On Feb. 16, the U.S. Department of Justice (DOJ) filed a complaint intervening in a qui tam action that two former employees brought against their former employer, Patient Care America (PCA), a compounding pharmacy located in Pompano Beach, Florida, complaint filed by the U.S. Department of Justice, United States Medrano v. Diabetic Care Rx, No. 15-cv-62617 (S.D.FL.). In its complaint, the DOJ alleges unjust enrichment, payment by mistake, and violations of the False Claims Act, 31 U.S.C. Sections 3729-33.

In addition to PCA, which the relators named as a defendant, the DOJ named Patrick Smith and Matthew Smith who acted as PCA's CEO and pharmacist, respectively. The DOJ also named Los Angeles-based private equity firm, Riordan, Lewis & Haden (RLH). RLH is the manager of a private equity fund called RLH Investors III, which has owned a controlling stake in PCA since July 15, 2012. In addition, two RLH partners, Michel Glouchevitch and Kenneth Hubbs, served as officers and directors of both PCA and a holding company with an ownership interest in PCA.

Before RLH invested in PCA, the latter's business focused on providing patients with renal nutritional therapy. According to the DOJ's complaint, PCA began losing revenue soon after RLC became involved with PCA due to changes made to Medicare's reimbursement of such therapy. As a result, RLH pushed PCA into a more profitable line of business in an effort to increase revenue, thereby increasing the value of PCA for RLH's anticipated sale of PCA within five years, the DOJ claims.

The new line of business was the sale of compounding pain creams, scar creams, and vitamins. In the context of pharmaceutical services, “compounding” is a method of combining different ingredients into a solution or compound designed by the prescribing doctor to address the specific needs of the patient. The goal is to create bespoke medicine based on the patient's unique condition.

The DOJ alleges that PCA's compounding goal was different. PCA's reimbursement claims were submitted to TRICARE, a federal-funded health plan provider intended to serve active and retired military personnel and their families. At the relevant time, TRICARE's policy was to reimburse for each of the individual ingredients in a compound. The DOJ alleges that PCA improperly manipulated its compounds with an eye toward maximizing the reimbursement in light of TRICARE's per-ingredient policy rather than toward maximizing the efficacy of the compound for the patient.

Compound manipulation was only part of the scheme that the DOJ alleges PCA established. Specifically, the DOJ's complaint tells of a scheme whereby PCA hired marketing companies who would target military members and their families, i.e., TRICARE beneficiaries. The marketing companies would then pressure the individuals to seek and fill prescriptions for PCA's compounded products even if such treatments were unnecessary. To facilitate this, the marketing companies allegedly paid telemedicine doctors to write the necessary prescriptions after “patient consultations” and “physical examinations” that never actually occurred. The DOJ alleges that this violated Florida prescriber-patient legal requirements.

To assuage the financial concerns of hesitant beneficiaries, the PCA allegedly paid part or all of many co-payments—without verifying financial need—utilizing money from a sham charity called PFARN. According to the DOJ, the charity performed no other function but paying the copayments of patients involved in PCA's scheme. In its complaint, the DOJ quotes emails between Matthew Smith and Steve Miller, the owner and operator of one of the hired marketing companies, TeleMedTech, wherein they discussed how a comparatively small co-payment could dissuade a patient from pursuing a comparatively expensive treatment. The DOJ quotes a later email wherein the two men discuss the procedure by which PFARN will cover the co-payments.

The DOJ's complaint focuses on an eight-month period ending April 29, 2015, and, in particular, claims that the private equity firm RLH knowingly participated in PCA's scheme between January 1, 2015, and April 29, 2015. During that eight-month period, the DOJ alleges, the scheme described above earned PCA revenues of approximately $68 million—nearly all of which were the result of compound prescription reimbursements from TRICARE. According to the complaint, PCA and their retained marketers split the profits.

The DOJ's Feb. 23, press release discussing this matter offered quotations from different professionals involved with this case and cases like it, but one of the statements is worth re-quoting. Randy Hummel, the executive assistant of the U.S. Attorney's Office for the Southern District of Florida, stated that, “We will hold pharmacies, and those companies that manage them, responsible for using kickbacks to line their pockets at the expense of taxpayers and federal health care beneficiaries.” Note that Hummel's statement expands the zone of responsibility from the health care provider itself, PCA, to “those companies that manage them”—i.e., RLH.

This should give investors, such as private equity firms, pause. By its nature, private equity is a more involved form of investment. The arrangement for most private equity investments requires the firm to get deeply involved in the target company by installing their own people, locating weaknesses, enacting corrective measures, increasing profitability, and thereby preparing the company for sale within three to five years. With that sort of horizon, taking comparatively aggressive steps to increase short-term profitability makes sense in light of the natural goal to make the company more appealing to prospective purchasers and then exit with a handsome return on investment. For that reason, it should surprise no one that RLH was as involved in PCA's operations as it was.

What may surprise readers, however, is the bold illegality of the alleged scheme. Given the details of the scheme and the DOJ's proofs, one may be tempted to dismiss the DOJ's decision to intervene as a one-off response to egregious facts rather than a sign of the DOJ's broader intentions. While that point may be valid, the DOJ's decision nevertheless suggests the potential for ongoing scrutiny of health care investment and management companies. With that, private equity firms in this space—and the individuals working for them—should take heed.

—Andrew Stein, an associate at Lamb McErlane, who focuses his practice on health and business law, assisted in the preparation of this article.

Vasilios J. Kalogredis is chairman of Lamb McErlane's health law department. He represents many medical and dental groups and thousands of individual physicians and dentists.