Reed Smith

LONDON u NEW YORK u LOS ANGELES u SAN FRANCISCO u WASHINGTON, D.C. u PHILADELPHIA u PITTSBURGH u OAKLAND u PRINCETON

FALLS CHURCH u WILMINGTON u NEWARK u MIDLANDS, U.K. u CENTURY CITY u RICHMOND u HARRISBURG u LEESBURG u WESTLAKE VILLAGE

r e e d s m i t h . c o m

CMS Stark II (Phase II) Final Rule

Prepared for:

Health Care Clients April 28, 2004

TABLE OF CONTENTS

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I. INTRODUCTION AND BACKGROUND....................................................................... 1A. Issuance Of Stark II (Phase II) Rule....................................................................... 1B. Abbreviated Statutory and Regulatory History...................................................... 2

II. GENERAL PROHIBITIONS UNDER THE STARK LAW............................................. 3A. Overview of Scope and Implementation Issues ..................................................... 3

1. Scope of Prohibitions/Exceptions .............................................................. 32. CMS’s Goal of “Bright Line” Rules .......................................................... 33. Reality of Complex Implementation.......................................................... 4

B. Sanctions for Stark Violations................................................................................ 41. Nonpayment/Refund .................................................................................. 42. Civil Money Penalties (“CMPs”) ............................................................... 53. Possible False Claims Act Exposure.......................................................... 5

C. Broad Interpretation of “Financial Relationships”................................................. 51. Expansive Scope of Stark Law................................................................... 52. Direct Financial Relationships................................................................... 53. Indirect Financial Relationships................................................................. 54. Financial Relationships Unrelated to DHS ................................................ 55. Stock Options and Convertible Securities.................................................. 6

D. Indirect Ownership Arrangement Clarifications.................................................... 61. Elements of Indirect Ownership................................................................. 62. Common Ownership .................................................................................. 63. “Cleansing” Link-In-Ownership-Chain ..................................................... 6

E. Indirect Compensation Arrangement Clarifications .............................................. 71. General Comments..................................................................................... 72. Elements of Indirect Compensation........................................................... 73. Phase II Clarification.................................................................................. 74. “Bottom Line” on Analyzing Indirect Compensation Arrangements ........ 85. Compensation Arrangement’s “Links-in-the-chain.”................................ 86. Physician “Standing In Shoes” of Wholly-Owned PC .............................. 9

F. Scope of Physician “Referrals”............................................................................ 101. Personally Performed Services................................................................. 102. “Incident To” Services............................................................................. 103. Referrals By Nurse Practitioner or Other Licensed Professionals ........... 104. Assigned Physician Claims ...................................................................... 10

G. Definition of “Consultation”................................................................................ 101. Overview.................................................................................................. 102. Services Supervised Within Group Practice ............................................ 103. Extension of Protection for Radiation Oncologists.................................. 11

III. PHYSICIAN COMPENSATION.................................................................................... 11A. Minimizing Differences In Physician Compensation Rules ................................ 11

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B. Percentage Compensation “Set In Advance”....................................................... 11C. Percentage Compensation For Personally Performed Services ........................... 12D. Risk-Sharing Arrangements ................................................................................. 12

IV. VOLUME OR VALUE STANDARDS........................................................................... 12A. Unit-based Compensation.................................................................................... 12B. Mandatory Referral Arrangements....................................................................... 12

V. EXCEPTIONS APPLICABLE TO OWNERSHIP AND COMPENSATIONARRANGEMENTS (GENERAL EXCEPTIONS) ......................................................... 13A. Physicians’ Services Exception............................................................................ 13B. In-Office Ancillary Services Exception............................................................... 13

1. General Comments................................................................................... 132. Covered DHS ........................................................................................... 143. Direct Supervision.................................................................................... 144. Building Requirements............................................................................. 14

a. Full-Time Practice Site With 35/30 Hour Test ............................ 16b. Part-Time Office Site With 8/6 Hour Referring Physician

Test............................................................................................... 16c. Part-Time Office Site With 8/6 Hour Referring Physician

Test............................................................................................... 165. The Billing Requirement .......................................................................... 18

C. Group Practice Definition.................................................................................... 181. Single Legal Entity Requirement ............................................................. 192. Unified Business Test............................................................................... 193. Number and Type of Physicians in the Group Practice ........................... 194. Addition of New Members....................................................................... 205. Volunteer and Academic Medical Services............................................. 206. Profit Sharing and Productivity Bonuses ................................................. 20

D. Prepaid Plans........................................................................................................ 21VI. OWNERSHIP IN PUBLICLY-TRADED SECURITIES AND MUTUAL

FUNDS............................................................................................................................. 21A. Timing of “Availability to Public”....................................................................... 22B. No De Minimus Exception................................................................................... 22C. Reporting Compliance Facilitated........................................................................ 22

VII. ADDITIONAL EXCEPTIONS RELATED TO OWNERSHIP ORINVESTMENT INTERESTS .......................................................................................... 22A. Rural Providers..................................................................................................... 22

1. Rural Areas Are Outside MSAs............................................................... 222. MMA Moratorium Incorporated .............................................................. 233. Grandfathering Hospitals in a De-Classified Rural Area......................... 23

B. Hospital Ownership (“Whole Hospital” Exception) ............................................ 23

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1. MMA Specialty Hospital Provision Incorporated.................................... 242. Clarification of the Statutory Criteria....................................................... 243. Exception Inapplicable to Services Furnished by Other Providers

Owned by a Hospital................................................................................ 24VIII. EXCEPTIONS RELATING TO OTHER COMPENSATION

ARRANGEMENTS......................................................................................................... 24A. Rental of Office Space and Equipment................................................................ 24

1. Early Termination.................................................................................... 252. Holdover................................................................................................... 253. Capital Leases .......................................................................................... 254. Subleases .................................................................................................. 255. Per Click Rental Payments....................................................................... 25

B. Bona Fide Employment Relationships................................................................. 251. “Incident to” Services............................................................................... 262. Requirements to Refer.............................................................................. 263. Restrictive Covenants............................................................................... 264. “Gainsharing” Incentives ......................................................................... 26

C. Personal Service Arrangements ........................................................................... 261. Early Termination.................................................................................... 272. Downstream Contracts ............................................................................. 273. Subcontracts............................................................................................. 274. Mixed Services/Equipment ...................................................................... 275. Gainsharing Incentives............................................................................. 276. Cross-References to Master List.............................................................. 277. “Safe Harbor” for Hourly Rates............................................................... 28

D. Remuneration Unrelated to the Provision of Designated Health Services........... 281. “Wholly Unrelated.”................................................................................. 282. Particular Arrangements........................................................................... 28

E. Physician Recruitment and Retention.................................................................. 291. Relocation of Practice .............................................................................. 292. No Fair Market Value Exception............................................................. 293. Residents and New Physicians ................................................................. 294. No Noncompetes...................................................................................... 295. Co-Recruitment with Existing Medical Practices .................................... 296. FQHC....................................................................................................... 307. Anti-Kickback Statute.............................................................................. 308. Physician Retention in Underserved Areas.............................................. 30

F. Isolated Transactions ............................................................................................ 311. Installment Payments ............................................................................... 312. Post-Closing Adjustments........................................................................ 31

G. Certain Group Practice Arrangements with Hospitals ......................................... 31H. Payments Made by a Physician for Items and Services; Discounts..................... 31

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1. Mutually Exclusive with other Exceptions .............................................. 322. Discounts.................................................................................................. 323. Extension to Immediate Family Members ............................................... 32

IX. REPORTING REQUIREMENTS ................................................................................... 321. Report Only Upon Request...................................................................... 322. Information Updates................................................................................. 333. Supporting Documentation...................................................................... 334. “Financial Relationship.”......................................................................... 33

X. DEFINITIONS................................................................................................................. 33A. Designated Health Services.................................................................................. 33B. Professional Services as Designated Health Services.......................................... 33C. Clinical Laboratory Services................................................................................ 34D. Physical Therapy Services ................................................................................... 34E. Radiology and Certain Other Imaging Services................................................... 34F. Radiation Therapy Services and Supplies............................................................ 34G. Outpatient Prescription Drugs .............................................................................. 35H. Inpatient and Outpatient Hospital Services.......................................................... 35I. Other Definitions .................................................................................................. 35

1. “Entity.”.................................................................................................... 352. “Fair Market Value.”................................................................................ 353. “Remuneration.”....................................................................................... 36

XI. REGULATORY EXCEPTIONS..................................................................................... 36A. Selected Highlights Regarding Phase I Exceptions ............................................. 36

1. Academic Medical Centers ...................................................................... 362. Services Furnished Under Certain Payment Rates................................... 373. Implants in an ASC.................................................................................. 384. Fair Market Value Exception................................................................... 385. Non-Monetary Compensation up to $300 and Medical Staff

Incidental Benefits.................................................................................... 386. Compliance Training................................................................................ 39

B. Selected Highlights Regarding Phase II Exceptions............................................ 391. Anti-Kickback Safe Harbors .................................................................... 392. Professional Courtesy............................................................................... 393. Charitable Donations By A Physician...................................................... 404. Intra-Family Rural Area Referrals. .......................................................... 415. Temporary Noncompliance With the Stark Law ..................................... 426. Retention Payments in Underserved Area ............................................... 437. Community-Wide Health Information Systems....................................... 43

Reed Smith

MEMORANDUM

LONDON u NEW YORK u LOS ANGELES u SAN FRANCISCO u WASHINGTON, D.C. u PHILADELPHIA u PITTSBURGH u OAKLAND u PRINCETON

FALLS CHURCH u WILMINGTON u NEWARK u MIDLANDS, U.K. u CENTURY CITY u RICHMOND u HARRISBURG u LEESBURG u WESTLAKE VILLAGE

r e e d s m i t h . c o m

TO: HEALTH CARE CLIENTS

DATE: April 28, 2004

RE: CMS Stark II (Phase II) Final Rule

I. INTRODUCTION AND BACKGROUND

A. Issuance Of Stark II (Phase II) Rule

On March 26, 2004, the Centers for Medicare and Medicaid Services (“CMS”)published an interim final rule with comment period (“Phase II” or “Phase II Rule”) 1

primarily designed to implement certain provisions of the “Stark II” physician self-referral statute (“Stark Law”) 2 that were not addressed in the Phase I final rule publishedon January 4, 2001 (“Phase I” or “Phase I Rule”).3 CMS will accept comments on thePhase II Rule until June 24, 2004. This regulation will become effective July 26, 2004.

In Phase II, CMS reiterates two of its key regulatory objectives articulated duringthe Phase I rulemaking process. CMS states that it has endeavored (i) “to reduce theburden and prescriptive nature of the rule while applying the statute and maintaining theintegrity of the regulatory framework,” and (ii) to provide “bright line” guidance

1 69 Fed. Reg. 16,054. The text of the rule is available on the internet at:

http://a257.g.akamaitech.net/7/257/2422/14mar20010800/edocket.access.gpo.gov./2004/pdf/04-6668.pdf. Two sections from the preamble to Phase II were inadvertently omittedfrom the March 26, 2004 publication, and were subsequently published on April 16, 2004at 69 Fed. Reg. 17933.

2 Social Security Act § 1877; 42 U.S.C. § 1395nn.

3 66 Fed. Reg. 856 (2001) (“Phase I” or “Phase I Rule”). A February 28, 2001 Reed Smithclient memo on the Phase I rule, “HCFA’s Final Stark II Regulations With CommentPeriod (Phase I),” is available from our office. Prior to the Phase I Rule, CMS issued onJanuary 9, 1998 a comprehensive proposed rule that would incorporate into regulationsthe Medicare and Medicaid program provisions of the Stark Law. 63 Fed. Reg. 1659(1998) (“Proposed Rule”). The Proposed Rule was discussed in our January 30, 1998client memo entitled “HCFA’s Proposed ‘Stark II’ With Comment Period.”

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regarding financial arrangements between referring physicians and health care providerswherever possible. In addition, in the interest of “expediting publication” of the Phase IIrules, CMS postponed the issuance of regulations applying the Stark Law to servicesfurnished under the Medicaid program (with the exception of the provision for Medicaidmanaged care plans).

The Phase II Rule provides a welcome degree of additional flexibility in a numberof respects (i.e., through new regulatory exceptions and modified interpretations) thatshould facilitate Stark compliance for a variety of common contracting arrangements.Phase II also attempts to clarify many of the ambiguities identified in public commentsfollowing issuance of the Phase I Rule. At the same time, however, substantial “grayareas” remain as a result of certain interpretations and standards adopted in this Rule, orleft unaddressed, that essentially undercut CMS’s “bright line” guidance goal. Further,while the Phase II Rule substantially reduces provider reporting requirements andattempts to create more flexible options for group practices in meeting the “samebuilding” requirement of the in-office ancillary services exception, even these less rigidstandards will likely entail substantial administrative burdens on providers seeking todocument their Stark compliance status. Representatives of CMS and the Department ofHealth and Human Services’ Office of Inspector General (“OIG”) have previouslyindicated that the government’s Stark Law enforcement efforts are likely to accelerateafter the Phase II regulations are in place. With the effective date in July 2004 soonapproaching, and increasing judicial acceptance of qui tam (whistleblowers) cases basedon Stark Law violations, the need for careful Stark Law compliance has never beengreater. Accordingly, this memorandum highlights those sections of the Phase II Rulethat we believe will be of greatest interest to our clients.

B. Abbreviated Statutory and Regulatory History

The Phase II Rule caps a Congressional initiative to address perceived abusesinvolving physician self-referrals that began almost 15 years ago.4 In brief, “Stark I,”named after its chief legislative sponsor, Representative Fortney “Pete” Stark (D-CA),was enacted as part of the Omnibus Budget Reconciliation Act of 1989. Stark I generallyprohibits, with certain exceptions, physicians from referring Medicare patients to clinicallaboratories with which those physicians or their immediate family members have certainfinancial relationships, effective January 1, 1992. Congress has amended Stark I onseveral occasions, most significantly in the Omnibus Budget Reconciliation Act of 1993(“OBRA ‘93”). The OBRA ‘93 physician self-referral limitations, which generallybecame known as “Stark II” or the “Stark Law,” expanded the self-referral limitations tonumerous other “designated health services” (“DHS”), generally effective January 1,

4 For a more detailed discussion of the statutory and legislative background, see our

February 28, 2001 client memo entitled, “HCFA’s Final Stark II Regulations WithComment Period (Phase I),” which is available on our internet site at:http://www.reedsmith.com/library/publicationView.cfm?itemid=3663.

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1995. Stark II also extended the physician self-referral restrictions to Medicaidprograms, and it provided for additional statutory exceptions. Congress again amendedthe list of covered DHS in the “Social Security Act Amendments of 1994.”

On August 14, 1995, the Health Care Financing Administration (“HCFA,” whichsubsequently has been renamed CMS) published final regulations to implement the StarkI restrictions. Although the Stark I regulations did not technically apply to the expandedStark II framework, HCFA indicated that the Stark I interpretations likely would appearin the subsequent Stark II regulations and would, in the interim, direct the agency’sassessment of referral arrangements under Stark II.

HCFA issued its Proposed Stark II Rule on January 9, 1998 (“Proposed Rule”).The Proposed Rule was criticized for being overly complex and for includinginterpretations of various aspects of the Stark Law that would have made its applicationvery broad, potentially disrupting many non-abusive arrangements. HCFA attempted toaddress these criticisms when it published its first Stark II final rule on January 4, 2001.This rule, dubbed “Phase I,” implemented only three subsections of the Stark Law – thegeneral prohibitions, the exceptions applicable to both ownership and compensationarrangements, and related definitions as applied to the Medicare program. Theseprovisions generally went into effect January 4, 2002, with certain exceptions.

The new Phase II Rule addresses most of the remaining issues not implemented inPhase I, including certain ownership and investment exceptions and compensationexceptions. It also creates several new regulatory exceptions for “nonabusive” financialrelationships and responds to public comments on the Phase I rule. The Phase II Rulegenerally does not address referrals for Medicaid-covered services, as CMS originallyhad anticipated, except that the regulation does amend the prepaid plans exception tocover Medicaid managed care plans.

II. GENERAL PROHIBITIONS UNDER THE STARK LAW

A. Overview of Scope and Implementation Issues

1. Scope of Prohibitions/Exceptions. The Stark Law is not triggered unlessthere is a DHS referral by a physician to an entity with which the physician (or animmediate family member) has a financial relationship. Phase I discussed key statutoryterms and criteria applicable to the Stark Law’s prohibitions including, among others:(i) direct and indirect ownership and compensation arrangements; (ii) the exception forindirect compensation arrangements; (iii) the “knowledge” requirement for indirectownership and compensation arrangements; and (iv) the definitions of “referral” and“consultation” as applied to the Stark Law’s restrictions on physician self-referrals.Phase II addresses these topics and other points resulting from CMS’s review of the manypublic comments it received on the Proposed Rule and the Phase I Rule.

2. CMS’s Goal of “Bright Line” Rules. CMS reiterates its goal of providing“bright line” guidance on Stark compliance issues wherever possible, while recognizingthat a degree of regulatory complexity is inevitable in a statutory scheme that

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encompasses such a broad range of physician/provider financial arrangements. Despitethe complexity of numerous Stark tests and standards, CMS asserts that three simple,straightforward points can be made about the Stark Law’s overall statutory and regulatoryscheme:

? Most physician ownership in DHS entities is prohibited;

? Most physician compensation must be set at a fair market value(“FMV”) payment rate; and

? The Phase I and Phase II rules, like the Stark statute itself, gives clearguidance for providers to comply with the law.

3. Reality of Complex Implementation. CMS’s stated objective of providing“bright line” tests and clear standards for Stark compliance is commendable. However,while Phase I and Phase II, read together as a “unified whole,” clarify many of the StarkLaw’s definitions, standards, and exceptions, we believe the overall results on “clarity”and certainty are decidedly mixed. For example, the Phase II Rule’s requirement in manyStark compensation arrangement exceptions (e.g., physician recruitment, physicians’charitable donations, non-monetary compensation up to $300, fair market valuecompensation, and others) that the arrangement must “not violate the anti-kickbackstatute . . . or any Federal or State law or regulation governing billing or claimssubmission” will result in uncertainty in many instances. Unless the Stark compensationarrangement fits squarely within an anti-kickback safe harbor or has been “blessed” by apositive advisory opinion from the OIG, the parties will not be sure that theirarrangements comply with the strict liability Stark Law. Many legally defensiblearrangements fail to qualify for safe harbor protection and relatively few arrangementshave been addressed in an Advisory Opinion. While the practical threat of a Starkenforcement action against a reasonably structured arrangement on an anti-kickbacktheory may not be great, the fact that many Stark regulations now “piggyback” on theintent-based anti-kickback statute and on a wide array of billing and claims processingrules could increase substantially an entity’s exposure for non-compliance under Stark asa consequence of CMS’s failure to provide the promised “bright lines.”

B. Sanctions for Stark Violations

Persons and entities subject to the Stark Law should understand the full scope ofpotential liability for non-compliance with this statute. To date, enforcement activityunder the Stark Law has been quite restrained. That could change, however, after thePhase II Rule takes effect.

1. Nonpayment/Refund. CMS states that the basic sanction under the StarkLaw is nonpayment for DHS referred by a physician with an improper financialrelationship with the DHS entity. In addition, an entity that collects payment based on aprohibited DHS referral must refund all collected amounts “on a timely basis” (i.e.,within 60 days of collection).

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2. Civil Money Penalties (“CMPs”). Individuals and entities that knowinglyviolate the self-referral prohibition may be subject to CMPs of up to $15,000 for eachsuch service. CMS concludes that the combination of nonpayment and CMPs constitutea “strong determent” to violating the Stark Law.

3. Possible False Claims Act Exposure. Another important potential basisfor liability for self-referral violations is the civil False Claims Act (“FCA”). FCAviolations can lead to tremendous financial liability, including treble damages and up to$11,000/claim penalties. CMS asserts in the Phase II preamble that violations of theStark Law may also be pursued under the False Claims Act, 31 U.S.C. §§ 3729-3733.While there is no uniform precedent in all the jurisdictions on this issue, a number ofcourts have allowed actions based on this legal theory to proceed. Moreover, actionsunder the FCA can be initiated by either the federal government or, perhaps more likely,a qui tam relator in a so-called “whistleblower” lawsuit. This non-compliance risktherefore can be a real “wild card” that needs to be considered carefully in connectionwith the development of a sound Stark compliance strategy.

C. Broad Interpretation of “Financial Relationships”

1. Expansive Scope of Stark Law. In Phase II, CMS confirms its priorinterpretation that virtually any financial relationship between a referring physician and aDHS entity can implicate the Stark Law. Therefore, each type of financial relationship(see below) will trigger the need for a Stark analysis.

2. Direct Financial Relationships. A direct ownership or compensationarrangement arises when payment passes between the entity furnishing DHS and areferring physician (or immediate family member) with no person or entity interposedbetween them. CMS received little public comment on direct financial relationships and,thus, confirmed its prior interpretations regarding these types of relationships.

3. Indirect Financial Relationships. An indirect financial relationship (i.e.,through either an ownership/investment or compensation arrangement) is created whereone or more persons or entities are interposed between the referring physician and theDHS entity. CMS received many comments about interpretations involving indirectfinancial relationships. Phase II provides helpful clarifications of the rules pertaining toindirect ownership and, especially, indirect compensation arrangements (discussed indetail in section II.E below).

4. Financial Relationships Unrelated to DHS. CMS confirms in Phase II itsprior interpretation that the Stark Law is implicated even by financial relationshipsbetween a referring physician and a DHS entity that are wholly unrelated to a Medicare-covered designated health service. For example, in the Proposed Rule, CMS cited a DHSprovider’s payments to a referring physician for items such as rent, compensation fornonmedical types of items or services, or for housing or travel expenses as creating acompensation arrangement under the Stark Law. Similarly, in Phase II, CMS cited as anexample a financial relationship involving only private pay business. Thus, unless these

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types of financial arrangements fit into a statutory or regulatory exception, the physiciancannot refer to the entity for DHS covered by the Medicare program and the entity isprohibited from submitting corresponding claims for such services.

5. Stock Options and Convertible Securities. In a change from Phase I, CMSacknowledges that stock options and convertible securities can often be purchased on theopen market and, when acquired in this manner, would constitute an ownership interestrather than a compensation arrangement (as CMS previously categorized them), untilexercised. Thus, in Phase II, CMS states that the determination of whether suchsecurities create an ownership or compensation arrangement will depend on themethod of acquisition.

D. Indirect Ownership Arrangement Clarifications

1. Elements of Indirect Ownership. The Stark Law’s self-referralprohibitions apply to a referring physician’s (or immediate family member’s) indirectownership or investment interest in a DHS entity when: (i) there is an unbroken chainbetween the physician (or immediate family member) and the DHS entity of one or morepersons or entities having an ownership interest; and (ii) the entity furnishing DHS knowsor has reason to suspect that the referring physician (or immediate family member) hassome ownership/investment interest in the DHS entity.

2. Common Ownership. In Phase II, CMS sought to clear up confusion fromPhase I about whether common ownership of an entity may create an indirect financialrelationship between the common owners. For example, an issue was raised as to whattype of financial relationship, if any, would be created if a referring physician and anentity furnishing DHS each had a common investment interest in another entity (i.e., notin the entity furnishing DHS). The Phase II preamble makes the following points aboutthis type of relationship:

? Common owners of an entity usually will not have anownership/investment interest in each other by virtue of their commonownership in another entity; but

? Such a common ownership arrangement could, in some cases, give riseto an indirect compensation arrangement between the two commonowners. If all the elements of an indirect compensation arrangementare present, then the Stark Law applies, but the parties may be able toprotect their relationship under the regulatory exception for indirectcompensation arrangements (discussed below).

3. “Cleansing” Link-In-Ownership-Chain. In another helpful Phase II pointof clarification/confirmation, CMS explains that a referring physician’s indirectownership interest in a DHS entity can be protected under the Stark exceptions for directownership interests. In other words, if one of the links in the ownership chain meets anownership exception, that will also protect the referring physician’s indirect ownership

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interest in that entity. For example, if a physician owns an interest in a limited liabilitycompany which, in turn, owns an interest in a hospital in Puerto Rico, then thephysician’s indirect ownership interest in that hospital will be protected under theexception for (direct) ownership in hospitals in Puerto Rico.

E. Indirect Compensation Arrangement Clarifications

1. General Comments. CMS’s treatment of indirect compensationarrangements in Phase I caused considerable confusion. The Phase II Rule clarifies theseissues by modifying the “indirect compensation” definition to better explain how thespecial rules on variable compensation (i.e., time-based or per-unit-of-service-basedcompensation) apply to that definition and to the standards for the indirect compensationexception. These changes support CMS’s stated intent to have the Stark Law’s treatmentof indirect compensation relationships parallel its treatment of direct compensationarrangements by defining broadly a universe of indirect arrangements that potentiallytrigger the Stark Law’s prohibitions, then creating a subset of such arrangements that canbe protected under the indirect compensation arrangement exception. Highlights of thesechanges are described below.

2. Elements of Indirect Compensation. Briefly stated, an indirectcompensation arrangement exists when the following elements are present:

? An unbroken chain exists between the referring physician (orimmediate family member) and the DHS entity consisting of one ormore persons or entities that have financial relationships (i.e., eitherownership or compensation) between them;

? The aggregate compensation received by the referring physician (orimmediate family member) from the person in the chain with whichthe physician has a direct financial arrangement (i.e., thecompensation arrangement closest to the physician) varies with, orotherwise reflects, the volume or value of referrals or other businessgenerated by the referring physician for the DHS entity; and

? The DHS entity has knowledge of, or acts in reckless disregard ordeliberate ignorance of, the fact that the referring physician (orimmediate family member) receives aggregate compensation thatvaries with, or otherwise reflects, the volume or value of referrals orother business generated by the referring physician for the DHS entity.

3. Phase II Clarification. Under Phase I, in determining whether aphysician’s aggregate compensation varies with the “volume or value” of referrals orother business generated by the referring physician, reference was made to theregulations’ “special rules on compensation,” which provide that unit-basedcompensation (e.g., time-based or per-unit-of-service formulae) will be deemed not totake into account the volume or value of referrals or other business generated. That

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special rule on compensation led some readers to conclude that unit-based variablecompensation arrangements would not fall within the definition of an “indirectcompensation arrangement” because the physician’s compensation would be deemed notto vary with the business he or she referred or otherwise generated.

The Phase II regulations have been amended/clarified, however, toprovide that aggregate compensation based on per-unit-of-time, per-unit-of-service, or“per-click” (as opposed to individual units of such compensation) does vary with thevolume and value of a physician’s referral and therefore satisfies that element of theindirect compensation arrangement definition. Accordingly, to be protected, such anarrangement must satisfy the indirect compensation arrangement exception. Theexception does not look to aggregate compensation, nor does it require that thecompensation received by the referring physician (or immediate family member) be “setin advance.” Therefore, most unit-based indirect compensation arrangements that are: (i)set at FMV; (ii) do not vary over the term of the agreement in any manner that takes intoaccount DHS referrals or other business generated by the referring physician; and (iii) donot violate the anti-kickback statute or federal/state billing rules should be permissibleunder Stark.

4. “Bottom Line” on Analyzing Indirect Compensation Arrangements.CMS’s Phase II clarification of the indirect compensation rules produces the followingresult: to determine whether certain common types of variable fee arrangements willtrigger application of the Stark Law and, if so, whether they nevertheless will bepermissible under that law, a two-step assessment should be undertaken:

? Any compensation arrangement (including time-based or unit-of-service ones) will meet the definition of “indirect compensationarrangement” where the aggregate compensation received by thereferring physician varies with, or otherwise reflects, the volume orvalue of referrals or other business generated between the parties.CMS concludes that aggregate per-unit compensation “will alwaysvary with the volume or value of referrals.” In such a case, determinewhether an exception applies.

? The indirect compensation arrangement exception will protect thatsubset of indirect compensation arrangements where the compensationis fair market value for services and items actually provided, andwhere the compensation does not reflect the volume or value ofreferrals or other business generated, as long as the other conditions ofthe exception are satisfied. Appropriately structured per-unitcompensation usually will meet this test. As noted, protection underthis exception also is contingent upon compliance with the anti-kickback statute and federal/state billing rules.

5. Compensation Arrangement’s “Links-in-the-chain.” The first element ofan “indirect compensation arrangement” is the existence of “an unbroken chain” of

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financial relationships between the DHS entity and the referring physician. In responseto public comments and questions about the relationship of the direct compensationarrangement exceptions to the criterion of “an unbroken chain” in the definition of an“indirect compensation arrangement,” CMS made the following points in Phase II:

? The definition of “indirect compensation arrangement” includes bothexcepted and unexcepted financial relationships. Thus, the chain offinancial relationships is not “broken” if one of the links qualifies foran exception. An indirect compensation arrangement would still exist(assuring the other two definitional criteria are satisfied), so that anexception would be required to protect the arrangement.

? On a related point, CMS declined to accept a number of commenters’position that an indirect compensation arrangement should beexcepted if any link in the chain fits one of the direct compensationarrangement exceptions (seemingly in contrast to CMS’s position forindirect ownership arrangements). CMS expressed concern that suchan interpretation “would permit a middle entity to redirectcompensation to referring physicians based on the volume or value ofreferrals . . . .”

In both of these cases, the parties to the arrangements should structure them tocomply with the indirect compensation arrangement exception. Alternatively, althoughnot addressed in Phase II, we believe the General Exceptions that protect certaincategories of services (e.g., in-office ancillary services, physician services that are DHS,and prepaid plans’ services) can also protect an indirect compensation arrangement, asCMS indicated in Phase I.

6. Physician “Standing In Shoes” of Wholly-Owned PC. Following Phase I,some commenters asserted that the fact that a physician practices through a wholly-owned PC should not convert a direct financial relationship with a DHS entity into anindirect relationship. For example, if a physician practicing through his/her wholly-owned PC has a medical director agreement with a hospital, that arrangement should beable to qualify for the Stark Law’s personal services arrangement exception (or otherapplicable exception for direct compensation arrangements) rather than having to qualifyfor the indirect compensation arrangement exception. CMS agreed, deciding it isunnecessary to treat a referring physician as separate from his or her wholly-owned PC.CMS modified the definition of “referring physician” to reflect that position. CMSdeclined, however, to adopt the same interpretation for a physician’s relationship to his orher “group practice.” Thus, in determining whether a financial relationship is direct orindirect and therefore what exceptions can apply, a physician will “stand in the shoes” ofa wholly-owned PC in order to qualify for the “direct” exceptions, but will not “stand inthe shoes” of a group practice and, accordingly, will be subject to an indirectcompensation arrangement analysis.

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F. Scope of Physician “Referrals”

1. Personally Performed Services. Significantly, in Phase I, CMS interpretedthe definition of “referral” to exclude services performed personally by the referringphysician. Phase II reaffirms that interpretation, confirming that no “referral” takesplace if a physician personally performs a designated health service. In that case, theStark Law will not be implicated.

2. “Incident To” Services. CMS declined, however, to extend the samedefinitional carve-out from the term “referral” to services performed by others “incidentto” the referring physician’s service. Accordingly, services ordered by the referringphysician but performed by the physician’s employees or independent contractors wouldconstitute “referrals” under the Stark Law. Many such referrals will likely be protectedby the “in-office ancillary services” or another exception.

3. Referrals By Nurse Practitioner or Other Licensed Professionals.Physicians often work together in a group practice with nurse practitioners (“NPs”) orother licensed physician-extenders. Referrals for DHS by these nonphysicianprofessionals will not, standing alone, constitute Stark-covered “referrals.” If, however,the physician has controlled or influenced the nonphysician’s referrals, then the StarkLaw could be implicated. The degree of physician control or influence of such a referralwill be determined in each individual case, based on all the facts and circumstances.

4. Assigned Physician Claims. CMS confirms that no “referral” occurs whena physician personally performs services in a hospital, even if the hospital bills for thosephysician services pursuant to an assignment. However, any technical componentsassociated with the physician’s personal services performed in the hospital wouldconstitute “referrals.”

G. Definition of “Consultation”

1. Overview. The definition of “referral” by a physician (“Physician ‘A’ ”)normally includes DHS provided in accordance with a consultation Physician “A” hasrequested from another physician (“Physician ‘B’ ”), including DHS performed orsupervised by the consulting physician. Thus, if Physician “B” performs or orders anyDHS pursuant to the consultation, that “referral” for DHS by Physician “B” usually alsoconstitutes a referral for DHS by Physician “A.” The Stark Law creates an exception fora small subset of services provided or ordered by certain consulting physician specialists(e.g., carving out of the term “referral” certain services ordered by a pathologist,radiologist, or radiation oncologist under defined circumstances). Phase II makes someminor modifications to address concerns expressed by consulting physicians in grouppractices and by radiation oncologists.

2. Services Supervised Within Group Practice. In Phase II, CMS interpretsthe term “consultation” to include services supervised by another pathologist, radiologist,or radiation oncologist in the same group practice as the consulting physician.Accordingly, as long as the other group practice specialist physician exercises the level of

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supervision required by the Medicare coverage and payment rules, then services orderedas a result of that “consultation” will not be considered a “referral.”

3. Extension of Protection for Radiation Oncologists. The exception forradiation oncologists who request services pursuant to a consultation has been extendedto protect necessary and integral ancillary services (e.g., CT, MRI and ultrasoundservices) requested by the radiation oncologist.

III. PHYSICIAN COMPENSATION

A. Minimizing Differences In Physician Compensation Rules

Numerous public commenters observed that physician compensationarrangements are structured in various ways for legitimate reasons. They argued that theform of the arrangement (e.g., employment, independent contractor, or group practicemembership) should not limit the types of compensation structures available to theparties. CMS responded that certain physician practice structures, such as a grouppractice arrangement, receive favorable treatment under the Stark Law itself, permittingthose physicians to divide revenues in less restrictive ways (e.g., based on “incident to”services) than under other types of arrangements between DHS entities and employed orindependent contractor physicians. CMS made certain changes in Phase II, however, tominimize the differences among different forms of physician relationships outside thegroup practice context, consistent with the statute.

B. Percentage Compensation “Set In Advance”

In a significant change from Phase I, the Phase II regulations allow certainpercentage compensation arrangements to satisfy the “set in advance” requirementcontained in several of the Stark compensation exceptions (e.g., the personal services, fairmarket value, and academic medical center exceptions). The change also puts percentagearrangements on a more equal regulatory footing with “per-unit” variable compensationarrangements. Phase II effectively finalizes a change that had been under considerationsince the Phase I regulations took effect (as seen through a series of delayedimplementation periods for the Phase I restriction on many percentage arrangements).Under Phase II, percentage compensation must be established with specificityprospectively, must be objectively verifiable, and may not be changed over the course ofthe agreement between the parties based on the volume or value of referrals or otherbusiness generated by the referring physician. We note, however, that uncertaintyremains as to whether a percentage compensation arrangement will satisfy the“volume or value” standard found in many Stark regulations. Therefore, unlessCMS provides further guidance on this point, percentage fee arrangements not tiedentirely to a physician’s personal services (which are not considered “referrals”) couldstill create a compliance issue under the Stark Law.

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C. Percentage Compensation For Personally Performed Services

Phase II confirms that all physicians, whether employees, independentcontractors, or academic medical center physicians, may be paid on a percentage ofrevenues or collections, and may receive a productivity bonus, for personally performedservices. Phase II reiterates that such personally performed services do not constitute a“referral” for DHS that would trigger application of the Stark Law.

D. Risk-Sharing Arrangements

Phase I established a new regulatory exception for compensation under a risk-sharing arrangement (e.g., withholds, bonuses and risk pools) for services furnished toenrollees of a commercial or employer-sponsored) health plan. Protection extends topayments made directly or through a subcontractor. Phase II confirms that grouppractice, employed, and academic medical center physicians, like independentcontractors, may be paid under risk-sharing arrangements. It also clarified that paymentsmade by a downstream subcontractor may be protected under the physician incentiveplan provisions of the personal services arrangements exception.

IV. VOLUME OR VALUE STANDARDS

A. Unit-based Compensation

As discussed above in the “indirect compensation arrangement” section, CMSclarifies in Phase II that per-use, per-unit-of-service, and “per-click” paymentmethodologies will be deemed not to take into account the volume or value of referrals orother business generated between the parties as long as the individual payment for eachunit reflects FMV and does not change during the course of the agreement based on thelevel of referrals or other business generated. In contrast, Phase II modifies theregulations to clarify that, in the aggregate, unit-based payment systems are likely tovary based on the volume or value of DHS referrals or other business generated. Thatfactor, however, would not bar qualification for the indirect compensation arrangementexception, which does not look to aggregate compensation.

B. Mandatory Referral Arrangements

Phase I acknowledged that, in limited circumstances, required referrals are areasonable and appropriate aspect of health care business arrangements that would notnecessarily implicate the Stark Law. In Phase II, however, CMS narrows itsinterpretation of acceptable mandatory referral arrangements. They will be permittedonly when they are related to the services a physician performs while acting underhis or her arrangements with an entity, such as a part-time arrangement with anemployer or a managed care entity. It is unclear whether this restriction means that thephysician cannot be required to refer at all for ancillary services that would be furnishedby others (a highly restrictive result), or can do so only when he or she is performingservices within the scope of the employment or managed care engagement. It is clear,however, that the entity cannot require the physician also to refer his or her private-pay

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patients to the same DHS entities. In all cases, the referral requirement must bereasonably necessary to effectuate the legitimate purposes of the compensationarrangement. These arrangements also must comply with the anti-kickback statute.

V. EXCEPTIONS APPLICABLE TO OWNERSHIP AND COMPENSATIONARRANGEMENTS (GENERAL EXCEPTIONS)

A. Physicians’ Services Exception

Under the Stark Law, physician services furnished personally by anotherphysician in the same group practice as the referring physician or under the personalsupervision of another physician in the same group practice are exempt from the statute’sprohibitions. “Personal supervision” is interpreted as the level of supervision requiredunder the applicable Medicare payment and coverage rules. The exception coversreferrals to, or physicians’ services supervised by, both a member of the group practice oran independent contractor who qualifies as a “physician in the group.” Because fewphysician services other than radiology are DHS, the exception has limited applicability.The Phase II Rule makes no changes to this exception. Phase II did confirm, however,for a group practice of allergists that the provision of antigens is a physician service thatcan be protected under this exception. CMS also noted that other exceptions and/or thedefinitional “carve out” of “referral” may also apply to protect that service.

B. In-Office Ancillary Services Exception

1. General Comments. The in-office ancillary services exception applies toboth ownership or investment interests and compensation arrangements and protects theprovision of certain DHS in the physician office setting. Physician groups typically relyon this exception to permit their physicians to make referrals for certain DHS provided bythe practices.

The Phase I Rule made significant changes to the Proposed Rule, includingmodifying the types of services that could qualify for protection under the exception, thelevel of physician supervision required, the kinds of physicians that could provide DHSunder the exception, and the locations where the services can be provided. Phase IImakes relatively few additional changes, with the exception of substantially modifyingthe location (i.e., same or centralized building) requirements.

For non-physician healthcare professionals who saw their business relationshipsadversely affected by the Phase I Rule changes, the Phase II Rule provides little relief.For instance, some physicians terminated their outside arrangements with physicaltherapists as a result of CMS liberalizing the direct supervision requirement under thein-office ancillary service exception, opting instead to provide these services in-house.Despite requests by non-physicians for a return to tighter requirements than those setforth in the Phase I rule, CMS declines to make any specific changes. Accordingly,other than addressing issues resulting from the change in location requirements, weanticipate that physician arrangements structured to comply with the Phase I Rule willcontinue in the much the same manner.

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2. Covered DHS. The Phase I Rule expanded the scope of DHS that can beprotected by the in-office ancillary services exception. First, Phase I clarified thatoutpatient prescription drugs may be “furnished” if given to a patient by a physician in aphysician office, even if they are used by a patient at home. Second, it permitted theprovision of external ambulatory infusion pumps that are DME and chemotherapyinfusion drugs under the exception. Third, Phase I expanded the in-office ancillaryservices exception to permit physicians to furnish certain types of DME (e.g., canes,crutches walkers and folding manual wheelchairs) for the convenience of a physician’spatients. The Phase II Rule makes no further changes to the DHS covered by the in-office ancillary services exception. Specifically CMS declines to allow physicians toprovide other types of wheelchairs beyond those that are folding and manual in nature.Notwithstanding, in connection with its discussion of the definition of the term “referral,”CMS indicates that there is no “referral” if a physician personally performs a DHS,including providing DME to a patient. This may provide another basis, separate andapart from reliance on the in-office ancillary services exception, for determining that aphysician’s personal provision of DME is not a “referral” and, therefore, does notimplicate the Stark Law. Additional guidance on the interrelationship of these twoprovisions would be helpful.

3. Direct Supervision. Under the Stark Law, to qualify for the in-officeancillary services exception, the services must be furnished personally by the referringphysician or another physician member of the same group practice, or personally byindividuals who are directly supervised by the physician or by another physician in thegroup practice. The Phase I Rule significantly relaxed CMS’s interpretation of the“direct supervision” requirement from its Proposed Rule by interpreting directsupervision to mean the level of physician supervision required under applicableMedicare payment or coverage rules for the specific service at issue. Phase I alsoallowed such supervision to be provided by owners of a group practice, employees of agroup practice, or independent contractors who provide services to a group practice’spatients in the group’s facilities under an arrangement that complied with the Medicarereassignment rules.

The Phase II Rule makes no significant changes to the direct supervisionrequirement. Phase II does, however, clarify the regulatory language to reflect CMS’sintent to permit a solo practitioner to provide DHS under this exception through a sharedfacility, as long as the arrangement meets the supervision, location, and billingrequirements.

4. Building Requirements. The Stark Law provides that, to qualify for the in-office ancillary services exception, the services must be furnished in the same buildingin which the referring physician or another physician member of the referring physician’sgroup practice furnishes physician services unrelated to DHS. Alternatively, where thereferring physician is a member of a group practice, the Stark Law provides that theservices may be furnished in another building used by the group practice for theprovision of some or all of the group’s clinical laboratory services or for the centralized

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provision of the group’s other DHS. The objective of the building requirements is toensure that DHS services are truly ancillary to a physician’s core medical practice.

CMS retains the Phase I definition of “building,” requiring that a building must bea structure with, or combination of structures that share, a single street address asassigned by the U.S. Postal Service, excluding all exterior space and interior parkinggarages. In the preamble to the Phase II Rule, CMS restates its position that a mobilevan or trailer is not considered a building or a part of a building for purposes ofdetermining whether a structure satisfies the building requirement. However, CMSrevises the regulations to clarify that physicians and group practices may purchase thetechnical components of mobile services and bill for them under the purchaseddiagnostic test rule.

CMS also retains, without substantive change, the Phase I “centralized buildingtest,” which requires a group practice to have full-time, exclusive ownership oroccupancy of the centralized space. In keeping with this rule, CMS continues to permita mobile facility to be regarded as a centralized location for a group practice’s provisionof DHS if the facility is owned and used exclusively by the group practice on more thana part-time basis.

The Phase II Rule makes significant changes to the “same building” test. ThePhase I rule required a referring physician (or another physician who is a member of thesame group practice) to furnish in the same building “substantial” physician servicesunrelated to the furnishing of DHS. CMS defined “physician services unrelated to thefurnishing of DHS” using a three-part test. In response to concerns that the Phase I three-part test was unclear, insufficiently “bright line,” and might be susceptible to abuse, CMShas developed for the Phase II Rule three new, alternative tests, only one of which needsto be satisfied to meet the “same building requirement.” CMS provides that the Phase IItests replace the tests promulgated under Phase I. Accordingly, arrangements that mayhave complied with the Phase I three-part test, but do not meet any of the new tests, mustbe restructured (or unwound), prior to the effective date of the regulation.

While CMS’s goal of simplifying the same building test under the Phase I Rule isadmirable, one will be hard-pressed to view the three new tests under the Phase II Rule asa significant improvement or simplification of the requirement. Although CMS haseliminated the requirement that a patient’s primary reason for coming to the medicalpractice may not be the receipt of DHS, given the specific details that must be satisfiedunder each of the three tests, they are, in many respects, more confusing and burdensome.We expect that CMS will receive a high volume of comments on the three tests andwould not be surprised if CMS further modifies or clarifies the requirements under each.Until then, group practices seeking to furnish in-office ancillary services in the samebuilding should ensure that their office structure is transparent and clearly identifiable asbeing compliant with one of the three tests. Documentation should be retained to supportthis conclusion.

All three of the new tests, described below, require the referring physician or

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group practice to have offices in the building that are normally open to their patients arequisite number of hours per week, notwithstanding occasional weeks when the office isopen fewer hours (e.g., vacation periods). The Phase II tests also require that thereferring physician (or, for the first and second tests, their group practice members)regularly practice medicine and furnish physician services for a minimum number ofhours per week in that office, again, notwithstanding unusual circumstances (e.g., unfilledappointment slots, cancellations). Finally, each of the three tests requires the provision of“some” (instead of “substantial”) physician services unrelated to the furnishing of DHS.CMS declines to define the term “some,” indicating that “some” should be interpreted “inits common sense meaning,” consistent with the Phase I Rule, CMS interprets this tomean physician services that are neither federal nor private-pay DHS, even if thephysician services lead to the ordering of a DHS. As an example, CMS states that aphysician examination will be considered a physician service even if it leads to theordering of a clinical laboratory test or an x-ray. To qualify as the “same building,” oneof the following three new tests must be satisfied:

a. Full-Time Practice Site With 35/30 Hour Test. The first testgenerally describes buildings that are the principal place of practice for physiciansor their groups. It provides that a DHS will be considered to be furnished in the“same building” if the building is one in which the referring physician or his orher group practice has an office that is normally open to their patients at least 35hours per week, and the referring physician or one or more group membersregularly furnish physician services to patients there at least 30 hours per week.Some of the services must be physician services unrelated to the furnishing offederal or private pay DHS (but may lead to the ordering of DHS). CMSdesigned the first new test to address concerns of radiologists, oncologists, andother physicians whose practices mainly consist of furnishing DHS. By no longerrequiring that the physician services unrelated to the furnishing of DHS be“substantial,” CMS believes that radiologists, oncologists and other specialtypractices that primarily provide DHS to their patient will be able to meet thelower threshold.

b. Part-Time Office Site With 8/6 Hour Referring Physician Test.Under the second test, services will be considered furnished in the same buildingif the building is one where a referring physician or his or her group practice hasan office that is normally open to their patients at least 8 hours per week. Thereferring physician also must regularly practice medicine and furnish physicianservices to his or her patients in that office at least 6 hours per week (includingsome physician services unrelated to the furnishing of DHS). Services providedby members of a referring physician’s group practice will not count toward theindividual referring physician’s 6-hour threshold. The building must be one inwhich the patient receiving the DHS usually sees the referring physician or othermembers of his or her group practice.

c. Part-Time Office Site With 8/6 Hour Referring Physician OrGroup Member Present For DHS Test. The third test describes buildings in

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which referring physicians (or group practice members) provide physicianservices to patients at least 1 day per week and the DHS are ordered during apatient visit or the physicians are present during the furnishing of the DHS. Thistest requires that the DHS being furnished must be in a building in which thereferring physician or his or her group practice has an office normally open totheir patients at least 8 hours per week, and the referring physician or other groupmember regularly practices medicine and furnishes physician services to patientsat least 6 hours per week in that office (including some physician servicesunrelated to the furnished of DHS). The referring physician must be present andorder the DHS in connection with a patient visit during the time the office is openor the referring physician or a member of his or her group practice must bepresent while the DHS is furnished. Presence in the same space or part of thebuilding is not required.

The requirements under the second and third tests are difficult todistinguish because each test requires that the physician office be open for at least8 hours per week. Unlike the second test, however, the third test does not requirethe referring physician to practice medicine and furnish physician services topatients at least 6 hours per week. This requirement may be met by either thereferring physician or a member of his or her group practice. As a trade-off tothis added flexibility, CMS requires physician presence, either by the referringphysician when ordering or a member of the physician group when furnished, inconnection with the provision of DHS. It may be difficult for a group practice tobe able to distinguish its operations as clearly meeting one test or the other as wellas to track and document its compliance with these various practice permutations.Accordingly, the utility of the three tests, and, in particular, the second and thirdtests, for purposes of satisfying the same building requirement remains uncertain.Further, the administrative burden of documenting compliance at all group officescould be substantial.

In connection with the same building requirement but separate and apartfrom the three tests described above, CMS also indicates that it will retain itsspecial provision that permits physicians, whose principal medical practiceinvolves treating patients in their private residences, to meet the “same building”test if DHS are provided in a private home contemporaneously with a physicianservice that is not a DHS. Under this provision, the physician must be present inthe patient’s private residence at the inception of the DHS. In commentary to thePhase II rule, CMS states its position that a private home does not include anursing, long-term care, or other facility or institution. However, CMS modifiesits position by considering a residence in an independent living facility or assistedliving facility to be “private” if the patient occupies the premises as a resident,through ownership or lease, and has the right to exclude others from the premises.CMS will not consider a common examination room in a nursing, long-term care,or other facility to be a private residence.

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5. The Billing Requirement. The Stark Law requires that services providedunder the in-office ancillary services exception must be billed by the physicianperforming or supervising the services, by a group practice of which such physician is amember under a billing number assigned to the group practice or by an entity that iswholly-owned by such physician or group practice. CMS retains these requirementswithout modification in the Phase II Rule. CMS also clarifies that billing by a physicaltherapist under his or her own billing number, as permitted for services provided afterMarch 1, 2003, does not satisfy the billing requirement because that number is notconsidered assigned to the group practice. A physical therapist may, however, reassignhis or her right to payment to the group, and the group may bill using its own billingnumber with the physical therapist’s number indicated on the bill.

C. Group Practice Definition

The Stark Law contains a unique, detailed definition of “group practice,” whichincludes the requirement that there be a group of two or more physicians legallyorganized as a partnership, professional corporation (“PC”), foundation, not-for-profitcorporation, faculty practice plan or similar association with the following characteristics:

? Each physician who is a member of the group provides substantially the fullrange of services which the physician routinely provides through the joint useof shared office space, facilities, equipment and personnel (the “full range ofservices test”);

? Substantially all the services of the physicians who are members of the groupare provided through the group and billed under a billing number assigned tothe group and amounts received are treated as group receipts (the“substantially all test”);

? The overhead expenses of and income from the practice are distributed inaccordance with previously-determined methods;

? No physician member of the group receives compensation, directly orindirectly, based on the volume or value of referrals by the physician exceptunder certain profit sharing and productivity bonuses; and

? Group members personally conduct no less than 75 percent of the physician-patient encounters of the group practice (the “75 percent physician-patientencounters test”).

In the Phase I Rule, CMS made changes to provide more flexibility in designingand managing group practices. Finding that most commenters “commended” the changesmade in the Phase I Rule, CMS makes no major changes to the definition of “grouppractice” in the Phase II Rule.

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1. Single Legal Entity Requirement. CMS continues to require that a grouppractice be a single legal entity. However, a group may use multiple legal entities solelyto comply with jurisdictional licensing laws as long as all entities are identical as toownership, governance and operation, and the states in which the group is operating arecontiguous.

CMS continues to require that a group must operate primarily for the purpose ofbeing a physician practice. An entity that has a substantial purpose other than operating aphysician group practice, such as operating a hospital, will not qualify. Further, hospitalsthat employ two or more physicians will not be considered physician group practices;however, this does not preclude a hospital from owning or acquiring a separate physiciangroup. Defunct medical groups no longer providing medical services can own or operatea medical practice that qualifies as a “group practice.” However, a group practice ownedby other functioning medical groups cannot meet the single legal entity requirement. Forfoundation-model practices that do not meet the definition of “group practice,” CMSsuggests that they look to the personal service arrangements exception.

2. Unified Business Test. The definition of “group practice” requires that theoverhead expenses of and income from the group practice must be distributed inaccordance with methods previously determined by the group. In Phase I, CMS providedthat a group practice must contain all of the following features:

? Centralized decision-making by a body representative of the practice, thatmaintains effective control over the group’s assets and liabilities (includingbudgets, compensation and salaries). The Phase II Rule clarifies that CMSdoes not intend to prescribe any particular process for managing budgets ordetermining compensation and salaries, only that the centralized managementof the group practice exercise substantial control over the process and outputof these activities and not “rubber stamp” decisions by various cost centers orlocations.

? Consolidated billing, accounting and financial reporting. The Phase II Rulemakes no changes to this requirement.

? Centralized utilization review. In recognition of the fact that many grouppractices do not perform utilization review, CMS is deleting this requirementin the Phase II Rule.

3. Number and Type of Physicians in the Group Practice. CMS reiterates itsposition that one or more of the physicians in a group practice can be part-time employedphysicians, if all other requirements of the definition are satisfied. CMS will considerleased employees that are bona fide employees of the group under IRS rules to beemployees of the group practice.

Independent contractor physicians continue to be excluded from being consideredgroup practice “members,” but they can be considered “physicians in the group” to

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satisfy other group practice requirements. For purposes of satisfying the “substantiallyall” test, the exclusion of independent contractors from being considered group practice“members” may be helpful in that the services provided by the independent contractoroutside of the group practice will not affect the group practice’s overall ability to satisfythis test. Independent contractors also cannot be used to satisfy the “75 percentphysician-patient encounters” test.

4. Addition of New Members. CMS adds a new provision to grant a grouppractice 12 months to come back into full compliance with the requirements of the“substantially all” test if its non-compliance results from the addition of a new member.The new rule applies only to new members who have relocated their medical practices, asdefined in the revised physician recruitment exception. Therefore, the exception haslimited utility because it cannot be relied on by groups that add new members throughmergers with other groups. Under this new requirement, the group practice must satisfythe following conditions:

? For the 12-month period, the group practice must be fully compliant with the“substantially all” test if the new member is not counted as a member of thegroup; and

? The new physician’s employment with, or ownership or investment interest in,the group practice must be documented in writing before commencement ofthe new employment or ownership.

5. Volunteer and Academic Medical Services. CMS clarifies that donatingvolunteer services to patients at free clinics or similar facilities should not prevent aphysician member of a group practice from satisfying the “substantially all” test, even ifthe patient care services furnished in the free clinic are different from those the physicianprovides for the group. In the event the donation of free services causes non-compliancewith the “75 percent threshold” test, CMS recommends that the services be donatedthrough the group rather than by an individual group practice member. CMS advisessimilar treatment in cases of arrangements for the provision of academic patient careservices.

6. Profit Sharing and Productivity Bonuses. The Stark Law provides that amember of a group practice may not be compensated, directly or indirectly, based on thevolume or value of his or her DHS referrals, but may receive a share of the overall profitsof the group or a productivity bonus based on services personally performed or incidentto such personally performed services. The share or bonus may not be determined in amanner directly related to the volume or value of referrals by the physician. The Phase IRule allowed group practices to pay member physicians and those independentcontractors who qualify as “physicians in the group” productivity bonuses based directlyon the physician’s personal productivity (including services incident to such personallyperformed services).

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The Stark Law also permits group practice members and physicians in the groupto receive shares of overall profits as long as these shares do not directly correlate to thevolume or value of DHS referrals generated by a physician and provided by someoneelse. The Phase I Rule defined “overall profits” as meaning a share of the entire DHSprofits of the entire group or any component of the group consisting of at least fivephysicians (e.g., grouped by specialty or sites of service).

CMS clarifies in Phase II that profit shares or productivity bonuses can be baseddirectly on services that are “incident to” the physician’s personally performed services.CMS also narrows the potential application of the profit shares and productivity bonusesprovision by stating that if a group practice relies on the bona fide employment, personalservice arrangements, or fair market value exceptions instead of the group practicedefinition of “physician in the group practice” to protect referrals from an independentcontractor to the group practice, the compensation rules applicable under thoseexceptions must be satisfied.

D. Prepaid Plans

The Stark Law provides an exception from the referral prohibition for servicesfurnished by a managed care organization (“MCO”) providing prepaid health coverage orindividuals enrolled with the organization. The exception applies specifically to healthmaintenance organizations, competitive medical plans, certain other entities operating ina capitated managed care system under Medicare and organizations offering coordinatedcare plans under the Medicare Advantage (formerly, Medicare+Choice) program. In thePhase II Rule, CMS has expanded the prepaid plans exception to include referrals ofenrollees to Medicaid managed care plans analogous to the Medicare plans previouslyincluded in the exception. Referrals under these plans will not result in the denial ofpayment or the denial of federal financial participation to the state Medicaid program inwhich the MCO is operating.

VI. OWNERSHIP IN PUBLICLY-TRADED SECURITIES AND MUTUAL FUNDS

The Stark Law creates an exception for ownership or investment in certainpublicly-traded securities that may be purchased on terms generally available to thepublic and are listed on the New York Stock Exchange, the American Stock Exchange,certain other regional, national or foreign exchanges, or traded under the NationalAssociation of Securities Dealers system. Further, the ownership interest must be in acorporation that had shareholder equity exceeding $75 million dollars at the end of thecorporation’s most recent fiscal year or on average during the previous 3 fiscal years.This exception also applies to ownership in mutual funds having total assets exceeding$75 million at the end of the company’s most recent fiscal year or on average during theprevious 3 fiscal years.

For purposes of the $75 million dollar test, the Proposed Rule defined stockholderequity as the difference in value between a corporation’s total assets and total liabilities.

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This interpretation is adopted in Phase II which also clarifies CMS’s interpretation of thisownership exception in several important ways.

A. Timing of “Availability to Public”

Under Phase II, the statutory requirement that the excepted securities must bethose that “may be purchased on terms generally available to the public” has beenreconsidered and is now interpreted to mean that the ownership interest must be insecurities that are generally available to the public at the time of the DHS referral. TheProposed Rule had taken a somewhat more restrictive position, interpreting the statutorylanguage to require that the securities had to be available to the public at the time thephysician or immediate family member acquired them. Thus, a physician (or immediatefamily member) can now acquire an ownership interest in a public company prior to apublic offering as long as the securities are generally available to the public at the time ofthe physician’s DHS referral.

B. No De Minimus Exception

Phase II reflects CMS’s decision not to expand this exception to cover investmentin smaller publicly-traded corporations or mutual funds. CMS rejects suggestions thatthe exception should be expanded to cover investments in companies with less than $75million in assets or shareholder equity in situations where the physician (or immediatefamily member) has an ownership interest that constitutes less than 5% of total ownershipin the company.

C. Reporting Compliance Facilitated

The Phase II Rule eliminates the burdensome reporting requirements, discussed inmore detail below, that would have existed under the Proposed Rule. Phase II alsomaintains the exception created in Phase I for entities that submit claims for DHS whenthe entity does not have actual knowledge, or act in reckless disregard or deliberateignorance, of the identity of the referring physician, and the claim otherwise complieswith applicable law.

VII. ADDITIONAL EXCEPTIONS RELATED TO OWNERSHIP OR INVESTMENTINTERESTS

The Stark Law contains certain exceptions that apply only to ownership orinvestment interests. While Phase II adopts the Proposed Rule’s interpretation of theexception for ownership of hospitals in Puerto Rico without change, the other ownershipexceptions were modified in various ways.

A. Rural Providers

1. Rural Areas Are Outside MSAs. The Phase II Rule adopts the criteria inthe Proposed Rule which defined “a rural provider” as an entity that furnishes at least 75percent of its total DHS to residents of a rural area. “Rural area” is defined as an area

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that is not an urban area as defined in 42 C.F.R. § 412.62(f)(1)(ii), i.e., is outside ametropolitan statistical area (“MSA”). The requirement in the Stark I regulations from1995 that the rural provider had to be located in a rural area also has been eliminated,although the DHS must be furnished in a rural area by the provider.

Since the Phase II regulations do not adopt the analogous anti-kickback safeharbor’s focus on underserved areas, compliance with both the Stark exception and theanti-kickback safe harbor may not be possible in certain situations. For example, aphysician’s investment in a DHS entity located in an underserved urban area could bestructured to satisfy an anti-kickback safe harbor. However, this arrangement will not fitthe Stark exception for investments in rural providers. Since the Stark Law is a strictliability statute, such arrangements will not be possible unless they can be structured to fitanother Stark Law exception, (e.g., such as the “whole hospital” exception).

2. MMA Moratorium Incorporated. Phase II also codifies the changes madeby the Medicare Prescription Drug, Improvement and Modernization Act of 2003(“MMA”) which effectively provides that for an 18-month period beginning onDecember 8, 2003, a provider will not qualify for the Stark Law’s rural providerexception if it is a “specialty hospital.” The Stark Law now includes the MMA’sdefinition of a specialty hospital; i.e., a hospital that is primarily or exclusively engagedin the care and treatment of patients: (i) with a cardiac condition; (ii) with an orthopediccondition; (iii) receiving a surgical procedure; or (iv) receiving any other specializedcategory of services designated by the Secretary of HHS (albeit no additional categorieshave been specified in Phase II and the Secretary’s ability to do so for particularcategories of hospitals is likely constrained by the MMA’s legislative history).“Specialty hospital” does not include a hospital under development or one in operationbefore November 18, 2003 as long as the hospital has not increased the number ofphysician investors, changed the categories of specialty services provided, or increasedthe number of beds on the hospital’s main campus by more than 50 percent of the numberof beds as of November 18, 2003 or by 5 beds, whichever is greater. CMS issuedadditional guidance of this definition in Transmittal 62 (March 19, 2004).

3. Grandfathering Hospitals in a De-Classified Rural Area. In response to arequest for a provision allowing investment in DHS entities furnishing services in ruralareas that are subsequently reclassified as non-rural areas, CMS indicates that the newregulatory exception for certain arrangements that inadvertently and temporary fall out ofcompliance with a Stark exception should be used. The requirements of this exceptionare described below in more detail.

B. Hospital Ownership (“Whole Hospital” Exception)

The Stark Law’s exception for hospital ownership protects DHS referrals if thereferring physician-owner is authorized to perform services at the hospital and theownership interest is in the hospital itself; not a subdivision (“the whole hospitalexception”).

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1. MMA Specialty Hospital Provision Incorporated. Similar to theownership exception for rural providers, Phase II modifies the exception for hospitalownership to include the MMA restrictions relating to the moratorium on specialtyhospitals as described above. In other words, physicians who invest in a “specialtyhospital” as defined in the statute will not be able to protect their referrals to such ahospital through reliance on the whole hospital exception for an 18-month periodbeginning December 8, 2003. Note, however, that most, if not all, physician investors inspecialty hospitals that existed or were under development (as defined by CMS) as ofNov. 18, 2003 will not be affected by this provision because they are protected by theMMA’s “grandfathering” provision.

2. Clarification of the Statutory Criteria. CMS emphasizes in the Phase IIpreamble that the physician must have a bona fide authorization to perform services inthe hospital. Privileges granted to a physician who is not expected to make use of themwill not satisfy the statutory standard. In addition, CMS points out that even if aphysician’s ownership of a hospital qualifies for the whole hospital (or other) Starkexception, the arrangements nevertheless may implicate the anti-kickback statute,depending on the circumstances. CMS cites, as an example, specialty hospital ventureswhere investment opportunities are substantially limited to physicians in a position torefer to the specialty hospital as potentially implicating the anti-kickback statute. Thiscomment raises an interesting parallel and contrast to the OIG’s stated rationale in thesafe harbor preamble for protecting a referring physician’s investment interest in anambulatory surgery center. This safe harbor applies when the facility is functionally anextension of a physician’s office practice, the physician-investor personally performssubstantial services there, and the facility serves a bona fide business purpose. In thatcase, the OIG concludes that the risk of improper payments for referrals is relatively low.

3. Exception Inapplicable to Services Furnished by Other Providers Ownedby a Hospital. There is considerable discussion in the Phase II preamble of CMS’scontinuing position that even if a physician has a financial relationship with a hospitalthat satisfies the whole hospital exception, that physician’s referrals to a DHS entityowned by the hospital (e.g., a home health agency) will not be protected by the wholehospital exception.

VIII. EXCEPTIONS RELATING TO OTHER COMPENSATION ARRANGEMENTS

A. Rental of Office Space and Equipment

The Stark Law includes exceptions for rental payments in consideration for theuse of premises or of equipment. The exceptions require that (1) the lease must be set outin writing, be signed by the parties, and specify the premises or equipment being leased;(2) the premises or equipment may not exceed that which is reasonable and necessary forthe legitimate purposes of the arrangement and must be used exclusively by the lesseewhen being used by the lessee (but a premises lease may include pro rata payments forcommon areas); (3) the lease must have a term of at least one year; (4) rental chargesmust be set in advance and be consistent with fair market value, and may not be

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determined in a manner that takes into account the volume or value of referrals or otherbusiness generated between the parties; and (5) the lease must be commerciallyreasonable in the absence of referrals.

The Phase II regulations include several new interpretations of these exceptions:

1. Early Termination. In the Proposed Rule, CMS interpreted the minimumone-year requirement to allow early “for cause” termination provisions in the lease, aslong as the parties did not enter into another lease until after the expiration of the originalterm. The Proposed Rule was silent on terminations not supported by “cause.” In PhaseII, CMS extends this interpretation to allow also early “without cause” terminationprovisions.

2. Holdover. Under Phase II, a month-to-month holdover tenancy for up tosix months is allowed if it is on the same terms and conditions as the original lease.

3. Capital Leases. The Proposed Rule would have limited these exceptionsto leases that are treated as “operating leases” rather than “capital leases”. Under PhaseII, both operating and capital leases qualify for the exceptions.

4. Subleases. In the Proposed Rule, CMS interpreted the “exclusive use”requirement as precluding subleases. In Phase II, CMS concluded that the exceptionswould apply to the lease arrangement, even if there were a sublease, as long as neitherthe lessee nor sublessee shares the rented space or equipment with the lessor during thetime it is rented or used by the lessee or sublessee.

5. Per Click Rental Payments. In Phase II, CMS acknowledges that, inaccordance with its interpretation of the “volume or value” standard in Phase I, “perclick” rental arrangements are permitted, even for designated health services referred bythe referring physician, as long as the payments are FMV and do not vary during thecourse of the compensation arrangement in any manner that takes into account the levelof referrals or other business generated by the referring physician.

B. Bona Fide Employment Relationships

A Stark Law exception exists for amounts paid by an employer to a physician or aphysician’s immediate family member who has a bona fide employment relationship forthe provision of services if (1) the employment is for identifiable services; (2) the amountof remuneration is consistent with the fair market value of the services and is notdetermined in a manner that takes into account directly or indirectly the volume or valueof any referrals by the referring physician (but may include productivity bonuses basedon personally-performed services); and (3) the remuneration is provided pursuant to anagreement that would be commercially reasonable even in the absence of referrals.

Phase II includes the following significant interpretations of this exception:

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1. “Incident to” Services. Despite requests from commenters, CMS refusedto allow an employed physician to be paid a productivity bonus based on the physician’ssupervision of services billed on an “incident to” basis. CMS observed that in manycases the amount of required supervision is minimal and such payments could maskimproper cross-referral or circumvention schemes. This limitation, however, does notextend to physicians employed by group practices that rely on the in-office ancillaryservice exception, which does allow compensation based on “incident to” services.

2. Requirements to Refer. In Phase I, CMS interpreted the “volume or value”standard to allow requirements to refer as long as such requirements were subject tophysician judgment, patient choice and insurer requirements. In Phase II, CMSsignificantly narrowed the circumstances under which a physician can be contractuallyrequired to direct referrals to another party. In particular, as a result of Phase II, aphysician’s compensation may be conditioned on referrals to a particular provider,practitioner or supplier only if the compensation is set in advance, consistent with fairmarket value and does not take into account the volume or value of anticipated orrequired referrals; the arrangement meets the requirements of a general exception or acompensation arrangements exception; the required referrals relate solely to thephysician’s services covered by the scope of employment or other contract; the referralrequirement is reasonably necessary to effectuate the legitimate business purpose of thecompensation relationship; and the requirement to refer is subject to patient preference,insurer determinations and physician judgment.

3. Restrictive Covenants. CMS agreed with commenters that, at least insome circumstances, exclusive contracting agreements serve legitimate business purposesand non-compete covenants in employment contracts generally do not take into accountthe volume or value of referrals (although payment for the non-compete covenant mustbe at fair market value).

4. “Gainsharing” Incentives. In the preamble to Phase II, CMS interpretsthe employment exception to preclude incentives to reduce or limit care to hospitalpatients. According to CMS, any such arrangement must meet the requirements of aqualified physician incentive plan under the personal service arrangement exception ormeet the prepaid plans or risk sharing arrangement exceptions.

C. Personal Service Arrangements

The statutory exception for personal service arrangements permits remunerationfrom an entity if (1) the arrangement is set out in writing, signed by the parties, andspecifies the services covered by the arrangement; (2) the arrangement covers all of theservices to be provided by the physician (or immediate family member); (3) the aggregateservices contracted for do not exceed those that are reasonable and necessary for thelegitimate business purposes of the arrangement; (4) the term of the arrangement is for atleast one year; (5) the compensation is set in advance, does not exceed fair market value,and is not determined in a manner that takes into account the volume or value of referralsor other business generated between the parties; and (6) the services to be performed do

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not involve the counseling or promotion of an activity that violates the law. Specificallypermitted are physician incentive plans as long as (1) no specific payment is madedirectly or indirectly as an inducement to reduce or limit medically necessary servicesprovided with respect to a specific enrolled individual; (2) if the plan places physicians atsubstantial financial risk the plan meets applicable Medicare requirements; and (3) theentity provides CMS with access to information concerning the plan.

The significant Phase II interpretations of this exception are:

1. Early Termination. Consistent with CMS’s interpretation of the one-yearrequirement for leases, Phase II allows a personal services agreement to be terminatedprior to the expiration of its minimum one-year term, either for cause or without cause, aslong as the parties do not enter into the same or a similar arrangement during the firstyear of the original term, and any subsequent agreement fits into an exception.

2. Downstream Contracts. Phase II clarifies the physician incentive planprovision to permit downstream subcontractor arrangements related to health planenrollees.

3. Subcontracts. In Phase II, CMS refuses to allow the personal servicesarrangements exception to apply where physicians engage independent contractors – asdistinguished from employees – to perform services that they contracted to provide.CMS states that allowing such subcontracting arrangements would permit physicians totake a fee as a broker for the services of the subcontractor without actually performingany services.

4. Mixed Services/Equipment. As a result of Phase II, CMS now allows thepersonal service arrangements exception to apply to arrangements where a physicianprovides items or equipment in connection with the personal services that they perform.

5. Gainsharing Incentives. Consistent with CMS’s position with respect toemployment arrangements, discussed above, CMS indicates that so-called gainsharingarrangements that reward physicians for reducing or limiting care to patients under theirclinical care are permitted only to the extent that they are specifically contemplated bythe personal service arrangements exception. Thus, such incentives are allowed onlywith respect to enrollees of a health plan.

6. Cross-References to Master List. To satisfy the statutory requirement thata written agreement covers all of the services to be provided, in Phase II, CMS ispermitting a simple cross-reference in each agreement involving the same parties to amaster list of all agreements. The Phase I option of incorporation of other agreements byreference also remains. The master list alternative can be met with multiple master lists,as long as, taken together, they cover all of the contracts with the referring physician.The master list or lists must be made available to CMS for inspection upon request, andmust preserve the historical record.

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7. “Safe Harbor” for Hourly Rates. In Phase II, CMS created a safe harborprovision for the consistency with fair market value of certain hourly physiciancompensation rates. Under the safe harbor, a physician’s hourly compensation rate willbe deemed to be fair market value under either of two methodologies. The firstmethodology requires that the hourly rate be less than or equal to the average hourly ratefor emergency room physician services in the relevant physician market, as long as thereare at least three hospitals providing emergency room services in the market. The secondmethodology protects a rate that is consistent with the average fiftieth percentile salaryfor the physician’s specialty in any four of six identified physician compensation surveys,divided by 2000 hours to arrive at an hourly rate. Where the survey does not have datafor the particular physician’s specialty, the salary for general practice is used. CMSemphasizes that compliance with the safe harbor is entirely voluntary, and parties mayestablish fair market value using other methods, although they continue to bear the riskthat their rates may not be considered fair market value.

D. Remuneration Unrelated to the Provision of Designated Health Services

Stark II contains an exception for “remuneration which is provided by a hospitalto a physician if such remuneration does not relate to the provision of designated healthservices.” CMS has consistently sought to confine the scope of this exception. Indiscussing this exception in the preamble to the Proposed Rule, for example, CMS statedthat the remuneration must be “completely unrelated” to designate health services. InPhase II, CMS continues its efforts to ensure that the scope of the exception is limited.Among its interpretations are the following:

1. “Wholly Unrelated.” Phase II interprets the exception to be available onlyif the remuneration is “wholly unrelated” to the furnishing of designated health servicesand does not take into account “in any way” the volume or value of referrals. Inparticular, Phase II provides that remuneration is related to the furnishing of designatedhealth services (so that this exception would not apply) if it is an item, service, or costthat could be allocated in whole or in part to Medicare or Medicaid under cost reportingprinciples; is furnished, directly or indirectly, explicitly or implicitly, in a selective,targeted, preferential, or conditional manner to medical staff or other persons in aposition to make or influence referrals; or otherwise takes into account the volume orvalue of referrals or other business generated by the referring physician.

2. Particular Arrangements. In the Proposed Rule, CMS allowed thatgeneral administrative or utilization review services could be the type of service that isunrelated to designated health services. In Phase II, CMS explicitly withdraws thatinterpretation. CMS implies also that the provision of malpractice insurance tophysicians would not fall within this exception. In response to a comment, CMS assertsthat a payment by a hospital to a physician for a covenant not to compete is “plainlyrelated to the provision of” designated health services. On the other hand, CMS indicatesthat remuneration for the rental of residential property is wholly unrelated to theprovision of DHS and could therefore qualify for this exception.

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E. Physician Recruitment and Retention

Remuneration provided by a hospital to a physician to induce the physician torelocate to the geographic area served by the hospital in order to be a member of thehospital’s medical staff is permitted by an exception in the Stark Law. The conditions tothe availability of the exception prohibit the recruited physician from being required torefer patients to the hospital, and prohibit the amount of remuneration from beingdetermined in a manner that takes into account (directly or indirectly) the volume orvalue of the physician’s referrals. In the Proposed Rule, CMS interpreted the exceptionto require that the recruited physician must relocate his residence from outside of thegeographic area to within it, and solicited comments on how to define a hospital’sgeographic area. CMS also suggested that some physician recruitment, such as recruitingphysicians already residing in the area, might fall under the proposed new fair marketvalue compensation arrangement.

In Phase II, CMS expands the scope of the exception through a number ofinterpretations, while narrowing its prior interpretation of the fair market value exceptionin the physician recruitment context.

1. Relocation of Practice. Phase II requires the relocation of the physician’smedical practice, rather than his or her residence. The new practice site must be withinan area defined by the lowest number of continuous postal zip codes from which thehospital draws at least 75 percent of its inpatients. In order for the physician’s medicalpractice to be considered to have relocated, the physician must have moved his practicesite a minimum of 25 miles, or at least 75 percent of the physician’s patient servicerevenue must be derived from services provided to new patients. “New patients” arepatients who have not been seen by the physician in his previous practice for at least threeyears.

2. No Fair Market Value Exception. CMS contradicted its previoussuggestion concerning the potential applicability of the fair market value exception torecruitment incentives. In Phase II, CMS indicates that such incentives cannot fit withinthe fair market value exception.

3. Residents and New Physicians. Phase II provides that the relocationrequirements will not apply to residents and physicians who have been practicing for lessthan one year. Thus, significant latitude exists for recruiting these new physicians whomCMS apparently believes will not typically have significant practices that wouldimplicate Stark Law concerns.

4. No Noncompetes. In Phase II, CMS clarifies that a hospital must allow arecruited physician to establish staff privileges at other hospitals and to refer to otherentities. CMS indicates, however, that reasonable credentialing restrictions on physiciansbecoming competitors of the hospital are permitted.

5. Co-Recruitment with Existing Medical Practices. In Phase II, CMSinterprets the recruitment exception to allow so-called “co-recruitment” arrangements

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with existing medical practices, whereby the recruited physician would join an existingmedical practice. CMS expresses concern that such arrangements might result inimproper payments for referrals from the existing physician practice, and, as a result,imposed several additional conditions to such arrangements. These conditions includerequirements that the arrangement between the hospital and the medical practice must beset out in writing and signed by the parties; the remuneration must be passed directlythrough to or remain with the recruited physician, and records of actual costs and passedthrough amounts must be maintained and made available to CMS; if the recruitmentincentive is in the form of an income guarantee for the recruited physician, the medicalpractice cannot allocate costs to the recruited physician in excess of its actual additionalincremental (marginal) costs; and the medical practice cannot impose additional practicerestrictions on the recruited physician such as a non-compete agreement, although it mayimpose conditions related to quality.

6. FQHC. CMS expands the physician recruitment exception to apply notonly to hospital recruitment, but also to recruitment by federally qualified health centers(“FQHCs”).

7. Anti-Kickback Statute. In Phase II, CMS adds a requirement that therecruitment arrangement must not violate the Anti-Kickback Statute and must complywith relevant reimbursement requirements. This is the same requirement that CMS hasimposed in each of the exceptions that it created under its regulatory authority.

8. Physician Retention in Underserved Areas. Commenters to the ProposedRule requested that CMS expand the recruitment exception to permit incentives to retainhospitals already on their medical staffs. In response, in the preamble to Phase II, CMSexpressed concern that retention incentives could lead to bidding wars between hospitals,but expressed sympathy to the problems faced by certain rural and inner city hospitals.As a result, CMS declined to expand the recruitment exception to retention arrangements,but did create a new, very narrow, exception for retention arrangements. The newexception contains the following requirements, among others: (1) the hospital or FQHCmust serve a health professional shortage area or an area for which an advisory opinionhas been issued confirming a demonstrated need for the physician; (2) the physician musthave a bona fide firm, written recruitment offer to move the location of his practice atleast 25 miles and outside of the geographic area served by the hospital or FQHC; (3) theretention payment must not exceed the lesser of the difference between the physician’scurrent income and the physician’s income under the recruitment offer or the amount thatthe hospital or FQHC would have to expend to recruit a replacement physician; (4) theretention payment must be subject to the same obligations and restrictions on repaymentor forgiveness as the bona fide recruitment offer; and (5) the hospital or FQHC may notenter into a retention arrangement with the same physician more frequently than onceevery 5 years and the amount and terms of the retention payment must not be alteredduring the term of the arrangement in any manner that takes into account the volume orvalue of referrals or other business generated by the physician.

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F. Isolated Transactions

The isolated transactions exception allows a physician to refer to an entity even ifhe has entered into an isolated financial transaction with the entity, such as a one-timesale of property or practice, if the amount of remuneration is consistent with fair marketvalue and is not determined directly or indirectly in a manner that takes into account thevolume or value of referrals, and is provided in accordance with an agreement that wouldbe commercially reasonable even in the absence of referrals. CMS’s Phase IIinterpretations of this exception include the following significant features:

1. Installment Payments. The Proposed Rule retained CMS’s interpretationunder Stark I that installment purchase payments are not permitted under this exception.CMS changes course in Phase II by allowing installment payments, as long at the totalaggregate payment is fixed before the first payment is made and does not take intoaccount, directly or indirectly, the volume or value of referrals or other businessgenerated by the referring physician; and the payments are “immediately negotiable orare guaranteed by a third party, secured by a negotiable promissory note, or subject to asimilar mechanism to assure payment even in the event of default by the purchaser orobligated party.”

2. Post-Closing Adjustments. Phase II also allows post-closing adjustmentsto the purchase price relating to the isolated transaction, as long as the adjustments occurwithin six months of the closing, do not take into account (directly or indirectly) thevolume or value of referrals or other business generated by the referring physician, andare commercially reasonable.

G. Certain Group Practice Arrangements with Hospitals

The Stark Law includes an exception for arrangements between a hospital and agroup under which designated health services are furnished by the group but are billed bythe hospital, but only if a number of conditions are met. Those conditions include,among others, that the arrangement began before December 19, 1989, and thatsubstantially all of the designated health services covered by the arrangement must befurnished by the group under the arrangement. In the Proposed Rule, CMS clarified thatany such arrangement must have begun prior to December 19, 1989 and continued ineffect, without interruption, since then, and interpreted the “substantially all” test torequire at least 75 percent of the designated health services covered under thearrangement furnished to patients of the hospital must be furnished by the group underthe arrangement. Phase II adopts the regulation as proposed.

H. Payments Made by a Physician for Items and Services; Discounts

The Stark Law creates an exception for payments made by a physician to alaboratory in exchange for the provision of clinical laboratory services, or to an entity ascompensation for other items or services, if the items or services are furnished at a pricethat is consistent with fair market value.

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1. Mutually Exclusive with other Exceptions. In the Proposed Rule, CMSinterpreted this exception to apply to physician purchases of any items or services, but tobe inapplicable if another exception could cover the arrangement. Phase II retains thisinterpretation. Thus, for example, a lease of equipment by a physician would have tomeet the equipment rental exception, which contains numerous conditions.

2. Discounts. In addition, in the Proposed Rule, CMS indicated that thisexception would apply to discounted arrangements only if a number of requirements weresatisfied, and proposed a separate discount exception that was conditioned on thediscount being passed on in full to patients and insurers. In Phase II, CMS changed itsposition and concluded that legitimate discounts will fall within the range of values that is“fair market value”.

3. Extension to Immediate Family Members. In Phase II, CMS extends thisexception to protect payments by a referring physician’s immediate family member underthe same terms as it applies to the physician.

IX. REPORTING REQUIREMENTS

Stark I affirmatively required any entity furnishing more than 20 Medicare-covered services in a calendar year to submit a report to CMS divulging the details of itsfinancial relationships (ownership, investment or compensation) with physicians andmembers of their immediate family. Specifically, Stark I required that entities report: a)the name and UPIN of each physician with a financial relationship; b) the name andUPIN of each physician who has an immediate family member with a financialrelationship; c) the nature of each financial relationship; d) if requested by CMS, adescription of the extent and value of each financial relationship; and e) a description ofall Medicare-covered services provided by the entity. Additionally, Stark I required thatentities submit any changes in reported information within 60 days of the change and,upon request by CMS, produce supporting documentation. Fortunately for health careproviders, CMS has never actually required that entities submit the required reports.

The Phase II regulations significantly revise and relax the reporting requirementsas follows:5

1. Report Only Upon Request. Stark I required that any entity providingmore than 20 Medicare-covered services per year affirmatively report the details of theirfinancial relationships with physicians to CMS. Phase II significantly modifies thereporting requirements to require that an entity providing more than 20 Medicare-coveredservices per year report need only report certain details of their financial relationshipswith physicians if specifically directed to do so by CMS or the OIG. If an entity isdirected to submit a report, the entity must be given no less than 30 days to respond. This

5 CMS inadvertently omitted this section from its publication of the Phase II Rule. That

omission was rectified in a subsequent correction. 69 Fed. Reg. 17933 (April 6, 2004).

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relatively short time frame for reporting “upon request” suggests that a prudentcompliance program would include a document identification and organization systemdesigned to facilitate a timely response if the need were to arise.

2. Information Updates. Stark I required that an entity submit any changesor updates to its reported information within 60 days of the change. Phase II eliminatesthe information update requirement.

3. Supporting Documentation. Phase II attempts to define the types ofrecords and other supporting documentation an entity must maintain on file and produceupon request by CMS or the OIG regarding its financial relationships with physicians.The entity’s records must include information that the entity “knows or should knowabout in the course of prudently conducting business,” such as IRS and SEC recordswhich the entity is required by law to maintain for a certain period of time and whichmay pertain to the entity’s financial relationships with physicians.

4. “Financial Relationship.” Phase II revises the definition of a reportable“financial relationship” to specifically exempt any ownership or investment interests thata physician or a physician’s immediate family member has in the entity that meets theStark exception for publicly-traded securities or mutual funds. Thus, a publicly-tradedcompany need not report information regarding physicians or family members who holdstock in the company if the physicians’ investment interests meet all of the requirementsof the publicly-traded company exception. However, if any of the shareholder-physicianshave a separate compensation relationship with the publicly-traded company (e.g.,medical director agreement) and the government requests a financial relationship report,the name and UPIN of the physician and the nature of the compensation relationship withthat physician must be disclosed to the government.

X. DEFINITIONS

A. Designated Health Services

Identification of DHS by CPT or HCPCS codes for the following services remainsunchanged by Phase II: clinical lab services; physical therapy, occupational therapy, andspeech-language pathology services; radiology and certain other imaging services; andradiation therapy services and supplies. CMS declines to exclude additional servicesfrom the definition of DHS or to create an exception for financial arrangements involvingparticular services. Thus, CMS did not add new regulatory exceptions for additionalDHS in Phase II. We address selected DHS services below.

B. Professional Services as Designated Health Services

In Phase II, CMS reiterates its position that both the technical and professionalcomponents of a designated health service such as “radiology and certain other imagingservices” are included in the definition of “DHS.” However, CMS also points out thatpotential compliance issues raised by including the professional component of a servicewithin DHS often can be resolved by other exceptions, such as the physician services

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exception or the in-office ancillary services exception, or by the personal performance ofservices by the referring physician, which will not be considered a “referral” under theStark Law

C. Clinical Laboratory Services

In Phase II, CMS modified the definition of “clinical laboratory services” slightlyto make clear that the entire scope of these services is defined by reference to theapplicable List of CPT/HCPCS Codes on the CMS website. CMS also concluded thateven CLIA-waived tests are included in the definition of clinical laboratory services, butreferrals for such tests would likely be protected by the in-office ancillary servicesexception.

D. Physical Therapy Services

CMS responded to public comments by adding and deleting several specificservices from the CPT/HCPCS Code list defining “physical therapy services” (includingspeech-language pathology services, as required by statute). Phase II also reiteratesCMS’s position that the definition applies to these services regardless of who providesthem (e.g., whether performed by a therapist, a physician or other qualified individual).Finally, CMS removes four codes for audiology services from the list, stating that it didnot intend to include audiology services within the scope of speech-language pathologyservices.

E. Radiology and Certain Other Imaging Services

The Stark Law includes in the “DHS” definitions radiology services, includingmagnetic resonance imaging, computerized axial tomography, and ultrasound services(i.e., as included in the agency’s list of CPT/HCPCS codes). In Phase I, CMS excludedcertain of these type services from the DHS definition including, among others, nuclearmedicine procedures. Despite concerns expressed by a number of commenters about thenuclear medicine exclusion, CMS made no change in Phase II to the favorable treatmentof nuclear medicine, but will continue to consider the issue. In other clarifications, PhaseII confirmed that (i) radiology services performed immediately after a procedure in orderto confirm placement of an item during the procedure are not DHS, and (ii) reiterated thatradiology included in the Ambulatory Surgery Center’s (“ASC”) composite rate is notDHS, but radiology performed in an ASC but not included in the composite rate is DHS.

F. Radiation Therapy Services and Supplies

No substantive revisions were made to this definition. CMS rejected a requestthat brachytheraphy (i.e., the placement of radioactive isotopes under the skin fortherapeutic reasons) be excluded from the definition of DHS, noting that Congress didnot intend the definitions of DHS “to be frozen in time.”

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G. Outpatient Prescription Drugs

Phase I defined “outpatient prescription drugs” as all prescription drugs coveredby Medicare Part B. Effective January 1, 2006, more outpatient prescription drugs willbe covered under the new Medicare Part D program. Because of this expanded coverageof outpatient prescription drugs provided for by the Medicare Modernization Act, CMSnotes that it will revisit the definition of outpatient prescription drugs in a futurerulemaking. It solicits comments to guide the expansion of the definition of outpatientprescription drugs to reflect the definition of “covered Part D drug” in the MMA. Inrejecting a definitional carve-out for drugs administered in a physician’s office, CMSmaintains its position that, under Stark, such drugs should not be treated any differentlyfrom prescription drugs dispensed by pharmacies. Moreover, office-dispensed drugsusually can be furnished under the in-office ancillary services exception or be excludedfrom the term “referral” when personally administered by the referring physician.

H. Inpatient and Outpatient Hospital Services

Although Phase II does not revise the definition of these services, it does makeclear its current policy (adopted following a court ruling unfavorable to the agency) thatlithotripsy will not be considered an inpatient or outpatient hospital service. While thisreversal of policy was a victory of sorts for urologists and other physicians who ownlithotripter devices that they often lease to hospitals where they also treat their patientswith the device, the victory appears to be more form over substance. The equipmentlease arrangement between the hospital and the physician/group must nevertheless meet aStark exception if the physician refers any other Medicare patients to the hospital/lessee,which often is the case.

I. Other Definitions

1. “Entity.” In Phase II, CMS amended the definition to provide greaterclarity, although the substance of the definition remains the same. CMS also rejects asuggestion to exclude independent practice associations (“IPAs”) from the definition of“entity” when the IPA furnishes DHS directly through employees or entities owned bythe IPA.

2. “Fair Market Value.” CMS reiterates that it will consider a range ofmethods for determining FMV, with the appropriate method depending on the nature ofthe transaction, its location and other specific factors. Moreover, while good faithreliance on a proper valuation may be relevant to intent, it does not determine theaccuracy of the evaluation figure itself. CMS notes, however, that it has establishedseveral “safe harbored” methodologies with regard to evaluating the FMV of physicianservices (as discussed above). CMS further emphasizes that the particular facts andcircumstances will determine whether use of regional and/or national data is appropriate,and parties should take reasonable steps to ensure that any “comparable” figures used arenot distorted.

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3. “Remuneration.” CMS notes that the Stark Law itself excludes from thedefinition of “remuneration” payments made by an insurer or self-insured plan to aphysician to satisfy a claim, submitted on a fee-for-service basis, for furnishing healthservices to an individual covered by a policy with that insurer or by the self-insured plan.To ensure that this exception has the effect intended, CMS has revised the Phase II Ruleto cover payments made by downstream subcontractors of insurers or self-insured plans(e.g., providers who have assumed risk under a plan).

XI. REGULATORY EXCEPTIONS

The Stark Law grants the Secretary authority to create new exceptions to thestatute’s self-referral prohibitions for arrangements that pose no risk of program orpatient abuse. The Secretary has used this authority as part of his effort to balance, on theone hand, the Stark Law’s program and patient protection objectives with, on the otherhand, the recognized need for a realistic, flexible, and pragmatic approach to regulatingso many different types of financial relationships in the country’s complex and evolvinghealth care delivery system. In Phase I, CMS created almost a dozen new regulatoryexceptions that are not in the statute. In Phase II, CMS modifies certain standards inseveral Phase I regulatory exceptions in response to public comment and creates sevennew regulatory exceptions. We will describe below selected highlights with respect tothe Phase I and Phase II regulatory exceptions.

A. Selected Highlights Regarding Phase I Exceptions

1. Academic Medical Centers. CMS recognized that the statutory exceptionsdo not adequately address the application of the Stark Law to academic medical centers,which often involve multiple affiliated entities jointly delivering health care services topatients, and among which there are frequent referrals and monetary transfers. Therefore,Phase I established a new regulatory exception for services provided by an academicmedical center that meets a series of conditions. These conditions included requirementsthat (i) the referring physician must be a bona fide employee of an academic medicalcenter component, have a bona fide faculty appointment at an affiliated medical school,and provide substantial academic or clinical teaching services for which the physicianreceives employment compensation; (ii) the total compensation to the referring physicianmust be “set in advance”, must not exceed fair market value and must not be determinedin a manner that takes into account the volume or value of any referrals or other businessgenerated by the referring physician; (iii) transfers of money between academic medicalcenter components must support teaching, indigent care, research or community servicemissions, the relationships among academic medical center components must be set forthin a written agreement adopted by the governing body of each component, and all moneypaid to a referring physician for research must be used for research; and (iv) the referringphysician’s compensation must not violate the Anti-Kickback Statute. The Phase Iexception defined an academic medical center as consisting of an accredited medicalschool, an affiliated nonprofit, tax-exempt faculty practice plan, and affiliated hospitals inwhich a majority of the medical staff is composed of faculty members and a majority ofhospital admissions are made by faculty physicians.

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In Phase II, CMS made numerous changes to the academic medical centersexception, most of which would make it easier to meet the exception’s requirements,including significant changes related to requirements for physician compensation.Specifically, the following are among the changes introduced in Phase II:

? Under Phase I, the requirement that the referring physician’scompensation must be “set in advance” made the academic medicalcenters exception unavailable if employed referring physicians arepaid on a percentage basis. As a result of Phase II’s modification ofthe definition of “set in advance,” discussed above in Section III.A,academic medical centers now qualify for this exception even ifthey pay physicians on the basis of a percentage of collections fortheir personally performed services.

? Phase II loosens the definition of academic medical center in a numberof respects. First, it eliminates the requirement that an academicmedical center include an accredited medical school; rather, anacademic medical center can exist also if it includes a hospital orhealth system that sponsors four or more approved medical educationprograms, which CMS refers to as an “accredited academic hospital.”Second, under Phase II, faculty practice plans need not be organized astax-exempt, nonprofit organizations and may be affiliated with amedical school, affiliated hospital or accredited academic hospital.

? To provide more certainty in meeting the requirement that a referringphysician provide substantial academic or clinical teaching services,Phase II creates a “safe harbor” if the referring physician spends atleast 20 percent of his or her professional time or 8 hours per weekproviding academic services and/or clinical teaching services.

? Phase II amends the academic medical centers exception to allowmoney transfers from nonprofit organizations supporting the teachingmission of the academic medical center; to clarify that academicmedical center components need not be separate legal entities; to allowmultiple writings or, in the case of a single legal entity, financialreports to satisfy the requirement that the relationship amongcomponents of an academic medical center be set out in writing; and toprovide flexibility in the use of research funds for teaching purposes ifconsistent with the research grant terms.

2. Services Furnished Under Certain Payment Rates. Because of changes toa variety of Stark Law interpretations from the initial implementation of the Stark I (in1995) rules to the present, CMS determined to be redundant, and therefore deleted, one ofits regulatory exceptions that had protected certain DHS furnished in a facility paid undera composite rate system. In connection with this change, the following points should bekept in mind:

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? The definition of “designated health services” excludes services thatMedicare pays for as part of a composite rate, such as DHS servicesincluded as part of the ASC payment rate, the skilled nursing facility(“SNF”) rate, or the End Stage Renal Disease (“ESRD”) compositerate. If, on the other hand, these entities furnish a DHS service that isnot paid for as part of the composite rate, these services would beincluded in the definition of DHS, so that another exception will beneeded.

? The above-described “carve-out” or exclusion from the DHS definitiondoes not extend to home health services, inpatient hospital services, oroutpatient hospital services, which are specifically identified as DHSin the Stark Law (notwithstanding their use of prospective (composite)payment systems).

3. Implants in an ASC. Phase I established an exception for implants (e.g.,prosthetic devices) furnished by an ASC, but which are not included in the ASC’scomposite rate (and are therefore DHS in need of an exception). In Phase II, CMSclarified that this exception is available only when the ASC (and not the physician) billsfor the implant. CMS also confirmed that the implantation of brachytherapy seeds cannotqualify for this exception, which applies only to implanted prosthetics, prosthetic devices,and implanted DME.

4. Fair Market Value Exception. In Phase I, CMS finalized an importantregulatory exception that protects compensation resulting from an arrangement betweenan entity and a physician (or immediate family members) or any group of physicians forthe provision of items or services by the physician, or group of physicians, to the entity.Several qualifying conditions must be satisfied, including that the compensation to thephysicians be consistent with fair market value. Phase II does not include anysubstantive changes to the fair market value exception. CMS declined to extend thescope of protectable “items or services” to cover the transfer, lease or license of realproperty rights, or to protect intangible property, property rights, or a covenant not tocompete. According to CMS, other exceptions might apply to financial arrangementsinvolving those types of property.

5. Non-Monetary Compensation up to $300 and Medical Staff IncidentalBenefits. In Phase II, CMS revises the $300 limit for non-monetary compensation andthe $25 limit for medical staff incidental benefits to permit both amounts to be indexedannually for inflation. CMS also clarifies that dedicated electronic or Internet items orservices can meet the medical staff incidental benefits exception if they are provided onlyduring periods when the medical staff members were engaged in other services oractivities that benefit the hospital or its patients. Covered items could include dedicatedpagers or two-way radios used to communicate with physicians who are away from thecampus in emergency or other urgent patient care situations.

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The Phase II preamble explains that the simple listing or identification of themedical staff on a hospital’s web site would be an incidental benefit that could fit withinthe exception, as could the listing of affiliated physicians in hospital advertising. CMSdraws a distinction between the aforementioned activities and the promotion of aphysician’s private practice on the hospital’s web site, which would not be covered by theexception.

The Phase I requirement that the benefits be of a type offered to medical staffmembers at other local hospitals or by comparable hospitals in comparable regions isdeleted, thereby eliminating any duty of inquiry on hospitals. Finally, the transcription ofhospital medical records is not considered to be a benefit to a physician on the medicalstaff and CMS would not consider the provision of such services by the hospital toconstitute a compensation arrangement. A distinction is drawn with transcriptionservices provided by the hospital to the physician’s private practice. Such anarrangement would constitute a compensation arrangement, with the result that it couldbe arranged to fit within an exception.

6. Compliance Training. In Phase II, CMS makes several changes to thecompliance training exception:

? Expands protection beyond compliance training programs conductedby hospitals to include such training programs conducted by otherentities as well.

? Compliance training can now be given to a physician and to thephysician’s office staff.

? Compliance training can now include topics involving compliancewith any relevant federal, state, or local law, regulation, or rule.

? CMS clarifies that this exception does not apply to continuing medicaleducation (“CME”) programs, although other exceptions may apply.

B. Selected Highlights Regarding Phase II Exceptions

1. Anti-Kickback Safe Harbors. CMS integrates two anti-kickback safeharbors into Stark’s regulatory exceptions for compensation arrangements: The safeharbors for (i) referral services and (ii) obstetrical malpractice insurance subsidies. CMSemphasizes that an arrangement must fit squarely within the applicable anti-kickback safeharbor to achieve Stark compliance and declines to undertake the “wholesaleimportation” of all the anti-kickback safe harbors in the Stark exceptions.

2. Professional Courtesy. In Phase I, CMS declined to create a professionalcourtesy exception. Instead, CMS sought public commentary about the topic. Oneconcern CMS had with creating a professional courtesy exception was the number ofanalytically different practices covered by the term “professional courtesy.” Physician

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practices commonly referred to “professional courtesies” as including waiving the entirefee for services provided to office staff, other physicians, and/or family members andwaiving coinsurance or other out-of-pocket expenses for physicians or their families (alsoreferred to as “insurance-only billing”).

Noting the long-standing tradition and widespread practice of professionalcourtesy arrangements, CMS created a professional courtesy exception in the Phase IIRule. Phase II defines ``professional courtesy'' as the provision of free or discountedhealth care items or services to a physician, or his or her immediate family members, oroffice staff. To qualify, the arrangement must meet the following conditions:

? A physician must offer the professional courtesy to all physicians onthe entity's bona fide medical staff or in the entity's local communitywithout regard to the volume or value of referrals or other businessgenerated between the parties;

? The health care items and services provided must be of a typeroutinely provided;

? The physician must set out the professional courtesy policy in writingand obtain approval in advance from the physician’s governing body;

? The professional courtesy policy must exclude any physician (orimmediate family member) who is a Federal health care programbeneficiary, unless there has been a good faith showing of financialneed;

? If the professional courtesy involves any whole or partial waiver ofany coinsurance obligation, the physician must inform the insurer inwriting of the reduction; and

? The professional courtesy arrangement must otherwise be legal,especially in regard to the anti-kickback statute and any billing orclaims submission laws or regulations.

This exception is a welcome addition. CMS, however, neither requires norencourages professional courtesy arrangements and encourages physicians to review thelegality of each arrangement. In particular, physicians are cautioned that compliancewith this exception does not ensure compliance with the anti-kickback statute and thecivil monetary penalties law against giving inducements to Medicare and Medicaidbeneficiaries.

3. Charitable Donations By A Physician. The new Phase II exception coversdonations made by physicians and those made by the physician’s immediate familymembers. To qualify, the donation must meet the following conditions:

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? The donation must be made to an organization tax exempt under theIRS Code (or to a tax exempt supporting organization, such as ahospital foundation);

? The donation must not be solicited or made in any manner that takesinto account the volume or value of referrals or other businessgenerated from one party for the other; and

? The donation must not violate the anti-kickback statute or otherapplicable federal or state laws or regulations concerning billing orclaims submission.

Charitable donations made by a physician to a DHS provider can create afinancial relationship. Accordingly, donations constitute remuneration as defined in thestatute, thereby creating a compensation arrangement between donor and donee.Therefore physicians must be careful to comply with this exception because any donationmade outside of its boundaries creates a compensation arrangement that may nototherwise be protected by a Stark exception. Generally, transactions such as the purchaseof a tax-exempt hospital’s charity ball ticket or a donation to a tax-exempt health careentity’s general fund-raising campaign meet the exception as long as the solicitation wasnot targeted specifically at the physician. Parties engaged in more selective or the fund-raising should ensure that those activities are not conducted in any manner that reflects ortakes into account referrals or the generation of business between the parties.

4. Intra-Family Rural Area Referrals. In responding to a comment on thePhase I provisions related to ownership exceptions, CMS promulgated a new exceptionfor intra-family referrals, if the patient resides in a rural area, and there are no other areaproviders or suppliers available to furnish certain home-based DHS in a timely manner inlight of the patient’s condition, or within 25 miles of the patient’s residence (with regardto services to be furnished outside the home). Although this exception may be used toprotect both ownership and compensation arrangements, the Phase II preambleemphasizes that this is a narrow exception.

? Obligation to Make Reasonable Inquiries. The exception focuses onthe location where services are furnished, not where the DHS entity islocated. Further, the physician (or immediate family member) mustmake reasonable inquiries as to the availability of persons or otherentities to furnish the services, e.g., by consulting telephonedirectories, professional associations, other providers or internetresources. There is no obligation to inquire as to the availability ofpersons or entities located further than 25 miles from the patient’sresidence. This exception also requires that the financial arrangementbetween the physician or immediate family member and the DHSentity must not violate the anti-kickback statute or any federal or statelaw or regulation concerning billing or claim submission.

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? Focus on Availability (Not Quality of Care). Acknowledging thedifficulty in crafting an objective quality standard, the Phase IIpreamble notes that this exception focuses on the availability, not thequality, of DHS entities. In other words, a physician may not make anintra-family referral because he or she is not satisfied with the qualityof care provided by an otherwise available DHS entity.

5. Temporary Noncompliance With the Stark Law. The Phase II Rule createsa limited exception that would permit, in narrowly-defined circumstances, an entity to billthe Medicare program for a DHS provided during a period of temporary noncompliancewith the Stark Law. An entity may bill for DHS services rendered during a compliancelapse only under the following circumstances:

? For at least 180 consecutive days prior to the compliance lapse, therelationship between the referring physician and the entity must havefully complied with an applicable Stark Law exception;

? The period of noncompliance arose from circumstances “beyond thecontrol of the entity”;

? The entity promptly takes steps to rectify the noncompliance;

? The financial relationship does not violate the anti-kickback statute orapplicable federal or state laws, rules, and regulations;

? The protection established by this exception applies only to DHSfurnished during the time it takes to correct the problem, which cannotexceed 90 consecutive days from the initial date of noncompliance(i.e., not from the date the entity became aware of the Starkcompliance problem);

? An entity may not use this exception more than once every three yearswith respect to a particular referring physician; and

? This exception does not apply to an entity’s noncompliance with (i)the non-monetary compensation up to $300 exception, or (ii) themedical staff incidental benefits exception.

In our view, the many limitations and restrictions contained in this exception willrender it of little practical use in most circumstances. Compliance lapses that are truly“beyond the control” of a provider are likely to be quite limited. CMS cites as anexample a rural provider that falls out of compliance with the “ownership of ruralprovider” exception through re-designation of a rural area as a non-rural area. As apractical matter, however, temporary compliance lapses result more often frominadvertence which, although understandable for a busy provider with many physicianrelationships, may not be found to be beyond the provider’s control. Moreover, the

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exception’s protection period extends only 90 days from the initial date ofnoncompliance. That brief period will likely be further shortened because discovery ofthe problem may well take a period of weeks or months – effectively eliminating use ofthe exception in such cases.

6. Retention Payments in Underserved Area. This new regulatory exceptionis described in Section VIII.E above, together with the exception for physicianrecruitment arrangements.

7. Community-Wide Health Information Systems. The Phase II Rule createda new exception for community-wide health information systems. The exception coversitems or services of information technology that a DHS entity gives to a physician thatallows access to, and sharing of, electronic health care records; complementary druginformation systems; general health information; medical alerts; and related informationfor patients served by community providers and practitioners, in order to enhance thecommunity's overall health, provided that:

? The items or services are available as necessary to enable thephysician to participate in a community-wide health informationsystem, are principally used by the physician as part of thecommunity-wide health information system, and are not provided tothe physician in any manner that takes into account the volume orvalue of referrals or other business generated by the physician;

? The community-wide health information systems are available to allproviders, practitioners, and residents of the community who desire toparticipate; and

? The arrangement does not violate the anti-kickback statute or anyFederal or State law or regulation governing billing or claimssubmission.

This exception provides that a hospital’s provision of a computer or othertechnology that is wholly dedicated to use in connection with hospital services providedto the hospital's patients does not constitute a financial relationship for purposes of Starklaw. The exception covers both hardware and software given to a physician to participatein a community-wide health information system designed to enhance the overall health ofthe community, under the circumstances set forth above.

CMS limits this exception to providing information technology items and servicesthat are necessary to enable the physician to participate in the health information system.For example, if a physician already owns a computer, providing only software or trainingspecific to the health information system may be necessary. Likewise, furnishing Internetaccess to a physician who already has Internet service is not necessary. In all cases, theinformation technology items or services must principally be used by the physician aspart of the community-wide health information system. Physicians and entities need to

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utilize this exception with particular care because CMS promises to revisit the terms ofthe exception, should abusive arrangements come to light.

* * * *

If you would like additional information, please contact Kevin R. Barry (202/414-9211,kbarry@reedsmith.com); Linda A. Baumann (202/414-9488, lbaumann@reedsmith.com); KarlA. Thallner, Jr. (215/851-8171, kthallner@reedsmith.com); Christine E. Bloomquist (202/414-9212, cbloomquist@reedsmith.com); Jarrell E. Williamson (202/414-9288,jwilliamson@reedsmith.com); Heather Zimmerman (202/414-9262,hzimmerman@reedsmith.com); or any other member of the Reed Smith Health Care Group withwhom you work.

THE CONTENTS OF THIS MEMORANDUM ARE FOR INFORMATIONALPURPOSES ONLY AND DO NOT CONSTITUTE LEGAL ADVICE.