In June, 2007, the United State Court of Appeals for the District of Columbia Circuit affirmed the dismissal of a lawsuit brought by a physician association, alleging that the “fair market value safe harbor” under the federal Stark law developed by the Centers for Medicare and Medicaid Services (“CMS”) is invalid because it was implemented without following proper procedure. The court did not rule on the merits of the association’s claim. Instead, the court decided that the association did not have standing to bring the suit because even if the court were to declare the “safe harbor” invalid, the substance of the “safe harbor” would likely still be relied on to demonstrate that physicians who refer Medicare and Medicaid patients to “designated health services” (DHS) providers with whom they have a financial relationship are being paid fair market value by the DHS providers for any contracted services they perform.

The Stark law is a federal law that prohibits physicians from referring Medicare and Medicaid patients to DHS providers (11 different categories of health care providers) if the referring physician has a “financial relationship” with the DHS provider, unless a specific Stark exception applies. The financial relationship can be an ownership interest or a compensation arrangement. Services resulting from a prohibited referral may not be billed by the DHS provider. It is common for certain health care providers to enter into a contract with a physician to act as medical director for the provider. In fact, in some instances, a provider must employ or contract with a medical director physician in order to satisfy the Medicare conditions of participation. A physician who acts as a medical director may prefer to refer patients to the provider for whom he so acts because he knows firsthand the level of competence of the provider.

The Stark law prohibits Medicare and Medicaid referrals by a medical-director physician unless a Stark law exception is met. One such exception is for “personal service arrangements”, which contains, among other things, a requirement that the payment for the services be set at fair market value. CMS recognizes that there is more than one acceptable methodology for determining fair market value and that any particular fair market value figure is something over which reasonable people can disagree. Nevertheless, the burden is on the parties to the financial arrangement to demonstrate the fair market value of the payment if challenged.

In recent years, the Stark law and is regulations have been amended. One such regulatory amendment, which was being challenged in the federal court lawsuit, was adopted by CMS effective July, 2004 by a “final rule with comment period”. It created two specific methodologies for determining the fair market value of an arrangement, either of which, if used, “deems” the payment to be fair market value.   The parties to the arrangement are not required to use either methodology. If they do not, the burden remains on them to demonstrate fair market value if challenged. Failure to prove fair market value would result in all Medicare and Medicaid referrals by the compensated physician during the time period of the financial relationship being problematic, and refunds by the DHS provider would be expected. Depending on the circumstances of how the parties to the arrangement determined the payment amount, it is possible that the parties, or either of them, would be at risk for triple damages and civil monetary penalties.

The Stark law is a strict liability statute. This means that if the referring physician has a financial relationship with a DHS provider, then the parties must meet a Stark exception or else there is a Stark violation. Defenses such as good faith of the parties or an unknowing violation by the parties are not available. Because of the strict liability nature of the law, there is little surprise that a regulation giving parties a way to deem a payment fair market value would create a strong incentive to use the deeming methodology. The physician association that brought the lawsuit complained that the government-chosen “deeming” methodologies result in a computation of lower fair market value amounts when compared to other methodologies that have historically been used by parties in the medical professions. The substantive effect of the regulation, according to the plaintiff, was that its members had been subjected to significant reductions in medical director payments on the basis of reliance on the “deeming” regulation. The association was seeking to have the regulation invalidated on the grounds that it was not promulgated properly under the Administrative Procedure Act.

The court did not agree that the lawsuit should go forward, because under a standing analysis, one of the things the plaintiff has to show is “redressability,” i.e., court action would likely change outcomes. The court found redressability lacking because, even if it declared the regulation invalid, there would not necessarily be any change in the fair market methodology the DHS providers would agree to use in the association’s members’ contracts. The court wanted considerable evidence presented at the outset of the pleading stage, before allowing the case to go forward, that if the regulation were held to be invalid, the effect would be a change in contract payment amounts at issue. Because of a lack of evidence at the initial pleading stage, the court, referring to the association’s theory as speculation, seemed to speculate itself that now that CMS has deemed certain methodologies as favorable, DHS providers might well prefer to continue to use them to achieve comfort in defending fair market value.

This analysis appears to beg the question. It appears the court was saying once CMS “deems” a methodology to result in a fair market value determination, even if the deemed methodology is judicially declared invalid, it will still have more legal effect than other, valid and acceptable methodologies. Considering the strict liability nature of the Stark law and the selection by CMS of fair market value methodologies that may result in lower medical director payments as compared to other, acceptable methodologies, the regulation is a substantive rule with significant potential to negatively affect many of the health care professions, including the association that challenged it. It should have been enacted only by following all procedural requirements. Federal courts should want to ensure that all such requirements were met. This case may have provided a vehicle for doing so.

The federal case is called Renal Physicians Association v. Department of Health and Human Services (Case No. 06-5133). It was decided on June 12, 2007.