[Federal Register Volume 61, Number 111 (Friday, June 7, 1996)]
[Rules and Regulations]
[Pages 29258-29264]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14331]
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DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT
24 CFR Part 3500
[Docket No. FR-3638-N-04]
Office of the Assistant Secretary for Housing-Federal Housing
Commissioner; Real Estate Settlement Procedures Act (RESPA); Statement
of Policy 1996-2 Regarding Sham Controlled Business Arrangements
AGENCY: Office of the Assistant Secretary for Housing-Federal Housing
Commissioner, HUD.
ACTION: Statement of policy 1996-2, sham controlled business
arrangements.
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SUMMARY: This statement sets forth the factors that the Department uses
to determine whether a controlled business arrangement is a sham under
the Real Estate Settlement Procedures Act (RESPA) or whether it
constitutes a bona fide provider of settlement services. It provides an
interpretation of the legislative and regulatory framework for HUD's
enforcement practices involving sham arrangements that do not come
within the definition of and exception for controlled business
arrangements under Sections 3(7) and 8(c)(4) of the Real Estate
Settlement Procedures Act (RESPA). It is published to give guidance and
to inform interested members of the public of the Department's
interpretation of this section of the law.
FOR FURTHER INFORMATION CONTACT: David Williamson, Director, Office of
Consumer and Regulatory Affairs, Room 5241, telephone (202) 708-4560.
For legal enforcement questions, Rebecca J. Holtz, Attorney, Room 9253,
telephone: (202) 708-4184. (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:
General Background
Section 8 (a) of the Real Estate Settlement Procedures Act (RESPA)
prohibits any person from giving or accepting any fee, kickback, or
thing of value for the referral of settlement service business
involving a federally related mortgage loan. 12 U.S.C. Sec. 2607(a).
Congress specifically stated it intended to eliminate kickbacks and
referral fees that tend to increase unnecessarily the costs of
settlement services. 12 U.S.C. Sec. 2601(b)(2).
After RESPA's passage, the Department received many questions
asking if referrals between affiliated settlement service providers
violated RESPA. Congress held hearings in 1981. In 1983, Congress
amended RESPA to permit controlled business arrangements (CBAs) under
certain conditions, while retaining the general prohibitions against
the giving and taking of referral fees. Congress defined the term
``controlled business arrangement'' to mean an arrangement:
[I]n which (A) a person who is in a position to refer business
incident to or a part of a real estate settlement service involving
a federally related mortgage loan, or an associate of such person,
has either an affiliate relationship with or a direct or beneficial
ownership interest of more than 1 percent in a provider of
settlement services; and (B) either of such persons directly or
indirectly refers such business to that provider or affirmatively
influences the selection of that provider.
12 U.S.C. 2602(7) (emphasis added).
In November 1992, HUD issued its first regulation covering
controlled business arrangements, 57 FR 49599 (Nov. 2, 1992), codified
at 24 CFR 3500.15. 1 That rule provided that a controlled business
arrangement was not a violation of Section 8 and allowed referrals of
business to an affiliated settlement service provider so long as: (1)
The consumer receives a written disclosure of the nature of the
relationship and an estimate of the affiliate's charges; (2) the
consumer is not required to use the controlled entity; and (3) the only
thing of value received from the arrangement, other than payments for
services rendered, is a return on ownership interest.
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\1\ All citations in this Statement of Policy refer to recently
streamlined regulations published on March 26, 1996 (61 FR 13232),
in the Federal Register (to be codified at 24 CFR part 3500).
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Section 3500.15(b) sets out the three conditions of the controlled
business arrangement exception. The first condition concerns the
disclosure of the relationship. The rule provides that the person
making the referral must provide the consumer with a written statement,
in the format set out in appendix D to part 3500. This statement must
be provided on a separate piece of paper. The referring party must give
the statement to the consumer no later than the time of the referral.
24 CFR 3500.15(b)(1).
The second condition involves the non-required use of the referred
entity. Section 3500.15(b)(2) provides that the person making the
referral may not require the consumer to use any particular settlement
service provider, except in limited circumstances. A
[[Page 29259]]
lender may require a consumer to pay for the services of an attorney,
credit reporting agency or real estate appraiser to represent the
lender's interest in the transaction. An attorney may use a title
insurance agency that operates as an adjunct to the attorney's law
practice as part of the attorney's representation of that client in a
real estate transaction. 24 CFR 3500.15(b)(2).
The third condition relates to what is received from the
relationship. The rule provides that the only thing of value that comes
from the arrangement, other than permissible payments for services
rendered, is a return on an ownership interest or franchise
relationship. 24 CFR 3500.15(b)(3). The rule describes what are not
proper returns on ownership interest at 24 CFR 3500.15(b)(3)(ii). These
include ownership returns that vary by the amount of business referred
to a settlement service provider, or situations where adjustments are
made to an ownership share based on referrals made.
Both the statute and HUD's 1992 regulation make the controlled
business arrangement exemption available in situations where referrals
are made to a ``provider of settlement services.'' These provisions do
not authorize compensation to shell entities or sham arrangements that
are not a bona fide ``provider of settlement services.'' Since issuing
the 1992 RESPA rule, HUD has received numerous complaints that some
CBAs are being established to circumvent RESPA's prohibitions and are
sham arrangements. The complaints often use the expression ``joint
venture'' as a generic way to describe these new sham arrangements.
While many joint ventures are bona fide providers of settlement
services, permissible under the exemption, it does appear that some are
not.
A joint venture is a special combination of two or more legal
entities which agree to carry out a single business enterprise for
profit, and for which purpose they combine their property, money,
effects, skill and knowledge. Some of the alleged sham arrangements may
be joint ventures; others, however, may involve different legal
structures, such as limited partnerships, limited liability companies,
wholly owned corporations, or combinations thereof. Regardless of form,
the common feature of these arrangements is that at least two parties
are involved in their creation: a referrer of settlement service
business (such as a real estate broker or real estate agent) and a
recipient of referrals of business (such as a mortgage banker, mortgage
broker, title agent or title company). At least one, if not both, of
these parties will have an ownership, partnership or participant's
interest in the arrangement.
Many of the complaints about these arrangements allege that the new
entity performs little, if any, real settlement services or is merely a
subterfuge for passing referral fees back to the referring party. For
example, in a letter to HUD dated September 30, 1994, the Mortgage
Bankers Association of America (MBA) expressed growing concern about
``sham joint venture'' controlled business arrangements. The MBA
stated:
Under this scenario, a lender and a real estate broker jointly
fund a new subsidiary that purports to be a mortgage broker but has
no staff and minimal funding, does no work (out sources all process
to the lender), receives all business by referral from the broker
parent, sells all production to the lender parent, and pays profits
to both parents in the form of dividends. We oppose such
arrangements because they afford compensation to brokers but impose
on them no work or business risk. In short, they are disguised
referral fee arrangements.
The MBA encouraged HUD to define eligible joint venture entities. It
suggested that such entities should have their own employees, perform
substantive functions in the mortgage process and share in the risks
and rewards of any viable enterprise in the marketplace.
Complaints also included arrangements that are wholly-owned by a
referring entity. An example of such a complaint involved an
arrangement promoted by a mortgage broker to real estate brokers to
help them set up a wholly owned mortgage brokerage subsidiary. The
mortgage broker claimed that the real estate broker ``can earn hundreds
or even thousands of dollars each month without investing any money or
changing [his or her] current business practices.'' The mortgage
broker's pitch was that ``my current staff can work for my company and
also for yours.'' The real estate broker's new company ``can use my
investors, my office, my phones, my copy machines, my promotional
material * * * Your company will have no overhead other than the taxes
due on the income you generate and the bank fees for the money accounts
your company must have. The entire annual expenses can be covered on
the first loan your company closes * * * I can manage your company at
the same time I manage mine so you won't have any time investment
either.'' HUD's concern about this and similar complaints prompted the
Department to issue this Statement of Policy.
In many of the arrangements that have come to HUD's attention, the
substantial functions of the settlement service business that the new
arrangement purports to provide are actually provided by a pre-existing
entity that otherwise could have received referrals of business
directly. In such arrangements the entity actually performing the
settlement services reduces its profit margin and shares its profits
with the referring participant in the arrangement. In some situations,
such as in the last example, companies that could have received
referrals of settlement service business directly (hereafter
``creators'') have assisted the referring parties in creating wholly
owned subsidiaries at little or no cost to the referring party. These
subsidiaries in turn refer or contract out most of the essential
functions of its settlement service business back to a creator that
helped set them up or use the creator to run the business.
The following illustrates the two general types of arrangements:
BILLING CODE 4210-27-P
[[Page 29260]]
[GRAPHIC] [TIFF OMITTED] TR07JN96.002
BILLING CODE 4210-27-C
[[Page 29261]]
There are numerous variations on these two general arrangements.
Regulatory and Legislative Framework
In amending RESPA to permit controlled businesses, Congress
specifically stated that it did not intend to ``change current law
which prohibits the payment of unearned fees, kickbacks, or other
things of value in return for referrals of settlement service
business.'' H.R. Rep. No. 123, 98th Cong., 1st Sess. at 76 (1983). The
statute's definition of ``controlled business arrangement'' uses the
term ``provider of settlement services'' to describe the entity
receiving the referral of business. 12 U.S.C. 2602(7). The term
``provider of settlement services'' means a person that renders
settlement services. The statute further defines ``settlement
services'' to include any service provided in connection with a real
estate settlement and includes a list of such services. If the
controlled entity performs little or none of its settlement service
function, it may not be ``providing'' settlement services, and
therefore may not meet the statutory definition of a controlled
business arrangement.
HUD's existing regulations address a shell controlled entity that
contracts out all of its functions to another entity. See Appendix B to
Part 3500, Illustration 10.2 Where the shell controlled entity
provides no substantive services for its portion of the fee, HUD deems
the arrangement as violating Section 8(a) and (b) of RESPA because the
controlled entity is merely passing unearned fees back to its owner for
referring business to another provider. Besides this Illustration,
however, HUD has not addressed arrangements that perform some, but not
all of the settlement service functions it purports to provide.
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\2\ Illustration 10. Facts: A is a real estate broker who refers
business to its affiliate title company B. A makes all required
written disclosures to the homebuyer of the arrangement and
estimated charges and the homebuyer is not required to use B. B
refers or contracts out business to C who does all the title work
and splits the fee with B. B passes its fee to A in the form of
dividends, a return on ownership interest.
Comments: The relationship between A and B is a controlled
business arrangement. However, the controlled business arrangement
exemption does not provide exemption between a controlled entity, B,
and a third party, C. Here, B is a mere ``shell'' and provides no
substantive services for its portion of the fee. The arrangement
between B and C would be in violation of Section 8(a) and (b). Even
if B had an affiliate relationship with C, the required exemption
criteria have not been met and the relationship would be subject to
Section 8.
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RESPA's earliest legislative history shows that Congress tried to
address whether a payment is for services actually performed or is a
disguised referral fee. See H.R. Rep. No. 1177, 93d Cong., 2d Sess.
1974 (hereafter ``the Report''). The Report stated that RESPA's anti-
kickback provisions were not intended to prohibit the payments for
goods furnished or services actually rendered, ``so long as the payment
bears a reasonable relationship to the value of the goods or services
received by the person or company making the payment. To the extent the
payment is in excess of the reasonable value of the goods provided or
services performed, the excess may be considered a kickback or referral
fee * * *. `` Id. at 7-8. The Report stated:
Those persons and companies that provide settlement services
should therefore take measures to ensure that any payments they make
or commissions they give are not out of line with the reasonable
value of the services received. The value of the referral itself
(i.e., the additional business obtained thereby) is not to be taken
into account in determining whether the payment is reasonable.
Id. at 8. The Report further explained that section 8(c) set forth the
``types of legitimate payments that would not be proscribed.'' As an
example, the Report noted that commissions paid by a title insurance
company to a duly appointed agent for services actually performed in
the issuance of a policy of title insurance would be permitted. The
Report explained:
Such agents * * * typically perform substantial services for and
on behalf of a title insurance company. These services may include a
title search, an evaluation of the title search to determine the
insurability of the title (title examination), the actual issuance
of the policy on behalf of the title insurance company, and the
maintenance of records relating to the policy and policy-holder. In
essence, the agent does all of the work that a branch office of the
title insurance company would otherwise have to perform.
Id. at 8 (emphasis added). Thus, the Report shows that Congress
anticipated that reasonable payments could be paid to entities that
perform ``all of the work'' normally associated with the settlement
service being provided.
The legislative history for the controlled business arrangement
provides guidance for cases in which a new entity does not perform
``all of the work'' that would otherwise need to be performed by a
fully functioning service provider. The testimony of officials of
existing affiliated companies at Congressional hearings in 1981
provided an analysis of companies that do little substantive work. Real
Estate Settlement Procedures Act--Controlled Business: Hearings Before
the Subcomm. on Housing and Community Development of the House Comm. on
Banking, Finance and Urban Affairs, 97th Cong., 1st Sess. 24, (1981)
(hereafter ``Hearings''). Charles R. Hilton, then Senior Vice
President, Coldwell, Banker & Co. stated: ``In our line of operation,
all of our ancillary services are operated as a full line service
company. We do our title searches; we do the examinations; we share in
the risk; we take all of the risk, in some cases.'' Hearings at 423.
Stanley Gordon, then Vice President and General Counsel for the
residential group of Coldwell, Banker & Co., acknowledged that some
title agencies may have been formed to circumvent Section 8 of RESPA.
He said:
The most common examples of circumvention are those agencies
which provide little or no service to their customers. They do not
perform a search of the title records, and have few of the other
characteristics of an ongoing business, such as a staff of employees
and related operating expenses. Such agencies, in our opinion, come
within the prohibition of Section 8.
* * * * *
There must be, for a violation of Section 8, the involvement of
a third party, such as a title insurance underwriter of a title
agency, that has agreed to make a kickback to the broker. This
arrangement is best established by the absence of reasonable
compensation from the underwriter to the title agency for the
services actually rendered by the title agency. The kickback is the
payment by the title insurer to the title agency (which is then
passed through to the broker owner) where there is no service being
rendered which reasonably corresponds to the payment * * *.
Hearings at 429-431.
Consequently, in cases where work is contracted out to another
entity (be it an independent third party, a creator, an owner, or a
participant in a joint venture), HUD has looked at whether the
contracting party receives payments from the new entity at less than
the reasonable value of the services rendered. If so, then the
difference between the payments made to the contracting party and the
reasonable value of the services rendered may be seen as a disguised
referral fee in violation of Section 8. 24 CFR 3500.14(g)(2).
Statement of Policy--1996-2
To give guidance to interested members of the public on the
application of RESPA and its implementing regulations to these issues,
the Secretary, pursuant to Section 19(a) of RESPA and 24 CFR
3500.4(a)(1)(ii), hereby issues the following Statement of Policy.
Congress did not intend for the controlled business arrangement
(``CBA'') amendment to be used to
[[Page 29262]]
promote referral fee payments through sham arrangements or shell
entities. H.R. Rep. 123, 98th Cong., 1st Sess. 76 (1983). The CBA
definition addresses associations between providers of settlement
services. 12 U.S.C. 2602(7). In order to come within the CBA exception,
the entity receiving the referrals of settlement service business must
be a ``provider'' of settlement service business. If the entity is not
a bona fide provider of settlement services, then the arrangement does
not meet the definition of a CBA. If an arrangement does not meet the
definition of a CBA, it cannot qualify for the CBA exception, even if
the three conditions of Section 8(c) are otherwise met. 12 U.S.C.
2607(c)(4)(A-C). Therefore, subsequent compliance with the CBA
conditions concerning disclosure, non-required use and payments from
the arrangement that are a return on ownership interest, will not
exempt payments that flow through an entity that is not a provider of
settlement services.
Thus, in RESPA enforcement cases involving a controlled business
arrangement created by two existing settlement service providers, HUD
considers whether the entity receiving referrals of business
(regardless of legal structure) is a bona fide provider of settlement
services. When assessing whether such an entity is a bona fide provider
of settlement services or is merely a sham arrangement used as a
conduit for referral fee payments, HUD balances a number of factors in
determining whether a violation exists and whether an enforcement
action under Section 8 is appropriate. Responses to the questions below
will be considered together in determining whether the entity is a bona
fide settlement service provider. A response to any one question by
itself may not be determinative of a sham controlled business
arrangement. The Department will consider the following factors and
will weigh them in light of the specific facts in determining whether
an entity is a bona fide provider:
(1) Does the new entity have sufficient initial capital and net
worth, typical in the industry, to conduct the settlement service
business for which it was created? Or is it undercapitalized to do the
work it purports to provide?
(2) Is the new entity staffed with its own employees to perform the
services it provides? Or does the new entity have ``loaned'' employees
of one of the parent providers?
(3) Does the new entity manage its own business affairs? Or is an
entity that helped create the new entity running the new entity for the
parent provider making the referrals?
(4) Does the new entity have an office for business which is
separate from one of the parent providers? If the new entity is located
at the same business address as one of the parent providers, does the
new entity pay a general market value rent for the facilities actually
furnished?
(5) Is the new entity providing substantial services, i.e., the
essential functions of the real estate settlement service, for which
the entity receives a fee? Does it incur the risks and receive the
rewards of any comparable enterprise operating in the market place?
(6) Does the new entity perform all of the substantial services
itself? Or does it contract out part of the work? If so, how much of
the work is contracted out?
(7) If the new entity contracts out some of its essential
functions, does it contract services from an independent third party?
Or are the services contracted from a parent, affiliated provider or an
entity that helped create the controlled entity? If the new entity
contracts out work to a parent, affiliated provider or an entity that
helped create it, does the new entity provide any functions that are of
value to the settlement process?
(8) If the new entity contracts out work to another party, is the
party performing any contracted services receiving a payment for
services or facilities provided that bears a reasonable relationship to
the value of the services or goods received? Or is the contractor
providing services or goods at a charge such that the new entity is
receiving a ``thing of value'' for referring settlement service
business to the party performing the service?
(9) Is the new entity actively competing in the market place for
business? Does the new entity receive or attempt to obtain business
from settlement service providers other than one of the settlement
service providers that created the new entity?
(10) Is the new entity sending business exclusively to one of the
settlement service providers that created it (such as the title
application for a title policy to a title insurance underwriter or a
loan package to a lender)? Or does the new entity send business to a
number of entities, which may include one of the providers that created
it?
Even if an entity is a bona fide provider of settlement services,
that finding does not end the inquiry. Questions may still exist as to
whether the entity complies with the three conditions of the controlled
business arrangement exception. 12 U.S.C. Sec. 2607(c)(4)(A-C). Issues
may arise concerning whether the consumer received a written disclosure
concerning the nature of the relationship and an estimate of the
controlled entity's charges at the time of the referral. 12 U.S.C.
Sec. 2607(c)(4)(A); 24 CFR 3500.15(b)(1). Other issues may arise
concerning whether the referring party is requiring the consumer to use
the controlled entity. 12 U.S.C. Sec. 2607(c)(4)(B); 24 CFR
3500.15(b)(2).
Still another area that may arise concerns the third condition of
the CBA exception, whether the only thing of value that comes from the
arrangement, other than permissible payments for services rendered, is
a return on ownership interest or franchise relationship. 12 U.S.C.
Sec. 2607(c)(4)(C); 24 CFR 3500.15(b)(3). Section 3500.15(b)(3)(ii) of
the regulations provides that a return on ownership interest does not
include payments that vary by the amount of actual, estimated or
anticipated referrals or payments based on ownership shares that have
been adjusted on the basis of previous referrals. When assessing
whether a payment is a return on ownership interest or a payment for
referrals of settlement service business, HUD will consider the
following questions:
(1) Has each owner or participant in the new entity made an
investment of its own capital, as compared to a ``loan'' from an entity
that receives the benefits of referrals?
(2) Have the owners or participants of the new entity received an
ownership or participant's interest based on a fair value contribution?
Or is it based on the expected referrals to be provided by the
referring owner or participant to a particular cell or division within
the entity?
(3) Are the dividends, partnership distributions, or other payments
made in proportion to the ownership interest (proportional to the
investment in the entity as a whole)? Or does the payment vary to
reflect the amount of business referred to the new entity or a unit of
the new entity?
(4) Are the ownership interests in the new entity free from tie-ins
to referrals of business? Or have there been any adjustments to the
ownership interests in the new entity based on the amount of business
referred? Responses to these questions may be determinative of whether
an entity meets the conditions of the CBA exception. If an entity does
not meet the conditions of the CBA exception, then any payments given
or accepted in the arrangement may be subject to further analysis under
Section 8(a) and (b). 12 U.S.C. Sec. 2607(a) and (b).
[[Page 29263]]
Some examples of how HUD will use these factors in an analysis of
specific circumstances are provided below.
Examples:
1. An existing real estate broker and an existing title
insurance company form a joint venture title agency. Each
participant in the joint venture contributes $1000 towards the
creation of the joint venture title agency, which will be an
exclusive agent for the title insurance company. The title insurance
company enters a service agreement with the joint venture to provide
title search, examination and title commitment preparation work at a
charge lower than its cost. It also provides the management for the
joint venture. The joint venture is located in the title insurance
company's office space. One employee of the title insurance company
is ``leased'' to the joint venture to handle closings and prepare
policies. That employee continues to do the same work she did for
the title insurance company. The real estate broker participant is
the joint venture's sole source of business referrals. Profits of
the joint venture are divided equally between the real estate broker
and title insurance company.
HUD Analysis. After reviewing all of the factors, HUD would
consider this an example of an entity which is not a bona fide provider
of settlement service business. As such, the payments flowing through
the arrangement are not exempt under Section 8(c)(4) and would be
subject to further analysis under Section 8. In looking at the amount
of capitalization used to create the settlement service business, it
appears that the entity is undercapitalized to perform the work of a
full service title agency. In this example, although there is an equal
contribution of capital, the title insurance company is providing much
of the title insurance work, office space and management oversight for
the venture to operate. Although the venture has an employee, the
employee is leased from and continues to be supervised by the title
insurance company. This new entity receives all the referrals of
business from the real estate broker participant and does not compete
for business in the market place. The venture provides a few of the
essential functions of a title agent, but it contracts many of the core
title agent functions to the title insurance company. In addition, the
title insurance company provides the search, examination and title
commitment work at less than its cost, so it may be seen as providing a
``thing of value'' to the referring title agent, which is passed on to
the real estate broker participant in a return on ownership.
2. A title insurance company solicits a real estate broker to
create a company wholly owned by the broker to act as its title
agent. The title insurance company sets up the new company for the
real estate broker. It also manages the new company, which is
staffed by its former employees that continue to do their former
work. As in the previous example, the new company also contracts
back certain of the core title agent services from the title
insurance company that created it, including the examination and
determination of insurability of title, and preparation of the title
insurance commitment. The title insurance company charges the new
company less that its costs for these services. The new company's
employees conduct the closings and issue only policies of title
insurance on behalf of the title insurance company that created it.
HUD Analysis. As was the case in the first example, HUD would not
consider the new entity to be a bona fide settlement service provider.
The legal structure of the new entity is irrelevant. The new company
does little real work and contracts back a substantial part of the core
work to the title insurance company that set it up. Further, the
employees of the new company continue to do the work they previously
did for the title insurance company which also continues to manage the
employees. The new entity is not competing for business in the market
place. All of the referrals of business to the new entity come from the
real estate broker owner. The creating title insurance company provides
the bulk of the title work. On balance HUD would consider these factors
and find that the new entity is not a bona fide title agent, and the
payments flowing through the arrangement are not exempt under Section
8(c)(4) and would be subject to further analysis under Section 8.
3. A lender and a real estate broker form a joint venture
mortgage broker. The real estate broker participant in the joint
venture does not require its prospective home buyers to use the new
entity and it provides the required CBA disclosures at the time of
the referral. The real estate broker participant is the sole source
of the joint venture's business. The lender and real estate broker
each contributes an equal amount of capital towards the joint
venture, which represents a sufficient initial capital investment
and which is typical in the industry. The new entity, using its own
employees, prepares loan applications and performs all other
functions of a mortgage broker. On a few occasions, to accommodate
surges in business, the new entity contracts out some of the loan
processing work to third party providers, including the lender
participant in the joint venture. In these cases, the new entity
pays all third party providers a similar fee, which is reasonably
related to the processing work performed. The new entity manages its
own business affairs. It rents space in the real estate
participant's office at the general market rate. The new entity
submits loan applications to numerous lenders and only a small
percent goes to the lender participant in the joint venture.
HUD Analysis. After reviewing all of the factors, HUD would
consider this an example of an entity which is a bona fide provider of
settlement service business rather than a sham arrangement. The new
entity would appear to have sufficient capital to perform the services
of a mortgage broker. The participant's interests appear to be based on
a fair value contribution and free from tie-ins to referrals of
business. The new entity has its own staff and manages its own
business. While it shares a business address with the real estate
broker participant, it pays a fair market rent for that space. It
provides substantial mortgage brokerage services. Even though the joint
venture may contract out some processing overflow to its lender
participant, this work does not represent a substantial portion of the
mortgage brokerage services provided by the joint venture. Moreover,
the joint venture pays all third party providers a similar fee for
similar processing services.
While the real estate broker participant is the sole source of
referrals to the venture, the venture only sends a small percent of its
loan business to the lender participant. The joint venture mortgage
broker is thus actively referring loan business to lenders other than
its lender participant. Since the real estate broker provides the CBA
disclosure and does not require the use of the mortgage broker and the
only return to the participants is based on the profits of the venture
and not reflective of referrals made to the venture, it meets the CBA
exemption requirements. HUD would consider this a bona fide controlled
business arrangement.
4. A real estate brokerage company decides that it wishes to
expand its operations into the title insurance business. Based on a
fair value contribution, it purchases from a title insurance company
a 50 percent ownership interest in an existing full service title
agency that does business in its area. The title agency is liable
for the core title services it provides, which includes conducting
the title searches, evaluating the title search to determine the
insurability of title, clearing underwriting objections, preparing
title commitments, conducting the closing, and issuing the title
policy. The agent is an exclusive title agent for its title
insurance company owner. Under the new ownership, the real estate
brokerage company does not require its prospective home buyers to
use its title agency. The brokerage has its real estate agents
provide the required CBA disclosures when the home buyer is referred
to the affiliated title insurance agency. The real estate brokerage
company is not the sole source of the title agency's business. The
real estate brokerage company receives a return on ownership in
proportion to its 50%
[[Page 29264]]
ownership interest and unrelated to referrals of business.
HUD Analysis. A review of the factors reflects an arrangement
involving a bona fide provider of settlement services. In this example,
the real estate brokerage company is not the sole source of referrals
to the title agency. However, the title agency continues its exclusive
agency arrangement with the title insurance company owner. While this
last factor initially may raise a question as to why other title
insurance companies are not used for title insurance policies, upon
review there appears to be nothing impermissible about these referrals
of title business from the title agency to the title insurance company.
This example involves the purchase of stock in an existing full
service provider. In such a situation, HUD would carefully examine the
investment made by the real estate brokerage company. In this example,
the real estate brokerage company pays a fair value contribution for
its ownership share and receives a return on its investment that is not
based on referrals of business. Since the real estate brokerage
provides the CBA disclosure, does not require the use of the title
agency and the only return to the brokerage is based on the profits of
the agency and not reflective of referrals made, the arrangement meets
the CBA exemption requirements. HUD would consider this a bona fide
controlled business arrangement.
5. A mortgage banker sets up a limited liability mortgage
brokerage company. The mortgage banker sells shares in divisions of
the limited liability company to real estate brokers and real estate
agents. For $500 each, the real estate brokers and agents may
purchase separate ``divisions'' within the limited liability
mortgage brokerage company to which they refer customers for loans.
In later years ownership may vary by the amount of referrals made by
a real estate broker or agent in the previous year. Under this
structure, the ownership distributions are based on the business
each real estate broker or real estate agent refers to his/her
division and not on the basis of their capital contribution to the
entity as a whole. The limited liability mortgage brokerage company
provides all the substantial services of a mortgage broker. It does
not contract out any processing to its mortgage banker owner. It
sends loan packages to its mortgage banker owner as well as other
lenders.
HUD analysis. Although HUD would consider the mortgage brokerage
company to be a bona fide provider of mortgage brokerage services, this
example illustrates an arrangement that fails to meet the third
condition of the CBA exception. 12 U.S.C. 2607(c)(4)(C). Here, the
capitalization, ownership and payment structure with ownership in
separate ``divisions'' is a method in which ownership returns or
ownership shares vary based on referrals made and not on the amount
contributed to the capitalization of the company. In cases where the
percent of ownership interest or the amount of payment varies by the
amount of business the real estate agent or broker refers, such
payments are not bona fide returns on ownership interest, but instead,
are an indirect method of paying a kickback based on the amount of
business referred. 24 CFR 3500.15(b)(3).
Authority: 12 U.S.C. 2617; 42 U.S.C. 3535(d).
Dated: May 31, 1996.
Nicolas P. Retsinas,
Assistant Secretary for Housing-Federal Housing Commissioner.
[FR Doc. 96-14331 Filed 6-6-96; 8:45 am]
BILLING CODE 4210-27-P