A “Stark” Result for South Carolina Hospital: Stark Law Violations May Cost Up to $357 Million in Penalties

by Cozen O'Connor

After a four-week retrial, a federal jury concluded on May 8, 2013 that Tuomey Healthcare System (Tuomey) violated both the Stark Law and the False Claims Act (FCA). The jury determined that Tuomey violated the Stark Law by entering into improper compensation arrangements with specialist physicians. Significantly, the jury also determined that the hospital violated the FCA by submitting 21,730 claims to the Medicare program (worth more than $39 million) that were tainted by improper provider referrals. Although the jury verdict has not been reduced to a final judgment, Tuomey faces a likely $39 million judgment plus up to $357 million in potential FCA liabilities.1

Although the retrial did not bring about any startling developments, it reinforced certain Stark Law principles with respect to fair market value and physician compensation.

The Underlying Arrangement

In 2003, local specialty physicians informed Tuomey that they were considering performing their outpatient procedures elsewhere. To dissuade these physicians, Tuomey entered into negotiations with all of the specialist physicians on its medical staff beginning in 2004. By November 2006, Tuomey (through a series of affiliated entities) had entered into part-time employment agreements with 19 specialist physicians whereby the physicians agreed to perform outpatient services exclusively at Tuomey Hospital and to reassign all amounts paid by third-party payers, including Medicare and Medicaid, to the hospital. In exchange, Tuomey agreed to provide full-time benefits and pay each physician an annual base salary that fluctuated based on the previous year’s net cash collections for outpatient procedures, a productivity bonus equal to 80 percent of net collections, and an incentive bonus up to 7 percent of the productivity bonus. Each agreement had a 10-year term and a two-year post-termination non-competition provision. The parties performed in accordance with the agreements, including Tuomey billing Medicare and other third-party payers for the professional service and technical component of the procedures.

History of United States ex rel. Drakeford v. Tuomey Healthcare System, Inc.

Tuomey’s negotiations with Dr. Michael Drakeford, an orthopedic surgeon, were unsuccessful and ended in 2005. Later that year, Dr. Drakeford filed an action in the District Court for the District of South Carolina as a qui tam relator under the FCA. The government subsequently intervened in Dr. Drakeford’s action, which was unsealed in 2007.

In its complaint, the government alleged, among other things, that Tuomey violated the FCA by submitting false or fraudulent claims for payment to the Medicare program for services rendered by physicians with whom Tuomey had entered into a financial relationship – the employment agreements – in violation of the Stark Law. The Stark Law prohibits a physician from making a referral for Medicare-reimbursable designated health services to an entity with which the physician (or an immediate family member) has a direct or indirect financial relationship, unless an exception applies. A “financial relationship” includes direct and indirect compensation arrangements, the latter of which exists if the referring physician receives aggregate compensation “that varies with, or takes into account, the volume or value of referrals or other business generated by the referring physician.”2 Due to the way the arrangement had been structured, Tuomey could not assert the Stark Law employment exception, which permits employers to direct their employed physician referrals, as a defense.

The government also argued that the compensation paid to the physicians did not meet any exceptions to the Stark Law (including the indirect compensation exception) because the agreements exceeded fair market value, were not commercially reasonable, and took into account the volume and value of referrals or other business generated between the parties (including the corresponding technical component for each procedure). With respect to fair market value, the government focused on the fact that the compensation paid by Tuomey was on average 19 percent higher than its collections for the professional services and the hospital was losing $1 to $2 million annually. In the government’s view, such an agreement would be commercially unreasonable unless the hospital wanted to secure a revenue stream through referrals.

The government also sought relief under the FCA. The FCA provides that any person who knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval is liable to the federal government for a civil penalty, which include treble damages, plus $5,500 to $11,000 per claim as well as the potential to be excluded from Medicare and all other federal health care programs. The government further alleged that Tuomey had collected $44.9 million from the Medicare program for services based on improper referrals under the Stark Law from the employed physicians. Consistent with the FCA, the government sought treble damages.

District Court Trial - March 2010

Following a four-week trial, the federal jury returned a split verdict in March 2010. The jury found that the employment agreements violated the Stark Law but found no liability under the FCA. Subsequently, in July 2010, the District Court ruled on post-trial motions; it entered a $44.9 million judgment against the hospital, set aside the jury’s verdict with respect to the FCA allegations, and ordered a new trial.3 Tuomey appealed.

Fourth Circuit Decision - March 2012

In a highly anticipated decision, in March 2012, the 4th Circuit Court of Appeals ruled that the $44.9 million judgment violated Tuomey’s Seventh Amendment right to a jury trial and vacated the judgment.4

Although the 4th Circuit remanded the case for retrial on procedural grounds, the court went on to address issues likely to recur on remand. To that end, the 4th Circuit focused on two questions of law: (1) whether the technical component that results from a personally performed service constitutes a “referral” within the meaning of the Stark Law; and (2) whether the agreements implicate the “volume or value” standard under the Stark Law by taking into account anticipated referrals.

To answer the first question, the 4th Circuit noted that the Stark Law and its regulations do not address whether the technical component of a personally performed service constitutes a referral. The court instead relied on the preamble to the final rule issued by the Centers for Medicare & Medicaid Services (CMS), which states, in pertinent part, that in the context of “outpatient hospital services, there would still be a referral of any hospital service, technical component, or facility fee billed by the hospital in connection with the personally performed service.”5 As such, the 4th Circuit rejected Tuomey’s argument that the technical component of a personally performed designated health service did not constitute a referral under the Stark Law and concluded that the physicians were making referrals to Tuomey.

On the second question, the government had contended that the compensation implicated the Stark Law’s “volume or value” standard because Tuomey considered a portion of the value of the anticipated technical component referrals when determining the physicians’ compensation. Tuomey argued that the relevant inquiry was “whether the physicians’ compensation takes into account the volume or value of referrals, not whether the parties considered referrals when deciding whether to enter the contracts in the first place.”6 The 4th Circuit concluded that compensation arrangements that take into account “anticipated referrals” implicate the volume or value standard under the Stark Law. To support its conclusion, the court cited CMS commentary and the definition of “fair market value,” which is defined, in relevant part, as compensation that “has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals.”7

On remand, the 4th Circuit stated that the jury must determine whether the compensation underlying the arrangements took into account the volume or value of the referrals the physicians made to Tuomey, and, if so, whether the employment agreements met the Stark Law’s indirect compensation exception.

District Court Retrial - May 2013

As noted above, on retrial, the federal jury found that Tuomey violated both the Stark Law and the FCA.

Throughout both trials, Tuomey had argued that it believed the arrangements were commercially reasonable and not in excess of fair market value given the shortage of physicians in the community,8 and the arrangements were permissible under federal statutes and regulations. In addition, Tuomey argued that it had sought and relied in good faith upon advice from various law firms and consultants regarding Stark Law compliance in connection with the employment agreements. The government, however, presented evidence that Tuomey was advised by a legal consultant in 2005 that the arrangements were problematic, and that Tuomey disregarded the advice, dismissed the consultant and continued with the problematic arrangements.

The 10-person jury returned a verdict for the Stark Law and FCA violations totaling $39.3 million. The parties will now submit proposals regarding the appropriate amount of FCA damages. Because the potential $357 million FCA liability would be financially catastrophic for the community hospital, Tuomey may not receive the maximum penalty. Tuomey has 28 days to file an appeal.


In light of this verdict and the 4th Circuit’s decision, both of which highlight the risks created by the Stark Law, there are some key points for hospitals and health systems to consider:9

Increased Stark Law Enforcement. This case demonstrates that the government is serious about enforcing the Stark Law. In addition, the favorable verdict may encourage federal prosecutors to more actively pursue FCA cases based on the Stark Law or other fraud and abuse law violations (and perhaps be less willing to settle out-of-court).

Stark Law Compliance. Tuomey highlights how tricky complying with the Stark Law can be. The Tuomey case provides certain guidance, including the following:

  • Basing physician compensation on personally performed services does not automatically make the Stark Law a non-issue.
  • It is necessary to review all physician arrangements involving inpatient or outpatient hospital services for Stark Law compliance because there will always be a referral of a technical component when a referring physician performs such services.
  • The overall transaction should be commercially reasonable – e.g., compensation should not be far in excess of collections.

Fair Market Value Opinions. Fair market value was critical in Tuomey. It is clear from this case that anticipated referrals of designated health services cannot be considered when structuring physician compensation (otherwise it will not be considered fair market value). Accordingly, compensation must reflect only the fair market value of the professional services being provided. For each arrangement that potentially implicates the Stark Law or federal anti-kickback law, a reliable fair market valuation should be obtained.

Whistleblowers. This case was a successful qui tam action. Dr. Drakeford stands to receive between 15 and 25 percent of any recovery from Tuomey. At a minimum, he will receive $5.895 million. This case also underscores that contractual arrangements do not always remain confidential, and that hospitals need to be prepared to demonstrate compliance with the Stark Law and other fraud and abuse laws, especially when negotiations are unsuccessful or become acrimonious.

If you have any questions about this decision, the Stark Law or the False Claims Act, or wish to discuss how it applies to your particular circumstance, please feel free to contact Judy Wang Mayer, or any member of the Health Law Group.

1 The Stark Law requires repayment of the full amount of “tainted” claims. The FCA permits the government to recover up to treble damages plus $5,500 to $11,000 per claim.

2 42 C.F.R. § 411.357(c)(2). In addition, in order for an indirect compensation arrangement to exist, there must also be an unbroken chain of relationships linking the referring physician with the entity furnishing designated health services, and the entity furnishing designated health services must have actual knowledge of, or act in reckless disregard or deliberate ignorance, of the arrangement.

3 No. 3:05-02858, 2010 WL 4000188 (July 13, 2010).

4 675 F.3d 394 (4th Cir. March 2012).

5 66 Fed. Reg. 856, 941 (Jan. 4, 2001).

6 675 F.3d at 408.

7 Id. (quoting 42 C.F.R. § 411.351 (internal quotations omitted)).

8 Tuomey is located in a Health Professional Shortage Area (HPSA).

9 There is some uncertainty about the impact of Tuomey as it was decided by jury verdict with no written opinion.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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