On January 3, 2003 the Federal Government withdrew its appeal of Judge Henry Kennedy's decision in American Lithotripsy Society and Urology Society of America v. Thompson. On January 10, 2003, the Court of Appeals accepted the withdrawal, and, accordingly, the District Court decision is final. In the opinion of ALS's counsel, the Order permanently enjoining the Center for Medicare and Medicaid Services ("CMS") from implementing and enforcing its Stark II regulation declaring lithotripsy a "designated health service" is in full force and effect.

What Did the Court Decide?

Stark II, passed in 1993, with an effective date of January 1, 1995, prohibited certain referrals for physicians with a financial interest in entities providing eleven "designated health services". Lithotripsy was not named as one of those "designated health services". On January 4, 1998, CMS' predecessor, the Health Care Financing Administration ("HCFA"), proposed rules which would include lithotripsy as a "hospital inpatient or outpatient service" because Medicare will only pay for lithotripsy services for Medicare patients to a hospital or "under arrangement" with a hospital. ALS submitted extensive comments to HCFA showing that Congress never intended lithotripsy to be covered under the Stark II ban. Undaunted, on January 4, 2001, HCFA adopted a final rule concluding that lithotripsy was covered under Stark II.

ALS and USA sued CMS contending that CMS' final Stark II regulations were unlawful. On July 12, 2002, the Federal District Court for the District of Columbia, Judge Henry H. Kennedy, Jr., issued an extensive opinion confirming ALS' and USA's contention that the Stark II statute did not provide that, and Congress did not intend, lithotripsy to be a "designated health service, thus subjecting physician owners of lithotripsy facilities to the ban of Stark II. The Court contemporaneously entered the following Order:

ORDERED that defendant's regulation including lithotripsy within the designated health service "inpatient and outpatient hospital services" is invalid and of no force and effect; and it is further

ORDERED that defendant is permanently enjoined from implementing and enforcing said regulation.

The federal government filed a notice of appeal with the U.S. Court of Appeals for the District of Columbia Circuit. It is that appeal which has now been withdrawn.

What Does the District Court's Decision Mean?

Stark II prohibits a physician from referring an individual to an entity with which the physician (or an immediate family member) has a direct or indirect financial relationship (ownership, investment or compensation) for certain services termed "designated health services" (“DHS”) that may be paid for by Medicare or Medicaid unless there is an exception under the Stark II statute or Stark II regulations that permits the arrangement. CMS' final rule was sort of a "bad news/good news" conclusion: The bad news was that lithotripsy was a DHS; the good news, according to CMS at least, was that if the physician entity met one of several Stark II exceptions, a urologist would be permitted to refer a patient for lithotripsy services furnished by the lithotripsy entity in which he/she is an investor. We thought it was "bad news/worse news": we disagreed that lithotripsy was DHS; and, while we generally would not have minded complying with the Stark II exceptions -- most elements of the exceptions are good business practice -- the requirement that the hospital/lithotripsy venture fee be "fair market value" AS DEFINED BY CMS was, in ALS's view, sufficiently unfair that a challenge was necessary.

The District Court, however, disagreed with CMS. A urologist referral for the provision of lithotripsy, is, therefore, not a referral for DHS under the Stark II law even when provided “under arrangement”. At their core, the District Court decision and Order stand for the proposition that a referral by a urologist to a lithotripsy entity in which that urologist is financially interested is not banned by Stark II, and is not required by the Stark II law or regulations to meet a Stark II exception.

However, the question remains whether the referral to the hospital by a urologist in a lithotripsy venture for DHS other than lithotripsy implicates Stark II. To illustrate, a lithotripsy venture typically is structured as follows:

According to CMS, even if lithotripsy provided under arrangement with a hospital is not a DHS, it still will result in an "indirect compensation relationship" between the urologist and the hospital with which the lithotripsy entity has an arrangement. Under that theory, referrals for DHS other than lithotripsy (e.g. radiology, radiation oncology, etc.) were still banned unless the lithotripsy facility/hospital arrangement met a Stark II exception. Thus, CMS contended (and probably still does) that the relief ALS and USA sought was "illusory". ALS disagrees.

First, in many urologist-owned lithotripsy arrangements, particularly mobile and transmobile arrangements, the only referrals made to a hospital by the urologist owners are for lithotripsy. Accordingly, as to those arrangements, the District Court decision is conclusive: arrangement not covered; no Stark II exception required as to lithotripsy referrals.

Secondly, in the situation diagramed above, ALS agrees that the investor physician would have an "indirect compensation arrangement" with the hospital, affecting referrals for DHS other than lithotripsy, but only if the compensation paid by the hospital to the lithotripsy entity is on a per procedure basis. In that case, CMS is correct that an exception would be necessary to comply with Stark II as to the referrals to the hospital by the urologist-investor of non-lithotripsy DHS.

If the compensation arrangement between the hospital and the lithotripsy entity is a flat payment rate (e.g., a set daily amount paid weekly, monthly or annually) because such an arrangement is not an “indirect compensation arrangement,” under the Stark II definition. Accordingly, in that case, the referral for non-lithotripsy DHS from the physician to the hospital would not be subject to Stark II prohibitions (provided, of course, that the physician has no fundamental interest in the non-lithotripsy DHS).

Thirdly, ALS believes that, where Stark II may apply to referrals by urologist owners for non-lithotripsy DHS, the District Court decision undercuts CMS' position on FMV. It would be useful at this point to remind ALS members that CMS adopted a "special" definition of FMV in the Stark II final rule.

"Because the prevalence of physician ownership of lithotriptors may distort pricing in the marketplace, we believe valuation methods that look to the prices charged by persons not in a position to refer to the hospital or that consider acquisition cost and rate of return are especially appropriate."

At the heart of CMS' "special FMV definition", is its conclusion that lithotripsy is a hospital service. Because of the court’s ruling that lithotripsy is not an inpatient or outpatient hospital service, CMS' premise that FMV is based upon acquisition cost to the hospital is erroneous. Since the lithotripsy services belongs to the physician owned entity, the entity is certainly entitled to the benefits of its ownership. Accordingly, ALS believes that compliance with the FMV element of any of the applicable exceptions should be met if there is an arm's length negotiation between the parties that accounts for the relative value of the services performed by each party. If, for example, the lithotripsy entity provides and/or performs 90% of the services and the hospital performs 10% of the services, a 90-10 split in the respective lithotripsy fees received by the hospital from the payor should meet the FMV test. We caution that the OIG may not agree with that definition of FMV. But, in light of the findings contained in the District Court decision, ALS believes CMS would be hard pressed to prevail on its contention that the hospital, not the urologist-owned facility, is entitled to the profits or returns of the facility that it does not own.

In summary, the practical significance of the American Lithotripsy Society v. Thompson case, therefore, is that:

(i) if a physician investor in a lithotripsy facility refers his/her patient to a hospital with which the facility has an "under arrangement" relationship, that referral is not subject to Stark II;

(ii) if a physician investor in a lithotripsy entity refers a patient for non lithotripsy DHS to the hospital with which the entity has a financial interest, the referral will not be subject to Stark II prohibitions if the compensation paid by the hospital to the lithotripsy facility is a flat fee; and

(iii) where a physician has an indirect compensation relationship with the hospital (because the lithotripsy facility in which he/she has an ownership interest is paid by the hospital on a per click basis), in light of the court’s ruling that lithotripsy is not an inpatient or outpatient hospital service, it appears that the payment by the hospital to the lithotripsy entity will meet the "fair market value" test in each applicable Stark II exception, if the lithotripsy entity receives from the hospital a portion of the lithotripsy fees paid to the hospital which reflects the relative contribution of the lithotripsy facility.

This member update addresses specific elements of the District Court decision in the case brought by ALS and USA against Medicare. It does not purport to be a comprehensive analysis of the Stark II law or regulations. Nor does it address the Anti-kickback law, which remains applicable to every physician referral and financial relationship. This ALS member update is intended to provide members with information on recent legal developments. It should not be construed as legal advice or a legal opinion. As always, ALS strongly encourages each member to consult qualified health care counsel with respect to the particulars of any relationships or transactions which implicate health care law or regulations.

Questions also may be directed to the Society's Executive Director, Wesley E. Harrington, CAE, at the ALS Headquarters in Waltham, Massachusetts, at 781-895-9098.

305 Second Avenue, Suite 200
Waltham, Massachusetts 02451
Telephone: 781-895-9098
Fax: 781-895-9088

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American Lithotripsy Society
305 Second Avenue, Suite 200
Waltham, Massachusetts 02451
Telephone: (781) 895-9098
Fax: (781) 895-9088

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