CMS Issues Phase II Stark Regulations


On March 26, 2004, the Centers for Medicare and Medicaid Services ("CMS") released new regulations interpreting the 1995 federal physician self-referral prohibition commonly known as the "Stark Law." The Stark Law governs the financial relationships between physicians and entities to which they refer certain designated health services ("DHS"). The new regulations, which are referred to as the "Phase II regulations," are long, complex and not easily distilled into a brief bulletin, and their full impact will likely not be known until some time in the future. That said, the purpose of this bulletin is to highlight what appear to be the most significant changes in the Phase II regulations.

  • Effective Date and Comment Period . The Phase II regulations will become effective July 26, 2004. CMS will take comments on the regulations through June 24, 2004. Accordingly, the regulations are potentially subject to change based on comments received. However, there can be no assurance that any changes will be made, and we believe affected parties should prepare themselves to be in compliance by the effective date.
  • No Grandfathering . Physicians and providers may be surprised to find that certain relationships previously believed to be compliant are not permitted under the Phase II regulations, specifically in the areas of physician recruiting and ancillary services shared between physician groups (both of which are discussed in more detail below). CMS takes the position that such relationships should be restructured or unwound before the July 26, 2004 effective date. It is therefore critical for physicians and providers to review their relationships in light of the new regulations.
  • In-Office Ancillary Services Exception/"Same Building" Rule. The "in-office ancillary services exception" allows physicians to operate ancillary services within their medical practices within certain limits. In order to meet this exception, the practice must operate the ancillaries within a "centralized building" or in the "same building" in which a member of the group has an office for the practice of medicine. The significance of operating an ancillary service in the "same building", as opposed to in a "centralized building," is that ancillaries offered in a building that meets the "same building" test can be shared with other practices. The ability to share an ancillary service allows one group that operates an expensive imaging modality such as an MRI to share the machine with another practice, within certain limits. The Phase II regulations tighten the definition of "same building" in order to prevent sharing situations that CMS deems abusive. Practitioners who have entered into "excess capacity leases" under the terms of which one practice purchases the excess capacity of an ancillary service owned by another practice should reevaluate the legality of their arrangement under the new definition for "same building."
  • Personal Services Exception. The Phase II regulations modify the requirement that personal services agreements with physicians (i.e., independent contractor arrangements) have a term of at least one year by allowing for termination of the agreement, with or without cause, as long as the parties do not enter into a subsequent agreement for the same or substantially the same services during the first year of the original term. The Phase II regulations provide some latitude in complying with the requirement that the arrangement with the physician cover all of the services to be furnished by the physician. To allow for multiple agreements with the same physician, the Phase II regulations interpret this requirement to allow the entity to (1) cross-reference all agreements with the physician in each agreement or (2) keep a master list of all agreements that is maintained and updated centrally and is available for review by CMS. Physicians may furnish services under this exception through employees, a wholly owned entity or through locum tenens, but not through the use of independent contractors.
  • Productivity Compensation for Employees and Independent Contractors . The Phase II regulations make it clear that physicians practicing as employees or independent contractors in situations where the group practice exception is not available may receive a productivity bonus based on work personally performed by the physician, but not based on ancillary revenue generated on an "incident to" basis.
  • Percentage Compensation Arrangements Permitted. The "Phase I" Stark regulations published in 2001 prohibited percentage-based compensation arrangements on the basis that the compensation is not "set in advance" as required by certain of the exceptions to the Stark Law. This interpretation was particularly problematic for certain management arrangements and professional services arrangements in which compensation was based on a percentage of collections or income. Due to objections raised to this interpretation, this part of the Phase I regulations was never implemented. In the Phase II regulations, CMS has now determined that percentage compensation arrangements are permitted if the methodology is set in advance, objectively verifiable, and not adjusted during the agreement based on the volume or value of referrals.
  • Hourly Rate Compensation for Physicians. The Stark Law requires that payments to physicians be at fair market value. The Phase II regulations create two voluntary "safe harbors" for determining fair market value for hourly compensation (e.g., hourly-based medical director compensation). The first safe harbor can be met if the hourly payment is less than or equal to the average hourly rate for emergency room physician services in the relevant physician market, provided there are at least three hospitals providing ER services in the market. The second safe harbor requires averaging the results from four of six recognized, widely available salary surveys. Hourly rates will be deemed "fair market value" by CMS if they meet either of these safe harbors. Entities may continue to use their own methodology for determining fair market value, but will bear the risk and the burden of proving that these rates are truly fair market value. It is too early to tell whether the industry will move towards the safe harbor methodology.
  • Office and Equipment Leases. The exceptions relating to the rental of office space and equipment have been modified to allow "without cause" termination clauses and month-to-month holdovers. The Stark Law generally requires leases to have an initial term of at least one year, and also requires renewals to be at least one year. Under the Phase II regulations, office and equipment leases may be terminated with or without cause before the end of the year term as long as the parties do not enter into another lease for the same space or equipment until the end of that year. In addition, leases that have expired may continue on a month-to-month basis for up to six months if the terms of the lease do not change.
  • Physician Recruitment. There are several major changes to the physician recruitment exception. The exception now specifically permits recruitment incentives for residents completing training (this has always been permitted by the federal anti-kickback statute, so this inconsistency in federal law has been corrected). There is also specific guidance on defining a hospital's service area for purposes of determining whether a physician is relocating to this service area. The most significant changes to this exception are the new requirements for recruitment arrangements in which the recruited physician joins an existing group practice. These requirements include: the practice must also sign the recruitment agreement if payments will be made to the practice, the practice may not impose a noncompete or other practice restrictions on the recruited physician, and for income guaranty arrangements, the calculation of the income guaranty payment may only include overhead costs that are additional incremental costs of the recruited physician (i.e., rent for existing office space and cost of existing personnel may not be allocated to the recruited physician in determining the net income payment).
  • Retention Payments to Physicians . Hospitals and FQHCs in Health Professional Shortage Areas are now allowed to make limited payments to physicians as a means of retaining those physicians in their geographic area. These payments require the physician in question to have in hand a firm, written recruitment offer from another hospital or FQHC that would require the physician to move outside the geographic area served by the hospital or FQHC making the retention payments.
  • Post-Closing Adjustments and Installment Payments in Purchase Agreements . The exception for "isolated transactions" is commonly used for purchase agreements, and generally permits a one-time fair market value payment as part of a single transaction. The exception has now been expanded to allow for payments pursuant to post-closing adjustments (e.g., working capital adjustments) within six months after the closing date, and also to allow for installment payments as long as the payments are secured or guarantied in some manner that insulates the seller from the risk of default by the buyer.
  • Medical Staff Benefits. The Stark Law permits hospitals to provide certain "incidental" benefits to their medical staff. This exception has been expanded in several respects in the Phase II regulations. The benefits provided no longer need to be consistent with the benefits offered by other facilities in the same area. Additionally, it is now permissible to provide benefits to only staff members in the same specialty, rather than to the entire medical staff. CMS has also clarified that it is permissible under this exception to identify a physician on a hospital's website or in a hospital advertisement, and to provide physicians with technology (internet access, pagers, etc) that allow the physicians to remotely access information or personnel at the hospital. The $25 dollar cap on each installment of benefits under this exception will be annually adjusted for inflation. The exception is now available to any facility with a bona fide medical staff (i.e., not just hospitals).
  • Professional Courtesy . Under this new exception, health care entities may provide all physicians on their medical staff or all physicians within the community (and, in both cases, the physicians' family members and office staff), free or discounted health care items or services as long as certain requirements are satisfied. These conditions include a requirement that professional courtesy not be offered to any Medicare beneficiaries unless there is a showing of financial need and a requirement that the professional courtesy be reported in writing to the patient's health insurance company.
  • Academic Medical Centers . The definition of "academic medical center" has been broadened to include more hospitals, and certain portions of the text of the exception have been revised for clarity. For example, the exception now includes a safe harbor defining what would be considered to be the provision of "substantial academic services or clinical teaching services," which is a requirement for the referring physician under the exception.

This bulletin is intended only as a general summary of the new regulations and should not be taken as specific legal advice. The Stark Law and the Phase II regulations are very technical, and nuances are often important in determining compliance.  Should you have specific questions or concerns about the effects of the Phase II regulations, we encourage you to contact any of our Health Care attorneys.