OTIS R. BOWEN, SECRETARY OF HEALTH AND HUMAN SERVICES, PETITIONER V. GEORGETOWN UNIVERSITY HOSPITAL, ET AL. No. 87-1097 In the Supreme Court of the United States October Term, 1987 The Solicitor General, on behalf of the Secretary of Health and Human Services, petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the District of Columbia Circuit in this case. Petition for a Writ of Certiorari to the United States Court of Appeals for the District of Columbia Circuit PARTIES TO THE PROCEEDING In addition to the parties named in the caption, Howard University as Howard University Hospital, Tuscon Hospital Liquidating Corp. (formerly Tuscon General Hospital), Greater Southeast Community Hospital, Tuscon Medical Center, St. Cloud Hospital, and Community Hospital of Battle Creek were plaintiffs in actions in the district court. These parties also were appellees in the court of appeals. TABLE OF CONTENTS Questions Presented Parties to the Proceeding Opinions below Jurisdiction Statutes involved Statement Reasons for granting the petition Conclusion OPINIONS BELOW The opinion of the court of appeals (App., infra, 1a-19a) is reported at 821 F.2d 750. The opinion and order of the district court (App., infra, 20a-42a) are unreported. JURISDICTION The judgment of the court of appeals (App., infra, 43a-44a) was entered on June 26, 1987, and a petition for rehearing was denied on September 1, 1987 (App., infra, 45a-46a). On November 23, 1987, the Chief Justice entered an order extending the time for filing a petition for a writ of certiorari to and including December 30, 1987. The jurisdiction of this Court rests upon 28 U.S.C. 1254(1). STATUTES INVOLVED 5 U.S.C. 551(4) provides in pertinent part: For the purpose of this subchapter -- * * * * * (4) "rule" means the whole or a part of an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy or describing the organization, procedure, or practice requirements of an agency * * * . 42 U.S.C. (Supp. III). 1395x(v)(1)(A) provides in pertinent part: The reasonable cost of any services shall be the cost actually incurred, excluding therefrom any part of inccurred cost found to be unnecessary in the efficient delivery of needed health services, and shall be determined in accordance with regulations establishing the method or methods to be used, and the items to be included, in determining such costs for various types or classes of institutions, agencies, and services; * * * . Such regulations shall * * * (ii) provide for the making of suitable retroactive corrective adjustments where, for a provider of services for any fiscal period, the aggregate reimbursement produced by the methods of determining costs proves to be either inadequate or excessive. QUESTIONS PRESENTED 1. Whether Section 1861(v)(1)(A)(ii) of the Medicare Act, 42 U.S.C. (Supp. III) 1395x(v)(1)(A)(ii), which allows the Secretary of Health and Human Services to promulgate "regulations * * * for the making of suitable retroactive corrective adjustments where, for a provider of services for any fiscal period, the aggregate reimbursement produced by the methods of determing costs proves to be either inadequate or excessive," authorizes the Secretary to promulgate a retroactive regulation establishing a ceiling on reimbursement for hospitals' wage costs, and to apply that regulation in reimbursement proceedings not final at the time that the regulation was promulgated. 2. Whether the Administrative Proceudre Act (APA), 5 U.S.C. (& Supp. IV) 551 et seq., prohibits an agency from promulgating retroactive regulations even if the decision to apply a regulation retroactively is not arbitrary, capricious, an abuse of discretion, or otherwise contrary to law. STATEMENT 1. At the time of the events at issue in this case, all "providers" of health care services to Medicare beneficiaries were reimbursed by the Secretary of Health and Human Services on an annual basis for the "reasonable cost" of those health care services. 42 U.S.C. (& Supp. III) 1395f(b), 1395x(u) and (v)(1)(A). /1/ Congress expressly authorized the Secretary to promulgate regulations "establishing the method or methods to be used, and the items to be included, in determining" reasonable costs (42 U.S.C. (Supp. III) 1395x(v)(1)(A)). Alarmed by dramatic increases in the cost of hospital care, Congress in 1972 authorized the Secretary to "establish( ) * * * limits on the * * * costs * * * to be recognized as reasonable" (42 U.S.C. (Supp. III) 1395x(v)(1)(A)). Thus, "based on estimates of the costs necessary in the efficient delivery of needed health services," the Secretary may by regulation limit both the types and amounts of costs that are reimbursable under the Medicare program (42 U.S.C. (Supp. III) 1395x(v)(1)(A)). In 1979, the Secretary exercised his authority to establish cost limits by promulgating a regulation that prescribed ceilings upon Medicare reimbursement for hospitals' inpatient general routine operating costs. See 44 Fed. Reg. 31806 (1979). The regulation divided these costs into two categories: wage costs and all other costs. It fixed maximum reimbursable non-wage costs on a nationwide basis for various categories of hospitals; the rule also set nationwide wage cost ceilings, but made those cost limits subject to adjustment on a hospital-by-hospital basis to account for variations in wage rates over different geographic areas. The adjustment was made by applying to the nationwide wage cost ceilings an index derived from Bureau of Labor Statistics data for hospital wages in the particular geographic area. A particular hospital's wage cost ceiling was thus dependent upon the index number for that hospital's geographic area. Id. at 31807-31808. /2/ The wage indices for each geographic area for hospital cost reporting periods beginning on or after July 1, 1979, were set forth in the regulation (id. at 31812-31813); /3/ the 1980 indices were published one year later (45 Fed. Reg. 41868, 41875-41876 (1980)). In 1981, the Secretary adjusted the formula used to calculate the wage indices by excluding data concerning the wages paid by hospitals owned by the federal government. See 46 Fed. Reg. 33638-33639 (1981). The Secretary explained that "(b)ecause these hospitals typically use national pay scales, the amounts they pay their employees do not necessarily reflect area wage levels. We believe excluding data from these hospitals will help improve the the accuracy of the wage index adjustment" (id. at 33639). /4/ The Secretary viewed this refinement in the index methodology as a "minor technical change( )" (46 Fed. Reg. 33638 (1981)). He accordingly did not provide notice or an opportunity to comment before placing the revised index formula into effect. The Secretary further found that the public interest required that the new wage indices be placed into effect immediately: "the current (1980) limits would (otherwise) remain in effect without adjustment for cost reporting periods beginning after June 30, (1981) since there is no provision in the current schedule for adjusting the limits for cost reporting periods that begin after the date" (id. at 33640). Several hospitals sought judicial review of the Secretary's action in the United States District Court for the District of Columbia, claiming that the Secretary had violated the Administrative Procedure Act, 5 U.S.C. (& Supp. IV) 551 et seq., by failing to provide notice and an opportunity to comment before altering the wage index methodology. The court concluded that "the Secretary's decision to exempt the (decision to alter the index methodology) from notice and comment must be declared unlawful" (App., infra, 60a). Citing the provisions of the Medicare Act limiting the availability of judicial review, the district court declined to issue an injunction barring the application of the 1981 wage indices to the plaintiffs' reimbursement claims. It instead issued an order declaring that the revised wage indices were "invalid" (App., infra, 66a). In February 1984, the Secretary issued a notice of proposed rulemaking proposing the reissuance of the 1981 wage indices. See 49 Fed. Reg. 6175 (1984). The notice stated that the indices set forth in the proposed rule would apply to cost reporting periods beginning on or after July 1, 1981 and ending after September 30, 1981, but would not apply to reporting periods beginning on or after October 1, 1982 (ibid.). /5/ Thus, "the rule was to apply to cost accounting periods that would have been covered prospectively by the Secretary's 1981 rule had that rule been promulgated in accordance with the procedural requirements of the APA" (App., infra, 9a). The Secretary stated (49 Fed. Reg. 6177 (1984)) that the exclusion of Federal government hospital data would improve the accuracy of the wage index because most Federal hospitals characteristically employ physicians and other high salaried professionals whose salaries are based on national rather than local wage scales. This factor tends to overstate the average hospital wage in areas with Federal institutions as compared to areas without such Federal facilities. Since the purpose of the wage index is to reflect area-by-area differences in the labor-related component of hospital costs, the exclusion of Federal hospital data better enables the wage index to accurately reflect area-by-area labor-related costs. The Secretary observed that where non-federal hospitals pay wages similar to those paid by the federal government, the data from non-federal hospitals would reflect those wages, and "the exclusion of Federal wages would have little effect on the wage index" (ibid.). If, on the other hand, "wages paid to Federal hospital employees are higher than most area hospital wage levels, then the inclusion of Federal data results in most hospitals receiving a higher Medicare cost limit than is warranted based on their expected costs. Such a result defeats the purpose of the cost limits, which is to limit a provider's reimbursement to only those costs necessary tin the efficient delivery of needed health services" (ibid.). The Secretary stated that the reissurance of the 1981 wage indices, which had been calculated without wage data from federally-owned hospitals, "avoids placing an unwarranted hardship and burden on intermediaries and many hospitals, while it would impose only a minimal burden on a few hospitals" (49 Fed. Reg. 6177 (1984)). Because "(t)he inclusion of Federal data in the wage index at this point in time would result in overpayments to many hospitals," intermediaries might be forced to review already-settled cost reports and hospitals that had received excess reimbursement would be required to repay these sums to the government (ibid.). "In contrast, those few hospitals that would receive less reimbursement if Federal hospital data are excluded from the wage index would not be unduly harmed or burdened by the reissurance of the wage index," because those hospitals could only have relied on the wage indices published in 1981 (ibid.). "Since these limits are prospectively established and published in advance, all hospitals knew before the beginning of their respective cost reporting periods what their cost limit would be. * * * This proposed notice would simply put the previously set cost limits back into effect" (ibid.). After considering comments submitted by interested parties, the Secretary reaffirmed the propriety of the change in index methodology and reissued the 1981 wage indices in final form (49 Fed. Reg. 46495 (1984)). She rejected the contention that the application of the 1984 rule to 1981 cost years constituted an impermissible retroactive rule, observing that "as a practical matter hospitals could only have relied on the (1981) rule in determining their respective cost limits" for the cost periods that would be covered by the 1984 rule (id. at 46497). Because "(e)ach hospital (therefore) knew in advance of its cost reporting period what its cost limit would be for this period," the Secretary concluded that the 1984 rule could properly be applied to 1981 cost reporting periods (ibid.). 2. Respondents are health care providers that operate hospitals. Respondents' fiscal intermediaries applied the 1984 wage indices to recoup funds previously reimbursed to respondents under wage indices that included federal hospital wage data. Respondents obtained the necessary certification from the Provider Reimbursement Review Board and commenced several actions in the United States District Court for the District of Columbia challenging the Secretary's decision to apply the revised index calculation methodology to their 1981 cost periods (see 42 U.S.C. (Supp. III) 1395oo(f)(1)). The district court consolidated the actions and entered judgment in favor of respondents. The court declined to address respondents' claims that the Secretary lacked the statutory authority to issue retroactive rules. Instead, the court held that the decision to apply the 1981 wage indices retroactively was invalid on the facts of this case. See App., infra, 20a-42a. In so ruling, the district court applied the five-factor balancing test set forth in Retail, Wholesale & Dep't Store Union v. NLRB, 466 F.2d 380, 388 (D.C. Cir. 1972), to determine whether the rule could properly be given retroactive effect. The court concluded (App., infra, 38a) that "the balancing of factors in this case compels the conclusion that Medicare statute interests are only minimally served, if at all, by the Secretary's retroactive application of his reissued wage index to recoup funds from these plaintiffs. In contrast, the ill effects of the Secretary's actions are substantial for these plaintiffs and for the general integrity of the administrative rule-making process. Accordingly, retroactive application against these plaintiffs must be denied." 3. The court of appeals affirmed, but rested its decision upon grounds different from those adopted by the district court (App., infra, 1a-19a). The court acknowledged that adjudicatory orders issued by administrative agencies may be given retroactive effect. But, citing the Administrative Procedure Act's definition of a "rule" as "an agency statement of general or particular applicability and future effect" (5 U.S.C. 551(4) (emphasis added)), the court concluded that "the APA requires that legislative rules be given future effect only. Because of this clear statutory command, equitable considerations are irrelevant to the determination of whether the Secretary's rule may be applied retroactively; such retroactive application is foreclosed by the express terms of the APA" (App., infra, 11a-12a, 13a). The court stated that when the district court invalidated the 1981 rule, "it necessarily reinstated the Secretary's 1979 rule, which required the Secretary to reimburse providers using a formula that included federal-hospital data" (App., infra, 13a (emphasis in original)). "The Secretary's 1984 rule obviously can have no application to cost accounting periods that were, by virtue of the District Court's ruling, governed by the Secretary's 1979 rule" (ibid.). In the Court's view, "agencies would be free to violate the rulemaking requirements of the APA with impunity if, upon invalidation of a rule, they were free to reissue that rule on a retroactive basis" (id. at 14a). The court acknowledged that if an agency rule is invalidated on procedural grounds, "the agency must, of course, be given an opportunity to correct the procedural defect and promulgate a new rule"; but "the corrected rule, like all other legislative rules, (must) be prospective in effect only" (ibid.). /6/ The court of appeals stated that Congress may "override the general terms of the APA by explicitly authorizing retroactive regulations in an agency's organic statute" (App., infra, 14a). Petitioner contended that the retroactive 1984 regulation was specifically authorized by Section 1861(v)(1)(A)(ii) of the Medicare Act, 42 U.S.C. (Supp. III) 1395x(v)(1)(A)(ii), which empowers the Secretary of Health and Human Services to issue "regulations" that "provide for the making of suitable retroactive corrective adjustments where * * * the aggregate reimbursement produced by the methods of determining costs proves to be either inadequate or excessive." The court of appeals rejected that argument, however, holding that "Congress did not intend to empower the Secretary to promulgate retroactive cost-limit rules" (App., infra, 15a (emphasis in original)). As an initial matter, the court stated that "(i)t was not until the litigation in the district court that the Secretary sought to invoke the retroactive adjustments provision as authority for the rule" (App., infra, 16a). Because the provision was not explicitly cited when the 1984 rule was promulgated, the court thought that it could not be invoked to justify that rule. With respect to the merits of this argument, the court of appeals discerned "a critical distinction between the power to promulgate retroactive rules of general application and the power to make retroactive corrective adjustments in the reimbursements of particular providers whose aggregate reimbursement is shown to be either 'inadequate or excessive'" in case-by-case evidentiary proceedings (App., infra, 17a). It concluded that Section 1861(v)(1)(A)(ii) confers only the latter power upon the Secretary, authorizing him to make retroactive adjustments to individual reimbursement determinations where he is able to "prove that inadequate or excessive reimbursements to a provider have resulted from his 'emthods of determining costs'" (App., infra, 18a (citation omitted)). In the absence of individualized proof that the reimbursement awarded respondents exceeded their reasonable costs, the court held that the Secretary had no authority to adjust those reimbursement awards retroactively (id. at 18a-19a). REASONS FOR GRANTING THE PETITION This case concerns an issue of considerable importance to the administration of the Medicare program -- whether the Secretary of Health and Human Services may give retroactive effect to regulations setting the amount of reimbursement that may be paid to providers of health services to Medicare beneficiaries. It is important to note at the outset that, while the rule at issue in this case does operate retroactively in the technical sense that it governs reimbursement for costs incurred by respondents prior to the date upon which the rule was promulgated, that retroactive effect has none of the qualities that have led the courts to take a cautious view of the retroactive application of legal standards. The wage indices at issue here were initially promulgated as an entirely prospective regulation issued in 1981. When that regulation was invalidated by the district court on procedural grounds in 1983, the Secretary decided not to appeal that determination; instead -- after subjecting the regulation to prior notice and comment -- she reissued the regulation in 1984 and gave the revalidated regulation the same 1981 effective date as the original regulation. Because the identical substantive standard had been adopted in 1981, all hospitals affected by the 1984 rule -- including respondents -- were plainly on notice before they incurred the costs subject to the 1984 rule that the reasonableness of those costs would be measured against the standard contained in that rule. Despite the fact that respondents can therefore demonstrate no prejudice of any kind from the Secretary's decision to give retroactive effect to the reissued rule, the court of appeals held that both the Medicare Act and the Administrative Procedure Act barred the Secretary from applying the rule on a retroactive basis. In reaching that result, the court of appeals adopted constructions of these statutes that squarely conflict with the decisions of numerous other courts of appeals. With respect to the Medicare Act, the court's determination cannot be reconciled with the express statutory language authorizing retroactive administrative action. And the court's unprecedented interpretation of the Administrative Procedure Act, precluding federal administrative agencies from engaging in virtually any retroactive rulemaking, is similarly at odds with that statute's language and legislative history. The scope of the Secretary's authority to give retroactive effect to rules governing Medicare cost reimbursement is a matter of considerable practical importance. In carrying out his statutory mandate to ensure that reimbursement neither exceeds nor falls short of a provider's reasonable costs, the Secretary may learn that a prior cost reimbursement methodology was flawed -- either in favor of providers or to their detriment -- and conclude that retroactive adjustment of reimbursement awards is therefore appropriate. By prohibiting the Secretary from making such adjustments through rules of general application, and requiring the Secretary to engage in a separate adjudication for each individual provider (in which it would be necessary to prove both the flaws in the old reimbursement methodology and the propriety of the new standard) the decision of the court below would effectively eliminate the only realistic method available to the Secretary to make retroactive corrections to reimbursement decisions. Moreover, the effect of the court's erroneous construction of the Administrative Procedure Act is not confined to the Medicare context; it dramatically reduces the rulemaking authority of all federal agencies, barring retroactive rule-making in essentially all circumstances regardless of the balance between the public interest and any prejudice to the affected parties. For all of these reasons, review by this Court is plainly warranted. /7/ 1. a. Section 1861(v)(1)(A)(ii) of the Medicare Act, 42 U.S.C. (Supp. III) 1395x(v)(1)(A)(ii), empowers the Secretary of Health and Human Services to issue regulations that "provide for the making of suitable retroactive corrective adjustments where * * * the aggregate reimbursement produced by the methods of determining costs proves to be either inadequate or excessive." There is a considerable disagreement among the courts of appeals regarding the scope of the Secretary's authority under this provision. Some court of appeals have concluded that "(u)pon determining that one of his cost reimbursement regulations produces inadequate or excessive payments to providers, the Secretary has a statutory duty (under Section 1861(v)(1)(A)(ii)) to make suitable retroactive corrective adjustments" through the issuance of regulations (Springdale Convalescent Center v. Mathews, 545 F.2d 943, 954 (5th Cir. 1977)). These courts have held that the Secretary may -- and in some circumstances must -- apply revised cost reimbursement regulations retroactively where the prior rule resulted in an improper level of reimbursement. Ibid.; see also Regents of the University of California v. Heckler, 771 F.2d 1182, 1188-1189 (9th Cir. 1985); Fairfax Nursing Center, Inc. v. Califano, 590 F.2d 1297, 1300 (4th Cir. 1979); Hazelwood Chronic & Convalescent Hospital, Inc. v. Weinberger, 543 F.2d 703, 707-708 (9th Cir. 1976), vacated on other grounds, 430 U.S. 952 (1977); Whitecliff, Inc. v. United States, 536 F.2d 347, 352 (Ct. Cl. 1976), cert. denied, 430 U.S. 969 (1977); Kingsbrook Jewish Medical Center v. Richardson, 486 F.2d 663, 669-670 (2d Cir. 1973); cf. Tallahassee Memorial Regional Medical Center v. Bowen, 815 F.2d 1435, 1453-1454 & n.36 (11th Cir. 1987), petition for cert. pending, No. 87-380 (applying balancing test to determine whether rule may be applied retroactively); Mason General Hospital v. Secretary of Health & Human Services, 809 F.2d 1220, 1225-1226 (6th Cir. 1987) (same). The court below took a narrower view of Section 1861(v)(1)(A)(ii), holding that the provision does not empower the Secretary to issue retroactive rules, but only authorizes retroactive adjustment of reimbursement awards on a case-by-case basis upon proof that a particular reimbursement award was either inadequate or excessive. App., infra, 16a-19a; see also St. Paul-Ramsey Medical Center v. Bowen, 816 F.2d 417, 419-420 (8th Cir. 1987) (holding that the Secretary has a duty to make retroactive adjustments without stating whether such adjustments may be made by regulation). A third group of courts has stated that the provision does not permit any retroactive reassessment of reimbursement decisions, but only directs the Secretary "to promulgate regulations that mandate retroactive adjustments in the payments received by providers, so as to bring the amounts paid to them on the basis of their monthly estimates in line with the amount actually due them under the annual audit." Daughters of Miriam Center for the Aged v. Mathews, 590 F.2d 1250, 1258 n.23 (3rd Cir. 1978) (emphasis in original); see also Adams Nursing Home of Williamstown, Inc. v. Mathews, 548 F.2d 1077, 1082 (1st Cir. 1977). On this view of Section 1861(v)(1)(A)(ii), the provision simply requires the Secretary to establish a mechanism for reconciling the Secretary's advance estimated payments with the amount finally determined to be due the provider following review of the provider's annual cost report. /8/ b. Section 1861(v)(1)(A)(ii) expressly authorizes the Secretary to issue regulations that "provide for the making of suitable retroactive corrective adjustments" in reimbursement awards. Where, as here, the Secretary concludes that application of a cost reimbursement regulation has resulted in either an excessive or inadequate reimbursement award, the statute by its plain language permits the Secretary to issue a retroactive regulation to adjust the erroneous reimbursement determination as long as that course of action is reasonable. Nothing in the language of the statute supports the court of appeals' conclusion that the Secretary may retroactively reexamine reimbursement decisions on a case-by-case basis, but may not issue retroactive rules of general application; the statute expressly authorizes the issuance of regulations providing for retroactive readjustments in reimbursement determinations. /9/ Not only is the court of appeals' interpretation at odds with the language of the statute, it is wholly unrealistic. It would permit retroactive adjustments to reimbursement determinations identical to that achieved by the 1984 rule, but only if the Secretary makes those adjustments in separate, individualized proceedings for each provider. In view of the vast scope of the Medicare program, that approach is simply unworkable. See City of Austin v. Heckler, 753 F.2d 1307, 1317 (5th Cir. 1985) ("regulation (of Medicare reimbursement) cannot be accomplished on a hospital-by-hospital basis"). If, as the court appears to agree, retroactive adjustments are permissible, then the Secretary must have the authority to make those adjustments in an administratively practicable manner. Because the Secretary can utilize regulations to set cost limits as an initial manner, it makes no sense to bar the Secretary from using regulations to adjust reimbursement awards retroactively. The court of appeals rested its construction of the statute in part upon the legislative history of the 1972 amendment to the Medicare statute that authorized the Secretary to promulgate cost limits such as the regulation at issue here (see page 3, supra), citing a statement in the congressional committee reports to the effect that this authority "'would be exercised on a prospective, rather than retrospective, basis, so that the provider would know in advance the limits to Government recognition of incurred costs and have the opportunity to act to avoid having costs that are not reimbursable'" (App., infra, 15a (citations omitted)). As a threshold matter, we are not certain that this legislative history is relevant in interpreting Section 1861(v)(1)(A)(ii), which was included in the original Medicare statute enacted in 1965, and thus was not enacted as part of the 1972 amendments. Even if the legislative history is relevant, however, it does not change the result here because respondents had ample notice of the very cost limits adopted in 1984 before those limits were placed into effect. As we have discussed (see pages 11-12, supra), the substantive standard contained in the 1984 regulation was first issued as a prospective rule in 1981. Indeed, that 1981 rule remained undisturbed for the entire time period affected by the retroactive rule -- the cost periods beginning after July 1981 and before October 1982 -- because the rule was not invalidated by the district court until 1983. Thus, respondents obviously were on notice that the reasonableness of their costs would be assessed against the standard set forth in the 1984 rule. /10/ 2. Even if the Secretary's express authority to alter reimbursement decisions retroactively does not empower the Secretary to issue retroactive rules of the type at issue here, the Secretary's action should be upheld as an exercise of his general rulemaking authority under the Medicare Act (see 42 U.S.C. (& Supp. III) 1395x(v)(1)(A), 1395hh) and the Administrative Procedure Act. The court of appeals' contrary determination -- which rests on the novel conclusion that the APA prohibits virtually all retroactive rulemaking -- should be reviewed by this Court. /11/ a. The decision of the court of appeals regarding the authority of a federal administrative agency to accord retroactive effect to one of its rules conflicts with the decisions of other courts of appeals with respect to that question. The court below stands alone in holding that, as a general matter, a rule promulgated pursuant to the Administrative Procedure Act may not be given retroactive effect (see App., infra, 13a). The other courts of appeals to address the question have stated that an agency's decision to give a rule retroactive effect may be upheld if that decision is found to be reasonable after assessment of the public and private interests affected by the decision to apply the rule retroactively. See, e.g., Texaco, Inc. v. Department of Energy, 795 F.2d 1021, 1025-1027 (Temp. Emer. Ct. App. 1986), cert. dismissed, No. 86-187 (Aug. 19, 1986); National Ass'n of Independent Television Producers & Distributors v. FCC, 502 F.2d 249, 255 nn. 10, 11 (2d Cir. 1974); Daughters of Miriam Center for the Aged v. Mathews, 590 F.2d at 1259-1260 (interpretive rule); General Telephone Co. v. United States, 449 F.2d 846, 863 (5th Cir. 1971); cf. Illinois v. Bowen, 786 F.2d 288, 292 (7th Cir. 1986) (upholding retroactive application of agency's new interpretation of existing rule). Prior decisions of the District of Columbia Circuit were to the same effect. Citizens To Save Spencer County v. EPA, 600 F.2d 844, 879-881 (D.C. Cir. 1979); see also Maxcell Telecom Plus, Inc. v. FCC, 815 F.2d 1551, 1554-1556 (D.C. Cir. 1987). b. The court of appeals' interpretation of the Administrative Procedure Act is clearly wrong. The court of appeals relied (App., infra, 11a-12a) upon the statutory definition of a "rule," which states that a rule is "the whole or any part of any agency statement of general or particular applicability and future effect" designed to implement law or policy or describe the agency's organization and procedure (5 U.S.C. 551(4)). Seizing upon the phrase "future effect," the court concluded that a rule may not be given retroactive effect. But the legislative history of Section 551(4) makes plain that Congress did not intend to impose any such general restriction upon rulemaking authority. The reference to "future effect" was designed to distinguish rulemaking from adjudication, not to prohibit retroactive application of rules as a matter of course (see Colyer v. Harris, 519 F. Supp. 692, 694 (S.D. Ohio 1981)). Thus, under the APA, a "rule" is a statement of law or policy which is not applied or enforced in the same proceeding in which it is announced; any application or enforcement will occur only in the future, i.e., in an adjudication. This understanding is confirmed by the report of the House Judiciary Committee, which added the phrase of the House Judiciary Committee, which added the phrase "future effect" to the statutory definition of "rule." The committee's report explains that "(t)he phrase 'future effect' does not preclude agencies from considering and, so far as legally authorized, dealing with past transactions in prescribing rules for the future." H.R. Rep. 1980, 79th Cong., 2d Sess. App. A, n.1 (1946), reprinted in, Legislative History of the Administrative Procedure Act, 1944-46, at 283 n.1; see also Attorney General's Manual on the Administrative Procedure Act 37 (1947) ("(n)othing in the Act precludes the issuance of retroactive rules when otherwise legal and accompanied by" a finding of good cause). The court of appeals also justified its interpretation of the APA by stating that retroactive rulemaking to correct an agency's procedural misstep is "completely at odds with basic tenets of administrative law" because "the effect of invalidating an agency rule is to 'reinstat(e) the rules previously in force.'" App., infra, 13a (quoting Action on Smoking & Health v. CAB, 713 F.2d 795, 797 (D.C. Cir. 1983) (emphasis in the original)). But the court's premise is incorrect; invalidation of a rule does not generally reinstate the rules previously in force. Rather, the agency is free to reconsider the entire matter, with its decision subject to further judicial review. See Burlington Northern, Inc. v. United States, 459 U.S. 131, 142-144 (1982); Motor Vehicle Manufacturers Ass'n v. State Farm Mutual Automobile Insurance Co., 463 U.S. 29, 57 & n.21 (1983); Addison v. Holly Hill Fruit Products, Inc., 322 U.S. 607, 619-620 (1944); Williams v. Washington Metropolitan Area Transit Comm'n, 415 F.2d 922, 939-940 (D.C. Cir. 1968) (en banc), cert. denied, 393 U.S. 1081 (1969). Accordingly, the administrative agency is free to decide in the first instance whether to apply prior law to a case covered by the invalidated regulation or give retroactive effect to a subsequently-promulgated regulation. By completely eliminating administrative discretion to determine whether to accord retroactive effect to a rule, it is the court of appeals that has ignored basic principles of administrative law. /12/ The fact that retroactive rulemaking is permissible under the APA does not, of course, mean that an agency's decision to give a rule retroactive effect must be upheld in every case. The decision to apply the rule retroactively must be set aside if it is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law" (5 U.S.C. 706(2)(A)). The threshold inquiry is whether the substantive statute granting rulemaking authority imposes any restriction upon the agency's authority to apply rules retroactively. If no such limitation exists, a court must consider whether the agency's decision is arbitrary and capricious. The touchstone for that inquiry is this Court's decision in SEC v. Chenery Corp., 332 U.S. 194 (1947), which upheld the retroactive application for a new principle of law in the context of an adjudication. The Court there stated that "such retroactivity must be balanced against the mischief of producing a result which is contrary to a statutory design or to legal or equitable principles. If that mischief is greater than the ill effect of the retroactive application of a new standard, it is not the type of retroactivity which is condemned by law" (332 U.S. at 203). Other courts have elaborated upon the application of this balancing test in the rulemaking context. See, e.g., Texaco, Inc. v. Department of Energy, 795 F.2d at 1025-1027; Citizens to Save Spencer County v. EPA, 600 F.2d at 879-881. In addition, the retroactive application of the rule must be consistent with the Constitution. The Court has concluded that "(t)he retroactive aspects of legislation, as well as the prospective aspects, must meet the test of due process, and the justifications for the latter may not suffice for the former" (Usery v. Turner Elkhorn Mining Co., 428 U.S. 1, 16-17 (1976)). That due process standard requires a "showing that the retroactive application of the (regulation) is itself justified by a rational * * * purpose" (Pension Benefit Guaranty Corp. v. R.A. Gray & Co., 467 U.S. 717, 730 (1984)). These tests are satisfied here. As we have discussed (see pages 11-12, supra), prior to incurring any of the costs that are subject to the 1984 rule, respondents had ample notice that the reasonableness of those costs would be assessed against the standard contained in that rule. Thus, respondents can have no reliance interest because the governing standard at the time they incurred the relevant costs was the standard that is contained in the current rule. In addition, the public interest weighs strongly in favor of applying the rule retroactively. Otherwise, respondents would gain a windfall -- approximately $2 million in excess reimbursement. /13/ 3. The issues presented in this case are of considerable practical significance. The Secretary is obligated to administer the Medicare program in a manner that ensures that providers will be reimbursed for reasonable costs, as defined by the Secretary, and no more. See 42 U.S.C. (& Supp. III) 1395f(b). Because the decision of the court of appeals effectively deprives the Secretary of any realistic ability to adjust flawed reimbursement methodologies on a retroactive basis, even in the face of practical experience or audit data establishing the flaws in those methods, it will greatly hamper the Secretary's ability to perform his statutory duty. If defective cost reimbursement rules allow providers such as respondents to reap a windfall -- or force them to suffer a shortfall -- the Secretary simply will not be able to adjust those awards. /14/ Although the reasonable cost system of reimbursement for Medicare services has been replaced to some extent by the prospective payment system (see note 1, supra), many Medicare providers continue to obtain reimbursement for their "reasonable" costs by filing cost reports. See 42 C.F.R. 412.20-412.32 (rehabilitation hospitals, psychiatric hospitals, children's hospitals, and hospitals with average length of stay greater than 25 days are not covered by PPS), 42 C.F.R. 413.1 (reasonable cost payment system applies to skilled nursing facilities, home health agencies, and other facilities providing services other than in-hospital care). Moreover, all providers are reimbursed for some categories of costs on a reasonable cost basis. See, e.g., 42 U.S.C. (Supp. III) 1395ww(a)(4) (anesthesia services provided by nurse); 42 C.F.R. 412.2(d) (capital costs, direct medical education costs, cost for direct medical and surgical services provided by certain physicians in teaching hospitals). The questions presented here regarding the Secretary's authority to adjust reimbursement awards on a retroactive basis therefore have continuing importance for the administration of the Medicare program. /15/ The implications of the court of appeals' construction of the Administrative Procedure Act range far beyond the Medicare context. The court's decision seriously limits the regulatory authority of virtually every federal administrative agency. /16/ By precluding retroactive rulemaking to correct procedural or technical missteps, the decision below permits plaintiffs, such as respondents here, to bootstrap procedural errors into substantive limitations upon the exercise of agency authority. That result will adversely affect an agency's ability to carry out its congressional mandate. The decision will also affect the government's litigating posture and the caseload of the federal appellate courts. If an agency cannot retroactively correct even an insignificant procedural error, the government will be forced to seek review of many more adverse lower court decisions in order to protect the agency's regulatory authority. The decision below thus threatens to burden the courts with issues that otherwise would have been resolved in the administrative process. For all of these reasons, review by this Court is plainly warranted. CONCLUSION The petition for a writ of certiorari should be granted. Respectfully submitted. DONALD B. AYER /17/ Acting Solicitor General RICHARD K. WILLARD Assistant Attorney General THOMAS W. MERRILL Deputy Solicitor General ANDREW J. PINCUS Assistant to the Solicitor General JOHN F. CORDES MARK W. PENNAK Attorneys DECEMBER 1987 /1/ A provider was reimbursed for its "customary charges" if those charges were less than the reasonable cost. 42 U.S.C. 1395f(b)(1). Most hospitals are no longer reimbursed for inpatient services to Medicare beneficiaries solely on the basis of the "reasonable cost" incurred in providing services to Medicare patients. In Title VI of the Social Security Amendments of 1983, Pub. L. No. 98-21, Sections 601-607, 97 Stat. 149-172, Congress adopted the prospective payment system (PPS). Under PPS (which has been implemented over a four-year transition period beginning on October 1, 1983), hospitals are paid predetermined rates for specific services, which rates are not tied to specific costs incurred by the hospital in providing those services. See 42 U.S.C. (Supp. III) 1395ww(d), as amended by the Consolidated Omnibus Budget Reconciliation Act of 1985, Pub. L. No. 99-272, Section 9102, 100 Stat. 155. Congress adopted PPS primarily "to reform the financial incentives hospitals face, promoting efficiency in the provision of services by rewarding cost/effective hospital practices" (H.R. Rep. 98-25, 98th Cong., 1st Sess. Pt. 1, at 132 (1983)). Many Medicare providers are not covered by the prospective payment system, however, and continue to obtain reimbursement for their "reasonable" costs. See pages 23-24, infra. /2/ As the court of appeals explained, "(t)he wage index for an individual hospital was to be calculated by dividing the 'local' average hospital wage by the 'national' average hospital wage"; "(i)f the hospital was located within a Standard Metropolitan Statistical Area ('SMSA'), the appropriate 'local' figure would be the average hospital wage within that SMSA, and the appropriate 'national' figure would be the average hospital wage among all SMSAs. If the hospital was located outside of a SMSA, the appropriate 'local' and 'national' figures would be calculated using non-SMSA wage data" (App., infra, 8a & n.9). /3/ The Secretary subsequently revised the cost limits for this period (see 44 Fed. Reg. 46949 (1979)). /4/ The Secretary also used approximate, rather than actual index values for 26 geographic areas because the Bureau of Labor Statistics could not supply actual data for those areas (46 Fed. Reg. 33638-33639 (1981)). /5/ Reimbursement of routine inpatient costs for those later cost periods is governed by different rules. See 49 Fed. Reg. 6175 (1984). /6/ In its order denying the petition for rehearing, the court of appeals stated that "(a)s a general rule, the APA requires that legislative rules be given future effect only. Whatever exceptions might exist to this general rule were not implicated in the case before us. Our opinion therefore does not purport to address circumstances in which there may be an exception to the rule against retroactive rulemaking" (App., infra, 45a). /7/ This case does not raise the jurisdictional problem presented in Bowen v. Commonwealth of Massachusetts, petition for cert. pending, No. 87-712, because the applicable waiver of sovereign immunity is contained in 42 U.S.C. (& Supp. III) 1395oo(f), not the Administrative Procedure Act or the Tucker Act. /8/ Indeed, the courts of appeals have themselves recognized the existence of a conflict regarding the proper interpretation of Section 1861(v)(1)(A)(ii). Tallahassee Memorial Regional Medical Center v. Bowen, 815 F.2d at 1454 n.36; Daughters of Miriam Center for the Aged v. Mathews, 590 F.2d at 1258-1259 n.23; App., infra, 16a (footnote omitted) (court below observed that its "sister circuits have struggled to define the precise contours of the retroactive corrective adjustments provision"); see also id. at 34a (district court opinion). /9/ The court of appeals stated that the Secretary could not rely upon Section 1861(v)(1)(A)(ii) because "(i)t was not until the litigation in the District Court that the Secretary sought to invoke the retroactive corrective adjustments provision as authority for the rule" (App., infra, 16a). But the Secretary did expressly invoke Section 1861(v), 42 U.S.C. (& Supp. III) 1395x(v) -- of which Section 1861(v)(1)(A)(ii) is a subsection -- as authority for the issuance of the 1984 rule. See 49 Fed. Reg. 6180 (1984); id. at 46501. Surely the Secretary is not required to separately list every subsection upon which he specifically relies in promulgating a rule. In any event, this Court has stated that an agency's failure to invoke the proper statutory authority for administrative action does not invalidate that action where the "mistake of the administrative body is one that clearly had no bearing on the procedure used or the substance of the decision reached." Massachusetts Trustees v. United States, 377 U.S. 235, 247-248 (1964); see also NLRB v. Wyman-Gordon, Co., 394 U.S. 759, 767 n.6 (1969); People of Illinois v. ICC, 722 F.2d 1341, 1348-1349 (7th Cir. 1983); cf. Baylor University Medical Center v. Heckler, 758 F.2d 1052, 1060 n.14 (5th Cir. 1985). That principle plainly applies here. /10/ The court of appeals suggested (App., infra, 12a n.11) that the Secretary's interpretation of the statute is flawed because it would allow the Secretary to make his regulations retroactive for an unlimited period of time. But Section 1861(v)(1)(A)(ii) does not override other provisions of the Medicare Act. Thus, when a reimbursement award is final and no longer subject to reopening (see 42 C.F.R. 405.1885), that award cannot be reconsidered pursuant to a rule issued under Section 1861(v)(1)(A)(ii). See 51 Fed. Reg. 11188 (1986) (stating that retroactive application of medical malpractice cost standard is limited to cost reports not yet closed and costs reports still subject to reopening). /11/ The court of appeals initially stated that all retroactive rulemaking was prohibited by the APA (see App., infra, 13a). In its order denying the petition for rehearing, the court indicated that there might be some exceptions to this "general rule," but declined to state what those exceptions might be (id. at 45a). That vague order does little to alleviate the impact of the court's decision and it does nothing to eliminate the fundamental error in the court's legal analysis -- the conclusion that the APA contains an independent limitation upon retroactive rulemaking. /12/ Contrary to the court of appeals' apparent belief, Action on Smoking & Health v. CAB, supra, did not purport to establish a general principle that invalidation of a rule automatically reinstates the pre-existing rule. Rather, the reinstatement of the prior rule in that case was ordered only because an agency had engaged in "repeated technical noncompliance" with the APA (713 F.2d at 802). The court's general principle is also plainly unworkable. It would reimpose a prior regulation that the agency had already found to be unsatisfactory and that might be contrary to intervening statutory provisions. The agency must exercise its expertise to determine in the first instance the suitable course of action following a remand. Cf. Vermont Yankee Nuclear Power Corp. v. National Resources Defense Council, Inc., 435 U.S. 519 (1978) (holding that a court may not impose additional procedural requirements on an agency). /13/ The district court reached a contrary conclusion in applying the balancing test set forth in Retail, Wholesale & Dep't Store Union v. NLRB, supra (see App., infra, 35a-39a). Its analysis was flawed by its failure to recognize that respondents' reliance interest must be assessed as of the time they engaged in the underlying conduct. The court erroneously concluded that respondents had a cognizable reliance interest in retaining the windfall they obtained by virtue of the application of the flawed reimbursement standard. Cf. Heckler v. Community Health Service of Crawford County, Inc., 467 U.S. 51 (1984). The court also erred in finding that the public interest weighed against the application of the revised methodology for calculation of the indices without first finding that that methodology was substantively invalid. If the methodology is valid, it is, by definition, the proper approach for calculating "reasonable" cost. Any award in excess of that amount violates the statute and therefore cannot be supported by the public interest. /14/ The District of Columbia Circuit's limited view of the Secretary's authority is especially significant because the Medicare statute permits any provider to seek judicial review of a reimbursement determination in that Circuit (see 42 U.S.C. (Supp. III) 1395oo(f)(1)). /15/ In addition, many disputes concerning hospitals' claims for reimbursement under the reasonable cost system are now pending on administrative and judicial review. The Department of Health and Human Services informs us that many of these cases involve challenges to the Secretary's authority to promulgate retroactive cost limit regulations. /16/ And, because almost all government agencies are subject to suit under the APA in the District of Columbia Circuit (see 28 U.S.C. 1391(e)), the court's decision will have nationwide impact. /17/ The Solicitor General is disqualified in this case. APPENDIX