CHARLESTON, W. Va. - The federal government has decided that the State of West Virginia owes it $4.1 million because of the way Attorney General Darrell McGraw handled a 2004 settlement with prescription drug manufacturer Purdue Pharma.

Instead of asking for a check, the federal Centers for Medicaid and Medicare Services is planning to withhold the amount from the next appropriation of federal funds to the state's Medicaid program, a move that could affect taxpayers if the program's budget falls short. The federal government supplies nearly 75 cents of every dollar spent on Medicaid in the state.

"Based on our review of the documentation provided in the complaint against Purdue Pharma, CMS concluded that the state agency failed to reimburse the federal government its share of the settlement proceeds," wrote Ted Gallagher, Associate Regional Manager of the CMS, to Marsha Morris, Commissioner for the Bureau of Medical Services portion of the state's Department of Health and Human Resources, which executes Medicaid spending.

Meanwhile, the State is planning to appeal the decision on the grounds the state's DHHR never received the money CMS is asking for, said Lara Ramsburg, spokesperson for Gov. Joe Manchin.

The DHHR never received the money thanks to McGraw, who structured the $10 million settlement with Purdue Pharma in a way that allowed his office to keep all of the funds. Chief Deputy Attorney General Fran Hughes admitted that before the state's Legislature when it questioned the settlement.

In February, she promised the Legislature that McGraw's office would stop appropriating the settlement funds on its own. She also said the money was not given to the DHHR because then the CMS could claim its share -- "We have arranged a methodology that has prevented the federal government from coming back and seizing money," Hughes said.

But since then, the office has continued to give the settlement proceeds to various substance abuse programs around the state, as well $500,000 for a pharmacy school at the University of Charleston.

Hughes previously served as general counsel for Human Services Management, a national consulting firm specializing in Medicaid financing. Part of the complaint against Purdue Pharma alleged that the state's Medicaid program had been subject to undue strain because of the company's controversial prescription painkiller OxyContin.

The company, it was alleged, misrepresented OxyContin's addiction capabilities, and the State was forced to spend Medicaid dollars treating addicts. Roughly 75 cents of every dollar alleged to be unfairly spent was provided by the federal government, but since the DHHR never received any of the settlement funds, the federal government could not claim what it feels is its share.

McGraw represented the DHHR, Public Employees Insurance Agency and the Bureau of Employment Programs in the lawsuit, filed in 2001 in McDowell County Circuit Court. None of those agencies received any of the funds, though the private practice attorneys hired by McGraw to help represent the State earned $3.3 million.

"Darrell McGraw has jeopardized funding for West Virginia's poor and disabled by essentially converting lawsuit settlement dollars into a political slush fund for his own pet projects," said Steve Cohen, Executive Director of the watchdog group Citizens Against Lawsuit Abuse.

McGraw's office and the DHHR did not return messages seeking comment, nor had the CMS at presstime.

Ramsburg said the appeal from the DHHR will go through a federal procedure for these types of disagreements.

"They're asking for money from the DHHR that the DHHR never received," she said, though she did not know if McGraw will again be representing the DHHR.

"They're taking action as if DHHR received money and they should then get a percentage of that money. Our position is (the DHHR) didn't receive it, therefore there is no money to split."

CMS arrived at its total of $4,143,075 million by taking the 74.65 percent (the rate of federal payment to the state for every dollar spent) out of $5.5 million of the settlement. That $5.5 million represents what the CMS feels should have been the equitable distribution of the settlement dollars among the three plaintiffs with respect to certain allegations involving Medicaid dollars.

Mary Kahn, a spokesperson for the CMS, has said she doesn't believe McGraw will be investigated by the Office of Inspector General for Medicaid fraud.

Currently, Purdue Pharma is supplying the third installment of the payment. The settlement stated the company would make four payments of $2.5 million.

"The State orders that the Final Order stipulated alternative uses of the award settlement dollars, thus prohibiting Medicaid from receiving its fair share," the CMS wrote.

"We disagree."