On October 31, 2012, 13 New York State agencies issued revised proposed regulations that limit New York State’s reimbursement for the administrative costs and executive compensation for not-for-profit and for-profit service providers. Each of these agencies first issued draft regulations on May 13, 2012. Many organizations had concerns with the original proposed rule and submitted comments requesting changes to the regulations.  

As is described  below, the revised proposals include a number of significant substantive changes. Consistent with the New York State Administrative Procedures Act requirements, because the new proposals include substantial revisions, the agencies are again soliciting comments. Comments may be submitted until November 30, 2012. The revised proposals have a new effective date of April 1, 2013, but would generally apply to the entire 2013 calendar year.    

In contrast to the original proposals which adopted the same regulatory template, there are some differences among the agencies’ revised proposals. In some cases, the differences may be substantive. This GT Alert focuses on the revised proposed regulation (“RPR”) issued by the Department of Health, but  the comments are generally applicable to the agencies’ proposals.

1. What types of contracts are subject to the regulations?

Although there are many significant changes to the proposal, the analysis of whether a contract is subject to the limitations imposed by the regulations remains essentially the same.  Service contracts and other agreements that result in the payment of “State Funds” or “State-authorized Payments” (i.e. payments that are disbursed pursuant to authorization from a State agency or other New York governmental entity) in exchange for providing “Program Services,” will be subject to the regulations.  Program Services are those services provided to and for the benefit of members of the public, by a covered person or entity, or their agents. Notably, the RPR does not differentiate between not-for-profit and for-profit entities that provide Program Services.  

The regulations do not affect vendors that enter into procurement contracts to sell commodities to the State.  In addition, the following types of contracts are not covered by the regulation:

• Contracts for services to be provided for the benefit of, or on behalf of, the State or the contracting governmental entity (as opposed to members of the general public);
• Procurement contracts awarded based on lowest price, consistent with section 163 of the State Finance Law;
• Awards to governmental units, unless those awards will subsequently be used to pay program service providers;
• Payments for capital expenses;
• Payments or vouchers provided directly to individuals in order to then obtain certain services or health insurance;
• Subsidies paid to employers to facilitate the hiring or retention of employees;
• Contracts with entities engaged exclusively in commercial or manufacturing activities rather than program services; and
• Contracts to conduct research or policy development.

Even if an entity receives payments from the government to provide Program Services, in order to determine if an entity is subject to the rule, the entity will also need to determine if it is a Covered Provider and if individuals at the entity are deemed to be Covered Executives.

2. Are all entities that have entered into a contract for Program Services subject to the regulations?

Significant revisions were made to the definition of entities that are subject to the regulations.  Generally, a government contractor providing Program Services is a Covered Provider if:

(a) the provider receives an annual average payment of more than $500,000 in State Funds or State authorized Payments during the 2 years prior to the reporting period, and

(b) at least 30% of the provider’s total annual New York revenues during the year prior to the relevant reporting period are derived from State Funds or State-authorized Payments.

As noted above, the term “State-authorized payments” is defined to include payments that a State agency disburses and thus continues to include Medicaid payments. The RPR clarifies that if an entity receives 30% of its revenue in Medicaid funding, the entity may be subject to the regulation even though the amount of direct State funding is only a portion of the total funding (the remainder being paid by the federal government and counties).  

More importantly, however, the RPR changes how the 30% is calculated.  First, the proposal no longer includes the provision that “[w]here the covered provider is organized as a part of a corporate structure that includes a parent and a subsidiary corporation, the total annual in-state revenues shall be measured as consolidated at the parent level.”  Thus, the analysis of whether the provider meets the 30% test must be conducted independently for each company in a corporate structure, if such company receives State Funds or State-authorized Payments (collectively “SF/SAP”).  Moreover, the RPR states that only funds received from New York State, and revenues derived from activities in New York State are to be considered; the business entity is not to take into account revenues from activities outside of New York.  In other words, in determining whether an entity meets the 30% standard, the entity must aggregate all New York SF/SAP to establish the numerator and must identify all of the revenues derived from the entity’s activities in New York during the year, to determine the denominator.  If the SF/SAP constitute 30% or more of the entity’s total monies received for services provided in New York State, then it would be deemed a Covered Provider.  Thus, companies with significant non-New York State revenue could now be covered.    

The RPR also sweeps in a major classification of companies who were previously excluded from the regulations -- subcontractors and agents of Covered Providers, regardless of whether they are related to the Covered Provider or wholly independent.  This change appears to be intended to insure that Medicaid providers remain subject to the regulation even if their reimbursement is not paid directly by a State agency.  

As in the original proposal, the RPR preserves an exemption for the following types of providers, regardless of the value and type of contract:

• State, county, and local governmental units in New York State, as well as all tribal governments located within the state;
• Persons and entities whose only State funding is child care subsidies received pursuant to the Social Services Law; 
• Individuals who, in their personal capacity, receive SF/SAP in exchange for providing at least 75% of services deemed to be program services;
• Individuals and entities who provide primarily or exclusively equipment and products, not services (e.g., durable medical equipment or pharmacy); and
• Entities that are in the same corporate family as a Covered Provider, unless that entity “would otherwise qualify as a Covered Provider but for the fact that it has received its State funds or State-authorized payments from” a related entity and not the State.

3. Which individuals affiliated with a covered entity are subject to the compensation limitations?

Individuals who meet the definition of a “Covered Executive” are subject to the compensation limitations described below. As initially drafted, the term Covered Executive was broadly defined. The regulation is still farreaching, but the RPR significantly modifies who is covered.  

The RPR still defines Covered Executive to include any “director, trustee, managing partner, or officer whose salary and/or benefits” are at least partially related to the management of the program, as well as any “key employee whose salary and/or benefits” are at least partially related to the management of the program, if the employee’s compensation is at least $199,000. However, the proposal now adopts the Internal Revenue Service’s (“IRS”) definitions  in determining whether someone is a director, trustee, officer, or key employee.  More importantly, however, the RPR provides that if there are more than 10 key employees who meet this definition of Covered Executive, the Covered Provider is required to report only the top ten highest paid key employees;the remaining key employees are not deemed to be Covered Executives.      

The class of individuals considered Covered Executives is further reduced in the RPR, as it now acknowledges that someone with administrative obligations may also be directly supporting the program services, and excludes those individuals from the definition.  Specifically, although the original proposal required the entity to treat any individual who makes at least $199,000 and provides at least some administrative services as a Covered Executive, the RPR states that “[c]linical and program personnel . . . fulfilling administrative functions that are nevertheless directly attributable to and comprise program services shall not be considered covered executives.”  

Finally, an individual may be deemed a Covered Executive even if his or her employer is not itself a Covered Provider.  If a Covered Provider pays a “Related Organization” (as such term is defined by the IRS) to provide administrative or programmatic services, the Covered Executives of the related entity will be subject to the regulations “if more than thirty percent of such Covered Executive’s compensation is derived from” SF/SAP received from the related Covered Provider.  Thus, this provision of the regulation continues to include entities that are related to a Covered Provider, but recognizes that individuals who derive  only a small amount of compensation from the indirect SF/SAP should be excluded from the scope of the regulation.  However, this provision also creates an anomaly because a similarly situated individual working for a Covered Provider, but whose compensation is derived from less than 30% of New York activities, is nonetheless covered.   

4. What types of compensation are covered?

The regulations continue to cover virtually all compensation provided to a Covered Executive.  This includes cash and non-cash payments, such as salary or wages, bonuses, dividends, distributions, and benefits such as personal vehicles, housing, below-market loans, personal travel, entertainment, and the value of personal use of the entity’s property.  The RPR clarifies, however, that this compensation is included only to the extent that it is “reportable on a Covered Executive’s W-2 form.” Mandated benefits (such as Social Security, worker’s compensation, unemployment insurance, and disability insurance), and benefits such as health and life insurance premiums and pension contributions, are excluded from the definition of compensation, but only to the extent that such benefits are substantially equal to the benefits provided to people at the organization who are not deemed to be Covered Executives.

5. What types of restrictions are imposed by the regulations?

A. Executive Compensation

1. Limit on Use of State or State Authorized Funds 

The specific limitations imposed by the regulations remain virtually the same in the RPR.  Covered Providers (and entities that are closely related to such providers) are barred from using SF/SAP to provide compensation greater than $199,000 to any Covered Executive. State agencies are to annually review this limitation to determine whether the amount should be adjusted, subject to approval by the Division of the Budget (“DOB”).

2. Overall Cap on Compensation  

In addition to the limitation on how SF/SAP may be used,  the regulations limit providers from paying Covered Executives compensation in excess of $199,000, regardless of the sources of funding, unless the compensation: (1) is no greater than the 75th percentile of compensation provided to comparable executives affiliated with comparable providers, consistent with the findings in a compensation survey acknowledged by the State; and (2) has been approved by the Covered Provider’s board of directors or other governing body, including at least twoindependent directors or members.  As the Governor’s May 2012 press release noted, this means that “[i]f a provider chooses to pay an executive more than $199,000 from other sources, the provider must keep compensation below the top 25 percent in the field, as determined by a compensation survey identified or recognized by the applicable state agency. Providers that pay an executive more than $199,000 must have the compensation approved by its board of directors, including at least two independent directors and must have performed a review of comparability data.” 

The RPR continues to provide that this compensation cap is not imposed on Covered Executives to the extent that the executives also perform programmatic services, and clarifies that this exception also applies to Covered Executives who provide “supervisory services . . . to facilitate the Covered Provider’s program services.” Individuals who engage in both managerial and programmatic services may be provided reasonable compensation for the programmatic function, even if that compensation is in excess of $199,000. A Covered Executive who engages in more than one role, however, should determine what percentage of his or her salary is attributable to program services, and that portion of the contribution should “not be considered in the calculation of his or her executive compensation.” Covered Providers must document what program services the executive provides and the regulation permits the State to request this information to justify the additional expenditure of SF/SAP for this aspect of the individual’s functions.  Finally, the RPR provides that individuals who serve in administrative roles “that are nevertheless directly attributable to and compromise program services shall not be considered Covered Executives,” for purposes of determining compliance with the limit on compensation.  

3.  Downstream Contracts  

The revised regulations create an obligation for all Covered Providers who enter into subcontracting arrangements to include in their contracts a statement that the subcontractor will also comply with these compensation limitations.  Such obligation  is imposed on any downstream vendor who provides program or administrative services and would otherwise have been deemed a Covered Provider, but for the fact that it received SF/SAP from a private entity, and not directly from the government. A critical outstanding issue is whether a vendor is covered if that vendor provides services that the State itself lacks authority to obtain by contract.    

4. Grandfathering Existing Covered Executives with Contracts 

The RPR exempts the contracts of certain individuals who would otherwise be subject to the regulation from complying with the executive compensation limitation.  If a Covered Provider entered into a contract or other agreement with a Covered Executive effective prior to April 1, 2012, the limitation shall not be imposed on the Covered Executive for the term of that contract.  If the contract, however, extends beyond April 1, 2014, or if the contract is going to be renewed after its completion date, then the Covered Provider will need to seek a waiver if the compensation package does not comply with the regulation.  

B. Limit on Administrative Expenses

As in the original proposed regulation, the RPR continues to limit Covered Providers from using more than 25% of the SF/SAP paid to the provider for administrative costs. Notably, however, certain administrative costs are excluded from this calculation, and the RPR broadened the costs that are to be excluded. The RPR provides thatat least 75% of the SF/SAP paid to the Covered Provider must be spent on “Covered Operating Expenses,” which is defined as the sum of “program services expenses and administrative expenses” incurred by the Covered Provider. The cap will increase by 5% each year until 2015, at which time Covered Providers will be required to spend at least 85% of the State payments for “Covered Operating Expenses.”

To the extent that there are Administrative Expenses imposed by the State, however, those expenses will not be subject to the cap. Additionally, there are certain costs that are not included in the calculation.  The original proposal noted that capital expenses, property rental or maintenance expenses, and equipment rental, depreciation and interest expenses would all be excluded.  The RPR further clarifies  that expenses for mortgages, taxes, and non-reoccurring and unanticipated costs greater than $10,000 are excluded from the cap. Furthermore, the RPR now expressly authorizes providers to allocate portions of certain expenses as either Administrative Expenses or Program Services Expenses.  This includes expenditures for goods that may be used for both programmatic and administrative purposes, as well as salaries for staff who may provide both programmatic and administrative support.  As a general matter, the allocation methodology used by the Covered Provider must track “the method of accounting used . . . in the preparation of its annual financial statements.”

Although the RPR provides additional flexibility in determining whether an expense should be treated as administrative or programmatic, the list of entities that may be subject to this limitation is expanded.  Just like the compensation limitations, the administrative expense limitations now explicitly apply to downstream vendors who subcontract with  a Covered Provider, regardless of whether the entities are otherwise related, provided that the subcontractor would have been deemed a Covered Provider if the payments were directly from a governmental entity, rather than the Covered Provider.  Covered Providers are obligated to include an affirmative statement in their agreements with such downstream vendors that the subcontractor will comply with the administrative limitations.       

6. The Waiver Process

The initial proposed regulations established a process that enabled the relevant agency to issue waivers to covered entities for both the executive compensation limitations and the limitations on administrative expenses. Aside from certain time periods, the process remains similar to what was originally proposed. 

The contracting agency and DOB may waive the $199,000 executive compensation limit upon a showing of good cause. This is a significant change from the original proposal which required that the showing be “compelling.” The service provider must apply for a waiver at least 90 days (i) before the reporting period; (ii) prior to filling the executive position, if the position “is created or becomes available during the reporting period”; or (iii) prior to the date of contract, its renewal, or extension. The waiver must be submitted to the relevant agency, or its designee, and DOB. If there is a reasonable cause for the delay, the agency may accept a late waiver application.  The RPR requires that the agency generally respond to all waiver requests within 60 calendar days of the application.  If the application is denied, the agency must explain why and then give the applicant an opportunity to appeal within 30 days. 

In determining whether there is a good cause to waive the executive compensation limitations, the agency and DOB shall consider:

• whether the compensation in question is comparable to the compensation provided to comparable executives at comparable providers;
• the extent to which disallowing the excessive compensation would prevent the service provider from providing the covered services at the requisite level of quality and availability;
• the Covered Provider’s nature, size, and complexity;
• the review and approval process used by the provider when determining the executive’s compensation; 
• the qualifications and experienced possessed by or required for the position; and
• the extent to which the service provider attempted to identify and hire comparable executives at lower compensation.

The agency and DOB also may waive the administrative expense cap upon a showing that there is good cause to do so. The RPR provides that the service provider apply for this waiver when submitting its cost report for the relevant period or, where there is a contract with the agency, prior to the date of the contract, the renewal, or extension. The agency is permitted to consider untimely waiver applications if there is reasonable cause for the delay.  Much like the compensation waiver application, the agency is to respond to these applications within 60 days.  Again, if denied, the agency must explain why, and provide the applicant 30 days to appeal.

When evaluating this waiver, the agency and DOB shall consider:

• whether the administrative costs are unavoidable;
• the extent to which disallowing the specific expenses would affect the availability or quality of the program services in that geographic area;
• the Covered Provider’s nature, size, and complexity;
• the extent to which the service provider has attempted to control and limit administrative expenses; and
• whether the service provider has attempted to find other sources of funding to pay for the additional administrative expenses.

The RPR notes that information provided during the waiver process, which is not already publicly available, will not be disclosed pursuant to the Freedom of Information Law (“FOIL”) “to the extent that one or more of the exemptions contained” in FOIL apply.  The regulations do not, however, make an affirmative statement that all waiver applications are exempt from FOIL. Thus, a waiver applicant will still need to show that disclosure of the information would result in a substantial injury to the Covered Provider’s competitive position, or qualify under a different FOIL exception. 

7. What are the disclosure obligations?

In addition to placing limits on compensation and administrative expenses, the regulations establish new reporting requirements for Covered Providers. The providers are required to submit reports to the relevant agency for each year of the relevant contract. These forms have not yet been established, nor do the regulations set forth specifically what information will need to be included in the report. The Governor’s earlier press release indicated that these forms will require disclosure of all public funds received by a covered services provider, the compensation that the service provider pays to its executives and highest paid employees, as well as the entity’s administrative expenses. It will be electronic and uniform, providing for a single place to disclose the information, even if the service provider receives funds from multiple state agencies. Failure to comply with the disclosure obligation could result in the termination or non-renewal of the State contract. These new obligations are in addition to any disclosure requirements the Attorney General or IRS may already impose on the service provider.  The agencies have stated that guidance regarding these forms will be provided eventually.  

8. What penalties exist for providers that fail to comply?

Although there are significant sanctions for failure to comply, there are several mechanisms included in the regulations to ensure that the providers are afforded due process. The State agency has an obligation, upon determination that a service provider has either failed to comply with the executive compensation limitations or the administrative expense cap, to notify the provider in writing. That provider then will have the opportunity to provide, within 30 days, evidence that the provider is in compliance. If ultimately the provider is found to be non-compliant, the agency must still give the provider an opportunity to cure. In order to remedy the violation, the service provider must establish a corrective action plan that shall be reviewed by the agency. If the agency approves the plan, the provider shall be on probation for 6 months, during which time the provider must show compliance with the corrective action plan. If there is a failure to cure the violation, the agency may modify and/or extend the probationary period, or impose sanctions such as: (1) redirect the State Funds or Stateauthorized Payments to ensure that they are used to fund program services; (2) suspend, modify, limit, or revoke the provider’s license to operate the relevant program; and (3) any other lawful actions or penalties that the agency deems appropriate.

9. When do these requirements take effect?

The RPR establishes the effective date as April 1, 2013. However, the RPR would still apply to the 2013 calendar year and only the reporting obligations are delayed until April 2013.

Conclusion

This Alert highlights some of the major requirements of the proposed executive compensation and administrative expense regulations, but does not address every issue. Additionally, it is important to note that the regulations may still change based on the comments that are submitted.