[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]



-----------------------------------------------------------------------


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.

-----------------------------------------------------------------------

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. <SUP>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.
---------------------------------------------------------------------------

    \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).
---------------------------------------------------------------------------

    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.<SUP>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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

    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