On April 7, 2010, the California Division of Labor Standards Enforcement (DLSE) issued an opinion letter addressing the requirements employers must meet in order to have unpaid interns in compliance with California law. Although widely published news reports, including a recent New York Times article analyzing the DLSE’s April 7th opinion letter, have raised hopes that California is relaxing its position with respect to the permissibility of unpaid internships, such optimism appears to be misplaced and employers must continue to exercise caution in this area.

The DLSE’s guidance is timely, as thousands of college graduates and students prepare to hit the job market in search of employment opportunities. Many employers offer internships for a variety of reasons, including providing useful “real world” experience to students seeking to learn more about a particular industry or profession, and trying to help the children of customers, business colleagues, or friends. However altruistic their reasons, employers must be aware that California and federal law severely limit the circumstances under which such internships can be unpaid.

In response to a letter from an attorney representing Year Up, Inc., (a program aimed at developing fundamental job and technical skills in information technology for 18- to 24-year-olds) about the classification of internships in California, the DLSE concluded that the interns enrolled in the internship program were not employees under California law, and therefore were exempt from coverage under California’s minimum wage law. In reaching its conclusion, the DLSE followed the federal Department of Labor’s (DOL’s) criteria for determining whether the interns were exempt from minimum wage coverage and examined the “totality of the circumstances” surrounding their activities. Ultimately, the DLSE’s opinion letter reiterated its longstanding position that California follows the same stringent federal factors in analyzing the classification of interns, and thus serves as a reminder to employers that improper classification of employees as unpaid interns can be costly.

The DOL has articulated six criteria to determine whether an “intern” or “trainee” is exempt from the Fair Labor Standard Act’s minimum wage coverage. In order to qualify as an unpaid internship, all six factors must be satisfied under state and federal law. The six criteria are as follows:

1. The training, even though it includes actual operation of the employer’s facilities, is similar to that which would be given in a vocational school.

2. The training is for the benefit of the trainees or students.

3. The trainees or students do not displace regular employees, but work under their close observation.

4. The employer derives no immediate advantage from the activities of the trainees or students, and, on occasion, the employer’s operations actually may be impeded.

5. The trainees or students are not necessarily entitled to a job at the conclusion of the training period.

6. The employer and the trainees or students understand that the latter are not entitled to wages for the time spent in training.

The DLSE’s new opinion letter concluded that all six criteria also must be satisfied in California. However, the agency now appears to take a more relaxed approach as to when an employer will meet certain aspects of the six factors. For example, in determining whether regular employees are displaced (i.e., the “non-displacement” criterion), the DLSE now takes the position that occasional or incidental work by an intern should not defeat the exemption provided such work does not intrude into activities that could be performed by regular workers and effectively displace them. As the stringent six criteria must still be satisfied, it will be difficult for companies, particularly for-profit companies, to have properly classified unpaid interns. The recent New York Times article regarding internships quoted Nancy J. Leppink, the acting director of the federal Labor Department’s Wage and Hour Division, as stating, “There aren’t going to be many circumstances [where for-profit companies can have unpaid internships and] still be in compliance with the law.”

Many companies have relied upon unpaid interns as a way to minimize costs and provide opportunities to eager workers who are willing to work for free in hopes of ultimately securing a paid position. Such an approach is risky, and employers must understand that the consequences of utilizing unpaid internships that do not comply with applicable law are potentially grave. As with misclassification of an employee as an independent contractor, employers with misclassified unpaid interns face potential liability for unpaid wages and violations relating to failure to pay minimum wage, which could be significant for a full-time intern. In addition to the wages due to unpaid interns, the employer could face potential liability for overtime and missed meal or rest periods. Moreover, the employer could be liable for various penalties under California’s Labor Code (including waiting-time penalties for failing to pay wages on a timely basis), as well as unpaid employment-related taxes owed to governmental agencies.

For more information about legal issues regarding interns, please contact Fred Alvarez, Kristen Dumont, Laura Merritt, Ulrico Rosales, Marina Tsatalis, Alicia Farquhar, or another member of the firm’s employment law practice.

The Act provides companies with a number of exemptions from federal registration requirements. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as “accredited investors” defined in rule 501 of Regulation D.  Offerings to accredited investors are exempt from the registration requirements on the theory that accredited investors are sophisticated enough to protect their own interests.

The following types of individuals are accredited investors:

• a director, executive officer, or general partner of the company selling the securities;
• a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase; or
• a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.

Net worth includes the value of houses and automobiles.  Thus, many homeowners are accredited investors due to the value of their houses.  The $1 million net worth and $200,000 income standards were established in 1982 and have not increased with inflation.

The following types of entities are accredited investors:

• a bank, insurance company, registered investment company, business development company, or small business investment company;
• an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
• a charitable organization, corporation, or partnership with assets exceeding $5 million;
• a business in which all the equity owners are accredited investors; or
• a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

In the chaotic securities markets of the 1920s, companies often sold stocks and bonds on the basis of glittering promises of fantastic profits – without disclosing any meaningful information to investors. These conditions contributed to the disastrous Stock Market Crash of 1929. In response, the U.S. Congress enacted the federal securities laws and created the Securities and Exchange Commission (SEC) to administer them.

Companies selling common stock, preferred stock or issuing options or warrants are issuing “securities.”  The Securities Act of 1933 generally requires companies selling securities to give investors full disclosure of all material facts that investors would find important in making an investment decision. The Act also requires companies to file a registration statement (i.e. see the Google IPO registration statement) with the SEC that includes information for investors, unless the security or the type of transaction is exempt from registration.

However, registering a securities offering with the SEC is a very expensive (typically costing over $1,000,000) and time-consuming process.  Therefore, sales of securities by companies to private investors or venture capitalists are usually structured to be exempt from the registration requirements of the Act.  These exemptions (post to come) are fairly technical and companies need advice from competent securities attorneys to ensure compliance.

Even if a securities offering is exempt from federal registration requirements, the company must also comply with securities laws in each state where securities are offered.  States may impose their own registration or qualification requirements that must be complied with unless an exemption is available.

Failure to comply with securities laws allows a purchaser to rescind or undo the purchase of securities and get his or her money back or recover damages.  These rescission rights create potential exposure to the company if its stockholders demand their money back.

Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the date of the violation upon which the action to enforce liability is based.  State remedies and statutes of limitations vary and depend upon the state in which the shares were purchased.  For example, the California statute of limitations for noncompliance with the requirement to register or qualify securities under the California Corporate Securities Law is the earlier of two years after the noncompliance occurred, or one year after discovery of the facts constituting such noncompliance.

In extreme cases, a company may make a rescission offer (i.e. offer to repurchase the securities plus interest) to stockholders that were sold securities in noncompliance with securities laws in an attempt to eliminate the exposure from rescission rights.  The rescission offer itself must comply with all relevant securities laws.  For example, Google’s noncompliance with securities laws in connection with option grants required it to file a registration statement with the SEC to make the rescission offer at the time of its IPO and resulted in a cease and desist order by the SEC.

• Need for an agreement. Entering into an NDA increases the risk that the recipient may face charges of trade secret misappropriation if it develops similar information in the future or inadvertently discloses or uses the information. This is the primary reason that VCs will not enter into NDAs.

• Mutual versus one-way. Some agreements only cover disclosure of confidential information by one party. Other agreements are mutual and cover disclosures by both parties. Generally speaking, mutual agreements are less likely to have provisions that are one-sided.

• Non-disclosure and non-use. There are two important restrictions in an NDA. The non-disclosure provision prevents the recipient from disclosing the confidential information to third parties. The non-use provision prevents the recipient from using the information other than for a specified purpose. Occasionally, an NDA may not have a non-use provision. This would allow the receiving party to use the information for its own purposes as long as it did not disclose the information

• Definition of confidential information. The discloser will want a broad definition of confidential information and may also want third party confidential information to be deemed confidential. The receiver will want to narrow the definition of confidential information in order to avoid being “tainted” by the information. The definition can be narrowed by (i) limiting it to information disclosed in writing (or oral disclosures reduced to writing within a certain time frame), (ii) specifically marking the information confidential, (iii) specifying the information that is deemed confidential or (iv) specifying the dates of disclosure. The discloser will want to avoid some of the limitations because of the possibility or inadvertent disclosure or over-marking information as confidential, which may impair the ability to enforce the agreement with respect to genuine trade secrets.

• Exceptions to confidential information. The recipient will want broad exceptions to the definition of confidential information. Typical exceptions to the definition of confidential information include (i) information publicly known or in the public domain prior to the time of disclosure, (ii) information publicly known and made generally available after disclosure through no action or inaction of the recipient, (ii) information already in the possession of recipient, without confidentiality restrictions, (iv) information obtained by the receiver from a third party without a breach of confidentiality, and (v) information independently developed by the recipient. The discloser will try to limit the exceptions or add qualifiers such as the discloser must prove the exception with contemporaneous written records. Please note that the typical exception for information required to be disclosed by law should be an exception to the duty to not disclose, as opposed to an exception from the definition of confidential information (which would allow the recipient to disclose the information to anyone).

• Residual information. The recipient will want to include a clause that allows the recipient to use the discloser’s information that is retained in its employees’ memory. The recipient will want to avoid being “tainted” by receiving the information. This is often strongly rejected by the discloser. In the event the residuals clause is included, the discloser may try to limit it to (i) use of general skills and knowledge, (ii) information retained in the unaided memory of employees after a certain amount of time after access to the confidential information, and (iii) explicitly noting that the discloser is not granting any license to the recipient.

• Permitted disclosures. The discloser will want to limit disclosures to employees and contractors on a need to know basis with similar non-disclosure obligations. In addition, if disclosure is required by law, the discloser will want the recipient to notify the discloser in advance and provide the opportunity to obtain a protective order or otherwise maintain the confidentiality of the information.

• Term. NDAs commonly have terms of three to five years. The period of time depends the strategic value of the information to the discloser and how quickly the information may become obsolete.