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What PE Firms Need to Know About Investing in Health Care

Chris Quote 800

The U.S. Department of Justice (DOJ) reported over $5.6 billion in False Claims Act (FCA) settlements and judgments in 2021, with $5 billion alone related to health care. But, the focus from the DOJ doesn’t stop there. As we have seen through recent qui tam suits against Riordan, Lewis & Haden, the Gores Group and Alliance, government officials have zeroed in on private equity firms as being potentially liable for the misconduct, fraud or malfeasance that occurred at portfolio companies.

In a recent webinar, “Staying Off the DOJ’s Radar and On a Forward-Moving Deal Path: Diligence and Compliance for Private Equity Investing in Health Care,” Matt Hays, partner at Gryphon, talked with Chris Harwood, partner at Morvillo Abramowitz Grand Iason & Anello PC and Caleb Hayes-Deats, partner at MoloLamken, about what the recent FCA litigation between the DOJ and private equity firms means for investing companies. They specifically discussed the risks involved in due diligence and compliance, and how to approach a deal involving the health care industry in a way that mitigates risk and ultimately saves time, money and reputation.

Broad Language, Broad Interpretation

The three kicked off the discussion by pointing out the broad language in the statutory text of the False Claims Act and how that, in turn, broadens the potential liability of not just the company and its directors and officers, but company owners.

“There is liability for any person who knowingly presents or causes a claim to be presented a false or fraudulent claim for payment. For example, if you look at a claim submitted for reimbursement Medicaid, how many people can be a cause of that single claim? Can you foresee at the time of a strategic business decision preceding that claim that this kind of claim is going to be submitted?” Hayes-Deats asked. “The scariest part for private equity firms are the cases where the allegation isn’t that they participated in the fraud, but that they were a passive investor or learned the problems through diligence and failed to do something about it.”

Harwood then referenced the Novartis case as an example of the expansive scope of potential liability. “Novartis makes drugs, and then hires sales reps to market the drugs. Novartis enacted a marketing structure where, according to the government, these sales reps were incentivized to provide perks to doctors that the government claimed constituted kickbacks, and the government claimed those kickbacks tainted the prescriptions the doctors later wrote that were reimbursed by the government. What happened? It cost Novartis over $600 million to settle.”

Pre- and Post-Pandemic Trends

When over $150 billion via the CARES Act floods the market in a record number of days, there is no surprise that scrutiny will follow, asking what may have gone wrong in a mad rush to boost the economy and save American businesses. As this excerpt from Ethan Davis’ remarks in 2020 sums up, private equity firms will be a target of that scrutiny when they exercise control over a company that has received government funds.

“Our enforcement efforts may also include, in appropriate cases, private equity firms that sometimes invest in companies receiving CARES Act funds. When a private equity firm invests in a company in a highly-regulated space like health care or the life sciences, the firm should be aware of laws and regulations designed to prevent fraud. Where a private equity firm takes an active role in illegal conduct by the acquired company, it can expose itself to False Claims Act liability. A pre-pandemic example is our recent case against the private equity firm Riordan, Lewis, and Haden, where we alleged that the defendants violated the False Claims Act through their involvement in a kickback scheme to generate referrals of prescriptions for expensive treatments, regardless of patient need. Where a private equity firm knowingly engages in fraud related to the CARES Act, we will hold it accountable.”

But, as Harwood pointed out, the scrutiny looks different now than it did before the pandemic. “Pre-pandemic, we don’t have cases where the DOJ is bringing cases against PE firms where they aren’t somehow actively involved. In the suit against Diabetic Care RX LLC, relators alleged that the PE owner directed the portfolio company to enter a kickback scheme. The PE firm allegedly was involved in the actual decision to retain a marketing company to target a specific population of government-insured patients, and played a direct role in the marketing company being paid for the conduct.”

PE firms playing an active role in the businesses of their portfolio companies can enhance those businesses, but this also creates risk for False Claims Act liability, according to Harwood. “If a PE firm comes in and replaces managers, appoints themselves as officers, or even appoints external managers, but plays a role in that decision-making process, at least some courts have said that is a potential basis for letting a suit proceed.” He cited examples of the risks of not adhering to best practices, including emails of individuals associated with the PE firm talking about the business of a portfolio company and using the pronoun “we” or a PE firm using wording in a press release that suggests the PE firm would be “participating” or “collaborating” in the business of the portfolio company.

Investing in Health Care Now

Because of the increased regulation around investing in health care and a developed relators bar, PE firms must be on high alert and arm themselves with due diligence, thoughtful and conscious decision-making, and documentation.

All three closed the panel by highlighting ways to go beyond checking the boxes:

  • Document diligence so you can show actions were not “reckless” and that you hired the right people to evaluate. Be prepared to show you did a reasonable effort in the diligence process.
  • In the diligence process, look at individuals, culture and reputation, in addition to financials.
  • Establish ongoing diligence monitoring.
  • If you identify something in the diligence process, get out in front of it. Contingencies can be built into the deal documents.
  • Name a compliance officer and establish a robust compliance program.

While these might seem like obvious actions to take, they can often be overlooked due to the fast-moving deal process, employee or executive turnover or simply a lack of resources. Don’t let hindsight be 20/20. “Understanding what you are getting yourself into outweighs any potential benefits you might have for not asking the right questions,” Harwood said. “You can’t draft documents around risks you don’t know about.”

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