Executive Session: Making sense of the new Stark Law regulations with Tim Smith

MGMA · Executive Session: Making Sense of the New Stark Rule with Tim Smith (Part 1)

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On Dec. 2, 2020, the Centers for Medicare and Medicaid Services (CMS) published a Final Rule titled “Modernizing and Clarifying the Physician Self-Referral Regulations.” This rule makes a number of modifications to the regulations implemented in physician self-referral, or Stark Law.

MGMA’s Government Affairs Office has closely monitored the new rule and has published advocacy letters and statements describing how the new rule will affect MGMA members.

In this Part 1 of a special two-part episode of Executive Session, I have the opportunity to speak with Tim Smith, CPA, ABV, Principal in TS Healthcare Consulting, a firm that focuses on valuing healthcare organizations and providing guidance on federal regulations, including Stark. Tim has authored numerous articles for MGMA and has also spoken at MGMA conferences. Tim is also a speaker at the upcoming Medical Practice Excellence Pathways Conference, addressing this and other topics at that meeting.

What follows is a transcript of this episode’s conversation. Check out Part 2 here.

DG: Tim, can you please introduce yourself and describe how you support MGMA members and their practices?

TIM SMITH: Thank you, Dave, and thank you for hosting me today to talk about the new Stark regulations. Just so everybody knows my background, I've been in healthcare for well over 25 years now. I started out at HCA Columbia back in the 1990s, looking at physician practice acquisition deals, back in that kind of consolidation wave of the mid-1990s. I then became a physician deal guy, where I actually negotiated physician deals on behalf of HCA. The last few years I was there, I got into compliance, and I actually ran HCA’s fair market value compliance program for physician compensation arrangements. I decided I liked valuation so much, I became a professional evaluator about 12 years ago.

And so, I've been very active in the market, doing thought leadership. I am the co-editor of the industry's primary textbook on physician comp, which is the BVR/AHLA Guide to Valuing Physician Compensation and Healthcare Service Arrangements. It’s a 1400-page book, written by 42 different authors, including me; I wrote a few hundred pages of it.

But I do a lot of different things in my consulting practice, TS Healthcare Consulting. Those include doing valuation work; I value both compensation arrangements as well as value provider entities, such as physician practices, surgery centers, dialysis centers, and the like. I do expert testimony. I have worked on a handful of the whistleblower cases.

And I was also, I should mention, along with a colleague of mine, a major contributor to the public comments to CMS, for the new Stark regulations. We actually gave CMS about 100 pages of material about the new Stark regs, related to FMV, fair market value, and commercial reasonableness. And I participated in two stakeholder calls with CMS.

Obviously, today, when we talk about CMS’ regs, CMS speaks for itself; I don't speak for CMS in any way. But I can give you some context about it. At least, I know the information we provided to them, that I think provides a backdrop, if you will, for some of their explicit statements. And I would encourage everyone who listens to this podcast to go read the regs for yourself. That's the best way, I think, to understand what CMS is trying to promulgate in terms of these new rules.

DG: Well, Tim, let's begin with a discussion of how the new regulations redefine fair market value, and then we'll look a little bit later at how practice losses may enter into the commercial reasonableness of a practice acquisition. I'm going to read directly from the Federal Register. This is page 77555, and this, I think, really gives the core of what fair market value is redefined as, but I think, myself, I had difficulty understanding what does this mean, so if you can clarify that. So, let me read first:

“The determination of general market value should be based solely on consideration of the economics of the subject transaction and should not include any consideration of other business the parties may happen with one another.” The regulation goes on to say, “A hospital may not value a physician’s services at a higher rate than a private equity investor or another physician practice, simply because the hospital could bill for designated health services referred by the physician under the hospital’s outpatient prospective payment system, whereas a physician practice owned by a private equity investor or their physicians would have to bill under the physician fee schedule, which may have lower payment rates.”

Can you help our listeners understand what does this mean, and how does that affect valuation as well as the organizations purchasing the practice?

TS: Yes, sure, Dave. And I should note, starting out here, that this language of general market value should be based solely on consideration of the economics of the subject transaction. That's actually some language that my colleague, Mark Dietrich, and I suggested to CMS in our initial request for information that was done in 2018. And the concept here, and I'll try to tell you what I think CMS is saying. You know, I can tell you what I thought when we wrote that language, but if you think about the whole import of the Stark Law, it's to prevent payment for referrals.

And so, general market value is this concept or label/word description that came up in the original statute for fair market value. And so, CMS has given us this new definition of general market value as, and just to summarize/paraphrase here, is it's bona fide bargaining by well-informed parties who are not in a position to generate business for each other. That's a near-verbatim quote. But the idea is that you're looking at parties who don't have the ability to generate business for each other. That is their way of taking the question of referrals – the volume of our referrals -- out of the equation. And they don't mention the volume of our referrals, because that was put into its own criteria. So, they worded it in terms of not in a position to generate business for the other, which also, I think, expands a little bit beyond just Medicare referrals.

But the concept here is you have two parties who transact by bona fide arm's length negotiation, so what would they be focused on? Well, they would be focused on the economics of the transaction they're entering into; that would be what they would be focused on. And the idea here is that you would look at these two arm's length parties focusing on the transaction, and that would let us focus on, well, what are the actual terms of the transaction or the arrangement, right? What services, for example, are in the service arrangement? What are the services that are being encompassed here?

That would also have us look at the full array of the terms of the arrangement. This is important, because many folks have responded to CMS, in the RFI process, that they thought fair market value, i.e., the general market value is kind of the basis for fair market value in the way that the Stark regs work. But they thought fair market value was a hypothetical transaction for a hypothetical doctor providing hypothetical services, and the focus of CMS’s response to that has been no, it needs to be the actual services for an actual doctor, based upon the actual facts and circumstances.

So, if we think about what's going on with an actual transaction, where you're going to have economics, right? You can have revenues and expenses that are directly related to that arrangement. So, for example, if you hire a physician to work in a practice, the practice is going to generate revenue, and the practice is going to have overhead. Those were the economics of that arrangement.

Now, if we look at the economics of, let’s say, a medical directorship, that's probably a little different. Medical directorships, generally speaking, don't generate specific revenue, right? That's just a resource input to, let's say, a health system’s or hospital’s overall operations. So, you wouldn't necessarily have revenue from it, but you do have a cost associated with it, so there's a cost component to it.

But I think that's really what we're talking about, when we talk about the economics of the subject arrangement. But CMS is saying you have to look at that in what they phrased as a “buyer-neutral framework.” And here, let me just read from the text of the regulatory commentary, where the regulators said, “The value of physician services should be the same, regardless of the identity of the purchaser of those services. We recognize that reliance on similar transactions in the marketplace could simplify the process of determining fair market value for purposes of the physician self-referral law, but adopting such a standard will allow parties to consider the additional or investment value to certain types of entities, skewing the buyer-neutral fair market value.”

Here, I think, CMS introduces this new labeling of an old concept in the valuation profession, called the buyer-neutral standard. In valuation, fair market value has typically been a hypothetical buyer and seller in the marketplace. That's if you ask various valuation professionals what that means, that's what they would point to. And typically, the hypothetical buyer and seller, depending on the market, you can have lots of different types of buyers in that market.

And the concept of fair market value would be well, it's the value to all these different types of buyers, even though the different buyers might have different economics that drive how they do a deal. For example, a private equity deal is generally driven off of the earnings that the physicians give up in order to get a cash pop up front, and then the theory would be, hopefully, as the private equity firm can grow that business to backfill for the earnings that the physicians gave up in order to do the original acquisition deal.

But the idea of fair market value would be, we're not going to take into account these buyer-specific economics, it's going to be buyer neutral. So, that means we can't take into account hospital economics to justify a price. And we'll talk about it mentioned in the example that you gave earlier, or text from the regulations, Dave, where it talked about the idea that you can't base the value of physician services on the fact that a hospital, for example, could convert the ancillaries over to hospital outpatient billing, which is typically billed at a higher rate. You couldn't therefore value the physician services higher, because only a hospital can do that kind of conversion, right? A private equity owner can’t do that. A physician practice that's owned by physicians can't do that. Even the ones that are owned by some of the payers can't do that either.

So, the idea is that you look at the economics of your deal, your transaction or financial arrangement, service arrangement, based upon the revenues and expenses of the arrangement on a buyer-neutral basis. Meaning, how would all the buyers in the marketplace have to look at it, not just based upon what the hospitals would do.

An important point of this is that you're precluded from relying on market data from parties who have other business relationships between them. So, for example, if you're looking at a data set that's hospitals and physicians, since that data set is from parties in a position to refer, CMS is saying you're precluded from relying on using that data to establish fair market value because that data can be skewed, and it might reflect the additional value of referrals or other business and wouldn't meet this buyer-neutral framework. And that's an old concept that CMS had 20 years ago, when they put out the first round of the Stark II regs that they carried forward in the new regs. And it's important for people to understand that, when they use market data, they need to be analyzing that data to make sure that it is not distorted or skewed by the fact that the underlying respondents to the data are from parties in a position to refer or generate business for each other.

DG: You know, you raise a couple of very good issues. And I'm going to add another that, when I read the Federal Register, and that many of our listeners who are part of hospital systems, may find somewhat disturbing, and this has to do with practice losses.

The next page of the Federal Register had a further discussion on how practice losses may enter into the commercial reasonableness of a practice acquisition. Specifically, the Federal Register states:

“An entity’s compensation of a physician at an ongoing loss may present program integrity concerns. The value of physician’s services is the value of any willing buyer, and the fact that the hospital could make up losses for the physician’s compensation through designated health services reimbursed at facility rates under the hospital outpatient prospective payment system, rather than physician fee schedule, may not be considered.”

I think this may have a significant impact on some physician-owned practices. Tim, can you give some insights on this specific area?

TS: I think it's important first, Dave, to state that this is the first time CMS gave a formal definition of commercial reasonableness. In the proposed Stark regs from the late 1990s, and in the phase I, phase II, and phase III regs that came out in the early 2000s, CMS never defined commercial reasonableness. They gave some commentary on what they thought it was, but there was never a formal definition. So, this time around, they gave the industry a formal definition. And one aspect of that formal definition was a statement that an arrangement can be commercially reasonable even if it doesn't result in a profit for one of the parties.

Now that was significant, because the issue of making a profit on an arrangement had been litigated significantly in the Tuomey case. And in many of the subsequent whistleblower cases that were settled out of court, practice losses figured very prominently in those cases. People may not be aware of the fact that the question of losing money on a physician service arrangement was very prominent in the Tuomey case. A lot of time was spent, in the testimony of the experts, on that particular question. And in fact, in the second trial, Tuomey put up an expert that said, well, every hospital loses money on its doctors, and so therefore, practice losses shouldn't matter, with respect to fair market value or primarily commercial reasonableness. But as you know, Tuomey lost both its trials.

And so, both in the Tuomey case and in 2015, we had this sweep of cases, where practice losses seem to figure prominently. That was in the Citizens Medical Center case, the North Broward case, and the Adventist cases that were settled in 2015. And there were several media interviews given by former members of the Department of Justice, as well as lawyers who were defending clients in front of the Department of Justice, who talked about how the Department of Justice seemed to have this idea that for something to be commercially reasonable, it had to make money.

So that's where we were in the mid-2010s, circa 2015/2016. But the word on the street in the litigation area was that somewhere in the latter part of the decade, CMS told DOJ to kind of pull back on basing cases solely on practice losses. And I'm not really sure about what all went on there. I'm kind of downstream from this, although I do have good sources that told me this. But essentially, what CMS did was come out and clarify and say, no, you don't have to make money for an arrangement to be commercially reasonable. That's now in the text of the regulation.

DG: Tim, I found that earlier, and that was about page 77531. I was going to ask that specific question, because I think CMS gave an out. And I'll read that, because that ties right into what you're discussing. It says “We acknowledge that even knowing in advance an arrangement may result in losses to one or more parties, it may be reasonable, if not necessary, nevertheless entered into the arrangement.

Examples of reasons why parties would enter into such transactions include community need, timely access to healthcare services, fulfilment of licensure, or regulatory obligations, including those under the Emergency Medical Treatment and Active Labor Act, also called EMTLA or EMTALA, and also the provision of charity care, and the improvement of quality health outcomes. I think this may be reassuring to many of our readers, who may understand that their practices do operate at a financial loss, but they're necessary for other reasons. Was this what you were looking at?

TS: Yes. I mean, that's part of it. CMS wanted to clarify that yes, you can lose money. And in the part of the regulatory commentary that you quoted, Dave, they went through a bunch of reasons why they thought it would be legitimate to lose money on an arrangement. At the same time, one of the things CMS said, however, was that they still think that ongoing losses, to use their term, may present program integrity concerns.

And so, the issue of practice losses hasn't gone away, and it's important to point out for the listeners that practice losses were discussed by CMS in two parts of the Stark regulations. One is in relation to commercial reasonableness, and the other is in respect to fair market value. The second set of responses and comments that they gave, or comments or responses that CMS provided, dealt with practice losses under the rubric of fair market value. And so, CMS appears to be looking at this at both levels, which, if you've read anything I've written about practice losses, I think it's primarily a fair market value issue and secondarily a commercial reasonableness issue.

I did give CMS some responses, in the public comment process, about losses. And so, what they've expressed is that it's an issue. No one's going to be held to the standard of “you have to make money,” but it is an issue that you need to be focused on. And the one thing they stated in a quote you read earlier, Dave, is that you can't justify losses based upon referrals or our unique economics to a hospital. For example, the idea of well, we lose money on our doctor practice, but we make it up on all the ancillaries they generate for the hospital. That would be a completely inappropriate way to think about the losses, and that would create, to use their words, program integrity concerns.

And I think what people have to focus on is, if I were to say, what's the framework where we have to think about it, or are our losses justifiable? I would say it's going to have to be based upon a limited set of circumstances that, in my mind/in my interpretation, focus on market conditions. And those market conditions would be experienced by any buyer in that marketplace who would be providing those services.

So, if we think about community need, typically community need means that the economics of that local market do not generate enough revenue for enough doctors to be there. So, there's either not enough volume, or the payer mix is poor, or the commercial rates are poor. So, you have a dearth of doctors, you need more doctors in that market to provide to the community. So, someone's going to have to subsidize that physician compensation to get doctors there. Well see, that's a market condition that would affect any buyer. Private equity would deal with that, a physician-owned practice would deal with that, and a health system would have to deal with that.

Now, the reality of the marketplace is that there's only one kind of buyer, typically, that steps in and will subsidize the doctors, and those are health systems, right? That is because health systems are typically set up to support community need, under the regulations and just the way the industry functions. So, if you are losing money because of market conditions that any buyer would experience, I think that's good ground to begin to say, yeah, you know, we are losing money for legitimate reasons. And we can talk later about other reasons, but that's where it gets a little bit murkier. You can go from the explicit list of things that CMS said, but you can also start to go into other areas and say, what other buyers experience this kind of loss in our marketplace? And CMS seems to be saying yeah, that's okay to have losses in those facts and circumstances.