Independent status of 60,000 reps in jeopardy

Scrutiny over whether broker-dealer representatives are employees or independent contractors is heating up again in California as a bill works its way through the state Legislature that would punish firms for willful misclassification. The proposed legislation, State Bill 459, is championed by Senate Majority Leader Ellen M. Corbett, a Democrat, and went to the state's Assembly Committee on Labor and Employment for a hearing last week. If passed, the law would affect more than 59,309 financial advisers in California, according to data provided by Meridian-IQ. Firms would be penalized for misclassifying employees as independent contractors and would be required to produce and archive for at least two years paperwork detailing a person's independent-contractor status. Noncompliant firms would face fines as high as $25,000 for intentionally misclassifying workers, and charging fees or making deductions to their compensation for any purpose. Failure to keep records or make them available for inspection by the state could lead to a $500 fine and a misdemeanor charge. Fierce Opposition The bill, which is intended to track down tax- and benefits-evading employers in all sectors of the economy, has run into fierce opposition from the Financial Services Institute, an independent-broker-dealer advocacy group, which sent a bulletin to its members about the measure last week. The FSI has teamed up with a coalition of local associations, including the California Chamber of Commerce and the California Farm Bureau Federation, to fight the rule. Specifically, the FSI is seeking an exemption that would permit independent-contractor broker-dealers to continue operating under their current business model. The broker-dealer advocacy group contends that the rule places an unnecessary burden on financial services employers. “We're an unintended consequence here, and we're trying to bring that point to their attention,” said Matt Schwartz, government affairs counsel for FSI. “In terms of the track it can take, we're concerned it's going to move unchanged through the state assembly.” The group anticipates the legislation will pass through committee but is working for the exemption before the bill is voted on by the full assembly. Compliance burden State Bill 459 is the latest threat to the independent-contractor broker-dealer business model. Registered reps affiliated with independent-contractor broker-dealers are small-business owners who are responsible for running their own practices and managing their own expenses. Independent-contractor broker-dealers with a large number of affiliated reps in California face a greater regulatory burden and higher costs of reporting and document retention if the bill becomes law, said Debra L. Fischer, a partner at Bingham McCutchen LLP, who specializes in employment law. As cash-strapped states seek more revenue, broker-dealers have become attractive targets. Last year, California state Sen. Darrell Steinberg called for a 3% tax on payments to all independent contractors. Also last year, Michigan governor Jennifer Granholm proposed extending sales taxes to investment advice, and Hawaii introduced a bill — which was defeated — that would have imposed a 4% tax on the gross income broker-dealers in the state derive from securities transactions in which they act as a principal. Although other states haven't followed California's lead in cracking down on independent contractors, the state tends to be a trendsetter in labor legislation. In the meantime, however, Ms. Fischer said that the bill's language and the way the state oversees independent contractors must be clarified. For instance, she said that there doesn't appear to be a uniform standard for independent-contractor status in California, which can lead to confusion among state agencies. In the bill, the state's Employment Development Department has been charged with developing a form containing information on an independent contractor's status, such as tax obligations and employment protections. However, other agencies under the Labor and Workforce Development Agency can determine whether an employee has been misclassified. “You're going to get litigation because the standards for determining independent contractors are not clear,” Ms. Fischer said. “You can't develop clear standards without a review of the industries.” Costly audit Unrelated to the bill, but on the same topic, at least two advisory firms in the state have been audited by their workers' compensation insurers over the same employee/ contractor distinction. Investment Architects Inc., a firm with about 30 independent reps in California, was hit with a bill for $20,000 following an audit from its carrier, the State Compensation Insurance Fund, a private company known as “State Fund.” The trigger for the unexpected expense was a phrase in Investment Architects' contract with its independent reps in which the brokers are required to obtain written permission from the firm before affiliating with another broker-dealer. That is a standard phrase in many broker-dealer contracts, according to Anthony Duckworth, vice president of Investment Architects. The State Fund told the firm that the phrasing constituted an exclusive relationship with the reps, meaning that they aren't contractors, he said. The firm is fighting the assessment and has decided to seek workers' compensation coverage elsewhere. Westland Financial Services Inc., a California firm with about 45 independent contractors and seven employees, also was audited by the State Fund but didn't run into any conflicts with the insurer after submitting its independent-contractor agreement. Still, had those advisers been found to be employees, the repercussions would have been serious, said Timothy U. Morton, Westland's chief operating officer. “The reps' compensation would be includable in our insurance premiums and since that's a calculation of total payroll, it would cost the employer a lot more money,” he said. “This is the first we've heard of an insurance company doing this.” Gina Simons, a spokeswoman for the State Fund, said that the insurer audits its employer customers every five years. “In general, the underwriters have to look at each case individually,” she said.