Podcast - What Healthcare Investors Should Learn from California's CPOM Actions

Morgan Ribeiro: Welcome to Counsel That Cares. This is Morgan Ribeiro, the host of the podcast and a director in Holland & Knight's healthcare practice. Today's episode focuses on one of the hottest issues in healthcare transactions, digital health and private equity backed healthcare platforms, and that is California's corporate practice of medicine doctrine, commonly referred to as CPOM. Over the past year, we've seen California regulators move from signaling concern to taking concrete enforcement actions, including the recent settlement involving Carbon Health. At the same time, other states are looking closely at California's approach, making this a conversation that extends far beyond the Golden State. To help us unpack these developments, I'm joined today by two people with deep experience in this area. First, my colleague Shalyn Watkins, a healthcare regulatory attorney in our Newport Beach office who counsels healthcare providers, investors, management companies and digital health organizations nationwide. And joining us as well is Phoebe Gutierrez, CEO of Camino Strategy Group and a longtime California healthcare policy strategist with extensive experience helping healthcare organizations navigate the state's regulatory and political landscape. Shalyn and Phoebe, welcome to the podcast.

Before we kind of jump into our discussion for today, I think it's always valuable for our listeners to learn a little bit more about our guests. So, Shalyn, how about you introduce yourself and tell us more about how your practice aligns with today's conversation.

Shalyn Watkins: So I'm a healthcare attorney here in California. I've been practicing law for the past decade, and over the last 10 years, I've learned a lot about how the landscape has changed, especially considering the corporate practice of medicine. I represent healthcare providers, investors. I do highly regulatory work for them, and I work really specifically in the digital health and telemedicine field where we see a lot of our providers who operate these large-scale, 50-state platforms often using the management services organization-professional corporation (MSO-PC) structure I assume we'll be talking about a lot today. And in my experience working with these clients, I've come to really love the idea of putting together the puzzle of how each of these states are reacting to these structures. I've been able to use my experience being a regulator in the past to help advise clients on litigation issues related to CPOM, as well as help teams whether they're on [their own] buy side or sell side of a transaction involving these really unique structures.

Morgan Ribeiro: Amazing, thank you. Phoebe?

Phoebe Gutierrez: Thanks, Morgan. So I run a Camino Strategy Group where I help founders and clinicians build compliant operational infrastructures. Similar to Shalyn, mainly partnering with digital health companies, telemedicine organizations or general clinicians that are wanting to launch a private practice. I spent about 12 years as a California state regulator, auditing hospital systems, health plans and provider groups. And interestingly enough, when I left the government landscape and came over into digital health and telemedicine, it was the wild, wild west. And I saw that really, there were a lot of companies that on paper looked, you know, compliant. But when you dug into their operations, you realized they were doing it really backwards and didn't actually understand the process of operationalizing these really important contracts and rules. So mostly my company helps with CPOM structuring, PC-MSO operational design, telehealth infrastructure and routing, and then ultimately provider staffing solutions.

Morgan Ribeiro: Awesome. Well, I'm excited to hear what you all can contribute to this conversation today, given your background. Phoebe, I want to start with you and just some context for this conversation. Most healthcare executives, I believe, understand that California has CPOM restrictions, but many don't understand why they're so deeply rooted. And I think that history is really important. So what makes California different from your perspective? And what's some of that history that brings us to where we are today?

Phoebe Gutierrez: Yeah, so California's approach really stems from long-standing policy preferences that really are saying that clinical decisions must remain in the hands of licensed healthcare professionals, not with investors or business executives or corporate entities. The concern historically has been that if business interests become too involved in the healthcare delivery side, financial incentives could influence treatment decisions, which we all know impacts patients negatively. While many states have some version of CPOM restrictions, California has always been [known] to apply the doctrine a little more aggressively and take a more expansive view of what constitutes as inappropriate corporate influence. So what we're seeing today is really not legal theory. What's changing is enforcement and regulators' willingness to challenge the structures that may have existed for years, and the proof is kind of in the pudding when we see all these different investigations and audits where they're digging into those contracts and making sure that they've been operationalized.

Morgan Ribeiro: Shalyn, I know we've got some other topics that we want to cover here, but I think it's important to kind of pause there and take a look at the wave of case law that colors some of what we're now seeing around corporate practice of medicine. And that really started with the Envision lawsuit. Can you tell us more about that and potentially other lawsuits that have covered this area?

Shalyn Watkins: At its core, CPOM in California is rooted in the Business and Professions Code, which pretty clearly states a lot of the rules for how a medical professional is supposed to own certain entities and operate them. And as a result, a few years ago, we saw in the Envision lawsuit, which really, there was this allegation that the MSO was really setting up these shell entities that weren't actually being overseen by medical providers who had licenses, which gave us our first insight to the idea that even practitioners might have a claim that maybe their license is being used inappropriately, which could impact kind of the operational issues that an entity might have. And over the years, we've kind of seen this happen more and more in litigation. More recently, a couple years ago, the Art Center Holdings case became the new thing that we were all looking at. And the issue there, which is still sitting in front of us right now, it's on appeal in California, was that the physician owner of the practice group was upset about a hiring decision that was made. It was a unilateral stock transfer where he didn't have any input in the ultimate transition of services and selling his PC. And to this day, that PC sits in a receivership that is kind of problematic and terrifying for a lot of people. You want to avoid those types of situations, and litigation risk often gets our eyes really big, just as much as regulatory risk, because sometimes when you're dealing with a statutory interpretation of a law or even a regulatory application from a rule, the litigation risk is more likely to get your attention as a business owner before you even see a regulator come through your front door.

Morgan Ribeiro: Awesome. Yeah. So with all of that, right, we know that the CPOM doctrine isn't new in and of itself, but regulators increasingly appear focused on how organizations operate in practice. Phoebe, can you kind of add to that?

Phoebe Gutierrez: Yeah, so, you know, historically many organizations believe that if they had the right documents in place, they were protected. So Shalyn, I'm sure you can sympathize with where's my stack of contracts or where's my policies and procedures. But today what we see is regulators are much more interested in asking kind of a different question, which is like who's actually making the decisions and show us some proof that that is actually how it is working within your organization.

Shalyn Watkins: Right. And those agreements that we're typically seeing in these situations, right? You have a management services agreement. That's usually between the MSO and the provider group. And then you have a stock transfer agreement that we'll talk a little bit about here in a second with our friendly PC structure. And then you have a continuity planning agreement that all three of those read together are supposed to kind of dictate how things are supposed to go on in the best-case scenarios and the worst-case scenario. And that's where we end up asking that question: Who's actually really making these decisions? There's also some other unique documents that some companies are starting to put together for this exact purpose.

Morgan Ribeiro: Great. And Shalyn, you sort of just touched on it, but this naturally leads into a discussion around friendly professional corporation, or friendly PC, models. For listeners who are not healthcare lawyers, can you explain what that structure is trying to accomplish?

Shalyn Watkins: So because the law is that a corporation can't practice medicine, the exception really to that rule is that a physician can open a professional corporation, which is its own special designation with the Secretary of State. It's tied to that physician's license. It's as though the physician, him or herself, is practicing, and there are a lot of benefits to having a corporate structure for doing so. And to use that PC structure and create a more quote-unquote "friendly" relationship with a management services organization, what an MSO typically will do is create a stock transfer restriction of some sort that prevents the PC in some way from making certain decisions that would financially impact their business dealings between each other, but with the appropriate consents of the physician, as you would hope. This is important for an MSO because the MSO is doing a lot of the groundwork. They're providing a lot of administrative services, all the back-end work to help that PC stay active. But they want to make sure that once they've given all the gold to the PC, they're not able to run away and start doing things on their own, therefore losing their investment. And on the backside, this is a great opportunity usually for what we end up calling the "friendly physician." Usually that physician will end up getting some sort of ownership or directorship role at the MSO where they can be a chief medical officer and they can help with clinical decisions and ideas and strategies that the MSO might be trying to create from top-down.

Morgan Ribeiro: That's very helpful. So one thing that's getting a lot of attention right now related to this topic is the case involving Carbon Health. Shalyn, why has this settlement attracted so much attention?

Shalyn Watkins: So the headline for Carbon Health was this is the first of its kind. And I think that itself is very jaw-dropping and exciting. But what's interesting about the Carbon Health settlement is there is big dollar amounts to be thinking about here. You're also seeing personal liability from the CEO of the MSO, as well as some questions about what additional conduct is indicative of a violation of the corporate practice of medicine. So because this case currently provides the clearest roadmap that we've seen regarding what regulators are currently thinking, I would say it's easily, you know, the thing that's catching everybody's eyes. So, in June, our state attorney general (AG), Rob Bonta, announced this settlement. It involved the company's structure violating CPOM, and in it there was approximately $4.4 million in penalties that were ascertained. The case was notable because it wasn't just the financial penalty, right? It identified several categories of arrangements that the regulators viewed as evidence of impermissible corporate control. And that included that management agreement granted really broad authority over the operations, that the MSO had some influence over staffing and employment and compensation decisions that were inappropriate. Ownership and succession mechanisms that gave the MSOs substantial practice control were also criticized, namely this idea that get out of that unilateral option agreement, which a lot of people try to tag on to these agreements, and it just would not fly in the state of California. And then there was a really special indication that unilateral financing where the MSO was the sole financing opportunity for the PC became something that was another indication of control. So the takeaway here is that the regulators are now looking beyond the labels of these categories we've seen in just the rules, and they're thinking a little bit more holistically. In fact, I'd say that you see in the press release this idea of the totality of the circumstances are now being considered. You learn that the AG is listening to the podcast that your CEO goes on, and he's hearing what you're saying. He's reading every headline. He's got somebody who's checking out every conversation you ever had and what you're putting out into the world about how you are running these PCs, and that itself is really interesting.

Morgan Ribeiro: Yeah, so this is no longer kind of a hypothetical risk, right? This is real, active enforcement here.

Shalyn Watkins: Exactly. And I would say that we're seeing it so proactively from the AG's office, that that Art Center Holdings case I just talked about a little bit earlier, the AG has also filed an amicus brief in that appeal. So it seems to be something that he cares about, his office cares about, and we should all just kind of remember that that's what's going on.

Morgan Ribeiro: Great. All right. So Phoebe, I want to turn back over to you to continue this conversation on Carbon Health. So many people initially view Carbon Health as this isolated action, but increasingly it feels like it's part of something larger, kind of a larger movement. So what's your perspective on that?

Phoebe Gutierrez: Very similar to Shalyn, I think that we're starting to see a slight shift in how regulators are viewing this kind of consolidation and the private equity involvement and really how corporate decision-making is potentially influencing patient care in these types of situations. I always joked like as a regulator, a new rule or law would drop and it would take us three years to figure out how we were going to monitor and enforce and actually start auditing health plans and provider groups. And I think if you look back, I mean we're right around that timeline, of you had kind of the digital health boom and the telemedicine boom and now we're starting to see that they are starting to pay attention because there is not really a regulatory agency that oversees telemedicine end to end. Carbon Health did not occur in a vacuum. We have seen the attorney general actively engage in other related litigation with dental organizations, which also have to comply with corporate practice of medicine. And that ultimately there's been other types of levers where we've seen this kind of bubble up.

So for healthcare companies, the important point to understand is that regulators increasingly view operational structures and governance practices and operational incentives as areas worthy of investigation. And primarily in the past, that was always reserved for, you know, I'm participating in a state or federal program like Medicaid or Medicare or taking insurance reimbursement. And with cash pay, it's really moving into other types of levers that also you must comply with, right? So the business structure, your overall operations of how you're managing and running these partnerships, what kind of documentation you actually have to demonstrate defensible practices. That's really where we're starting to see a lot of companies kind of flounder as they have this kind of set in stone, but they never actually operationalized  it.

Morgan Ribeiro: Great, well, and I think, Shalyn, I think I mentioned this earlier in my introduction, but it's like California is getting the big splashy headlines and it seems like it's for a long time had a lot of this attention. And so one thing we hear from healthcare investors in particular is like, we don't have portfolio companies that are headquartered in California or they don't have entities that are based there, so why should we care? And Shalyn, what would your response be to, you know, a statement like that?

Shalyn Watkins: Yeah, I think there's actually two responses, right? The first overall response is typically like, California often acts as a bellwether state. We're usually the first in trend reports, right. We see something, we act on it, and then you'll see other states kind of following suit. And so you should care just because you know what's coming, right. Oregon's also doing this. There are other states where we're seeing a lot more stricter CPOM. And even if it's not coming as just an AG action, for example in Oregon there's currently a private right of action, which is just as scary. We're also starting to see the need to revisit these CPOM agreements because even if your PC, for example, is a Florida PC that's foreign qualified in the state of California for very small minute business reasons, there's still an application of these rules, and there's just growing scrutiny in states like Illinois as well, where we're seeing the question of operational control and ownership structures being at the highlight and the forefront of a lot of conversations. And even somewhat from the federal side, we're seeing this, right? We have seen the fraud task force come up and especially there's a West Coast strike force right now that is really thinking about Silicon Valley and digital health. And oftentimes those fraud considerations, you'll see a lot of the settlements that are made there. The question is, was somebody just rubber stamping these claims that are being made to the government? Was a clinician even involved? Because once the federal government has found that that was occurring from a false claim standpoint, then you've still opened yourself up to the question of if a state government is going to be seeing that as a violation of CPOM, too. So organizations shouldn't just assume that their historical model will remain untouched. Even if another state doesn't adopt exactly what California is doing as their approach, we're seeing this broader movement that I like to say now means we should be reevaluating these contracts and these things every couple of years. And then surely when we see something like the settlement come up, we should certainly stop and say, if we have some things happening in California, are any of those things that we saw in that structure that were stricken down in our documents? Let's just fix those. Let's do an amended agreement real quick.

Morgan Ribeiro: Yeah. Well, I think, you know, to your point, it's almost like assume that if you have investments in certain states, like it might start to turn in a direction where the regulations get stricter, not looser. Particularly, I think we're seeing this on so many levels when the federal government isn't acting, the states have really taken matters into their own hands, particularly when it comes to CPOM doctrines and MSO arrangements. So I always like to end, I think it's important in these conversations to offer up some practical guidance. So, suppose a healthcare platform, behavioral health provider, physician group, digital health company or private equity sponsor wants to expand into California. What should they do first? Shalyn, I'll look to you, but I definitely want to hear from both of you on this topic.

Shalyn Watkins: Yeah, I think step one is conducting a structure assessment. How many clinics do we have? Who are our physicians? What are the things that we want everybody to be able to do? And what contracts and what payments are going to be flowing from where to where? And in doing that assessment, the key questions I would be asking are, who's actually controlling provider hiring, compensation decisions, payer contracting, marketing, specifically in California. There are states that don't really have the marketing and advertising provisions in their CPOM, but in California marketing and advertising requires that clinician approval. And who's controlling the clinical protocols? How does governance function in real life? What do the documents actually say? So even if it's not a de facto "We, as the MSO, will be unilaterally deciding to do X," if it operationally kind of has that same effect, thinking about that. Do those documents include the idea that instead of just unilaterally making a decision that falls into these categories that the California Medical Board has indicated are physician-led decision-making requirements? Does it say that the MSO is going to assist the PC in doing that? Or does it make it solely a responsibility of the MSO? If any of the answers to these questions point toward dominance by the MSO, we've got some red flags. We need to take a little break, step back, think about our best way of approaching, let's get closer to yellow and green. And how can everybody at the table get comfortable with this? And to that same point, this is the perfect time to empower physicians. I think the reason why MSO structures are very attractive for physicians, I guess, lawyers are not born businesspeople. They love the idea that somebody's going to help them run their practice, but really empowering them to remember that they need to run their business and that the MSO is there to make their business as profitable as possible and is there by their side.

This is by no way and no means a talk that says you can't invest in healthcare in California. I think Carbon Health actually tells us the exact opposite. It says if you're going to do it, do it right. Don't stand on the corner shouting, I'm going to control and run all my clinics. No, instead say, hey, I've got some really great clinics that I've been working with and we're going make them really profitable. We're going to help them really get in the front of some really great patients who are helping bring healthcare to the people who want it most and need it the most. And then I think your second thing after you do that red flag test is reviewing every single agreement, not just the management services agreement (MSA). You're looking at all your financing agreements, your succession provisions. The California Medical Board specifically states what should be triggers for succession, right? Like, it is very clear, especially if you also read Art Center Holdings, the death of a shareholder, the disability, the loss of licensure, certain penalties that could bring risk or harm to patients, like crimes that have been committed, are clearly OK to have a succession event. Tying a succession event to an actual clinical decision, however, could be considered an employment decision. And that's what Art Center Holdings told us. So think about instead working with your other clinicians to ascertain whether someone has clinically made any mistakes or missteps that would trigger a succession event. And then anything that revolves around equity rights, governance rights, operational policies, all of those things are what matter. I'd say, you just make sure the day-to-day operations align with the legal structure that a lawyer like me, hopefully, has really helped you put together. And somebody like Phoebe can come in and help you just operationalize and maximize. You take really good teams that know what they're doing to set you up right and then ask how to implement it on the day to day.

Morgan Ribeiro: Awesome. Phoebe, what's your advice?

Phoebe Gutierrez: Yeah, I mean, I think the biggest thing is you definitely don't want to treat California as just another market. So a lot of times in my practice, I get a lot of people that I will, you know, they'll be asking different questions and it's like, well, this company is doing it like this and this company's doing it like this, so I want to copy them — and they're doing it wrong. Which is always kind of a fun conversation. I think companies often underestimate how closely healthcare operations, policy, politics intersect in California and how you really have to make sure that you're setting it up correctly from the beginning to make sure you're not inadvertently building your business on quicksand. Of course you want to engage experienced regulatory counsel. And I'm going to like double tap and emphasize on understanding California landscape. I work with multiple law firms. One of my companies actually works with a New York lawyer, and a lot of the stuff that she's hearing about California actually comes from me. And so you really want to talk to a healthcare attorney who understands California because we are a breed of our own. And really understanding the policy environment. In addition to kind of like state rules, there are state policies that also come out that kind of give you some glimpses into how different enforcement actions may occur. So really keeping close on the policy side as well as just the legal side is really important.

You want to build compliance — not just your growth strategy, but also like your launch — versus treating it like an afterthought. So more often than not, I hear companies making really, really, really big instrumental decisions kind of in the aftermath. So one of the biggest decisions that you're going to have to make is who is your physician owner that you are partnering with in this type of relationship. And a lot of times they will go with either a staffing company or finding a doctor on Indeed, where it's like there really hasn't been any sort of like trust or like rapport or any sort of like rationale why they're choosing that physician besides just that they understand corporate practice of medicine and they're willing to kind of partner on something like this. I think that's the biggest decision, and probably the biggest mistake that I see in my career because you want to make sure that you are working with a doctor who really understands the landscape and how to actually operationalize it. Of course, organizations that proactively invest in governance and compliance expand a lot smoother. And also do it for a lot cheaper. And again, double tapping on physicians need to be in the room making some of these decisions and it needs to all be documented. So very similar to what Shalyn was saying, is, how are you engaging your physician to vet and approve all clinical hires? How are you engaging them to review clinical protocols and getting formal signoffs? There are so many different elements where you have to loop that physician in to be the decision-maker. And more often than not, that's a step that a lot of these organizations or companies fail to do and have the paper trail to defend themselves in the event that there was an investigation. So for me, again, it's always thinking about, I always joke because a lot of people will come to me and go, hey, can you verify that I am compliant with everything? And it's like, well, what are you doing? What are your operations? Compliance is a journey. It is not a quick checklist where you can just check things off. And I think that's a huge misconception. So my big thing is take it seriously, think about it thoughtfully and really have a strategic roadmap that maps to what your goals are on what you're trying to achieve as a business, but also that are fully compliant so you can build it correctly from day one.

Morgan Ribeiro: Well, and I think, I mean, all of that is completely accurate. And in today's environment, at the state and federal level, where things are rapidly evolving, checking your regulatory or compliance box is not a one-time event. It's a thing that you've got to check on a regular basis. And a lot of these entities don't have a compliance officer or an in-house general counsel (GC). And so it's just important that that's a part of their process. It's a part of their governance that they are, you know, regularly checking these things because you may be compliant today, but a year from now that may not be the case. And so, for those organizations that don't have the in-house resources, really relying on folks like yourself is really important and just needs to be a part of their process, just like submitting your tax returns, right? It's just something that is part of operating your business and staying compliant and in good faith with all the regulators.

Shalyn Watkins: I've given somebody a document suite, and then I don't hear from them again for years. Because it's like, I'm going to hear from you again and there is now going to be a litigation. Those fees are way worse than, you know, the fee of having experienced counsel or having a good consultant. I'm sure that giving away that secret is probably bad for business, but I'd rather have clients that are always happy when they call me instead of those who call me when they're sad because we haven't talked in five years after that first document suite. So I completely agree, Morgan.

Morgan Ribeiro: Awesome. Well, thank you both for this conversation. I think we'll continue to monitor what's happening in California, but this conversation is definitely not over. But appreciate all the practical points that you all have provided today and think that our listeners should definitely have something to take away from this.