Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca8-05-04372/USCOURTS-ca8-05-04372-0/pdf.json

Nature of Suit Code: 890
Nature of Suit: Other Statutory Actions
Cause of Action: 

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United States Court of Appeals

FOR THE EIGHTH CIRCUIT

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No. 05-4372

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Baptist Health, doing business as

Baptist Memorial Medical

Center-North Little Rock,

Appellant,

v.

Tommy G. Thompson, in his

official capacity as Secretary,

United States Department of

Health and Human Services,

Appellee.

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Appeal from the United States

District Court for the

Eastern District of Arkansas.

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Submitted: June 12, 2006

 Filed: August 15, 2006 (Corrected on: 10/27/06)

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Before SMITH, HEANEY and GRUENDER, Circuit Judges. 

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GRUENDER, Circuit Judge.

Baptist Memorial Medical Center-North Little Rock (“Baptist Memorial”)

challenges a decision by the Secretary of the Department of Health and Human

Services (“HHS”) denying, for Medicare reimbursement purposes, “approved

educational activity” status for classroom costs incurred by Baptist Memorial in

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The Honorable William R. Wilson, Jr., United States District Judge for the

Eastern District of Arkansas.

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connection with its affiliation with a nursing school. The district court1

 upheld the

Secretary’s decision. For the reasons discussed below, we affirm.

I. BACKGROUND

HHS administers the Medicare program, 42 U.S.C. § 1395 et seq., through its

component Centers for Medicare and Medicaid Services (“CMS”). The Secretary

contracts with fiscal intermediaries, such as Blue Cross/Blue Shield in the instant

case, to audit the costs submitted by Medicare provider hospitals and approve or

disapprove Medicare reimbursement. See 42 U.S.C. § 1395h; 42 C.F.R. § 405.902

(defining fiscal intermediary). A provider hospital may appeal the reimbursement

decision of the fiscal intermediary to HHS’s Provider Reimbursement Review Board

(“PRRB”). 42 U.S.C. § 1395oo. The PRRB’s decision becomes the final decision

of the agency unless the Secretary, on his own motion, decides to affirm, reverse or

modify the decision. Id. § 1395oo(f)(1). 

Prior to 1983, all Medicare-eligible costs incurred by a provider hospital were

reimbursed on a “reasonable cost” basis—essentially, each hospital’s actual costs

incurred were reimbursed dollar-for-dollar so long as the Secretary found the costs

reasonable. See 42 U.S.C. § 1395f(b). In Title VI of the Social Security

Amendments of 1983, Pub. L. 98-21, 97 Stat. 65 (1983) (“PPS legislation”), Congress

established the Prospective Payment System (“PPS”) as an incentive for hospitals to

reduce costs and operate more efficiently. See H.R. Rep. No. 98-25, at 132 (1983),

reprinted in 1983 U.S.C.C.A.N. 219, 351. Under PPS, a provider hospital receives

Medicare reimbursement at a flat rate for each patient based on the patient’s category

of treatment. Id.; 42 U.S.C. § 1395ww(d).

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The Secretary later promulgated a new version of the regulation which

expressly includes the requirement of direct operation by the hospital. See 42 C.F.R.

§ 413.85(c)(1), (f) (2001). This version became final in 2001 and is therefore

inapplicable to the instant case. The Secretary made the change to “clarify” the

previous version of the regulation at issue here. 66 Fed. Reg. 3358, 3361 (Jan. 12,

2001).

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Congress exempted a few costs from PPS, allowing continued reasonable-cost

Medicare reimbursement under § 1395f(b) (“pass-through treatment”) for, among

other things, “approved educational activities.” 42 U.S.C. § 1395ww(a)(4). Congress

did not define “approved educational activities” in the statute. The Secretary

published a regulation stating that approved educational activities included neither

“[c]linical training of students not enrolled in an approved education program

operated by the provider,” 42 C.F.R. § 413.85(d)(6) (1986) (emphasis added), nor

“[o]ther activities that do not involve the actual operation of an approved education

program,” id. § 413.85(d)(7). During the notice-and-comment phase of the

regulation’s publication, the Secretary elaborated that “only the costs of those

approved medical education programs operated directly by a hospital [are] excluded

from [PPS].” 49 Fed. Reg. 234, 267 (Jan. 3, 1984) (emphasis added).2

In addition to costs for programs that would qualify as approved educational

activities under 42 C.F.R. § 413.85, Congress established pass-through treatment for

another category of educational-activity costs borne by provider hospitals in § 6205

of the Omnibus Budget Reconciliation Act of 1989 (“OBRA 1989”), Pub. L. 101-239,

103 Stat. 2106 (1989), extended in § 4004(b) of the Omnibus Budget Reconciliation

Act of 1990 (“OBRA 1990”), Pub. L. 101-508, 104 Stat. 1388 (1990). This passthrough treatment category includes only the costs of clinical nursing school

programs conducted on the premises of, but not necessarily directly operated by, a

provider hospital so long as certain conditions specified in OBRA 1990 are met. 

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Baptist Memorial asserts that PPS reimbursement for educational activities is

actually no reimbursement at all because a provider hospital with educational

activities not qualifying for pass-through treatment would receive the same flat-rate

PPS payment as an identical provider hospital with no educational activities

whatsoever. In making this assertion, Baptist Memorial apparently assumes that such

educational activities would have no financially beneficial indirect effects on the

operation of the hospital. The record on this issue is not sufficient to allow us to

determine whether the assumption is a valid one, and in any event resolution of the

issue would have no effect on the outcome of this appeal.

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In short, educational activities at a provider hospital that do not qualify for

pass-through treatment under either 42 C.F.R. § 413.85 or OBRA 1990 are

reimbursed as part of the flat-rate PPS payment for the hospital’s normal operating

costs. Pass-through treatment for educational activities is financially desirable for the

provider hospital because the PPS payment for normal operating costs essentially

depends only upon the number of patients discharged and their diagnoses, and does

not directly compensate the costs of educational activities.3

Baptist Memorial is owned and operated by Baptist Health, Inc., a non-profit

corporation that also owned and operated three other Medicare-provider hospitals

from 1991 to 1994. Baptist Health also owned and operated Baptist School of

Nursing (“Nursing School”) during that time. The four hospitals and the Nursing

School were not separate subsidiary corporations but were each operated as separate

business units and maintained separate bookkeeping. Each hospital had its own

Medicare provider number, but Baptist Health was the legal entity that contracted for

the numbers.

After the institution of the PPS system, Baptist Health allocated the costs of the

Nursing School among its four hospitals. Each hospital then characterized its share

of those costs as “approved educational activities” and received pass-through

reimbursement. In 1990, however, the regional CMS office notified the hospitals’

fiscal intermediary that the Nursing School costs were not eligible for pass-through

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treatment because the provider hospitals did not operate the Nursing School. In

response, in 1991 Baptist Health moved all Nursing School costs to the books of

Baptist Medical Center, its hospital in Little Rock, Arkansas. An allocation of a

portion of the Nursing School costs was made from Baptist Medical Center’s books

to other Baptist Health hospitals, including Baptist Memorial, based on the amount

of time nursing students spent at each institution. Baptist Memorial and the Nursing

School executed a Memorandum of Agreement outlining the responsibilities of

Baptist Memorial to support the school.

From 1991 to 1994 Baptist Memorial submitted its Nursing School costs for

pass-through treatment, but the fiscal intermediary denied reasonable-cost

reimbursement. On administrative appeal, the PRRB reversed, finding that the costs

qualified for pass-through treatment as an “approved educational activity” because

Baptist Memorial “was engaged in, to a significant extent, the operation of the

nursing education program.” The Administrator of CMS, acting under the authority

of the Secretary, vacated the PRRB’s decision because Baptist Memorial did not

directly operate the Nursing School. However, the Administrator remanded to the

PRRB for a determination of whether any of the nursing school costs were qualified

clinical costs under OBRA 1990. On remand, the PRRB approved all submitted

clinical costs for pass-through treatment under OBRA 1990 and also reinstated its

already rejected finding that the non-clinical, or classroom, costs were eligible for

pass-through treatment as an “approved educational activity.” The Administrator

affirmed that the clinical costs were eligible for pass-through treatment under OBRA

1990 but reversed again on the classroom costs because Baptist Memorial did not

directly operate the Nursing School.

Baptist Memorial sued for review of the agency’s decision in federal district

court. The district court affirmed the Administrator’s decision, relying on the D.C.

Circuit’s resolution of a similar dispute in Community Care Foundation v. Thompson,

318 F.3d 219 (D.C. Cir. 2003). Baptist Memorial now appeals the denial of passAppellate Case: 05-4372 Page: 5 Date Filed: 08/15/2006 Entry ID: 2078393
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through treatment for the classroom costs associated with the Nursing School, arguing

that the “direct operation” requirement is not a permissible interpretation of the

statute and that it conflicts with the Secretary’s prior interpretation. Baptist Memorial

also argues that, even under the direct-operation standard, its affiliation with the

Nursing School qualified as an “approved educational activity.”

II. DISCUSSION

The final decision of the Secretary is reviewed under the Administrative

Procedure Act (“APA”), 5 U.S.C. § 701 et seq. 42 U.S.C. § 1395oo(f)(1)

(incorporating the APA standard of review). “Under the APA, the Secretary’s

decision is ‘set aside if it is arbitrary, capricious, an abuse of discretion, unsupported

by substantial evidence, or contrary to law.’” St. Luke’s Methodist Hosp. v.

Thompson, 315 F.3d 984, 987 (8th Cir. 2003) (quoting Hennepin County Med. Ctr.

v. Shalala, 81 F.3d 743, 748 (8th Cir.1996)); see also 5 U.S.C. § 706(2)(A), (E). “We

review the district court’s decision de novo, making our own independent review of

the Secretary’s decision under the APA.” Shalala v. St. Paul-Ramsey Med. Ctr., 50

F.3d 522, 527 (8th Cir. 1995). 

A. The Secretary’s Interpretation of the Statute

Baptist Memorial argues that it is arbitrary and capricious for the Secretary to

interpret the statutory language “approved educational activity” to include a

requirement that the provider hospital directly operate the educational program. The

Chevron test determines whether the Secretary’s rule is a permissible interpretation

of the statute:

[W]e ask first whether “the intent of Congress is clear” as to “the precise

question at issue.” If, by “employing traditional tools of statutory

construction,” we determine that Congress’ intent is clear, “that is the

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end of the matter.” But “if the statute is silent or ambiguous with

respect to the specific issue, the question for the court is whether the

agency’s answer is based on a permissible construction of the statute.”

If the agency’s reading fills a gap or defines a term in a reasonable way

in light of the Legislature’s design, we give that reading controlling

weight, even if it is not the answer “the court would have reached if the

question initially had arisen in a judicial proceeding.”

Regions Hosp. v. Shalala, 522 U.S. 448, 457 (1998) (citations omitted) (quoting

Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842, 843 & n.9,

n.11 (1984)). 

Under step one of the Chevron analysis, we determine whether the statute

makes clear the intent of Congress as to the meaning of the term “approved

educational activities.” The statute does not expressly define the term, but Baptist

Memorial contends that Congress implicitly adopted an existing definition from a

pre-PPS Medicare regulation. The term “approved educational activities” was

defined in Medicare regulations in 1966 as “formally organized or planned programs

of study usually engaged in by providers in order to enhance the quality of patient

care in an institution.” 20 C.F.R. § 405.421 (1966). Prior to the establishment of the

PPS system in 1983, the Secretary adopted the holding of a Seventh Circuit case, St.

John’s Hickey Memorial Hospital, Inc. v. Califano, 599 F.2d 803, 808-09 (7th Cir.

1979), which interpreted the regulation to mean that a provider hospital need only be

“engaged in,” rather than the “legal operator” of, an educational program for the

program to meet the regulatory definition of an “approved educational activity.”

In support of its argument that Congress intended to incorporate the definition

of “approved educational activities” from 20 C.F.R. § 405.421 (1966) into the 1983

PPS legislation, Baptist Memorial cites Toyota Motor Manufacturing, Kentucky, Inc.

v. Williams, 534 U.S. 184 (2002), and Bragdon v. Abbott, 524 U.S. 624 (1998), for

the proposition that “Congress’ repetition of a well-established term carries the

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The ADA defined “disability” as:

(A) a physical or mental impairment that substantially limits one or more

of the major life activities of such individual;

(B) a record of such an impairment; or

(C) being regarded as having such an impairment.

42 U.S.C. § 12102(2).

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implication that Congress intended the term to be construed in accordance with

pre-existing regulatory interpretations.” Bragdon, 524 U.S. at 631; see also Toyota

Motor, 534 U.S. at 193-94. The relevant issue in both Toyota Motor and Bragdon

was the interpretation of the definition of “disability” provided in the Americans with

Disabilities Act of 1990 (“ADA”). The Supreme Court noted that the detailed, threepart definition4

 provided in the ADA was drawn “almost verbatim” from the

definition of “handicapped individual” in the earlier Rehabilitation Act of 1973, 29

U.S.C. § 706(8)(B), and the definition of “handicap” contained in the Fair Housing

Amendments Act of 1988, 42 U.S.C. § 3602(h)(1). Bragdon, 524 U.S. at 631; see

also Toyota Motor, 534 U.S. at 193. In addition, the Court noted that the ADA

expressly stated, “Except as otherwise provided in this chapter, nothing in this

chapter shall be construed to apply a lesser standard than the standards applied under

title V of the Rehabilitation Act of 1973 (29 U.S.C. 790 et seq.) or the regulations

issued by Federal agencies pursuant to such title.” Toyota Motor, 534 U.S. at 194

(quoting 42 U.S.C. § 12201(a)); Bragdon, 524 U.S. at 631-32 (quoting 42 U.S.C. §

12201(a)). Based on the adoption of identical, detailed language from the earlier

statutes and the express reference to the standards set by one of the earlier statutes

and its associated regulations, the Court found that the regulations associated with the

earlier statute were appropriate sources of guidance for interpreting the terms of the

definition in the ADA. Toyota Motor, 534 U.S. at 193-94; Bragdon, 524 U.S. at 632.

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Baptist Memorial also echoes an argument made, and rejected, in Community

Care that a lone comment in the legislative history of the PPS legislation proves

unambiguously that Congress meant to incorporate the earlier regulatory definition.

See H.R. Rep. No. 98-25 at 140 (1983), reprinted in 1983 U.S.C.C.A.N. 219, 359

(stating that “approved education programs (as defined in current regulation,

including nursing education programs) would continue to be paid on the basis of

reasonable cost”). However, as the D.C. Circuit aptly noted in regard to this

argument, “reviewing legislative history is like ‘looking over a crowd and picking out

your friends,’” and one “friend” in a crowd as large as this one is insufficient to

demonstrate unambiguous Congressional intent. Cmty. Care, 318 F.3d at 226

(quoting Wald, Some Observations on the Use of Legislative History in the 1981

Supreme Court Term, 68 Iowa L. Rev. 195, 214 (1983) (quoting Leventhal, J.)).

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Toyota Motor and Bragdon do not support the proposition that Congress

implicitly intended to incorporate the definition of “approved educational activities”

from 20 C.F.R. § 405.421 (1966) into the PPS statutory scheme. First, the ADA

adopted an entire three-part, 33-word definition from the relevant earlier statutes, not

just a single term; in contrast, the PPS legislation used only the term “approved

educational activities” and conspicuously failed to incorporate the associated 24-word

definition provided in the earlier regulation. Second, the ADA adopted the definition

from earlier statutes, not merely from an agency’s regulatory definition, as Baptist

Memorial suggests happened in this case. Finally, the ADA expressly referenced the

standards developed from the applicable earlier statute and its associated regulations;

the PPS legislation does not do so. Under these circumstances, we cannot find any

Congressional intent to incorporate the definition of “approved educational activities”

from 20 C.F.R. § 405.421 (1966), as elaborated upon in St. John’s Hickey and its

progeny, into the 1983 PPS legislation. Instead, we agree with the D.C. Circuit that

Congress, by its silence, left the definition of “approved educational activities” to the

Secretary. Accord Cmty. Care, 318 F.3d at 225.5

We now proceed to step two of the Chevron analysis and determine “whether

the agency’s [definition] is based on a permissible construction of the statute.”

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Regions Hosp., 522 U.S. at 457 (quotation omitted). In proposing the regulation at

issue here, the Secretary described why the definition of the “approved educational

activities” made eligible for pass-through treatment in the PPS legislation was

important to the policy goals of that legislation:

We are also amending [20 C.F.R.] § 405.421 [later 42 C.F.R. § 413.85

(1986)] to clarify the definition of allowable costs for medical education,

because certain medical education costs are excluded from payment

under [PPS]. This was not necessary before, since all the costs were

reimbursed on the same reasonable cost basis. However, under [PPS],

failure to properly define those medical education costs, for which

payment in addition to prospective payments is permitted, could result

in unnecessary and inappropriate payments.

48 Fed. Reg. 39752, 39803 (Sep. 1, 1983).

Later, in response to comments on the proposed new regulation, the Secretary

explained why a requirement of direct operation of the educational program by the

provider hospital was necessary to implement Congress’ Medicare goals: 

Comment – A number of comments were received concerning whether

the pass through of direct education costs is limited to only the costs of

those approved medical education programs that a hospital directly

operates itself. If this is the case, commenters were concerned that

certain costs, such as the costs of clinical training for students enrolled

in programs other than at the hospital, may not be excluded from the

prospective payment system, but rather are considered to be normal

operating costs.

Response – We believe that only the costs of those approved medical

education programs operated directly by a hospital be excluded from the

prospective payment system. If a program is operated by another

institution, such as a nearby college or university, [it] must be noted that

by far the majority of the costs of that program are borne by that other

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Baptist Memorial argues that the specific reference to “clinical training”

indicates that the direct-operation requirement was only intended to apply to clinical

costs, not classroom costs. However, the reference to “clinical training” occurs in

response to some specific concerns raised by commenters. The first sentence of the

response indicates that the regulation requires that all “approved medical education

programs,” not just clinical training programs, be “operated directly by a hospital.”

49 Fed. Reg. 234, 267 (Jan. 3, 1984).

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institution, and not by the hospital. While it is true that the hospital may

incur some costs associated with its provision of clinical training to

students enrolled in a nearby institution, the hospital also gains in return.

For example, it obtains the services of the trainee (often at no direct cost

to itself). We do not believe that this type of relationship was what

Congress intended when it provided for a pass through of the costs of

approved medical education programs. Rather, we believe that

Congress was concerned with those programs that a hospital operates

itself, and for which it incurs substantial direct costs.

We are revising § 405.421(d)(6) [later 42 C.F.R. § 413.85(d)(6) (1986)]

to clarify that the costs of clinical training for students enrolled in

programs, other than at the hospital, are normal operating costs.

49 Fed. Reg. 234, 267 (Jan. 3, 1984).6

The Secretary’s explanation of why a direct-operation requirement for

“approved educational activities” was necessary to implement Congress’ goals for the

PPS legislation is eminently “reasonable . . . in light of the Legislature’s design.”

Regions Hosp., 522 U.S. at 457. Therefore, we hold that the Secretary’s rule is a

permissible interpretation of the statute.

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The three PRRB decisions are St. Mary’s Med. Ctr. v. Blue Cross/Blue Shield,

PRRB No. 97-D82 (July 15, 1997); Barberton Citizens Hosp. v. Blue Cross/Blue

Shield, PRRB No. 94-D61 (July 28, 1994); and St. Ann’s Hosp. v. Blue Cross/Blue

Shield, PRRB No. 93-D61 (July 21, 1993).

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As a corollary, Baptist Memorial argues that the change in position violates

Medicare rule-change procedures in 42 U.S.C. § 1395hh(a)(2) (“No rule, requirement,

or other statement of policy . . . that establishes or changes a substantive legal

standard governing . . . payment for services . . . shall take effect unless it is

promulgated by the Secretary by regulation . . . .”). However, we agree with the

courts that have held that this provision imposes no standards greater than those

established by the APA. See, e.g., Erringer v. Thompson, 371 F.3d 625, 633 (9th Cir.

2004) (rejecting an argument that § 1395hh(a)(2) “creates a requirement for

promulgation by regulation broader than that of the APA”). Therefore, our analysis

under the APA applies also to Baptist Memorial’s § 1395hh(a)(2) argument.

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B. The PRRB’s Conflicting Prior Interpretations

In three decisions7

 announced between 1993 and 1997, involving cost years

from 1987 to 1989, the PRRB analyzed “approved educational activities” under the

St. John’s Hickey “engaged in” standard, rather than the more strict direct-operation

standard originally associated with 42 C.F.R. § 413.85(d)(6) (1986). The Secretary

declined review of those decisions. Baptist Memorial argues that it is arbitrary and

capricious for the Secretary now to change his interpretation and apply the directoperation standard in this case.8

 We disagree.

When we evaluate an agency’s change of position,

the mere fact that an agency interpretation contradicts a prior agency

position is not fatal. Sudden and unexplained change or change that

does not take account of legitimate reliance on prior interpretation may

be arbitrary, capricious or an abuse of discretion. But if these pitfalls are

avoided, change is not invalidating, since the whole point of Chevron is

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to leave the discretion provided by the ambiguities of a statute with the

implementing agency.

Smiley v. Citibank (S.D.), N.A., 517 U.S. 735, 742 (1996) (internal citations and

quotations omitted).

Baptist Memorial argues that “[w]here an agency applies different standards

to similarly situated entities and fails to support this disparate treatment with a

reasoned explanation and substantial evidence in the record, its action is arbitrary and

capricious and cannot be upheld.” Burlington N. & Santa Fe Ry. Co. v. Surface

Transp. Bd., 403 F.3d 771, 777 (D.C. Cir. 2005). Our closest case on point is SSM

Rehabilitation Institute v. Shalala, 68 F.3d 266 (8th Cir. 1995). In that case, to

determine whether the Secretary’s application of a regulation to SSM was an arbitrary

change of position, we relied on contemporaneous decisions of the PRRB that applied

the same regulation. Id. at 270. Because the contemporaneous final decisions, as

rendered by the PRRB, were consistent with the decision of the Secretary regarding

SSM, we held the Secretary’s decision was not an arbitrary change of position. Id.

Our holding in SSM suggests that if the Secretary’s interpretation in a case is

inconsistent with contemporaneous final decisions rendered by the PRRB, the change

would be arbitrary. In the instant case, however, while the three prior decisions cited

by Baptist Memorial are inconsistent with the Secretary’s decision, they are not

contemporaneous decisions of the agency. The instant case deals with the cost years

1991 to 1994, while the three previous decisions covered cost years 1987 to 1989.

The first decision of the Administrator, on behalf of the Secretary, applying the

direct-operation standard in this case was issued in 2001, while the three previous

decisions were issued between 1993 and 1997. As a result, SSM does not suggest a

finding of arbitrariness here. Contrary to Baptist Memorial’s assertion, because

different cost years were involved in the three PRRB decisions, this is not a case

“[w]here an agency applie[d] different standards to similarly situated entities.”

Burlington N. & Santa Fe Ry. Co., 403 F.3d at 777.

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Baptist Memorial also argues that it relied on the Secretary’s Provider

Reimbursement Manual (“PRM”), which as late as 1995 continued to state that nonprovider-operated educational activities meeting the “engaged in” test were eligible

for pass-through treatment. However, “[t]he PRM, while a useful guide to

interpreting the Medicare statute and regulations, is not strictly binding on the

Secretary.” Paragon Health Network, Inc. v. Thompson, 251 F.3d 1141, 1147 (7th

Cir. 2001). Reliance on the PRM would not have been reasonable in light of the

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More generally, we do not find the Secretary’s decision to apply the directoperation requirement after the three earlier PRRB decisions to be “sudden and

unexplained.” Smiley, 517 U.S. at 742. The Secretary has explained fully the

underlying rationale for the direct-operation test, as discussed ante, and the change

as applied to cost years 1991 through 1994 was not sudden because HHS notified

Baptist Memorial and its sister hospitals beforehand, as memorialized in an August

1990 letter, that the Nursing School costs would not be eligible for pass-through

treatment because the provider hospitals did not operate the Nursing School. Again,

we agree with the D.C. Circuit, which held in regard to an identical argument based

on the same three prior PRRB cases, “All that we or the regulated entity can properly

ask of the agency is that it explain its departure. This the Secretary has expressly

done.” Cmty. Care, 318 F.3d at 227.

Neither is the Secretary’s decision contrary to “legitimate reliance on prior

interpretation” in the PRRB decisions. Smiley, 517 U.S. at 742 (citing United States

v. Penn. Indus. Chem. Corp., 411 U.S. 655, 670-675 (1973) and NLRB v. Bell

Aerospace Co., 416 U.S. 267, 295 (1974)). Legitimate reliance on prior

administrative decisions can be shown where “some new liability is sought to be

imposed on individuals for past actions which were taken in good-faith reliance on

[agency] pronouncements.” Bell Aerospace, 416 U.S. at 295. In this case, the

arrangement between Baptist Memorial and the Nursing School beginning in 1991

could not have been made in reliance on the PRRB decisions, which were announced

between 1993 and 1997.9

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direct communication from HHS in August 1990 asserting that the direct-operation

requirement contained in the regulations would be applied.

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We conclude that it is not arbitrary and capricious for the Secretary to apply the

direct-operation standard in this case.

C. Application of the Direct-Operation Standard

We review the Secretary’s decision, made under the direct-operation standard,

that Baptist Memorial’s classroom costs associated with the Nursing School do not

qualify for pass-through treatment to determine if it is supported by substantial

evidence in the record as a whole. Flanery v. Chater, 112 F.3d 346, 349 (8th Cir.

1997). We find that substantial evidence supports the Secretary’s finding that Baptist

Memorial was not the operator of the Nursing School.

Baptist Memorial does not challenge the Secretary’s findings that “[t]he

responsibilities associated with the operation of a nursing program reside with the

School of Nursing, not the Provider” and “the costs at issue were not directly incurred

by the Provider, but rather were allocated to the Provider.” Instead, Baptist Memorial

contends that the Nursing School is operated by a provider because Baptist Memorial

and the Nursing School are part of a single corporation, Baptist Health. This

argument fails. The Secretary correctly noted that, while Baptist Health is a

corporation that operates several provider hospitals and nursing schools, it does not

itself qualify as a provider under the statute. See 42 U.S.C. § 1395x(u) (“The term

‘provider of services’ means a hospital, critical access hospital, skilled nursing

facility, comprehensive outpatient rehabilitation facility, home health agency, [or]

hospice program . . . .”). Moreover, the fact that a provider hospital and an

educational institution are under common ownership does not circumvent the

regulations that determine when the costs of the educational institution are

attributable to the provider hospital for Medicare purposes. See Thomas Jefferson

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Univ. v. Shalala, 512 U.S. 504 (1994) (affirming that a medical college could not

redistribute some costs of an approved educational program to an associated provider

hospital where both were owned and operated by the same legal entity). 

In short, the Medicare reimbursement system is based on the costs incurred by

individual provider hospitals, without regard to underlying ownership structure.

Indeed, if Baptist Memorial’s common-ownership reimbursement theory were

accurate, there would be no need for each of the four hospitals owned and operated

by Baptist Health to have separate Medicare provider numbers. We conclude that

substantial evidence supports the Secretary’s finding that Baptist Memorial was not

the operator of the educational activity.

III. CONCLUSION

We hold that the direct-operation requirement is a permissible interpretation

of “approved educational activities” and that it does not represent an arbitrary change

from the Secretary’s prior interpretation. We also hold that substantial evidence

supports the Secretary’s finding that Baptist Memorial was not the operator of the

educational activity. Accordingly, we affirm the judgment of the district court.

HEANEY, Circuit Judge, dissenting.

I concur in the majority’s holding that the Secretary was entitled to limit passthrough reimbursement for clinical or classroom costs to those programs that were

directly operated by the hospital. I respectfully dissent, however, from that portion

of the opinion that holds that Baptist Health, through its subsidiary Baptist Memorial,

does not qualify for such reimbursement.

Baptist Health is a single corporation. It owns and operates both Baptist

Memorial and the Baptist School of Nursing. Baptist Memorial does not maintain its

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own board of trustees or have separate corporate officers. It does not operate

independently whatsoever; it is merely a wing of Baptist Health. Likewise, Baptist

Health’s board of trustees controls the operations of the nursing school, and Baptist

Health holds the nursing school’s license. Baptist Health has but one tax

identification number, shared by all of its subsidiaries.

Given the above evidence, I cannot agree that Baptist Memorial is a separate

entity from Baptist School of Nursing. Baptist Health owns both. In my view, the

direct link between the two provided by their common ownership and operation

qualifies Baptist Memorial as a direct provider of the nursing program. Indeed, the

two subsidiaries appear to have believed as much: when Baptist Memorial agreed to

host the nursing school’s programs, it did so through a memorandum of agreement

rather than a contract, since the signatories for each subsidiary would have been the

same. Thus, although I agree that we accord the Secretary’s findings deference,

substantial evidence simply does not support the view that the nursing program was

not provider operated.

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