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US government sues PE firm for alleged kickback scheme

The case against buyout firm RLH and one of its portfolio companies may signal a 'significant development' in attempts to hold PE managers liable for portfolio company conduct, law firms say.

A US government fraud case against a private equity firm and one of its portfolio companies may signal what one law firm describes as a “significant further development in a recent trend involving attempts to hold private equity managers liable for portfolio company conduct.”

The United States government is suing Los Angeles buyout firm Riordan Lewis & Haden and its portfolio company Diabetic Care, alleging that the pharmacy paid illegal kickbacks to induce prescriptions for compounded drugs reimbursed by the US government’s military healthcare program, TRICARE. The US Department of Justice said it was suing RLH for its involvement in the alleged kickback scheme.

The US government says Diabetic Care, RLH and two executives of the pharmacy company, “paid kickbacks to marketing companies to target TRICARE beneficiaries for prescriptions for compounded pain creams, scar creams, and vitamins, without regard to the patients’ medical needs.”

The complaint goes on to say that RLH, Diabetic Care and the executives “allegedly paid telemedicine doctors to prescribe the creams and vitamins without seeing the patients, and sometimes paid the patients themselves to accept the prescriptions,” in a scheme which the government alleges “generated tens of millions of dollars” in profits which were split between the defendants.

“RLH has cooperated fully with the government’s investigation, but disputes the basis of the lawsuit,” Murray Rudin, managing director at RLH, told pfm. “RLH did not violate any law nor has the RLH fund which invested in Patient Care America profited from that investment. We intend to vigorously contest the allegations against RLH.”

RLH acquired Diabetic Care, since rebranded as Patient Care America, in 2012.

In a client memo, law firm Paul Weiss says the case is noteworthy because it “signals a possibly more expansive view of manager liability for portfolio company conduct.” The New York lawyers said that some of the allegations “highlight relatively common industry practices, including having a private equity firm’s partners serve as portfolio company board members, playing a role in selecting portfolio company management and implementing internal controls over portfolio company spending.”

Other lawyers agree that the case underscores the need for private equity managers to consider their level of control at an underlying portfolio company, especially in the healthcare space.

“The complaint’s emphasis on the private equity firm’s involvement with, knowledge about and control over certain elements of the pharmacy may suggest that the greater the involvement in the portfolio company, the more likely it could be for the private equity firm to face liability under the False Claims Act,” Leslie Levinson and Erica Youngerman at US law firm Robinson+Cole wrote in a note on the case.

“This case highlights the need for private equity firms to be cognizant of their level of involvement in the operations of their portfolio companies. Examples of areas to consider include, but are not limited to: whether or not to have private equity leadership serve on the portfolio company’s board, what level of control to maintain over the portfolio company’s directions or objectives and what approval rights to retain over spending and contracting.”

RLH, which invests in healthcare, business services and government services businesses, is currently investing its fourth fund which it closed in October last year on $511 million.