Fourth Circuit Adopts Safeco Scienter Standard to Prove False Claims Act Violation in Legal Falsity Cases

Cozen O'Connor
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Cozen O'Connor

A few weeks ago, the U.S. Court of Appeals for the Fourth Circuit answered a critical inquiry in the False Claims Act (“FCA”) context: does a defendant violate the FCA when its reading of the regulation is objectively reasonable and there is no government guidance discouraging or rejecting that interpretation? Answering in the negative in a 2-1 decision, the court affirmed the dismissal of the case and injected into FCA cases the requisite state of mind (i.e., scienter) for violating a regulation as set out in Safeco Ins. Co. of Am. v. Burr, 551 U.S. 47, 127 S. Ct. 2201 (2007) by the U.S. Supreme Court. United States ex rel. Sheldon v. Allergan Sales, LLC, 24 F.4th 340, 347–48 (4th Cir. 2022). In doing so, the Fourth Circuit joined the ranks of five other circuit courts that had considered the issue. Disturbed by the exceedingly complex Medicaid rules at issue that were open to varying interpretations and the constitutional implications of “the veritable thicket of Medicaid regulations, “labyrinthine reporting requirements,” and “the most completely impenetrable texts within human experience,” the Fourth Circuit placed the onus on the government “to indicate a way through the maze.” Id. at 344, 350, 352 (internal quotations and citations omitted).

Factual Background

In August 2014, Troy Sheldon, a former sales manager at Forest Laboratories, LLC (“Forest”), filed a qui tam lawsuit, contending that Forest had violated the Medicaid Drug Rebate Statute. To ensure Medicaid coverage of their prescriptions, health care manufacturers must enter into a Rebate Agreement with the federal government and report their drugs’ average manufacture price (“AMP”) and best price (“Best Price”) to the federal government. In addition, based on the AMP and Best Price, manufacturers must remit quarterly rebates to participating states based on drug sales. 42 U.S.C. § 1396r-8; cf. 42 C.F.R. § 447.505. That rebate is the total number of drug units purchased by a state Medicaid program multiplied by “the greater of (1) the statutory minimum rebate percentage, or (2) the difference between the AMP and the Best Price.” 42 U.S.C. § 1396r-8(c)(1)(A).

Whereas AMP is the average price paid directly to manufacturers for a drug on a per unit basis, id. § 1396r-8(k)(1)(A), Best Price is the “lowest price available from the manufacturer during the rebate period to any wholesaler, retailer, provider, health maintenance organization, nonprofit entity, or governmental entity,” which “shall be inclusive of cash discounts, free goods that are contingent on any purchase requirement, volume discounts, and rebates.” Id. § 1396r-8(c)(1)(C)(i), (ii)(I). Of import, the Rebate Agreements recognized that “in the absence of specific guidance, manufacturers should make reasonable assumptions in their calculations of Best Price, consistent with the requirements and intent” of the law and the Rebate Agreements. Sheldon, 24 F.4th at 345 (cleaned up).

How much manufacturers remit to states in rebates is especially critical: the federal government reduces its Medicaid payments to states by the rebates provided by the manufacturers. 42 U.S.C. § 1396r-8(b)(1)(B). In the event the rebates are improperly deflated, the federal government will have overpaid the states. That’s precisely what the qui tam plaintiff contended here. Forest had allegedly underpaid states by over $680 million between 2005 and 2014 after its drug reporting failed to take into account a complete itemization of discounts offered to customers, thereby causing the federal government to foot larger-than-necessary Medicaid payments to participating states. Sheldon, 24 F.4th at 346.

Under Sheldon’s theory (backed by the government’s amicus brief), the manufacturer must aggregate all discounts provided to separate entities in the distribution channel to calculate the Best Price. Here, as Sheldon maintained, when Forest offered a discount to both an insurer and pharmaceutical, it should have “stacked” those discounts in assessing the Best Price. Id. For example, in 2013, when Forest offered a 20% discount to a patient’s insurer for a drug and also offered a 10% discount to that same patient’s pharmacy, Forest should have baked a 30% discount into its Best Price calculation. It did not do so, according to Sheldon, but instead represented that 20% was Forest’s Best Price, and so because the statutory minimum rebate percentage in 2013 was 23.1%, Forest applied that minimum to calculate the rebates remitted to participating states. Id. Consequently, Sheldon maintained that Forest’s underreporting violated the FCA.

Holding

A. Scienter Standard

There is FCA liability when a person “knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation . . . to the Government” or “knowingly conceals or knowingly and improperly avoids or decreases an obligation . . . to the Government.” 31 U.S.C. § 3729(a)(1)(G). In other words, Sheldon’s burden was to show that (1) Forest made false statements or engaged in fraudulent conduct; (2) Forest had the requisite knowledge (i.e., scienter); (3) Forest’s statements or conduct were material; and (4) the government suffered monetary damages. United States ex rel. Rostholder v. Omnicare, Inc., 745 F.3d 694, 700 (4th Cir. 2014). On appeal, the Fourth Circuit considered only the second element—scienter—in ultimately concluding that Sheldon failed to meet his burden. Sheldon, 24 F.4th at 347.

Before reaching that conclusion, the court, insisting on a “rigorous” application of the scienter element, weighed whether to join the unanimous consensus of five circuit courts that had agreed to apply Safeco’s scienter standard. Id. at 344, 347 (quoting Universal Health Servs., Inc. v. United States ex rel. Escobar, 579 U.S. 176, 136 S. Ct. 1989, 2002 (2016)). Eventually, the Fourth Circuit joined the consensus, finding that the scienter required by the FCA was similar to the scienter required by the statute under consideration in Safeco: the Fair Credit Reporting Act (“FCRA”). Id. at 347–48 (“Given this parallel, we hold that Safeco’s reasoning applies to the FCA’s scienter requirement.”).

In Safeco, the U.S. Supreme Court noted that to be liable under the FCRA, the defendants must have acted “willingly.” Safeco, 551 U.S. at 58 (citing 15 U.S.C. § 1681n(a)). Because the FCRA failed to define “willingly,” the Supreme Court considered its common-law meaning, which covered both knowing and reckless violations. Digging deeper, the Supreme Court held that an objective standard applied to recklessness: it entails “an unjustifiably high risk of harm that is either known or so obvious that it should be known.” Id. at 68 (internal quotation marks and citation omitted). Therefore, to measure recklessness, Safeco adopted a two-part analysis that asked the following: first, was the defendant’s interpretation of the law objectively reasonable, and second, is there any authoritative guidance from the relevant agency and courts that may have warned the defendant about that interpretation? Id. at 69–70. Stated differently, even if the interpretation is erroneous, so long as it was objectively reasonable and there is no authority to guide the interpretation, then the defendant could not have acted recklessly and therefore not willfully. Id. Importantly, subjective intent is irrelevant. Id. at 70.

Importing Safeco’s two-step scienter analysis was a no-brainer to the Fourth Circuit majority for several reasons. First, the common-law meaning of “willingly” was substantially similar to the FCA’s definition of “knowingly,” defined as either having actual knowledge or acting in deliberate ignorance or reckless disregard of the truth or falsity of the information. Sheldon, 24 F.4th at 348 (citing 42 U.S.C. § 3729(b)(1)(A)). Second, the analysis “is narrowly cabined to legally false claims,” cases where the dispute centers around “contested statutory and regulatory requirements.” Id. at 350. By contrast, Safeco won’t apply to factually false claims, the “paradigmatic FCA action [that] targets” someone that “has submitted an incorrect description of goods or services provided or a request for reimbursement for goods or services never provided.” Id. at 349 (internal quotation marks and citations omitted). Third, “profoundly troubling” were the due-process implications if manufacturers were to face liability here—where, faced with a morass of complicated regulations, manufacturers are left to act without any guidance from the government. Id. at 350–51.

B. Applying Safeco to Qui Tam Allegations

Here, Forest argued that the calculation of its Best Price was objectively reasonable and that there was no official guidance from the Centers for Medicare & Medicaid Services (“CMS”) or judicial precedent to dissuade it from that calculation. The Fourth Circuit agreed. In reviewing the Rebate Statute and CMS regulations, the court opined that the plain and natural reading of the language focused on “a single entity” to whom a manufacturer may provide a discount: that is, “the lowest-price given to a single entity,” not the aggregation of discounts offered to multiple entities in a distribution channel. Id. at 351–353 (analyzing 42 U.S.C. § 1396r-8(c)(1)(C)(i); 42 C.F.R. § 447.505(a). As a result, “Forest ha[d] offered, at minimum, an objectively reasonable reading of the Rebate Statute.” Id. at 353.

Next, the court summarized the landscape of available guidance on the Rebate Statute. For any guidance to be a sufficient warning, it must come from the appropriate source (here, CMS or circuit court precedent) and contain “sufficient specificity.” Id. CMS, however, had merely parroted the language of the law, thereby creating a “strategic ambiguity” that granted manufacturers like Forest a “permission slip” instead of a warning. Id. at 354–55. On several occasions, CMS had opportunities to crystallize how to calculate the Best Price and even knew as early as 2006 that manufacturers were not consolidating discounts among multiple entities. Id. Yet at no point did CMS provide an unequivocal demonstration of the appropriate calculation. Id. Holding that “[r]etaining ambiguity in order to expand potential liability . . . cannot pass muster,” the Fourth Circuit concluded that “CMS did not warn Forest away from its objectively reasonable reading.” Id. at 356. Therefore, with no guidance to challenge Forest’s reasonable interpretation of the Rebate Statute, it could not have acted knowingly to violate the FCA. Id.

Dissent

Judge Wynn vigorously dissented, opining that the majority had effectively gutted the FCA to allow many bad actors to get away by conveniently overlooking Sheldon’s factual allegations. Id. at 357 (expressing concern that “fraudsters [may] escape any liability so long as they can come up with a post hoc legal rationale that passes the smell test”) (emphasis in original). In particular, Sheldon had averred that, after CMS had proposed a rule to clarify the definition of Best Price, Forest had submitted concerns that the proposed definition would require manufacturers to stack drug discounts provided to multiple entities. Id. at 359–60. It was because of these concerns, according to Sheldon, that Forest hired auditors to scrape the multiple discounts offered to different entities within a drug distribution channel unless they were preferred customers. Id. at 360–61.

Judge Wynn worried that the majority’s standard was too rigid and failed to meaningfully consider these allegations. By enhancing the recklessness scienter standard as a threshold finding before the other two scienter standards (actual knowledge and deliberate ignorance), the majority focused exclusively on an objective standard that “makes ‘deliberate wrongdoing’ completely irrelevant.” Id. at 366–67 (citation omitted). Judge Wynn, therefore, objected to this “overhaul” that “artificially narrowed the [FCA’s] scienter requirement.” Id. at 357–58, 367–68. Judge Wynn further expressed concern with adopting Safeco’s scienter standard, finding that the Supreme Court’s holding and the FCRA are diametrically opposed to the FCA. Id. at 362–64. And even under the Safeco standard, Judge Wynn would find that, while the Rebate Statute is ambiguous, there were several interpretations by CMS that should have guided Forest to apply the correct Best Price calculation. Id. at 372–76. For these reasons, Judge Wynn would have reversed the District Court’s decision.

Considerations

Hardly a week goes by without the media reporting involving an FCA violation. Indeed, in the fiscal year 2021 alone, the Department of Justice recovered nearly $6 billion from FCA actions, most of which came from cases involving health care fraud and abuse (“over $5 billion,” according to the DOJ press release). Whistleblowers, entitled under the FCA to a percentage of the government’s recovery, received over $1.6 billion from the nearly 600 qui tam lawsuits filed in the fiscal year 2021. Needless to say, FCA claims against the health care industry will not slow down anytime soon. In advance of this, industry players should ensure that, in addition to achieving a full understanding of the regulations, they follow the regulations objectively and reasonably. This is especially critical if neither CMS nor the courts have provided any authoritative guidance on the regulations.

More importantly, manufacturers should document how, in the absence of such authoritative guidance, they are objectively and reasonably following regulations. This includes detailing the reasons for their decisions and how they interpret what may seem like an ambiguous statute, harmonizing these deliberations with the purpose and intent of the law. These details should further narrate the efforts made to unearth guidance from CMS and the courts and, if available, the interpretations made by other manufacturers. To further insulate themselves from liability, manufacturers should consider whether to outline in their compliance plans the official steps to follow when faced with regulations that, on their face, lend themselves to varying interpretations. It’s not enough to turn a blind eye or plead ignorance; a thorough, robust, and well-documented process will go a long way.

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