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Nationwide continuously maintained that Special Investigators were properly classified as exempt administrative employees under federal and state wage and hour law. To qualify for the FLSA’s administrative exemption, employees must be compensated at a rate not less than $455 per week; their “primary duty” must be the “performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers;” and the primary duty must include “the exercise of discretion and independent judgment with respect to matters of significance.” In March 2010, the court found that Nationwide had satisfied the first two elements of the administrative exemption test, but determined that material issues of fact existed as to the third element.

In September 2011, a two-week trial commenced before U.S. District Judge Edmund A. Sargus Jr. on the remaining issue of whether the Special Investigators’ primary duty includes the exercise of discretion and independent judgment. The parties called sixteen witnesses to testify at the trial, submitted testimony from two additional witnesses via deposition transcript, and admitted dozens of exhibits into evidence. The court ultimately concluded that the Special Investigators’ primary duty is to conduct investigations into suspicious claims for the purpose of resolving indicators of fraud present in those claims. The court further concluded that this primary duty includes the exercise of discretion and independent judgment with respect to matters of significance in at least two ways: Special Investigators: (1) are tasked with resolving indicators of fraud; and (2) have nearly unilateral discretion to refer claims to law enforcement or the National Insurance Crime Bureau (“NICB”).

While the plaintiffs contended that resolving indicators of fraud was merely the gathering and reporting of facts, the court disagreed. The court concluded that the Special Investigators determine the truth about what happened on a suspicious claim, which “necessarily requires judgment and discretion.” The court noted that nearly all of the Special Investigators who testified at trial characterized their investigations as searches for the truth and that “A doctorate in philosophy is not required to realize that the ‘truth’ is not an entirely objective concept. Determining truth requires ‘factual findings,’ a process that necessarily requires judgment and discretion.” In addition, because the Special Investigators’ resolution of fraud indicators can have an influence on a claims adjuster’s decision to pay or deny a claim, they exercised discretion and independent judgment on matters of significance.

The plaintiffs also claimed that referrals to law enforcement and NICB are automatic. However, the court noted that such referrals are made when the Special Investigator is unable to resolve the indicators of fraud. Accordingly, the judgment and discretion that is inherent in the resolution of fraud indicators also attaches to the decision to make a referral. In addition, because these referrals can subject individuals to criminal prosecution, they pertain to matters of significance.

Finally, because the parties stipulated that the New York claims would rise or fall with the FLSA claims, the court awarded judgment to Nationwide on those state claims, and also awarded judgment to Nationwide on the California state law claims after determining that the Special Investigators satisfied the California Labor Code requirement that they are “primarily engaged in the duties that” meet the administrative exemption, and “customarily and regularly exercise[] discretion and independent judgment in performing” those duties.

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In Harris, the California Supreme Court overruled the Court of Appeal, which held that the claims adjusters were “production” workers because their work “ investigating claims, determining coverage, setting reserves, etc. is not carried on at the level of policy or general operations, so it falls on the production side of the dichotomy.” Thus, the lower appellate court concluded, they did not perform in a role that was “directly related to management policies or general business operations” and were therefore not exempt administrative employees. The California Supreme Court disagreed.

First, the court rejected the Court of Appeal’s almost exclusive reliance on the administrative/production worker dichotomy analysis. The rigid application of this analysis, the court stated, ignores the limitations of the dichotomy and results in a “strained attempt to fit the operations of modern-day post-industrial service-oriented businesses into the analytical framework formulated in the industrial climate of the late 1940s.” The court clarified, however, that it was not holding that “the dichotomy can never be used as an analytical tool. We merely hold that the Court of Appeal improperly applied the administrative/production worker dichotomy as a dispositive test.”

Second, the court clarified that under the federal regulations California looks to for guidance in applying state exemption classifications, work that is “directly related to management policies or general business operations” includes “advising management, planning, negotiating, and representing the company.” The court admonished the Court of Appeal for interpreting this prong of the administrative exemption too narrowly. In other words, work may be directly related to management policies or general business operations even if it is not performed at the corporate policy level. In this regard the court pointed out that the Ninth Circuit and other federal courts, applying recent applicable federal regulations, have determined claims adjusters satisfy the administrative exemption under the Fair Labor Standards Act “if they perform activities such as interviewing witnesses, making recommendations regarding coverage and value of claims, determining fault and negotiating settlements.”

Third, the court emphasized the importance of assessing the language of the relevant statutes and wage orders as applied to the particular facts of each case, noting “the difficulty in relying on the particular role of employees in one enterprise to deduce a rule applicable to another kind of business.”

The Harris decision therefore is a victory for Liberty Mutual, but it is also a good reminder to California employers of the importance of reviewing the particular circumstances and actual job duties of their exempt administrative employees – as well as their other exempt employees – not just relying on their job descriptions to determine that the exempt classifications are appropriate.

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FLSA2009-14 addresses deductions during voluntary and mandatory reduced workweeks and complete weeks off. First, it examines whether an employer risks destroying exempt status by seeking volunteers to take partial weeks off and allowing the volunteers to choose to take a salary deduction or to be paid with accrued vacation or personal time. If an employee chooses to use accrued time and receives the equivalent of his regular salary, then all is well. The problem arises if the employee chooses salary deduction. The DOL acknowledges that 29 CFR § 541.602(b)(1) allows deductions from an exempt employee’s pay if the employee is voluntarily absent for one or more full days for personal reasons. However, it then states, “the employee’s decision to take [voluntary time off] . . . must be completely voluntary and not ‘occasioned by the employer or by the operating requirements of the business.’” (emphasis added). The underlined text suggests an employer who relies on “volunteers” to work reduced workweeks and allows the volunteers to choose salary deduction does so at its peril. Should the employee decide after the fact that he was coerced into taking the reduced weeks, the employer will bear the very difficult burden of proving the “voluntary” nature of the decisions. This may not be a risk worth taking.

The letter next determines that an employer risks destroying exempt status by mandating partial weeks off and allowing employees to choose whether to take a salary deduction or use accrued vacation or personal time to be paid. If an employee uses the accrued time and receives the equivalent of full salary, there should be no problem. If, however, a salary deduction occurs, then exempt status will be destroyed. Under 29 CFR § 541.602(a), “[a]n employee is not paid on a salary basis if deductions from the employee’s predetermined compensation are made for absences occasioned by the employer or by the operating requirements of the business.” The DOL advises that “salary deductions due to a mandatory reduction of hours worked for short-term business needs” are exactly the sort of activities encompassed in the phrase “by the operating requirements of the business.” Any deduction in this situation – even one an employee chooses – destroys the exemption.

Third, FLSA2009-14 addresses whether an employer places exempt status at risk by mandating, or seeking volunteers to take, an entire week off. The letter quotes 29 CFR § 541.602 (a): “Exempt employees need not be paid for any week in which they perform no work.” So an employer does not harm exempt status by not paying exempt employees’ salaries for any week in which the employees do no work – regardless of whether employees volunteer to take the week off or the employer mandates the week off.

FLSA2009-18 combines issues addressed in the first two letters with slightly different twists. The letter first determines that an employer does not jeopardize employees’ exempt status by requiring use of PTO in periods where workload mandates reduced hours on certain work days. Consistent with Letter 2009-2, the DOL takes the position that requiring employees to use PTO for time off due to reduced workload is acceptable – even for mandated absences of less than a day – so long as employees receive an amount equal to their guaranteed salaries for any week in which they perform work.

Finally, FLSA2009-18 indicates that an employer will destroy exempt status if it occasionally reduces exempt employees’ working hours in times of low business volume and makes corresponding salary deductions. The letter contrasts two situations. In the first, an employer decides to run a plant only four days a week instead of five, makes a long-term scheduling change for all employees from 40- hour weeks to 32-hour weeks, and reduces salaries by a fifth. In the second, an employer makes short term reductions in scheduled hours depending on the day-to-day needs of the business. According to the DOL, the first situation does not circumvent the salary basis requirement. Employees are still receiving a fixed salary for each week in which they perform work. In contrast, the second situation – like the deductions for mandatory partial weeks off addressed in FLSA 2009-14 – circumvents the salary basis requirement and destroys the exemption because “deductions from salary due to day-to-day or week-to-week determinations of the operating requirements of the business are precisely the circumstances the salary basis test is intended to preclude.”

These letters should raise employers’ comfort levels when requiring employees to use accrued paid leave time during business downturns. However, the letters leave little doubt that while hour reductions based on day-to-day or week-to-week operating needs of a business are acceptable, any resulting deductions from exempt employees’ salaries will quickly destroy the employees’ exempt status. These letters also only interpret federal wage and hour law as it applies to these situations. Employers should take care to ensure compliance with individual state wage and hour laws, some of which differ from the federal law, as well.

This blog entry was written by Jane Ann Himsel.