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Legal Update
Does Equity Have to be Equal?
Jennifer Vecchio, Webb Millsaps
Publish Date: June 10, 2008

It's smart business to provide investment opportunities in your ASC to surgeons who help it profit. You might also be inclined to offer larger equity positions to the physician-investors who most use, or will most use, the ORs. But varying the percentages of ownership among physician-investors is risky under both federal and state anti-kickback laws, which strongly disfavor equity offers that correlate with previous or expected referral patterns. Two recent examples:

  • Federal regulators disapproved a hospital's proposed ASC acquisition because the hospital sought to buy out only a select group of physician-investors' equity, rather than to buy equity uniformly from all of the physician-investors.
  • A New Jersey court ruled against an ASC in which physicians owned varying amounts of equity, finding an unacceptable nexus between the varied percentages of ownership and the relative income the ASC expected to earn from each referring physician.

Offering every potential physician-investor the same percentage of equity in your ASC seems to be the low-risk approach. There are, however, specific instances when non-uniform ownership may occur or be accomplished without raising red flags, depending on the facts and intent of the equity offering. Here's a brief review.

Physicians' choice
When you offer equity interests to potential physician-investors, it may well be with the expectation that they'll make referrals and help generate income. This is standard practice in the ASC industry. But you may not skew the sizes of the offerings among them. You must offer each an equal opportunity to purchase the same amount of equity.

That doesn't mean they will, of course, and as long as physician-investors are offered equal investment opportunities (for example, each could buy up to 10 equity units), they may permissibly choose to buy various portions on an individual level (let's say one elects to buy seven units, another eight).

The equality of the offer must be uniform in all meaningful respects, however, not just in price and number of units. In particular, it is considered an unequal offer if explicit or implicit pressure is applied to encourage or discourage some of the investors in purchasing fewer or more shares than their peers.

Start-up "promoters"
For start-up surgical centers, on the other hand, there may be an exception to the rule of uniformly offered equity. In certain situations, founder or "promoter" physician-investors may permissibly be offered the opportunity to buy higher, non-uniform percentages in comparison to later investors, since reasonable arguments can be made that the founders or promoters — who spend significant time and effort developing the ASC — are differently situated than those who purchase equity after the ASC's initial development stage.

In this context, as in the one described earlier, offerings should be equal within similarly situated groups. Each promoter should be offered the same opportunity as the other promoters.

Offering promoters different investment opportunities than non-promoters is not necessarily free of regulatory risk, though. If the promoters hold the highest percentages of equity, on account of their greater investment opportunities, and are also the highest users of the ASC, it could be inferred that equity was sold based on expected referrals and prompt regulatory scrutiny, even if such a correlation was unintended or unanticipated.

Past as pattern
For existing ASCs seeking to raise capital through new physician-investors, the safest course of action is for each new investor to be given the opportunity to purchase an equivalent number of equity units as the investors in prior rounds were given.

Perhaps your ASC's circumstances have changed since an earlier investment round, though. In that case, you may be able to validly offer the new investors different amounts of equity than the previous investors were offered. The key here is whether there are valid reasons for the modified offering that are unrelated to and unmotivated by physician-investors' referral patterns.

Keep in mind that regulators tend to be suspicious of correlations involving non-uniform ownership and non-uniform utilization. For example, a regulator may question your intent if your ASC offered 10 units each to three high-utilizing physicians in July, then in October offered five units each to two new physicians who, coincidentally, are moderate utilizers. Even if there are new circumstances guiding this difference, regulators may question the rationale behind the two offerings and suspect they're based on referrals.

On the Books

  • CON Changes. Iowa legislators approved a bill that lets the state's 82 rural hospitals bypass the public hearing and approval stage that was required before certificates of need were granted for construction. Meanwhile, Florida Gov. Charlie Crist signed a bill requiring challengers to hospitals' new construction proposals to submit their concerns during the review, post a $1 million bond before appealing a CON approval and cover the hospital's legal expenses if their challenge fails.
  • Path Fee-splitting Loophole Closed. In dismissing a lawsuit challenging CMS's anti-markup rule, which bars physicians from billing for off-site anatomic pathology services, a federal judge has opened the door to its enforcement. The rule had been under a temporary injunction while three urology practice groups and path lab management company Uropath argued against it, but the judge ruled that the practices should have channeled their complaint through the Department of Health and Human Services and that Uropath, which doesn't participate in Medicare, had no legal standing to challenge the rule. The rule closes what critics saw as a loophole enabling fee-splitting.

— Compiled by David Bernard

Shares and share alike
Healthcare laws prohibit the offering of additional equity to existing physician-investors to induce or reward referrals, even if they're required to pay fair market value for those shares.

An ASC could be exposed to regulatory risk even when it's not a direct party to equity reapportionment, such as when one physician-investor sells shares directly to another. If a physician-investor with lower utilization sells equity to one with higher utilization, regulators may try to determine if pressure was applied to facilitate the sale. Indeed, physician-investors who claim to have been pressured might be the ones who bring regulatory scrutiny to your ASC.

That said, depending upon your facility's situation, it may be possible for your center to offer additional equity interests to either all existing physician-investors or to a defined subset of them, as long as the subset is defined by parameters unrelated to referral patterns. In both instances, there must be a commercially reasonable basis for the new offer, such as the ASC's need for more capital.

As before, you must offer each physician-investor eligible for the offer an equal opportunity to purchase the same number of additional units at fair market value. If structured properly, the offering may permissibly include over-allotment rights in the event that the amount of equity initially offered isn't fully sold. In that case, the leftover, unsold equity units could be offered on a pro rata basis to physician-investors who fully subscribed when the additional equity opportunity was first issued.

Under a sharp focus
The rapid growth of the ambulatory surgery industry and its dependence on referring physician-investors have led regulators to sharpen their focus on ASC equity arrangements. To reduce the risk of anti-kickback violations, it's essential to properly structure equity offerings and re-syndications involving your referring physicians. Before engaging in such activities, you should seek a risk analysis and the advice of a qualified health law attorney.