If You Can t Monitor It, Don t Execute It: Ways to Develop Compliant Agreements that are Commercially Reasonable and Consistent with Fair Market Value

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1 If You Can t Monitor It, Don t Execute It: Ways to Develop Compliant Agreements that are Commercially Reasonable and Consistent with Fair Market Value Allison Carty, JD, MBA Curtis H. Bernstein, CPA/ABV, ASA, CVA, MBA I. The Healthcare Industry & Compliance Challenges a. Healthcare Transactions Landscape 1. Due to numerous regulations, the healthcare industry is a complex environment in which to operate and navigate financial transactions. In addition to state-specific requirements, federal regulations include the Stark Law, the Anti-Kickback Statute, the False Claims Act, and rules for 501(c)(3) organizations. These regulations are particularly relevant to financial relationships between healthcare organizations and physicians. 2. Non-compliance with regulatory requirements can bring significant risk, including considerable fines and penalties or exclusion from governmental healthcare programs. During 2012 alone, several settlements were reached which illustrate the risk surrounding these types of financial arrangements. These settlements included 1 : Payment of over $157,000 by Bristol Hospital and Bristol Gastroenterology Associates to settle False Claims Act allegations stemming from Stark violations related to improper lease arrangements (Connecticut); Payment of over $3.5 million by Cayuga Medical Center to settle False Claims Act allegations stemming from Stark violations related to physician recruitment agreements (New York); Payment of $650,000 by Jack L. Baker, a radiology physician, to settle claims alleging violations of the False Claims Act, the Anti-Kickback Statute, Stark, and state law related to payment of illegal compensation to physicians to induce them to refer patients to an imaging center owned by Dr. Baker (Texas); Payment of nearly $1.28 million by Memorial Health Care System to settle alleged violations of the False Claims Act stemming from Stark and Anti-Kickback violations related to payment of illegal financial incentives to certain physicians to induce patient referrals to its facilities (Tennessee); and Payment of $16.5 million by HCA, Inc. to settle False Claims Act allegations stemming from Stark violations related to noncompliant rental payments for leased office space (Tennessee). 1 Refer to 1

2 In addition to these settlements, convictions were upheld in 2012 in the case of the United States v. Krikheli 2. That particular case involved Medicare fraud convictions as part of a bribery and kickback scheme. That scheme accordingly resulted in Anti-Kickback violations based on the one purpose test to establish intent. In this case, Medicare patients were referred to a particular diagnostic imaging facility. Because at least one purpose of the scheme was to induce or reward referrals reimburseable by federal health care programs, the Anti-Kickback Statute was violated and criminal convictions followed. 3. Because of the potential consequences involved, healthcare leaders must mitigate compliance risk. Therefore, clearly defined and comprehensive compliance programs should be developed and used by healthcare attorneys and executives in every organization. b. Challenges Facing Healthcare Attorneys and Compliance Officers 1. Attorneys and compliance officers face on-going pressure to mitigate risk for their clients and organizations. To do so, these individuals must carefully assess the facts specific to each arrangement and transaction. These facts are often further complicated by competing bids from other health systems or factors within a specific market. 2. Attorneys and executives may often be faced with notable timing or other constraints. Despite these facts, they should carefully scrutinize and evaluate each arrangement for regulatory compliance. As a result, these assessments often require both balancing the needs of the parties while engaging in thorough and objective analyses. Developing a comprehensive framework for assessing healthcare transactions will not only help to mitigate risk but will also assist with balancing competing demands. c. Gaining Physician Buy-In 1. Gaining physician buy-in and an understanding of regulatory risk is another helpful step in managing compliance risk. This factor continues to be an important but often overlooked consideration. 2. Physicians should understand relevant concepts to ensure the arrangement meets regulatory scrutiny. These concepts (which are discussed in the following sections) are often influenced by common market factors faced by both hospitals and physicians. In considering these factors, healthcare attorneys must maintain focus on ensuring consistency across their clients physician agreements, including policies related to monitoring and documentation. d. Two Key Factors: Commercial Reasonableness and Fair Market Value 1. Compliance with healthcare regulations often requires that two key elements be met commercial reasonableness and fair market value. These requirements are explicitly referenced in numerous exceptions to both the Stark Law and the federal Anti-Kickback Statute. 2 United States v. Krikheli, 2d Cir., No

3 2. Financial relationships between hospitals and physicians must be both commercially reasonable and at fair market value in order to pass many key regulatory requirements. Healthcare attorneys and executives must therefore weigh specific facts related to each proposed transaction to ensure that both elements are successfully met. 3. A key question surrounding these requirements is often: How do the two concepts overlap and what are the critical factors for assessing each? As the following sections further discuss, commercial reasonableness and fair market value are related concepts that have some differentiation in terms of evaluation criteria. II. Commercial Reasonableness: Broad Scope of Arrangement a. Fallacy of Reviewing Fair Market Value in Isolation 1. Hospital executives and compliance officers take an important step in managing regulatory risk by evaluating fair market value associated with their physician arrangements. These assessments are often completed with the assistance of third party valuators. Valuators are generally tasked with assisting entities on their assessment of the financial terms associated with a particular arrangement which begs the question: How much should be paid? 2. To fully manage regulatory risk, however, attorneys and healthcare executives should also be considering the reasonableness of the arrangement in aggregate. This assessment is often beyond the scope of the typical fair market value engagement completed by a third party valuator. While the financial terms do represent a key component as to whether an arrangement is reasonable, additional considerations may be necessary. b. Scope of Reasonableness Review 1. Guidance within the Stark Law commentary and proposed rules offers definitional language surrounding the concept of commercial reasonableness. The 1998 Stark proposed rule states that: An arrangement [which is commercially reasonable] appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals. 3 In addition, 2004 commentary by the Centers for Medicare and Medicaid Services ( CMS ) indicates: An arrangement will be considered commercially reasonable if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope 3 63 Fed. Reg., 1659, 1700 (Jan. 9, 1998). 3

4 and specialty, even if there were no potential designated health services ( DHS ) referrals This guidance on the standard of commercial reasonableness indicates that overall business logic and solid rationale must exist as the core of arrangements between physicians and hospitals. As a result, the scope of this requirement entails a review of the arrangement in aggregate, apart from the financial terms in and of themselves. 3. Particularly as third party valuators are concerned, an engagement to assess fair market value does not necessarily involve a discussion of the broad strategic, operational, or other business considerations. Instead, those factors are often left to the discretion of the attorneys and hospital representatives involved in the transaction. Careful consideration should thus be given to a practical framework for assessing the overall implications and rationales for each arrangement. Third party valuators may serve as an independent resource in developing this type of assessment structure or with reviewing particular arrangements which may involve additional risk. c. Specific Considerations Commercial Reasonableness 1. Because commercial reasonableness is a broad and somewhat abstract concept, a first step in ensuring regulatory compliance with this requirement is to develop a framework for evaluating each arrangement. 2. This framework should comprise at least three key components related to the specific factors involved, including those which are (i) qualitative, (ii) quantitative, and (iii) administrative. (i) Qualitative Matters 1. Qualitative factors surrounding an arrangement may provide key insights into underlying business logic. These factors are often nonfinancial in nature but supply key information which is critical for establishing the core rationale for a proposed transaction. 2. These qualitative factors are often strategic or operational in nature. Examples of strategic factors influencing the need for a transaction may include: Development of a particular service line or introduction of new service; Competitive targets including specialized service offerings or market share expansion; and/or Achievement of higher quality targets and patient care satisfaction Fed. Reg , March 26,

5 Similarly, operational factors underlying a transaction may include: Increased departmental efficiencies, including streamlining of scheduling and proper adherence to applicable standards; Improvement in provider education and training targets aimed to improve operations or enable more expedient service line ramp up of new policies; and/or Reduction in overcrowding within emergency or operating departments. 3. These factors are often discussed internally and may be shared with third party valuators to the extent the facts are relevant to their fair market value assessment. The valuator will then incorporate the facts supplied by the hospital into its assessment of fair market value per the circumstances provided. 4. However, an engagement specific to commercial reasonableness entails additional discussion and does not include the assumption that the arrangement has a solid rationale. In this way, commercial reasonableness is connected to fair market value from a conceptual standpoint, but does involve a different type of assessment. 5. To assess these types of qualitative considerations, healthcare attorneys and executives should develop a framework that considers factors such as the following: Whether the arrangement is necessary in addition to the resources already available to the hospital (e.g., physicians providing services at the hospital, duties required of the medical staff, and protocols at affiliated facilities); Whether the arrangement has a defined and specific purpose; Whether the arrangement will further the goals of the hospital (e.g., business, clinical, or community); Whether the arrangement has a particular objective (e.g., profit contribution or services development); Whether the arrangement will meet patient needs (e.g., access to a particular specialty or service); and Whether patient acuity levels indicate the need for the arrangement. (ii) Quantitative Matters 1. Quantitative factors in addition to fair market value should be considered to determine whether an arrangement is commercially reasonable. Additional financial and other quantitative factors may play a critical role in regulatory compliance. 5

6 2. In addition to fair market value, these quantitative factors may include consideration of profits and losses as well as substitute cost scenarios. Specific examples may include: Physicians compensation which may reflect their specialty, experience, etc., but which is causing losses to a hospital s service line on a sustained basis; Lack of volume for the number of providers being compensated/staffed which causes losses within a particular department; Staffing on a non-leveraged basis which results in payments from the hospital which are higher than necessary (i.e., when the use of mid-level providers may be appropriate); Payment on a market comparable basis in lieu of a cost-to-build model; and/or Arrangements with physicians in lieu of negotiating with other providers or substituting alternate staffing models (e.g., hospitalist, laborist). 3. In addition to qualitative matters, these types of quantitative factors should not only be considered on the front end of an arrangement but also continually monitored throughout its term. Changing facts during the course of an arrangement may have a material effect on whether an agreement remains reasonable for purposes of renewal or continuation. 4. As with the qualitative factors, quantitative matters are often peripherally discussed in connection with a fair market value engagement. However, a determination as to reasonableness may require additional consideration. In this way, quantitative factors also require a further type of assessment than the financial analysis associated solely with a fair market valuation. 5. To evaluate relevant quantitative matters, healthcare attorneys and executives should include in their assessment framework factors such as the following: Whether a less expensive level of service would be appropriate (i.e., non-physician provider or non-specialty physician); Whether additional considerations exist which may affect compensation (e.g., provider experience or market conditions such as a provider shortage within a particular specialty); Whether an alternate model may result in similar services at lower costs (e.g., hospitalist coverage, equipment purchase in lieu of services leasing); Whether the amount of time required under a particular arrangement has been considered, particularly in combination with other duties required of the physician; 6

7 Whether market comparable data exists which is relevant to the proposed arrangement; Whether patient demand justifies the level or amount of service being contemplated; and Whether the size of the hospital and its patient population is commensurate with the proposed services. (iii) Administrative Matters 1. A commercially reasonable arrangement will incorporate certain administrative matters. These administrative factors are unlike the qualitative and quantitative matters which are more substantive in nature. Instead, these factors entail the execution and oversight of the arrangement and are a critical component in managing risk associated with the commercial reasonableness requirement. 2. The supervision and management component of these matters make them a key element in maintaining commercially reasonable arrangements not only at their outset but throughout the term. The importance of the role of administrative matters are included in examples such as the following: Physicians receiving compensation for services that they do not actually provide 5 ; Hospitals entering into or continuing an arrangement without proper documentation and approval; and/or Physicians providing services under agreements for which there are not performance reviews or determinations of continued need. 3. These factors are of importance not only at the time an arrangement is executed but also during its term. As a result, attorneys and compliance officers should carefully consider administrative elements as part of an arrangement assessment framework. Factors of importance to consider within this component include: Whether the need for and specific purposes of the arrangement are documented; Whether a written agreement contains the material terms of the arrangement; Whether the hospital will appropriately engage in management and attorney review of the proposed arrangements; Whether approval of the arrangement will come from decision-makers of sufficient independence (including the board); 5 Refer to U.S. v. Campbell, 2011 WL 43012, No (D. N.J., Jan 4, 2011). 7

8 Whether safeguards are maintained to reduce risks of abuse (e.g., payments for unnecessary or duplicated services); Whether the hospital has a process which will formally evaluate arrangements; Whether the hospital will use performance assessments to evaluate whether arrangements are effective and/or needed; Whether the hospital will maintain documentation detailing the actual performance of services and the resulting outcomes; and Whether the hospital will engage in oversight to ensure services are actually performed. d. Balancing Test & Results Determination 1. A determination as to commercial reasonableness will ultimately result from a carefully crafted balancing test. Because numerous unique facts and considerations are involved in each arrangement, this test involves a collective review of all relevant information. 2. This test should be completed prior to executing a transaction and throughout the course of the arrangement at regular intervals. Doing so will promote effective monitoring to ensure it remains reasonable for its duration. 3. The assessment framework for determining commercial reasonableness should be tailored for each arrangement such that the key focus areas specific to each agreement remain in the forefront throughout its term. III. Fair Market Value: Range of Financial Terms within Overall Arrangement a. Importance of Factual Considerations Assessed for Reasonableness 1. The scope of a fair market value assessment will likely focus on the financial and payment terms only and thus is narrow in comparison to a commercial reasonableness evaluation. Nonetheless, factual considerations are critical for this area of review as well. 2. Many of the facts which are relevant to commercial reasonableness may also have an effect on fair market value. While a fair market value review may not explore the rationale of the underlying information, it will need to consider specific facts (e.g., provider experience) to fully understand the issues that may affect compensation. As a result, healthcare attorneys and executives should continue to fully address and document relevant facts as part of fair market value assessments. 8

9 b. Scope of Fair Market Value Review 1. Commonly accepted definitions of fair market value include the following: The amount at which property would change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have reasonable knowledge of the relevant facts. 6 This definition is compatible with the value definitions specific to Stark as follows: Fair market value means the value in arm s-length transactions, consistent with the general market value. General market value means the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or the compensation that would be included in a service agreement as the result of bona fide bargaining between wellinformed parties to the agreement who are not otherwise in a position to generate business for the other party on the date of acquisition of the asset or at the time of the agreement. 7 These Stark definitions are also consistent with similar fair market value guidance related to the Anti-Kickback Statute 8 and with the definition relied upon by the Internal Revenue Service. 2. The relevant definitions indicate that the remuneration exchanged between parties to an arrangement is critical to a finding of fair market value. The definitions also make clear that the parties should both be willing, be at arm s length, engage in good faith, bona fide bargaining, and have reasonable knowledge of the relevant facts. c. Specific Considerations Fair Market Value 1. Each arrangement will require a specific and unique fair market value assessment based on the particular facts at hand. A fair market value review (whether internal or one performed by an outside valuator) must consider the significance of the relevant facts and the manner in which they may affect the value. 2. To manage risk and ensure consistency across agreements, attorneys and healthcare executives should maintain a compliance framework related to determining fair market value. (i) Fact-Finding 1. The fair market value process begins with a gathering of all relevant facts. 6 Revenue Ruling CFR USC 1320a-7b. 9

10 2. These facts will typically fall into three categories which should be gathered in sequential order as follows: (i) hospital and provider specifics, (ii) performance, industry, and market considerations, and (iii) benchmarking metrics. 3. A collective review of facts within each of these categories will provide the necessary framework and context for an ultimate fair market value determination. a. Hospital and Provider Specifics 1. The first step in the fact-finding process will typically involve ascertaining specifics regarding the hospital and proposed provider. This information will lay the groundwork related to the structure of the proposed arrangement to be valued. 2. The types of facts gathered as part of this step will likely include particulars such as the following: The physician specialty required; The requirements of the hospital regarding staffing and/or coverage needs; The party performing the billing function; The hospital s prior attempts, if any, to secure staffing specific to the relevant specialty; and/or The description of any prior arrangement for the staffing being requested or with the relevant physician. b. Performance, Industry, and Market Considerations 1. Upon ascertaining an overview of the arrangement, the hospital or external valuator will likely gather and interpret information which may have a material impact on fair market value including performance, industry, or market considerations. 2. Examples of key information within this context may include: The physician s experience and historical performance; The supply of the particular specialty within the market and community demand for those services; The trends in compensation and reimbursement for the particular specialty at issue; The impact of the hospital s locale, including any market comparable data; The results of quality measures specific to the physician; and/or 10

11 The hospital s payor mix, supply of alternate providers, and need for the services. c. Benchmarking Metrics 1. A final step in the fact-finding process will include gathering benchmarking results specific to the physician s specialty and for the type of arrangement being proposed. This data may include metrics related to production and compensation as well as expense and practice performance standards. 2. A review of this data in combination with the material facts pertaining to the arrangement will provide an indicator of the type of value involved in a particular transaction. However, this data may require adjustment to fit the facts and circumstances of a particular arrangement (e.g., unique capabilities which are not prevalent within a particular specialty). (ii) Methodology Selection & Assessment 1. Given the need to assess benchmark data in relevant context, the second step in the fair market value process involves reconciling all relevant information to enable the selection of an appropriate methodology. 2. A careful application of the factual content will have a critical impact on the analysis. The methodology selection will depend upon numerous factors influenced by available data, alternate options available to the parties, and the type of arrangement. 3. Based on the facts involved in a particular situation, valuation methodologies may include: Relational assessment of benchmark data (e.g., production and compensation); Cost to build modeling; Reimbursement analysis; Financial support analysis; and/or Locum tenens staffing analysis. 4. Each method will not be relevant for every arrangement evaluated. However, the use of various valuation methodologies may provide additional perspective relevant to value based on key facts. 5. The type of approach(es) ultimately selected should not only be based on the required staffing or service needs but also on what viable alternatives may exist (e.g., cost to build versus a review solely of market comparable data). While a facility may not ultimately implement the alternate model, its results may nevertheless provide a relevant indicator of value. 11

12 6. These types of varied approaches are a prudent practice to ensure reasonable results that are consistent with fair market value. d. Assessment Following Value Determination 1. As facts change during the course of an agreement (e.g., new providers are recruited, patient demand decreases), attorneys and compliance officers should note these updates. These types of updated facts may have a material impact on whether an arrangement remains at fair market value or should be renewed. Many multi-year agreements now call for periodic fair market value review in the event key facts do change which may impact the value. 2. Given the prevalence of multi-year agreements and the potential for factual changes, continuous monitoring should take place. Doing so will help to ensure that arrangements are not only at fair market value upon execution but that they remain so throughout their terms. IV. Ongoing Compliance a. Typical Compliance Assessment 1. Oftentimes significant effort is placed on ensuring regulatory compliance prior to entering into a transaction. During this time, healthcare attorneys and executives discuss proposed arrangement terms and often retain the services of outside valuators to determine the fair market value. Despite efforts on the front end, monitoring of arrangements including necessary assessment and documentation often does not continue. 2. Careful review of key terms should not cease beyond the initial execution of an agreement. Facts may change which are relevant to the commercial reasonableness or fair market value of an arrangement, or both. 3. Because of the potential for factual changes, it is critical that hospital develop and maintain a framework and system for monitoring its physician arrangements on an ongoing basis. Without developing a framework, updated facts could call into question the relevance, reasonableness, or value of its physician arrangements. 4. Examples of revised fact patterns that could have a material effect on regulatory compliance may include those such as the following: Community demand decreasing given changes in health or referral patterns; Market factors impacting need such as the introduction of new competitors; Physician supply increasing which may result in the availability of additional providers (e.g., call coverage burden lessened); Competitor action involving the launch of a new service offering (i.e., decreasing demand at any one community hospital); and/or 12

13 Internal objectives and strategies including the decision to shut down certain services (i.e., making continued physician payments illogical following service line closure). 5. Certain factual revisions can even result in key assumptions or hospital representations no longer being valid. Hospitals typically sign off on certain representations if it retains an outside valuator to perform fair market valuations. The valuator has in turn used these representations for purposes of its assessment. Under some circumstances, those representations may no longer be valid (e.g., need for a physician s services if demand has decreased). If this is the case, the arrangement may no longer be reasonable and any fair market value opinion may not be valid to the extent it is predicated on revised assumptions and representations. b. Prudent Practice: On-going Monitoring and Oversight Beyond Execution 1. Given the potential for factual changes, hospitals should be engaging in due diligence prior to executing transactions and also during the course of physician arrangements. 2. As part of ongoing due diligence, internal compliance should monitor key facts as well as engage in thorough documentation relevant to continued or changing needs. 3. To accomplish continuous oversight and management, attorneys and hospitals should develop and maintain a framework for internal agreement monitoring. This type of framework should remain consistent with the hospital s physician agreement standards. While furthering these standards, the framework should also ensure compliance with all applicable requirements, including commercial reasonableness and fair market value. 4. Key elements involved in an arrangement monitoring framework will likely include several key components including determination of (i) an internal policy, (ii) arrangement thresholds, (iii) assessment framework, (iv) action items. 1. Determine Internal Policy 1. A hospital s internal monitoring policy should further its physician agreement standards by aiming to both avert risk and to maintain consistency across its arrangements. 2. By developing an internal policy, the hospital will be able to better manage regulatory risk. This type of policy will ensure that each arrangement undergoes a consistent review in keeping with its standards. 3. In addition to mitigating risk, an arrangement monitoring policy may also lead to the identification of focus areas (e.g., quality improvement, community outreach, service line growth, etc.). 4. As with the arrangements themselves, this policy should be subject to ongoing review to ensure consistent administration and identification for areas of improvement. 13

14 2. Determine Arrangement Thresholds 1. A key component of an internal arrangement monitoring policy will include the determination of thresholds. These thresholds will serve as markers for purposes of identifying areas of additional risk (e.g., compensation above certain benchmarks, compensation exceeding production) and can be established internally or with the assistance of third party valuators. 2. The thresholds and evaluation criteria may be based on numerous proposed terms and compensation models, including those with various components (e.g., base compensation, production bonuses, profit sharing, quality payments, administrative services, call coverage). 3. The hospital also has the ability to develop criteria that are applicable to rewarding individual or collective physician performance or that promote a value-based care model. 3. Determine Assessment Framework 1. Based on the internal monitoring policy and thresholds established, a framework for assessing arrangements can be determined. 2. This framework may include whether (and under what circumstances) physician agreements will be evaluated for purposes of fair market value and also commercial reasonableness. A comprehensive framework may also establish a clear structure for assessing aggregate annual compensation for agreements with numerous components. 3. Given the potential for factual changes during the term of arrangements, this step will remain critically important to ensure compliance over time. As such, the framework may include guidelines specific to the timing of periodic arrangement auditing and monitoring. 4. Determine Action Items per Assessment Outcomes 1. In addition to the evaluation criteria themselves, hospitals should develop a plan in the event its internal monitoring identifies an arrangement with heightened compliance risk. 2. To facilitate this step and ensure ongoing compliance, the hospital will likely want to receive input from legal counsel and even an outside valuator. 3. While immense planning and effort is required to identify compliance risk on an on-going basis, hospitals must act effectively in order to bring about results that actually mitigate their risks by addressing any potential issues. As a result, this step in the process remains of the utmost importance to avert regulatory risk throughout the term of each arrangement, not just at the outset. 14

15 V. Key Takeaways & Conclusion 1. Hospitals are currently entering into various arrangements with physicians at a furious pace. 2. Given the recent healthcare reform legislation in addition to existing regulations focused on physician-hospital relationships, hospitals must carefully navigate this landscape in order to mitigate its risks. 3. Hospital relationships with physicians must almost certainly meet two key regulatory requirements commercial reasonableness and fair market value. 4. These requirements must be complied with not only at the outset of the transaction but during the entire term of the arrangement. 5. Because physician agreements are often multi-year arrangements, hospitals should develop a framework to carefully assess compliance throughout each agreement s term. These arrangements must be compliant both at the time of execution and also for its duration. As a result, hospitals should monitor its physician arrangements to ensure the standards of commercial reasonableness and fair market value are continuously met. 6. While these standards are interrelated, a commercial reasonableness assessment is likely more broad in scope than one concerning fair market value. Nevertheless, both standards are highly fact dependent. 7. Because of the factual context of the commercial reasonableness and fair market value standards, hospitals must develop an evaluation framework and maintain on-going monitoring. 8. Facts surrounding an arrangement could change during its term and affect prior hospital representations, reasonableness, or fair market value. In these cases, hospitals should be aware of this status, engage in appropriate documentation, and involve legal counsel (as appropriate) in potentially altering or terminating an arrangement. 9. By ensuring compliance at the time of a transaction as well as throughout an agreement s term, hospitals will take great strides toward mitigating their regulatory compliance risk. 15