In the premiere episode of The Professor’s Corner, David Pivnick, Partner at McGuireWoods, shared best board practices to mitigate risk when making challenging decisions. In this follow-up episode, David expands on a larger trend in healthcare litigation: private equity funds are finding themselves legally responsible for the activity of the companies in their portfolio.

David believes these claims are driven primarily from the whistleblower bar and not the Department of Justice. By leaning on Qui Tam laws, litigators can cast a wide net in who they name in their court filings.

Despite these cases being relatively easy to defend, they still require significant investments in time and money.

To minimize a private equity fund’s risk spectrum, investors should think proactively about board practices, ensuring that relationships are appropriately vetted, and that specific concerns are addressed and corrected. In addition, especially when making decisions that involve substantial gray areas, owners need to seek counsel to ensure the legality of their choices.

Featured Experts

Name: Geoffrey Cockrell

What he does: Geoff is the Chair of McGuireWood's private equity group and serves on the firm's Board of Partners; he has extensive experience in mergers and acquisitions, especially in the healthcare space.

Organization: McGuireWoods

Connect: LinkedIn

Name: David Pivnick

What he does: As a partner at McGuireWoods, David co-chairs the Healthcare and Life Sciences Industry Team. David primarily practices complex commercial litigation in healthcare.

Organization: McGuireWoods

Words of wisdom: “The darker the shade of the gray, the more likely that conduct ends up coming under scrutiny generally, which means it's more likely that as an owner, you could get swept up in an investigation.”

Connect: LinkedIn

Notes From the Professor’s Corner

Top takeaways from this episode

★ Qui tam rules make it easier for litigators to include private equity funds in their claims. The growing trend of litigating against PE funds is driven primarily from the whistleblower bar, not the Department of Justice. While these claims rarely carry much legal weight, they can lead to significant financial strain for investors who must hire a legal defense team.

★ The darker the gray, the greater the risk. Most claims against PE funds from the Department of Justice include clear misconduct by investors who serve on their portfolio company’s board. David warns that making decisions that involve a lot of gray area opens everyone involved up to a greater risk spectrum. Seeking counsel in these situations is recommended.

★ Investors have a responsibility to ensure proper conduct. Because most boards in private equity-funded healthcare companies are decision-making boards, investors would be wise to ensure that companies in their portfolio are following regulatory compliance standards.

Episode Insights

[01:33] A growing trend: David sees increasing instances of the government pursuing claims and investigating the potential for claims against private equity funds.

[02:06] Improper conduct: David outlines past examples of how PE funds have gone to court for allegedly engaging in improper activity for financial gain.

[03:39] Identify problematic areas: David presents a spectrum of activity for private equity funds to pursue to bolster best practices and mitigate risk.

[06:21] In pursuit of deeper pockets: The Department of Justice and the whistleblower bar have differing mindsets about when and why to pursue private equity funds in litigation.

[07:24] Qui tam’s wide net: David and Geoff discuss how whistleblowers can leverage qui tam rules to target a broad range of defendants.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Professor's Corner, a McGuire Woods series, exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuire Woods's partner, Geoff Cockrell, as he and specialists share real world insight to help enhance your knowledge.

Thank you everyone for joining us for another segment of The Professor's Corner, where we dive into a little bit more technical, legal regulatory elements of healthcare, private equity investing, and I'm joined by some of my colleagues and others where we dive into more nuts and bolts of how to think about some of these elements. In our last segment, I was joined by my partner, David Pivnick, and we were discussing a recent case, where a private equity fund itself found itself needing to settle with the government in connection with activities at a portfolio company. Those were a little jarring, and we ticked through some of the best practices of how a private equity member of the board of a platform company should think about compliance, think about their role and how to mitigate that risk. David is joining us again. It might be worth spending a little time and thinking about some of the other areas where private equity funds should be mindful of how they can create exposure for themselves as an owner of a platform company through the things that they do.

Yeah, absolutely, Geoff. I mean, obviously the matter we talked about, and again, I appreciate you having me on with you, the matter we talked about last time dealt with board involvement and knowledge and understanding of the issue and not correcting things, instead moving forward. We've seen a little bit of an increase in activity over the last couple years, and still by no means a groundswell, but certainly more activity where the government is either pursuing claims or has investigated the potential for claims against private equity funds. And I think it's going to be an important trend to monitor because unfortunately the whistleblower bar is fairly sophisticated and chases the money. So if they think there's a pathway here, they'll explore it, which is why I think these other areas are worth looking at.

So one of the other areas that we've seen some government interest and some investigations and cases being brought is where the allegation is specific to improper conduct that was done or instigated directly by, or at least allegedly directly by the PE funds. So for example, if there is an alleged kickback relationship and the allegation is it was a private equity fund that issued the tainted payment or that structured the improper relationship, we've seen some activity there. This came up a couple years ago at beginning of 2020 specifically. There was a matter where the concern was raised that a certain billing practice had been identified in billing and coding audit. It was very nuanced and discreet. And the auditor had said to the fund, "You should be refunding these dollars and not billing for these claims for these services going forward." And instead of refunding the dollars and proceeding with the refund and the corrective action, there was a discount taken on the transaction price, like a renegotiation on that front, and an attempt to correct going forward, but the dollars were not refunded back to the government on the back end.

And the perception was sort of, you leveraged this to your financial advantage in the deal, but didn't make the government whole, which means you benefited from this issue. Those were more direct examples where the fund was directly involved, but I do think it's practical to recognize those concerns and to think about how to navigate them, particularly where, again, of structuring, compensation relationships, or transaction dollars, making sure that you're getting fair market value, appraisals done, and working with [inaudible 00:03:56] to make sure that the relationships are vetted and our appropriate. And then to similarly, if you're identifying specific concerns, make sure you take appropriate steps to correct those concerns, which oftentimes can be as simple as going forward and making sure billing and coding audits are done in the future, that claims that were improper and refunded, et cetera, but being cognizant of it, both pre and post transaction is important.

There's a spectrum of activity, and your description started with direct payments by the private equity fund. That I can see the example you gave, where the fund is self profited through purchase price adjustments off of bad actions is similar in the degree of direct engagement by the fund. The steps beyond that get a little more nuanced in my mind of ... You talk about structuring things. If you pause it at the outset that the private equity fund is controlling the business, which is generally correct. There's degrees of engagement, but most middle market funds at least are pretty heavily involved in the day-to-day decision making, but it's still decision making at the platform.

Are you seeing the government starting to lose that distinction of direct activity by the fund for the fund's benefit, and the fact that the private equity fund has three of five board members and are involved in those decisions and therefore becoming a target themselves? Or is it, for now at least, more limited to what feels to be more egregious activity by the fund itself, that direct payment and the pricing concession that they just took for themselves seems more egregious on that spectrum. How would you respond to that question on where to seat the exposure on that spectrum?

Right now the cases that I'm seeing, I think would fit in the latter bucket, where it is either more open and obvious egregious conduct, or at least conduct that is perceived by the government as being more egregious and more of a direct involvement on the part of the PE fund, as compared to bringing a claim just by virtue of the PE fund being an investor or having board seats or even board control.

As we talk here, I don't expect, frankly, the Department of Justice to lose sight of that distinction either, and I don't think they run their investigations just to locate deeper pockets. So I think, A, I would say I'm seeing it more where it is direct wrongdoing that's at issue, and B, I'm not expecting a near term shift. I do have some concern, as I alluded to a few minutes ago, that because the whistleblower bar is a well coordinated bar, and I don't think they share necessarily the same high minded ambitions at the Department of Justice by any terms of rooting out wrongdoers and getting at the right sources. I think the whistleblower bar is happier and perfectly fine striking out at deeper pockets. I worry that distinction may be lost on them, and there could be some KTM cases that are brought with multiple defendants, frankly, improperly, and that will be able to land and navigate, but are still going to cause time and money to be spent on the defense in the interim.

Under the KTM rules, a KTM whistleblower plaintiff, in theory, could cast a broad net, is the idea?

That's correct. They can control their case. We've seen lots of cases that we've worked on where a whistleblower brings a claim against the entity defendant and there's one target and that's it. We've seen others where individual owners are named, individual executives are named, the private equity fund might be named, and oftentimes there isn't a lot by way of allegations in the complaint, other than John Smith owned in business X, or this company invested, and because they invested $50 million, they had a strong interest to make sure the underlying company succeeded and was profitable. Obviously there's nothing legal or improper about that, and those ones tend to be easy to defend because they can't point to any wrongdoing. But I think there's an increased risk, not that the DOJ will start bringing tenuous claims like that, but that the whistleblower bar and whistleblowers might because they're happy to, as you put it, cast a broad net and see where things land, hope they can get to discovery and might learn something that bolsters what was otherwise a somewhat frivolous allegation.

Is one way to think about when a company is making decisions that are truthfully on a gray scale, where you've got lighter gray progressing to darker gray in the legal and regulatory analysis, that as people's comfort level, whether that's with advice of counsel or their assessment of how other people are viewing this, but as you move into darker shades, which that's the nature of a continuum on that spectrum, as you move into darker shades of gray, are you also progressively increasing the risk as an owner in that calculus, or is that not exactly the right way to think about it?

I think that's in some ways, correct. I think the darker the shade of the gray, the more likely that it's going to be conduct that ends up coming under scrutiny generally, which means it's more likely that as an owner, you could get swept up in an investigation relating to it. I think the more direct cause and effect and risk is the higher the level of engagement and involvement that the owner, the PE fund, the board members have in structuring, approving or promulgating the arrangement as it gets into the darker shades of gray. So I think the worse the relationship is or the arrangement is from a legality standpoint, the more general risk there's going to be, which means everyone has an increased risk spectrum, but I think for it to really be more of an increased risk for the private equity fund or for the board, it needs to be more about their involvement and their level of connectivity and connective tissue to the actual conducted issue.

Well, thank you again for joining me for another segment of The Professor's Corner. Again, we're tackling the narrower topics of a regulatory and technical variety a little bit more deeply. There'll be more of these to come, and we hope it's helpful for everyone. We'll see you on the next installment.

Thank you for joining us on this installment of The Professor's Corner. To learn more about today's discussion, please email host Geoff Cockrell at GCockrell@mcguirewoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuire Woods for informational purposes only. By accessing this series, you acknowledge that McGuire Woods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuire Woods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.