Tuesday, December 17, 2013

Better Get While the Gettin's Good

On December 11, 2013, Reuters reported that the two private equity companies that took human resources management software firm Kronos Inc. private in 2007 are looking to sell the company. Hellman & Friedman LLC and JMI Equity are exploring a sale of Kronos, which could be valued at more than $4 billion. Interested purchasers are reported to include TPG, KKR and Bain.

The Reuters article states that Hellman & Friedman and JMI have taken advantage of Kronos' strong cash flow to draw more than $1.5 billion in dividends from Kronos, and so have already earned twice the $752.9 million they committed as equity when they agreed to acquire the company in 2007. In November 2013, the two companies had Kronos borrow to pay themselves a $490 million dividend.

Who should be interested in a potential sale of Kronos by Hellman & Friedman and JMI, other than the sellers, potential buyers and Kronos employees? The hundreds of employers that are customers of the Kronos talent acquisition and employee assessment services.

Why should those employers be interested? The risks to those employers from the ongoing systemic investigation by the Equal Employment Opportunity Commission (EEOC) of several Kronos customers, an investigation focused on whether the Kronos assessment services violate the Americans with Disabilities Act (ADA) by illegally screening out persons with disabilities.

What are EEOC systemic investigations? Systemic investigations involves pattern or practice, policy, and/or class cases where the alleged discrimination has a broad impact on an industry, profession, company, or geographic areaIn connection with systemic investigations, the EEOC’s enforcement tools include issuing broad information requests and subpoenas on employers that are named as respondents in EEOC charges, particularly when the EEOC suspects systemic discrimination, and filing pattern or practice class lawsuits in federal court.

What are the risks to employers? Systemic investigations by the EEOC and class action claims by job applicants for damages and injunctive relief. For some employers, the potential class size can be measured in the millions of plaintiffs. Employers have primary liability under the ADA, but Kronos has indemnified many of its employer customers. If Kronos does not have the financial resources, however, the indemnification is illusory.

What is Kronos?

Kronos is a U.S.-based workforce management software and services company. According to the company, tens of thousands of organizations in more than 100 countries - including more than half of the Fortune 1000 - use Kronos.

In August 2006, Kronos acquired Unicru, Inc., a company specializing in software used to assess and hire hourly workers. At the time of the acquisition by Kronos, Unicru had as customers for its assessment (the Unicru assessment) more than 140 leading companies and brands, including SuperValu, Kroger, Toys "R" Us, Best Buy, CVS, Borders, Lowe's, Caribou Coffee, and Marquis Healthcare.

The Unicru assessment consists of a number of statements, to which an applicant must answer “strongly disagree,” “disagree,” “agree,” or “strongly agree.” It includes statements such as: “You have confidence in yourself”; "You try to sense what others are thinking and feeling”; “You always say whatever is on your mind”; and “It is easy for you to feel what others are feeling.”

The systemic investigation of Kronos assessment customers, including Kroger, arose from a charge filed with the EEOC more than six years ago by a Kroger job applicant.  The charge led to an investigation that has been ongoing for more than six years and has generated a number of district court and appellate court decisions as Kronos has unsuccessfully sought to avoid disclosing information about the Unicru assessment and its impact on persons protected by the ADA.

Cloning Employees and Institutionalizing Biased Hiring Practices

According to Kronos, the Unicru assessment is an artificial intelligence test that uses neural networks to “learn” the characteristics of a customer’s “best” employees.  As stated by Kronos’ Chief Scientist and the developer of the Unicru assessment, Dr. David Scarborough, in chillingly Orwellian terms, "[o]ur system allows you to clone your best, most reliable people."

First used for engineering and industrial applications during the mid-1980s, neural networks evolved from early artificial intelligence research. Modeled on the function of the human brain, a neural network attempts to imitate human reasoning. Large amounts of data are fed into the network, which looks for relationships and reaches conclusions.

"There are a couple of dangers," states Jai Shekhawat, CEO of Chicago-based Fieldglass Inc., which develops software for managing workers. "Is something a correlation--a predictor--or merely a coincidence? At best, [these methods] are complementary to human judgment, not a substitute for it."

Notwithstanding such dangers, Kronos customers like Kroger are substituting this “coincidence” for human judgment. Based on the prospective employee's answers on the application, the Unicru assessment categorizes the applicant as red, green or yellow. In most cases, red is usually an automatic discard, or, as Dr. Scarborough stated “[m]anagers are strongly discouraged from hiring first quartile (“red”) applicants …”

There is no evidence that the Unicru assessment determines whether an employer’s hiring practices are biased or discriminatory. For example, if the Unicru assessment had been utilized fifty years ago, many companies’ “best” employees would have the personality traits of white males – persons of color, women and those with disabilities need not have applied.

The Unicru assessment embeds and industrializes existing stigma, bias and discrimination in the hiring process. As stated by Cynthia Dwork and Deirdre K. Mulligan in a recent Stanford Law Review article:
While automated decisionmaking systems “may reduce the impact of biased individuals, they may also normalize the far more massive impacts of system-level biases and blind spots.” Rooting out biases and blind spots in big data depends on our ability to constrain, understand, and test the systems that use such data to shape information, experiences, and opportunities.
As a “blind” tool that “learns” from the employer, the Unicru assessment replicates the existing bias of the employer and applies it on a massive scale. All applicants have their test responses fed through a discriminatory filter that is the Unicru assessment (a filter that is biased both on its own and in conjunction with its “learned” behavior). 

Illegal Medical Examination

The ADA prohibits the use of pre-employment medical examinations. At the pre-offer stage, an employer is only entitled to ask about an applicant's ability to perform the essential functions of the job. The ADA's prohibition against pre-employment examinations seeks to ensure that the applicant's disability is not considered prior to the assessment of the applicant's qualifications.

EEOC guidance provides a seven-factor test for analyzing whether a test or procedure qualifies as a “medical examination,” including:
  • whether the test is designed to reveal an impairment of physical or mental health such as those listed in the Diagnostic and Statistical Manual of Mental Disorders (“DSM”); and
  • whether the test is interpreted by a health care professional.
According to the guidance, the presence of any one of the seven factors is enough to support a finding that the test is a medical examination and the Unicru assessment meets the two factors listed above. 

Since the Unicru assessment is based on the five-factor model (FFM) of personality it meets the first factor listed above. As set out in previous posts -  ADA, FFM and DSM and Employment Assessments are Designed to Reveal an Impairment - assessments based on the FFM are designed to reveal an impairment of mental health, such as those listed in the DSM.

As to the second factor, whether the test is interpreted by a health care professional, the individuals who developed the Unicru assessment are psychologists, most of whom are members of the APA. In developing the Assessments, the psychologists establish the rules by which the assessments are to be interpreted (i.e., how the responses to the questions are to be scored, including whether the applicant receives a green, yellow or red rating).

According to the APA Model Act for State Licensure of Psychologists, “[t]he practice of psychology includes … (a) psychological testing and the evaluation or assessment of personal characteristics, such as intelligence; personality; cognitive, physical, and/or emotional abilities; … [and] (f) provision of direct services to … groups for the purpose of enhancing … organizational effectiveness, using psychological principles, methods, and/or procedures … for making decisions about the individual, such as selection …”

EEOC guidance states that psychologists are among the “variety of health professionals [that] may provide documentation regarding psychiatric disabilities” for ADA purposes. Accordingly, the psychologists who developed the Unicru assessment are "health care providers" for purposes of the ADA.

The CVS Example

In July 2011, CVS and the Rhode Island Civil Liberties Union (ACLU) entered into a voluntary settlement addressing the ACLU’s complaint challenging CVS’s use of a pre-hire questionnaire that the ACLU claimed could have a discriminatory impact on people with certain mental impairments or disorders. 

The CVS questionnaire contained statements to which applicants were required to respond, including: “You change from happy to sad without any reason,” “You get angry more often than nervous,” “Your moods are steady from day to day,” and “There’s no use having close friends; they always let you down.”

Responding to a complaint filed by the ACLU, the Rhode Island Commission for Human Rights had issued a finding in February 2011 that there was "probable cause" to believe that the questionnaire used by CVS violated state anti-discrimination laws that bar employers from eliciting information that pertain to job applicants' mental or physical disabilities.

Although employers may legally ask questions designed to help determine an applicant’s personality or aptitude for a job, the ACLU’s complaint argued that questions found in the CVS pre-offer assessment “could have the effect of discriminating against applicants with certain mental impairments or disorders, and go beyond merely measuring general personality traits.” 

Pursuant to the settlement agreement, CVS agreed to permanently remove the questions at issue from its online application.

Systemic Risk to Employers

The success of workforce science companies in developing employment personality and assessment tests over the past twenty years has created "systemic risk" for their employer customers. If one employer has violated the law and subjected itself to significant liability as a consequence of its use of an assessment provided by a workforce science company, then all customers of that company are similarly at risk. Workforce science companies provide their services to thousands of employers, including many of the largest employers in the U.S. 

The lack of diversity in the psychological model underlying many of the personality tests offered by workforce science companies (the five-factor model of personality or Big Five) also means that if one workforce science company's personality tests that use the Big Five is found to be an illegal medical examination under the Americans with Disabilities Act (ADA), all workforce science companies that use the Big Five (and, more importantly, their customers) are similarly at risk. 

There are multiple risks to employers arising from the use of personality tests and workforce assessments, including: 
  1. Claims under the ADA and the Rehabilitation Act of 1973 that the personality tests are illegal medical examinations or that they illegally screen out persons with mental illness (as set out above); 
  2. Claims under the ADA and the Rehabilitation Act of 1973 that the employer fails to select and administer the assessment in the most effective manner to ensure that the assessment results accurately reflect the skills, aptitude or whatever other factor that the assessment purports to measure, rather than reflecting an applicant’s impairment; 
  3. Claims that employers and workforce assessment companies fail to properly safeguard confidential medical information obtained from the personality tests and illegally use that confidential medical information in violation of the ADA; and
  4. Claims under Title VII of the Civil Rights Act that the workforce analytics cause there to be a disparate impact on the hiring of blacks and Hispanics.
As to the potential size of the plaintiff classes for the claims listed above, they range from a percentage of all applicants (in the case of claims that the tests illegally screen out persons with mental illness and claims of disparate impact under Title VII) to all applicants over the past 12 months (in the case of claims that the personality test is an illegal medical examination) to all applicants, employees and ex-employees over a longer period of time (in the case of claims that employers and workforce assessment companies failed to safeguard confidential medical information).

For some employers, the potential class size can be measured in the millions of plaintiffs. Consistent with the 2011 Supreme Court decision in Wal-Mart Stores, Inc. v. Dukes, plaintiffs in a class action suit predicated on the use of personality tests and workforce analytics will be challenging a uniform, company-wide practice. The uniform use of testing by an employer demonstrates that "there are questions of law or fact common to the class," or commonality, as required by the rules governing class actions.

Illusory Indemnification?

A key element in continuing to use Kronos assessment services is Kronos' ability to indemnify its employer customers. As noted above, the success of workforce assessment companies in marketing personality tests and workforce analytics over the past twenty years has created "systemic risk" for its customers. If one employer has violated the law and subjected itself to significant liability as a consequence of its use of a solution provided by a workforce assessment company, then all customers of that workforce assessment company are similarly at risk.

Even assuming workforce assessment companies are willing to provide indemnification to all customers, those employers need to independently assess whether the workforce assessment companies and their insurers have adequate resources to indemnify all customers. 

As Kenexa, an employment assessment company, consistently noted in its annual 10-K risk factor disclosures prior to its December 2012 acquisition by IBM:
The failure of our solutions to comply with employment laws may require us to indemnify our customers, which may harm our business. Some of our customer contracts contain indemnification provisions that require us to indemnify our customers against claims of non-compliance with employment laws related to hiring. To the extent these claims are successful and exceed our insurance coverages, these obligations would have a negative impact on our cash flow, results of operation and financial condition.
Similarly, customers of Kronos might be concerned about Kronos' ability to fulfill its indemnification obligations. As noted above, Kronos' current owners have paid themselves significant dividends during their ownership tenure, including causing the company to borrow to pay a $490 million dividend earlier this year.

The current owners of Kronos are also delaying substantive interaction with the EEOC in connection with its systemic investigation of Kronos customers, including the more than five years of litigation over the EEOC's information requests, while at the same time looking to sell Kronos. It may be possible that Hellman & Friedman LLC and JMI Equity end up with more than $5 billion from a $752 million investment, while leaving the new owner with the contingent indemnification liabilities. Kronos, under the new owner, may not have sufficient resources to cover the indemnification claims of its employer customers.

* * * * *

"Better Get While the Gettin's Good," the title of this post, is a lyric from Credence Clearwater Revival's song Up Around the Bend. The song's first verse reads:
There's a place up ahead and I'm goin'
Just as fast as my feet can fly
Come away, come away if you're goin',
Leave the sinkin' ship behind.
The question is whether the owners of Kronos Inc. are trying to get while the gettin's good by selling the company and leaving that sinking ship behind?

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