Post-AB 3129, California Sponsored MSOs Must Focus on Compliance, Strategic Growth, and Exit Planning

California’s legislature recently passed AB 3129, and it is awaiting Governor Gavin Newsom’s signature.

While AB 3129 impacts several different provider types, this article focuses on its impact on Management Service Organizations (MSOs) and Physician Practice Management Companies (PPMCs) as the historically accepted structure for purposes of complying with the prohibitions on the corporate practice of medicine (CPOM). In its initial drafts, AB 3129 seemed highly focused on MSOs and the Friendly PC models for PPMs in the state.

While much of the early language regarding MSOs seems to have been shed from the bill, some ambiguity remains regarding whether, and in what contexts, sponsored MSOs will need to give pre-transaction notice to, or obtain the consent of, the California Attorney General (AG).  A later section of the bill highlights what will likely be CPOM enforcement priorities and is worth the close attention of all MSOs operating in the state.

With regard to its CPOM provisions, the bill does not appear to break new ground—most explicitly prohibited activity would likely already be considered a violation of the state’s CPOM prohibitions. However, the bill both explicitly prohibits activity that was previously prohibited in a more implicit manner and, critically, applies a legal obligation/penalty directly on MSOs rather than using licensure law to penalize the physicians.

AB 3129’s Provisions

The bill is best analyzed in three chunks:

• First, the bill’s notice and consent provisions describe the obligation for a “private equity group” or “hedge fund” to file notice with, and obtain the written consent of, the California AG before a transaction with certain health care entities, including both facilities and providers.
• Second, section 1190.40 provides a detailed list of prohibitions for any “private equity group” or “hedge fund” that is “involved in any manner with a physician, psychiatric, or dental practice doing business in the state.”
• Third, the remainder of the bill provides guidance with regard to interpretation and implementation and adds a provision exempting transactions captured by sections 1190.10 through 1190.30 from the requirement to provide advance notice of a transaction to the recently created California Office of Health Care Affordability (OHCA).

Notice and Consent Provisions

At its heart, AB 3129 creates a requirement that “private equity groups” and “hedge funds” seek the consent of the state’s AG before proceeding with any transaction with certain enumerated health care entities. Nearly every word in the preceding sentence is, or is standing in for, a defined term, so the reality is somewhat more complex than a simple description implies. It’s helpful to walk through each term and qualifier in order.

Who has to seek permission?

“Private equity groups” and “hedge funds” are required to seek the AG’s consent to transact, and each of those terms is defined. A “private equity group” is defined as “investor or group of investors who primarily engage in the raising or returning of capital and who invests, develops or disposes of specified assets.”

Similarly, a “hedge fund” is described as “a pool of funds managed by investors for the purpose of earning a return on those funds, regardless of the strategies used to manage the funds…includ[ing] private limited partnerships.” Further qualifiers provide that the definition excludes investors in “hedge funds” and entities that provide or manage debt financing secured by health care entity assets, including banks, real estate lenders, and bond underwriters.

These definitions, and who does and does not fall into them, will be important. Since AB 3129’s requirements apply only to “private equity groups” and “hedge funds,” whether an entity does or does not fall into either group could have outsized consequences.

What is a “transaction”?

A “transaction” is “the direct or indirect acquisition in any manner…by a private equity group or hedge fund of a material amount of the assets or operations, or a change of control, of a health care facility, provider group, or provider doing business in this state.” A transaction hits the materiality threshold where 15 percent of the target entities’ assets of value is involved or where a “change of control” occurs, even if the 15 percent threshold is not met. “Transaction” does not include any transaction entered into prior to January 1, 2025, including subsequent renewals, so long as the renewals do not involve a material change to the relationship. The definition also excludes the pledge of assets to secure a debt obligation.

“Change of control” is also defined as “an arrangement in which a private equity group or hedge fund establishes a change in governance or sharing of control over health care services provided by a health care facility, provider group, or provider doing business in this state, or in which a private equity group or hedge fund otherwise assumes direct or indirect control over the operations of a health care facility, provider group, or provider in whole or in part doing business in this state.”

On its face, the bill’s language captures only transactions between sponsors and health care entity targets. In the case of professional entities, of course, a direct ownership transaction is already prohibited by CPOM. Transactions are conducted with a portfolio management company. Whether a contemplated transaction meets the definition of a “Transaction” is a question MSOs should review with counsel.

What targets are covered?

Transactions with “health care facilities” (except hospitals), “provider groups” (except dermatology groups), “providers,” and “non-physician providers” require notice and, in most cases, consent. Each is defined.

The definition of “health care facility” is complex, broad, and too long for this article. Suffice it to say that likely all facilities that would meet the common understanding of a health care facility that treats patients are included. It makes sense to review this definition in detail with counsel if there is any uncertainty as to whether or not a transaction target is a “health care facility.” In one surprising twist, while hospitals are included in the definition of a “health care facility” (as one might expect), they are specifically excluded from the transaction notice and consent requirements.

“Provider Group” is defined to include any group of “licensed health professionals” acting within the scope of their practice and generating $25 million in gross revenue or a group of 10 or more licensed health professionals acting within the scope of their licensure and generating less than $25 million in gross revenue. The definition also explicitly excludes dermatologists, noting, “A provider group also does not include any combination of licensed health professionals if the primary purpose of the group is to deliver dermatology services.”

“Provider” is defined as any group of two to nine licensed health professionals that is not a “Provider Group.” There is no matching exclusion for dermatology in the definition of “provider.”

“Non-Physician Provider” includes a group of two or more health professionals licensed under California Business and Professions Code Division 2 (including eye care professionals, dentists, physical and other therapists, and veterinarians, among others).

The term “Licensed health professionals” is interestingly defined to “include” Physicians and Surgeons, Dentists, Optometrists, Pharmacists, Non-physician mental health professionals, physician assistants, APRNs, NPs, CNAs, nurse-midwives, nurse anesthetists, and clinical nurse specialists. The definition of “licensed health professionals” includes some non-physician providers and is specifically not limited to the inclusive list provided. To be safe, it should be assumed that “licensed health professionals” includes all physicians and specialties as well as all “non-physician providers.”

When is notice/consent required?

The provisions governing notice and requiring consent are detailed and complex, but for the purposes of this high-level view, a limited subset of the situations described applies. In addition to other, less likely transactional situations, notice to, and consent of, the AG is required for transactions between a private equity group or hedge fund and:

• a health care facility (except for hospitals);
• a provider group;
• a provider, but only where the private equity group or hedge fund has been directly or indirectly involved with a transaction with a health care facility, provider group, provider, or related health care service within the last seven years; or
• any health care facility, provider group, or provider that controls, is controlled by, or is affiliated with a payor if the purchaser has ever been involved in a transaction with a health care facility, provider group, or provider.

Notice must be provided (but consent is not necessary) for transactions with non-physician providers who have gross annual revenue over $4 million but less than $25 million. This cutoff in gross annual revenue likely reflects the fact that transactions with entities with more than $25 million in annual revenue are already required to provide advance notice to OHCA.

What is the process?

Full details of the process are too detailed and extensive for this article, but at a high level:

• Notice must be submitted at least 90 days before the transaction and at the same time as any notice is submitted to any other state or federal agency. (In many cases, this would mean that notice would be required well in advance of 90 days as other states and or federal requirements may require notice in advance of that deadline.)
• The notice must include all information necessary for the AG to evaluate whether the transaction will have anti-competitive effects or reduce health care access or to determine whether a waiver is appropriate.
• The AG may extend the review by 45 days for additional information or if the transaction is modified.
• The AG may extend the review by 14 days by deciding to hold a public meeting.
• The AG may stay any time period listed “upon notice to the parties to the transaction, pending any review by a state or federal agency that has also been notified as required by federal or state law.”
• Waivers are primarily for health care entities in financial extremis and will typically not apply to most MSO transactions.
• If the AG has not provided written consent at the conclusion of all applicable time periods (90 days plus all stays and extensions), the transaction may proceed.
• If a submitter chooses to object to the AG’s election to hold a public meeting and instead takes the matter before an administrative law judge, the transaction must remain on hold until all litigation is concluded (including any judicial appeals) and a written determination of the AG is issued.

What are the penalties for non-compliance?

The AG can sue to stop a transaction and seek costs. The AG may also require that the transaction be modified in certain ways. The bill also explicitly provides that nothing in its language is intended to reduce or limit the AG’s pre-existing ability to seek damages from companies acting in restraint of trade.

CPOM Provisions

Section 1190.40 of the bill restates much of California’s existing CPOM prohibitions. Under the bill, however, it’s clear that liability for CPOM failings would accrue directly to the “private equity group or hedge fund involved in any manner with a physician, psychiatric, or dental practice doing business in the state” rather than only to the licensed providers with whom they have contracted. Entities involved with physician, psychiatric, and dental practices may not:

• Interfere with professionals making health care decisions, including:
  • determining appropriate diagnostic tests;
  • determining the need for referrals or consultations with any other licensed health professional;
  • being responsible for the ultimate care of the patient, including treatment options; or
  • determining how many patients a professional can see in a period or how many hours per day they shall work.

Similarly, they may not:

• “Exercise control over, or be delegated power to do, any of the following”:
  • own or determine the content of patient records;
  • select, hire, or fire professionals based in whole or in part on clinical proficiency;
  • set the parameters under which third-party payor contracts are accepted;
  • make “decisions regarding coding and billing procedures for patient care services”; or
  • approve the selection of medical equipment and medical supplies for the practice.

A further provision restates existing California law on restrictive covenants, and another provides a new provision prohibiting the entry into a contract which “would enable” any of the above described transgressions.

Violations of the bill’s CPOM provisions permit the AG to seek injunctive and other equitable relief as well as costs. Further, as noted above, nothing in the bill limits the AG’s existing authority to seek damages.

Interpretation and Implementation Guidance

Other bill provisions exempt transactions subject to review under this bill from the requirement to notify OHCA, permit the AG to issue regulations and seek expert guidance, and attempt to provide insulation from judicial review with provisions providing for blue-penciling and severability.

Finally, the bill provides important insight into its purpose. In sections directly describing the purpose of the bill and providing the AG’s review standards, the bill’s drafters have provided clear insight into the concerns that drove their drafting and the goals they sought to achieve.  In a paragraph devoted to intentions, the bill notes it is intended to impeded transactions that lead to “higher prices…lower quality…less cost-efficien[cy]…restricted access…closure of services…and less choice…leads to higher prices and more inconvenience for consumers, and higher total cost of care for services.”

Similarly, in a section devoted to describing the AG’s review, the bill provides the AG should make decisions intended to “…protect…competitive and accessible health care markets for prices, quality, choice, accessibility, and availability of all health care services for local communities, regions, or the state as a whole…” Negative effects may involve the substantial risk of increases in prices or costs, decreases in quality, or the lessening of access to or availability of services. Benefits from the transaction may include price or cost decreases directly passed to patients, improvements in access or availability of services in the community, or capital improvements that will benefit local community care if that financing cannot be reasonably obtained elsewhere.

This language should guide sponsor and portfolio company actions now that the bill seems certain to become law.

What Now?

Initial drafts of this bill seemed poised to render illegal, or at least practically impossible, the continued operation of friendly PC and MSO structures in California. While that language may not have remained in the bill, it is clear that activities around these structures that regulators consider abusive have driven the creation of this new regulatory structure. Sponsors and MSOs should respond accordingly.

Focus on Compliance

CPOM compliance has always required attention, but AB 3129 makes it clear that CPOM and related enforcement will now be a focus of the state regulators, and non-compliant MSOs can and will be the target. Competitors seeking to undermine the competition may seek to leverage this new focus on compliance against other market participants. For those seeking to make an acquisition or otherwise enter the state—aggressive diligence on CPOM and other compliance concerns, down to an operational, not merely documentary, level is recommended. MSOs should discuss their compliance posture, and cost-effective means to improve it, with capable and experienced counsel.

Plan for Growth

The bill specifically identifies the “negative effects” its drafters believe likely or possible in sponsored MSOs. In evaluating potential growth strategies, efforts should be made in advance to address any concerns around patient outcomes, patient access, fairness, and cost. Acquisition targets should be evaluated with these review parameters in mind. Patient outcome metrics, patient reviews, pricing, utilization—all of these metrics will prove invaluable in making the case, either during a review or in a defense, that the concerns around sponsored roll-ups don’t apply to this particular MSO. Growth plans and strategies, as well as the plan to evaluate targets, should be reviewed with capable and experienced counsel.

Plan for Exit

Those seeking to exit an MSO operating in California should plan for delays and aggressive diligence. If an exit is on the visible horizon, potential delays occasioned by this bill (and other similar state laws) should be discussed at the outset with outside counsel and then with potential purchasers. The regulatory environment can change, but preparation for a delay may be what saves a transaction when a regulator acts on an unexpected interpretation.

Similarly, for those companies seeking an exit in the near term, there should be an expectation for more aggressive regulatory compliance diligence. The sooner known issues can be discussed with counsel and plans for correction made or completed, the better. It is better to discover your own skeletons than to let someone else do it as a surprise.

Finally, staying on top of regulatory developments will be a must for private equity-backed MSOs. Whether the bill is ultimately signed, how it is implemented, what regulatory interpretations are issued, and what enforcement actions undertaken will be essential data points for affected parties.