The long-awaited, much anticipated new Directive on OFCCP's compensation analysis methodology has finally arrived … but for those contractors hoping for radical reform, the unfortunate news is there will be little change in the Agency's approach to compensation evaluations. For that reason, Directive 2018-05 – "Analysis of Contractor Compensation Practices During a Compliance Evaluation" (issued August 24, 2018) ("Directive 2018-05") has been met by the contractor community with more of a whimper, than a bang. Rather than re-aligning Agency practices with established federal law, Directive 2018-05 doubles-down on many of the controversial aspects of "Directive 307" – the highly criticized, now-rescinded Agency guidance that shaped the last several years of OFCCP compensation investigations.

That said, the new Directive 2018-05 brings much-needed transparency to the Agency's processes, including clearly-articulating explanations of OFCCP's policies and specific technical approaches to its statistical analyses. And there is a lot of good for contractors in those details. This article discusses the new directive, and discusses how contractors may use it to better position themselves for an audit.

First, How Did We Get Here?

With the issuance of Directive 2018-05, OFCCP officially rescinded the notorious "Directive 307." Directives are internal, sub-regulatory guidance for Agency employees on how to do their jobs. Directive 307 was criticized by the contractor and statistical communities for, among other things, promoting analyses of large-scale, dissimilar groupings of employees that violate the well-developed Title VII law. Under Title VII, a claim of employment discrimination can be based on comparisons only between "similarly situated" employees.

Specifically, Directive 307 directed compliance officers to create large "pay analysis groups" or "PAGs," large enough for robust statistical analyses (typically, at least 30 people). In practice, this led to OFCCP rolling up several groups of differently-situated employees (such as employees performing different jobs, in different pay grades, and under different compensation systems) into something large enough for robust statistical modelling – even though the skills, effort, and responsibility of those roles were objectively different.

Many have criticized Directive 307 as encouraging the issuance of violations alleging pay discrimination among employees who are not "similarly situated" – contrary to Title VII principles. In fact, in September 2017, the U.S. Chamber of Commerce published a scathing review of the Agency's audit practices, called "Office of Federal Contract Compliance Programs: Right Mission, Wrong Tactics." In a section dedicated to Directive 307, the report reads:
 

  • In practice, Directive 307 has led OFCCP compliance officers to compare the pay of the following groups of employees during actual compliance evaluations since 2014:
    • All exempt and nonexempt employees in a location.
    • Some, but not all employees, across multiple job groups.
    • All employees in a certain EEO-1 category regardless of job title or job group.
    • Employees in managerial roles without regard to function or role.
    • Employees in different job titles who may or may not be in the same job group.
  • In this way, many of the principles set forth in Directive 307 are contrary to well-established Title VII law regarding appropriate analyses of compensation. OFCCP's reliance on PAGs is wholly without support, as courts across this country have held that although similarly situated employees need not be "identical," they must be "directly comparable to the plaintiff in all material respects. …" Indeed, OFCCP field staff have completely disregarded the Directive's mandates for determining whether compensation discrimination exists.
  • Right Mission, Wrong Tactics, p. 42, citing Caskey v. Colgate–Palmolive Co., 535 F.3d 585, 592 (7th Cir. 2008); Eskridge v. Chicago Bd. of Educ., 47 F. Supp. 3d 781, 790-91 (N.D. Ill. 2014); Alexander v. Ohio State University College of Social Work, 697 F.Supp.2d 831, 846–47 (S.D. Ohio 2012); Lopez v. Kempthorne, 684 F.Supp.2d 827, 856–57 (S.D. Tex. 2010).

The other common complaint from contractors regarding Directive 307 was its lack of transparency. Directive 307 provided significant leeway to OFCCP regarding how to create PAGs and how to structure analyses, and yet there was little technical detail about how these tasks could be accomplished with any consistency or predictability. This left many contractors scratching their heads during the compliance review process.

Directive 307 changed the way OFCCP approaches pay discrimination investigations in audits, and it led to some very big settlements for OFCCP. For example, OFCCP's 2017 Fiscal Year saw record pay discrimination settlements – the most we've seen in more than a decade. These big settlements have seemed to embolden the Agency to continue focusing on manufactured PAGs that reach well beyond "similarly situated" employee groups.

The Good – Transparency

Again, there is a lot of good in the details of Directive 2018-05. First and foremost, the Agency continues to bring transparency to its processes. This shows the Agency is listening and responding to complaints from contractors. The Agency's new compensation transparency initiative manifests in at least three important ways.

First, the new directive provides the technical details and methodology about how the Agency conducts pay analyses. According to OFCCP, this is the information contractors need to conduct proactive, internal pay equity analyses. In fact, Directive 2018-05 states its intent is to "provide greater clarity regarding the compliance review process, which will allow contractors to perform self-audits and come into full compliance in advance of a compliance review or enforcement matter."

Second, Directive 2018-05 OFCCP commits to sharing more information about its analyses and findings during the compliance review process. Under the new directive, OFCCP will:
 

  1. Provide written notice to contractors of the general nature of any preliminary compensation disparities at the conclusion of the desk audit phase;
  2. Provide sufficient individual-level data to enable contractors to replicate the Agency's PAGs and regression results with all compensation-related Pre-Determination Notices and Notices of Violation; and
  3. Involve representatives from OFCCP's Branch of Expert Services in conciliation discussions with contractors to shed additional light on OFCCP's statistical findings.

This is a big change for the Agency, which has previously held analysis details very close to the chest throughout the process, including in conciliation discussions, citing a "deliberative process" privilege. The increased transparency will hopefully improve the audit and conciliation processes by giving contractors information necessary to make informed decisions and highlight potential errors in the Agency's approach before violations are issued.

Third, perhaps most importantly, Directive 2018-05 provides technical details about how the Agency conducts its statistical analyses. Many of these analytical updates are grounded in sound practices. For instance, OFCCP will separately analyze differing pay components. Because different factors drive different components of pay – and two employees with the same "total compensation" may arrive there due to different combinations of pay types – this make sense. The Agency has also disclosed that it is investigating differences in pay among subminority race groups (comparing each race to the race group that has at least five employees and the highest average pay in the group). This transparency can help employers understand what the Agency is doing and predict areas likely to draw Agency attention before requests for data and documents arrive. The Directive also acknowledges that more sophisticated approaches to certain variables – such as analyzing the natural log of salary or squaring time variables – may be appropriate in certain circumstances. This shows a level of thoughtfulness in the Agency's approach and indicates contractors may have flexibility in working with OFCCP to explain pay differences in their workforces.

bq lquo …OFCCP will base its pay groups on a company's "compensation hierarchy and job structure," if such a structure exists. bq rquo

More Good – Contractor Input on Pay Analysis Groups

Unlike Directive 307, the new Directive empowers employers to participate in the development of PAGs. Specifically, the Directive explains that OFCCP will base its pay groups on a company's "compensation hierarchy and job structure," if such a structure exists. But, there's a catch: In an effort to pursue large-scale, systemic pay discrimination evaluations, the Agency may disregard a company's actual "compensation hierarchy and job structure," as well as the contractor's statements regarding which employees are similarly situated, in favor of larger groupings. OFCCP appears to claim this is appropriate where pay analysis groups that are actually based on the contractor's compensation system lack "sufficient size to conduct a meaningful systemic statistical analysis."

And, should a company not provide a "compensation hierarchy" or "job structure," or if the Agency believes appropriate groups of similarly situated employees are "too small for a meaningful statistical analysis," OFCCP may seek to build large pay analysis groups based on EEO-1 Category or AAP Job Group, regardless of whether the contractor pays its employees based on these categories.

The Bad – OFCCP Failed to Listen to Criticism Over Pay Groups That Go Beyond "Similarly Situated"

Despite all the criticism of Directive 307's reliance on overly broad, Agency-constructed PAGs, Directive 2018-05 confirms that OFCCP will still roll-up smaller, similarly situated employee groups into larger, disparate groups to reach Agency-imposed statistical thresholds to utilize its preferred investigative approach. But, under well-established Title VII case law, employees must be "directly comparable … in all material respects." Caskey, 535 F.3d at 592 ("Similarly situated individuals must be ‘nearly identical' …. Where different decision makers or supervisors are involved, their decisions are rarely ‘similarly situated' in relevant ways for establishing a prima facie case."); Alexander v. Ohio State University College of Social Work, 697 F.Supp.2d 831, 846-47 (S.D. Ohio 2012) (requiring similarly situated comparators to have the same responsibilities and occupy the same level position). As such, the Agency's approach sacrifices Title VII's "similarly situated" requirement in favor of grouping employees in different divisions, business units, product lines, locations, jobs with different skills, efforts, and responsibilities and under different supervision chains only so that the Agency may conduct large-scale regression analyses.

While OFCCP's technique of aggregating groups to get additional "observations" for trend analyses may make sense to evaluate large-scale trends – much like the raw, national "wage gap" – it cannot support a violation (or enforcement) because it analyzes such "differently-situated" employees. Simply put, OFCCP's overreliance on large-scale regression as the Alpha and Omega approach to analyzing compensation often results in the principles of Title VII and the contractor's actual pay practices being cast aside.

Further underscoring the fact that Title VII does not permit comparisons of such diverse positions, several states (including California, New Jersey, Massachusetts, and Oregon) passed new equal pay legislation to authorize pay discrimination based on broader employee groups than Title VII. California and New Jersey, for example, have enacted a "substantially similar" employee group standard; Massachusetts permits claims between employees performing "comparable work"; and Oregon ensures fair pay among employees performing "work of a comparable character." None of these broader standards apply to OFCCP compliance reviews because OFCCP is bound by Title VII.

So why would OFCCP double down on these broad groupings? The unfortunate reality is that OFCCP has not been required to defend its approach in court. Many contractors facing pay discrimination violations alleged by OFCCP find it much cheaper and less painful (particularly with public perception considerations) to conciliate with OFCCP rather than endure the long, expensive and (very) public process of a public trial before a Department of Labor Administrative Law Judge, and appeal review, before they reach federal court and its developed precedent.

The Analytics – and How to Best Prepare for OFCCP Audits

As noted above, despite officially being rescinded, Directive 307's spirit (and approach) remains intact. Without a meaningful overhaul of its approach, the Agency will likely continue to suffer from many of the same shortcomings that existed under Directive 307. Nevertheless, there are important lessons to learn in OFCCP's new Directive 2018-05, particularly in two areas: (1) How OFCCP approaches employee groupings for analysis; and (2) How OFCCP approaches control variables in its analyses.

Pay Analysis Groups

According to the new directive, the Agency's pay analysis groups should "mirror a contractor's compensation system." Further, OFCCP acknowledges that only "employees who would be expected to be paid the same based on: (a) job similarity (e.g., tasks performed, skills required, effort, responsibility, working conditions and complexity); and (b) other objective factors such as minimum qualifications or certifications" should be compared against one another for pay purposes. This is a step in the right direction, but still permits folks who are performing very different jobs to be grouped together in OFCCP's analysis.

Directive 2018-05 also discloses that OFCCP intends to develop pay analysis groupings of comparable employees and statistically control for any further (a) structural differences among members of the pay analysis group (e.g., division, business unit, product line, location); and (b) individual employee characteristics related to the contractor's pay determinations (e.g., company tenure, prior experience, education, grade level), suggesting that OFCCP plans to analyze employees in different locations, business units, divisions, education levels, and even grade levels in the same pay analysis group.

On the whole, the new directive's analytical approach balances in favor of large-scale analyses and against the "similarly situated" employee group standard.

Control Variables

OFCCP has provided guidance on not only the number of variables it will consider in an analysis, but how it will technically transform employee data (and perhaps hard copy records) into a database for analyses. For example, Directive 2018-05 explains that OFCCP will:
 

  • Control for variables such as employee grade, employee level within a role, education, and performance ratings "by creating a series of component dichotomous (0-1) variables minus a reference category" and similar variables, as the Agency deems appropriate, to capture meaningful pay differentials;
  • Adjust components of employee tenure and time in position to avoid multicolinearity – for example not analyze the time an employee has been in their current role as both a component of "tenure" and a component of "time in position";
  • Consider market data "on a case-by-case basis"; and
  • Analyze employee age "as a proxy for prior experience" in its regression analyses during the desk audit stage (but will seek to obtain actual prior experience in subsequent analyses);
  • Test all variables for neutrality, and omit any variables that the Agency determines are "tainted by discrimination."

Similarly, FAQ no. 15 on the new Directive explains that OFCCP will combine variables with fewer than five observations in the pay analysis group with other similar variables before being considered in an analysis. This technical decision is important and warrants an example. If four people in a pay analysis group earned a "significantly achieves expectations" performance rating, OFCCP would not consider that variable in its analyses. Instead, the Agency would group it with what it believes to be another similar variable – perhaps "achieves expectations" – to analyze the trends of "high performers." This approach is better than ignoring that certain employees are the highest achievers but it fails to accurately account for any differences in salary that the higher performance rating warrants.

As with other parts of Directive 2018-05, the Agency has provided transparency as to what how it will technically apply control variables. This disclosure highlights areas to focus on during the compliance evaluation process and in conciliation with the Agency. It is important to determine whether the Agency's manipulation of contractor data was done appropriately, given the specific workforce and practices under review.

How to Prepare for an Audit in Light of Directive 2018-05

Following the new directive, contractors are wise to implement a two-fold approach to audit preparation.

First, perform an honest assessment of how your pay should be analyzed. Applying Title VII, employers should examine their workforce (to roles with similar tasks, skills, effort, responsibility, working conditions, and complexity) and pay practices (to determine how they actually work). Once it is determined who is similarly situated and what factors drive pay, employers should engage in privileged pay analyses to evaluate whether any unexplained pay differences may be attributed to race or gender. These reasonable and appropriate analyses square with long-standing Title VII case law and would be used to explain employee pay differences during an audit, in conciliation, or in court.

Second, diagnose the risk of a protracted pay audit. Directive 2018-05 is the Agency's roadmap for a compensation investigation. It suggests OFCCP will analyze by an employer's "compensation hierarchy and job structure," EEO-1 Category, or AAP Job Group as presumptive groups for analysis and provides guidance on how it will transform and use control variables. Setting aside enforceability, OFCCP has told us where it will go with our compensation data. Contractors are wise to explore it before submitting compensation data to OFCCP.

Conclusion

If nothing else, Directive 2018-05 brings transparency to OFCCP's approach in compensation investigations. While there are still questions about the uniform enforceability of its methods, the Agency clearly intends to apply large-scale regression analyses during compensation audits. Employers should become familiar with Directive 2018-05 to better understand the areas OFCCP will investigate.

Compliance reviews will always be smoother if we can explain pay using the Agency's preferred methods. But, if all else fails, be prepared to explain how OFCCP's analyses fail to compare similarly situated employees.
 

For assistance and advice on defending OFCCP audits, conducting pay equity analyses, affirmative action planning or any other questions, please contact authors Scott Pechaitis at 303-876-2201 or scott.pechaitis@jacksonlewis.com or Chris Patrick at 303-876-2202 or christopher.patrick@jacksonlewis.com.

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