Under California law, an employer must pay nonexempt employees overtime if they work above a set number of hours. A person employed in an administrative capacity, however, is exempt from the overtime rules if he or she is primarily engaged in exempt duties and is paid a salary that meets specified criteria. These rules are discussed in detail in Chapter 10 of the Wage and Hour Manual for California Employers by Attorney Richard J. Simmons of Sheppard Mullin, which was cited in the case below.

On November 9, 2020, the California Court of Appeal addressed the state administrative exemption in Semprini v. Wedbush Securities, Inc., __ Cal. App. 5th __ (2020). The case involved a class claim that the employer had misclassified financial advisors as exempt employees. The question presented was whether a compensation plan based solely on commissions, with recoverable advances on future commissions, qualifies as a “salary” for purposes of the exemption. The court concluded it does not and reversed the judgment of the trial court in favor of the employer.

1. Facts

The employer, Wedbush Securities, Inc., is a securities broker-dealer firm that provides financial planning and investment products through its financial advisors. It classifies its California financial advisors as exempt under the administrative exemption. That exemption only applies if an employee satisfies a duties test and earns a monthly “salary” equivalent to at least twice the state minimum wage. The central issue in the case was whether the Wedbush compensation model met that requirement.

a. The Commission Plan

The employer pays its financial advisors on a commission-only basis. It uses a computer program to track the trades they make in a given month and then calculates the compensation owed based on what commission tier the employee met that month. The higher the employee’s total monthly gross product sales, the higher the percentage used to calculate the employee’s monthly commission payment.

b. The Draw/Advance System

If the amount of commissions a financial advisor earns in a given month is not at least double the California minimum wage, the employer pays the financial advisor the commission due plus a “draw” – or advance on future commissions – in an amount equal to the difference between the commission and double the minimum wage. According to the employer, this ensures financial advisors always receive a minimum monthly payment of at least double the minimum wage. The employer pointed out that most financial advisors earn compensation above the guaranteed minimum.

Notably, financial advisors are expected to repay the draw and then carry it forward as a deficit, month to month and even year to year, until it is repaid. To recoup draw payments, the employer reduces the employee’s future monthly commission payments, to the extent they exceed double the minimum wage, until the draw is repaid in full.

2. The Lawsuit

Two individuals sued the employer in a proposed class action on behalf of employees who were paid once a month and earned commissions in the preceding four-year period. They asserted various wage and hour claims based on the alleged misclassification of financial advisors as exempt. In response, the employer raised the administrative exemption as one of its affirmative defenses.

The trial court granted a motion to certify the class of approximately 105 class members. The court then bifurcated trial to decide first whether the employer’s compensation structure satisfied the salary basis test. Following a bench trial, the court ruled that the compensation plan satisfied the salary basis test and that the administrative exemption provided a complete defense to all remaining claims. Accordingly, it entered judgment in the employer’s favor.

3. Court Relied On Simmons’ Wage And Hour Manual For California Employers

The Court of Appeal began its analysis by stating that the only issue before it was whether the compensation plan satisfied the administrative exemption’s salary basis test. The parties stipulated the duties test was satisfied.

In addressing the question, the Court of Appeal cited with approval Section 10.4 of the Wage and Hour Manual for California Employers by Richard J. Simmons. It noted that the treatise recognized that “salaried employees are paid for the general value of their services rather than the precise amount of time spent on the job.”

The court also referenced the federal regulations, stating that an employee is paid on a salary basis if the employee “regularly receives each pay period on a weekly, or less frequent basis, a predetermined amount constituting all or part of the employee’s compensation, which amount is not subject to reduction because of variations in the quality or quantity of the work performed.” The regulations then add the following: “An employee is not paid on a salary basis if deductions from the employee’s predetermined compensation are made for absences occasioned by the employer or by the operating requirements of the business. If the employee is ready, willing and able to work, deductions may not be made for time when work is not available.”

4. The Court's Analysis

The court recognized that no California court had addressed whether a compensation plan based solely on commissions, with a recoverable draw against future commissions, qualifies as a “salary” for purposes of the administrative exemption. The court concluded it does not. It pointed out that the issue presented in the case before it was not whether paying a base salary of at least twice the minimum wage, plus commissions, satisfied the salary basis test. It noted that it might well reach a different conclusion if it were. Interestingly, the court considered new federal regulations that took effect on January 1, 2020, and referred to the payment of non-discretionary bonuses, incentives and commissions that are paid annually or more frequently.

a. The Role Of Advances

The court stated that “an advance is not a wage.” The employer therefore could not rely on its advances to satisfy the salary basis test, which requires employers to pay their employees at least double the minimum wage, not loan them that amount. Because the employer recoups the advances from future commissions, it does not pay wages (much less a salary) equivalent to twice the minimum wage.

b. Recapturing Draws At Termination

The court also chose to address conflicting evidence in the record as to what happens if a financial advisor’s employment is terminated before he or she has repaid all draws. To the extent the employer forces its employees to repay advances at termination, any such policy or practice would be “particularly problematic,” as an employee could conceivably work full-time, yet earn nothing at all.

For example, suppose the employer hired an investment advisor who, for one reason or another, sold no products for the first three months of employment, despite working 50 hours per week. Because the investment advisor earned zero commissions, the employer advanced the employee the equivalent of twice the monthly minimum wage for those first three months. If the employee’s employment is terminated at the end of that period, and if the employer forced repayment of all advances after the employee worked more than full-time for those months, that employee would receive net zero compensation for the time he or she worked. According to the court, such an arrangement would not only fail the salary basis test; it would violate state minimum wage requirements.

This portion of the new law essentially exempts app-based driver companies from the requirements of AB 5 and the ABC Test if the above conditions are met.

5. The Court's Conclusion

The court concluded that the employer’s commission-based compensation structure did not satisfy the salary basis test. Thus, the administrative exemption did not apply. The case offers several lessons regarding the exemptions in California law and the salary basis rules. Employers must understand that California’s wage-hour standards and exemption requirements are very stringent and at times unforgiving. Employers should further understand that compensation structures that appear creative on their face may encounter significant hurdles if they are challenged.

There is no substitute for advice from experienced wage-hour experts when designing and implementing compensation systems. This is particularly true when employers seek to classify employees as exempt. As the court pointed out, the Wage and Hour Manual for California Employers can be a useful resource, along with advice from expert counsel in this area.

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