NH Hospital Association v. Hargan

United States Court of Appeals
For the First Circuit

No. 17-1615

NEW HAMPSHIRE HOSPITAL ASSOCIATION; MARY HITCHCOCK MEMORIAL
HOSPITAL; LRGHEALTHCARE; SPEARE MEMORIAL HOSPITAL; VALLEY
REGIONAL HOSPITAL, INC.,

Plaintiffs, Appellees,

v.

ALEX AZAR, United States Secretary of Health and Human Services;*
CENTERS FOR MEDICARE AND MEDICAID SERVICES; SEEMA VERMA, in her
official capacity as Administrator, Centers for Medicare and
Medicaid Services,

Defendants, Appellants.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF NEW HAMPSHIRE

[Hon. Landya B. McCafferty, U.S. District Judge]

Before

Kayatta, Selya, and Lipez,
Circuit Judges.

Tara S. Morrissey, Attorney, Appellate Staff, Civil Division,
U.S. Department of Justice, with whom Chad A. Readler, Acting
Assistant Attorney General, Civil Division, U.S. Department of
Justice, John J. Farley, Acting U.S. Attorney, Mark B. Stern,

* Pursuant to Fed. R. App. P. 43(c)(2), Secretary of Health
and Human Services Alex Azar has been substituted for former Acting
Secretary of Health and Human Services Eric D. Hargan, who had in
turn been substituted for former Acting Secretary of Health and
Human Services Don J. Wright.
Attorney, Appellate Staff, Civil Division, U.S. Department of
Justice, Heather Flick, Acting General Counsel, Centers for
Medicare and Medicaid Services Division, U.S. Department of Health
and Human Services, Janice L. Hoffman, Associate General Counsel,
Centers for Medicare and Medicaid Services Division, U.S.
Department of Health and Human Services, Susan M. Lyons, Deputy
Associate General Counsel for Litigation, Centers for Medicare and
Medicaid Services Division, U.S. Department of Health and Human
Services, David L. Hoskins, Attorney, Office of the General
Counsel, Centers for Medicare and Medicaid Services Division, U.S.
Department of Health and Human Services, and Lindsay S. Goldberg,
Attorney, Office of the General Counsel, Centers for Medicare and
Medicaid Services Division, U.S. Department of Health and Human
Services, were on brief, for appellants.
Ann M. Rice, Deputy Attorney General, Civil Bureau, State of
New Hampshire, and Nancy J. Smith, Senior Assistant Attorney
General, Civil Bureau, State of New Hampshire, on brief for State
of New Hampshire, Department of Health and Human Services, amicus
curiae.
W. Scott O'Connell, with whom Morgan C. Nighan and Nixon
Peabody LLP were on brief, for appellees.
Geraldine E. Edens, Christopher H. Marraro, Baker & Hostetler
LLP, Susan Feign Harris, and Morgan Lewis & Bockius LLP on brief
for Children's Hospital Association, amicus curiae.

April 4, 2018
 KAYATTA, Circuit Judge. When hospitals treat Medicaid

patients, the Medicaid payments received from the government often

do not cover the full costs of care. In 1981, Congress authorized

the payment of additional sums to lessen the burden on hospitals

that treat a high number of indigent patients. Years later,

concerned that this payment adjustment overshot the mark in some

instances, Congress passed another law seeking to cap such payments

at each hospital's "costs incurred." Of particular relevance to

this litigation is to what extent "costs incurred" equals the total

costs of service, rather than the costs net of payments from other

sources, namely, Medicare and private insurance. This question

arises because some patients qualify for coverage under both

Medicaid and either Medicare or private insurance.

Rather than specifying expressly the full extent to

which "costs incurred" are limited to costs net of other sources

of payment, Congress identified two specific sources of payment

that must be offset against total costs, but otherwise simply

stated that "costs incurred" are "as determined by the Secretary"

of the United States Department of Health and Human Services. In

2008, the Secretary promulgated a regulation. But the regulatory

text, like the statute, contained no express direction on the

question at issue. Then, in 2010, the Secretary announced, in the

form of answers to "Frequently Asked Questions" posted on

medicaid.gov, that the payments to be offset against total costs

- 3 -
in calculating "costs incurred" also included reimbursements

received from Medicare and private insurance. For ease of

reference, we will call this pronouncement "the FAQs" or "the FAQs

announcement."

Ruling in favor of the plaintiff hospitals and their

association, the district court found that the set-off rule

announced in the FAQs represented a substantive policy decision

that could not be adopted without notice and comment. For the

following reasons, we affirm the district court's ruling on this

same ground, without reaching the plaintiffs' other challenges.

I.

Medicaid is a cooperative federal-state health insurance

program that enables states to provide medical assistance to the

disabled, the elderly, and families with dependent children,

"whose income and resources are insufficient to meet the costs of

necessary medical services." 42 U.S.C. § 1396-1. The program is

funded by both the federal and state governments, but is

administered by the states. 42 C.F.R. § 430.0. Although

participation in Medicaid is voluntary, a state that elects to

participate must comply with the requirements imposed by federal

statute and regulations promulgated by the Secretary. See Stowell

- 4 -
v. Ives, 976 F.2d 65, 68 (1st Cir. 1992) (quoting Wilder v. Va.

Hosp. Ass'n, 496 U.S. 498, 502 (1990)).

Once a participating state establishes a state plan that

complies with the Medicaid Act, the federal government reimburses

the state for certain patient care costs. See 42 U.S.C. §§ 1396a,

1396b. The state, in turn, reimburses the medical facilities that

provided the care. These Medicaid reimbursements often do not

cover the hospitals' full costs of treating Medicaid-eligible

individuals.

Concerned about the financial burden thus placed on

hospitals that treat largely indigent communities, Congress

amended the Medicaid statute in 1981 to "take into account the

situation of hospitals which serve a disproportionate number of

low income patients with special needs." Omnibus Budget

Reconciliation Act of 1981, Pub. L. No. 97-35, § 2173, 95 Stat.

357 (codified as amended at 42 U.S.C. § 1396a(a)(13)(A)(iv)).

Giving practical effect to its intent, Congress provided a "payment

adjustment" for hospitals deemed "disproportionate share

hospitals" ("DSH"). See 42 U.S.C. § 1396r-4(c). Several years

later, Congress became aware of reports that certain types of

hospitals had received payment adjustments "that exceed the net

costs, and in some instances the total costs, of operating the

facilities." H.R. Rep. No. 103-111, at 211 (1993). According to

these reports, the excess funds were then being redirected to

- 5 -
finance other state government projects, such as road construction

and maintenance. Id. at 211-12. In 1993, Congress responded to

this unintended consequence by imposing a cap on the DSH payment

adjustment ("the DSH cap"). See Omnibus Budget Reconciliation Act

of 1993, Pub. L. No. 103-66, § 13621, 107 Stat. 312 (codified at

42 U.S.C. § 1396r-4(g)). This hospital-specific DSH cap limited

the payment adjustment to the "costs incurred" in treating

Medicaid-eligible individuals, less Medicaid payments received.1

42 U.S.C. § 1396r-4(g)(1)(A). The provision now states, in

relevant part:

A payment adjustment during a fiscal year
shall not . . . exceed[] the costs incurred
during the year of furnishing hospital
services (as determined by the Secretary and
net of payments under this subchapter, other
than under this section, and by uninsured
patients) by the hospital to individuals who
either are eligible for medical assistance
under the State plan or have no health
insurance (or other source of third party
coverage) for services provided during the
year.

Id.

1 In addition to Medicaid-eligible individuals, the DSH
payment adjustment also provides payments for treating individuals
with no health insurance, and the statutory cap includes costs
incurred in treating these patients, less "payments . . . by
uninsured patients." 42 U.S.C. § 1396r-4(g)(1)(A). For the
purpose of this appeal, however, we are only concerned with costs
incurred in treating Medicaid-eligible individuals and any related
payments.

- 6 -
 In 2003, Congress made a further amendment to the

Medicaid statute. This time, Congress expanded the government's

enforcement mechanism by requiring states, as a condition of

receiving DSH payments, to submit both an annual report and an

annual audit of their qualifying hospitals' expenses and received

DSH payments. See Medicare Prescription Drug, Improvement, and

Modernization Act of 2003, Pub. L. No. 108-173, § 1001(d), 117

Stat. 2066 (codified at 42 U.S.C. § 1396r-4(j)). The reporting

provision of this act requires states to identify each hospital

within the state that received a payment adjustment and the amount

of that adjustment, as well as "[s]uch other information as the

Secretary determines necessary to ensure the appropriateness of

the payment adjustments made under this section." 42 U.S.C.

§ 1396r-4(j)(1)(B). In turn, the audit requirement in the 2003

legislation requires the state to "verif[y]," by "independent

certified audit," that, among other things, the payment adjustment

complied with the statutory cap and that "[o]nly the uncompensated

care costs of providing inpatient hospital and outpatient hospital

services to individuals described in [42 U.S.C. § 1396r-

4(g)(1)(A)] are included in the calculation of the hospital-

specific limits." Id. § 1396r-4(j)(2)(B)-(C).

So, in three steps, Congress provided for additional

payments to certain hospitals, imposed a limit on those payments,

and then created a mechanism for verifying compliance with the

- 7 -
limit. No party claims that this statutory scheme in so many words

expressly addresses the underlying question that gives rise to

this case: how to treat, in determining Medicaid payment

adjustments, costs associated with individuals eligible for both

Medicaid and other health coverage, namely, Medicare or private

insurance. For these individuals -- to whom the parties refer as

"dual eligibles" or those with "dual coverage" -- the additional

coverage may kick in to reimburse hospital costs before Medicaid

does, as Medicaid is often the "payer of last resort."

Massachusetts v. Sebelius, 638 F.3d 24, 26 (1st Cir. 2011)

(citation omitted). So, the question arose: In calculating the

DSH cap, should states deduct Medicare and private insurance

payments for those with dual coverage when determining the

hospitals' "costs incurred"?

In 2008, the Secretary promulgated a rule following

notice and comment. But in so doing, the Secretary exercised

authority not under section 1396r-4(g)(1)(A) (which established

the DSH cap), but rather under the Secretary's delegated authority

to define the scope of information necessary to satisfy the 2003

Modernization Act's reporting requirement. See Disproportionate

Share Hospital Payments, 73 Fed. Reg. 77,904, 77,904 (Dec. 19,

2008) (stating that the rule "implement[s] the reporting

- 8 -
requirement in Section 1923(j)(1) of the Act"2). This regulation

requires states, as a condition of receiving DSH payments, to

report eighteen categories of information to the Centers for

Medicare and Medicaid Services ("CMS") -- the arm of the United

States Department of Health and Human Services responsible for

administering the Medicaid program -- including "Total Medicaid

Uncompensated Care." Id. at 77,950-51. But here too, the

regulatory text is silent on the proper treatment of costs and

revenues associated with dual eligibles.

The regulation's preamble, on the other hand, does

address the issue, albeit only to the extent of adding Medicare

payments as a type of reimbursement that need be offset from the

associated costs. Responding to a comment, the preamble instructs

that, "in calculating th[e] uncompensated care costs" of treating

dual eligibles, "it is necessary to take into account both the

Medicare and Medicaid payments made." Id. at 77,912.

In 2010, the Secretary provided further guidance. In a

"Frequently Asked Questions" document posted on medicaid.gov,3 but

2 Section 1923 of the Act is codified at 42 U.S.C. § 1396r-
4.
3 As best we can tell, this document is no longer accessible
through general navigation on medicaid.gov. As of publication of
this opinion, however, it is available at the following link:
https://www.medicaid.gov/medicaid/financing-and-reimbursement/
downloads/part-1-additional-info-on-dsh-reporting-and-auditing
.pdf. Consistent with First Circuit policy, a copy of the relevant
page will be available on the public docket.

- 9 -
issued without notice and comment, the Secretary stated that both

Medicare payments and private insurance payments associated with

individuals also eligible for Medicaid should be deducted in

calculating the DSH cap. The relevant statements appear in the

responses to FAQs 33 and 34.

Several New Hampshire hospitals and the New Hampshire

Hospital Association (collectively, "plaintiffs") subsequently

filed this challenge to the procedural propriety of the two FAQs

as well as to the substance of the policy articulated in the FAQs.

The conflict arose in 2014, when the New Hampshire Department of

Health and Human Services retained an independent accounting firm

to conduct its statutorily required audit of DSH payments made to

New Hampshire hospitals for fiscal year 2011. The auditor's report

followed the Secretary's guidance articulated in the FAQs. In

calculating the DSH cap, it thus reduced the total "costs incurred"

by the plaintiff hospitals by the amount of payments received from

both Medicare and private insurance in connection with treating

Medicaid-eligible patients. According to this calculation, the

plaintiff hospitals had received a significant overpayment in

fiscal year 2011. The regulatory scheme requires the state to

recover this sum. See 42 C.F.R. § 433.312.

Plaintiffs first petitioned CMS to withdraw the FAQs.

CMS denied their petition. Plaintiffs then brought a challenge in

federal district court under the Administrative Procedure Act,

- 10 -
seeking declaratory and injunctive relief. They alleged that

because the rule articulated in the FAQs effected a substantive

regulatory change, it was procedurally improper for having been

issued without the notice-and-comment procedures prescribed by the

APA. This impropriety, according to plaintiffs, rendered the

agency's action invalid as both being taken "without observance of

procedure required by law," 5 U.S.C. § 706(2)(D), as well as being

"arbitrary, capricious, an abuse of discretion, or otherwise not

in accordance with law," id. § 706(2)(A). Plaintiffs also argued

that Congress itself, by specifying only two sources of payment to

be offset against total costs (payments from Medicaid and from

uninsured patients), had precluded the Secretary from requiring

that all sources of reimbursement be offset.

The district court granted plaintiffs' request for a

preliminary injunction. Approximately a year later, the district

court granted plaintiffs' motion for summary judgment and

permanently enjoined the Secretary from enforcing FAQs 33 and 34.

In a nutshell, the court concluded that the rule set forth a

substantive policy for which the APA required the agency to follow

notice-and-comment procedures, and was thus procedurally improper

under 5 U.S.C. § 706(2)(A) and (D). Having so ruled, the district

court saw no need to reach plaintiffs' substantive challenge and

thus did not address whether the agency, after notice and comment,

could issue the same rule.

- 11 -
 On April 3, 2017, approximately one month after the

district court granted plaintiffs' motion for summary judgment,

the Secretary promulgated a rule following notice and comment that

amended the reporting requirement at issue in this litigation.

See Disproportionate Share Hospital Payments -- Treatment of Third

Party Payers in Calculating Uncompensated Care Costs, 82 Fed.

Reg. 16,114 (Apr. 3, 2017) (codified at 42 C.F.R. § 447.299). The

amendment defined "costs incurred" as "costs net of third-party

payments, including, but not limited to, payments by Medicare and

private insurance." Id. at 16,122 (codified at 42 C.F.R.

§ 447.299(c)(10)). This rule, in effect, codified the policy

previously announced in the FAQs. Because the new rule did not

become operative until June of 2017, it does not apply to the

fiscal years at issue in this action. Plaintiffs challenge the

substance of the 2017 regulatory amendment in a separate action,

and we do not decide the merits of that challenge here.

II.

For purposes of this appeal, we accept arguendo the

Secretary's stated position that Congress granted the Secretary

the "latitude" to decide what, if any, other sources of payments

made in connection with Medicaid-covered costs need be offset from

the total costs of providing such services. The issue is whether

the Secretary has exercised that latitude in a procedurally proper

manner. Resolution of that issue requires us to consider two

- 12 -
questions: First, is the decision to add Medicare and private

party insurance reimbursements to the list of payments that must

be offset against total costs in calculating "costs incurred" the

type of decision that must be effected through notice-and-comment

procedures under the APA? Second, if so, did the Secretary employ

such procedures?

A.

The APA generally requires that before a federal agency

adopts a rule it must first publish the proposed rule in the

Federal Register and provide interested parties with an

opportunity to submit comments and information concerning the

proposal. 5 U.S.C. § 553. Failure to abide by these requirements

renders a rule procedurally invalid. See Warder v. Shalala, 149

F.3d 73, 75 (1st Cir. 1998); see also Hoctor v. U.S. Dep't of

Agric., 82 F.3d 165, 167 (7th Cir. 1996) (stating that, unless an

exception applies, a "rule promulgated by an agency that is subject

to the [APA] is invalid unless the agency" follows notice-and-

comment procedures). As the Secretary points out, however,

exempted from this requirement are "interpretive rules, general

statements of policy, or rules of agency organization, procedure,

or practice." 5 U.S.C. § 553(b). And the Secretary argues that

the FAQs in question fit comfortably within this exception from

the notice-and-comment requirement, as a form of interpretive

rule. Whether this is so is a question of law that we review de

- 13 -
novo, without the benefit of any definition in the APA itself.

Warder, 149 F.3d at 79.

An interpretive rule is issued by an agency merely to

"advise the public of the agency's construction of the statutes

and rules which it administers." Perez v. Mortg. Bankers Ass'n,

135 S. Ct. 1199, 1204 (2015) (quoting Shalala v. Guernsey Mem'l

Hosp., 514 U.S. 87, 99 (1995)). Although interpretive rules "do

not have the force and effect of law," id., they nevertheless may

have a substantial impact on regulated entities, see Levesque v.

Block, 723 F.2d 175, 182 (1st Cir. 1983). The alternative to an

interpretive rule is a legislative rule (interchangeably called a

substantive rule), for which, absent another exception, the APA

requires the agency to follow notice-and-comment procedures. See

5 U.S.C. § 553. We have said that a legislative rule is one that

"creates rights, assigns duties, or imposes obligations, the basic

tenor of which is not already outlined in the law itself." La

Casa Del Convaleciente v. Sullivan, 965 F.2d 1175, 1178 (1st Cir.

1992).

Somewhere along a spectrum, a rule transitions from

being interpretive to being legislative. But, in a refrain now

frequently recited, the point at which a rule crosses that line is

a question "enshrouded in considerable smog." Id. at 1177 (quoting

Gen. Motors Corp. v. Ruckelshaus, 742 F.2d 1561, 1565 (D.C. Cir.

1984)); see also Mortg. Bankers Ass'n, 135 S. Ct. at 1204

- 14 -
(declining to "wade into" the "scholarly and judicial debate"

concerning the term's "precise meaning"). Nevertheless, in this

case five considerations lead us to conclude that the rule

announced in the FAQs is legislative.

1.

First, we look at the words of the statute. In a

subsection titled "Amount of adjustment subject to uncompensated

costs," the statutory text provides that a hospital-specific

payment adjustment shall not exceed the hospital's "costs

incurred" in furnishing hospital services to Medicaid-eligible

individuals and those without health insurance, which it says are

"as determined by the Secretary and net of payments [by Medicaid]

and by uninsured patients." 42 U.S.C. § 1396r-4(g)(1). The House

Report on the 1993 legislation confirms that Congress was well

aware of the difference between "net" and "total" costs. See

H.R. Rep. No. 103-111, at 211-12 (noting reports that DSH payments

had exceeded "the net costs, and in some instances the total costs,

of operating" healthcare facilities). But rather than specifying

the precise manner in which costs should be calculated, Congress

used the unqualified term "costs incurred" in the statute. 42

U.S.C. § 1396r-4(g)(1)(A). The statute then requires the

Secretary to net out two specific types of reimbursements, but

otherwise leaves it to the Secretary to "determine[]" the meaning

of "costs incurred." Id. This textual silence on whether to

- 15 -
offset other sources of payment leads us to believe that any

authority that the Secretary may have to adopt the rule at issue

would most likely flow from Congress's delegation of a power to

make a decision that Congress chose not to make itself. And, as

the D.C. Circuit has said, "[w]here Congress has specifically

declined to create a standard, the [agency] cannot claim its

implementing rule is an interpretation of the statute." Mendoza

v. Perez, 754 F.3d 1002, 1022 (D.C. Cir. 2014).

The Secretary accepts that the statute leaves

"unaddressed" the question of whether to offset Medicare and

private insurance payments, and agrees that "Congress expressly

delegated authority to the Secretary to address such issues." The

Secretary nevertheless posits that an agency need not

"always . . . exercise expressly delegated authority by

regulation." That may be true. But, as our case law makes clear,

when Congress leaves such a policy choice to an agency, we should

lean toward finding that the agency's making of that choice

requires notice and comment. See Warder, 149 F.3d at 80; La Casa

Del Convaleciente, 965 F.2d at 1179; Levesque, 723 F.2d at 182.

Otherwise, it would be "difficult to imagine what regulations would

require notice and comment procedures." Mendoza, 754 F.3d at 1021.

Thus, contrary to the Secretary's argument, this is not

a case like Guernsey Memorial Hospital. There, the Secretary

argued, and the Court appeared to agree, that the only plausible

- 16 -
interpretation of the statutory and regulatory scheme was the one

advanced by the Secretary. See 514 U.S. at 98-99. The Secretary

was thus simply following the statutory command, and was not making

a discretionary policy judgment. We would have a similar situation

in this case if, for example, Congress had expressly specified

that all sources of third party reimbursements be offset from costs

incurred, and the Secretary then implemented that directive by

identifying Medicare payments as just such a reimbursement.

In sum, assuming that the Secretary has the authority

asserted here, the text read in context suggests that any such

authority is the result of Congress's decision to delegate a

substantive policymaking choice to the Secretary.

2.

Second, we look at the explanation or lack thereof given

by the agency in adopting a policy. Had the Secretary merely been

interpreting the governing statute and regulation, then one would

expect that the agency's justification for the rule would rely on

an interpretive methodology. See Warder, 149 F.3d at 78 (noting

that the agency discussed "relevant statutes, regulations,

legislative history, and administrative materials before reaching

its conclusion"); Metro. Sch. Dist. of Wayne Twp. v. Davila, 969

F.2d 485, 490 (7th Cir. 1992) (stating that the Secretary's

reliance on "the language of both the statute and an implementing

regulation, and the legislative history of the Act" in a letter

- 17 -
announcing the rule was an "important" factor "weigh[ing] in favor

of a determination that the rule is interpretive" (internal

citation omitted)); Gen. Motors Corp., 742 F.2d at 1565 (noting

that the agency's "entire justification for the rule" in the

Federal Register "is comprised of reasoned statutory

interpretation, with reference to the language, purpose and

legislative history of" the statute). Here, however, in announcing

and explaining the FAQs, the Secretary offered no meaningful hint

that the Secretary derived the policy announced in the FAQs from

an interpretation of the statute or the regulation. And to the

degree that the Secretary articulated the same policy in the

preamble to the 2008 regulation, that announcement is no different.

Although not dispositive, such an announcement, without reasoned

interpretive explanation, looks to us more as if the Secretary is

using delegated power to announce a new policy out of whole cloth,

rather than engaging in an interpretive exercise.

Even now, on appeal, the Secretary does not meaningfully

contend that the agency's rule is the result of a strictly

interpretive exercise. The Secretary does place weight on the

terms "uncompensated" costs and "costs incurred," as used in both

the statute and the regulation. But the Secretary nowhere argues

that further defining or applying these terms necessarily calls

only for interpretation rather than policymaking. To the contrary,

the Secretary repeatedly and expressly refers to the agency's

- 18 -
position as a "policy," and even goes so far as to characterize

the rule as an exercise of a delegated authority to make "policy

judgments."

The Secretary does stress that the agency has "broad

methodological leeway" to interpret terms like "costs." Verizon

Commc'ns, Inc. v. FCC, 535 U.S. 467, 500 (2002). While the cases

relied on by the Secretary may stand for the proposition that the

agency has broad authority in this realm, see Abraham Lincoln Mem'l

Hosp. v. Sebelius, 698 F.3d 536, 549-50 (7th Cir. 2012); Kindred

Hosps. E., LLC v. Sebelius, 694 F.3d 924, 928-29 (8th Cir. 2012);

Cheshire Hosp. v. N.H.-Vt. Hospitalization Serv., Inc., 689 F.2d

1112, 1119 (1st Cir. 1982), the existence of authority is not our

concern in our current procedural inquiry. Rather, assuming the

agency has the authority to establish the rule at issue (a question

we do not decide), we are concerned only with the manner in which

the agency can exercise that authority. And, cutting against the

Secretary's position, the agency's description of that authority

as "broad" nudges us along the spectrum toward finding an act more

akin to a legislative rule for which notice and comment is

required.

That being said, it is certainly true that the "agency's

own characterization" of its rule as interpretive warrants

attention. Warder, 149 F.3d at 80. But the probative value of

the Secretary's own characterization of a pronouncement as

- 19 -
interpretive is limited, and we do not place on it more weight

than its merits can bear. See La Casa Del Convaleciente, 965 F.2d

at 1178 (describing the agency's own characterization as "not

conclusive"). Otherwise, we would create an easy end run around

the APA's procedural protections.

3.

Third, we look to whether the rule is "inconsistent with

another rule having the force of law," Warder, 149 F.3d at 81

(quoting Chief Prob. Officers v. Shalala, 118 F.3d 1327, 1337 (9th

Cir. 1997)), or otherwise "alter[s] or enlarg[es] obligations

imposed by a preexisting regulation," Aviators for Safe & Fairer

Regulation, Inc. v. FAA, 221 F.3d 222, 226-27 (1st Cir. 2000). As

the Secretary points out, the FAQs do not explicitly conflict with

any existing regulations. But mere consistency, while perhaps

necessary, cannot be sufficient to render a rule interpretive when

the range of "consistent" choices includes materially different

policy options that alter or enlarge existing obligations.4

4 To illustrate the point, the D.C. Circuit, in an apt
analogy, said:

Consistency with the statute may be enough to sustain a
rule duly promulgated after notice and comment, just as
consistency with the Commerce Clause, Art. I, § 8, cl.
3, may be enough to sustain the constitutionality of a
statute. But no one would say, for instance, that the
detailed provisions of the Clean Air Act were
interpretations of the language of the Constitution.

- 20 -
Otherwise, the first time an agency promulgates a rule on a subject

it could always avoid notice and comment by pointing out that the

new rule does not conflict with any prior regulation.

4.

Fourth, we consider the manner in which the Secretary's

actions fit within the statutory and regulatory scheme. See

Warder, 149 F.3d at 81. In Warder, the agency issued an

administrative ruling classifying certain wheeled medical braces

as "durable medical equipment" rather than "braces" for Medicare

reimbursement purposes. 149 F.3d at 75. A "comprehensive

classification of equipment" in the statutes and regulations as

either braces or durable medical equipment, id. at 81, including

several qualitative criteria, id. at 76-77, informed the agency's

decision. Thus, in addressing a "small overlap in this scheme,"

id. at 81, the agency in Warder constructed its decision using the

tools of statutory interpretation, id. at 78. Here, by contrast,

the statute has a gap rather than an overlap, and it is a gap that

the Secretary has sought to fill by exercising what it tells us is

its policy prerogative.

5.

Finally, pragmatic considerations reinforce our decision

to classify the rule at issue in this case as legislative. The

Catholic Health Initiatives v. Sebelius, 617 F.3d 490, 496 (D.C.
Cir. 2010).

- 21 -
precise question addressed by the rule -- whether to offset

Medicare and third party reimbursements -- calls for a categorical

resolution that affects a broad range of payments and scenarios

and likely involves large sums of money. Additionally, in contrast

to the circumstances present in Aviators, 221 F.3d at 227, the

Secretary points to no evidence that the agency consistently

implemented the statute between 1993 and 2010 in accord with the

Secretary's present policy. Indeed, at oral argument the Secretary

was unable to point to any evidence that the agency had ever

previously enforced the policy articulated in the FAQs.

Instead, the Secretary can only point to the fact that

in one letter in 2002 to state Medicaid directors on the subject

of payments for prisoner inmate care and supplemental upper payment

limits, CMS noted that the DSH cap must be calculated "net of

Medicaid payments (except DSH) made under the state plan and net

of third party payments." That sentence simply paraphrases the

statute, albeit replacing "uninsured payments" with "third party

payments." See 42 U.S.C. § 1396r-4(g)(1)(A). Read literally, in

hindsight, the substituted term is broad enough to include Medicare

and private insurance payments. But such a statement in a single

letter that emphasizes the offset "of Medicaid payments" falls far

short of demonstrating any longstanding -- or even short-standing

- 22 -
-- actual implementation of the statute as calling for the offset

of Medicare and private insurance payments.5

In short, the FAQs announced a new policy on a matter of

some considerable import. In such circumstances, the burdens that

might weigh against requiring notice and comment for interstitial,

minor, or confirmatory pronouncements guiding agency operation are

much more easily justified in order to ensure the benefits of

notice and comment.

B.

Our conclusion that the decision to require the set-off

of Medicare and private insurance reimbursements in calculating

"costs incurred" cannot be implemented without notice and comment

brings us to our next inquiry: Whether the agency followed the

necessary procedures in issuing its policy.

The Secretary concedes that the FAQs were not themselves

the result of notice and comment. Instead, the Secretary points

to the notice and comment that preceded the promulgation of the

2008 regulation. The Secretary then argues that the FAQs are

exempt from notice and comment as a mere interpretive explanation

of that regulation. A logically necessary intermediate step in

this argument is that, if the decision to offset Medicare and

5 We note, too, that the letter was written years before
the adoption of the 2008 regulation that the Secretary says is
the object of the FAQ's interpretive exercise.

- 23 -
private insurance payments from total costs is indeed a legislative

decision delegated to the Secretary, then the Secretary made that

decision in promulgating the 2008 regulation, with the FAQs serving

only to add a mere interpretative gloss to the regulation. Under

this view, the FAQs did not alter, enlarge, or otherwise effect a

substantive regulatory change, and thus functioned outside the

scope of actions that require lawmaking power. See Aviators, 221

F.3d at 226-27; see also Warder, 149 F.3d at 80 ("[A] rule is

exempt from notice and comment as an interpretive rule if it does

not 'effect a substantive change in the regulations.'" (quoting

Guernsey Mem'l Hosp., 514 U.S. at 100)).

The 2008 regulation provides an unlikely vehicle for

exercising the Secretary's delegated power to "determine[]" costs

incurred under the DSH cap. 42 U.S.C. § 1396r-4(g)(1)(A). It

never addresses the substance of the cap, nor even purports to

implement the cap legislation itself. Rather, it claims to

implement the reporting requirement of the 2003 Modernization Act.

See 73 Fed. Reg. at 77,904. The regulation then lays out various

categories of information that must be reported to the Secretary,

including "Total Medicaid Uncompensated Care," which it defines as

the "total amount of uncompensated care attributable to Medicaid

inpatient and outpatient services." 42 C.F.R. § 447.299(c)(11)

- 24 -
(2012).6 It further clarifies that this "amount should be the

result of subtracting the amount identified in § 447.299(c)(9)

from the amount identified in § 447.299(c)(10)." Id. Subsection

(c)(10) presents the "total annual costs incurred by each hospital

for furnishing inpatient hospital and outpatient hospital services

to Medicaid eligible individuals," while subsection (c)(9) lists

the various Medicaid payments deducted.

The Secretary points to two terms as the basis of the

rule: "costs incurred" as used in subsection (c)(10), and

"uncompensated" care as used in subsection (c)(11), which, as

explained above, is defined to incorporate "costs incurred." The

Secretary argues that the subsequent FAQs simply fleshed out in an

interpretive manner that those two terms meant that Medicare and

third party insurance payments need be offset.

If the DSH cap statute itself left the Secretary the

broad latitude the Secretary claims in deciding whether to classify

Medicare and third party insurance payments as requiring set-offs

in calculating "costs incurred," then the regulation itself cannot

reasonably be read as manifesting the exercise of that latitude.

Rather, the regulatory text, as the Secretary concedes, is silent

6
We cite the 2012 version of the rule because the rule
originally promulgated in 2008 contained several technical, but
substantial errors. These were corrected in 2009. See 74 Fed.
Reg. 18,656, 18,656-57 (Apr. 24, 2009). The current version of
the rule, however, incorporates the Secretary's 2017 amendment,
which is not at issue in this case.

- 25 -
as to the proper treatment of third-party payments, i.e., payments

from Medicare and private insurance. And the portions of the

regulation from which the Secretary claims to derive the rule --

the terms "uncompensated" and "costs incurred" -- merely parrot

the statutory language. Indeed, the term "costs incurred" is

exactly the term used in the statute and the term "uncompensated

costs" is the caption of the pertinent statutory subsection. See

42 U.S.C. § 1396r-4(g)(1)(A). Nothing in this regulation mentions

-- either directly or indirectly -- payments from Medicare or from

private insurance.

So the sequence is this: Congress specified that the

DSH payment adjustment not exceed "uncompensated costs," which it

defined as "costs incurred" less received Medicaid payments, and

one specified other source of payments, and charged the Secretary

with more precisely determining "costs incurred." Without

providing such further definition, the Secretary enacted a

regulation that in material respects simply parrots the statute.

Then, in a purportedly interpretive rule published a few years

later on the Medicaid website, the Secretary announced that "costs

incurred" excludes payments received from Medicare and private

insurance associated with individuals eligible for dual coverage.

Thus, the Secretary exercised delegated power not

through notice-and-comment regulation, but in a guidance document

issued without the APA's procedural protections. To deem this

- 26 -
adequate would mean an agency could largely eliminate pre-decision

public comment on the merits of the agency's exercise of its

delegated powers to make substantive choices: The agency would

simply adopt a regulation parroting the statute, and then reveal

its choice through a rule "interpreting" the regulation. As the

D.C. Circuit has recognized,

the purpose of the APA would be disserved if
an agency with a broad statutory command . . .
could avoid notice-and-comment rulemaking
simply by promulgating a comparably broad
regulation . . . and then invoking its power
to interpret that statute and regulation in
binding the public to a strict and specific
set of obligations.

Elec. Privacy Info. Ctr. v. U.S. Dep't of Homeland Sec., 653 F.3d

1, 7 (D.C. Cir. 2011).

The Secretary argues that the regulation here does more

than parrot the pertinent statutory term. For one, while the

statute spells out that costs incurred relate to "hospital

services," the regulation further specifies that the costs

incurred must be attributable to "inpatient hospital and

outpatient hospital services." Similarly, while the statute says

that costs incurred should net out Medicaid payments, the

regulation specifies three particular categories of Medicaid

payments, and includes payments under Section 1011. See 42 C.F.R

§ 447.299(c)(6)-(8), (13). But these specifications that go

beyond the statutory text have no bearing whatsoever on the issue

- 27 -
at hand, as evidenced by the fact that the Secretary relies on

none of these added specifications as providing any basis for

deeming "costs incurred" to be limited to costs net of Medicare or

other third party insurance payments.

As a fallback position, the Secretary argues that the

agency established the relevant policy in the preamble to the 2008

reporting regulation, rather than in its text. The preamble does

clearly state, at least with respect to individuals eligible for

both Medicare and Medicaid (but not private insurance payments),

that Medicare payments should be deducted from the hospitals'

"costs incurred." See 73 Fed. Reg. at 77,912. But this argument

fails because, if the agency did establish its rule in the

preamble, it is procedurally improper for the same reasons we

deemed the FAQs announcement procedurally improper. Although the

2008 regulation was subject to notice and comment, the preamble,

like the FAQs announcement, was not. See Leslie Salt Co. v. United

States, 55 F.3d 1388, 1393 (9th Cir. 1995) ("It is undisputed that

the preamble has not been subjected to notice and comment."). A

rule stated in a preamble is subject to the same analysis of

whether its articulated policy is interpretive or legislative, and

if it is the latter, it is procedurally improper. See id. at 1393-

94 (conducting this analysis for a rule articulated in a preamble);

Fertilizer Inst. v. EPA, 935 F.2d 1303, 1307-09 (D.C. Cir. 1991)

(same). Thus, because we concluded that the relevant policy choice

- 28 -
is one that must be made through notice and comment, the agency's

implementation of this delegated lawmaking authority in a preamble

is procedurally improper.

Finally, to the degree the Secretary argues that we

should defer to the preamble to discern the meaning of the

regulation, we are similarly unconvinced. Because the adoption of

a substantive policy in a preamble added to a regulation after

notice and comment is procedurally improper, cf. Leslie Salt Co.,

55 F.3d at 1393-94; Fertilizer Inst., 935 F.2d at 1307-09, such a

policy cannot be the source of an interpretation to which a court

defers, see Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117,

2125 (2016) ("Chevron deference is not warranted where the

regulation is 'procedurally defective' -- that is, where the agency

errs by failing to follow the correct procedures in issuing the

regulation."(quoting United States v. Mead Corp., 533 U.S. 218,

227 (2001))). But even if that were not the case, we would harbor

doubts about whether deference is appropriate here. It is true

that, in certain circumstances, we have deferred to a regulation's

preamble as an agency's interpretation of its own ambiguous

regulation. See, e.g., Rucker v. Lee Holding Co., 471 F.3d 6, 12

(1st Cir. 2006). But here, we see no ambiguity in the relevant

sense. As we explained above, we assume, without deciding, that

the agency has the power to adopt a policy following notice and

comment that excludes dual-eligible Medicare payments from the

- 29 -
definition of "costs incurred." Had the regulation been ambiguous

about whether the agency intended to adopt this policy, then

deferring to the preamble to resolve the ambiguity may have been

appropriate. But that is not the case. Nowhere in the regulatory

text does the Secretary mention Medicare payments or individuals

eligible for dual-coverage, nor does the text provide any other

hook -- beyond the terms also used in the statute -- to which the

Secretary can point to demonstrate ambiguity about whether the

Secretary intended to adopt the rule at issue. It is insufficient

that there may be ambiguity about what rule the agency would adopt,

given the choice. Where the agency is granted broad delegated

authority, but makes no overtures in the regulatory text about its

intention to adopt a policy pursuant to that authority, there is

no relevant ambiguity that can be resolved by the preamble.

Our conclusion that deference is inappropriate in this

circumstance is buttressed by what we see as strong policy

considerations. The Secretary concedes that both the statutory

and regulatory texts are silent on the operative question of

whether "costs incurred" includes Medicare payments and private

insurance payments. We have determined that this issue reflects

a substantive policy choice for which the APA requires notice and

comment. Thus, if deference to the preamble allowed the agency to

implement its dual-eligible policy, the agency would be able to

execute a substantive policy choice without notice and comment.

- 30 -
We find such a subversion of the APA's procedural requirements

unacceptable.

III.

Because we affirm the district court's decision on the

grounds that the Secretary's rule is procedurally improper for

having failed to observe the notice-and-comment procedures

prescribed by the APA, we decline to reach plaintiffs' substantive

challenge under 5 U.S.C. § 706(2)(C). In so doing, we neither

express nor imply any view on whether the agency can adopt the

policy articulated in the FAQs following notice-and-comment

rulemaking. Nor do we accept the plaintiffs' invitation to pass

judgment upon the validity of the 2017 regulation; that is a matter

for another day.

For the foregoing reasons, the district court's decision

is affirmed.

- 31 -