Plaintiff s Lawyers Bullish On Merrill Lynch: Brokerage Firm Agrees To Pay $37 Million To Settle Overtime Claims By Stockbroker

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1 AUGUST 26, 2005 Plaintiff s Lawyers Bullish On Merrill Lynch: Brokerage Firm Agrees To Pay $37 Million To Settle Overtime Claims By Stockbroker By Dale A. Hudson In a settlement that may well be a harbinger of things to come for the financial services industry, the brokerage firm of Merrill, Lynch, Pierce, Fenner & Smith has agreed to pay $37 million to settle claims that it failed to pay its California stockbrokers overtime as required by federal and California law. The Merrill Lynch settlement illustrates the formidable challenges that confront employers who attempt to fully comply with the applicable provisions of state and federal laws regulating wage and hour matters. The settlement also demonstrates the risk employers take when they simply assume that their wage and hour practices must be legal because they are consistent with the standard practices of their industry. In fact, federal and state laws create overlapping rules governing wage and hour matters which are complex, technical, and often conflicting. This is particularly true for companies that have employees in California, which has adopted comprehensive wage and hour laws to supplement federal laws. Under both California and federal law, employers must pay overtime premiums to employees who work in excess of 40 hours a week unless the employees are exempt from overtime rules. California employers are also obligated to pay daily overtime premiums to employees who work in excess of eight hours in a work day. The most frequently invoked exemptions to the overtime rules are those for executive, administrative, and professional employees. The Merrill Lynch case involved interpretation of the administrative exemption, as well as a more obscure exemption for commissioned salespersons. (Both federal and California law also recognize a broader exemption for outside salespersons who spend more than half of their time away from the business making sales calls. In addition, since 2004, federal law has recognized a new exemption for highly compensated individuals who earn at least $100,000 per year.) 1 of 5

2 To be exempt from overtime (and minimum wage) rules under the administrative exemption, an employee must satisfy two tests: a duties test and a salary basis test. Under recently amended federal regulations, to satisfy the salary basis test, the employee must be paid a predetermined amount -- of not less than $455 per week -- which is not subject to reduction because of variations in the quality or quantity of work performed. The federal duties test requires that the employee s primary duty consist of office or non-manual work directly related to the management or general business operations of the employer or the employer s customers. In addition, the employee must exercise discretion and independent judgment with respect to matters of significance. California recognizes the administrative exemption, but imposes more stringent tests than federal law. To satisfy the salary basis test under California law, the employee must be paid a salary of not less than $540 per week, which, again, may not be subject to reduction because of variations in the quality or quantity of work performed. The California duties test is similar to the federal test, but further restricts the type of work that the employee may perform, and requires that the employee customarily and regularly exercise discretion and independent judgment with respect to matters of significance related to the management policies or general business operations of the employer or the employer s customers. In addition, the California administrative exemption generally requires that the employee spend more than half of his or her time doing exempt administrative work or work that is directed and closely related to exempt administrative work. In addition, federal and California law both recognize an exemption to overtime rules for certain employees who are paid by commission. To qualify for this exemption under federal law, (1) the employee must work in a retail or service establishment, (2) more than half of the employee s compensation must come from commissions on sales of goods or services; and (3) the employee must regularly be paid more than one and one-half times the applicable minimum wage (generally 1.5 $5.15 per hour). California law contains a similar exemption for commissioned employees, but it is not limited to retail or service establishments; it applies to employers covered by the Wage Orders governing the mercantile industry and professional, technical, clerical, mechanical and similar occupations. The Merrill Lynch litigation played out in this labyrinth of overlapping and conflicting rules. To use this labyrinth to its advantage, the plaintiff s attorney first broke the brokers into two general subclasses, those who were paid purely by commission, and those who received a salary or a combination of salary and commission. With respect to those brokers who were paid strictly by commission, Merrill Lynch argued that the brokers fell under the exemption for commissioned employees under both federal and California law. Although this argument was viable under California law, it could not succeed under federal law unless Merrill Lynch constituted a retail or service establishment. Regulations issued by the Department of Labor contain detailed listings of those businesses which the Department considers to be retail or service establishment. Unfortunately for Merrill Lynch, those regulations specifically state the stock or commodity brokers are not engaged in such a business. (The regulations also exclude many 2 of 5

3 other businesses that might otherwise be considered retail or service businesses, such as banks, mortgage companies, insurance brokers, finance companies, and tax and accounting service firms.) Moreover, plaintiff argued that these commissioned employees did not fall within the administrative exemption because, among other things, they were not paid on a salary basis. Merrill Lynch argued that because the brokers received a minimum draw each month, the salary basis test was satisfied. The brokers paid strictly by commission sought recovery of unpaid overtime under federal law only. With respect to those brokers who received at least part of their wages in the form of a salary, Merrill Lynch argued that they were covered by the administrative exemption. In response, the plaintiff argued that the brokers did not customarily and regularly exercise discretion and independent judgment with respect to matters of significance to the employer s business. The plaintiff also argued that these brokers did not satisfy the administrative duties test for administrative employees because they were engaged in production work, i.e., they were producing the product that Merrill Lynch was in the business of producing. Under the federal and California law, a worker who produces the day-to-day goods, services, or sales that are the employer s product are doing production work. In contrast, administrative work is defined as the intra-company work that supports or administers the management of the employer s (or its clients ) business, creates or enforces its internal policies, or oversees its general operations. As to this subclass of brokers, the plaintiff sought recovery of unpaid overtime (including daily overtime) under California law only. Although it is not clear that the brokers would qualify for the administrative exemption under the less rigorous federal test, those brokers did not seek recovery of unpaid overtime under federal law. The plaintiff also sought recovery on behalf of a third subclass of brokers from whose pay Merrill Lynch had made allegedly unlawful deductions for losses occasioned by trading errors or other mistakes. Under California law, employers are generally not allowed to make deductions from an employee s paycheck on account of losses occasioned by an employee s simple negligence, as opposed to gross negligence or dishonest or willful acts. In addition, the plaintiff alleged that Merrill Lynch took illegal deductions from the brokers earned commissions to cover a portion of the compensation for the broker s sales assistants. Under California law, non-management employees are generally not responsible for such business costs, and the rules governing deductions from all employees earned wages are quite strict. The plaintiff also sought recovery of penalties for failure to provide accurate wage statements, failure to provide rest and meal periods, and, as to former employees, failure to pay all wages upon termination. The tentative settlement, which requires court approval, calls for Merrill Lynch to pay an average of about $8,500 to 3,250 brokers, all located in California. Merrill Lynch will also pay the plaintiff s attorney s fees, which could constitute an additional $9.3 million. The settlement involves no admission of wrongdoing on the part of Merrill Lynch, but undoubtedly reflects Merrill Lynch s assessment as to the probable outcome if the case were tried. 3 of 5

4 It may come as a rude surprise to many businesses to learn that highly compensated brokers and salespersons, earning six-figure incomes, must be paid overtime for hours worked in excess of eight hours per day or forty hours per week. Indeed, it may well be that it is the very promise of commissions that motivates salespersons to work long hours with the understanding that those lucrative commissions will be compensation enough. However, as the Merrill Lynch litigation illustrates, if those employees fail to satisfy each of the requirements of an applicable exemption under both state and federal law, the employees are not exempt and must be paid overtime. The payroll practices followed by Merrill Lynch are apparently widespread through the brokerage industry, so copycat lawsuits are likely to follow. Typically, because the employees are entitled to recover, in addition to the unpaid overtime, various types of penalties and attorney s fees, the employer s exposure in such litigation is often several times the amount of the overtime that was not paid. Thus, it behooves companies in the financial services industry who employ inside salespersons to audit their practices to spot potential problem areas before a plaintiff s attorney does. We recommend that prudent employers: 1. Carefully review the distinct requirements of the applicable state and federal exemptions for commissioned employees to assure that all of the requirements are satisfied. 2. Review the job responsibilities of all employees currently classified as exempt to determine whether the classification is appropriate under both state and federal law. 3. While job descriptions constitute an appropriate starting point for this analysis, the focus should be on the actual duties performed by the employee on a day-to-day basis. 4. Review company practices with respect to payroll adjustments for exempt employees, making sure that deductions are only being taken as permitted by applicable federal and state law. 5. Consider implementing a safe harbor policy to preserve the salary basis portion of the federal administrative (and executive) exemption if inadvertent, but improper salary deductions are made. Federal regulations specify that an exemption will not be lost if, among other things, the employer has a clearly communicated policy prohibiting improper deductions, if it has a complaint mechanism to resolve disputes about such deductions, and if it reimburses the employee when it discovers that a deduction was improper. This safe harbor provision would not apply to overtime claims made under California law, but only to those made under federal law. 6. If you perceive that an employee is abusing exempt status by working an insufficient number of hours, this must be treated as a performance issue, not a payroll issue. The employee can be admonished or, in extreme cases, even terminated. In the alternative, you may elect to reclassify an employee as non-exempt (although this creates its own risks). 4 of 5

5 7. Do not rely on industry practice in classifying employees as exempt or non-exempt. It is not unlikely that your competitors are out of compliance with applicable laws, and industry practice is not a defense to a lawsuit. For more information on this issue or other employment law matters, please contact Dale A. Hudson (at or dhudson@nixonopeabody.com), or your Nixon Peabody attorney. The foregoing summary is provided by Nixon Peabody for education and informational purposes only. It is not a full analysis of the matter summarized and is not intended and should not be construed as legal advice. This publication may be considered advertising under applicable laws. If you are not currently on our mailing list and would like to receive future publications of Employment Law Alert or if you would like to unsubscribe from this mailing list, please send your contact information, including your name and address, to lblaney@nixonpeabody.com with the words Employment Law Alert in the subject line. Prior publications of Employment Law Alert are available on our Web site at 5 of 5