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Surfing Stark II: prohibition against self-referrals.

In December 1991, the Health Care Financing Administration (HCFA) published regulations for the Ethics in Patient Referrals Act (Stark I).[3] However, no case law has addressed the legislation itself or its regulations. Thus, Stark I remains an uncertain piece in the health care reform puzzle. Regulations, however, do provide some guidance in the area of reporting requirements.

Information must be submitted to HCFA and shall include the name and physician identification number of each physician, or relative of a physician, who has a financial relationship with the entity, as well as the nature of that relationship. "Financial relationship" is defined as any ownership or investment interest or any compensation arrangement.[4] The regulations also provide one major exception: entities need not report ownership arrangements if the entity provides 20 or fewer covered services or items per calendar year.[5] Finally, the reporting entity must submit the required information on an HCFA form. All entities will be given 30 days from the date of the servicing carrier's request to respond. Thereafter, supplemental information regarding changes in submitted information must be provided within 60 days of the change.[6]

Stark II: The Law

Congress expanded the reach of Stark I, making amendments in the Omnibus Reconciliation Act of 1993. The new law, known as "Stark II," begins with a broad prohibition against referrals and, unlike Stark I, applies to both Medicare and Medicaid.[7] The key to understanding its breadth lies in defining both the terms of the proscription and its numerous exceptions. The general rule of Stark II is that, effective January 1, 1995, no physician or physician family member who has a financial relationship with an entity may refer a patient to that entity for designated health services.[8] However, Stark II not only places restrictions on the referring physician, but also on the entity that becomes the provider. That entity is prohibited from presenting a claim or a bill to any individual, third party, or other entity for services furnished pursuant to a prohibited referral.[9]

The key terms to understand in Stark II's general rule are "financial relationship, and "designated health services." Unlike Stark I, which only applied to clinical laboratory services, Stark II bans a comprehensive list of physician services, equipment, and supplies. The law defines "designated health services" as clinical laboratory services; physical therapy services; occupational therapy services; radiology or other diagnostic services; radiation therapy services; durable medical equipment; parenteral and enteral nutrients, equipment, and supplies; prosthetics, orthotics, and prosthetic devices; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services.[10]

Significantly, the term "other diagnostic services" remains undefined. HCFA has admitted that it is uncertain how to define this category and recently requested an interpretation from Congress.[7] Until HCFA issues Stark II regulations, it is advisable for physicians to consult their legal representatives before referring any diagnostic service to another entity. Because the law is new, administrative agencies, and even courts, have not yet had an opportunity to interpret its provisions. Because the penalties for noncompliance are severe, it is certainly better to err on the side of compliance when referring any service that could remotely be considered diagnostic in nature.

The next potential issue is determining whether a "financial relationship" exists. Stark II defines this term as either an ownership or investment interest in the entity, which may be achieved through equity or debt, or a compensation arrangement between the physician and the entity.[11] Compensation arrangements include any arrangement involving direct or indirect remuneration between a physician and an entity.[12] However, this does not include the forgiveness of amounts owed for mistakenly performed procedures. Nor does it encompass supplies used solely to process specimens or communicate test results. Finally, it does not apply to certain payments made by insurers that satisfy a litany of other requirements.[12] Investment interests, on the other hand, are far-reaching. Stark II does not require a minimum percentage of ownership or investment amount to implicate liability for referrals.[13] Thus, even physicians who own a minuscule share of an entity must divest that interest.

Compensation Arrangement


Like most laws, Stark II contains exceptions to the general rule that prohibits referrals. Indeed, there is a section riddled with the following exemptions, which are not considered compensation arrangements and, therefore, are not prohibited:

* Office Space or Equipment Rental. The lease must be for at least one year, in writing, and signed by the parties and must specify the covered premises or equipment. Rent must be set in advance, may not be based on the volume of referrals generated between the parties, and must be commercially reasonable even if no referrals are made.

* Bona Fide Employment Relationships. Employment must be for identifiable services. Compensation must be at the fair market value of the services and be part of an agreement that is commercially reasonable, even if no referrals are made.

* Personal Service Arrangements. Compensation for incentive provisions in physician service arrangements are allowed if payment is set in advance and is consistent with the fair market value of services performed without regard to the volume of referrals, if the arrangement is for at least one year and covers all services to be provided by the physician, and if services to be performed do not include a promotion or business arrangement in violation of any state or federal law.

* Remuneration Unrelated to Designated Health Services. Payment by a hospital to a physician for nondesignated health services is not prohibited.

* Physician Recruitment. A physician may be paid to relocate to a hospital if the physician is not required to refer patients to the hospital and the compensation does not take the number of referrals into account.

* Isolated Transactions. One-time sales of property qualify if they satisfy the requirements set forth for "Bona Fide Employment Relationships."

* Group Practice Arrangements. An arrangement where a group of physicians provide services to patients, who are then billed by the hospital, must have begun prior to December 19, 1989. It only applies to inpatient services, most of which are provided by the group. Compensation must conform to the fair market value for the services and be commercially reasonable, even if no referrals are made.

* Physician Payments. Must be payments by a physician to a laboratory in exchange for clinical services or to an entity as compensation for the fair market value of items or services provided by an entity.[14]

Exemptions for compensation arrangements, although useful, raise several concerns. For example, if a physician contemplates using one of these exceptions, he or she must be ready to defend the arrangement. Most likely, the physician will either have to show that the arrangement is commercially reasonable or that any compensation paid is in line with the fair market value of those services. Again, because the law is new, the terms "reasonable" and "fair market value" are rather vague and not yet defined by law, practice, interpretation, or regulation. The statute provides some direction and guidance with respect to the second term, stating that, in the case of rentals, the value should not consider proximity to the lessor, where the lessor is a potential referral source.[15] However, the statute also fails to give this term any real meaning, stating that "fair market value" should be consistent with the "general market value."[15] Thus, it is not advisable to attempt to use any of these categories unless the physician is ready to justify the arrangement and support it with some type of proof, such as showing comparable rents or payments for similar arrangements.

Ownership Exceptions

In addition to exemptions for certain compensation agreements, Stark II contains three exceptions that permit referring physicians to maintain their ownership interest in the following entities without violating the law:

* Puerto Rican hospitals.

* Rural providers. Ownership of these providers is exempt only if substantially all of the designated health services are furnished to people who live in the rural area.

* Hospital ownership. Referring physicians may own part of a hospital if they are authorized to perform services at the hospital and if the interest is in the hospital itself and not merely a subdivision.[16]

The rural providers exception, which pertains to clinical laboratories in Stark I, has been narrowed somewhat in Stark II. Stark I's exception applied to all rural providers, regardless of where their patients lived. Stark II limits this exception, creating the prerequisite that the patients must live in the rural area in which the provider is located. This obviously is a gray area, because the term "area" is left undefined. It is anticipated that regulations will address this topic and describe a geographic boundary that provides rural physicians with an idea as to whether a facility qualifies for the exception. Such uncertainty may pose severe problems for nonurban area physicians. Depending on whether a facility qualifies, either all or none of the physician's referrals to the provider will be exempted.

General Exceptions

Finally, there is a category of general exceptions that relates to both ownership interests and compensation agreements. One notable exception, which will certainly be used by many physicians, is investments in publicly traded companies and in mutual funds. In order for the exception to apply, the securities must be in a company with equity exceeding $75,000,000 that is listed on either the New York or the American Stock Exchange, or any regional exchange on which quotes are published daily.[17] Note that the mutual fund exemption was not available in Stark I. The other general exceptions are:

* Prepaid Plans. Federally qualified HMOs are exempted, as are other Medicare and Medicaid managed care organizations. The exception is limited, because it does not apply to integrated networks such as PPOs.

* Physician's Services. Services provided personally by or under the supervision of the referring physician or another physician in the same group practice are exempt. A group practice is defined as two or more physicians organized as a partnership, professional corporation, or other association in which each member provides a full range of services through the use of shared office space. All receipts, overhead, and income are paid or received through the group. Bonuses can be paid to group physicians if they are not based on the volume of referrals.

* In-Office Ancillary Services. Services other than durable medical equipment (excluding infusion pumps), parenteral and enteral nutrients, equipment, and supplies are exempted if furnished personally by a referring physician, a physician in a group practice, or a physician supervised by either of the two. The service must be performed in the building in which the physician practices or in another building used by the group practice. Finally, the service must be billed by the physician, a member of the group practice, or an entity owned wholly by the group.[18]

Reporting Requirements

As previously mentioned, under Stark II, the referring physician is not the only one with an obligation. On the other end of the referral is the provider, to whom the new law also assigns a duty. Unlike those of the referring physician, the provider's duties are fairly easy to identify. Every entity that provides items or services covered in Stark II has two basic requirements it must satisfy. The provider must provide the Secretary of Health and Human Services with the covered items and services provided by the entity and with the names and identification numbers of physicians or their family members who have an ownership interest or investment in the entity.[19] Although regulations for Stark II are yet to appear, look for them to follow the regulations on reporting requirements in Stark I.


Stark II provides severe penalties for noncompliance by both referring physicians and providers. Such heavy fines are designed to deter overutilization by making the potential costs of violating the statute outweigh the potential gains of an illegal referral arrangement. Not only must a physician refund any money collected for a payment he or she knows, or should have known, was illegal, but he or she will also be subject to fines of not more than $15,000 for each service. Furthermore, the physician may be terminated from Medicare and Medicaid programs.[20]

Penalties also exist if a physician enters into a scheme, such as a cross-referral arrangement, whose purpose the physician knows, or should have known, was to ensure referrals to an entity. Each physician or entity may be fined up to $100,000 for each arrangement.[20] Finally, potential fines exist for any person who fails to meet the statute's reporting requirements. Any person who is required to report information and fails to do so may be fined up to $10,000 for each day reporting is required to be made.[20] Notice that no maximum penalty exists for this violation, so it is especially important for providers to comply with this requirement.

Other Concerns

As if compliance with Stark II were not sufficiently complicated, physicians should be cognizant of various other concerns relating to referrals. First, state laws on this subject also exist. Because many of these laws are more comprehensive in their requirements for compliance than Stark II, it is possible to completely comply with federal law and still violate a more stringent state law. Second, Stark II does not contain a "grandfather" clause that exempts prohibited arrangements made prior to its effective date of January 1, 1995. Thus, it is advisable for all physicians and health care providers to review any referral agreements into which they have entered. Any agreements that violate Stark II can, and should, be amended so that they are in compliance with the new law. This not only means rewriting ownership and compensation agreements, but also divesting oneself of ownership interests in entities to which the physician refers patients.[2]

Finally, Stark II is a separate law from both the federal "safe harbor" regulations and the federal antifraud and abuse statute.[7] Effective January 1, 1995, health care providers must consider all three when making referrals. The most significant difference between Stark II and the antifraud statute is that Stark II does not only target a physician who "knowingly and willfully" pays or receives remuneration in exchange for referrals,[7] but also outlaws all such payments; the physician's state of mind is irrelevant. Furthermore, exceptions in Stark II differ from the safe harbor regulations in that they are generally more difficult to satisfy.[7] Consequently, compliance with the safe harbor regulations does not ensure compliance with Stark II.


Stark II is here, and it is complicated, so review it carefully. It is its own law, not an extension of other safe-harbor or antifraud legislation. Accordingly, it contains its own comprehensive rules regarding violations, compliance, and sanctions. While all this appears to be ominous for physicians and providers, they should take refuge in the fact that "surfing" this new law carefully will avoid pitfalls. A health care provider that has a compensation arrangement with, investment interest in, or is part of an entity to which services or equipment are referred should consult with someone knowledgeable about the act to ensure compliance with it. Penalties for noncompliance are severe. Until federal regulations are published, many terms will be left undefined. It is better to play it safe than to risk the consequence and be sorry.


[1.] H.R. 939, 101st Cong., 1st Sess. (1989), "The Ethics in Patient Referrals Act of 1989" introduced Feb. 9, 1989. [2.] "New Legislation and Increased Efforts to Curtail Health Care Fraud and Abuse." Mich. B.J. 73:166, Feb. 1994. [3.] 42 C.F.R. [subsections] 411.350 and 411.361. [4.] 42 C.F.R. [sections] 411.361(d) and (e). [5.] 42 C.F.R. [sections] 411.36(b). [6.] 42 C.F.R. [sections] 411.361(f). [7.] Stark II Limits on Physician Self-Referral." Fla. B.J. 68:75, May 1994. [8.] 42 U.S.C. [sections] 1395nn(a)(1)(A). [9.] 42 U.S.C. [sections] 1395nn(a)(1)(B). [10.] 42 U.S.C. [sections] 1395nn(h)(6)(a-k). [11.] 42 U.S.C. [sections] 1395nn(a)(2). [12.] 42 U.S.C. [sections] 1395nn(h)(1). [13.] How New Federal Laws Prohibiting Physician Self-Referrals Affect Integrated Delivery Systems. " HealthSpan 4:21, April 1994. [14.] 42 U.S.C. [sections] 1395nn(e)(1-8). [15.] 42 U.S.C. [sections] 1395nn(h)(3). [16.] 42 U.S.C. [sections] 1395nn(d)(1-3). [17.] 42 U.S.C. [sections] 1395nn(c)(1-2). [18.] 42 U.S.C. [sections] 1395nn(b). [19.] 42 U.S.C. [sections] 1395nn(f)(1-2). [20.] 42 U.S.C. [sections] 1395nn(g).

Howard J. Swibel and Miles J. Zaremski are Cochairs of the Health Care Law Department, Arnstein & Lehr, Chicago, Ill., and West Palm Beach, Fla. The authors gratefully acknowledge the assistance of Jeffrey L. Widman, JD, an associate at Arnstein & Lehr, in the preparation of the article.
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Author:Zaremski, Miles J.
Publication:Physician Executive
Date:Feb 1, 1995
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