"In Forcing Subsidiary Divestiture, OIG Shakes Up Health Care Enforcement"
For the first time in a health care fraud case, the Office of the Inspector General of the Department of Health and Human Services (OIG) has forced a company to divest itself of a subsidiary as a condition for the parent to avoid exclusion from federal health care programs. This extraordinary remedy may prove to be the beginning of a trend in health care settlements.
Clients should note that the OIG has taken this step in addition to the responsible corporate officer (RCO) prosecutions of four top officers. While the four executives remain to be sentenced, they also face, following sentencing, potential exclusion from federal health care programs.
Synthes, Inc. (Synthes) and its subsidiary Norian Corporation (Norian) agreed to a criminal, civil, and regulatory settlement with the Department of Justice (DOJ) and OIG on October 4, 2010. The government alleged a pattern of wrongdoing by Synthes and Norian pertaining to Synthes’s bone cement device, including conducting unauthorized trials on human subjects and making false statements to the government. According to the government, the bone cement was linked to several patient deaths. Norian pled guilty to a felony, conspiracy to impair and impede the lawful functions of the FDA and to commit crimes against the United States, and 110 misdemeanor counts of adulteration and misbranding. Synthes pled guilty to a single misdemeanor count of adulteration and misbranding. On the civil side, the government alleged that both companies violated the False Claims Act. Together, the companies will pay approximately $24 million in criminal and civil penalties. Synthes also agreed to a Corporate Integrity Agreement with OIG to govern its conduct for five years.
Unique to this settlement is a side Divestiture Agreement signed by OIG, Synthes and Norian. This agreement requires Synthes to sell all Norian’s assets and operations or dissolve the subsidiary by May 24, 2011.
Exclusion As a Cleaver
One of OIG’s most powerful enforcement tools is its ability to exclude companies or individuals from federal health care programs. Excluded entities may not participate in Medicare and other programs, effectively excluding them from the health care industry altogether. Mandatory exclusion (principally 42 U.S.C. § 1320a-7(a)) results when an entity has been convicted of certain enumerated crimes, which are generally serious and may involve federal health care programs. For lesser convictions or a finding of other misconduct, OIG may exercise its permissive exclusion authority under 42 U.S.C. § 1320a-7(b)).
In this case, Norian’s felony conviction will subject the company to mandatory exclusion, and Synthes will be subject to permissive exclusion for its misdemeanor conviction. The government’s charging decisions, and acceptance of the charges by the companies, put OIG and DOJ in position to compel Synthes to divest itself of Norian. Because Norian is subject to mandatory exclusion for at least five years, it will have little value to Synthes. And, because OIG has the capacity to essentially put Synthes out of business through permissive exclusion — but also the discretion to refrain from doing so — OIG has considerable leverage to achieve its desired result through negotiation. Indeed, the Divestiture Agreement was explicit in conditioning Synthes’s nonexclusion on its divestiture of Norian.
OIG agreed to withhold notice of intent to exclude Norian until after the deadline for Synthes’s divestiture of the company. Although the Divestiture Agreement states that the reason for this delay is to minimize disruption to beneficiaries, the delay also reflects the reality that owning an excluded company is fraught with risk. Under 42 U.S.C. § 1320a-7(b)(15), any individual who has a direct or indirect ownership or control interest in a sanctioned entity and who knows or should know of the action constituting the basis for the conviction or exclusion or who is an officer or managing employee of such an entity is subject to permissive exclusion. Thus, many individuals could face exclusion were Norian to become a sanctioned entity prior to divestiture.
Although one might expect that OIG’s delay in excluding Norian would remove the risk under (b)(15) until the date of exclusion, a close reading of the statute reveals that Norian may be a sanctioned entity before it is excluded. “Sanctioned entity” includes an entity that has been convicted of an offense that forms the basis of an (a)(3) exclusion, such as the offense to which Norian will be pleading guilty. OIG could, then, permissively exclude individuals with an indirect ownership interest in Norian who know of the action constituting the basis for the conviction, as well as officers and managing employees of Norian, as soon as Norian’s guilty plea is accepted by the court.1
Additional Specifics on the Divestiture
The Divestiture Agreement is not without some favorable provisions for Synthes. The parent must take “all prudent and reasonable steps” to divest itself of Norian, but it may also request an extension from OIG. Also, OIG explicitly agrees to meet with any “bona fide” prospective buyer of Norian’s assets and operations, presumably to provide that buyer with some assurance about OIG’s intentions.
For OIG’s benefit, Synthes must submit monthly reports between October 2010 and May 2011 on its progress in divesting itself of Norian. These status reports must include, at a minimum, identification of prospective buyers, the status of negotiations, the status of any regulatory approvals, the status of due diligence reviews, and any other material information, plus additional materials OIG may request. If the divestiture deadline passes without Synthes’s divestiture of Norian or an extension, OIG may impose a stipulated penalty of $10,000 a day on Synthes. And, in the event that OIG does issue an exclusion pursuant to the Divestiture Agreement, the agreement prohibits Synthes and Norian from seeking administrative or judicial review of the exclusion in any court and requires the companies to waive their statutory right to “reasonable notice” of exclusion pursuant to 42 U.S.C. § 1320a-7(c)(1).
A final twist: The Divestiture Agreement states that if the divestiture does not take place by the deadline, OIG “may” exclude Norian “in its sole discretion” pursuant to the mandatory exclusion authority of 42 U.S.C. § 1320a-7(a)(3). However, it has long been OIG’s position — repeatedly affirmed by administrative tribunals and federal courts — that mandatory exclusion must follow a conviction that forms the predicate of mandatory exclusion, with the agency having no discretion to forego mandatory exclusion. It is unclear how OIG has reconciled these two contradictory positions.
In addition to the charges filed against Synthes and its subsidiary, the grand jury also charged four corporate officers with misdemeanor violations of the Food, Drug and Cosmetic Act. These officers held the following positions during the relevant period: president of Synthes North America (a subsidiary of Synthes); president of Synthes Spine; vice president of operations for Synthes; and director of regulatory and clinical affairs for Synthes. Each was specifically charged with violating the Food Drug and Cosmetic Act as an RCO and each admitted in plea colloquy that he held such a position; one officer entered a nolo contendere plea to the misdemeanor charge. Although the pleas were entered in the summer or 2009, the four officers have not yet been sentenced.
While the federal court proceedings remain pending for these four officers, it can be anticipated that once the court proceedings have concluded, the OIG will then decide whether to use its discretionary exclusion authority to exclude these four officers from further participation in federal health care programs. In the recent past, the OIG has determined to exclude high-level executives employed by a drug manufacturer following the misdemeanor convictions of those individuals.
Future Outlook for Companies
With this Divesture Agreement, a new chapter is being written for pharmaceutical and device companies facing federal enforcement actions. First, unless and until OIG’s measure is successfully challenged, forced divestiture becomes a distinct possibility in future settlements. Norian is a relatively small subsidiary of Synthes, but in future cases, the subsidiary to be divested might be a large or even critical component of the overall corporation. OIG plainly has the power and inclination to fundamentally reshape health care businesses through enforcement actions. For this reason, it will be more important than ever for companies to conduct careful due diligence in assessing the compliance of business components. It also will be advisable, in some cases, for companies to divest prematurely. If there is a threat that OIG will force divestiture of a subsidiary, the parent will be in a much stronger selling position vis à vis potential buyers if it is selling the subsidiary or assets and operations on its own volition, rather than on a tight timetable with exclusion looming.
Second, OIG is clearly signaling that is prepared to wield its exclusion authority in unconventional ways. This could mean that divestiture is just the beginning. For example, senior OIG officials have stated that the agency may force companies to waive exclusivity, the statutory or patent protections that permit companies to market a drug for a period of time without generic competition.2 The agency may also elect to force companies to disassociate from individuals, i.e., fire top or key individuals that OIG believes have played a role in the conduct at issue, as part of a resolution with the corporation that allows the corporation to escape exclusion. Companies need to evaluate the possibility of such consequences at the outset of an investigation and build such considerations into their defense strategies earlier than ever before. In some cases, such consequences may make settlement a practical impossibility, forcing companies to litigate.
Third, the days of OIG excluding shell companies may be coming to an end. In the past, when mainline pharmaceutical and device companies or providers faced a felony that would require mandatory exclusion, they were sometimes able to have a subsidiary take the plea and be excluded. In turn, the operational company would participate in the civil settlement and be subject to a conduct-modifying Corporate Integrity Agreement with OIG. To be sure, a version of this has transpired in the Synthes/Norian case-after all, Synthes is not taking a felony and will not be excluded if it keeps up its end of the agreement-but unlike past pleading subsidiaries, Norian is a real subsidiary with nearly 100 employees. Assistant Inspector General of the Department of Health and Human Services Greg Demske acknowledged the shift in an interview with The New York Times: “In the past a lot of these cases have been resolved with the conviction of basically a shell subsidiary where our exclusion had no impact on the company’s business,” he said. Here, however, “[w]e didn’t allow the parent company to essentially shift operations of the convicted entity to another part of the corporate family.”
1 For exclusion purposes, “conviction” can occur when a guilty plea is accepted by a court. 42 U.S.C. § 1320a-7(i)(3).
2 See Remarks by OIG Chief Counsel Lew Morris, PBS Nightly Business Report (Mar. 18, 2010).