Phase III Stark Rule

On September 5, 2007, the Centers for Medicare and Medicaid Services (“CMS”) published the third phase of its fi nal rule making (the “Phase III Rule”) regarding the federal physician self-referral law (the “Stark Law”), which will become effective on December 4, 2007. The Phase III Rule clarifi es, and in some cases substantially revises, various concepts, defi nitions and exceptions to the Stark Law. The Phase III Rule does not, however, create any new exceptions. This Bulletin highlights some of the more signifi cant changes and clarifi cations in the Phase III Rule.

Regulatory Framework

The Stark Law prohibits physicians from making referrals for certain “designated health services” (“DHS”) payable by Medicare to an entity with which the physician or a member of the physician’s immediate family has a fi nancial relationship (e.g., an ownership or investment interest or a compensation arrangement), unless an exception applies. The Stark Law also prohibits entities from submitting claims to Medicare for DHS furnished as a result of a prohibited referral. The Stark Law does provide for exceptions, which allow physicians and applicable entities to set up arrangements that do not fall under the Stark Law’s prohibitions. Commonly used exceptions include offi ce space and equipment rentals and the exception for in-offi ce ancillary services.

CMS, on an annual basis, publishes a list of CPT and HCPCS codes that identifi es those items and services that are considered DHS, as well as a list of items and services that may qualify for certain exceptions. This list may be found at: 11listofCodes.asp#TopofPage.

Key Changes

A. Stand in the Shoes

CMS has revised the defi nition of an “indirect compensation arrangement” in the Phase III Rule. Prior to the enactment of the Phase III Rule, hospitals and other DHS entities could enter into a contractual relationship with a physician practice or a group practice rather than directly with its physicians, and the resulting relationship between the referring physician and the applicable DHS entity was not viewed as a “direct compensation arrangement.” These relationships were instead analyzed as potential “indirect compensation arrangements.” The Phase III Rule now provides that a referring physician has a “direct compensation arrangement” with the DHS entity if the only intervening entity between the physician and the DHS entity is his/her “physician organization.” A “physician organization” is “a physician (including a professional corporation of which the physician is a sole owner), a physician practice or a group practice.” Under the Phase III Rule, the physician will now “stand in the shoes” of the physician organization and the physician is deemed to have the same compensation arrangements (with the same entities providing DHS and on the same terms) as the physician organization does.

This significant revision to the defi nition of “indirect compensation arrangements” will require hospitals and other DHS entities to review and possibly amend agreements with physician organizations that were previously structured to comply with the indirect compensation exception. Such arrangements must now satisfy one of the Stark exceptions applicable to a “direct compensation arrangement” with a physician (e.g., personal services or fair market value compensation). For purposes of applying the various compensation exceptions, the parties to the arrangement are considered to be the DHS entity and the physician organization, including all members, employees or independent contractor physicians. However, existing arrangements that were structured to satisfy the requirements of the “indirect compensation arrangement” and were entered into and compliant as of September 5, 2007, need not be amended for the duration of the original term or the current renewal term of the arrangement. Any arrangements involving a physician organization and a DHS entity entered into after September 5, 2007, must be reviewed under the “stand in the shoes” provision and if applicable must satisfy a direct compensation exception by the December 4, 2007 effective date of these regulations. Furthermore, the grandfathering provision will not apply to all arrangements between a physician organization and DHS entity in which the structure did not implicate an “indirect compensation arrangement” (i.e., the arrangement was deemed to be completely outside of the Stark Law). These arrangements must also now qualify for a direct compensation exception.

Please note that the “stand in the shoes” provision applies solely to arrangements between a DHS entity and a physician organization and would not apply to structures involving an intervening entity other than a physician organization. For example, an arrangement with several links not involving a physician organization (e.g., DHS entity–leasing company–physician) should still be analyzed as an “indirect compensation arrangement” subject to the indirect compensation exception.

B. Physician Recruitment

The Stark Law provides for an exception from remuneration provided by a hospital to a physician to induce the physician to relocate to the geographic area served by the hospital in order to be a member of the hospital’s medical staff. The Phase III Rule modifi es the physician recruitment exception in a number of ways. The following is a brief overview of some of the more pertinent revisions:

  • Most importantly, the Phase III Rule and commentary surrounding the Phase III Rule provide that physicians and physician practices that are parties to a hospitalphysician recruitment arrangement may impose restrictions on the recruited physician that would not have a substantial effect on the recruited physician’s ability to remain and practice in the hospital’s geographic services area. Restrictions cited by CMS as not having a substantial effect include reasonable noncompete provisions, restrictions on moonlighting, nonsolicitation provisions (applying to both patients and employees) and requiring the physician to pay reasonable liquidated damages should the physician leave the practice and remain in the community. Restrictions that violate state or local laws such as laws governing noncompetition provisions or agreements would run the risk of being considered unreasonable.
  • The Phase III Rule expands the defi nition of geographic service area served by the hospital. For a hospital that draws fewer than 75% of its inpatients from contiguous zip code zones, the hospital’s geographic service area can be the area represented by all contiguous zip code zones from which the hospital’s inpatients are drawn. This revision is particularly applicable to a hospital with a national reputation, which may draw patients from outside of its geographic service area. This expansion will also allow hospitals to recruit physicians to outlying portions of the hospital’s geographic service area.
  • The Phase III Rule permits rural hospitals to determine their geographic services area as the area that encompasses the lowest number of contiguous zip code zones from which the hospital draws at least 90% of its inpatients.
  • The Phase III Rule also exempts from the relocation requirement physicians employed on a full-time basis by the federal or state bureau of prisons, the Department of Defense or Veterans Affairs, or facilities of the Indian Health Services for at least two years immediately preceding the recruitment arrangement. To qualify for this exception, the recruited physician could not have maintained a separate private practice while employed by the applicable entity. Residents and fellows in practice for less than a year also continue to qualify for an exception from the practice relocation requirements.
  • The Phase III Rule permits a more generous option for allocating costs to a recruited physician joining an existing practice when replacing a physician in a rural area or health professional shortage area who has died, retired or relocated in the past twelve months. A physician practice may, for purposes of an income guarantee, allocate its aggregate overhead and other expenses among physicians, including the recruited physician on a per capita basis, provided the percentage of costs allocated to the newly recruited physician does not exceed 20% of the practice’s aggregate expenses.
  • The Phase III Rule permits rural health clinics to utilize the recruitment exception.

C. Shared Space and Equipment

While CMS, in the Phase III Rule, did not make any substantive changes to the regulations governing the in-offi ce ancillary services exception, CMS provided some important clarifi cations regarding the sharing of such offi ce space or equipment (e.g., sharing a clinical laboratory or imaging center). CMS articulates that a physician sharing a DHS facility in the same building must control the facility and the staffi ng (for example, the supervision of services) at the time the DHS is furnished to the patient. CMS states that in effect carefully structured block-leasing arrangements may be the only permissible solution in such situations; however, common areas may be shared if the rent is appropriately prorated. As a result, any nonexclusive relationships involving space and equipment in a DHS facility where physicians simultaneously use the facilities and simply share the costs of administration of DHS without separate lease arrangements will need to be restructured. CMS also provided commentary that common per-use fee arrangements are unlikely to satisfy the supervision requirements of the in-offi ce ancillary service exception and in fact such per-use fee arrangements may violate the Federal Anti-Kickback Statute.

D. Productivity Bonus and Profit Shares

Within Group Practices CMS clarifies in the preamble to the Phase III Rule that productivity bonuses in group practices may be directly related to the volume or value of DHS performed by the physician or to referrals by the physician for services and supplies that are “incident to” the physician’s personally performed services. CMS states that services that have their own separate and independently listed benefi t category, except as otherwise expressly permitted by statute, such as “incident to” billing of physical therapy services, cannot be billed as “incident to” services. CMS also clarifi es that “incident to” services includes both services and supplies (including drugs). For example, in allocating a productivity bonus a group practice may consider referrals by a physician for outpatient prescription drugs performed “incident to” his/her services. However, a productivity bonus cannot be directly related to any other DHS referrals, such as diagnostic tests. In contrast, the allocation of profi ts among physicians in a group practice is subject to different rules from those that apply to productivity bonuses. CMS states in the preamble to the Phase III Rule that “profi ts must be allocated in a manner that does not directly relate to DHS referrals, including any DHS that is billed as an incident to service.”

E. Utilization of Independent Contractors

CMS, in the Phase III Rule, has modified the definition of a “physician in the group practice” to clarify that the actual contract must be with the individual physician and not with another entity such as another physician practice or a staffi ng company. This modifi cation will impact many group practices that rely on independent contractor physicians for the provision of various ancillary and physician services billed by the groups. These relationships are often structured in such a manner to ensure that the group practice qualifi es for both the physician services and inoffi ce ancillary services exceptions; however, both of these exceptions require that the applicable contracted physician qualify as a “physician in the group practice.” Pursuant to this modifi cation, existing contractual arrangements with independent contractor physicians will need to be amended to ensure that each individual contractor signs the existing contractual arrangement. Additionally, CMS states that leased physicians do not qualify as “physicians in the group practice” since there is not a suffi cient nexus between the group practice and the individual. Group practices will want to review any contracts they may currently have involving leased employees, given that an applicable Stark exception may no longer apply.


CMS clarifies that, when a DME is personally performed by the referring physician, there is no referral of DHS and no exception would be needed. However, CMS, in the applicable preamble discussion to the Phase III Rule, states that it is highly unlikely that a physician could personally furnish and supply DME to a patient. In order to qualify as personally performing the DME, the physician would need to enroll in Medicare as a DME supplier and personally perform the multiple and varied duties of a supplier as set forth in the applicable supplier standards.

G. Miscellaneous Changes

The Phase III Rule contains a few additional noteworthy changes that are briefl y outlined below.

  • Personal services agreements that satisfy the personal service exception are permitted to continue for a holdover period of six months on the same terms and conditions as the original agreement.
  • The Phase III Rule clarifies that a charitable donation by a physician may not be offered or solicited in any manner that is tied to or refl ects the volume or value of referrals.
  • CMS made two changes to the nonmonetary compensation exception. First, CMS allows entities with a formal medical staff to have one medical staff appreciation function for the entire medical staff each year in addition to the dollar limitation of $300 plus CPI per physician. However, any gifts or gratuities provided in connection with the medical staff appreciation event are subject to the limit set by the nonmonetary compensation exception. Second, CMS created a cure mechanism that may be used if an entity inadvertently exceeds the dollar limitation by no more than 50% during a calendar year. The cure may be effected by having the physician repay the excess amount within the earlier of (i) the end of the calendar year in which the excess compensation was received; or (ii) 180 days from the day the excess compensation was received. A DHS entity may use this provision only once every three years for the same physician. Furthermore, the agency advises that once a DHS entity becomes aware that it has inadvertently provided nonmonetary compensation in excess of the limit, the DHS entity should delay billing and claims submission for the physician’s DHS referrals until the physician has refunded the money in compliance with the above payback provision.
  • CMS clarified that the professional courtesy exception applies only to hospitals or entities with formal medical staffs. CMS also eliminated the requirement that a provider provide notice to the insurer that the provider is waiving all or part of the coinsurance.
  • The fair market value exception was also amended to apply to compensation provided to a physician from a DHS entity and to compensation provided to a DHS entity from a physician. The expansion of the fair market value exception will limit the use of the “payments by a physician” exception. The “payments by a physician” exception may only be used when no other exception applies to the arrangement.
  • The fair market value exception may not be applied, however, to leases for offi ce space. Such offi ce space arrangements must be structured to meet the rental of offi ce space exception.
  • The compliance training exception now includes programs that offer CME credit, provided the compliance training is the primary purpose of the program.
  • The Phase III Rule also substantially reworked the exception permitting retention payments in underserved areas. The Phase III Rule provides that rural health clinics may now make retention payments. The revised exception also permits retention payments in the absence of a written recruitment offer or offer of employment under certain conditions. Additionally, this offer no longer needs to be from a hospital, but it can now be from a hospital, academic medical center, physician organization, rural health clinic or federally qualifi ed health center.


Although there are not many fundamental changes in the Phase III Rule, the changes to the defi nition of “indirect compensation arrangements” and the requirement of entering into individual contractor arrangements with independent physicians will require entities and physicians who bill Medicare for DHS services to reevaluate and if necessary amend or enter into new contractual relationships. Another potential concern is the impact of CMS commentary regarding the sharing of space or equipment, which may limit the willingness of some practice groups located in the same building to share ancillary facilities.

Some of the Phase III Rule changes are benefi cial, such as eliminating the prohibitions of practice restrictions for hospital recruitment and clarifying policies regarding professional courtesy. Other positive changes include additional guidance regarding productivity bonuses and expansion of the retention payment exception. Additionally, in many ways the Phase III Rule’s modifi cations to the Stark Law are less worrisome than the proposed changes to the Stark Law under the 2008 Medicare Physician Fee Schedule (“MPFS”).