The Department of Justice (“DOJ”) on September 18, 2019, announced a $21.36 million settlement with compounding pharmacy Patient Care America (“PCA”), two PCA executives, and private equity firm Riordan, Lewis & Haden, Inc. (“RLH”), controlling owner of PCA. The settlement resolves the government’s False Claims Act (“FCA”) and Anti-Kickback Statute (“AKS”) allegations against the parties, and, significantly, marks the first time the government has named a private equity firm as a defendant in an FCA matter.

Medrano v. Diabetic Care Rx, LLC d/b/a Patient Care America

In March 2018, the government intervened in a whistleblower complaint brought by former PCA employees. The complaint in intervention alleged that RLH and PCA, through its named executives, violated the AKS by paying illegal kickbacks to third-party marketers to secure, and often induce, compounded drug prescriptions. Those compounded prescriptions, by definition intended to be tailored to meet a patient’s medical needs, were instead allegedly adjusted by PCA staff to maximize profitability. According to the complaint, PCA then fraudulently submitted claims for these prescriptions for reimbursement by TRICARE, the government health care program for military personnel and their families. The complaint also alleged that PCA committed further violations by routinely covering patient copays in order to induce patients to accept the prescriptions, as well as by submitting claims for prescriptions that were made without a physician-patient relationship, and often even without patient consent.

At the time of RLH’s investment, PCA primarily provided intravenous nutritional therapy to end stage renal disease patients receiving dialysis. After RLH’s controlling investment, however, the firm directed PCA’s entry into compounded topical pain creams, recognizing the extraordinarily high reimbursement rates at the time for such prescriptions and seeking a rapid return on the firm’s investment. RLH’s involvement in the scheme was highlighted in the complaint, which noted that two RLH partners held a majority of PCA board seats and allegedly led the pain cream prescription initiative. The partners did this despite legal advice that the third-party marketing commissions could constitute illegal kickbacks in violation of the AKS, compliance with which was necessary for TRICARE reimbursement.

RLH contested its involvement in a motion to dismiss the complaint, arguing that the government failed to adequately plead the firm’s knowledge or causation of the alleged schemes. A district court judge, relying on a magistrate judge’s report and recommendation, dismissed the FCA claim as to all defendants without prejudice, finding it was not appropriately pleaded. That opinion rendered moot, however, the magistrate judge’s further finding that the government had, in fact, satisfied the pleading burden as to RLH with respect to at least the kickback scheme, pointing to specific actions taken and information reviewed by the RLH partners on PCA’s board. After the government amended its complaint, the parties reached the settlement, leaving undecided for now the question of whether a private equity firm can be held liable for its portfolio company’s FCA violations.

Lessons for Private Equity Firms from Medrano

Although no determination of liability was made, the settlement was a victory for the government, which has never before named a private equity firm as a defendant in an FCA case. In the DOJ’s press release announcing the settlement, Assistant Attorney General Jody Hunt noted that the case’s resolution demonstrates the DOJ’s “continuing commitment to hold all responsible parties to account for the submission of claims to federal health care programs that are tainted by unlawful kickback arrangements.” This may indicate the DOJ intends to continue this strategy of targeting the controlling funds behind health care portfolio companies, particularly at a time where health care investing is growing.

Private equity firms who invest in the health care space should take certain precautions to avoid potential liability for FCA violations.

Conduct Appropriate Pre-Investment Regulatory Due Diligence

Shortly after RLH invested in PCA, Medicare reduced reimbursement rates for PCA’s core product line. Those cuts, along with extraordinarily high reimbursement rates for compounded pain creams at the time, incentivized PCA to shift its focus to maximize profits, particularly in the short term. Private equity firms investing in the health care space need to be well informed of the industry’s complex regulatory mandates as well as anticipated changes in reimbursement rates and practices.

Establish and Implement Effective Corporate Compliance Programs

Private equity firms investing in health care companies should ensure appropriate formal corporate compliance programs are either already in place or promptly implemented upon investment in order to minimize exposure to FCA liability for both the portfolio company and the firm. Programs should be strictly enforced, with a compliance officer regularly updating the board and maintaining a presence in the day-to-day operations of the company. Employees should also be empowered to report suspected misconduct or problematic practices within the company. The more hands-on the firm intends to be in managing the portfolio company, the more critical effective compliance programs will be to reducing liability exposure.

Thoroughly Consider Advice of Legal Counsel and Other Advisors

Although boards are exculpated from liability when decisions are based on directors’ well-reasoned business judgment, decisions made against the advice of advisors such as legal counsel will be subject to heightened scrutiny. In the case of PCA, the company’s part time general counsel and several other health care attorneys advised the board against paying commissions to outside marketers, foreseeing that they could constitute illegal kickbacks in violation of the AKS. If choosing to undertake a particular course of action despite professional advice against it, the board must be prepared to support its decision with thoroughly considered arid documented rationale as to why they chose a contrary strategy.

Hire Knowledgeable and Capable Executives

The complaint in intervention against PCA and RLH alleged that a recruiting firm warned the board that Chief Executive Officer Patrick Smith “would require more careful management than [RLH] may wish to provide.” PCA nonetheless hired Smith, but retained authority over certain decisions and expenses by requiring board approval. Executives with deep experience in the health care industry and a sophisticated understanding of its regulatory mandates are critical to the success of a private equity firm’s investment in a health care portfolio company.

Regardless of the approach, a private equity firm investing in the health care space must ensure that its business objectives and profit-driving strategies are in line with regulatory mandates and ethical considerations. Health care investments may require a greater degree of oversight than investments in less regulated industries, but private equity firms can take precautions to ensure they are protected from liability.