Safe harbors throw unexpected curve at radiologist investment in centers

August 14, 1991

Diagnostic imaging centers are scrambling to restructure in compliancewith safe harbor regulations implemented last month by the Departmentof Health and Human Services (SCAN 7/31/91). The rules will restrict physician involvement in medical

Diagnostic imaging centers are scrambling to restructure in compliancewith safe harbor regulations implemented last month by the Departmentof Health and Human Services (SCAN 7/31/91).

The rules will restrict physician involvement in medical imaginglimited partnerships and chop the profits of many imaging serviceproviders, according to industry observers. The HHS regulationswill provide investors with golden opportunities to buy sharesthat referring physicians now need to sell, though they are boundto tarnish some centers' sterling financial results.

Surprisingly, the safe harbor rules restrict radiologists frombuying up those shares. They are subject to the same limitationsas clinicians who invest in medical businesses when the centerspay them for services provided to Medicare patients. The regulationswill make it more difficult for radiologists to acquire interestsin imaging center joint ventures.

How soon the fallout from safe harbors will be felt is uncertain,but the regulations will likely slow the formation of new imagingjoint ventures. Whatever their form, sweeping changes lie aheadfor the imaging services industry, predicted Terrance Gill, presidentof Medical Ventures in Solana Beach, CA.

"The safe harbors are going to force virtually every physician-ownedjoint venture to restructure. It's going to be a cumbersome anddifficult process, but at least they'll know that they are operatingwithin the law," Gill said.

The impact of the safe harbors will be compounded as Blue Crossand Blue Shield groups, private insurers and workers' compensationplans adopt similar self-referral restrictions, according to RobertD. Carl III, president of Health Images, an Atlanta imaging serviceschain. "Joint-ventured centers will have a serious problemcountering that trend," he said.

The HHS will prosecute those found engaging in kickback schemes.The penalty includes up to $25,000 in fines and up to five years'imprisonment. Physician violators can be barred from Medicareparticipation.

Physicians or hospitals may own shares in publicly traded companieswith more than $50 million in undepreciated net tangible assets,said Diane Millman, a partner in the Washington-based law officeof McDermott, Will and Emery. Such companies must have securitiesregistered with the Securities and Exchange Commission and tradedon a major stock exchange.

Radiologists who thought safe harbors would present opportunitiesto buy into joint-ventured centers are out of luck. The regulationslump them with hospitals and physician investors who must limittheir ownership share. Radiologists will not be barred from becomingjoint-venture partners, but their shares will be counted the sameas a referring facility or physician, according to HHS lawyerThomas Crane.

A planned safe harbor will protect radiologists who venturewith other radiologists in the ownership of imaging services,he said. Crane could not predict when that change will be final.

The American College of Radiology supported the safe harborrules. But Rep. Fortney "Pete" Stark (D-CA) criticizedHHS for not going far enough.

"Banning self-referral arrangements will save money. Ibelieve all referrals by physicians with an ownership interestshould be banned," he said.

The final rules were considerably more stringent than draftsafe harbors distributed two years ago. American Imaging Associationlobbying efforts had little effect. None of the group's initiativesto modify the regulations were incorporated in the final rules.

"This was a situation impregnable to lobbying. There wasnothing we could do about it," said Frank Kyle, presidentof MedInc of Nashville. Kyle was the first president of the AIA.

Few joint-ventured imaging centers can meet the safe harborsdictating how much revenue can come from referring-physician owners,Millman said. To comply, centers have four options: selling thecenter, finding replacement investors for existing shares, dilutingthe investment equity to expand the investment base, or acceptingthe risk of potential prosecution.

The last option is the most attractive to many businesses,Millman said.

"The safe harbors are so narrowly drawn that they leavemost joint ventures exactly where they were before. They are notparticularly better or worse off by taking their chances on theexisting statute," she said.

Selling out to one of the seven imaging center chains ableto meet the "large entity" safe harbor is another potentiallypopular option. Four companies are publicly traded and are inthe $50 million asset range: American Health Services in NewportBeach, CA, MICA in San Diego, NMR of America in Morristown, NJ,and Health Images in Atlanta.

Privately held companies that could quickly qualify includedMedInc, Advanced Diagnostic Imaging in New York, American SharedServices in San Francisco, LINC in Chicago, and TME in Houston.Mobile imaging specialists, such as MTI in Los Angeles and AllianceImaging in Southern California, may also get into the act.

American Health Services can help centers meet their 60/40structural safe harbor threshold, said president E. Larry Atkins.He would like to buy 40% of the shares in centers that are now100% physician-owned.

"At the risk of sounding opportunistic, the safe harborscreate a business opportunity," he said.

The safe harbors provide medium-size companies, such as six-centerimaging chain Advanced Diagnostic Imaging of New York, with anincentive for rapid growth, said Drew Netter, ADI president.

"The safe harbors give us guidelines to work with, suchas the $50 million in assets," he said.

The safe harbors encourage MedInc, which has $75 million inconsolidated assets, to go public at some future point. The regulationscreate an incentive to initiate a public stock offering soonerrather than later, Kyle said.

The 60/40 revenue requirement will increase competition formanaged care contracts among imaging centers, according to Gill.Such contracts could quickly help centers dilute their dependenceon self-referral.

But managed care deals have their price.

"HMO and PPO contracting will encourage pressure to reduceprices for imaging exams in communities where managed care hasan especially strong presence," Gill said. Discounted pricingwill translate into lower profitability.

Radiologists looking for imaging center investments shouldbe careful, said Dr. Lawrence Muroff, director of nuclear medicineat University Community Hospital in Tampa, FL. Centers that thrivedbefore the safe harbors could self-destruct as they try to meetthe new requirements.

"I would make sure I knew the referral patterns and thelocal competitive situation before investing," he said.

ELEVEN SAFE HARBORS define financial arrangements for diagnosticimaging centers that comply with the Medicare anti-kickback law:

  • Investment interests--large entities.
  • Exempts publicly traded entities reporting $50 million in undepreciated net tangible assets.
  • General public must have an equal opportunity to invest.
  • No special treatment for self-referring physician investors.
  • Health-care providers cannot lend money to investors.
  • Dividends must not be linked to referral volume.
  • Dividends must be proportional to investment size.

  • Investment interests--limited and general partnerships.
  • 60% of every security class to be held by non-referring investors (referring investors include physicians, hospitals and radiologists).
  • 60% of gross revenue to originate from non-investor physicians.
  • Marketing of securities cannot favor self-referring physician investors.
  • Physician investors cannot be required to refer patients to the center.
  • Health-care providers cannot lend money to investors.
  • Dividends must be proportional to the size of the investment interest.

  • Space rental.

  • Equipment rental.

  • Personal service contracts.
  • Contracts must be in writing.
  • Written contracts cover at least one year of service.
  • Charges must reflect fair market value.

  • Sale of practice.
  • Prohibits hospitals from purchasing physician practices.
  • One-year transition allowed as new physician-owner learns practice.

  • Referral services.
  • Referral services may decide which practitioners participate.
  • Fees based on operating costs, not referrals.
  • Safe harbor defines disclosures to consumers who call for assistance.

  • Warranties.
  • Warranty to cover out-of-pocket expenses.
  • Safe harbor only protects original manufacturer warranty.

  • Discounts.
  • Precludes bundling.
  • Permits rebates.
  • Permits year-end discounts when cost reports are used.
  • Charge-based providers need not reduce charges.

  • Employees.
  • Bona fide employees, defined by IRS, may market services to the general physician community.
  • Rule does not extend to independent contracts. These payments are covered under personal services safe harbor.

  • Group purchasing organizations (GPOs).
  • Permits vendor payment to GPO rather than GPO recovering costs from hospitals.
  • Requires written contracts. GPO to report payments received from vendors.

  • Waiver of beneficiary deductible and co-insurance.
  • Inpatient hospital co-payments may be waived when there is no cost to Medicare and all Medicare beneficiaries are included.
  • Public Health Act grant programs define safe harbor for other co-payment waivers.
  • All other waivers are illegal.