On our campus tour, we’ve covered the basics of the prohibition on kickbacks and the splitting of fees, explored the lighthouse in the Section 8(c) safe harbor, reviewed how to set up a compliant joint venture, and took a peek at the AP course in setting up affiliated business arrangements (AfBAs). Before the final bell, our RESPA professors gave us their takeaways – the habits to hone and the practices to avoid – for those looking to add RESPA compliance to their course load.
Holly Bunting, partner at Mayer Brown, recommended those wanting to do RESPA legal work have a solid understanding about how the different businesses in the real estate ecosystems interact and how they conduct their business. Knowing what their economic incentives are, the challenges they face in obtaining customers, and how they work together is effective when evaluating the many fact patterns that arise under that statute.
“As you discuss with clients about the various business scenarios that are proposed, all of them require you to ask questions about how the business is operating,” Bunting said. “You have to understand the motives of the parties involved. By asking those questions in various fact patterns, you really start to be able to piece together how the businesses work.”
What would set a new associate looking to make a RESPA career apart is curiosity – asking the good questions and thinking through the business motivations and what pressure points could turn into legal fault lines.
Florida Agency Network chief operating officer Mike LaRosa mentioned in his dealings with affiliated business arrangements (AfBAs), he would recommend sticking with the federally prescribed disclosure forms.
Sometimes issues can arise when clients want to bury the disclosure language, or change what it says on the disclosure form, to promote the AfBA. But, as LaRosa pointed out, there is a form included in the statute, and language promoting the AfBA is not on it.
“The RESPA guidelines have a form and says your form should look basically like this,” he said. “If you read the opinion letters, they don’t look kindly upon taking that form and turning it into a marketing piece. … Give the consumer the form, in the manner it was laid out. It’s very specific, very dry, but I’ve literally, in 20 plus years in the industry, never seen a single transaction fail because of a provision in an affiliated business arrangement form – a proper one.”
Consumers have declined to use the AfBA, but the lender has never lost the deal. Using the federal form is important, because the disclosure is not supposed to be hidden, or buried amongst myriad other disclosures.
“They don’t want to see the language squished into other paragraphs, or, say, a Realtors’ listing agreement,” he added. “The regulators want a separate page in normal font, with very specific language that states, ‘I’m referring you to this title company because I have a financial interest in it. I have a vested interest, and could benefit financially, or otherwise. You’re free to shop around – you’re not required to use [the affiliated business] for the deal to be consummated.’ It’s pretty basic stuff.”
Franzén & Salzano President Loretta Salzano said when it comes to AfBAs and disclosure forms, she has seen instances where the disclosure form doesn’t appropriately describe the settlement services offered through the AfBA, or doesn’t provide accurate estimations of the ownership interests. This should be avoided.
“There’s not a lot of detail about how you have to describe the relationship,” Salzano said. “It says you should include a percentage of the ownership, but it can be very complex if you have multiple parties with indirect ownership.
“So, whenever we prepare a disclosure, we try to prepare it so that it’s as technically compliant as possible, but at the same time, not confusing to a consumer.”
Salzano said a lot of the time, these subpar disclosure forms are due to sloppiness, or a lack of understanding by the person who drafted them. Another issue she has seen is the disclosure not being included on a separate sheet of paper, but instead combined with other documents, or with the disclosure about a marketing services agreement. But these, she said, are not the same thing.
“The best practice is the way the form reads, or the way the law reads,” she said. “It requires you to disclose the fees, the way they would be disclosed in a HUD-1 settlement statement. The law never changed to say ‘closing disclosure,’ because this was not changed post-TRID, but we assume you’re supposed to do things the same way post-TRID.”
As an example, if it’s a title fee that needs to be disclosed, then it should be “Title -” and then list the disclosure the same way it would be on the closing disclosure. A similar process should be followed for the AfBA disclosure, Salzano said, and some people aren’t doing that.
Salzano said some of the largest pitfalls she has seen is the timing of the disclosure occurring too late. Unless you are a mortgage professional, she said, the disclosure is supposed to occur at the time of the referral. A lot of the time, that doesn’t happen, and the disclosure doesn’t occur until closing, and by that point, it is too late for it to be a meaningful disclosure that gives the consumer choice.
“If you’re dealing with a real estate broker, with a brokerage company as the owner [of the AfBA], it’s easy to build that into your processes, so that any time you have someone sign a buyers representation agreement, a listing agreement, or contract, that piece of paper will just go in with everything, whether it’s electronic or not.
“Even though it has to be on its own separate piece of paper, that doesn’t mean it can’t be part of a stack of documents.”
Another challenge that can pop up is with the provision of Section 8(c) that states the only thing of value that can be received by the parties is a return on the ownership interest.
“That’s a quagmire for a lot of reasons,” Salzano said. “One is that you clearly cannot be messing with distributions or percentages of ownership based on referrals. There’s a lot of direction in the regulations about that.”
A significant concern is where there are multiple parties, like in agent-owned ventures. While the amount of business that each agent brings in may vary each month, the return they receive cannot be constantly changed to reflect the business brought in. If each agent came in with a 10 percent interest, they should be receiving a return reflecting that amount.
“HUD [The U.S. Department of Housing and Urban Development] used to say it was OK to consider the transactional volume of people before you invite them to join, but once they’re in, there’s no fooling around with that ownership interest, and no fooling around with the distributions or priority of distributions. Everyone has to be treated the same based on their ownership interest.”
While things can be straight forward when the ownership interests and structures are simple, Salzano cautioned the fancier the structure, the more sensitive to this issue you need to be. Creating an exit strategy for participants also presents its own challenge.
Forcing someone out based on non-referral reasons, such as a loss of license, a felony conviction, or a death triggering a sale to the remaining partners as opposed to going to heirs, is all right and common. But forcing a party out because they are not bringing in business can be problematic, because it is untested.
Salzano also said there also can be issues when one of the owners of an AfBA, often the non-referring owner, is giving things away to support the venture, such as additional management services or office space. This should not happen, as AfBAs are meant to be able to operate independently to be compliant, but also because that means the non-referring partner is giving something of value that isn’t shared equally among the owners.
Marx Sterbcow, managing attorney at The Sterbcow Law Group, LLC, recommended finding an attorney who specializes in RESPA if you are unsure about setting up an AfBA.
“These operating agreements [for AfBAs] aren’t your standard operating agreements,” Sterbcow said. “These are very customized operating agreements for joint ventures. You don’t want to go find a corporate business attorney to draft these things up. You need somebody that has the relevant expertise to draft up the agreement and the accompanying documentation as well.”
Snippet: When RESPA was passed in 1974, it put in place a prohibition on kickbacks and unearned fees when it came to settlement services related to real estate loans.
While this seemed like a sweeping ban, Congress did carve out an exemption for certain relationships and payments.
When RESPA was passed in 1974, it put in place a prohibition on kickbacks and unearned fees when it came to settlement services related to real estate loans. While this seemed like a sweeping ban, Congress did carve out an exemption for certain relationships and payments. Section 8(c) is the safe harbor the legislature provided (and unsurprisingly, it is longer than the section it exempts).
Section 8(c) reads: “Nothing in this section shall be construed as prohibiting
“For purposes of the preceding sentence, the following shall not be considered a violation of clause (4)(B): (i) any arrangement that requires a buyer, borrower, or seller to pay for the services of an attorney, credit reporting agency, or real estate appraiser chosen by the lender to represent the lender’s interest in a real estate transaction, or (ii) any arrangement where an attorney or law firm represents a client in a real estate transaction and issues or arranges for the issuance of a policy of title insurance in the transaction directly as agent or through a separate corporate title insurance agency that may be established by that attorney or law firm and operated as an adjunct to his or its law practice.”
That’s a lot of text. To make it a little more digestible, RESPA News asked Mike LaRosa, Florida Agency Network chief operation officer, to point out the landmarks that tell a traveler on the RESPA sea they’ve reached the lighthouse in the storm.
“No one wants to read the regulations, but I’ve read them 100 times,” LaRosa said. “It’s dense, it can be confusing, but at the end of the day, if you let common sense be your guide, generally, you’re going to be on the right side of the RESPA regulations.”
LaRosa said the Section 8(c) carve-out for bona fide services and payment for services actually performed just supports how business should be done – people should get paid for services rendered. The situations referred to in Section 8(c) where the service being provided by an attorney or a title company (Section 8(c)(1)(A and B)) adds value to the consumer, and it only make sense for them to be compensated for their contribution to the mortgage origination process. Lenders paying their agents for services also is a normal part of doing business – LaRosa said this one does not often pop up in his line of work.
LaRosa said the exception for employers making payments to their own employees (Section 8(c)(1)(C)) for referral activities can be a bit of a gray area, because he has seen instances where people tried to manipulate this provision. For example, take a lender who wants to pay a real estate agent and wants to set the agent up as a part-time referral source. This doesn’t fly, LaRosa said, because but for the referral, you would never hire that real estate agent.
“But if you wanted to pay your loan officers, if you had your own sales team in house, you could certainly create a compensation plan that includes referral fees or commissions based on transactions realized through their sales activities,” LaRosa explained.
“It’s when you leave common sense behind, and you’re trying to creatively pay somebody or couch their activities in terms of sales that conveniently sound like those of an employee, but in fact they’re not – apply logic and ask, does this pass the sniff test?”
LaRosa said the section the carries the most risk of abuse, but also the most potential for success, is Section 8(c)(4): the carve out for affiliated business arrangements (AfBA).
“As long as the very specific rules around the creation and operation of AfBAs are met, it can get everyone where they want to be, from a servicing standpoint, and from an ancillary revenue standpoint. And the consumer can actually benefit if [the AfBA] is managed correctly.”
Section 8(c)(4) houses the rules governing AfBAs. These rules require certain disclosures to clients about the relationship, making the consumers aware that use of the referred vendor is not required to consummate the transaction, and that they can shop around or take their business elsewhere without offending the transaction itself. Turning this disclosure into a marketing piece or trying to hide the language sometimes defeats the purpose of the disclosure itself, LaRosa said, and regulators do not take too kindly to these tactics.
Beyond the disclosure, there are other requirements for AfBAs to remain compliant. Making sure one is set up correctly from the get-go provides a strong base for these requirements and makes maintaining them easier. This includes investing sufficient capital and ensuring that the affiliated business operates like any other business.
Loretta Salzano, Franzén & Salzano president, breaks the AfBA requirements for compliance into three parts: giving the disclosure at the time the AfBA is referred, no requirement that the affiliated business be used, and the thing of value received by the involved parties is a return on their ownership interest.
While those are the only things required by statute, the former enforcing agency for RESPA, the U.S. Department of Housing and Urban Development (HUD), issued a policy statement in the 1990s with the 10 factors it considers when analyzing an AfBA. This balancing test was used to determine if it was a legitimate business or a sham for covering up illicit kickbacks.
While at least one court has held the policy statement does not have the force of law, Salzano said that does not mean the regulators won’t still use these factors.
“It’s still prudent to follow [the policy statement] as a kind of ‘how-to,’ so whenever a client comes to us and wants to do an AfBA, I always give them that as background material, and to show them where the regulators heads are, because even though that was HUD, we now have the CFPB [Consumer Financial Protection Bureau], and the CFPB can still apply these factors.
“These are still a good foundation to build a robust [AfBA].”
For more on the 10-part test, how to build compliant AfBAs and JVs, as well as some do’s and don’ts of RESPA, click here.
Marx Sterbcow, managing attorney at The Sterbcow Law Group, LLC and Mike LaRosa, Florida Agency Network chief operating officer, spoke with attendees at the Spring RESPRO session to share their views on the evolving affiliated business arrangement (AfBAs) model. RESPA News took a field trip to hear the speakers provide insight on how to remain compliant while transforming fixed costs into variable expenses in an uncertain market.
Sterbcow kicked off the session by giving an overview of the current regulatory environment. The federal agencies aren’t the only ones enforcing RESPA and looking at AfBAs with a critical eye, he reminded the audience.
“There are a number of states that are very active where attorneys general have gotten together, particularly the District of Columbia, Maryland, Virginia, Pennsylvania, and New Jersey,” he said. “They’re adding some additional states to clamp down on some of the bad actors in business, which needs to happen, because it’s almost like the wild, wild West, like 2008 all over again.”
With the attorneys general focusing on AfBAs, it is important to have your model down, and to keep in mind some models have less compliance risk than others, he added. One model that has popped up in recent years came out of the North Carolina, South Carolina, and Georgia. These AfBA are joint ventures (JVs) forming a brand-new entity that will issue a short closing protection letter, the insurance policy, and the remittance back to the underwriter, and that is their full function. This model is becoming more popular, with Virginia, Maryland, D.C., Pennsylvania, Colorado, Arizona, and Michigan seeing an increase in their numbers.
“This model carries a little bit more regulatory scrutiny with it, because of the purchase agreements,” Sterbcow said. “Let’s say you have an escrow company, and somebody is doing a settlement, which oftentimes is the parent [company], and then you have a title issuing company. Are they both listed on that purchase agreement?
“If they’re not, you’ve got a problem. Because how did that consumer get both of these companies, when one of them isn’t even listed [on the purchase agreement]?”
Sterbcow noted the full-service title agency model, one that has been around for longer and has less compliance risk, might make more sense. But either way, the parties need to be on the purchase agreement – Sterbcow said in his experience with the Consumer Financial Protection Bureau showed him “they’re going to want that in writing.”
In addition to looking for the affiliates listed on the purchase agreement, he also said the states are looking at what percentage of all the purchases are done by affiliates, and looking at them from a very granular level, something that the states were not doing previously.
When building an AfBA or a JV, Sterbcow recommended putting at least six months of operating capital for initial capitalization, and in one state he said no less than $100,000. This amount can be for payroll, office supplies, leases, or software, and the list goes on.
“The more expenses you can put down on your pro forma, the better it is for you,” Sterbcow said. “If you’re just putting a few things here and there, it looks terrible from a regulator’s standpoint, and the odds are, you’re typically not putting all of the actual fixed costs and expenses into it.
“Regulators want to see 2-3 percent of your overall revenues going toward outside advertising per year – not advertising to the brokerage that is part of your joint venture or agents,” he added. “They want it to go to the public – and that is a really critical element to have in place.”
Advertising examples were TV commercials, Little League baseball parks, magnet advertising, and magazines. One suggestion from the bureau Sterbcow has seen is membership in a trade organization, like RESPRO or the American Land Title Association.
Mergers and acquisitions can pose a big compliance risk for AfBAs, he said, because oftentimes there is a lapse in management style, where everyone is still doing their own thing and none of it is consolidated. These companies will “move to the top of the class” from an investigation standpoint because there is no corporate structure, pricing is inconsistent, and it is unclear who came up with the numbers.
“You really want to have some sort of organized central structure; it can be done, but you don’t want to have a ‘loosey goosey’ sort of management style,” he said.
LaRosa addressed listeners about backing up the legitimacy of your AfBA. While Marx stated earlier if your entity can’t support one full-time staff member, it probably should not exist, as a good starting point, LaRosa said he would go even further than that.
“Why are you in business, if you can only employ one person?” he posited.
One of the main considerations when looking to form a business entity is whether there is sufficient volume to justify the opening of an ancillary entity, LaRosa said. The parent company should not prop up the JV – it should be able to operate independently. And the price on starting something like that can cause some “sticker shock.”
“You need to legitimately capitalize [the entity] from inception,” he said. “There has to be a risk of loss. And once the entity is set up, think about what kind of services you are providing, whether their core or non-core.”
LaRosa said when he is helping clients build their JVs or AfBAs, his goal is for the ancillary entity to stand out as a separate business – separate signage, reception, and staff. And when set up correctly, he said clients will find they are providing a better product in a more cost-effective way, and that is an added value for the consumer.
“Whenever we create one of these entities, we go through the process of making sure we have a full-time licensed person in charge,” he said. “And that’s your bare minimum. From there, we don’t run operations with less than two people, though that’s just us.”
He said generally, he puts a full staff of 10-15, depending on the amount of growth, to have people in seats, performing the functions the company is required to provide. Being an open book and being able to confidently answer regulators’ questions is the key to success.
Ultimately, it comes down to common sense, LaRosa added.
“There’s a million different iterations of how these AfBAs can work…there’s so many easy ways to misstep. At the end of the day, regardless of who your partner is, it comes down to common sense.”
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