OIG Approves Arrangement Involving Physician-Owned Device Manufacturer— Distinguishes Prior Special Fraud Alert on Physician-Owned Entities

May 2, 2022
Firm Publication

On April 25, the Office of Inspector General (OIG) for the U.S. Department of Health and Human Services published Advisory Opinion 22-07, approving an arrangement whereby physicians hold ownership interests in a medical device company that manufacturers devices that the physicians or their family members may order for their patients.

This favorable opinion is noteworthy because it marks the first time OIG has issued an opinion analyzing a physician’s ownership interest in a medical device manufacturer since the issuance of the 2013 Special Fraud Alert on Physician-Owned Entities (the 2013 Special Fraud Alert).

The Arrangement

The requestors include three related orthopedic surgeons—Physician A, his daughter (Physician B), and his daughter’s husband (Physician C)—their medical group and a medical device company formed by Physician A (Company). Physician A is the inventor of the Company’s intellectual property and acts as its chief scientific officer but is not involved in Company’s day-to-day operations. He also has ownership interests in an ambulatory surgery center (ASC) where the requestor-Physicians and others in their medical group perform surgeries in which they may use Company products.

The Company granted a majority ownership interest to Physician A and his spouse in return for Physician A’s assignment of his ownership interest in proprietary technology to the Company. Physician A and his spouse later contributed their majority ownership interest to two irrevocable trusts benefitting each other and their children, including Physician B (the Trusts). The Trusts collectively hold the majority ownership interest in the Company through a holding company.

The requestors certified that the Company’s grant of the majority ownership interest to Physician A was solely in return for Physician A’s assignment of his ownership interest in proprietary technology to the Company and not in return for any past or anticipated referrals. None of the Company’s other owners are healthcare practitioners or related to healthcare practitioners who order the Company’s products. Although the requestor-Physicians order Company products, the combined total of their orders and the orders by other physicians in their medical group constitute less than 1% of Company revenues, with further dilution anticipated as the Company’s domestic and international sales expand.

The Company had not made any profit distributions at the time of the request. The requestors stated that any future distributions would be proportional to each owner’s investment interest, except that revenues generated by the requestor-Physicians and their medical group members would be carved out from distributions to the Trusts. The requestor-Physicians further certified that they do not, and would not, condition referrals to hospitals or ASCs on the purchase of Company products.

The Company also certified that the Trusts’ ownership interests are not contingent on any of the requestor-Physicians or their medical group partners generating business for the Company. While the Company generates certain daily and monthly sales reports, it does not track orders from the requestor-Physicians or their medical group partners except as necessary to reduce any potential distribution to the Trusts. Finally, the Physicians and their medical group partners provide several disclosures related to the Physicians’ ownership interests in the Company, both to their patients and to the hospitals and ASCs at which they perform procedures. These disclosures include a notice to patients of the Physicians’ ownership interests in the Company and the names of alternative medical device companies in which the Physicians do not have ownership interests. Patients with whom the Physicians have the opportunity to consult before surgery may instruct the Physicians to use one of these alternate devices.

OIG’s Analysis

OIG concluded that the arrangement implicates the federal Anti-Kickback Statute, 42 U.S.C. 1320a-7b(b), because the Physicians are beneficiaries (or, in one case, the spouse of a beneficiary) of the Trusts, which in turn hold ownership interests in the Company through the holding company, and the Physicians order or recommend federally reimbursable products from the Company. OIG concluded that the arrangement does not qualify for the small entity investment safe harbor at 42 C.F.R. 1001.952(a)(2) because the Trusts hold more than 40% of the investment interests in the Company, and the Physician-beneficiaries of the Trusts are in a position to refer Company business.

Nevertheless, after reiterating its longstanding concerns associated with physician ownership in medical device companies, OIG distinguished the arrangement from the 2013 Special Fraud Alert and concluded that the facts and circumstances, including several helpful safeguards, warranted a favorable opinion.

OIG first observed that the arrangement lacked certain suspect characteristics associated with problematic physician-owned entities, in which parties may create illegitimate shell companies to profit from their own referral decisions. OIG noted that the Company is a viable and legitimate business entity that designs, develops, and tests medical products that it markets both domestically and internationally employs dozens of individuals and submits regulatory filings with the Food and Drug Administration (FDA) and other international regulatory bodies. The Company’s entire business model is founded on marketing and selling devices that Physician A invented.

Although the Company’s legitimacy is a critical safeguard, that alone likely would not have been enough to secure a favorable opinion. Other safeguards upon which OIG relied include:

  • The arrangement dilutes the financial incentives the Physician-beneficiaries of the Trusts may have to order the Company’s products by reducing any distributions through carve-outs.
  • The Physicians’ and their medical group partners’ purchases of Company products make up a very small (and declining) percentage of the Company’s overall revenues.
  • The Company does not, and would not, treat the Physicians preferentially compared with non-Physician owners when making any profit distributions.
  • While the Company creates daily and monthly sales reports, it neither uses the reports to encourage additional orders from the Physicians or their medical group partners nor tracks their orders differently from orders from other sources of business.
  • Neither the initial transfer of a majority ownership interest in the Company to Physician A nor the subsequent transfer to, and continued interest held by, the Trusts were based on any Physician’s past or anticipated referrals.
  • Although the Physicians may recommend Company products and order Company products for surgeries they perform at hospitals and ASCs, the Physicians will not otherwise attempt to influence hospitals or ASCs to purchase the Company’s products.
  • The Physicians and their medical group partners are transparent about the arrangement, making numerous disclosures about the ownership interests to patients and the hospitals and ASCs at which they perform procedures and, when possible, patients are given the opportunity to select an alternate device.

Takeaways

This advisory opinion is noteworthy for several reasons, not the least of which is that it is rare for OIG to issue a favorable opinion involving conduct that has been the subject of a Special Fraud Alert. The number and extent of the safeguards present here reinforce the underlying fraud and abuse risks that continue to be associated with physician ownership in medical device companies when such ownership interests are not protected by the investment interests safe harbor. Of particular importance, in the authors’ opinion, are two safeguards:

  1. The Company’s legitimacy, as evidenced by its range of operations and the exceedingly small portion of the Company’s sales the Physicians’ orders represent.
  2. The carve-out of the Physicians’ and their medical group’s orders from the distributions to the Trusts.

Although it is difficult, if not impossible, to determine the exact percentage of physician referrals that might cause OIG to call a company’s legitimacy into question, it seems clear that the government will continue to closely scrutinize medical device companies that derive a significant percentage of their business from physician-investors. Such scrutiny is particularly likely during a company’s early stages when the company’s products have not yet been widely adopted. Such companies may wish to consider implementing broad carve-outs similar to the one present in Advisory Opinion 22-07, which carved out the Physicians’ referrals and the referrals from the Physicians’ family members and medical group partners from the distributions to the Trusts.

Meanwhile, entities that imposed across-the-board bans on purchasing medical devices from companies in which ordering physicians have ownership interests in response to the 2013 Special Fraud Alert may now wish to reconsider such policies in circumstances where the companies have implemented appropriate safeguards.

If you have any questions about how this latest Advisory Opinion may impact your business, please contact the authors.