Why this matters: Learn to identify impermissible fees for your referral of a transaction participant to a third-party provider as a duplicate charge and a prohibited kickback and establish broker-owned services and refer clients to use them to capture legally entitled profit from transactional services otherwise received by third-party providers.
Follow along with an audio reading of this article adapted as a chapter from our upcoming Real Estate Practice course update.
Fees barred for referral of a transaction participant
In times of slowed residential sales, astute brokers generate additional income by offering diverse services in their brokerage business. When broadening the real estate services they offer, a broker expands into a full-service broker — they are providing transaction-related services the broker owns or co-owns. The broker then advises participants in transactions they arrange, such as buyers and owners, to use the services the broker owns.
These broker-owned business relationships are classified as affiliated business arrangements (ABAs) or controlled business arrangements, a business structure called vertical integration. Thus, an ABA enables a broker to indirectly benefit financially — without the kickback of a referral fee — by advising clients and other participants to use the broker’s transaction services.
When a transaction broker owns or co-owns an ABA service used by buyers and sellers in sales transactions the broker is paid a fee to negotiate, the broker shares in any net income the ABA earns due to referrals. [See RPI Form 205 and 519; 10 Calif. Code of Regulations §2903]
Referral fees for a broker are barred by federal regulations when the broker expects to receive a fee for assisting participants in a buyer-occupant single family residential (SFR) sales transaction funded by mortgage financing. [12 United States Code §2607]
Here, the payment of a referral fee, unless prohibited, augments the buyer’s or seller’s transaction costs in the amount of the referral fee paid for a transaction agent’s ordinary advice, a “kickback” by classification.
Further, a broker’s referral of participants is advice a transaction agent is duty bound to provide in a transaction as part of the services they render to earn a fee for their representation.
Referral fees are unlawful when paid to a transaction broker by a third-party provider of services in exchange for referring transaction participants to the provider.
Service providers essential to closing a sale include:
- title companies;
- mortgage loan originators (MLOs);
- credit reporting agencies;
- home inspectors;
- pest control operators;
- hazard insurance agents;
- escrow companies; and
- other brokers.
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Profits from a referral to a broker affiliated service
For the broker to meet conditions to profit from an ABA, the broker needs to:
- have an ownership interest greater than one percent in the business recommended to the buyer or seller; and
- provide a written disclosure of the broker’s affiliation with the controlled business the person referred. [See RPI Form 519]
As an owner of the service provider, the financial benefit the broker receives from the referral is their share of annual earnings in the ABA, not the additional payment of an unlawful referral fee. [12 Code of Federal Regulations §1024.15]
Thus, when the seller broker of a property for sale refers the property owner they represent to a pest control business they own or co-own, the broker as its owner earns an income from the ABA services performed. The broker discloses their ownership of the ABA which permits the broker to legally benefit by sharing in any end-of-year profit the business realizes on the referral.
Conversely, the broker who does not possess an ownership interest in the referred business is not involved in an ABA. Thus, the broker receives neither a referral fee nor any financial benefit from the referral.
However, a transaction broker may receive an additional fee when they also provide another service in the home sales transaction, such as MLO financing, hazard insurance, escrow service, etc. [See RPI Form 114]
Related article:
The votes are in: Undisclosed referral fees are unlawful kickbacks
Permitted referral fee situations
Compensation for a referral is permitted between brokers when:
- payment is to the buyer broker from the seller broker and is paid through escrow on closing;
- the referral arrangements are between a real estate agent and their employing broker;
- a transaction broker pays any person a bona fide salary, compensation for goods, facilities furnished or services performed, such as finders employed by the broker; and
- an employing broker pays their employees for referrals to an ABA. [12 USC §2607(c)]
Further, California controls broker and agent conduct when paying or accepting referral fees from other brokers and their agents. Agents and broker-associates of an employing broker may only accept a fee or other benefit by payment from their employing broker, never directly from any other person for services related to real estate. Also, agents and broker-associates may not pay a fee to any other broker or agent without arranging for payment through their employing broker. [Calif. Business and Professions Code §10137]
Related video:
Referral fee disclosure
Brokers and their agents as fiduciaries advise the client they represent about any compensation they receive which arise out of the client’s real estate transaction. When the broker does not disclose transaction related compensation (monetary or otherwise), agents and their employing broker are subject to their client recovering all fees they received. Further, as licensees, they are at risk of the DRE suspending or revoking their license in response to a complaint.
Additionally, when a broker refers a seller or buyer to a service provider that they own or co-own (an ABA), they must disclose their ownership interest in that provider at the time they make the referral. The disclosure includes the nature of the business relationship between the broker and the business providing services, as well as an estimate of the cost or range of charges incurred with the ABA. [See RPI Form 519; 12 CFR §1024.14(f)(1)]
Other disclosure forms exist for direct or indirect compensation in conjunction with the ABA. For example, the Compensation Disclosure in a Real Estate Transaction form discloses the type of compensation, the dollar amount, its source and any other benefits the broker anticipates receiving. The broker may receive compensation from any participant or provider due to their client’s entry into a purchase agreement or other real estate transaction. [See RPI Form 119]
However, disclosure or consent of the client does not legalize fees prohibited by the Real Estate Settlement Procedures Act (RESPA) in buyer-occupied SFR transactions with MLO mortgage financing. [Bus & P C §10176(g)]
A broker or agent controlled by RESPA who accepts a referral fee or fails to disclose the existence of an affiliated relationship is subject to criminal penalties of up to $10,000, one year in jail or both for each offense. The principal referred to the service provider may recover up to three times the amount of the improper referral fee received by the broker plus attorney fees in a civil suit. [12 USC §§2607(a), 2607(c)(4), 2607(d)]
Related video:
Read more about RESPA and mortgages.
RESPA: No additional service, no additional fee
A transaction agent (or broker) may receive an additional fee paid by an MLO in an SFR buyer transaction when the broker renders substantial services in the mortgage origination process. The services rendered by the broker are services otherwise performed by the MLO. Again, RESPA regulates this payment from the MLO to a transaction broker.
In essence, this is a “no-service, no-fee” restriction on fees, imposed by RESPA, in addition to the representation fees earned in a transaction. The fee restriction controls fee sharing in MLO processing for MLO-endorsed real estate brokers and agents representing buyer-occupants or sellers in SFR transactions funded by a mortgage.
An MLO in an SFR mortgage financed, buyer-occupant transaction may pay a fee to a transaction broker as an exception to the prohibition when the broker is already receiving a fee for their services in the transaction. The MLO may share their fee with a transaction broker, who is likely MLO endorsed, when the broker performs significant services otherwise handled by the MLO.
Here, a transaction agent may not be paid a second fee for acting solely as a referral agent. The referral is part of the services a transaction agent owes the buyer or seller.
Related video:
Read more about unpermitted kickbacks.
Significant second service
The broker and their agent are entitled to a second fee in a sales transaction when they handle the mortgage escrow or process a mortgage application and documentation — among other services such as notary. These services are significantly more involved than the obligatory agency act of a mere referral.
An MLO and broker comply with the “no-service, no-fee” rule when 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)]
Before a broker and their agent may accept a fee for a second significant service in addition to a broker fee on an SFR mortgaged buyer-occupant transaction, the broker or agent needs to perform numerous activities unrelated to the sales transaction but related to processing the mortgage origination.
Further, when the broker or their agent performs sufficient mortgage origination activities for an MLO (or as an MLO), the second fee for the mortgage-related services must be justified as a competitive dollar amount for fees paid for the same services by other MLOs.
Related video:
Read more about mortgage fee disclosures.
Real estate sales transactions are increasingly subject to duplicate charges — garbage fees — imposed on both buyers and sellers by brokers, lenders, escrow agencies and title companies during periods of rising property values. Duplicate charges for integral services, called kickbacks — hidden costs — are redundant fees for included services, an overcharge the buying and selling public frequently experience.
A third-party service provider openly undertakes kickbacks to brokers and agents in an unlawful effort to garner a larger share of the available business. This effort is a corrupt mode of business and a RESPA violation in a mortgage funded SFR buyer/owner-occupant transaction. In turn, legitimate operators find it difficult or even impossible to compete with fraud without themselves stooping to the same corrupt kickback practices.
Referral fees are not the only form of kickback which violate RESPA. Indirect kickbacks commonly provided by third-party services 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;
- paying for real estate advertising; and
- paying for subscriptions to 800 numbers and call-capture numbers.
However, promotional and educational activities are allowed when:
- 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 CFR §1024.14(g)(vi)]
Related video:
Read more about RESPA violations.
The improper “closed office” and the preferred provider
Another classic example of kickbacks takes place at a so-called “closed office.” Here, the broker bans third-party service providers from legitimately soliciting business which competes with their chosen service provider — their “preferred” title insurer, MLO or escrow. The enforced preference is mostly the result of some direct or indirect backhanded payment arrangement the broker has with an MLO, escrow or title company.
Whether in the form of referral fees or other indirect financial incentive, kickbacks paid by providers steer or capture business. Kickbacks to transaction agents hinder access to lower rates and removal of unnecessary fees.
Rather than directing buyers to legitimate service operators, buyers are referred to a business providing an illegal kickback to the broker or agent. DRE licensees must instinctively avoid this corruption as they will be approached to violate the rules of conduct.
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