August 2004 Bulletin

The state of Stark: Phase II regs

New regulations are complex, challenging

By Steven E. Fisher, MBA

This article summarizes key provisions of the “Stark laws.” It also defines some of the terminology necessary for AAOS members to determine if they are in compliance with the regulations. Additional information, including a series of questions and answers, can be found online on the AAOS Web site in the Practice Management Center and the Washington Office Legislative Scene. The Stark legislation is extremely complex and some states have anti-self-referral laws of their own. For compliance advice, AAOS members are urged to contact their legal counsel.

The “Stark” laws are named after Rep. Pete Stark (D-Calif.), who sponsored the initial legislation. Congress passed the laws after studies showed that some physicians with an ownership interest in entities to which they referred patients ordered excessive medical services. Patients received unnecessary care, resulting in higher health care costs. Costs for patients covered by government programs were ultimately passed on to taxpayers.

Stark has a long and somewhat convoluted history.

Summary of the law

Stark II prohibits physicians from referring Medicare and certain Medicaid managed care patients for designated health services (DHS) to entities in which they or an immediate family member have a financial interest unless an exception applies. (See the accompanying sidebar on page 38 for definitions of these terms.) Stark laws also prohibit the entities to which referrals are made from submitting payment claims to the government for the specified services. Stark laws are not the same as the federal Anti-kickback Statute. It’s possible to comply with Stark and violate anti-kickback laws, or vice versa.

Penalties for violating Stark laws include:

Violations could also draw attention to physicians, resulting in increased monitoring by the Department of Health and Human Services (HHS) for all types of fraud and abuse.

The confusing language of the Stark laws has frequently delayed enforcement of certain aspects of the regulations, sometimes for years. However, this situation may be changing. Representatives of CMS and the HHS Office of Inspector General have indicated that enforcement efforts are likely to accelerate after the July 26 effective date.

Confusion and ambiguity

The Phase II regulations eliminate some of the confusion created by ambiguous language in the Phase I rules. For example, Phase II rules clarify when a financial relationship exists between a physician and a DHS entity, particularly in indirect compensation arrangements. Unfortunately, the clarification has been more than offset by a tremendous increase in complexity. AAOS members should review their relationships with any organization, institution or individual that might be subject to Stark to verify whether or not a financial interest, particularly an indirect compensation arrangement, exists.

Phase II regulations also clarify the circumstances under which referrals are permitted—the “exceptions.” Again, however, the reduction in ambiguity is more than offset by an increase in complexity. Depending on how they are classified, there are currently 15 to 20 exceptions to Stark.

These all-important exceptions can be grouped in four general categories: (a) those that apply to both ownership/investment interests and compensation arrangements; (b) those that relate to ownership/investment only; (c) those that relate to compensation arrangements only and (d) the so-called “regulatory exceptions.”


The five exceptions most important to orthopaedic surgeons are: in-office ancillary services in a group practice or by a sole practitioner, bona fide employment, personal service arrangements, fair market value compensation and academic medical centers.

In-office ancillary services in a group practice or by a solo practitioner: Ancillary services include DHS services such as physical therapy, occupational therapy, radiology and some durable medical equipment such as canes, walkers and folding manual wheelchairs. For this exception to apply, the services must be performed (a) personally by the referring physician, (b) by a member of the referring phsyician’s group practice, (c) by an individual directly supervised by the referring physician, or (d) by another physician in the practice who is not a true group member, such as an independent contractor or a leased employee. Certain location, supervision and billing requirements also must be met for this exception to apply.

Bona fide employment: The bona fide employment relationship exception allows payments of any amount by an employer to a physician or a member of the physician’s immediate family for providing covered services if the individual has a bona fide employment relationship and if certain other requirements are met. The three most significant requirements are:

Personal service arrangements: This exception allows a physician to serve as an independent contractor to the referred-to entity under a contract arrangement. To qualify under this exception, the arrangement must be in writing; the services must be specified and not exceed those that are reasonable and necessary; and the compensation must not take into account the volume or value of referrals.

Fair market value (FMV): FMV relates to compensation resulting from an arrangement between an entity and a physician (or a member of the physician’s immediate family) or any group of physicians for the provision of items or services by the physician, family member or group. This exception establishes strict criteria that must be met. For example, there must be a written agreement; the agreeement must specify the term and the compensation; the compensation must be consistent with fair market value and not take into account the volume or value of referrals; and the transaction must be commercially reasonable and further the legitimate business purposes of the parties involved. The agreement also must meet an anti-kickback safe-harbor or otherwise be in compliance with the fraud and abuse regulations. The services must not involve the counseling or promotion of a business arrangement or other activity that violates state or federal law. Quite obviously, this exception can function as a safety net, applying to transactions that don’t quite meet all of the requirements of one of the other exceptions.

Academic medical centers (AMC): Services provided by an AMC can qualify if the referring doctor meets specific employment, licensure and faculty appointment standards. The AMC must be an accredited medical school with one or more faculty practice plans and one or more affiliated hospitals. Moreover, transfers of money between components of the AMC must directly or indirectly support the missions of teaching, indigent care, research or community service. The relationship among the various AMC components must be set forth in writing.


Compensation is another aspect of the Stark regulations that has been plagued with confusion because of the way the previous regulations were written. Phase II has cured some, but not all, of the misunderstandings. Moreover, Phase II rules are complex; several pages are dedicated to defining what exactly is meant by terms such as “production credit,” “aggregate compensation,” “percent compensation that is set in advance,” “per-click and per-unit payments” and “direct supervision.”

The regulations also set forth specific criteria as to when an in-office ancillary service is or is not “delivered in the same building” where a physician sees patients, and the criteria differ depending on whether the physician is part of a group practice or a solo practitioner. Finally, there remains a certain amount of ambiguity about what constitutes a referral, particularly in the arena of DME that is personally furnished by the physician.

The bottom line is that, even where a Stark exception exists, there are limits to the degree that the doctor can be compensated based on the volume and/or value of referrals to the DHS entity. Group practice physicians have been granted substantially more flexibility in their compensation arrangements than physicians working in other practice structures. The chart below answers six key compensation-related questions for the five exceptions described above.

Additional information about important compensation-related definitions and legal compensation methodologies can be found online in the AAOS Practice Management Center.


The “stark” truth is that at this point, no one fully understands the Stark regulations that went into effect this past July. The “Compliance” listserv of the Health Lawyers Association, for example, is filled with dozens of questions about Stark regulations, ranging from when an indirect compensation arrangement exists to what is meant by “temporary non-compliance.”

The AAOS online Practice Management Center contains a great deal of detailed information about Stark. Neither this article nor the online material, however, constitute legal advice. It is crucial for AAOS members to secure such advice from competent counsel in their state to ensure compliance with both federal law and state regulations.

Steven E. Fisher, MBA, is manager, practice management affairs, in the AAOS department of state and socioeconomic affairs. He can be reached at

Compensation issues for selected exceptions

    Exceptions to Stark

Compensation Questions


In-office Ancillary Services in Group Practices

Bona Fide Employment Relationships

Personal Service Arrangements

Fair Market Value Arrangements

Academic Medical Centers

Must compensation be “fair market value” (FMV)?






Must compensation be “set in advance?”






What is the scope of volume/value restriction?

DHS referrals

DHS referrals

DHS referrals
and other business

DHS referrals and other business

DHS referrals and other business

What is the permitted scope of productivity bonuses?

Personally performed and “incident-to” services; plus indirect bonuses and profit shares

Personally performed services

Personally performed services

Personally performed services

Personally performed services

Are overall profit shares allowed?






Is a written agreement required?



Yes; with a minimum one year term

Yes, except for employment; no minimum term required


Group practice definition

To qualify as a group practice under Stark, an entity must meet all of the following requirements:

  • There are two or more physicians.
  • The company is legally organized as a partnership, professional corporation, foundation or faculty practice plan.
  • The primary purpose of the company is physicians’ practice (that is, the company is not just formed to provide ancillary services).
  • Every physician who is a member of the group must furnish substantially the full range of services that he or she routinely provides through the joint use of shared office space, facilities, equipment and personnel.
  • Substantially all of the member physicians’ services are furnished through the group and billed under the group’s assigned billing number, and payments are treated as receipts of the group.
  • The overhead expenses and income of the practice are distributed according to predetermined methods.
  • There is a unified business with centralized decision making and consolidated billing, accounting and financial reporting.
  • No member physician directly or indirectly receives compensation based on the volume or value of referrals generated by the individual except for permitted profit distributions and personal productivity bonuses.
  • The member physicians personally conduct at least 75 percent of the physician-patient encounters of the practice.

Stark requires that groups be able to document their time allocations via time cards, diaries, schedules or another reasonable method that is fixed in advance. AAOS members who believe they qualify for a Stark exception based on the fact that they practice in a group are urged to obtain qualified legal counsel before claiming the exception. CMS has made it very clear, for example, that group practices without walls and other pseudo-group arrangements will not be considered as true groups for purposes of the anti-self-referral laws.

A Stark glossary

Referral: A request by a physician for an item or service for which payment may be made under Medicare Part B. This includes a request for a consultation (including tests or procedures performed by or under the supervision of a consulting physician) and the request or establishment of a plan of care by a physician that includes the furnishing of designated health services (DHS). Services provided personally by the physician in the office or at the hospital do not count as referrals. Until phase III regulations are issued, however, services—including incident-to services—provided by the doctor’s employees, coworkers and independent contractors are considered referrals.

Designated health services (DHS): Under current Stark regulations, referrals are prohibited for the following DHS: clinical laboratory services; physical therapy (PT) services; occupational therapy (OT) services; radiology services and supplies including ultrasound, MRI and CT scans; radiation therapy services and supplies; durable medical equipment (DME) and supplies; parenteral and enteral nutrients, equipment, and supplies; prosthetics, orthotics, and prosthetic devices and supplies; home health services; outpatient prescription drugs, and inpatient and outpatient hospital services.

The regulations use CPT and HCPCS codes to specify prohibited referrals for clinical laboratory services, PT and OT services, radiology services and supplies, and radiation therapy services and supplies. The code list will be updated every year. Categories of particular interest to orthopaedists include PT and OT services, radiology, DME, and inpatient and outpatient hospital services.

Immediate family member: A person whose financial interest in a DHS entity will trigger a Stark prohibition—the provider’s spouse; any birth or adoptive parent, child or sibling; any stepparent, stepchild or stepsibling; any direct in-law relations (parent, child, sibling); any grandparent or grandchild; and any spouse of a grandparent or a grandchild.

Financial relationships: These may be direct or indirect. They fall into two broad categories: ownership and investment interests, and compensation arrangements. An example of direct ownership interest is a physician’s equity investment in a DHS entity. A direct compensation arrangement would exist if the doctor receives a salary as medical director. An example of indirect ownership interest is a physician’s equity interest in a corporation that owns a DHS entity. An indirect compensation arrangement would exist if a doctor has a contract with an entity that, in turn, has a contract with a hospital to which the physician refers patients.

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