[Federal Register Volume 59, Number 139 (Thursday, July 21, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-17598] [[Page Unknown]] [Federal Register: July 21, 1994] _______________________________________________________________________ Part V Department of Housing and Urban Development _______________________________________________________________________ Office of the Assistant Secretary _______________________________________________________________________ 24 CFR Part 3500 Real Estate Settlement Procedures Act; Amendments to Regulation X; Proposed Rule ======================================================================= ----------------------------------------------------------------------- DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT Office of the Assistant Secretary for Housing-Federal Housing Commissioner 24 CFR Part 3500 [Docket No. R-94-1725; FR-3638-P-01] RIN 2502-AG26 Amendments to Regulation X, the Real Estate Settlement Procedures Act Regulation (1994 Revisions) AGENCY: Office of the Assistant Secretary for Housing-Federal Housing Commissioner, HUD. ACTION: Proposed rule. ----------------------------------------------------------------------- SUMMARY: The Department of Housing and Urban Development is proposing to revise Regulation X, the regulation implementing the Real Estate Settlement Procedures Act (RESPA), as amended to extend its coverage to subordinate liens and for other purposes and to make technical corrections. This proposed rule addresses referral payments, computer loan origination services, and controlled business disclosure requirements, and is intended to protect consumer interests while recognizing the potential benefits of technological and business arrangement innovations relating to these areas. DATES: Comment due date: September 19, 1994. During this comment period owners and operators of computerized loan origination systems (CLOs) are also invited to participate in a Technology Demonstration of Computerized Loan Origination Systems, to be sponsored by the Department and held in Washington, DC, on September 26, 1994, beginning at 9:30 a.m. (EST), as discussed more fully in the preamble under SUPPLEMENTARY INFORMATION. (Requests for participation must be received on or before August 11, 1994, as provided under the ADDRESSES section.) ADDRESSES: Interested persons are invited to submit written comments regarding this rule to the Rules Docket Clerk, Office of General Counsel, Room 10276, Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410-0500. Communications should refer to the above docket number and title. Facsimile (FAX) comments are not acceptable. A copy of each communication submitted will be available for public inspection and copying between 7:30 a.m. and 5:30 p.m weekdays at the above address. To participate in the Technology Demonstration, contact David Williamson, Director, RESPA Enforcement, at (202) 708-4560, or in writing at room 5241, Department of Housing and Urban Development, 7th and D, SW., Washington, DC 20410, or on E-Mail through Internet at [email protected], on or before August 11, 1994. The TDD number for persons who are hearing- or speech-impaired is (202) 708-4594. (The telephone numbers are not toll-free.) FOR FURTHER INFORMATION CONTACT: William Reid, Senior Economist, Office of Policy Development and Research, room 8212, telephone (202) 708- 0421. The TDD number for persons who are hearing- or speech-impaired is (202) 708-0770. For legal questions, Grant E. Mitchell, Senior Attorney for RESPA, room 10252, telephone (202) 708-1552; or Kenneth A. Markison, Assistant General Counsel for GSE/RESPA, room 10252, telephone (202) 708-3137. The address for all the above-listed persons is: Department of Housing and Urban Development, 451 Seventh Street, SW., Washington, DC 20410. (The telephone numbers are not toll-free.) SUPPLEMENTARY INFORMATION Paperwork Reduction Act Statement The information collection requirements regarding controlled business disclosures and the CLO disclosures (appendices D and E of this rule) have been approved by the Office of Management and Budget, under section 3504(h) of the Paperwork Reduction Act of 1980 (44 U.S.C. 3501-3520), and assigned OMB control number 2502-0265. I. Technology Demonstration The purpose of the Technology Demonstration (see additional information under the headings DATES and ADDRESSES, above) is to provide owners and operators of computer loan origination systems (CLOs) with an opportunity to demonstrate or discuss the operation and benefits of their systems and the impact of the proposed rule on their systems, and to provide consumer groups, industry organizations, and members of the public with an opportunity to witness such presentations or demonstrations. As discussed more fully below, this rule proposes to modify the application of the current Regulation X to CLOs. Information gained by the Department from the Technology Demonstration may be used in developing a final rule. Owners and operators are invited to notify the Department of their interest in participating in this Technology Demonstration. Participants will be free to make visual or conceptual presentations without including actual use of computer loan origination systems. Based upon the number of interested parties and other practical considerations, the Department will determine the format, timing, and logistical arrangements for the Technology Demonstration. To the extent feasible, the Department will provide electrical and telephonic hook-ups for participants. The Department reserves the option of limiting the length of presentations, or setting any other guidelines for participation, in accordance with the number of participants. II. Background On November 2, 1992, HUD published a revised Real Estate Settlement Procedures Act of 1974 (12 U.S.C. 2601 et seq.) (RESPA) rule (hereinafter ``final rule'' or ``1992 final rule''), which became effective on December 2, 1992, and was amended on February 10, 1994 (59 FR 6505). Technical corrections were published on March 30, 1994 (59 FR 14748). The final rule contained long-awaited provisions implementing amendments to RESPA regarding controlled businesses. These amendments were originally enacted in 1983 as section 461 of the Housing and Urban-Rural Recovery Act (HURRA), Pub. L. 98-181. The final rule also updated the original RESPA rule, which had not been amended since 1976. On October 28, 1992, a few days before publication of the final rule in the Federal Register, then-President Bush signed the Housing and Community Development Act of 1992 (Pub. L. 202-550) (1992 Act), which amended RESPA to state specifically that the making of a mortgage loan was a covered transaction (a Federal court case had created uncertainty) and that refinancing transactions were transactions covered by RESPA. The 1992 Act also extended RESPA's coverage to all subordinate liens involving 1- to 4-family residential property. Implementing provisions, along with revisions of the final rule, are set forth in the Federal Register of February 10, 1994, and are effective on August 9, 1994. The effect of the statutory and regulatory changes was to expand substantially the coverage of this criminal and civil statute. Following issuance of the final rule, two lawsuits were filed: one by the Mortgage Bankers Association and one by a group of independent service providers, called CRISIS. Both suits objected to provisions of the final rule and alleged that HUD had not complied with the Administrative Procedure Act (5 U.S.C. 551 et seq.) in promulgating the November 2, 1992, rule. The cases have been dismissed, but are subject to being reinstituted at any time. Upon assuming office, HUD officials in the new Administration were inundated with comments--mostly complaints--about the final rule issued in the last days of the previous Administration. Notably absent from the interests contacting HUD about the final rule were any representatives of consumer interests. Instead, comments came almost entirely from the affected industries. Some industry representatives argued that the provisions of the final rule benefited consumers, while others argued that the provisions, sometimes the same provisions, were harmful to consumers. The Department also received allegations that the final rule created uncertainty about whether referral fees were in fact prohibited by RESPA. Specifically, some commenters claimed that the introduction in the final rule of an employer-employee exemption from the prohibition on referral fees prompted some persons to set up sham employer-employee relationships to shield prohibited referral fees, and prompted others to ``extort'' referral fees from other settlement service providers on the premise that HUD now allowed such compensation. The final rule did not authorize such practices; however, some commenters argued that the existence of confusion about whether it did suggested that the final rule failed to establish a bright line, comprehensible to industry participants, between permissible and impermissible activities. Given the controversy over the final rule, the Secretary determined that a review of the previous policies was needed, particularly focusing on the final rule's impact on consumers. The Secretary also articulated three principles to guide that review: (1) HUD's responsibility is to protect the consumer--not to mediate among industry interests. (2) HUD should regulate multibillion dollar industries responsibly--principally by acting quickly to end uncertainty. (3) Technological and business arrangement innovations have the potential to provide significant consumer benefits, and HUD does not serve consumers well if its regulations unduly stifle such advancements. On July 6, 1993, in an effort to ensure that the new Administration heard the views of all interested parties, the Department published a ``notice of written comment period and informal public hearing'' (58 FR 38176), inviting testimony and written comments on the impact on consumers of the following four provisions of the final rule: Issue 1 Section 3500.14(g)(2)(ii), which provides that RESPA Section 8 does not prohibit ``an employer's payment to its own employees for any referral activities * * *.'' (Hereafter, this issue is referred to as the ``employer-employee exemption'' or ``Issue 1''.) Issue 2 Section 3500.14(g)(2)(iii), which provides that Section 8 of RESPA does not prohibit ``any payment by a borrower for computer loan origination services, as long as the disclosure set forth in Appendix E of [the final rule] is provided the borrower.'' (Hereafter, this issue is referred to as the ``computer loan origination (CLO) exemption'' or ``Issue 2''.) Issue 3 Section 3500.13(b)(2), which provides that ``in determining whether provisions of State law or regulations concerning controlled business arrangements are inconsistent with RESPA or this part, the Secretary may not construe those provisions that impose more stringent limitations on controlled business arrangements as inconsistent with RESPA, as long as they give more protection to consumers and/or competition.'' (Hereafter, this issue is referred to as ``preemption policy'' or ``Issue 3''.) Issue 4 Section 3500.15(b)(1), which provides for a ``written disclosure in controlled business situations, in the format of the Controlled Business Arrangement Disclosure Statement set forth in appendix D of this part'' of certain information regarding the ownership and financial relationships between referring and referred-to parties, and for certain timing and other methods for disclosure. (Hereafter, this issue is referred to as ``controlled business disclosure policy'' or ``Issue 4''.) At a public hearing held on August 6, 1993, at the General Services Administration (GSA) Auditorium in Washington, DC, all 36 parties who had requested to testify did so. Twenty-two witnesses opposed provisions of the rule and 14 witnesses supported provisions of the rule. The Department also received 1,553 written comments.\1\ Of the 1,526 comments reviewed, 1,148 comments opposing provisions of the final rule were received from mortgage lenders, or State or regional organizations representing mortgage lending professionals; consumer organizations; 3 Federal agencies; and, in both combined comments and separately, several State Attorneys General. An additional 325 critical comments were received from law firms and title insurance companies. Twenty-four comments were wholly or generally supportive of the final rule, including comments from individuals and organizations in real estate-related industries, lenders or title insurance providers, real estate brokers, a builder, and the Federal Reserve Board. The remainder of the comments were not characterized. --------------------------------------------------------------------------- \1\A total of 1,553 comments were officially logged in by the Department's Rules Docket Clerk. More than two dozen were duplicates, leaving 1,526 unduplicated comments. --------------------------------------------------------------------------- III. The Secretary's Position: A Brief Summary Based on a complete review of the substantive arguments in support of and in opposition to the final rule provided in the testimony at the August 6, 1993, hearing; the written comments received; and a review of the RESPA statute, its purpose, and its history, the Department reached certain conclusions about its policy objectives on Issues 1-4, set forth above. The Department therefore proposes to amend the final rule as described below. Recognizing the rapid evolution of technology and business practices, the Department believes that development of the final rule will require additional collateral information about how certain details of this proposal will work in practice and whether these details will further the Department's policy objectives. Therefore, the Department has developed a series of questions about specific aspects of the proposal and asks commenters to offer any information they may have about how the rules would work. These questions are detailed throughout this preamble. The following are the Department's policy objectives in addressing each issue and the Department's conclusions as set forth in the proposed rule: A. Issue 1: The Employer-Employee Exemption (1) HUD's objective. Controlled business arrangements and so-called ``one-stop shopping'' may offer consumers significant benefits including reducing time, complexity, and costs associated with settlements. If they do, the market should produce incentives for the creation of controlled business arrangements without HUD authorizing incentive payments (otherwise impermissible under RESPA) to encourage these arrangements. However, HUD cannot scrutinize every aspect of the financial relationship between interrelated companies. Therefore, HUD's objective is primarily to prohibit compensation for business development for related entities at a point when that compensation has the greatest potential for overwhelming the other considerations that go into business referrals, e.g., long-term customer satisfaction. (2) HUD Proposal. (a) The exemption under the final rule permitting employers to pay their own employees referral fees is proposed to be withdrawn. Under this proposal, no employee of a company may be paid referral fees, even for referrals to an affiliate company. This proposal is based on the Department's view that the exemption under the final rule was too expansive and compromised the statute's purpose of protecting the consumer from being referred for settlement services based on financial gain to the referrer, rather than on the highest quality and best price of the services. (b) In the interest of avoiding undue interference with the internal operations of controlled businesses, which Congress has concluded are permitted business arrangements under RESPA, the proposed rule would allow the payment of bonuses and compensation to managerial employees in controlled businesses for such purposes as the generation of business among affiliates; provided, however, that the compensation: (i) Is not tied on a one-to-one basis or calculated as a multiple of the number or value of any referrals; and (ii) these employees do not routinely deal with the public. B. Issue 2. Computerized Loan Origination Systems (1) HUD's Objective. The comments and witnesses at the public hearing demonstrated that there is some confusion concerning the scope of the Department's authority under RESPA to regulate CLOs. Thus, the Department's first objective in this area is to clarify what the RESPA rules can and cannot do. (See section below describing the legal framework for analysis of payments for CLO services.) In addition, the Secretary wishes to encourage the exploration and use of new technology, especially when the new technology may provide information and services to better inform consumers about one of the largest and most complex financial transactions in their lives, thus allowing the consumers to be more effective shoppers. However, the use of that technology does not justify increasing the cost of mortgage loan originations when the technology does not provide meaningful information otherwise available without charge, or when there is no additional convenience, clarity, or other benefit. (2) HUD Proposal. The final rule would be amended to define a CLO and to provide that payments made by borrowers to CLO operators for use of a qualified CLO are exempt from RESPA scrutiny. The definition would set forth reasonable requirements for qualified CLO systems for access, lender-neutrality, and disclosure to consumers. Systems that fall outside the exemption would have to meet the basic test of Section 8 of RESPA that the borrower's payments be for goods or facilities actually furnished or for services actually performed. C. Issue 3: Preemption There are no proposed changes to the preemption provisions. The Secretary has concluded that change to these provisions is not warranted at this time. D. Issue 4: Controlled Business Disclosure Form The rule would be amended to add an acknowledgement provision on the controlled business disclosure form and to make other small revisions. IV. Discussion of Comments A. Commenters Opposing the 1992 Revised RESPA Rule The following summarizes the nature of the commenters and comments opposing and supporting provisions on which HUD invited comment in its July 6, 1993, notice (58 FR 38176), as well as the positions taken in this proposed rule. In general, commenters were responsive to the notice's invitation and focused their remarks on the four identified provisions of the rule. A few comments raised other issues concerning the final rule, but the focus of the hearing and request for comments was the four specific areas listed. This proposed rule deals only with the four issues on which comment was invited. Eleven hundred forty-eight commenters opposed provisions of the final rule. Commenters included mortgage lenders, realtors, and State or regional organizations representing mortgage lending professionals. The Department received an additional 325 comments critical of the rule from law firms and title insurance providers. Opposition was also expressed by six national organizations representing elements of the mortgage finance or title insurance industries, two national consumer organizations, an economist, a legal aid society, a real estate consultant, a law student, and four commenters whose professional interest could not be ascertained. A few national or regional computer service providers also commented on the rule. Finally, 3 Federal agencies--the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision--submitted comments on the final rule, and 4 opposition comments were received from State Attorneys General, including 1 comment representing the unified position of the Attorneys General of 16 States. B. Commenters in Support of the Revised RESPA Rule Comments wholly or generally supportive of the final rule were received from 24 individuals and organizations engaged in real estate- related industries, including 15 lenders or title insurance providers; 6 real estate brokers or agents; an organization composed of controlled businesses, including realtors, which was formed in part to support the final rule (RESPRO); a builder; and the Federal Reserve.\2\ --------------------------------------------------------------------------- \2\Support for portions of the final rule was also expressed in scattered comments received from individuals and businesses writing to criticize other specific features. The only issue receiving an appreciable amount of positive comment from critics of the rule's other features was Issue number 4 of the July 6 notice--the controlled business disclosure form. --------------------------------------------------------------------------- C. Summary of the Comments In the ensuing discussion, arguments presented by the commenters related to these four issues will be summarized under the four issue headings. When commenters have asserted related arguments affecting the disposition of two or more of these issues, those comments will be mentioned in the course of discussing the issue that HUD perceives to be the core argument made by the particular commenter. (1) Issue 1: The Employer-Employee Exception The employer-employee exception provision in Sec. 3500.14(g)(2)(ii) of the final rule--allowing ``an employer's payment to its own employees for any referral activities * * *''--was the subject of more adverse comment than any other issue raised by the July 6, 1993, notice. Hundreds of lenders, attorneys, and settlement agents objected to the rule's provision permitting employer payments to employees for ``referral activities''. Objections were focused, in large part, on what commenters perceived as the anticompetitive effect of permitting referral-based payments. Additionally, the Mortgage Bankers Association, sixteen State attorneys general, and a large number of other institutional and individual commenters saw the referral payment provision as being directly contrary to the RESPA statute, or, at a minimum, as contravening statutory intent. The supporting commenters cited the desirability of vertical integration and the difficulty in enforcing employer-employee arrangements when the employer controlled all of the relevant documentation. (a) ``Anticompetitive'' Arguments Against Referral Payments. The central argument raised by numerous commenters, including the combined comments of attorneys general of several States, was that referral payments were a breach of the trust of prospective home purchasers, particularly in transactions involving real estate agents and affiliated companies: Consumers expect to be treated fairly by their real estate agents and therefore trust that a referral to a settlement service provider is based solely on their agent's knowledge of comparative prices and service features. When there was no financial incentive for the [real estate agent], consumers were justified in thinking that they were referred to a settlement service provider because that provider offered good service at a reasonable price, not because the agent received a payment in exchange for the referral. This is no longer the case. Comments of State Attorneys General Referral payments, commenters repeatedly pointed out, permit vertically integrated real estate companies to provide financial incentives to their employees to make all settlement service referrals to affiliated companies. As a result, settlement service providers tied to a real estate company are ``insulated from competition on prices and services.'' RESPA was adopted, one commenter observed, because of Congress' recognition that the very nature of the real estate transaction is arcane and cumbersome, and that the typical consumer lacks any comparable economic experiences. The Consumers Federation of America (CFA) noted that the consumer has traditionally relied for assistance on the real estate broker (who ordinarily is an agent of the seller)--a person in ``a highly privileged position of influence over the consumer * * *.'' CFA concluded that RESPA evidences congressional recognition that this influence can be easily abused for broker self-gain at the material expense of consumers. The Mortgage Bankers Association (MBA) and other commenters remarked that in the absence of referral fees, real estate agents may be expected to afford good advice to home buyers. The real estate agent has an incentive (the prospect of a sales commission, as well as potential business referrals and repeat business) to send a buyer to a lender offering the best combination of service and price. However, when the person making the referral has another motive--a direct financial interest--it becomes less clear that the agent or broker's referral will be made with the best interests of the home buyer uppermost, the MBA asserted. According to its opponents, the principal consequences of the employer-employee exemption were: (i) Failure to refer home buyers to lenders and other settlement service providers that provide the best service and prices; and (ii) Ultimate reduction or elimination of competition in the industry, brought about by ``unfair competition'' driving out small, independent settlement service providers. CFA echoed the arguments of lenders, attorneys, and title insurance providers who repeatedly asserted that home buyers lacked the experience to be sophisticated consumers: For better or worse, consumers are simply not effective financial services shoppers * * *. Since there is no possibility of one-stop shopping because the consumer is not shopping, the core claim of consumer benefit offered by controlled business arrangement advocates--consumer choice--crumbles under the weight of economic reality * * *. Although shopping may not be occurring, there is, nonetheless, the profound opportunity for `reverse competition' created by a captive market willing to pay higher-than-market prices. What this rule champions is not one-stop shopping, but, rather, one-stop pick- pocketing of the consumer through the multi-layers of a diversified financial services holding company.\3\ --------------------------------------------------------------------------- \3\CFA cited and characterized a report commissioned by HUD from Peat Marwick in 1980 as finding that two-thirds of home buyers included in that sample did no ``shopping'' at all for a lender, and that more than 80 percent failed to ``shop'' for settlement services. Commenters opposed to referral payments were not persuaded by arguments in the 1992 final rule in support of permitting employer- employee referrals. ``What matters,'' one commenter said, ``is not that the payment is going from employer to employee * * * [but] that there is payment for a raw referral, creating the very anti-competitive and anti-consumer financial incentive Section 8 [of RESPA] was intended to eliminate.'' (b) Legal Arguments Against Referral Payments. Many of the same commenters who opposed referral payments on policy or economic grounds also argued that permitting employer-employee payments for referrals directly violated the RESPA statute. CFA, after characterizing the events that led to the Congress' 1983 controlled business arrangement amendments to RESPA, asserted that the Congress' clear intent was to permit controlled business arrangements ``only under certain specific conditions.'' The final rule, CFA claimed, ``grossly exceeds any reasonable interpretation of statutory authority, and * * * has returned the settlement service marketplace--or at least the controlled business arrangement market--to the pre-RESPA era of anti-consumer and anti-competitive brokerage steering.'' MBA and other commenters observed that Section 8(c)(4)(C) of RESPA states that controlled business arrangements are permissible as long as ``the only thing of value that is received from the arrangement, other than payments permitted under this subsection, is a return on the ownership interest or franchise relationship.'' MBA argued that because the final rule permits employees to receive a ``bonus'' when they refer settlement business to affiliates, the rule ``fails to give effect to the plain language of the statute.'' (c) Arguments in Support of the Employer-Employee Exception. Several institutional commenters, along with real estate brokers, lenders, insurance companies, and vertically integrated real estate service providers, expressed support for the employer-employee exception provided for in Sec. 3500.14(g)(2)(ii) of the final rule. The Director of the Consumer and Community Affairs Division of the Federal Reserve System supported the rule's exemption for employer payments to its own employees for referral services, saying that it is a ``legitimate expectation'' that an employee would make referrals for the employer and be compensated for the referrals. Prohibiting payment for referrals, the Federal Reserve spokesperson said, would prove difficult from an enforcement standpoint, since examiners would then be required to review employer bonus and salary policies to determine whether compensation was based on general performance, or whether it included payments for referrals. The Federal Reserve spokesperson also expressed a concern related to the Community Reinvestment Act of 1977 (12 U.S.C. 2901 et seq.) and to the Federal Reserve's efforts to encourage banks to refer business to community-based lenders: * * * A bank may support these efforts by rewarding employees for referring potential applicants who have not previously considered the [Community Reinvestment target] bank an accessible community lender. An adverse interpretation by HUD of this provision could be detrimental to future innovations and developments in community lending. The Real Estate Services Providers Council (RESPRO) pointed out that the November 2, 1992, rule makes clear that employer payments to employees cannot be reimbursed by the party receiving the referral, or that employer payments cannot be made to nonemployees. The Consumer Bankers Association (CBA), although generally supportive of the final rule, urged HUD to go further by expanding the exemption to the referral fee prohibition to allow payment for referrals to employees of affiliated businesses. In the absence of such an expansion, CBA argued, the structure of the institution could determine whether an employee could receive a payment for referrals. CBA urged that the difference in the legal treatment of a referral payment based on the internal structure of a banking organization lacks any policy justification. Other commenters asked for expansion of the employer payments principle to allow entities with common ownership to pay referral fees to affiliated companies. (d) The Proposed Rule's Position on the Employer-Employee Exception. The Department reviewed the extensive history relating to this issue, including the history of the controlled business arrangements amendment to RESPA. In enacting Section 8 of RESPA in 1974, Congress prohibited all fees, kickbacks, or things of value for the referral of settlement service business. The statute, as originally enacted, did not address referrals of business to affiliated companies. In 1980, the case of Coldwell Banker v. Department of Insurance (102 Cal.App.3d 381 (2d. Dist. 1980)) reached the courts. In that case the California Insurance Commissioner refused to grant a license to a wholly owned subsidiary of a real estate company to act as a title insurer. The denial was based on a concept of restriction of trade. This case drew HUD and congressional attention to whether this or similar controlled business arrangements might violate Federal law. On July 24, 1980, HUD issued an Interpretive Rule (subsequently withdrawn) that stated that ``controlled business arrangements may be a violation of Section 8.'' (49 FR 49360; withdrawn on May 18, 1982, 47 FR 21304.). Two days of congressional hearings were held on September 15 and 16, 1981, and, in 1983, Congress enacted the ``controlled business arrangement'' amendment to RESPA. The 1983 controlled business arrangement amendment represented a compromise between those who wanted no restrictions on the ability of real estate settlement service professionals to refer settlement service business to entities with which they had an ownership interest and those who wanted a blanket prohibition against such referrals. The compromise (see H.R. Report 97-532, at page 52) made clear that controlled business arrangements do not violate RESPA--allowing affiliated entities, such as real estate professionals, to refer settlement business to related entities--provided that specified disclosure requirements and safeguards are satisfied, including: (1) A requirement that the relationship between the provider of settlement services and the person making the referral be disclosed, along with the estimated charges of the provider; (2) a bar against the required use of a particular provider, except under certain specified exceptions under Section 8; and (3) a bar against anything of value being received by the referring party, beyond a return on ownership interest or franchise relationship or payments otherwise permissible under Section 8(c) of RESPA. Between the enactment of the 1983 amendments to RESPA and the issuance of the 1992 final rule, HUD had issued several informal legal opinions concerning the extent to which employers could pay referral fees to employees. The opinions made clear that bona fide full-time employees could be compensated for generating business for their own employers, as this would be within the scope of their employment. These opinions also made clear that uncompensated referrals to affiliated companies were not prohibited. These opinions did not, however, broadly approve compensation to all employees for referrals to affiliated companies. In the circumstances addressed by HUD informal opinions prior to the final rule, the permissibility of compensation of employees for referral related activities depended upon the structure of the affiliated companies or on whether the employees were acting within the scope of their employment. The 1992 final rule went beyond any of these previous positions and created an exemption for any and all employer payments to its own employees for referrals of business, including referrals to affiliated companies. The final rule only retained the stricture that the company receiving the settlement business could not directly or indirectly compensate anyone for such business. Although the rule did not limit this exemption to controlled businesses, the exemption has little utility for entities other than affiliated companies, since it is unlikely that an employer would pay its own employees for making referrals to unrelated individuals or companies. The preamble of the final rule set forth the position that payments from an employer for referrals were exempt from Section 8 because a business entity acts through its employees; the action of the employees is not sufficiently distinct from the action of the employer to provide the requisite plurality of actors needed to violate Section 8. Although the rule permitted an employer to compensate its own employees for referrals, it indicated that if the company receiving the referral reimbursed the employer or the referring employees, Section 8 of RESPA would be violated. Entities critical of the 1992 final rule have characterized the provision permitting employers' payments to their own employees for referrals as broadly sanctioning referral payments. Trade and business press have frequently restated this position without examination. Also, the Department's attention has been drawn to a number of advertisements and mailings in which various companies have cited RESPA as authority for bogus or sham programs under which fees may be paid to individuals who will become ``employees.'' While the final rule did not permit sham arrangements, neither did it adequately clarify the extent of the exemption. Following a full consideration of the testimony and comments, the Secretary has concluded that the 1992 final rule's employer-employee exemption was too broad. Accordingly, the Secretary proposes to amend the final rule by withdrawing the exemption set forth in Sec. 3500.14(g)(2)(ii) of that rule. This amendment will have the effect of providing that, while an employer may compensate its own bona fide employees for the generation of its own business, all compensation for referrals to outside entities, including affiliates, will be prohibited under RESPA. In addition to withdrawing the exemption, the proposal clarifies specifically when compensation to employees runs afoul of the requirements of RESPA. The rule provides that: (i) No employee or agent may receive compensation from his or her employer or any other source when the compensation is tied on a one-to- one basis to, or is calculated as a multiple of the number or value of, referrals of business to an affiliated entity; and (ii) The compensation of agents or employees who routinely are in direct contact with the consumer may not be based in whole or in part on the value or number of referrals made to affiliated entities. These two clarifications are designed to minimize any incentive that a person in a position to make or influence a referral might have to make a referral based on his or her own financial interests. Clearly, compensation calculated as a multiple of the number or value of referrals creates a powerful incentive to make referrals that maximize one's own compensation. Similarly, agents or employees who ordinarily are in direct contact with the consumer may be influenced in making referrals if their overall performance is measured and compensation is set, even in part, based on the number or value of referrals to affiliated entities. The proposal makes clear that RESPA prohibits such compensation. By withdrawing the broad exemption, the potential for conflict of interest by those persons making referrals is reduced, increasing the possibility of true competition among settlement service providers based on the cost and quality of the services provided. Most facets of the settlement services business are very competitive, and the Secretary wants to assure that the rule does nothing to harm this competitiveness. The provisions set forth above that would clarify how RESPA affects employee compensation can be enforced and will not require HUD to interfere unduly with the internal operations of controlled business arrangements. Because Congress has clearly ruled on the acceptability, with conditions, of controlled business arrangements, the role of the Department is not to encourage or discourage controlled business arrangements, but to clarify what activities between interrelated companies are permissible or not permissible under RESPA. With the withdrawal of the exemption, employees of controlled business arrangements could continue to send consumers to affiliated companies, but they may be more likely to exercise independent judgment reflecting the interests of the consumer if the inducement of referral- specific compensation is not present. The proposal to withdraw the exemption would obviate the need for a full examination of the question raised by some commenters about whether the exemption in the proposed rule is contrary to the statute, particularly since the Department has decided not to withdraw the employer-employee exemption without notice-and-comment rulemaking. In any event, the Department believes the exemption in the final rule would be legally sustainable, because of the broad exemption authority of the Secretary under Section 19 of RESPA. Pending this proposed rule becoming final, the existing employer- employee exemption remains operational and employer payments made in accordance with the existing RESPA regulation will not be treated by the Department as conduct violative of the RESPA statute. However, the exemption in the existing rule is only available for employees, not independent contractors, a class that, under the Internal Revenue Code, includes most real estate agents and many others in the settlement services business. Those persons engaging in sham practices in an attempt to avoid the strictures of RESPA are not protected under the 1992 final rule during the pendency of these revisions. (e) Questions and comments on this proposal. The Secretary's proposal on the employer-employee issue seeks to clarify RESPA's consumer protections while avoiding unnecessary intrusion into controlled businesses. The Secretary intends to be flexible in finalizing this proposal in pursuit of these objectives. To assist in this rulemaking, the Secretary is particularly interested in comments containing responses to the following questions: (i) To what extent do you believe the Secretary's proposal will accomplish the objectives of eliminating compensated referrals and other payments that pose the greatest dangers to consumers without overwhelming other legitimate considerations for referrals, such as long-term customer satisfaction? (ii) What effect will the proposal have on the ability of firms to provide high-quality and well-priced services to consumers? (iii) To what extent do you believe the proposal will unduly interfere with the operations of controlled businesses? (iv) What would be the effect of any such interference (with the operations of controlled businesses) on consumers? (v) To what extent do you believe this proposal will interfere with legitimate business development programs of affiliated companies? (vi) To what extent do you believe that the proposal will result in increased competition in the settlement services industry? (vii) If you disagree with the approach embodied in the proposal, what alternative approaches would increase competition? (viii) Do you believe that the proposal will adequately protect consumers from steering? (ix) If you do not believe the proposals will provide adequate protection from steering, what alternatives would provide such protection? (x) To what extent do you believe the proposal will lead to cost savings through increased efficiencies in the settlement services industry? (xi) If you disagree that the proposal will lead to cost savings, what alternatives would you suggest to facilitate efficiencies? In promulgating a final rule, the Secretary invites, and will consider, economic and other data submitted on the effect on the settlement services industry and consumers of the Secretary's and other proposals. (2) Issue 2: Computer Loan Origination Services (``CLOs'') (a) Comments Critical of the CLO Provision. The final rule's revision of the RESPA regulations indicated that payment by a borrower for computer loan origination services was not 'prohibited by RESPA or Regulation X. This provision also drew hundreds of adverse comments, as well as support from several commenters responding to the Department's July 6, 1993, notice. Many commenters treated the CLO issue and the issue of referral payments as closely related concerns. Computer loan origination services, these commenters claimed, often are nothing more than thinly disguised arrangements for the referral of settlement services. The commenters argued that both referral payments and superficial or nominal CLO services involve the ``steering'' of homebuyers to a limited choice of service providers. A number of these commenters indicated their belief that simple disclosure of the fact that a fee is being charged affords inadequate protection against these dangers. The Consumer Federation of America (CFA) entered vigorous objections to the borrower fee authorized by the final rule. ``If there is economic value to the adoption of electronic loan origination technology, CFA believes that the marketplace will, on its own, adopt it. There is no reason why the consumer should foot the bill for the industry's capital investment.'' The CFA asserted that the RESPA statute was ``suspicious'' of fees for services of unknown or questionable value, and it objected to any ``sanctioned levy against consumers for CLO services.'' Several commenters expressed their confusion concerning a CLO- related question posed to the public in the July 6, 1993, notice. The question presented was whether further clarifications or additional conditions regarding CLOs are needed or would be desirable to protect consumers, particularly if any payment for the CLO service comes directly or indirectly from a lender. (Emphasis supplied.) Some commenters addressing this issue said they had assumed that the final rule only permitted ``customer-pay'' systems. If lender-pay systems are permissible, these commenters claimed, a major new problem is presented. Lender-pay systems are especially dangerous, the commenters declared, because the broker's financial gain and incentive to steer may be totally hidden. A significant minority of the commenters (including many who otherwise opposed features of the final rule) believe that CLO services are the wave of the future and that computer-based systems promise real benefit to prospective homebuyers. These commenters, however, joined with other critics of the CLO provision in questioning the legitimacy of linking CLO systems to referral fee arrangements. Others commenters objected to the final rule's failure to assure universal access to CLOs by lenders doing business in a particular location. Hundreds of comments--predominantly from lenders and related settlement service providers--urged that a comprehensive, limiting definition of CLO services be added to the rule. A commenter representing an automated service provider expressed his fear that CLOs operated by real estate brokers and agents could be used to ``display financial information [about other lenders] inferior to what [the broker's affiliate] is offering, and charge the borrower for doing it; then use the CLO fee collected for payment of `employee compensation' to guide the buyer to the broker-owned title company, closing service, insurance agency, home warranty company, and pest control company. The referral fee will not come from the normal real estate commission, but instead each service generates sufficient income to pay a referral fee to capture the next service, commencing with the CLO fee.'' The commenter further stated: Information provided through technology is not only valuable, but vital given today's complex and sophisticated lending; but, to allow a real estate broker to charge a purchaser for providing this information without having adequate guidelines in place assuring that the consumer will, in fact, receive information that is in the best interest of the consumer * * * is a terrible disservice to the consumer * * *. Commenters on the CLO issue had an array of suggestions for revising the RESPA regulations to limit, expand, or otherwise control the use of homebuyer- or lender-compensated CLO services, and to add suitable definitions of the term ``CLO''. Among these suggestions were: (i) Creating an (unspecified) ``market mechanism'' to keep CLO fees reasonable and closely related to the true value of the service being performed; (ii) Requiring the borrower to pay for CLO services at the time the service is being provided (a number of commenters believed that such a requirement would help assure that the homebuyer would insist on receipt of a ``real'' service, ``rather than unknowingly subsidize a disguised referral fee that is buried at the end of escrow''); (iii) Mandating that a substantial number of lender participants be included in any CLO system, and defining the term ``computer loan origination service'' in such a way as to exclude CLO providers that afford the borrower only limited information; (iv) Requiring CLOs operated by real estate brokers or agents to make special disclosures concerning use of CLO systems, in greater detail than the disclosures set out in Appendix E to 24 CFR part 3500. (A large number of lender-commenters asserted that special disclosure was unnecessary when CLOs are used by lenders, arguing that real estate brokers, ``who may be receiving another fee in the transaction,'' were the only parties for whom CLO-related disclosures should be required.); (v) Cautioning HUD not to permit lenders to pay for CLO services (arguing that any payment coming directly or indirectly from a lender should be subject to the anti-kickback provisions of Section 8 of RESPA). While the 1992 final rule addressed only the issue of fees paid by borrowers, commenters also discussed the issue of fees paid by lenders for inclusion on CLO systems, in response to the invitation for such comments in the July 6, 1993, notice. Most commenters referred to such payments as thinly disguised referral fees. (vi) Requiring disclosure that particular CLO listings provide only partial information about available loans. (A few commenters urged that the CLO fee disclosure form include ``bold print'' disclosing that the same information could be acquired by the prospective homebuyer ``for free'' by shopping on their own.); (vii) Recognizing that CLO services, if performed by a real estate broker or agent for a homebuyer, create a conflict of interest and a ``potentiality for fraud'' for the broker or agent, whose fiduciary duty is to the seller. Unified comments from 16 State Attorneys General asserted that the use of CLOs by real estate agents is analogous to the situation once prevalent in the travel industry: * * * where independent travel agents using computer reservation services steered travelers to whichever airline happened to own the computer system used by the travel agent. Those flights were not always the most convenient or cheapest for the consumer. Private antitrust enforcement actions were required to rein in these practices. The Attorneys General declared that the economic costs of these airline-industry practices are ``trivial compared to the costs to consumers if CLOs are used to steer consumers in large numbers to more expensive mortgages than are readily available [elsewhere] in the market.'' (viii) Suggesting that (in defining a CLO system) HUD require equal access to the system by any lender requesting access; (ix) Urging that fees for CLO services be proscribed because access to lender information has, before, been a free service performed by real estate agents or brokers; thus CLO charges would ``create a new fee for no real [new] value or service provided;'' (x) Arguing that borrower information achieved through the CLO process was near-worthless, because lenders will have to reverify any information provided before underwriting loan applications; and (xi) Requiring that the CLO disclosure (and acknowledgement) occur before the borrower agrees to use computer loan origination services. In addition to these recommendations from multiple commenters, the Mortgage Bankers Association (MBA) recommended specific modifications to Sec. 3500.14(g)(2)(iii): (one) Prohibiting the receipt of compensation for operating a CLO by any person who already receives compensation for the same transaction in another capacity; (two) Defining ``computer loan origination services'' in a manner that would require interactive communication with the computer systems and the listing of multiple lenders upon request and for no charge; and (three) If the first two recommendations are not accepted by HUD, requiring that the CLO fee be both disclosed and paid for before the CLO is accessed. The MBA also urged that the rule set out the principle that the mere performance of ``clerical loan origination activities, most or all of which will have to be repeated by the lender'' does not constitute a service justifying the collection of a fee. (b) Comments Supportive of the CLO Provision. Comments in support of the CLO provision of the rule were varied. In general, these comments urged retention of the final rule's disclosure-based authorization of CLOs and CLO charges to borrowers. However, supporters of the CLO provision and other commenters on the provision expressed considerable sentiment that substantial clarification of the rule was necessary in this area. Several commenters observed that the rule was silent on the question of what disclosure (if any) would be required if the borrower was not charged a fee for access to a CLO service. One commenter ventured that, evidently, the rule's silence on the issue would indicate that no disclosure would be required when, for example, the lender paid CLO-connected fees. While the commenter approved this result, he added that ``further clarification would be welcome.'' The comment recommended that no separate disclosure be required for lender-pay or for ``no charge'' CLO services--even where it was clear that no-fee CLO systems were being paid for out of loan origination fees or lump-sum fees that are charged to lenders and mortgage brokers to process and underwrite mortgage loan applications. In these instances, the commenter maintained, the CLO services were less like traditional settlement services and more like services purchased by a settlement service provider to help it perform its normal functions--``back office'' loan origination services. In general remarks, the same commenter argued that overregulation of CLO services would stifle innovation and competitiveness. It was pointed out that one of the major advantages of CLO services was the expansion of housing opportunity ``into sectors of the U.S. economy not now adequately served by the mortgage lending industry.'' Several commenters suggested that, with the very recent revision of Sec. 3500.14(g)(2)(iii), the Department should not make immediate changes, but should allow the marketplace to develop and experiment with CLOs without additional regulation. However, in a number of instances commenters supportive of the final rule's treatment of CLO services joined opponents in requesting that HUD provide clarifications of the rule that would: (i) Define the term ``computer loan origination services''; (ii) Indicate whether payment for CLO services must come solely from borrowers, or whether lender-paid services are permitted; and (iii) Advise whether there exists an ``implicit limitation'' on the fees that can be paid to CLO providers (such as a reasonable relationship to the market value of the services performed). Other pro-rule commenters joined commenters that had objections to the CLO services provision in supporting an explicit requirement that the CLO fee disclosure statement be given to the borrower before the fee is imposed, and that the fee be paid to the CLO operator before services are performed. ``By requiring upfront disclosure and payment,'' one commenter observed, ``the borrower will be aware that a separate fee is being imposed for services not required by the mortgage lender and will be able to determine whether the services provided by the CLO operator merit such a fee.'' On the subordinate issue of the number of lenders included on CLOs, commenters supporting the CLO provision generally differed with opponents, many of whom urged much closer regulation of this aspect. The pro-CLO services commenters generally advocated ``leaving to the marketplace'' the determination of how many lenders were appropriate for a CLO service. One commenter argued that dictating how many lenders must appear on the CLO system ``is another example of well-intentioned regulation which could ultimately hurt consumers.'' The commenter pointed out that individual lenders may want to develop competing CLO products, each marketing its own software products, with the CLO operator then having access to several single-lender CLOs. The commenter concluded, as did several other supporters of the final rule's CLO services provision, that a consumer provided with full disclosure can determine the services for which the consumer is willing to pay. A few commenters anticipated adverse comment on the CLO systems issue and urged the Department not to bend to those commenters who would impose limitations on fees for CLO services or would require that fees be collected up-front. One commenter whose overall position strongly supported the final rule took a position comparable to many anti-CLO commenters in several respects. To protect consumers this commenter supported the imposition of additional conditions relating to CLO systems, such as: (i) Up-front disclosure of the CLO fee, and payment in advance of the performance of services; and (ii) A regulatory requirement that real estate brokers be required to perform services ``beyond electronically providing a menu of lenders' interest rates and products.'' The same commenter, however, joined other CLO services proponents in urging that HUD should not attempt to regulate the number of lenders to be included in CLOs. One commenter, evidently the operator of a large, independent computer loan origination system, made several points from that perspective: (i) The commenter's independent CLO system avoided ``steering'' abuses because steering arises when lenders offer commissioned loan officers or mortgage brokers a larger commission on some products than on others, thus encouraging lenders to sell a particular type of loan. The commenter's system required uniform charges across loan products and lenders, which are established by contract among participants and monitored by the CLO service provider; (ii) The system encourages competitive loan pricing, by including a wide variety of information affecting the overall cost of a loan to a consumer and making it simple for a loan counselor to find the ``best deal''; (iii) The system increases competition in rural areas, by expanding the number of lenders offering loans; (iv) The system helps to avoid racial and other forms of discrimination against borrowers by making the loan-decision process ``demonstrably race-blind''; (v) The system avoids the criticism that CLO systems are mere ``kickback schemes,'' because the loan counselors working with the system perform full loan-origination functions. This commenter recommended that RESPA be revised to stipulate that real estate brokers may not charge for origination services (implicitly, CLO services) unless they actually register a loan commitment with the lender. ``This assures that the [broker] has at least qualified the borrower, and made a loan selection with the borrower's concurrence. These are non-trivial functions for which a payment is justified,'' the commenter said. The commenter favored this ``functional'' test, as opposed to a regulatory limitation on the number of CLO services provided or a ban on single-lender CLOs. Several comments from real estate brokers stated their support for the CLO services provision of the final rule. Among these, at least two real estate broker commenters assumed that CLO services would involve multiple lenders: [I assume that] all CLOs will offer the rates and costs of many lenders. When lenders realize that they are in competition with other lenders, they will be forced to deliver the best rates at the lowest cost * * *. I can assure you that if a home buyer walks into a lender's office to obtain a loan, there is little chance that lender would send the buyer to a competitor even though the rates and costs may be lower. A second real estate broker described his company's CLO service as having access to an affiliate and 20 competitors, indicating that this variety and choice afforded borrowers with distinct advantages over borrower-initiated loan shopping. (c) Description of the Legal Framework for Analysis of Payments for CLO Services. HUD has found that the use of the term ``CLO exemption'' in the preamble of the 1992 final rule may have created certain misperceptions. To ensure that there is no confusion about the scope of the regulatory exemption proposed below, the Department believes that it will be helpful to set out the legal framework for its analysis of payments for CLO services. In general, the provision of CLO services may be financed by the operator of a CLO system in several ways: (i) The operator could charge lenders to have information about their products displayed on the CLO system; (ii) The operator could charge borrowers to use the CLO system; (iii) The operator could charge both lenders and borrowers; and (iv) The operator could provide the service free of charge to both lenders and borrowers in the belief that providing the service will attract more customers for the operator's related settlement service business. Section 8(a) of RESPA prohibits a lender from paying a CLO operator a referral fee. Section 8(b) of RESPA prohibits a CLO operator from accepting a payment from a borrower ``other than for services actually performed.'' Therefore, in the absence of any regulatory exemption, under RESPA: (one) Payments by a lender to a CLO operator are subject to scrutiny to determine whether the payment is a referral fee or is bona fide compensation for goods or facilities actually furnished or for services actually performed; (two) Payments by a borrower to a CLO operator are subject to scrutiny to determine whether the payment is a sham or duplicative charge, rather than a payment for goods or facilities actually furnished or services actually performed; and (three) When neither borrowers nor lenders pay a fee for the CLO services, only certain disclosures are required. The 1992 final rule created an exemption from Section 8 for ``any payment by a borrower for computer loan origination services,'' as long as certain disclosures were provided (emphasis added). This rule did not address payments made by lenders, thus leaving such payments subject to Section 8 scrutiny. Although the term ``CLO exemption'' is frequently used, including in the preamble of the 1992 final rule, the exemption was not for the CLO itself, but only for payments made for CLO services by borrowers. Many commenters were concerned about whether any system that merely claimed to be a CLO deserved to be given an exemption from RESPA's requirements. As noted in the above statement of HUD's objective, the Department seeks to encourage the use of new technology in ways that provide meaningful information and services to consumers. Uncertainty about how RESPA applies to CLOs may inhibit their development. Therefore, the Department has determined that continuation of such an exemption is justified; however, the Department seeks to limit the exemption only to payments for access to CLO systems that provide meaningful information and services to consumers. Payments for access to systems that provide such benefits will not be subject to scrutiny under Section 8. Accordingly, the Department proposes to amend the 1992 final rule to limit the exemption to payments made by borrowers for services from ``qualified CLOs'' only, and to define qualified CLOs to be those systems that the Department believes provide meaningful information and services to consumers. Payments by borrowers for services of systems other than ``qualified'' CLOs are not prohibited; rather those payments are subject to scrutiny under the Section 8 test articulated above. Similarly, the 1992 final rule did not mention payments made by lenders to CLO operators. However, having proposed to limit the scope of the exemption for borrower payments and certain lender payments, the Department asks commenters to address whether a parallel exemption for payments made by lenders to operators of ``qualified CLOs'' would be in the best interest of consumers. (d) Position of the Proposed Rule on CLOs. Based upon a review of the comments and testimony on this issue, the Secretary concluded that the potential of CLOs to be convenient and provide consumers with meaningful information about their choices justified the encouragement of certain CLOs and the continuation of an exemption for borrower payments for certain CLOs. The Secretary also determined that it is necessary to amend the rule to define the type of CLO for which borrower payments are permitted without further RESPA scrutiny, in order to maximize the potential consumer benefits from this developing technology and protect consumers. Accordingly, the Secretary proposes to amend the rule to provide that payments made by borrowers for qualified CLO services only are exempt, and to define qualified CLOs as those systems meeting the following requirements: (i) Qualified CLOs must be responsive to information about the borrower and provide information regarding loan options for that borrower. (This provision is responsive to commenters who feared that without definition, a system using FAX-transmitted data or even telephone calls might qualify as a CLO system.) (ii) Qualified CLOs must meet certain fair participation and display requirements, including that participation and display of loan products from numerous lenders offering various loan products must be allowed, factors for selecting lenders to participate on the CLO system be fair and legitimate; and information on individual loan products must be displayed in a lender-neutral manner. While the Department recognizes that there are practical limits on the number of lenders that can be included usefully on a system, because of technological and other limitations, the proposed rule contemplates that a minimum of 20 lenders will participate on a qualified CLO system. (The Department asks for comments on whether this number is appropriate or another number would better ensure competition while providing a meaningful level of information to the consumer.) The exemption is still available when less than 20 lenders choose to participate, as long as the CLO system remains open to and accepts additional lenders. Selection of lenders for participation must be done as a result of the fair application of impartial criteria, which may include, but are not limited to, the date of the lender's application for participation on the CLO system (e.g., first-come, first-served), the quality of services and capabilities a lender provides to consumers, the types of loan products offered by a lender and its pricing practices, and the extent to which a lender's participation will increase the variety of loan products offered to consumers by the system. (The application of factors may not be used to avoid the 20 lender requirement.) CLO system operators must have a reasonable justification supported by documentation for selection decisions. No lender may be favored or disfavored by the manner in which information regarding the lender or its products is presented to the borrower or is utilized on the system, or by the scope of information that a particular lender is permitted to include as compared to another lender. (iii) Qualified CLOs must provide borrowers with a CLO disclosure form that states that use of the system is not required, space on the system is limited, the full range of products meeting the borrowers' needs may not be listed on the system, and other lenders not listed on the system may offer better terms and conditions including lower rates. A disclosure format for this and other information is set forth in the proposed rule as Appendix E. (iv) Qualified CLOs must charge borrowers the same fee for the same CLO service or the same components of service. The exemption does not attempt to fix a price for CLO services; market forces and market experiences should continue to shape the evolution and development of qualified CLO systems. Rather, where fees are charged, all borrowers must be treated equally. If fees are waived by a CLO provider, they must be waived fairly and not because of the choice of a particular lender. If the fee is contingent on use of a loan product on the system, the contingency must apply equally to all loan products and lenders on the system. (v) An operator of a qualified CLO may also charge lenders for access to the system and for a portion of maintenance and operation costs of the system. However, the schedule of charges for each lender on the system must be identical. Furthermore, qualified CLOs must disclose to the borrower, on the form prescribed in Appendix E and on the HUD-1 or the HUD-1A, the amount of any anticipated payments by a lender. (vi) Fees and disclosures about the CLO system must also be prominently displayed and visible to the potential borrower on the premises near where the CLO terminal is located. The information that more advantageous loan alternatives may exist that are not displayed on the system must be similarly disclosed. (vii) Any borrower payment to a CLO operator for use of a qualified CLO must be paid outside of and before closing. A borrower must receive full disclosure of the amount of the fee before the CLO services are performed. In this proposed rule, the Department is establishing the minimum requirements that must be met by a qualified CLO system if payments by a borrower to the operator of the system are to enjoy an exemption from RESPA. The Department believes that these requirements are responsive to the many comments on CLOs, and that compliance with the requirements will assure that: CLO systems receiving the benefit of the exemption are operated fairly; these systems will not be used as disguised means of steering borrowers to particular lenders on a basis other than the quality of services provided; and lenders wishing to participate in qualified CLO systems will be permitted to do so on a fair and equitable basis. In addition, this proposed rule would continue and augment certain requirements for all providers of CLO services, whether or not the CLO is a qualified CLO. In all circumstances where a CLO is utilized, the CLO disclosure set forth in Appendix E must be provided to borrowers before the CLO services are performed. The existence of any controlled business arrangement involving the operator of a CLO and any participating lender must be disclosed to the borrower before the system is utilized. Similarly, lender payments to other settlement service providers for CLO services must continue to be disclosed on the Good Faith Estimate and on the HUD-1 or HUD-1A, in accordance with the February 10, 1994 (59 FR 6505) revision of the regulations, and the possibility of such payments must be noted on the CLO disclosure. (e) Questions and comments on this proposal. In formulating the final rule, the Department may modify the requirements for the exemption, based on comments from the public. The Department seeks public comment on all aspects of its proposal to limit the exemption for borrower payments to payments made for qualified CLOs, including: (i) Does the approach embodied in this proposal--establishing a safe harbor for borrower payments for qualified systems, continuing to scrutinize borrower payments for nonqualified systems under RESPA, and mandating certain disclosures for all systems--the best approach to encourage the use of technology to benefit consumers and, at the same time, protect consumers from unfair practices? Instead, should the Department provide that any payment for a CLO system that does not qualify for the safe harbor is presumed to violate RESPA? (Commenters who believe that there should be broader prohibitions should detail the legal and other justifications for this belief.) (ii) Would establishment of a parallel exemption for payments made by lenders to operators of qualified CLOs be in the best interest of consumers? If so, should the requirements for a lender payment CLO exemption be the same as the requirements for the borrower payment exemption? Those commenters who believe the requirements should be different should specify what differences they recommend. (iii) Are most CLO systems likely to be financed using borrower payments, lender payments, or a combination of both? Will any CLO system provide access to the system to lenders and borrowers free of charge? (iv) Are the benefits of having borrower payments exempt from RESPA scrutiny sufficient to encourage CLO operators to develop qualified CLOs? Will CLO operators prefer to be subject to the general test under RESPA that borrower payments must be in exchange for services actually performed or to meet the requirements for qualified CLOs? (v) Will the requirements for qualified CLOs in the proposal result in cost-effective CLOs offering meaningful services to consumers? (vi) Is the requirement for CLO disclosure to consumers in this proposal reasonable and does it serve the consumers' best interests? (vii) Is the definition of a qualified CLO sufficiently flexible, considering the nature of this emerging industry and the Secretary's consumer protection objectives? (viii) Are the requirements concerning lender-neutrality and the selection of lenders on a qualified CLO reasonable? (ix) Is the minimum number of lenders on a qualified CLO (i.e., 20) practical from an operational perspective? Is it sufficient to ensure competition? (If another number is suggested, please explain why this number would be superior in promoting competition and the consumers' interests?) (x) Is the requirement that all disclosures be made before performance of CLO services reasonable? (xi) What will be the impact of the requirement that any borrower payments must be made outside of and before closing? (xii) Does the requirement that qualified CLOs must provide the borrower with certain information about loans generally available; collect information about the borrower, the property, and the loan sought; and provide the borrower with information about loan products available to that borrower accomplish the intended objective of ensuring that a meaningful service is provided? The Department anticipates that the Technology Demonstration that it plans to conduct (see Section I of this preamble) will also be a useful vehicle for developing answers to some of these questions. (3) Issue 3: Preemption of State Laws or Regulations In Sec. 3500.13(b)(2), the November 2, 1992, final rule provided that ``in determining whether provisions of State law or regulations concerning controlled business arrangements are inconsistent with RESPA or this part, the Secretary may not construe those provisions that impose more stringent limitations on controlled business arrangements as inconsistent with RESPA so long as they give more protection to consumers and/or competition.'' In connection with the preemption issue, the Department's July 6, 1993, notice requested comments on establishing standards to be used in evaluating whether provisions in State laws provide greater protection to consumers. The Department also invited any other comment relative to the preemption provision of the 1992 final rule. (a) Positions Taken by Commenters Critical of the Rule's Preemption Policy. While the Department received hundreds of comments addressing the preemption question, this issue attracted fewer expressions of opinion than did the other three issues raised in the July 6, 1993, notice. Most of the commenters addressing the issue (excluding identical-form responses) were attorneys or major institutional commenters. However, even among the comments from organizations representing institutional interests or segments of the real estate and real estate finance industries, preemption was the least-frequently addressed of the four issues. Commenters who were critical of other aspects of the rule had a mixed approach to the preemption issue and reflected suspicion of the Department's motives. These comments assumed that, despite the benign phrasing of Sec. 3500.13(b)(2), HUD would (in light of the other features of the 1992 final rule) use preemption in the future to weaken State-initiated regulation of controlled business arrangements. Those commenters who shared this suspicion varied in their recommendations for improvement of the rule's preemption feature. Several commenters advised HUD to provide ``greater clarity'' regarding a State's right to ban or closely regulate controlled business arrangements. Other commenters referenced particular existing State laws that require controlled business entities to seek a substantial portion of their business from sources other than their affiliated entities. These commenters urged that HUD provide explicitly that State laws and regulations of this type would not be subject to preemption. The tone of these comments suggested that the standard set out in the final rule--i.e., no preemption, so long as a State law affords ``more protection to consumers and/or competition''-- was insufficient assurance against Federal preemption. Apparently the final rule was perceived by the commenters as being ``anti-consumer'' in the guise of a consumer protection regulation. The commenters believed it was clear that State laws forcing controlled businesses to draw business from nonaffiliates should never be preempted under RESPA authority. The commenters were not persuaded that the Department intended to apply Sec. 3500.13(b)(2) in a manner that would treat these State laws as ``pro-consumer''. Concerned commenters made diverse recommendations: several asked the Department to clarify in the rule that preemption would not be applied; other commenters, clearly equally averse to preemption of State laws, recommended case-by-case judgments regarding preemption, using the existing standard set out in Sec. 3500.13(b)(2). These latter commenters often combined their status quo recommendation with an urging that HUD modify or reverse positions taken on the employer- employee exception or CLO issues. Their thrust was that HUD's preemption policy would not be objectionable if the RESPA rule were modified to cure the specific problems being addressed by commenters in their accompanying remarks. The combined comment of the 16 State Attorneys General stated the belief that it would be too difficult to ``define criteria for preemption in the abstract.'' The comment recommended a case-by-case approach. (Again, this comment was made in the context of a strong statement of opposition to the final rule's employer-employee fee policy and CLO exemption.) The predominant position of institutional commenters addressing the preemption issue was that it is unnecessary for HUD to set out strict standards to evaluate whether State law provisions provide greater protection to the consumer. However, there was considerable sentiment in favor of regulatory ``clarifications'' to serve, in essence, as guarantees that the Department would not preempt State laws in any instance where its goal was to limit controlled business arrangements. Consumers Union believed that HUD's own rules should be changed to afford consumers stronger protections, but, if this was not to be, ``at the very least States should be free to protect their own consumers''. Accordingly, Consumers Union favored the enunciation of standards for determining whether State law provisions provide greater protection: * * * These standards are necessary since the final rule is anti-consumer, but was presented as if it were pro-consumer. To eliminate any resulting ambiguity, HUD should clarify that [State- originated] rules totally eliminating any incentive to steer business to an affiliate would be viewed as stronger consumer protection. A large number of comments received from individuals and small businesses (mainly lenders) favored the establishment of written standards for the evaluation of State laws. However, these comments offered no specific advice concerning the content of the favored written standards. Comments submitted by the American Land Title Association (ALTA) claimed that the November 1992 rule on preemption had ``frightened'' State legislators and regulators ``into believing that the RESPA disclosure provisions [would be read by HUD to] preempt more stringent state legislation or regulations.'' The ALTA expressed the belief that the new regulations were ``perverting'' congressional policy regarding the circumstances warranting preemption. The ALTA further claimed that the preemption provision suggests that ``only if the Secretary of HUD determines that a state controlled business provisions gives more protection to consumers and competition would the state provisions not be preempted.'' (Emphasis in original.) The ALTA also complained that the final rule was deterring State governments from considering more stringent regulation of controlled business, and suggested that the Department support legislative revisions to RESPA to replace ``ineffective'' consumer disclosure requirements with Federal ``public business'' requirements (i.e., requirements that controlled businesses derive a significant proportion of their business from nonaffiliates). One of the Federal agencies commenting on the rule, the Office of Thrift Supervision (OTS), suggested that separate review standards for preemption determinations were unnecessary and that HUD could employ a case-by-case analysis, using the review method outlined in Sec. 3500.13(c) of the final rule. (OTS submitted comments critical of the final rule on the referral fee and CLO issues.) (b) Positions Taken by Supporters of the Preemption Provisions. As in the case of commenters critical of the final rule, supporters of the rule commented less frequently on the preemption issue than any of the other questions raised in the July 6, 1993, notice. However, there was perhaps a greater gulf between supporters of the 1992 final rule and its opponents on this issue than on any other. As indicated earlier in this preamble, opponents of the rule expressed widespread fear that the Department would use its preemption power to nullify what the opponents perceived as salutary State regulation of controlled business. Proponents of the final rule also read Sec. 3500.13(b)(2) of the rule as promising extensive HUD employment of preemption; however, these commenters welcomed it. The commenters regarded RESPA as sufficient to provide consumers with protection against unfair pricing by settlement service providers. Often, the commenters claimed, State laws that purport to be protective of consumers are actually designed to benefit local settlement service providers, by hindering the entry of larger, broad-based providers into local markets. Commenters appeared to assume that the chief intended target of preemption would be State laws directly or indirectly preventing real estate brokers from owning affiliated title businesses, prohibiting mortgage lenders from affiliating with title agencies, or restricting the percentage of business that can be derived from referrals from affiliated businesses. A lender with nationwide business objected strongly to the inefficiencies it said resulted from multiple and inconsistent State law requirements. While these varying requirements are justified if they provide identifiable consumer benefits, the commenter said, they frequently represent attempts to limit competition among lenders, and actually increase the costs paid by consumers. The experience in Kansas is instructive. After the state enacted a law limiting referrals to affiliated entities, many title agent affiliates of real estate brokers and mortgage companies were forced out of business. Freed from the need to compete with such providers, we understand that independent title agents increased their rates by approximately 60%. The Department need look no further than this example to recognize that protection of ``turf,'' rather than protection of consumers, is normally at the heart of such limitations. The commenter went on to urge that HUD make clear that State limitations affecting controlled business arrangements are preempted by RESPA. One commenter said that RESPA regulations encourage nationwide service providers to diversify their product offerings and enter new geographic markets. Accordingly, Federal preemption of adverse State laws would result in increased competition. While a few commenters appeared to be recommending summary preemption of the array of State laws affecting controlled business, other commenters, responding to the Department's direct question, urged the establishment of standards for the case-by-case determination of whether State laws or regulations are inconsistent with RESPA in the controlled business area, i.e., whether a particular law ``give(s) more protection to consumers and/or competition'' than does RESPA. One commenter suggested that the final rule's treatment of preemption should be fundamentally changed because it is ``unclear and vaguely worded'': ``What is meant by `stringent limitations' and `give more protection to * * * competition?''' Another commenter cited the legislative history of the 1983 RESPA amendments as indicating Congress' expectation that, if necessary to protect consumers or encourage competition, HUD would recommend further legislation to place a percentage limitation on the amount of controlled business that could be transacted. The commenter observed that in the ten years since the controlled business exemption became law, HUD has not recommended further legislation in this area. Additionally, the commenter claimed, many State governments have not seen the necessity of enacting restrictions on the percentage of business that can be derived from affiliated entities. The commenter concluded that State ``percentage of business'' laws were inconsistent with RESPA and should be preempted as anticompetitive. (c) Position on Preemption in the Proposed Rule. Based upon the comments and testimony, the Secretary has determined that it is unnecessary at this time to set out specific written standards for preemption of State laws. As numerous commenters, including the State Attorneys General, observed, setting out comprehensive and informative preemption standards presents an almost insurmountable task, in the absence of a wide array of specific fact situations that are raising preemption issues. If it becomes necessary to consider this issue further, the Secretary may reopen the issue by rulemaking or deal with specific preemption issues by means of interpretive rules. No amendments are proposed on this subject in this rule. (4) Issue 4: Adequacy of the Controlled Business Disclosure Statement In Sec. 3500.15(b)(1) of the 1992 final rule, provision was made for ``written disclosure, in the format of the Controlled Business Arrangement Disclosure Statement set forth in appendix D of this part.'' This disclosure referred to certain information regarding the ownership and financial relationships between referring and referred-to parties, as well as information regarding the timing of the disclosure and other methods for disclosure. HUD solicited the views of commenters in its July 6, 1993, Federal Register notice concerning whether the controlled business disclosures outlined in appendix D ``are adequate to protect the consumer, and, if not, how they might be improved.'' (a) Comments Critical of the Disclosure Statement. A majority of the commenters expressing dissatisfaction with one or more features of the 1992 final rule's employer payments provisions also objected to the Controlled Business Arrangement Disclosure Statement set out in Appendix D to part 3500. Generally, these objections were twofold. First, commenters argued that even the best and most complete form of disclosure imaginable was not an effective means of coping with what the commenters perceived as anticonsumer aspects of controlled business arrangements. Second, opposition commenters urged that if, against their advice, HUD continued to sanction referral payments by employers to employees, the form of disclosure required should be strengthened substantially, and the timing of the required disclosure should be pinpointed for maximum effect in affording consumers a realistic opportunity to choose alternative settlement service providers. More than 800 comments from lenders and settlement attorneys urged expansion of the controlled business disclosure to assure that borrowers understand that the referral ``will provide a financial benefit to the related parties.''4 --------------------------------------------------------------------------- \4\HUD notes that the Appendix D disclosure format already requires: (1) Disclosure of the nature of the relationship between the referring party and the prospective provider of the service, including ownership or other financial interests; (2) estimates of the charges for the service or services; and (3) a statement that the consumer ``may be able to get these services at a lower rate by shopping with other settlement service providers.'' (57 FR 49600, 49622; November 2, 1992.) --------------------------------------------------------------------------- Perhaps the most comprehensive criticism of the disclosure policy was expressed by the 16 State Attorneys General in their comments. After criticizing both the referral payments provision and the CLO exemption, the Attorneys General said that they were skeptical that disclosures can remedy the inherent dangers to consumers when there are financial incentives for referrals of business. Conceding that the 1983 RESPA amendments expressly permitted controlled business arrangements, the Attorneys General urged that the disclosure contemplated by the regulatory amendment ``be as clear and explicit as possible to alert consumers to the potential for harm.'' The comment advocated that the disclosure form state with greater clarity the purpose for which a disclosure is made and the harm against which it is aimed. Specifically, the State Attorneys General criticized as vague the form's reference to a ``business relationship'' and advocated the inclusion of a statement that, in making the referral to the controlled business, the referring company or agent (to be identified by name) would benefit ``financially or otherwise.'' The State Attorneys General wanted the form to indicate that, in addition to lower rates, consumers might receive ``better services'' by shopping around. ``Indeed, consumers must be affirmatively encouraged to shop around * * * consumers should be warned in clear, unambiguous language of the pitfalls of relying on a controlled business referral and encouraged to make intelligent choices among settlement service providers.'' Consumers should also be told in explicit terms, the comment continued, that they are ``free to choose [their] own settlement service provider and will not be denied any services or loan for exercising this choice.'' Finally, the State Attorneys General favored disclosure of the ``existence of and amounts of'' any fees or kickbacks paid, directly or indirectly, to the real estate broker or another referring party, or to an affiliated provider, for the performance of settlement services. A large number of individual commenters and the Coalition to Retain Independent Services in Settlements (CRISIS) echoed this position. The CFA disparaged disclosure, by itself, as being an ``inadequate remedy for the market risks that consumers are exposed to in the purchase of real estate'': The Department's rule has placed before the consumer a new array of fees for which the delivery of the equivalent of a tollgate ticket is hardly ample protection. One of the central problems of controlled business arrangements is that the underlying purchase is carried out under conditions of urgency and stress that will always overwhelm a captive consumer. The ability to distinguish between what must be done--and purchased--and what is optional, is limited. The MBA advocated elimination of the employer-employee referral fee exception, but urged that, at least, the disclosure form should be expanded to include the existence and amount of the referral fee. Similar advice was received from Consumers Union and from individual commenters. The FDIC also expressed some doubt about the efficacy of written disclosure, calling the disclosure form ``just one of dozens of confusing papers handed to [consumers] over the course of a real estate transaction.'' FDIC nevertheless advocated strengthening the form by requiring the disclosing entity to meet specific content guidelines and to use layman's language, ``* * * so less opportunity [is] given for `creative writing'.'' The FDIC also advocated the use of an acknowledgement line or box on the form, to show that the consumer had read and understood the controlled business arrangement disclosure. The Office of Thrift Supervision (OTS), while expressing concern about employer-employee referral fees and the efficacy of CLO disclosures, commented that the content and timing requirements for controlled business disclosures, as set out in the final rule, seemed adequate to protect consumers. Departing from the recommendations of other commenters to the effect that the disclosure form should be expanded to highlight the presence of referral fees and other relationships between the referrer and the service provider, ALTA's spokesman called the disclosure process ``worthless as a consumer protection measure in the settlement services arena.'' The ALTA claimed that the consumer is likely to rely upon the recommendation of a trusted professional, ``even where a personal financial inducement is disclosed.'' ALTA's spokesman advocated legislative solutions, including amendment of RESPA to permit a competitor's right of action and the institution of blanket prohibitions on controlled businesses. (b) Comments from Supporters of the Final Rule's Disclosure Statement. The Department received detailed comments on controlled business disclosure policy from more than a dozen commenters who supported the final rule in most of its particulars. Typically, these commenters believed that the form and level of detail of disclosure of controlled business arrangements that were in the final rule were ``more than adequate'' to permit informed choice by consumers concerning settlement service providers. Several commenters pointed out that the required form of disclosure appeared to exceed the statutory disclosure requirements in several respects. One, the commenters urged that the statute required only that the ``existence'' of a financial interest be disclosed, while the regulation required that the disclosure outline the ``ownership and financial interest.'' Two, the regulation requires that all disclosures, not just those related to costs, be made in writing. Three, the regulations require separate disclosure of controlled business relationships. Finally, the ``suggested format'' for the disclosure (although not the regulation itself) includes the caution: ``You may be able to get these services at a lower rate by shopping with other settlement service providers.'' Most commenters who raised these points did not address them as objections to, or criticisms of, the 1992 final rule. Instead, these observations were cited as indications that, in the commenters' views, the rule already was suitably attentive to consumer protection concerns, in that it went beyond bare-bones statutory disclosure requirements. Several of these comments went on to urge that the Department continue to limit its RESPA regulations to disclosure- related concerns, and not bend to the will of advocates of other methods of regulating or curbing controlled business arrangements: RESPA is predicated on the belief that consumers, when provided with appropriate disclosures, are capable of making informed decisions. Those who argue otherwise frequently do so only to protect their competitive position, not to advance the interests of consumers. * * * [T]he information contained in the existing controlled business arrangement disclosures is sufficient and the requirements should not be disturbed. The Federal Reserve Board's comment agreed that the controlled business disclosure policy set out in the rule and the format were ``more than adequate'' as disclosures. ``* * * [I]f anything, it may be over-disclosing given the quantity of information that a consumer receives when applying for a mortgage loan.'' A few lender-commenters expressed a similar view. The Federal Reserve suggested that the consumer needs to know that the two parties involved in the referral are related, but may not need further details. While the Federal Reserve agreed it is important that the consumer know that use of the provider is not required, it suggested that including the estimated charges for the service was ``redundant,'' since such costs would have been disclosed on the Good Faith Estimate. One lender argued that controlled business arrangements arise in a variety of situations, and that it is ``impossible'' to mandate the use of a form that is suitable for all providers in all situations. The commenter asked the Department to provide for flexibility concerning format, ``as long as consumers are informed of the referral and the relationship between the parties.''5 --------------------------------------------------------------------------- \5\The same commenter, a lender, asked for more flexibility in the timing of the controlled business disclosure. Many referrals do not occur at face-to-face meetings between the consumer and the referring party, the commenter suggested, and asked that the rule clarify that the service provider be required to furnish a disclosure ``at the time of the initial contact between the consumer and the provider.'' --------------------------------------------------------------------------- Another comment urged that the controlled business disclosure form not be required for disclosure of the specific providers of ``lender required services such as credit reports, appraisals, [or] flood plain searches.'' The commenter suggested that early disclosure of the identity of these providers was impractical and provided ``absolutely no benefit to the consumer.'' The information, the commenter concluded, would appear on the HUD-1 Settlement Statement. The most frequent criticism of the rule's controlled business disclosure requirements from commenters supportive of the rule was that, in some instances, it was unclear when a controlled business arrangement was required to be disclosed. Several commenters asked whether the disclosure was required when a bank has a wholly-owned subsidiary mortgage company or when a mortgage company is a wholly- owned subsidiary of the same holding company as the bank. The situations in which related businesses were required to make disclosure also were questioned. One commenter asked whether, if a bank is affiliated with a mortgage company by common ownership, the bank has to make disclosures to consumers in the following circumstances:When a consumer is directly referred to the mortgage company for a mortgage loan; When the consumer is simply informed of the availability of loans from the mortgage company; and When the bank includes references to the mortgage company in its advertising or its brochures. One commenter, stating that the entire category of ``referrals'' was not intended to fall within the coverage of the controlled business arrangement rules, recommended creation of an exemption to the controlled business arrangement rules for ```referrals' between bank holding companies' wholly-owned subsidiaries.'' Two commenters asserted that failing to provide this exemption would be placing mortgage companies within bank holding companies at a competitive disadvantage when compared to bank mortgage departments. ``The purpose of RESPA is not to dictate the form in which a bank structures its lending business.'' (c) Position Taken in the Proposed Rule on the Controlled Business Disclosure Statement. The Secretary concluded that the elimination of the employer-employee exception would, in turn, eliminate a number of the strongest concerns regarding the information in the controlled business disclosure. However, the Secretary has accepted some suggestions for modifications to the disclosure as useful and beneficial to the consumer. Accordingly, certain of these suggestions have been included in the proposed rule and in the format of Appendix D. The suggested borrower-acknowledgement box has been added to the controlled business disclosure format. Additional plain language has been added to the format. Section 3500.15(b) proposes a requirement that disclosure be given at a time to be relevant to the consumer: either (i) at the time of referral or no earlier than 3 days before; or (ii) if the lender requires the use of a particular provider, the time of the loan application. The preamble of revisions that extended RESPA coverage to subordinate lien transactions (59 FR 6505, 6510, February 10, 1994) also discussed the appropriateness of disclosures, stating that ``incidental and uncompensated referrals, such as brochures in a bank lobby or street directions given by a bank employee, are not perceived as rising to the level necessary to require a controlled business disclosure.'' More sweeping modification of the controlled business disclosure form is not considered necessary. While many commenters disparaged the use of written disclosure as a means of coping with perceived controlled business-related problems, the Department continues to believe that full disclosure is useful as a means of informing consumers. Disclosure is also a preeminent principle of the RESPA statute. V. Other Matters Regulatory Flexibility Act The Secretary, in accordance with the Regulatory Flexibility Act (5 U.S.C. 605(b)), has reviewed this rule before publication and by approving it certifies that this rule does not have a significant economic impact on a substantial number of small entities, other than those impacts specifically required to be applied universally by the RESPA statute. Environmental Impact A finding of no significant impact with respect to the environment has been made in accordance with HUD regulations in 24 CFR part 50 that implement section 102(2)(C) of the National Environmental Policy Act of 1969 (42 U.S.C. 4332). The finding is available for public inspection during regular business hours in the Office of the General Counsel, Rules Docket Clerk, room 10276, 451 Seventh Street SW., Washington, DC 20410. Executive Order 12866 This proposed rule was reviewed by the Office of Management and Budget under Executive Order 12866, Regulatory Planning and Review. Any changes made to the rule as a result of that review are clearly identified in the docket file, which is available for public inspection at the Office of the Rules Docket Clerk, Office of the General Counsel, room 10276, Department of Housing and Urban Development, 451 Seventh Street SW., Washington, DC 20410-0500. A Regulatory Impact Analysis (RIA) performed on this proposed rule is also available for review at the same address. Executive Order 12612, Federalism The General Counsel, as the Designated Official under section 6(a) of Executive Order 12612, Federalism, has determined that the policies contained in this proposed rule will not have substantial direct effects on States or their political subdivisions, or the relationship between the federal government and the States, or on the distribution of power and responsibilities among the various levels of government. As a result, the rule is not subject to review under the Order. Promulgation of this rule expands coverage of the applicable regulatory requirements pursuant to statutory direction. Executive Order 12606, The Family The General Counsel, as the Designated Official under Executive Order 12606, The Family, has determined that this proposed rule does not have potential for significant impact on family formation, maintenance, and general well-being, and, thus, is not subject to review under the order. No significant change in existing HUD policies or programs will result from promulgation of this rule, as those policies and programs relate to family concerns. Regulatory Agenda This rule was listed as Item 1586 in the Department's Semiannual Agenda of Regulations published on April 25, 1994 (59 FR 20424, 20447), in accordance with Executive Order 12866 and the Regulatory Flexibility Act. List of Subjects in 24 CFR Part 3500 Consumer protection, Housing, Mortgages, Real property acquisition, Reporting and recordkeeping requirements. For the reasons set out in the preamble, part 3500 of title 24 of the Code of Federal Regulations is proposed to be amended as follows: PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT 1. The authority citation for part 3500 would continue to read as follows: Authority: 12 U.S.C 2601 et seq. 2. Section 3500.2, effective on August 9, 1994 (February 10, 1994 at 59 FR 6505, 6511), is amended by adding, in alphabetical order, definitions for ``CLO'', ``CLO access fee'', ``CLO operator'', ``CLO services'', ``CLO system'', ``managerial employee'', and ``qualified CLO system'', and by removing the word ``and'' at the end of paragraph (14), redesignating paragraph (15) as paragraph (16), and adding a new paragraph (15) to the definition of ``settlement service'', to read as follows: Sec. 3500.2 Definitions. * * * * * CLO means computer loan origination. CLO access fee means a fee paid by a borrower to a CLO operator for CLO services. CLO operator means a provider of settlement services who operates a CLO system for a borrower. CLO services means services provided to a borrower by a CLO operator using a CLO system. CLO system means a computer system that: (1) Provides to prospective borrowers information regarding the rates and terms of federally related mortgage loans; (2) Collects, assembles, and transmits information concerning the borrower, the property, and other information on a potential mortgage loan for evaluation by a lender(s); and (3) Based on the data transmitted, responds to the borrower with detailed information, including, without limitation, loan terms, rates, and payment schedules for various loan products that would be available to the borrower from such lender(s). * * * * * Managerial employee means an employee of a settlement service provider who does not routinely deal directly with the public, and who either hires, directs, assigns, promotes, and rewards other employees or is in a position to formulate, determine, or influence the policies of their employer. Neither the term ``managerial employee'' nor the term ``employee'' includes real estate agents or other independent contractors. * * * * * Qualified CLO system means a CLO system that meets the requirements of Sec. 3500.14(g)(3). * * * * * Settlement service * * * (15) Provision of CLO services; and * * * * * 3. Section 3500.14 is amended by revising paragraph (g)(2); by redesignating paragraphs (g) (3) and (4) as paragraphs (g) (5) and (6), respectively; and by adding new paragraphs (g) (3) and (4), to read as follows: Sec. 3500.14 Prohibition against kickbacks and unearned fees. * * * * * (g) * * * (2) Section 8 of RESPA does not prohibit normal promotional and educational activities that are not conditioned on the referral of business and that do not involve the defraying of expenses that otherwise would be incurred by persons in a position to refer settlement services or other related business. (3) Section 8 of RESPA does not prohibit any payment by a borrower for CLO services provided by a qualified CLO system that provides CLO services and meets the following requirements: (i) Multiple Products and Lenders. The qualified CLO system shall provide openings for 20 or more lenders offering various loan products. The factors for selecting the lenders to be included on a qualified CLO system (see paragraph (g)(3)(ii) of this section) may not be designed to limit or have the effect of limiting eligibility to less than 20 lenders. When the qualified CLO system has less than 20 lenders, the system shall remain open to and accept additional lenders until at least 20 lenders participate. (ii) Selection Factors. To determine eligibility for inclusion in the system, the qualified CLO system shall utilize selection factors that are fair and impartial and are designed to contribute to the efficiency and quality of the system. These factors may include, but are not limited to, the date of the lender's application for participation on the qualified CLO system, the quality of services and capabilities the lender provides to consumers, the types of loan products offered by the lender and its pricing practices, and the extent to which the lender's participation will increase the variety of loan products offered to consumers by the system. Qualified CLO system owners shall have a reasonable justification for selection decisions, supported by documentation which they must maintain. (iii) Neutrality. The CLO operator of a qualified CLO system and the qualified CLO system shall provide borrowers with information in a neutral manner. No lender shall be favored or disfavored by the manner in which information regarding the lender or its products is utilized or is presented to the borrower, is used on the system, or is presented by the CLO operators, or by the scope of information that one lender is permitted to include as compared to another lender. No payments, disincentives, or penalties may be provided directly or indirectly to CLO operators of qualified CLO systems by any person, including the CLO operator's employer, to influence the CLO operator to favor any lender on the qualified CLO system. (iv) Disclosure Statement. The CLO operator of a qualified CLO system shall provide a CLO disclosure form to the borrower before CLO services are performed. The CLO operator shall require the borrower to sign on the CLO disclosure form an acknowledgment that the borrower has received the disclosure. An enlarged, completed copy of the CLO disclosure form (no smaller than 16'' by 20''), including any applicable fee, shall be displayed prominently within 5 feet of the CLO terminal. The CLO disclosure form shall: (A) Be in the format established in Appendix E of this part; (B) Specify the fee and services being provided; and (C) Include statements that use of the system is not required; space on the system is limited; the full range of products meeting the borrower's needs may not be listed on the system; and other lenders not listed on the system may offer better terms and conditions, including lower rates. (v) CLO Access Fee. The CLO operator of a qualified CLO system shall charge all borrowers using the qualified CLO system the same CLO access fee(s) for the same service or the same components of service. The CLO operator of a qualified CLO system shall require the borrower to pay any CLO access fee outside of and before the closing of any loan that may be obtained through use of this system. The CLO operator of a qualified CLO system may only waive the CLO access fee based on business considerations of the operator and not on any action of a lender. If the payment of the CLO access fee is contingent on use of a loan product on the qualified CLO system, the contingency shall apply equally to all loan products and lenders on the qualified CLO system. (vi) Lender Charges for Access. The CLO operator of a qualified CLO system may charge lenders for access to the qualified CLO system if: (A) Charges are set forth in a written schedule of charges; (B) Charges for the same services and components of services are the same for all lenders on the system; and (C) The charges are reasonably related to the costs of maintenance and operation of the qualified CLO system (i.e., the facilities furnished or the services actually performed). (4) Any payment by a borrower to a CLO operator for services from a nonqualified CLO system, and any payments by a third party settlement service provider to a CLO operator for access to any CLO system in relation to a federally related mortgage loan, will be subject to examination under Section 8 of the Act and this part. The disclosure format set forth in Appendix E of this part and Box 2 of Appendix E of this part shall be utilized by all CLO operators for all CLO systems and shall be completed before any CLO services are performed. * * * * * 4. Section 3500.15 is amended by revising paragraph (b)(1); by removing the word ``and'' at the end of paragraph (b)(3)(i)(A); by removing the period at the end of paragraph (b)(3)(i)(B) and replacing it with ``; and''; and by adding paragraph (b)(3)(i)(C), to read as follows: Sec. 3500.15 Controlled business arrangements. (b) * * * (1) The person making a referral has furnished to each person whose business is referred a written disclosure, in the format of the Controlled Business Arrangement Disclosure Statement set forth in Appendix D of this part. This disclosure shall specify the nature of the relationship (explaining the ownership and financial interest) between the provider of settlement services (or business incident thereto) and the person making the referral, and shall describe the estimated charge or range of charges (using the same terminology, as far as practical, as Section L of the HUD-1 or HUD-1A settlement statement) generally made by the provider of settlement services. The disclosure must be provided on a separate piece of paper at or no earlier than 3 business days before each referral, or, if the lender requires the use of a particular provider, the time of loan application, except that: * * * * * (3) * * * (i) * * * (C) No agent or employee may accept any payment from his or her principal or employer or any other source when that payment is correlated on a one-to-one basis or calculated as a multiple of the number or value of any referrals of business from his or her employer or principal to an affiliated entity. For example, no person shall pay any managerial employee or any employee or agent who is in direct contact with the public a bonus or other compensation correlated on a one-to-one basis or calculated as a multiple of the number or value of any referral of settlement service business by the employee or the employee's organizational unit to an entity affiliated with the employer or principal. In addition, no compensation of an employee or agent who is routinely in direct contact with the public may be based in whole or in part on the number or value of referrals that the employee or agent makes to affiliated entities. 5. Appendix B to part 3500 is amended by revising Illustration 11 to read as follows: Appendix B to Part 3500--Illustration of Requirements of RESPA * * * * * 11. Facts: A, a mortgage lender, is affiliated with B, a title company, and C, an escrow company, and offers consumers a package of mortgage title and escrow services at a discount from the prices at which such services would be sold if purchased separately. Neither A, B, or C, requires consumers to purchase the services of their sister companies, and each company sells such services separately and as part of the package. A also pays its employees (i.e., loan officers, secretaries, etc.) a bonus for each loan, title insurance, or closing that A's employees generate for A, B, or C. A pays such employees bonuses out of its own funds and receives no bonuses or reimbursements for these bonuses from B or C. At or before the time that customers are told by A or its employees about the services offered by B and C and about the package of services that is available, the customers are provided with a controlled business arrangement disclosure form. Comments: Selling a package of settlement services at a discount is not prohibited by RESPA. Also, A may compensate its own employees for business generated for A's company, but A may not directly or indirectly compensate A's employees who are routinely in contact with consumers for business generated for B or C. Nor may B or C directly or indirectly compensate A or A's employees for business referred to B or C by A's employees. Sections 3500.15(b)(3)(i) (A) and (B) set forth the permissible exchanges of funds between controlled business entities. No employee or agent may receive compensation correlated on a one-to-one basis or calculated as a multiple of the number or value of referrals of business to an affiliated entity. Nothing in the RESPA rule prohibits bonuses or other compensation based, in part, on the generation of business by A to B and C being paid to managerial employees who are not routinely in contact with consumers. 6. Appendix D to Part 3500 is revised to read as follows: Appendix D to Part 3500 Controlled Business Arrangement Disclosure Statement Format Notice To:-------------------------------------------------------------------- From:------------------------------------------------------------------ (Entity Making Statement) Property:-------------------------------------------------------------- Date:------------------------------------------------------------------ This is to give you notice that [referring party] has a business relationship with [provider receiving referral] . [Describe the nature of the relationship between the referring party and the provider, including percentage of ownership interest, if applicable.] Because of this relationship, this referral may provide [referring party] a financial or other benefit. Set forth below is the estimated charge or range of charges by [provider] for the following settlement services: ____________: $____________ ____________: $____________ ____________: $____________ ____________: $____________ ____________: $____________ You are NOT required to use [provider] as a condition for [settlement of your loan on] [or] [purchase, sale, or refinance of] the subject property. YOU MAY BE ABLE TO GET THESE SERVICES OR BETTER SERVICES AT A LOWER RATE BY SHOPPING WITH OTHER SETTLEMENT SERVICE PROVIDERS, AND THIS IS SOMETHING YOU SHOULD CONSIDER DOING.\1\ --------------------------------------------------------------------------- \1\Where the lender is requiring an attorney, credit reporting agency, or real estate appraiser to represent its interests, this paragraph and the corresponding acknowlegment should be omitted. --------------------------------------------------------------------------- A lender is allowed to require the use of an attorney, credit reporting agency, or real estate appraiser chosen to represent the lender's interest.\2\ Acknowledgment [I/we have read this disclosure form and understand its contents, as evidenced by my/our signature(s) below.]\2\ --------------------------------------------------------------------------- \2\Use this paragraph and acknowledgment for disclosures involving required attorneys, credit reporting agencies, or real estate appraisers and omit the second acknowledgment. For all other disclosures, use the second acknowledgment. --------------------------------------------------------------------------- [I/we have read this disclosure form, and understand that [referring party] is referring me/us to purchase the above-described settlement services from [provider receiving referrals], and may receive income as the result of this referral.] ---------------------------------------------------------------------- (Applicant's signature) ---------------------------------------------------------------------- (Co-applicant's signature) ---------------------------------------------------------------------- ---------------------------------------------------------------------- [Specific timing rules for delivery of the controlled business disclosure are set forth in 24 CFR 3500.5(b)(1)(i) (Regulation X).] 7. Appendix E to part 3500 is revised to read as follows: Appendix E to Part 3500 CLO Fee Disclosure To:-------------------------------------------------------------------- [Potential Borrower] From:------------------------------------------------------------------ [Person Making Disclosure] NOTICE: I have available a Computer Loan Origination System (CLO), a computer system that can access a variety of mortgage loans and rates. The CLO is available to you under the following conditions: 1. [ ] You are obligating yourself today to pay $________, outside of and before the settlement of any loan that may be obtained through use of this system by ________ check, ________ credit card, ________ cash, ________ other ______. (specify) 2. [ ] You will not be charged a direct fee, but the lender who funds your loan will pay us a fee related to your loan estimated to be $--------------------, which will likely be recovered by the lender in the cost of your loan. 3. [ ] I am providing you access to the CLO without a separate charge. USE OF THIS SYSTEM IS NOT REQUIRED. SPACE ON THE SYSTEM IS LIMITED, THE FULL RANGE OF PRODUCTS MEETING YOUR NEEDS MAY NOT BE LISTED, AND BETTER TERMS AND CONDITIONS, INCLUDING LOWER RATES, MAY BE AVAILABLE FROM OTHERS NOT LISTED ON THE SYSTEM. [INSTRUCTIONS: Include the following text, when applicable. Instructions in square brackets, including these instructions, should be omitted, as appropriate.] [(Name of operator of the system) has an affiliated business relationship with (name(s) of lender(s) on the system under which this overall organization gains financially if you enter into a mortgage loan with them. A further explanation of this business relationship is set forth in the controlled business arrangement disclosure form that is also being given to you at this time.] The following services will be provided: [ ] Displaying a variety of mortgage loans and rates that may be available to you. [ ] Counseling you regarding the different types of loans available and the relative rates in a fair and equitable manner. [ ] Relating your financial needs with available mortgage loan programs; and assisting you in deciding which, if any, meet your needs. [ ] Entering information regarding you into the Computer Loan Origination System. [ ] Reviewing responses to submitted information. [ ] Other ____________________ Acknowledgment I/we have read this disclosure form, and understand its contents, as evidenced by my/our signature(s) below. ---------------------------------------------------------------------- Applicant's signatures ---------------------------------------------------------------------- Co-Applicant's signature ---------------------------------------------------------------------- Date: July 14, 1994. Nicolas P. Retsinas, Assistant Secretary for Housing-Federal Housing Commissioner. [FR Doc. 94-17598 Filed 7-20-94; 8:45 am] BILLING CODE 4210-27-P