By Jessica Wilson

Structuring a family’s investment activities can be complex. Across assets, activities, relationships and the particular circumstances of each family member-investor, a family office will typically provide a spectrum of services. While the role of the family office is, in part, to substitute the range of independent advisors needed, structuring a family office in a tax-efficient manner can be difficult due to the limitations that the tax law places on related persons and managing one’s own investments. One such limitation has been the inability to deduct trade or business expenses related to the family office. However, recent court cases offer new guidance to family offices that may entitle taxpayers to a deduction for trade or business expenses if the family office is structured properly.

Background

Lender Management, LLC v. Commissioner of Internal Revenue, T.C. Memo. 2017-246 (2017), provides family offices with a potential way to obtain trade or business expense deductions under Internal Revenue Code (the “Code”) Section 162 in connection with rendering investment management services.

Prior to tax reform legislation enacted in December of 2017 (the “2017 Tax Act”), Code Section 212 allowed taxpayers to deduct expenses incurred for the production or collection of income, to the extent such expenses exceeded 2% of the taxpayer’s adjusted gross income. The 2017 Tax Act suspended miscellaneous itemized deductions under Code Section 212 from 2018 through 2025.

Code Section 162, on the other hand, has not been suspended. Section 162 allows a taxpayer to claim as a deduction all of the ordinary and necessary expenses paid or incurred by the taxpayer during the taxable year in carrying on a “trade or business.” For example, payment of salaries and other compensation is deductible as a trade or business expense. However, it has long been held that an investor is not, by virtue of activities undertaken to manage and monitor his or her own investments, engaged in a trade or business.

Therefore, given the suspension of deductions under Section 212, it would be beneficial for the owners of income-producing activities if those activities were treated as a trade or business expense for tax purposes rather than as an investment activity engaged in for the production and collection of income.

Lender Facts

A recent case that many taxpayers and practitioners have been relying on to work around the suspension of Code Section 212 is Lender Management, LLC v. Commissioner. The Lender case involved a family business consisting of multiple LLCs. Every LLC at issue in Lender was co-owned, whether individually or through an entity, by the child, grandchild or great-grandchild of the family patriarch, or by the spouse of one of those people. Lender Management, LLC (“Management LLC”) directed the investment and management of assets owned by three investment LLCs, each of which were owned by Lender family members. Management LLC was also owned indirectly by two Lender family members. Management LLC owned only a minority interest in the investment LLCs.

The operating agreements of the investment LLCs provided Management LLC with a profits interest as compensation for its services to the extent that it successfully managed its clients’ investments. While Management LLC was owned by, and provided services to, Lender family members, it also held itself out as an active management entity to various governmental authorities, clients, investment banks, hedge funds and private equity funds. While each investor in the investment LLCs was in some way a member of the Lender family, Management LLC’s clients did not act collectively. The Tax Court noted that they were geographically dispersed, and some of them were even in conflict with each other. Thus, it did not simply make investments on behalf of the Lender family group. It provided investment advisory services and managed investments for each of its clients individually, regardless of the clients’ relationship to each other.

The Tax Court found that Management LLC was engaged in a trade or business for purposes of the deduction under Code Section 162. The Tax Court focused its attention on the activities of Management LLC and the family relationship among the investors. While family relationships are generally subject to heightened scrutiny, Lender Management’s activities and the positive facts in this case satisfied the Tax Court and the deduction under Section 162 was allowed.

Hellmann

About a year after the Lender decision, the Hellmann family petitioned the Tax Court for a similar issue. However, the Hellmann family had less favorable facts.

The Hellmanns were a group of family members who owned and operated GF Family Management, LLC (“GFM”). Like Lender, the issue raised in Hellmann was whether GFM was engaged in a trade or business within the meaning of Section 162, which would entitle it to claim ordinary business expense deductions for its operating costs. The IRS, as it did in Lender, argued that GFM was not engaged in a trade or business.

The Hellmann case eventually settled without a ruling, so it cannot be certain how the Court would have ruled. Prior to settlement, however, the Tax Court issued an order outlining some of its preliminary thoughts, which highlighted the differences between Hellmann and Lender:

• There were four Hellmann family members related to the court case; they all resided in the same city, had a good relationship, and the family office made investment decisions for the group as a whole. While the Lender family members, on the other hand, were geographically dispersed, in some cases did not get along or did not know each other at all, and the family office made decisions for each family member separately.
• The Hellman family members owned 99% of the relevant investment partnerships, and each of the four family members held a 25% interest in the family office. In contrast, the Lender family office did not own a significant portion of the LLCs it managed, and most of the family members who invested in the LLCs did not have an ownership interest in the family office.

Concluding Thoughts

While the Lender case does provide a helpful look at what the Tax Court views as a valid trade or business for purposes of deducting expenses under Code Section 162, it is important to keep in mind that the facts are key. The structure in Lender may not be the typical family office structure, but for clients with the appropriate expertise and family structure, Lender potentially provides an avenue for deducting family office expenses under Section 162.

Each family office attempting to deduct expenses under Section 162 should analyze its unique circumstances in connection with these cases. This article was authored by Jessica Wilson. If you are interested in establishing a family office, restructuring an existing family office to fit within this guidance, or would like to learn more about ways to maximize value to your family, please contact Jessica Wilson at jwilson@coblentzlaw.com or James Mitchell at jmitchell@coblentzlaw.com.

To view a PDF version of this article, please click here.

By Peter Wang and Jennifer Leung

This alert updates our initial alert on the CTA published on March 1, 2021, to reflect the final rule published by the Financial Crimes Enforcement Network (FinCEN) bureau of the U.S. Department of the Treasury on September 30, 2022.

On January 1, 2021, Congress passed the Corporate Transparency Act (CTA) as part of the 2021 National Defense Authorization Act. The CTA requires most private companies formed in the U.S. or registered to do business in the U.S. to report beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN) bureau of the U.S. Department of the Treasury. Although the CTA is intended to eliminate the anonymity of individuals that use shell companies for illegal activities, the reporting requirements will affect legitimate private companies. Companies should be aware of and prepare for the new reporting requirements to avoid civil and criminal penalties for failure to file the information when required.

FinCEN was tasked with adopting regulations detailing how the CTA would be implemented.  On September 30, 2022 FinCEN published its final rule implementing the CTA’s requirements for reporting.

Who Must Report?

Companies that are required to report their beneficial owners and applicants to FinCEN under the CTA are:

• Any domestic corporation, limited liability company, or other entity (limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships and business trusts) that is created by the filing of a document with a secretary of state or similar office (including an American Indian tribal office).
• Any foreign corporation, limited liability company, or other entity (limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships and business trusts) that is formed under the laws of a foreign country and registered to do business in any state or tribal jurisdiction by filing of a document with a secretary of state or similar office (including an American Indian tribal office).

Legal entities that are not created by the filing of a document with a secretary of state or similar office, including certain trusts, are excluded from the reporting requirements.

Who is Exempt from Reporting?

Twenty-three types of entities are exempt from the reporting requirements, most of which are regulated entities already required to report beneficial ownership information to regulators. The 23 types of exempt entities are Securities Issuers; Domestic Governmental Authorities; Banks; Domestic Credit Unions; Bank Holding Companies and Savings and Loan Holding Companies; Registered Money Transmitting Businesses; Broker-Dealers; Securities Exchange or Clearing Agents; Other Exchange Act Registered Entities; Registered Investment Companies and Advisers; Venture Capital Fund Adviser; State-Regulated Insurance Companies; State-Licensed Insurance Producers; Commodity Exchange Act Registered Entities; Public Accounting Firms; Public Utilities; Financial Market Utilities; Pooled Investment Vehicles; Tax Exempt Entities; Entities Assisting Tax Exempt Entities; Large Operating Companies; Subsidiaries of Exempt Entities; and Inactive Entities.

Large operating companies may also be exempt. For the large operating company exemption, the entity must have:

• 20 or more full-time employees in the U.S.;
• Operating presence at a physical office in the U.S. (not including a residence or shared space, except spaces shared with affiliates); and
• Filed a tax return in previous year showing more than $5 million in U.S.-sourced gross receipts or sales.

Certain subsidiaries may also be exempt. For the subsidiary exemption, if a reporting company is directly or indirectly owned by one or more exempt entities and an individual is a beneficial owner of the reporting company exclusively by virtue of such individual’s ownership interest in the exempt entity, the reporting company’s report should list the name of the exempt entity in lieu of the beneficial ownership information of such individual.

What must be Reported?

Reporting companies must file a report with FinCEN containing the following information regarding its “beneficial owners”:

• Full legal name;
• Date of birth;
• Current residential or business address; and
• Unique identifying number and issuing jurisdiction from an acceptable identification document (and the image of such document), such as a driver’s license or passport.

For reporting companies formed or registered on or after January 1, 2024, the reporting company must also report the above information for “company applicants.”

Definitions of Beneficial Owner and Company Applicants

A “beneficial owner” is any individual who, directly or indirectly, either exercises substantial control over the reporting company or owns or controls at least 25% of the ownership interests of the reporting company.

An individual exercises “substantial control” over a reporting company if such individual:

• Serves as a senior officer (except for corporate secretary or treasurer);
• Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body);
• Directs, determines, or has substantial influence over important decisions made by the reporting company; or
• Has any other form of substantial control over the reporting company, including as a trustee of a trust.

The five exclusions from the definition of a beneficial owner include:

1. Minor children, if the child’s parent’s or guardian’s information is reported properly;
2. Individuals acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
3. An individual acting solely as an employee who is not a senior officer;
4. An individual whose interest in an entity is only through a right of inheritance; or
5. Certain creditors.

“Ownership interests” includes equity interests in the reporting company, as well as capital or profit interests, convertible instruments, warrants or rights or other options or privileges to acquire equity, capital or other interests in a reporting company. Any debt instrument is also deemed to be an “ownership interest” to the extent it enables the holder to exercise the same rights as one of the specified equity or other interests in the definition of “ownership interests.”

When determining whether an individual owns or controls 25% or more of the ownership interests, the individual’s ownership interests should be aggregated and should be compared to the “undiluted ownership interests” of the reporting company. If options or profits interests are outstanding, they are deemed to be exercised and “in the money” for purposes of the 25% ownership test. If there is more than one class of equity interests outstanding, the 25% threshold is determined as a percentage of all outstanding interests if possible, but, failing that, more than 25% of any class of equity interests triggers the reporting requirement.

An individual may directly or indirectly own or control an ownership interest of a reporting company through a variety of means, including through the following, among others:

• Joint ownership with one or more other persons of an undivided interest in an ownership interest;
• Control of such ownership interest owned by another individual; and
• With regard to a trust or similar arrangement that holds an ownership interest:
  • acting as a trustee of the trust or other individual (if any) with the authority to dispose of trust assets;
  • being a beneficiary of the trust who (a) is the sole permissible recipient of income and principal from the trust, or (b) has the right to demand a distribution of or withdraw substantially all of the assets from the trust; or
  • being a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust: (a) through ownership or control of one or more intermediary entities, or ownership or control of the ownership interests of any such entities that separately or collectively own or control ownership interests of the Reporting Company, or (b) through any other contract, arrangement, understanding or relationship.

“Company applicants” are limited to two persons:

• The individual who directly files the document to create or register the reporting company; and/or
• The individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing.

For example, if an attorney oversees the preparation and filing of incorporation documents and a paralegal files them, the reporting company would report both the attorney and paralegal as company applicants.

When are Reports Due?

Reporting companies created or registered before January 1, 2024 will have until January 1, 2025 to file their initial beneficial ownership reports with FinCEN. Reporting companies created or registered on or after January 1, 2024, will be required to file initial beneficial ownership reports within 30 days of formation or registration.

If there is any change with respect to required information previously submitted to FinCEN concerning a reporting company or its beneficial owners, including any change with respect to who is a beneficial owner or information reported for any particular beneficial owner, the reporting company is required to file an updated report within 30 calendar days of when the change occurred.

How Will Companies Report?

FinCEN is developing a Beneficial Ownership Secure System (BOSS) where the reports will be submitted electronically through an online interface. The BOSS will be secured to the highest information security protection level under the CTA. FinCEN intends to issue additional regulations governing who may access the information and what safeguards will be required to ensure that the information is secured and protected.

FinCEN will also publish reporting forms and guidance documents that companies will use to comply with their obligations under the CTA in advance of the date the reports are due.

What Happens if a Reporting Company Fails to Report?

Companies or individuals who violate the CTA will be subject to civil penalties of not more than $500 per day, capped at $10,000, and imprisonment of up to two years if an individual willfully provides false information or fails to report. Beneficial owners and senior officers of the reporting company can be held liable.

What Should I do Now?

Management of companies should determine if they are a reporting company and start compiling the required information on all of the beneficial owners and company applicants. They should also consider including the following in their company’s operative documents:

• A representation by each shareholder, member or partner, as applicable, that it will be in compliance with or exempt from the CTA;
• A covenant by each shareholder, member or partner, as applicable, requiring continued compliance with and disclosure under the CTA or to provide evidence of exemption from its requirements;
• An indemnification by each shareholder, member or partner, as applicable, to the company and its other shareholders, members or partners, as applicable, for its failure to comply with the CTA or for providing false information; and
• A consent by each disclosing party for the company to disclose identifying information to FinCEN, to the extent required by law.

Investment funds should consider adding similar representations and covenants by their investors to their subscription and management agreements. Lenders should also consider adding similar representations and covenants by their borrowers to their loan documents.

For questions, or to further discuss how to prepare your business to comply with the Corporate Transparency Act, please contact Peter Wang at pwang@coblentzlaw.com, Jennifer Leung at jleung@coblentzlaw.com, or any member of the Coblentz Corporate team.

 

 

 

By Hannah Jones, Anthony Risucci, Fred Alvarez

Beginning January 1, 2023, California will join a minority of jurisdictions that impose significant pay transparency requirements on employers. California’s law, however, goes further than existing mandates in Colorado, New York City, and other states and municipalities. In case you missed it, California’s new law was covered extensively in our previous alert.

To recap, SB1162 imposes four main obligations of California employers. First, employers with 15 or more employees must post pay scales on all job postings. Second, the new law will require all employers—regardless of size—to provide pay scale information to employees upon request. Third, employers must maintain pay history information for every employee for three years after termination. Finally, employers with more than 100 employees must submit annual “pay data reports” to the California Civil Rights Division by the second Wednesday of every May starting May 2023.

Failure to comply with SB1162’s pay scale mandates can result in civil penalties ranging from $100 to $10,000 per violation, depending on the circumstances. While the Labor Commissioner is authorized to assess and levy penalties, the new law also provides a private right of action for individuals to seek injunctive and “any other relief that the court deems appropriate” for violations. While the law has yet to be tested in court, and despite there being a private right of action, aggrieved employees may also attempt to claim the right to sue collectively under the California Private Attorneys General Act (PAGA)—a law that allows employees to pursue civil penalties on behalf of the state on a representative basis without meeting the rigorous requirements of class certification. Thus, non-compliance can lead to significant litigation exposure beyond just the penalty for one violation.

To assess whether your organization is ready for California’s pay transparency obligations and to protect against the litigation risks of non-compliance, consider the following:

1. Have you established the “pay scale” for all positions within your organization?
2. How will you set the “pay scale” range given factors like geography, experience and education, and will you follow the same formula for each role?
3. Do you have a process for responding to employee requests for pay scale information?
4. How will you draft job postings for remote positions that can be performed anywhere, including California?
5. Are you compliant with existing pay transparency laws (e.g., Colorado and New York City), and will you provide pay transparency information to applicants and employees outside of states that require it?
6. What additional pay records will you need to maintain beyond your current practice?
7. How will you respond to questions from existing employees that request pay information regarding where they sit in the pay scale?

While this is not an exhaustive list to help prepare for pay transparency in 2023, these are some of the key questions that each organization should consider and answer before the new year. Contact Coblentz Patch Duffy & Bass LLP’s Labor and Employment practice group for more information about pay transparency compliance.

By Karen Frank and Sabrina Larson 

In December 2020, Congress passed the Trademark Modernization Act (the “TMA”), providing for numerous changes in the processes for registering trademarks and maintaining trademark registrations in the United States. Key elements of the TMA come into effect on December 1, 2022. This client alert discusses important terms of the TMA that companies should be aware of that provide new tools to clear unused trademarks from the U.S. Trademark Register and for the Trademark Office (the “USPTO”) to move applications through examination more efficiently.

Key terms of the TMA:

Office Action Response Time Shortened to Three Months
To-date, applicants for trademark registration have had six months to respond when the USPTO raises issues on an application (an “Office Action”). The TMA shortens the response time to three months. The TMA provides the option for Applicants to obtain one three-month extension to respond to an Office Action, for a $125 fee. This shortened response time is expected to significantly speed up the timing for obtaining trademark registrations.

Two New USPTO Ex Parte Proceedings
The TMA creates two new proceedings under which anyone can petition the USPTO to investigate the validity of a U.S. trademark registration. Under these so-called “ex parte” proceedings, a party can petition to have a trademark registration to be reexamined with regard to select goods or services, or expunged entirely, based on a reasonable investigation showing that the mark has not been used for some or all of the goods or services covered by the registration. The petition for expungement may be filed between 3 and 10 years after a mark is registered, and the petition for reexamination must be filed within 5 years of registration. These new Trademark Office proceedings create opportunities to clear the U.S. Trademark Register of registrations that are based on inaccurate claims of use in commerce in the United States. The proceedings are expected to be faster, more efficient, and less extensive (and generally less expensive) alternatives to more formal proceedings before the Trademark Trial and Appeal Board.

Trademark Litigation: Presumption of Irreparable Harm
The TMA creates a statutory nationwide uniform standard of a presumption of irreparable harm to be applied in trademark cases where the trademark owner establishes infringement. This resolves a previous circuit split among the courts and reduces the evidentiary burden on trademark owners seeking to obtain injunctive relief in litigation.

If you have any questions about the TMA or seek counsel regarding trademarks, please do not hesitate to reach out to Karen Frank or Sabrina Larson.

By Anthony Risucci

On September 27, 2022, Governor Newsom signed Senate Bill (“SB”) 1162 into law. The law alters and expands pay reporting obligations to California’s Civil Rights Department (“CRD”)1 for private employers with 100 or more employees. The law also increases pay transparency obligations under Labor Code Section 432.3, including changes that apply to both public and private employers of all sizes.

As explained in more detail below, SB 1162 requires employers to do the following:

• Private employers with more than 100 employees must submit detailed “pay data reports” to the CRD by the second Wednesday of May every year. The pay data report submission obligation now exists independently of similar federal reporting obligations to the Equal Employment Opportunity Commission.
• All employers must provide pay scale information to employees and job applicants for their position upon request.
• All employers with more than 15 employees must publish pay scale information on every job posting for the position being filled.
• All employers must maintain pay history information for every employee for the duration of their employment, and for three (3) years beyond the date their employment ends.

Pay Data Reporting Requirements

A. Pay Data Reporting Requirements Before SB 1162
Prior to the enactment of SB 1162, private employers with 100 or more employees were required to file a “pay data report” to the CRD. Pay data reports are required to contain employee pay data for specific job categories broken down by race, ethnicity, and sex.  

California law allowed for this requirement to be met by filing an Employer Information Report (“EEO-1”) (a form specifically prepared for the Equal Employment Opportunity Commission for similar federal reporting requirements) on or before March 31 each year, so long as the EEO-1 report included substantially similar pay data information. California law also required employers with multiple establishments to submit a report for each establishment and a consolidated report that included all employees. The first such reports were due in 2021.  

B. New Pay Data Reporting Requirements
SB 1162 simultaneously streamlines and complicates pay data reporting requirements by amending Government Code Section 12999. That statute now requires private employers with more than 100 employees to submit a pay data report to the CRD. An EEO-1 form is no longer sufficient. (See Gov. Code § 12999, subd. (a)(1).) Private employers with 100 or more employees hired through labor contractors within the prior calendar year are also now covered by the reporting requirements (collectively referred to as “Covered Employers”).² (Gov. Code § 12999, subd. (a)(2).)   

Covered Employers must now submit pay data reports containing all of the following information:

1. The number of employees by race, ethnicity, and sex in each of the following job categories:

• Executive or senior level officials and managers;
• First or mid-level officials and managers;
• Professionals;
• Technicians;
• Sales workers;
• Administrative support workers;
• Craft workers;
• Operatives;
• Laborers and helpers; and 
• Service workers.

2. The number of employees by race, ethnicity, and sex whose annual earnings fall within each of the pay bands used by the United States Bureau of Labor Statistics in the Occupational Employment Statistics survey.

3. The median and hourly wage rate within each job category, for each combination of race, ethnicity, and sex.

4. A “snapshot” that counts all of the individuals employed in each job category by race, ethnicity, and sex during a single pay period of the employer’s choice between October 1 and December 31 of that reporting year.

5. A calculation of the total earnings, as shown on Internal Revenue Service form W-2, for each employee in the “snapshot,” for the entire reporting year, regardless of whether or not an employee worked for the full calendar year. The employer must tabulate and report the number of employees whose W-2 earnings during the reporting fell within each pay band.

6. The total number of hours worked by each employee counted in each pay band during the reporting year.

7. The employer’s North American Industry Classification (NAICS) code.

(Gov. Code § 12999, subd. (b).) Pay data reports must also include a section for employers to provide clarifying remarks on the information provided and be made available in a format that allows the CRD to search and sort the information using “readily available software.” (Gov. Code § 12999, subds. (d)-(e).) Covered Employers that hire employees through a labor contractor are also required to disclose the ownership names of all labor contractors used to supply employees. (Gov. Code § 12999, subd. (a)(2).)

Pay data reports must be submitted on or before the second Wednesday of May 2023 and on or before the second Wednesday of May each year thereafter.³ (Gov. Code § 12999, subd. (a)(1).) Covered Employers with multiple establishments are still required to submit pay data reports for each establishment but are no longer required to submit a consolidated report for all employees in addition to establishment-specific reports.⁴ (See Gov. Code § 12999, subd. (c).)

Failure to comply with pay data reporting requirements may subject an employer to one or more of the following: (1) an order requiring compliance (with all costs associated with seeking the order being recoverable by the CRD); (2) a civil penalty not to exceed one hundred dollars ($100) per employee for an initial failure to file a report; and (3) a civil penalty not to exceed two hundred dollars ($200) per employee for continued failure to file a report. (Gov. Code § 12999, subd. (f).)

C. Confidentiality of Pay Data Reports Submitted by Covered Employers
Earlier versions of SB 1162 would have required CRD to publish individual employers’ pay data reports on a publicly accessible website. That is not the case with the version of the bill that Governor Newsom signed. The public posting requirement was removed from the bill by the Assembly Appropriations Committee.  

As was the case prior to SB 1162, CRD is permitted to compile data from pay data reports and publish “aggregate reports” that are available to the public. (Gov. Code § 12999, subd. (i).) Importantly, such reports must be drafted so as to be “reasonably calculated to prevent the association of any data with any individual business or person.” (Ibid.)  

SB 1162 also makes it “unlawful” for CRD “to make public in any manner . . . any individually identifiable information obtained” from a pay data report unless an investigation or enforcement proceeding is initiated against an employer.⁵ (Gov. Code  § 12999, subd. (g).) Any individually identifiable information submitted to CRD is also considered “confidential information and not subject to disclosure pursuant to the California Public Records Act.” (Gov. Code Section 12999, subd. (h).)

Pay Transparency Obligations

SB 1162 also greatly increases employer obligations under Labor Code Section 432.3. Unlike the pay data reporting requirements of Government Code Section 12999, changes to Labor Code Section 432.3 apply to all public and private employers. 

Prior to SB 1162, Section 432.3 primarily served to prohibit an employer from seeking salary history information about a job applicant or relying upon such information as a factor in determining what salary to offer that applicant. (Lab. Code § 432.3, subds. (a)-(b).) SB 1162 left those prohibitions in place, but added additional requirements for employers aimed at increasing pay transparency.  

All employers are now required to provide the pay scale for a position to a job applicant upon their request.⁶ (Lab. Code § 432.3, subd. (c)(1).) Current employees are also entitled, upon request, to the pay scale for the position they are currently employed in. (Lab. Code § 432.3, subd. (c)(2).)  

If an employer has 15 or more employees, they are required to include the pay scale for a position on any job posting—a significant change to the prevailing practice of not including salary information on job postings. (Lab. Code § 432.3, subd. (c)(3).) Use of a third party to announce, post, publish, or otherwise make an employer’s job posting known does not eliminate the requirement to include the pay scale in the job posting. (Lab. Code § 432.3, subd. (c)(5).) 

Employers are required to maintain records of job title and wage rate history for each employee for the duration of their employment, and until 3 years after their employment ends. (Lab. Code § 432.3, subd. (c)(4).) These records are open to inspection by the Labor Commissioner. (Ibid.) Failure to keep such records creates a rebuttable presumption in favor of an employee’s claim that the Labor Code has been violated. (Lab. Code § 432.3, subd. (d)(5).) 

An employee or job applicant that claims a violation of this statute may file a written complaint with the Labor Commissioner within one year of the alleged violation, or file a civil action that can provide “for injunctive relief or any other relief the court deems appropriate.” (Lab. Code § 432.3, subds. (d) (1)-(2).) The Labor Commissioner may levy fines against violating employers between one hundred dollars ($100) and ten thousand dollars ($10,000) per violation. (Lab. Code § 432.3, subd. (d)(4).) First time violators, however, may avoid civil penalties by demonstrating that all job postings for open positions have been updated to include pay scales. (Ibid.)

Conclusion

SB 1162 is part of a growing wave of pay transparency laws, including recently enacted laws in New York City, Colorado, and Washington state. Employers should prepare for pay transparency obligations to continue to arise in various jurisdictions. Attorneys of Coblentz Patch Duffy & Bass LLP’s Labor and Employment practice group are familiar with the new requirements imposed by SB 1162 and can assist employers in complying with these changes in the law.

 

[1] Formerly known as the Department of Fair Employment and Housing (“DFEH”).
[2] SB 1162 defines “employee” as “an individual on an employer’s payroll, including a part-time individual, and for whom the employer is required to withhold federal social security taxes from that individual’s wages.” (Gov. Code § 12999, subd. (k)(1).) A “labor contractor” is defined as “an individual or entity that supplies, either with or without a contract, a client employer with workers to perform labor within the client employer’s usual course of business.” (Gov. Code § 12999, subd. (k)(2).) If an employer has both 100 or more employees and 100 or more employees hired through a labor contractor, the legislation appears to require two separate reports, one for each category of employees. (See Gov. Code § 12999, subd. (a)(2).)
[3] SB 1162 does not alter pay data reporting obligations for 2021 or 2022, which were due on or before March 31 of each of those years. (Gov. Code § 12999, subd. (m).) The legislation also does not eliminate the possibility of administrative enforcement actions for failure to comply with reporting requirements in those years. (Ibid.).
[4] An “establishment” is defined as “an economic unit producing goods or services.” (Gov. Code § 12999, subd. (k)(3).)
[5] “Individually identifiable information” means “data. . . that is associated with a specific person or business.” (Gov. Code § 12999, subd. (g).)
[6] A “pay scale” means the salary or hourly wage range that the employer reasonably expects to pay for the position. (Lab. Code § 432.3, subd. (m).)

Originally published to the Transnational Litigation Blog, May 25, 2022.

By Alexander Preve

Two law firms recently filed a class action lawsuit on behalf of Rohingya refugees in the United States seeking at least $150 billion in compensatory damages from Meta (formerly Facebook). The plaintiffs in Doe v. Meta allege that Meta’s algorithms were designed to promote hate speech and misinformation about the Rohingya, a Muslim-minority population in Myanmar that has long been subject to discrimination and scapegoated by the Buddhist majority as terrorist “foreigners.” In response, Meta argues that it is immune from suit under the Communications Decency Act (“CDA”).

Although the plaintiffs attempt to plead around the limits of the CDA and Ninth Circuit precedent, these efforts are likely to fail. In an effort to sidestep Section 230 immunity, the plaintiffs contend that the district court should conduct a choice-of-law analysis solely on the immunity issue. This post first surveys the doctrinal landscape relating to Section 230. It then explains why the plaintiffs’ choice-of-law arguments are flawed and why the plaintiffs err in ignoring the presumption against extraterritoriality. It concludes with a proposal for how Congress should amend the CDA to achieve greater accountability when technology companies transition from publishers of information to creators of content.

Section 230 Immunity

This is not the first time a suit has alleged that a technology company has incited violence through its machine-learning algorithms. The Ninth Circuit has held that technology companies like Facebook, Twitter, and Google are immunized from civil liability when they act as “publishers” of information posted by third parties. The immunity provision of the CDA at issue, 47 U.S.C. § 230(c)(1), provides that “[n]o provider or user of an interactive computer service shall be treated as the publisher or speaker of any information provided by another information content provider.” From this provision, the Ninth Circuit has developed a three-fold test: a technology company enjoys immunity under the CDA if it is “(1) a provider or user of an interactive computer service (2) whom a plaintiff seeks to treat, under a state law cause of action, as a publisher or speaker (3) of information provided by another information content provider.” However, the Ninth Circuit has also held that this grant of immunity only applies if the interactive computer service provider (like Meta) is not itself an information content provider, which the CDA defines as someone who is responsible (in whole or in part) for the creation or development of the offending content.

The plaintiffs in Doe v. Meta seek to leverage this distinction by characterizing Meta as an information content provider that created and proliferated anti-Rohingya hate speech through its machine-learning algorithms. It will be difficult for the plaintiffs to make this distinction in light of Ninth Circuit precedent. In Gonzales v. Google LLC, the plaintiffs sued Google, Facebook, and Twitter, alleging that these technology companies facilitated the terrorist activities of ISIS by recommending ISIS recruitment videos to users and enabling users to locate other videos and accounts related to ISIS. The Ninth Circuit found that the plaintiffs had not alleged (1) that Google’s algorithms had prompted ISIS to post unlawful content, or (2) that Google’s algorithms treated ISIS-created content differently than any other third-party created content. Thus, the Ninth Circuit held that these companies’ algorithms were “content-neutral” and entitled to Section 230 immunity. In Doe, the plaintiffs seek to distinguish Gonzalez by arguing that Meta’s algorithms in Myanmar were “far from neutral” because Meta developed a “dopamine-triggering reaction mechanism” that intentionally promoted the most hateful and divisive content regarding the Rohingya. The plaintiffs also argue that the theory of liability in Gonzalez (which relied on a “matchmaking” theory based on Google’s recommendations of terrorist content to other users) is different from the plaintiffs’ primary theory of liability, which alleges that Meta used reward-based algorithms that induced users to post harmful content.

These arguments are unlikely to succeed. The Ninth Circuit has interpreted Section 230 extremely broadly, particularly when it comes to machine-learning algorithms that recommend content and connections to users. The plaintiffs creatively argue that the CDA is inapplicable because they are suing Meta as the designer of a defective product rather than in its capacity as a publisher exercising editorial discretion. This is one of the plaintiffs’ stronger arguments. The Ninth Circuit recently considered the same argument in a lawsuit against Snapchat. In Lemmon v. Snap, Inc., the plaintiffs alleged that Snapchat negligently designed a “filter” that incentivized users to send photos while operating vehicles at high speeds. The Ninth Circuit held that Section 230 immunity did not apply because the plaintiffs sought to hold Snapchat liable for its distinct duty to design a reasonably safe product (rather than seeking to hold Snapchat liable as a publisher). The problem is that the legal theory in Doe rests on Meta’s acts and omissions as a moderator of third-party content, as opposed to Meta’s acts as the designer of an app.

The question of whether the district court will grant immunity to Meta is an interesting one. But there is also the question of when the court will rule on the immunity issue. It is unclear whether Section 230 immunity is like other forms of immunity (e.g., qualified immunity) that are frequently applied at the pleading stage to immunize defendants not just from liability, but from being subject to costly and potentially embarrassing discovery. Here, the plaintiffs contend that the immunity issue can be postponed to a later stage of the litigation. As the plaintiffs note, the Seventh Circuit has followed this approach and allowed discovery to proceed. If the district court denies Meta’s motion to dismiss and permits discovery, this could have broader implications for Meta (even if the Court later grants Section 230 immunity).

Doe v. Meta is being brought at a time when there is a growing consensus that Section 230 of the CDA, which was enacted in 1996, sweeps far too broadly. In Gonzalez, Judge Berzon concurred in the majority opinion but urged the Court “to reconsider [its] precedent en banc to the extent that it holds that section 230 extends to the use of machine-learning algorithms to recommend content and connections to users.” And as Professor Rebecca J. Hamilton notes in a recent article on accountability for platform-enabled crimes, there are bipartisan efforts to repeal or reform the CDA.

This case is a prime example of how times have changed. The plaintiffs in Doe note that the vast majority of Burmese citizens obtained cell phones in 2011, and Facebook arranged for them to use the Facebook app without incurring data charges. For many Burmese, Facebook was the internet, which made the dissemination of hateful rhetoric that much easier. The business reality today, when technology companies play a vital role in the dissemination of information, differs markedly from the reality that existed in 1996.

Presumption Against Extraterritoriality

The plaintiffs in Doe v. Meta argue that Section 230 does not apply on the facts presented. They claim that this statute conflicts with Burmese law, which (according to the plaintiffs’ expert declaration) does not immunize technology companies from liability for third-party content published on their platforms. The plaintiffs do not assert that Burmese law conflicts with the causes of action for strict product liability and negligence, which are governed by California law. Instead, the plaintiffs contend that a choice-of-law analysis is warranted solely for Meta’s asserted defense of immunity under the CDA, if the court finds that Section 230 immunity applies.

The plaintiffs’ arguments are flawed. The CDA is a federal statute, the applicability of which does not depend on state choice-of-law rules. To determine whether the CDA applies to claims arising out of Meta’s activities in Myanmar, the court should look instead to the federal presumption against extraterritoriality. The presumption against extraterritoriality is a canon of statutory interpretation that provides that, absent clearly expressed congressional intent to the contrary, federal laws are construed to only have domestic application. Under a two-step framework, courts first ask whether the statute provides a clear, affirmative indication that it applies extraterritorially. If not, then courts move on to the second step and ask whether the case involves a domestic application of the statute. To make that determination, courts look to the statute’s “focus.” The Supreme Court has defined the focus of a statute as the “object of its solicitude,” which can include the conduct the statute seeks to regulate and the parties or interests it seeks to protect or vindicate. If the conduct relevant to the statute’s focus occurred in the United States, then the case involves a permissible domestic application of the statute. But if the conduct relevant to the focus of the statute occurred in a foreign country, then the case involves an impermissible extraterritorial application of the statute.

In Gonzalez, the Ninth Circuit applied the presumption against extraterritoriality to Section 230. Since the CDA does not contain a clear, affirmative statement that it applies extraterritorially, the Ninth Circuit moved on to the second step and analyzed the focus of Section 230. Because the object of the CDA’s solicitude is to encourage providers of interactive computer services to monitor their websites by limiting their liability, the court held that “the relevant conduct occurs where immunity is imposed, which is where Congress intended the limitation of liability to have an effect, rather than the place where the claims principally arose.” The Ninth Circuit therefore concluded that the Gonzalez plaintiffs’ claims involved a domestic application of Section 230 and that the defendants were entitled to immunity.

The district court is likely to follow this reasoning and find that the Doe plaintiffs’ claims against Meta similarly involve a domestic application of Section 230. The plaintiffs seek to circumvent this analysis, arguing that “Gonzalez addressed the CDA extraterritoriality argument … [which is] an argument that Plaintiff[s] [are not] making here.” Unfortunately for the plaintiffs, the Ninth Circuit’s prior interpretation of Section 230 binds the district court regardless of whether the plaintiffs raise the presumption against extraterritoriality in their complaint.

The notion that the court must engage in a choice-of-law analysis under California law to determine whether a federal statute—the CDA—applies to the claims fundamentally misunderstands the nature of the inquiry. Courts do not apply state choice-of-law rules to determine the applicability of federal statutes. In support of their choice-of-law argument, plaintiffs cite Bassidji v. Goe, which applied California choice-of-law rules to decide whether an Executive Order prohibiting U.S. citizens from doing business with Iran applied to a contract made in Hong Kong. In Bassidji, however, the court ultimately held that federal law did apply by utilizing California’s public policy exception. Regardless of whether the Ninth Circuit was correct in Bassidji to examine the question through the lens of state choice of law rules, the plaintiffs have not cited any case in which courts have used such rules to displace federal law in favor of foreign law.

Conclusion

Doe v. Meta is a stark reminder of the need for Section 230 reform. Technology companies such as Meta exercise enormous influence over the dissemination of information, particularly in developing countries with low rates of digital literacy. Machine-learning algorithms can facilitate violence, misinformation, and atrocity crimes, and there is bipartisan consensus that the current system of self-regulation is outdated.

To address these issues, Congress should amend Section 230 of the CDA to provide that an individual or entity acts as an information content provider when it employs algorithmic friend-suggestion features. The Doe v. Meta complaint notes that Meta’s algorithms provide “friend suggestions” based on an analysis of users’ existing social connections on Meta and other behavioral and demographic data. The plaintiffs allege that Facebook’s friend suggestion algorithms connected violent extremists and susceptible potential violent actors who were sympathetic to the anti-Rohingya cause. By tailoring friend suggestions to individual users, Meta was arguably creating its own content rather than acting as a publisher exercising editorial discretion, which is the function that the CDA immunizes from liability. Friend-suggestion features are a creature of online social networks, which were virtually nonexistent when the CDA was enacted in 1996. By excluding friend-suggestion features from Section 230 immunity, Congress can modernize the CDA to (1) ensure some level of accountability when social media companies facilitate atrocity crimes and (2) more accurately capture the conduct that makes an individual or entity the publisher of third-party content.

By Stephen T. Lanctot

As with every new year, California rolled out new laws affecting the workplace beginning January 1, 2022. Below is a summary of some of the most relevant changes that may affect your business. As always, please reach out to any of our labor and employment attorneys at Coblentz if you have any questions or concerns about new legislation or amendments to existing laws.

California’s Minimum Wage Increase – SB 3: Effective January 1, 2022, California’s state minimum wage will increase to $15 per hour for employers with more than 25 employees, and it will increase to $14 per hour for employers with 25 or fewer employees. As a result, the minimum monthly salary for California exempt-status employees will increase to $5,200 per month, or $62,400 annual salary (which is equal to twice the minimum wage based on a
40-hour workweek). Note, however, that many cities and counties in California have their own minimum-wage requirements, but the minimum salary threshold is based on California law.

Expansion of California Family Rights Act (CFRA) – AB 1033: The CFRA requires employers with five or more employees to provided up to 12 weeks of leave in a 12-month period for an employee to attend to his or her own serious medical condition or to care for a family member with a serious medical condition. This bill expands the list of covered family members to include parents-in-law. Additionally the bill clarifies the requirements for the mediation of claims alleging a violation of a job protected leave by employers of five to 19 employees.

Non-Disparagement And Non-Disclosure Provisions in Settlement And Separation Agreements (“Silenced No More Act”) – SB 331: This bill amends Code of Civil Procedure § 1001 to prohibit non-disclosure provisions in settlement agreements involving any form of prohibited workplace discrimination, harassment, or retaliation under the Fair Employment and Housing Act. This requirement is in addition to Section 1001’s existing prohibition of any settlement agreements that prevent the disclosure of information pertaining to a civil or administrative claim related to sexual assault, harassment, or other sex-based workplace discrimination or retaliation.

The bill also amends Government Code § 12964.5 to limit the use of non-disparagement or other contractual provisions in employment agreements, including separation agreements, even if no civil action or complaint is filed. Any non-disparagement agreement or other contractual provision that restricts an employee’s ability to disclose information related to conditions in the workplace must include: “Nothing in this agreement prevents you from discussing or disclosing information about unlawful acts in the workplace, such as harassment or discrimination or any other conduct that you have reason to believe is unlawful.” Additionally, employers, under Section 12964.5, must include written notification of the employee’s right—even if they are above the age of 40—to consult counsel and a consideration period no fewer than five business days in separation agreements. The changes offered by SB 331 are not retroactive; instead, they apply to agreements entered into after January 1, 2022.

Arbitration Invoice Payment Requirements – SB 762: This bill amends Code of Civil Procedure §§ 1281.97 and 1281.98 to require that all arbitrator invoices are due upon receipt, if the parties’ arbitration agreement is silent on the number of days the parties have to pay the arbitrator’s fees. Under the amended sections, any extensions for invoice payments must be agreed upon by all parties to the arbitration.

Personnel Records Retention – SB 807: This bill extends the current personnel records retention requirement from two to four years from the date of creation, date of termination, or date of non-hire for an applicant. If a complaint has been filed with the Department of Fair Employment and Housing (DFEH), then the employer must retain the at-issue personnel records until the employer is notified that the action has been fully resolved or the first date after the statute of limitations for filing a civil action (or related appeal) has expired. SB 807 makes several procedure modifications to the DFEH’s enforcement rules, such as authorizing the use of electronic service of administrative complaints, extending the time for the DFEH to complete its investigation of group or class discrimination claims to two years before issuing a right-to-sue letter, and permitting group or class discrimination claims to be filed in any county within California.

Criminalization of Wage Theft – AB 1003: This bill creates Penal Code § 487m and makes the intentional theft of wages, including gratuities, in an amount greater than $950 from any one employee, or $2,350 in the aggregate from two or more employees, by an employer in any consecutive 12-month period punishable as grand theft and imprisonment for up to 3 years. Because this bill includes independent contractors within the meaning of employee, the misclassification of a service provider bears significantly greater risk.

Food Delivery Platforms And Workers’ Tips – AB 286: Beginning January 1, 2022, this bill will make it unlawful, among other things, for a food delivery platform to retain any portion of tips or gratuities paid from the customer to the delivery worker.

Owners of Real Property Subject to Liens for Wage Violations – SB 572: This bill will add Section 90.8 to the Labor Code to permit the Labor Commissioner to create and implement a lien on real property to recover amount due wage-and-hour violations stemming from final citations, findings, or administrative decisions. Preexisting law permitted the Labor Commissioner to obtain a lien on real property to only recover amounts due under final court orders.

Garment Workers Excluded from Piece-Rate Pay – SB 62: Beginning January 1, 2022, employers may no longer pay their employees who are engaged in garment manufacturing by the piece. Rather, employers must pay garment workers at least the minimum wage for all hours worked. This bill also expands wage-and-hour violation liability to “brand guarantors,” which is defined as any person contracting for the performance of garment manufacturing. SB 62’s expansion could hold clothing brands liable for violations that take place in manufacturing facilities by their vendors, in essence creating a joint-employer relationship.

Unionized-Janitorial Private Attorneys General Act (PAGA) Exemption – SB 646: This bill enacts Labor Code § 2699.8 to create an exemption that precludes janitorial employees covered by a collective bargaining agreement from bringing a representative action under PAGA. In order for the exemption to apply, the CBA must (1) provide total hourly compensation; (2) prohibit the Labor Code violations that are actionable and offer a collective grievance procedure with binding arbitration to address such Labor Code violations on a representative basis; (3) expressly and unambiguously waive PAGA claims; and (4) allow the arbitrator to award remedies under the Labor Code, except for penalties payable to the Labor & Workforce Development Agency (LWDA). The janitorial employer must inform the LWDA of such a CBA within 60 days of the enactment of this statute.

Electronic Transmission of Workplace Notices – SB 657: As remote working becomes more prevalent, the myriad of mandated state and federal workplace notice postings (e.g., Wage Orders, payday schedules, whistleblower rights, etc.) may now also be delivered to employees as an attachment to an email. Employers must still continue to adhere to their obligations to post such notices physically.

Recall Obligations for COVID-19 Layoffs – SB 93: While not new to 2022, this bill went into effect on April 16, 2021 and expires on December 31, 2024. It requires certain employers to rehire employees who were laid off due to COVID-19 if they worked at least six months prior to their layoff. Employers under SB 93 include the following employers: (1) hotels with 50 or more guest rooms; (2) private clubs with 50 guest rooms for overnight lodging; (3) event centers with 50,000 square feet or 1,000 seats; (4) airport hospitality operations and service providers; and (5) office services, e.g., janitorial and security services. Reopened positions must be offered to laid-off employees within 5 business days of the opening.

CAL-OSHA Presumption Creation – SB 606: This bill creates a rebuttable presumption that a workplace safety violation committed by an employer with multiple worksites is enterprise-wide if the employer has a written policy or procedure that violates certain health and safety regulations, or Cal-OSHA finds evidence of a pattern or practice of safety violations at more than one of the employer’s worksites. Additionally, the bill adds a definition of “egregious violation” which carries added penalties and expands Cal-OSHA’s enforcement power to issue and enforce a subpoena if an employer fails to promptly provide requested information.

Warehouse Distribution Employees – AB 701: Under newly-enacted Labor Code §§ 2100–2112, employers with 100 or more employees at a single warehouse distribution center or 1,000 or more employees at one or more warehouse distribution centers in California are required to provide nonexempt employees, either upon hire or within 30 days of this new law’s enactment, with a written description of each quota they are subject to (e.g., quantified number of tasks to be performed or materials to be handled) within a defined period of time and any potential adverse employment action that may result from failure to meet the quota. This bill prohibits adverse employment actions against employees who fail to meet their quota if the quota was not properly disclosed to the employee. AB 701 prohibits quotas that prevent an employee from taking his or her meal or rest breaks, use of restrooms, or that interfere with compliance with California’s occupational health and safety laws.

Independent Contractor Exemptions Expanded – AB 1561: This bill offers several changes. First, it extends the expiration date for the statutory exemptions granted to licensed manicurists and construction trucking subcontractors in AB 5 from January 1, 2022 to January 1, 2025. Second, the bill also extends the exemption for newspaper publishers and distributors through January 1, 2025. Third, the bill clarifies that Labor Code § 2782 does not apply to the relationship between a data aggregator and a research subject, and it removes the requirement that research subjects are to be paid minimum wage for the research task that they have willingly engaged. Fourth, Labor Code § 2783 is amended to expand exemptions for individuals who provide claims adjusting or third-party administration for insurance or financial service industries.