The Industry Subpoenaed: Our Perspective
BY JOHN MCCORMICK, APRIL 4, 2005
The healthcare industry has long been the subject of regulation by complex laws that do not exist in other industries and which, under certain circumstances, may seem almost excessive and counter-intuitive. The enforcement of these laws has been significant and visible over the last several years, and is most recently starting to impact the orthopedic device industry in a yet-to-be-determined fashion.
The Facts
On Wednesday, March 30/2005, the United States Attorney's Office ("USAO") in Newark, New Jersey issued subpoenas to Smith & Nephew, Stryker Corp., Biomet, Inc., and Johnson & Johnson's DePuy Orthopaedics. The subpoenas requested consulting contracts, professional service agreements, and remuneration agreements between the respective companies and any orthopedic surgeon, orthopedic surgeon in training, or even medical school students using or considering the surgical use of hip or knee joint replacement or reconstruction products made or sold by the companies for the period beginning January 2002 through the present. Zimmer received a similar subpoena on Thursday March 31/2005.
Companies have understandably been cautious about communicating the nature of these events and therefore little factual information beyond press releases has been obtainable. Wall Street reacted on Thursday by punishing orthopedic stock valuations to the tune of nearly $3 billion (a nearly 4% loss in aggregate valuation) with notable emphasis on the companies that were actually subpoenaed. It turns out that this inquiry has had little or no effect at all in other areas of the orthopedic device industry such as spine, sports medicine, bracing or trauma. Wall Street analysts, lacking any real information or foresight, sheepishly downgraded Stryker, Biomet, Smith & Nephew and Zimmer while stocks such as Nuvasive, ArthroCare, Kyphon and many others were not affected.
We must emphasize that there is no indication of wrongdoing at this time and that many industry professionals and analysts, including ourselves, have not downgraded their long term positive outlook of the industry.
What is the US Government Looking for?
Only the Department of Justice knows the real answer to this question and the USAO has not made its intentions in issuing the subpoenas clear. What can we infer if we examine the available facts in the context of precedent and existing federal statues?
The USAO subpoenas cover a very specific segment of the orthopedic industry. To our knowledge, only 5 out of approximately 1,500 companies in the industry have been subpoenaed and the focus appears to be mainly on hip and knee and is specific to physician consulting contracts and professional service agreements issued by these companies. Within the boundaries of these subpoenas a fairly wide net has been cast, however.
If the consulting and other agreements are examined for compliance with respect to the Federal Anti-Kickback Statute, it is possible to infer that the Government may look for the making or accepting of payments in return for referrals, or for recommending referrals, of items or services paid for in whole or in part by a federally funded program such as Medicare or Medicaid. Based on the lessons learned from past investigations, it can be surmised that the Department of Justice likely will evaluate the consulting agreements it subpoenaed to determine whether they require (i) the physicians to provide services worthy of compensation and (ii) whether, even if worthy, the compensation is at fair market value. Although orthopedic device companies frequently pay physicians for feedback on existing products and to help them design new ones, if the consulting relationship is not legitimate, it may increase the risk of overutilization of hip or knee joint replacement or reconstruction products, thus resulting in increased costs to federal healthcare programs. As an example, this could occur by encouraging physicians to favor a more expensive product, manufactured by a company for which the physician serves as a consultant, over a less expensive but equally effective product, manufactured by a competing company.
The Anti-Kickback Statute is powerful stuff and its provisions impose civil or even criminal liability (or both) as well as possible exclusion from federal health care programs. If the inquiry is tested under the provisions of The False Claims Act, there is a risk that civil liabilities on any person or entity who knowingly submits a false or fraudulent claim for payment to the United States Government could be imposed.
What has Happened in the Past?
Many branches of the US Government including the United States Department of Health and Human Services ("HHS") Office of Inspector General ("OIG") and the Department of Justice ("DOJ") regularly conduct healthcare investigations and inquiries. These can often drag on for years and have led to significant fines for a number of healthcare industry sectors, including pharmaceutical manufacturers, laboratories and hospitals. Such activity often follows on the heels of the OIG's issuance of compliance program guidance or other industry-issued voluntary guidance. For example, the OIG issued compliance program guidance for both hospitals and clinical laboratories in 1998, draft compliance program guidance for pharmaceutical manufacturers in 2002, and final compliance program guidance for pharmaceutical manufacturers in 2003. In each case, there were either ongoing, or soon to follow, investigations of providers in such industries. Many of these investigations included allegations of violations of the Anti-Kickback Statute for inappropriate payments, including payments for, among other things, research services, grants and professional meetings. It is worth noting that the OIG issued compliance program guidance for the durable medical equipment ("DME"), prosthetics, orthotics and supply industry in 1999, and that AdvaMed (with input from the OIG) issued its Code of Ethics on Interactions with Healthcare Professionals in 2003. AdvaMed is a key industry association for medical device developers and manufacturers. We can't say that all of this is an absolute predictive tool that the Anti-Kickback Statute will be the guiding principle of the inquiry, but there is a pattern here.
Most recently, the pharmaceutical industry has been the subject of especially intense scrutiny by the Department of Justice and the OIG. Just days ago, PharMerica Inc. entered into a settlement of a June 2004 OIG administrative action arising from the 1997 purchase of a small Virginia pharmacy by a PharMerica subsidiary. The OIG had alleged that PharMerica had violated the Anti-Kickback Statute by paying an excessive amount for the pharmacy in return for the seller's commitment to refer its Medicare and Medicaid pharmacy business to the Company for the next seven years. The seller also owned 17 nursing homes and eight assisted living facilities. The OIG had initially demanded $21.8 million from PharMerica in damages and penalties as well as its exclusion from participation in federal healthcare programs for ten years. Under the terms of the actual settlement, PharMerica paid almost $6 million to HHS and entered into a five-year corporate integrity agreement ("CIA") with the OIG. As part of the settlement, PharMerica denied any wrongdoing, and the OIG dropped its exclusion demand.
In May 2004, Warner-Lambert, a subsidiary of Pfizer, Inc., entered into a substantial $430 million settlement with federal and state agencies to resolve allegations of the illegal off-label marketing of its blockbuster epilepsy drug, Neurontin. Although physicians are legally permitted to prescribe drugs for off-label uses, it is illegal for pharmaceutical manufacturers to promote off-label uses. The methods used by Warner-Lambert to promote Neurontin were novel and may shed some light on the theories underlying the USAO's issuance of the subpoenas to orthopedic device providers. The methods used by Warner-Lambert included payments to prescribers for "research" that were, in effect, viewed to be kickbacks for off-label prescribing, and lavish perks (including advisory fees) to physicians who attended or spoke at continuing medical education classes where Neurontin was promoted for off-label uses. The Warner-Lambert investigation presents a relevant example of circumstances where arrangements with providers resulted in, from the Government's perspective, inappropriate, unnecessary and ineffective services that were paid for by a federal health program, and thus constituted false claims. In terms of extraordinary settlements of this nature, we would highlight that it takes years for such cases to resolve, during which time the companies continue to operate normally and such settlements often do not have a meaningful long term impact on companies' operating performance.
From the Industry's Perspective
We see physician consulting contracts and professional service agreements as essential components of product and technology development, which ultimately benefits the patient and society. If the US Government is really going to understand the orthopedic medical device industry, it is going to have to accept that companies co-develop, test and evaluate products with surgeons in a vital two-way dialogue that supports innovation. Such relationships with physicians are also essential because company research and development relies on critical feedback from the operating room to better improve implants and instruments. Physician consulting contracts and service agreements are particularly important for new and innovative companies. Think about how a truly great industry innovator such as Kyphon has produced a miracle: helping elderly women get back on their feet after suffering debilitating osteoporotic fractures. Could such a marvel been achieved without close collaboration with the physician community? Highly unlikely. Stated plainly, Medicare funds used to pay for reducing a lifetime of pain is money well spent.
We are also puzzled by how the USAO is going to prove how less expensive hip and knee implants are "equally effective". Why are doctors so interested in expensive implants? Because the doctor wants to keep a consulting contract? In fact, much of the demand in the hip and knee industry is driven by patient choice and we see plenty of evidence that people are willing to pay for medical device innovation themselves (see my March 21 article What Price Innovation?).We are certain that the industry will be able to confront the Government with troves of data on how premium priced products such as ceramic on ceramic hips have the smoothest articulating surfaces available and that such innovative and valuable devices are, in fact, attracting younger patients who are in desperate need of longer lasting implants. It is highly unlikely that a groundbreaking innovation such as the ceramic on ceramic hip could have been achieved without these important consulting and advisory relationships.
Finally, this is a notable inquiry in light of the fact that companies in the orthopedic medical device industry have been vigilant about modifying sales policies in recent years in order to prevent unethical selling practices. In fact, the industry has taken concrete steps towards adopting ethical guidelines put forth by AdvaMed in 2003. These guidelines, which appreciate the clinical value of "research collaborations and consulting relationships" with physicians, are very specific about how to develop such contracts and relationships in order to prevent violations of the kind suggested by the Anti-Kickback Statute. We note that the AdvaMed guidelines were developed with input from the OIG.
Conclusions
Further details on the scope and focus of the Government's investigation are certain to emerge over the coming weeks and months, but right now very little is known. Today, this is what we know for certain: (i) 5 companies in the hip and knee segment have been subpoenaed for information about their physician consulting contracts and professional service agreements and (ii) there are no indications of any wrongdoing at this time.
Prior inquiries where the Anti-Kickback statute has been employed may shed some light on the legal theories of how the United States Attorney's Office may try to build a case against the hip and knee manufacturers. Although we feel strongly that physician consulting contracts and professional service agreements are necessary to the industry's important innovation dynamic and that the industry will have mountains of evidence to support its case, it is difficult to argue that the Government won't persist in its efforts.
Just about the only other things we can be sure of today is that this inquiry will take years to resolve and the outcome cannot be determined at present. If the hip and knee leaders ultimately have to settle with the US Government, then past settlements may be a useful proxy. If that is the case, then we can reasonably conjecture that the orthopedic medical device industry will survive this affront to its integrity and continue to serve and innovate on behalf of its patients for decades to come.
