Disparate Impact Need Not Apply – Merit Based Compensation Systems Can be Exempt Under Title VII

A recent decision by the Seventh Circuit Court of Appeals affirmed a District Court’s judgment in favor of Merrill Lynch on a race discrimination claim involving a performance-based compensation system for Merrill Lynch brokers. This has important ramifications for the financial industry, and perhaps for a number of other employers with similar compensation arrangements.

This is a class action matter and has a number of the usual legal twists and turns. But the most interesting aspect of the case is its reference to a relatively little used section of Title VII of the 1964 Civil Rights Act found at 42 USC 2000e-2(h). That section, usually referenced as Section 703(h) because of the goofy way the law was written, states that it is not unlawful for an employer to apply different standards of compensation or different terms, conditions, or privileges of employment, as part of a “bona fide seniority or merit system, or a system that measures its earnings by quantity or quality of production”, provided that the system is not set up to intentionally discriminate because of race, color, religion, or national origin.

Merrill Lynch was sued by a group of African American brokers, who claimed that its bonus compensation system, based on production credits which reflected commissions earned on client assets managed by the broker, discriminated against them because of their race. As the Court noted, “the production – credit system is about as direct a measure of production as one could have imagined in the financial services industry.”

Under these circumstances, the Court determined that the bonus program at issue compensated brokers on the basis of production and that it did so in a race neutral way. Once that determination was made, the Plaintiffs lose because the statute expressly exempts these types of systems from its scrutiny.

The Plaintiffs tried to avoid this result by arguing the bonus system was biased because it didn’t accurately measure the parties’ true efforts in getting a commission. The Court made quick work of this, noting that the bonus calculations were made directly on their managed assets performance, and nothing else. The Court stated that it would have been different if a broker’s compensation depended on some type of subjective analysis that might be infected with racial animus. But given that the numbers were applied equally to everyone, the Court had no basis to allow the complaint to go forward.

The Plaintiffs next tried to argue that the 703 (h) provision applied only to manufacturing production systems, such as piecework rates, and not the sort of financial  asset production credit system at issue. Again, the Court said that there was no basis for this assertion, that the statute did not make the distinction, and there was no basis for the Court to look at any type of legislative history to make that call.

The decision is important for employers that have the capability to structure a compensation or a promotion decision based on some type of directly measurable qualitative or quantitative product, whether it it’s the number of widgets turned out per hour or the performance of client assets in a stock portfolio. To the extent that employers can characterize their performance systems as qualitative or quantitative measurement-based, they can effectively insulate themselves from discrimination claims under Title VII.