Changes to Stark Law’s Foundational Terminology

Valuation Implications

On November 20, 2020, the Centers for Medicare & Medicaid Services (CMS) issued a final rule to modernize and clarify the Stark Law. The Stark Law governs those physicians (or their immediate family members) who have a financial relationship with an entity, and prohibits those individuals from making Medicare referrals to those entities for the provision of designated health services (DHS).  Notably, the law contains a large number of exceptions, which describe ownership interests, compensation arrangements, and forms of remuneration to which the Stark Law does not apply. This article will focus on the definitional changes to commercial reasonableness, fair market value (FMV), and general market value.

On November 20, 2020, the Centers for Medicare & Medicaid Services (CMS) issued a final rule to modernize and clarify the Stark Law.[1] The Stark Law governs those physicians (or their immediate family members) who have a financial relationship (i.e., an ownership investment interest or a compensation arrangement) with an entity, and prohibits those individuals from making Medicare referrals to those entities for the provision of designated health services (DHS).[2]  Notably, the law contains a large number of exceptions, which describe ownership interests, compensation arrangements, and forms of remuneration to which the Stark Law does not apply.^[3]

Many of the exceptions to the Stark Law require that one or more of the following requirements be met: that the compensation arrangement be commercially reasonable, that the compensation methodology not be determined in a manner that takes into account the volume or value of referrals (or other business generated between the parties), and that the amount of compensation paid be fair market value (FMV).[4] This article will focus on the definitional changes to commercial reasonableness, FMV, and general market value.

Commercial Reasonableness

In the final rule, CMS recognized that it had only addressed the concept of commercial reasonableness once, in a 1998 proposed rule, interpreting the term “commercially reasonable” to mean an arrangement that appears to be: “… a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals.”^[5]

To provide some clarity, CMS finalized its definition of the term as follows:

“Commercially reasonable means that 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. An arrangement may be commercially reasonable even if it does not result in profit for one or more of the parties.”[6]

CMS noted that the finalized definition “is consistent with the guidance we provided in the 1998 proposed rule [set forth above], appropriately considers the characteristics of the parties to the actual arrangement being assessed for its commercial reasonableness and will adequately ensure that parties cannot protect abusive arrangements under the guise of ‘commercial reasonableness.’”[7]

CMS dedicated a sizable portion of the final rule to a discussion of the phrase “furthers a legitimate business purpose of the parties,” contained within the commercial reasonableness definition. While CMS acknowledged that “identifying the business purpose of an arrangement may entail an inquiry into the parties’ intent for the arrangement,” the requirement that the arrangement further a legitimate business purpose of the parties “would be considered only after the determination that there actually exists a legitimate business purpose for the arrangement.”[8] According to CMS, some of the purposes that could “qualify as ‘legitimate business purposes’ of the parties to an arrangement,” includes:

1. Addressing community need;
2. Providing timely access to healthcare services;
3. Fulfilling licensure or regulatory obligations, such as those under the Emergency Medical Treatment and Labor Act (EMTALA);
4. Providing charity care; and,
5. Improving quality and health outcomes.[9]

Fair Market Value

Historically, the Stark Law has defined FMV generally (with additional modifications of the definition as applies to equipment leases and office space leases[10]) as:

“the value in arm’s-length transactions, consistent with the general market value … Usually, the fair market price is the price at which bona fide sales have been consummated for assets of like type, quality, and quantity in a particular market at the time of acquisition, or 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.”[11]

CMS restructured the FMV definition by establishing three separate FMV definitions: (1) generally, (2) for the rental of equipment, and (3) for the rental of office space.[12] However, the agency emphasized that “the proposed structure of the definition merely reorganizes for clarity, but does not significantly differ from the [previous] statutory language” of the Stark Law.[13]

CMS finalized the three separate FMV definitions as follows:

1. General—The value in an arm’s-length transaction:
   a. 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:
   b. Of rental property for general commercial purposes (not taking into account its intended use); and,
   c. 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:
   a. Of rental property for general commercial purposes (not taking into account its intended use);
   b. 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,
   c. Consistent with the general market value of the subject transaction.[14]

Notably, the revised definition of FMV (as well as the revised definition of general market value, discussed below) eliminates the connection to the volume or value standard. CMS noted that “a careful reading of the statute shows that the FMV requirement is separate and distinct from the volume or value standard and the other business generated standard,” and thus there is no need to intertwine the discrete standards.[15]

The prior version of the Stark Law required that FMV “be consistent with the general market value,” which was defined as:

“… the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party, or 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, on the date of acquisition of the asset or at the time of the service agreement.”[16]

In addition to the delineated definitions for FMV set forth above, CMS finalized its proposal to define general market value separately from FMV and delineate the definitions for general market value similar to the FMV definitions:

1. Assets: “the price that an asset would bring on the date of acquisition of the asset as the result of bona fide bargaining between a well-informed buyer and seller that are not otherwise in a position to generate business for each other.”
2. Compensation: “the compensation that would be paid at the time the parties enter into the service arrangement as the result of bona fide bargaining between well-informed parties that are not otherwise in a position to generate business for each other.”
3. Rental of equipment or office space: “the price that rental property would bring at the time the parties enter into the rental arrangement as the result of bona fide bargaining between a well-informed lessor and lessee that are not otherwise in a position to generate business for each other.”[17]

The October 2019 proposed rule discussed the equivalence of general market value and “‘market value,’ the term uniformly used in the valuation industry.”[18] However, in the final rule, CMS admitted that its “use of the term ‘market value’ in our preamble discussion, although not carried into the proposed definition of ‘general market value,’ may have been inaccurate.”[19] In response to those commenters who pointed out that general market value does not equate to the market value of a transaction as such terminology is used in the valuation industry, CMS did not finalize its proposed statements equating general market value with market value, reasoning that, “if finalized, [our proposals] could have had an unintended limiting effect on the regulated community, as well as the valuation community.”[20]

CMS spent a significant amount of space in the final rule reconciling the terms FMV and general market value, stating that it:

“continue[s] to believe that the [FMV] of a transaction—and particularly, compensation for physician services—may not always align with published valuation data compilations, such as salary surveys. In other words, the rate of compensation set forth in a salary survey may not always be identical to the worth of a particular physician’s services.”[21]

In making its point, CMS discussed when “extenuating circumstances may dictate that parties to an arm’s length transaction veer from values identified in salary surveys and other valuation data compilations that are not specific to the actual parties to the subject transaction,”[22] and responded to several comments on the reliance on salary surveys:

• “It appears from the comments that stakeholders may have been under the impression that it is CMS policy that reliance on salary surveys will result, in all cases, in a determination of [FMV] for a physician’s professional services. It is not CMS policy that salary surveys necessarily provide an accurate determination of [FMV] in all cases … Consulting salary schedules or other hypothetical data is an appropriate starting point in the determination of [FMV], and in many cases, it may be all that is required.”[23]
• “[W]e agree that a hospital may find it necessary to pay a physician above what is in the salary schedule, especially where there is a compelling need for the physician’s services. For example, in an area that has two interventional cardiologists but no cardiothoracic surgeon who could perform surgery in the event of an emergency during a catheterization, a hospital may need to pay above the amount indicated at a particular percentile in a salary schedule to attract and employ a cardiothoracic surgeon.”[24]
• “We are uncertain why the commenters believe that it is CMS policy that compensation set at or below the 75th percentile in a salary schedule is always appropriate, and that compensation set above the 75th percentile is suspect, if not presumed inappropriate. The commenters are incorrect that this is CMS policy.”[25]

Conclusion

The most significant takeaways from the Stark Law final rule stem from CMS’s acknowledgment that: not all physicians, or compensation arrangements, are the same; compensation arrangements may have qualitative benefits that outweigh quantitative costs, i.e., profitability; and salary surveys are only a starting point in the valuation of a healthcare transaction. These revisions further demonstrate the need for valuation professionals in the healthcare industry who utilize an evidence-driven methodology that includes both qualitative and quantitative assessments of the specific facts and circumstances related to the transaction; document their consideration of these facts and circumstances; and articulate their ultimate applicability to the transaction in support of their opinion.

[1]       “HHS Makes Stark Law and Anti-Kickback Statute Reforms to Support Coordinated, Value-Based Care” U.S. Department of Health & Human Services, November 20, 2020, https://www.hhs.gov/about/news/2020/11/20/hhs-makes-stark-law-and-anti-kickback-statute-reforms-support-coordinated-value-based-care.html (Accessed 2/11/21).

[2]          “Limitation on Certain Physician Referrals” 42 U.S.C. § 1395nn.

[3]          Ibid.

[4]          “Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations” Federal Register, Vol. 85, No. 232, (December 2, 2020), p. 77507.

[5]      Ibid., p. 77530.

[6]      Ibid., p. 77531.

[7]      Ibid., p. 77532.

[8]      Ibid., p. 77533.

[9]      Ibid.

[10]     Ibid.), p. 77506.

[11]       “Definitions” 42 C.F.R. § 411.351.

[12]     “Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations” Federal Register, Vol. 85, No. 232, (December 2, 2020), p. 77553.

[13]     Ibid.

[14]     Ibid.

[15]     Ibid., p. 77552.

[16]       “Definitions” 42 C.F.R. § 411.351.

[17]     “Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations” Federal Register, Vol. 85, No. 232, (December 2, 2020), p. 77659.

[18]       “Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations” Federal Register Vol. 84, No. 201 (October 17, 2019), p. 55798.

[19]     “Medicare Program; Modernizing and Clarifying the Physician Self-Referral Regulations” Federal Register, Vol. 85, No. 232, (December 2, 2020), p. 77553.

[20]     Ibid.

[21]     Ibid., p. 77554.

[22]     Ibid., p. 77557.

[23]     Ibid.

[24]     Ibid.

[25]     Ibid., p. 77558.

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Todd A. Zigrang, MBA, MHA, ASA, CVA, FACHE, is president of Health Capital Consultants, where he focuses on the areas of valuation and financial analysis for hospitals and other healthcare enterprises. Mr. Zigrang has significant physician-integration and financial analysis experience and has participated in the development of a physician-owned, multispecialty management service organization and networks involving a wide range of specialties, physician owned hospitals as well as several limited liability companies for acquiring acute care and specialty hospitals, ASCs, and other ancillary facilities.

Mr. Zigrang can be contacted at (800) 394-8258 or by e-mail to tzigrang@healthcapital.com.

Jessica Bailey-Wheaton, Esq., is Vice President and General Counsel for Heath Capital Consultants, where she conducts project management and consulting services related to the impact of both federal and state regulations on healthcare exempt organization transactions, and provides research services necessary to support certified opinions of value related to the Fair Market Value and Commercial Reasonableness of transactions related to healthcare enterprises, assets, and services. She is a member of the Missouri and Illinois Bars and holds a JD, with a concentration in Health Law, from Saint Louis University School of Law.

Ms. Bailey-Wheaton can be contacted at (800) 394-8258 or by e-mail to jbailey@healthcapital.com.