Fourth Circuit Limits Who Can Act "Knowingly" Under False Claims Act

Health care industry participants frequently operate under nuanced legal frameworks that apply to the receipt of government funds. A breach of these regulations can open the door to draconian liability under the FCA even when the law is unclear. But in U.S. ex rel. Sheldon v. Allergan Sales, LLC, a divided panel of the Fourth Circuit issued the latest appellate decision holding that a defendant cannot act "knowingly" under the FCA—and thus cannot be liable—"if it bases its actions on an objectively reasonable interpretation of the relevant statute when it has not been warned away from that interpretation by authoritative guidance." This ruling extends the Supreme Court's Fair Credit Reporting Act ("FCRA") decision in Safeco Insurance Company of America v. Burr to the FCA. In doing so, Sheldon joined every other circuit that has considered whether Safeco's reasoning applies to the FCA's scienter requirement, including most recently the Seventh Circuit's decision in U.S. ex rel. Schutte v. SuperValu Inc. 

In Sheldon, a qui tam relator alleged that the defendant drug manufacturer violated the Medicaid Drug Rebate Statute by not properly aggregating customer discounts when reporting its "Best Price" to the Centers for Medicare & Medicaid Services ("CMS")—which, in turn, reduced the Medicaid rebates paid by the defendant and gave rise to potential FCA liability. But as the Fourth Circuit recounted, a "2019 HHS Inspector General Report found that eighty percent of manufacturers reported making reasonable assumptions about the precise issue here," and CMS had not clarified its position on exactly how discounts were to be aggregated. The district court granted the defendant's motion to dismiss, holding that a "plain and natural reading" of the statute did not require aggregating discounts and explaining there was not "a single example where CMS explicitly state[d] that manufacturers must aggregate discounts" along the lines suggested by the relator. 

In an opinion authored by Judge Wilkinson, the Fourth Circuit affirmed, emphasizing the need for "strict enforcement" of the FCA's "rigorous" scienter requirement. Noting that the FCA requires "knowing" misconduct, the Fourth Circuit explained that the FCA does not expressly state how this standard applies in "situations where it is unclear if a defendant complied with the law." But the Fourth Circuit held that Safeco addressed the same issue under the FCRA, which has a similar scienter standard, and the court extended Safeco to the FCA. Under that standard, if a defendant follows an objectively reasonable understanding of the law that has not been authoritatively rejected, then the defendant cannot have knowingly violated the law—and thus cannot be liable under the FCA. Sheldon further clarified that authoritative guidance on a legal question must: (i) come either from "circuit court precedent" or "the relevant agency," and (ii) "have a high level of specificity." 

As the Fourth Circuit explained, this standard is critical in light of the FCA's "punitive aspect," for it would be "profoundly troubling to impose such massive liability on individuals or companies without any proper notice as to what is required." Indeed, "[c]lear regulations constrain regulatory power and limit future flexibility, which is why an agency might find them undesirable," but "allowing agencies to take advantage of companies like this would not be right." 

Importantly, Sheldon also rejected the relator's argument that deciding this scienter question on a motion to dismiss was premature. Instead, the Sheldon majority stressed that district courts can decide this objective issue on the pleadings, "even when the case involve[s] the question of whether a defendant was warned away from its interpretation." A defendant's subjective intent is not relevant to this threshold inquiry. 

Judge Wynn dissented. He argued that the FCRA and FCA scienter standards were not the same. In his view, by nonetheless applying Safeco to the FCA, the majority effectively gutted the FCA's scienter element and adopted a test "that only the dimmest of fraudsters could fail to take advantage of." The majority disagreed, however, emphasizing that "Safeco does not write defendants a blank check" because it does not "shield bad faith defendants that turn a blind eye" to agency guidance—but "[i]f the government wants to hold people liable for violating labyrinthine reporting requirements, it at least needs to indicate a way through the maze." 

Sheldon is the latest decision strengthening the scienter defense for FCA defendants accused of violating ambiguous regulatory frameworks. Notably, no appellate ruling has rejected the application of Safeco to the FCA. But as the dissents in Sheldon and Schutte indicate, there is still not judicial consensus on this issue, which defendants should accordingly track closely.