This proposed bill in California could have a big impact on digital health

Let’s talk about California AB 3129.

Most people in digital health aren’t following this proposed bill, but the lawyers are. That’s because it could have major implications for digital health companies backed by private equity and venture capital.

The bill has two major pieces:

What #2 threatens particular is the “captive PC” or “friendly PC” model, which is about 40 years old. This model is very common because of laws in many states related to the “corporate practice of medicine,” which means non-doctors can’t own medical practices or direct medical care. So VC’s, as well as hospitals and health plans, use the friendly PC model. It also protects the VC firm via share transfer agreements if a physician owner goes rogue by selling the practice to someone else. Investors ultimately need to make returns and they need to protect their companies against potential risks — for them, it can’t just be about the mission.

How does that work? In very simple terms, explains Manatt’s Randi Seigel, investors invest in management companies that contract with a physician practice, owned by one or more licensed physicians (one in very common) to provide all the non-clinical management and administration support under a management services agreement. This sets up operations so that the physician focuses solely on the supervision and quality of the medical care. The patient doesn’t see most of this on the back-end, unless they read the fine print. Underneath that is the medical group and the management company and there’s a relationship between the two.

Per legal experts I spoke to including from Manatt and Foley & Lardner - this bill could make it really hard to execute this model in California. So for Second Opinion subscribers, I dug into some of the potential impact, as well as the likelihood that a bill like this could pass in California. Where the macro concern seems to be on the regulatory side is that the lines are being blurred between the management services arm and the physician-owned practice.

“Yes, this legislation could actually pass and, signed into law, would likely eliminate the friendly PC model in California as we know it,” explained Nate Lacktman from Foley & Lardner. “Other states could follow suit,” he said.

Let’s discuss in more detail.

According to Seigel from Manatt, a telehealth expert, the proposed California bill would make this model challenging if the hedge fund and PE fund (that includes VCs) has any control over the management services (MSO) entity or the business support services provided. The language is not totally clear however, but could be interpreted to mean “any fee charged as a management services fee” to the physician practice is problematic. That would be a big problem for the current models, because of how common it is for digital health companies to use these models.

Via Seigel, “the language also would prohibit the management service organization from directly charging a payor or patient a fee for services, such as for care management or concierge services.”

The lawyers I spoke to are all digging into this provision, but several indicated that it could make it very difficult for venture capital-backed digital health companies to operate, assuming the bill passes.

Is there a simple solution to fix that? The fee part seems very integral to the system, so if it’s banned, then potentially really smart and creative lawyers can get around that, but it’s likely going to be expensive. And digital health companies in this market are under pressure to stay as lean as possible. Making matters worse, small emerging companies have already paid out thousands of dollars to set up compliant structures, so asking them to redo that is going to be a lot of time and money they don’t have.

Yes, in some form. It still has to move through the Senate and it’s hard to say what the final version will look like. Per Shean, the version that’s out now should cause “some alarm” in the venture capital community. The threat to the friendly PC model is extremely common - it’s THE path that virtual clinic companies are opting for right now.

There’s legitimate concerns that there needs to be guardrails around investors dictating medical decision-making. But Shean and other lawyers are concerned that there’s not enough nuance, particularly as it pertains to the difference between private equity, hedge funds, venture capital, as well as larger health systems and health plans. This could make it very hard to invest in companies that are doing wonderful things for underrepresented patient communities, including companies that provide gender-affirming care or support people in virtual settings who wouldn’t have access to medical care otherwise.

The bill presumes all VCs and PEs are focused on driving up costs and down quality when in fact many are doing the opposite - and we know that because they have agreements in place that ensure they’re only financially incentivized when they achieve those outcomes. Digital health isn’t perfect, but there’s a lot of good here.

“I think we need more voices talking about what works in digital health and finding the right balance and guardrails when physicians and non-physicians and private investments is involved” said Shean.

One concern, per the legal experts I spoke to, is that there won’t be a lot of sympathy for private equity and venture capital firms. In general, venture-backed digital health has not done a good enough job to demonstrate the positive impact it’s having.

Per Lacktman: Oregon has similar pending legislation and New York has a strong opposition to corporate practice of medicine. Friendly PCs for medical groups are already problematic in New Jersey following a first-of-it’s-kind 2017 New Jersey Supreme Court decision.

Oregon tried something similar with HB 4130, because of consolidation concerns around private equity or so-called “corporate medicine,” but state legislators took the time to understand the unintended impacts on digital health models. So they put in an exemption for telehealth organizations, per Shean. The bill ultimately did not pass but will be brought back. Shean says to change the rules in such a profound way warrants more discussion than it’s been given.

So yes, this is a big deal potentially. The term that I heard used by a few legal instruments - it’s a “blunt instrument.”

It seems to be stemming from concerns that private investment in U.S. healthcare is having a deleterious effect. There’s also been issues related to telehealth and digital health companies that don’t have clinical oversight and are run instead by technologists. We have also seen the federal government respond in the context of private equity ownership of skilled nursing facilities.

Would this bill, if it passes, have a chilling effect on investment? It could.

Seigel said: “This law may cause hedge funds and PE funds, remember defined broadly enough to include VCs, to slow down investing in health care professional practice models innovating or operating in California, and cause existing health care professional practices operating outside of California using a friendly physician model to change their scaling strategy to deprioritize entering into California until some of these questions are answered. The AG approval provisions will create another hurdle for PE and hedge funds to acquire or sell existing professional practices in California.”

My opinion? Growth-stage companies will be fine, because they’ll likely have the funds to figure it out. Where I’m most worried is seed-stage and Series A, which don’t have the resources to hire a team of lawyers to think through the implications. California is an important state for digital health companies, in part because many are based there and it’s an extremely large stage.

On the flip-side, there’s going to lobbying efforts that could cause some of these impacts to slow down. So the exact timeline on all this is still very up in the air.

Stay tuned.