Large General Acute-Care Hospital Abandons Acquisition Of 15-Bed Surgical Specialty Center As A Result Of FTC Challenge

by Sheppard Mullin Richter & Hampton LLP

[authors: David R. Garcia and Helen C. Eckert]

Just three days after the Federal Trade Commission, jointly with the Pennsylvania Attorney General, issued an administrative complaint challenging Reading Health System’s (RHS) proposed acquisition of Surgical Institute of Reading L.P. (SIR), a 15-bed surgical specialty center, both entities abandoned the proposed acquisition, citing the high costs associated with a protracted court battle with the government. This FTC victory provides more valuable insight into how antitrust enforcement agencies are evaluating the increasing number of consolidations within the healthcare industry, particularly after passage of the Affordable Care Act. Specifically, this case highlights the government’s very granular analysis of effects on competition through highly specialized “service markets,” as well as the risk for entities that ordinary-course-of-business documents surrounding the proposed consolidation can play a significant role in the government’s challenge. It also appears to be another example of an FTC challenge to a transaction below the Hart-Scott-Rodino reporting threshold.

RHS is a comprehensive, not-for-profit health care system in Berks County, Pennsylvania which operates, among others, a 735-bed general acute-care hospital.  According to the FTC, RHS has been and is the dominant healthcare provider in the Reading area due to its market share and ownership of the largest hospital, several outpatient facilities, two large physician groups, and a local provider network.  The FTC included within RHS’s market share calculations an outpatient ambulatory surgery center and a provider network, of which RHS has 50 percent ownership, based on the fact that RHS has significant control over the entities’ daily operations and treats them as its own facilities in competitive analyses conducted in the ordinary course of business. 

SIR, on the other hand, is a much smaller, for-profit specialty surgical center owned largely by a small group of physicians providing a variety of inpatient and outpatient surgical services, with only 15 licensed beds.  Since its opening in 2007, SIR has focused on high quality of care and better patient service, achieving patient satisfaction rates above national standards and well above those of its competitors (including RHS).  

The FTC’s complaint alleged that SIR has drawn significant volumes of patients in important surgical service lines away from RHS. RHS, in response, competed aggressively with SIR by lowering its rates and seeking to improve quality to attract patients back to RHS, all benefits of vigorous competition which, according to the FTC, would be lost if the acquisition were allowed to proceed. The FTC also alleged that one of RHS’s primary motivations in acquiring SIR – as evidenced by documents created by RHS executives in the ordinary course of business – was to protect its market share. The FTC’s redacted complaint suggests that RHS executives were alarmed by the loss of patients to SIR and ultimately decided that it made more sense to respond to competition from SIR by acquiring it and eliminating it as a competitor. Other internally-created RHS documents suggested that the acquisition would indeed dampen RHS’s incentive to improve quality and efficiency in response to competition from SIR. And notably, the FTC found no evidence that either RHS or SIR attempted to ever consider or quantify any likely efficiencies from the proposed acquisition.

The FTC concluded that significant anticompetitive effects could be inferred from the direct evidence alone. However, substantial increases in post-acquisition market share and market concentration in each of the relevant markets provided additional support to demonstrate that the acquisition would result in significant harm to competition. The FTC cited four highly specialized relevant “service markets” in which head-to-head competition between RHS and SIR would be eliminated: (1) inpatient orthopedic surgical services; (2) outpatient orthopedic surgical services; (3) outpatient ear, nose and throat surgical services; and (4) outpatient general surgical services. The FTC alleged that the proposed acquisition would result in combined market shares ranging from 49 to 71 percent. Notably, the FTC also hinted at the appropriateness of even more granular analysis of relevant markets delineated by a single medical procedure. For example, the FTC explained, inpatient orthopedic surgical services represented a cluster of basic orthopedic and spine surgical services, such as knee, hip and joint replacement surgeries and spinal fusions. And, while the acquisition’s “likely effect on competition could be analyzed separately for each of the dozens of affected medical procedures,” it was appropriate in this case to evaluate competitive effects across this cluster of services because they are offered to Reading area residents under similar competitive conditions (e.g., by the same set of competitors).

The FTC also alleged that high barriers to entry by new firms and the difficulties the few remaining competitors faced in expanding their services made it impossible to counteract the acquisition’s likely serious competitive harm in the relevant markets. The FTC highlighted the prohibition on both the formation of any new physician-owned hospitals and the expansion of existing ones by the Affordable Care Act, rendering it impossible for a new physicians group to replicate SIR’s 2007 entry into the market. On this point, we note that there has been a dramatic increase in physician-owned outpatient centers in the last ten to fifteen years, and owners of such facilities must be cognizant of the fact that sales of these facilities to their natural purchasers (i.e., hospitals) may be subject to full-dress review by antitrust enforcement authorities as horizontal acquisitions, particularly if such sales are driven by the Affordable Care Act’s prohibition on expansion of physician-owned hospitals.

Finally, in noting the absence of any extraordinary competition-enhancing efficiencies necessary to justify the acquisition in light of the significant potential harm to competition, the FTC relied almost exclusively on the fact that RHS and SIR did not quantify or even consider efficiencies when contemplating the proposed acquisition.


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Sheppard Mullin Richter & Hampton LLP

Sheppard Mullin Richter & Hampton LLP on:

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