Private Equity Firms as FCA Targets—“The Reunion”

Back in February, we blogged about a case in which a court declined to dismiss FCA allegations brought by a relator against certain private equity investors.  We promised Qui Notes readers that the case would be monitored for developments and now write to provide an update.  But just like the beginning of the next season for many binge worthy shows, we start with a brief recap.

United States ex rel. Martino-Fleming v. South Bay Mental Health Ctr.¹ arose from the private equity firm’s ownership of a mental health center through a portfolio company, and the health center’s allegedly false submissions to Medicaid for medical services purportedly performed by unqualified and unsupervised clinicians.  Besides claiming that the mental health center and portfolio company had common officers and board members, the relator’s complaint also alleged that the portfolio company’s CEO and Board were informed about the regulatory noncompliance but had rejected recommendations to take corrective action and address the violations.  As a result, the court denied the defendants’ motion to dismiss, noting that such ostrich-like behavior could constitute “sufficient participation in the claims process to trigger FCA liability.”

Fast forward to May 2021 and the private equity firm’s summary judgment motion predictably fared no better.  Heavily relying on its prior decision, the court applied the same reasoning to reject the private equity firm’s contention that no reasonable juror could find for the plaintiffs on the issues of scienter and causation.² The court concluded that discovery revealed sufficient evidence to raise a genuine dispute of material fact about the private equity firm’s knowledge of the ongoing regulatory noncompliance.  For example, the court cited evidence that the private equity firm’s members were aware that state Medicaid regulations imposed certain requirements and were also informed that the health center’s clinicians were both unqualified and inadequately supervised.  In essence, the court found that because the private equity firm’s principals, who sat on boards of both the portfolio company and the health center, were aware of the deficiencies but ignored recommendations to remedy them, a reasonable jury could find that the scienter element was satisfied through this “reckless disregard for the truth.” 

For related reasons, the court likewise rejected the private equity firm’s argument that it did not cause the submission of false claims to Medicaid.  Although the court recognized that the private equity firm could not have participated in any violations occurring before it had acquired the health center, it nonetheless held that FCA liability could flow from the private equity firm’s “knowing ratification” of the prior policy, resulting in the submission of false claims.  In other words, once it was on notice of the regulatory noncompliance, it “had the power to fix the regulatory violations” but “failed to do so.”

This decision confirms the growing dangers for a private equity firm should it choose to exercise a significant degree of control over the entity submitting claims for payment.  It is important for private equity firms to be aware of the risk of FCA liability as they consider the appropriate degree of involvement in a portfolio company’s day-to-day operations and implementation of compliance programs. 

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.