No potential investment in a health care company should be contemplated without considering federal health regulatory compliance issues and completing adequate due diligence to address these issues.

The Office of Inspector General of the Department of Health and Human Services and the Department of Justice have ramped up their enforcement efforts for violations of applicable law. Penalties for noncompliance are large and accumulate rapidly, and statutes of limitations for violations of health care laws are long.

Health care companies that receive even one dollar of federal health care program money are subject to federal fraud and abuse laws. This is true even if the government does not pay the company directly, but instead, the company has a compensation arrangement with a health care provider or supplier that files claims with federal health care programs.

The most prevalent of these laws are the Anti- Kickback Statute (“AKS”), the Civil Monetary Penalty Law (“CMPL”), the patient referral law known as “Stark,” and the False Claims Act (including whistleblower or qui tam suits).

What’s a Kickback?

The AKS covers all remuneration, paid knowingly and willfully, in cash or in kind, directly or indirectly, in return for the referral of an individual, to induce the referral of an individual, or to arrange for the referral of an individual, for any item or service payable by any federal or state health care program. The AKS covers the offer and payment of remuneration and the solicitation and receipt of payment.

A kickback is usually thought of by laymen as an overt bribe to induce referrals. However, the government takes a much more expansive view of kickbacks. Common business practices that are entirely legal and proper outside of the health care arena are viewed by the government as kickbacks. For example, in many start-up business ventures, the founders would allocate ownership interests in accordance with the customers or clients each founder is expected to generate, and capital contributions are often made in accordance with such allocations. However, if the founders are all surgeons and establish an ambulatory surgery center to which each is expected refer patients, they cannot allocate ownership in accordance with their expected referrals. The government would likely determine that they are being paid for their referrals, constituting an illegal kickback.

Other behavior viewed as kickbacks includes changing ownership interests as referrals change (increasing ownership if referrals increase, decreasing or redeeming ownership interests if referrals decline); contracts to provide phantom services (or little services) given to persons in a position to refer patients; below fair market value leases given to tenants expected to provide referrals and above fair market value leases to tenants who are expected to receive referrals; and above fair market value employment or independent contractor agreements with providers of referrals. Earn-outs paid to a seller post-closing based on referrals to be provided by the seller following the closing can also be viewed as kickbacks.

The AKS is a criminal statute. Violation is a felony punishable by up to $25,000, up to five years in prison or both. The government can also prosecute a violation of the AKS as a civil violation under the CMPL. The offending conduct would be the same, but the government has a lesser burden to prove its case under the CMPL. The civil penalties are up to $50,000 per act and up to three times the amount of payments received from the government.

Stark and Other Referral Laws

The Stark law, named for Congressman Pete Stark, prohibits referrals by a physician of Medicare patients for certain “designated health services” to an “entity” with which the physician or an immediate family member of the physician has a direct or indirect financial relationship unless an exception in the Stark law or regulations permits the referrals. Most states also have enacted patient referral laws that may be more stringent than Stark, covering a broader range of heath care providers than physicians, and covering more services than just the ten “designated services” under the Stark law.1

Stark financial relationships include ownership interests, investment interests, and compensation arrangements. It is often the compensation arrangements that are overlooked in diligence. Medical director agreements, leases, management services agreements, and similar arrangements must be scrutinized to ensure compliance with Stark laws.

Most exceptions to the requirements of the Stark law require remuneration at fair market value, among other things. Each element of an available exception must be satisfied in order for a financial arrangement to qualify. If a financial arrangement does not comply fully with a Stark exception, all of the physician’s referrals to the entity are tainted. The entity cannot bill Medicare or Medicaid, the patient, or any other person for the services. In addition, there is a $15,000 per violation penalty for causing such a claim to be presented.

False Claims Act

The federal False Claims Act prohibits, among other things, the submission of a false or fraudulent claim to a government health plan for services. A false claim can include a claim for services not rendered, filing for services at a higher rate (upcoding), and overpayments. Courts have increasingly found that if an arrangement violates either the AKS or Stark, any claims filed can form the basis of a False Claims Act case. A provision in the health reform bill enacted into law in March codifies this interpretation with regard to AKS violations.

The False Claims Act is also used as a vehicle by whistleblowers (also referred to as qui tam plaintiffs) to sue on behalf of the government. Many of the large health care fraud settlements were originated as qui tam suits.

How to Protect Your Investment

Health care diligence should be in the forefront of any investor’s due diligence investigation of a health care company. It is important to scrutinize relationships with anyone in a position to make referrals for health care items or services. This includes a review of company structure, employment and independent contractor agreements, leases, and agreements with suppliers. Amounts paid to or received from referral sources must be at fair market value. Business formation documents should be reviewed to determine the basis on which initial and later granted ownership interests, if any, were allocated and the basis on which distributions are made. In addition, it is important to note whether the company has in place a corporate compliance plan that targets fraud and abuse issues, training given to employees, and how comprehensive the plan is. In addition to reviewing the compliance plan structure, compliance committee minutes should be reviewed.

Once an investment in a company is made, it is important to ensure that the company maintains a vibrant compliance program. The compliance committee should meet on a regular basis. Training for employees should be ongoing. Employees who believe there may be a violation should have a way to voice their concerns. New arrangements with referral sources and potential referral sources must be structured carefully to comply with fraud and abuse laws. In short, the company should have a culture of compliance.