In a defendant-friendly opinion, a split panel held that conduct based on an “objectively reasonable” reading of an ambiguous statute, absent contrary circuit court precedent or agency guidance, cannot constitute “knowing” misconduct under the False Claims Act. The decision adds to an emerging consensus among circuit courts that the Safeco defense applies to FCA scienter.

In United States ex rel. Sheldon v. Allergan Sales, LLC, a split Fourth Circuit panel affirmed the dismissal of a non-intervened qui tam, or whistleblower, action alleging fraudulent price reporting by a drug manufacturer to Medicaid in violation of the False Claims Act (FCA).[1] Relying on the Supreme Court’s analysis of the Fair Credit Reporting Act’s (FCRA) “analogous”[2] scienter provision in Safeco Insurance Company of America v. Burr ,[3] the majority held that the defendant “did not act ‘knowingly’ under the [FCA]” because its reading of the relevant statute was “at the very least objectively reasonable” and because the defendant “was not warned away from that reading by authoritative guidance.”[4] In applying Safeco’s scienter requirement in the FCA context,[5] the court aligned with “every other circuit to consider the issue.”[6]

Background and District Court Dismissal

The Medicaid Drug Rebate Statute is part of the complex landscape of federal Medicaid payments to states to help defray state spending on prescription drug reimbursements to low-income individuals.[7] Under the statute, manufacturers must report pricing data for each prescription drug to the Centers for Medicare and Medicaid Services (CMS).[8] That reporting includes the “Best Price” at which the manufacturer sells the product “to any purchaser in the United States,” including “prices to wholesalers, retailers, [nonprofits], or governmental entities” and net of rebates and other discounts.[9]

The defendant interpreted “Best Price” to mean the lowest price for the drug given to any individual customer net of discounts to that customer.[10] The relator, in contrast, argued that the statute requires manufacturers computing “Best Price” to aggregate all discounts given to different customers, such as drug wholesalers, insurers, and pharmacies.[11] Under that view, not aggregating all discounts to multiple entities anywhere on the distribution chain in determining Best Price made defendant’s invoices to Medicaid false claims under the FCA.[12]

To survive a Rule 12(b)(6) motion to dismiss, under the relevant FCA provisions, a plaintiff must plausibly plead four elements: (1) false statements or a fraudulent course of conduct, (2) made with the requisite knowledge, (3) that were material, and (4) that caused the government to issue payment.[13] At issue in Allergan were the first two, falsity and scienter; the district court considered them together, focusing chiefly on scienter.[14] This meant determining whether the relator adequately pled one of the three statutory definitions of “knowing” conduct: (i) actual knowledge, (ii) deliberate ignorance, or (iii) reckless disregard.[15]

Proving scienter in FCA actions alleging legal falsity can be particularly difficult where the statute or regulation in question is ambiguous.[16] The district court, finding the Rebate Statute ambiguous, applied the two-step analysis laid out by the Third Circuit in Streck, asking (1) whether the defendant’s interpretation of the ambiguity “was objectively []reasonable” and (2) even if it was reasonable, whether the defendant “was warned away from that interpretation by available administrative [or] judicial guidance.”[17] In light of the imprecisions and inconsistencies in the relevant statutory and regulatory texts, the court found that the defendant’s interpretation was objectively reasonable,[18] and that CMS did not “warn [the defendant] away” from that interpretation.[19] Therefore, the district court found both falsity and scienter defeated, and granted the motion to dismiss.[20]

Fourth Circuit Decision and Safeco

A divided panel of the Fourth Circuit affirmed, relying heavily on the Supreme Court’s “objectively reasonable interpretation” test from Safeco concerning the FCRA’s scienter provision, which the majority characterized as “analogous” to that under the FCA.[21] In particular, the majority drew on Safeco’s treatment of the FCRA’s “willfulness” requirement, which the Supreme Court interpreted to include not just “knowing” misconduct but also “reckless disregard”[22]—paralleling the inclusion of “reckless disregard” among the ways the FCA’s knowledge element can be met.[23]

In Safeco, plaintiffs brought an FCRA[24] action against an auto insurer.[25] That statute requires a company taking an “adverse action” against a consumer (such as cancelling or raising the cost of insurance coverage)[26] based on information in a consumer credit report to notify the consumer;[27] where a violation is “willful,” punitive damages may be awarded.[28] The defendant argued it had reasonably (though incorrectly) interpreted an ambiguous statute; the issue became whether only “knowing” violations of the statute were “willful,” or whether “reckless disregard” of the statute’s requirements could also qualify.[29] The Supreme Court held that, because the statute did not define the term “willful,” the common law meaning prevailed, which embraced both knowledge and recklessness.[30] To determine whether the defendant acted in “reckless disregard” of a statutory obligation, the Court then looked both to whether the defendant’s reading of the statute was reasonable, and whether it had the benefit of “guidance from the courts of appeals” or from the relevant government agency.[31] The Court found the defendant’s reading was reasonable, particularly given the absence of any authoritative guidance that might have pointed the defendant in another direction.[32]

In Allergan, the majority carried out a two-step reckless disregard analysis within a framework grounded in Safeco.[33] The inquiry asked first “whether defendant’s interpretation was objectively reasonable,” and then whether “authoritative guidance” existed that “might have warned defendant away” from its interpretation.[34]  In the first step, the majority examined the defendant’s reading of the Best Price reporting requirement and concluded it was objectively reasonable.[35] Indeed, the majority found the defendant’s interpretation “best” comported with the statute’s “plain and natural” meaning.[36]

Next, the majority considered whether the defendant was “warned away” from its reasonable, though incorrect, interpretation. As the opinion stressed, even an “objectively reasonable” interpretation can be defeated by the existence of contrary circuit court precedent or agency guidance to which a “bad faith defendant[]” may not “turn a blind eye.”[37] Agency guidance, moreover, must be more than merely “related” to the at-issue question, but must address it with “a high level of specificity.”[38] And, although the Allergan majority did not emphasize this point, Safeco makes clear that “authoritative” guidance means guidance promulgated through “substantive rulemaking authority” and not in informal, non-binding opinion letters.[39] Ultimately, the majority found CMS provided no such guidance regarding price aggregation, despite manufacturer requests for clarification.[40] Instead, CMS instructed manufacturers, “in the absence of specific guidance,” to calculate Best Price using “reasonable assumptions.”[41]

The majority concluded that the defendant “made eminently reasonable assumptions based on the statutory text, and CMS invited assumptions of precisely this sort.”[42] Therefore, it met both Safeco prongs, and did not “knowingly” submit a false claim.[43] For the majority, the punitive nature of the FCA makes notice all the more vital: “If the government wants to hold people liable for violating labyrinthine reporting requirements,” it must “indicate a way through the maze.”[44]

Dissent

The strongly worded Allergan dissent charged the majority with “effectively neuter[ing] the False Claims Act” by “eliminating” the knowledge and deliberate ignorance scienter standards and so distorting the remaining standard that “fraudsters [can] escape any liability so long as they can come up with a post hoc legal rationale that passes the smell test.” [45] However, it is not apparent that Safeco actually gives FCA defendants an all-purpose liability escape hatch. Safeco, as the majority cautioned, is not a “blank check” but instead requires a defendant’s reading of a statute to be both “objectively reasonable”[46] and not contravened by on-point circuit court precedent or agency guidance.[47]

The dissent also questioned the strength of the consensus among the circuits, noting that two of the five opinions invoked by the majority[48] were unpublished. Additionally, the dissent cited the Eleventh Circuit in Phalp as “declin[ing] to import” into the FCA “the recklessness standard recognized in Safeco,” and thus contradicting the majority’s assertion that “every other circuit to consider the issue” has endorsed Safeco as an FCA defense.[49] But Phalp does not mention Safeco; what it declines to adopt is a rule permitting reasonable interpretation of an ambiguous statute, without more, to defeat scienter.[50] The dissent therefore cited no circuit court opinion expressly rejecting Safeco‘s applicability to FCA scienter.

Overview and Outlook

The majority’s holding in Allergan adds to the emerging consensus among the circuit courts that Safeco’s “objectively reasonable interpretation” test can be applied as a defense to FCA scienter. Four published circuit court opinions now adopt this holding, and two other circuits have done so in unpublished form. Defendants operating in an ambiguous statutory or regulatory framework can stand on firm ground asserting that they interpreted the relevant provisions in an objectively reasonable way, provided they can demonstrate the statute’s ambiguity, and show that no circuit court authority or relevant agency guidance available at the relevant time pointed away from that reading.

Allergan stands strongly for the principle that proper notice is required before liability can be imposed on a defendant, particularly under a statute like the FCA with its punitive treble damages scheme. Rejecting “liability through ambush,” [51] the majority underscored the government’s duty to “provide a reasonably clear standard of culpability” both to put parties on notice of their obligations and to “circumscribe the discretion of the enforcing authority.”[52]