NAILTA Supports Goliath (Loan Originator Compensation)

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions, and the President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

Rarely is there a significant controversy surrounding a government agency's work, especially where litigation is involved, when nearly all industry groups array on one side and the agency is alone to fend for itself on the other side. The FRB has now received support  for its promulgating and interpretation of the TILA Loan Originator Compensation rule (Rule) from an important industry organization, with respect to the Rule as it relates to affiliate compensation.

In its letter of March 17, 2011, the National Association of Independent Land Title Agents (NAILTA), an organization representing independent title insurance agents and independent real estate settlement professionals, came out in support of the FRB's definition of the term "affiliate" as a "single person" for the purposes of the Rule.

Let's now consider NAILTA's point of view, as expressed in its letter (NAILTA Letter).

NAILTA Letter's Arguments - A Salient Selection

This Commentary offers a brief outline of selected arguments against the TILA Loan Originator Compensation rule (Rule). I am leaving out citations, where possible, for ease of reading. This outline is not meant to be comprehensive, authoritative, or relied upon for legal advice. It offers only a brief synopsis of the argumentation. For citations, exhibits, and argumentation, I suggest that you read the NAILTA Letter. (See Below)

Debate

On March 3, 2011, I notified you about a joint letter sent to the FRB from the most prominent organizations (hereinafter, "trade associations") in the residential real estate finance industry (Letter). [FRB: Mangles Affiliate Compensation]

Dated February 28, 2011, the Letter contests the FRB staff's interpretation relating to affiliate compensation and offers two alternatives.

According to the Letter, the FRB "would consider all lending affiliates of an originator as one person as stated in the [R]ule, but that [the FRB] also would consider fees paid to a mortgage company's affiliated real estate brokerage and title/settlement service companies as one person, meaning that fees paid for the fair market value of services performed by these affiliated companies could be considered as loan compensation." (My emphasis)

This is the "single person" construct, a feature that prevents "dual compensation."

Dual Compensation: A Syllogism    

Allow me to provide the following syllogism outlining the FRB's position on dual compensation

(1) The Rule prohibits payment to originators based on loan terms or conditions;

(2) The Rule prohibits "dual compensation" of loan originators, such as compensation received by entities for brokering loans to loan originators;

(3) An "affiliate" is a "single person;" therefore, as such and by extension,

(4) An affiliate is subject to the "dual compensation" prohibition.

Here's the essential logic: just as the FRB is attempting to prevent "circumvention" of the final rule by prohibiting a producing branch manager from participating in profits because they are derived from the rates and terms of loans (i.e., cannot be a basis for loan originator compensation), by extension, the same criteria applies to other participants in the loan origination, including affiliates, and for much the same reasons.

I have already discussed elsewhere this "dual compensation" dilemma in various contexts.

Here's just one of those articles.

NAILTA Sees Things Otherwise  

NAILTA takes the position that the trade associations have "stifled competition in the real estate settlement marketplace, eliminated healthy competition and stymied consumer choice when it comes to the selection of a real estate settlement service provider." 
In the NAILTA Letter, the following claim is advanced:

"Since the 1980's, each of the trade associations who authored the February 28th correspondence have benefited from a coordinated effort to consolidate and steer the services of all real estate settlement providers, including title insurance, to one source called a 'one-stop shop' in the hopes of dominating local, regional and national real estate service markets." (My emphasis)

To use the word "steer" is rather bold. For an affiliate to avoid "steering," among other things, it must comply with RESPA Section 8, which governs conduct between settlement service providers and makes it a crime for providers to pay and for real estate sales associates or brokers to receive fees for the referral of settlement service business.

Indeed, RESPA's anti-kickback provisions occur when real estate practitioners and lenders establish joint ventures called affiliated business arrangements or AfBAs. To take advantage of the AfBA exemption, partners must satisfy a four-part, safe-harbor test under Section 8(c)(4) of RESPA.

So to allege that the trade associations are steering is tantamount to alleging that they are violating RESPA.

One-Stop Shop

It is interesting the NAILTA Letter specifically points to the "one-stop shop" feature as deleterious to competition, the very feature that was mentioned in the trade associations' Letter as a "successful and long-established affiliated business model...that offers consumers one-stop shopping, which Congress had expressly authorized in a 1983 amendment to the Real Estate Settlement Procedures Act (RESPA)."

According to the NAILTA Letter, a "byproduct" (sic) of the "one-stop shop" process, is that real estate firms, mortgage companies and banks "have stretched out into all areas of the real estate settlement service field in an attempt to consolidate such services as title insurance, surveying, mortgage origination, homeowner's insurance, and appraisals into their 'one-stop shops.'"

On the face of it, this would seem to be the case. After all, and in contradistinction, in the trade associations' Letter it is clear that what NAILTA believes is disadvantageous to the consumer (i.e., one-stop shopping) is held out by the trade associations as advantageous to the consumer, as indicated by the following statement:

"According to the independent real estate research firm REALTrends, Inc., 285 of the nation's 500 largest residential real estate brokerage firms -- which were involved in 30% of all home purchase transactions in 2007 -- offer mortgages, and 240 of the top 500 firms offer title, closing or escrow services. According to a 2010 survey of home buyers by Harris Interactive, the parent of Harris Poll, 29% of recent home buyers used a one-stop shopping service in 2010 compared to 20% in 2002 - an increase of 45%."

The percentage of growth and number of firms involved in AfBAs seem to buttress NAILTA's point of view.

But does the growth of the "one-stop shop" processes reflect some kind of "coordinated effort" to "steer" services or the best and most efficient way to serve the interests of the consumer by effectively delivering settlement related services?

NAILTA Takes A Stand

The following may sum up NAILTA's position:

1. NAILTA rejects the trade association argument that the rule harms consumers or competition.
2. NAILTA advises the FRB to do the same.

Furthermore, NAILTA claims:

1. Even by the trade associations' own data, consumers lack an understanding of "one-stop shops."
2. An overwhelming majority of consumers do not believe there is any real benefit to using an AfBA.
3. NAILTA can provide a "plethora of national examples of actual anti-competitive market practices perpetrated by the trade associations and their members in real estate transactions across the United States, whether from strong-arm steering of consumers to their affiliate 'one-stop shops' or by referral sources unilaterally preventing independent real estate service providers from acting as real estate settlement mediums." (My emphasis)

Is "Single Person" Correctly Construed?

NAILTA supports the FRB's definition of the term "affiliate" as a "single person" for the purposes of the Rule.

An AfBA, according to NAILTA's view, is a single entity and, accordingly, should be subject to the "single person" compensation requirements. Indeed, the trade associations refer to the "affiliate" as a "one-stop" shop. 

Therefore, treating them differently for purposes of the Rule "ignores their own intent - a single location for all real estate settlement services."

Our Library contains a copy of the Letter.

FAQs - Loan Originator Compensation (Now Available!)

Our FAQs Outline - Loan Originator Compensation is now available to the public!

Effective Date: April 1, 2011 – Loan Originator (Officer) Compensation

The Effective Date of the Loan Originator Compensation requirements is April 1, 2011 and the mortgage industry has been scrambling to implement new policies and procedures, automated responses, new disclosures, compensation plans and employment agreements, and seeking out educational venues to determine appropriate actions.

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Press Release
FAQs Outline - Loan Originator Compensation
Lenders Compliance Group
March 21, 2011

FRB: Mangles Affiliate Compensation

Jonathan Foxx is a former Chief Compliance Officer of two publicly traded financial institutions. He is the President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

As if the confusion caused by the FRB's lack of substantive guidance regarding TILA loan originator compensation were not enough for the industry to absorb, the FRB now sallies into adversely affecting another market segment of the residential real estate finance industry: affiliates.  

It is one thing for the FRB to find regulatory means to implement Dodd-Frank; however, it is unacceptable to discombobulate affiliate relationships by an overreaching interpretation regarding loan originator compensation in a way that amplifies the confusion.

Action is eloquence. Coriolanus, Shakespeare

While so many market participants are rightfully concerned with the consequences following April 1, 2011, the effective date of the new TILA loan originator compensation requirements, I want to bring your attention to the FRB's stance with respect to affiliates, a core business relationship feature, and how affiliate compensation is being imperiled by the forthcoming TILA revisions.

Recently, several leading industry organizations announced that they had sent a joint letter to the FRB (Letter). The Letter - which is dated February 28, 2011 and addressed to Ben Bernanke, FRB Chairman, and Sandra Braunstein, Director of the FRB's Consumer and  Community Affairs Division - contests the FRB staff's interpretation and offers two reasonable alternatives.

Some media sources have mentioned the Letter, but they have provided scant information about it.

So I reached out to a trusted friend and leader in one of the Letter's sponsoring organizations, and was graciously given a copy. In my view, the points raised in the Letter deserve to be more fully known by the public, and the views therein expressed should be added to the other industry requests, previously placed with the FRB, to either delay the aforementioned effective date or provide credible, unambiguous, and supportable guidance prior to the effective date. A brief synopsis follows.

But before I discuss certain salient issues, permit me to list the signatories to the Letter:

• Community Mortgage Banking Project (CMBP)

• Consumer Mortgage Coalition (CMC)

• National Association of Homebuilders (NAHB)

• National Association of Mortgage Brokers (NAMB)

• National Association of REALTORS (NAR)

• Real Estate Services Providers Council, Inc. (RESPRO)

• The Realty Alliance 

These organizations are among the most prominent in the residential real estate finance industry, with substantial membership, and have dedicated themselves for many years to providing support, guidance, and advocacy to industry participants and the public.

True is it that we have seen better days. As You Like It, Shakespeare

The FRB's view can be stated, as follows: (1) the loan originator compensation rule prohibits payment to originators based on loan terms or conditions, and, further, (2) it prohibits "dual compensation" of loan originators, such as compensation received by entities for brokering loans to loan originators, and (3) an "affiliate" is a single person; therefore, as such and by extension, (4) an affiliate is subject to the "dual compensation" prohibition. 

I have already discussed elsewhere this "dual compensation" dilemma.

A clever sleight of hand is taking place here. By extending dual compensation to affiliates through the "single person" concept, the FRB maintains a certain consistency with respect to the final rule. Here's the logic: just as the FRB is attempting to prevent "circumvention" of the final rule by prohibiting a producing branch manager from participating in profits because they are derived from the rates and terms of loans, thus cannot be a basis for loan originator compensation, by extension, the same criteria can be applied to other participants in the loan origination, including affiliates, and for much the same reasons. I know that's convoluted, but it is what it is!

FRB's Scenario

Here is one "circumvention" scenario that the FRB uses:

[T]he rule would be circumvented, for example, if a parent company that has two mortgage lending subsidiaries could arrange to pay a loan originator greater compensation on higher rate loans offered by subsidiary A than the compensation it would pay the same originator for a lower rate loan made by subsidiary "B". To address this issue, the Board treats such subsidiaries of the parent company as a single person so that if a loan originator is able to deliver loan (sic) to both subsidiaries, they must compensate the loan originator in the same manner. Accordingly, if a loan originator delivers a loan to subsidiary B and the interest rate is 8 percent, the originator must receive the same compensation that would have been paid by subsidiary A for a loan with a rate of either 7 or 8 percent.

Our remedies oft in ourselves do lie. All's Well That Ends Well, Shakespeare

The Letter states that FRB staff has decided "they not only would consider all lending affiliates of an originator as one person as stated in the rule, but that they also would consider fees paid to a mortgage company's affiliated real estate brokerage and title/settlement service companies as one person, meaning that fees paid for the fair market value of services performed by these affiliated companies could be considered as loan compensation." (My emphasis)

The organizations allege that the FRB's interpretation would "for no justifiable reason" adversely impact "the use of a successful and long-established affiliated business model employed by many members of the undersigned associations that offers consumers one-stop shopping." The Letter states the fact that the "one-stop shopping" concept was contemplated by Congress in a 1983 amendment to RESPA.

Now, for some background, we must take a very cursory, but necessary digression from TILA (FRB's domain) to RESPA (HUD's domain). RESPA is primarily a disclosure and anti-kickback statute. With respect to anti-kickbacks, Section 8 of RESPA makes it a crime for settlement service providers to pay and for real estate brokers to receive fees for the referral of settlement service business.

RESPA provides an exemption to affiliated business arrangements (ABAs) that conform to specific guidelines. An ABA 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. Partners to an ABA must satisfy, among other things, a multi-prong, safe-harbor test under Section 8(c)(4) of RESPA to get the exemption. One of the safe harbor prongs, for instance, requires that a partner's share of the profits corresponds to its ownership interest and payments may not be conditioned on the number of loans referred to the ABA.

Returning to TILA, it is significant that the Letter contends that "under the [FRB] staff's interpretation, bona fide and reasonable compensation paid by a seller/buyer for real estate brokerage services to that firm would be considered ... as direct compensation paid to the mortgage company, which would mean that the real estate broker's affiliated mortgage company could not broker any loans and be paid for such brokerage activity by the lender without violating the dual source compensation prohibition." (My emphasis)

Out, damn'd spot! Out, I say!-One; two: why, then 'tis time to do't.
Macbeth, Shakespeare

Here's the crux of the matter:

1) Dodd-Frank expressly exempts real estate brokers from the definition of loan originator. The interpretation of "affiliate" goes far beyond Dodd-Frank by considering real estate brokerage fees to be loan originator compensation, because Dodd-Frank specifically exempts real estate brokers from being considered a loan originator. So "to the extent that Dodd-Frank treats title agencies in a manner similar to that contained in the Board's the final rule, [Dodd-Frank] permits exemptions from these statutory rules." Thus, "when 'third party' bona fide reasonable charges were declared to be exempt, affiliates, by definition, would be excluded from treatment as a 'third party' because of a common ownership interest with the creditor/originator."   

2) Mortgage companies often have title agency affiliates and, if the FRB's interpretation holds, then if a buyer uses the mortgage company's title affiliate and if either the borrower or the seller pays part of the title or closing costs to the title affiliate, the lender with whom the title agent is affiliated could not broker any loans for payment by the lender without violating the "dual compensation" prohibition.

Here's the organizations' view:

1) Title insurance rates in forty-four states are set by the states, approved by the states, or are filed with the states. The established, approved, and/or filed rates are the rates that have to be charged. "For the overwhelming majority of transactions, there is no risk that an affiliated lender could circumvent the final rule by inflating the title rates."

2) Regarding third party charges, the FRB holds that the term "compensation" includes "amounts retained by the loan originator, but does not include amounts that the loan originator receives as payments for bona fide, third party charges, such as title insurance. . . ."  So, under the FRB's interpretation an "affiliate" does not qualify as a third party pursuant to this exemption. Even though in 90% of transactions the title fees of independent companies and affiliated companies are restricted or filed as a matter of state law, the FRB has "adopted an interpretation that in effect would preclude mortgage companies from brokering loans when the consumer uses an affiliated title company but permits it when the consumer uses a non-affiliated company that charges the exact same filed rate." Bona fide reasonable title charges of title affiliates would not be exempted, even if they are the same as bona fide reasonable charges of unaffiliated title companies.

3) The FRB's interpretation of the term "affiliate" would seriously disadvantage some real estate brokerage firms or title companies that are part of corporate holding companies, entities that may own other businesses such as utilities and insurance companies. Scenario: if, at closing, it is discovered that a consumer has paid a fee to one of these insurance companies or utilities - such fee would be subsumed under the "affiliates" term vis-à-vis Dodd-Frank's "common control" definition - and the FRB's interpretation would lead to preventing the mortgage company from receiving a fee from the lender to which it brokered the loan, because "the consumer's fee to the insurance company or utility also would count as loan originator compensation."

These organizations have it exactly right: the FRB's interpretation leads to "illogical consequences."

More matter with less art. Hamlet, Shakespeare

What is needed at this late date, just a few weeks before the April 1, 2011 effective date, is more substance and less rhetoric.

The above-mentioned signatories offer two resolutions, both quite reasonable, each consistent with existing law.

Solution # 1: Continue to define an "affiliate" as one person but interpret the term "third party" to include affiliates, so that the fees of third party title companies, appraisal companies, real estate brokers, et cetera (whether affiliated with the originator or not) may be exempted from loan originator compensation so long as they are bona fide and reasonable.

Solution # 2: Limit the definition of "affiliate" to include  mortgage lending and mortgage brokering businesses, as specifically stated in the rule, but not include non-mortgage providers in that definition.

It seems to me that, with either solution, the organizations are going out of their way to resolve the situation in a manner that provides continuing stability to the real estate finance industry. The FRB should meet immediately with representatives of these organizations. Relationships that are important to a well-functioning industry now are imperiled by the lack of FRB guidance.

When this Letter is added to the previous correspondence and communications to the FRB from the SBA Office of Advocacy, the MBA, the NAIHP, the IMMAAG, and the NAMB, the situation begs for the FRB's expeditious clarification of TILA loan originator compensation revisions or a determination to delay their implementation.

If you want to read the Letter in its entirety, a copy is available in our Library.

What do you think?

I would welcome your comments.
Please feel free to email me or leave your comments below.