TAUGHT BY EXPERTS: WHAT THE EXPERT TESTIMONY IN TUOMEY AND HALIFAX TELLS US ABOUT PHYSICIAN TRANSACTIONS TODAY

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1 AMERICAN HEALTH LAWYERS ASSOCIATION 2015 FRAUD AND COMPLIANCE FORUM TAUGHT BY EXPERTS: WHAT THE EXPERT TESTIMONY IN TUOMEY AND HALIFAX TELLS US ABOUT PHYSICIAN TRANSACTIONS TODAY THE COMMERCIAL REASONABLENESS CONUNDRUM WILLIAM W. HORTON JONES WALKER LLP BIRMINGHAM, ALABAMA SEPTEMBER 2015 I. INTRODUCTION Hospital-physician relationships under the Stark Law 1 and the Anti-Kickback Statute 2 present numerous challenges, it is true. Historically, one relatively safe refuge has been hospital employment of physicians; bona fide employment relationships are protected by statutory exceptions under both statutes, 3 as well as by a relatively generous Stark exception 4 and Anti- Kickback Statute safe harbor 5 in the regulations under the respective statutes. Further, although they pose more opportunities for error, non-employment personal services arrangements also benefit from a fairly straightforward Stark exception 6 and Anti-Kickback Statute safe harbor. 7 Indeed, it is fair to say that the conventional wisdom over the years has been that if a physician employment arrangement or personal services arrangement got over the procedural requirements of the applicable safe harbor or exception written contract signed by the parties, 1 42 U.S.C. 1395nn and the associated regulations at 42 C.F.R U.S.C. 1320a-7b(b) and the associated regulations at 42 C.F.R See 42 U.S.C. 1395nn(e)(2) and 42 U.S.C. 1320a-7b(b)(3)(B) C.F.R (c) C.F.R (i) C.F.R (d) C.F.R (d). {BH } 2015 William W. Horton. This paper may be used in whole or in part in other publications and presentations by the author. The views expressed are those of the author alone and should not be ascribed to any current or former employer or client of the author. The author may be reached at whorton@joneswalker.com.

2 term of at least one year, etc. the principal difficulty in defending such an arrangement arose in adequately documenting the fair market value nature of the compensation provided for in the arrangement. Indeed, a veritable cottage industry has arisen around the art and science of providing fair market value analyses in the healthcare setting. In recent years, the federal enforcement authorities have become quite aggressive in challenging hospital-physician financial relationships, even in what had been assumed to be the relatively insulated setting of physician employment relationships. A number of enforcement cases have either gone to trial or gotten far enough into the litigation process to generate considerable documentation relating to the government s approach to examining these arrangements. In some of those cases, the government has not limited itself to challenging whether the arrangements in question satisfied the fair market value test. Instead, the government has added a new approach to its attack challenging the arrangements on the basis that, in the government s view, they were not commercially reasonable. Commercial reasonableness is an inherently more subjective analysis than the relatively quantitative question of fair market value, and the commercial reasonableness standard is arguably much less clearly defined in the Stark/Anti-Kickback context. Because of this inherent subjectivity, it may actually be harder for the target of an investigation to respond to the government s arguments on commercial reasonableness than it is to deal with fair market value questions, where at least the dueling expert witnesses are likely speaking a common language. For this reason, it is important to understand the approach the government has taken in its commercial reasonableness analysis, and to consider effective bases for defending against a claim that a hospital-physician arrangement is commercially unreasonable. Recently, the government s expert-of-choice on these issues has been Kathleen McNamara, CPA, of Myers and Stauffer LC, who has testified as an expert for the government in, among other cases, the high-profile United States ex rel. Baklid-Kunz v. Halifax Hospital Medical Center 8 and United States ex rel. Drakeford v. Tuomey Healthcare System 9 cases. Using public testimony and expert reports from these cases, as well as subsequent public statements by Ms. McNamara, this paper will attempt to identify common threads in the government s approach to commercial reasonableness analysis, to discuss some of the issues raised by those common threads, and to consider other factors that might be overlooked in the government s approach. 8 U.S. ex rel. Baklid-Kunz v. Halifax Hospital Medical Center, No. 6:09-CV-1002-ORL-31 DAB, M.D. Fla., Complaint in Intervention filed Nov. 4, U.S. ex rel. Drakeford v. Tuomey, No. 3:05-CV-02858, D.S.C., Amended Complaint in Intervention filed Dec. 21, The case was tried to a jury twice, after the Fourth Circuit ordered a new trial when the original jury verdict was appealed. The appellate opinion between the first and second trials is at 675 F.3d 394 (4 th Cir. 2012), and the final appellate opinion upholding the jury s verdict in the second trial is at 792 F.3d 364 (2015). {BH } 2

3 II. A DEFINITIONAL PROBLEM: WHAT IS COMMERCIAL REASONABLENESS, ANYWAY? The concept of commercial reasonableness runs throughout compensation exceptions provided for in the Stark regulations. 10 Despite the pervasiveness of the concept, however, neither the text of the Stark Law nor the Stark regulations themselves define commercial reasonableness. The definition(s) relied upon by the Centers for Medicare and Medicaid services in construing commercial reasonableness requirements are instead reflected only in regulatory commentary. In the preamble to the original Stark II proposed regulations in January 1998, CMS said, without reference to any particular precedent or authority, 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. 11 In the preamble to the Phase II final regulations six years later, CMS noted that a commenter had criticized that interpretation as inject[ing] an unwarranted subjective element into the test. CMS essentially non-responded to that comment by amplifying its original statement, but with no further explanation or citation to authority: 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 See, e.g., 42 C.F.R (a)(6) (space lease agreement must be commercially reasonable even if no referrals were made between the lessee and the lessor ; (b)(5) (same, with respect to equipment leases); (c)(3) (remuneration paid to a bona fide employee must be provided under an agreement that would be commercially reasonable even if no referrals were made to the employer ); (f)(2) (same, with respect to remuneration paid in connection with an isolated transaction); (f)(3) (no post-closing transactions between the parties to an isolated transaction for six months, except for commercially reasonable post-closing adjustments that do not take into account (directly or indirectly) the volume or value of referrals or other business generated by the referring physician ); (h)(6) (compensation from a hospital to a physician group for certain grandfathered under arrangements services must be commercially reasonable even if no referrals were made to the entity ); (l)(4) (arrangement relying on fair market value compensation exception must be commercially reasonable (taking into account the nature and scope of the transaction) and further[] the legitimate business purposes of the parties ); (p)(2) (compensation to a bona fide employee in an indirect compensation arrangement must be for identifiable services and be commercially reasonable even if no referrals are made to the employer ). In addition, the exception for compensation payable pursuant to personal services arrangements has what amounts to an implicit requirement of commercial reasonableness. See (d)(3) ( [t]he aggregate services contracted for must not exceed those that are reasonable and necessary for the legitimate business purposes of the arrangement(s) ) and (d)(5) ( [t]he compensation to be paid over the term of each arrangement is set in advance, does not exceed fair market value, and is not determined in a manner that takes into account the volume or value of any referrals or other business generated between the parties ). 11 Proposed Rule: Medicare and Medicaid Programs; Physicians Referrals to Health Care Entities With Which They Have Financial Relationships, 63 Fed. Reg (Jan. 9, 1998). 12 Interim Final Rule: Medicare Program; Physicians Referrals to Health Care Entities With Which They Have Financial Relationships (Phase II), 69 Fed. Reg (Mar. 26, 2004). {BH } 3

4 This more expansive statement varied the original 1998 statement in two respects. First, the 1998 version did not explicitly include a requirement that the particular parties involved be, in fact, reasonable parties. Thus, arguably at least, the 2004 statement changed the test from a subjective approach that took into account what the actual parties in question believed was sensible and prudent to the sort of hypothetical reasonable person test that the law tends to regard as objective. Second, the 2004 statement introduced the type and size and scope and specialty concepts, suggesting that notwithstanding the adoption of an objective reasonable person standard, there could be some sort of sliding scale, where what was sensible and prudent might vary depending upon the particular traits of the parties in question. At bottom, though, both statements were more in the nature of tautologies than definitions: an arrangement would be commercially reasonable for purposes of the Stark exceptions if it were reasonable for reasonable persons to enter into the arrangement except, of course, that the parties could not consider the possibility of referrals in deciding what might be reasonable. Certain safe harbors under the Anti-Kickback Statute also reference the concept of commercial reasonableness. 13 If anything, however, the Office of Inspector General of the Department of Health and Human Services, which interprets and enforces the Anti-Kickback Statute, has been even less forthcoming than CMS. About the most that the OIG has done is to imply that a compensation arrangement with a referring physician must involve compensation that is reasonable and necessary to obtain necessary and legitimate services, without taking into account the potential for referrals. 14 Thus, as important as the concept of commercial reasonableness is in physician-hospital financial arrangements, from a definitional standpoint CMS and the OIG have tended to suggest a We know it when we see it sort of standard. An arrangement is commercially reasonable in the absence of referrals between the parties if the parties have a legitimate business purpose underlying the arrangement and the arrangement would be reasonable in furtherance of that purpose without regard to referrals. That is sort of indisputable, but not all that helpful. When one layers in the fact that it would be, in fact, commercially unreasonable in most cases for physicians and hospitals to enter into business arrangements if they affirmatively believed that there would, in fact, be no referrals or other business generated between them why, for example, would a hospital employ a physician in the first place if the hospital did not expect the relationship with that physician to benefit it in some fashion? the practical implications of a commercial reasonableness tests can be somewhat challenging to work with See, e.g., 42 C.F.R (b)(6) ( aggregate space rented [under a space lease arrangement with a referral source must] not exceed that which is reasonably necessary to accomplish the commercially reasonable business purpose of the rental ); (c)(6) (same, for equipment leases); (d)(7) ( aggregate services contracted for [under a personal services or management contract with a referral source must] not exceed those which are reasonably necessary to accomplish the commercially reasonable business purpose of the services ). 14 See, e.g., Notice: OIG Supplemental Compliance Program Guidance for Hospitals, 70 Fed. Reg (Jan. 31, 2005) ( Are the items and services obtained from a physician legitimate, commercially reasonable, and necessary to achieve a legitimate business purpose of the hospital (apart from obtaining referrals)? ). 15 Note that there are reported court decisions and other governmental interpretations of commercial reasonableness, particularly from the Internal Revenue Service, that may influence the analysis. For discussion of some of these sources, see, e.g, Martin D. Brown & William Lyle Oelrich Jr., Commercial Reasonableness: Defining Practical Concepts and Determining Compliance in Health Care Transactions for Physician Services, in {BH } 4

5 This, then, is the slate not blank, but not all that substantively wordy either in which the battle of the experts may occur in cases like those to be discussed below. III. THE GOVERNMENT S VIEWS ON COMMERCIAL REASONABLENESS Set forth below are brief discussions of the commercial reasonableness analyses used by Ms. McNamara, on behalf of the government, in the Tuomey and Halifax cases. In that regard, note that both of these cases involved issues besides commercial reasonableness, and the discussion below is not intended as any sort of comprehensive analysis of either case. A. The Tuomey Case The Tuomey case, which was tried, appealed to the Fourth Circuit, sent back down and tried again, with a jury verdict of $237 million in favor of the government being upheld on the second appeal, dealt with a series of somewhat curious part-time employment agreements between subsidiaries of Tuomey Healthcare System, a hospital system in rural South Carolina, and a number of physicians who were engaged to act as part-time employees of Tuomey parttime, in that they only served as employees of Tuomey when they were performing outpatient procedures at Tuomey: The employment agreements were, it may be said, unusual. Unusual, of course, is not synonymous with illegal. Nonetheless, they appear to the casual observer to display a considerable generosity of spirit on the part of Tuomey. The contracts provided for part-time employment, but not on any specified schedule, or even for any particular aggregate amount of time in any period; rather, the contracts essentially provided that whenever the physicians were performing outpatient procedures at Tuomey facilities, they would be employees of Tuomey, but they would not be employees when performing any other services. The contracts had a 10-year term (automatically renewing from year to year thereafter unless terminated) and provided for noncompetition restrictions for up to two years after termination or expiration of the contract, restricting the physicians from performing outpatient procedures at any location (other than Tuomey) within a 30-mile radius of Tuomey's hospital. In exchange for these springing employee services, the physicians received a handsome financial package: Compensation consisting of a base salary (under the gastroenterologist contracts, this could be lowered for each year if the physician did not perform a specified minimum number of procedures in the preceding year and could be increased in each year by any generally applicable annual increase for Tuomey employees; under the other contracts, the base salary for each year could be raised or lowered based on the net cash collections for the BVR/AHLA GUIDE TO HEALTHCARE INDUSTRY COMPENSATION AND VALUATION (Timothy Smith & Mark O. Dietrich, eds.) (Business Valuation Resources 2012), at ; 2 ROBERT JAMES CIMASI, HEALTHCARE VALUATION: THE FINANCIAL APPRAISAL OF ENTERPRISES, ASSETS, AND SERVICES (Wiley 2014), at {BH } 5

6 professional services performed by the physician as an employee during the prior year), a Productivity Bonus equal to 80% of net cash collections for the professional services performed by the physician as an employee, and an Incentive Bonus of up to 7% of the Productivity Bonus for meeting certain nonfinancial objectives; First-dollar family coverage under Tuomey's health, dental, and vision plans in effect from time to time; Malpractice coverage applicable to the physician's practice, both for services rendered as an employee and services rendered independently; Allowances aggregating over $10,000 for continuing education, professional materials, license fees, cellular phone, and pager service, etc.; and Other employee benefits as generally provided by Tuomey. 16 In opining that these arrangements were not commercially reasonable, Ms. McNamara focused fairly exclusively on the part-time nature of the employment arrangements and on the compensation terms. After observing that Tuomey may have had a bona fide business reason for entering into the part-time physician employment agreements in the first place, 17 she gave little or no attention to what that possible reason might have been (or whether one actually existed at all), instead identifying these factors which indicated to her that the arrangements were not commercially reasonable: The employment agreements had 10-year terms, with no provision for periodic assessments of the fair market value nature of the compensation. Tuomey incurred significant annual losses on the physician practices. Unlike the case with certain surgeons employed by Tuomey on a full-time basis, there was no requirement that the part-time physicians net collections cover their base salaries or other overhead before they were eligible for productivity or incentive bonuses. The part-time physicians were paid nearly 100% of their net collections and over 100% once benefits and malpractice insurance premiums paid by Tuomey were taken into account. The benefit terms offered to the part-time physicians were inconsistent with, and materially greater than, the terms offered to other part-time Tuomey employees. Even though some of the physicians spent only 3%-5% of their time as Tuomey employees, they were provided with large benefits and perks that they would ordinarily have had to pay for out of their own private practice income, or as to which they at least would have received only a prorated share in a more typical part-time physician employment agreement. (Ms. McNamara s reported noted that If entering into such benefit arrangements were common and commercially reasonable, one would expect 16 William W. Horton, In the Eye of the Beholder: Physician Transactions, Professional Responsibility, and the Winding Road from Anderson to Tuomey, in HEALTH LAW HANDBOOK (Alice Gosfield, ed.) (Thomson Reuters 2011 ed.) 7.4. The facts of the Tuomey case through the time of the first trial are described in some detail in that section. 17 Kathleen A. McNamara, Myers and Stauffer Fair Market Value, Commercial Reasonable Assessment, U.S. ex rel Michael K. Drakeford, M.D., v. Tuomey Healthcare System, Inc., March 13, 2009, at 12. {BH } 6

7 there to be a proliferation of hospitals employing doctors for just a few hours each week in order to pay for such extras. Based on our knowledge, this simply is not the case. ) 18 Ms. McNamara concluded that The part-time physician compensation terms are commercially unreasonable for all groups because absent the part-time physicians referrals, there does not appear to be a legitimate business purpose for entering into the described physician employment agreements. In the absence of a viable referral stream, in our opinion, the compensation and benefit terms do not make commercial sense, and would not have been entered into by a reasonable entity of similar type and size. 19 Although acknowledging the possibility of a legitimate business purpose for the part-time employment arrangements, Ms. McNamara s initial report did not discuss that purpose or appear to consider in any serious way whether the arrangements were in fact sensible and prudent, or arrangements that 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. Instead, her focus seemed to be almost exclusively on the raw, absolute-dollar compensation payable to the physicians in comparison to other employees and on the fact that the part-time practices, considered solely from a self-contained financial perspective, ran at significant losses. It might be fairly said that Ms. McNamara s analysis seemed to assume as a fundamental premise that the purpose of the arrangement was to procure or retain physician referrals, and then to identify those financial factors that arguably supported that conclusion without consideration of other potential motivations. Tuomey offered its own expert report, from one Steve Rice of Integrated Health Strategies. Mr. Rice s report identified various other motivations for the Tuomey arrangements, summarized in a rebuttal report by Ms. McNamara as follows: Tuomey was attempting to stabilize a service that was in crisis The agreements reflect a reasonable first step toward a more integrated physician model This agreement allowed Tuomey to recruit and retain physicians The structure of the compensation model was such that it was based upon physician productivity and therefore adjusted with activity. 20 The rebuttal report in general took issue with all these assertions, sometimes with detailed analysis, but often with a we find that assertion not to be credible approach. In considering what might be the most compelling justification for Tuomey s strategy the competition and 18 Id. at Id. at Kathy McNamara, CPA, Rebuttal Report-Amended, U.S. ex rel Michael K. Drakeford, M.D. v. Tuomey Healthcare System, Inc., May 18, 2009, amended 5/22/09, at 2. {BH } 7

8 potential losses presented to Tuomey by the establishment of a competing surgery center and the threatened development of other competing centers by physicians who were, instead, recruited into the part-time arrangements Ms. McNamara s response was simply The price [one assumes that compensation was what was meant here] paid to the physicians should never take into account the volume or value of a physician s anticipated or actual referrals. 21 The Tuomey arrangements were, as has been pointed out by many (this author included), at best unusual and aggressive; at worst, and as two federal juries have found, they involved Stark Law violations. However, the government s approach to commercial reasonableness, as laid out in the McNamara approach, seems to belie the standards set forth by CMS in the Stark regulations preamble language quoted above. Several facts about the Tuomey situation seem to be indisputable: Tuomey was the sole community hospital in a rural area that had a limited ability to support specialists and that was designated as a medically underserved area. Tuomey faced a credible threat from a number of physicians to move the most lucrative parts of their surgical/procedure-based practices to privately owned, for-profit surgery centers (with the correlative threat of concentrating their least lucrative cases at Tuomey). The physicians had already refused what everyone, including Tuomey s lawyers, saw as the most compliance-friendly strategy, moving the physicians to full-time employment. It would not have been unreasonable for Tuomey to assume that its ability to continue to serve the needs of its community would have been jeopardized if it lost much of its more profitable case volume. (Further, while it is not especially relevant to the commercial reasonableness issues, there does not appear to have been any particular allegation that the physicians changed their utilization volumes or that the arrangement had any particular effect on the amount of money spent by governmental payors in Tuomey s market.) The initial analysis by Ms. McNamara was highly (and arguably not unreasonably) critical of the financial terms of the part-time employment agreements, which were unusual, to say the least. However, that analysis gave very limited attention to the question of whether the arrangement was reasonable and prudent in the particular circumstances in which Tuomey found itself. If in fact a significant number of specialists had the will and apparent means to redirect their most lucrative business away from the hospital, was the hospital required to stand by and watch that happen? If not, what arrangements might the hospital have entered into that did not in some manner take into account the retention of referrals from the physicians (because the commercial reasonableness test does not allow that consideration to be a factor)? At the first Tuomey trial, Ms. McNamara testified at modest length concerning her commercial reasonableness opinion. 22 In general, it is not unfair to summarize her testimony as 21 Id. at The testimony on this topic occurred on March 12 and 15, 2010, beginning at page 973 of the trial transcript and continuing off and on over the next 100+ pages. {BH } 8

9 focusing on two things: the fact that the hospital lost money on the part-time practices, considered on a stand-alone basis, and the fact that the financial arrangements were not, in her view, typical, based on what she had seen elsewhere. She returned at multiple points to an assertion that there was no legitimate business purpose for the employment arrangements, but that was generally stated in a conclusory fashion. Essentially, the only consideration she gave to whether the hospital might have any purpose in employing the physicians other than to induce referrals was to note that some of the physicians hd testified in deposition or at trial that they did not intend to move away from the area, thereby rebutting, in her view, any suggestion that there was a community need to retain the physicians. 23 All of this illustrates the difficulty in applying the commercial reasonableness standard. It appears, for example, that Ms. McNamara s analysis might have been undercut, at least to some extent, if the part-time practices had been profitable on a stand-alone basis. Yet, it cannot be the answer that that is the decisive criterion for commercial reasonableness in the physician employment setting. Hospitals enter into arrangements with physicians all the time that are not expected to be profitable on a stand-alone basis. A typical physician recruitment subsidy, for example, is always a dead financial loss to a hospital if it works out. In the typical subsidy arrangement, a hospital lends money to the recruited physician, usually in the form of an income guaranty, which loan is forgiven over time if the physician stays in the community. The hospital gets no financial benefit from the loan forgiveness; only if the physician leaves the community does the hospital get repaid, and then with no profit other than a market rate of interest. Yet, the law allows such arrangements because the hospital s stated purpose in making the arrangement is not to make a profit, but to help fill a community need for physicians in the particular specialty. More generally, hospitals may employ or contract with physicians in various specialties to fill in gaps in the services they can make available in their communities. In some cases, inducing a physician in the appropriate specialty to affiliate with the hospital in some manner may involve a loss for the hospital, because it is necessary to pay a physician enough to get him or her to move his or her practice to an area that may not be as favorable in terms of patient demand, indigenous payor mix, etc., as the area where the physician currently practices. The hospital s motive in entering into such an arrangement, however, may not be based on the expectation that the physician s own practice will generate referrals for the hospital; instead, it may be based on the fear that the hospital may lose patients in general to larger facilities offering a greater range of services for example, the fear that a patient who has to go to a hospital in another city to see an oncologist might be inclined to seek out other care at that hospital as well, even though such other care could also be provided at the local hospital. Under those circumstances, would it be sensible and prudent for the hospital to enter into an unprofitable arrangement unprofitable on a stand-alone basis with an appropriate specialist in order to avoid potential erosion in the hospital s overall competitive position? 23 Interestingly, while Ms. McNamara made this point more than once at trial, it could not possibly have been considered by her in arriving at her original commercial reasonableness opinion, because her trial testimony indicated that she was relying on deposition and trial testimony by the physicians which would not, of course, have existed at the time she rendered her opinion. {BH } 9

10 The fact is that commercially reasonable even in the absence of referrals is a misleadingly simple standard when applied to the physician employment setting. Note that this is not true in all physician-hospital relationships. It would not be commercially reasonable to pay a physician for medical director services that were not required (or not performed), or to pay four physicians for full-time medical director services when only one FTE medical director was needed; it would not be commercially reasonable for a hospital to lease space or equipment that it had no need or use for. However, it is almost inconceivable that a hospital would enter into an employment arrangement with a physician if it did not expect some direct or indirect referrals to be associated with that physician. Indeed, the Anti-Kickback Statute safe harbor (and statutory exception) and the statutory and regulatory Stark exceptions incentivize hospitals to enter into employment agreements with referring physicians, because an employment arrangement is the least challenging relationship from a compliance perspective. If commercial reasonableness is to be determined simply by whether an employment arrangement is profitable, considered in isolation, it would have been relatively easy for Congress, CMS and/or the OIG to say so. Instead, however, they have provided an ill-defined standard of commercial reasonableness, which in turn leads to the kind of irreducible, and unresolvable, argument seen on that point in Tuomey: You had no legitimate reason for entering into this arrangement, because I can t understand what it could have been. We did so have a legitimate reason. Did not. Did so. And so on ad infinitum. B. The Halifax Case The Halifax Hospital Medical Center case involved a variety of different physician employment arrangements, but the issues of commercial reasonable arose in the context of the hospital s arrangements with employed neurosurgeons. Unlike the employment arrangements in Tuomey, the Halifax case involved full-time employment agreements with the neurosurgeons. The alleged issues of commercial reasonableness centered, at least in the government s view, about the level, and elements, of compensation paid to the neurosurgeons. Once again, the government called on Ms. McNamara as its expert on both fair market value and commercial reasonableness issues. In her report, 24 Ms. McNamara stated that a commercial reasonableness inquiry evaluates if there is a sound business reason for employing the neurosurgeons and whether the terms of the compensation agreements with the referring physicians are commercially reasonable. 25 In concluding that this test which, it should be noted, does not conform to either of the formulae previously identified by CMS was not satisfied, Ms. McNamara focused on a number of factors: The neurosurgeons received car allowances, which no other physicians employed by Halifax received. Further, she viewed the car allowances as excessive, since they were substantially more than the car expenses one of them had incurred in independent private practice. 24 United States of America ex rel. Baklid-Kunz v. Halifax Hospital Medical Center, et al., Expert Report, Prepared by: Kathy McNamara, 12/21/ Id. at 27. {BH } 10

11 The neurosurgeons were identified on Halifax s Form 990 filings as being among the five most highly paid employees of Halifax. The neurosurgeons were the only employed specialists, other than medical oncologists, whose compensation was near the 90 th percentile of what Ms. McNamara had determined to be market compensation levels. The neurosurgeons got a variety of other subsidies not available to other employed physicians. The neurosurgeons compensation amounted to 100% of their net collections, so that the practices always incurred losses on a stand-alone basis. The neurosurgeons received call pay for what Ms. McNamara characterized as normal call, not just excessive call. Other aspects of the neurosurgeons contracts favored the neurosurgeons in ways that Ms. McNamara found unusual (although she cited no authority that she used in testing the usual-ness of the provisions). 26 Halifax offered up two expert reports to rebut that of Ms. McNamara. Ronald L. Vance of Navigant Consulting, Inc. found that the aggregate compensation paid to the neurosurgeons was a commercially reasonable, based upon an unmet community need for neurosurgeons and based upon his view that the compensation paid to the neurosurgeons during the relevant period was less that the potential recruitment and retention costs the hospital might have had to pay to fill the neurosurgeon deficit. 27 Kevin O Brien of Berkeley Research Group focused on factors derived from Internal Revenue Manual , including the specialized training and experience of the neurologists, the nature of their duties and associated responsibilities: To summarize, the neurosurgeons and medical oncologists have received specialized training and education. They perform complex and stressful procedures on patients needing sophisticated care. They incur substantial amounts of time providing needed access to care to residents of their community at a large district hospital. Their total compensation is not determined until year end and it 26 Id. at Interestingly, in a later presentation discussion Halifax, Ms. McNamara expressed her view that the commercial reasonableness applied not only at the initial of a physician employment arrangement, but throughout a physician s continued employment as well, and that a hospital should be able to present [v]igilant on-going proof of commercial reasonableness. See Kathy McNamara & Richard Romero, Halifax: A View from the Experts Seat, contained in the program materials from National Association of Certified Valuators and Analysts, Advanced Healthcare Valuation and Consulting Symposium, Dec. 12, 2014, at slides 23 and 58. The source of this position is not entirely clear, and Ms. McNamara s presentation does not suggest any particular intervals at which the commercial reasonableness of an arrangement should be reassessed. While it appears difficult to argue that Stark would not require a renewed assessment of commercial reasonableness when the time came to renew or extend an employment agreement, it seems anomalous (and without support in the language of the statute or the exception) to argue that the parties to an employment agreement have any duty to monitor the commercial reasonableness of an arrangement on a constant, continuous basis, especially where the agreement did not by its terms create any sort of midstream termination right. 27 Commercial Reasonableness Assessment of Selected Neurosurgery Physician Compensation Arrangements ( ) and Fair Market Value Opinion of Non-Employed Psychiatry ( ) Physician Compensation Arrangements, Halifax Health, Valuation Date: February 11, 2013, by Navigant Consulting, Inc., at 5. {BH } 11

12 is not related to the sale of a business asset. After considering each of the IRS recommended factors discussed above, it is my opinion the employment agreements entered into between Halifax and the individual neurosurgeons and medical oncologists for the period 2002 through 2011 are commercially reasonable. 28 Ultimately, these differing approaches were not tested in court, as the Halifax case settled. One might suggest that the fact that none of them seems overwhelmingly persuasive demonstrates the difficulty in applying the commercial reasonableness test to hospital-physician employment arrangements, in that there appears to be little common ground among experts as to how to approach the issue. What is disturbing in Halifax, though, is something that was also disturbing in Tuomey: the government s reliance on expert testimony that is based pretty much solely on the personal experience and subjective beliefs of the expert. Ms. McNamara s reports and testimony in Tuomey offer, multiple times over, a justification for her conclusion that the contracts at issue there were not commercially reasonable that is based on her unsupported assertion that a particular term or provision was atypical, not usual, or not consistent with what we usually see. In Halifax, a more detailed level of subjectivity is obvious. For example, consider again the factors she identified as supporting her conclusion that the neurosurgeons contracts were not commercially reasonable, as quoted above, with some observations in response: The neurosurgeons received car allowances, which no other physicians employed by Halifax received. Further, she viewed the car allowances as excessive, since they were substantially more than the car expenses one of them had incurred in independent private practice. o Car allowances, in practice, are simply another bucket for cash compensation. Aside from its being unclear that the car allowances and past car expenses are an apples-to-apples comparison, it is not especially relevant whether other physicians received car allowances or not; the relevant question is whether the aggregate compensation package, including the car allowances, was reasonable in furtherance of any legitimate goal the hospital had in entering into the arrangement. The neurosurgeons were identified on Halifax s Form 990 filings as being among the five most highly paid employees of Halifax. o Physicians tend to be relatively highly compensated relative to non-physicians, and experienced neurosurgeons tend to be among the more highly compensated physicians. There is no obvious connection between the compensation needed to attract and retain neurosurgeons and the compensation needed to attract and retain hospital personnel in general, so this fact is neither particularly interesting nor particularly informative. 28 Expert Report of Kevin L. O Brien Prepared in the Matter of United States of America ex rel. Baklid- Kunz v. Halifax Hospital Medical Center, et al., Civ. Act. No. 6:09-CV-1002-ORL-31 DAB, United States District Court, Middle District of Florida, Orlando Division, February 2013, at {BH } 12

13 The neurosurgeons were the only employed specialists, other than medical oncologists, whose compensation was near the 90 th percentile of what Ms. McNamara had determined to be market compensation levels. o Again interesting, but by definition someone has to be at or near the 90 th percentile of any range. Were there factors productivity, reputation, patient satisfaction ratings, whatever that might have justified compensating these physicians at that level? Were those factors different than those that obtained for other Halifax-employed physicians? It is not clear that Ms. McNamara explored those questions at all, except in comparing the physicians compensation to their collections. The neurosurgeons got a variety of other subsidies not available to other employed physicians. o Again interesting, but analytically similar to the car allowance issue. Did these subsidies make the neurosurgeons aggregate compensation unreasonable, when considered in the context of the total package? The neurosurgeons compensation amounted to 100% of their net collections, so that the practices always incurred losses on a stand-alone basis. o To some degree, this should always raise a red flag signaling the need for further evaluation of an physician employment arrangement. However, as discussed above (and as Ms. McNamara has acknowledged), there may be permissible, commercially reasonable reasons for structuring a practice to run at a loss. The neurosurgeons received call pay for what Ms. McNamara characterized as normal call, not just excessive call. o Here, Ms. McNamara makes totally unsupported and one could argue inaccurate and unjustified assertions about what call pay arrangements are usual. For example, in the author s own experience (and her experience is the only authority that Ms. McNamara cites, so it does not seem unfair to use the author s own experience in rebuttal), the concepts of normal call and excessive call are not typically part of a call pay arrangement; a physician either gets call pay or not. (Ms. McNamara also notes that the Halifax medical staff bylaws required physicians to take call. It is fair to note, however, that most medical staff bylaws require physicians on the active staff to take call and yet call payment arrangements proliferate. There is, simply put, no way to practically enforce a bylaws-based call requirement if the relevant specialists decline to take call unless they are paid.) Other aspects of the neurosurgeons contracts favored the neurosurgeons in ways that Ms. McNamara found unusual. o The thing is, there is nothing in the commercial reasonableness requirement that says that an arrangement is commercially reasonable if and only if the government s expert has seen it before. Indeed, in the preamble to the Stark Phase I final rule, the government strongly implied that commercial {BH } 13

14 reasonableness is a fact-specific test: With respect to determining what is commercially reasonable, any reasonable method of valuation is acceptable, and the determination should be based upon the specific business in which the parties are involved, not business in general. 29 The test is not whether Ms. McNamara, or any other government expert or representative of an enforcement agency, believes the arrangement is usual, customary, typical, etc., based on his or her own observation, although that may certainly be relevant to the analysis. It is whether it would be reasonable and prudent for similarly situated parties to enter into that arrangement for legitimate purposes that do not take into account the volume or value of referrals. Do these criticisms of Ms. McNamara s analytical approach mean that the arrangements between Halifax and the neurosurgeons were commercially reasonable? No, of course not. Do they mean that none of Ms. McNamara s points were valid or relevant to the analysis? No, of course not. The point is simply this: Unlike the approaches to analyzing fair market value, as to which there are a variety of methods that are generally accepted by qualified practitioners as legitimate, there is no particularly scholarly or quantitative approach that is generally accepted as a means of determining commercial reasonableness across all types of arrangements. The absence of such an industry standard does not mean there are not circumstances in which an expert may render a useful and valid opinion on the commercial reasonableness of an arrangement. However, it likewise should not mean that an opinion should be recognized as an expert opinion if it is based predominantly on the expert s own experience and observation, without other authority. Put another way, it may be possible for someone in Ms. McNamara s position to say, I ve looked at these factors and, based on what I ve read and observed in my own experience, I do not believe this arrangement is commercially reasonable. It is a much less defensible position to suggest that one s own experience is a sufficient basis, in and of itself, to establish universal truth. IV. CONCLUSION: THE STANDARD THAT WASN T (ALWAYS) THERE This, then, is the ongoing challenge in applying the Stark commercial reasonableness requirement in the physician employment setting. As noted above, there are some areas where it is pretty clearly commercially unreasonable to enter into an arrangement with a referring physician unless referrals were being taken into account. A hospital that leases a superfluous or obsolete piece of equipment from a referring physician; a hospital that pays a referring physician for a no-show administrative job; even a hospital that employs a referring physician s shiftless, high-school-dropout nephew as assistant vice president of public affairs or something all those are situations in which the lack of commercial reasonableness is likely to be pretty apparent, with or without expert testimony. In the physician employment setting, the analysis may be much more subtle, and much more difficult. Again, there is unlikely ever to be a circumstance in which a hospital employs a referring physician with no expectation of referrals from that physician. At the same time, there 29 Final Rule with Comment Period: Medicare and Medicaid Programs; Physicians Referrals to Health Care Entities With Which They Have Financial Relationships, 66 Fed. Reg. 919 (Jan. 4, 2001). {BH } 14

15 may be a variety of legitimate, socially useful reasons why it is in the best interests of a hospital, and its community, for the hospital to employ a physician that have little to do with the referrals from that physician. In those circumstances, it is relevant and necessary for the hospital to consider what it will take, within the bounds of fair market value, to get the physician to agree to an employment arrangement. What it will take may be something that is common and usual, or it may be something that is not; however, that is not determinative of whether the end result is a sensible, prudent business arrangement. The application of the commercial reasonableness standard in the employment setting, then, is an elusive concept. Note that none of the above discussion should be construed as indicating that the contracts at issue in either Tuomey or Halifax were, in fact, commercially reasonable. There are lots of reasons to be skeptical about them, at least in certain respects. However, the more overarching concern is that the government s attempt to apply a vaguely defined requirement by what amounts to reverse-engineering establishes potentially dangerous precedent. In both cases, the commercial reasonableness analysis appears to be a tagalong, constructed in an effort to rebut any arguments that an exception might apply after the government had already decided that a violation had occurred. If the government continues to utilize expert testimony that takes the form of This is not commercially reasonable because it s different than what I m used to, without the more expansive reasonable parties analysis that CMS s own language calls for, demonstrating commercial reasonableness is going to be a hard row to hoe. {BH } 15