On July 12, 2007, the Centers for Medicare and Medicaid Services (“CMS”), as part of the proposed 2008 Medicare Physician Fee Schedule, also proposed changes to the Stark physician self-referral regulations. If implemented, these changes would have major impact on many existing healthcare delivery arrangements and service models. Potentially affected would be “under arrangement” models involving hospitals and physician entities, space and equipment leases involving “per click” payments, and percentage-based compensation arrangements. Also under the proposed amendments, an entity that provides designated health services (a “DHS Entity”) would “stand in the shoes” of any entity that it owns or controls and that receives physician referrals for designated health services. The proposed rules would also contain an anti-markup restriction that would affect various diagnostic joint ventures involving physicians and hospitals, as well as physicians and other providers or suppliers. CMS also commented on the in-office ancillary services exception and the perceived abuses presented by “turn key” arrangements structured to satisfy that exception on paper. CMS did not at this juncture propose any changes to the ancillary services exception, which medical practices have widely relied on in structuring their ancillary ventures. However, CMS is soliciting comments on potential changes, which could appear in the upcoming Phase III rules as this agency (along with the OIG) continues to target what are perceived as abusive joint-venture arrangements. CMS, on the other hand, is also considering the adoption of criteria under which arrangements that may inadvertently fail to satisfy all elements of a Stark exception may nonetheless be deemed Stark compliant. But these criteria may prove, in practice, as difficult to satisfy as the applicable Stark exception.

Stark Law

The basic prohibition under Stark law is that a physician may not refer to an entity for designated health services with which the physician or an immediate family member has a financial relationship unless a Stark “exception” is satisfied. The regulatory history of the Stark law reflects the challenges that CMS has faced in implementing this prohibition, and its highly technical exceptions, in a real-time business environment in which health care providers have tried to adapt to increasing government regulation. Stark law was first enacted under the Omnibus Budget Reconciliation Act of 1989 and, in its original form (now known as “Stark I”), only applied to clinical lab services. “Stark II” resulted from 1993 amendments to the 1989 Act and expanded the range of health care services that are subject to Stark restrictions to so called, “designated health services” (or “DHS”). Although Stark II has been in effect since 1995, the development by CMS of implementing regulations[2] continues now late into the first decade of the new millennium. Phase I regulations were finalized on January 4, 2001 and the Phase II (“Interim Final”) Rule on March 26, 2004. We now anticipate publication of the proposed Phase III “Final Rule” by no later than March 2008. 

“Under Arrangement” Ventures

In its proposed Stark amendments, CMS has targeted joint ventures between hospitals and physicians involving the provision of services for which the hospital ultimately bills Medicare – so-called, “under arrangement” ventures.

[W]e pay a hospital separately for each clinical laboratory test, for each therapy service, and for the vast majority of radiology and other imaging services. We have received anecdotal reports of hospital and physician joint ventures that provide hospital imaging services formerly provided by the hospital directly. There appears to be no legitimate reason for these arranged for services other than to allow referring physicians an opportunity to make money on referrals for separately payable services. Many of these services furnished by the joint venture were previously furnished directly by the hospitals, and in most cases, could continue to be furnished directly by hospitals.[3]

The July 12th proposed amendments, if implemented, would render illegal many, if not most, transactions in which an organization owned (wholly or in part) by physicians provides equipment and personnel for the delivery of services billed as hospital (or other provider) services furnished “under arrangement.” CMS would accomplish this through a technical change to the definition of the term, “entity,” such that the basic Stark referral prohibition would extend to the entity providing the service under arrangement with the hospital. In other words, a physician will be making a referral that implicates Stark restrictions by referring to either the hospital or the entity providing the “under arrangement” service. Potentially affected by this change would be physician ownership in diagnostic and therapy facilities that provide services only reimbursable by Medicare as a hospital service. Such a rule change would obviously curtail future physician investment in various service ventures and lead to an unwinding of current physician ownership in such ventures.

Per Click” Lease Payments

One type of payment arrangement among physicians and other providers that has so far survived the phased, Stark rule-making process has been space and equipment leased on a time or unit-of-service (i.e., “per click”) basis. For example, physicians and medical practices have been able to lease diagnostic equipment to hospitals and be paid a certain amount for each use of the equipment, even where the use resulted from the lessor physician’s own referral.[4] This would no longer be so under the proposed amendments. Although “per click” lease payments would still be permissible, they would have to exclude the lessor physician’s referrals to avoid violating Stark law. CMS is also soliciting comments as to whether it should prohibit time or unit-of-service payments in converse arrangements – that is, when paid by a physician lessee to an entity (e.g., hospital) lessor and reflecting services rendered pursuant to referrals from the entity to the physician.

Percentage-Based Compensation Arrangements

The Office of Inspector General (“OIG”), which, like CMS, is housed under the Department of Health and Human Services, has had a long-standing concern that percentage-based compensation arrangements may cause abusive referral practices. This concern is evidenced by the fact that such arrangements will not satisfy the “set in advance” payment requirements under applicable safe harbors to the federal anti-kickback statute. Failure to satisfy an anti-kickback safe harbor, however, does not necessarily mean that an arrangement is illegal under the anti-kickback statute, but failure to satisfy a Stark exception does mean that a covered arrangement is in violation of this strict-liability statute. Note that CMS specifically held back from prohibiting percentage-based compensation arrangements in Phase II of the Stark II regulations.[5] But CMS is now revisiting this issue:

Despite our intent that percentage compensation arrangements could be used only for compensating physicians for the physician services they perform, it has come to our attention that percentage compensation arrangements are being used for the provision of other services and items, such as equipment and office space that is leased on the basis of a percentage of the revenues raised by the equipment or in the medical office space. We are concerned that percentage of compensation arrangements in the context of equipment and office space rentals are potentially abusive. . . . Although we are concerned primarily with percentage compensation arrangements in the context of equipment and office space rentals, we believe there is the potential for percentage compensation to be utilized in other areas as well.[6]

Thus CMS is proposing to only permit percentage-based compensation when paid to physicians for their own “physician services” and derived from revenues directly resulting from such services. CMS has omitted important details, including how it would define “physician services” in this context. However, depending on how the final rule would be structured, this change would potentially ban many compensation arrangements that are common in the health care industry, such as percentage-based management arrangements, percentage of fee-schedule arrangements, and percentage-based compensation in connection with quality indicators, to name a few.

Standing in the shoes” of Owned or Controlled Entities

Under the proposed regulatory amendments, a DHS Entity would “stand in the shoes” of any entity that it owns or controls and that receives physician referrals for designated health services reimbursed by Medicare. Thus the DHS Entity would be deemed to have the same compensation arrangement with physicians as the entity that the DHS Entity owns or controls. Here, CMS is attempting to block what it perceives as a means for providers to insulate themselves from Stark liability through the creation of intervening entities or relationships.

We believe that it is necessary to collapse [such relationships] to safeguard against program abuse by parties who endeavor to avoid the application of the physician self-referral requirements by simply inserting an entity or contract into a chain of financial relationships linking a DHS entity and a referring physician.[7]

For example, under the proposed amendments, a hospital that owns a foundation that, in turn, contracts with physicians would be considered for Stark purposes has having a direct compensation arrangement with the physicians. In contrast, under the present regulatory structure, the foundation would have a direct and the hospital an indirect compensation arrangement with the physicians. Stark regulations provide an exception for indirect compensation arrangement that would presumably no longer be available to the hospital in this example. In other words, the hospital would be analyzed as if it had the same direct payment arrangements with the physicians as the foundation. CMS is currently soliciting comments as to how it should apply a “stand in the shoes” approach to various types of financial arrangements.

“Anti-Markup” Provisions

CMS continues to be concerned that permitting physicians and group practices to contract for diagnostic testing services, and thus obtain the right to bill Medicare for the technical component (“TC”) and/or professional component (“PC”) of such services, may lead to program abuse in the form of over utilization. As a result, CMS has proposed anti-markup provisions that would affect both the professional and technical components of diagnostic services rendered by outside suppliers.

Based on comments received and other information we considered, we are proposing to impose an anti-markup provision on the TC and PC of diagnostic tests. We would apply the anti-markup provision irrespective of whether the billing physician or medical group outright purchases the PC or TC, or whether the physician or other supplier performing the TC or PC reassigns his or her right to bill to the billing physician or medical group (unless the performing supplier is a full-time employee of the billing entity).[8]

Thus the anti-markup provision would apply whenever the service is provided by anyone who is not a full time employee of the physician or medical group that is billing for the diagnostic service. For example, where a medical group contracts with a radiologist to provide professional reads, and where the radiologist reassigns the right of reimbursement for the read to the medical group, the medical group could only bill Medicare for the group’s actual “net charges” in purchasing the read. Moreover, the “net charges” could not include any cost of equipment or space leased to the performing physician or other supplier – this to “prevent gaming” by inflating such costs.

In-Office Ancillary Services Exception

CMS’ suspicion of turn-key arrangements and the like has caused this agency to reconsider the in-office ancillary services exception. Simply put, to CMS the purpose of this exception is to permit a physician in a medical group to provide ancillary services, such as urinalyses or blood tests, related to the medical condition that caused the patient to come in for the office visit in the first place. But CMS believes that this exception, in its current form, permits business arrangements which, although structured to meet the technical requirements of this exception, exceed this limited purpose.

[S]ervices furnished today purportedly under the in-office ancillary services exception are often not as closely connected to the physician practice. For example, pathology services may be furnished in a building that is not physically close to any of the group practice’s other offices, and the professional component of the pathology services may be furnished by contractor pathologists who have virtually no relationship with the group practice (in some cases, the technical component of the pathology services is furnished by laboratory technologists who are employed by an entity unrelated to the group practice). . . . In sum, these types of arrangements appear to be nothing more than enterprises established for the self-referral of DHS.

CMS did not propose any specific changes to the in-office ancillary services exception in the proposed 2008 Physician Fee Schedule. But CMS is seeking comments, and we would hardly be surprised if this agency imposes substantial limitations on the availability of this exception in the Phase III regulations.

Alternative Criteria for Satisfying Certain Exceptions

Because intent is irrelevant under Stark law, innocent and trivial violations of the self-referral prohibition can lead to enormous penalties for a provider that submits claims to Medicare. CMS acknowledged that it has received comments to this effect as part of the Phase II rulemaking process. CMS provides a hupothetical example where a hospital failed to obtain a physician’s signature on a lease or a contract for personal services, resulting in the hospital being required to repay Medicare for all reimbursement received pursuant to such physician’s referrals made during the period of the technical Stark violation. CMS has indicated that it does not have discretion to waive Stark requirements, but it is considering an “alternative method for compliance,” where there are “only inadvertent, violations in which an agreement fails to satisfy the procedural or ‘form’ requirements of an exception of the statute or regulations.” Under this proposed alternative method of compliance –

if an arrangement does not meet all the existing prescribed criteria of an exception, the arrangement nevertheless would meet the exception if: (1) The facts and circumstances of the arrangement are self-disclosed by the parties to [CMS]; (2) [CMS determines] that the arrangement satisfied all but the prescribed procedural or “form” requirements of the exception at the time of the referral for DHS at issue and at the time of the claim for such DHS; (3) the failure to meet all the prescribed criteria of the exception was inadvertent; (4) the referral for DHS and the claim for DHS were not made with the knowledge[9] that one or more of the prescribed criteria of the exception were not met . . . ; (5) the parties have brought (or will bring as soon as possible) the arrangement into complete compliance with the prescribed criteria or have terminated (or will terminate as soon as possible) the financial relationship among them; (6) the arrangement did not pose a risk of program or patient abuse; (7) no more than a set amount of time had passed since the time of the original noncompliance with the prescribed criteria; and (8) the arrangement at issue is not the subject of an ongoing Federal investigation or other proceeding (including, but not limited to, enforcement matter).[10] [Emphasis supplied.]

Whether providers will find comfort in this proposed alternative method for compliance is unclear given its many requirements, uncertainties, and to-be-defined terms, such as “set amount of time” (beyond which, presumably, an arrangement would not be compliant even if it satisfied all other requirements of this alternative method).


CMS is accepting comments on these and other proposed Stark amendments[11] until August 31, 2007. The proposed Stark amendments, if adopted, are scheduled to go into effect on January 1, 2008. Given the breadth of these provisions, providers would have little time to restructure their arrangements to comply with the new regulations by this date. To aggravate this situation, providers could anticipate a similar drill with the issuance of the much-anticipated, Phase III “final” regulations during the first quarter of 2008.