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OIG Issues Favorable Advisory Opinion for Physician-Owned Medical Device Company

On April 25, 2022, the Office of Inspector General (“OIG”) issued Advisory Opinion No. 22-07 which evaluated the risk of fraud and abuse under the federal anti-kickback statute (“AKS”) posed by an arrangement involving physician-ownership of a medical device company. The opinion identified six characteristics of the arrangement which greatly reduced the risk of fraud and abuse.

At issue in the opinion is an arrangement (the “Arrangement”) in which three physicians who are members of a medical group (the “Physicians”) have an ownership interest in a medical device company (the “Company”) through two irrevocable trusts (the “Trusts”). Physician A formed the Company to develop his upper-extremity surgical inventions into medical devices sold on the market. Physician B is Physician A’s daughter and Physician C is Physician B’s husband. The Company manufactures devices for surgeries that may be ordered by the Physicians.

The OIG opined on whether the Arrangement would constitute grounds for the imposition of sanctions under the AKS. Under the AKS, it is a criminal offense to knowingly and willfully offer, pay, solicit, or receive any renumeration to induce, or in return for, the referral of an individual to a person for the furnishing of, or arranging for the furnishing of, any item or service reimbursable under a federal health care program.

The OIG concluded that the AKS is implicated by the Arrangement because (1) the Physicians are beneficiaries of the Trusts which hold an ownership interest in the Company, (2) the Physicians order products from the Company that may be reimbursable by federal health care programs, and (3) the Physicians may recommend the Company’s products to others. Historically, the OIG has been concerned with fraud and abuse issues related to physician-owned entities that derive revenue from selling medical devices ordered by their physician-owners for procedures performed by the physician-owners.

Although potentially applicable, the OIG concluded that the Arrangement failed to satisfy the ‘small entity investment’ safe harbor because the Trusts collectively hold more than 40 percent of the investment interests in the Company, and the Physicians affiliated with the Trusts are in a position to make or influence referrals to the Company. In the absence of safe harbor protection, the OIG evaluated the Arrangement based on the totality of the facts and circumstances.

The OIG concluded that the Arrangement poses a low risk of fraud and abuse and does not raise concerns of suspect behavior under the AKS. In making this determination, the OIG identified six harm-reducing characteristics of the Arrangement.

1. Business Legitimacy of the Company

The OIG found the Company has several characteristics which reduce the risk that the Company exists only as a shell entity. The Company develops devices which are sold in national and international markets, employs dozens of individuals, and is responsible for the full-range of operations related to a legitimate medical device company. Additionally, the Company’s business is rooted in the marketing and selling of devices invented by Physician A and the Physicians’ ownership interests in the Company stem from Physician A’s inventions.

2. Mode of Profit Distributions

The opinion noted the AKS is designed to prevent overutilization or inappropriate utilization, corrupt decision-making, increased costs to federal health care programs, and unfair competition. The manner in which the Arrangement makes profit distributions reduces the likelihood of those harms occurring. The Arrangement reduces any distributions to the Trusts by a carve-out amount (equivalent to the amount of revenue generated by orders from any Physician or other medical group member that would otherwise be owed to the Trusts) which decreases the Physicians’ financial incentives to order the Company’s products. Further, Physician and non-physician owners are treated equally with regard to the Company’s profit distribution. Finally, the Company certified it will make any future profit distribution in direct proportion to each owner’s interest in the Company.

3. Limited Business Generated by the Physician-Owners

The risk of fraud and abuse is reduced because the Physicians are not the sole or even primary source of business for the Company. The Physicians and other medical group members generated less than 1% of all gross revenue of Company sales in the United States for the previous three years. The Company certified that the percentage of orders by the medical group has been decreasing for the past seven years, and will continue to do so, as the Company expands its sales in national and international markets.

4. Nature of the Ownership Interest

The nature of the Physicians’ ownership sets the Arrangement apart from other physician-owned entity arrangements. The Company certified the grant of majority ownership interest and preferential voting rights to Physician A was not because of any past or anticipated orders or recommendations from any of the Physicians. Rather, it was in exchange for Physician A assigning ownership to the Company of a substantial portfolio of proprietary technology. The ownership interest held by the Trusts is not contingent on the Physician or medical group generating business for the Company. The Company has not reserved the right to repurchase the Trusts’ ownership interest and does not require that the Trusts divest their ownership interest if the Physicians no longer order from the Company or practice medicine. Lastly, the Company certified that while it creates daily and monthly sales reports, it does not use these reports to encourage orders from the Physicians or the medical group.

5. No Physician Influence on ASC and Hospital Purchases

Although the Physicians order Company products for surgeries they perform at hospitals and ambulatory surgical centers (“ASCs”) as well as recommend Company products, they certified they will not otherwise attempt to influence hospitals or ASCs to purchase Company products. The Physicians also certified they do not, and will not, condition referrals to hospitals or ASCs on the purchase of Company products and that they choose products for medical procedures based on a patient’s unique clinical needs.

6. Transparency Regarding Ownership Interest

The Physicians’ ownership disclosures to patients, facilities, and the public in conjunction with the Arrangement’s other safeguards further reduces the Arrangement’s risk of fraud and abuse. Each patient is given written notice of each Physician’s ownership interest in the Company prior to undergoing a surgery involving a Company product. All ASCs in which the Physicians perform surgeries have been informed of the ownership interests and the Physicians certified they will notify any other facilities they practice at in the future of their ownership interests. Disclosures are also provided when a Company product is the subject of any academic presentation, lecture or peer-reviewed publication by a Physician.

Based on these facts, the OIG opined that although the Arrangement would generate prohibited renumeration under the AKS if the requisite intent were present, no administrative sanctions would be imposed due to the Arrangement’s low risk of fraud and abuse.

Despite the OIG’s approval of the Arrangement, traditional physician-owned distributorships remain under scrutiny. In May 2022, Reliance Medical Systems, a spinal implant maker, settled a False Claims Act case against it. In United States of America vs. Reliance Medical Systems, the government alleged the owners of Reliance Medical Systems paid illegal kickbacks to surgeons who used the company’s products in spinal surgeries on Medicare patients. The owners of Reliance Medical Systems formed two intermediary companies, which are “physician-owned distributorships”, from which physicians ordered the devices.

 

Arushi Pandya is a law clerk in the firm’s Washington, D.C. location and contributed to this article.

Copyright © 2022, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XII, Number 178
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About this Author

Kathleen Stratton, Sheppard Mullin Law Firm, Washington DC, Corporate Law Attorney
Senior Counsel

Kathleen M. Stratton is Special Counsel in the Corporate Practice Group in the firm’s Washington D.C. office.

Areas of Practice

Kathleen Stratton represents health care industry clients in a range of matters focusing predominantly on regulatory compliance, licensure, certification, and operational issues facing a vast array of provider types. Over the past 30 years, her provider clients have included hospitals, specialty pharmacies, ambulatory surgery centers, durable medical equipment suppliers,...

202-747-1956
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