Mercy Catholic Medical Center v. Tommy G. Thompson, Secretary of Health

PRECEDENTIAL
UNITED STATES
COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 03-2292
MERCY CATHOLIC
MEDICAL CENTER,
Appellant
v.
TOMMY G. THOMPSON,
SECRETARY OF HEALTH
AND HUM AN SERVICES
On Appeal from the
United States District Court for the
Eastern District of Pennsylvania
D.C. Civil Action No. 02-cv-00419
(Honorable Ronald L. Buckwalter)
Argued April 19, 2004
Before: SCIRICA, Chief Judge,
GARTH and BRIGHT*, Circuit Judges
(Filed: August 18, 2004 )
Mark H. Gallant, Esquire (Argued)
Cozen & O'Connor
The Atrium
1900 Market Street
Philadelphia, Pennsylvania 19103
Attorney for Appellant
Michael Leonard, Esquire (Argued)
Department of Health & Human Services
Office of the General Counsel,
Region III
The Public Ledger Building, Suite 418
150 South Independence Mall West
Philadelphia, Pennsylvania 19106
Attorney for Appellee
OPINION OF THE COURT
SCIRICA, Chief Judge.
At issue is an acute care hospital’s
reimbursement from Medicare for
graduate medical training. Mercy Catholic
Medical Center1 seeks reversal of the
Provider Reimbursement Review Board’s
decision denying reclassification of certain
graduate medical education costs2 and its
r e f u s a l t o a d j u s t M e d i c a r e ’ s
reimbursement of operating costs. The
*The Honorable Myron H. Bright,
United States Circuit Judge for the Eighth
Judicial Circuit, sitting by designation.
1Mercy Catholic Medical Center is an
acute care hospital located in Philadelphia.
2Graduate Medical Education costs
refer to Medicare payments made to
hospitals to support Medicare’s share of
costs related to medical training programs
and to support higher patient costs
associated with the training and education
of residents.

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2
Board also found Mercy Catholic Medical
Center did not provide sufficient
documentation to justify a reclassification
and recision of costs. The District Court
affirmed the Provider Reimbursement
Review Board’s decision and granted
summary judgment to the Secretary of the
Department of Health and Human
Services. We will reverse and remand.
I.
A. Statutory Background
The federal Medicare program,
administered by the Centers for Medicare
and Medicaid Services3 of the United
States Department of Health and Human
Services, is the largest public program
financing health care services for the aged
and disabled. Hospitals that provide
services to Medicare patients are
reimbursed for their expenses under Title
XVII of the Social Security Act (the
“Medicare Act”), 42 U.S.C. § 1395 et seq.
Part A of the Medicare Act authorizes
payment to participating hospitals
(“providers”) for their direct and indirect
costs of providing inpatient care to
beneficiaries. 42 C.F.R. § 413.9(a), (b).
Medicare also reimburses teaching
hospitals for the costs of graduate medical
education, including physician time for
instructing and supervising interns and
residents. 42 U.S.C. § 1395ww(h).
Medicare services are furnished by
“providers of services”4 that have entered
into provider agreements with the
Secretary of the United States Department
of Health and Human Services. 42 U.S.C.
§§ 1395x(u), 1395cc. To receive payment
from the Secretary, providers are required
to comply with the provider agreement, as
well as all Medicare statutes and
regulations. 42 U.S.C. § 1395cc(b)(2).
From its inception, Medicare
reimbursed hospitals for all reasonable
incurred costs related to providing medical
care to patients. The Medicare Act defines
"reasonable cost" as “the cost actually
incurred,” less any costs “unnecessary in
the efficient delivery of needed health
services.” 42 U.S.C. § 1395x(v)(1)(A).
Under the historical system of reasonable
cost reimbursement, no reimbursement
distinction turned on whether costs were
reported as operating costs (the day-to-day
expenses incurred in running a business)
or graduate medical education costs.
Medicare paid its full pro rata share of all
allowable graduate medical education
costs and operating costs actually incurred,
consistent with the statutory requirement
preventing shifting the costs of services
incurred on behalf of Medicare
beneficiaries to other patients or third party
payers. 42 U.S.C. § 1395x(v)(1)(A).
3Centers for M edicare and Medicaid
Services was formerly known as the
Health Care Financing Administration.
4As defined by 42 U.S.C. § 1395x(u), a
“provider of services” means “a hospital,
critical access hospital, skilled nursing
fa cil ity, comprehensive outpatient
rehabilitation facility, home health agency,
[or a] hospice program.”

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3
In 1982, Congress modified the
Medicare program to require hospitals to
render services more economically. In the
Tax Equity and Fiscal Responsibility Act
of 1982 (“TEFRA”), Pub. L. No. 97-248,
Congress amended the Medicare Act by
imposing a ceiling on the rate-of-increase
of inpatient operating costs recoverable by
a hospital. Under TEFRA, costs were still
reimbursed on a reasonable cost basis, but
subject to rate-of-increase limits. The rate-
of-increase limit was computed according
to a “target amount,” which, in turn, was
calculated according to a hospital’s
allowable net Medicare operating costs in
the hospital's base year. See 42 U.S.C. §
1395ww(b); 42 C.F.R. § 413.40(c) (2002).
In 1983, Congress amended the
Medicare Act again, establishing a
p rospective payment s ys t e m f or
reimbursing inpatient operating costs of
acute care hospitals. See 42 U.S.C. §
1395ww(d). Hospitals now are
reimbursed on the basis of prospectively
determined national and regional rates for
each discharge, rather than on the basis of
retrospectively determined reasonable
costs incurred. Under this system,
payment is made at a predetermined rate
for each hospital discharge, according to
the patient's diagnosis.
The prospective payment system
was phased in over four years, during
which hospitals were reimbursed a
combination of the prospective payment
system hospital-specific rate and the
prospective payment system national and
regional rates. A hospital's specific rate is
based on its operating costs during a
particular base year. See 42 C.F.R. §§
412.71, 412.73. For most hospitals the
prospective payment system base year was
FY 1983. Therefore, for the first four
years of the prospective payment system, a
hospital’s reimbursement was still
significantly affected by its actual
operating costs in the FY 1983 base year.
As part of the prospective payment system
transition period, the Health Care
Financing Administration promulgated the
Consistency Rule, which required graduate
medical education costs for cost reporting
periods during the prospective payment
system transition period be determined in
a manner “consistent with the treatment of
these costs for purposes of determining the
hospital-specific . . . rate.” 42 C.F.R. §
412.113(b)(3). In effect, the Consistency
Rule locked in the classification of
graduate medical education costs and
operating costs from the prospective
payment system base year (FY 1983)
forward.
The TEFRA and prospective
payment system reimbursements applied
only to inpatient operating costs. Graduate
medical education costs were specifically
excluded from the definition of “inpatient
operating cos ts.” 4 2 U .S.C . §
1395ww(a)(4), 1395ww(d)(1)(A). Thus,
grad uate medical education costs
continued to be reimbursed under the
previous reasonable cost system until
1986.
In 1986, Congress enacted a
separate prospective payment system for
graduate medical education costs for all
cost reporting periods beginning on or

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4
after July 1, 1985. 42 U.S.C. §
1395ww(h). Central to this new payment
system was the determination of the base
average per-resident amount (“APRA”).
The APRA is determined by dividing the
hospital's base year graduate medical
education costs by the number of full-time-
equivalent residents working at the
hospital in the base year. The graduate
medical education base year is the
hospital’s fiscal year beginning during the
federal fiscal year 1984. 42 U.S.C. §
1395ww(h)(2)(A). For most Pennsylvania
hospitals, this is the fiscal year ended June
30, 1985. The APRA then serves as the
base figure in the formula to calculate
g r a d u a t e m e d i c a l e d u c a t i o n
reimbursements for 1985 and future cost
years. 42 U.S.C. § 1395ww(h)(2)(C), (D);
1395ww(h)(3).
1. Determining the APRA.
In 1990, to assure maximum
accuracy of each hospital’s APRA
determination, the Secretary required fiscal
intermediaries5 to reaudit all hospitals’
1985 graduate medical education base year
costs. The reaudit would ensure the future
payments would be based on an accurate
determination of the hospitals' graduate
medical education costs in the base-year.
To prevent over-reimbursement, the
regulations instruct intermediaries to
deduct from each reaudited hospital’s base
year graduate medical education amount
any operating costs misclassified as
education costs. 4 2 C .F.R . §
413.86(e)(1)(ii)(B). To prevent under-
reimbursement, the regulations authorize
intermediaries, “upo n a ho spital’s
request,” to include in the base year
graduate medical education amount any
teaching costs misclassified as operating
costs in the base-year cost report. 42
C.F.R. § 413.86(e)(1)(ii)(C). After
determining the hospital's APRA upon
reaudit, the intermediary notifies the
hospital of the amount by a Notice of
A v e r a g e P e r R e s i d e n t A m o u n t
(“NAPRA”). 42 C.F.R. § 413.86(e)(1)(v).
The hospital may appeal this amount to the
Secretary within 180 days of the NAPRA.
Id.
To supp ort a claim for
reclassification of misclassified graduate
medical education costs, a hospital must
present the intermediary with "sufficient
documentation" requiring a change in the
classification of costs. 42 C.F.R. §
413.86(l)(2)(ii). The regulations required
actual documentation developed during the
base year that was maintained in an
5The Medicare program uses “fiscal
inter me diar ies,” ge ne ra lly p rivate
insurance companies, to perform many of
the program's administrative functions.
Fiscal intermediaries are responsible for
determining the amount of payments to be
made to providers. In the present case,
Mercy Catholic Medical Center’s fiscal
intermediary at the relevant time was
Independence Blue Cross. The
Interm ediary, in turn, engaged a
subcontractor, in this case Johnston,
Young & O’Fria, to conduct the graduate
medical education reaudit.

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5
auditable format. See 42 C.F.R. §
405.481(g) (1986); Medicare Program;
Changes in Payment Policy for Direct
Graduate Medical Education Costs, 54
Fed. Reg. 40,301 (Sept. 29, 1989).
The Secretary recognized, however,
that some hospitals would no longer have
the records required to support a
reclassification of costs. As such, the
Secretary allowed auditors to accept time
records from subsequent time periods as
proxy. “Graduate Medical Education:
Documentation to Support the Physician
Cost/Time Allocation” (1990), JA 211-
215.6 Where subsequent year records were
also unavailable, hospitals were allowed to
perform three-week time studies7 of
current physician workloads to provide a
rough estimate of the time allocation of
teaching physicians in the base year. See
Medicare Program; Changes to the
Inpatient Hospital Prospective Payment
System and Fiscal Year 1991 Rates, 55
Fed. Reg. 36,064.
The Secreta ry noted these
alternative forms of documentation were
i n h e r e n t l y l e s s r e l i a b l e t h a n
contemporaneous records from the
graduate medical education base year. Id.
A limited exception was created restricting
the use of substitute documentation from
later years to verify costs originally
claimed as graduate medical education
costs in the graduate medical education
base year, but disallowing the use of
documents from later years to increase the
grad uate medical education costs
originally claimed. As published in the
Federal Re giste r, the S ecreta ry’s
interpretation read:
As an equitable solution to
t h e p ro b le m o f t h e
nonexistence of physician
allocation agreements, time
r e c o r d s , a n d o t h e r
i n f o r m a t i o n , w e a r e
allowing prov iders to
furnish documentation from
cost repo rting periods
subsequent to the base
period in support of the
allocation of physician
compensation costs in the
GME base period . . . . In
no event will the results
obtained from the use of the
r e c o r d s f r o m a c o st
reporting period later than
the base period serve to
increase or add physician
compensation costs to the
costs used to determine the
per resident amounts.
55 Fed. Reg. at 36,063-64.
6The policy was later published in the
Federal Register at 55 Fed. Reg. 35,990,
36,063-64 (Sept. 4, 1990).
7In performing a time study, a physician
would, on a daily basis, log time worked
for a provider over a period of several
weeks allocating time to various activities
such as administration, supervision, or
teaching of interns and residents.

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6
2. Adjusting Hospital-Specific
Rate and Target Amount for
Misclassified Costs.
A hospital may also request the
reclassification of misclassified operating
costs. Misclassified operating costs are
costs that had been included as graduate
medical education costs in the graduate
medical education base year, but were
reclassified by the intermediary as
operating costs. 42 C.F.R. § 413.86(e)(1).
If the misclassified operating costs were
treated as graduate medical education costs
in both the graduate medical education
base year and the prospective payment
system base year, an upward adjustment of
the hospital’s specific rate or TEFRA
target amount may be warranted since the
hospital-specific rate and target amount are
derived from operating costs in a base
year. 54 Fed. Reg. 40,286, 40,289 (Sept.
29, 1989). Conversely, if the reaudit
revealed misclassified graduate medical
education costs (which would increase the
ARPA), a corresponding downward
adjustment of operating costs for the
graduate medical education base year was
required. Id.
The regulations allow a hospital to
“request that the intermediary review the
classification of the affected costs in its
rate-of-increase ceiling or prospective
payment base year for purposes of
adjusting the hospital's target amount or
hospital-specific rate.” 42 C.F.R. §
413.86(l)(1)(i). To reclassify these costs,
a hospital must specifically "request
review of the classification of its . . . costs
no later than 180 days after the date of the
[NAPRA]” and “include sufficient
documentation to demonstrate to the
intermediary that adjustment of the
hospital’s hospital-specific rate or target
a m o u n t i s w a r r an t e d .” I d . §
413.86(l)(1)(ii).
B. Facts
On December 21, 1989, Mercy
Catholic Medical Center received notice
the Intermediary (“Independent Blue
Cross”) was reopening its cost reports for
FYE (“Fiscal Year Ended”) 1985, 1986,
1987 and 1988 to perform the reaudit
under the graduate medical education
regulation. During the reaudit, the
Intermediary made several downward
adjustments to Mercy Catholic Medical
Center's graduate medical education costs
but refused to make other adjustments to
its graduate medical education costs and
operating costs. The Intermediary's
downward adjustment of graduate medical
education costs and refusal to reclassify
certain operating costs as graduate medical
education costs reduced Mercy Catholic
Medical Center's APRA from $81,745 to
$73,657. Mercy Catholic Medical Center
filed a timely appeal of the Notice of
Average Per Resident Amount with the
Board.
At the time, however, Mercy
Catholic Medical Center no longer
possessed all of the original supporting
documentation of its base year graduate
medical education costs because the
governing rules only required hospitals to

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7
retain physician allocation agreements8
(also known as “339s”) for four years from
the close of FYE 1985 (i.e., until June 30,
1989). Furthermore, Mercy Catholic
Medical Center had experienced a flood in
the basement storage area and discarded
all damaged records that were beyond their
retention date.
Mercy Catholic Medical Center did,
however, retain some of the 339s for the
departments in question. At oral argument
before this Court, both parties stipulated
some 339s were included in the
administrative record, although not
included as formal exhibits. The Provider
Reimbursement Review Board, however,
did not acknowledge them. See Mercy
Catholic Med. Ctr. v. Blue Cross Blue
Shield Ass’n, PRRB Dec. No. 2001-D55
(Sept. 28, 2001), Medicare and Medicaid
Guide (CCH) ¶ 80,747, at 202,481
(“PRRB Dec.”) (“[T]here was insufficient
evidence regarding forms 339 and
physician allocation agreements.”).9
During late 1990, however, Mercy
Catholic Medical Center conducted a
three-week time study that tracked what
portion of each teaching physician's time
was devoted to services that qualify as
graduate medical education costs. During
the reaudit, Mercy Catholic Medical
Center realized it had misclassified all of
the time spent by physicians in three
Departments—OB/GYN, Laboratory, and
Radiology—as operating costs in the
graduate medical education base year.
Even though these physicians had in fact
been providing substantial graduate
medical education services, it had been
Mercy Catholic Medical Center’s historic
practice to report as operating costs all
costs for physicians whose duties were not
primarily teaching. Id. The 1990 time
studies included all of the physicians who
performed teaching duties in 1985,
including those in the three “missing
departments.” In seeking graduate medical
education credit, Mercy Catholic Medical
Center timely requested the requisite
downward adjustment to its hospital-
specific rate and target amount under 42
C.F.R. § 413.86(l)(2).
In performing the reaudit, the
Subcontractor (“Johnston, Young &
O’Fria”) accepted Mercy Catholic Medical
Center's 1990 time studies as accurate and
compliant with the Health Care Financing
Administration’s instructions of June 22,
1990, and relied upon them to reduce the
compensation and related teaching costs
Mercy Catholic Medical Center had
claimed as graduate medical education
expenses. The Subcontractor advised
Mercy Catholic Medical Center, however,
that it had been instructed by the
Intermediary (“Independence Blue Cross”)
to strictly limit its reaudit to only those
8A physician allocation agreement
specifies the respective amount of time a
physician spends on teaching and
supervision as opposed to time spent on
patient care. 55 Fed. Reg. at 36,063.
9The 339s were not supported by
contemporaneous time sheets or “source
documentation .” Ora l A rgument
Transcript at 29-30.

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8
FYE 1985 costs that Mercy Catholic
Medical Center had reported as graduate
medical education costs in the graduate
medical education base year—to validate
or reduce those costs—and to ignore
evidence of any other costs, including
physician and support expenses, that had
previously been claimed in FYE 1985 as
operating costs. Accordingly, the
Subcontractor declined to review time
studies and other documentation pertaining
to these three missing departments while,
on the basis of the 1990 time studies, the
Intermediary reclassified $719,055 in
graduate medical education costs from
FYE 1985 as operating costs and excluded
that amount from the APRA calculation.
According to Mercy Catholic
Medical Center, the reclassifications
reduced its total graduate medical
education costs from $6,876,731 to
$6,157,676, and its APRA from $81,745 to
$73,657. Recognition of the misclassified
graduate medical education costs from the
three missing departments based on the
1990 time studies, which the Intermediary
refused, would have resulted in an APRA
of $79,685.80. The retrospective
application of the disputed APRA reduced
Mercy Catholic M edical Center’s
r e i m b u r se m e n t b y a p pr ox im a t e ly
$2,500,000 from FY 1986-91, and by
approximately $250,000 to $500,000
annually. Mercy Catholic Medical Center
also lost approximately $275,000 in
hospital-specific rate reimbursement
during the prospective payment system
transition period as a result of the refusal
to increase the hospital-specific rate to
include Mercy Catholic Medical Center’s
misclassified operating costs, and is losing
approximately $50,000 to $200,000 in
annual reimbursement for its psychiatric
unit as a result of the refusal to increase
Mercy Catholic Medical Center’s target
amount.
In addition to requesting credit for
grad uate medical education costs
attributa ble to the three missing
departments, Mercy Catholic Medical
Center also asked the Intermediary to
increase its hospital-specific rate and target
amount to include any operating costs that,
based upon the 1990 time studies, had
properly been determined to have been
misclassified in FYE 1985 as graduate
medical education costs. See 42 C.F.R. §
413.86(l). Mercy Catholic Medical Center
also requested a corresponding downward
adjustment to its hospital-specific rate and
target amo unt if a ny physic ian
compensation costs originally classified as
operating costs were reclassified as
graduate medical education costs. See 42
C.F.R. § 413.86(l)(2). Finally, Mercy
Catholic Medical Center asked the
Intermediary to increase the hospital-
specific rate and the target amount of its
prospective payment system-exempt
psychiatric unit to include the operating
costs determined to have been erroneously
reported in FY 1985 as graduate medical
education costs under § 413.86(e)(1)(v)
and (l)(1). The Intermediary refused to
make the requested hospital-specific rate
and target amount adjustments.

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9
C. The Provider Reimbursement
Review Board’s Decision
Mercy Catholic Medical Center
appealed two issues to the Provider
Reimbursement Review Board: (1) the
Intermediary's refusal to recognize the
graduate medical education costs from the
three missing departments in the APRA
and; (2) the Intermediary's refusal to
increase its hospital-specific rate and target
amount to take into account those costs
that were reclassified from graduate
medical education costs to operating costs
in the reaudit. The Board held a hearing
and issued its decision on September 28,
2001.
T h e B o a r d affirm ed th e
Intermediary on both issues. As a
threshold matter, the Board agreed with
Mercy Catholic Medical Center that over-
allocations and under-allocations of base
year graduate medical education costs
were properly subject to correction during
the reaudit under 42 C.F.R. § 413.86(e),
because the statute and GME rule envision
“a ‘two way street’ of changing
erroneously claimed GME costs to
operating costs (‘OC’) and vice versa.”
PRRB Dec. at 202,480. In light of this, the
Board found the Intermediary had
incorrectly instructed its Subcontractor to
ignore the time studies and other evidence
of misclassified graduate medical
education costs (as opposed to
misclassified operating costs). PRRB Dec.
at 202,480-81. In fact, the Board’s
decision included the following finding:
15. The HCFA instructions
reinforced this concept;
however, an addendum
consisting of questions and
answers was incorrectly
i n t e r p r e t e d b y t h e
Intermediary as meaning
that no new GME costs
could be added by the re-
audit from OC.
a. The Intermediary, IBC
[Independence Blue Cross],
wrongfully instructed the
audit subcontractor not to
increase the GME costs by
r e c l a s s i f y i n g a n y
misclassified OC.10
The Board found nonetheless "there
[was] no creditable evidence in the record
to reclassify the misclassified OC to GME
costs because of the lack of form 339's and
the fact that the 1990 time studies were not
audited by the Intermediary, nor is there
adequate documentation in the record
regarding these time studies." PRRB Dec.
at 202,481.
On the second issue, the Board
agreed Mercy Catholic Medical Center had
timely requested revision of its hospital-
specific rate and target amount. Id. It
concluded, however, the Intermediary was
10We think the Board intended
“misclassified GM E” in this finding. But
the result is the same: The Board found
originally claimed graduate medical
education costs could be increased by
adding misclassified costs.

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10
not required to revise the hospital-specific
rate or target amount because Mercy
Catholic Medical Center had not provided
the required documentation directly to the
Intermediary within 180 days of the Notice
of Average Per Resident Amount.
D. District Court Decision
The District Court affirmed the
Board. Mercy Catholic Med. Ctr. v.
Thompson, No. 02-419, 2003 U.S. Dist.
LEXIS 4688 (E.D. Pa. Mar. 5, 2003).
Reviewing the first issue, the District
Court determined the limited exception to
the requirement for contemporaneous
documentation restricted the use of
substitute documentation from later years
to verify costs originally claimed as
graduate medical education costs in the
graduate medical education base year, and
did not serve to add or increase costs to the
original graduate medical education costs
claimed. Id. at *22-23. For support, the
Court cited the Secretary’s representations
that later year records “were inherently
less reliable,” and that providers had
“significant incentives to inflate their
GME costs in the base year under the new
methodology.” Id. at *24 (quoting
Presbyterian Med. Ctr., No. 95-1939,
1998 U.S. Dist. LEXIS 6254, at 12-13
(D.D.C. April 21, 1998), aff’d, 170 F.3d
1146 (D.C. Cir. 1999)).
The District Court also affirmed on
the basis of lack of documentation. The
Court found Mercy Catholic Medical
Center’s claims suspect because the
a d m i n i s t r a t i v e r e c o r d l a c k e d
contemporaneous evidence of 339's in the
three missing departments. The Court
wrote: “[t]he record indicates that Mercy
no longer had any of the 339s and that
Mercy did not submit any other evidence
[to support a reclassification of costs],
other than the time study conducted in
1990.” Id. at *24-25. Although
recognizing Mercy Catholic Medical
Center was not notified of a reaudit until
after the record retention period had
expired, the District Court nonetheless
concluded Mercy Catholic Medical Center
could be penalized for failing to maintain
its 339 forms because it had received
“constructive notice” that those costs
“would likely be the subject of ongoing
review.” Id. at *27.
On the second issue, the District
Court affirmed the Board’s ruling that
Mercy Catholic Medical Center was not
entitled to increases in its hospital-specific
rate and target amount because it failed to
present documentation comparing Mercy
Catholic Medical Center’s FY 1983 and
1985 graduate medical education programs
directly to the intermediary, noting that it
was the hospital’s “burden . . . to present
sufficient evidence.” Id. at *33.
II.
We have jurisdiction under 28
U.S.C. § 1291. We review the grant of
summary judgment de novo. Fertilizer
Inst. v. Browner, 163 F.3d 774, 777 (3d
Cir. 1998). Like the District Court, we
review a final decision of the Secretary11
11In this case, the Board’s decision was
the final decision of the Secretary.

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11
under 42 U.S.C. § 1395oo(f)(1), which
incorporates the standard of review of the
Administrative Procedure Act, 5 U.S.C. §
706. Under the APA, we will affirm
unless the Secretary’s decision is
"arbitrary, capricious, an abuse of
discretion, or otherwise not in accordance
with law; [or] unsupported by substantial
evidence." 5 U.S.C. § 706(2)(A),(E);
Robert Wood Johnson Hosp. v. Thompson,
297 F.3d 273, 280 (3d Cir. 2002). But
when applying this standard, a reviewing
court may not merely rubber-stamp the
Secretary’s actions, but must ensure that
the agency’s ruling is neither clearly
erroneous nor inconsistent with applicable
regulations. Thomas Jefferson Univ.
Hosp. v. Shalala, 512 U.S. 504, 512
(1994). Further, we may affirm the
agency’s decision only on grounds on
which the agency actually relied, and not
on the basis of alternative rationales or
justifications put forward by counsel on
appeal. SEC v. Chenery Corp., 318 U.S.
80, 87 (1943).
III.
A. Graduate Medical Education Costs
1. As Applied to the Facts of this
C a s e , t h e S e c r e t a r y ’ s
Interpretive Rule is Arbitrary
and Capricious.
Mercy Catholic Medical Center
contends the Secretary’s failure to consider
its 1990 time studies to the extent they
supported a positive adjustment to its
reported FY 1985 graduate medical
education costs was arbitrary and
capricious. As a threshold matter, we must
determine the level of deference, if any, to
afford the Secretary’s interpretation of the
graduate medical education reaudit rule.12
As noted, when it became clear
providers did not always retain
contemporaneous time records to facilitate
the reaudit, the Secretary issued a special
grad uate m edical education cost
documentation rule for reaudits as an
official instruction to fiscal intermediaries,
“ G r a d u a t e M e d i c a l E d u c a t io n :
Documentation to Support the Physician
Cost/Time Allocation” (1990), JA 211-
215. The Secretary’s written interpretation
provides that later-year time studies, of the
sort relied on by Mercy Catholic Medical
Center, could only serve to verify costs
that were originally claimed as graduate
medical education costs in the base year,
and could not support the addition of costs
not originally claimed as graduate medical
education costs. The limited exception to
the record-keeping policy provides:
As an equitable solution to
t h e p r o b l e m o f t h e
nonexistence of physician
allocation agreements, time
r e c o r d s , a n d o t h e r
i n f o r m a t i o n , w e a r e
allowing providers to
furnish the documentation
from cost reporting periods
subsequent to the base
period in support of the
12The District Court did not explicitly
address the level of deference it warranted
the Secretary’s interpretive rule.

-- 11 of 26 --

12
allocation of physician
compensation costs in the
GM E base period . . . . It is
only in the absence of base
period documentation that
subsequent documentation
should be considered as a
proxy for base period
documentation for purposes
of determining the per
resident amount. In no
event will the results
obtained from the use of the
r e c o rds from a cost
reporting period later than
the base period serve to
increase or add physician
compensation costs to the
costs used to determine the
per resident amounts.
55 Fed. Reg. at 36,063-64 (emphasis
added).13
Following its interpretation, the
Secretary now argues the limited exception
to the rule requiring contemporaneous
documentation only allows the use of
records from subsequent cost reporting
periods to verify costs and allocations
claimed as graduate medical education
costs during the graduate medical
education base year—not to support
increases to those costs in the base year.
We owe no deference to an agency
interpretation plainly inconsistent with the
relevant statute. See Pub. Employees
Retirement Sys. v. Betts, 492 U.S. 158, 171
(1989) (“[N]o deference is due to agency
interpretations at odds with the plain
language of the statute itself.”). In the
same vein, an agency’s interpretation of its
own regulations is not entitled to
substantial deference by a reviewing court
where “‘an alternative reading is
compelled by the regulation’s plain
meaning or by other indications of the
Secretary’s intent at the time of the
regulation’s promulgation.’” Thomas
13The Agency supplemented its rule
with the following question and answer:
Question: If a provider did
n o t c h a r g e p hy s ic ia n
compensation to GME in
the base period, can it
request that documentation
from a subsequent period be
used, at this time, to revise
its base period costs for the
purpose of calculating its
a v e r a g e p e r r e si d e n t
amount?
Answer: No. As explained
in HCFA’s instructions, the
use of subsequent period
documentation to support
the allocation of physician
costs may not be used to
increase the amount of
physician compensa tion
originally claimed by the
provider in its GME base
period. Graduate Medical
Education: Questions and
Answers (Nov. 8, 1990), JA
872.

-- 12 of 26 --

13
Jefferson Univ. Hosp., 512 U.S. at 512
(quoting Gardebring v. Jenkins, 485 U.S.
415, 430 (1988)). Mercy Catholic Medical
Center contends the graduate medical
education rule is written in neutral
language that compels intermediaries to
accurately calculate graduate medical
education costs, and to correct all
misclassified costs, operating costs and
graduate medical education costs, to arrive
at the most accurate APRA possible. We
agree and find the Se cre tar y’s
interpretation directly contradicts the plain
language of the graduate medical
education regulation and cannot be upheld.
The plain language of the graduate
medical education rule does not support
limiting corrections upon reaudit to
misclassified operating costs, but rather
anticipates corrections of misclassified
graduate medical education costs and
operating costs.
42 C.F.R. § 413.86(e) and (l)
provide:
(e) Determining per resident
amounts for the base period
– (1) For the base period.
(i) . . . the intermediary
determines a base-period per
resident amount for each
hospital as follows . . .
(ii) In determining the base
p e r i o d a m o u n t u n d e r
paragraph (e)(1)(i) of this
section, the intermediary – .
. .
(A) Verifies the hospital’s
b a s e - p e r i o d g r a d u a t e
medical education costs and
the hospital’s average
number of FTE residents;
(B) Excludes from the base-
period graduate medical
e d u c a t i o n c o s t s a n y
n o n a l l o w a b l e o r
m i s c l a s s i f i e d c o s t s ,
including those previously
a l l o w e d u n d e r §
4 1 2 .113(b)( 3 ) o f t h is
chapter; and
(C) Upon a hospital’s
request, includes graduate
medical education costs that
were misclassified as
operating costs during the
h o s p i t a l ’ s p r o s p e c t i v e
payment base year and were
not allowable under §
4 1 2 . 1 1 3 (b )( 3 ) o f t h is
chapter during the graduate
medical education base
period. These costs may be
included only if the hospital
requests an adjustment of its
p r o s p e c t i v e p a y m e n t
hospital-specific rate or
target amount as described
in paragraph [(l)(2)] of this
section.
(l) Adjustment of a
hospital’s target amount or
p r o s p e c t i v e p a y m e n t
hospital-specific rate – (1)

-- 13 of 26 --

14
M isclassified oper ating
costs . . .
(2) Misclassification of
graduate medical education
costs – (i) General rule. If
costs that should have been
classified as graduate
medical education costs
were treated as operating
costs during both the
graduate medical education
base period and the rate-of-
increase ceiling base year or
prospective payment base
year and the hospital wishes
to receive benefit for the
appropriate classification of
these costs as graduate
medical education costs in
t h e g radu ate m edic a l
education base period, the
hospital must request that
the intermediary review the
classification of the affected
costs in the rate-of-increase
ceiling or pro spec tive
payment base year for
purposes of adjusting the
hospital’s target amount or
hospital-specific rate.
42 C.F.R. § 413.86(e), (l) (emphasis
added).
The regulation’s plain language
requires the Intermediary to correct all
misclassified costs, not just misclassified
graduate medical education costs. The
Secretary’s restrictive approach conflicts
with the regulatory language.
Additionally, the intent of the rule
supp orts our inter pre tatio n. I n
promulgating § 413.86, the Secretary
determined a reaudit of FY 1985 cost
reports was warranted because hospitals
may not have accurately distinguished
between teaching time and administrative
and other time spent by teaching
physicians in FY 1985, since at that point
in time there were no real reimbursement
c o n s e q u e n c e s e i t h er w a y , a n d
Intermediaries had applied the audit rules
inconsistently. 54 Fed. Reg. 40,286,
40,288-89, 40,301-02. In this vein, the
Secretary noted: “In establishing the base-
period per resident amount for a specific
hospital . . . it is important that the amount
determined be an accurate determination
of providers’ 1984 GME costs.” 54 Fed.
Reg. 40,286, 40,288. The goal of an
accurate determination of costs supports
both increases and decreases to 1984
graduate medical education costs. The
Secretary’s intent is particularly relevant to
this case where Mercy Catholic Medical
Center is not seeking to add additional
costs not audited in 1985, but rather, seeks
to reallocate operating costs as graduate
medical education costs based on the same
time studies the Intermediary relied on to
reclassify costs in the opposite direction.
Our position is consistent with the
Supreme Court’s interpretation of the
graduate medical education reaudit rule in
Regions Hosp. v. Shalala, 522 U.S. 448
(1998). In upholding the reaudits, the
Court wrote, the audits were required “to
catch errors that, if perpetual, could
grossly distort future reimbursement.” 522

-- 14 of 26 --

15
U.S. at 457-58. To make the APRA
accurate and avoid perpetrating errors, the
reaudit requires correcting all relevant
classification errors, not merely those that
result in a reduction of graduate medical
education costs.
As noted, we find the reaudit rule
envisions a two-way street. The
Secretary’s interpretation is at odds with
this principle. Significantly, the Provider
Reimbursement Review Board agreed,
holding the graduate medical education
rule r e q uired reclassification o f
misclassified graduate medical education
costs and operating costs. PRRB Dec. at
202,480. In doing so, the Board explicitly
discredited the interpretation of the rule
adopted by the Secretary in this litigation.
E v e n i f th e S ec re tar y’ s
interpretation were not at odds with the
plain language of the rule, his
interpretation is still not entitled to
Chevron-level deference.14 An Agency
interpretation “‘qualifies for Chevron
deference when it appears that Congress
delegated authority to the agency generally
to make rules carrying the force of law,
and that the agency interpretation claiming
deference was promulgated in the exercise
of that authority.’” George Harms Constr.
Co. v. Chao, 371 F.3d 156, 161 (3d Cir.
2004) (quoting United States v. Mead
Corp., 533 U.S. 218, 226-27 (2001)).
Agency statements contained in opinion
letters, policy statements, agency manuals,
and enforcement guidelines lack the force
of law and “do not warrant Chevron-style
deference.” Christensen v. Harris County,
529 U.S. at 587; Madison v. Res. for
Human Dev., Inc., 233 F.3d 175, 185 (3d
Cir. 2000). “To grant Chevron deference
to informal agency interpretations would
unduly validate the results of an informal
process.” Madison, 233 F.3d at 186. We
have made clear that agency interpretive
guidelines “do not rise to the level of a
regulation and do not have the effect of
law.” Id. (quoting Brooks v. Village of
Ridgefield Park, 185 F.3d 130, 135 (3d
Cir. 1999)).
As for the persuasiveness of agency
interpretive guidelines, we continue to rely
on the framework laid out in Skidmore v.
Swift, 323 U.S. 134 (1944). See
Christensen, 529 U.S. at 587; Madison,
14In Presbyterian Medical Center, 1998
U.S. Dist. LEXIS 6254, aff’d, 170 F.3d
1146, the District Court for the District of
Columbia held the Secretary’s instruction
on the use of later time-records was an
“interpretive rule,” and afforded the rule
Chevron deference. Id. at *9. We note
Presbyterian was decided before
Christensen v. Harris County, 529 U.S.
576 (2000), where the Supreme Court
clarified the deference due agency opinion
letters. See id. at 587 (declining to afford
Chevron deference to Department of
Labor’s opinion letter). We believe the
instruction at issue is an interpretive rule.
See 5 U.S.C. § 553(b)(A) (discussing
informal rule-making without notice and
comment). But we disagree with the level
of deference granted in Presbyterian
Medical Center.

-- 15 of 26 --

16
233 F.3d at 186. The Skidmore Court
explained:
We consider that the rulings,
interpretations and opinions
of the Administrator under
t h i s A c t , w h i le n o t
controlling upon the courts
by reason of their authority,
do constitute a body of
experience and informed
judgment to which courts
and litigants may properly
resort for guidance. The
weight of such a judgment
in a particular case will
d e p e n d u p o n t h e
thoroughness evident in its
consideration, the validity of
its reasoning, its consistency
with earlier and later
pronouncements, and all
those factors which give it
power to persuade, if
lacking power to control.
323 U.S. at 140.
Under Skidmore analysis, we find
the Agency has inconsistently applied the
Secretary’s instructions concerning what
costs can be recognized in the reaudit
process. In Abbott v. NW Mem’l Hosp.,
PRRB Dec. No. 95-D10, Medicare &
Medicaid Guide (CCH) ¶ 42, 970 (Dec. 7,
1994) aff’d, HCFA Adm’r Dec., Medicare
& Medicaid Guide (CCH) ¶ 43,136 (Feb.
2, 1995), the provider presented base year
physician allocation agreements, but did
not produce supporting time records from
the base year.15 The HCFA Administrator
determined that subsequent year time
studies may be used to increase physician
compensation in excess of amounts
originally claimed in the graduate medical
education cost center if the time studies
were consistent with contemporaneous
data. The Administrator subsequently
repudiated his earlier position, see
Presbyterian Med. Ctr., 1998 U.S. Dist.
LEXIS 6254, and adopted his current
position, that the amount claimed in the
graduate medical education cost center
could only be increased based on
contemporaneous documentation, not
subsequent period time studies. “The
Secretary is not estopped from changing a
view . . . believe[d] to have been grounded
upon a mistaken legal interpretation,”
Good Samaritan Hosp. v. Shalala, 508
U.S. 402, 417 (1993), but this
inconsistency can affect the level of
d e f e r e n ce af fo rd ed an ag en cy’ s
interpretation. See Skidmore, 323 U.S. at
140. The Secretary’s internally conflicting
positions on this issue militate against
affording deference to the interpretive
rule.16
15As noted, M ercy Catholic Medical
Center did retain some of its 339 allocation
agreements, and these were included in the
administrative record.
16Mercy Catholic Medical Center also
argues the Secretary endorsed a position
inconsistent with that taken in the current
case when defending the validity of the
graduate medical education rule before the
Supreme Court in Regions, 522 U.S. 448.

-- 16 of 26 --

17
In Regions, the Supreme Court considered
the broader issue of whether the
Secretary’s enactment of the rule
providing for a retrospective reaudit of
graduate medical education costs was a
reasonable interpretation of the graduate
medical education amendment, 42 U.S.C.
§ 1395ww(h), under Chevron. The Court
conditioned its affirmance of the graduate
m e d i c a l e d ucatio n rule o n th e
understanding that hospitals would not be
penalized for lack of documentation which
they were no longer required to maintain.
Id. at 465. The Secretary overcame this
problem through the “equitable solution”
discussed above. According to Mercy
Catholic Medical Center, Government
counsel suggested the Secretary would
allow providers to add to, as well as
decrease, base-year graduate medical
education costs based on the following
discussion at oral argument:
Question [Breyer, J.]: I
would just like to be clear in
my own mind. What
petitioner said . . . [is] that
they have changed the
classification of certain
f i x e d c o s t s , t h e
administrative costs, from
education costs to operating
costs, not because of new
e vidence but b e c a u se
petitioner no longer had
audit documentation . . . .
Am I right in thinking that
isn’t the problem, because if
there are some pieces of
paper and other evidence
that are no longer around,
the Secretary will permit the
hospital to introduce –
Ms. Blatt [government
counsel]: Yes
Question: – other evidence,
later evidence, or anything
that –
Ms. Blatt: That’s correct,
and ironica lly, Justice
Breyer, the petitioner did
present subsequent year data
. . . because the [old] time
records did not break . . .
down the costs [sufficiently]
. . . they were allowed to use
a new time study, and that’s
why there was a settlement
in this case, the petitioner
actually got an increase in
the per-resident average . . .
.
Oral Argument Transcript at 16, Regions
Hospital v. Shalala, No. 96-1375, 1997
WL 751915 (U.S.S.Ct. Dec. 1, 1997).
Based on this interchange, Mercy Catholic
Medical Center argues that the principle of
judicial estoppel should prevent the
Secretary from switching positions in this
litigation. Because we find the Secretary’s
interpretive rule contrary to the plain
language of the regulation, inconsistently

-- 17 of 26 --

18
Nonetheless, the Secretary argues
its interpretative rule is reasonable and
entitled to deference. Contending later
year records are inherently less reliable,
the Secretary argues it is reasonable to
limit the weight afforded to these records.
According to the Secretary, hospitals may
attempt to manipulate graduate medical
education costs with documentation
developed after the base year, for purposes
of increasing their APRA.
In Presbyterian Medical Center v.
Shalala, 170 F.3d 1146 (D.C. Cir. 1999),
the Court of Appeals for the D.C. Circuit
noted the Secretary’s interpretive rule was
reasonable because:
GME costs claimed in the
base year have already gone
through a verif icatio n
p r o c e s s r e q u i r i n g
c o n t e m p o r a n e o u s
documentation. Additional
GME costs claimed during
reaudit have not. Because
later year record are
inherently less reliable, and
because hospitals have
significant incentives to
inflate their GM E costs in
the base year . . . we think
the interpretive rule, by
p r o h i b i t i n g
n o n c o n t e m p o r a n e o u s
records from supporting
GME costs . . . reasonably
f u r t h e r s — n o t
f r u s t r a t e s — a c c u r a t e
determination of GME
costs.”
Id. at 1150-51 (internal quotations and
citations omitted). We respectfully
disagree.
We see no valid reason to generally
ascribe to teaching hospitals wrongful
over-reporting of teaching costs. Because
of the Consistency Rule, hospitals had no
opportunity to change classification of
costs in FY 1985 from that reported in FY
1983, the prospective payment system base
year. 42 C.F.R. § 412.113(b)(3). Nor did
teaching hospitals have a financial
incentive to misallocate either graduate
medical education costs or operating costs
in the prospective payment system base
year, 1983, as Medicare reimbursed both
education costs and operating costs on a
reasonable cost basis during that period.
Consequently, there is no reason to expect
errors in cost reporting in 1984-85 would
have favored reporting costs in one
category or the other. Additionally, since
§ 1395ww(h) was enacted in 1986 and
mandated the use of FY 1985 as the
graduate medical education base year—a
year which predated this change in the
law— to set the APRA, providers had no
notice or opportunity to “game the system”
by over-reporting teaching costs.17
applied, and lacking valid reasoning, we
do not reach Mercy Catholic Medical
Center’s judicial estoppel argument.
17The Secretary’s Interpretive Rule does
not clarify the difference between adding
graduate medical education costs not

-- 18 of 26 --

19
previously claimed, and reclassifying
misclassified graduate medical education
costs previously classified as operating
costs. The district court in Presbyterian
noted the specific question before the court
was “whether later year records can be
used to support an increase in GME costs
over what was originally claimed in the
base year.” 1998 U.S. Dist. LEXIS 6254,
at *9. In discussing the Secretary’s
interpretive rule, the court noted: “In [the
Secretary’s] judgment, however, she did
not think it appropriate for hospitals to be
able to use later year records to support an
increase in GME costs over what hospitals
had originally claimed.” Id. at *12-13; see
also Cleveland Clinic Found. v. Shalala,
No. 1:94 CV 2414, 1996 WL 636135, at
*2 (N.D. Ohio, Aug. 28, 1996) (rejecting
provider’s “attempts to claim additional
costs no[t] previously claimed in the base
year period”).
Unlike the situation in Presbyterian
and Cleveland Clinic, Mercy Catholic
Medical Center’s requested reclassification
of misclassified gra duate medical
education costs would serve only to
partially offset the graduate medical
education costs that were found by the
Intermediary to have been misclassified on
reaudit, and would not raise Mercy
Catholic Medical Center’s graduate
medical education costs above the amount
contemporaneously claimed in FY 1985.
In Abbott as well, the graduate
medical education cost additions did not
result in total graduate medical education
costs in excess of the amount the hospital
had previously claimed. There, the
Provider Reimbursement Review Board
noted:
The provider is not
attempting to increase or
a d d t h e p h y s i c i a n
compensation cost to the
costs claimed on its 1984
cost report which was used
to determine the Provider’s
per resident amount. All of
the costs that the Provider
has claimed were claimed in
the base year, although they
may not have been claimed
specifically in the Intern and
Resident cost center.
Abbott, Medicare & Medicaid Guide
(CCH) ¶ 42, 970, at 42,898.
The Agency supplemented its
interpretive rule with the following
question and answer:
Question: If a provider did
n o t c h a r g e p h ys i c i a n
compensation to GME in
the base period, can it
request that documentation
from a subsequent period be
used, at this time, to revise
its base period costs for the
purpose of calculating its
a v e r a g e p e r r e si d en t
amount?
Answer: No. As explained
in HCFA’s instructions, the
use of subsequent period
documentation to support
the allocation of physician

-- 19 of 26 --

20
The Secretary’s interpretation
requires the Intermediary to apply the
graduate medical education reaudit rule in
a one-sided fashion. An agency acts
arbitrarily and capriciously when it
construes or applies a regulation in an
inconsistent manner. See Walter Boswell
Mem’l Hosp. v. Heckler, 749 F.2d 788,
799 (D.C. Cir. 1984) (“It would be
arbitrary and capricious for HHS to bring
varying interpretations of the statute to
bear [in allocating costs to Medicare],
depending on whether the result helps or
hurts the Medicare’s balance sheets . . . .”).
Furthermore, the Secre tar y’s
interpretation eschews the fundamental
goal of neutral accuracy in a reaudit. See,
e.g., Boswell, 749 F.2d at 799; County of
Los Angeles v. Shalala, 192 F.3d 1005
(D.C. Cir. 1999). In County of Los
Angeles, the Court of Appeals for the D.C.
Circuit rejected the Secretary’s explanation
for selectively ignoring data where it
would increase Medicare payments based
on “[a] long line of precedent
[establishing] . . . that an agency action is
arbitrary when the agency offers
insufficient reasons for treating similar
situations differently.” Id. at 1022
(quoting Transactive Corp. v. United
States, 91 F.3d 232, 237 (D.C. Cir. 1996)).
The court held the Secretary’s discretion,
although broad, “is not a license to . . .
treat like cases differently.” Id. at 1023
(quoting Airmark Corp. v. FAA, 758 F.2d
685, 691 (D.C. Cir. 1985)).
By allowing non-contemporaneous
records to verify graduate medical
education costs or deduct graduate medical
education costs claimed in the base-year
cost report, but not allowing such records
to support the inclusion of graduate
medical education costs misclassified as
o p e rating co sts , th e S ec re tar y’ s
interpretive rule frustrates the regulatory
goal of ensuring an accurate determination
of a provider’s graduate medical education
costs. The Secretary either credits or
ignores later year time studies depending
on whether the correction of errors will
result in a reduction or increase in a
hospital’s graduate medical education
reimbursement. The Secretary’s restrictive
interpretive rule is arbitrary and capricious
because it contradicts the plain language of
the rule, has not been applied consistently,
and is unreasonable.18
costs may not be used to
increase the amount of
physician compensation
originally claimed by the
provider in its GME base
period.
Graduate Medical Education: Questions
and Answers (Nov. 8, 1990), JA 872
(emphasis added). As this case concerns
misclassified graduate medical education
costs, we find the Secretary’s position
concerning costs not originally claimed,
does not su pport the Secretary’s
interpretation as applied to this case.
18The Secretary’s rule may also effect
an illegal cost-shifting of Medicare costs
to non-Medicare patients, as it will shift
costs properly borne by Medicare to other
p a t i e n t s . S e e 4 2 U . S . C .

-- 20 of 26 --

21
2. Evidentiary Issues Support
Remand.
Mercy Catholic Medical Center
contends the District Court and the Board
erred in rejecting its appeal on the added
ground that Mercy Catholic Medical
Center failed to produce form 339
physician allocation agreements for the
three missing departments. We recognize
the able District Court was presented with
a confusing administrative record.
Nonetheless, we reverse and remand based
o n t h e a lt e r n a ti v e g ro u n d t h at
contemporaneous evidence of teaching
programs, including 339 forms, was
presented to the Provider Reimbursement
Review Board.
There is no dispute that Mercy
Catholic Medical Center conducted
accredited medical residency programs in
its Laboratory, OB/GYN, and Radiology
Departments in 1984-85. Before the
Board, Mercy Catholic Medical Center
i n t r o d u c e d c o n t e m p o r a n e o u s
documentation verifying its graduate
medical education activities. The Board
found: “In fiscal year 1985, the provider
conducted GME teaching programs in its
OB/GYN, Laboratory, and Radiology
Departments.” PRRB Dec. at 202,480.
Yet, the Board noted, “[t]here is no
creditable evidence in the record to
reclassify the misclassified OC to GME
costs because of the lack of form 339's . .
. .” Id. at 202,481. The District Court also
concluded, “[t]he record indicates that
Mercy no longer had any of the 339s and
that Mercy did not submit any other
evidence, other than the time study
conducted in 1990.” Mercy Catholic Med.
Ctr., 2003 U.S. Dist. LEXIS 4688, at *24-
25.
At oral argument, and in a
subsequent letter to this Court, Mercy
Catholic Medical Center proved that some
original 339s from the missing
departments had been included in the
administrative record, though, apparently,
not as formal exhibits.19 To the extent the
Provider Reimbursement Review Board
and the District Court grounded their
decisions on Mercy Catholic Medical
Center’s inability to produce copies of the
339 forms for the three missing
departments, it is clear that at least some of
these forms were produced in the
administrative record.20 Therefore, we will
§ 1395(x)(v)(1)(A).
19According to Mercy Catholic Medical
Center’s letter to this Court dated May 4,
2004, a “departmental 339 allocation”
form for the Radiology Department was
introduced as PRRB Exhibit 32.
20Although no 339 forms for individual
doctors were included in the appendix to
this Court, a “departmental 339 allocation”
form for all teaching physicians in the
Radiology Department in 1985 was
included. JA 381. Health Care Financing
A d m i n i s t r a t i o n ’ s i n s t r u c t io n s t o
in termediaries specify that suc h
“departmental time allocations may be
accepted” on reaudits. Instructions for
Implementing Program Payments for

-- 21 of 26 --

22
reverse and remand on the alternative
ground that sufficient contemporaneous
documentation of teaching programs in the
“missing departments” was produced to
support the reclassification of costs and
should have been considered by the Board.
In sum, the Secretary’s position that
later year time studies may only be used to
correct misclassified operating costs, and
not misclassified graduate medical
education costs, is arbitrary and capricious.
We will reverse and remand with
i n s t r u c t i o n s t o t h e P r o v i d e r
Reimbursement Review Board to order the
Intermediary to recalculate Mercy Catholic
Medical Center’s graduate medical
education costs after auditing the time
studies and other available documentation
from the three missing departments.
B. Hospital-Specific Rate and Target
Amount
Mercy Catholic Medical Center also
contends the District Court failed to order
the Intermediary to increase its hospital-
specific rate and TEFRA target amount.
As noted, the Board declined to order the
Intermediary to increase Mercy Catholic
Medical Center’s hospital-specific rate and
target amount in an amount corresponding
to the Intermediary’s reduction of the same
costs from the APRA because Mercy
Catholic Medical Center had not provided
d o c u m e n t a t io n d i r e ct l y t o t h e
Intermediary, but rath er to th e
Subcontractor. PRRB Dec. at 202,481.
The District Court affirmed, noting, “[t]he
fact that the Subcontractor may have the
documents in its possession does not
satisfy the requirements set forth by the
regulations.” Mercy Catholic Med. Ctr.,
2003 U.S. Dist. LEXIS 4688, at *33-34.
We cannot agree.
As noted, an increase in the
hospital-specific rate and target amount is
anticipated by the Secretary’s own
regulations to achieve consistent
classification of costs where costs
originally classified as graduate medical
education costs should have been reported
as operating costs. See 42 C.F.R. §
413.86(l)(1). Additionally, because of the
Consistency Rule, allowable operating
costs involved in setting the hospital-
specific rate and target amount must be
treated consistently throughout the
prospective payment transition period (i.e.
Mercy Catholic Medical Center’s FY
1985-1989). 42 C.F.R. § 412.113(b)(3).21
Once it is determined that misclassified
Graduate Medical Education Costs, JA
341.
21Mercy Catholic Medical Center also
contends that because its Target Amount
applied only to a psychiatric unit not in
operation until FY 1985, there was no
rational basis to require Mercy Catholic
M e d i c a l C e n t e r t o i n t r o d u c e
d o c u m e n t a t i o n e v i d e n c i n g t h e
comparability of its FY 1983 and FY 1985
costs as a precondition to increasing the
t a rg e t am oun t. T her efo re, n o
“comparability data” was necessary to
adjust the target amount, and the Board’s
finding on insufficient documentation was
irrelevant to the target amount adjustment.

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graduate medical education costs should
have been reimbursable as operating costs,
an increase to the hospital-specific rate and
target amount is required not merely for
consistency purposes, but also in light of
Medicare’s cost-shifting prohibition. 42
U.S.C. § 1395x(v)(1)(A). For these
reasons, the hospital-specific rate/target
amount adjustment is critical. Mercy
Catholic Medical Center’s request for a
revision of both its hospital-specific rate
and target amount was appropriate and
timely.
As discussed, the Provider
Reimbursement Review Board did not
deny the adjustments for substantive
reasons. See PRRB Dec. at 202,481.
Mercy Catholic Medical Center had
provided the appropriate and sufficient
documentation to the Intermediary’s
Subcontractor.22 JA 161. The Board,
however, refused to order the hospital-
spec ific rate and targ et amount
adjustments on the technicality that Mercy
Catholic Medical Center provided the data
supporting comparability within the 180
day period to the Intermediary’s
Subcontractor rather th an dire ctly
providing it to the Intermediary. PRRB
Dec. at 202,481. We do not find this
distinction legally significant.
Providing data to the on-site
Subcontractor is the legal equivalent of
providing the data to the Intermediary
under Centers for Medicare and Medicaid
Services Manuals and principles of
agency. In collecting data for an audit, the
Subcontractor steps into the shoes of the
Intermediary. See Medicare Intermediary
Manual, JA 919. A subcontracted audit
firm is authorized to receive cost reports
and make its working papers available to
the Intermediary for review and to obtain
necessary information. See id. pt. F (“The
independent audit firm’s [Subcontractor’s]
working papers, including permanent files
and reviews of internal control, are to be
made available to representatives of the
Secretary and the intermediary, at all
reasonable times, for review and obtaining
any necessary information.”). Under the
Medicare Intermediary Manual, the
Intermediary and the Subcontractor are
interchangeable in the function of
receiving documents. The Board’s
decision also described the Intermediary
p e r f o r m i n g a u d i t s “ t h r o ug h i t s
Subcontractor.” PRRB Dec. at 202,466.
Under these circumstances, we find
the documents were plainly within the
control of the “prime contractor” (in this
case, the Intermediary). In the context of
22The record demonstrates the evidence
provided by Mercy Catholic Medical
Center was sufficient to make the
adjustments to the hospital-specific rate
and target amount. The Board found “the
Subcontractor . . . had received adequate
information for . . . revisions to the
HSR/TEFRA target amount.” PRRB Dec.
at 202,481. In fact, the “best evidence” of
comparability between the prospective
payment system and graduate medical
education base years was the cost reporting
data and supporting audit records that were
already in the Intermediary’s possession
until at least 1992. JA 156.

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Fed. R. Civ. P. 34(a), so long as the party
has the legal right or ability to obtain the
documents from another source upon
demand, that party is deemed to have
control. See Fed R. Civ. P. 34(a)
(allowing “[a]ny party [to] serve on any
other party a request . . . any designated
documents . . . which are in the possession,
custody or control of the party upon whom
the request is served); see also Poole v.
Textron, 192 F.R.D. 494, 501 (D. Md.
2000) (“[A] party is charged with
knowledge of what its agents know or
what is in the records available to it.”)
(internal quotation omitted). In the Rule
34 context, control is defined as the legal
right to obtain required documents on
demand. See Gerling Int’l Ins. Co. v.
Comm’r, 839 F.2d 131, 140 (3d Cir.
1988); 8A Charles Alan Wright & Arthur
R. Miller, Federal Practice and Procedure
§ 2210 (2d ed. 1994). The Medicare
Intermediary Manual specifically requires
the Subcontractor’s working papers and
files be made available to the Intermediary
and Secretary at all “reasonable times.”
Medicare Intermediary Manual pt. F.
Because the record demonstrates Mercy
Catholic Medical Center provided the
necessary documents to the Subcontractor,
and the Intermediary employed the
Subcontractor to conduct the audit and
receive documents, the documents were
accessible to the Intermediary and within
its control.
While there is no question the
Intermediary determines the APRA and
corresponding adjustments to the hospital-
specific rate and the Target Amount under
§ 413.86, it does not follow that the
provider may not supply the data to the
Interm edia ry throug h the o n-site
Subcontractor. The Subcontractor was
entitled to receive cost documentation
from Mercy Catholic Medical Center as
the Intermediary’s agent. An agency
relationship may be established by: (1)
express authority; (2) implied authority, to
do all that is proper, usual and necessary
for the authority actually granted; (3)
apparent authority, as where the principal
holds one out as agent by words or
conduct; and (4) agency by estoppel. See
SEI Corp. v. Norton & Co., 631 F. Supp.
497, 501 (E.D. Pa. 1986).
Based on the relationship between
the Subcontractor and Intermediary, the
subcontractor likely had express or implied
authority to receive documents from
Mercy Catholic Medical Center. See
Medicare Intermediary Manual pts. D-F.
The Subcontractor undoubtably possessed
the authority to conduct the reaudit of the
graduate medical education costs. JA 153.
As noted, adjustment of the hospital-
specific rate and target amount is tied to
the classification of hospitals’ costs. See
42 C.F.R. § 413.86(l). Rationally, the
Subcontractor should be authorized to
receive documents for both cost
reclassifications and adjustments to a
hospital’s specific rate and target amount.
Alternatively, if the subcontractor lacked
express authority to receive documents, the
fact that it had conducted the graduate
medical education reaudit, and had
conducted all of Mercy Catholic Medical
Center’s audits since the “mid 70s,” JA

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153, demonstrates the Subcontractor had
apparent authority to receive the
documents. “It is well settled that apparent
authority (1) ‘results from a manifestation
by a person that another is his agent’ and
(2) ‘exists only to the extent that it is
reasonable for the third person dealing
with the agent to believe that the agent is
authorized.’” Taylor v. People’s Natural
Gas Co., 49 F.3d 982, 989 (3d Cir. 1995)
(quoting Restatement (Second) of Agency
§ 8 cmts. a & c (1958)). Mercy Catholic
Medical Center reasonably believed the
Subcontractor had the authority to receive
the relevant documentation. The
Intermediary and the Subcontractor were
jointly obligated to safeguard the
hospital’s documents. Therefore, Mercy
Catholic Medical Center fulfilled its
burden by providing appropriate data to
the Intermediary’s agent.
Mercy Catholic Medical Center also
contends it was entitled to present
evidence not submitted to the Intermediary
to the Provider Reimbursement Review
Board for de novo review, and that the
Board violated 42 U.S.C. § 1395oo(d) by
not considering this evidence.23 In this
vein, Mercy Catholic Medical Center
argues it should be allowed to present
evidence comparing the prospective
payment system and the graduate medical
education base years—to effect an
adjustment of the hospital-specific
rate—until the Board has determined
whether to approve a reaudit classification
of operating costs to graduate medical
education costs.
The Secretary maintains Mercy
Catholic Medical Center’s reliance on 42
U.S.C. § 1395oo(d) is unavailing. We
agree. This statute does not require the
Board to receive additional evidence not
considered by the Intermediary, but only
confers discretion on the Board as to what
will be allowed into the administrative
record. Taking Mercy Catholic Medical
Center’s argument to its logical
conclusion, all statutory or regulatory
deadlines imposed on providers for
purposes of Medicare reimbursement
would be inconsequential, since providers
could proffer all required reports and
documents by the time of the hearing.
Nevertheless, because we find
Mercy Catholic Medical Center to have
fulfilled its burden by presenting sufficient
data for adjusting its hospital-specific rate
and target amount to the Subcontractor, we
will reverse the Board and the District
Court on this issue. We will remand to the
District Court to remand to the Provider
Reimbursement Review Board with
instructions to order the Intermediary to
adjust Mercy Catholic Medical Center’s
hospital-specific rate and target amount to
correspond to reclassified operating costs
and graduate medical education costs.
2342 U.S.C. § 1395oo(d) provides in
relevant part: “A decision by the Board
shall be based upon the record made at
such hearing, which shall include the
evidence considered by the intermediary
and such other evidence that may be
obtained or received by the Board . . . .”

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26
IV.
For the reasons stated, we will
reverse and remand the judgment of the
District Court for proceedings consistent
with this opinion.

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