Advanced Valuation Issues in Oncology Transactions

2. A Brave New World – But Not for the Unwary Advanced Valuation Issues in Oncology Transactions Adria Warren Jason Ruchaber Foley & Lardner, LLP Berkeley Research Group Curtis Bernstein Andrea Ferrari Pinnacle Healthcare HealthCare Appraisers, Inc. Consulting

3. FMV – Why it Matters Regulatory Framework • Federal Anti-Kickback Statute • Federal Stark Law • False Claims Act • Civil Monetary Penalty Law • Tax Exemption Issues • Private Benefit and Private Inurement • Intermediate Sanctions • State Laws

4. FMV – Why it Matters Anti-Kickback Statute • Prohibits knowing and willful offer or receipt of remuneration intended to induce or arrange for referrals of business paid for by Medicare/Medicaid programs • Civil monetary and criminal penalties • CMP of $50,000 per violation • Criminal penalties: $25,000 per violation and/orup to five years in jail • Exclusion

5. FMV – Why it Matters Anti-Kickback Statute • Any purpose test and problem of mixed motives • ACA § 6402(f)(2): violation does not require actual knowledge of AKS or specific intent to commit a violation • ACA § 6402(f)(1): claim for items or services resulting from AKS violation constitutes a false claim under the False Claims Act • Safe Harbors provide immunity • Safe harbors are not required • Many safe harbors require FMV and commercially reasonable remuneration

6. FMV – Why it Matters Anti-Kickback Statute • Is the purchase price a disguised kickback from the buyer (overpayment) or seller (underpayment) to induce post-deal referrals? • Valuation may help negate an adverse inference of improper intent • To the extent that a payment exceeds FMV, it can be inferred that the excess amount over FMV is intended as payment for the referral of health-program business. U.S. v. Lipkis, 770 F.2d 1447, 1449 (9th Cir. 1985)

7. FMV – Why it Matters Stark Law In general, if a physician has a direct or indirect financial relationship with a DHS entity : • The physician may not make a referral to that entity for the furnishing of designated health services" (“DHS”) for which payment otherwise may be made under Medicare, • and the entity may not bill Medicare, an individual or another payor for the DHS performed pursuant to the prohibited referral • "Designated health services" includes all inpatient and outpatient hospital services, lab, imaging, pharmacy, DME, radiation therapy, PT, occupational and speech therapy, perenteral and enteral drugs, nutrients, and supplies, prosthetics, orthodics, and home health services • … unless a specific exception applies

8. FMV – Why it Matters Stark Law • $15,000 civil monetary penalty assessed against physician for each prohibited referral • DHS entity must refund DHS billed pursuant to a prohibited referral • $15,000 civil monetary penalty assessed against DHS entity for billing for service rendered pursuant to a prohibited referral, unless it can show that it did not have actual knowledge and did not act in reckless disregard or deliberate ignorance of the prohibited referral • $100,000 civil monetary penalty for circumvention schemes • Requirement to report to HHS financial relationships with physicians upon request; $10,000 penalty for failure to report • Potential exclusion

9. FMV – Why it Matters Stark Law • Strict liability/zero tolerance law • Burden of proof is on defendant • Violations are not remedied until referring physician/DHS entity repays excess compensation or arrangement is terminated • Exceptions: • Isolated Transactions • Personal Services Arrangements • Bona Fide Employment • Rental of Space, Equipment • Fair Market Value Compensation • Indirect Compensation Arrangements • Multiple exceptions have fair market value requirement

10. FMV – Why it Matters False Claims Act • Permits private persons -- “relators” or “whistleblowers”, to recover damages on behalf of the United States from, any person who: • knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval; • knowingly makes, uses or causes to be made or used, a false record or statement material to a false or fraudulent claim; • conspires to [defraud the government]; or • knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the government or knowingly conceals… avoids or decreases an obligation to pay or transmit money or property to the government. • Violations of the FCA are punishable by up to $10,000, plus treble damages.

11. FMV – Why it Matters Tax Exemption IRC § 501(c)(3) • Entities tax-exempt under this section must operate exclusively for tax exempt purposes and not engage in compensation practices that result in private inurement • Penalties for non-compliance • Intermediate sanctions • Loss of tax exemption • Many hospitals, health systems, academic medical centers are tax exempt • General guidelines • Compensation to physicians should be FMV for services provided • Total compensation paid should be reasonable for the market and responsibilities • IRC § 162 – “reasonable” compensation is the amount that would ordinarily be paid for like services by like enterprises under like circumstances

12. FMV – Why it Matters State Laws State Law Issues • State self-referral laws • May apply to a broader scope of relationships than Stark (not just physician financial relationships) • May apply to a broader scope of services than “DHS” • State anti-kickback issues • May apply with respect to all services, not just those payable by Medicare or other Federal healthcare programs • May include “fee splitting” prohibitions

13. FMV – Why it Matters In the health care context, -- FMV is generally defined to mean FMV for actual and necessary items furnished or services rendered, based upon an arm’s length transaction, and without taking into account, directly or indirectly, the value of volume of any past or future referrals or the ability to influence the flow of business generated between the parties. (70 Fed. Reg., 4858, 4866 (2005)) -- Commercial Reasonableness is generally defined to mean a sensible, prudent business arrangement from the perspective of the particular parties involved, even in the absence of referrals (69 Fed. Reg. 16093 (2004))

14. FMV – Why it Matters 2005 OIG Supplemental Compliance Program Guidance for Hospitals Arrangements under which hospitals (1) provide physicians with items or services for free or less than fair market value, (2) relieve physicians of financial obligations they otherwise would incur, or (3) inflate compensation paid to physicians for items or services pose significant risk. In such circumstances, an inference arises that the remuneration may be in exchange for generating business. (70 Fed. Reg., 4858, 4866 (Jan. 31, 2005))

15. FMV – Why it Matters 2015 OIG Fraud Alert: Physician Compensation Arrangements May Result in Significant Liability • Physicians who enter into compensation arrangements, such as medical directorships, must ensure those arrangements reflect FMV for bona fide services the physicians actually provide • Arrangement may violate AKS if even one purpose is to compensate the physician for referrals • Government recently reached settlements with 12 individual physicians who entered into questionable medical directorship and office staff arrangements • OIG believed it took into account referrals and did not reflect FMV because the physicians did not actually provide the services contemplated

16. FMV – Why it Matters Enforcement • Enforcement through qui tam suits is on the rise • 700+ qui tam actions filed in each of FY2013 and FY2014, 638 filed in FY2015 (source: DOJ press releases) • $16.5 billion in Federal health care fraud recoveries since 2009, $1.9 billion of that amount was in 2015 • Focus on physician compensation arrangements • The “Yates Memo” – Individual accountability in the eyes of the DOJ? • Select 2015 enforcement actions: • Tuomey Healthcare – $237.5M judgment; settled for $72.4M • Columbus Regional Healthcare System –$35M • Citizen’s Medical Center - $21.74M • North Broward Hospital District – $69.5M • Adventist Health System - $118M

17. FMV – Why it Matters Fair Market Value is central to the compliance analysis; payments must be FMV, commercially reasonable, and cannot vary with anticipated referrals.

18. Valuation Challenges in Oncology Business TransactionsJason Ruchaber Berkeley Research Group

19. Emerging Trends and Challenges • Reimbursement environment continues to be uncertain • RT negative impact in 2016 MFPS • Transition to Value Based Reimbursement • New restrictions on HOPD conversions in the Budget Act • Transactions are becoming more complex and multi-faceted • Fewer straight equity acquisitions or joint ventures • Increase in Service Line Joint Venture and contractual affiliation arrangements • Increase in intellectual property commercialization and licensing

20. Impact of Reimbursement Uncertainty • Valuation is a function of the expectations for future economic benefits adjusted for the uncertainty (risk) of realizing those benefits. • Reimbursement uncertainty impacts value by lowering expectations for growth (lower growth = lower value) and increasing the risk that a change could materially impact the business. • Note: The risk profile for reimbursement is asymmetric, with little to no change of a material increase, and a higher likelihood of a material decrease.

21. Service Line Joint Ventures • Often structured as contractual joint ventures where no equity ownership is involved • Critical to understand the contract terms to value the arrangement, including: • Governance and oversight • Measurement of initial contributions • Ongoing measurement of income and expenses • Financial treatment of future capital expenditures and ownership upon termination • Payments between parties upon dissolution • Use of gained knowledge outside of SLJV • Restrictive covenants

22. Service Line JV Valuation Considerations • Should not be valued as if an equity investment, but should consider the characteristics of the contract: • Duration of arrangement • Measurement of income • Taxation • Executive oversight, control • Ownership rights on exit/dissolution • Appraisal should consider FMV of both entity’s service line independent of the JV • Appraisal should also consider changes in rights, obligations and benefits that may result from the JV structure

23. Intellectual Property • Types of IP • Marketing related IP (Brand Names, logos, etc.) • Clinical Protocols, Pathways • “Franchise Models” • Licensing Considerations • Geography, Duration, Exclusivity • Incremental benefits obtained through use of IP • Availability and prevalence of acceptable alternatives • Rate of technological advancement / obsolescence • Inclusion of services / know-how • Cross-licenses

24. Employment of Physicians Curtis Bernstein Pinnacle Healthcare Consulting

25. Benchmarking Overview of Benchmarking Process • Comparison to a known standard • * Most common for compensation valuation purposes

26. Market Approach Detail Benchmarking • Three sub-methodologies under the Market Approach all rely upon different types of benchmark data • Published Compensation Method • Published surveys report total annual compensation by physician specialty • Often normalized to hourly rates • Productivity Method • Published surveys report annual productivity (typically WRVUs) per FTE physician • Production matched with compensation ratios ($/WRVU) to match compensation to work effort • Market Comparable Method • Compensation arrangements identified through Pinnacle’s internal database and primary research

27. Prevalence of Published Data in Valuation Analysis Benchmarking • Though not perfect, survey-based methodologies often relied upon heavily in valuation analysis

28. In-Depth Analysis of Primary Published Sources Benchmarking * Additional sources (BLS, specialty societies, etc.) utilized when necessary

29. Factors to Consider when Utilizing Benchmark Data Benchmarking • Physician / Arrangement Specific Factors • FTE status • Historical compensation and productivity • Unique training or sub-specialization • Market Specific Factors • Community Need / Demand for Services • Supply / Demand of Key Specialties • Payer Mix and Reimbursement • Practice Efficiency / Expense • Community Expectations • Remoteness / Access to Other Services • Competition

30. Common Pitfalls in Use of Benchmark Data Benchmarking • Inconsistent application of data (“Cherry Picking”) • Failure to normalize data to match survey definitions • E.g., including malpractice premium in calculation of compensation • Matching annual compensation / productivity percentiles to ratios

31. Recent Trends in Benchmarks

32. Recent Trends in Benchmarks

33. Application of the 90th Percentile Benchmarking • Discussion within valuation industry around when / if it is appropriate to apply the 90th percentile of survey data • Although it can be viewed as an aggressive approach by some, it is Pinnacle’s opinion that there are a number of situations where the 90th percentile of data is a valid comparison • Specific instances where 90th percentile is applicable • WRVUs that exceed the 90th percentile • Sub-specialty data not available, broader specialty data applied as a proxy (e.g., hematology / oncology vs. bone marrow transplant) • Significant training, sub-specialization and / or leadership responsibilities (“KOL” status) • Calculation of premium for PRN coverage • Additional circumstances, analyzed case-by-case • Additional documentation is advised when the 90th percentile is selected

34. $/WRVU and Highly Productive Physicians Benchmarking Employed physicians consistently exceeding 90th percentile WRVUs Pinnacle’s stance is that physicians should be rewarded for more work…to a point Safeguards should be in place to validate production at these levels (coding audits, financial analysis of professional collections, etc.) The organization takes on risk with respect to quality / patient satisfaction as productivity moves farther above 90th percentile (what resources can be deployed to support?)

35. Compensation Valuation Examples Compensation Valuation Step-by-step walkthrough of valuation process for relevant arrangement types (medical directorship, physician employment arrangement) Discussion of how components of a given arrangement fit together from an FMV perspective and when it is / is not appropriate to “stack” compensation

36. Compensation Valuation Examples Compensation Valuation At a high level, the goal of compensation is to match the expectations of the hospital to the physician’s duties and responsibilities while considering market factors and regulatory requirements

37. Compensation Valuation – Drivers of Value Compensation Valuation

38. Compensation Valuation – Drivers of Value Compensation Valuation

39. Compensation Valuation – Drivers of Value Compensation Valuation

40. Compensation Valuation – Drivers of Value Compensation Valuation

41. Let’s Ride in the Time Machine: Assessing Value Then, Now and in the Future Andrea Ferrari, JD, MPH Healthcare Appraisers, Inc.

42. The World in 2011 • Notable increase in practice acquisitions and physician employment by hospitals • Belief that employment could reduced risks • Referral and sharing of ancillaries without violating fraud and abuse laws • Hiring for competitive purposes

43. The World in 2011 • PSA arrangements gaining in popularity • Group physicians paid compensation on an aggregate fixed fee or wRVU basis • May eliminate risk of reimbursement reductions and collections • Purchase of equipment, management services, staff through employee lease • Hospital establishes new satellite sites or facility and new book of oncology business • Good contribution margin due to combination of hospital rates and physician office cost structure • Potential for 340B pricing

44. The World in 2011Compensation Stacking: If you label compensation layers by different names, you can stack them higher and higher! • Sign-on bonus • Productivity bonus • Medical directorship • Retention bonus • Call pay • Tail insurance • Excess vacation • Relocation costs • Additional Benefits • Co-management • Quality bonus

45. (Fast Forward) The World in 2016 U.S. ex rel. Schaengold v. Memorial Health, Inc. – Settled December 2015 Filed: 2011 Settlement amount: $9.8 million Relator: Former hospital CEO Allegations: Hospital’s payments to purchase physician practice and employ practice’s physicians exceeded fair market value, were not commercially reasonable and took into consideration the volume and value of the physician’s referrals; key evidence related to alleged lack of need for the physicians’ services to support the hospital, and known and persistent hospital losses from the payments to the physicians if one did not take into consideration hospital revenue from referrals U.S. ex rel. Drakeford v. Tuomey Health System– Settled October 2015 Filed: 2006 (nearly a decade of investigation and litigation) Settlement amount: $79.5 million (after $237.5 million judgement was issued by trial court and upheld by appeals court) Relator: Staff physician who declined to enter the arrangement offered to him Allegations: Employment arrangements with 19 physicians were not fair market value, not commercially reasonable, and took into account the physicians’ volume and value of referrals; evidence included known and persistent losses from physician compensation in excess of collections, and physician compensation that varied with technical revenues; defendant’s 3 page fair market value report , which indicated that agreements were fair market value, unpersuasive in the trial

46. The World in 2016 U.S. ex rel. Payne/Dorsey, et al. v Adventist Health – Settled September 2015 Filed: 2010 Settlement amount: $118 million! ($115 million to Feds, balance to state governments) Relators: Included Compliance Officer, Risk Manager, and Chief Operating Officer of physician enterprise Allegations: Compensation to employed physicians and midlevel providers was above fair market value, not commercially reasonable and based on volume or value of referrals; evidence included substantial and consistent losses by the employer and inflated RVUs used as the basis for the compensation; allegation that inpatient and ancillary services contribution margins from referrals were internally tracked and included in methodology for calculating bonuses; alleged strategy to pay excessive compensation to employed physicians in order to draw them away from competitor hospitals and control referrals U.S. ex rel. Barker v. Columbus Regional Healthcare Sys.– Settled Sept 2015 Filed: 2013 Settlement amount: up to $35 million for hospital, $425,000 for physician defendant Relator: Administrator of cancer center Allegations: Among other allegations, allegation that compensation to employed physicians (oncologists) was in excess of fair market value and based on inflated wRVUs, improper billings and consideration for hospital contribution margins from referrals

47. The World in 2016 U.S. ex rel. Reilly v. North Broward Hospital District– Settled September 2015 Filed: 2011 Settlement amount: $69.5 million Relator: Staff physician Allegations: Hospital entered into physician employment arrangements with above fair market value compensation in order to induce referrals; evidence included employment compensation that was in excess of the physician’s pre-employment collections for their services , inflated RVUs used to establish compensation; and persistent employer losses from professional services while secretly tracking contribution margin from referral of hospital services ETC., ETC. (only going back to September here due to space and time limits)

48. The World in 2016 – Oncology Arrangements Challenged United States ex rel. Baklid-Kunz v. Halifax Hospital Med. Ctr., et al. – Settled March 2014 Filed: 2009 Relator: Halifax’s Director of Physician Services Government intervened: 2011 Allegations: Halifax knowingly violated the Stark Law by executing contracts with six employed medical oncologists that provided above fair market value compensation, including an incentive bonus that improperly included the value of prescription drugs and tests that the oncologists ordered and that Halifax billed to Medicare;  also, Halifax knowingly violated the Stark Law by paying three employed neurosurgeons more than the fair market value of their personally performed services. • November 2013 - court rules that arrangements with medical oncologists violated the Stark Law via the improper bonuses • Case was set for trial in 2014 to adjudicate the government’s remaining claims against Halifax • Potential damages and penalties estimated at $1 billion(!) • Case settled on the eve of trial for $85 million, a record-setting amount • Halifax’s legal fees from the case reported as $21 million

49. U.S. ex rel. State of Georgia ex rel. Barker v. Columbus Regional Healthcare System et al. - Oncology Transactions Challenged • First filed under seal in 2012, amended complaint filed in 2013 • DOJ announced settlement in September 2015 • $26 to $35 million owed by hospital, depending on contingencies • $425,000 owed by physician defendant, Dr. Pippas • Legal fees unknown • Detail of Allegations: • Purchase transaction for a radiation oncology center was not a commercially reasonable transaction because: (i) there was no hospital need for the purchased assets: and (ii) the price paid was not fair market value and far exceeded value of the “worthless” tangible assets. • Non-FMV, non-commercially reasonable salaries and medical director payments for physicians staffing the radiation oncology center, including payments for duplicative services and payments for work performed by others rather than personally performed • Questioned validity of valuation opinions

50. U.S. ex rel. State of Georgia ex rel. Barker v. Columbus Regional Healthcare System et al. - Practice Purchase “The purchase of [the radiation therapy center] was not commercially reasonable because the purchase was not designed to meet a commercially reasonable need (such as additional capacity or needed new equipment) but [instead] to ensure that no competitors to JCACC/CRHS entered the market for radiation oncology therapy services. Second, the purchase price did not reflect fair market value, but reflected the price CRHS believed it would have to pay to keep competitors out for the market... In fact, as [hospital] Defendants determined in December 2012 after Dr. Tidwell retired, the equipment they purchased was essentially worthless.”