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Stark II and physicians’ outside relationships

By Karl A. Thallner, Jr., Esq.

The federal Stark law limiting physician self-referrals is highly technical and its application to many physician arrangements is not clear from the statutory language. That is why many in the health care industry had been anticipating the issuance by the Health Care Financing Administration of final regulations under the Stark law.

On January 4, 2001, nearly eight years after Congress enacted the law, six years after the law became effective, and three years after HCFA published proposed regulations, HCFA finally issued Phase One of its final Stark regulations, which will become effective next year. While in some respects the final regulations provide greater flexibility for physician financial relationships, in other important respects they interpret the Stark law to apply to financial relationships for which little concern for abusive referrals is warranted.

Unless an exception applies, the Stark law prohibits physicians from referring Medicare or Medicaid patients to an entity for the provision of “designated health services” if the physician (or a member of the physician’s immediate family) has a direct or indirect financial relationship with the entity. There are eleven categories of designated health services, including, for example, laboratory, radiology, physical therapy, home health, outpatient prescription drugs and inpatient and outpatient hospital services. The Stark law establishes numerous statutory exceptions, each of which contains specific, detailed requirements and limitations. The law requires HCFA to issue interpreting regulations and authorizes it to develop new regulatory exceptions.

The Stark law applies to both a physician’s financial relationships with his medical practice to which he makes referrals, and to a physician’s direct or indirect financial relationships with outside entities, such as hospitals, to which the physician refers. This article will touch on some of the significant features of the final Stark regulations that affect principally a physician’s direct or indirect relationships with hospitals and entities other than his medical practice.

Indirect Compensation Arrangements

The final regulations reflect a significant change in the way HCFA would apply the Stark law to a physician’s indirect financial relationships with an entity to which he makes referrals. An indirect financial relationship could arise, for example, if a physician has a contract with, or ownership in, an entity that, in turn, has a contract with a hospital to which the physician refers. The final regulations articulate a three-part test to determine whether a physician has an indirect financial relationship with an entity. First, there must be an “unbroken chain” of financial relationship between the referring physician and the entity to which he makes a referral. A financial relationship is included as a link in the chain whether it is an ownership interest or compensation arrangement, whether or not it meets a Stark exception, and whether or not it has anything to do with the provision of designated health services.

Second, the compensation received by the physician (or the first entity in the chain in which he has a direct or indirect ownership interest) must “vary with or otherwise reflect” the volume or value of the physician’s referrals. For example, “per click” rental payments to a referring physician for equipment leased to a hospital would certainly fall into this category; it is less clear whether flat periodic compensation could ever be regarded as “otherwise reflecting” the volume or value of a physician’s referrals. Third, the entity to which the physician refers must have actual knowledge or a reason to suspect that the physician’s compensation varies with or otherwise reflects the volume or value of his referrals.

Exception for Indirect Compensation Arrangements

If a physician has an indirect compensation arrangement with an entity, referrals to the entity may be prohibited unless a Stark exception applies. In the final regulations, HCFA indicates that it would regard many of the familiar Stark exceptions (such as the exception for personal services arrangements) as not being applicable to indirect compensation arrangements because those exceptions assume a direct financial relationship. Therefore, HCFA has created an entirely new exception for indirect compensation arrangements.

The new exception includes three requirements. First, the compensation received by the physician (or the first entity in the chain in which he has a direct or indirect ownership interest) must be fair market value and must not take into account the volume or value of referrals or other business generated by the referring physician. Second, except in the case of an employment arrangement, there must be a signed written agreement covering the arrangement. Third, the arrangement must not violate the federal anti-kickback statute. Oddly, the indirect compensation arrangement exception is stricter than some of the other exceptions, but is less onerous than other exceptions, that might otherwise apply to an analogous direct financial relationship. For example, if the employment exception were to apply, Stark compliance would not be conditioned on anti-kickback statute compliance, but if the personal services exception could be used, HCFA’s limiting “set in advance” standard (discussed below) would have to be met.

Variable Compensation Arrangements

Many of the Stark exceptions for a referring physician’s compensation arrangements require that the compensation must be set in advance and not vary with the volume or value of referrals by the physician. On the positive side, the final regulations clarify that compensation based on time of service or units of service are acceptable, even when the physician receiving the payment has made a referral that triggers the right to payment. For example, a physician who leases radiology equipment to a hospital may be paid “per click” rental payments where the physician refers patients to the hospital for a diagnostic test using the equipment. The time of service or unit of service payments must be consistent with fair market value at the inception of the arrangement and they may not change during the term in a manner that takes into account referrals for designated health services.

The bad news is that HCFA has defined the “set in advance” requirement as precluding most common percentage compensation arrangements. The final regulations provide that percentage compensation based on a fluctuating or indeterminate amount, such as percentage of collections, income or expenses of an entity, is not regarded as fixed in advance. In some cases, this requirement may preclude paying physicians based on a percentage basis, even where the compensation would not vary with the physician’s referrals for designated health services. This result seems incongruous with HCFA’s increased lenience in allowing physicians to receive at least some financial benefit from their referrals under other arrangements.

Common Ownership

HCFA also changed its position on referrals by physicians to entities with which they are co-owners. Examples include a physician’s ownership of a PHO that is also partially owned by a hospital to which the physician refers, or a medical office building owned by physicians and an imaging center to which the physicians refer. Previously, HCFA stated that, if the entity that is jointly owned is not a provider of designated health services, the common ownership would not create a financial relationship among the owners.

In the final regulations, HCFA reverses that position, and asserts that common ownership could create an indirect financial relationship among the co-owners if the three-part test for such relationships (discussed above) is satisfied. How one would apply the definition of indirect financial relationship, and the new exception for indirect compensation arrangements, to a common ownership situation is far from clear.

Fair Market Value Compensation Exception

The final regulations also adopt a new regulatory exception for fair market value compensation arrangements. The new exception can be used for any compensation arrangement, even if another exception potentially applies. The exception contains many requirements present in other Stark compensation exceptions, such as requirements that the arrangement be documented in a written agreement, and provide for fair market value compensation that is not determined based on the volume or value of referrals. In addition, the new exception includes the requirement that the arrangement not violate the anti-kickback statute, which in effect incorporates an intent element into Stark’s supposedly clear-cut proscriptions. Finally, the new exception includes the rigid “set in advance” standard, which, as discussed above, would make it unavailable for many percentage compensation arrangements.

Fair Market Value

Many of the Stark exceptions require that the compensation paid to a physician be consistent with fair market value. A frequent issue is what documentation would be sufficient to establish fair market value. HCFA’s commentary accompanying the final regulations provides some guidance. Generally, HCFA indicates that a party may rely on any commercially reasonable method that provides evidence of what is ordinarily paid in the relevant geographic area in an arms length transaction among parties who are not in a position to refer to each other. In the rental context, HCFA suggests that a list of rents for comparable properties or an appraisal from an outside expert could be sufficient. Where inadequate comparables exist, HCFA advises looking at market data in different but similar geographic areas or at alternate valuation methodologies, such as cost plus a reasonable rate of return. HCFA acknowledges that there is no affirmative requirement to use an independent valuation consultant when other valuation methodologies are available, but cautioned that internally generated valuation assessments would have reduced evidentiary value because they are susceptible to manipulation.

New Exceptions for Minor Benefits

The final regulations include three new exceptions for minor benefits provided to physicians who refer to the entity providing the benefit. First, a new exception was created for non-monetary benefits with a value of up to $300 per year. Among other things, the benefits cannot take into account the volume or value of the physician’s referrals, and the compensation may not be solicited by the physician. Second, certain non-cash medical staff benefits provided by a hospital to physicians are allowed under another new exception. The exception, which is intended to cover such things as free parking or discounted food services, must have a value of less than $25 per occurrence, among other requirements. Third, an additional exception allows a hospital to provide physicians with free compliance training covering the basic elements of a physician compliance program and the requirements of federal health programs.


The final regulations will have a significant impact on the way certain physician financial relationships with outside entities are analyzed under the Stark law. In some respects they provide greater flexibility. In other important respects they produce substantial uncertainty or clear limitations with respect to arrangements that previously were thought to be compliant with the Stark law.

Karl A. Thallner, Jr., Esq., is a partner with the law firm of Reed Smith LLP, where he heads the health care law practice of the firm’s Philadelphia office.

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