In a speech this summer to the US Chamber of Commerce, Ethan Davis of the US Department of Justice discussed efforts to fight possible fraud during the pandemic.
Strikingly, principal deputy attorney general Davis singled out one group as a particular target for law enforcement: “Our enforcement efforts may also include, in appropriate cases, private equity firms that sometimes invest in companies receiving CARES Act funds. When a private equity firm invests in a company in a highly regulated space like healthcare or the life sciences, the firm should be aware of laws and regulations designed to prevent fraud. Where a private equity firm takes an active role in illegal conduct by the acquired company, it can expose itself to False Claims Act liability.”
This focus on PE investors is not limited to Davis or the CARES Act. Rather, recent activity under the False Claims Act – the government’s principal weapon for punishing contractors allegedly defrauding the US, with treble damages plus penalties of approximately $11,000 to $23,000 per false claim – shows PE firms are in the DoJ’s and private whistleblowers’ crosshairs.
In 2018, the US government for the first time brought a False Claims Act lawsuit against a PE owner for the conduct of a portfolio company. In US ex rel. Medrano v. Diabetic Care RX, LLC, et al., No 15-cv-62617 (SD Fla), the DoJ intervened in a whistleblower’s lawsuit against compound pharmacy company Diabetic Care RX, and, notably, also asserted claims against PE investor Riordan, Lewis & Haden and two of its partners.
The government’s complaint alleged a scheme by the pharmacy to pay kickbacks in the form of commissions to outside marketing companies, payments to telemedicine doctors, and co-payments to TRICARE (a government insurance program for military service members) patients. The DoJ contended RLH knew of and financed the plan to pay the outside marketers to unlawfully generate the prescriptions. It also charged that two of RLH’s partners who served on the pharmacy’s board had led the corporate initiative that resulted in the alleged kickbacks, receiving regular reports on sales to federal programmes and the allegedly illegal commissions. RLH moved to dismiss the claims arguing it lacked knowledge of the fraud, but a magistrate judge rejected this contention. The result was a settlement late last year where the defendants (including RLH and its partners) agreed to pay $21.36 million to resolve the False Claims Act claims.
The ongoing case of US ex rel. Martino-Fleming v. South Bay Mental Health Center, Inc, No 15-cv-13065 (D. Mass), tells a similar story. There, a qui tam whistleblower accused a mental health provider, South Bay Mental Health Center, of submitting false claims to federal health care programs because of its use of unlicensed, unqualified and unsupervised employees. The private whistleblower also alleged that HIG Capital, which owned South Bay through Community Intervention Services, was liable for causing the submission of the false claims. Although the US declined to intervene in the case, the Commonwealth of Massachusetts has joined the action on the side of the plaintiff.
Once again, the PE firm denied the allegations of wrongdoing, but its attempt to escape from the lawsuit was unsuccessful, with the district court concluding: “Because it is alleged that HIG members and principals formed a majority of the CIS and South Bay Boards, and were directly involved in the operations of South Bay, the motion to dismiss the HIG entities is also denied. A parent may be liable for the submission of false claims by a subsidiary where the parent had direct involvement in the claims process.”
Consequently, the claims against the PE investor were allowed to proceed to discovery and are still pending.
Whistleblowers also named HIG as a defendant in US ex rel. Cho v. Surgery Partners, Inc, et al, 17-cv-983 (MD Fla). This lawsuit charged that Surgery Partners ordered medically unnecessary drug tests and had improper financial relationships with doctors. With the benefit of the previous actions against RLH and HIG, the private whistleblowers also filed an amended complaint charging that HIG (again) participated in the “management, control and direction” of its portfolio company and thus was liable for the false claims submitted by Surgery Partners. Although the district court dismissed the lawsuit on other grounds, it is a safe bet that more actions against private equity investors are likely.
False Claims Act settlements and awards can involve staggering amounts, often reaching the hundreds of millions of dollars. In 2019, for example, total False Claims Act recoveries exceeded $3 billion. In his remarks, DoJ’s Davis was careful to emphasize that the False Claims Act applied only to knowing violations of federal law and that PE firms could “rest assured that the Civil Division will not pursue companies that made immaterial or inadvertent technical mistakes in processing paperwork, or that simply and honestly misunderstood the rules, terms and conditions, or certification requirements”.
Yet, aggressive government line attorneys may have different views about what is “immaterial or inadvertent” or whether a PE investor “simply and honestly misunderstood the rules”. Whistleblowers’ attorneys certainly will have few compunctions about using the False Claims Act (and the settlement leverage of its treble damages and onerous penalties) against deep-pocket PE investors.
Private equity investors should be prepared for the new reality that they are inviting targets for DoJ and whistleblower counsel wielding the False Claims Act. This may take a number of forms. Before any investment, due diligence should consider False Claims Act risk, carefully evaluating government regulatory and reimbursement issues. Once an investment is made, firms should closely scrutinize their portfolio’s company operations and policies for possible compliance concerns. Compliance programmes also should be reviewed to ensure best practices are followed, with adequate internal reporting systems and robust audit and investigative capabilities. When compliance issues are identified, there should be full documentation of the investigation and remediation undertaken. Through these and other measures, PE investors can best position themselves to avoid or, if necessary, defeat False Claims Act lawsuits.
Michael Waldman is a trial and appellate litigator at the law firm of Robbins, Russell, Englert, Orseck, Untereiner & Sauber in Washington, DC. He has extensive experience in civil, criminal, and debarment cases arising from federal fraud investigations, with special expertise in representing defendants in False Claims Act and qui tam lawsuits.