Under proposed regulations recently unveiled by HUD, residential mortgage lenders who compensate brokers may be presumed guilty of making criminal kickbacks unless they can prove their innocence.
The proposed regulations are pursuant to section 8 of the Real Estate Settlement Procedures Act.
Since Congress enacted Respa in 1974, residential mortgage lenders have struggled to determine whether their payments to mortgage brokers are illegal referral fees or "reasonable compensation" for services, goods, or facilities. Accelerating this search for clarity is the recent surge of class actions challenging lender payments to originators.
As the federal agency charged by Congress with interpreting and enforcing the act, the housing department routinely has advised the industry that the reasonableness of compensation is a factual inquiry.
Last year HUD sponsored negotiated rulemaking to bring together consumer groups, industry players, and state agencies to interpret section 8. The initiative was largely unsuccessful.
There were, however, certain shared realizations.
First, mortgage brokers could perform valuable services, but many borrowers misunderstood the role and allegiances of mortgage brokers.
Second, the literal provisions of the 25-year-old statute did not accommodate neatly the legitimate payment of mortgage broker fees by lenders. There, absent congressional clarification, HUD should prescribe a "safe harbor," the compliance with which would be presumed to satisfy Respa.
The centerpiece of such a safe harbor, many thought, should be a contract between borrowers and mortgage brokers, clarifying whom the mortgage broker represents and how the broker gets paid. The actual content of the contract and its legal impact under Respa were unresolved.
HUD's proposal is a direct response to these issues. Unfortunately, it dramatically increases the potential liability of lenders and brokers under both Respa and state law. The proposal also completely sidesteps the critical question of what a lender may pay a mortgage broker under Respa.
The proposed regulation creates a one-page disclosure form-"the honest lending contact"-to be signed by a mortgage broker before a borrower applies for the loan. On the front, brokers are required to check one of three boxes describing the nature of their representation:
"I Represent You."
"I Represent You, But I May Receive a Fee From a Lender."'
"I Do Not Represent You."
If the broker elects to represent the borrower under the first two boxes, it further covenants to get the most favorable rate for the customer's stated objectives. The form further discloses that, under the last two boxes, the broker may be paid by a lender.
Finally, in all cases the form requires the mortgage broker to disclose the total compensation that it subsequently may collect from both the borrower and lender.
According to a fact sheet provided by HUD at the news conference:
"Fees earned by a mortgage broker who uses and abides by the contract would be considered within a 'qualified safe harbor.' That is, those fees would be exempt from challenge under section 8 of Respa unless the fees do not pass a test that will be developed before the rule is final."
Similarly, the press release provides that "mortgage brokers who use the disclosure agreement will be entitled to protection from enforcement action under Respa unless their fees fall outside parameters to be set when the rule becomes final."
Finally, the fact sheet provides that "mortgage brokers who fail to use the disclosure contract, or use it but breach its terms, will be subject to potential liability under section 8 of Respa unless they can prove that their fees are related to the services provided."
Notice carefully what HUD has done. It did not define what is reasonable compensation for services performed under Respa-the very issue at the heart of the class actions. Instead, HUD has superimposed a new substantive requirement on lenders and mortgage brokers to execute and fulfill the "honest lending contract." Failure to meet this requirement results in a presumption that the lender and mortgage broker have violated the anti- kickback provisions of Respa.
Instead of HUD or a class action plaintiff's lawyer having to prove the impropriety of a lender's conduct, the tables are tuned on the lender to prove its innocence. And the lender may be unable to prove its innocence unless it can prove that the broker found the most favorable loan for the borrower that was available at the time.
How could a lender possibly prove this? Even if this difficult burden is met, the safe harbor is not available to the lender and broker unless the reasonableness of their compensation is proven. Aside from Respa liability, the government mandated contract will lead to breach of contract claims, as well as state law claims of breach of fiduciary duty, fraud and misrepresentation.
The rule could also have an adverse impact on small businesses. Under the proposal, brokers must cap their fees at the time of loan application or be presumed in violation of Respa.
No other settlement service provider is subject to a similar restriction under the act. This facet will exacerbate even further the inequitable regulatory treatment of mortgage broker transactions. HUD has certified in the proposal that its approach has no impact on small businesses; expect that conclusion to be challenged.
Don't be fooled by the hype of HUD's press conference and the admittedly laudable goal of helping borrowers become better consumers. This proposal is an engraved invitation to the class action plaintiff's bar to sue lenders.
