A battle in California over whether representatives at two broker-dealers are employees or independent contractors could have far-reaching implications at independent broker-dealers across the country.
As a result of recent audits, the State Compensation Insurance Fund, California's largest workers' compensation insurance company, claims that independent registered reps at Investment Architects Inc. and WBB Securities LLC are really employees, as opposed to independent contractors.
State Fund, which was created by the California Legislature to act as an insurer of last resort for employers that can't obtain the legally required workers' compensation coverage from private insurers, is basing its conclusion on the fact that the Financial Industry Regulatory Authority Inc. requires all broker-dealers to supervise securities transactions by reps at affiliated firms.
CONTROL ISSUES
Finra's requirements “establish with the brokerage firm a pervasive level of direction and control over the duties and operations of the representatives that are far beyond that which could be considered "independent contractor' in nature for workers' compensation purposes,” Lynette Carrillo, a senior audit specialist for State Fund, wrote in a Nov. 4 letter to Anthony Duckworth, vice president of Investment Architects.
The broker-dealers, for their part, are disputing State Fund's findings, saying Finra's supervisory rules cover investment operations such as trading and compliance, but do not cover business administration or operations. Both insist that their affiliated reps are small-business owners responsible for running their own practices and managing their own expenses.
Although the two firms involved have only about 75 brokers between them, the outcome of the case could have far-reaching implications for the brokerage industry, which counts more than 193,000 registered reps as independent contractors.
Having independent reps deemed employees would be a costly undertaking for broker-dealers, especially for those in California, where more than 59,000 reps work. If the State Fund case is upheld in court, not only would B-Ds have to pay workers' compensation for reps, they also would have to withhold taxes for them.
“There are a number of large independent broker-dealers in California, and this would be a significant business disadvantage for those companies in particular,” said Lisa Roth, chief executive of Keystone Capital Corp. and chairman emeritus of the National Association of Independent Broker/Dealers. “Many independent firms have offices here that would be affected, and I hope they're mounting a challenge.”
The NAIBD's small-firm constituency discussed the potential consequences of the case on a conference call last week.
“If a firm [had to change] the designation of an independent contractor to an employee for workers' compensation purposes, it would be more difficult to maintain that these people are independent contractors for other purposes,” said Debra L. Fischer, a partner at Bingham McCutchen LLP.
One of their arguments is that the State Fund is overstepping its authority.
“The problem with an outside company or agency dictating who must be an employee under Finra rules is that they are stepping into the shoes of the government, which has created its own rules about who's an independent contractor and who's an employee,” Ms. Fischer said.
If other entities begin to interpret Finra's requirements as a means to establish an employer-employee relationship, it could affect larger firms and spread outside of the Golden State, which is often seen as a labor law bellwether, experts said.
Benjamin Edokpayi, a spokes-man for State Fund, declined to make one of the insurer's executives available for an interview.
In an e-mail, however, he wrote that State Fund evaluates the relationship created by Finra's supervisory rules from the perspective of California's labor code in order to determine a rep's eligibility to receive workers' comp benefits.
State Fund has been interpreting Finra's guidelines in such a manner “for several years,” Mr. Edokpayi wrote.
But attorneys and broker-dealer executives maintain this is the first time that they have heard of a workers' compensation insurer's use of Finra's guidelines as a way to re-characterize the relationship be-tween reps and their firms.
Finra declined to comment.
Although the dispute is nascent enough to be below the radar of the Financial Services Institute Inc., executives at larger independent broker-dealers are paying close attention to the issue and are ready to push back if State Fund's interpretation sticks.
Paul Tolley, chief compliance officer at Commonwealth Financial Network, pointed out a 2010 amicus brief from the FSI that highlighted language in the Taxpayers Relief Act of 1997.
That legislation indicates that in determining whether a rep is an employee in the context of the Internal Revenue Code, no weight should be given to the supervisory requirements imposed by regulators.
“The control we have is strictly limited to the enforcement of securities laws,” he said. “If this went forward, I expect we'd do everything we could as an industry to fight it and get support at the state and federal level.”
Email Darla Mercado at [email protected]
