PROVING THE UNLAWFUL CORPORATE STRUCTURE OF A PROFESSIONAL CORPORATION

PROVING THE UNLAWFUL CORPORATE STRUCTURE OF A PROFESSIONAL CORPORATION INTRODUCTION Between 1992 and 2001, reports of suspected automobile insurance fraud increased by 275%, the bulk of

PROVING THE UNLAWFUL CORPORATE STRUCTURE OF A

PROFESSIONAL CORPORATION

INTRODUCTION Between 1992 and 2001, reports of suspected automobile insurance fraud increased by

275%, the bulk of the increase occurring in no-fault insurance fraud Reports of no-fault fraud rose from 489 cases in 1992 to 9,191 in 2000, a rise of more than 1700% By one estimate, the combined effect of no-fault insurance fraud has been an increase of over $100 per year in annual insurance premium costs for the average New York motorist

A principal cause of this “concededly rampant abuse” (Medical Society of the State of New York v

Serio, 100 N.Y.2d 854 [2003]) was the proliferation of layman controlled professional corporations that

flouted the prohibitions against laymen ownership and control of professional corporations found in N.Y Business Corporation Law' §§ 1507, 1508 and N.Y Education Law § 6507(4)(c).[1] [2] These entities, passing facially as legitimately licensed professional corporations, were known derisively as “Doc-in-the-box” operations

The Article below examines this problem in detail, and blue prints practical approaches for insurers and their counsel to combat this problem

Pete Legal and Legislative History ……… p.3

The Nature of the Layman Scripted Entity ……… p 7

Telltales ……… p 9

Following on Malella Proving Illegal Corporate Structure …………p 12

Following on Law Enforcement ……….p 12

Leveraging Intelligence ……… p 16

Augmenting Law Enforcement and SIU Intelligence in Litigation …p 18

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LEGAL AND LEGISLATIVE HISTORY

In 1973, the Legislature enacted the Comprehensive Automobile Insurance Reparations Act (see L.

1973, ch 13), which supplanted common-law tort actions for most victims of automobile accidents with asystem of no-fault insurance Under the no-fault system, payments of benefits "shall be made as the loss isincurred" (Insurance Law § 5106[a] ) The primary aims of this new system were to ensure promptcompensation for losses incurred by accident victims without regard to fault or negligence, to reduce the

burden on the courts and to provide substantial premium savings to New York motorists (see Governor's

Mem approving L 1973, ch 13, 1973 McKinney's Session Laws of N.Y., at 2335)

In 1977, the Superintendent first adopted regulations establishing time frames in which to submitforms and notices pertaining to no-fault claims Those regulations, adopted as Regulation 68 were codified at

A principal cause of this “concededly rampant abuse” (Medical Society of the State of New York v

Serio, 100 N.Y.2d 854 [2003]) was the proliferation of layman controlled professional corporations that

flouted the prohibitions against laymen ownership and control of professional corporations found in N.Y.Business Corporation Law' §§ 1507, 1508 and N.Y Education Law § 6507(4)(c).[1] [2]

These entities, passing facially as legitimately licensed professional corporations, were knownderisively as “Doc-in-the-box” operations The professionals whose names appeared on the corporatelicenses were in truth, at best, nothing more than salaried employees These schemes enabled unscrupulouslaymen to reap enormous profits from the operation of “Medical Mills” which “treated” patients pursuant topredetermined scripts, without regard to their medical condition, and which churned out blizzards of bills forunnecessary treatments, goods and services.

In 1999, in an effort to combat this widespread abuse, the Superintendent proposed an amendedRegulation 68 The Medical Society of the State of New York successfully challenged these regulations for

failure to substantially comply with the State Administrative Procedure Act Matter of Medical Socy of Stateof

N.Y v Levin , 185 Misc.2d 536, 712 N.Y.S.2d 745 [Sup.Ct., N.Y County 2000 ], affd 280 A.D.2d 309,

723 N.Y.S.2d 133 (App Div 1st Dept., 2001] [Medical Society I] ) While the appeal was pending, theSuperintendent re-initiated the rulemaking process and promulgated revised Regulation 68 (repealing andreplacing 11 NYCRR part 65)

This second promulgation by the Superintendent in turn gave rise to Medical Society II (MedicalSociety of the State of New York v Serio, 100 N.Y.2d 854 (2003)) Therein the Court of Appealsunanimouslyheld that Regulation 68, although manifestly altering the way claims are processed, was well within thelawful authority of the Superintendent of Insurance to issue and affirmed the retroactive implementation ofthese regulations to April of 2002

These new Regulations, dealing directly with the problem of laymen controlled professionalcorporations provided at 11 NYCRR § 65- 3.16(a)(12) that "a provider of health care services is not eligiblefor reimbursement under section 5102(a)(1) of the Insurance Law if the provider fails to meet any applicableNew York State or local licensing requirement ", a reference of course to to N.Y Business CorporationLaw' §§ 1507, 1508 and N.Y Education Law § 6507(4)(c) [3]

During the course of these events, while the old regulations were still in control, a sweeping claim

by State Farm that numerous entities ostensibly owned by Mallela were in fact fraudulently owned andoperated laymen entities was dismissed by J Sifton in Federal Court State Farm Mutual Automobile

Insurance Company v Mallela, 175 F Supp2d 401 (EDNY 2001) ) As it proved this case would not rest and

eventually provided the Court of Appeals of the State of New York the platform necessary to put the issue torest

Following the re-promulgation of the new regulations a second Mallela case was commenced, (State

Farm Mutual Automobile Insurance Company v Mallela, (Not Reported in F.Supp.2d, 2002 WL 31946762(E.D.N.Y.) (Mallela II)).

Even though the new regulations now clearly provided at 11 NYCRR § 65- 3.16(a)(12) that "aprovider of health care services is not eligible for reimbursement under section 5102(a)(1) of the InsuranceLaw if the provider fails to meet any applicable New York State or local licensing requirement ", JudgeSifton still declined to alter his previous ruling significantly He noted "I am reluctant to undermine thelegislative goal of speedy payment in order to permit insurers such as plaintiff to avoid paying licensedmedical service providers for medically necessary services provided to insured individuals by licensedphysicians."

At this point the state of the law in Federal Courts was largely at odds with State Court andArbitration decisions For instance in In the Matter of JRWB Diagnostic against The Travelers InsuranceCompany, Arbitrator Mellis determined that JRWB, a large radiological entity, was in fact controlled by aunlicensed laymen and inelligible to recover No-Fault payments,[4], citing North Bronx Medical, P.C a/a/oPaulette Cleckley and Allstate Insurance Company, NF2988 [5]

The Court of Appeals of the State of New York had no such reluctance however when respondingaffirmatively to the certified question posited by the Second Circuit, that is "whether 'A medical corporationthat was fraudulently incorporated under N.Y Business Corporation Law' §§ 1507, 1508 and N.Y EducationLaw § 6507(4)(c) [is] entitled to be reimbursed by insurers, under New York Insurance Law §§ 5101 et seqand its implementing regulations, for medical services rendered by licensed medical practitioners.'

The Court wrote “We accepted the certification and now answer that such corporations are notentitled to reimbursement." State Farm Automobile Ins Co v Robert Mallela 4 N.Y.3d 313, 320, 794N.Y.S.2d 700, 827 N.E.2d 758

It is important to note at this point that the crucial issue under consideration all along was not merelywhether a professional corporation was facially in compliance with its licensing requirements, butwhether in fact it was truly controlled by a professional

Thus, the legislature requires professional health service corporations to be owned and

controlled only by those who are licensed to practice medicine, and, in order to obtain the

requisite certificate of authority to practice medicine, a professional service corporation must

certify that each of its directors, officers, and shareholders is licensed to practice

medicine.See N.Y.Bus.Corp.Law §§ 1503, 1507, 1508; Educ.Law § 6507(4)(c) State Farm

Mutual Automobile Insurance Company v Mallela, 175 F Supp2d 401 [EDNY 2001] )

As discussed below, with the Malella III decision the Court of Appeals set the stage for the delivery

of justice and reckoning to the countless layman controlled “professional corporations” whoseunscrupulous, greedy and dangerous activities ravaged and permeated the entirety of the New York No-faultsystem

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THE NATURE OF THE LAYMAN SCRIPTED ENTITY

Purported professional corporations that are in fact owned and controlled by laymen for the purpose

of lining their own pockets at the expense of their “patients” wellbeing, are commonly referred to as “Doc

in the Box” operations and “Medical Mills” The term Layman Scripted Entity is perhaps a more accuratelabel, recognizing the eminence of the layman in control of the entity, and the principal money makingscheme by which all patients are subjected to a regimen of expensive treatment determined by a pre-existingplan or “script” without regard to the patients condition

A typical “script” that patients are subjected to consists of initial examinations by a physicianfollowed by extensive and concurrent physical therapy, acupuncture and chiropractic treatment Overpriceddurable medical equipment is prescribed immediately and may include steep bills for “custom fitted”orthotics and inflated TENS units Psychological treatment is arranged, frequently through a fictitious “selfreferral” process The psychological treatment commences billing with an evaluation, coupled with manyhours of specious “testing”, followed by psychotherapy sessions or biofeedback Dental services arecommon with an emphasis on exotic “TMJ” treatments, billing for multiple x-rays and expensive customfitted orthotics Multiple MRIs are prescribed either immediately or after several weeks and usually held onseparate days to maximize billing In addition electrodiagnostic testing consisting of NCV and needle EMGprocedures generally occur at about the four week mark and are generally the most expensive proceduresbilled for

Other common abuses are “upcoding” wherein a service is billed as if it were much more expensive

procedure, [6] and “unbundling” wherein components of a single procedure are impermissibly broken outand billed separately [7] It is additionally common for layman scripted entities to bill for services that werenever rendered and for patients to sign their name to sign-in sheets many times at once resulting in so called

“shadow patients” [8] It is typical for some $20,000 in billing to be submitted for each patient obtained by alayman scripted entity

Indispensable to the revenue streams at the heart of these schemes are payments made toobtain patients These payments may be made to the patients themselves, but are most commonly made

to runners or cappers who obtain, present or refer the patients along with a police report (therebyestablishing there is viable insurance coverage) and who themselves may stage or cause accidents Runners,cappers and steerer typically receive $1,500 to $2,500 per patient referred [9]

Rounding out the picture is the synergy between the illegal corporation and the motor vehicleliability system Working hand in hand with unscrupulous attorneys, layman controlled entities acceptpayments that are ostensibly for patient ‘records’ but which are in fact received for the benefit of referringpatients to the attorneys The motor vehicle liability system is also, at the end of the day, the principal reasonfor the continued participation of patients in the scripted medical treatment The expectation is that if theycontinue to treat they will eventually receive a profitable settlement of their liability case [10]

The exact manner in which layman scripted entities are configured and the associated schemesdevised vary in nature and scope, limited only by the ingenuity, industry or intelligence of the criminalsinvolved All schemes, however, share two common purposes; maximizing the number and size of therevenue streams flowing into the entity, and sweeping all entity profits to the controlling layman Indeed itmay be said that the bright line test of whether an entity is illegally operated in contravention of BusinessCorporation Law § 1507, § 1508 is whether the professional benefits from the profits of the corporation

The prototypical layman scripted entity is the stand-alone “multi-disciplined provider” operating onthe license of a single physician and in co-habitation with physical therapy, chiropractic and acupuncturepractices A small billing company handling all the bills may be owned by the laymen in true control of theoperation, or it may be that the chiropractor himself is in fact the one pulling the strings At the end of theday the revenue from all of the operations under the common roof are pocketed by the layman in charge

An entity of this sort will typically employ the services of various medical service vendors thatostensibly provide dental, radiological, psychological and nerve testing services These vendors themselvesare typically laymen controlled entities and may be quite small, or in the case of the radiological entities

enormous

There are four common financial inducements for using these vendors There may be a direct cashkickback or the vendor may pay “rent” for a room at the layman scripted entity to conduct its services Incertain instances the vendor may strike an arrangement which permits an entity professional to bill for thetechnical component the vendor services Finally there may in fact be an ownership interest in the vendor bythe layman scripted entity and its controller.[11]

A larger scaled layman scripted entity may control both the multi-disciplined provider and theassociated vendor services[12], and there have been instances of jumbo enterprises where scores ofprofessional corporations managed by dozen of billing companies fed into a single entity at thepinnacle [13]

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TELLTALES

There are common telltales of the laymen scripted entity are found in the medical records, thedocuments describing with the relationship between the professional corporation and management or billingcompanies, and the associated financial records

Treatment Scripts

Whether a treatment script is being used by an entity, and if so its precise nature, will invariably bequickly revealed by an examination of several claimant files The nature of the treatment provided, thetiming of the diagnostic tests prescribed, the template and boilerplate reports, diagnosis, prognosis andsymptomology will be unique from provider to provider, but nearly identical from patient to patient within a

given provider Examinations Under Oath of a number of claimants from the same provider will often yieldsimilar results, but can be inexact for these purposes given the variations in the witnesses ability to recall andrelate what occurred to them.

The identification of such a script is a near conclusory indication of a laymen scripted entity since itdemonstrates the complete lack of any meaningful medical analysis or decision making occurring inconnection with patient care at the facility

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Contractual Agreements

As part of the process of insuring that the laymen is in complete control of the professionalcorporation, elaborate and exorbitant management and leasing agreements typically exist between theprofessional corporation and the management or billing company These may be wildly disproportionate tofair market values and contain clauses, like liquidated damages clauses that handcuff the professional andgrant unfettered control, especially over financial matters, to the layman Certain crucial terms of thecontract, including the purported compensation to be paid to the “management company” may be left blank

If the terms are provided for, upon discovery of the entity finances, it is typically found that what is in factoccurring at the entity is inconsistent with what the agreements ostensibly called for

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Financial Necessities

Sharp variances between what contracts may calls for and what is actually happening willnecessarily occur because of the true nature of the core financial scheme Since the entities exist for the

express purpose of sweeping all profits to the controlling layman, the professional involved is in fact nothingmore than a salaried employee receiving a monthly stipend, or an independent contractor paid a per-procedure fee When the entity thrives the stipend or fee to the professional will not increase, butincreasingly large amounts of money will be pocketed by the laymen If the tax returns of the professionalcorporation are inspected, or credible testimony of a principal is obtained, it should be expected that thesewill show all of the businesses profit being swept away to the management company, and amounts claimed

to have been paid as management and leasing fees increasing or decreasing in direct proportion to the grossrevenues of the professional corporation

This pegging of the management fees to the gross revenues of the professional corporation is ofcourse of primary importance to the laymen controlling the professional corporation As the professionalcorporation thrives, so he expects to thrive Such a direct linkage to gross revenues, however, is the verydefinition of fee splitting [14]Accordingly demonstrating this point is often at the heart of any successfuleffort to prove the illegal nature of the professional corporation

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Other telltales

The professional corporation will change “owners” repeatedly, but since the professional figurehead

of the professional corporation has no financial interest in the entity, the transfer of ownership will occur for

no consideration

The physician will exert little practical control over the professional corporation, he will not hire orfire employees, the accountants who prepared “his” corporations tax returns and the attorneys who collect

“his” bills will be retained without any input from him whatsoever

The professional will typically have no knowledge of how much money the corporation is grossing

or netting, and have no involvement in the financial process other than collect his check and possibleendorse checks out of the professional corporation account into the management company account

The use of name stamps will typically be rampant and unfettered, the physician may not know howmany exist, who possesses them, what purposes they are put to use for or how they came into existence

In an effort to disrupt facially obvious fee splitting, the laymen will seek to divert revenues beforethey reach the professional corporation checking accounts An inspection of cancelled checks returned to theinsurer may show that they have been cashed at casinos and check cashing stores.

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FOLLOWING ON MALLELA: PROVING ILLEGAL CORPORATE STRUCTURE.

The decision of Mallela III sets the stage for insurers to prove the illegality of laymen scriptedentities in an unprecedented fashion Several cases have been decided in insurer’s favor on the heels ofMallela, and an examination of these cases demonstrates the different methods by which a favorable Malleladecision may be obtained

Briefly, and as outlined in more detail below, an insurer may expect to prove the illegality of aProfessional Corporation by leveraging SIU intelligence, by following up on law enforcement activities and

by using their own attorneys discovery and subpoena powers in conjunction with declaratory judgmentactions

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FOLLOWING ON LAW ENFORCEMENT

As evident from the number of press releases annotated in the foot notes of this document, lawenforcement arrests and prosecutions of fraudulent no-fault providers occur at a steady clip Prosecutions areroutinely brought by the State Attorney Generals Office, the United States Attorney’s Office and localDistrict Attorneys offices in conjunction with local, state and federal police forces

In case where the prosecution ends in a plea or conviction, the fact of the conviction, in conjunctionwith the allocutions of the defendants, may provide irrefutable proof of the fraudulent scheme of

the professional corporation sufficient to resolve the issue in associated civil cases.

A leading example of a case where litigation along these lines currently is currently being contested

is Metroscan Imaging PC v Geico Ins Co 2005 WL 1384369 (N.Y.City Civ.Ct.), 2005 N.Y Slip Op 25228

In Metroscan the insurer consolidated 60 pending actions and sought to follow on the plea allocutions of alayman in control of this large radiological entity Noting that the insurer had “articulated a "founded belief"that the health providers, all incorporated by [the same Doctor] and all subject to a management agreementwith non-licensed professionals, have violated both New York's business corporation and education laws” thecourt consolidated the cases for purposes of hearing to determine whether in fact the professionalcorporations were in violation of the New York Business Corporation and Education Laws

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Evidentiary Considerations

Several evidentiary considerations attend this approach since it relies on out of court statements fromdifferent actions to establish the desired result in the current litigation Complications are injected by thisfact, and by the fact that there will necessarily be at least two principal criminal actors, the Doctor and thetrue owner As the state of the law currently stands, the statements of one will not necessarily be admissibleagainst the other

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Doctor’s Plea of Guilty

If, in his criminal allocution, the Doctor admits that he was not in control of the enterprise hisstatements will be admissible against himself and, by extension, the entity on at least two grounds, andshould be dispositive on the question of the entities standing to recover reimburstment under the No-Faultlaw

As a party declarant, the admissibility of the Doctor’s own statements are subject to a well settled

hearsay exception (People v Collins, 301 A.D.2d 452, 755 N.Y.S.2d 365 [2003] (defendant's statement to a

third party properly admitted under the party admission exception to the hearsay rule as "inconsistent with

defendant's position at trial") People v Auricchio, 141 A.D.2d 552, 529 N.Y.S.2d 163 [1988] ) Moreover,

the declaration against penal interest exception to the hearsay rule has been accepted in New York since 1970

( People v Brown, 26 N.Y.2d 88 [1970], cert denied 480 U.S 948]).

If the Doctor has admitted the illegal structure of the corporation, for instance by acknowledging thatmedical treatment and services were routinely performed without his knowledge or direction, or that theprofits of the company were going to someone other than himself, the statements will not merely beadmissible but should also be directly dispositive on the question of the entity’s corporate structure oncollaterall estopell grounds Under this construct; the Doctor will be barred in the civil action fromrelitigating an issue he has admitted to in the criminal proceeding (Fisch on NY Evidence [2 ed] Sec

803; Ando v Woodberry, 8 N.Y.2d 165, 167 [203 N.Y.S.2d 74, 168 N.E.2d 520] ) “While defendant may not

relitigate the issue of his guilt, he may offer proof relevant to character of crime committed” (Matter of

Levy, 37 N.Y.2d 279 [372 N.Y.S.2d 41, 333 N.E.2d 350] ).

If however, the Doctor has merely plead or allocated to crimes which do not directly implicate thecorporate structure of the entity, (perhaps simple larceny or insurance fraud, depending on the circumstances

of his allocution), the situation may be different His statements, while still admissible, might now proveirrelevant to the question of the entities corporate structure In such a circumstance, the attorney should beprepared to prove the illegal structure by other means

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Layman’s Guilty Plea

If it is the layman who has plead guilty to criminal activities concerning the entity, a different set oflegal considerations arise As noted, the declaration against penal interest exception to the hearsay rule has

been accepted in New York since 1970 [See, People v Brown, 26 N.Y.2d 88 [1970], cert denied 480 U.S.

948]

In Criminal actions however, the current state of the law generally prohibits out of court statements