Conducting an Internal Wage and Hour Audit: Part 1

February 1, 2022

Photo courtesy of U.S. Department of Labor

This guide addresses wage and hour audits under the federal Fair Labor Standards Act (FLSA),  including preliminary issues private sector employers should consider, common wage and hour  issues to evaluate, options for responding to problems discovered during the audit, and best  practices going forward.  

Preliminary Considerations Private Sector Employers Should Consider  

1. Get Senior Management Involved 

2. Determine When to Audit 

3. Define the Scope of the Audit 

4. Determine Who Should Conduct the Audit 

5. Determine What to Document About the Audit

The Fair Labor Standards Act (FLSA) is the primary federal law providing wage and hour protections to  covered employees. The FLSA applies to most employers and is administered and enforced by the  Department of Labor’s (DOL) Wage and Hour Division (WHD). Most states also have a department of  labor (or equivalent) responsible for enforcing the state’s wage and hour laws. Employers must consider  federal, state, and local law for wage and hour compliance. 

Employers that do not comply with applicable wage and hour laws face potentially significant legal and  financial liability. Wage and hour claims are some of the most costly employers can face  because federal and state law frequently provides for collective or class actions on behalf of multiple  plaintiffs, liquidated or other exemplary damages, and attorneys’ fees. 

Employers can reduce the risk of legal and financial exposure by auditing their practices to ensure  they comply with federal, state, and local wage and hour law, including the core requirements of: 

• Paying minimum wage and overtime compensation, including 

understanding: 

• what time is compensable; and 

• how to properly calculate overtime pay. 

• Classifying workers properly as: 

• exempt or nonexempt employees; 

• independent contractors; or 

• interns, trainees, or volunteers. 

• Restricting the use of child labor. 

• Satisfying equal pay requirements. 

• Recordkeeping. 

This guide addresses federal law. Employers should also consider applicable state and local law as part  of any internal wage and hour audit.

Preliminary Considerations 

1. Get Senior Management Involved 

Before beginning a wage and hour audit, an employer should ensure that senior management  supports the audit, including by committing sufficient financial and other resources necessary to  complete the audit and resolve any compliance issues discovered during the audit. 

Senior management should understand that wage and hour audits may: 

• Confirm that the employer is in full compliance with 

wage and hour laws. 

• Reveal: 

• minor violations; or 

• significant violations that may be costly to address. 

If the employer does not address violations revealed by the audit, the employer’s risk of legal and  financial exposure may increase because plaintiffs or the DOL may argue that: 

• The employer cannot rely on the good faith defense in future wage and hour actions (for more information, see Practice Note, Defending Wage and Hour Collective Actions Under the FLSA: Overview: Good-Faith Defenses). 

• The employer’s violations are willful, invoking the three-year statute of limitations (for more information, see Practice Note, Defending Wage and Hour Collective Actions Under the FLSA: Overview: Statute of Limitations and Tolling). 

2. Determine When to Audit 

2a. Periodic Audits 

Employers should consider conducting regularly scheduled audits, such as at the beginning or end of  each fiscal or calendar year. Employers that conduct periodic wage and hour audits often perform  them in conjunction with reviews of other employment practices to: 

• Allow the employer to address wage and hour issues as part of a general review of best practices. 

• Avoid unnecessarily raising red flags if workers are: 

• misclassified, such as nonexempt employees misclassified as exempt, or employees misclassified as independent contractors; or 

• owed back pay. 

2b. Risk-Driven Audits 

Employers should also be prepared to conduct a wage and hour audit when there is an increased  risk of noncompliance or litigation. Common examples include: 

• A reorganization or restructuring, particularly if: 

• employee job duties change; or 

• there is a reduction in force (RIF). 

• Other changes in the employer’s business model, such as changes in: 

• management structure; 

• the types of employees hired; or 

• the employer’s use of independent contractors. 

• Changes in the FLSA, its implementing regulations, DOL guidance, or case law, or similar changes to applicable state or local wage and hour law (see, for example, Legal Updates, DOL’s Final Overtime Rule Increases the Minimum Salary for White Collar Exemptions to $35,568 Annually). 

• An increase in hours worked in job categories that are not clearly exempt. • Internal employee complaints (verbally or in writing) about: 

• misclassification; 

• unpaid working time; or 

• improper deductions from pay. 

Monitoring – Employers can also protect against the risk of costly wage and hour litigation by  monitoring wage and hour compliance on an ongoing basis. Ongoing monitoring does not need to  be onerous, but employers should: 

• Check for compliance in high-risk areas, such as: 

• exempt employee classifications; 

• independent contractor classifications; 

• calculation of the regular rate of pay and overtime pay for 

nonexempt employees; and 

• employee timekeeping and meal period and rest break practices. 

• Understand employee work practices, especially routine work habits. 

• Address any compliance problems as they arise.

 3. Define the Scope of the Audit 

Before starting an audit, an employer should determine the scope, such as which employees,  positions, and issues it will review. The scope of the audit is typically closely related to its purpose. For  example, if the employer wants to conduct an organization-wide review to proactively address wage  and hour compliance issues, the audit should be a comprehensive review of all wage and hour  practices. If the audit is in response to a specific change in law, however, the audit can be specifically  targeted at the employees or practices affected by the new development. 

When planning the audit, an employer should consider its purpose and determine, for example: • What issues and practices to evaluate. 

• Which employees, positions, or job categories to review. 

• Which worksites to include. 

• Which records to review. Common examples include: 

• job descriptions; 

• payroll records; 

• timekeeping records, such as time sheets, punch cards, and security records showing workplace entry and exit times; 

• log-in information, such as data showing whether and when employees logged in to their computer or email system from home or during non-working hours; 

• performance documents, including self-evaluations; and 

• personnel and independent contractor records. 

• Which policies and procedures, written and unwritten, to review, such as payroll and timekeeping policies, forms, and training materials. 

• Whether any employees will be interviewed, and if so, which employees. 

Although employers should identify the scope of the audit at the beginning of the process,  employers should also be prepared to modify the scope in response to information learned as part  of the review. For example, an employer may begin an audit to specifically review meal period and  rest break practices, but discover during the audit that employees are not recording time  accurately. In that case, the employer should consider expanding the scope of the audit to review  general timekeeping and payroll practices. 

4. Determine Who Should Conduct the Audit 

Once an employer decides to conduct an internal audit, it should select an appropriate individual or  team to conduct the audit. The audit team should include someone who is: 

• A relatively senior employee in the organization or a person with sufficient authority and relationships to adequately address any compliance concerns that may arise. 

• Trained in applicable federal, state, and local wage and hour law. 

• Aware of new developments, such as: 

• changes in employee job functions and responsibilities; and 

• legal developments. 

Typically, the audit is led by one or a combination of the following: 

• One or more of the employer’s human resources 

professionals. 

• The employer’s in-house counsel. 

• The employer’s outside counsel. 

4a. Benefits of Using Human Resources Personnel or In-House Counsel 

The benefits of having human resources personnel or in-house counsel conduct a wage and hour audit  include: 

• Speed and efficiency. Human resources personnel and in-house counsel typically have background and institutional knowledge that may expedite the audit process, including familiarity with: 

• business operations; 

• employer policies and practices; 

• job descriptions; and 

• job duties. 

• Cost. Because human resources personnel and in-house counsel are already on the employer’s payroll, it may be more cost effective to have them conduct an internal audit when compared to hiring outside counsel.

In addition, the benefits of using experienced in-house employment counsel to conduct the audit include: 

• Expertise. Experienced in-house employment counsel may have an in-depth knowledge of wage and hour law they can use in evaluating the employer’s practices. 

• Reducing damages in litigation. An employer may be able to avoid liquidated damages in litigation if it can show a good faith belief that it was complying with the FLSA. The employer must show subjective good faith and an objectively reasonable basis to believe its conduct complied with the FLSA. An employer’s reliance on an opinion by experienced in-house employment counsel may be sufficient, but reliance on audits conducted by human resources personnel may not. For more information, see Practice Note, Defending Wage and Hour Collective Actions Under the FLSA: Overview: Good-Faith Defenses. 

• Privilege. Legal analyses, conclusions, and recommended courses of action by in-house counsel may be protected by the attorney-client privilege, the work product doctrine, or both. In contrast, audits performed by human resources professionals generally are not protected by either the attorney-client privilege or work product doctrine, unless the work is being done at the direction of an attorney or in anticipation of litigation (see, for example, Lewis v. Wells Fargo & Co., 266 F.R.D. 433 (N.D. Cal. 2010)). For more 

information, see Conducting Internal Corporate Investigations Toolkit: Attorney-Client Privilege and the Work Product Doctrine. Employers hoping to protect an internal audit under the attorney-client privilege should fully consider the implications, such as being unable to use a privileged investigation in litigation without waiving the attorney-client privilege. 

4b. Benefits of Using Outside Legal Counsel 

Hiring outside legal counsel to conduct an audit may increase the employer’s out-of-pocket costs, but  possible benefits include: 

• Independence. Outside legal counsel may be able to analyze wage and hour practices and procedures: 

• with a fresh perspective; and 

• Expertise. Given the number of wage and hour lawsuits and frequent new developments in this area of law, it can be difficult for human resources professionals and in-house counsel who are not experienced in wage and hour law to stay up to date with the current legal landscape, depending on their other responsibilities. 

• Reducing damages in litigation. Like reliance on an opinion by experienced in-house counsel, an employer’s reliance on an opinion by outside counsel may be sufficient to demonstrate the good faith belief required to avoid liquidated damages in litigation. For more information, see Practice Note, Defending Wage and Hour Collective Actions Under the FLSA: Overview: Good-Faith Defenses. 

• Privilege. Like investigations conducted by in-house counsel, audits conducted by outside counsel may be protected from discovery under the attorney-client privilege, the work product doctrine, or both (for more information, see Conducting Internal Corporate Investigations Toolkit: Attorney-Client Privilege and the Work Product Doctrine). As with in-house counsel, employers using outside counsel and hoping to protect an audit under the attorney-client privilege should fully consider the implications, including being unable to use a privileged investigation in litigation without waiving the attorney-client privilege. 

• Anonymity. Outside counsel may consult the DOL for guidance without revealing the identity of their clients. 

4c. Partnership Between In-House Personnel and Outside Legal Counsel 

Employers may also have in-house human resources professionals or in-house counsel partner with  outside legal counsel to conduct a wage and hour audit. In this partnership, typically: 

• Human resources professionals or in-house counsel consult the outside attorneys at the outset of the audit process. 

• Outside attorneys direct and supervise the human resources professionals or in-house counsel, who perform the primary fact-gathering tasks (for example, updating and collecting job descriptions, payroll records, and other relevant documents). 

• Outside attorneys partner with human resources professionals or in-house counsel to conduct additional fact gathering (for example, interviewing direct supervisors) where warranted. 

• Once the fact gathering is completed, the outside attorneys then: 

• review and assess the facts; 

• analyze the employer’s compliance with the FLSA and applicable state and local wage and hour law; and 

• recommend a course of action. 

5. Determine What to Document About the Audit 

Employers should consider what to document about the scope, purpose, and results of the audit. Factors to  consider include: 

• Who is conducting the audit. 

• The context in which the audit occurs, including the risk of litigation or investigation by the DOL or equivalent state agency. 

• How the employer intends to use the audit results. 

• Whether the audit is privileged, and if so, whether the privilege may ultimately be waived. 

• The results of the audit. • Whether and how the employer plans to address any issues discovered during the audit.

This guide addresses wage and hour audits under the federal Fair Labor Standards Act (FLSA),  including preliminary issues private sector employers should consider, common wage and hour  issues to evaluate, options for responding to problems discovered during the audit, and best  practices going forward. 

Founded by attorneys Andreas Koutsoudakis and Michael Iakovou, KI Legal focuses on guiding companies and businesses throughout the entire legal spectrum as it relates to their business including day-to-day operations and compliance, litigation and transactional matters.

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