Tag: Employment Law

Employment Law – What’s in Store for 2011?

Melvin J. Muskovitz of Dykema Gossett, PLLC is a featured guest blogger this week at the National Law Review. Three pending Supreme Court decisions are discussed along with their potential impact for employers:  

Many employers faced challenges in 2010 related to the economy.  These challenges often involved personnel issues, including workforce reductions.  With unemployment still a serious problem heading into 2011, terminated employees are less likely to  find new employment opportunities and may be more inclined to claim they were terminated for illegal reasons.  This  article looks at three decisions the Supreme Court will be addressing this year that involve wrongful discharge claims.  Regardless of the outcome, these cases underscore the importance of  carefully considering all adverse employment decisions.

Additionally, this article will briefly address the new regulations and a step employers can take to protect themselves against violations of the Genetic Information Nondiscrimination Act  (GINA).

Supreme Court Decisions on the Horizon

Oral complaints – are they protected under the FLSA’s anti-retaliation provision?

The Fair Labor Standards Act (FLSA), which provides minimum wage and overtime protections to employees, also provides protection from retaliation against employees who file a complaint  alleging FLSA violations.  In Kasten v. Saint-Gobain Performance Plastics Corp, the Supreme Court will decide if an oral complaint satisfies the FLSA provision that protects employees  against retaliation because the employee “has filed any complaint.”   Kevin Kasten worked for Saint-Goban Performance Plastics and was required to use a time card to swipe in and out of an on-site time clock.  Kasten was disciplined on four separate occasions for violations of the time card policy.  Discipline for the infractions was progressive and eventually resulted in  his termination.  Kasten alleges that before the third infraction and thereafter, he verbally complained to his supervisor and Human Resource personnel that the location of the time clock was illegal.  He claims that he was terminated in retaliation for his verbal complaints that the location of the time clock violated the FLSA.

The lower courts are split on the issue of whether an oral complaint satisfies the “has filed any complaint” threshold.  The Supreme Court will resolve this discrepancy between the various federal circuits.

Retaliation against a third party – is it protected?

Title VII, which prohibits discrimination based upon protectedcharacteristics (sex, race, etc.), also prohibits retaliation against an employee who “has made a charge,  testified, assisted, or participated in any manner in an investigation, proceeding, or hearing.”  In Thompson v North American Stainless, the Supreme Court will decide if a third party to the charge is also protected from retaliation. Eric Thompson worked for North American Stainless as a metallurgical engineer.  He was engaged to a co-worker.  The co-worker/fiancée filed a complaint with the EEOC alleging that she was discriminated against because of her  gender.  Three weeks after the EEOC notified North American of the complaint, Thompson was terminated.  He alleges that he was terminated in retaliation for his fiancée’s EEOC charge.

The 6th  Circuit Court of Appeals (which includes Michigan) ruled for the employer, stating that the anti-retaliation provision is  “limited to persons who have personally engaged in protected activity.”  The Supreme Court will decide whether to uphold that decision or whether to extend anti-retaliation protections to third parties who did not personally engage in protected activities.

Influence over decision maker – when does it become illegal?

The Uniformed Services Employment and Reemployment Rights Act (USERRA) protects employees from discrimination based upon their military service.  In Staub v Proctor Hospital,  the Supreme Court will decide under what circumstances an employer may be held liable based upon the discriminatory bias of someone who influenced the ultimate decision maker, but who did not make the employment decision at issue.

Vincent Staub worked for Proctor Hospital as an angiopraphy technologist.  He was also an army reservist and therefore was unavailable for work one weekend a month and for two weeks during the summer.  One of his supervisors, the second in command in Staub’s department and the person responsible for preparing the work schedules, frequently expressed anti-military bias and  was openly displeased about having to accommodate Staub’s schedule.  Staub was disciplined by  the supervisor for reasons unrelated to his military service and he was ultimately terminated  based upon that discipline.  While the decision to terminate Staub was made by Human  Resources, Staub alleged that the decision was actually the result of the supervisor’s anti-military  bias.

A jury found in favor of Staub, a decision that was overturned by the 7th  Circuit Court of  Appeals.  The Supreme Court has agreed to decide under what conditions an employer can be held liable for the bias of a person who influenced or caused an adverse employment action – but  who did not actually make the decision.  A ruling in favor of the employee could have far  reaching implications for employers as the rationale would likely apply to other statutes that  prohibit discrimination.

Genetic Information Nondiscrimination Act (GINA) Regulations

On November 9, 2010, the Department of Labor issued the final regulations that interpret and  implement GINA.  The regulations take effect on January 10, 2011.  GINA, which went into  effect on November 21, 2009 and applies to employers with 15 or more employees,  prohibits the  use of genetic information in making employment decisions, restricts acquisition of genetic information by employers, and strictly limits the disclosure of genetic information.  Genetic nformation includes (1) an individual’s genetic tests,  (2) genetic tests of family members, (3)  family medical history, (4) genetic services and/or (5) genetic information of a fetus carried by  an individual or a family member.  While the use and disclosure of genetic information is under  the control of the employer, situations may  arise where an employer inadvertently acquires genetic information about an employee.  For example, an FMLA health certification from a  healthcare provider may inadvertently provide the employer with genetic information about the  employee.  The final regulations acknowledge this dilemma and provide a “safe harbor” for employers who inadvertently acquire such information.    In order for the acquisition of genetic information to be considered inadvertent, the employer must direct the individual or healthcare provider from whom it is requesting medical information not to provide genetic information.  The final  regulations provide a sample notice that an employer can use to satisfy the requirement. The final regulations can be found at  http://www.gpo.gov/fdsys/pkg/FR-2010-11-09/pdf/2010-28011.pdf and the sample notice can be found at section 1635.8(b)(1)(i)(B).

Bottom Line

Employees suffering adverse employment consequences are finding creative ways of expanding  their protections.  Employers should exercise due diligence in all employment decisions

© 2011 Dykema Gossett PLLC.

Sunshine (State) Surprise – Florida's New E-Verify Requirement

From recent featured guest blogger at the National Law Review, Dawn M. Lurie and Kevin Lashus of Greenberg Traurig provide some needed details on Florida’s new E-Verify Requirement: 

Governor Rick Scott wasted no time in making the state of Florida the 14th the nation to have a mandatory E-Verify requirement. Only minutes after being sworn in, the governor signed his second executive order of the day—the first created the Office of Fiscal Accountability and Regulatory Reform to review regulations in the Sunshine State. Scott had touted ideas about mandating E-Verify during his heated primary fight with former Attorney General Bill McCollum but the magnitude of the actual order caught many by surprise.

Executive Order No. 11-02 requires:

1) All agencies under the direction of the governor to verify the employment eligibility of ALL current and prospective agency employees through the U.S. Department of Homeland Security’s E-Verify system;

2) All agencies under the direction of the governor to include, as a condition of all state contracts, an express requirement that contractors utilize the U.S. Department of Homeland Security’s E-Verify system to verify the employment eligibility of:

a) all persons employed during the contract term by the contractor to perform employment duties within Florida; and b) all persons (including subcontractors) assigned by the contractor to perform work pursuant to the contract with the state agency.

b) all persons (including subcontractors) assigned by the contractor to perform work pursuant to the contract with the state agency.

3) Agencies not under the direction of the governor are encouraged to verify the employment eligibility of their current and prospective employees utilizing the E-Verify system, and to require contractors to utilize the E-Verify system to verify the employment eligibility of their employees and subcontractors.

E-Verify is web-based, voluntary program that compares an employee’s Form I-9 information with the Social Security Administration and Department of Homeland Security databases. E-Verify is considered a best practice by the government in terms of immigration compliance, has recently been upgraded to include a photo-matching component for U.S. passports, and will soon debut a driver’s license pilot program. In September of 2009, Congress required that all federal contractors and their subs use E-Verify for new employees (new hires) and all existing employees assigned to a federal contract. This was the only instance where E-Verify was authorized to use to verify a current workforce—until now. Scott’s Executive Order requiring re-verification of current and prospective employees transcends what is legally allowed under current federal law, and is therefore likely to face an immediate court challenge. Prospective employees? Lawyers over at the Office of Special Counsel for Immigration-Related Unfair Employment Practices (the part of the Department of Justice that enforces the antidiscrimination provisions of the Immigration and Nationality Act) are likely reeling from the breadth of the Order. And, the Verification Division at USCIS—the agency responsible for running the E-Verify program—may also be scramblingto determine whether to help Floridian employers implement compliance practices under these terms. As proposed, this represents a third typeof E-Verify for them to administer: normal, FAR-impacted and Florida. It is unclear who will be responsible to pay for development of the application on these terms. How might it work? Does this harken back to the Arizona question again—can the state trump the federal government on immigration requirements?

Ironically, Rhode Island Governor Lincoln Chafee rescinded Rhode Island Executive Order 08-01 that required the state, as well as contractors and vendors doing business with Rhode Island, to register and use E-Verify for all new hires. Chafee called the use of E-Verify a “divisive issue.”

Regardless of the future, Florida’s state agencies now need to be aware of the E-Verify process and should—like all other employers participating in E-Verify—undergo a comprehensive I-9 training, conducted by competent counsel, so that each of the designated E-Verify specialists may become experienced in the intricacies of employment eligibility verification. The verification process has become increasingly complex. Florida’s governor just complicated E-Verify even more. Any missteps by employees charged with verification compliance could be deadly. Employers must recognize that even the most well-intentioned individuals could attract both civil and criminal liability, not only upon themselves, but also upon their employers for failing to follow the verification process accurately and completely.

©2011 Greenberg Traurig, LLP. All rights reserved.

The Crackdown on Employment of Illegal Immigrants Spreads to California

Featured Guest Bloggers this week at the National Law Review are from Greenberg Traurig LLP.  Mahsa Aliaskari and Matthew B. Hayes have written one of the most  comprehensive articles we’ve  come accross reagrding E-Verify – especially as it applies in California.  

Murrieta and Temecula Join Growing List of Southern California Cities Requiring Employers to Use E-Verify

In 2007, Arizona became the first state to pass legislation requiring employers to use the voluntary E-Verify1 program to confirm the employment eligibility of new hires. Since then, Arizona has been the focal point for publicity and legal challenges on attempts by states and localities to crack down on the employment of illegal immigrants. However, Arizona is not the only place where we are seeing state and local action.

Behind the scenes, several Southern California cities have quietly followed Arizona’s lead enacting similar laws mandating use of E-Verify. On July 13, 2010, Temecula joined the growing list of Southern California cities requiring employers to use E-Verify as a condition for maintaining a business license, and on December 20, 2010, Murrieta’s city council moved forward with its plans to institute a similar ordinance. While the State of California has not jumped on the bandwagon, many of its localities are taking action and increasing the burden on companies doing business not only across state lines but across city and county lines.

Given the expansion of immigration laws at the state and local level, it is imperative that employers keep abreast of developments in this area and ensure that their hiring practices are legally compliant in each of the locations they employ workers.

The Trend Toward Making Use of E-Verify Mandatory

The growing trend of states and localities enacting their own legislation to police immigration related-activity has its roots in frustration over the federal government’s inability to effectively address illegal immigration and enact comprehensive immigration reform. While the frustration may be justified, the federal government did not make use of E-Verify mandatory for many reasons. A January of 2010 report2 conducted by Westat researchers found that E-Verify is not immune from identity theft. According to the report 4.1% of those passing E-Verify are not truly authorized workers. More specifically, 54% of unauthorized workers who were run through E-Verify were inaccurately identified as workauthorized. The findings appear to support claims of various groups that have criticized EVerify as being particularly vulnerable to identity theft and fraud. In addition, while improving, there continues to be false positives — while the rate is low there are still U.S. citizens and workauthorized foreign nationals who are denied employment through E-Verify.

What is more alarming though is the opportunity for intentional or unintentional abuse and misuse of E-Verify by employers who violate program rules. There have been reports of employers restricting work assignments, delaying job training, reducing pay or simply not hiring non-U.S. citizens based on database errors. In March of 2010, USCIS posted a fact sheet outlining its agreement and plans to share information with the Office of Special Council3 (OSC) at the Department of Justice. The fact sheet notes that the purpose of the Memorandum of Agreement (MOA) “is to establish a streamlined process for referring E-Verify matters falling within the other’s jurisdiction. OSC will receive referrals of potential discrimination that come to USCIS; in turn, USCIS will receive from OSC referrals of potential employer misuse of E-Verify that does not fall within DOJ’s enforcement arena.” Potential misuse of the program is cause for concern for all employers and a discrimination suit waiting in the shadows for employers who are not well versed in the proper use of the program. These problems and pitfalls should serve as a warning to states and localities considering and instituting E-Verify mandates.

Regardless of the federal government’s reasons for not mandating the use of the program, many states and localities continue to march forward with their own E-Verify requirements. Employers failing to comply with these E-Verify laws can face substantial penalties, including monetary fines, preclusion from contracting with federal, state and local governments, and suspension or revocation of their business licenses.

While Arizona has been at the forefront of this trend since enacting the Legal Arizona Workers Act, which went into effect on January 1, 2008,4 Arizona simply paved the way for others. Several other states have since passed or adopted similar legislation. For instance, in 2008 Mississippi passed legislation requiring that all private employers participate in E-Verify, with a phase-in period beginning in 2008 and full participation by 2011. On March 31, 2010, Utah adopted the Private Employer Verification Act that requires employers with 15 or more employees to use E-Verify or another verification system approved by the Department of Homeland Security to confirm the employment eligibility of hew hires. The South Carolina Illegal Immigration Reform Act, passed in 2008, requires all employers to use E-Verify to confirm the eligibility of new hires, or in the alternative, hire only workers who possess or qualify to obtain a South Carolina driver’s license or identification card. The South Carolina law goes even further by authorizing the state to scrutinize a businesses’ hiring records and cite or fine employers found to have unauthorized workers on their payrolls.

California Localities Join in With Their Own E-Verify Mandates

Currently, California does not have any statewide laws mandating the use of E-Verify. However, in the last few years, several cities in Southern California passed local ordinances requiring the use of E-Verify for some or all businesses. These cities and their respective E-Verify requirements include:

  • Mission Viejo: Effective July 1, 2007, the city and employers with city contracts must verify the eligibility of new employees through E-Verify.
  • Palmdale: Effective July 1, 2008, to be eligible for contracts with the city exceeding $50,000, a contractor must be enrolled in E-Verify.
  • Lancaster: Effective December 31, 2009, all employers in the city must use E-Verify to confirm eligibility of new hires. Failure to comply with this requirement can result in business license suspension.
  • Temecula: Effective January 1, 2011, all employers in the city must use E-Verify to confirm the eligibility of new hires as a condition of receiving or maintaining a business license.
  • Murrieta: The City Council is expected to approve an ordinance mandating that all locally operated enterprises use E-Verify. Code enforcement officers would have authority to confirm compliance with EVerify. Enforcement tools will include fines and license revocation.

Constitutional Challenge to State and Local Laws Requiring Use of E-Verify

The constitutionality of state and local governments requiring employers to use E-Verify to confirm employment eligibility is presently unresolved. On December 8, 2010, the United States Supreme Court heard arguments on Chamber of Commerce v. Candelaria, No. 09-115. The Supreme Court’s decision is expected in Spring 2011 and will likely determine the fate of similar laws recently enacted throughout several Southern California cities. The lawsuit challenges the constitutionality of the Legal Arizona Workers Act (LAWA).

Arizona’s law increased the level of state action by taking advantage of an exception to the preemption clause of the Immigration Reform & Control Act of 1986 (IRCA) relating to licensing laws. The law’s bold move in authorizing Arizona state courts to suspend or revoke business licenses provides the state with an enforcement mechanism not used previously. One of the primary issues in that case is whether the preemption clause applies and if state and local governments — as opposed to only the federal government — can require participation in the E-Verify program. Those challenging Arizona’s E-Verify requirement argue that immigration related legislation falls within the purview of the federal government, consequently laws like that enacted in Arizona conflict with, and are therefore preempted by, federal laws. In this instance referring to federal laws which contemplate that, except in limited circumstances, the use of E-Verify by employers would be voluntary. Prior to the Supreme Court granting review of the case, the Ninth Circuit upheld Arizona’s legislation, finding that it was not preempted by federal law. In light of the decision and arguments upholding the LAWA, it will be interesting to see the outcome of the pending Supreme Court case.

What These Developments Mean for California Employers

Pending the Supreme Court’s decision on the Arizona law, the number of state and local governments enacting laws mandating use of E-Verify is expected to continue and increase. In light of the evolving nature of immigration compliance and the intricacies of E-Verify and the Memorandum of Understanding that employers must agree to and sign when enrolling in E-Verify, it is critical that employers remain apprised of relevant developments, understand the E-Verify laws applicable in each state and city where they employ workers, and ensure their hiring practices are legally compliant. If your company has not yet enrolled in E-Verify and it is being considered either because of legal mandate or as a best practice, it is critical that an internal review of the existing workforce and Form I-9s be conducted first and with experienced counsel. The “culture of compliance” is the theme of the Obama administration and it is spreading to cities and states across the nation. A few proactive steps will go a long way in limiting liabilities and exposure.

Resources

Promoting a Culture of Compliance — Best Practices for your Business

  • Establish a comprehensive immigration compliance policy
  • Conduct in-house audits of Form I-9 documents and company policies, as well as E-Verify if applicable
  • Establish policies, protocols and training for employment verification
  • Diligently verify the identity of job applicants to ensure that they “are who they say they are”
  • Consider use of E-Verify after consultation with experienced immigration compliance counsel
  • Establish protocols for addressing Social Security No-Match letters
  • Establish and maintain safeguards against the use of the I-9 process for unlawful discrimination
  • Create a protocol for immigration compliance related to contractors and subcontractors

ICE utilizes various tools to target employers, particularly those involved with vital infrastructure and national security, as well as the usual suspects – unofficially “targeted” industries – food service, textile, meat/poultry plants and constructions. Employers must take steps now to ensure full compliance or face serious consequences. Actions taken before a government-initiated audit or investigation generally help mitigate damages, reduce exposure and save the company both time and money in the long-run.

1 E-Verify is an Internet-based system operated by the Department of Homeland Security in partnership with the Social Security Administration. Its purpose is to enable participating employers to electronically verify the employment eligibility of their workforce. Under the system, employers fill out an online form with the information provided by new hires on the Employment Eligibility Verification Form (commonly referred to as the I-9 Form). That information is then cross-referenced with an assortment of government databases to confirm the worker’s employment eligibility.

2 The evaluation was conducted by Westat, a Rockville, Maryland-based social science research firm under contract to U.S. Citizenship and Immigration Services (USCIS). The evaluation was managed by the USCIS Office of Policy and Strategy, independent of the E-Verify program office, which is run by the USCIS Verification Division.

3 OSC is responsible for enforcing the anti-discrimination provisions of the INA. The antidiscrimination provisions include violations involving: (1) citizenship status discrimination, (2) national origin discrimination, (3) unfair documentary practices during the employment eligibility verification process (document abuse) and (4) retaliation.

4 That legislation requires all employers in Arizona to use E-Verify to confirm the employment eligibility of new hires. It penalizes employers who knowingly or intentionally hire illegal immigrants by suspending or revoking their business licenses.

©2011 Greenberg Traurig, LLP. All rights reserved.

 

 

Agencies Issue Additional FAQs on Health Care Reform and the Mental Health Parity Act

Recent featured guest blogger at the National Law Review Penny C. Wolford of Ford & Harrison LLP – brings to our attend the recent actions by Departments of Health and Human Services, Labor and Treasury regarding the implementation of the the Patient Protection and Affordable Care Act (“health care reform”) and the Mental Health Parity and Addiction Equity Act.  Of most note to employers is: 

Right before the holidays, the Departments of Health and Human Services, Labor and Treasury issued additional Frequently Asked Questions (FAQs) regarding implementation of the Patient Protection and Affordable Care Act (“health care reform”) and the Mental Health Parity and Addiction Equity Act. The guidance of most note to employers is as follows:

1. Automatic Enrollment in Health Plans: The agencies clarified that the automatic enrollment requirement of health care reform does not become effective until the agencies issue regulations on the requirement. The Department of Labor indicated that it intends to issue regulations on the automatic enrollment requirement sometime before 2014.

2. 60-Day Prior Notice Requirement for Material Modifications: Health care reform requires group health plans to provide notice of modifications to participants no later than 60 daysprior to the date on which the modification becomes effective. The agencies clarified that group health plans are not required to comply with the 60-day advance notice requirement until standards for the requirement are issued by the agencies.

3. Dependent Coverage of Children to Age 26: Health care reform prohibits group health plans from making distinctions based upon age in dependent coverage. (For example, charging a higher premium for adult children than for minor children would be a prohibited distinction.) The agencies clarified that health care reform does not prohibit distinctions based upon age that apply to all coverage under the plan. Therefore, in answer to the specific question posed in the FAQs, the agencies determined that it is permissible for a group health plan that normally charges a co-payment for physician visits that do not constitute preventive services, to charge a co-payment to individuals age 19 and over, including employees, spouses, and dependent children but waive the requirements for those under age 19.

4. Grandfathered Health Plans: The agencies clarified that a fixed amount cost-sharing, other than a co-payment, that is based on a percentage-of-compensation formula, will not cause a plan to lose grandfathered plan status as long as the formula remains the same as that which was in effect on March 23, 2010, even though the actual cost-sharing may change as a result of a change in the employee’s compensation.

5. Mental Health Parity Act: The agencies issued several answers to questions on the Mental Health Parity Act, including: (a) confirming that a small employer exempt from the Act is an employer with 50 or fewer employees; (b) stating that a contracting health care provider can request and is entitled to receive the plan’s criteria for medical necessity determinations; and (c) explaining that plans can apply for the increased cost exemption under the Act if costs under the plan have increased at least 2 percent in the first year that the Act applies to the plan (the first plan year beginning after October 3, 2009), or at least 1 percent in any subsequent plan year (generally, plan years beginning after October 3, 2010.) The exemption lasts for one year and allows the plan to be exempt from the requirements of the Act for the following year. Plans can apply for the cost exemption by following the exemption procedures described in the 1997 Mental Health Parity Act regulations.

6. Wellness Programs: Along with health care reform and the Mental Health Parity Act, the agencies also addressed a few FAQs on HIPAA and wellness programs. Most notably, the Department of Labor explained that under health care reform, the maximum reward that can be provided under a HIPAA wellness program will increase from 20% to 30%. The increase will not occur under health care reform until 2014. However, the agencies intend to propose regulations using regulatory authority under HIPAA to raise the percentage for the maximum reward that can be provided under a HIPAA wellness program to 30% before the year 2014.

Employers’ Bottom Line

The agencies continue to define the landscape of health care reform even for the first round of requirements that have already gone into effect or will be going into effect for employer‑sponsored plans beginning on or after the first plan year following September 23, 2010. Employers should keep an eye out for additional guidance and make a good-faith effort to comply with existing guidance with an understanding that additional adjustments may be necessary as further guidance and clarifications are issued.

© 2011 Ford & Harrison LLP

Arizona Employers Must be Ready for New Medical Marijuana Use Law

From featured guest blogger at the National Law Review Dinita L. James of Ford & Harrison LLP, a great overview of Arizona’s Medical Marijuana Use Law: 

Almost two weeks after the polls closed, Arizona became the 15th state in the nation to allow the use of marijuana for medical purposes. Proposition 203, or the Arizona Medical Marijuana Act, appeared unlikely to pass early on election night. However, after the early voter and provisional ballots were finally counted, the tally put the yes votes ahead by a mere 4,341 votes out of the nearly 1.7 million cast.

The election results became official November 29, 2010. The Arizona Department of Health Services (ADHS) has 120 days from that date to promulgate regulations implementing the law. According to information from the ADHS, the agency will publish an informal draft of the regulations by December 17, 2010 and a formal draft by January 31, 2011. The agency has stated that it expects to issue final regulations by March 28, 2011. Thus, by spring of 2011, Arizona employers need to have reviewed their drug-testing and employment discrimination policies to ensure they comply with the new law.

What Does the Law Provide?

Generally, the law permits medical marijuana cardholders (which includes qualifying patients, designated caregivers, and nonprofit medical marijuana dispensary agents) to possess, transport and, in some situations, cultivate an allowable amount of marijuana for medical use. Significantly for employers, the law prohibits discrimination against medical marijuana cardholders and registered qualifying patients.

Discrimination Prohibited: The law provides that employers may not discriminate against a person in hiring, termination or by imposing any term or condition of employment or otherwise penalize a person because of that person’s status as a medical marijuana cardholder, unless a failure to do so would cause an employer to lose a monetary or licensing related benefit under federal law or regulations. As noted above, medical marijuana cardholders may include not only patients, but also designated caregivers and nonprofit medical marijuana dispensary agents. Thus, the law creates a new category of individuals protected from discrimination.

The law also prohibits discrimination against a registered qualifying patient based on that person’s positive test for marijuana unless the patient was impaired by marijuana on the employer’s premises or during the hours of employment. While the law does not require an employer to permit an employee to ingest marijuana at work or to work while under the influence of marijuana, it also states that a registered qualifying patient is not considered to be under the influence of marijuana solely because that person tests positive for marijuana metabolites in an amount that is insufficient to cause impairment.

Who is a Qualifying Patient? A qualifying patient is a person who has been diagnosed by a physician as having a debilitating medical condition. Debilitating medical conditions include diseases such as cancer, HIV/AIDS, Hepatitis C, amyotrophic lateral sclerosis (Lou Gehrig’s disease), Crohn’s disease, and other conditions that result in certain symptoms such as wasting syndrome, severe and chronic pain, severe nausea, or severe and persistent muscle spasms. For a qualifying patient to receive a registry identification card, the patient must submit written certification from his or her physician stating that in the physician’s professional opinion the patient is likely to receive therapeutic or palliative benefit from the medical use of marijuana to treat or alleviate the patient’s debilitating medical condition or symptoms associated with the debilitating medical condition.

ADHS will establish a process for issuing photo ID cards for qualified patients, designated caregivers, and authorized agents of dispensaries. The law requires the ADHS to act on applications for ID cards within 10 days and to issue photo ID cards within 5 days after approving an application. Thus, based on the time-frame given by the ADHS, employers can expect to see medical marijuana ID cards by mid-April 2011 and should be prepared to comply with the law by that date, at the latest.

Employers’ Bottom Line:

The law presents employers with a number of issues, some of which may be clarified after the ADHS issues its regulations. Zero-tolerance and pre-employment drug-testing policies likely will present the most challenges under the new law in light of the prohibition of discrimination against qualifying patients based on the presence of marijuana metabolites insufficient to cause impairment. Because there is no accepted testing standard for determining impairment due to marijuana use, this determination will by necessity be subjective unless the state issues regulations defining a standard to be used under the law.

© 2011 Ford & Harrison LLP

E-Verify Tentative Nonconfirmations: Don’t Panic Just Yet

Recent Business of Law Guest Blogger at the National Law Review, John Fay of LawLogix Group, Inc. provides a nice walk-through of what employers can expect when they receive a mismatch or tentative nonconfirmation (TNC) through the e-verify system. 

As an employer, there’s a certain amount of trepidation that comes with using the E-Verify system. While roughly 97% of all employees are instantly (or shortly thereafter) confirmed as work authorized, it’s the potential 3% which receive a mismatch or tentantive nonconfirmation (TNC)  that keep us up at night. Was there a mistake in the information that we submitted or perhaps a mistake with the SSA or DHS database? Or what if the employee is unauthorized to work? When do I have to terminate him? Processing a TNC requires employer guidance, employee action, and often, lots of patience. The most important thing to remember is that a TNC does not mean that your employee is unauthorized to work. It’s just the first step in an E-Verify dance with government systems. Sounds like fun, right?

Process Overview

First, there are many perfectly legitimate reasons for a TNC, and your role as the employer is to communicate that fact with your employee. For example, your employee could receive a Social Security mismatch because of the following:

  • Name, SSN or date of birth is incorrect in SSA database
  • Employee failed to report a name change to SSA (married name, perhaps?)
  • USCIS immigration status was not updated with SSA

You might also receive a DHS TNC because of the following:

  • Photo ID of green card, EAD , or US passport (starting September 26th) does not match DHS records (this is a comparison you would perform manually when prompted)
  • Information was not updated in DHS records
  • Citizenship or immigration status has recently changed
  • Name, alien number, and/or I-94 admission number were incorrect in DHS database

Regardless of the reason, you must first notify the employee in private of the TNC case result by printing the TNC Notice (to be signed) which is automatically generated by the E-Verify system. This letter explains all of the possible reasons why the TNC may have occurred and instructs the employee to review their information to make sure it was correct. Assuming it was, the employee then has 2 choices: CONTEST or NOT CONTEST. If the employee chooses to contest, then you must initiate a referral (in the E-Verify system) and provide them with a TNC Referral Letter (to be signed) that is automatically generated. This letter instructs the employee to contact the appropriate government agency (SSA or DHS) within 8 federal government work days to resolve the case. If there was a photo mismatch, you will also be instructed to send a copy to E-Verify. Alternatively, if the employee chooses not to contest, you may terminate employment and close the case.

The Waiting Game

Assuming that your employee has contested and you have properly referred them, the waiting game begins. E-Verify instructs employers that they will provide a case update (in the system) within 10 federal government working days. Employers using the web interface will need to check the system periodically, whereas employers using electronic I-9 systems can see updates automatically on their dashboard. Regardless of how you check, remember that you may not ask the employee for additional evidence of confirmation that SSA or DHS resolved the case. Doing so might be viewed as discriminatory. On the other hand, you should be diligent in checking on the case to see if there are updates. I did say this was a dance didn’t I?

Occasionally, the SSA or DHS may need more time to resolve a TNC – this could happen for a variety of reasons. Local SSA offices may be over-burdened with their core tasks (application for SSA benefits) or the employee may not have the documentation needed by SSA to support a change in their records. These record requests can add weeks to the process, and needless gray hairs to the worried HR representative. Regardless, the rules make it clear that you may not terminate, suspend, delay training, withhold or lower pay, or take any other adverse action against an employee based on the employee’s decision to contest a TNC or while the case is still pending with SSA.

The End Game

If all goes well, SSA or DHS will update its records and the employee’s case in E-Verify to indicate “Employment Authorized.” Occasionally, SSA may require the employer, employee or the U.S. Department of Homeland Security (DHS) to take additional action before a final case result can be issued. In these cases, SSA will update the employee’s case with a different message. Once the employee has received a final case status, such as “Employment Authorized” or “SSA FNC,” the employer must close the case in E-Verify. If the employee received an “SSA FNC,” the employer must also indicate whether the employee was terminated.

Paper Trail

If you review the last 4 paragraphs, you’ll notice I mentioned a variety of letters and notices. As with most areas of I-9 compliance, documentation is key. Therefore, as an employer, you’ll want to make sure to keep these signed letters on file with the I-9 (as instructed in your E-Verify User Manual). In the event of a government audit (relating to I-9s or E-Verify), you may be required to present these.  If you are usinga good electronic I-9 and E-Verify compliance system, the employee and employer should be able to electronically sign these letters, and the system should automatically attach them to the employee’s record along with a detailed audit trail.  Documentation is good, but paperless documentation with detailed audit trails is even better yet in building your “Good Faith” defense in case of an EEOC/OFCCP investigation and/or ICE audit!

More Information

Resolving TNCs can be a complicated process, and I’ve just given you a very brief overview. For more information, check out the USCIS web site here and review the latest E-Verify user manual. And if you’re stuck with a tricky E-Verify situation, make sure you consult experienced immigration counsel to avoid any missteps in this government dance

LawLogix Group, Inc. © 2001-2010 All Rights Reserved

Adult Dancers at Penthouse, Claiming they are Employees not Independent Contractors, Granted Right to Proceed with Wage Claims as a Class Action

Who says Labor & Employment Law isn’t sexy? Richard J. Reibstein of Pepper Hamilton doesn”t think so.  In a recent post at the National Law Review, Richard provides some good insight on how businesses can effectively navigate the possible pitfalls of using Independent Contractors.

Within the past month, a federal court in Manhattan granted a motion for class action certification to a group of  adult dancers who have worked at the Penthouse Executive Club in New York City.  They alleged, among other things, that the Club violated the federal Fair Labor Standards Act (FLSA) by failing to pay them overtime for hours worked in excess of 40 per week, requiring them to pay a “house fee” that sometimes exceeded $100 per night, deducting service charges for tips paid in scrip issued by the Club, and requiring that the dancers share their tips with other Club personnel. Penthouse asserted as a defense that the adult dancers were independent contractors.

Judge Naomi Reice Buchwald found unpersuasive all five of Penthouse’s arguments, including that class certification would be improper because the issue of whether the dancers were independent contractors was unsuitable for class action treatment.  Penthouse argued that this type of inquiry regarding their status as employees or independent contractors required an individualized, fact intensive inquiry into the nature of the dancer’s relationships with the Club.

In a 16-page opinion, the New York federal district court judge rejected that argument.  As Judge Buchwald stated, a plaintiff’s burden in seeking a preliminary class action certification is “simply to make a ‘modest factual showing sufficient to demonstrate that [plaintiffs] and potential plaintiffs together were victims of a common policy or plan that violated the law.’ ”  In dismissing this argument, the judge noted that members of the proposed class “all hold the same job title, have the same job responsibilities, work at the same location, and, by extension, are subject to the same ownership and management.”  She concluded that “[i]f such a group does not merit at least preliminary class treatment, one would expect that class treatment would rarely be granted in FLSA actions, a proposition that is plainly incorrect as an empirical matter.”

This is by no means the first adult club class action misclassification case.  Other class action cases involving claims by adult dancers that they were improperly classified as independent contractors include an exotic dancer case in Massachusetts, an adult entertainment dancer case in Georgia, and another New York City adult dancer case.

A Couple of Takeaways:

1. Where a business uses a relatively large number of independent contractors or is built on an independent contractor model, it faces misclassification liability not only for unpaid overtime but also for unpaid:

  • unemployment taxes,
  • workers compensation premiums,
  • payroll taxes, and
  • employee benefits,

just to name some of the many types of claims made by workers who claim they were misclassified as independent contractors.

2. Businesses that use many independent contractors or pay workers on a 1099 basis are well advised to address the issue of their independent contractor compliance before receiving a notice from a state unemployment or workers compensation office, before receiving notice from the IRS or state revenue department that it will be conducting a tax audit, or before being served with a summons and complaint (which can lead to class action certification if the case involves a substantial number of similarly situated workers).

Regardless of any business’s current state of compliance with such laws, there are a number of ways by which organizations can enhance their future compliance and minimize their exposure to future misclassification liabilities, including the costs of defending class actions by workers who receive 1099s instead of W-2s.  See “Independent Contractor Misclassification: How Companies Can Minimize the Risks,” Pepper Hamilton LLP, Apr. 26, 2010.  Indeed, some of these class actions seek damages for unpaid employee benefits – an area of exposurethat can often be avoided simply by properly amending the language of a company’s benefit plans, as explained in the above article.

While efforts today to enhance independent contractor compliance cannot eliminate past exposure to misclassification liability, any changes that enhance compliance with the independent contractor laws will not only minimize or avoidfuture liability but also lessen the likelihood that the business will become a target for class action lawyers and government agencies.

Copyright © 2010 Pepper Hamilton LLP

Final Genetic Information Non Discrimination Act "GINA" Regulations Impact All Employers

From National Law Review’s featured blogger Patricia Anderson Pryor of Taft Stettinius & Hollister LLP, important information for both employers and employees about the Genetic Information Non Discrimination Act (“GINA”).

On November 9, 2010, the EEOC published its final regulations concerning the employment aspects of the Genetic Information Non Discrimination Act (“GINA”).

Although very few employers consciously utilize genetic information or discriminate against individuals because of genetic information, the prohibitions in GINA impact all employers.  Prohibited genetic information includes medical information about an employee’s family members.  The new regulations provide that an employer may violate GINA even if the employer does not specifically intend to acquire genetic (or family medical) information.

Many employers inadvertently come into contact with what the law defines as “genetic information” when they send employees for medical exams, when they request medical information in connection with requests for accommodation or requests for leave, when they provide employee wellness programs, when their supervisors engage in, or overhear, general, water cooler type conversations or even when supervisors look through Facebook posts.

In order to protect themselves, employers may need to update postings, policies and leave of absence or other medical request forms.

Employers should take precautions to avoid receiving genetic information in connection with requests for medical information and medical exams.

An employer who requests medical information from an employee or provider to support a request for an accommodation, FMLA leave or other leave, may inadvertently receive genetic information, including family medical information, that is already contained in the provider’s file.  The regulations provide that such receipt will not run afoul of GINA if either the employer informed the provider not to provide genetic information, with language similar to that suggested by the EEOC, or the request was so narrowly tailored that the request for medical information was not likely to result in the production of genetic information.

However, according to the final regulations, if an employer is requiring an employee to submit to a medical exam in connection with employment (either a pre-employment/post-offer exam or a fitness for duty exam), the employer “must” tell the health care provider not to collect genetic information, including family medical history, as part of the exam.  If the provider nonetheless requests genetic information, the regulations provide that the employer may need to take additional reasonable measures, including potentially no longer using that health care professional’s services.

Wellness programs cannot include a financial incentive for the disclosure of genetic information.

Many wellness programs include a health risk assessment that often requests family medical history.  Requesting genetic information in connection with a wellness program is permissible only if the employee’s participation is knowing and voluntary (among other things).  The final regulations clarify that “voluntary” means that an employer cannot offer a financial incentive to induce individuals to provide genetic information.  If a health risk assessment includes questions concerning genetic information, the employer must inform the employees that any incentive will be provided regardless of whether the employee answers the particular questions identified as requesting genetic or family medical information.

Information obtained through casual conversations or social network sites may still be inadvertent, as long as there is no intentional probing.

The final regulations keep intact the exceptions for certain inadvertent acquisitions of genetic information, including a supervisor overhearing a conversation about an employee’s genetic information or a family member’s medical condition or a supervisor viewing similar information on a social media site that he or she had permission to access.

However, the new regulations clarify that although an employer may obtain genetic information inadvertently or through information that is publicly or commercially available, these exceptions do not apply if the employer has deliberately sought the information by asking probing questions or searching for genetic information on line.

GINA’s requirements go far beyond simply prohibiting genetic testing.

Copyright © 2010 Taft Stettinius & Hollister LLP. All rights reserved.

Time to Retire the ESOP from the 401k: Assessing the Liabilities of KSOP Structures in Light of ERISA Fiduciary Duties and Modern Alternatives

The National Law Review would like to congratulate Adam Dominic Kielich of  Texas Wesleyan University School of Law as one of our 2010 Fall Student Legal Writing Contest Winners !!! 

I. Introduction

401k plans represent the most common employer-sponsored retirement plans for employees of private employers. They have replaced defined benefit pension plans, as well as less flexible vehicles (such as ESOPs) as the primary retirement plan.1 However; some of these plan models have continued their legacy through 401ks through structures that tie the two together or place one inside the other. A very common and notable example is the Employee Stock Ownership Plan (ESOP). ESOPs are frequently offered by companies as an investment vehicle within 401ks that allow participants to invest in the employer’s stock as an alternative to the standard fund offerings that are pooled investments (e.g. mutual funds or institutional funds). Participants may be unaware that the company stock option in their 401k is a plan within a plan. These combination plans are sometimes referred to as KSOPs.2

Although this investment vehicle seems innocuous, KSOPs generate considerable risk to both participants and sponsors that warrants serious consideration in favor of abandoning the ESOP option. Participants face additional exposure in their retirement savings when they invest in a single company, rather than diversified investment vehicles that spread risk across many underlying investments. They may lack the necessary resources to determine the quality of this investment and invest beyond an appropriate risk level. Moreover, sponsors face substantial financial (and legal) risk by converting their plan participants into stockholders within the strict protections of ERISA.3 The risk is magnified by participant litigation driven by the two market downturns of the last decade. Given the growing risk, sponsors may best find themselves avoiding the risks of KSOPs by adopting a brokerage window feature (sometimes labeled self-directed brokerage accounts) following the decision in Hecker.4

II.  Overview and History of ESOPs

A.  ESOP Overview

ESOPs are employer-sponsored retirement plans that allow the employee to invest in company stock, often unitized, on a tax-deferred basis. They are qualified defined contribution plans under ERISA. As a standalone plan, ESOPs take tax deferred payroll contributions from employees to purchase shares in the ESOP, which in turn owns shares of the employer’s stock. That indirect ownership through the ESOP coverts participants into shareholders, which gives them shareholder rights and creates liabilities to the participants both as shareholders and as participants in an ERISA-protected plan. They may receive dividends, may have the option to reinvest dividends into the plan, and may be able to receive distributions of vested assets in cash or in-kind, dependent upon plan rules.5

ESOPs offer employers financial benefits: they create a way to add to employee benefit packages in a manner that is tax-advantaged while providing a vehicle to keep company stock in friendly hands – employees – and away from the hands of parties that may seek to take over the company or influence it through voting. Additionally, ESOPs create a consistent flow of stock periodically drawn out of the market, reducing supply and cushioning prices. Moreover, with those shares in the hands of employees, who tend to support their employer, there are fewer shares likely to vote against the company’s decision-makers or engage in shareholder activism.6

B.  Brief Relevant History of ESOPs

ESOPs are generally less flexible and less advantageous to employees than 401ks. ESOPs lack loan options, offer a single investment option, typically lack a hardship or in-service distribution scheme and most importantly, lack diversification opportunities. Individual plans may adopt more restrictive rules to maintain funds within the plan as long as possible, as long as it is ERISA-compliant. Perhaps the most important consequence of that lack of diversity is that it necessarily ties retirement savings to the value of the company. If the company becomes insolvent or the share price declines without recovery, employees lose their retirement savings in the plan, and likely at least some of the pension benefits funded by the employer. The uneven distribution of benefits to employees helped pave the way for ERISA in 1974.7

C.  Current State of Law on ESOPs

1.  ESOPs Within 401k Plans

After the ERISA regulatory regime paved the way for 401k plans, employers began folding their ESOPs and other company stock offerings into the 401ks. For decades employers could mandate at least some plan assets had to be held in company stock. When corporate scandals and the dot com bubble burst in 2001, it evaporated significant retirement savings of participants heavily invested in their employer’s stock, often without their choice. Congress responded by including in the Pension Protection Act of 2006 (PPA) by eliminating or severely restricting several permissible plan rules that require 401k assets in any company stock investment within 401k plans.8

2. ERISA Litigation of the 2000s

Participants who saw their 401k assets in company stock vehicles disappear with the stock price had difficulty recovering under ERISA until recent litigation changed how ERISA is construed for 401k plans. ERISA was largely written with defined benefit plans in mind. Defined benefit plans hold assets collectively in trust for the entire plan. Participants may have hypothetical individual accounts in some plan models, but they do not have actual individual accounts. ERISA required that suits brought by participants against the plan (or the sponsor, trust, or other agent of the plan) for negligence or malfeasance would represent claims for losses to the plan collectively for all participants, so any monetary damages would be awarded to the plan to benefit the participants collectively, similar to the shareholder derivative suit model. Damages were not paid to participants or used to increase the benefits payable under the plan.

Defined contribution plans with individual participant accounts, such as 401k plans and ESOPs, were grafted onto those rules. Therefore, any suit arising from an issue with the company stock in one of these plans meant participants could not be credited in their individual accounts relative to injuries sustained. It rendered participant suits meaningless in most cases because the likelihood of recovery was suspect at best.9

The Supreme Court affirmed this view in 1985 in Russell, and courts have consistently held that individual participants could not individually benefit from participant suits. Participants owning company stock through the plan could take part separately in suits as shareholders against the company, but these are distinguished from suits under ERISA. In 2008, the Supreme Court revisedRussell in LaRue and held that Russell only applied to defined benefit plans. Defined contribution plan participants could now bring claims individually or as a class and receive individual awards as participants. This shift represented new risks to sponsors that immediately arose with the market crash in 2007.10

III.  Risks to Employees

The primary risk to employees is financial; a significant component of employee financial risk is the investment risk. 401k sponsors are required to select investments that are prudent for participant retirement accounts. This is why 401k plans typically include pooled investments; diversified investment options spread risk. ESOPs are accepted investments within 401k plans, although they are not diversified.11 This increases the risk, and profit potential, participants can expose themselves to within their accounts. While added risk can be exponentially profitable to participants when the employer has rising stock prices or a bull market is present, the downside can also be significantly disastrous when the company fails to meet analyst expectations or the bears take over the markets.

Moreover, employees may be more inclined to invest in the employer’s stock than an independent investor would. Employees tend to be bullish about their employer for two reasons.12 First, employees are inundated with positive comments from management while typically negative information is not disclosed or is given a positive spin. This commentary arises in an area not covered by ERISA, SEC, or FINRA regulations. This commentary is not treated as statements to shareholders; they arise strictly from the employment relationship. This removes much of the accountability and standards that otherwise are related to comments from the company to participants and shareholders. Management can, and should, seek to motivate its employees to perform as well as possible. While the merit of misleading employees about the quality of operations may be debatable, the ability to be positive to such an end is not.

Second, employees tend to believe in the quality of their employer, even if they espouse otherwise. They tend to believe the company is run by experienced professionals who are leading the company to long term success. Going to work each day, seeing the company operating and producing for its customers encourages belief that the company must be doing well. It can even develop into a belief that the employee has the inside edge on knowing how great the company is, although this belief is likely formed with little or no knowledge of the financial health of the company. The product of the internal and external pressures is a strong likelihood employees will invest in an ESOP over other investment options for ephemeral, rather than financial, reasons.13

Additionally, participants may have greater exposure to the volatility of company stock over other shareholders due to 401k plan restrictions. While some plans are liberally constructed to give participants more freedom and choice, some plans conversely allow participants few options. This is particularly relevant to the investment activity within participant accounts. Participants may be limited to a certain number of investment transfers per period (e.g. quarterly or annually), may be subject to excessive trade restrictions, or may even find themselves exposed to company stock through repayment of a loan that originated in whole or in part from assets in the ESOP. Additionally, the ESOP may have periodic windows that restrict when purchases or redemptions can occur. While a regular shareholder can trade in and out of a stock in seconds in an after-tax brokerage account, ESOP shareholders may find themselves hung out to dry by either the ESOP or 401k plan rules. These restrictions are not penal; they represent administrative decisions on behalf of the sponsor to avoid the added expense generally associated with more liberal rules.

Although employees take notable risk to their retirement savings portfolio by investing in ESOPs within their 401k plans, it can add up to a tremendous financial risk when viewed in the bigger picture of an employee’s overall financial picture. Employees absorb the biggest source of financial risk by nature of employment through the company because it is the major, if not sole, income stream during an employee’s working years. This risk increases if the employer is also the primary source of retirement assets or provides health insurance. The employee’s present and future financial well being is inherently tied directly to the employer’s financial well being. This risk is compounded if the employee also has stock grants, stock options, or other stock plans that keep assets solely tied to the value of the company stock. If the employee is fortunate enough to have a defined benefit plan (not withstanding PBGC coverage) or retirement health benefits through the company, then that will further tie the long term success of the company to the financial well being of the employee. Adding diversification in the retirement portfolio may be a worthwhile venture when those other factors are considered in a holistic fashion.

IV.  Risks to the Sponsor

ERISA litigation is a serious risk and concern to sponsors. Although there is exposure in other areas related to participants as stockholders, ERISA establishes higher standards towards participants than companies otherwise have towards shareholders. Sponsors once were able to protect themselves under ERISA but since LaRue participants have an open door to reach the sponsor to recover losses related to the administration of the plan.14 ERISA requires sponsors to make available investment options that are prudent for 401k plans. The dormant side of that rule requires sponsors to remove investment options that have fallen below the prudent standard. Company stock is not excluded from this requirement.15

Any time the market value of the stock declines, the sponsor is at risk for participant losses for failure to remove the ESOP (or other company stock investment option) as an imprudent investment within the plan. Participants are enticed to indemnify losses through the sponsor. Such a suit is unlikely to succeed when the loss is short term and negligible, or the value declined in a market-wide downturn. However, as prior market downturns indicate, investors look to all possible avenues to indemnify their losses by bringing suits against brokers, advisors, fund companies, and issuers of their devalued assets. There is no reason to believe that participants would not be enticed to try this route; LaRuewas born out of the downturn in the early 2000s.16

The exposure for sponsors runs from additional costs to mount a defense to massive monetary awards to indemnify participants for losses. In cases where participants are unlikely to recover, sponsors still must finance the defense against what often turns into expensive, class action litigation or a long serious of suits. However, there is a serious risk of sponsors having to pay damages, or settle, cases where events have led to a unique loss in share value. Participants have filed suit under the theory that the sponsor failed to remove imprudent investment options in a timely fashion. BP 401k participants filed suit following the gulf oil leak under a similar theory that the sponsor failed to remove the company stock investment option from the plan, knowing that it would have to pay clean up costs and settlements. While it remains to be seen if these participants will be successful, they surely will not the last to try.17

Sponsors should take a good, long look at the ESOP to determine whether the sponsor receives more reward than risk – particularly future risk – from its inclusion. The risk to a company does not have as severe as the situation BP faced this year. Even bankruptcy or mismanagement that results in serious stock decline can merit suit when the sponsor fails to immediately withdraw the ESOP, since it has prior knowledge of the bankruptcy or mismanagement prior to any public release.

To hedge these risks, sponsors can adopt several options. First, sponsors may limit the percentage of any account that may be held in company stock. This is easily justified as the sponsor taking a position in favor of diversification and responsible execution of fiduciary duties. While this may not completely absolve the sponsor of the duty to remove imprudent investment options, it does act as a limit on liability. Although it does provide some protection against risk, it is an imperfect solution.

Second, ESOP plans can adopt pricing structures to discourage holding large positions of company stock for the purpose of day trading. Some 401k plans allow participants to trade between company stock and cash equivalents without restraint. When the ESOP determines share pricing based on the closing price of the underlying stock, it creates a window where participants can play the company stock very differently than the constraints of most 401k investment options.

It is a very alluring reason to take advantage of the plan structure by taking an oversized position in company stock. Add the possibility to indemnify losses in court and it becomes even more desirable. The process is simple: participants can check the trading price minutes before the market closes. If the stock price is higher than the basis, they sell and net profit. If it is below, they hold the stock and try against each day until the sale is profitable. They will then buy back into the ESOP on a dip and repeat the process. This is distinguishable from the standard diversified fund options in 401k plans, where ignorance of the underlying investments preempts the ability to game closing prices. Funds generally discourage day trading – and may even carry redemption fees to penalize it – and encourage long term investing strategies more consistent with the objective of retirement accounts.

Available solutions are directly tied to the cause of the problem; changing the ESOP pricing scheme can eliminate gaming closing prices. ESOPs can adopt other pricing schemes such as average weighted pricing and next day order fulfillment. Average weighted pricing gives participants the average weighted prices of all transactions in the stock, executed that day, by a given entity. For example, if the ESOP is held with Broker X as the trustee, it may rely upon Broker X to provide the prices and volumes of all of its executed orders that day in the stock, which is used to determine the average weighted price participants will receive that day. Alternately, participants could be required to place orders on one day and have the order fulfilled on the following day’s closing with that day’s closing price. Both of these pricing schemes introduce some mystery into the price that diminishes gaming the closing price. This is also an imperfect solution, even if combined with the first option, because it maintains the risks of the ESOP.

Sponsors may also take advantage of brokerage windows to expand employee investment options, including company stock, without the risks afforded to ESOPs. Brokerage windows create brokerage accounts within 401k plans. The brokerage window is not an investment in itself; it is a shell that allows employees to reach through the window to access other investments. Sponsors found good reason to be suspicious of brokerage windows, seeing it as liability for all the available investments that could be deemed imprudent for retirement accounts. A minute minority of participants saw it as a way to have their cake and eat it too during the last rise and fall of the markets; they could invest more aggressively within their 401ks and then demand sponsors indemnify their losses when the markets gave up years of gains on the basis of sponsor failure to review the available contents of the window under the prudence standard.

However, in Deere the court handed down a critcal decision: sponsors could not be responsible for the choices made by participants within brokerage windows. InDeere, several Deere & Co. (John Deere) employees sued the company for making available investments that were imprudent for 401k accounts that caused substantial losses in the 2007 market downturn. John Deere had not reviewed the thousands of available options under the ERISA prudence standard. Although the plaintiffs’ theory was a compelling interpretation of ERISA duties, the court rejected the theory on two grounds. First, it would be impossible for any sponsor to review every investment available through the window. Second, participants had taken ownership of the responsibility to review their investment decisions by choosing to invest through the window.18

Following the court’s decision in Deere, brokerage windows gained new life as a means for sponsors to expand investment availability at less risk. Rather than having to review a menu of funds and company stock for prudence under ERISA, sponsors can justifiably limit the fund selection directly offered through the plan and leave the rest of the options to the brokerage window. Importantly, this includes offering company stock in the window. By utilizing the brokerage window, sponsors allow access to the company stock without the liabilities of offering an ESOP through the plan. The sponsor will likely lose out on any benefits received from the ESOP, although for most established employers ESOPs are likely more of a convenience factor and a legacy offering rooted in the history of employer-sponsored plans.

Although Deere foreclosed participant abuse of brokerage windows, this option is not without its own negative aspects. Future litigation may reestablish some liability upon the sponsor for the brokerage link. Sponsors may face alternate liability under ERISA for selecting a brokerage window with excessive commissions or fees, similar to requirements for funds under ERISA.19 Given the flurry of awareness brought to 401k management fees and revenue sharing agreements between sponsors and fund providers following the market crash in 2007, it is likely that brokerage windows will be the hot ticket for participants in the next market crash. Therefore, sponsors should preemptively guard against future litigation by reviewing available brokerage window options to make sure any fees or commissions are reasonable and the categories of investment options are reasonable (even if specific investments in those categories are not).

Perhaps a lesser concern, sponsors need to consider overall plan operation and any negative impacts that may arise from shifting to a brokerage window-based investment offering. These concerns may be less of a legal risk issue than a risk of participant discontent and dealing with those effects. There are primarily two areas that brokerage windows can create discontent. First, when participants want to move from a fund to the brokerage window, they must wait for the sale to settle from the fund and transfer to the window, which generally makes the money available in the window the day after the fund processes the order. Conversely, selling investments in the window may delay transferring money into plan funds because of settlement periods and the added delay of settlement with the fund once the funds are available to move out of the window. Additionally, the settlement periods within the window may frustrate participants, although the plan has no control over those timeframes. Those natural delays in processing the movement of money may create discontent, especially for those participants trying to invest based upon short term market conditions.

Second, those same processes and delays can negatively affect plan distributions. Many plans offer loans and withdrawal schemes, and while sponsors may have their own reasons for making those options available, participants often use those offerings to finance emergency financial needs. Brokerage windows can complicate and delay releasing money to participants. Settlement periods will create delays; if money has to be transferred out of the window to another investment to make those funds available for a distribution that will add at least one more day before money can be released. If participants find themselves in illiquid investments, the money may not be able to move for a distribution at all. Although these issues may not be of legal significance but they will be significant to the people responsible for absorbing participant complaints and there may be additional expenses created in handling those issues.

An additional concern is that the Department of Labor (DOL) is still fleshing out several requirements surrounding brokerage windows and how they relate to ERISA requirements. For example, the DOL October 2010 modification of 401k disclosure rules affects plans as a whole, but it leaves open several areas of ambiguity around the specific effects on brokerage windows. Sponsors may face continuing financial costs complying and determining how to comply with DOL requirements. Future changes in the regulations may negatively affect plans that rely heavily on brokerage windows to provide access to a greater range of investment options.20

These considerations are not exhaustive to the benefits or risks of either ESOPs or brokerage windows, they merely highlight some of the more salient points as they relate generally to the legal and significant financial benefits and risks to sponsors. There may be additional concerns equally salient to sponsors given their particular situation, such as participant suspicion of the removal of the ESOP or unwillingness at the executive level to retire the ESOP.

V.  Conclusion

Although brokerage windows may open the door to some new liabilities, it closes the door to the risks of ESOPs, for both participants and sponsors. Sponsor diligence in administering retirement plans will always be the most successful method of checking liability; however, as discussed ESOPs risk putting sponsors in an unwinnable position. Removing the company stock option may not be the most beneficial option in all cases but it may be time for sponsors to consider retiring the ESOP from the 401k in light of the current regulatory regime. A brokerage window option is well suited to take advantage of participant ownership of the employer’s stock, as well as other investment opportunities, while limiting the risk that normally accompanies that ownership. Ultimately, sponsors must consider what is best for the plan and its participants over both the short term and the long term.

Endnotes.

1. Chris Farrell, The 401(k) Turns Thirty Years Old, Bloomberg Businessweek Special Report, Mar. 15, 2010,http://www.businessweek.com/investor/content/mar2010/pi20100312_874138.htm.

2. National Center for Employee Ownership401(k) Plans as Employee Ownership Vehicles, Alone and in Combination with ESOPs, (no date provided),http://www.nceo.org/main/article.php/id/15/.

3. Id.; 29 U.S.C. § 1104 (2010); the term “sponsor” can be used interchangeably with “employer” for purposes of this discussion, however there are some situations where the employer is not the sponsor, such as union plans, or the employer is not the sole sponsor in the case of multi-employer plans. This discussion relates to KSOPs where the sponsor is the employer. Different rules and different liability may apply to other plan structures.

4. Hecker v. Deere & Co., 556 F.3d 575, 590 (7th Cir. 2009), cert. denied, 130 S. Ct. 1141 (2010).

5. Todd S. Snyder, Employee Stock Ownership Plans (ESOPs): Legislative History, Congressional Research Service, May 20, 2003.

6. William N. Pugh et al. The Effect of ESOP Adoptions on Corporate Performance: Are There Really Performance Changes?, 21Managerial & Decision Econ., 167, 167-180 (2000).

7. Supra note 5.

8. Pension Protection Act of 2006 § 901, 29 U.S.C. 401 (2010).

9. LaRue v. DeWitt, Boberg & Assocs., Inc., 552 U.S. 248, 254-55 (2008).

10. Id. at 255-56.

11. Shlomo Benartzi et al., The Law and Economic of Company Stock in 401(k) Plans, 50 J.L. & Econ. 45, 45-79 (2007).

12. Id.

13. Id.

14. LaRue, 552 U.S. at 254-55.

15.  § 1104.

16. LaRue, 552 U.S. at 250-51.

17. E.g., In Re: BP P.L.C. Securities Litigation, MDL No. 2185, 2010 WL 3238321 (J.P.M.L. Aug. 10, 2010).

18. Hecker, 556 F.3dat 590.

19. §1104.

20. 29 C.F.R. § 2550 (2010).

© Copyright 2010 Adam Dominic Kielich

 

Congressional Approach to Misclassification of Employees as Independent Contractors Would Confuse Rather than Clarify the Law

From featured guest blogger at the National Law Review   Richard J. Reibstein of Pepper Hamilton LLP – good commentary on why what Congress is proposing concerning Independent Contractors won’t work and what should be done instead: 

Congress has introduced two bills intended to discourage businesses from misclassifying employees as independent contractors and end the issuance of Form 1099s to workers who are not legitimate independent contractors.  Both bills – one a labor bill and the other a tax bill – have the laudable objective of curtailing misclassification of employees as independent contractors.  But the two bills, although related, contain different tests for determining who is an independent contractor or employee. 

The Obama Administration has firmly endorsed both bills.  While some Administration-supported legislative initiatives have little chance of passage in the lame-duck session of Congress or in 2011, these bills have a far better chance of passage because they are both revenue raisers.  Between the two bills, the labor bill may be passed earlier, inasmuch as hearings on the bill have already been held.

It can hardly be disputed that businesses that intentionally issue Form 1099s to workers contribute to the tax gap, deprive workers of federal, state, and local workplace protections, and places businesses that properly classify workers at a competitive disadvantage.  But, what about unintentional misclassification by businesses confused by varying definitions and legal standards used to determine who is an independent contractor and who an “employee” under an array of labor, tax, and benefits laws?

A 2006 report to Congress by the Government Accountability Office addressing misclassification observed that “the tests used to determine whether a worker is an independent contractor or an employee . . . differ from law to law,” even among various federal labor, employment, and employee benefits laws.  The GAO report notes, “For example, the NLRA, the Civil Rights Act, FLSA, and ERISA each use a different definition of an employee and various tests, or criteria, to distinguish independent contractors from employees.”  A 2009 report by theGAO concluded that while “the independent contractor relationship can offer advantages to both businesses and workers” and “[m]any independent contractors are classified properly,” Congress should take steps to help businesses that “may be confused about how to properly classify workers.” 

The tax bill expressly seeks to clarify confusion over who is an employee or independent contractor under the federal employment tax laws; however, the labor bill not only contains a test at odds with the tax bill but is also inconsistent with the test used in most other federal laws dealing with labor and employment.

The passage of the labor bill as drafted, with or without passage of the tax bill, will contribute to an even more confusing legal landscape for the hundreds of thousands of businesses that treat certain workers as independent contractors.

The Tax Bill:  The Fair Playing Field Act of 2010 

In mid-September 2010, both the Senate (S. 3786) and House (H.R. 6128) introduced the more recent of the two bills addressing misclassification – the Fair Playing Field Act of 2010.  The bill would close what the sponsors of the legislation, Senator John Kerry (D-MA) and Representative Jim McDermott (D-WA), refer to as a “tax loophole allowing businesses to misclassify workers as independent contractors.”  As set forth in the preamble of the bill, “Such misclassification for tax purposes contributes to inequities in the competitive positions of businesses and to the Federal and State tax gap, and may also result in misclassification for other purposes, such as denial of unemployment benefits, workplace health and safety protections, and retirement or other benefits or protections available to employees.”

The “loophole” that the Fair Playing Field Act seeks to close is Section 530 of the Revenue Act of 1978.  For the past 30 years, that law has afforded businesses a “safe harbor” to treat workers as independent contractors for employment tax purposes as long as the company has had a reasonable basis for such treatment and has consistently treated such employees as independent contractors by reporting their compensation on a Form 1099.

The tax bill’s “findings” recognize that while “many workers are properly classified as independent contractors, in other instances workers who are employees are being treated as independent contractors.”  The bill continues: “Workers, businesses, and other taxpayers will benefit from clear guidance regarding employment tax status.”  The bill therefore directs the Secretary of the Treasury to issue guidance in the form of regulations “allowing workers and businesses to clearly understand the proper federal tax classification of workers.” 

The Fair Playing Field Act bill provides that, in issuing such guidance, the term “employment status” for any individual shall be determined “under the usual common law rules applicable in determining the employer-employee relationship, as an employee or as an independent contractor (or other individual who is not an employee).”  

The IRS and the courts have historically used the “common law” test for determining independent contractor status under the Tax Code.  But, as noted below, the other federal bill seeking to curtail misclassification not only refers to a different test for determining who is an employee and who is an independent contractor, but also is out of sync with prevailing judicial precedent.

The Labor Bill:  The Employee Misclassification Prevention Act (EMPA)

EMPA was introduced in late April 2010 by the Senate (S. 3254) and House (H.R. 5107).  EMPA would amend an existing law, the Fair Labor Standards Act (FLSA), by creating a new labor law offense: misclassification of an employee as an independent contractor. 

If passed, EMPA would also impose strict record-keeping and notice requirements upon businesses with respect to workers treated as independent contractors, expose such businesses to fines of $1,100 to $5,000 per employee for each misclassification, and award triple damages for violations of the minimum wage or overtime provisions of the FLSA.

EMPA also makes specific reference to the definition of “employee” found in the FLSA, a 1938 law that regulates child labor and mandates the payment of minimum wage and overtime for employees who work more than 40 hours in a workweek. For decades, courts have interpreted the word “employee” in FLSA cases under an expansive legal standard that is commonly referred to as the “economic realities” test.  As the Supreme Court has noted, this expansive interpretation under the FLSA derives from laws that were intended to prevent child labor violations, and “stretches the meaning of ‘employee’ to cover some parties who might not qualify as [an employee] under a strict application of traditional [common] law principles.”

As drafted, however, the EMPA bill would arguably incorporate the FLSA’s broad “economic realities” test into its definition of “employee.”  That test gives undue weight to the economic dependence by workers on the business that has retained them.  Such a test is inconsistent with the Supreme Court’s most recent judicial precedents applying the “common law” test and is at odds with what the that Court referred to as  the “common understanding…of the difference between an employee and an independent contractor.”

At least one house of Congress is presumably well aware of this disconnect.  As the Assistant Secretary of Labor testified in writing before the Senate at a hearing held on EMPA on June 17, 2010, “Whether a worker is an employee [or independent contractor] depends on which law is applicable.”  He continued, “We recognize that it is conceivable for a worker to be correctly classified differently under the different standards that apply for different statutory purposes.”  Thus, absent a legislative “fix,” a business that properly classified a particular worker under the “common law” test used to determine independent contractor status under the Tax Code, ERISA, and the nation’s discrimination laws, may be found to have misclassified the same worker under the new EMPA law if the “economic realities” test of the 1938 FLSA law is used. 

Congress Should Provide a Common Federal Definition of “Employee” for Misclassification Purposes

The “common law” test for determining if an individual is an independent contractor or employee focuses on whether the business controls the manner and means that the work is accomplished.  The Supreme Court has set forth twelve factors relevant to the issue of “control,” but noted that there are many additional factors that can be useful in determining employee status, including the additional factors set forth in the IRS’s so-called “20 factor” test.

According to the Supreme Court, the “common law“ test “comports…with our recent precedents and with the common understanding, reflected in those precedents, of the difference between an employee and an independent contractor.”  Those recent precedents include the Court’s determination of whether a worker was an employee or independent contractor under the nation’s pension law and under one of the most important post-Civil Rights discrimination laws – the Americans with Disabilities Act (ADA).

The sponsors of EMPA as well as witnesses who testified in favor of the bill’s passage at a Senate committee hearing in June have noted that EMPA is intended to serve a number of important objectives: closing the tax gap that has deprived the federal and state governments of tax revenues; affording protections to misclassified workers under an array of federal laws that govern employers and employees (including ERISA, FLSA, OSHA, and the federal discrimination laws); and promoting fair business competition by outlawing the practice of misclassification, which creates an unfair advantage for businesses that improperly avoid the payment of payroll taxes.  Notably, these are the very same purposes set forth in the preamble of the Fair Playing Field Act.  Thus, both misclassification bills are intended to serve the same broad tax, labor, and business purposes.  There is no reason, therefore, for Congress to have two different and potentially conflicting tests for determining if a worker is an employee or independent contractor. 

The FLSA is one of over a dozen major federal labor and employment laws; it is not a misclassification statute.  Congress appears to have attached EMPA to the FLSA merely as a matter of legislative convenience. The value of piggy-backing new legislative initiatives on existing laws can have many benefits, such as eliminating the need for Congress to draft definitional, administrative, procedural, and other similar provisions for a new piece of legislation. 

This valuable use of legislative piggy-backing, however, should not automatically incorporate special definitional sections within the existing law where the definitions were enacted to serve purposes wholly unrelated to the purpose of the new legislation.  Indeed, the Congressional Declaration of Policy underlying the FLSA, which was enacted as part of the New Deal legislation, was to address “labor conditions detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers.”  The broad purposes of EMPA have little if nothing to do with the narrow remedial purposes of the FLSA or the child labor law statutes that were used to craft the expansive definition of “employee” in the FLSA. 

The Congressional goal expressed in the Fair Playing Field Act of “allowing workers and businesses to clearly understand the proper federal tax classification of workers” is beneficial, but if Congress allows EMPA to be passed with a different definition of “employee” than what prevails under the Tax Code and most other federal laws, all Congress will have done is created more confusion among workers and businesses.  In addition, in order to comply with all federal laws covering “employees,” a prudent business would have to disregard the “common law” test applicable under most federal statutes including the Fair Playing Field Act and only treat workers as independent contractors if they satisfied the narrower test under the New Deal child labor and wage and hour law.  This would have the effect of limiting the use of legitimate independent contractors, a result that Congress has never articulated as a purpose of either of the two bills.  Indeed, as stated in the preamble to the Fair Playing Field Act, Congress has found that “many workers are properly classified as independent contractors….”

What Congress Should Do

Congress should use the legislative process to take one of the following two steps to remedy this important discrepancy between the two bills or, if only the labor bill is passed, to ensure that it does not create even greater confusion about who is and who is not an independent contractor: 

  • Modify the definition of “employee” within EMPA so that it uses the same wording found in the Fair Playing Field Act for determining employee or independent contractor status.  Such determinations under that law should be made, as stated in the Fair Playing Field Act, “under the usual common law rules applicable in determining the employer-employee relationship, as an employee or as an independent contractor (or other individual who is not an employee).” 
     
  • Make it crystal clear in the legislative history of the bill, including the Senate and House committee reports, that the definition of “employee” for purposes of EMPA should be construed in a manner consistent with both the “common law” test – which is the prevailing judicial standard under most federal laws including ERISA, the ADA, and the Tax Code – and the “common understanding” of contemporary independent contractor relationships. 

Another approach would be to amend the definition of “employee” or “employ” under the FLSA to language that updates the New Deal definitional terms and, like the Fair Playing Field Act bill,  incorporates the “common law” test that prevails under virtually every other federal law.   

The urgent need for thoughtful federal legislation in the area of misclassification is hard to argue against.  The one witness that testified in a critical manner about EMPA at the Senate hearing this past June did not suggest that federal legislation is not needed.  Rather, he criticized the size of the proposed penalties for misclassification, the nature of the record-keeping requirements, the language of the proposed notice to be given to all workers, and the potential that the anti-retaliation provision could reward unethical conduct. 

The determination of whether an individual worker is an independent contractor or employee is, more often than not,  in the “gray area” and it oftentimes presents a close question of law.  Regardless of whether Congress conducts further hearings on EMPA, it is imperative that legislators avoid placing businesses and workers in the untenable position where they may be found by the very same court to have properly classified an individual under one of the two new proposed laws but improperly classified him or her under the other.

Copyright © 2010 Pepper Hamilton LLP

Congress has introduced two bills intended to discourage businesses from misclassifying employees as independent contractors and end the issuance of Form 1099s to workers who are not legitimate independent contractors.  Both bills – one a labor bill and the other a tax bill – have the laudable objective of curtailing misclassification of employees as independent contractors.  But the two bills, although related, contain different tests for determining who is an independent contractor or employee. 

The Obama Administration has firmly endorsed both bills.  While some Administration-supported legislative initiatives have little chance of passage in the lame-duck session of Congress or in 2011, these bills have a far better chance of passage because they are both revenue raisers.  Between the two bills, the labor bill may be passed earlier, inasmuch as hearings on the bill have already been held.

It can hardly be disputed that businesses that intentionally issue Form 1099s to workers contribute to the tax gap, deprive workers of federal, state, and local workplace protections, and places businesses that properly classify workers at a competitive disadvantage.  But, what about unintentional misclassification by businesses confused by varying definitions and legal standards used to determine who is an independent contractor and who an “employee” under an array of labor, tax, and benefits laws?

A 2006 report to Congress by the Government Accountability Office addressing misclassification observed that “the tests used to determine whether a worker is an independent contractor or an employee . . . differ from law to law,” even among various federal labor, employment, and employee benefits laws.  The GAO report notes, “For example, the NLRA, the Civil Rights Act, FLSA, and ERISA each use a different definition of an employee and various tests, or criteria, to distinguish independent contractors from employees.”  A 2009 report by theGAO concluded that while “the independent contractor relationship can offer advantages to both businesses and workers” and “[m]any independent contractors are classified properly,” Congress should take steps to help businesses that “may be confused about how to properly classify workers.” 

The tax bill expressly seeks to clarify confusion over who is an employee or independent contractor under the federal employment tax laws; however, the labor bill not only contains a test at odds with the tax bill but is also inconsistent with the test used in most other federal laws dealing with labor and employment.

The passage of the labor bill as drafted, with or without passage of the tax bill, will contribute to an even more confusing legal landscape for the hundreds of thousands of businesses that treat certain workers as independent contractors.

The Tax Bill:  The Fair Playing Field Act of 2010 

In mid-September 2010, both the Senate (S. 3786) and House (H.R. 6128) introduced the more recent of the two bills addressing misclassification – the Fair Playing Field Act of 2010.  The bill would close what the sponsors of the legislation, Senator John Kerry (D-MA) and Representative Jim McDermott (D-WA), refer to as a “tax loophole allowing businesses to misclassify workers as independent contractors.”  As set forth in the preamble of the bill, “Such misclassification for tax purposes contributes to inequities in the competitive positions of businesses and to the Federal and State tax gap, and may also result in misclassification for other purposes, such as denial of unemployment benefits, workplace health and safety protections, and retirement or other benefits or protections available to employees.”

The “loophole” that the Fair Playing Field Act seeks to close is Section 530 of the Revenue Act of 1978.  For the past 30 years, that law has afforded businesses a “safe harbor” to treat workers as independent contractors for employment tax purposes as long as the company has had a reasonable basis for such treatment and has consistently treated such employees as independent contractors by reporting their compensation on a Form 1099.

The tax bill’s “findings” recognize that while “many workers are properly classified as independent contractors, in other instances workers who are employees are being treated as independent contractors.”  The bill continues: “Workers, businesses, and other taxpayers will benefit from clear guidance regarding employment tax status.”  The bill therefore directs the Secretary of the Treasury to issue guidance in the form of regulations “allowing workers and businesses to clearly understand the proper federal tax classification of workers.” 

The Fair Playing Field Act bill provides that, in issuing such guidance, the term “employment status” for any individual shall be determined “under the usual common law rules applicable in determining the employer-employee relationship, as an employee or as an independent contractor (or other individual who is not an employee).”  

The IRS and the courts have historically used the “common law” test for determining independent contractor status under the Tax Code.  But, as noted below, the other federal bill seeking to curtail misclassification not only refers to a different test for determining who is an employee and who is an independent contractor, but also is out of sync with prevailing judicial precedent.

The Labor Bill:  The Employee Misclassification Prevention Act (EMPA)

EMPA was introduced in late April 2010 by the Senate (S. 3254) and House (H.R. 5107).  EMPA would amend an existing law, the Fair Labor Standards Act (FLSA), by creating a new labor law offense: misclassification of an employee as an independent contractor. 

If passed, EMPA would also impose strict record-keeping and notice requirements upon businesses with respect to workers treated as independent contractors, expose such businesses to fines of $1,100 to $5,000 per employee for each misclassification, and award triple damages for violations of the minimum wage or overtime provisions of the FLSA.

EMPA also makes specific reference to the definition of “employee” found in the FLSA, a 1938 law that regulates child labor and mandates the payment of minimum wage and overtime for employees who work more than 40 hours in a workweek. For decades, courts have interpreted the word “employee” in FLSA cases under an expansive legal standard that is commonly referred to as the “economic realities” test.  As the Supreme Court has noted, this expansive interpretation under the FLSA derives from laws that were intended to prevent child labor violations, and “stretches the meaning of ‘employee’ to cover some parties who might not qualify as [an employee] under a strict application of traditional [common] law principles.”

As drafted, however, the EMPA bill would arguably incorporate the FLSA’s broad “economic realities” test into its definition of “employee.”  That test gives undue weight to the economic dependence by workers on the business that has retained them.  Such a test is inconsistent with the Supreme Court’s most recent judicial precedents applying the “common law” test and is at odds with what the that Court referred to as  the “common understanding…of the difference between an employee and an independent contractor.”

At least one house of Congress is presumably well aware of this disconnect.  As the Assistant Secretary of Labor testified in writing before the Senate at a hearing held on EMPA on June 17, 2010, “Whether a worker is an employee [or independent contractor] depends on which law is applicable.”  He continued, “We recognize that it is conceivable for a worker to be correctly classified differently under the different standards that apply for different statutory purposes.”  Thus, absent a legislative “fix,” a business that properly classified a particular worker under the “common law” test used to determine independent contractor status under the Tax Code, ERISA, and the nation’s discrimination laws, may be found to have misclassified the same worker under the new EMPA law if the “economic realities” test of the 1938 FLSA law is used. 

Congress Should Provide a Common Federal Definition of “Employee” for Misclassification Purposes

The “common law” test for determining if an individual is an independent contractor or employee focuses on whether the business controls the manner and means that the work is accomplished.  The Supreme Court has set forth twelve factors relevant to the issue of “control,” but noted that there are many additional factors that can be useful in determining employee status, including the additional factors set forth in the IRS’s so-called “20 factor” test.

According to the Supreme Court, the “common law“ test “comports…with our recent precedents and with the common understanding, reflected in those precedents, of the difference between an employee and an independent contractor.”  Those recent precedents include the Court’s determination of whether a worker was an employee or independent contractor under the nation’s pension law and under one of the most important post-Civil Rights discrimination laws – the Americans with Disabilities Act (ADA).

The sponsors of EMPA as well as witnesses who testified in favor of the bill’s passage at a Senate committee hearing in June have noted that EMPA is intended to serve a number of important objectives: closing the tax gap that has deprived the federal and state governments of tax revenues; affording protections to misclassified workers under an array of federal laws that govern employers and employees (including ERISA, FLSA, OSHA, and the federal discrimination laws); and promoting fair business competition by outlawing the practice of misclassification, which creates an unfair advantage for businesses that improperly avoid the payment of payroll taxes.  Notably, these are the very same purposes set forth in the preamble of the Fair Playing Field Act.  Thus, both misclassification bills are intended to serve the same broad tax, labor, and business purposes.  There is no reason, therefore, for Congress to have two different and potentially conflicting tests for determining if a worker is an employee or independent contractor. 

The FLSA is one of over a dozen major federal labor and employment laws; it is not a misclassification statute.  Congress appears to have attached EMPA to the FLSA merely as a matter of legislative convenience. The value of piggy-backing new legislative initiatives on existing laws can have many benefits, such as eliminating the need for Congress to draft definitional, administrative, procedural, and other similar provisions for a new piece of legislation. 

This valuable use of legislative piggy-backing, however, should not automatically incorporate special definitional sections within the existing law where the definitions were enacted to serve purposes wholly unrelated to the purpose of the new legislation.  Indeed, the Congressional Declaration of Policy underlying the FLSA, which was enacted as part of the New Deal legislation, was to address “labor conditions detrimental to the maintenance of the minimum standard of living necessary for health, efficiency, and general well-being of workers.”  The broad purposes of EMPA have little if nothing to do with the narrow remedial purposes of the FLSA or the child labor law statutes that were used to craft the expansive definition of “employee” in the FLSA. 

The Congressional goal expressed in the Fair Playing Field Act of “allowing workers and businesses to clearly understand the proper federal tax classification of workers” is beneficial, but if Congress allows EMPA to be passed with a different definition of “employee” than what prevails under the Tax Code and most other federal laws, all Congress will have done is created more confusion among workers and businesses.  In addition, in order to comply with all federal laws covering “employees,” a prudent business would have to disregard the “common law” test applicable under most federal statutes including the Fair Playing Field Act and only treat workers as independent contractors if they satisfied the narrower test under the New Deal child labor and wage and hour law.  This would have the effect of limiting the use of legitimate independent contractors, a result that Congress has never articulated as a purpose of either of the two bills.  Indeed, as stated in the preamble to the Fair Playing Field Act, Congress has found that “many workers are properly classified as independent contractors….”

What Congress Should Do

Congress should use the legislative process to take one of the following two steps to remedy this important discrepancy between the two bills or, if only the labor bill is passed, to ensure that it does not create even greater confusion about who is and who is not an independent contractor: 

  • Modify the definition of “employee” within EMPA so that it uses the same wording found in the Fair Playing Field Act for determining employee or independent contractor status.  Such determinations under that law should be made, as stated in the Fair Playing Field Act, “under the usual common law rules applicable in determining the employer-employee relationship, as an employee or as an independent contractor (or other individual who is not an employee).” 
     
  • Make it crystal clear in the legislative history of the bill, including the Senate and House committee reports, that the definition of “employee” for purposes of EMPA should be construed in a manner consistent with both the “common law” test – which is the prevailing judicial standard under most federal laws including ERISA, the ADA, and the Tax Code – and the “common understanding” of contemporary independent contractor relationships. 

Another approach would be to amend the definition of “employee” or “employ” under the FLSA to language that updates the New Deal definitional terms and, like the Fair Playing Field Act bill,  incorporates the “common law” test that prevails under virtually every other federal law.   

The urgent need for thoughtful federal legislation in the area of misclassification is hard to argue against.  The one witness that testified in a critical manner about EMPA at the Senate hearing this past June did not suggest that federal legislation is not needed.  Rather, he criticized the size of the proposed penalties for misclassification, the nature of the record-keeping requirements, the language of the proposed notice to be given to all workers, and the potential that the anti-retaliation provision could reward unethical conduct. 

The determination of whether an individual worker is an independent contractor or employee is, more often than not,  in the “gray area” and it oftentimes presents a close question of law.  Regardless of whether Congress conducts further hearings on EMPA, it is imperative that legislators avoid placing businesses and workers in the untenable position where they may be found by the very same court to have properly classified an individual under one of the two new proposed laws but improperly classified him or her under the other.

Copyright © 2010 Pepper Hamilton LLP