THE END OF FREE LABOR?

What's happened?

When considering environmental, social, and governance (ESG) factors, many primarily associate it with climate change, but this significantly overlooks the risks and opportunities associated with the latter two letters of the acronym.  

On the “S” side of the equation, the Department of Labor (DOL) recently announced it would be returning to long-standing rules about worker classification, and in so doing may be helping push ESG goals forward. In returning to these rules, the Department of Labor is making it easier to identify a worker as an employee, rather than an independent contractor. 

What does this mean? 

Many companies use a mix of employees and independent contractors for day-to-day business. However, these two types of workers are treated very differently.  

• Financially, an independent contractor is typically paid on a project or contractual basis. They are not entitled to benefits, workers compensation, and depending on the city or state, they are not protected by human rights legislation.  
• Conversely, employees are afforded benefits such as insurance, workers compensation, unemployment benefits, and protection from discrimination.  

There are a variety of reasons why a worker or a company would prefer one arrangement over the other. For example, from a worker’s perspective, a freelance writer may appreciate the ability to work for multiple publications without being tied down to just one.  

OK, got it—but what’s the big deal? 

With the rise of the gig economy, classifying employees has become a more pervasive and immediate concern. More and more workers have been joining the gig economy, sometimes full time.  

On March 11, 2024, the DOL changed a Trump-era rule redefining which workers are employees. Under the prior rule, it was easier to classify a worker as an independent contractor, allowing employers to avoid paying benefits to those workers; the proponents for changing the rule believe companies want to classify workers as contractors to avoid providing required benefits. For example, as large companies such as Uber and Alphabet comprise a greater number of contractors than employees, proponents worry a large part of the workforce will be left without protections. 

OK, it’s important…but what’s changed? 

The DOL’s test to classify workers as either contractors or employees is largely based on economic dependence. The previous rule in 2021 narrowed the factors for employee consideration, making it more difficult for workers to claim employee status. 

According to the DOL, the current rule intends to “reduce the risk that employees are misclassified as independent contractors while providing a consistent approach for businesses that engage with individuals who are in business for themselves.”  

In general, an employee is deemed to be economically dependent on a company when applying the economic realities test. The test weighs the totality of circumstances.  The final rule examines six factors (up from 2021’s five). These factors include: 

1. The opportunity for profit or loss depending on managerial skill 
2. Investments by the worker and the potential employer 
3. The degree of permanence of the work relationship 
4. The nature and degree of control 
5. The extent to which the work performed is an integral part of the potential employer’s business 
6. Skill and initiative 

These factors are weighted equally, whereas the previous rule emphasized higher predetermined weights for two of the factors at the expense of others. Additional factors may be considered if they are relevant to the overall question of economic dependence. 

What happens if a worker is misclassified? 

There are stiff penalties if a worker is misclassified, and the DOL has identified the classification of workers as a key issue this term. In addition to the national implications, many states have their own enforcement and penalties as well. The rules as they stand are expected to make it easier to find workers as employees and afford them more protections, which is a key goal of broader ESG initiatives emphasizing fairer practices. 

Why should you care? 

For long-term investors, understanding the implications of the DOL’s worker classification changes is crucial. While there may be short-term financial impacts, the broader alignment with ESG principles offers the potential for sustainable growth and resilience. Investors should focus on companies that not only comply with these new regulations but also leverage them to foster a more engaged and satisfied workforce, thereby driving long-term profitability and societal value. 

For example, tech companies, which have heavily relied on independent contractors to keep labor costs off their balance sheets, will be significantly impacted.  

• As these companies face new requirements to classify more workers as employees, the immediate financial implications will include increased labor costs due to benefits, insurance, and other employee protections.  
• However, by adhering to the new classification rules, companies can mitigate these risks, ensuring compliance and avoiding costly legal battles.  
• Long-term investors should favor companies that proactively address these regulatory changes, as they are likely to be more resilient against future regulatory scrutiny and potential litigation.  

Additionally, companies able to swiftly integrate these changes may also gain an early competitive edge. By leading in ethical labor practices, they can differentiate themselves in the market, potentially attracting investors who prioritize ESG and relevant values-aligned factors. This strategic advantage could enhance their market position, driving long-term growth and stability, while simultaneously strengthening their brand reputation and customer loyalty. In the long run, such companies will likely attract a more dedicated and productive workforce, potentially leading to greater innovation and efficiency.