1. INTRODUCTION

Recently there have been significant developments in the federal government’s nationwide investigation of Columbia/HCA’s alleged submission of false claims to Medicare and other government health programs including the unsealing of the complaint in the Federal False Claims Act ("FCA") suit and the filing of an answer in the related Internal Revenue Service ("IRS") tax dispute. This memorandum addresses both matters.

On October 1, 1998, the U.S. Department of Justice announced it had joined the civil false claims action against Hospital Corporation of America ("HCA") successors Columbia/HCA Healthcare Corp. ("Columbia") and Quorum Health Group ("Quorum"). On October 5, 1998, the United States District Court for the Middle District of Florida, Tampa Division, unsealed the complaint against Columbia and Quorum. James Alderson, former chief financial officer at North Valley Hospital in Whitefish, Montana, filed the qui tam false claims lawsuit under seal in 1993. The unsealing of the civil false claims complaint against the company provides additional insight into the government’s allegations of wrongful misconduct.

Specifically, the lawsuit alleges that since 1984, "[a]ware of the limited capacity of the Government and its intermediaries to delve deeply into their cost reports," the companies violated the Federal False Claims Act, 31 U.S.C. §§ 3729 et seq. as amended, by engaging in three abusive practices: (1) regularly preparing "reserve cost reports" which explicitly identify exaggerated and unallowable claims included in the filed cost reports, (2) setting aside funds to repay the federal government for the amount of overcharges included in the filed cost reports in the event the inflated figures were ever discovered, and (3) prohibiting the disclosure of the reserve papers to auditors. As a result, the complaint alleges that the United States and state Medicaid programs have been damaged in the amount of "many millions of dollars in Medicare, Medicaid and CHAMPUS funds." The allegations contained in the complaint are characterized as blatant efforts on the part of health care providers to engage in elaborate schemes to exaggerate their annual Medicare cost reports. In reality, however, many of the practices described are commonplace in the industry and traditionally have been considered legitimate reimbursement disputes, not fraudulent activity. Thus, the progress of this case may be of interest to all health care proprietors.

2. OVERVIEW: THE MECHANICS OF REIMBURSEMENT COST REPORTING

Because the Medicare reimbursement process is complex and often based on subjective rather than formulaic determinations, we will provide a brief overview of the mechanics of reimbursement and highlight areas of potential conflict. First, we will describe the method of computing reimbursable costs. Then, we will describe the procedure by which providers submit their cost reports and the resulting interplay between provider and Medicare intermediary as the cost reports are settled.

There are essentially three basic steps in the computation of reimbursable costs: (1) determining "allowable" costs by cost centers, (2) allocating overhead costs to revenue producing cost centers, and (3) calculating the portion of the total costs related to Medicare patients. In the first step, the provider must take costs from its own general ledger of cost centers of which there may be hundreds and consolidate them into approximately 60 cost centers specified in the Medicare cost report. The reported costs relate to all patients, including Medicare patients. Although there are certain shared understandings as to where costs should be reported, there is great variation among providers. In addition, while there are specific Medicare regulations and Provider Reimbursement Manual ("PRM") principles for certain costs, see PRM § 2100 et seq., many provider costs fall into categories for which there is no specific guidance but rather for which costs are paid according to the principle that only those which are "reasonable," "necessary, " and "related to the care of Medicare beneficiaries" are allowed. See 42 C.F.R. § 413.9. In this portion of the cost report, there are often conflicts over what is considered an allowable cost, how to define a cost center, and whether costs have been classified in the proper cost report cost centers.

The second step of the process is called "cost finding." For this undertaking, providers must allocate overhead or indirect costs to revenue-producing cost centers because Medicare determines its share of total costs only after the costs have been determined for each revenue-producing cost center. While most providers use the "single step-down" method of cost finding, providers may seek prior approval to use more complex methods for cost finding provided they support their alternative method with data demonstrating its greater accuracy or cost savings. PRM §§ 2231, 2312, 2313-2313.2. At this stage, there may be conflict regarding the bases of allocation for each overhead cost center, since providers that have obtained prior approval from their fiscal intermediary ("FI") can apply their own bases of allocation and ignore Medicare’s preferred bases of allocation. There also may be disputes over whether, and to what extent, overhead costs should be allocated to non-allowable costs.

In the third step, Medicare determines the portion of each cost center that is attributable to Medicare beneficiaries and, therefore, is reimbursable. This calculation is performed for each cost center independently using one method for "routine" cost centers (areas where patients are assigned a bed) and another method for "ancillary" cost centers (where volume of service may vary significantly from one patient to another). A provider’s own charges furnish the relevant apportionment statistics necessary to accurately gauge the utilization of services for Medicare patients relative to the total volume of services supplied by the department. Controversies may arise at this stage in apportioning the costs of ancillary cost centers and determining routine cost centers. There are some items such as bad debts that do not fit into the reimbursement formula and are calculated separately. As a final step, the provider undertakes a "settlement" calculation to determine whether it will receive money from or pay money to the Medicare program.

Providers are permitted to file cost reports under protest and treat the questionable amounts in a manner favorable to the provider as long as the provider identifies for the FI the nature and extent of the protested claims. Providers are also permitted to dispute regulatory and policy interpretations and must include the non-allowable item in the cost report in order to establish an appeal issue. However, providers that deliberately include non-reimbursable costs in the cost report without disclosing the fact that the regulations do not permit such costs may be subject to provisions concerning suspected fraud and abuse.

Since actual costs of services cannot be determined until the end of the accounting period, providers are paid at least monthly interim payments on an estimated cost basis during the year. These interim payments are based both on the number of Medicare-eligible patients the providers are treating and on the cost report data filed in the proceeding year. A provider will file a cost report with an FI five months after the end of the provider’s cost reporting period (usually one year).

Generally, within one month of receiving the cost report, the FI conducts a "desk review" in which the FI assures that the report is complete and the calculations are correct and identifies matters requiring further investigation on audit. If the filed cost report shows that the provider owes Medicare money, the provider must pay that amount when the report is filed. However, if the report shows an amount owed to the provider, the FI is not required to pay the full amount to the provider, although often the FI will make a tentative settlement and pay a certain percentage of the amount soon after completing the desk review. If the cost report is not settled after desk review, providers undergo a field audit. Prior to settling the cost report, the parties will meet in an "exit conference," and the FI will explain the proposed audit adjustments. At that meeting or soon thereafter, the provider usually will offer additional information or arguments in opposition to the proposed adjustments. Medicare does not collect interest on settlement adjustments; thus, a provider that receives reimbursement to which it is not entitled and then is required to repay that amount after adjustments by the FI, does so interest-free.

Next the FI issues a "Notice of Program Reimbursement" ("NPR") which contains the FI’s final determination and often is the notice from which an appeal to the Provider Reimbursement Review Board ("PRRB") is taken. Commonly, there is a delay of a couple of years from the end of the provider’s cost reporting period to the issuance of an NPR. Ultimately, if a provider is dissatisfied with the final decision at the administrative level, it may seek judicial review in federal district court.

3. ALLEGATIONS CONTAINED IN THE COLUMBIA COMPLAINT

Columbia is accused of violating the Federal Civil False Claims Act, 31 U.S.C. §§ 3729 et seq., as amended, for over a decade by submitting "false, exaggerated and/or ineligible" cost reports for reimbursement under Medicare, Medicaid, and the Civilian Health and Medical Program of the Uniformed Services ("CHAMPUS"). By engaging in the practice of underestimating the amounts of interim payments in program payments, deductibles, coinsurance, third party payor receipts, Medicaid amounts, and outpatient charges, the complaint charges that defendants reduced or eliminated funds due Medicare at the time of cost report submission. The complaint also asserts that because Medicare cost reports form the basis for reimbursement under state Medicaid and the CHAMPUS program, the providers’ false information on the Medicare cost reports "would generally cause false claims for reimbursement" on the Medicaid and CHAMPUS programs as well.

The allegations focus primarily on Columbia’s practice of keeping two sets of cost reports, one that it would submit to Medicare for reimbursement purposes containing the alleged exaggerated and unallowable claims and a second set containing a more conservative "worst case scenario" set of claims. The reserve cost reports allegedly contain analyses of the actual or estimated effect of the false claim on the provider’s Medicare/Medicaid reimbursement, which, according to the complaint, reveal knowledge of the fraudulent nature of the claims. In addition, the allegations claim Columbia set aside reserves (portions of which were amassed from interim payments received) for non-allowable items in case the submitted costs were rejected and repayment was expected. The allegations suggest, moreover, that if the intermediary accepted the amounts of interim payment submissions, the amount of the tentative settlement would be too high and the defendants would have use of Medicare funds interest-free until the final settlement of the cost report.

There are numerous allegations contained in the complaint. As such, we have provided a brief summary of the various claims of alleged wrongdoing including a description of appropriate reimbursement procedures followed by specific examples of the government’s allegations concerning Columbia’s fraudulent activities.

1. Capital Related Claims

Medicare regulations define capital costs to include: net depreciation expense, adjusted by gains and losses from the disposal of depreciable assets; leases and rentals; taxes on land and depreciable assets; costs of improvements; net capital interest offset by insurance on depreciable assets; and reasonable capital costs of related organizations. See 42 C.F.R. § 413.130. Medicare will pay its share of capital expenses called "allowable capital costs" including depreciation on capital assets. See id. at § 413.134. The complaint alleges:

• Defendants claimed costs as capital-related knowing that Medicare regulations require such expenses to be treated as operating expenses. On their reserve analyses and work papers, however, the defendants properly characterized the expenses as operating costs.
• Defendants claimed home office capital costs that were not allowable or exceeded amounts previously allowed by the FIs.
• Because of advantageous reimbursement treatment, defendants often designated capital costs as "old capital," knowing that the item was actually "new capital."

1. Interest Expenses

Interest expenses, such as bond discounts, expenses incurred in issuing bonds, and debt cancellation are allowable costs provided they are "necessary" (relate to a patient-related asset or was required to obtain working capital, and all available provider funds were expended before or concurrent with incurring the debt) and "proper" (incurred on a debt established with an unrelated party and the rate of interest is fair market value). 42 C.F. R. § 413.153. In some cases, costs must be amortized over the life of the loan rather than claimed in the year paid. The complaint claims that:

· Defendants shortened amortization periods, thereby overstating costs in the cost reporting periods.

· Defendants included borrowing costs for portions of bonds unrelated to patient care.

· Medicare regulations encourage providers to fund depreciation by setting aside money for the replacement of capital assets and require the earned interest to offset interest expenses. Despite the availability of depreciation funds, defendants "unnecessarily" borrowed money for equipment and claimed interest expenses.

· Healthtrust, one of the defendant companies, incurred substantial interest expenses on behalf of its individual hospitals in the process of purchasing back HCA’s interest in Healthtrust. Although Medicare regulations limit the reimbursable interest expenses to those allowable to the former owner, HCA, Healthtrust nevertheless claimed reimbursement for the full amount of newly incurred allowable interest expense.

2. Depreciation

Depreciable assets generally include buildings, building equipment, major movable equipment, land improvements, and leasehold improvements. The costs of capital assets are reimbursed during the years in which the assets are used rather than in a lump sum at the time such assets are purchased. "Annual depreciation" cost is the amount of costs attributable to the portion of an asset’s cost that is consumed during a particular accounting period. See PRM § 104 et seq. The complaint asserts that:

• For Medicare cost reporting, defendants calculated depreciation expenses using a formula that assigned shorter lives to assets than those specified in the American Hospital Association’s ("AHA") Useful Life Guidelines. For reserve reporting, defendants used the AHA guidelines, calculated the reimbursement differential between the two schedules, and reserved that amount.
• Defendants claimed depreciation costs which were unrelated to patient care such as a physician’s office building.

1. Non-Allowable Costs

Medicare regulations provide for the reimbursement of a provider’s reasonable costs that are defined as necessary and proper costs incurred in the furnishing of health services. Medicare will reimburse only the portion attributable to Medicare patients which is known as "allowable costs." 42 C.F.R. § 413.9. The government contends that Columbia abused these rules as follows:

• Defendants included the following non-allowable costs: (a) physician recruitment, dues, and membership costs; (b) advertising and marketing costs not associated with patient care; (c) space either unoccupied or being used for a non-reimbursable activity; (d) physician billing and costs associated with electronically linking physicians to hospitals; (e) property and franchise taxes; (f) television and telephone costs incurred for service to patients; and (g) non-allowance portions of cafeteria operations.
• Defendants provided improper documentation of emergency room stand-by fees.
• Defendants failed to report rebates and refunds that should have been applied to offset other allowable operating costs.

1. Non-Reimbursable Cost Centers

Indirect costs (general service costs) are costs necessary for facility operations that cannot be associated with the rendering of a particular service. Indirect costs can be allocated to both reimbursable cost centers and non-reimbursable cost centers, but costs in a non-reimbursable cost center may not be reduced by revenue generated by that cost center. See PRM §§ 2307, 2328. The government claims that:

• By reducing costs in a center by earned income from the cost center, defendants either significantly reduced costs in a non-reimbursable cost center or eliminated them completely.
• By failing to establish non-reimbursable cost centers on their as-filed cost reports for gift shops, catering, physician office building, guest meals, public relations and marketing, defendants increased their Medicare reimbursement for overhead costs.

1. Different Statistics

Only a certain percentage of indirect costs are allowable, and providers are required to maintain allocation statistics for the distribution of indirect costs (such as time and square footage) to areas utilizing those costs including statistics for non-allowable cost centers. Any changes in statistical bases for allocation must be explicitly approved prior to the beginning of a fiscal year. Non-allowable cost centers, to which general service costs apply, must be handled according to a "step-down" process. Revenue derived from non-allowable activities may not be offset against the non-allowable cost centers prior to or during the cost-finding process. See 42 C.F.R. § 413.24. The government maintains that the companies violated these requirements as follows:

• Instead of using an allocation statistic to step-down costs, defendants reclassified costs. For example, defendants reclassified costs from pharmacy to drugs charged to patients and costs from central supply to medical supplies charged to patients.
• Defendants used incorrect statistics for square footage allocation and nursing administration costs, or failed to include allocation statistics for the non-reimbursable cost center of physicians’ offices and adolescent programs under housekeeping cost claims.

• Defendants misreported the number of residents and beds for the indirect medical education reimbursement calculation.

1. Other Charges

The allegations contained in the complaint include a variety of other charges of fraudulent practices:

• Combining Departments: A cost center is a department or subunit with a common function for which direct and indirect cost are accumulated, allocated, and apportioned. Once identified and accounted for, each cost center must be reported separately on the cost report. Utilizing a computer program, defendants combined various departments to find maximum reimbursement opportunities despite their ability to treat departments separately. For example, they combined the cost centers of the CT scan or MRI with radiology, day surgery with operating rooms, and cafeteria with dietary. After filing the combinations on the cost report, they reserved the additional costs.

• Malpractice Insurance Costs: Medicare regulations specify the ratio by which costs of malpractice insurance premiums and malpractice self-insurance fund contributions should be attributed to Medicare patients. Defendants allegedly manipulated both the ratio and contributions and did not reduce allowable malpractice insurance costs by refunds or credits received for premiums.

• Part A Hours: Although lacking any documentation, defendants claimed reimbursement for administrative duties performed by physicians and reserved the amounts claimed.

• Inpatient/Outpatient Transfer: Certain services such as ambulance services are covered under Medicare Part B. If costs are reimbursed under Part B, they must be removed from a provider’s costs under Part A. Defendants transferred inpatient charges to the outpatient area of the cost report.
• Bad Debts: Bad debts are deductions from revenue and are not included as allowable costs except those arising from unpaid deductible and coinsurance amounts related to beneficiary care. Defendants claimed reimbursement for bad debt that did not meet Medicare qualifications. The criteria for allowable debt include: (1) bill remains unpaid for greater than 120 days, (2) provider undertakes a reasonable and customary attempt to collect, and (3) when using a collection agency, the provider refers all uncollected patient charges of like amount to the agency without regard to the class of patient. 42 C.F.R. § 413.80.

• Employee Stock Ownership Plans ("ESOP"): Providers may claim costs of non-statutory stock option or ownership plans as compensation expenses. Healthtrust claimed ESOP costs that had not been incurred.
• Hospital-Based Services: Home health agencies ("HHA") and skilled nursing facilities ("SNF") are reimbursed through the hospital cost report on the basis of costs subject to certain limits. Thus, it is advantageous to shift costs to hospital-based services. Defendants included non-allowable costs, thereby inflating costs allocated to HHAs and SNFs.

1. IRS TAX CLAIMS AGAINST COLUMBIA

The IRS has likewise taken an interest in Columbia’s practice of reserving funds for repayment to Medicare/Medicaid and is asserting that such reserved amounts should be included in taxable income. See Columbia/HCA Healthcare Corp. & Consol. Subsidiaries, No. 23906-97 (U.S.T.C. filed Dec. 11, 1997). The IRS determined that the reserves "represent cash that has been received without restriction as to its use or disposition and therefore, are required to be included in income pursuant to Internal Revenue Code Section 61 and 451."

It appears the IRS considers the reserves to represent amounts that Columbia already received for reimbursement of services based on preliminary estimates of proper reimbursable amounts and thus, despite the reserve for repayment, the full amount received should still be included in Columbia’s taxable income. In its initial complaint challenging the IRS’ treatment of the reserves, Columbia defended its practice by stating that the reserves "represent amounts that were unbilled and will never be billed because these amounts were in excess of the predetermined fee for particular diagnoses related groups." In the alternative, Columbia asserted that the reserves "represent amounts received . . . that may be returned to Medicare/Medicaid pursuant to specific legal and contractual requirements, without any subsequent performance or consideration required from or on behalf of Medicare/Medicaid."

In answering Columbia’s complaint, the IRS admitted only that Columbia "maintains a series of accounts relating to federal health care reimbursement programs which appear to incorporate a calculation of properly reimbursable costs for patients with respect to whom petitioner has received prospective payment from the United States." The IRS outright denied, or denied for lack of knowledge, the defenses provided by Columbia. See Respondent Answer, Columbia/HCA, No. 23906-97 (U.S.T.C. filed Feb. 17, 1998). Because Columbia’s practice of reserving costs without including them in taxable income is believed to be consistent with the manner in which many in the industry treat such costs, the progress of this case should be followed closely.

2. CONCLUSION

There is nothing illegal or improper about submitting a cost report in a manner that will produce the greatest payment as long as the provider adheres to Medicare reimbursement regulations. In fact, utilizing computer programs which simulate the operation of the cost reporting process, providers often experiment with the effects of different reporting options, including classifying general ledger costs in a variety of cost centers, allocating indirect costs to different non-reimbursable cost centers, changing the order of cost centers, and altering the statistical bases of allocation. Equally as important, the regulations do not prohibit providers from submitting items for reimbursement if they in good faith believe there are no provisions to the contrary. Medicare cost reporting is not an exact science, and it is not unusual for there to be some give and take between the FIs and the providers as both parties attempt to interpret and understand reimbursement parameters.

Even the courts have acknowledged the complex intricacies involved with Medicare’s system. For example, in a case addressing the amount of the Medicare copayment for which a state is responsible under the Medicare buy-in provisions, the Fourth Circuit opined:

Rehabilitation Ass’n of V.A. v. Kozlowski, 42 F.3d 1444, 1450 (4^th Cir. 1994). Based upon the allegations contained in the complaint, it appears that many of Columbia’s alleged improper submissions represent issues of a highly technical nature where reasonable minds have, and may continue to, differ.

Even the executive branch of the government has acknowledged need for additional guidance on the treatment of certain costs because of the imprecise nature of cost reporting and the potential for mistaken inclusion of non-allowable costs. In a General Accounting Office ("GAO") report to the Secretary of Health and Human Services entitled "MEDICARE Better Guidance is Needed to Preclude Inappropriate General and Administrative Charges," the GAO found:

GAO Report No. GAO/NSAID-94-13 (October 1993).

This tangled web of regulations coupled with the nonexistence of necessary guidance on cost allocation suggests that, at least in some instances, however, that Columbia may lack the requisite intent needed to sustain a conviction under the FCA. In order to establish liability under the FCA, 31 U.S.C. §§ 3729, et seq., a plaintiff bears the burden of showing: a) that the defendant submitted or caused the submission of a claim to the federal government; b) that the claim was false or fraudulent, or the defendant made or used false or fraudulent records or statements to obtain the claim’s payment or approval; and c) that the defendant either had actual knowledge of the claim’s falsity or acted in reckless disregard of the claim’s validity. U.S. v. Abbott Washroom Systems, Inc., 49 F.3d 619, 624 (10^th Cir. 1995). The scienter element requires that a defendant act in "reckless disregard" or "deliberate ignorance" of the validity of a claim, and it is