Mercy Catholic Med v. Thompson

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Precedential or Non-Precedential: Precedential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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 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

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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.

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