Do You Work For YOU-Or Your IBD?

Hey indie rep, ready to punch a time clock? Once again the issue of the misclassification of independent contractors has reared its head. While two federal bills addressing the topic died out with the last congressional session, a similar bill was introduced in California's state Senate in February and it may have legs. If the California bill passes, other states could follow, say industry experts. The Financial Services Institute and SIFMA, trade groups for the broker/dealer industry, have been working on getting an exemption, but so far, they're not having much luck.

Previous bills proposed at the federal level have focused on eliminating the safe harbor provision Section 530 of the Revenue Act of 1978, which allows organizations to treat a worker as an independent contractor for income tax and employment tax purposes — even if a common law test classifies workers as employees. Employers only need 530 relief when the IRS determines that workers are misclassified. But the proposed California bill says nothing about eliminating safe harbor; instead, it would prohibit “willful” misclassification of independent contractors, with penalties of between $10,000 and $25,000 per violation. It would also require that firms submit additional disclosures to independent contractors about their independent contractor status, and it would require the maintenance of records of independent contractors for at least two years with failure subject to a civil penalty of $500.

The fight over who qualifies as an independent contractor has been a long one. In the 1990s, the IRS successfully pursued Microsoft's use of long-term independent contractors and demanded Microsoft pay Social Security and other back taxes on the employees. The bottom line is, it's cheaper to use independent contractors than employees. Employers don't withhold taxes for independent contractors, unlike employees. Also unlike employees, independent contractors don't qualify for workers' compensation coverage, minimum wage, overtime protections and family and medical leave, nor do they have the right to organize and collectively bargain.

But most independent broker/dealer advisors consider themselves independent business owners and wouldn't have it any other way.

The Bellwether State

So far, the California bill has been introduced and moved into the Assembly Appropriations Committee, which will take it up following the summer recess, which ends Aug. 15. Matt Schwartz, government affairs counsel for the Financial Services Institute, which has been lobbying for an exemption from the legislation for independent broker/dealers, says the bill is likely to pass given that Democrats are in control, and the sponsor of the legislation, Ellen Corbett, a Democrat, is the Senate majority leader.

The California bill, S.B. 459, would only affect firms with a large chunk of their reps in the state. According to Meridian-IQ, there are 17,308 independent b/d advisors in California, accounting for $239 billion in assets under management. But there is a possibility that other states could follow suit. “California tends to be a trailblazer,” says Debra Fischer, a partner at Bingham McCutchen.

Schwartz says he doesn't believe other states will follow California's lead in 2011. But next year may be another matter. Many states, including California, are dealing with budget shortfalls, and Schwartz expects this to accelerate in 2012. Fining firms for misclassification could be an easy revenue-generating initiative for such states, he notes.

Independent advisors all over the country should be paying attention to this, says Valerie Brown, CEO of Cetera in El Segundo, Calif., which includes IBDs Financial Network Investment Corporation, Multi-Financial Securities Corporation, and PrimeVest Financial Services. The industry needs to educate the state's assemblymen around the issue to set the right tone so b/ds don't have to have this conversation in all 50 states, she adds. Cetera is currently encouraging its 750 advisors across Financial Network and Multi-Financial to contact their local assemblymen.

An Unintended Consequence?

FSI and SIFMA believe that financial advisors were never the intended targets of the legislation. “The bill is designed to get at a problem we are not a part of,” said Kim Chamberlain, managing director and counsel, state government affairs for SIFMA. “The bill does not include appropriate carve-outs or exemptions for independent contractor advisors.”

In a letter to the California State Assembly, SIFMA outlined the characteristics of independent b/d reps that distinguish them from other independent contractors. The letter pointed out that reps are sophisticated, highly educated entrepreneurs who operate as small independent businesses with their own offices, staff and operational expenses. Reps are also required to be associated with an SEC-registered b/d and to be registered with FINRA to sell securities products, SIFMA said. Their contracts with the affiliated b/d clearly state their status as independent contractors.

But under the common law definition, independent b/d advisors might qualify as employees. To figure out which bucket a worker falls into, you must ask three questions, according to the IRS. The first is behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? The second is financial: Are the business aspects of the workers' jobs controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools and supplies. And the third is what type of relationship the individual has with the firm: Are there written contracts or employee-type benefits? Will the relationship continue and is the work performed a key aspect of the business?

When describing the relationship between advisors and b/ds, the answer to some of these questions might be yes. For example, b/ds are responsible for supervising their independent reps' activities, control certain ways in which the workers are paid and what expenses are reimbursed, and their relationships are governed by written contracts.

Meanwhile, state legislators don't want to exempt individual industries. “The Assembly has indicated that they don't want to exempt industries on a one-off basis as they see this as a slippery slope,” says FSI's Schwartz. “Accordingly, we are asking for amendments to the notice and record keeping requirements of the bill.”

Fischer says the law is overbroad and doesn't provide any additional information about what defines an independent contractor. This is what concerns Carlsbad, Calif.-based Financial Advisers of America, as well, which has 63 advisors in the state, out of 200. The firm feels it's well-prepared for the record-keeping requirements, but the uncertainty around the interpretation of the rule is a problem, says Jodi Johnston, CEO of FAA. For example, Johnston says that if the firm only allows a rep to be registered with FAA and no other firms, this could be a violation of the legislation as it's now written. But under SEC and FINRA rules, reps cannot be registered with more than one firm. “There needs to be a distinction that there's a higher level that we answer to,” she says.

Wilson Williams, president of 300-rep IBD Williams Financial Group in Dallas, Texas, says the bill makes him wonder whether he even wants to recruit in California or not. As it is, the bill is too vague and doesn't describe what an independent contractor is, he claims. “I don't want to subject my firm to fines and penalties in a subjective way.”