FSI legal action pushes to preserve advisors' independent status

Industry groups are mounting a last-ditch legal challenge to a new rule viewed by many as a threat to wealth managers' ability to work independently of large employers.

The Financial Services Institute, a lobbying group for independent broker dealers, filed a motion in the Fifth Circuit Court of Appeals on Jan. 11 seeking to revive a previous case against the U.S. Department of Labor's attempt to more strictly define who can qualify as an "independent contractor" under federal employment law. The legal action comes two days before implementation of a new rule meant to keep non-payroll workers from being exploited by unscrupulous employers.

Labor officials have long worried that too many people are being taken advantage of by being mislabeled as independent contractors. Employers can generally avoid paying overtime and minimum wages for workers who aren't on their official employee rosters. They also don't owe payroll taxes for independent contractors.

"Misclassifying employees as independent contractors is a serious issue that deprives workers of basic rights and protections," Acting Labor Secretary Julie Su said in a statement accompanying the publication of the rule on Jan. 9.

Declarations of independence

Concerns about employee misclassification are common in industries like construction and trucking, in which short work seasons and frequent job hopping can make direct employment relations seem tenuous. Labor officials have also grown anxious that workers in the so-called gig economy — Uber and Lyft drivers, for instance — are vulnerable to exploitation by being misclassified as independent workers.

For many financial planners, though, independence isn't something that they've been saddled with in spite of their best interests. It's instead a status many have chosen after trying direct employment at large firms and deciding it's an experience they don't care to repeat.

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"The whole notion behind the DOL effort is that there are people who are being taken advantage of by employers and being incorrectly classified," said Mark Quinn, director of regulatory affairs at the independent broker-dealer Cetera Financial Group. "I talk to a lot of independent contractors in our industry. They've been employees, and they don't want to be employees. They've chosen independence. They are not being exploited, and they are not being manipulated."

The DOL did not respond to a request for comment.

FSI has estimated that 64% of all registered representatives, meaning brokers and advisors who work for broker-dealers, operate as self-employed independent contractors. The wealth management industry had more than 612,000 registered representatives in 2021, according to the Financial Industry Regulatory Authority.

Legal table tennis

FSI's lawsuit comes as the latest volley in a legal pingpong match over the definition of independent contractors. Under former President Donald Trump, the DOL issued a rule attempting to lay out a simple test for ascertaining which workers belong on official payrolls and which don't.

In January 2021, in the waning days of Trump's presidency, the DOL came forward with a test laying out five employment-related considerations for deciding workers' status. But rather than give each factor equal weight, it placed emphasis on two: how much control workers exercise over their work and how much they stand to profit or lose from their own activities and decisions.

The Financial Services Industry and similar groups hailed that change for presenting a relatively simple means of ascertaining employment status. So when the DOL under President Joe Biden tried to withdraw the test in May 2021, the industry groups responded with a lawsuit.

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Specifically, the Financial Services Institute and two largely nonunion construction groups — the Associated Builders and Contractors and Associated Builders and Contractors of Southeast Texas — took aim at how the DOL under Biden had sought to replace the previous Trump administration rule. The plaintiffs accused the DOL of violating provisions of the Administrative Procedures Act, which lays out steps for the adoption of new federal regulations.

The plaintiffs got a federal court in eastern Texas to agree in March 2022, and the Trump administration rule remained in effect.

The DOL responded with an appeal but eventually asked for a stay of the proceedings pending its plans to release yet another test for independent contractors. With the new criteria now scheduled to replace the old Trump rule on March 11, the Financial Services Institute and its fellow plaintiffs are asking the courts to consider again whether the DOL has run afoul of the Administrative Procedures Act.

David Bellaire, the executive vice president and general counsel for the group, said the Financial Services Institute plans to pursue "really any and all avenues we can to challenge the Department of Labor on this independent contractor rulemaking."

He said the Financial Services Institute is seeking to have the case remanded from the appellate to the Eastern Texas district court that had previously ruled in its favor. That lower court, Bellaire said, is already familiar with the arguments presented in the dispute and should be able to reach a final ruling with greater "judicial economy."

"We have a court that's already reviewed these issues in a different context, but understands the issues," he said.

Future court challenges

Both Quinn and Bellaire said they wouldn't be surprised to see lawsuits filed challenging the legal underpinnings of the new rule if it does take effect as planned on March 11. Bellaire noted that one group, the nonprofit Pacific Legal Foundation, filed a legal challenge in federal court in Georgia on Wednesday on behalf of freelance writers and other independent contractors questioning the new rule.

Bellaire said it's too early to say if the Financial Services Institute would take part in a direct legal challenge of the regulation rather than simply question the process used to adopt it.

"I don't want to get ahead of where we are," he said. "We've identified the path we want to take. And, hopefully, the Fifth Circuit will agree with us that this is the appropriate way to move forward with this decision."