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Private Equity and the Physician Enterprise: Key Issues Affecting the Investor-Professional Entity Model of Health Care Delivery
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Private equity is increasingly prevalent in the physician practice space, leading to complex arrangements. Richard Chasinoff, Director, Veralon, speaks with Michele Masucci, Partner, Nixon Peabody, about current issues in the private equity backed professional corporation and management services organization (PC-MSO) model of health care delivery. They discuss the structure of the model; the financial, transactional, and regulatory climate; the unique legal and compliance challenges; and some of the impacts on physicians and their practices. Sponsored by Veralon.
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Speaker 2Hello everyone, and thank you for joining this discussion regarding current issues in the private equity backed professional corporation and management services organization model of healthcare services delivery, more commonly known as the PC MSO model. Today, we want to share some of our observations related to the financial climate, the transaction climate, the regulatory climate, and some of the impact that we're seeing on physicians and their practices. My name is Richard Chasnoff , and I'm a director with Baron . We're a healthcare management consulting firm, and a large part of my work is with practices PE firms and management services organizations we're both seeking to implement or have already implemented the P-C-M-S-O model. Um, I help organizations maximize the value in these relationships while remaining compliant with many regulations all surrounding them. Uh , I'm here today with Michelle Masucci . Uh , Michelle, you wanna say hello and introduce yourself?
Speaker 3Hi, rich. Um, hi everybody. I'm a partner at Nixon Peabody and I'm a healthcare transactional lawyer. Rich and I have worked together for years from the very beginning of the P-C-M-S-O kind of , um, explosion in our, our industry. Um, I work with a lot of private equity firms, physician practices, trying to make sure that they are buying compliant practices, getting into compliance, figuring out what they should be paying for them. Um, and it's been quite a journey , uh, with Rich all these years. So I'm excited to be a participant in this podcast. Thank you for inviting me. And , um, let's talk about what we're seeing in the, in , in the industry.
Speaker 2Sound sounds good. rhel . So I think it would be helpful if we started by leveling the playing field a little bit. A lot of people come to a podcast or meeting and maybe have their own thoughts about what this model is or what we're gonna talk about. So I thought maybe it would be helpful if we just spent a minute to define the model. Um, do you wanna take a stab at that?
Speaker 3Yeah, I, I will. Um, so in the healthcare services industry , um, most entities are bound by what's called the corporate practice of medicine or the corporate practice of dentistry, which means that the entity that is providing the service that's billing in collecting the service has to be owned by a professional. So that's the pc. Um, the PC does not allow investment under state law by , um, lay , lay people like me or Rich. So what has happened over the years is that this PC MSO model has been developed where an MSO is providing all of the nonclinical services. So think about it in the pc. Um , you walk into a doctor's office, there's going to be doctors , there's gonna be billing people, there's going to be equipment in the P-C-M-S-O model, all of that back office or nonclinical stuff is moved to the, the MSO, and that becomes the investment vehicle for the private equity firm. Um, the, the objective, all the clinical , uh, value is left in the pc, meaning that's where the doctors, the licensed people are in the payer contracts. So in the P-C-M-S-O model, the economics are shifted through a management agreement to the MSO that the private equity , uh, firm or a non, any non , um, physician or provider can invest in the management fee. And that's something that Rich and I work on a lot needs to be fair market value , um, and we get valuations to support that man management fee. And one of the reasons we do that is to address any corporate practice of medicine issues, which might say that, well, if management fee isn't fair market value, the private equity firm is really owning the, the, the pc. So that's the basic, that's the basic structure. The MSO now , um, has all of that nonclinical value , um, and provides the services to the pc. Um, and that's where the investors lay people invest.
Speaker 2Yeah. Yeah. That is, that is the basics. And, and I would add related to the, the MSO , uh, that, that Michelle laid out, it's really important through that MSO , um, to, to shift all of the, not only all of the services, the , the nonclinical services, anything that can legally be per permitted to be shifted to the MSO should be , um, as well as shifting as much of the risk, because by shifting the risk and shifting the services, you can really shift the economics, which is, which is the point that Michelle was making, so that you can move , um, move the economics and move the, the profits and distributions to that MSO , the investor owned entity as well.
Speaker 3So , rich, what do you think that the big issues are when a doctor gets approached by a private equity firm, when a large physician group, regardless of the specialty, what are the things that they are thinking about first? What are the big issues that they're thinking about first?
Speaker 2Sure . So , so there , there are a number of them, and I think it, it depends to where they are in the , their , their lifecycle. But, but as organizations think about the process, they're , when they first get approached, they're first thinking , um, about purchase price. And they may be thinking about how much money is my practice , uh, worth , uh, in this? So that's certainly a big piece. But the other piece is, is the ongoing compensation. Once they, once they sell, the physicians have been used to earning the full value of their, of their practice through their ongoing compensation. So one thing that typically happens in an arrangement like this is the compensation gets reduced in some way to assure that there's profit left , uh, for the, for the management services entity. Um, that's the only way the economics, the economics can work. And it's a trade-off that the physicians are making between compensation and purchase. Price becomes this, this piece. So the , the other question in addition to purchase price is what is my, what is my ongoing compensation? Once they get by those, they have some much more practical , uh, questions that they ask. Like, are you gonna change my practice? Are things gonna change? What's pr what, what, what might this look like for me? Prospectively? Um, how committed are you? How long are , are you, the, my my new partner, my new private equity partner going to be to be in this , uh, in this space with me? Um, and, and how do I get out and how do you , how do you get out if we, if if we aren't, aren't happy or aren't satisfied with the, with the arrangement? So they're thinking about a lot of those, those sort of things. But once they get into it, the questions begin to shift. They start to think about how are we gonna grow? How are we gonna grow this practice? Uh, will we, will we add new doctors, new locations, new practices through acquisition? In what geography will we do that? On what timeframe will we do that? And then the next question is , uh, what, what is the structure that we might, we might use to do that? Um, will we, will we do a , a sub MSO in order to , um, to assure that the economics can, can remain with that other practice? Or is it a pure acquisition? So there are a number of different structures that, that everybody's thinking once the , the model becomes more and more mature.
Speaker 3So, so Rich, let's can , let's take these things one, one at a time. Um, sure. One of the things, and we're gonna talk about it a little bit later, one of the things that we're, we are seeing as lawyers and , um, regulators, is that there's been tremendous backlash against the private equity firms. So we're seeing all these new laws, notice requirements, the FTC rules , et cetera . And I think that's because of the fact that when we, you first look at a , an PC MSO transaction with a private equity firm, what are the two things you're talking about price, and you're talking about compensation. So you think maybe that's all that the PE firm is interested in. Um, and I, I think that as we peel away the , um, the layers, we, we might learn that they're not just interested in that, but in the , in the, in the world, what we're seeing in terms of the negativity towards these, you know, these, these models is the focus on price and compensation. So can we take one and these one at a time? Tell me what you see as the most compelling compensation structures that, that are , um, that the doctors tend to like. And then we could talk about the operational issues that , um, the doctors are most concerned about and what PE can really bring to those, those , um, operational structures and the growth. So, so talk to me first about physician compensation.
Speaker 2Sure . So, so physic , there are a lot of ways , uh, to, to compensate doctors and physicians get compensated in many, many ways. Probably the most, the most common , um, in this model relates to that we've seen is percent of collect is some percent of collections model , um, where the physicians are taking, where , where the physicians are, are invested in the growth of the business and the , and the overall financials of the business, because that they feel like that makes the, the most sense. Then there are other incentive models around, around growth , uh, to the extent of course working with , uh, with council around how can you , what, what types of compensation can be tied to, if any, to ancillary services and other things. But it , it , it largely ties to, to revenue to make the, the economics, the economics work.
Speaker 3And I can tell you in the olden days, like in maybe six, seven years ago, I think the doctors were shocked. They didn't quite understand that they were getting their money upfront , and that's why their compensation was going to be , um, changed. I think that those conversations are, that I have with them anyway, is much, much less. They kind of understand what they're getting themselves into . Um, and on the, on the ancillaries, what's , what's interesting is that , um, you would think a lot of these practices have already been organized so that they're taking advantage of the , the ancillary services, but some of them haven't, and some of them haven't had the capital. So the private equity , um, resource that they have to develop the labs, the MRIs , um, does , um, is become a ha is a selling point to some doctors in cer certain specialties like ob um, that yeah, they'll be able to take advantage of advantage of these ancillaries that they hadn't been able to because they couldn't afford to make the investment in them.
Speaker 2Exactly. And, and it also comes as, as per , as the platform grows and as new acquisitions come, not only does it come with, with the capital, but it also comes with the structure and, and a, a process for integrating ancillaries into the practice , uh, as well. So there's, there's a learning that happens as once you get through the entire , the initial platform. And , and as you start adding those, those ancillaries become, to begin to make more sense for those, those add-on practices as as they continue to grow and become newly acquired.
Speaker 3So, so tell me, what, what do you , um, when you see these deals happen, when , what do you see makes a, a physician group happy after the deal is done and unhappy after the deal is done? And, and I'm thinking, I'm really focusing now on like operational type issues .
Speaker 2Yeah, so there are a number of things. First of all, I think the, the , the goal of these is to, is to improve, develop, and expand the , the , there's never a goal of, of start of maintaining the status quo, either from a financial standpoint or from a, from a complete footprint standpoint. So, so there's definitely a , a goal to, to grow. There are some very specific structures that that , that are going to be looked at, of course, to , uh, to , to take that on, whether it's , um, uh, billing information, technology, scheduling, coding, staffing, all of those things are gonna get looked at as a , as a way to, to take a look at, at the overall economics. But I think physicians, physicians are happiest when they feel supported and continue to feel like they're, they're able to practice medicine the way that they had always intended and hoped , uh, and the way that it felt and, and the way that they developed it within their practice. So I think that providing the support to allow physicians to do that when it's done in a unique way or, or on an improved way based on the platform, is the thing that's gonna keep physicians, you know, ke keeps physicians engaged and interested. And then of course, as they see the growth continue to happen, they see what can happen to, to their, their comp , their compensation as it grows, and the value, the ultimate value of the business, which they now have a share in as well On the MSO side.
Speaker 3So I was at a conference the other day and one of the speakers said , um, that who, who works with a lot of physicians said that , um, profit is not a strategy. I like that . And I love , I love that because , um, what I have seen in the practices that have done these deals is where they find that the private equity firm is just looking to increase profit. Like that's the goal. That's where, and that obviously is one of the, one of the goals, but where that is the only goal , um, that that creates , um, very difficult environment because rather than getting the support that you're talking about and building on the expertise that the private equity firm might be able to bring, they're just trying to get the doctors to generate more revenue. And that creates a very bad, bad situation. And I, what I always tell the doctors before they go and they do a deal, is if they can talk to another doctor who is already in a deal with, with this platform to see how, how they really are treated afterwards, do they really, you know, get, get the, the staff in there educated in answering the phones? Do we really have increased patient satisfaction? Do we really have better medical records system? Are they really making the investments in the ancillary so that they could grow their prac practice that way? Are they really letting the doctors know and, and, and have input onto who the new doctors are going to be in the platform? I mean, that's a , that is a really important thing. The practices that I've seen that are the happiest are the ones that are really, they know, they continue to grow their practice with people that they know or know of who they respect. Um, and they are not treated as, as widgets. So I think private equity can bring a, a lot in terms of resources. And , um, and I think that when they do that and they allow the doctors to keep practicing the way that they work , that's where you have the happiest result. Um, and when the private equity firm comes in and just tries to trim costs without building around it, I think that's where you have the unhappiest results.
Speaker 2Yeah, I, I would agree. I think the , the initial practice that starts the platform was usually engaged because they had something special. There was some secret sauce or special component that allowed that practice to not only grow to a , to a meaningful size that had attracted the interest of private equity, but also to, to develop and grow , um, on its own before the, before private equity. And I think it's capitalizing on those, those things and then improving them is where, where this model really becomes the most successful. We can take an already successful model a , a practice with, with, with something unique and special, and then not only grow that practice, but also use that, that business model and the, the , uh, the expertise, the PR platform, the p the patient flow to allow new practices to come in, new acquisitions to come in and take advantage of that, that expertise that they've already, that's been developed and honed over the years.
Speaker 3So, so Rich, can we shift the discussion a little bit , uh, a little bit now, we, we, we and I have been around during times when money was really available and very inexpensive, and it was, it's never easy to do a deal, but there was a lot of exuberance in the market to do deals. Um, and now that financial , um, environment has changed a little bit. Can we talk about how , what impact higher interest rates , um, are making, are , is having on the , um, m and a environment?
Speaker 2Sure. Um, in general, it's slowing it down. It's not surprising that, that that higher interest rates are making more money, more expensive for, for private equity. Um, and that that model of cash flow and the , the more expensive money is pushing purchase prices down. Um , the thing about that is it's, it's not actually changing the seller's expectations yet. So often we're seeing a start start at a place of, of disconnectedness, if you will, where, where a a seller might be expecting one purchase price, but is being offered something that feels , um, feels quite a bit lower. So that's being managed , um, in a number of ways. Yeah , everybody's trying to manage the risk . People's still trying to get, get deals done, but we're seeing longer earnouts payment over time. We're seeing increased d diligence requirements on, on revenue, quality of earnings, et cetera, are really trying to, to help fine tune the analysis just a little bit more , uh, as, as deals as everybody comes into, comes to the table to, to start this process.
Speaker 3Mm-Hmm .
Speaker 2<affirmative> , whatcha
Speaker 3Do you say , Michelle? And I'm , I'm seeing, I , well, I'm seeing a lot of, I'm seeing a lot of deals that start , um, and discussions start, and the doctors get down the road and they say, I'm not selling my practice for that amount. They're not giving me what I expected. I may as well just keep doing what I'm doing for a while . And then they're trying to figure out how they can do what they're doing and grow, right? So that when , uh, the market turns around, they could sell their practice at a higher price. So we're doing some restructurings of practices. Um, more practices now are , um, proactively shifting to A-P-S-O-P-P-C-M-S-O model in anticipation of being bought down the road, or that they're going out and buying practices or affiliating or doing loose affiliations. So I, whereas maybe a year ago I would've told the practice, don't, don't, you know, spend the money and restructure into A-P-C-M-S-O model because if you are sold, the, the buyer will restructure it , uh, as part of , you know, we will restructure it as part of the deal now. Um, seeing that there are more practices that want to do that proactively, and they're, you know, sitting and waiting. Um, so they might go and do some roll-ups on their own with different types of strategies, either , um, loose affiliation, a, you know, easy in , easy out affiliation like we used to see. Um, so it's, it's interesting times. It's not like things have just stopped moving. Um, I, I, I just think that that , um, the , all the parties are trying to look at what is the best place for them to be now, and then how does it best situate them for a year from now.
Speaker 2Yeah . I , I would add the , the other, the other vehicle we're seeing use , the , the other reason that the P-C-M-S-O model is being used is for estate planning. We're seeing physicians start to , uh, think about how they can transfer some of the value of the practice, their practice to their, their children and spouses. And we're seeing it set up that way so that the , uh, so that family members can, can own , uh, a piece of the MSO as
Speaker 3Well . Yeah , that makes , that makes a lot of sense . Um , so can we talk a bit little bit about the , the regulatory , um, environment and what I was talking about before about the, about the , uh, pushback that PE firms are getting now and some of the regulations Yeah. That, that we're seeing? Okay. So , um, so in the past, I don't know, 12 months, we've seen a lot of , uh, regulations coming at, at , um, consolidation. I would say consolidation in the industry, the concern that regulators have that consolidation is a bad thing and increasing prices. Um, so they've come at it in a few ways. One is with all these different state law requirements for either notice or approval of healthcare transactions over a certain amount , a certain material threshold, some of them include MSOs, some of them exclude MSOs, some of them are , um, uh, are just notice some of them are approval, even if there's just notice, we think there's approval. So we've been spending a lot of time trying to figure out which of our deals would, would , um, be, would implicate some of these rules. Um , and , and how you get around these rules if you can get around these rules. Um, mostly we think that they create a timing issue, right? So if you have to give 90 days notice, it's just another , uh, requirement. The approval is, is different. Um, and we're , we're, we're where we're getting to, we're getting to a place where if these, if you think that your deal is going to trigger antitrust review, meaning that you've created too much consolidation monopoly power in some way , or in some way can affect payer rates, then um, you , you're likely to have trouble under these, these, these rules. So I think that there's been a tremendous amount of focus now on the antitrust principles. So we see the FTC and the DOJ coming out with these guidelines. Um, a lot, a lot of it did, I think, come from a bad rap that private equity is getting. Um, and I think that there's just this, this visceral reaction that , um, you shouldn't be making money in healthcare. People shouldn't be making money in healthcare. Um, and I think that while we as healthcare lawyers have to figure out how to get around these, well , I say get around, deal with these regulations and not get around them, but to, to deal with them , um, I think it's private equity's job eventually to come up for a reason for their being other than just , um, being be better able to articulate the good that they're doing to the system other than just making money. Because I think that in, in, in our, in our country, we just have this , uh, real , uh, issue in healthcare , um, with profit motive, and it , it's rearing its head also like New York requires that you explain how , um, the transaction addresses , um, health equity issues. So it's coming from all different places. Um, I think that we're having a real conversation in the country now about , um, healthcare that we haven't had , um, before and the policy implications of it. So that's what I think, rich.
Speaker 2Yeah, no, no, I would, I would, I would agree. And we're certainly seeing that as well. Um, I think it's also important for companies and for the, for the PC and MSO to, to behave in the way that it's, that it's structured. And I think that's gonna help as well. In addition to the, the , the structures that, that Michelle walked through. It's once the, once a transaction is complete, you, you do have at least two businesses. You have a professional corporation and you have an MSO, and it's really important to run and operate them separately. Uh, you know , often we see financials and financial statements even commingled in ways, a lot of transactions back and forth, and that's sometimes necessary, but I think, but it's also really important to maintain two clean sets of financials. And that will help, it'll help not only from a regulatory and audit standpoint , um, but it al it will also help from a , uh, an understanding of behaving within the model standpoint, making sure that the MSO is doing its role and the PC is doing its role , uh, recognizing that there's of course, a very tight relationship between the, between the two .
Speaker 3One thing that, that we are always concerned about is in the corporate practice of medicine world , um, to make sure that the MSO doesn't have too much , um, control or any control over the clinical , um, experience of the doctor . Um, and, and that's always something that we negotiate strongly with in our management agreements. Um, I think that there's been such a, an, an explosion of people who are working in this space that sometimes they're not as , um, sensitive about those issues as they they should be. I think that one of, one of the things that has been remarkable to me too is, especially like in the telemedicine space where there's the P-C-M-S-O model, a lot of the people are coming from retail business, people are coming from retail based environments, so they don't even understand the whole regulatory world. And there's a lot of , um, education , uh, for healthcare lawyers in that world. So you have people who are used to working in the Uber environment and who wanna impose those , um, strategies here. And they are always surprised about the healthcare regulations and how that hampers their ability to do the things that they wanna do.
Speaker 2Yeah. And, and I would add that the , the, the uniqueness of healthcare is not limited to the regulations, the reimbursement environment, the payer environments, the, the , the way that that money flows in healthcare is also very unique. And as some , uh, private equity firms try to do their first transaction in this space , uh, they , they are, it is the proverbial, you know, drinking from a fire hose , uh, as they learn not only the regulatory , uh, side of things, but also the financial side and the funds flow in healthcare is, is also very unique. And it's, it's important to have, you know, to have good advisors along that, that way people who have done this before and , and move , move through it , um, the , the expertise is , is really helpful , uh, both on the regulatory side and on the business side as well.
Speaker 3I think in the telemedicine space of the <inaudible> , see how persons who are not used to , um, the, the regulations have a hard time even adjusting just as simple as if they, if just as simple as bank accounts, you know, they're not used to the idea that the revenue from the PC needs to go into a separate bank account, and why can't it just go to the MSO? Um, so it's again, a real learning curve.
Speaker 2Yeah. We've experienced, we've experienced the same, and of course we've talked earlier, you , you know, in , in our time together about the, the payment from the practice to the management company for, for management services. And often what our, our initial conversation with, with a potential new client or with a new client is, you know, starts with, well, we just, we just take whatever's left and we move it over. And that, that doesn't, of course meet the regulatory , um, requirements that Michelle walked us through , uh, earlier. So it's really important to have a, a management services agreement that clearly defines the services, clearly defines what the manager is going to provide to the professional corporation and the fee that's gonna be payable for those services. Um, and it is the hope of everybody that, that the, that fee will be sufficient to completely move the , uh, move the any profits or move, shift the economics from the PC over to the , uh, over to the management company. But it's not necessarily a guarantee that that is subject to fair market value rules, which is where we , uh, Michelle and I spend a lot of time , uh, working together to, to work through those, those issues.
Speaker 3So , um, rich, do you, do you , um, my , do you see a lot of , um, joint ventures now between private equity firms and hospitals?
Speaker 2Y that, that is an emerging , um, area and Yes, we, we, we are definitely seeing those. They're , they're more and more every day . Um, and we're seeing really them in, in two different structures. Uh, one is to actually bo both sides will contribute assets, maybe , maybe one , um, maybe the , the hosp the health system has , uh, has , uh, a business in , in a particular specialty. And there's another platform in a , in a , in a similar specialty or a complementary specialty where they contribute assets to a joint venture. Um, or sometimes it's a hospital buying in to , um, to a private equity backed platform , um, as well. And both models are, are becoming more and more , um, common. I think health systems are, are generally trying to, to figure out how they work in this space. They see this, they, they see private equity backed , uh, entities , uh, coming into their communities , uh, more and more. And they're trying to figure out , uh, as they always do, how to, how to work, work with them. Um, they're also, there's also a competition for doctors as well. Um, and they, they each offer different, different things. Uh, of course health systems can often , uh, offer , uh, co you know, high different levels of compensation and can offer , um, some stability and continuity, longstanding relationships in the community. Uh, whereas as we've been talking about , uh, pre , uh, PE firms can , can offer that, that upfront cash buyout, that that purchase price that health systems often can't offer. So it depends. Different physicians , uh, gravitate in different ways. Uh, but, but health systems are also trying to figure out how they , uh, they offer some things that maybe PE can't offer in terms of connecting and, and the con connectedness with, with the community and with the, the broader health system and broader healthcare environment in the community as well.
Speaker 3So , um, and thank , thanks, rich . Going back to the , um, hospital , um, PE joint ventures, the hospital has to consider, we're, we're seeing them more. Um, some are at the talking stages, some have actually been consummated. Um, so the private equity firm is bringing resources that the , um, hospital's capital that the, the hospitals in need of. Um, but the, it's a very, you have to make sure that you look at the tax exemption issues for the hospital , um, the not-for-profit issues. And generally you are able to work around them , um, and, and then they're not really obstacles, they just have to be considered. Um, so what do you think, rich, is private equity here to stay
Speaker 2<laugh>? I do. I I think these models are, are here to, to stay. We, we know that , uh, most physicians around the country are, are employed , uh, at this point, whether by health systems or private equity. Uh, the model of healthcare delivery is changing, and I think they, they continue to , uh, private equity backed entities , uh, have a role I think, I think they're going to, to evolve over time. I think we're going to have to address some of the issues that, that you, that you mentioned earlier, Michelle , of, of demonstrating value. Uh, I think they're , that we're gonna clean up and get more comfortable with some of the regulatory issues and, and learn how to, you know, work in that environment and the regulations will probably change to fit the environment as well. Um, but, but I do think they're here to stay. What do you think, Michelle?
Speaker 3Well, I think, I think that , um, I think that our regulators could complain about private equity, but I don't see anybody else stepping in to, to give the, the industry these resources or to provide the resources. So I don't see anybody else coming in to fill the gap. Um, so I, I just think that private equity is here, here to stay, but I do believe that as we go through these challenging times with these changes and laws and regulations, private equity is going to have to be a little bit more , um, vocal about what they, the positive things that they're bringing to the environment, like resources. Um , I think they need to really come out with , uh, their value, more vocal about their value proposition, because what we see in the papers are all the negative things about private equity. Um, but there, I think there's real value to it in terms of capital resources growth. Um, and I think that's going to be the challenge for, for private equity over, over the next few years, beating back these regulations, dealing with these regulations, and at , at the same time coming up with , um, their , their , their reason, the important reason for being other than just profit. So , um, that's what I have to say about this new world of private equity rich. Um,
Speaker 2Yeah, I think, I think that's a good place to leave it. I , I think this has been a wonderful discussion, Michelle. I appreciate you joining , uh, me to have this discussion , uh, and appreciate , uh, everyone for listening and, and appreciate a HLA for putting this together. Uh , thank you very much and have a great rest of the day.
Speaker 1Thank . Thanks , rich . Thank you for listening. If you enjoyed this episode, be sure to subscribe to a HLA speaking of health law wherever you get your podcasts. To learn more about AHLA and the educational resources available to the health law community, visit American health law.org.