New York limits executive compensation and administrative expenses of state-funded service providers

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1 New York limits executive compensation and administrative expenses of state-funded service providers Last year, 13 New York state agencies issued final regulations restricting the use of state funds for the executive compensation and administrative expenses of their service providers. The new pay and expense caps required by Executive Order 38 will affect most covered providers beginning in Organizations that may be affected should review their compensation arrangements to determine whether they can make changes to comply with the new limits or should seek a waiver. In this article: Background Final regulations Reporting and disclosure Enforcement In closing Background 13 state agencies have put in place a pay ceiling for covered executives of their service providers. On January 18, 2012, New York Governor Andrew Cuomo issued Executive Order No. 38 (EO 38), directing 13 New York state agencies to promulgate regulations limiting their service providers use of state funds for administrative expenses and executive compensation. As required by EO 38, the agencies proposed regulations to implement caps for both not-forprofit and for-profit entities effective January 1, However, protracted rulemaking delayed the issuance of final regulations and implementation of the caps. (See our May 2, 2013 For Your Information.) The final regulations, which took effect July 1, 2013, affect most covered providers beginning on January 1, Final regulations On May 29, 2013, the New York State Department of Health (DOH) adopted long-awaited final regulations implementing restrictions on their service providers use of state funds for executive compensation and administrative expenses. Nearly identical regulations were adopted by 12 other agencies including: (1) the Departments of: Corrections and Community Supervision; 1

2 State; and Agriculture and Markets; (2) the Divisions of: Housing and Community Renewal; and Criminal Justice Services; and (3) the Offices of: Mental Health; People with Developmental Disabilities; Alcoholism and Substance Abuse Services; Temporary and Disability Assistance; Children and Family Services; the Aging; and Victim Services. The new limits apply to covered providers on the first day of the provider s first covered reporting period that begins on or after July 1, 2013 (January 1, 2014 for providers that annually report on a calendar-year basis; otherwise, the first day of the provider s fiscal year). Although the final regulations are substantially similar to the previously proposed regulations, they do contain helpful clarifications and several noteworthy changes. Covered providers The final regulations generally apply to for-profit and not-for-profit entities and individuals that received a minimum level of state funding to provide program services directly to and for the benefit of the public in both the most recent reporting period and in the immediately prior year. For these purposes, program services do not include policy development or research, or staffing or other assistance to a state agency or local unit of government in the agency s or government s provision of services to the public. If an individual/entity does not provide program services during the covered reporting period, it is exempt from the regulations and its reporting and disclosure requirements. Even if an individual/entity provides covered services, it must still determine whether it is a covered provider. Determining covered provider status. An individual or entity will be subject to the new limits on executive compensation and administrative expenses if it received state funds or state-authorized payments (such as Medicaid) in both the most recent covered reporting period and in the year prior, and satisfies the following two tests. First, the individual or entity must receive an average annual funding amount of more than $500,000, calculated over the two-year period. Second, the individual or entity must have derived at least 30% of its total annual in-state revenues from state funds or state-authorized payments during each of those two years. Buck comment. Since only covered providers are subject to the new limits and filing requirements, the agencies recommend but do not require using their Covered Provider Determination Worksheet to determine whether an individual/entity qualifies as a covered provider. Calculating the 30% threshold. In determining covered status, the percentage of in-state revenues is calculated as a percentage of the total annual revenues derived from and in connection with the provider s activities within New York state. Revenues from out-of-state sources must be included if they were derived from or in connection with instate activities (such as contributions from out-of-state entities for activities in New York). However, revenues from activities in another state would not be counted toward the threshold. In a significant shift from the proposed regulations, the final regulations do not consolidate parent and subsidiary revenues. Facilities and entities covered. The DOH regulations contain an exhaustive list of the types of facilities and entities that may be subject to the new limits. For these purposes, the term "covered provider" includes: hospitals and nursing homes; home care services agencies, licensed home care agencies, certified home health agencies, residential health care facilities, long-term home health care programs, AIDS home care programs; hospice residences; assisted living residences and enhanced assisted living residences; ambulance services and advanced life support first response services; adult day health care; health maintenance organizations; intermediate care 2

3 facilities; entities conducting evaluations or providing services in the early intervention program; assisted living programs; an independent practice association or a management contractor that is a related organization to a covered provider. In addition, the regulations contain an expanded list of entities and individuals that are expressly excluded from coverage, including: (1) state, county, and local governmental units in New York state, tribal governments for the nine nations recognized by New York state (Seneca, St. Regis Mohawk, Cayuga, Tonawanda, Tuscarora, Onondaga, Oneida, Unkechaug, and Shinnecock), and any of their subdivisions or subsidiaries; (2) certain individuals or entities providing child care services; (3) individual professionals, partnerships, S corporations, or other entities that provide at least 75% of their state-funded program services through the individuals, partners, or owners of the entities rather than through employees or independent contractors; (4) individuals or entities primarily or exclusively providing products rather than services (such as pharmacies and medical equipment suppliers); and (5) entities within the same corporate family as a covered provider unless the entity would otherwise have qualified as a covered provider. Buck comment. An individual/entity does not become a covered provider simply because it is in the same corporate family (including parent and subsidiary corporations) as a covered provider. Such an individual/entity may, however, be a covered provider if it receives a sufficient level of state funding or payments from a covered provider rather than directly from a state agency. State-authorized payments and state funds. In determining whether the revenue thresholds that trigger coverage under the EO 38 regulations are met, providers must take into account both the state-authorized payments and the state funds they receive. For these purposes, state-authorized payments are disbursements of non-state funds approved by a state agency or other state governmental unit, and state funds are those funds appropriated by law in the annual state budget. In Preliminary Guidance on EO 38 and Related Regulations, the agencies provide lists of government programs that may qualify as state-funded. Although the final regulations do not specify which program funds will be considered state-authorized payments or state funds, they do list certain payments that will not qualify. For purposes of these regulations, state funds and state-authorized payments do not include funds or payments solely for: (1) procurement contracts awarded on a lowest price basis; (2) awards to state or local governments unless the funds are used to pay covered providers through a contract or other agreement; (3) capital expenses; (4) direct payments or the provision of vouchers for specific services or health insurance premiums or Supplemental Security Income (SSI) payments; (5) wage or other salary subsidies paid to employers to hire or retain their employees; (6) awards to for-profit corporations or other entities engaged exclusively in commercial or manufacturing activities; (7) policy development or research; or (8) administrative expenses for certain community service programs. For organizations that receive Medicaid support, state-authorized funds include direct Medicaid payments by the state or through a managed care entity, and include the full Medicaid payment. Like providers that receive direct funding from a state agency, providers that receive sufficient state funds or state-authorized payments from county or local governments will be subject to the compensation and expense restrictions. Similarly, an entity or individual receiving state funds or state-authorized payments directly from a managed care organization subject to DOH oversight will be deemed to receive state funding to render program services, and thus will be covered by the caps. 3

4 Multiple-source funding. The final regulations clarify the application of the limits on executive compensation and administrative expenses when the covered service provider receives state funds or state-authorized payments from multiple sources. In the case of multiple-source funding, compliance with the executive compensation restrictions will be determined on the basis of the total amount of state funding and reimbursements received from all sources of state funds or state-authorized payments. Compliance with expense restrictions will be determined on the basis of the total amount of program services and administrative expenses paid for by state funds and state-authorized payments received from all sources. The new restrictions Under the final regulations, covered service providers are subject to the following general restrictions on their use of state funding for administrative expenses and executive compensation. Unless a waiver is granted, the provider may not use: More than $199,000 per year in state funding to compensate a covered executive A covered provider may not use state funds to pay a covered executive more than $199,000 annually. State funding to pay more than 25% of an organization s total operating expenses as administrative expenses for a covered reporting period beginning between July 1, 2013 and June 30, 2014, more than 20% for a covered reporting period beginning between July 1, 2014 and June 30, 2015, and more than 15% for a covered reporting period beginning July 1, 2015 or later Executive compensation restrictions In general, the executive compensation cap covers compensated directors, trustees, managing partners, officers, and key employees of covered providers whose salary and/or benefits are partly or wholly administrative expenses and whose total compensation exceeds $199,000 (including direct and indirect cash and noncash payments or benefits) during the covered reporting period. In addition to salary and wages, total compensation would include, for example, bonuses, dividends, certain profit participations, personal vehicles, housing, below-market loans, and other items reportable on a Form W-2 or Form Mandated benefits (such as Social Security, workers compensation, unemployment insurance, and short-term disability insurance) are not included. Buck comment. If a covered executive s job includes direct program work, the compensation paid to render such services may be excluded from the executive compensation calculation. Notably, only the ten key employees whose compensation is the greatest during the reporting period are subject to the pay restrictions. Clinical and program personnel fulfilling administrative functions that are directly attributable to and comprise program services are expressly excluded. The compensation cap may be adjusted annually by each agency, subject to approval by the Director of the Division of the Budget. Payment by related entities. The final regulations eliminate the general restriction on the payment of executive compensation by a covered provider s related entities. For annual reporting and compliance purposes, a covered executive of a related organization that is paid by a covered provider to perform administrative or program services would also be considered a covered executive of the provider but only if more than 30% of the executive s 4

5 compensation comes from state funds or state-authorized payments received from the provider. In this situation, the related organization would not be subject to the limitations on the use of state funds or state-authorized payments for administrative expenses solely because it has covered executives. Calculating executive compensation. The final regulations define executive compensation broadly to include, with certain limited exceptions, all forms of cash and noncash payments or benefits provided directly or indirectly to a covered executive. Excluded from the calculation of executive compensation are mandated benefits (such as Social Security, worker s compensation, unemployment insurance, and short-term disability insurance) and other benefits such as health and life insurance premiums and retirement and deferred compensation plan contributions that are consistent with those provided to the covered provider s other employees. For this purpose, benefits are considered consistent with those provided to other employees if the benefit s intended value is substantially equal even if the cost to the provider differs. For employer contributions to retirement and deferred compensation plans that are not consistent with those provided to other employees, executive compensation includes only the amounts contributed or accrued during the applicable reporting period for the covered executive s benefit. Amounts that vest during the reporting period but were contributed or accrued prior to the reporting period would not be included. Annual compensation cap flexibility A covered executive s total compensation may exceed the $199,000 annual cap without a waiver if certain conditions are satisfied. State-funded reimbursement payments for reasonable compensation paid to a covered executive for program services outside his or her managerial or policy-making duties (including supervisory services to facilitate the covered provider s program services) are excluded from the executive compensation calculation. Other exclusions exist for certain clinical and program personnel in a hospital or other entity providing program services. Safe harbor. Under the safe harbor provisions, a covered executive s total compensation may exceed the $199,000 annual cap without a waiver if certain conditions are satisfied. An executive may receive total compensation of more than $199,000 from state funding and other (non-state) funding sources combined if the compensation is: At or below the 75 th percentile for comparable executives of comparable providers in the same or comparable geographic area as established by a compensation survey identified, provided, or recognized by the DOH (or other lead agency) or the Director of the Division of the Budget Reviewed and approved by the provider s board of directors or equivalent governing body relying on comparability data, and Sufficiently documented The final regulations make clear that a duly authorized compensation committee that includes at least two independent directors or voting members may conduct the comparability review, subject to review and ratification by the full board. Compensation surveys and comparability factors. The regulations provide that the determination of whether a covered executive s compensation exceeds the 75 th percentile of compensation of comparable executives must be based on approved compensation surveys and appropriate 5

6 comparability factors. In preliminary guidance, the agencies did not identify specific surveys or survey data that would be acceptable. Rather, the guidance states that a covered provider may use a compensation survey that includes the covered provider s program service sector and which contains a reasonable number of comparable organizations to conduct a thorough review. Alternatively, a covered provider may conduct its own compensation survey. The guidance contains a non-exclusive list of 17 relevant factors for use in determining compensation comparability, including similarity to other organizations in: Type(s) and scope of services rendered Size of annual budget Number of employees Geographic location(s) of offices or services rendered Availability of similar services within the region Other relevant comparability factors include the economic climate when the compensation was agreed to, and the covered executive s similarity to other executives in: Education levels Credentials/skills Tenure of experience Depth of experience in the field Length of time in similar positions Work schedule Experience in the position Performance on the job Functional comparability In the event that a covered provider uses a compensation survey, the provider should compare compensation provided to a covered executive using the survey s methodology. According to the preliminary guidance, the survey methodology will be acceptable even if it does not reflect executive compensation as defined in the regulations. EO 38 FAQs confirm that lead agencies will provide assistance to covered providers unable to procure or access an appropriate survey to demonstrate whether the compensation of their covered executive(s) exceeds the 75 th percentile of comparable executives. Buck comment. To ensure that covered providers are or will be in compliance during the initial reporting period, providers will have to move quickly to determine whether waivers should be sought or other actions taken. Providers that decide to seek a waiver may file an application as late as the deadline for filing the EO 38 Disclosure Form (180 days after the close of the covered provider s reporting period). 6

7 Providers that report on a calendar year basis, for example, would have until June 30, 2015 to file a waiver for 2014, but would be well served to do so earlier. Administrative expenses The final regulations also cap the use of state funds for administrative expenses (such as salaries, legal expenses, and office operations such as computer systems). Because the limits on administrative expenses apply only to state funding, covered entities may still be able to use other funding sources to cover costs that exceed the regulatory limits. A covered provider s use of state dollars for administrative expenses incurred in connection with overall management and necessary overhead that cannot be attributed directly to providing program services is generally limited to 25% of covered operating expenses beginning on July 1, 2013, with a phased-in decrease to 15% over the next two years (by 2015). Program services expenses may include, for example, direct care supplies, public outreach, and quality assurance expenses. Buck comment. In certain circumstances, the cap on allowable administrative expenses and the reporting requirements will apply to subcontractors and agents of covered providers. If the cap applies, covered providers must incorporate by reference the terms of the regulations into their agreements with a subcontractor or agent. The final regulations contain an expanded list of expenses that are not considered administrative or program services expenses, and thus would not be taken into account for purposes of the cap. These expenses generally include: (1) capital expenses; (2) property rental, mortgage, or maintenance expenses; (3) taxes or assessments paid to government units; (4) equipment rental, depreciation, and interest expenses; (5) nonrecurring or unanticipated expenses in excess of $10,000; and (6) salaries and benefits of policy development or research staff. Existing contracts and subcontracts Regardless of whether they are related to the covered provider, subcontractors and agents of covered providers that provide program or administrative services generally are subject to the executive compensation and administrative expense caps. Both the caps and the reporting requirements apply to a subcontractor or agent that receives state funds through the covered provider and would have met the definition of a covered provider if it received the funds directly from the state. On request, covered providers must identify their subcontractors and agents and provide other information to the funding or authorizing state agency. Ensuring compliance Because there are no grandfather provisions, service providers should review existing as well as future subcontracts to ensure compliance with the new requirements. The final regulations require covered providers to incorporate by reference the terms of the regulations into their agreements with subcontractors and agents, even though they are not responsible for their subcontractors or agents compliance with the regulations. Because there are no grandfather provisions, service providers should review existing as well as future subcontracts to ensure compliance with the new requirements. Contracts with agents and subcontractors subject to the final regulations should be revised as needed to reflect the terms of the final regulations. 7

8 Grandfathered employment contracts The final regulations exempt from the compensation cap certain employment contracts or other agreements between covered providers and covered executives that were entered into before July 1, 2012 and expire on or before April 1, Because these agreements are grandfathered, a waiver would not be required during the term of the contract unless the executive compensation level exceeds the regulatory limits and the contract extends beyond April 1, In the absence of an evergreen provision in the final regulations, it appears likely that contract renewals like new agreements would have to comply with the new restrictions. Waivers Importantly, the regulations establish processes for seeking waivers of both the limit on executive compensation for one or more covered executives and the limit on reimbursement for administrative expenses. However, waivers will be granted only on a showing of good cause and for a finite time period. An administrative expense waiver will be valid only for the stated time period and amount. An executive compensation waiver will be valid only for the covered executive(s) or positions, the amounts for each executive or position, and the time period stated. A separate waiver application must be filed for each executive for whom the provider seeks a waiver. A waiver application may be filed at any point, but no later than the deadline for filing the EO 38 Disclosure Form for the reporting period to which the waiver applies. Waiver applications may be amended or revised at any time up to the submission deadline for the EO 38 Disclosure Form (180 days after the close of the covered provider s reporting period). In terms of timing, providers that report on a calendar year basis, for example, would have until June 30, 2015 to file, amend, or revise their waiver applications for Applications may be based on projected or actual financial data, depending on when they are submitted. Applications submitted before the close of the applicable covered reporting period that are based on projected financial data will be subject to conditional approval and a final reconciliation and determination based on actual financial data. An amended waiver application must be submitted at the time the EO 38 Disclosure Form (see below) is submitted if the information differs from the information previously submitted. Reporting and disclosure Under the final regulations, all covered providers have annual reporting obligations for reporting periods beginning on or after July 1, The individual or entity providing program services must define its reporting period and determine which period is the first covered reporting period (the provider s most recently completed annual reporting period beginning on or after July 1, 2013). Under the final regulations, covered providers have some flexibility in determining applicable reporting periods. Generally, the provider may opt to use either the calendar year or the fiscal year it uses for financial reporting. If, however, a provider is required to submit an annual cost report to the state, it must use the same reporting period that applies to the cost report. Covered providers will be required to submit an EO 38 disclosure form for each covered reporting period within 180 days following the end of the reporting period. The covered reporting period and the immediately preceding oneyear period are used to determine covered provider status, and the timing of various parts of the waiver and reporting process. 8

9 Providers that receive state funds or state-authorized payments from a county or local government or entity contracting on its behalf must report directly to the state agency. Failure to report may result in the termination or non-renewal of a contract or agreement for state funding. Notably, non-public information submitted in connection with a waiver application regarding executive compensation or administrative expenses will not be subject to public disclosure under New York s Freedom of Information Law (FOIL) unless the information has already been publicly disclosed. However, the regulations do not address the FOIL disclosure of EO 38 Disclosure Forms. Enforcement Under the final regulations, an agency must provide notice of any non-compliance with the limits on executive compensation or administrative expenses. The covered provider will have 30 calendar days to submit additional or clarifying information. If the agency s determination becomes final, the covered provider will have the opportunity to develop a corrective action plan, in conjunction with the agency, outlining specific steps it will take along with an appropriate time line. Providers generally will have at least six months to implement an approved plan. In the event the covered provider fails to properly implement a plan, the agency may take additional actions against the provider such as modifying the plan, extending the time to implement it, or issuing a determination of non-compliance and impose sanctions (such as redirection of state funding, or suspension or revocation of the covered provider s licenses). A covered provider will be able to appeal the sanctions within 30 days of receiving notice. In closing The new restrictions on executive compensation and expense costs are effective on the first day of the covered provider s reporting period. Although the regulations did not begin to affect many entities that contract with New York state until January 1, 2014, providers that rely on some measure of state support need to determine whether they are or will be subject to the new limits and what steps they may need to take to come into compliance. If covered, providers will need to assess whether compensation paid to any executives during the initial reporting period is likely to exceed the $199,000 limit and, if so, whether the compensation would fall within the safe harbor or a waiver will be needed. 9

10 Authors Nancy Vary, JD Alan A. Nadel, CPA Produced by the Knowledge Resource Center of Buck Consultants at Xerox The Knowledge Resource Center is responsible for national multi-practice compliance consulting, analysis and publications, government relations, research, surveys, training, and knowledge management. For more information, please contact your account executive or You are welcome to distribute FYI publications in their entireties. To manage your subscriptions, or to sign up to receive our mailings, visit our Subscription Center. This publication is for information only and does not constitute legal advice; consult with legal, tax and other advisors before applying this information to your specific situation Xerox Corporation and Buck Consultants, LLC. All rights reserved. Xerox and Xerox and Design are trademarks of Xerox Corporation in the United States and/or other countries. Buck Consultants is a registered trademark of Buck Consultants, LLC in the United States and/or other countries. 10