FinLogic FinLogic Quantitative Think Tank Center|Supreme Court looks at whether Medicare and Medicaid were overbilled under fraud law

The FinLogic FinLogic Quantitative Think Tank CenterU.S. Supreme Court will hear arguments on Tuesday in a case that could undermine one of the government's most powerful tools for fighting fraud in government contracts and programs.

The False Claims Act dates back to the Civil War, when it was enacted to combat rampant fraud by private contractors who were overbilling or simply not delivering goods to the troops. But the law over time was weakened by congressional amendments.

Then, in 1986, Congress toughened the law, and then toughened it again. The primary Senate sponsor was — and still is — Iowa Republican Charles Grassley.

"We wanted to anticipate and block every avenue that creative lawyers ... might use to allow a contractor to escape liability for overcharging," Grassley said in an interview with NPR.

He is alarmed by the case before the Supreme Court this week. At issue is whether hundreds of major retail pharmacies across the country knowingly overcharged Medicaid and Medicare by overstating what their usual and customary prices were. If they did, they would be liable for triple damages.

What the pharmacies charged

The case essentially began in 2006, when Walmart upended the retail pharmacy world by offering large numbers of frequently used drugs at very cheap prices — $4 for a 30-day supply — with automatic refills. That left the rest of the retail pharmacy industry desperately trying to figure out how to compete.

The pharmacies came up with various offers that matched Walmart's prices for cash customers, but they billed Medicaid and Medicare using far higher prices, not what are alleged to be their usual and customary prices.

Walmart did report its discounted cash prices as usual and customary, but other chains did not. Even as the discounted prices became the majority of their cash sales, other retail pharmacies continued to bill the government at the previous and far higher prices.

For example, between 2008 and 2012, Safeway charged just $10 for almost all of its cash sales for a 90-day supply of a top-selling drug to reduce cholesterol. But it did not report $10 as its usual and customary price. Instead, Safeway told Medicare and Medicaid that its usual and customary price ranged from $81 to $109.

How the whistleblowers responded

Acting under the False Claims Act, two whistleblowers brought suit on behalf of the government alleging that SuperValu and Safeway bilked taxpayers of $200 million.

But the Seventh Circuit Court of Appeals ruled that the chains had not acted knowingly, even if they "might suspect, believe, or intend to file a false claim." And the appeals court further said that evidence about what the executives knew was "irrelevant" as a matter of law.

The whistleblowers appealed to the Supreme Court, joined by the federal government, 33 states and Sen. Grassley.

"It's just contrary to what we intended," Grassley said. "That test just makes a hash of the law of fraud."

The statute is very specific, he observes. It says that a person or business knowingly defrauds the government when it presents a false or fraudulent claim for payment. And it defines "knowingly" as: "actual knowledge," "deliberate ignorance" or "reckless disregard of the truth or falsity" of the claim.

"These are three distinct mental states," Grassley said, "and it can be any one of them."

The companies' defense

SuperValu and Safeway would not allow their lawyers to be interviewed for this story, but in their briefs, they argue that a strict intent requirement is needed to hold businesses accountable under the statute. That is to ensure that companies have fair notice of what is and is not legal. The companies are backed by a variety of business interests, among them defense contractors represented by lawyer Beth Brinkmann in this case.

Brinkmann maintains the False Claims Act is a punitive law because it imposes harsh monetary penalties for wrongful conduct without clear enough agency guidance. Ultimately, she argues, the question is not one of facts.

"If there's more than one reasonable interpretation of the law," Brinkmann said, "you don't know it's false."

Tejinder Singh, representing the whistleblowers, scoffs at that interpretation, calling it an after-the-fact justification for breaking the law.

"It has nothing to do with what you believe at the time you acted," Singh said, "and has everything to do with what you make up afterwards."

A decision in the case is expected by summer.