The infectious kickback
When sales volume and prices rise, kickbacks in real estate sales become curiously infectious. Although kickbacks, typically in the form of referral fees, were banned by the Real Estate Settlement Procedures Act (RESPA) in 1974, they remain under the government radar in many forms and for many reasons. In fact, they continue to be one of the most pervasive RESPA violations.
Referral fees become unlawful kickbacks, wrongly taken by a broker or agent, when they negotiate a fee-generating home sale. Here, the only service rendered in exchange for the referral fee is, well, the referral.
Referral fees of the kickback variety arise out of a transaction in which the agent is already set to receive a fee. They are improper and outlawed for the reason they adversely attack the efficiency of the real estate market. Worse, kickbacks increase the cost of doing business by the provider paying the kickback. To stay in business, providers always pass the cost to buyers and sellers in the sales transactions since profit margins are not reduced. There are no free lunches, since they always come at a cost at some point.
Kickbacks absolutely result in the elimination of better and cheaper competition. Instead of buyers being directed by agents to more competitive lenders, escrows, title insurers or other types of third-party service providers offering equal quality services, buyers are referred only to those businesses providing surreptitious kickbacks to the broker or agent. The broker and agent deception usually also extends to income tax reporting of the referral fee income as well. Occasionally the broker does not discover what their agents are doing with providers, but some intentionally require the kickbacks.
Kickbacks to brokers and agents representing sellers and buyers in a home sales transaction are flagrantly undertaken in an unlawful effort by a third-party service provider to garner a larger share of the available business.
This in any economy is destructive of competition and thus a corrupting business policy. Legitimate operators find it difficult, if not impossible, to compete with fraud without themselves stooping to the same corrupt kickback practices. Thus, government legislatures and agencies regulate against this practice as businesses can do nothing collectively to stop it without government policing efforts. The real estate commissioner needs their bully pulpit to do more.
A bad habit, at best
So what’s wrong with being paid a referral fee for sending valuable business to another company?
Kickbacks are a bad habit real estate professionals have to kick. To the individual real estate agent, they make so much linear sense. After all, don’t brokers and agents deserve a cut of the action they produce?
What these enterprising individuals willfully misunderstand (in the face of evidence of their bad behavior) is that they are getting their cut — twice. RESPA expressly prohibits the agent from collecting a second fee for no or nominal services when the fee is split with another service provider in the transaction: the tell-tale sign of a kickback. RESPA does not consider recommending a service provider to be a service deserving of a fee.
For example, an unlawful kickback occurs when:
- a real estate licensee accepts a fee in a transaction for services rendered to a client;
- the licensee refers the client (or other participant) to a provider of a service related to the same real estate transaction;
- the client pays a separate fee to the referred provider for the service; and
- the provider pays a cut of that fee, fixed or percentage, to the licensee.
In this scenario, it is clear that the real estate licensee has been paid twice without providing any additional services in the transaction that warrant the payment of a further fee. The fact the fee was funneled through another service provider does not “launder” the payment — the client has still been charged twice.
RESPA rules for brokers and third-party service providers
The referral-steering of a client in an existing fee-paying transaction is not a separate service rendered in exchange for the kickback. It is an inclusive service owed the client to care for and protect them in the sales transaction.
In contrast, payments between third-party service providers and brokers (for their agent’s efforts) on a sales transaction to be legitimate fee income need to be taken in exchange for performing a significant portion of the services rendered by the provider who is paying the agent. Thus, the fee can never be paid a transaction agent for the referral, but can only be paid for services additionally performed which would otherwise have been performed by the provider.
However, brokers and agents rarely perform services on behalf of service providers beyond the referral (which was done on behalf of the client, not the provider), and therefore may not receive a referral fee — the kickback.
Referral fees are not the only form of kickback which violates RESPA. Indirect kickbacks commonly provided by third-party service providers in exchange for referrals include:
- entry into a “referral contest” drawing for referring a lead;
- paying for sporting events or theater tickets;
- throwing a party for anyone who referred business;
- paying the admission to a real estate seminar or course;
- paying rent for space in a broker’s office not required for the provider to do business; and
- paying for real estate advertising.
However, promotional and educational activities are allowed if:
- they are not conditioned on the referral of business; and
- they do not involve the payment of expenses (rent, IT services, supplies, etc.) incurred by a broker or agent in a position to refer business. [12 Code of Federal Regulations §1024.14(g)(vi)]
Another classic example of kickbacks is prevalent in so-called “closed offices.” Here, brokers ban third-party service providers from competing for business with their one chosen service provider — their “preferred” lender, escrow or title company. The kickback is labeled whatever the provider and the broker agree to.
In addition, lenders may not pay a fee to a real estate broker representing a participant in the sale the lender is to finance, unless the broker performs a significant service on behalf of the lender. For instance, a broker may receive a second fee — a further fee in the same transaction — when they render significant mortgage origination services on behalf of the lender, which in the case of a homebuyer’s mortgage will require the broker to have a mortgage loan originator (MLO) endorsement. Many are, and do the processing as MLOs on behalf of a lender or for funding themselves.
However, multiple broker services need to be performed by separate individuals under the broker to receive two fees on the same transaction. Thus, a single individual who represents the client in the real estate transaction is barred from receiving a second fee for originating the client’s mortgage in the same transaction. [12 Code of Federal Regulations §1026.36(d)(1)]
The splitting of fees and the payment of referral fees in a sales transaction involving a consumer mortgage origination — the sale of a one-to-four unit residential property to a buyer-occupant contingent on purchase assist financing — is regulated by RESPA. Here, if the broker or their agent is already involved in the sale as a transaction agent (TA) for a fee, the broker is prohibited, with two major exceptions, from giving or receiving a referral fee. [24 United States Code §2607(a); 12 CFR §1024.14(b)]
The two exceptions in consumer mortgage transactions which allow fees to be shared include:
- referral fees paid to or received from other brokers (not in the broker’s employ), a horizontal disbursement from one broker to another, excluding the receipt of any fee from a mortgage broker or lender who is or will be processing or originating the consumer mortgage [12 CFR §1024.14(g)(1)(v)]; and
- fees paid by the employing broker to their licensed sales agents, broker associates or unlicensed finders, a vertical disbursement within the broker’s office, which bars payment of a fee to other providers or persons connected with the consumer mortgage transaction. [12 CFR §1024.14(g)(1)(vii)]
Any person who violates RESPA may be:
- fined up to $10,000;
- imprisoned for up to one year; and
- held liable for three times the amount paid for the settlement service to the person charged for the settlement service. [12 United States Code §2607(d)]
In addition, RESPA violations are often combined with other private lawsuit claims such as antitrust violations, exposing violators to additional civil liability. Additionally, accepting kickbacks often leads to income tax evasion, as unlawful earnings are seldom reported as income.
Referral fees between brokerages
Referral fees are allowed between two brokers if the broker receiving the referral fee is not involved in providing a service in the home sales transaction such as financing, insurance, escrow, etc.
Compensation for a referral permitted by or between brokers under RESPA includes:
- payments to the buyer’s broker by the seller’s broker, and referral arrangements between real estate agents and brokers;
- payment to any person of a bona fide salary or compensation or other payments of goods or facilities actually furnished or for services actually performed, such as finders employed and used by a broker; and
- an employer’s payment to its own employees for any referral activities. [Calif. Business & Professions Code §10177.4; 12 USC §2607]
Although the RESPA exceptions in a consumer mortgage transaction allow fee-splitting activity, the California Bureau of Real Estate (CalBRE) limits fee splitting to:
- payments between brokers (who then may split the fee with their employees); or
- payments by a broker to their employees, licensed or unlicensed. [Bus & P C §§10130 et seq.]
Accordingly, a licensed salesperson may only receive a fee or other compensation for acts which require a CalBRE license if they are employed by a broker.
Agents are prohibited from accepting a fee or other benefit from any person other than their employing broker. Agents are also forbidden from paying a fee to any other broker or agent without first directing the payment through the agent’s employing broker. [Bus & P C §10137]
Finally and as a fiduciary matter, brokers and their agents always need to advise their clients of the dollar amount of any compensation received from service providers related to the real estate transaction in which their client is involved. If the compensation (monetary or otherwise) is not disclosed, agents and their employing broker are subject to their client recovering all fees received, as well as license suspension or revocation. However, fees prohibited by RESPA cannot be legalized by disclosure or consent of the client. [Bus & P C §10176(g)]
Bottom line, referral fees are prohibited between brokers and third-party providers with one exception. In order for a broker or agent to receive a referral fee when they are set to receive a fee on a home sales transaction, a tangible inclusive service — besides the referral — needs to be performed on behalf of the business paying the referral fee.