The Governor of New York has taken a strong and outspoken stance aimed at placing those with the largest paychecks at institutional nonprofits under a microscope. Governor Cuomo’s newly formed Task Force on Not-For-Profit Entities will be conducting a review of current compensation levels of not-for-profit organizations that have received funds from the State of New York.

The first action by the Task Force was the recent issuance of a data request to the boards of several not-for-profit organizations, the responses to which must be submitted to the Task Force by no later than September 15. Other organizations will also receive such requests in the near future. While some not-for-profit organizations will be excluded from these rolling requests for information, institutions which are in the areas of health care and higher education will likely be featured in the spotlight.

For example, the media attention from the compensation package for Dr. Philip Levy of the Young Adult Institute (“YAI”) fueled a firestorm which raised the antenna of state officials. YAI is a New York nonprofit organization which specializes in services for the developmentally disabled. The New York Times ran a feature article on August 2, 2011 detailing YAI’s seven-figure compensation packages for Dr. Levy and his brother, which the Times cited as including luxury cars for both, tuition payments for their children, and in the case of Dr. Levy, a payment of $50,400 towards his daughter’s living expenses. The Task Force was announced the day after the Times article. As YAI received a significant amount of Medicaid funding from the state over the past decade, the Governor’s office likely took note in its plans to address compensation at nonprofits.

Yet executive and board compensation is not a new issue in the State of New York. The New York State Board of Regents removed the board of trustees of a private university in 1996, for among other reasons, breaching its fiduciary duty by granting an excessive compensation package to its president. However, the trend in recent years in New York and on a national level has shown continuing increases with respect to the compensation of senior executives at large nonprofit organizations.

The Task Force has been given the mandate of auditing compensation levels and to provide recommendations on future rules for consideration by the state. The recent inquiry sent to numerous not-for-profit organizations requests detailed compensation and financial data, including the amounts paid in base compensation, deferred compensation, bonus or any other benefits to an executive, administrator, board member or any individual who received more than $100,000 in aggregate compensation.

The targets of the Task Force’s investigation are no secret. As noted above, the nonprofit organizations which have led the way in executive compensation are in the areas of health care and higher education. Doug Sauer, CEO of the New York Council of Nonprofits, has asserted that while such abuses are not widespread, they are more likely to occur in these fields. The state’s interest in health care and higher education is heightened not only by the grant of nonprofit/tax-exempt status from the organization’s corporate charter, but also the billions of dollars which flow by way of Medicaid funding and financial aid to colleges and universities.

The composition of the Task Force highlights the focus of the Governor’s office. Benjamin Lawsky, the Superintendent of the Department of Financial Services, will chair the Task Force. Joining Superintendent Lawsky will be Senator Carl Marcellino, Assemblyman Steve Englebright, State Inspector General Ellen Biben, Secretary of State Cesar Perales, Medicaid Inspector General Jim Cox and Commissioners Michael Hogan, Courtney Burke, Arlene Gonzalez-Sanchez, and Nirav Shah from the Office of Mental Health, Office of Alcohol and Substance Abuse, Department of Health, and the Office of People with Developmental Disabilities, respectively.

One question left open by the formation of the Task Force, particularly in light of its mandate to recommend rules for the state’s consideration in regulating not-for-profit executive compensation, is: does compliance with the Federal “intermediate sanctions” regulations automatically ensure compliance with the requirements imposed by the State of New York? Possibly not.

Under Section 4958 of the Internal Revenue Code, the IRS may impose certain excise taxes on “disqualified persons” or “organization managers” who either benefit from or approve an excess benefit transaction of a public charity exempt under Sections 501(c)(3) or (4). These rules, commonly referred to as the “intermediate sanctions” regulations since they impose a penalty less severe than revocation of tax-exempt status, are aimed at preventing undue compensation arrangements with senior managers and removing conflicts of interest from the process of compensation decisions.

Many tax-exempt organizations have relied upon the “safe harbor” provisions of the intermediate sanctions regulations. Under the safe harbor rules, an authorized governing body of the organization (usually the board or a committee of the board) can create a rebuttable presumption of reasonableness of the compensation arrangement if (1) it is approved by the authorized body as composed entirely by individuals not having a conflict of interest in the transaction; (2) the authorized body relied upon appropriate data for comparisons on the compensation arrangement; and (3) the authorized body timely documents its basis for the compensation decision.

There are critics who have argued that the safe harbor is too flexible given the purpose of Section 4958. These critics include William Josephson, the former chief of the New York State Attorney General’s Charities Bureau. As a result, large institutional non-for-profit organizations in New York (and potentially other states) should be on alert that safeguarding against adverse action may require more than the IRS currently mandates. It is recommended that large and mid-sized not-for-profit organizations receive guidance on best practices for not only documenting compensation decisions, but also ways to defend a board’s determination that a particular executive or board compensation package set at or above existing market rates is appropriate.