AFFINITY RELATIONSHIPS UNDER RESPA:
MAKING MONEY THE “OLD FASHIONED WAY” 1
By: Howard A. Lax of Lipson, Neilson, Cole, Seltzer & Garin, P.C. *
Affinity relationships are a wonderful means of developing a supplemental income stream. Unfortunately, many affinity relationships are implemented outside of the framework of Section 8 of RESPA. 2 Many times, this is the result of misunderstanding what RESPA requires, and what it does not. This is evident from the settlements 3 entered into by real estate brokers, mortgage brokers, lenders, title agencies, and title companies that were found by HUD to have violated Section 8 of RESPA. Section 8 of RESPA prohibits certain “kickbacks,” but that does not explain when a “kickback” is illegal and when it is not.
Consumers understand “kickbacks” as rebates. You buy a product from a retailer, and the manufacturer gives you some of your money back. Businesses understand kickbacks as “referral fees.” You work as my employee to find a customer for my goods and services, and you earn a commission. Both of these examples are “kickbacks,” but neither example is prohibited by RESPA. Therein lays the confusion. A reasonable person does not understand why “scratching someone’s back” can be an illegal kickback if it benefits both parties, and what “magic bullet” makes it a legitimate relationship.
Section 8(a) of RESPA 4 prohibits paying or receiving any fee or other thing of value (even a referral) in return for the referral of “settlement services” in a “federally related transaction.” Section 8(b) 5 of RESPA states that a person cannot accept a settlement service fee, or a split of a settlement service fee, in a “federally related transaction” without providing “settlement services.” Just as the commandment, “Thou shall not kill” does not elucidate the exceptions for self defense, military action, and police action, the above prohibitions do not describe the exceptions to the rule.
Most real estate professionals and home builders are looking for supplemental sources of income. Section 8(c) of RESPA 6 gives us a number of exceptions to the prohibition against kickbacks that permit such compensation. The most useful exception in Section 8(c) of RESPA is the “goods and services” exception. 7 A settlement service provider may pay for substantive goods and services, even when the payee refers consumers to the provider for settlement services. The payment must be earned for goods and services, not for the referral of mortgage loan customers, and not for services that duplicate services already provided as part of the loan origination process. Just as lenders “bundle” settlement services, real estate agents, builders, and other referral sources may “bundle” their services to benefit mortgage brokers and lenders, and receive fair compensation for these services. Mortgage brokers and lenders, to a lesser extent, may bundles services and sell these to title agencies. There are a number of ways for mortgage brokers and mortgage lenders to interact with real estate professionals, title agencies, residential builders, and others, to earn additional income by utilizing this exception. The keys to developing these affinity relationships are (a) to find a “bundle of services” that benefits both parties, and (b) to identify the market rate payable for these services. The parties must then identify the goods and services provided in a written agreement, and to pay no more than market rates for the goods and services. Any amount in excess of market rates will be inferred to be an illegal kickback for the referral of business.
Adding services to a transaction, or providing cash rebates to the borrower as part of the “bundle,” gives the borrower an incentive to choose to receive mortgage origination services or title and escrow services through the affinity relationship. 8 This drives additional compensation to the affinity partners. The result is a win-win arrangement for the mortgage professional, the affinity partner and the consumer.
Does RESPA Apply?
The first question a law professor would ask is whether the transaction is subject to RESPA. RESPA only applies to “federally related transactions.” Any person or entity originating one million dollars or more of residential mortgage loans in a calendar year that is also subject to disclosure requirements of the Truth in Lending Act (TILA) generates “federally related transactions.” Any transaction that is assisted with money from the federal government, or is insured or guaranteed by the federal government, or is sold to FNMA or FHLMC, is a “federally related transaction.” Hence, we perceive all mortgage transactions as subject to RESPA, but that is not the case. The following are exempt from RESPA:
- Typical one-time seller financing that is not valued at over one million dollars, or the seller does not engage in a sufficient number of transactions to be a “creditor” subject to TILA. 9
- Business purpose credit transactions that are exempt from TILA. For example, a mortgage loan to an investor to acquire residential rental property is a business purpose loan that is not subject to TILA or RESPA. 10
- Cash transactions are not subject to RESPA.
HUD also carved out other loans from RESPA by rule 11 :
- Loans secured by 25 contiguous acres are not subject to RESPA.
- Loans secured by multi-family housing (5 or more units).
- Loans secured solely by land that will not be developed for at least two years.
In contrast, some transactions that we might assume are exempt from RESPA are still subject to the anti-kickback rule:
- Construction loans if the lender makes the end loan, or the borrower buys the lot with the first draw.
- Home equity lines of credit even though certain disclosures are excused.
- Loan modifications if the note is replaced or the mortgage is amended.
- Mortgage assumptions if the lender must approve the assumption.
Discussion of these exceptions is largely an academic exercise. RESPA applies to the majority of residential mortgage transactions. For the remainder of this article, we will ignore transactions that fall outside of the scope of RESPA, and concentrate on core businesses dependent upon residential mortgage transactions.
What is an Illegal Kickback?
To understand what RESPA prohibits, you must grasp and thoroughly digest the definition of an illegal kickback. Section 8(a) of RESPA states:
“No person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or a part of a real estate settlement service involving a federally related mortgage loan shall be referred to any person.”
There are three elements to an illegal kickback: (1) a “thing of value,” (2) an “agreement or understanding,” and (3) a “referral.” If any of these three essential elements is missing, the activity is not illegal under RESPA. Section 14 of HUD’s Regulation X 12 defines each of these three elements:
Things of Value
First, a “thing of value” “includes, without limitation, monies, things, discounts, salaries, commissions, fees, duplicate payments of a charge, stock, dividends, distributions of partnership profits, franchise royalties, credits, future opportunities, chances, retained or increased earnings, increased, accounts, special or unusual contract terms, reduced rates for goods and services, increased payments for goods and services, lease or rental payments based in whole or in part on the amount of business referred, payment of another person's expenses, or reduction in credit against an existing obligation.” 13 When HUD refers to a “payment,” it means the giving of anything of value, whether it is money, a chance to win a prize, a referral, or some future consideration.
Lesser known examples of a “thing of value” include:
- Defraying costs that a party would ordinarily have to pay, such as the cost of mandatory continuing education courses.
- Promising to provide a referral in the future (an agreement for mutual referrals).
- Chances in a lottery or raffle (the ticket has a value, win or lose).
- Providing something that has a dual use may be a thing of value if used for two purposes (e.g. a non-dedicated fax machine).
- Promising an appraiser that he will perform the appraisal for each borrower the appraiser refers to a related lender.
There is no “de minimis” kickback that escapes scrutiny under RESPA. Contrary to popular belief, a gift under $25 is not exempt from being a “thing of value,” and charitable contributions are not exempt from the rule. Nevertheless, there is a point at which the “thing of value” becomes too attenuated to identify. For example, a referral to an affiliate cannot be directly compensated (there is no universal agreement on this issue). However, the referral contributes to the overall profitability of the combined enterprise, and increases the pool from which all employees are paid a bonus. The incremental increase in the referring employee’s bonus is too attenuated from the referral to be a “thing of value” paid for the referral. The point of “no return” must be evaluated on a case by case basis.
Agreement or Understanding
You know an agreement exists when you see it. An agreement or understanding for the referral of settlement service business can be oral, written, or established by a practice, pattern or course of conduct. When a thing of value is received repeatedly and is connected in any way with the volume or value of the business referred, the receipt of the thing of value is evidence that it is made pursuant to an agreement or understanding for the referral of business. Requiring the borrower to use a particular service provider infers that an agreement or understanding exists for the referral of business. 14
There are several exceptions to this definition. First, the borrower cannot be a party to a kickback in his own loan transaction. Defraying the borrower’s closing costs to persuade the borrower to take a loan is not a kickback. Paying a borrower to refer friends and family is an illegal kickback. Second, some Federal Appellate Courts have ruled that unilaterally increasing the price of a third party service fee (and keeping the difference) is not an illegal kickback because there is no agreement. 15 There is a split of opinion on this issue, with HUD and state regulators opposing this practice.Referral
“Referral” is defined two ways. First, a referral includes any oral or written action directed to a person that has the effect of affirmatively influencing the person to use a particular settlement service provider and pay a fee for the service. Second, a referral also occurs whenever a person paying for a settlement service is required to use a particular provider of a settlement service. “Required use” means a situation in which a person must use a particular provider of a settlement service and pay their fee in order to have access to some distinct service or property. 16
here are exceptions that do not constitute a “referral.” First, providing a bundle of services that is significantly discounted from the cost of the individual services does not constitute a “required use” of the provider of the services. For example, a lender that negotiates with settlement service providers for substantially reduced charges so that an origination fee of $300 covers the automated underwriting system fee (AUS), credit report, and appraisal services does not require the use of the AUS service, credit bureau and appraiser if the ordinary actual cost of the services provided individually would be $400. 17
Second, a mortgage originator can buy leads if the person selling the leads does not mention the name of, or do anything to influence the consumer to contact, the broker, lender or other settlement service provider. No endorsements, no hints, no nothing. The broker or lender does all the soliciting of the lead. There are several important caveats to buying leads, such as the requirement that financial institutions must maintain the confidentiality and security of non-public consumer information (with certain exceptions). 18
Illegal Kickbacks Are Like a Three Legged Stool
Think of an illegal kickback as a three legged stool. If any of the three legs are missing, the stool falls over. The same is true under RESPA. If any of the three elements of a kickback is missing, or an exception exists for one of the elements, the transaction is not illegal. Each element must be evaluated individually.
It is easy to presume that an agreement exists when the person making the referral receives a benefit from the recipient of the referral. It is difficult to prove that an agreement exists if (a) the thing of value does not directly benefit the party providing a referral, or (b) the thing of value does not originate from the person receiving the benefit of the referral. You need to show the existence of some independent action by one of the parties tying the payment to the referral when there is an indirect benefit. Take the example where a mortgage lender offers to pay for the cost of the title commitment for any borrower referred to him by a real estate salesperson. The lender’s payment of a title premium, defrays the seller’s cost, not the real estate broker’s costs. The real estate salesperson is making the referral, not the seller. If there is no agreement or understanding tying the seller’s benefit with the referral by the real estate salesperson, the payment is legal. However, if the real estate salesperson used the mortgage lender’s payment to negotiate his commission (with the lender’s knowledge), that action ties the payment to the referral, and the payment is an illegal a kickback.
Let’s try this one more time. A mortgage broker gives coupons to builders for $1000 off the buyer’s closing costs in return for the referral of home buyers for a loan. The coupon that defrays the buyer’s cost, not the builder’s costs. Ordinarily, the buyer cannot be a party to a kickback in his own loan, and the coupons are legal. However, if the builder uses the coupon to negotiate up his construction price, there is a kickback. Furthermore, if the mortgage lender gives the coupons only to builders who give him referrals, there may be a kickback.
Our third example demonstrates the effect that an intervening borrower will have on a referral fee. A lender pays $100 to a church for each member who closes a loan. The church advertises the loan program to its members and encourages them to borrow from the lender. If the lender writes the check to the church, it is a kickback. If the lender writes the check to the borrower, who then voluntarily signs the check over to the church, there is no kickback. The borrower cannot be a party to a kickback in his own loan transaction since the borrower is protected by RESPA. Hence, the borrower breaks the connection between the settlement service provider and the church making the referral for a fee.
Change the facts a little. The lender buys the church membership list and solicits the members. Loan officers attend the church picnic to pass out fliers advertising loan products. If the lender pays for access to the picnic (other than the cost of the meal and other activities for the loan officers), there may be a kickback. If the church endorses the lender, there may be a kickback. If the lender hires the pastor to take loan applications, there may be a kickback (depending on whether the pastor is a bona fide employee of the lender).
Selling leads is not an illegal kickback because there is no a referral. A lead company finds consumers who are willing to apply for a loan, but the lead company does not take any action directed at the consumer to influence the consumer to use any particular lender. Only the lenders that buy leads solicit consumers to apply for a loan. Why don’t lenders buy leads from the public at large? A lender that gives the borrower $50 for giving him the names of friends and relatives who are looking to refinance or to buy a home is purchasing a list. The borrower is not asked to do anything to influence friends and relatives to use the lender. However, the borrower cannot refrain from telling his friends about the lender, and the lender expects this to occur. Even if the lender ordered the borrower not to solicit for the lender, the lender cannot guaranty that the borrower will refrain from making referrals. If the borrower breaks his promise, and talks about the lender after receiving his $50, both the lender and the borrower are liable for a violation of Section 8.
No Thing of Value
The classic example is the lender that rents space in a title agency’s building and refers borrowers to the title agency for title insurance. An illegal kickback could exist if the title agency were giving something of value to the lender. If the lender is paying market rates or above market rates for rent, it is not receiving anything of value for its referrals. If, however, the lender is paying below market rent, the difference is presumed to be a benefit for the referral of settlements service business.
The discounted value of title services was the basis of significant litigation in Michigan over the past several years. 19 Assume that title agencies charge $25 to a builder for the owner’s title policy, and the buyer pays the remainder of the basic fee for the mortgage policy. Does the discount represent a benefit paid to the builder for referring business to the title agency? There are good arguments on each side of this issue. The title agency has less work to write title commitments for the lots because the title agency is able to perform one search for the whole project, and then just provide an update for each lot. On the flip side, the reduced cost of the owner’s policy is an inducement for the builder to send all of his title business to the one title agency, and refer all borrowers there as well. If the title agent were truly lowering its fees due to decreased work, it would lower the basic insurance fee (to benefit the borrower and the builder). Furthermore, title insurance is priced according to the amount of coverage. The $25 premium is not related to the level of risk assumed by the title underwriter. The implication is that the significantly discounted insurance premium is a kickback. Large settlements occurred in Michigan cases, resulting in title companies paying tens of millions of dollars in damages for overcharging borrowers for title insurance on new construction.
Section 8(b) of RESPA – The Other Shoe
The “little brother” of Section 8(a) of RESPA is Section 8(b) 20 :
“No person shall give and no person shall accept any portion, split, or percentage of any charge made or received for the rendering of a real estate settlement service in connection with a transaction involving a federally related mortgage loan other than for services actually performed.”
Section 8(b) prohibits a mortgage broker or a title agent from taking a fee without providing substantial services. That much was established in two HUD Statements of Policy. HUD Statement of Policy 1999-1 21 defined the minimal services that a mortgage broker must perform to earn a fee. HUD Statement of Policy 1996-4 22 defined the core title services that a title agency must perform to earn the title insurance premium. The Statement of Policy covering mortgage broker fees was needed to stem a tide of litigation that threatened to swamp the mortgage broker industry. 23 The Statement of Policy regarding title insurance services was needed to stem business arrangements that allowed referral sources to earn a fee without providing much in the way of services.
The minimal services that a mortgage broker must perform were first espoused by HUD in an informal letter to the Independent Bankers Association of America, dated February 14, 1995. This letter identified fourteen services that a mortgage broker may perform to originate a mortgage loan. These include:
(a) Taking information from the borrower and filling out the application;
(b) Analyzing the prospective borrower's income and debt and pre-qualifying the prospective borrower to determine the maximum mortgage that the prospective borrower can afford;
(c) Educating the prospective borrower in the home buying and financing process, advising the borrower about the different types of loan products available, and demonstrating how closing costs and monthly payments could vary under each product;
(d) Collecting financial information (tax returns, bank statements) and other related documents that are part of the application process;
(e) Initiating/ordering VOEs (verifications of employment) and VODs (verifications of deposit);
(f) Initiating/ordering requests for mortgage and other loan verifications;
(g) Initiating/ordering appraisals;
(h) Initiating/ordering inspections or engineering reports;
(i) Providing disclosures (truth in lending, good faith estimate, others) to the borrower;
(j) Assisting the borrower in understanding and clearing credit problems;
(k) Maintaining regular contact with the borrower, realtors, lender, between application and closing to apprise them of the status of the application and gather any additional information as needed;
(l) Ordering legal documents;
(m) Determining whether the property was located in a flood zone or ordering such service; and
(n) Participating in the loan closing.
These fourteen services were incorporated into HUD Statement of Policy 1999-1 published on March 1, 1999. HUD’s Statement of Policy required a mortgage broker to provide five services from the list above in addition to taking the loan application. HUD also recognized that services (b), (c), (d), (j), and (k) on the list above were “counseling type” services that could provide more of a substantive benefit to the lender than to the borrower. Hence, a mortgage broker’s services would be closely scrutinized if the mortgage broker provided only these five “counseling services.”
HUD acknowledged that these are not the only services that a mortgage broker may provide, and that some of these services may be provided through technology rather than the efforts of a mortgage broker. Nevertheless, the important principle of this Statement of Policy is that it provided a safe harbor for mortgage brokers. Mortgage brokers could earn a fee by providing a limited number of identifiable services. Furthermore, the mortgage broker’s total compensation should be measured against the totality of the services provided. Class action lawsuits that separately measured the services provided to the mortgage lender and services provided to the borrower against the amount that each party paid were no longer viable.
HUD’s Statement of Policy 1996-4 established minimum title agency services:
“Section 8(c)(1)(B) specifically exempts payments of a fee ‘by a title company to its duly appointed agent for services actually performed in the issuance of a policy of title insurance.’ A more general provision, section 8(c)(2), exempts the ‘payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed.’ (See also 24 CFR 3500.14(g)(1).)….
“To qualify for a section 8(c)(1)(B) exemption, the attorney title insurance agent must ‘provide his client with core title agent services for which he assumes liability, and which includes, at a minimum, the evaluation of the title search to determine insurability of the title, and the issuance of a title commitment where customary, the clearance of underwriting objections, and the actual issuance of the policy or policies on behalf of the title company. ’”
More specifically, HUD defined five services that a title agency must perform to earn the entire its portion of title insurance premium (typically 70% to 85% of the premium) without scrutiny of the split between the agency and the underwriter:
“’Core title services’ are those basic services that a title insurance agent must actually perform for the payments from or retention of the title insurance premium to qualify for RESPA’s section 8(c)(1)(B) exemption for ‘payments by a title company to its duly appointed agent for services actually performed in the issuance of a policy of title insurance.’ In performing core title services, the title insurance agent must be liable to his/her title insurance company for any negligence in performing the services. In considering liability, HUD will examine the following type of indicia: the provisions of the agency contract, whether the agent has errors and omissions insurance or malpractice insurance, whether a contract provision regarding an agent's liability for a loss is ever enforced, whether an agent is financially viable to pay a claim, and other factors the Secretary may consider relevant.
“’Core title services’ mean the following in Florida:
a. The examination and evaluation, based on relevant law and title insurance underwriting principles and guidelines, of the title evidence (as defined below) to determine the insurability of the title being examined, and what items to include and/or exclude in any title commitment and policy to be issued.
b. The preparation and issuance of the title commitment, or other document, that discloses the status of the title as it is proposed to be insured, identifies the conditions that must be met before the policy will be issued, and obligates the insurer to issue a policy of title insurance if such conditions are met.
c. The clearance of underwriting objections and the taking of those steps that are needed to satisfy any conditions to the issuance of the policies.
d. The preparation and issuance of the policy or policies of title insurance.
e. The handling of the closing or settlement, when it is customary for title insurance agents to provide such services and when the agent's compensation for such services is customarily part of the payment or retention from the insurer.”
Controversy exists regarding core title services and retained risk, even after this guidance was published. For example, title plants provide an electronic document that mimics Schedule B of a title commitment. HUD’s position is that “if the title insurance company provides its title insurance agent with a pro forma commitment, typing, or other document preparation services, the title insurance agent is not ‘actually performing’ these services. As such, the title insurance agent would not be providing ‘core title services’ for the payments to come within the section 8(c)(1)(B) exemption.” What level of scrutiny of the title search is required before the commitment can be generated from the search document? Does the agency fulfill its obligation to provide all “core title services” if the title agent simply accepts the document provided by the search service and pushes a few keys to create the commitment?
Controversy also exists regarding the sharing of risks between insurance companies. State Insurance Commissioners recently fined several title insurance companies for entering into reinsurance agreements with title companies owned by builders. The reinsurance agreement paid the builders’ reinsurance companies a fee that was disproportionate to the risk that the reinsurer absorbed. The Commissioners found that splitting the insurance premium, without absorbing substantial risk, violated state insurance codes and RESPA.
HUD has not officially established minimum or core services that other settlement service providers must perform to earn a fee. Therein lays a problem. Section 8(b) implies that splitting a fee by agreement is illegal if no services are performed. However, is a modicum of service all that is necessary to earn a substantial fee? Furthermore, is it illegal to take a fee without providing a service when there is no second party that knowingly splits the fee? Without guidance from HUD, the issue of what other settlement service providers must do to earn a fee was left to the courts.
Back to Court
Once litigation subsided over mortgage broker fees, borrowers increasingly challenged miscellaneous lender compensation. Borrowers claimed that document preparation fees greatly exceeded the actual cost of preparing closing documents, underwriting fees exceeded the cost charged by automated underwriting systems, credit report fees exceeded the cost of the credit report, and that some lenders were making excessive profits from “junk fees.” These claims took two forms. First, borrowers claimed that lenders cannot make a profit from third party services. These profits are termed “markups.” Second, borrowers claimed that lenders cannot charge excessive fees, far above the cost or the value of services provided. These profits are termed “overcharges” or “overages.” HUD supported claims in amicus briefs filed in various borrower lawsuits that markups and overcharges violate RESPA.
HUD and the Department of Justice enforce an informal policy that a settlement service provider cannot earn a fee without providing substantial services. HUD will take action against a lender or title agency that marks up third party settlement service fees passed on to the borrower. Markups typically occur when a service provider (typically a credit bureau) bills a lender monthly for services, or the actual cost (e.g. the recording fee) is determined after the closing. Charges for online credit reports vary (typically ranging from $8 to $15). The lender may have no idea what the credit report costs at the time of closing and, therefore, the lender charges the borrower a flat fee that is the average cost of the credit report. Title agents also charge flat fees for recording documents since they do not know until just before the closing how many pages are in the deed and mortgage.
HUD believes that each borrower should pay no more than the actual cost for third party services. Hence, anyone who paid $12 for an $8 credit report is entitled to a refund. HUD has fined several lenders for these infractions. While some fines have been substantial, many fines imposed by HUD were a few thousand dollars per lender – amounts too small to be economically worthwhile to contest.
Consumers have been less successful arguing to a court that they should receive compensation for fee markups. Three Circuit Courts of Appeals held that Section 8(b) clearly and unambiguously does not prohibit mark-ups. 24 These courts held that:
- There is no violation of RESPA when there is no agreement or understanding between the credit bureau and the lender, or between the title agent and the Register of Deeds, that the lender would keep the difference between the charge to the borrower and the actual cost of the service.
- Section 8 requires a court to find two parties guilty. The only other party to the transaction is the borrower, but the borrower cannot be a party to a kickback in the borrower’s own loan. Holding the borrower liable under a statute designed to protect the borrower leads to an absurd result.
Later court decisions by three different Courts of Appeals deferred to the arguments espoused by HUD to hold that a markup could be a kickback. 25 However, if the service provider can show that it rendered some service that can be compensated (and there is no overlap of other compensation or fee for the service), then there is no kickback. In theory, a lender or a title agent can earn a fee for almost anything. Enforcement of HUD’s position has been limited in the past few years. Instead, state regulators have fined lenders for marking up credit reports on the basis that state laws expressly limit fees collected for third party services to the actual cost of these services.
There are several means of avoiding this issue:
- Raise the origination fee to bundle the origination of the loan with the credit report fee, and show the flat fee to the credit bureau or to the Register of Deeds as an estimated POC payment.
- Charge a credit review fee instead of a credit report fee, and show the flat credit report fee as an estimated POC payment.
- Increase the closing fee to include the cost of recording documents, and show an estimated POC payment to the Register of Deeds.
- Charge a recording service fee in addition to the fee charged by the Register of Deeds.
All of these methods are being used to level out the cost of services. However, a more prevalent practice creeping into the market is to increase “junk” fees rather than to bundle fees. HUD has, in effect, opened a Pandora’s Box by making a mountain out of a molehill. Consumers are now paying more for incremental services than they did by paying an average amount for the cost of the third party service.
Overcharges and Overages
HUD and the Department of Justice have also argued, unsuccessfully to this point, that an excessive fee violates Section 8(b) of RESPA. HUD’s argument, asserted in Statement of Policy 2001-1, 26 is that “A single service provider . . . may be liable under Section 8(b) when it charges a fee that exceeds the reasonable value of goods, facilities, or services provided.” HUD's argument is based on a statement in Regulation X: “If the payment of a thing of value bears no relationship to the goods or services provided, then the excess is not for services or goods actually performed or provided.” In HUD’s view, too many points, an oversized document preparation fee, or too high of a yield spread premium, is a fee split – the borrower is charged a reasonable fee for services, and the borrower is charged an additional amount for which the borrower receives no benefit. However, the 1973 legislative history of RESPA indicates that Congress rejected an explicit price control proposal when RESPA was enacted. Instead, it directed HUD to report to Congress on “whether Federal regulation of the charges for real estate settlement services in federally related mortgage transactions is necessary and desirable.” 27 Congress took no further action regarding price controls. Thus the courts rejected HUD’s argument since it was based on a HUD rule which was not supported by RESPA.
Exceptions to the Rule
Every rule has its exceptions, including Section 8 of RESPA. Five principal exceptions to the kickback rule (in addition to the “missing stool leg” concept discussed previously) are used to create affinity relationships between settlement service providers:
1. Payments for rendering services or providing goods.
Section 8(c) of RESPA allows payments for bona fide services and goods actually received, regardless of whether the party receiving the payment refers business to the party paying for the services and goods. 28 These services and goods typically take the form of subleases, desk licenses, joint advertising, marketing services, and other miscellaneous services. There are several caveats to this exception:
HUD will presume that any markup of third party services and goods by a person in a position to refer settlement service business is a payment for the referral of business. If a real estate broker sublets a bare office to a lender, the rent should be based on actual cost, and should not be marked up. 30 Services and charges for services provided by a referral source should be uniform. Real estate brokers should not charge a higher desk license fee to a lender simply because the lender may make a significant profit from referrals. Furthermore, office services provided to a lender under a desk license should be comparable to the office services provided by a real estate broker to its real estate salespersons with a desk license.
A real estate broker may charge more than its cost per square foot to sublet an office to a lender or title agent if the real estate broker provides extra services on a commercially reasonable basis. A real estate broker may provide postage, copying, fax, reception, conference rooms, etc., in addition to renting an office to a mortgage lender. If the real estate broker provides these services on a commercially reasonable basis, e.g. comparable to the service provided in an executive office suite, the real estate broker may price the subleased office comparable to the cost of space in a local executive office suite. If services provided to a lender are the same as are provided to a real estate salesperson with a desk license, the real estate broker should justify the license fee based on the market rate for the desk license. If the mortgage lender will use fewer services than a real estate salesperson, reduce the desk license fee accordingly. It is imperative that a lender or other settlement service provider should never pay a premium for introductions or referrals to business opportunities.
Similarly, a mortgage company or a title agency should not pay for “make work” that has little or no value. For example, marketing agreements that require the “service” of real estate salespersons to attend educational programs, or that require “access” to real estate professionals, are questionable at best. What is the utility of such a “service”? Marketing efforts should be justified under the education and marketing exception discussed below.
2. Affiliated Business Arrangements
The owners of a mortgage company, title agency, real estate brokerage, and/or other settlement service providers may earn a profit from a bona fide business investment, 31 even when some of the profit is generated through leads sent to the partially owned business, provided that:
Remember also that HUD informal policies and HUD Statements of Policy 1996-4 and 1999-1 require any title agency, mortgage brokerage, or other settlement service business to provide substantive services. Any settlement service business must have at least one bona fide employee to perform substantive services. Fee splitting between affiliated businesses based on a split of substantive services is difficult and often runs afoul of secondary market or insurance underwriter requirements.
3. Secondary Market Sales
Prices paid by investors and borrowers to mortgage broker/lenders in table funded transactions must be commensurate with the level of work that the broker/lender provided toward originating the loan and completing the transaction. Mortgage brokers do not “own” an application or a loan, and the borrower is not anyone’s “property.” However, premium prices paid by an investor to buy a loan from a lender are beyond the oversight of HUD. 34 A lender’s ownership of a loan is established by two factors, both of which must be present:
4. Educational and marketing expenditures.
Ordinary educational and marketing expenditures are exempt from scrutiny under RESPA, provided that the expenditure is referral neutral and it does not defray costs ordinarily incurred by the recipient. 35 A weekend retreat and education program provided for real estate professionals, or tickets to a sporting event or a golf outing, are acceptable, provided that the invited target audience is based on bona fide business criteria (such as all of the real estate agents operating in a geographic area), and the invitation is not conditioned on the past, present, or future referral of business. Providing a free CLE course required for licensure would not be permitted because it is a cost that the recipient would ordinarily incur.
The hard part of marketing is being referral neutral. Rewarding builders with golf outings and sports tickets for referrals is prohibited. You can beg, but you cannot blackmail, bribe, compensate, extort, manipulate, reward, payoff, shakedown, or threaten referral sources to make referrals. Please also note that some state licensing laws prohibit gifts and other expenditures to obtain leads. 36
5. Bona Fide Employment.
Section 14(g)(iv) and (vii) of HUD’s Regulation X permit:
“(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;” and
“(vii) An employer's payment to its own employees for any referral activities.” (emphasis added)
Settlement service providers should be able to hire pure “finders” and “rainmakers” that have no responsibilities other than to generate new clients for a settlement service business and its affiliates. However, HUD gave us a different message in a settlement agreement with Znet Financial. HUD fined Znet for paying $400 to real estate salespersons for each application for credit completed for Znet. Znet claimed that the real estate salespersons were employees being paid bona fide compensation, but HUD disagreed.
This settlement sends a clear message that certain employees must perform substantive services (similar to a mortgage broker’s services) to earn bona fide compensation. That is not what the rule says, but that is how HUD enforces its rule. HUD will only allow an employer to compensate bona fide employees. Furthermore, compensation may only be paid for settlement services benefiting the employer. For example, HUD will allow a company to compensate employees for referring new business to their employer, but HUD will fine a company for paying compensation to employees for referring business to the employer’s affiliate. 37
HUD evaluates twenty factors outlined in IRS Revenue Ruling 87-41 to determine whether a person is a “bona fide” employee or an independent contractor. Unfortunately, we do not know how may of these factors must be satisfied under HUD scrutiny, or which factors weight more heavily than others. The twenty factors are:
Several other exceptions are listed in the statute and regulation; however, these exceptions have not been used to establish affinity relationships between different types of settlement service providers. These include:
HUD has authority to create other exemptions, but that is unlikely.
Special Title Agent Rules Lead to Special Litigation
Some of the usual avenues of developing business are not available to title agencies. Section 9 of RESPA 38 states:
“No seller of property that will be purchased with the assistance of a federally related mortgage loan shall require directly or indirectly, as a condition to selling the property, that title insurance covering the property be purchased by the buyer from any particular title company.”
This means that one of the title agent’s best source of referral business - the form purchase agreement given to the seller - cannot specify that the buyer will use a particular title agent to purchase the mortgagee title insurance policy.
Furthermore, some state laws and rules prohibit or restrict affinity relationships by (a) limiting the amounts that title agencies and underwriters can spend on marketing, (b) prohibiting rebates to insured parties or reductions in filed rates, or (c) prohibiting payments for leads. Hence, title agencies and companies engage in joint ventures to generate referral business more than other settlement service providers.
Joint ventures between title agencies and real estate brokers work well, provided that there is a sufficient volume of referrals to make the joint venture profitable. The real estate broker partner refers sellers to the affiliated title agency to purchase the owner’s policy. The title agency charges the seller the basic title insurance premium (less any reissue credits), and charges the buyer a “split premium” or “simultaneous issue” premium for the lender’s policy. For example, if the basic premium for a $100,000 policy is $500, and both the owner’s policy and the lender’s policy were purchased from the same agency, the seller pays $300 for the owner’s policy and the buyer pays 40% of the basic premium for the lender’s policy ($200, or less if the mortgage loan is less than the purchase price). If the seller and the buyer purchase title insurance from different title agencies, each party would pay $500 for their policy.
The buyer, faced with the choice of paying $200 or $500 for the same policy, would choose the seller’s agency to simultaneously issue the lender’s policy. The title agency that issues the lender’s policy must close the loan so that the lender receives a first lien letter, closing protection letter, and final policy without standard exceptions. Hence, the buyer was usually locked into the real estate agent’s affiliated title agency without any contractual requirement to use that agency.
This scenario changed as lenders established their own joint ventures with title companies. Most title underwriters now offer simultaneous issue premiums for the lender’s policy that allow lender affiliated title agencies to effectively compete with real estate broker affiliated title agencies. The lender will steer borrowers to an affiliated title agency to issue the lender’s policy and close the loan. The borrower pays the same premium to the lender’s affiliated title agency that would be charged by the agency issuing the owner’s policy. Sometimes the lender’s affiliated title agency will charge a below market closing fee to entice the borrower to use its services.
Competition lead to modest range wars in certain markets. Some real estate brokers and their favored title agencies began charging a documentation fee to the buyer if the buyer permitted the lender’s title agency to close the transaction. Section 9 of RESPA prohibits sellers from directly or indirectly requiring borrowers to use a specific title agent. Litigation ensued, alleging that the documentation fee is a condition of selling the property that indirectly requires the buyer to use the seller’s preferred title agency.
Recently, a Minnesota real estate broker was attacked for violating fiduciary duties to its customers. Revising the title commitment order form and real estate broker advertisements to specify that real estate brokers and title agencies are independent contractors (comparable to the Mortgage Origination Agreement used by mortgage brokers) may address some state law issues, but it will not resolve RESPA claims. The result of this litigation may not be known for several years.
Flying Too Close to the Sun
Profit sharing programs and insurance premium splits in three affinity programs were attacked on the basis that the split favors a referral source, or the payment violates state law. These are worth noting, simply to point out how these programs failed despite the best intentions of the parties. Please note that these matters were settled without any admission of wrongdoing.
First, private mortgage insurance companies offered to sell “Performance Notes” to lenders that purchased PMI policies. The performance Notes paid interest at a rate based on the payment performance of the lender’s loan portfolio. OCC Interpretive Letters 833 and 834, and an informal HUD opinion under RESPA, authorized national banks to purchase these notes. Lenders steered borrowers to purchase mortgage insurance from companies that offered “Performance Notes.” The more policies the insurer issued to the lender’s borrowers, the more notes a lender could purchase. Performance Notes were phased out because (a) the New York Insurance Commissioner stated in Insurance Department Circular Letter No. 2 that Performance Notes violated state insurance laws by sharing insured risk with unlicensed entities, and (b) Performance Notes faced increasing litigation under RESPA.
Second, private mortgage insurance companies offered secondary mortgage pool insurance to lenders to replace the fees paid to investors for “special” servicing rights. In “ordinary” servicing, the lender makes principal and interest payments when the borrower defaults. The lender is repaid if and when the secured property is foreclosed and sold. Investors offered “special” servicing contracts to lenders (for a fee) that required the investor to take the risk that a foreclosure sale of the property would not recoup all principal and accrued interest. Investors accepted pool insurance policies in lieu of special servicing fees. Litigation against the mortgage insurers alleged that unreasonably low pool insurance premiums were illegal kickbacks for the referral of individual mortgage insurance policies. 39
Third, title companies encouraged builders to establish reinsurance companies. The concept was simple – split the risk of loss and the title insurance premium with the builder’s reinsurance company. However, the builders’ reinsurance companies assumed little risk and were paid a significant portion of the premium. State regulators, and later HUD, entered into settlements with these title companies and builders. 40
All of these affinity programs failed because they skirted one of the “golden rules” of affinity relationships. Payments to someone in a position to refer settlement services must be commensurate with the substantive services or goods provided, or the risk absorbed. The difference between the payment (or discount) and the market value of the service or goods is presumed to be a kickback for the referral of settlement service business.
Howard A. Lax is a corporate law attorney and shareholder with Lipson, Neilson, Cole, Seltzer & Garin, P.C. Howard A. Lax specializes in financial institutions consumer compliance and regulatory affairs, and real property law. He earned his J.D. cum laude, from Wayne State University's School of Law and holds a bachelor's degree from the University of Michigan. Active in the community, he is a member of the State Bar of Michigan's Business Law Section, is a member of the governing council of Real Property Law Section, and a member of the MMLA. Mr. Lax also writes and publishes The Mortgage News, a bimonthly mortgage banking compliance newsletter, and he writes a column in RESPANews.com , an October Research publication. The Mortgage News can be found at: http://www.lipsonneilson.com/news.html. Mr. Lax may be contacted at:
Lipson, Neilson, Cole, Seltzer & Garin, P.C.
3901 Telegraph Rd., Suite 200
Bloomfield Hills , MI 48302
Tel.: (248) 593-5000
Fax: (248) 593-5040
1. This article discusses portions of Sections 8 and 9 of RESPA, 12 U.S.C. 2607 and 12 U.S.C. 2608, in relation to marketing and other affinity relationships between mortgage brokers, mortgage lenders, title agencies, real estate brokers, other settlement service providers, and other parties involved in residential transactions. This article by no means provides a complete discussion of these statutes, or the various inventions that settlement service providers create to attract business.
This article is presented in two parts. Part 1 discusses the practical implications of Sections 8 and 9 of RESPA, and portions of HUD’s Regulation X (24 CFR Part 3500) for settlement service providers. Part 1 will discuss the definition of a kickback, and its exceptions in an academic exercise. You must understand what is prohibited to understand what is allowed. Part 2 will discuss practical considerations for implementation of various marketing and affinity arrangements with regarding to the restrictions and exceptions imposed by these statutes and regulations. In plain English, Part 2 will discuss various methods of establishing affinity relationships that do not violate RESPA. Please note that this article is adapted from a weekly column previously published in RESPANews.com ( http://www.respanews.com).
This article is for general information only and should not be used as a basis for specific action without obtaining further legal advice.
DISCLOSURE UNDER TREASURY CIRCULAR 230: The United States Federal tax advice, if any, contained in this document and its attachments may not be used or referred to in the promoting, marketing or recommending of any entity, investment plan or arrangement, nor is such advice intended or written to be used, and may not be used, by a taxpayer for the purpose of avoiding Federal tax penalties. Advice that complies with Treasury Circular 230's "covered opinion" requirements (and thus, may be relied on to avoid tax penalties) may be obtained by contacting the author of this document.
3. All of the published settlement agreements between HUD and various settlement service providers are available at HUD’s web site. Some settlement agreements are not published at all, and some settlements are simply announced through a press release.
7. 12 U.S.C. 2607(c)(2) states, “Nothing in this section shall be construed as prohibiting…the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed…”
8. Providing a true discount to the borrower for a bundle of settlement services has the added advantage of eliminating the restrictions on the “required use” use of an affiliated settlement provider. Section 15(b)(2) of HUD’s Regulation X, 24 C.F.R. 3500.15(b)(2) prohibits anyone from requiring the use of an affiliated settlement service provider if the borrower will be required to pay for the service. However, Section 2(b) of HUD’s Regulation X, 24 C.F.R. 3500.2(b) states:
“Required use means a situation in which a person must use a particular provider of a settlement service in order to have access to some distinct service or property, and the person will pay for the settlement service of the particular provider or will pay a charge attributable, in whole or in part, to the settlement service. However, the offering of a package (or combination of settlement services) or the offering of discounts or rebates to consumers for the purchase of multiple settlement services does not constitute a required use. Any package or discount must be optional to the purchaser. The discount must be a true discount below the prices that are otherwise generally available, and must not be made up by higher costs elsewhere in the settlement process.”
Hence, a lender can require its borrowers to use an affiliated title agency to obtain the lender’s title policy and for the closing of a loan if the title agency offers a package of closing costs that bundles the title insurance premium, closing fee, and recording fees at a significant discount to the cost of these services if priced separately.
9. 12 CFR 226.2(a)(17) states:
Creditor means: (i) A person (A) who regularly extends consumer credit 3 that is subject to a finance charge or is payable by written agreement in more than 4 installments (not including a downpayment), and (B) to whom the obligation is initially payable, either on the face of the note or contract, or by agreement when there is no note or contract.
3 A person regularly extends consumer credit only if it extended credit (other than credit subject to the requirements of §226.32) more than 25 times (or more than 5 times for transactions secured by a dwelling) in the preceding calendar year. If a person did not meet these numerical standards in the preceding calendar year, the numerical standards shall be applied to the current calendar year. A person regularly extends consumer credit if, in any 12-month period, the person originates more than one credit extension that is subject to the requirements of §226.32 or one or more such credit extensions through a mortgage broker.
11. Section 5 of HUD’s Regulation X, 24 C.F.R. 3500.5
15. Courts of Appeals for Fourth, Seventh, and Eighth Circuits held that a markup of a third party fee without an agreement with the third party is not illegal. See Boulware v. Crossland Mortgage Corp. , 291 F.3d 261 (4th Cir. 2002); Echevarria v. Chicago Title & Trust Company, 256 F.3d 623 (7th Cir. 2001); and Haug v. Bank of America, N.A. , 317 F.3d 832 (8th Cir. 2003). The Second, Third, and Eleventh Circuits held that identifying a third party in agreement with the markup is not needed to find a violation of Section 8(b) of RESPA. See Kruse v. Wells Fargo Home Mortgage, Inc. , 383 F.3d 49 (2d Cir. 2004); Santiago v. GMAC Mortgage Group, Inc. , 417 F.3d 384 (3d Cir. 2005); and Sosa v. Chase Manhattan Mortgage Corp. , 348 F.3d 979 (11th Cir. 2003). None of these courts has held that an overcharge or an excessive fee for services rendered is prohibited by RESPA.
18. See FTC financial privacy disclosure rules at 16 C.F.R. Part 313, and FTC information security rules at 16 C.F.R. Part 314. Similar rules were promulgated by federal banking regulators for depository institutions, and by states for insurance entities, pursuant to Article V of the Gramm Leach Bliley Act.
19. See the settlement agreement in Jergess v. TransNation Title Insurance Company, E.D. Mich., S.D. Consolidated Case No.: 00-72124 (February 8, 2006).
23. Over 100 class action lawsuits were filed against lenders claiming that the yield spread premium paid to brokers violated RESPA. HUD Statement of Policy 1999-1 did not stop the lawsuits since the first Court of Appeals to examine this issue after HUD issued its Statement, Culpepper v. Irwin Mortgage Corp. (Culpepper III), 253 F.3d 1324 (11th Cir. 2001), cert. denied, 122 S. Ct. 930 (2002), interpreted HUD’s policy very narrowly. HUD’s Statement of Policy 2001-1 ( 66 F.R. 53052 (10/18/2001))expressly rejected the narrow interpretation in Culpepper III. Courts of Appeals issuing opinions following the 2001 Statement supported HUD’s interpretation of Section 8 of RESPA regarding lender paid broker fees and rejected the opinion in Culpepper III. See, e.g., Glover v. Standard Federal Bank , 283 F.3d 953, 963-965 (8th Cir. 2002); Schuetz v. Banc One Mortgage Corp. , 292 F.3d 1004, 1007. (9th Cir. 2002); O’Sullivan v. Countrywide Home Loans, Inc. , 319 F.3d 732, 738 (5th Cir. 2003).
27. See Kruse v. Wells Fargo Home Mortgage, Inc. , 383 F.3d 49 (2d Cir. 2004). See also the discussion in Martinez v. Wells Fargo Bank, N.A., Case No . C-06-03327 RMW (N.D. CA, San Jose Div. 3/30/2007)
28. 24 C.F.R. 3500.14(g) states, in part:
(g) Fees, salaries, compensation, or other payments. (1) Section 8 of RESPA permits…
(iii) A payment by a lender to its duly appointed agent or contractor for services actually performed in the origination, processing, or funding of a loan;
(iv) A payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed;…
29. See the HUD settlement with Metropolitan Title Company.
“(7) Secondary market transactions. A bona fide transfer of a loan obligation in the secondary market is not covered by RESPA and this part, except as set forth in section 6 of RESPA (12 U.S.C. 2605) and Sec. 3500.21. In determining what constitutes a bona fide transfer, HUD will consider the real source of funding and the real interest of the funding lender. Mortgage broker transactions that are table-funded are not secondary market transactions. Neither the creation of a dealer loan or dealer consumer credit contract, nor the first assignment of such loan or contract to a lender, is a secondary market transaction (see Sec. 3500.2.)”
36. See, for example, Michigan Office of Financial and Insurance Services Bulletin No. 2001-07-INS. But see Chicago Title Ins. Co. v. Butler, 770 So. 2d 1210, 1214 (Fla. 2000), in which the Court held that statutes prohibiting rebates of commissions paid to insurance agents were an unconstitutional infringement on the public’s right to effective bargaining power with those from whom they seek to purchase services.
37. See the HUD settlements with Coldwell Banker Residential Real Estate, Inc., and with Prudential Locations, LLC. Not all attorneys agree with this interpretation. Some attorneys believe that HUD objected to payments to real estate sales agents by these two real estate brokerage businesses because the real estate sales agents were agents by definition and not employees of the real estate brokerage business. Under this alternative interpretation, any employee other than a real estate sales agent may receive a bonus for making a referral to an affiliate. Yet, IRS Technical Advice Memorandum 9648003 (August 9, 1996) states that a real estate agent is an employee. Federal law and IRS rules only provide an exception to the requirement that employment taxes be withheld from employee compensation for real estate brokerage services. Furthermore, HUD informally adopted the twenty factors outlined in IRS Revenue Ruling 87-41 to evaluate whether an employee is a bona fide employee, and compensation is bona fide compensation, in its enforcement investigations. Withholding of employment taxes is only one factor determining whether a person is a bona fide employee or not under the IRS revenue ruling.
39. Several lawsuits were filed on December 17, 1999 in U.S. District Court for the Southern District of Georgia against Mortgage Guaranty Insurance Company, PMI Mortgage Insurance Company, Republic Mortgage Insurance Company, and United Guaranty Corporation. One of these lawsuits was dismissed on the basis that state laws, not federal laws, regulate insurance activities. Marie Pedraza, et al. v. United Guaranty Corp., et al. , No. 99-239, slip op. (S.D. Ga. Aug. 14, 2000). One lawsuit was filed in the Eastern District of Texas, Moore v. Radian Group, Inc. et al., and another in North Carolina. See also the order in Barnes v. Republic Mortgage Insurance Company, Case No. CV199-240 (S.D. GA 2/5/2003) denying class certification. One of these cases lead to litigation between the mortgage insurance company and its professional liability insurance carrier over who would foot the $1.4 million bill for defense of these various lawsuits (the mortgage insurer won). See PMI Mortgage Insurance Company v. American International Specialty Lines Insurance Company, 394 F.3d 761, (9 th Cir. 2005).
40. See, e.g., the settlement between HUD and AHT Reinsurance, Inc.