Proposed Regulations Limiting Executive Compensation of State-Funded Service Providers: “One Size Fits All” Gives Way to More Nuanced ApproachMay 31, 2012
On May 16, 2012, the New York State Department of Health (“DOH”) and twelve other State agencies that fund for-profit and not-for-profit service providers released proposed regulations (the “Proposed Regulations”) to implement Executive Order No. 38, issued by Governor Andrew Cuomo on January 18, 2012, limiting the use of State funds for executive compensation and administrative expenses.1 The Proposed Regulations were published in the New York State Register on May 30, 2012 (page 32), with a 45-day public comment period until July 16, 2012. The Office for People with Developmental Disabilities (“OPWDD”) is the only agency that has scheduled public hearings on the Proposed Regulations, for July 16, 2012 in New York City and July 18th in Schenectady.2 The Proposed Regulations promulgated by DOH are identical to the regulations released by the other twelve agencies, with the exception of the language in the preamble referencing the statutory authority. The regulations are scheduled to go into effect on January 1, 2013.3
Briefly, rather than impose a hard and fast cap of $199,000 on how much a provider can pay its executives, the Proposed Regulations contemplate that a provider can pay a higher level of compensation, by either meeting the regulatory “safe harbor” or obtaining a “good cause” waiver, provided that State funds are not used to pay amounts above the $199,000 threshold.
This memorandum discusses the series of questions that providers would need to consider to determine if they would be subject to the Proposed Regulations, and what steps they would need to take to comply with the proposed executive compensation limits. We will also discuss the new reporting obligations imposed on providers concerning executive compensation, the proposed penalties for noncompliance with executive compensation limits, and the rights of providers to appeal any adverse determinations.
Preliminarily, however, it would be helpful to put the Proposed Regulations into proper historical and legal context with a discussion of the events and developments preceding the promulgation of the Proposed Regulations as well as the statutory bases for such regulations.
Summary of Recent State Developments Involving Executive Compensation
The publication of the Proposed Regulations occurs against the backdrop of heightened governmental scrutiny of executive compensation of publicly funded health care and other service providers. Over the past year, a number of State government agencies and officials have focused their attention on perceived abuses in executive compensation, initially in the not-for-profit provider sector and, more broadly, among all Medicaid and State-funded service providers regardless of sponsorship.
Governor Cuomo. On August 3, 2011, one day after the New York Times published an article about executive compensation paid by a non-for-profit agency serving the developmentally disabled, Governor Cuomo created the Task Force on Not-for-Profit Entities (the “Task Force”) to investigate executive compensation packages at not-for-profit organizations that receive State taxpayer support.4 Notably, the Task Force’s review was limited to not-for-profit entities. In the months following its creation, the Task Force collected detailed executive compensation information from literally thousands of not-for-profit entities that receive funding from the State.5
On January 17, 2012, Governor Cuomo released his proposed budget for 2012-13, which included provisions to limit executive compensation and administrative costs of both not-for-profit and proprietary state providers.6 The following day, Governor Cuomo released Executive Order No. 38, the terms of which mirrored the provisions of the budget proposal. Briefly, Executive Order No. 38 directed each executive agency that provides state funds to service providers to promulgate regulations barring the use of State funds for executive compensation exceeding $199,000 per year and limiting the use of State funds toward a provider’s administrative costs, initially to 25% of total operating costs and lowering the cap by 5% per year to 15% by 2015.
The New York State Senate. On February 6, 2012, with the Governor’s budget proposal and Executive Order pending, the New York State Senate Committee on Investigations and Government Operations (“GovOps”) convened a public hearing “to examine executive compensation at not-for-profit organizations receiving State funding and the actions needed to prevent State tax dollars from being wasted on excessive salaries.”7 The Senate GovOps Committee received testimony from various not-for-profit representatives, most of whom were critical of the Governor’s proposed cap and advocated instead for incorporating into New York law, existing Federal IRS standards for reasonable compensation governing IRC § 501(c)(3) organizations.
On February 16, 2012, the Senate GovOps Committee issued a report recommending, among other things, that the Executive Order be limited to not-for-profit organizations; that State reimbursement limits on executive compensation be based on the level of an organization’s revenue or the value of State contracts, rather than a “one size fits all” cap; and that the terms “reasonable” and “compensation” in the New York Not-for-Profit Corporation Law (“N-PCL”) be defined by reference to Internal Revenue Service (“IRS”) definitions and guidelines.8
The New York State Attorney General. In June 2011, Attorney General Eric Schneiderman had convened the “Leadership Committee for Nonprofit Revitalization”, comprised of not-for-profit representatives, academics, attorneys and Attorney General staff, to develop recommendations for strengthening accountability of not-for-profit organizations while reducing the financial and regulatory burdens on not-for-profits.9 The Leadership Committee widened its focus to include not-for-profit executive compensation following the Governor’s actions, described earlier. The Leadership Committee took a different approach from the apparently more absolute restrictions suggested by Executive Order No. 38, and recommended amendments to New York State Not-for-Profit Corporation Law to enhance board oversight over executive compensation.
Much like the Senate GovOps Committee, the Leadership Committee recommended reforms that largely reflect the Internal Revenue Service’s “rebuttable presumption” test for reasonable compensation of 501(c)(3) organizations, including: (i) requiring independent board oversight of executive compensation; (ii) setting forth definite criteria for board review of compensation, including total compensation, relevant comparability data, employees’ qualifications and performance, payments or other benefits from related entities, and the not-for-profit’s overall financial position; (iii) requiring contemporaneous documentation of board justifications for and reasonableness of compensation; and (iv) requiring the adoption of policies and procedures to ensure adequate oversight of compensation consultants.10 Bills based on recommendations from the Senate GovOps Committee and the Leadership Committee have been introduced in the Senate and are currently pending.11
Regardless of the fate of the competing executive and legislative proposals, providers should prepare to comply with the Proposed Regulations by January 1, 2013. At the same time, providers should recognize that the proposed executive compensation limits may be modified in the Final Regulations in response to public comments, and more generally that the current focus and interest in executive compensation may evolve in response to broader political and legislative developments.
What is the State’s Authority for Promulgating the Proposed Regulations?
The N-PCL already regulates the executive compensation of not-for-profit executives by authorizing payment of a “reasonable amount to members, directors, or officers for services rendered;”12 proscribing the inurement of not-for-profit assets, income or profits to its members, directors and officers;13 requiring officer and director compensation to be “reasonable” and “commensurate with services performed;”14 and allowing not-for-profit directors and officers to rely in good faith on advice of one or more of the corporation’s officers, employees, committees or consultants, provided that such advice does not demonstrate incompetence or bad judgment.15 The Executive Order and Proposed Regulations, it may be argued, encroach upon the Attorney General’s regulation of not-for-profit organizations and enforcement of the N-PCL.16
On the other hand, the Department of Health’s statutory oversight extends to for-profit and not-for-profit providers alike, both because they are subject to DOH licensure and regulation and because they receive State Medicaid dollars. In this regard, the Proposed Regulations do cite to the agency’s general authority to promulgate rules to implement the Medicaid program under the Social Services Law17 and broad powers to receive, expend, and regulate funds made available for public health purposes under the Public Health Law.18
Do the Proposed Regulations Apply to My Organization?
The Proposed Regulations would apply to both not-for-profit and for-profit “covered providers” that meet both of the following criteria:
1) The provider has received “State funds” or “State-authorized payments” such as Medicaid that have averaged over $500,000 a year during the past three years;19 and
2) The State funding accounted for at least 30% of the provider’s total “in-state”20 revenues in the most recent reporting period as measured on a consolidated basis with any parent or subsidiary entities.21 (The Proposed Regulations do not define the terms “parent” and “subsidiary” organizations.)
- Based on the definition of “State-authorized payments,” the federal share of Medicaid funding paid by New York State would be included in the calculation of both the $500,000 and 30% State-funding thresholds. On the other hand, federal Medicare reimbursements would not be included.22
- Governmental providers, certain individuals providing child care services, and professionals providing program services individually would be exempt from the Proposed Regulations.23
- For the purposes of the Proposed Regulations, “State funds” or “State-authorized payments” also do not include (i) procurement contracts awarded on a “lowest price” basis, except for contracts for program services awarded on a “lowest price” basis; (ii) awards to State or local governmental units, except where used to pay covered providers through a contract or other agreement; (iii) capital-related expenses; (iv) direct payments or the provision of vouchers used to secure specific services selected by the individual or health insurance premiums; (v) wage or salary subsidies paid to employers to support the hiring or retention of employees (such as recruitment and retention funds for direct home care workers under Public Health Law §§ 3614 and ); (vi) awards to entities engaged exclusively in commercial or manufacturing activities; or (vii) policy development or research.24
- Not-for-profit continuing care retirement communities, assisted living residences, and independent housing providers that do not receive 30% or more of revenue from Medicaid or other State funding would likely not be subject to the Proposed Regulations.
- Because the 30% threshold is based on consolidated revenues, a health care network receiving primarily private pay or Medicare revenue would likely be exempt even if one subsidiary may receive more than 30% of its revenue from Medicaid.
What are the Limits on Executive Compensation?
Key Terms. The Proposed Regulations would prevent a covered provider or its “related entities” from using State funds or State-authorized payments to pay more than $199,000 per year25 in “executive compensation” to a “covered executive.”
- A “related entity” would include any entity that either (i) shares three or more officers, directors, trustees, or employees with the covered provider; (ii) appoints 25% or more of the officers, directors, trustees, or employees of the covered provider, or vice versa; (iii) is controlled by a common parent entity as the covered provider; (iv) directly or indirectly owns any interest in the capital or profits of the covered provider; or (v) substantially controls the executive compensation or financial affairs of the covered provider, or vice versa.26
- “Executive compensation” would include, but not be limited to, salary and wages, bonuses, dividends, personal vehicles, meals, housing, educational benefits, below-market loans, payment for personal travel, entertainment, and personal use of the organization’s property. The calculation of executive compensation would exclude statutory benefits such as Social Security, worker’s compensation, unemployment insurance, and disability insurance, as well as standard health and pension benefits also provided to the organization’s non-covered executive employees.27 The limit would not apply to reimbursement with State funds for reasonable compensation paid to an executive for specific program services rendered by the executive outside of his or her managerial or policy-making role.28
- A “covered executive” would include a director, trustee, managing partner, officer, or employee, such as the executive director or chief executive officer, controller or accounting personnel, and public relations personnel, whose salary and benefits, in whole or in part, are “administrative expenses” incurred in connection with overall management and not attributable to particular program services.
- Is a “downstream” provider or vendor a “covered provider”? The executive compensation limits apply to subcontractors and agents that are “related” to a covered provider if State funding or payments “pass through” the covered provider to the subcontractor or agent.29 Thus, if a covered provider contracts with a related entity, such as a management company, for administrative or program services, the covered executives of the related entity would be considered covered executives of the covered provider. On the other hand, an unrelated entity that contracts with a covered provider to provide program services, such as a licensed home care services agency (“LHCSA”) contracting with a certified home health agency (“CHHA”) or long term home health care program (“LTHHCP”), it appears, would not be subject to the Proposed Regulations.
Can A Covered Executive be Paid More than the $199,000 Limit?
Safe Harbor. The Proposed Regulations along with Executive Order No. 38 and the Governor’s accompanying press release evidence an intent to cap the level of compensation that can be paid with State funds at $199,000 a year per covered executive.30 Notwithstanding the cap on State funding, however, a provider can pay a covered executive more than $199,000 with other sources of funding if the following criteria are met:
- The compensation is below the 75th percentile for executives of comparable providers of the same size and in the same sector and geographic area, as established by a compensation survey recognized by DOH or the New York State Division of the Budget (“DOB”);
- Compensation is approved by the provider’s board of directors, including at least 2 independent directors using comparability data; and
- The above requirements are substantiated with sufficiently detailed contemporaneous documentation.31
Can An Executive Be Paid Above the 75th Percentile?
Executive compensation within the top quartile may still be allowed, upon a showing of “good cause,” through a waiver from DOH and DOB. A provider seeking a waiver must apply no later than 60 days prior to the reporting period, or the DOH contract renewal date (if applicable), whichever comes first. To obtain a waiver, a provider must demonstrate “compelling circumstances” and provide any documentation requested by DOH or DOB.
DOH or DOB will consider the following factors when deciding a waiver application:
- Comparability of executive compensation to executives in the field;
- Extent to which reimbursement for executive compensation exceeding the limits is needed to maintain the level of program quality and availability;
- Nature, size and complexity of the covered provider’s operations and the services provided;
- Rigor of the provider’s review and approval process; and
- Provider’s efforts to secure executives with the same level of experience, expertise and skills at lower levels of compensation.32
The Proposed Regulations allow for a similar waiver of the caps on State funding of administrative expenses, including such additional factors as (i) “the extent to which the administrative expenses . . . are necessary and avoidable” and (ii) “evidence that a failure to reimburse specific administrative expenses . . . would negatively affect the availability or quality of program services in the covered provider’s geographic area.”
Cautionary Note. While these factors should inform DOH’s or DOB’s review, the agency would still retain discretion in deciding a waiver application, which would present a risk to a provider relying on a waiver to support its executive compensation (or, for that matter, administrative expenses). Moreover, the executive compensation limits may present compliance challenges, particularly for providers reimbursed substantially or entirely by Medicaid, as such providers may not have much latitude to use alternative sources of funding to compensate executives at a level greater than the $199,000 State funding cap.
Duration of a Waiver. Under the Proposed Regulations, waivers may be deemed revoked when an executive’s compensation is increased by more than 5% in one year or “upon notice provided at the discretion of DOH or its designee as a result of additional relevant circumstances.”
Can a Provider Appeal the Denial of a Waiver?
The Proposed Regulations would establish a procedure to request reconsideration of a waiver denial within 30 days of written notice. Upon reconsideration, DOH and DOB could affirm, revoke or modify the proposed denial.33 The decision upon reconsideration would then be final, which presumably could be subject to judicial review in an Article 78 proceeding. (The Proposed Regulations do not establish a separate procedure to contest the revocation of an existing waiver.)
What Are the Reporting Obligations Under the Proposed Regulations?
Beginning with the 2013 reporting period, every covered provider must submit an electronically available disclosure report for each reporting period. Providers reimbursed by multiple agencies will only need to submit one disclosure report. Failure to provide a report may result in the termination or non-renewal of the contract for State funding.34 The disclosure report form is not yet publicly available, and it is unclear what information will be requested on the form.
In addition to the annual disclosure report, covered providers would have to “promptly report” the identity of any subcontractors and agents that are “related entities,” to the extent that such related entities receive State funds or State authorized payments from the provider during the reporting period.35
Are the Reports and Waiver Applications Subject to FOIL Disclosure?
The annual disclosure reports, as well as any waiver applications, would likely be accessible to the public under the New York Freedom of Information Law (“FOIL”). Documents filed with government agencies are presumptively discoverable unless they are subject to a specific statutory exemption, such as trade secrets information or records that, if disclosed, would constitute an unwarranted invasion of personal privacy.36 Covered providers should consider designating those portions of their reports or waiver applications containing commercially sensitive trade secret information, such as details about comparability studies, and other personal private information (beyond level of compensation) as exempt from FOIL. Given the arguably strong public interest in transparency about the use of taxpayer funds, it is uncertain that such a request would be honored.
What are the Penalties for Noncompliance?
Noncompliance with the executive compensation limits can result in serious penalties such as the revocation of a provider’s license, redirection of State funds, or termination of State contracts, or “any lawful actions or penalties deemed appropriate.” If DOH (or DOB) ultimately determines that a provider is not in compliance with the regulations, the provider will be notified in writing and given 15 days to furnish DOH additional or clarifying information. If the provider fails to provide additional information, or if after receiving the additional information, DOH determines that a violation has occurred, the provider will be sent a notice of violation and notice to cure, providing a minimum of six months to correct the violation prior to imposition of penalties and requiring the provider to furnish a corrective action plan (“CAP”) within 15 days. DOH may approve or require clarification or alteration of the CAP within 30 days of receiving it. Once approved, the provider will have six months to complete the CAP. If, at the end of that period, DOH determines that the CAP has been successfully completed, the matter will be closed.
If the violation is not timely cured, DOH may extend the cure period, modify the CAP, or impose sanctions. The provider may request an administrative appeal of a final violation determination within 10 days of final determination and notice of proposed sanctions. The request must include a detailed explanation of the legal and factual bases for the challenge. The provider’s appeal is limited to an administrative review unless the agencies seek to impose sanctions, for which an administrative hearing would otherwise be required by statute or regulation.37
Is Executive Compensation Deemed Excessive, Subject to Clawback Under the Proposed Regulations?
The Proposed Regulations do not expressly provide for recoupment of executive compensation deemed excessive. Nevertheless, the agency’s authority to impose sanctions of “any . . . lawful actions or penalties deemed appropriate” suggests that the State may seek to “clawback” compensation retroactively as a remedy. Notably, last year’s questionnaire distributed by the Task Force to not-for-profit providers expressly sought information about the responding organization’s views and policies with respect to recoupment and/or clawback of executive and board compensation. Indeed, a return of any amounts paid by the State in excess of the permitted level may be a component of an acceptable CAP. In the case of allegedly excessive executive compensation funded by non-State sources, it is unclear to whom or what entity any recouped funds would be returned. Conceivably, the State might seek to recoup those funds as well.
The Proposed Regulations do not address whether a provider would be permitted to pay executive compensation beyond the regulatory cap while a waiver application is pending. Likewise, there is nothing in the Proposed Regulations that would suggest paying executive compensation at the level requested in the pending waiver application would be a violation so long as the application has been timely submitted. Regardless, the risk of recoupment of allegedly excessive compensation if the waiver is ultimately denied could make it an untenable option for providers.
Clarification about the State’s intentions in this regard would be helpful.
1 N.Y. Reg. (May 30, 2012) The other twelve New York State agencies are the Office for People with Developmental Disabilities; Office of Mental Health; Office of Alcoholism and Substance Abuse Services; Office of Children and Family Services; Office of Temporary and Disability Assistance; Office for the Aging; Division of Criminal Justice Services; Office of Victim Services; Department of Corrections and Community Supervision; Department of Agriculture and Markets; Division of Housing and Community Renewal and Department of State.
2 Id. at 35.
3 Id. at 33.
4 See Governor’s Press Office, Governor Cuomo Orders Statewide Review of Executive Compensation at Taxpayer Supported Not-for-Profits (Aug. 3, 2011).
5 To date, the Task Force has not released an official analysis or report.
6 See 2012-13 Executive Budget & Reform Plan (Jan. 17, 2012), http://publications.budget.ny.gov/eBudget1213/fy1213littlebook/BriefingBook.pdf.
7 N.Y.S. Senate Standing Committee on Investigations and Government Operations, Investigations and Government Operations Calendar, http://www.nysenate.gov/committee/Investigations%20and%20Government%20Operations/events/2012-02-06?mini=committee%2FInvestigations%20and%20Government%20Operations%2Fevents%2F2012-02.
8 N.Y.S. Senate Standing Committee on Investigations and Government Operations, Report on the Hearing Held on February 6, 2012 on Executive Compensation at Not-for-Profits 11 (Feb. 16, 2012).
9 N.Y.S. Att’y Gen, Leadership Committee for Nonprofit Revitalization: Report to Attorney General Eric T. Schneiderman 8 (Feb. 16, 2012).
10 Id. at 24-25.
11 N.Y.S. S.B. S06930, An Act to Amend the Executive Law and the Not-for-Profit Corporation Law, in Relation to Compensation of Executive of Certain Not-for-Profit Corporations (Apr. 13, 2012); N.Y.S. S.B. No. S07431, Non-Profit Revitalization Act (May 15, 2012).
12 N.Y. Not-for-Profit Corp. Law § 515(b) (McKinney 2005 & Supp. 2012).
13 Id. § 102(a)(5).
14 Id. § 202(a)(12).
15 Id. § 717(b). See also People ex rel. Spitzer v. Grasso, 11 N.Y.3d. 64, 70 (2008) (recognizing that the Legislature made a policy decision to provide not-for-profit “directors and officers with the protections of the business judgment rule,” and that the Attorney General could not override the fault-based liability scheme envisioned by the Legislature by attempting to premise a strict liability claim for unreasonable executive compensation on the N-PCL).
16 Grasso, 11 N.Y.3d. at 69, 71 (2008).
17 N.Y. Soc. Servs. Law § 363-a(2) (McKinney 2010 & Supp. 2012).
18 N.Y. Pub. Health Law §§ 201(1)(o), (p), 206(3), (6) (McKinney 2002 & Supp. 2012).
19 Proposed section 1002.2(d) of 10 N.Y.C.R.R.
20 Id. Presumably, any revenue generated from operations outside of New York State would be excluded from the calculation of the 30% threshold.
22 The definition of “State-authorized payments” includes funds disbursed to a provider “by virtue of the provider having a state license in New York State to operate the program for which such payments are being made.” Proposed section 1002.2(k) of 10 N.Y.C.R.R. If literally construed, that definition arguably could encompass Medicare payments even though Medicare funds are entirely federal dollars, on the ground that a Medicare provider operating in New York State is authorized to participate in Medicare by virtue of State licensure. That interpretation, it appears, is a strained reading of the Proposed Regulations. The stated purpose and text of Executive Order No. 38 and the Proposed Regulations, coupled with the Governor’s accompanying press release, support the conclusion that “State-authorized payments” are limited to funding provided or disbursed by New York State.
23 Proposed section 1002.2(d) of 10 N.Y.C.R.R.
24 Proposed sections 1002.2(k), (l) of 10 N.Y.C.R.R.
25 Proposed sections 1002.2(c), (e), (i) and 1002.4 of 10 N.Y.C.R.R. DOH, with Division of the Budget approval, has the discretion to adjust the $199,000 figure annually “based on appropriate factors.”
26 Proposed section 1002.2(i) of 10 N.Y.C.R.R.
27 Proposed section 1002.2(c) of 10 N.Y.C.R.R.
28 Proposed section 1002.4(c) of 10 N.Y.C.R.R.
29 Proposed section 1002.4(e) of 10 N.Y.C.R.R.
30 The Proposed Regulations suggest that a covered provider can apply for a “good cause” waiver even from this State-funding cap.
31 Proposed section 1002.4(b) of 10 N.Y.C.R.R.
32 Proposed section 1002.5(a) of 10 N.Y.C.R.R.
33 Proposed section 1002.5(c) of 10 N.Y.C.R.R.
34 Proposed section 1002.6 of 10 N.Y.C.R.R.
35 Proposed sections 1002.3(b), 1002.4(e) of 10 N.Y.C.R.R.
36 See N.Y. Pub. Off. Law §§ 87(2), 89(b) (McKinney 2008 & Supp. 2012).
37 Proposed section 1002.7 of 10 N.Y.C.R.R.