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

1All 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).

employer for a referral to an affiliated

entity.

5. Neutral Display of Information on

Settlement Service Providers and Their

Products

Section 8(a) of RESPA prohibits

compensated referrals. HUD may

scrutinize non-neutral displays of

information on settlement service

providers and their products because

favoring one settlement service provider

over others may be affirmatively

influencing the selection of a settlement

service provider which could constitute

a referral under RESPA. 24 CFR

3500.14(f). An agreement or

understanding for the referral of

business incident to or part of a

settlement service may be established by

a practice, pattern, or course of conduct.

24 CFR 3500.14(e). For example, if one

lender always appears at the top of any

listing of mortgage products and there is

no real difference in interest rates and

charges between the products of that

lender and other lenders on a particular

listing, then this may be a non-neutral

presentation of information which

affirmatively influences the selection of

a settlement service provider.

Furthermore, if there is an affiliate

relationship between the CLO and a

favored settlement service provider, the

non-neutral presentation of information

under certain circumstances could

constitute a required use in violation of

3500.15(b)(2). This guidance on neutral

displays should not be read to

discourage CLOs from assisting

consumers in determining which

products are most advantageous to

them. For example, if a CLO

consistently ranks lenders and their

mortgage products on the basis of some

factor relevant to the borrower’s choice

of product, such as APR calculated to

include all charges and to account for

the expected tenure of the buyer, HUD

would consider this practice as a neutral

display of information.

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. 96–14330 Filed 6–6–96; 8:45 am]

BILLING CODE 4210–27–P

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.

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 hearingand 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 abovelisted 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.

§ 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. § 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.

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
Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations 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
29260 Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

BILLING CODE 4210–27–C
Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations 29261

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.

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.

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 policyholder. 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
29262 Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

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.

§ 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. § 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.

§ 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. § 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. § 2607(a) and (b).
Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations 29263

Some examples of how HUD will use

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%
29264 Federal Register / Vol. 61, No. 111 / Friday, June 7, 1996 / Rules and Regulations

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

24 CFR Part 3500

[Docket No. FR–3638–N–05]

Office of the Assistant Secretary for

Housing-Federal Housing

Commissioner; Real Estate Settlement

Procedures Act (RESPA); Statement of

Policy 1996–3, Rental of Office Space,

Lock-outs, and Retaliation

AGENCY: Office of the Assistant

Secretary for Housing-Federal Housing

Commissioner, HUD.

ACTION: Statement of Policy 1996–3,

Rental of Office Space, Lock-outs, and

Retaliation.

SUMMARY: This statement sets forth the

Department’s interpretation of Section 8

of the Real Estate Settlement Procedures

Act (RESPA) and its implementing

regulations with regard to the rental of

office space, lock-outs and retaliation. It

is published to give guidance and to

inform interested members of the public

of the Department’s position on

enforcement of this section of the law.

FOR FURTHER INFORMATION CONTACT:

David R. Williamson, Director of the

Office of Consumer and Regulatory

Affairs, Room 5241, telephone: (202)

708–4560. For legal enforcement

questions, Peter Race, Assistant General

Counsel for Program Compliance, or

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 abovelisted 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. 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.

2601(b)(2).

Since July 1993, the Department has

been seeking comments and advice

concerning the final rule of November 2,

1992, implementing Section 8 of

RESPA. On July 21, 1994, the

Department published a new proposed

rule on certain Section 8 issues.

Simultaneously with the issuance of

this Statement of Policy, HUD is

publishing a final rule in that

rulemaking. As part of that rulemaking

process, the Department received

comments concerning the application of

Section 8 of RESPA to the rental of

office space, lock-outs and retaliation in

connection with real estate brokerage

office practices. In addition, the

Department’s enforcement officials have

received numerous complaints dealing

with these same issues.

Rental of Office Space

In the last few years, the Department

has received numerous complaints

alleging that certain settlement service

providers, particularly lenders, are

leasing desks or office space in real

estate brokerage offices at higher than

market rate in exchange for referrals of

business. In HUD’s rulemaking docket,

number R–94–1725 (FR–3638), many

commenters argued that HUD should

scrutinize this rental practice. The

concern expressed is that real estate

brokers charge, and settlement service

providers pay, high rent payments for

the desk or office space to disguise

kickbacks to the real estate broker for

the referral of business to the settlement

service provider. In this Statement of

Policy, the Department sets forth how it

distinguishes legitimate payments for

rentals from payments that are for the

referral of business in violation of

Section 8.

Lock-outs

The Department also received

comments and complaints alleging that

settlement service providers were being

excluded from, or locked-out of, places

of business where they might find