Buy High, Sell Low, and Restrict Competition: The Allegations Underlying the Government’s Case Against DaVita and the Implications of the Settlement

On October 22, DaVita HealthCare Partners Inc., one of the nation’s largest dialysis companies, and its wholly owned subsidiary, Total Renal Care, Inc. (collectively, “DaVita”), agreed to pay $389 Million to settle allegations that DaVita violated the federal False Claims Act (FCA) 31 U.S.C. §§3729 et seq. by inducing physicians to refer business to DaVita in violation of the federal Anti-Kickback Statute (AKS) 42 U.S.C. §1320a-7b(b) and then submitting claims for reimbursement under Medicare or Medicaid despite these violations. The settlement amount does not include amounts to be paid to the whistleblower, which were still under negotiation at the time of settlement. The complaint, filed by a former DaVita senior financial analyst turned qui tam relator, alleged that DaVita induced physicians to refer business to its facilities and monetarily rewarded those who provided such referrals by (a) selling them shares in existing DaVita dialysis centers for below-market rates, (b) buying shares in the physicians’ dialysis centers for above-market rates, (c) giving physicians kickbacks masked as profits from joint ventures, and (d) paying physicians to refrain from building competing dialysis centers.   

As a part of the settlement, DaVita entered into a Corporate Integrity Agreement (CIA) with the Office of Inspector General of the Department of Health and Human Services (OIG). Among other things, the CIA requires that DaVita unwind 11 of its joint ventures during the first year of the CIA, either by selling its interests in such joint ventures or by purchasing the interests in such joint ventures that are held by the nephrologists or nephrology practices.

Prohibition at Issue

The AKS makes it a felony to knowingly and willfully offer or pay any remuneration (including any kickback, bribe, or rebate) directly or indirectly, overtly or covertly, in cash or in kind, to any person to induce such person to refer 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.¹ The statute not only prohibits obvious conduct such as a direct payment to a physician in exchange for a referral, but also prohibits less conspicuous forms of payment such as providing items or services at less than fair market value or investment arrangements in which a physician has a substantial financial incentive to refer his or her patients to the entity that the physician has invested in.  

The OIG, which is responsible for interpreting the AKS, acknowledges that certain relationships with referral sources (that may otherwise be construed as violating the AKS) pose a low risk of fraud and abuse and, as such, has promulgated safe harbor regulations to the AKS. In these regulations, the OIG articulates criteria for referral source relationships that, if met, can provide protection against an allegation that a relationship violate the AKS.² The AKS safe harbor regulations include a safe harbor for investment interests³ that could apply to dialysis joint ventures with referral sources; however, the government’s complaint alleged that DaVita’s joint ventures do not meet all the required criteria of the investment interest safe harbor.

The OIG has indicated particular concern about certain types of transactions and their likelihood of violating the AKS, including (1) transactions wherein referring physicians are compensated through excessive payments for an interest in the physician’s practice by an entity that is in a position to receive ongoing referrals from the physician,⁴ (2) transactions wherein physicians receive compensation for entering into noncompetition agreements,⁵ and (3) joint ventures in which a referring physician owns an interest in an entity to which he or she refers patients.⁶ The OIG provides that these types of transactions should be subject to heightened scrutiny when it comes to determining whether they violate the AKS. In its amended complaint against DaVita (the “Complaint”), the government alleged that DaVita had engaged in all three of these troubling types of transactions, and that such arrangements violated the AKS and were not sanctioned by any AKS safe harbor.

Allegations

The government’s Complaint alleged that DaVita’s business has been fundamentally dependent on its relationships with referring physicians and that in order to bolster its business, DaVita endeavored to lock in referrals by engaging in conduct violative of the AKS, namely (1) purchasing interests in dialysis centers owned by referral sources for purchase prices well above fair market value, (2) selling interests in DaVita dialysis centers to referral sources at purchase prices well below fair market value, and (3) using noncompetition agreements to secure referrals from physicians to whom DaVita had paid kickbacks. The Complaint referred to DaVita’s tactic as its “Buy High/Sell Low” strategy, which the government claimed DaVita employed to mask illegal kickbacks to physicians and to secure a steady flow of referrals from them.

Selling Low

The Complaint alleged that DaVita manipulated its financial models in order to undervalue interests in DaVita-owned dialysis centers that it proposed to sell to physician referral sources. Allegedly, DaVita accomplished this primarily by applying a financial algorithm referred to as HIPPER (in other words, “High-Paying Patient”) compression. This algorithm assumes that, within three years, private payors that pay the most for dialysis will be able to negotiate lower reimbursement rates, and it thus assumes that no insurer will pay more than $750 per treatment beginning in year three of the model. The Complaint claimed that HIPPER compression is an overly conservative valuation methodology and cited an email from DaVita’s chief financial officer, which stated that the assumption is not realistic. Additionally, in an effort to emphasize the disparity between the valuation methods that DaVita used in buying and selling interests in dialysis centers, the Complaint noted that HIPPER was overridden when DaVita purchased interests from referral sources, and sometimes was not used at all in acquisitions so as to avoid artificially driving down the price of interests that DaVita was buying in dialysis centers.

Buying High

The government alleged that DaVita routinely manipulated its financial models in order to over-value interests that it would buy in dialysis centers owned by referring physicians. The Complaint alleged that DaVita sometimes accomplished this by manipulating down the estimated cost per treatment (for example, by significantly reducing the G&A cost estimate from the level used in DaVita’s internal modeling, which does not increase with inflation or by using artificially low values for expected bad debt), which unrealistically inflated expected profits and increased the projected value of a dialysis center. The Complaint alleged that DaVita does not engage in these types of manipulations when selling interests to referring physicians. Another way in which the Complaint alleged that DaVita increased projected revenues was by using an assumption referred to as the “HIPPER bus,” which assumes that a mythical bus full of high-paying patients with private insurance will routinely drop patients off at the dialysis center. The Complaint also provided that, in order to increase the estimated value of dialysis centers it would acquire from physician referral sources, DaVita would increase the amount of Epogen (a very expensive biologic) that each patient was projected to receive, thereby increasing expected revenue per treatment, and increasing the terminal value.

According to the Complaint, the result of DaVita’s alleged Buy High/Sell Low strategy was that it had paid on average more than seven times a center’s expected future annual EBITDA for dialysis centers that it had purchased from physicians and had charged less than three times a center’s annual historical EBITDA when selling dialysis centers to physicians. The Complaint alleged that DaVita hid this stark variance by selectively using third-party valuations and by providing already manipulated data to its third-party appraisers.

Non-Competition Covenants

In addition to paying artificially high prices for dialysis center acquisitions and receiving below-market prices for sales of dialysis centers to referring physicians, the Complaint alleged that “DaVita fraudulently ensures that it will receive the referrals from a physician or group to whom it pays kickbacks by requiring them to execute Medical Director Agreements with non-competition provisions.” Though it is well-known that these noncompetition agreements play a part in nearly every dialysis joint venture, the Complaint suggested that the agreements played too integral a role in DaVita’s transactions and that they were designed to discourage DaVita’s medical directors from referring patients to competing centers by ensuring that such physicians would have no financial incentive to do so. The Complaint also noted that DaVita would pay varying amounts for dialysis centers on the basis of the number of physicians who would be bound to refer to DaVita through noncompetition agreements. The Complaint cited an email from a DaVita Vice President that tied the price that DaVita would pay for an acquisition to the number of physicians so bound.

Return on Investment

The government’s Complaint also claimed that the extraordinarily high rate of return that physicians earned on their joint ventures with DaVita was further evidence of the alleged kickbacks, which ranged from 120 percent to 220 percent or more within the first two years, not including the gain in value of the shares due to the below-fair-market purchase price. The Complaint stated that, when compared to expected returns on investment for dialysis centers, these returns were disproportionately large and constituted an “ongoing stream of kickbacks.”

Implications

Pursuant to DaVita’s CIA with the OIG, an independent monitor selected by the OIG will be retained by DaVita to oversee, approve, and report on certain compliance-related matters, in particular, arrangements between DaVita and health care providers⁷ that involve the provision of anything of value (although such arrangements do not include single-patient agreements, stat lab agreements, or transfer agreements that DaVita enters into with a hospital or related corporate entity). 

With regard to existing DaVita joint ventures and medical director agreements, the terms of the CIA require that DaVita send to each of its joint venture partners and to each of its medical directors a notice that states that (1) each recipient is free to refer patients to non-DaVita-owned dialysis centers; (2) DaVita will not enforce any patient-related nondisparagement or nonsolicitation clauses contained in any existing agreements; and (3) in connection with joint venture dialysis centers formed as a result of DaVita selling a portion of its interest in such center, DaVita will not enforce the investment noncompetition provisions that it may have in the related joint venture and medical director agreements. Given that DaVita is not permitted to enforce any patient-related nondisparagement or nonsolicitation clauses in its existing agreements, it should also follow that its agreements will not contain any of those provisions in the future. Additionally, the third element of the required notification seems to suggest that a physician practice that purchased an interest in a DaVita-owed dialysis center and that agreed to be bound by DaVita’s standard noncompetition provision prohibiting investment in competing centers within a certain designated radius may nevertheless now invest in or be a medical director of a competing center, and that DaVita will not seek to enjoin the investment or sue the practice for a breach of its noncompetition obligations.

As a result of the CIA, all of DaVita’s joint venture transactions with physicians and other health care providers⁸ will be subject to enhanced scrutiny over the next five years. Additionally, under the terms of the CIA, for the next five years DaVita is not permitted to enter into partial divestitures of its interest in DaVita-owned facilities, except in certain enumerated scenarios (e.g., selling an interest in a DaVita dialysis center to a multi-specialty practice or hospital is permitted). Because DaVita settled without any admission of wrongdoing, it is difficult to say whether this case established any clear rules regarding what conduct definitively constitutes unlawful kickbacks in violation of the AKS. It is likely that the case will result in DaVita’s partners seeing more consistently applied valuation methodologies. This could result in DaVita paying lower purchase prices for interests in physician-owned dialysis centers, charging higher sales prices for interests in DaVita-owned dialysis centers, or both. 

Less clear is whether DaVita will be forced to, or will choose to, take a different approach to noncompetition agreements when it purchases interests in dialysis centers owned by referral sources. The government did cite DaVita’s alleged willingness to pay more in transactions when more referral sources would be bound by noncompetition agreements as support for its argument that DaVita was paying illegal kickbacks. However, sale-of-business transactions, whether in the dialysis industry or otherwise, commonly involve noncompetition covenants binding on the seller of a business and, absent other aggravating factors, this case does not seem to establish that imposing such covenants on physicians who are selling interests in their dialysis centers necessarily violates the AKS.

 

¹ See 42 U.S.C. § 1320a-7b(b)(2)(A).

² See 42 C.F.R. § 1001.952.

³ See 42 C.F.R. § 1001.952(a)(2).

⁴ See December 22, 1992 HHS OIG Opinion Letter.

⁵ See Id.

⁶ HHS OIG Advisory Opinion 97-5, at 7 (October 6, 1997).

⁷ Under the CIA, “health care providers” include nephrologists, physician practices, hospitals, and related corporate entities that are DaVita joint venture partners or parties to a letter of intent to become DaVita joint venture partners, and DaVita joint ventures.

It should be noted that Exhibit E of the CIA lists a subset of DaVita joint venture entities that are subject to a more limited set of requirements under the CIA.

⁸ See Id.