AMARILLO, TX – Apples and oranges. Venus and Mars. Under the law, there is a difference between a W2 employee and a 1099 independent contractor. There is no such thing as a “1099 employee” and there is no such thing as a “W2 independent contractor.” Only a human being can be an employee; an “it” cannot be an employee. In other words, while John Smith (a human being) can be an employee, John Smith Marketing Group, LLC (an “it”) cannot be an employee. John Smith is either a W2 employee…or a 1099 independent contractor……but not both.

The federal anti-kickback statute (“AKS”) prohibits offering, paying, soliciting, or receiving anything of value in exchange for referring (or arranging for the referral of) a patient to a person or entity for any item or service covered by a federal health care program (“FHCP”) or in exchange for purchasing, leasing, ordering, or arranging for or recommending purchasing, leasing, or ordering any FHCP-covered item or service.

There is a safe harbor to the AKS that says that it is permissible for a provider/supplier to compensate a bona fide full-time or part-time W2 employee who generates FHCP business for the supplier. Ideally, the employee will receive a base salary plus discretionary bonuses based on a number of factors, one which is the generation of business. The reasoning behind this safe harbor is that the supplier has the obligation to supervise and control its employee, and the supplier is liable for the acts of its employee.

On the other hand, a supplier has no duty to supervise and control a 1099 independent contractor, and the supplier is not liable for the acts of a 1099 independent contractor. And so while it is permissible for a DME supplier to compensate a bona fide employee who generates FHCP business to the supplier, it is a violation of the AKS if the supplier compensates a 1099 independent contractor, who generates FHCP business to the supplier, on a production basis. The AKS cuts both ways: the payor of the money (the DME supplier) and the recipient of the money (the 1099 independent contractor) are both liable under the AKS.

A 1989 statement by the Department of Health and Human Services (DHHS) is illuminating: “We are aware of many examples of abusive practices by sales personnel who are paid as independent contractors and who are not under appropriate supervision. We believe that if individuals and entities desire to pay a salesperson on the basis of the amount of business they generate, then to be exempt from civil or criminal prosecution, they should make these salespersons employees where they can and should exert appropriate supervision for the individual’s acts.”

Also instructive is OIG Advisory Opinion No. 99-03 that addressed a proposed arrangement in which a sales representative for a medical supply manufacturer would be paid a monthly commission based on a percentage of amounts invoiced for products sold pursuant to the sales representative’s efforts. According to the OIG: “Sales agents are in the business of recommending or arranging for the purchase of the items or services they offer for sale on behalf of their principals, typically manufacturers, or other sellers (collectively, “Sellers”).

Accordingly, any compensation arrangement between a Seller and an independent sales agent for the purpose of selling health care items or services that are directly or indirectly reimbursable by a Federal health care program potentially implicates the ant-kickback statute, irrespective of the methodology used to compensate the agent. Moreover, because such agents are independent contractors, they are less accountable to the Seller than an employee. For these reasons, this Office has a longstanding concern with independent sales agency arrangements.” However, the AO did state that in some circumstances, these type of arrangements may be permissible if the sales rep’s contact is structured to fit the Personal Services and Management Contracts (“PSMC”) safe harbor to the AKS.

When promulgating the proposed rule containing this safe harbor, DHHS highlighted that it was crafted in light of the fact that arrangements for services frequently arise between health care providers/suppliers and their referral sources. According to DHHS, it established the safe harbor “for joint ventures and other arrangements involving payments for personal services or management contracts, but only if certain standards are met and safeguards are present to limit the opportunity to provide financial incentives in exchange for referrals.”

Although a 1099 independent contractor relationship may be established under the PSMC safe harbor, such an arrangement must comply with the specific elements of the safe harbor, including the following: (i) payments to the 1099 independent contractor must be pursuant to a written agreement with a term of at least one year, and (ii) the methodology for calculating the compensation paid to an independent contractor must be set in advance, be consistent with fair market value (“FMV”), and not be determined in a manner that takes into account the volume or value of any referrals or business generated.

Note also that the OIG has taken the position that if a 1099 independent contractor paid on a production basis is generating both commercial and federally funded health care program referrals, any arrangement where the independent contractor is paid commissions only for the referrals of commercial patients and is paid nothing for the patients covered by a government program, nevertheless violates the AKS. The reasoning is that the commissions for the commercial patients, in reality, also serve as compensation for the patients covered by an FHCP. As stated in OIG Advisory Opinion No. 06-02: “[A]s a threshold matter, we must address whether the “carve out” of Federal business is dispositive of the question of whether the Existing Arrangement implicates the anti-kickback statute. It is not. The OIG has a long-standing concern about arrangements pursuant to which parties “carve out” Federal health care program beneficiaries or business generated by Federal health care programs from otherwise questionable financial arrangements. Such arrangements implicate and may violate the anti-kickback statute by disguising remuneration for Federal business through the payment of amounts purportedly related to non-Federal business.”

Here are the “take aways” from all of this:

1. It is permissible to pay bona fide W2 part-time or full-time employees, who generate FHCP business, as follows: (i) base salary plus (ii) bonuses (at the discretion of the employer) that are based on a number of factors, including the generation of business.
2. The employment arrangement must be “bona fide,” not a “sham.” The smell test applie Let’s say that the DME supplier and the sales rep sign a written employment agreement; let’s say that the supplier withholds taxes from the rep’s paycheck; let’s say that the supplier gives a W2 to the rep; but let’s say that the supplier, in reality, exercises no supervision and control over the rep. It is likely that the this “employment” arrangement will be considered to be a “sham” arrangement … meaning that a government enforcement agency will likely take the position that the rep is, in fact, a 1099 independent contractor of the supplier. This, in turn, will result in a violation of the AKS.
3. A sales rep (who generates patients covered by an FHCP) can be a 1099 independent contractor if the arrangement complies with the PSMC safe harbor.
4. If a 1099 independent contractor sales rep generates both commercial and FHCP patients, the parties cannot avoid violating the AKS by the DME supplier paying commissions only for the commercial patients … and paying nothing for the FHCP patie
5. Lastly, let’s say that the rep is a 1099 independent contractor, is paid production-based compensation, and only generates commercial patients for the DME supplier. In this scenario, the AKS will not apply. However, the parties will need to review the state’s anti-kickback statute. All states have anti-kickback statutes that are similar to the AKS. Some state anti-kickback statutes only come into play when the payor is the state’s Medicaid progra Other state statutes come into play regardless of the payment source.

Utilization of a 1099 Marketing Rep: Two Case Studies

In the real world, it is common for a business to outsource marketing to a marketing company. Unfortunately, what works in the real world often does not work in the health care universe. An example of this has to do with marketing companies. If a marketing company generates FHCP patients for a DME supplier, then the supplier cannot pay commissions to the marketing company.

The OIG has repeatedly expressed concern about percentage-based compensation arrangements involving 1099 independent contractor sales agents. In Advisory Opinion No. 06-02, the OIG stated that “[p]ercentage compensation arrangements are inherently problematic under the Anti-Kickback Statute, because they relate to the volume or value of business generated between the parties.” Moreover, in Advisory Opinion No. 99-03, is discussed at the beginning of this article.

Further, in its response to comments submitted when the safe harbor regulations were originally proposed, the OIG stated:

[M]any commentators suggested that we broaden the [employee safe harbor] to apply to independent contractors paid on a commission basis. We have declined to adopt this approach because we are aware of many examples of abusive practices by sales personnel who are paid as independent contractors and who are not under appropriate supervision. We believe that if individuals and entities desire to pay a salesperson on the basis of the amount of business they generate, then to be exempt from civil or criminal prosecution, they should make these salespersons employees where they can and should exert appropriate supervision for the individual’s acts.

54 Fed. Reg. 3,088, 3,093 (Jan. 23, 1989).

A number of courts have held that marketing agreements are illegal under the AKS and are, therefore, unenforceable. See Med. Dev. Network, Inc. v. Prof’l Respiratory Care/Home Med. Equip. Servs., Inc., 673 So. 2d 565 (Fla. Dist. Ct. App. 1996); Nursing Home Consultants, Inc. v. Quantum Health Services, Inc., 926 F. Supp. 835 (E.D. Ark. 1996), aff’d per curiam, 112 F.3d 513 (8th Cir. 1997); Zimmer, Inc. v. Nu Tech Med., Inc., 54 F. Supp. 2d 850 (N.D. Ind. 1999).

And as previously discussed, the OIG has taken the position that even when an arrangement will only focus on commercial patients and “carve out” FHCP patients, the arrangement will still likely violate the anti-kickback statute. See the preceding discussion of OIG Advisory Opinion No. 06-02.

Two cases in the pharmacy space exemplify the risks of paying commissions to 1099 independent contractor marketing reps. In the first case, Monty Grow (a former NFL player) was convicted by a Florida federal jury of receiving kickbacks to steer patients to a compounding pharmacy that, in turn, billed TRICARE for compounded drugs. Mr. Grow was convicted of health care fraud, conspiracy to defraud, receipt and payment of kickbacks, and money laundering. Mr. Grow had been accused by federal prosecutors of an arrangement to recruit and refer patients (covered by TRICARE) to Pompano Beach, FL – based compounding pharmacy, Patient Care America. According to the government, Mr. Grow effected the arrangement through his company, MGTEN Marketing Group, Inc. The evidence at trial showed that: (i) the prescriptions were signed by telemedicine companies using pre-printed prescriptions, (ii) there was no determination of medical need, (iii) the drugs were not, in fact needed and (iv) not only did the pharmacy pay kickbacks to Mr. Grow … but he, in turn, paid kickbacks to the TRICARE beneficiaries.

In the second case, Steven M. Butcher, a former pharmaceutical sales rep, pled guilty to one count of health care fraud and one count of violation of the AKS. Mr. Butcher joined three others who previously pled guilty to their roles in the arrangement, that prosecutors said was conducted through MedMax, LLC, a New York compounded medication sales and marketing company that Mr. Butcher allegedly owned and operated.

• Butcher and other MedMax sales representatives sought out participants of insurance plans that covered compounded drugs and encouraged them to obtain prescriptions for these medications … whether they were actually needed or not.
• The prescriptions were then sent to compounding pharmacies that would, in turn, pay a percentage commission to Mr. Butcher.
• Butcher would pay commissions to MedMax sales reps to incentivize them to obtain more unnecessary prescriptions.
• In some cases, Mr. Butcher and other sales reps reached out to physicians they knew in order to persuade them to prescribe unnecessary compounded medications.

Granted, these two cases (i) involve a lot of money and (ii) contain facts that are appalling. Nevertheless, broken down to their simplest components, a key fact in each case is that a marketing company (1099 independent contractor) is generating FHCP patients for a pharmacy and is, in return, receiving commissions for such patients.

Jeffrey S. Baird, JD, is chairman of the Health Care Group at Brown & Fortunato, a law firm with a national health care practice based in Texas. He represents pharmacies, infusion companies, HME companies, manufacturers, and other health care providers throughout the United States. Mr. Baird is Board Certified in Health Law by the Texas Board of Legal Specialization and can be reached at (806) 345-6320 or [email protected].