NY Proposes Limits on Non-Profit Executive Compensation

NY Proposes Limits on Non-Profit Executive Compensation

June 1 2012

PDF of Client Alert

Much like the recent focus on compensation paid to executives at public companies, increasingly, press reports focus on and critique all facets of executive pay at non-profit organizations.  Public outcry and donor sentiment have also led some regulators, including the State of New York, to attempt to curb executive compensation levels at non-profits.  On Wednesday May 16th New York State Governor Cuomo, in cooperation with 13 state agencies, announced proposed regulations to limit executive compensation at certain non-profits that receive NY State support.1 These regulations are scheduled to take effect on January 1, 2013 and were designed to implement Governor Cuomo’s January 2012 Executive Order, which stated generally that non-profits receiving state funding would need to cap compensation paid to any executive at $199,000 per year.

The proposed regulations do not go as far as some feared the Governor’s January Executive Order may have been suggesting.  Instead of imposing an absolute cap on compensation to non-profit executives receiving state funding, the regulations prohibit the use of State funds to pay any amount of compensation in excess of $199,000 to an executive.  However, as described in greater detail below, even if a non-profit uses alternative funding sources to pay an executive more than $199,000, the non-profit will be subject to additional restrictions and possible penalties.

What do These Regulations Apply to?

Only Certain Non-Profits
A non-profit is only subject to these regulations if it receives (i) more than $500,000 annually in NY State funds (which includes State-authorized payments) and (ii) at least 30% of its annual funding from NY State, (a “covered non-profit”).

Given the requirement that at least 30% of the organization’s funding must come from NY State, it appears that these regulations will most significantly affect smaller non-profits and/or those receiving significant funding from NY State.

Only Compensation Paid to Covered Executives
These regulations will apply to “total compensation” that is (i) an administrative expense (at least in part) and (ii) paid to (a) any director, trustee, managing partner, or officer of a covered non-profit, or (b) any employee if it is equal to or exceeds $199,000 during a reporting period, (together a “covered executive”).  In addition, if a non-profit contracts with a related entity for administrative or program services, the provision will also apply to any covered executives of the related entity.

Almost All Payments or Benefits to a Covered Executive
Generally, it appears that any payments or benefits (direct or indirect) to a covered executive will be considered “compensation” under these regulations.

Based upon the proposed regulations, “total compensation” includes all cash and noncash payments or benefits given directly or indirectly to such executive, including but not limited to “salary and wages, bonuses, dividends and other financial arrangements or transactions such as personal vehicles, meals, housing, personal and family educational benefits, below-market loans, payment of personal or family travel, entertainment, and personal use of the organization’s property, except that mandated benefits (e.g., Social Security, worker’s compensation, unemployment insurance and disability insurance), and health insurance premiums and pension contributions consistent with those provided to a covered provider’s non-covered executive employees shall not be included in the calculation of executive compensation.”2

Can a Covered Non-Profit Pay More than $199,000?

Using Other Funding Sources
Compensation to a covered executive may exceed $199,000 provided that NY State funds are not used to pay any amount of compensation exceeding the cap.  This emphasizes the importance of carefully tracking where specific funding is spent.

Subject to Restrictions
If compensation to a covered executive does exceed $199,000, in addition to using other funding sources for any compensation exceeding the cap, the non-profit must satisfy one of the following three requirements:

  1. Using a compensation survey, the non-profit must ensure that the compensation falls within the 75th percentile of compensation provided to comparable executives at similar non-profits (size, program service sector, comparable geographic area).  The compensation survey must be identified or recognized by the applicable state agency;
  2. Using compensation data, the Board of Directors of the non-profit (including at least two independent Directors) must assess “appropriate comparable compensation data” (as discussed below) and approve the total compensation package.  Unlike when using a single survey as described above, by using appropriate comparable compensation data the compensation need not fall within a specified percentile of compensation paid to comparable executives; or
  3. Upon a showing of good cause, the covered non-profit may obtain a waiver form the state agency supplying the funds or an amended amount of the cap or the restrictions.

Where either the survey data does not provide satisfactory comparisons or where the compensation exceeds the 75th percentile of the survey, a Board may need to look beyond a single compensation survey and assess appropriate comparable compensation data.

What is Appropriate Comparable Compensation Data?
As with the IRS regulations, which impose a reasonableness standard on non-profits when setting executive compensation,3 “appropriate comparable compensation data” is a tool non-profit Boards can use to help protect against the imposition of penalties for paying excessive compensation.

Comparable compensation data should be compensation paid to individuals holding similar positions, providing similar services at similar organizations.  In some respects, this process mirrors the process undertaken and subsequently disclosed by for-profit companies.  The challenge, however, is that non-profits are not subject to the same disclosure requirements as for-profits.  Therefore, finding comparable peers can be a more time-intensive, research-based process.  The selected peer group should be appropriately comparable across a number of factors including, size, location, and mission.

Documenting the Board and/or Committee’s process in assessing the comparable compensation data may include consideration of, and reliance upon, written professional advice as to the reasonableness of the compensation.  Using the standards established by the IRS, a written determination should:

  1. Be reasoned professional advice of a compensation consultant or other qualified professional with respect to all elements of the decision within the consultant’s expertise;
  2. Address all the facts (elements and amounts of compensation, geographic considerations, organization characteristics, executive’s tenure and experience, etc.);
  3. Detail the comparable data;
  4. Articulate and apply the applicable standards; and
  5. State and explain the determination as to reasonableness.

What is the Consequence of Non-Compliance?
After receiving notice on non-compliance and a failure to cure, the sanctions that may be imposed can have significant ramifications on the non-profit.  Sanctions may include:

  1. Redirection of State funds to be used to provide program services;
  2. Suspension, modification, or revocation of license(s) needed to deliver program services;
  3. Suspension, modification or termination of contracts with the organization; and
  4. Any other lawful actions or penalties deemed appropriate in the sole discretion of the applicable State agency.

Our View
As a preliminary matter, we believe that it is critical for all Non-Profit Boards (whether or not subject to these regulations) to establish procedures for reviewing compensation.  By establishing policies and procedures that allow Boards to systematically review compensation decisions, non-profits are able to operate with greater efficiency and predictability and are more likely to protect against penalties imposed under the proposed regulations and/or the IRS.  These procedures should include how to proactively establish a presumption of reasonableness with respect to the individual compensation arrangements that are ultimately approved by the Board, and how to react to an internal or regulatory investigation/audit of compensation determinations.  Once these proactive and reactive procedures have been established, the Board is able to consider and approve compensation decisions.  For our suggestions on the specifics of establishing these procedures, please see “Systematic Compensation Review for Non-Profit Boards” on our website at http://www.shallpartners.com/category/our-thinking/articles/.

Once a compensation arrangement has been considered and approved in accordance with the established procedures, the Board should take care to document: the terms of the arrangement; date of approval; members present; member voting results; professional advice considered; details on comparable data reviewed; and the reasons for why the decisions were made.

Competitive compensation packages above the 75th percentile may be necessary to attract and retain the key talent necessary for establishing, implementing and/or carrying out the mission of the non-profit.  If the facts and circumstances warrant it, a Board should not shy away from approving compensation what may be deemed to be above-market compensation packages.  Documenting the process and having a well thought-out rationale is even more important when a Board has decided to pay (or continue to pay) a non-profit executive above the 75th percentile of the market or where the approved compensation otherwise varies in material ways (form, mix, timing, etc.) from the market.

Next Steps
We urge all covered non-profits to review the total compensation paid to all employees, particularly to any director, trustee, managing partner, or officer.  Where the compensation exceeds $199,000, the Board must take steps to:

  1. Ensure that other funding sources are used to pay for any compensation to a covered executive that exceeds the cap;
  2. Satisfy one of the three requirements described above under “Subject to Restrictions;” and
  3. Document all steps taken in assessing and approving such compensation.

For more information on establishing reasonable non-profit compensation or the IRS penalties associated with a failure to do so, please see “What is Reasonable Compensation for a Non-Profit Executive?” on our website at http://www.shallpartners.com/category/our-thinking/articles/.

 

About Steven Hall & Partners
Steven Hall & Partners (“SH&P”) is a totally independent compensation consulting firm, specializing exclusively in the areas of executive compensation, board remuneration, non-profit compensation and related corporate governance issues.  By focusing solely on this critical and complex segment of the human resources arena, we are able to provide our clients with the highest quality expertise and best counsel available on a practical basis.

SH&P has established a practice dedicated to non-profit compensation because we recognize the unique and particular importance of providing executive compensation consulting to non-profit organizations.  Our clients often struggle to balance the need to pay competitively to retain talented executives with the desire to honor the organization’s mission and use donor resources responsibly.  Unlike their peers at public companies, when assessing the reasonableness of compensation, non-profit Boards are faced with a deficit of timely, publicly available compensation data for non-profit organizations.  We strive to partner with our non-profit clients to ensure that they have the tools and information needed to successfully navigate the questions surrounding non-profit executive compensation.  For more information on our non-profit practice, please see “Non-Profit Compensation” on our website at http://www.shallpartners.com/services/.

 

Contacting Steven Hall & Partners
This publication is provided by SH&P as a service to clients and colleagues.  The information contained in this publication should not be construed as legal, tax or accounting advice.  Questions regarding the matters discussed in this publication may be directed to any of our consulting staff listed below, or to any member of our consulting staff with whom you have consulted in the past on similar matters.  If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Kathie Mulroe (212-488-5400; kmulroe@shallpartners.com).

Contacts
Sandra Pace
212-488-5400
space@shallpartners.com

Endnotes

1.  A copy of the Governor’s Press Release can be found here: http://www.governor.ny.gov/press/05162012State-Funded-Providers
2.  New York State Department of Health, Proposed Regulations Part 1002.2(e).  A copy of the proposed regulations can be found here: http://w3.health.state.ny.us/dbspace/propregs.nsf/4ac9558781006774852569bd00512fda/fe1abd5a1b78ad8585257a00005afe2e?OpenDocument
3. For additional information on these IRS Regulations, also known as Intermediate Sanctions, please see “Overview of Intermediate Sanctions” on our website at www.shallpartners.com/our-thinking/articles.