Brokers commonly refer their clients to title companies, but when may a broker benefit or profit from these referrals? This article clarifies the line between lawful and unlawful referral practices.
Clients’ reliance on referrals
Choosing a title insurance company is probably the last thing on your homebuyer clients’ minds. This is something they rely on other professionals to worry about for them. As a result, few of them shop around for different rates or levels of service.
This indifference on the part of homebuyers makes them more likely to overpay due to overreliance on broker or lender referrals to title companies. By extension, referring a title company is a natural point in the transaction when the broker may be tempted to receive unlawful kickbacks.
The prohibition against kickbacks exists to protect consumers. A homebuyer relies on their broker to provide unbiased referrals, guiding them toward the businesses which provide the most reliable customer service and lowest rates. But brokers who refer businesses due to kickbacks are not steering homebuyers towards the best choice, but only toward those companies which directly benefit the broker.
The Real Estate Settlement Procedures Act (RESPA) regulates referrals made by brokers representing clients purchasing a one-to-four unit property and originating a mortgage. The aim of RESPA is to protect SFR owner-occupant homebuyers (not investors) when they are shopping for a mortgage and mortgage-related services. Section 8 of RESPA prohibits kickbacks — improper fee-sharing — during the mortgage origination process. [12 Code of Federal Regulations §2607(a)]
In California, even stricter rules apply regarding unlawful kickbacks and benefits received by the broker in exchange for a referral. Read on for the details on when a broker may refer a business, what disclosures need to be provided and when this behavior is strictly prohibited.
Example: receiving a fee for referring a title company
For example, consider an SFR homebuyer shopping for title insurance. Their broker refers them to a title company that is not owned or co-owned by the broker. In exchange for the referral, the title company gives the broker a referral fee.
Is the referral fee allowed under RESPA?
No! A broker who refers a settlement service company involving a one-to-four unit SFR may not receive a fee for doing so. [12 CFR §1024.14(b)]
RESPA prohibits the splitting of unearned fees between multiple parties. However, it does not regulate pricing or overcharging (so-called “garbage fees”). [Freeman et al. v. Quicken Loans, Inc. (5th Cir. 2012) 626 F3d 799]
A broker receiving a broker fee for negotiating the sale or purchase of a one-to-four unit residential property involving a mortgage origination may not receive a referral fee in addition to their broker fee received on the sale. This is true even if the broker discloses the fee and/or receives consent from the homebuyer. [Calif. Business and Professions Code §10176(g)]
The penalty for accepting a referral fee is a fine of up to $10,000 and/or one year in jail for each offense. [12 CFR §2607(d)(1)]
In California, anti-kickback laws apply to all California Department of Real Estate (DRE) licensees engaged in real estate activities (not just those covered by RESPA), including the purchase, sale or lease of residential or commercial real estate or vacant land.
Further, the state anti-kickback laws expose a DRE licensee to disciplinary action for accepting anything of value in exchange for referring business to other related businesses, like title insurance companies or home inspectors. [Bus. & P C §10177.4]
Example: referring a title company which rents desk space
Consider the same scenario above, but in this case the title company rents desk space from the broker. The broker has no ownership interest in the title company, and they do not receive a referral fee for referring the homebuyer.
Is the broker lawfully allowed to refer the title company renting desk space in the broker’s office?
It depends. On its face, the relationship between the title company renting desk space and the broker’s referral is completely innocent. But in reality, these arrangements often result in backdoor dealings which benefit the broker.
For example, the title company may pay an inflated rental rate in exchange for the broker referring their clients to the company. The title company may pay for all of the brokerage’s utilities or buy fancy catered lunches for the office in exchange for referrals. These are each considered things of value, and thus fall under the same RESPA prohibitions as referral fees and kickbacks. [12 USC §1024.14(d)]
Alarm bells go off for regulators when observing so-called closed offices, where brokers ban third-party service providers from competing legitimately with their chosen service provider. These “preferred” title companies or lenders are usually benefiting the broker in some indirect or direct way, and thus are engaging in unlawful activity under RESPA.
Example: using a marketing service agreement (MSA)
Consider a broker who signs a marketing service agreement (MSA) with a title company. The MSA specifies that the broker will provide marketing services for the title company for a fee.
On the surface, an MSA is a simple tool used by title companies and other settlement service providers to gain business. But MSAs are more often used as a disguise for the sending and receipt of unlawful kickbacks and referral fees.
For example, the Consumer Financial Protection Bureau (CFPB) reported in 2015 that MSAs carry significant regulatory risks. In one case, the CFPB found a title company using an MSA which paid out based on the number of referrals received and the profits generated from those referrals. In another case, the CFPB found a settlement service provider did not disclose its affiliated relationship and did not tell its clients they had the option to shop around for other services before steering them toward their affiliated provider.
In both cases, an MSA was used to disguise the unlawful behavior which violates RESPA’s anti-kickback regulations.
How to lawfully benefit from referrals
In a recent first tuesday poll, 30% of respondents said their broker rents desk space to a title company or encourages the exclusive use of a title company by closing their office to other titles companies. (first tuesday has repeated this poll over the years — in 2017, 22% responded “yes” and 32% responded “yes” in 2016).
Of course, not all of these arrangements are necessarily unlawful. But brokers who rent desk space to title companies and refer those companies to their clients walk a thin line. Closed offices and MSAs are not necessarily RESPA violations, but they put the broker at risk of violating RESPA and are best avoided.
Still, this doesn’t mean brokers aren’t allowed to branch out and find alternate revenue streams for their brokerage.
Diversified brokerages go beyond the simple services of listing and representing buyers of property, offering additional services to increase their income streams. To that end, they may become full-service brokers, referring buyers and sellers to lenders and service providers they own or co-own. Thus, the broker indirectly benefits from making referrals to these service providers by sharing in any profits produced by the referrals.
This relationship is called an affiliated business arrangement (ABA), when a broker may lawfully profit from referring a client to a service provider the broker owns or co-owns (having a disclosed ownership interest greater than one percent in the title company they are referring to the homebuyer). When the broker makes this referral, they need to use an ABA disclosure. [See RPI Form 519 and Form 205]
The compensation the broker receives due to the ABA is a conflict of interest which creates a fundamental agency dilemma. In contrast to brokerage fees, a conflict of interest addresses a broker’s or agent’s personal relationships with others that are potentially at odds with their agency duty of care and protection owed the client.
Conversely, the broker may lawfully refer a client to a business in which they do not possess an ownership interest as long as they do not receive a fee or any other financial benefit from the referral.
Further, fees and benefits received by the broker need to be disclosed to the client, including compensation received in the form of:
- professional courtesies;
- familial favors; and
- preferential treatment by others toward the broker or their agents. [See RPI Form 119]
Unless disclosed and the client has given their consent, an undisclosed conflict of interest is a breach of the broker’s fiduciary duty of good faith, fair dealing and trust owed to the client. Therefore, full-service brokers need to always be transparent with their clients, disclosing to them the ABA and the potential fees and benefits the broker will receive if the client chooses to use their owned or co-owned services.