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Zenefits is hot tech startup that provides HR software to small businesses. It lives off a combination of funding, including a large investment from actor Jared Leto, and the money it makes when companies purchase services through its software, including insurance and payroll services. Its goal is to automate and simplify HR. Like its founders, Zenefits’ first clients were embedded in Silicon Valley tech culture and were frustrated by how complicated HR can be and how much of the industry still works in pen and paper (that frustrates me too, guys). Zenefits’ system allows small business and startups to get away with not having an in house HR person, and to do all of their on and off boarding in one screen, with a matter of keystrokes (sounds good to me).
The trouble, as it always does, came in the form of compliance. In Zenefits’ case, compliance with insurance broker training rules. Because Zenefits makes its money when services are purchased through them, not when clients purchase their software – which they offer for free – the startup is acting as a broker. In March of last year, Zenefits co-founder Parker Conrad told FastCompany that
“Insurance happens to be one of the most lucrative spokes [of the Zenefits wheel]. When companies use Zenefits to buy a group plan, we get a commission from the insurance carrier, like any other broker. People buy insurance through us because it’s integrated in one place online, and we do a good job with it. Zenefits also integrates with different payroll systems. We get a revenue share from the payroll companies on the clients we send to them.”
Zenefits has been in trouble over the last year thanks to a series of investigations into its compliance with insurance regulations. Because Zenefits employees are facilitating the sale of insurance products, they must be certified insurance agents, and the rules that govern insurance sales are complex and differ from state to state. Complying with all of these rules and regulations is a job in of itself. A job usually done by the the very people whose jobs Zenefits wants to disrupt: your friendly neighbourhood HR ladies and legal team.
On Thursday, Buzzfeed reported that Zenefits had found a work around to get their California employees certified faster: tricking the system. In California, potential reps are required to spend 52 hours on online training and then sit an exam (also online). Zenefits created a program, or macro, that would trick the online training program into seeing idle computers as being active. By preventing automatic logouts, reps could take off for the weekend while their laptops clocked their required training hours. After completing the 52 hour training period and the exam, reps signed a form declaring that they had completed the training and exam on their own and in good faith. Of course, they lied. The California Department of of Insurance is now investigating.
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Last week, amid news of these revelations, Zenefits’ CEO and co-founder, Parker Conrad, resigned. He was quickly replaced by Zenefits’ COO, David Sacks, previously of PayPal. According to Fortune,
“Because of its problems with regulators, Zenefits says that Parker has agreed to step down and let Sacks, who has experience navigating complex financial regulations as PayPal’s former COO, to take over as Zenefits’ CEO. In a memo to employees about the management change, Sacks didn’t dance around the company’s issues when it comes to regulatory compliance.
‘The fact is that many of our internal processes, controls, and actions around compliance have been inadequate, and some decisions have just been plain wrong. As a result, Parker has resigned,’ writes Sacks. ‘In order for us to move forward as a company, we cannot seek to hide or downplay the problem.'”
The value of disruption, the driving logic of so many tech startups, is holy writ inside the tech bubble, but regarded much more dubiously outside the Valley. As Emily Jane Fox put it in Vanity Fair, “[r]egulators do not care how swooned-over a C.E.O. is. To them, a law is a law, no matter how shiny the unicorn.” Zenefits, Uber, AirBNB and other firms are learning a hard lesson in what can and cannot be disrupted. Or at least a lesson in which industries will go quietly into the night, and which regulatory bodies are willing to be silenced.
HR and insurance compliance rules and enforcement are hard and unforgiving and not interested in being disrupted. Unlike other industries that tech startups have successfully disrupted, like transportation and hospitality, insurance agencies and regulators hold a hell of a lot of power. When they push back, they do it with ruinous force.
The company previously ran into trouble in Utah, where legislators banned and then unbanned Zenefits because of concerns that the company’s business model essentially offers customers a rebate on insurance rates – a practice already banned in Utah, apparently to cut down on insurance price wars. Because Zenefits’ reps make a much smaller commission than do other insurance sales people, lawyers for established Utah insurance firms argued that Zenefits’ business model – free software, competitive fees for purchasing services – fell under banned rebate behaviour. In 2014 the state ruled that Zenefits would have to pay a $97,000 fine and slog through two years of probation. In 2015, Utah lifted the ban and the governor declared the state “open for [disruptive] business.” Insurance providers are understandably miffed and, one expects, may be reconsidering some of their PAC donations.
Zenefits’ raison d’être is to disrupt the heavily regulated insurance, benefits and HR industries, by cutting through the red tape that slows things down. They want to offer a cleaner, easier and quicker product – a complete and frictionless HR package. That’s attractive because HR and insurance are heavily regulated, heavily specialized markets that require years of study and certification to operate in. A one-size-fits-all solution that promises to cut out all the headache-inducing paperwork is incredibly enticing – especially for small business who can’t afford on staff HR and legal people. But the very thing that makes Zenefits attractive is what makes its business model so vulnerable to regulatory investigation – the complexity of HR and insurance make taking shortcuts attractive, but they also make tripping over your own cleverness very easy.
Dave Jones, California’s Insurance Commissioner sums it up nicely:
“New technologies and new business models can bring value and convenience to California consumers, but businesses deploying new technologies and new business models must comply with California’s strong consumer protection laws, including the laws and regulations governing the licensing and training of insurance agents and brokers, which are designed to make sure that only individuals and firms with the expertise and integrity to transact insurance are allowed to do so.”
Disruptive tech firms can simplify our lives and make previously expensive services cheaper. But when safety – personal, legal and financial – is on the line, they must obey existing rules, working with legislators and regulators, not around them. The stakes are too high, both for them and for their users, to do otherwise.