One Step Ahead: The New Sheriff, Her Deputies and Compliance in the Face of an Eroding Administrative Exemption

David G. Islinger and James M. McDonnell

President Barack Obama’s proposed budget for the 2011 fiscal year includes an additional $25 million for the Department of Labor’s “new sheriff,” Secretary of Labor Hilda Solis.¹   The proposed increase comes on the heels of a year in which the Department of Labor added 250 wage and hour investigators, a staff increase of more than one-third.²   These increased enforcement efforts come as courts clarify the scope of the administrative exemption under the federal Fair Labor Standards Act (“FLSA”).  An employer that proactively audits employee classifications and payroll practices may, however, stay one step ahead of the posse.
 
As recent court decisions indicate, an employer may not simply rely upon an individual’s job functions or duties to properly classify a worker as administratively exempt.  An employer must analyze the industry, the employee’s role in the organization and the manner in which an employee is evaluated to determine proper classification.  The recent clarification in the scope of the administrative exemption facilitates the Department of Labor’s ability to target specific industries³ or positions in their compliance efforts.  Accordingly, employers must be on guard.
   
The Administrative Exemption

The FLSA provides that individuals employed in a bona fide administrative capacity are exempt from the statute’s overtime provisions.⁴  The Federal Regulations explain that that to qualify for the administrative exemption, the employee in question must perform “non-manual work directly related to management or general business operations of the employer […] [w]hose primary duty includes the exercise of discretion and independent judgment with respect to matters of significance.”⁵  The courts traditionally recognized employees in human resources, marketing, accounting, etc., as individuals employed in an administrative capacity.  On the other hand, employees in manufacturing, sales or other “production” related positions generally did not qualify for the administrative exemption.  The “production/administrative” guidance was particularly helpful when the United States’ economy was based upon manufacturing and retail sales.

The “production/administrative” distinction became less clear as globalization ushered in an economy dominated by service-based and financial industries rather than manufacturing.  Absent the tangible “product,” courts struggled to define the scope of the administrative exemption.  Many employees in service-based and financial industries performed non-manual work and exercised discretion and independent judgment with respect to matters of significance.  The crucial component to the equation emerged: whether an employee’s work related to management or general business operations.  That is, did the employee actually “service” the business or did the employee perform “production” services to generate revenue for the employer.  As two recent court decisions explain, an employer must examine the context in which an employee performs his or her responsibilities to determine whether the employee is “servicing” the business or working in a “production” capacity.
    
Recent Clarification of the Administrative Exemption

The Second Circuit recently explained “[t]he context of a job function matters” in determining whether an employee is properly classified as administratively exempt.⁶   In Davis v. J.P. Morgan Chase & Co., the plaintiff, an underwriter, sought overtime wages from his employer claiming the company improperly classified him as exempt.⁷  The plaintiff’s job functions included non-manual work that, to some extent, included the exercise of discretion and independent judgment.⁸  Specifically, the plaintiff evaluated loan applications in accordance with a credit guide to determine whether to approve loans.⁹
 
The court held that the employer improperly classified the plaintiff as an administratively exempt.¹⁰   The evidence demonstrated the employee’s primary responsibility was to sell (i.e., “produce”) loans.¹¹   The employer’s nomenclature and evaluation processes also factored into the court’s decision.¹²   Specifically, underwriters fell under the ambit of the “operations” or “production” department.¹³   The company also evaluated and paid performance bonuses to underwriters based upon the number of applications reviewed.¹⁴   The court explained that, in the context of the financial services industry, underwriters manufacture the product (i.e., loans) that generates revenue for the employer.¹⁵

Similarly, the Second Circuit found that a complimentary magazine’s sales director was improperly classified as exempt.¹⁶   Although an editorial staff “produced” the content of the magazine, the court analyzed the publisher’s business model to determine whether the plaintiff was employed in a “production” or “administrative” capacity.¹⁷  Because the company distributed the magazine on a complimentary basis and generated its revenue from selling advertising space, the court held that advertising space was the company’s product.¹⁸   The court reasoned the plaintiff could not be properly classified as exempt because her duties directly related to “production” rather than “administration”, i.e., the plaintiff did not service the business.¹⁹
  
A Step Ahead: Audits and Review of Pay Practices

Secretary Solis announced plans to embark on a campaign of “targeted enforcement” against companies that improperly classify employees as exempt.  Employers should review employee classifications and pay-practices to remain a step-ahead of the Department of Labor’s enforcement initiatives.  While time consuming and, at times, costly, the repercussions of improperly classifying employees could prove far more expensive.

In-house counsel must develop new audit techniques to account for developing case law regarding the administrative exemption.  The basics (e.g., analysis of employee job functions, the amount of time spent performing exempt tasks versus non-exempt tasks, etc.) remain, but ingenuity and imagination are required to determine the applicability of the administrative exemption.  Specifically, an audit must start with a basic question: “what is the company’s product?”  The answer may lie beneath the surface in financial and service industries, requiring an analysis of a company’s profit centers, specifically the positions responsible for generating revenue.  The answer to this question typically determines whether an employee’s responsibilities are related to general business operations or production.
 
Even where the answer appears clear, a proper audit will assess all potential weaknesses which an investigator may attempt to investigate.  Accordingly, the audit should encompass an analysis of incentive pay and performance evaluation practices or policies.  If an employee is rated or compensated based upon revenue levels or productivity rather than accuracy, the Department of Labor may take the position that the individual is employed in “production.”  The policies may serve as pseudo-admissions by an employer as they express the company’s expectations and opinions of the employee’s purpose in the overall operations.  While there may be logical explanations (e.g., bonuses to the marketing department based upon sales revenue), the audit must identify the questions and answers to prevent any surprises during an investigation.

*  *  *  *  *

These recent political and legal developments suggest the Department of Labor’s enforcement activities will increase in the coming year.  Employers must take swift and decisive action to remain one step ahead of the impending campaign of investigations and enforcement actions. 

Footnotes:

1.  Posting of Kate Thomas to SEIU Blog, “New Sheriff In Town: Labor Secretary Solis Takes Oath of Office” (Mar. 16, 2009, 13:21 EST).
2. Press Release, U.S. Department of Labor Wage and Hour Division, Statement by U.S. Secretary of Labor Hilda L. Solis on Wage and Hour Division’s Increased Enforcement and Outreach Efforts (Nov. 19, 2009) 
3. Id. (“I have hired an additional 250 new wage and hour investigators, a staff increase of more than one third, to ensure that we promptly respond to complaints and can undertake more targeted enforcement.”)
4. 29 U.S.C. §213(a)(1)
5. 29 C.F.R. §541.200
6. Davis v. J.P. Morgan Chase & Co., 587 F.3d 529 (2d Cir. 2009).
7.  Id.
8.  Id,
9.  Id.
10.  Id.
11.  Id.
12.  Id.
13.  Id.
14.  Id.
15.  Id.
16.  Reiseck v. Universal Communications of Miami, Inc., 591 F.3d 101 (2d Cir. 2010).
17.  Id.
18.  Id.
19.  Id.

David G. Islinger is a Partner in the Morristown, New Jersey office of Jackson Lewis LLP.  Mr. Islinger devotes his practice primarily to traditional labor law, training and counseling matters; is a member of Jackson Lewis’ Wage & Hour practice group and is an editor of the New Jersey Wage and Hour Handbook - A Practice Guide for Small Business.
James M. McDonnell represents management exclusively in all aspects of employment litigation and is a member of Jackson Lewis’ Wage & Hour and Class Action practice groups. Mr. McDonnell has successfully represented clients in matters before the United States Court of Appeals for the Third Circuit and the Appellate Division of the New Jersey Superior Court. Mr. McDonnell has been named a Rising Star in the Super Lawyers edition of Law & Politics magazine for two consecutive years.