                                                                                                                           Opinions of the United
2004 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


8-18-2004

Mercy Catholic Med v. Thompson
Precedential or Non-Precedential: Precedential

Docket No. 03-2292




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"Mercy Catholic Med v. Thompson" (2004). 2004 Decisions. Paper 368.
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                         PRECEDENTIAL        Mark H. Gallant, Esquire (Argued)
                                             Cozen & O'Connor
         UNITED STATES                       The Atrium
        COURT OF APPEALS                     1900 Market Street
      FOR THE THIRD CIRCUIT                  Philadelphia, Pennsylvania 19103
                                                   Attorney for Appellant

               No. 03-2292                   Michael Leonard, Esquire (Argued)
                                             Department of Health & Human Services
                                             Office of the General Counsel,
          MERCY CATHOLIC                     Region III
          MEDICAL CENTER,                    The Public Ledger Building, Suite 418
                      Appellant              150 South Independence Mall West
                                             Philadelphia, Pennsylvania 19106
                    v.                              Attorney for Appellee

      TOMMY G. THOMPSON,
      SECRETARY OF HEALTH                               OPINION OF THE COURT
      AND HUM AN SERVICES

                                             SCIRICA, Chief Judge.
          On Appeal from the
                                                      At issue is an acute care hospital’s
   United States District Court for the
                                             reimbursement from Medicare for
    Eastern District of Pennsylvania
                                             graduate medical training. Mercy Catholic
   D.C. Civil Action No. 02-cv-00419
                                             Medical Center1 seeks reversal of the
   (Honorable Ronald L. Buckwalter)
                                             Provider Reimbursement Review Board’s
                                             decision denying reclassification of certain
                                             graduate medical education costs2 and its
          Argued April 19, 2004
                                             r e f u sa l t o a d j u st M e d i c a r e ’s
                                             reimbursement of operating costs. The
   Before: SCIRICA, Chief Judge,
 GARTH and BRIGHT * , Circuit Judges
                                                1
                                                 Mercy Catholic Medical Center is an
         (Filed: August 18, 2004 )           acute care hospital located in Philadelphia.
                                                    2
                                                    Graduate Medical Education costs
                                             refer to Medicare payments made to
                                             hospitals to support Medicare’s share of
                                             costs related to medical training programs
     *
      The Honorable Myron H. Bright,         and to support higher patient costs
United States Circuit Judge for the Eighth   associated with the training and education
Judicial Circuit, sitting by designation.    of residents.
Board also found Mercy Catholic Medical                  Medicare services are furnished by
Center did not provide sufficient                 “providers of services”4 that have entered
documentation to justify a reclassification       into provider agreements with the
and recision of costs. The District Court         Secretary of the United States Department
affirmed the Provider Reimbursement               of Health and Human Services. 42 U.S.C.
Review Board’s decision and granted               §§ 1395x(u), 1395cc. To receive payment
summary judgment to the Secretary of the          from the Secretary, providers are required
Department of Health and Human                    to comply with the provider agreement, as
Services. We will reverse and remand.             well as all Medicare statutes and
                                                  regulations. 42 U.S.C. § 1395cc(b)(2).
                    I.
                                                          From its inception, Medicare
A. Statutory Background
                                                  reimbursed hospitals for all reasonable
       The federal Medicare program,              incurred costs related to providing medical
administered by the Centers for Medicare          care to patients. The Medicare Act defines
and Medicaid Services3 of the United              "reasonable cost" as “the cost actually
States Department of Health and Human             incurred,” less any costs “unnecessary in
Services, is the largest public program           the efficient delivery of needed health
financing health care services for the aged       services.” 42 U.S.C. § 1395x(v)(1)(A).
and disabled. Hospitals that provide              Under the historical system of reasonable
services to Medicare patients are                 cost reimbursement, no reimbursement
reimbursed for their expenses under Title         distinction turned on whether costs were
XVII of the Social Security Act (the              reported as operating costs (the day-to-day
“Medicare Act”), 42 U.S.C. § 1395 et seq.         expenses incurred in running a business)
Part A of the Medicare Act authorizes             or graduate medical education costs.
payment to participating hospitals                Medicare paid its full pro rata share of all
(“providers”) for their direct and indirect       allowable graduate medical education
costs of providing inpatient care to              costs and operating costs actually incurred,
beneficiaries. 42 C.F.R. § 413.9(a), (b).         consistent with the statutory requirement
Medicare also reimburses teaching                 preventing shifting the costs of services
hospitals for the costs of graduate medical       incurred on behalf of Medicare
education, including physician time for           beneficiaries to other patients or third party
instructing and supervising interns and           payers. 42 U.S.C. § 1395x(v)(1)(A).
residents. 42 U.S.C. § 1395ww(h).

                                                     4
                                                      As defined by 42 U.S.C. § 1395x(u), a
                                                  “provider of services” means “a hospital,
                                                  critical access hospital, skilled nursing
    3
     Centers for M edicare and Medicaid           fa cil ity, comprehensive outpatie nt
Services was formerly known as the                rehabilitation facility, home health agency,
Health Care Financing Administration.             [or a] hospice program.”

                                              2
       In 1982, Congress modified the               particular base year. See 42 C.F.R. §§
Medicare program to require hospitals to            412.71, 412.73. For most hospitals the
render services more economically. In the           prospective payment system base year was
Tax Equity and Fiscal Responsibility Act            FY 1983. Therefore, for the first four
of 1982 (“TEFRA”), Pub. L. No. 97-248,              years of the prospective payment system, a
Congress amended the Medicare Act by                hospital’s reimbursement was still
imposing a ceiling on the rate-of-increase          significantly affected by its actual
of inpatient operating costs recoverable by         operating costs in the FY 1983 base year.
a hospital. Under TEFRA, costs were still           As part of the prospective payment system
reimbursed on a reasonable cost basis, but          transition period, the Health Care
subject to rate-of-increase limits. The rate-       Financing Administration promulgated the
of-increase limit was computed according            Consistency Rule, which required graduate
to a “target amount,” which, in turn, was           medical education costs for cost reporting
calculated according to a hospital’s                periods during the prospective payment
allowable net Medicare operating costs in           system transition period be determined in
the hospital's base year. See 42 U.S.C. §           a manner “consistent with the treatment of
1395ww(b); 42 C.F.R. § 413.40(c) (2002).            these costs for purposes of determining the
                                                    hospital-specific . . . rate.” 42 C.F.R. §
         In 1983, Congress amended the
                                                    412.113(b)(3). In effect, the Consistency
Medicare Act again, establishing a
                                                    Rule locked in the classification of
p ro sp e c t ive payment s ys t e m f or
                                                    graduate medical education costs and
reimbursing inpatient operating costs of
                                                    operating costs from the prospective
acute care hospitals. See 42 U.S.C. §
                                                    payment system base year (FY 1983)
1 3 95 w w(d).      Hospitals now are
                                                    forward.
reimbursed on the basis of prospectively
determined national and regional rates for                  The TEFRA and prospective
each discharge, rather than on the basis of         payment system reimbursements applied
retrospectively determined reasonable               only to inpatient operating costs. Graduate
costs incurred.      Under this system,             medical education costs were specifically
payment is made at a predetermined rate             excluded from the definition of “inpatient
for each hospital discharge, according to           operating cos ts.”         4 2 U .S.C . §
the patient's diagnosis.                            1395ww(a)(4), 1395ww(d)(1)(A). Thus,
                                                    grad uate medical education costs
      The prospective payment system
                                                    continued to be reimbursed under the
was phased in over four years, during
                                                    previous reasonable cost system until
which hospitals were reimbursed a
                                                    1986.
combination of the prospective payment
system hospital-specific rate and the                      In 1986, Congress enacted a
prospective payment system national and             separate prospective payment system for
regional rates. A hospital's specific rate is       graduate medical education costs for all
based on its operating costs during a               cost reporting periods beginning on or

                                                3
after July 1, 1985.            42 U.S.C. §          1985 graduate medical education base year
1395ww(h). Central to this new payment              costs. The reaudit would ensure the future
system was the determination of the base            payments would be based on an accurate
average per-resident amount (“APRA”).               determination of the hospitals' graduate
The APRA is determined by dividing the              medical education costs in the base-year.
hospital's base year graduate medical               To prevent over-reimbursement, the
education costs by the number of full-time-         regulations instruct intermediaries to
equivalent residents working at the                 deduct from each reaudited hospital’s base
hospital in the base year. The graduate             year graduate medical education amount
medical education base year is the                  any operating costs misclassified as
hospital’s fiscal year beginning during the         education costs.         4 2 C .F.R . §
federal fiscal year 1984. 42 U.S.C. §               413.86(e)(1)(ii)(B). To prevent under-
1395ww(h)(2)(A). For most Pennsylvania              reimbursement, the regulations authorize
hospitals, this is the fiscal year ended June       intermediaries, “upo n a ho spital’s
30, 1985. The APRA then serves as the               request,” to include in the base year
base figure in the formula to calculate             graduate medical education amount any
grad uate medical education                         teaching costs misclassified as operating
reimbursements for 1985 and future cost             costs in the base-year cost report. 42
years. 42 U.S.C. § 1395ww(h)(2)(C), (D);            C.F.R. § 413.86(e)(1)(ii)(C).        After
1395ww(h)(3).                                       determining the hospital's APRA upon
                                                    reaudit, the intermediary notifies the
        1. Determining the APRA.
                                                    hospital of the amount by a Notice of
      In 1990, to assure maximum                    Average Per Resident Amount
accuracy of each hospital’s APRA                    (“NAPRA”). 42 C.F.R. § 413.86(e)(1)(v).
determination, the Secretary required fiscal        The hospital may appeal this amount to the
intermediaries5 to reaudit all hospitals’           Secretary within 180 days of the NAPRA.
                                                    Id.
                                                            To supp ort a claim for
    5
      The Medicare program uses “fiscal             reclassification of misclassified graduate
inter me diar ies,” ge ne ra lly p rivate           medical education costs, a hospital must
insurance companies, to perform many of             present the intermediary with "sufficient
the program's administrative functions.             documentation" requiring a change in the
Fiscal intermediaries are responsible for           classification of costs.    42 C.F.R. §
determining the amount of payments to be            413.86(l)(2)(ii). The regulations required
made to providers. In the present case,             actual documentation developed during the
Mercy Catholic Medical Center’s fiscal              base year that was maintained in an
intermediary at the relevant time was
Independence Blue Cross.             The
Interm ediary, in turn, engaged a                   Young & O’Fria, to conduct the graduate
subcontractor, in this case Johnston,               medical education reaudit.

                                                4
auditable format.    See 42 C.F.R. §                   graduate medical education base year. Id.
405.481(g) (1986); Medicare Program;                   A limited exception was created restricting
Changes in Payment Policy for Direct                   the use of substitute documentation from
Graduate Medical Education Costs, 54                   later years to verify costs originally
Fed. Reg. 40,301 (Sept. 29, 1989).                     claimed as graduate medical education
                                                       costs in the graduate medical education
       The Secretary recognized, however,
                                                       base year, but disallowing the use of
that some hospitals would no longer have
                                                       documents from later years to increase the
the records required to support a
                                                       grad uate medical education costs
reclassification of costs. As such, the
                                                       originally claimed. As published in the
Secretary allowed auditors to accept time
                                                       Federal Re giste r, the S ecreta ry’s
records from subsequent time periods as
                                                       interpretation read:
proxy. “Graduate Medical Education:
Documentation to Support the Physician                        As an equitable solution to
Cost/Time Allocation” (1990), JA 211-                         t h e p r o b le m o f t h e
215.6 Where subsequent year records were                      nonexistence of physician
also unavailable, hospitals were allowed to                   allocation agreements, time
perform three-week time studies7 of                           record s, and other
current physician workloads to provide a                      information, w e are
rough estimate of the time allocation of                      allowing prov iders to
teaching physicians in the base year. See                     furnish documentation from
Medicare Program; Changes to the                              cost repo rting periods
Inpatient Hospital Prospective Payment                        subsequent to the base
System and Fiscal Year 1991 Rates, 55                         period in support of the
Fed. Reg. 36,064.                                             allocation of physician
                                                              compensation costs in the
          The Se creta ry noted these
                                                              GME base period . . . . In
alternative forms of documentation were
                                                              no event will the results
i n h e r e n t l y l e s s re l i ab l e t h an
                                                              obtained from the use of the
contemporaneous records from the
                                                              r e c o r d s f r o m a c o st
                                                              reporting period later than
      6
    The policy was later published in the                     the base period serve to
Federal Register at 55 Fed. Reg. 35,990,                      increase or add physician
36,063-64 (Sept. 4, 1990).                                    compensation costs to the
                                                              costs used to determine the
  7
   In performing a time study, a physician                    per resident amounts.
would, on a daily basis, log time worked
                                                       55 Fed. Reg. at 36,063-64.
for a provider over a period of several
weeks allocating time to various activities
such as administration, supervision, or
teaching of interns and residents.

                                                   5
       2. Adjusting Hospital-Specific                 [NAPRA]” and “include sufficient
          Rate and Target Amount for                  documentation to demonstrate to the
          Misclassified Costs.                        intermediary that adjustment of the
                                                      hospital’s hospital-specific rate or target
        A hospital may also request the
                                                      a m o u n t i s w a r r an t e d .” Id. §
reclassification of misclassified operating
                                                      413.86(l)(1)(ii).
costs. Misclassified operating costs are
costs that had been included as graduate              B. Facts
medical education costs in the graduate
                                                              On December 21, 1989, Mercy
medical education base year, but were
                                                      Catholic Medical Center received notice
reclassified by the intermediary as
                                                      the Intermediary (“Independent Blue
operating costs. 42 C.F.R. § 413.86(e)(1).
                                                      Cross”) was reopening its cost reports for
If the misclassified operating costs were
                                                      FYE (“Fiscal Year Ended”) 1985, 1986,
treated as graduate medical education costs
                                                      1987 and 1988 to perform the reaudit
in both the graduate medical education
                                                      under the graduate medical education
base year and the prospective payment
                                                      regulation.     During the reaudit, the
system base year, an upward adjustment of
                                                      Intermediary made several downward
the hospital’s specific rate or TEFRA
                                                      adjustments to Mercy Catholic Medical
target amount may be warranted since the
                                                      Center's graduate medical education costs
hospital-specific rate and target amount are
                                                      but refused to make other adjustments to
derived from operating costs in a base
                                                      its graduate medical education costs and
year. 54 Fed. Reg. 40,286, 40,289 (Sept.
                                                      operating costs.      The Intermediary's
29, 1989). Conversely, if the reaudit
                                                      downward adjustment of graduate medical
revealed misclassified graduate medical
                                                      education costs and refusal to reclassify
education costs (which would increase the
                                                      certain operating costs as graduate medical
ARPA), a corresponding downward
                                                      education costs reduced Mercy Catholic
adjustment of operating costs for the
                                                      Medical Center's APRA from $81,745 to
graduate medical education base year was
                                                      $73,657. Mercy Catholic Medical Center
required. Id.
                                                      filed a timely appeal of the Notice of
        The regulations allow a hospital to           Average Per Resident Amount with the
“request that the intermediary review the             Board.
classification of the affected costs in its
                                                            At the time, however, Mercy
rate-of-increase ceiling or prospective
                                                      Catholic Medical Center no longer
payment base year for purposes of
                                                      possessed all of the original supporting
adjusting the hospital's target amount or
                                                      documentation of its base year graduate
hospital-specific rate.” 42 C.F.R. §
                                                      medical education costs because the
413.86(l)(1)(i). To reclassify these costs,
                                                      governing rules only required hospitals to
a hospital must specifically "request
review of the classification of its . . . costs
no later than 180 days after the date of the

                                                  6
retain physician allocation agreements 8          was devoted to services that qualify as
(also known as “339s”) for four years from        graduate medical education costs. During
the close of FYE 1985 (i.e., until June 30,       the reaudit, Mercy Catholic Medical
1989).     Furthermore, Mercy Catholic            Center realized it had misclassified all of
Medical Center had experienced a flood in         the time spent by physicians in three
the basement storage area and discarded           Departments—OB/GYN, Laboratory, and
all damaged records that were beyond their        Radiology—as operating costs in the
retention date.                                   graduate medical education base year.
                                                  Even though these physicians had in fact
       Mercy Catholic Medical Center did,
                                                  been providing substantial graduate
however, retain some of the 339s for the
                                                  medical education services, it had been
departments in question. At oral argument
                                                  Mercy Catholic Medical Center’s historic
before this Court, both parties stipulated
                                                  practice to report as operating costs all
some 339s were included in the
                                                  costs for physicians whose duties were not
administrative record, although not
                                                  primarily teaching. Id. The 1990 time
included as formal exhibits. The Provider
                                                  studies included all of the physicians who
Reimbursement Review Board, however,
                                                  performed teaching duties in 1985,
did not acknowledge them. See Mercy
                                                  including those in the three “missing
Catholic Med. Ctr. v. Blue Cross Blue
                                                  departments.” In seeking graduate medical
Shield Ass’n, PRRB Dec. No. 2001-D55
                                                  education credit, Mercy Catholic Medical
(Sept. 28, 2001), Medicare and Medicaid
                                                  Center timely requested the requisite
Guide (CCH) ¶ 80,747, at 202,481
                                                  downward adjustment to its hospital-
(“PRRB Dec.”) (“[T]here was insufficient
                                                  specific rate and target amount under 42
evidence regarding forms 339 and
                                                  C.F.R. § 413.86(l)(2).
physician allocation agreements.”).9
                                                          In performing the reaudit, the
       During late 1990, however, Mercy
                                                  Subcontractor (“Johnston, Young &
Catholic Medical Center conducted a
                                                  O’Fria”) accepted Mercy Catholic Medical
three-week time study that tracked what
                                                  Center's 1990 time studies as accurate and
portion of each teaching physician's time
                                                  compliant with the Health Care Financing
                                                  Administration’s instructions of June 22,
     8
       A physician allocation agreement           1990, and relied upon them to reduce the
specifies the respective amount of time a         compensation and related teaching costs
physician spends on teaching and                  Mercy Catholic Medical Center had
supervision as opposed to time spent on           claimed as graduate medical education
patient care. 55 Fed. Reg. at 36,063.             expenses. The Subcontractor advised
                                                  Mercy Catholic Medical Center, however,
      9
      The 339s were not supported by              that it had been instructed by the
contemporaneous time sheets or “source            Intermediary (“Independence Blue Cross”)
documentation .”     Ora l A rgument              to strictly limit its reaudit to only those
Transcript at 29-30.

                                              7
FYE 1985 costs that Mercy Catholic                       include Mercy Catholic Medical Center’s
Medical Center had reported as graduate                  misclassified operating costs, and is losing
medical education costs in the graduate                  approximately $50,000 to $200,000 in
medical education base year—to validate                  annual reimbursement for its psychiatric
or reduce those costs—and to ignore                      unit as a result of the refusal to increase
evidence of any other costs, including                   Mercy Catholic Medical Center’s target
physician and support expenses, that had                 amount.
previously been claimed in FYE 1985 as
                                                                In addition to requesting credit for
operating costs.       Accordingly, the
                                                         grad uate medical education costs
Subcontractor declined to review time
                                                         attributa ble to the three missing
studies and other documentation pertaining
                                                         departments, Mercy Catholic Medical
to these three missing departments while,
                                                         Center also asked the Intermediary to
on the basis of the 1990 time studies, the
                                                         increase its hospital-specific rate and target
Intermediary reclassified $719,055 in
                                                         amount to include any operating costs that,
graduate medical education costs from
                                                         based upon the 1990 time studies, had
FYE 1985 as operating costs and excluded
                                                         properly been determined to have been
that amount from the APRA calculation.
                                                         misclassified in FYE 1985 as graduate
          According to Mercy Catholic                    medical education costs. See 42 C.F.R. §
Medical Center, the reclassifications                    413.86(l). Mercy Catholic Medical Center
reduced its total graduate medical                       also requested a corresponding downward
education costs from $6,876,731 to                       adjustment to its hospital-specific rate and
$6,157,676, and its APRA from $81,745 to                 targe t amo unt if a ny physic ian
$73,657. Recognition of the misclassified                compensation costs originally classified as
graduate medical education costs from the                operating costs were reclassified as
three missing departments based on the                   graduate medical education costs. See 42
1990 time studies, which the Intermediary                C.F.R. § 413.86(l)(2). Finally, Mercy
refused, would have resulted in an APRA                  Catholic Medical Center asked the
of $79,685.80.              The retrospective            Intermediary to increase the hospital-
application of the disputed APRA reduced                 specific rate and the target amount of its
Mercy Catholic M edical Center’s                         prospective payment system-exempt
r e i m b u r se m e n t b y a p pr ox im a t e ly       psychiatric unit to include the operating
$2,500,000 from FY 1986-91, and by                       costs determined to have been erroneously
approximately $250,000 to $500,000                       reported in FY 1985 as graduate medical
annually. Mercy Catholic Medical Center                  education costs under § 413.86(e)(1)(v)
also lost approximately $275,000 in                      and (l)(1). The Intermediary refused to
hospital-specific rate reimbursement                     make the requested hospital-specific rate
during the prospective payment system                    and target amount adjustments.
transition period as a result of the refusal
to increase the hospital-specific rate to


                                                     8
C. The Provider Reimbursement                               15. The HCFA instructions
   Review Board’s Decision                                  reinforced this concept;
                                                            however, an addendum
       Mercy Catholic Medical Center
                                                            consisting of questions and
appealed two issues to the Provider
                                                            answers was incorrectly
Reimbursement Review Board: (1) the
                                                            interpreted by the
Intermediary's refusal to recognize the
                                                            Intermediary as meaning
graduate medical education costs from the
                                                            that no new GME costs
three missing departments in the APRA
                                                            could be added by the re-
and; (2) the Intermediary's refusal to
                                                            audit from OC.
increase its hospital-specific rate and target
amount to take into account those costs                     a. The Intermediary, IBC
that were reclassified from graduate                        [Independence Blue Cross],
medical education costs to operating costs                  wrongfully instructed the
in the reaudit. The Board held a hearing                    audit subcontractor not to
and issued its decision on September 28,                    increase the GME costs by
2001.                                                       reclassifying        any
                                                                             10
                                                            misclassified OC.
       The      Board      affirm ed   th e
Intermediary on both issues.         As a                    The Board found nonetheless "there
threshold matter, the Board agreed with              [was] no creditable evidence in the record
Mercy Catholic Medical Center that over-             to reclassify the misclassified OC to GME
allocations and under-allocations of base            costs because of the lack of form 339's and
year graduate medical education costs                the fact that the 1990 time studies were not
were properly subject to correction during           audited by the Intermediary, nor is there
the reaudit under 42 C.F.R. § 413.86(e),             adequate documentation in the record
because the statute and GME rule envision            regarding these time studies." PRRB Dec.
“a ‘two way street’ of changing                      at 202,481.
erroneously claimed GME costs to
                                                            On the second issue, the Board
operating costs (‘OC’) and vice versa.”
                                                     agreed Mercy Catholic Medical Center had
PRRB Dec. at 202,480. In light of this, the
                                                     timely requested revision of its hospital-
Board found the Intermediary had
                                                     specific rate and target amount. Id. It
incorrectly instructed its Subcontractor to
                                                     concluded, however, the Intermediary was
ignore the time studies and other evidence
of misclassified graduate medical
education costs (as opposed to                               10
                                                               We think the Board intended
misclassified operating costs). PRRB Dec.
                                                     “misclassified GM E” in this finding. But
at 202,480-81.      In fact, the Board’s
                                                     the result is the same: The Board found
decision included the following finding:
                                                     originally claimed graduate medical
                                                     education costs could be increased by
                                                     adding misclassified costs.

                                                 9
not required to revise the hospital-specific         three missing departments. The Court
rate or target amount because Mercy                  wrote: “[t]he record indicates that Mercy
Catholic Medical Center had not provided             no longer had any of the 339s and that
the required documentation directly to the           Mercy did not submit any other evidence
Intermediary within 180 days of the Notice           [to support a reclassification of costs],
of Average Per Resident Amount.                      other than the time study conducted in
                                                     1990.”     Id. at *24-25.        Although
D. District Court Decision
                                                     recognizing Mercy Catholic Medical
       The District Court affirmed the               Center was not notified of a reaudit until
Board. Mercy Catholic Med. Ctr. v.                   after the record retention period had
Thompson, No. 02-419, 2003 U.S. Dist.                expired, the District Court nonetheless
LEXIS 4688 (E.D. Pa. Mar. 5, 2003).                  concluded Mercy Catholic Medical Center
Reviewing the first issue, the District              could be penalized for failing to maintain
Court determined the limited exception to            its 339 forms because it had received
the requirement for contemporaneous                  “constructive notice” that those costs
documentation restricted the use of                  “would likely be the subject of ongoing
substitute documentation from later years            review.” Id. at *27.
to verify costs originally claimed as
                                                             On the second issue, the District
graduate medical education costs in the
                                                     Court affirmed the Board’s ruling that
graduate medical education base year, and
                                                     Mercy Catholic Medical Center was not
did not serve to add or increase costs to the
                                                     entitled to increases in its hospital-specific
original graduate medical education costs
                                                     rate and target amount because it failed to
claimed. Id. at *22-23. For support, the
                                                     present documentation comparing Mercy
Court cited the Secretary’s representations
                                                     Catholic Medical Center’s FY 1983 and
that later year records “were inherently
                                                     1985 graduate medical education programs
less reliable,” and that providers had
                                                     directly to the intermediary, noting that it
“significant incentives to inflate their
                                                     was the hospital’s “burden . . . to present
GME costs in the base year under the new
                                                     sufficient evidence.” Id. at *33.
methodology.”       Id. at *24 (quoting
Presbyterian Med. Ctr., No. 95-1939,                                      II.
1998 U.S. Dist. LEXIS 6254, at 12-13
                                                             We have jurisdiction under 28
(D.D.C. April 21, 1998), aff’d, 170 F.3d
                                                     U.S.C. § 1291. We review the grant of
1146 (D.C. Cir. 1999)).
                                                     summary judgment de novo. Fertilizer
        The District Court also affirmed on          Inst. v. Browner, 163 F.3d 774, 777 (3d
the basis of lack of documentation. The              Cir. 1998). Like the District Court, we
Court found Mercy Catholic Medical                   review a final decision of the Secretary11
Center’s claims suspect because the
a d m i n i s tr a t iv e record la c k e d
                                                        11
contemporaneous evidence of 339's in the                  In this case, the Board’s decision was
                                                     the final decision of the Secretary.

                                                10
under 42 U.S.C. § 1395oo(f)(1), which               determine the level of deference, if any, to
incorporates the standard of review of the          afford the Secretary’s interpretation of the
Administrative Procedure Act, 5 U.S.C. §            graduate medical education reaudit rule.12
706. Under the APA, we will affirm
                                                             As noted, when it became clear
unless the Secretary’s decision is
                                                    providers did not always retain
"arbitrary, capricious, an abuse of
                                                    contemporaneous time records to facilitate
discretion, or otherwise not in accordance
                                                    the reaudit, the Secretary issued a special
with law; [or] unsupported by substantial
                                                    grad uate m edical education c o st
evidence." 5 U.S.C. § 706(2)(A),(E);
                                                    documentation rule for reaudits as an
Robert Wood Johnson Hosp. v. Thompson,
                                                    official instruction to fiscal intermediaries,
297 F.3d 273, 280 (3d Cir. 2002). But
                                                    “ G r a d u a t e M e d i c a l E d u c a t io n :
when applying this standard, a reviewing
                                                    Documentation to Support the Physician
court may not merely rubber-stamp the
                                                    Cost/Time Allocation” (1990), JA 211-
Secretary’s actions, but must ensure that
                                                    215. The Secretary’s written interpretation
the agency’s ruling is neither clearly
                                                    provides that later-year time studies, of the
erroneous nor inconsistent with applicable
                                                    sort relied on by Mercy Catholic Medical
regulations.     Thomas Jefferson Univ.
                                                    Center, could only serve to verify costs
Hosp. v. Shalala, 512 U.S. 504, 512
                                                    that were originally claimed as graduate
(1994). Further, we may affirm the
                                                    medical education costs in the base year,
agency’s decision only on grounds on
                                                    and could not support the addition of costs
which the agency actually relied, and not
                                                    not originally claimed as graduate medical
on the basis of alternative rationales or
                                                    education costs. The limited exception to
justifications put forward by counsel on
                                                    the record-keeping policy provides:
appeal. SEC v. Chenery Corp., 318 U.S.
80, 87 (1943).                                               As an equitable solution to
                                                             the problem o f the
                    III.
                                                             nonexistence of physician
A. Graduate Medical Education Costs                          allocation agreements, time
                                                             records, and other
       1. As Applied to the Facts of this
                                                             information, we are
          C ase , t h e S e c re t ar y ’s
                                                             allowing pr ovide rs to
          Interpretive Rule is Arbitrary
                                                             furnish the documentation
          and Capricious.
                                                             from cost reporting periods
       Mercy Catholic Medical Center                         subsequent to the base
contends the Secretary’s failure to consider                 period in support of the
its 1990 time studies to the extent they
supported a positive adjustment to its
reported FY 1985 graduate medical                       12
                                                         The District Court did not explicitly
education costs was arbitrary and
                                                    address the level of deference it warranted
capricious. As a threshold matter, we must
                                                    the Secretary’s interpretive rule.

                                               11
         allocation of physician                           Following its interpretation, the
         compensation costs in the                 Secretary now argues the limited exception
         GM E base period . . . . It is            to the rule requiring contemporaneous
         only in the absence of base               documentation only allows the use of
         period documentation that                 records from subsequent cost reporting
         subsequent documentation                  periods to verify costs and allocations
         should be considered as a                 claimed as graduate medical education
         proxy for base period                     costs during the graduate medical
         documentation for purposes                education base year—not to support
         of determining the per                    increases to those costs in the base year.
         resident amount.      In no
                                                          We owe no deference to an agency
         event will the results
                                                   interpretation plainly inconsistent with the
         obtained from the use of the
                                                   relevant statute. See Pub. Employees
         r e c o rds from a cos t
                                                   Retirement Sys. v. Betts, 492 U.S. 158, 171
         reporting period later than
                                                   (1989) (“[N]o deference is due to agency
         the base period serve to
                                                   interpretations at odds with the plain
         increase or add physician
                                                   language of the statute itself.”). In the
         compensation costs to the
                                                   same vein, an agency’s interpretation of its
         costs used to determine the
                                                   own regulations is not entitled to
         per resident amounts.
                                                   substantial deference by a reviewing court
55 Fed. Reg. at 36,063-64 (emphasis                where “‘an alternative reading is
added).13                                          compelled by the regulation’s plain
                                                   meaning or by other indications of the
                                                   Secretary’s intent at the time of the
    13
      The Agency supplemented its rule             regulation’s promulgation.’”        Thomas
with the following question and answer:

         Question: If a provider did                      in HCFA’s instructions, the
         n o t c h a r g e p hy s ic ia n                 use of subsequent period
         compensation to GME in                           documentation to support
         the base period, can it                          the allocation of physician
         request that documentation                       costs may not be used to
         from a subsequent period be                      increase the amount of
         used, at this time, to revise                    physician compensa tion
         its base period costs for the                    originally claimed by the
         purpose of calculating its                       provider in its GME base
         a v e r a g e p e r r e si d e n t               period. Graduate Medical
         amount?                                          Education: Questions and
                                                          Answers (Nov. 8, 1990), JA
         Answer: No. As explained                         872.

                                              12
Jefferson Univ. Hosp., 512 U.S. at 512               (A) Verifies the hospital’s
(quoting Gardebring v. Jenkins, 485 U.S.             base-p eriod graduate
415, 430 (1988)). Mercy Catholic Medical             medical education costs and
Center contends the graduate medical                 the hospital’s average
education rule is written in neutral                 number of FTE residents;
language that compels intermediaries to
                                                     (B) Excludes from the base-
accurately calculate graduate medical
                                                     period graduate medical
education costs, and to correct all
                                                     e d u c atio n c o s t s an y
misclassified costs, operating costs and
                                                     nonallowable               or
graduate medical education costs, to arrive
                                                     m i s c l a ss i f ie d costs ,
at the most accurate APRA possible. We
                                                     including those previously
a g r e e a n d find the S e cre tar y’s
                                                     allowed             under    §
interpretation directly contradicts the plain
                                                     4 1 2 .113( b)( 3 ) o f t h is
language of the graduate medical
                                                     chapter; and
education regulation and cannot be upheld.
                                                     (C) Upon a hospital’s
       The plain language of the graduate
                                                     request, includes graduate
medical education rule does not support
                                                     medical education costs that
limiting corrections upon reaudit to
                                                     were misc lassifie d as
misclassified operating costs, but rather
                                                     operating costs during the
anticipates corrections of misclassified
                                                     hospital’s pros pectiv e
graduate medical education costs and
                                                     payment base year and were
operating costs.
                                                     not allowable under §
           42 C.F.R. § 413.86(e) and (l)             4 1 2 . 1 1 3 (b )( 3 ) o f t h is
provide:                                             chapter during the graduate
                                                     medical education base
       (e) Determining per resident
                                                     period. These costs may be
       amounts for the base period
                                                     included only if the hospital
       – (1) For the base period.
                                                     requests an adjustment of its
       (i) . . . the intermediary
                                                     prosp e c t iv e p a yment
       determines a base-period per
                                                     hospital-specific rate or
       resident amount for each
                                                     target amount as described
       hospital as follows . . .
                                                     in paragraph [(l)(2)] of this
       (ii) In determining the base                  section.
       period amount under
                                                     (l) Adjustment of a
       paragraph (e)(1)(i) of this
                                                     hospital’s target amount or
       section, the intermediary – .
                                                     prospective payment
       ..
                                                     hospital-specific rate – (1)



                                                13
       M isclassified    oper ating                          Additionally, the intent of the rule
       costs . . .                                 supp orts our inter pre tatio n.             In
                                                   promulgating § 413.86, the Secretary
       (2) Misclassification of
                                                   determined a reaudit of FY 1985 cost
       graduate medical education
                                                   reports was warranted because hospitals
       costs – (i) General rule. If
                                                   may not have accurately distinguished
       costs that should have been
                                                   between teaching time and administrative
       classified as graduate
                                                   and other time spent by teaching
       medical education costs
                                                   physicians in FY 1985, since at that point
       were treated as operating
                                                   in time there were no real reimbursement
       costs during both the
                                                   c o n s e q u e n c e s e i t h er w a y , a n d
       graduate medical education
                                                   Intermediaries had applied the audit rules
       base period and the rate-of-
                                                   inconsistently. 54 Fed. Reg. 40,286,
       increase ceiling base year or
                                                   40,288-89, 40,301-02. In this vein, the
       prospective payment base
                                                   Secretary noted: “In establishing the base-
       year and the hospital wishes
                                                   period per resident amount for a specific
       to receive benefit for the
                                                   hospital . . . it is important that the amount
       appropriate classification of
                                                   determined be an accurate determination
       these costs as graduate
                                                   of providers’ 1984 GME costs.” 54 Fed.
       medical education costs in
                                                   Reg. 40,286, 40,288. The goal of an
       t h e g radu ate m edic a l
                                                   accurate determination of costs supports
       education base period, the
                                                   both increases and decreases to 1984
       hospital must request that
                                                   graduate medical education costs. The
       the intermediary review the
                                                   Secretary’s intent is particularly relevant to
       classification of the affected
                                                   this case where Mercy Catholic Medical
       costs in the rate-of-increase
                                                   Center is not seeking to add additional
       ceiling or pro spec tive
                                                   costs not audited in 1985, but rather, seeks
       payment base year for
                                                   to reallocate operating costs as graduate
       purposes of adjusting the
                                                   medical education costs based on the same
       hospital’s target amount or
                                                   time studies the Intermediary relied on to
       hospital-specific rate.
                                                   reclassify costs in the opposite direction.
42 C.F.R. § 413.86(e), (l) (emphasis
                                                          Our position is consistent with the
added).
                                                   Supreme Court’s interpretation of the
       The regulation’s plain language             graduate medical education reaudit rule in
requires the Intermediary to correct all           Regions Hosp. v. Shalala, 522 U.S. 448
misclassified costs, not just misclassified        (1998). In upholding the reaudits, the
graduate medical education costs. The              Court wrote, the audits were required “to
Secretary’s restrictive approach conflicts         catch errors that, if perpetual, could
with the regulatory language.                      grossly distort future reimbursement.” 522


                                              14
U.S. at 457-58. To make the APRA                     interpretation “‘qualifies for Chevron
accurate and avoid perpetrating errors, the          deference when it appears that Congress
reaudit requires correcting all relevant             delegated authority to the agency generally
classification errors, not merely those that         to make rules carrying the force of law,
result in a reduction of graduate medical            and that the agency interpretation claiming
education costs.                                     deference was promulgated in the exercise
                                                     of that authority.’” George Harms Constr.
        As noted, we find the reaudit rule
                                                     Co. v. Chao, 371 F.3d 156, 161 (3d Cir.
envisions a two-way street.             The
                                                     2004) (quoting United States v. Mead
Secretary’s interpretation is at odds with
                                                     Corp., 533 U.S. 218, 226-27 (2001)).
this principle. Significantly, the Provider
                                                     Agency statements contained in opinion
Reimbursement Review Board agreed,
                                                     letters, policy statements, agency manuals,
holding the graduate medical education
                                                     and enforcement guidelines lack the force
rule r e q uired reclassification o f
                                                     of law and “do not warrant Chevron-style
misclassified graduate medical education
                                                     deference.” Christensen v. Harris County,
costs and operating costs. PRRB Dec. at
                                                     529 U.S. at 587; Madison v. Res. for
202,480. In doing so, the Board explicitly
                                                     Human Dev., Inc., 233 F.3d 175, 185 (3d
discredited the interpretation of the rule
                                                     Cir. 2000). “To grant Chevron deference
adopted by the Secretary in this litigation.
                                                     to informal agency interpretations would
       Even     if   th e   S ec re ta r y’ s        unduly validate the results of an informal
interpretation were not at odds with the             process.” Madison, 233 F.3d at 186. We
plain language of the rule, his                      have made clear that agency interpretive
interpretation is still not entitled to              guidelines “do not rise to the level of a
Chevron-level deference.14 An Agency                 regulation and do not have the effect of
                                                     law.” Id. (quoting Brooks v. Village of
                                                     Ridgefield Park, 185 F.3d 130, 135 (3d
  14                                                 Cir. 1999)).
     In Presbyterian Medical Center, 1998
U.S. Dist. LEXIS 6254, aff’d, 170 F.3d                      As for the persuasiveness of agency
1146, the District Court for the District of         interpretive guidelines, we continue to rely
Columbia held the Secretary’s instruction            on the framework laid out in Skidmore v.
on the use of later time-records was an              Swift, 323 U.S. 134 (1944).              See
“interpretive rule,” and afforded the rule           Christensen, 529 U.S. at 587; Madison,
Chevron deference. Id. at *9. We note
Presbyterian was decided before
Christensen v. Harris County, 529 U.S.               instruction at issue is an interpretive rule.
576 (2000), where the Supreme Court                  See 5 U.S.C. § 553(b)(A) (discussing
clarified the deference due agency opinion           informal rule-making without notice and
letters. See id. at 587 (declining to afford         comment). But we disagree with the level
Chevron deference to Department of                   of deference granted in Presbyterian
Labor’s opinion letter). We believe the              Medical Center.

                                                15
233 F.3d at 186.    The Skidmore Court            the base year.15 The HCFA Administrator
explained:                                        determined that subsequent year time
                                                  studies may be used to increase physician
      We consider that the rulings,
                                                  compensation in excess of amounts
      interpretations and opinions
                                                  originally claimed in the graduate medical
      of the Administrator under
                                                  education cost center if the time studies
      t h i s A c t , w h i le n o t
                                                  were consistent with contemporaneous
      controlling upon the courts
                                                  data. The Administrator subsequently
      by reason of their authority,
                                                  repudiated his earlier position, see
      do constitute a body of
                                                  Presbyterian Med. Ctr., 1998 U.S. Dist.
      experience and informed
                                                  LEXIS 6254, and adopted his current
      judgment to which courts
                                                  position, that the amount claimed in the
      and litigants may properly
                                                  graduate medical education cost center
      resort for guidance. The
                                                  could only be increased based on
      weight of such a judgment
                                                  contemporaneous documentation, not
      in a particular case will
                                                  subsequent period time studies. “The
      depend          upon      the
                                                  Secretary is not estopped from changing a
      thoroughness evident in its
                                                  view . . . believe[d] to have been grounded
      consideration, the validity of
                                                  upon a mistaken legal interpretation,”
      its reasoning, its consistency
                                                  Good Samaritan Hosp. v. Shalala, 508
      with earlier an d later
                                                  U.S. 402, 417 (1993), but this
      pronouncements, and all
                                                  inconsistency can affect the level of
      those factors which give it
                                                  d e f e r e n ce af fo rd ed an ag en cy’ s
      power to persuade, if
                                                  interpretation. See Skidmore, 323 U.S. at
      lacking power to control.
                                                  140. The Secretary’s internally conflicting
323 U.S. at 140.                                  positions on this issue militate against
                                                  affording deference to the interpretive
       Under Skidmore analysis, we find
                                                  rule.16
the Agency has inconsistently applied the
Secretary’s instructions concerning what
costs can be recognized in the reaudit                15
                                                       As noted, M ercy Catholic Medical
process. In Abbott v. NW Mem’l Hosp.,             Center did retain some of its 339 allocation
PRRB Dec. No. 95-D10, Medicare &                  agreements, and these were included in the
Medicaid Guide (CCH) ¶ 42, 970 (Dec. 7,           administrative record.
1994) aff’d, HCFA Adm’r Dec., Medicare
                                                     16
& Medicaid Guide (CCH) ¶ 43,136 (Feb.                  Mercy Catholic Medical Center also
2, 1995), the provider presented base year        argues the Secretary endorsed a position
physician allocation agreements, but did          inconsistent with that taken in the current
not produce supporting time records from          case when defending the validity of the
                                                  graduate medical education rule before the
                                                  Supreme Court in Regions, 522 U.S. 448.

                                             16
In Regions, the Supreme Court considered                 there are some pieces of
the broader issue of whether the                         paper and other evidence
Secretary’s enactment of the rule                        that are no longer around,
providing for a retrospective reaudit of                 the Secretary will permit the
graduate medical education costs was a                   hospital to introduce –
reasonable interpretation of the graduate
medical education amendment, 42 U.S.C.                   Ms. Blatt [government
§ 1395ww(h), under Chevron. The Court                    counsel]: Yes
conditioned its affirmance of the graduate
m e d i c a l e d ucatio n rule o n th e                 Question: – other evidence,
understanding that hospitals would not be                later evidence, or anything
penalized for lack of documentation which                that –
they were no longer required to maintain.
Id. at 465. The Secretary overcame this                  Ms. Blatt: That’s correct,
problem through the “equitable solution”                 and ironica lly, Justice
discussed above. According to Mercy                      Breyer, the petitioner did
Catholic Medical Center, Government                      present subsequent year data
counsel suggested the Secretary would                    . . . because the [old] time
allow providers to add to, as well as                    records did not break . . .
decrease, base-year graduate medical                     down the costs [sufficiently]
education costs based on the following                   . . . they were allowed to use
discussion at oral argument:                             a new time study, and that’s
                                                         why there was a settlement
      Question [Breyer, J.]: I                           in this case, the petitioner
      would just like to be clear in                     actually got an increase in
      my own mind.             What                      the per-resident average . . .
      petitioner said . . . [is] that                    .
      they have changed the
      classification of certain                   Oral Argument Transcript at 16, Regions
      fixed        costs,       the               Hospital v. Shalala, No. 96-1375, 1997
      administrative costs, from                  WL 751915 (U.S.S.Ct. Dec. 1, 1997).
      education costs to operating                Based on this interchange, Mercy Catholic
      costs, not because of new                   Medical Center argues that the principle of
      e v i dence but b e c a u se                judicial estoppel should prevent the
      petitioner no longer had                    Secretary from switching positions in this
      audit documentation . . . .                 litigation. Because we find the Secretary’s
      Am I right in thinking that                 interpretive rule contrary to the plain
      isn’t the problem, because if               language of the regulation, inconsistently

                                             17
        Nonetheless, the Secretary argues                 GME costs . . . reasonably
its interpretative rule is reasonable and                 f u r t h e r s — n o t
entitled to deference. Contending later                   frustr a t e s — accurate
year records are inherently less reliable,                determination of GME
the Secretary argues it is reasonable to                  costs.”
limit the weight afforded to these records.
                                                   Id. at 1150-51 (internal quotations and
According to the Secretary, hospitals may
                                                   citations omitted).    We respectfully
attempt to manipulate graduate medical
                                                   disagree.
education costs with documentation
developed after the base year, for purposes                We see no valid reason to generally
of increasing their APRA.                          ascribe to teaching hospitals wrongful
                                                   over-reporting of teaching costs. Because
       In Presbyterian Medical Center v.
                                                   of the Consistency Rule, hospitals had no
Shalala, 170 F.3d 1146 (D.C. Cir. 1999),
                                                   opportunity to change classification of
the Court of Appeals for the D.C. Circuit
                                                   costs in FY 1985 from that reported in FY
noted the Secretary’s interpretive rule was
                                                   1983, the prospective payment system base
reasonable because:
                                                   year. 42 C.F.R. § 412.113(b)(3). Nor did
       GME costs claimed in the                    teaching hospitals have a financial
       base year have already gone                 incentive to misallocate either graduate
       through a verif icatio n                    medical education costs or operating costs
       process        requiring                    in the prospective payment system base
       contemporaneous                             year, 1983, as Medicare reimbursed both
       documentation. Additional                   education costs and operating costs on a
       GME costs claimed during                    reasonable cost basis during that period.
       reaudit have not. Because                   Consequently, there is no reason to expect
       later year record are                       errors in cost reporting in 1984-85 would
       inherently less reliable, and               have favored reporting costs in one
       because hospitals have                      category or the other. Additionally, since
       significant incentives to                   § 1395ww(h) was enacted in 1986 and
       inflate their GM E costs in                 mandated the use of FY 1985 as the
       the base year . . . we think                graduate medical education base year—a
       the interpretive rule, by                   year which predated this change in the
       p r o h i b i t i n g                       law— to set the APRA, providers had no
       noncontemporaneous                          notice or opportunity to “game the system”
       records from supporting                     by over-reporting teaching costs.17


                                                     17
applied, and lacking valid reasoning, we               The Secretary’s Interpretive Rule does
do not reach Mercy Catholic Medical                not clarify the difference between adding
Center’s judicial estoppel argument.               graduate medical education costs not

                                              18
previously claimed, and reclassifying               had previously claimed.           There, the
misclassified graduate medical education            Provider Reimbursement Review Board
costs previously classified as operating            noted:
costs. The district court in Presbyterian                  The provider is not
noted the specific question before the court               attempting to increase or
was “whether later year records can be                     add the physician
used to support an increase in GME costs                   compensation cost to the
over what was originally claimed in the                    costs claimed on its 1984
base year.” 1998 U.S. Dist. LEXIS 6254,                    cost report which was used
at *9. In discussing the Secretary’s                       to determine the Provider’s
interpretive rule, the court noted: “In [the               per resident amount. All of
Secretary’s] judgment, however, she did                    the costs that the Provider
not think it appropriate for hospitals to be               has claimed were claimed in
able to use later year records to support an               the base year, although they
increase in GME costs over what hospitals                  may not have been claimed
had originally claimed.” Id. at *12-13; see                specifically in the Intern and
also Cleveland Clinic Found. v. Shalala,                   Resident cost center.
No. 1:94 CV 2414, 1996 WL 636135, at                Abbott, Medicare & Medicaid Guide
*2 (N.D. Ohio, Aug. 28, 1996) (rejecting            (CCH) ¶ 42, 970, at 42,898.
provider’s “attempts to claim additional                   The Agency supplemented its
costs no[t] previously claimed in the base          interpretive rule with the following
year period”).                                      question and answer:
        Unlike the situation in Presbyterian               Question: If a provider did
and Cleveland Clinic, Mercy Catholic                       n o t c h a r g e p h ys i c i a n
Medical Center’s requested reclassification                compensation to GME in
of misclassif ied gra duate medical                        the base period, can it
education costs would serve only to                        request that documentation
partially offset the graduate medical                      from a subsequent period be
education costs that were found by the                     used, at this time, to revise
Intermediary to have been misclassified on                 its base period costs for the
reaudit, and would not raise Mercy                         purpose of calculating its
Catholic Medical Center’s graduate                         a v e r a g e p e r r e si d en t
medical education costs above the amount                   amount?
contemporaneously claimed in FY 1985.                      Answer: No. As explained
        In Abbott as well, the graduate                    in HCFA’s instructions, the
medical education cost additions did not                   use of subsequent period
result in total graduate medical education                 documentation to support
costs in excess of the amount the hospital                 the allocation of physician

                                               19
        The Secretary’s interpretation                on “[a] long line of precedent
requires the Intermediary to apply the                [establishing] . . . that an agency action is
graduate medical education reaudit rule in            arbitrary when the agency offers
a one-sided fashion. An agency acts                   insufficient reasons for treating similar
arbitrarily and capriciously when it                  situations differently.”       Id. at 1022
construes or applies a regulation in an               (quoting Transactive Corp. v. United
inconsistent manner. See Walter Boswell               States, 91 F.3d 232, 237 (D.C. Cir. 1996)).
Mem’l Hosp. v. Heckler, 749 F.2d 788,                 The court held the Secretary’s discretion,
799 (D.C. Cir. 1984) (“It would be                    although broad, “is not a license to . . .
arbitrary and capricious for HHS to bring             treat like cases differently.” Id. at 1023
varying interpretations of the statute to             (quoting Airmark Corp. v. FAA, 758 F.2d
bear [in allocating costs to Medicare],               685, 691 (D.C. Cir. 1985)).
depending on whether the result helps or
                                                                 By allowing non-contemporaneous
hurts the Medicare’s balance sheets . . . .”).
                                                      records to verify graduate medical
       F u r thermore, the Secre tar y’s              education costs or deduct graduate medical
interpretation eschews the fundamental                education costs claimed in the base-year
goal of neutral accuracy in a reaudit. See,           cost report, but not allowing such records
e.g., Boswell, 749 F.2d at 799; County of             to support the inclusion of graduate
Los Angeles v. Shalala, 192 F.3d 1005                 medical education costs misclassified as
(D.C. Cir. 1999). In County of Los                    o p e r a ting co sts , th e S ec re tar y’ s
Angeles, the Court of Appeals for the D.C.            interpretive rule frustrates the regulatory
Circuit rejected the Secretary’s explanation          goal of ensuring an accurate determination
for selectively ignoring data where it                of a provider’s graduate medical education
would increase Medicare payments based                costs. The Secretary either credits or
                                                      ignores later year time studies depending
                                                      on whether the correction of errors will
       costs may not be used to                       result in a reduction or increase in a
       increase the amount of                         hospital’s graduate medical education
       physician compensation                         reimbursement. The Secretary’s restrictive
       originally claimed by the                      interpretive rule is arbitrary and capricious
       provider in its GME base                       because it contradicts the plain language of
       period.                                        the rule, has not been applied consistently,
Graduate Medical Education: Questions                 and is unreasonable.18
and Answers (Nov. 8, 1990), JA 872
(emphasis added). As this case concerns
                                                         18
misclassified graduate medical education                    The Secretary’s rule may also effect
costs, we find the Secretary’s position               an illegal cost-shifting of Medicare costs
concerning costs not originally claimed,              to non-Medicare patients, as it will shift
does not su pp ort the S ecretary’s                   costs properly borne by Medicare to other
interpretation as applied to this case.               patients.         See     42    U.S.C.

                                                 20
       2. Evidentiary Issues Support                   Mercy no longer had any of the 339s and
          Remand.                                      that Mercy did not submit any other
                                                       evidence, other than the time study
       Mercy Catholic Medical Center
                                                       conducted in 1990.” Mercy Catholic Med.
contends the District Court and the Board
                                                       Ctr., 2003 U.S. Dist. LEXIS 4688, at *24-
erred in rejecting its appeal on the added
                                                       25.
ground that Mercy Catholic Medical
Center failed to produce form 339                              At oral argument, and in a
physician allocation agreements for the                subsequent letter to this Court, Mercy
three missing departments. We recognize                Catholic Medical Center proved that some
the able District Court was presented with             or iginal 339s from the missin g
a confusing administrative record.                     departments had been included in the
Nonetheless, we reverse and remand based               administrative record, though, apparently,
o n t h e a lt e r n a ti v e g ro u n d t h at        not as formal exhibits.19 To the extent the
contemporaneous evidence of teaching                   Provider Reimbursement Review Board
programs, including 339 forms, was                     and the District Court grounded their
presented to the Provider Reimbursement                decisions on Mercy Catholic Medical
Review Board.                                          Center’s inability to produce copies of the
                                                       339 forms for the three missing
         There is no dispute that Mercy
                                                       departments, it is clear that at least some of
Catholic Medical Center conducted
                                                       these forms were produced in the
accredited medical residency programs in
                                                       administrative record.20 Therefore, we will
its Laboratory, OB/GYN, and Radiology
Departments in 1984-85. Before the
Board, Mercy Catholic Medical Center                      19
                                                           According to Mercy Catholic Medical
introduced contemporaneous
                                                       Center’s letter to this Court dated May 4,
documentation verifying its graduate
                                                       2004, a “departmental 339 allocation”
medical education activities. The Board
                                                       form for the Radiology Department was
found: “In fiscal year 1985, the provider
                                                       introduced as PRRB Exhibit 32.
conducted GME teaching programs in its
OB/GYN, Laboratory, and Radiology                         20
                                                             Although no 339 forms for individual
Departments.” PRRB Dec. at 202,480.                    doctors were included in the appendix to
Yet, the Board noted, “[t]here is no                   this Court, a “departmental 339 allocation”
creditable evidence in the record to                   form for all teaching physicians in the
reclassify the misclassified OC to GME                 Radiology Department in 1985 was
costs because of the lack of form 339's . .            included. JA 381. Health Care Financing
. .” Id. at 202,481. The District Court also           A d m i n i s t r a t i o n ’ s i n s t r u c t io n s t o
concluded, “[t]he record indicates that                in te r me dia r ie s specify that suc h
                                                       “departmental time allocations may be
                                                       accepted” on reaudits. Instructions for
§ 1395(x)(v)(1)(A).                                    Implementing Program Payments for

                                                  21
reverse and remand on the alternative                     The District Court affirmed, noting, “[t]he
ground that sufficient contemporaneous                    fact that the Subcontractor may have the
documentation of teaching programs in the                 documents in its possession does not
“missing departments” was produced to                     satisfy the requirements set forth by the
support the reclassification of costs and                 regulations.” Mercy Catholic Med. Ctr.,
should have been considered by the Board.                 2003 U.S. Dist. LEXIS 4688, at *33-34.
                                                          We cannot agree.
          In sum, the Secretary’s position that
later year time studies may only be used to                       As noted, an increase in the
correct misclassified operating costs, and                hospital-specific rate and target amount is
not misclassified graduate medical                        anticipated by the Secretary’s own
education costs, is arbitrary and capricious.             regulations to achieve consistent
We will reverse and remand with                           classification of costs where costs
i n s tr u c t io n s to th e P r o v i d er              originally classified as graduate medical
Reimbursement Review Board to order the                   education costs should have been reported
Intermediary to recalculate Mercy Catholic                as operating costs. See 42 C.F.R. §
Medical Center’s graduate medical                         413.86(l)(1). Additionally, because of the
education costs after auditing the time                   Consistency Rule, allowable operating
studies and other available documentation                 costs involved in setting the hospital-
from the three missing departments.                       specific rate and target amount must be
                                                          treated consistently through out the
B. Hospital-Specific Rate and Target
                                                          prospective payment transition period (i.e.
   Amount
                                                          Mercy Catholic Medical Center’s FY
          Mercy Catholic Medical Center also              1985-1989). 42 C.F.R. § 412.113(b)(3).21
contends the District Court failed to order               Once it is determined that misclassified
the Intermediary to increase its hospital-
specific rate and TEFRA target amount.
                                                              21
As noted, the Board declined to order the                        Mercy Catholic Medical Center also
Intermediary to increase Mercy Catholic                   contends that because its Target Amount
Medical Center’s hospital-specific rate and               applied only to a psychiatric unit not in
target amount in an amount corresponding                  operation until FY 1985, there was no
to the Intermediary’s reduction of the same               rational basis to require Mercy Catholic
costs from the APRA because Mercy                         M e d i c a l C e n t e r to i n t ro d u c e
Catholic Medical Center had not provided                  d o c u m e n t a t io n e v i d e n c i n g t h e
d o c u m e n t a t io n d i r e c t l y t o t h e        comparability of its FY 1983 and FY 1985
I n t e rm e d iary, but rath er to th e                  costs as a precondition to increasing the
Subcontractor. PRRB Dec. at 202,481.                      t a rg e t am oun t.        T he r e f o r e , n o
                                                          “comparability data” was necessary to
                                                          adjust the target amount, and the Board’s
Graduate Medical Education Costs, JA                      finding on insufficient documentation was
341.                                                      irrelevant to the target amount adjustment.

                                                     22
graduate medical education costs should              adjustments on the technicality that Mercy
have been reimbursable as operating costs,           Catholic Medical Center provided the data
an increase to the hospital-specific rate and        supporting comparability within the 180
target amount is required not merely for             day period to the Intermediary’s
consistency purposes, but also in light of           Subcontractor rather th an dire ctly
Medicare’s cost-shifting prohibition. 42             providing it to the Intermediary. PRRB
U.S.C. § 1395x(v)(1)(A).         For these           Dec. at 202,481. We do not find this
reasons, the hospital-specific rate/target           distinction legally significant.
amount adjustment is critical. Mercy
                                                                Providing data to the on-site
Catholic Medical Center’s request for a
                                                     Subcontractor is the legal equivalent of
revision of both its hospital-specific rate
                                                     providing the data to the Intermediary
and target amount was appropriate and
                                                     under Centers for Medicare and Medicaid
timely.
                                                     Services Manuals and principles of
       As discussed, the Provider                    agency. In collecting data for an audit, the
Reimbursement Review Board did not                   Subcontractor steps into the shoes of the
deny the adjustments for substantive                 Intermediary. See Medicare Intermediary
reasons. See PRRB Dec. at 202,481.                   Manual, JA 919. A subcontracted audit
Mercy Catholic Medical Center had                    firm is authorized to receive cost reports
provided the appropriate and sufficient              and make its working papers available to
documentation to the Intermediary’s                  the Intermediary for review and to obtain
Subcontractor.22 JA 161. The Board,                  necessary information. See id. pt. F (“The
however, refused to order the hospital-              independent audit firm’s [Subcontractor’s]
spec ific rate and targ et amount                    working papers, including permanent files
                                                     and reviews of internal control, are to be
                                                     made available to representatives of the
  22
    The record demonstrates the evidence             Secretary and the intermediary, at all
provided by Mercy Catholic Medical                   reasonable times, for review and obtaining
Center was sufficient to make the                    any necessary information.”). Under the
adjustments to the hospital-specific rate            Medicare Intermediary Manual, the
and target amount. The Board found “the              Intermediary and the Subcontractor are
Subcontractor . . . had received adequate            interchangeable in the function of
information for . . . revisions to the               receiving documents.               The Board’s
HSR/TEFRA target amount.” PRRB Dec.                  decision also described the Intermediary
at 202,481. In fact, the “best evidence” of          p e r f o r m i n g a u d i t s “ t h r o ug h i t s
comparability between the prospective                Subcontractor.” PRRB Dec. at 202,466.
payment system and graduate medical
                                                            Under these circumstances, we find
education base years was the cost reporting
                                                     the documents were plainly within the
data and supporting audit records that were
                                                     control of the “prime contractor” (in this
already in the Intermediary’s possession
                                                     case, the Intermediary). In the context of
until at least 1992. JA 156.

                                                23
Fed. R. Civ. P. 34(a), so long as the party         § 413.86, it does not follow that the
has the legal right or ability to obtain the        provider may not supply the data to the
documents from another source upon                  Interm edia ry throug h the o n-site
demand, that party is deemed to have                Subcontractor. The Subcontractor was
control.     See Fed R. Civ. P. 34(a)               entitled to receive cost documentation
(allowing “[a]ny party [to] serve on any            from Mercy Catholic Medical Center as
other party a request . . . any designated          the Intermediary’s agent. An agency
documents . . . which are in the possession,        relationship may be established by: (1)
custody or control of the party upon whom           express authority; (2) implied authority, to
the request is served); see also Poole v.           do all that is proper, usual and necessary
Textron, 192 F.R.D. 494, 501 (D. Md.                for the authority actually granted; (3)
2000) (“[A] party is charged with                   apparent authority, as where the principal
knowledge of what its agents know or                holds one out as agent by words or
what is in the records available to it.”)           conduct; and (4) agency by estoppel. See
(internal quotation omitted). In the Rule           SEI Corp. v. Norton & Co., 631 F. Supp.
34 context, control is defined as the legal         497, 501 (E.D. Pa. 1986).
right to obtain required documents on
                                                           Based on the relationship between
demand. See Gerling Int’l Ins. Co. v.
                                                    the Subcontractor and Intermediary, the
Comm’r, 839 F.2d 131, 140 (3d Cir.
                                                    subcontractor likely had express or implied
1988); 8A Charles Alan Wright & Arthur
                                                    authority to receive documents from
R. Miller, Federal Practice and Procedure
                                                    Mercy Catholic Medical Center. See
§ 2210 (2d ed. 1994). The Medicare
                                                    Medicare Intermediary Manual pts. D-F.
Intermediary Manual specifically requires
                                                    The Subcontractor undoubtably possessed
the Subcontractor’s working papers and
                                                    the authority to conduct the reaudit of the
files be made available to the Intermediary
                                                    graduate medical education costs. JA 153.
and Secretary at all “reasonable times.”
                                                    As noted, adjustment of the hospital-
Medicare Intermediary Manual pt. F.
                                                    specific rate and target amount is tied to
Because the record demonstrates Mercy
                                                    the classification of hospitals’ costs. See
Catholic Medical Center provided the
                                                    42 C.F.R. § 413.86(l). Rationally, the
necessary documents to the Subcontractor,
                                                    Subcontractor should be authorized to
and the Intermediary employed the
                                                    receive documents for both cost
Subcontractor to conduct the audit and
                                                    reclassifications and adjustments to a
receive documents, the documents were
                                                    hospital’s specific rate and target amount.
accessible to the Intermediary and within
                                                    Alternatively, if the subcontractor lacked
its control.
                                                    express authority to receive documents, the
       While there is no question the               fact that it had conducted the graduate
Intermediary determines the APRA and                medical education reaudit, and had
corresponding adjustments to the hospital-          conducted all of Mercy Catholic Medical
specific rate and the Target Amount under           Center’s audits since the “mid 70s,” JA


                                               24
153, demonstrates the Subcontractor had             payment system and the graduate medical
apparent authority to receive the                   education base years—to effect an
documents. “It is well settled that apparent        adjustment of the hospital-specific
authority (1) ‘results from a manifestation         rate—until the Board has determined
by a person that another is his agent’ and          whether to approve a reaudit classification
(2) ‘exists only to the extent that it is           of operating costs to graduate medical
reasonable for the third person dealing             education costs.
with the agent to believe that the agent is
                                                           The Secretary maintains Mercy
authorized.’” Taylor v. People’s Natural
                                                    Catholic Medical Center’s reliance on 42
Gas Co., 49 F.3d 982, 989 (3d Cir. 1995)
                                                    U.S.C. § 1395oo(d) is unavailing. We
(quoting Restatement (Second) of Agency
                                                    agree. This statute does not require the
§ 8 cmts. a & c (1958)). Mercy Catholic
                                                    Board to receive additional evidence not
Medical Center reasonably believed the
                                                    considered by the Intermediary, but only
Subcontractor had the authority to receive
                                                    confers discretion on the Board as to what
the relevant documentation.             The
                                                    will be allowed into the administrative
Intermediary and the Subcontractor were
                                                    record. Taking Mercy Catholic Medical
jointly obligated to safeguard the
                                                    Center’s argument to its logical
hospital’s documents. Therefore, Mercy
                                                    conclusion, all statutory or regulatory
Catholic Medical Center fulfilled its
                                                    deadlines imposed on providers for
burden by providing appropriate data to
                                                    purposes of Medicare reimbursement
the Intermediary’s agent.
                                                    would be inconsequential, since providers
       Mercy Catholic Medical Center also           could proffer all required reports and
contends it was entitled to present                 documents by the time of the hearing.
evidence not submitted to the Intermediary
                                                            Nevertheless, because we find
to the Provider Reimbursement Review
                                                    Mercy Catholic Medical Center to have
Board for de novo review, and that the
                                                    fulfilled its burden by presenting sufficient
Board violated 42 U.S.C. § 1395oo(d) by
                                                    data for adjusting its hospital-specific rate
not considering this evidence.23 In this
                                                    and target amount to the Subcontractor, we
vein, Mercy Catholic Medical Center
                                                    will reverse the Board and the District
argues it should be allowed to present
                                                    Court on this issue. We will remand to the
evidence comparing the prospective
                                                    District Court to remand to the Provider
                                                    Reimbursement Review Board with
    23                                              instructions to order the Intermediary to
      42 U.S.C. § 1395oo(d) provides in
                                                    adjust Mercy Catholic Medical Center’s
relevant part: “A decision by the Board
                                                    hospital-specific rate and target amount to
shall be based upon the record made at
                                                    correspond to reclassified operating costs
such hearing, which shall include the
                                                    and graduate medical education costs.
evidence considered by the intermediary
and such other evidence that may be
obtained or received by the Board . . . .”

                                               25
                  IV.
       For the reasons stated, we will
reverse and remand the judgment of the
District Court for proceedings consistent
with this opinion.




                                            26
