Editor’s note: This is the third in a series of conversations between top executives as they discuss business scenarios that affect the boardroom.
How does a company classify, compensate and define employees? According to Robert J. Nobile, a partner at Seyfarth Shaw, and Kathleen M. Connell, PhD, director of the Corporate Directors Enterprise at UC Berkeley Haas School of Business, a board’s assessment of a company’s risk profile should include due diligence on litigation as it relates to workplace issues.
Robert J. Nobile: The greatest concern of corporations today—and I can see this in dealings with my clients—is the enhanced enforcement that is occurring, certainly at the federal level. The Department of Labor, Occupational Safety and Health Administration (OSHA), Office of Federal Contract Compliance Programs (OFCCP) and the Equal Employment Opportunity Commission (EEOC), have all been literally doing the circuit, speaking nationally about increased enforcement of the equal opportunity, wage and hour, and health and safety laws. In the past, these agencies might have turned the other cheek and been willing to settle more quickly. Today, they are feeling—and I will say this from first-hand experience—very empowered with the authority they now have, and more brazen in pushing matters to litigation that probably would have settled in the past.
Kathleen M. Connell: The heightened exposure for employers is a result of both the stronger regulatory mentality of the Obama Administration and its commitment of necessary resources for enforcement actions. Corporate boards need to become increasingly sophisticated in their understanding of issues in the arena of workplace litigation and employment-related class-action lawsuits.
A proactive director should reframe the board’s discussion of employment matters as a risk- management concern. Boards tend to receive bottom-line employee cost-savings data from the CFO and compensation materials from human resources departments. Neither provides the integrated perspective a board requires to determine the potential “risk exposure” of employment practices. It’s the board’s responsibility to discuss a company’s employment policies in the context of a regulatory environment—understanding that the way a company classifies employees, compensates them and defines their status as full, part-time or contractor must meet stringent national labor standards.
Nobile: In my experience, what boards need to be concerned about is that perhaps a lot of companies are playing a numbers game. Former President Bush used to call it “fuzzy math.” I advise clients they should look very closely at the issue of who is an employee, versus who is a consultant or an independent contractor. The resistance that companies always get—and I hear this from human resources executives—is that the financial officers, the CFOs, the controllers and so on, are very concerned about head count. So, in effect, CFOs will refuse to give human resources the authority to add to head count, while at the same time authorizing thousands and thousands of dollars on independent contractors and consultants doing the work of employees, and are, in effect, misclassified.
There’s real concern everywhere, even at the federal level with the IRS and with many state agencies, about revenue. The government and the states are losing revenue when individuals are misclassified, because taxes are not being withheld and reported appropriately. Consultants take deductions that would be impermissible for an employee to take, such as commuting, meals and other business-related expenses. Quite frankly, it’s a revenue numbers game for the federal and state tax agencies—and when they see an apparent misclassification, they will be aggressive.
Many corporations misuse independent contractors. It’s a major issue in terms of potential liability for boards. I’ll give you a real-life example. Several years ago, Arch Financial Services got a call from the head of human resources, who had a lawyer’s letter. The lawyer was representing an “independent contractor” who had been working for this company for about seven years. The contractor’s child became seriously ill. The contractor had a very poor employee-benefits program and most of the expenses were not covered. The contractor sought advice from a private attorney about filing for bankruptcy because he couldn’t pay the medical expenses. The bankruptcy attorney asked him, “Why aren’t these expenses covered? These seem like expenses that would be covered under any normal group health-insurance program.” The contractor explained, “Well, I don’t have group health insurance because I’m not an employee; I’m an independent contractor.”
The lawyer’s letter to the company stated that the employee for the last seven years had been misclassified as an independent contractor. Such misclassification resulted in his not receiving pension benefits or health insurance. The medical bills for the contractor’s child at that point in time were about a quarter of a million dollars. His lawyer presented two options. Make him an employee, put him into the benefit programs, and make sure it’s retroactive so that his expenses are covered; or prepare to defend against a class action on his behalf and everyone else in a similar situation. The company chose to settle, wrote out a nice check, put him into their plans, and then audited and reclassified about 75 other individuals as well. There was potential major liability for this corporation because of the misclassification.
Connell: You’ve identified a perfect example in today’s “new normal” economy, in which companies are reluctant to make a long-term commitment to new employees, rather choosing to make a commitment to a job position. The company seeks flexibility, not knowing the certainty of its future business growth, and chooses a contract employee, avoiding the benefit responsibilities normally attached to a company employee. Utilizing contractor status to avoid issues of overtime, benefits and bonuses may well trigger legal issues leading to litigation and financial exposure.
Misclassification of employees was an issue for one company where I served as a director because it had both employees and contractors performing similar duties. The contracted “employees” did not receive overtime or bonuses. They would have been better compensated had they been salaried employees and been paid overtime for their weekends, evenings and holiday employment. In their minds, they were being “abused” because they were compensated at a fixed rate with no inclusion in the company’s benefits or bonus programs.
Yet, they were working excessive hours, well beyond 40 hours a week. Such an arrangement was attractive to the contract employees as a temporary position, but as the contract employees became personally integrated into the culture of the company, the compensation arrangement became contentious. Eventually, the company—under pressure from state regulatory offices—ended the contractor relationship and added additional employee positions.
Many employment practices once viewed as temporary and implemented in a recessionary period have morphed into permanent changes in attitude towards full-time employment. I urge directors to request an employment audit from their human resources department, accompanied by a risk analysis from the general counsel. Such reports would review current classifications of employees and determine whether such classifications and employment practices represent a long-term strategy that is both beneficial to the company’s growth and in compliance with regulatory standards. Perhaps it would be advisable for boards to retain outside legal counsel with specialty in employment law to review the company’s overall employment practices, and to determine whether they’re compliant with existing laws. It’s vital boards of directors understand that utilization of outside consultants, annuitants, part-time employees and even interns carries exposure that they may not anticipate, given the obligations of companies to provide training, healthcare and pension benefits, and to protect such employees against any type of liability that might occur in a workplace environment.
Nobile: If the board, for example, is going to conduct or commission an audit, one of the first things it should certainly do—and you mentioned getting the general counsel involved, and I think it’s an important point to highlight—is make sure whatever audit that’s done is a privileged and confidential audit to the maximum extent practicable. Getting the general counsel involved, perhaps with either internal counsel or outside counsel, could help privilege the report or study, and perhaps prevent it from being discoverable in litigation, which is obviously a critical point. If you’re going forward and conducting an audit, you better be prepared to implement whatever findings the auditor comes out with at the end. If the auditor states that jobs are misclassified—someone is classified as exempt when they should be nonexempt, or is classified as an independent contractor when they should be an employee, or someone is classified as an intern and should be an employee—the company wants to be in a position to argue that the study is a privileged study and, thus, not discoverable. The last thing you would want to see is a class-action lawsuit being filed, based on an audit report, the results of which were not implemented.
Connell: That raises the role of boards in terms of corrective actions. It is generally assumed that human resources practices are the responsibility of management. Boards adopt a hands-off attitude, becoming unwilling to consider modifying personnel policies and then delegate that responsibility to the human resources department.
Boards should be advised to focus serious attention on risk-management responsibilities. Their risk-analysis radar should be broad enough to recognize the potential red flag of poorly defined or executed personnel practices. The plaintiffs’ bar is becoming more sophisticated, as they look at this whole new arena of employee benefits and compensation.
Boards of directors may also choose to define a process for considering their company’s obligations under the new healthcare legislation. Both “best practices” for employment policies and effective healthcare implementation are worthwhile topics for board retreats where more extended discussion is possible.
Nobile: There is no more heavily regulated area of business than the HR side of the business. At the federal level alone in the United States, we have in excess of two dozen statutes that govern every decision that an employer makes, from inception and recruitment through termination of employment. We also have state and local laws in every jurisdiction as well that compound the problems that employers have in terms of compliance.
Quite frankly, I think education is much needed, to show board members some of the trends that are occurring out there. When you look at litigation, right now, wage and hour cases are probably number one in the United States. There are literally hundreds of class actions that are filed against every major corporation, and there have been some phenomenal settlements. Wal-Mart, for example, recently had a $172-million verdict in a wage and hour case. Merrill Lynch had a $37-million settlement in a wage and hour case. But the reality is, no employer is immune from these types of actions, and board members should be aware of the trends and what is happening with other similarly situated companies. What’s going on in industry? What are the plaintiffs’ lawyers focusing on these days?
Connell: As boards report to the Securities and Exchange Commission on their risk-management policies, citing areas where the company might have long-term exposure, potential employment litigation should be included, given the increase in litigation, and the impact that it has on the perception of a company’s brand. As employment litigation exposure increases for companies, it’s vital for boards to become better educated on employment issues—not to micromanage this issue, but to be proactive in defining strategies that are protective of the company’s interests.
It’s important that a company seeks to create a culture where best employment practices are upheld and present, and future employees are respected. Well-formulated employment practices will reduce the likelihood of costly employment litigation and enhance a company’s brand and reputation.