[co-author: Zoe Simon]

Private equity firms investing in healthcare should take note of increasing False Claims Act (FCA) scrutiny by the government and whistleblowers. In two recent cases, the government has demonstrated a willingness to pursue private equity (PE) firms that invest in healthcare providers and take an active role in operations.

A recent example is the government’s case against Riordan, Lewis & Haden, Inc. (RLH), its portfolio pharmacy, doing business as Patient Care America (PCA), and PCA executives. DOJ extended the reach of the FCA to RLH in reliance on the fact that a RLH investment fund held a controlling
interest in PCA, two RLH partners were PCA board members and officers/directors and the two RLH partners were actively involved in PCA’s operational decisions. The government also highlighted the PE firm’s alleged push to generate a strong return on investment. And, importantly, DOJ further alleged that “[a]s an investor in health care companies, RLH knew or should have known when it acquired PCA … that health care providers that bill federal health care programs are subject to laws and regulations designed to prevent fraud[.]” The parties recently settled for $21.36 million.

In another case, Massachusetts alleged that a mental health center operator, its former CEO and a PE firm submitted false claims to Medicaid. A federal court agreed that “a defendant may be liable where the submission of false claims by another entity was the foreseeable result of a business practice.” When denying the PE firm’s motion to dismiss, the court noted that the boards, with a majority of the membership held by the firm’s members and principals, was allegedly involved in the provider’s operations in the form of “approving contracts, strategic planning, budgeting, and earnings issues.” With the defendants denying the allegations, the case remains in litigation as of the date of this publication.

Takeaways for PE Firms:

1. As a major economic driver, healthcare is an attractive investment opportunity particularly with expected expansion as our nation’s population ages. New entrants to the market, however, should understand the complex and dynamic laws that regulate the industry. Business activities that may be common in other business sectors may trigger civil or criminal liability under healthcare laws.
2. Carefully diligence a target’s compliance with fraud and abuse laws. Civil fraud enforcement typically arises under a “knew or should have known” standard. While the law is evolving as to where that standard is for PE firms, the statute of limitations for FCA cases is six years (and in some cases ten years). Knowing the risks at the beginning allows a PE firm to adjust deal terms when the scope of liable actors may not be known for years.
3. If a provider is a portfolio client, monitor legal compliance but refrain from participating in provider operations. Moreover, carefully consider whether PE firm partners should sit on the provider’s board.
4. Evaluate executive incentive compensation programs to ensure rapid business growth does not come at the expense of legal compliance. For example, in some cases, the government has required monitored entities in the wake of a fraud case to have “claw back” provisions in executive compensation plans that are triggered if non-compliance is identified.
5. If a potential problem is identified, discontinue funding the practices, hold executives accountable and evaluate the firm’s potential exposure.