Physician Relationships with Medical Supply and Distribution Companies Under Scrutiny

by | Aug 9, 2012


Increased federal investigation into alleged inappropriate arrangements between the pharmaceutical and medical device industries and physicians has led to significant scrutiny over certain “distribution” arrangements. Most recently, physician-owned distributorships (“PODs”) have come under attack. Inspector General Levinson recently outlined plans for the Office of Inspector General’s (“OIG”) nationwide study to determine the extent to which PODS supply spinal implants to hospitals and will evaluate, among other things, the proliferation of PODs and whether they offer any cost savings to hospitals. Proponents argue that PODs can result in reduced pricing on medical devices to hospitals because of the lower distribution costs and increased quality of products, including customization. Opponents, however, argue that PODs are nothing more than a mechanism used to reward physicians for referrals. PODs are just one of several ventures that have attracted physicians in the medical device supply chain. There are a number of laws and regulations governing these arrangements.

Anti-Kickback Statute

The federal Anti-Kickback Statute proscribes the offering, payment, solicitation or receipt of any remuneration in exchange for a patient referral or referral of other business for which payment may be made by a Federal health care program, including Medicare and Medicaid. Violations of the Anti-Kickback Statute can result in significant criminal penalties, civil penalties of up to $50,000 for each violation, as well as imprisonment. The primary concern PODs and other medical device company ventures present under the Anti-Kickback Statute is whether the compensation paid to the physicians (or the venture) or dividend or distribution payment from such a venture to the physicians constitutes disguised remuneration for referrals.

In connection with the Anti-Kickback Statute, the government historically has had a policy of increased scrutiny of joint ventures and other transactions between and among health care providers and potential referral sources in order to reduce potential fraud and abuse of the Medicare and Medicaid programs. In 1989, and again in 1994, the government, through the OIG, published a Special Fraud Alert that discusses features of joint venture arrangements that may violate the Anti-Kickback Statute. The Special Fraud Alert distinguishes between “legitimate” joint ventures and those that are “suspect” under the Anti-Kickback Statute (i.e., those where remuneration paid to physician-investors in exchange for referrals may be “disguised” as profit distributions). As noted by the OIG, suspect joint ventures may be intended not so much to raise investment capital legitimately to start a business, but to lock-up a stream of referrals from the investors and to compensate them indirectly for their referrals.

The concern with PODs is that the venture may provide little risk to the physician with significant returns and the opportunity to invest in the venture is related to physician referrals to the hospital at which the physician maintain privileges and performs surgeries. Given the severity of the criminal and civil sanctions under the federal Anti-Kickback Statute, physicians need to carefully structure these arrangement and ensure that any such arrangements comply with applicable safe harbor regulations. PODs would need to be structured to comply with the small investment interest safe harbor. To obtain protection under this safe harbor, a POD 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 (the “Investment Test”).
  • 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 “Revenue Test”).

These strict requirements may significantly impair the ability of a POD to achieve safe harbor protection since all of the POD’s owners (if physicians) may be in a position to refer and generate revenue for the POD.


Generally, Stark prohibits a physician (or immediate family member) who has a financial relationship with an entity from making referrals to that entity for the furnishing of designated health services for which payment may be made under the federal health care programs, unless an exception or safe harbor is satisfied. PODs implicate Stark where there exists a financial relationship between the POD and hospitals and the physicians-owners of the POD are making referrals to the hospitals for the provision of designated health services, including inpatient and outpatient hospital services.

Under the POD model, an indirect compensation arrangement would exist between the physician-owners and hospitals to which they refer. Accordingly, physician-owners would be prohibited from referring government reimbursed patients for inpatient and outpatient hospital services to those hospitals in which a financial relationship exists unless an exception is satisfied. The exception applicable to such an arrangement would be the indirect compensation exception. Critical to satisfying the exception is that payments made by the hospital to the PODs are set at fair market value and not calculated based on volume or value of referrals and the arrangement does not violate the federal Anti-Kickback Statute.

Group Purchasing Organizations

Other businesses focused on cost reduction are purchasing agents in the medical supply chain. GPOs are purchasing agents authorized to act for their members, thus allowing them to enter into agreements with manufacturers through which items and supplies can be purchased by members at competitive prices. Since GPOs are funded by fees received from manufacturers, they are able to furnish these services at little cost to their members.

Given their tremendous benefits, physician groups and hospitals looking for purchasing power, alternative revenue streams and value adds have begun to invest in and develop their own specialty GPOs. These arrangements, however, are not without risk, since many of the payment arrangements often implicate the federal Anti-Kickback Statute There are three payment streams in the GPO-medical supply chain that generally implicate the federal Anti-Kickback Statute and necessitate safe harbor protection, including: administrative fees from suppliers to the GPO, discounts or rebates from suppliers to GPO members and dividend or distribution payments to GPO member-owners. Dividend or distribution payments may be the most difficult to protect. The safe harbor available to protect distribution payments is the small investment interests safe harbor discussed above. To obtain protection under this safe harbor, the GPO would have to be carefully structured to comply with the Investment and Revenue Tests (as well as the other requirements of the safe harbor).

False Claims Act

The False Claims Act prohibits a physician from submitting or causing to submit a false or fraudulent claim for payment to the government. The False Claims Act could be implicated when claims for payment are submitted based on a false certification that the physician submitting the claim has complied with all applicable laws and regulations. Where claims are submitted pursuant to an otherwise illegal arrangement (for example, an arrangement that violates the federal Anti-Kickback Statute or Stark), it is considered a false claim. Sanctions for violating the False Claims Act include treble damages, fines and administrative penalties.

Even if physician-owned distribution companies comply with applicable safe harbors and exceptions, it is unclear whether the OIG (and the Centers for Medicare and Medicaid Services (“CMS”)) will conclude that they are legitimate business ventures, although properly structured GPOs appear to pass muster. Both OIG and have expressed concern over PODs. Opponents argue that the POD model is not a valid business model and PODs are nothing more than sales agents for manufacturers, which cannot comply with safe harbor. Additionally, under the “opportunity theory”, espoused by the OIG in one of its advisory opinions, opponents have also taken the position that since hospitals are providing physicians with an “opportunity” to generate a fee, even if the arrangement satisfies safe harbor, it is contrary to the statute and cannot be protected. We will have to wait and see where the regulators end up on these critical issues. Until then, however, physicians should always look to OIG’s and CMS’ guidance (and applicable safe harbors) when structuring health care ventures.

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