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The Independent Contractor Question

You may have read, in passing, that the Financial Services Institute—the broker-dealer lobbying organization—has filed a lawsuit in the U.S. District Court for the Eastern District of Texas (why there?) against a revised Department of Labor rule that specifies who should be considered an independent contractor and who should be considered an employee under the Fair Labor Standards Act.  The DOL rule was finalized on January 9 and is set to go into effect as you read this.

If you read the legal brief, you might be convinced that the DOL is threatening the entire BD business model, by recharacterizing the IAR offices under the BD’s RIA to employee status, making reps who are clearing through (and selling through) the BD entitled to wages, benefits and, well, things that would cost the BDs out-of-pocket expenses beyond their current costs.  

Broker-dealers live off of the activities of their affiliated reps; they facilitate the transactions and asset management for a percentage of the commissions and fees that advisors/reps receive from their clients.  The reps could get their transactions handled essentially for free elsewhere (we have a number of independent custodians, after all), but to sell annuities and other products, they are required to work through a FINRA-affiliated BD.  One might argue that the reps are paying for access to commissionable products, and the other primary benefit they receive is compliance supervision—making sure they are in fairly strict compliance with the sales-related rules that FINRA and the SEC have promulgated.  One might wonder if this is a benefit to them or to the BD that wants to protect itself from lawsuits.

Okay; so what about these new independent contractor rules?  You can find an FAQ explanation here:, and decide for yourself whether IARs are employees or independent contractors under the new DOL rules.  If they are, then it potentially blows up the entire broker-dealer business model.  If they are not, then it’s business as usual.  The fact that the Financial Services Institute is filing a lawsuit suggests that its attorneys have reason to suspect that those ‘independent’ offices have been employees all along, based on the new guidelines.

The updated Rule lists six factors to consider when making this determination, but the rule makes clear that there is is no weighting of them, no requirement that somebody would have to meet all of the factors to be considered an employee (or not), and it seems clear that just about everybody would fall under some of the guidelines and others would not be relevant to their circumstances.  The DOL talks about a ‘totality’ test, on a case-by-case, industry-by-industry basis.

Let’s look at each, and see whether ‘independent’ IAR offices would seem to meet (or not) the standards.

The first is ‘opportunity for profit or loss depending on managerial skill.’  Does the worker have opportunities for profit or loss based on their activities, that are not directly provided by the putative employer?  Do the workers determine their own income through their actions?  Do they engage in marketing, advertising or other efforts to expand their business or secure more work, and do they make decisions to hire others, purchase materials and equipment and/or rent space on their own?

I think all of this points, quite clearly, to independent contractor status for IAR offices.

The second standard is ‘investments by the worker and the potential employer.’  The DOL will consider whether investments by the worker are entrepreneurial in nature.  Costs that the putative employer imposes unilaterally on its workers are evidence of employee status; costs that the workers voluntarily take on, which involve extending market reach and achieving greater efficiency, are evidence of entrepreneurial (independent contractor) status.

Unless the broker-dealer requires the IAR offices to buy a particular tech stack, or mandates who is hired within the firm (which I think is rare), this standard would seem to point to independent contractor status.

The third standard is ‘degree of permanence of the work relationship.’  Is the work performed exclusively for the putative employer, or is the worker free to work for others at the same time?  Is the worker marketing him/herself to multiple entities, often on a temporary basis?  If so, then this is an independent contractor relationship.  If the worker does the work exclusively for the putative employer in a longstanding relationship where the work is fairly clearly specified, then that would indicate the status of an employee.

This standard is almost certainly problematic for the BDs who claim their IARs are independent contractors.  Yes, the office is free to move to another BD, but so too is an employee who decides to leave one firm to work for another doing the same work.  By this standard, I would think the DOL would decide that the ‘independent’ offices and their staffs are employees.

Next?  The DOL standards include ‘nature and degree of control.’  Does the putative employer exert control over the performance of the work and the economic aspects of the working relationship?  The FAQ asks whether the putative employer sets the worker’s schedule (‘no’ in the case of BDs) and whether the potential employer supervises the performance of the work, or explicitly limits the worker’s ability to work for others.  Does the putative employer use ‘technological means’ to supervise the performance of the work, and reserve the right to supervise or discipline workers?  Does it set control over the prices or rates for services provided by the worker?

Before you jump to conclusions here, note that the DOL specifically says that ‘actions taken by the potential employer for the sole purpose of complying with a specific, applicable federal, state, tribal or local law or regulation are not indicative of control.’

I think this standard is somewhat ambiguous.  The BDs don’t set work hours, but their compliance regime does supervise client communications—but not the planning advice given or the way portfolios are managed.  The BD doesn’t control prices charged to clients except to the extent that it facilitates commissions.  I would argue that most of the control relates to compliance, and that by this standard, the IARs are independent contractors.

The fifth standard in the new DOL independent contractor rule is the ‘extent to which the work performed is an integral part of the potential employer’s business.’  The FAQ asks whether the function that the worker performs is integral to the business; is it critical, necessary or central to the putative employer’s principal business.  ‘This factor weighs in favor of workers being independent contractors when the work they perform is not critical, necessary or central to the potential employer’s principal business.’

The BD would not exist without its affiliated IARs.  By this standard, they and their staff are employees.

Finally, the last standard in the proposed DOL Rule is ‘skill and initiative.’  Does the worker use specialized skills to perform the work?  If not, then the worker is probably an employee.  But where the worker uses specialized skills in connection with what the DOL calls ‘business-like initiative,’ then that suggests the worker is an independent contractor.

It’s hard to see how financial planning and professional advice is not a specialized skill, and that the offices are utilizing them in business-like initiatives in their communities.  This standard would pretty clearly indicate independent contractor status for IARs and their staff.

The proposed Rule also talks about ‘additional factors’ that might be applied, which basically means looking at whether the worker is in some way in business for him/herself.  Again, this standard leans toward independent contractor status.

By my count, two of the standards would argue for employee status, three would clearly indicate independent contractor status, and one is a bit ambiguous, but if I were a judge, I would say that it leans toward independent contractor status as well.  So one might wonder why the FSI is so riled up about the DOL’s new rules and guidelines.  The only thing that comes to mind is the IARs who are primarily in sales mode, that are cranking out annuity and insurance sales.  Would they be considered employees based on the first, second and sixth standards?  

I would have to know more about how salespeople operate in today’s environment, but I know that sales activities and commissions still make up at least half of most BD revenues (although there are exceptions like Commonwealth and Cambridge), so it’s possible that BDs and their FSI lobbying teams worry that their sales agents will be recharacterized as employees.

  I’m a bit suspicious about where the court challenge was filed (why not the DOL’s home location in the Washington, D.C.? area) which tells me the FSI and other industries have found a compatible judge.  This is going to be an interesting story to follow, in part because the traditional broker-dealer model might have to change as a result.