In the years following the Great Recession, the California Public Employees’ Retirement System (CalPERS) has aggressively sought to curb so-called “pension spiking.”¹ Section 571 of Title 2 of the California Code of Regulations (CCR 571), promulgated by CalPERS in 1994, is one of the key tools it has used to do so. CCR 571 exclusively defines the types of non-base pay, so-called “special compensation,” items that are pensionable (PERSable), and vests CalPERS with the discretion to exclude those it determines fail to comply with one or more of the rule’s nine listed standards.

Even though CCR 571 only refers to contracting agency and school members, CalPERS has, since at least 2012, sought to apply it to state members. In a recent published decision, the First District Court of Appeal squarely held that CCR 571 cannot be applied to state members. See Hale v. California Pub. Employees’ Ret. Sys. (2022) 82 Cal.App.5th 764 (Hale). Thus, going forward, whether a non-base pay compensation will be PERSable for state members will depend only on whether it satisfies Government Code Section 20636(g)(3), not CCR 571.

Hale has significant implications for state agencies, including The California State University, and their employees, and it remains to be seen how CalPERS will respond. Moreover, although neither raised nor considered in Hale, Section 20636 may, based on its express language and legislative history, be properly interpreted as limiting CalPERS’ authority to even determine what constitutes special compensation for state members in the first instance. State agencies and their employees should consider these implications when designing non-base pay compensation intended to be PERSable on the front end and when appealing adverse benefit determinations on the back end.

Historical Background

In 1993, Senate Bill 53 (SB 53) amended the Public Employees’ Retirement Law (PERL), the statutory scheme that governs the defined benefit pension plan for state, school, and contracting agency members.²

Among other things, SB 53 amended what is now Section 20636. That section defines “compensation earnable” to include both “payrate” and “special compensation.”³ Specifically, as amended, Section 20636(c) defines “special compensation.”⁴ But Section 20636(c) also directs CalPERS to promulgate regulations to define what constitutes special compensation “as used in this section.”⁵ (The Legislature intended this statutory grant of rulemaking authority to give CalPERS a tool to curb pension spiking by local agencies.⁶) Crucially, however, Section 20636(g)(3), as amended, provides that, “notwithstanding subdivision (c),” special compensation for state members shall mean the listed items that follow, including “compensation for performing normally required duties, such as holiday pay . . .”⁷

After SB 53’s enactment, CalPERS promulgated CCR 571, which consists of four interconnected subsections.⁸ Subsection (a) provides the exclusive list of what constitutes special compensation for contracting agency and school members.⁹ Subsection (b) lists nine standards CalPERS must determine the items listed in subsection (a) have presumptively met to be reportable as special compensation.¹⁰ Subsection (c) gives CalPERS authority to review special compensation reported to it for continued compliance with the standards in subsection (b). Finally, subsection (d) prohibits CalPERS from using special compensation not listed in subsection (a) or that doesn’t comply with any of the standards in subsection (b) in calculating a member’s final compensation.¹¹

Thus, the plain language of CCR 571 strictly limits special compensation for contracting agency and school members to the exclusive list of items in subsection (a) that CalPERS determines meet the standards in subsection (b).¹²  Hale considered whether CalPERS could apply these same limits to state members.

The Court of Appeal Decision

In 2013, two former employees of California’s Department of Forestry and Fire Protection, Hale and Wolf, retired. Their union then asked CalPERS to include automatic cash-outs of holiday pay they received, but were never reported to CalPERS, in calculating their final compensation.

CalPERS determined that the cash-outs were not PERSable and excluded them in calculating both members’ final compensation. Hale and Wolf appealed. CalPERS prevailed at the administrative hearing, and the CalPERS Board adopted the administrative law judge’s (ALJ) proposed decision as its own. Hale and Wolf filed a petition challenging the decision in the superior court. That petition was denied and, as relevant here, both the ALJ and the superior court accepted CalPERS’ argument that the cash-outs didn’t constitute special compensation because they didn’t meet the definition of “holiday pay” in CCR 571(a), and were not reported to CalPERS in accordance with that rule.

The Court of Appeal reversed. Even though apparently not raised in the administrative hearing or in the trial court, the Court considered and ultimately agreed with Hale and Wolf’s new argument on appeal that CCR 571 didn’t apply to them as state members for several reasons.

First, CCR 571(a)’s definition of special compensation items is expressly limited to contracting agency and school members, not state members, and subsection (b), setting forth the standards the items listed in subsection (a) must meet, and all of the remaining subsections of CCR 571 refer back to subsection (a). The rulemaking history for CCR 571, analyzed at length in DiCarlo v. County of Monterey (2017) 12 Cal.App.5th 468, confirms the rule was implemented in response to concerns about local agencies engaging in “pension spiking.”

Second, Section 20636(c), which directed CalPERS to promulgate CCR 571, defines special compensation for members in general. But another portion of the statute, subsection (g)(3), specifically states that, “notwithstanding subdivision (c),” pay items that “shall” constitute special compensation for state members include “compensation for performing normally required working duties, such as holiday pay” of the type at-issue in Hale.¹³

Last, the Court rejected CalPERS’ argument that, even if CCR 571 wasn’t directly applicable to state members, the Court should “be guided” by its definition of “holiday pay” in interpreting the meaning of that term for them. While acknowledging it must generally accord great weight to CalPERS’ longstanding and consistent interpretation of the PERL and its own regulations, the Court concluded it could not abdicate its duty to apply its independent judgment to legal issues such as whether CCR 571 applied to state members. The Court further concluded that the general rule of deference was inapplicable under the facts presented both because CalPERS had identified no longstanding interpretation that CCR 571 applied to state members and because a judicially noticed, non-precedential decision adopted by the CalPERS Board contradicted any claim by CalPERS that state members are subject to CCR 571.¹⁴

Consequently, the Court concluded that Hale and Wolf’s holiday cash-outs were special compensation that must be included in calculating their pensions because they were compensation for performing their normal required working duties within the meaning of Section 20636(g)(3). Thus, that the need for holiday work that gave rise to the holiday cash-outs at issue didn’t arise from the need for scheduled staffing or that the cash-outs were never reported to CalPERS – requirements found only in CCR 571 – was improper because that rule doesn’t apply to state members.

What Does It All Mean?

CCR 571 still applies to contracting agencies and school members, and remains a powerful tool for curbing pension spiking that we expect CalPERS will continue to apply to those members. Hale, however, confirms that CalPERS cannot apply CCR 571—either directly or by analogy—to state members. Rather, the PERSability of state members’ special compensation must be based on the less rigorous and broader definition of that term in Section 20636(g).

Whether the Legislature tries to close the gap between the two different definitions of special compensation for, on the one hand, state members and, on the other hand, contracting agency and school members remains to be seen. Absent that, any attempt by CalPERS to promulgate rules similar to CCR 571 for state members may be subject to challenge based on the apparent existing statutory limits on its authority to do so. For the time being, CalPERS must apply different standards in determining special compensation for state members than it applies to contracting agency and school members. Short of legislative action, CalPERS may try to close the gap by relying on a broad interpretation of the standards in Section 20636(g)(3) to exclude special compensation —including, for example, by arguing that amounts were not paid as compensation “for normally required duties”¹⁵ or “furnished … in payment for the member’s services.”¹⁶ CalPERS may also try to characterize otherwise PERSable special compensation as non-PERSable “final settlement pay.”¹⁷

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¹  “Pension spiking” is “[t]he practice of increasing a member’s retirement allowance by increasing final compensation or including various non-salary items (such as unused vacation pay) in the final compensation figure used in the member’s retirement benefit calculations, and which has not been considered in prefunding of the benefits.” See Public Pensions For Retirement Security (February 2011), at p. 73 available at https://lhc.ca.gov/sites/lhc.ca.gov/files/Reports/204/Report204.pdf

²  Cal. Gov’t Code § 20000, et seq.

³  “Payrate” generally means a member’s regular base pay, whereas “special compensation” generally includes non-base pay payments received for special skills, knowledge, abilities or work assignment, such as incentive, educational, premium, and special assignment pay. Ultimately, “Final compensation” (generally, a member’s highest average annual compensation earnable during any consecutive 12 or 36-month period as applicable) is multiplied by the member’s years of credited service and a benefit factor (percent of final compensation based on age at retirement) to determine the member’s pension benefit. Gov. Code, § 20630(b).

⁴  Cal. Gov’t Code § 20636(c).

⁵  Cal. Gov’t Code § 20636(c)(6).

⁶  See DiCarlo v. County of Monterey (2017) 12 Cal.App.5th 468, 484-488 (explaining that this subsection was intended to give CalPERS the authority to promulgate a regulation to combat the “recently uncovered, but apparently widely used, practice of ‘spiking’ . . . the final ‘compensation’ . . . of employees of [Cal]PERS local contracting agencies”).

⁷  Cal. Gov’t Code § 20636(g)(3)(A)-(D).

⁸  See 2 CCR § 571.

⁹  2 CCR § 571(a).

¹⁰  2 CCR § 571(b).

¹¹  2 CCR § 571(d).

¹²  See 2 CCR § 571(b)-(d) and supra at fn. 11.

¹³  See Gov. Code § 20636(g)(3)(b).

¹⁴  Hanson Bridgett successfully represented the state agency in the administrative appeal and hearing that resulted in the non-precedential decision referenced in Hale. See In the Matter of the Appeal Regarding the Final Compensation Calculation of Thomas Blanco and Department of Corrections and Rehabilitation, Respondents, Agency Case No. 2020-1209, OAH Case No. 2021030825, April 25, 2022.

¹⁵  Cal. Gov’t Code § 20636(g)(3)(B).

¹⁶  Cal. Gov’t Code § 20636(g)(3)(A).

¹⁷  Cal. Gov’t Code § 20636(f); see also 2 CCR § 571.