• Member-Owned Group Purchasing Organizations: What You Need to Know
  • April 20, 2005 | Author: John W. Jones
  • Law Firm: Pepper Hamilton LLP - Philadelphia Office
  • In light of the response received regarding our April Health Care Law Alert article titled "GPO Arrangements Coming Under Government Scrutiny: Are These Harbors Still Safe", we thought an update about safe harbor protection of investment interests in GPOs might be helpful.

    Federal Anti-Kickback Statute

    Generally, the federal Anti-Kickback Statute prohibits an individual or entity from knowingly and willfully offering or paying, or from soliciting or receiving, remuneration to induce the referral or the arranging for the referral of business reimbursed by the federal health care programs, including Medicare and Medicaid. The federal Anti-Kickback Statute has been interpreted to cover any arrangement where one purpose of the remuneration was to obtain money for the referral of services or to induce further referrals.

    Accordingly, where a member-owner of a GPO receives payments from the GPO in the form of dividends or distributions, and the member-owner purchases items and supplies through the GPO's vendor agreements, the federal Anti-Kickback Statute would be implicated. Under such an arrangement, the Office of Inspector General's (OIG) primary concern would be whether the dividend or distribution payments to investors constitute disguised remuneration for referrals. Although OIG has adopted safe harbors to protect certain health care ventures, strict and rather onerous requirements of these safe harbors do not always make them a viable option.

    Safe Harbors

    Cooperative Hospital Service Organization

    Under the federal Anti-Kickback Statute's cooperative hospital service organization safe harbor, prohibited remuneration does not include any payment made between a cooperative hospital service organization (CHSO) and its patron hospital, both of which are tax-exempt under 501(c)(3) of the Internal Revenue Code of 1986 (IRC), where the CHSO is wholly owned by two or more patron hospitals, provided that the following requirements are satisfied:

    • where a patron hospital makes a payment to the CHSO, the payment must be for the bona fide operating expenses of the CHSO; or
    • where the CHSO makes a payment to a patron hospital, payment must be for the purpose of paying a distribution of net earnings required to be made under section 501(e)(2) of the IRC.

    Accordingly, under the CHSO safe harbor, payments from a patron hospital to the CHSO must be for bona fide operating expenses of the CHSO, and any payment from the CHSO to the patron hospital must be limited to a distribution of net earning required to be made under the IRC.

    The CHSO safe harbor has several limitations. First, it protects certain payments in connection with certain tax-exempt hospital cooperatives only. The safe harbor does not extend to other types of hospital and non-hospital cooperatives. Second, any payment by a patron hospital to the CHSO must be for bona fide operating expenses. Third, any payment (not otherwise protected under other applicable safe harbors) from the CHSO to a patron hospital must be for paying distributions required under the IRC. Clearly beyond the scope of protection would be payments made to its member-owners for their purchases through the CHSO. Said another way, the CHSO could not tie a member-owner's dividend or distribution payments to the volume or value of the member-owner's purchases. Such an arrangement would be inconsistent with the federal Anti-Kickback Statute.

    Investment Interests Safe Harbor

    Under the federal Anti-Kickback Statute, prohibited remuneration does not include any payment that is a return on an investment interest, such as a dividend or interest income, made to an investor provided the arrangement complies with either the large investment interests safe harbor or small investment interests safe harbor. Elements common to both safe harbors include:

    • The entity or any investor must not market or furnish the entity's services or items (or those of another entity as part of a cross referral agreement) to passive investors differently than it would to non-investors.
    • The entity or any investor (or other individual or entity acting on behalf of the entity or any investor in the entity) must not loan funds to or guarantee a loan for an investor who is in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity if any part of the loan is to obtain the investment interest.
    • The amount of payment to an investor in return for the investment interest must be directly proportional to the amount of capital invested by that investor.

    Large Investment Interests

    If within the previous fiscal year or previous 12-month period, the GPO possesses more than $50 million in undepreciated net tangible assets (based on the net acquisition cost of purchasing such assets from an unrelated entity) related to the furnishing of health care items and services, the investment interests held in that GPO could receive safe harbor protection under the large investment interests safe harbor, provided the following requirements were satisfied:

    • Investment interests that constitute equity securities must be registered with the Securities and Exchange Commission.
    • The terms (including any direct or indirect transferability restrictions and price) on which an investment interest is offered to an investor in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity must be no different from the terms equally available to the public when trading on a registered securities exchange, such as the New York Stock Exchange or the American Stock Exchange, or in accordance with the National Association of Securities Dealers Automated Quotation System.

    Small Investment Interests

    Historically, the investment interests safe harbor for small investments has been used to protect hospital joint venture arrangements. To obtain protection under this safe harbor, a health care venture has to satisfy a number of stringent requirements, including:

    • No more than 40 percent of the value of the investment interests of each class of investment interests of the entity may be held in the previous fiscal year or previous 12-month period (Look-Back Period) by investors who are in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity.
    • No more than 40 percent of the entity's gross revenue related to the furnishing of health care services and items in the Look-Back Period may come from referrals or business otherwise generated from investors.
    • The terms on which an investment interest in an entity is offered to a passive investor, if any, who is in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity must be no different from the terms offered to other passive investors in the entity.
    • The terms on which an investment interest in an entity is offered to an investor who is in a position to make or influence referrals to, furnish services or items to, or otherwise generate business for the entity must not be related to the previous or expected volume of referrals, items or services furnished, or the amount of business otherwise generated from that investor to the entity.
    • There is no requirement that a passive investor in an entity, if any, make referrals to, be in a position to make or influence referrals to, furnish services or items to, or otherwise generate business for the entity as a condition of remaining an investor in the entity.

    GPO Safe Harbor

    Although the GPO safe harbor is designed to protect administrative fees paid by a supplier to a GPO, it contains certain standards regarding the capital structure of a GPO and its arrangements with its members. Specifically, members of the GPO cannot be wholly owned by the GPO. OIG has indicated that the GPO safe harbor is not intended to protect payments for arranging for referrals within a single organization. Second, the members of the GPO cannot be subsidiaries of a parent corporation that wholly-owns the GPO (either directly or through another wholly owned entity). Accordingly, where GPO members are subsidiaries of a parent company, the parent company could not wholly-own the GPO and still obtain safe harbor protection for administrative fees received from suppliers.

    OIG's Position on Health Care Joint Ventures

    OIG has long been concerned with the fraud and abuse risk posed by health care joint ventures in which investors are also sources of referrals. In 1989, OIG issued a special fraud alert concerning suspect health care joint ventures. In the alert, OIG distinguishes between legitimate health care joint ventures and those which it considers suspect. Importantly, OIG indicated that under suspect health care joint ventures, certain individuals or entities may be investors not so much for raising investment capital to start a business, but rather to lock up a stream of referrals from those individuals and entities in exchange for compensation for those referrals. Some questionable features of suspect health care joint ventures include:

    Selection and Retention of Investors

    • Investors are chosen because they are in a position to make referrals to the venture.
    • There is discrimination in the opportunity of investors to invest based on their ability to make referrals.
    • Investors are encouraged to make referrals and may be encouraged to divest their ownership interest where they fail to maintain an acceptable level of referrals.
    • The venture tracks referrals and distributes the information to investors.

    Business Structure

    • One party to the health care joint venture may be an ongoing entity that is already engaged in a particular line of business, and acts as the reference supplier under the arrangement with the venture, the venture being nothing more than a shell entity.
    • The health care joint venture contracts out of all of the services and conducts very few services on its own premises, even though it bills the federal health care programs for the services.

    Financing and Profit Distributions

    • Capital invested by investors is disproportionately small, the risk involved in the venture is low, and the returns on investment are disproportionately large.
    • Investors may borrow their capital contribution from the entity and pay it back through deductions of profit distributions.

    Not all health care joint ventures achieve safe harbor protection. Most, however, are legitimate and work to achieve cost-savings for the investors and the federal health care programs. To manage the uncertainty and potential risk of liability presented by these ventures, including GPOs, the parties should consider tailoring the venture as closely as possible to OIG's guidance in this area, implementing certain safeguards, including:

    • The terms on which an investment is offered in the GPO should not take into account any previous or expected volume of referrals, services furnished or amount of business generated from such investors. Dividend or distribution payments to investors should not be tied, directly or indirectly, to the value or volume of referrals or items or services otherwise purchased through the GPO's vendor agreements.
    • Non-hospital owned cooperatives are not protected under CHSO safe harbor.
    • The investor's return on investment should be directly proportional to the amount of capital investment of that investor, not purchasing volume of the investor.
    • If using the small investment interest safe harbor to protect the investment interests held in the GPO, no more than 40 percent of the value of the investment interests of each class of investment interests should be held in the Look-Back Period by investors who are in a position to generate business for the venture, and no more than 40 percent of the venture's gross revenue related to the furnishing of health care services and items in the Look-Back Period may come from business generated from investors.
    • There is no requirement that a passive investor, if any, make referrals to, be in a position to make or influence referrals to, furnish services or items to, or otherwise generate business for the entity as a condition of remaining an investor in the entity.
    • Interests offered by the GPO to passive investors in a position to generate business for the GPO should not be made on terms different from those of other passive investors. Additionally, the GPO should not market or furnish the entity's services or items differently to passive investors and non-investors.
    • The GPO should not loan or guarantee funds to an investor if the loan or guarantee would be used to obtain the investment interest.
    • Members of the GPO should not be wholly owned by the GPO and where GPO members are subsidiaries of a parent company, the parent should not wholly own the GPO.