On June 19, 2007, the Office of Inspector General of the U. S. Department of Health and Human Services (“OIG”) issued Advisory Opinion 07-05, regarding the proposed sale of a minority ownership interest in an ambulatory surgery center (the “ASC”) by physician investors to a local hospital (the “Hospital”). The physician investors in the ASC included three orthopedic surgeons who collectively held a 94% ownership interest in the limited liability company, and two gastroenterologists and two anesthesiologists who collectively owned the remaining 6% interest. Under the proposed arrangement, the orthopedic surgeons would sell the Hospital a 40% ownership interest in the ASC. The parties certified that the purchase price to be paid by the Hospital was consistent with the fair market value of the interest. Not surprisingly, the amount to be paid by the Hospital for the 40% interest was greater than the initial amount paid for such interests by the selling physician investors.
The OIG first restated its long-standing concerns about joint venture arrangements between parties in a position to refer business and those who furnish items or services reimbursable by Federal health care programs. The OIG next determined that the proposed arrangement would not qualify for protection under the safe harbor for hospital/physician-owned ASCs, in part because the return on investment of each investor would not be directly proportional to the amount of capital invested by each investor following the transaction.
The OIG concluded that it was unclear whether the proposed arrangement was related, at least in part, to referrals of Federal health care program business and, therefore, that the proposed arrangement posed a heightened risk of fraud and abuse. In other words, the OIG surmised that the proposed payment by the Hospital to the orthopedic surgeons may be intended to reward or influence the orthopedic surgeons to make referrals to the Hospital and the ASC.
The OIG based its conclusion on a number of factors, including the following:
- The orthopedic surgeons did not offer to sell their interests in the ASC to any other prospective buyers, including the other physician investors in the ASC, and the other physician investors did not propose to sell any of their ownership interests to the Hospital.
- The proposed purchase by the Hospital would have involved the payment of funds directly to the orthopedic surgeons, rather than an investment in the capital of the ASC, thereby enabling the orthopedic surgeons to realize a profit on a portion of their original investment in the ASC and providing no infusion of additional capital to the ASC.
- Following the acquisition of the 40% interest by the Hospital, the return on investment experienced by all of the investors in the ASC would not be proportional to the amount of capital invested by each investor. The OIG acknowledged that the returns to investors would be proportional to their respective ownership interests in the Company; however, it also noted that because the Hospital would pay more per unit of ownership interest than the physician investors paid for their interests, it would receive a lower rate of return on its investment than the physician investors.
The OIG confirmed that the mere existence of one or all of the foregoing factors did not necessarily indicate the existence of fraud and abuse. However, it also concluded that the difference in the cost of “capital acquisition,” which would result in financial gain to the orthopedic surgeons, may be indicative of a payment in exchange for future referrals by such physicians.
Unfortunately, the OIG’s conclusion ignores the economic reality that the value of a successful business tends to increase over time. It also casts doubts in situations where new investors buy into a joint venture at different prices, which will be the case whenever investors buy-in following the initial offering of investment interests. Further, it is unclear what would have satisfied the OIG. Would the OIG have preferred that subsequent sales of units be set at the original sales price, even though the original sales price would be inconsistent with fair market value? Certainly, the OIG could not have intended this sort of inference.
The advisory opinion also appears to be somewhat of a departure from the OIG’s prior position in Advisory Opinion 01-21. In that opinion, the OIG specifically acknowledged the legitimacy of differences in prices paid to acquire ownership interests in a joint venture ASC resulting from the appreciation in the overall enterprise value of an ASC over time, and it concluded that the distribution of profits in proportion to equity ownership percentages rather than relative capital investment does not increase the risk of fraud or abuse. It is unclear whether this advisory opinion marks a change in the OIG’s analysis of this issue in general.
Another issue created by the advisory opinion is whether new investors should be able to buy units from existing investors, where the money goes to a selling interest holder, rather than the joint venture. That is, is a capital contribution to the joint venture required?
In summary, we believe that the advisory opinion creates more questions than answers, and wonder whether there were other facts not evident from a reading of the advisory opinion itself. We expect that this advisory opinion will spur significant comments to the OIG from the provider community and could result in a clarification statement from OIG, as has happened in the past. Although the opinion will certainly cause providers and their counsel to more closely examine the sales of interests in health care joint ventures, we do not expect to see a slow down in secondary sales for such entities.
For more information on OIG Advisory Opinion 07-05 and its impact on joint venture arrangements involving physician investors, please feel free to call Andy Murray
at 615-252-2366, or another member of the Boult Cummings Health Care