California Ends the Legislative Session with Expanded Reporting Requirements, Less Clarity

From the West Coast Healthcare Desk

Amendments made by the California Office of Health Care Affordability (OHCA) to its cost and market impact review (CMIR) regulations became effective on Aug. 22, 2024, and serve to expand the scope of the Health Care Quality and Affordability Act (the Act) and, in turn, the reach of OHCA into the California healthcare marketplace. Further impacting the role of private equity in healthcare, the California State Legislature recently passed Assembly Bill (AB) 3129 (which awaits the Gov. Gavin Newsom's signature) to increase scrutiny of healthcare transactions involving private equity companies or hedge funds. Each of these developments raise many unanswered questions about how California will interpret and implement its expanding regulatory landscape for monitoring healthcare transactions, the most critical of which to the dealmaking process we summarize below.

Amended OHCA Regulations

OHCA's August 2024 amendments to the CMIR regulations effectively expanded OHCA's reach as an apparent response to OHCA's perception that an insufficient number of transactions were being reported. The amended regulations broaden the scope of healthcare entities subject to the Act's transaction reporting requirements. In pertinent part, the amended CMIR regulations:

• require any healthcare entities that are the "subject of" (versus only those that are a "party to") a material change transaction to file a notice to OHCA. Inclusion of the phrase "subject of" means the transaction must be reported if it would result in the transfer in whole or in part of a healthcare entity's assets, control, responsibility, governance, or operations to one or more entities.
• expand the definition of material change transactions to include transactions involving entities that own or control a healthcare entity with at least $25 million in revenue or assets (versus strictly focusing on the healthcare entity).

Although the intent of these regulations is clear (to increase the number of transactions being reported), how OHCA will interpret and implement these regulations presents several unanswered questions¹, including:

• What are the boundaries of the "subject of" language given the broad language about the transfer of assets, control, responsibility, governance or operations? Could this pick up lenders, landlords, software vendors, staffing companies and other third-party vendors that do not provide healthcare services?
• Does this regulation reach transactions involving a management service organization (MSO) that typically oversees the day-to-day, nonclinical operations of a supported medical practice?
• Do entities that "own or control" a healthcare entity include only direct parent companies? How far up the ownership chain will this regulation reach?
• Are the regulations intended to capture out-of-state transactions conducted by parent companies or controlling affiliates of healthcare entities located in California?

Assembly Bill 3129

The California State Legislature on Aug. 31, 2024, passed AB 3129, a law that would require private equity and hedge funds to obtain the California Attorney General's (AG) consent before closing certain healthcare transactions in California.² California Gov. Newsom's last day to sign or veto the bill is Sept. 30, 2024.

AB 3129 would arguably be a first-in-the-nation law that is solely focused on private equity investment in healthcare.³ In its current form, AB 3129 would apply to a broad spectrum of transactions between private equity or hedge funds and healthcare entities and licensed professionals, including some transactions regardless of revenue thresholds. Additionally, AB 3129 strengthens and expands the applicability of California's prohibition against the corporate practice of medicine (CPOM) by codifying existing CPOM guidance from the California Board of Medicine and applying such guidance to California's prohibition against the corporate practice of dentistry (CPOD).

Whereas AB 3129 extends the reach of the Act to include dentists and dental groups (providers who are not subject to the CMIR regulations), other aspects of AB 3129 seemingly exclude other professions and group practices from the Act's requirements. For example, AB 3129 was amended, in part, to expressly exclude from the definition of a "provider group" a provider group whose "primary purpose" is the delivery of dermatology services. However, there is no express guidance in determining what qualifies as the "primary purpose" (for example, 51 percent of revenue in a multispecialty practice) or in explaining how this dermatology group exemption impacts the Act's AG notice and review process.

There also are competing interpretations of AB 3129 as to whether it applies to transactions involving the change of ownership of MSOs and/or dental support organizations (DSOs). On one hand, MSOs and DSOs are administrative/management organizations that do not provide healthcare services. As a result, neither MSOs nor DSOs fall within the Act's definitions of "health care facility," "provider group," or "provider." Therefore, it follows that MSO and DSO transactions should not be subject to the Act's requirements. The AG, however, could take the position that MSO and DSO transactions are subject to the Act because such transactions allow private equity sponsors to obtain indirect control over the nonclinical operations of a medical or dental practice. Regardless of the application of AB 3129 to platform-level deals, MSOs and DSOs that engage in add-on transactions with medical and dental groups will need to evaluate the application of the Act to such transactions.

If signed into law, AB 3129's CPOM and CPOD provisions likely would take effect immediately, so the time to revisit and pressure test MSO contracts and DSO contracts is now. On the other hand, AB 3129's transaction reporting and consent provisions likely apply to transactions closing on or after Jan. 1, 2025. There is an exemption for transactions "entered into" prior to this date, but such exemption does not apply to transactions that result in a material change on or after Jan. 1. While vague, the language suggests that deals signed this year that close in 2025 would still be subject to AB 3129. What that means in practice is unclear, as no standards for submissions have been published to date.

AB 3129, in its current form, raises the following critical questions about how the California AG will interpret and implement the law, which is anticipated to be refined in implementing regulations and guidance:

• Will the AG scrutinize transactions similarly to how the AG has historically reviewed nonprofit healthcare transactions?
• On what types of transactions will the AG focus its limited resources? Will the AG review all transactions or just those involving platforms that have significant market share, assets or operations in California?
• How is "annual gross revenue" measured for the revenue thresholds? Is it based on a calendar-year basis, is it limited to only in-state revenue or only healthcare revenue, or only revenue attributed to the aspects of the entity that trigger notice and approval?
• What does "health professional" mean, in the definition of "nonphysician providers?" The definition of "nonphysician providers" does not use the term "licensed healthcare professionals" (which is separately and specifically defined in the law). Would "health professional" include aestheticians, veterinarians, veterinary technicians, massage therapists and acupuncturists, to name a few?
• When determining headcount thresholds for providers, are independent contractors included? What about those who work part-time or on a locum tenens basis? And, will different legal entities be aggregated if provider employees work for multiple entities, but each entity is separately credentialed?
• Other than psychologists, licensed clinical social workers, and marriage, family and child counselors, what licensed professions are "nonphysician mental health professionals"?
• What are the boundaries of the dermatology exemption? Are practices that offer multiple service lines (e.g., plastic surgery, dermatology and aesthetics) exempt? Is there a revenue percentage that needs to be met for the exemption to apply?
• What specific information will need to be provided to the AG when submitting notice?
• Will documentation and information submitted be confidential or under seal?
• If a transaction also triggers a filing under the Hart-Scott-Rodino Act, will the AG's review process differ or perhaps be more streamlined?

Conclusion

OHCA's amended regulations and AB 3129 continue California's trend of expanding government scrutiny of healthcare transactions. But, they also raise many unanswered questions about how the regulations and AB 3129, if enacted, would be interpreted and implemented. Stakeholders should familiarize themselves with OHCA's amended regulations and monitor rulemaking processes in California for clarifying regulations and guidance for both the amended regulations and AB 3129 (in the event it is signed into law). In the meantime, Holland & Knight will continue to follow and carefully analyze these and other developments.

For additional information or more detailed analyses, please contact our team of Holland & Knight attorneys and use HK Navigator to stay up-to-date on the latest developments in this space nationwide.

Notes

¹ Holland & Knight published a written comment to OHCA on June 19, 2024, raising many of these same questions.

² For detailed prior discussions of AB 3129, see Holland & Knight's previous alerts, "Healthcare Private Equity Transactions Under Scrutiny: Midyear Review," Aug. 1, 2024; "California Court Decision Further Scrutinizes the Friendly PC Model – Now What?," June 24, 2024; "New Bill Would Empower California AG to Curtail Healthcare Private Equity Transactions," June 12, 2024; and "Private Equity Healthcare Transactions Under Scrutiny," March 14, 2024.

³ An Indiana healthcare transaction law recently took effect that, in part, focuses on private equity investments and models, but private equity is not the singular focus of the law.

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