Zenefits' free software business model has been declared 'illegal' in the state of Washington

Zenefits COO David SacksZenefitsZenefits’ David Sacks

It’s been two steps forward and one step back for troubled startup Zenefits and its legal problems after it admitted earlier this year it was selling insurance without proper licensing in multiple states.

On Thursday, the state of Washington’s insurance commission said that Zenefits’ basic business model, of giving away HR software for free to customers who buy insurance from it, was illegal in that state.

Insurance Commissioner Mike Kreidler ordered Zenefits to cease the free distribution of its employee benefits software, saying the tactic violates Washington state insurance law against inducements.

Zenefits has agreed to charge Washington state businesses $5 per user for the software that it gives away for free in other states.

Kreidler had also previously fined Zenefits $100,000 in October 2016 for selling insurance without proper licensing in that state.

This news comes days after Zenefits announced that it had settled its problems with California. Zenefits paid $7 million to California to settle its most egregious legal issues, including its admission that it had skirted some legal requirements for training people for their California state insurance licenses.

The disclosures of its licensing issues led to the sudden resignation of its founder CEO Parker Conrad earlier this year, replaced by investor, COO, and Valley executive A-lister David Sacks. Since then, Sacks has been negotiating with state regulators, many of who imposed small fines.

Sacks also banned the practice of drinking alcohol at work, laid off workers, renegotiated with investors, and reduced the valuation of the company by half to $2 billion. He offered the remaining workers a chance to walk with severance if they didn’t want to stay, fired other executives involved in the licensing issues, reorganized leadership, and launched a new version of the company’s main product.

Zenefits founder CEO had once promised that its core software will always be free.

Here’s the full press release from the insurance commissioner.

OLYMPIA, Wash. — Insurance Commissioner Mike Kreidler ordered Zenefits to cease free distribution of its employee benefits software, noting the tactic violates Washington state insurance law against inducements.

Washington is the first state to take action against the company for violating inducement laws. Under an agreement with Kreidler, Zenefits can challenge the order within 90 days.

California-based Zenefits began operations in Washington in 2014, selling online human resources services to businesses. As part of its free software offer, Zenefits provided certain features with a paid commission. To access these premium features, the company required the client to designate Zenefits as its broker of record, then collected the commissions associated with the insurance product sold.

“The inducement law in Washington is clear,” Kreidler said. “Everyone has to play by the same rules.”

The law permits a licensed producer to offer no more than $100 per person during a consecutive period of 12 months.

Zenefits markets software’s value at $29,100 to $45,000 per year. The company will determine what fee to charge its Washington customers starting Jan. 1, 2017, in accordance with the order.

Kreidler also fined Zenefits $100,000 in October 2016 for employing unlicensed producers to sell insurance in Washington. The company allowed unlicensed employees to complete 179 insurance transactions between Jan. 1, 2014 and Nov. 30, 2015. Washington is among a handful of states, most recently California, to fine Zenefits for allowing unlicensed producers to sell insurance.

Both actions resulted from a two-year investigation of Zenefits by Kreidler’s office.

Kreidler’s investigation also found:

  • Zenefits offered individual clients up to $2,000 in cash for referring companies through a program called “Friends with Zenefits.” Zenefits paid at least one individual $250 for two referrals.
  • At least 25 state residents chose Zenefits as their insurance broker after a demonstration of the company’s software.

Here’s the full statement from Zenefits lawyer, Josh Stein.

Today, Zenefits has reached a compromise agreement with the Washington Office of the Insurance Commissioner (OIC) on how Zenefits will price its services in Washington State. Beginning January 1, at the order of OIC, Zenefits may no longer provide free software services in Washington. As a result, Zenefits will charge all Washington state customers $5 per employee per month for our core HR product.

This agreement arises from OIC’s interpretation of its anti-rebating statute, which prohibits brokers from refunding part of their commission back to clients. These anti-rebating statutes are designed to protect consumers from discriminatory pricing. Unfortunately, the Washington commissioner seeks to use a consumer protection statute to raise prices for Washington consumers, a counter-intuitive and wrong decision that we disagree with.

The Washington viewpoint is a decidedly minority view. Since its founding, Zenefits has had conversations with regulators about our business model, which includes some free HR apps. Many states have looked into the issue and concluded that free software from Zenefits is not a problem; in fact, it’s in the interest of consumers. Only one state other than Washington has disagreed. Utah’s department of insurance tried to force Zenefits to raise prices for consumers, and Utah’s state legislature and governor quickly took action, passing a bill to clarify that its rebating statute should not be interpreted to prohibit innovative new business models that deliver value to consumers.

We do appreciate the efforts of Commissioner Kreidler and the OIC’s staff to reach this compromise agreement with us. This agreement provides a template for Zenefits to do business in states with a minority interpretation of the rebating statute (whereas the short-lived Utah decision would have effectively prohibited us from doing business in the state). But an even better solution would be for all states to interpret the rebating statute in the way it was intended — to protect consumers, not brokers that compete with Zenefits.

We believe that our core HR product is worth the $5 price that we will charge, and we’re going to include our new HR Adviser app as part of the bundle to make this an even better deal for our customers. But that’s not the point. Zenefits and every other company should have the freedom to set prices for our products and services in the way that drives the best value for consumers. We will work with the legislature and other stakeholders in the coming months to uphold this principle.

In the meantime, our customer service teams will be reaching out directly to all our Washington customers to make it as easy as possible for them as we transition to this new pricing structure in Washington.

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