Throughout the past several years, private equity funds have made substantial investments in the healthcare industry. These funds have invested in many facets of the industry, including in physician practices, ambulatory surgical centers, and hospitals. More recently, the Department of Justice (“DOJ” or “Government”) has pursued claims against private equity sponsors under the False Claims Act (“FCA”).

One notable example is the case of U.S. ex rel. Medrano v. Diabetic Care Rx, LLC, Case No. 15-cv-62617-BLOOM (S.D. Fla. 2018). In Medrano, the DOJ intervened in an FCA case against a private equity sponsor, the pharmacy in which the investment was made, and two pharmacy employees.  In its Complaint, the Government alleged that the fund had a “controlling interest” in the pharmacy, 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. The Complaint also alleged that the private equity fund had acted with the required intent under the FCA because it 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.” Id.

Specifically, the Government alleged that the pharmacy executed a provider agreement with Tricare’s contracted pharmacy benefits manager, and then submitted false claims that were generated through kickbacks paid to marketing companies in exchange for patient referrals. Kickbacks were also allegedly given directly to patients through waivers of co-pays. In the provider agreement, the pharmacy agreed to be bound by fraud, waste, and abuse laws, and specifically required compliance with the Anti-Kickback Statute.

The Defendants moved to dismiss, and, on November 30, 2018, the Magistrate Judge issued an opinion recommending that the FCA claims be dismissed. The Magistrate Judge’s opinion concluded that the government had adequately alleged the submission of “legally false” claims, but that the Government had failed to adequately allege any false express certification of compliance. Furthermore, the Magistrate Judge opined that the Government had failed to support its implied certification theory of liability with allegations that Defendants had submitted claims containing specific representations about the goods or services provided and that the Defendants had failed to disclose noncompliance with material statutory, regulatory, or contractual requirements. In contrast, the Magistrate Judge did conclude that the Government had satisfied the second “materiality” prong of the Escobar standard.

Notably, the Magistrate Judge also analyzed the arguments raised by the pharmacy’s private equity investor. One such argument was that the Government had failed to adequately allege that the investor “knew of, directed, or profited from” the alleged fraud. The Magistrate Judge acknowledged the allegation that the investor had communicated to the pharmacy manager that “routine copayment waivers could violate the AKS,” and noted that, without more, such an allegation was insufficient to establish the investor’s intent to violate the FCA. However, the fact that the investor: (1) received legal advice that paying commissions to marketers could violate the AKS, (2) “approved” of the pharmacy’s decision to “use marketers to generate referrals,” (3) knew of the commissions paid to the marketers, and (4) funded commissions paid to marketers, was adequate to allege the fund’s knowledge of the submission of false claims.

More recently, on March 6, 2019, the District Judge adopted the Magistrate Judge’s opinion and recommended that the Government’s complaint be dismissed for failing to adequately plead a false certification. However, the District Judge granted the Government leave to amend over the defendants’ objection.

The Medrano case is notable because it represents one of the more publicized FCA cases that the Government has pursued against a private equity fund based upon an investment in the healthcare industry. The case reflects the DOJ’s willingness to pursue claims based upon such investments. Of note, it does not appear that the Government was taking a bright-line stance against private equity investment in healthcare. Rather, it appears that the Government was focused on the private equity fund’s allegedly direct involvement in the management and operations of the pharmacy. It will be worth monitoring Medrano further in the future. Regardless of the ultimate result, Medrano provides a reminder for private equity funds to carefully consider their investments in the healthcare industry, to conduct appropriate due diligence, and to ensure that their involvement in the management of such entities, and the entities’ conduct generally, is consistent with all applicable laws and regulations.