Amendments to Regulation X, the Real Estate Settlement Procedures Act Regulation (1994 Revisions)

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Office of the Assistant Secretary for Housing-Federal Housing

Commissioner

24 CFR Part 3500

[Docket No. R-94-1725; FR-3638-P-01]

RIN 2502-AG26

Amendments to Regulation X, the Real Estate Settlement Procedures

Act Regulation (1994 Revisions)

AGENCY: Office of the Assistant Secretary for Housing-Federal Housing

Commissioner, HUD.

ACTION: Proposed rule.

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SUMMARY: The Department of Housing and Urban Development is proposing

to revise Regulation X, the regulation implementing the Real Estate

Settlement Procedures Act (RESPA), as amended to extend its coverage to

subordinate liens and for other purposes and to make technical

corrections. This proposed rule addresses referral payments, computer

loan origination services, and controlled business disclosure

requirements, and is intended to protect consumer interests while

recognizing the potential benefits of technological and business

arrangement innovations relating to these areas.

DATES: Comment due date: September 19, 1994.

During this comment period owners and operators of computerized

loan origination systems (CLOs) are also invited to participate in a

Technology Demonstration of Computerized Loan Origination Systems, to

be sponsored by the Department and held in Washington, DC, on September

26, 1994, beginning at 9:30 a.m. (EST), as discussed more fully in the

preamble under SUPPLEMENTARY INFORMATION. (Requests for participation

must be received on or before August 11, 1994, as provided under the

ADDRESSES section.)

ADDRESSES: Interested persons are invited to submit written comments

regarding this rule to the Rules Docket Clerk, Office of General

Counsel, Room 10276, Department of Housing and Urban Development, 451

Seventh Street, SW., Washington, DC 20410-0500. Communications should

refer to the above docket number and title. Facsimile (FAX) comments

are not acceptable. A copy of each communication submitted will be

available for public inspection and copying between 7:30 a.m. and 5:30

p.m weekdays at the above address.

To participate in the Technology Demonstration, contact David

Williamson, Director, RESPA Enforcement, at (202) 708-4560, or in

writing at room 5241, Department of Housing and Urban Development, 7th

and D, SW., Washington, DC 20410, or on E-Mail through Internet at

[email protected], on or before August 11, 1994. The TDD number for

persons who are hearing- or speech-impaired is (202) 708-4594. (The

telephone numbers are not toll-free.)

FOR FURTHER INFORMATION CONTACT: William Reid, Senior Economist, Office

of Policy Development and Research, room 8212, telephone (202) 708-

0421. The TDD number for persons who are hearing- or speech-impaired is

(202) 708-0770. For legal questions, Grant E. Mitchell, Senior Attorney

for RESPA, room 10252, telephone (202) 708-1552; or Kenneth A.

Markison, Assistant General Counsel for GSE/RESPA, room 10252,

telephone (202) 708-3137. The address for all the above-listed persons

is: Department of Housing and Urban Development, 451 Seventh Street,

SW., Washington, DC 20410. (The telephone numbers are not toll-free.)

SUPPLEMENTARY INFORMATION

Paperwork Reduction Act Statement

The information collection requirements regarding controlled

business disclosures and the CLO disclosures (appendices D and E of

this rule) have been approved by the Office of Management and Budget,

under section 3504(h) of the Paperwork Reduction Act of 1980 (44 U.S.C.

3501-3520), and assigned OMB control number 2502-0265.

I. Technology Demonstration

The purpose of the Technology Demonstration (see additional

information under the headings DATES and ADDRESSES, above) is to

provide owners and operators of computer loan origination systems

(CLOs) with an opportunity to demonstrate or discuss the operation and

benefits of their systems and the impact of the proposed rule on their

systems, and to provide consumer groups, industry organizations, and

members of the public with an opportunity to witness such presentations

or demonstrations.

As discussed more fully below, this rule proposes to modify the

application of the current Regulation X to CLOs. Information gained by

the Department from the Technology Demonstration may be used in

developing a final rule. Owners and operators are invited to notify the

Department of their interest in participating in this Technology

Demonstration. Participants will be free to make visual or conceptual

presentations without including actual use of computer loan origination

systems. Based upon the number of interested parties and other

practical considerations, the Department will determine the format,

timing, and logistical arrangements for the Technology Demonstration.

To the extent feasible, the Department will provide electrical and

telephonic hook-ups for participants. The Department reserves the

option of limiting the length of presentations, or setting any other

guidelines for participation, in accordance with the number of

participants.

II. Background

On November 2, 1992, HUD published a revised Real Estate Settlement

Procedures Act of 1974 (12 U.S.C. 2601 et seq.) (RESPA) rule

(hereinafter ``final rule'' or ``1992 final rule''), which became

effective on December 2, 1992, and was amended on February 10, 1994 (59

FR 6505). Technical corrections were published on March 30, 1994 (59 FR

14748). The final rule contained long-awaited provisions implementing

amendments to RESPA regarding controlled businesses. These amendments

were originally enacted in 1983 as section 461 of the Housing and

Urban-Rural Recovery Act (HURRA), Pub. L. 98-181. The final rule also

updated the original RESPA rule, which had not been amended since 1976.

On October 28, 1992, a few days before publication of the final

rule in the Federal Register, then-President Bush signed the Housing

and Community Development Act of 1992 (Pub. L. 202-550) (1992 Act),

which amended RESPA to state specifically that the making of a mortgage

loan was a covered transaction (a Federal court case had created

uncertainty) and that refinancing transactions were transactions

covered by RESPA. The 1992 Act also extended RESPA's coverage to all

subordinate liens involving 1- to 4-family residential property.

Implementing provisions, along with revisions of the final rule, are

set forth in the Federal Register of February 10, 1994, and are

effective on August 9, 1994. The effect of the statutory and regulatory

changes was to expand substantially the coverage of this criminal and

civil statute.

Following issuance of the final rule, two lawsuits were filed: one

by the Mortgage Bankers Association and one by a group of independent

service providers, called CRISIS. Both suits objected to provisions of

the final rule and alleged that HUD had not complied with the

Administrative Procedure Act (5 U.S.C. 551 et seq.) in promulgating the

November 2, 1992, rule. The cases have been dismissed, but are subject

to being reinstituted at any time.

Upon assuming office, HUD officials in the new Administration were

inundated with comments--mostly complaints--about the final rule issued

in the last days of the previous Administration. Notably absent from

the interests contacting HUD about the final rule were any

representatives of consumer interests. Instead, comments came almost

entirely from the affected industries. Some industry representatives

argued that the provisions of the final rule benefited consumers, while

others argued that the provisions, sometimes the same provisions, were

harmful to consumers.

The Department also received allegations that the final rule

created uncertainty about whether referral fees were in fact prohibited

by RESPA. Specifically, some commenters claimed that the introduction

in the final rule of an employer-employee exemption from the

prohibition on referral fees prompted some persons to set up sham

employer-employee relationships to shield prohibited referral fees, and

prompted others to ``extort'' referral fees from other settlement

service providers on the premise that HUD now allowed such

compensation. The final rule did not authorize such practices; however,

some commenters argued that the existence of confusion about whether it

did suggested that the final rule failed to establish a bright line,

comprehensible to industry participants, between permissible and

impermissible activities.

Given the controversy over the final rule, the Secretary determined

that a review of the previous policies was needed, particularly

focusing on the final rule's impact on consumers. The Secretary also

articulated three principles to guide that review:

(1) HUD's responsibility is to protect the consumer--not to mediate

among industry interests.

(2) HUD should regulate multibillion dollar industries

responsibly--principally by acting quickly to end uncertainty.

(3) Technological and business arrangement innovations have the

potential to provide significant consumer benefits, and HUD does not

serve consumers well if its regulations unduly stifle such

advancements.

On July 6, 1993, in an effort to ensure that the new Administration

heard the views of all interested parties, the Department published a

``notice of written comment period and informal public hearing'' (58 FR

38176), inviting testimony and written comments on the impact on

consumers of the following four provisions of the final rule:

Issue 1

Section 3500.14(g)(2)(ii), which provides that RESPA Section 8 does

not prohibit ``an employer's payment to its own employees for any

referral activities * * *.'' (Hereafter, this issue is referred to as

the ``employer-employee exemption'' or ``Issue 1''.)

Issue 2

Section 3500.14(g)(2)(iii), which provides that Section 8 of RESPA

does not prohibit ``any payment by a borrower for computer loan

origination services, as long as the disclosure set forth in Appendix E

of [the final rule] is provided the borrower.'' (Hereafter, this issue

is referred to as the ``computer loan origination (CLO) exemption'' or

``Issue 2''.)

Issue 3

Section 3500.13(b)(2), which provides that ``in determining whether

provisions of State law or regulations concerning controlled business

arrangements are inconsistent with RESPA or this part, the Secretary

may not construe those provisions that impose more stringent

limitations on controlled business arrangements as inconsistent with

RESPA, as long as they give more protection to consumers and/or

competition.'' (Hereafter, this issue is referred to as ``preemption

policy'' or ``Issue 3''.)

Issue 4

Section 3500.15(b)(1), which provides for a ``written disclosure in

controlled business situations, in the format of the Controlled

Business Arrangement Disclosure Statement set forth in appendix D of

this part'' of certain information regarding the ownership and

financial relationships between referring and referred-to parties, and

for certain timing and other methods for disclosure. (Hereafter, this

issue is referred to as ``controlled business disclosure policy'' or

``Issue 4''.)

At a public hearing held on August 6, 1993, at the General Services

Administration (GSA) Auditorium in Washington, DC, all 36 parties who

had requested to testify did so. Twenty-two witnesses opposed

provisions of the rule and 14 witnesses supported provisions of the

rule. The Department also received 1,553 written comments.\1\ Of the

1,526 comments reviewed, 1,148 comments opposing provisions of the

final rule were received from mortgage lenders, or State or regional

organizations representing mortgage lending professionals; consumer

organizations; 3 Federal agencies; and, in both combined comments and

separately, several State Attorneys General. An additional 325 critical

comments were received from law firms and title insurance companies.

Twenty-four comments were wholly or generally supportive of the final

rule, including comments from individuals and organizations in real

estate-related industries, lenders or title insurance providers, real

estate brokers, a builder, and the Federal Reserve Board. The remainder

of the comments were not characterized.

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\1\A total of 1,553 comments were officially logged in by the

Department's Rules Docket Clerk. More than two dozen were

duplicates, leaving 1,526 unduplicated comments.

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III. The Secretary's Position: A Brief Summary

Based on a complete review of the substantive arguments in support

of and in opposition to the final rule provided in the testimony at the

August 6, 1993, hearing; the written comments received; and a review of

the RESPA statute, its purpose, and its history, the Department reached

certain conclusions about its policy objectives on Issues 1-4, set

forth above. The Department therefore proposes to amend the final rule

as described below. Recognizing the rapid evolution of technology and

business practices, the Department believes that development of the

final rule will require additional collateral information about how

certain details of this proposal will work in practice and whether

these details will further the Department's policy objectives.

Therefore, the Department has developed a series of questions about

specific aspects of the proposal and asks commenters to offer any

information they may have about how the rules would work. These

questions are detailed throughout this preamble.

The following are the Department's policy objectives in addressing

each issue and the Department's conclusions as set forth in the

proposed rule:

A. Issue 1: The Employer-Employee Exemption

(1) HUD's objective. Controlled business arrangements and so-called

``one-stop shopping'' may offer consumers significant benefits

including reducing time, complexity, and costs associated with

settlements. If they do, the market should produce incentives for the

creation of controlled business arrangements without HUD authorizing

incentive payments (otherwise impermissible under RESPA) to encourage

these arrangements. However, HUD cannot scrutinize every aspect of the

financial relationship between interrelated companies. Therefore, HUD's

objective is primarily to prohibit compensation for business

development for related entities at a point when that compensation has

the greatest potential for overwhelming the other considerations that

go into business referrals, e.g., long-term customer satisfaction.

(2) HUD Proposal. (a) The exemption under the final rule permitting

employers to pay their own employees referral fees is proposed to be

withdrawn. Under this proposal, no employee of a company may be paid

referral fees, even for referrals to an affiliate company. This

proposal is based on the Department's view that the exemption under the

final rule was too expansive and compromised the statute's purpose of

protecting the consumer from being referred for settlement services

based on financial gain to the referrer, rather than on the highest

quality and best price of the services.

(b) In the interest of avoiding undue interference with the

internal operations of controlled businesses, which Congress has

concluded are permitted business arrangements under RESPA, the proposed

rule would allow the payment of bonuses and compensation to managerial

employees in controlled businesses for such purposes as the generation

of business among affiliates; provided, however, that the compensation:

(i) Is not tied on a one-to-one basis or calculated as a multiple of

the number or value of any referrals; and (ii) these employees do not

routinely deal with the public.

B. Issue 2. Computerized Loan Origination Systems

(1) HUD's Objective. The comments and witnesses at the public

hearing demonstrated that there is some confusion concerning the scope

of the Department's authority under RESPA to regulate CLOs. Thus, the

Department's first objective in this area is to clarify what the RESPA

rules can and cannot do. (See section below describing the legal

framework for analysis of payments for CLO services.) In addition, the

Secretary wishes to encourage the exploration and use of new

technology, especially when the new technology may provide information

and services to better inform consumers about one of the largest and

most complex financial transactions in their lives, thus allowing the

consumers to be more effective shoppers. However, the use of that

technology does not justify increasing the cost of mortgage loan

originations when the technology does not provide meaningful

information otherwise available without charge, or when there is no

additional convenience, clarity, or other benefit.

(2) HUD Proposal. The final rule would be amended to define a CLO

and to provide that payments made by borrowers to CLO operators for use

of a qualified CLO are exempt from RESPA scrutiny. The definition would

set forth reasonable requirements for qualified CLO systems for access,

lender-neutrality, and disclosure to consumers. Systems that fall

outside the exemption would have to meet the basic test of Section 8 of

RESPA that the borrower's payments be for goods or facilities actually

furnished or for services actually performed.

C. Issue 3: Preemption

There are no proposed changes to the preemption provisions. The

Secretary has concluded that change to these provisions is not

warranted at this time.

D. Issue 4: Controlled Business Disclosure Form

The rule would be amended to add an acknowledgement provision on

the controlled business disclosure form and to make other small

revisions.

IV. Discussion of Comments

A. Commenters Opposing the 1992 Revised RESPA Rule

The following summarizes the nature of the commenters and comments

opposing and supporting provisions on which HUD invited comment in its

July 6, 1993, notice (58 FR 38176), as well as the positions taken in

this proposed rule. In general, commenters were responsive to the

notice's invitation and focused their remarks on the four identified

provisions of the rule. A few comments raised other issues concerning

the final rule, but the focus of the hearing and request for comments

was the four specific areas listed. This proposed rule deals only with

the four issues on which comment was invited.

Eleven hundred forty-eight commenters opposed provisions of the

final rule. Commenters included mortgage lenders, realtors, and State

or regional organizations representing mortgage lending professionals.

The Department received an additional 325 comments critical of the rule

from law firms and title insurance providers. Opposition was also

expressed by six national organizations representing elements of the

mortgage finance or title insurance industries, two national consumer

organizations, an economist, a legal aid society, a real estate

consultant, a law student, and four commenters whose professional

interest could not be ascertained. A few national or regional computer

service providers also commented on the rule.

Finally, 3 Federal agencies--the Federal Reserve Board, the Federal

Deposit Insurance Corporation (FDIC), and the Office of Thrift

Supervision--submitted comments on the final rule, and 4 opposition

comments were received from State Attorneys General, including 1

comment representing the unified position of the Attorneys General of

16 States.

B. Commenters in Support of the Revised RESPA Rule

Comments wholly or generally supportive of the final rule were

received from 24 individuals and organizations engaged in real estate-

related industries, including 15 lenders or title insurance providers;

6 real estate brokers or agents; an organization composed of controlled

businesses, including realtors, which was formed in part to support the

final rule (RESPRO); a builder; and the Federal Reserve.\2\

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\2\Support for portions of the final rule was also expressed in

scattered comments received from individuals and businesses writing

to criticize other specific features. The only issue receiving an

appreciable amount of positive comment from critics of the rule's

other features was Issue number 4 of the July 6 notice--the

controlled business disclosure form.

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C. Summary of the Comments

In the ensuing discussion, arguments presented by the commenters

related to these four issues will be summarized under the four issue

headings. When commenters have asserted related arguments affecting the

disposition of two or more of these issues, those comments will be

mentioned in the course of discussing the issue that HUD perceives to

be the core argument made by the particular commenter.

(1) Issue 1: The Employer-Employee Exception

The employer-employee exception provision in Sec. 3500.14(g)(2)(ii)

of the final rule--allowing ``an employer's payment to its own

employees for any referral activities * * *''--was the subject of more

adverse comment than any other issue raised by the July 6, 1993,

notice.

Hundreds of lenders, attorneys, and settlement agents objected to

the rule's provision permitting employer payments to employees for

``referral activities''. Objections were focused, in large part, on

what commenters perceived as the anticompetitive effect of permitting

referral-based payments. Additionally, the Mortgage Bankers

Association, sixteen State attorneys general, and a large number of

other institutional and individual commenters saw the referral payment

provision as being directly contrary to the RESPA statute, or, at a

minimum, as contravening statutory intent.

The supporting commenters cited the desirability of vertical

integration and the difficulty in enforcing employer-employee

arrangements when the employer controlled all of the relevant

documentation.

(a) ``Anticompetitive'' Arguments Against Referral Payments. The

central argument raised by numerous commenters, including the combined

comments of attorneys general of several States, was that referral

payments were a breach of the trust of prospective home purchasers,

particularly in transactions involving real estate agents and

affiliated companies:

Consumers expect to be treated fairly by their real estate

agents and therefore trust that a referral to a settlement service

provider is based solely on their agent's knowledge of comparative

prices and service features. When there was no financial incentive

for the [real estate agent], consumers were justified in thinking

that they were referred to a settlement service provider because

that provider offered good service at a reasonable price, not

because the agent received a payment in exchange for the referral.

This is no longer the case.

Comments of State Attorneys General

Referral payments, commenters repeatedly pointed out, permit

vertically integrated real estate companies to provide financial

incentives to their employees to make all settlement service referrals

to affiliated companies. As a result, settlement service providers tied

to a real estate company are ``insulated from competition on prices and

services.''

RESPA was adopted, one commenter observed, because of Congress'

recognition that the very nature of the real estate transaction is

arcane and cumbersome, and that the typical consumer lacks any

comparable economic experiences. The Consumers Federation of America

(CFA) noted that the consumer has traditionally relied for assistance

on the real estate broker (who ordinarily is an agent of the seller)--a

person in ``a highly privileged position of influence over the consumer

* * *.'' CFA concluded that RESPA evidences congressional recognition

that this influence can be easily abused for broker self-gain at the

material expense of consumers.

The Mortgage Bankers Association (MBA) and other commenters

remarked that in the absence of referral fees, real estate agents may

be expected to afford good advice to home buyers. The real estate agent

has an incentive (the prospect of a sales commission, as well as

potential business referrals and repeat business) to send a buyer to a

lender offering the best combination of service and price. However,

when the person making the referral has another motive--a direct

financial interest--it becomes less clear that the agent or broker's

referral will be made with the best interests of the home buyer

uppermost, the MBA asserted.

According to its opponents, the principal consequences of the

employer-employee exemption were:

(i) Failure to refer home buyers to lenders and other settlement

service providers that provide the best service and prices; and

(ii) Ultimate reduction or elimination of competition in the

industry, brought about by ``unfair competition'' driving out small,

independent settlement service providers.

CFA echoed the arguments of lenders, attorneys, and title insurance

providers who repeatedly asserted that home buyers lacked the

experience to be sophisticated consumers:

For better or worse, consumers are simply not effective

financial services shoppers * * *. Since there is no possibility of

one-stop shopping because the consumer is not shopping, the core

claim of consumer benefit offered by controlled business arrangement

advocates--consumer choice--crumbles under the weight of economic

reality * * *.

Although shopping may not be occurring, there is, nonetheless,

the profound opportunity for `reverse competition' created by a

captive market willing to pay higher-than-market prices. What this

rule champions is not one-stop shopping, but, rather, one-stop pick-

pocketing of the consumer through the multi-layers of a diversified

financial services holding company.\3\

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\3\CFA cited and characterized a report commissioned by HUD from

Peat Marwick in 1980 as finding that two-thirds of home buyers

included in that sample did no ``shopping'' at all for a lender, and

that more than 80 percent failed to ``shop'' for settlement

services.

Commenters opposed to referral payments were not persuaded by

arguments in the 1992 final rule in support of permitting employer-

employee referrals. ``What matters,'' one commenter said, ``is not that

the payment is going from employer to employee * * * [but] that there

is payment for a raw referral, creating the very anti-competitive and

anti-consumer financial incentive Section 8 [of RESPA] was intended to

eliminate.''

(b) Legal Arguments Against Referral Payments. Many of the same

commenters who opposed referral payments on policy or economic grounds

also argued that permitting employer-employee payments for referrals

directly violated the RESPA statute. CFA, after characterizing the

events that led to the Congress' 1983 controlled business arrangement

amendments to RESPA, asserted that the Congress' clear intent was to

permit controlled business arrangements ``only under certain specific

conditions.'' The final rule, CFA claimed, ``grossly exceeds any

reasonable interpretation of statutory authority, and * * * has

returned the settlement service marketplace--or at least the controlled

business arrangement market--to the pre-RESPA era of anti-consumer and

anti-competitive brokerage steering.''

MBA and other commenters observed that Section 8(c)(4)(C) of RESPA

states that controlled business arrangements are permissible as long as

``the only thing of value that is received from the arrangement, other

than payments permitted under this subsection, is a return on the

ownership interest or franchise relationship.'' MBA argued that because

the final rule permits employees to receive a ``bonus'' when they refer

settlement business to affiliates, the rule ``fails to give effect to

the plain language of the statute.''

(c) Arguments in Support of the Employer-Employee Exception.

Several institutional commenters, along with real estate brokers,

lenders, insurance companies, and vertically integrated real estate

service providers, expressed support for the employer-employee

exception provided for in Sec. 3500.14(g)(2)(ii) of the final rule.

The Director of the Consumer and Community Affairs Division of the

Federal Reserve System supported the rule's exemption for employer

payments to its own employees for referral services, saying that it is

a ``legitimate expectation'' that an employee would make referrals for

the employer and be compensated for the referrals. Prohibiting payment

for referrals, the Federal Reserve spokesperson said, would prove

difficult from an enforcement standpoint, since examiners would then be

required to review employer bonus and salary policies to determine

whether compensation was based on general performance, or whether it

included payments for referrals.

The Federal Reserve spokesperson also expressed a concern related

to the Community Reinvestment Act of 1977 (12 U.S.C. 2901 et seq.) and

to the Federal Reserve's efforts to encourage banks to refer business

to community-based lenders:

* * * A bank may support these efforts by rewarding employees

for referring potential applicants who have not previously

considered the [Community Reinvestment target] bank an accessible

community lender. An adverse interpretation by HUD of this provision

could be detrimental to future innovations and developments in

community lending.

The Real Estate Services Providers Council (RESPRO) pointed out

that the November 2, 1992, rule makes clear that employer payments to

employees cannot be reimbursed by the party receiving the referral, or

that employer payments cannot be made to nonemployees.

The Consumer Bankers Association (CBA), although generally

supportive of the final rule, urged HUD to go further by expanding the

exemption to the referral fee prohibition to allow payment for

referrals to employees of affiliated businesses. In the absence of such

an expansion, CBA argued, the structure of the institution could

determine whether an employee could receive a payment for referrals.

CBA urged that the difference in the legal treatment of a referral

payment based on the internal structure of a banking organization lacks

any policy justification.

Other commenters asked for expansion of the employer payments

principle to allow entities with common ownership to pay referral fees

to affiliated companies.

(d) The Proposed Rule's Position on the Employer-Employee

Exception. The Department reviewed the extensive history relating to

this issue, including the history of the controlled business

arrangements amendment to RESPA. In enacting Section 8 of RESPA in

1974, Congress prohibited all fees, kickbacks, or things of value for

the referral of settlement service business. The statute, as originally

enacted, did not address referrals of business to affiliated companies.

In 1980, the case of Coldwell Banker v. Department of Insurance

(102 Cal.App.3d 381 (2d. Dist. 1980)) reached the courts. In that case

the California Insurance Commissioner refused to grant a license to a

wholly owned subsidiary of a real estate company to act as a title

insurer. The denial was based on a concept of restriction of trade.

This case drew HUD and congressional attention to whether this or

similar controlled business arrangements might violate Federal law. On

July 24, 1980, HUD issued an Interpretive Rule (subsequently withdrawn)

that stated that ``controlled business arrangements may be a violation

of Section 8.'' (49 FR 49360; withdrawn on May 18, 1982, 47 FR 21304.).

Two days of congressional hearings were held on September 15 and 16,

1981, and, in 1983, Congress enacted the ``controlled business

arrangement'' amendment to RESPA.

The 1983 controlled business arrangement amendment represented a

compromise between those who wanted no restrictions on the ability of

real estate settlement service professionals to refer settlement

service business to entities with which they had an ownership interest

and those who wanted a blanket prohibition against such referrals. The

compromise (see H.R. Report 97-532, at page 52) made clear that

controlled business arrangements do not violate RESPA--allowing

affiliated entities, such as real estate professionals, to refer

settlement business to related entities--provided that specified

disclosure requirements and safeguards are satisfied, including: (1) A

requirement that the relationship between the provider of settlement

services and the person making the referral be disclosed, along with

the estimated charges of the provider; (2) a bar against the required

use of a particular provider, except under certain specified exceptions

under Section 8; and (3) a bar against anything of value being received

by the referring party, beyond a return on ownership interest or

franchise relationship or payments otherwise permissible under Section

8(c) of RESPA.

Between the enactment of the 1983 amendments to RESPA and the

issuance of the 1992 final rule, HUD had issued several informal legal

opinions concerning the extent to which employers could pay referral

fees to employees. The opinions made clear that bona fide full-time

employees could be compensated for generating business for their own

employers, as this would be within the scope of their employment. These

opinions also made clear that uncompensated referrals to affiliated

companies were not prohibited. These opinions did not, however, broadly

approve compensation to all employees for referrals to affiliated

companies. In the circumstances addressed by HUD informal opinions

prior to the final rule, the permissibility of compensation of

employees for referral related activities depended upon the structure

of the affiliated companies or on whether the employees were acting

within the scope of their employment.

The 1992 final rule went beyond any of these previous positions and

created an exemption for any and all employer payments to its own

employees for referrals of business, including referrals to affiliated

companies. The final rule only retained the stricture that the company

receiving the settlement business could not directly or indirectly

compensate anyone for such business. Although the rule did not limit

this exemption to controlled businesses, the exemption has little

utility for entities other than affiliated companies, since it is

unlikely that an employer would pay its own employees for making

referrals to unrelated individuals or companies. The preamble of the

final rule set forth the position that payments from an employer for

referrals were exempt from Section 8 because a business entity acts

through its employees; the action of the employees is not sufficiently

distinct from the action of the employer to provide the requisite

plurality of actors needed to violate Section 8. Although the rule

permitted an employer to compensate its own employees for referrals, it

indicated that if the company receiving the referral reimbursed the

employer or the referring employees, Section 8 of RESPA would be

violated.

Entities critical of the 1992 final rule have characterized the

provision permitting employers' payments to their own employees for

referrals as broadly sanctioning referral payments. Trade and business

press have frequently restated this position without examination. Also,

the Department's attention has been drawn to a number of advertisements

and mailings in which various companies have cited RESPA as authority

for bogus or sham programs under which fees may be paid to individuals

who will become ``employees.'' While the final rule did not permit sham

arrangements, neither did it adequately clarify the extent of the

exemption.

Following a full consideration of the testimony and comments, the

Secretary has concluded that the 1992 final rule's employer-employee

exemption was too broad. Accordingly, the Secretary proposes to amend

the final rule by withdrawing the exemption set forth in

Sec. 3500.14(g)(2)(ii) of that rule. This amendment will have the

effect of providing that, while an employer may compensate its own bona

fide employees for the generation of its own business, all compensation

for referrals to outside entities, including affiliates, will be

prohibited under RESPA.

In addition to withdrawing the exemption, the proposal clarifies

specifically when compensation to employees runs afoul of the

requirements of RESPA. The rule provides that:

(i) No employee or agent may receive compensation from his or her

employer or any other source when the compensation is tied on a one-to-

one basis to, or is calculated as a multiple of the number or value of,

referrals of business to an affiliated entity; and

(ii) The compensation of agents or employees who routinely are in

direct contact with the consumer may not be based in whole or in part

on the value or number of referrals made to affiliated entities.

These two clarifications are designed to minimize any incentive

that a person in a position to make or influence a referral might have

to make a referral based on his or her own financial interests.

Clearly, compensation calculated as a multiple of the number or value

of referrals creates a powerful incentive to make referrals that

maximize one's own compensation. Similarly, agents or employees who

ordinarily are in direct contact with the consumer may be influenced in

making referrals if their overall performance is measured and

compensation is set, even in part, based on the number or value of

referrals to affiliated entities. The proposal makes clear that RESPA

prohibits such compensation. By withdrawing the broad exemption, the

potential for conflict of interest by those persons making referrals is

reduced, increasing the possibility of true competition among

settlement service providers based on the cost and quality of the

services provided.

Most facets of the settlement services business are very

competitive, and the Secretary wants to assure that the rule does

nothing to harm this competitiveness. The provisions set forth above

that would clarify how RESPA affects employee compensation can be

enforced and will not require HUD to interfere unduly with the internal

operations of controlled business arrangements. Because Congress has

clearly ruled on the acceptability, with conditions, of controlled

business arrangements, the role of the Department is not to encourage

or discourage controlled business arrangements, but to clarify what

activities between interrelated companies are permissible or not

permissible under RESPA.

With the withdrawal of the exemption, employees of controlled

business arrangements could continue to send consumers to affiliated

companies, but they may be more likely to exercise independent judgment

reflecting the interests of the consumer if the inducement of referral-

specific compensation is not present.

The proposal to withdraw the exemption would obviate the need for a

full examination of the question raised by some commenters about

whether the exemption in the proposed rule is contrary to the statute,

particularly since the Department has decided not to withdraw the

employer-employee exemption without notice-and-comment rulemaking. In

any event, the Department believes the exemption in the final rule

would be legally sustainable, because of the broad exemption authority

of the Secretary under Section 19 of RESPA.

Pending this proposed rule becoming final, the existing employer-

employee exemption remains operational and employer payments made in

accordance with the existing RESPA regulation will not be treated by

the Department as conduct violative of the RESPA statute. However, the

exemption in the existing rule is only available for employees, not

independent contractors, a class that, under the Internal Revenue Code,

includes most real estate agents and many others in the settlement

services business. Those persons engaging in sham practices in an

attempt to avoid the strictures of RESPA are not protected under the

1992 final rule during the pendency of these revisions.

(e) Questions and comments on this proposal. The Secretary's

proposal on the employer-employee issue seeks to clarify RESPA's

consumer protections while avoiding unnecessary intrusion into

controlled businesses. The Secretary intends to be flexible in

finalizing this proposal in pursuit of these objectives. To assist in

this rulemaking, the Secretary is particularly interested in comments

containing responses to the following questions:

(i) To what extent do you believe the Secretary's proposal will

accomplish the objectives of eliminating compensated referrals and

other payments that pose the greatest dangers to consumers without

overwhelming other legitimate considerations for referrals, such as

long-term customer satisfaction?

(ii) What effect will the proposal have on the ability of firms to

provide high-quality and well-priced services to consumers?

(iii) To what extent do you believe the proposal will unduly

interfere with the operations of controlled businesses?

(iv) What would be the effect of any such interference (with the

operations of controlled businesses) on consumers?

(v) To what extent do you believe this proposal will interfere with

legitimate business development programs of affiliated companies?

(vi) To what extent do you believe that the proposal will result in

increased competition in the settlement services industry?

(vii) If you disagree with the approach embodied in the proposal,

what alternative approaches would increase competition?

(viii) Do you believe that the proposal will adequately protect

consumers from steering?

(ix) If you do not believe the proposals will provide adequate

protection from steering, what alternatives would provide such

protection?

(x) To what extent do you believe the proposal will lead to cost

savings through increased efficiencies in the settlement services

industry?

(xi) If you disagree that the proposal will lead to cost savings,

what alternatives would you suggest to facilitate efficiencies?

In promulgating a final rule, the Secretary invites, and will

consider, economic and other data submitted on the effect on the

settlement services industry and consumers of the Secretary's and other

proposals.

(2) Issue 2: Computer Loan Origination Services (``CLOs'')

(a) Comments Critical of the CLO Provision. The final rule's

revision of the RESPA regulations indicated that payment by a borrower

for computer loan origination services was not 'prohibited by RESPA or

Regulation X. This provision also drew hundreds of adverse comments, as

well as support from several commenters responding to the Department's

July 6, 1993, notice.

Many commenters treated the CLO issue and the issue of referral

payments as closely related concerns. Computer loan origination

services, these commenters claimed, often are nothing more than thinly

disguised arrangements for the referral of settlement services. The

commenters argued that both referral payments and superficial or

nominal CLO services involve the ``steering'' of homebuyers to a

limited choice of service providers. A number of these commenters

indicated their belief that simple disclosure of the fact that a fee is

being charged affords inadequate protection against these dangers.

The Consumer Federation of America (CFA) entered vigorous

objections to the borrower fee authorized by the final rule. ``If there

is economic value to the adoption of electronic loan origination

technology, CFA believes that the marketplace will, on its own, adopt

it. There is no reason why the consumer should foot the bill for the

industry's capital investment.'' The CFA asserted that the RESPA

statute was ``suspicious'' of fees for services of unknown or

questionable value, and it objected to any ``sanctioned levy against

consumers for CLO services.''

Several commenters expressed their confusion concerning a CLO-

related question posed to the public in the July 6, 1993, notice. The

question presented was whether further clarifications or additional

conditions regarding CLOs are needed or would be desirable to protect

consumers, particularly if any payment for the CLO service comes

directly or indirectly from a lender. (Emphasis supplied.)

Some commenters addressing this issue said they had assumed that

the final rule only permitted ``customer-pay'' systems. If lender-pay

systems are permissible, these commenters claimed, a major new problem

is presented. Lender-pay systems are especially dangerous, the

commenters declared, because the broker's financial gain and incentive

to steer may be totally hidden.

A significant minority of the commenters (including many who

otherwise opposed features of the final rule) believe that CLO services

are the wave of the future and that computer-based systems promise real

benefit to prospective homebuyers. These commenters, however, joined

with other critics of the CLO provision in questioning the legitimacy

of linking CLO systems to referral fee arrangements. Others commenters

objected to the final rule's failure to assure universal access to CLOs

by lenders doing business in a particular location. Hundreds of

comments--predominantly from lenders and related settlement service

providers--urged that a comprehensive, limiting definition of CLO

services be added to the rule.

A commenter representing an automated service provider expressed

his fear that CLOs operated by real estate brokers and agents could be

used to ``display financial information [about other lenders] inferior

to what [the broker's affiliate] is offering, and charge the borrower

for doing it; then use the CLO fee collected for payment of `employee

compensation' to guide the buyer to the broker-owned title company,

closing service, insurance agency, home warranty company, and pest

control company. The referral fee will not come from the normal real

estate commission, but instead each service generates sufficient income

to pay a referral fee to capture the next service, commencing with the

CLO fee.'' The commenter further stated:

Information provided through technology is not only valuable,

but vital given today's complex and sophisticated lending; but, to

allow a real estate broker to charge a purchaser for providing this

information without having adequate guidelines in place assuring

that the consumer will, in fact, receive information that is in the

best interest of the consumer * * * is a terrible disservice to the

consumer * * *.

Commenters on the CLO issue had an array of suggestions for

revising the RESPA regulations to limit, expand, or otherwise control

the use of homebuyer- or lender-compensated CLO services, and to add

suitable definitions of the term ``CLO''. Among these suggestions were:

(i) Creating an (unspecified) ``market mechanism'' to keep CLO fees

reasonable and closely related to the true value of the service being

performed;

(ii) Requiring the borrower to pay for CLO services at the time the

service is being provided (a number of commenters believed that such a

requirement would help assure that the homebuyer would insist on

receipt of a ``real'' service, ``rather than unknowingly subsidize a

disguised referral fee that is buried at the end of escrow'');

(iii) Mandating that a substantial number of lender participants be

included in any CLO system, and defining the term ``computer loan

origination service'' in such a way as to exclude CLO providers that

afford the borrower only limited information;

(iv) Requiring CLOs operated by real estate brokers or agents to

make special disclosures concerning use of CLO systems, in greater

detail than the disclosures set out in Appendix E to 24 CFR part 3500.

(A large number of lender-commenters asserted that special disclosure

was unnecessary when CLOs are used by lenders, arguing that real estate

brokers, ``who may be receiving another fee in the transaction,'' were

the only parties for whom CLO-related disclosures should be required.);

(v) Cautioning HUD not to permit lenders to pay for CLO services

(arguing that any payment coming directly or indirectly from a lender

should be subject to the anti-kickback provisions of Section 8 of

RESPA). While the 1992 final rule addressed only the issue of fees paid

by borrowers, commenters also discussed the issue of fees paid by

lenders for inclusion on CLO systems, in response to the invitation for

such comments in the July 6, 1993, notice. Most commenters referred to

such payments as thinly disguised referral fees.

(vi) Requiring disclosure that particular CLO listings provide only

partial information about available loans. (A few commenters urged that

the CLO fee disclosure form include ``bold print'' disclosing that the

same information could be acquired by the prospective homebuyer ``for

free'' by shopping on their own.);

(vii) Recognizing that CLO services, if performed by a real estate

broker or agent for a homebuyer, create a conflict of interest and a

``potentiality for fraud'' for the broker or agent, whose fiduciary

duty is to the seller. Unified comments from 16 State Attorneys General

asserted that the use of CLOs by real estate agents is analogous to the

situation once prevalent in the travel industry:

* * * where independent travel agents using computer reservation

services steered travelers to whichever airline happened to own the

computer system used by the travel agent. Those flights were not

always the most convenient or cheapest for the consumer. Private

antitrust enforcement actions were required to rein in these

practices.

The Attorneys General declared that the economic costs of these

airline-industry practices are ``trivial compared to the costs to

consumers if CLOs are used to steer consumers in large numbers to more

expensive mortgages than are readily available [elsewhere] in the

market.''

(viii) Suggesting that (in defining a CLO system) HUD require equal

access to the system by any lender requesting access;

(ix) Urging that fees for CLO services be proscribed because access

to lender information has, before, been a free service performed by

real estate agents or brokers; thus CLO charges would ``create a new

fee for no real [new] value or service provided;''

(x) Arguing that borrower information achieved through the CLO

process was near-worthless, because lenders will have to reverify any

information provided before underwriting loan applications; and

(xi) Requiring that the CLO disclosure (and acknowledgement) occur

before the borrower agrees to use computer loan origination services.

In addition to these recommendations from multiple commenters, the

Mortgage Bankers Association (MBA) recommended specific modifications

to Sec. 3500.14(g)(2)(iii):

(one) Prohibiting the receipt of compensation for operating a CLO

by any person who already receives compensation for the same

transaction in another capacity;

(two) Defining ``computer loan origination services'' in a manner

that would require interactive communication with the computer systems

and the listing of multiple lenders upon request and for no charge; and

(three) If the first two recommendations are not accepted by HUD,

requiring that the CLO fee be both disclosed and paid for before the

CLO is accessed.

The MBA also urged that the rule set out the principle that the

mere performance of ``clerical loan origination activities, most or all

of which will have to be repeated by the lender'' does not constitute a

service justifying the collection of a fee.

(b) Comments Supportive of the CLO Provision. Comments in support

of the CLO provision of the rule were varied. In general, these

comments urged retention of the final rule's disclosure-based

authorization of CLOs and CLO charges to borrowers. However, supporters

of the CLO provision and other commenters on the provision expressed

considerable sentiment that substantial clarification of the rule was

necessary in this area.

Several commenters observed that the rule was silent on the

question of what disclosure (if any) would be required if the borrower

was not charged a fee for access to a CLO service.

One commenter ventured that, evidently, the rule's silence on the

issue would indicate that no disclosure would be required when, for

example, the lender paid CLO-connected fees. While the commenter

approved this result, he added that ``further clarification would be

welcome.'' The comment recommended that no separate disclosure be

required for lender-pay or for ``no charge'' CLO services--even where

it was clear that no-fee CLO systems were being paid for out of loan

origination fees or lump-sum fees that are charged to lenders and

mortgage brokers to process and underwrite mortgage loan applications.

In these instances, the commenter maintained, the CLO services were

less like traditional settlement services and more like services

purchased by a settlement service provider to help it perform its

normal functions--``back office'' loan origination services.

In general remarks, the same commenter argued that overregulation

of CLO services would stifle innovation and competitiveness. It was

pointed out that one of the major advantages of CLO services was the

expansion of housing opportunity ``into sectors of the U.S. economy not

now adequately served by the mortgage lending industry.''

Several commenters suggested that, with the very recent revision of

Sec. 3500.14(g)(2)(iii), the Department should not make immediate

changes, but should allow the marketplace to develop and experiment

with CLOs without additional regulation. However, in a number of

instances commenters supportive of the final rule's treatment of CLO

services joined opponents in requesting that HUD provide clarifications

of the rule that would:

(i) Define the term ``computer loan origination services'';

(ii) Indicate whether payment for CLO services must come solely

from borrowers, or whether lender-paid services are permitted; and

(iii) Advise whether there exists an ``implicit limitation'' on the

fees that can be paid to CLO providers (such as a reasonable

relationship to the market value of the services performed).

Other pro-rule commenters joined commenters that had objections to

the CLO services provision in supporting an explicit requirement that

the CLO fee disclosure statement be given to the borrower before the

fee is imposed, and that the fee be paid to the CLO operator before

services are performed. ``By requiring upfront disclosure and

payment,'' one commenter observed, ``the borrower will be aware that a

separate fee is being imposed for services not required by the mortgage

lender and will be able to determine whether the services provided by

the CLO operator merit such a fee.''

On the subordinate issue of the number of lenders included on CLOs,

commenters supporting the CLO provision generally differed with

opponents, many of whom urged much closer regulation of this aspect.

The pro-CLO services commenters generally advocated ``leaving to the

marketplace'' the determination of how many lenders were appropriate

for a CLO service. One commenter argued that dictating how many lenders

must appear on the CLO system ``is another example of well-intentioned

regulation which could ultimately hurt consumers.'' The commenter

pointed out that individual lenders may want to develop competing CLO

products, each marketing its own software products, with the CLO

operator then having access to several single-lender CLOs. The

commenter concluded, as did several other supporters of the final

rule's CLO services provision, that a consumer provided with full

disclosure can determine the services for which the consumer is willing

to pay.

A few commenters anticipated adverse comment on the CLO systems

issue and urged the Department not to bend to those commenters who

would impose limitations on fees for CLO services or would require that

fees be collected up-front.

One commenter whose overall position strongly supported the final

rule took a position comparable to many anti-CLO commenters in several

respects. To protect consumers this commenter supported the imposition

of additional conditions relating to CLO systems, such as:

(i) Up-front disclosure of the CLO fee, and payment in advance of

the performance of services; and

(ii) A regulatory requirement that real estate brokers be required

to perform services ``beyond electronically providing a menu of

lenders' interest rates and products.'' The same commenter, however,

joined other CLO services proponents in urging that HUD should not

attempt to regulate the number of lenders to be included in CLOs.

One commenter, evidently the operator of a large, independent

computer loan origination system, made several points from that

perspective:

(i) The commenter's independent CLO system avoided ``steering''

abuses because steering arises when lenders offer commissioned loan

officers or mortgage brokers a larger commission on some products than

on others, thus encouraging lenders to sell a particular type of loan.

The commenter's system required uniform charges across loan products

and lenders, which are established by contract among participants and

monitored by the CLO service provider;

(ii) The system encourages competitive loan pricing, by including a

wide variety of information affecting the overall cost of a loan to a

consumer and making it simple for a loan counselor to find the ``best

deal'';

(iii) The system increases competition in rural areas, by expanding

the number of lenders offering loans;

(iv) The system helps to avoid racial and other forms of

discrimination against borrowers by making the loan-decision process

``demonstrably race-blind'';

(v) The system avoids the criticism that CLO systems are mere

``kickback schemes,'' because the loan counselors working with the

system perform full loan-origination functions.

This commenter recommended that RESPA be revised to stipulate that

real estate brokers may not charge for origination services

(implicitly, CLO services) unless they actually register a loan

commitment with the lender. ``This assures that the [broker] has at

least qualified the borrower, and made a loan selection with the

borrower's concurrence. These are non-trivial functions for which a

payment is justified,'' the commenter said. The commenter favored this

``functional'' test, as opposed to a regulatory limitation on the

number of CLO services provided or a ban on single-lender CLOs.

Several comments from real estate brokers stated their support for

the CLO services provision of the final rule. Among these, at least two

real estate broker commenters assumed that CLO services would involve

multiple lenders:

[I assume that] all CLOs will offer the rates and costs of many

lenders. When lenders realize that they are in competition with

other lenders, they will be forced to deliver the best rates at the

lowest cost * * *. I can assure you that if a home buyer walks into

a lender's office to obtain a loan, there is little chance that

lender would send the buyer to a competitor even though the rates

and costs may be lower.

A second real estate broker described his company's CLO service as

having access to an affiliate and 20 competitors, indicating that this

variety and choice afforded borrowers with distinct advantages over

borrower-initiated loan shopping.

(c) Description of the Legal Framework for Analysis of Payments for

CLO Services. HUD has found that the use of the term ``CLO exemption''

in the preamble of the 1992 final rule may have created certain

misperceptions. To ensure that there is no confusion about the scope of

the regulatory exemption proposed below, the Department believes that

it will be helpful to set out the legal framework for its analysis of

payments for CLO services.

In general, the provision of CLO services may be financed by the

operator of a CLO system in several ways:

(i) The operator could charge lenders to have information about

their products displayed on the CLO system;

(ii) The operator could charge borrowers to use the CLO system;

(iii) The operator could charge both lenders and borrowers; and

(iv) The operator could provide the service free of charge to both

lenders and borrowers in the belief that providing the service will

attract more customers for the operator's related settlement service

business.

Section 8(a) of RESPA prohibits a lender from paying a CLO operator

a referral fee. Section 8(b) of RESPA prohibits a CLO operator from

accepting a payment from a borrower ``other than for services actually

performed.'' Therefore, in the absence of any regulatory exemption,

under RESPA:

(one) Payments by a lender to a CLO operator are subject to

scrutiny to determine whether the payment is a referral fee or is bona

fide compensation for goods or facilities actually furnished or for

services actually performed;

(two) Payments by a borrower to a CLO operator are subject to

scrutiny to determine whether the payment is a sham or duplicative

charge, rather than a payment for goods or facilities actually

furnished or services actually performed; and

(three) When neither borrowers nor lenders pay a fee for the CLO

services, only certain disclosures are required.

The 1992 final rule created an exemption from Section 8 for ``any

payment by a borrower for computer loan origination services,'' as long

as certain disclosures were provided (emphasis added). This rule did

not address payments made by lenders, thus leaving such payments

subject to Section 8 scrutiny. Although the term ``CLO exemption'' is

frequently used, including in the preamble of the 1992 final rule, the

exemption was not for the CLO itself, but only for payments made for

CLO services by borrowers.

Many commenters were concerned about whether any system that merely

claimed to be a CLO deserved to be given an exemption from RESPA's

requirements. As noted in the above statement of HUD's objective, the

Department seeks to encourage the use of new technology in ways that

provide meaningful information and services to consumers. Uncertainty

about how RESPA applies to CLOs may inhibit their development.

Therefore, the Department has determined that continuation of such an

exemption is justified; however, the Department seeks to limit the

exemption only to payments for access to CLO systems that provide

meaningful information and services to consumers. Payments for access

to systems that provide such benefits will not be subject to scrutiny

under Section 8.

Accordingly, the Department proposes to amend the 1992 final rule

to limit the exemption to payments made by borrowers for services from

``qualified CLOs'' only, and to define qualified CLOs to be those

systems that the Department believes provide meaningful information and

services to consumers. Payments by borrowers for services of systems

other than ``qualified'' CLOs are not prohibited; rather those payments

are subject to scrutiny under the Section 8 test articulated above.

Similarly, the 1992 final rule did not mention payments made by

lenders to CLO operators. However, having proposed to limit the scope

of the exemption for borrower payments and certain lender payments, the

Department asks commenters to address whether a parallel exemption for

payments made by lenders to operators of ``qualified CLOs'' would be in

the best interest of consumers.

(d) Position of the Proposed Rule on CLOs. Based upon a review of

the comments and testimony on this issue, the Secretary concluded that

the potential of CLOs to be convenient and provide consumers with

meaningful information about their choices justified the encouragement

of certain CLOs and the continuation of an exemption for borrower

payments for certain CLOs. The Secretary also determined that it is

necessary to amend the rule to define the type of CLO for which

borrower payments are permitted without further RESPA scrutiny, in

order to maximize the potential consumer benefits from this developing

technology and protect consumers. Accordingly, the Secretary proposes

to amend the rule to provide that payments made by borrowers for

qualified CLO services only are exempt, and to define qualified CLOs as

those systems meeting the following requirements:

(i) Qualified CLOs must be responsive to information about the

borrower and provide information regarding loan options for that

borrower. (This provision is responsive to commenters who feared that

without definition, a system using FAX-transmitted data or even

telephone calls might qualify as a CLO system.)

(ii) Qualified CLOs must meet certain fair participation and

display requirements, including that participation and display of loan

products from numerous lenders offering various loan products must be

allowed, factors for selecting lenders to participate on the CLO system

be fair and legitimate; and information on individual loan products

must be displayed in a lender-neutral manner. While the Department

recognizes that there are practical limits on the number of lenders

that can be included usefully on a system, because of technological and

other limitations, the proposed rule contemplates that a minimum of 20

lenders will participate on a qualified CLO system. (The Department

asks for comments on whether this number is appropriate or another

number would better ensure competition while providing a meaningful

level of information to the consumer.) The exemption is still available

when less than 20 lenders choose to participate, as long as the CLO

system remains open to and accepts additional lenders. Selection of

lenders for participation must be done as a result of the fair

application of impartial criteria, which may include, but are not

limited to, the date of the lender's application for participation on

the CLO system (e.g., first-come, first-served), the quality of

services and capabilities a lender provides to consumers, the types of

loan products offered by a lender and its pricing practices, and the

extent to which a lender's participation will increase the variety of

loan products offered to consumers by the system. (The application of

factors may not be used to avoid the 20 lender requirement.) CLO system

operators must have a reasonable justification supported by

documentation for selection decisions. No lender may be favored or

disfavored by the manner in which information regarding the lender or

its products is presented to the borrower or is utilized on the system,

or by the scope of information that a particular lender is permitted to

include as compared to another lender.

(iii) Qualified CLOs must provide borrowers with a CLO disclosure

form that states that use of the system is not required, space on the

system is limited, the full range of products meeting the borrowers'

needs may not be listed on the system, and other lenders not listed on

the system may offer better terms and conditions including lower rates.

A disclosure format for this and other information is set forth in the

proposed rule as Appendix E.

(iv) Qualified CLOs must charge borrowers the same fee for the same

CLO service or the same components of service. The exemption does not

attempt to fix a price for CLO services; market forces and market

experiences should continue to shape the evolution and development of

qualified CLO systems. Rather, where fees are charged, all borrowers

must be treated equally. If fees are waived by a CLO provider, they

must be waived fairly and not because of the choice of a particular

lender. If the fee is contingent on use of a loan product on the

system, the contingency must apply equally to all loan products and

lenders on the system.

(v) An operator of a qualified CLO may also charge lenders for

access to the system and for a portion of maintenance and operation

costs of the system. However, the schedule of charges for each lender

on the system must be identical. Furthermore, qualified CLOs must

disclose to the borrower, on the form prescribed in Appendix E and on

the HUD-1 or the HUD-1A, the amount of any anticipated payments by a

lender.

(vi) Fees and disclosures about the CLO system must also be

prominently displayed and visible to the potential borrower on the

premises near where the CLO terminal is located. The information that

more advantageous loan alternatives may exist that are not displayed on

the system must be similarly disclosed.

(vii) Any borrower payment to a CLO operator for use of a qualified

CLO must be paid outside of and before closing. A borrower must receive

full disclosure of the amount of the fee before the CLO services are

performed.

In this proposed rule, the Department is establishing the minimum

requirements that must be met by a qualified CLO system if payments by

a borrower to the operator of the system are to enjoy an exemption from

RESPA. The Department believes that these requirements are responsive

to the many comments on CLOs, and that compliance with the requirements

will assure that: CLO systems receiving the benefit of the exemption

are operated fairly; these systems will not be used as disguised means

of steering borrowers to particular lenders on a basis other than the

quality of services provided; and lenders wishing to participate in

qualified CLO systems will be permitted to do so on a fair and

equitable basis.

In addition, this proposed rule would continue and augment certain

requirements for all providers of CLO services, whether or not the CLO

is a qualified CLO. In all circumstances where a CLO is utilized, the

CLO disclosure set forth in Appendix E must be provided to borrowers

before the CLO services are performed. The existence of any controlled

business arrangement involving the operator of a CLO and any

participating lender must be disclosed to the borrower before the

system is utilized. Similarly, lender payments to other settlement

service providers for CLO services must continue to be disclosed on the

Good Faith Estimate and on the HUD-1 or HUD-1A, in accordance with the

February 10, 1994 (59 FR 6505) revision of the regulations, and the

possibility of such payments must be noted on the CLO disclosure.

(e) Questions and comments on this proposal. In formulating the

final rule, the Department may modify the requirements for the

exemption, based on comments from the public. The Department seeks

public comment on all aspects of its proposal to limit the exemption

for borrower payments to payments made for qualified CLOs, including:

(i) Does the approach embodied in this proposal--establishing a

safe harbor for borrower payments for qualified systems, continuing to

scrutinize borrower payments for nonqualified systems under RESPA, and

mandating certain disclosures for all systems--the best approach to

encourage the use of technology to benefit consumers and, at the same

time, protect consumers from unfair practices? Instead, should the

Department provide that any payment for a CLO system that does not

qualify for the safe harbor is presumed to violate RESPA? (Commenters

who believe that there should be broader prohibitions should detail the

legal and other justifications for this belief.)

(ii) Would establishment of a parallel exemption for payments made

by lenders to operators of qualified CLOs be in the best interest of

consumers? If so, should the requirements for a lender payment CLO

exemption be the same as the requirements for the borrower payment

exemption? Those commenters who believe the requirements should be

different should specify what differences they recommend.

(iii) Are most CLO systems likely to be financed using borrower

payments, lender payments, or a combination of both? Will any CLO

system provide access to the system to lenders and borrowers free of

charge?

(iv) Are the benefits of having borrower payments exempt from RESPA

scrutiny sufficient to encourage CLO operators to develop qualified

CLOs? Will CLO operators prefer to be subject to the general test under

RESPA that borrower payments must be in exchange for services actually

performed or to meet the requirements for qualified CLOs?

(v) Will the requirements for qualified CLOs in the proposal result

in cost-effective CLOs offering meaningful services to consumers?

(vi) Is the requirement for CLO disclosure to consumers in this

proposal reasonable and does it serve the consumers' best interests?

(vii) Is the definition of a qualified CLO sufficiently flexible,

considering the nature of this emerging industry and the Secretary's

consumer protection objectives?

(viii) Are the requirements concerning lender-neutrality and the

selection of lenders on a qualified CLO reasonable?

(ix) Is the minimum number of lenders on a qualified CLO (i.e., 20)

practical from an operational perspective? Is it sufficient to ensure

competition? (If another number is suggested, please explain why this

number would be superior in promoting competition and the consumers'

interests?)

(x) Is the requirement that all disclosures be made before

performance of CLO services reasonable?

(xi) What will be the impact of the requirement that any borrower

payments must be made outside of and before closing?

(xii) Does the requirement that qualified CLOs must provide the

borrower with certain information about loans generally available;

collect information about the borrower, the property, and the loan

sought; and provide the borrower with information about loan products

available to that borrower accomplish the intended objective of

ensuring that a meaningful service is provided?

The Department anticipates that the Technology Demonstration that

it plans to conduct (see Section I of this preamble) will also be a

useful vehicle for developing answers to some of these questions.

(3) Issue 3: Preemption of State Laws or Regulations

In Sec. 3500.13(b)(2), the November 2, 1992, final rule provided

that ``in determining whether provisions of State law or regulations

concerning controlled business arrangements are inconsistent with RESPA

or this part, the Secretary may not construe those provisions that

impose more stringent limitations on controlled business arrangements

as inconsistent with RESPA so long as they give more protection to

consumers and/or competition.'' In connection with the preemption

issue, the Department's July 6, 1993, notice requested comments on

establishing standards to be used in evaluating whether provisions in

State laws provide greater protection to consumers. The Department also

invited any other comment relative to the preemption provision of the

1992 final rule.

(a) Positions Taken by Commenters Critical of the Rule's Preemption

Policy. While the Department received hundreds of comments addressing

the preemption question, this issue attracted fewer expressions of

opinion than did the other three issues raised in the July 6, 1993,

notice. Most of the commenters addressing the issue (excluding

identical-form responses) were attorneys or major institutional

commenters. However, even among the comments from organizations

representing institutional interests or segments of the real estate and

real estate finance industries, preemption was the least-frequently

addressed of the four issues.

Commenters who were critical of other aspects of the rule had a

mixed approach to the preemption issue and reflected suspicion of the

Department's motives. These comments assumed that, despite the benign

phrasing of Sec. 3500.13(b)(2), HUD would (in light of the other

features of the 1992 final rule) use preemption in the future to weaken

State-initiated regulation of controlled business arrangements. Those

commenters who shared this suspicion varied in their recommendations

for improvement of the rule's preemption feature. Several commenters

advised HUD to provide ``greater clarity'' regarding a State's right to

ban or closely regulate controlled business arrangements. Other

commenters referenced particular existing State laws that require

controlled business entities to seek a substantial portion of their

business from sources other than their affiliated entities. These

commenters urged that HUD provide explicitly that State laws and

regulations of this type would not be subject to preemption.

The tone of these comments suggested that the standard set out in

the final rule--i.e., no preemption, so long as a State law affords

``more protection to consumers and/or competition''-- was insufficient

assurance against Federal preemption. Apparently the final rule was

perceived by the commenters as being ``anti-consumer'' in the guise of

a consumer protection regulation. The commenters believed it was clear

that State laws forcing controlled businesses to draw business from

nonaffiliates should never be preempted under RESPA authority. The

commenters were not persuaded that the Department intended to apply

Sec. 3500.13(b)(2) in a manner that would treat these State laws as

``pro-consumer''.

Concerned commenters made diverse recommendations: several asked

the Department to clarify in the rule that preemption would not be

applied; other commenters, clearly equally averse to preemption of

State laws, recommended case-by-case judgments regarding preemption,

using the existing standard set out in Sec. 3500.13(b)(2). These latter

commenters often combined their status quo recommendation with an

urging that HUD modify or reverse positions taken on the employer-

employee exception or CLO issues. Their thrust was that HUD's

preemption policy would not be objectionable if the RESPA rule were

modified to cure the specific problems being addressed by commenters in

their accompanying remarks.

The combined comment of the 16 State Attorneys General stated the

belief that it would be too difficult to ``define criteria for

preemption in the abstract.'' The comment recommended a case-by-case

approach. (Again, this comment was made in the context of a strong

statement of opposition to the final rule's employer-employee fee

policy and CLO exemption.)

The predominant position of institutional commenters addressing the

preemption issue was that it is unnecessary for HUD to set out strict

standards to evaluate whether State law provisions provide greater

protection to the consumer. However, there was considerable sentiment

in favor of regulatory ``clarifications'' to serve, in essence, as

guarantees that the Department would not preempt State laws in any

instance where its goal was to limit controlled business arrangements.

Consumers Union believed that HUD's own rules should be changed to

afford consumers stronger protections, but, if this was not to be, ``at

the very least States should be free to protect their own consumers''.

Accordingly, Consumers Union favored the enunciation of standards for

determining whether State law provisions provide greater protection:

* * * These standards are necessary since the final rule is

anti-consumer, but was presented as if it were pro-consumer. To

eliminate any resulting ambiguity, HUD should clarify that [State-

originated] rules totally eliminating any incentive to steer

business to an affiliate would be viewed as stronger consumer

protection.

A large number of comments received from individuals and small

businesses (mainly lenders) favored the establishment of written

standards for the evaluation of State laws. However, these comments

offered no specific advice concerning the content of the favored

written standards.

Comments submitted by the American Land Title Association (ALTA)

claimed that the November 1992 rule on preemption had ``frightened''

State legislators and regulators ``into believing that the RESPA

disclosure provisions [would be read by HUD to] preempt more stringent

state legislation or regulations.'' The ALTA expressed the belief that

the new regulations were ``perverting'' congressional policy regarding

the circumstances warranting preemption. The ALTA further claimed that

the preemption provision suggests that ``only if the Secretary of HUD

determines that a state controlled business provisions gives more

protection to consumers and competition would the state provisions not

be preempted.'' (Emphasis in original.)

The ALTA also complained that the final rule was deterring State

governments from considering more stringent regulation of controlled

business, and suggested that the Department support legislative

revisions to RESPA to replace ``ineffective'' consumer disclosure

requirements with Federal ``public business'' requirements (i.e.,

requirements that controlled businesses derive a significant proportion

of their business from nonaffiliates).

One of the Federal agencies commenting on the rule, the Office of

Thrift Supervision (OTS), suggested that separate review standards for

preemption determinations were unnecessary and that HUD could employ a

case-by-case analysis, using the review method outlined in

Sec. 3500.13(c) of the final rule. (OTS submitted comments critical of

the final rule on the referral fee and CLO issues.)

(b) Positions Taken by Supporters of the Preemption Provisions. As

in the case of commenters critical of the final rule, supporters of the

rule commented less frequently on the preemption issue than any of the

other questions raised in the July 6, 1993, notice. However, there was

perhaps a greater gulf between supporters of the 1992 final rule and

its opponents on this issue than on any other. As indicated earlier in

this preamble, opponents of the rule expressed widespread fear that the

Department would use its preemption power to nullify what the opponents

perceived as salutary State regulation of controlled business.

Proponents of the final rule also read Sec. 3500.13(b)(2) of the rule

as promising extensive HUD employment of preemption; however, these

commenters welcomed it.

The commenters regarded RESPA as sufficient to provide consumers

with protection against unfair pricing by settlement service providers.

Often, the commenters claimed, State laws that purport to be protective

of consumers are actually designed to benefit local settlement service

providers, by hindering the entry of larger, broad-based providers into

local markets.

Commenters appeared to assume that the chief intended target of

preemption would be State laws directly or indirectly preventing real

estate brokers from owning affiliated title businesses, prohibiting

mortgage lenders from affiliating with title agencies, or restricting

the percentage of business that can be derived from referrals from

affiliated businesses.

A lender with nationwide business objected strongly to the

inefficiencies it said resulted from multiple and inconsistent State

law requirements. While these varying requirements are justified if

they provide identifiable consumer benefits, the commenter said, they

frequently represent attempts to limit competition among lenders, and

actually increase the costs paid by consumers.

The experience in Kansas is instructive. After the state enacted

a law limiting referrals to affiliated entities, many title agent

affiliates of real estate brokers and mortgage companies were forced

out of business. Freed from the need to compete with such providers,

we understand that independent title agents increased their rates by

approximately 60%. The Department need look no further than this

example to recognize that protection of ``turf,'' rather than

protection of consumers, is normally at the heart of such

limitations.

The commenter went on to urge that HUD make clear that State

limitations affecting controlled business arrangements are preempted by

RESPA.

One commenter said that RESPA regulations encourage nationwide

service providers to diversify their product offerings and enter new

geographic markets. Accordingly, Federal preemption of adverse State

laws would result in increased competition.

While a few commenters appeared to be recommending summary

preemption of the array of State laws affecting controlled business,

other commenters, responding to the Department's direct question, urged

the establishment of standards for the case-by-case determination of

whether State laws or regulations are inconsistent with RESPA in the

controlled business area, i.e., whether a particular law ``give(s) more

protection to consumers and/or competition'' than does RESPA.

One commenter suggested that the final rule's treatment of

preemption should be fundamentally changed because it is ``unclear and

vaguely worded'': ``What is meant by `stringent limitations' and `give

more protection to * * * competition?'''

Another commenter cited the legislative history of the 1983 RESPA

amendments as indicating Congress' expectation that, if necessary to

protect consumers or encourage competition, HUD would recommend further

legislation to place a percentage limitation on the amount of

controlled business that could be transacted. The commenter observed

that in the ten years since the controlled business exemption became

law, HUD has not recommended further legislation in this area.

Additionally, the commenter claimed, many State governments have not

seen the necessity of enacting restrictions on the percentage of

business that can be derived from affiliated entities. The commenter

concluded that State ``percentage of business'' laws were inconsistent

with RESPA and should be preempted as anticompetitive.

(c) Position on Preemption in the Proposed Rule. Based upon the

comments and testimony, the Secretary has determined that it is

unnecessary at this time to set out specific written standards for

preemption of State laws. As numerous commenters, including the State

Attorneys General, observed, setting out comprehensive and informative

preemption standards presents an almost insurmountable task, in the

absence of a wide array of specific fact situations that are raising

preemption issues. If it becomes necessary to consider this issue

further, the Secretary may reopen the issue by rulemaking or deal with

specific preemption issues by means of interpretive rules. No

amendments are proposed on this subject in this rule.

(4) Issue 4: Adequacy of the Controlled Business Disclosure Statement

In Sec. 3500.15(b)(1) of the 1992 final rule, provision was made

for ``written disclosure, in the format of the Controlled Business

Arrangement Disclosure Statement set forth in appendix D of this

part.'' This disclosure referred to certain information regarding the

ownership and financial relationships between referring and referred-to

parties, as well as information regarding the timing of the disclosure

and other methods for disclosure.

HUD solicited the views of commenters in its July 6, 1993, Federal

Register notice concerning whether the controlled business disclosures

outlined in appendix D ``are adequate to protect the consumer, and, if

not, how they might be improved.''

(a) Comments Critical of the Disclosure Statement. A majority of

the commenters expressing dissatisfaction with one or more features of

the 1992 final rule's employer payments provisions also objected to the

Controlled Business Arrangement Disclosure Statement set out in

Appendix D to part 3500.

Generally, these objections were twofold. First, commenters argued

that even the best and most complete form of disclosure imaginable was

not an effective means of coping with what the commenters perceived as

anticonsumer aspects of controlled business arrangements. Second,

opposition commenters urged that if, against their advice, HUD

continued to sanction referral payments by employers to employees, the

form of disclosure required should be strengthened substantially, and

the timing of the required disclosure should be pinpointed for maximum

effect in affording consumers a realistic opportunity to choose

alternative settlement service providers.

More than 800 comments from lenders and settlement attorneys urged

expansion of the controlled business disclosure to assure that

borrowers understand that the referral ``will provide a financial

benefit to the related parties.''4

---------------------------------------------------------------------------

\4\HUD notes that the Appendix D disclosure format already

requires: (1) Disclosure of the nature of the relationship between

the referring party and the prospective provider of the service,

including ownership or other financial interests; (2) estimates of

the charges for the service or services; and (3) a statement that

the consumer ``may be able to get these services at a lower rate by

shopping with other settlement service providers.'' (57 FR 49600,

49622; November 2, 1992.)

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Perhaps the most comprehensive criticism of the disclosure policy

was expressed by the 16 State Attorneys General in their comments.

After criticizing both the referral payments provision and the CLO

exemption, the Attorneys General said that they were skeptical that

disclosures can remedy the inherent dangers to consumers when there are

financial incentives for referrals of business. Conceding that the 1983

RESPA amendments expressly permitted controlled business arrangements,

the Attorneys General urged that the disclosure contemplated by the

regulatory amendment ``be as clear and explicit as possible to alert

consumers to the potential for harm.'' The comment advocated that the

disclosure form state with greater clarity the purpose for which a

disclosure is made and the harm against which it is aimed.

Specifically, the State Attorneys General criticized as vague the

form's reference to a ``business relationship'' and advocated the

inclusion of a statement that, in making the referral to the controlled

business, the referring company or agent (to be identified by name)

would benefit ``financially or otherwise.'' The State Attorneys General

wanted the form to indicate that, in addition to lower rates, consumers

might receive ``better services'' by shopping around. ``Indeed,

consumers must be affirmatively encouraged to shop around * * *

consumers should be warned in clear, unambiguous language of the

pitfalls of relying on a controlled business referral and encouraged to

make intelligent choices among settlement service providers.''

Consumers should also be told in explicit terms, the comment continued,

that they are ``free to choose [their] own settlement service provider

and will not be denied any services or loan for exercising this

choice.''

Finally, the State Attorneys General favored disclosure of the

``existence of and amounts of'' any fees or kickbacks paid, directly or

indirectly, to the real estate broker or another referring party, or to

an affiliated provider, for the performance of settlement services. A

large number of individual commenters and the Coalition to Retain

Independent Services in Settlements (CRISIS) echoed this position.

The CFA disparaged disclosure, by itself, as being an ``inadequate

remedy for the market risks that consumers are exposed to in the

purchase of real estate'':

The Department's rule has placed before the consumer a new array

of fees for which the delivery of the equivalent of a tollgate

ticket is hardly ample protection.

One of the central problems of controlled business arrangements

is that the underlying purchase is carried out under conditions of

urgency and stress that will always overwhelm a captive consumer.

The ability to distinguish between what must be done--and

purchased--and what is optional, is limited.

The MBA advocated elimination of the employer-employee referral fee

exception, but urged that, at least, the disclosure form should be

expanded to include the existence and amount of the referral fee.

Similar advice was received from Consumers Union and from individual

commenters.

The FDIC also expressed some doubt about the efficacy of written

disclosure, calling the disclosure form ``just one of dozens of

confusing papers handed to [consumers] over the course of a real estate

transaction.'' FDIC nevertheless advocated strengthening the form by

requiring the disclosing entity to meet specific content guidelines and

to use layman's language, ``* * * so less opportunity [is] given for

`creative writing'.'' The FDIC also advocated the use of an

acknowledgement line or box on the form, to show that the consumer had

read and understood the controlled business arrangement disclosure.

The Office of Thrift Supervision (OTS), while expressing concern

about employer-employee referral fees and the efficacy of CLO

disclosures, commented that the content and timing requirements for

controlled business disclosures, as set out in the final rule, seemed

adequate to protect consumers.

Departing from the recommendations of other commenters to the

effect that the disclosure form should be expanded to highlight the

presence of referral fees and other relationships between the referrer

and the service provider, ALTA's spokesman called the disclosure

process ``worthless as a consumer protection measure in the settlement

services arena.'' The ALTA claimed that the consumer is likely to rely

upon the recommendation of a trusted professional, ``even where a

personal financial inducement is disclosed.'' ALTA's spokesman

advocated legislative solutions, including amendment of RESPA to permit

a competitor's right of action and the institution of blanket

prohibitions on controlled businesses.

(b) Comments from Supporters of the Final Rule's Disclosure

Statement. The Department received detailed comments on controlled

business disclosure policy from more than a dozen commenters who

supported the final rule in most of its particulars. Typically, these

commenters believed that the form and level of detail of disclosure of

controlled business arrangements that were in the final rule were

``more than adequate'' to permit informed choice by consumers

concerning settlement service providers.

Several commenters pointed out that the required form of disclosure

appeared to exceed the statutory disclosure requirements in several

respects. One, the commenters urged that the statute required only that

the ``existence'' of a financial interest be disclosed, while the

regulation required that the disclosure outline the ``ownership and

financial interest.'' Two, the regulation requires that all

disclosures, not just those related to costs, be made in writing.

Three, the regulations require separate disclosure of controlled

business relationships. Finally, the ``suggested format'' for the

disclosure (although not the regulation itself) includes the caution:

``You may be able to get these services at a lower rate by shopping

with other settlement service providers.''

Most commenters who raised these points did not address them as

objections to, or criticisms of, the 1992 final rule. Instead, these

observations were cited as indications that, in the commenters' views,

the rule already was suitably attentive to consumer protection

concerns, in that it went beyond bare-bones statutory disclosure

requirements. Several of these comments went on to urge that the

Department continue to limit its RESPA regulations to disclosure-

related concerns, and not bend to the will of advocates of other

methods of regulating or curbing controlled business arrangements:

RESPA is predicated on the belief that consumers, when provided

with appropriate disclosures, are capable of making informed

decisions. Those who argue otherwise frequently do so only to

protect their competitive position, not to advance the interests of

consumers. * * * [T]he information contained in the existing

controlled business arrangement disclosures is sufficient and the

requirements should not be disturbed.

The Federal Reserve Board's comment agreed that the controlled

business disclosure policy set out in the rule and the format were

``more than adequate'' as disclosures. ``* * * [I]f anything, it may be

over-disclosing given the quantity of information that a consumer

receives when applying for a mortgage loan.'' A few lender-commenters

expressed a similar view. The Federal Reserve suggested that the

consumer needs to know that the two parties involved in the referral

are related, but may not need further details. While the Federal

Reserve agreed it is important that the consumer know that use of the

provider is not required, it suggested that including the estimated

charges for the service was ``redundant,'' since such costs would have

been disclosed on the Good Faith Estimate.

One lender argued that controlled business arrangements arise in a

variety of situations, and that it is ``impossible'' to mandate the use

of a form that is suitable for all providers in all situations. The

commenter asked the Department to provide for flexibility concerning

format, ``as long as consumers are informed of the referral and the

relationship between the parties.''5

---------------------------------------------------------------------------

\5\The same commenter, a lender, asked for more flexibility in

the timing of the controlled business disclosure. Many referrals do

not occur at face-to-face meetings between the consumer and the

referring party, the commenter suggested, and asked that the rule

clarify that the service provider be required to furnish a

disclosure ``at the time of the initial contact between the consumer

and the provider.''

---------------------------------------------------------------------------

Another comment urged that the controlled business disclosure form

not be required for disclosure of the specific providers of ``lender

required services such as credit reports, appraisals, [or] flood plain

searches.'' The commenter suggested that early disclosure of the

identity of these providers was impractical and provided ``absolutely

no benefit to the consumer.'' The information, the commenter concluded,

would appear on the HUD-1 Settlement Statement.

The most frequent criticism of the rule's controlled business

disclosure requirements from commenters supportive of the rule was

that, in some instances, it was unclear when a controlled business

arrangement was required to be disclosed. Several commenters asked

whether the disclosure was required when a bank has a wholly-owned

subsidiary mortgage company or when a mortgage company is a wholly-

owned subsidiary of the same holding company as the bank.

The situations in which related businesses were required to make

disclosure also were questioned. One commenter asked whether, if a bank

is affiliated with a mortgage company by common ownership, the bank has

to make disclosures to consumers in the following circumstances:

When a consumer is directly referred to the mortgage

company for a mortgage loan;

When the consumer is simply informed of the availability

of loans from the mortgage company; and

When the bank includes references to the mortgage company

in its advertising or its brochures.

One commenter, stating that the entire category of ``referrals''

was not intended to fall within the coverage of the controlled business

arrangement rules, recommended creation of an exemption to the

controlled business arrangement rules for ```referrals' between bank

holding companies' wholly-owned subsidiaries.'' Two commenters asserted

that failing to provide this exemption would be placing mortgage

companies within bank holding companies at a competitive disadvantage

when compared to bank mortgage departments. ``The purpose of RESPA is

not to dictate the form in which a bank structures its lending

business.''

(c) Position Taken in the Proposed Rule on the Controlled Business

Disclosure Statement. The Secretary concluded that the elimination of

the employer-employee exception would, in turn, eliminate a number of

the strongest concerns regarding the information in the controlled

business disclosure. However, the Secretary has accepted some

suggestions for modifications to the disclosure as useful and

beneficial to the consumer. Accordingly, certain of these suggestions

have been included in the proposed rule and in the format of Appendix

D.

The suggested borrower-acknowledgement box has been added to the

controlled business disclosure format. Additional plain language has

been added to the format. Section 3500.15(b) proposes a requirement

that disclosure be given at a time to be relevant to the consumer:

either (i) at the time of referral or no earlier than 3 days before; or

(ii) if the lender requires the use of a particular provider, the time

of the loan application. The preamble of revisions that extended RESPA

coverage to subordinate lien transactions (59 FR 6505, 6510, February

10, 1994) also discussed the appropriateness of disclosures, stating

that ``incidental and uncompensated referrals, such as brochures in a

bank lobby or street directions given by a bank employee, are not

perceived as rising to the level necessary to require a controlled

business disclosure.''

More sweeping modification of the controlled business disclosure

form is not considered necessary. While many commenters disparaged the

use of written disclosure as a means of coping with perceived

controlled business-related problems, the Department continues to

believe that full disclosure is useful as a means of informing

consumers. Disclosure is also a preeminent principle of the RESPA

statute.

V. Other Matters

Regulatory Flexibility Act

The Secretary, in accordance with the Regulatory Flexibility Act (5

U.S.C. 605(b)), has reviewed this rule before publication and by

approving it certifies that this rule does not have a significant

economic impact on a substantial number of small entities, other than

those impacts specifically required to be applied universally by the

RESPA statute.

Environmental Impact

A finding of no significant impact with respect to the environment

has been made in accordance with HUD regulations in 24 CFR part 50 that

implement section 102(2)(C) of the National Environmental Policy Act of

1969 (42 U.S.C. 4332). The finding is available for public inspection

during regular business hours in the Office of the General Counsel,

Rules Docket Clerk, room 10276, 451 Seventh Street SW., Washington, DC

20410.

Executive Order 12866

This proposed rule was reviewed by the Office of Management and

Budget under Executive Order 12866, Regulatory Planning and Review. Any

changes made to the rule as a result of that review are clearly

identified in the docket file, which is available for public inspection

at the Office of the Rules Docket Clerk, Office of the General Counsel,

room 10276, Department of Housing and Urban Development, 451 Seventh

Street SW., Washington, DC 20410-0500. A Regulatory Impact Analysis

(RIA) performed on this proposed rule is also available for review at

the same address.

Executive Order 12612, Federalism

The General Counsel, as the Designated Official under section 6(a)

of Executive Order 12612, Federalism, has determined that the policies

contained in this proposed rule will not have substantial direct

effects on States or their political subdivisions, or the relationship

between the federal government and the States, or on the distribution

of power and responsibilities among the various levels of government.

As a result, the rule is not subject to review under the Order.

Promulgation of this rule expands coverage of the applicable regulatory

requirements pursuant to statutory direction.

Executive Order 12606, The Family

The General Counsel, as the Designated Official under Executive

Order 12606, The Family, has determined that this proposed rule does

not have potential for significant impact on family formation,

maintenance, and general well-being, and, thus, is not subject to

review under the order. No significant change in existing HUD policies

or programs will result from promulgation of this rule, as those

policies and programs relate to family concerns.

Regulatory Agenda

This rule was listed as Item 1586 in the Department's Semiannual

Agenda of Regulations published on April 25, 1994 (59 FR 20424, 20447),

in accordance with Executive Order 12866 and the Regulatory Flexibility

Act.

List of Subjects in 24 CFR Part 3500

Consumer protection, Housing, Mortgages, Real property acquisition,

Reporting and recordkeeping requirements.

For the reasons set out in the preamble, part 3500 of title 24 of

the Code of Federal Regulations is proposed to be amended as follows:

PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT

1. The authority citation for part 3500 would continue to read as

follows:

Authority: 12 U.S.C 2601 et seq.

2. Section 3500.2, effective on August 9, 1994 (February 10, 1994

at 59 FR 6505, 6511), is amended by adding, in alphabetical order,

definitions for ``CLO'', ``CLO access fee'', ``CLO operator'', ``CLO

services'', ``CLO system'', ``managerial employee'', and ``qualified

CLO system'', and by removing the word ``and'' at the end of paragraph

(14), redesignating paragraph (15) as paragraph (16), and adding a new

paragraph (15) to the definition of ``settlement service'', to read as

follows:

Sec. 3500.2 Definitions.

* * * * *

CLO means computer loan origination.

CLO access fee means a fee paid by a borrower to a CLO operator for

CLO services.

CLO operator means a provider of settlement services who operates a

CLO system for a borrower.

CLO services means services provided to a borrower by a CLO

operator using a CLO system.

CLO system means a computer system that:

(1) Provides to prospective borrowers information regarding the

rates and terms of federally related mortgage loans;

(2) Collects, assembles, and transmits information concerning the

borrower, the property, and other information on a potential mortgage

loan for evaluation by a lender(s); and

(3) Based on the data transmitted, responds to the borrower with

detailed information, including, without limitation, loan terms, rates,

and payment schedules for various loan products that would be available

to the borrower from such lender(s).

* * * * *

Managerial employee means an employee of a settlement service

provider who does not routinely deal directly with the public, and who

either hires, directs, assigns, promotes, and rewards other employees

or is in a position to formulate, determine, or influence the policies

of their employer. Neither the term ``managerial employee'' nor the

term ``employee'' includes real estate agents or other independent

contractors.

* * * * *

Qualified CLO system means a CLO system that meets the requirements

of Sec. 3500.14(g)(3).

* * * * *

Settlement service * * *

(15) Provision of CLO services; and

* * * * *

3. Section 3500.14 is amended by revising paragraph (g)(2); by

redesignating paragraphs (g) (3) and (4) as paragraphs (g) (5) and (6),

respectively; and by adding new paragraphs (g) (3) and (4), to read as

follows:

Sec. 3500.14 Prohibition against kickbacks and unearned fees.

* * * * *

(g) * * *

(2) Section 8 of RESPA does not prohibit normal promotional and

educational activities that are not conditioned on the referral of

business and that do not involve the defraying of expenses that

otherwise would be incurred by persons in a position to refer

settlement services or other related business.

(3) Section 8 of RESPA does not prohibit any payment by a borrower

for CLO services provided by a qualified CLO system that provides CLO

services and meets the following requirements:

(i) Multiple Products and Lenders. The qualified CLO system shall

provide openings for 20 or more lenders offering various loan products.

The factors for selecting the lenders to be included on a qualified CLO

system (see paragraph (g)(3)(ii) of this section) may not be designed

to limit or have the effect of limiting eligibility to less than 20

lenders. When the qualified CLO system has less than 20 lenders, the

system shall remain open to and accept additional lenders until at

least 20 lenders participate.

(ii) Selection Factors. To determine eligibility for inclusion in

the system, the qualified CLO system shall utilize selection factors

that are fair and impartial and are designed to contribute to the

efficiency and quality of the system. These factors may include, but

are not limited to, the date of the lender's application for

participation on the qualified CLO system, the quality of services and

capabilities the lender provides to consumers, the types of loan

products offered by the lender and its pricing practices, and the

extent to which the lender's participation will increase the variety of

loan products offered to consumers by the system. Qualified CLO system

owners shall have a reasonable justification for selection decisions,

supported by documentation which they must maintain.

(iii) Neutrality. The CLO operator of a qualified CLO system and

the qualified CLO system shall provide borrowers with information in a

neutral manner. No lender shall be favored or disfavored by the manner

in which information regarding the lender or its products is utilized

or is presented to the borrower, is used on the system, or is presented

by the CLO operators, or by the scope of information that one lender is

permitted to include as compared to another lender. No payments,

disincentives, or penalties may be provided directly or indirectly to

CLO operators of qualified CLO systems by any person, including the CLO

operator's employer, to influence the CLO operator to favor any lender

on the qualified CLO system.

(iv) Disclosure Statement. The CLO operator of a qualified CLO

system shall provide a CLO disclosure form to the borrower before CLO

services are performed. The CLO operator shall require the borrower to

sign on the CLO disclosure form an acknowledgment that the borrower has

received the disclosure. An enlarged, completed copy of the CLO

disclosure form (no smaller than 16'' by 20''), including any

applicable fee, shall be displayed prominently within 5 feet of the CLO

terminal. The CLO disclosure form shall:

(A) Be in the format established in Appendix E of this part;

(B) Specify the fee and services being provided; and

(C) Include statements that use of the system is not required;

space on the system is limited; the full range of products meeting the

borrower's needs may not be listed on the system; and other lenders not

listed on the system may offer better terms and conditions, including

lower rates.

(v) CLO Access Fee. The CLO operator of a qualified CLO system

shall charge all borrowers using the qualified CLO system the same CLO

access fee(s) for the same service or the same components of service.

The CLO operator of a qualified CLO system shall require the borrower

to pay any CLO access fee outside of and before the closing of any loan

that may be obtained through use of this system. The CLO operator of a

qualified CLO system may only waive the CLO access fee based on

business considerations of the operator and not on any action of a

lender. If the payment of the CLO access fee is contingent on use of a

loan product on the qualified CLO system, the contingency shall apply

equally to all loan products and lenders on the qualified CLO system.

(vi) Lender Charges for Access. The CLO operator of a qualified CLO

system may charge lenders for access to the qualified CLO system if:

(A) Charges are set forth in a written schedule of charges;

(B) Charges for the same services and components of services are

the same for all lenders on the system; and

(C) The charges are reasonably related to the costs of maintenance

and operation of the qualified CLO system (i.e., the facilities

furnished or the services actually performed).

(4) Any payment by a borrower to a CLO operator for services from a

nonqualified CLO system, and any payments by a third party settlement

service provider to a CLO operator for access to any CLO system in

relation to a federally related mortgage loan, will be subject to

examination under Section 8 of the Act and this part. The disclosure

format set forth in Appendix E of this part and Box 2 of Appendix E of

this part shall be utilized by all CLO operators for all CLO systems

and shall be completed before any CLO services are performed.

* * * * *

4. Section 3500.15 is amended by revising paragraph (b)(1); by

removing the word ``and'' at the end of paragraph (b)(3)(i)(A); by

removing the period at the end of paragraph (b)(3)(i)(B) and replacing

it with ``; and''; and by adding paragraph (b)(3)(i)(C), to read as

follows:

Sec. 3500.15 Controlled business arrangements.

(b) * * *

(1) The person making a referral has furnished to each person whose

business is referred a written disclosure, in the format of the

Controlled Business Arrangement Disclosure Statement set forth in

Appendix D of this part. This disclosure shall specify the nature of

the relationship (explaining the ownership and financial interest)

between the provider of settlement services (or business incident

thereto) and the person making the referral, and shall describe the

estimated charge or range of charges (using the same terminology, as

far as practical, as Section L of the HUD-1 or HUD-1A settlement

statement) generally made by the provider of settlement services. The

disclosure must be provided on a separate piece of paper at or no

earlier than 3 business days before each referral, or, if the lender

requires the use of a particular provider, the time of loan

application, except that:

* * * * *

(3) * * *

(i) * * *

(C) No agent or employee may accept any payment from his or her

principal or employer or any other source when that payment is

correlated on a one-to-one basis or calculated as a multiple of the

number or value of any referrals of business from his or her employer

or principal to an affiliated entity. For example, no person shall pay

any managerial employee or any employee or agent who is in direct

contact with the public a bonus or other compensation correlated on a

one-to-one basis or calculated as a multiple of the number or value of

any referral of settlement service business by the employee or the

employee's organizational unit to an entity affiliated with the

employer or principal. In addition, no compensation of an employee or

agent who is routinely in direct contact with the public may be based

in whole or in part on the number or value of referrals that the

employee or agent makes to affiliated entities.

5. Appendix B to part 3500 is amended by revising Illustration 11

to read as follows:

Appendix B to Part 3500--Illustration of Requirements of RESPA

* * * * *

11. Facts: A, a mortgage lender, is affiliated with B, a title

company, and C, an escrow company, and offers consumers a package of

mortgage title and escrow services at a discount from the prices at

which such services would be sold if purchased separately. Neither

A, B, or C, requires consumers to purchase the services of their

sister companies, and each company sells such services separately

and as part of the package. A also pays its employees (i.e., loan

officers, secretaries, etc.) a bonus for each loan, title insurance,

or closing that A's employees generate for A, B, or C. A pays such

employees bonuses out of its own funds and receives no bonuses or

reimbursements for these bonuses from B or C. At or before the time

that customers are told by A or its employees about the services

offered by B and C and about the package of services that is

available, the customers are provided with a controlled business

arrangement disclosure form.

Comments: Selling a package of settlement services at a discount

is not prohibited by RESPA. Also, A may compensate its own employees

for business generated for A's company, but A may not directly or

indirectly compensate A's employees who are routinely in contact

with consumers for business generated for B or C. Nor may B or C

directly or indirectly compensate A or A's employees for business

referred to B or C by A's employees. Sections 3500.15(b)(3)(i) (A)

and (B) set forth the permissible exchanges of funds between

controlled business entities. No employee or agent may receive

compensation correlated on a one-to-one basis or calculated as a

multiple of the number or value of referrals of business to an

affiliated entity. Nothing in the RESPA rule prohibits bonuses or

other compensation based, in part, on the generation of business by

A to B and C being paid to managerial employees who are not

routinely in contact with consumers.

6. Appendix D to Part 3500 is revised to read as follows:

Appendix D to Part 3500

Controlled Business Arrangement Disclosure Statement Format Notice

To:--------------------------------------------------------------------

From:------------------------------------------------------------------

(Entity Making Statement)

Property:--------------------------------------------------------------

Date:------------------------------------------------------------------

This is to give you notice that [referring party] has a business

relationship with [provider receiving referral] . [Describe the

nature of the relationship between the referring party and the

provider, including percentage of ownership interest, if

applicable.] Because of this relationship, this referral may provide

[referring party] a financial or other benefit.

Set forth below is the estimated charge or range of charges by

[provider] for the following settlement services:

____________: $____________

____________: $____________

____________: $____________

____________: $____________

____________: $____________

You are NOT required to use [provider] as a condition for

[settlement of your loan on] [or] [purchase, sale, or refinance of]

the subject property. YOU MAY BE ABLE TO GET THESE SERVICES OR

BETTER SERVICES AT A LOWER RATE BY SHOPPING WITH OTHER SETTLEMENT

SERVICE PROVIDERS, AND THIS IS SOMETHING YOU SHOULD CONSIDER

DOING.\1\

---------------------------------------------------------------------------

\1\Where the lender is requiring an attorney, credit reporting

agency, or real estate appraiser to represent its interests, this

paragraph and the corresponding acknowlegment should be omitted.

---------------------------------------------------------------------------

A lender is allowed to require the use of an attorney, credit

reporting agency, or real estate appraiser chosen to represent the

lender's interest.\2\

Acknowledgment

[I/we have read this disclosure form and understand its

contents, as evidenced by my/our signature(s) below.]\2\

---------------------------------------------------------------------------

\2\Use this paragraph and acknowledgment for disclosures

involving required attorneys, credit reporting agencies, or real

estate appraisers and omit the second acknowledgment. For all other

disclosures, use the second acknowledgment.

---------------------------------------------------------------------------

[I/we have read this disclosure form, and understand that

[referring party] is referring me/us to purchase the above-described

settlement services from [provider receiving referrals], and may

receive income as the result of this referral.]

----------------------------------------------------------------------

(Applicant's signature)

----------------------------------------------------------------------

(Co-applicant's signature)

----------------------------------------------------------------------

----------------------------------------------------------------------

[Specific timing rules for delivery of the controlled business

disclosure are set forth in 24 CFR 3500.5(b)(1)(i) (Regulation X).]

7. Appendix E to part 3500 is revised to read as follows:

Appendix E to Part 3500

CLO Fee Disclosure

To:--------------------------------------------------------------------

[Potential Borrower]

From:------------------------------------------------------------------

[Person Making Disclosure]

NOTICE: I have available a Computer Loan Origination System

(CLO), a computer system that can access a variety of mortgage loans

and rates. The CLO is available to you under the following

conditions:

1. [ ] You are obligating yourself today to pay $________,

outside of and before the settlement of any loan that may be

obtained through use of this system by ________ check, ________

credit card, ________ cash, ________ other ______. (specify)

2. [ ] You will not be charged a direct fee, but the lender who

funds your loan will pay us a fee related to your loan estimated to

be $--------------------, which will likely be recovered by the

lender in the cost of your loan.

3. [ ] I am providing you access to the CLO without a separate

charge.

USE OF THIS SYSTEM IS NOT REQUIRED. SPACE ON THE SYSTEM IS

LIMITED, THE FULL RANGE OF PRODUCTS MEETING YOUR NEEDS MAY NOT BE

LISTED, AND BETTER TERMS AND CONDITIONS, INCLUDING LOWER RATES, MAY

BE AVAILABLE FROM OTHERS NOT LISTED ON THE SYSTEM.

[INSTRUCTIONS: Include the following text, when applicable.

Instructions in square brackets, including these instructions,

should be omitted, as appropriate.] [(Name of operator of the

system) has an affiliated business relationship with (name(s) of

lender(s) on the system under which this overall organization gains

financially if you enter into a mortgage loan with them. A further

explanation of this business relationship is set forth in the

controlled business arrangement disclosure form that is also being

given to you at this time.]

The following services will be provided:

[ ] Displaying a variety of mortgage loans and rates that may

be available to you.

[ ] Counseling you regarding the different types of loans

available and the relative rates in a fair and equitable manner.

[ ] Relating your financial needs with available mortgage loan

programs; and assisting you in deciding which, if any, meet your

needs.

[ ] Entering information regarding you into the Computer Loan

Origination System.

[ ] Reviewing responses to submitted information.

[ ] Other ____________________

Acknowledgment

I/we have read this disclosure form, and understand its

contents, as evidenced by my/our signature(s) below.

----------------------------------------------------------------------

Applicant's signatures

----------------------------------------------------------------------

Co-Applicant's signature

----------------------------------------------------------------------

Date: July 14, 1994.

Nicolas P. Retsinas,

Assistant Secretary for Housing-Federal Housing Commissioner.

[FR Doc. 94-17598 Filed 7-20-94; 8:45 am]

BILLING CODE 4210-27-P