Tag: Regulatory

Private Placement of Alternative Investment Funds in the European Union (EU): Changing Regulatory Landscape

GT Law

I. Overview

The European Commission’s Alternative Investment Fund Managers Directive (“AIFMD”) was designed to establish a unified framework throughout the EU for regulating previously unregulated Alternative Investment Funds (“AIF”).

The AIFMD is effective as per July 22, 2013. The AIFMD, as any other EU directive, however needs to be transposed into European Union members’ national laws before it will actually have effect. Moreover, the AIFMD leaves the member states with the flexibility to make their own choices on certain aspects. This concerns also the private placement of units in AIF´s.

In preparation for its enforcement by the individual EU member states, this memorandum will discuss the AIFMD’s effect on non-EU managers of AIFs (“AIFM”) marketing non-EU AIFs within the EU.  The memorandum will first give a broad overview of some of the AIFMD’s measures significant for non-EU AIFMs, followed by a table summarizing how the private placement of AIF´s in the major capital markets of the EU is affected the AIFMD.

It should be noted that prior to July 22, 2013, the marketing of AIF´s in EU member states already required an individual analysis for each member state. For the time being not much has changed in this respect but marketing unregulated funds to selected non retail investors has certainly become more complex due to the AIFMD. Also these distributions may no longer be expected to remain of relatively little interest to securities regulators and fund managers may therefore be required to strengthen their compliance efforts in this area.

II. Regulatory Target – AIF Managers

The AIFMD seeks to regulate a set of previously unregulated AIFs, namely, “all collective investment undertakings that are not regulated under the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.”  These include hedge funds, private equity funds, commodity funds, and real estate funds, among others.

Rather than regulating AIFs directly, however, the AIFMD regulates AIFMs—that is, entities providing either risk or portfolio management to an AIF.  According to the AIFMD, each AIF may only have a single entity as its manager.

The AIFMD applies to AIFMs that are: (1) themselves established in the EU (“EU AIFM”); (2) AIFMs that are not established in an EU country (“non-EU AIFM”), but that manage and market AIFs established in the EU (“EU AIF”); or (3) non-EU AIFMs that market AIFs that are not established in a EU country (“non-EU AIF”) within an EU jurisdiction.

This memo principally deals with the third category, non-EU AIFMs that market non-EU AIFs in the EU.

III. Exemption – Small AIFs

Pursuant to the AIFMD, AIFMs that manage small funds are exempt from the full rigor of the AIFMD regulatory regime.  A lighter regulatory regime is applicable to these AIFMs.

The AIFMD defines AIFMs that manage small funds as either: (1) an AIFM with aggregate assets under management not exceeding € 500 million, where the AIFs are not leveraged, and the investors do not have redemption rights for the first five years after their investment; or (2) an AIFM with aggregate assets under management not exceeding € 100 million.

AIFMs of smaller funds are largely exempted from the AIFMD, and will only be subject to registration, and limited reporting requirements.

IV. Marketing – Definition

As previously discussed, the AIFMD applies to non-EU AIFMs marketing non-EU AIFs in one or more EU jurisdictions.

The AIFMD defines marketing as “a direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the Union.”  This marketing definition does not include reverse solicitation, where the investor initiates the investment, and the investment is not at the AIFM’s direct or indirect initiative.

Thus, for example, if an EU investor initiated an investment in a U.S. AIF, managed by a U.S. AIFM, the U.S. AIFM and AIF would be unaffected by the AIFMD.  The AIFMD would only apply to U.S. AIFMs managing U.S. AIFs, if the U.S. AIFM solicited investment in the EU.

V. Regulating Non-EU AIFMs – National Private Placement Regimes

The AIFMD is designed to phase out national private placement regimes, creating a unified regulatory regime throughout the EU.  However, the AIFMD is scheduled to come into force in stages.

Between July 22, 2013, and 2018 (at the earliest), non-EU AIFMs will be able to market their non-EU AIFs in an EU jurisdiction (“EU Target Jurisdiction”) subject to the national private placement regimes applicable in that EU jurisdiction.

Thus for example, a U.S. AIFM marketing a U.S. AIF in the UK will be able to do so subject to the UK’s private placement regime.

VI. Regulating Non-EU AIFMs – Additional AIFMD Requirements

As explained, through 2018, the AIFMD will largely permit non-EU AIFMs to market non-EU AIFs subject to the private placement regime in the EU Target Jurisdiction.

However, the AIFMD does include three additional requirements for the non-EU AIFMD to be able to take advantage of the EU Target Jurisdiction’s private placement regime.  These include, specific disclosure and reporting requirements, cooperation agreements, and exclusion of AIFs and AIFMs established in certain countries.  Each of these will be discussed in turn.

a. Applicable AIFMD Reporting Requirements

By its terms, the AIFMD will require even non-EU AIFMs marketing non-EU AIFs pursuant to national private placement regimes to comply with certain AIFMD provisions concerning annual reports, disclosures to investors, periodic reporting to regulators, and acquisition of control over EU companies.

A non-EU AIFM will thus be required to make available: (1) an annual report for each non-EU AIF that it markets in the EU; (2) information relevant to potential investors, as well as changes in material information previously disclosed; (3) regular reports to the national regulator in the EU Target Jurisdiction; and (4) disclosure information to a listed or unlisted EU company over which the non-EU AIFM acquires control.

b. Cooperation Agreements

For non-EU AIFMs to be able to market their non-EU AIFs in an EU jurisdiction, the AIFMD requires that there be cooperation agreements in place between the regulator in the non-AIFM’s home jurisdiction, and the EU Target Jurisdiction.

ESMA has negotiated memoranda of understanding (“MOU”) with 34 regulators in a variety of jurisdictions.  These include regulators in Albania, Australia, Bermuda, Brazil, the British Virgin Islands, Canada (the provincial regulators of Alberta, Quebec and Ontario as well as the Superintendent of Financial Institutions), the Cayman Islands, Dubai, Guernsey, Hong Kong (Hong Kong Monetary Authority and Securities and Futures Commission), India, the Isle of Man, Israel, Jersey, Kenya, Malaysia’s Labuan Financial Services Authority, Mauritius, Montenegro, Morocco, Pakistan, Serbia, Singapore, Switzerland, Tanzania, Thailand, the United Arab Emirates and the United States (Federal Reserve Board, Office of the Comptroller of the Currency and Securities and Exchange Commission).

These MOUs, however, are insufficient to permit non-EU AIFMs to market their non-EU AIFs in any EU jurisdiction.  Rather, the EU Target Country must have a separate cooperation agreement with the regulator in the non-EU AIFM’s home jurisdiction (presumably these separate cooperation agreements will be based on the MOUs negotiated by ESMA).

Thus, for example, for a U.S. AIFM to be able to market its U.S. AIF in the UK, the UK’s Financial Conduct Authority must have a cooperation agreement with the United States’ Securities and Exchange Commission.

c. Exclusion of Non-Cooperative Country or Territory

Finally, pursuant to the AIFMD, to be able to market based on the EU Target Country’s private placement regime, neither the non-EU AIFM nor the non-EU AIF may be considered a country considered a “Non-Cooperative Country or Territory,” by the Financial Action Task Force on anti-money laundering, and terrorist financing.

In sum, through 2018, non-EU AIFMs may market their non-EU AIFs in EU jurisdictions according to the relevant EU Target Jurisdiction’s private placement regime, subject to a few additional AIFMD requirements.

VII. The AIFMD in Each EU Jurisdiction

The above discussion outlines the AIFMD’s general requirements pertaining to non-EU AIFMs marketing non-EU AIFs.

However, because to take effect the AIFMD must be transposed into the national law of each EU jurisdiction, and because through 2018 the AIFMD largely relies on national private placement rules to regulate non-EU AIFMs, there is bound to be substantial variation in the AIFMD’s application across EU jurisdictions.

The table below details relevant aspects of the AIFMD’s application in each of the EU jurisdictions (plus Norway, and Switzerland).  Supplementing the memorandum, the table serves as a basic guide for the AIFMD’s application to non-EU AIFMs seeking to market their non-EU AIFs in each of the EU jurisdictions.  The chart includes, for each country, whether it has transposed the AIFMD on time (“On time” / “Not on time”), an overview of the private placement regime, relevant reporting requirements, transitional provisions, and a list of the countries with which a cooperation agreement is in place.

Because some of the EU countries have yet to transpose the AIFMD, or have not completed the transposition, and cooperation agreement process we will indicate on the outline where completion of the process is pending.

BELGIUM

  • AIFMD Transposition
    • Not on time
  • Private Placement Regime
    • At present, AIFMs must be registered locally, and are subject to a minimum investment amount of € 250,000.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions – Pending
  • Cooperation Agreements with non-EU Countries – Pending

DENMARK

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • Denmark permits marketing to a maximum of 8 offerees, and requires that a non-EU AIFM be licensed in its member state of reference.1
  • Relevant Reporting Requirements
    • Non-EU AIFs licensed in another EU jurisdiction pursuant to AIFM regulations must submit additional documentation to the Danish FSA, including operating and managing plans, and contact information.
  • Transitional Provisions
    • Transitional provisions will permit non-EU AIFMs to market AIFs under Denmark’s current private placement regime until at least July 22, 2014 (provided that the AIFMs commenced marketing prior to the transposition date of July 22, 2013).
  • Cooperation Agreements with non-EU Countries – Pending

FINLAND

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • Finland’s private placement regime permits AIFMs to market only to “professional” clients.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions
    • The AIFMD is not expected to apply to non-EU AIFMs until 2015.
    • Transitional rules have been proposed (although not yet adopted) permitting AIFMs to market pursuant to existing private placement rules, provided that the AIFMs can show that they have made a good faith effort to comply with AIFMD.
  • Cooperation Agreements with non-EU Countries – Pending

FRANCE

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Under its present private placement regime, France does not permit AIFMs to actively solicit investment.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions
    • It appears that a transitional period will apply until 22 July 2014, during which all French AIFMs will be able to continue marketing and / or managing any AIFs in France on the pre-AIFMD basis (for example by using reverse solicitation).
    • Other AIFMs (whether EU but outside France or non-EU) would, therefore, need to be authorized.
  • Cooperation Agreements with non-EU Countries – Pending

GERMANY

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Under the new German private placement regime, non-EU AIFMs may market to professional investors, subject to requirements.
    • To market in Germany, the non-EU AIFM must appoint an independent entity to act as a depositary (as defined in the AIFMD), and notify BaFin, Germany’s markets regulator, of the appointed depository’s identity.
  • Relevant Reporting Requirements
    • Notifying BaFin of its intention to market in Germany, and include an application with a comprehensive list of information and documents.  BaFin will have up to two months to review, and decide upon the application.
    • Making certain initial and ongoing investor disclosures.
    • Complying with reporting requirements to BaFin.
  • Transitional Provisions
    • Non-EU AIFMs that marketed funds in Germany by prior to the AIFMD’s July 22, 2013 effective date (“previously marketed funds”) will be permitted to continue marketing those previously marketed funds under existing private placement rules until July 21, 2014.
  • Cooperation Agreements with non-EU Countries – Pending

IRELAND

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Under Ireland’s private placement regime, non-EU AIFMs will be able to market in Ireland without restrictions additional to those of the AIFMD, discussed above.
  • Relevant Reporting Requirements
    • Ireland will only require that the non-EU AIFMs comply with the AIFMD’s reporting requirements for non-EU AIFMs discussed above.
  • Transitional Provisions
    • Non-EU AIFMs managing qualified investor alternative investment funds (“QIAIF”), as defined under the relevant Irish provisions, which were authorized prior to the July 22, 2013 transposition date will not be required to be AIFMD compliant until July 22, 2015.
    • Non-EU AIFMs managing QIAIFs authorized after July 22, 2013 will have two years from the QIAIF’s launch date to become AIFMD compliant.
  • Cooperation Agreements with non-EU Countries – Pending

ITALY

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • Under Italy’s current private placement regime, which it seems will be available to non-EU AIFMs through 2015, AIFMs may market only to “expert” investors.
  • Relevant Reporting Requirements
    • Currently, AIFMs must disclose their balance sheets, certain administrative documents, and financial reports regarding their managers’ activities.
  • Transitional Provisions – Pending
  • Cooperation Agreements with non-EU Countries – Pending

LUXEMBOURG

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Through 2018, Luxembourg will permit small and non-EU AIFMs to market pursuant to its private placement regime.
  • Relevant Reporting Requirements
    • Luxembourg imposes certain transparency requirements on AIFMs, including disclosure of an AIFM’s net asset value, and disclosures upon gaining control of an EU company.
  • Transitional Provisions
    • Beginning on July 22, 2014, in addition to complying with Luxembourg’s private placement regime, non-EU AIFMs will be required to comply with the third country provisions of the AIFMD.
  • Cooperation Agreements with non-EU Countries
    • Luxembourg signed cooperation agreements with all 34 of the regulators that entered into MOUs with ESMA.

THE NETHERLANDS

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Netherlands will permit certain AIFMs to market pursuant to its private placement regime provided offerings are: (1) to less than 150 persons; (2) units have an individual nominal value of at least EUR 100,000 or consist of a package of units with at value of at least EUR 100,000; or (3) offered to professional investors only.
    • Non-EU AIFMs are exempted for offerings to qualified investors only if the AIFM is not domiciled in a non cooperative country under FATF rules and the Dutch regulator and the foreign regulator entered into a MOU.
    • AIFMs licensed by the relevant securities regulators in the USA, Jersey and Guernsey may offer to any investor under a license recognition regime.
  • Relevant Reporting Requirements
    • Notification to Netherlands Financial Markets Authority and reporting of investments, risk positions and investment strategy of AIF to Dutch Central Bank.
  • Transitional Provisions
    • Several grandfathering provisions for non-EU AIF’s that stopped marketing prior to 22 July 2013.
  • Cooperation Agreements with non-EU Countries – Pending

POLAND

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • So far, the Polish regulator has not published an AIFMD transposition regulation.
    • However, under the existing private placement regime, non-EU AIFs that wish to market its units in Poland may do so if:
      • The units are qualified as equity or debt securities under their respective governing law; and
      • The units are offered under the “private placement” regime, meaning a nonpublic offer to sell securities to no more than 149 identified investors
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions
    • As mentioned above, the Polish regulator has not made an official announcement concerning AIFMS transposition.
  • However, a representative of the Polish regulator recently indicated in an interview that:
    • AIFMs currently marketing AIFs in Poland will have two years to determine whether they fall within the regulations of the AIFD; and
    • If so, the AIFMs will be required to become AIFMD compliant within the two-year period.
  • Cooperation Agreements with non-EU Countries – Pending

SPAIN

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • Currently, no private placement regime is available, and it in not anticipated that a private placement regime will be made available in the implementation of the AIFMD.
    • Under proposed rules, registration with, and authorization from the Spanish regulator is required for non-EU AIFMs to market non-EU AIFs to professional investors only in Spain.
    • Authorization to market may be denied if:
      • The non-EU AIF’s home state applies discriminatory marketing rules against Spanish AIFs;
      • The non-EU AIF provides insufficient assurance of compliance with Spanish law, or insufficient protection of Spanish investors; or
      • The non-EU AIFs will disrupt competition in the Spanish AIF market.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions – Pending
  • Cooperation Agreements with non-EU Countries – Pending

SWEDEN

  • AIFMD Transposition
    • Not on time.
  • Private Placement Regime
    • At present, there is no private placement regime for marketing AIFs in Sweden.
    • Many AIFs, simply fall outside the scope of Sweden’s regulations, and may market freely in Sweden
    • Other AIFs affected by Sweden’s regulation may only be marketed by a Swedish AIFM, or an AIFM regulated in another EU country.
    • It is unclear whether non-EU AIFMs will be able to continue to market freely after the AIFMD comes into force, or whether they will be prevented from marketing in Sweden altogether
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions – Pending
  • Cooperation Agreements with non-EU Countries – Pending

UNITED KINGDOM

  • AIFMD Transposition
    • On time.
  • Private Placement Regime
    • Provided that an AIF has been marketed by the non-EU AIFM prior to July 22, 2013 in an EEA jurisdiction, the non-EU AIFM will be able to continue to market the funds under the UK’s private placement regime until July 21, 2014 without complying with the requirements of the AIFMD.
    • For new funds marketed from July 22, 2013, the non-EU AIFM will need to comply with the reporting requirements of the AIFMD set out below.
  • Relevant Reporting Requirements
    • Prior to marketing in the UK, an AIFM must give the FCA written notification of its intention to do so.
    • In the notification, the AIFM must affirm that it is responsible for complying with the relevant AIFMD requirements, and that these relevant requirements have been satisfied.
    • Once it has submitted the notification to the FCA, the AIFM may begin marketing—it need not wait for the FCA’s approval.
    • Additionally, the AIFM is subject to disclosure requirements, including:
      • Ensuring that investor disclosure in fund marketing materials meets the disclosure and transparency requirements set out in the directive;
      • Reporting either annually or semi-annually to the FCA proscribed information; and
      • Submitting and publishing an annual report for each AIF that the AIFM manages or markets.
  • Transitional Provisions
    • The non-EU AIFMs that marketed any AIF in the EU prior to the AIFMD’s July 22, 2013 effective date will be permitted to market AIFs in the UK under the pre-AIFMD rules until July 21, 2014.
    • Non-EU AIFMs taking advantage of the transitional provision may do so irrespective of whether or not the FSA has cooperation agreements in place
  • Cooperation Agreements with non-EU Countries
    • The UK signed cooperation agreements with all 34 of the regulators that entered into MOUs with ESMA.

NORWAY2

  • Private Placement Regime
    • At present, Norway does not permit soliciting investment in AIFs.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions – Pending
  • Cooperation Agreements with EU Countries – Pending

SWITZERLAND

  • Private Placement Regime
    • Non-EU AIFMs may market through the Swiss private placement regime without any additional regulation, approval, or license requirement or the investor is:
      • A License financial institution;
      • A regulated insurance institution; or
      • An investor that has concluded a written discretionary asset management agreement with a licensed financial institution, or a financial intermediary, provided that information is provided to the investor through the financial institution, or intermediary, and that the financial intermediary is:
        • Regulated by anti-money laundering regulation;
        • Governed by the code of conduct employed by a specific self-regulatory body recognized by the Swiss regulator; and
        • Compliant with the recognized standards of the self-regulatory body.
  • Relevant Reporting Requirements – Pending
  • Transitional Provisions
    • Non-Swiss AIFMs have until March 1, 2015 to:
      • Appoint a Swizz representative, and a Swiss paying agent; and
      • Comply with all relevant regulations.
    • Non-Swiss AIFMs that have yet to be subject to Swiss regulation must:
      • Contact, and register with the Swiss regulator by September 1, 2013; and
      • If not sufficiently licensed in their home country, apply for a license by March 1, 2015.
    • Cooperation Agreements with EU Countries – Pending

1 An AIFM’s member state of reference (“MSR”) is the member state where the marketing of most of the AIF takes place.  So, for example if a U.S. AIFM markets in Denmark, and Denmark is the Member State of Reference, then the Danish FSA must issue the U.S. AIFM a license prior to commencement of the U.S. AIFM’s marketing activities in Denmark.

2 Norway, and Switzerland are non-EU countries of interest.  Because they are not part of the EU, they are not required to transpose the AIFMD.

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Next Time, Buy the CDs, Re: Illegal Music Download

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Following the lead of other courts addressing statutory penalties for illegal music downloading, the U.S. Court of Appeals for the First Circuit upheld a $675,000 fine for downloading and distributing 30 songs.  Sony BMG Music Entertainment  v. Tenenbaum, Case No. 12-2146 (1st Cir., June 25, 2013) (Howard, J.).

For over eight years, Tenenbaum ignored the warnings of his father, his college and the music industry and continued to download and distribute thousands of songs he knew were copyrighted.  In 2007 five record companies sued Tenenbaum under the Copyright Act for statutory damages and injunctive relief.  The record companies only pursued claims for 30 songs, though Tenenbaum admitted at trial he had distributed as many as 5,000 songs.  The trial court held as a matter of law that Tenenbaum had violated the Copyright Act and the jury found his violations were willful.  The jury awarded $22,500 for each of Tenenbaum’s thirty violations (15 percent of the statutory maximum), for a total award of $675,000.  The district court reduced the award to $67,500 finding that the jury’s award violated due process.  The First Circuit vacated the district court’s judgment holding that the principle of constitutional avoidance required the court to first address the issue of remittitur before determining the due process question.  On remand the district court determined remittitur was inappropriate and that the original $675,000 award comported with due process. Tenenbaum appealed the decision solely on due process grounds.

musical notes

The Court reviewed two questions: what is the correct standard for evaluating the constitutionality of an award of statutory damages under the Copyright Act; and (b) did the $675,000 award violate Tenenbaum’s right to due process?

The 1st Circuit looked to St. Louis, I.M. & S. Ry. Co. v. Williams, not BMW of North America, Inc. v. Gore, as the proper standard for reviewing the constitutionality of statutory damages under the Copyright Act, noting that Gore applies to punitive damages and the concerns regarding fair notice to the parties of the range of possible awards were “simply not present in a statutory damages case where the statute itself provides notice of the scope of the potential award.”  Under Williams, a statutory damage award only violates due process “where the penalty prescribed is so severe and oppressive as to be wholly disproportioned to the offense and obviously unreasonable.”

The 1st Circuit examined the purpose of the Copyright Act’s statutory damages and Tenenbaum’s behavior to determine if $675,000 metWilliams’ standard for constitutionality.  The 1st Circuit found that in 1999 Congress increased the Copyright Act’s minimum and maximum statutory awards specifically because of new technologies allowing illegal music downloading.  The record companies presented evidence that Tenenbaum’s activities had led to the loss of value of its copyrights and reduced its income and profits—precisely the harm Congress foresaw.  The Court went on to find that Tenenbaum’s conduct was egregious—he pirated thousands of songs for a number of years despite numerous warnings.  The Court held that “much of this behavior was exactly what Congress was trying to deter when it amended the Copyright Act.”  The 1st Circuit rejected Tenenbaum’s argument that the damages award had to be tied to the actual injury he caused, relying on Williams to find that the damages were imposed for a violation of the law and did not need to be proportional to the harm caused by the offender.

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Doing Business In Latin America: Does Your Local Supplier Have Best Practices In Place So That Your Company Can Avoid Liability Under The Foreign Corrupt Practices Act (FCPA)?

Sheppard Mullin 2012

Imagine yourself the CEO of a successful multinational company. In the past few years, you have overseen ACME’s expansion into Latin America – a market whose demographic profile holds the promise of mouthwatering profits for your company, particularly with the upcoming holiday season. As they say, la vida es buena!

In planning for the Latin America expansion, you knew about the rules and prohibitions of the Foreign Corrupt Practices Act (“FCPA”) and implemented measures to ensure your employees do not run afoul of the law. However, you may not have known that the company can incur FCPA liability for payments made by third parties, such as such as suppliers, logistics providers, and sales agents, with whom your company works. In fact, a company can be held liable if it knows or should know that a third-party intends to make a corrupt payment on behalf of or for the benefit of the company. Because a company can be responsible for conduct of which it should have known, a conscious disregard or deliberate ignorance of the facts will not establish a defense.

To protect your company from third party liability, it is essential to perform due diligence on potential business partners. This is not to say that you cannot consider the recommendations of local employees in selecting business partners. Relying on those recommendations alone, however, could expose the company to FCPA liability if that company does not conduct itself with the same level of integrity that you do. The amount of diligence necessary varies from one potential business partner to the next and can include an anti-corruption questionnaire, document review, reference interviews, or local media review, among other things.

That’s all well and good, but what about companies with whom you are already doing business and whom you now realize you may not have adequately investigated? Asking to review those companies’ FCPA compliance policies is a good first step. If you determine that a policy is inadequate, you may ask the company to provide FCPA training to its employees. You should also carefully monitor the company’s contract performance to ensure compliance. In particular, you should consider evidence of unusual payment patterns, extraordinary “commissions,” or a lack of transparency. The key question is: how is the company spending your money?

When in doubt, experienced legal counsel can assist you in navigating these and other FCPA issues. For example, Sheppard Mullin offers Spanish language training on the provisions of the FCPA and advice for successfully implementing internal safeguards and controls to protect against FCPA liability.

With a solid FCPA plan in place, your thoughts wander back to the upcoming holiday season and your company’s projected profits for the new Latin America division and you smile to yourself. La vida es buena.

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International Trade Commission Addresses Use of Standard-Essential Patents in Section 337 Investigations

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The International Trade Commission (ITC) addressed for the first time the issue of whether infringement of a patent that has previously been declared “standard-essential” may form the basis for either a limited exclusion order or cease-and-desist order under a § 337, ruling that nothing in the ITC’s enabling statute prevents issuing an exclusion order, even if the complainant is under an obligation to license the patent.  Certain Electronic Devices, Including Wireless Communication Devices, Portable Music and Data Processing Devices, and Tablet Computers, Inv. No. 337-TA-794, (U.S. ITC, June 4, 2013) (ITC, per curiam); Commissioner Pinkert, dissenting).

The complainant, Samsung Electronics, held two patents that it had previously declared to be “standard-essential” to the Universal Mobile Telecommunications System promulgated by the European Telecommunications Standards Institute (ETSI).  ETSI’s Intellectual Property Rights policy required Samsung to offer licenses to such patents on fair, reasonable and non-discriminatory (FRAND) terms.  After licensing negotiations between Samsung and the respondent, Apple, broke down, Samsung filed a complaint at the ITC requesting a limited exclusion order against Apple’s mobile communication products.  After the administrative law judge ruled, on an initial determination (ID), that none of the patents at issue were valid and infringed, the ITC determined to review the ID and sought views from both the parties and the public as to whether Samsung’s declaration of the patents at issue as “standard-essential” should affect either the ITC’s analysis of whether there was a violation of § 337 or what relief should be provided.

In its final determination, the ITC found one of the two patents to be both valid and infringed, and that the proper relief was a limited exclusion and cease-and-desist order directed to the infringing articles.  The ITC first rejected Apple’s argument that the Commission should not investigate an alleged violation of § 337 based on infringement of patents subject to a FRAND undertaking, ruling that under § 337(b)(1), the ITC is required to investigate any alleged violation based upon a complaint under oath, whether or not those patents have been declared standard-essential.  The ITC also rejected Apple’s theory that the Commission “cannot address infringement of standard-essential patents other than in the exceptional scenarios such as where a potential licensee has refused to pay a royalty after a U.S. court has determined that royalty to be FRAND, or where no U.S. court has jurisdiction over the potential licensee in order to set a FRAND rate,” ruling that the remedies provided under § 337 could be imposed in addition to any damages or injunctions available from a district court.

The ITC further determined that Apple had not “properly argued any affirmative defense that would preclude the Commission from finding a violation based on assertion of a declared-essential patent,” such as a breach of contract, promissory estoppel, laches or fraud  The ITC ruled that even if Apple had offered sufficient evidence that the FRAND declaration was a legally enforceable obligation, the patents at issue were actually necessary to practice the standard and that Samsung was required to grant irrevocable licenses under FRAND terms to any party, it still would not have found in Apple’s favor, because the parties’ final offers were sufficiently close to each other that Samsung did not violate its obligation to negotiate in good faith.  Importantly, the ITC found that Samsung was not under any obligation to make an initial offer that was FRAND, because “the SSO intends the final license to be accomplished through negotiation” and “even if it were true that a FRAND agreement that requires Apple to pay Samsung ultimately is not reasonable, the offers that Apple criticizes do not necessarily demonstrate that Samsung has violated its FRAND obligations by failing to negotiate in good faith” (emphasis in original).  Finally, the ITC rejected the theory that whether a patent has been declared standard-essential should be considered when the public interest is analyzed, finding that its consideration of the public interest is limited solely to the four factors listed in § 337(d)(1).

Uncommonly for a Commission opinion, Commissioner Dean Pinkert wrote a dissent arguing that the ITC should not issue an exclusion order based on Samsung’s obligation to license the patents on a FRAND basis, that the evidence indicated Samsung was unwilling to make a FRAND licensing offer with respect to the standard-essential patents and that the absence of a FRAND offer should have a bearing on whether relief under § 337 is in the public interest.  Specifically, Commissioner Pinkert found that it was neither fair nor non-discriminatory for a FRAND-encumbered patent holder to require licenses to non-FRAND-encumbered patents as a condition for licensing the FRAND-encumbered patent.  Commissioner Pinkert also would have found that the statutory language of § 337(d)(1), as well as the legislative history of the statute that “any evidence” of price gouging or monopolistic practices on the part of the complainant would be a proper basis for denying exclusion, suggests that the section should be read broadly.

Practice Note:  The Commission’s rejection of a per se rule barring exclusion orders for patents that have been declared standard-essential is likely to lead to have a number of effects, including increased litigation of standard essential patents at the ITC, counter-suits requesting that a district court rule determine what royalty rate is FRAND and/or requesting that a complainant be enjoined from proceeding before the ITC, presidential review taking on increased importance and potential legislative action to curb the ITC’s jurisdiction.

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Recent Data Breach Reports: And the Hits Keep on Coming….

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The ”hits” to data bases, in any event.   Here is a rundown of some of the most recent data breach reports –

Oregon Health & Science University Data Breach Compromises 3,000 Patients’ Records in the Cloud.

Modern Healthcare (subscription may be required) reports that the Oregon Health & Science University announced it is “notifying more than 3,000 of its patients of a breach of their personally identifiable information after their data were placed by OHSU resident physicians on a pair of Google’s cloud-based information-sharing services.” The data breach, which involves “patients’ names, medical record numbers, dates of service, ages, diagnoses and prognoses and their providers’ names” posted to Gmail or Google Drive, was discovered in May by an OHSU faculty member.  According to  Healthcare IT News, this is OHSU’s “fourth big HIPAA breach since 2009 and third big breach just in the past two years, according to data from the Department of Health and Human Services.”

Citigroup Reports Breach of Personal Data in Unredacted Court Filings; Settles with Justice Department

American Banker reports that Citigroup recently admitted having failed to safeguard the personal data (including birthdates and Social Security numbers) of approximately 146,000 customers who filed for bankruptcy between 2007 and 2011. Citi apparently failed to fully redact court records placed on the Public Access to Court Electronic Records (PACER) system. “The redaction issues primarily resluted from a limitation in the technology Citi had used to redact personally identifiable information in the filings,” Citi said in a statement. “As a result of this limitation in technology, personally identifiable information could be exposed and read if electronic versions of the court records were accessed and downloaded from the courts’ online docket system and if the person downloading the information had the technical knowledge and software to restore the redacted information.”

In a settlement with the Justice Department’s U.S. Trustee Program, Citi has agreed to redact the customer information, notify all affected debtors and third parties, and offer all those affected a year of free credit monitoring.

University of Delaware Reports Cyberattack – 72,000 Records Affected

The University of Delaware is notifying the campus community that it has experienced a cyberattack in which files were taken that included confidential personal information of more than 72,000 current and past employees, including student employees. The confidential personal information includes names, addresses, UD IDs (employee identification numbers) and Social Security numbers.

Stanford University Reports Hack – Investigating Scope

Stanford University has announced that its information technology infrastructure has been breached, “similar to incidents reported in recent months by a range of companies and large organizations in the United States,” according to a Stanford press release. Though the school does not yet “know the scope of the intrusion,” an investigation is underway. “We are not aware of any protected health information, personal financial information or Social Security numbers being compromised, and Stanford does not conduct classified research.”

Japan’s Railway Company Apologizes for Unauthorized “Sharing”

The Wall Street Journal reported yesterday (registration may be required) that Japan’s national railway system has apologized for sharing its passengers’ travel habits and other personal information with a pre-paid fare card system without user consent, The Wall Street Journal reports. East Japan Railway admitted to selling the data to Suica—one of the pre-paid card businesses. The data included card holders’ ID numbers, ages, genders and where and when passengers got on and off the train. A transportation ministry official, however, said they will not investigate the issue for privacy violations because the railway company “told us that it wasn’t personal information, as it didn’t include names and addresses of users.” The Ministry of Internal Affairs and Communications is looking into the issue and has set up a team to research the matter, the report states.

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Health Resources and Services Administration (HRSA) Publishes Orphan Drug Rule for 340B Program

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Rule requires most manufacturers to change government pricing methodologies, calculations, and systems.

On July 23, the Health Resources and Services Administration (HRSA) of the U.S. Department of Health and Human Services (HHS) published a regulation[1] increasing the number of entities to which pharmaceutical manufacturers must sell orphan drugs at statutory ceiling prices under the 340B drug discount program, and complicating the determination of eligibility to purchase these drugs at the 340B price. This regulation conditions the ability of certain hospitals to purchase orphan drugs at the 340B price on implementation of costly new systems for tracking drug use and requires virtually every brand drug manufacturer to change its government pricing methodologies, calculations, and systems.

340B Program Background

The 340B drug discount program is a voluntary program created by section 340B of the Public Health Service Act, 42 U.S.C. § 256b, and implemented through a pharmaceutical pricing agreement (PPA) between manufacturers and HHS. Manufacturers opt into the program by signing these agreements and assuming the obligations set forth in their terms, which are specified by statute and linked, in many respects, to the terms of the Medicaid drug rebate statute. At the core of the agreement is the obligation to charge covered entities no more than a statutory ceiling price for drugs covered by the statute, which are defined by the term “covered outpatient drug” in the Medicaid statute.

Section 7101 of the Affordable Care Act (ACA) expanded the categories of hospitals eligible to purchase at the 340B ceiling price to include freestanding cancer hospitals, sole community hospitals, rural referral centers, and critical access hospitals. The ACA, as amended, simultaneously limited these hospitals’ participation in the program by excluding “a drug designated by the Secretary [of HHS] under section [526 of the Federal Food, Drug, and Cosmetic Act (FFDCA)] for a rare disease or condition”[2] from the definition of “covered outpatient drug.”

Orphan Drug Rule

HRSA’s regulation, codified at 42 C.F.R. part 10, includes a new section 10.21 (the Final Rule or the Orphan Drug Rule), which establishes standards for determining when the statutory exclusion applies, i.e., when a drug designated under section 526 is excluded from the definition of “covered outpatient drug.”[3]

The Final Rule interprets the statutory exclusion from manufacturers’ obligations under their pharmaceutical pricing agreements as being limited to purchases of designated drugs when used by their customers to treat orphan indications. As a result of this regulatory limitation, the Final Rule requires manufacturers to charge the newly added hospitals no more than the statutory ceiling price for drugs designated as orphan drugs when these drugs are used for nonorphan indications. At the same time, the Final Rule allows an affected hospital to purchase drugs at the 340B price only if the hospital has developed a system for tracking outpatient use of a purchased drug that satisfies the requirements of the Final Rule.

HRSA’s regulatory requirements are predicated on an interpretation of congressional intent underlying this provision of the ACA, which ties the definition of “covered outpatient drug” under the 340B drug discount program to the scope of other unrelated benefits of orphan drug designation, such as marketing exclusivity and tax credits. However, there are other indicia that Congress did not intend the orphan drug exclusion to be as narrow as HRSA has now declared through rulemaking. When asked to clarify the scope of the exclusion for all the newly added hospitals, Congress instead removed children’s hospitals (originally subject to the orphan drug exclusion in the ACA) from the provision and restated the exclusion for the rest.[4]

Legislative Rulemaking Authority

Congress has not yet delegated authority to HRSA to promulgate substantive regulations that set standards for determining the scope of manufacturers’ obligations under the statute or that impose new duties on manufacturers not specified in the terms of their agreements. The only authority that Congress has previously delegated to HRSA to promulgate regulations is the limited authority provided in section 7102 of the ACA, which allows HRSA to issue the following: 1) regulatory standards and methodology for calculating ceiling prices; 2) regulations establishing standards for the imposition of civil monetary penalties; and 3) a regulation establishing an administrative process for the resolution of claims.

HRSA has called the Orphan Drug Rule a “clarification” of the statutory exclusion; however, the rule imposes new obligations on all stakeholders. It requires manufacturers to include in the program drugs designated under section 526 of the FFDCA and concurrently allows affected hospitals to purchase them at the 340B price, under certain circumstances, and then establishes standards and requirements for determining those circumstances.

340B Entity Implementation Issues

In order to ensure that drugs used by covered entities for orphan diseases or conditions are excluded, the Final Rule provides that covered entities may not purchase designated orphan drugs for nonorphan indications under the 340B drug discount program unless they provide HRSA with assurances that they have systems capable of identifying and tracking the use of designated drugs in treating their patients and transmitting the data to their purchasing systems. Thus, a sale of a particular drug to a particular affected hospital could be classified as purchased under the 340B program or outside the 340B program, depending on whether the purchaser 1) has informed HRSA that it has a system capable of complying with the rule’s requirements and 2) uses the drug to treat a patient for an orphan disease or condition.

Because the 340B program is an outpatient program only, hospitals must distinguish between drugs purchased for inpatient and outpatient purposes. HRSA allows hospitals to have a single physical inventory and maintain separate accounts for inpatient purchases and outpatient purchases, and many hospitals have split-billing systems that order 340B drugs only as needed under the program. The same rules apply when contract pharmacies order drugs to fill prescriptions of 340B hospital patients and the hospital purchases drugs to replenish the pharmacy’s inventory.

However, hospitals’ existing 340B purchasing systems and pharmacy prescription data do not currently include hospital billing codes or other information from patients’ medical records indicating the diseases or conditions for which drugs are prescribed. Thus, it may be some time before hospitals seeking to purchase orphan drugs for nonorphan indications at 340B prices are able to comply with the requirements of the Orphan Drug Rule. Due to the difficulties in satisfying the requirements, some affected hospitals may choose to purchase all of their orphan drugs outside the 340B program if they cannot or do not wish to develop a compliant tracking system. Alternatively, some hospitals may choose to have certain of their facilities purchase outside the 340B program.

The Orphan Drug Rule provides for acceptable “alternate” tracking systems if HRSA approves such systems, but the rule does not provide hospitals with the standards for what would be acceptable to ensure compliance. It also does not appear that manufacturers will have any advance insight into the systems or an opportunity to comment on them. Additionally, the Final Rule does not offer assistance to stakeholders on how contract pharmacies can ascertain from prescription information whether a patient of a 340B hospital has been prescribed a drug to treat an orphan indication or some other indication.

Alternatives for Hospitals 

Hospitals affected by the Orphan Drug Rule, such as rural referral centers, may also qualify for 340B participation as disproportionate share hospitals, which are not subject to the rule. In that case, they may choose not to satisfy the requirements of the rule (applicable to rural referral centers) but would be prohibited from purchasing outpatient drugs outside the program, such as those carved out for Medicaid, through group purchasing organization (GPO) agreements (applicable to disproportionate share hospitals).

For most of the new categories of hospitals, individual entities may purchase orphan drugs outside the program under GPO agreements and benefit from the discounts available through those agreements. Thus, they are not disadvantaged by the 340B drug discount program if they cannot or are unwilling to satisfy the requirements to purchase orphan drugs under the program. However, for freestanding cancer hospitals, the Final Rule maintains the statutory prohibition against purchasing covered outpatient drugs through GPO arrangements. If these hospitals do not comply with the regulatory requirements, they must purchase orphan drugs in the open market or negotiate contracts with manufacturers.

Manufacturer Government Pricing System Issues

Based on the Final Rule, the classification of a manufacturer’s sale as a 340B program sale for purposes of the manufacturer’s drug price reporting obligations depends on each eligible hospital’s compliance with the rule’s requirements. That means a manufacturer’s operations must code each affected hospital and, in some cases, facilities within a medical center to determine whether the purchase of an orphan drug for a nonorphan indication is under the program or outside the program. These codings can change quarter to quarter as 340B hospital entities elect either to start or stop using the required tracking systems. Likewise, wholesalers processing invoices must be provided with information that allows them to know when a hospital is eligible to order an orphan drug under the 340B agreement at statutory ceiling prices (as opposed to under a GPO agreement, other contract, or open market), and the manufacturer’s chargeback validation system must be able to differentiate as well. Otherwise, a manufacturer could easily and inadvertently provide 340B pricing outside the program, which could trigger a best price under the Medicaid drug rebate program and simultaneously drive down the quarterly 340B statutory ceiling price. Many manufacturers’ current government pricing systems seek to identify best price-eligible sales at the class-of-trade level, with sales of orphan drugs to 340B entities coded for inclusion in best price, while sales of nonorphan drugs to these same entities are excluded from best price. Manufacturers of orphan drugs must now develop solutions that permit identification of the eligible and ineligible price points necessitated by the Final Rule.

Since the inception of the Medicaid drug rebate program, the Centers for Medicare and Medicaid Services (CMS) has refused to consider all transactions with covered entities to be exempt from best price and—in the absence of a clear statutory provision, such as the exemption of inpatient drug prices paid by disproportionate share hospitals—it is risky for manufacturers to assume all outpatient sales of orphan drugs to 340B eligible hospitals will be exempt from best price. Currently, for example, CMS’s proposed government pricing rule excludes from best price only “[p]rices charged under the 340B drug pricing program to a covered entity described in section 1927(a)(5)(B) of the Act.”[5]

Off-Label Use

The Final Rule does not answer comments about concerns with off-label use. The Final Rule states that a drug must be approved by the Food and Drug Administration for marketing to be in the program; however, it does not answer the question of whether a drug should be excluded if it is designated for an orphan indication, approved only for a nonorphan indication, but used by a covered entity off-label for the designated orphan indication. The Final Rule also does not indicate whether a manufacturer with a product approved only for an orphan indication will be deemed to be selling the product to a hospital for off-label use if it provides the 340B price for that off-label nonorphan use.

Implications

Hospitals added to the 340B program by the ACA (other than children’s hospitals) need to review their existing systems and modify them to satisfy their obligations under the Final Rule before they can purchase orphan drugs under the program. Manufacturers need to review their drug price reporting systems to ensure they are able to identify when a covered hospital is purchasing orphan drugs outside the program to avoid inadvertently setting their best price at the 340B price.

[1]. Exclusion of Orphan Drugs for Certain Covered Entities Under 340B Program, 78 Fed. Reg. 44,016 (July 23, 2013) (to be codified at 42 C.F.R. pt. 10), available here.

[2]. 42 U.S.C. § 256b(e).

[3]. Exclusion of Orphan Drugs, supra note 1.

[4]. See Medicare and Medicaid Extenders Act of 2010, Pub. L. 111-309, § 204.

[5]. Medicaid Program; Covered Outpatient Drugs 77 Fed. Reg. 5318, 5363 (Feb. 2, 2012) (emphasis added), available here.

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Health Care Reform Update – Week of July 29, 2013

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Senate HELP Updates Track-and-Trace, Compounding Proposals

On July 24th, the Senate Health, Education, Labor, and Pensions (HELP) Committee released updates to its drug compounding and track and trace legislation. Committee Chairman Tom Harkin (D-IA) and Ranking Member Lamar Alexander (R-TN) say they hope the Senate will pass the measure by unanimous consent in the near future. On July 25th, the Congressional Budget Office (CBO)indicated the bill would have virtually no impact on the federal budget.

House Energy and Commerce Subcommittee Advances SGR Bill

On July 24th, the House Energy and Commerce Subcommittee on Health passed by voice vote a bill to repeal the sustainable growth rate (SGR) Medicare physician payment method. The bill now moves to the full committee, which will consider a repeal of the SGR on July 31st. Rep. Michael Burgess (R-TX) suggested the committee will support the bill, but he said the legislation could become part of larger budget negotiations near the end of 2013.

Implementation of the Affordable Care Act

On July 22nd, Republicans on the House Ways and Means Committee sent a letter to Treasury Secretary Lew requesting information regarding a delay of the ACA employer mandate. The letter criticizes testimony provided by Treasury official Mark Iwry in previous committee hearings, stating he failed to provide sufficient information.

On July 22nd, House and Senate Republicans sent a letter to HHS Secretary Sebelius that urges a release of information regarding health insurance premiums in 34 states taking part in the ACA federal and federal-state partnership exchanges.

On July 23rd, while speaking with members of the National Council of La Raza, First Lady Michelle Obama urged supporters to go out and inform their families and friends about the facts regarding the implementation of the ACA.

On July 23rd, the Government Accountability Office (GAO) issued a report on pre-ACA base insurance premium rates. The report was requested by Senator Orrin Hatch (R-UT).

On July 24th, Rep. Diane Black (R-TN) introduced H.R. 2775, a bill to prohibit ACA subsidies from being provided to Americans until a system is in place to verify the financial standing of individuals applying for subsidies.

On July 24th, the American Medical Association (AMA) and the American Hospital Association (AHA) called on HHS to delay Stage Two requirements relating to the development of meaningful use of electronic health records (EHRs). The AMA and AHA suggest Stage Two should be delayed by one year to provide flexibility to small and rural providers.

On July 25th, during a Senate Small Business Committee hearing on the implementation of the ACA, Senator Mary Landrieu (D-LA)said she understands some business owners are harmed by coverage mandates of the law. Senator Landrieu said she is open to exploring ACA changes that will avoid harming business owners.

On July 25th, Speaker of the House John Boehner (R-OH) said no decision has been made on if Republicans will use a continuing resolution to block additional funding for ACA implementation and enforcement.

On July 26th, CMS announced a moratorium on enrollment of home health agencies in Miami and Chicago and a temporary halt on ambulance suppliers in Houston.

On July 26th, Maryland released premium rates for individual health insurance to be sold on the state’s ACA exchange. Nine carriers will offer plans through the exchange.

Other HHS and Federal Regulatory Initiatives

On July 22nd, the Food and Drug Administration (FDA) provided Teva Pharmaceuticals exclusive rights until 2016 to sell its Plan B One-Step emergency contraception over the counter and without age restrictions.

On July 22nd, CMS announced the suspension of the National Average Retail Prices (NARP) survey, which provided pricing information on over 4,000 common drugs.

On July 23rd, the U.S. District Court of Appeals for D.C. ruled that the HHS Secretary is able to delegate his or her authority to outside contractors.

On July 23rd, HHS issued a final rule that orders discounts for orphan drugs, which are often used to treat rare conditions, to apply when used to treat non-orphan conditions.

On July 26th, the FDA released two proposed rules to regulate the safety of imported food. The first rule is available here, and the second rule can be found here.

Other Congressional and State Initiatives

On July 24th, the House Appropriations Labor-HHS Subcommittee delayed a markup of the FY 2014 appropriations bill that was scheduled for July 25th. A spokesperson for the full committee indicated scheduling conflicts resulted in the delay.

On July 25th, the CBO wrote a letter noting the Senate’s immigration bill, S. 744, will reduce deficits largely because of cash flows related to Social Security and Medicare Part A.

Other Health Care News

On July 24th the Institute of Medicine (IOM) published a report on the variation in health care spending among Medicare beneficiaries.

Hearings and Mark-Ups Scheduled

Senate

On July 30th, the Senate Budget Committee will conduct a hearing to examine containing health care costs.

On July 31st, the Senate Environment and Public Works Committee will conduct a hearing to examine toxic chemical threats and public health protections.

House of Representatives

On July 30th, the House Energy and Commerce Committee will conduct a markup of legislation to reform the sustainable growth rate (SGR) Medicare physician payment method. The markup is scheduled to continue on July 31st.

On July 31st, the House Ways and Means Health Subcommittee will hold a hearing to analyze the Obama administration’s authority to offer tax credits through the ACA exchanges.

On July 31st, the House Science Research and Technology Subcommittee will hold a hearing on the frontiers of human brain research.

On August 1st, the House Ways and Means Committee will hold a hearing to analyze the implementation of the ACA.

On August 1st, the House Energy and Commerce Committee will hold hearing to understand the latest issues relating to the implementation of the ACA. 

David Shirbroun also contributed to this update.

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Health Resources and Services Administration (HRSA) Clarifies 340B Orphan Drug Exception But 340B Audit Enforcement Remains Murky

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Recently, HRSA publicly announced the issuance of a final rule clarifying when 340B covered entities can purchase and distribute orphan drugs through the 340B Drug Pricing Program.  Separately, HRSA quietly posted a report on its completed audits of 340B covered entities through July 12, 2013.  While the new rule does shed light on when 340B entities can purchase orphan drugs at 340B discounted prices, the new audit report keeps 340B entities in the dark on HRSA enforcement of established regulatory violations.

Orphan Drugs

The Orphan Drug Act specifies that drugs used to treat a specific rare condition or disease, such as ALS or Huntington’s disease, qualify as orphan drugs, and provides incentives for manufacturers of such drugs.  The FDA designates which drugs qualify as orphan drugs.

The Affordable Care Act excludes orphan drugs from 340B pricing, but does not provide specifics on the breadth of the exclusion.  The new 340B rule, which will go into effect October 1, 2013, specifies that the orphan drug exclusion only applies to three types of qualified 340B covered entities:

  • Free standing cancer hospitals
  • Critical access hospitals, and
  • Rural referral and sole community hospitals.

Other types of covered entities can still purchase orphan drugs at 340B prices, as long as the entity is in compliance with other conditions of the 340B program.

Under the final rule, the orphan drug exception is only applicable to the three types of entities if the drug at issue is designated as orphan by the FDA and is being transferred, prescribed or sold for the rare condition or disease for which it was designated as orphan by the FDA.  So, for example, if drug X is designated as orphan for treatment of ALS, but is also FDA-approved to treat anorexia, it may be purchased at 340B discounts to dispense to anorexia patients.

A word of warning – providers can potentially qualify as a 340B covered entity under more than one of the eligibility classifications.  Going forward, HRSA will require that each covered entity designate itself as a single type of covered entity and abide by all governing regulations specific to that type of entity.   Providers will want to consider the applicability of the orphan drug exception when deciding which type of entity they will be for 340B purposes.

Audit Update

HRSA did not announce that it posted a report on completed FFY 2012 program audits through July 12, 2013.  While there is some interesting information in the report, the report is more striking for what it doesn’t say.

The report reflects:

  • HRSA completed a total of 34 FFY 2012 audits.
  • HRSA conducted audits of 340B covered entities in 20 different states:  5 audits in Texas, 3 in Georgia and Illinois, and 2 in California, Florida, Kentucky, Washington and Wisconsin, and multiple states had only 1 reported audit.
  • Half of the audits had no adverse findings and half had 1 or more adverse findings.
  • The most common adverse finding was dispensing drugs to ineligible patients, this included situations involving ineligible sites and or use of ineligible providers.
  • The second most common finding was a violation of the duplicate discount prohibition through Medicaid billings.
  • The third most common adverse finding was inaccurate record entries, involving incorrect addresses, listing of closed facilities, or use of an unlisted contract pharmacy.

The report does not reflect the total number of entities audited during FFY 2012 or how many audits are yet to be completed.

In several audits where the only listed violation involved an incorrect record regarding a site or contact, no sanction was imposed and corrective action was either limited to correction of the database or is pending.  But where the inaccurate record included use of an unlisted contract pharmacy, or where there were other findings regarding ineligible patients or duplicate discounts, sanctions are reported as “to be determined” and corrective action remains “pending.”

So we know HRSA is actively auditing 340B entities and the activities it finds problematic, but we still don’t know what they are going do about those activities.

In Largest Known Data Breach Conspiracy, Five Suspects Indicted in New Jersey

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On July 25, 2013, the United States Attorney for the District of New Jersey announced indictments against five men alleging their participation in a global hacking and data breach scheme in which more than 160 million American and foreign credit card numbers were stolen from corporate victims, including retailers, financial institutions, payment processing firms, an airline, and NASDAQ.  The scheme is the largest of its kind ever prosecuted in the United States.

The Second Superseding Indictment alleges the defendants (four Russian nationals and one Ukrainian national) and other uncharged co-conspirators targeted corporate victims’ networks using “SQL [Structured Query Language] Injection Attacks,” meaning the hackers identified vulnerabilities in their victims’ databases and exploited those weaknesses to penetrate the networks.  Once the defendants had access to the networks, they used malware to create “back doors” to allow them continued access, and used their access to install “sniffers,” programs designed to identify, gather and steal data.

Once the defendants obtained the credit card information, they allegedly sold it to resellers all over the world, who in turn sold the information through online forums or directly to individuals and organizations.  The ultimate purchasers encoded the stolen information on blank cards and used those cards to make purchases or withdraw cash from ATMs.

The defendants allegedly used a number of methods to evade detection.  They used web-hosting services provided by one of the defendants, who unlike traditional internet service providers, did not keep records of users’ activities or share information with law enforcement.  The defendants also communicated through private and encrypted communication channels and tried to meet in person.  They also changed the settings on the victims’ networks in order to disable security mechanisms and used malware to circumvent security software.

Four of the defendants are charged with unauthorized access to computers (18 U.S.C. §§ 1030(a)(2)(C) and (c)(2)(B)(i)) and wire fraud (18 U.S.C. § 1343).  All of the defendants are charged with conspiracy to commit these crimes.

Two of the defendants have been arrested, with one in federal custody and the other awaiting an extradition hearing.  The other three defendants, two of whom have been charged in connection with hacking schemes, remain at large.

This conspiracy is noteworthy for its massive scale, and for the patience the hackers demonstrated in siphoning data from the networks.  The U.S. Attorney “conservatively” estimates more than 160 million credit card numbers were compromised in the attacks, and alleges that the hackers had access to many victims’ computer networks for more than a year.  Many prominent retailers were targets, including convenience store giant 7-Eleven, Inc.; multi-national French retailer Carrefour, S.A.; American department store chain JCPenney, Inc.; New England supermarket chain Hannaford Brothers Co.; and apparel retailer Wet Seal, Inc.  Payment processors were also heavily targeted, including one of the world’s largest credit card processing companies, Heartland Payment Systems, Inc., as well as European payment processor Commidea Ltd.; Euronet, Global Payment Systems and Ingenicard US, Inc. The hackers also targeted financial institutions such as Dexia Bank of Belgium, “Bank A” of the United Arab Emirates; the NASDAQ electronic securities exchange; and JetBlue Airways.  Damages are difficult to estimate with precision, but they total several hundred million dollars at least.  Just three of the corporate victims suffered losses totaling more than $300 million.

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Unpaid Internships – Opportunity or Liability for Businesses?

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Unpaid internships have long been viewed by students, recent graduates and industry newcomers as a chance to gain experience that might help them select or launch a career, and to some, a chance to eventually land a paying job.  Employers can capitalize on this to teach their trade or profession and find new talent; but, they should not use interns just to cut labor costs.

The United States Department of Labor and many states use six criteria to determine whether internships in for-profit company operations can lawfully be unpaid: 1) the internship must be similar to training given in an educational institution; 2) regular paid workers are not displaced; 3) the intern works under close observation; 4) the employer derives no immediate advantage from intern activities; 5) there is no guaranty of employment upon internship completion; and 6) it is clear up front that there is no expectation of payment.  The overarching theme is that unpaid internships must be educational and predominantly for the benefit of the intern, not the employer.

Some employers have no idea the criteria exist and unwittingly expose themselves to expensive single-plaintiff, class action and regulator’s claims to reclassify interns as employees and to recover unpaid minimum wages, overtime pay, interest, multiple penalties and attorneys fees.  [For more on this see our post on Unpaid Interns Deemed Employees Under the FLSA].  Add to that, there are potential employer and decision maker risks for failure to withhold income and employment taxes.

“Warning bell” examples of internship programs that may be subject to reclassification include, use of unpaid internships to simply minimize labor costs or merely as an extended job interview to see if interns can make the cut later for a paid job; no real, supervised education and training, beyond what the intern might happen to observe; and a predominance of work assigned to interns that paid employees would normally do to generate or support the business.  Likewise, interns whose work is primarily running errands, answering phones, filing, organizing documents, data entry, scanning or coping images, or cleaning – even though they arguably have good exposure to work going on around them – tend to look like they are merely doing what paid support staff employees ought to be doing.

By contrast, if the intern is closely supervised and taught learning objectives that can be applied to multiple different employers, with occasional support staff type work incidental to the learning, with no guaranty of employment, and a writing that specifies a limited duration of an internship without pay, odds are better that intern can lawfully be unpaid.  As a practical matter, if a school or college will give the intern course credit, the odds of legal compliance increase.

A safe path to avoid classification risks is to pay interns at least minimum wage and for any overtime worked, afford meal and rest breaks, and manage their work assignments to reduce overtime needed.   Depending on employer policies and applicable laws, an intern who is part-time or a short-term temporary employee may not be eligible for certain employee benefits.

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