On March 26, 2004, The Centers for Medicare and Medicaid Services (CMS) issued the long awaited Phase II of the Stark II Regulations. Stark II, originally passed by Congress in 1993, prohibits the referral of Medicare or Medicaid patients for certain designated health services by physicians or their family members or entities in which physicians have a financial interest.

Proposed regulations were issued in 1998 and addressed ownership and investment interests, as well as compensation arrangements. Unfortunately, the proposed regulations did little to clear up the confusion left by the legislation itself and the industry waited for further clarification. HCFA (the forerunner to CMS) issued Phase I of the Final Regulations on January 4, 2001, generally effective on January 4, 2002, which principally addressed the prohibition on referrals, general exceptions to the ownership and investment interests and compensation arrangements and addressed several new exceptions. The newly released Phase II regulations address the remaining Stark II exceptions not addressed in the Phase I regulations, primarily related to compensation arrangements. Also addressed are certain reporting requirements. Phase II is an interim final rule with a 90 day comment period. The rule is effective on July 24, 2004.

Significant clarification was provided by CMS in the area of personal service arrangements. CMS eliminated the requirement that aggregate compensation be set in advance and clarified that this exemption is applies to both professional and non-professional services. In addition, items and equipment may be covered by this exception although CMS indicates that items and equipment will be evaluated separately from services in the determination of fair market value. Academic medical center physician employees may be covered by this exception if certain requirements are met. Such physicians may be compensated using a percentage-based method that takes into account the value of their own services, provided the methodology is set in advance. In general, a fair market value safe harbor is established. However, what may prove most troublesome is that in order to qualify for the personal service exception, the written agreement must either cross reference all other contracts between the designated health service provider and the referring physician or reference a master list maintained by the designated health service provider. It should also be noted that CMS has interpreted this exception to apply to employed physicians but not to independent contractors.

Phase II regulations set forth significant new changes in permissible compensation arrangements for physicians. Under the Phase II regulations, physicians may be paid on a percentage of revenue and receive a productivity bonus for personally performed services. This exception was applied uniformly under the employment, personal service, fair market value and academic medical center exceptions. CMS expands the set in advance exception to apply to percentage compensation in certain circumstances. As a result, independent contractors and physicians in academic medical centers may not be compensated on a percentage basis and are eligible for productivity bonuses based on personally performed services.

The new regulations permit "per click" rental agreements, including for designated health services, so long as the payments are at fair market value and do not vary based on the volume or value of referrals or other business generated by the referring physician.

CMS has set forth significant changes in physician recruitment rules. Most importantly, perhaps, the proposed rule now permits hospitals to compensate the group the recruited physician is joining, provided that certain safeguards are in place. Relocation will now focus on the physician’s practice rather than his or her residence and recruited physicians will no longer be able to be locked into the recruiting hospital. They must be allowed to establish staff privileges at other hospitals and refer to other entities even competitors.

In another welcome response to comments CMS has received to the Phase I regulations, the proposed Phase II regulations expand the definition of "isolated transaction" to allow installment payments if the total aggregate payments is set in advance and certain other safeguards are met. In addition, commercially reasonable post-closing adjustments are permitted under certain circumstances.

The proposed Phase II regulations create several new safe harbors: including professional courtesy arrangements, certain inadvertent and temporary lapses in compliance, provision of information technology and services for participation in a community-wide heath information system, charitable contributions by physicians and intra-family referrals in rural areas.

Phase II of the regulations reflects an attempt by CMS to bring more clarity to field and give providers added flexibility in certain areas. However, as is often the case, this area is treacherous and compliance with Stark is often daunting. Providers should be sure to consult with counsel before entering into any arrangements.

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