Physician-owned distributors (PODs) that sell medical devices have seen substantial growth over the last few years as well as increased regulatory scrutiny. We expect both trends to continue in 2013. PODs are arrangements in which a physician purchases an ownership interest in a medical device distributor and then shares in the profits received by the distributor from sales to hospitals and surgery centers. Proponents of PODs believe they help reduce medical device costs as compared to traditional distribution channels because the device manufacturer does not have to spend the time and expense to market to these physicians. Opponents of PODs see them as the next big health care scandal, citing concerns regarding physician conflicts of interest, overutilization, anti-competitive effects and violation of the federal Anti-Kickback Statute (AKS).

The primary federal regulator, the Office of Inspector General for the U.S. Department of Health and Human Services (OIG), has indicated that it will focus on the sales practices of spinal implant PODs. However, there has been little enforcement action against PODs to date, so the jury is still out on whether PODs comply with applicable regulatory requirements. Health care providers that choose to invest in or contract with PODs should be aware that there are various models for how PODs can be operated, and some models seem to pose less regulatory scrutiny than others.

Background

There are primarily three types of POD models – distributor, manufacturer and group-purchasing organizations (GPOs). In a distributor model, the POD acts as a product distributor that buys devices from manufacturers (taking risk of ownership), and then resells them to the purchaser. In a manufacturer model, the POD contracts with the purchaser to manufacture the device, but outsources the actual manufacturing to a third party that usually ships the device directly to the purchaser. Finally, in a GPO model, the POD acts as a GPO for its members, thereby aggregating buying power to negotiate lower prices from manufacturers.

The recent focus of news and U.S. Senate reports have been on the explosion of PODs over the past 10 years. The concern is that this growth in these PODs coincides with a 15-fold increase in the number of spinal fusion surgeries provided to Medicare beneficiaries from 1997 to 2008.

In 2011, the OIG indicated that they had initiated a review to determine the extent to which PODs provide spinal implants purchased by hospitals. To date, the OIG has noted that the legality of any physician-owned entity (including PODs) is dependent on several key factors, including:

• Details of the PODs legal structure and operational safeguards;
• Actual conduct of its investors, management entities, suppliers and customers during the implementation phase and ongoing operations;
• Investment opportunity for a referring physician to earn a profit, including through an investment in an entity for which the physician generates business;
• Terms under which a physician may invest in the entity or be required to divest his or her ownership interest in the entity;
• Actual return or projected return on the physician's investment; and
• Amount of revenues generated for the entity by its physician investors.

These “key factors” harken back to a Special Fraud Alert published by the OIG over 20 years ago regarding “suspect joint ventures.” Many of these same factors may be present in PODs and could pose added enforcement risk.

Enforcement Risk and Best Practices

The main enforcement statute applicable to PODs is the federal AKS. Medical device purchase agreements with a POD could violate AKS if, for example, one purpose of the hospital doing business with the POD is to induce patient referrals from the physician investors through the purchasing of a device that is paid for by a federal health care program. The AKS risk is elevated in cases where a physician investor in a POD is also on the hospital committee that determines which devices will be used at the hospital.

AKS provides a “small investments” safe harbor that may be available to PODs. This safe harbor sets forth the “60-40 rule,” among other requirements, that limits to no more than 40 percent ownership by physicians who are in a position to induce referrals or otherwise generate business for the entity. Likewise, no more than 40 percent of the entity’s gross revenue may come from referrals or other business generated by its investors. If the POD does not qualify for this safe harbor, it does not mean the POD is in violation of AKS, but it does mean that the POD’s arrangements would be subject to a full “facts and circumstances” analysis, the outcome of which can be uncertain.

It may not be possible to eliminate all enforcement risk related to PODs. However, PODs should consider adopting certain best practices to attempt to reduce the enforcement risk:

• Compliance with applicable AKS safe harbors as well as Stark Law requirements (such as the indirect compensation exception);
• Financial risk to the physician investors in the POD, including taking device ownership risk (i.e., warehousing) and sizable up-front investment requirements;
• Compensation of each physician investor equally regardless of personal referrals;
• Prohibition against physicians altering their referral patterns based on POD agreements with hospitals; and
• A business culture where physician investors remain active with the POD and view themselves as having an investment opportunity to profit from a real business venture, and not a guaranteed return for generating business.