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Fall 2007

The Three-Prong Changes To "Stark" That You Must Understand

By Mark F.Weiss, J.D.
Advisory Law Group

If you have any concern about com­plying with Stark, the federal prohibition against self-referral, you need to under­stand the three-prong changes that have occurred since the beginning of July. Without this understanding, you will be unable to make an informed decision as to whether your activities conform to Stark’s requirement of absolute compliance.

Although Stark is a civil, not a crimi­nal statute, if you have a financial relationship, as defined by Stark, in an enti­ty to which you make Medicare or Medicaid referrals for “designated health services,” you must strictly fall within an exception in order to avoid substantial civil penalties and exclusion from Medicare and Medicaid program participation.

Complying with Stark is akin to trying to hit a moving target: Since the original statute’s enactment in 1989, the law has been amended multiple times and the Centers for Medicare and Medicaid Services’ process of issuing final regulations has spanned seven years, including four major regulatory pronouncements.

Even though it is difficult to argue that the government should not have a role in fighting fraud and abuse within federally funded healthcare programs, Stark’s tortured and esoterically complex legislative and regulatory scheme makes clear that the law’s authors, and the government employees charged with writing the interpretive regulations, have little understanding of business reality. They certainly have no appreciation of the impossibility of planning and executing complex business transactions in a regulatory environment is continually changing – what was legal under Stark yesterday is illegal today.

Three recent legislative and regulatory actions have increased this complexity.


This past July, the Centers for Medicare and Medicaid Services (“CMS”) issued its Proposed Revisions to Payment Policies Under the Physician Fee Schedule. Those revisions impact the Stark regulations, including:

  • Suggestions of possible changes to the “same building” and “ centralized location” definitions pertaining to Stark exception.
  • Suggestions that percentage based compensation deals would be considered to meet the “set in advance” requirement only in those circumstances in which they are based on revenue from services personally performed by the physician receiving the compensation.
  • Proposed changes to the definition of an “entity” to include both the person or entity that presents the claim and the person or entity that either provides the designated health services or causes the claim to be presented. The impact of this would be to make illegal “under arrangements” services contracts between physicians and hospitals.
  • Expanding the definition of ownership and investment interests to include a physician’s, or her family member’s, interest in a retirement plan, such that if the retirement plan has an interest in a DHS enti­ty, the physician’s referrals to that entity would be prohibited unless subject to an exception.
  • The requirement that the burden be on the entity submitting the claim to prove that the service was not furnished pursuant to a prohibited referral.


In August, the United States House of Representatives passed the Children’s Health and Medicare Protection Act of 2007, commonly referred to in the press as the “SCHIP amendment legislation,” which includes language severely limiting Stark’s “whole hospital” exception.

As presently in effect (that is, unaffected by the proposed new law), there is an exception to the general Stark law prohibition on referrals by a physician to a hospital in which the physician has an ownership interest. This exception is referred to as the “whole hospital” exception as it permits an ownership interest in the whole facility, as opposed to an interest in merely a part of the facility. The House version of the Children’s Health and Medicare Protection Act of 2007 eliminates that exception. It grandfathers in hospitals with physician ownership that were in operation with Medicare provider agreements as of July 24, 2007, as long as they do not increase the number of beds or the number of operating rooms that were in existence on that date. However, it requires grandfathered hospitals to reduce physician ownership to an aggregate of no more than 40% of the facility and to no more than 2% individually within 18 months of enactment. It also mandates new disclosure of ownership rules as well as the disclosure to patients if the hospital fails to have 24 hour physician coverage.

The version of SCHIP amendment legislation passed by the Senate does not include this Stark law change. Although it is unknown in what final form the Act will emerge from conference committee or whether it will be signed into law, the prospect of loss of the whole hospital exception is already having a chilling effect on physician ownership of hospital deals.

If the Stark amendment language of the House version of the Act becomes law, the market for, and valuation of, hospitals will be affected greatly. Facilities which are owned largely, or entirely, by referring physicians will face particularly tough challenges: Divest to whom? Who must be cut from the investor roster entirely and who may remain? Stop participating in Medicare and Medicaid? Close? Cease any plans for expansion? Divestiture may create bargains in the hospital market; however, as physician ownership patterns change, so too will referral patterns, placing, in some instances, doubt on the continuation of historical operating margins and, therefore, on valuation.


On September 2007, CMS released its purportedly final phase, Phase III, of the Stark regulations. As it did with the proposed revisions to the Physician Fee Schedule, CMS used the Phase III regulations to further attack percentage based compensation.

CMS has a history of flip-flopping on this issue. Originally, CMS took the position that percentage compensation failed because it did not meet the “set in advance” requirement. Next, under pressure from the industry to recognize percentage payment as a common practice, CMS retreated from its former position, such that a percentage set in advance was seen as compensation that is set in advance. However, in the Phase III regulations, CMS reverses itself on the larger issue of percentage arrangements, taking the position that percentage compensation arrangements will often fail because they will not meet the additional requirement that compensation not take into account the volume or value of referrals.

In its Phase II final Stark regulations, issued in 2004, CMS created a safe harbor definition for fair market value of physi­cian compensation that was based upon specific compensation survey data. CMS eliminates that safe harbor definition in the Phase III regulations.

CMS made clear in Phase III that for an independent contractor to qualify as a “ physician in the group practice,” the group’s contract must be with the individual physician or his professional corporation and not via a separate entity, such as another physician practice or a staffing company. Leased physician employees are not within the definition of physicians in the group practice. The Phase III regulations include clarifications by CMS that within group practices, productivity bonuses may be paid based on services that the physician has personally performed and/or services and supplies “incident to” such personally performed services. However, the allocation of profits within a group is subject to different rules, in that they must be allo­cated in a manner that does not relate directly to designated health services referrals, including those services which are billed “incident to.”

The regulations include new policy statements by CMS in connection with shared space and equipment. Specifically, physicians in more than one medical group may not simultaneously share space or equipment. A physician sharing a DHS facility in the same building must control the facility and the staffing at the time the that DHS is furnished to the patient. The practical effect is that block-leasing arrangements may be required. All shared facility arrangements must be carefully structured and operated in order to be compliant.

The definition of “indirect compensa­tion arrangements” has been changed. A physician is deemed by the Phase III regulations to “stand in the shoes” of her group practice such that an arrangement between the group and an entity contracting with the group to provide DHS creates a direct compensation agreement with the physician. Previously, those sorts of relationships created “indirect” compensation relationships or perhaps no compensation relationship at all.

Phase III restates CMS’s position that when DHS is personally performed by the referring physician, there is no Stark law “referral.” However, CMS states in the preamble to Phase III that this position is not likely to apply to the provision of durable medical equipment, as there are few, if any, situations in which the refer­ring physician is enrolled in Medicare as a DME supplier and personally performs all of the duties imposed on such suppliers.


The rules for Stark law compliance have changed and they will undoubtedly change again soon. The “finality” of the regulations is transitory. Existing referral relationships, in addition to new ones, must be tested for compliance with Stark’s ever changing requirements in order to avoid significant monetary penalties and exclusion from participation in Medicare and Medicaid.

Mark F. Weiss is a nationally recognized expert, and a frequent author and speaker, on the business and legal issues affecting physicians. He practices law with Advisory Law Group, A Professional Corporation, representing clients across the country from offices in Los Angeles and Santa Barbara, California. He is a Clinical Assistant Professor at USC’s Keck School of Medicine. Mr. Weiss offers our readers a series of complimentary educational materials. Mr. Weiss may be contacted via e-mail at markweiss@advi­ or via phone at 877-883-2803.