HEALTH INDUSTRY ONLINE - Selling Physician Interests in an ASC to a Hospital

On June 12, 2007, the Office of the Inspector General (“OIG”) issued an Advisory Opinion in which it held that a hospital’s proposed purchase of an ownership interest in a limited liability company which owned an ambulatory surgery center may violate the Federal Anti-Kickback Statute. The OIG’s analysis has caused concern among potential and current investors in physician joint ventures. However, a review of the proposed arrangement and the OIG’s opinion indicates the concern is overstated. Indeed, the OIG’s decree is likely less far reaching than initially believed.

The company which was the subject of the Advisory Opinion was owned by three orthopedic surgeons, two gastroenterologists, and two anesthesiologists. The orthopedic surgeons owned approximately ninety-four percent (94%) of the equity in the company, and the gastroenterologists and anesthesiologists owned the other six percent (6%).

The physician investors were the exclusive providers of professional services to patients of the ambulatory surgery center (the “ASC”). The ASC, the orthopedic surgeons and the gastroenterologists billed third party payors, including federal health care programs, for services provided in the ASC.

Under the proposed business arrangement, the orthopedic surgeons would sell to a local hospital the number of ownership units necessary for the hospital to own forty percent of the company. The company certified to the OIG that the purchase price, which was more per unit than the orthopedic surgeons originally invested for these same units, was set at the fair market value. The orthopedic surgeons only made the offer of sale of the forty percent ownership interest to the hospital, and did not offer units in the company to any other prospective buyer, including the other physician investors. The physician investors, other than the orthopedic surgeons, did not propose to sell any of their ownership interests in the company.

Before entering into the transaction, the hospital and physician investors asked the OIG for an advisory opinion on whether the proposed arrangement would potentially violate the federal fraud and abuse statutes.

The anti-kickback statute makes it a criminal offense to knowingly and willfully offer, pay, solicit or receive any remuneration to induce or reward referrals of items or services reimbursable by a federal health care program. The safe harbor regulations define practices that are not subject to the anti-kickback statute because such practices would be unlikely to result in fraud or abuse. The safe harbors set forth specific conditions that, if met, protect entities against prosecution or sanctions for the arrangement qualifying for the safe harbor. However, safe harbor protection is afforded only to those arrangements that precisely meet all of the conditions set forth in the safe harbor. There is a safe harbor for investments in hospital/physician owned multi-specialty ambulatory surgery centers. Among the conditions of this safe harbor are that (i) the amount of payment to an investor in return for the investment must be directly proportional to the amount of the capital investment of that investor; (ii) the hospital must not be in a position to make or influence referrals directly or indirectly to the ASC or any of its investors; and (iii) each physician investor must receive at least one third of his or her medical practice income from ASC procedures and must perform at least one third of such procedures at the ASC in which he or she invests.
As the OIG noted in its Advisory Opinion, the proposed arrangement fails to meet any of the conditions listed above. First, while each investor would receive a return on investment proportional to the investor’s ownership share in the company, distributions of profits and losses based on relative equity ownership interests would not be directly proportional to capital invested. For example, the orthopedic surgeons and the hospital’s distributions would not be directly proportional to their capital investments because the hospital paid more per unit than the orthopedic surgeons. Additionally, as the Advisory Opinion specifically notes, in the arrangement not all of the physician investors satisfy the “1/3, 1/3 rule” and the hospital will be in a position to refer patients to the ASC and the physician investors.

The OIG determined that the proposed arrangement could generate prohibited remuneration and thus violate the anti-kickback statute. In doing so, the OIG focused on three factors. First, the hospital’s proposed investment took the form of a purchase of shares from the orthopedic surgeons for cash, rather than an investment of capital in the company itself. Second, the return on the investment would not be directly proportional to the amount of the capital each investor invested. The amount payable to the investors would be proportional to their ownership interest in the company; however, because the hospital would pay more per ownership unit than the orthopedic surgeons paid, the orthopedic surgeons would receive a higher rate of return on their remaining shares than the hospital would receive on its newly-purchased shares. Third, not all of the physician investors would sell a portion of their ownership units to the hospital at the appreciated price, only the orthopedic surgeons. This raises the possibility that at least one purpose of the hospital’s investment is to reward or influence a subset of the physician investors whose referrals of patients to the hospital or to the ASC itself may be particularly valuable.

The OIG’s analysis of the first two factors is simplistic. As the ASC is a going concern and does not need additional capital contributions, the addition of new investors would only make sense if the current investors were permitted to cash out. To require new investors to enter the investment through the issuance of new units would prevent investors from being able to cash out when their investment has appreciated. Physician investors cash out of their investments all the time at appreciated rates without violating any laws. The OIG also takes issue with the fact that the orthopedic surgeons are selling for more than they paid. However, if the orthopedic surgeons were to sell at a price equal to what they initially paid for the units in question, the OIG would object that the purchase price was not set at fair market value. Consequently, the orthopedic surgeons are caught in a catch-22 situation. Granted, the OIG does state that neither of these factors, whether standing alone or in combination, necessarily indicates fraud or abuse. The OIG, given all the facts, could not conclude that the difference in costs of capital acquisition, which could result in financial gain to a subset of the physician investors whose referrals may be particularly valuable, is not related, directly or indirectly, to the value or volume of referrals or other business generated between the parties, including referrals by the selling orthopedic surgeons to the hospital or the ASC.

Accordingly, the crux of the OIG’s position comes down to the third factor. The hospital’s offer to purchase the units was only made to the orthopedic surgeons and the orthopedic surgeons did not offer to sell the units to anyone else. This factor gives the appearance that the orthopedic surgeons are being rewarded for referrals they have made or might make in the future. If the physician investors sold the forty percent interest in accordance with their respective ownership interests, the OIG would likely have held that the transaction was not related to the volume or value of referrals. Because the orthopedic surgeons owned ninety-four percent of the company, they could have sold ninety-four percent of the forty percent interest without raising the OIG’s objection.

The overarching lesson of the OIG’s ruling is that special treatment to one investor, or one set of investors, to the exclusion of other investors will be viewed with distrust. Such is true whether the disparate treatment comes in offers to buy units, sell units, or issue distributions. However, when all of the investors are treated equally, it negates the argument that the transaction is structured to reward an investor for making referrals.

The OIG explicitly states that an arrangement does not have to fit within all the conditions listed in a safe harbor, but, in such cases, a facts and circumstances test will be performed. It is advisable to consult with a health law specialist before engaging in any transaction involving remuneration including investment cash-outs for guidance in performing this test.