Employer, Audit Thyself

The message from the headlines is clear: Beware class actions under the Fair Labor Standards Act (FLSA). Not only is the number of such suits high—in 2001, FLSA class actions outnumbered discrimination class actions—they also are shockingly expensive: Such suits have cost Starbucks $18 million, Bank of America $22 million and Rite Aid $25 million. The rise of these suits—and the high price tags—is driven by several factors inherent to the law itself. For example, the FLSA has a two-year statute of limitations—three for willful violations. (By comparison, employees have only 300 days to file job discrimination suits.) And, unlike other types of claims that usually center on a specific, discrete event, FLSA violations can occur every time employees receive their paychecks—so the statute of limitations begins anew every time employees are paid incorrectly.

In addition, employers that violate the statute are automatically subject to double damages—unpaid wages plus an equal amount in liquidated damages—unless they can prove they acted in good faith and reasonably believed they were in compliance with the law. (For more information on how quickly damages can add up, see “Scary Math.”)

“The plaintiffs’ bar has gotten very savvy about how relatively easy it is to make a case and how big the numbers get when you’re talking about a sizable affected class and two or three years of back pay,” says Rosemary C. Lumpkins, an employment attorney in the Atlanta office of Constangy, Brooks & Smith. And, she adds, if your organization has an FLSA problem that “goes unchecked and unresolved, you could be caught unaware and find yourself facing significant exposure.”

To avoid being caught unaware, legal experts say employers must exercise constant vigilance over wage and hour compliance. “It’s a lifestyle,” says Richmond, Va., attorney David F. Dabbs, a member of the labor and employment law group in the firm of McGuire Woods LLP.

And it’s one that requires accountability. “Somebody’s got to be in charge,” adds San Francisco attorney R. Brian Dixon, head of the wage and hour practice for the law firm of Littler Mendelson. “The most important thing a company can do is to say that [wage and hour compliance] is an ongoing responsibility and it is someone’s job.”

But both Dabbs and Dixon recognize that, for a variety of reasons, employers don’t always keep up with day-to-day monitoring. In such situations, the next best solution is to undertake a systematic review—from time to time—of wage payment practices and job classifications for overtime purposes. In other words, conduct a wage and hour audit.

How often should such audits be conducted? Wage-and-hour law specialist Caryn Pass, a partner in the Washington, D.C., law firm Krupin O’Brien, recommends scheduled annual “check-ups,” as opposed to occasional, unscheduled audits. “Sometimes you get out of compliance and don’t even realize you’re out of compliance,” she says. “It’s always better to know what your exposure is than to get caught with your pants down.”

At the very least, employers should conduct audits when certain red flag conditions occur. These might include:

• Significant process changes or a reorganization affecting more than a few job classifications.
• Changes in federal or state law.
• An abrupt increase in hours worked by employees in a job classification that is neither clearly exempt nor non-exempt.

Employers also should pay attention to employee grumbling, especially from lower-level supervisors, says Kimberli Aboyade, an attorney with the Pittsburgh firm of Eckert Seamans Cherin & Mellott. Piling more and more tasks on lower-level supervisors—perhaps as a result of a downsizing—can result in unknowing misclassification.

And when supervisors feel overworked and underpaid, they are vulnerable to solicitations from eager plaintiffs’ attorneys seeking to build a case for a class action. Engineering managers, pharmacists and retail store managers are likely targets of such solicitations, says Aboyade.

Employers also are vulnerable to such solicitations during union organizing campaigns, say experts.

Get Management Buy-In

A wage and hour audit is a calculated gamble because you never know what you’ll find. You could come back with a clean bill of health, or you could discover significant problems that will require fundamental changes in how employees work and how pay is calculated.

Fixing such problems, even only partially, might require a great deal of money, so it is vital that upper-level management buy in to the audit before it is conducted.

A thorough explanation of the potential liability associated with FLSA violations should go a long way toward persuading top management to support an audit. Beyond that, Dixon suggests that both fairness and corporate responsibility require informing managers who have decision-making authority for wage payment practices of their potential personal liability if non-compliant practices continue.

Management support for the audit should include an explicit commitment to bring the organization into compliance, experts say. “When you undertake an audit, you should be prepared to live with the results,” Dixon says.

Aboyade agrees: “You’d better, up front, get everybody on board and do what you can to remedy it.”

Companies that don’t remedy problems they uncover in an audit could unwittingly provide plaintiffs’ attorneys with evidence of a willful violation. And, as mentioned previously, employers that commit willful violations are liable for an extra year of damages; they also are unlikely to avoid double damages.

Who Conducts the Audit?

One way to keep sensitive audit information out of the hands of plaintiffs’ attorneys is to involve legal counsel in the process. This strategy won’t protect the facts of your audit under the cloak of attorney-client privilege or attorney work product privilege, but it will protect the legal analysis, recommendations and conclusions that your attorney provides.

If someone other than an attorney provides those recommendations—and your organization does not follow them—that information could be discovered by plaintiffs’ attorneys and could work against you in court.

That’s an important reason to get your attorney involved, but it’s not the only one. Another is that even experienced HR professionals may have trouble conducting an audit because the law is constantly being refined by the courts. Since 1990, the judiciary has issued a checkerboard of decisions that can be difficult to keep up with, even for legal specialists.

“Case law is what’s driving wage-and-hour right now,” Dixon says, and “counsel is going to be a little more in touch with the case law.”

Relying on an attorney’s expertise also can reduce damages, says Dixon. To avoid double damages, employers must prove they had a good faith and reasonable belief they were in compliance. “To have a reasonable belief, you have to consult with someone who’s reasonably knowledgeable,” says Dixon. “A well-informed HR representative may not always fill that bill” as well as an attorney.

In Dabbs’ view, attorneys “should be consulted at the outset, should direct and supervise the process and should review the recommendations before they are finalized.” In addition to attorney-client privilege, this approach provides an early reading on possible exposure and ensures that the audit proceeds on sound legal principles.

It also means that employers don’t have to pay attorneys to do the entire audit but can, instead, rely on less-costly help—such as in-house HR resources.

“I do not think the lawyers have to do the audit,” says Dabbs. Lumpkins agrees that, provided certain protocols for establishing privilege have been met, the actual field work of the audit “can be conducted by non-lawyers at the direction of counsel.”

The one group that shouldn’t know about your audit, agree attorneys, is the Department of Labor (DOL), which has been inviting employers to seek compliance assistance without fear of enforcement. Dabbs, Pass and Dixon advise HR professionals to refrain from letting the agency know of internal company audits.

“Once you get on their radar screen, there may be more of a reason for them to come visit you,” says Pass.

Moreover, Dabbs is not persuaded that DOL compliance assistance staffers—as opposed to enforcement staffers—can be relied on for the best advice. “At the moment, the people who have the best practical knowledge of how these rules are being applied are still in enforcement”—and even enforcement officers in different localities sometimes offer varying interpretations of the law, he says.

Dixon notes that counsel can consult DOL without disclosing who the client is: “Another good reason to have counsel involved.”

Ready, Set, Go

Whether conducted entirely by counsel or implemented under their direction by HR professionals, a wage and hour audit will consist of a systematic analysis of each job in your organization. At issue will be your organization’s exempt and non-exempt job classifications, timekeeping and pay procedures, methods for calculating the regular rate of pay, and, in certain industries, child labor practices.

There is no single best way to conduct an audit. An effective analysis can use varying degrees of surveys, questionnaires, interviews, examinations of records and documents, and other techniques. The extent to which these tools are used, and how, depends on the auditor.

“Rarely will a job description tell you whether someone is exempt or not,” says Dixon. A questionnaire will sort out some positions, but probably not “the people in the middle ground.” Talking to managers is a good place to start, but managers “don’t know in as much detail how the work gets done as the people who do the work.” Employees, he says, are generally the best source of information.

Dabbs starts by examining industry-specific exemptions to determine overtime status, then judges whether other exemptions might exclude significant segments of the organization. He evaluates any remaining positions on the basis of job descriptions, organizational charts and pay rates.

Pass focuses on individual employees, not job titles, because some employees in a job classification may be exercising discretion that qualifies them for the administrative exemption. “My mother’s a bookkeeper, but she’s exempt because she’s been doing it for 30 years,” says Pass. “You really need to look at each individual employee.”

If unable to glean definitive information from HR, Pass might ask line managers what particular employees do. “I’m not a big fan of that,” she says. “It pulls more people into this process than need to be.”

There are other pitfalls involved in interviewing employees. “Some employees may have an inkling about what the inquiry is about and may begin to provide information more calculated to lead to a certain result—whether exempt or non-exempt—rather than to correctly classifying their job,” says Dixon.

In such situations, employers can explain inquiries about employees’ job duties without explicitly drawing attention to the exempt/non-exempt issue, says Dabbs.

Lumpkins suggests incorporating the wage and hour compliance investigation into a broader analysis of organizational structure and efficiency. “Attorneys can help to structure the investigative process so that it doesn’t send up a red flag,” she says.

Payroll Issues

A key issue in auditing payroll systems is determining overtime-eligible employees’ “regular rate” of pay, which is multiplied by 1.5 to determine overtime pay. An employee’s regular rate could be increased by several factors, such as bonuses and shift differentials.

Dabbs and Pass note that employers frequently fail to calculate non-discretionary bonuses—which might be based on attendance, number of hours worked or production standards—into employees’ regular rate. “That makes Department of Labor investigators’ eyes light up,” Dabbs cautions.

Pay practices also are relevant for determining whether certain employees meet the “salary basis test” for some of the FLSA’s overtime exemptions. With limited exceptions, docking salaried employees’ pay for partial day absences is inconsistent with paying them a fixed salary. This practice can change salaried employees’ status, making them eligible for overtime.

Paying extra for hours above a certain number is also inconsistent with the salary basis test for exempt status, according to some courts, although the DOL allows it.

Finally, an audit should review recordkeeping practices, which are vital for defending FLSA suits. Employers that fail to keep adequate records will face a “nearly insurmountable burden” when disputing employees’ claims regarding the hours they have worked, Dixon writes in his book The Federal Wage & Hour Laws, 2nd ed. (Society for Human Resource Management, 2002). (For more information on recordkeeping, see this month’s Legal Trends column on page 109.)

Heal Thyself

If a wage and hour audit reveals problems, you’ll need to remedy any possible violations. But the self-administered cure can be a bitter pill to swallow.

For example, reclassifying employees from exempt to non-exempt will affect your compensation budget. Non-exempt employees must be paid for certain functions, such as training, travel, driving time, working meals, etc. As a result, your company may not be able to afford to pay overtime-eligible employees to travel, take training, or attend working lunches and dinners.

If changes need to be made, you are neither obligated—nor necessarily well-advised—to announce possible errors to employees. “I typically do not recommend a ‘mea culpa’ approach,” Dabbs says.

Instead, focus on the positives. In general, overtime is a benefit to employees, so when reclassifying employees from exempt to non-exempt “you present that as good news,” says Dabbs. The downside is that the affected employees now have to record or report their hours when they may not have before.

Another approach, says Lumpkins, is to add staff, thereby eliminating the need for reclassified employees to work overtime. “Once that’s done, you can reclassify with less risk of exposure,” she says.

Re-engineering jobs to render them exempt is another compliance tactic, but “it’s very difficult to do and rarely does it make a difference,” says Dixon. For example, changing a few aspects of a job may not enhance an employee’s decision making authority enough to change that worker’s overtime status.

And even if a change does work, legally speaking, it may not be practical. “If you try to make a job different so it’s exempt, it probably will create inefficiencies that will [cause the job to] slide back,” says Dixon.

One approach to remedying misclassifications that both Dabbs and Dixon suggest is putting salaried employees in questionably exempt positions on a fluctuating workweek method of overtime compensation. That protocol, authorized by DOL regulation (29 C.F.R. § 778.114), allows employers to pay half-time overtime to employees in certain situations.

This is a great savings over the time-and-a-half overtime rate required for employees who receive no base salary. It does not work in California, but it can be minimally disruptive where it is allowed, Dabbs says.

The toughest question employers face is whether to remedy possible wage-and-hour violations going forward, or whether to pay all the back pay that would have been owed under the FLSA’s two-year statute of limitations. The decision involves a balancing of corporate values, cost and risk, say legal experts.

“Organizations vary in my experience,” says Dixon. Some voluntarily pay millions in back pay because they want their practices to be unassailable. “Some run into liabilities they just don’t think they can deal with.” If misclassified employees have been working very little overtime, the employer’s risk of exposure is reduced, Lumpkins points out, so it may be a reasonable solution to pay them overtime only from this point forward.

“I do try to point out that the consequences of being wrong and being called on it are typically several times the cost of dealing with the issue up front,” Dabbs says.

But while employers assume greater potential liability down the line if they do not make employees whole for unpaid overtime, the failure to offer back pay itself is not a separate violation of the FLSA, experts say; this failure also is not automatic proof of a willful violation, but it could work against you in court, says Dixon.

Margaret M. Clark, J.D., SPHR, is senior legal editor for HR Magazine.