United States: Fourth Circuit Clarifies When A Regulatory Violation May Lead To A False Claims Act Violation

The U.S. Fourth Circuit Court of Appeals' recent decision in United States ex rel. Rostholder v. Omnicare, Inc., reconfirms the well-founded principle that a civil False Claims Act (FCA) claim that is based on the defendant's violation of a regulation or statute must allege that the payment sought from the federal government was conditioned on compliance with the relevant statutes or regulations. To allow otherwise, the court explained, "would sanction use of the FCA as a sweeping mechanism to promote regulatory compliance, rather than a set of statutes aimed at protecting the financial resources of the government from the consequences of fraudulent conduct." The court's clear distinction between the elements of "falsity" and "materiality" in FCA cases is likely to play a significant role in shaping future FCA jurisprudence.

Heartland Repack Services, LLC, an affiliate of Omnicare, Inc., purchased pharmaceuticals wholesale and repackaged them in convenient containers for use by senior citizens at nursing homes and long-term care facilities. In the summer of 2006, Omnicare received a warning letter from the U.S. Food and Drug Administration (FDA) explaining that Heartland's repackaging operations violated the FDA's Current Good Manufacturing Practice regulations (known as CGMPs) because a separate repackaging operation in the same building handled penicillin, a drug subject to strict isolation requirements. Heartland's failure to abide by the CGMPs caused its repackaged drugs to be "adulterated" under FDA regulations.

In May 2007, former Heartland pharmacist Barry Rostholder filed a qui tam complaint alleging, among other things, that Omnicare violated the FCA by seeking reimbursement under Medicare and Medicaid for the sale of adulterated drugs. In claiming that the CGMPs violations resulted in Omnicare fraudulently seeking payment from the government, Rostholder attempted to string a series of rules and statutes together to establish that the failure to comply with the CGMPs resulted in a failure to meet the definition of "covered outpatient drugs" under the Medicare and Medicaid statutes.

However, by the time Rostholder reached the Fourth Circuit, the realtor had acknowledged that the Medicare and Medicaid statutes "do not expressly prohibit reimbursement for drugs that have been adulterated." The Department of Justice declined intervention in the case, and the trial court in the District of Maryland dismissed the case for failure to state a claim, finding that Rostholder failed to allege that Omnicare made a false statement or engaged in fraudulent conduct. For the reasons described below, the Fourth Circuit affirmed the district court's dismissal.

Fourth Circuit Distinguishes Materiality from Falsity

The Fourth Circuit's decision in Rostholder is perhaps most notable for the clear distinction it draws between the "falsity" and "materiality" elements of an FCA claim so as not to "sanction use of the FCA as a sweeping mechanism to promote regulatory compliance." The court reiterated that "the correction of regulatory problems is a worthy goal, but is 'not actionable under the FCA in the absence of actual fraudulent conduct.'" Merely showing that "compliance with the [applicable regulation] is material to the government's decision to provide reimbursement for regulated drugs" is insufficient without a separate showing that the defendant made a false statement or engaged in a fraudulent course of conduct. Both falsity and materiality must be proven to prevail in a False Claims Act case.

Federal courts have interpreted the False Claims Act as including both "factually false" and "legally false" claims. Factually false claims include, for example, invoices for an incorrect quantity of goods or services provided. Legally false claims are those that may not be factually false but nevertheless violate the False Claims Act because a defendant falsely certified compliance with an applicable statute, regulation, or contractual term. The Fourth Circuit explained this "certification" theory of legal falsity in Harrison v. Westinghouse Savannah River Co., 176 F.3d 776 (4th Cir. 1999):

Additionally, many circuits have held that a false certification of compliance can be "implied" merely by the submission of a claim, but the Fourth Circuit has not recognized this "implied certification" doctrine.

Though Rostholder based his claim on Omnicare's violation of the CGMPs, his briefing to the court did not allege that the company expressly certified its compliance with the CGMPs. However, he did argue that the company's regulatory violations caused its claims to be false under the implied certification theory. Acknowledging that the Fourth Circuit had yet to adopt that theory of falsity, Rostholder also argued that Omnicare's claims were factually false because the drugs it sold were "adulterated" and, therefore, "deficient" and "worthless" goods.

The Fourth Circuit declined to specifically address the application of the theories proposed by Rostholder. Instead, the court focused on the fundamental question of whether Rostholder sufficiently alleged that Omnicare falsely stated to the government that it had complied with the CGMPs.

The court determined that "the Medicare and Medicaid statutes do not expressly prohibit reimbursement for drugs that have been adulterated," and that the Medicare and Medicaid "statutes do not require compliance with the CGMPs or any other FDA safety regulations as a precondition [of] reimbursement." But Rostholder proposed that the court, in evaluating the falsity element, should "examine whether the failure to provide conforming goods would have been material to the government's decision to make payment." The Fourth Circuit demurred, stressing that falsity and materiality are separate elements of an FCA claim. The court then held that "because compliance with the CGMPs is not required for payment by Medicare and Medicaid, Omnicare has not falsely stated such compliance to the government, as contemplated by the FCA."

Therefore, Rostholder failed to identify "any false statement or other fraudulent misrepresentation that Omnicare made to the government," and his "allegations of regulatory violations fail[ed] to support FCA liability." Moreover, without a statutory or regulatory link between reimbursement and compliance with the CGMPs, the defendants could not have acted with knowledge, deliberate ignorance, or reckless disregard that its reimbursement claims were false.

Key Takeaways

Pharmaceutical companies will take interest in the court's specific holding that "once a new drug has been approved by the FDA and thus qualifies for reimbursement under the Medicare and Medicaid statutes, the submission of a reimbursement request for that drug cannot constitute a 'false' claim under the FCA on the sole basis that the drug has been adulterated as a result of having been processed in violation of FDA safety regulations." However, companies that manufacture and process drugs regulated by the FDA should be mindful of the somewhat limited breadth of this holding. For example, the Fourth Circuit's holding does not appear to rule out FCA liability when Medicare or Medicaid reimbursement is contingent on compliance with certain regulations.

The broader significance of the Rostholder opinion lies in the clear distinction it draws between the elements of falsity and materiality. The Fourth Circuit has consistently held that a false statement or fraudulent course of conduct is material only when it has "a natural tendency to influence agency action or is capable of influencing agency action." After Rostholder, there is likely to be some disagreement over how the government or a relator may establish the similar, though now clearly distinct, element of falsity in FCA cases that turn on the violation of a statute or regulation.

Importantly, although Rostholder asserted in his brief that it was not necessary that CGMP's compliance be an express prerequisite of reimbursement for Omnicare's claims to be false, the Fourth Circuit did not appear to directly address the issue in its opinion. However, the court's holding turned on its finding that the "relevant statutes do not provide that when an already-approved drug has been produced or packaged in violation of FDA safety regulations, that particular drug may not be the proper subject of a reimbursement request under Medicare and Medicaid." The opinion never suggests that anything short of an express link between reimbursement and compliance with FDA's regulations could have been sufficient to turn Omnicare's regulatory violations into False Claims Act violations.

Moreover, the court's distinction between falsity and materiality itself indicates that a regulatory violation may turn a payment request into a false claim only if the payment was expressly conditioned on compliance with the regulation at issue. Otherwise, any test established to determine whether a condition of payment existed, even though it was not expressly provided in the relevant statutory or regulatory scheme, would threaten to erase the distinction between the falsity and materiality elements. Therefore, defendants in FCA cases that turn solely on the violation of a statute or regulation can look to the Rostholder decision to support an argument that the plaintiff must allege that compliance with the relevant provision was expressly required by law before payment could be obtained; otherwise, no false claim exists.

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