Are you including the value of broad-based equity awards in overtime payment calculations?

In recent years, some companies have started offering their stock-based awards to more of their “rank and file” employees or have made one-time or periodic, broad-based grants in connection with special occasions. In addition, many private emerging growth companies, which tend to make grants to their general employee population, have also started granting RSUs instead of options to their employees as the company gets closer to an initial public offering. If you fall within this category of companies that is granting RSUs or restricted stock awards (or phantom stock awards such as cash-settled stock denominated awards) to a broad-based population in the US, you may wish to consider whether the value of those awards should be included in any overtime wages that are payable to your non-exempt employees.

Earlier this year, the U.S. Department of Labor (DOL) announced a proposed rule to clarify and update the regular rate requirements under the Fair Labor Standards Act (FLSA). The regular rate determines how much non-exempt employees covered by the FLSA receive in overtime pay given that the FLSA generally requires overtime pay of at least 1.5 times the regular rate for time worked in excess of 40 hours per workweek. Regular rate requirements define what forms of payment employers include and exclude in the 1.5 time calculation when determining employees’ overtime rates. The proposed rule focuses primarily on clarifying whether certain kinds of perks, benefits, or other miscellaneous items must be included in the regular rate of pay.

Admitting that the FLSA regular rate regulations were effectively outdated because they had not been significantly revised in over 50 years, the DOL’s apparent rationale for the proposed rule was to provide guidance on the application of the regular rate rules to the types of compensation and benefits that are currently paid to employees given that new and different types of compensation have been introduced since the time that the original regulations were promulgated. For instance, the proposed rule contemplates the exclusion from an employee’s regular rate of pay of employer-sponsored wellness programs, onsite specialist treatment, gym access and employee discounts on retain goods and services, among other forms of perks. It may also be possible to exclude certain types of discretionary bonuses, benefit plans and educational tuition programs from an employee’s regular rate of pay. Yet, the proposed rule was curiously silent on the excludability of RSUs.

It would have been appropriate for the proposed rule to have addressed RSUs given that RSUs were not a prevalent form of equity awards when the regular rate regulations were first adopted. While the preamble to the proposed rule did not mention RSUs, it did remind us that options, stock appreciation rights (SARs) and stock purchase rights could be designed to be excluded from the calculation of overtime payments. Perhaps the DOL was of the impression that the treatment of RSUs was adequately addressed in the previous guidance relating to options, SARs and stock purchase rights. Under this guidance (Fact Sheet #56), options, SARs and stock purchase rights are excludible from an employee’s regular rate of pay generally if these rights have a minimum six-month vesting period, the purchase price discount cannot exceed 15% (based on the fair market value on the date of grant) and the exercise of the right is voluntary. Unfortunately, the requirements under Fact Sheet # 56 are not entirely compatible with and generally cannot be applied to RSUs (and similar full-value, stock-based awards). While an RSU could be designed to have a minimum six-month vesting period, it generally could not be made to comply with the remaining requirements because RSUs, given their design, do not require payment on the part of the holder and are not a type of right that can be exercised.

It is noteworthy that when Fact Sheet #26 was issued in 2008, RSUs were not commonly granted. Therefore, the absence of a discussion of RSUs in the DOL guidance should not necessarily be construed to conclude that RSUs were not excludible under a different set of rules that the DOL could have made available for RSUs as it did for options, SARs and stock purchase rights. After all, one of the cited reasons for creating an exclusion for options was the concern that the general FLSA rule would have resulted in excluding non-exempt employees from participating in employee stock plans. Now that many companies have changed their granting practice in favor of granting RSUs over options or SARs, it would seem appropriate for the DOL to provide an exclusion for RSUs as is available for options/SARs given that the failure to do so will result in excluding non-exempt employees from participating in employee stock plans.

Assuming the value of RSUs is required to be included in an employee’s regular rate of pay, you will need to navigate the unwieldly rules that apply to the calculation of overtime amounts. The overtime payments will need to be determined for the compensation that was payable during the period in which the RSUs were considered to be earned. Further, because the DOL has not issued any guidance on the calculation of overtime payments that includes the value of RSUs, the rules applicable to options would likely need to be applied to RSUs by analogy.

Lastly, note that while this discussion has been limited to RSUs, restricted stock awards and phantom stock awards (cash-settled awards denominated in stock or the value of which is based on the underlying stock) would likely be treated similarly to how RSUs are treated under the FLSA regular rate regulations. Therefore, the same overtime payment considerations that you should consider weighing when granting RSUs would also be relevant if you are granting these other types of stock-based awards to your non-exempt employees.

The general definition of “regular rate” of pay (which is intended to include “all remuneration for employment”) and the DOL’s decision to affirmatively omit RSUs as a potential category of compensation that is excludible from an employee’s regular rate of pay, particularly in light of the opportunity presented by the proposed rule to clarify the treatment of RSUs, lead to a conclusion that the value of RSUs should likely be included in an employee’s regular rate of pay for purposes of determining any overtime amounts owed to the employee. Until the DOL provides additional guidance, it may be prudent to limit the grant of broad-based equity awards to options, stock appreciation rights or stock purchase rights, unless you wish to undertake the unenviable task of calculating overtime payment owed to non-exempt employees.

Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits. Victor advises global US and non-US companies – both public and private – on all aspects of executive compensation and benefits matters, including the corporate, securities and tax law, and ERISA issues arising in the implementation and administration of compensation programs. He regularly helps clients with the design and implementation of equity and non-equity based incentive compensation programs and nonqualified deferred compensation programs. Victor also has extensive experience advising on compensations and benefits issues in mergers and acquisitions, corporate reorganizations, private equity and other corporate transactions.