Valuators Take Note

Fair market value is key to compliance with both the Stark Law and the Anti-Kickback Statue. Solid, well-reasoned valuations can be essential in establishing compliant arrangements, and these must consider practice losses as applicable. In this article, Lynn Gordon, Esq., states that it is “prudent to have a valuation in place that supports compensation as fair market value,” especially if the practice area incurs losses. Gordon adds this is especially important in “high-stakes transactions likely to draw attention (e.g., transactions with significant inpatient care reimbursement such as cardiology and orthopedic surgery).” Gordon advises, “valuator[s] should work together to assess and document the reasons for such losses—how they are not indicative of overpayments but rather a condition not attributable to excess compensation.” This analysis, she argues, “result[s] in better economic efficiencies for the health system as its valuator works through a root-cause analysis of less obvious factors driving expenses.” Doing this should lead to “an in-depth assessment to identify room for improvement, further diminishing net losses.”

Consolidation and integration is cyclical within the healthcare industry—the latest cycle is being driven in large part by healthcare reform as providers come together to work more collaboratively in delivering healthcare.  Episodic care is being supplanted by a care system or structure that requires patient care management across the spectrum, integrating care components to facilitate higher quality and more cost efficient healthcare delivery.  The current wave of consolidation continues at a steady pace, with physician integration initiatives dominating many regions since physicians are an integral component of care delivery.  Hospital and health systems are prioritizing physician practice acquisitions, physician employment, and other physician contracting initiatives.

As hospitals and health systems move forward with these initiatives, they often rely on well-informed valuators to help navigate certain fair market value (FMV) regulatory tripwires that implicate Stark and Anti-Kickback rules and regulations governing hospital-physician financial relationships.  More focused regulatory attention on such matters indicates that practice losses in particular can invite scrutiny.  Accordingly, as valuators assist their healthcare clients in establishing physician compensation, it is prudent that they also understand the regulatory implications of practice losses and address these appropriately in valuation opinions and other consulting reports as applicable.

Tripwires: The Stark Law and Anti-Kickback Statute
Although the integration of physicians and physician practices into hospital systems can be a very successful endeavor, it can also be the source of numerous potential fraud and abuse issues.  Relationships between physicians and hospitals are highly regulated under healthcare fraud and abuse rules and regulations.  There are two key federal laws that govern financial relationships between physicians and other entities involved in the delivery of healthcare: the Stark Law and the Anti-Kickback Statute (AKS).

The Stark Law is a physician-centric law in that it prohibits physicians from referring Medicare patients to any entity with which the physician (or an immediate family member) has a financial relationship for the provision of what the government calls “designated health services” or DHS, unless an exception applies.[1]  This is generally referred to as the Stark Law “Referral Prohibition.”  The Stark Law also prohibits any entity from billing any individual, third-party payor or other entity for any of these DHS provided pursuant to a prohibited referral.  This is generally referred to as the Stark Law “Billing Prohibition.”[2]

Practically speaking, any hospital that engages physicians in a business relationship must be cognizant of Stark implications.  The DHS list of health services specified under the Stark Law explicitly includes all hospital inpatient and outpatient services, serving as a significant catch-all for hospitals.[3]  Therefore, as long as a hospital participates in Medicare on a fee-for-service basis, each of its financial relationships with a referral-source physician must fit squarely within a Stark exemption or exception to the extent such physician is referring Medicare beneficiaries to the provider for DHS or all resulting DHS referrals and related DHS provider claims will be prohibited. The Stark exceptions cover many common arrangements, including physician employment, fair market value compensation, and commercial reasonableness are common parameters.

While the Stark Law focuses on physician financial matters, the AKS is a criminal law that is much broader in scope in terms of implicated parties and activities under its purview. The AKS applies to any entity or individual tied in some way to federal healthcare reimbursement, including hospitals and physicians, medical manufacturers and purchasing providers, or those who refer patients for use of equipment. In simple terms, it is illegal for any entity or individual to pay for, directly or indirectly, the (i) referral of (or in some cases even the recommendation of) federal healthcare program patients; and/or (ii) other goods or services that federal healthcare programs pay for, in whole or in part.[4]  It is also illegal to solicit such payment.  Although a hospital must fit a financial relationship within a Stark exception if the Stark Law is implicated, it is not required to meet an applicable AKS “safe harbor,” but safe harboring is prudent.  As with the Stark Law, fair market value and commercial reasonableness are two concepts drilled into many of the safe harbors.

Hospital employment of physicians, whether following a practice acquisition or done as part of a recruiting initiative, should meet the Stark Employment Exception: (1) the employment is for identifiable services; (2) the amount of the remuneration under the employment is: (i) consistent with the fair market value of the services; and (ii) except with respect to a productivity bonus based on services performed personally by the physician, is not determined in a manner that takes into account (directly or indirectly) the volume or value of any referrals by the referring physician; and (3) the remuneration is provided under an agreement that would be commercially reasonable even if no referrals were made to the employer.[5]  The AKS employment safe harbor is much simpler: the employment must be a bona fide employment relationship with the employer.[6]

Practice losses beg the question of whether the employer is paying in excess of fair market value or is acting in a commercially reasonable manner, since it is a common assumption that a business should cover its expenses through its revenue.  Where a physician practice is generating losses for a hospital employer, regulators may query whether physicians are being paid in excess of fair market value.  Taken further, their analysis would consider whether the “excess” payment is in exchange for referrals (i.e., the facility and technical revenue associated with the physician’s practice) which could result in substantial penalties under one or both of these federal laws.

Fair Market Value Defined and Applied: Assessing FMV in Light of Practice Losses
FMV is key to compliance with both the Stark Law and the AKS.   Solid, well-reasoned valuations can be essential in establishing compliant arrangements, and these must consider practice losses as applicable.  Regulators have provided the following guidance as to maintaining a fair market value arrangement:

Fair market value means the value in arm’s-length transactions consistent with the general market value. General market value means…the compensation that would be included in a service agreement as the result of bona fide bargaining between well-informed parties to the agreement who are not otherwise in a position to generate business for the other party…at the time of the service agreement. Usually the fair market price is…the compensation that has been included in bona fide service agreements with comparable terms at the time of the agreement, where the price or compensation has not been determined in any manner that takes into account the volume or value of anticipated or actual referrals.[7]

Healthcare appraisers also use an adjusted “classic” definition of fair market value (the hypothetical buyer definition):

The price…at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length without any referral relationships, in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.[8]

Excessive payments may also indicate that an arrangement is not commercially reasonable.  As a concept related to fair market value, regulators define commercial reasonableness as follows:

We are interpreting ‘commercially reasonable’ to mean that an arrangement appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.[9] An arrangement will be considered ‘commercially reasonable’ in the absence of referrals if the arrangement would make commercial sense if entered into by a reasonable entity of similar type and size and a reasonable physician (or family member or group practice) of similar scope and specialty, even if there were no potential DHS referrals.[10]

It is prudent to have a valuation in place that supports compensation as fair market value, as well as an evaluation of commercial reasonableness as defined above, especially in high-stakes transactions likely to draw attention (e.g., transactions with significant inpatient care reimbursement such as cardiology and orthopedic surgery).  Moreover, to the extent compensation would or likely could result in practice losses, the health system and valuator should work together to assess and document the reasons for such losses—how they are not indicative of overpayments but rather a condition not attributable to excess compensation.  This exercise could result in better economic efficiencies for the health system as its valuator works through a root-cause analysis of less obvious factors driving expenses.  It is not uncommon for an in-depth assessment to identify room for improvement, further diminishing net losses.

For example, in communities serving a material percentage of charity care or Medicaid patients where the reimbursement falls short of the reasonable expenses of the care being delivered, hospitals often cannot recruit and retain physicians unless the hospital is prepared to assume practice losses in light of the payor mix.  Also, in health systems just starting to build physician practice infrastructures, there may be more up-front expenditures that adversely impact profitability in the short run.  Similarly, systems implementing or changing an electronic health record or migrating a physician practice to an existing EHR may adversely impact physician productivity as employed physicians must slow down and acclimate to a new system.  Collections may be impacted for a period of time.  While this may drive losses, it doesn’t necessarily indicate excess compensation.  A solid report would document these factors as driving practice losses, whether long-term or more temporary in nature.

In terms of room for improvement, hospital physician practices may carry excess overhead that a valuator can help to identify and remediate based upon comparatives, thereby achieving better cost efficiencies for the hospital.  Similarly, consultants often can assist in pricing and third-party payor negotiations.  Hospitals with a solid track record in negotiating hospital payments may find themselves in unfamiliar territory when it comes to physician services.  Certain valuation firms offer managed care contracting support which, in turn, may ameliorate practice revenue shortfalls.

While this approach may add a layer to the valuation exercise, case law clearly demonstrates how costly noncompliance may be.  For example, the Tuomey case is a Stark Law battle that began when a physician whistleblower filed an action in 2005 concerning alleged excessive payments by Tuomey Healthcare System to referral-source physicians.  The government intervened in the case on 2007 and the case has been through a trial, an appeal and a retrial.  On October 1, 2013, U.S. District Judge Margaret Seymour ruled against Tuomey Healthcare System, Inc., on virtually every post-trial issue addressing the hospital’s contractual relationships with surgeons and granted the government’s request to impose $237.5 million in Stark penalties and False Claims Act fines.[11]

The government’s position in the case included the following: the total compensation to the physicians, including benefits, on average was 19 percent higher than the corresponding professional component collections assigned to the hospital, and compensation varied with the volume and value of referrals, because the physicians only earned money for work that simultaneously generated a fee for the hospital.  In other words, excessive payments were at issue, as was the alleged inherent tie between payments for contracted professional services and the corresponding technical/facility fees that the hospital billed based upon the surgeon referrals.  The government’s expert testified that all of the physicians’ compensation exceeded fair market value, some in cash alone, and others in benefits.  She also noted a number of “red flags” some of which weighed against the requisite finding of commercial reasonableness absent illegal consideration of the volume or value of referrals.

While the Tuomey case is ongoing (under appeal), the opinions to date under this case reiterate the critical need to establish and effectively document a fair market value relationship that does not consider the volume or value of referrals for DHS.  Moreover, they clearly reflect the scrutiny that may result from payments which exceed the professional collections resulting from the services being delivered by the employed physician.  In engagements where the valuator anticipates that practices losses may ensue—such as with a client in the process of building its physician practice infrastructure or a client staffing indigent care clinics or serving a patient population with a challenging payor mix—the client may be well served by a more comprehensive opinion or report which also assesses anticipated practice losses.  Not only will this process help to demonstrate compliance with the Stark Law and AKS, it may also help to increase profitability as hospitals and health systems continue their foray into physician practice management and operations.

Lynn Gordon, Esq., is partner and chair of healthcare of Ungaretti & Harris, a Chicago-based law firm, with a Springfield, IL branch focused on government services. Ms. Gordon concentrates her practice in the area of corporate and regulatory healthcare law, with a particular emphasis on the transactional, regulatory, and operational legal counsel needs of hospitals, health systems, FQHCs, and specialty provider groups, including mergers and acquisitions, provider networks, healthcare joint ventures, contract drafting and negotiations, physician integration, antitrust, Stark, anti-kickback, and IRC 501(c)(3) regulatory compliance, and Medicare and Medicaid recoupment and repayment (self-disclosure) matters. Ms. Gordon can be reached at (312) 977-4134 or by e-mail at

[1] 42 U.S.C. §1395 nn et seq. (2013).  Designated health services is a list of health services specified under the Stark Law.  (This prohibition applies to all designated health services rendered after December 31, 1994.)  The designated health services—meaning the limited set of services which implicate the Stark Law—include (i) clinical laboratory services, (ii) physical therapy, occupational therapy and speech-language pathology services, (iii) radiology and certain other imaging services, (iv) radiation therapy services and supplies, (v) durable medical equipment and supplies, (vi) parental and enteral nutrients, equipment and supplies, (vii) prosthetics, orthotics and prosthetic devices and supplies, (viii) home health services, (ix) outpatient prescription drugs, and (x) inpatient and outpatient hospital services (collectively, “DHS”).  42 C.F.R. §411.351 (2013).

[2] See 42 U.S.C. §1395nn(a)(1)(B) (2013).

[3] 42 CFR §411.351 (2013).

[4] 42 USC §1320a-7b(b)(1) (2013).

[5] 42 CFR §411.357(c) (2013) (emphasis added).

[6] 42 CFR §1001.952(d) (2013).

[7] 42 CFR §411.351 (2013).

[8] International Glossary of Business Valuation Terms.

[9] Physician’s Referrals to Health Care Entities With Which They Have Financial Relationships, 63 Fed. Reg. 1659, 1700 (Jan. 9, 1998) (to be codified at 42 CFR Pt. 411).

[10] Physician’s Referrals to Health Care Entities With Which They Have Financial Relationships (Phase II), 69 Fed. Reg. 16093, 16054 (Mar. 26, 2004) (to be codified at 42 CFR Pt. 411).

[11] Tuomey has appealed this ruling, and a post-verdict out-of-court settlement is under consideration as well.  The opinion is available at The damage amount is believed to be the largest of its kind against a community hospital in U.S. history, involving more than 21,000 Medicare claims worth $39.3 million that a jury had determined violated the Stark law and the False Claims Act. See Modern Healthcare, “Out-of-Court Settlement for Tuomey May be in the Works Following Ruling Against the System,” available at

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