WASHNGTON (Legal Newsline) - The federal government plans to withhold nearly a half-million dollars the next time it doles out Medicaid funding to the State of West Virginia as a result of a settlement engineered by state Attorney General Darrell McGraw.

The Department of Health and Human Services recently decided that the federal Centers for Medicare and Medicaid Services was entitled to $446,607 of McGraw's 2004 settlement with pharmaceuticals manufacturer Dey, Inc.

That case, which alleged the company improperly inflated the cost of its drugs and ripped off the state's Medicaid program (largely funded by the federal government), resulted in an $850,000 settlement. That money went to McGraw's Consumer Protection Fund and three state agencies.

The major questions to be answered in the appeal, the DHHS appeals board said, were if the CMS is allowed to withhold funding and if the CMS calculated the amount correctly.

"In this decision, we conclude that the federal government was entitled to a share of the Dey settlement proceeds," says the May 26 decision, reached by a three-person panel.

"We also conclude that CMS had an appropriate basis for determining that the federal government's proper share of the settlement proceeds was 67.2084 percent."

The settlement also provided an extra $250,000 for attorneys fees. In 2003, the State estimated the damages to its Medicaid program by Dey's alleged actions was approximately $1.4 million.

"Because CMS's allocation rests on the State's own damages estimate in preparation for litigation, an estimate that in turn was based on a substantial volume of claims and reimbursement data supplied by the affected programs, and because there is no indication in the memorandum and spreadsheets that the estimates were seriously flawed or substantially overstated the alleged relative loss to Medicaid, we conclude that a reasonable basis exists for CMS to allocate approximately 67 percent of the Dey settlement proceeds to Medicaid," the decision says.

Dey is a U.S. affiliate of Merck KGaA, which is based in Germany. McGraw had claimed it submitted inflated average wholesale prices to organizations that pass them on to State agencies.

"Prices of prescription drugs are too high," McGraw said when he announced the settlement. "The State cannot continue to pay inflated prices for drugs which our citizens need.

"This settlement will help relieve the State's budgetary burden."

In 2007, the CMS decided to withhold $634,525 from its next appropriation because of the settlement.

McGraw's other controversial settlement is 2004's $10 million agreement with Purdue Pharma, manufacturer of the prescription painkiller OxyContin.

He has used the money on substance abuse programs around the state, as well $500,000 to the University of Charleston for a pharmacy school.

Chief Deputy Attorney General Fran Hughes admitted to the Legislature that the money was not given to the state's Department of Health and Human Resources, which administers the Medicaid program, because CMS would then be able to claim a share -- "We have arranged a methodology that has prevented the federal government from coming back and seizing money," Hughes said.

Hughes formerly served as general counsel for a national consulting firm that specialized in Medicaid financing.

Private practice attorneys hired by McGraw to represent the State earned $3.4 million in the settlement. CMS arrived at a total withholding of $4,143,075 million by taking 74.65 percent (the rate of federal payment to the state for every dollar spent) out of $5.5 million of the settlement.

That $5.5 million represents what the CMS feels should have been the equitable distribution of the settlement dollars among the three plaintiffs (the DHHR, the Public Employees Insurance Agency and the Bureau of Employment Programs) with respect to certain allegations involving Medicaid dollars.

McGraw's office is representing the DHHR in its appeal of that decision. The federal DHHS appeals board determined a year ago that CMS was planning to withhold too much.

From Legal Newsline: Reach John O'Brien by e-mail at john@legalnewsline.com.