Private Equity Funds Face Increasing Risk of False Claims Act Liability

Evidence is mounting that DOJ is willing to pursue private equity funds in False Claims Act cases, particularly ones based on alleged violations of healthcare fraud and abuse laws.  Earlier this year, for the first time the Department intervened in one such False Claims Act case against a private equity sponsor, the fund’s portfolio pharmacy, and two pharmacy employees.  U.S. ex rel. Medrano v. Diabetic Care Rx, LLC, Case No. 15-62617-CIV-BLOOM, S.D.Fl.

In its complaint-in-intervention in Diabetic Care, the government alleged that the fund had a “controlling interest” in the pharmacy; that two representatives of the fund served as both board members and officers of the pharmacy; and that these individuals played an active role in the management of the pharmacy.   The government further alleged the PE fund had acted with the requisite “intent,” alleging that “[a]s an investor in healthcare companies, [the fund] knew or should have known . . . . that healthcare providers that bill federal healthcare programs are subject to laws and regulations designed to prevent fraud, including the [Anti-Kickback Statute.]”  The PE fund has filed a motion to be dismissed from that case, arguing that the absence of allegations that it knew of, or participated in the fraud, inoculates it from False Claims Act liability.

While awaiting a ruling from the Diabetic Care court on this issue, DOJ recently filed a notice drawing the court’s attention to a recent decision by another court on the precise issue which supported the government’s position.  In that case, in which DOJ has declined to intervene, a private whistleblower and the Commonwealth of Massachusetts alleged that a mental health center owned by PE funds provided services that were not properly reimbursable because they were provided in violation of various state law and contractual requirements.  U.S. ex rel. Martino-Fleming v. South Bay Mental Health Center, Civ. Action No. 15-13065, D. Mass.  The PE fund defendants filed a motion for dismissal from the case on the ground that there were no allegations that they had “directly” caused the mental health center to submit any false claims or engage in improper conduct.  They further argued that mere failure to stop the practices could not support False Claims Act liability.  The South Bay court rejected those arguments, holding that a PE fund can be liable “where the submission of false claims by another entity was the foreseeable result of a business practice.”  Moreover, the court found the complaint adequately alleged that the PE funds had caused the submission of the false claims based on allegations that the PE fund “members and principals formed a majority of the . . . South Bay Board[], and were directly involved in the operations of South Bay.”

These developments make explicit that which has long been implicit:  Active engagement in the management of portfolio companies potentially exposes private equity sponsors to the draconian penalties under the False Claims Act.