61 FR 29258

					29258            Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

employer for a referral to an affiliated     24 CFR Part 3500                               After RESPA’s passage, the
entity.                                                                                   Department received many questions
                                             [Docket No. FR–3638–N–04]                    asking if referrals between affiliated
5. Neutral Display of Information on                                                      settlement service providers violated
Settlement Service Providers and Their                                                    RESPA. Congress held hearings in 1981.
                                             Office of the Assistant Secretary for
Products                                     Housing-Federal Housing                      In 1983, Congress amended RESPA to
                                             Commissioner; Real Estate Settlement         permit controlled business
   Section 8(a) of RESPA prohibits
                                             Procedures Act (RESPA); Statement of         arrangements (CBAs) under certain
compensated referrals. HUD may
                                             Policy 1996–2 Regarding Sham                 conditions, while retaining the general
scrutinize non-neutral displays of                                                        prohibitions against the giving and
information on settlement service            Controlled Business Arrangements
                                                                                          taking of referral fees. Congress defined
providers and their products because         AGENCY:  Office of the Assistant             the term ‘‘controlled business
favoring one settlement service provider     Secretary for Housing-Federal Housing        arrangement’’ to mean an arrangement:
over others may be affirmatively             Commissioner, HUD.                              [I]n which (A) a person who is in a
influencing the selection of a settlement    ACTION: Statement of policy 1996–2,          position to refer business incident to or a part
service provider which could constitute      sham controlled business arrangements.       of a real estate settlement service involving
a referral under RESPA. 24 CFR                                                            a federally related mortgage loan, or an
3500.14(f). An agreement or                  SUMMARY:    This statement sets forth the    associate of such person, has either an
understanding for the referral of            factors that the Department uses to          affiliate relationship with or a direct or
                                             determine whether a controlled               beneficial ownership interest of more than 1
business incident to or part of a                                                         percent in a provider of settlement services;
settlement service may be established by     business arrangement is a sham under
                                                                                          and (B) either of such persons directly or
a practice, pattern, or course of conduct.   the Real Estate Settlement Procedures        indirectly refers such business to that
24 CFR 3500.14(e). For example, if one       Act (RESPA) or whether it constitutes a      provider or affirmatively influences the
lender always appears at the top of any      bona fide provider of settlement             selection of that provider.
listing of mortgage products and there is    services. It provides an interpretation of
                                                                                          12 U.S.C. 2602(7) (emphasis added).
no real difference in interest rates and     the legislative and regulatory framework        In November 1992, HUD issued its
                                             for HUD’s enforcement practices              first regulation covering controlled
charges between the products of that
                                             involving sham arrangements that do          business arrangements, 57 FR 49599
lender and other lenders on a particular
                                             not come within the definition of and        (Nov. 2, 1992), codified at 24 CFR
listing, then this may be a non-neutral      exception for controlled business
presentation of information which                                                         3500.15. 1 That rule provided that a
                                             arrangements under Sections 3(7) and         controlled business arrangement was
affirmatively influences the selection of    8(c)(4) of the Real Estate Settlement
a settlement service provider.                                                            not a violation of Section 8 and allowed
                                             Procedures Act (RESPA). It is published      referrals of business to an affiliated
Furthermore, if there is an affiliate        to give guidance and to inform               settlement service provider so long as:
relationship between the CLO and a           interested members of the public of the      (1) The consumer receives a written
favored settlement service provider, the     Department’s interpretation of this          disclosure of the nature of the
non-neutral presentation of information      section of the law.                          relationship and an estimate of the
under certain circumstances could            FOR FURTHER INFORMATION CONTACT:             affiliate’s charges; (2) the consumer is
constitute a required use in violation of    David Williamson, Director, Office of        not required to use the controlled entity;
3500.15(b)(2). This guidance on neutral      Consumer and Regulatory Affairs, Room        and (3) the only thing of value received
displays should not be read to               5241, telephone (202) 708–4560. For          from the arrangement, other than
discourage CLOs from assisting               legal enforcement questions, Rebecca J.      payments for services rendered, is a
consumers in determining which               Holtz, Attorney, Room 9253, telephone:       return on ownership interest.
products are most advantageous to            (202) 708–4184. (The telephone                  Section 3500.15(b) sets out the three
them. For example, if a CLO                  numbers are not toll-free.) For hearing-     conditions of the controlled business
consistently ranks lenders and their         and speech-impaired persons, this            arrangement exception. The first
mortgage products on the basis of some       number may be accessed via TTY (text         condition concerns the disclosure of the
factor relevant to the borrower’s choice     telephone) by calling the Federal            relationship. The rule provides that the
of product, such as APR calculated to        Information Relay Service at 1–800–          person making the referral must provide
include all charges and to account for       877–8339. The address for the above-         the consumer with a written statement,
the expected tenure of the buyer, HUD        listed persons is: Department of Housing     in the format set out in appendix D to
would consider this practice as a neutral    and Urban Development, 451 Seventh           part 3500. This statement must be
display of information.                      Street, SW, Washington, DC 20410.            provided on a separate piece of paper.
                                                                                          The referring party must give the
  Authority: 12 U.S.C. 2617; 42 U.S.C.       SUPPLEMENTARY INFORMATION:
                                                                                          statement to the consumer no later than
3535(d).                                     General Background                           the time of the referral. 24 CFR
  Dated: May 31, 1996.                                                                    3500.15(b)(1).
                                               Section 8 (a) of the Real Estate
Nicolas P. Retsinas,                         Settlement Procedures Act (RESPA)               The second condition involves the
Assistant Secretary for Housing-Federal      prohibits any person from giving or          non-required use of the referred entity.
Housing Commissioner.                        accepting any fee, kickback, or thing of     Section 3500.15(b)(2) provides that the
[FR Doc. 96–14330 Filed 6–6–96; 8:45 am]     value for the referral of settlement         person making the referral may not
                                             service business involving a federally       require the consumer to use any
                                             related mortgage loan. 12 U.S.C.             particular settlement service provider,
                                             § 2607(a). Congress specifically stated it   except in limited circumstances. A
                                             intended to eliminate kickbacks and            1 All citations in this Statement of Policy refer to
                                             referral fees that tend to increase          recently streamlined regulations published on
                                             unnecessarily the costs of settlement        March 26, 1996 (61 FR 13232), in the Federal
                                             services. 12 U.S.C. § 2601(b)(2).            Register (to be codified at 24 CFR part 3500).
               Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations                                29259

lender may require a consumer to pay           arrangements may be joint ventures;             wholly owned mortgage brokerage
for the services of an attorney, credit        others, however, may involve different          subsidiary. The mortgage broker
reporting agency or real estate appraiser      legal structures, such as limited               claimed that the real estate broker ‘‘can
to represent the lender’s interest in the      partnerships, limited liability                 earn hundreds or even thousands of
transaction. An attorney may use a title       companies, wholly owned corporations,           dollars each month without investing
insurance agency that operates as an           or combinations thereof. Regardless of          any money or changing [his or her]
adjunct to the attorney’s law practice as      form, the common feature of these               current business practices.’’ The
part of the attorney’s representation of       arrangements is that at least two parties       mortgage broker’s pitch was that ‘‘my
that client in a real estate transaction. 24   are involved in their creation: a referrer      current staff can work for my company
CFR 3500.15(b)(2).                             of settlement service business (such as         and also for yours.’’ The real estate
   The third condition relates to what is      a real estate broker or real estate agent)      broker’s new company ‘‘can use my
received from the relationship. The rule       and a recipient of referrals of business        investors, my office, my phones, my
provides that the only thing of value          (such as a mortgage banker, mortgage            copy machines, my promotional
that comes from the arrangement, other         broker, title agent or title company). At       material * * * Your company will have
than permissible payments for services         least one, if not both, of these parties        no overhead other than the taxes due on
rendered, is a return on an ownership          will have an ownership, partnership or          the income you generate and the bank
interest or franchise relationship. 24         participant’s interest in the                   fees for the money accounts your
CFR 3500.15(b)(3). The rule describes          arrangement.                                    company must have. The entire annual
what are not proper returns on                    Many of the complaints about these           expenses can be covered on the first
ownership interest at 24 CFR                   arrangements allege that the new entity         loan your company closes * * * I can
3500.15(b)(3)(ii). These include               performs little, if any, real settlement        manage your company at the same time
ownership returns that vary by the             services or is merely a subterfuge for          I manage mine so you won’t have any
amount of business referred to a               passing referral fees back to the referring     time investment either.’’ HUD’s concern
settlement service provider, or                party. For example, in a letter to HUD          about this and similar complaints
situations where adjustments are made          dated September 30, 1994, the Mortgage          prompted the Department to issue this
to an ownership share based on referrals       Bankers Association of America (MBA)            Statement of Policy.
made.                                          expressed growing concern about ‘‘sham
                                               joint venture’’ controlled business               In many of the arrangements that have
   Both the statute and HUD’s 1992                                                             come to HUD’s attention, the substantial
regulation make the controlled business        arrangements. The MBA stated:
                                                                                               functions of the settlement service
arrangement exemption available in               Under this scenario, a lender and a real
                                                                                               business that the new arrangement
situations where referrals are made to a       estate broker jointly fund a new subsidiary
                                               that purports to be a mortgage broker but has
                                                                                               purports to provide are actually
‘‘provider of settlement services.’’ These                                                     provided by a pre-existing entity that
                                               no staff and minimal funding, does no work
provisions do not authorize                                                                    otherwise could have received referrals
                                               (out sources all process to the lender),
compensation to shell entities or sham         receives all business by referral from the      of business directly. In such
arrangements that are not a bona fide          broker parent, sells all production to the      arrangements the entity actually
‘‘provider of settlement services.’’ Since     lender parent, and pays profits to both         performing the settlement services
issuing the 1992 RESPA rule, HUD has           parents in the form of dividends. We oppose     reduces its profit margin and shares its
received numerous complaints that              such arrangements because they afford           profits with the referring participant in
some CBAs are being established to             compensation to brokers but impose on them      the arrangement. In some situations,
circumvent RESPA’s prohibitions and            no work or business risk. In short, they are
                                               disguised referral fee arrangements.
                                                                                               such as in the last example, companies
are sham arrangements. The complaints                                                          that could have received referrals of
often use the expression ‘‘joint venture’’     The MBA encouraged HUD to define                settlement service business directly
as a generic way to describe these new         eligible joint venture entities. It             (hereafter ‘‘creators’’) have assisted the
sham arrangements. While many joint            suggested that such entities should have        referring parties in creating wholly
ventures are bona fide providers of            their own employees, perform                    owned subsidiaries at little or no cost to
settlement services, permissible under         substantive functions in the mortgage           the referring party. These subsidiaries in
the exemption, it does appear that some        process and share in the risks and              turn refer or contract out most of the
are not.                                       rewards of any viable enterprise in the         essential functions of its settlement
   A joint venture is a special                marketplace.                                    service business back to a creator that
combination of two or more legal                  Complaints also included                     helped set them up or use the creator to
entities which agree to carry out a single     arrangements that are wholly-owned by           run the business.
business enterprise for profit, and for        a referring entity. An example of such
which purpose they combine their               a complaint involved an arrangement               The following illustrates the two
property, money, effects, skill and            promoted by a mortgage broker to real           general types of arrangements:
knowledge. Some of the alleged sham            estate brokers to help them set up a            BILLING CODE 4210–27–P
29260            Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

                   Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations                                            29261

  There are numerous variations on                       Cong., 2d Sess. 1974 (hereafter ‘‘the            Banking, Finance and Urban Affairs,
these two general arrangements.                          Report’’). The Report stated that                97th Cong., 1st Sess. 24, (1981)
                                                         RESPA’s anti-kickback provisions were            (hereafter ‘‘Hearings’’). Charles R.
Regulatory and Legislative Framework
                                                         not intended to prohibit the payments            Hilton, then Senior Vice President,
   In amending RESPA to permit                           for goods furnished or services actually         Coldwell, Banker & Co. stated: ‘‘In our
controlled businesses, Congress                          rendered, ‘‘so long as the payment bears         line of operation, all of our ancillary
specifically stated that it did not intend               a reasonable relationship to the value of        services are operated as a full line
to ‘‘change current law which prohibits                  the goods or services received by the            service company. We do our title
the payment of unearned fees,                            person or company making the                     searches; we do the examinations; we
kickbacks, or other things of value in                   payment. To the extent the payment is            share in the risk; we take all of the risk,
return for referrals of settlement service               in excess of the reasonable value of the         in some cases.’’ Hearings at 423. Stanley
business.’’ H.R. Rep. No. 123, 98th                      goods provided or services performed,            Gordon, then Vice President and
Cong., 1st Sess. at 76 (1983). The                       the excess may be considered a kickback          General Counsel for the residential
statute’s definition of ‘‘controlled                     or referral fee * * *. ‘‘ Id. at 7–8. The        group of Coldwell, Banker & Co.,
business arrangement’’ uses the term                     Report stated:                                   acknowledged that some title agencies
‘‘provider of settlement services’’ to                                                                    may have been formed to circumvent
describe the entity receiving the referral                  Those persons and companies that provide
                                                         settlement services should therefore take        Section 8 of RESPA. He said:
of business. 12 U.S.C. 2602(7). The term                 measures to ensure that any payments they
‘‘provider of settlement services’’ means                                                                   The most common examples of
                                                         make or commissions they give are not out        circumvention are those agencies which
a person that renders settlement                         of line with the reasonable value of the         provide little or no service to their customers.
services. The statute further defines                    services received. The value of the referral     They do not perform a search of the title
‘‘settlement services’’ to include any                   itself (i.e., the additional business obtained   records, and have few of the other
service provided in connection with a                    thereby) is not to be taken into account in      characteristics of an ongoing business, such
real estate settlement and includes a list               determining whether the payment is               as a staff of employees and related operating
of such services. If the controlled entity               reasonable.                                      expenses. Such agencies, in our opinion,
performs little or none of its settlement                Id. at 8. The Report further explained           come within the prohibition of Section 8.
service function, it may not be                          that section 8(c) set forth the ‘‘types of       *     *      *     *      *
‘‘providing’’ settlement services, and                   legitimate payments that would not be               There must be, for a violation of Section 8,
therefore may not meet the statutory                     proscribed.’’ As an example, the Report          the involvement of a third party, such as a
definition of a controlled business                                                                       title insurance underwriter of a title agency,
                                                         noted that commissions paid by a title
arrangement.                                                                                              that has agreed to make a kickback to the
                                                         insurance company to a duly appointed            broker. This arrangement is best established
   HUD’s existing regulations address a                  agent for services actually performed in         by the absence of reasonable compensation
shell controlled entity that contracts out               the issuance of a policy of title                from the underwriter to the title agency for
all of its functions to another entity. See              insurance would be permitted. The                the services actually rendered by the title
Appendix B to Part 3500, Illustration                    Report explained:                                agency. The kickback is the payment by the
10.2 Where the shell controlled entity                                                                    title insurer to the title agency (which is then
provides no substantive services for its                    Such agents * * * typically perform
                                                                                                          passed through to the broker owner) where
                                                         substantial services for and on behalf of a
portion of the fee, HUD deems the                                                                         there is no service being rendered which
                                                         title insurance company. These services may
arrangement as violating Section 8(a)                    include a title search, an evaluation of the
                                                                                                          reasonably corresponds to the payment
and (b) of RESPA because the controlled                                                                   * * *.
                                                         title search to determine the insurability of
entity is merely passing unearned fees                   the title (title examination), the actual        Hearings at 429–431.
back to its owner for referring business                 issuance of the policy on behalf of the title       Consequently, in cases where work is
to another provider. Besides this                        insurance company, and the maintenance of        contracted out to another entity (be it an
Illustration, however, HUD has not                       records relating to the policy and policy-       independent third party, a creator, an
addressed arrangements that perform                      holder. In essence, the agent does all of the    owner, or a participant in a joint
some, but not all of the settlement                      work that a branch office of the title           venture), HUD has looked at whether
service functions it purports to provide.                insurance company would otherwise have to
                                                                                                          the contracting party receives payments
   RESPA’s earliest legislative history                                                                   from the new entity at less than the
shows that Congress tried to address                     Id. at 8 (emphasis added). Thus, the             reasonable value of the services
whether a payment is for services                        Report shows that Congress anticipated           rendered. If so, then the difference
actually performed or is a disguised                     that reasonable payments could be paid           between the payments made to the
referral fee. See H.R. Rep. No. 1177, 93d                to entities that perform ‘‘all of the work’’     contracting party and the reasonable
                                                         normally associated with the settlement          value of the services rendered may be
   2 Illustration 10. Facts: A is a real estate broker
                                                         service being provided.                          seen as a disguised referral fee in
who refers business to its affiliate title company B.      The legislative history for the
A makes all required written disclosures to the                                                           violation of Section 8. 24 CFR
homebuyer of the arrangement and estimated               controlled business arrangement                  3500.14(g)(2).
charges and the homebuyer is not required to use         provides guidance for cases in which a
B. B refers or contracts out business to C who does      new entity does not perform ‘‘all of the         Statement of Policy—1996–2
all the title work and splits the fee with B. B passes
its fee to A in the form of dividends, a return on
                                                         work’’ that would otherwise need to be              To give guidance to interested
ownership interest.                                      performed by a fully functioning service         members of the public on the
   Comments: The relationship between A and B is         provider. The testimony of officials of          application of RESPA and its
a controlled business arrangement. However, the          existing affiliated companies at                 implementing regulations to these
controlled business arrangement exemption does           Congressional hearings in 1981
not provide exemption between a controlled entity,
                                                                                                          issues, the Secretary, pursuant to
B, and a third party, C. Here, B is a mere ‘‘shell’’     provided an analysis of companies that           Section 19(a) of RESPA and 24 CFR
and provides no substantive services for its portion     do little substantive work. Real Estate          3500.4(a)(1)(ii), hereby issues the
of the fee. The arrangement between B and C would        Settlement Procedures Act—Controlled             following Statement of Policy.
be in violation of Section 8(a) and (b). Even if B had
an affiliate relationship with C, the required
                                                         Business: Hearings Before the                       Congress did not intend for the
exemption criteria have not been met and the             Subcomm. on Housing and Community                controlled business arrangement
relationship would be subject to Section 8.              Development of the House Comm. on                (‘‘CBA’’) amendment to be used to
29262          Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

promote referral fee payments through        the new entity for the parent provider          § 2607(c)(4)(A–C). Issues may arise
sham arrangements or shell entities.         making the referrals?                           concerning whether the consumer
H.R. Rep. 123, 98th Cong., 1st Sess. 76         (4) Does the new entity have an office       received a written disclosure concerning
(1983). The CBA definition addresses         for business which is separate from one         the nature of the relationship and an
associations between providers of            of the parent providers? If the new             estimate of the controlled entity’s
settlement services. 12 U.S.C. 2602(7).      entity is located at the same business          charges at the time of the referral. 12
In order to come within the CBA              address as one of the parent providers,         U.S.C. § 2607(c)(4)(A); 24 CFR
exception, the entity receiving the          does the new entity pay a general               3500.15(b)(1). Other issues may arise
referrals of settlement service business     market value rent for the facilities            concerning whether the referring party
must be a ‘‘provider’’ of settlement         actually furnished?                             is requiring the consumer to use the
service business. If the entity is not a        (5) Is the new entity providing              controlled entity. 12 U.S.C.
bona fide provider of settlement             substantial services, i.e., the essential       § 2607(c)(4)(B); 24 CFR 3500.15(b)(2).
services, then the arrangement does not      functions of the real estate settlement            Still another area that may arise
meet the definition of a CBA. If an          service, for which the entity receives a        concerns the third condition of the CBA
arrangement does not meet the                fee? Does it incur the risks and receive        exception, whether the only thing of
definition of a CBA, it cannot qualify for   the rewards of any comparable                   value that comes from the arrangement,
the CBA exception, even if the three         enterprise operating in the market              other than permissible payments for
conditions of Section 8(c) are otherwise     place?                                          services rendered, is a return on
met. 12 U.S.C. 2607(c)(4)(A–C).                 (6) Does the new entity perform all of       ownership interest or franchise
Therefore, subsequent compliance with        the substantial services itself? Or does it     relationship. 12 U.S.C. § 2607(c)(4)(C);
the CBA conditions concerning                contract out part of the work? If so, how       24 CFR 3500.15(b)(3). Section
disclosure, non-required use and             much of the work is contracted out?             3500.15(b)(3)(ii) of the regulations
                                                (7) If the new entity contracts out
payments from the arrangement that are                                                       provides that a return on ownership
                                             some of its essential functions, does it
a return on ownership interest, will not                                                     interest does not include payments that
                                             contract services from an independent
exempt payments that flow through an                                                         vary by the amount of actual, estimated
                                             third party? Or are the services
entity that is not a provider of                                                             or anticipated referrals or payments
                                             contracted from a parent, affiliated
settlement services.                                                                         based on ownership shares that have
                                             provider or an entity that helped create
   Thus, in RESPA enforcement cases                                                          been adjusted on the basis of previous
                                             the controlled entity? If the new entity
involving a controlled business                                                              referrals. When assessing whether a
                                             contracts out work to a parent, affiliated
arrangement created by two existing                                                          payment is a return on ownership
                                             provider or an entity that helped create
settlement service providers, HUD                                                            interest or a payment for referrals of
                                             it, does the new entity provide any
considers whether the entity receiving                                                       settlement service business, HUD will
                                             functions that are of value to the
referrals of business (regardless of legal                                                   consider the following questions:
                                             settlement process?
structure) is a bona fide provider of           (8) If the new entity contracts out             (1) Has each owner or participant in
settlement services. When assessing          work to another party, is the party             the new entity made an investment of
whether such an entity is a bona fide        performing any contracted services              its own capital, as compared to a ‘‘loan’’
provider of settlement services or is        receiving a payment for services or             from an entity that receives the benefits
merely a sham arrangement used as a          facilities provided that bears a                of referrals?
conduit for referral fee payments, HUD       reasonable relationship to the value of            (2) Have the owners or participants of
balances a number of factors in              the services or goods received? Or is the       the new entity received an ownership or
determining whether a violation exists       contractor providing services or goods at       participant’s interest based on a fair
and whether an enforcement action            a charge such that the new entity is            value contribution? Or is it based on the
under Section 8 is appropriate.              receiving a ‘‘thing of value’’ for referring    expected referrals to be provided by the
Responses to the questions below will        settlement service business to the party        referring owner or participant to a
be considered together in determining        performing the service?                         particular cell or division within the
whether the entity is a bona fide               (9) Is the new entity actively               entity?
settlement service provider. A response      competing in the market place for                  (3) Are the dividends, partnership
to any one question by itself may not be     business? Does the new entity receive or        distributions, or other payments made
determinative of a sham controlled           attempt to obtain business from                 in proportion to the ownership interest
business arrangement. The Department         settlement service providers other than         (proportional to the investment in the
will consider the following factors and      one of the settlement service providers         entity as a whole)? Or does the payment
will weigh them in light of the specific     that created the new entity?                    vary to reflect the amount of business
facts in determining whether an entity          (10) Is the new entity sending               referred to the new entity or a unit of
is a bona fide provider:                     business exclusively to one of the              the new entity?
   (1) Does the new entity have sufficient   settlement service providers that created          (4) Are the ownership interests in the
initial capital and net worth, typical in    it (such as the title application for a title   new entity free from tie-ins to referrals
the industry, to conduct the settlement      policy to a title insurance underwriter         of business? Or have there been any
service business for which it was            or a loan package to a lender)? Or does         adjustments to the ownership interests
created? Or is it undercapitalized to do     the new entity send business to a               in the new entity based on the amount
the work it purports to provide?             number of entities, which may include           of business referred? Responses to these
   (2) Is the new entity staffed with its    one of the providers that created it?           questions may be determinative of
own employees to perform the services           Even if an entity is a bona fide             whether an entity meets the conditions
it provides? Or does the new entity have     provider of settlement services, that           of the CBA exception. If an entity does
‘‘loaned’’ employees of one of the parent    finding does not end the inquiry.               not meet the conditions of the CBA
providers?                                   Questions may still exist as to whether         exception, then any payments given or
   (3) Does the new entity manage its        the entity complies with the three              accepted in the arrangement may be
own business affairs? Or is an entity that   conditions of the controlled business           subject to further analysis under Section
helped create the new entity running         arrangement exception. 12 U.S.C.                8(a) and (b). 12 U.S.C. § 2607(a) and (b).
                Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations                                          29263

  Some examples of how HUD will use              company for the real estate broker. It also           HUD Analysis. After reviewing all of
these factors in an analysis of specific         manages the new company, which is staffed          the factors, HUD would consider this an
circumstances are provided below.                by its former employees that continue to do        example of an entity which is a bona
                                                 their former work. As in the previous              fide provider of settlement service
   Examples:                                     example, the new company also contracts
   1. An existing real estate broker and an      back certain of the core title agent services
                                                                                                    business rather than a sham
existing title insurance company form a joint    from the title insurance company that created      arrangement. The new entity would
venture title agency. Each participant in the    it, including the examination and                  appear to have sufficient capital to
joint venture contributes $1000 towards the      determination of insurability of title, and        perform the services of a mortgage
creation of the joint venture title agency,      preparation of the title insurance                 broker. The participant’s interests
which will be an exclusive agent for the title   commitment. The title insurance company            appear to be based on a fair value
insurance company. The title insurance           charges the new company less that its costs        contribution and free from tie-ins to
company enters a service agreement with the      for these services. The new company’s
joint venture to provide title search,                                                              referrals of business. The new entity has
                                                 employees conduct the closings and issue           its own staff and manages its own
examination and title commitment                 only policies of title insurance on behalf of
preparation work at a charge lower than its      the title insurance company that created it.
                                                                                                    business. While it shares a business
cost. It also provides the management for the                                                       address with the real estate broker
joint venture. The joint venture is located in      HUD Analysis. As was the case in the            participant, it pays a fair market rent for
the title insurance company’s office space.      first example, HUD would not consider              that space. It provides substantial
One employee of the title insurance company      the new entity to be a bona fide                   mortgage brokerage services. Even
is ‘‘leased’’ to the joint venture to handle     settlement service provider. The legal             though the joint venture may contract
closings and prepare policies. That employee     structure of the new entity is irrelevant.         out some processing overflow to its
continues to do the same work she did for        The new company does little real work
the title insurance company. The real estate                                                        lender participant, this work does not
                                                 and contracts back a substantial part of           represent a substantial portion of the
broker participant is the joint venture’s sole
source of business referrals. Profits of the     the core work to the title insurance               mortgage brokerage services provided by
joint venture are divided equally between the    company that set it up. Further, the               the joint venture. Moreover, the joint
real estate broker and title insurance           employees of the new company                       venture pays all third party providers a
company.                                         continue to do the work they previously            similar fee for similar processing
   HUD Analysis. After reviewing all of          did for the title insurance company                services.
the factors, HUD would consider this an          which also continues to manage the
                                                                                                       While the real estate broker
example of an entity which is not a              employees. The new entity is not
                                                                                                    participant is the sole source of referrals
bona fide provider of settlement service         competing for business in the market
                                                                                                    to the venture, the venture only sends
business. As such, the payments flowing          place. All of the referrals of business to
                                                                                                    a small percent of its loan business to
through the arrangement are not exempt           the new entity come from the real estate
                                                                                                    the lender participant. The joint venture
under Section 8(c)(4) and would be               broker owner. The creating title
                                                                                                    mortgage broker is thus actively
subject to further analysis under Section        insurance company provides the bulk of
                                                                                                    referring loan business to lenders other
8. In looking at the amount of                   the title work. On balance HUD would
                                                                                                    than its lender participant. Since the
capitalization used to create the                consider these factors and find that the
                                                                                                    real estate broker provides the CBA
settlement service business, it appears          new entity is not a bona fide title agent,
                                                                                                    disclosure and does not require the use
that the entity is undercapitalized to           and the payments flowing through the
                                                                                                    of the mortgage broker and the only
perform the work of a full service title         arrangement are not exempt under
                                                                                                    return to the participants is based on the
agency. In this example, although there          Section 8(c)(4) and would be subject to
                                                                                                    profits of the venture and not reflective
is an equal contribution of capital, the         further analysis under Section 8.
                                                                                                    of referrals made to the venture, it meets
title insurance company is providing                3. A lender and a real estate broker form       the CBA exemption requirements. HUD
much of the title insurance work, office         a joint venture mortgage broker. The real          would consider this a bona fide
space and management oversight for the           estate broker participant in the joint venture
                                                                                                    controlled business arrangement.
venture to operate. Although the                 does not require its prospective home buyers
                                                 to use the new entity and it provides the             4. A real estate brokerage company decides
venture has an employee, the employee            required CBA disclosures at the time of the        that it wishes to expand its operations into
is leased from and continues to be               referral. The real estate broker participant is    the title insurance business. Based on a fair
supervised by the title insurance                the sole source of the joint venture’s             value contribution, it purchases from a title
company. This new entity receives all            business. The lender and real estate broker        insurance company a 50 percent ownership
the referrals of business from the real          each contributes an equal amount of capital        interest in an existing full service title agency
estate broker participant and does not           towards the joint venture, which represents        that does business in its area. The title
compete for business in the market               a sufficient initial capital investment and        agency is liable for the core title services it
place. The venture provides a few of the         which is typical in the industry. The new          provides, which includes conducting the title
essential functions of a title agent, but        entity, using its own employees, prepares          searches, evaluating the title search to
                                                 loan applications and performs all other           determine the insurability of title, clearing
it contracts many of the core title agent        functions of a mortgage broker. On a few           underwriting objections, preparing title
functions to the title insurance                 occasions, to accommodate surges in                commitments, conducting the closing, and
company. In addition, the title                  business, the new entity contracts out some        issuing the title policy. The agent is an
insurance company provides the search,           of the loan processing work to third party         exclusive title agent for its title insurance
examination and title commitment work            providers, including the lender participant in     company owner. Under the new ownership,
at less than its cost, so it may be seen         the joint venture. In these cases, the new         the real estate brokerage company does not
as providing a ‘‘thing of value’’ to the         entity pays all third party providers a similar    require its prospective home buyers to use its
referring title agent, which is passed on        fee, which is reasonably related to the            title agency. The brokerage has its real estate
to the real estate broker participant in a       processing work performed. The new entity          agents provide the required CBA disclosures
                                                 manages its own business affairs. It rents         when the home buyer is referred to the
return on ownership.                             space in the real estate participant’s office at   affiliated title insurance agency. The real
  2. A title insurance company solicits a real   the general market rate. The new entity            estate brokerage company is not the sole
estate broker to create a company wholly         submits loan applications to numerous              source of the title agency’s business. The real
owned by the broker to act as its title agent.   lenders and only a small percent goes to the       estate brokerage company receives a return
The title insurance company sets up the new      lender participant in the joint venture.           on ownership in proportion to its 50%
29264           Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

ownership interest and unrelated to referrals    payment structure with ownership in           and Urban Development, 451 Seventh
of business.                                     separate ‘‘divisions’’ is a method in         Street, SW, Washington, DC 20410.
   HUD Analysis. A review of the factors         which ownership returns or ownership
                                                                                               SUPPLEMENTARY INFORMATION:
reflects an arrangement involving a              shares vary based on referrals made and
bona fide provider of settlement                 not on the amount contributed to the          General Background
services. In this example, the real estate       capitalization of the company. In cases         Section 8 (a) of the Real Estate
brokerage company is not the sole                where the percent of ownership interest       Settlement Procedures Act (RESPA)
source of referrals to the title agency.         or the amount of payment varies by the        prohibits any person from giving or
However, the title agency continues its          amount of business the real estate agent      accepting any fee, kickback, or thing of
exclusive agency arrangement with the            or broker refers, such payments are not       value for the referral of settlement
title insurance company owner. While             bona fide returns on ownership interest,      service business involving a federally
this last factor initially may raise a           but instead, are an indirect method of        related mortgage loan. 12 U.S.C. 2607(a).
question as to why other title insurance         paying a kickback based on the amount         Congress specifically stated it intended
companies are not used for title                 of business referred. 24 CFR                  to eliminate kickbacks and referral fees
insurance policies, upon review there            3500.15(b)(3).                                that tend to increase unnecessarily the
appears to be nothing impermissible                Authority: 12 U.S.C. 2617; 42 U.S.C.        costs of settlement services. 12 U.S.C.
about these referrals of title business          3535(d).                                      2601(b)(2).
from the title agency to the title                 Dated: May 31, 1996.                          Since July 1993, the Department has
insurance company.                               Nicolas P. Retsinas,
                                                                                               been seeking comments and advice
   This example involves the purchase                                                          concerning the final rule of November 2,
                                                 Assistant Secretary for Housing-Federal
of stock in an existing full service                                                           1992, implementing Section 8 of
                                                 Housing Commissioner.
provider. In such a situation, HUD                                                             RESPA. On July 21, 1994, the
                                                 [FR Doc. 96–14331 Filed 6–6–96; 8:45 am]
would carefully examine the investment                                                         Department published a new proposed
                                                 BILLING CODE 4210–27–P
made by the real estate brokerage                                                              rule on certain Section 8 issues.
company. In this example, the real                                                             Simultaneously with the issuance of
estate brokerage company pays a fair                                                           this Statement of Policy, HUD is
                                                 24 CFR Part 3500
value contribution for its ownership                                                           publishing a final rule in that
share and receives a return on its               [Docket No. FR–3638–N–05]                     rulemaking. As part of that rulemaking
investment that is not based on referrals                                                      process, the Department received
of business. Since the real estate               Office of the Assistant Secretary for         comments concerning the application of
brokerage provides the CBA disclosure,           Housing-Federal Housing                       Section 8 of RESPA to the rental of
does not require the use of the title            Commissioner; Real Estate Settlement          office space, lock-outs and retaliation in
agency and the only return to the                Procedures Act (RESPA); Statement of          connection with real estate brokerage
brokerage is based on the profits of the         Policy 1996–3, Rental of Office Space,        office practices. In addition, the
agency and not reflective of referrals           Lock-outs, and Retaliation                    Department’s enforcement officials have
made, the arrangement meets the CBA              AGENCY:  Office of the Assistant              received numerous complaints dealing
exemption requirements. HUD would                Secretary for Housing-Federal Housing         with these same issues.
consider this a bona fide controlled             Commissioner, HUD.                            Rental of Office Space
business arrangement.                            ACTION: Statement of Policy 1996–3,              In the last few years, the Department
   5. A mortgage banker sets up a limited        Rental of Office Space, Lock-outs, and        has received numerous complaints
liability mortgage brokerage company. The        Retaliation.                                  alleging that certain settlement service
mortgage banker sells shares in divisions of
the limited liability company to real estate
                                                                                               providers, particularly lenders, are
                                                 SUMMARY:   This statement sets forth the
brokers and real estate agents. For $500 each,                                                 leasing desks or office space in real
                                                 Department’s interpretation of Section 8
the real estate brokers and agents may                                                         estate brokerage offices at higher than
                                                 of the Real Estate Settlement Procedures
purchase separate ‘‘divisions’’ within the                                                     market rate in exchange for referrals of
                                                 Act (RESPA) and its implementing
limited liability mortgage brokerage company                                                   business. In HUD’s rulemaking docket,
to which they refer customers for loans. In      regulations with regard to the rental of
                                                                                               number R–94–1725 (FR–3638), many
later years ownership may vary by the            office space, lock-outs and retaliation. It
                                                                                               commenters argued that HUD should
amount of referrals made by a real estate        is published to give guidance and to          scrutinize this rental practice. The
broker or agent in the previous year. Under      inform interested members of the public       concern expressed is that real estate
this structure, the ownership distributions      of the Department’s position on               brokers charge, and settlement service
are based on the business each real estate       enforcement of this section of the law.
broker or real estate agent refers to his/her                                                  providers pay, high rent payments for
                                                 FOR FURTHER INFORMATION CONTACT:              the desk or office space to disguise
division and not on the basis of their capital
contribution to the entity as a whole. The       David R. Williamson, Director of the          kickbacks to the real estate broker for
limited liability mortgage brokerage company     Office of Consumer and Regulatory             the referral of business to the settlement
provides all the substantial services of a       Affairs, Room 5241, telephone: (202)          service provider. In this Statement of
mortgage broker. It does not contract out any    708–4560. For legal enforcement               Policy, the Department sets forth how it
processing to its mortgage banker owner. It      questions, Peter Race, Assistant General      distinguishes legitimate payments for
sends loan packages to its mortgage banker       Counsel for Program Compliance, or            rentals from payments that are for the
owner as well as other lenders.                  Rebecca J. Holtz, Attorney, Room 9253,        referral of business in violation of
   HUD analysis. Although HUD would              telephone: (202) 708–4184. (The               Section 8.
consider the mortgage brokerage                  telephone numbers are not toll-free.) For
company to be a bona fide provider of            hearing- and speech-impaired persons,         Lock-outs
mortgage brokerage services, this                this number may be accessed via TTY             The Department also received
example illustrates an arrangement that          (text telephone) by calling the Federal       comments and complaints alleging that
fails to meet the third condition of the         Information Relay Service at 1–800–           settlement service providers were being
CBA exception. 12 U.S.C. 2607(c)(4)(C).          877–8339. The address for the above-          excluded from, or locked-out of, places
Here, the capitalization, ownership and          listed persons is: Department of Housing      of business where they might find

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