Employment and Labor

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1 Employment and Labor Analysis of the Department of Labor s Proposed Changes Under the Fair Labor Standards Act* Thomas J. Flaherty tflaherty@pillsburywinthrop.com Tel June 2003 Pillsbury Winthrop LLP 1600 Tysons Boulevard McLean, Virginia Phone: Fax: Blake M. Guy bguy@pillsburywinthrop.com Tel Elizabeth A. Lalik elalik@pillsburywinthrop.com Tel * These proposed regulations, while potentially very significant in many states, may have little or no impact in California. Employers with operations or work forces in California must comply with California s more stringent wage/hour laws and regulations. The proposed amendments to the regulations under the Fair Labor Standards Act would not change the existing California law. While a change at the federal level might ultimately be adopted by the California Legislature or the California Industrial Welfare Commission, employers in the interim would be required to continue to observe the more stringent California standards. These include daily overtime (overtime pay for non-exempt employees who work more than 8 hours in a day); narrower and more restrictive exemptions; and different methods for calculation of overtime pay.

2 Introduction and Overview On March 31, 2003, the Department of Labor ( DOL ) published proposed regulations that redefine the white collar exemptions under the Fair Labor Standards Act ( FLSA or the Act ). The proposed rules would substantially modify which employees are exempt from the minimum wage and overtime requirements of the FLSA, and would alter the tests employers use to classify their employees as exempt or non-exempt under the Act. There are several key changes in the proposed rules: 1. Special rule for highly compensated employees : if an employee makes $65,000 or more annually and he/she performs any one of certain exempt duties, that employee is classified as exempt even if they do not meet all of the criteria ordinarily required to qualify as an exempt executive, administrative, or professional employee; 2. Liberalization of the safe harbor provision : currently, if an employer makes improper deductions from a single employee s salary, the employer risks losing the exemption for an entire class of employees (subject to the FLSA s window of correction for inadvertent mistakes). Under the proposed rules, the exemption is only lost if there is a pattern and practice of improper deductions, in which case the lost exemption applies only to employees in the same job classification and working for the same manager who is responsible for the impermissible deductions. Moreover, the rules contain a new safe harbor provision: if the employer has a written policy prohibiting improper deductions which it publishes to employees, and it reimburses employees for any improper deductions, then the employer would not lose the exemption for any employees unless the policy is repeatedly and willfully violated; 3. Authorization of full-day deductions from pay for disciplinary reasons: currently an employer risks losing the exemption if it docks an employee s pay for disciplinary reasons other than a violation of a significant safety rule. The proposed rules would permit an employer to discipline an employee who has violated workplace conduct rules (such as sexual harassment or workplace violence policies), by docking the employee s salary for one or more full days without risking the exemption; 4. Elimination of short and long tests and increase in the minimum salary level: the current regulations contain two tests a short test and a long test for each of the three white-collar exemptions (executive, administrative, or professional). The proposed rules contain only one set of criteria for each exemption. The proposed rules also increase the minimum salary level to qualify as exempt from $250/week (under the current long tests) to $425/week ($22,100 annually); Page 2

3 5. Liberalization of outside sales employees exemption: the proposed rule eliminates the current requirement that to qualify for the outside sales exemption, a sales employee must not spend more than 20% of his/her time on activities unrelated to their own outside sales or solicitations; 6. Modification of computer employees exemption: the proposed rule eliminates the requirement that an employee must consistently exercise discretion and judgment in order to qualify as an exempt computer professional. DOL has requested comments from the public regarding certain specific issues under the proposed rules, including: 1) the ease of application of the computer employee exemption, 2) whether the new, higher minimum salary requirement is appropriate, and 3) whether certain of the duties requirements related to the administrative, executive, and professional exemptions should be retained or discarded. At the conclusion of the comment period, which is drawing to a close, DOL is likely to issue some form of the proposed rules in final form. Employers then will need to re-evaluate their workforces to ensure compliance under the new FLSA standards. DOL s Estimated Cost to Employers DOL estimates that the proposed rules will raise the number of non-exempt employees (who are entitled to overtime pay) by approximately 12 million, and will cost some industry sectors as much as $163 million in implementation and payroll costs (such as the health services sector). DOL further predicts that certain industry sectors will incur costs that substantially exceed any benefits derived from the proposed rules (for example, manufacturing (including electronics), transportation, and communications). On the other hand, DOL estimates that the proposed rules will result in overall savings to private industry of $354.6 million. Brief Overview of FLSA Exemptions Employees subject to the FLSA are entitled to be paid at least the federal minimum wage, as well as overtime pay (of time and one-half) for all hours worked over 40 in a work week. 1 Not all employees are subject to the FLSA, however. Any employee engaged in an executive, administrative, or professional capacity, or in the capacity of an outside salesman, is exempt from minimum wage and overtime requirements. These exemptions are collectively referred to as the white-collar exemptions. The Act itself does not define these exemption terms. 1 If a State or local law establishes a higher standard than the provisions of the FLSA, the higher standard applies. See 29 U.S.C Page 3

4 Instead, the Department of Labor has issued regulations which define the scope of the exemptions. 2 It is those regulations to which employers routinely turn in order to classify their employees as exempt or non-exempt from the FLSA s requirements. DOL is now proposing to replace these regulations with the new rules it has published for public comment. In addition to the specific requirements of each exemption, the current rules require that three general tests be met for one of the white-collar exemptions to apply: (1) the employee must be paid a fixed salary without reduction for variations in quantity or quality of work; (2) the amount of salary must exceed a designated threshold; and (3) the employee s job duties must primarily involve executive, administrative, professional or outside sales duties. 3 DOL s Reasons for the Proposed Rules DOL points to a report issued by the General Accounting Office ( GAO ) to explain its interest in revising the FLSA regulations. DOL explains that employers are concerned about the complicated and confusing nature of the current regulations, which leads to potential liability (particularly with respect to the salary basis test and related no-docking requirements). At the same time, DOL explains, employee representatives are concerned about the perceived overuse of the exemptions to limit overtime pay and to increase the standard workweek beyond 40 hours. In reaction to these concerns and in addition to the outdated nature of the regulations (which are essentially 50 years old), DOL concluded that a revision of the rules was appropriate. Proposed Changes Shared By The Exemptions The proposed regulations contain certain changes common to each of the white-collar exemptions. First, as the regulations currently stand, the executive, administrative, and professional exemptions each have associated long and short tests to determine whether an employee qualifies for the particular exemption. The long test applies if the employee makes more than $155/week (or $170/week for the professional exemption) but less than $250/week. If the employee makes more than $250/week, the short test (containing fewer duties requirements) applies. Under the proposed rules, the long and short tests associated with each exemption classification would be eliminated and replaced with a standard test. 4 Second, since only a single standard test would apply to each exemption, DOL would also eliminate the current multiple minimum salary levels applicable to the executive, administrative, and professional exemptions. 5 DOL would increase the minimum salary threshold for all of the 2 These regulations have the binding effect of law. Batterton v. Francis, 432 U.S. 416, 425 n. 9 (1977). 3 Parts 1 and 2 are generally referred to as the salary test. Part three is generally referred to as the duties test. 4 The standard test consists of two elements: salary and duties. 5 Outside sales representatives can qualify for the exemption without meeting any minimum salary requirement. Page 4

5 exemptions to a standard $425 per week. DOL expects that this change alone will result in the lowest paid 20% of all current salaried employees to fall below the minimum salary requirement and be automatically entitled to overtime pay. Third, the current regulations require that an employee customarily or consistently exercises discretion and independent judgment for each of the executive, administrative, and professional exemptions, with the sole exception being the short test for the executive exemption. The new regulations would eliminate that requirement entirely in determining the exemption status of an employee. Fourth, the long test requirement that an exempt employee devote no more than 20% of his or her time to activities not directly and closely related to exempt work would be eliminated entirely for exemption. Proposed Changes to Specific Exemptions A. Executive Exemption In order to qualify for the Executive exemption under the proposed rules, an employee would have to satisfy the following four requirements: Salary of $425 per week. Primary duty of management of the enterprise or a recognized department or subdivision (currently a requirement under both the short and long tests). 6 Customarily and regularly directs the work of two or more other employees (currently a requirement under both the short and long tests). 7 Has authority to hire or fire other employees (or recommendations as to hiring, firing, promotion or other changes of status of other employees are given particular weight) (currently a requirement under the long test). DOL eliminates the long test requirements that the employee customarily and regularly exercises discretionary powers and does not devote more than 20% of his or her time (40% in retail or service establishments) to non-exempt work. 6 Primary duty is defined as the principal, main, major or most important duty that the employee performs. 7 Customarily and regularly is defined as a frequency that must be greater than occasional but which may be less than constant. Page 5

6 Additionally, although DOL proposes to rename the current executive exemption regulation titled Working Foremen to Working Supervisors, the Department notes that it intends to make no substantive change in the rule. As it stands, employees with supervisory functions who also perform work unrelated or only remotely related to their supervisory functions are not exempt executives if their primary duty consists of the same kind of work performed by their subordinates, work that consists of ordinary production or sales works, or routine, recurrent or repetitive tasks. B. Administrative Exemption In order to qualify for the Administrative exemption under the proposed rules, an employee must satisfy the following three requirements: $425 per week. Primary duty of performing office or non-manual work directly related to the management or general business operations of the employer or the employer s customers (currently a requirement under both the short and long tests). 8 Holds a position of responsibility with the employer, defined as either (1) performing work of substantial importance or (2) performing work requiring high level skill or training (new requirement). 9 DOL eliminates the requirement under both the short and long tests that the employee customarily and regularly exercises discretion and independent judgment. Also eliminated are the long test requirements that the employee: 1) does not devote more than 20% of his or her time (40% in retail or service establishments) to non-exempt work, and 2) regularly and directly assists a proprietor or exempt administrative or executive employee, or performs specialized or technical work requiring special knowledge under only general supervision, or executes special assignments under only general supervision. 8 The proposed rule includes an illustrative list of such types of work areas that meet this requirement: tax, finance, accounting, auditing, quality control, purchasing, procurement, advertising, marketing, research, safety and health, personnel management, human resources, employee benefits, labor relations, government relations and similar activities. 9 The proposed rule includes a list illustrating the types of activities that are generally considered of substantial importance for purposes of the exemption including: formulating or interpreting management policies, providing consultation and expert advice to management, making or recommending decisions that have a substantial impact on business operations or finances, analyzing and recommending changes to operating practices, planning long or short-term business objectives, analyzing data, and handling complaints, arbitrating disputes and resolving grievances. Page 6

7 C. Professional Exemption 1. Learned Professional Exemption In order to qualify for the Learned Professional exemption under the proposed regulations, an employee must satisfy the following two requirements: $425 per week. Primary duty of performing office or non-manual work requiring knowledge of an advanced type in a field of science or learning customarily acquired by a prolonged course of specialized intellectual instruction, but which also may be acquired by alternative means such as an equivalent combination of intellectual instruction and work experience (modification of a current similar requirement under both the short and long tests). DOL eliminates the current short and long test requirement that the employee consistently exercises discretion and judgment, as well as the long test requirements that the employee: 1) does not devote more than 20% of his or her time to non-exempt work, and 2) performs work that is predominantly intellectual and varied in character and the output/result produced cannot be standardized in relation to a given period of time. 2. Creative Professional Exemption In order to qualify for the Creative Professional exemption under the proposed regulations, an employee must satisfy the following two requirements: $425 per week. Primary duty of performing work requiring invention, imagination, originality or talent in a recognized field of artistic or creative endeavor (modification of current similar requirements under both the short and long tests). DOL eliminates the current long test requirements that the employee: 1) consistently exercises discretion and judgment, 2) does not devote more than 20% of his or her time to nonexempt work, and 3) performs work that is predominantly intellectual and varied in character and the output/result produced cannot be standardized in relation to a given period of time. Page 7

8 D. Computer Employee Exemption In order to qualify for the Computer Employee exemption under the proposed regulations, an employee must satisfy the following three requirements: $425 per week or $27.63 per hour. Primary duty of (A) application of systems analysis techniques and procedures, including consulting with users to determine hardware, software or system functional applications; or (B) design, development, documentation analysis, creation, testing, or modification of computer systems or programs, including prototypes, based on and related to user of system design specifications; or (C) design, documentation, testing, creation or modification of computer programs related to machine operating systems; or (D) a combination of duties described in (A), (B) and (C), the performance of which requires the same level of skills (currently a requirement under the Section 13(a)(17) statutory test). Employed as a computer systems analyst, computer programmer, software engineer, or other similarly skilled worker in the computer software field (currently a requirement under the short, long and statutory tests). DOL eliminates the short and long test requirements that the employee: 1) consistently exercises discretion and judgment, and 2) has a primary duty of performing work requiring theoretical and practical application of highly-specialized knowledge in computer systems analysis, programming, and software engineering. Also eliminated are the long test requirements that the employee: 1) does not devote more than 20% of his or her time to nonexempt work, and 2) performs work that is predominantly intellectual and varied in character and the output/result produced cannot be standardized in relation to a given period of time. E. Outside Sales Employee Exemption In order to qualify for the Outside Sale Employee exemption under the proposed regulations, an employee must satisfy the following two requirements: Primary duty of making sales; or of obtaining orders or contracts for service or for the use of facilities for which a consideration will be paid by the client or customer (modification of a current long test requirement). Page 8

9 Customarily and regularly engaged away from the employer s place or places of business (modification of a current long test requirement). 10 DOL eliminates the long test requirement that the employee does not devote more than 20% of the hours worked by nonexempt employees of the employer to activities that are not incidental to and in conjunction with the employee s own outside sales or solicitations. F. Special Rule for Highly Compensated Employees Under the proposed rules, employees paid $65,000 or more annually and performing office or non-manual work would be exempt if they perform any one or more of the duties identified in the proposed standard tests for the executive, administrative or professional exemptions. 11 These employees would not have to meet all of the duties of any particular standard test to qualify for an exemption. Moreover, in determining whether an employee is paid $65,000, an employer may include not only salary payments, but commissions (paid on a monthly basis), non-discretionary bonuses, and other non-discretionary compensation as well. Modifications to the Salary Basis Test and the Safe Harbor Provisions As noted above, under the current regulatory scheme an employer must pay an employee a regular predetermined amount of salary, not subject to reductions because of variations in the quality or quantity of the work performed, in order for the employee to qualify for the executive, administrative, or professional exemptions. DOL takes the position that the existing salary basis test also prohibits an employer from making deductions from an exempt employee s salary as a result of absences from work related to personal matters or disciplinary problems (except as a penalty for violation of a certain safety rules) for any week in which the employee performs any work (commonly referred to as no-docking rules). 12 The current regulations provide that an employer who improperly deducts from a particular employee s guaranteed salary can lose the exemption not only for that employee, but for an entire class of employees throughout the company. The current window of correction permits the employer to save the exemption in the event of inadvertent mistakes by reimbursing the employee for inadvertent improper deductions and promising to comply with the FLSA in the future. 10 There is no minimum salary requirement under either the current or proposed rules for this exemption. 11 For employees who commence employment after the beginning of the year, a pro rata portion of the minimum guarantee may be used. 12 These are but two of several prohibitions against docking an employee s salary. Page 9

10 The proposed rules modify the salary basis test, the potential consequences of improper deductions, and the safe harbor provision. First, the proposed rules would permit certain disciplinary deductions from an exempt employee s salary for absences of a full day or more. 13 If an employee violates a workplace conduct rule, the employer may suspend the employee from work for a full day or more (even if less than a week) and make appropriate deductions in the employee s pay. For example, an employer would be permitted to suspend an employee without pay for reasons such as sexual harassment or workplace violence. In order to maintain the employee s exempt status in such a case, the suspension must based on a written policy applied uniformly to all workers. Second, the proposed rules would modify the scope of potential consequences resulting from improper deductions from an employee s salary. Under the proposed regulations, the exemption would be lost only if there is a pattern and practice of improper deductions, and then only for employees in the same job classification and working for the same manager who is responsible for the improper pay docking decision or policy. Third, the proposed rules would create a new safe harbor provision: if an employer has a written policy, notifies employees of that policy 14, and reimburses employees for any improper deductions, then that employer would not lose the exemption for any employees unless the employer s policy prohibiting such deductions is repeatedly and willfully violated. These last two modifications, if issued in final, are likely to substantially assist prudent employers faced with allegations of improper pay docking. Comment Period Specific topics on which DOL has requested written comments from the public include: whether the computer employee exemption may be further clarified; whether the proposed salary level of $425 per week should be modified or eliminated; which occupations should be included as specific examples which ordinarily satisfy the requirements for a particular exemption; 13 Partial day deductions remain impermissible. 14 For example, by publishing the policy to employees at the time of hire, in an employee handbook or on the employer s Intranet. Page 10

11 whether the working supervisor section appropriately distinguishes between exempt and non-exempt executive employees; whether the supervision of two or more employees required for the executive exemption should be modified to include the customary or regular leadership, alone or in combination with others, of two or more employees; whether other types of work should be added to the list of jobs that ordinarily meet the administrative exemption requirement of performing office or non-manual work related to the management or general operations of the employer, or the employer s customer; whether additional activities should be included in the illustrative list of activities that satisfy the administrative exemption requirement of substantial importance; whether the administrative exemption requirement of discretion and independent judgment should be retained in some capacity. Although drawing to a close, the time period for submitting comments on the proposed regulations remains open until June 30, Please do not hesitate to call any of us if you would like to submit comments to DOL, or if you have questions about either the current regulatory scheme or DOL s proposed regulations. Page 11