Introduction

Five months after initially promulgating regulations, the New York State Department of Health (“DOH”) on October 31, 2012 released revised proposed regulations (the “Revised Proposed Regulations”) superseding the proposed regulations published on May 30, 2012 (the “Initial Proposed Regulations”) 1 to implement Executive Order No. 38 (the “Executive Order”), issued by Governor Andrew Cuomo on January 18, 2012, limiting use of State funds for executive compensation and administrative expenses paid or incurred by the State’s health care providers. Notice of the Revised Proposed Regulations was published in the New York State Register on October 31, 2012 and a full copy of the text is available on the DOH web site. All thirteen State agencies that had issued proposed regulations last May promulgated revised regulations, with all except one providing a 30-day comment period ending November 30, 2012.2 The Office for People with Developmental Disabilities (“OPWDD”) will accept comments through December 24, 2012.

With the public comment period extending through November 30th, the Revised Proposed Regulations will not be finalized until December, at the earliest. Consequently, the effective date of the regulations has been pushed forward from January 1, 2013 to April 1, 2013. Moreover, the deadline for any waiver application from the executive compensation or administrative expense limits for the first reporting period – due 90 days in advance (discussed below) – is January 2, 2013.3

The “Assessment of Public Comments”, released with the Revised Proposed Regulations, notes that providers raised a variety of concerns and objections to the proposed limits on executive compensation and administrative costs, which DOH attempted to summarize and address. To be sure, the Revised Proposed Regulations do moderate some of the burdens imposed on providers, by, for instance, giving more time for appealing waiver denials, “grandfathering” existing employment contracts, and conforming defined terms and reporting requirements with those used or required by the Internal Revenue Service (“IRS”) in the Form 990, “Return of Organization Exempt From Income Tax”, filed by certain tax exempt organizations. On the whole, however, the Revised Proposed Regulations do not fundamentally change the limits on executive compensation and administrative costs set forth in Executive Order 38 and in the Initial Proposed Regulations.

Briefly, with respect to executive compensation –

  • absent a waiver, “covered providers” – including both not-for-profit and for-profit entities – would be prohibited from using State funds or State-authorized payments to pay more than $199,000 per year in “executive compensation” to a “covered executive”;
  • there remains a safe harbor for executive compensation exceeding $199,000 (provided it is paid without State dollars) that falls within the 75th percentile for comparable executives; and
  • compensation above the 75th percentile (or above the State-funded cap of $199,000) requires a waiver from DOH or the New York State Division of the Budget (“DOB”)4 for “good cause” (the alternative references to a “compelling circumstances” standard have been deleted).

With respect to administrative costs, covered providers would still be limited to using State funds to pay for administrative costs, initially to 25% of total operating costs beginning in 2013 and lowering the cap by 5% per year to 15% by 2015. A waiver of the cap on State funding of administrative costs may also be obtained.5

For your convenience, we have attached a link to our previous Clients & Friends Memorandum discussing the Initial Proposed Regulations. The remainder of this memorandum will discuss the more salient changes made by the Revised Proposed Regulations as they pertain to the topics addressed in our previous memorandum. A chart summarizing the most significant differences between the two sets of regulations is attached at the end of this memorandum.

What is the State’s Authority for Promulgating the Proposed Regulations?

The DOH rejected the many arguments made in the comments submitted in response to the Initial Proposed Regulations, which had questioned or challenged the agency’s authority to promulgate regulations restricting executive compensation and administrative costs, and summarily concluded that it has authority to regulate in this area.6 One comment in particular pointed out that Governor Cuomo had included the same limits in his initial 2012-13 budget and, the following day, issued Executive Order No. 38, directing agencies to impose the limits, without obtaining any legislative authorization. In response, DOH asserted that the Legislature “did not reject the proposal made in the Executive Order,” but “[r]ather, that the Governor’s Office chose to proceed by regulation in part to ensure that the rules developed in this area could be monitored and revised as necessary over time.”7

Do the Revised Proposed Regulations Apply to My Organization?

A “covered provider” would be subject to the executive compensation and administrative cost limits if it has received “State funds” or “State-authorized payments” (1) averaging over $500,000 a year during the past two years (the Initial Proposed Regulations used a third-year average);8 and (2) accounting for at least 30% of its total “in-state” revenue.9 The Revised Proposed Regulations include guidance to providers for determining whether the regulations apply to them. For instance, they add a non-exhaustive list of facilities and entities that are considered “covered providers”, including hospitals, nursing homes, home care agencies, hospices, assisted living providers, health maintenance organizations, and other Public Health Law Article 44 entities, such as managed long term care plans.

A provider’s method of calculating in-state revenues, used for determining tax liability or completion of its financial statements, may be used for determining whether the 30% threshold has been met.10 The Revised Proposed Regulations also clarify that “in-state” revenue includes a provider’s total annual revenues derived from programs and activities within New York State, even if the sources of funding are outside New York State, including, for example, contributions by out-of-state individuals or entities for in-state activities.”11

Notably, the Revised Proposed Regulations have deleted the provision in the Initial Proposed Regulations requiring a provider to measure its revenue for purposes of calculating the 30% threshold, on a “consolidated” basis with any “parent” or “subsidiary” entities. Instead, a new provision defines “covered provider” to include entities within the same “corporate family” as a covered provider, such as parents or subsidiaries, to the extent those entities receive State funds from the covered provider, as opposed to directly from a government agency, that average over $500,000 a year and account for at least 30% of their total in-state revenue.12

Subcontractors and Agents. The executive compensation and administrative cost limits in the Revised Proposed Regulations now apply to “subcontractors” and “agents” of a covered provider regardless of whether they are “related” to the covered provider, if the subcontractor or agent has received State funds through the covered provider to provide program or administrative services during the reporting period and would otherwise be considered a covered provider but for the fact that it received such funds through the covered provider rather than the government (i.e. would satisfy the $500,000 and 30% thresholds).13

Thus, “downstream” providers would arguably be subject to the executive compensation and administrative cost limits, whether or not they are related to the covered provider, if State funds “pass through” the covered provider to them to pay for contracted program or administrative services. For instance, a licensed home care services agency (“LHCSA”) contracting with a certified home health agency (“CHHA”) or long term home health care program (“LTHHCP”) could conceivably be subject to the executive compensation limits, whether or not the LHCSA is related to the CHHA or LTHHCP. Under the Revised Proposed Regulations, covered providers would be required to incorporate by reference into their agreements with subcontractors and agents, the terms of the regulations, to require and facilitate compliance.14

Managed Care Contracting Providers. Notably, the Revised Proposed Regulations specify that providers contracting with a State-funded managed care plan to provide program services for a plan’s enrollees are also considered “covered providers” if, by virtue of income received through its managed care contract, they would meet the $500,000 in-state revenue and 30% thresholds. This is so even though such a “downstream” provider, like the subcontractor or agent, is not directly paid by Medicaid.15

Federal Medicare/Medicaid Dollars. The Revised Proposed Regulations also remove any doubt that Medicare reimbursements are not considered “State-authorized payments,” by deleting language that extended the definition of “State-authorized payments” to payments received “by virtue of the provider having a State license in New York State to operate the program for which such payments are being made.”16 At the same time, the Revised Proposed Regulations also confirm that “State-authorized payments” include the “Federal and county portions of Medicaid program payments approved by the state agency.”17

New Exemptions. Interestingly, the Revised Proposed Regulations expressly exempt Medicaid or State-funded suppliers, including pharmacies and medical equipment suppliers, from compliance with the regulations.18 The Assessment of Public Comments, however, includes no rationale or explanation for this new exemption. In this regard, the Executive Order and Initial Proposed Regulations addressed only appropriate limits on executive compensation and administrative expenses for service providers. The State may have considered extending the restrictions to taxpayer-funded suppliers as well as service providers but, for reasons unstated, determined to expressly limit their reach to providers.

The definition of “State funds” was revised to add another, seemingly particularized exemption for “funds expressly intended to pay exclusively for administrative expenses, including but not limited to Community Service Program ‘core’ contract funding for HIV/AIDS services programs.”19 The DOH has otherwise undertaken to publish a list of government programs whose funds will be considered “State-authorized payments” and “State funds” prior to the effective date of the regulation.20

What are the Limits on Executive Compensation?

The Revised Proposed Regulations would prevent a covered provider, or its “related organizations”, from using State funds or State-authorized payments to pay more than $199,000 per year in “executive compensation” to a “covered executive.” The Revised Proposed Regulations require, rather than merely permit, DOH to review this figure annually to determine whether an adjustment is necessary “based on appropriate factors and subject to the approval of the Director of [DOB].”21 This modification appears to address public comments concerning the reasonableness of a $199,000 cap in today’s executive marketplace.

Executives of a covered provider’s “related organization”, paid by a covered provider to perform administrative or program services, would be considered “covered executives” of the covered provider for purposes of compliance and reporting if more than 30% of their compensation was derived from State funds received from the covered provider.22

Grandfathered Employment Contracts. The new regulations also include a new, limited provision for exempting, or “grandfathering”, employment contracts entered into prior to April 1, 2012. A waiver would be required if (i) the term of the employment contract extends beyond April 1, 2014 and (ii) the compensation levels would not comply with the regulations. Any contract renewals would also have to comply with the regulations.23

Consistency with IRS Terminology. Several key terms pertaining to the limits on executive compensation were modified in the Revised Proposed Regulations to be consistent with IRS and other existing reporting obligations:

  • The term “related entity”24 in the Initial Proposed Regulations was replaced with “related organization” in the Revised Proposed Regulations, as the latter term is understood in Schedule R of IRS Form 990.25
  • The definition of “executive compensation” was modified to include only payments and benefits reportable on a covered executive’s Form W-2, “Wage and Tax Statement”. Expressly excluded from the calculation of executive compensation are mandated benefits, health and life insurance premiums, and qualified retirement plan pension contributions (including 401 and 403 plans, and deferred compensation plans) that are “consistent with those provided to the covered provider’s other employees,” meaning the intended value of the benefit is substantially equal.26 Also, with respect to non-qualified deferred compensation plans, only the amount contributed or accrued during the reporting period is included in that period’s calculation of executive compensation.27
  • The definition of “covered executive” was modified to conform with IRS guidance. Specifically, the terms “director”, “trustee”, “officer” and “key employee” are now defined to have the same meaning as those same terms in the Instructions accompanying IRS Form 990, Part VIII.
  • Furthermore, if a health care provider or system has multiple “key employees”, the provider need only report the ten most highly compensated key employees.

Clinical/Medical Staff. Also expressly exempted from “covered executives” are clinical and program personnel in a hospital or other entity providing program services, including chairs of departments, heads of service, chief medical officers, directors of nursing, or similar types of personnel fulfilling administrative functions that are nevertheless directly attributable to and comprise program services.28 Similarly, that portion of the compensation of a covered executive paid for providing “program services, including . . . supervisory services . . . outside of his or her managerial or policymaking duties,” does not count toward his or her “executive compensation”.29 The new exception could spur some providers to review and reconsider the duties and responsibilities of their seniorlevel staff, or their job descriptions, in the face of the limits being imposed on “executive compensation”.

Can A Covered Executive be Paid More than the $199,000 Limit?

The Revised Proposed Regulations continue to afford a “safe harbor” for executive compensation above the $199,000 cap. A provider can pay a covered executive more than $199,000 – without applying for a waiver, and with non-State sources only – if (i) the compensation is below the 75th percentile for executives of comparable providers of the same size and in the same sector and geographic area, as established by a compensation survey recognized by DOH or DOB; (ii) compensation is approved by the provider’s board of directors or governing body, including at least two independent directors, relying on comparability data; and (iii) the above requirements are substantiated with sufficiently detailed contemporaneous documentation.30

Can An Executive Be Paid Above the 75th Percentile?

Executive compensation within the top quartile (i.e., above the 75th percentile) may be allowed if DOH or DOB grants a waiver upon a showing of “good cause”. Any reference to a “compelling circumstances” standard has been stricken from the Revised Proposed Regulations, arguably a sign that waivers will be granted more liberally. Nevertheless, the grounds for “good cause” include essentially the same factors delineated in the Initial Proposed Regulations,31 retaining the broad, “catch all” language – “any other [factors] deemed relevant by [DOH] or its designee and the Director of [DOB].” The Revised Proposed Regulations do add as a factor, the qualifications and experience possessed by the executive or required for the position.32

The Revised Proposed Regulations provide greater flexibility for securing a waiver. For instance, waivers for longer than a single reporting period may be granted. Late waiver applications may also be granted where “a reasonable cause for delay is shown.”33

Waiver applications must be filed 90 (increased from 60) calendar days prior to the reporting period for which the waiver is being sought. In the case of newly created or available executive positions, the Revised Proposed Regulations provide that the waiver application must be submitted 90 calendar days before the new position is actually filled.

The Revised Proposed Regulations now impose a deadline for DOH or DOB to decide on a timely submitted waiver application – no later than 60 days after submission, unless additional information was requested but not received from the covered provider. This provision was evidently added in response to concerns expressed in the comments that providers seeking a waiver would be left in regulatory limbo and in jeopardy if the State had not reviewed and acted on the application prior to the reporting period. However, DOH may still take longer than 60 days if DOH determines more information is required from the applicant.

What are the Limits on Administrative Costs?

The Revised Proposed Regulations also do not change the core mandate that covered providers limit the amount of State funds used to pay for administrative costs, initially to 25% of total operating costs and lowering the cap by 5% per year to 15% by 2015. However, the Revised Proposed Regulations appear to reduce the burden of compliance, in discrete ways. For example, the definition of “administrative expenses” as well as “program services” now excludes (i) taxes or assessments paid by the provider and (ii) expenses exceeding $10,000 that would otherwise be administrative, except that they are either (a) “non-recurring” (no more than once every five years) or “not anticipated” by a covered provider (such as litigation expense).34

Electronic Medical Records. The Revised Proposed Regulations also classify as “program services expenses” rather than “administrative expenses,”35 “information technology and computer services and systems directly attributable to program services such as . . . electronic patient records systems to facilitate improved patient care or computer systems used in program services delivery or documentation of program services provided, quality assurance and control expenses.” It is unclear whether DOH views this change as its effort to provide relief from the effects of “unfunded mandates,” as suggested in the Assessment of Public Comments.36

Enforcement. As noted in the Assessment of Public Comments, enforcement of the administrative expense limit is not immediate. Rather, “providers would not be subject to sanctions for items disclosed in the 2013 report addressing the 2012 financials” but will be subject to enforcement in 2014 relating to the 2013 financials.37 Given that the effective date of the Revised Proposed Regulations was pushed back to April 1, 2013, the financial data from the truncated reporting period of April 1, 2013 to December 31, 2013 would be subject to agency scrutiny.

Allocated Expenses. The Revised Proposed Regulations recognize that some expenses are not readily characterized as either solely administrative expenses or program services. In this regard, the Revised Proposed Regulations provide that “[i]n determining whether an expense is a program service expense or an administrative expense, a covered provider may allocate a portion of the expense to each type if such allocation is supported by the nature of the expense. Such allocation may include allocation of portions of an employee’s time and compensation to administrative or program services.”38

Can a Provider Appeal the Denial of a Waiver?

The Revised Proposed Regulations do not change the procedures that a provider must follow to request reconsideration of a waiver denial. See attached chart.

What Are the Reporting Obligations Under the Revised Proposed Regulations?

The Revised Proposed Regulations do not materially alter the reporting obligations. They do refer to an “EO#38 Disclosure Form”, for each reporting period, which is not yet publicly available. It is unclear what information will be requested on the form. In any event, the Revised Proposed Regulations make clear that a system with multiple covered providers need only file one form. In addition to the annual disclosure report, covered providers would have to “promptly report” the identity of any subcontractors and agents subject to the executive compensation and administrative cost limits.39

Are the Reports and Waiver Applications Subject to FOIL Disclosure?

In response to comments about the need to safeguard a provider’s confidential and trade secret information, the Revised Proposed Regulations now provide that, with respect to waiver applications, but not disclosure reports, “[u]nless already publicly disclosed, information provided by a covered provider to [DOH] . . . shall not be subject to public disclosure under the State’s Freedom of Information Law to the extent that one or more of the exemptions contained in the Public Officers Law is applicable.”40 In rather circular wording, then, DOH will grant a FOIL exemption to a waiver application (or portions thereof) if a FOIL exemption applies to the material submitted. This provision appears to merely restate existing law and provides no new categorical or presumptive protection for waiver applications (and none for reports) against FOIL disclosure. However, DOH’s acknowledgment that a FOIL exemption may apply suggests that it is at least mindful of providers’ privacy and related concerns. Perhaps, DOH will provide additional guidance in its postings or in the EO#38 Disclosure Form itself.

What are the Penalties for Noncompliance?

The Revised Proposed Regulations lengthen the time frames for determining whether to impose penalties, but do not change the potential penalties themselves. See attached chart. Indeed, the Revised Proposed Regulations preserve the broad (and vague) prerogative to impose as sanctions for non-compliance, “any lawful action or penalties deemed appropriate.”

Is Executive Compensation Deemed Excessive Subject to Clawback Under the Revised Proposed Regulations?

The Revised Proposed Regulations do not expressly provide for recoupment of executive compensation deemed excessive. Nevertheless, the Assessment of Public Comments suggests that the agency may pursue that action as a remedy for certain violations (“Recovery of non-State funds or non-State-authorized payments would only be pursued under the regulations if determined to be appropriate, as required by proposed section 1002.6(d)(2)(d).”)41

Looking Forward

The new public comment period may provoke further refinement of the Revised Proposed Regulations promulgated by DOH and other agencies. However, given that the core provisions were not substantially modified following the first public comment period, it is questionable whether the final regulations will materially change the basic limits on executive compensation and administrative expenses as originally proposed.

Notable Differences Between Initial and Revised Proposed Regulations Limiting Executive Compensation and Administrative Expenses

Click here to view chart.