The Fair Labor Standards Act (FLSA), the federal law governing the payment of minimum and overtime wages, turns 70 next year, and notwithstanding all the cosmetic revisions and amendments it has experienced at the hands of Congress, it is finally showing its age.
Courts are struggling with uniformly interpreting and applying FLSA and the U.S. Department of Labor's (DOL) interpretive regulations, particularly those governing overtime classification of employees. The result has been divergent opinions and guidance. This, in turn, has created confusion for employers as to the proper method for paying employees, particularly smaller companies that feel they do not have the resources to properly assess FLSA's practices and policies.
In the meantime, plaintiffs' attorneys continue to discover that FLSA collective actions represent low risk and lucrative undertakings because of a statutory provision requiring employers to pay for plaintiffs' attorneys' fees and costs incurred by plaintiffs to recover back wages. This makes these types of suits expensive, time-consuming and invasive for employers.
But there is some good news. You can take precautions to decrease the likelihood of FLSA lawsuits or, at least, minimize potential liability. The best precaution is to conduct an internal wage and hour audit of wage payment practices and job classifications for overtime purposes. The resources required to conduct an audit will pale in comparison to the costs of becoming embroiled in litigation.
What is an audit?
An internal wage and hour audit is a systematic evaluation of your wage and hour policies and practices and overtime classifications. At a minimum, an audit must review and evaluate exempt and nonexempt job classifications and timekeeping and pay practices and policies, which includes assessing your regular rate calculations, overtime calculations and the number of hours actually worked by employees.
Why audit?
Employers who violate FLSA automatically are 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 complying with the law. Monetary damages also extend forward until an employer corrects an FLSA violation; in other words, monetary damages may continue to increase even as an FLSA lawsuit is litigated.
Not only are FLSA lawsuits attractive to employees because of the potential damages, but an employee also has a longer time period to file an FLSA claim than other employment claims. For example, an employee must file an employment discrimination claim within 300 days of the alleged discrimination, but FLSA allows for a two-year (or three-year for willful violations) statute of limitations. Unlike most employment discrimination claims, FLSA violations can occur each time employees receive their paychecks, and the statute of limitations begins anew each time employees are paid incorrectly.
A wage and hour audit reduces the likelihood you will face an FLSA lawsuit because you can remedy problems discovered in an audit before they spiral into a lawsuit.
If you already are involved in FLSA litigation, a wage and hour audit may reduce the damages ultimately awarded to employees. FLSA provides a defense to liquidated damages if you can prove you had a good-faith belief that your pay practices complied with FLSA requirements. A wage and hour audit may prove just that.
In addition, an audit can prepare you for a DOL investigation and audit. Even easier than filing a lawsuit, a disgruntled employee can complain to DOL about your pay practices. What happens next? DOL's Wage and Hour Division comes knocking at your door, unannounced, demanding a complete audit of your wage and hour records and various pay practices.
In recent years, DOL has stepped up its enforcement of FLSA—it collected more than $171 million in back wages for more than 246,000 employees during fiscal year 2006, representing a 30 percent increase over back wages collected in fiscal year 2001. There is no better way to be prepared for an unannounced DOL visit than to have previously conducted a comprehensive internal wage and hour audit.
Another benefit of an audit is that it can help you navigate legal complexities and changes. As with most government regulations, understanding FLSA and its regulations can be daunting. The statute and regulations are complex and often counterintuitive, and DOL and the courts are constantly refining (or muddying, depending on your perspective) the state of the law. The only way you can be ensured of compliance with the complex and ever-changing law is by conducting detailed audits at appropriate times.
When to audit?
In a perfect world, you would conduct scheduled wage and hour audits annually. But realistically, you may not have the time or resources to do so. In that case, you should conduct checkups of your wage and hour practices annually, following up in any areas found to be out of compliance in prior years.
If annual checkups are not feasible, you should, at a minimum, conduct audits when certain "red flag" conditions occur, such as:
As most employers know, disgruntled employees often will do anything to get back at an employer, including filing FLSA complaints and lawsuits. When employees feel overworked and underpaid, they are especially vulnerable to solicitations from eager attorneys attempting to gather employees for a class action and to union organizers promising a powerful cure-all. Pay particular attention to these disgruntled employees.
Preparing for an audit
Because a wage and hour audit is a preventative tool, you often cannot anticipate an audit's result. An audit may show your pay and classification practices comply with FLSA, or it may show the exact opposite. If an audit discovers significant problems with how employees work and how pay is calculated, you will likely spend a substantial amount of money and resources to remedy the problems.
Before conducting an audit, it is imperative senior management understand the importance of the internal audit process and reasonably anticipate the costs of remedying potential problems discovered by the audit process. Senior managers must be committed to complying with FLSA mandates, which includes taking the necessary remedial steps to bring the organization into compliance. If this level of commitment is lacking, the audit likely should not proceed.
The scope of an internal wage and hour audit largely depends on your ultimate goals for the audit process. If you are concerned about a particular area of your work force or classification of a particular employee, the audit should be focused on bringing that particular area or employee job into FLSA compliance. But you probably will want a broad, all-inclusive audit of your payment and classification practices.
Different auditors employ different methods when evaluating an employer's pay practices. An effective audit should use some combination of surveys; questionnaires; interviews; and examinations of records and documents, including organizational charts, job descriptions and other specialized techniques. When preparing for the audit process, you (with input from an outside auditor if you choose to hire one) should determine what methods and tools you will use in your evaluation and analysis.
Generally, much of a wage and hour audit is spent ensuring employees are correctly classified as exempt or nonexempt according to FLSA and DOL. There are different ways to gather this information. Some auditors solely talk with human resources managers or middle managers to gather information about particular jobs and job duties. Others believe such managers are a good place to start but employees also must be consulted. The feasibility of consulting employees directly, of course, is guided by the size of the work force.
But consulting employees directly has its risks. For example, employees who understand exempt and nonexempt issues may be inclined to provide slanted information that is calculated to lead to a certain result—whether exempt or nonexempt. Further, when asked about job duties, an informed employee's interests may be sparked, and you may have a potential plaintiff on your hands. An experienced auditor, such as an outside consultant or attorney, may be able to structure the questioning of employees to minimize these risks.
Therefore, before embarking on the audit process, determine to what extent managers and employees will be involved in the audit process by weighing the benefits against the potential risks.
The audit
There is no perfect way to conduct an internal wage and hour audit because much of an audit is personalized to an individual company's needs and goals. But the following general procedures should be followed when conducting an audit.
First, take an accurate snapshot of your work force. Ensure all employees are accurately matched with a job title, and then divide them into departments and job groups depending on their job titles. You should develop a master list that accounts for each employee, his or her job title, department and job group, and how each employee is currently paid (exempt/nonexempt status and regular rate of pay for overtime-eligible employees). An accurate organizational chart can help you obtain this snapshot and properly classify employees.
Also, look outside the company and assess whether workers performing work as independent contractors are in fact employees for purposes of wage and hour laws. Misclassifying employees as independent contractors can expose you to a host of potential federal and state tax and wage and hour liabilities.
Generally, courts will look at factors such as the degree of direction and control over the performance of an independent contractor's work. For instance, do you provide instruction or training to the worker? What is the extent of the worker's investment in equipment and facilities in performing services? What is the extent to which the worker can realize a profit or incur a loss? Are there written contracts describing the relationship you and the worker intended to create? How permanent is the relationship? Does the worker perform services for other similar businesses?
If you determine you have misclassified employees as contractors, those employees should be included in the scope of the audit.
After taking a snapshot, you need to determine whether employees are exempt from FLSA overtime requirements; to do so, carefully review employees' job duties. Although you should maintain accurate job descriptions for each job in your company, job descriptions alone rarely reveal whether an employee is exempt or nonexempt. Analyzing an employee's status based solely on a job description or title is often insufficient because some employees with a certain job title may be exercising more discretion that qualifies them for some type of exemption under FLSA.
After getting an accurate picture of each employee's job duties, determine whether employees qualify for any exemptions under FLSA. If an audit is being conducted by in-house staff and an outside auditor, an auditor with expertise in the law is most useful at this point in the audit. To determine whether an employee qualifies for an exemption, use the following three tests, each of which must be satisfied:
FLSA provides for additional exemptions for outside sales employees, computer employees and other industry-specific exemptions that are described in detail in DOL regulations. Also, consider that many states have wage and hour statutes that parallel FLSA but are separately enforced. State laws can be even more restrictive than FLSA and have narrower or fewer exemptions.
After employees are properly classified, the next step in the audit process is to analyze your pay practices.
Your pay practices should be analyzed to ensure exemptions under FLSA are not destroyed by such pay practices. For example, you may risk destroying an employee's exemption if you dock a salaried employee's pay for a partial-day absence.
To ensure proper pay practices, carefully analyze them to make sure you are paying overtime-eligible employees correctly and that overtime pay is being properly calculated. Under federal law, overtime pay for eligible employees is determined by multiplying the number of hours worked in excess of 40 in a workweek by 1 1/2 times the employees' regular rate of pay. State law may require otherwise.
In addition to an employee's base hourly rate, other forms of compensation, such as commissions, prizes, shift differentials and certain bonuses, must be factored into the regular rate when determining overtime pay.
For instance, if an employee receives a quarterly performance bonus pursuant to company policy, that bonus must be prorated over the course of the quarter in which it was earned and included for purposes of determining a new, higher regular rate for that period of time, which will increase the employer's overtime obligation.
Above and beyond actual calculation of overtime pay, it is important for you to verify employees are receiving proper pay for time considered "worked" under applicable laws. For instance, certain types of waiting time, on-call time, meal periods and rest breaks, time spent in training and meetings, and travel time are considered time worked and must be included in calculating employee overtime.
In addition, you will need to analyze your record retention policies and procedures. FLSA includes extensive and complicated recordkeeping requirements for employers. Records required for exempt employees differ somewhat from those required for nonexempt employees.
At a minimum, FLSA requires employers to preserve at least two years worth of basic employment and earnings records; wage rate tables; order, shipping and billing records; and records of additions to or deductions from wages paid.
FLSA additionally requires employers to preserve the following documents for at least three years: payroll records; certificates, collective bargaining agreements and individual contracts; and sales and purchase records. If you are party to a multiemployer union pension or health and welfare plans, you may consider preserving records for a longer time period because the statute of limitations for bringing claims for delinquent contributions may be significantly longer, depending on your state.
Failing to keep the necessary records can be disastrous for you if you are defending an FLSA lawsuit. Without the necessary records and documentation, it will be virtually impossible to dispute employees' claims regarding the hours they have worked or the pay they have received. Even worse, the absence of such records may result in a negative inference about what those records would show if they existed.
In addition to recordkeeping requirements, you must display DOL's Wage and Hour Division's minimum wage poster, which briefly outlines FLSA requirements. A copy of this poster can be obtained from DOL's Web site, www.dol.gov. Also, check to ensure that any posters required by state law are displayed.
As a final step, consider whether other policies or procedures can be affected by any pay changes. Similarly, an analysis of your written employment policies and procedures should be conducted to ensure such written policies do not conflict with FLSA and its regulations.
For example, changes in job classifications or pay could affect classifications and data on which your affirmative plan is based. Changes in time reporting or method of pay (salary versus hourly) may affect the timing or frequency of pay so as to require a revision of the applicable payroll system. These are just two examples of the many other changes, beyond pay changes, a wage and hour audit may require.
After the audit
If your internal wage and hour audit reveals compliance problems, remedy the problems as soon as possible or, at least, have a carefully considered reason for not fixing the problems. You should keep the results in a confidential file.
An internal wage and hour audit is an essential preventative tool for employers. Not only can internal wage and hour audits reduce the risk of FLSA lawsuits and hefty damage payments, but they also help you navigate the messy waters of FLSA and its regulations. An annual—or at least an "as needed"—wage and hour audit should be at the top of every employer's "to do" list.
Victoria L. Donati and Jason C. Kim are partners in the employment law group with the Chicago-based law firm Neal, Gerber & Eisenberg LLP.
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