Finding a Safe Harbor: Anti-Kickback Implications of Medical Device Consulting Agreements

Medical Device & Diagnostic Industry Magazine
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An MD&DI May 1999 Column

To avoid violating government bribery regulations, device companies need to be extremely careful in planning, drafting, and monitoring consulting agreements with physicians who use their products.

Most medical device companies are familiar with governmental enforcement actions through FDA's Office of General Counsel and its Office of Criminal Investigations, which enforce the provisions of the Federal Food, Drug, and Cosmetic Act. Fewer companies have experience with the HHS Office of the Inspector General (OIG), which, in conjunction with the Department of Justice, enforces the Medicare and Medicaid fraud and abuse laws. Chief among these is the Anti-Kickback Statute, 42 USC 1320-7b, which criminalizes any payment by a supplier to a customer made—in whole or in part—to induce sales.

Medical device companies often enter into consulting agreements with physicians who use their products. These agreements can call for substantial payments—on occasion amounting to hundreds of thousands of dollars per year per physician—yet frequently have only vaguely defined duties for which there may be little follow-up or tangible result. Such arrangements are vulnerable under the Anti-Kickback Statute because they have not been designed to satisfy the provisions of that law and its attendant regulations. Substantially more thought and analysis needs to go into constructing these arrangements and following up on their provisions, lest device manufacturers find themselves on the wrong end of an OIG civil or criminal investigation—an experience that can result in enormous short- and long-term costs.

This article reviews the application of the Anti-Kickback Statute to medical device consulting agreements. (Although the case law developed around the marketing practices of pharmaceutical companies and healthcare providers, it is equally applicable to device manufacturers.) Some of the common pitfalls of consulting agreements are discussed, along with the potential civil and criminal consequences that can arise from a poorly drafted, poorly documented, or poorly monitored agreement. Recommendations are also offered on how to design agreements that minimize the risks of exposure under the statute.

ANTI-KICKBACK STATUTE REVIEW

The Anti-Kickback Statute is extremely broad. The law punishes anyone who "knowingly and willfully offers or pays any remuneration (including any kickback, bribe, or rebate) directly or indirectly, overtly or covertly, in cash or in kind to any person to induce such person . . . to purchase, lease, order, or arrange for or recommend purchasing, leasing, or ordering any good, facility, service, or item for which payment may be made in whole or in part under a Federal health care program."¹ To prove a violation of the Anti-Kickback Statute under the prevailing law, the government must demonstrate that the defendant knowingly and willfully offered or paid remuneration to a healthcare professional or patient; that the defendant made the offer or payment with the purpose of inducing the healthcare professional or patient to recommend or order its product; and that the cost of the product was reimbursed in whole or in part by a federal healthcare program.² For a violation to occur, only one purpose of the payment needs to be the inducing of a recommendation or order.³

Because the statute covers virtually any relationship with a customer, OIG promulgated regulations—termed "safe harbors"—that set out certain types of arrangements for which the government will not seek enforcement action despite a literal violation of the terms of the law. One of the most widely used safe harbors governs personal-services contracts.⁴ For an agreement to fall within this safe harbor, six requirements must be satisfied:

The personal-services contract safe harbor creates a trap for the unwary. If any one of the six requirements is not satisfied, the safe harbor does not apply, and the company can face criminal, civil, and administrative enforcement actions for perceived violations of the Anti-Kickback Statute.

CONSULTING ARRANGEMENT PITFALLS

The following discussion highlights a number of pitfalls common to the typical consulting agreements that medical device companies enter into with physicians who may be in a position to use or recommend their products.

Consultant Selection. The first shortcoming of many consulting agreements relates to the selection of the physician who is actually going to do the consulting work. The understandable goal from the company's perspective is to sign up the most influential member of the medical community possible, thereby securing the services of a national or local leader in a surgical or diagnostic field. This goal, unfortunately, may be overly influenced by the desire to obtain commitments from users of the company's products or to sign up an influential physician as an unofficial endorser of the company's product line, rather than for the substantive contribution that the physician can make as a consultant.

Part of the problem may stem from the organizational unit within the company that selects the consultants, especially when these decisions are made by the sales or marketing departments rather than by the engineering, research and development, or regulatory affairs departments. Even when the sales or marketing department does not have control over the decision-making process, these departments typically weigh in with their opinions. Perhaps inevitably, actual or potential sales creep in as an explicit or implicit factor in consultant selection or recommendation.

As in any other business environment, the analysis of how an action will impact sales is a rational consideration. However, given the government's current view of healthcare companies as an enforcement priority and the litigious healthcare environment of the late 20th century, the existence of a document assessing the impact of payments on sales is akin to handing a prosecutor a loaded gun. As discussed above, under the Anti-Kickback Statute, the government only needs to prove that one purpose—perhaps not even the most important purpose—of a consulting agreement was to increase sales.³ Often, the company's internal documents provide the necessary evidence of purpose, typically in memorandums from the sales department making a case for a consulting agreement based on current or future sales to that consultant. Moreover, these same documents can disqualify a company from the protection of the personal-services contract safe harbor.⁵

Duties. Another pitfall common to medical consulting agreements is the manner in which the duties to be performed by the consultant are defined. Frequently, the agreements deal only in vague generalities regarding the type of work the consultant is being asked to undertake. For example, there are often broad references to providing "such consulting services as are required" by the company, or to providing "clinical advice and assistance" regarding a particular medical device.

The problem with such broad language is that it makes a consultant's performance—the services a company is actually getting for its money—difficult to measure. Indeed, when the duties are not carefully defined in the agreement, the value of the consulting services for which the company is paying is not apparent, which may lend credence to a prosecutor's argument that the agreement is a sham to cover up a bribe to a customer. Moreover, the safe harbor itself requires that the agreement specify "the services to be provided" by the consultant.⁶

Even when the consultant's duties are more narrowly defined, the particular language in an agreement can make a consultant's performance difficult to monitor and evaluate. For instance, "collecting and maintaining efficacy data" does not specify the form or accessibility of a database, while "reviewing clinical outcomes data" does not indicate the level of analysis or provide a format for the review.

Similarly, many consulting agreements do not adequately define the consultant's time commitment. There is no clause in the contract specifying that the consultant will devote a certain number of hours or days for a set time period to the company's projects. This lack of specificity may make the government suspicious by creating the impression that little is being required of the consultant. In addition, it will remove the agreement from the safe-harbor provisions, which require such specificity.⁶

Compensation. Although reasonable by industry standards, the numbers involved in medical device consulting agreements can be staggering to a layperson. Payments of $50,000, $100,000, or even $250,000 a year are common—for what can be viewed as, at most, a side job requiring a few hours of work a week. Such sums can be difficult to defend to a jury inexperienced in industry norms and uninformed about the value of physicians' services, especially if the duties are not well defined and a careful analysis of the compensation to be paid has not been undertaken.

In fact, many consulting agreements give evidence of a troubling lack of forethought regarding how much the consultant should be paid. Often, no fair-market-value analysis is undertaken to determine what the price of the services should be, as is required under safe-harbor provisions.⁵ When confronted with a government investigation into such a consulting agreement, the company can be left to scramble to justify the amount of money conferred on the consultant. When that justification is unconvincing, the government naturally assumes that it is a post hoc attempt to defend the indefensible.

Even when there has been some fair-market-value analysis of the consultant's services, it may be the wrong analysis. Medical device companies often use the amount of money foregone by the consultant as a measure of what his or her services are worth. Thus, if a surgeon generates $10,000 from procedures each day, the company uses that figure as a basis for computing a daily or hourly fee for consulting services.

The potential problem with using a foregone-income analysis is that it compensates the consultant for the income given up, rather than for the value of services rendered to the company. To the government, this may look too much like simply paying the consultant to focus on (or use) the company's products. Such a payment scheme may violate the safe harbor for personal-services contracts in the anti-kickback regulations, leaving the company vulnerable to government enforcement action.⁵ Even if a company ultimately persuades the government of the validity of its analysis, the effort will be costly and time-consuming.

Negotiation. In some medical device firms, the negotiation of consulting agreements with physician/customers is handled by the sales department or even by independent distributors. These circumstances can cloud the objective assessment of a consultant's expertise and potential to contribute to the development of the company's products or lead to the retention of a consultant on the company's payroll when his or her performance no longer merits it.

As important as the identity of the negotiator is the manner in which consultant expenses are allocated. When the consulting agreement is negotiated by the sales or marketing department, it often appears as a line item in that department's budget on the general ledger. No matter how innocent the intentions, and regardless of the actual value provided by the consultant, a $50,000 payment to a consultant that is journaled as an expense under "sales" may give the wrong impression to a government investigator.

Drafting an Agreement. A surprising number of consulting agreements with physician/customers are not drafted or approved by counsel thoroughly familiar with the Anti-Kickback Statute and the safe-harbor provisions. Rather than being routed through the company's legal department or outside counsel for substantive review, consulting agreements are often written by the senior businessperson responsible for sales or research and development. At best, this process may produce documents that lack standard contractual language protecting the company's interests. At worst, the agreements may contain contingencies that could be viewed as direct evidence of anti-kickback violations, such as requirements that the consultant use the company's products.⁷

The failure to route documents through counsel also reduces the standardization of the agreements. Moreover, without a centralized location where agreements are maintained, the company can lose track of what agreements it has outstanding and what provisions the various iterations and drafts contain.

Document control becomes vital when the government mounts an investigation. Through its subpoena power, the government will have access to documents from many sources in addition to the company's files. If there is an agreement that exists in a customer's or a distributor's file, but cannot be located in the company's files, the company will essentially be flying blind during the investigation. In this arena, what you don't know—or can't find—can hurt you.

Documentation. Another area where medical device companies commonly fall short is in documenting a consultant's services—neglecting, for example, to keep a contemporaneous written record of work accomplished. Thus, a surgeon may provide critical advice to the company's engineering department regarding the instrumentation necessary to implant a device, but that input is not preserved in any written record.

Similarly, the consultant often has no accountability to the company for the performance of the duties described in the consulting agreement. There may not be a provision permitting the company to rescind the agreement if the consultant fails to provide the agreed-upon services or devote the agreed-upon time, or the company may simply fail to follow up with the consultant to monitor performance. In other instances, the company may have an agreement in place with a willing consultant but never call upon the consultant to provide any services.

Once an inquiry begins, proper documentation becomes critical. In order to successfully defend an agreement, the company must be able to assemble documents proving that the consultant lived up to his or her end of the bargain by providing legitimate and valuable services, which were monitored and evaluated by the company. When an agreement has been in place for several years with a major customer without documentation of effort, monitoring and evaluation of performance, and tangible results, the government's doubt can translate into an enforcement action.

CONSEQUENCES OF NONCOMPLIANCE

The costs of defending an investigation brought by the government under the Anti-Kickback Statute can be extraordinarily high. The combination of attorneys' fees, the disabling effect on employee productivity, and the distraction from the company's business goals alone can make a poorly structured consulting agreement seem like an unwise investment. When criminal, civil, and administrative sanctions are added, however, costs can soon increase geometrically.

Criminal Sanctions. Criminal sanctions against a company can be severe. Under the principles of corporate liability, a company is liable for the acts of its agents, including officers, employees, and independent contractors.⁸ Both the company and individual employees and officers can be prosecuted, resulting in criminal convictions, fines, and imprisonment.

Under federal law, all organizations convicted of criminal offenses are subject to the federal sentencing guidelines, which are likely to be the starting point for any negotiated settlement and will establish the fine if the company is convicted after a trial. The sentencing guidelines direct that—in lieu of calculating the base fine under the organizational sentencing guidelines—the court is to use the greatest of "the value of the unlawful payment; the value of the benefit received; or the consequential damages resulting from the unlawful payment."⁹

The value of the unlawful payment is relatively straightforward. The government will contend that the consulting agreement was a scheme to bribe doctors for sales, thereby making the aggregate of all of the consulting payments the relevant loss for calculation of the organizational fine. Because this calculation will usually not yield the greatest dollar amount, the fine is likely to turn on a calculation of the benefit conferred or the consequential damages resulting from the unlawful payment.

The "value of the benefit received" refers to the value of the action to be taken or effected in return for the bribe.¹⁰ In a commercial bribery case, for both parties, the value of an additional contract obtained by the bribe is the net benefit conferred, which is determined by taking gross revenues minus direct costs. Indirect costs such as overhead are not deducted from gross value because they have no impact on the harm caused by the illegal conduct.¹¹Direct costs are defined as "all variable costs that can be specifically identified as costs of performing a contract, that is, expenses which would not have been incurred, but for the corruptly obtained orders. . . ."¹² The amount of the bribe itself is not deductible as a direct expense.¹³ Moreover, the significant costs of research and development of the device may not be deductible as direct expenses.¹⁴ The costs of goods sold and the costs of delivery would, however, be deductible as direct expenses.¹⁵

The government will likely take the position that the value of the benefit conferred would be the total sales of the relevant product or products to doctors with consulting agreements or their respective institutions. From this total sales figure, direct costs would have to be deducted to determine the net benefit conferred. Thus, the government's settlement offer, or its position at sentencing, will cost the company all of the sales generated by the consultant's practice.

The third method of establishing a fine under the sentencing guidelines is according to the consequential damages resulting from the unlawful payment. The government would likely assert that this measure includes at least two components: the loss to payers resulting from the unlawful payments, and the value of the business taken from other competitors as a result of the unlawful payments.

The government often argues that the loss to payers resulting from the unlawful conduct is the cost of treating those patients who were treated by physicians receiving consulting payments. As under the previous measure, the company could lose its total sales to physicians with consulting agreements.

The other aspect of consequential damages, loss to competitors, is more difficult to measure. According to one court of appeals, in a commercial bribery case, "the harm caused by a bribe is the value lost to a competing party had the bribe not been paid."¹⁶ Under the sentencing guidelines, the government frequently contends that it does not have to prove the loss to competitors with any precision.¹⁷ As a result, the company could also be penalized for its competitors' lost sales.

Collateral Consequences. A company can face serious collateral consequences from a criminal conviction under the Anti-Kickback Statute. Regulations recently issued by the government mandate that indirect suppliers, such as medical device companies, must be excluded on conviction of a healthcare offense from receiving direct or indirect reimbursement from the government for a period up to five years— surely the death knell for any medical device company.¹⁸ The company and individuals will also likely be debarred from entering into any new direct supplier contracts with the government.¹⁹ These debarment and exclusion provisions give the government almost irresistible settlement leverage.

If a publicly held company is convicted, shareholder litigation is almost a certainty. Defense of such actions is made difficult by the preclusive effect of the criminal conviction. As a result, the company faces the likelihood of significant litigation expenses, both in terms of attorneys fees and settlement costs. Finally, even more than these short-term costs, the damage to the company's reputation and share value can be incalculable.

CREATING SAFE AGREEMENTS

The important thing to remember is that there is nothing wrong with consulting agreements if they are the product of careful thought and consistent follow-through. In fact, there are important reasons for medical device companies to have consulting agreements with physicians who use their products.

Many devices have unique features that require the services of knowledgeable medical practitioners for proper evaluation. For example, device performance cannot always be adequately measured in short-term clinical trials; companies often need outcomes data over long periods of time to measure the performance of their products. Clinicians are positioned to collect and maintain this type of information as they follow their own patients through follow-up visits over the patients' lifetimes.

Physicians who use devices in procedures often have invaluable insights about the design and use of such products. Because surgical and diagnostic conditions are not possible to replicate in an engineering laboratory, such experiential knowledge can be irreplaceable.

These and other valid rationales for consulting agreements can be effectuated by some relatively straightforward considerations that will enable medical device companies to avoid potential problems.

Consultant Selection. Although perhaps a truism, consultants should be selected based solely on their expertise and on the need for their services, not on their sales figures.

Duties. Under the safe-harbor provisions, the consultant's duties and obligations need to be clearly defined in the agreement. Whether it's a question of testing devices; collecting data on implanted devices; reviewing IDEs, 510(k)s, or other regulatory submissions; or performing other consulting services, the agreement should expressly delimit the consultant's duties. Moreover, the agreement should specify the time commitment required from the consultant on a monthly, quarterly, or some other periodic basis, and it is advisable to pay the consultant for services rendered rather than in advance.

Merely defining the duties and time commitment is not enough; the company must also monitor the consultant's performance. In the unusual cases in which the consultant does not meet agreed-upon expectations, the company must reduce or eliminate compensation.

Compensation. Under the safe harbor for personal-services contracts, the consultant's compensation must be set at fair market value—not by foregone income—and specified for each interval of work to be performed. Thus, the cost of hiring a like expert for like services determines the range within which the consultant can be paid.

Making this determination can be difficult when there is no easily determinable market for the consultant's services. In such instances, the company must make its best approximation, based on some rational, defensible method that will withstand governmental scrutiny. Sometimes, the consultant will set the hourly or daily fee required for compensation; in other cases, the company must analyze the services to be provided and assign them a reasonable value.

Negotiation. The negotiation of the consulting agreements should be taken out of the hands of the sales and marketing departments and should not represent a line item in those departments' budgets. Once a standardized agreement has been developed, the engineering or research and development department may be the most appropriate one to negotiate and pay for consulting services.

Drafting an Agreement. Consulting agreements should be standardized agreements that have been reviewed and approved by in-house counsel as well as by counsel familiar with the provisions of the Anti-Kickback Statute. These agreements should be maintained in a centralized location for ease of review and access. Among other things, the agreements should contain standard contractual terms regarding consideration, severability, choice of law, and arbitrability of disputes, as well as provisions that give the company the right to rescind the agreement for nonperformance or reduce the compensation for unsatisfactory work. Under the safe harbor, the agreement must be for a term of at least one year.²⁰ Because these agreements are contracts, they should be drafted with the same care accorded any binding agreement to which the medical device company is a party.

Documentation. Once the consultant's duties are defined and compensation agreed upon, the company must be careful to document the effort expended by the consultant. This documentation can often be generated simply by requesting invoices or statements of work performed from the consultant, which can then be centrally maintained for future reference.

Equally important is the documentation of the result produced by the consultant's efforts. Whether in the form of notes in an engineering laboratory notebook or a memorandum of conversation in the file, some energy needs to be devoted to producing and maintaining a record of the consultant's advice. Because the consultant's input may come, for example, in the form of a telephone conversation suggesting a modification in a device or its instrumentation, there may not be any document reflecting the value added by the consultant—thus justifying payment—without the company taking steps to ensure that it is recorded.

One cannot underestimate the importance of collecting and maintaining this documentation of the consulting services. These documents will constitute evidence that the company can show to the government to defend the legitimacy of the agreement. Moreover, if these documents are produced and maintained in the regular course of business, as is suggested here, they will be admissible in court in the event that the government pursues litigation.

CONCLUSION

According to the old saying, an ounce of prevention is worth a pound of cure. The straightforward steps outlined in this article will go a long way in defending against a government investigation into a company's consulting agreements with its physician/customers. Although nothing is foolproof, this relatively small investment of time and resources up front can pay substantial dividends in the long run.