Since the enactment of the Eliminating Kickbacks in Recovery Act (“EKRA”), we have a seen a significant industry shift away from labs using an employed and commissioned sales force in favor of “flat fee” sales contracts with independent contractor marketing groups. While generally well-intentioned and in many cases recommended by counsel, we believe that this move to flat fee 1099 marketing substantially increases enforcement risk under the Anti-Kickback Statute (“AKS”), and as a result, we have consistently recommended against proposals to make this transition. Early judicial interpretation of the EKRA and contemporaneous enforcement action under the AKS supports this recommendation.
We recommend against transitions from commissioned W-2 sales to flat fee 1099 structures for two primary reasons:
- The EKRA does not appear to prohibit commissioned sales employees as long as they are not beneficiaries or referring practitioners.
In April of 2020, we noted that “the EKRA does not adopt the broadly inclusive language of the AKS. It does not prohibit payments that are made for ‘arranging for or recommending.’ Instead, the EKRA prohibits payments made to ‘induce a referral’ or ‘in exchange for an individual using the services.’ In our view, the first restriction prohibits payments to referral sources, and the second prohibits inducing payments to beneficiaries. These are some of the most rampant and problematic types of payments in the laboratory and recovery home spaces, and there is significant reason for the government to put in place greater safeguards against such payments.”
The OIG and DOJ have an extensive history of reliance on the AKS’s prohibition of payments in exchange for “arranging for or recommending” as the basis for their enforcement authority reaching marketing payments to independent sales groups (who are not practitioners or beneficiaries). They have an equally extensive history of explicitly favoring employed marketers over contracted marketers. It seems unlikely that the government would omit without comment the “arranging for or recommending” prohibition of the AKS and would abandon the W-2/1099 distinction if it intended for the EKRA to apply to employed marketers. In contrast, the removal of the W-2/1099 distinction in EKRA is very reasonable if its application is interpreted narrowly as applying to only beneficiary and practitioner payments. In neither of these contexts is there the extensive body of sub-regulatory guidance promoting employment.
In S&G Labs Hawaii, LLC v. Graves, the first case to interpret the EKRA, the Court took a similar position. It noted that the commissioned employee was not a recipient of laboratory services (i.e., he was not a beneficiary) and went on to note that that the marketer was not in a position to directly refer individuals to the lab (i.e., he was not a practitioner). It held that commission payments to an employed marketer did not violate the EKRA.
While the S&G opinion has generally been described as “surprising” to the legal community, we believe that it is well-decided. If the government wanted the EKRA to criminalize “arranging for or recommending,” it would have said so. At a minimum, it would have given industry participants notice that the definitions it has promoted for decades no longer apply, and that payments “to induce a referral” and “in exchange for an individual using” now include payments for “arranging for or recommending” use.
- Labs that move to flat fee 1099 sales models are facing increased enforcement.
Perhaps the more important factor in favor of maintaining a W-2 sales force is that the shift to a flat fee independent contractor model does not appear to be working. We have seen a large and increasing number of enforcement actions brought by the DOJ based on nominally flat fee payments to marketing groups. With few exceptions, the government has had little difficulty demonstrating that the arrangements are not entitled to protection under the personal services safe harbor to the AKS. Sometimes this loss of safe harbor protection is due to intentional misconduct, but more often, it arises from the fundamental nature of the arrangement.
The business reality is that marketers are paid to market successfully. It is nearly impossible to maintain a marketing relationship without “tak[ing] into account the … business otherwise generated between the parties ….” Any performance review and any cost-benefit analysis of the marketing contract necessarily draws the connection between results and payment and potentially undermines the safe harbor protection of the deal. As a result, it is incredibly difficult for labs to demonstrate that their “flat fee” contract is truly independent of marketing results, and it is very easy for the government to argue that the flat fee agreement is a sham or a fig leaf for a performance-based arrangement. In pursuit of a theoretically viable solution under the EKRA, labs often lose the protection of the bona fide employment safe harbor without being able to secure AKS protection under the personal services safe harbor.
Labs need to ensure that the employment agreements that they enter accurately describe the actual relationship between the parties and should implement appropriate oversight of all sales activities. If you are a lab owner or executive seeking guidance on appropriate structuring of sales force compensation, please do not hesitate to contact Michael Elliott at 469.758.4152 or email@example.com.