COLLAZO FLORENTINO & KEIL LLP

Client Advisory

For Clients And Friends Of The Firm

August 22, 2014

New York Executive Order 38 and State Agency Regulations on State-Funded Executive Compensation New York Executive Order 38, “Limits on State-Funded Administrative Costs and Executive Compensation,” issued by Governor Cuomo in May 2013, promises to significantly impact both for-profit and non-profit entities that receive New York State funds. In particular, the State agency regulations promulgated at the direction of Executive Order 38 limit the use of taxpayer monies for the purpose of compensating certain executives, and provide for the imposition of severe penalties in the event of non-compliance. The validity and enforceability of Executive Order 38 and the agency regulations have been challenged in several lawsuits filed across New York State, but the conflicting court decisions issued thus far have failed to provide affected entities with definitive guidance. Background and Stated Purpose of Executive Order 38 Executive Order 38 applies to both non-profit and for-profit entities that receive, either directly or indirectly, taxpayer dollars for the provision of critical services to New Yorkers. The stated purpose of Executive Order 38 is to address these entities’ purported use of a disproportionately large amount of State funds for administrative costs and executive compensation, rather than for the provision of direct care or client services. To that end, Executive Order 38 directed thirteen State agencies to promulgate regulations addressing the extent and nature of a covered provider’s use of State funds or State-authorized payments for administrative costs and executive compensation. These regulations went into effect July 1, 2013. Who is a “Covered Provider” Under Executive Order 38 and the Regulations? A “covered provider” is an entity that receives State funds or State-authorized payments during the “covered reporting period” and the year prior to the covered reporting period that: 1) amount to an annual average of more than $500,000, and 2) constitute at least 30% of the entity’s total annual in-state revenues (which are revenues – including revenues from sources outside the State – that are derived from and in connection with activities conducted within New York State). The regulations

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limit the definition of “covered provider” to: hospitals and nursing homes, home care service agencies, certified home health agencies, residential health care facilities, long term home health care programs, AIDS home care programs, assisted living facilities, and other similar healthcare providers and programs. “Covered providers” do not include state, county, and local governmental units, or entities that primarily or exclusively provide products, rather than services, in exchange for State funds/Stateauthorized payments, such as pharmacies or medical equipment suppliers. The term “covered reporting period,” as used in the regulations, refers to either the calendar or fiscal year used by the provider, or, where a provider is required to file an annual cost report with the State, the applicable reporting period for that cost report, beginning on or after July 1, 2013. What are State Funds and State-Authorized Payments? “State funds” are defined rather broadly by the regulations to include all funds appropriated by law in the annual New York State budget. “State-authorized payments” refer to all other funds distributed with State agency approval, including but not limited to the federal and county portions of approved Medicaid payments. The “Guidance Document,” developed by the State as an interpretive aid for Executive Order 38 and the regulations, lists program or services funding that may be considered State funds or State-authorized payments. (See executiveorder38.ny.gov/ content/guidance (Appendix B).) 1 Which Executives are Covered by Executive Order 38 and the Regulations? The regulations define a “covered executive” as a compensated director, trustee, managing partner, officer, or key employee whose “executive compensation” exceeds $199,000 during the covered reporting period. Covered executives do not include clinical and program personnel in a hospital, department chairs, heads of service, chief medical officers, or directors of nursing. If a covered provider has many covered executives, only the ten executives with the highest executive compensation need to be reported.

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The only reference in Appendix B to Medicare payments as possible State-approved payments is the Senior Medicare Patrol Program (SMPP), which is administered by the New York State Office for the Aging.

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“Executive compensation” includes not only salary, wages, and bonuses, but also dividends, partner/shareholder distributions, and payments for personal vehicles, housing, travel, or entertainment, as well as the provision of below-market loans, and personal use of an organization’s property. Mandated benefits, such as Social Security, workers’ compensation, unemployment insurance, and short-term disability insurance are not included in the definition of “executive compensation.” Benefits such as health and life insurance premiums and retirement and deferred compensation plan contributions are also not included in the definition of “executive compensation” so long as these benefits are “consistent” with those paid to other employees, 2 such that the intended value of the benefit is substantially equal, even if the cost to the covered provider to provide such benefits may be different. The regulations provide that to the extent employer contributions to a covered executive’s retirement and deferred compensation plans are not consistent with those provided to other employees, “executive compensation” will be deemed to include only those amounts contributed or accrued during the reporting period for the benefit or intended benefit of the covered executive (even if not reported on the covered executive’s W-2 or 1099), and would not include amounts that vested during the reporting period if they were contributed or accrued prior to that period. How Do Executive Order 38 and the Regulations Impact Executive Compensation? Executive Order 38 and the regulations impose two limitations on the use of State funds and State-authorized payments for executive compensation, unless a waiver is obtained. Notably, these limitations apply regardless of the covered provider’s size or complexity of services. First, a covered provider may not pay executive compensation to covered executives in an amount greater than $199,000 annually when that compensation is sourced entirely from State funds or State-authorized payments.

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The regulations do not define the term “other employees,” and do not specify whether this refers to other comparable or similarly-situated employees or any other employees of the covered provider.

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Second, a covered provider may not use any source of funding (including not only State funds or State-authorized payments, but also any other funding source) to pay executive compensation greater than $199,000 annually unless: 1) the th compensation is less than the 75 percentile of the compensation provided to comparable executives employed by similar providers, and 2) the compensation was reviewed and approved by the provider’s board of directors or equivalent governing body (which must include at least two independent directors or voting members). As noted above, this second restriction applies to executive compensation paid for with “not only State funds and State-authorized payments but also any other sources of funding.” 10 N.Y.C.R.R. 1002.3(b). This regulatory language appears, on its face, to refer to executive compensation funded with a mixture of State funds/State-authorized payments and non-State money. It is clear from the State’s interpretative guidance issued in conjunction with Executive Order 38 and its regulations, however, that the State has a much broader interpretation of this regulatory language. Indeed, these guidance materials set forth that, in the State’s view, the second restriction applies to executive compensation in excess of $199,000 that is funded from any source – including sources that comprise a mixture of Statefunds/State-approved payments and non-State money, as well as entirely non-State money sources. (See, e.g., Guidance Document at pp. 39-40, and further discussion in the text below.) In conducting the 75th percentile analysis, a covered provider may use a compensation survey that includes the covered provider’s sector of program service, and which contains a reasonable number of comparable organizations. The compensation survey should examine various factors of comparability, including: the covered provider’s similarity to other organizations in terms of type and scope of services rendered, annual budget, number of employees, and geographical locations; the availability of similar services within the geographic location; and the covered executive’s similarity to other executives in terms of education, credentials, work experience, and job performance. The regulations require covered providers to submit the “EO#38 Disclosure Form,” which certifies their compliance with these provisions, to the appropriate State entity no later than 180 days after the end of the covered reporting period.

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How Can a Covered Provider Obtain a Waiver From the Executive Compensation Limitations? If a covered provider exceeds (or projects that it will exceed) the executive compensation limitations set forth in the regulations, it may submit a waiver application along with its EO#38 Disclosure Form. The waiver application must describe the extent to which the covered executives’ compensation is comparable to the compensation paid to similar executives employed by comparable providers, and explain why it would be unable to provide the same quality of services without paying executive compensation in excess of the regulatory limit. The waiver application must also contain a description of the covered provider’s process for reviewing and approving executive compensation levels. Additionally, if the executive compensation exceeds the 75th percentile, the waiver application must disclose the compensation survey used by the covered provider and describe its rationale for approving such compensation. Finally, the waiver application must describe the covered provider’s efforts to secure executives with similar experience and skills to serve in the covered executives’ positions at lower levels of compensation. What are the Potential Penalties for Non-Compliance? If a covered provider fails to comply with the provisions of Executive Order 38 and the regulations, it will be given an opportunity to correct any violations and submit a corrective action plan to the relevant State agency. If a covered provider fails to fully and properly implement the corrective action plan, it may be assessed penalties, including the loss of its State funds or State-authorized payments, and the revocation, suspension, or modification of its license to provide program services. Interpretive Case Law Since the issuance of both Executive Order 38 and its accompanying regulations, affected providers (including both non-profit and for-profit providers) have commenced lawsuits in the Supreme Courts of Nassau, Suffolk, and Albany counties challenging their validity and enforceability. Unfortunately, the court decisions issued thus far have provided conflicting legal and factual analyses and have reached different conclusions.

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Decision Favorable to Executive Order 38 and Regulations On July 29, 2014, the Suffolk County Supreme Court upheld both Executive Order 38 and the regulations promulgated by the New York State Department of Health (“DOH”). In that case, plaintiff Concerned Home Care Providers, Inc., a nonprofit trade association consisting of 18 home health agency members (17 of which were for-profit entities), alleged that Governor Cuomo and the DOH exceeded their respective executive and administrative powers and usurped the New York State Legislature’s authority, in violation of the separation of powers principle contained in the New York State Constitution. The court disagreed, concluding that the New York Public Health Law and Social Services Law clearly authorized the DOH to regulate the financial assistance provided by the State in connection with public health activities, and the DOH’s regulation of the amount of State funds and State-authorized payments used to pay executive compensation clearly fulfills that statutory mandate. The court also found that the Executive Order and DOH regulations were both in accord with the legislative policy governing the expenditure of funds by non-profit corporations. The court relied, in part, on its finding that the substance of Executive Order 38 and the DOH regulations had never been voted on by the New York State Legislature. Although the Governor’s 2012-2013 Executive Budget Submission originally contained a proposal regarding limiting the use of State money for executive compensation, the budget bill ultimately passed by the Legislature did not include that proposed language. The court concluded “legislative inaction” is not a basis to infer legislative disapproval and, thus, the Executive Order was not improperly issued on the heels of the Governor’s failed attempts to enact its substance in legislative form. Finally, the court “emphasized” that the regulations only limited the amount of State funds or State-authorized payments that could be used for executive compensation, and did not, in the court’s view, restrict or limit the use of other funds for payment of executive compensation. Because the regulations only limited the use of State funds or State-authorized payments, the court concluded, they were a “far cry” from other, more extensive, regulations that had been struck down by New York courts. As noted above, however, it appears from the State’s guidance materials that the State does not share the court’s interpretation of the regulations on this point. The relevant regulatory language sets forth that the second restriction on executive

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compensation (which allows executive compensation in excess of $199,000 per year only when the 75th percentile test and the review test are met) applies to compensation paid for with “not only State funds and State-authorized payments but also any other sources of funding.” 10 N.Y.C.R.R. 1002.3(b). This language could be read as referring solely to funding sources stemming from a mixture of non-State money and State money. The FAQ portion of the State’s Executive Order 38 website states that the second restriction applies to compensation from “other sources of funding or a mix of State and non-State funding sources.” (See http://executiveorder38.ny.gov/faq-page (FAQ # 36).) Moreover, the Guidance Document also clearly sets forth that the second restriction applies to executive compensation that is funded “using any sources of revenue.” (Guidance Document at pp. 39-40.) Contrary to the view of the Concerned Home Care Providers court, therefore, the State appears to interpret the regulations as limiting the use of any sources of funding (whether that funding is a mix of non-State money and State funds/State-approved payments or entirely non-State money) for payment of executive compensation. Unfavorable Decisions Regarding Executive Order 38 and the Regulations In Agencies for Children’s Therapy Services, Inc. (“ACTS”) v. New York State Department of Health, the Supreme Court in Nassau County found that both Executive Order 38 and the DOH regulations are invalid and may not be enforced. The plaintiff, a non-profit corporation comprised of more than twenty-five for-profit providers of Early Intervention and special education services, asserted that the Governor and DOH had each exceeded the scope of their authority by issuing Executive Order 38 and promulgating regulations in an improper attempt to make legislative policy decisions. The court agreed, concluding that none of the statutes cited by the DOH gave it the authority to regulate the amount of compensation that for-profit entities (such as plaintiff’s member entities) paid its executives. (Interestingly, the DOH had attempted to invoke the New York Public Health Law and Social Services Law – the same statutes it cited in the Concerned Home Care Providers case. As noted above, in the Concerned Home Care Providers case, the Suffolk County Supreme Court found that the scope of authority granted to the DOH by those statutes did, in fact, encompass the ability to regulate executive compensation. In ACTS, however, the Nassau County Supreme Court expressly disagreed, reasoning that those statutes applied only to either non-profits (while ACTS’s members were for-profit entities) or to Medicaid recipients.)

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The court in ACTS also concluded that Executive Order 38 and the DOH regulations constituted an impermissible attempt to “act[ ] in an area which the Legislature had repeatedly tried – and failed – to reach an agreement.” The ACTS court noted, as the Concerned Home Care Providers court had, that the substance of Executive Order 38 had originally been included in the 2012-2013 Executive Budget Submission made by the Governor in January 2012. However, while the court in Concerned Home Care Providers found that the Governor’s proposal was not included in the final budget bill as a result of “legislative inaction,” the ACTS court concluded that the Legislature had expressly “rejected” that proposal. Therefore, the ACTS court found, Executive Order 38 and the DOH regulations constituted an improper attempt to set forth a comprehensive set of rules that were identical to those already rejected by the Legislature. (It is unclear from the ACTS decision why the court determined that the Legislature “rejected” the proposals. The legislative histories of Assembly bill (A. 9056) and Senate bill (S. 6256) do not indicate that any formal vote was taken prior to passing the 2012-2013 Budget Bill on March 30, 2012. The court in ACTS relied on an affidavit of Steven Sanders, Executive Director of ACTS, and a former member of the New York State Assembly from 1978 through 2005, for the legislative history of the bills.) More recently, the Supreme Court in Albany County denied a motion to dismiss a complaint challenging Executive Order 38 and the DOH Regulations. That lawsuit was filed by, inter alia, plaintiff trade associations representing more than 1,000 forprofit and non-profit providers. In a decision issued on August 13, 2014, the court found that the plaintiffs had adequately stated a claim that Executive Order 38 and the DOH regulations violated the constitutional separation of powers doctrine and were arbitrary and capricious. That decision did not indicate whether the plaintiffs had sought a preliminary injunction enjoining the enforcement of the regulations. Currently, the State has made clear that – despite the pending legal challenges – it intends to enforce Executive Order 38 and the regulations issued by all thirteen State agencies, and that all covered providers, except those that conduct business solely in Nassau County, are expected to submit EO#38 Disclosure Forms as required. The State’s Executive Order 38 website contains the following “Legal Notice”:

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Based upon the April 8, 2014 decision in Agencies for Children’s Therapy Services, Inc. v. New York State Department of Health, et al. (“ACTS”), covered providers conducting business in Nassau County need not file Executive Order # 38 disclosures . . . Please note that the ACTS decision is under appeal. Those affected by the ACTS decision should periodically check the EO 38 website for updates regarding any change to this notice. Given the conflicting interpretive case law discussed above, covered providers will have to await appellate guidance regarding the validity and enforceability of Executive Order 38 and its regulations. While the outcome is far from definitive, it appears that the State’s application of the regulations in a manner that would dictate how for-profit entities spend entirely non-State money to compensate their executives is particularly susceptible to attack, and could provide a basis for the invalidation of the entire regulatory scheme. Specifically, an appellate court could conclude that such regulation exceeds the bounds of the statutory authority granted to State agencies, such as the DOH, by the New York Public Health Law and Social Services Law. The New York Court of Appeals recently concluded that the New York City Board of Health engaged in just this type of improper policy-making when it attempted to restrict the ability of food service establishments to serve sugary beverages in oversized cups and containers. Until New York’s appellate courts offer clear guidance in this area, however, entities that could be deemed “covered providers” are advised to consult the State’s Executive Order 38 website, http://executiveorder38.ny.gov, which contains the Guidance Document, a FAQ section, interactive worksheets, and waiver applications. If you would like more information or assistance, please contact Laura Monaco at (212) 758-7754, or any other attorney at the Firm. This Advisory is intended for informational purposes only and should not be considered legal advice. If you have any questions about anything contained in this Advisory, please contact Collazo Florentino & Keil LLP. All rights reserved. Attorney Advertising.