05/01/2004

Stark II – Phase II Rulemaking: Are We There Yet?; New Regulations Complete Two-Phased Rulemaking

Robert E. Mazer
410-347-7359
remazer@ober.com

On March 26, 2004, the Centers for Medicare and Medicaid Services (CMS) published the second phase of the rulemaking addressing the federal self-referral prohibition, "Physicians' Referrals to Health Care Entities With Which They Have Financial Relationships" (69 Fed. Reg. 16054). The self-referral ban — referred to frequently as "Stark II," reflecting its close association with Congressman Fortney ("Pete") Stark — prohibits a physician from referring clinical laboratory tests and other so-called "designated health services" (DHS) covered by Medicare to an entity with which the physician has a financial relationship.

Providers of clinical laboratory services and other DHS have been clamoring for detailed guidance regarding this law for almost a decade. The Phase II rulemaking, which will become effective on July 26, 2004, completes, for now, the regulatory framework for a law in effect since Jan. 1, 1995. (According to CMS, the statute's application to Medicaid services has been reserved for a future rulemaking. In addition, the Phase II rulemaking is an interim final rule with comment period, requiring CMS to publish the final regulation after review of comments.)

Phase I of the rulemaking, addressing several aspects of the statute, was published on Jan. 4, 2001, and generally became effective on Jan. 4, 2002. CMS states that Phase I and Phase II should be read "as a unified whole." Except where the agency clearly indicated a policy change, Phase I remains in effect. Different language in the Phase II rulemaking reflects the agency's attempt to "explain or clarify" the Phase I rulemaking only, not change it. By contrast, the 1995 final rule addressing an earlier version of the statute limited to clinical laboratory services (Stark I) has now been superseded and will not be in effect.

CMS stated that in preparing the Phase II rulemaking it attempted to provide flexibility to minimize the law's effect on many common business arrangements, while maintaining the "core statutory prohibition." As discussed below, the agency was successful in many respects — common business and commercial practices can be maintained. This article addresses provisions in the Phase 11 rulemaking that are most likely to be significant to clinical laboratory services providers.

Lease Arrangements
Clinical laboratories frequently lease space from physicians, for example, for draw stations. Several provisions in the Phase II rulemaking affect those arrangements. The Stark statute requires that rental charges reflect fair market value, not taking into account volume or value of referrals or other business generated between the parties. Fair market value must reflect use of the space for general commercial purposes, without regard to its proximity or convenience to potential referral services. In the Phase II rulemaking, CMS cautions against use of "comparables" in determining fair market value where the parties to the "comparable" arrangement were in a position to refer to one another.

Additionally, according to the agency, good faith reliance on a proper valuation does not establish its accuracy. Accordingly, if CMS (or, as discussed below, a qui tam relator) disagrees with a valuation relied on by a clinical laboratory, it could assert that the statute has been violated. Obviously, a valuation report that is well-researched and includes a thorough analysis — reflecting fair market value concepts incorporated in the statute and regulations — will be more difficult to challenge than less complete documentation used to support particular rental amounts.

Regulations resulting from the Phase II rulemaking permit a party to an arrangement for rental of office space to terminate the lease — with or without cause — so long as the parties do not enter into a new contract during the first year of the agreement's original term. Any new lease must comply independently with the rental of office space exception. Holdover month-to-month rental arrangements will also be permitted for up to six months based on the terms previously in effect. However, the arrangement must follow an agreement that was in effect for one year or more, and which satisfied the statute's office lease exception.

The Phase II rulemaking provides additional comfort to laboratories that lease space primarily or exclusively to draw blood or test specimens from the practice from which the space is rented. Laboratories were concerned that these arrangements might not be found "commercially reasonable even if no referrals were made between the parties" as the statute requires. However, CMS states in the Phase II rulemaking that "referrals" means referrals of DHS covered under Medicare only. Therefore, if the arrangement would make commercial sense to reasonable parties based on the physician's or group practice's non-Medicare referrals, plus testing for patients of other physicians (including Medicare patients), the "commercially reasonable" requirement should be satisfied.

Additionally, as a result of the Phase II rulemaking, parties to a lease arrangement may rely on the exception for rental of office space, even if the tenant subleases all or part of the space. However, the landlord cannot use space that it has "leased" to another person or entity — whether or not the space has been subleased. Therefore, a clinical laboratory that rents space from a medical group cannot allow the group practice (or any related person or entity) to use the space to take vital signs — exclusively or concurrently with the laboratory — while the space is being leased. (Likewise, the group practice's use of a laboratory employee to take vital signs could result in a financial relationship between the laboratory and group practice physicians.)

According to CMS, a laboratory cannot avoid the stringent requirements of the exception for rental of office space by relying, instead, on the fair market value exception. While that exception may protect equipment leases, it does not apply to lease of space.

Exceptions For Payment For Services
The Phase II rulemaking addresses compensation-related restrictions included in various exceptions covering a DHS provider's payments to physicians, including group practices that furnish DHS in their offices. The employment exception prohibits compensation from taking "referrals" into account. However, "referrals" are defined generally to include only requests for DHS covered by Medicare. In addition, personally performed services are not considered "referrals." Thus, so long as compensation paid to a physician-employee is fair market value, it can reflect services ordered by the physician that are not considered "referrals," including clinical laboratory services that are not covered by Medicare and services that are not considered DHS.

By contrast, the exceptions for personal service arrangements (for independent contractors), fair market value, and academic medical centers also prohibit consideration "of other business generated between the parties." This includes non-federal health care business generated by the referring physician (except for personally performed services).

As a result, the amount paid to the physician cannot take into account any services the physician ordered (except those he or she performed personally). Group practice physicians — whether owners, employees, or independent contractors — can receive compensation that reflects indirectly their referrals of clinical laboratory services and other DHS for Medicare patients through profit-sharing arrangements, so long as the group practice compensation arrangement satisfies specified requirements.

Percentage arrangements are also treated favorably in the Phase II rulemaking. After delaying implementation of a Phase I provision preventing many percentage arrangements from satisfying the "set in advance" requirement, CMS eliminated this provision. As a result of this change and regulations specifying that personally performed services are not referrals (or other business generated), physicians furnishing services under the exceptions for bona fide employment, personal services (independent contractors), fair market value, and academic medical centers, as well as group practice physicians, can receive a percentage of revenues or collections from their personally performed services. Group practice physicians can also receive percentage compensation for services furnished "incident to" their personally performed services.

While the prohibition against paying physicians based on the volume or value of referrals — incorporated in virtually all exceptions — generally prohibits paying physicians for referrals, the Phase II rulemaking states that it also prevents paying physicians to limit utilization of clinical laboratory services and other DHS. These types of incentives are permitted only in furnishing services to enrollees of certain health plans, i.e., qualified physician incentive plans under the personal service arrangement exception, or as part of an arrangement covered by the prepaid plan or risk-sharing exception.

CMS also provided a "safe harbor" under which an hourly fair market value for physician services can be determined based on amounts paid to area emergency room physicians or based on specified recognized surveys. Use of a safe harbor is strongly encouraged. According to CMS, entities using other methods to determine fair market value "will continue to bear the risk that their rates may not be considered fair market value." The safe harbor could be of significant assistance to hospitals negotiating service contracts with physicians. The safe harbor could provide a measure of clarity, and, where appropriate, support for their contention that amounts requested by a physician are potentially problematic.

The personal services arrangement exception (for independent contractor arrangements) requires that the contract cover all services to be provided by the physician. The Phase II rulemakng permits incorporating other agreements into each personal services contract or cross-referencing to one or more master lists of contracts that are maintained and updated centrally. Financial statements that include relevant information and are cross-referenced in the agreement may serve as a master list. The master list must be available for inspection and must preserve the historical record. As in connection with the lease exception, the Phase II rulemaking permits a personal service arrangement to be terminated, with or without cause, if the parties do not enter into another contract for the same or substantially the same services during the first year of the original contract term.

Contractually Required Referrals
With increasing frequency, health systems and other organizations require physicians under contract to refer clinical laboratory and other ancillary services to a particular service provider, often part of the same organization. The Phase II rulemaking clarifies that in limited circumstances this requirement will not prevent a financial arrangement from complying with an exception to the self-referral ban. According to CMS, referral requirements may be permissible as part of employment, managed care, and other contract arrangements if they relate to the physician services covered under the contract and are "reasonably necessary to effectuate the legitimate business purpose, of the compensation arrangement."

A hospital, for example, that contracts for parttime physician services might require the physician to refer patients to the hospital's laboratory while working for the hospital. The hospital could not, however, require that physician to use the hospital laboratory when the physician is not working for the hospital. Similarly, it is unlikely that requiring a physician tenant in a medical office building to refer tests to his hospital landlord would be acceptable.

Temporary NonCompliance
The Phase II rulemaking created a new exception for arrangements "involving temporary noncompliance." This exception may be used when an arrangement has "unavoidably and temporarily fallen out- of compliance" with an exception to the self-referral ban. This exception might apply, for example, when fully signed copies of renewal agreements have been delayed (such as an agreement for physician services) or a geographic area has been redesignated from rural to urban, preventing continued reliance on the rural provider exception. The exception is subject to multiple conditions. The arrangement must have satisfied another exception (other than the exception for non-monetary compensation up to $300 or medical staff incidental benefits) for at least 180 consecutive days and must comply with the federal anti-kickback statute and applicable billing rules. The arrangement must have fallen out of compliance for reasons beyond the entity's control. Also, the entity must attempt to rectify the problem promptly. Finally, the exception can be relied on for 90 days only and can be used for the same physician once every three years only.

Payments By Physicians
The statute protects payments made by a physician to a laboratory for clinical laboratory services. It also excludes a physician's payments to an entity for "other items or services" furnished at fair market value. Under the Phase II rulemaking, "legitimate discounts" for those other items or services are permissible, i.e., the discounted charge will fall within the range of values that is considered fair market value. CMS makes clear, however, that the exception for payments by a physician may not be used for items and services covered by another exception, such as for leases or personal services. The more stringent requirements included in those exceptions must be satisfied.

Remuneration Unrelated to DHS
The exception for remuneration paid by a hospital to a physician that does not relate to DHS was defined narrowly. Benefits offered to physicians selectively cannot be protected. Additionally, if the related cost can be included on the Medicare or Medicaid cost report, the exception will not apply. For example, payments to physicians for general administrative or utilization review services would be considered related to DHS and would have to comply with another exception.

Publicly Traded Entities
The Phase II rulemaking may facilitate companies "going public" and making use of the statutory exception for ownership in certain publicly traded securities and mutual funds. A physician or family member can purchase stock prior to a public offering, so long as the stock is generally available to the public at the time of the physician's referral. Existing publicly traded entities also received regulatory relief. They will not have to report information about shareholders whose ownership interest is protected by the exceptions for publicly traded securities or mutual funds.

Conclusion — A New Day In Stark II Enforcement?
Providers of clinical laboratory services must continue to comply with any applicable state self-referral statute. It may prohibit arrangements that are permissible under the federal law. However, as a result of the Phase II rulemaking, effective July 26, 2004, some arrangements between laboratories and physicians that were not permissible under federal law will become legally acceptable. In fewer situations, arrangements will become noncompliant.

Potentially more significant for many laboratories, as of July 26, 2004, the stakes of noncompliance may increase dramatically. Regulations implementing the self-referral ban will then be essentially complete. It may then become increasingly difficult to defend questionable practices based on lack of regulatory guidance. This development may not be lost on government agencies, or potential qui tam plaintiffs, seeking to pursue noncompliant arrangements under the False Claims Act. Laboratories should use the intervening time wisely to ensure that their arrangements with referring physicians can withstand careful scrutiny.

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