As we have discussed in prior posts (here), private equity investors in the healthcare and life sciences industries increasingly face direct risk under the FCA where they actively manage portfolio companies accused of regulatory noncompliance leading to the submission of false claims. In each of the cases discussed in these earlier actions the PE fund defendant was the sole or majority investor and DOJ and the courts relied on facts demonstrating that the funds were aware of and endorsed or otherwise participated directly in the underlying fraud.
DOJ may have pressed this emerging enforcement trend substantially forward in a recently announced settlement with a company that conducts ambulatory EEG testing and its minority PE investor. The allegations against the testing lab were set forth in six separate whistleblower lawsuits and are garden-variety healthcare fraud: the lab allegedly paid kickbacks to doctors to order its tests, billed for tests that were not provided, or billed for higher levels of testing than performed. The lab agreed to pay approximately $13.5 million to resolve claims on this basis. The settlement agreement also reflects an agreement by the minority investor to pay $1.8 million to resolve allegations that it caused the false claims tainted by the alleged kickback scheme to continue to be submitted following its investment in the company.
The agreement cites to the fact that, in addition to holding two Board seats, the minority investor had a management service agreement with the company. The DOJ press release states that the investor “learned of the kickbacks based on due diligence it performed prior to investing in Alliance and then caused false claims by allowing that conduct to continue once it entered into an agreement to manage Alliance.” To the extent that liability arose because of the investor’s role in management, this case is consistent with DOJ’s prior cases in this area. The qui tam complaints remain sealed, so it is unclear whether they set forth allegations that the investor actively participated in the kickback scheme.
DOJ’s reference to knowledge acquired by investors during diligence, however, raises the troubling question whether DOJ expects investors who become aware of issues of non-compliance during diligence to take steps to remediate those issues post-investment – whether or not they actively engage in management activities. Such an expectation would reflect a substantial expansion of DOJ’s prior theories of liability and should be of significant concern to private equity investors in the heavily regulated healthcare and life sciences sectors. Such an expectation also would raise the important question of what actions, if any, an investor who does not assume managerial control could or should take to remediate any issues of potential non-compliance of which it becomes aware.
Certainly where the investor does intend to take on any active management role – through a management services agreement or otherwise – it should be educated on and attentive to the particular fraud and abuse risks facing their portfolio company and should take steps to mitigate those risks. But even investors who do not participate in the day-to-day management should assume that they may be subject to FCA (and other) liability. Investors who learn of potential issues of non-compliance and who have the authority to address those issues, either because of a controlling interest or through a management services function, should also take appropriate steps to address the resulting exposure. Among other steps, funds should:
- Understand the complex regulatory and federal healthcare program contract requirements applicable to their portfolio companies both during and after diligence.
- Ensure that portfolio companies have sound compliance programs that satisfy the HHS-OIG’s defined elements of effective compliance programs, including monitoring and auditing. Communicate clear insistence on sound compliance practices to portfolio companies throughout the life of a fund’s investment in any healthcare portfolio company.
- Implement a process for board oversight of compliance efforts – e.g., periodic reporting up from management, including the CCO – and memorialize compliance with that process. Such a process should, as a substantive matter, ensure an acceptable level of compliance, and at the same time establish contemporaneous evidence of the fund’s “intent” should questions about that intent ever arise.
- Follow-up on issues of non-compliance identified during diligence and document that follow-up. Such efforts should be initiated promptly post-close and in general remediation efforts should be completed within a reasonable period of time, dependent on the complexity of the operation.
We will continue to report on this enforcement area of focus here.
This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.