48 soc.sec.rep.ser. 195, 19 Employee Benefits Cas. 1824, Medicare & Medicaid Guide P 43,401 Dominguez Valley Hospital Ontario Community Hospital Ojai Community Hospital Manteca Hospital Doctors Hospital of Lakewood Los Alamitos Medical Center, Los Alamitos Medical Center--Psych Chico Community Hospital Memorial Hospital of Redding, Redding Medical Center, Redding Medical Center--Rehabilitation, Redding Medical Center--Detox Modesto City Hospital Garfield Medical Center--Rehabilitation Lodi Community Hospital Doctors Hospital--Modesto Doctors Hospital--Modesto Hha Doctors Hospital of Pinole Doctors Hospital of Pinole--Detox Indio Community Hospital Los Altos Hospital Doctors Hospital of Lakewood--South Alvarado Community Hospital Doctors Hospital of Montclair Twin Cities Community Hospital Palms of Pasadena Hospital John F. Kennedy Memorial Hospital Lake Seminole Hospital Hollywood Medical Center Seven Rivers Community Hospital Medfield Center Sierra Medical Center Meadowcrest Hospital St. Charles General Hosp
Docket: 94-55182
Court: Court of Appeals for the Ninth Circuit; June 14, 1995; Federal Appellate Court
Appellant hospitals, including Dominguez Valley Hospital and others, are appealing a decision by the Secretary of Health and Human Services regarding the denial of reimbursement for employee stock options granted to managerial staff. The hospitals, which participate in the Medicare program, claim reimbursement under the Medicare Act for costs incurred in providing services to Medicare patients. The Secretary rejected the reimbursement request, asserting that according to generally accepted accounting principles (GAAP), specifically Accounting Principles Board Opinion No. 25, no costs were incurred since the stock options were granted at the market price on the grant date. The U.S. District Court for the Central District of California upheld the Secretary's decision, leading to this appeal. The Ninth Circuit reviewed the case to determine if the Secretary's actions were arbitrary or not in accordance with the law and ultimately affirmed the lower court's ruling. The stock options in question were fixed options that vested after three years and had a ten-year exercise period.
The hospitals argue that the Secretary's use of APB No. 25 to value their stock options was arbitrary and capricious. However, referencing HCA Health Services of Midwest, Inc. v. Bowen, the Secretary's decision is affirmed. In HCA, it was established that employee stock options should be valued on the grant date rather than the exercise date, as fixed options priced at or above market yield no costs. The hospitals concede their stock options are similar to those in HCA but claim that GAAP should apply solely to timing issues, not allowability. They assert their reimbursement claims for stock options qualify as allowed fringe benefits under regulations. Furthermore, they argue for the Black-Scholes method to calculate stock option value, claiming actual costs of approximately $33 million. However, the Secretary acknowledges that employee stock option costs are permissible but contends the issue is about the valuation method, not reimbursement eligibility. The Secretary's silence in regulations on stock option valuation justifies the application of GAAP through APB No. 25. The hospitals' attempts to differentiate HCA are ineffective, as the case hinges on valuation rather than allowability. They cannot establish a basis for departing from GAAP without specific Medicare regulations addressing the issue.
The Secretary is permitted to deviate from Generally Accepted Accounting Principles (GAAP) when necessary to comply with Medicare regulations or when GAAP does not accurately reflect patient care costs. However, the Secretary is not prohibited from using GAAP for determining allowability issues, as established in previous rulings, such as Villa View. The decision to apply Accounting Principles Board (APB) No. 25 rather than the Black-Scholes method for valuing stock options was upheld, with the courts rejecting claims that this choice ignored the real economic costs associated with the options, consistent with the HCA decision. The Secretary's valuation method, APB No. 25, was deemed rational and reasonable, validating the denial of reimbursement for the stock options in question. The judgment of the district court was affirmed, and the case was deemed appropriate for decision without oral argument. The specific reimbursement dispute arose from a fiscal intermediary's initial disallowance, which was upheld by the Provider Reimbursement Review Board after a hearing, leading to a final agency decision subject to district court review. The stock option plans involved were approved by the board and shareholders of National Medical Enterprises, Inc. The prospective payment system enacted in 1983 does not apply to these options. The hospitals' expert testified on the factors involved in the Black-Scholes calculation, admitting the need for adjustments to account for nontransferability and other considerations.
42 C.F.R. Sec. 413.5(c)(7) and the Provider Reimbursement Manual, PRM Sec. 2144 establish guidelines for reimbursement related to Generally Accepted Accounting Principles (GAAP). The appellate case Mother Frances Hosp. v. Shalala (15 F.3d 423) initially distinguished between 'allowability' and 'timing' concerning GAAP; however, this decision was vacated by the Supreme Court, which overruled a related Sixth Circuit decision in Shalala v. Guernsey Memorial Hosp. (115 S.Ct. 1232). Consequently, the Mother Frances ruling is deemed unhelpful for appellants, as it references Sun Towers, Inc. v. Heckler, which clarified that while the Secretary can deviate from GAAP, such deviations must be reasonable.
Several cases support the Secretary's obligation to adhere to GAAP. For instance, National Medical Enterprises, Inc. v. Bowen (851 F.2d 291) mandated that the Secretary use GAAP for allocating return-on-equity payments, and Villa View Community Hosp. v. Heckler (720 F.2d 1086) required compliance with GAAP regarding amortization of land use costs. However, the Supreme Court's decision in Shalala v. Guernsey Memorial Hosp. indicated that the Secretary may deviate from GAAP without specific regulations.
Further cases, such as Providence Hosp. (52 F.3d 218-19) and National Medical Enterprises, Inc. v. Sullivan (916 F.2d 542), illustrate instances where the Secretary appropriately diverged from GAAP. Villa View's consideration of both allowability and timing demonstrates the limited significance of distinguishing between the two. The Secretary's use of APB No. 25 is justified by the hospitals' own financial practices, as they did not report stock option costs in their statements, and no Medicare rationale has been provided to treat hospital employee stock options differently from those in other businesses under GAAP.
