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December 15, 2014

Healthcare transaction scrutiny is becoming increasingly more common in today’s complex regulatory environment. Deals such as the consolidation of physician practices, hospital mergers and acquisitions, and hospital purchases of physician groups and specialty clinics all require a high level of valuation and healthcare compliance expertise to ensure that all state and U.S. regulatory requirements have been met.

The failure to comply with the necessary valuation and healthcare regulatory requirements can result in significant penalties. In the past four years alone, over $300 million in fines have been calculated to health providers as a result of improper assessments of values stemming from actual and perceived physician referrals, as well as unintended physician benefits. The U.S. Justice Department and the Office of the Inspector General have taken a hard stand requiring healthcare providers to properly assess transactions with respect to Fair Market Value (FMV) and commercial reasonableness as required by various regulations.

There are several key regulations that healthcare entities (or consultants representing these entities) should be aware of; if not followed, penalties can be significant.

  • Internal Revenue Code Section §501(c)(3) prohibits a tax-exempt organization from using any of its income or assets to unduly benefit any person who has a close relationship with that organization. For example, in the case of a tax exempt healthcare system, a physician on staff at the hospital would be considered to have such a relationship with the hospital. Any payments to the physician must be at FMV for the services or assets provided to avoid the implication of a private benefit and / or private inurement transaction.
  • Section 1128B of the Social Security Act, otherwise known as the anti-kickback provision, indicates: Whoever knowingly and willfully offers / pays or solicits / receives any remuneration (including any kickback, bribe, or rebate) directly or indirectly, overtly or covertly, in cash or in kind – (a) in return for referring an individual to a person for the furnishing (or arranging for the furnishing) of any item or service for which payment may be made in whole or in part under a Federal health care program, or (b) in return for purchasing, leasing, ordering or arranging for or recommending purchasing, leasing or ordering any good, facility, service or item for which payment may be made in whole or in part under Federal health care program – shall be guilty of a felony and upon conviction thereof, shall be fined or imprisoned.
  • Stark Law (Section 1877 of the Social Security Act) prohibits a physician from making referrals for certain designated health services to an entity with which he or she (or an immediate family member) has a financial relationship (ownership, investment, or compensation), unless an exception applies. However, there is no exception for technical violations even though such violations may be harmless. The primary concern for healthcare organizations is that once any violation occurs, the government views all referrals thereafter as prohibited.
  • False Claims Act imposes penalties on persons and companies who defraud governmental programs.
  • Under various financial accounting standards (mainly ASC 958-805 – dealing with not-for-profit mergers and acquisitions and ASC 805 – dealing with business combinations) all assets and liabilities must be recorded at fair value.

Under all these regulations and standards, the following valuation concepts and definitions need to be considered and documented.

  • Commercial Reasonableness: In 1998, – Centers for Medicare & Medicaid Services (CMS), in its Stark proposed rule, interpreted "'commercially reasonable' to mean that an arrangement appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals." Later, in the preamble to the Stark Phase II interim final rule, CMS gave a definition to commercially reasonable as "an arrangement will be considered 'commercially reasonable' in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential designated health services (DHS) referrals."
  • The idea of FMV and Fair Value (FV). The general gist is that the value of an asset must be determined in arms-length transactions that are consistent with the general market value between well-informed parties, in an open and unrestricted market when neither is under compulsion to buy or sell. It should be noted that there are some nuances depending on whether the FMV is examined under the Stark Law, the Code of Federal Regulations, or under the Internal Revenue Code which would need to be examined on a case-by-case basis.

As noted above, the legal and regulatory environment is such that all financial arrangements between healthcare entities (business and / or physicians) will be scrutinized for the transfer of potential excess benefits. The implication is that there are hidden payments for referrals or potential abuses of government programs.

Examples of common mistakes that have been observed in regards to commercial reasonableness and FMV and FV include: (1) mistaking investment value for FMV and FV; (2) failing to analyze operational data; (3) failing to consider impacts of Medicaid and Medicare reimbursement issues; (4) disaggregating business and compensation valuations; (5) failure to properly consider MGMA and AMGA survey data; (6) lack of understanding value-based-payment models; (7) benchmarking improperly; (8) incorrectly utilizing valuation approaches; (9) assuming statistically flawed compensation levels; (10) incorrect use or application of lack of control and lack of marketability discounts and control premiums; and (11) not understanding the impact of the Affordable Care Act.

The good news is all of these issues can be addressed before a transaction is completed, reducing legal, regulatory, and compliance risk. Normally, the best defense of commercial reasonableness and FMV and FV issues is a well thought out analysis provided by the attorney structuring the deal and a healthcare valuation professional documenting the transaction.

While the regulatory landscape is challenging, compliance for healthcare transactions is essential. Companies have paid a price for improper structures and not following government regulations. A healthcare valuation professional can assist a company in meeting all of the compliance requirements and allow the business to operate without extra scrutiny from federal oversight.