1. OVERVIEW I. INTRODUCTION

1. OVERVIEW I. INTRODUCTION The country's first ambulatory surgery centers ("ASCs") opened in 1969. From that date until 1982, growth in the country's ASCs was slow but reasonably consistent. In 1982, Medicare approved reimbursement for ASCs. Since 1982, the growth in ASCs has exploded. Today, there are close to 2,600 ASCs in operation. ASCs, for purposes of this monograph, are providers that focus on outpatient surgery. They are physically and organizationally separate from another provider, whether a hospital or a physician practice. The separation can be permanent or semi-permanent. The typical ASC is freestanding in that it is not physically within the four walls of either a hospital or a practice. However, an ASC can be operated under a separate license from a hospital and be considered a hospital-based ASC. Hospitals, as of 1999, principally provide outpatient surgical services through hospital outpatient departments. The distinction between a hospital-based ASC and hospital outpatient department is principally related to reimbursement. This distinction is discussed in chapter 5. Operators and owners of ASCs include hospitals, physicians and management companies. Ownership is often shared by one or more of these parties. The development of an ASC can be driven by many factors. For example, initially ASCs were often encouraged or developed by health plans. Since then, ASCs have been and are developed by physicians based on various motives, including practice convenience, operating site control, and profit. Finally, ASCs are developed by hospitals to accomplish one or more objectives. These may include the freeing up of operating room space to focus on larger-scale surgical programs or to use an ASC as a joint venture and solidify relationships with physicians. Because ASCs have multiple types of owners, and because they serve a number of goals and involve a wide range of legal issues, healthcare lawyers have regular and significant opportunities to work in one manner or another on behalf of ASCs, or one of the partners to the ASC. The healthcare lawyer may represent, for example, one of the partners information; the medical director or anesthesiologist in his or her contractual relationships with the ASC; the ASC (or an opposing party) in its certificate of need and licensing efforts; the ASC or holding company in its sale of interests through private placements; a partner or the ASC itself in its antitrust, Stark, Medicare and Medicaid fraud and abuse, tax exemption or other legal analysis; or one of many other parties. This chapter discusses four critical issues. First, it summarizes the national growth in ASCs. Second, it explores the tensions often raised by ASCs between hospitals and physicians. Third, it examines the potential benefits to the joint venturing of ASCs by hospitals and physicians. Fourth, it outlines the key legal issues related to ASCs. 1

This monograph, in addition to providing an overview of ASCs and their legal issues, covers several principal areas of concern in the context of ASCs. First, it discusses Medicare and Medicaid federal fraud and abuse statute issues and Stark issues. Second, it reviews tax exemption and other tax related issues. Third, it reviews state self-referral laws and their impact on ASCs. Fourth, the monograph explains ASC and hospital outpatient reimbursement. Fifth, it details certificate of need, licensure, and accreditation issues. Finally, the publication includes sample documents with annotations and a chapter that reviews miscellaneous issues. Throughout the monograph, we attempt to focus on current issues and provide practical and useful guidance. II. GROWTH IN ASCS As of 1999, there were approximately 2,600 ASCs in operation in the United States. 1 Of these, a majority have physician owners. Many ASCs also are owned, in whole or in part, by hospitals or health systems or by a corporate chain or national company owners. The largest national chains in the ASC area remain Columbia/ HCA and Health South. However, there are also a number of smaller chains that also own multiple centers (e.g., United Surgical Partners, Amsurg, Ambulatory Resource Centers). The growth in ASCs has exploded since 1982. In that year, Medicare approved payments to ASCs. At the time, there were approximately 293 ASCs in existence. 2 Today, there are approximately 2,600 ASCS. 3 A great deal of today's ASCs are fully built-out, multispecialty surgery centers that provide a broad range of outpatient surgical services. SMG Marketing Group, Inc. conducts an annual national review of ASCs. Their report provides a great array of statistical data regarding ASCs. For example, its 1997 report indicates: Approximately 2,100 ASCs are Medicare certified. Nearly 70% of all surgeries are now conducted on an outpatient basis. 9% of all ASCs perform more than 5,000 surgeries per year. Almost 90% of independent centers (often physician-owned) perform fewer than 3,000 surgeries per year. Ophthalmology, gastroenterology and OB/GYN procedures remain the most frequently performed procedures in ASCs. 1 FEDERATED AMBULATORY SURGERY ASSOCIATION, HISTORY AND GROWTH OF THE AMBULATORY SURGERY CENTER INDUSTRY (l998). 2 Id. 3 Id. 2

Average charges per ASC case were between $1,100 to $1,200 in 1996. 4 This movement from inpatient to outpatient surgery, plus the development of outpatient surgical centers to handle a great amount of the outpatient surgery, has coincided with significant changes in the hospital environment. As of 1999, there are approximately 5,200 medical-surgical hospitals throughout the country. This is significantly fewer than the number of medical-surgical hospitals that existed in 1980. At that time, there were approximately 5,900 medical-surgical hospitals. 5 Hospitals perform nearly 55% of all their surgeries on an outpatient basis as compared to an inpatient basis. This is a significant change from ten years ago, when the great majority of hospital surgery was inpatient surgery. 6 III. TENSIONS BET EEN ASCS AND HOSPITAL The development of the ASC business as an industry has led to great tensions between hospitals and physicians. These tensions are particularly acute in small- and mediumsized communities as opposed to larger metropolitan areas. Of course, they are also acute in specific market segment areas in larger communities. The tensions revolve around competition for a limited total number of cases, surgeons and healthcare dollars. The tensions often manifest themselves in the following areas. Certificate of Need. A Certificate of Need ("CON") is required to develop an ASC in many states. A certificate of need application often creates a battle between a group of physicians or a national company attempting to obtain a CON and a local hospital attempting to maintain its market position with respect to technical fees and outpatient surgery. In certain situations, a hospital may attempt to obtain its own CON or expand its operations to make it more difficult for others to obtain approval. For example, CONS are often granted or denied based on statistical criteria that review cases per operating room performed in an area. If the hospital can open more operating rooms without CON approval, it can unilaterally reduce the number of cases per operating room in an area and make it impossible to meet the CON criteria needed for another party to develop an ASC. CON battles are also often lodged at the legislative level, with hospitals attempting to tighten CON laws and other groups attempting to reduce CON restrictions. 7 Differences in CON legislation from state to state have led to large 4 See SMG MARKETING GROUP, INC., FREESTANDING OUTPATIENT SURGERY CENTERS, REPORT AND DIRECTORY INDUSTRY TRENDS, MARKET PROJECTIONS, COMPARATIVE ANALYSIS July 1997). 5 AMERICAN HOSPITAL ASSOCIATION, HISTORICAL TRENDS IN UTILIZATION, PERSONNEL AND FINANCES FOR SELECTED YEARS FROM 1996 THROUGH 1996 (1998). 6 See Alden Solovy, Benchmarking Guide, 73 HOSPITALS AND HEALTH NETWORKS, 49 (January 1999). 7 See Peg Boyles, Do ASCs Cause Hospital Closures,... Rural Hospitals Battle Outpatient Surgicenters, 21 NEW HAMPSHIRE BUSINESS REVIEW (January 29,1999). In the waning weeks of 1998, a health care dispute that's simmered for decades erupted into vitriolic public warfare. It's a war all parties involved in insist they don't want, can't afford and shouldn't have to fight. But 3

differences in the number of ASCs in operation. For example, California, a state without CON restrictions, has more than 400 ASCs in operation. 8 New York, in contrast, which until recently had very tight restrictions, has fewer than 50 ASCs in operation. 9 Payor Contracting. The development of an ASC often leads to extensive price competition between hospitals and ASCs. Traditionally, certain out-patient surgical procedures had provided large profit margins for hospitals (particularly on the commercial payor side). The development of additional sites for outpatient surgery increases competition significantly, and will lead to price cutting with payors. In certain situations, it also leads to efforts to obtain exclusive contracts with payors to cut off a source of cases for the competitor. Market and Primary Care Dominance. Conflict between ASCs and hospitals often leads to other financial and strategic actions. For example, in response to the threat of a physician-owned assert greater control over the primary care physician community (via acquisition of practices or otherwise). Then it may attempt to restrict referrals by such primary care physicians away from surgical specialists who use the ASC. On the public relations side, the hospitals may attempt to characterize the physicians as money oriented and not concerned about the greater community welfare. Physician Recruitment. The establishment of an ASC often leads a hospital to target areas for recruitment to compete with the ASC. For example, a hospital may recruit orthopedic surgeons to compete with an ASC owned or used by orthopedic surgeons. To reduce these conflicts, many hospitals and physicians have attempted to collaborate in joint venture ASCs. Potential benefits of these joint ventures are discussed next. IV. JOINT VENTURES POTENTIAL BENEFITS Many potential benefits can be gained from joint ventures between hospitals and physicians. A brief review of these potential benefits is as follows: CON Battle. Often, where the hospital and the physicians combine to attempt to obtain a CON, the opposition to the CON is co-opted. Thus, a CON is often easier to obtain. Moreover, the ASC can become operational much quicker if a long, drawn-out CON battle can be avoided. the fighting intensifies, waged before state regulatory bodies, in the press, the Legislature and the courts. The battle pits the state's rural hospital networks against physician/investor groups seeking the freedom to own and manage freestanding outpatient facilities that compete directly with the hospitals. 8 SMG Marketing Group, Inc., MARKET FACTS (SURGERY CENTERS) (1998). 9 Id. 4

Amortization of Costs. When all parties are involved in the same joint venture, these is an ability to amortize the costs of the venture over a greater number of cases. Because the two principal costs relevant to an ASC are fixed in part (lease or building costs and many of the administrative and employee costs), the addition of cases simply makes the surgery center more viable and more profitable. It can also allow the ASC to buy better equipment, employ better staff and technology and better accept risk. Payor Contracts. By combining the resources of multiple physicians or physicians and a hospital, there is often an ability to provide a broader array of services to a payor. The combination of resources may also provide additional leverage in negotiating with payors. Indigent Care and Medicaid Services. By joint venturing a surgery center, it is often easier to ensure that a hospital will have physician resources available to assist with providing services to indigents and Medicaid patients. Protection Against Risks. Partners to the joint venture often can ensure the provision of additional capital to the venture. In many situations, the greatest problems revolve around surgery centers having insufficient cash flow and surgery centers having or carrying too much debt. Additional partners reduce the debt load for the center and reduce the risks inherent in a larger debt load. Professional and Competitive Jealousy. Surgery centers, by having multiple partners, can avoid the jealousy that exists when one or two physicians own the surgery center. In short, when there is a variety of partners, the surgery center is often viewed as a community asset rather than simply a method to provide profits to a few physicians. In many situations, this has very positive effects upon the surgery center. The most successful ASCs are used heavily and in large part by physicians who are not owners of the surgery center. When there are multiple owners, non-owners become far more comfortable using the center because they do not perceive that they are simply benefiting a few physicians. V. PRINCIPAL LEGAL ISSUES Lawyers involved in structuring ASC joint ventures, in acquiring surgery joint ventures or in simply providing day-to-day counseling to surgery centers must be familiar with and provide guidance on a variety of issues. A brief overview of the principal legal issues is set forth below. These issues are discussed in greater detail in chapters 2 through 6 of this monograph. A. Antitrust Does the involvement of a hospital in an ASC joint venture lead to Sherman Act conspiracy concerns? Does the joint venture include "price-fixing terms" between the hospital and the ASCs? 5

Is the joint venture intended to monopolize outpatient surgical services in the market area? Will a joint venture or acquisition require a Hart-Scott-Rodino ("HSR") filing? Because most individual ASCs do not meet the size requirement for HSR, HSR filings are typically not an issue. B. Medicare and Medicaid Anti-Kickback and Fraud and Abuse Will the ownership and compensation relationships be deemed intended to induce referrals of Medicare or Medicaid business to the ASC? Will the proposed surgery center fit within a safe harbor? Will the venture be structured to concur with guidance provided by the Health Care Financing Administration ("HCFA") and the Office of Inspector General ("OIG") regarding physician ownership of providers, including ASCs? Do other compensation relationships such as medical director, anesthesiologist or management relationships raise fraud and abuse concerns? Can primary care physicians own interests in the joint venture? Can returns be made to surgeons based on their referrals? C. Tax-Exempt Issues Will the participation of a tax-exempt entity in an ASC venture hurt its tax- exempt status? Will the income of the tax-exempt entity from the venture be considered exempt or unrelated business taxable income? Do leases or other management contracts create tax exemption or taxexempt financing issues or concerns? D. Certificate of Need Does the development of an ASC require a certificate of need? What criteria are used to judge CON applications statistical or subjective? Can an ASC certificate of need application of a competitor be challenged? Is the ASC exempt from CON under a specific state exemption? For example, exemptions from the requirement to obtain a CON often exist for ASCs that are: 6

a. owned by health maintenance organizations ("HMOs"); b. operated in physician offices; c. operated by single practices; or d. which are expanded if they spend less than a certain amount of money on the expansion. E. Stark Act Will the services of the ASC be considered "Stark-designated health services"? Typically, if not "hospital-based," the basic services are not deemed Stark services. Will the center be "hospital-based?" Will it be a hospital outpatient department? Or will it be "free-standing"? Will the surgery center provide ancillary services that are not billed as part of the ASC payment rate? For example, will the ASC provide imaging or lab services? Will a related party provide such services? F. Employee Benefits and Employee Issues Will the surgery center be considered an "affiliated service group" of its owners for ERISA purposes? Will the surgery center hire its own employees? G. State Self-Referral Issues Does the State Self-Referral Act permit physician ownership? If the state act permits physician ownership, does the state's Anti-kickback Statute or state version of the Stark Act provide for specific exceptions or specific requirements? Is there a mandatory patient disclosure requirement? H. Licensure, Accreditation and Medical Staff Issues Does the state specifically license surgery centers? Does the center intend to obtain third-party Medicare "deemed status" by an accrediting agency such as the JCAHO or AAAHC? 7

Will the medical staff be open or closed? Will the ASC have an exclusive contract with anesthesiologists and with other physicians? What is the process for actually obtaining the provider number in the state of operation? How quickly are provider numbers being processed? How will cash flow be handled while the ASC is waiting for the provider number? I. Real Estate-Related Issues Will the surgery center own its property? Will it lease property pursuant to a full lease or pursuant to a ground lease? What terms and representations will the ground lease or lease contain? Who owns improvements and structure? Will the relationships raise taxexempt or fraud and abuse issues? Will the surgery center have control of the property for a long period of time to enable it to amortize capital and other improvements? Is the CON location specific? Does relocation require state approval? VI. SUMMARY This monograph discusses legal issues applicable to ASCs. It specifically reviews in detail Medicare and Medicaid fraud and abuse, tax exemption, Stark, certificate of need, tax-related and licensing issues. It also provides samples of documentation with annotations. We intend for this to be useful to the experienced lawyer who desires a reference guide for specific issues. However, this monograph should also be useful to the novice healthcare lawyer looking for an overview issues critical to ASCs. Throughout the monograph, in addition to providing a full discussion and articulating positions proffered by HCFA and others, we have attempted to identify frequently asked questions and to address those questions. We hope this will be helpful to your efforts. 8

2. MEDICARE AND MEDICAID ANTI-KICKBACK FRAUD AND ABUSE STATUTE AND STARK ACT SELF-REFERRAL ISSUES ASCs, like most healthcare providers, rely on physician referrals for cases to be performed at the ASC, and, thus, for their revenues. For a variety of reasons, ASCs can be a fertile source of federal anti-kickback problems. A few of these are: Many ASCs rely heavily on Medicare cases (e.g., ophthalmology). Many ASCs are overbuilt and thus heavily indebted, giving rise to situations in which an ASC requires substantial business to remain open. Many ASCs rely too heavily on only a few physicians. The federal government has encouraged growth in ASCs and has been reasonably relaxed in its investigation, advisory and prosecution efforts against ASCs. These factors have arguably led many ASCs to "stretch the envelope" in terms of the practices they engage in to encourage business referrals to ASCs. Practices that can be considered problematic in the ASC context include: selling interests to physicians at below-market value; paying excessive rents for equipment or property to physicians who refer business to the ASC; paying excessive director fees to physicians who refer business to the ASC; paying lease or service payments that may be based on the volume of business generated at the ASC; requiring ASC-based anesthesiologists to "buy services" from the ASC; providing discounts to physicians that do "globally billed" procedures (e.g., plastic surgery) in exchange for the referral of other business; offering to waive co-payments or deductibles, or offering other benefits to patients; receiving benefits in exchange for providing ancillary referrals; conditioning physician ownership in the ASC on performance; 9

tying permitted ownership amounts to business generated at the ASC; and tying management fees to profits of the ASC. These reflect typical fraud and abuse problems. The Stark Act 1, in contrast to the Fraud and Abuse Statute, 2 does not apply to most non-hospital ASCs. Freestanding, nonhospital-based ASCs are not themselves generally viewed as providing outpatient hospital services as defined under the Stark Act. However, the Stark Act does apply to: ASCs that are hospital-based; and ancillary services, such as lab services or imaging services, if separately provided and billed for by the ASC. This chapter discusses case law as well as HCFA and OIG guidance relating to ASCs and joint ventures under the Fraud and Abuse Statute and the Stark Act. It also provides a sample compliance plan. I. THE FRAUD AND ABUSE STATUTE Guidance under the Fraud and Abuse Statute can be derived from many sources, including the Statute itself, the regulatory safe harbors, case law that applies the Statute to joint ventures, OIG commentary to the safe harbors and OIG advisory opinions. In examining these sources of guidance, it is helpful to have an understanding of the typical issues raised in the ASC context. A. Frequently Raised Fraud and Abuse Questions Can surgeons invest in ASCs? Can primary care physicians invest in ASCs? Can a non-referring partner or the entity finance physician investment in an ASC? Can the non-physician partner in an ASC guarantee debt or finance the ASC s operations? Can the ASC provide for distributions or payments based on production? Can a management company be paid based on a percentage of revenues? Can a physician-owned entity manage an ASC? If so, how can it be paid? 1 42 U.S.C. 1395nn. 2 U.S.C. 5 1320a-7b(b). 10

Can the ASC require the performance by investors of a certain number of cases at the ASC? Can the ASC require the buyout of a physician if he or she is not in a position to perform services at the ASC? Can physicians own more than 60% of the ASC? These questions should be analyzed in light of both OIG commentary and existing case law. This analysis may differ, however, from state to state (1) based on state law concerns, and (2) based on whether a tax-exempt entity is involved in the venture. B. The Proposed ASC Safe Harbor and OIG Advisory Opinion No. 98-12 OIG, through its proposed ASC safe harbor, and through OIG Advisory Opinion No. 98-12, has clearly articulated a level of comfort with a surgeon's investment in an ASC to which the surgeon refers cases and in which the surgeon also performs services. OIG, in its commentary relating to the proposed ASC safe harbor, stated as follows: A special situation may exist when a physician sees a patient in his or her office, makes a referral to an entity in which he or she has an ownership interest and performs the service for which the referral is made. This concept is often referred to as an extension of the physician's office practice. In the above situation, the physician-investor receives two payments: (1) the professional fee for furnishing the service, and (2) the profit distribution from the entity based on the program payment the entity receives that was generated from the referral. We do not consider the statute to be implicated by the first payment. However, we believe that the second payment is potentially covered by the statute. As with any investment interest held by a potential referral source, the profit distribution provides some financial incentive to refer patients to the entity. To the extent this payment has the potential to induce physicianinvestors to overutilize the entity, no safe harbor protection is warranted. In contrast, where these payments do not constitute a significant inducement to make referrals, they may merit safe harbor protection. Where the professional fee generated by a referral is substantially greater than the facility fee generated by the referral, we believe that the profit distribution payment (which results from the facility fee) does not constitute a significant improper inducement. Only where a great disparity between the facility and professional fees exists will the incremental increase in profit distribution from a referral be so small as to be 11

inconsequential when compared to the corresponding professional fee. Therefore, we will only consider providing safe harbor protection to types of extensions of practice that receive facility fees from referrals that are greatly disparate from the professional fee generated by the referral. Because we believe that ASCs generally fit this criterion, we have proposed a safe harbor for certain investment interests in ASCs. When a patient is referred to an ASC for surgery, there is a great disparity between the surgeon's professional fee and the ASC s facility fee. Therefore, we propose to protect the payment of profit distributions from the ASC to investors where all investors in the ASC are surgeons in a position to refer to the ASC and perform services. This proposed safe harbor applies only to ASCs certified under 42 CFR part 416. We are not proposing to protect ASCs located on the premises of a hospital that share their operating or recovery room space with the hospital for treatment of the hospital s inpatients or outpatients. 3 The comments also note that the reasoning for the safe harbor should not be deemed applicable to nonsurgeons: The rationale underlying this safe harbor does not extend to investment interests held by physicians who are not in a position to refer patients directly to the ASC and perform surgery. Such physicians do not receive a professional fee performed by the entity. An example to illustrate the potential perils of protecting profit distributions to such investors would be where a non-surgeon physician investor may refer a patient to a surgeoninvestor who may, in turn, refer the patient to the ASC where the surgeoninvestor may perform the surgery. In this scenario, the non-surgeon investor would receive a return, through the ASC's profit distribution, for the "indirect referral" of the patient. Because of the potential for improper inducement of referrals illustrated in this example, we do not think investment interests held by non-surgeon investors merit safe harbor protection. 4 The proposed safe harbor includes five standards: It precludes an investor from being afforded better investment terms based on past or expected referrals or amount of services furnished to the entity; It requires that a passive investor not be require to make referrals to the entity in order to continue as an investor; It prohibits the entity or any investor from loaning funds to the investor for use in obtaining an investment interest; It requires that payments not be based on referrals; and 3 58 Fed. Reg. 49,008, 49,009 (Sept. 21,1993). 4 Id. at 49,010. 12

The practitioner must agree to treat Medicare and Medicaid patients. 5 OIG Advisory Opinion No. 98-12 6 reviews similar issues as those raised in the ASC safe harbor. Specifically, it reviews the formation of an ASC by five physicians: two anesthesiologists and three orthopedic physicians. In this advisory opinion, OIG s analysis was articulated as follows: Owners Provide Substantial Capital. The Physician-Investors will be the shareholders of the corporation, or the owner-members of the limited liability company, and will make substantial capital contributions to the ASC. 7 Ownership Interest Not Tied to Referrals. The Physician-Investors have certified that the amount of their capital contributions will not be based on any expected volume of referrals to the other Physician-Investor. 8 Proportionate Voting and Control Among the Members. The Physician- Investors will receive voting and distribution rights proportional to their investment. 9 Proportionate Guarantees by Members. The Physician-Investors will personally guarantee payment under the lease for the ASC's prernises. 10 Expected Use by Physicians; Office-Like Setting Evidences Practice-Like Setting. The Physician-Investors expect to utilize the ASC as their preferred ambulatory surgical center for procedures for which it is appropriately equipped. The Physician-Investors have represented that each Physician- Investor will perform the majority of his ambulatory surgical center procedures at the ASC. ASC procedures currently include certain pain management procedures performed by the Physician-Investors who are anesthesiologists. 11 Priority Scheduling. Although the ASC will be available for use by non-investor physicians, the Physician-Investors will be given priority scheduling and have represented that they will perform over 80% of the total procedures performed at the ASC. 12 5 Id. at 49,011. 6 OIG Advisory Opinion No. 98-12 (Sept. 16,1998). 7 Id. 8 Id. 9 Id. 10 Id. 11 Id. 12 Id. 13

No Separate Ancillaries. All ancillary services performed at or by the ASC will be integrally related to the primary procedure a Physician-Investor is performing at the ASC. 13 Small Amount of Medicare Business. The Physician-Investors have certified that Medicare reimbursement will account for approximately 5% of the ASC annual revenue. 14 Professional Fees Billed Separately. Each of the Physician-Investors will directly bill his patients and related third-party payors, including Medicare and Medicaid, for the professional component of the ASC procedures he performs. 15 Patient Disclosure. The Physician-Investors will provide their p disclosure of their ownership in the ASC, explaining referring patients to the ASC. 16 Based on these facts, OIG articulated its position at length. There, it stated a degree of comfort with physician-asc joint ventures but distinguished ASCs from other joint ventures: This Office has long been concerned with the risk of abuse posed by healthcare joint ventures in which investors are also sources of referrals or suppliers of items or services to the joint venture. In 1989, the Office of Inspector General issued a 'Special Fraud Alert' specifically addressing joint venture arrangements. The Special Fraud Alert distinguishes between those joint ventures that are clearly legitimate and those that are suspect under the anti-kickback statute. A joint venture may be suspect when physicians are both investors in the joint venture and are in a position to refer to the joint venture. Under these circumstances, remuneration paid to the physicians in exchange for referrals may be disguised as profit distributions. Such suspect joint ventures... may be intended not so much to raise investment capital legitimately to start a business, but to lock up a stream of referrals from the physician investors and to compensate them indirectly for these referrals. Because physician investors can benefit financially from their referrals, unnecessary procedures and tests may be ordered or performed, resulting in unnecessary program expenditures. 59 Fed. Reg. 65373-74 ( ec. 19, 1994). Substantial ownership by investors who are in a position to refer patients to the joint venture ('Interested Investors') is an indicator of a suspect joint venture because such ownership increases the likelihood that the joint venture's primary purpose is to control a stream of referrals. See 56 Fed. 29,1991). Other factors that could indicate potentially unlawful activity include the Interested Investors receiving a disproportionate return on their investments, and the joint 13 Id. 14 Id. 15 Id. 16 Id. 14

venture being structured as a 'shell' for use by on-going entities already engaged in a particular line of business...... The Proposed Arrangement is the antithesis of the small entity investment safe harbor business structure. All of the investors will be referral sources to the ASC, and virtually all such business of the ASC will be from investor referrals. Nevertheless, for the reasons and in the circumstances set out below, we conclude that although the Proposed Arrangement may potentially violate the anti-kickback statute, we would not impose sanctions. At the outset, we note that the Healthcare Financing Administration promotes ambulatory surgical centers as a cost-effective alternative to higher cost settings, such as hospital inpatient surgery facilities. Many patients prefer treatment in less intensive settings, such as ambulatory surgical centers. Thus, ambulatory surgical centers benefit both the Medicare program and its beneficiaries. This Office has proposed a safe harbor to protect surgeons who, as an extension of their personal office practice, routinely per- form procedures in ambulatory surgical centers in which they have investment interests. See 58 Fed. Reg. 49013 (Sept. 21,1993). There are obvious and legitimate business and professional reasons for surgeons to want to own an ambulatory surgical center in which they will personally perform services on a routine basis. These reasons include personal and patient convenience, professional autonomy, accountability, and quality control. Moreover, any risk of overutilization or unnecessary surgery is already present by reason of the opportunity for a surgeon to generate his professional fee; the additional financial return from the ambulatory surgical center investment is not likely to increase the risk of overutilization substantially. Notwithstanding, this Office is concerned about the potential for investments in ambulatory surgical centers to serve as vehicles to reward referring physicians indirectly. For example, a primary care physician, who performs little or no services in an ambulatory surgical center in which he has an ownership interest, may refer to surgeons utilizing the ambulatory surgical center, thereby receiving indirect remuneration for the referral through the ambulatory surgical center's profit distribution. Similarly, an investment by orthopedic surgeons in an ambulatory surgical center that is not equipped for orthopedic surgical procedures, or that is exclusively used by anesthesiologists performing pain management procedures on patients referred by the orthopedic surgeons, would be suspect. 15

The situation presented here is very different. First, all Physician-Investors will be making substantial financial investments in the ASC and incurring financial exposure for the ASC's lease. Second, although not all Physician- Investors are surgeons, each Physician-Investor has certified that he currently derives, and anticipates continuing to derive, at least 40% of his aggregate medical practice income from ASC procedures. In addition, each Physician-Investor has certified that he will perform the majority of his ASC Procedures in the ASC. Third, given that the revenue from procedures on Medicare beneficiaries is estimated to be only 5% of the ASC's total revenues, any income from procedures performed on referred Medicare patients will be insubstantial compared to the income from procedures performed on the Physician-Investors' own patients. Fourth, any return on investment to the Physician-Investors will be proportional to their capital investments, and not based on referrals. In these circumstances, the Proposed Arrangement is substantively equivalent to an "all surgeon" ambulatory surgical center and presents a minimal risk that the return on investment would be a disguised payment for referrals. Finally, the Physician-Investors will provide their patients with a written disclosure of their ownership in the ASC, explaining that they are referring patients to the ASC. This written disclosure is required by the state's law. While we do not believe that disclosure to patients offers sufficient protection from program abuse, effective and meaningful disclosure offers some protection against possible abuses of patient trust. 17 The proposed safe harbor and the Advisory Opinion are useful in under- standing what OIG does and does not condone. Specifically: OIG, in the opinion, condones the intent of the physicians to refer to the ASC and receive the profit return. OIG bases its approval on its belief that ASCs are good for the Medicare Program rather than basing its approval on the statute itself. Because OIG's attitudes toward types of patients and providers change as abuses arise in certain areas, it is critical that providers be cautious in relying on such current beliefs as opposed to relying on the statute itself. OIG does not condone primary care investment. OIG disfavors ownership based on potential referrals. OIG permits returns based on ownership but not returns based on level of referrals. OIG prefers that an entity or partner not lend funds to a physician to finance investment. 17 Id. 16

The guidance applies to investment ownership but not compensation relationships. OIG's guidance provides a good starting point for answering questions relating to the actual structure of the investment in an ASC and to those questions relating to primary care investment in ASCs. C. Small Investment Safe Harbor In its commentary related to the small investment safe harbor, OIG articulated a number of principles that provide useful guidance in the structuring of joint ventures. 18 OIG elaborated on these principles as follows: Equal Marketing. The entity or any investor must not market or furnish the entity's items or services to passive investors in a manner different than that marketed or furnished to non-investor. 19 In other words, although an entity may seek referrals or other business from passive investors, it must promote and furnish its items or services to investors and noninvestors in the same manner. No Distribution of Referral Information. Any distribution to passive investors of individual or aggregate investor referral patterns would not be protected under this provision. 20 No Cross-Referrals. The entity or any investor must not promote the items or services of other entities as part of a cross-referral agreement. 21 No Loans to Investors. The entity must not loan funds to or guarantee a loan for an investor to use for the purpose of obtaining the investment interest. 22 OIG stated that it did not believe that protection should be afforded where an investor is loaned money from the entity, or from a parent or subsidiary corporation (or is guaranteed a loan by the entity or a related organization), and the investor makes an investment based on that loan. 23 In such a situation, the investor is adding no real capital to the entity. OIG, however, noted that safe harbor protection is available where the investor borrows from other sources. 24 A large number of commentators to the small investment safe harbor argued that physician involvement in joint ventures is necessary because physicians provide 18 56 Fed. Reg. 35,952 (July 29, 1991). 19 Id. at 35,966. 20 Id. 21 Id. 22 Id. 23 Id. 24 Id. at 35,970. 17

needed capital. 25 Other commentators, in contrast, questioned whether investors are really generating capital for the joint ventures in which they invest. 26 Many suggested that the OIG should only protect an investor's capital in cases where the capital was genuinely at risk. 27 In other words, if the investor's interest is obtained through a no-interest loan paid off through deductions from future dividend distributions, there was never really any capital placed in risk. 28 OIG responded as follows: For example, the entity may borrow from the investor, and investors may borrow from other sources to obtain funds to use for the capital investment. But as we discussed above, where investors make their investment with money loaned from the entity, they are adding no real capital to it. Thus, this standard will help assure that physicians and other investors in fact provide new needed capital and that the joint venture is not in reality a sham to facilitate the distribution of payments for referrals. 29 Returns Proportionate to Ownership. The amount of payment in return for the investment interest must be directly proportional to the amount of the capital investment. 30 Such payments are consistent with the type of corporate dividend payment that OIG is trying to protect. Equal Investment Opportunity. (1) A bona fide opportunity to invest is made on an equal basis without regard to the investor's ability to make referrals, (2) no requirement is imposed on the investor to make referrals, and (3) payments are not related to referral. 31 ' The standards address the problems of discriminatory marketing strategies that result in the offer of better deals, for example, more shares or a better price, to individuals who will refer a high volume of patients. Safe harbor protection also requires that an offering to a passive investor is not conditioned on his or her ability to refer business to the venture and, further, that an offering is not made on more favorable or otherwise different terms based on the expectations as to how much business can be generated by an investor. D. Suspect Joint Ventures Fraud Alert A Special Fraud Alert provides further guidance on permitted ways to structure and invest in ASCs and other joint ventures. 32 In the Fraud Alert, OIG laid out and discussed key factors that suggest that a particular joint venture is suspect under the fraud and abuse statute: 25 Id. 26 Id. 27 Id. 28 Id. 29 Id. 30 Id. at 35, 966. 31 Id. 32 59 Fed. Reg. 65,373 (Dec. 19, 1994). 18

Capital Versus Business Referrals. Under these suspect joint ventures, physicians may become investors in a newly formed joint venture entity. The investors refer their patients to this new entity and are paid by the entity in the form of "profit distribution. 33 These suspect joint ventures may be intended not so much to legitimately raise investment capital to start a business, but to lock up a stream of referrals from the physician investors and to compensate them indirectly for these referrals. Because physician investors can benefit financially from their referrals, unnecessary procedures and tests may be ordered or performed, resulting in unnecessary program expenditures. 34 Divestment. Physician investors may be actively encouraged to make referrals to the joint venture, and they may be encouraged to divest their owner- ship interest if they fail to sustain an acceptable level of referrals. 35 Investors may be required to divest their ownership interest if they cease to practice in the service area, for example, if they move, become disabled or retire. 36 Tracking Referrals. The joint venture tracks its sources of referrals, and distributes this information to the investors. 37 Shell Ventures. The structure of some joint ventures may be suspect. For example, one of the parties may be an ongoing entity already engaged in a particular line of business. That party may act as the reference laboratory or DME supplier for the joint venture. In some of these cases, the joint venture can be best characterized as a shell. 38 In the case of a shell laboratory joint venture, for example: It conducts very little testing on the premises, even though it is Medicare certified. The reference laboratory may do the vast bulk of the testing at this central processing laboratory, even though it also serves as the "manager" of the shell laboratory. Despite the location of the actual testing, the local "shell" laboratory bills Medicare directly for these tests. 39 In the case of a shell DME joint venture, for example: 33 Id. 34 Id. 35 Id. 36 Id. 37 Id. 38 Id. 39 Id. 19

It owns very little of the DME or other capital equipment; rather, the ongoing entity owns them. The ongoing entity is responsible for all day-to-day operations of t joint venture, such as delivery of the DME and billing. 40 The following guidance, that can be derived from the safe harbor and from the Fraud Alert, is as follows: No difference in price or investment opportunity should be based on referrals. No requirements to refer should be imposed on physician investors. No financing of investment interests should be provided by partners or related entities. Any disproportionate provision of profits to one partner as compared to capital or ownership should be viewed as suspect. True joint ventures are significantly preferred to contract or shell joint ventures. Exit provisions must be defensible as not intended to lock up referrals. Having privileges at other providers should not be prohibited. E. Case Law and Other Guidance Primary Care Investment and Management The safe harbors and the Fraud Alert are extremely helpful in setting the ground rules for a surgeon's investment. However, they do not fully resolve issues relating to primary care investment or to other compensation and management relationships. The OIG, as noted above, has expressed concerns regarding primary care investment in ASCs. However, arguments exist that primary care investments in ASCs should not be deemed per se prohibited. In Hanlester Network v. Shalala, 31 E3d 1 1995) and in Baglio v. Baska, 940 F. Supp. 819 (1996), aff d, 116 E2d 467 (3r Cir. 1997), the courts asserted that referral joint ventures not be deemed per se unlawful. In the Hanlester case, the court stated: Healthcare joint ventures such as that entered into were not per se unlawful. The evidence shows that Hanlester desired to comply with the law and structured its business operation in a manner which it believed to be lawful. There is ample evidence that appellants intended to encourage limited partners to refer business to the joint venture laboratories. The appellants offered physicians the opportunity to profit indirectly from 40 Id. 20

referrals when they could not profit directly. Potential partners were told that the success of the limited partnerships depended on referrals from the limited partners. While substantial cash distributions were made to limited partners by the joint venture labs, dividends were paid to limited partners based on each individual's ownership share of profits, and not on the volume of their referrals. Payments were made to limited partners whether or not they referred business to the joint venture labs. The fact that a large number of referrals resulted in the potential for a high return on investment, or that the practical effect of low referral rates was failure for the labs, is insufficient to prove that appellants offered or paid remuneration to induce referral. 41 Similarly, in Baglio, the court stated that physician self-referral joint ventures are not prohibited per se by the plain language of the [fraud and abuse] statute. 42 In this case, the plaintiff alleged that the actions of various defendant physicians, officers and directors in promoting and establishing a clinical pathology laboratory joint venture with a hospital violated the fraud and abuse statute. The court evaluated the joint venture arrangement in light of the Hanlester case and held that, by itself, the fact that the return on investment rises and falls in direct relation to the level of referrals to the joint venture is not enough to demonstrate that a joint venture arrangement violates the fraud and abuse statute. 43 Based on case law, it appears that something more than investment itself and a return thereon is necessary to declare primary care investment illegal. This premise is supported by the fact that the Stark Act does not generally prohibit investment and, further, that OIG (at least in the Stark Act regulations) has asserted that a return on investment itself is not compensation. 44 Given OIG's position, it is apparent that nonsurgeon investment must be very carefully structured to assure that the purpose of the investment is not to encourage referrals. 45 This is also important because many states specifically prohibit ownership by physicians that can refer but not treat patients at a venture. 46 Although OIG expresses comfort with a surgeon's investment in an ASC, it does not extend this comfort to a surgeon's compensation relationship with ASCS. 47 Nevertheless, promoters and ASCs in certain situations attempt to encourage surgeon involvement in ASCs through compensation without an actual investment in the ASC. This is common in situations where either state law places restrictions on direct investment (through self- 41 Hanlester, 51 F.3d at 1399. 42 Baglio, 940 F. Supp. at 833. 43 Id. 44 42 C.F.R. 1001.952(a) (1997); 63 Fed. Reg. 1659,1686-87 (1998). 45 Id. at 42 C.F.R. 9 1001.952(a); Id. at 63 Fed. Reg. 168687. 46 See Chapter 4. 47 63 Fed. Reg. 1686-87 (1998). 21

referral or certificate of need reinvestment) or situations in which the owner designs to retain greater control. The structure of such management relationships must be carefully developed so as not to mimic ownership. In short, OIG's favor with partnership returns does not extend to compensation that is intended to mimic ownership. Therefore, most management or compensation relationships should be structured as annual fixed fee and fair market value relationships that do not vary based on the referral of business. The safe harbor for management and personal services is as follows: The personal services and management contracts safe harbor provides protection for personal services contracts if all of the following six standards are met: (i) the agreement is set out in writing and signed by the parties; (ii) the agreement specifies the services to be performed; (iii) if the services are to be performed on a part-time basis, the schedule for performance is specified in the contract; (iv) the agreement is for not less than one year; (v) the aggregate amount of compensation is fixed in advance, based on fair market value in an arms-length [sic] transaction, and not determined in a manner that takes into account the volume or value of any referrals or business otherwise generated between the parties for which payment may be made by Medicare or a State healthcare program; and (vi) the services performed under the agreement do not involve the promotion of business that violates any Federal or State law. 48 The OIG has further commented on percentage-based relationships in Opinion 984 and in safe harbors. In this advisory opinion, the OIG stated: Percentage compensation arrangement for marketing services may implicate the anti-kickback statute. In our preamble to the 1991 final safe harbor rules, 56 Fed. Reg. 35952 (July 29,1991), we explained that the anti-kickback statute "on its face prohibits offering or acceptance of remuneration, inter alia, for the purposes of arranging for or recommending, purchasing, leasing, or ordering any...service or item payable under Medicare or Medicaid. Thus, we believe that many marketing and advertising activities may involve at least technical violations of the statute. 56 Fed. Reg. at 35974. This Proposed Arrangement is problematic for the following reasons. The Proposed Arrange may include financial incentives to increase patient referrals. The compensation that Company B receives for its management services is a percentage of Company A s net revenue, including revenue from business derived from managed care contracts arranged by Company B. Such activities may potentially implicate the anti-kickback statute, because the compensation Company B will receive will be in part for marketing services. Where such compensation is based on a percentage, there is at least a potential technical 48 42 C.F.R. 1001.952 (d) (1997). 22

violation of the anti-kickback statute. In addition, Company B will be establishing networks of specialist physicians to whom Company A may be required to refer in some circumstances. Further, Company B will presumably receive some compensation for its efforts in connection with the development and operation of these specialist networks. In these circumstances, any evaluation of the Proposed Arrangement requires information about the relevant financial relationships. However, Company B is not a requestor for the advisory opinion, and Company A does not have information regarding Company B's related business arrangement. 49 In deciding to use physicians as managers, one must be able to support the choice of the physician or group as a qualified manager, and to support the compensation as fair market value. It is often difficult to keep the fees low enough to meet a fair market value standard and, at the same time, satisfy the business goals of the parties. Parties must be very careful in structuring relationships with managers that are also referring parties. These concerns also extend to non-physicians who can be perceived as providing marketing services for the ASC. Evidence of OIG's disfavor toward percentage compensation arrangements for nonphysicians can also be found within the Medicare billing regulations. The regulations specifically prohibit Medicare payment to agents that furnish billing and collection services to providers where the agent's compensation is related in any way to the dollar amounts billed or collected. 50 This prohibition suggests that OIG is concerned that payments based on the level of business generated by the provider serve to encourage an agent acting on a physician's behalf to increase his or her efforts in increasing business performed by the physician. This sort of behavior is a manifestation of the intent to refer business and, therefore, violates the fraud and abuse statute. Because compensation methods that base payment upon the volume of business generated have potential fraud and abuse implications, physicians should consider entering payment arrangements that are fixed (such as flat fee arrangements) when contracting to perform services themselves, or when contracting with third parties to perform administrative or management functions for them. F. Other Common Fraud and Abuse Issues Waiver of Copayments. At one time, ASCs routinely advertised that they would waive copayments to patients in order to attract business. This practice is illegal. OIG Advisory Opinion No. 974 (Sept. 25,1997) stated as follows: We have said previously that providers who routinely waive Medicare Copayments may be held liable under the anti-kick- back statute. See Special Fraud Alert, 59 Fed. Reg. 242 (1994). 51 When providers forgive financial 49 OIG Advisory Opinion No. 984 (Apr. 15, 1998). 50 42 C.F.R. 5 424.73(3)(ii) (1999). 51 51 OIG Advisory Opinion No. 974 (Sept. 25,1997). Although the Special Fraud Alert addressed chargebased providers, we expressly stated that the Special Fraud Alert should not be interpreted to legitimize 23

obligations for reasons other than genuine financial hardship of the particular patient, they unlawfully may be inducing the patient to purchase items or services in violation of the anti-kickback statute's proscription against offering or paying something of value as an inducement to generate business payable by a Federal healthcare program. Thus, except in those special cases of financial hardship, providers must make a good faith effort to collect Medicare Copayments. One indicator of a suspect waiver is the failure to collect Medicare Copayments for a specific group of Medicare patients for reasons unrelated to indigence. Here, the Proposed Agreement is subject because it would effectively waive the Medicare Copayment for the specific group of Medicare patients covered by the Company X complementary coverage, if Company X continues to deny payment. Moreover, an inference can be drawn that the Proposed Arrangement's waiver of the Medicare Copayment for reasons unrelated to individualized financial hardship may unlawfully induce patients to purchase services from Center B that are reimbursable by Medicare. For these reasons, the Proposed Arrangement may be subject to sanction under the anti-kickback statute, 42 U.S.C. 1320a-7b(b).... Section 231(h) defines "remuneration" as including, inter alia, the waiver of coinsurance and deductible amounts (or any part thereof). Waivers of coinsurance and deductible amounts are excepted from the definition of remuneration if: (i) the waiver is not offered as part of any advertisement or solicitation; (ii) the person making the waiver does not routinely waive co- insurance or deductible amounts; and (iii)the person making the waiver (I) (II) waives the coinsurance and deductible amounts after determining in good faith that the individual is in financial need; or fails to collect coinsurance or deductible amounts after making reasonable collection efforts. See 42 U.S.C. 1320a-7a(i)(6), as amended by section 4331 of the Balanced Budget Act of 1997. P.L. 105-33. 52 Subsections (i), (ii), and at least one prong of subsection (iii) must be satisfied for the exception to apply. 53 routine waiver of Medicare copayments with respect to providers paid under prospective payment or costbased systems. 52 Id. The statute, as amended, contains three further exceptions, not applicable here, for (i) certain permissible waivers specified in section 1128(B)(b)(3) of the Social Security Act or in regulations issued by the 24

Productivity-Based Returns Shared Ownership Agreements. Lawyers are regularly asked whether the ASC can divide revenues or profits based on productivity by doctor or by group. Typically, we are not able to provide comfort as to the ability to develop or enter into a compensation formula that does not center strictly upon ownership returns. That stated, many ventures cannot be structured because groups of doctors do not want to share revenues generated by their technical fees with the group as a whole. In essence, they want the technical fees from their cases. An alternative that allows groups to be self-dependent and retain their own revenues has been proposed to OIG in the form of a single ASC facility that is actually licensed and accredited for two different entities. Under this type of arrangement, the two different ASC operating companies use the same space, but on different days of the week. Each entity can be considered an individual owner if each operates the ASC facility independently, even if the entities simply lease space from the actual owner of the ASC. As such, we strongly encourage that each facility independently meet the Medicare certification requirements enumerated under 42 C.F.R. Part 416, be reimbursed as a separate entity and must separately comply with all ownership reporting requirements as set forth in 42 C.F.R. Part 420. In other words, the arrangement should be structured as two independent ASCs operating in the same facility. While this concept may work in theory, we have not yet seen a group use this option. In sum, physicians who fail to obtain separate ASC certification but desire to share revenues based on performance expose themselves to potential fraud and abuse liability. Per Use Lease Payments. Ten years ago, per use leases were a staple of physician-asc relationships. The physician would buy a piece of equipment and lease the equipment to the ASC. Then the ASC would pay rent to the physician each time the equipment was used. By tying rent to use, the ASC encouraged the physician to use the ASC. It is our belief that ASCs should be very cautious regarding their use of per use lease arrangements. With regard to per use arrangements, OIG has stated as follows: Commentators requested clarification as to whether these safe harbor provisions protect any types of percentage, 'per use' or 'per procedure' leases or contracts in which the amount of compensation fluctuates in accordance with the actual use of premises or equipment, or the frequency of services performed. A few commentators inquired whether parentage leases between parities in a position to refer Medicare or Medicaid business were a per se violation of the statute... Secretary; (ii) certain differentials in coinsurance and deductible amounts as part of a benefit plan design; and (iii) certain incentives given to individuals to promote the delivery of preventative care. 53 Id. 25

As we explained... in discussing wear and tear clauses, percentage or per use agreements between healthcare providers in a position to refer Medicare or Medicaid business threaten to violate the statute because the payments in these arrangements are directly tied to the volume of business or amount of revenue generated, providing an improper incentive to refer. Moreover, historically, percent and contracts have been rife with abuse. These sorts of arrangements need to be examined on a case-by-case basis. For example, a lease to a hospital of major medical equipment, such as a magnetic resonance imaging scanner, may specify that higher rent is to be paid when more than a predetermined number or procedures is performed. Such an arrangement can be troublesome if the lessor is a partnership of radiologists on the hospital's medical staff, because the incentive for overutilization is clear. It is the nature of the relationship, if any, between overall volume of use and referrals that triggers the statute. Thus, if the owner of equipment were not in a position to make referrals to the lessee, the agreement would not violate the statute. For these reasons, we specifically decline to protect rental charges or compensation for personal services where the aggregate amounts of payment are not set out in advance. This does not mean, however, that percentage or per use leases and contracts that are based on overall volume (including business form referral sources with no financial interest to motivate them), are per se violations of the statute. We recognize that legitimate considerations, such as the depreciation of equipment, could result in some part of the payment to be based on a percentage of per use payment arrangement without these payments influencing or being or being influenced by Medicare or Medicaid referrals. However, the more the payments appear to reflect the volume of referrals from the financially-interested party, the more suspect the arrangement becomes and the more likely we will need to examine it carefully. 54 In contrast to per use leases by which physicians rent equipment to ASCs, it is not uncommon for physicians to lease operating room time from ASCs. This is common for surgeons such as plastic surgeons who bill for services on a global fee basis but require operating room assistance and backup. Here, there are a few basic ground rules that should be followed. First, the lease payments should not vary based on the amount of procedures the physician does at the ASC that are not billed under such global fee. Second, the physician should agree to indemnify the ASC for malpractice claims and all other billing- and collections-related claims that arise from such procedures. Third, the physician should agree that he or she remains completely subject to the governance and authority of the ASC. Fourth, the physician should represent that he or she will not bill Medicare or 54 56 Fed. Reg. 35,952, 35,973 (July 29, 1991). 26

Medicaid for any technical fees or provide any kickbacks to others for case referrals. Anesthesiology Referrals. An anesthesiologist practicing at an ASC is dependent upon his or her position at the ASC to obtain business from the specialists performing the procedures at the ASC. Because of this dependence upon the ASC for business, financial arrangements between an ASC and anesthesiologists are more likely to be suspect under the fraud and abuse law than those between an ASC and physicians who have a variety of external referral sources. A financial arrangement between an ASC-based anesthesiologist and an ASC violates the fraud and abuse law if, through the arrangement, the ASC receives remuneration from the anesthesiologist in exchange for the business the ASC generates for the anesthesiologist. 55 Suspect arrangements between an anesthesiologist and an ASC include those in which the anesthesiologist is required to provide payments or other remuneration to the ASC in excess of the fair market value of the services actually provided by the ASC. 56 For example, an ASC might charge the anesthesiologist more than fair market value to lease the equipment and supplies needed to administer anesthesia. Similarly, an arrangement whereby an anesthesiologist is required to pay the ASC a portion of his or her profits for capital improvements or capital expenditures might be suspect under the fraud and abuse law. 57 OIG has discussed suspect arrangements between facilities and facility-based physicians in the context of hospitals. In expressing its concern over such arrangements, OIG stated: These potentially illegal financial arrangements may have several unfortunate results. Hospitals may award the exclusive contract based on improper financial considerations instead of on traditional considerations centering on the professional qualifications of the physician. In addition, the remuneration gives hospitals a financial incentive to develop policies and practices which encourage greater utilization of the services of hospital-based physicians payable under Medicare Part 8. Hospital-based physicians faced with lowered incomes may also be encouraged to do more procedures in order to offset the payments to the hospitals. These problems are among the recognized purposes of having the anti-kickback statute on the books in the first place... 55 OIG Advisory Opinion No. 98-12 (Sept. 16, 1998). 56 Id. 57 Id. 27

...[ T]o avoid potential legal liability, all contracts between hospitals and hospital-based physicians should comply with all the safe harbor provisions that may apply under the con- tract between the two parties. 58 Preoperative Laboratory Referrals. Another area of potential fraud and abuse concern arises in the context of an arrangement between a hospital (or physician) and an ASC through which the ASC sends patients for tests to be performed in the hospital's laboratory prior to the performance of the surgical procedure at the ASC. HCFA has suggested that ASCs may, in fact, make arrangements with an independent laboratory or other laboratory, such as a hospital laboratory, to perform diagnostic tests prior to surgery. 59 However, an arrangement between an ASC and a hospital through which the ASC agrees to send patients to the hospital's laboratory could be perceived as the ASC's offering the hospital an inducement to refer cases to the ASC. ASCs should ensure that the preoperative testing is actually medically necessary and not a condition to receiving the referral for the surgical case from the physician or hospital. II. THE STARK ACT HCFA has articulated its view of physician ownership of ASCs under the Stark Act in numerous contexts. Generally, HCFA does not view ownership in a freestanding nonhospital-based ASC as a prohibited relationship under the Stark Act as long as the ASC does not itself provide specifically billable Stark services. HCFA states: ASC facility services are services that are furnished by an ASC in connection with a covered surgical procedure and that would otherwise be covered if furnished on an inpatient or outpatient basis in a hospital in connection with that procedure. Medicare regulations at 5416.61 describe the scope of facility services. Generally, clinical laboratory services are not considered to be facility services. That is because under 5416.61 (b), ASC facility services do not include items and services for which payment may be made under other provisions in 42 CFR part 405, such as physicians' services, laboratory services, and x-ray or diagnostic procedures (other than those directly related to performance of the surgical procedure). As a result, there are a limited number of diagnostic laboratory tests that are considered ASC facility ser- vices and which are included in the ASC rate. We agree with the commentary that referrals for laboratory tests that are performed in an ASC and included in the ASC rate should be excepted because there is not incentive to overutilize these services. On the other hand, some ASCs have onsite laboratories that per- form and bill for other laboratory testing furnished to ASC patients. Before enactment of CLIA, these laboratories were certified as "independent laboratories" and billed Medicare directly for their services. These laboratory facilities are now required 58 OIG Management Advisory Report Concerning Financial Arrangements Between Hospitals and Hospital-Based Physicians (Sept. 1989). 59 HCFA MEDICARE CARRIERS MANUAL - CLAIMS PROCESS (Pub. No. 14-3). 28

to be certified under CLIA and continue to bill the Medicare program for the laboratory testing performed on the ASC premises, since general laboratory testing is not considered to be part of the ASC facility rate. We believe that, if the onsite laboratory facility is owed or operated by the ASC, referrals to the laboratory for general laboratory testing by a physician who has a financial relationship with the ASC should be prohibited, unless another statutory exception applies. 60 HCFA, in proposed regulations, has also articulated its position as follows: Services furnished under certain payment rates. (1) Services furnished in an ambulatory surgical center (ASC) or ERSD facility or by a hospice if payment for those services is included in the ASC payment rate, the ERSD composite payment rate, or as part of the hospice payment rate, respectively. 61 We would also like to point out that intraocular lenses that are implanted in an ambulatory surgical center (ASC) would be covered under the ASC payment rate. We have excluded any services covered under the ASC rate from the referral prohibition under an exception we created in 411.355(d). 62 The exception does not extend to hospital-based centers that are deemed to provide outpatient hospital services. III. COMPLIANCE EFFORTS ASCs should adopt a basic compliance plan to inform their employees and members of legal concerns. In the ASC context, this is an important effort but need not be a monumental or expensive effort. A form of a compliance plan together with a form client letter is included here as an example. (See Exhibit A.) 60 60 Fed. Reg. 41,914, 41,970 (Aug. 14, 1995). 61 63 Fed. Reg. 1659,1724 (Jan. 9,1998) (to be codified at 42 C.F.R. 411.355 (d)). 62 29

3. TAX EXEMPTION AND TAX-RELATED ISSUES Tax exemption issues affect ASCs in numerous ways. For example, issues relating to the tax-exempt status of an entity and the tax character of income attributable to an entity are raised when: A tax-exempt entity enters into an ASC joint venture. A tax-exempt entity engages a manager for its outpatient operations. An ASC joint venture involving a tax-exempt partner enters into a management agreement. The tax-exempt entity provides management or other services to an ASC joint venture or to other entities. An ASC joint venture or third party leases space from a medical office building funded in part with tax-exempt financing. An issue related to each of these concerns is whether the use of a for-profit subsidiary eliminates these concerns. Other tax and tax exemption issues also arise in the ASC context. These include such issues as: Will the relationship or transaction be deemed to provide an excess benefit per Internal Revenue Service Code Section 4958? 1 Will the ASC use the cash or accrual method for its tax accounting? What flexibility will the ASC have in its choice of tax year? Will the ASC be considered an affiliated service group of its members for ERISA purposes? The critical concerns that drive many of these issues include: Will the relationship or transaction harm the tax-exempt status of the tax exempt entity? Will the income from the entity be deemed unrelated business income and thus be subject to tax? 1 I.R.C. 4958 (West 1998). 30

Will the relationship or structure cause a default of bond covenants or lead bond interest to be taxable? This chapter reviews each of these issues and questions in the context of ASC business relationships. It is divided into three principal parts. Specifically, it includes (1) a review of joint venture issues and concerns; (2) a discussion of management and lease relationships; and (3) a review of miscellaneous tax exemption and taxrelated issues. The first portion of the following sections discusses and outlines Internal Revenue Code sections and related regulations. The sections and regulations typically provide an overview and analytical starting point. The remaining portions of each section discuss ASC issues in the context of case law and Internal Revenue Service (IRS) guidance and interpretations related specifically to ASCs and related topics. I. JOINT VENTURES A. Internal Revenue Code Sections and Regulations-Background Section 501(a) of the Internal Revenue Code ("IRC" or the "Code") provides for tax exemption for organizations operated per Section 501(c)(3) exclusively in furtherance of charitable purposes. Under Revenue-Ruling 69 545, 2 the promotion of health (i.e., the direct operation of healthcare providers by providers that meet certain conditions) has long been considered a charitable purpose. 3 In contrast and of note to healthcare organizations, providing management services is generally not considered a charitable activity. 4 Income Tax Regulations issued under Section 501(c)(3) further define the contours of tax exemption and tax-exempt activity. Section 1.50l (c)(3)-1 (c)(l) of the Income Tax Regulations provides that an organization will be regarded as operated exclusively for exempt purposes only if it engages primarily in activities that accomplish one or more of the purposes specified in section 501(c)(3) of the Code. In contrast, an organization will not be regarded as charitable if more than a nonsubstantial part of its activities is in furtherance of nonexempt purposes. For example, the Supreme Court in Better Business Bureau of Washington, DL., Inc. v. United States, 5 held that a single, nonexempt purpose if substantial in nature destroys a claim for exemption. 6 The Regulations, at Section 1.501(c)(3)-l(d)(l)(ii), further narrow the scope of Section 501(c)(3). Here, the regulations provide that an organization is not organized exclusively for exempt purposes unless it serves public rather than private interests. Specifically, 2 Rev. Rul. 69 545,1969 2 C.B. 177. 3 Id. 4 Id. 5 Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945). 6 Id. at 283. 31

benefits may be received by private individuals provided those benefits are incidental quantitatively and qualitatively to exempt purposes being served. These sections serve to frame issues such as will an ASC venture or management relationship further charitable purposes or will it serve private interests? If the venture or relationship serves private interests, will the activity either be so substantial as to destroy the exemption of the participating entity or will the activity benefit insiders and be deemed to cause private inurement? Section 1.501(c)(3)-l(e) of the Regulations permits an organization to engage in noncharitable trades and businesses. It states that an organization may qualify under Section 501(c)(3) even if it operates a trade or business as a substantial part of its activities, if the operation of such trade or business is in furtherance of the organization's exempt purposes and if the organization is not organized or operated for the primary purpose of carrying on an unrelated trade or business. Section 511 of the Code provides for taxes to be paid on the unrelated business income of tax-exempt organizations. Unrelated business taxable income is defined as the gross income derived from any unrelated trade or business within the meaning of Section 153. Section 513(a) of the Code defines the term unrelated trade or business as any trade or business the conduct of which is not substantially related to the performance of the purposes constituting the basis for its exemption under section 501 [eg., charitable health activities under Section 501(c)(3)]. Section 1.513 l(b) of the Income Tax Regulations provides that the term trade or business includes any activity carried on for the production of income from the performance of services. Section 513(a)(2) of the Code excepts from the definition of unrelated trade or business a trade or business that, in the case of an organization described in Section 501(c)(3), is carried on primarily for the convenience of its patients. Section 1.513-l(d)(l) of the regulations further provides that gross income derives from unrelated trade or business, within the meaning of section 513(a), if the conduct of the trade or business which produces the income is not substantially related (other than through the production of funds) to the purposes for which exemption is granted. Section 1.513-1 (d) (2) then provides that to be "substantially related," the activity must have a causal relationship to the achievement of exempt purposes and it must contribute importantly to the accomplishment of those purposes. Determinations per the unrelated business and trade regulations must be made as to whether a joint venture furthers exempt purposes or private purposes. If the relationship is deemed to further private purposes, income will be subject to Unrelated Business Income Tax ("UBIT"). 32

Section 514 of the Code provides for the taxation (under Section 512 of the Code) of income from debt financed property. Section 514(b)(l)(A)(i) of the Code, however, provides that the definition of debt financed property does not include any property substantially all the use of which is substantially related to the exercise or performance by such organization of the charitable purposes constituting the basis for its exemption under Section 501. From these Code sections and regulations, a number of observations can be made: Involvement in a venture in which the private benefits are not incidental to the public benefit can harm a participant entity's tax-exempt status. Involvement in a venture or relationship in which the net earnings of the taxexempt entity "inure" to "insiders" can harm the tax-exempt status of an entity. Involvement in a venture that does not contribute to tax-exempt purposes but is not substantial in comparison to the tax-exempt entity's operations and which does not provide for improper or private benefit may not cause harm to the tax-exempt entity but will give rise to taxable income. Income from management services and lease revenues, if not substantial as compared to the entire issuance or operation and not creating substantial private benefit or private inurement, can lead to tax not cause a loss of tax-exempt status. In practice, the goal in representing a tax-exempt entity is to structure a joint venture or other activity such that it does not give rise to taxable income or harm tax-exempt status. However, if the activity is not structured to avoid taxable income, then the second goal is that the activity is not viewed as substantial in scope to the tax- exempt entity's operations as a whole, and that the activity or venture will not cause harm to the tax-exempt status of the organization. For example, if involvement in an ASC joint venture encompasses 60% of an entity's activities and that activity is not deemed to serve community purposes, taxexemption would likely be lost at the hospital entity level. To avoid the loss of tax-exempt status and the generation of UBIT, entities attempt to assure that the ventures cooperate with IRS guidance relative to joint ventures. In situations where the venture may not meet the UBIT guidelines and where revenue may be deemed "substantial to the tax-exempt entity," the tax-exempt entity may prefer to participate or hold its interest through a for-profit subsidiary. For-profit subsidiary issues are discussed below. B. IRS Guidance The IRS, through the widely read General Counsel Memorandum ( GCM ) 39,862, 7 several private letter rulings, certain CPE promulgations, and a tax commissioner ruling 7 Gen. Couns. Mem. 39,862 (Dec. 2, 1991). 33

related to Redlands Surgical Services and Revenue Ruling 98-15 8, has provided extensive guidance relative to joint ventures. From this guidance, many helpful principles can be gleaned. The IRS, however, has not yet ruled on certain situations which attempt to provide a negotiated middle balance between the IRS s rejected and accepted factual situations. The table on the following page outlines in basic terms IRS preferred situations, IRS rejected situations and situations in which the IRS has not provided clear guidance. The table provides an overview of factors raised and discussed in IRS joint venture guidance. Most factors are not in and of themselves individually dispositive. For example, a venture may include minority ownership for the tax-exempt entity but enough control may be provided to the tax-exempt entity to survive IRS scrutiny. Moreover, a venture may not create a new service or provider but may serve sufficient community needs and purposes so as to not produce UBIT or cause tax-exempt concerns. IRS Preference IRS Rejected Unclear Majority ownership Minority ownership with Minority ownership with little control reserve rights to tax-exempt Charitable purposes trump profits language Clear and full reserve rights to tax-exempt entity Sharing of all debt and liability in proportion to ownership Clear cataloging of benefits Tax-exempt serves as general partner but minimal debt recourse and liability and full control Mutual agreement on key executives and manager significant control over manager New service and provider clear need demonstrated by Certificate of Need or clear need study No reference State law reserve rights Disproportionate liability for tax-exempt entity Joint venture without clarity as to community benefits other than profit retention General partner but no control Partner serves as long term manager. But see PLR94 07 022 Joint venture through revenue stream or joint venture of existing business entity benefits entity Qualified but not categorical; reference to charitable purpose Qualified reserve rights Payment to tax-exempt entity for debt guarantee Tax-exempt entity lends money to venture Money gained from sale of venture interests used for specified health care purposes General partner with control and some added liability Mutual agreement on long term manager Joint venture existing entity certain benefits articulated 8 Rev. Rul. 98-15, 1998 12 I.R.B. 6. 34

Open medical staff All Medical and indigent patients to be served 1. Private Letter Rulings Closed staff No language; minimal record of treatment Qualified requirements to treat comparable to hospital This section discusses three ambulatory joint venture ("PLRs"). These include PLR 97 09 014, 9 PLR 94 07 0221 10 and PLR 96 45 018. 11 Two of these PLRs involve ASCs and one involves an end stage renal dialysis facility. These provide a helpful understanding of fact patterns the IRS finds acceptable. (a) PLR 97 09 014. Here, the IRS permits the 40% general partnership interest held by a for-profit subsidiary of a tax-exempt entity to be transferred from the for-profit subsidiary to the tax-exempt entity. The ruling, by allowing the transfer to the tax-exempt entity, indicates approval of the operation and structure of the joint venture. 12 Key Factors Sixty percent. The tax-exempt entity's for-profit subsidiary holds another 20%. Thus, the tax-exempt entity indirectly holds or controls 60% of the venture. 13 Certificate of Need. The ASC received a CON from the State Department of Health to establish and operate the freestanding ambulatory surgical center. The ASC has its own provider number. The CON helps show community need. 14 Conditions to Issuance. The Certificate of Need is subject to certain conditions including; (1) access to ambulatory surgery services by the medically indigent cannot be diminished by relocation of this hospital service to the freestanding ambulatory surgical center; (2) care must be provided at the freestanding ambulatory surgical center on a free or partial pay basis to Medicaid eligible or medically indigent persons; (3) indigent patients shall not be charge additional fees; (4) charges to hospital inpatients shall not increase as a result of relocation of this hospital service to the freestanding ambulatory surgical center; (5) surpluses generated must be dedicated to support directly the freestanding ambulatory surgical center or the tax-exempt entity. 15 9 Priv. Ltr. Rul. 97 09 014 (Feb. 28,1997). 10 Priv. Ltr. Rul. 94 07 022 (Feb. 18,1994). 11 Priv. Ltr. Rul. 96 45 018 (Nov. 8, 1996). 12 Priv. Ltr. Rul. 97 09 014 (Feb. 28,1997). 13 Id. 14 Id. 15 Id. 35

Medicaid and Indigent Ratios. The patient mix at the freestanding ASC consists of Medicaid patients (1.5%), Medicare patients (22%) and private pay patients (76.5%). Patients are not discriminated against according to their ability to pay. Charity care patients are accepted. 16 Open Staff. Access is not limited to physician investors of the partnership. Any physician can use the facility as long as the physician meets the ASC's credentialing standards and approval process. 17 Tax-exempt Control. Under the partnership agreement, management rests exclusively with the tax-exempt entity. Thus, the tax-exempt entity can ensure that the ASC is operated in a manner consistent with taxexempt purpose. 18 Proportionate Profits and Losses. Profits and losses will be allocated among all partners in proportion to their respective capital account balances. 19 Non Recourse Debts. The tax-exempt entity, by serving as the general partner, will not put its assets at risk in that the majority of the liabilities are in the form of a non recourse mortgage collateralized by the ambulatory facility. 20 Based on these factors, the IRS reasoned: Participation by a Section 501 (c)(3) organization in a partnership arrangement with for-profit partners does not per se endanger the organization's tax-exempt status. However, it is necessary to assure that the obligations of the tax-exempt organization as a partner do not conflict with its ability to pursue its charitable goals. Thus, in all partnership cases, the initial focus should be on whether the tax-exempt organization is serving a charitable purpose. Once charitability has been established, the partnership arrangement itself should be examined to see whether it permits the exempt organization to act exclusively in furtherance of the purposes for which exemption may be granted and not for the benefit of the forprofit partners. [T]he information submitted indicates that your proposed control over the management of the limited partnership, along with the requirements of the Certificate of Need, will promote the health of the citizens in your area by ensuring that the existing freestanding ambulatory surgical center will be operated 16 Id. 17 Id. 18 Id. 19 Id. 20 Id. 36

in a manner consistent with your tax-exempt purpose. Further, the health care resources of the community will be enhanced by your ability to operate this facility and the ambulatory surgery center in your hospital in the most efficient and cost effective manner.... [T]he information submitted further indicates that your proposed participation in the limited partnership would permit you to act exclusively in furtherance of your exempt purposes and not for the benefit of your for-profit partners. In that regard, the partnership agreement will provide that management and control of the partnership rests exclusively with you as sole general partner, and that profits and losses of the partnership will be allocated among all partners in proportion to their respective capital account balances. Further, the CON provides that any surpluses generated from the operation of the freestanding ambulatory surgical center and payable to C must be dedicated to support directly the freestanding ambulatory surgical center or B. Finally, since the majority of D's liabilities are in the form of a nonrecourse mortgage collateralized by the freestanding ambulatory surgical center, as sole general partner, you will not be putting your assets at risk with regard to the debts of D. All of the above factors ensure that the partnership will not be used exclusively for the benefit of your for-profit partners. 21 (b) PLR 94 07 022. The IRS, in PLR 94 07 022, 22 approved the addition to an existing hospital owned ASC of physician partners. Of import, physician ownership was contemplated from the initial development of the ASC. 23 Kev Factors Need for ASC. Because the city and surrounding area badly needed the surgery center, the hospital and physicians agreed that the tax- exempt entity (W) would construct the surgery center ASC without the initial ownership participation of the physicians. A CON for a free standing multi-specialty ambulatory surgical facility with four operating rooms was issued. 24 Option to Purchase: 50/50 Partnership. The physicians (through entity X) were given an option to purchase one half of the surgery center for a two year period beginning on the date the ASC opens. The agreement also provided that the hospital and the physicians would be equal partners. 25 21 Id. 22 Priv. Ltr. Rul. 94 07 022 (Feb. 18,1994). 23 Id. 24 Id. 25 Id. 37

Affiliated Services Group Concern. After receipt of a favorable ruling on affiliated service group issues under Section 414(m) of the Code, X elected to exercise its option to purchase one half of the surgery center. 26 Purchase Amount Allocated to Clear Need; Cardiac Need Fully Detailed. The proceeds from the sale of one half of the surgery center to X would yield approximately $2.7 million to W. W intends to use proceeds to directly expand cardiac surgery and related services to meet current service needs. Demand for these services has proven to be great. W has been unable to expand the cardiology services to meet existing needs. 27 The PLR further articulated that the above cardiac expenditures will only meet W's current cardiac service needs. It is anticipated that in order to meet community needs in two to three years, it will be necessary to build a four story addition to W to house a cardiovascular surgical unit... An expenditure of this magnitude would come at the expense of providing other health care ser- vices unless a funding source becomes available. 28 Purchase Price Formula. The actual purchase price of the surgery center was calculated using an actual cost based formula that is designed to approximate the fair market value of the facility. In general, the formula price is equal to one half of the cost to W to build the surgery center plus a 10% interest cost that accrues from the date W incurred the specific cost until the closing date. 29 Management. Management would be vested in part with the physicians. 30 Based on these factors, the IRS held: The joint venture to be formed under the option agreement will allow W to raise additional capital which will be used by W to expand its healthcare resources. The option agreement had contractually obligated W to restore X to the position it would have been in prior to the conflict caused by the affiliated service group issue. The option agreement was entered into because you believe that operating the ambulatory outpatient surgery facility through a partnership allowed you to obtain the capital and expertise of the participating partners of X. You believe that by allowing management control of the surgery center by X, the 26 Id. 27 Id. 28 Id. 29 Id. 30 Id. 38

surgery center will be more efficiently operated since X will have an ownership interest in the surgery center. Due to this fact you expect a more highly motivated and innovative staff resulting in improvement of treatment at the surgery center and a more efficiently managed facility resulting in a reduction in costs to patients.-thus, W's participation in the proposed transactions based on its obligation under the option agreement allowed it to expand the provision of healthcare services to the community and therefore furthers its charitable purpose. In addition, you have stated that the proposed transactions will not cause W to violate any federal or state laws.... [I]n this case, W's participation in the joint venture arrangement honors its contractual obligation under the option agreement which was entered into to obtain the capital and expertise of the participating partners of X. This allowed you to expand your provision of healthcare services to the community and furthers your exempt charitable purposes to advance the health of the community. The sale of one half of the surgery center will also contribute to increased availability of medical services because the proceeds of the sale will be devoted to expanding W's capacity to provide cardiac care. 31 (c) PLR 96 45 018. This PLR examined the joint venture of a dialysis facility. 32 Key Factors Independence of the Physicians. Three nephrologists (the "Physicians"), who owned 100% of an LLC, will own in the aggregate 37.5% of the LLC if the requesting entity and Healthcare System exercise options to acquire partial ownership of the LLC.-The Physicians are not officers or board members of either exempt entity. 33 Hospital Facility Is Out of Date. [T]he Hospital Dialysis Facility is antiquated and unable to satisfy the need for such services in your area. 34 Governing Board Determined Need Independent of Nephrologists. The hospital's governing board began investigating the need for a new outpatient dialysis facility several years ago. 35 31 Id. 32 Priv. Ltr. Rul. 96 45 018 (Nov. 8, 1996). 33 Id. 34 Id. 35 Id. 39

Flexibility to Pursue Hospital's Perceived Needs. The hospital began to negotiate with the Physicians to acquire a part ownership in the LLC with the flexibility to also construct a new dialysis facility on its own campus, if space is available. 36 Clear Community Need. To meet community needs, the Hospital plans to create its own facility. It also will invest in the LLC joint venture. Once both dialysis facilities are completed, the total outpatient dialysis stations in the area will be increased from twenty to twenty four. The hospital projects that there will be a community need for twenty four to thirty such stations in the future. 37 Arm's Length; Physicians Moving Forward; Hospital Services Are Not Gifts of Goods or Services. The Physicians will continue with plans regardless of whether the Healthcare System becomes an owner. "The Physicians contributed $25,000 each as their initial capital contribution. 38 The LLC borrowed monies needed to construct the lessee improvements from a commercial lender (the Bank ). In addition, LLC made arrangements with the Bank for a line of credit and a loan to finance the equipment needed in the LLC Dialysis Center: all of the loans were negotiated at arm's length between independent parties. Each of the Physicians has personally guaranteed the loans up to a set amount. 39 The exercise price for hospital purchase is set forth in the Agreement. The price is the same rate and terms as was acquired by the Physicians, less all distributions and payments (exclusive of any salaries or fees, unless such amounts of salaries and fees are in excess of $180,000 per year) made to the Physicians and their affiliates, plus interest. 40 Upon purchasing a membership interest in the LLC, all parties will assume a pro rata share of any guarantees to the Bank. If additional loans are needed by the LLC to fund its activities, the parties will share proportionately in the debt. Any additional capital contributions to LLC by all owners will be in proportion to their ownership interests. Any allocation of profit and losses or distributions of cash flow will also be in proportion to ownership interest. 41 Patient Choice; Projections. Patients may elect to receive treatment at either facility. Projections anticipate that approximately 50% of the existing hemodialysis patients will elect to be treated at the LLC Dialysis Center during the first year since it will be a state of the art facility and 36 Id. 37 Id. 38 Id. 39 Id. 40 Id. 41 Id. 40

will be located adjacent to the offices of the Physicians with easy access to parking. 42 Noncompetition. The Agreement provides that during its terms and for a period of two years thereafter, the parties to the Agreement agree not to: (1) engage in the ownership, operation, management or control of any outpatient dialysis center or related facility within a radius of 40 miles of the LLC Dialysis Center or any other dialysis facility owned by LLC, (2) influence or attempt to influence LLC Dialysis Center patients to transfer their patron- age from LLC to any other business which is competitive with LLC and, (3) hire or attempt to hire or solicit LLC employees or other party's employees who provide dialysis or other related services to LLC. 43 Tax-Exempt Reserve Powers. The Operating Agreement authorizes the tax-exempt entity to approve: (1) any proposed amendment to LLC's Articles of Organization and the Operating Agreement of LLC, (2) the dissolution or merger of LLC, (3) the sale of all or a substantial portion of the assets of LLC and, (4) whether a member of the Board of Managers and LLC may engage in a transaction involving an actual or potential conflict of interest. 44 Certain Powers Prior to Tax-Exempt Ownership. During the first two years of operations, the Operating Agreement requires that LLC must obtain the consent of at least one of the members of the Board of Managers elected by the tax-exempt entity prior to (1) borrowing money or incurring other debts or obligations in excess of $100,000 in the aggregate in any 12 month period; (2) making any capital expenditure in excess of $100,000 in the first 12 month period; (3) in- creasing the number of dialysis stations at the LLC Dialysis Center; and, (4) authorizing the sale of additional membership interest in LLC. 45 Thereafter, the tax-exempt entity or entities will control the Board. 46 No Physician Management Company. Management and employees serve at the pleasure of the LLC Board of Managers. There will be no 42 Id. 43 Id. 44 Id. 45 Id. 46 Id. 41

management company controlled by the Physicians involved in the management of the LLC Dialysis Center. 47 Open Staff; Indigents. [A]ll nephrologists in the LLC Dialysis Center's service area will be allowed to admit patients and provide services at the LLC Dialysis Center. [The LLC Dialysis Center] will provide services to Medicare and Medicaid beneficiaries on a nondiscrirninatory basis. 48 Based on these factors, the IRS reasoned: 2. General Counsel Memorandum 39,862 The control you and Healthcare Systems will exercise by electing the majority of the members of the Board of Managers of LLC will ensure that exempt organizations retain control of the LLC Dialysis Center's operations and will ensure that medical services will be available to anyone in the community who needs them, regardless of ability to pay. Thus, your ownership interest in LLC will enable you to promote health in a charitable manner. Since your involvement in the pro- posed joint venture will further your charitable purpose, your involvement is related to your exempt purposes, under section 513(a) of the Code. 49 This GCM 50 outlined very clearly the IRS's concerns with ASC physician hospital joint ventures. It is probably one of the most significant issuances by the IRS in the healthcare context. It shows an unusual business and industry understanding that is not often articulated by regulatory authorities. It is notable for many reasons. For example, it reversed formerly common practices, including practices approved in PLRs, and it showed an unusual understanding of the underlying purposes of certain ventures. Key Factors Hospital Reliance on Physicians. [A] hospital's medical staff physicians hold the key to maintaining or improving its utilization, revenue, and expense profile (i.e., the bottom line ). Of course, patients actually bring revenues to a facility, but they rarely decide for themselves when or where to be hospitalized or what tests to order. Recent studies suggest that individual practitioners control from 70 to 90 per- cent of health care expenditures. Since most medical staff physicians are not hospital employees, and typically do not provide services to or receive direct 47 Id. 48 Id. 49 Id. 50 Gen. Couns. Mem. 39,862 (Dec. 2, 1991). 42

compensation from the hospitals at which they practice, managers have had to look for innovative ways to influence their behavior. 51 Multiple Reasons for ASC JVs. [T]here often are multiple reasons why hospitals are willing to engage in joint ventures and other sophisticated financial arrangements with physicians. In seeking Service approvals for transactions, hospitals frequently cite the need to raise capital and to give physicians a stake in the success of a new enterprise or service. Other reasons may be less readily apparent, but typically are no less important. In addition to the hope for or expectation of additional admissions and referrals, hospitals may act out of fear that a physician will send patients elsewhere, or, worse, establish a new competing provider. These hopes and fears are a reaction to the competition many hospitals now face from other hospitals, both for-profit and not, and increasingly, from free standing health providers owned or controlled by physicians. 52 Careful Scrutiny of Non-Traditional Transactions. Whenever a charitable organization engages in unusual financial transactions with private parties... the sale of revenue stream transactions described above must be carefully scrutinized. We believe the [transaction in GCM 39,862 and the relevant private letter rulings] cannot withstand such scrutiny and should not be the subject of favorable rulings. 53 Jeopardize Tax-Exempt Status. [T]hese transactions must be viewed as jeopardizing a hospital's taxexempt status for three reasons: they allow inurement of part of a charitable organization's net earnings to the benefit of private individuals; they confer more than incidental benefits on private interests; and they may well violate federal law. 54 Financing Needs Viewed Skeptically. One hospital based benefits on the concept that it would have the benefit of receiving the discounted cash value of its expected revenue stream in advance and that it would experience greater utilization of ancillary and inpatient services. The IRS countered that it made no allegation that obtaining the advanced funds was necessary to fund the joint venture or enable the hospital to carry out its 51 Id. 52 Id. 53 Id. 54 Id. 43

exempt purposes, nor did it explore other sources of financing. 55 In fact, the entities contributed funds to its subsidiary to purchase the joint venture interest and establish a loss reserve. 56 Profit Based Debt Receipt Improper. Here the IRS states: We do not believe it would be proper under most circumstances for a charitable organization to borrow funds under an agreement, even with an outside commercial lender, where the organization would pay as interest a stated percentage of its earnings. While doing so might not constitute inurement if an outside lender were involved... it would if the lender were, as here, an insider. In any event, we do not believe these transactions were undertaken to raise needed cash. 57 IRS Articulated that Real Purpose Is Business Generation. Here the IRS states: We believe the hospitals engaged in these ventures largely as a means to retain and reward members of their medical staffs; to attract their admissions and referrals; and to pre-empt the physicians from investing in or creating a competing provider... Giving (or selling) medical staff physicians a proprietary interest in the net profits of a hospital under these circumstances creates a result that is indistinguishable from paying dividends on stock. Profit distributions to persons having a personal and private interest in the activities of the organization are made out of the net earnings of the organization. Thus, the arrangements confer a benefit which violates the inurement proscription of section 501 (c)(3). 58 Serving as a General Partner. The IRS indicated in the GCM that participation as a general partner is not per se inconsistent with exemption. 59 However, the Act must be scrutinized for private inurement or more than incidental private benefit: GCM 39005, EE 58 82 (Dec. 17, 1982), sets forth the required analysis in testing an exempt organization's participation as a general partner in a limited partnership. This Office stated that participation by a section 501(c)(3) organization as a general partner in a limited partnership would not per se endanger its exempt status. 60 55 Id. 56 Id. 57 Id. 58 Id. 59 Id. 60 Id. 44

Approved Joint Ventures. The IRS points out that approved joint ventures offer (1) a new healthcare provider or resource being made available to the community, and (2) the joint venture entity itself actually becoming the property owner or service provider, subject to all the attendant risks, responsibilities and potential rewards. 61 Limited Risk; Shell Ventures. Revenue streams can be viewed as a shell type of arrangement when the hospital continues to own and operate the facilities in question and the joint venture invests only in a profits interest. 62 These arrangements enable a hospital to share its net profits. A hospital's participation in this type of partnership does not clearly further any exempt purpose. 63 Business Goals Are Not Charitable Goals. Paying doctors to steer patients to improve efficiency was viewed by the IRS as distant from a mission of providing needed care. 64 We question whether the Service should ever recognize enhancing a hospital's market share vis a vis other providers, in and of itself, as furthering a charitable purpose. 65 Board Covenants. Where facilities have been financed with outstanding tax-exempt bonds, devotion of the income the facilities generate to further private purposes may be incompatible with bond covenants and may constitute a prohibited private use. 66 Limits on Use of For-Profit Affiliates. The IRS also noted that where the hospitals themselves sold the revenue streams or originated the ventures, their exemption is directly placed at issue. 67 Substantial Notice of Activities. GCM 34,631 states that more must be considered than the ratio an activity bears to the activities that further exempt purposes. The relative amount required to be considered substantial will vary according to the character and non exempt quality of the activity. 68 Arrangements at issue are more likely to be deemed "substantial" if: (1) authorized by the directors and most senior managers of the hospitals involved with knowledge of the risk that they might violate the anti-kickback law, (2) central to the activities through which the 61 Id. 62 Id. 63 Id. 64 Id. 65 Id. 66 Id. 67 Id. 68 Id. at n. 16. 45

3. Revenue Ruling 98-15 hospitals accomplish their exempt purposes, and (3) potentially harmful to the charitable class the hospitals were established to serve. 69 The Internal Revenue Service issued Revenue Ruling 98-15 70 which relates to whole hospital joint ventures. It also appears that the IRS will apply the principles of 98-15 to ambulatory and ancillary joint ventures. The IRS reviewed two hospitals' joint ventures. The IRS found favor with one venture and disfavor with the second venture. Key Factors: Favored Venture Commitment to Charitable Purpose. The governing documents of C commit C to providing healthcare services for the benefit of the community as a whole and to give charitable purposes priority over maximizing profits for C's owners. 71 Board Structure. Furthermore, through A's appointment of members of the community familiar with the hospital to C's board, the board's structure, which gives A's appointees voting control, and the specifically enumerated powers of the board over changes in activities, disposition of assets, and renewal of the management agreement, A can insure that the assets it owns through C and the activities it conducts through C are used primarily to further exempt purposes. Thus, A can ensure that the benefit to B and other private parties, like the management company, will be incidental to the accomplishment of charitable purposes. 72 Reasonable Management. The terms and conditions of the management contract, including the terms for renewal and termination, are reasonable. 73 Charitable Grants. Key Factors: Disfavored Venture A's grants are intended to support education and research and give resources to help provide healthcare to the indigent. 74 69 Id. 70 Rev. Rul. 98-15, 1998 12 I.R.B. 6. 71 Id. at 2. 72 Id. at 19. 73 Id. 74 Id. at 20. 46

Healthcare Itself Is Not Enough. More is required than the diagnosis and cure of disease. 75 Agreements Do Not Require Charitable Care. In the absence of a binding obligation in F's governing documents for F to serve charitable purposes or other- wise provide its services to the community as a whole, F will be able to deny care to segments of the community, such as the indigent. 76 Shared Control Without Charitable Community. Because D will share control with E, D will not be able to initiate programs within F to serve new health needs within the community without the agreement of at least one governing board member appointed by E. 77 No Priority to Charity. As a business enterprise, E will not necessarily give priority to the health needs of the community over the consequences for F's profits. 78 Management Company Discretion and Control. The management company itself will have broad discretion over F's activities and assets that may not always be under the board's supervision. For example, the management company is permitted to enter into all but "unusually large" contracts without board approval. The management company may also unilaterally renew the management agreement. 79 Critical Concepts Revenue Ruling 98-15 leads to a number of critical concepts. These concepts include: Control. The hospital must retain significant reserve powers and authority over the venture to assure that the income and assets of the joint venture serve community benefits. Charitable Commitment. The venture must purport and have means to serve community purposes, such as by serving indigent patients and 75 Id. at 20, 21. 76 Id. at 21. 77 Id. 78 Id. 79 Id. at 21, 22. 47

Medicare and Medicaid patients, and involving itself in other functions helpful to the community as a whole. The entity documents must provide significant assurances to the tax-exempt entity that it will be positioned to assure that the venture serves community health needs. Risks Are Proportionate. The tax-exempt entity cannot disproportionately accept risks for the venture. 4. Redlands Surgical Services. Through Redlands Surgical Services, 80 the Tax Commissioner determined that an ASC venture jeopardized the tax-exempt status of the participating institution. Key Factors Little Control. The tax-exempt entity had little or no control over the venture. No Community Benefit. The venture did not serve or purport to serve community benefits (i.e., it did not develop new facilities, nor did it have any obligation to serve community needs). Disproportionate Liability. The IRS also looked negatively upon the venture in that the tax-exempt entity served as the general partner and thus had a disproportionate amount of exposure to liability than other parties. Substantial in Nature. Finally, the IRS noted that the venture did not have other methods by which to serve community benefits other than through investment in the venture. In short, the venture was the sole activity of the entity attempting to maintain tax-exempt status. There, the IRS determined that the tax-exempt subsidiary should be denied taxexempt status. 5. Announcement 92 83 Exempt Organizations and Exemption Guidelines The IRS, in its advice manual to its auditors, provided comments in 1992 that are applicable to joint ventures. 81 Because most of the guidance is articulated in the previous rulings, this section solely recites a number of items not clearly articulated above. Here, advice to be gleaned includes: Indigents; Medicaid. Determine if the hospital admits and treats Medicare and Medicaid patients in a nondiscriminatory manner. 82 80 Redlands Surgical Services v. Commissioner of The Internal Revenue Service, 11025 97 (T.C. 1997). 81 Announcement 92 83,1992 22 I.R.B. 59. 82 Id. at 5 333.1(6)(b). 48

Compare Population Served with Community and Hospital. Compare the proportion of services provided to Medicaid patients to the proportion of Medicaid beneficiaries living in the hospital's service area. The organization may be able to provide the statistics on beneficiaries. Or, if it is suspected that Medicaid patients are not being served in a nondiscriminatory manner, contact the State Medicaid agency personally to secure the statistics. 83 Leases. Physicians (or ASCs) being charged no rent or below market rent for space in hospital owned office buildings, or ASCs, or physicians being charged less than fair market value for practice management services. 84 Support Staff. The hospital may provide support staff for use in providing services. Time and use of support staff must be apportioned between hospital activities and private practice activities, also and there must be a reasonable charge for use attributable to private practice activities. 85 Other Inurement Concerns. Examples of private inurement issues are: (1) participation imposes obligations on the tax-exempt organization that conflict with its exempt purposes; (2) there is a disproportionate allocation of profits and losses to the joint venture that is commercially unreasonable (inadequate security or low interest rate); (3) the tax-exempt partner provides property or services to the joint venture at less than fair market value; (4) a non exempt partner receives more than reasonable compensation for the sale of property or services to the joint venture. 86 Non-cash Contributions. Review non-cash contributions received (other than publicly traded securities). Determine what use the hospital is making of the donated assets, whether any have been disposed of by sale or otherwise (a subsequent arm's length sale might indicate donor's estimate of fair market value was substantially overstated), whether donors still have use of the property, or other factors affecting the amount or deductibility of the contribution. 87 C. Practical Guidance for Joint Ventures New Provider. A venture that creates a new provider, adds a new service or clearly improves a service should be easier to defend than the joint venture of an existing entity., particularly without particular benefits. 83 See Id. at 5 333.1(6)(f). 84 See Id. at 5 333.3(3)(a). 85 See Id. at 333.3(7)(c). 86 See Id. at 333.4(3). 87 See Id. at 333.5(10). 49

Valuations. All contributions of non-cash assets should be valued. All compensation relationships should be defensible as at fair market value. Liability and Risks. Liability and risks should generally be shared in proportion to ownership and profits. Catalog and Articulate Benefits. The parties should be able to demonstrate the community benefit served by the venture's operation and formation. This may be through use of the funds received, use of funds saved, need as articulated by CON, or studies of indigent and Medicaid patients to be served. Open Medical Staff. The venture should provide for an open medical staff. 88 Medicaid; Indigent Patients Profits. The ventures should serve Medicaid and indigent patients. Proportions should be periodically compared to population and to hospital efforts. 89 Control; Reserve Powers. Tax-exempt should have sufficient board and reserve powers to assure that venture serves the community purposes purported to be served. Ownership. While not dispositive, the tax-exempt should have sufficient ownership to avoid assertion that entity principally serves personal motives of individuals. If ownership is small, it becomes more important to maintain greater control by the entity. D. Use of a For-Profit Subsidiary Where it is unclear that a venture will not harm the tax-exempt status of a partner, either because it will generate UBIT and/or the activity is so substantial as to be deemed "insubstantial," it is common for a tax-exempt entity to use a for-profit subsidiary to act as the partner in an ASC joint venture. This should assist in limiting harm to the taxexempt entity as long as: The subsidiary is not funded with tax-exempt financing. There is no private inurement from the tax-exempt entity. The tax-exempt entity does not contribute assets or provide services at below fair market value. The for-profit is operated separately from the tax-exempt entity: separate boards, management, books, etc. The for-profit has distinct purposes. 88 See Id. at 9333.1. 89 Id. 50

The day to day operations of the entities are separates. 90 These characteristics will not assist the tax-exempt entity if the subsidiary engages in illegal activities, but they should prevent harm from a subsidiary where the subsidiary simply does not have enough control to assure that community powers are served. II. MANAGEMENT AND LEASE RELATIONSHIPS A. Management Services Provided by the Tax-Exempt Entity Management by a tax-exempt entity of a third-party ASC or of a joint venture is likely to have a variety of consequences. First, as long as the services are provided in exchange for fair market value compensation, and the services are a small proportion of the tax-exempt's activities, provision of services should not hurt the status of the entity. Second, the income from the services is like services are provided to a subsidiary or a party with a common parent. Third, the provision of services can harm the tax-exempt status of the e the provision of the services makes up a substantial portion of the activities of the tax- exempt entity. 91 B. Management Services Provided by a Third Party to the Tax-Exempt Entity or to a Joint Venture At one point, it was common for hospitals to permit third parties, including physician owned entities, to manage hospital departments or hospital based ambulatory surgery centers. With regard to physician o this has become significantly less common as a result of a variety of rulings enactments in various sectors, including GCM 39,862, the Stark Act, and Revenue Procedure 97-13. 92 To permit physician management, it is critical that valid purposes be developed and be supportable as to why a physician owned entity will serve as the manager. First, for example, the often touted expertise of physicians in management may be viewed as an excuse to share revenues or induce physician referrals. Second, it is unclear as to whether management services provided by a physician owned manager that is not a group practice qualify under the Stark Act or HCFA proposed Stark regulations. Third, the amounts payable should equate to fair market value. Particularly in the physician context, although industry custom may indicate other- wise, payments should not be tied to the value of business or profits. Fourth, the agreement should comply with Revenue Procedure 97-13 90 See Id. at 5333.4. 91 See Priv. Ltr. Rul. 98-22-004 (May 29,1998) and Arthur DeVaux, MSO Loses Tax-Exempt Status, Health Care Monthly (Oct. 1998), for a more complete discussion of these issues. 92 Rev. Proc. 97-13,1997-5 I.R.B. 18. 51

if the hospital or provider has been financed with tax-exempt financing.-revenue Procedure 97-13, in short, dictates as follows: Not greater than 10% of an issue may be used for private business use. 93 Certain management and use agreements will be deemed to create private business use. 94 The compensation requirements of Revenue Procedure 97-13 are as follows: The contract must provide for reasonable compensation for services rendered with no compensation based, in whole or in part, on a share of net profits from the operation of the facility. 95... [R]eimbursement of the service provider for actual and direct expenses paid by the service provider to unrelated parties is not by itself treated as compensation. 96 To be permissible under Revenue Procedure 97-13, the management contract must be described in section 5.03(1), (Z), (3), (4), (5), or (6) of this Revenue Procedure. 97 These are more specifically indicated as follows: 95 percent periodic fixed fee arrangements. At least 95 percent of the compensation for services for each annual period during the term of the contract is based on a periodic fixed fee. The term of the contract, including all renewal options, must not exceed the lesser of 80 percent of the reasonably expected useful life of the financed property and 15 years. For purposes of this section 5.03(1), a fee does not fail to qualify as a periodic fixed fee as a result of a one time incentive award during the term of the con- tract under which compensation automatically increases when a gross revenue or expense target (but not both) is reached if award is equal to a single, stated dollar amount. 98 80 percent periodic fixed fee arrangements. At least 80 percent of the compensation for services for each annual period during the term of the contract is based on a periodic fixed fee of the contract, including all renewal options, must not exceed the lesser of 80 percent of the reasonably expected useful life of the financed property and 10 years. For purposes of this section 5.03(2), a fee does not fail to qualify as a periodic fixed fee as a result of a one time incentive award during the term of the con- tract under which compensation automatically increases when a gross revenue or expense target (but not both) is reached if that award is equal to a single, stated dollar amount. 99 93 Id. at 2.01(1). 94 Id. 95 Id. at 2.01(6). 96 Id. at 2.01(7)(d). 97 Id. at 55.03. 98 Id. at 5.03(1). 99 Id. at 503.(2). 52

Percentage of revenue or expense fee arrangements in certain 2 year contracts. All the compensation for percentage of fees charged or a combination of a per unit fee and a percentage of revenue or expense fee.-during the start u riod, however, compensation may be based on a percentage of either gross revenues, adjusted gross revenues, or expenses of a facility. The term of the contract, including renewal options, must not exceed 2 years. The contract must be terminable by the qualified user on reasonable notice, without penalty or cause, at the end of the first year of the contract term. This section 5.03(6) applies only to: (a) (b) Contracts under which the service provider primarily provides services to third parties (for example, radiology services to patients); and Management contracts involving a facility during a start up period for which there have been insufficient operations to establish a reasonable estimate of the amount of the annual gross revenues and expenses (for example, a contract for general management services for the first year of operations). 100 Revenue Procedure 97-13 further states: Management contract means a management, service, or incentive payment contract between a qualified user and a service provider under which the service provider provides services involving all, a portion of, or any function of, a facility. For example, a contract for the provision of management services for an entire hospital, a contract for management services for a specific department of a hospital, and an incentive payment con- tract for physician services to patients of a hospital are each treated as a management contract. 101 Periodic fixed fee means a stated dollar amount for services rendered for a specified period of time. For example, a stated dollar amount per month is a periodic fixed fee. The stated dollar amount may automatically increase according to a specified, objective, external standard that is not linked to the output or efficiency of a facility. For example, the Consumer Price Index and similar external indices that track increases in prices in an area or increases in revenues or costs in an industry are objective external standards. Capitation fees and per unit fees are not periodic fixed fees. 102 The more the agreement articulates a fixed price for services, the less concern the IRS has that the agreement provides private parties with control and use of the assets. Concerns for turning over facility operations to non-physician-owned management companies are similar, but certain differences exist. First, Stark concerns should not be an 100 Id. at 5.03(6). 101 Id. at 53.03; see also Income Tax Regs. 51.141-3(b)(4)(ii) and 1.145-2. 102 Id. at 3.05. 53

issue. Second, fraud and abuse issues should not be a concern as long as the manager does not provide marketing or referral services. The agreement should state that these are not the roles of the manager. The management contract should still be structured such that it does not share profits and such that it complies with Revenue Procedure 97-13. Moreover, efforts should be made to ensure that owners and executives of the manager do not have inside or other relationships with the tax-exempt entity. The third-party management of the ASC joint venture should be carefully structured to assure that (1) it does not prevent the hospital from ensuring that the ASC serves community purposes (i.e., it should have enough control over the exercise of manager powers and decisions), (2) it should be for a reasonable time period, (3) it should be at fair market value. A higher level of concern presents itself where physician managers will serve as the managers of the joint venture but do not have demonstrated capacity or expertise to provide management services to the ASC. C. Lease Relationships Leasing relationships between a hospital and related physicians or a joint venture ASC raise a variety of issues. These include issues such as whether the lease income will be viewed as providing UBIT and whether the lease relationship will be deemed to cause private inurement. Lease relationships with referring and staff physicians have been examined at length in a variety of revenue rulings and in private letter rulings. The rulings indicate that the leases will be more likely not to create UBIT if they ostensibly serve community purposes. Also, to avoid private inurement, it is critical that the lease terms be negotiated at fair market value and at arm s length. Key guidance can be summarized from various rulings. Most of the rulings are specific to medical practices and not to ASC leases. A review of the rulings, however, indicates that it will be easier to defend an ASC lease if the ASC itself complements the hospital's goals and serves community purposes. Medical Practices. Revenue Ruling 69463 103 holds that a hospital leasing its adjacent office building, and furnishing certain office services, to a medical group to encourage doctors to carry on their professional activities on the hospital premises is not engaging in an unrelated trade or business. 104 The Revenue Ruling states that the lease was negotiated at arm's length and the group used the facility to provide medical services for its private patients. 105 One of the effects of this activity was to fulfill the hospital's role as the health center of the community. 106 The revenue ruling further holds that, based on the facts of this case, the group practice contributed importantly to the hospital's operations and was therefore substantially relate to the carrying on of the hospital functions. 107 103 Rev. Rul. 69463, 1969-2 C.B. 131. 104 Id. 105 Id. 106 Id. 107 Id. 54

Revenue Ruling 69-464 108 holds that leases of office space in an adjacent office building by an exempt hospital to members of its medical staff who contribute importantly to the performance of hospital functions are not considered to be business leases within the meaning of section 514(b) of the Code (since repealed.). 109 The revenue ruling states that benefits derived from leasing the office space indicate that the leases are entered into primarily for purposes that are substantially related to the performance of hospital functions. 110 Construction Development Ground Lease. The Revenue Ruling also noted: The Boards of Trustees of M and Hospital have determined that a professional office building should be constructed on the campus of the Hospital, with ownership of said building being separate from the Hospital. The Boards believe that this building will strengthen service, and ethical bonds between the medical staff. The legal structure will consist of a limited partnership, which is to be formed and is presently referred to as 0. The general partner of this partnership will be F, an unrelated third party. The limited partners will be members of Hospital's medical staff. P will assume the responsibility for the development, ownership, and management of the building to be constructed on Hospital owned real estate. P will also package the entire project including design, construction, supervision, financing, and syndication. M will execute a one (1) year, $2X letter of credit for the benefit of the construction lender which will be collateralized by the assignment and escrow of M's funds. If any payment is made pursuant to the letter of credit, M will receive a subordinated note from 0 in the amount of such funding. Interest will be at prevailing prime rate. Principal will be due upon sale of the building. This letter of credit is being provided as an inducement at the request of the developer to allow the construction of the facilities to begin as soon as possible. The offices will be leased to current members of Hospital's Provisional or Active Medical or Dental staff and other persons or entities providing health care support services, and licensed under the laws of the State, including the Hospital. There will be capacity for approximately forty (40) medial or dental professionals. The rental costs would be at a reasonable rate consistent with rates charged for commercial medical office buildings of the same type and location in the community. The term of the ground lease will be for a period of twenty (20) years, commencing with the approval by Lessor and Lessee of plans and specifications, which must be within ten (10) days of the execution of the ground lease. Lessee shall have the option to renew the lease for two (2) 108 Rev. Rul. 69464, 1969-2 C.B. 132. 109 Id. 110 Id. 55

consecutive terms of twenty (20) years each on the same terms and conditions, except the rental for each renewal shall be at a rental rate as set forth in an exhibit attached to the lease. As additional rent, Lessee will also be required to pay taxes, insurance and maintenance expenses. Lessee will also maintain liability insurance for any personal injury and property damage that occur on the leased premises. The lease requires Lessee to construct a professional medical office building on the land in accordance with plans and specifications approved by Lessor and Lessee. Lessee will use all reasonable efforts to fully tenant the building. Lessee shall give first priority to tenants recommended by Lessor in accordance with Lessor's guidelines on the "specialty mix" of the tenants. Lessor shall lease the entire area of the ground floor at fair market value rates for ambulatory surgery space. Based on these facts and assertions, the IRS ruled that the ground lease would not lead to UBIT. In general, leases whereby the operations of the tenant have a strong relationship to the hospital and to serving community needs and provide benefits in a manner consistent with hospital missions appear easier to defend as not creating UBIT. Thus, a joint venture ASC, that serves community benefits should not create UBIT, but a third-party ASC lease without commitments to community benefit or other nexus to the hospital might create UBIT problems. III. MISCELLANEOUS TAX-RELATED ISSUES A. IRC Section 4958 Taxes on Excess Benefit Transactions The IRS, in August 1998, issued regulations ("Regulations") to the Excess Transactions sections of the Taxpayer Bill of Rights. 111 The Regulations are helpful in their effort to define "Disqualified Persons" and their efforts to guide appropriate exempt entity approval processes. The excess benefit taxes apply to transactions in which an economic benefit is provided by a tax-exempt organization to a person when the value provide person is in excess of the benefit provided to the tax-exempt organization. 112 An excess benefit transaction also includes certain revenue sharing transactions. 113 Under the Regulations, a person includes any individual who, at any time during the five-year period ending on the date of the excess benefit transaction, was in a position to exert substantial influence over the affairs of the tax-exempt organization. 114 Persons also 111 I.R.C. $4958 (West 1998). 112 Id. at 4958(c)(l)(A). 113 Id. at 4958(c)(2). 114 Id. at 4958(f)(l)(A). 56

include family members of such persons and organizations in which such persons hold at least 35% of the equity or control interests. 115 The excess benefit taxes include three types of taxes. First, a tax equal to the excess benefit may be imposed. 116 Second, a 200% tax is imposed if the transaction is not rescinded. 117 Third, the Regulations include a tax of 10% of the excess benefit, which is to be paid by any organizational manager who participates in an excess benefit transaction knowingly, willfully and without reasonable cause. 118 An organizational manager is defined as an officer, director or trustee of the tax-exempt organization or any individual having powers or responsibilities similar to those of an officer, director or trustee. 119 A rebuttable presumption may be made under the Regulations by satisfying the following three requirements: (1) The compensation arrangement or terms of transfer must be approved by the organization's governing body or a committee of the governing body, composed entirely of individuals who do not have a conflict of interest with respect to the arrangement or transactions. (2) The governing body, or commit- tee, must obtain and rely upon appropriate data as to comparability prior to making its determination, (3) The governing body or committee must adequately document the basis for its determination concurrently with making that determination. 120 The presumption established by satisfying these three requirements may be rebutted by additional information showing that the compensation was not reasonable or that the transfer was not at fair market value. 121 Relevant information for this purpose includes, but is not limited to: Compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; independent compensation surveys compiled by independent firms; actual written offers from similar institutions competing for the services of the person; and independent appraisals of the value of property that the applicable tax-exempt organization intends to purchase from, or sell or provide to the person. 122 Finally, the transaction's approval must be documented properly. To be documented adequately: The written or electronic records of the governing body or committee must note the terms of the transaction that were approved and the date on which it was approved; the members of the governing body or committee who were present during debate on the transaction or arrangement that was approved and those who 115 Id. at 4958(f) (1) (B-C). 116 Id. at 4958(a)(1). 117 Id. at 4958(b). 118 Id. at 4958(a)(2). 119 Id. at 4958(f)(2). 120 Taxes on Excess Benefit Transactions, 63 Fed. Reg. 41,486,41,492 (Aug. 4, 1998). 121 Id. 122 Id. at 41,493. 57

voted on it; the comparability data obtained and relied upon by the committee and how the data was obtained; and the actions taken with respect to consideration of the trans- action by anyone who is otherwise a member of the governing body or committee but who had a conflict of interest with respect to the transaction or arrangement. If the governing body or committee determines that reasonable compensation for a specific arrangement is higher or lower than the range of comparable data obtained, the governing body or committee must record the basis for its determination. For a decision to be documented concurrently, records must be prepared by the next meeting of the governing body or committee occurring after the final action or actions of the governing body or committee are taken. Records must be reviewed and approved by the governing body or committee as reasonable, accurate and complete within a reasonable time period thereafter. 123 B. Cash Versus Accrual Many ASCs, if given the choice, would prefer to file income tax returns on the cash basis. The filing of tax returns on the cash basis delays the payment of income taxes on income that may have accrued when receipts have not actually been received. The Internal Revenue Code provides limitations on use of the cash method that can be applicable to ASCs. Section 448(a) of the Code specifically provides that the cash method may not be used by (1) a C corporation, (2) a partnership that has a C corporation as a partner, or (3) a tax shelter. Here, two further clarifications are important. First, the limitations provided for C corporations and partnerships with C corporation partners are not applicable for entities with gross receipts of less than $5million. Thus, many ASCs can escape Section 448(a)'s coverage because approximately 80% of ASCs generate receipts of less than $5 million per year. Second, the definition of tax shelter is fairly broad and can apply to many ASCs. Tax shelters, under Section 461(i) of the Code, include (1) any enterprise if at any time interests in such enterprise have been offered for sale in any offering required to be registered under any federal or state agency having the authority to regulate the offering of securities for sale, (2) any syndicate within the meaning of Code Section 1256(e)(3)(B), and (3) any tax shelter as defined in Section 6662(d)(2)(C)(ii). The syndicate rules were not drafted to be applicable to ASCs but state that an entity shall be deemed a syndicate if greater than 35% of the interests are held by limited partners or limited entrepreneurs. This arguably avoids use of the cash basis for limited partnerships and limited liability companies where greater than 35% of the interests will be held by non-managing physicians. The securities registration requirement should pose little risk to ASCs. However, some have asserted that it should be interpreted to cover entities that are required to file materials with the state or federal government to perfect an exemption. This would include a Regulation D or ULOE filing. 123 Id. 58

Also, entities that qualify as "tax shelters" are not allowed to use the cash method. Included in this prohibition are any entities that have offered for sale at anytime any interests in such enterprise that are required to be registered with any federal or state agency having the authority to regulate the offer of securities for sa1e. 124 C. Choice of Tax Year ASCs in most situations are pleased to use the calendar year as their tax year. However, in certain situations, such as where a hospital or health system is a partner, there is a desire to have the tax year be the same as the tax year of the system or partner. The limitations on use of the fiscal year include that the tax year may not be different from the tax year of the majority interest tax year [Section 706(b) of the Code] or the tax year of all of the principal partners, and if there is no calendar year defined by these two clauses, the tax year shall be the calendar year. Thus, it may be possible to use the fiscal year of the hospital or health system when the system owns greater than 50% of the partnership or LLC. It is also possible to apply for a different tax year based on a business purpose. However, "business purpose" has been defined relatively narrowly by the IRS. This is due to a concern that entities would game the tax year to defer the reporting of income. D. Affiliated Services Group The affiliated services group sections of the Code can present problems for ASCs. A broad interpretation of Section 414(M)(2)(A) could lead one to conclude that a physician who owns interests in an ASC and performs services at the ASC should be required to treat the ASC and his or her practice as affiliated entities. This argument can be made under Code sections that provide that two parties are deemed affiliated if the first organization is a service organization and the service organization is a shareholder or partner in the "first organization" and either performs services for the organization or is regularly associated with the organization in providing services to third parties. Here, proposed regulations under these sections indicate that the intent of these code sections is to ensure that organizations that are providing services hand-in-hand are treated as affiliated for employee benefit plan testing. Examples include situations in which law partners share offices and jointly provide services to third parties, or where physicians or others act in concert with similar employees to provide services. Other examples focus on the joint ownership of Management Services Organizations. The ASC, in contrast to these situations, often involves a situation in which a physician owns a small percentage of the organization and provides services at the ASC. There, the ASC and the physician can be technically viewed as associated in providing services to third parties. In short, because there is no limit to the de minimis ownership of the ASC, the physician or his or her practice (assuming ownership attribution back to his or her practice applies) can be viewed as affiliated with the ASC and subject to performing all discrimination testing for employee plans of the ASC. This result appears to clearly not have been the intent of the drafters of these sections of the Code. However, the lawyer, in structuring the venture and in requesting determination letters regarding plans, should be 124 I.R.C. 448(d) and 461(1)(3)(A). 59

aware of this potential result. To provide notice to potential investors, a disclosure of the following type is also often made in the private placement memorandum: Pension Planning and Affiliated Service Group Issues The federal government's rules and regulations relative to permitted deferred contribution plans, retirement plans, and benefit plans should be reviewed by each Member to assure that such rules and regulations will not adversely impact the ability of a Member to maximize his or her deferral of income for retire purposes. Section 414(m) of the Internal Revenue Code, as amended ("Code") requires that certain related organizations which provide services for each other, or in association with each other provide services to third parties, be treated as members of an affiliated service group. Characterization of related organizations as an affiliated service group results in all members of group being considered as one employer, and all of the employees of all of the related entities treated as employees of one employer, for purposes of determining the satisfaction of various requirements imposed upon employee benefit plans the Employee Retirement Income Security Act of 1974 ("ERISA"). Essentially, the employee benefit plans of each member of an affiliated service group must satisfy certain minimum participation and coverage requirements (which will be more difficult or expensive to comply with if the plan sponsor is a member of an affiliated service group) or such plans would be required to provide benefits comparable to the benefits provided to employees of other members of the group. Failure to satisfy the applicable tests with respect to a plan of a member of the group could lead to the disqualification of such member's employee benefit plans, causing the loss of tax deductions and other benefits associated with qualified plans. Furthermore, a literal interpretation of Code section 414(m) may require that all of the Group Practice's employees be covered under an investor s pension or profit sharing plan. There is a possibility that the Group Practice and its investors (or its investors' professional corporations) could be considered members of an affiliated service group. If the Internal Revenue Service were successful in arguing that such an affiliated service group employee benefit plans of all members of the group would have to be analyzed to determine if all such plans satisfy the requirements of the Code. Such an analysis could lead of a plan changing the plan in order to avoid or deciding to terminate a plan or a determination that a plan does not qualify under ERISA. The Partners and Members are thus subject to the risk that the investment in the company will negatively impact their pension planning. IV. SUMMARY It is a prerequisite for counsel to be well-versed with tax exemption and the related issues commonly raised by ASCs. As ventures have proliferated, these issues have become more and more important in the structuring of plans and ventures. Although not discussed here, the lawyer should also be familiar with allocation and distribution rules related to 60

partnerships. These can have particular impact with respect to formation, "buy in" and "buy out" events, and liquidation events. 61

4. STATE SELF-REFERRAL ISSUES State self-referral laws, for ASCs, serve in a complementary position to the Medicare and Medicaid Fraud and Abuse Laws and the Federal Stark Act. From a structuring perspective, ASCs must comply with both the federal laws and the relevant state laws. The state laws, as a general rule, have three principal impacts on ASCs: They may expressly prevent ownership by either referring and performing physicians and/or by non-performing physicians. The second category includes primary care physicians who refer but do not perform. 1 The laws can require disclosure of ownership to patients. The laws extend coverage to include nongovernmental patients (self-pay and commercially insured patients). A lawyer working with ASCs is charged with understanding the impact state law will have on ASC structures, providing structuring choices and disclosing the impact of the laws to clients. This disclosure is often made through memoranda or a client memorandum. However, the lawyer may also use the disclosure, in a private placement memorandum, for example, to set up defenses to govern- mental challenges. Here, he or she must set up the challenge, but not mislead a client as to the risks under applicable state law. Finally, the contractual agreements should provide means for attempting to restructure agreements in the event that state or federal laws change or are interpreted to prohibit physician ownership. This chapter provides an overview of the impact of state self-referral laws on ASCs. I. TYPES OF PROHIBITIONS AND LAWS State self-referral laws typically are of one of three types. First, they may modeled after the Stark Act and prohibit relationships with regard to certain services. Second, they may be similar to the Federal Fraud and Abuse Statute. Here, they may more generally prohibit remuneration and kickback re specific services. Third, they may require disclosure to patients. State restrictions are often found in either a state self-referral act, an anti-kickback statute or in a state physician code. State department health and attorney general opinions and actions often supplement the acts and codes through advisory opinions and interpretations. A. Requiring Performance 1 Federal law implies favor with surgeons who invest and perform services in ASCs but disfavors ownership by nonperforming physicians (e.g., primary care physicians) 62

The clearest impact that state statutes often have on ASCs is the clarity of their restriction on ownership by nonperforming physicians. Per these statutes, surgeons, but not primary care physicians or group practices, may be permitted to own ASC interests. Examples of this type of legislation are set forth below. These laws serve to extend the proposed federal safe harbor for surgeons a step further by actually prohibiting ownership by nonsurgeon referring parties. Montana. Mont. Code Ann., 5 39-71-1108 (1998). Physicians self referral prohibition. (1) Unless authorized by the insurer, a treating physician may not refer a claimant to a health care facility at which the physician does not directly provide care or services when the physician has an investment interest in the facility, unless there is a demonstrated need in the community for the facility and alternative financing is not available [emphasis added]. The insurer or the claimant is not liable for charges incurred in violation of this section. Illinois. 225 Ill. Comp. Stat. 47/20 (1998). Prohibited referrals and claims for payment. Sec. 20. Prohibited referrals and claims for payment. (a) A health care worker shall not refer a patient for health ser- vices to an entity outside the health care worker's office or group practice in which the health care worker is an investor, unless the health care worker directly provides health services within the entity and will be personally involved with the provision of care to the referred patient [emphasis added]. Maine. 22 Me. Rev.Stat. Ann 5 2085 (1997). Prohibited referrals and claims for payment. 1. PROHIBITED REFERRALS. A health care practitioner may refer a patient to an outside facility in which that health care practitioner is an investor only when that health care practitioner directly provides health services within the facility and will be personally involved with the provision of care to the referred patient [emphasis added]. North Carolina. N.C. Gen. Stat 5 90406 (1999). Self-referrals prohibited. (a) A health care provider shall not make any referral of any patient to any entity in which the health care provider or group practice or any member of the group practice is an investor. Referral does not mean any designated health care service or any referral to an entity for a designated health care service which is provided by, or provided under the personal supervision of, a sole health care 63

provider or by a member of a group practice to the patients of that health care provider or group practice. New York. N.Y. Pub. Health Law 238 a (1998). Prohibition of financial arrangements and referrals. 1. (a) A practitioner authorized to order clinical laboratory services, pharmacy services, radiation therapy services or x-ray or imaging services may not make a referral for such services to a health care provider authorized to provide such services where such practitioner or immediate family member of such practitioner has a financial relationship with such health care provider. 2. Subdivision one of this section shall not apply in any of the following cases: (a) practitioners' services in the case of practitioners' services provided personally by, or under the supervision of, another practitioner in the same group practice as the referring practitioner [emphasis added]. The New York Statute differs from certain of the foregoing in that it applies to specific services as opposed to all services. B. Disclosure Statutes Many state statutes do not fully prohibit ownership by referring many require disclosure to the patient of the referring physician's ownership interest. In certain states, the exact form of disclosure is mandated by law. Examples of these types of statutes are as follows: Florida. Florida Stat. Ann. 5 459.013 (1998). Referring any patient, for health care goods or services, to any partnership, firm, corporation, or other business entity in which the physician or the physician's employer has an equity interest of 10 percent or more unless, prior to such referral, the physician notifies the patient of her or his financial interest and of the patient's right to obtain such goods or services at the location of the patient's choice. This section shall not apply to the following types of equity interest... [emphasis added]. California. Cal. LabCode 139.3 (1999). A physician who refers to or seeks consultation from an organization in which the physician has a financial interest shall disclose this interest to the patient or if the patient is a minor, to the patient's parents or legal guardian in writing at the time of the referral [emphasis added] 64

A California attorney general opinion, in explaining the disclosure requirement, articulated the laws implied as follows: 2 This opinion discusses three aspects of newly enacted section 654.2 of the Business and Professions Code (Stats. 1984, ch. 639, 1), which reads as follows: (a) It is unlawful for any person licensed under this division [i.e., div. 2 of the Bus. & Prof. Code] or under any initiative act referred to in this division to charge, bill, or otherwise solicit payment from a patient on behalf of, or refer a patient to, an organization in which the licensee, or the licensee's immediate family, has a significant beneficial interest, unless the licensee first discloses in writing to the patient that there is such an interest and advises the patient regarding other alternative services, if available [emphasis added]. 3 1. The organization, entity or facility to which the patient is being referred should be identified. 2. A patient should be advised that the practitioner has a beneficial interest in an organization, entity or facility to which the patient is being referred. The particular interest need not be revealed. 3. The patient should be advised that he or she may have the services performed at another facility which offers the same or similar services, and 4. The patient should either be given names of the specific alternative facilities that are available or information as to where a listing of them might be obtained. 4 2 68 Op. Atty. Gen. Cal. 140 (1985). 3 Id. At 1. 4 Id. at n.8. The Attorney General has discussed how this is met. Section 654.1 requires that "the written disclosure shall indicate that the patient may choose any clinical laboratory for purposes of having any laboratory work or assignment performed." To comply, the disclosure need only show that an option exists. The physician is clearly not obligated to give specific information about other avail- able clinical laboratories. Section 654.2, however, requires that the licensee "advise the patient regarding other alternative services, if available [emphasis added]." We think the requirement is met if the practitioner either identifies specific alternative facilities or instructs the patient as to how he or she may identify specific alternative facilities which can provide the same service. For instance, referring a patient to a professional society referral service or directory, or the yellow pages where such identification of alternative facilities may be obtained should suffice. 65

Minnesota. Minn. Stat. 197.091(~)(3) (1998). [The statute prohibits] referring a patient to any healthcare provider (as defined in Minnesota Statutes 144.335) in which the referring physician has a significant financial interest unless the physician has disclosed the physician's own financial interest. Arizona. Ariz. Rev. Stat. 32-1854 (1998). C. Stark-Type Statutes 35. [The statute prohibits] referring a patient to a or treatment facility or prescribing goods and services without disclosing that the physician has a direct pecuniary interest in the facility, goods or services to which the patient has been referred or prescribed [emphasis added]. This paragraph not apply to a referral by one physician to another physician within a group of physicians practicing together. Many states, in a manner similar to the Stark Act, outlaw ownership or compensation services with regard to certain types of services. Typically, these are services that are viewed as prone to overutilization. ASC services are usually not directly covered by these prohibitions. This is because management of the overutilization s relative to self-referral focused on ownership of laboratories and imaging centers. California. California Business and Professions Code Unlawful referrals; Definitions (a) Notwithstanding Section 650, or any other provisions of law, it is unlawful for a licensee to refer a person for laboratory, diagnostic nuclear medicine, radiation oncology, physical therapy, physical rehabilitation, psychometric testing, home infusion therapy, or diagnostic imaging goods or services if the licensee or his or her immediate family has a financial interest with the person or in t entity that receives the referral. Florida. Fla. Stat. 455.654 (1998). Exceptions for ASCs. "Designated health services" means, for purposes of this section, clinical laboratory services, physical therapy services, comprehensive rehabilitative services, diagnostic-imaging services, and radiation therapy services. Florida, for example, specifically excludes ASCs from its coverage. Florida Stat. 455.654 states: The following orders, recommendations, or plans or care shall not constitute a referral by a health care provider: a. By a radiologist for diagnostic-imaging services. 66

D. Statutes Not Clear b. By a physician specializing in the provision of radiation therapy services for such services. c. By a medical oncologist for drugs and solutions to be prepared and administered intravenously to such oncologist's patient, as well as for the supplies and equipment used in connection therewith to treat such patient for cancer and the complications thereof. d. By a cardiologist for cardiac catheterization services. e. By a pathologist for diagnostic clinical laboratory tests and pathological examination services, if furnished by or under the supervision of such pathologist pursuant to a consultation requested by another physician. f. By a health care provider who is the sole provider or member of a group practice for designated health services or other health care items or services that are prescribed or provided solely for such referring health care provider's or group practice's own patients, and that are provided or performed by or under the direct supervision of such referring health care provider or group practice. g. By a health care provider for services provided by an ambulatory surgical center licensed under chapter 395 [emphasis added]. In most cases, either because the statute only prohibits certain services, permits ownership by referring physicians as long as disclosure is made to the patient or permits ownership as long as specific conditions are met, surgeons can own interests in ASCs. In a few states, the law is not expressly clear. This may be true even in states in which many physician-owned ASCs exist. Examples of these states include Michigan, New Jersey and Washington. Michigan. Public Health Code 16221 (1998). Section 16221 of the Public Health Code (PHC), 5 provides that a licensed health care professional shall be disciplined for the following: (iv) Directing or requiring an individual to purchase or secure a drug, device, treatment, procedure, or service from another person, place, facility, or business in which the licensee has a financial interest [emphasis added]. 5 1998 Mich. Pub. Acts 333.1101(e)(iv). 67

This Michigan statute has been interpreted broadly by at least one court to fully prohibit referrals by a doctor to an entity in which he or she owns an interest. There, the court stated the facts and its opinion as follows: II. The Partnership Agreement There is nothing in the facility's limited partnership agreement (or in any other agreement) requiring that the Physicians refer patients or patient specimens there. In fact, the facility's partnership agreement expressly prohibits physician- partners from directing or requiring patients to use the facility. Some of the facility's physician-partners use competing facilities in addition to using this one. Each physician receives a distribution of the facility's business profits based solely on his proportionate ownership interest in the facility, without regard for his referrals. The amount of a physician-partner s ownership shares does not depend on referrals, and physician-owners receive no payments in exchange for referrals. Each of the Physicians has posted signs in this office, readily visible to patients needing the facility's services, containing this language: Patient Disclosure IMPORTANT INFORMATION In connection with the treatment of our patients it may be necessary to refer them or submit patient specimens to a [ of facility]. Where appropriate our office uses [name of facility], which is owned in part by members of this office. Board Decision The Michigan Board of Medicine ruled that when a physician refers a patient or specimen to a facility in which he is a limited partner under the circumstances set forth by Doctors Indenbaum and Liddell, the physician is "directing or requiring" in violation of Section 16221 (1) (e) (iv).... Court Opinion on Appeal After reviewing the authorities with respect to the word directing, we cannot agree with petitioners that the common and ordinary meaning of this word in the context of this case is limited only to command or orders. as a verb, "directing" is defined as follows: 1. to manage or guide by advice, instruction, etc. 2. to regulate the course of; control. 3. to administer, manage; supervise... 4. to give authoritative 68

instructions order or ordain... 5. to serve as a director in or performance of (a musical work, play, motion picture, etc.). 6. to tell or show (a person) the way to 7. to aim or send toward a place or object... 8. focus toward a given result, object, or end (o or toward)... 9. to address (words, a speech, etc.) to a person or persons. 10. to address (a letter, package, etc.) to an intended recipient.... 6 The word "direct," when used as a verb, is also defined as follows: To point to; guide; order; command; instruct. To advise, suggest; request 7 We find helpful the following distinction: DIRECT, ORDER, COMMAND mean to issue instructions. Direct suggests also giving explanations or advice; the emphasis is on steps necessary to accomplish a purpose: He directed me to organize the files. Order connotes a more personal relationship and instructions that leave no room for refusal. She ordered him out of the class. Command suggests greater formality and a more fixed authority: The officer commanded the troops to advance. 8 The Board's interpretation of "directing or requiring," while not longstanding, does not overcome the statute's plain meaning and is supported by the cogent reason of preventing overutilization of health services. Thus, the Board's interpretation is entitled to some deference. 9 We conclude that the Board's ruling that under the circumstances of this case petitioners were "directing or requiring" in violation of 5 16221(e)(iv) was not an abuse of discretion or affected by a substantial and material error of law. The trial court erred in determining otherwise. New Jersey. N. J. Admin. Code Title 35-6.17 (1998). This section describes the requirements concerning professional fees and investments, as well as the prohibitions of kickbacks. This statute first defines healthcare services as follows: Health care service means a business entity which provides on an inpatient or out-patient basis: testing for or diagnosis or treatment of human disease or dysfunction or dispensing of drugs or medical devices for the treatment of human disease or dysfunction. Health care service includes, but is not limited to, a bioanalytical laboratory, pharmacy, home health 6 Random House Webster's College Dictionary (1995). 7 Black's Law Dictionary (6th ed). 8 Random House Webster's College Dictionary (1995), "Direct," p. 381. 9 Wozniak v. General Motors Corp (After Remand), 212 Mich. Ap. 40, 44; 536 N.W. 2nd 841 (1995). 69

care agency, home infusion therapy company, rehabilitation facility, nursing home, hospital, or a facility which provides radiologic or other diagnostic imaging services, physical therapy, ambulatory surgery, or ophthalmic services [emphasis added]. Additionally, the statute has as a principal part of its regulatory scheme a requirement regarding disclosure to patients. Under this requirement, disclosure shall be made by the practitioner in ways appropriate to form prepared as set forth below, at least 8% by 11 inches in size, in the practitioner's waiting room in all office locations. The patient shall also be provided with a personal copy of the notice. The actual format of the notice is included at 35-6.17 (b). The statute also imposes restrictions such as the one found at 35-6.17 (h)(l), which states: The charging of a "facility fee,"... is forbidden, except by a registered Medicare provider of surgical services who is billing pursuant to criteria for such fee established by rules of the United States Department of Health and Human Services. The statute also provides specific restrictions for ASCs without a Certificate of Need: A licensee who owns or practices in premises used for the performance of personal medical services including, but not limited to, ambulatory surgery services but not holding a Certificate of Need from the State Department of Health, shall not charge, or permit or condone a charge or "facility fee" separate from the fee for professional services. A facility fee may, however, be charged by a licensee who is a registered Medicare provider of surgical services, who is billing pursuant to criteria for such fee established by rules of the United States Department of Health and Human Services. 35-6.l7 (h) (5). New Jersey. New Jersey Statutes Annotate Title 45:9 22.5 (1998). Reference to healthcare service by practitioner with significant beneficial interest; disclosure to patient; exceptions. 1. A practitioner shall not refer a patient or direct an employee of the practitioner to refer a patient to a health care service in which the practitioner, or the practitioner's immediate family, or the practitioner in combination with practitioner s immediate family has a significant beneficial interest; except that, in the case of a practitioner, a practitioner's immediate family or a practitioner in combination with the practitioner s immediate family who had interest prior to the effective date of P.L. 1991, c. 187 (C. 26:2H- 18.24 et. seq.), the practitioner may continue to refer a patient or 70

direct an employee to do so if that practitioner discloses the significant beneficial interest to the patient. 2. If a practitioner is permitted to refer a patient to a health care service pursuant to subsection a. of this section, the practitioner shall provide the patient with a written disclosure form, prepared pursuant to section 3 of P.L.1989, c. 19 (C. 45:9-22.6), and post a copy of this disclosure form in a conspicuous public place in the practitioner's office. 3. The restrictions on referral of patients in this section shall not apply to: (1) a health care service that is provided at the practitioner's medical office and for which the patient is billed directly by the practitioner; and (2) radiation therapy pursuant to an oncological protocol, lithotripsy and renal dialysis. Washington. Wash. Rev. Code Ann. 19.68.030 (1998). License may be revoked or suspended. The license of any person so licensed may be revoked or suspended if he has directly or indirectly requested, received or participated in the division, transference, assignment, rebate, splitting or refunding of a fee, or has directly or indirectly requested, received or profited by means of a credit or other valuable consideration as a commission, discount or gratuity in connection with the furnishing of medical, surgical or dental care, diagnosis or treatment or service, including x-ray examination and treatment, or for or in connection with the sale, rental, supplying or furnishing of clinical laboratory service or supplies, x-ray services or supplies, inhalation therapy service or equipment, ambulance service, hospital or medical supplies, physiotherapy or other therapeutic service or equipment, artificial limbs, teeth or eyes, orthopedic or surgical appliances or supplies, optical appliances, supplies or equipment, devices for aid of hearing, drugs, medication or medical supplies or any other goods, services or supplies prescribed for medical diagnosis, care or treatment, except payment, not to exceed thirty-three and one-third percent of any fee received for x-ray examination, diagnosis or treatment, to any hospital furnishing facilities for such examination diagnosis or treatment. E. General Anti-Kickback and Anti-Remuneration Statutes Many states in a manner similar to the Federal Fraud and Abuse Statutes simply prohibit kickbacks. Examples of this type of statute include: 71

Washington. Wash. Rev. Code Ann 19.68.010 (1998). Rebating prohibited; disclosure; list of alternative facilities. It shall be unlawful for any person, firm, corporation or association, whether organized as a cooperative, or for profit or nonprofit, to pay, or offer to pay or allow, directly or indirectly, to any person licensed by the state of Washington to engage in the practice of medicine and surgery, drugless treatment in any form, dentistry, or pharmacy and it shall be unlawful for such person to request, receive or allow, directly or indirectly, a rebate, refund, commission, unearned discount or profit by means of a credit or other valuable consideration in connection with the referral of patients to any person, firm, corporation or association, or in connection with the furnishings of medical, surgical or dental care, diagnosis, treatment or service, on the sale, rental, furnishing or supplying of clinical laboratory supplies or services of any kind, drugs, medication, or medical supplies, or any other goods, services or supplies prescribed for medical diagnosis, care or treatment. Ownership of a financial interest in any firm, corporation or association which furnishes any kind of clinical laboratory or other services prescribed for medical, surgical, or dental diagnosis shall not be prohibited under this section where (1) the referring practitioner affirmatively discloses to the patient in writing, the fact that such practitioner has a financial interest in such firm, corporation, or association; and (2) the referring practitioner provides the patient with a list of effective alternative facilities, informs the patient that he or she has the option to use one of the alternative facilities, and assures the patient that he or she will not be treated differently by the referring practitioner if the patient chooses one of the alter- native facilities. Louisiana. La. Rev. Stat. Ann. 37, 1745 (1998). Part VII. Health Care Providers 1745. Prohibition on payment for patient referrals. 1. For the purposes of this Section, the following terms shall have the following meanings: (1) "Board" means the Louisiana State Board of Medical Examiners, Louisiana Board of Chiropractic Examiners, Louisiana State Board of Optometry Examiners, Louisiana State Board of Physical Therapy Examiners, Louisiana State Board of Examiners for Psychologists, Louisiana State Board of Nursing, Louisiana Licensed Professional Counselor Board of Examiners, Louisiana State Board of Practical Nurse Examiners, and Louisiana Board of Pharmacy. 72

(2) B. No health care provider shall offer, make, solicit, or receive payment, directly or indirectly, overtly or covertly, in cash or inkind, for referring or soliciting patients. Payments representing a return on investment based upon a percentage of ownership are not considered a direct or indirect payment for the purposes of this Section. II. COMPLIANCE AND RENEGOTIATION The impact of the state laws on ventures is reflected in operating and share- holder agreements and in disclosure materials. It also is reflected in structures which may have interests in management companies but not the venture itself. Operating agreements typically define who is eligible to invest and hold interests and whether physicians might be required to divest ownership if they can no longer perform cases at the center. Agreements may also indicate a process for resolving situations in which laws change or a practice, such as ownership by referring physicians, becomes illegal. An example of agreement provisions related to these areas is as follows: Limited Renegotiation. This Agreement shall be construed to be in accordance with any and all federal and state statutes, including Medicare, Medicaid and all federal and state rules, regulations, principles and interpretations. In the event there is a change in (or the interpretation of) Medicare, Medicaid or other federal or state statutes, rules, regulations, principles or interpretations that renders any of the material terms of this Agreement unlawful or unenforceable, including any services rendered or compensation to be paid hereunder, if the continuation of this Agreement would render any other relationship(s) amongst the parties hereto illegal, or if the Institutional Member determines that its continued participation as a Member of the Company and ownership of Membership Units adversely effects or may adversely effect the Section 501(c)(3) tax exempt status of the Institutional Member's tax exempt corporate parent or Affiliates, either party shall have the immediate right to initiate the renegotiation of the affected term or terms of this Agreement, upon notice to the other party, to remedy such condition in a manner that substantially maintains the then existing economic relationships of the parties if it is legal to accomplish the change while maintaining substantially such economic relationship. If the parties cannot renegotiate such relationships, the Institutional Member shall have the option to acquire all Units held by Physician Member Class at amount equal to fair market value as determined in accord with Section 5.4 hereof without discount. If the parties do not agree to renegotiate the Agreement, and the Institutional not exercise the acquisition rights described herein, then the Company shall be dissolved in accord with Article XII. III. PRIVATE PLACEMENT MEMORANDUM (PPM) 73

The PPM is often used both to inform investors of the impact on the venture of regulations as well as to develop defenses to government challenges. Typical disclosures relating to state self-referral issues may read as follows: Section 44-113-10 South Carolina Self-Referral Law. The South Carolina Provider Self-Referral Act of 1993 ("Self- prohibits physicians from referring patients to an entity in which the physician has an investment interest unless the physician directly provides health care services within the entity, or is personally involved in the provision, supervision, or direction of care to the referred patient. The Self-Referral Act also does not apply to certain non-publicly held entities that satisfy the following statutory requirements: o No more than fifty percent (50%) of the value of the investment interests are held by investors who are in a position to make referrals to the entity; o The terms under which an investment interest is offered to an investor who is in a position to make referrals to the entity are no different from the terms offered to investors who are not in a position to make referrals; o The terms under which an investment interest is offered to an investor who is in a position to make referrals to the entity are not related to the previous or expected volume of referrals from that investor to the entity; and o There is no requirement that an investor be in a position to make referrals to the en for becoming or remaining an investor. When a physician owns an investment interest in an en satisfies the foregoing conditions, he or she may refer to such entity if the patient is provided with a written disclosure form informing the patient of: o The existence of the investment interest; o The name and address of each applicable entity to which a referral is made in which the referring physician is an investor; o The patient's right to obtain the items or services for which the patient has been referred at the location or from the provider of the patient's choice, including the entity in which the referring physician is an investor; o The names and addresses of at least two alternative sources of the items or services available to the patient; and 74

o A schedule of typical fees for items or services usually provided by the entity, or, if impracticable because of the nature of the treatment, a written estimate specific to the patient. The Self-Referral Act by implication does not prohibit a Physician Member from owning an interest in an ASC to which he or she refers cases. However, there is no assurance that the applicable laws will not change to prohibit such physician ownership. In addition, the Self-Referral Act prohibits physicians from offering, paying, soliciting, or receiving a kickback (whether directly or indirectly), in cash or in kind, for referring or soliciting patients. As noted above, the Center will not provide remuneration to any person with the intent of inducing referrals to the Center. As such, the Company believes that it will be operated in compliance with the anti-kickback provision of the Self- Referral Act. 75

5. REIMBURSEMENT This chapter discusses reimbursement for outpatient surgical procedures. Specifically, it discusses each current and proposed payment method for ASCs and for hospital outpatient departments ("HOPDs"). The chapter also examines (1) what is included in the technical fee for outpatient surgery, (2) what procedures are reimbursed as outpatient surgical procedures, and HCFA policy related thereto, (3) the fee schedules used by HCFA under the current and proposed fee schedules, (4) the requirement for inclusion as an ASC under HCFA requirements and (5) a variety of other issues. I. CURRENT METHODOLOGY A. Payment Rates - ASCs and HOPDs HCFA currently reimburses ASCs, whether freestanding or hospital-based, under a fee schedule with eight groupings. The fee schedule categorizes procedures from minimally complex and lower costs at Group 1 to the highest level of complexity at Group 8. The fee schedule, as of 1999, was as follows: Group 1, $314; Group 2, $422; Group 3, $482; Group 4, $595; Group 5, $678; Group 6, $789 ($639 plus $150 for intraocular lens); Group 7, $941; and Group 8, $928 ($778 plus $150 for intraocular lens). Hospital outpatient departments are reimbursed based on the lower of their reasonable costs or customary charges or a blend based in part on their costs or charges and in part on the ASC payment groupings. Specifically, under section 1833(i)(3)(A) of the Social Security Act, the aggregate payment to hospital outpatient departments for covered ASC procedures is equal to the lessor of the following two amounts: The amount paid for the same services that would be paid to the hospital under section 1833(a)(2)(B) (that is, the lower of the hospital's reasonable costs or customary charges less deductibles and coinsurance); or The amount determined under section 1833(i)(3)(B)(i) based on a blend of the lower of the hospital's reasonable costs or customary charges, less deductibles and co-insurance, and the amount that would be paid to a free- standing ASC in the same area for the same procedures. B. Lithotripsy 76

In addition to the eight groupings, HCFA had initially proposed a ninth grouping for lithotripsy. Here, HCFA in 1991 proposed a rate considered very low by the ASC industry. That rate - $1,150 - led to extensive litigation over the rate. As a consequence, lithotripsy has not been reimbursed to ASCs. This changes under the proposed ASC regulations. A HCFA discussion of issues relating to the lithotripsy payment debate is as fo1lows: 1 On December 31, 1991 we published a final notice with comment period in the 56 Fed. Reg. 67,666 in which we added CPT code 50590, Lithotripsy, extracorporeal shock wave (ESWL), to the list of ASC covered procedures. We set the payment rate for ESWL at $1,150 on the basis of a procedure cost matrix model. A new payment group 9 was created solely for ESWL. Payment of a facility fee for ESWL, as an ASC covered procedure, was effective for services furnished beginning January 30,1992. On January 30, 1992, the American Lithotripsy Society (ALS) filed a complaint and motion to preliminarily enjoin enforcement and implementation of the December 31, 1991 notice insofar as it concerned ESWL. In American Lithotripsy Society v. Louis W. Sullivan, M.D., et al. 85 F. Supp. 1034 (D.D.C. 1992), the plaintiff challenged HCFA's determination that ESWL is a surgical procedure under the ASC benefit and the amount payable for the services in an ASC setting. The plaintiff alleged that the $1,150 rate was not based on an estimate of "a fair fee" which took into account costs incurred by ASCs performing such services as required by section 1833(i)(Z)(a) of the Act and that the rate was not supported by the administrative record. On March 12, 1992, the United States District Court for the District of Columbia held that HCFA's decision to classify ESWL as a surgical procedure was reasonable. However, it remanded the rate-setting issue in the December 31, 1991 notice to the Secretary for further consideration and stayed the regulation, insofar as it related to lithotripsy, pending remand. On remand, the Secretary is required to publish all material information that is relevant to the setting of the ESWL rate, receive comments, and publish a final notice in accordance with the applicable statutes and regulations. On March 19, 1992 we asked our regional offices to instruct carriers and intermediaries to cease payments to Medicare participating ASCs for ESWL services and to resume calculation of payments for ESWL services furnished in a hospital outpatient setting on a reasonable cost basis. On October 1, 1993, we published a proposed notice in the Federal Register (58 FR 51355) in which we proposed an A payment rate of $1,000 for ESWL. Virtually every commentor objected to our proposed $1,000 ESWL payment rate, the methodology and cost model that we used to set the rate, and the assumptions 1 This is derived from 63 Fed. Reg. 32,290 and 32,315 (June 12,1998). 77

upon which we based the ratesetting methodology and cost model, stating that we had failed to take into account, as required by the statute, the costs incurred by facilities to furnish ESWL services. C. Requirements for Reimbursement An entity must meet certain requirements to be reimbursed as an ASC. This is true regardless of whether the ASC is freestanding, hospital-owned or hospital-based. Reimbursement by Medicare is only provided to ASCs for services on HCFA s ASC list. Exclusions and inclusions from such list are hotly disputed. The definition of an ASC for this purpose is as follows: An Ambulatory Surgical Center or ASC means a supplier that: Has its own National Identifier under Medicare; Is a separate entity with respect to its licensure, accreditation, governance, professional supervision, administrative functions, clinical services, record keeping, and financial aid and accounting systems; Has as its sole purpose the furnishing of services in connection with surgical procedures that do not require inpatient hospitalization; and Meets the conditions and requirements set forth in all subparts of this part. 2 "Hospital-operated ASC" means an ASC that is owned and operated by a hospital but that is a separate entity with respect to its licensure, accreditation, governance, professional supervision, administrative functions, clinical services, record keeping and financial and accounting systems. Once a hospital decides to be reimbursed as an ASC it cannot change its decision. An ASC must also meet the following conditions: Have State licensure in States where licensure is required. Meet the conditions for coverage specified in subpart D of this part and report promptly to HCFA any failure to do so. Charge the beneficiary or any other person on the beneficiary's behalf only the applicable deductible and coinsurance amounts for services for which the beneficiary: o Is entitled to have payment made on his or her be part; or 2 42 U.S.C. 416.2 (1999). 78

o The beneficiary's entitlement period falls within the time the ASC's agreement with HCFA is in effect. Furnish to HCFA, if requested, information necessary to establish payment rates as specified in subpart C, and in the form and manner that HCFA requires; Accept assignment for all items and services that it furnishes to Medicare beneficiaries for which payment may be made under Medicare Part B in connection with procedures on the ASC list. For purposes of this section, assignment means an assignment under 424.55 of this chapter of the right to receive payment under Medicare Part B and payment under 5424.64 of this chapter (when an individual dies before assigning the claim). Are in compliance with ASC requirements set forth in Part 488 - Survey, Certification, and Enforcement Procedures. Have in effect a validated Medicare health care provider/supplier enrollment application. 3 D. ASC List of Reimbursed Procedures Procedures that will be reimbursed at ASCs under the current regulations and policy are determined as follows. First, HCFA has set basic standards. The standards include limits on operating room and recovery time. The general standards in existing Section 416.65(a) define ASC procedures as procedures that are: Commonly performed on an inpatient basis but may be safely performed in an ASC; Not of a type that are commonly performed or that may be safely performed in physicians' offices; Requiring a dedicated operating room or suite and generally requiring a postoperative recovery room or short-term (not overnight) convalescent room; and Not otherwise excluded from Medicare coverage. 4 The HCFA standards traditionally limit ASC procedures to those that do not generally exceed ninety minutes' operating time, a total of four hours recovery or convalescent time and, if anesthesia is required, the anesthesia must be local or regional anesthesia or general anesthesia of not more than ninety minutes duration. 3 Id. at 416.3. 4 Id. 79

The standards are supplemented by HCFA policies used to identify procedures to include on the ASC HCFA list. A HCFA discussion of its traditional policy is as follows: 5 In April 1987, we adopted numerical criteria as a tool for identifying procedures that were commonly performed either in a hospital inpatient setting or in a physician's office. Collectively, commenters responding to a notice published in the Federal Register on February 16, 1984 (49 FR 6023) had recommended that virtually every surgical CPT code be included on the ASC list. Consulting with other specialist physicians and medical organizations as appropriate, our medical staff reviewed the recommended additions to the list to determine which code or series of codes were appropriately performed on an ambulatory basis within the framework of the regulatory criteria in g416.65. However, when we arrayed the proposed procedures by the site where they were most frequently performed according to our claims payment data files (1984 Part B Medicare Data BMAD)), we found that many codes were not commonly performed on an inpatient basis or were performed in an physician's office a majority of the time, contrary to our regulations. Therefore, we decided that if a procedure was performed on an inpatient basis 20 percent of the time or less or in a physician's office 50 percent of the time or more, it should be excluded from the ASC list. (See Federal Register of April 21,1987 (52 FR 13176).) At the time, we believed that these utilization thresholds best reflected the legislative objectives of moving procedures from the more expensive hospital inpatient setting to the less expensive ASC setting without encouraging the migration of procedures from the less expensive physician's office setting to the ASC. We applied these place of service tests not only to codes proposed for addition to the ASC list, but also to the codes that were currently on the list, to delete codes that did not meet the 20/50 site of service thresholds. The trend towards performing surgery on an ambulatory or out- patient basis grew steadily, and by 1995, we discovered that a number of procedures that were on the ASC list at the time fell short of the 20/50 threshold even though the procedures were obviously appropriate to the ASC setting. The most notable of these was cataract extraction with intraocular lens insertion, very few cases of which were being performed on an inpatient basis by the early 1990's. We were also excluding from the ASC list certain newer procedures, such as CPT code 66825. Repositioning of intraocular lens prosthesis, requiring an incision (separate procedure), that from their inception were almost never per- formed on a hospital inpatient basis but that were certainly appropriate for the ASC setting. And, strict adherence to the same 20/50 thresholds both to add and remove procedures did not provide latitude for minor fluctuations in utilization settings or errors that could occur in the site-of-service data drawn from the National Claims History File that we were using, replacing BMAD data, for analysis. In an effort to avoid these anomalies but still retain a relatively objective standard for determining which procedures should comprise the ASC list, we adopted in the last revision of 5 63 Fed. Reg. 32,290 (June 12,1998). 80

the list, which was published in the Federal Register on January 26, 1995 (60 FR 5185), a modified standard for deleting procedures already on the ASC list. We deleted from the list only those procedures whose combined inpatient, hospital out- patient, and ASC site-of-service volume was less than 46 percent of the procedure's total volume, and that were performed 50 percent of the time or more in a physician's office or 10 percent of the time or less in an inpatient hospital setting. We retained the 20/50 standard to determine which procedures should be added to the ASC list. 6 E. ASC Services - Technical Versus Professional Reimbursement provided under the ASC list includes payment for facility services but not professional services. The facility services are defined to include: 7 ASC Services We continue to consider the following to be ASC facility services: the services of nurses, technicians, and other staff involved in patient care; the patient's use of the facility, including but not limited to its operating room, recovery room, waiting room, rest rooms, locker area; administrative, recordkeeping, and house- keeping items and services that constitute indirect overhead expenses, including but not limited to employees and contracted services related to scheduling, admitting, discharging, and billing patients, to maintenance, utilities, laundry, debt service, plant and property costs, and insurance; and, intraocular lenses that are defined by the statute specifically as an ASC facility service. In addition, ASC services include medical and other health services such as surgical supplies, medical equipment, drugs, biologicals, and pharmaceuticals; materials for anesthesia, including the anesthetic itself and any equipment and supplies necessary to administer and monitor anesthesia; and, splints, casts, pins, wires, and other supplies used to reduce fractures and dislocations. Conflicts over reimbursement often arise when ASCs desire to bill for ancillary diagnostic or lab sources. HCFA has provided further guidance on such issues in its current proposed regulations. 8 Current section 416.61(a)(4) states that facility services include "diagnostic or therapeutic services or items directly related to the provision of a surgical procedure." Section 416.61 (b) "excluded services" among other things, "X-ray or diagnostic procedures (other than those directly related to the surgical procedure)..." We have had a number of inquiries as to which diagnostic or therapeutic services are considered within the scope of ASC facility services and which are not. From 6 Id. 7 Id. at 32,312. 8 Id. 81

a payment perspective the distinction is important, to determine if the diagnostic therapeutic services can be paid for separately, in addition to the facility fee. In an effort to clarify the distinction, we have revised the regulation, and we propose to adopt the following policy. We assume that when the descriptor for a CPT code includes explicit reference to some kind of imaging, guidance, or other diagnostic test, the cost, and therefore the ASC payment rate that we have derived for that procedure, include the imaging, guidance, or other diagnostic test, and those services are considered to be within the scope of ASC services. An example of such a procedure is CPT code 56362, Laparoscopy with guided transhepatic cholangiography; without biopsy. In the case of a procedure such as this, because the imaging is explicitly integral to and inseparable from the surgical procedure, it is considered within the scope of service and no separate payment is allowed for the imaging. When the descriptor for a CPT code specifies "with or without" some kind of imaging, guidance, or other diagnostic test, we assume that the cost, and therefore the ASC payment rate that we have derived for that procedure, do not include the imaging, guidance, or other diagnostic hest, and those services are considered to fall outside the scope of ASC facility services. Therefore, the ASC facility fee for the procedure would not include payment for costs incurred to furnish this type of monitoring. There are other procedures, such as CPT code 36533, insertion of implantable venous access port, with or without subcutaneous reservoir, where the physician may or may not elect to use some type of imaging such as a fluoroscope to assist in placing the device. In such cases, we assume that the cost, and therefore the ASC payment rate for procedure, do not include the imaging or guidance. In the case of these procedures, the imaging, guidance, or other diagnostic test is considered to fall outside the scope of ASC facility services, and the ASC facility fee does not include payment for the costs incurred to furnish these services. Payment for the costs incurred by an ASC to perform any tests granted waived status under the Clinical Laboratory Improvement Amendments of 1988 (CLIA) as part of preparing a patient for surgery on the day of surgery is included in the ASC facility fee for the surgical procedure, and no separate payment for these tests is allowed. If an entity that is approved by Medicare as an ASC also wants to be paid by Medicare for diagnostic laboratory services, other than tests granted waived status under CLIA, that entity must meet the laboratory requirements spelled out in 42 CFR Part 493. In this case, the entity would be considered a certified laboratory billing Medicare for certified laboratory services, not as a Medicare approved ASC billing Medicare for ASC facility services. Classification as a certified laboratory or classification as a Medicare approved ASC is, for Medicare billing purposes mutually exclusive. 9 F. Multiple Procedures 9 Id. 82

When more than one procedure is performed on one patient, HCFA rules provide that the second procedure (the lower-priced procedure) is reimbursed at 50% of its rate. (a) Single and multiple surgical procedures. (1) If one procedure on the ASC list is performed in a single operative session, payment of the ASC facility fee is based on the prospectively determined rate for that one procedure. (2) If more than one surgical procedure is furnished in a single operative session, payment is based on: (i) (ii) The full rate for the procedure with the highest prospectively determined rate; and One half of the prospectively determined rate for each of the other procedures. 10 II. PROPOSED PAYMENT METHODS HCFA, as of June 1999, formally proposed an overhaul of the payment methodology for ASCs. 11 Here, it proposed adoption of a system based on ambulatory payment classifications ("APCs"). The APCs effectively expand payment groups from 8 to 105, and include a revised payment amount for lithotripsy. Under the new system, each ASC and hospital-based outpatient department will be paid using the APCs. However, the ASC rates are based on data obtained from a 1999 HCFA study of ASCs. In contrast, the hospital departments are reimbursed using data developed from a 1996 study of hospital data. Each of the current and proposed ASC rate-setting methodologies consists of four major components: (1) determine a per procedure cost for every reported code at the individual facility level, (2) determine a per procedure cost for ever reported CPT code across all facilities, (3) determine the proper classification for procedures, and (4) determine a standard payment rate that is generally a fair all the procedures within each group. The standard payment rate arrive final step becomes the Medicare ASC facility fee or payment rate. 12 Here HCFA comments: In developing the payment rates proposed in this notice, we have retained the same basic methodology that is explained in the final notice published in the Federal Register on February 8,1990 (52 FR 4526) and outlined above. We have introduced a few refinements that we believe enable us to measure more precisely 10 Id. at 32,327. 11 See generally, Id. 12 Id. at 32,301. 83

the costs incurred by ASCs individually and collectively to perform procedures on the ASC list. 13 The 1994 data used for ASCs and the APCs are summarized as follows Summary of Facility Costs ASC Survey Data (HCFA) 295 Facilities Categories of Facilities Costs: Minimum Facility Cost Maximum Facility Cost Average Facility Cost Median Facility Cost Plant and 3,972 1,516,086 268,889 227,521 property Equipment 1,434 1,507,214 164,846 120,307 Supply 3,700 2,098,636 550,070 488,237 Intraocular 327 5,560,666 113,649 66,205 lenses Contractual labor 68 1,223,695 76,793 29,330 Employee labor 11,480 2,488,294 692,779 583,883 Owner s 894 1,457,035 124,454 46,869 comensation Bad debt 101 601,498 65,252 35,440 Other costs 2,181 4,506,573 429,304 318,293 Total costs 55,156 9,674,071 2,300,432 2,130,765 Note: Not all facilities reported data for all categories of cost. The proposed regulations affect a number of different issues. For example, the system dramatically impacts co-payments to be paid by beneficiaries. A. Copayments Beneficiaries pay a copayment equal to 20% of Medicare payments. Under the current outpatient system, however, beneficiaries pay a copayment equal to 20% of the charges for each outpatient service. Because charges have historically risen faster than payments, the current copayment for most services is often greater than 20% of Medicare payments. Under the outpatient PPS, beneficiary copayments are set at 20% of the median charges for each APG group. For those APGs in which the copayment is greater than 20% of the APG payment rate, the copayment amounts will be frozen until increases in program payments over time reduce the copayment share to 20% of total payments. B. Second Procedures; Terminated Procedures 13 Id. 84

The new system also provides for special rules for second procedures and for reimbursement when a procedure is terminated prior to completion. Payments will be discounted in two situations. When more than one procedure is performed during a single operative procedure session, the full Medicare payment would be made for the procedure having the highest APG rate, and 50% of the APG rate would be paid for all other procedures performed during the same operative session. When a surgical procedure is terminated before anesthesia is introduced, the hospital would be paid 50% of the APG rate. By contrast, full payment would be made if the procedure is terminated after anesthesia induction or if the procedure was started (for example, after an incision was made) but terminated before conclusion of the procedure. C. Revised ASC List and Policy The new regulations also articulate clearly the new guidelines for development of the ASC list. Here, HCFA has discontinued use of the numerical criteria and expanded the use of ASCs for slightly more complex procedures. In addition, HCFA has attempted to eliminate certain procedures from the ASC list that can be more readily performed in physicians' offices. The criteria and policies for the ASC list are as follows: 416.22 ASC list. The ASC list consists of those procedures that HCFA, in consultation with appropriate trade and professional associations, specifies as being appropriately and safely performed in an ASC. The criteria HCFA used to determine if a procedure is to be placed on the ASC list are set forth below. (a) Procedures on the ASC list. Procedures on the ASC list are those surgical and other medical procedures that generally: (1) Require surgical facilities and services of the kind are typically provided in a hospital inpatient setting; (2) Would not be expected to necessitate admission as an inpatient to a hospital either to perform the procedure or to recover from the procedure post-operatively; (3) Require a dedicated operating room (or suite) or procedure room and a room for post-operative recovery; and (4) Are not otherwise excluded under 411.15 of this chapter, or paragraph (b) of this section. 14 (b) Procedures excluded from the ASC list. 14 Id. at 32,326. 85

A procedure with any of the following characteristics is not considered safe or appropriate in an ASC setting. A procedure with any of these characteristics is not reasonable or medically necessary in an ASC setting. Payment of an ASC facility fee for procedures excluded from the ASC list in accordance with any of the following characteristics is not allowed. A procedure is exclude from the ASC list if it: D. Controversies (1) Generally results in extensive blood loss; (2) Requires major or prolonged invasion of body cavities; (3) Directly involves major blood vessels; (4) Is generally emergent or life threatening in nature; or (5) Requires admission to a hospital on an inpatient basis in order to have the procedure performed from the procedure. 15 The principal controversies under the new methodology relate to two items. First, the new rates include large reductions in reimbursement for commonly performed urology, ophthalmology and gastroenterology procedures. For example, Arent Fox's report states ophthalmic facilities affected by this proposed rule due to the fact that the two highest volume ASC reimbursed procedures under the Medicare program have been modified. Under the proposed Rulemaking, CPT Code 66984 (Extra capsular cataract removal with IOL) and CPT Code 66821 (Laser surgery, e.g., YAG laser) would experience payment decreases of 7.0% and 35.1% respectively. These two procedures alone represent over 42% of the Medicare program's total volume for ASC services. Other high volume ophthalmic procedures reduced under the proposal include CPT Code 67904 (Tarso, levator resection or advancement, external approach) which has a current payment rate of $595.00. Under the new proposed rate the same procedure will be reimbursed at a rate of $415.00 a 17% decrease in reimbursement. In addition, CPT Code 66170 (Trabeculotomy ab externo in absence of previous surgery) is reduced under the proposed rulemaking from $595.00 to $415.00, representing a decrease of 30%. 16 Further guidance on the reductions was reported as follows by SMG Marketing Group: FOSC ( Freestanding Outpatient Surgery Centers ) Market Faces New Challenges 15 Id. 16 Arent Fox, Dramatic Changes for Ambulatory Surgery Centers Proposed by HCFA, Decem- ber 12, 1998, at http://calvin.arentfox.com/alerts/dram~chg~hcfa.html. 86

According to Mark Mayo, executive director of the Illinois Free- standing Surgery Center Association ("IFSCA"), single-specialty outpatient ophthalmology centers will be hit the hardest by the new APC system. The proposal includes a 7Y0 decrease for cataract procedures and a 35% decrease for YAG (yttrium aluminum garnet) laser procedures, which combined currently makes up half of the Medicare volume. In addition, the system may also redesign the payment rates for intraocular lens ("IOL") procedures later this year. SMG data reveals that 710 of the Medicare certified FOSCs reported cataract surgery as their most common procedure, representing almost 27% of FOSCs. Of these facilities, 441 or 62% perform a lower than average number of surgical procedures. In addition, the data show that 488, or 18.5% of FOSCs, use YAG laser treatment. This is coupled with the fact that ophthalmology cases have already shown a slight decrease in recent years. Certain endoscopic procedures will also take the hit. Those pro- posed to have the largest decreases are: upper G I(22%), colonoscopy (16%), and cystoscopy (32%). At the same time, reimbursements for arthroscopy procedures will increase between 67% and 80%. Knee arthroscopy, in particular, is proposed to increase 36%. Further conflict has also arisen based on HCFA's efforts to increase reimbursement for certain orthopedic procedures. Here, HCFA has increased certain rates to encourage such procedures to be performed in ASCs and not hospitals. 87

6. MEDICARE CERTIFICATION, LICENSING AND CERTIFICATE OF NEED ISSUES FOR ASCS Most ASCs desire and are structured to be eligible to receive reimbursement from the Medicare program. Being eligible to receive reimbursement from Medicare is commonly referred to as being Medicare certified. To be Medicare certified, the ambulatory surgery center must 1. comply with the Medicare conditions of coverage contained in Section 416 of Part B; (2) be certified by a state as in compliance with such conditions or, alternatively, be certified by one of the three national accrediting agencies that have the authority to deem a surgery center in compliance with the Medicare conditions of coverage; (3) meet state licensing requirements, if any, and (4) meet state CON requirements, if any. The Medicare conditions of participation were initially set forth in 1982 when Medicare approved reimbursement for ASCs. Traditionally, the responsibility survey and inspect facilities was a state agency responsibility. As of 1996, this responsibility may be handled either by a state or a national accrediting agency. The accrediting agencies, in exchange for a fee paid by the ASC, then serve as the surveying agency of the center to review compliance with the conditions of coverage. The three authorized accrediting agencies are the Joint Commission on the Accreditation of Healthcare Organizations ("JCAHO"), the Accreditation Association for Ambulatory Health Care ("AAASC") and the American Association of Ambulatory Surgery Facilities. The intent of the government in using third-party accrediting agencies is to lessen the burden on the states to handle reviews and inspections. The first two agencies will be discussed in detail in this chapter. Even though ASCs are permitted to use third-party accrediting agencies, states are still permitted to set additional requirements for certification as an ambulatory surgery center. For example, many states continue to have separate licensing and certificate of need programs. Medicare will not certify an ambulatory surgery center for inclusion in the Medicare program unless an ambulatory surgery center complies with the specific licensure or certificate of need programs of the state in question. This chapter discusses each of the Medicare conditions of coverage, and the authority of the national accrediting bodies to accredit ambulatory surgery centers. It also provides a review of common licensing and certificate of need issues in the context. I. Medicare conditions of Coverage The Medicare conditions of coverage are set forth in sub-sections of Section 416 set forth requirements and definitions relating to items such as: the definition of an ASC; the ability to be "deemed" in compliance; 88

the inclusion of hospital-based ASCs; the ASC's physical plant and environment; the quality review; the organization of the medical staff; the required policies and procedures; the governing body and management; the provision of noncovered services. Many of these sections are reproduced below. A. Definition of an ASC Section 416.2 definitions. As used in this part: Ambulatory surgical center or ASC means any distinct entity that operates exclusively for the purpose of providing surgical ser- vices to patients not requiring hospitalization, has an agreement with HCFA to participate in Medicare as an ASC, and meets the conditions set forth in subparts B and C of this part. B. Deemed Compliance Section 416.26. Qualifying for an agreement. (a) Deemed compliance. HCFA may deem an ASC to be in compliance with any or all of the conditions set forth in subpart C of this part if (1) The ASC is accredited by a national accrediting body, or licensed by a State agency, that HCFA determines pro- vides reasonable assurance that the conditions are met; (2) In the case of deemed status through accreditation by a national accrediting body, where State law requires licensure, the ASC complies with State licensure requirements; and (3) The ASC authorizes the release to HCFA of the findings of the accreditation survey. C. Hospital Operated ASCs Section 416.30. Terms of agreement with HCFA. 89

(f) ASCs operated by a hospital. In an ASC operated by a hospital - (1) The agreement is made effective on the first day of the next Medicare cost reporting period of the hospital that operates the ASC; and (2) The ASC participates and is paid only as an ASC, without the option of converting to or being paid as a hospita1 outpatient department, unless HCFA deter there is good cause to do otherwise. (3) Costs for the ASC are treated as a non-reimbursable cost center on the hospital's cost report. D. Governing Body Requirements Section 416.4(1) Condition for coverage governing body and management. The ASC must have a governing body that assumes full legal responsibility for determining, implementing, and monitoring policies governing the ASC s total operation an ensuring that these policies are administered so as to provide quality healthcare in a safe environment. When service provided through a contract with an outside resource, the must assure that these services are provided in a safe an effective manner. Standard: Hospitalization. The ASC must have an effective procedure for the immediate transfer to hospital of patients requiring emergency medical care b the capabilities of the ASC. This hospital must be a local, care participating hospital or a local, nonparticipating hospital that meets the requirements for payment for emergency services under 482.2 of this chapter. The ASC must have a written transfer agreement with such a hospital, or all physicians performing surgery in the ASC must have admitting privileges at such hospital. E. Quality Review Section 416.43. Condition for coverage evaluation of quality. The ASC, with the active participation of the medical staff, must conduct an ongoing comprehensive self-assessment of the quality of care provided, including medical necessity of procedures performed and appropriateness of care, and use findings, when appropriate, in the revision of center policies and consideration of clinical privileges. F. Environment Section 416.44. Condition for coverage environment. 90

The ASC must have a safe and sanitary environment, constructed, equipped, and maintained to protect the health and safety of patients. (a) Standard: Physical environment. The ASC must provide a functional and sanitary environment for the provision of surgical services. (1) Each operating room must be designed and equipped so that the types of surgery conducted can be performed in a manner that protects the lives and assures the physical safety of all individuals in the area. (2) The ASC must have a separate recovery room and waiting area. (3) The ASC must establish a program for identifying and preventing infections, maintaining a sanitary environment, and reporting the results to appropriate authorities. (b) Standard: Safety from fire. (1) Except as provided in paragraphs (b) (2) and (3) of this section, the ASC must meet the provisions of the 1985 edition of the Life Safety Code of the National Fire Protection Agency (which is incorporated by reference) that are applicable to ambulatory surgical centers. G. Medical Staff Section 416.45. Condition for coverage medical staff. The medical staff of the ASC must be accountable to the governing body. (a) (b) (c) Standard: Membership and clinical privileges. Members of the medical staff must be legally and professionally qualified for the positions to which they are appointed and for the performance of privileges granted. The ASC grants privileges in accordance with recommendations from qualified medical personnel. Standard: Reappraisals. Medical staff privileges must be periodically reappraised by the ASC. The scope of procedures performed in the ASC must be periodically reviewed and amended as appropriate. Standard: Other practitioners. If the ASC assigns patient care responsibilities to practitioners other than physicians, it must have established policies and procedures, approved by the governing body for overseeing and evaluating their clinical activities. 91

H. Records Requirements Section 416.47. Condition for coverage medical records. The ASC must maintain complete, comprehensive, and accurate medical records to ensure adequate patient care. (a) (b) Standard: Organization. The ASC must develop and maintain a system for the proper collection, storage, and use of patient records. Standard: Form and content of record. The ASC must maintain a medical record for each patient. Every record must be accurate, legible, and promptly completed. Medical records must include at least the following: (1) Patient identification. (2) Significant medical history and results of physical examination. (3) Pre-operative diagnostic studies (entered before surgery), if performed. (4) Findings and techniques of the operation, including a pathologist's report on all tissues removed during surgery, except those exempted by the governing body. (5) Any allergies and abnormal drug reactions. (6) Entries related to anesthesia administration. (7) Documentation of properly executed informed patient consent. (8) Discharge diagnosis. I. Pharmaceutical Requirements Section 416.48. Condition for coverage pharmaceutical services. The ASC must provide drugs and biologicals in a safe and effective manner, in accordance with accepted professional practice, and under the direction of an individual designated responsible for pharmaceutical services. (a) Standard: Administration of drugs. Drugs must be prepared and administered according to established policies and acceptable standards of practice. 92

(1) Adverse reactions must be reported to the physician responsible for the patient and must be documented in the record. (2) Blood and blood products must be administered by only physicians or registered nurses. (3) Orders given orally for drugs and biologicals must be followed by a written order, signed by the prescribing physician. J. Laboratory Services Section 416.49. Condition for coverage laboratory and radiologic services. If the ASC performs laboratory services, it must meet the requirements of part 493 of this chapter. If the ASC does not provide its own laboratory services, it must have procedures for obtaining routing and emergency laboratory services from a certified laboratory in accordance with part 493 of this chapter. The referral laboratory must be certified in the appropriate specialties and subspecialties of service to perform the referred tests in accordance with the requirements of part 493 of this chapter. The ASC must have procedures for obtaining radiologic services from a Medicare approved facility to meet the needs of patients. K. Included Versus Excluded Services Section 416.61. Scope of facility services. (b) Excluded services. Facility services do not include items and services for which payment may be made under other provisions of Part 405 of this chapter, such as physicians' services, laboratory, X-ray or diagnostic procedures (other than those directly related to performance of the surgical procedure), prosthetic devices (except IOLs), ambulance services, leg, arm, back and neck braces, artificial limbs, and durable medical equipment for use in the patient's home. In addition, they do not include anesthetist services furnished on or after January 1,1989. II. OBTAINING A MEDICARE PROVIDER NUMBER The actual effort to obtain a Medicare provider number focuses on two efforts. First, one needs to complete the application HCFA Form 855. Second, and with more difficulty, one must shepherd the application through the various bureaucratic channels. The typical process involves first providing the HCFA application, with licensing application, if any, to a state agency. The state agency, once it has completed its review (including any survey for licensing purposes), will forward the application to the regional carrier (often a Blue Cross, Wisconsin Physicians Service, or other entity) that handles 93

applications for the state in question. The carrier will often ask for additional information and attempt to verify certain information. Of late, carrier efforts have focused heavily on review of management and collections and billings arrangements. Often, the provider will be asked to make changes to such agreements based on the carrier's review. Finally, once the carrier has completed its effort, the application will be provided to HCFA itself, in most regions, to actually issue the provider number. A number of observations can be made about the process. First, it differs from the state process. Thus, we suggest that one make phone calls to state and federal agencies to understand the exact process in the applicable state. Second, it is necessary to continually follow up with the agencies to keep the process moving. Third, the processes have slowed down greatly in many states. Here, getting applications in quickly is critical because applications are generally processed in the order they are received. Fourth, expect to do some follow-up work on the application at the request of the carrier. Here, the contracts should include the right to amend agreements to comply with carrier requests. Fifth, keep exact records of your processing in terms of filing, follow-up phone calls and follow-up correspondence. This can be used to prod the agencies to act more quickly. Sixth, ensure that you and your client understand the importance and meaning of the application. Inaccurately completed applications now turn into qui tam cases. Parties assert that if the initial application was not accurate, all claims filed under the provider number are false claims. III. ACCREDITING AGENCIES DEEMED COMPLIANCE In 1996, HCFA approved both the JCAHO and AAAHC to evaluate ASC compliance with HCFA conditions of coverage. 1 This effort greatly enhanced the ability of ASCs to move forward with certification efforts in a timely manner. In granting the authority to an agency to deem an ASC in compliance, HCFA effectively surveys the accrediting agency to ensure that it is capable of performing its role and to ensure that its conditions meet or exceed HCFA's. HCFA, in establishing deemed compliance, articulated its goals as follows: A. Enacting Deemed Status This notice grants deemed status to two organizations, the Joint Commission on the Accreditation of Healthcare Organizations (JCAHO) and the Accreditation Association for Ambulatory Health Care (AAAHC), for their accredited ambulatory surgical centers (ASCs) that request Medicare certification. We believe that accreditation of ASCs by either organization demonstrates that all Medicare ASC conditions are met or exceeded, and, thus, we grant deemed status to each organization. 2 Section 1865 of the Act includes a provision that permits ASCs to be exempt from routine surveys by the state survey agencies to determine compliance with the 1 61 Fed. Reg. 67,041 (Dec. 19,1996). 2 Id. 94

Medicare conditions for coverage. Specifically, section 1865(b) of the Act provides that if we find that accreditation of a provider entity by a national accrediting body demonstrates that all Medicare conditions or requirements are met or exceeded, we would (for certain providers, including ASCs) deem these entities as meeting the applicable Medicare conditions. Under our regulations at 42 CFR 416.40 ( Condition for coverage-compliance with State licensure law ), an ASC must still meet the State's licensure requirements. 3 B. Reviewing the Agency Here, HCFA also points to the following as its standards for review of the accrediting agency. In making our finding as to whether the accreditation body demonstrates all Medicare conditions or requirements, we consider factors such as the body's accreditation requirements, its survey procedures, its ability to provide adequate resources for conducting required surveys and supplying information for use in enforcement activities, its monitoring procedures for provider entities found to be out of compliance with the conditions or requirements, and its ability to provide us with necessary data for validation. 4 Under revised section 1865(b)(2) of the Act and our regulations at 488.8 ( Federal review of accreditation organizations ), our review and evaluation of a national accreditation organization was conducted in accordance with, but was not necessarily limited to, the following factors: The equivalency of an accreditation organization's requirements for an entity to our comparable requirements for the entity. The organization's survey process to determine for the following : o The composition of the survey team, surveyor qualifications, and the ability of the organization to provide continuing surveyor training. o The comparability of its process to that of State agencies, including survey frequency, and the ability to investigate and respond appropriately to complaints against accredited facilities. o The organization's procedures for monitoring providers or suppliers found by the organization to be out of compliance with program requirements. These monitoring procedures are used only when the organization identifies noncompliance. If noncompliance 3 Id. at 67,042. 4 Id. 95

is identified through validation reviews, the survey agency monitors corrections as specified at 488.7(b)(2). o The ability of the organization to report deficiencies to the surveyed facilities and respond to the facility s plan of correction in a timely manner. o The ability of the organization to provide us with electronic data in ASCII comparable code and reports necessary for effective validation and assessment of the organization's survey process. o The adequacy of staff and other resources. o The organization's ability to provide adequate funding for performing required surveys. o The organization's policies with respect to whether surveys are announced or unannounced. The accreditation organization's agreement to with a copy of the most current accreditation survey together with any other information related to the survey as we may require (including corrective action plans). 5 HCFA, in responding to public comments, addresses the inter accreditation and state licensure as follows: Under 42 CFR 488.8(f)(8) an affected ASC ret status for 60 days after notification and it can be extended an additional 60 days if we determine that the ASC submitted an application within the initial 60-days time frame to another approved accreditation organization or to us so that compliance with Medicare conditions can be determined. An ASC's failure to do so will jeopardize its participation in the Medicare program. Comment: One commenter requested that HCFA address the issue of an ASC applying to a deemed accreditation organization for Medicare certification based on its accreditation when the ASC is exempted by its State from licensure requirements. The commenter gave the example of an entity qualifying as a physician's office which is exempt from licensure under State law. In this case, the comrnenter concluded the accreditation organization would request that the ASC produce either a license or evidence of exemption from licensure. Response: Section 416.26(a)(2) requires that facilities seeking Medicare certification as ASCs based on their accreditation by either JCAHO or AAAHC comply with State licensure requirements where applicable. Therefore, in the example cited, the commenter is correct in stating that the accreditation 5 Id. at 67,042-43. 96

organization would request a license or evidence of exemption if the State permits a physician's office to operate as an ASC. Comment: One commenter questioned if deemed status will apply to physicians' offices that meet the standards set by AAAHC for ASCs but do not otherwise qualify as ASCs as defined by State laws. Response: As previously stated, if State Law requires a license for a facility to operate in that State as an ASC, such requirement must be met before an entity such as a physician's office accredited by the JCAHO or AAAHC under its ASC accreditation pro- gram can be granted deemed status for Medicare certification as an ASC. 6 IV. CERTIFICATE OF NEED AND STATE LICENSING OF ASCS This section focuses on the applicability of CON and licensing laws to ASCs. Then, it specifically discusses exemptions to CON and licensure and common issues raised in attempting to obtain a CON for an ASC. Two state-specific questions must be addressed immediately for all ASC projects, whether developments, acquisitions or expansions: (1) does the state license ASCs, and (2) does the state require a CON for an ASC? If the answer to either of these questions is yes, one focuses on whether there are exemptions to the licensure or CON requirements. If no exemptions are available, one focuses efforts on obtaining the CON and/or license. A. Common Exemptions and Related Issues Exemptions are commonly provided for a number of actions. For example, one state articulates the following situations as not qualifying as an ASC and thus not requiring a license or CON. 7 The following is a typical exemption: (2) Ambulatory surgical facility does not include: (i) The office of one or more health care practitioners seeking only professional reimbursement for the provisions of medical services, unless: 1. The office operates under contract or other agreement with a payor as an ambulatory surgical facility regardless of whether it is paid a technical or facility fee; or 6 Id. at 67,045. 7 Md. Health Gen. 19-3B-01 (1998). 97

2. The office is designated to receive ambulatory surgical referrals in accordance with utilization review or other policies adopted by a payor; (ii) (iii) Any facility or service owned or operated by a hospital and regulated under Subtitle 2 of this title; The office of a health care practitioner with not more than one operating room if: 1. The office does not receive a technical or facility fee; and 2. The operating room is used exclusively by the health care practitioner for patients of the health care practitioner; (iv) The office of a group of health care practitioners with not more than one operating room if: 1. The office does not receive a technical or facility fee; and 2. The operating room is used exclusively by members of the group practice for patients of the group practice; or (v) An office owned or operated by one or more dentists licensed under the Health Occupational Article. 8 Counsel in many situations is charged with determining whether an exemption is available and what steps must be taken to meet the exemption's conditions. Exemptions are often provided for : relocations expenditures below a certain amount practice-related surgery expansion below a certain amount or size Operation by an HMO Change of ownership or acquisition. The goal is to receive as much certainty as possible that the operation meets an exemption so as to avoid a situation where, as a result of private party or state action, the 8 98

ASC (even if built out) cannot be licensed, certified or used. For example, a response from the State of Georgia to one request to perfect an exemption was drafted as follows: Marcelo N. Corpuz, III Ross and Hardies 150 North Michigan Avenue Chicago, Illinois 60601-7567 RE: Request For Letter of Non-Reviewability For Physician Owned, Single Specialty Ambulatory Surgical Facility Dear Mr. Corpuz: The State Health Planning Agency is in receipt of your correspondence of March 12,1999, requesting a letter of non-reviewability for a physicianowned ambulatory surgery center. Thank you for your efforts to comply with the State's Certificate of Need ( CON ) laws... It is the understanding of the Agency that Drs. V, W, X Y and Z are owners of a single group practice, XYZ Associates, P.A., which is a single specialty orthopedic practice. These five physicians plan to construct a new medical office building, to be located in Georgia. The medical office building will house their clinical practice, and will also include an ambulatory surgery suite. The surgery center will be operated by a limited liability company to be known as XYZ Surgery Center, LLC. These five physicians are the only persons who will perform surgical procedures in the proposed office based surgical facility, and all have documented ownership interests in both the group practice and the entity that will operate the surgery center. The proposed office based surgery suite will comprise approximately 5,000 square feet, and have two (2) operating rooms. The capital expenditure to establish the center will be approximately $1,050,365. This amount includes $400,000 for capital construction, and $650,365 for new and used equipment. Any surgeons who may wish to operate in the center in the future must have documented ownership interests in both the medical practice entity and a separate surgical center entity. Based on the foregoing information, the Agency can classify this surgical center as a single-specialty, physician owned, ambulatory surgery facility. Please accept this letter as an official letter of non-reviewability for this site. I hope that this letter adequately addresses this issue. Please do not hesitate to contact the Agency should there be any further questions or concerns about this matter. 99

Sincerely, General Counsel cc: Health Care Section (ORS) The exemption letter articulates both a limit on use to practice-affiliated surgeons and a limit on expenditures. Even if an exemption letter is granted, however, practitioners must be aware that the issuance of the exemption letter may be challenged administratively or in court. Thus, it is incumbent upon the ASC's legal counsel to be able to defend the assertions and representations made in the initial request for an exemption. Accordingly, the practitioner must be able to substantiate all facts and figures with the proper documentation (e.g., copies of contracts, agreements, etc.). A failure to do so may result in the rescission of the exemption letter. Common Exemption Issues Issues often raised in the ASC exemption process are: Will the ASC meet a group practice exemption? Can the center do 23-hour cases? Can the expansion or buildout be structured to fit below a certain dollar threshold? Practice-Based Exemption Many states provide that licenses or CONS are not needed for practice officebased ASCs. Requirements to meet the exemption vary from state to state. Conditions often include: Medicare certification will not be pursued. Only practice-affiliated doctors may use the ASC. The state may impose a limit on the number of operating rooms and/or the amount of ASC expenditures. For example, the following provision permits office-based surgery to be per- formed without a CON or license as long as the ASC is used by a single practice and expenditures are below $1,000,000. (iii) Surgery in an operating room environment, including but not limited to ambulatory surgery; provided, however, this provision shall not apply to surgery 100

performed in the offices of an individual private physician or single group practice of private physicians if such surgery is performed in a facility that is owned, operated, and utilized by such physicians who also are of a single specialty and the capital expenditure associated with the construction, development, or other establishment of the clinical health service does not exceed the amount of $1 million 9 A similar Kentucky provision exempts offices from CON unless they attempt to obtain Medicare certification: (2) Nothing in this chapter shall be construed to authorize the licensure, supervision, regulation, or control in any manner of: (a) (b) Private offices and clinics of physicians, dentists, and other practitioners of the healing arts, except any physician's office that meets the criteria set forth in KRS 216B.015(4); Office buildings built by or on behalf of a health facility for the exclusive use of physicians, dentists, and other practitioners of the healing arts; unless the physician's office meets the criteria set forth in KRS 216B.015(4), or unless the physician's office is also an abortion facility as defined in KRS 2168.015, except no capital expenditure or expenses relating to any such building shall be chargeable to or reimbursable as a cost for providing inpatient services offered by a health facility. 10 Another type of office exemption permits practice use as long as the principal use is for the practice. Many states have this type of concept. (vii) Ambulatory surgical facility means a facility primarily organized or established for the purpose of performing surgery for outpatients and is a separate identifiable legal entity from any other health care facility. Such term does not include the offices of private physicians or dentists, whether for individual or group practice, and does not include any abortion facility as defined in Section 41-75-1 (e). 11 23-Hour Stay Cases As more procedures have moved to ASCs, debate has focused on whether the ASC can perform cases that require a 23-hour stay or a stay longer than four hours. The Medicare procedures list has traditionally been developed using the pr that only cases that require less than a four-hour recovery will be placed on its list. In policies and licensing for 9 Ga. Code Ann. 31-6-2 (1998). 10 Ky. Rev. Stat. Ann. 5 216B.020 (1998). 11 Miss. Code Ann. 9 41-7-173 (1998). 101

ASCs, states have either used HC or developed their own criteria for the types of cases that can be performed in ASCs. States using the ASC standards will often limit the ASC to cases that do not require 23- hour or overnight recovery. Many other states will permit non-medicare 23-hour stay cases to be performed. As Medicare changes its criteria to expand the ASC list to 3-hour cases an payors add further pressure to use the lowest-cost sites for surgery, it is likely that more and more states will permit 23-hour recovery cases in ASCs. Expenditure Limitations Many states permit expansion of ASCs or the provision of surgical services as long as the expenditures are below a certain limit. For these states, it is critical to understand what expenditures are counted toward the limits. For example, in many states, the ASC is permitted to exclude expenditures made by the landlord, expenditures for the shell of the building and expenditures that will be leased or that will be operating expenditures. By carefully defining what is and what is not included in expenditure limits and confirming by letter such inclusions and exclusions with state, it is often possible to build a much larger plant and ASC than one anticipated. B. Certificate of Need Required As of 1999, approximately half of all states have Certificate of that are applicable to ASCs. CON Procedures and Issues Certificate of need applications and procedures differ greatly fro In terms of procedure, most states require that a letter of intent be filing of the actual certificate of need application. In certain states, these letters of intent can be submitted at any time during the year. In other states, the state requires that a strict schedule be adhered to. 12 For example, letters of intent must be filed by a certain date set forth in the calendar and then applications must be filed within a certain period of time thereafter. Hearings are held thereafter. For example, Virginia and Kentucky each adhere to a specific planning calendar. Illinois and Iowa allow filing at any time. The letter of intent, depending upon the state, can either be very specific or can be quite general. For example, in certain states, the party applying for the certificate of need is 12 In some states, rather than waiting for applications, the state declares a need and seeks applications. In keeping with the requirements of P.L. 93-641, as amended by EL. 96-79, Section 1523(a) (l)(b) the State Agency, in consultation with the Statewide Health Coordinating Council, has determined that there is statewide need for dedicated outpatient surgery facilities in locations throughout the State where there are sufficient number of surgical procedures to justify the existence of one or more dedicated outpatient surgery units. See Washington Regional Medical Center v. Medical Care International, Inc. 711 S.W.2d 457, 460 (Ark. 1986). 102

required to set forth in detail such issues as the exact location of the intended surgery center, the exact number of operating rooms and the sources of financing. In other situations, a more general statement as to city location and preliminary plans can be set forth at the letter of intent stage. In each situation, at the application stage, it is usually required that much greater detail be provided and much greater specificity be provided regarding the plans. The letter of intent, in addition to informing the planning board that an application will be forthcoming, also informs potential opposing parties to the certificate of need that an application will be submitted. Here, the letter of intent may lead parties to submit a competing application. Alternatively, it may lead opposing parties to either prepare to oppose the application or amend their own plans to make it more difficult to obtain the certificate of need. For example, a hospital not restricted by the CON law may announce a plan to expand or to open up operating rooms not being used to make it more difficult to show that CON criteria based on usage of operating rooms are met. Opening more operating rooms will decrease the average cases per operating room in the certificate of need area. CON Criteria Objective Versus Subjective The criteria used to judge a certificate of need application differs from state to state. Principally, it differs in that the states may employ an objective standard or a subjective set of criteria to judge applications. For example, in many states, the determination as to whether a certificate of need will be granted is a function of a numeric calculation. This calculation can relate to either population per operating room or per services in the community 13 or to the number of cases being performed per operating room in the certificate of need area. Alternatively, a state may use a more subjective set of criteria to judge CON. In Mississippi, for example, the 1992 State Health Plan at page 1-1-2 lists the following general certificate of need policies: General Certificate of Need Policies: The general purposes of health planning in Mississippi are to: (1) Improve the health of Mississippi residents; (2) Increase the accessability acceptability, continuity, and quality of health services; (3) Prevent unnecessary duplication of health resources; and (4) Provide some cost containment. Similarly, in Connecticut, the state traditionally has judged applications as follows: 13 For example, one court points to the objective criteria being used as follows: It is clear from the record that a population base of approximately 200,000 to 300,000 is required before these type services may be approved and the facility proposing the service must prove that it has the referral network to ensure the caseload required. Magnolia Hospital us. Mississippi State Department of Health, 559 So. 2d 1042,1044 (Miss. 1990). 103

In its deliberations...the commission shall take into consideration and make written findings concerning each of the following criteria: (1) the relationship of the proposal to the State Health Plan; (2) the relationship of the proposal to the applicant's long-range plan; (3) the financial feasibility of the proposal, and its impact on the applicant's rates and financial condition; (4) the proposal's contribution to quality, accessibility and cost- effectiveness in health care delivery in the region; (5) the relationship of the proposed change to the applicant's current utilization statistics; (6) the teaching and research responsibilities of the applicant; (7) the special characteristics of the patient-physician mix of the applicant; (8) the voluntary efforts of the applicant in improving productivity and containing costs; (9) and any other facts which this commission deems relevant, including... such factors as, but not limited to, the business interests of all owners, partners, associates, incorporators, directors, sponsors, stockholders and operators... CON Application Core Concepts A proponent for a certificate of need should attempt to develop three or four core concepts that will serve as the core arguments in the application and through the hearing process for the certificate of need. These core concepts will often relate to the ability to provide care at lower cost than in the hospital setting, the ability to ease overcrowding of area operating rooms and the ability to provide greater access and care to indigents. A mix of statistics, analysis and community support is used to make these arguments. Tools used to support applications often include: letters from payors letters from local businesses support from doctors support from patients 104

population data support from national health care and consulting experts case volume data price data indigent care service commitments maps demonstrating service area. Data is often obtained from private entities as well as state and local government sources (e.g., HCFA, SMG, Marketing Group, Inc., etc.). Reduced Costs To make the case as to lower costs to patients and payors, one may attempt to support the position of lower cost by showing such items as: A comparison of invoices at local hospitals for outpatient procedures for the last couple of years versus the expected price of services at the pro- posed ambulatory surgery center; Showing the difference in co-payments for Medicare patients for procedures performed at a hospital as opposed to procedures performed in an ambulatory surgery center. Because the co-payment at the hospital is based on a charges calculation or a cost calculation, and the co-payment at the ASC is based on the Medicare groupings, the co-payment paid by the patient is usually significantly lower at an ASC. Note that this difference is expected to continue for comparisons of hospital outpatient departments versus ASCs even with the development of APCs, because of the difference in the method by which the APCs for ASCs as opposed to outpatient departments are being calculated. Letters from payors and community groups indicating their expectation that an ambulatory surgery center will be able to provide lower-cost ser- vices than the current hospital providers. An example of one table detailing the differences in costs is as follows: AVERAGE FACILITY FEE AND AVERAGE FEE OF ALL HOSPITAL-AREA PROVIDERS FOR COMMON OUTPATIENT PROCEDURES Medicare Medicare Average ASC Average Procedure Category ASC Rate Fee Hospital Fee 1. IOL (cataract) 8 $928 $1,225 $1,600 105

2. Hernia repair 4 $592 $900 $2,183 3. Colonoscopy 2 $419 $650 $1,944 4. Tonsillectomy 5 $675 $1,000 $1,363 5. Knee 3 $480 $1,700 $3,300 arthroscopy 6. Epidural pain 1 $312 $550 $700 blocks 7. YAG laser 2 $408 $525 $930 capsulotomy 8. Breast biopsy 1 $312 $750 $800 9. Lap. $3,500 $5,200 Cholecystectomy 10. Laparoscopy 5 $675 $750 $2,648 Note: Currently, laporoscopic cholecystectomy is not reimbursed as a Medicare procedure. It is expected that approximately 33% of the surgery center surgeries will be reimbursed by Medicare. All ASC reimbursement figures are approximations. Medicare reimbursement rates do not factor in the CPI-U index for area. Thus, they will vary slightly. Operating Rooms Are Busy A second core argument focuses on demonstrating that operating rooms in the community are very busy. Here, there is often flexibility in the use of assumptions that affect conclusions as to capacity (i.e., whether operating rooms are either extremely busy or not too busy). As a general rule, if more than 950 to 1,000 cases per year per operating room in the certificate of need area are being performed, it may be easy to demonstrate that operating rooms are busy. In contrast, if operating rooms are being used for less than 700 or 800 cases per year, it is hard to demonstrate a need based completely on the undercapacity of operating rooms. Factors that affect the calculation of operating room usage include: Population growth. Number of cases per population. Difference of population between elderly and nonelderly. Definition of the geographic radius of the certificate of need community. In many states, the state does not specifically define what needs to be included in the certificate of need planning area. Thus, for example, by excluding an outlying community hospital that is not busy, it will be much easier to show statistically that the core area has operating rooms that are very busy. 106

Breaking down the cases in the area into inpatient and outpatient cases. Applying expected number of minutes per case to operating rooms in the area. For example, an inpatient case may take an average of 90 to 120 minutes, and an outpatient case may take only 40 or 50 minutes. By using these and by taking the total amount of time that an operating room is open per year, one can demonstrate the amount of capacity in cases per operating room in the community. Then, if one can demonstrate that use is about 1,000 cases per operating room on average and that the addition of two operating rooms would not significantly reduce capacity, then it may be possible to show a need for additional operating rooms. Using Assumptions State Guidelines. Because of the amount of manipulation that has been and can be done with this type of data, many state planning boards have developed specific rules to guide calculations. For example, the state may categorically set the radius for the CON planning area, dictate the number of minutes per case or dictate the threshold number of cases per operating room that can be performed. The State of Illinois, for example, requires that all operating rooms within thirty minutes of the planned site be included in the data and calculations. Here, parties then attempt to demonstrate that certain operating rooms are really more than thirty minutes away as opposed to within thirty minutes. Building While on Appeal In many situations, a hearing officer or the planning department or board has approval of certificate of need. Then, however, another party may contest the certificate of need at an appellate level. In certain of these situations, after the initial grant, the provider granted the certificate of need has moved forward to begin development of the facility. Here, case law indicates that moving forward with development is done with significant risk. One court noted this issue as follows: We are not unaware of the fact that MMC elected to build the North Campus facility prior to receiving this Court's ruling on the validity of the project. It must be considered unwise for any litigant to take costly steps in anticipation of a favorable ruling by this Court. In the case of the appeal of a ruling which was reversed once by the Chancellor, and which only narrowly avoided reversal a second time, this action must be considered a risk assumed solely by MMC. The fact that a litigant has taken such costly steps in anticipation of a ruling by this Court should not, of course, affect the course of this Court's deliberations. To do otherwise would be to abdicate our role as highest court of this State. It is our hope that MMC's motivation in building the North Campus project prior to our decision was not to present this Court with a fait accompli which we would be unwilling to disturb. 14 14 St. Dominic-Jackson Memorial Hospital v. Mississippi State Department of Health, 728 So. 2d 81 (Miss. 1998). 107

Review of Alternatives A third key CON effort focuses on demonstrating that the ASC is the preferred expansion mode for the community. Here, it is typical to address other key alternatives and then articulate that the ASC is the preferred plan. An example of this discussion is as follows. There are four possible alternatives to the proposed project. Each of the four alternatives is either not practicable, or does not offer the same efficiencies an benefits as the proposed Facility. Utilization of Other Freestanding Outpatient Surgery Facilities. The closest freestanding ambulatory surgery centers are located nearly eighty (80) miles away in Davenport, Iowa. The growing needs of patients within the primary service area, and the great distance to other ambulatory surgery centers, make this an impractical a1ternative to the current overutilization problem in Des Moines County and the surrounding counties. Hospital Alternatives to Multispecialty Freestanding ASC. The hospital operating room typically does not offer cost efficiencies for outpatient surgery. For example, studies have indicated that the average supply cost per equivalent procedure is highly dependent on the ownership and setting of the facility and that hospital supply costs are typically much higher than ASC supply costs per procedure. Hospital settings simply do not provide the incentives to utilize resources efficiently. The higher costs resulting from inefficient use of supplies ultimately results in higher costs to patients and payors. Moreover, remodeling a hospital to facilitate the improved provision of surgery is likely to be extremely costly and more expensive as compared to building a freestanding ambulatory surgery center. In fact, the Hospital has stated that remodeling would be as expensive as building the new proposed facility. Such costs are then passed on to payors and patients. Construction of a new hospital facility in the Hospital area will be significantly more costly, higher than construction costs associated with the Facility. Hospital projects cost of a new hospital to equal $72 million. Moreover, note that the timing of the proposed project appears peculiar in that Hospital stated approximately two (2) years ago that it expected such move to Area to be made in the longer term future rather than in response to plans to build an outpatient facility by PHC. At the same time it was reported that Hospital had informed a bond rating service (Moody's) that it had no more plans for capital improvements within the next ten (10) years. Hospitals also do not allow for certain benefits envisioned for the Facility such as: 108

Each of hospital based ambulatory surgical centers and hospital based same day surgery result in higher costs to payors and out of pocket costs to patients in the form of higher coinsurance payments. The Facility's design is small as opposed to a large institution which has considerably greater expense and delay required for construction, development and internal transportation needs (Hospital estimates at least two to three years to build a new hospital). Patient convenience is enhanced with easy access, convenient parking and shorter distances. Anesthesia induction and block rooms will reduce turnover time and improve patient care. The small team prevents dilution of care and potential errors when patient care is transferred. Many health planning authorities have determined a need for freestanding ambulatory surgery center capacity irrespective of hospital operating room capacity. This is because hospital operating rooms and freestanding ambulatory surgery centers are distinctly different in terms of cost, quality of care and physician efficiency. Often, they are not viewed as simple substitutes for one another. Establish a Hospital Owned and Operated Freestanding ASC. As indicated in studies by SMG Marketing Group, charges in hospitalowned freestanding ambulatory surgery centers are typically at least twenty-five percent (25%) higher than charges in independently owned ambulatory surgery centers. Thus, as of 1995, approximately eighty percent (80%) of the nation's freestanding surgery centers were independently owned. It is widely contended that hospitals have been slow to build ASCs because Medicare allows hospitals reimbursement for the same cases at a higher rate than ambulatory surgery centers. Therefore there is no incentive for hospitals to create ambulatory surgery centers. Moreover, if built, Medicare allows hospitals to charge patients higher amounts per case than independent ASCs. This translates to a large difference in costs to payors and in patient co-payment responsibility. Surgery in Doctors' Offices. 109

V. SUMMARY The investment required to provide appropriate in office capacity for surgery and to ensure top quality care and personnel is large and must be shared by multiple specialties and groups to make it efficient. Medicare certification is required for reimbursement of many procedure a certificate of need. A strong knowledge of the impact of and relationship between certification, licensing and CON issues is needed to advise clients as to their options. This knowledge should help one develop and explain options and should shorten the period between conceptualizing a project and actually moving a project to completion. 110

AFTERWORD: THE OIG SAFE HARBOR As this monograph went to press, the Office of the Inspector General of the United States Department of Health and Human Services (the OIG ) released a final safe harbor for ambulatory surgical centers ( ASCs ). 1 This final safe harbor provides many of the same concepts initially set forth in the proposed safe harbor. However, the OIG focuses its analysis on only one of the initial principles it had set forth for safe harbor protection for ASCs. Moreover, it disregards one of its other initial proposed ASC safe harbor theories. The final safe harbor also makes a number of additional changes and modifications. This afterword provides an overview of the issues as they affect ASCs. I. GENERAL CONCEPTS The safe harbors set forth a number of general concepts. The three overriding principals are as follows: The OIG reiterates its position that the failure to meet a safe harbor does not itself make an arrangement or particular conduct illegal. This is particularly important in the ASC context, in that a great percentage of existing and developing ASCs are not likely to meet the safe harbor criteria. Here, the OIG states: The anti-kickback statute, on the other hand, establishes an intentbased criminal prohibition with optional statutory and regulatory safe harbors that do not purport to define the full range of lawful activity. Rather, safe harbors provide a means of assuring that payment practices are not illegal. Payment practices that do not fully comply with a safe harbor may still be lawful if no purpose of the payment practice is to induce referrals of Federal health care program business. 2 The OIG clarifies that hospitals, management companies and other parties can still be considered referral sources for purposes of the fraud and abuse statute. With hospitals, the focus is on referrals by captive and friendly professional corporations, employed physicians, referral services, and marketing efforts. With management companies, the focus appears to be on marketing and administrative related efforts. The safe harbors continue to strongly discourage situations where the investment entity provides assistance of any form to the investors to help them make their investment. For example, the investment entity should not 1 64 Fed. Reg. 63518 (1999) (to be codified at 42 C.F.R. pt. 1001). The safe harbor is reproduced below. 2 Id. at 63519. The OIG further states, "The failure of a particular business arrangement to com- ply with these provisions does not determine whether or not the arrangement violates the statute because this regulation does not make conduct illegal." Id. at 63520. 111

pledge assets or guarantee loans on behalf of the physician investors. Here, the OIG states: On the other hand, the safe harbor condition is intended to preclude from protection loan guarantees, collateral assignments or other arrangements made by an investment entity or any of its investors, or its individuals or entities acting on their behalf, to secure a loan from a bank or other unrelated third party, if the loan is used in whole or in part by an investor to obtain an in- vestment interest in the entity. 3 II. ASC SPECIFIC COMMENTS AND GUIDANCE The safe harbor sets forth a number of concepts and notions that are very specific to ASCs. In fact, it articulates that the analysis set forth in the safe harbor for ASCs should not be applied to other types of investment entities, and that other types of investment entities and providers do not enjoy the same preference for development from the OIG that ASCs enjoy. A summary of a number of the critical concepts are as follows: The purpose of the ASC safe harbor is to protect investment interests held by physicians who utilize the ASC as an extension of their practice. Thus, safe harbor protection is focused on surgeons who perform more than a of their cases at outpatient settings, as well as, in certain situations, surgeons that will agree to perform not less than one-third of their outpatient procedures at the investment entity. The safe harbor disregards the old analysis for protection of ASCs. Specifically, it states that the differential between "professional" and technical fees no longer is a useful measuring stick because such differences change constantly and are not uniformly applicable. Here, the OIG states: In this final rule, we are expressly departing from the underlying rationale for our original safe harbor proposal, which was the professional fee/facility fee differential. The existence of a significant disparity between the facility fee and the professional fee, such that the facility fee is significantly smaller than the professional fee, minimizes the risk of improper incentives for referrals; however, we are aware that professional and facility fees have changed and may continue to change over time and that the ratio between them will not always, by itself, provide a clear basis for safe harbor protection. So although the fee differential was meaningful at the time, we will in the future look more broadly for 3 Id. at 63524. 112

indicia that an ASC investment represents the extension of a physician's office space and not a means to profit from referrals. 4 The safe harbor does not extend to ownership by primary care physicians or multi-specialty groups that include primary care physicians. The OIG expresses concerns that ASC ownership by such persons may be a way to reward such persons for referrals to surgeons and other investors. Specifically, the OIG indicates specific concerns about investments by primary care physicians where the primary care physicians invest nominal amounts and where primary care physicians refer to other owner physicians. Here, the OIG states in the context of an ASC: [O]ur chief concern is that a return on an investment in an ASC might be a disguised payment for referrals. Two examples illustrate the potential problem. First, primary care physicians could be offered an investment interest in an ASC for nominal capital contribution as an incentive to refer patients to surgeon owners of the ASC. The primary care physicians would not perform any services at the ASC, but would profit from any referrals they make. 5 The OIG indicates its belief that ASCs do not necessarily pose less risk than other providers in terms of program abuse. This should be viewed as a clear warning by the OIG to be cautious in the structuring and development of surgery centers. The OIG states, [t]he answer is that ASC investments do not necessarily pose less risk. Rather... investments in ASCs raise concerns that are different from those addressed by the small entity investment safe harbor; therefore, investments in ASCs warrant different safe harbor criteria, including different safeguards, limitations and controls. 6 The ASC safe harbor provides protection for four types of entities. These include entities which are specifically surgeon-owned, entities which provide services only as a single specialty, entities that are owned by multi-specialty investors, and entities that are jointly owned by hospitals and physicians. The base criteria for each of these categories are similar. However, the safe harbor adds additional criteria for certain other categories. The categories have six safe harbor elements in common. These include: The ASC must be Medicare certified. 4 Id. at 63535-36. 5 Id. at 63536. 6 Id. at 63535. 113

No one investor may receive financing help from the investor or other investors. The same terms must be offered to each investor without regard to the potential volume or value of referrals. All ancillary services must not be separately billed or reimbursable and may be provided only through the ASC rate. The ASC and the investors must not discriminate against Medicare or Medicaid program beneficiaries. Disclosure must be provided to patients of the ownership interest in the facility. The safe harbor clarifies that protection is not limited to physician-owned entities. Thus, ownership may be held by third parties such as hospitals, non-referral sources, management companies, and others. For surgeon or physician ownership to be protected, not less than a of the professional income of a physician must be generated from the performance of ambulatory surgical procedures listed on the ASC list. For protection under the multi-specialty surgery center safe harbor, an additional requirement is added. Here, the surgeons must also perform not less than a of their procedures at the surgery center in which they invest. This is intended to assure that certain physicians who do not perform are not being rewarded for the efforts of or referrals to other physicians who do perform procedures at the surgery center. The OIG's concern is that such parties refer to the other surgeons and are receiving the benefits of returns from the surgery center due to their referrals. For the hospital physician joint venture safe harbor category, the hospital cannot be in a position to refer patients to the surgery center. III. SUMMARY The new safe harbors provide a needed clarity and several advantages to persons who own and operate surgery centers. Nevertheless, it has significant limitations. It does not provide clear guidance to ownership by multi-specialty groups which are not entirely composed of surgeons. It also provides limited com- fort to hospital physician joint ventures because most hospitals are likely to be considered in a position to refer patients to the surgery center. It also provides little clarity or comfort to management company ownership of interests in joint ventures. Finally, the safe harbors do little to provide information or guidance to specialty hospitals. 114

We expect that many ASCs will attempt to incorporate the performance standards articulated in the multi-specialty joint venture safe harbor. They will use this to assure an amount of performance at the surgery center that will ensure the viability and success of the surgery center, opposed to using the effort to simply assure that the ventures do not reward parties for indirect referrals. ASC SAFE HARBORS (r) Ambulatory surgical centers. As used in section 11288 of the Act, remuneration does not include any payment that is a return on an investment interest, such as a dividend or interest income, made to an investor, as long as the investment entity is a certified ambulatory surgical center (ASC) under part 416 of this title, whose operating and recovery room space is dedicated exclusively to the ASC, patients referred to the investment entity by an investor are fully informed of the investor's investment interest, and all of the applicable standards are met within one of the following four categories: 1. Surgeon-owned ASCs: If all of the investors are general surgeons or surgeons engaged in the same surgical specialty, who are in a position to refer patients directly to the entity and perform surgery on such referred patients; surgical group practices (as defined in this paragraph) composed exclusively of such surgeons; or investors who are not employed by the entity or by any investor, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to make or influence referrals directly or indirectly to the entity or any of its investors, all of the following six standards must be met: (i) The terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnished, or the amount of business otherwise generated from that investor to the entity. (ii) At least one-third of each surgeon investor's medical practice income from all sources for the previous fiscal year or previous 12- month period must be derived from the surgeon's performance of procedures (as defined in this paragraph). (iii) The entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest. (iv) The amount of payment to an investor in return for the investment must be directly proportional to the amount of the capital investment (including the fair market value of any preoperational services rendered) of that investor. 115

(v) All ancillary services for Federal health care program beneficiaries performed at the entity must be directly and integrally related to primary procedures performed at the entity, and none may be separately billed to Medicare or other Federal health care programs. (vi) The entity and any surgeon investors must treat patients receiving medical benefits or assistance under any Federal health care program in a nondiscriminatory manner. 2. Single-Specialty ASCs. If all of the investors are physicians engaged in the same medical practice specialty who are in a position to refer patients directly to the entity and perform procedures on such referred patients; group practices (as defined in this paragraph) composed exclusively of such physicians; or investors who are not employed by the entity or by any investor, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to make or influence referrals directly or indirectly the entity or any of its investors, all of the following six standards must be met (i) (ii) (iii) (iv) (v) The terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnished, or the amount of business otherwise generated from that investor to the entity. At least one-third of each physician investor's medical practice income from all sources for the previous fiscal year or previous 12- month period must be derived from the surgeon's performance of procedures (as defined in this paragraph). The entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest. The amount of payment to an investor in return for the investment must be directly proportional to the amount of the capital investment (including the fair market value of any pre-operational services rendered) of that investor. All ancillary services for Federal health care program beneficiaries performed at the entity must be directly and integrally related to primary procedures performed at the entity, and none may be separately billed to Medicare or other Federal healthcare programs. 116

(vi) The entity and any physician investors must treat patients receiving medical benefits or assistance under any Federal health care program in a nondiscriminatory manner. 3. Multi-Specialty ASCs. If all of the investors are physicians who are in a position to refer patients directly to the entity and perform procedures on such referred patients; group practices, as defined in this paragraph, composed exclusively of such physicians; or investors who are not employed by the entity or by any investor, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to make or influence referrals directly or indirectly to the entity or any of its investors, all of the following seven standards must be met: (i) (ii) (iii) (iv) (v) (vi) (vii) The terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnished, or the amount of business otherwise generated from that investor to the entity. At least one-third of each physician investor's medical practice income from all sources for the previous fiscal year or previous 12- month period must be derived from the physician's performance of procedures (as defined in this paragraph). At least one-third of the procedures (as defined in this paragraph) performed by each physician investor for the previous fiscal year or previous 12-month period must be performed at the investment entity. The entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest. The amount of payment to an investor in re the investment must be directly proportional to the amount of the capital investment (including the fair market value of any pre-operational serves rendered) of that investor. All ancillary services for Federal health care program beneficiaries performed at the entity must be directly and integrally related to primary procedure at the entity, and none may be separately billed to Medicare or other Federal heath care programs. The entity and any physician investors must treat patients receiving medical benefits or assistance under any Federal health care program in a nondiscriminatory manner. 117

4. Hospital/Physician ASCs. If at least one investor is a hospital, and all of the remaining investors are physicians who meet the requirements of paragraph (r) (I), (r)(2) or (r)(3) of this section; group practices (as defined in this paragraph) composed of such physicians; surgical group practices (as defined in this paragraph) or investors who are not employed by the entity or by any investor, are not in a position to provide items or services to the entity or any of its investors, and are not in a position to refer patients directly or indirectly to the entity or any of its investors, all of the following eight standards must be met: (i) (ii) (iii) (iv) (v) (vi) The terms on which an investment interest is offered to an investor must not be related to the previous or expected volume of referrals, services furnish amount of business otherwise generated from that investor to the entity. The entity or any investor (or other individual or entity acting on behalf of the entity or any investor) must not loan funds to or guarantee a loan for an investor if the investor uses any part of such loan to obtain the investment interest. The amount of payment to an investor in re the investment must be directly p amount of the capital investment (market value of any pre-operational service of that investor. The entity and any hospital or physician investor must treat patients receiving medical benefits or assistance under any Federal health care program in a nondiscriminatory manner. The entity may not use space, including, but not limited to, operating and recovery room space, located in or owned by any hospital investor, unless such space is leased from the hospital in accordance with a lease that complies with all the standards of the space rental safe harbor set forth in paragraph (b) of this section; nor may it use equipment owned by or services pro- vided by the hospital unless such equipment is leased in accordance with a lease that complies with the equipment rental safe harbor set forth in paragraph (c) of this section, and such services are provided in accordance with a contract that complies with the personal services and management contracts safe harbor set forth in paragraph (d) of this section. All ancillary services for Federal health care program beneficiaries performed at the entity must be directly and integrally related to primary procedures performed at the entity, and none may be 118

separately billed to Medicare or other Federal health care programs. (vii) The hospital may not include on its cost report or any claim for payment from a Federal health care program any costs associated with the ASC (unless such costs are required to be included by a Federal health care program). (viii) The hospital may not be in a position to make or influence referrals directly or indirectly to any investor or the entity. 5. For purposes of paragraph (r) of this section, procedures means any procedure or procedures on the list of Medicare-covered procedures for ambulatory surgical centers in accordance with regulations issued by the Department and group practice means a group practice that meets all of the standards of paragraph (p) of this section. Surgical group practice means a group practice that meets all of the standards of paragraph (p) of this section and is composed exclusively of surgeons who meet the requirements of paragraph (r)(l) of this section. 119