Periodically, the California Department of Real Estate (DRE) conducts financial compliance audits of real estate brokerages. These audits primarily focus on trust fund handling by licensees and compliance with real estate law.

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However, DRE audits also look for compliance with financial-related laws and regulations such as:

  • predatory lending;
  • multi-lender law;
  • private money reporting ;
  • broker-escrow laws; and
  • subdivider assessment payments.

The DRE performs two types of audits:

  • investigative audits; or
  • routine audits.

Investigative audits are initiated based a complaints from the public or tips indicating probable violations by a licensed broker, salesperson or broker-associate.

The DRE performs routine audits on randomly selected brokerages, especially those engaged in real estate activities where the risk of financial loss to the public is high, such as:

  • mortgage loan brokers;
  • property managers; and
  • broker-owned escrows.

A brokerage selected for an audit will receive a letter from the DRE giving notice of the audit. In addition to reviewing trust fund records, the auditor will investigate any number of the brokerage’s procedures and documents within the brokerage, including:

  • licensing compliance;
  • transaction files; and
  • recordkeeping.

Audits are similar to but distinguished from broker office surveys the DRE also conducts. Broker office surveys involve unannounced visits to brokers’ offices. Here, the DRE reviews specific issues and transaction documentation to evaluate a broker’s business practices and compliance with real estate law.

Surveys do not typically include in-depth examinations of trust fund handling or finance-related compliance. However, when an investigator suspects trust fund or financial-related noncompliance, they will request an audit for a detailed DRE examination.

Audits typically begin with a series of questions by the auditor. The auditor may request documentation for their review, which the broker locates beforehand. Typical documentation requested includes:

  • copies of all salespersons’ licenses and broker-agent employment agreements [See RPI Form 505 and 506];
  • bank and reconciliation statements for all trust accounts [See RPI Form 544-1];
  • trust fund records including receipts, deposits and disbursements;
  • transaction files; and
  • corporate records.

Common violations found in an audit

The most common violations found during DRE audits involve:

  • record retention;
  • fictitious business name use;
  • mortgage loan disclosures; and
  • trust funds, specifically:
    • maintaining trust fund records (or lack thereof);
    • reconciliation of trust accounts;
    • trust fund shortages;
    • trust fund handling;
    • trust account withdrawals; and
    • commingling.

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A broker maintains a record of all trust funds received and deposited for each separate beneficiary or transaction and enters it in columnar form in chronological order. This record needs to account for all deposited funds and identify each beneficiary with funds in the account. [Department of Real Estate Regulation §2831; see DRE Form RE 4522]

The broker reconciles the total of all separate beneficiary or transaction records with the balance of all trust funds received and paid out at least once a month, unless no bank account activities occurred. This confirms the balance of all trust fund records is equal to the bank account’s cash balance. [DRE Reg. §2831.2; see RPI Form 544-1]

trust fund shortage occurs when the balance of a trust fund account is less than the total broker liability to all beneficiaries. Trust fund shortages are often the result of:

  • failing to record a disbursement;
  • understating the amount of a check disbursed; or
  • overstating the amount of a deposit on the beneficiary ledger.

These simple mistakes lead to the broker’s ledger showing more funds available than are actually in the trust fund account. When it comes time to pay the beneficiaries, brokers pay out what is shown in their ledgers, instead of reviewing the actual funds available. Thus, the payout is greater than the available funds, causing a trust fund shortage.

When handling trust funds for multiple beneficiaries, a broker is required to obtain written consent from every beneficiary in the account prior to any disbursement that will cause the balance of the account to be less than the trust funds held by all trust fund beneficiaries. [DRE Reg. 2832.1]

Within three business days of receiving trust funds on behalf of another, the broker is required to place the funds received:

  • into the hands of the owner of the funds;
  • into a neutral escrow depository; or
  • into a trust fund account. [Calif. Business and Professions Code §10145; DRE Reg. §2832]

Withdrawals from a trust fund account may be made only with the broker’s signature or, when specifically authorized in writing by the broker, by:

  • a salesperson licensed to the broker;
  • a broker-associate under an employment or independent contractor agreement with the broker [See RPI Form 505 and 506]; or
  • an unlicensed employee of the broker with fidelity bond coverage equal to or greater than the maximum amount of trust funds the employee has access to at any time. [DRE Reg. §2834; see RPI Form 507]

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A broker may not commingle their own funds with the funds of others which they receive and hold. However, a broker is allowed to deposit up to $200 of their own funds for account maintenance in the trust account. [Bus & P C §10145; DRE Reg. §2835]

A broker who misuses trust funds is subject to penalties, including:

  • civil liability for money wrongfully converted;
  • disciplinary action by the DRE;
  • income tax liability; and
  • criminal sanctions for embezzlement.

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When a broker misuses advance fees

, the owner of the funds may recover treble money losses plus attorney fees from the broker. Also, a broker who fails to account for advance fees to the owner is presumed to be guilty of embezzlement. [Bus & P C §10146]

However, the existence of specific statutory provisions relating to the misuse of advance fees does not mean the misuse of other types of trust funds will go unpunished. Penalties for the misuse of trust funds for other purposes fall under more general statutory schemes.

Recordkeeping

As a real estate broker, you are required to retain records for three years. Records include copies of:

  • listings;
  • deposit slips;
  • canceled checks;
  • trust records; and
  • other documents executed or obtained in connection with any transactions for which a real estate license is required. [Bus & P C §10148(a)]

Prior to a DRE audit, a broker is required to make their books, accounts and records available for examination and copying by the DRE’s representative. [Bus & P C §10148(a)]

Fictitious name use

Licensees may only use fictitious names while conducting an activity requiring a license when that name is on their license. [DRE Reg. §2731]

Fictitious name violations commonly occur when:

  • a broker or their agents believe registering their “doing business as” name (DBA) with the county is sufficient to allow them to use it in their real estate business; or
  • a broker fails to add the DBA back onto their license when the fictitious name lapses for a brief period of time.

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http://journal.firsttuesday.us/brokerage-reminder-is-your-team-playing-by-the-rules/25584/ Written mortgage loan disclosure statements

Mortgage origination

A broker handling mortgage loan originations (MLO) is required to prepare and hand the borrower a mortgage loan disclosure statement within the earlier of either:

  • three days after receipt of a completed mortgage application; or
  • three days before the borrower becomes obligated on the note. [Bus & P C §10240]

The broker maintains completed copies of the mortgage disclosure in their files.

To best prepare for an audit, a broker needs to review office policies and procedures often to keep their activities in compliance. The DRE’s regulations outline basic rules and procedures necessary to avoid disciplinary action by the DRE.

For a more thorough evaluation of your brokerage, perform a self-evaluation of your real estate business activities using DRE’s Compliance Checklist. [See DRE Form RE 540]

This article was originally posted May 2014, and has been updated.