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Background
Many companies balk at the notion that their policies, procedures, and compliance with wage and hour laws may place them at significant legal and financial risk. As previously discussed, class action lawsuits can cost companies millions in settlement fees — let alone the cost of legal representation.1 Based on data compiled by Ankura from settlements and judgments, the average settlement from 2024 to 2025 is almost $1.5 million, and the median settlement is just under $1 million.
Companies warehouse a wide array and volume of data that is typically produced in discovery during litigation. This data can be, and is, used to determine liability and calculate related damages for non-compliance with various wage and hour laws at the state and federal levels. Companies should know what information is in their data warehouse, identify potential risks, and take actionable steps to minimize regulatory or statutory violations before litigation begins.
Regular payroll audits are key to this endeavor.
There Are 4 Main Reasons Why a Company Should Conduct a Payroll Audit
1. Statutory and Regulatory Compliance
Every company needs to comply with the Fair Labor Standards Act (FLSA)2 as well as laws for the states and municipalities in which they operate. A payroll audit should be conducted with federal, state, and local laws in mind to confirm compliance or identify gaps under current or anticipated laws and regulations.
2.Compliance With Internal Policy
Companies often have internal policies and procedures that may be more stringent than statutory or regulatory requirements. A payroll audit can help validate compliance with the company's internal policies and procedures.
3. Due Diligence Before a Merger or Acquisition
A payroll audit can be critical to determining existing liability before acquiring a company. This evaluation can be embedded into the merger and acquisition due diligence process and should be completed before the transaction is finalized so that financial reserves can be made accordingly.
4. Minimizing Risk and Remediation
A payroll audit can identify risk areas and allow for time to remediate any problems before a complaint is filed. The cost to remediate proactively is magnitudes less than the cost of reactive litigation and settlements. Furthermore, demonstrating remediation efforts can be seen as a good fact when facing potential future litigation.
Key Parties That Should Be Included in a Payroll Audit
Outside Counsel
Special care should be taken during the payroll audit because any work product from the audit could be made available during discovery in a future lawsuit. As such, all audits should be conducted under privilege and at the direction of outside counsel. Furthermore, counsel can work with the company on defining the scope for specific issues or remediation and strategize with outside consultants on deeper, more thorough analyses.
Company Representatives
Key stakeholders know the company's data and the internal
policies with which employees should be complying. A series of
interviews with company representatives who:
1) know the data and can identify the key available data sources
and the format of that data; 2) are familiar with policies and
procedures and can assist with identifying potential risk areas;
and 3) will assist with understanding historical payroll processes
and procedures, including how regular rate and how overtime
payments were calculated during the normal course of business.
External Consultants
For an audit to be truly successful, thorough data analysis will be required. External consultants skilled in data analysis and labor regulations are indispensable during this process to perform in-depth analysis of the data and detailed, complex calculations to determine risk areas and potential remediation. They also allow for independent, third-party review of the data. Consultants should be engaged by outside counsel and work under their direction
Conclusion
In our next article, we will explore key differences between federal and state laws and what an audit should consider.
Footnotes
1 In California, the average settlement based on our data gathering is approximately $1.37 M for an average class size of around 2,000 employees. See more here: https://ankura.com/insights/a-new-day-in-the-life-of-a-paga-action-what-do-paga-settlements-look-like-what-will-we-find-when-analyzing-the-information-gathered-from-paga-filings
2 https://www.dol.gov/agencies/whd/flsa
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
