CMS Proposes Changes to Arrangement Valuation Terms Under the Federal Stark Law

In Short

The Situation: There has been longstanding uncertainty in the health care industry related to interpreting certain compensation valuation terms used throughout the statutory and regulatory exceptions to the federal physician self-referral law, 42 U.S.C. § 1395nn ("Stark Law").

The Action: The Centers for Medicare and Medicaid Services ("CMS") has published a proposed rule containing multiple proposed reforms to modernize the regulations that interpret the Stark Law, including, among others, more explicit language to define the compensation valuation terms used throughout the statutory and regulatory exceptions to the Stark Law—"commercially reasonable," "fair market value," and the volume or value of referrals standard.

Looking Ahead: Stakeholders have until December 31, 2019, to direct comments on the proposed definitions to CMS.

On October 9, 2019, CMS published a package of proposed reforms to modernize the regulations that interpret the Stark Law. CMS' proposal was issued in parallel to a package of proposed reforms to the federal Anti-Kickback Statute ("AKS") and federal Civil Monetary Penalties Law ("CMP") issued by the Office of the Inspector General ("OIG"). One goal of CMS' proposed reforms is to address longstanding uncertainty regarding the compensation valuation terms used throughout the Stark Law regulations, including "commercially reasonable," "fair market value," and the volume or value of referrals standard.

CMS first emphasized in its proposal that each of these terms represents a separate and distinct requirement, and that each must be satisfied when present within an exception. CMS then addressed each term, in turn.

Commercially Reasonable

Although commercial reasonableness is a core requirement of many exceptions to the Stark Law, the only guidance CMS has provided to date is in a 1998 proposed rule (63 FR 1700). There, CMS proposed defining "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."

In the current proposed rule and the preamble, CMS clarified that an arrangement can be commercially reasonable even if it does not generate a profit for one or more of the parties (e.g., to meet community need, provide timely access to care, or satisfy licensure requirements). Indeed, CMS highlighted examples in which health care providers could otherwise worry that providing hospital services within certain units that typically operate at a loss—such as burn units and psychiatric units—might violate the Stark Law.

In light of this clarification, CMS proposes two alternative definitions in the preamble for "commercially reasonable" and requests comments on each.

  • The first alternative would require that "the particular arrangement furthers a legitimate business purpose of the parties and is on similar terms and conditions as like arrangements." Only this first definition is included in the actual text of the proposed rule.
  • The second alternative would require that "the arrangement makes commercial sense and is entered into by a reasonable entity of similar type and size and a reasonable physician of similar scope and specialty."

CMS has not offered any clarity on its view of the difference between an arrangement that serves a "legitimate business purpose" versus an arrangement that, more vaguely, "makes commercial sense." CMS did note that simply because one arrangement makes commercial sense duplicating those services may not. For example, a single department may not need the services of two medical directors. Likewise, arrangements that violate the criminal laws would not be in furtherance of a legitimate business purpose.

CMS also has not clarified how it views the difference between whether an arrangement is on "similar terms and conditions as like arrangements" versus a more party-centric requirement that other reasonable similar parties would enter or have entered such arrangements. Ultimately, the two alternative definitions seem to reach the same result, which is to require both an evaluation of the business purpose as well as some evaluation of similar arrangements with similarly situated parties. Both proposed definitions also omit language from the 1998 proposed rule that would have required an evaluation of commercial reasonableness "in the absence of potential referrals" though various compensation arrangements must still satisfy the absence of referrals requirement.

Volume or Value of Referrals or Other Business Generated Standards

Many Stark Law exceptions include a requirement that the compensation paid under the arrangement is not determined in a manner that takes into account the volume or value of referrals or generation of other business between the two parties (collectively, hereinafter, "referrals"). CMS proposed four special rules to address the variations in how the requirement is applied to arrangements where remuneration flows from entity to physician and vice versa, each in the context of either variable or fixed compensation arrangements. CMS indicated its intent to provide a more "objective test" for whether such standards are violated, in part, because parties currently have difficulty knowing whether many compensation arrangements would be insulated from scrutiny under the approach taken by the government in certain of its enforcement actions. CMS intends that, if finalized, the proposed rules would supersede all other guidance defining these standards.

After providing a detailed history of the agency's guidance on the volume or value standards, CMS explained that it is proposing that variable compensation would violate the standards only when the mathematical formula used to calculate compensation correlates to the volume or value of referrals between the parties. Similarly, fixed compensation arrangements violate the standards only if the parties utilize a predetermined tiered approach such that compensation tiers correlate to previous referrals between the parties. CMS clarified that it would require a "positive correlation" for remuneration flowing from the entity to the provider (i.e., compensation increases with increased volume of referrals), and a "negative correlation" for remuneration flowing from the provider to the entity (i.e., remuneration, such as property rents, abate with increased volume of referrals). CMS emphasized that there must be a "predetermined, direct, and meaningful 'if x, then y' correlation" and that "simply hoping for or anticipating referrals is not enough" to violate the standards. 

To illustrate this rule, CMS used an example of a hospital renewing a physician employment agreement under which the physician is paid based upon a predetermined rate per physician work relative value unit (wRVU). Under the arrangement, the physician's compensation rate for the renewal term is based upon a tier whereby the physician would be paid $30 per wRVU for having ordered 300 or fewer outpatient diagnostic tests during the prior employment year versus $35 per wRVU for having ordered more than 300 outpatient diagnostic tests during the prior employment year. CMS explained that because this arrangement demonstrates a positively correlated "if x, then y" relationship between the physician's compensation and the volume or value of the physician's previous referrals to the organization, it violates the rule, even if the physician never hits the 300 wRVU threshold.

Finally, CMS specifically clarified that employed physicians may be issued a productivity bonus. Physicians compensated under a personal service arrangement also may be compensated using a unit-based formula for personally performed services even though the entity bills for designated health services that correspond to such personally performed services. Overall, CMS' proposed approach would narrow the current application of these standards in certain government enforcement actions.

Fair Market Value

CMS first emphasized that Fair Market Value ("FMV") is a separate and distinct requirement of remuneration under the Stark Law from the volume or value standards. Indeed, CMS clarified that even an arrangement that takes referrals into account may be consistent with FMV.

After reviewing a detailed history of the agency's guidance on FMV, CMS proposed modifying the definition of FMV to remove any previous intonation that FMV is inclusive of the referrals standards. The proposed definition for FMV is "[t]he value in an arm's-length transaction with like parties and under like circumstances, of like assets or services, consistent with the general market value of the subject transaction" (with similar language specific to defining FMV for purposes of equipment and property rentals).

CMS then proposed a definition of "General Market Value," which serves to modify FMV, to align the definition of general market value more closely with accepted market valuation principles. The proposed definition of "general market value" is "[t]he price that assets or services would bring as the result of bona fide bargaining between the buyer and seller" at the time the parties enter into the arrangement (with additional specific language to address property or equipment rentals). Thus, the proposed definition of FMV is focused on hypothetical parties whereas the definition of general market value is focused on the particular parties and circumstances involved in a financial arrangement.

Currently, general market value is defined as "the price that an asset would bring as the result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business for the other party." (CMS applies a similar definition with respect to the general market value of services.) By comparison with the proposed definition, the current definition of "general market value" functions as a stronger limit upon what would otherwise be accepted as FMV because it does not expressly include an allowance for compensation variance based upon specific party circumstances.

CMS' current proposal includes such an allowance, thereby broadening the range of what might be considered FMV. For example, CMS noted that the proposed definitions might require parties to deviate from values identified in salary surveys and other hypothetical valuation data that is not specific to the actual parties to the subject transaction. This might include providing higher compensation to a highly sought after specialty surgeon or providing lower compensation to a physician being recruited to an area with low cost of living but desirable schools and recreational options.

Ultimately, the proposed definitions tend to both resolve some historical valuation difficulties by aligning the definition of FMV with accepted market principles and increase the range of acceptable physician compensation levels at the high and low ends.


In sum, CMS has proposed significant changes to the regulations interpreting the Stark Law to provide more concrete guidance to industry stakeholders in terms of valuing the compensation flowing between entities and physicians. Importantly, however, the proposed language is expressly limited to application under the Stark Law and would not affect OIG's (or any other governmental agency's) interpretation or ability to interpret such terms for purposes of laws or regulations under the AKS, CMP, Internal Revenue Code, or state laws and regulations that use the same or similar terminology. Stakeholders have until December 31, 2019 to submit comments regarding these proposed definitions, including perhaps suggesting that the two agencies under HHS (CMS and OIG) and the IRS adopt common definitions of key terms such as FMV.

Three Key Takeaways

  1. CMS proposed two potential new definitions for "Commercially Reasonable," both of which would require an evaluation of the business purpose of the arrangement as well as some evaluation of similar arrangements with similarly situated parties;
  2. CMS proposed definitions for the volume or value of referrals standards that would significantly narrow application of these standards to circumstances where there is a "direct and meaningful" correlation between compensation and referral volume; 
  3. CMS proposed definitions for Fair Market Value and General Market Value to align these terms with widely accepted market principles that would have the effect of broadening the range of acceptable physician compensation levels at both the high and low ends.
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