Recent Healthcare Fraud Suit Puts Private Equity Industry on Notice as to Potential Liability for Portfolio Company Conduct

by White and Williams LLP
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In February, the Department of Justice (DOJ) intervened in a False Claims Act case alleging healthcare fraud, a common enough event.

The case in question, originally began in 2015 as a whistleblower case brought by two former employees of a compounding pharmacy. The case centers on an alleged violation of the False Claims Act (FCA) through the payment of kickbacks in the form of commissions to outside marketing companies that resulted in prescriptions for topical pain and scar treatment creams and vitamins filled by the compounding pharmacy, which were then submitted for reimbursement to TRICARE, a US government program which provides healthcare for active duty and retired military personnel and their dependents. Additionally, it is alleged that the compounding pharmacy manipulated the pain cream ingredients to optimize reimbursement rates ultimately paid by TRICARE, a practice that can be viewed unfavorably from a health care or government fiscal responsibility perspective. A complaint with a government beneficiary at its center, with credible allegations of fraud or abuse, always has the potential to result in government interest, investigation or intervention. In that sense, the allegations presented in this complaint can serve as a reminder to healthcare companies of the need to incorporate compliance guidance, review and oversight practices into core operational practices, including new service offerings, but it is not what makes this case of heightened interest.

What makes the United States ex rel. Medrano v. Diabetic Care RX, LLC, No. 15 Civ. 62617 (S.D. Fla.) case particularly noteworthy is the fact that it includes asserted claims against not only the compounding pharmacy and its managing executives, but also the private equity firm that holds a controlling stake in the compounding pharmacy. The case should put private equity firms and their partners on notice of possible expansion of regulatory scrutiny in FCA complaints in the healthcare industry and possibly other industries which are actively engaged in business with the government or subject to significant government oversight (e.g. Department of Defense contractors, federally insured loan lenders). While the private equity firm in this case is described as having been actively involved in the management of the company, and was implicated in the actual payment of some of the amounts at issue, most of the DOJ’s complaint centers on practices that can be viewed as common industry practices in the private equity industry. They include:

  1. Investment in the company with a plan to “increase value and sell it for a profit in five years”;
  2. the private equity firm led the shift from the company’s original focus to one of “extraordinarily high profitability” based on its understanding of a changed regulatory landscape;
  3. the private equity firm actively participated in the search for the compounding pharmacy’s new CEO and the CEO’s compensation package included incentives related to the significant growth of business; and
  4. the private equity firm regularly received financial statements and updates from the compounding pharmacy company, including its primary sources of revenue.

However, additional allegations specific to the complaint in this case may have been key to the DOJ’s intervening in the case as they call into question the private equity firm’s potentially heightened involvement in the day-to-day management of business operations of the compounding pharmacy and the specific actions at issue. These allegations include the fact that two of the private equity firm’s partners in their capacities as board members of the company, led the pain management initiative, which resulted in the alleged kickbacks, as well as the fact that the private equity firm transferred funds to the company for payments as part of this plan, despite knowing that the money it was providing was going to be used to pay kickbacks in the form of commissions to outside marketing firms that generated the prescriptions. It is these allegations in particular that may make this case an anomaly. However, now that the DOJ has taken the step of pursuing an action against a private equity firm with respect to actions tied to managing its portfolio company, and given the breadth of the factors considered by the complaint, it should be fair warning to private equity firms to be sensitive to and focus on the regulatory issues applicable to the operations of their healthcare industry portfolio. It appears that the DOJ may intend to leverage the customary control, oversight and management typical of private equity investments as a tool against private equity firms when allegations of false claims are in play.

Further, it is also noteworthy that the complaint reflects a coordinated investigation by five US government agencies. This complaint may reflect a broader trend by both the government and civil litigants to hold private equity firms liable for the conduct of their portfolio companies. For example, over the past couple of years, we have seen claims directly against private equity firms under ERISA and attempts at holding private equity firms liable under theories such as control person liability, and aiding and abetting liability.

While the precedential value of the complaint must be taken in context of all facts in question and there has been no determination in the case to date, when considering investments in the healthcare space, private equity firms should be cognizant of the potential risks highlighted by this case and conduct adequate due diligence on the payment and reimbursement practices and other regulatory controls and policies of the target company. While this case is specific to the healthcare industry, such advice is also applicable to investments in other regulated industries. Once an investment is made, private equity firms should make sure that they periodically evaluate and monitor the practices, policies, internal controls and responsibilities of their portfolio companies and the strength of their existing compliance programs to prevent, detect, and correct any FCA or other regulatory risks or violations. Furthermore, private equity firms should make sure that their portfolio companies are engaged in ongoing monitoring of legal or regulatory guidance developments and there should be periodic review of the composition of portfolio company boards, committees and executive management teams to ensure inclusion and authority of compliance subject matter experts specific to a portfolio company’s industry.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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