In January 2012, New York’s Governor unveiled a proposal to limit the State’s reimbursement to not-for-profit and for-profit service providers for the administrative costs and the compensation paid to executives. Approximately 16 months later, 13 State agencies announced final adoption of regulations that take effect July 1, 2013. (Despite this effective date, as is described below, many affected entities will not be required to comply with the restrictions until 2014 and will not have reporting obligations until 2015.)

Companies and individuals that contract with any of the following agencies should be aware of the applicable agency’s specific regulations: 

• State Office of the Aging

• Department of Agriculture and Markets

• Office of Alcoholism and Substance Abuse Services

• Office of Children and Family Services

• Department of Corrections and Community Supervision

• Division of Criminal Justice Services

• Department of Health

• Division of Housing and Community Renewal

• Office of Mental Health

• Office of People with Developmental Disabilities

• Department of State

• Office of Temporary and Disability Assistance

• Office of Victim Services

This memorandum summarizes the adopted regulations and highlights some key distinctions of the Department of Health (DOH) regulations. However, the regulations promulgated by other agencies are nearly identical. 

1. What contracts are subject to the regulations?

Service contracts and other agreements that result in the payment of “State Funds” or “State-authorized Payments” (SF/SAP) – 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” are subject to the regulations. Program Services are those services provided by a covered person or entity to, and for the benefit of, members of the public.

2. What contracts are NOT subject to the regulations?

The regulations exempt a variety of types of contracts from the restrictions:

• 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 the 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;

• Contracts intended to pay exclusively for administrative services; and

• Contracts to conduct research or policy development.

As a result, the regulations do not apply to vendors that enter into traditional procurement contracts to sell commodities to the State. Additionally, entities that contract with the State for “direct payments . . . or provision of vouchers or other items of monetary value that may be used to secure specific services selected by the individual, or health insurance premiums including but not limited to New York State Health Insurance Program (NYSHIP) premium payments, or supplemental Security Income (SSI) payments to or on behalf of individual members of the public,” are not subject to the restrictions.

3. What entities must comply with the regulations?

Entities that meet the definition of “Covered Provider” are required to comply with the regulations. Additionally, the regulations apply to subcontractors and agents of Covered Providers. Finally, certain individuals affiliated with an entity deemed to be a Covered Provider’s “Related Organization,” are subject to some of the limitations imposed by the regulations.

A Covered Provider is any individual or entity, whether for-profit or not-for-profit, that contracts with a relevant State agency to provide Program Services, if:

(i) The individual or entity receives an annual average payment of more than $500,000 in SF/SAP “during the covered reporting period and the year prior,” and

(ii) 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.

Several of the agencies’ regulations note that when determining whether an individual or entity is a Covered Provider, funds received “directly from a managed care organization subject to the oversight of” the applicable State agency, shall be treated as receiving SF/SAP even though the funds are not directly from the State.

The DOH regulations further limit the definition of Covered Provider by including an “exclusive” list of types of facilities and entities that may be considered Covered Providers, namely:

• Hospitals

• 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

• Enhanced Assisted Living Residences

• Ambulance Services

• Advanced Life Support Services

• First Response Services

• Adult Day Health Care

• Health Maintenance Organizations and Other Entities Authorized Pursuant to Article 44 of the Public Health Law

• Intermediate Care Facilities

• Early Intervention Providers And Evaluators

• Assisted Living Programs

• Independent Practice Associations (IPAs) or Management Contractors that are Related Organizations of Covered Providers

The agencies also exclude five categories of persons and entities from the definition of Covered Provider:

(i) Governmental entities within New York, as well as tribal governments for the New York recognized Indian nations;

(ii) Child care service providers whose only State funding are child care subsidies received pursuant to the Social Services Law;

(iii) Professionals or entities, at least 75% of whose Program Services paid for by SF/SAP are provided by the individual professionals or by the entity’s partners or owners, rather than by employees or independent contractors;

(iv) Individuals or entities that provide primarily or exclusively products, rather than services, including pharmacies and medical equipment providers; and

(v) Companies within the same corporate family as a Covered Provider, unless the company would be deemed a Covered Provider, but for the fact that it receives SF/SAP from a Covered Provider and not a governmental entity.

As noted above, subcontractors and agents of Covered Providers are also subject to the regulation. The regulations clarify, however, that the restrictions only extend to these entities if the subcontractor or agent provides Program or Administrative Services and would have been deemed a Covered Provider, but for the fact that it receives SF/SAP from a private entity and not directly from the government.

4. Who is subject to the compensation limitations?

As is described in detail below, the regulations result in limitations on the Executive Compensation that may be paid to Covered Executives. Covered Executives include any “compensated 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. The regulation uses the Internal Revenue Service’s (IRS) definitions in determining whether an individual is a director, trustee, officer or key employee. See http://www.irs.gov/pub/irs-pdf/i990.pdf. To the extent that a Covered Provider has more than 10 key employees who meet the definition of Covered Executive, the Covered Provider shall treat only the covered directors, trustees, officers and the top 10 highest paid key employees as Covered Executives.

Notwithstanding the foregoing, individuals who serve as “[c]linical and program personnel . . . [who fulfill] administrative functions that are nevertheless directly attributable to and comprise program services shall not be considered covered executives,” even if they make more than $199,000.

Some individuals may be deemed a Covered Executive even if the 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 30 percent of such Covered Executive’s compensation is derived from” SF/SAP received from the related Covered Provider. Related Organizations that have Covered Executives are not, however, subject to the administrative expense limitations described below. 

5. What is “compensation” for purposes of the regulations?

Virtually all compensation provided to a Covered Executive and reportable on a Covered Executive’s W-2 or 1099 form is deemed Executive Compensation, and therefore subject to the regulations. Executive Compensation includes cash and non-cash payments such as salary or wages, bonuses, dividends, or benefits such as personal vehicles, meals, housing, education, below-market loans, personal travel, entertainment, and the value of personal use of a Covered Provider’s property. Mandated benefits, such as Social Security, worker’s compensation, unemployment insurance and disability insurance, and benefits such as health and life insurance premiums and “retirement and deferred compensation plan contributions that are consistent with those provided to . . . other employees,” are not considered Executive Compensation. The final regulations clarify that to the extent that an employer contribution to retirement or deferred compensation plans for a Covered Executive is inconsistent with what is provided to other employees, “only those amounts contributed or accrued during the reporting period, for the benefit or intended benefit of the Covered Executive” shall be deemed Executive Compensation, and shall be included in the calculation, “even if [it is] not reported on the executive’s W-2 or 1099 for that reporting period.”

The final version of the regulations also explicitly includes “distributions to a shareholder/partner from the current reporting period’s earnings where such distributions represent compensatory or guaranteed payments or compensatory partnership profits allocation or compensatory partnership equity interest for services rendered during such reporting period,” in the definition of Executive Compensation. Thus, to the extent that an organization may consider certain payments to be profit-sharing, if those payments are guaranteed to the Covered Executive or are in consideration for certain services that were provided, the payment may still be considered Executive Compensation.

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

A. Limits on Executive Compensation

(i) Limits on use of SF/SAP

Beginning on July 1, 2013, but applicable to each Covered Provider on the first day of the entity’s covered reporting period, Covered Providers are prohibited from using SF/SAP to provide compensation greater than $199,000 to any Covered Executive. The State agencies have the authority to annually adjust this limit on the use of SF/SAP, but only with the approval of the Division of the Budget (DOB).

(ii) Overall Cap on Compensation

In addition, the regulations include an overall cap on what Covered Providers may pay Covered Executives. No Covered Executive may receive more than $199,000 – regardless of the source of the funds – 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 recognized by DOB; and (2) has been approved by the Covered Provider’s board of directors or other governing body, including at least two independent directors or members. The adopted version of the regulations clarifies that the second prong of this test will be satisfied if an authorized compensation committee, that includes at least two independent directors or voting members, reviewed the compensation package, and the full board then reviews and ratifies the recommendation of the compensation committee. This limitation remains consistent with the Governor’s statement from May 2012 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.

See http://www.governor.ny.gov/press/05162012State-Funded-Providers.

Despite the foregoing, State agencies may use SF/SAPs to reimburse Covered Providers for compensating Covered Executives more than $199,000 if that executive also performs programmatic services. This exception also applies to Covered Executives who provide “supervisory services . . . to facilitate the Covered Provider’s program services.” 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 exclude that portion of the compensation “in the calculation of his or her executive compensation.” In that scenario, the Covered Provider must document the program services the executive provides.  The State is authorized to request copies of this information to justify the additional expenditure of SF/SAP for this aspect of the individual’s functions. Clinical and program personnel who fulfill “administrative functions that are . . . directly attributable to and compromise program services shall not be considered Covered Executives,” and are not subject to the reimbursement limitations. 

(iii) Effect on Downstream Contracts

Subcontractors and agents of Covered Providers are also required to comply with these Executive Compensation limitations as if they were Covered Providers, but only to the extent that the downstream subcontractor or agent would have been deemed a Covered Provider if it contracted directly with the State agency. Covered Providers are required to include in their contracts with relevant entities that the downstream contractor is subject to the regulations. The State agencies are authorized to request information from the Covered Providers regarding these subcontractors and agents; however, the regulations explicitly State that Covered Providers “shall not be held responsible for a subcontractor’s or agent’s failure to comply with these regulations.”

(iv) Compliance Dates

Contracts entered into prior to July 1, 2012 are excluded from the Executive Compensation limitation provisions for the duration of the contract, unless the contract extends beyond April 1, 2015. To the extent that the contract period extends beyond that date, the Covered Provider will need to seek a waiver. Additionally, to the extent that such a contract is renewed at the end of its term, even if that date is prior to April 1, 2015, the limitations will apply to the renewed contract.

For all other entities, the compensation limitations will apply beginning with the first date of the Reporting Period, following July 1, 2013. The regulations define Reporting Period as either the calendar year or the Covered Provider’s fiscal year. The Covered Provider may select which year to use, “[h]owever, where a provider is required to file an annual Cost Report with the State, reporting period shall mean the reporting period applicable to said Cost Report.” Thus, as is illustrated in the chart below, to the extent that a Covered Provider does not have any grandfathered employees, and the Covered Provider opts to use a calendar year as its Reporting Period, it would not be subject to the compensation limitations until January 1, 2014. To the extent that an entity opts to use a fiscal year, and its fiscal year is June 1 through May 31, it is possible that the entity will not be required to comply with the compensation limitations until June 2014.

B. Limit on Administrative Expenses

Effective on the same schedule as the limits on Executive Compensation, Covered Providers will no longer be permitted to spend more than 25% of the SF/SAP received from the relevant State agency on Administrative Expenses. Beginning with the first day of the new Reporting Period following July 1, 2013, Covered Providers must spend at least 75% of its SF/SAP on Program Services. This will increase by 5% the following year, at which time Covered Providers will be required to spend at least 80% of its SF/SAP on Program Services and in 2015 they will be required to spend at least 85% of its SF/SAP on Program Services.

Administrative Expenses are essentially management and overhead costs incurred by a Covered Provider  that “cannot be directly attributed to program services.” However, the regulations broadly define Program Services Expenses, and exclude from the definition of administrative expenses such things as: capital expenses, “property rental, mortgage or maintenance expenses,” taxes, most equipment rental, certain non-reoccurring and unexpected expenses in excess of $10,000, and the “portion of the salaries and benefits of staff performing policy development or research.” Additionally, the regulations expressly authorize 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 that 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.”

7. What is the waiver process?

The regulations establish a process that enables the relevant agency to issue waivers to Covered Providers for both the Executive Compensation limitations and the limitations on Administrative Expenses.

The contracting agency and the DOB may waive the $199,000 Executive Compensation limit upon a showing of good cause. The regulations indicate that a waiver request must be submitted to the relevant agency and DOB, and provide that such waivers may be granted “for one or more covered executives, or for one or more positions, during the reporting period and, where appropriate, for a longer period upon a showing of good cause.” At a minimum, the agency and DOB shall consider the following in determining whether to waive the executive compensation limitations:

• 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; and

• The extent to which the service provider attempted to identify and hire comparable executives at lower compensation.

The agency and DOB may also waive the Administrative Expense limitations. When evaluating these waiver requests, 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.

Waiver applications are due no later than when the Covered Provider is required to file is disclosure statements (generally 180 days after the close of the Covered Reporting Period). Waivers are to be granted upon a showing of “good cause.” The determination as to whether a waiver is granted will generally be issued within 60 calendar days of the application submission. If either type of waiver request is denied, the relevant agency and/or DOB shall inform the Covered Provider of the reasons for the denial. A Covered Provider may appeal this final determination within 30 days of receiving the notice and reasons for the denial. A request for reconsideration should include “any written documentation that would controvert the reason(s) for the denial or disclose that the denial was based upon a mistake of fact.” 

The final version of the regulations provides that the information provided in these waiver applications is generally to be excluded from public disclosure under the Freedom of Information Law, unless the information therein is already publicly available. 

8. What are the disclosure obligations?

Each agency is expected to release more information regarding the reporting obligations for Covered Providers in the coming months, but the final regulations are essentially the same as the initial proposal. Covered Providers are required to submit reports to the relevant agency for each year of the relevant contract. The disclosure form for the relevant period will generally be due no later than 180 calendar days following the close of the Covered Reporting Period. The specifics of what will be required to be reported in these forms remains unclear, but it will likely involve disclosure of how much compensation is being paid to Covered Executives, how much is being spent on Administrative versus Program Services, and what, if any, subcontractors or agents are being used to provide program services. Failure to comply with the yet to be finalized disclosure obligations could result in “the termination or non-renewal of a contract or agreement” for SF/SAP.

9. What are the penalties for non-compliance?

If the State believes that a Covered Provider is not complying with the restrictions imposed by these regulations, and the Covered Provider has not obtained a waiver, the relevant agency will notify the Covered Provider. Within 30 days of receiving such a notification, the Covered Provider must submit documentation demonstrating compliance with the regulations. If the Covered Provider fails to respond, or if the State agency determines that the Covered Provider is out of compliance, the Covered Provider will be afforded an opportunity to cure the defect. The Covered Provider will be required to make these changes within six months of a negative finding and develop a corrective action plan within 30 days. If the agency approves the corrective action plan, but the Covered Provider fails to implement the necessary changes, the agency shall notify the Covered Provider that the State is either granting the Covered

Provider more time to implement the corrective action plan or sanctioning the Covered Provider for non-compliance. Sanctions may include:

• Redirecting the SF/SAP to ensure that they are used to fund Program Services;

• Suspending, modifying, limiting, or revoking the Covered Provider’s license to operate the relevant program;

• Suspending, modifying, or terminating contracts with the Covered Provider; and

• Any other lawful actions or penalties that the agency deems appropriate.

10. When do the restrictions take effect?

As is described above, the regulations take effect on July 1, 2013, but the limits do not apply to Covered Providers until the beginning of the Reporting Period. As illustrated below, because the Reporting Period is based on either the Covered Provider’s calendar or fiscal year most entities will not be required to comply with the restrictions until sometime during 2014.

Conclusion

After several revisions, the regulations limiting Executive Compensation and Administrative Expenses are now final. This memorandum highlights some of the major requirements of the 13 different agencies’ regulations. However, the application of these limitations will be fact-specific. Entities receiving State funds should carefully evaluate whether they are covered by the regulations and, if so, determine how to comply.