In addition to the size and volume of investments in the healthcare industry, PE deals are happening faster than ever before.The conveniences of Zoom and other virtual programs have assisted dealmakers in doing so. Too many investors and a significant amount of capital with too few assets are pushing the supply and demand envelope more than ever before.
The more PE firms funnel dry powder into the healthcare sector at this unprecedented pace, however, the more they risk heightened exposure to the uniquely treacherous legal and regulatory landscape in which they are investing. Today, both whistleblowers and the government are turning their attention both to PE firms’ portfolio companies and to PE firms themselves. History indicates that government enforcement efforts will follow private investment and government reimbursement dollars. In their eagerness to take advantage of the current investment landscape, PE firms and their portfolio companies must be careful not to sacrifice due diligence efforts under an increasingly watchful eye on the regulatory and legal side. If PE firms are to avoid an enforcement collision of great magnitude, they must strongly consider how to limit liability under laws like the False Claims Act, which can lead to massive, almost draconian exposure due to its provisions allowing for both treble damages and statutory penalties for each false claim submitted to the government.
Private Equity’s Role in the Healthcare Sector
It can help small healthcare companies scale up quickly — in some cases, creating an entirely new market for those firms and their customers. PE firms can provide more than just capital, too.
All of these effects can and do contribute to significant, positive advancements and improved patient outcomes in healthcare.
Despite those numerous benefits, however, some believe PE’s role in the healthcare industry is misplaced because its profit-driven focus is contrary to the ultimate goal of providing the best patient care possible. A May 2021 white paper, published by experts at UC Berkeley and the American Antitrust Institute, concluded that
Profit-based healthcare, they say, threatens patients’ trust in their doctors, and can lead to lost jobs, the destruction of previously-successful businesses, lost lives, and more expensive, lower quality healthcare.
Regardless of one’s view, both sides should be mindful that the healthcare industry is built upon a complex web of laws and regulations designed to protect patients from the misalignment of interest that can result from profit-driven healthcare. The False Claims Act is one such tool — and an extremely powerful one at that. Today, it is being used with greater force than ever before against PE firms’ portfolio companies and PE firms themselves.
The Interaction of the False Claims Act and PE Firms in Healthcare
The False Claims Act is a federal law that permits private persons (also known as “whistleblowers” or “relators”) to file qui tam lawsuits on behalf of the federal government. The government can intervene in the lawsuit and assume responsibility for the litigation, or can leave the whistleblower to litigate the case on his or her own.Many states have similar counterpart laws related to state government healthcare programs.
Virtually every type of actor in the healthcare sector has routinely been the target of qui tam actions in the past. Although PE firms historically have avoided significant and consistent scrutiny, now they, and not just their portfolio companies, are in danger of being swept into those enforcement efforts.
Davis stated: “When a private equity firm invests in a company in a highly-regulated space like healthcare or the life sciences, the firm should be aware of the laws and regulations designed to prevent fraud.
Enforcement efforts against PE firms are still developing.
According to the government, RLH was not merely a passive owner but managed the pharmacy on behalf of its investors and allegedly knew of and agreed to the plan to pay outside marketers to generate the prescriptions and financed the kickback payments to marketers. The pharmacy and RLH ultimately agreed to pay approximately $21 million to settle the claims, with two of the PE firm’s executives paying approximately $315,000, collectively.
As part of the settlement, the Gores Group (TGG), the PE owner of the company, agreed to pay an additional $1.5 million to resolve allegations that the portfolio company continued the alleged improper sales and promotion practices after TGG acquired the company, in part due to sales pressure that TGG applied to the company.
The PE firm Ancor Holdings LP, a minority owner in Alliance Family, agreed to pay an additional $1.8 million to resolve allegations that it discovered the portfolio company’s alleged wrongdoing during due diligence but failed to take action to stop it.
The lawsuit alleged that H.I.G.’s portfolio company South Bay Medical Center used unqualified or unlicensed staff to provide mental health services to patients and that it failed to supervise that staff appropriately. Although the DOJ declined to intervene in the case, the Commonwealth of Massachusetts intervened and pursued damages for claims submitted to the Massachusetts Medicaid program, MassHealth. Two of South Bay Medical’s former executives agreed to pay an additional $5.05 million to resolve the case.
Interestingly, the settlement came only months after a May 2021 district court decision denying H.I.G.’s and the two executives’ attempts to dismiss the case on summary judgment. The court found there was sufficient evidence to conclude that H.I.G. could have known of fraudulent conduct at South Bay Medical Center but failed to correct it. The court pointed out the various times H.I.G.’s members were informed about inadequate supervision at South Bay.This was the first time a False Claims Act case against a PE firm proceeded through discovery and summary judgment before settling.
The relator, a former vice president for defendant BioMatrix Specialty Pharmacy, alleged that the specialty pharmacies employed regional care coordinators (RCCs) specifically to recruit hemophilia patients to use the specialty pharmacies’ services. The relator alleged that the RCCs were improperly compensated based on the number of patients each RCC referred to the pharmacies and the amount of product the referred patient filled through the pharmacies. With respect to the PE defendants, the relator alleged that the PE owners were aware of the scheme, including participating in board meetings where lucrative “referral source relationships” were discussed.
The DOJ investigated the matter for three and a half years but ultimately declined to intervene. Although the PE owners were alleged to have been informed about “referral source relationships” generally, the qui tam complaint did not allege more specific knowledge of the purported kickback scheme or more direct management of or participation in the portfolio company’s operations, which may have diminished the DOJ’s interest in the case.
Best Practices: How PE Firms and Their Portfolio Healthcare Companies Can Recalibrate to Accommodate the Increased Enforcement Focus
PE’s investment in the healthcare industry shows no signs of slowing down. Consequently, PE investors and their portfolio companies must be mindful of the government’s increased enforcement focus and consider ways to protect themselves when considering and executing investments. Some key factors for investors and their counsel to consider to limit potential False Claims Act exposure include:
- Diligence: PE firms must conduct comprehensive diligence about both the target company and the specific sector in which it operates or will operate. Investors should make sure that they are aware of past compliance issues or enforcement efforts both specific to the investment and in that sector more generally. Investors’ due diligence should comport with and reflect the specific risk factors the target company faces in its day-to-day operations. Depending on the structure of the transaction and its role moving forward, the target company also may be well served to conduct due diligence about the PE investor, including any history of investing in and/or operating healthcare companies.
- Compliance: PE firms and their portfolio companies should maintain effective compliance functions that comport with the Department of Health and Human Services Office of Inspector General’s guidance and that ideally, where practicable given the size and complexity of the organization, are separate from business and financial personnel and have a direct line to the controlling Board or its compliance officer or committee. The compliance function should be evaluated regularly at the company and Board level and adjusted to address shifting risk factors and government enforcement efforts. The compliance programs should be supported by an effective “compliance culture” and “tone at the top,” starting with the highest levels of management and the decision makers of the organization, typically the Board and any associated compliance committee, as well as the CEO. Even where the compliance function is independent, business and financial personnel should receive compliance training as well.
- Management: Owners should make deliberate and informed decisions about how much direct involvement the PE firm will have in the portfolio company’s operations, as that level of involvement could directly affect the scope of the firm’s exposure. The extent of ownership’s specific knowledge of the company’s activities and the degree to which ownership actively manages the company’s operations likely will be relevant factors to the government in an enforcement action. Nonetheless, a PE firm cannot be willfully ignorant of risk factors or compliance issues to avoid exposure.
PE’s investment in the healthcare industry likely will continue to grow. The history of government healthcare fraud and abuse enforcement efforts teaches that an influx of investment dollars – and the associated reimbursement dollars by the government – leads to increased government scrutiny. PE firms investing in healthcare companies must make deliberate and informed decisions about how those investments are structured and how the portfolio companies will operate moving forward in order to minimize potential False Claims Act exposure. To do so, PE firms must stay up to date on healthcare fraud and abuse enforcement efforts generally and on enforcement efforts specific to PE investors. Although no amount of diligence can foreclose government scrutiny entirely, taking proactive measures to minimize red flags can help not only to reduce exposure but also to short circuit what might otherwise become drawn out and expensive response processes.