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Regulatory Viewpoint
Carefully Review Your Arrangements With Distributors And Wholesalers
Mark Langdon
Sidley Austin LLP
Although much of the governmental enforcement efforts targeted at medical device companies that we have discussed previously in this column has related to those companies’ interactions with physicians and providers, such as hospitals, who directly provide orthopedic devices to patients and receive reimbursement for the surgical procedures from insurers such as the Medicare program for the furnishing of those services, an area that we have not focused on, but that may be likely to receive increased scrutiny in the future, and that has been the focus of recent rulemaking in the pharmaceutical context, has to do with manufacturers’ interactions with the “middlemen” who actually distribute the products to customers. This column presents a brief discussion of these arrangements, and the potential compliance risks they can raise.
In short, orthopedic device companies, like most medical device manufacturers, typically engage the services of distributors or wholesalers to handle the actual delivery of their products to end users such as hospitals, surgery centers and physicians. The distributors or wholesalers usually buy the products from the manufacturer and then resell them to hospitals and other providers. Often, however, they do more than simply buy and resell products. In fact, sometimes there are various types of financial relationships—some more complicated than others—between the manufacturers and the distributors or wholesalers. The most common types of arrangements involve the payment of chargebacks or rebates to distributors or wholesalers based on product purchases. In other instances, however, there can be more sophisticated compensation arrangements whereby the middlemen are compensated for providing specific services to the manufacturer. However, because the distributors or wholesalers are in a position to arrange for the purchase of products that may be reimbursed by federal healthcare programs, such arrangements must be structured with care.
Once again, the major federal healthcare law that comes into play when evaluating arrangements between manufacturers and distributors or wholesalers is the Federal Anti-Kickback Statute. Although the focus here is only on the potential applicability of this law, there are other laws, including in the antitrust arena, that may be relevant when evaluating these types of arrangements. In short, excessive payments to such entities could be construed as illegal inducements under the anti-kickback statute or violations of other fraud and abuse laws, including the Federal Civil False Claims Act. Therefore, if a manufacturer is paying a wholesaler to furnish certain services such customer sales tracing information, and the manufacturer pays for such services at a rate that is in excess of fair market value, this could raise concerns under the anti-kickback statute, and it also could render any claims submitted to federal healthcare programs for the relevant products false or fraudulent.
Stay Compliant With a Safe Harbor
Given the broad reach of the anti-kickback statute, orthopedic device companies would be well advised to consider structuring their arrangements to comply with an applicable “safe harbor” to the law, whenever that is possible and practical. Full compliance with a safe harbor will ensure that an arrangement is immune from prosecution under the anti-kickback statute. The “personal services” safe harbor requires that an agreement between a principal and an agent performing services:
• Be written and executed by the parties
• Cover the services to be provided during the term and specify the services
• Specify the schedule, length and exact charge of intervals during which services are performed on a periodic or part-time basis
• Have a term of at least one year
• Include the aggregate compensation paid over the term of the agreement be set in advance, be consistent with fair market value in arms-length transactions, and does not include consideration of the volume or value of any referrals or business otherwise generated between the parties
• Not involve services related to the counseling or promotion of a business arrangement that violates any state or federal law.
The failure to comply with a safe harbor does not necessarily mean that an arrangement constitutes a violation of federal law. Because the guidance provided by the government on this issue has been so limited, often there is little information available to assist manufacturers and others in understanding what is precisely required to either comply with the safe harbor or to otherwise comply with the anti-kickback statute. Recently, the Centers for Medicare & Medicaid Services (CMS), which is the agency charged with administering the Medicare and Medicaid programs, issued guidance regarding “bona fide service fees” in the pharmaceutical context. Although this guidance has not been extended to the medical device arena, orthopedic device companies could consider the applicability of the instruction when weighing the relative risks involved in various financial arrangements involving wholesalers or distributors.
In the guidance document, the CMS states that a bona fide service fee must meet the following: first, the fee paid must be for a bona fide, itemized service that actually is performed on behalf of the manufacturer; second, the manufacturer would have had to otherwise perform or contract for the service in the absence of the arrangement; third, the fee must represent fair market value for the services provided; and, fourth, the fee must not be passed on, in whole or in part to a client or customer. With respect to what constitutes fair market value, the agency indicated that bona fide service fees mean expenses that generally would have been paid for by the manufacturer at the same rate had these services been performed by other or similarly situated entities.
Accordingly, whenever orthopedic device companies engage the services of wholesalers or distributors to provide specific services to the manufacturer, in order to reduce any risks under the anti-kickback statute, care should be exercised by the manufacturer to ensure that the arrangement is structured consistent with the personal services safe harbor as well as the CMS bona fide service fee test. A key aspect of any such evaluation is ensuring that the services are truly needed by the manufacturer and making certain that they are described with particularity in a written and signed agreement between the parties. In verifying that the payments are reflective of fair market value, ideally, the company should contract with an independent company to provide an appraisal of the relevant services.
It also is important to note that the guidance set forth above is only relevant to the extent that the manufacturer is compensating the middleman for providing services. If, on the other hand, the manufacturer is providing discounts or rebates to the wholesaler or distributor that are based on product purchases (eg, an X% rebate based on the distributor’s purchases of X amount of Product A), instead of payment for specific services, then, if properly structured, and if there is no untoward intent to induce overutilization of healthcare services in a way that might present clinical quality of care issues, such arrangements might involve reduced risks under the anti-kickback statute. Again, however, such arrangements would need to be carefully reviewed under another exception or safe harbor to the anti-kickback statute.
