SCOTUS Rejects Objective Knowledge Standard in False Claims Act; Defendant’s Subjective Belief Is Key to Scienter

In a unanimous opinion issued on June 1, 2023, the Supreme Court of the United States clarified the relevant standard for scienter — or knowledge — in False Claims Act (“FCA”) actions by ruling that an objectively reasonable view that a defendant’s conduct was compliant with the law does not preclude the conclusion that the defendant “knowingly” violated the FCA in the face of evidence that the defendant subjectively believed that its conduct was illegal. In doing so, the Supreme Court vacated and remanded two consolidated cases to the United States Court of Appeals for the Seventh Circuit — U.S. ex rel. Schutte v. SuperValu Inc., No. 21-1326, and U.S. ex rel. Proctor v. Safeway, No. 22-111 — where the lower courts had concluded that so long as defendants’ conduct was consistent with an objectively reasonable interpretation of the relevant law, then defendants could not have “knowingly” submitted false claims, even if they never actually held the objectively reasonable interpretation.

The FCA imposes liability on anyone who “knowingly” submits a “false” claim to the government, and regulations promulgated by the Centers for Medicare and Medicaid Services (“CMS”) require pharmacies, including defendants in Schutte and Proctor, to report to their “usual and customary” prescription drug prices when submitting claims for reimbursement to the Medicare and Medicaid programs. Defendants were accused of violating the FCA by reporting their higher retail prices (rather than available lower discounted prices) as their “usual and customary” prices, and thus overcharging the Medicare and Medicaid programs for certain prescription drugs.

In both Schutte and Proctor, the district court determined that the discounted drug pricing represented the defendants’ “usual and customary” prices. However, defendants’ discounted pricing was never reported to CMS as required, rendering the submitted claims false. Nevertheless, the district court granted summary judgment in favor of defendants after determining that they could not have acted “knowingly” under the FCA. The Seventh Circuit affirmed, holding that defendants could not have acted “knowingly” — despite evidence they subjectively believed they were required to report their discounted prices — because their actions were consistent with an objectively reasonable interpretation of the phrase “usual and customary,” which could refer to retail drug pricing.

In vacating the lower courts’ judgments, the Court held that “the FCA’s scienter element refers to a defendant’s knowledge and subjective beliefs — not to what an objectively reasonable person may have known or believed.” Addressing the ambiguity of the phrase “usual and customary,” the Court pointed to the plaintiffs’ evidence of the defendants’ subjective belief:

To be sure, the phrase “usual and customary” on its face appears somewhat open to interpretation. But petitioners contend that respondents were informed that their lower, discounted prices were their “usual and customary” prices, believed their discounted prices were their “usual and customary” prices, and tried to hide their discounted prices from regulators and contractors. Petitioners have presented evidence that they claim supports that theory. . . . Petitioners argue that this and other evidence show that respondents thought that their claims were inaccurate yet submitted them anyway.

Evidence of the defendants’ subjective knowledge that their conduct was (or likely was) illegal was indispensable to the Court’s conclusion and evident in its reasoning. It observed that “[t]he FCA’s scienter element refers to respondents’ knowledge and subjective beliefs.”

The Court considered evidence of subjective belief as bearing on whether the defendants made an “honest mistake,” a factor that it clearly found important, noting that “the Seventh Circuit did not hold that respondents made an honest mistake; it held that, because other people might make an honest mistake, defendants’ subjective beliefs became irrelevant to their scienter.” The Court’s “reasonable speeds” hypothetical drives home the point that FCA plaintiffs need evidence of a defendant’s subjective belief to overcome an objectively reasonable interpretation of governing law:

Although the terms, in isolation, may have been somewhat ambiguous, that ambiguity does not preclude respondents from having learned their correct meaning—or, at least, becoming aware of a substantial likelihood of the terms’ correct meaning. To illustrate why, consider a hypothetical driver who sees a road sign that says, “Drive Only Reasonable Speeds.” That driver, without any more information, might have no way of knowing what speeds are reasonable and what speeds are too fast. But then assume that the same driver was informed earlier in the day by a police officer that speeds over 50 mph are unreasonable and then noticed that all the other cars around him are going only 48 mph. In that case, the driver might know that “Reasonable Speeds” are anything under 50 mph; or, at the least, he might be aware of an unjustifiably high risk that anything over 50 mph is unreasonable. . . .

Applying this hypothetical, the Court observed that the plaintiffs produced evidence that the defendants “received notice that the phrase ‘usual and customary’ referred to their discounted prices” and “comprehended those notices and then tried to hide their discounted prices.” It then concluded that “[i]f that is true, then perhaps respondents actually knew what the phrase meant; or perhaps respondents were aware of an unjustifiably high risk that the phrase referred to their discounted prices.”

The Court made clear that ignoring an objectively reasonable interpretation requires proof the defendant subjectively held a contrary belief:

Under the FCA, petitioners may establish scienter by showing that respondents (1) actually knew that their reported prices were not their “usual and customary” prices when they reported those prices, (2) were aware of a substantial risk that their higher, retail prices were not their “usual and customary” prices and intentionally avoided learning whether their reports were accurate, or (3) were aware of such a substantial and unjustifiable risk but submitted the claims anyway. §3729(b)(1)(A). If petitioners can make that showing, then it does not matter whether some other, objectively reasonable interpretation of “usual and customary” would point to respondents’ higher prices. For scienter, it is enough if respondents believed that their claims were not accurate.

The Court concluded that FCA’s scienter element focuses on the defendant’s subjective thoughts and beliefs because the FCA defines “knowingly” to include actual knowledge, deliberate ignorance, or recklessness. The Court also noted that while the meaning of the phrase “usual and customary” may be ambiguous, this “alone is not sufficient to preclude a finding that respondents knew their claims were false.”

AGG Takeaways

• The defendant’s subjective belief is key to scienter. A defendant’s subjective understanding of its legal obligations is critical to satisfying the FCA’s scienter standard. To satisfy this standard, the government or a relator must prove that the defendant subjectively believed or recklessly disregarded the risk that its conduct was illegal. If this burden is satisfied, it will not be sufficient for the defendant to point to a hypothetical objectively reasonable interpretation that did not undergird the defendant’s actions.
• A defendant’s subjective belief and understanding of complex and potentially ambiguous rules and regulations requires a fact-intensive analysis. Therefore, defendants in False Claims Act cases should expect discovery focused on their knowledge and views of the regulations at issue. Plaintiffs still have the burden of proving scienter, so defendants may still prevail on summary judgment on the scienter requirement if plaintiffs do not present evidence of defendant’s contemporaneous subjective knowledge.
• Scienter and falsity are separate elements. The defendant’s subjective interpretation of an ambiguous legal provision is relevant to scienter. It does not answer the question whether the defendant’s claims were false. To answer that question, the court must decide whether the defendant’s actions were in compliance with the governing law and whether noncompliance was material to payment. In this case, for example, the Supreme Court was clear that it was not deciding whether “usual and customary” actually required defendants to report their discounted prices. If the Seventh Circuit on remand interprets this language as referring to the retail, non-discounted prices that the defendants submitted, then defendants’ claims would not be false notwithstanding the defendants’ subjective interpretation of “usual and customary.”