In United States ex rel. Spay v. CVS Caremark Corp., 875 F.3d 746 (3d Cir. 2017), the Third Circuit recently affirmed the lower court’s dismissal of a former employee’s False Claims Act (“FCA”) claim against CVS Caremark (“Caremark”), holding that the misrepresentations the plaintiff had alleged were immaterial under the standard of materiality the U.S. Supreme Court established in Universal Health Services v. Escobar, 136 S. Ct. 1989 (2016). Specifically, the Third Circuit held that Caremark’s submission of allegedly incorrect information to the Centers for Medicare and Medicaid Services (“CMS”) was immaterial to the government’s decision to pay the claims. Although Caremark had allegedly used “dummy” prescriber identification numbers (“Prescriber IDs”) for certain claims, this was merely a workaround for errors associated with the lack of compatible Prescriber IDs on claims that Caremark had authorized for payment and which the government would have authorized in any event. In addition to its materiality holding, the Third Circuit considered for the first time – although in dicta – the government knowledge inference doctrine (“KID”). Below we consider the implications of both Spay’s materiality holding and its adoption of the KID.

Background in Spay

From 2006 to 2007, Caremark submitted approximately 4,500 Prescription Drug Event (“PDE”) records to the government via CMS using dummy Prescriber IDs. The purpose of the PDE records was for Caremark and other Pharmacy Benefit Managers (“PBM”) under Medicare Part D to submit their claims for reimbursement to CMS to recover costs for dispensing prescriptions. Prescriber IDs are numbers associated with each individual with prescribing authority (e.g., a physician, dentist, or nurse practitioner). A PDE record that did not include a Prescriber ID would be automatically rejected by CMS’ electronic system, preventing payment to the submitting pharmacy. Caremark employees identified approximately 4,500 PDEs that Caremark had authorized for payment, but which had not been submitted to CMS because the PDEs had “errored out” because of an incompatible Prescriber ID. To circumvent this problem, and to avoid having legitimate claims rejected by the CMS system due to the absence of a Prescriber ID, Caremark created a “dummy” Prescriber ID for the 4,500 PDEs. Caremark later used additional dummy Prescriber IDs for the same reason. The relator, a former pharmacist and auditing consultant for Caremark, claimed that Caremark violated the FCA by submitting false information to CMS and falsely certifying the accuracy of its claims.

The district court granted summary judgment in favor of Caremark on a ground that the Third Circuit did not – i.e., the KID. As the Third Circuit later explained in a portion of its opinion not essential to its holding, and quoting the lower court, the KID is the idea that “when the government knows and approves of the facts underlying an allegedly false claim prior to presentment, an inference arises that the claim was not knowingly submitted, regardless of whether the claim itself is actually false.” Although rejecting this doctrine as a basis for dismissing the complaint in this particular case, the Third Circuit joined six of its sister circuits in adopting the doctrine and established a two-part test for its application. Accordingly, a defendant invoking the doctrine in the Third Circuit as a defense to an FCA claim must now show that: “(1) the government agency knew about the alleged false statement(s); and (2) the defendant knew the government knew.” The court explained that the doctrine distinguishes between the submission of false claims and the knowing submission of false claims.

Under the facts of Spay, the Court concluded that while there was enough evidence to suggest that CMS knew that Caremark was utilizing dummy Prescriber IDs (this was an industry-wide practice), there was insufficient evidence to show that Caremark knew that CMS was aware of the issue. Thus, the doctrine did not apply. Importantly, the Court noted that cases where the government KID does apply typically involve “cooperation and collaborative problem-solving” or even “open and ongoing discussions about the purportedly false claims.” In both scenarios, the government’s interactions with the defendant can establish a defendant’s knowledge of the government’s awareness of the false claim.

The Third Circuit’s Materiality Holding in Spay

Since the alleged acts of Caremark occurred in 2006-2007, the Third Circuit first addressed whether materiality was an element of an FCA violation before the enactment of the Fraud Enforcement and Recovery Act of 2009, Pub. L. No. 111-21 (2009) (“FERA”). In light of Escobar, and pre-FERA case law, the Third Circuit concluded that even before 2009 a judicially-imposed materiality requirement did exist.

Applying the materiality standard of the Supreme Court’s more recent Escobar decision, the Third Circuit concluded that this case was “precisely the situation” described in Escobar: “if the Government regularly pays a particular type of claim in full despite actual knowledge that certain requirements were violated, and has signaled no change in position, that is strong evidence that the requirements are not material.” Under Escobar (and the pre-2009 case law), determining materiality boils down to whether the government would have processed an allegedly false claim even if it had known of the invalidity of the claim. Thus, CMS’ decision to pay Caremark’s claims despite CMS’ knowledge of the dummy Prescriber IDs was evidence of the immateriality of the alleged false claims. Going one step further, the Court noted that the dummy IDs were used as a matter of administrative convenience—a situation that amounted to more of a creative workaround by Caremark—not the type of fraud the FCA is intended to prevent. “The misstatements that gave rise to this qui tam action allowed patients to get their medication, and they are precisely the type of ‘minor or insubstantial’ misstatements where “[m]ateriality . . . cannot be found.”

Implications of Spay for FCA Defendants

The Third Circuit’s Spay decision is likely to provide ammunition to FCA defendants in cases where the false claim alleged is inaccurate as a technical matter, but is the equivalent of mere harmless error because the falsity is of no real consequence. Those situations present a stark contrast to the FCA’s historical origins. As the Third Circuit noted, the FCA was signed into law by President Abraham Lincoln to address fraud in defense contracts during the Civil War, including the government paying for artillery shells filled with sawdust instead of explosives, or the same horse being sold to Union cavalry two or three times.

Thus, unlike the self-evident fraud of the Civil War-era artillery shells, Spay offers defendants in FCA cases an opportunity to portray relator allegations as technical nitpicks, and not of any importance to the government’s decision to pay the claims. And where a defendant can show not only that the government knew, but that the defendant knew the government knew, the KID offers yet another arrow in the defendant’s quiver. Given that the discussion of the KID in Spay was dicta, however, it remains to be seen how the KID is applied in future cases in the Third Circuit.