                     United States Court of Appeals
                             FOR THE EIGHTH CIRCUIT
                                  ________________

                                     No. 05-4372
                                  ________________

Baptist Health, doing business as        *
Baptist Memorial Medical                 *
Center-North Little Rock,                *
                                         *
             Appellant,                  *
                                         *     Appeal from the United States
      v.                                 *     District Court for the
                                         *     Eastern District of Arkansas.
Tommy G. Thompson, in his                *
official capacity as Secretary,          *
United States Department of              *
Health and Human Services,               *
                                         *
             Appellee.                   *

                                  ________________

                             Submitted: June 12, 2006
                                 Filed: August 15, 2006 (Corrected on: 10/27/06)
                               ________________

Before SMITH, HEANEY and GRUENDER, Circuit Judges.
                         ________________

GRUENDER, Circuit Judge.

      Baptist Memorial Medical Center-North Little Rock (“Baptist Memorial”)
challenges a decision by the Secretary of the Department of Health and Human
Services (“HHS”) denying, for Medicare reimbursement purposes, “approved
educational activity” status for classroom costs incurred by Baptist Memorial in
connection with its affiliation with a nursing school. The district court1 upheld the
Secretary’s decision. For the reasons discussed below, we affirm.

I.    BACKGROUND

       HHS administers the Medicare program, 42 U.S.C. § 1395 et seq., through its
component Centers for Medicare and Medicaid Services (“CMS”). The Secretary
contracts with fiscal intermediaries, such as Blue Cross/Blue Shield in the instant
case, to audit the costs submitted by Medicare provider hospitals and approve or
disapprove Medicare reimbursement. See 42 U.S.C. § 1395h; 42 C.F.R. § 405.902
(defining fiscal intermediary). A provider hospital may appeal the reimbursement
decision of the fiscal intermediary to HHS’s Provider Reimbursement Review Board
(“PRRB”). 42 U.S.C. § 1395oo. The PRRB’s decision becomes the final decision
of the agency unless the Secretary, on his own motion, decides to affirm, reverse or
modify the decision. Id. § 1395oo(f)(1).

       Prior to 1983, all Medicare-eligible costs incurred by a provider hospital were
reimbursed on a “reasonable cost” basis—essentially, each hospital’s actual costs
incurred were reimbursed dollar-for-dollar so long as the Secretary found the costs
reasonable. See 42 U.S.C. § 1395f(b). In Title VI of the Social Security
Amendments of 1983, Pub. L. 98-21, 97 Stat. 65 (1983) (“PPS legislation”), Congress
established the Prospective Payment System (“PPS”) as an incentive for hospitals to
reduce costs and operate more efficiently. See H.R. Rep. No. 98-25, at 132 (1983),
reprinted in 1983 U.S.C.C.A.N. 219, 351. Under PPS, a provider hospital receives
Medicare reimbursement at a flat rate for each patient based on the patient’s category
of treatment. Id.; 42 U.S.C. § 1395ww(d).



      1
       The Honorable William R. Wilson, Jr., United States District Judge for the
Eastern District of Arkansas.

                                         -2-
       Congress exempted a few costs from PPS, allowing continued reasonable-cost
Medicare reimbursement under § 1395f(b) (“pass-through treatment”) for, among
other things, “approved educational activities.” 42 U.S.C. § 1395ww(a)(4). Congress
did not define “approved educational activities” in the statute. The Secretary
published a regulation stating that approved educational activities included neither
“[c]linical training of students not enrolled in an approved education program
operated by the provider,” 42 C.F.R. § 413.85(d)(6) (1986) (emphasis added), nor
“[o]ther activities that do not involve the actual operation of an approved education
program,” id. § 413.85(d)(7). During the notice-and-comment phase of the
regulation’s publication, the Secretary elaborated that “only the costs of those
approved medical education programs operated directly by a hospital [are] excluded
from [PPS].” 49 Fed. Reg. 234, 267 (Jan. 3, 1984) (emphasis added).2

       In addition to costs for programs that would qualify as approved educational
activities under 42 C.F.R. § 413.85, Congress established pass-through treatment for
another category of educational-activity costs borne by provider hospitals in § 6205
of the Omnibus Budget Reconciliation Act of 1989 (“OBRA 1989”), Pub. L. 101-239,
103 Stat. 2106 (1989), extended in § 4004(b) of the Omnibus Budget Reconciliation
Act of 1990 (“OBRA 1990”), Pub. L. 101-508, 104 Stat. 1388 (1990). This pass-
through treatment category includes only the costs of clinical nursing school
programs conducted on the premises of, but not necessarily directly operated by, a
provider hospital so long as certain conditions specified in OBRA 1990 are met.




      2
       The Secretary later promulgated a new version of the regulation which
expressly includes the requirement of direct operation by the hospital. See 42 C.F.R.
§ 413.85(c)(1), (f) (2001). This version became final in 2001 and is therefore
inapplicable to the instant case. The Secretary made the change to “clarify” the
previous version of the regulation at issue here. 66 Fed. Reg. 3358, 3361 (Jan. 12,
2001).

                                        -3-
       In short, educational activities at a provider hospital that do not qualify for
pass-through treatment under either 42 C.F.R. § 413.85 or OBRA 1990 are
reimbursed as part of the flat-rate PPS payment for the hospital’s normal operating
costs. Pass-through treatment for educational activities is financially desirable for the
provider hospital because the PPS payment for normal operating costs essentially
depends only upon the number of patients discharged and their diagnoses, and does
not directly compensate the costs of educational activities.3

      Baptist Memorial is owned and operated by Baptist Health, Inc., a non-profit
corporation that also owned and operated three other Medicare-provider hospitals
from 1991 to 1994. Baptist Health also owned and operated Baptist School of
Nursing (“Nursing School”) during that time. The four hospitals and the Nursing
School were not separate subsidiary corporations but were each operated as separate
business units and maintained separate bookkeeping. Each hospital had its own
Medicare provider number, but Baptist Health was the legal entity that contracted for
the numbers.

        After the institution of the PPS system, Baptist Health allocated the costs of the
Nursing School among its four hospitals. Each hospital then characterized its share
of those costs as “approved educational activities” and received pass-through
reimbursement. In 1990, however, the regional CMS office notified the hospitals’
fiscal intermediary that the Nursing School costs were not eligible for pass-through

      3
        Baptist Memorial asserts that PPS reimbursement for educational activities is
actually no reimbursement at all because a provider hospital with educational
activities not qualifying for pass-through treatment would receive the same flat-rate
PPS payment as an identical provider hospital with no educational activities
whatsoever. In making this assertion, Baptist Memorial apparently assumes that such
educational activities would have no financially beneficial indirect effects on the
operation of the hospital. The record on this issue is not sufficient to allow us to
determine whether the assumption is a valid one, and in any event resolution of the
issue would have no effect on the outcome of this appeal.

                                           -4-
treatment because the provider hospitals did not operate the Nursing School. In
response, in 1991 Baptist Health moved all Nursing School costs to the books of
Baptist Medical Center, its hospital in Little Rock, Arkansas. An allocation of a
portion of the Nursing School costs was made from Baptist Medical Center’s books
to other Baptist Health hospitals, including Baptist Memorial, based on the amount
of time nursing students spent at each institution. Baptist Memorial and the Nursing
School executed a Memorandum of Agreement outlining the responsibilities of
Baptist Memorial to support the school.

       From 1991 to 1994 Baptist Memorial submitted its Nursing School costs for
pass-through treatment, but the fiscal intermediary denied reasonable-cost
reimbursement. On administrative appeal, the PRRB reversed, finding that the costs
qualified for pass-through treatment as an “approved educational activity” because
Baptist Memorial “was engaged in, to a significant extent, the operation of the
nursing education program.” The Administrator of CMS, acting under the authority
of the Secretary, vacated the PRRB’s decision because Baptist Memorial did not
directly operate the Nursing School. However, the Administrator remanded to the
PRRB for a determination of whether any of the nursing school costs were qualified
clinical costs under OBRA 1990. On remand, the PRRB approved all submitted
clinical costs for pass-through treatment under OBRA 1990 and also reinstated its
already rejected finding that the non-clinical, or classroom, costs were eligible for
pass-through treatment as an “approved educational activity.” The Administrator
affirmed that the clinical costs were eligible for pass-through treatment under OBRA
1990 but reversed again on the classroom costs because Baptist Memorial did not
directly operate the Nursing School.

      Baptist Memorial sued for review of the agency’s decision in federal district
court. The district court affirmed the Administrator’s decision, relying on the D.C.
Circuit’s resolution of a similar dispute in Community Care Foundation v. Thompson,
318 F.3d 219 (D.C. Cir. 2003). Baptist Memorial now appeals the denial of pass-

                                        -5-
through treatment for the classroom costs associated with the Nursing School, arguing
that the “direct operation” requirement is not a permissible interpretation of the
statute and that it conflicts with the Secretary’s prior interpretation. Baptist Memorial
also argues that, even under the direct-operation standard, its affiliation with the
Nursing School qualified as an “approved educational activity.”

II.   DISCUSSION

       The final decision of the Secretary is reviewed under the Administrative
Procedure Act (“APA”), 5 U.S.C. § 701 et seq. 42 U.S.C. § 1395oo(f)(1)
(incorporating the APA standard of review). “Under the APA, the Secretary’s
decision is ‘set aside if it is arbitrary, capricious, an abuse of discretion, unsupported
by substantial evidence, or contrary to law.’” St. Luke’s Methodist Hosp. v.
Thompson, 315 F.3d 984, 987 (8th Cir. 2003) (quoting Hennepin County Med. Ctr.
v. Shalala, 81 F.3d 743, 748 (8th Cir.1996)); see also 5 U.S.C. § 706(2)(A), (E). “We
review the district court’s decision de novo, making our own independent review of
the Secretary’s decision under the APA.” Shalala v. St. Paul-Ramsey Med. Ctr., 50
F.3d 522, 527 (8th Cir. 1995).

      A.     The Secretary’s Interpretation of the Statute

       Baptist Memorial argues that it is arbitrary and capricious for the Secretary to
interpret the statutory language “approved educational activity” to include a
requirement that the provider hospital directly operate the educational program. The
Chevron test determines whether the Secretary’s rule is a permissible interpretation
of the statute:

      [W]e ask first whether “the intent of Congress is clear” as to “the precise
      question at issue.” If, by “employing traditional tools of statutory
      construction,” we determine that Congress’ intent is clear, “that is the


                                           -6-
      end of the matter.” But “if the statute is silent or ambiguous with
      respect to the specific issue, the question for the court is whether the
      agency’s answer is based on a permissible construction of the statute.”
      If the agency’s reading fills a gap or defines a term in a reasonable way
      in light of the Legislature’s design, we give that reading controlling
      weight, even if it is not the answer “the court would have reached if the
      question initially had arisen in a judicial proceeding.”

Regions Hosp. v. Shalala, 522 U.S. 448, 457 (1998) (citations omitted) (quoting
Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842, 843 & n.9,
n.11 (1984)).

       Under step one of the Chevron analysis, we determine whether the statute
makes clear the intent of Congress as to the meaning of the term “approved
educational activities.” The statute does not expressly define the term, but Baptist
Memorial contends that Congress implicitly adopted an existing definition from a
pre-PPS Medicare regulation. The term “approved educational activities” was
defined in Medicare regulations in 1966 as “formally organized or planned programs
of study usually engaged in by providers in order to enhance the quality of patient
care in an institution.” 20 C.F.R. § 405.421 (1966). Prior to the establishment of the
PPS system in 1983, the Secretary adopted the holding of a Seventh Circuit case, St.
John’s Hickey Memorial Hospital, Inc. v. Califano, 599 F.2d 803, 808-09 (7th Cir.
1979), which interpreted the regulation to mean that a provider hospital need only be
“engaged in,” rather than the “legal operator” of, an educational program for the
program to meet the regulatory definition of an “approved educational activity.”

       In support of its argument that Congress intended to incorporate the definition
of “approved educational activities” from 20 C.F.R. § 405.421 (1966) into the 1983
PPS legislation, Baptist Memorial cites Toyota Motor Manufacturing, Kentucky, Inc.
v. Williams, 534 U.S. 184 (2002), and Bragdon v. Abbott, 524 U.S. 624 (1998), for
the proposition that “Congress’ repetition of a well-established term carries the


                                         -7-
implication that Congress intended the term to be construed in accordance with
pre-existing regulatory interpretations.” Bragdon, 524 U.S. at 631; see also Toyota
Motor, 534 U.S. at 193-94. The relevant issue in both Toyota Motor and Bragdon
was the interpretation of the definition of “disability” provided in the Americans with
Disabilities Act of 1990 (“ADA”). The Supreme Court noted that the detailed, three-
part definition4 provided in the ADA was drawn “almost verbatim” from the
definition of “handicapped individual” in the earlier Rehabilitation Act of 1973, 29
U.S.C. § 706(8)(B), and the definition of “handicap” contained in the Fair Housing
Amendments Act of 1988, 42 U.S.C. § 3602(h)(1). Bragdon, 524 U.S. at 631; see
also Toyota Motor, 534 U.S. at 193. In addition, the Court noted that the ADA
expressly stated, “Except as otherwise provided in this chapter, nothing in this
chapter shall be construed to apply a lesser standard than the standards applied under
title V of the Rehabilitation Act of 1973 (29 U.S.C. 790 et seq.) or the regulations
issued by Federal agencies pursuant to such title.” Toyota Motor, 534 U.S. at 194
(quoting 42 U.S.C. § 12201(a)); Bragdon, 524 U.S. at 631-32 (quoting 42 U.S.C. §
12201(a)). Based on the adoption of identical, detailed language from the earlier
statutes and the express reference to the standards set by one of the earlier statutes
and its associated regulations, the Court found that the regulations associated with the
earlier statute were appropriate sources of guidance for interpreting the terms of the
definition in the ADA. Toyota Motor, 534 U.S. at 193-94; Bragdon, 524 U.S. at 632.




      4
       The ADA defined “disability” as:

      (A) a physical or mental impairment that substantially limits one or more
      of the major life activities of such individual;
      (B) a record of such an impairment; or
      (C) being regarded as having such an impairment.

42 U.S.C. § 12102(2).

                                          -8-
       Toyota Motor and Bragdon do not support the proposition that Congress
implicitly intended to incorporate the definition of “approved educational activities”
from 20 C.F.R. § 405.421 (1966) into the PPS statutory scheme. First, the ADA
adopted an entire three-part, 33-word definition from the relevant earlier statutes, not
just a single term; in contrast, the PPS legislation used only the term “approved
educational activities” and conspicuously failed to incorporate the associated 24-word
definition provided in the earlier regulation. Second, the ADA adopted the definition
from earlier statutes, not merely from an agency’s regulatory definition, as Baptist
Memorial suggests happened in this case. Finally, the ADA expressly referenced the
standards developed from the applicable earlier statute and its associated regulations;
the PPS legislation does not do so. Under these circumstances, we cannot find any
Congressional intent to incorporate the definition of “approved educational activities”
from 20 C.F.R. § 405.421 (1966), as elaborated upon in St. John’s Hickey and its
progeny, into the 1983 PPS legislation. Instead, we agree with the D.C. Circuit that
Congress, by its silence, left the definition of “approved educational activities” to the
Secretary. Accord Cmty. Care, 318 F.3d at 225.5

      We now proceed to step two of the Chevron analysis and determine “whether
the agency’s [definition] is based on a permissible construction of the statute.”


      5
        Baptist Memorial also echoes an argument made, and rejected, in Community
Care that a lone comment in the legislative history of the PPS legislation proves
unambiguously that Congress meant to incorporate the earlier regulatory definition.
See H.R. Rep. No. 98-25 at 140 (1983), reprinted in 1983 U.S.C.C.A.N. 219, 359
(stating that “approved education programs (as defined in current regulation,
including nursing education programs) would continue to be paid on the basis of
reasonable cost”). However, as the D.C. Circuit aptly noted in regard to this
argument, “reviewing legislative history is like ‘looking over a crowd and picking out
your friends,’” and one “friend” in a crowd as large as this one is insufficient to
demonstrate unambiguous Congressional intent. Cmty. Care, 318 F.3d at 226
(quoting Wald, Some Observations on the Use of Legislative History in the 1981
Supreme Court Term, 68 Iowa L. Rev. 195, 214 (1983) (quoting Leventhal, J.)).

                                          -9-
Regions Hosp., 522 U.S. at 457 (quotation omitted). In proposing the regulation at
issue here, the Secretary described why the definition of the “approved educational
activities” made eligible for pass-through treatment in the PPS legislation was
important to the policy goals of that legislation:

      We are also amending [20 C.F.R.] § 405.421 [later 42 C.F.R. § 413.85
      (1986)] to clarify the definition of allowable costs for medical education,
      because certain medical education costs are excluded from payment
      under [PPS]. This was not necessary before, since all the costs were
      reimbursed on the same reasonable cost basis. However, under [PPS],
      failure to properly define those medical education costs, for which
      payment in addition to prospective payments is permitted, could result
      in unnecessary and inappropriate payments.

48 Fed. Reg. 39752, 39803 (Sep. 1, 1983).

      Later, in response to comments on the proposed new regulation, the Secretary
explained why a requirement of direct operation of the educational program by the
provider hospital was necessary to implement Congress’ Medicare goals:

      Comment – A number of comments were received concerning whether
      the pass through of direct education costs is limited to only the costs of
      those approved medical education programs that a hospital directly
      operates itself. If this is the case, commenters were concerned that
      certain costs, such as the costs of clinical training for students enrolled
      in programs other than at the hospital, may not be excluded from the
      prospective payment system, but rather are considered to be normal
      operating costs.

      Response – We believe that only the costs of those approved medical
      education programs operated directly by a hospital be excluded from the
      prospective payment system. If a program is operated by another
      institution, such as a nearby college or university, [it] must be noted that
      by far the majority of the costs of that program are borne by that other

                                         -10-
      institution, and not by the hospital. While it is true that the hospital may
      incur some costs associated with its provision of clinical training to
      students enrolled in a nearby institution, the hospital also gains in return.
      For example, it obtains the services of the trainee (often at no direct cost
      to itself). We do not believe that this type of relationship was what
      Congress intended when it provided for a pass through of the costs of
      approved medical education programs. Rather, we believe that
      Congress was concerned with those programs that a hospital operates
      itself, and for which it incurs substantial direct costs.

      We are revising § 405.421(d)(6) [later 42 C.F.R. § 413.85(d)(6) (1986)]
      to clarify that the costs of clinical training for students enrolled in
      programs, other than at the hospital, are normal operating costs.

49 Fed. Reg. 234, 267 (Jan. 3, 1984).6

      The Secretary’s explanation of why a direct-operation requirement for
“approved educational activities” was necessary to implement Congress’ goals for the
PPS legislation is eminently “reasonable . . . in light of the Legislature’s design.”
Regions Hosp., 522 U.S. at 457. Therefore, we hold that the Secretary’s rule is a
permissible interpretation of the statute.




      6
        Baptist Memorial argues that the specific reference to “clinical training”
indicates that the direct-operation requirement was only intended to apply to clinical
costs, not classroom costs. However, the reference to “clinical training” occurs in
response to some specific concerns raised by commenters. The first sentence of the
response indicates that the regulation requires that all “approved medical education
programs,” not just clinical training programs, be “operated directly by a hospital.”
49 Fed. Reg. 234, 267 (Jan. 3, 1984).

                                          -11-
      B.     The PRRB’s Conflicting Prior Interpretations

       In three decisions7 announced between 1993 and 1997, involving cost years
from 1987 to 1989, the PRRB analyzed “approved educational activities” under the
St. John’s Hickey “engaged in” standard, rather than the more strict direct-operation
standard originally associated with 42 C.F.R. § 413.85(d)(6) (1986). The Secretary
declined review of those decisions. Baptist Memorial argues that it is arbitrary and
capricious for the Secretary now to change his interpretation and apply the direct-
operation standard in this case.8 We disagree.

      When we evaluate an agency’s change of position,

      the mere fact that an agency interpretation contradicts a prior agency
      position is not fatal. Sudden and unexplained change or change that
      does not take account of legitimate reliance on prior interpretation may
      be arbitrary, capricious or an abuse of discretion. But if these pitfalls are
      avoided, change is not invalidating, since the whole point of Chevron is



      7
       The three PRRB decisions are St. Mary’s Med. Ctr. v. Blue Cross/Blue Shield,
PRRB No. 97-D82 (July 15, 1997); Barberton Citizens Hosp. v. Blue Cross/Blue
Shield, PRRB No. 94-D61 (July 28, 1994); and St. Ann’s Hosp. v. Blue Cross/Blue
Shield, PRRB No. 93-D61 (July 21, 1993).
      8
        As a corollary, Baptist Memorial argues that the change in position violates
Medicare rule-change procedures in 42 U.S.C. § 1395hh(a)(2) (“No rule, requirement,
or other statement of policy . . . that establishes or changes a substantive legal
standard governing . . . payment for services . . . shall take effect unless it is
promulgated by the Secretary by regulation . . . .”). However, we agree with the
courts that have held that this provision imposes no standards greater than those
established by the APA. See, e.g., Erringer v. Thompson, 371 F.3d 625, 633 (9th Cir.
2004) (rejecting an argument that § 1395hh(a)(2) “creates a requirement for
promulgation by regulation broader than that of the APA”). Therefore, our analysis
under the APA applies also to Baptist Memorial’s § 1395hh(a)(2) argument.

                                          -12-
      to leave the discretion provided by the ambiguities of a statute with the
      implementing agency.

Smiley v. Citibank (S.D.), N.A., 517 U.S. 735, 742 (1996) (internal citations and
quotations omitted).

       Baptist Memorial argues that “[w]here an agency applies different standards
to similarly situated entities and fails to support this disparate treatment with a
reasoned explanation and substantial evidence in the record, its action is arbitrary and
capricious and cannot be upheld.” Burlington N. & Santa Fe Ry. Co. v. Surface
Transp. Bd., 403 F.3d 771, 777 (D.C. Cir. 2005). Our closest case on point is SSM
Rehabilitation Institute v. Shalala, 68 F.3d 266 (8th Cir. 1995). In that case, to
determine whether the Secretary’s application of a regulation to SSM was an arbitrary
change of position, we relied on contemporaneous decisions of the PRRB that applied
the same regulation. Id. at 270. Because the contemporaneous final decisions, as
rendered by the PRRB, were consistent with the decision of the Secretary regarding
SSM, we held the Secretary’s decision was not an arbitrary change of position. Id.
Our holding in SSM suggests that if the Secretary’s interpretation in a case is
inconsistent with contemporaneous final decisions rendered by the PRRB, the change
would be arbitrary. In the instant case, however, while the three prior decisions cited
by Baptist Memorial are inconsistent with the Secretary’s decision, they are not
contemporaneous decisions of the agency. The instant case deals with the cost years
1991 to 1994, while the three previous decisions covered cost years 1987 to 1989.
The first decision of the Administrator, on behalf of the Secretary, applying the
direct-operation standard in this case was issued in 2001, while the three previous
decisions were issued between 1993 and 1997. As a result, SSM does not suggest a
finding of arbitrariness here. Contrary to Baptist Memorial’s assertion, because
different cost years were involved in the three PRRB decisions, this is not a case
“[w]here an agency applie[d] different standards to similarly situated entities.”
Burlington N. & Santa Fe Ry. Co., 403 F.3d at 777.


                                         -13-
       More generally, we do not find the Secretary’s decision to apply the direct-
operation requirement after the three earlier PRRB decisions to be “sudden and
unexplained.” Smiley, 517 U.S. at 742. The Secretary has explained fully the
underlying rationale for the direct-operation test, as discussed ante, and the change
as applied to cost years 1991 through 1994 was not sudden because HHS notified
Baptist Memorial and its sister hospitals beforehand, as memorialized in an August
1990 letter, that the Nursing School costs would not be eligible for pass-through
treatment because the provider hospitals did not operate the Nursing School. Again,
we agree with the D.C. Circuit, which held in regard to an identical argument based
on the same three prior PRRB cases, “All that we or the regulated entity can properly
ask of the agency is that it explain its departure. This the Secretary has expressly
done.” Cmty. Care, 318 F.3d at 227.

       Neither is the Secretary’s decision contrary to “legitimate reliance on prior
interpretation” in the PRRB decisions. Smiley, 517 U.S. at 742 (citing United States
v. Penn. Indus. Chem. Corp., 411 U.S. 655, 670-675 (1973) and NLRB v. Bell
Aerospace Co., 416 U.S. 267, 295 (1974)). Legitimate reliance on prior
administrative decisions can be shown where “some new liability is sought to be
imposed on individuals for past actions which were taken in good-faith reliance on
[agency] pronouncements.” Bell Aerospace, 416 U.S. at 295. In this case, the
arrangement between Baptist Memorial and the Nursing School beginning in 1991
could not have been made in reliance on the PRRB decisions, which were announced
between 1993 and 1997.9


      9
       Baptist Memorial also argues that it relied on the Secretary’s Provider
Reimbursement Manual (“PRM”), which as late as 1995 continued to state that non-
provider-operated educational activities meeting the “engaged in” test were eligible
for pass-through treatment. However, “[t]he PRM, while a useful guide to
interpreting the Medicare statute and regulations, is not strictly binding on the
Secretary.” Paragon Health Network, Inc. v. Thompson, 251 F.3d 1141, 1147 (7th
Cir. 2001). Reliance on the PRM would not have been reasonable in light of the

                                        -14-
       We conclude that it is not arbitrary and capricious for the Secretary to apply the
direct-operation standard in this case.

      C.     Application of the Direct-Operation Standard

      We review the Secretary’s decision, made under the direct-operation standard,
that Baptist Memorial’s classroom costs associated with the Nursing School do not
qualify for pass-through treatment to determine if it is supported by substantial
evidence in the record as a whole. Flanery v. Chater, 112 F.3d 346, 349 (8th Cir.
1997). We find that substantial evidence supports the Secretary’s finding that Baptist
Memorial was not the operator of the Nursing School.

        Baptist Memorial does not challenge the Secretary’s findings that “[t]he
responsibilities associated with the operation of a nursing program reside with the
School of Nursing, not the Provider” and “the costs at issue were not directly incurred
by the Provider, but rather were allocated to the Provider.” Instead, Baptist Memorial
contends that the Nursing School is operated by a provider because Baptist Memorial
and the Nursing School are part of a single corporation, Baptist Health. This
argument fails. The Secretary correctly noted that, while Baptist Health is a
corporation that operates several provider hospitals and nursing schools, it does not
itself qualify as a provider under the statute. See 42 U.S.C. § 1395x(u) (“The term
‘provider of services’ means a hospital, critical access hospital, skilled nursing
facility, comprehensive outpatient rehabilitation facility, home health agency, [or]
hospice program . . . .”). Moreover, the fact that a provider hospital and an
educational institution are under common ownership does not circumvent the
regulations that determine when the costs of the educational institution are
attributable to the provider hospital for Medicare purposes. See Thomas Jefferson


direct communication from HHS in August 1990 asserting that the direct-operation
requirement contained in the regulations would be applied.

                                          -15-
Univ. v. Shalala, 512 U.S. 504 (1994) (affirming that a medical college could not
redistribute some costs of an approved educational program to an associated provider
hospital where both were owned and operated by the same legal entity).

      In short, the Medicare reimbursement system is based on the costs incurred by
individual provider hospitals, without regard to underlying ownership structure.
Indeed, if Baptist Memorial’s common-ownership reimbursement theory were
accurate, there would be no need for each of the four hospitals owned and operated
by Baptist Health to have separate Medicare provider numbers. We conclude that
substantial evidence supports the Secretary’s finding that Baptist Memorial was not
the operator of the educational activity.

III.   CONCLUSION

      We hold that the direct-operation requirement is a permissible interpretation
of “approved educational activities” and that it does not represent an arbitrary change
from the Secretary’s prior interpretation. We also hold that substantial evidence
supports the Secretary’s finding that Baptist Memorial was not the operator of the
educational activity. Accordingly, we affirm the judgment of the district court.

HEANEY, Circuit Judge, dissenting.

       I concur in the majority’s holding that the Secretary was entitled to limit pass-
through reimbursement for clinical or classroom costs to those programs that were
directly operated by the hospital. I respectfully dissent, however, from that portion
of the opinion that holds that Baptist Health, through its subsidiary Baptist Memorial,
does not qualify for such reimbursement.

    Baptist Health is a single corporation. It owns and operates both Baptist
Memorial and the Baptist School of Nursing. Baptist Memorial does not maintain its

                                         -16-
own board of trustees or have separate corporate officers. It does not operate
independently whatsoever; it is merely a wing of Baptist Health. Likewise, Baptist
Health’s board of trustees controls the operations of the nursing school, and Baptist
Health holds the nursing school’s license. Baptist Health has but one tax
identification number, shared by all of its subsidiaries.

       Given the above evidence, I cannot agree that Baptist Memorial is a separate
entity from Baptist School of Nursing. Baptist Health owns both. In my view, the
direct link between the two provided by their common ownership and operation
qualifies Baptist Memorial as a direct provider of the nursing program. Indeed, the
two subsidiaries appear to have believed as much: when Baptist Memorial agreed to
host the nursing school’s programs, it did so through a memorandum of agreement
rather than a contract, since the signatories for each subsidiary would have been the
same. Thus, although I agree that we accord the Secretary’s findings deference,
substantial evidence simply does not support the view that the nursing program was
not provider operated.
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