Employers under attack: the threat of employee misclassification in the financial services industry
The wave of collective action lawsuits and U.S. Department of Labor (“DOL”) audits brought under the Fair Labor Standards Act (“FLSA”) continues to crash down on employers. Indeed, a recent study indicates that the number of FLSA collective actions increased again in 2008, and this trend shows no sign of subsiding. Moreover, the DOL’s Wage and Hour Division recently announced that it will hire an additional 200 investigators to step up enforcement of the FLSA.
Employers in the financial services industry have been particularly hard hit by claims that many of their most highly paid employees have been misclassified as exempt and should have received overtime. Numerous suits have been filed across the country by employees in a number of traditionally “white collar” and lucrative positions—including stockbrokers, traders, loan officers, and financial advisors—and many of these suits have been successful, resulting in significant judgments or, more often, settlements.
Several major players in the financial services industry have recently settled claims by white collar employees for substantial amounts.
- In July 2009, a federal court approved a $50 million settlement between Morgan Stanley & Co. Incorporated and a class of financial advisors, who claimed that the company had failed to pay them for overtime that they worked, and had improperly taken business expenses, such as the salary for financial assistants and errors in transactions with clients, from their wages.
- In May 2009, a federal court preliminarily approved a $39 million settlement between Wachovia and some 10,000 brokers and trainees who claimed that they were misclassified as exempt administrative employees under the FLSA and various state wage-hour laws. The judge also approved a final settlement in which Prudential Financial Inc., which sold its retail brokerage division to Wachovia in 2003, agreed to pay its former brokers $11 million
- In 2006, UBS Financial Services agreed to settle the misclassification claims of its stockbrokers for as much as $89 million. That same year, Citigroup’s Smith Barney brokerage unit settled the misclassification claims of its brokers for $98 million.
- In 2005, Merrill Lynch agreed to settle the misclassification claims of about 3,000 stock brokers for $37 million.
Unfortunately, enormous settlements in such cases are fast becoming the rule rather than the exception. Success by these well-compensated employees in bringing such suits and obtaining such large settlements demonstrates the difficulty employers face when a Depression-era statute is applied to employees with job titles and duties that did not exist (and could not have even been contemplated) when the FLSA was drafted. They also reflect the steep penalties that employers who violate the FLSA can face, including back pay going back three years, as well as liquidated damages (which serve to double the back pay owed) and attorneys’ fees.
The potential for a significant monetary recovery, as well as the lenient standard for obtaining certification as a collective action, provide a strong and continuing incentive for employees and their attorneys to bring these cases. As a result, employees—and particularly their lawyers—have become well-versed in the intricacies of the FLSA and employers would greatly benefit from a similar understanding. Identifying any issues, and addressing them head on, before they become the subject of litigation, can save thousands, if not millions, of dollars down the road.
This article will review the basic requirements for exemption from the FLSA’s overtime requirements, and provide employers with a number of tips for avoiding (or at least minimizing) liability.
The legal issue
When a group of employees alleges that they have been misclassified under the FLSA, they are essentially arguing that their employer has incorrectly classified them as exempt from the overtime requirements of the FLSA. Under the FLSA, any employee who performs work that does not fit within an exemption must be paid overtime for weeks in which he or she works over 40 hours.
In cases involving the financial services industry, employees most commonly allege that they were improperly classified as exempt “administrative” employees under the FLSA. In order to meet the administrative exemption, the following criteria must be met:
- The employee must be compensated on a salary or fee basis of not less than $455 per week;
- The employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers; and
- The employee’s primary duty must include the exercise of discretion and independent judgment with respect to matters of significance.
In 2004, the FLSA’s interpreting regulations were revised for the first time in fifty years. In doing so, the DOL specifically addressed application of the FLSA to positions in the financial services industry, and included language designed to clarify the duties that would support a finding that an employee was exempt. Subsequently, in November 2006, the DOL issued an opinion letter that concluded that securities industry employees who perform the duties of a registered representative would be considered exempt.
Unfortunately, as set forth above, the revised regulations and DOL opinion letter have done little to quell the tide of suits being brought by employees. FLSA misclassification cases continue to be filed in large numbers, and the financial services industry remains a prime target. Although the regulations do provide more guidance to employers, they remain subject to interpretation (and misinterpretation). Moreover, many employers have failed to comply with even the most basic requirements of the exemption, leaving their classifications susceptible to challenge. Fortunately, some precautionary steps can help employers avoid some of the most common pitfalls concerning misclassification.
Salary basis test
As set forth above, in order to qualify for the administrative exemption, employees must satisfy a salary basis test. Specifically, they must be paid on a salary or fee basis of at least $455 per week. While this requirement may appear easy to fulfill at first glance, employers often overlook the fact that employees must be guaranteed a certain amount of money per week in order to be considered exempt. This requirement often creates problems for financial services companies whose employees are in commission oriented (i.e., “eat what you kill”) positions. Although employees can receive commissions and be considered exempt, they must also be guaranteed a minimum amount each week. Failure to pay such a minimum amount will automatically result in the loss of the exemption, regardless of the duties the employee performs, and regardless of the amount the employee receives in commissions.
For example, in 2006, a federal court in California held that brokers were not paid on a salary basis where their monthly draw was merely a loan against future commissions earned. Takacs v. A.G. Edwards & Sons, Inc., 444 F. Supp. 2d 1100 (S.D. Cal. 2006). In other words, the court held that a draw—which was recoverable and, therefore, not guaranteed—violated the FLSA’s salary requirement. However, a non-recoverable (i.e., guaranteed) draw, along with the potential to earn commissions, would satisfy the FLSA’s salary basis requirement. For example, the Second Circuit recently ruled that a mortgage underwriter was compensated on a salary basis where she received a guaranteed quarterly amount, along with additional incentive compensation, which was subject to reduction. Havey v. Homebound Mortgage, Inc., 547 F.3d 158 (2d Cir. 2008). The appeals court reached this conclusion because, even though the employee was paid under a compensation system that allowed her to receive more pay by agreeing to process more loans subject to reduction depending on the quality of the work, she was always guaranteed a certain amount of money per quarter.
It should be noted that there is no level of compensation that would automatically exempt someone from the FLSA’s overtime requirements. Although the DOL’s recent revisions to the FLSA regulations added an exemption for “highly compensated employees,” i.e., those earning at least $100,000 per year, the exemption still incorporates aspects of the FLSA’s duties and salary requirement. Specifically, in order to meet the exemption, the employee must meet one (rather than both) of the prongs of the primary duties test and must be paid at least $100,000 per year in guaranteed compensation. Accordingly, an employee who is paid solely on a commission basis—even if such commissions exceed $100,000 per year—will not satisfy the salary basis requirement and, therefore, will not be considered exempt.
Primary duties test: the work prong
The work prong requires an employee to perform work directly related to the management or general business operations of an employer.
In the financial services industry, this prong of the administrative exemption is often difficult to fulfill. Plaintiffs will argue that the marketing, sale, and servicing of financial products and services is the business of financial services employers, and therefore these employees are engaged in production or selling, rather than administrative functions.
The DOL regulations provide examples of exempt administrative work in the financial services industry, and the sale of such products is specifically excluded. Thus, in Wong v. HSBC Mortgage, Inc., 2008 U.S. Dist. LEXIS 21729 (N.D. Cal. 2008), a federal court held that loan officers did not fulfill the work test where it was undisputed that the officers’ duties primarily involved the sale of various types of loans, mortgages, and other financial products.
On the other hand, the regulations also provide that work such as collecting and analyzing information regarding a customer’s income, assets, investments, or debts; determining which financial products best meet the customer’s needs and financial circumstances; advising the customer regarding the advantages and disadvantages of different financial products; and marketing, servicing, or promoting the employer’s financial products will generally fulfill the administrative exemption. In Hein v. PNC Financial Servs. Group, Inc., 511 F. Supp. 2d 563 (E.D. Pa. 2007), the court held that a broker’s work was exempt where a majority of his time was spent on exempt activities such as information gathering and making sales strategy decisions.
Financial services employers must therefore undertake a close review of the actual work performed by employees to determine whether their position fulfills the work prong of the primary duties test.
Primary duties test: the discretion prong
Employees must also exercise discretion and independent judgment with respect to matters of significance in order to fulfill the administrative exemption. This prong of the exemption is often difficult to demonstrate where employees must adhere to strict and detailed guidelines provided by management.
In DeFilippo v. Barclays Capital Inc., 552 F. Supp. 2d 417 (S.D.N.Y. 2008), a federal court held that there was a genuine issue of material fact as to whether analysts exercised the requisite level of discretion and independent judgment, as their primary duties consisted of cross-checking trading reports, releasing trades that matched up in the reports, preparing wire transmissions, and manually inputting data. Moreover, even when the analysts did exercise some discretion, it was narrowly confined and did not involve making judgments independent of their supervisors.
In contrast, one court has held that underwriters exercised sufficient discretion and independent judgment where they had the ability to bind their employer to make loans of up to $500,000, independently considered customers’ explanations for variations in their credit history, and ultimately approved customers’ loans. Whalen v. JP Morgan Chase & Co., 569 F. Supp. 2d 327 (W.D.N.Y. 2008).
Employees’ authority and responsibility to exercise discretion and independent judgment must therefore also be carefully examined in order to determine whether they fulfill this element of the primary duties test.
As demonstrated by the above examples, employers in the financial services industry face significant exposure if their employees are misclassified. As such, it would greatly benefit employers— particularly those in the financial sector—to conduct a review of their employment classifications, with the assistance of counsel, in order to determine whether certain employees are properly classified. Indeed, the current economic environment is the ideal time to conduct such a review and, if necessary, make appropriate changes, as employees are less likely to leave and pursue other employment.
If a review indicates that problems exist, employers have a number of options, including reclassifying the employees and/or restructuring their duties or pay. Employers may also decide to provide retroactive (overtime) pay, begin tracking employees’ hours, or restrict employees’ working time, in an effort to reduce the likelihood of litigation, or at least minimize the damages. Of course, employers in these situations often feel they have been put between a rock and a hard place—making changes is almost sure to lead to unrest, which may lead to litigation, while not making changes only serves to increase the damages, if/when a litigation is brought. Accordingly, any changes should be made in consultation with counsel, who can assist with both identifying and minimizing the dangers. In the end, most employers wisely find it better to address the problem up-front, rather than wait for the seemingly inevitable lawsuit and experience the regret from not having done something sooner.