CMS’ Proposed Stark Rule Change and Guidance on “The Big Three”: Fair Market Value, Commercial Reasonableness, and Taking Into Account Volume or Value Referrals

Seyfarth Shaw LLP
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As part of a larger “Regulatory Sprint to Coordinated Care” the Centers for Medicare & Medicaid Services (CMS) of the U.S. Department of Health & Human Services (HHS) recently issued a proposed rule aimed at modernizing and streamlining the Federal Stark Regulations.

But with the deadline rapidly approaching to provide comments on the proposed changes, HHS officials and industry leaders are weighing in publicly with comments and perspectives on the changes’ potential application.

The proposed rule, according to CMS’s statements in the Federal Register, provides “critically necessary guidance for physicians and health care providers and suppliers whose financial relationships are governed by the physician self-referral statute and regulations.”

Nevertheless, there is particular concern and focus across the industry regarding CMS’ dramatic changes to what it calls “The Big Three” definitions in Stark law:

  • Fair market value,
  • Commercial reasonableness, and
  • Prohibition on “taking into account” the volume or value of a physician’s referrals.

CMS further stated that the proposed rule “would also create a new exception for certain arrangements under which a physician receives limited remuneration for items or services actually provided by the physician; create a new exception for donations of cybersecurity technology and related services; and amend the existing exception for electronic health records (EHR) items and services.”

The proposed rule is “part of a much broader effort to update, reform, and cut back our regulations to allow innovation toward a more affordable, higher quality, value-based healthcare system, while maintaining the important protections patients need,” said Deputy Secretary Eric Hargan, in a press release.

According to Seyfarth Partner Bill Eck, chair of Seyfarth’s national Health Care Mergers & Acquisitions practice, “the proposed regulations offer important clarifications and simplifications in the big three areas that practitioners and industry face on a daily basis. Moreover, they offer guidance that if adopted will reduce risk by tightening the analysis of concepts that had become somewhat muddled, and by making clear that some arrangements typical in the industry do not pose a threat to the Medicare program or its beneficiaries and should not be deemed to violate the physician self-referral law.”

“This is going to provide much more flexibility in certain financial or compensation arrangements or value based structures,” said Daniel Platten, Director in the Valuation Advisory Services business of Duff & Phelps and member of its Healthcare & Life Sciences Industry practice. “This is definitely a step in the right direction to achieve what CMS set out years back as part of the ACA value-based care initiative.”

From a transactional standpoint, the proposed rule is likely to “free up providers to enter into arrangements which may have been restricted and providers were trying to avoid,” added Andreas Chrysostomou, Managing Director in the Valuation Advisory Services of Duff & Phelps and the Global Leader of its Healthcare & Life Sciences Industry practice.

I. Fair Market Value - Breaking It Down

Fair Market Value” is currently defined in the Section 1877 of the Social Security Act (42 U.S.C. 1395nn) as “the value in arms length transactions, consistent with the general market value, and, with respect to rentals or leases, the value of rental property for general commercial purposes (not taking into account its intended use) and, in the case of a lease of space, not adjusted to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee.”

The proposed rule would modify the definition in 42 C.F.R. § 411.351 of ‘‘fair market value’’ to provide for a definition of general application, a definition applicable to the rental of equipment, and a definition applicable to the rental of office space.

Specifically, the changes would be as follows:

  1. The value in an arm’s-length transaction, with like parties and under like circumstances, of like assets or services, consistent with the general market value of the subject transaction.
  2. Rental of equipment. With respect to the rental of equipment, the value in an arm’s-length transaction, with like parties and under like circumstances, of rental property for general commercial purposes (not taking into account its intended use), consistent with the general market value of the subject transaction.
  3. Rental of office space. With respect to the rental of office space, the value in an arm’s-length transaction, with like parties and under like circumstances, of rental property for general commercial purposes (not taking into account its intended use), without adjustment to reflect the additional value the prospective lessee or lessor would attribute to the proximity or convenience to the lessor where the lessor is a potential source of patient referrals to the lessee, and consistent with the general market value of the subject transaction.

The goal of this approach, according to CMS, is that it “provides parties with ready access to the definition of ‘fair market value,’ with the attendant modifiers, that is applicable to the specific type of compensation arrangement at issue.”

In addition, CMS is proposing changes to the definition of “general market value,” currently contained to reflect the following:

  1. The price that assets or services would bring as the result of bona fide bargaining between the buyer and seller in the subject transaction on the date of acquisition of the assets or at the time the parties enter into the service arrangement.
  2. Rental of equipment or office space. The price that rental property would bring as the result of bona fide bargaining between the lessor and the lessee in the subject transaction at the time the parties enter into the rental arrangement.

According to CMS, the goal of these changes is for the definition of “general market value” to “mean the price that assets or services would bring as the result of bona fide bargaining between the buyer and seller in the subject transaction on the date of acquisition of the assets or at the time the parties enter into the service arrangement; or, in the case of the rental of equipment or office space, the price that rental property would bring as the result of bona fide bargaining between the lessor and the lessee in the subject transaction at the time the parties enter into the rental arrangement.”

Eck commented that the proposed change “clarifies that ‘fair market value’ is a stand-alone concept, which is not related to the ‘commercial reasonableness requirement’ or the volume or value of referrals standard.”

Eck, who has served as outside regulatory counsel in numerous public company transactions involving the Stark laws, added that, “This much needed clarity should be quite useful in the application of the fair market value requirement going forward and, we would suggest, closer to the statutory intent than some Courts have strayed.”

Platten thinks the changes here go back adding increased flexibility. “In identifying a hypothetical transaction buyer, I think this gives a little more leeway in terms of what the definition historically stated.”

Nevertheless, these new definitions could end up muddying the waters a bit. According to Platten, while FMV’s prior definitions came straight out of the tax code, there has been some confusion in the industry regarding where the new definitions in the proposed rule came from and how CMS exactly arrived at the new language.

“It will take the first few cases to challenge [this new language] before the new interpretation will come out,” Chrysostomou added.

II. Commercial Reasonableness - It Doesn’t Have to Profitable to be Reasonable

CMS is proposing two alternative definitions for commercial reasonableness

  • Option 1: Commercially reasonable means that the particular arrangement furthers a legitimate business purpose of the parties and is on similar terms and conditions as like arrangements. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.
  • Option 2: Commercially reasonable means that the particular arrangement makes commercial sense and is entered into by a reasonable entity of similar type and size and a reasonable entity of similar scope and specialty. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.

The key differences between these two proposals, as evident by its language is that the first definition requires a “legitimate business purpose” to be commercially reasonable and the second requires that the arrangement “makes commercial sense.”

Both proposed definitions are designed to clear up what CMS has stated is a “widespread misconception about our position on the nexus between the commercial reasonableness of an arrangement and its profitability. We wish to clarify that compensation arrangements that do not result in profit for one or more of the parties may nonetheless be commercially reasonable.”

Eck believes that this change in definition for “commercial reasonableness” is a “key development and may put to rest the ‘practice loss’ theory embraced by the Tuomey Courts1.”

If adopted as a final rule, Eck warned that “industry players will nevertheless be well-advised to tread cautiously, because it may continue to be tempting for Courts to find losses to be evidence of an absence of commercial reasonableness.”

III. “Taking into account” the volume or value of a physician’s referrals - A “Bright-Line” “Objective” Rule

In addition to providing guidance on fair market value and commercial reasonableness, the new proposed rule is designed to provide “an objective test for determining whether the compensation is determined in any manner that takes into account the volume or value of referrals or takes into account other business generated between the parties.” In other words, this is a “bright-line rule sought by commenters and other stakeholders[.]”

According to Eck, “CMS’s approach is mathematically simple, which it has not always been, at least not as interpreted by the Tuomey and Bookwalter Courts2. Here too, CMS offers clarity to the industry, and its approach, while not always yielding the results some desire, has the benefit of being much easier to apply.”

For example, the new rule would allow compensation from an entity furnishing designated health services to a physician to take into account the volume or value of referrals in certain circumstances where, for example:

  • The formula used to calculate the physician’s (or immediate family member’s) compensation includes the physician’s referrals to the entity as a variable, resulting in an increase or decrease in the physician’s (or immediate family member’s) compensation that positively correlates with the number or value of the physician’s referrals to the entity; or
  • There is a predetermined, direct correlation between the physician’s prior referrals to the entity and the prospective rate of compensation to be paid over the entire duration of the arrangement for which the compensation is determined.

Similarly, compensation from a physician (or immediate family member of the physician) to an entity furnishing designated health services may take into account the volume or value of other business generated under the new rule only if—

  • The formula used to calculate the entity’s compensation includes other business generated by the physician for the entity as a variable, resulting in an increase or decrease in the entity’s compensation that negatively correlates with the physician’s generation of other business for the entity; or
  • There is a predetermined, direct correlation between the other business previously generated by physician for the entity and the prospective rate of compensation to be paid over the entire duration of the arrangement for which the compensation is determined.

Similar changes are being proposed for compensation from an entity furnishing designated health services to a physician takes into account the volume or value of other business generated.

According to CMS, this is an “approach that, rather than deeming compensation under certain circumstances not to have been determined in a manner that takes into account the volume or value of referrals or takes into account other business generated between the parties, defines exactly when compensation will be considered to take into account the volume or value of referrals or take into account other business generated between the parties.” (emphasis added)

CMS has emphasized that these special rules apply only for purposes of section 1877 of the Act and the physician self-referral regulations.

Ultimately, the implementation of these various changes will create greater flexibility in financial relationships between hospitals and health systems and their referring physicians, said Seyfarth Partner John Shire. “While these rules remain far from clear, on a granular level, hospitals, health systems and physician groups should take advantage of these regulatory changes to update their agreements to fall more closely in line with the practical realities of their precise business arrangements. We should view this as a positive trajectory,” he said.

The proposed rule was published on October 17, 2019, in the Federal Register (84 FR 55766-55847). Comments must be submitted by close of business on December 31, 2019.

Also on October 17, 2019, the Office of Inspector General (OIG) of HHS published in the Federal Register (84 FR 55694-55765) a proposed rule to revise safe harbors under the federal anti-kickback statute and the civil monetary penalty law that prohibits inducements offered to patients. Seyfarth is preparing a separate summary of that proposed rule which it will issue shortly.


1. U.S. ex rel. Drakeford v. Tuomey Healthcare System, 675 F.3d 394 (4th Cir. 2012)

2. U.S. ex rel. Bookwalter v. UPMC, 938 F.3d 397 (2019).

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