U.S. Fraud Crackdown Eroding Private Equity’s Liability Shield

U.S. Fraud Crackdown Eroding Private Equity’s Liability Shield

2021-02-23 06:00:26
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Insiders said a company had sent unnecessary painkillers to the US military; another promoted an unproven treatment for children with cancer; and a third used unlicensed counselors to treat poor people with mental illness.

In all three cases, the taxpayers paid the bill – and it wasn't long before the government began looking for the owners of the companies: private equity.

For a long time, these investment firms have been shielded from legal obligations at the companies that buy them, and are increasingly dragged into a mess when their costs run into trouble. An important reason: private equity has mainly penetrated to companies that depend on tax money healthcare

That has exposed them to so-called false claims, with corporate whistleblowers bringing allegations of civil fraud to the attention of the federal government. Only a handful of cases have emerged so far. But experts expect more, given the tremendous potential for fraud in the extensive federal tools set up to help the economy get through the pandemic. They also expect the Biden administration on Wall Street to go after deep pockets.

"The ultimate safeguard you have is the threat of enforcement," said William McSwain, who left his post as Philadelphia's top federal prosecutor in January to join law firm Duane Morris. "That won't change under President Biden; it will intensify."

PPP funds

The government is now going after bad actors after throwing billions of dollars out of the door to companies and the healthcare system floating during the pandemic. Among other things, it investigates whether companies lied about needing loans under the Paycheck Protection Program, a relief effort that largely sought to exclude private equity-backed companies.

In June, Ethan Davis, who was then the second officer in the Civil Division of the United States Department of Justice, warned in a speech that private equity firms would be sued if they knowingly participated in emergency fraud.

The government has the option of joining whistleblowers under the False Claims Act to hold companies that do business liable for fraudulent billing.

In 2018, Massachusetts Attorney General Maura Healey filed a civil fraud complaint against private equity firm HIG Capital, claiming a role in allegations related to his behavioral medicine company, Community Intervention Services Inc.

Christine Martino-Fleming, who worked as an education coordinator, said in her complaint that an HIG staff member ignored her concerns about unmonitored, unrecognized therapists treating patients with mental health.

“The pressure to grow was astronomical compared to what it was,” before HIG bought the company, another executive testified, the lawsuit said.

Community Intervention Services settled $ 4 million, and HIG is in mediation. In court documents, the companies denied unnecessary pressure to increase revenues. They said no false claims had been made, that Martino-Fleming never notified them, and that the concern did not suffer.

Lawyers and former regulators have warned the private equity industry that the more active they are with investments, the greater the legal risks.

The industry's playbook is to review management, create efficiencies and keep a close eye on finances so that investments can be sold at a hefty profit within a few years. After losses during the 2008 financial crisis, private equity became even more involved with their companies to avoid similar setbacks.

Still, in most cases, private equity owners manage to avoid scrutiny. Since 2013, at least 25 private equity-backed healthcare companies have jointly paid $ 573 million in government fraud settlements, according to a report released Monday by the government. Private Equity Stakeholder Project, a nonprofit advocacy group that scrutinizes the industry. Only in three of the cases did private equity firms agree to pay money.

The industry remains concerned. Companies caught defrauding the government have to pay three times the damages, up to $ 23,000 per claim.

In 2019, private equity firm RLH Equity Partners and pharmaceutical company Patient Care America reached a $ 21 million settlement with the federal government. She resolved claims that the drug company paid marketers to promote expensive pain creams to military members who didn't need the treatment. Representatives from RLH and Patient Care America said they were both fully cooperating with the government and the affected employees are no longer working at the company.

Prosecutors said the private equity firm was involved because it approved the use of marketers, reviewed financial statements with payments to them, and funded some of their commissions. RLH said the government has never proved it was aware of any alleged fraud.

"RLH has learned an important lesson," said Murray Rudin, a general manager of RLH, in an email. "We are more careful in our continued enforcement of the law within our portfolio companies, especially those that provide healthcare."

In November, federal prosecutors announced a new settlement. When Gores Group, a private equity firm run by billionaire Alec Gores, Therakos Inc. In 2013, the medical device company falsely promoted a lymphoma treatment for use in children with bone marrow transplants, the government said. Gores, who denied fraud, agreed to pay $ 1.5 million.

These settlements set a precedent for private equity as a defendant, said Murad Hussain, a partner at law firm Arnold & Porter Kaye Scholer. "The courts, the jurisprudence and the individuals who file most of these cases are taking notice," he said.

–With the assistance of Peter Eichenbaum.

Copyright 2021 Bloomberg.


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