24 May 2021

Judge Saris Green Lights FCA Claims Against PE Fund Based on Regulatory Non-Compliance of its Portfolio Company Healthcare Provider for Trial

Late last week, Judge Patti Saris (D. Mass.) issued an opinion on cross-motions for summary judgment filed by a qui tam relator and Massachusetts and a group of defendants that includes South Bay Mental Health Center (“South Bay”) and its private equity fund owner, permitting the vast majority of plaintiffs’ claims to proceed to the jury.  The opinion addresses important questions of law as to each of the elements of the FCA related to claims to Medicaid for services allegedly provided in violation of various state regulatory requirements.  However, the opinion is most notable for being the first to hold at the dispositive motion stage that a private equity fund and its principals can act with the requisite scienter and cause the submission of false claims, and thus be exposed directly to the treble damages and statutory penalties of the FCA as a result of conduct by a healthcare provider portfolio company.  As such, we may expect it to add momentum to DOJ’s stated intent to pursue FCA claims against PE investors in the industry, as we previously reported here.

This case, in which DOJ declined to intervene, involves allegations that South Bay submitted claims to Medicaid that were false because the underlying mental health services were not timely supervised by adequately licensed personnel or lacked appropriate documentation of adequate and timely supervision, 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.  As we previously reported, here, the court rejected motions to dismiss the case, including the motion filed by the PE fund defendants, 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 fund 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.”

The parties cross-moved for partial summary judgment last year and Judge Saris published her opinion on May 19.  Therein, Judge Saris rejected the PE fund’s arguments as to the scienter and causation elements of the FCA.  First, the court held that plaintiffs had identified sufficient evidence to raise a genuine dispute of material fact as to whether the PE fund knew of South Bay’s regulatory non-compliance, citing evidence that the fund’s “leadership understood that South Bay’s revenues were tied to Medicaid,” “understood that Medicaid had terms and conditions of payment,” that the fund’s members “were aware that MassHealth regulations required certain forms of supervision,” and “were informed that clinicians at South Bay were provided with inadequate supervision.”  Interestingly, some of the evidence the court cited in this regard was drawn from diligence materials made available to the PE fund at the time of its investment regarding potential gaps in clinical supervision at South Bay.  On this evidence, the court held that the PE fund should have known compliance with the regulations was material to payment and that “a reasonable jury could conclude that the scienter element is satisfied” with respect to the PE fund.

Second, the court held that plaintiffs had established sufficient evidence that the PE fund caused the submission of the false claims to survive the fund’s summary judgment motion.  In reaching this decision the court cited back to its opinion denying defendants’ motion to dismiss the suit, which held that the PE fund’s “knowing ratification of ‘the prior policy of submitting false claims by rejecting recommendations to bring South Bay into regulatory compliance constitutes sufficient participation in the claims process to trigger [FCA] liability.’” Specifically, the court held that because the PE fund principals held positions on the Board of the portfolio company that owns and operates South Bay the fund “had the power to fix the regulatory violations which caused the presentation of false claims but failed to do so.”  Elsewhere in the opinion, the court cited evidence that following the PE fund’s acquisition of South Bay there was increasing focus on improving profitability at the same time that various employees were expressing concerns about gaps in clinical supervision.  Although the court did not specifically link its holding on the causation issue to this focus on profitability it is likely to be an important theme plaintiffs will advance if the case proceeds to trial.

More broadly, and not specifically related to the PE fund’s liability, the court held that claims submitted by South Bay for services rendered despite non-compliance with a host of regulations regarding the licensure of the provider supervising the therapy, the frequency with which therapy was supervised, and the manner in which that supervision was documented are false.  The court rejected defendants’ arguments that claims submitted to Medicaid managed care organizations were not false, finding the argument “makes little sense given the overarching requirement that all MassHealth mental health centers comply with MassHealth regulations.”

Finally, the court rejected defendants’ arguments that the regulations at issue were immaterial to MassHealth’s decision to pay, which were premised the fact that MassHealth continued to pay claims after the relator informed Massachusetts of her concerns and it never audited South Bay for compliance with those requirements.  Noting that MassHealth stopped paying South Bay when it became aware of “the scope of the allegations once the complaint in the present case was unsealed,” the court held “that no reasonable juror could find that misrepresentations of compliance with the licensure and supervision requirements are not material.”  However, the court also noted that “minor deviations from the licensing, supervision and documentation requirements are not material to payment,” apparently leaving for the jury to sort out “minor deviations” from material acts of noncompliance.

This decision underscores the risk PE funds and their principals assume when they become actively engaged in the management of their portfolio companies, are aware of material issues of non-compliance, and fail to act. We will continue to update the industry on this case as it proceeds, and on the broader trend of FCA suits against PE investors in the healthcare industry.

The decision is available here.

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