                             UNITED STATES DISTRICT COURT
                             FOR THE DISTRICT OF COLUMBIA

___________________________________
                                    )
ALLINA HEALTH SERVICES, et al.,     )
                                    )
            Plaintiffs,             )
                                    )
       v.                           )                 Civil Action No. 10-1463 (RMC)
                                    )
KATHLEEN SEBELIUS, Secretary,       )
U.S. Department of Health and       )
Human Services,                     )
                                    )
            Defendant.              )
___________________________________ )

                                             OPINION

                Medicare, a federal program that pays for health coverage for most Americans

aged 65 and older is, to put it mildly, a complex program with reams of statutory provisions and

regulations. Banking on this complexity to execute a fancy two-step, the Secretary of Health and

Human Services excuses a lack of proper rulemaking and reasoned explanation for a new

statutory interpretation of the reimbursement formula for certain hospitals serving low-income

patients in the hopes that the Court will defer to her expertise. The Court recognizes both the

Secretary’s expertise and the flaws in the procedures she defends, with deference to the former

but not to the latter.

                 Plaintiffs 1 are twenty-seven hospitals that serve “a significantly disproportionate

share of low-income patients” without private health insurance. Consolidated Omnibus Budget



1
 Plaintiff Hospitals include Allina Health Services, Highland Hospital of Rochester, Kaleida
Health, Kingsbrook Jewish Medical Center, Lutheran Medical Center, Maimonides Medical
Center, Methodist Dallas Medical Center, Methodist Hospitals of Dallas, Montefiore Medical
Center, Mount Sinai Medical Center of Florida, Inc., New York Hospital Medical Center of
Queens, New York Methodist Hospital, New York Presbyterian Hospital, North Carolina Baptist


                                                  1
Reconciliation Act of 1985, Pub. L. No. 99-272, § 9105 (1986) (COBRA); 42 U.S.C.

§ 1395ww(d)(5)(F)(i)(I); see also North Broward Hosp. Dist. v. Shalala, 172 F.3d 90, 92 (D.C.

Cir. 1999). Medicare pays such disproportionate share hospitals (DSH) additional monies, on

top of Medicare’s normal fees-for-service, to help cover the costs associated with the care of the

very poor.    This case concerns the formula for calculating DSH payments, a messy and

incomplete rulemaking process, and the Secretary’s unreasoned change in statutory

interpretation.

                                          I.     FACTS

                  This is not the first time the Secretary’s calculation of DSH payments has been

litigated recently.    The D.C. Circuit noted the Secretary’s “about-face in 2004,” when she

announced her new interpretation of the statute in a preamble to a final rule. Ne. Hosp. Corp. v.

Sebelius, 657 F.3d 1, 15 (D.C. Cir. 2011). 2 Therefore, in reviewing this record and deciding this

case, the Court starts with the proposition that the Secretary had a different practice for

calculating DSH payments at least until 2004, when she abruptly announced a change in policy.

The Court relies for background on Northeast Hospital, which lays out the dispute in “numbing

detail,” id. at 18 (Kavanaugh, J., concurring), and will advance to the immediate issues here.




Hospital, North Shore Long Island Jewish Health System, Inc., Shands Medical Center, Inc.,
Shands Teaching Hospital and Clinics, Inc., University of Rochester, Florida Health Sciences
Center, Inc., and the Henry Ford Health System.
2
  The Secretary’s pretense in briefing the instant matter—that her current interpretation is
entirely consistent with the past—is, as the Court explains below, clearly forestalled by
Northeast Hospital. It is also irregular legal gamesmanship, which wastes time and casts
unfortunate doubt on counsel’s credibility. The D.C. Circuit has ruled and the Secretary is not
free to pretend otherwise when in this Circuit. If such an argument were to be made properly, it
would at least need to recognize precedent and attempt to distinguish or argue to change it.
Nothing of the kind happened here.


                                                 2
                         A.      The Medicare DSH Payment System

               Medicare pays benefits through different plans, three of which are relevant here.

“Plan A covers medical services furnished by hospitals and other institutional care providers.”

Id. at 2; 42 U.S.C. §§ 1395c to 1395i-5. “Part B is an optional supplemental insurance program

that pays for medical items and services not covered by Part A, including outpatient physician

services, clinical laboratory tests, and durable medical equipment.” Ne. Hosp., 657 F.3d at 2; 42

U.S.C. §§ 1395j to 1395w-4. “Part C governs the ‘Medicare + Choice’ (M+C) program, which

gives Medicare beneficiaries an alternative to the traditional Part A fee-for-service system,”

allowing enrollment in a managed care plan. Id.; see 42 U.S.C. §§ 1395w-21 to 1395w-29. The

Secretary pays the health care provider directly under Parts A and B but pays the managed-care

plan under Part C, which in turn pays the provider.

               DSH payment adjustments depend on the DSH percentage for each hospital,

determined by way of a complicated statutory formula. It involves adding the results of two

computations and expressing the sum as a percentage referred to as the “disproportionate patient

percentage.”    42 U.S.C. § 1395ww(d)(5)(F)(vi).        One computation is identified as the

Medicare/Supplemental Security Income (SSI) fraction and the other is identified as the

Medicaid fraction.    42 U.S.C. §§ 1395ww(d)(5)(F)(vi)(I) (Medicare/SSI fraction) & (II)

(Medicaid fraction); see also 42 C.F.R. § 412.106(b) (2012). 3

               The Medicare/SSI fraction is meant as a proxy for low-income Medicare patients

and is defined as:

               [T]he fraction (expressed as a percentage), the numerator of which
               is the number of such hospital’s patient days for such period which


3
 SSI is a federal program that pays stipends to people who are aged, blind or disabled; most SSI
recipients are entitled to Medicare coverage. Medicaid is a joint federal-state program, managed
by the states, which provides health coverage for low-income adults, children and the disabled.


                                                3
               were made up of patients who (for such days) were entitled to
               benefits under part A of [Title XVIII] and were entitled to [SSI]
               benefits (excluding any State supplementation) under [Title] XVI
               of this chapter, and the denominator of which is the number of
               such hospital’s patient days for such fiscal year which were made
               up of patients who (for such days) were entitled to benefits under
               part A of [Title XVIII] . . . .

42 U.S.C. § 1395ww(d)(5)(F)(vi)(I) (emphasis added). Thus, the Medicare/SSI fraction is based

on the number of a hospital’s patient days for individuals entitled to both Medicare Part A and

SSI benefits on the top of the fraction over the number of patient days for all patients under Part

A on the bottom.

               The statute defines the Medicaid fraction, meant as a proxy for low-income, non-

Medicare patients, as:

               [T]he fraction (expressed as a percentage), the numerator of which
               is the number of the hospital’s patient days for such period which
               consist of patients who (for such days) were eligible for medical
               assistance under a State [Medicaid] plan . . . but who were not
               entitled to benefits under [Medicare] Part A . . . and the
               denominator of which is the total number of the hospital’s patient
               days for such period.

Id. § 1395ww(d)(5)(F)(vi)(II).     Thus, the Medicaid fraction is based on the number of a

hospital’s patient days for individuals who are eligible for Medicaid, but are not entitled to

benefits under Medicare Part A, over the total number of all patient days for the hospital.

               M+C was established by Congress as part of the Balanced Budget Act of 1997

(BBA), Pub. L. No. 105-33 (1997).         The M+C program is now known as the Medicare

Advantage (MA) program. 4 Wherever possible, the Court uses either “M+C” or “Part C” to be

consistent with the record and the briefs. In order to enroll in M+C, an individual must be




4
   See Medicare Prescription Drug, Improvement, and Modernization Act of 2003, Pub. L. No.
108-173, § 201(b), 117 Stat, 2066, 2176 (2003).


                                                 4
“entitled to benefits under part A . . . and enrolled under part B.”         42 U.S.C. § 13952-

21(a)(3)(A).

               After implementation of M+C, “between 1999 and 2004, the Secretary routinely

excluded M+C [inpatient hospital] days from the Medicare fraction.” Ne. Hosp., 657 F.3d at 15.

The “actual practice was to not count the M+C days in the [Medicare] fraction prior to 2004.”

Id. (citation and internal quotation marks omitted). It was not until 2007 that the Secretary even

began to collect the data needed to include M+C days in the Medicare/SSI fraction. Id.; see

Change Request 5647, CMS Pub. 100-04, Transmittal No. 1331 (July 20, 2007). The Secretary’s

excuse for this failure was “not convincing” to the D.C. Circuit, 657 F.3d at 15, just as her

current excuses do not convince this Court.

                        B.      Details of the Secretary’s “About Face”

               The Secretary’s actions in 2003, 2004, and 2007 are the focal points of the

parties’ disputes.

                                       1.     2003 NPRM

               In 2003, in a notice of proposed rulemaking (“2003 NPRM”) published in the

Federal Register, the Secretary stated the following:

               We have received questions whether patients enrolled in an M+C
               Plan should be counted in the Medicare fraction or the Medicaid
               fraction of the DSH patient percentage calculation. The question
               stems from whether M+C plan enrollees are entitled to benefits
               under Medicare Part A since M+C plans are administered through
               Medicare Part C.

               We note that, under § 422.50, an individual is eligible to elect an
               M+C plan if he or she is entitled to Medicare Part A and enrolled
               in Part B. However, once a beneficiary has elected to join an M+C
               plan, that beneficiary’s benefits are no longer administered under
               Part A.

               Therefore, we are proposing to clarify that once a beneficiary
               elects Medicare Part C, those patient days attributable to the


                                                 5
               beneficiary should not be included in the Medicare fraction of the
               DSH patient percentage. These patient days should be included in
               the count of total patient days in the Medicaid fraction (the
               denominator), and the patient’s days for the M+C beneficiary who
               is also eligible for Medicaid would be included in the numerator of
               the Medicaid fraction.

Medicare Program, Proposed Changes to the Hospital Inpatient Prospective Payment Systems

and Fiscal Year 2004 Rates, 68 Fed. Reg. 27154, 27208 (May 19, 2003).

               The proposed clarification was the last and shortest of eight proposed changes in a

section   entitled   “Indirect   Medical   Education    (IME)    Adjustment    (§ 412.105)    and

Disproportionate Share Hospital (DSH) Adjustment (§ 412.105).” Id. at 27201–08.

                        2.       Comments Received After 2003 NPRM

               The public comments on the 2003 NPRM appear in the Rulemaking Record

(R.R.), Dkt. 31, 33, 34, and are relatively sparse. A small number of hospitals submitted

comments, some of which were nearly identical, asserting that the proposal was “inconsistent”

with the Medicare Act and urging that “M+C days continue to be treated as Medicare days in the

DSH calculation.” See, e.g., Comment of North Shore University Hospital at Plainview, R.R. at

343; see also Comment of Association of American Medical Colleges, R.R. at 370–71 (arguing

that Part C patients should be included in the Medicare/SSI fraction). But a smaller number of

commenters—the Secretary has identified only two, see Def. MSJ Mem., Dkt. 35, at 33—urged

that the Secretary include Part C days in the Medicaid fraction. E.g., Comment of Mercy Health

System, R.R. at 389–90.

               Three other comments are particularly noteworthy. One commenter, Southwest

Consulting Associates, stated: “In our work with data from CMS [Centers for Medicare &

Medicaid Services], it appears that the SSI fraction generally does not include Medicare HMO

days[, . . . which were] inconsistently counted in the SSI fraction from provider to provider and



                                                6
from year to year. . . . To count all indigent [patients] (the purpose of the calculation), we

support the inclusion of Medicare HMO days in the Medicaid fraction.” R.R. at 140–41; see

also id. at 147–49 (supplemental comment from same commenter arguing that “CMS’s exclusion

of [M+C] days from the Medicaid percentage . . . violates the plain language of the DSH

provisions of the Medicare statute” and is inconsistent with “Congress’ and the Secretary’s

readings of similar language in another Medicare payment area, as well as prior CMS policy”).

              Another commenter, a CMS contractor, expressed confusion over the 2003

NPRM. See Comment of Cahaba Safeguard Administrators, LLC, R.R. at 516 (“We assume that

the Medicare fraction refers to the SSI% used in the DSH patient percentage. Is this a correct

assumption? Does the proposal mean that M+C days were included in the SSI% prior to this

proposal, and will no longer be included in the SSI%?”). A third commenter observed:

              Insufficient data is provided in the proposed rule to make a rational
              evaluation of this proposal. When a beneficiary elects M+C
              coverage, Medicare Part A no longer administers their benefits, but
              Part A entitlement does not end. M+C plans also did not exist
              when the DSH formula was devised, and hove [sic] not been
              otherwise addressed by Congress in this regard. So it is possible
              for CMS to support inclusion of these days in the Medicare
              fraction or in the Medicaid fraction, depending on the argument
              selected. We would like to see data on the effects (by provider
              number) of removing M+C days from the SSI percentage
              calculation.

Comment of Memorial Healthcare System, R.R. at 354.

                                    3.     2004 Final Rule

              The Secretary did not adopt the proposed clarification. Instead, in 2004, she

changed course and announced the following, referred to in this opinion as the “2004 Final

Rule”:

              We have received questions whether the patient days associated
              with patients enrolled in an M+C Plan should be counted in the
              Medicare fraction or the Medicaid fraction of the DSH patient


                                               7
              percentage calculation. The question stems from whether M+C
              plan enrollees are entitled to benefits under Medicare Part A since
              M+C plans are administered through Medicare Part C.

              We note that, under existing regulations at § 422.50, an individual
              is eligible to elect an M+C plan if he or she is entitled to Medicare
              Part A and enrolled in Part B. However, once a beneficiary has
              elected to join an M+C plan, that beneficiary’s benefits are no
              longer administered under Part A. In the proposed rule of May 19,
              2003 (68 FR 27208), we proposed that once a beneficiary elects
              Medicare Part C, those patient days attributable to the beneficiary
              would not be included in the Medicare fraction of the DSH patient
              percentage. Under our proposal, these patient days would be
              included in the Medicaid fraction. The patient days of dual-
              eligible M+C beneficiaries (that is, those also eligible for
              Medicaid) would be included in the count of total patient days in
              both the numerator and denominator of the Medicaid fraction.

              Comment: Several commenters indicated that they appreciated
              CMS’s attention to this issue in the proposed rule. The commenters
              also indicated that there has been insufficient guidance on how to
              handle these days in the DSH calculation. However, several
              commenters disagreed with excluding these days from the
              Medicare fraction and pointed out that these patients are just as
              much Medicare beneficiaries as those beneficiaries in the
              traditional fee-for-service program.

              Response: Although there are differences between the status of
              these beneficiaries and those in the traditional fee-for-service
              program, we do agree that once Medicare beneficiaries elect
              Medicare Part C coverage, they are still, in some sense, entitled to
              benefits under Medicare Part A. We agree with the commenter
              that these days should be included in the Medicare fraction of the
              DSH calculation. Therefore, we are not adopting as final our
              proposal stated in the May 19, 2003 proposed rule to include the
              days associated with M+C beneficiaries in the Medicaid fraction.
              Instead, we are adopting a policy to include the patient days for
              M+C beneficiaries in the Medicare fraction. As noted previously,
              if the beneficiary is also an SSI recipient, the patient days will be
              included in the numerator of the Medicare fraction. We are
              revising our regulations at § 412.106(b)(2)(i) to include the days
              associated with M+C beneficiaries in the Medicare fraction of the
              DSH calculation.

Medicare Program; Changes to the Hospital Inpatient Prospective Payment Systems and Fiscal

Year 2005 Rates, 69 Fed. Reg. 48916, 49099 (Aug. 11, 2004).


                                               8
               Despite the statement in the Federal Register that 42 C.F.R. § 412.106(b)(2)

would be amended, no revised regulation was issued until 2007.

                              4.    2007 Changes to Regulations

               In summer 2007, the Secretary issued what the agency characterized as a

“technical correction” to the regulation regarding CMS’s policy on Part C days. Medicare

Program; Changes to the Hospital Inpatient Prospective Payment System and Fiscal Year 2008

Rates, 72 Fed. Reg. 47130, 47384 (Aug. 22, 2007). Specifically, the Secretary amended 42

C.F.R. § 412.106(b)(2) to define the numerator and denominator of the Medicare/SSI fraction to

include patients who are “entitled to Medicare Part A (or Medicare Advantage (Part C)).” Id. at

47411 (emphasis added). The Secretary said that she had “inadvertently” failed to make this

change earlier despite her 2004 “policy change.” Id. at 47384. The effective date for the 2007

rule was October 1, 2007, the beginning of federal fiscal year 2008. 5 Id. at 47130. The

Secretary waived notice and comment for the 2007 regulatory-text amendment pursuant to 5

U.S.C. § 553(d)(3) because she viewed the amendment as a technical correction for the oversight

of not having done so in 2004. 6

               CMS did not begin collecting all the data necessary to implement its new policy

until 2007. In Change Request 5647, CMS stated that “[p]atients who are enrolled in [Part

C] . . . should also be included in the Medicare fraction.” Transmittal No. 1311 (July 20, 2007),

available at https://www.cms.gov/transmittals/downloads/R1311CP.pdf at 8.              With an


5
  The Secretary further amended 42 C.F.R. § 412.106(b)(2)(i)(B) and (iii)(B) in 2010 to use the
word “including” in place of “or,” in an apparent attempt to bolster further her position. The
relevant language presently in place for both the numerator and denominator of the Medicare/SSI
fraction is “entitled to . . . Medicare Part A (including Medicare Advantage (Part C)).” Id.
(emphasis added).
6
  The validity of the waiver is not directly at issue in this case because the parties’ arguments
focus on the notice given by the 2003 NPRM and the explanation given in the 2004 Final Rule.


                                               9
implementation date of January 7, 2008 and a purported “effective date” of October 1, 2006, the

change request directed that “hospitals . . . begin to submit ‘no pay’ bills to their Medicare

contractor for the [Part C] beneficiaries they treat, in order for these days to be eventually

captured in the DSH . . . calculations.” Id. at 1 (emphasis added). As stated in the transmittal,

CMS’s goal was to include the Part C days in the Medicare/SSI fraction “starting with federal

FY 2007.” Id. at 2. CMS revised the Medicare Claims Processing Manual to reflect this goal:

“[H]ospitals may go back and submit claims with discharge dates on or after October 1, 2006

(FY 2007), so that SSI data for FY 2007 and beyond will include [Part C] patient days.” Id.

(emphasis added); see also Medicare Claims Processing Man. (CMS Pub. 100-04), ch. 3, § 20.3,

available at http://www.cms.gov/manuals/downloads/clm104c03.pdf (requiring hospitals to

submit informational only bills to “ensure that these days are included in the SSI [fraction] for

Fiscal Year 2007 and beyond”).

              On March 6, 2009, CMS issued Transmittal No. 1695, in which it expanded and

strengthened its previously stated policy that providers “may go back and submit claims with

discharge dates on or after October 1, 2006,” see Change Request 5647 at 2 (emphasis added),

and now required all hospitals that received DSH payments in FY 2006 to submit claims for

those Part C days for discharges on or after October 1, 2005: “Non-teaching IPPS hospitals that

received Medicare DSH payments in FY 2006 . . . must submit claims for [Part C] patients with

discharge dates on or after October 1, 2005 through September 30, 2006 (FY 2006), in order to

ensure that Medicare DSH calculations for FY 2006 accurately reflect [Part C] inpatient days.”

See Change Request 6329, Transmittal No. 1695 (March 6, 2009), available at

https://www.cms.gov/transmittals/downloads/R1695CP.pdf.




                                               10
                     C.      Procedural History of the Hospitals’ Claims

               Private insurance companies, known as “fiscal intermediaries,” act on the

Secretary’s behalf to process payments to qualifying hospitals and other providers of medical

services. 42 C.F.R. §§ 421.1, 421.3, 421.100–.128. These intermediaries calculate a provider’s

DSH adjustment by determining the Medicare and Medicaid fractions. A hospital aggrieved by

an intermediary’s calculation can appeal to the Provider Reimbursement Review Board (PRRB).

See 42 U.S.C. § 1395oo; 42 C.F.R. §§ 405.1807, 405.1835. The PRRB’s determination as to an

appeal is considered the final agency action unless the Secretary, on her own motion, reverses,

affirms, or modifies that decision. 42 U.S.C. § 1395oo(f)(1). The Secretary has authorized the

Administrator of CMS to act on her behalf in reviewing the PRRB’s decisions; therefore, the

Administrator’s review of a PRRB ruling is considered the final decision of the Secretary. See

42 C.F.R. § 405.1875. A hospital has the right to seek judicial review in federal district court of

any final decision by the Board or the Secretary. 42 U.S.C. § 395oo(f)(1).

               The Hospitals, dissatisfied with intermediaries’ inclusion of Part C days in the

Medicare/SSI fraction for FY 2007, sought PRRB review. Pl. MSJ Mem. [Dkt. 32–1] at 11. The

PRRB denied relief and granted expedited judicial review; the parties timely filed in this Court. 7

See 42 U.S.C. § 1395oo(f)(1); 42 C.F.R. § 405.1842.



7
  Two other cases, both captioned Florida Health Sciences Center, Inc. v. Sebelius—civil actions
number 10-1462 and number 12-328—were consolidated with this case, civil action number 10-
1463. The PRRB granted expedited judicial review to the plaintiffs in this case in the first
instance. See A.R. 6–12, 1185–91. In 2010, the PRRB denied expedited judicial review to the
plaintiffs in the Florida Health Sciences Center cases, but, in 2012, concluded that expedited
judicial review was appropriate. See Consent Motion to Consolidate, [Dkt. 7], Civ. No. 12-328.
The Court has consolidated all three cases. Order, [Dkt. 10], Civ. No. 10-1463; Minute Order
Dated April 30, 2012, Civ. No. 12-328. The parties agree that the three cases are ripe for
decision, raise no procedural issues, and present the identical issue of whether the Secretary’s
inclusion of Medicare Part C days in the Medicare/SSI fraction in FY 2007 was proper.
Accordingly, the Court’s analysis of that issue is dispositive of all three cases.


                                                11
          D.      Related Litigation Over 2004 Policy Change; Impact on this Case

               As mentioned above, this case’s history is intertwined with that of Northeast

Hospital, which presented issues related to the ones in this case.

               On March 29, 2010, another judge of this Court, the Honorable John Bates, held

that the Secretary’s inclusion of the Medicare Part C days in the Medicare/SSI fraction for fiscal

years 1999–2002 failed under Chevron steps one and two. 8 See Ne. Hosp. Corp. v. Sebelius, 699

F. Supp. 2d 81, 92–95 (D.D.C. 2010), aff’d on limited grounds, 657 F.3d 1 (D.C. Cir. 2011).

The Hospitals sought a preliminary injunction against the Secretary in this case based on the

Judge Bates’s ruling, Dkt. 12, and the Secretary filed a motion to stay these proceedings while

the D.C. Circuit ruled on her appeal, Dkt. 7. By Memorandum Opinion and Order dated

December 22, 2010, this Court denied the Hospitals’ motion and granted the Secretary’s motion

to stay, concluding that “despite the fact that some measure of irreparable injury might result to

the Hospitals until the D.C. Circuit render[ed] its decision . . . the balance of the equities and the

harm [an injunction] would cause to the public interest” weighed in favor of awaiting an

appellate ruling in Northeast Hospital. See Allina Health Servs. v. Sebelius, 756 F. Supp. 2d 61,

71 (D.D.C. 2010).

               In 2011, the D.C. Circuit issued its ruling, concluding first that the Medicare

statute did not “unambiguously foreclose the Secretary’s interpretation” of the DSH calculation

for the purposes of a Chevron step one analysis. Ne. Hosp., 657 F.3d at 11, 13 (“Congress has

not clearly foreclosed the Secretary’s interpretation that M+C enrollees are entitled to benefits



8
 Under the two-step analysis of Chevron, U.S.A., Inc. v. Natural Resources Defense Council, the
Court first determines “whether Congress has directly spoken to the precise question at issue.”
467 U.S. 837, 842 (1984). “[I]f the statute is silent or ambiguous” on that question, then the
Court defers to the agency's interpretation if it is “based on a permissible construction of the
statute.” Id. at 843.


                                                 12
under Part A. Rather, it has left a statutory gap, and it is for the Secretary, not the court, to fill

that gap.”) (citation omitted). The D.C. Circuit did not reach the second step of Chevron,

whether the Secretary’s interpretation was reasonable, “because even if the Secretary’s present

interpretation is reasonable, it cannot be applied retroactively to fiscal years 1999–2002.” Id. at

13.

                The D.C. Circuit firmly rejected the Secretary’s argument that her post-2004

interpretation of the DSH calculation merely “codified a longstanding policy” because her pre-

2004 practice was not to count Part C days in the Medicare/SSI fraction. Id. at 15. Finding that

the Secretary’s “actual treatment of M+C days” prior to 2004, as well as “her statements in the

2004 rulemaking and in [the] subsequent 2007 technical revision,” belied her claim that her

inclusion of Part C days with Part A days was “longstanding,” id. at 16, the D.C. Circuit

concluded:

                [I]t is apparent that the Secretary’s decision to apply her present
                interpretation of the DSH statute to fiscal years 1999–2002 violates
                the rule against retroactive rulemaking. The Secretary’s
                interpretation, as set forth in the 2004 rulemaking and resulting
                amendment to § 412.106, contradicts her former practice of
                excluding M+C days from the Medicare fraction. Moreover, the
                amendment attaches new legal consequences to hospitals’
                treatment of low-income patients during the relevant time period.

Id. at 16–17.

                Judge Kavanaugh, in a concurring opinion, agreed with the district court’s

analysis in Northeast Hospital and would have held that 42 U.S.C. § 1395ww(d)(5)(F)(vi)

unambiguously foreclosed the Secretary’s proffered interpretation at step one of the Chevron

analysis.    Id. at 24 (Kavanaugh, J., concurring) (“[D]espite HHS’s effort to fog it up,

§ 1395ww(d)(5)(F)(vi) is sufficiently clear in establishing that a Part C beneficiary is not

simultaneously entitled to benefits under Part A for any specific patient day.”). Moreover, Judge



                                                 13
Kavanaugh agreed with the majority in rejecting the Secretary’s argument that her post-2004

interpretation of the statute was consistent with longstanding practice. Id. at 21 (“[I]t is quite

telling that, until 2004, HHS itself interpreted the statute as the Hospital does here. In 2004, HHS

abruptly changed course, apparently because of an overriding desire to squeeze the amount of

money paid to Medicare providers (and beneficiaries) in light of the country’s increasingly

precarious fiscal situation.”).

                The parties completed briefing after the D.C. Circuit issued its ruling in Northeast

Hospital, and the case is now ripe for decision.

                                  II.     LEGAL STANDARD

                Three legal standards are applicable in this case: (1) the general standard of

review for summary judgment in cases under the Administrative Procedure Act, 5 U.S.C. § 701

et seq.; (2) the standard for the notice and comment required of the Secretary in rulemaking

under the APA and the Medicare Act; and (3) the standard governing the Hospitals’ claim that

the Secretary’s interpretation of the DSH calculation was insufficiently explained and thus

arbitrary and capricious in violation of the APA. 9

              A.      Standard of Review for Summary Judgment in APA Cases

                Under Rule 56 of the Federal Rules of Civil Procedure, summary judgment shall

be granted “if the movant shows that there is no genuine dispute as to any material fact and the

movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a); accord Anderson v.

Liberty Lobby, Inc., 477 U.S. 242, 247 (1986). “In a case involving review of a final agency

action under the [APA], 5 U.S.C. § 706, however, the standard set forth in Rule 56[] does not

apply because of the limited role of a court in reviewing the administrative record.” Sierra Club


9
  As set forth more fully below, the Hospitals advanced other claims that the Court need not
reach to dispose of the pending motions.


                                                   14
v. Mainella, 459 F. Supp. 2d 76, 89 (D.D.C. 2006); see also Charter Operators of Alaska v.

Blank, 844 F. Supp. 2d 122, 126–27 (D.D.C. 2012); Buckingham v. Mabus, 772 F. Supp. 2d 295,

300 (D.D.C. 2011). Under the APA, the agency’s role is to resolve factual issues to reach a

decision supported by the administrative record, while “the function of the district court is to

determine whether or not as a matter of law the evidence in the administrative record permitted

the agency to make the decision it did.” Sierra Club, 459 F. Supp. 2d at 90 (quoting Occidental

Eng’g Co. v. INS, 753 F.2d 766, 769 (9th Cir. 1985) (internal quotation marks omitted)).

“Summary judgment thus serves as the mechanism for deciding, as a matter of law, whether the

agency action is supported by the administrative record and otherwise consistent with the APA

standard of review.” Id. (citing Richards v. INS, 554 F.2d 1173, 1177 & n.28 (D.C. Cir. 1977)).

                   B.      Notice & Comment—APA and the Medicare Act

               Under the APA and the Medicare Act, the Secretary must provide the public with

adequate notice of a proposed rule and an opportunity to comment thereon. See 5 U.S.C.

§ 553(b)–(c) (APA); 42 U.S.C. § 1395hh(b)(1) (“[B]efore issuing in final form any regulation

. . . the Secretary shall provide for notice of the proposed regulation in the Federal Register and a

period of not less than 60 days for public comment thereon.”); 42 U.S.C. § 1395hh(a)(2) (“No

rule, requirement, or other statement of policy . . . that establishes or changes a substantive legal

standard governing . . . the payment for services . . . shall take effect unless it is promulgated by

the Secretary by regulation under [42 U.S.C. § 1395hh(a)(1)].”).

               “Notice requirements are designed (1) to ensure that agency regulations are tested

via exposure to diverse public comment, (2) to ensure fairness to affected parties, and (3) to give

affected parties an opportunity to develop evidence in the record to support their objections to

the rule and thereby enhance the quality of judicial review.” Int’l Union, UMWA v. MSHA, 407




                                                 15
F.3d 1250, 1259 (D.C. Cir. 2005). An agency may promulgate a final rule that is different from

a proposed rule, but only if the final rule is a “logical outgrowth” of the proposed rule, i.e., only

if “interested parties ‘should have anticipated that the change was possible, and thus reasonably

should have filed their comments on the subject during the notice-and-comment period.’” Id.

(quoting Ne. Md. Waste Disposal Auth. v. EPA, 358 F.3d 936, 952 (D.C. Cir. 2004)); accord 42

U.S.C. § 1395hh(a)(4) (“If the Secretary publishes a final regulation that includes a provision

that is not a logical outgrowth of a previously published notice of proposed rulemaking or

interim final rule, such provision shall be treated as a proposed regulation and shall not take

effect until there is the further opportunity for public comment and a publication of the provision

again as a final regulation.”). Thus, neither a brand-new rule nor one built on vague insinuations

for which an interested party would have had to “divine [the Agency’s] unspoken thoughts” will

qualify as a “logical outgrowth.” See Ariz. Pub. Serv. Co. v. EPA, 211 F.3d 1280, 1299 (D.C.

Cir. 2000); Int’l Union, UMWA, 407 F.3d at 1260.

       C.      The APA’s Prohibition Against Arbitrary & Capricious Agency Action

               The Hospitals’ claim that the Secretary’s rulemaking was insufficiently explained

falls under the APA’s prohibition against arbitrary and capricious agency action. The APA

provides that a reviewing court may set aside an agency action that is “arbitrary, capricious, an

abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. § 706(2)(A); Tourus

Records, Inc. v. DEA, 259 F.3d 731, 736 (D.C. Cir. 2001). “The scope of review under the

‘arbitrary and capricious’ standard is narrow and a court is not to substitute its judgment for that

of the agency.” Motor Vehicle Mfrs. Ass’n of U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S.

29, 43 (1983). At the same time, “the agency must examine the relevant data and articulate a

satisfactory explanation for its action including a ‘rational connection between the facts found




                                                 16
and the choice made.’” Id. (quoting Burlington Truck Lines v. United States, 371 U.S. 156, 168

(1962)); see also Pub. Citizen, Inc. v. FAA, 988 F.2d 186, 197 (D.C. Cir. 1993) (“The

requirement that agency action not be arbitrary or capricious includes a requirement that the

agency adequately explain its result.”). While the agency action under review is “entitled to a

presumption of regularity[,] . . . that presumption is not to shield [an] action from a thorough,

probing, in-depth review.” Citizens to Pres. Overton Park, Inc. v. Volpe, 401 U.S. 402, 415

(1971), abrogated on other grounds by Califano v. Sanders, 430 U.S. 99 (1977).

               “An agency interpretation of a relevant provision which conflicts with the

agency’s earlier interpretation is entitled to considerably less deference than a consistently held

agency view.” INS v. Cardoza-Fonesca, 480 U.S. 421, 446 n.30 (1987) (internal quotation

marks and citation omitted); see also Good Samaritan Hosp. v. Shalala, 508 U.S. 402, 417

(1993) (“[T]he consistency of an agency’s position is a factor in assessing the weight that

position is due.”). “One of the core tenets of reasoned decision-making is that an agency [when]

changing its course . . . is obligated to supply a reasoned analysis for the change.” See Republic

Airline Inc. v. Dep’t of Transp., 669 F.3d 296, 299 (D.C. Cir. 2012) (internal quotation marks

and citations omitted). “Where the agency has failed to provide a reasoned explanation, or

where the record belies the agency’s conclusion, [the court] must undo its action.” Cnty. of Los

Angeles v. Shalala, 192 F.3d 1005, 1021 (D.C. Cir. 1999) (internal quotation marks and citation

omitted).

                                       III.   ANALYSIS

               The Hospitals challenge the Secretary’s 2004 policy change on a number of

procedural and substantive grounds.      Procedurally, the Hospitals assert, the Secretary: (1)

provided inadequate opportunity for notice and comment in violation of the APA and the




                                                17
Medicare Act; (2) failed to explain the reasons behind the policy change, in violation of the

APA; and (3) provided insufficient financial analysis of the proposed change in violation of the

Regulatory Flexibility Act.     The Hospitals also make two substantive challenges to the

Secretary’s policy. First, arguing that the D.C. Circuit’s conclusion to the contrary in Northeast

Hospital is dictum that does not bind this Court, they contend that the 2004 policy change fails

the first step of Chevron because the Medicare statute precludes the interpretation assigned by

the Secretary. Second, the Hospitals ask the Court to invalidate the Secretary’s interpretation

under the second step of Chevron as unreasonable.

               As set forth below, the Court agrees with the Hospitals as to the first two of their

procedural arguments. Because these conclusions require vacatur and remand of this matter to

the Secretary, the Court does not reach the Hospitals’ other arguments.

               Before reaching these matters, however, the Court must address briefly a

threshold matter. Many of the Secretary’s arguments rely on the factual premise that her post-

2004 interpretation did not constitute a change in policy. The D.C. Circuit held otherwise in

Northeast Hospital, and the Court need not dwell on that issue at length.

                         A.      The Secretary’s 2004 Policy Change

               The Secretary takes the position in this case that the 2004 rulemaking did not

constitute a policy change because her policy has always been to include Part C days in the

Medicare/SSI fraction. E.g., Def. MSJ Mem. at 28 (“On a factual level, plaintiffs’ claim that the

2004 rule was an unexplained departure from a long-established interpretation is little more an

ipse dixit, entirely without basis.”). She concedes that CMS had failed “to specifically address

the intersection between the DSH calculation and Medicare Part C,” which “had left interested

parties with questions about how M+C days were to be counted” and that “[t]here may even have




                                                18
been some variation in how these days had been being handled from one hospital and fiscal

intermediary to the next.” Id. at 30 (citations omitted).    However, the Secretary insists that,

based on a 1990 rulemaking statement, “the Secretary had a policy of ‘including HMO days in

the SSI/Medicare percentage,’” which was a “longstanding inclusion” that “Congress must be

presumed to have been aware of when it enacted Part C” in 1997. Id. at 22 (citing Medicare

Program; Changes to the Inpatient Hospital Prospective Payment System and Fiscal Year 1991

Rates, 55 Fed. Reg. 35990, 35994 (Sept. 4, 1990)); Medicare Program; Changes to the Hospital

Inpatient Prospective Payment Systems and Fiscal Year 1997 Rates, 61 Fed. Reg. 46166, 46207

(Aug. 30, 1996)). Northeast Hospital is not dispositive, the Secretary argues in a footnote,

because “the Court of Appeals found that CMS had a prior ‘practice of excluding M+C days

from the Medicare fraction.’ . . . [But] a de facto practice is quite different from an official

agency policy. Moreover, the Northeast court did not find—nor was it the case—that CMS had

either a policy or practice of counting M+C days in the Medicaid fraction.” Def. MSJ Mem. at

30 n.11 (citations omitted).

               The Hospitals cry foul, and with good reason. “The Secretary’s factual premise,”

they argue, “has been rejected by binding Circuit precedent [in Northeast Hospital] . . . [and] is

‘unacceptable non-acquiescence’ in the law of this Circuit.” Pl. Opp’n Mem. [Dkt. 38] at 4

(quoting Hosp. of Univ. of Pa. v. Sebelius, 847 F. Supp. 2d 125, 139 (D.D.C. 2012)). The

Hospitals assert that the Secretary’s attempts to distinguish between agency policy and practice,

as well as between appellate findings about the Medicare/SSI fraction versus the Medicaid

fraction, offer no basis to remove the case from the scope of Northeast Hospital. Id. at 6–9.

               The plain text of the D.C. Circuit’s opinion undercuts the Secretary’s position.

That Court’s evaluation—that “[a] brief look at the Secretary’s treatment of M+C days prior to




                                                19
2004 . . . belies her claim that the revision to § 412.106 codified a longstanding policy,”

Northeast Hospital, 657 F.3d at 15—is unequivocal and inescapable.                Nor did Northeast

Hospital give room for a legally significant difference between practice and policy. In fact, the

appellate court went to pains to state the opposite, rejecting the Secretary’s attempt to rely on the

1990 rulemaking. Id. at 16 (“Aside from the Secretary’s actual treatment of M+C days, her

statements in the 2004 rulemaking and in a subsequent 2007 technical revision confirm that she

changed her interpretation of the DSH provision in 2004.”); see also id. (discussing how the

Secretary “called her 2004 decision to include M+C days in the Medicare fraction a ‘policy

change’” (quoting 72 Fed. Reg. at 47384)).        Northeast Hospital also rejected any distinction

between policy regarding the Medicare and Medicaid fractions, making the common-sense

observation that the interpretation of the two is tied because a patient is either “entitled” or “not

entitled” to Part A benefits and thus necessarily falls in one fraction or the other. Id.

               Accordingly, in addressing the Hospitals’ arguments as to whether the Secretary’s

2004 interpretation of the DSH calculation can be applied to calculate FY 2007 reimbursement

rates, the Court begins with the proposition that “[t]he Secretary’s interpretation [of the DSH

calculation], as set forth in the 2004 rulemaking and resulting amendment to § 412.106,

contradicts” and is a “substantive departure” from “her former practice of excluding M+C days

from the Medicare fraction.” Ne. Hosp., 657 F.3d at 17.

                   B.      Notice & Comment—APA and the Medicare Act

               The Court turns first to the Hospitals’ argument that the Secretary violated both

the APA, 5 U.S.C. § 553, and the Medicare Act, 42 U.S.C. § 1395hh, by failing to provide notice

that she was changing her interpretation to include Part C days in the Medicare/SSI fraction.

According to the Hospitals, “the Secretary clarified one policy in 2003, then announced the




                                                  20
inverse of that policy in 2004, without notice and comment and without amending the DSH

regulation as necessary to effectuate the new rule. . . . Then, in August 2007, she amended the

regulation without advance notice or comment to implement the [2004] policy change. . . . Two

years later, the Secretary attempted to implement the new policy for the [2006 fiscal year]

through further instructions issued in 2009 . . . .” Pl. MSJ Mem. at 17–18.

                                  1.      Parties’ Arguments

               The parties’ arguments as to the sufficiency of prior notice center on the

effectiveness of the 2003 NPRM. According to the Secretary, she satisfied her duty to “fairly

apprise[] [the] interested parties of the issues involved” because the 2003 NPRM identified the

issue—whether Part C enrollees should be counted in the Medicare/SSI fraction or the Medicaid

fraction—and there were only two possible outcomes. Def. MSJ Mem. at 36–37 (citing Nuvio

Corp. v. FCC, 473 F.3d 302, 310 (D.C. Cir. 2006)). The fact that the Secretary settled in 2004

on including Part C subscribers in the Medicare/SSI fraction as opposed to the Medicaid fraction,

as she suggested in 2003 NPRM, is of no matter because the 2004 rule was a “logical outgrowth”

of the 2003 NPRM. Id. at 36 (citing Ne. Md. Waste Disposal Auth., 358 F.3d at 951). The

comments received in response to the 2003 NPRM bear this out, the Secretary asserts, because

they show that reasonable parties understood that she was proposing two options in the 2003

NPRM from which she would select one. Def. MSJ Mem. at 39–40 (citing Appalachian Power

Co. v. EPA, 135 F.3d 791, 816 (D.C. Cir. 1998)); see also Def. Reply [Dkt. 40] at 14.

               The Hospitals respond that the 2003 NPRM “gave no reason to conclude that

when she was clarifying her old policy, the Secretary was actually proposing to adopt its

inverse.” Pl. MSJ Mem. at 19. They claim that the 2003 NPRM was insufficient to put them on

notice that the Secretary would announce “a new policy in 2004 that was diametrically opposed




                                               21
to the policy clarified in 2003.” Id. Thus, according to the Hospitals, the 2004 interpretation

cannot have been a “logical outgrowth” of the 2003 proposal. Id. at 19–20. The Hospitals also

rely on the manner in which the Secretary phrased the 2003 notice, observing that the notice did

not propose any change to the regulatory text and did “not state that the Secretary planned to

determine” the answer to this issue—it stated that the agency “had ‘received questions.’” Pl.

Opp’n Mem. at 10 (quoting 68 Fed. Reg. at 27208) (first emphasis added by Court, second by

Plaintiffs). Accordingly, “[t]he agency did not identify any proposed change in policy because

the Secretary was merely clarifying the policy and practice the agency had been following since

[P]art C was enacted in 1997, which comported with her 1986 policy that ‘entitled to benefits

under part A’ means paid under the part A payment system.’” Id. at 11 (citation omitted).

                                         2.      Analysis

                The Court concludes that the Secretary’s interpretation of the fractions in the DSH

calculation, announced in 2004 and not added to the Code of Federal Regulations until the

summer of 2007, was not a “logical outgrowth” of the 2003 NPRM. See Int’l Union, UMWA,

407 F.3d at 1259. The rulemaking procedure was flawed due to both the single-minded way the

NPRM presented the issue and the fact that the Secretary adopted the polar opposite of the

original proposal. Contrary to the Secretary’s argument, the comments do not remedy these

deficiencies.

                First, the text of the 2003 NPRM was not written in a way that “interested parties

‘should have anticipated’ that the change was possible[] and thus reasonably should have filed

their comments on the subject during the notice-and-comment period.” Ne. Md. Waste Disposal

Auth., 358 F.3d at 952 (citing, inter alia, City of Waukesha v. EPA, 320 F.3d 228, 245 (D.C. Cir.

2003); see also Small Refiner Lead Phase-Down Task Force v. U.S. E.P.A., 705 F.2d 506, 549




                                                22
(D.C. Cir. 1983) (“Agency notice must describe the range of alternatives being considered with

reasonable specificity.”).   The 2003 NPRM, consisting of three paragraphs and nowhere

proposing any amendment to the C.F.R., stated that the Secretary had “received questions” and

was “proposing to clarify” that Part C patients should be counted in the Medicaid fraction. 68

Fed. Reg. at 27508.      Leaving aside the Secretary’s failure to acknowledge explicitly her

longstanding practice, discussed above, the NPRM does not support the Secretary’s

characterization of the issue as an open, binary choice between two equally valid interpretations.

To the contrary, the 2003 NPRM firmly slants toward inclusion of Part C patients in the

Medicaid fraction. The second paragraph reasons that, although “an individual is eligible to elect

an M+C plan if he or she is entitled to Medicare Part A and enrolled in Part B[,] . . . once a

beneficiary has elected to join an M+C plan, that beneficiary’s benefits are no longer

administered under Part A.” Id. The NPRM then immediately segues: “Therefore, we are

proposing to clarify that once a beneficiary elects Medicare Part C, those patient days

attributable to the beneficiary should not be included in the Medicare fraction of the DSH patient

percentage.” Id. The Secretary did not ask for comment on whether her interpretation was

consistent with the statute or what the practical impact of the proposed interpretation might be.

The 2003 NPRM reads more like an afterthought of a clarification than a proposed rule

susceptible of multiple interpretations.

               Second, even setting aside its semantic issues, the 2003 NPRM is problematic

because the Secretary adopted the exact opposite interpretation from the one she proposed.

While this is not a per se death knell for a proposed rule, given the 180-degree shift, this is not a

case in which “any reasonable party should have understood that [the Secretary] might reach the

opposite conclusion after considering public comments,” and the mere passing mention of the




                                                 23
alternative, in the context of this specific notice, does not overcome the NPRM’s weaknesses.

See Ariz. Pub. Serv. Co., 211 F.3d at 1230.         The parties argue at length about whether

Environmental Integrity Project v. EPA, 425 F.3d 992 (D.C. Cir. 2005), dictates the conclusion

that notice was invalid. See Pl. Opp’n Mem. at 12–13, Def. MSJ Mem. at 38–39, Def. Reply at

13. In that case, the EPA gave notice that it proposed to delete certain language from a prefatory

paragraph in the C.F.R. to clarify, as it had held in two administrative proceedings, that two

emissions regulations operated independently and, thus, parties needed to obtain permits

complying with both regulations on a case-by-case basis. Envtl. Integrity Project, 425 F.3d at

994–95.   In the final rule, however, the EPA “switched course and adopted the opposite

position,” concluding that the regulations operated dependently such that permits meeting one

regulation would meet the other. Id. at 995. The D.C. Circuit, reasoning that the term “logical

outgrowth” did “not include the [EPA’s] decision to repudiate its proposed interpretation and

adopt its inverse,” concluded that the EPA violated the notice-and-comment requirement. Id. at

998.

               The Secretary seeks to avoid Environmental Integrity Project, arguing that it

involved “minor amendments” to “conform” regulations “to an existing regulatory interpretation

that the agency had adopted through prior adjudications,” while rulemaking in the instant matter

involved “how best to interpret an ambiguous provision.”         Def. MSJ Mem. at 38.        This

understates the holding of Environmental Integrity Project and ignores, yet again, the Secretary’s

longstanding “former practice of excluding M+C days from the Medicare fraction.” Ne. Hosp.,

657 F.3d at 17. To be sure, a de facto practice is not quite as strong as the administrative

opinions at issue in Environmental Integrity Project. But the slate is not blank as the Secretary

claims, making this case far more like Environmental Integrity Project and others in which




                                               24
agencies “use the rulemaking process to pull a surprise switcheroo on regulated entities.” 425

F.3d at 996 (giving as an example Int’l Union, UMWA v. MSHA, 407 F.3d 1250 (D.C. Cir.

2005)).

               Finally, the Secretary points to the comments she received as evidence that the

2003 NPRM sufficiently put the public on notice of the “subjects and issues involved,” 5 U.S.C.

§ 553(b)(3).   Def. MSJ Mem. at 39–40.          But an agency cannot “bootstrap notice from a

comment,” which is exactly what the Secretary is trying to do here. See Fertilizer Inst. v. U.S.

E.P.A., 935 F.2d 1303, 1312 (D.C. Cir. 1991) (citing Small Refiner Lead Phase-Down Task

Force, 705 F.2d at 549); see also Nat’l Ass’n Psych. Health Sys. v. Shalala, 120 F. Supp. 2d 33,

40 (D.D.C. 2000) (“[T]he adequacy of notice cannot be judged by the number and type of

comments in response to the NPRM.”). As the Secretary notes, Def. Reply at 14, some of the

commenters understood the import of the 2003 NPRM and either supported or opposed it, and

some of the Hospitals even argued in favor of the interpretation they now challenge. E.g., R.R.

at 343 (Comment of North Shore University Hospital at Plainview). But the shortcoming in the

Secretary’s argument is that the comments—which are, at any rate, limited in number—is that,

taken as a whole, they reflect confusion and misunderstanding. E.g., R.R. at 516. The very

comment from North Shore University-Plainview, which the Secretary claims “cannot assert

with a straight face that [it was] denied an opportunity to voice [its] objection,” Def. Reply at 14,

misstated the Secretary’s pre-2004 practice, describing the 2003 NPRM as a “change” rather

than a codification. See id. (“[The proposal] would remove M+C days from the Medicare day

count.” (emphasis added)).     In light of the lack of clarity reflected by the comments, the

Hospitals should not be estopped from arguing that Part C patients belong in the Medicaid

fraction; instead, the Secretary must be accountable for the confusion that her “administrative




                                                 25
law shell game” has engendered. See Am. Tel. & Tel. Co. v. F.C.C., 978 F.2d 727, 732 (D.C.

Cir. 1992).

                For the foregoing reasons, the Court concludes that the 2003 NPRM did not

provide adequate notice of the interpretation of the DSH fraction adopted by the Secretary in

2004 in violation of the APA and the Medicare Act. The Court cannot say that the Hospitals,

“‘ex ante, should have anticipated that such a requirement might be imposed.’” Ariz. Pub. Serv.

Co., 211 F.3d at 1299 (quoting Aeronautical Radio, Inc. v. FCC, 928 F.2d 428, 445–46 (D.C.

Cir. 1991)).

               Having concluded that the 2003 NPRM was procedurally defective, the Court

need not address the Hospitals’ alternative argument that the Secretary’s responses to the

submitted comments were insufficient under the APA; that issue is better addressed in the

context of whether the Secretary’s action was arbitrary and capricious, discussed below. 10

Moreover, the Court need not dwell on the Secretary’s contention that “even if plaintiffs were to

show that the Secretary failed to provide notice, they have not shown that the failure resulted in

prejudice,” and thus there was no notice-and-comment violation. Def. MSJ Mem. at 40. The

confusion over the Secretary’s interpretation of the DSH calculation and large amount of money

at stake meet the “not . . . particularly robust showing of prejudice” courts require in these cases.

See Chamber of Commerce of U.S. v. S.E.C., 443 F.3d 890, 904 (D.C. Cir. 2006) (citing, inter

alia, Sugar Cane Growers Co-op. of Fla. v. Veneman, 289 F.3d 89, 96 (D.C. Cir. 2002)). In

addition, as the Secretary acknowledged in both the 2003 NPRM and 2004 Final Rule, 42 U.S.C.

§ 1395ww(d)(5)(F)(vi) is susceptible to multiple interpretations; the APA and Medicare Act

10
   That having been said, it is telling that the Secretary neither directly acknowledged the
confusion reflected in the comments nor responded to the detailed comment asserting that the
2003 NPRM’s explanation was too cursory. See 69 Fed. Reg. at 49099 (discussing comments
received in response to 2003 NPRM).


                                                 26
require that the Hospitals have a chance to understand what was at stake in the Secretary’s

proposal and weigh in.

       C.     The APA’s Prohibition Against Arbitrary & Capricious Agency Action

               The Court turns next to whether the Secretary’s action was “arbitrary, capricious,

an abuse of discretion, or otherwise not in accordance with the law,” 5 U.S.C. § 706(2)(A), due

to her alleged failure to “articulate a satisfactory explanation” for her 2004 policy change. 11 See

Motor Vehicle Mfrs. Ass’n, 463 U.S. at 43. The Court thus reviews the record of the 2004

rulemaking to determine if the Secretary has supplied a “reasoned analysis for the change.”

Republic Airline, Inc., 669 F.3d at 299.

                                   1.      Parties’ Arguments

               The Hospitals argue that the explanation offered by the Secretary is flawed in two

ways: it failed to acknowledge that she was changing from her prior interpretation, and it failed

to give a reason for the departure. Pl. MSJ Mem. at 24–26. According to the Hospitals, the only

explanation the Secretary offered for the 2004 change is that Part C enrollees are “still, in some

sense, entitled to benefits under Medicare Part A,” which is a “vacuous utterance [that] explains

nothing” and is “entirely devoid of genuine reasoning.” Id. at 25. The Secretary’s explanation is

fatally conclusory, the Hospitals contend, because she “did not explain why part C days, which

are not paid under the part A prospective payment system, should suddenly start to be reflected

in a DSH formula designed by Congress to adjust part A payments to account for services to

low-income part A patients.” Id. at 24. Moreover, because “[t]here is no reference to Medicare

provisions outside of the DSH calculation, no examination of congressional purpose in enacting

11
   The Secretary asserts that she “cannot be faulted for failing to acknowledge a ‘prior
established interpretation’ that she did not have.” Def. MSJ Mem. at 28 (citation omitted). The
Court follows Northeast Hospital and declines to engage in semantic debates about what, in fact,
the Secretary’s pre-2004 position should be called.


                                                27
the Part C program, [] no invocation of ‘sound policy’ reasons for the change,” and no

explanation of “the inconsistency with the Secretary’s other interpretation of the very same word

‘entitled’ in the very same sentence of the Medicare DSH statute.” Id.

               The Secretary responds that her explanation in the 2004 Federal Register was

adequate because she explained that “an individual is eligible to elect an M+C plan only ‘if he or

she is entitled to Medicare Part A,’ and that ‘each M+C plan must provide coverage of all

services that are covered by Medicare Part A.’” Def. MSJ Mem. at 27–28. When the Secretary

said “still, in some sense, entitled to benefits under Part A,” “it was obvious in what ‘sense’ the

Secretary meant—namely, in the sense that the phrase is employed as a term of art in the DSH

provision.’” Id. at 28. According to the Secretary, her explanation was sufficient because she

provided a “basic indication of why the agency chose to do what it did.” Id. (citing, inter alia,

Nat’l Cable & Telecomms. Ass’n v. FCC, 567 F.3d 659, 669 (D.C. Cir. 2009)).

                                         2.     Analysis

               The Court concludes that the Secretary’s cursory explanation in the 2004 Final

Rule failed to meet the requirements of the APA. The Secretary argues extensively that her

alleged failure to acknowledge her pre-2004 practice has no bearing on whether the post-2004

practice was adequately explained, e.g., Def. Reply at 20, but this argument is flawed from both

legal and logical standpoints. It is true, as the Secretary notes, that there is no “heightened

standard of review when examining the reasoning behind a change in policy.” Def. MSJ Mem.

at 27 (citing FCC v. Fox Television Stations, 556 U.S. 502 (2009)). But Fox itself makes clear

that a policy change is relevant to the Court’s inquiry in run-of-the-mill cases: “[T]he

requirement that an agency provide reasoned explanation for its action would ordinarily demand

that it display awareness that it is changing position.” 556 U.S. at 515 (emphasis added).




                                                28
               In fact, this case falls squarely within the admonition in Fox that, when an

agency’s “prior policy has engendered serious reliance interests,” an agency “must” give “a more

detailed justification than what would suffice for a new policy created on a blank slate.” Id.

(citing Smiley v. Citibank (South Dakota), N. A., 517 U.S. 735, 742 (1996)). “It would be

arbitrary or capricious to ignore such matters.”       Id.   The closest the Secretary came to

acknowledging her policy change in the meager explanation of the 2004 Final Rule was the

statement that “commenters . . . indicated that there has been insufficient guidance on how to

handle these days in the DSH calculation.” 69 Fed. Reg. at 49099. This statement, by which the

Secretary herself did not admit regulatory confusion but intimated that it was only commenters

who believed it to exist, fell woefully short of owning up to, and explaining her decision to vary

from, “longstanding practice.”

               Even setting aside the Secretary’s failure to acknowledge her “about-face,”

Northeast Hospital, 657 F.3d at 15, her reasoning for the change was brief and unconvincing.

There were only two portions of the statement accompanying the 2004 Final Rule that can fairly

be described as an explanation. The first was a summary of the comments favoring inclusion of

Part C days in the Medicare/SSI fraction: “[S]everal commenters . . . pointed out that these

patients are just as much Medicare beneficiaries as those beneficiaries in the traditional fee-for-

service program.” 69 Fed. Reg. at 49099. The second was the Secretary’s own rationale, which

was limited to a single sentence: “Although there are differences between the status of these

beneficiaries and those in the traditional fee-for-service program, we do agree that once

Medicare beneficiaries elect Medicare Part C coverage, they are still, in some sense, entitled to

benefits under Medicare Part A.” Id. This statement contained no “reasoned explanation,” Cnty.

of Los Angeles, 192 F.3d at 1021; it merely restated the very same problem being fought over in




                                                29
this case: in some sense, Part C enrollees are still “entitled to” Part A benefits—but, in another

sense, they are not because a patient cannot be paid Part A benefits and Part C benefits at the

same time. See Ne. Hosp., 657 F.3d at 19–20 (Kavanugh, J., concurring) (“‘[P]ayments under a

contract with a Medicare+Choice organization . . .[,] with respect to an individual electing a

Medicare+Choice plan offered by the organization[,] shall be instead of the amounts which (in

the absence of the contract) would otherwise be payable under [Medicare] parts A and B.’”

(quoting 42 U.S.C. § 1395w–21(i)(1)).

               The Secretary contends that, under Fox, “where an agency changes its policy, ‘it

suffices that the new policy is permissible under the statute, that there are good reasons for it,

and that the agency believes it to be better . . . .’” Def. Reply at 19 (quoting 556 U.S. at 515).

That is true. But “the agency must show that there are good reasons for the new policy.” Fox,

556 U.S. at 515 (emphasis added). One comment to the 2003 NPRM noted two of the subjects

the Secretary neglected to address in the 2004 Final Rule: the need to reconcile Congressional

intent regarding the DSH fraction and the M+C program, which were enacted years apart, and

the financial impact of counting Part C days in the Medicaid fraction. 12 See R.R. at 354. There

are other topics that the Secretary might have addressed, such as the logistics of implementing

the Secretary’s new method of calculation (which, the record shows, took years) and how

regulated entities should reconcile the possibility of two different definitions of the word

“entitled” in the same sentence in 42 U.S.C. § 1395ww(d)(5)(F)(vi)(I). These are subjects that

the Secretary has confronted in this case, e.g., Def. MSJ Mem. at 15–21 (arguing why the

Secretary’s interpretation was reasonable), as well as in Northeast Hospital. But the Secretary

should have wrestled with those issues earlier and then shown at least some of her work in her

12
  As discussed earlier, this commenter, like others, believed the Secretary had been including
Part C days in the Medicare/SSI fraction.


                                               30
explanation of the 2004 Final Rule. See Alpharma, Inc. v. Leavitt, 460 F.3d 1, 6 (D.C. Cir. 2006)

(“[P]ost hoc rationalizations ‘have traditionally been found to be an inadequate basis for review’

of agency decisions.” (quoting Citizens to Pres. Overton Park, 401 U.S. at 419)).

                  “[A]n agency must cogently explain why it has exercised its discretion in a given

manner.” Motor Vehicles Ass’n, 463 U.S. at 48 (citations omitted). In this case, the Secretary

failed to do so and “depart[ed] from a prior policy sub silentio,” Fox, 556 U.S. at 515, thus acting

arbitrary and capriciously in violation of the APA, 5 U.S.C. § 706(a)(2).

                                           D.     Remedy

                  “[T]he law of this circuit” governing remedies in cases involving flawed agency

actions is the Allied-Signal test. Heartland Reg’l Med. Ctr. v. Sebelius, 566 F.3d 193, 197 (D.C.

Cir. 2009) (citing Allied-Signal, Inc. v. U.S. Nuclear Regulatory Comm’n, 988 F.2d 146 (D.C.

Cir. 1993)). 13    In determining whether to vacate the flawed agency action or leave it in place

pending remand, “the district court should be guided by two principal factors: (1) ‘the

seriousness of the . . . deficiencies’ of the action, that is, how likely it is ‘the [agency] will be

able to justify’ its decision on remand; and (2) ‘the disruptive consequences of vacatur.’” Id.

(quoting Fox Television Stations, Inc. v. FCC, 280 F.3d 1027, 1048-49, modified on reh’g on

other ground, 293 F.3d 537 (D.C. Cir. 2002)). Here, both factors weigh in favor of vacatur.

This Court need not decide now whether the Secretary’s post-2004 interpretation would pass

muster under Chevron step two if the proper procedure were followed and if the decision were

sufficiently explained. Cf. Ne. Hosp., 657 F.3d at 18 (declining to reach second step of Chevron



13
  The parties dispute whether the plain text of the Medicare Act, 42 U.S.C. § 1395hh(a)(4),
automatically requires vacatur for a notice-and-comment violation, trumping the discretionary
vacatur that is customary under the APA. Def. Reply at 24, Pl. Opp’n Mem. at 43–44. The
Court does not reach that issue because it also concludes that the Secretary’s action was arbitrary
and capricious and that the Allied-Signal test requires vacatur.


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analysis because new interpretation of the DSH calculation could not be applied retroactively to

FY 1999–2002). As set forth above, the Secretary’s rulemaking process was gravely flawed in

several respects so that vacatur is appropriate.

               The second Allied-Signal factor heavily favors vacatur because the Court’s ruling

affects reimbursement rates for past years that the Secretary has, through use of the new

interpretation, tried to recalculate. The portion of the 2004 Final Rule at 69 Federal Register

48916, 49099, that announced the Secretary’s interpretation of the Medicare Disproportionate

Share Hospital Fraction, as codified in 2007 at 42 C.F.R. § 412.106(b)(2) and as further modified

in 2010, is tantamount to the retroactive rulemaking that the D.C. Circuit held impermissible in

Northeast Hospital.     657 F.3d at 17.      Because the Secretary did not validly change her

interpretation of the DSH calculation prior to FY 2007, and because there is “no statute that

authorizes the Secretary to promulgate retroactive rules for DSH calculations,” id., the Secretary

cannot impose her new interpretation on the FY 2007 calculations challenged in this case.

Accordingly, the danger of disruption from vacatur is low. See Heartland Reg’l Med. Ctr., 566

F.3d at 197.

                                      IV.     CONCLUSION

               For the foregoing reasons, the Hospitals’ motion for summary judgment [Dkt. 32]

will be granted. The Secretary’s motion for summary judgment [Dkt. 35] will be denied. The

portion of the 2004 Final Rule at 69 Federal Register 48916, 49099, that announced the

Secretary’s interpretation of the Medicare Disproportionate Share Hospital Fraction, as codified

in 2007 at 42 C.F.R. § 412.106(b)(2) and as further modified in 2010, will be vacated, and the

case will be remanded to the Secretary for further action consistent with this Opinion.




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            A memorializing Order accompanies this Opinion.



DATE: November 15, 2012
                                                              /s/
                                               ROSEMARY M. COLLYER
                                               United States District Judge




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