Investor, Beware: New Prosecutorial Scrutiny of Private Equity Investment in Healthcare Companies

Government Enforcement Update

Firm Alert

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A bedrock principle of private equity investment is that investors expect to make money on their investments. A recent lawsuit by the Department of Justice (DOJ), however, might force private equity investors in healthcare to think twice about that previously uncontroverted principle.

Recent case development

In February 2018, the United States Attorney’s Office for the Southern District of Florida – historically one of the most active districts prosecuting healthcare fraud – announced it had filed a civil False Claims Act lawsuit against a compound pharmacy (Patient Care America) and its two chief executives. See U.S. ex rel. Medrano v. Diabetic Care Rx, LLC et al, No. 15-cv-62617, S.D. Fla. Notably, the DOJ also named as a defendant a private equity firm – Riordan, Lewis & Haden, Inc. (RLH).

The lawsuit alleges that the pharmacy improperly paid kickbacks to receive lucrative referrals of patients eligible for compounded medications. The vast majority of the suit focuses on the pharmacy and its executives, alleging they failed to comply with the Anti-Kickback Statue.

But with regard to the private equity investor, the DOJ took a different focus – the investor’s goal of making a profit. Specifically, the DOJ alleged that RLH had a “controlling stake” in the compound pharmacy and “planned to increase [the pharmacy’s] value and sell it for a profit in five years.” Further, the DOJ went to lengths to explain that the private equity firm’s “primary objective” was to increase the profitability of their investment (the pharmacy).

The private equity firm’s alleged sin was to advise the pharmacy to shift to higher-reimbursement product lines. In this case, the private equity group allegedly encouraged the pharmacy to move from Medicare End Stage Renal Disease patients to TRICARE compound medication beneficiaries. According to the DOJ, the private equity group steered its acquired pharmacy into compound prescriptions to generate a “very fast payback on [its] investment.”

Throughout its complaint, the DOJ makes a litany of allegations that the pharmacy paid illegal kickbacks to patient recruiters to obtain lucrative referrals. The private equity group was allegedly aware of the existence of these recruiters and the amount of commissions they were receiving. According to the complaint, this was wrong because the private equity group, “[a]s an investor in healthcare companies, knew or should have known … that healthcare providers that bill federal healthcare programs are subject to laws and regulations designed to prevent fraud.”

Practical advice for private equity investors

At first glance, it appears that the DOJ is simply taking issue with the private equity investors’ interest in improving the return on their investment. But viewed from the DOJ’s perspective, the investment firm was focused on “profits over patients” in order to make a “very fast payback.” And in the DOJ’s own words, the private equity group should have been more mindful of the complex legal and regulatory landscape governing healthcare fraud.

While it is important not to read too much into one complaint – particularly one not yet litigated – this matter offers several practical suggestions for private equity investors seeking to do business with companies that participate in federal government healthcare programs, including:

  • Carefully review healthcare laws and regulations. The DOJ may expect that private equity investors involved in the healthcare industry will become familiar with applicable healthcare fraud and abuse regulations, including the Stark Law, the Anti-Kickback Statute and the False Claims Act. Because the Anti-Kickback Statute, in particular, imposes criminal penalties on potential wrongdoers, the stakes have never been higher for investors in healthcare companies.
  • Avoid colorful language and statements about profits over patient care. Whenever possible, private equity investors should not explicitly ascribe profitability motives – particularly colorful statements like receiving a “very fast payback” – to investments in federal healthcare providers. To that end, investors should remember that the DOJ often will look for any evidence (including pitch materials and promotional packets) that might suggest improper motivations or influences.
  • Perform all appropriate due diligence – early and often. As always, investors ought to exercise appropriate diligence in researching their potential investment targets. Investors would benefit from asking the tough questions before the government comes knocking. These questions include whether the potential equity target is compliant with all rules and has a compliance department that proactively addresses any legal or regulatory concerns.
  • Be wary of unrealistic returns in healthcare investments. Lastly, private equity investors in the healthcare space should heed the adage: “If it seems too good to be true, it probably is.” Given rising federal healthcare expenditures, the DOJ is closely watching lucrative, high-reimbursement healthcare providers. And when the DOJ suspects wrongdoing, it ordinarily pursues all involved – either directly or, in RLH’s case, indirectly. Thus, steering clear of “get rich quick” schemes, particularly in the complicated regulatory environment of government healthcare, is a best practice.

Ultimately, no one suggestion will inoculate investors from prosecutorial scrutiny. Nonetheless, the practices outlined above will go a long way in ensuring compliance and minimizing the pain of a protracted DOJ investigation. Indeed, for private equity investors in the federal healthcare arena, never has it been more true that an ounce of prevention is worth a pound of cure.