As recently reported, the Senate Finance Committee has issued a report and requested HHS OIG to investigate the increased use of physician-owned distribution companies in the medical device industry, and whether PODs violate the federal anti-kickback statutes.

The federal health care anti-kickback statute (“Anti-Kickback statute”) is a criminal statute that prohibits, among other things, giving or receiving any financial benefit or “remuneration” in exchange for, or to induce, the referral of any patients for, or the purchase, order or recommendation of, any item or service for which payment may be made under Medicare or other federal health care programs. Remuneration is defined broadly to include the transfer of anything of value, in cash or in kind, directly or indirectly, covertly or overtly. Violation of the Anti-Kickback statute constitutes a felony punishable by a maximum fine of $25,000, imprisonment up to 5 years, or both. Conviction will also lead to automatic exclusion from Medicare, Medicaid, and other federally-funded federal healthcare programs. Exclusion may also be sought by HHS through an administrative proceeding. In addition, violations of the Anti-Kickback statute are also subject to civil monetary penalties of up to $50,000 for each “act” committed in violation of the statute and penalties of up to three times the amount of the alleged illegal “remuneration.”

While it is clear that the Anti-Kickback statute is expansive in scope and prohibits quid pro quo payments for patient referrals, it is far less clear how the statute should be applied to arrangements that do not simply involve a payment per patient referral, but instead contemplate investments or business relationships between two or more individuals or organizations. In 1985, in United States v. Greber, the Third Circuit established that the Anti-Kickback statute is violated if one purpose of the payment in question was to induce referrals, irrespective of the existence of other legitimate purposes. This decision was followed by the First Circuit’s decision in United States v. Bay State Ambulance & Hospital Rental Service, which held that simply giving a person the opportunity to earn money may be an inducement to that person to channel Medicare payments toward a particular recipient in violation of the Anti-Kickback statute. However, in a more recent decision, the Tenth Circuit stated that the mere hope or expectation that referrals may result from remuneration designed for entirely different purposes is not itself a violation, and that there must be an actual offer or payment or remuneration to induce referrals. The court went on to note that “the intent to gain such influence must, at least in part, have been the reason that the remuneration was offered or paid.”

Even though it is unclear how courts would ultimately construe the Anti-Kickback statute as applied to the relationship between a medical device company and a physician-owned distributor, the government may argue that the use of PODs violates the Anti-Kickback statute because at least one purpose of the contractual arrangement is to induce the investing physicians to utilize the medical device company’s products for their patients. Liability would depend on the government’s ability to prove intent. Liability would also depend on whether a defendant was able to prove that its conduct fell within one of the safe harbor exceptions included in the Anti-Kickback statute, two of which may be relevant to the physician-owned distributor question:

• Investment Interests in Small Entities: The investment interests safe harbor permits investments by providers in small entities, such as limited partnerships and joint ventures. As applied here, relevant factors include:

• No more than 40% of the gross revenues of the entity can be derived from referrals or business otherwise generated by investors, including physicians;

• No more than 40% of the investments interests in each class may be held by investors who are in a position to make or influence referrals to, or otherwise generate business for, the entity;

• The terms on which interests are offered to referring investors who are passive investors must be no different that the investment interests offered to other passive investors;

• The terms on which interests are offered to referring physicians must not be related to the previous or expected volume of referrals from, or business generated by, the physician for the entity; and

• There must be no requirement that a physician who is a passive investor make referrals to, be in a position to make or influence referrals to, or otherwise generate business as a condition for remaining an investor.

• The Discount Safe Harbor: The discount safe harbor defines a protectable discount as “a reduction in the amount a buyer (who buys either directly or through a wholesaler or group purchasing organization) is charged for an item or service based on an arm’s length transaction.” Although the application of this safe harbor to physician-owned distributors has been criticized, we could find no case where the discount safe harbor has been analyzed in the context of physician-owned distribution arrangements with medical device companies. It is important to note that in other contexts consignment arrangements have been held to be outside of the discount safe harbor, and thus it is recommended that any distribution relationship require that the physician-owned distributor take title to the medical device inventory.

In addition to the federal Anti-Kickback statute, forty-two states and the District of Columbia have enacted statutes prohibiting kickbacks or self-referrals by healthcare providers. Although some statutes refer to definitions and standards found in the federal statutes, others vary materially from the federal statutes. Thus, some state anti-kickback statutes apply only to items and services reimbursable under state health programs, whereas others apply to any referral for healthcare goods and services. Similarly, some states prohibit referrals by physicians to certain types of providers with whom the physician has an investment relationship, while other states merely mandate disclosure of the relationship at the time the referral is made.

In addition to the Anti-Kickback statute, the Stark Law, which is actually a combination of statutes and three phases of regulations that address the federal physician self-referral provision, could be used by regulatory authorities to challenge the physician-owned distribution model. The cornerstone is the Stark Statute, which prohibits a physician from referring patients to entities with which the physician has a financial relationship for certain designated health services that are reimbursable by Medicare. It also prohibits the entities furnishing designated health services from billing Medicare, or any other payor or individual for services performed as a result of a prohibited referral. The purpose of the Stark Law is to create a bright line, “strict liability” prohibition against physicians having financial relationships with the healthcare facilities to which they refer their Medicare or Medicaid patients. As a result, “regardless of the intent of the parties, if a referral does not comply with the Stark Law, any designated health services performed as a result of a prohibited referral constitute overpayments.” CMS has clearly stated that medical devices implanted as part of inpatient or outpatient hospital services do in fact constitute designated health services under the Stark Law.

The significance of this is not so much in the Stark Law remedies themselves. The primary remedy for a Stark violation is denial of payment for a prohibited claim or required return (refund) of any amounts collected under such claim. Civil penalties may also be imposed as $15,000 for each service that violates the statute and penalties of $100,000 for arrangements designed to circumvent the Stark Statute.

Rather, the significance is in the context of the Civil False Claims Act, pursuant to which the government or a private plaintiff could seek per claim penalties and treble damages for each claim that should have been disallowed for violation of the Stark Law.

Although federal law does not authorize the government (or private parties) to bring a lawsuit for damages arising from a violation of the Anti-Kickback statute or the Stark Law, private litigants and the government alike have been successful in using alleged violations of these healthcare fraud and abuse provisions as a basis for an action under the Civil False Claims Act (“FCA”). Under the FCA, the United States (or private relators who “stand in the shoes of the government” for purposes of bringing an FCA action), may recover treble damages and per claim penalties in the amount of $5,500 to $11,000 for anyone who knowingly presents or causes to be presented a false or fraudulent claim to any federal agency or entity making payments on claims using federal funds. It is important to note that the FCA has been increasingly used by private plaintiffs in cases alleging a violation of the Anti-Kickback statute because it provides that private parties who are successful in bringing qui tam actions will receive a percentage of the recovery, attorneys fees and costs as a reward.

If the government were to bring a claim under the FCA, we believe that it would allege that the use of physician-owned distributors violates the Anti-Kickback statute or that the resulting services should have been disallowed for violations of the Stark Law’s self-referral provisions. The government would further argue that, as a result, none of the claims submitted by the hospitals for implantation of the medical devices supplied by the physician-owned distribution company were properly paid and are thus “false claims” within the meaning of the FCA. Under such an action, the government would contend that the medical device manufacturer knowingly assisted in the submission by the hospital of these allegedly false claims because of its allegedly improper relationship with the physician-owned distributor.