CMS Finalizes and Clarifies Key Valuation Terms in the Stark Law

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This Commentary is part of a series of nine Commentaries on the newly finalized Stark Law and Anti-Kickback Statute exceptions and safe harbors seeking to remove regulatory barriers to care coordination.

In Short

The Situation: Under the federal Physician Self-Referral Law ("Stark Law"), many physician arrangements must meet one or more of the so-called "big three" requirements: that the arrangement be "commercially reasonable," that the amounts paid not be based on the "volume or value of referrals or other business generated for a party," and that the amounts paid be consistent with "fair market value" ("FMV"). These three terms are used throughout the Stark Law regulations and appear in many of the Stark Law exceptions, but there has been long-standing uncertainty surrounding the terms' respective meanings.

The Action: The Centers for Medicare & Medicaid Services ("CMS") issued a final rule, effective January 19, 2021, which makes key updates to these cornerstone terms. In addition to creating a definition of "commercially reasonable," the final rule provides bright-line tests for determining whether compensation will vary with the volume or value of referrals or other business generated by a party. It also revises the definition of FMV to add a separate definition of "general market value" and organize the definition by transaction type.

Looking Ahead: Although the updates in the final rule do not resolve entirely the uncertainty surrounding these three key terms, each of the updates provides a more objective standard against which the health care industry can measure compliance. CMS explained that these updates were primarily intended for clarification and organization, and that it does not intend for the updates to require major overhauls to compliance protocols. Nonetheless, health care organizations should consider evaluating their physician arrangements to ensure they align with the revised definitions.

On December 2, 2020, the Centers for Medicare & Medicaid Services ("CMS") finalized long-awaited changes to the rules under the Physician Self-Referral Law, known as the "Stark Law." As discussed in our publication in 2019, CMS proposed the regulatory revisions in part to resolve uncertainty surrounding the terms "commercially reasonable," "volume or value of referrals," and "fair market value." In publishing the final rule, CMS explained that it intended "to establish bright-line, objective regulations" in an effort to enhance government enforcement capability as well as to "to reduce the burden of compliance" for health care providers.

Commercially Reasonable

New Definition: CMS has finally defined "commercially reasonable": "the particular arrangement furthers a legitimate business purpose of the parties to the arrangement and is sensible, considering the characteristics of the parties, including their size, type, scope, and specialty." In doing so, CMS declined to include a proposed requirement that compensation arrangements be on "similar terms as like arrangements," explaining that this standard did not provide adequate clarity and could increase the regulatory burden on parties by requiring outside experts to ensure compliance.

Related Analysis: The new definition expressly confirms that an arrangement may be commercially reasonable even if it is not profitable. However, profitability is not "always unrelated to a determination of its commercial reasonableness." CMS declined commenters' requests to codify examples of permissible, though unprofitable, arrangements. But the agency described as "compelling" the comments it received concerning the legitimate benefits of unprofitable service lines, such as burn units and psychiatric units, and the risks of shifting reimbursement methodologies.

In response to comments regarding the commercial reasonableness of arrangements "even if no referrals were made between the parties," CMS explained that it would be redundant to include this phrase in the definition of commercially reasonable because similar language appears in the text of many of the exceptions. Proving the point, CMS added the qualification to the fair market value compensation exception.

Despite requests for additional guidance from commenters, CMS did not clarify what constitutes a "legitimate business purpose." Instead, the agency simply stated that the requirement is an "objective standard" and recycled obvious examples from the proposed rulemaking: addressing community need, timely access to health care services, fulfillment of licensure or regulatory obligations (including those under the Emergency Medical Treatment and Labor Act (EMTALA)), the provision of charity care, and the improvement of quality and health outcomes.”

Volume or Value of Referrals

New Definition: Many stakeholders had requested clarity on when physician compensation takes into account "the volume or value of referrals," especially given the threat of False Claims Act ("FCA") litigation predicated on noncompliance with the Stark Law. The final rule is largely consistent with the proposed rule: a physician's compensation takes into account the volume or value of referrals only "if the formula used to calculate the physician's…compensation includes the physician's referrals to the entity as a variable, resulting in an increase or decrease in the physician's compensation…that positively correlates with the number or value of the physician's referrals to" or other business generated for the entity. For example, if an entity paid a physician one-fifth of a bonus pool that included all collections from a variety of services furnished by the entity, including collections from designated health services ("DHS") referred but not personally performed by the physician, the value of referrals is a variable in the compensation arrangement.

Related Analysis: CMS had proposed an "if X then Y" correlative test for determining whether fixed-rate compensation is determined in a manner that takes into account the volume or value of referrals. Rather than finalizing this test, CMS revised 42 C.F.R. § 411.354(d)(4), setting forth what CMS describes as a "clearer standard" for requirements that must be met if the physician's compensation is conditioned on referrals to a particular provider. The agency also explained that the existing special rules for unit-based compensation cannot "save" an arrangement that is deemed to take into account the volume or value of referrals. Although the unit-based compensation rules are no longer effective as of January 19, 2021, CMC retained the language in the regulation for historical purposes for easier analysis of compliance for prior periods.

In the final rule's preamble, CMS reiterated that a productivity bonus based on personally performed services could be paid in connection with a bona fide employment relationship or personal services arrangement. The agency "reaffirm[ed]" that such compensation did not take into account the volume or value of referrals simply because corresponding hospital services are billed each time the physician performs a service. In light of recent FCA litigation, commenters had requested that CMS codify this position in the regulation, but CMS declined.

CMS also set forth an important new test relating to the definition of an "indirect compensation arrangement," which the agency suggested could alleviate the industry's enforcement concerns. The test largely aligns with the new special rules on compensation. Specifically, an indirect compensation arrangement exists if compensation to the physician varies with the volume or value of referrals or other business generated for the DHS entity and the individual unit of compensation (i) is not fair market value; or (ii) includes the physician's referrals to or other business generated for the DHS entity as a variable, resulting in an increase or decrease in the physician's compensation that positively correlates with the number or value of the physician's referrals. In addition, the DHS entity must act with knowledge or reckless disregard that the compensation so varies. CMS explained that it hopes these changes will facilitate "the identification of truly problematic physician compensation…at an earlier stage of analysis." This modification could offer defendants an opportunity to seek dismissal of certain meritless FCA cases, rather than having to prove compliance with the indirect compensation exception at the summary judgment stage, as some courts have required.

Although several commenters expressed strong support for CMS's proposal to remove the phrase "varies with" from the definition of indirect compensation arrangements, the agency did not finalize this proposal. CMS noted that such a change would have eliminated most unbroken chains of financial relationships from the Stark Law's scrutiny without allowing CMS to confirm that such compensation does not improperly influence physicians' medical decision making. However, CMS expressed that its finalized changes will reduce the number of indirect compensation arrangements subject to the Stark Law.

Fair Market Value and General Market Value

Fair Market Value: CMS finalized revisions to the definition of fair market value ("FMV") and created a standalone definition of "general market value"—a concept that, until now, was included within the definition of FMV. CMS also finalized its proposal to eliminate "the volume or value standard" in the definition of FMV. The agency explained that FMV and the volume or value standard are separate and distinct requirements of remuneration that must be independently satisfied for each applicable Stark Law exception. Specifically, CMS removed the sentence from the FMV definition that directly referenced the fair market price as having "not been determined in any manner that takes into account the volume or value of anticipated or actual referrals."

The final definition of FMV contains three parts, with separate definitions for (i) general application; (ii) the rental of equipment; and (iii) the rental of office space. FMV for general application means: "The value in an arm's-length transaction, consistent with the general market value of the subject transaction." CMS chose not to finalize the inclusion of "like parties and under like circumstances," which had been proposed. Although CMS did not explain this decision, the agency may have concluded that such language would have required outside experts, as it noted when rejecting similar phrasing in the definition of commercially reasonable. The final definitions for FMV applicable to rental of equipment and rental of office space are similar to the general application definition. This three-part structure is consistent with the proposed rule, but the final definitions are nearly identical to the language in the existing regulation.

General Market Value: CMS also added a three-part definition of "general market value"—one for asset acquisitions, one for compensation for services, and one for rental of equipment or office space. Rather than finalizing the language of the proposed definition for general market value—the price that would result from "bona fide bargaining between the buyer and seller"—the three final definitions instead retain the existing language for general market value: the price that would result from "bona fide bargaining between well-informed buyers and sellers that are not otherwise in a position to generate business for each other." CMS explained that retaining the existing language would be less disruptive to the health care industry and valuation professionals, which have developed protocols and standards in accordance with the existing regulation.

Related Analysis: CMS explained that, in retaining the existing language, it rejected the analytical framework of the proposed rule, in which FMV focused on hypothetical parties while general market value focused on the particular parties involved in a financial arrangement. Nonetheless, CMS stated that "[a]lthough we are not finalizing the proposed analytical framework related to ‘hypothetical' versus ‘actual' transactions, we continue to believe that the fair market value of a transaction … may not always align with published valuation data compilations, such as salary surveys." CMS went on to affirm all of the examples of general market value provided in the proposed rule, with modifications to eliminate terminology not included in the final regulations. Thus, CMS may view the finalized language as a difference in form and not substance from the framework outlined in the proposed rule. That is, although FMV should not be a subjective determination influenced by other business between the specific parties, hypothetical valuation data may not provide a complete picture of the subject transaction—the nature of the transaction, its location, and other facts and circumstances may affect the parties' proper calculation of FMV.

Ultimately, CMS appears to view the changes with respect to FMV as minor revisions meant for clarification, organization, and to disentangle the volume or value standard from FMV. The final definitions do little to resolve historical valuation difficulties presented by the distinction between FMV under the Stark Law and FMV under general market principles (in fact CMS retracted all of its statements equating the two concepts). And despite CMS's explanation in the preamble to the final rule, the final definitions do not create an allowance for compensation variance based on specific party circumstances.

Looking Forward and Backward

CMS explained that its changes to the valuation terms, which take effect on January 19, 2021, were primarily intended to "clarify" existing standards (for both industry and law enforcement) rather than significantly modify requirements. CMS acknowledged comments from stakeholders that FCA case law has "exacerbated the challenge of complying" with Stark Law regulations, and the agency reiterated its intent to balance program integrity concerns against compliance burdens on industry. Accordingly, certain aspects of the final rule emphasize how the new regulations—as well as the discussion of concepts in the preamble—align with CMS's past views. For example, although CMS explained that its special rules regarding compensation supersede prior guidance, CMS also said that the final regulations are "consistent" with positions taken by CMS in the Phase I Stark Law rulemaking. Likewise, CMS characterized its definition of commercially reasonable as "consistent with the guidance [CMS] provided in the 1998 proposed rule." CMS also stated multiple times that the views it expressed with respect to FMV were reflective of the agency's "continued" beliefs. These types of statements could prove useful for health care entities defending past arrangements in connection with FCA litigation or government enforcement activities.

Three Key Takeaways:

  1. CMS revised the Stark Law regulations to offer clarity to stakeholders on the "big three" valuation requirements that appear in many of the Stark Law exceptions.
  2. Notable changes include a new definition of commercial reasonableness that specifies that an arrangement need not be profitable to be commercially reasonable, an objective correlative test for determining whether compensation takes into account the volume or value of referrals, and distinct, restructured definitions for the terms "fair market value" and "general market value."
  3. CMS expressed that the majority of its changes are intended to reduce burdens on the health care industry and law enforcement. Even so, health care organizations should consider reviewing documentation associated with physician arrangements for consistency with the new regulations and accompanying guidance from CMS in the preamble to the final rule.

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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