On September 2, 1998, the Office of Inspector General ("OIG") of the Department of Health and Human Services ("HHS") issued a significant final rule expanding the scope of its administrative sanction authority to exclude individuals and entities from Medicare, Medicaid, and other federal health care programs. (FN1) The rule makes a number of changes to existing exclusion provisions (establishing new minimum periods of exclusion, setting out further mitigating factors to affect the length of exclusions, and more), and, most significantly, it broadens the OIG’s exclusion authority to extend to indirect providers and suppliers of items reimbursed by these programs. Under the final rule, effective October 2, 1998, the OIG will be able to exclude individuals and entities which provide items and services to practitioners and providers which themselves submit claims. Manufacturers of health care items and supplies – drugs, devices, diagnostic products, and the like – along with distributors, are considered "indirect providers" subject to exclusion under the new rule.

The potential significance of the new rule cannot be overstated. Essentially, the rule enables the OIG, through a civil or a criminal procedure, to exclude all of a manufacturer’s products from coverage by federal health care programs, so that no payment for the products would be available to any direct provider, practitioner, or supplier. For example, assume that a pharmaceutical company made a research grant to a physician, and the OIG found, upon investigation, that the grant was a sham and simply a disguised inducement to prescribe one of the company’s drugs. As discussed further below, the OIG could then undertake a civil or a criminal action to exclude all products of that manufacturer from Medicare, Medicaid, and federal health program reimbursement, with the result that no hospital, physician, or other direct provider could receive reimbursement for those products. Similarly, the exclusion of a device manufacturer would eliminate all Medicare or other reimbursement to hospitals, home medical equipment companies, and others for all of the manufacturer’s products. The rule marks a major change in policy, reversing the stance taken by the OIG in a prior rulemaking in 1992.

This memorandum provides an overview of this new policy and its potential impact on industry, as well as a brief review of the other provisions of the new rule.

Section 1128 of the Social Security Act (42 U.S.C. § 1320a-7) ("the Act") contains the exclusion authority for the Medicare and Medicaid programs. As initially written, section 1128(a) required the OIG to exclude from the programs any individuals or entities convicted of a program-related crime, or of patient abuse or neglect. These exclusions were mandatory and not subject to the OIG’s discretion. Section 1128(b) granted the OIG permissive authority to exclude providers from the program on the basis of convictions involving the delivery of health care items or services that were not program-related. Over time, numerous other grounds for permissive exclusion have been added, including license revocation or suspension, failure to provide access to records or payment information, and others.

The Health Insurance Portability and Accountability Act of 1996, Pub. L. 104-191 ("HIPAA"), amended the exclusion provisions of the Act to strengthen the OIG’s sanction authority. The mandatory exclusion provisions of section 1128(a) were expanded to include any felony conviction under federal, state, or local law relating to health care fraud, regardless of whether government programs were involved. The OIG’s discretionary exclusion authority under section 1128(b) was revised to cover individuals and entities convicted of misdemeanor health fraud offenses, as well as criminal offenses relating to fraud, theft, embezzlement, breach of fiduciary responsibility, or other financial misconduct in non-health care programs funded by federal, state, or local agencies.

The Act was amended further by the BBA, which revised section 1128A(a)(6) of the Act to permit the OIG to impose new CMPs on individuals or entities who arrange or contract with an individual or entity that the person knows or should know is excluded from participation in a federal health care program. The stated purpose of the new provision was to deter program participants from entering into transactions with excluded individuals or entities.

Until this time, the OIG has not sought to apply its exclusion authority under the Act to indirect providers such as manufacturers that do not also directly participate in Medicare or Medicaid as suppliers of products or services. In fact, in a 1992 rulemaking to implement the exclusion authorities of the Act, the OIG explicitly chose not to extend the exclusion provisions to indirect providers. At that point, the OIG stated that it believed the Act gave it authority to exclude indirect providers, but that such a practice would prove to be administratively difficult because the indirect providers were not in direct contact with HHS. (FN2) Thus, the new rule marks a full reversal of policy for the OIG. In the preamble, the OIG states that its previous approach was not consistent with the legislative intent of section 1128 of the Act and its subsequent amendments, and that "it is not appropriate to continue to exempt untrustworthy manufacturers and distributors of products from exclusion, when many other providers are excluded every year due to similar concerns." (FN3)

The final rule extends the OIG's exclusion authority to indirect providers by means of a minor addition to the existing regulatory framework. The regulations governing exclusion provide that no payment will be made by Medicare, Medicaid, or other federal health care programs "for any item or service furnished . . . by an excluded individual or entity." (FN4) The final rule creates a new definition of "furnished" that extends this provision to indirect providers. The new definition states that:

As a further clarification, the final rule defines the term "directly" as the provision of items and services by individuals or entities who submit claims to Medicare, Medicaid, or other federal health care programs, even if the items or services are manufactured, ordered, or prescribed by another individual or entity. The term "indirectly" is defined as the provision of items and services manufactured, distributed, or otherwise supplied by individuals or entities who do not directly submit claims, but who provide those items or services to providers, practitioners, or suppliers who submit claims for the items and services. (FN6)

This relatively minor change in the definition of a single word -- "furnished" -- results in a major policy shift. Taking the example stated above of the pharmaceutical manufacturer making sham research payments to a physician, the manufacturer’s exclusion could come about in several ways. First, the OIG could bring a criminal action under the anti-kickback statute, and upon "conviction" (defined very broadly to include pleas of nolo contendere), the manufacturer would be subject to a mandatory exclusion from Medicare, Medicaid, and other federal health care programs. Importantly, however, the same result could flow from a civil action. Pursuant to the authority granted last year by section 4304(b) of the BBA [42 U.S.C. § 1320a-7a(a)(7)], the OIG could seek a civil monetary penalty, or CMP, for the kickback. It could then use the CMP as the basis for a permissive exclusion, employing the authority granted to it in section 1128(b)(7) of the Act [42 U.S.C. § 1320a-7(b)(7)]. Alternatively, the OIG could avoid the need to bring a separate CMP action, and simply use its existing and extremely broad sanction authority to exclude the manufacturer as having engaged in "fraud and kickbacks and other prohibited activities." [42 U.S.C. § 1320a-7(b)(7)].

Following the manufacturer's or distributor's exclusion, direct providers no longer would be able to obtain reimbursement for products purchased from the excluded entity. The potential impact on manufacturers of drugs, medical devices, and other medical supplies which make up the vast majority of "indirect providers" under the new definition is tremendous. To state the obvious, if a direct provider cannot obtain reimbursement for an indirect provider’s items and services, it likely will stop using that indirect provider and seek another for whose products reimbursement is available. Moreover, the effect of the exclusion is wide-ranging. The exclusion would apply to all of a manufacturer’s items and services, even if the items and services are unrelated to the item or practice which formed the basis for the exclusion. Thus, a device manufacturer subject to exclusion for improper promotional or other practices related to wheelchairs, for example, could find its pacemaker products also excluded from reimbursement, even though the situation involved different product lines, the products were ordered by different physicians, and the items were sold by different sales representatives.

The OIG received a large number of comments from health care providers and organizations when it proposed the rule on September 8, 1997. They noted that the OIG's broad expansion of its exclusion authority would prove difficult to administer, would unfairly punish innocent third parties, and could result in shortages of needed medical supplies and equipment. The OIG disagreed with most of these comments, but it did add certain provisions to the final rule in an attempt to temper the impact of the new policy.

In response to comments questioning the impact of the new rule on current inventories held by providers (e.g., whether a provider would be reimbursed for items in inventory that were manufactured by an indirect provider who was then excluded, or what would happen in the case of items whose manufacturer was difficult or impossible to determine), the OIG added a provision to the final rule permitting reimbursement for health care items ordered from an excluded manufacturer prior to the effective date of its exclusion, and delivered up to 60 days after that effective date. The 60-day grace period will be reduced to 30 days after the new rule has been in effect for one year. (FN7) More generally, the OIG stated in the preamble to the final rule that it will seek to exercise its sanction authority "prudently," and to offer guidance to direct providers on a case-by-case basis. In addition to this vague assurance, the OIG stated that, when appropriate and permitted by law, it will entertain requests for waivers of exclusions so that no substantial harm comes to direct providers or program beneficiaries. It gives as an example the instance of a convicted pharmaceutical manufacturer that produces the only drug deemed effective to treat a particular disease. The OIG also noted that if a state agency requests such a waiver, the OIG has the discretion to extend it to all state Medicaid programs and Medicare if it deems such waiver to be appropriate. (FN8)

The OIG disagreed with comments that the new rule would impose a significant new administrative burden on direct providers by requiring them to establish systems for ensuring that they do not submit claims for items or services furnished by excluded entities. Stating that exclusions of manufacturers are rare and generally garner substantial publicity, the OIG assured that it will give notice of exclusions over the Internet. Moreover, the OIG stated that direct providers already are required to monitor exclusions to ascertain that their own claims are reimbursable and to avoid the new CMPs for contracting with or employing an excluded individual or entity. It may or may not be the case that direct providers already have adequate systems in place for monitoring exclusions, but the new rule certainly raises the stakes for them to do so.

The final rule contains a number of other provisions relating to the OIG exclusion authority. While not as substantial as the changes for indirect providers, they are worth noting briefly. Aside from technical and conforming changes to the regulations, noteworthy provisions include the following:

• In accordance with HIPAA, the final rule provides for permissive exclusions of individuals who have a majority ownership interest in or significant control over operations of an entity that has been convicted of an offense or excluded. This provision is intended to prevent such individuals from evading punishment by simply forming a new corporation and continuing business as they did before the exclusion. (FN9)
• Also in accordance with HIPAA, the final rule establishes minimum periods of exclusion for permissive exclusions. Specifically, a standard period of three years is established for convictions of misdemeanor health care fraud offenses, criminal offenses relating to fraud in non-health care programs, obstructions of investigations of health care fraud, and misdemeanor controlled substance convictions. A minimum one year exclusion is established for individuals or entities found to have submitted claims for excessive charges or to have furnished substandard items or services, and for health maintenance organizations that failed to provide medically necessary items and services. Permissive exclusions derived from suspension or exclusion from other federal health care programs will be imposed for a period not less than that of the exclusion from the other program. Persons required to surrender their health care licenses will be excluded for a period not less than the surrender of the licenses. (FN10)
• The final rule adds a new aggravating factor for cases of patient abuse or neglect that considers whether the conduct was premeditated, was part of a continuing pattern of behavior, or consisted of non-consensual sexual acts. (FN11)
• The final rule adds a new mitigating factor for setting exclusion terms that considers whether an individual or entity’s cooperation resulted in (1) additional cases being investigated or (2) reports being issued by law enforcement agencies identifying program vulnerabilities or weaknesses. (FN12)
• The final rule revises the definition of "patient" to include any individual receiving health care services, regardless of whether such care is rendered in the traditional medical care setting or whether it is reimbursed by Medicare, Medicaid, or other federal health care programs. (FN13)
• The final rule requires state Medicaid agencies to notify the OIG promptly of all actions taken to limit an individual’s or entity’s ability to participate in its program. (FN14)

The OIG’s new rule significantly alters the regulatory landscape for manufacturers of pharmaceuticals, medical products, and supplies, as well as for their customers. With new authority to exclude indirect providers from Medicare, Medicaid, and other federal health programs, the OIG's arsenal now includes the ability to drive out of business some of the nation's largest health care companies. Indeed, the scope of this new power is so great that the OIG will not need to exercise it often, or perhaps at all, in order to influence its relationships with industry. The threat of exclusion, even unspoken, will significantly affect the course of investigations and subsequent negotiations with manufacturers. Indirect providers could now find themselves under substantially greater pressure to reach accommodations with the OIG rather than risk convictions that could result in exclusion.

Increased attention to regulatory compliance issues by the manufacturer community, along with heightened scrutiny of promotional and other marketing practices, is critical at this time. Some manufacturers still have "compliance" or "ethics" programs limited to campaign contribution issues, foreign corrupt practices, antitrust concerns, and the like. Compliance plans should also cover regulatory issues relating to Medicare, Medicaid, and other state and federal health care programs. Some areas which we believe require special scrutiny include:

• the provision of free or "value-added" items and services to individuals and entities in a position to recommend purchase of the manufacturers’ products;
• the liberal awarding of "unrestricted grants" by marketing or sales representatives to potential referral sources for questionable activities;
• the awarding of "educational" grants to undertake projects which do not serve an educational function but, rather, subsidize or enrich the ongoing operations of the grantee;
• the funding of "research" projects of questionable clinical or scientific value, or which may duplicate existing research; and
• the sponsorship of "educational" or like programs for those in a position to recommend products or the purchase of products (e.g., besides physicians, these might include formulary managers, purchasing agents, pharmacists, and the like), which include lavish entertainment in resort or like locations, and little or no educational or scientific programming.

The provider, supplier, and practitioner communities, in turn, must establish mechanisms and procedures for regularly monitoring the monthly list of excluded entities and individuals. This obligation now is a two-fold one: not only must care be taken not to hire or contract with an excluded entity or individual – practices for which exclusions of the direct provider or supplier may be sought – but caution must be exercised not to furnish items or supplies of excluded indirect providers, typically manufacturers, for which no reimbursement will be available. The HHS notice is published monthly, and can be accessed via the Internet at:

http://www.dhhs.gov/progorg/oig/cumsan/index.htm.

Please do not hesitate to contact Elizabeth Carder, David Bloch, or any other member of the Reed Smith health care group with whom you work if you would like additional information or if you have any questions.

The contents of this Memorandum are for informational purposes only, and do not constitute legal advice.