Episode 29: Let’s Talk Compliance: How Compliance Issues Affect Health Care Transactions
In this episode, partner Jana Kolarik of Foley’s Health Care Practice Group interviews partner Roger Strode of Foley’s Health Care and Transactional Practice Groups and Michael Ramey, managing principal of PYA’s Strategic and Transaction Solutions on how compliance issues impact the health care transaction process.
For more information regarding the “Let’s Talk Compliance” podcast series, please click here.
Please note that the interview copy below is not verbatim. We do our best to provide you with a summary of what is covered during the show. Thank you for your consideration, and enjoy the show!
Angie Caldwell
Hello and welcome to the Let’s Talk Compliance Podcast series of Health Care Law Today, presented by Foley & Lardner and PYA. I’m your co-host, Angie Caldwell, consulting principal with PYA. Before we begin our show, we want to remind you to subscribe to Health Care Law Today, either on iTunes or your preferred podcast app. Please visit healthcarelawtoday.com, all one word, or pyapc.com. For today’s show, my co-host Jana Kolarik, a partner in Foley’s Health Care Practice Group, is interviewing Roger Strode, a partner in Foley’s Health Care and Transactional Practice Group, and Michael Ramey, managing principal of PYA’s Strategic and Transaction Solutions for an informative discussion on compliance issues that impact health care transactions. Take it away.
Jana Kolarik
Thanks so much, Angie. This is Jana Kolarik. I’m a partner with Foley’s Health Care Practice Group. And as Angie said, I’ll be interviewing Michael Ramey from PYA and Roger Strode from Foley & Lardner. Michael, why don’t you tell us a little bit about yourself?
Michael Ramey
Thanks, Jana. As she mentioned, Michael Ramey of PYA. I lead our strategic and transaction solutions program and a part of that we’re helping to facilitate transactions and even more so perform due diligence on various different transactions.
Jana Kolarik
Fantastic. And Roger, give us some details about you.
Roger Strode
Hi, Jana. Hi Michael. Happy to be here. Thank you for having me. I am Roger Strode. Jana and I are partners. We are both in the health care practice group at Foley & Lardner. My office is out of our Chicago office. My practice is primarily a transactional-based practice. I represent both for-profit and not-for-profit buyers and sellers of health care service providers focused on hospital and health system transactions, private equity transactions, and ancillary service providers, imaging, ambulatory surgery, physical therapy, telemedicine, et cetera. And I’m happy to be here. Thank you for having me.
Jana Kolarik
Wonderful. Great to have both of you guys. So today we’re going to be talking really about compliance issues that affect health care transactions. So in thinking, you guys, about your past experiences with transactions, how do compliance issues really factor into the deal? Michael, why don’t you start us off?
Michael Ramey
Sure, Jana. From my perspective of leading due diligence engagements over decades, compliance matters can have the biggest impact on whether a deal actually moves forward. If we find through a quality of earnings assessment that the financials have fallacies, that has certainly stopped deals mainly because expectations for value are no longer aligned between the buyer and the seller. But those issues can be overcome barring some pervasive controls on fraud issues that may be found and there’s a chance to recut the deal on the new earnings.
But compliance issues are the reasons that I see more buyers walk away from a deal, that and reputational issues that may come up during the course of a deal process. So I think it’s because there’s a lot of uncertainty around compliance issues, how much a regulator’s going to penalize a provider upon discovery of those issues, or even self-disclosure. We’ve seen those penalties can be pretty extreme. We all have our stories, but in the hospital segment, I’ve seen penalties completely cripple a hospital. Timelines are long also to know what those penalties can be, so that can really frighten a buyer whenever they’re looking at that. Roger, what are your thoughts?
Roger Strode
Yeah, Michael, in my experience, I’m on both the, as I mentioned earlier, on both the for-profit as well as the not-for-profit sides of both buying and selling health care providers. And I agree with you, compliance, while not my bailiwick and not my background, really do on the front end of deals drive both price and timing. And from a price perspective, if you take for example, and I think you alluded to this on the whole Q of E example, if you assume that say you’ve got a physician recapitalization transaction where the physician practice is going to trade at some double-digit multiple of earnings, call it 10 times, trailing 12 months earnings or 10 times projected earnings, and you find out that there’s a compliance issue because a particular service has been miscoded and you were billing incorrectly for that service and it’s a million dollar hit to earnings, well, that million dollar hit just got multiplied by 10, and all of a sudden that million dollar hit is a $10 million hit to value. That can be very disturbing for buyers and even more so for sellers.
On the not-for-profit side hospital transactions, I see it probably not necessarily… I’ve not seen it cripple transactions, but I have seen it pop up where hospital buyers will say, “This has got to get cleaned up before we take over.” And one of the reasons really, there’s multiple reasons for that, but in both of those transactions, you’re taking on the provider number of the entity being sold. When you take on that provider number of the entity being sold, the government really doesn’t care if that problem happened on your watch. All they care is that it happened and someone has to pay for it. So from that perspective, I see it, again, becoming both a price and a time issue.
Finally, with respect to certain transactions, especially for profit in the private equity space, it becomes particularly acute because private equity buyers are very, very precise when they go in and they price a deal and the returns that they expect. So they get very, very skittish once they find or if they find a compliance issue. And the other reason it’s important to them is they never buy an entity without a view towards an exit. These are not buy and hold companies. These are companies that buy, aggregate, build up and sell, and if a compliance issue is found, it needs to be cleaned up prior to closing and they need to ensure that they’re not going to perpetuate a mistake because it’ll make their exit tougher.
Michael Ramey
Yeah, Roger, I agree with all of those points. I’m glad also you mentioned about the provider number because in most all transactions for health care providers, we see that provider number come across even if it’s an asset deal. Because if they don’t, the risk of foregone or delayed reimbursement while setting up a new provider number is usually just economically untenable to be able to do that. So in many cases, most all cases we see that they do have to assume that risk. So that’s why it’s important to have that thorough due diligence process to uncover potential compliance risks.
But those improprieties following the provider number, if we see similar to what you’re saying, whether it’s a short period or even a longer period of let’s say overcoding without supporting documentation to substantiate the bill that’s coded, we’ll see buyers get very skittish. And there’s also, I think, where there’s smoke, there’s fire mentality for buyers and definitely for consultants who are doing due diligence. I know if our team sees that management or providers are lackadaisical in one area, it raises the concern on whether there may be other areas that may have issues and our level of professional skepticism rises as well.
Jana Kolarik
That’s super helpful, you guys. So from each of your perspectives and sort of drilling down a little bit and we got some detail there, but what are the most prevalent compliance issues that you guys have encountered? And really have you seen those change over time? Because I know you both have been in industry for a while.
Roger Strode
Yeah, maybe I’ll take that one, Jana. In the deals that I work on, the umbrella issue almost always starts with a P and its physician. The relationships between the entity and the physicians, whether they be the physician owners or physician employees, are almost always the predominant issues that I run into when it comes to compliance concerns. And I think partly is, and it may be a function of my practice, but I deal with a lot of Stark law issues and designated health services issues. And anyone who works in the health care industry and works around physicians understands that the Stark Law is a very complicated and very byzantine set of statutes and rules that compliance with those can be extraordinarily difficult.
And on the physician practice side, the reason it becomes so is because physician practices oftentimes don’t have the resources behind them, whether it’s legal resources or compliance resources, to ensure that they’re always in compliance with some of these rules. And when I say physician practices and problems, what kind of problems do I see? I see anything from physicians who own interests in an entity that provides designated health services, but the interests that they own or their relationship doesn’t meet a necessary exemption. I also see physicians who believe that they’re complying with the… Physician practices, I should say, who believe that they’re complying with the in-office ancillary services exception, but yet they don’t realize how complicated that exception is and that meeting all of the tests is necessary. They believe that they’ve met the tests, for example, the way they might carve up profits amongst physicians just as an example, and they believe that they’ve been in compliance with it, and yet they find out in the course of a deal that they’ve been out of compliance for maybe a decade. So those are the types of things.
And then finally, I find billing and coding issues oftentimes are a problem where physician practices believe that they’re billing something correctly and that they have been billing it correctly, but they find out that they’re using the wrong modifier to bill it, or they find out that billing rules around it have changed and they haven’t kept up with it. And I guess one last thing that I see from time to time is physicians who believe that they aren’t involved in a designated health service when in fact they are. And how does this happen? Again, I think it happens really because the physician practices themselves, again, don’t have the resources or they will reach out to what they believe to be an expert in the area on a one-off basis, they then sally forth after that, and they never check back in, or they never confirm with whoever it is that they’ve checked with, whether it’s a compliance expert or whether it’s legal counsel. They never check back in to make sure that they’re doing it correctly. So there’s that.
On the not-for-profit, the hospital side where we see issues around physicians is usually, again, it can be AKS and it can be as well as it can be Stark Law. And oftentimes it’s either overpayments where they’re paying the physicians too much, they’re paying the physicians too much compensation, or they have arrangements that aren’t fair market value arrangements with physicians, or they have failed to adequately document those to meet the Stark Law and the anti-kickback, either the anti-kickback safe harbors or the Stark Law exceptions.
Jana Kolarik
Yeah. And you and I have encountered those together, Roger, so completely, completely agree with you. So Michael, from your perspective, and I think some of your experience may be a little bit different than ours, so curious about what you consider the most prevalent issues that you’ve encountered from a compliance perspective?
Michael Ramey
Yeah, I would say from a prevalence perspective… Well, let me back up. I want to echo Roger’s comments about those areas that are definitely more complex or thorny. Anything that touches the provider number, physician compensation, coding, any of that is definitely, those are the harder ones. I would say sometimes when you’re talking about frequency, it may be some other adjacent areas, real estate being one.
I had a partner once who actually was in front of a not-for-profit board who was evaluating a particular opportunity and setting the stage for some news that was going to be delivered, said if there was ever a contest to find the first compliance issue, he’d run straight to the real estate office because you have so many different just areas where you can trip up. Now, the regulations have softened some, but there’s still a lot of non-compliant leases out there with entities or individuals that have the ability to refer.
So in hospital transactions, this is almost always an issue. It can be inconsistency between the contract and the rent roll that’s being administered. It can be an expired lease that was never renewed, but still occupying the space or lease rates that haven’t been reviewed in years and may not be within fair market value in today’s market. So there’s a lot of opportunity there for some thorny compliance matters and potentially voluminous ones that may lead to some type of rectifying issue prior to close or self-disclosure.
Other areas also include IT. We think about this in terms of Stark and anti-kickback from a compliance perspective, but areas that can be extremely challenging for a buyer who’s assessing the risk is the level of IT security compliance, because how secure is… Is their network housing PHI? Are they vulnerable to cyber attacks? Or even worse, have they had a breach and not performed an appropriate disclosure mitigating actions? Those are things that can quickly, quickly torpedo a transaction if those come up.
So all these things we’ve thrown out there. What we have found is most important to look at is to look at these matters holistically. So don’t piecemeal the analysis on various different due diligence. Any particular issue can possibly be overcome. We can address it. Roger, I know you’ve got ways that you’ve done that from a legal perspective in the past, but whenever you kind of see the preponderance of issues, that’s what really I think can sink a deal. So that’s why my opinion, my experience is that assessing that enterprise wide risk through due diligence is so imperative. We’re fortunate enough at PYA to have a breadth of services. We can look into all these different areas, be it coding compliance, medical necessity, compliance program management, physician compensation, IT security, real estate, other areas that can lead to compliance issues in addition to the financial matters so that we can help our clients to really assess this from a comprehensive risk perspective.
Jana Kolarik
That’s super helpful. Thanks, Michael and Roger. And I think what’s interesting is the breadth of the issues that you guys touched on. And we’ve talked about sort of sinking deals, but I think a lot of these things can be worked through. So how do you solve for those issues from a deal context? And Roger, let’s start that discussion with you.
Roger Strode
Yeah. I mean there’s several ways obviously. If in a transaction during diligence, and these almost always pop up, they will pop up during diligence because you’ve got guys like Michael’s group who come in and will diligence a business, or they’ll call in billing and coding specialists from different firms. Or just legal diligence, it’ll pop up when you’re starting to do reviews of, again, leases and physician compensation arrangements, et cetera. And it will really depend. It depends upon the timing and how quickly you want to get the deal done. Obviously, the first thing that the buyer will do is insist that the seller stop doing whatever it is that they’re doing. And usually sellers, once they see it, will stop doing whatever it is that they’re doing. Then you have to decide under the Stark law, “Is this is self-disclosure problem? Should we go ahead and get a self-disclosure done and get it rolling?”
And that’s oftentimes done and it’s been done. Jana and I are working on a deal right now where it’s been done. I’ve worked on several physician recap deals in PE where we’ve done it and you do it during the course of the deal, and oftentimes the buyer won’t close until that particular self-disclosure is taken care of, and at least we get rolling on it with the CMS. T.
Hen you deal with it through the deal documents. The way we deal with it through the deal documents is if it’s a known problem… For those who do a lot of deal work, you understand that in a for-profit deal, you generally will have an indemnification provision in your purchase agreement that says that if we run into problems and specific types of problems, “Hey, you seller are going to indemnify us for those problems. They’re your problems, we’re buying into them. And if we find out we buy into them, you’re going to take care of us.”
There are generally two types of indemnities that you have in these arrangements. One are called sort of general indemnities, and a general indemnity would be one that would pop up in the representations and warranties that are in the purchase agreement. And I can tell you that I’ve not ever done a health care deal where there’s not a robust set of representations and warranties around billing and coding around physician compensation, around compliance with, again, cybersecurity compliance, HIPAA compliance, high-tech compliance. Generally, these purchase agreements are replete with these types of representations and warranties. And so, if something pops up post-closing, it’ll generally be covered by one of these. If it’s a known problem before you close, we usually will draft what we call a very specific indemnity.
So again, take my example where you found a problem with a billing and coding problem or a Stark Law problem, and in the Stark Law you’ve made a disclosure to the CMS under the self-referral disclosure protocols. What you will do is set up a specific indemnity that says, “Whatever happens here, you’re going to take care of it. It won’t be subject to usually caps, it won’t be subject to baskets. There won’t be any discussion about whether or not there’s been a breach of a representation in warranty because it’s set forth directly in that agreement.” And then oftentimes what you do is you will buttress that with an escrow where the parties will make some sort of a good faith estimate of what they think the penalties are going to be and you’ll escrow those amounts. So that’s normally how I see these things taken care of.
And I just wanted to echo something that Michael said, and Michael is right. I have been involved in situations where there’s such rampant non-compliance that it makes the buyer nervous that we won’t find everything and we may not have enough resources left over, so deal needs to be off until you guys go back and clean up your shop, then we’ll come back and see you.
Michael Ramey
Roger, you raise a good point. I was actually going to mention this. Part of it is address the issue before it becomes a transaction issue. So we also work on not-for-profit and private equity backed deals on health care services. And on those private equity deals, we’re seeing more sellers, and for that matter, sellers advisors, be attuned to the compliance matters than they were say maybe five years ago. So our coding compliance team is getting pulled in more and more by sellers of physician practices and their advisors and various other ambulatory service providers before they go to market.
So this is usually an investment banker, an attorney urging to do this, but know what you’re dealing with before you go to market. We’re doing that along with sell-side Q of E to get ahead of potential issues so they can be addressed. Roger, to your point, clean up the house first before you go through a lengthy process to go to market, find a preferred partner and go through the due diligence and negotiation process only to find out that there’s something fundamental underneath it that’s going to jeopardize the transaction on the expectations that you have. So we’re seeing more and more of that as well.
Roger Strode
Yeah, I think that really runs too, Michael, that old saying that we have, that once you ink a deal, that the deal never gets better for the seller. It can only get worse whether it’s through time, whether it’s through problems being unearthed. And I do agree with you, we are seeing more sellers begin to make sure that there are not skeletons in their closets that they don’t know about in the… I would say I’m going to sound like an old guy, but in the old days we were always told, “We’re clean, everything’s good. We have great lawyers, we have great compliance. We’ve never had an issue.” And I can almost always tell you when I hear those words, there’s going to be an issue.
Jana Kolarik
Yeah, too complicated a landscape. You guys mentioned, and Roger, rep and warranties being sort of important obviously in the purchase agreement. Because we’ve heard more and more about rep and warranty insurance, why has that become so important?
Roger Strode
It’s kind of changed the landscape and deals a little bit. Representations and warranties that kind of the uninitiated here are promises that a seller makes with respect to its business to the buyer. A good example is you’ll make a promise that, “At no time during the last six years have we materially miscoded or materially misbuild for a matter that is reimbursable in whole or in part under a federal health care program.” That might be one. Or, “We are in compliance with all material Stark law rules or all Stark law rules and have been so over the past six years.” Those are promises you make.
What has happened is buyers and sellers have either created, or insurers have created a market to ensure against those risks and to ensure those promises. And you have found, and it really didn’t come out of health care, it came out of the general M&A market where there was a market to go out there for buyers to say, “Listen, I’m going to make this attractive to a seller because I’m going to insure against the risk of loss here, and maybe I’ll split the premium. We’ll go out and hire an insurance company. That insurance company will come in due diligence on the business right along with us, and we will pay them a premium in exchange for coverage.” Oftentimes, that coverage is somewhere around 10 to 15% of the total enterprise value of the seller. There’ll be, of course a deductible and some retention of risk by the buyer and the seller, but they can insure against it.
And again, the insurance companies have saw a market for it. Buyers saw the fact that they were willing to do it because if you think about it, if you’re in an auction for a business and you go to a seller and say, “Listen, we’re going to reduce what you have to put into escrow, we’re going to reduce your exposure for any post-closing indemnification because we’re going to go out and get this insured by a third party insurer,” if you can do that, you’re going to make yourself much more attractive to a buyer in that instance, especially if you’re in a competitive bid situation.
So we are seeing a lot of representation in warranty insurance. And for a while, they wouldn’t insure over health care risks. As they’ve gotten more sophisticated, they’ve been more amenable to ensuring over health care risks. And what that really does from both a buyer and a seller’s perspective is it puts a little less pressure on your reps and warranties. You as a seller are going to be more amenable to a broader rep or warranty on, say, a health care compliance matter. If you feel as though it’s going to be insured. Of course, they won’t insure over fraud and they won’t insure over known risks. But that’s what we’re seeing and that’s what we’re seeing in the health care M&A market.
Michael Ramey
Yeah, I agree. It’s definitely picked up. In fact, it’s picked up to the point that in the peak of transactions in health care in 2021, 2022, towards the end of that, it started getting hard to find reps warranty insurance because so much had been committed already. But it certainly is helping get the deals done. And I would say there are certainly efficiencies. There’s also somewhat of a shift in the focus and for them having the back and forth that may happen during a transaction lifecycle because while it helps mitigate the strain and challenges of negotiating and defining the reps and warranties in the definitive agreement, the insurance provider is going to require a level of due diligence, Roger, just like you said, to be able to underwrite that policy.
So that may be additional due diligence on top of what the buyer’s doing. So depending upon when it’s pulled in, and we’d recommend if there’s a deal, try to pull in as quickly as possible, sometimes it requires some additional back and forth. But all in all, I do think it’s more efficient to be able to get the deal done just a little bit more lifting during the diligence phase.
Roger Strode
Yeah. And I agree with that in getting it sooner. There’s always that push and that pull, because as a seller, you want to see that commitment sooner because that influences and informs how hard you’re going to negotiate on the indemnity provisions because you have to build the concept of rep and warranty insurance into your indemnity provisions and how hard you’re going to negotiate on the reps and warranties themselves. But yet the insurer wants to see, they don’t want to oftentimes commit the resources to try to underwrite that risk until they know there’s going to be a deal. So there’s a little bit of chicken and egg that goes on. Usually we meet it, but what we do as sellers councils, we usually say to the buyer, “We’re not going to sign off 100% on this agreement until we see that commitment from that insurer.” And most buyers understand that, and they’re trying to get as much coverage as they can possibly get as well.
Jana Kolarik
So as a final note, are there any sort of issues that you want to flag for our listeners who may be contemplating selling their business or contemplating buying a business as far as sort of last thoughts? Roger, why don’t you start?
Roger Strode
There are several things that I think that have arisen that are going to become more and more frequently addressed. One in pure compliance, corporate practice of medicine. We are seeing a lot more enforcement by states around arrangements that may not be compliant with the corporate practice of medicine, the corporate practice of dentistry, the corporate practice say of physical therapy, et cetera. So we see that. While not a compliance issue, I think you’re going to start to see, depending upon states you’re in, your employment agreements may be out of compliance with state law because of non-competes. As we see more and more states putting in statutes that are going to vitiate non-competes, especially in physician agreements, Indiana, Minnesota, Connecticut. You’re looking still at this looming FTC action. So we’re seeing I think a great deal of that. And then finally, antitrust. While not compliance, we have an FTC that is very activist and we’re starting to see state AGs become a little bit more emboldened and activist as well.
Jana Kolarik
Yeah. And Michael, your final thoughts for us?
Michael Ramey
Sure. Just within the lane of compliance, it really does require very competent counsel as you’re going through this, whether you’re a seller or a buyer. So making sure you’ve got those individuals who have deep understanding of these regulations. And there’s a lot of regulations out there, but having that deep understanding of those regulations to help navigate you through that is really important. I know the way that we kind of approach it, and I appreciate that Foley does this as well, while we aren’t physicians we kind of view ourselves as operating akin to a clinical care model where you gather all the experts in the respective fields and then you look at the situation and you collaboratively diagnose the matter. It’s that type of approach with the expertise in health care and transactions that are going to be necessary to be able to navigate these. Otherwise, you’re going to wake up one day and see, “Oh my goodness, I’ve got an issue. How do I address this?”
Jana Kolarik
Yeah, love that teamwork concept as the final note. So I want to thank you, Michael and Roger, so much for participating in the podcast today. Thank you guys. Appreciate it.
Roger Strode
It’s my pleasure. Thank you for having me.
Michael Ramey
Jana, thank you so much.
Angie Caldwell
Thank you Roger and Michael for a great discussion. We appreciate you taking the time to join us today. We want to thank our listeners for joining our Let’s Talk Compliance Podcast series with Health Care Law Today, your connection to timely legal updates in the health care and life sciences industry. We encourage you to subscribe to this podcast. Visit Foley’s Health Care Law Today blog at healthcarelawtoday.com, and pyapc.com. If you liked this show, don’t forget to subscribe and be sure to rate us five stars. Until next time, I’m Angie Caldwell at PYA.
