U.S. Fraud Crackdown Eroding Private Equity’s Liability Shield

Insiders said one company pushed unnecessary pain medication to the U.S. military; another promoted an unproven treatment for children with cancer; and a third used unlicensed counselors to treat poor people with mental illness.

In all three cases, taxpayers footed the bill — and, before long, government authorities came looking for the companies’ owners: private equity.

Long insulated from legal liabilities at the companies they buy, these investment firms increasingly are being dragged into the mess when their charges get in trouble. A key reason: private equity has pushed into businesses that rely on taxpayer money, in particular, health care.

That has exposed them to so-called false-claims actions, where corporate whistle-blowers bring allegations of civil fraud to the attention of the federal government. So far, only a handful of cases have emerged. But experts expect more, given the vast potential for fraud in the expansive federal relief programs put in place to help the economy through the pandemic. They also expect the Biden administration to go after deep pockets on Wall Street.

“The ultimate safeguard you have is the threat of enforcement,” said William McSwain, who left his post as Philadelphia’s top federal prosecutor in January to join law firm Duane Morris. “That won’t change under President Biden; it will intensify.”

PPP Funds

The government is now going after bad actors after rushing billions of dollars out the door to keep companies and the health-care system afloat during the pandemic. Among other things, it is investigating whether businesses lied about needing loans under the Paycheck Protection Program, a relief effort that largely attempted to exclude private equity-backed companies.

In June, Ethan Davis, who was then the second-ranking official at the U.S. Department of Justice’s civil division, warned in a speech that private equity firms would be taken to task if they knowingly participated in relief fraud.

The government has the option to join whistle-blowers under the False Claims Act to hold companies it does business with accountable for fraudulent billing.

In 2018, Massachusetts Attorney General Maura Healey filed a civil fraud complaint against private equity firm HIG Capital, alleging it had a role in allegations related to its behavioral-health company, Community Intervention Services Inc.

Christine Martino-Fleming, who worked as a training coordinator, said in her complaint that an HIG staffer ignored her concerns about unsupervised, unlicensed therapists that treated mental-health patients.

“The pressure to grow was astronomical compared to what it had been” before HIG purchased the company, another staffer testified, according to the lawsuit.

Community Intervention Services settled for $4 million, and HIG is in mediation. In court papers, the companies denied undue pressure to increase revenue. They said no false claims were filed, Martino-Fleming never alerted them and care didn’t suffer.

Lawyers and former regulators have cautioned the private equity industry that the more active they are with investments, the greater the legal risks.

The industry’s playbook is to overhaul management, create efficiencies and keep close tabs on finances so investments can be sold for a hefty profit in several years. Following losses in the 2008 financial crisis, private equity became even more engaged with their companies to prevent similar mishaps.

Still, in most cases, private equity owners manage to avoid scrutiny. Since 2013, at least 25 private equity-backed health care companies have paid a combined $573 million in government fraud settlements, according to a report to be released Monday by the Private Equity Stakeholder Project, a nonprofit advocacy group that scrutinizes the industry. In only three did private equity firms agree to pay any money.

The industry remains worried. Businesses caught defrauding the government must pay triple the damages and as much as $23,000 per claim.

In 2019, private equity firm RLH Equity Partners and pharmaceutical company Patient Care America reached a $21 million settlement with the federal government. They resolved claims that the drug firm paid marketers for promoting expensive pain creams to military members that didn’t need the treatment. Representatives of RLH and Patient Care America said they both cooperated fully with the government and that the employees involved are no longer with the company.

Prosecutors said the private equity firm was involved because it approved of using marketers, reviewed financial statements with payments to them and funded some of their commissions. RLH said the government never proved it knew about alleged fraud.

“RLH learned an important lesson,” Murray Rudin, an RLH managing director, said in an email. “We are more careful in our ongoing monitoring of legal compliance within our portfolio companies, especially those that provide health-care services.”

In November, federal prosecutors announced another settlement. When Gores Group, a private equity firm run by billionaire Alec Gores, bought Therakos Inc., in 2013, the medical device company was improperly promoting a lymphoma treatment for use on children with bone marrow transplants, the government said. Gores, which denied any fraud, agreed to pay $1.5 million.

These settlements set a precedent for private equity as a defendant, said Murad Hussain, a partner at law firm Arnold & Porter Kaye Scholer. “The courts, case law and the private individuals who file most of these cases are taking notice,” he said.

–With assistance from Peter Eichenbaum.