January 5, 2020|RESPA
Paying Reasonable Market Value for Broker Services
Other than noted RESPA expert Phil Schulman (who apparently just wants my grilling tips), I suspect many of you might read Mortgage Musings for my RESPA takes. Admittedly, last month’s offering may have been a bit pedestrian talking about “TAO” (transitional authority). Well then, file this in the category of “be careful what you wish for”. And, if you’re a wholesaler or mortgage broker (even if you’re a bank or mortgage banker who occasionally does TPO’s) you had better grab your favorite glass of bourbon (or try this rye) and listen up. When it comes to RESPA and mortgage brokering in 2020, the industry might be a bit over its skis.
First, a Solution
I’m going to explain the problem, but I’ll give you a solution first. Make broker to lender referrals exempt just like realtor to realtor referrals (see Reg. X §1024.14 (g)(1)(v)). I’ll explain the justification and “how-to” for this idea later, but this would render this whole issue I’m about to explain, moot. This solution, of course, like execution of any idea, is easier said than done, so please hear me out on the RESPA concerns to understand the motivation for action.
The Yield Spread Litigation RESPA Lesson
Rob Chrisman likes to talk about the aging of the mortgage industry, and since everyone learns from the past (right, Georges Santayana?), most of you probably remember yield spread premium (YSP) litigation. Just in case you don’t remember, I’ll give you a brief background refresher and start by illustrating with a question:
RESPA prohibits referral fees for loans, so how is it that mortgage brokers (who don’t fund their own loans) can get paid for referring borrowers to wholesale lenders?
OK, that was a trick question. Brokers don’t get paid to refer loans. Per HUD’s 1999 Statement of Policy (the 1999 SOP)[1] Brokers get paid to provide services to the wholesale lender.
Back to the YSP litigation history: In the late 1990’s the industry was getting whacked around nationwide by dozens of class action attorneys who claimed, essentially, paying a broker for a loan was a RESPA violation; i.e., a paid referral of settlement services. The plaintiffs focused on what the industry called, yield spread, which was basically another word for overage. Now I could go full-on RESPA geek on the broker fee issue getting totally wonky by debating this Harvard Law professor article, but I’ll spare everyone and just give you the upshot. The industry went into a full court press: hiring top notch national legal counsel coordinated through the MBA to fight for the wholesale business model, implementing consistent and effective national legal strategies against the plaintiffs and hosting magnificent industry lawyer dinners in “wine caves” (in the words of lead counsel Mike Agoglia, “Bob Pratte’s wine pairings were truly inspired!”).
Anyway, the victory against the YSP litigation scourge was only finally secured by HUD’s 1999 SOP. The 1999 SOP detailed how services provided by brokers to wholesalers conforms to the 8(c)(2) (services rendered) exception to RESPA’s referral fee prohibition. Basically, the 1999 SOP said that as long as brokers took the application and performed at least 5 out of 12 (or 14) services, they can be paid a fee “reasonably related” to those services as a mortgage broker.
That clarification essentially meant the YSP class actions were doomed because a court now had to examine each loan individually to see if the broker actually performed the 5 or more services in each instance. Individual review means you can’t adjudicate the cases as a class action due to lack of “commonality”. Class action attorneys generally aren’t as interested in individual cases because, well, they like to get paid. So, after the 1999 SOP was issued, the class action bar took some settlements and slithered over to the greener pastures such as TCPA and wage/hour cases where they now rail against the evils of robocalls and underpaid LO’s.
Brokered Loan RESPA Compliance Today
Wholesale/broker RESPA compliance after the 1999 SOP focuses on making sure that brokers provide the 5 out of 12 services. 20 years later, every broker package requires the broker to certify they performed at least 5 services. But, is this sufficient “proof” of RESPA compliance?
As anyone who takes RESPA and marketing service agreement (MSA) compliance seriously knows, there’s more to RESPA compliance than just making sure you got the services: you also can’t pay more than “reasonable market value” for those services. This was made clear in the DC Circuit’s recent en Banc decision against the CFPB regarding PHH rejecting Richard Cordray’s dim view of 8 (c)(2). To paraphrase now Supreme Court Justice Kavanaugh’s words, ‘nothing stops you from paying a referral source for services rendered, but you still can’t pay more than reasonable market value for those services.’
Reasonable Market Value Compensation
At the time the YSP litigation was wrapping up, some of us RESPA geeks wondered whether the regulators or class action guys might challenge the reasonableness of broker fees that are based on a percentage of the loan amount. The issue is that it’s hard to say that a fee is reasonable where on a $100k loan the broker gets paid $1,000 (@100 bp), but gets $4,000 for a $400k loan for basically the exact same services. With a %-based fee, it seems like the fee is directly tied to the loan’s value which could violate RESPA (see Reg. X § 1024.14 (g)(2)).
Nevertheless, over the last 20 years that issue wasn’t enough to whet the appetite of the regulators or the class action bar into challenging the basis point model as being unreasonable. Moreover, the LO Comp Rule came along in 2011 (Final Rule in 2014) and expressly blessed basis point compensation as a permitted method to compensate mortgage originators. I’m sure I’ll talk about LO Comp in future Musings. So now, despite the noted disparity in fees for the same services based on loan value, challenging %-based compensation alone as being unreasonable under RESPA doesn’t seem like a winner.
The RESPA Risk Today
Lately, however, the wholesale industry has been offering a whole lot more than just a % based broker fee to brokers in return for the brokers’ services. Wholesale competition is fierce and extends beyond cutthroat pricing and BRAWLs. Origination and closing systems, training, marketing materials and other stuff is commonly being offered to brokers by wholesalers to gain market share. With everything wholesalers are doing for the broker, it can be difficult to assess exactly what services the broker is really performing (including application taking).
Anyone who has attended one of my RESPA training sessions knows that I focus on articulating a compliant narrative. What’s the compliant narrative for all these other goodies offered by the wholesalers to brokers in addition to a %-based fee? If these are “things of value” then they can’t be offered in return for referrals of loans. The RESPA compliance obligation under the services rendered exception after PHH are clear: (i) confirm that you got the services you paid for, but also (ii) do not pay more than reasonable market value for those services. Find solutions for determining reasonable market value here.
Meanwhile, the 1999 SOP said you have to look at total compensation in assessing reasonable market compensation and that includes things a referral source would otherwise have to pay for themselves. Even assuming basis point-based compensation is reasonable under RESPA, offering more compensation for fewer services performed poses compliance and legal risks wholesalers and their broker customers should consider carefully.
Solution: Extend the Secondary Market Exception
Licensed Realtors can share commissions and make referrals between them with a complete exemption from RESPA. There are no tests for “services” or “reasonableness of fees” imposed on that sharing arrangement. In 1974 when RESPA was enacted, all real estate agents and brokers were required to be state licensed. Not so much for IMB’s and mortgage brokers. Now, however, we have the SAFE Act, NMLS, robust state mortgage regulators and originator licensing in every state. There is no reason that a transaction between a licensed (or exempt e.g., a bank) lender making a referral to another licensed (or exempt) lender should not be exempt from RESPA in the same way that Realtor to Realtor referrals are exempt from RESPA.
The CFPB has looked at when the secondary market exception begins previously and could maintain disclosure requirements in any policy statement or rulemaking. The politics of getting CFPB (or Congress) to acknowledge the need for such an exemption will be challenging, but I don’t think the mortgage industry should wait for the class action guys to circle back to the RESPA gold mine now that Spokeo, FCC action and arbitration agreements are making their current class action targets less attractive.
[1] The 1999 SOP was mostly written by two great friends of mine (and Musings readers) who built tremendous careers with mortgage related trade associations after leaving HUD.