Fraud and abuse risks facing private equity investors in healthcare, life sciences

Sponsors are facing direct exposure and liability as a result of increased scrutiny by the Department of Justice and other enforcement agencies.

By Jaime Jones, Chris Abbinante, Catherine Stewart

Private equity sponsors that invest in the healthcare and life sciences industries have long appreciated the risk their portfolio companies may face under the myriad fraud and abuse laws.  More recently, these sponsors are facing direct exposure and liability as a result of increased scrutiny by the Department of Justice (“DOJ”), states Attorneys General, and other enforcement agencies and to significant liability.  Indeed, the new head of DOJ’s Civil Division, Ethan Davis, recently highlighted the risks private equity firms and their principals active in the healthcare or life sciences sectors face under the False Claims Act. Davis warned that “[w]hen a private equity firm invests in a company in a highly-regulated space like health care or the life sciences, the firm should be aware of laws and regulations designed to prevent fraud.  Where a private equity firm takes an active role in illegal conduct by the acquired company, it can expose itself to False Claims Act liability.”

Chris Abbinante, Sidley Austin

The Civil War-era False Claims Act (“FCA”) is an exceptionally broad statute that has been DOJ’s primary lever over the last twenty years in extracting billions of dollars of recoveries from the healthcare industry.  It imposes treble damages plus penalties on companies and individuals that knowingly submit or cause the submission of false claims for payment to the federal healthcare programs resulting from a broad range of underlying conduct, running the gamut from clear fraud to mere regulatory infractions.  Notably, underlying health care fraud laws that can be leveraged for FCA penalties generally reach “any person” who engages in, or causes, actionable conduct, regardless of where, or for whom, they work.  The FCA’s liability provisions are further broadened by an intent standard that defines “knowingly” to include not only actual knowledge, but also reckless disregard and deliberate ignorance, with no proof of specific intent to defraud required.

Catherine Stewart, Sidley Austin

Over the last several years, DOJ and private whistleblowers have targeted FCA actions at PE firms investing in healthcare and life sciences portfolio companies.  In 2018, for example, DOJ for the first time joined a whistleblower suit involving a PE sponsor.  In that suit, DOJ alleged that a compounding pharmacy violated the FCA by paying illegal kickbacks to induce prescriptions for drugs reimbursed by Medicare and Medicaid and further alleged that the PE fund that held a controlling stake in the business should be liable because it and its principals were actively involved in the management of the pharmacy. As to the issue of “”knowledge,” the government alleged that “[a]s an investor in health care companies, [the fund] knew or should have known . . . . that health care providers that bill federal health care programs are subject to laws and regulations designed to prevent fraud, including the [AKS.]”  The Magistrate Judge in that case agreed that liability could flow to the fund based on allegations that the fund had a “controlling interest,” that two representatives of the fund served as both board members and officers of the pharmacy, and that these individuals played an active role in the management of the pharmacy. In September 2019, the PE fund and its portfolio pharmacy elected to pay $21M to resolve the FCA allegations against them.

Citing this enforcement precedent, Davis made clear that among other priorities, DOJ is actively looking to pursue similar actions against PE firms that invest in the healthcare industry. In that regard, DOJ’s perspective is that PE firms must quickly come up to speed on the myriad and complex laws and regulations that are designed to prevent fraud in connection with federal programs.

The risk to PE funds may further be heightened by an intersection with what Davis described as DOJ’s top enforcement priority: combating fraud generally in connection with CARES Act funding.  Significant portions of those stimulus dollars are being pumped into the healthcare industry, including under relief funds targeted at healthcare providers.  PE funds whose portfolio companies access stimulus dollars but who fail to comply with the requirements for receipt and use of those funds may quickly find themselves within the crosshairs of DOJ and other enforcement agencies.

To control for these risks, PE funds must take steps to come up to speed on the particular fraud and abuse risks and regulatory and federal healthcare program contract requirements applicable to their portfolio companies. Where possible, PE funds may be well advised to maintain adequate separation from the day-to-day management of healthcare portfolio companies.  Funds whose investing strategy and value proposition includes active involvement in the operations of portfolio companies will themselves face greater risk of enforcement scrutiny and liability under the FCA.  To mitigate that risk, they should take steps to ensure the adequacy of systems and personnel capable of understanding federal healthcare program and stimulus funding requirements, and monitoring and auditing for compliance with the terms and conditions of those programs.

This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The content therein does not reflect the views of the firm.

Jaime LM Jones is global co-leader of the Healthcare practice at Sidley Austin LLP and serves on the firm’s COVID-19 Task Force. She can be reached at jaime.jones@sidley.com.

Chris E. Abbinante is co-leader of Sidley’s Private Equity practice. He can be reached at cabbinante@sidley.com.

Catherine D. Stewart is an associate in Sidley’s Healthcare practice. She can be reached at catherine.stewart@sidley.com.