New regulations limiting executive compensation and administrative expense by entities that contract with New York State are about to take effect and affected entities must now assess whether their current executive compensation practices and administrative expense experience will comply with the final regulations. Uncertainty about certain elements of the regulations, along with the potential of a legal challenge to the regulations, has complicated the compliance challenge faced by both not-for-profit and for-profit entities that do business with New York State.
On May 29, 2013, eighteen months after Governor Andrew Cuomo issued Executive Order 38 to cap executive compensation and administrative expense by state-funded organizations, thirteen New York State agencies adopted final regulations to implement the new limitations. The nearly 200 pages of regulations collectively issued by New York State regulatory and funding agencies, which were first proposed in May of 2012, were revised and republished three times before being finalized. Originally expected to become effective on January 1, 2013, the regulations will now take effect July 1, 2013.
For many entities that contract with New York State, the actual impact of the regulations will actually be delayed even further. For those state-funded entities whose cost-reporting periods or fiscal years are on a calendar year basis, the regulations will not apply until January 1, 2014. And, because entities are not required to disclose their executive compensation and administrative expense information until as much as six months after the reporting year has ended, the compliance burdens of the new regulations will not actually be fully borne by state-funded entities until well into 2015.
Nevertheless, despite the prolonged regulatory process and the gradual implementation of the regulations, state-funded entities in New York need to prepare now for the new regulatory regime. Although many provider organizations and individual entities complained that the regulations would place unjustified and unreasonable limitations on state-funded entities and would hinder their ability to recruit the best executive talent, the regulations are now going forward, consistent with the broad outlines of the Governor’s Executive Order. Failure to comply with the regulations could cost state-funded entities their contracts and state funding and could even result in efforts to recoup funds from executives who, after the fact, have been deemed overpaid.
A detailed analysis of the regulations would exceed the scope of this article. Instead, after outlining the major elements of the regulations, the following describes the additional guidance that is urgently awaited, reviews some of the “judgment calls” that covered providers will have to make, explores the uneven applicability of the regulations to state-funded entities and evaluates the prospect that either legislation or litigation might undo or modify the regulations.
Overview of regulations: Although the details of the regulations have undergone considerable revision, the basic construct of the regulations has remained essentially consistent:
>>> For-profit and not-for-profit “covered providers”—those that receive more than $500,000 in state support for at least two years and whose state and state-authorized funding exceeds thirty percent of their total funding—may not use state funds or state authorized funds to pay executives in excess of $199,000, unless granted a waiver. For those organizations that receive Medicaid support, “State-authorized funds” explicitly include Medicaid payments, whether made directly by the State or by a managed care entity, and include the full Medicaid payment, not just the state share.
>>> Compensation in excess of $199,000 may not be paid by covered providers even if compensation is supplemented with non-state funds unless:
>>> the compensation is below the 75th percentile of compensation provided to comparable executives, in comparable size agencies, same program area and comparable geographic area, as established by surveys “identified, provided or recognized” by the relevant state agency and the State Division of Budget; and
>>> the compensation was reviewed and approved by the board or a compensation committee or its equivalent, including at least two independent directors, and involved the review of comparability data; or
>>> the covered provider receives a waiver.
A covered provider may obtain a waiver from these compensation limits if “good cause” is shown to warrant the waiver, which will consider: comparability of the compensation; the potential inability to provide the program services at the same levels of quality; the nature, size and complexity of the organization; the organization’s compensation review practices; the qualifications and experience of the executive; and the efforts made to find executives at lower levels of compensation. The regulations contain detailed provisions governing the waiver process, its duration and the right to appeal a waiver denial.
>>>Covered providers must maintain administrative expenses below 25 percent of their overall state-funded program services expenditures, and must reduce that percentage by five percent a year for two years, culminating with a 15 percent administrative cap in 2015 and thereafter. Waivers may also be sought from these requirements, as well, if “good cause” is shown, which will involve consideration of the necessity of the administrative expenses, their impact on quality, the nature and size of the organization and other factors.
A host of detailed provisions govern issues such as: the applicability of the regulations to related organizations and subcontractors; the waiver process, including the procedures for requesting them, the criteria for approving them and the grounds for appealing their denial; and definitions of “compensation,” “administrative expense,” and other key terms.
Awaiting guidance: Even as the new regulations are about to become effective, crucial additional guidance on the new regulations that has been promised by New York State officials has yet to be issued. Clarification is anticipated on how to determine covered provider status, the applicable reporting period and what specific funding is encompassed within State funds and State-authorized funds, as well as guidance on the differentiation between program service expenses and administrative expenses—along with the sample forms and procedures that will govern reporting requirements and waiver requests.
In addition, organizations that want to assess whether the compensation paid to their executives falls below the 75th percentile “safe harbor” have been waiting to learn how that comparability calculation will be made. Covered providers have sought guidance on the compensation surveys that will be “identified, provided or recognized” by the relevant state agency and the State Division of Budget to make that calculation. The latest response by the New York State Department of Health to the formal regulatory comments on the regulations promised that “additional information regarding how this information will be identified, provided or recognized will also be provided.” The evolution of the regulations suggests that there may be a willingness to allow covered providers to submit their own or a consultant’s compensation comparability analysis to support their calculation, as opposed to having the State compile its own comparability data to gauge the compensation of executives in a wide variety of for-profit and not-for-profit entities.
The manner in which the regulations are implemented creates additional uncertainty for covered providers, regardless of what additional guidance might be offered. As drafted, the regulations make the reporting requirements and any waiver requests due six months after the close of the provider’s reporting period—potentially leaving covered providers uncertain about whether a waiver will be granted, or even required, until long after the compensation has already been paid.
Judgment calls: With or without the additional guidance, the regulations will require covered providers to exercise discretion in applying the new regulations to their compensation and expenditure practices. The revisions to the regulations carved out “clinical and program personnel” from the definition of “covered executive,” thereby exempting individuals whose roles are “directly attributable to and comprise program services,” including supervisory services, subject to adequate documentation. Covered providers will have the opportunity, it would appear, to exercise some judgment as to which executives may thereby fall outside of the executive compensation limitations.
Likewise, covered providers will need to distinguish their unique “administrative” and “program” expenses in accordance with the regulations’ definitions to determine whether they are in compliance with the caps on administrative expense. To the relief of covered providers, the regulations were modified to incorporate a broader array of expenditures within the program expense category and providers may find themselves categorizing expenditures for the purposes of these regulations in a manner that is not necessarily consistent with other cost reporting requirements.
Uneven applicability: The regulations’ impact on covered providers will vary significantly. Although executive compensation agreements entered into before July 1, 2012 will not be subject to the regulations through April 1, 2015, more recent employment agreements will be fully subject to the regulations. Entities funded by the State Education Department—not subject to the Executive Order—are not covered by the regulations. The rules involving related organizations and subcontractors will snare certain entities and not others.
Most dramatically, otherwise potentially affected entities that do not receive over thirty percent in state funding or state authorized funding—including some of the State’s largest private hospitals, for example— are entirely exempt from the regulations. The regulations will have their greatest impact on entities that rely more heavily on state support and particularly on those that may be unable to supplement compensation from non-state sources.
Legislative or Judicial Intervention: Having failed to dissuade the State from proceeding with the regulations, potentially affected parties have turned to the Legislature and to the courts for potential relief.
On the legislative front, a bill was introduced in the New York State Senate and Assembly (Assembly Bill No. 2120/Senate Bill No. 4783) that would put in place an alternative executive compensation regulatory scheme, with stronger enforcement powers granted to the New York State Attorney General. In addition, the bill would enact a series of IRS-like standards to be satisfied by the not-for-profit board, including independent review of compensation by the board and/or board committee accompanied by an analysis that would ensure that the compensation levels were no more than 110 percent of comparable salary levels. The bill would, moreover, expressly preempt the Executive Order that is the basis of these regulations. While the bill appears to have substantial support in the Republican and Independent Democrat-led State Senate, it has not progressed in the Democrat-dominated Assembly—and, since it directly undermines the Executive Order, it seems likely that the bill, even if it passed both houses, would be vetoed by the Governor.
In just the past week, litigation was commenced in Suffolk County, Long Island, that challenges the legal validity of the Executive Order. In Concerned Home Care Providers, Inc. v. Department of Health, a trade group for home health care agencies serving New York City, Long Island and Westchester County is seeking a declaratory judgment that the issuance of the Executive Order and the accompanying regulations, in the absence of any express statutory authority, exceeded the authority of the Governor and the state agencies. It is expected that a motion for a temporary restraining order that would block the implementation of the regulations will be made shortly. Additional legal challenges from other parties may also be likely in the weeks ahead. The ultimate outcome of the Concerned Home Care Providers case or any other litigation will not be known for some time: however these issues are likely to be decided by the lower courts, the case is likely to be appealed.
In the absence of any immediate legislative or litigation fix, entities in New York should now be focused on what they need to do to satisfy the new regulations, even as guidance on how to do so is still urgently awaited.