Lawsuit challenges DOL's 'independent contractor' rule days before it takes effect

The Department of Labor has offered plenty of assurance that its new definition of "independent contractor" won't disrupt the business models of independent advisory firms.

But groups like the Financial Services Institute just aren't buying it. 

On Tuesday, the lobbying and advocacy group representing more than 80 independent firms and 130,000 advisors joined a coalition mounting a legal challenge to the Department of Labor's new definition of independent contractor. That rule, meant to protect workers who aren't direct employees from various labor abuses, was approved in January. 

Labor officials have long worried that workers in industries ranging from construction and trucking to "gig economy" jobs at companies like Uber 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 in the Federal Register in January.

The rule was expected to take effect on March 11 — that is, unless the courts first derail it.

That's exactly what the Financial Services Institute and its fellow plaintiffs, including the U.S. Chamber of Commerce and National Federation of Independent Business, are asking for in their lawsuit in the U.S. District Court for the Eastern District of Texas. 

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As much as DOL's concerns may be valid in some types of business, groups like Financial Services Institute argue they're misplaced in the financial services industry. The plaintiffs, collectively calling themselves the Coalition for Workforce Innovation, contend in their complaint that, "Financial advisors' status as independent contractors gives them the flexibility to manage their own businesses, set their own hours, offer their preferred products and services, and enjoy a healthy work-life balance."

Most advisors, the critics contend, decide to go independent only after trying out direct employment at a large firm and deciding it's not for them.

"Independent financial advisors choose to be independent so that they can operate their own businesses and better serve their clients," Dale Brown, the president and CEO of the Financial Services Institute, said in a statement. "We remain committed to ensuring our members maintain that choice and have security in their classification status."

The Chamber of Commerce suggested the same is true in other industries.

"Individuals work as independent contractors for all kinds of reasons, including greater work-life balance, the ability to choose when and how to work, and the opportunity to be one's own boss," Marc Freedman, vice president of the U.S. Chamber of Commerce's employment policy division, said in a statement.

The Financial Services Institute 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 620,000 registered representatives by the end of 2022, according to the Financial Industry Regulatory Authority.

The new definition of independent contractors was proposed by the Labor Department in October 2022 as a replacement for a similar rule adopted under former President Donald Trump. Many industry groups had hailed the Trump rule as a welcome simplification because it made independent-contractor status depend mainly on the answers to two questions: How much control do workers exercise over their work? And how much do they stand to profit or lose from their own activities and decisions?

The new rule, adopted under President Joe Biden, will replace that with a six-factor test looking at the "totality of the circumstances" of a person's employment. When trying to decide someone's status, regulators will be taking into account the amount of skill required for a certain type of work, the permanence of a given working relationship and whether the work being performed is just one part of providing a particular product or service.

The Financial Services Institute and others in the industry responded with concerns that the new rule muddied the water by giving employers too many factors to weigh when deciding how to classify employees. Some also worried that firms that merely reminded their independent contractors of their duty to abide by federal and state law would be found by regulators to be exercising the sort of control that requires direct employment status.

In a list of frequently asked questions released when the new rule was published in the Federal Register, the DOL sought to quell these anxieties. The agency wrote that the rule had been amended to clarify that "actions taken by the potential employer for the sole purpose of complying with specific, applicable federal, state, tribal or local law or regulation" would not indicate "control."  

The Financial Services Institute's lawsuit makes it clear it's not convinced.

"Our members should not have to risk losing their independent contractor status because, for example, they are complying with federal and state securities rules," Brown said in his statement. 

The Financial Services Institute's lawsuit specifically challenges the steps the DOL has taken in adopting its new independent contractor rule. Specifically, it's questioning if the agency isn't violating the federal Administrative Procedures Act by "arbitrarily and capriciously" replacing the former Trump rule.

Similar arguments also arose in a previous attempt by the Biden Administration DOL to roll back the Trump definition of independent contractors. Not long after the inauguration in early 2021, the Labor Department under Biden issued an order withdrawing the Trump administration rule.

The FSI and other groups responded with a lawsuit that eventually led the U.S District Court for the Eastern District of Texas to overturn the withdrawal of the Trump rule. The DOL appealed to the Fifth Circuit Court of Appeals but that attempt was stayed after the agency announced it would be coming out with the new independent contractor test now being challenged.

The Financial Services Institute separately asked the Fifth Circuit Court of Appeals in January to revive that case. In both disputes, the industry group and its allies rely on similar arguments.

Not only do they accuse the DOL of violating the federal Administrative Procedures Act. They also say the agency has made no attempt to fulfill its obligation of estimating how much its proposed rule change is likely to cost affected businesses and workers. 

The suit contends the DOL has neglected to take into account costs stemming from Social Security and Medicare taxes firms will have to start paying if they have to reclassify contractors as direct employees, stricter recordkeeping requirements and the likelihood of increased litigation.

"The Department also ignores that forcing businesses to reclassify independent contractors as employees will result in decreased opportunities for independent workers, as many employers will not be able to afford to pay the costly benefits associated with reclassification," according to the suit. "Alternatively, those workers previously performing contract work will have to decide whether to accept employee roles at what will likely be lower rates of pay due to the benefit costs included in employer pay determination."