v. Heckler, 576 F. Supp. 1081,

1085 (E.D. Pa. 1983), aff'd, Abington Memorial Hosp. v.

Heckler, 750 F.2d 242 (3d Cir. 1984), cert. denied, sub

nom. Heckler v. Abington Memorial Hosp., 474 U.S. 863

(1985) (citation omitted). Here, the Court’s only source

of information regarding the “rulemaking process” is a

self-serving memorandum prepared by the agency after

the hearing at the Board and without opportunity for

rebuttal. Joint Appendix at 6-8. Thus, the Secretary’s

informal process, far from meeting the intent of the

notice and comment rulemaking requirements of the

APA, actually flies in the face of that provision.

That Congress intended that the Secretary would

exercise her delegated, substantive rulemaking authority

in accordance with established rulemaking procedures is

clear. First, the plain language of the statute mandates

the issuance of regulations establishing the method or

—

methods to be used. 42 U.S.C. § 1395x(v)(1)(A). More-

over, in enacting this section, Congress recognized that

it was providing only the broad framework for Medicare

reimbursement determinations based on “reasonable

costs,” and directed that the methods to be used in deter-

mining reasonable costs “shall be developed in regula-

tions of the Secretary....” S. Rep. No. 404, 89th

Cong., Ist Sess. reprinted in U.S.C.C.A.N. at 1976

(1965). Noting that issues relating to payment for hospi-

tal services had been “the subject of extended and

painstaking consideration for more than a decade,”

Congress directed the Secretary to take “full advantage”

of the experience of private agencies, organizations and

associations in developing the regulations. Jd. The

Senate Report specifically noted, “(t]he concept of rea-

sonable cost and the principles and methods for translat-

ing this concept into practice in individual circumstances

are of concern to consumers, providers of services, in-

suring organizations, and State and Federal Governmen-

tal programs.” Jd. at 1977.

Rather than respond to the congressional directive to

make use of the experience of /private agencies and or-

ganizations, the Secretary seeks to avoid the opportunity

to obtain public comment on her rules. Such an ap-

proach is not only inconsistent with the directive found

in the Medicare statute, but it is inconsistent with the

purpose and underlying philosophy of the APA.

CONCLUSION

The Judgment of the United States Court of Appeals

for the Sixth Circuit should be affirmed.

Respectfully submitted,

ROBERT A. KLEIN

Counsel of Record

WEISSBURG AND ARONSON, INC.

Attorneys for Amici Curiae