Specialty Labs Coping With Unique Challenges

Regulatory sanctions and lab consolidation each require a detailed management response

CEO SUMMARY: Few laboratory executives have ever been tested as intensely as those of Specialty Laboratories, Inc. Since the first of the year, Quest Diagnostics Incorporated has purchased two of its biggest lab clients. In April, state and federal lab regulators issued sanctions. Both developments are roiling the market for hospital send-out testing.

IT’S THE PROVERBIAL “rock and hard spot” for Specialty Laboratories, Inc., based in Santa Monica, California. Not only has it been hit by sanctions from state and federal lab regulators, but Quest Diagnostic Incorporated has acquired two its biggest lab clients.

As Quest Diagnostics integrates the operations of American Medical Laboratories, Inc. (AML) and Unilab Corp., it is expected that much of the reference testing referred to Specialty Laboratories by these two companies will be redirected to labs belonging to Quest Diagnostics.

Plan of Correction (POC)

Even as this unfolds in coming months, Specialty Labs must also come to an understanding with its lab regulators and develop a plan of correction (POC). It will then need to implement that POC and correct the deficiencies which triggered sanctions announced in April.

Strategically, this means that Specialty Laboratories must develop a business plan which addresses declines in specimen volume caused by the acquisition of two big clients, along with reductions in its test menu as an internal response to its regulatory situation.

One impact of the federal sanctions issued to Specialty Laboratories is the uncertainty they raised about Medicare billing for referred testing. Since federal regulations lack clarity about the unique circumstances of Specialty Labs’ case, the lab company has issued a letter of opinion from its law firm. This letter of opinion can be found on the company’s Web site at www.specialtylabs.com.

Resolution of the federal and state sanctions is the most pressing priority at the Santa Monica-based lab company. The departure of Chairman and CEO James B. Peter, M.D., Ph.D. last month and the appointment of Douglas Harrington, M.D. as interim CEO is a major part of that effort. Dr. Harrington is a long-time board member for Specialty Labs. He is also Chairman of Chromavision, Inc., based in San Juan Capistrano.

One reason for Dr. Harrington’s appointment as interim CEO is his considerable experience at working with laboratory regulators from the California Department of Health Services (CDHS) to correct deficiencies in an esoteric laboratory setting.

One of the lab industry’s best-kept secrets is that, in the late 1980s and early 1990s, Nichols Institute, then an independent, publicly-traded lab company, was inspected by CDHS and found to have serious deficiencies, some involving the same issues of “non-licensed personnel” performing and supervising tests. (See pages 16- 17.) Dr. Harrington supervised development of a plan of correction (POC) which resolved those deficiencies and brought Nichols Institute back into compliance. This type of experience obviously now has high value within Specialty Laboratories.

Reduced Test Menu

Another part of Specialty’s effort to address deficiencies involves its existing test menu, numbering some 3,000 assays. Clients should expect to see a reduction in the number of available tests. Infrequently-ordered assays will probably no longer be offered. By reducing the wide spectrum of seldom-ordered tests, Specialty Labs will find it easier to reorganize lab operations and cure the deficiencies that were cited by state and federal regulators.

For lab executives and pathologists, the sanctions issued to Specialty Laboratories raise questions about whether lab regulators are actively sending a message to the lab industry. In particular, are federal lab regulators preparing to become tougher in their enforcement of CLIA-88 standards?

Elsewhere in this issue, THE DARK REPORT reviews earlier cases of lab deficiencies in California. These earlier cases seem to indicate that some of Specialty Lab’s current problems are similar to deficiencies identified by state regulators at other labs in past years. When the full story becomes public, there is also most likely lots of blame in how the executive team at Specialty Labs responded to the concerns of lab regulators.

Unrealistic Regulations

As well, another contributing factor will turn out to be the rather unrealistic regulations that define a CLS—clinical laboratory scientist—and how CLS-licensed personnel conduct and supervise laboratory tests in the state. This is particularly true for Ph.D.s whose line of study may not have included much of the “med tech” curriculum that California regulations require for a CLS license.

THE DARK REPORT will also go out on a limb and predict that the end to the Specialty Labs-regulator spat may come sooner than anyone expects. Certainly Specialty Labs has every incentive and motivation to negotiate a speedy and swift resolution to its problems with state and federal lab enforcers.

But what of the enforcers? The decision by federal regulators to issue sanctions that include the revocation of Specialty Labs’ license, now stayed on legal appeal, has put them squarely in the spotlight. This first-ever revocation of a public lab company’s CLIA-88 license, and its financial consequence to Specialty Labs, certainly attracts the scrutiny of elected officials from both the executive and legislative branches.

THE DARK REPORT’s point is simple: both parties to this dispute have good reasons for a speedy resolution. If that happens within weeks, it will be a welcome break for the beleaguered executives at Specialty Laboratories.

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