[Federal Register Volume 61, Number 111 (Friday, June 7, 1996)]
[Rules and Regulations]
[Pages 29238-29255]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14329]




[[Page 29237]]


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Part IV





Department of Housing and Urban Development





_______________________________________________________________________



24 CFR Part 3500



Real Estate Settlement Procedures Act; Statements of Policy, Withdrawal 
of Employer-Employee and Computer Loan Origination Systems Exemptions; 
Final Rules

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

[[Page 29238]]



DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR-3638-F-06]
RIN 2502-AG26


Office of the Assistant Secretary for Housing--Federal Housing 
Commissioner; Amendments to Regulation X, the Real Estate Settlement 
Procedures Act: Withdrawal of Employer-Employee and Computer Loan 
Origination Systems (CLOs) Exemptions

AGENCY: Office of the Assistant Secretary for Housing-Federal Housing 
Commissioner, HUD.

ACTION: Final rule.

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SUMMARY: In this final rule, the Department of Housing and Urban 
Development is revising Regulation X, which implements the Real Estate 
Settlement Procedures Act of 1974 (RESPA). This rule completes a 
process that started with a public hearing and comment period on August 
6, 1993, followed by a proposed rule published on July 21, 1994.
    In the interest of protecting consumers from practices prohibited 
by RESPA, while making available to consumers the potential benefits of 
innovative business arrangements, this rule withdraws an exemption for 
employer-employee payments, introduces two more-limited exemptions for 
payments that would otherwise be prohibited by the statute--employer 
payments to managerial employees and employees who do not perform 
settlement services in any transaction. In addition, to relieve any 
uncertainty, the rule adds an additional exemption to clarify that 
payments made to an employer's own bona fide employee for generating 
business for that employer are permissible. The rule also revises 
certain controlled business disclosure requirements. HUD has chosen to 
use its exemption authority under Section 8(c)(5) of RESPA, having 
consulted with other Federal agencies as required by that provision, as 
well as the authority under Section 19(a) of RESPA, to permit these 
payments.
    The rule also withdraws an exemption for payments made by borrowers 
for computer loan origination (CLO) services, because the exemption was 
found to be of little benefit to consumers or the loan origination 
industry. However, in order to assure that consumers in the mortgage 
lending marketplace continue to benefit from technological innovation, 
simultaneously with the publication of this rule, the Department is 
issuing a Statement of Policy analyzing payments for CLOs under the 
RESPA regulations. In addition, the Department is simultaneously 
publishing two other Statements of Policy on issues raised by comments 
on the proposed rule, although not directly related to the proposed 
rule, and which involve interpretation rather than new rulemaking.

EFFECTIVE DATE: This rule is effective on October 7, 1996.

FOR FURTHER INFORMATION CONTACT: David Williamson, Director, Office of 
Consumer and Regulatory Affairs, Room 5241, telephone (202) 708-4560; 
or, for legal questions, Kenneth Markison, Assistant General Counsel 
for GSE/RESPA, or Grant E. Mitchell, Senior Attorney for RESPA, Room 
9262, telephone (202) 708-1550. (The telephone numbers are not toll-
free.) For hearing- and speech-impaired persons, this number may be 
accessed via TTY (text telephone) by calling the Federal Information 
Relay Service at 1-800-877-8339. The address for the above-listed 
persons is: Department of Housing and Urban Development, 451 Seventh 
Street, SW, Washington, DC 20410.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act Statement

    The information collection requirements regarding controlled 
business disclosures (Appendix D of this rule) have been approved by 
the Office of Management and Budget, under the Paperwork Reduction Act 
of 1995 (44 U.S.C. 3501-3520), and assigned OMB control number 2502-
0265. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless the 
collection displays a valid control number.
    The Department has eliminated the CLO disclosure statement which 
previously was contained in Appendix E to the RESPA rule. Based on 
prior cost estimates, the Department estimates the annual savings to 
business from eliminating this paperwork requirement to be $3,247,100.

I. Events Leading to Today's Final Rule

A. History of CBAs and CLOs

1. Controlled Business Arrangements
    In 1983, Congress enacted the ``controlled business arrangement'' 
amendment to RESPA. This amendment, codified under section 461 of the 
Housing and Urban-Rural Recovery Act of 1983 (HURRA) (Pub. L. 98-181, 
97 Stat. 1230) established that controlled business arrangements do not 
violate RESPA, provided that:
    (a.) The relationship between the person performing settlement 
services and the person making the referral is disclosed, along with 
the estimated charges of the provider;
    (b.) Consumers are not required to use an affiliated settlement 
service provider, except under certain specified exemptions under 
Section 8 of RESPA; and
    (c.) Nothing of value is received by the referring party, beyond a 
return on ownership interest or franchise relationship or payments 
otherwise permissible under Section 8(c) of RESPA.
    Following the enactment of these amendments, HUD issued several 
informal legal opinions concerning the extent to which employers could 
pay referral fees to employees. The opinions stated 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. HUD did not, however, 
broadly approve compensation to employees for referrals to affiliated 
companies.
2. Computer Loan Origination Systems (CLOs)
    During the 1980's, a number of private companies and trade 
organizations began to develop systems where some or most of the usual 
mortgage origination services could be performed by computers. These 
computer services frequently linked real estate brokerage offices to 
lenders or other settlement service providers. Concerns were raised to 
HUD regarding the interplay of these systems with Section 8 of RESPA, 
particularly whether the existence of such systems could result in 
illegal steering or compensation for referrals of business, or whether 
the use of the systems would allow the operators to impose charges for 
activities which represented little or no actual services. Several 
developers of such systems and potential competitors asked HUD for its 
views on payments made in connection with these systems under RESPA.
    In the mid-1980's, HUD issued several informal interpretations 
generally concluding that payments for CLO systems did not violate 
Section 8 of RESPA. The opinions stated that, so long as payments by 
the lenders (or real estate brokerage offices) went to cover 
``operational fixed costs'' of the CLO services, no referral fees 
existed. Moreover, the opinions stated that

[[Page 29239]]

borrower payments to CLOs were analogous to arrangements whereby 
borrowers voluntarily pay mortgage brokers for locating lenders. 
Accordingly, the Department concluded that such payments were not 
pursuant to a prohibited ``agreement or understanding'' under Section 
8(a) of RESPA and thus, were not proscribed by Section 8(a) of RESPA.
    On two subsequent occasions, the Department revisited RESPA's role 
in payments for CLO services through informal opinions. Both cases 
involved payments to CLO operators from either lenders or real estate 
brokers. In these two opinions, the Department concluded that such fees 
did not violate Section 8(b) of RESPA so long as the fees were 
reasonably related to services actually rendered. Controversy continued 
to surround the use of CLO systems, with many mortgage bankers 
opposing, and realtors supporting, HUD's position. All opinions were 
withdrawn pursuant to a final rule published on November 2, 1992 (57 FR 
49600) under RESPA (hereinafter ``final rule'' or ``1992 final rule'').
    In May 16, 1988, HUD opened up this matter for review and 
discussion without specifically mentioning CLOS, by proposing a rule 
(53 FR 17428, 17438) that would have added an exception under 
Sec. 3500.14, to allow the following:

    Voluntary payment by a borrower to a person who has acted as a 
mortgage broker or has otherwise assisted in bringing the lender and 
borrower together, provided that such voluntary payment is disclosed 
on both the good faith estimate of settlement costs and the HUD-1 
settlement statement and is not a condition of the loan or other 
settlement service.

    The 1992 final rule did not adopt the so-called ``mortgage broker 
exception'', but did adopt a CLO exemption.

B. The 1992 Rule

    On November 2, 1992, HUD published the 1992 final rule, which 
became effective on December 2, 1992. The 1992 final rule contained 
provisions implementing congressional amendments to RESPA regarding 
controlled businesses and created an exemption for payments by 
borrowers to computer loan origination systems. The final rule also 
updated the original RESPA regulations, which had not been amended 
since 1976.
1. Employer-Employee Exemption
    The 1992 final rule went beyond HUD's previous positions, as 
articulated through informal legal opinions that were withdrawn by the 
1992 final rule, and created an exemption for payments by an employer 
to its own employees for any referrals of settlement service business. 
Employees were thus allowed to receive compensation from their 
employers for generating business for their own employer or for any 
other business entity (including affiliates). The final rule contained 
a stricture, in Sec. 3500.14(b), that the business entity receiving the 
referrals of settlement business could not directly or indirectly 
compensate anyone for such business. The rule did not limit this 
exemption to controlled business arrangements. The exemption, however, 
had little utility for entities outside an affiliate business setting, 
since it was unlikely that an employer would pay its own employees for 
making referrals to unaffiliated individuals or companies. As noted, 
while the rule permitted an employer to compensate its own employees 
for referrals, it also indicated that if the business entity receiving 
the referral reimbursed the employer of the employees making the 
referrals, Section 8 of RESPA would be violated.\1\
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    \1\ The 1992 final rule was a marked departure from HUD 
interpretations in recent years. After the issuance of the May 1988 
proposed rule, which led to the 1992 final rule, HUD's position, 
expressed in a number of General Counsel's opinions, was that an 
employer could not compensate its employee for referrals to other 
business entities (including affiliates). These opinions only 
indicated that an employer could compensate its employees for 
generating business for that employer (not to affiliates).
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    Following the 1992 final rule's issuance, two lawsuits were filed 
objecting to provisions of the revised regulations as inconsistent with 
the statute and claiming failure by the Department to comply with the 
Administrative Procedure Act in the rule's promulgation.\2\ In 
addition, upon assuming office, HUD officials in the new Administration 
were inundated with comments about the final rule.
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    \2\ Plaintiffs in Mortgage Bankers Association of America v. 
United States of America, No. 92-2699 (D.D.C.), and Coalition to 
Retain Independent Services in Settlements (CRISIS) v. Cisneros, No. 
92-2700 (D.D.C.), filed separate actions seeking a declaration that 
the ``employee exception'' provision was invalid and injunctive 
relief enjoining implementation of this provision. The MBA suit also 
alleged that the CLO provision was invalid. These suits were 
dismissed without prejudice, that is, subject to reinstatement. A 
hearing regarding the Department's progress in issuing revised 
regulations is scheduled for October 1996.
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    The Department received allegations that the final rule created 
uncertainty about whether referral fees were in fact prohibited by 
RESPA. Some entities critical of the 1992 final rule characterized the 
provision permitting employers' payments to their own employees for 
referrals as broadly sanctioning referral payments. The trade and 
business press frequently restated this position without examination. 
Also, some commenters claimed that the creation 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 it prompted others to ``extort'' referral fees from 
other settlement service providers on the premise that HUD now allowed 
such compensation. While the final rule was not intended to permit sham 
arrangements, neither did it clarify the extent of the employer-
employee exemption. Commenters argued that the final rule failed to 
establish a bright line, comprehensible to industry participants, 
between permissible and impermissible activities.
 2. CLO Exemption
    The 1992 final rule also introduced a CLO exemption, which provided 
that borrower payments to CLO systems were exempt from Section 8 so 
long as a specified disclosure was made. The 1992 final rule did not 
adopt the mortgage broker exception proposed in the May 1988 proposed 
rule. The Department reasoned that well-informed choices by consumers 
did not require special protection under RESPA. Moreover, this 
exemption was intended to prevent RESPA's restrictions against unearned 
fees from unduly inhibiting the development of technology which could 
permit consumers to shop, apply for and/or obtain mortgage loans 
electronically. CLO systems were not specifically defined in the 1992 
rule.

C. A Public Dialogue

    Given the controversy over the 1992 final rule, the Secretary 
determined that a review of the previous policy--primarily concerning 
the exemptions for employer payments to employees and borrower payments 
to CLOs--was needed. The review would particularly focus on the final 
rule's impact on consumers. The Secretary 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 multimillion 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 views of all 
interested parties

[[Page 29240]]

were heard, the Department published a ``notice of written comment 
period and informal public hearing'' (58 FR 38176), inviting testimony 
and written comments on the following four provisions of the final 
rule:
     Issue 1--The ``employer-employee'' exemption. Section 
3500.14(g)(2)(ii) of the 1992 final rule, which provided that Section 8 
of RESPA does not prohibit ``an employer's payment to its own employees 
for any referral activities * * *.''
     Issue 2--The ``computer loan origination'' (CLO) 
exemption. Section 3500.14(g)(2)(iii) of the 1992 final rule, which 
provided 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 is provided the borrower.''
     Issue 3--Preemption policy. Section 3500.13(b)(2) of the 
1992 final rule, which provided that ``in determining whether 
provisions of State law or regulations concerning controlled business 
arrangements are inconsistent with RESPA * * * 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.'' \3\
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    \3\ As discussed, infra, HUD announced in a July 21, 1994, 
proposed rule that it would not propose new rules on this issue and 
would consider preemption questions on a case-by-case basis. Since 
HUD has not changed its position on this issue, this final rule does 
not address the issue further.
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     Issue 4--Controlled business disclosure policy. Section 
3500.15(b)(1) of the 1992 final rule, which provided for a written 
disclosure in controlled business situations regarding the ownership 
and financial relationships between referring and referred-to parties, 
and for certain timing and other methods for disclosure.
    On August 6, 1993, HUD conducted a public hearing, which produced 
testimony and documents from 36 interested parties. The request for 
written comment generated 1,526 public comments on these four issues.

D. The 1994 Proposed Rule

    Following a detailed examination of the testimony and comments, HUD 
published a proposed rule (59 FR 37360, July 21, 1994) \4\ containing 
substantial revisions to the RESPA regulation. The proposed rule 
discussed the views expressed in response to the pre-rule solicitation 
of public comment and took positions on each of the earlier-presented 
four major issues, inviting further public comment in light of the 
additional revisions to the RESPA regulation that HUD was proposing.
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    \4\ A more comprehensive discussion of the issues presented, the 
Secretary's initial position on further amendment of the RESPA 
regulations, and a summary of the hearing testimony and the comments 
received are contained in the preamble of the proposed rule.
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    The proposed rule reflected the Secretary's conclusion that the 
1992 final rule's employer-employee exemption was too broad. In the 
proposed rule, HUD proposed to withdraw this exemption because it 
compromised the statute's purpose of protecting the consumer from being 
referred to settlement service providers because of financial gain to 
the referrer, rather than because of the quality and price of the 
services. The proposed rule would have removed an exemption that 
permitted an employer to pay employees referral fees for referrals to 
an affiliate business entity.\5\ The proposed rule rejected the view 
that all employer payments to its employees for referrals to third-
party settlement service providers should be exempt. When HUD viewed 
the payments from the perspective of the consumer, it was clear that 
payments by the employer to an employee, who performs settlement 
services, for third-party referrals were indistinguishable from 
payments directly from the third-party settlement service provider. 
While HUD has the authority to exempt all employer payments for third-
party referrals under its Sections 8(c)(5) \6\ or 19(a) authority, the 
Secretary concluded in the proposed rule, as a policy matter, that such 
a broad exemption was inconsistent with the purposes of RESPA. In this 
final rule, the Secretary is exercising this authority under Sections 
8(c)(5) and 19(a) to exempt employer payments to their employees in 
those circumstances where adequate consumer protection exists.
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    \5\ This proposal was consistent with congressional admonitions. 
See H.R. Rep. No. 123, 98th Cong., 1st Sess. 76 (1983) (controlled 
business provisions are not intended to change current prohibitions 
against unearned fees, kickbacks, or other things of value in return 
for referrals of settlement service business).
    \6\ In accordance with section 8(c)(5) of RESPA, HUD consulted 
with the other agencies listed before exercising its authority under 
section 8(c)(5).
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    In adopting the proposed rule, the Department also recognized that 
Congress had clearly established that controlled business arrangements 
were permissible under certain conditions. In the interest of avoiding 
undue interference with the internal operations of controlled 
businesses, expressly permitted under the 1983 amendments to RESPA, the 
proposed rule would not have prohibited 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:
    1. No employee or agent could 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 affiliate business entity; and
    2. The compensation of agents or employees who routinely are in 
direct contact with the public could not be based, in whole or in part, 
on the value or number of referrals made to affiliated entities.
    These clarifications were 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, or his or her employer's, financial 
interests, without requiring HUD to interfere unduly with the internal 
operations of controlled business arrangements.
    As it relates to the regulation of payments to CLO systems, the 
proposed rule reflected a determination that it was desirable to amend 
the final rule to establish minimum standards for qualified systems, 
payments to which would be exempt from Section 8. Under 
Sec. 3500.14(g)(3) of the proposed rule, ``qualified'' systems would 
have had to meet a number of specific regulatory requirements.\7\ The 
proposed rule also asked for advice as to whether to create a similar 
exemption for payments by lenders to operators of ``qualified'' CLOs.
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    \7\ These requirements are described in Part II, Section C, of 
this preamble.
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    To assist in the promulgation of a final rule, the Secretary 
requested comments and invited information on the effect of all of the 
above proposals on the settlement services industry and consumers. As 
an additional vehicle for obtaining public input, on September 30, 
1994, as part of the rulemaking process, the Department conducted an 
open house for operators of CLO systems to demonstrate their systems to 
HUD and to the public.8
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    \8\ Twenty-one CLO operators accepted the Department's 
invitation and demonstrated their systems to officials of the 
Department and to the public during an all-day session on September 
30, 1994.
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    Later in the rulemaking process, in August and September 1995, the 
Department convened two working group meetings of interested industry, 
government, and public officials, to obtain their individual input and 
to

[[Page 29241]]

further explore the development and use of CLOs.

E. Today's Final Rule

    Today's final rule addresses the comments received in response to 
the proposed rule and considering the comments, promulgates rules 
relating to Issues 1 (the employer-employee exemption), Issue 2 
(payments to CLOs), and Issue 4 (controlled business disclosure 
format). With respect to Issue 1, the rule withdraws the employer-
employee exemption and introduces three more-limited exemptions 
designed to recognize the variety of business organizations without 
doing damage to RESPA's core objective of consumer protection. On Issue 
2, the rule withdraws the CLO exemption and issues a related Statement 
of Policy that illustrates how CLO payments and activities are analyzed 
under the existing and new RESPA regulations. As discussed, supra, 
respecting Issue 3, the proposed rule did not propose any changes to 
the preemption provisions, for the reasons explained in the proposed 
rule, and, therefore, requested no comments. On Issue 4, the rule 
revises the Controlled Business Arrangement Disclosure Statement.
    In reading this preamble, the reader should be aware that HUD's 
RESPA rule was recently streamlined through a separate rulemaking (61 
FR 13232, March 26, 1996). This streamlining caused several provisions 
of the RESPA rule to be renumbered. Except as is otherwise indicated in 
the context of the preamble, this rulemaking refers to provisions by 
their current section number, incorporating all revisions to date as a 
result of the streamlining and today's rulemaking.

II. Analysis of Issues in Final Rule

A. Overview of the Public Comments

    The Department received 354 \9\ comments on the July 21, 1994, 
proposed rule. Of these, 100 were from attorneys, most of whom stated 
that they were, or previously had been, actively engaged as settlement 
lawyers. Only 2 comments from attorneys were identified by the writers 
as written on behalf of clients; the remaining 98 appeared to be 
individually originated comments by the attorneys or law firms on their 
own behalf.\10\ An additional 73 comments came from bank holding 
companies, banks, or other mortgage lenders; comments were received 
from 46 real estate brokers; 34 comments were from mortgage brokers; 19 
were identifiable as multi-service real estate service organizations; 
\11\ 14 comments were from title company executives, 9 comments came 
from credit unions; 8 from CLO service providers; and 6 commenters 
identified themselves as consultants. One comment was received from a 
journalist, one from a mortgage insurance firm, one from a credit 
reporting service, and one from a student, and three comments were 
received from persons whose professional interest in the rule could not 
be determined.
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    \9\ Three-hundred fifty-seven comments were received, but three 
were found to be duplicate copies of other comments.
    \10\ Not included as ``attorney comments'' were comment letters 
written by house counsel for banks, lenders, or other organizations 
communicating, through counsel, on their own behalf.
    \11\ It was not always clear from a commenter's remarks, or from 
the commenter's business letterhead, whether the commenter spoke for 
a multiple-service entity. Accordingly, some commenters classified 
here as lenders, mortgage brokers, real estate brokers, or other 
categories may also, in fact, be multiple-service business entities.
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    Twenty-two State, local, or regional organizations representing 
portions of the real estate brokerage, lending, and settlement 
industries provided comments, as did 16 organizations classified as 
national advocacy organizations.
    Attitudes toward the proposed rule varied greatly, not only 
according to the professional background of the commenters, but also 
according to whether a commenter was engaged in a controlled business 
arrangement. For this reason, lenders and other settlement service 
providers expressed a wide variety of views concerning the rule. The 
majority (but by no means all) of the comments received from real 
estate brokers and agents favored the existing regulatory structure 
(the 1992 final rule) and sought to discourage changes in the rule 
which, they argued, would impede their ability to provide benefits to 
consumers.
    Issue 1 (the employer-employee exemption) attracted the greatest 
attention among commenters. Virtually all commenters, on both sides of 
the issue, were at least moderately dissatisfied with the proposed 
rule's revisions. Commenters who opposed any authorization of referral 
payments frequently thanked the Department for the effort made in the 
proposed rule to limit the practice, but virtually all of these 
commenters were displeased that the Department was proposing to exclude 
from RESPA coverage certain compensation to managerial employees in 
controlled businesses.
    On the other hand, commenters who wanted referral payments to 
employees to continue to be allowable expressed strong opposition to 
the proposed rule's limitation on such payments. Additionally, many of 
these commenters asked for clarifications concerning the scope of the 
``managerial'' exemption.
    Issue 2 (the CLO exemption) was the second-most-frequently 
addressed subject. A significant minority of the commenters who 
addressed the issue credited the Department with a good effort at 
better defining ``CLO services'' in the proposed rule, and there was 
some positive support for the HUD definition. However, most commenters 
who addressed the CLO question found fault with HUD's proposed 
disposition of the issue, with the proposed CLO definition, or both. A 
wide variety of suggestions for further refinement of the definition 
was provided.
    Issue 3 (the preemption issue) drew a few comments, even though the 
Department had not requested any comments on it and had determined in 
the July 21, 1994 proposed rule not to propose new rules on this issue. 
The Department stated in the proposed rule that ``setting out 
comprehensive and informative preemption standards present[ed] an 
almost insurmountable task, in the absence of a wide array of specific 
fact situations that are raising preemption issues.'' The Department 
determined to consider preemption questions on a case-by-case basis. 
Accordingly, the final rule does not address this issue.
    Issue 4 (the controlled business arrangement disclosure statement) 
attracted a significant amount of comment. In general, commenters on 
both sides of the other issues were undisturbed by what they perceived 
as the somewhat minor changes in the controlled business disclosure 
statement that HUD proposed to adopt. There were, however, a number of 
technical suggestions, and significant criticism of what was regarded 
as the unduly negative tone of language proposed to be employed in the 
Appendix D format to suggest that consumers shop for services. 
Additionally, commenters continued to identify unresolved questions 
about the disclosure form and to suggest modifications of both its 
language and its applicability.
    What follows is a more comprehensive discussion of the views 
expressed by the commenters on Issues 1, 2, and 4, together with the 
Department's rule-making decisions.

B. Issue 1: Withdrawal of Employer-Employee Exemption

1. In General
    In the proposed rule, the Department proposed the withdrawal of the 
existing regulatory exemption that permits

[[Page 29242]]

employers to pay referral fees to their own employees for referring 
settlement service business to business entities, including those 
within an affiliate relationship. This exemption applied whether or not 
employers were in an affiliate or ``controlled business'' relationship, 
but practically only benefited affiliate arrangements, as an employer 
was unlikely to compensate its employees for referrals to unaffiliated 
providers. The proposal included a limited exemption for payment of 
bonuses for managerial employees who did not deal with the public, 
provided such bonuses were not 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.
2. The Public Comments
    Virtually all of the comments from attorneys approved of the 
proposal to eliminate the employer-employee exemption. (About 30 
percent of all the comments received on the proposed rule were from law 
firms providing settlement services, and the overwhelming majority of 
attorney comments were focused upon the employer-employee exemption.) 
The combined comments of the Attorneys General of 11 States commended 
the Department for focusing the rule's impact on consumers and for 
articulating, as the first of HUD's guiding principles, the protection 
of the consumer, rather than the mediation of industry interests. They 
called the proposed rule a ``vast improvement'' over the November 2, 
1992, rule.
    Some major industry organizations expressed support for the 
withdrawal of the exemption. For example, the Mortgage Bankers 
Association expressed its ``substantially favorable reaction'' to the 
changes HUD was proposing. MBA called employer-paid referral fees 
``fundamentally inconsistent with the purposes of RESPA,'' and approved 
the proposed rule's elimination of the exemption for fees paid to 
employees with direct contact with consumers.
    The basic premise of these commenters, who wanted a total 
withdrawal of the employer-employee exemption, was that Section 8(a) of 
RESPA should be construed to prohibit all ``compensated referrals,'' 
and any standard less than this bright line test opened up this civil 
and criminal statute to unnecessary ambiguity and uncertainty. These 
commenters generally maintained that no exceptions or exemptions should 
be made.
    In contrast, comments favoring the retention of the employer-
employee exemption argued that the 1992 formulation of the regulations 
had not yet had time to work and be measured, much less to be found 
insufficient. One diversified real estate, finance, management, and 
insurance company from Illinois argued that ``controlled business 
arrangements'' was an unfortunate misnomer that left the impression 
that great control was being exercised over consumers. The commenter's 
own company, it was claimed, had a ``capture rate'' of only around 14 
percent of its real estate customers choosing to use its mortgage 
services:

    This means that at least 86 percent of those customers still 
seek a different mortgage provider. This hardly represents a 
coercive customer problem that's needing more regulation * * *. The 
real danger in attempting to further regulate companies such as ours 
[is that it] will result in reduced customer choice which we clearly 
provide, and retarding competition * * *

    An Illinois local office of a nationwide finance organization 
argued strenuously that the elimination of employer-employee referral 
fees would change little.

    * * * [I]n the absence of any referral compensation, employees 
will not discontinue referring consumers to affiliate settlement 
service providers. This is because, when dealing with the consumer, 
the employee is an agent of the employer and, as such, acts in 
accordance with [his] employer's direction. * * * [A]rguments that 
not paying a referral fee to an employee will result in an employee 
acting independently of the employer's interests [are] simply not 
based on reality.

    The Real Estate Services Providers Council (RESPRO), an advocate of 
the 1992 final RESPA rule, stated its continuing support of a 
regulatory environment that would permit unfettered ``one-stop 
shopping'' for real estate services. RESPRO favored both management 
compensation and front-line employee compensation based upon profits or 
on the amount of referred business the manager/employee was responsible 
for producing. HUD's proposed rule suggesting the withdrawal of the 
exemption in the 1992 final rule has, RESPRO commented, stifled 
companies from developing one-stop shopping programs in the most cost-
efficient manner. The new proposed rule ``would significantly decrease 
cost efficiencies within diversified companies by preventing them from 
utilizing their own management to carry out the company's one-stop 
shopping goals.''
    HUD's apparent objective in regulating referrals, RESPRO argued, 
was to eliminate the possibility of adverse steering. However, HUD's 
principal concern appears to be focused on perceived abuses in the real 
estate sales industry, and the examples of abuses cited by HUD (and by 
commenters responding to the earlier request for comments) involved 
real estate brokers and salespersons. RESPRO argued that the 1994 
proposed rule's prohibition on employer-employee referral payments goes 
far beyond any rule necessary to reduce adverse steering, and that the 
rule deprives diversified companies of the efficiencies they need to 
lower costs to consumers and would place diversified companies at a 
competitive disadvantage, relative to independent competitor companies.
    Comments from the National Association of Federal Credit Unions 
(NAFCU) also opposed the elimination of the RESPA exemption for 
employer-employee referral fees.
    Another commenter who opposed the elimination of the exemption and 
stated its support for the 1992 RESPA regulation was the National 
Association of Neighborhoods (NAN). NAN's comments expressed concern 
that the proposed rule's changes would reduce competition and consumer 
choice by limiting the ability of one class of providers--diversified 
companies--to offer homebuyers services on a cost-efficient basis. NAN 
also expressed concern about the effect of the revisions on the 
Community Reinvestment Act, noting the Federal Reserve Board's earlier 
comments that restrictions on employee referral-based compensation 
might be ``detrimental to future innovations and developments in 
community lending.''
    A mortgage finance consultant from Virginia cited recent 
legislative proposals in Pennsylvania that would restrict the 
percentage of business referrals permitted in a realtor-mortgage banker 
controlled business arrangement. The commenter noted that Congress had 
rejected similar proposals in the 1983 amendments to RESPA:

    In my experience, all of the attempts to limit CBAs have been 
motivated by industry, not to protect consumers or to provide lower 
fees or better service, but to keep another industry from entering 
the business. I would urge HUD to ensure that congressional intent 
is followed by allowing CBAs to exist in the states unfettered by 
the kinds of restrictions that were rejected in the 1983 CBA 
amendments to RESPA.

    Many supporters of controlled business arrangements reiterated 
their earlier contentions that ``one-stop

[[Page 29243]]

shopping'' leads to greater efficiency in the settlement process and to 
cost-savings for borrowers. Several of these commenters objected 
strongly to the proposed withdrawal of the employer-employee exemption, 
and urged that the Department reconsider and retain the existing 
employer-employee exemption.
    The National Association of Realtors (NAR) supported HUD's 
clarification of the meaning of the November 2, 1992 rule, as set forth 
in the preamble of the July 21, 1994 proposed rule, which indicated 
that real estate agents were normally ``independent contractors'' and 
therefore not employees within the meaning of the rule. Such agents, 
therefore, could not receive referral-based compensation. NAR counsel, 
however, requested clarification that an employer may legitimately 
compensate its own employees ``for the generation of its own 
business.'' Another commenter (Commercial Credit Corporation) wanted a 
clarification in the final rule that RESPA did not apply to the 
compensation arrangements for the generation of settlement service 
business by either an employee or an agent of a settlement service 
provider, in a particular multi-layered business structure, who 
originated settlement services business exclusively for that settlement 
service provider.12
---------------------------------------------------------------------------

    \12\  The commenter described a circumstance in which a mortgage 
broker entered into an exclusive agency agreement with a lender to 
deliver mortgage loan applications to the lender. The mortgage 
broker used its exclusive agents (who were not otherwise engaged in 
performing settlement services) to generate these loans. The 
commenter represented that the consumer was at all times aware of 
the exclusive relationship between the agent and the mortgage broker 
and lender principals.
    Payments by a mortgage lender to its exclusive agents reasonably 
related to services actually performed, in the circumstances 
described, fall under the exemption in Section 8(c)(1)(C) and 24 CFR 
3500.14(g)(1)(iii). Thus, HUD concluded that the requested 
clarification to address the issue raised by the commenter was not 
necessary.
---------------------------------------------------------------------------

3. The Final Rule's Approach--Overview
    After a complete review of all comments and points of view, the 
Department withdraws the broad employer-employee exemption. HUD has 
determined that a broad exemption, as contained in the 1992 rule, 
unnecessarily allows persons who serve consumers and gain their trust 
to receive referral fees, in contravention of the express intent of 
Congress in enacting Section 8(a). However, to allow controlled 
business arrangements to operate and provide beneficial services and 
packages of services to consumers, the rule establishes three 
exemptions for permissible payments by employers to bona fide 
employees. Specifically, the exemptions permit employer payments to 
their own bona fide employees for referrals of business if:
    (a.) The employee is a managerial employee, and the payment is not 
calculated as a multiple of the number or value of referrals.
    (b.) The employee does not perform settlement services in any 
transaction; prior to the referral the employee provides the person 
being referred a written disclosure in the format of the Controlled 
Business Arrangement Disclosure Statement, set forth in Appendix D to 
this part; and the referral is to a settlement service provider which 
has an affiliate relationship with the employer or in which the 
employer has a direct or beneficial ownership interest of more than one 
percent. For purposes of this exemption, the marketing of a settlement 
service or product of an affiliated entity, including the collection 
and conveyance of information or the taking of an application or order 
for the services of an affiliated entity, does not constitute the 
performance of a settlement service. Under the exemption, marketing of 
a settlement service or product also may include incidental 
communications with the consumer after the application or order, such 
as providing the consumer with information about the status of an 
application or order; marketing may not include serving as the ongoing 
point of contact for coordinating the delivery and provision of 
settlement services.
    (c.) The payment is to that employer's own employees for generating 
business for the employer itself--but not its affiliates. The 
Department believes that it was clear that such payments were 
permissible payments under RESPA. However, because some commenters 
indicated uncertainty regarding this position, and it is HUD's intent 
that such payments continue to be permissible, the rule clarifies the 
issue with a new exemption providing that payments made to bona fide 
employees for generating business for their employer are permissible 
under Sec. 3500.14(g)(1)(vii). This exemption means that an employee 
may accept payments for referrals to its own employer. In an affiliated 
relationship, the employer is only the business entity for whom the 
employee directly works.13
---------------------------------------------------------------------------

    \13\  In addition, pursuant to 24 CFR 3500.14(g)(3), any person 
who is in a position to refer settlement service business, such as 
an attorney, mortgage lender, real estate broker or agent, or 
developer or builder, may continue to receive payments for providing 
additional settlement services as part of a real estate transaction, 
if such payments are for services that are actual, necessary, and 
distinct from the primary services provided by that person.
---------------------------------------------------------------------------

    These new exemptions provide that payments must be to a bona fide 
employee. Individuals may not be hired on a part-time basis to make 
referrals because of their access to consumers as settlement service 
providers. Sham employment arrangements, such as a title company paying 
a one hour ``salary'' to a real estate agent who provides a referral, 
and issuing a W-2 for ``services'' rendered to justify compensating a 
referral, are, and will continue to be, violations of RESPA.
    The Secretary has authority to create exemptions under Section 
19(a) of RESPA for classes of transactions as may be necessary to 
achieve the purposes of the Act. 12 U.S.C. 2617(a). In addition, under 
Section 8(c)(5) of RESPA, the Secretary may create regulatory 
exemptions for ``such other payments or classes of payments,'' after 
consulting with various Federal agencies. 12 U.S.C. 2607(c)(5). The 
three exemptions created under this final rule are issued pursuant to 
the Secretary's clear authority to create reasonable exemptions to 
further the purposes of the Act.
    In creating these new exemptions, HUD is not directly regulating 
wages to bona fide employees. Rather, HUD is creating an exemption for 
certain payments within an employment context that otherwise would be 
prohibited by Section 8(a). The Secretary believes that such payments 
to bona fide employees are not designed as a subterfuge to facilitate 
kickbacks among affiliated companies.
    The exemptions for managerial employees and employees who do not 
perform settlement services in any transaction are explored in detail 
below.
4. Managerial Employees
    a. The Public Comments. Several commenters supported allowing 
compensation to managerial employees based on referrals and criticized 
the formulation regarding managerial compensation in HUD's proposed 
rule. NAR supported the idea of compensation for managerial employees 
or others who are not sales agents or otherwise involved in the direct 
provision of settlement services. At the same time, NAR asked that the 
proposed definition of ``managerial employee'' clarify that mere 
possession of a broker's license or a salesperson's license to sell 
real estate would not affect an individual's status as a managerial 
employee. Many States, NAR indicated, require managers in the real 
estate

[[Page 29244]]

business to hold licenses as brokers or sellers.
    NAR counsel, responding separately to the proposed rule on behalf 
of the organization, further elaborated on the national organization's 
position regarding referral payments. He distinguished ``primary 
services'' from ``secondary services,'' and argued:

    NAR recognizes that the historic and legitimate thrust of 
Section 8(a) of RESPA has been to prohibit compensation for 
referrals by persons who are ``in a position to refer settlement 
business,'' understood as referring to real estate professionals 
providing settlement services (``primary services'') to whom 
consumers may look for advice regarding sources of other required 
settlement services (``secondary services'') with the expectation 
that such advice will be based on professional knowledge and 
experience and not tainted by additional compensation payable by the 
highest bidder for the referral.

    He suggested that HUD prohibit referral-based payments for any 
individual who has significant contact with consumers regarding the 
provision of a settlement service, where a principal part of the 
individual's income consists of compensation based on settlement 
services performed for the person's employer or an affiliate. The 
prohibition against sharing of compensation related to a ``secondary 
service,'' NAR counsel argued, could apply to all services performed by 
the secondary service provider and not just to specific referrals. He 
asserted that HUD could more easily enforce his suggestion than HUD's 
proposal, since HUD's rule evidently required proof of an actual 
``referral'' by the initial service provider.

    * * * [A] regulation based on identification of actual referrals 
will likely prove unworkable, leading either to no enforcement or to 
adoption of presumptions that might exceed HUD's authority.

    Additionally, NAR counsel argued that the proposed rule's 
``managerial exemption'' would unduly complicate the ability of a 
diversified company to devise workable incentive compensation schemes 
for managers. NAR counsel further suggested a change to the definition 
of ``managerial employee'' to exclude situations wherein a managerial 
employee may, from time to time, act as a direct service provider. (In 
such circumstances, the NAR-suggested definition would not permit 
referral-based compensation in addition to the sometime-manager's 
commission.) NAR counsel added, in comments varying somewhat from the 
stated NAR position:

    In general, we do not believe that the permissibility of 
compensation should turn on status as an ``employee'' vs. 
``independent contractor,'' provided that the independent contractor 
is one whose services are provided exclusively for a single 
principal and who is, therefore, in the eyes of the consumer, 
indistinguishable from an employee.

    MBA stated its concern about the lack of clarity in the 
``managerial employees'' exemption in the proposed rule, seeking to 
narrow the category of persons eligible for payments for referrals:

    We believe it is imperative to have more detail in the 
definition, so that the lending and real estate broker industries 
will know exactly where the line is between `managerial employees' 
and those that have `routine contact with the public.' For example, 
if a person manages a branch office and consequently has supervisory 
control over all of the staff that deal directly with the public, in 
which category does that person fall? We strongly urge that such a 
person [not be] eligible for the exemption because of his or her 
involvement with the public implicit in the supervisory role * * *.
    * * * [U]sing real estate offices as examples, office managers 
and real estate brokers can exercise considerable influence over the 
activities of the independent agents through manipulation of the 
terms and conditions of their work * * *.

    MBA asked that the term ``managerial'' be further defined to 
include only individuals working at ``higher corporate levels'' where 
there would be no opportunity to steer consumers. It was urged that the 
definition be amended to clarify that only employees who do not work in 
offices where consumers regularly visit could qualify for the 
managerial exemption. The National Association of Mortgage Brokers 
(NAMB) also asked that HUD revise the rule to elaborate on the 
definition of ``employees'' to make clear that the term excludes 
independent contractors and real estate agents.
    RESPRO favored both management compensation and front line employee 
compensation based upon profits or on the amount of referred business 
the manager/employee was responsible for producing. RESPRO claimed that 
the proposed rule's restrictions on compensation for managerial 
personnel were so vague that they would, effectively, prohibit all 
management compensation in one-stop shopping programs. One of HUD's 
Fact/Comment Illustrations in the proposed rule indicated that 
``Nothing in the RESPA rule prohibits bonuses or other compensation 
based, in part, on the generation of business by A (a lender) to B and 
C (a title company and escrow company) being paid to managerial 
employees who are not routinely in contact with customers.'' However, 
RESPRO claimed, the text of the proposed rule is not consistent with 
the statement in the quoted Fact/Comment illustration.
    The American Bankers Association (ABA) objected to the managers' 
compensation provision of the proposed rule as ``too narrow,'' and 
advocated that all employees of banking institutions should be able to 
receive compensation or bonuses based on their referral of business 
within the bank or to affiliates. Even if HUD were to retain only the 
managerial exemption, the rule needs modification, ABA said, to clarify 
the circumstances under which an employer could legitimately compensate 
a manager.
    In contrast, many of the attorneys commenting on the rule 
(virtually all of whom supported the withdrawal of the employer-
employee exemption) were highly critical of the proposal to allow the 
payment of referral-related bonuses and compensation to managerial 
employees in controlled businesses, under conditions set out in the 
proposed rule. The managerial exemption was regarded as an ``enormous 
loophole'' in the new rule that would substantially overwhelm the 
benefits these commenters expected from the proposed elimination of the 
exemption for fees to line employees. Typical of attorney comments 
received was one from an Alabama practitioner who said he ``applauded'' 
HUD's partial change of position ``to eliminate the objectionable 
`employee bonus/kickback scheme'.'' However, the commenter said, ``by 
creating the manager bonus loophole, you have simply encouraged and 
promoted indirect schemes to circumvent basic consumer protection.'' 
The attorney ``implored'' HUD to ``stop playing politics with the basic 
rights of consumers that the Real Estate Settlement Procedures Act was 
designed to safeguard.'' Similar views were expressed by a Memphis 
attorney:

    If HUD allows bonuses to be paid to real estate managers even 
though the bonuses are not strictly calculated on the basis of the 
referral business, but merely takes it into account as a factor, the 
managers and the agents will find a way to tie the bonuses directly 
to the amount of business generated. HUD will have ``opened the 
door'' to the abusive practices of kickbacks, tie-ins, fee 
splittings, controlled business practices, and conflicts of interest 
that existed prior to RESPA and which RESPA has largely eliminated.
    Once the door is opened, everyone will stampede through it.

    The American Bar Association's General Practice Section and 
Standing Committee on Lawyers' Title Guaranty Funds echoed the 
``loophole'' complaint of other practitioners:


[[Page 29245]]


    Prohibiting ``one-to-one'' Basis Referral Fees will not 
eliminate the payment of referral fees* * *. Allowing [managerial] 
payments* * * would be a dramatic departure from the Act's 
congressional intent and basically would render the previously 
mentioned withdrawal of the employer-employee exemption impotent.

    The combined comments of the Attorneys General of eleven States 
opposed the proposed new ``managerial'' exemption.

    HUD cannot allow compensation systems, even for managerial 
employees, which depend, even in part, on the level of employee 
referrals to affiliated companies* * *. [Managerial referral 
compensation] will still create strong incentives within the company 
to make as many referrals to affiliated companies as possible, 
regardless of whether those referrals are in the consumers' best 
interest or not.

    A large number of other real estate professionals also submitted 
objections to the proposed modified managerial exemption. These 
commenters, along with most of the lawyer-commenters, believed that 
controlled business arrangements constituted unfair competition, or 
that they invariably would lead to increased costs for consumers. 
Whether the payment is to an employee who is in contact with the 
consumer for a business referral generated by that employee to the 
employer or to an affiliate business entity, or whether the referral-
related payment is to a managerial employee, the objectors believed 
that the effect would be the same: A determination would be made to 
refer business based on the dollar benefit of the referral, rather than 
on considerations of what would be most advantageous to the consumer.
    Similar views were expressed by a New Jersey real estate broker who 
said that he was ``strongly in favor of any changes in RESPA which 
would ban payments for referrals from mortgage lenders, title insurers, 
escrow agents and other real estate settlement service providers.'' 
``[I]t would seem very obvious,'' the realtor wrote, ``that payment of 
referral fees would result in the agent selecting the service 
provider.''
    The Coalition to Retain Independent Services in Settlements 
(CRISIS), an organization of independent settlement service providers, 
responded to the proposed rule's referral provisions arguing for a 
total ban on referral fees and referral-based compensation factors to 
employees and managers. Consumer Federation of America also called for 
a total ban on referral-based compensation involving affiliate 
entities, as did the National Association of Mortgage Brokers (NAMB).
    b. The Final Rule's Approach. The rule revises the proposed rule's 
formulation and defines a ``managerial employee'' as one of a limited 
class of employees who do not routinely deal with the public, but who 
function in a management or executive capacity. It makes permissible 
certain bonuses and payments to these managerial employees. Active real 
estate agents, who are independent contractors, cannot be managerial 
employees, although a managerial employee can hold a real estate 
brokerage or agency license. HUD agrees with NAR counsel that managers' 
``mere status as licensed brokers or salespersons should not exclude 
them from being `managerial employees' if their principal functions'' 
are the types of managerial functions indicated in the definition, 
rather than face-to-face dealings with consumers.
    The rule provides that managerial employees in controlled business 
arrangements may be paid bonuses based on performance criteria, 
including profitability, capture rate or other thresholds, but the 
bonus may not be directly calculated as a multiple of the number or 
value of settlement transactions referred to a business entity in an 
affiliate relationship. Thus, for example, the final rule does not 
prohibit a managerial employee from receiving an annual bonus based on 
an affiliate business entity capturing a percentage of the business 
from the managerial employee's unit (e.g., a $1,000 bonus for an 
affiliated lender's 10% capture rate of real estate brokerage customers 
and a $2,500 bonus for a 20% capture rate). Managerial employees may 
not, however, receive a bonus or other compensation calculated as a 
multiple of the number or value of referrals of settlement service 
business to a business entity in an affiliate relationship. Thus, a 
compensation system that awarded a managerial employee $20 for every 
referral continues to be prohibited, as would a compensation system 
that awarded a managerial employee $100 for every 5 referrals.
    In the rule, the phrase ``does not routinely'' is used to establish 
a ``de minimis'' standard for consumer contact. HUD intends the phrase 
``does not routinely'' to mean that managerial employees who 
occasionally deal with consumers, which is almost inevitable in small 
offices, are not precluded from receiving year-end bonuses because of 
this minimal contact. Similarly, HUD intends this phrase to allow a 
managerial employee who performs and is compensated for occasional 
settlement services (not more than three transactions a year) to be 
eligible for this exemption. This standard will effectively limit the 
class of managerial employees who may receive these types of bonuses to 
those ``whose contacts with consumers are only casual or peripheral, at 
most, and who do not occupy the special positions of trust, arising 
from their relationship to consumers as well as the arcane nature of 
certain of the services required, that are developed by real estate 
agents or the comparable providers of other services,'' as suggested by 
NAR.
    HUD has chosen to use its exemption authority under Section 
8(c)(5), having consulted with other Federal agencies as required by 
that provision, as well as the authority under Section 19(a) of RESPA 
to permit these payments which would otherwise be prohibited by the 
statute. As noted in the proposed rule (59 FR at 37365), Congress has 
clearly determined that RESPA does not prohibit controlled business 
arrangements, with certain conditions. The final rule's exemption 
permitting managerial employees to receive payments of a bonus based on 
criteria relating to performance conforms with Congress's intent to 
permit controlled business arrangements to operate.
    This exemption is appropriate because managers do not routinely 
deal directly with consumers. Therefore, the manager is not in a 
position of trust with the consumer to directly influence the 
consumer's choice of settlement service providers. By providing this 
exemption, the regulation will not require HUD to interfere unduly with 
the internal operations of controlled business arrangements. The 
exemption reflects the Department's acknowledgement that it would be 
difficult to enforce RESPA in circumstances which would require 
detailed scrutiny of complex compensation arrangements for management 
in affiliated settings.
    The exemption draws a line, however, for payments to managers that 
are transaction based. This regulation does not allow payments to 
managerial employees which mimic referral fees. Thus, where a payment 
of a bonus to a managerial employee is calculated as a multiple of the 
number or value of referrals of settlement service business to an 
entity in the controlled business arrangement, it would appear to be a 
payment in violation of the Act and contrary to the intent of Section 
8(a).
    The foregoing provisions have been amplified by a revised 
Illustration 12 that is being added to Appendix B.

[[Page 29246]]

5. Employees Who Do Not Perform Settlement Services in Any Transaction
    a. The Public Comments. Several commenters advocated, either 
directly or indirectly, that the rule allow businesses to pay bonuses 
for referrals to business entities in affiliate relationships to those 
employees who do not perform settlement services. Many of these 
comments focused on the way in which a host of Federal and State 
regulations affect the way particular industries do business and are 
structured. These comments urged HUD to allow compensation systems 
which are sensitive to these structures.
    ABA criticized HUD's proposed rule as insensitive to the structure 
of banks, noting that, under the proposed rule, if the loan were made 
by the bank itself, employees could be compensated for generating that 
business, but if the loan were made by a subsidiary mortgage company, 
such compensation would be a prohibited referral fee.

    Individuals seeking a residential mortgage loan who enter a bank 
and inquire as to the availability of such a loan do so voluntarily 
with the goal of receiving information and possibly applying for and 
obtaining such a loan. Whether or not the bank is structured * * * 
to process such loans within the bank, the bank holding company or a 
subsidiary or affiliate of each makes absolutely no difference to 
the consumer and in no way affects his or her decision * * * whether 
or not to do business with the bank * * *. Providing information in 
order to expedite the customer's objective is appropriate and 
beneficial to all parties. The structure of the mortgage lending 
operation within the bank, its affiliate, or within the bank holding 
company is inconsequential and shouldn't trigger any RESPA activity.

    Other banker-commenters echoed the ABA's concern that the proposed 
rule's referral-related modification was a poor fit for the varied 
structures of banks and their integrated or affiliated real estate 
service entities. A Minnesota bank holding company was among several 
banking organizations arguing that there was a fundamental difference 
between a referral by a bank employee to the bank's mortgage lending 
affiliate, and the type of referral that might involve another party to 
a real estate transaction, e.g., from a real estate agent to a mortgage 
lender:

    If an individual contacts a bank to inquire about a mortgage 
loan * * * it is because the individual perceives the bank as a 
lender that would offer that type of loan. The customer is not going 
to the bank because he or she is seeking an objective, unbiased 
referral to another lender. The customer * * * expects that whatever 
bank they talk to will promote its own products. If that bank does 
offer [mortgage loans] they would simply proceed to give information 
to the potential customer * * * If, however, a bank holding company 
[has formed] a separate subsidiary to handle * * * mortgage 
lending[,] the proposed rules add additional burdens to that bank by 
limiting its ability to design a compensation system for managers 
that promotes the affiliate relationship and by requiring an 
additional layer of disclosure.
    * * * [E]xcessive requirements place the bank with a separate 
mortgage lending subsidiary at a disadvantage compared to banks that 
* * * offer such products within the bank itself.

    ABA also asked that HUD reconsider this aspect of the rule in light 
of the strong framework of existing bank regulation, State and Federal:

    Unless appropriately modified, this proposed regulation 
penalizes banks, their affiliates, bank holding companies * * * 
solely because of their corporate structures. These structures have 
been specifically authorized by statute, implemented by state or 
federal bank regulatory authorities and constantly monitored and 
examined for safety and soundness and compliance purposes.

    ABA asserted that the HUD regulation effectively applies only to 
banks and other banking institutions:

    It is only these institutions which will be examined on a 
periodic basis by bank examiners for compliance with this 
regulation. HUD does not maintain its own compliance examiners for 
non-bank settlement service providers. Other settlement service 
providers do not and will not face this intensive examination 
process.

    ABA recommended that bank examiners not be required to examine for 
this aspect of RESPA compliance--unless HUD intends to provide similar 
supervision and enforcement for settlement service providers other than 
banks.
    Finally, ABA's comments indicated that banks are encouraging 
employees to focus attention on compliance with the Community 
Reinvestment Act (which encourages residential lending activity in the 
banks' immediate service areas and neighborhoods). Many banks, ABA 
claimed, find it advantageous to structure lending programs to provide 
financial incentives to their employees to promote Community 
Reinvestment Act objectives. The proposed rule would eliminate these 
incentives arbitrarily, ABA stated.
    A comment from the Securities Industry Association (SIA) similarly 
objected to the proposed change in the referral fee rule. Some SIA 
members, the comment said, are part of diversified services firms, with 
mortgage lending affiliates. SIA believed that referrals made by 
securities firms' representatives should be distinguished from those 
made by employees of entities whose business is to perform settlement 
services. The commenter argued that the potential harm to consumers 
that HUD is attempting to deal with as ``inherent'' in referrals made 
by persons performing settlement services is not present when the 
referring individual is a registered securities representative. SIA 
requested reconsideration, or an express exemption from the rule 
applicable to employees of securities firms.
    Virtually all commenters who objected strongly to the proposed 
withdrawal of the existing employer-employee exemption, also approved 
of the proposed rule's retention of an exemption, albeit in a modified 
form. For example, RESPRO recommended that the (old) employee 
compensation exemption be retained, but modified to exclude any real 
estate agent, sales associate, or other person who assists consumers 
with the listing or purchase of a home, and who has regular and 
meaningful contact with consumers. This, RESPRO argued, would achieve 
the HUD policy objective of discouraging adverse steering by real 
estate agents, without interfering with the cost efficiencies of 
diversified companies.
    Several commenters also specifically advocated that the rule allow 
businesses to pay bonuses for referrals to business entities in 
affiliate relationships, to those employees who are financial service 
representatives (FSRs), i.e., persons employed in affiliate businesses 
to cross-market products. RESPRO argued that HUD's proposed rule would 
place diversified companies at a competitive disadvantage to their 
independent competitors by preventing them from compensating 
salespersons who offer more than one of the company's products or 
services, in the same manner as their independent competitors. Whereas 
independent mortgage, title, and homeowners insurance companies follow 
the traditional practice of encouraging a salesperson's productivity by 
paying him or her on a commission basis, HUD's proposed rule would 
result in diversified companies either having to hire less productive 
salespersons (persons who could not be compensated based on commissions 
which encourage productivity), or to pay three separate employees 
(instead of one) to offer three separate services (so they can properly 
motivate the FSR). RESPRO urged that HUD's final rule allow a broad 
array of compensation to management and employees for developing and 
implementing one-stop shopping, including: (1) the hiring and 
compensating of a financial services manager, i.e., a branch manager 
who is

[[Page 29247]]

responsible for supervising the performance of the real estate agent, 
title agent, mortgage loan officer, and other persons performing 
settlement services; and (2) the hiring and compensating on a 
commission basis of a ``customer services representative'' or 
``financial services representative'' who is not a real estate agent, 
but ``who markets more than one settlement service (not real estate 
brokerage)'' either in or outside of a real estate office.
    NAR counsel urged that HUD place no restrictions on the 
compensation of employees whose function is to promote sales of 
``secondary services'' (i.e., other settlement services) provided by 
affiliates at the point of sale of ``primary services.'' NAR counsel 
commented, ``Notwithstanding that these individuals have direct contact 
with consumers, we do not believe that they are in positions to develop 
the special relationships of trust and expectation that are developed 
by the `primary service' providers.''
    b. The Final Rule's Approach. In response to these comments, the 
final rule allows a limited exemption for an employer's payment to bona 
fide employees who do not perform any settlement services,14 so 
long as prior to the referral, the consumer is provided with a written 
disclosure in the format of Appendix D. This exemption will cover at 
least two situations frequently mentioned in the comments. First, this 
exemption will allow employers to pay their own bona fide employees who 
are not involved in the provision of settlement services, such as 
securities sales persons or bank tellers, for referrals of settlement 
service business to business entities in affiliate relationships. This 
approach achieves substantially the same result recommended by counsel 
to the NAR.
---------------------------------------------------------------------------

    \14\  Section 3(3) of RESPA (12 U.S.C. 2602(3)) and 24 CFR 
Sec. 3500.2 define the term ``settlement services''. However, for 
purposes of this exemption, the marketing of a settlement service or 
product of an affiliated entity, including the collection and 
conveyance of information or the taking of an application or order 
for the services of an affiliated entity, does not constitute the 
performance of a settlement service. Under the exemption, marketing 
of a settlement service or product also may include incidental 
communications with the consumer after the application or order, 
such as providing the consumer with information about the status of 
an application or order; marketing may not include serving as the 
ongoing point of contact for coordinating the delivery and provision 
of settlement services.
---------------------------------------------------------------------------

    Second, this exemption will allow employers to pay their own bona 
fide employees, whose primary function is to market the services of the 
affiliates of the employer. Employees who perform settlement services 
remain subject to Section 8's prohibitions. However, as with a 
managerial employee who holds a real estate license, a securities sales 
person or bank teller who holds a mortgage broker license would not be 
precluded from qualifying for the exemption, if the securities sales 
person or bank teller is not actually involved in the provision of 
settlement services.
    The exemption created here establishes a test: if an employer's 
payment is to an employee who does not perform settlement services in 
any transaction, the exemption applies and payments are not subject to 
Section 8 scrutiny so long as the disclosure is made.
    A primary purpose of RESPA is to prevent consumers from being 
unwittingly steered (in exchange for referral payments) by one 
settlement service provider to other particular settlement service 
providers. Although the statute, on its face, covers all referrals of 
settlement service business, regardless of who makes the referral, 
Congress did not express as high a level of concern about the referral 
activities of those who do not perform settlement services. The 
Department believes that the structure of affiliated businesses, 
particularly in the financial services industry, wherein services are 
often divided among different affiliates, is frequently a response to 
State and Federal laws, such as the Bank Holding Company Act, rather 
than an attempt to circumvent RESPA. The Department believes that the 
industry should not be unnecessarily disadvantaged in competition by 
its mandated or chosen business structure. Thus, HUD has chosen to use 
its exemption authority under Section 8(c)(5) and Section 19(a) of 
RESPA to permit these payments otherwise prohibited by the statute.
    This exemption only covers payments made by the employer, not by 
the party to whom the settlement service business is referred. It also 
only applies to payments for referrals to affiliate business entities. 
Further consideration should be given to a broader exemption for 
payments to those who do not perform settlement services received 
directly from either: (1) An affiliated party receiving the referral; 
or (2) an unaffiliated party receiving the referral. However, these 
issues were not raised by this rulemaking and the record is 
insufficient to determine the impact of such changes.
    A similar proposal is included in legislation currently under 
consideration in the United States Senate. This legislation would allow 
anyone who does not receive another fee in the particular transaction 
to receive a referral fee from any source. The stated purpose of the 
proposal is to exempt from RESPA coverage ``co-branding'' and 
``affinity marketing,'' as such payments are known in the industry. The 
Department believes that this proposal also could be accomplished by 
regulation, using HUD's exemption authority under Section 8(c)(5) and 
Section 19(a) of RESPA. However, both approaches--an exemption for all 
payments to those not performing settlement services or an exemption 
for all payments for those not receiving another fee in the 
transaction--require further scrutiny. While it is desirable to 
facilitate business generation where there is little danger of the 
adverse steering that RESPA was designed to prevent, it is important to 
ensure that loopholes are not created through which such adverse 
steering can slip. HUD intends to undertake further rulemaking on this 
subject and to seek public comments.
    The Department also recognizes the market trend, described 
particularly in RESPRO's comments, that many companies are choosing to 
hire one or more individuals whose primary function is to generate 
business for his or her employer and affiliated companies. Such 
individuals are sometimes referred to as marketers or customer or 
financial service representatives.
    In response to these realities, the Department has created an 
exemption sufficiently broad to allow an employer's payments to its 
bona fide employees whose primary function is to generate business for 
entities within an affiliated relationship with that employer. The 
Department has restricted this exemption to payments to those who do 
not perform settlement services in any transaction including, for 
example, those settlement services of a real estate agent, loan 
processor, settlement agent, attorney, or mortgage broker. For purposes 
of this exemption, the marketing of a settlement service or product, 
including the collection and conveyance of information or the taking of 
an application or order for the services of an affiliate does not 
constitute the performance of a settlement service. Under the 
exemption, marketing of a settlement service or product also may 
include incidental communications with the consumer after the 
application or order, such as providing the consumer with information 
about the status of an application or order; marketing may not include 
serving as the ongoing point of contact for coordinating the delivery 
and provision of settlement services.
    As discussed above, the Department's review of the legislative 
history revealed that steering of unsophisticated consumers from one 
settlement service

[[Page 29248]]

provider to other settlement service providers was a substantial 
congressional concern. A settlement service provider frequently is 
trusted by the consumer and appears to the consumer to be an expert in 
the settlement process and to have the consumer's interests in mind. If 
a person performing settlement services is also receiving compensation 
for referring business to another settlement service provider, there is 
a potential conflict of interest. The consumer's trust in the person 
performing settlement services may cause the consumer to lose any 
natural wariness he or she might otherwise have of following the advice 
of a salesperson who derives income from sales performance. The 
consumer might ignore the conflict of interest because of trust that 
has accrued from the provision of another settlement service. A person 
who is not performing a settlement service, but is merely marketing the 
affiliated companies, is less likely to attain trusted-advisor status 
concerning the transaction. The consumer is more likely to be aware of 
and weigh carefully the incentives of a person who is not performing a 
settlement service but is generating business for that person's own 
employer and its affiliates. The application of the rule's prohibition 
to all settlement service providers, whether involved in the specific 
settlement or not, prevents two providers from swapping referrals.
    The Department is also requiring that disclosure of the affiliate 
relationship be provided to the consumer when the referral is made, so 
that the consumer will be alerted to the affiliate relationship, be 
informed of the potential business interest of the employee making the 
referral, and be able to make an educated decision about whether to use 
the recommended provider or another. Finally, the Department is 
requiring that, for the exemption to apply, the referral of settlement 
service business be to a settlement service provider that has an 
affiliate relationship with the employer or in which the employer has a 
direct or beneficial ownership interest of more than one percent. This 
requirement is consistent with congressional intent to allow controlled 
business arrangements and is responsive to comments indicating that the 
circumstances described in the exemption are those in which an 
exemption would be most beneficial. Where these requirements are met, 
the Department believes the consumer is adequately protected. The 
Department, therefore, has used its exemption authority under Section 
8(c)(5) and Section 19(a) of RESPA to permit these payments otherwise 
prohibited by the statute.
    The foregoing provisions have been amplified by revised 
Illustrations 11 and 12 which are being added by this rule to Appendix 
B.

C. Issue 2: Computer Loan Origination Systems (CLOS)

1. Background
    The 1992 final rule specifically exempted from RESPA's coverage any 
borrower payment for computer loan origination systems or CLOs. The 
exemption was intended to prevent RESPA's restrictions against unearned 
fees from unduly inhibiting the development of technology which could 
permit consumers to shop, apply for or obtain mortgage loans 
electronically. A CLO system was not defined in the 1992 rule.
2. The Proposed Rule, CLO Demonstration and CLO Working Groups
    In response to the earlier comments, the proposed rule undertook to 
establish minimum standards for a system falling within the exemption. 
HUD proposed to designate such CLO systems as ``qualified CLOs.'' 
Payments by consumers to such systems would not then be ``scrutinized 
under RESPA.'' A ``qualified'' system would:
    (a.) Provide openings for 20 or more lenders offering various loan 
products;
    (b.) Utilize selection factors for lenders that are fair and 
impartial and are designed to contribute to the efficiency and quality 
of the system;
    (c.) Provide borrowers information in a lender-neutral manner;
    (d.) Provide borrowers a CLO disclosure form before CLO services 
are performed;
    (e.) Charge all borrowers using the system the same CLO access 
fee(s) for the same service or the same components of service; and
    (f.) Be allowed to charge lenders for access only if charges are 
set forth in a written schedule of charges, charges for the same 
services and components of services are the same for all lenders on the 
system, and charges for the same services are reasonably related to the 
costs of maintenance and operation of the qualified CLO system.
    The proposed rule asked for advice on whether to create a similar 
exemption for payments by lenders to ``qualified lender'' CLOs, or 
whether to leave such systems to be governed by the general rules of 
RESPA regarding kickbacks, unearned fees and referral fees.
    As an additional vehicle for obtaining public input, on September 
30, 1994, as part of the rulemaking process, the Department conducted 
an open house for operators of CLO systems to demonstrate their systems 
to HUD and to the public. Twenty-one CLO operators accepted the 
invitation and participated in this all-day demonstration in 
Washington, D.C. At the demonstration, the capabilities of the systems, 
the number of lenders displayed, the arrangements for payment, among 
other characteristics, differed widely.
3. The Public Comments
    The public comments received on the proposed rule reflected a wide 
array of criticisms that suggested continuing problems with the rule's 
approach, or that indicated that the CLO definition HUD had arrived at 
would not work under particular circumstances. Additionally, a few 
commenters (including RESPRO, NAR, and separate comments by NAR 
counsel) not only questioned the particulars of HUD's CLO proposal, but 
also suggested that the Department lacked adequate authority under 
Section 8(b) of RESPA to establish ``qualified'' or ``non-qualified'' 
CLO systems by regulation, as proposed.
    NAR and several individual commenters advocated that the rule 
should distinguish computer systems that merely provided basic 
information about prospective lenders (e.g., a comparison of current 
interest rate quotations for particular mortgages) and those systems 
that actually may be said to ``originate'' loans by means of 
qualification (or at least, pre-qualification) of borrowers.15
---------------------------------------------------------------------------

    \15\ See further discussion later in this Issue 2 section, under 
heading (g), ``Other CLO Issues Raised by Commenters''.
---------------------------------------------------------------------------

    Many commenters objected to the proposed rule's requirement that a 
borrower's payment for CLO services be made ``outside of and before 
closing,'' arguing that this requirement would dampen or completely 
destroy the market for CLO services, and that determining the 
appropriate timing of the borrower's payment would create ambiguities 
and resulting compliance difficulties. The combined comments of the 
State attorneys general objected to the proposed rule's concept of 
``qualified'' and ``non-qualified'' CLOs and suggested, instead, that 
HUD permit only qualified CLOs to operate at all.
    The several most-frequently raised CLO issues are summarized below.
    a. The Legal Issue. RESPRO, NAR, and others raised the issue of 
HUD's authority to establish minimum standards (i.e., a ``safe harbor''

[[Page 29249]]

exemption) and to subject non-qualifying CLO systems to scrutiny. 
Noting that the proposed rule cited Section 8(b) of RESPA as a basis of 
HUD's authority to regulate in this area and to prohibit a CLO operator 
from accepting a payment from a borrower for a sham or duplicative 
charge, these commenters argued that Section 8(b) of RESPA was 
inoperative as authority for regulating CLO payments unless the CLO 
operator shared fees with a third party.
    According to the commenters, Section 8(b) governs only a ``portion, 
split, or percentage'' of any charge made or received. If the CLO 
operator is the only party charging or receiving a fee for CLO-related 
services, the commenters argued, then Section 8(b) cannot be the 
authority for the proposed borrower payment exemption ``safe harbor'' 
or for regulating non-qualifying CLOs. The commenters cited as 
authority for this position certain judicial precedents.
    HUD is aware of these cases, which never involved HUD as a party, 
but finds their reasoning not to be persuasive or their holdings not to 
be determinative of the issue. HUD believes that Section 8(b) of the 
statute and the legislative history make it clear that no person is 
allowed to receive ``any portion'' of charges for settlement services, 
except for services actually performed. The provisions of Section 8(b) 
could apply in a number of situations: (1) where one settlement service 
provider receives an unearned fee from another provider; (2) where one 
settlement service provider charges the consumer for third-party 
services and retains an unearned fee from the payment received; or (3) 
where one settlement service provider accepts a portion of a charge 
(including 100% of the charge) for other than services actually 
performed.
    The interpretation urged, that a single settlement service provider 
can charge unearned or excessive fees so long as the fees are not 
shared with another, is an unnecessarily restrictive interpretation of 
a statute designed to reduce unnecessary costs to consumers. The 
Secretary, charged by statute with interpreting RESPA, interprets 
Section 8(b) to mean that two persons are not required for the 
provision to be violated. HUD, therefore, had adequate authority to 
promulgate the rule it proposed, although it has chosen not to do so.
    b. Impact on Mortgage Brokers. On the merits of the CLO proposal, 
the Mortgage Bankers Association and many other commenters were alarmed 
about possibly unintended effects of the CLO provisions on mortgage 
brokers. First, MBA feared that merely by using a computer in its 
activities, a mortgage broker could be deemed a CLO operator, since 
mortgage brokers typically perform many or all of the functions set out 
in the ``CLO system'' definition contained in Sec. 3500.2 of the 
proposed rule. MBA anticipated that mortgage brokers might therefore 
find themselves faced with a new disclosure requirement (relating to 
CLO systems) that HUD probably did not intend. Revision of the 
definition was urged to clarify this point.
    c. Time of Payment for CLO Services. RESPRO, NAR, and many other 
commenters strenuously objected to the requirement in the proposed rule 
that for a system to qualify, payment for CLO services be ``outside of 
and before'' loan closing.
    d. Twenty-Lender Requirement. RESPRO and a large number of 
individual commenters objected to the proposed rule's requirement that 
CLO systems provide access to at least 20 lenders. RESPRO asserted that 
its members, as well as CLO operators, uniformly believed that 20 
lenders would constitute ``information overload'' and would 
discriminate against small and local CLO operators. Other commenters 
reflected that 20 lenders, each offering, perhaps, multiple variations 
of mortgage loan packages, would overtax a CLO system and increase its 
operating costs, to no useful purpose. Consumer Federation of America 
was among the very few commenters who suggested that access by 20 
lenders would be inadequate.
    e. Lender-Pay Systems. The Attorneys' General comment objected to 
the fact that the rule did not prohibit lenders from paying for CLO 
services, viewing lender-paid services as ``harboring the same 
potential for consumer abuse as direct kickbacks.'' MBA also opposed 
permitting lender-paid fees, arguing that they constitute hidden costs 
to the consumer. Consumer Federation of America strongly objected to 
lender payments, saying that they would place consumers at ``great risk 
of being steered into noncompetitive products.'' Conversely, comments 
from the National Association of Federal Credit Unions (NAFCU) urged 
HUD not only to create a parallel exemption for payments by lenders for 
qualified CLO systems, but suggested that HUD not intervene in setting 
lender-CLO operator fee schedules. NAFCU believed that negotiated fees 
for CLO services to lenders would promote competition.
    f. ``Information'' vs. ``Origination''. NAR and numerous other 
commenters urged that a sharp distinction be made in the rule between 
computer loan information systems (dubbed by NAR and others as 
``CLIs'') and computer loan origination systems (``true'' CLOs), with 
which a computer link-up can be made with lenders and a genuine loan-
application-approval process originated. Another commenter similarly 
explained that vast differences existed in the functions and 
sophistication of ``loan origination technology,'' ranging from 
relatively simple information transmittal systems to ``electronic 
decision makers'' that utilize artificial intelligence. These latter 
systems, the commenter claimed, were essentially computer underwriting 
systems. The commenter went on to recommend that HUD narrow its CLO 
definition to require that qualified systems not only collect data, but 
evaluate it.
    g. Other CLO Issues Raised by Commenters. A nationwide finance 
organization believed that the CLO system definition should not require 
the transmission of information concerning a prospective property. CLO 
systems offer the same benefits to consumers in the pre-qualification 
stage, the commenter asserted.
    Comments on the issue of CLO-related disclosures varied greatly. 
Commenters sympathetic to the regulatory scheme proposed for CLOs were 
also supportive of the form of disclosure, although some additional 
disclosures were occasionally suggested. Commenters otherwise critical 
of HUD's definition, the proposed CLO regulatory scheme, or other 
aspects of the proposal tended to object as well to the form of 
disclosure proposed. Generally, objections to the CLO disclosure format 
were mild, except the American Bankers Association and a few other 
commenters specifically objected to the ``acknowledgement box'' 
requirement for the same reasons that consumer-acknowledgement 
procedures were objected to in connection with the controlled business 
arrangement disclosure statement.16
---------------------------------------------------------------------------

    \16\ See discussion of CBA disclosure statement format under the 
heading ``Issue 4'' elsewhere in this preamble.
---------------------------------------------------------------------------

4. Working Group Meetings
    After review of all of the comments and the information gleaned 
from the technology demonstration, HUD believed that it did not have 
sufficient information on CLOs and how they were actually functioning 
in the provision of services to consumers. Accordingly, HUD convened 
the first of two CLO working group meetings on August 11, 1995, in 
Washington, D.C. Participants included CLO vendors, related industry 
associations, State regulators, consumer groups, and

[[Page 29250]]

individual advocates. The purpose was to get their individual input on 
CLO issues.
    The working group examined a number of CLO trends and CLO systems 
and identified the types and characteristics of CLOs currently 
operating. Presentations were made regarding several operating systems, 
as well as the Federal National Mortgage Association's (Fannie Mae's) 
Desktop Underwriter and the Federal Home Loan Mortgage Corporation's 
(Freddie Mac's) Loan Prospector. Views expressed by one or more members 
of the group included:
     CLOs are merely a technology for automating the loan 
process and not necessarily an independent settlement service.
     There should not be a special exemption for CLO services.
     A separate set of disclosures for CLOs and CLIs should not 
be created, but consumers should be given understandable and meaningful 
disclosures.
     HUD should not attempt to set rates.
     HUD should define the level of service that must be 
performed in the origination process in order to receive compensation.
    Many participants argued that HUD should not attempt to regulate, 
define, or set standards for an evolving technology. Many argued that 
greater clarity about how the RESPA regulations applied to loan 
originations would be preferable to a separate exemption or ``safe 
harbor,'' for which HUD set required characteristics by regulation. At 
the conclusion of the first meeting, the group agreed to meet again and 
discuss further the development of CLO technology.
    HUD held a second working group meeting on September 26, 1995. At 
this meeting, many also argued again that the RESPA regulations should 
apply equally to all participants in the market, regardless of their 
use of technology, and that the applicable test should be whether the 
fees paid were for services actually performed. Many in the group 
believed that HUD should provide additional guidance about how this 
basic RESPA test applies in the CLO context. Some participants 
criticized a distinction between services paid for by lenders and 
services paid for by borrowers, arguing that the borrower was the final 
source of funds for all services. State regulators also discussed the 
licensing and other requirements applicable to CLOs in many 
jurisdictions.
5. The Final Rule's Approach
    After further internal review and discussion, the Department 
determined to abandon the approach taken in the proposed rule, withdraw 
the CLO exemption that had been contained in 24 CFR 
3500.14(g)(1)(viii),17 and replace it with guidance analyzing the 
application of RESPA and the RESPA regulations to common CLO issues. 
The final rule also withdraws Appendix E, the CLO disclosure.
---------------------------------------------------------------------------

    \17\ Prior to HUD's regulatory streamlining, this provision was 
codified at 24 CFR Sec. 3500.14(g)(2)(iii).
---------------------------------------------------------------------------

    Simultaneously with the publication of this final rule, the 
Department is issuing a Statement of Policy. That Statement of Policy, 
issued under Sec. 3500.4(a)(1)(ii), is being published in today's 
Federal Register and constitutes a ``rule, regulation, or 
interpretation'' within the meaning of Section 8.

D. Issue 4: CBA Disclosure Form

1. The Public Comments
    Proposed changes in the controlled business disclosure form also 
attracted significant attention from commenters. Eleven Attorneys 
General commended the Department for accepting most of the suggestions 
made by State Attorneys General in the earlier round of public comment 
on RESPA regulations. However, the Attorneys General questioned whether 
the addition of a borrower acknowledgement box on the form is helpful 
and suggested it may actually prove harmful:

    * * * While it may appear that such a box induces the consumer 
to read the disclosures, in fact, it may be just one more document 
in a blizzard of such forms which the consumer signs. It is likely 
that lenders will find this acknowledgement more useful than 
consumers and will attempt to use the acknowledgement in defending 
any suits by consumers who feel they have been misled.

    A few commenters affirmatively supported the revised disclosure 
statement requirement as appropriate and useful.
    Other commenters, however, were more critical of the content of the 
revised disclosure statement. Especially singled out for criticism was 
the required statement ``YOU MAY BE ABLE TO GET THESE SERVICES AT A 
LOWER RATE BY SHOPPING WITH OTHER SETTLEMENT SERVICE PROVIDERS, AND 
THIS IS SOMETHING YOU SHOULD CONSIDER DOING.''
    A multi-service company in Massachusetts called the quoted sentence 
a ``negative statement'' that would discourage consumers from using an 
affiliated service. ``If HUD is serious about allowing diversified 
service providers to compete, this statement should be eliminated.'' 
(Emphasis in original.) Another commenter, a Missouri attorney, 
objected in particular to the last phrase, ``* * * and this is 
something you should consider doing.''

    * * * This phrase clearly denotes that there are better services 
available, and that the service which will be provided by the 
referred settlement service would be inadequate * * *. To suggest * 
* * that buyers would be better off looking elsewhere, is far beyond 
protection of the consumer and actually is hinting to the consumer 
that there is something inherently wrong with the controlled 
business arrangement * * *. (Emphasis in original.)

    An Iowa realty company urged that the statement be made more 
``provider neutral,'' and that all mortgage service providers be called 
upon to provide similarly worded disclosures regarding the value of 
comparison shopping.
    A Kansas lender complained that ``No other industry in this country 
is required to urge its customers to seek services elsewhere* * *.''
    A Chicago title guaranty company expressed sympathy for the 
objectives of the disclosure statement, but agreed that the proposed 
rule's version implied that substandard service was being provided. The 
following alternative statement was offered:

    There are many providers of settlement services providing 
quality products at competitive rates. You are encouraged to shop 
around to ensure that you are receiving the best quality product at 
the best rate available for the same or similar services.

    NAR's comments echoed the concerns of the above-quoted individual 
commenters by asking for a ``provider neutral'' statement and that all 
mortgage settlement service providers be called upon to provide 
similarly worded statements, ``thus preventing multiple service * * * 
firms from being placed at a relative disadvantage vis-a-vis other 
mortgage service providers.''
    Several banker-commenters again pressed the point that the required 
disclosure statement was inappropriate for the circumstances of banks 
and bank holding companies. Because these organizations commonly 
conduct their residential mortgage lending activities through mortgage 
company affiliates, ``* * * the consumer that contacts the bank * * * 
expects to be referred to the bank's mortgage lending operations, 
whether that consists of a department of the bank or an affiliate.''
    The American Bankers Association objected to the elaborate 
disclosure statement in the context of the kind of incidental and 
uncompensated referrals

[[Page 29251]]

involved in the bank/affiliate mortgage company operation. ``It is 
sufficient consumer protection,'' ABA argued, ``for banks to indicate 
that there might be services provided at a lower rate and not to add a 
statement that such shopping is recommended.''
    ABA and a few individual commenters also protested the requirement 
that the disclosure be acknowledged in writing. A title guaranty firm 
made the point that documents are frequently mailed to consumers to be 
signed and returned, and that it is difficult to secure the return of 
such documents, possibly raising unnecessary doubts concerning the 
validity of the disclosure actually given. ABA raised several 
questions:

    * * * [W]hat is the status of a bank's compliance with the 
acknowledgment and signature requirement if only the applicant and 
not the co-applicant signs the acknowledgment?
    What efforts does the bank have to expend in order to obtain the 
co-applicant's signature?
    Should not the applicant's acknowledgement be sufficient for 
compliance purposes?

    The process of obtaining these signatures, ABA concluded, ``creates 
compliance burdens for banks while providing negligible benefits to 
consumers.''
2. The Final Rule's Approach
    After review of all comments, the Department retains the 
requirement of the applicants' acknowledgement. In addition to focusing 
the attention of the applicant on the document, the acknowledgement 
also protects the lender from charges that it had failed to inform the 
prospective borrower of the controlled business arrangement. In 
response to comments, only one signature is now required.
    The Department has not adopted the NAR's suggestion that HUD 
require all settlement service providers to provide a statement 
encouraging consumers to shop around. The statute requires such a 
statement in the context of controlled businesses, but has no such 
requirement for any other situation. This rule only requires the 
disclosure in the context of controlled business arrangements.
    Also, the Department reformulates the discussion of the 
desirability of borrowers shopping for settlement services. In response 
to criticism that the proposed language intimated that the services 
offered by the disclosing servicer might be substandard or overpriced, 
the Department adopts more neutral wording that continues to inform 
consumers of their freedom to seek the most advantageous rates or 
services in a competitive market. The Department remains committed to 
the policy that ample disclosure, a preeminent principle of the RESPA 
statute, is a valuable means of informing consumers and promoting 
competition in the settlement services industry.
    The new formulation for the CBA disclosure is set forth in Appendix 
D. It now reads:

    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. THERE ARE FREQUENTLY OTHER SETTLEMENT SERVICE 
PROVIDERS AVAILABLE WITH SIMILAR SERVICES. YOU ARE FREE TO SHOP 
AROUND TO DETERMINE THAT YOU ARE RECEIVING THE BEST SERVICES AND THE 
BEST RATE FOR THESE SERVICES.

E. Other Matters Raised by Commenters

1. The Public Comments
    In addition to the specific comments received in response to the 
Department's request, some commenters raised concerns that some 
employers were engaging in practices of retaliation or discrimination 
against employees and agents for not referring business to affiliate 
entities. Other commenters complained that settlement service providers 
were being excluded from, or locked-out of, places of business where 
they might find potential customers. They also alleged that high-priced 
real estate office space arrangements with particular lenders, 
frequently coupled with lock-out arrangements, raised RESPA concerns.
2. The Final Rule's Approach
    The Department determined that these issues were distinct from 
those raised by the proposed rule. Moreover, they do not require 
rulemaking, but rather an interpretation, applied to specific 
circumstances, of the statute and the implementing regulations. 
Therefore, HUD is issuing a separate Statement of Policy on the issues 
of retaliation, lock-outs, and appropriate office rents to provide the 
guidance sought by so many commenters. That Statement of Policy is 
being published in today's Federal Register, simultaneously with the 
publication of this final rule.

Other Matters

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 General Counsel, the 
Rules Docket Clerk, room 10276, 451 Seventh Street, SW, Washington, DC 
20410.

Executive Order 12866

    This final 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 General Counsel, 
Room 10276, Department of Housing and Urban Development, 451 Seventh 
Street, SW, Washington, D.C. 20410-0500. An Economic Analysis (EA) 
performed on this proposed rule is also available for review at the 
same address.

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. An Economic Analysis prepared in connection with this 
rule considers the impact on small entities.

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 final 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 final 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.

[[Page 29252]]

List of Subjects in 24 CFR Part 3500

    Consumer protection, Condominiums, Housing, Mortgages, Mortgage 
servicing, Reporting and recordkeeping requirements.

    Accordingly, for the reasons set out in the preamble, part 3500 of 
title 24 of the Code of Federal Regulations is amended as follows.

PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT

    1. The authority citation for shall continue to read as follows:

    Authority: 12 U.S.C. 2601 et seq.

    2. Section 3500.2(b) is amended by adding, in alphabetical order, a 
definition of ``managerial employee'', to read as follows:


Sec. 3500.2  Definitions.

* * * * *
    (b) * * *
    Managerial employee means an employee of a settlement service 
provider who does not routinely deal directly with consumers, and who 
either hires, directs, assigns, promotes, or rewards other employees or 
independent contractors, or is in a position to formulate, determine, 
or influence the policies of the employer. Neither the term 
``managerial employee'' nor the term ``employee'' includes independent 
contractors, but a managerial employee may hold a real estate brokerage 
or agency license.
* * * * *
    3. Section 3500.8(c)(2) is amended in the fourth sentence by 
removing the reference ``Appendix F'' and adding in its place the 
reference ``Appendix E''.
    4. Section 3500.14 is amended by revising the last sentence of 
paragraph (b), the heading of paragraph (g), and paragraph (g)(1), to 
read as follows:


Sec. 3500.14  Prohibition against kickbacks and unearned fees.

* * * * *
    (b) * * * A business entity (whether or not in an affiliate 
relationship) may not pay any other business entity or the employees of 
any other business entity for the referral of settlement service 
business.
* * * * *
    (g) Exemptions for fees, salaries, compensation, or other payments.
    (1) The following are permissible:
    (i) A payment to an attorney at law for services actually rendered;
    (ii) A payment by a title company to its duly appointed agent for 
services actually performed in the issuance of a policy of title 
insurance;
    (iii) A payment by a lender to its duly appointed agent or 
contractor for services actually performed in the origination, 
processing, or funding of a loan;
    (iv) A payment to any person of a bona fide salary or compensation 
or other payment for goods or facilities actually furnished or for 
services actually performed;
    (v) A payment pursuant to cooperative brokerage and referral 
arrangements or agreements between real estate agents and real estate 
brokers. (The statutory exemption restated in this paragraph refers 
only to fee divisions within real estate brokerage arrangements when 
all parties are acting in a real estate brokerage capacity, and has no 
applicability to any fee arrangements between real estate brokers and 
mortgage brokers or between mortgage brokers.)
    (vi) Normal promotional and educational activities that are not 
conditioned on the referral of business and do not involve the 
defraying of expenses that otherwise would be incurred by persons in a 
position to refer settlement services or business incident thereto;
    (vii) A payment by an employer to its own bona fide employee for 
generating business for that employer;
    (viii) In a controlled business arrangement, a payment by an 
employer of a bonus to a managerial employee based on criteria relating 
to performance (such as profitability, capture rate, or other 
thresholds) of a business entity in the controlled business 
arrangement. However, the amount of such bonus may not be calculated as 
a multiple of the number or value of referrals of settlement service 
business to a business entity in a controlled business arrangement; and
    (ix)(A) A payment by an employer to its bona fide employee for the 
referral of settlement service business to a settlement service 
provider that has an affiliate relationship with the employer or in 
which the employer has a direct or beneficial ownership interest of 
more than 1 percent, if the following conditions are met:
    (1) The employee does not perform settlement services in any 
transaction; and
    (2) Before the referral, the employee provides to the person being 
referred a written disclosure in the format of the Controlled Business 
Arrangement Disclosure Statement, set forth in Appendix D to this part.
    (B) For purposes of this paragraph (g)(1)(ix), the marketing of a 
settlement service or product of an affiliated entity, including the 
collection and conveyance of information or the taking of an 
application or order for an affiliated entity, does not constitute the 
performance of a settlement service. Under this paragraph (g)(1)(ix), 
marketing of a settlement service or product may include incidental 
communications with the consumer after the application or order, such 
as providing the consumer with information about the status of an 
application or order; marketing shall not include serving as the 
ongoing point of contact for coordinating the delivery and provision of 
settlement services.
* * * * *
    5. Section 3500.15 is amended by revising the introductory text of 
paragraph (b)(1), to read as follows:


Sec. 3500.15  Controlled business arrangements.

* * * * *
    (b) * * *
    (1) Prior to the referral, the person making a referral has 
provided 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 person performing 
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 no later than the time of each referral or, if 
the lender requires the use of a particular provider, the time of loan 
application, except that:
* * * * *


Sec. 350017  [Amended]

    6. Section 3500.17 is amended as follows:
    a. In paragraph (b), in the definitions of ``Aggregate (or) 
composite analysis'' and ``Single-item analysis'', by removing the 
reference ``Appendix F'' in the last sentence of each definition and 
adding in its place the reference ``Appendix E''.
    b. In paragraph (c)(1)(i), in the second sentence, by removing the 
reference ``Appendix F'' and adding in its place the reference 
``Appendix E''.
    c. In paragraph (d)(1)(ii), in the last sentence, by removing the 
reference ``Appendix F'' and adding in its place the reference 
``Appendix E''.
    7. Appendix B is amended by revising Illustration 11, redesignating 
Illustrations 12 and 13 as Illustrations

[[Page 29253]]

13 and 14 respectively, and adding a new Illustration 12, to read as 
follows:

Appendix B to Part 3500--Illustrations 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. A, B, 
and C are subsidiaries of H, a holding company, which also controls 
a retail stock brokerage firm, D. None of A, B, or C requires 
consumers to purchase the services of its sister companies, and each 
company sells such services separately and as part of the package. A 
also pays an employee T, a full-time bank teller who does not 
perform settlement services, a bonus for each loan, title insurance 
binder, or closing that T generates for A, B, or C. A pays T these 
bonuses out of A's own funds and receives no reimbursements for 
these bonuses from B, C, or H. At the time that T refers customers 
to B and C, T provides the customers with a disclosure using the 
controlled business arrangement disclosure format. Also, Z, a 
stockbroker employee of D, occasionally refers her customers to A, 
B, or C; gives a statement in the controlled business disclosure 
format; and receives a payment from D for each referral.
    Comments: Selling a package of settlement services at a discount 
is not prohibited by RESPA, consistent with the definition of 
``required use'' in 24 CFR 3500.2. Also, A is always allowed to 
compensate its own employees for business generated for A's company. 
Here, A may also compensate T, an employee who does not perform 
settlement services in this or any transaction, for referring 
business to a business entity in an affiliate relationship with A. 
Z, who does not perform settlement services in this or any 
transaction, can also be compensated by D, but not by anyone else. 
Employees who perform settlement services cannot be compensated for 
referrals to other settlement service providers. None of the 
entities in an affiliated relationship with each other may pay for 
referrals received from an affiliate's employees. Sections 
3500.15(b)(3)(i)(A) and (B) set forth the permissible exchanges of 
funds between controlled business entities. In all circumstances 
described a statement in the controlled business disclosure format 
must be provided to a potential consumer at or before the time that 
the referral is made.
    12. Facts: A, a real estate broker, is affiliated with B, a 
mortgage lender, and C, a title agency. A employs F to advise and 
assist any customers of A who have executed sales contracts 
regarding mortgage loans and title insurance. F collects and 
transmits (by computer, fax, mail, or other means) loan applications 
or other information to B and C for processing. A pays F a small 
salary and a bonus for every loan closed with B or title insurance 
issued with C. F furnishes the controlled business disclosure to 
consumers at the time of each referral. F receives no other 
compensation from the real estate or mortgage transaction and 
performs no settlement services in any transaction. At the end of 
each of A's fiscal years, M, a managerial employee of A, receives a 
$1,000 bonus if 20% of the consumers who purchase a home through A 
close a loan on the home with B and have the title issued by C. 
During the year, M acted as a real estate agent for his neighbor and 
received a real estate sales commission for selling his neighbor's 
home.
    Comments: Under Sec. 3500.14(g)(1), employers may pay their own 
bona fide employees for generating business for their employer 
(Sec. 3500.14(g)(1)(vii)). Employers may also pay their own bona 
fide employees for generating business for their affiliate business 
entities (Sec. 3500.14(g)(1)(ix)), as long as the employees do not 
perform settlement services in any transaction and disclosure is 
made. This permits a company to employ a person whose primary 
function is to market the employer's or its affiliate's settlement 
services (frequently referred to as a Financial Services 
Representative, or ``FSR''). An FSR may not perform any settlement 
services including, for example, those services of a real estate 
agent, loan processor, settlement agent, attorney, or mortgage 
broker. In accordance with the terms of the exemption at 
Sec. 3500.14(g)(1)(ix), the marketing of a settlement service or 
product of an affiliated entity, including the collection and 
conveyance of information or the taking of an application or order 
for the services of an affiliated entity, does not constitute the 
performance of a settlement service. Under the exemption, marketing 
of a settlement service or product also may include incidental 
communications with the consumer after the application or order, 
such as providing the consumer with information about the status of 
an application or order; marketing may not include serving as the 
ongoing point of contact for coordinating the delivery and provision 
of settlement services.
    Thus, in the circumstances described, F and M may receive the 
additional compensation without violating RESPA.
    Also, employers may pay managerial employees compensation in the 
form of bonuses based on a percentage of transactions completed by 
an affiliated company (frequently called a ``capture rate''), as 
long as the payment is not directly calculated as a multiple of the 
number or value of the referrals. 24 CFR 3500.14(g)(1)(viii). A 
managerial employee who receives compensation for performing 
settlement services in three or fewer transactions in any calendar 
year ``does not routinely'' deal directly with the consumer and is 
not precluded from receiving managerial compensation.
* * * * *
    8. Appendix D is revised to read as follows:

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[GRAPHIC] [TIFF OMITTED] TR07JN96.001



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[[Page 29255]]

    9. Appendix E is removed and Appendix F is redesignated as Appendix 
E.

    Dated: May 31, 1996.
Nicolas P. Retsinas,
Assistant Secretary for Housing-Federal Housing Commissioner.
[FR Doc. 96-14329 Filed 6-6-96; 8:45 am]
BILLING CODE 4210-27-P