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OIG Advisory Opinion 07-05: How a Fair Market Value Deal Can Place Hospital-Physician Joint Venturers at Risk of Kickback Violation

Jun.21.2007

In an Advisory Opinion released June 19, 2007, (OIG Advisory Opinion No. 07-05), the Department of Health and Human Services Office of Inspector General (“OIG”) made clear its disdain for the partial sale of physician ownership interests in an existing ambulatory surgery center (“ASCs”) to a local hospital. The impact of this opinion on the future of hospital-physician ASC ownership ventures will no doubt be the subject of much rumination in the health care industry in the months to come. As in any Advisory Opinion, however, the particular facts at issue are crucial to obtaining a full understanding of the OIG’s analysis. Here, those facts reflect a proposed transaction with particularly unique characteristics which all impacted upon the OIG’s decision. Nonetheless, the transactional value and potential transferability of physician ownership interests in ASCs – at least to an acquiring local hospital partner – may well have been diminished by this Advisory Opinion.

OIG Advisory Opinion No. 07-05 addresses a factual scenario involving a physician-owned, multi-specialty ASC, whose ownership is comprised of three orthopedic surgeons, two gastroenterologists and two anesthesiologists. The orthopedic surgeons own 94% of the equity in the ASC, while the other physicians collectively hold a 6% ownership interest. In the proposed scenario, the orthopedic surgeons would sell 40% of the ownership interests in the ASC to a local hospital, at a price the parties certify would be “fair market value.” The payments would be made directly to the physician owners, not to the ASC itself.

Acknowledging that the compensation to be paid for the physicians’ ownership interests would be fair market value, the OIG was nonetheless troubled that the amount the hospital would pay the surgeons for the 40% interest exceeded the amount that the surgeons had originally paid for their ownership at the time of their own investment. As a result, the OIG noted that while both the hospital and the physician investors would receive a return on investment proportional to their respective ownership interests, “distributions of profits and losses based on relative equity ownership interests would not be directly proportional to capital invested.” Based on this observation, the OIG expressed concern that the orthopedic surgeons would receive a higher “rate of return” on their remaining 54% interest than the hospital would realize on its recently purchased 40% interest.

If this basic economic reality – which will always be the case when a later purchasing investor acquires its ownership interests in a successful, existing ASC at “fair market value” – is troublesome to the OIG, it is impossible to see how the purchase of an ownership interest in an existing, successful ASC could ever be both a) accomplished at fair market value and b) result in the same rate of return for the new owner as it would for any other owner purchasing an ownership interest at fair market value at any other moment in time. By adopting a “rate of return”-based analysis in lieu of a “return proportional to ownership” analysis, it is difficult to understand what acquisition terms would ever satisfy the OIG. On reflection, this is perhaps the point of the Advisory Opinion, especially since a hospital and referring physicians are involved.

Several other seemingly unremarkable, normal course aspects of the proposed transaction were also concerning to the OIG. For example, the OIG focused on the fact that only the orthopedic surgeons were selling ownership interests in the ASC, and that the gastroenterologists and the anesthesiologists were not. This fact, along with the appreciated price of the ownership interest, suggested to the OIG that perhaps “one purpose” of the hospital’s purchase price was to reward the more lucrative referrers in the ASC joint venture. It was not clear whether that potential reward might have been for future ASC or hospital referrals, but this did not technically matter to the OIG – nor did the fact, once again, that the purchase price for the shares was certified to be fair market value.

The OIG was also troubled by the fact that the hospital would be obtaining its ownership interest in the ASC by paying cash directly to the orthopedic surgeons as opposed to investing capital into the ASC entity. This concern, too, is hard to understand. What is the ultimate economic difference between this form of acquisition and a corporate entity acquiring existing ownership interests, converting these interests to treasury shares and selling new shares to the new owner, all at fair market value, with a resultant dissolution in previous ownership interests? We question what more the OIG could be asking for here, when the parties propose a transaction involving a single, direct, fair market value sale of interests for cash. We note, while not of course relevant to the legal issue, the irony that the proposal would seem to otherwise fall squarely within at least two Stark exceptions (including the “isolated transaction” exception), yet still raise anti-kickback concerns before the OIG.

The OIG acknowledges that none of these considerations, standing alone or in combination, necessarily evidenced fraud or abuse. In the end, however, the OIG could not get past the differential in acquisition costs between the orthopedic surgeons and the hospital, which would result in financial gain “to a subset of physician investors whose [ongoing] referrals may be particularly valuable” to the ASC (and, presumably, the hospital itself).

The sponsors of this Advisory Opinion may well have thought the fact pattern submitted to the OIG contained sufficient protections to obtain the OIG’s blessing – particularly where a single, one time transaction, involving a certified fair market value purchase price, was involved. The OIG, however, has long been wary of any form of hospital-physicians combination, and could not find comfort in this proposal either. In the end, it appears this overriding concern, which now seems to have risen to an intractable policy level, carried the day.

This said, it is nonetheless important, to place the narrow nature of the Advisory Opinion in context. First, as with any Advisory Opinion request, the sponsors were seeking the OIG’s blessing of the proposal, a high bar indeed; that the proposal was not condoned, nor deemed to fall within a safe harbor, but instead considered to involve “potential risk,” does not, of course, make the transaction illegal. Second, as noted above, the facts here are particularly important. This transaction involved a) the purchase of ownership interests by a hospital b) from a subset of existing physician owners, c) which physician owners would remain as referrers to the ASC and, presumably, the hospital itself. Thus, as we caution when a “positive” Advisory Opinion is issued, this Advisory Opinion, too, must technically be considered to apply only to the parties and facts involved.

In sum, Advisory Opinion 07-05 may well serve as the most recent harbinger of heightened government concern over hospital-physician financial relationships. All such relationships naturally carry some risk and must be carefully analyzed and constructed. Certainly, and more specifically, hospital acquisitions of equity interests in physician-owned ASCs, where the selling physicians remain active in and continue to refer to the ASC, have now become particularly difficult to properly craft.

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