The importance of regulatory due diligence in life science transactions

January 22, 2007

Private Equity Newsletter

by Jill Alvarez, Partner

Traditionally, due diligence audits for significant transactions of companies doing business in the life science industry have focused on financial, intellectual property, and other key business considerations. Sophisticated financial sponsors and investors know that a critical component of due diligence audits is the regulatory portion. In today’s market, buyers and investors must identify, understand, and manage the regulatory risks inherent in dealing with manufacturers and distributors of pharmaceutical, biotech, and medical device manufacturers, as well as other life science companies.

The value of regulatory due diligence audits in the highly regulated life science industry

The life science industry, already a heavily regulated industry, is likely to confront further regulation from the federal government, state governments, and international governmental authorities in the near future. The existing regulations include laws, regulations, guidances, and other issuances of the Food and Drug Administration (“FDA”), Centers for Medicare and Medicaid Services, Federal Trade Commission, Drug Enforcement Agency, United States Department of Agriculture, Department of Transportation, Department of Environmental Protection, and each of their state equivalents.

The life science industry has also experienced a dramatic increase in government investigations and enforcement actions targeted at the industry over the past decade, which are likely to continue as regulators gain in sophistication in and understanding of the industry, and as settlements from these investigations, continue to generate substantial revenue for the government. The government has successfully pursued investigations and won civil and criminal enforcement actions and monetary penalties, against both life science companies and investors – including companies acquiring or investing in the target company after the questionable activities had ceased. Against this background, the need for and value of regulatory due diligence in an acquisition or investment becomes readily apparent. The results of such due diligence will generate information that can then be translated into fact-specific representations and warranties, which can then be used to allocate risk among the parties.

Critical components of regulatory due diligence audits

While the scope of the regulatory due diligence audits will vary case by case, the following is a description of the general components of both federal and state regulatory audits.

Clinical research

A due diligence audit of clinical research sponsored by a target company focuses not only on the research agreements themselves and the parties to them, but also on matters such as Good Clinical Practices and Good Laboratory Practices, approvals by and oversight of the research by institutional review boards (both commercial and institution affiliated), privacy and confidentiality of subject-related health information, documentation and compliance with human-subject protection requirements (including the informed consent process), restrictions on the promotion of investigational products, compliance with investigation-related submissions (e.g., new drug submissions and device exemptions, including underlying supporting data), adverse event reporting, and compliance with record-keeping requirements.

Moreover, federal grant recipients must comply with additional laws and regulations, such as time and expense reporting requirements, conflicts of interest, and additional human-subject protection requirements. These requirements may also apply to certain sites used for research by the sponsor manufacturing company. Thus, a thorough due diligence review should include an examination of such sites as well as determining, for example, if a federal-wide assurance is in place that makes these requirements apply to all research conducted at that site.


The products of a company and the way in which the company does business should always be examined. One should also analyze whether the target has rights of access to other data and FDA records, and the strengths of those access rights. An examination of each product and its class should reveal whether any particular product or class is inherently risky; for example, because of off-label uses.

We also recommend reviewing the status of any remaining marketing exclusivity periods on a product-by-product basis, as well as adverse events associated with both the product and its class. Packaging, labeling, promotional practices, advertising (whether directed to health-care professionals or consumers), and disease state awareness or reminder ads must be reviewed as well. The audit should also look at similar products in the market, from both the branded and generic perspective.

Governmental investigations

A critical part of any regulatory compliance review necessarily entails a detailed examination of all government contacts, correspondence, investigations, enforcement actions, inspections, warning letters and untitled letters, and enforcement actions. In addition, an analysis should be undertaken of the target’s compliance with any current corporate integrity agreements, required reports, post-marketing requirements, establishment listings, and Good Manufacturing Practices.

Reimbursement and pricing issues

Regulatory due diligence can also provide a valuable understanding of how, or whether, products will be covered and paid for by third-party payors after market launch. Such information can be useful in determining the adequacy of existing reimbursement rates from Medicare/Medicaid, and whether new rates should be sought. This reimbursement and pricing review should also look at whether there are 340B drug pricing issues and other pricing issues involving government contracts. In addition, a buyer or investor should determine whether current reimbursement rates are likely to rise or fall, and whether the products are part of ongoing government cost containment efforts, such as competitive bidding programs for reimbursement of certain orthotic, orthopedic, and DME products. For medical devices, the due diligence review should include an analysis of coding advice disseminated by the company to its customers and whether the codes are “crowded,” which could have a potentially adverse impact on reimbursement. Such information would bear heavily on the issue of whether a new code or reimbursement rate should be sought, which, in turn, has a direct bearing on deal price.

Operational review

Various operational aspects of the sales force, both internal and outsourced, should be examined, with a particular emphasis on compensation methodology, training, monitoring, promotional materials, expense accounts, and relationships with medical liaisons and other non-sales-related divisions of the target. Likewise, the target’s relationship with providers, key opinion leaders, institutions, hospitals, and other potential referrers and customers should be reviewed, with an eye toward evaluating issues such as compensation arrangements, a fair market value assessment, and the selection process for advisory boards, consultants, research grants, speakers’ bureaus, and other relationships that may give rise to actions for false claims, fraud and abuse, anti-kickback violations, and other regulatory violations. Standard Operating Procedures relating to grantmaking procedures, sales force promotional activities, discounts, gifts to providers, and conflicts of interests are also of particular concern. The target’s human resource division should be consulted to determine if any employees or ex-employees could be potential whistleblowers for false claims actions. A thorough review should include interviews with other key employees as well.

The target’s agreements and arrangements with distributors and customers should be reviewed to identify discounts, rebates, free goods, and other benefits or payments, to determine if such arrangements, and the companies in general, are compliant with Best Pricing, rebate, and other pricing requirements.


In light of the highly regulated industry in which life science companies operate, regulatory due diligence audits now play an important role in helping buyers and investors identify, understand, and manage the regulatory risks inherent in their deals. Like other complex due diligence audits, a regulatory due diligence audit is only as good as the due diligence team that conducts the review. Based on the complexity of the transaction and the products and companies involved, the regulatory due diligence team should likely include not only FDA regulatory attorneys but also consultants with experience in the specific class of the target’s products or technology. The time, effort, and resources invested in such a regulatory due diligence audit will likely produce far-reaching dividends for a buyer or investor in the life science sector.

The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.

Back to top