                      United States Court of Appeals
                          FOR THE EIGHTH CIRCUIT
                                  ___________

                                  No. 06-3263
                                  ___________

State of Minnesota,                      *
                                         *
             Petitioner,                 *
                                         * On Petition for Review of an
       v.                                * Order of the Secretary of
                                         * Health and Human Services.
Centers for Medicare and Medicaid        *
Services; Leslie V. Norwalk, in her      *
official capacity as Deputy              *
Administrator for the Centers for        *
Medicare & Medicaid Services;            *
Michael O. Leavitt, in his official      *
capacity as Secretary of the United      *
States Department of Health and          *
Human Services,                          *
                                         *
             Respondents.                *
                                    ___________

                            Submitted: May 16, 2007
                               Filed: July 31, 2007
                                ___________

Before WOLLMAN, BRIGHT, and JOHN R. GIBSON, Circuit Judges.
                          ___________

BRIGHT, Circuit Judge.

      In March 2003, the state of Minnesota submitted a state plan amendment (“2003
plan amendment”) to the Centers for Medicare and Medicaid Services (“Medicaid
Services” or “CMS”), seeking a $1,529,000 increase in the annual supplemental
Medical Assistant payments made by the federal Medicaid program to fourteen
county-owned nursing homes. After requesting additional information from the state,
Medicaid Services disapproved the 2003 plan amendment and denied Minnesota’s
request for reconsideration. The state now petitions this court to review and reject the
final determination of the Secretary of Health and Human Services (“HHS”) adverse
to Minnesota. We deny the petition.

                                          I.

       The Medicaid program, authorized by Title XIX of the Social Security Act, 42
U.S.C. §§ 1396-1396v, benefits children, the poor, and the elderly. We have observed
that “[a]lthough a state’s participation in the Medicaid program is optional,
participating states in compliance with the applicable federal rules and regulations are
given matching funds by the federal government.” Bowlin v. Montanez, 446 F.3d
817, 818 (8th Cir. 2006); see 42 U.S.C. § 1396 (requiring participating states to
submit for approval “plans for medical assistance”). Minnesota’s petition centers on
three rules. A state’s plan must: (1) “provide for financial participation by the State
equal to not less than 40 per centum of the non-Federal share of the expenditures
under the plan,” 42 U.S.C. § 1396a(a)(2); (2) “provide such safeguards as may be
necessary to assure that eligibility for care and services under the plan will be
determined, and such care and services will be provided, in a manner consistent with
simplicity of administration and the best interests of the recipients,” 42 U.S.C.
§ 1396a(a)(19); and (3) “assure that payments are consistent with efficiency,
economy, and quality of care,” 42 U.S.C. § 1396a(a)(30)(A).

       Minnesota’s 2003 plan amendment requested additional federal funds to match
the state’s decision to increase supplemental payments to county-owned nursing
homes. See 2003 Minn. Laws ch. 9, sec. 2 (codified at Minn. Stat. § 256B.431, subd.




                                          -2-
23(d) (2004)).1 The state legislation allocated $1,529,000 from the state’s general
fund, see 2003 Minn. Laws ch. 9, sec. 3, and simultaneously increased the
intergovernmental transfer payments paid by the counties to the state, see Minn. Stat.
§ 256B.19, subd. 1d(d) (2004).2 Intergovernmental transfers move funds from
localities to the state. The increased intergovernmental transfers, according to the
state, represented the counties’ share of Medicaid expenses funded through local
property taxes.

      Minnesota requested federal Medicaid funds to match the state’s allocation
from its general fund:

             C. Beginning in 2003, in addition to the payments in items A and
      B, on May 31 the Department [of Health and Human Services] shall pay
      to a nursing facility described in item A a disproportionate share nursing
      facility payment adjustment in an amount equal to $12.32 per calendar
      day multiplied by the number of beds licensed in the nursing facility on
      May 31, multiplied by 181 days. . . .

Minn. SPA No. 03-06, attach. 4.19-D (NF), sec. 20.080(C.).




      1
       “Beginning in 2003, in addition to any payment under paragraphs (a) and (c),
the commissioner shall pay to a nursing facility described in paragraph (a) an
adjustment in an amount equal to $6.11 per calendar day multiplied by the number of
beds licensed in the facility on that date. . . .” Minn. Stat. § 256B.431, subd. 23(d)
(2004).
      2
       “Beginning in 2003, in addition to any transfer under paragraphs (b) and (c),
each of the governmental units designated in this subdivision shall transfer before
noon on May 31 to the state Medicaid agency an amount equal to the number of
licensed beds in any nursing home owned and operated by the county on that date,
with the county named as licensee, multiplied by $2,230.” Minn. Stat. § 256B.19,
subd. 1d(d) (2004).

                                         -3-
       Medicaid Services, however, requested additional information from the state.
See 42 U.S.C. § 1396n(f)(2) (permitting Secretary to request in writing “any
additional information which is needed in order to make a final determination with
respect to the request”). In a June 2003 letter, Medicaid Services asked Minnesota to
explain: (1) whether the services funded by the 2003 plan amendment complied with
42 U.S.C. § 1396a(a)(30)(A) (the “efficiency, economy, and quality of care” rule); (2)
how the services were funded; (3) whether counties funded the non-federal portion of
the Medicaid payment; (4) the role of intergovernmental transfers in the funding
mechanism; (5) whether the nursing homes retained all of the Medicaid payments; and
(6) whether the payments were below the upper payment limit.

       Before the state could respond Medicaid Services sent a second request in
August 2003 asking: (1) whether the nursing facilities retained all of the Medicaid
funds paid to them or whether they returned funds to the state or their local
governments; (2) if the state complied with the 40 percent state-share requirement of
42 U.S.C. § 1396a(a)(2) and how the state provided its share (through legislative
appropriations, intergovernmental transfers, or other means); (3) if the payments
complied with 42 U.S.C. § 1396a(a)(30)(A)’s “efficiency, economy, and quality of
care” rule; (4) for a detailed upper payment limit calculation; and (5) whether the state
recoups any payments to facilities that exceed the cost of services.

      Minnesota responded to the requests in August 2003. Notably, the state equated
Medicaid’s upper payment limit with § 1396a(a)(30)(A)’s efficiency requirement and
observed that:

      [i]f CMS [Medicaid Services] now finds that the upper payment limit .
      . . is set so high that it allows payment rates that are inefficient and not
      economical, then the proper response should be to amend the upper
      payment limit regulation, not to impose new, burdensome requirements
      on states to justify payment rates that are below the upper payment limit,
      especially against an unspecified standard.


J.A. at 60.

                                          -4-
      Consistent with its reliance on the upper payment limit, Minnesota also
responded that “[n]one of the funds are ‘returned.’ Once the Medical Assistance
program pays a provider, the funds are not tracked.” J.A. at 63. As a result, the state
could not “calculate a ratio between the state and local share of the nonfederal share
of Medicaid,” though it assured Medicaid Services that the state’s share exceeded the
40 percent required by § 1396a(a)(2). J.A. at 65.

       Finally, the state made the claim that “a rate can comply with the efficiency and
economy requirement . . . without a comparison to cost, or even be above cost, as long
as the rates are under the required limits . . . . Because there is no cost limit, a payment
is not necessarily excessive simply because it may be greater than cost.” J.A. at 66.

                                            II.

       To understand Minnesota’s responses to Medicaid Services, it is necessary to
briefly explain Medicaid’s upper payment limit. To help control rising Medicaid
expenses HHS established the upper payment limit, which created a Medicaid
payment ceiling based on expenses that would be allowed under Medicare payment
rules. See Indep. Acceptance Co. v. California, 204 F.3d 1247, 1250 n.5 (9th Cir.
2000) (citing 42 C.F.R. § 447.253(a), (b)(2)). A state must assure Medicaid Services
that the payments requested through a plan amendment do not exceed the upper
payment limit before Medicaid Services may approve the plan. But, prompted by ever
rising Medicaid reimbursements, the Government Accountability Office (“GAO”) and
the Office of the Inspector General determined in 2001 that even the upper payment
limit lead to “misuse and excessive federal Medicaid spending.”3 Alaska Dep’t of
Health & Soc. Servs. v. Ctrs. for Medicare and Medicaid Servs., 424 F.3d 931, 936
(9th Cir. 2005).

     HHS amended the upper payment limit regulations in 2001, see Revision to the
Medicaid Upper Payment Limit Requirements, 66 Fed. Reg. 3148 (Jan. 12, 2001), but

       3
      The Government Accountability Office was known until July 7, 2004, as the
General Accounting Office.

                                            -5-
the problem continued. In 2003 the GAO identified Medicaid as a high-risk program,
concluding that “[l]imited oversight has afforded states and health care providers the
opportunity to increase federal funding inappropriately.” GAO, Performance &
Accountability Series: Dep’t of Health & Human Servs., “Highlights” (2003). One
concern in particular provoked Medicaid Services’s scrutiny of Minnesota’s 2003 plan
amendment. The GAO reported that:

      For more than a decade, states have used various financing schemes to
      inappropriately generate excessive federal Medicaid matching funds
      while their own share of expenditures has remained unchanged or
      decreased. Using statutory and regulatory loopholes, some states have
      created the illusion that they have made large Medicaid payments to
      certain providers, such as county health facilities, in order to generate
      federal matching payments. In reality, generally through electronic funds
      transfers, the states have only momentarily made payments to these
      providers, as states have required the payments to be returned.
             ....
      Although the Congress and CMS [Medicaid Services] have repeatedly
      acted to curtail abusive financing schemes when they have come to light,
      states have consistently developed new variations to this basic approach.
      Each variant has the same result: the state’s share of program
      expenditures is shifted to the federal government, while federal Medicaid
      payments escalate, with no assurances that the excessive federal
      payments are used for valid Medicaid expenditures for covered
      beneficiaries.

Id. at 27-28 (emphasis added). Minnesota’s responses did not distinguish the 2003
plan amendment from the scheme described by the GAO.

      Medicaid Services initially disapproved the 2003 plan amendment in June 2004.
The state sought reconsideration, but Presiding Official Kathleen Scully-Hayes
reached the same conclusions in her proposed hearing decision. The official rejected
the contention that compliance with the upper payment limit is alone sufficient
because “CMS [Medicaid Services] is obligated to inquire further to ensure that the
SPA [state plan amendment] complies with the statutory requirements set forth [sic]
§ 1902(a)(30)(A).” The official continued, “[t]he problem is that Minnesota has

                                         -6-
offered nothing to show that those funds would be specifically earmarked by the
individual counties for use solely by the nursing facilities for their patients.” “For the
same reasons,” the official concluded that Minnesota has not shown compliance with
§ 1396a(a)(19), which requires plans that are in the “best interests of the recipients.”
Finally, the official rejected Minnesota’s argument that Medicaid Services was
imposing new requirements because, according to her “CMS [Medicaid Services] is
simply taking a closer look at SPAs before approving them,” which “does not trigger
a rulemaking requirement.”

       Minnesota timely filed its exceptions to the proposed hearing decision. The
state primarily argued that Medicaid Services’s request for additional information
represented a “substantial new criterion” for state plan amendment approval and that
the new approach effectively prohibited the use of intergovernmental transfers, in
violation of 42 U.S.C. § 1396b(w)(6)(A). Minnesota also drew attention to various
assurances and affidavits it provided throughout the hearing and reconsideration
process, which supported approval but, according to the state, Medicaid Services
ignored.

       Medicaid Services, through Deputy Administrator Leslie Norwalk, adopted the
presiding official’s proposed hearing decision, making the disapproval the final
decision of the Secretary. The deputy administrator’s decision reiterated Minnesota’s
failure to explain its Medicaid funding mechanism, leaving Medicaid Services unable
to determine whether the 2003 plan amendment complied with § 1396a(a)(2) (setting
out the 40 percent rule). While acknowledging that intergovernmental transfers are
permitted, the deputy administrator explained that “[i]f providers refund part or all of
the Medicaid payments to the State, or its political subdivisions, the proposed payment
rate would not reflect the net expenditures and the net non-Federal share would not
meet the requirements” of the Act. Similarly, the decision observed that Minnesota
provided “unsupported assertions” to ensure that the 2003 plan amendment met
§ 1396a(a)(30)(A)’s “efficiency, economy, and quality of care” requirement and
observed that the state’s failure to explain its funding system and monitor the use of
Medicaid funds by county-owned nursing facilities left Medicaid Services unable to


                                           -7-
ensure compliance with the Act. For similar reasons, the deputy administrator also
concluded that Medicaid Services could not determine that the 2003 plan amendment
complied with § 1396a(a)(19) (requiring payments in “the best interest of the
recipients”). This appeal followed.

                                          III.

      Medicaid is a federal-state partnership that HHS is obligated to administer. In
2003 the GAO identified it as a high-risk program, concluding that “[l]imited
oversight has afforded states and health care providers the opportunity to increase
federal funding inappropriately.” GAO, Performance & Accountability Series: Dep’t
of Health & Human Servs., “Highlights” (2003). This petition tests the ability of the
Secretary to increase his oversight of the program.

        Minnesota’s petition raises two issues, both governed by The Administrative
Procedures Act (“APA”), 5 U.S.C. § 701 et seq. The first is whether the Secretary’s
rejection of its 2003 plan amendment was predicated on a “new substantive rule”
requiring notice and comment rule making. See Shell Offshore Inc. v. Babbitt, 238
F.3d 622, 630 (5th Cir. 2001). If the Secretary’s decision was not based on a new
rule, it must nevertheless comport with the APA’s requirements for an individual
adjudication. “Under the APA, the Secretary’s decision is ‘set aside if it is arbitrary,
capricious, an abuse of discretion, unsupported by substantial evidence, or contrary
to law.’ ” Baptist Health v. Thompson, 458 F.3d 768, 773 (8th Cir. 2006) (quoting
St. Luke's Methodist Hosp. v. Thompson, 315 F.3d 984, 987 (8th Cir. 2003).

                                          A.

       We turn first to the argument the 2003 plan amendment could not be rejected
without an alteration of the Secretary’s procedure for review through notice and
comment rule making. Minnesota does not contend that Medicaid Services followed
a written procedure, which it failed to subject to notice and comment. Rather, the state



                                          -8-
argues that the procedure followed by Medicaid Services had the effect of imposing
a new substantive rule. The Fifth Circuit observed in Shell Offshore that:

      An agency that, as a practical matter, has enacted a new substantive rule
      cannot evade the notice and comment requirements of the APA by
      avoiding written statements or other “official” interpretations of a given
      regulation. If a new agency policy represents a significant departure from
      long established and consistent practice that substantially affects the
      regulated industry, the new policy is a new substantive rule and the
      agency is obliged, under the APA, to submit the change for notice and
      comment.

238 F.3d at 630. In Shell Offshore the Department of the Interior “switch[ed] from
one consistently long followed permissible interpretation to a new one without
providing an opportunity for notice and comment.” Id. at 629. The alteration of its
existing procedures, the court determined, could not be achieved without notice and
comment.

       Minnesota argues that the Secretary has similarly departed from its prior
practice by substantively limiting the use of intergovernmental transfers. But that
contention is inconsistent with the record and the text of the Secretary’s final decision.
The Secretary recognized that intergovernmental transfers are permissible as a funding
mechanism, see 42 U.S.C. § 1396b(w)(6)(A), but required Minnesota to explain their
role in its Medicaid system. Medicaid Services’s request for further information did
not imply a rejection of intergovernmental transfers and therefore could not be a new
substantive rule. See West Virginia v. Thompson, 475 F.3d 204, 210-11 (4th Cir.
2007); Alaska, 424 F.3d at 941-42.

       Next, Minnesota argues that Medicaid Services imposed additional reporting
requirements that Medicaid Services had explicitly rejected when it modified the
upper payment limit in 2001, see 66 Fed. Reg. 3148 (Jan. 12, 2001), and that these
requirements also constitute a new substantive rule. Compliance with the upper
payment limit, however, does not prevent the Secretary from further exploring the
state’s 2003 plan amendment. The upper payment limit is not the exclusive measure

                                           -9-
of a proposed state plan amendment’s compliance with the requirements described in
42 U.S.C. § 1396a. As HHS explained in its 2001 upper payment limit rule, the
system was implemented because:

      [a] high volume of uninsured patients had increased the costs of
      providing services in State government-owned or operated facilities.
      These costs, in turn, were passed on to the State. To offset those higher
      costs, States established payment methodologies that paid State
      government-owned or operated facilities at a higher rate than privately
      operated facilities. Higher Medicaid payments to State
      government-owned or operated facilities allowed States to obtain
      additional Federal Medicaid dollars to cover costs formerly met entirely
      by State dollars.

66 Fed. Reg. 3149. In order to limit this practice, HHS has continued to refine the
upper payment limit as potential abuses of the system arise.

      The upper payment limit cannot, however, curb every abuse of the Medicaid
system. Because the upper payment limit is only part of the mechanism for ensuring
compliance with the Medicaid statutes, it does not define the boundaries of the
Secretary’s obligation to review proposed state plan amendments. As the Ninth
Circuit has observed, rejecting an argument similar to the one raised by Minnesota:

      [a]lthough the UPL [upper payment limit] regulations are clearly
      grounded in economic concerns, in that they proscribe payment levels
      that exceed certain limits, the terms ‘efficiency’ and ‘economy’ are
      nowhere defined in the Medicaid Act or its implementing regulations.
      Thus, we cannot equate mere compliance with the UPL regulations as
      conclusive proof of compliance with the broader statutory requirement.

See Alaska, 424 F.3d at 940. Thus, although Medicaid Services may have
implemented the upper payment limit to provide some flexibility to states, Minnesota
cannot rely on compliance with the upper payment limit to reject every effort of the
Secretary to otherwise ensure compliance with the Medicaid statutes.



                                        -10-
          Accordingly, the increased scrutiny of Minnesota’s 2003 plan amendment,
including Medicaid Services’s requests for additional information, was consistent with
the Secretary’s authority in an individual adjudication. “The APA does not require
that all the specific applications of a rule evolve by further, more precise rules rather
than by adjudication.” Shalala v. Guernsey Mem’l Hosp., 514 U.S. 87, 96 (1995).

                                           B.

        We conclude that Medicaid Services did not impose a new substantive rule and
thus move to considering whether the denial of the 2003 plan amendment was
“arbitrary, capricious, an abuse of discretion, unsupported by substantial evidence, or
contrary to law.” Hennepin County Med. Ctr. v. Shalala, 81 F.3d 743, 748 (8th Cir.
1996). Minnesota argues that the Secretary failed to consider information and
assurances provided by the state, particularly during the reconsideration process. The
state’s argument generally attacks Medicaid Services’s attempt to understand
Minnesota’s funding system. To demonstrate the acceptability of the 2003 plan
amendment, the state highlights its compliance with the upper payment limit, the
permissibility of county-owned nursing homes assigning their Medicaid payments to
their county-parents, and the impossibility of providing information (such as the use
of Medicaid payments to local governments) that would require “micromanag[ing]
local governments.” Specifically, the state also suggests that the Secretary relied only
on its initial response, despite an additional assurance regarding its compliance with
§ 1396a(a)(2) (the 40 percent rule).

       Recognizing, as Minnesota argues, that the Secretary’s scrutiny of its 2003 plan
amendment differed from prior adjudications, the Secretary’s vigilance here was not
arbitrary and capricious. Baptist Health, 458 F.3d at 777; see also Smiley v. Citibank
(S.D.), N.A., 517 U.S. 735, 742-43 (1996). To the contrary, the 2001 revision of the
upper payment limit signaled the Secretary’s commitment to detecting abusive
requests for Medicaid funding. In order to discover these abuses where they exist, the
Secretary’s review of present state plan amendments necessarily differs from his prior
practice. This does not, however, constitute “[s]udden and unexplained change or


                                          -11-
change that does not take account of legitimate reliance on prior interpretation.” Id.
at 742 (citations omitted). To the extent that Minnesota argues that the decision was
arbitrary and capricious simply because it was based on Medicaid Services’s scrutiny
of aspects of the 2003 plan amendment that may not have drawn the attention of the
Secretary in past adjudications, we reject that argument.

       We also determine that the decision is supported by substantial evidence in the
record. See, e.g., Baptist Health, 458 F.3d at 778. According to the Secretary,
Minnesota failed to provide information and assurances that the funds requested in its
2003 plan amendment would be economical and efficient, § 1396a(a)(30)(A), and in
the best interests of recipients, § 1396a(a)(19). The Secretary’s decision, which at
base rejected Minnesota’s 2003 plan amendment for lack of information, is supported
by the still unresolved questions regarding the ultimate use of the Medicaid funds
requested by the state, including the use of the funds by the county-owned nursing
homes. The lack of information raises the specter that the required intergovernmental
transfers will create the abusive funding structure that Medicaid Services is attempting
to prevent. The Secretary’s scepticism was thus warranted and substantial evidence
supports the denial of the 2003 plan amendment.4




      4
       The Secretary also relied on § 1396a(a)(2) (the 40 percent rule). Minnesota
argues that it provided an assurance, during the reconsideration process, that the state
funded at least 40 percent of the expenditure proposed by the 2003 plan amendment
and, in any event, the requirement should not have been a basis for the Secretary’s
decision because the initial disapproval and hearing officer’s proposed decision did
not rely on the section. We need not reach either argument, however, because the
Secretary’s reliance on §1396a(a)(30)(A) and (a)(19) supports the rejection of the
2003 plan amendment.

                                         -12-
                                       IV.

      We determine that Medicaid Services’s increased scrutiny of Minnesota’s 2003
plan amendment neither required notice and comment rule making nor ignored
adequate assurances provided by the state.

      Accordingly, the petition for review is denied.
                      ______________________________




                                      -13-
