Regulatory Thresholds for the MSO-PC Model: Part 2

The landscape of federal healthcare legislation imposes certain regulatory requirements on the joint venture commonly known as the MSO-PC model. As discussed in Part 1, parties to an MSO-PC model must first navigate state-level regulations that prohibit the corporate practice of medicine (“CPOM”). Compliance thresholds under federal law, along with their valuation implications for stakeholders, are examined in more detail here.

In addition to ensuring a CPOM-compliant division between clinical and non-clinical duties, MSO-PC models need to be free of any function that incentivizes or incorporates the movement of patients for services reimbursable under federal healthcare programs (e.g., Medicare, Medicaid).

Arrangements in which a physician stands to gain from his or her own patient referral patterns are regulated at the federal level by the Physician Self-Referral Law (“PSL”). Commonly referred to as “Stark Law”, the PSL is a civil statute that restricts how a physician can and cannot refer their federally insured patients to facilities in which they have a financial stake (e.g., ownership percentage, compensation arrangement). The PSL was enacted to address “conflict of interest” concerns from policymakers that self-referral activities were driving up an overutilization of medical services and, in turn, an overuse of federal healthcare programs. Unless an exception applies and its requirements are satisfied, the PSL prohibits any arrangement that enables a physician to refer and bill patients for certain “designated health services” ^[1] reimbursable under federal healthcare programs to entities in which the physician has a direct—or indirect—financial interest. PSL violations can result in denial of payments, civil monetary penalties (up to $15,000 per prohibited service or $100,000 per circumventing arrangement), and exclusion from federal healthcare programs.

Financial arrangements violating the PSL may also be implicated under the federal Anti-Kickback Statute (“AKS”). Originally enacted to combat fraud and abuse in the healthcare system, the AKS is an intent-based criminal statute that outlaws the “knowing and willful” solicitation, offer, or exchange of any remuneration to induce or reward referrals for services or items reimbursable under federal healthcare programs. Unlike the PSL, which only applies to physician financial arrangements, the AKS applies to all healthcare financial arrangements. A single AKS violation can result in up to $100,000 in criminal monetary penalties and up to 10 years in prison.

Any reimbursement claim from a prohibited kickback arrangement to a federal healthcare program is also, by its nature, a false claim under the False Claims Act (“FCA”). The civil FCA statute permits the government and/or private whistleblowers to bring suit against anyone who knowingly ^[2] submits a false or fraudulent claim to the government. FCA violations can result in mandatory civil monetary penalties ^[3] for each violation plus three times the cost of damages incurred by the government. There is also a criminal FCA statute, which can result in up to five years of prison time in cases of clear intent.

The PSL provides 28 exceptions for compensation arrangements that do not constitute a referral relationship if certain conditions are met. Arrangements involving the provision of services, facility space, and/or equipment to physicians are included among the PSL exceptions. The U.S. Department of Health and Human Services (“HHS”) also provides 37 regulatory safe harbor exceptions for payment practices that do not constitute an AKS violation if certain conditions are met. ^[4] Arrangements involving management contracts are included among the AKS exceptions.

To qualify as a permissible exception under both the PSL and the AKS, compensation paid to an MSO must be:

Embedded within the above federal requirements for permissible MSO-PC arrangements are three compliance thresholds commonly referred to by the industry as “The Big 3”: the Fair Market Value standard, the Volume or Value standard, and the Commercial Reasonableness standard. Any level of value that is ascribed or assigned to an MSO-PC joint venture by stakeholders must be in harmony with these three standards.

As a standard in healthcare valuation, fair market value (“FMV”) is best described and defined from three perspectives as:

For the MSO-PC model, the FMV standard establishes the parameters of the dollar amount that is ultimately be paid to the MSO. From a valuation process standpoint, public commentary from CMS provides leeway here and does not impose a specific methodology requirement. ^[5] However, an actual FMV analysis needs to take place for the FMV requirement to be satisfied. It is not enough for parties to simply agree that a proposed compensation structure represents FMV; it needs to be backed by external documentation that can be readily shared in the event of an audit or investigation. Failure to obtain an independent FMV analysis invites regulatory scrutiny and increases the likelihood of the MSO fee “drifting” outside the range of compliance.

The MSO’s scope of services will ultimately dictate how the determination of FMV is approached. A standard industry practice utilizes a blended form of the cost and market approaches where the costs to provide the services are recreated with a reasonable market margin. Using market-based data to develop an estimated cost profile is particularly useful for start-up arrangements (where costs may need to accommodate scaling considerations) and when determining reasonable compensation for MSO personnel (especially for any owners) who dedicate time to running the MSO’s business operations. The general question under examination is whether the fee that is paid to the MSO reflects a market-derived markup on costs consistent with those of similar outsourced services across the industry. There is no established cap on an MSO’s management fees but there needs to be support from external data to satisfy the FMV requirement.

Any FMV determination for compensation paid to the MSO will also need to be aligned with a fee structure that is legally permissible in the local jurisdiction. CPOM states have different restrictions on how MSO compensation can be structured. For example, some states (e.g., California) allow fees to be based on a percentage of the PC’s revenue—provided no PSL or AKS violations exist—while other states (e.g., New York) strictly prohibit variable fee structures. For arrangements that include any level of marketing services, a fixed fee may also be required.

Stakeholders pursuing a potential MSO-PC arrangement often face challenges when it comes to determining the initial FMV fee amount. For a start-up venture, FMV can be difficult to substantiate before the inception of any business operations or before having any understanding of the venture’s financial prospects. It is not uncommon for a “placeholder” fee to be included within the initial MSA ahead of any operational commencement. In such cases, the parties should make reasonable efforts to document and demonstrate a good faith intent to detach referral volumes from consideration until they can substantiate and solidify an amount commensurate with FMV.

While not codified as a distinct definition, the Volume or Value standard is presented and interpreted by CMS to mean:

The Volume or Value standard, as promulgated by CMS, is separate and distinct from the FMV requirement. ^[7] While it may be common for valuation practitioners to approach FMV as a corrective measure that implicitly removes the impact of referral volumes, the two standards should be considered independently. CMS provides two bright-line thresholds for determining whether a compensation arrangement violates the Volume or Value standard. For any compensation paid to a physician by an entity furnishing designated health services, a violation exists if (and only if):

For any compensation paid by a physician to an entity furnishing designated health services, a violation exists if (and only if):

An arrangement that would clearly raise a red flag under the Volume or Value standard is one in which a physician, as co-owner of an MSO, refers his or her patients to another facility (e.g., a physical therapy clinic) that is serviced by the same MSO. The concern here would center on the fact that a positive correlation exists between the physician’s share of distributed MSO profits and the referrals he or she makes to the outpatient facility (whose fee payment contributes to the MSO’s revenue stream).

Another example would be an arrangement in which an MSO rewards a physician practice with a lower management fee based on the amount of service volumes the practice sends to other MSO-managed entities. Here, the concern would center on the negative correlation that exists between the discounted fee charged by the MSO to the practice and the amount of “other business generated” by the practice for the MSO.

A more subtle example—and another common problem area—is an arrangement that includes some sort of volume-based marketing component within the MSO’s service scope. Because the provision of marketing services is often formalized with ambiguous language in the MSO’s governing document, it becomes easy to use “marketing” as a vehicle to hide referral activities. In this case, the cause for concern is the potential positive correlation between patient referrals and the incentive-based marketing compensation that the MSO incorporates into the fee it ultimately charges. To withstand regulatory scrutiny, the inclusion of any marketing component within an MSO’s service scope should be approached with caution and structured in a way that avoids commission-based efforts.

CMS currently defines commercial reasonableness as follows:

Despite appearing as a term throughout the PSL exceptions, the concept of commercial reasonableness tends to be far less understood than the previous two standards. This is due in part to the fact that there are no standardized methodologies that can readily determine what constitutes a “commercially reasonable” arrangement. It is also difficult to avoid entangling commercial reasonableness with FMV since both concepts share the presumption that parties to an arrangement are reasonably informed and have conducted legitimate negotiations (i.e., “bona fide bargaining”). One key distinction is that FMV takes a hypothetical market participant perspective and focuses only on “what is the right dollar amount” for an arrangement. In contrast, commercial reasonableness considers the actual parties, services, and compensation involved and focuses on the qualitative justification for the entire arrangement in the first place.

Stakeholders should be aware that just because an arrangement is commensurate with FMV does not automatically mean it is commercially reasonable. For an MSO-PC model to be commercially reasonable, it needs to not only satisfy the FMV requirement but also resolve a legitimate business objective without creating duplicative or unnecessary functions. As an example, an MSO-PC model might provide non-clinical staffing in return for a fee that aligns with FMV. But if those staffing functions are already handled (in whole or in part) by the PC, the arrangement would not be considered commercially reasonable. Similar to its distinction from FMV, commercial reasonableness does not serve as a substitute for the Volume or Value standard. If the compensation and overall attractiveness of an MSO-PC arrangement is contingent on any presence of embedded referrals, the arrangement will simultaneously fail on all three standards.

One additional element to note is that an arrangement can still be deemed commercially reasonable even when it results in a loss to one or more parties. It is not uncommon for some MSO-PC arrangements to generate profit to the MSO and a loss to the PC. Such an arrangement can still further a legitimate business purpose, such as addressing a community need, ensuring timely access to healthcare, or improving quality and health outcomes. ^[9] However, this should not be construed as a universal statement that profitability is completely irrelevant to determining commercial reasonableness. Public commentary from CMS leaves the door open for regulators to treat the lack of profit as an indicator that parties having knowingly entered into an unprofitable arrangement for the sole purpose of capturing referral volumes. ^[10] From a compliance perspective, if an MSO-PC arrangement is not generating profit to both parties, it is important to understand why. The extent to which the service scope, compensation structure, and overall business purpose can be justified in such cases becomes even more relevant.

Consultation with trusted valuation professionals who have expertise in healthcare transactions can help parties maintain a compliant MSO-PC arrangement and alleviate concerns in the face of regulatory scrutiny. An independent FMV opinion from a third party provides credibility to an arrangement’s fee structure and helps demonstrate good faith efforts to comply with legal and regulatory standards. Withum’s team of experts can assist parties with FMV guidance both at the beginning stages of structuring an MSO and when there is an existing MSO-PC arrangement already in place.

Once a compliant fee is established, it is still important to ensure that it does not run afoul at a later date. FMV is also not static and may change over time due to market dynamics, industry trends, or changes to the MSO’s service scope. Withum therefore advises a periodic assessment and, if necessary, adjustment to the MSO’s compensation to ensure ongoing compliance with FMV.

In addition to the valuation services, Withum offers in-depth consulting and forensic accounting services for transactions, arrangements, and disputes across the broader healthcare industry. Whether you require expert assistance for regulatory compliance, strategic advisory, tax planning, financial reporting, or litigation support, Withum’s Healthcare Valuation Services Team is equipped with the requisite knowledge and experience to provide guidance that you can trust.

[1] See 42 U.S.C. §1395nn(h)(6). As it relates to MSO-PC models, it should be noted that “designated health services” includes the provision of durable medical equipment and supplies, which is not uncommon to an MSO’s scope of services.

[2] The civil FCA statute defines “knowingly” to mean that a person has actual knowledge of the information and acts in deliberate ignorance or reckless disregard of its truth or falsity. No proof of specific intent to defraud is required for enforcement of the civil statute.

[3] The statute language imposes a civil penalty “of not less than $5,000 and not more than $10,000, as adjusted by the Federal Civil Penalties Inflation Adjustment Act of 1990”. Effective January 15, 2025, the inflation-adjusted range of this penalty now falls between $14,308 and $28,619. See 89 Fed. Reg. 106310 (Dec. 30, 2024).

[4] It should be noted that the failure to satisfy all conditions of a safe harbor does not automatically render the arrangement illegal under the AKS. However, an arrangement must directly satisfy each condition stipulated in the applicable safe harbor to receive the benefit of safe harbor protection. HHS commentary on this can be found here.

[5] See 72 Fed. Reg. 51015-51016 (Sept. 5, 2007).

[6] See 85 Fed. Reg. 77535 (Dec. 2, 2020). Technically, the requirement that compensation not take into account “other business generated between the parties” is referred to separately by CMS as the “Other Business Generated Standard”. The requirement that compensation not take into account “the volume or value of referrals by the physician who is a party” is referred to by CMS as the “Volume or Value Standard”. Because the bright-line thresholds for determining noncompliance with these two standards are virtually identical in application, this article has consolidated the “Other Business Generated Standard” with the “Volume or Value Standard”.

[7] See 85 Fed. Reg. 77552 (Dec. 2, 2020).

[8] CMS initially introduced an abbreviated concept of commercial reasonableness in 1998 before later expanding on its meaning and codifying the current definition in 2020. Commercial reasonableness was originally presented by CMS to mean that “an arrangement appears to be a sensible, prudent business agreement, from the perspective of the particular parties involved, even in the absence of any potential referrals”. See 63 Fed. Reg. 1700 (Jan. 9, 1998).

[9] See 85 Fed. Reg. 77531 (Dec. 2, 2020).

[10] See 85 Fed. Reg. 77534 (Dec. 2, 2020).