There was some discussion of this topic at the Healthcare Conference to be sure. Here is a quote from Advisory Opinion 09-09, footnote 5:

"Our conclusion might be different if the valuation of the respective contributions of the investors included intangible assets. For example, given the circumstances of the Proposed Arrangement, we might be concerned if the valuation were based on a cash flow analysis of the Surgeon ASC as a going concern. Because the Surgeon Investors are referral sources for the Surgeon ASC, a cash flow-based valuation of that business potentially would include the value of the Surgeon Investors’ referrals over the time that their ASC was in existence prior to the merger with the Hospital ASC. The result might be that the Surgeon Investors would receive a greater return on their capital investment than the Hospital, which could reflect the value of their referrals to the Surgeon ASC. (In these circumstances, the Hospital ASC, being newly developed at the time of the proposed merger, may have little or no cash flow record, but we might be similarly concerned with a valuation based on a cash flow analysis of a hospital-owned ASC for which the hospital could influence referrals.) We do not assert that a cash flow-based valuation or other valuation involving intangible assets would necessarily result in a violation of the anti-kickback statute; the existence of a violation depends upon all the facts and circumstances of a particular case."

This comment harkens back to the Thornton letters (1992/1993) 

and Advisory Opinion 07-05,

the latter of which caused considerable consternation.    At issue is that the OIG appears to define "capital invested" as cash and tangible assets rather than the term used in "fair market value" (market value of invested capital) which includes intangible assets. As the quote indicates, intangible assets may be problematic from a AKS standpoint, given all the facts and circumstances.

Thanks to my colleague Tim Smith for elucidating my thinking on this.

I received a question the other day inquiring as to the basis for  my statement in the November 2005 Journal of Accountancy that "the IRS says physician compensation in a valuation model should agree with any post-transaction employment contract."  I thought my response to that question would assist a lot of other appraisers.

This concept originally appeared in a letter attached to the valuation submitted in connection with the exemption ruling for the Friendly Hills Transaction as described below:

Quote from my book:

“The Friendly Hills HealthCare Foundation was the first ruling by the IRS in favor of tax exemption for an Integrated Delivery System (IDS) involving physician compensation in tax-exempt settings.  Certain aspects of the Ruling, including the use of the Discounted Cashflow Method, were later elaborated upon in the 1995 Exempt Organization Continuing Professional Education Technical Instruction Program Textbook.  Notably, the value determined in Friendly Hills was based, in part, on an agreed-upon reduction in physician compensation.”

“In fact, the valuation submitted in connection with the Friendly Hills transaction  contains a letter signed by the managing partner stating that the partners recognized they were selling a portion of their earnings and that their future incomes would be less by virtue of that sale.  In relevant part he states “… It has been clearly stated to the partners that, in the past, their compensation reflected not only the value of their medical services, but also the profits attributable to their ownership of the Network; that the latter element will be replaced by a cash payment, which they can invest … that the Medical Group’s income will thereafter be derived from arms-length contract for medical services; and that these rates will necessarily be significantly lower than the total historical income they have been receiving …” (emphasis added).  (Friendly Hills Valuation Report)”

See the 1994 Exempt Organization CPE text INTEGRATED DELIVERY SYSTEMS (eotopicn94.pdf) and 1995 Exempt Organization CPE text INTEGRATED DELIVERY SYSTEMS AND JOINT VENTURE DISSOLUTIONS UPDATE (eotopicl95.pdf).  Note in particular bottom of page 8 forward in 1994 text and the general discussion of compensation in 1995.  You can obtain these at These are still cited as recently as 2004.

Fundamentally, why would a hospital buy a practice for a value based upon the physicians receiving X compensation for their future services, when the Employment contract provided they would be paid X+?  You would not buy my practice, or I yours, for a $1 million and continue to pay me/you everything it generates, I suspect.  For a hospital to do so raises serious inurement and excess benefit issues, and more importantly, Stark and AKS issues.

Opinion No. 07-05 involves the sale of a 40% interest at fair market value in an existing ASC by certain physicians to a tax-exempt hospital.  The fact pattern includes 94% of the interest owned by orthopedic surgeons and 6% by gastroenterologists and anesthesiologists.  The subject 40% interest is owned by the orthopods; the sale proceeds would not be invested in the ASC entity itself but would go directly to the orthopods. 

The OIG concluded that the proposed transaction raised issues under the AKS since not all the physicians were selling interests and more importantly, “the return on the investment would not be directly proportional to the amount of the capital invested by each investor. The amounts payable to the investors would be proportional to their ownership interest in the Company; however, because the Hospital would pay more per ownership unit than the Orthopedic Surgeons paid, the Orthopedic Surgeons would receive a higher rate of return on their remaining shares than the Hospital would receive on its newly-purchased shares.”

On the surface, this Advisory raises serious concerns about sales of interests in ASCs (and just about anything else regulated by the AKS for that matter) since the OIG’s conclusion is that the transaction poses a risk under the AKS.  Particularly problematic from a valuation standpoint is the OIG’s failure to recognize one of the fundamental tenets of Fair Market Value: namely, that the cash proceeds of the sale are exactly equal to the present value of the future returns on the underlying investment.  Therefore, the premise for the OIG’s adverse conclusion that “the Orthopedic Surgeons would receive a higher rate of return on their remaining shares than the Hospital” for the OIG’s adverse conclusion” is entirely false.  ‘Return’ is based upon the fair market value TODAY of the underlying shares which is exactly what the Opinion states the hospital is paying and the orthopods are receiving.  ‘Return’ includes both cash distributions and appreciation.  The orthopods are receiving cash for the appreciation to date and foregoing future cash distributions on the portion sold.


One can only hope that something more was in the submitted documentation from those requesting the ruling that gave the OIG cause for concern.


April 3rd, 2007 | Posted by Mark Dietrich in Seminars & Publications - (1 Comments)

I am pleased to report that I received confirmation that my article entitled A Healthcare Appraiser Reviews a Judge-Appraiser’s "Report" will be published in the Summer 2007 edition of Business Valuation Review.  This article takes an entirely different look at last Spring’s Delaware Open MRI decision, focusing on errors in the assumptions in the income approach, including use of the industry risk premium and terminal growth rate. BVR uses a blind peer review system and the article was extensively re-written and improved as a result of the hard work of the editorial review board, to whom I am grateful.

The BVR article, along with the article I co-authored on the Caracci case, which has been favorably received but not yet accepted, represent the culmination of two years of work on clarifying  the correct application of the income approach in the healthcare industry and exposing weaknesses in the market approach. The two other works: Medical Practices: A BV Rx in the November 2005 Journal of Accountancy and Identifying Appropriate Valuation Approaches under Stark and the AKS in the December 2006 edition of the American Bar Association’s Health Lawyer were also subject to intensive editorial review and re-write. 

Taken as a whole, the four pieces present a comprehensive framework for identifying common errors and correct approaches in healthcare industry valuation.

The Health Lawyer

December 3rd, 2006 | Posted by Mark Dietrich in Uncategorized - (0 Comments)

My article Identifying Appropriate Business Valuation Approaches under Stark and the AKS with Reed Tinsley, CPA/CVA appears in the current issue of The Health Lawyer from the American Bar Association. As indicated in earlier posts, we believe this article contains an important analysis of the issues surrounding incorporating quantitative assumptions that conform with regulatory standards into valuation models. We also review the customary definitions of Fair Market Value and the modifications to those definitions contained in the Stark regulations and implied by the Anti-Kickback Statute. Finally, there is an analysis of the use of the Market Approach and why it has serious limitations in the regulated healthcare sector.

I will be speaking on these issue in April at the Health Care Compliance Association’s Compliance Institute in Chicago.