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On May 16, thirteen New York State agencies released virtually identical proposed regulations to guide entities that do business with the State on new limitations on executive compensation and administrative expense. The regulations were formally published on May 30 and will be subject to a 45-day comment period. If and when adopted, the new regulations will have a significant impact on both nonprofit and for-profit entities that provide services with New York State support and could prove to be a blueprint for similar initiatives elsewhere to curb real or perceived abuses by entities that receive public funding.

The issuance of the proposed regulations is just the latest step by Governor Andrew Cuomo to address what has been perceived as excessive executive compensation in the not-for-profit and for-profit entities that contract with New York State. In 2011, revelations of extravagant benefits and outsized salaries in state-funded nonprofit organizations prompted the governor to convene a Not-for-Profit Entities Task Force that solicited detailed compensation and other financial information from nonprofit providers. In January 2012, Governor Cuomo proposed -- first through state legislation and, a day later, by executive order (EO No. 38) -- to limit executive compensation and administrative expense within entities that contract with New York State. The governor’s proposed legislation was not enacted, but EO No. 38 remains in place and authorized the regulations that were recently issued.

EO No. 38 prohibits using state funds to pay provider executives more than $199,000 per year, tying salaries in state-funded entities to the current salary schedule for senior federal government executives. The limit would apply to contracting service providers that “receive reimbursements directly or indirectly” from the State, but would allow for waivers. In addition, the order requires that at least 75 percent of the state-funded operating expenses of contracting entities must be “directed to provide direct care or services rather than to support the costs of administration.” The "direct services” percentage would increase by 5 percent per year until it reaches 85 percent on April 1, 2015.

A host of questions arose as to how the relatively terse executive order would be implemented, including to what extent non-state funds could supplement executive compensation, how “compensation” and “administrative expense” would be defined and how these new requirements these new requirements would be monitored and enforced. The proposed regulations were intended to clarify these and other issues might be addressed by the Cuomo administration.

The executive compensation regulations. Beginning in 2013, the regulations would require, that “covered providers” -- those that receive more than $500,000 in state support for at least two years and whose state funding exceeds 30 percent of their total funding -- may not use state funds or “state authorized payments” to pay executives in excess of $199,000. In addition, executive pay in these entities may not exceed $199,000, even if compensation is supplemented with non-state funds, unless the salary is below the 75th percentile of comparable executive pay and was properly reviewed and approved by the covered provider’s board of directors. The limitation would apply to executives employed by “related entities” that provide administrative or program services to the provider.

Compensation includes salary and wages, bonuses, dividends, and other financial benefits, such as vehicles, meals, housing, educational benefits, below market loans, travel, and entertainment. While it generally excludes mandated benefits (Social Security, Worker’s Compensation, unemployment and disability insurance), health insurance and pension contributions may be included if they are more generous than are provided to other less well compensated executive employees.

If providers are either using state funds to compensate executives over the $199,000 limit or if they cannot satisfy the 75th percentile requirement, waivers may be granted for “compelling circumstances.” To obtain a waiver, the provider must document that the salary is, in fact, comparable to compensation paid by comparable providers, or that the quality and availability of the provider’s services may be jeopardized if the cap applied, or that the nature, size and complexity of the provider justifies the compensation. Waivers will be time limited and may be revoked if compensation increases by more than five percent annually or for other “relevant circumstances.”

The administrative expense regulations. Also beginning in 2013, the regulations would require that administrative expenses are maintained at or below 25 percent of overall state-funded program services expenditures, and providers must reduce that percentage by 5 percent a year for two years, culminating with a 15 percent administrative cap in 2015 and thereafter.

“Administrative expenses” are those incurred in connection with “overall management and necessary overhead” that are not attributed directly to the provision of program services and include executive salaries and benefits, legal services, office operation expenses, including telephones, computers, dues, licenses, permits, insurance premiums and audit services. “Program services expenses” are those incurred in direct connection with the provision of program services and include program, supervisory and quality assurance staff salaries and benefits, as well as other expenses incurred in connection with program services, including travel, supplies and legal expenses directly related to program services. Certain expenses -- notably capital expenses -- are excluded from both categories. Where the provider receives state funds from multiple programs or funding streams, the limitation is calculated based on total program services expenses from all such sources. If a more stringent limitation on administrative expenses exists, that standard applies.

Waivers may also be obtained from these requirements for “compelling circumstances.” Waivers may be granted if the administrative expenses were necessary or avoidable, if the cap would have a negative impact on availability or quality of services, if the nature, size, and complexity of the provider’s operations warranted the waiver or if the provider’s efforts to control administrative expenses and/or to defray administrative expenses justified the dispensation.

Reporting requirements, penalties, and enforcement. The relevant state agencies would issue disclosure forms to be completed by contracting entities for each reporting period and contractors would be required to submit those reports or risk that their contracts or agreements will be terminated or not renewed. If the state agency believes that a provider is not in compliance with these requirements, the provider would be given notice and an opportunity to prepare a corrective action plan. If the provider remains out of compliance or has not implemented a corrective action plan, the relevant state agency could impose appropriate sanctions, which may include: redirection of state funds to provide program services; suspension, modification, limitation or revocation of the provider’s license; suspension, modification or termination of contracts or agreements with the non-compliant provider; or other penalties that may be deemed appropriate.

Reaction from state-funded entities. The regulations were greeted with a mixture of relief and resignation from the not-for-profit and for-profit state contracting entities. Entities with more modest amounts of state support took comfort from their exemption. For those still subject to the requirements, the fact that compensation above the $199,000 threshold would be permitted if it were supplemented by non-state funds and was within the 75th percentile of comparable positions was viewed as a realistic and more flexible approach. A number of practical and operational concerns persist, however, as contracting organizations begin to contemplate how these regulations will actually be implemented, including the following:

Definition of “state authorized payments”: In an effort to ensure that state funding was broadly defined, the regulation extends to “state authorized payments,” which include funds “distributed or 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.” Every dollar a licensed health care facility or entity receives has been paid “by virtue of the provider having a State license in New York State to operate the program.” If interpreted that broadly, the 30 percent threshold would exempt virtually no one and there would be virtually no non-state funds available to supplement salaries above the $199,000 level.

Assessment of comparability: While the inclusion of IRS-like standards for the review of compensation in contracting entities was viewed favorably, state agencies will rely on compensation surveys that they recognize and will not necessarily accept the salary data submitted by the providers. Given the wide array of contracting entities subject to the regulation and the unique market conditions that govern compensation for specialized positions, the regulations present the prospect that state agencies will be relying on data that does not accurately or fully reflect the going rate for comparable executive leadership. From a practical perspective, contracting entities have questioned how they will be able to recruit new executive personnel without knowing how their proposed salaries will fare under the uncertainties created by the new regulatory scrutiny.

Applicability to “related entities”: The regulations seek to extend these requirements to entities that share governance, employees, control and various financial interests with the covered provider and may sweep within its ambit a whole host of entities that may not directly receive state support. In some cases, these “related entities” may have been established to provide only administrative services to the covered provider: as a result, the imposition of a limit on the administrative services provided by the related entity would essentially render them useless.

Reporting and enforcement burdens: Although the regulatory impact statement assures the affected entities that the regulations will “require limited additional information to be reported to the agency by providers receiving State funds or State-authorized payments,” the information necessary to calculate compliance with both the compensation and administrative expense components of the regulation will not necessarily have been captured by existing reporting protocols -- and may, ironically, only add to what the administration may view as excessive administrative expense, as well as placing new substantial burdens on the state agencies themselves. Providers will face very short timeframes to prepare corrective action plans or to appeal state agency determinations and are accorded more limited due process -- generally, no right to a hearing, for example -- than might have been anticipated, given the stakes involved.

Legal authority for the regulations: Questions also remain over whether an executive order may properly serve as the basis for this comprehensive regulatory scheme -- particularly when the administration initially sought but did not obtain legislative authority for the initiative. Whether any covered providers or potentially impacted executives will actually step forward to challenge the regulations remains to be seen.

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