Does a Commissions-Only Pay Structure Meet the Administrative Exemption’s Salary Basis Test?

Commission

Recently, the California Court of Appeals 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.

It doesn’t, and an advance, by definition, isn’t a wage, the Court said.

The Los Angeles securities broker-dealer firm’s financial advisors, who were paid on a commission-only basis, should not have been classified as exempt because the salary basis test of the administrative exemption wasn’t satisfied. Associate Justice Thomas M. Goethals wrote in his opinion that under California law, an employer generally must pay its employee overtime if he or she works above a set number of hours. But a person employed in an administrative capacity is exempt from this and other wage and hour requirements if he or she performs certain duties and is paid a monthly salary equivalent to at least twice the state minimum wage for full-time employment.

Payment Scheme for Financial Advisors

In this case, Wedbush Securities paid its financial advisors on a commission-only basis. The company 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 satisfied for the month. The higher the employee’s total monthly gross product sales, the higher the percentage used to calculate the employee’s monthly commission payment.

If the amount of commissions a financial advisor earns in a given month isn’t at least double the California minimum wage, Wedbush pays that 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. Wedbush argued that this ensures that its financial advisors always receive a minimum monthly payment of at least double the minimum wage. Wedbush also noted that its financial advisers can earn compensation above the guaranteed minimum, and “most of them did.”

However, the financial advisors are expected to repay the draw, and they carry it forward as a deficit until it is repaid. To get reimbursed for the draw payments, Wedbush reduces the employee’s future monthly commission payments—to the extent they exceed double the minimum wage— until the draw is repaid in full.

The Court’s Analysis

California law provides exemptions for employees who perform certain duties and who “earn[] a monthly salary equivalent to no less than two times the state minimum wage for full-time employment.” The law states that “persons employed in professional, technical, clerical, mechanical, and similar occupations,” are exempt under the administrative exemption if that employee: (i) is primarily engaged in exempt duties; and (ii) earns a monthly salary equivalent to no less than two times the state minimum wage for full-time employment.

Justice Goethals noted that the applicable law didn’t define what constitutes a “salary” or what it means to pay an employee on a salary basis for purposes of the exemption, but explained that a salary is generally understood to be a fixed rate of pay as distinguished from an hourly wage. But he explained that California courts follow the federal salary basis test and the regulations under the Fair Labor Standards Act for guidance in interpreting the salary basis test. These regulations say that to be exempt from the federal overtime pay requirement, an administrative employee must be engaged in specified administrative job duties and be paid on a “salary or fee basis.” Moreover, the regs state 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.”

Also, an employee isn’t 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.” 

[Effective January 1, 2020, this regulation was changed to add that “[u]p to ten percent of the salary amount required by § 541.600(a) may be satisfied by the payment of nondiscretionary bonuses, incentives and commissions, that are paid annually or more frequently.”]

The Wage and Hour Division of the U.S. Department of Labor states that “[e]mployers may satisfy up to 10 percent of the standard salary requirement ($68.40 per week) with nondiscretionary bonuses, incentive payments, and commissions,” but “must pay the exempt executive, administrative, or professional employee on a salary basis at least 90 percent ($615.60 per week) of the standard salary level.” Further, the WHD added that “this does not mean bonuses, [incentive payments, or commissions] are capped. It only means that the amount an employer may credit against the weekly standard salary level is limited to 10 percent of the required salary amount.”

Applying these standards, Justice Goethals reasoned that a commission-only compensation plan—i.e., a compensation plan based 100% on commissions—doesn’t satisfy the federal salary basis test. And since California follows the federal salary basis test, a commissions-only compensation plan can’t pass California’s salary basis test.

In addition, the federal regulations state that to meet the salary basis test, the employee must regularly receive “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.” Here, Wedbush’s compensation model doesn’t fit within that definition because the financial advisors’ commissions fluctuated every month based on their performance and the quantity of their sales. As such, this compensation system does not meet the salary basis test, the Court held. Wedbush’s financial advisers make less money if they sell fewer products, so their commissions aren’t a “predetermined amount” and can’t be considered a salary.

An Advance is Not a Wage

Also, the Court found that while earned commissions are wages under California law, advances on not-yet-earned commissions are not. Citing a 2005 decision, Justice Goethals wrote:

The essence of an advance is that at the time of payment the employer cannot determine whether the commission will eventually be earned because a condition to the employee’s right to the commission has yet to occur or its occurrence as yet is otherwise unascertainable. An advance, therefore, by definition is not a wage because all conditions for performance have not been satisfied.

Because an advance isn’t a wage, Wedbush couldn’t rely on its advances to satisfy the salary basis test. The salary basis test requires employers to pay their employees at least double the minimum wage, not loan them that amount, the Justice wrote. Because Wedbush recoups the advances from future commissions, it doesn’t pay wages (much less a salary) equivalent to twice the minimum wage.

Thus, Wedbush’s compensation structure doesn’t satisfy the salary basis test, and the administrative exemption doesn’t apply. Semprini v. Wedbush Securities, Inc., 57 Cal. App. 5th 246 *; 2020 Cal. App. LEXIS 1061 **; 171 Lab. Cas. (CCH) P62,084 (Cal. App. 4th November 9, 2020).

Takeaway

If you’re an employer trying to satisfy the “salary basis” test by paying your employees on a commission-basis, you should review your compensation models in light of this decision by the Court of Appeals.

California business owners should also note that the Court did state that up to 10% of an employee’s salary can be paid by nondiscretionary bonuses and commissions.

Questions about how to properly classify your salaried employees or how the Administrative Exemption’s Salary Basis Test applies to your business? Contact the experienced California employment law attorneys at Eanet, PC at (310) 997-4185.

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