1. Fair Market Value in
Hospital and Physician
Transactions
Jeff Fitzgerald, Shareholder, Polsinelli Shughart
Curtis Bernstein, Director, Sinaiko Healthcare Consulting
December 1, 2011

2. Outline of Presentation
 Legal Background
 Noteworthy Judicial Determinations
 Top Six Valuation Concerns
 Ways to Manage Compliance with FMV
 Summary and Takeaways
2

3. Legal Background
 Anti-kickback Statute
 Stark Law
 Tax exempt status
3

4. Legal Background - AKS
 AKS prohibits any person from knowingly and
willfully offering, paying, soliciting, or receiving
remuneration in exchange for or to induce the
referral or any item or service covered by Medicare
 Broadly interpreted by the courts to have been violated “if
one purpose of the payment was to induce future referrals”
 But, the criminal intent element requires proof that the
defendant acted in a knowing and willful manner, meaning
that the defendant knew his/her conduct was illegal or
wrongful
 PPACA tweaks but does not eliminate the intent element
4

5. Legal Background - AKS
 Many safe harbors have FMV as an element
 PPACA expanded the False Claims Act to
include civil liability for a violation of the AKS
 If not FMV, then government theory
 Amount paid in excess of FMV is a payment for
referrals
 All “tainted” claims are false
5

6. Legal Background - Stark
 Prohibits payment to hospitals for
"designated health services" if physician
making the referral has a financial
relationship that does not meet an exception
 Strict liability – Medicare payment is
prohibited regardless of intent
 False Claims Act liability – if noncompliance
is “knowing” then penalties may apply
 Most exceptions require FMV
6

7. Legal Background - Stark
Fair market value means the value in arm‟s-length transactions, consistent with the
general market value. „„General market value‟‟ means the price that an asset would
bring as the result of bona fide bargaining between well-informed buyers and sellers
who are not otherwise in a position to generate business for the other party, or the
compensation that would be included in a service agreement as the result of bona
fide bargaining between well-informed parties to the agreement who are not
otherwise in a position to generate business for the other party, on the date of
acquisition of the asset or at the time of the service agreement. Usually, the fair
market price is the price at which bona fide sales have been consummated for
assets of like type, quality, and quantity in a particular market at the time of
acquisition, or the compensation that has been included in bona fide service
agreements with comparable terms at the time of the agreement, where the price or
compensation has not been determined in any manner that takes into account the
volume or value of anticipated or actual referrals. With respect to rentals and leases
described in § 411.357(a), (b), and (l) (as to equipment leases only), „„fair market
value‟‟ means the value of rental property for general commercial purposes (not
taking into account its intended use). In the case of a lease of space, this value may
not be adjusted to reflect the additional value the prospective lessee or lessor would
attribute to the proximity or convenience to the lessor when the lessor is a potential
source of patient referrals to the lessee. For purposes of this definition, a rental
payment does not take into account intended use if it takes into account costs
incurred by the lessor in developing or upgrading the property or maintaining the
property or its improvements. 42 CFR § 411.351
7

8. Legal Background – Stark
 Additional Stark Law concept
 Most exceptions also require compensation to
“not take into account the volume or value of
referrals or other business generated between the
parties”
 Separate from FMV element but leads to
ambiguous and circular logic
 If not FMV, then takes into account referrals …
 If takes into account referrals, then not FMV
8

9. Legal Background - Tax exempt
status
 Private inurement prohibits use of a charity‟s
assets to unreasonably benefit an "insider"
 Sanctions include loss of tax exempt status
 IRS Intermediate Sanctions provisions
authorize excise taxes and penalties for the
payment of excessive compensation to
disqualified persons
 Compensation listed on form 990
9

10. Judicial Developments
 What is FMV mean in health care space?
 Caracci
 Bergquist
 Derby
 What are the fraud and abuse issues related
to FMV
 Bradford
 Tuomey
 Covenant
10

11. Caracci v. Commissioner
(2006)
 Home health companies converted from tax-exempt to for-profit
 Companies sustained repeated losses and at the end of fiscal
year 1995, had a capital deficit of $1.4 million.
 Home health companies in Mississippi required a certificate of
need and Mississippi issued a moratorium on new CONs
 Two appraisers valued the home health companies for
purposes of the conversion and determined that liabilities
exceeded the value of tangible and intangible assets
 Intangible assets, including the CONs, would not result in
positive fair market value because that assets had been
consistently unprofitable
 IRS determined that the value of the assets transferred
exceeded the value of liabilities by $18.5 million and imposed
excise taxes and income tax deficiencies and penalties
11

12. Caracci v. Commissioner
 Tax Court findings
 Rejected the net asset approach by Caracci‟s expert
 The home health companies‟ expert dismissed the
market approach in light of the difference between
market comparable transactions and public companies
 Tax court accepted that Commissioner‟s expert‟s use of
the market approach but reduced the revenue to price
multiple without a full explanation as to why
 Based on the market approach, the tax court found
that home health companies had value and excess
economic benefit of $5.2 million was transferred
 Tax court ordered the taxpayer to pay $69.7 million
12

13. Caracci v. Commissioner
 U.S. Court of Appeals
 The appeals court considered certain undisputed facts
 Sta-Home relied on Medicare for 95% to 97% of revenue for which Medicare only
reimbursed up to actual cost and disallowed 0.7% of annual costs
 As a result of this reliance on Medicare, the more services provided, the larger
the losses of the company grew
 The was no likely potential buyer for Sta-Home
 The Tax Court incorrectly compared Sta-Home to solvent, publicly traded
companies
 The Tax Court‟s conclusion that Sta-Home had the potential to make a profit was
erroneous
 Tax court has a long standing position that unprofitable intangible assets do not
contribute to FMV unless those assets produce net income or earnings
 IRS Revenue Rule 59-60 requires the IRS to assign zero value to unprofitable
intangible assets
 The presence of goodwill and its value, therefore, rests upon the excess of net
earnings over and above a fair return on the net tangible assets
 The Tax Court clearly erred and violated its own prior rulings in failing to
recognize that the unprofitable intangible assets – including the workforce, the
licenses, the CONs, the Medicare dependent client base, and the aging and
largely uncollectible accounts receivable – had little or no market value
13

14. Bergquist v. Commissioner (2008)
 Background
 University Anesthesiologists, P.A. (UA) was the exclusive
provider of anesthesiology to Oregon Health & Science
University Hospital
 In 1998, Hospital formed OHSU Medical Group as a
501(c)(3) and required all physician groups that wished to
remain affiliated with Hospital to consolidate into the group
by Jan. 2002
 In Sept. 2001, anesthesiologists in UA donated stock in UA
to a charity and claimed a charitable donation
 UA‟s valuation expert used going concern value
 Charity valued donated stock at $0
 On Jan. 1, 2002, anesthesiologists became employed by
OHSU Medical Group
14

15. Bergquist v. Commissioner
 Tax Court findings
 UA should not be valued as a going concern because
the consolidation of UA into OHSU Medical Group was
foreseeable at the date of donation
 UA would not have donated the stock without the
consolidation
 Commissioner‟s expert valued UA at net asset value
 Value estimated to be less than 10% of that claimed
by Bergquist
 Court agreed with Commissioner‟s findings
 Court concluded that no reasonable buyer would have
paid at a going concern rate for UA stock knowing that
UA was being consolidated
15

16. Derby v. Commissioner (2008)
 Background
 Petitioner-physicians sold their practices to Sutter
Health and entered into employment contracts
 Sutter Health was unwilling to pay anything for the
intangible assets or goodwill
 Physicians claimed that they each donated the
intangible assets of their medical practice to
Sutter (and estimated the value by an expert
appraisal)
16

17. Derby v. Commissioner
 Tax Court findings
 Physician‟s transfer of intangible assets
contingent on employment agreement
 No donation because transaction was “inherently
reciprocal” and intangible assets were leveraged
for employment compensation
 Burden on physicians to show that the value
transferred is greater than value received
 Physicians could not show that future salaries not
netted out of the contributions
17

18. Judicial Developments
 What are the fraud and abuse issues related
to FMV
 Bradford
 Tuomey
 Covenant
18

19. U.S. ex rel. Singh v. Bradford Regional (2010)
 Group of two physicians lease nuclear camera from
GE and perform services in office rather than in
hospital
 Hospital rents camera from Group (with non-
compete); camera remains in Group‟s office
 Hospital pays $23,655 per month, an amount derived from
Group‟s revenue from use of the camera ($6,500 per
month related to prime lease from GE)
 Per Stark, fixed rental rate not take into account volume or
value of referrals 66 Fed Reg. at 877
19

20. U.S. ex rel. Singh v. Bradford Regional
 District Court granted summary judgment
against the hospital
 Court placed burden of proof to show FMV on
hospital
 Found that amount of compensation was arrived
at by taking into account the anticipated referrals
of the physicians
 Found that if price takes into account referrals,
then price is not FMV
20

21. U.S. ex rel. Singh v. Bradford Regional
 Lessons
 FMV analysis and reports are useful, but courts
may look behind at the underlying purpose/terms
 Need to identify clear non-referral related basis for
intangible assets or counterintuitive FMV terms
 Some things just can‟t be purchased
21

22. U.S. ex rel. Drakeford v. Tuomey
(2011)
 Surgeons begin development of an ASC
 Hospital hires surgeons as employees
 Part-time; during surgical procedures; surgeons maintain
office practice separately
 Fixed salary, plus 80% of collections, plus quality
incentives
 DOJ alleged that compensation exceeded 100% of actual
collections (and was up to 140% of collections)
 Hospital internal documents project losses on all
employment agreements
22

23. U.S. ex rel. Drakeford v.
Tuomey
 DOJ argues that compensation is not FMV
because “the hospital‟s motivation in entering
into these part-time agreements was to avoid
losing the referrals”
 While Stark Law is strict liability, the DOJ looked
at motivation of parties
 At trial, jury concludes Stark Law violated, but
not False Claims Act
 Jury awards DOJ $49.4 million
 New trial ordered on False Claims issues
23

24. U.S. ex rel. Drakeford v.
Tuomey
 Lessons
 Employment exception large, but not infinite
 Motivation can color FMV analysis
 Risk exists where employment compensation not
based upon survey or comparable data
 Long term physician employment losses could
receive more scrutiny
 Basis for losses needs to be justified or presumption is
that the loss is tied to referrals
24

25. U.S. v. Covenant Medical
(2009)
 Covenant Medical Center of Waterloo, Iowa
paid $4.5 million to settle Stark Law and
False Claims allegations
 DOJ claimed that payments to 5 employed
physicians exceeded FMV
 Two physicians paid more than $2M per year
 Three others were paid more than $1M per year
 Salaries were published on hospital‟s form 990
 Whether hospital relied upon FMV reports is
unclear 25

26. U.S. v. Covenant Medical
 Lessons
 Full time employment is subject to potential
enforcement action
 Beware of the Lake Wobegon effect (everyone is
above average)
 DOJ enforcement can depend on overall optics
 Look at both the forest and the trees
26

27. U.S. v. Campbell v. UMDNJ et
al.
 Background:
 University Hospital was a Level 1 Trauma Center
 Maintenance of this license was dependent on the annual
performance of a certain number of cardiac procedures, including
cardiac catheterizations and cardiothoracic surgeries
 Since 1995, University Hospital failed to perform the requisite number
of cardiac procedures to maintain its Level 1 Trauma Center license
 In Spring 2002, UMDNJ engaged in a cardiology recruitment
initiative
 UMDNJ entered into part-time employment contracts with local
community cardiologists in private practice to work at University
Hospital as Clinical Assistant Professors, providing teaching,
lecturing, and research in exchange for an annual salary
 Defendant Campbell states that he “duly performed all of the
services enumerated in the contract which he was given the
opportunity to perform, and that he was compensation until the
contract was cancelled.

28. U.S. v. Campbell v. UMDNJ et
al.
 Findings:
 If there was no requirement to actually perform
the duties of a CAP then the compensation could
not be the fair market value for those services,
and thus would serve some other purpose, such
as compensation for patient referrals.

29. Kosenske v. Carlisle HMA, Inc.
 Background:
 Anesthesiologists had an exclusive service arrangement with
hospital in which group provided pain management services at
an outpatient clinic.
 Anesthesiologists were able to use office space, medical
equipment, and personnel at no cost
 Finding:
 Group received numerous benefits as a result of its relationship
to hospital which constitutes remuneration for purposes of the
Stark Law.
 Established a compensation arrangement and financial relationship
between group and hospital.
 Arrangement did not qualify for the personal service
arrangements exception from the restrictions of the Stark Law

30. VALUATION CONCERNS
THE TOP 6 LIST
30

31. Number 6: Purchasing the
Ancillaries of a Practice
 Certain physician practices have significant ancillary service lines (e.g.,
EKG, nuclear medicine, PET, catheterization lab for cardiologists or
MRI and physical therapy for orthopedic surgeons)
 Hospital may choose to purchase the ancillary services lines only leaving the
physician practice to remain a separate entity or enter into an exclusive
professional services agreement with the physician practice.
 Questions that must be answered:
 Does the ancillary business line have value outside of the practice?
 For example, would a third party purchase an imaging business of an orthopedic
practice knowing that the orthopedic surgeons are entering into an exclusive
arrangement with another party?
 The answer to this question may be no, but what if the imaging business was owned by
Radiologists?
 Must explore the specifics of the entity – for example, does the entity own a
transferable certificate of need?
 Will the physician owners earn the same or more compensation than they
earned post transaction?
 Under the model where the practice remains a separate entity with no PSA, the
answer is generally no.
 Under the model in which an exclusive PSA is entered into, the answer is generally
yes.
 Fallacy: So long as the compensation under the PSA is FMV, then the compensation does
not need to be considered in the valuation of the ancillaries.
31

32. Number 5: Post Transaction
Compensation
 As a result of Derby v. Commissioner, the valuation community
has generally accepted that post transaction compensation must
be considered in the valuation of a physician practice.
 FMV assumes hypothetical buyer with knowledge of the
transaction
 Question – Is post transaction specific to the buyer or the transaction?
 Determining FMV of physician services
 A number of hospitals still determine compensation through
unadjusted direct application of the compensation per wRVU
table presented in benchmark surveys
 The physicians producing at the upper levels of productivity generally do
not earn compensation per wRVU at the upper levels
 Compensation within the benchmark surveys is aggregate
compensation
 All compensation paid to a physician (e.g., clinical, call coverage, medical
directorship, etc.) must remain fairly consistent with market data
 “Reference to multiple, objective, independently published salary
surveys remains a prudent practice for evaluating fair market
value.”*
* Federal Register, Volume 72, Number 171 page 51015
32

33. Using Benchmark Surveys
Specialty: General Compensation per wRVU
Cardiology 25th %ile 50th %ile 75th %ile 90th %ile
Reported
= $46.30 = $57.95 = $74.77 = $128.05
Compensation
25th %ile
= 4,710 $218,073 $272,945 $352,167 $603,116 $309,469
50th %ile
wRVUs
= 6,634 307,154 384,440 496,024 849,484 431,740
75th %ile
= 9,078 420,311 526,070 678,762 1,162,438 544,123
90th %ile
= 12,092 559,860 700,731 904,119 1,548,381 700,736
Source: Medical Group Management Association Physician Compensation and Productivity Survey: 2011 based on 2010 results
Not an opinion of value – For illustrative purposes only 33

34. Partnership Model
Compensation wRVUs Compensation
per wRVU
Physician A $575,000 26,000 $22.12
Physician B $550,000 15,000 $36.67
Physician C $525,000 9,500 $55.26
Physician D $550,000 12,500 $44.00
Physician E $600,000 14,000 $42.85
Physician F $575,000 18,000 $31.94
Total $3,375,000 95,000 $36.00
34

35. Statistical Analysis of Partnership
Model
10th %ile 25th %ile 50th %ile 75th %ile 90th %ile
Compensation
$537,500 $550,000 $562,500 $575,000 $587,500
wRVUs
11,000 12,875 14,500 17,250 22,000
Compensation per
wRVU $27.03 $33.13 $39.76 $43.71 $49.63
Mathematically, multiplying the 90th percentile wRVUs times the 90th percentile
compensation per wRVU results in compensation of approximately $1.1 million,
which significantly exceeds the compensation of any physician in the group. We
can note that because of the “partnership model” of this group, Physician A
takes significantly lower compensation per wRVU than Physician C. We also
note that compensation per wRVU is decreasing as the number of wRVUs
performed increases. If each physician was paid a consistent compensation per
wRVU, the average compensation per wRVU is $36, which approximates the
40th percentile.
35

36. Number 4: Guaranteed
Compensation
 When assessing what level of guaranteed compensation to
pay a physician, historical compensation may be a good
starting point
 The health system must remember that historical
compensation is aggregate, which means that it may include
compensation for clinical and administrative services.
 Accordingly, application to clinical services only may not make
sense
 Historical compensation may include “other income.” For
example, certain physicians may take a lower compensation
in the current year to purchase a partnership interest in the
practice resulting in higher compensation to shareholders.
 Historical compensation may be lower than market because of
income tax strategies like tax-deferred compensation and
retirement plans, agreements not at FMV between related
parties (e.g., rent), etc.
36

37. Number 3: Call Coverage and
Medical Director Compensation
 Compensation for call coverage should account for the actual burden to
the physician providing coverage.
 OIG Opinion 07-10 outlined the following issues that must be considered in
determining FMV compensation:
 Severity of illness typically encountered by that specialty in treating a patient
presenting at the ED;
 Likelihood of having to respond when on-call at the ED;
 Likelihood of having to respond to a request for inpatient consultative services for
an uninsured patient when on-call; and
 Degree of inpatient care typically required of the specialty for patients that initially
present at the ED.
 Depending on the compensation structure and actual compensation
paid, compensation for call coverage paid to independent contractors
may not always equal the amount paid to employees
 The risk of reimbursement gets shifted from the physician to the health
system
 The cost of benefits is generally paid separately from call compensation by
the health system but is included in the payment to independent contractors
37

38. Call Coverage Compensation
 Procedure:
 Determine number of FTEs required to provide call
coverage
 Not strictly based on hours on call; Must be adjusted
in light of the limited number of hours required to
actually provide clinical services
 Determine FMV for clinical services for the specialty
 Reduce expected collections from the provision of
coverage from the product of FTEs and compensation
 Include any reimbursement for services provided on
indigent patients (i.e., hospital may pay 100% of
Medicare for these services)
38

39. Medical Directorships
 “A fair market value hourly rate may be used to compensate
physicians for both administrative and clinical work, provided that
the rate paid for clinical work is fair market value for the clinical
work performed and the rate paid for administrative work is fair
market value for the administrative work performed. We note that
the fair market value of administrative services may differ from
the fair market value of clinical services. A fair market value
hourly rate may be used to determine an annual salary, provided
that the multiplier used to calculate the annual salary accurately
reflects the number of hours actually worked by the physician.”*
 Time sheet should be checked diligently prior to compensating a
physician for his or her services.
 Payment for non medical director services has been a key
enforcement area for the federal government
*Federal Register, Volume 72, Number 71, page 51016
39

40. Number 2: Co-Management
Agreements
 Incentive paid for quality measures must be
set based on improvement in quality as
opposed to maintenance
 Services must actually be provided and
compensation must be for the level of
services provided
40

41. Relationship of Management Fee
to Level of Services
100.0%
90.0%
80.0%
Percent of Traditional Services
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
3.0% 4.0% 5.0% 6.0%
Percent of Revenue
Not an opinion of value – For illustrative purposes only
41

42. Relationship of Management Fee
to Net Revenue of Department
$350.0
Millions
$300.0
$250.0
$200.0
$150.0
$100.0
$50.0
$-
6.0% 5.5% 4.0% 3.0% 2.0% 1.5%
Percent of Revenue
Not an opinion of value – For illustrative purposes only
42

43. Number 1: Aggregate
Compensation
 Regardless of whether the individual
components are paid at FMV, the overall
compensation must still make sense.
 Compensation data provided in benchmark
surveys present aggregate compensation.
 May include compensation for clinical services,
transition, quality and other incentive bonuses,
call coverage, medical directorships, and other
administrative services.
43

44. Aggregate Compensation
Calculation
General Cardiology At $45 per At $55 per At $65 per
wRVU wRVU wRVU
Clinical Compensation (10,000 wRVUs x $ $450,000 $550,000 $650,000
per wRVU)
Quality Incentive 25,000 25,000 25,000
Call Coverage (73 days x $500 per day) 36,500 36,500 36,500
Medical Directorship (20 hours per month x
$150 per hour) 36,000 36,000 36,000
Total Aggregate Compensation $547,500 $647,500 $747,500
wRVUs 10,000 10,000 10,000
Effective Compensation per wRVU $54.75 $64.75 $74.75
Not an opinion of value – For illustrative purposes only
44

45. Benchmarking Aggregate
Compensation
At $45 per wRVU At $55 per wRVU At $65 per wRVU
Aggregate 68th Percentile 85th Percentile 106 x 90th
Compensation Percentile
wRVUs 76th Percentile 76th Percentile 76th Percentile
Compensation per 44th Percentile 52nd Percentile 58th Percentile
wRVU
Not an opinion of value – For illustrative purposes only
45

46. WAYS TO MANAGE COMPLIANCE WITH FMV
46

47. Policies and Procedures
 Improve policies on how FMV for services is determined internally
 Include procedures on when an external FMV opinion is required
 Include procedures on acceptable approaches to determining
FMV (e.g., FMV based on what the physician is paid by the
hospital across town is generally not sufficient documentation)
 Implement standard forms to track services provided including time
sheets for medical directorships
 Improve policy on sign off by multiple executive staff
 Review policies and procedures around physician compensation on a
regular basis
 Educate board of directors on FMV compliance and proper methods for
determining FMV for various services (i.e., most agreements will require
board approval before agreements are executed).
47

48. Medical Directorship Form
Med Dir Duty Physician Executive
Date Description of Service Provided Reference* Initials Initials
* Enter line number reference from exhibit in medical director agreement to which duty corresponds
48

49. Change the Payment Structure
 Major concern in hospitals is the payment of stipends for
inpatient coverage that is too high
 Change the structure to pay per FTE, per shift, per wRVU, per
ASA unit, etc.
 Straight variable structures are not recommended because the group will
need some minimal staff (e.g., if volumes increase so that another
physician is required, the group may not be able to hire a 0.1 FTE
physician)
 For co-management structures, explore compensating the base
rate on a hourly compensation for actual time provided (e.g.,
attending meetings)
 Incentive compensation cannot exceed fixed compensation paid
(see Revenue Ruling 97-13)
 For call coverage or inpatient coverage, look at paying a fixed
amount per encounter (e.g., 100% of Medicare for services to
indigent patients)
49

50. Monitor
 Centralize the task of documenting FMV
compliance, ordering of FMV opinions, and
review of FMV opinions
 Have an effective compliance team in place
to monitor all compensation arrangements
 Compliance team will review internal
documentation and approve requests for third
party appraisals
50

51. FMV Reports
 Review closely for seemingly immaterial
inaccuracies
 Look at core financial assumptions
 If possible document basis for key
assumptions that drive conclusions
 Check timeliness of data and report
 Retain in location where can be found in the
future
51

52. SUMMARY AND TAKEAWAYS
52

53.  Make sure compensation arrangements with
referral sources comply with the FMV requirement
under various laws
 Have policy in place to appropriately document
FMV for services provided using reasonable
approaches as discussed throughout this webinar
 Monitor compliance with policies
 Review third party opinions for completeness,
accuracy, and reasonableness
 Review services actually provided to those
required under agreements
 Check all line items on medical director time sheets
 Verify time spent providing co-management
services
 Use common sense in determining if
compensation pays for referrals
 Beware of Bradford and Tuomey
53

54. Fair Market Value in
Hospital and Physician
Transactions
Jeff Fitzgerald, Shareholder, Polsinelli Shughart
jfitzgerald@polsinelli.com
Curtis Bernstein, Director, Sinaiko Healthcare
Consulting
curtis.bernstein@sinaiko.com
54