The Fourth Circuit Raises the Bar for Proving Scienter Under the False Claims Act

Client Alert

The author would like to thank Bob Fabrikant, Frank LaPallo, and Sirena Castillo for their contributions to this alert.

On January 25, 2022, the U.S. Court of Appeals for the Fourth Circuit issued an important opinion for companies trying to navigate the complex statutory scheme in heavily regulated areas like Medicare and Medicaid. In United States ex rel. Sheldon v. Allergan Sales, LLC, the Fourth Circuit held that companies in such industries should not be penalized under the False Claims Act (FCA) for adopting “objectively reasonable” interpretations of complex statutes and regulations when the relevant agency has not issued any “authoritative guidance” to the contrary or discouraged companies from adopting such interpretations. In affirming the dismissal of a qui tam relator’s complaint, the court more broadly clarified the standard for proving knowledge (or scienter) under the FCA, which should apply equally to actions brought by either relators or the government itself. The court emphasized that “[i]f the government wants to hold people liable for violating labyrinthine reporting requirements, it at least needs to indicate a way through the maze.” If the government fails to do so, then companies should not be held liable under the FCA for acting reasonably under the circumstances.

This consequential decision is reviewed in more detail below.

The Case

In Allergan Sales, the Fourth Circuit dismissed the relator’s FCA claim that a manufacturer had knowingly violated the Medicaid Drug Rebate Statute by failing to aggregate discounts for purposes of reporting “Best Price.” The court found that the manufacturer’s reading of the statute “was at the very least objectively reasonable and because [the manufacturer] was not warned away from that reading by authoritative guidance, it did not act ‘knowingly’ under the [FCA].” The appeals court relied on the district court judge’s “sound counsel that the Rebate Statute’s ‘plain and natural reading’ did not require aggregating discounts, along with her sensible conclusion that there was not ‘a single example where CMS explicitly state[d] that manufacturers must aggregate discounts to different customers along the supply chain in a given sale.’” Heeding the Supreme Court’s instruction in Universal Health Servs., Inc. v. United States ex rel. Escobar, which requires “‘strict enforcement’ of the FCA’s ‘rigorous’ scienter requirement,” the court refused to allow FCA liability (even under the “reckless disregard” standard) where “CMS never clearly stated” that the manufacturer’s “objectively reasonable” interpretation of the Rebate Statute was incorrect.

In joining with a number of other circuit courts that had reached similar decisions, the Fourth Circuit found it “profoundly troubling” that—without this rule—individuals or companies might face “massive liability [under the FCA] ... without any proper notice as to what is required.” The court found that its standard “avoids this trouble by making the government ‘provide a reasonably clear standard of culpability to circumscribe the discretion of the enforcing authority and its agents.’” But if the government fails to issue such “authoritative guidance,” then a company “cannot act ‘knowingly’ [under the FCA] if it bases its actions on an objectively reasonable interpretation of the relevant statute.”

The court further made it clear that agencies, like CMS, cannot purposefully keep their regulations ambiguous to obtain flexibility in enforcement decisions. The court noted that “CMS may not wish to specify its position on [an] issue” because “[c]lear regulations constrain regulatory power and limit future flexibility, which is why an agency might find them undesirable.” But the court flatly rejected this approach of post hoc regulation through the FCA:

“Retaining ambiguity in order to expand potential liability for regulated entities cannot pass muster. In a world where the administrative state ‘wields vast power and touches almost every aspect of daily life,’ … allowing agencies to take advantage of companies like this would not be right.”

Why It Matters

This case provides an important tool for companies facing potential FCA claims based on interpretations of Medicare or Medicaid regulations that are beyond the plain language of the statute or regulation in question. The Fourth Circuit made it clear that defendants “must be put on notice before facing liability for allegedly failing to comply with complex legal requirements” and noted that any other holding could be a violation of due process. In doing so, the court strongly criticized FCA enforcement actions (whether by qui tam relators or the government) that seek to expand the scope of generic or ambiguous statutes beyond the specific agency guidance currently in existence. While emphasizing that a company’s statutory interpretation must be reasonable, the court concluded that government regulation should be done by agencies in advance, not through after-the-fact enforcement actions under the FCA.

This holding is an important one to consider when assessing how to handle an FCA investigation or lawsuit. If a company is facing expansive allegations seeking to penalize a reasonable interpretation of an ambiguous statute, it may have important defenses to such overreach. The company should consider all of its options, in conjunction with experienced counsel, to make sure that it is protected.

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