All That Glitters Is Not Gold: The Importance of Compliance Due Diligence In Assessing Healthcare Transaction ValueSeptember 30, 2013 |
The healthcare industry is undergoing rapid consolidation in response to an array of economic drivers. Medicare and Medicaid reimbursement cuts have resulted in downward pressure on revenues. Meanwhile, other industry trends flowing from recent healthcare legislation like the Patient Protection and Affordable Care Act (“PPACA”) call for increased expenditures on expensive electronic health record information systems and other changes, as healthcare organizations restructure their care models and seek a greater degree of physician practice integration. In addition, the federal and state governments continue to aggressively investigate fraud and abuse, resulting in forced refunds and other substantial compliance-related costs. These economic realities are driving the consolidation trend and causing healthcare organizations to combine in order “in order to cut overhead, share resources and intellectual capital, and benefit from a stronger market position for managed care contracting and vendor contracting purposes.”
But what can sometimes be lost in this flurry of mergers and acquisitions is the careful compliance due diligence that is required in order to ensure that all is as it seems in terms of the value of the assets being acquired. Of course, any investor who is seriously considering taking a sizable stake in another company always will perform close due diligence on that company’s financials—e.g., income statement, balance sheet, cash flow statement, etc.—in order to gauge the financial health of the target company. In the healthcare industry, however, where hospitals and health systems are now combining at a furious rate, it is especially important that investors also perform careful compliance due diligence. This is critical, not only to ensure there are no undisclosed fraud and abuse issues that can create significant successor liability and/or reputational harm for the acquiring entity, but also to confirm that the revenue streams of the target entity – which presumably factored prominently in any transaction valuation performed – are real.
When a health system, hospital or physician practice discloses its financial condition as part of the standard due diligence process, how does one know that the revenues listed have been generated in a compliant fashion rather than being the inflated result of improper coding or billing practices? An annual revenue figure on a financial statement, even a certified financial statement, is just a number. It does not tell you how those revenues were generated, and whether they may have been exaggerated over a multi-year period as a result of coding errors of various kinds. And if those revenues need to be modified downward as a consequence, the prospective transaction might look very different from a value perspective. What previously seemed like an attractive business combination might no longer make sense at all, or at least may require a substantial adjustment to the purchase price in order to proceed.
One need only review the most recent Work Plan for Fiscal Year 2013 (“Work Plan”), published by the Department of Health and Human Services, Office of Inspector General (“OIG”), to understand all of the ways in which the OIG is focusing its efforts to uncover billing and coding improprieties by hospitals and other providers. The Table of Contents lists a virtual cornucopia of investigative targets. For hospitals alone, priority inquiries include coding and billing errors relating to overpayments for same-day readmissions, overpayments for mechanical ventilation services, overpayments for patient transfers billed as discharges, overpayments for patient transfers to hospice care, overpayments for discharges to swing beds in other facilities, overpayments for graduate medical education, overpayments for interrupted stays at long-term care hospitals, overpayments for non-covered outpatient dental claims and overpayments for in-patient services based on improper outlier payment claims. Other targeted areas for providers include overpayments for physical therapy services, overpayments for sleep testing services, overpayments for anesthesia services, overpayments for ophthalmological services, overpayments for electro-diagnostic and diagnostic radiology testing, overpayments for laboratory testing, overpayments for “incident-to” services performed by non-physicians, overpayments for E/M services, and overpayments based on improper place-of-service coding. And the list goes on.
These areas of potential overpayment, in the context of a healthcare merger or acquisition, represent opportunities for revenue inflation, which can seriously depress the value of a prospective transaction, and generate a veritable witch’s brew of compliance problems and concerns for a would-be acquirer. That is hardly a risk worth taking.
On a relative basis, and given the stakes involved, the investment required to address this risk is not large, particularly when viewed in the context of all of the other costs associated with this type of business transaction. All that is required is to perform a coding/billing audit on a random sample of files to provide sufficient assurance to the acquiring entity that the historical revenues of the target organization have not been significantly overstated. For a physician practice with relatively few providers, this could cost as little as $10,000 to $15,000. For a larger organization, such as a large physician practice, a hospital or a health system, the investment will be proportionately greater, and might range from $15,000 to $25,000 or more. But given the overall expense of the transaction, this is a small price to pay to ensure the deal does not carry hidden compliance risks that make the purchase price grossly inflated or that potentially create regulatory issues down the road, which could be far more costly. Preferably, the audit should be overseen by counsel with healthcare compliance expertise, both to ensure that the effort is cloaked with attorney-client privilege and to appraise any compliance risks from a regulatory and law enforcement perspective.
As noted, the healthcare industry is undergoing tumultuous changes and, while these changes certainly present both opportunities and risks, there is no reason to assume greater risk than necessary when making investment decisions in other healthcare organizations. Do the smart thing by making the modest investment required to delve beneath the veneer of the target company’s financials. Perform a coding/billing audit to validate the target’s revenues and unearth any hidden compliance risks. Remember: “All that glitters is not gold.”
 Gordon, Lynn, Gilbert, Carrie, “Consolidation in a Rapidly Changing Industry: Navigating Options, Antitrust and Other Obstacles,” American Health Lawyers Association, Hospitals and Health Systems Law Institute (February 12, 2013)
 Id. at 4 (“The industry’s move toward electronic health records requires hospitals to invest in technology and modernize their systems. Estimates of the cost of implementation range from $3 million for a small hospital to as much as $200 million for a large hospital.”).
 Id. at 3, 5 (“The healthcare landscape is changing rapidly, and larger systems are likely in a better position to react and adapt financially, administratively, technologically, and intellectually.”)
 Id.at 1, n. 1 (reporting that over 250 healthcare mergers, acquisitions and affiliations took place in the second quarter of 2012, and that in that same quarter, “in dollar volume, healthcare technology transactions increased by 87% and healthcare services transactions tripled from the first quarter of 2012.”)