48 Soc.sec.rep.ser. 195, 19 Employee Benefitscas. 1824,medicare & Medicaid Guide P 43,401dominguez Valley Hospital; Ontario Community Hospital;ojai Community Hospital; Manteca Hospital; Doctorshospital of Lakewood; Los Alamitos Medical Center, Losalamitos Medical Center--psych; Chico Community Hospital;memorial Hospital of Redding, Redding Medical Center,redding Medical Center--rehabilitation, Redding Medicalcenter--detox; Modesto City Hospital; Garfield Medicalcenter--rehabilitation; Lodi Community Hospital; Doctorshospital--modesto; Doctors Hospital--modesto Hha; Doctorshospital of Pinole; Doctors Hospital of Pinole--detox;indio Community Hospital; Los Altos Hospital; Doctorshospital of Lakewood--south; Alvarado Community Hospital;doctors Hospital of Montclair; Twin Cities Communityhospital; Palms of Pasadena Hospital; John F. Kennedymemorial Hospital; Lake Seminole Hospital; Hollywoodmedical Center; Seven Rivers Community Hospital; Medfieldcenter; Sierra Medical Center; Meadowcrest Hospital; St.charles General Hospital; Rehabilitation Institute Ofoklahoma; Jackson Specialty Hospital/snf; Wilmotpsychiatric/medicenter, Tucson; San Diego Physicians &surgeons; Mid-south Hospital; Highland Hospital; Dallasrehabilitation Institute; Northgate General Hospital;community Hospital of Los Gatos; Delray Community Hospital;forkosh Memorial Hospital; Flint Goodridge Hospital; J.e.smith/f.e. Hebert Hospitals/snf; Dedman Medicalcenter/brookhaven/snf; Placentia Linda Community Hospital;carrollton Community Hospital; University Medical Center,plaintiffs-appellants, v. Donna E. Shalala, Secretary of the Department of Health &human Services, Defendant-appellee, 57 F.3d 832 (9th Cir. 1995)

Patric Hooper, Hooper, Lundy & Bookman, Los Angeles, CA, for plaintiffs-appellants.

Henry A. Azar, Jr., U.S. Dept. of Justice, Washington, DC, for defendant-appellee.

Appeal from the United States District Court for the Central District of California.

Before: HALL, LEAVY, Circuit Judges, and LEVI, District Judge.^** 

LEVI, District Judge:

Appellant hospitals appeal from a decision of the Secretary of Health and Human Services ("the Secretary") declining to reimburse the hospitals for stock options granted to certain employees. The hospitals participate in the Medicare program and seek reimbursement from the Secretary under that program. The Secretary refused reimbursement for the stock options, finding that under generally accepted accounting principles ("GAAP"),¹  the hospitals had not incurred any costs.²  The district court affirmed the Secretary's decision, granting the secretary's motion for summary judgment. We review the Secretary's final decision to determine "whether the agency action was 'arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.' "³  We have jurisdiction under 28 U.S.C. § 1291, and we affirm.

In the fiscal years 1980 through 1984, appellant hospitals granted stock options to certain top managerial employees.⁴  The stock options were "fixed" options; they gave recipients the right to purchase a specific number of shares at a fixed price. The fixed price for a given employee's option was the market price of the stock on the date that the option was initially granted. The option became fully vested three years after the grant date; the right to exercise the option lasted until ten years after that date.

The hospitals seek reimbursement for the costs of their employee stock options under the Medicare Act, which provides for reimbursement of the "reasonable cost"--defined as "the cost actually incurred"--in rendering covered services to Medicare patients. 42 U.S.C. §§ 1395f(b), 1395x(v) (1) (A).⁵  The Secretary denied the hospitals' reimbursement request, finding that under Accounting Principles Board Opinion No. 25 (Accounting Principles Bd.1972) ("APB No. 25"), the hospitals incurred no costs because the exercise price of each option was the stock's market price on the grant date. The hospitals contend that the Secretary's decision to apply APB No. 25 to value their stock options was arbitrary and capricious. In accord with our decision in HCA Health Services of Midwest, Inc. v. Bowen, 869 F.2d 1179 (9th Cir. 1989), we affirm the Secretary's decision.

In HCA the secretary applied generally accepted accounting principles to find that under the accrual basis of accounting mandated by the regulations, employee stock options are to be valued not on the date of exercise, but on the date of grant. We held that the Secretary reasonably followed APB No. 25, which, we noted, is "the authoritative pronouncement of the accounting profession on the measurement associated with employee stock option plans," id. at 1182. HCA affirmed the Secretary's finding that at the time the hospitals granted the stock options, they incurred no costs, because under APB No. 25 fixed options offered at or above market price yield a cost of zero. Id. at 1181-82 & n. 4.

While our decision in HCA would seem to definitively resolve the question of whether the Secretary reasonably may apply APB No. 25 to value the cost of fixed employee stock options, appellant hospitals contend otherwise. They concede that the stock options at issue in the present case are indistinguishable from those considered in HCA, but they argue that in HCA the court was not required to resolve whether GAAP applied because the parties agreed that it did. Instead, the hospitals argue that GAAP may be applied only to determine issues of "timing," but not issues of "allowability." They argue that their claimed reimbursement costs must be allowed because they are claims for "fringe benefits," which are expressly allowed by the regulations. Finally, the hospitals argue that instead of applying APB No. 25, the Secretary must apply the "Black-Scholes method" to calculate the value of their stock option plans. Under this method, which relies on six factors to assign a value to a stock option at the date of its grant, the hospitals claim that they incurred actual costs of approximately thirty-three million dollars, less a nine percent discount.⁶ 

The hospitals' attempts to distinguish or limit HCA are unavailing. To begin with, there is no issue in this case as to whether stock option plans may create reimbursable costs. The Secretary concedes that health care providers' employee stock option costs are allowable fringe benefits⁷  and would agree that if the stock options had an exercise price less than the market price on the date they were granted, the options would have generated reimbursable costs. Rather, the question presented is whether APB No. 25 is appropriately relied upon to define and value the cost of the options. None of the Secretary's regulations or interpretive guidelines answers this question. The fringe benefit regulations and guidelines do not dictate a particular method of valuing cost. Because the Secretary's regulations and interpretive guidelines are silent on the issue of stock option valuation, the Secretary applied GAAP in the form of APB No. 25 to make this determination.

Appellant hospitals argue that cases from this and other circuits suggest that while the Secretary must use GAAP to determine accounting issues related to "timing," the Secretary may not use GAAP to determine issues of "allowability," that is, whether certain costs are reimbursable at all. This proposed distinction is of no assistance here, and we reject it in any event. First, the distinction has no bearing on this case. As stated previously, the issue in this case is one of valuation, not one of allowability. Second, even could the issue be characterized as one of allowability, no reported decision of this court or any other federal court requires the Secretary to depart from GAAP to determine allowability in the absence of an applicable Medicare regulation.⁸  We have previously held that the Secretary may not depart from GAAP when her departure is inconsistent with Medicare regulations,⁹  and we have held that the Secretary may depart from GAAP when she finds that GAAP does not accurately reflect the cost of patient care.¹⁰  But we have never held that the Secretary may not use GAAP to determine issues of allowability. Indeed, we have held to the contrary. See Villa View, 720 F.2d at 1093.¹¹ 

Finally, the Secretary's decision to use APB No. 25 instead of the "Black-Scholes method" to value the cost of the options was not an abuse of discretion. The hospitals' argument that by using APB No. 25 to value the stock options the Secretary arbitrarily ignored the "real economic costs" involved in granting the options is foreclosed by our decision in HCA, in which we expressly rejected the same argument. HCA, 869 F.2d at 1181-82 & n. 6. Because we have previously held that the valuation method selected by the Secretary, APB No. 25, is supported by rational considerations sufficient to provide a reasonable basis for its use, see HCA, 869 F.2d at 1182, the Secretary's decision to refuse to use the hospitals' alternative valuation method and to deny reimbursement for the stock options at issue in this case must be affirmed.¹² 

For the above stated reasons, the judgment of the district court is

AFFIRMED.