DOL’s Six-Part Independent Contractor Test Would Challenge Advisors

The rule is scheduled to take effect in March, but it’s unclear exactly what advisors will have to do to comply — or whether the rule will stand.

By Joena Bartolini Mitchell
Joena Bartolini Mitchell
Joena Bartolini Mitchell

Several years ago, Sarah, an advisor in the Midwest, embarked on a journey toward independence. At that point, she had been working for nearly a decade as an advisor under the W-2 employee model at a regional broker-dealer. Sarah was feeling constrained by the work environment and constant interaction with a centralized supervisory team that was not intimately familiar with her clients or practice. She yearned for the freedom to chart her own course. After months of research and deliberation, Sarah decided to become an independent contractor. Under this new model, she found increased freedom to offer her clients bespoke advice and solutions, and to curate a practice and brand identity that embodied her values.

However, Sarah’s path towards autonomy and personalized service now faces a new challenge from the Department of Labor’s (DOL) recent rule change, “Employee or Independent Contractor Classification Under the Fair Labor Standards Act.” The rule, published on January 10 and set to take effect on March 11, introduces a six-part test to determine worker classification. This will replace the previous “economic reality” test that focused on evaluating economic dependence.

Breaking It Down

The new six-part test dives deep into the nuances of the working relationship between advisors and their firms. The test examines:

  1. Opportunity for Profit or Loss Depending on Managerial Skill: Assesses whether the worker has the chance to earn a profit or incur a loss based on their own managerial decisions and business expertise. Independent contractors often have more control over their financial outcomes, while employees typically do not share in these financial risks.
  2. Investments by the Worker and the Employer: Considers whether the worker or the employer has made significant investments in tools, equipment or materials required for the job. Independent contractors typically invest in their resources, whereas employees often rely on employer-provided tools.
  3. Permanence of the Work Relationship: Examines the duration and continuity of the working relationship. A long-term or indefinite relationship is often associated with employment, while project-based or temporary work suggests independent contractor status.
  4. Nature and Degree of Control: Evaluates the extent to which the employer controls how the work is done, including work hours, methods and specific tasks. A higher degree of employer control is indicative of an employment relationship.
  5. Whether Work Performed Is Integral to the Employer’s Business: Assesses the degree to which the worker’s services are essential to the core operations of the employer’s business. If the services are closely tied to the central functions of the business, it may indicate an employment relationship.
  6. Skill and Initiative: Considers the level of skill and entrepreneurial initiative required for the work. Independent contractors are often specialists who bring their expertise to the table; employees may receive training and supervision.

The DOL has stated that each factor is to hold equal weight and that each should be considered in the overall context of the relationship. “No factor or set of factors has a predetermined weight, and a totality of the circumstances of the working relationship must be considered,” Jessica Looman, administrator of the DOL’s Wage and Hour Division, said in a Jan. 8 press briefing. “The six factors are not exhaustive, nor are any of them more important than any others.”

Advisor Concerns

For advisors like Sarah, the DOL change raises several concerns as they struggle to forecast what the rule will mean for them and their clients.

Advisors who were previously classified as independent contractors but are reclassified as employees will likely lose at least some of the flexibility and independence that first drew them to the independent contractor model. Factors that they value in their practices — including the ability to set their work hours, make personnel decisions, and choose products and services tailored to their clients’ needs — could be compromised.

Additional Reading: Final DOL Rule May Threaten Advisory Firm Status

There is also the real possibility that the advisor-client relationship will face new restrictions. Employee advisors often face firmwide constraints on their ability to attract, retain and manage client relationships. Reclassified advisors will need to comply with company policies that broadly dictate how they interact with clients. This could curtail their ability to provide individually tailored client experiences.

As advisors transition to employee status, they may also experience changes that lead to increased, and costly, tax obligations. Further, reclassified advisors will likely lose the higher payouts and commissions based on favorable fee schedules they have come to enjoy as an independent contractor. The combination of higher taxes and lower revenue may be financially devastating to many advisors.

Broker-Dealer Considerations

The rule is not without consequences for broker-dealer firms. If advisors are deemed employees under this rule, firms will become subject to minimum wage and overtime pay requirements. This could increase their labor costs. Advisors may also become eligible for employment benefits, such as health insurance and paid leave, which will increase costs, too. Further, broker-dealers will have to invest in legal and administrative resources to adjust contracts, payroll processes, supervisory systems and tax-withholding procedures to align with the reclassification of advisors.

Clarity or Confusion?

While the stated goal of the DOL is to provide clarity, the current guidance seems to indicate that interpretation, and therefore enforcement, of the rule will be almost entirely subjective. This uncertainty, coupled with questions surrounding how the DOL and courts will interpret the rule, may prompt many advisors to explore alternative paths. Joining or forming registered investment adviser (RIA) firms or independent broker-dealers can offer a means to retain autonomy in the face of changing regulatory landscapes.

It’s important to note that the specific impact of the DOL’s independent contractor rule can vary based on the final wording of the rule and how it is enforced. Advisors and firms should closely monitor any updates to the rule and consult with legal, risk and compliance experts to ensure they remain in compliance with labor laws.

Joena Bartolini Mitchell, MSM, JD, is the president of JBM Advisors. Joena has spent over 20 years in the financial services industry in diverse roles including high net worth retirement planning, lending solutions, and sales management. For the last nine years, she has focused on the RIA and broker-dealer custody and clearing space. JBM Advisors provides outcome-driven consulting services focused on regulatory change, litigation strategy and risk management. Please visit us at jbmadvisors.com or send an email to hello@jbmadvisors.com.

 

 

 

 

 

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