The New Private Equity Post-Acquisition Paradigm
With private equity deals under harsh scrutiny from the Department of Justice, it is critical that sponsors follow appropriately structured pre and post-acquisition best practices to avoid enforcement exposure and best position their assets for exit sale. After a decade of successive policy announcements, the DOJ has at long last provided real opportunities for private equity sponsors buying or selling companies in regulated industries to protect themselves and their portfolio companies against criminal or civil penalties and protect the value of their assets.
A Carrot-and-Stick Strategy
The Threat of Enforcement – The Stick
The DOJ has increasingly been rattling its saber at the perceived evils of private equity investments leading to anti-competitive roll-ups, fraud affecting government contracts and entitlement programs, and “disastrous patient outcomes,” in the health care space.
Deputy Attorney General Brian Boynton put it most pointedly when he “emphasize[d] the department’s commitment to holding accountable third parties that cause the submission of false claims, [including] private equity firms, among others.” Boynton continued that the DOJ “will not hesitate” to pursue private equity investors in health care companies who “undermine medical judgment [or] inappropriately influence the doctor/patient relationship.” He criticized investors who “influence patient care by providing express direction for how a provider should conduct their business, or more indirectly by providing revenue targets or other indirect benchmarks intended to prioritize reimbursement.”
Raising the threat level on the legislative side, Senators Warren and Markey of Massachusetts introduced a bill with criminal penalties for investor profit-taking that can be tied to a patient’s death. The FTC and Department of Health and Human services recently solicited public comment into the impact of private equity and alternative asset manager ownership in health care. Although the results of that analysis have not yet been released, it’s a safe bet that it will result in a further threat escalation from the DOJ.
Although health care cases in which the government can point to patient harm will always be the highest priority, DOJ is looking to hold private equity sponsors liable for any significant fraud impacting the government. The Department is clearly on the hunt to make examples of private equity sponsors where it can show that investors took some active role in directing misconduct.
Even without a direct role in any violation, DOJ has signaled that an acquirer that fails to detect and remediate some wrongdoing in either pre- or post-acquisition diligence can be hit with successor liability for prior violations by the acquired company. Through various recently announced initiatives, the DOJ’s carrot-and-stick approach is designed to give rise to more robust acquirer oversight of any M&A transaction but is particularly applicable in the private equity space.
The False Claims Act, with its staggering specter of treble damages, has incentivized corporate insiders, through its qui tam provisions, to report any suspected fraud on the government directly to the DOJ in return for a significant share of the financial recovery. Reports of possible fraud are frequently made to the government instead of reporting those suspicions through internal corporate compliance channels. The DOJ has recently further sweetened the pot for whistleblowers with new programs launched for individuals to obtain financial rewards outside of the qui tam process.
Voluntary Self-Disclosure – The Carrot
Having effectively demonstrated the brute force of the False Claims Act’s enormous damages provisions and with heightened risks to companies from new whistleblower financial incentives, the DOJ introduced its Voluntary Self-Disclosure protocol as a pathway for companies that discover and disclose a violation before the company is aware of any government investigation. The DOJ has been encouraging self-disclosure for the past decade. Finally, however, through iterative speeches and policy memos from DOJ leadership, the Department has at last provided sufficient transparency and predictability around its promises of leniency, such that the notion of self-disclosing a violation is now something that companies are obligated to consider and consider quickly if an issue arises.
What private equity sponsors should take away from these developments and incorporate into their deal life cycles is the need and opportunities to protect both themselves and their portfolio companies from DOJ scrutiny and liability, all the while achieving their growth goals, enhancing their reputation for good, legally compliant growth, and maximizing the return on their investment.
What this means for private equity sponsors – best practice to avoid exposure and protect good growth in asset value
In this threat-heavy environment, the best practice requires continued rigorous pre-acquisition diligence before completing any acquisition as well as conducting a robust post-acquisition risk assessment and implementing industry-appropriate compliance functions at each stage of the growth strategy. In addition to the carrots and sticks described above, the DOJ recently announced a six-month M&A safe harbor. This initiative gives an acquirer six months to detect, disclose, and remediate any criminal or other fraudulent conduct by the acquired company. In most situations, an acquirer that does so will avoid any successor liability that would become the acquirer’s problem after the six-month window post-close.
The Voluntary Self-Disclosure protocol and six-month safe harbor should be viewed as part of the acquisition process and a means to make sure the acquired company or platform is operating on a clean slate as the roll-up or other growth strategy begins. The author has utilized DOJ’s Voluntary Self-Disclosure protocol favorably in the private equity life cycle to disclose and resolve pre-existing issues prior to the exit sale of a portfolio company.
To properly protect both the sponsor and portfolio companies for the life of any investment, especially in highly regulated areas such as life sciences, health care, defense or government procurement and contracting, careful attention must be paid to the result of a post-acquisition risk assessment and implementation of a compliance program tailored to the industry and specific risk profile. Beyond any existing risks, a sponsor or operating partner’s direct involvement in any alleged wrongdoing by a portfolio company can and will expose the sponsor to liability. However, a robust compliance program should not inhibit innovation, growth, or profit and should minimize the likelihood of enforcement exposure. A well-functioning compliance program will be evident and enhance the value of any company at exit.
Deploying appropriate resources after completing a deal to assess risk, detect and address any existing issues, and put proper protections in place before executing a growth strategy is the best practice and the model for successful investments in the current environment with amped-up scrutiny of private equity deals. Doing so quickly after a buy-side deal to take advantage of the six-month safe harbor is critical. On the sell-side, assessing any risk and possibly disclosing it ahead of the sale process eliminates the risk of a deal getting scuttled during diligence or significantly impacting the value of the asset.
While self-disclosure will certainly not be the best option in every situation in which a potential issue is detected, it is an option that must be considered, and quickly, to ensure the greatest benefit if that route is pursued. A robust compliance program’s key function is to prevent any wrongdoing before it occurs or detect it quickly if it does. Private equity sponsors who neglect to do a quick but deep enough dive after an acquisition or neglect to implement an appropriate compliance function in those regulated industries where it’s warranted run an increased risk of coming into the crosshairs of the DOJ and becoming a scapegoat for the supposed evils of private equity.
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