MAY 14, 2004

U.S. Department of Labor Releases Final Regulations Governing White Collar Exemptions Under The Fair Labor Standards Act

James Coleman

After a lengthy and contentious rulemaking proceeding spanning the past year, the U.S. Department of Labor has published its final regulations revising the criteria governing the white collar exemptions under the Fair Labor Standards Act. The final regulations were published in the Federal Register on April 23, 2004, and are scheduled to become effective, 120 days later, on August 21, 2004.

In a move that appears to be designed to improve the Labor Department’s ability to defend the final regulations under the anticipated Congressional scrutiny that will surely follow publication, many changes have been made to what was proposed in March 2003. Unfortunately for employers, most of these changes have the impact of narrowing the scope of the exemptions in various ways.

In the spring of 2003 the U.S. Department of Labor, Wage and Hour Division, began a rulemaking proceeding to amend the regulations defining the so-called “white collar” exemptions under the Fair Labor Standards Act. These regulations define which employees are exempt from the FLSA’s minimum wage and overtime requirements under the classifications of “executive,” “administrative,” “professional,” “computer employee,” and “outside sales.” For the most part, these regulations have remained unchanged for several decades.

Most of these exemptions are conditioned upon the satisfaction of several criteria generally related to the manner in which the employee is compensated, and the employee’s job responsibilities and duties. If the exemption criteria are satisfied, then the employee is exempt from the FLSA’s minimum wage and overtime requirements.

The final regulations are significant in that they are comprehensive and touch on virtually all aspects of the exemption criteria for each of the exempt classifications. On the compensation side, where salary levels are required, they have been increased over the levels that were proposed last year. Similarly, on the “job duties” side, the Labor Department has backed away from many of the more significant changes it proposed last year.

When I described the Labor Department’s proposal last year, I advised employers that it contained significantly more good news than bad news. Unfortunately for employers, in analyzing the differences between the proposal of last year and the final regulations, the bad news has gotten worse, and the good news, or at least some of it, has been significantly curtailed.

With a few very limited exceptions, under the final regulations, executive, administrative and professional employees earning a weekly salary of less than $455 have no chance of qualifying for any of these exemptions. The $455 threshold represents a $30 per week increase over what the Labor Department proposed last year. For so-called “computer employees,” the new compensation criteria are either a salary of not less than $455 per week, or an hourly wage of not less than $27.63. The outside sales employee exemption never had compensation criteria, and the final regulations do not change that part of the exemption.

Most of the changes to the “job duties” criteria do appear to be intended to simplify application of the exemptions, thus making it easier for employers to classify employees with a greater comfort level. Many of the changes proposed last year have been eliminated in response to strong criticism by organized labor. The easiest way to summarize the various exemptions is to simply analyze them in the order in which they are presented in the final regulations, and attempt to summarize, at the risk of oversimplification, the changes to the current law that will take place when the final regulations become effective 120 days after they are published in the Federal Register. Because each exemption has different criteria, each needs to be addressed separately.

Executive Exemption General Rule:

The new “General Rule” for the executive exemption basically represents the current “Short Test,” with two changes. The first is the higher salary requirement of $455 per week versus the current $250 per week. The second change is the addition of the fourth criterion concerning the authority to hire and fire. This was always a requirement under the current “Long Test,” but not under the current “Short Test.” For most employers, this requirement should not pose a problem. Most executive employees with true supervisory/management responsibilities are involved in the hiring and firing process, and the requirement does not mandate that the employee have final hiring and firing authority as long as his or her recommendations in this regard are given “particular weight” by the employer. In determining whether the employee’s recommendations are given “particular weight,” the regulations specify factors to be considered, including whether it is part of the employee’s job duties to make such suggestions and recommendations, the frequency with which such suggestions and recommendations are made or requested, and the frequency with which the employee’s suggestions and recommendations are relied upon.

In another retreat from what was proposed last year, the Labor Department eliminated the “Sole Charge Executive” provisions that were part of the original proposal. These provisions would have granted the executive exemption to employees in sole charge of an independent establishment or a physically separated branch establishment, as long as the compensation requirements were satisfied. The impact of this change will fall most heavily upon chain retailer employers that have hundreds or thousands of separate establishments. It does not mean that the managers of those establishments cannot qualify for the executive exemption, but it does mean that in order to do so they will have to satisfy all requirements of the Executive Exemption General Rule.

The remaining provisions of the new “General Rule” for the executive exemption provide interpretive guidance as to the exemption criteria. Generally, the interpretations are consistent with the Labor Department’s historical enforcement position, since the exemption criteria are not new. However, there are several instances where the proposal goes to some length to clarify application of the criteria in a manner that is favorable to employers, including the much- litigated issue of permissible deductions from salary and the so-called “window of correction” that is available to employers when they discover that they have violated the provisions governing impermissible deductions from salary. These provisions are discussed later in this memorandum.

Administrative Exemption General Rule:

Similar to the “General Rule” for the executive exemption, the Administrative Exemption General Rule basically represents the current “Short Test” for determining exempt status as an Administrative employee with the exception of the increased compensation requirement. In a major departure from last year’s proposed changes, the Labor Department has returned to the “discretion and independent judgment” requirement contained in the current regulations, and abandoned the “position of responsibility” requirement that had been proposed as a replacement. The preamble to the final regulations reveals that the Labor Department received much criticism of its proposal, and therefore decided to return to the existing criteria. On the positive side, however, the final regulations and the preamble go to lengths to clarify and refine application of the “discretion and independent judgment” requirement. Thus, there is hope that future application of the Administrative exemption may be a little less subjective, and therefore less likely to give rise to litigation challenges.

Learned Professional General Rule:

The primary change here, as compared with the current “Short Test,” is the increased compensation requirement. While not stated as a separate requirement, the final regulations make clear that “work requiring advanced knowledge” means work requiring the consistent exercise of discretion and judgment. In another rollback of what was proposed last year, the final regulations have eliminated the previously proposed language expanding application of the exemption to individuals who may have acquired the requisite knowledge of an advanced type through a means other than formal academic education. That proposed language proved to be highly controversial and was strongly criticized by organized labor as expanding the professional exemption to all sorts of quasi-professional positions. In response to this criticism the Labor Department has eliminated the added language in the final regulation, and in the preamble stated that it was never the intent to expand the exemption to quasi-professionals.

Creative Professional Exemption General Rule:

Computer Employee Exemption General Rule:

This proposed exemption tracks, as it must, actual statutory language contained in the Fair Labor Standards Act as a result of some amendments enacted in 1990 and 1996. For the most part, the so-called “white collar exemptions” are a creature of regulatory promulgation by the Secretary of Labor as a result of broad regulatory authority contained in the statute. However, the history of the computer employee exemption is somewhat unique. Notwithstanding the existence of regulatory provisions containing a “Short Test” and a “Long Test” for computer employees, Congress amended the statute in 1990 and 1996 and specifically provided for a computer employee exemption that was different from the existing regulatory provisions. Among the differences was the alternate compensation criteria allowing for an hourly basis of pay, which was established as an amount at least equal to 6 _ times the then-current minimum wage. Since that time there have been two alternative methods of determining the exempt status of computer employees: one regulatory, and the other statutory. The new final regulation represents an effort by the Labor Department to align these two criteria. Thus, it tracks the statutory criteria, including the alternative compensation options. The final regulations make it clear that, as in the past, the exemption is not intended to apply to employees engaged in the manufacture or repair of computer hardware and related equipment.

Outside Sales Employee Exemption General Rule:

The outside sales employee exemption differs significantly from the other white collar exemptions because there is no salary or other compensation criteria. The final regulations are generally similar to the current regulatory criteria, but with one significant difference. Under the current regulations, outside sales employees may not spend more than 20 percent of their workweek performing non-exempt work; i.e., duties that are not related to their own outside sales activities. The final regulation eliminates this 20 percent limitation on the performance of non-exempt work, and replaces it with the primary duty requirement. Based on the preamble to the final regulation, the primary duty requirement is a relaxed standard that will allow employers to avoid the need to track hours worked by outside sales employees. This should prove to be a significant improvement for employers seeking to use this exemption.

Highly Compensated Employees:

The final regulations also contain a new approach to determining the exempt status of “highly compensated” executive, administrative and professional employees, defined as “guaranteed total annual compensation of at least $100,000.” For such highly compensated employees who perform office or non-manual work, they need only satisfy any one or more of the exempt duties or responsibilities defined in the “General Rule” for executive, administrative or professional employees. Obviously, this results in a substantially reduced duties/responsibilities analysis. Unfortunately, the $100,000 annual compensation threshold is a significant increase over the $65,000 threshold that the Labor Department originally proposed last year.

The minimum annual compensation of $100,000 is not limited to guaranteed salary only, but also includes base salary, commissions, non-discretionary bonuses and other forms of incentive compensation. It does not include the cost of fringe benefits, such as medical or life insurance, or retirement plan contributions. In an added requirement differing from last year’s proposal, the final regulation requires that the employee be compensated on a salary or fee basis of not less than $455 per week, as part of the $100,000 in total annual compensation. If, at the end of an annual cycle, an employee’s total compensation fails to reach $100,000 – for example, because various forms of contingent compensation are not realized – the employer may make a final payment sufficient to reach the required level for highly compensated employees. If the employer fails to do this, the employee will not qualify for exemption under the “highly compensated employee” provisions. However, he or she may still qualify under the more rigorous criteria contained in the “General Rule” for executive, administrative or professional employees.

The proposal provides for proration of the annual compensation requirement during an employee’s first or last partial year of employment.
The theory behind the highly compensated employee provision is that if an employee is earning $100,000 or more annually, he or she does not need to be subjected to the more rigorous duties/responsibilities criteria contained in the governing “General Rule.”

The End of the Long/Short Tests?

The Labor Department talks about having abolished the old “Long Test” and “Short Test” distinctions in the final regulations. However, in reality, the new “General Rule” versus “Highly Compensated Employee” analysis is very similar. The “General Rule” resembles the current “Long Test,” although greatly simplified and improved. The “Highly Compensated Employee” provisions resemble the current “Short Test,” although, again, improved and simplified. Unfortunately for employers, because of the changes made in the final regulations, application of the much simpler “Highly Compensated Employee” analysis is severely restricted because of the higher compensation threshold.

Salary Deduction Issues Under Standard Test:

Much litigation has occurred over the years in connection with determining whether an employee has been paid on a salary basis, which is a fundamental requirement for most of the white collar exemptions. The existing regulations basically prohibit deductions from salary that are based on either quality or quantity of work performed. The regulations also provide fairly detailed guidance in attempting to define permissible deductions and impermissible deductions.

The final regulations incorporate most of the same rules governing permissible and impermissible salary deductions. However, in a departure from current practices, the final regulations allow employers to make salary deductions for unpaid disciplinary suspensions of a full day or more that are imposed in good faith for violations of workplace conduct rules. Such deductions are not permitted under current law.

Effect Of Impermissible Salary Deductions:

Under the current regulations and case law interpreting the regulations, the impact of certain impermissible salary deductions can be devastating. Improper deductions can result in the retroactive disqualification of entire classes of otherwise exempt employees -- even though many or most of such employees never actually suffered an impermissible salary deduction. Much of the case law demonstrates a willingness by the courts to invalidate the exempt status of entire classes of exempt employees simply because they were “subject to” a policy or practice that provided for impermissible deductions. Much of the adverse case law on this issue has resulted from overly technical application of the existing regulations.

The final regulations attempt to clarify for the courts the circumstances in which such class-wide invalidation of the exemption should and should not occur. The final regulations contain factors that should be considered in making this determination, such as the number of improper deductions, the time period involved, the number and geographic location of employees who were subject to the deductions, the person or persons responsible for making the deduction, whether the employer has a clearly communicated policy prohibiting improper deductions, and whether the employer has corrected the deductions. In an effort to simplify and clarify this issue, the final regulations provide that if an employer has a clearly communicated policy prohibiting improper salary deductions, notifies employees of the policy, includes a complaint mechanism, reimburses employees for any improper deductions, and makes a good faith commitment to comply in the future, the employer will not lose the exemption. In such a case, the exemption will not be invalidated for any employee unless the employer willfully violates the policy by continuing to make improper deductions after receiving employee complaints. The final regulations urge employers to adopt a written policy to this effect.

Conclusion:

The final regulations are not perfect. But they do appear to be a move in the direction of clarifying and simplifying application of the white collar exemptions. Unfortunately for employers, the added clarification comes with a significant cost in terms of greatly increased compensation requirements.

Employers will need to carefully evaluate the new final regulations and their potential impact on their current classifications of employees. Depending upon industries involved, pay scales, and job responsibilities, there may very well be a need to either change exempt classifications or adjust compensation and/or job responsibilities in order to comply with the new requirements.

It should be remembered that the final regulations are scheduled to become effective August 21, 2004; thus, they will become the governing law on and after that date, unless Congress or a court intervenes. In this regard, the U.S. Senate has already passed two provisions that would, if enacted, modify the final regulations. However, it is generally believed that there is less chance that such measures will pass in the House, and The White House is maintaining its strong support for the final regulations as promulgated by the Department of Labor. Nonetheless, these regulations remain a politically charged issue, thanks in part, to a very effective misinformation campaign, waged by the opposition, to convince the public that the regulatory changes sought by the Department of Labor are anti-worker. Thus, while it is impossible to accurately predict the outcome of the political process, particularly in an election year, as of now the final regulations remain on track to become law on August 21, 2004. Employers with questions are urged to contact their Constangy attorney for further analysis.

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