MONTGOMERY, Ala. (Legal Newsline) - A federal judge says the U.S. Government sidestepped formal rulemaking procedures when it crafted a new plan for claiming funds from state-filed Medicaid fraud lawsuits.

Former Alabama Attorney General Troy King alleged in 2008 that a letter sent to state health officials outlining new procedures amounted to a final agency action by the federal Centers for Medicare and Medicare Services. The problem, King said, is that the rule was finalized without the formal notice-and-comments period.

The letter, sent in October 2008, said CMS would begin claiming a percentage of civil penalties from settlements and verdicts. The federal government funds the majority of each state's Medicaid program and already asks for the corresponding percentage from funds designated as recovery for state Medicaid programs. In 2008, CMS provided 68 cents of every dollar Alabama spent on Medicaid.

Had U.S. District Judge Mark Fuller ruled that the letter was not a final agency action, then the federal government would have had sovereign immunity against the claim.

"The 'guidance' that the SHO letter conveys to states is much more like an implementation of the Medicaid Act than an interpretation," Fuller's ruling says. "As pointed out by the Court's thorough analysis of the substance of the SHO letter, there is hardly any linguistic connection between the legal duties created by the letter and the text of the statute.

"The defendants contend that even in the portions of the letter that do not quote or cite statutory language, 'it is clear from context that the agency is interpreting such a provision.' The Court disagrees with this contention.

"Additionally, the SHO letter creates new law. Contrary to the letter's assertion that 'the Act's broad mandate demands' the rules set out in the SHO letter, nothing in the text of the statute requires the rules that CMS chose."

Fuller vacated the letter, ruling that it will cause minimal disruption to CMS's administration of the Medicaid program.

"The narrow set of circumstances to which the SHO letter applies - suits filed by states to recover from fraud-and-abuse defendants - represents a very small part of the entire Medicaid scheme," he wrote.

"In the absence of the SHO letter, states will continue reporting predicted expenditures to (the Department of Health and Human Services) and HHS will continue to pay each state the federal share of Medicaid expenses."

The decision can have multi-million dollar consequences.

King, who was succeeded by new Attorney General Luther Strange, was trying to protect millions of dollars from lawsuits filed against 79 pharmaceutical companies in 2005. The State has taken in at least $89 million in settlements.

But the largest amounts he was defending came from jury awards. Three cases earned the State more than $270 million, but the state Supreme Court overturned all three.

And recently, CMS finalized its decision to take more than $18 million from a $49 million settlement reached in 2006 by Michigan Attorney General Mike Cox and Omnicare.

That decision may have cemented the plaintiffs' argument. CMS wrote that its decision to take the money was "consistent with" the policy implemented in the letter. Cox, who is no longer in office after a failed attempt at governor, had filed an amicus brief in King's case.

"Among other things, CMS's reconsideration decision indicates that CMS is continuing to enforce the requirements of the SHO letter as they are written and that states who disobey the SHO letter's requirements do so at their own peril," King's attorneys wrote.

Approximately one-third of the settlement reflected recovery of Medicaid funds, while the rest was classified a civil penalty. Cox contended that he had already paid CMS its proper share of the settlement.

New Michigan Attorney General Bill Schuette can appeal the decision by taking the issue to the Departmental Appeals Board.

If the DAB upholds the disallowance, then Schuette could take the issue to federal court. West Virginia Attorney General Darrell McGraw has filed two such lawsuits against CMS.

McGraw and CMS are arguing over CMS's decision to claim a percentage of funds obtained by McGraw in a 2004 settlement with Dey, LP. McGraw is appealing a district judge's determination that CMS is right to withhold nearly $450,000 from its next appropriation of Medicaid funds to the State.

CMS noted that McGraw and the private attorneys he hired to represent the State estimated that Dey LP, the defendant in the case, caused more than $950,000 of damage to the state Medicaid program. Dey settled for $850,000.

"West Virginia did not reimburse HHS for the federal share of its Medicaid overpayments or inform HHS of its settlement with Dey," the federal government's attorneys wrote in the brief.

"Instead, the State gave $750,000 to (the Public Employees Insurance Agency) - i.e., roughly five times the State's own damages estimate for PEIA - and gave the remaining $100,000 to the Consumer Protection Fund of the West Virginia Attorney General's Office."

That case, currently awaiting a May hearing before the U.S. Court of Appeals for the Fourth Circuit, will have a direct influence on a nearly identical case involving a $2.7 million withhold stemming from McGraw's 2004 $10 million settlement with OxyContin-maker Purdue Pharma.

From Legal Newsline: Reach John O'Brien by e-mail at

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