Although private equity (PE) sponsors have been active investors in the health care services industry for the last decade, PE-backed health care providers today constitute only 4% of the United States health market by revenue. Moreover, growth in PE investment in health care has slowed over the past six years. The year-over-year growth rate in the number of PE-backed health care companies has slowed from nearly 25% in 2018 to less than 1% in the first quarter of 2024.[i]
Despite the relative lack of depth of PE investment in the health care sector, government and media attention has grown dramatically targeting PE sponsors and highlighting concerns over the care of patients, the maintenance of facilities, and the treatment of employees. Some of the concerns may have merit in some cases, while many are misplaced or applied with too broad a swath. Nonetheless, private equity investment is not going away in short term, and recent trends show an uptick in private equity in oncology, a key topic discussed at the September 2024 Cancer Care Business Exchange. Overshadowing the deal activity are a number of quickly evolving legal and regulatory trends, that investors and providers alike should take into account.
Government Scrutiny of PE-Backed Health Care Providers Appears Likely to Continue to Increase
The Federal Government and various state governments have set their sights on health care private equity investors. This focus has included, among other things, proposed Federal legislation (discussed in our earlier blog) requiring “transparency” into private equity investments by mandating annual reporting to the Department of Health and Human Services, proposals to repeal traditional Federal income tax advantages from health care real estate investment trusts, hearings on and demonization of private equity sponsors, proposals for criminal penalties to be applied to health care executives in the event of deaths to patients and significant claw backs of compensation paid to health care private equity executives under certain circumstances.
Moreover, the Federal Trade Commission (FTC) and United States Department of Justice (DOJ) have shown a keen interest in pursuing antitrust claims against providers whose market share has grown slowly, through so-called “creeping” acquisitions (i.e., transactions at sizes below Federal antitrust agency reporting thresholds).
Finally, certain states, including California, Connecticut, Illinois, Indiana, Massachusetts, Minnesota, Nevada, New York, Oregon, Washington, and Pennsylvania, have considered, passed, or are in the process of passing, statutes that will require investors interested in acquiring or recapitalizing health care providers, such as hospitals, health systems, skilled nursing facilities, hospices, ambulatory surgery centers, and physician practices, to report transactions of a certain size or character to state regulators to allow those regulators to determine whether or not such deals will be allowed to move forward. In brief, this scrutiny appears widespread and is likely to intensify, at least in the short term.
The FTC’s Rule Prohibiting Covenants Not to Compete was Recently Enjoined. What is Next?
On August 20, 2024, the U.S. District Court for the Northern District of Texas issued a ruling enjoining the FTC’s enforcement of its rule (issued earlier in 2024, and described in our earlier blog) banning most employment covenants not to compete.[ii] The rule, had it not been temporarily restrained, would have taken effect on September 4, 2024, and would have prohibited for-profit employers from enforcing non-competes it currently has with most of its employees, including physicians and clinicians who provide most of the services to patients. While there are certain exceptions — for example, for certain “senior executives” — those exceptions are narrowly tailored and would not have applied to rank-and-file physicians and other clinical employees. The injunction has provided temporary relief for most employers, many of whom likely are breathing a sigh of relief. The Texas district court took the position that the rule is overly broad and that the FTC exceeded its authority under the FTC Act in writing that rule. Of note, the injunction does not mean that the rule has been deemed to violate the Constitution, and the FTC has stated that it likely will appeal the court’s ruling. If it does, the fight will be far from over. In the interim, covenants not to compete remain in effect, and so long as they don’t violate applicable state law (with some states, notably Massachusetts and Connecticut, expressly prohibiting enforcement of non-competition agreements with physicians), should remain enforceable.
Antitrust Concerns on the Rise
The FTC and the DOJ are becoming increasingly interested in antitrust issues related to competition and competitive behavior among health care providers, including those controlled and managed by private equity sponsors. Several years ago, the FTC brought an action against U.S. Anesthesia Partners (USAP), a Welsh Carson and Stowe-backed company.[iii] The FTC alleged that USAP, and Welsh Carson, had engaged in anticompetitive behavior in the Texas market. USAP is an anesthesia medical practice that grew dramatically across the US, and most especially in Texas. Recently, a Federal court dismissed Welsh Carson from the action, but did not dismiss USAP. This ruling was on the heels of a recent Request for Information issued by the FTC and the DOJ relative to role of, among others, private equity sponsors in health care markets. The FTC and the DOJ have shown a keen interest in “roll up” strategies that avoid reporting under the Hart Scott Rodino Antitrust Improvements Act but, ultimately, result in platform businesses with significant market power and the ability to engage in — what those regulators believe is — anticompetitive behavior such as predatory pricing.
Enforcement of Stark Law Penalties on the Rise
As of April 2024, the DOJ has been showing increased focus on enforcing the Physician Self-Referral Law, also known as the “Stark Law,” through the False Claims Act (FCA). This includes filing complaints and announcing settlements related to Stark Law violations. In one high profile and ongoing example, in December 2023, Steward Health Care and Steward Medical Group were accused of violating the Stark Law by paying a cardiologist almost $4.9 million in incentive compensation.[iv]
Many private equity-backed provider platforms are rich with ancillary services, such as imaging, lab, physical therapy, orthotics and prosthetics, and — particularly in oncology — outpatient prescription drugs. These ancillaries are, often, the basis of high margin services, but referrals to them can implicate the Stark Law and the FCA. Given the new focus on Stark Law violations, private equity sponsors and their provider businesses are well counseled to pay careful attention to the various exceptions that allow physicians to refer to these ancillaries without violating the Stark Law or implicating the FCA. For example, we believe that the Government is likely to look carefully at valuations of compensation or other remuneration paid to physicians, the commercial reasonableness of arrangements and the review of physician compensation, including the arrangement of ancillary services bonus pools.
Increase in PE-Backed Bankruptcies
2023 and 2024 have seen an increase in bankruptcies among private equity backed providers, the most notable of which has been Steward Health Care System, which filed for bankruptcy in early 2024 amid allegations of facility and patient neglect, hospital closures, layoffs, confiscatory compensation of upper-level executives and management malfeasance. Steward owns and operates 31 hospitals and employs more than 1500 physicians across the United States. Almost all of Steward’s facilities are subject to leases with Medical Properties Trust (MPT), all of which were purchased by MPT over the past several decades. The proceeds of the real property sales were distributed to Steward’s investors and Steward was left with expensive leases which resulted in a substantial drain to Steward’s finances.
Steward has become a lightning rod for Federal and state governments intent on protecting the public from certain types of for-profit health care and will likely cause the regulatory scrutiny discussed above to continue escalating. In 2023 alone there were 79 health care bankruptcies involving companies with more than $10 million of indebtedness.[v] Record high interest rates (at least during the last several decades) are cited as one of the causes of these failures. Other reasons are, likely, the cessation of CARES Act payments, rate and pricing pressure from payors including Medicare and Medicaid, national and local labor shortages (coupled with increasing wages) and high supply costs. These factors have created a “perfect storm” that has pushed companies with weak balance sheets to seek bankruptcy protection from creditors. Note that the rate of filings is down over 2023, but still number almost 60.[vi] Overly leveraged providers, those with weak cash positions, as well as those heavily dependent upon reimbursement from Federal health care programs will remain susceptible to financial failure.
Takeaways
Despite the increasing legal and regulatory headwinds, it is reasonable to expect increasing private equity-backed activity in oncology, and health care more generally.
[i] See “Quantifying PE Investment in Healthcare Provider” by Rebecca Springer, Ph.D., Pitchbook, July 8, 2024, available at: https://files.pitchbook.com/website/files/pdf/Q3_2024_PitchBook_Analyst_Note_Quantifying_PE_Investment_in_Healthcare_Providers.pdf
[ii] FTC v. United States Anesthesia Partners, Inc., 2024 U.S. Dist. LEXIS 85714, 2024 WL 2137649.
[iii] Fed. Trade Comm’n v. U.S. Anesthesia Partners, Inc., No. 4:23-CV-03560, 2024 U.S. Dist. LEXIS 85714 (S.D. Tex. May 13, 2024).
[iv] https://oig.hhs.gov/fraud/enforcement/united-states-files-complaint-against-st-elizabeths-medical-center-steward-medical-group-and-steward-health-care-system/
[v] https://www.fiercehealthcare.com/finance/chapter-11-bankruptcies-spiked-across-healthcare-2023-particularly-hospitals
[vi] https://www.fiercehealthcare.com/finance/healthcare-bankruptcy-filings-slow-2024-gibbins-advisors-analysis-finds
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