• CMS Issues Stark II Phase III Regulations
  • January 2, 2008 | Authors: Michael A. Dowell; Andrew G. Russell
  • Law Firm: Theodora Oringher Miller & Richman PC - Los Angeles Office
  • The Centers for Medicare and Medicaid Services ("CMS") recently published the Stark II Phase III final rule ("Phase III"), which will go into effect on December 4, 2007.

    Under the Stark Law, physicians are prohibited from referring federal healthcare program (e.g., Medicare and Medi-Cal) patients for the provision of designated health services to entities with which the physician (or an immediate family member) has a financial relationship, unless the financial relationship fits within an exception to the law. Phase III includes a number of changes to the Stark Law that add further complexity to an already complex statute. This Health Care Legal Update highlights and describes the impact of some of the changes in Phase III.

    Indirect Compensation Arrangements

    The Stark Law includes an exception for indirect compensation arrangements. However, under Phase III, when an entity that provides designated health services ("DHS entity") contracts with a physician organization, the DHS entity is considered to have a direct compensation arrangement with physicians in the physician organization (including members, employees and independent contractors and their immediate family members). Compensation arrangements with physician groups that were previously permissible indirect compensation arrangements or that fall outside the scope of the Stark Law will now need to fit within an exception for direct compensation arrangements. This change does not apply to compensation arrangements with academic medical centers and not-for-profit integrated health systems until December 4, 2008. It applies to compensation arrangements with all other DHS entities on December 4, 2007.

    New Analysis for Indirect Compensation Arrangements

    • Contracts with physician organizations will now be treated as a contract with each physician in the physician organization
    • These contracts must now meet one of the direct Stark exceptions such as the exception for leases; the exception for indirect arrangements is no longer available
    • Existing contracts that meet the indirect compensation exception as of September 5, 2007 will be grandfathered through the end of their current term
    • Hospitals and other DHS entities should revise their policies and procedures for tracking physician relationships to include contracts with physician organizations and contracts that physician organizations have with individual physicians
    • Physicians should review their existing contracts and leases with physician groups to determine whether they will need to be revised when they are renewed

    Fair Market Value

    Phase III eliminates the fair market value safe harbor that CMS had previously established for payments to physicians for personal services. In commentary to Phase III, CMS notes that the safe harbor was difficult to comply with. Without the safe harbor, hospitals and physicians need to make their own determination as to whether payments to physicians are at fair market value, and CMS will continue to scrutinize the fair market value of arrangements.

    In addition, Phase III expands the fair market value compensation exception. It now applies both to (1) compensation to a physician, and (2) compensation from a physician. Consequently, the existing Stark Law exception for payments by a physician for items and services can no longer be used since it applied only when no other exception was available. The fair market value exception will not be available (although it will not apply to office space leases).

    Financial relationships that had relied on the fair market value exception for payments by a physician for items and services should be restructured to meet another exception. Reference to financial appraisals is still deemed a prudent practice, according to CMS, but fair market value will be based on a case-by-case analysis.

    Physician Recruitment and Retention

    A number of significant changes were made to the exception for physician recruitment and retention under Phase III including, without limitation, the following changes which loosen or restrict the prior applicable requirements.

    Stark III Impact on Analysis of Physician Recruitment Arrangements

    • A physician recruited must relocate his or her medical practice from outside the "geographic area served by the hospital" into that area and (2) move 25 miles (or establish a new medical practice where at least 75% of the patients are new patients). This new requirement significantly restricts cross-town recruiting arrangements, with limited exceptions
    • Physicians may qualify if they have served two or more years in specified government employment positions
    • The "geographic area served by the hospital" now includes all of the contiguous zip codes from which a hospital draws its inpatients if it draws fewer than 75% of its patients from contiguous zip codes
    • Allows hospitals in rural areas and health professional shortage areas to include an overhead component when calculating costs in an income guarantee
    • Allows medical groups to impose reasonable non-competition and other practice restrictions
    • Eliminates the ability to rely on the indirect compensation exception in physician recruiting arrangements

    Physician recruitment and retention agreements should be reviewed to ensure they are compliant with all applicable Phase III changes. Any current physician recruitment arrangement structured to meet the 75% patient base test in which the physician did not relocate his or her practice from outside to inside the service area is impermissible and must be restructured before December 4, 2007.

    "Set in Advance" and "One Year" Rules

    Several Stark Law exceptions, such as the exceptions for office space leases, equipment leases, personal services and fair market value, require financial relationships to be "set in advance" and to be for at least "one year." Phase III provides clarification regarding both of these requirements.

    When the "set in advance" requirement applies, parties cannot change their compensation at any time during the agreement between the parties. Amendments to the agreement that aren't related to the volume or value of referrals or other business generated between the parties won't violate the "set in advance" requirement. If the parties want to change their compensation prior to the expiration of the agreement, they will need to terminate the agreement and enter into a new agreement. Phase III reiterates that percentage-based compensation will be considered "set in advance" when it is fixed at the outset of the arrangement in sufficient, verifiable detail, and remains unchanged during the course of the agreement. When the "one year" rule applies, the parties may enter into a new agreement only after the first year of the original term of the agreement, and the new agreement must be for a term of at least one year.

    Percentage of revenue, capitation and other payment arrangements that are not fixed fees should be examined to see if they are in accordance with the Phase III rules. Any arrangements that are currently relying on a Stark Law exception that includes "set in advance" or "one year" requirements should be reviewed.

    Shared Space Leases

    The Stark Law exception for office space leases permits the shared use of common areas. According to the Preamble in Phase III, the term "common areas" is to be interpreted narrowly, and does not include exam rooms. CMS indicated that physicians sharing space for a DHS facility in the same building must control the DHS facility and the staffing at the time the DHS is furnished to the patient. As a practical matter, the requirement necessitates a block lease for space and equipment used to provide the DHS. Common per-use or per-click fee arrangements are unlikely to satisfy the supervision requirements of the in-office ancillary service exception and may implicate the anti-kickback statute. Any parties that are sharing office space and are relying on the office space lease exception should review their arrangement to ensure that exam rooms are not treated as common areas. Any parties sharing office space for the provision of DHS should review and restructure such arrangements to meet new requirements regarding control of the facility and staffing in the shared space.

    Group Practices

    Physicians who are treated as "physicians in the group practice" may provide or supervise designated health services under the in-office ancillary services exception and may participate in profit sharing and receive a productivity bonus. The definition of "physician in a group practice" has been revised in Phase III to require a direct contractual relationship between the physician and the group practice. Previously, independent contractor physicians had not been required to have a direct contractual relationship with the group practice. In addition, under Phase III an independent contractor physician will be considered a "physician in the group practice" only when he or she is performing services in the group practice's facilities. Any arrangements involving an independent contractor physician who is treated as a "physician in a group practice" should be reviewed to ensure compliance with the Stark Law.

    CMS also made changes to the group practice definition making clear that productivity bonuses can be based directly on "incident to" services but that overall profit shares cannot related directly to "incident to" services. Group practice productivity bonuses and overall profit share distributions based on the old group practice definition should be reviewed and restructured to comply with the new group practice definition.


    In order to ensure compliance with the Stark Law, health care organizations should audit and review all contractual and other relationships with physicians and consult qualified legal counsel prior to entering into any such relationships.