Benefits of Physician-owned Group Purchasing Organizations

By John W. Jones, Jr., Esq.

Group purchasing organizations (GPOs) are purchasing agents authorized to act for their members, thus allowing them to enter into agreements with suppliers or manufacturers through which items and supplies can be purchased by members at competitive prices. Because of their large member base, GPOs are able to negotiate much more favorable prices with suppliers for a particular item or service than individual providers could on their own. Additionally, since GPOs are funded by fees received from suppliers, they are able to furnish these services at little cost to their members. Given their tremendous benefits, physician groups looking for purchasing power, alternative revenue streams and value adds have begun to invest in and develop their own specialty GPOs. These arrangements, however, are not without risk, since many of the payment arrangements often implicate the federal Anti-Kickback Statute. There are three payment streams in the GPO-medical supply chain that generally implicate the federal Anti-Kickback Statute and necessitate safe harbor protection, including: administrative fees from suppliers to the GPO, discounts or rebates from suppliers to GPO members and dividend or distribution payments to GPO member-owners.

Administrative Fees

Since GPOs are in a position to arrange for the referral of business to suppliers (through their negotiation of contracts for the benefit of their members) and receive an administrative fee in return for these services, a GPO’s arrangement with a supplier implicates the federal Anti-Kickback Statute. These fees represent the bulk of a GPO’s revenue and, therefore, protection of these arrangements is critical to a GPO’s financial survival.

The group purchasing organization safe harbor protects (under certain circumstances) administrative fees from a supplier to a GPO. Specifically, for purposes of the federal Anti-Kickback Statute, remuneration does not include any payment made by a supplier of goods or services to a GPO, as part of an agreement to furnish such goods or services to an entity or individual, provided the GPO has a written agreement with each GPO member for which items or services are furnished. The agreement must provide that participating suppliers from which the member will purchase goods or services will pay a fee to the GPO of three percent or less of the purchase price of the goods or services provided by that supplier; provided, however, that in the event that the fee paid to the GPO is not fixed at three percent or less of the purchase price of the goods or services, the agreement must specify the amount (or if not known, the maximum amount) each supplier will pay to the GPO (where such amount may be a fixed sum or a fixed percentage of the value of purchases made from the supplier by the members under the agreement between the supplier and the GPO). Additionally, if the member that receives the goods or services from the supplier is a health care provider of services, the GPO must disclose in writing to the member at least annually, and to the Secretary of the Department of Health and Human Services (HHS) upon request, the amount received from each supplier with respect to purchases made by or on behalf of the member. Satisfying these standards requires adequate infrastructure and sufficient resources, but offers the GPO significant protection of administrative fees earned.

Although the GPO safe harbor is designed to protect administrative fees paid by a supplier to a GPO, it contains certain standards concerning the permissible structure of a GPO (for it to qualify as a GPO) and its arrangements with its members. Specifically, members of the GPO cannot be wholly-owned by the GPO. Second, the members of the GPO cannot be subsidiaries of a parent corporation that wholly-owns the GPO (either directly or through another wholly-owned entity). Accordingly, where GPO members are subsidiaries of a parent company, the parent company could not wholly-own the GPO and still obtain safe harbor protection for administrative fees received from suppliers.

Discounts and Rebates

Discounts give a seller (or offeror) the ability to provide buyers with more competitive pricing. Discounts implicate the federal Anti-Kickback Statute because they are viewed as remuneration being transferred to a provider (i.e., a potential referral source) who is in a position to purchase items or services from the supplier providing the discount. There is safe harbor protection for certain discounts to GPO members who enter into contracts with sellers and offerors (such as suppliers and GPOs) of health care goods and services. The term “discount” means a reduction in the amount a buyer (who buys either directly or through a wholesaler or a GPO) is charged for an item or service based on an arm’s-length transaction. A discount also includes a rebate, which is any discount the terms of which are fixed and disclosed in writing to the buyer at the time of the initial purchase to which the discount applies, but which is not given at the time of sale. The discount safe harbor focuses on the disclosure and reporting obligations of the parties involved in these transactions, including buyers, sellers and offerors. For purposes of the safe harbor, a GPO’s members would be considered buyers, the supplier, a seller and the GPO, an offeror.

If the GPO member is an entity or individual in whose name a request for payment is made, and payment may be made to that buyer under the Federal health care programs, the discount must be made at the time of sale of the good or service or the terms of the rebate must be fixed and disclosed in writing to the buyer at the time of the initial sale of the good or service, and the buyer must provide, upon request, the information regarding the discount to HHS or state health care program as provided to the buyer by the seller or offeror.

Both GPOs (as offerors) and suppliers (as sellers) can provide discounts to GPO members. The requirements of an offeror under the GPO safe harbor are substantially similar to those of a seller. An offeror of a discount is an individual or entity which is not a seller but promotes (such as a GPO) the purchase of an item or service by a buyer. If the GPO member is an individual or entity that is not a cost-reporting entity or health maintenance organization or competitive medical plan, the seller must comply with either of the following two standards (as applicable):

• Where the seller submits a claim or request for payment on behalf of the buyer and the item or service is separately claimed, the seller must provide, upon request by the Secretary or a state agency, discount information provided by the offeror.
• Where the buyer submits a claim, the seller must fully and accurately report such discount on the invoice, coupon or statement submitted to the buyer; inform the buyer in a manner reasonably calculated to give notice to the buyer of its obligations to report such discount and to provide discount information upon request; and refrain from doing anything that would impede the buyer from meeting its obligations under the safe harbor.

Critics argue these disclosure and reporting requirements are insufficient to protect against potentially abusive or anti-competitive activity. Supporters, however, contend that these safe harbors are sufficient and protect legitimate business arrangements that are crucial to the financial success of the parties involved in the medical supply chain, including consumers. There is little, if any, dispute, however, that discounts and rebates go a long way in a member’s purchasing decisions and potentially choice of GPO.

Distributions and Dividend Payments

The safe harbor regulations do not protect dividend and distribution payments to every type of member-owned GPO. On the contrary, the safe harbors protect certain distribution and dividend payments made by a cooperative hospital service organization to its patron-hospitals under the cooperative hospital service organizations (CHSO) safe harbor, and other ventures that comply with the large or small investment interests safe harbor. Since physician-owned GPOs could not comply with the CHSO safe harbor, they would have to avail themselves to the large or small investment interests safe harbor.

Under the federal Anti-Kickback Statute, prohibited remuneration does not include any payment that is a return on an investment interest, such as a dividend or interest income, made to an investor provided the arrangement complies with either the large investment interests safe harbor or small investment interests safe harbor.

If within the previous fiscal year or previous 12-month period, the GPO possesses more than $50,000,000 in undepreciated net tangible assets (based on the net acquisition cost of purchasing such assets from an unrelated entity) related to the furnishing of health care items and services, the investment interests held in that GPO could receive safe harbor protection under the large investment interests safe harbor, provided certain requirements are satisfied, including:

• Investment interests that constitute equity securities must be registered with the Securities and Exchange Commission.
• The terms (including any direct or indirect transferability restrictions and price) on which an investment interest is offered to an investor in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity must be no different from the terms equally available to the public when trading on a registered securities exchange, such as the New York Stock Exchange or the American Stock Exchange, or in accordance with the National Association of Securities Dealers Automated Quotation System.

Historically, the investment interests safe harbor for small investments has been utilized to protect hospital joint venture arrangements, but could be used to protect GPO arrangements as well. To obtain protection under this safe harbor, a health care venture has to satisfy a number of stringent requirements, including:

• No more than 40 percent of the value of the investment interests of each class of investment interests of the entity may be held in the previous fiscal year or previous 12-month period (Look-Back Period) by investors who are in a position to make or influence referrals to, furnish items or services to, or otherwise generate business for the entity.
• No more than 40 percent of the entity’s gross revenue related to the furnishing of health care services and items in the Look-Back Period may come from referrals or business otherwise generated from investors.

These strict requirements may significantly impair the ability of a member-owned GPO to achieve safe harbor protection since all of the members would be in a position to refer and generate revenues for the GPO. Although OIG has adopted safe harbors to protect certain health care ventures, strict and rather onerous requirements of these safe harbors do not always make them a viable option. Most health care joint ventures, including GPOs, however, are legitimate and work to achieve cost-savings not only for the investors, but the federal health care programs, as well.

OIG has long been concerned with the fraud and abuse risk posed by health care joint ventures in which investors are also sources of referrals. In 1989, OIG issued a special fraud alert concerning suspect health care joint ventures. In the alert, OIG distinguishes between legitimate health care joint ventures and those which it considers suspect. Importantly, OIG indicated that under suspect health care joint ventures, certain individuals or entities may be investors not so much for raising investment capital to start a business, but rather to lock-up a stream of referrals from those individuals and entities in exchange for compensation for those referrals.

To manage the uncertainty and potential risk of liability presented by these ventures, including GPOs, the parties should consider tailoring the venture as closely as possible to OIG’s guidance in this area, implementing certain safeguards, including the following.

The terms on which an investment is offered in the GPO should not take into account any previous or expected volume of referrals, services furnished or amount of business generated from such investors. Dividend or distribution payments to investors should not be tied, directly or indirectly, to the value or volume of referrals or items or services otherwise purchased through the GPO’s vendor agreements.

The investor’s return on investment should be directly proportional to the amount of capital investment of that investor, not purchasing volume of the investor.

If utilizing the small investment interest safe harbor to protect the investment interests held in the GPO, no more than 40 percent of the value of the investment interests of each class of investment interests should be held in the Look-Back Period by investors who are in a position to generate business for the venture; and no more than 40 percent of the venture’s gross revenue related to the furnishing of health care services and items in the Look-Back Period may come from business generated from investors.

There is no requirement that a passive investor, if any, make referrals to, be in a position to make or influence referrals to, furnish services or items to, or otherwise generate business for the entity as a condition of remaining an investor in the entity.

Interests offered by the GPO to passive investors in a position to generate business for the GPO should not be made on terms different from those of other passive investors. Additionally, the GPO should not market or furnish the entity’s services or items differently to passive investors and non-investors.

The GPO should not loan or guarantee funds to an investor if the loan or guarantee would be used to obtain the investment interest.

Members of the GPO should not be wholly-owned by the GPO and where GPO members are subsidiaries of a parent company, the parent should not wholly-own the GPO.

If properly structured, GPOs offer physicians tremendous benefits, including buying power, revenue enhancement and utilizing supplies and devices of their choosing. These arrangements, however, are not without risk and should be properly tailored to comply with the federal Anti-Kickback Statute and other applicable laws and regulations.

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John W. Jones, Jr., Esq., is a member of the Health Care Services Group at Pepper Hamilton in Philadelphia, Pa.