A law meant to curtail anti-competitive behavior has been making its way through the legislative process, and while experts expect it would lead to immense burdens for PE firms investing in California physician groups, there may be caveats.
As written, California Senate Bill 977 would give attorney general Xavier Becerra the ability to “deny consent to a change of control or an acquisition between a health care system, private equity group, hedge fund, and a healthcare facility, provider, or both.”
That is, unless the involved party successfully shows the transaction will result in either a substantial likelihood of clinical integration, a substantial likelihood of increasing or maintaining the availability and access of services to an underserved population, or both.
SB 977 is currently awaiting a full assembly vote, and assuming its passage, the controversial law would be voted on by California’s governor by the end of September.
“The language is not super clear, so there is going to be a lot of head scratching in how it’s interpreted, so you’d immediately see a major slowdown,” said Paul Pitts, a member of Reed Smith’s Life Sciences Health Industry Group.
Charitable hospitals, or non-for-profit health systems, are already under the oversight of AGs across the country. But “this is a totally different ball game,” Pitts said.
“It is pretty much unprecedented,” said Rick Zall, chair of Proskauer’s Healthcare Industry Practice. “It goes further than any state has gone. I think it will chill a lot of deal activity because, just practically speaking, the whole process of obtaining consent and what could be considered relevant is broad.”
While the criteria under the law would create tremendous uncertainty, the private equity community will adapt, according to Eric Klein, team leader of SheppardMullin’s healthcare practice: “Folks will get smart and understand how to deal with this.”
In fact, there’s one “big bombshell” for private equity groups, Klein said.
When you look at the language, the law talks about PE groups being restricted, but it doesn’t talk about portfolio companies, he said.
“Arguably, you can have a portfolio company not be covered. So unless this comes up in regulations, I can think of six different ways that my PE clients can get around this,” Klein said.
“It certainly will give PE firms a pause when they evaluate transactions in the state of California,” added Angela Humphreys, chair of the healthcare practice group and co-chair of the healthcare private equity team at Bass, Berry & Sims. “That said, there may be structuring opportunities for physicians in advance of a transaction that they may be able to implement.”
Further, additional language added to the law on August 24 clarifies that acquisitions of “nonphysician providers” are not subject to AG approval.
The amendment implies that many providers – dentists, physical and occupational therapists, nurses, social workers, chiropractors, acupuncturists, optometrists, opticians, pharmacists and veterinarians – would not be covered by the law, explained Gary Gertler, managing partner of the Los Angeles office of McDermott, Will & Emery.
Hospice and home health agencies, so long as they are not owned by physicians, or so long as no physician services are provided as part of the agency at a clinic or treatment center, would also be excluded, he said.
While about five months have passed since PE funds and hedge funds were added to the legislation, SB 977 hasn’t been dislodged, Gertler said: “Private equity wasn’t able to put together a lobby group to really try to scale the legislation to what it really was intended for: healthcare systems. So they are sort of stuck with this stuff.”
In Gertler’s view, the AG has largely underestimated the number of healthcare transactions occurring. Considering the AG’s expectations that they will see some 20 to 25 qualifying transactions annually – as stated in a June 23 Senate Floor Analysis – legislators are poised for a rude awakening should it pass, he said.
“I probably do 10 or 12 deals in California myself; just me, not my whole firm,” Gertler said. “I think they have no idea how many deals are being done in California and that the world is going to be overloaded here.”
According to Gertler, one provision in the legislation likely stems from a more recent understanding among legislators that many more cases than originally anticipated would be covered.
That is, the AG would be given a 60-day window to either clear, grant a waiver or request additional information from the parties.
“I believe a lot of the physician deals, the smaller deals, that are going to get caught up in this will go through the 60 days [without hearing from the AG] – similar to the HSR [Hart-Scott-Rodino] filings,” Gertler said. “A lot of the non-controversial, smaller deals will go this way. They have to.”
Still, Klein said there’s a concern among many of his physician group clients that they won’t be able to survive without finding a partner.
“This full review process could take anywhere from four to 12 months. If you’re a distressed group, you’re going to wind up selling to somebody that’s not covered by this,” Klein said.
The competition for those groups will be much lower, and therefore, buyers will end up getting bargains, Klein said. “What we’ll see unfortunately is a further weakening of the physician network.”
The legislation would also come at a time in which many healthcare providers are already feeling immense economic pressure stemming from the pandemic. To impose these additional obligations would add yet another barrier to the healthcare system, Zall said.
“It feels like the timing is all wrong,” Zall said. “This is a pretty blunt instrument that I think will create a real disincentive for capital to come in and [encourage] people to think about new ways of doing things without having to go ask permission and be told there are lots of restrictions.”
Tipping the power
As acquisitions and investments grow more burdensome for certain groups, some believe the law is contrary to its objective of reducing anti-competitive behavior.
“If you can allow some types of buyers and exclude others, all this does is create an unequal market,” Klein said. “It’s not balanced. It goes ahead and it allows for the regulation to be placed on private equity and hedge funds and larger health systems, but it doesn’t go ahead and apply to all the [other] potential buyers.”
The law does not, for example, apply to a publicly traded company or a subsidiary of a publicly traded company that may also be a consolidator in the space. Large healthcare payers, for example – UnitedHealth’s Optum – have established themselves as active buyers of physician groups.
“If you’re going to do this why aren’t you covering any player? I don’t know why this is,” Zall commented. “It tilts the competition.”
“It appears that as a result of this legislation PE is viewed as a target,” added Humphreys. “What is not appreciated is the level of compliance and operational efficiencies that PE firms bring to bear.”
“In my experience, any PE-backed physician company has an enhanced level of compliance compared to what the individual practices may have had on a stand-alone basis,” Humphreys continued.
PE firms are also very good at working with physician practices to analyze their use of non-practitioners, which very well may result in cost savings to payers, Humphreys said.
SB 977 was in large part created in response to a settlement involving Sacramento’s Sutter Healthcare and their approach to the marketplace, industry lawyers said.
The not-for-profit healthcare system in December agreed to pay a $575 million fine following assertions brought by the attorney general that it was leveraging its market dominance to boost the cost of healthcare in Northern California.
Emboldened by the outcome of Sutter Health and other labor concerns, SB 977 is rooted in consolidation in healthcare and the potential to reduce salaries and earnings of professionals located in those consolidated practices, according to Pitts.
“Healthcare is so fragmented, right? Which leads to all sorts of inefficiencies,” Pitts said. “Private equity is trying to drive at that, which obviously leads to consolidation. Americans don’t seem afraid of that, but it is a different politics when it’s healthcare.”
The concern that PE will create more chaos and disruption in the marketplace harkens back to the 1990s.
“California has a bit of a scar from that,” Klein said. “Back in the 90s, we had a very large wave of physician consolidation and entities that did fail. They aggregated quickly, they did not integrate, and then fell apart. The California provider network was left in shambles.”
The result: There’s a long-stated mindset in certain parts of the California government that consolidation by financial investors is adverse to the California citizens.
Today there remains a significant concern as to what happens to pricing when hospital systems purchase other hospitals or physician entities. “There’s significant conflicting research. Second, as you go ahead and as you aggregate, the question is: what happens to the rest of the doctors who are now facing better, larger enterprises? And will that result in further instability in the physician community which has already been [challenged] by covid?” Klein said.
A representative of the attorney general did not return a request for comment.
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