Case background
The defendants in the case are LaTonya Mallory, who founded Health Diagnostics Laboratory (HDL) in 2008 to provide specialized testing for cardiovascular disease and diabetes, and Floyd Calhoun Dent III, and Robert Bradford Johnson, who founded BlueWave Health Care Consultants, Inc. (BlueWave). In 2009, BlueWave entered into a contract with HDL and another laboratory called Singulex to provide marketing and sales services. HDL and Singulex, in turn, paid BlueWave a percentage of the revenue they generated from BlueWave sales. In addition, both labs also paid physicians a “process and handling fee” for patient specimens sent to the labs for testing.
At trial, the government argued that the payment of volume-based commissions violated the AKS because it constituted the knowing and willful payment by the laboratories of remuneration to induce BlueWave to arrange for, or recommend, ordering clinical laboratory services reimbursed by Federal health care programs in violation of 42 U.S.C. § 1320a-7b(b)(2)(B), and that BlueWave’s receipt of such remuneration violated 42 U.S.C. § 1320a-7b(b)(1)(B). The jury found the defendants liable.
The Fourth Circuit’s decision
The focus of the appeal was the defendants’ contention that the Government failed to prove that the defendants “knowingly and willfully” violated the AKS. They asserted that the AKS is ambiguous and argued that they had reasonably concluded that the statute does not prohibit the payment of volume-based commissions to independent sales contractors. As a consequence, they argued, they did not “knowingly” violate the FCA.
Affirming the verdict, the court found “abundant evidence” supported the jury’s finding of knowledge and intent. Mallory, 988 F.3d at 736. Among other things, the general counsel and another lawyer who oversaw HDL’s compliance efforts, as well as outside lawyers for the companies, had warned the defendants that paying commissions to independent contractors might well violate the AKS. Although the defendants adduced evidence that attorneys helped draft the contracts that provided for the commission payments, the labs did not obtain legal opinions saying that such payments were permitted under the AKS. The trial court refused to give a stand-alone “advice-of-counsel” instruction to the jury, and the Fourth Circuit affirmed that ruling, holding that a more generic “good faith” instruction sufficed given the defendants’ failure to show both that they made full disclosure of all pertinent facts to counsel and that they solicited a specific legal opinion during the relevant period of time.[1] Id. at 738-39.
The defendants also argued that commissions to salespeople can never constitute kickbacks under the AKS, and that they were entitled to judgment as a matter of law on that basis. But the court held that no language in the statute provides protection for all such arrangements, and said that “federal appellate courts have frequently, and indeed invariably, upheld [AKS] violations based on commission payments to third parties.” Id. at 738, citing United States v. St. Junius, 739 F.3d 193, 209-10 (5th Cir. 2013); United States v. Vernon, 723 F.3d 1234, 1256-58 (11th Cir. 2013); and United States v. Polin, 194 F.3d 863, 864-66 (7th Cir. 1999).
While the court recognized that the AKS expressly excepts from its coverage commission-based payments to bona fide employees, it held that this protection does not extend to independent contractors. The court observed that the Department of Health and Human Services (HHS) had, in 1989 and 1991, declined to expand the regulatory safe harbor for bona fide employees to allow payment to independent contractors on a commission basis, and that, on both occasions, HHS had justified its refusal on evidence of “abusive practices by sales personnel who are paid as independent contractors.” Mallory, 988 F.3d at 738, quoting 54 Fed. Reg. 3088, 3093 (Jan. 23, 1989); see also 56 Fed. Reg. 35952 (July 29, 1991).
The court also rejected the defendants’ contention that because BlueWave sales representatives did not directly refer the laboratories’ tests to patients, the defendants could not have violated the AKS. The court found that “the [AKS] expressly prohibits individuals from receiving remuneration in exchange for ‘arranging for or recommending purchasing’ healthcare services.” Mallory, 988 F.3d at 738, citing 42 U.S.C. §§ 1320a-7b(b)(1)(B) and (b)(2)(B). The fact that the sales contractor did not market directly to patients or refer the patients to the labs did not preclude a violation of the AKS, because the statute covers “sales representatives who are compensated for recommending a healthcare service, like the HDL or Singulex tests, to physicians.” Mallory, 988 F.3d at 738.
Industry lessons for independent sales agent relationships & the cost of FCA cases
The Fourth Circuit opinion in Mallory is a cautionary precedent for a few reasons. First, the application of the AKS to commission-based payments to independent sales contractors underscores the inherent risks posed by such arrangements given the broad language of the AKS. The court’s reliance on the appellate opinions in criminal AKS cases, like St. Junius, Vernon, and Polin, suggests that concerns about the nature of the underlying marketing and promotional activities – such as the processing and handling fees paid to the ordering physicians in the Mallory case – likely heighten the risk of scrutiny and legal exposure.
While commission-based payments to independent contractors do not enjoy safe harbor protection, the fact that an arrangement does not fit within a safe harbor does not mean that the arrangement is unlawful. And while the Office of Inspector General for HHS (OIG) has said that it believes “that many marketing and advertising activities may involve at least technical violations of the statute,” whether that would be the basis for an actual enforcement action depends on the underlying facts and circumstances. 56 Fed. Reg. 35952, at 35974 (July 29, 1991). The OIG it has never taken the position that all commission-based payments to contract sales agents are prohibited.
Indeed, independent sales agent arrangements are commonplace in the health care industry, and the OIG has issued guidance suggesting that such arrangements are permitted where the circumstances do not involve the risk of abuse. In its Pharmaceutical Manufacturer Compliance Program Guidance, for example, the OIG said that “[s]ales agents, whether employees or independent contractors, are paid to recommend and arrange for the purchase of the items or services they offer for sale on behalf of the pharmaceutical manufacturer they represent,” and that if such an arrangement cannot be structured to comply with the requirements of a safe harbor, it should be “carefully reviewed.” 68 Fed. Reg. at 23739 (May 5, 2003) (emphasis added). Among the factors that should be evaluated are: the amount of compensation; the identity of the sales agent engaged in the marketing or promotional activity (e.g., if the agent is a ‘‘white coat’’ marketer or otherwise in a position of exceptional influence); the sales agent’s relationship with his or her audience; the nature of the marketing or promotional activity; the item or service being promoted or marketed; and the composition of the target audience.” Id.
Similarly, when reviewing such arrangements in its advisory opinions, the OIG has considered the presence of factors like the following in assessing their appropriateness:
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compensation based on percentage of sales;
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direct billing of a Federal health care program by the seller for the item or service sold by the sales agent;
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direct contact between the sales agent and physicians in a position to order items or services that are then paid for by a Federal health care program;
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direct contact between the sales agent and Federal health care program beneficiaries;
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use of sales agents who are health care professionals or persons in a similar position to exert undue influence on purchasers or patients; or
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marketing of items or services that are separately reimbursable by a Federal health care program
See, e.g., Advisory Opinions 98-10 and 99-3. According to the OIG, “the more factors that are present, the greater the scrutiny we ordinarily will give an arrangement. Of course, in all cases the statute is not violated unless the parties have the requisite intent to induce referrals.” Id.
Mallory also underscores that the AKS’s proscription against remunerating any person to “arrange for or recommend” purchasing or ordering any service or item for which payment may be made under a Federal health care program is not toothless. See 42 U.S.C. § 1320a-7b(b)(2)(B). The Mallory opinion may serve as a reminder to entities that engage independent sales contractors or agents that, in addition to considering the factors the OIG has outlined, they need to ensure that they have in place appropriate compliance training, controls, and oversight over the incentives and activities of independent sales contractors.
Finally, Mallory illustrates that courts have no hesitation in applying the damage trebling and civil penalty provisions of the FCA to the damages awarded by a jury. After finding that “[a] violation of the [AKS] … automatically constitutes a false claim under the FCA,” the court affirmed the district court’s damages assessment under the FCA. Mallory, 988 F.3d at 735. This resulted in a judgment totaling more than $114 million, even though the jury only found a little more than $16 million in actual damages. Mallory shows the devastating financial impact that can flow from a violation of the FCA, particularly in the delivery of health care services, where the sheer volume of claims can result in a staggering number of statutory penalties. Mallory is just the most recent example of an FCA case where a defendant who went to trial ended up burdened with a judgment that imposed statutory penalties on all of the actionable claims, and a full measure of treble damages as well.
Authored by Mike Theis, Ron Wisor, and David Bastian
