This Health Law Update provides an overview of the Phase II Regulations, including certain key implications for the health care industry.

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1 April 19, 2004 PHASE II OF THE FINAL STARK II REGULATIONS On March 26, 2004, the Centers for Medicare and Medicaid Services (CMS) published Phase II of the final Stark II regulations (the Phase II Regulations), the long-awaited sequel to Phase I of CMS s rulemaking (the Phase I Regulations). This publication (along with an April 6, 2004 correction), includes the full text of the Stark regulations as amended by the Phase II Regulations, and a preamble discussion by CMS of the Phase II Regulations and key provisions of the Phase I Regulations. Highlights of the rulemaking include: methods for establishing physician compensation that will be deemed to be consistent with fair market value; an accommodation for percentage and other formula-based physician compensation methodologies; CMS s decision to adopt a very narrow interpretation of the statutory exception for hospital remuneration unrelated to designated health services; a new bright-line definition of same building for purposes of the in-office ancillary services exception; a physician recruitment incentives exception that permits certain incentives to residents and interns already practicing in the hospital s service area, and incentives to physicians recruited to existing medical practices; a new physician retention incentive exception; and a new exception for unavoidable and temporary lapses in compliance. Published as an interim final rule, the Phase II Regulations, including certain document retention requirements, are effective July 26, CMS is accepting comments on the Phase II Regulations through June 24, 2004, and, according to CMS officials, will eventually republish the Phase II Regulations as a final rule in which CMS will respond to such comments. This Health Law Update provides an overview of the Phase II Regulations, including certain key implications for the health care industry. TABLE OF CONTENTS PAGE I. INTRODUCTION...2 II. THE GENERAL PROHIBITION ON PHYSICIAN SELF-REFERRAL... 2 III. THE GENERAL EXCEPTIONS...7 IV. OWNERSHIP AND INVESTMENT EXCEPTIONS 16 V. THE COMPENSATION EXCEPTIONS...17 A. PHYSICIAN COMPENSATION...17 B. HOSPITAL RELATED COMPENSATION EXCEPTIONS 20 C. OTHER COMPENSATION EXCEPTIONS.25 D. INNOCENT ENTITIES EXCEPTIONS.. 28 VI. EXCEPTIONS RELATING TO MANAGED CARE ARRANGEMENTS VII. REPORTING REQUIREMENTS... 29

2 INTRODUCTION Named after its legislative sponsor and proponent, Rep. Pete Stark (D. Calif.), the Stark Law prohibits physicians from making referrals to an entity for Medicare-covered designated health services (DHS) if the physician, or an immediate family member, has a financial relationship with the entity, unless an exception applies. The Stark Law also imposes certain reporting requirements on entities that furnish DHS (DHS Entities). Services rendered pursuant to a prohibited referral are not payable by Medicare, and anyone submitting claims to Medicare or billing any entity for such services has an obligation to make a prompt refund. Submission of such claims or failure to promptly refund payments is punishable by civil monetary penalties and, potentially, exclusion from the Medicare program. The U.S. Department of Justice is also pursuing cases under the federal civil False Claims Act predicated on violations of the Stark Law. The Stark regulations exceptions are divided into four categories. The first category of exceptions are referred to as the general exceptions. These exceptions apply to certain DHS and/or DHS Entities, and apply regardless of the nature of the financial relationship between the referring physician and the DHS Entity. The second category of exceptions are the ownership or investment exceptions. These exceptions describe ownership or investment exceptions that will not be considered financial relationships for purposes of the Stark Law. The third category of exceptions are the compensation exceptions, which describe compensation arrangements that will not be considered financial relationships for purposes of the Stark Law. Finally, the fourth category of exceptions, so-called innocent entity exceptions, allow certain entities, because of specified extenuating circumstances, to submit DHS claims and receive payment, even though the DHS was furnished pursuant to a prohibited referral. The Phase II Regulations generally cover those parts of the 1998 proposed Stark II regulations not covered by the Phase I Regulations: the ownership and investment exceptions, the compensation arrangement exceptions, and the reporting requirements. However, because Phase II also includes CMS s response to public comments on the Phase I Regulations, the preamble to the Phase II Regulations addresses an array of Stark Law provisions first dealt with in Phase I. The only subject that CMS has not addressed in either Phase I or Phase II is the applicability of the Stark Law to referrals for Medicaid-covered services. Certain Medicaid managed care arrangements, however, are specifically addressed in the Phase II Regulations. For a description of the regulatory history of the Stark Law, please see McDermott s On the Subject, CMS Issues Long-Awaited Phase II Stark Regulations (March 30, 2004). For a detailed discussion of the Phase I Regulations, please see McDermott s Health Law Update, Health Care Financing Administration Issues Phase I of the Final Stark II Rule (January 26, 2001). THE GENERAL PROHIBITION ON PHYSICIAN SELF-REFERRAL The Phase I Regulations defined the key terms of the Stark Law s general prohibition on physician self-referral. CMS revised certain key terms of the general prohibition in the Phase II Regulations, and clarified other terms, each of which are discussed below

3 Referral The Phase I Regulations defined referral broadly as any request for, order of, certification or recertification of the need for or establishment of a plan of care that includes a DHS. CMS excluded from the definition of referral services performed or provided personally by the referring physician, but included referrals for services performed incident to the services of the referring physician, and a request for a consultation with another physician and any test or procedure ordered or performed by (or under the supervision of) that other physician. In addition, referrals directed by or controlled by a physician, such as the referrals of a physician s employees, are attributed to the physician. The determination whether a physician controls or directs the referrals of another physician or practitioner turns on the facts and circumstances and nature of the relationship. Following the statutory definition, the Phase I Regulations excepted from the definition of referral requests by a pathologist for clinical laboratory services and pathological examinations, requests by a radiologist for diagnostic radiology services, and requests by a radiation oncologist for radiation therapy, provided the request results from a consultation requested by another physician, and the tests or services are furnished by or under the supervision of the pathologist, radiologist, or radiation oncologist. The Phase II Regulations allow this supervision to be provided by another pathologist, radiologist or radiation oncologist in the same group practice. Further, based on comments, CMS agreed to revise the regulations to except referrals by radiation oncologists for necessary and integral ancillary services requested, and appropriately supervised, by the radiation oncologist. However, CMS does not appear to have actually revised the text of the regulations to except such referrals. Responding to comments on the Phase I Regulations, CMS agrees with a commenter requesting clarification that there is no referral if a physician personally provides durable medical equipment (DME) to a patient. CMS also notes in a different comment that prescription drugs ordered and personally furnished or administered by a physician would not constitute a DHS referral by the physician. This interpretation by CMS would seem to produce anomalous results, meaning that a medical practice could furnish any medically necessary DME to its patients, e.g., home oxygen equipment and supplies (not just the subset of DME permitted under the in-office ancillary services exception), provided the referring physician personally hands the DME to the patient and instructs the patient on its use. Because such DME would not be considered a referral, the physician personally furnishing the DME can even get personal production credit for the DME under the practice s compensation plan (something the physician could not even get under the in-office ancillary services exception). Similarly, a physician could get production credit for ordered drugs that do not satisfy the in-office ancillary services exception, provided the physician personally dispensed or administered the drug. Other anomalous results follow from application of this interpretation to parenteral and enteral nutrients and supplies that could be ordered and personally furnished by a physician. We suspect that CMS might change its interpretation once it realizes the potential consequences; however, for now, there is a reasonable basis for relying on the interpretation. Referring Physician In the Phase I Regulations, CMS dropped group practices from the definition of referring physician, restricting the definition to a physician who makes a referral... or who directs another person or entity to make a referral or who controls referrals made by another person or - 3 -

4 entity. The Phase II Regulations retained the concept of a referring physician as an individual physician; however, it provides that a referring physician and the professional corporation of which he or she is a sole owner are the same for purposes of the regulations. Nonetheless, certain exceptions include references to compensation to physician groups, which confuses the analysis of who is the referring physician. (The personal services exception applies to remuneration to a group practice, and the fair market value exception applies to compensation paid to a group of physicians.) Based on remarks by CMS in the preamble to the Phase II Regulations, CMS clearly intends for compensation arrangements between group practices and DHS Entities to involve an indirect compensation analysis, which is consistent with the notion that group practices are not referring physicians. Thus, direct compensation arrangements between DHS Entities and group practices are only relevant because of the indirect compensation arrangements they may create between individual physicians in the group practice (or their sole-shareholder professional corporations) and the DHS Entity. This means that many compensation arrangements that used to be analyzed under one of the common compensation exceptions to the Stark Law, such as the office space rental or personal services exceptions, are now analyzed under the indirect compensation arrangement exception (discussed below). Financial Relationship The Stark Law defines a financial relationship as an ownership or investment interest or a compensation arrangement. Each type of financial relationship is discussed separately below. Ownership or Investment Interest ~ The Phase I Regulations provided that an ownership or investment interest (ownership interest) may be through debt, equity or other means, and includes stock, partnership shares, limited liability company memberships, and loans, bonds or other financial instruments. Only debt that is secured by property or revenue gives rise to an ownership interest, and, as the Phase II Regulations clarify, stock options and convertible securities granted as compensation do not create an ownership interest until the options are exercised and the convertible securities are converted to equity. The Phase II Regulations generally retain the Phase I Regulation s definition of an indirect ownership arrangement as an unbroken chain of ownership interests between the referring physician (or immediate family member) and the DHS Entity. However, CMS revised the definition to clarify that common ownership in an entity does not, in and of itself, establish an indirect ownership interest by one common owner in another common owner. The unbroken chain of ownership interests between the referring physician and the DHS Entity must be such that the referring physician has an indirect ownership interest in the DHS Entity. For example, if a referring physician owns an interest in entity A, which owns an interest in entity B, and entity C, a DHS Entity, holds an ownership interest in entity B, the referring physician would not have an ownership interest in the DHS Entity based on this chain of ownership interests. Moreover, an indirect ownership interest does not exist unless the DHS Entity has actual knowledge of, or acts in reckless disregard or deliberate ignorance of, the fact that the referring physician (or immediate family member) has some ownership interest (through any number of intermediary interests) in the DHS Entity, even if the DHS Entity does not know of the precise composition of the unbroken chain or the specific terms of the ownership interests that form the links in the chain

5 Compensation Arrangements ~ A compensation arrangement arises from any remuneration, direct or indirect, between a DHS Entity and a referring physician (or immediate family member). In Phase I, CMS established a three-part definition of indirect compensation that many have found perplexing. First, there must exist between the DHS Entity and the referring physician (or immediate family member) an unbroken chain of persons or entities that have financial relationships between them. Second, the aggregate compensation received by the referring physician (or immediate family member) from the person or entity with which the physician has a direct financial relationship must vary with or otherwise reflect the volume or value of the physician s referrals or other business generated for the DHS Entity. (If the referring physician s (or immediate family member s) direct financial relationship is one of ownership or investment, this second test is applied to the first compensation arrangement up the chain from the referring physician (or immediate family member).) Third, the DHS Entity must have actual knowledge or act in reckless disregard or deliberate ignorance of the fact that the referring physician (or immediate family member) receives aggregate compensation that varies with or reflects the volume or value of referrals or other business generated for the DHS Entity. CMS has not changed this definition in the Phase II Regulations; however, it has attempted to dispel a lot of confusion over how the first and second parts of the definition operate. First, CMS considered and rejected the argument that a financial relationship in the chain of financial relationships between the referring physician and the DHS Entity that qualifies for a Stark exception should break the chain and, thus, end the analysis of whether an indirect compensation arrangement exists. CMS remains concerned that a chain of financial relationships between the referring physician and the DHS Entity could still offend the Stark Law, even if one of the links in the chain qualifies for a Stark Law exception. Second, although the Phase I Regulations provide that time-based or per unit of service-based compensation does not take into account the volume or value of referrals if, among other things, the time-based or unit of service based compensation is fair market value, CMS clarifies in the Phase II Regulations that such time-based or per unit of service based compensation arrangements can, for purposes of the indirect compensation definition, result in aggregate compensation that varies with or reflects the volume or value of referrals. For example, if a physician owns a company that furnishes physical therapy services to a hospital for $50 per hour, and the physician refers patients to the hospital for physical therapy, the hospital s aggregate payments to the therapy company will vary or reflect the volume of the physician s referrals to the hospital, even if the hourly rate is fair market value. Consequently, the arrangement meets the definition of an indirect compensation arrangement, and therefore must be further analyzed to determine whether the indirect compensation exception applies. If an indirect compensation arrangement exists, the indirect compensation exception applies if, among other things, the compensation received by the referring physician (or immediate family member) is not determined in a manner that takes into account the volume or value of referrals or other business generated by the referring physician for the DHS Entity. For purposes of this exception, compensation does not take into account the volume or value of referrals if, among other things, the compensation, including any time-based or per unit of service compensation, is fair market value for services and items actually provided. Thus, using the above example of the physician who owns a therapy company that is paid $50 per hour of therapy by a hospital, this hourly rate compensation could qualify for the indirect compensation exception, even though we - 5 -

6 have already established that the aggregate compensation paid to the therapy company would vary with or reflect the volume of the physician s referrals. The distinction between aggregate compensation that varies with or reflects the volume or value of the physician s referrals, and a time-based or per unit of service-based compensation that is deemed not to take into account the volume or value of the physician s referrals was not as clear as it could have been in the Phase I Regulations. Consequently, CMS s clarification of the indirect compensation analysis in the Phase I Regulations is helpful. Nonetheless, the indirect compensation analysis remains highly technical, making it challenging for non-lawyers and many lawyers to discern whether an indirect compensation arrangement exists and, if so, whether it qualifies for the indirect compensation exception. Further, because compliance with the federal Anti-Kickback Statute, which turns on motive, is a requirement of the indirect compensation exception, parties to an indirect compensation arrangement can only be certain that the arrangement qualifies for the indirect compensation exception if the arrangement also fits squarely within an anti-kickback safe harbor or the parties obtain a favorable advisory opinion from the Department of Health and Human Services, Office of the Inspector General (OIG). The difficulties with the indirect compensation analysis are compounded by the fact that, because most physicians furnish services through a group practice entity, a substantial percentage of compensation arrangements with physicians now have to be analyzed as potential indirect compensation arrangements. Entity Generally, the DHS entity is the person or entity that CMS pays for the DHS, under either an assignment or certain permitted reassignments. Thus, for example, entities that furnish hospital services under arrangements with a hospital are not DHS Entities, because they are not paid by CMS for the hospital service. The Phase II Regulations provide that entity does not include a physician s practice when it bills Medicare for a purchased diagnostic test consistent with rules prohibiting physicians from marking up a purchased diagnostic test to the Medicare program. Physicians self-referrals for purchased diagnostic tests that are DHS will no longer need to qualify for the in-office ancillary services or other exception. Designated Health Services The Stark DHS are the following services, when payable by Medicare: (1) clinical laboratory services; (2) physical therapy, occupational therapy, and speech-language pathology services; (3) radiology and certain other imaging services; (4) radiation therapy services and supplies; (5) DME and supplies; (6) parenteral and enteral nutrients, equipment and supplies; (7) prosthetics, orthotics, and prosthetic devices and supplies; - 6 -

7 (8) home health services; (9) outpatient prescription drugs; and (10) inpatient and outpatient hospital services. DHS does not include DHS paid by Medicare as part of a composite rate for a service that is not a DHS. For example, laboratory services paid as part of the composite rate for end-stage renal dialysis (ESRD) services, physical therapy services paid as part of the RUGs per diem rate for skilled nursing services, and radiology services paid as part of the facility fee for ambulatory surgical services are not DHS. Clinical laboratory services, physical therapy, occupational therapy and speech-language pathology services, radiology and certain other imaging services, and radiation therapy services and supplies are defined entirely by reference to a list of specific CPT and HCPCS codes. These codes are listed in an Addendum to the Phase II Regulations, posted on the CMS website ( and published (and updated) annually in the Medicare physician fee schedule final rule. The definitions of other DHS are based on existing legal definitions of the services for purposes of Medicare coverage. The definitions of DHS published in the Phase I Regulations generally remain unchanged by the Phase II Regulations. However, the following revisions are notable. First, revisions were made to the list of CPT/HCPCS codes for physical therapy, occupational therapy and speech-language pathology services. Second, the exception from the definition of radiology and certain other imaging services for radiology procedures integral to the performance of a nonradiological medical procedure and performed during such procedure was expanded. The exception now also applies to radiology procedures performed immediately following the nonradiological medical procedure when necessary to confirm placement of an item placed during the nonradiological procedure. Third, CMS indicated that it would not consider lithotripsy an inpatient or outpatient hospital service. Finally, CMS added five bone density tests to the list of CPT/HCPCS codes for radiology services. This revision removes any doubt that CMS considers bone density testing services DHS. THE GENERAL EXCEPTIONS The general exceptions apply to both ownership/investment interests and compensation arrangements between the referring physician and the DHS Entity. The Phase II Regulations add a new general exception for intra-family rural referrals and eliminate the exception for ASC/ESRD/Hospice services that had been included in the Phase I Regulations. The ASC/ESRD/Hospice exception has been eliminated because it is unnecessarily duplicative in light of the exclusion from the definition of DHS services that are paid on a composite rate basis. The Phase II Regulations also make substantial revisions to the in-office ancillary services and academic medical center exceptions, and clarifies the other general exceptions. These changes are discussed in detail below, with the exception of the prepaid plan exception, which is discussed in the section on managed care arrangements

8 Intra-Family Rural Referrals This new exception is intended to protect intra-family referrals in rural areas where the DHS is needed and cannot otherwise be provided to the patient in a timely manner. The new exception protects services provided pursuant to a referral from a referring physician to his or her immediate family member or to an entity with which such family member has a financial relationship, if certain conditions are met. The patient referred must reside in a rural area, and, for nonhome-based services, not have available within 25 miles of the patient's residence any other person or entity to furnish the needed services in a timely manner. In the case of homebased services, there is no distance limitation; the requirement is simply that that the needed item or service is not available from any other person or entity in a timely manner. To qualify for the exception, the referring physician or the immediate family member must make reasonable inquiries as to the availability of other persons or entities to furnish the DHS. However, there is no obligation to inquire as to the availability of anyone located more than 25 miles from the patient's residence. CMS suggests that to fulfill the duty to make reasonable inquiry, the referring physician or immediate family member should consult telephone directories, professional associations and/or Internet resources. CMS also warns that lack of availability of a quality service is not lack of availability triggering the exception. This is to protect against abuse on the basis of subjective judgment about quality by the referring physician and the immediate family member. The financial relationship between the referring physician and the immediate family member must also comply with the federal Anti-Kickback Statute and with federal and state law governing billing and claims submission. In-Office Ancillary Services The in-office ancillary services exception is the principal exception relied upon by physicians who are owners, employees or contractors of medical groups in order to make DHS referrals to their own group or to other physicians in their group. To meet this exception, the group must meet supervision, location (i.e., centralized building or same building ) and billing tests, as well as satisfy the definition of a group practice. Many of the revisions to this exception that were adopted in the Phase I Regulations were confirmed without change, including: --The exception covers all DHS except DME (other than external ambulatory infusion pumps, canes, walkers, crutches, blood glucose monitors, and manual folding wheel chairs, under specified conditions), and parenteral and enteral nutrients, equipment and supplies. The Phase II Regulations clarify that the physician group must be approved by CMS as a DMEPOS supplier in order to provide permitted DME services. --Chemotherapy drugs administered or dispensed in the physician s office are considered furnished in the office for purposes of the exception even if they are self-administered at home by the patient. --The requirement that the DHS be directly supervised by a physician in the group practice, means that the supervision must meet the physician supervision requirements under applicable Medicare coverage or payment rules for the specific service at issue. --Supervision of DHS can be provided by physicians in the group, which is defined to include owners, employees, independent contractors, leased employees and locum tenens physicians

9 --The definition of a centralized building for purposes of the location test continues to mean all or part of a building (including a mobile vehicle, van or trailer) that is owned or leased on a full-time basis (i.e., 24 hour per day, 7 days per week, for a term of not less than 6 months) by a group practice and that is used exclusively by the group practice (and is not shared with any other provider or supplier) for some or all of the group's DHS. A group can have more than one centralized building for the provision of DHS. The Phase II Regulations clarify that a group practice is not precluded by the exclusivity requirement of the centralized building definition from providing services to patients of other providers or suppliers, absent a prohibited financial relationship with the referring provider or supplier. New Same Building Standards ~ The Phase II Regulations make substantial changes to the same building requirements for purposes of the location test. The Stark II statute requires that the same building be one in which the referring physician (or a member of his or her group practice) furnishes physician services unrelated to the furnishing of DHS. In the Phase I Regulations, CMS interpreted this standard as requiring the referring physician (or group member) to furnish in the same building substantial physician services unrelated to the furnishing of DHS, and that the primary purpose of the patient seeing the physician in the building was to receive physician services unrelated to DHS. CMS received public comments objecting to these requirements, particularly from radiologists and oncologists, who pointed out that many of their patients see them almost exclusively for DHS services-- imaging or outpatient drugs. Accordingly, patients may see these specialists primarily for DHS purposes, and these specialists may not provide substantial unrelated services in their offices. As a result of these comments CMS decided to eliminate these requirements and develop new same building standards that are more straightforward and flexible, and less susceptible to abuse. The new standards are applicable to both group practices and solo practitioners. To satisfy the new standards, the physician or group must meet any one of the following three alternative tests: 1. The building is a principal place of practice for the physician or group, as evidenced by: --An office of the physician or group that is normally open to the physician s or group's patients for medical services at least 35 hours a week; --The referring physician or one or more members of the physician's group practice regularly furnishes physician services to patients at the office at least 30 hours a week; and --At least some of the physician services are unrelated to DHS payable by any payor. 2. The referring physician practices at least one day per week at the office and it is the principal place at which the physician's patients usually receive services from the physician or members of his group, as evidenced by: --The patient receiving the DHS usually receives physician services from the referring physician or members of his group at the building; --The office is owned or leased by the referring physician or his group and is normally open to the physician s or group's patients for medical services at least eight hours per week; - 9 -

10 --The referring physician regularly practices medicine and furnishes services at the office at least six hours per week; and --At least some of the services furnished during those six hours are unrelated to DHS payable by any payor. 3. The referring physician or his group provides physician services at the office at least one day per week and either DHS are ordered during a patient visit or the physician or a member of the group is present during the furnishing of the DHS, as evidenced by: --The referring physician or his/her group owns or rents an office that is normally open to the physician's or group's patients for medical services at least eight hours per week; --The physician or members of his/her group regularly practices and furnishes physician services at the office at least six hours per week; --At least some of the services furnished during those six hours are unrelated to DHS payable by any payor; and --The referring physician is present and orders the DHS during a visit on the premises, or --The referring physician or a member of his/her group is present while DHS is being furnished during occupancy of the premises. The DHS must be furnished in an office that meets one of these new same building tests, but it need not necessarily be performed in the same space or part of the building as other services provided by the physician. CMS clarifies that the requirement that the office normally be open, or that the physician or group regularly practice at the site is not breached if the office is occasionally open fewer hours due to vacations, unfilled appointments, cancellations, or occasional gaps. CMS also confirms that the requirement that some unrelated services be performed at the office has its commonsense meaning, and does not require that any particular minimum amount of unrelated services be performed. Unrelated services are construed by CMS to include physical exams and other services that can be reasonably anticipated to lead to the ordering of DHS (e.g., lab, x-ray services). With the elimination of the primary purpose and substantial unrelated service standards, DHS referrals by radiologists and oncologists should now be able to meet the location test of the in-office ancillary services exception. However, groups or groups and independent DHS suppliers (e.g., imaging suppliers) who are currently sharing a DHS facility in reliance on the same building approach, will need to review the arrangement for compliance with the new objective standards. Special Rule For Home Care ~ In the Phase I Regulations, CMS created an exception to the same building requirement for physicians who may not have an office because their principal medical practice is treating patients in their private homes. To meet this exception the referring physician (or a qualified person accompanying the physician, such as a nurse or technician) must provide the DHS contemporaneously with a physician service that is not a DHS in the patient's

11 home. CMS clarifies that the contemporaneous standard only requires the physician to be present at the inception of the DHS, and that the physician need not be present throughout the procedure. In the Phase II Regulations, CMS also amends this exception to clarify that it applies to a private home in an assisted living or independent living facility. To apply in this context, the DHS must be performed in the patient's residence (that the patient owns or leases) and not in a central exam room in the facility. The exception also does not apply to DHS performed in a nursing home, long-term care facility or other institution. Group Practice Definition ~ The Phase II Regulations made no major changes to the definition of group practice for purposes of the in-office ancillary services and physician services exceptions, but it clarifies certain elements of that definition. The Phase II Regulations amend the single legal entity part of the group practice definition as follows: --The primary purpose of the single legal entity must be to operate a physician group. In the Phase II Regulations, CMS amends the definition of single legal entity to clarify that the purpose of the entity at the time of its formation is not the relevant point to determine purpose. Rather the relevant inquiry about primary purpose is at the time of the DHS referral. If the entity's primary purpose at that time is to operate a medical group, it will qualify as a single legal entity for group practice purposes. --In the Phase I Regulations, CMS indicated that a single legal entity could not be owned by another operating medical group. In Phase II, CMS clarifies that the single legal entity can be organized or owned (in whole or in part) by another medical practice, provided that the other medical practice is not an operating physician practice (and regardless of whether the medical practice meets the conditions for a group practice). The single legal entity may also own subsidiaries. --The Phase II Regulations add a new provision to the definition of single legal entity that provides relief for multi-state practices that, due to state law requirements, are composed of separate mirror entities on a state-by-state basis. To meet the definition of a single legal entity under these circumstances, the states in which the group practice is operating must be contiguous (although each state need not be contiguous with every other state); the legal entities must be absolutely identical as to ownership, governance and operation; and, organization as multiple entities must be necessary to comply with jurisdictional licensing laws of states in which the group operates. (The reference to jurisdictional licensing laws and identical governance may be problematic if the reason for the group's multiple entities arises from corporate laws, which may require that owners, directors and/or officers be composed solely of physicians who are licensed and actively practicing in the state). Other Phase II changes and clarifications to the group practice definition include: --CMS clarifies that the requirement that the group have two or more physicians who are members of the group can be satisfied by one physician owner combined with one or more physician-employees, whether they are full-time employees, part-time employees or leased (bona fide) employees. The two physician requirement, however, cannot be satisfied by one physician owner combined with an independent contractor physician

12 --- Members of the group include owners of the group, employees, locum tenens physicians, on-call physicians and leased employees (who meet the IRS definition of a bona fide employee), but not independent contractors. Independent contactors and leased employees who are not bona fide employees are considered physicians in the group practice, as originally proposed in the Phase I Regulations, and so are not counted for purposes of the 75% patient care services or physician-patient encounter tests. ---In determining whether a physician who is a member of the group furnishes substantially the full range of patient care services through the group, CMS will not take into account the nature or extent of free services furnished by group members at free clinics. Free clinic services and time spent supervising residents and providing academic clinical services will also not be counted against the group in calculating the 75% substantially all test (i.e., at least 75% of the patient care services of physicians who are members of the group must be furnished through the group and billed under the group billing number), if the services are contracted through the group. Under such circumstances, CMS will view the services as being furnished and billed through the group, notwithstanding that no bills are sent or collected. ---In the Phase I Regulations, CMS created a 12-month grace period for start-up practices to meet the 75% substantially all test. CMS now clarifies that the grace period does not apply when the group reorganizes or admits a new member. However, the Phase II Regulations include a new 12-month grace period for a new member who relocates to join an existing group practice, provided that for the 12- month period the group is fully compliant with the substantially all test, if the new member is excluded from the calculation, and the new member's employment with, or ownership interest in, the group practice is documented in writing no later than the beginning of his or her relationship with the group. ---The Phase I Regulations established a unified business test to assure that the group is sufficiently integrated and centrally managed to be considered a true group. In Phase II, CMS eliminates the prong of the test that required the group to have centralized utilization review, since many groups do not perform U/R for their members. Physician Services The Phase I regulations finalized the proposed physician services exception, a statutory general exception that, like the in-office ancillary services exception, applies to certain DHS regardless of the nature of the financial relationship between the referring physician and a group practice. The physician services exception is limited to DHS that are physician services (e.g., professional interpretations of Medicare-covered x-rays) referred to another physician in the group practice. In addition, the exception covers referrals for physician services that are supervised by another physician in the group practice, provided Medicare payment and coverage rules for the physician services are met. This reference to physician services supervised by another physician in the group practice apparently refers to physician services rendered by nurses and other nonphysician practitioners and covered by Medicare as services incident to the services of the referring physician. The exception does not, however, extend to incident to services, such as physical therapy services, that are not physician services. This exception remains intact in the Phase II Regulations, and, although of limited utility, might be useful in circumstances where the

13 DHS that is a physician service performed by another physician in the group practice (e.g., x-ray interpretations) does not qualify for the in-office ancillary services exception. Academic Medical Centers The academic medical center (AMC) exception, as set forth in the Phase I Regulations, was roundly criticized for failing to describe accurately the complex web of academic, teaching, administrative, clinical and financial relationships that are implicated by AMC arrangements with academic physicians. In response to comments on Phase I, CMS has made substantial changes to the AMC exception to make it more flexible and useful. For services provided by the AMC to qualify for this exception, the referring physician must meet certain standards, the AMC must meet defined structural requirements, and the referring physician's compensation must meet the set in advance, fair market value, and volume/value standards. In addition, the referring physician's compensation arrangement must not violate the federal Anti-Kickback Statute or any federal or state law regulation governing billing or claims submission. The physician compensation standards are discussed below in the section on physician compensation. The referring physician standards and the AMC definition/standards are discussed here. Referring Physician Standards. The referring physician standards require that the referring physician must: (1) Be a bona fide employee of a component of the academic medical center on a full-time or substantial part-time basis. In the Phase 1 Regulations, components of an AMC were limited to an affiliated medical school, faculty practice plan, hospital, teaching facility, institution of higher education, or departmental professional corporation. In Phase II, CMS amends this definition to also include a nonprofit support organization whose primary purpose is supporting the teaching mission of the academic medical center (e.g., a fund raising foundation). CMS further clarifies that the components need not be separate legal entities, and that some or all of them may be divisions of a single legal entity. (2) Be licensed to practice medicine in the State(s) in which he or she practices medicine. (3) Have a bona fide faculty appointment at the affiliated medical school. In the Phase II Regulations, CMS recognizes that in AMCs, certain faculty appointments (such as clinical adjuncts) may be solely with the teaching hospital. Accordingly, in the Phase II Regulations, CMS introduces the concept of an accredited academic hospital and permits the referring physician to qualify for the AMC exception by a faculty appointment at one or more of the educational programs at the accredited academic hospital. The term accredited academic hospital is defined in the Phase II Regulations as a hospital or health system that sponsors four or more approved medical education programs. (4) Provide either substantial academic services or substantial clinical teaching services for which the faculty member receives compensation as part of his or her employment relationship with the academic medical center. In the Phase II Regulations, CMS clarifies that this requirement can be met by a combination of academic services and clinical teaching services. CMS fashions a safe harbor in the Phase II Regulations by which to meet this substantial

14 services standard. A physician will be deemed to meet this requirement if he or she spends at least 20 percent of his or her professional time or eight hours per week providing academic or clinical teaching services (or a combination thereof). Failure to meet the safe harbor is not fatal; a physician who fails to meet the safe harbor is not precluded from qualifying for the exception. CMS also amends the Phase II Regulations to require that the parties use a reasonable and consistent method for calculating a physician s academic and clinical teaching services. AMC Definition/Standards. The Phase II Regulations provide a more flexible definition of an academic medical center, but make only minor changes to the standards that an AMC must meet to qualify for the AMC exception. The term academic medical center is redefined in the Phase II Regulations for purposes of the AMC exception as: (1) An accredited medical school (including a university, when appropriate) or an accredited academic hospital (as defined below). (2) One or more faculty practice plans affiliated with the medical school, the affiliated hospital(s), or the accredited academic hospital. This definition permits the AMC to have more than one faculty practice plan that can be organized in any manner, whether as a tax-exempt entity or a for-profit professional corporation. It eliminates the requirement under the Phase I Regulations that the faculty practice plan be a tax exempt entity or under the umbrella of the AMC. (3) One or more affiliated hospital(s) in which a majority of the physicians on the medical staff consists of physicians who are faculty members and a majority of all hospital admissions are made by physicians who are faculty members. In determining whether these majority tests are met, courtesy and volunteer faculty members are counted as faculty, faculty from any affiliated medical school or accredited academic hospital education program may be aggregated, and residents and ancillary professionals are not counted as part of the medical staff of the affiliated hospital. In the Phase II Regulations, CMS also clarifies that the affiliated hospital for purposes of this requirement may be the same academic hospital that satisfies the first definitional element above. The academic medical center must meet all of the following standards for the AMC exception to apply: (1) All transfers of money between components of the academic medical center must directly or indirectly support the missions of teaching, indigent care, research, or community service. This requirement is unchanged by the Phase II Regulations. (2) The relationship of the components of the academic medical center must be set forth in written agreement(s) or other written document(s) that have been adopted by the governing body of each component. CMS clarifies that documentation of the relationship among the AMC components can appear in multiple instruments, including policies or other documents that establish a course of conduct among the components. The Phase II Regulations also provide that

15 if the academic medical center is one legal entity, the documentation requirement will be satisfied if transfers of funds between components of the academic medical center are reflected in the routine financial reports of the components. (3) In the Phase I Regulations all money paid to a referring physician for research had to be used solely to support bona fide research. Phase II permits research funds also to be used for teaching (but not for indigent care or community services) and, in any event, requires such funds to be used consistent with the terms and conditions of the grant. As revised by the Phase II Regulations, the AMC exception is more flexible and, thus, will apply to a greater variety of faculty compensation arrangements. However, faculty practice plans furnishing DHS will often desire the greater flexibility in structuring physician compensation afforded by the in-office ancillary services exception, and indirect compensation arrangements between a medical school faculty member and an affiliated hospital are often able to be resolved under the indirect compensation analysis. Nonetheless, certain AMCs with myriad physician compensation arrangements may find it desirable to rely on the AMC exception, both to simplify Stark compliance for the DHS Entities within the AMC and to be certain that hospital-medical school financial arrangements on other than fair market value terms are Stark-compliant without the necessity of obtaining a favorable advisory opinion for each such arrangement under the federal Anti-Kickback Statute. Implants Furnished by an ASC CMS has revised the implants exception to clarify that the exception applies only to implants billed by an ambulatory surgery center (ASC) as an ASC service. It also only applies to implanted prosthetics, prosthetic devices and DME. The exception does not, for instance, apply to brachytherapy implants. It also does not apply to implants billed by a physician or medical group, even if furnished in an ASC setting. These other DHS implants would need to be protected by another exception, such as the in-office ancillary services exception. EPO and Other Dialysis-Related Drugs Furnished in or by an ESRD Facility In the Phase II Regulations, CMS expands the list of drugs covered by this exception to include drugs that are required for the efficacy of dialysis and are identified on the CMS eligibility list appended to the Regulations. CMS has amended the list to include levocarnitine, albumin, calcitoninsalmon, and the thrombolytics: steptokinase, urokinase, and retaplase. CMS also clarifies that heparin and normal saline are covered within the ERSD composite rate, and, thus, do not need to be included in this exception. CMS further amends this exception to exclude any drugs dispensed for self-administration at home, other than EPO and Aranesp. This is a significant change to the Phase I Regulations, which covered all eligible drugs, whether administered in the ESRD facility or dispensed for self-administration at home. Preventative Screening Tests, Immunizations, and Vaccines The preventive services covered by this exception involve those Medicare covered items and services listed on the CPT/HCPCS code list attached to the Phase II Regulations. CMS has removed all bone densitometry services from the list, since it views them diagnostic services not preventive screening tests. CMS also clarifies that while screening mammographies are covered preventive tests, diagnostic mammographies and PAP smears are not. Also eliminated is the requirement that the eligible items and services be reimbursed by Medicare on a fee schedule