Labor: The 3 “C’s” of auditing FLSA compliance

Use a solid compliance plan to minimize the legal risk of violating the FLSA.

I recently asked an in-house counsel which compliance issues kept him awake at night. His reaction was immediate: wage and hour land mines. Describing concerns about unpaid overtime, off-the-clock work and misclassification of exempt employees as a “speeding train hurtling down the track,” he admitted that he had difficulty sorting the potential issues into a manageable compliance framework. No doubt, his concerns are not unique.

For years, the Fair Labor Standards Act (FLSA) was a sleeping giant. Even though collective actions allowing damages for large categories of employees could be pursued with relative ease, very few plaintiff lawyers waded into this highly technical area. Employers, in turn, were either naive about the costly ramifications of non-compliance or they closed their eyes, crossed their fingers and hoped for the best.

Well, we all know that the FLSA sleeping giant woke up. FLSA lawsuits, particularly bottom-line impacting collective actions, continue to mushroom. Focusing on FLSA regulations that are often counter-intuitive, plaintiffs’ lawyers see an opportunity to collect on behalf of scores of employees. The speeding train, however, can be derailed, or at least knocked off course, by targeted audits and a solid compliance plan.

Auditing FLSA practices can be generally grouped into three areas:

1. Classifying employees exempt or non-exempt from statutory overtime pay
2. Counting all “hours worked” by non-exempt employees
3. Calculating overtime pay accurately by including all required remuneration into the regular rate

Each of these areas is a minefield for FLSA litigation.

Classifying employees as exempt or non-exempt

Misclassifying employees as exempt or non-exempt from mandatory overtime pay, as well as minimum wage, is one of the most common FLSA errors. Unless exempt, employees must generally be paid at the rate of 1.5-times their “regular rate” of pay for all hours worked  more than 40 in a week. The exemptions are narrow and the burden is on the employer to show that overtime requirement was properly not applicable. The most common exemptions—the so-called “white collar” exemptions—apply to executive, administrative, professional, outside sales and certain computer-related employees.

Assuming these employees receive a bona fide salary of at least $455 each week and meet the regulatory definitions for both the “duties” and “salary basis” tests, they do not have to be paid overtime because their salary is intended to cover all of their working time.

If an employee is misclassified as exempt, though, the company may be responsible for unpaid overtime, liquidated damages (i.e., double back pay), civil penalties, injunctions and other relief. Depending on whether the violation is willful, the statute of limitations is either two or three years. Managers or supervisors can be found individually liable. Equally troubling, if an employer’s payroll practices allow exempt employees’ salaries to be docked in ways that conflict with the salary basis test, scores of employees can be converted to non-exempt status and thus, entitled to unpaid overtime. The liability can be enormous. To reduce the risk of surprises, the FLSA added a “safe harbor” provision allowing employers to preserve exemption through written policies and robust internal complaint procedures.

In auditing whether employees perform exempt duties and are paid on a salary basis, employers should consider these factors:

  • Are job descriptions, profiles, and employee self-evaluations reviewed? Do they accurately depict the primary duties of the position as exempt?
  • Do annual performance evaluations reflect exempt work? Do employees sign their evaluations to acknowledge the job duties expected of them?
  • Does the organization have a written safe harbor policy prohibiting improper salary deductions (such as deductions for partial-day absences that are not unpaid FMLA leave)?
  • Does payroll administration provide for a manual review of any partial day docking of an exempt employee’s salary?

Counting all hours worked      

After misclassification, the next wave of FLSA litigation focuses on hours worked. We start with the assumption that non-exempt employees are entitled to overtime pay for all hours more than 40 in a work week. Because hours worked under the FLSA is broadly defined to include all hours employees are “suffered or permitted to work” for their employer, including time they are necessarily required to be on duty on the employer’s premises or at a prescribed workplace, the issues are ripe for challenge.

Claiming “off-the-clock” work under circumstances where their time, if properly tracked and paid, would have resulted in overtime hours, groups of employees have taken to filing collective actions for unpaid overtime. Typically, these allegations are buttressed by proof that managers knew of the extra work, for example, through emails, computer log-in records or company provided mobile telephones, and benefited from the uncompensated effort. Double wages for unpaid time going back three years, plus attorney fees and costs, are possible remedies.

The trouble is that otherwise nickel and dime issues—a few minutes here, a few there—can quickly add up when multiplied by the number of employees and looking back three years. Likewise, assuming that even a few minutes of unpaid work can be ignored as de minimis is a risky strategy since increasingly sophisticated electronic timekeeping systems can track working time to the minute.

Examples of common mistakes employers make in counting hours worked are:

  • Excluding time employees spend “donning” and “doffing” required safety gear or protective clothing that is integral and indispensable to the job
  • Not properly counting and paying for missed unpaid meal breaks or certain training and travel time
  • Assuming that work employees do remotely at home in off hours with the tacit approval of their supervisors is “on their own time”
  • Shaving employee working time through payroll assumptions and overly broad rounding practices

Calculating overtime pay

With increasing frequency, non-exempt employees are claiming their overtime pay was shorted because not all payments by the employer were factored in the “regular rate” before calculating their overtime premium. Under the FLSA, all compensation that is “remuneration for employment” must be included in the regular rate unless it falls within a narrowly construed statutory exception. Many employers, to their peril, confuse the regular rate with the base hourly rate or salary and fail to include commissions, shift differentials, certain bonuses and other similar payments into the overtime calculation, thus shaving the overtime pay owed to the employee. These errors are particularly susceptible to collective-action treatment because unpaid overtime can be recalculated for broad groups of affected employees with relative ease. After all, it is just math.    In auditing FLSA regular rate compliance, examples of payments that generally must be included in the regular rate are:

  • On-call pay
  • Shift differentials and hazardous duty pay
  • Commissions
  • Salary and hourly rate increases, including retroactive pay raises

Conclusion

Employers who understand the three C’s of FLSA compliance and plan strategies around them are less likely to face unintended legal exposure. Auditing how your company classifies employees, counts hours worked and calculates overtime pay is the first step in minimizing the legal risk of violating the FLSA.

Contributing Author

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Meg Alli

Meg Alli is a shareholder in the Bloomfield Hills, Mich. office of Ogletree Deakins and a member of the firm's Wage and Hour Practice Group.

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