This article reports recent case law involving settlement service providers accused of violating RESPA laws that prohibit the unlawful practice of paying kickbacks to real estate brokers for client referrals.
Guess who is on the receiving end?
Kickbacks can run but they can’t hide. Although the unethical duplicate charge was banned by enactment of the Real Estate Settlement Procedures Act (RESPA) in 1974, the kickback has remained under the radar in many forms and for many reasons. Referral fees paid by home warranty companies (HWC), mortgage lenders, title insurers and other settlement service providers to real estate brokers for recommending their services have proved to be among the most pervasive RESPA violations in recent years.
Two major organizations offering settlement services and thousands of cooperating real estate professionals have been recently implicated in kickback scandals. Fidelity National Financial (FNF) is on the hook with the U.S. Department of Housing and Urban Development (HUD) for $4.5 million, which comes days after news of a settlement reached with Prospect Mortgage, LLC at $3.1 million for RESPA kickback violations relating to joint “sham-ventures.” [For more information on the HUD settlement with Fidelity National Financial, see HUD Letter No. 11-142; for more information on the HUD settlement with Prospect Mortgage, see HUD letter No. 11-146.]
HUD, however, is not the only sheriff in town. Although the total figure has yet to be released, a recent class action settlement was awarded to homebuyers who alleged American Home Shield Corp. (AHS), one of the nation’s largest HWCs, paid real estate brokers undisclosed kickbacks for pushing their warranty policies on buyers. HWCs have been paying such kickbacks for years and it seems that the opulent era of the HWC referral fee has come to a close. [For more information on the AHS class action settlement, see the Abney class action settlement agreement.]
The anatomy of a kickback
The recent claim settled against AHS is controversial among unionized real estate brokers — and for good reason. The settlement reveals the impropriety in the long-standing practice of HWCs paying real estate brokers for doing nothing more than recommending their home warranty policies to buyers in a sales transaction where the brokers are already receiving a broker fee for their advice and counsel. In the case of the AHS kickback scheme, when an agent successfully “sold” a warranty policy to a buyer, the homebuyer paid a one-time fee of around $500 at closing for the home warranty policy, with roughly ten percent of that amount being paid to the referring transaction agent.
RESPA prohibits the payment of referral fees to transaction agents for arranging settlement services associated with the kickbacks in question. Contention over what qualifies as a kickback has sprung from unionized brokers who dispute that the referral fees should be considered kickbacks. They claim the service provided by arranging the referral allows them to earn these additional fees. Conversely, some large brokerage firms, such as Redfin, are calling a kickback a kickback and condemning the payment of any home warranty referral fees to their agents.
However, trade unions such as the National Association of Realtors (NAR) stand behind the rebates to union member brokers claiming the issuance of home insurance policies is not a settlement service controlled by RESPA and thus the referral payment is not a kickback. [For more information on the methods used to sidestep the law, see the January 2010 first tuesday article, Lender’s take steps to avoid HUD’s new GFE.]
Do you believe fees paid to real estate brokers for referring clients to home warranty companies should be considered kickbacks?
- Yes (71%, 89 Votes)
- No (29%, 36 Votes)
Total Voters: 125
HUD does not vacillate on this issue however, calling it a kickback loud and clear. To wit, HUD has issued a ruling prohibiting any real estate broker, and by extension, any agent who receives a brokerage fee as a transaction agent in a home sale involving a purchase-assist loan from accepting a referral fee from a third party for promoting a home warranty service. If, on a case-by-case basis, the broker or his agent can prove they performed substantive services in the preparation and delivery of the third-party service beyond broker services normally provided to buyers and seller as part of a typical sales transaction, then they are not subject to the prohibition. [For more information on HUD’s home warranty kickback ruling, see the June 2010 interpretive rule 2010-15355.]
RESPA — rules worth reiterating
How can this be put as clearly as possible? A kickback is a kickback is a kickback.
A key (and well-known, long-standing) aspect of RESPA is the no-service, no-fee restriction on the second fee when a real estate broker is already receiving a fee for acting on behalf of a buyer or seller in an SFR real estate transaction financed by a RESPA classified loan (which are all consumer loans secured by SFR properties). A business involved in the closing of a home sale is prohibited from paying brokers and their agents a fee of any type for a referral when the broker is already receiving a fee on the sale for broker services they render on behalf of the buyer or seller, unless the broker performs significant services on behalf of the third-party provider in the delivery of their service. Stated more directly, a second fee cannot be paid to the broker, much less his agent, by anyone if it is received by the agent for activity limited merely to referring the buyer or seller to the third party provider, here the HWC.
RESPA’s prohibition against payments by a third party service provider to a transaction agent (read: broker, as agents may not directly receive fees) should be distinguished from a seller’s or buyer’s broker paying a referral fee to another broker for initially referring a client. The same applies to the broker’s employment of an unlicensed finder to locate clients in exchange for payment of a fee (but for a different reason).
The RESPA rule does not prohibit the receipt by another broker (and thus indirectly his agent) of a fee as a cooperating broker (read: fee-splitting) for initially referring the buyer to the seller’s broker (or vice versa) in a sales transaction. [For more information on finders as a non-licensed referral service, see the June 2011 first tuesday Letters to the editor.]
In the case of a finder or a fee-splitting broker, the referring agent is providing only a single service in the sales transaction — the referral — and is receiving only one fee — the referral fee. Further, relocation referral fees are a common variety of the single service, fee-sharing arrangements, which are properly paid and received in home sales transactions and thus do not constitute a RESPA violation.
A settlement service provider and a broker are in compliance with the no-service, no-fee rule if the earnings the broker is to receive for the second service are due the broker as:
- payment for goods;
- or payment for services rendered, other than the referral. [12 USC §2607(c)]
Unfortunately for the HWCs and their colluding brokers that are in violation, this doesn’t seem to be the case.
Trade union complicity
NAR’s argument: their brokers who are receiving a fee are offering substantial services in counseling the homebuyer about the pros and cons of purchasing a home warranty policy. This argument of course is defective. “Counseling” (assuming for the sake of argument that any counseling in this matter is actually taking place) is already part of the duties a California broker and his agents owe to their buyer in the normal course of rendering agency services as transaction agents.
Aside from such phantom counseling services, the home warranty kickback scheme results in an undisclosed fee being earned by the broker in violation of agency law. California requires brokers and their agents to disclose to their clients all benefits they receive in connection to the transaction in which they are representing the client, which, of course, includes home warranty referral fees. But for the representation, they would not be receiving the referral fees. [See first tuesday Form 119 — Compensation Disclosure in a Real Estate Transaction; Calif. Business and Professions Code §10176(g), DRE Reg. 2904]
Thus, the second fee paid by an HWC to a broker for referral services is a duplicate charge for a service inherent to negotiations between a buyer and a seller in purchase agreement forms and in the counseling and representation on that transaction for which a sales transaction fee is paid — in other words, a kickback! Worse, a serious conflict of interest is patent in the broker’s selection and straight-faced recommendation to his client of the service provider paying a fee for the reference. [For more information on HUD’s regulation of duplicate charges, see the April 2010 first tuesday article, When it comes to fees: charge only one and disclose it to your client.]
NAR’s stance on this issue, even in the face of HUD’s new rule, only reveals the primary reason for the trade association’s existence: earn as many fees as possible for its constituents. Is this intrinsically wrong? Perhaps not.
But when an organization holds itself out as meeting and indeed exceeding the highest level of “ethical standards” in the real estate industry, one has to wonder why they would condone behavior that smacks of bad faith and downright duplicity on the part of the California broker receiving the kickback. [For more information on NAR’s stance on the home warranty kickback issue, see the NAR-sponsored bill that seeks to make home warranty referrals an exception to RESPA, H.R. 2446.]
Ramifications to avoid
Sound economics and public policy to keep home purchase costs free of corruption suggest that duplicate charges are improper since they make the real estate market function less efficiently. The systemic approval of garbage fees artificially increases a broker’s income (and the buyer’s or seller’s transaction costs) and results in the systematic elimination of more competent and less-costly competition settlement service providers that properly chooses to abide by the rules. Kickbacks to brokers and builders in violation of federal RESPA laws are still openly undertaken by some mortgage lenders (to say nothing about the conduct of the largest title insurance companies) in an illegal effort to garner a greater share of the available business. [Busby v. JRHBW Realty, Inc. (2008) 513 F.3d. 1314]
Kickbacks are a corrupting business policy. Legitimate settlement service providers find it difficult to compete with fraud without also stooping to the same fraudulent actions to meet the corrupt competition — social structures fall apart when rules for competitive conduct are ignored.
Kickbacks, in the form of referral fees or other indirect financial benefits used to steer or capture business, deliberately interfere with the availability of lower rates with fewer charges offered by competitors. The buyer is referred to the lender (or other settlement service provider) who provides the largest kickback, away from the legitimate non-participating competition who refuses to take part in the consumer fraud.
An ethical real estate professional recommends a warranty service they truly believe will benefit their client (read: fiduciary), not the company which will pay the highest undisclosed illegal kickback. Trade the $90 duplicate fee for a priceless reward: a satisfied client who is confident in your good faith and fair dealing that will recommend your services to others. Dare to disclose: no referral fees are being paid or received in this transaction.