In a recent Advisory Opinion, the U.S. Department of Health and Human Services’ Office of Inspector General (OIG) determined that an arrangement involving certain physicians who have an ownership interest in a medical device company that manufactures products that may be ordered by the physician owners (the “Company”) was not considered a suspect physician-owned distributorship. Despite concluding that the arrangement implicated the federal Anti-Kickback Statute and generated prohibited remuneration, the OIG relied on specific aspects of the arrangement in determining that the risk of fraud and abuse was significantly reduced and that administrative sanctions would not be imposed.

By way of background, the OIG issued a Special Fraud Alert in 2013 that set forth its historical concern regarding physician-owned entities that derive revenue from selling implantable medical devices for use in procedures that their physician owners perform at hospitals or ambulatory surgery centers (ASCs). Arrangements that can be particularly concerning to the OIG include those that require investors who cease practicing in the service area to divest their ownership interests, or that condition physician referrals to hospitals or ASCs on the facility’s purchases of the physician-owned entity’s devices. Through this lens, the OIG analyzed the current arrangement.

Under the proposed arrangement, three physicians (A, B, and C) are orthopedic surgeons and members of the same medical group (“Medical Group”). Physician A is a hand and upper extremity surgeon who formed the Company to develop upper extremity surgical technologies that he invented into medical devices that the Company sells in the U.S. and elsewhere. Physician B is Physician A’s daughter, and Physician C is Physician B’s husband. The Company granted the majority ownership interest in the Company to Physician A and his spouse, who later contributed their majority ownership interest to two irrevocable trusts—one trust created by Physician A that benefits his spouse and their children, including Physician B, and another trust created by Physician A’s spouse that benefits Physician A and their children, including Physician B (the “Trusts”).

Physicians A and B are the only physicians with an ownership interest in the Company who order products from the Company, and Physician C is the only immediate family member of an individual with an ownership interest in the Company who orders products from the Company. As of the date of the advisory opinion, the Company had not made any profit distributions to Company owners except annual distributions to cover each owner’s income tax obligation deriving from the owner’s ownership interest. Future distributions to owners would be to all owners in direct proportion to their investment interests in the Company. Distributions to the Trusts are reduced by the amount of revenue generated by orders from any physician or Medical Group member that would otherwise be owed to the Trust, which is referred to as the Carve-Out Amount.

The Physicians also certified that while they may order Company products for surgeries they personally perform at hospitals and ASCs that permit the use of Company products, and may recommend Company products to others, the Physicians will not otherwise attempt to influence hospitals or ASCs to purchase the Company’s products.

In upholding the arrangement, one of the aspects that the OIG noted was that the arrangement dilutes the financial incentives the Physicians may have to order the Company’s products by reducing any distributions to the Trusts by way of the Carve-Out Amount. The Company also certified that it has not reserved the right to repurchase the Trusts’ ownership interest, and that it will not have any requirement that the Trusts divest their ownership interests if any of the Physicians cease practicing medicine or ordering from the Company. On the whole, the OIG found that the Physicians and their Medical Group partners are transparent about the Trusts’ ownership interest in the Company.

Other factors that reduce the risk of fraud and abuse, in the OIG’s view, are that the Company does not have characteristics of a shell entity, including that the Company develops medical products that are sold domestically and internationally; employs dozens of individuals; and is responsible for several operations such as development and testing of products, marketing, inventory management, and submitting regulatory filings to the U.S. Food and Drug Administration and international regulatory bodies.

Significantly, the devices sold or manufactured by physician-owned entities generated less than one percent of all gross revenue generated from Company sales in the U.S. in each of the last three years. Except for a slight increase from 2020 to 2021, the percentage of orders by the Medical Group steadily decreased over the past seven years, even as the Company’s sales expanded to more physicians who are ordering the products and who do not have ownership interests in the Company.

Lastly, the OIG noted that the Physicians’ various disclosures to patients, facilities, and the public further decreased the risk of fraud and abuse. These disclosures include notices to patients with names of alternative medical device companies in which neither the Physicians nor any of their family members have ownership interests.

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