Fourth Circuit’s Decision Bolsters Trend Toward Objective Scienter Standard Under the False Claims Act

Fourth Circuit’s Decision Bolsters Trend Toward Objective Scienter Standard Under the False Claims Act

Client Alert


On January 25, 2022, in United States ex rel. Sheldon v. Allergan Sales, LLC,1 a divided panel of the U.S. Court of Appeals for the Fourth Circuit held that a defendant accused of violating the False Claims Act (FCA) by knowingly making a false certification of its compliance with a law as a condition of payment lacks the necessary scienter if it bases its actions on an objectively reasonable interpretation of the law and was not warned away from that interpretation by authoritative guidance. In reaching this conclusion, the court relied on Safeco Insurance Co. of America v. Burr,2 in which the Supreme Court established this approach to scienter for alleged violations of the Fair Credit Reporting Act (FCRA). In extending Safeco’s analysis to the FCA, the Fourth Circuit joined a growing consensus of courts of appeals that have come to the same conclusion on this highly consequential question.

Case Background

Like many recent FCA cases, this case arises in the heavily regulated health care context. Under the Medicaid Drug Rebate Statute, pharmaceutical manufacturers seeking to have a drug covered by Medicaid must report to the Centers for Medicare & Medicaid Services (CMS) the drug’s “Best Price,” which the statute and CMS regulations define as the lowest price available to any entity inclusive of rebates and discounts. In 2014, relator Troy Sheldon filed a qui tam action under the FCA against his former employer Forest Laboratories (now part of Allergan), alleging that Forest misrepresented to CMS the Best Price for its drugs, and thereby violated the statute’s reporting requirement, by not aggregating discounts given to different customers along the supply chain.

Forest moved to dismiss the complaint on the ground—among others—that the complaint failed to plausibly allege scienter under the FCA. Forest argued that, as an initial matter, the Rebate Statute did not require companies to aggregate rebates provided to different customers in calculating a drug’s Best Price, and thus Forest’s failure to do so did not render its pricing submissions to CMS false. Relying on Safeco, Forest then argued that even if the Rebate Statute could be interpreted to require such aggregation of rebates to different customers, the complaint did not adequately allege that Forest “knowingly” violated the statute because the company’s interpretation was at least objectively reasonable, and there was no authoritative guidance warning it off that interpretation. The district court agreed and dismissed the relator’s complaint.

The Court’s Decision

On appeal, the Fourth Circuit affirmed the dismissal of relator’s FCA claims. The court began by recounting Safeco’s analysis of “willfulness” under the FCRA, which reaches both knowing and reckless misconduct. In Safeco, the Supreme Court defined recklessness as “conduct violating an objective standard.”3 And it set forth a two-step inquiry that requires courts to determine (1) whether the defendant’s interpretation of the law was objectively reasonable and, if so, (2) whether there was any authoritative guidance warning the defendant away from that interpretation. Under Safeco, a defendant who interprets the law in an objectively reasonable manner in the absence of authoritative guidance to the contrary cannot be held to have acted recklessly, even if its interpretation is later held to be incorrect.  

The Safeco framework, the Fourth Circuit concluded, extends to a subset of FCA claims. In particular, the court held that Safeco does not govern “factually false” claims—for example, that a defendant billed the government for goods or services it never provided. But so-called “legally false” claims turn on whether the defendant correctly interpreted and complied with its legal obligations. As the court explained, the FCA penalizes misstatements only if they were made “knowingly,” which the statute defines to include reckless disregard of the truth or falsity.4 Given that parallel with the FCRA’s scienter standard at issue in Safeco, the court held that a defendant’s statements about legal compliance are not reckless if the defendant bases its actions on an objectively reasonable interpretation of the law and had not been warned away from that interpretation by authoritative guidance. The court noted that the government can issue guidance clarifying its own interpretation of the law, and defendants cannot turn a blind eye to that guidance. The court emphasized, however, that defendants must be put on notice before facing potentially massive FCA liability—including mandatory treble damages and civil monetary penalties—for allegedly failing to adhere to complex and often ambiguous regulations.

Applying Safeco, the court determined that the relator’s complaint did not plausibly allege scienter under the FCA. Forest’s interpretation of the Rebate Statute, it held, was not only objectively reasonable but also the most natural reading. And the court rejected the relator’s argument that CMS had warned Forest away from that reading, explaining that for purposes of warning away, there must be “authoritative guidance” that canvasses and speaks to the precise issue “at a high level of specificity.”5 Here, CMS was aware from comments on its proposed Medicaid drug pricing rule that Forest and other pharmaceutical manufacturers interpreted Best Price to mean the single lowest price available to a given customer, without aggregating discounts available to different customers. Yet, in adopting the final Medicaid drug pricing rule, CMS chose not to specifically address and clarify that issue.  

Key Takeaways

In holding that the Safeco framework applies to the FCA, the Fourth Circuit joined every other circuit court that has considered that question.6 That trend, as well as the Fourth Circuit’s opinion, reinforces that an FCA defendant’s subjective intent is irrelevant to the scienter inquiry when a defendant is alleged to have misrepresented its regulatory compliance. Instead, what matters is whether the defendant’s interpretation of the governing law is objectively reasonable and whether the defendant has been warned away from its interpretation by authoritative guidance. The Fourth Circuit’s decision underscores that courts will examine these FCA claims by looking to the language of the relevant law and the existence of authoritative guidance on the issue. While the court acknowledged that regulators may choose to maintain “strategic ambiguity” on an issue to preserve “future flexibility,” it rejected any attempt by relators or the government to then use that ambiguity “to take advantage of companies” in FCA proceedings.7 

In addition, the Fourth Circuit’s decision sheds some light on what constitutes “authoritative guidance,” although significant questions remain about how courts will apply that standard in future cases. The court clarified that to be authoritative, guidance must come from the “right source,” i.e., either circuit precedent or the relevant agency, and it must address the question with sufficient specificity.  It is not enough “merely to be related to the question at hand.”8 The Fourth Circuit did not address, however, whether agencies must clarify their interpretation of the law through notice-and-comment rulemaking or whether informal guidance, including ex parte communications with a particular company, may suffice. The overlap in these cases between often complex regulations and FCA actions by the government and the qui tam bar makes it important for companies to seek legal advice early on from both subject-matter experts and experienced FCA litigators, in order to formulate and defend their best understanding of their legal obligations and avoid potentially significant liability.

WilmerHale’s False Claims Act and Administrative Law practices can assist companies in navigating these issues. We will continue to closely monitor developments in this area.