Stark II, Phase III Final Regulation:

Changing The Compliance Landscape

The Centers for Medicare & Medicaid Services (“CMS”) continues to change the compliance landscape facing pathologists, radiologists, and other physicians as well as hospitals, laboratories, and imaging providers. On September 5, 2007, CMS published the long-awaited Phase III final regulation under the Stark physician self-referral law. See 72 Fed. Reg. 51,012 (Sept. 5, 2007). The changes are different from (although somewhat related to) the changes in the proposed 2008 Medicare Physician Fee Schedule (“MPFS”). See 72 Fed. Reg. 38,122 (July 12, 2007). While the MPFS changes were only proposed, the Phase III changes are final and become effective December 4, 2007.

The Phase III regulation contains some important changes. CMS also made statements in the preamble to the Phase III regulation that are not labeled changes, but have the practical effect of changing commonly held views of how the Stark law operates. These changes and “clarifications” will require reconsideration and possibly renegotiation of thousands of existing arrangements.

Recruitment and Retention Exceptions
CMS clarified the physician recruitment exception to allow hospitals to impose reasonable credentialing restrictions on physicians whom they recruit. These restrictions cannot take into account “in any way” the volume or value of referrals or other business generated. This leaves open the question of whether hospitals may impose minimum procedure requirements for quality of care purposes. CMS specifically refused to take a position on economic credentialing.

CMS issued considerable clarification to the relocation requirements under the recruitment exception. CMS clarified that the recruited physicians must relocate their practice from outside hospital’s Geographic Service Area (“GSA”) to inside the hospital’s GSA. The relocation requirement also requires recruited physicians to move their medical practice 25 miles or have a new medical practice that derives at least 75% of its revenues from professional services furnished to patients not seen or treated by the physician during the proceeding three years. CMS created greater latitude for physicians who, for two years immediately prior to recruitment, had no separate private practice and were employed on a full-time basis to serve patients of (i) federal or state prisons; (ii) the Department of Defense or Department of Veterans Affairs; and (iii) Indian Health Service facilities.

CMS provided flexibility under the “zip code rules” for defining the hospital’s GSA. The basic rule is that the hospital’s GSA is the lowest number of contiguous zip codes from which the hospital draws at least 75% of its inpatients. In Phase III, CMS created a new rule for relocating a physician to a zip code “hole” that would not otherwise be part of the hospital’s GSA. The zip code hole rule is available where no inpatients reside in the zip code, but the zip code is entirely surrounded by zip codes in the GSA. CMS also has created an exception in circumstances where all of a hospital’s contiguous zip codes do not account for 75% of the inpatients. CMS created an alternative zip code rule to for certain rural hospitals to allow them to use certain non-contiguous zip codes.

CMS clarified that a hospital may use any configuration of zip codes that meets the regulatory requirements at the time the parties enter into the recruitment arrangement. CMS added that a hospital may use different zip code configurations for each recruitment arrangement even if the arrangements are entered into on the same date.

Phase II limited the overhead costs that can be allocated to a recruited physician to “actual, additional incremental costs” attributed to the recruited physician. Despite many requests, CMS generally declined to permit other cost allocation methods citing to potential abuse of the program. However, CMS added some flexibility where physicians are relocating into a practice in a rural area or HPSA to replace a physician who has left the practice within 12 months because the physician retired, relocated outside the hospital’s GSA, or died. In such cases, a per capita allocation of overhead may be used so long as it does not exceed 20% of the practice’s aggregate cost.

CMS modified its position with respect to practice restrictions, allowing non-compete clauses to the extent that they do not “unreasonably restrict the recruited physician’s ability to practice medicine” in the hospital’s GSA. CMS indicated that liquidated damages provisions would be acceptable so long as the amount was not unreasonable or otherwise had a substantial effect on the physician remaining in the hospital’s GSA.

CMS expanded the retention exception by eliminating the requirement of a written offer and permitting the use of bona fide opportunities for future employment. The physician must provide written certification to support the bona fide opportunity. In addition, the hospital must take reasonable steps to verify that the employment opportunity requires the physician to relocate outside of the hospital’s GSA. Retention payments are limited to 24 months. CMS clarified that the amount of a retention payment is not limited to the cost of recruiting a new physician but rather a physician who is new to the hospital’s GSA. Retention payments may take into account physician’s experience, training, and length of service in the area.

Office Space and Equipment Rental Exceptions
While Phase III did not make any changes to the office space or equipment rental exceptions, CMS added some clarifications. CMS indicated that parties may amend lease agreements during the first year as long as no change is made to the rental charge. Such amendments do not require the agreement to be extended for an additional year. If the parties wish to change any lease term that is material to the rental charges, including the amount paid, the amount of space leased, or type of equipment rented, CMS advised that the existing agreement should be terminated and a new agreement entered into. The new agreement may not begin until the first year of the original lease is complete. CMS stated that the fair market value exception is not applicable to office space or equipment leases.

With respect to office-sharing arrangements, CMS emphasized that a lessee must have exclusive use of the leased space or equipment, with the exception of common areas. CMS stated that exam rooms are not common areas. In the preamble, CMS did not distinguish between block leases, which are typically exclusive use arrangements versus cost sharing arrangements where physicians typically share space, equipment, and costs on a non-exclusive basis.

CMS clarified that lessors may charge a premium for holdover terms provided such premiums are set in advance and do not take into account the volume or value of referrals or other business generated by the parties. CMS declined to extend the holdover period beyond six months in cases where a landlord is trying to evict a tenant.

Personal Services Exception
CMS included a six-month holdover provision to the personal services exception similar to the provision under the office space and equipment rental exceptions. CMS also stated that amendments to the compensation paid under a personal services agreement should be accomplished by terminating the existing agreement and entering into a new agreement.

Non-monetary Compensation Exception
Phase III contains a new repayment provision that permits a physician to repay certain amounts that exceed the limit under the non-monetary compensation exception (currently $329). The amount repaid may not exceed 50% of the limit. In addition, the physician must repay the excess within the same calendar year it was provided or 180 days, whichever is earlier. This new repayment provision may be used only once per referring physician every three years.

CMS added a provision allowing entities with formal medical staffs to provide one “local medical staff appreciation event” per year that does not count toward the non-monetary compensation limits. The provision does not apply to laboratories because they do not have formal medical staffs.

“Stand in the Shoes”
In Phase III, CMS added a “stand in the shoes” provision to the definition of direct compensation arrangements so that arrangements between DHS entities and group practices are treated as arrangements between the DHS entity and the individual physicians in the group. Consequently, such arrangements can no longer rely on the indirect exception. CMS also revised the definition of “physician organization” to include a physician practice, a physician group practice, or a professional corporation of which the referring physician is the sole owner. CMS did not include corporations, limited liability companies, or partnerships unless they are physician practices or group practices.

Recognizing that many existing arrangements had been structured to comply with Phase II, CMS created a grandfather provision. The provision is limited to arrangements in existence prior to the publication date of Phase III (September 5, 2007) that comply with the Phase II indirect compensation arrangement exception need not be amended during the original term of the arrangement or the current renewal term.

Fair Market Value
In Phase II, CMS created a “safe harbor” under the fair market value definition for hourly payments for physician services determined using the average hourly rate for emergency room physicians in a relevant market or certain national physician compensation surveys. Based on concerns about the impracticability of meeting the “safe harbor” and the negative inference on payments not meeting the safe harbor, CMS eliminated the safe harbor.

Group Practice (Physician in the Group, Reassignment, and “Incident to” Services)
In prior Stark regulations, CMS drew a distinction between physicians who are “members of the group” (owners, employees, and locum tenens physicians, but not independent contractors) and “physicians in the group” (members and independent contractors). In Phase III, CMS modified the definition of “physician in the group” to require an independent contractor physician to furnish patient care services for a group under a contractual arrangement directly with the group. CMS stated in the preamble that the arrangement may not be between the group practice and another entity, such as a staffing company. CMS also emphasized that independent contractor physicians are considered “physicians in the group” only when performing services in the group practice’s facilities.

In Phase III, CMS adopted the definition of “incident to” services under the Medicare billing rules and clarified that the definition applies to both services and supplies. CMS also modified its position regarding compensating physicians in the group through profit shares or productivity bonuses based on “incident to” services. For profit sharing, CMS now takes the position (in a change from Phase II) that profits must be allocated in a manner that does not directly relate to DHS referrals, including any DHS billed as “incident to” services. Under Phase II, CMS had permitted profit sharing based directly on “incident to” DHS services. For productivity bonuses, CMS continues to permit such payments to be based directly on services that the physician personally performed and services “incident to” such personally performed services (even if those “incident to” services are otherwise DHS).

Referrals and DME
CMS previously concluded that services personally performed by the referring physician did not constitute a referral and did not have to satisfy a Stark exception. In Phase III, CMS did not change the definition of “referral” but concluded that it was practically impossible for a physician to personally furnish DME. According to CMS, a physician would have to be enrolled as a Medicare DME supplier and personally perform all of the duties of a DME supplier to personally furnish DME. CMS specifically stated that continuous positive airway pressure equipment (“CPAP”) is DME that does not qualify for the in-office ancillary services exception.

Academic Medical Center Exception
In Phase III, CMS clarified that the compensation paid to a physician must meet three criteria to fall within the AMC exception: (1) compensation paid by each component of an AMC must be set in advance; (2) compensation paid by each component must not take into account the volume or value of referrals; and (3) the aggregate compensation of all academic medical center components cannot exceed fair market value. CMS emphasized that the exact amount paid by each component need not be established in advance, but any formula or methodology must be “set in advance.” CMS recognized that the compensation paid by each component of an AMC does not have to be fair market value as long as the aggregate amount paid by all AMC components is fair market value.

Phase III revised the definition of “academic medical center” to clarify that individual physicians with the same class of privileges must either be included or excluded for purposes of determining whether a majority of physicians on an affiliated hospital’s medical staff are faculty members of the affiliated medical school.

Intra-family Rural Referral Exception
Phase III expanded the intra-family rural referral exception to provide an alternative distance test based on transportation time from the patient’s residence. Under the new provision, a physician may qualify to make an intra-family rural referral if timely DHS is needed and cannot otherwise be provided within 45 minutes transportation time from the patient’s residence. CMS recommended that physicians retain mileage or driving time information from independent sources such as on MapQuest and, if relevant, published weather reports.

Compliance Training Exception
CMS reversed its position to permit DHS entities to provide physicians and their office staff with compliance training where continuing medical education (“CME”) credit is available, although only where “compliance training is the primary purpose of the program.” CMS also clarified that hospitals may provide compliance training online under certain circumstances.

[The authors would like to thank Ober|Kaler Associates Kristin Cilento, Josh Freemire, and Emily Wein for their assistance with this article.]

This article originally appeared in the October 2007 issue of G-2 Compliance Report. It is reproduced here with permission from Washington G-2 Reports.