Office of the Assistant Secretary for HousingFederal Housing Commissioner; Amendments to Regulation X, the Real Estate Settlement Procedures Act: Withdrawal of Employer-Employee and Computer Loan Origination Systems (CLOs) Exemptions

SUMMARY: In this final rule, the Department of Housing and Urban

Development is revising Regulation X, which implements the Real Estate

Settlement Procedures Act of 1974 (RESPA). This rule completes a

process that started with a public hearing and comment period on August

6, 1993, followed by a proposed rule published on July 21, 1994.

In the interest of protecting consumers from practices prohibited

by RESPA, while making available to consumers the potential benefits of

innovative business arrangements, this rule withdraws an exemption for

employer-employee payments, introduces two more-limited exemptions for

payments that would otherwise be prohibited by the statute--employer

payments to managerial employees and employees who do not perform

settlement services in any transaction. In addition, to relieve any

uncertainty, the rule adds an additional exemption to clarify that

payments made to an employer's own bona fide employee for generating

business for that employer are permissible. The rule also revises

certain controlled business disclosure requirements. HUD has chosen to

use its exemption authority under Section 8(c)(5) of RESPA, having

consulted with other Federal agencies as required by that provision, as

well as the authority under Section 19(a) of RESPA, to permit these

payments.

The rule also withdraws an exemption for payments made by borrowers

for computer loan origination (CLO) services, because the exemption was

found to be of little benefit to consumers or the loan origination

industry. However, in order to assure that consumers in the mortgage

lending marketplace continue to benefit from technological innovation,

simultaneously with the publication of this rule, the Department is

issuing a Statement of Policy analyzing payments for CLOs under the

RESPA regulations. In addition, the Department is simultaneously

publishing two other Statements of Policy on issues raised by comments

on the proposed rule, although not directly related to the proposed

rule, and which involve interpretation rather than new rulemaking.

EFFECTIVE DATE: This rule is effective on October 7, 1996.

FOR FURTHER INFORMATION CONTACT: David Williamson, Director, Office of

Consumer and Regulatory Affairs, Room 5241, telephone (202) 708-4560;

or, for legal questions, Kenneth Markison, Assistant General Counsel

for GSE/RESPA, or Grant E. Mitchell, Senior Attorney for RESPA, Room

9262, telephone (202) 708-1550. (The telephone numbers are not toll-

free.) For hearing- and speech-impaired persons, this number may be

accessed via TTY (text telephone) by calling the Federal Information

Relay Service at 1-800-877-8339. The address for the above-listed

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

Street, SW, Washington, DC 20410.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act Statement

The information collection requirements regarding controlled

business disclosures (Appendix D of this rule) have been approved by

the Office of Management and Budget, under the Paperwork Reduction Act

of 1995 (44 U.S.C. 3501-3520), and assigned OMB control number 2502-

0265. An agency may not conduct or sponsor, and a person is not

required to respond to, a collection of information unless the

collection displays a valid control number.

The Department has eliminated the CLO disclosure statement which

previously was contained in Appendix E to the RESPA rule. Based on

prior cost estimates, the Department estimates the annual savings to

business from eliminating this paperwork requirement to be $3,247,100.

I. Events Leading to Today's Final Rule

A. History of CBAs and CLOs

1. Controlled Business Arrangements

In 1983, Congress enacted the ``controlled business arrangement''

amendment to RESPA. This amendment, codified under section 461 of the

Housing and Urban-Rural Recovery Act of 1983 (HURRA) (Pub. L. 98-181,

97 Stat. 1230) established that controlled business arrangements do not

violate RESPA, provided that:

(a.) The relationship between the person performing settlement

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

the estimated charges of the provider;

(b.) Consumers are not required to use an affiliated settlement

service provider, except under certain specified exemptions under

Section 8 of RESPA; and

(c.) Nothing of value is received by the referring party, beyond a

return on ownership interest or franchise relationship or payments

otherwise permissible under Section 8(c) of RESPA.

Following the enactment of these amendments, HUD issued several

informal legal opinions concerning the extent to which employers could

pay referral fees to employees. The opinions stated 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. HUD did not, however,

broadly approve compensation to employees for referrals to affiliated

companies.

2. Computer Loan Origination Systems (CLOs)

During the 1980's, a number of private companies and trade

organizations began to develop systems where some or most of the usual

mortgage origination services could be performed by computers. These

computer services frequently linked real estate brokerage offices to

lenders or other settlement service providers. Concerns were raised to

HUD regarding the interplay of these systems with Section 8 of RESPA,

particularly whether the existence of such systems could result in

illegal steering or compensation for referrals of business, or whether

the use of the systems would allow the operators to impose charges for

activities which represented little or no actual services. Several

developers of such systems and potential competitors asked HUD for its

views on payments made in connection with these systems under RESPA.

In the mid-1980's, HUD issued several informal interpretations

generally concluding that payments for CLO systems did not violate

Section 8 of RESPA. The opinions stated that, so long as payments by

the lenders (or real estate brokerage offices) went to cover

``operational fixed costs'' of the CLO services, no referral fees

existed. Moreover, the opinions stated that

[[Page 29239]]

borrower payments to CLOs were analogous to arrangements whereby

borrowers voluntarily pay mortgage brokers for locating lenders.

Accordingly, the Department concluded that such payments were not

pursuant to a prohibited ``agreement or understanding'' under Section

8(a) of RESPA and thus, were not proscribed by Section 8(a) of RESPA.

On two subsequent occasions, the Department revisited RESPA's role

in payments for CLO services through informal opinions. Both cases

involved payments to CLO operators from either lenders or real estate

brokers. In these two opinions, the Department concluded that such fees

did not violate Section 8(b) of RESPA so long as the fees were

reasonably related to services actually rendered. Controversy continued

to surround the use of CLO systems, with many mortgage bankers

opposing, and realtors supporting, HUD's position. All opinions were

withdrawn pursuant to a final rule published on November 2, 1992 (57 FR

49600) under RESPA (hereinafter ``final rule'' or ``1992 final rule'').

In May 16, 1988, HUD opened up this matter for review and

discussion without specifically mentioning CLOS, by proposing a rule

(53 FR 17428, 17438) that would have added an exception under

Sec. 3500.14, to allow the following:

Voluntary payment by a borrower to a person who has acted as a

mortgage broker or has otherwise assisted in bringing the lender and

borrower together, provided that such voluntary payment is disclosed

on both the good faith estimate of settlement costs and the HUD-1

settlement statement and is not a condition of the loan or other

settlement service.

The 1992 final rule did not adopt the so-called ``mortgage broker

exception'', but did adopt a CLO exemption.

B. The 1992 Rule

On November 2, 1992, HUD published the 1992 final rule, which

became effective on December 2, 1992. The 1992 final rule contained

provisions implementing congressional amendments to RESPA regarding

controlled businesses and created an exemption for payments by

borrowers to computer loan origination systems. The final rule also

updated the original RESPA regulations, which had not been amended

since 1976.

1. Employer-Employee Exemption

The 1992 final rule went beyond HUD's previous positions, as

articulated through informal legal opinions that were withdrawn by the

1992 final rule, and created an exemption for payments by an employer

to its own employees for any referrals of settlement service business.

Employees were thus allowed to receive compensation from their

employers for generating business for their own employer or for any

other business entity (including affiliates). The final rule contained

a stricture, in Sec. 3500.14(b), that the business entity receiving the

referrals of settlement business could not directly or indirectly

compensate anyone for such business. The rule did not limit this

exemption to controlled business arrangements. The exemption, however,

had little utility for entities outside an affiliate business setting,

since it was unlikely that an employer would pay its own employees for

making referrals to unaffiliated individuals or companies. As noted,

while the rule permitted an employer to compensate its own employees

for referrals, it also indicated that if the business entity receiving

the referral reimbursed the employer of the employees making the

referrals, Section 8 of RESPA would be violated.\1\

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\1\ The 1992 final rule was a marked departure from HUD

interpretations in recent years. After the issuance of the May 1988

proposed rule, which led to the 1992 final rule, HUD's position,

expressed in a number of General Counsel's opinions, was that an

employer could not compensate its employee for referrals to other

business entities (including affiliates). These opinions only

indicated that an employer could compensate its employees for

generating business for that employer (not to affiliates).

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Following the 1992 final rule's issuance, two lawsuits were filed

objecting to provisions of the revised regulations as inconsistent with

the statute and claiming failure by the Department to comply with the

Administrative Procedure Act in the rule's promulgation.\2\ In

addition, upon assuming office, HUD officials in the new Administration

were inundated with comments about the final rule.

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\2\ Plaintiffs in Mortgage Bankers Association of America v.

United States of America, No. 92-2699 (D.D.C.), and Coalition to

Retain Independent Services in Settlements (CRISIS) v. Cisneros, No.

92-2700 (D.D.C.), filed separate actions seeking a declaration that

the ``employee exception'' provision was invalid and injunctive

relief enjoining implementation of this provision. The MBA suit also

alleged that the CLO provision was invalid. These suits were

dismissed without prejudice, that is, subject to reinstatement. A

hearing regarding the Department's progress in issuing revised

regulations is scheduled for October 1996.

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The Department received allegations that the final rule created

uncertainty about whether referral fees were in fact prohibited by

RESPA. Some entities critical of the 1992 final rule characterized the

provision permitting employers' payments to their own employees for

referrals as broadly sanctioning referral payments. The trade and

business press frequently restated this position without examination.

Also, some commenters claimed that the creation 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 it prompted others to ``extort'' referral fees from

other settlement service providers on the premise that HUD now allowed

such compensation. While the final rule was not intended to permit sham

arrangements, neither did it clarify the extent of the employer-

employee exemption. Commenters argued that the final rule failed to

establish a bright line, comprehensible to industry participants,

between permissible and impermissible activities.

2. CLO Exemption

The 1992 final rule also introduced a CLO exemption, which provided

that borrower payments to CLO systems were exempt from Section 8 so

long as a specified disclosure was made. The 1992 final rule did not

adopt the mortgage broker exception proposed in the May 1988 proposed

rule. The Department reasoned that well-informed choices by consumers

did not require special protection under RESPA. Moreover, this

exemption was intended to prevent RESPA's restrictions against unearned

fees from unduly inhibiting the development of technology which could

permit consumers to shop, apply for and/or obtain mortgage loans

electronically. CLO systems were not specifically defined in the 1992

rule.

C. A Public Dialogue

Given the controversy over the 1992 final rule, the Secretary

determined that a review of the previous policy--primarily concerning

the exemptions for employer payments to employees and borrower payments

to CLOs--was needed. The review would particularly focus on the final

rule's impact on consumers. The Secretary 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 multimillion 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 views of all

interested parties

[[Page 29240]]

were heard, the Department published a ``notice of written comment

period and informal public hearing'' (58 FR 38176), inviting testimony

and written comments on the following four provisions of the final

rule:

Issue 1--The ``employer-employee'' exemption. Section

3500.14(g)(2)(ii) of the 1992 final rule, which provided that Section 8

of RESPA does not prohibit ``an employer's payment to its own employees

for any referral activities * * *.''

Issue 2--The ``computer loan origination'' (CLO)

exemption. Section 3500.14(g)(2)(iii) of the 1992 final rule, which

provided 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 is provided the borrower.''

Issue 3--Preemption policy. Section 3500.13(b)(2) of the

1992 final rule, which provided that ``in determining whether

provisions of State law or regulations concerning controlled business

arrangements are inconsistent with RESPA * * * 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.'' \3\

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\3\ As discussed, infra, HUD announced in a July 21, 1994,

proposed rule that it would not propose new rules on this issue and

would consider preemption questions on a case-by-case basis. Since

HUD has not changed its position on this issue, this final rule does

not address the issue further.

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Issue 4--Controlled business disclosure policy. Section

3500.15(b)(1) of the 1992 final rule, which provided for a written

disclosure in controlled business situations regarding the ownership

and financial relationships between referring and referred-to parties,

and for certain timing and other methods for disclosure.

On August 6, 1993, HUD conducted a public hearing, which produced

testimony and documents from 36 interested parties. The request for

written comment generated 1,526 public comments on these four issues.

D. The 1994 Proposed Rule

Following a detailed examination of the testimony and comments, HUD

published a proposed rule (59 FR 37360, July 21, 1994) \4\ containing

substantial revisions to the RESPA regulation. The proposed rule

discussed the views expressed in response to the pre-rule solicitation

of public comment and took positions on each of the earlier-presented

four major issues, inviting further public comment in light of the

additional revisions to the RESPA regulation that HUD was proposing.

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\4\ A more comprehensive discussion of the issues presented, the

Secretary's initial position on further amendment of the RESPA

regulations, and a summary of the hearing testimony and the comments

received are contained in the preamble of the proposed rule.

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The proposed rule reflected the Secretary's conclusion that the

1992 final rule's employer-employee exemption was too broad. In the

proposed rule, HUD proposed to withdraw this exemption because it

compromised the statute's purpose of protecting the consumer from being

referred to settlement service providers because of financial gain to

the referrer, rather than because of the quality and price of the

services. The proposed rule would have removed an exemption that

permitted an employer to pay employees referral fees for referrals to

an affiliate business entity.\5\ The proposed rule rejected the view

that all employer payments to its employees for referrals to third-

party settlement service providers should be exempt. When HUD viewed

the payments from the perspective of the consumer, it was clear that

payments by the employer to an employee, who performs settlement

services, for third-party referrals were indistinguishable from

payments directly from the third-party settlement service provider.

While HUD has the authority to exempt all employer payments for third-

party referrals under its Sections 8(c)(5) \6\ or 19(a) authority, the

Secretary concluded in the proposed rule, as a policy matter, that such

a broad exemption was inconsistent with the purposes of RESPA. In this

final rule, the Secretary is exercising this authority under Sections

8(c)(5) and 19(a) to exempt employer payments to their employees in

those circumstances where adequate consumer protection exists.

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\5\ This proposal was consistent with congressional admonitions.

See H.R. Rep. No. 123, 98th Cong., 1st Sess. 76 (1983) (controlled

business provisions are not intended to change current prohibitions

against unearned fees, kickbacks, or other things of value in return

for referrals of settlement service business).

\6\ In accordance with section 8(c)(5) of RESPA, HUD consulted

with the other agencies listed before exercising its authority under

section 8(c)(5).

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In adopting the proposed rule, the Department also recognized that

Congress had clearly established that controlled business arrangements

were permissible under certain conditions. In the interest of avoiding

undue interference with the internal operations of controlled

businesses, expressly permitted under the 1983 amendments to RESPA, the

proposed rule would not have prohibited 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:

1. No employee or agent could 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 affiliate business entity; and

2. The compensation of agents or employees who routinely are in

direct contact with the public could not be based, in whole or in part,

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

These clarifications were 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, or his or her employer's, financial

interests, without requiring HUD to interfere unduly with the internal

operations of controlled business arrangements.

As it relates to the regulation of payments to CLO systems, the

proposed rule reflected a determination that it was desirable to amend

the final rule to establish minimum standards for qualified systems,

payments to which would be exempt from Section 8. Under

Sec. 3500.14(g)(3) of the proposed rule, ``qualified'' systems would

have had to meet a number of specific regulatory requirements.\7\ The

proposed rule also asked for advice as to whether to create a similar

exemption for payments by lenders to operators of ``qualified'' CLOs.

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\7\ These requirements are described in Part II, Section C, of

this preamble.

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To assist in the promulgation of a final rule, the Secretary

requested comments and invited information on the effect of all of the

above proposals on the settlement services industry and consumers. As

an additional vehicle for obtaining public input, on September 30,

1994, as part of the rulemaking process, the Department conducted an

open house for operators of CLO systems to demonstrate their systems to

HUD and to the public.8

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\8\ Twenty-one CLO operators accepted the Department's

invitation and demonstrated their systems to officials of the

Department and to the public during an all-day session on September

30, 1994.

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Later in the rulemaking process, in August and September 1995, the

Department convened two working group meetings of interested industry,

government, and public officials, to obtain their individual input and

to

[[Page 29241]]

further explore the development and use of CLOs.

E. Today's Final Rule

Today's final rule addresses the comments received in response to

the proposed rule and considering the comments, promulgates rules

relating to Issues 1 (the employer-employee exemption), Issue 2

(payments to CLOs), and Issue 4 (controlled business disclosure

format). With respect to Issue 1, the rule withdraws the employer-

employee exemption and introduces three more-limited exemptions

designed to recognize the variety of business organizations without

doing damage to RESPA's core objective of consumer protection. On Issue

2, the rule withdraws the CLO exemption and issues a related Statement

of Policy that illustrates how CLO payments and activities are analyzed

under the existing and new RESPA regulations. As discussed, supra,

respecting Issue 3, the proposed rule did not propose any changes to

the preemption provisions, for the reasons explained in the proposed

rule, and, therefore, requested no comments. On Issue 4, the rule

revises the Controlled Business Arrangement Disclosure Statement.

In reading this preamble, the reader should be aware that HUD's

RESPA rule was recently streamlined through a separate rulemaking (61

FR 13232, March 26, 1996). This streamlining caused several provisions

of the RESPA rule to be renumbered. Except as is otherwise indicated in

the context of the preamble, this rulemaking refers to provisions by

their current section number, incorporating all revisions to date as a

result of the streamlining and today's rulemaking.

II. Analysis of Issues in Final Rule

A. Overview of the Public Comments

The Department received 354 \9\ comments on the July 21, 1994,

proposed rule. Of these, 100 were from attorneys, most of whom stated

that they were, or previously had been, actively engaged as settlement

lawyers. Only 2 comments from attorneys were identified by the writers

as written on behalf of clients; the remaining 98 appeared to be

individually originated comments by the attorneys or law firms on their

own behalf.\10\ An additional 73 comments came from bank holding

companies, banks, or other mortgage lenders; comments were received

from 46 real estate brokers; 34 comments were from mortgage brokers; 19

were identifiable as multi-service real estate service organizations;

\11\ 14 comments were from title company executives, 9 comments came

from credit unions; 8 from CLO service providers; and 6 commenters

identified themselves as consultants. One comment was received from a

journalist, one from a mortgage insurance firm, one from a credit

reporting service, and one from a student, and three comments were

received from persons whose professional interest in the rule could not

be determined.

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\9\ Three-hundred fifty-seven comments were received, but three

were found to be duplicate copies of other comments.

\10\ Not included as ``attorney comments'' were comment letters

written by house counsel for banks, lenders, or other organizations

communicating, through counsel, on their own behalf.

\11\ It was not always clear from a commenter's remarks, or from

the commenter's business letterhead, whether the commenter spoke for

a multiple-service entity. Accordingly, some commenters classified

here as lenders, mortgage brokers, real estate brokers, or other

categories may also, in fact, be multiple-service business entities.

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Twenty-two State, local, or regional organizations representing

portions of the real estate brokerage, lending, and settlement

industries provided comments, as did 16 organizations classified as

national advocacy organizations.

Attitudes toward the proposed rule varied greatly, not only

according to the professional background of the commenters, but also

according to whether a commenter was engaged in a controlled business

arrangement. For this reason, lenders and other settlement service

providers expressed a wide variety of views concerning the rule. The

majority (but by no means all) of the comments received from real

estate brokers and agents favored the existing regulatory structure

(the 1992 final rule) and sought to discourage changes in the rule

which, they argued, would impede their ability to provide benefits to

consumers.

Issue 1 (the employer-employee exemption) attracted the greatest

attention among commenters. Virtually all commenters, on both sides of

the issue, were at least moderately dissatisfied with the proposed

rule's revisions. Commenters who opposed any authorization of referral

payments frequently thanked the Department for the effort made in the

proposed rule to limit the practice, but virtually all of these

commenters were displeased that the Department was proposing to exclude

from RESPA coverage certain compensation to managerial employees in

controlled businesses.

On the other hand, commenters who wanted referral payments to

employees to continue to be allowable expressed strong opposition to

the proposed rule's limitation on such payments. Additionally, many of

these commenters asked for clarifications concerning the scope of the

``managerial'' exemption.

Issue 2 (the CLO exemption) was the second-most-frequently

addressed subject. A significant minority of the commenters who

addressed the issue credited the Department with a good effort at

better defining ``CLO services'' in the proposed rule, and there was

some positive support for the HUD definition. However, most commenters

who addressed the CLO question found fault with HUD's proposed

disposition of the issue, with the proposed CLO definition, or both. A

wide variety of suggestions for further refinement of the definition

was provided.

Issue 3 (the preemption issue) drew a few comments, even though the

Department had not requested any comments on it and had determined in

the July 21, 1994 proposed rule not to propose new rules on this issue.

The Department stated in the proposed rule that ``setting out

comprehensive and informative preemption standards present[ed] an

almost insurmountable task, in the absence of a wide array of specific

fact situations that are raising preemption issues.'' The Department

determined to consider preemption questions on a case-by-case basis.

Accordingly, the final rule does not address this issue.

Issue 4 (the controlled business arrangement disclosure statement)

attracted a significant amount of comment. In general, commenters on

both sides of the other issues were undisturbed by what they perceived

as the somewhat minor changes in the controlled business disclosure

statement that HUD proposed to adopt. There were, however, a number of

technical suggestions, and significant criticism of what was regarded

as the unduly negative tone of language proposed to be employed in the

Appendix D format to suggest that consumers shop for services.

Additionally, commenters continued to identify unresolved questions

about the disclosure form and to suggest modifications of both its

language and its applicability.

What follows is a more comprehensive discussion of the views

expressed by the commenters on Issues 1, 2, and 4, together with the

Department's rule-making decisions.

B. Issue 1: Withdrawal of Employer-Employee Exemption

1. In General

In the proposed rule, the Department proposed the withdrawal of the

existing regulatory exemption that permits

[[Page 29242]]

employers to pay referral fees to their own employees for referring

settlement service business to business entities, including those

within an affiliate relationship. This exemption applied whether or not

employers were in an affiliate or ``controlled business'' relationship,

but practically only benefited affiliate arrangements, as an employer

was unlikely to compensate its employees for referrals to unaffiliated

providers. The proposal included a limited exemption for payment of

bonuses for managerial employees who did not deal with the public,

provided such bonuses were not 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.

2. The Public Comments

Virtually all of the comments from attorneys approved of the

proposal to eliminate the employer-employee exemption. (About 30

percent of all the comments received on the proposed rule were from law

firms providing settlement services, and the overwhelming majority of

attorney comments were focused upon the employer-employee exemption.)

The combined comments of the Attorneys General of 11 States commended

the Department for focusing the rule's impact on consumers and for

articulating, as the first of HUD's guiding principles, the protection

of the consumer, rather than the mediation of industry interests. They

called the proposed rule a ``vast improvement'' over the November 2,

1992, rule.

Some major industry organizations expressed support for the

withdrawal of the exemption. For example, the Mortgage Bankers

Association expressed its ``substantially favorable reaction'' to the

changes HUD was proposing. MBA called employer-paid referral fees

``fundamentally inconsistent with the purposes of RESPA,'' and approved

the proposed rule's elimination of the exemption for fees paid to

employees with direct contact with consumers.

The basic premise of these commenters, who wanted a total

withdrawal of the employer-employee exemption, was that Section 8(a) of

RESPA should be construed to prohibit all ``compensated referrals,''

and any standard less than this bright line test opened up this civil

and criminal statute to unnecessary ambiguity and uncertainty. These

commenters generally maintained that no exceptions or exemptions should

be made.

In contrast, comments favoring the retention of the employer-

employee exemption argued that the 1992 formulation of the regulations

had not yet had time to work and be measured, much less to be found

insufficient. One diversified real estate, finance, management, and

insurance company from Illinois argued that ``controlled business

arrangements'' was an unfortunate misnomer that left the impression

that great control was being exercised over consumers. The commenter's

own company, it was claimed, had a ``capture rate'' of only around 14

percent of its real estate customers choosing to use its mortgage

services:

This means that at least 86 percent of those customers still

seek a different mortgage provider. This hardly represents a

coercive customer problem that's needing more regulation * * *. The

real danger in attempting to further regulate companies such as ours

[is that it] will result in reduced customer choice which we clearly

provide, and retarding competition * * *

An Illinois local office of a nationwide finance organization

argued strenuously that the elimination of employer-employee referral

fees would change little.

* * * [I]n the absence of any referral compensation, employees

will not discontinue referring consumers to affiliate settlement

service providers. This is because, when dealing with the consumer,

the employee is an agent of the employer and, as such, acts in

accordance with [his] employer's direction. * * * [A]rguments that

not paying a referral fee to an employee will result in an employee

acting independently of the employer's interests [are] simply not

based on reality.

The Real Estate Services Providers Council (RESPRO), an advocate of

the 1992 final RESPA rule, stated its continuing support of a

regulatory environment that would permit unfettered ``one-stop

shopping'' for real estate services. RESPRO favored both management

compensation and front-line employee compensation based upon profits or

on the amount of referred business the manager/employee was responsible

for producing. HUD's proposed rule suggesting the withdrawal of the

exemption in the 1992 final rule has, RESPRO commented, stifled

companies from developing one-stop shopping programs in the most cost-

efficient manner. The new proposed rule ``would significantly decrease

cost efficiencies within diversified companies by preventing them from

utilizing their own management to carry out the company's one-stop

shopping goals.''

HUD's apparent objective in regulating referrals, RESPRO argued,

was to eliminate the possibility of adverse steering. However, HUD's

principal concern appears to be focused on perceived abuses in the real

estate sales industry, and the examples of abuses cited by HUD (and by

commenters responding to the earlier request for comments) involved

real estate brokers and salespersons. RESPRO argued that the 1994

proposed rule's prohibition on employer-employee referral payments goes

far beyond any rule necessary to reduce adverse steering, and that the

rule deprives diversified companies of the efficiencies they need to

lower costs to consumers and would place diversified companies at a

competitive disadvantage, relative to independent competitor companies.

Comments from the National Association of Federal Credit Unions

(NAFCU) also opposed the elimination of the RESPA exemption for

employer-employee referral fees.

Another commenter who opposed the elimination of the exemption and

stated its support for the 1992 RESPA regulation was the National

Association of Neighborhoods (NAN). NAN's comments expressed concern

that the proposed rule's changes would reduce competition and consumer

choice by limiting the ability of one class of providers--diversified

companies--to offer homebuyers services on a cost-efficient basis. NAN

also expressed concern about the effect of the revisions on the

Community Reinvestment Act, noting the Federal Reserve Board's earlier

comments that restrictions on employee referral-based compensation

might be ``detrimental to future innovations and developments in

community lending.''

A mortgage finance consultant from Virginia cited recent

legislative proposals in Pennsylvania that would restrict the

percentage of business referrals permitted in a realtor-mortgage banker

controlled business arrangement. The commenter noted that Congress had

rejected similar proposals in the 1983 amendments to RESPA:

In my experience, all of the attempts to limit CBAs have been

motivated by industry, not to protect consumers or to provide lower

fees or better service, but to keep another industry from entering

the business. I would urge HUD to ensure that congressional intent

is followed by allowing CBAs to exist in the states unfettered by

the kinds of restrictions that were rejected in the 1983 CBA

amendments to RESPA.

Many supporters of controlled business arrangements reiterated

their earlier contentions that ``one-stop

[[Page 29243]]

shopping'' leads to greater efficiency in the settlement process and to

cost-savings for borrowers. Several of these commenters objected

strongly to the proposed withdrawal of the employer-employee exemption,

and urged that the Department reconsider and retain the existing

employer-employee exemption.

The National Association of Realtors (NAR) supported HUD's

clarification of the meaning of the November 2, 1992 rule, as set forth

in the preamble of the July 21, 1994 proposed rule, which indicated

that real estate agents were normally ``independent contractors'' and

therefore not employees within the meaning of the rule. Such agents,

therefore, could not receive referral-based compensation. NAR counsel,

however, requested clarification that an employer may legitimately

compensate its own employees ``for the generation of its own

business.'' Another commenter (Commercial Credit Corporation) wanted a

clarification in the final rule that RESPA did not apply to the

compensation arrangements for the generation of settlement service

business by either an employee or an agent of a settlement service

provider, in a particular multi-layered business structure, who

originated settlement services business exclusively for that settlement

service provider.12

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\12\ The commenter described a circumstance in which a mortgage

broker entered into an exclusive agency agreement with a lender to

deliver mortgage loan applications to the lender. The mortgage

broker used its exclusive agents (who were not otherwise engaged in

performing settlement services) to generate these loans. The

commenter represented that the consumer was at all times aware of

the exclusive relationship between the agent and the mortgage broker

and lender principals.

Payments by a mortgage lender to its exclusive agents reasonably

related to services actually performed, in the circumstances

described, fall under the exemption in Section 8(c)(1)(C) and 24 CFR

3500.14(g)(1)(iii). Thus, HUD concluded that the requested

clarification to address the issue raised by the commenter was not

necessary.

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3. The Final Rule's Approach--Overview

After a complete review of all comments and points of view, the

Department withdraws the broad employer-employee exemption. HUD has

determined that a broad exemption, as contained in the 1992 rule,

unnecessarily allows persons who serve consumers and gain their trust

to receive referral fees, in contravention of the express intent of

Congress in enacting Section 8(a). However, to allow controlled

business arrangements to operate and provide beneficial services and

packages of services to consumers, the rule establishes three

exemptions for permissible payments by employers to bona fide

employees. Specifically, the exemptions permit employer payments to

their own bona fide employees for referrals of business if:

(a.) The employee is a managerial employee, and the payment is not

calculated as a multiple of the number or value of referrals.

(b.) The employee does not perform settlement services in any

transaction; prior to the referral the employee provides the person

being referred a written disclosure in the format of the Controlled

Business Arrangement Disclosure Statement, set forth in Appendix D to

this part; and the referral is to a settlement service provider which

has an affiliate relationship with the employer or in which the

employer has a direct or beneficial ownership interest of more than one

percent. For purposes of this exemption, the marketing of a settlement

service or product of an affiliated entity, including the collection

and conveyance of information or the taking of an application or order

for the services of an affiliated entity, does not constitute the

performance of a settlement service. Under the exemption, marketing of

a settlement service or product also may include incidental

communications with the consumer after the application or order, such

as providing the consumer with information about the status of an

application or order; marketing may not include serving as the ongoing

point of contact for coordinating the delivery and provision of

settlement services.

(c.) The payment is to that employer's own employees for generating

business for the employer itself--but not its affiliates. The

Department believes that it was clear that such payments were

permissible payments under RESPA. However, because some commenters

indicated uncertainty regarding this position, and it is HUD's intent

that such payments continue to be permissible, the rule clarifies the

issue with a new exemption providing that payments made to bona fide

employees for generating business for their employer are permissible

under Sec. 3500.14(g)(1)(vii). This exemption means that an employee

may accept payments for referrals to its own employer. In an affiliated

relationship, the employer is only the business entity for whom the

employee directly works.13

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\13\ In addition, pursuant to 24 CFR 3500.14(g)(3), any person

who is in a position to refer settlement service business, such as

an attorney, mortgage lender, real estate broker or agent, or

developer or builder, may continue to receive payments for providing

additional settlement services as part of a real estate transaction,

if such payments are for services that are actual, necessary, and

distinct from the primary services provided by that person.

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These new exemptions provide that payments must be to a bona fide

employee. Individuals may not be hired on a part-time basis to make

referrals because of their access to consumers as settlement service

providers. Sham employment arrangements, such as a title company paying

a one hour ``salary'' to a real estate agent who provides a referral,

and issuing a W-2 for ``services'' rendered to justify compensating a

referral, are, and will continue to be, violations of RESPA.

The Secretary has authority to create exemptions under Section

19(a) of RESPA for classes of transactions as may be necessary to

achieve the purposes of the Act. 12 U.S.C. 2617(a). In addition, under

Section 8(c)(5) of RESPA, the Secretary may create regulatory

exemptions for ``such other payments or classes of payments,'' after

consulting with various Federal agencies. 12 U.S.C. 2607(c)(5). The

three exemptions created under this final rule are issued pursuant to

the Secretary's clear authority to create reasonable exemptions to

further the purposes of the Act.

In creating these new exemptions, HUD is not directly regulating

wages to bona fide employees. Rather, HUD is creating an exemption for

certain payments within an employment context that otherwise would be

prohibited by Section 8(a). The Secretary believes that such payments

to bona fide employees are not designed as a subterfuge to facilitate

kickbacks among affiliated companies.

The exemptions for managerial employees and employees who do not

perform settlement services in any transaction are explored in detail

below.

4. Managerial Employees

a. The Public Comments. Several commenters supported allowing

compensation to managerial employees based on referrals and criticized

the formulation regarding managerial compensation in HUD's proposed

rule. NAR supported the idea of compensation for managerial employees

or others who are not sales agents or otherwise involved in the direct

provision of settlement services. At the same time, NAR asked that the

proposed definition of ``managerial employee'' clarify that mere

possession of a broker's license or a salesperson's license to sell

real estate would not affect an individual's status as a managerial

employee. Many States, NAR indicated, require managers in the real

estate

[[Page 29244]]

business to hold licenses as brokers or sellers.

NAR counsel, responding separately to the proposed rule on behalf

of the organization, further elaborated on the national organization's

position regarding referral payments. He distinguished ``primary

services'' from ``secondary services,'' and argued:

NAR recognizes that the historic and legitimate thrust of

Section 8(a) of RESPA has been to prohibit compensation for

referrals by persons who are ``in a position to refer settlement

business,'' understood as referring to real estate professionals

providing settlement services (``primary services'') to whom

consumers may look for advice regarding sources of other required

settlement services (``secondary services'') with the expectation

that such advice will be based on professional knowledge and

experience and not tainted by additional compensation payable by the

highest bidder for the referral.

He suggested that HUD prohibit referral-based payments for any

individual who has significant contact with consumers regarding the

provision of a settlement service, where a principal part of the

individual's income consists of compensation based on settlement

services performed for the person's employer or an affiliate. The

prohibition against sharing of compensation related to a ``secondary

service,'' NAR counsel argued, could apply to all services performed by

the secondary service provider and not just to specific referrals. He

asserted that HUD could more easily enforce his suggestion than HUD's

proposal, since HUD's rule evidently required proof of an actual

``referral'' by the initial service provider.

* * * [A] regulation based on identification of actual referrals

will likely prove unworkable, leading either to no enforcement or to

adoption of presumptions that might exceed HUD's authority.

Additionally, NAR counsel argued that the proposed rule's

``managerial exemption'' would unduly complicate the ability of a

diversified company to devise workable incentive compensation schemes

for managers. NAR counsel further suggested a change to the definition

of ``managerial employee'' to exclude situations wherein a managerial

employee may, from time to time, act as a direct service provider. (In

such circumstances, the NAR-suggested definition would not permit

referral-based compensation in addition to the sometime-manager's

commission.) NAR counsel added, in comments varying somewhat from the

stated NAR position:

In general, we do not believe that the permissibility of

compensation should turn on status as an ``employee'' vs.

``independent contractor,'' provided that the independent contractor

is one whose services are provided exclusively for a single

principal and who is, therefore, in the eyes of the consumer,

indistinguishable from an employee.

MBA stated its concern about the lack of clarity in the

``managerial employees'' exemption in the proposed rule, seeking to

narrow the category of persons eligible for payments for referrals:

We believe it is imperative to have more detail in the

definition, so that the lending and real estate broker industries

will know exactly where the line is between `managerial employees'

and those that have `routine contact with the public.' For example,

if a person manages a branch office and consequently has supervisory

control over all of the staff that deal directly with the public, in

which category does that person fall? We strongly urge that such a

person [not be] eligible for the exemption because of his or her

involvement with the public implicit in the supervisory role * * *.

* * * [U]sing real estate offices as examples, office managers

and real estate brokers can exercise considerable influence over the

activities of the independent agents through manipulation of the

terms and conditions of their work * * *.

MBA asked that the term ``managerial'' be further defined to

include only individuals working at ``higher corporate levels'' where

there would be no opportunity to steer consumers. It was urged that the

definition be amended to clarify that only employees who do not work in

offices where consumers regularly visit could qualify for the

managerial exemption. The National Association of Mortgage Brokers

(NAMB) also asked that HUD revise the rule to elaborate on the

definition of ``employees'' to make clear that the term excludes

independent contractors and real estate agents.

RESPRO favored both management compensation and front line employee

compensation based upon profits or on the amount of referred business

the manager/employee was responsible for producing. RESPRO claimed that

the proposed rule's restrictions on compensation for managerial

personnel were so vague that they would, effectively, prohibit all

management compensation in one-stop shopping programs. One of HUD's

Fact/Comment Illustrations in the proposed rule indicated that

``Nothing in the RESPA rule prohibits bonuses or other compensation

based, in part, on the generation of business by A (a lender) to B and

C (a title company and escrow company) being paid to managerial

employees who are not routinely in contact with customers.'' However,

RESPRO claimed, the text of the proposed rule is not consistent with

the statement in the quoted Fact/Comment illustration.

The American Bankers Association (ABA) objected to the managers'

compensation provision of the proposed rule as ``too narrow,'' and

advocated that all employees of banking institutions should be able to

receive compensation or bonuses based on their referral of business

within the bank or to affiliates. Even if HUD were to retain only the

managerial exemption, the rule needs modification, ABA said, to clarify

the circumstances under which an employer could legitimately compensate

a manager.

In contrast, many of the attorneys commenting on the rule

(virtually all of whom supported the withdrawal of the employer-

employee exemption) were highly critical of the proposal to allow the

payment of referral-related bonuses and compensation to managerial

employees in controlled businesses, under conditions set out in the

proposed rule. The managerial exemption was regarded as an ``enormous

loophole'' in the new rule that would substantially overwhelm the

benefits these commenters expected from the proposed elimination of the

exemption for fees to line employees. Typical of attorney comments

received was one from an Alabama practitioner who said he ``applauded''

HUD's partial change of position ``to eliminate the objectionable

`employee bonus/kickback scheme'.'' However, the commenter said, ``by

creating the manager bonus loophole, you have simply encouraged and

promoted indirect schemes to circumvent basic consumer protection.''

The attorney ``implored'' HUD to ``stop playing politics with the basic

rights of consumers that the Real Estate Settlement Procedures Act was

designed to safeguard.'' Similar views were expressed by a Memphis

attorney:

If HUD allows bonuses to be paid to real estate managers even

though the bonuses are not strictly calculated on the basis of the

referral business, but merely takes it into account as a factor, the

managers and the agents will find a way to tie the bonuses directly

to the amount of business generated. HUD will have ``opened the

door'' to the abusive practices of kickbacks, tie-ins, fee

splittings, controlled business practices, and conflicts of interest

that existed prior to RESPA and which RESPA has largely eliminated.

Once the door is opened, everyone will stampede through it.

The American Bar Association's General Practice Section and

Standing Committee on Lawyers' Title Guaranty Funds echoed the

``loophole'' complaint of other practitioners:

[[Page 29245]]

Prohibiting ``one-to-one'' Basis Referral Fees will not

eliminate the payment of referral fees* * *. Allowing [managerial]

payments* * * would be a dramatic departure from the Act's

congressional intent and basically would render the previously

mentioned withdrawal of the employer-employee exemption impotent.

The combined comments of the Attorneys General of eleven States

opposed the proposed new ``managerial'' exemption.

HUD cannot allow compensation systems, even for managerial

employees, which depend, even in part, on the level of employee

referrals to affiliated companies* * *. [Managerial referral

compensation] will still create strong incentives within the company

to make as many referrals to affiliated companies as possible,

regardless of whether those referrals are in the consumers' best

interest or not.

A large number of other real estate professionals also submitted

objections to the proposed modified managerial exemption. These

commenters, along with most of the lawyer-commenters, believed that

controlled business arrangements constituted unfair competition, or

that they invariably would lead to increased costs for consumers.

Whether the payment is to an employee who is in contact with the

consumer for a business referral generated by that employee to the

employer or to an affiliate business entity, or whether the referral-

related payment is to a managerial employee, the objectors believed

that the effect would be the same: A determination would be made to

refer business based on the dollar benefit of the referral, rather than

on considerations of what would be most advantageous to the consumer.

Similar views were expressed by a New Jersey real estate broker who

said that he was ``strongly in favor of any changes in RESPA which

would ban payments for referrals from mortgage lenders, title insurers,

escrow agents and other real estate settlement service providers.''

``[I]t would seem very obvious,'' the realtor wrote, ``that payment of

referral fees would result in the agent selecting the service

provider.''

The Coalition to Retain Independent Services in Settlements

(CRISIS), an organization of independent settlement service providers,

responded to the proposed rule's referral provisions arguing for a

total ban on referral fees and referral-based compensation factors to

employees and managers. Consumer Federation of America also called for

a total ban on referral-based compensation involving affiliate

entities, as did the National Association of Mortgage Brokers (NAMB).

b. The Final Rule's Approach. The rule revises the proposed rule's

formulation and defines a ``managerial employee'' as one of a limited

class of employees who do not routinely deal with the public, but who

function in a management or executive capacity. It makes permissible

certain bonuses and payments to these managerial employees. Active real

estate agents, who are independent contractors, cannot be managerial

employees, although a managerial employee can hold a real estate

brokerage or agency license. HUD agrees with NAR counsel that managers'

``mere status as licensed brokers or salespersons should not exclude

them from being `managerial employees' if their principal functions''

are the types of managerial functions indicated in the definition,

rather than face-to-face dealings with consumers.

The rule provides that managerial employees in controlled business

arrangements may be paid bonuses based on performance criteria,

including profitability, capture rate or other thresholds, but the

bonus may not be directly calculated as a multiple of the number or

value of settlement transactions referred to a business entity in an

affiliate relationship. Thus, for example, the final rule does not

prohibit a managerial employee from receiving an annual bonus based on

an affiliate business entity capturing a percentage of the business

from the managerial employee's unit (e.g., a $1,000 bonus for an

affiliated lender's 10% capture rate of real estate brokerage customers

and a $2,500 bonus for a 20% capture rate). Managerial employees may

not, however, receive a bonus or other compensation calculated as a

multiple of the number or value of referrals of settlement service

business to a business entity in an affiliate relationship. Thus, a

compensation system that awarded a managerial employee $20 for every

referral continues to be prohibited, as would a compensation system

that awarded a managerial employee $100 for every 5 referrals.

In the rule, the phrase ``does not routinely'' is used to establish

a ``de minimis'' standard for consumer contact. HUD intends the phrase

``does not routinely'' to mean that managerial employees who

occasionally deal with consumers, which is almost inevitable in small

offices, are not precluded from receiving year-end bonuses because of

this minimal contact. Similarly, HUD intends this phrase to allow a

managerial employee who performs and is compensated for occasional

settlement services (not more than three transactions a year) to be

eligible for this exemption. This standard will effectively limit the

class of managerial employees who may receive these types of bonuses to

those ``whose contacts with consumers are only casual or peripheral, at

most, and who do not occupy the special positions of trust, arising

from their relationship to consumers as well as the arcane nature of

certain of the services required, that are developed by real estate

agents or the comparable providers of other services,'' as suggested by

NAR.

HUD has chosen to use its exemption authority under Section

8(c)(5), having consulted with other Federal agencies as required by

that provision, as well as the authority under Section 19(a) of RESPA

to permit these payments which would otherwise be prohibited by the

statute. As noted in the proposed rule (59 FR at 37365), Congress has

clearly determined that RESPA does not prohibit controlled business

arrangements, with certain conditions. The final rule's exemption

permitting managerial employees to receive payments of a bonus based on

criteria relating to performance conforms with Congress's intent to

permit controlled business arrangements to operate.

This exemption is appropriate because managers do not routinely

deal directly with consumers. Therefore, the manager is not in a

position of trust with the consumer to directly influence the

consumer's choice of settlement service providers. By providing this

exemption, the regulation will not require HUD to interfere unduly with

the internal operations of controlled business arrangements. The

exemption reflects the Department's acknowledgement that it would be

difficult to enforce RESPA in circumstances which would require

detailed scrutiny of complex compensation arrangements for management

in affiliated settings.

The exemption draws a line, however, for payments to managers that

are transaction based. This regulation does not allow payments to

managerial employees which mimic referral fees. Thus, where a payment

of a bonus to a managerial employee is calculated as a multiple of the

number or value of referrals of settlement service business to an

entity in the controlled business arrangement, it would appear to be a

payment in violation of the Act and contrary to the intent of Section

8(a).

The foregoing provisions have been amplified by a revised

Illustration 12 that is being added to Appendix B.

[[Page 29246]]

5. Employees Who Do Not Perform Settlement Services in Any Transaction

a. The Public Comments. Several commenters advocated, either

directly or indirectly, that the rule allow businesses to pay bonuses

for referrals to business entities in affiliate relationships to those

employees who do not perform settlement services. Many of these

comments focused on the way in which a host of Federal and State

regulations affect the way particular industries do business and are

structured. These comments urged HUD to allow compensation systems

which are sensitive to these structures.

ABA criticized HUD's proposed rule as insensitive to the structure

of banks, noting that, under the proposed rule, if the loan were made

by the bank itself, employees could be compensated for generating that

business, but if the loan were made by a subsidiary mortgage company,

such compensation would be a prohibited referral fee.

Individuals seeking a residential mortgage loan who enter a bank

and inquire as to the availability of such a loan do so voluntarily

with the goal of receiving information and possibly applying for and

obtaining such a loan. Whether or not the bank is structured * * *

to process such loans within the bank, the bank holding company or a

subsidiary or affiliate of each makes absolutely no difference to

the consumer and in no way affects his or her decision * * * whether

or not to do business with the bank * * *. Providing information in

order to expedite the customer's objective is appropriate and

beneficial to all parties. The structure of the mortgage lending

operation within the bank, its affiliate, or within the bank holding

company is inconsequential and shouldn't trigger any RESPA activity.

Other banker-commenters echoed the ABA's concern that the proposed

rule's referral-related modification was a poor fit for the varied

structures of banks and their integrated or affiliated real estate

service entities. A Minnesota bank holding company was among several

banking organizations arguing that there was a fundamental difference

between a referral by a bank employee to the bank's mortgage lending

affiliate, and the type of referral that might involve another party to

a real estate transaction, e.g., from a real estate agent to a mortgage

lender:

If an individual contacts a bank to inquire about a mortgage

loan * * * it is because the individual perceives the bank as a

lender that would offer that type of loan. The customer is not going

to the bank because he or she is seeking an objective, unbiased

referral to another lender. The customer * * * expects that whatever

bank they talk to will promote its own products. If that bank does

offer [mortgage loans] they would simply proceed to give information

to the potential customer * * * If, however, a bank holding company

[has formed] a separate subsidiary to handle * * * mortgage

lending[,] the proposed rules add additional burdens to that bank by

limiting its ability to design a compensation system for managers

that promotes the affiliate relationship and by requiring an

additional layer of disclosure.

* * * [E]xcessive requirements place the bank with a separate

mortgage lending subsidiary at a disadvantage compared to banks that

* * * offer such products within the bank itself.

ABA also asked that HUD reconsider this aspect of the rule in light

of the strong framework of existing bank regulation, State and Federal:

Unless appropriately modified, this proposed regulation

penalizes banks, their affiliates, bank holding companies * * *

solely because of their corporate structures. These structures have

been specifically authorized by statute, implemented by state or

federal bank regulatory authorities and constantly monitored and

examined for safety and soundness and compliance purposes.

ABA asserted that the HUD regulation effectively applies only to

banks and other banking institutions:

It is only these institutions which will be examined on a

periodic basis by bank examiners for compliance with this

regulation. HUD does not maintain its own compliance examiners for

non-bank settlement service providers. Other settlement service

providers do not and will not face this intensive examination

process.

ABA recommended that bank examiners not be required to examine for

this aspect of RESPA compliance--unless HUD intends to provide similar

supervision and enforcement for settlement service providers other than

banks.

Finally, ABA's comments indicated that banks are encouraging

employees to focus attention on compliance with the Community

Reinvestment Act (which encourages residential lending activity in the

banks' immediate service areas and neighborhoods). Many banks, ABA

claimed, find it advantageous to structure lending programs to provide

financial incentives to their employees to promote Community

Reinvestment Act objectives. The proposed rule would eliminate these

incentives arbitrarily, ABA stated.

A comment from the Securities Industry Association (SIA) similarly

objected to the proposed change in the referral fee rule. Some SIA

members, the comment said, are part of diversified services firms, with

mortgage lending affiliates. SIA believed that referrals made by

securities firms' representatives should be distinguished from those

made by employees of entities whose business is to perform settlement

services. The commenter argued that the potential harm to consumers

that HUD is attempting to deal with as ``inherent'' in referrals made

by persons performing settlement services is not present when the

referring individual is a registered securities representative. SIA

requested reconsideration, or an express exemption from the rule

applicable to employees of securities firms.

Virtually all commenters who objected strongly to the proposed

withdrawal of the existing employer-employee exemption, also approved

of the proposed rule's retention of an exemption, albeit in a modified

form. For example, RESPRO recommended that the (old) employee

compensation exemption be retained, but modified to exclude any real

estate agent, sales associate, or other person who assists consumers

with the listing or purchase of a home, and who has regular and

meaningful contact with consumers. This, RESPRO argued, would achieve

the HUD policy objective of discouraging adverse steering by real

estate agents, without interfering with the cost efficiencies of

diversified companies.

Several commenters also specifically advocated that the rule allow

businesses to pay bonuses for referrals to business entities in

affiliate relationships, to those employees who are financial service

representatives (FSRs), i.e., persons employed in affiliate businesses

to cross-market products. RESPRO argued that HUD's proposed rule would

place diversified companies at a competitive disadvantage to their

independent competitors by preventing them from compensating

salespersons who offer more than one of the company's products or

services, in the same manner as their independent competitors. Whereas

independent mortgage, title, and homeowners insurance companies follow

the traditional practice of encouraging a salesperson's productivity by

paying him or her on a commission basis, HUD's proposed rule would

result in diversified companies either having to hire less productive

salespersons (persons who could not be compensated based on commissions

which encourage productivity), or to pay three separate employees

(instead of one) to offer three separate services (so they can properly

motivate the FSR). RESPRO urged that HUD's final rule allow a broad

array of compensation to management and employees for developing and

implementing one-stop shopping, including: (1) the hiring and

compensating of a financial services manager, i.e., a branch manager

who is

[[Page 29247]]

responsible for supervising the performance of the real estate agent,

title agent, mortgage loan officer, and other persons performing

settlement services; and (2) the hiring and compensating on a

commission basis of a ``customer services representative'' or

``financial services representative'' who is not a real estate agent,

but ``who markets more than one settlement service (not real estate

brokerage)'' either in or outside of a real estate office.

NAR counsel urged that HUD place no restrictions on the

compensation of employees whose function is to promote sales of

``secondary services'' (i.e., other settlement services) provided by

affiliates at the point of sale of ``primary services.'' NAR counsel

commented, ``Notwithstanding that these individuals have direct contact

with consumers, we do not believe that they are in positions to develop

the special relationships of trust and expectation that are developed

by the `primary service' providers.''

b. The Final Rule's Approach. In response to these comments, the

final rule allows a limited exemption for an employer's payment to bona

fide employees who do not perform any settlement services,14 so

long as prior to the referral, the consumer is provided with a written

disclosure in the format of Appendix D. This exemption will cover at

least two situations frequently mentioned in the comments. First, this

exemption will allow employers to pay their own bona fide employees who

are not involved in the provision of settlement services, such as

securities sales persons or bank tellers, for referrals of settlement

service business to business entities in affiliate relationships. This

approach achieves substantially the same result recommended by counsel

to the NAR.

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\14\ Section 3(3) of RESPA (12 U.S.C. 2602(3)) and 24 CFR

Sec. 3500.2 define the term ``settlement services''. However, for

purposes of this exemption, the marketing of a settlement service or

product of an affiliated entity, including the collection and

conveyance of information or the taking of an application or order

for the services of an affiliated entity, does not constitute the

performance of a settlement service. Under the exemption, marketing

of a settlement service or product also may include incidental

communications with the consumer after the application or order,

such as providing the consumer with information about the status of

an application or order; marketing may not include serving as the

ongoing point of contact for coordinating the delivery and provision

of settlement services.

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Second, this exemption will allow employers to pay their own bona

fide employees, whose primary function is to market the services of the

affiliates of the employer. Employees who perform settlement services

remain subject to Section 8's prohibitions. However, as with a

managerial employee who holds a real estate license, a securities sales

person or bank teller who holds a mortgage broker license would not be

precluded from qualifying for the exemption, if the securities sales

person or bank teller is not actually involved in the provision of

settlement services.

The exemption created here establishes a test: if an employer's

payment is to an employee who does not perform settlement services in

any transaction, the exemption applies and payments are not subject to

Section 8 scrutiny so long as the disclosure is made.

A primary purpose of RESPA is to prevent consumers from being

unwittingly steered (in exchange for referral payments) by one

settlement service provider to other particular settlement service

providers. Although the statute, on its face, covers all referrals of

settlement service business, regardless of who makes the referral,

Congress did not express as high a level of concern about the referral

activities of those who do not perform settlement services. The

Department believes that the structure of affiliated businesses,

particularly in the financial services industry, wherein services are

often divided among different affiliates, is frequently a response to

State and Federal laws, such as the Bank Holding Company Act, rather

than an attempt to circumvent RESPA. The Department believes that the

industry should not be unnecessarily disadvantaged in competition by

its mandated or chosen business structure. Thus, HUD has chosen to use

its exemption authority under Section 8(c)(5) and Section 19(a) of

RESPA to permit these payments otherwise prohibited by the statute.

This exemption only covers payments made by the employer, not by

the party to whom the settlement service business is referred. It also

only applies to payments for referrals to affiliate business entities.

Further consideration should be given to a broader exemption for

payments to those who do not perform settlement services received

directly from either: (1) An affiliated party receiving the referral;

or (2) an unaffiliated party receiving the referral. However, these

issues were not raised by this rulemaking and the record is

insufficient to determine the impact of such changes.

A similar proposal is included in legislation currently under

consideration in the United States Senate. This legislation would allow

anyone who does not receive another fee in the particular transaction

to receive a referral fee from any source. The stated purpose of the

proposal is to exempt from RESPA coverage ``co-branding'' and

``affinity marketing,'' as such payments are known in the industry. The

Department believes that this proposal also could be accomplished by

regulation, using HUD's exemption authority under Section 8(c)(5) and

Section 19(a) of RESPA. However, both approaches--an exemption for all

payments to those not performing settlement services or an exemption

for all payments for those not receiving another fee in the

transaction--require further scrutiny. While it is desirable to

facilitate business generation where there is little danger of the

adverse steering that RESPA was designed to prevent, it is important to

ensure that loopholes are not created through which such adverse

steering can slip. HUD intends to undertake further rulemaking on this

subject and to seek public comments.

The Department also recognizes the market trend, described

particularly in RESPRO's comments, that many companies are choosing to

hire one or more individuals whose primary function is to generate

business for his or her employer and affiliated companies. Such

individuals are sometimes referred to as marketers or customer or

financial service representatives.

In response to these realities, the Department has created an

exemption sufficiently broad to allow an employer's payments to its

bona fide employees whose primary function is to generate business for

entities within an affiliated relationship with that employer. The

Department has restricted this exemption to payments to those who do

not perform settlement services in any transaction including, for

example, those settlement services of a real estate agent, loan

processor, settlement agent, attorney, or mortgage broker. For purposes

of this exemption, the marketing of a settlement service or product,

including the collection and conveyance of information or the taking of

an application or order for the services of an affiliate does not

constitute the performance of a settlement service. Under the

exemption, marketing of a settlement service or product also may

include incidental communications with the consumer after the

application or order, such as providing the consumer with information

about the status of an application or order; marketing may not include

serving as the ongoing point of contact for coordinating the delivery

and provision of settlement services.

As discussed above, the Department's review of the legislative

history revealed that steering of unsophisticated consumers from one

settlement service

[[Page 29248]]

provider to other settlement service providers was a substantial

congressional concern. A settlement service provider frequently is

trusted by the consumer and appears to the consumer to be an expert in

the settlement process and to have the consumer's interests in mind. If

a person performing settlement services is also receiving compensation

for referring business to another settlement service provider, there is

a potential conflict of interest. The consumer's trust in the person

performing settlement services may cause the consumer to lose any

natural wariness he or she might otherwise have of following the advice

of a salesperson who derives income from sales performance. The

consumer might ignore the conflict of interest because of trust that

has accrued from the provision of another settlement service. A person

who is not performing a settlement service, but is merely marketing the

affiliated companies, is less likely to attain trusted-advisor status

concerning the transaction. The consumer is more likely to be aware of

and weigh carefully the incentives of a person who is not performing a

settlement service but is generating business for that person's own

employer and its affiliates. The application of the rule's prohibition

to all settlement service providers, whether involved in the specific

settlement or not, prevents two providers from swapping referrals.

The Department is also requiring that disclosure of the affiliate

relationship be provided to the consumer when the referral is made, so

that the consumer will be alerted to the affiliate relationship, be

informed of the potential business interest of the employee making the

referral, and be able to make an educated decision about whether to use

the recommended provider or another. Finally, the Department is

requiring that, for the exemption to apply, the referral of settlement

service business be to a settlement service provider that has an

affiliate relationship with the employer or in which the employer has a

direct or beneficial ownership interest of more than one percent. This

requirement is consistent with congressional intent to allow controlled

business arrangements and is responsive to comments indicating that the

circumstances described in the exemption are those in which an

exemption would be most beneficial. Where these requirements are met,

the Department believes the consumer is adequately protected. The

Department, therefore, has used its exemption authority under Section

8(c)(5) and Section 19(a) of RESPA to permit these payments otherwise

prohibited by the statute.

The foregoing provisions have been amplified by revised

Illustrations 11 and 12 which are being added by this rule to Appendix

B.

C. Issue 2: Computer Loan Origination Systems (CLOS)

1. Background

The 1992 final rule specifically exempted from RESPA's coverage any

borrower payment for computer loan origination systems or CLOs. The

exemption was intended to prevent RESPA's restrictions against unearned

fees from unduly inhibiting the development of technology which could

permit consumers to shop, apply for or obtain mortgage loans

electronically. A CLO system was not defined in the 1992 rule.

2. The Proposed Rule, CLO Demonstration and CLO Working Groups

In response to the earlier comments, the proposed rule undertook to

establish minimum standards for a system falling within the exemption.

HUD proposed to designate such CLO systems as ``qualified CLOs.''

Payments by consumers to such systems would not then be ``scrutinized

under RESPA.'' A ``qualified'' system would:

(a.) Provide openings for 20 or more lenders offering various loan

products;

(b.) Utilize selection factors for lenders that are fair and

impartial and are designed to contribute to the efficiency and quality

of the system;

(c.) Provide borrowers information in a lender-neutral manner;

(d.) Provide borrowers a CLO disclosure form before CLO services

are performed;

(e.) Charge all borrowers using the system the same CLO access

fee(s) for the same service or the same components of service; and

(f.) Be allowed to charge lenders for access only if charges are

set forth in a written schedule of charges, charges for the same

services and components of services are the same for all lenders on the

system, and charges for the same services are reasonably related to the

costs of maintenance and operation of the qualified CLO system.

The proposed rule asked for advice on whether to create a similar

exemption for payments by lenders to ``qualified lender'' CLOs, or

whether to leave such systems to be governed by the general rules of

RESPA regarding kickbacks, unearned fees and referral fees.

As an additional vehicle for obtaining public input, on September

30, 1994, as part of the rulemaking process, the Department conducted

an open house for operators of CLO systems to demonstrate their systems

to HUD and to the public. Twenty-one CLO operators accepted the

invitation and participated in this all-day demonstration in

Washington, D.C. At the demonstration, the capabilities of the systems,

the number of lenders displayed, the arrangements for payment, among

other characteristics, differed widely.

3. The Public Comments

The public comments received on the proposed rule reflected a wide

array of criticisms that suggested continuing problems with the rule's

approach, or that indicated that the CLO definition HUD had arrived at

would not work under particular circumstances. Additionally, a few

commenters (including RESPRO, NAR, and separate comments by NAR

counsel) not only questioned the particulars of HUD's CLO proposal, but

also suggested that the Department lacked adequate authority under

Section 8(b) of RESPA to establish ``qualified'' or ``non-qualified''

CLO systems by regulation, as proposed.

NAR and several individual commenters advocated that the rule

should distinguish computer systems that merely provided basic

information about prospective lenders (e.g., a comparison of current

interest rate quotations for particular mortgages) and those systems

that actually may be said to ``originate'' loans by means of

qualification (or at least, pre-qualification) of borrowers.15

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

\15\ See further discussion later in this Issue 2 section, under

heading (g), ``Other CLO Issues Raised by Commenters''.

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

Many commenters objected to the proposed rule's requirement that a

borrower's payment for CLO services be made ``outside of and before

closing,'' arguing that this requirement would dampen or completely

destroy the market for CLO services, and that determining the

appropriate timing of the borrower's payment would create ambiguities

and resulting compliance difficulties. The combined comments of the

State attorneys general objected to the proposed rule's concept of

``qualified'' and ``non-qualified'' CLOs and suggested, instead, that

HUD permit only qualified CLOs to operate at all.

The several most-frequently raised CLO issues are summarized below.

a. The Legal Issue. RESPRO, NAR, and others raised the issue of

HUD's authority to establish minimum standards (i.e., a ``safe harbor''

[[Page 29249]]

exemption) and to subject non-qualifying CLO systems to scrutiny.

Noting that the proposed rule cited Section 8(b) of RESPA as a basis of

HUD's authority to regulate in this area and to prohibit a CLO operator

from accepting a payment from a borrower for a sham or duplicative

charge, these commenters argued that Section 8(b) of RESPA was

inoperative as authority for regulating CLO payments unless the CLO

operator shared fees with a third party.

According to the commenters, Section 8(b) governs only a ``portion,

split, or percentage'' of any charge made or received. If the CLO

operator is the only party charging or receiving a fee for CLO-related

services, the commenters argued, then Section 8(b) cannot be the

authority for the proposed borrower payment exemption ``safe harbor''

or for regulating non-qualifying CLOs. The commenters cited as

authority for this position certain judicial precedents.

HUD is aware of these cases, which never involved HUD as a party,

but finds their reasoning not to be persuasive or their holdings not to

be determinative of the issue. HUD believes that Section 8(b) of the

statute and the legislative history make it clear that no person is

allowed to receive ``any portion'' of charges for settlement services,

except for services actually performed. The provisions of Section 8(b)

could apply in a number of situations: (1) where one settlement service

provider receives an unearned fee from another provider; (2) where one

settlement service provider charges the consumer for third-party

services and retains an unearned fee from the payment received; or (3)

where one settlement service provider accepts a portion of a charge

(including 100% of the charge) for other than services actually

performed.

The interpretation urged, that a single settlement service provider

can charge unearned or excessive fees so long as the fees are not

shared with another, is an unnecessarily restrictive interpretation of

a statute designed to reduce unnecessary costs to consumers. The

Secretary, charged by statute with interpreting RESPA, interprets

Section 8(b) to mean that two persons are not required for the

provision to be violated. HUD, therefore, had adequate authority to

promulgate the rule it proposed, although it has chosen not to do so.

b. Impact on Mortgage Brokers. On the merits of the CLO proposal,

the Mortgage Bankers Association and many other commenters were alarmed

about possibly unintended effects of the CLO provisions on mortgage

brokers. First, MBA feared that merely by using a computer in its

activities, a mortgage broker could be deemed a CLO operator, since

mortgage brokers typically perform many or all of the functions set out

in the ``CLO system'' definition contained in Sec. 3500.2 of the

proposed rule. MBA anticipated that mortgage brokers might therefore

find themselves faced with a new disclosure requirement (relating to

CLO systems) that HUD probably did not intend. Revision of the

definition was urged to clarify this point.

c. Time of Payment for CLO Services. RESPRO, NAR, and many other

commenters strenuously objected to the requirement in the proposed rule

that for a system to qualify, payment for CLO services be ``outside of

and before'' loan closing.

d. Twenty-Lender Requirement. RESPRO and a large number of

individual commenters objected to the proposed rule's requirement that

CLO systems provide access to at least 20 lenders. RESPRO asserted that

its members, as well as CLO operators, uniformly believed that 20

lenders would constitute ``information overload'' and would

discriminate against small and local CLO operators. Other commenters

reflected that 20 lenders, each offering, perhaps, multiple variations

of mortgage loan packages, would overtax a CLO system and increase its

operating costs, to no useful purpose. Consumer Federation of America

was among the very few commenters who suggested that access by 20

lenders would be inadequate.

e. Lender-Pay Systems. The Attorneys' General comment objected to

the fact that the rule did not prohibit lenders from paying for CLO

services, viewing lender-paid services as ``harboring the same

potential for consumer abuse as direct kickbacks.'' MBA also opposed

permitting lender-paid fees, arguing that they constitute hidden costs

to the consumer. Consumer Federation of America strongly objected to

lender payments, saying that they would place consumers at ``great risk

of being steered into noncompetitive products.'' Conversely, comments

from the National Association of Federal Credit Unions (NAFCU) urged

HUD not only to create a parallel exemption for payments by lenders for

qualified CLO systems, but suggested that HUD not intervene in setting

lender-CLO operator fee schedules. NAFCU believed that negotiated fees

for CLO services to lenders would promote competition.

f. ``Information'' vs. ``Origination''. NAR and numerous other

commenters urged that a sharp distinction be made in the rule between

computer loan information systems (dubbed by NAR and others as

``CLIs'') and computer loan origination systems (``true'' CLOs), with

which a computer link-up can be made with lenders and a genuine loan-

application-approval process originated. Another commenter similarly

explained that vast differences existed in the functions and

sophistication of ``loan origination technology,'' ranging from

relatively simple information transmittal systems to ``electronic

decision makers'' that utilize artificial intelligence. These latter

systems, the commenter claimed, were essentially computer underwriting

systems. The commenter went on to recommend that HUD narrow its CLO

definition to require that qualified systems not only collect data, but

evaluate it.

g. Other CLO Issues Raised by Commenters. A nationwide finance

organization believed that the CLO system definition should not require

the transmission of information concerning a prospective property. CLO

systems offer the same benefits to consumers in the pre-qualification

stage, the commenter asserted.

Comments on the issue of CLO-related disclosures varied greatly.

Commenters sympathetic to the regulatory scheme proposed for CLOs were

also supportive of the form of disclosure, although some additional

disclosures were occasionally suggested. Commenters otherwise critical

of HUD's definition, the proposed CLO regulatory scheme, or other

aspects of the proposal tended to object as well to the form of

disclosure proposed. Generally, objections to the CLO disclosure format

were mild, except the American Bankers Association and a few other

commenters specifically objected to the ``acknowledgement box''

requirement for the same reasons that consumer-acknowledgement

procedures were objected to in connection with the controlled business

arrangement disclosure statement.16

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

\16\ See discussion of CBA disclosure statement format under the

heading ``Issue 4'' elsewhere in this preamble.

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

4. Working Group Meetings

After review of all of the comments and the information gleaned

from the technology demonstration, HUD believed that it did not have

sufficient information on CLOs and how they were actually functioning

in the provision of services to consumers. Accordingly, HUD convened

the first of two CLO working group meetings on August 11, 1995, in

Washington, D.C. Participants included CLO vendors, related industry

associations, State regulators, consumer groups, and

[[Page 29250]]

individual advocates. The purpose was to get their individual input on

CLO issues.

The working group examined a number of CLO trends and CLO systems

and identified the types and characteristics of CLOs currently

operating. Presentations were made regarding several operating systems,

as well as the Federal National Mortgage Association's (Fannie Mae's)

Desktop Underwriter and the Federal Home Loan Mortgage Corporation's

(Freddie Mac's) Loan Prospector. Views expressed by one or more members

of the group included:

CLOs are merely a technology for automating the loan

process and not necessarily an independent settlement service.

There should not be a special exemption for CLO services.

A separate set of disclosures for CLOs and CLIs should not

be created, but consumers should be given understandable and meaningful

disclosures.

HUD should not attempt to set rates.

HUD should define the level of service that must be

performed in the origination process in order to receive compensation.

Many participants argued that HUD should not attempt to regulate,

define, or set standards for an evolving technology. Many argued that

greater clarity about how the RESPA regulations applied to loan

originations would be preferable to a separate exemption or ``safe

harbor,'' for which HUD set required characteristics by regulation. At

the conclusion of the first meeting, the group agreed to meet again and

discuss further the development of CLO technology.

HUD held a second working group meeting on September 26, 1995. At

this meeting, many also argued again that the RESPA regulations should

apply equally to all participants in the market, regardless of their

use of technology, and that the applicable test should be whether the

fees paid were for services actually performed. Many in the group

believed that HUD should provide additional guidance about how this

basic RESPA test applies in the CLO context. Some participants

criticized a distinction between services paid for by lenders and

services paid for by borrowers, arguing that the borrower was the final

source of funds for all services. State regulators also discussed the

licensing and other requirements applicable to CLOs in many

jurisdictions.

5. The Final Rule's Approach

After further internal review and discussion, the Department

determined to abandon the approach taken in the proposed rule, withdraw

the CLO exemption that had been contained in 24 CFR

3500.14(g)(1)(viii),17 and replace it with guidance analyzing the

application of RESPA and the RESPA regulations to common CLO issues.

The final rule also withdraws Appendix E, the CLO disclosure.

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

\17\ Prior to HUD's regulatory streamlining, this provision was

codified at 24 CFR Sec. 3500.14(g)(2)(iii).

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

Simultaneously with the publication of this final rule, the

Department is issuing a Statement of Policy. That Statement of Policy,

issued under Sec. 3500.4(a)(1)(ii), is being published in today's

Federal Register and constitutes a ``rule, regulation, or

interpretation'' within the meaning of Section 8.

D. Issue 4: CBA Disclosure Form

1. The Public Comments

Proposed changes in the controlled business disclosure form also

attracted significant attention from commenters. Eleven Attorneys

General commended the Department for accepting most of the suggestions

made by State Attorneys General in the earlier round of public comment

on RESPA regulations. However, the Attorneys General questioned whether

the addition of a borrower acknowledgement box on the form is helpful

and suggested it may actually prove harmful:

* * * While it may appear that such a box induces the consumer

to read the disclosures, in fact, it may be just one more document

in a blizzard of such forms which the consumer signs. It is likely

that lenders will find this acknowledgement more useful than

consumers and will attempt to use the acknowledgement in defending

any suits by consumers who feel they have been misled.

A few commenters affirmatively supported the revised disclosure

statement requirement as appropriate and useful.

Other commenters, however, were more critical of the content of the

revised disclosure statement. Especially singled out for criticism was

the required statement ``YOU MAY BE ABLE TO GET THESE SERVICES AT A

LOWER RATE BY SHOPPING WITH OTHER SETTLEMENT SERVICE PROVIDERS, AND

THIS IS SOMETHING YOU SHOULD CONSIDER DOING.''

A multi-service company in Massachusetts called the quoted sentence

a ``negative statement'' that would discourage consumers from using an

affiliated service. ``If HUD is serious about allowing diversified

service providers to compete, this statement should be eliminated.''

(Emphasis in original.) Another commenter, a Missouri attorney,

objected in particular to the last phrase, ``* * * and this is

something you should consider doing.''

* * * This phrase clearly denotes that there are better services

available, and that the service which will be provided by the

referred settlement service would be inadequate * * *. To suggest *

* * that buyers would be better off looking elsewhere, is far beyond

protection of the consumer and actually is hinting to the consumer

that there is something inherently wrong with the controlled

business arrangement * * *. (Emphasis in original.)

An Iowa realty company urged that the statement be made more

``provider neutral,'' and that all mortgage service providers be called

upon to provide similarly worded disclosures regarding the value of

comparison shopping.

A Kansas lender complained that ``No other industry in this country

is required to urge its customers to seek services elsewhere* * *.''

A Chicago title guaranty company expressed sympathy for the

objectives of the disclosure statement, but agreed that the proposed

rule's version implied that substandard service was being provided. The

following alternative statement was offered:

There are many providers of settlement services providing

quality products at competitive rates. You are encouraged to shop

around to ensure that you are receiving the best quality product at

the best rate available for the same or similar services.

NAR's comments echoed the concerns of the above-quoted individual

commenters by asking for a ``provider neutral'' statement and that all

mortgage settlement service providers be called upon to provide

similarly worded statements, ``thus preventing multiple service * * *

firms from being placed at a relative disadvantage vis-a-vis other

mortgage service providers.''

Several banker-commenters again pressed the point that the required

disclosure statement was inappropriate for the circumstances of banks

and bank holding companies. Because these organizations commonly

conduct their residential mortgage lending activities through mortgage

company affiliates, ``* * * the consumer that contacts the bank * * *

expects to be referred to the bank's mortgage lending operations,

whether that consists of a department of the bank or an affiliate.''

The American Bankers Association objected to the elaborate

disclosure statement in the context of the kind of incidental and

uncompensated referrals

[[Page 29251]]

involved in the bank/affiliate mortgage company operation. ``It is

sufficient consumer protection,'' ABA argued, ``for banks to indicate

that there might be services provided at a lower rate and not to add a

statement that such shopping is recommended.''

ABA and a few individual commenters also protested the requirement

that the disclosure be acknowledged in writing. A title guaranty firm

made the point that documents are frequently mailed to consumers to be

signed and returned, and that it is difficult to secure the return of

such documents, possibly raising unnecessary doubts concerning the

validity of the disclosure actually given. ABA raised several

questions:

* * * [W]hat is the status of a bank's compliance with the

acknowledgment and signature requirement if only the applicant and

not the co-applicant signs the acknowledgment?

What efforts does the bank have to expend in order to obtain the

co-applicant's signature?

Should not the applicant's acknowledgement be sufficient for

compliance purposes?

The process of obtaining these signatures, ABA concluded, ``creates

compliance burdens for banks while providing negligible benefits to

consumers.''

2. The Final Rule's Approach

After review of all comments, the Department retains the

requirement of the applicants' acknowledgement. In addition to focusing

the attention of the applicant on the document, the acknowledgement

also protects the lender from charges that it had failed to inform the

prospective borrower of the controlled business arrangement. In

response to comments, only one signature is now required.

The Department has not adopted the NAR's suggestion that HUD

require all settlement service providers to provide a statement

encouraging consumers to shop around. The statute requires such a

statement in the context of controlled businesses, but has no such

requirement for any other situation. This rule only requires the

disclosure in the context of controlled business arrangements.

Also, the Department reformulates the discussion of the

desirability of borrowers shopping for settlement services. In response

to criticism that the proposed language intimated that the services

offered by the disclosing servicer might be substandard or overpriced,

the Department adopts more neutral wording that continues to inform

consumers of their freedom to seek the most advantageous rates or

services in a competitive market. The Department remains committed to

the policy that ample disclosure, a preeminent principle of the RESPA

statute, is a valuable means of informing consumers and promoting

competition in the settlement services industry.

The new formulation for the CBA disclosure is set forth in Appendix

D. It now reads:

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. THERE ARE FREQUENTLY OTHER SETTLEMENT SERVICE

PROVIDERS AVAILABLE WITH SIMILAR SERVICES. YOU ARE FREE TO SHOP

AROUND TO DETERMINE THAT YOU ARE RECEIVING THE BEST SERVICES AND THE

BEST RATE FOR THESE SERVICES.

E. Other Matters Raised by Commenters

1. The Public Comments

In addition to the specific comments received in response to the

Department's request, some commenters raised concerns that some

employers were engaging in practices of retaliation or discrimination

against employees and agents for not referring business to affiliate

entities. Other commenters complained that settlement service providers

were being excluded from, or locked-out of, places of business where

they might find potential customers. They also alleged that high-priced

real estate office space arrangements with particular lenders,

frequently coupled with lock-out arrangements, raised RESPA concerns.

2. The Final Rule's Approach

The Department determined that these issues were distinct from

those raised by the proposed rule. Moreover, they do not require

rulemaking, but rather an interpretation, applied to specific

circumstances, of the statute and the implementing regulations.

Therefore, HUD is issuing a separate Statement of Policy on the issues

of retaliation, lock-outs, and appropriate office rents to provide the

guidance sought by so many commenters. That Statement of Policy is

being published in today's Federal Register, simultaneously with the

publication of this final rule.

Other Matters

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 General Counsel, the

Rules Docket Clerk, room 10276, 451 Seventh Street, SW, Washington, DC

20410.

Executive Order 12866

This final 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 General Counsel,

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

Street, SW, Washington, D.C. 20410-0500. An Economic Analysis (EA)

performed on this proposed rule is also available for review at the

same address.

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. An Economic Analysis prepared in connection with this

rule considers the impact on small entities.

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 final 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 final 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.

[[Page 29252]]

List of Subjects in 24 CFR Part 3500

Consumer protection, Condominiums, Housing, Mortgages, Mortgage

servicing, Reporting and recordkeeping requirements.

Accordingly, for the reasons set out in the preamble, part 3500 of

title 24 of the Code of Federal Regulations is amended as follows.

PART 3500--REAL ESTATE SETTLEMENT PROCEDURES ACT

1. The authority citation for shall continue to read as follows:

Authority: 12 U.S.C. 2601 et seq.

2. Section 3500.2(b) is amended by adding, in alphabetical order, a

definition of ``managerial employee'', to read as follows:

Sec. 3500.2 Definitions.

* * * * *

(b) * * *

Managerial employee means an employee of a settlement service

provider who does not routinely deal directly with consumers, and who

either hires, directs, assigns, promotes, or rewards other employees or

independent contractors, or is in a position to formulate, determine,

or influence the policies of the employer. Neither the term

``managerial employee'' nor the term ``employee'' includes independent

contractors, but a managerial employee may hold a real estate brokerage

or agency license.

* * * * *

3. Section 3500.8(c)(2) is amended in the fourth sentence by

removing the reference ``Appendix F'' and adding in its place the

reference ``Appendix E''.

4. Section 3500.14 is amended by revising the last sentence of

paragraph (b), the heading of paragraph (g), and paragraph (g)(1), to

read as follows:

Sec. 3500.14 Prohibition against kickbacks and unearned fees.

* * * * *

(b) * * * A business entity (whether or not in an affiliate

relationship) may not pay any other business entity or the employees of

any other business entity for the referral of settlement service

business.

* * * * *

(g) Exemptions for fees, salaries, compensation, or other payments.

(1) The following are permissible:

(i) A payment to an attorney at law for services actually rendered;

(ii) A payment by a title company to its duly appointed agent for

services actually performed in the issuance of a policy of title

insurance;

(iii) A payment by a lender to its duly appointed agent or

contractor for services actually performed in the origination,

processing, or funding of a loan;

(iv) A payment to any person of a bona fide salary or compensation

or other payment for goods or facilities actually furnished or for

services actually performed;

(v) A payment pursuant to cooperative brokerage and referral

arrangements or agreements between real estate agents and real estate

brokers. (The statutory exemption restated in this paragraph refers

only to fee divisions within real estate brokerage arrangements when

all parties are acting in a real estate brokerage capacity, and has no

applicability to any fee arrangements between real estate brokers and

mortgage brokers or between mortgage brokers.)

(vi) Normal promotional and educational activities that are not

conditioned on the referral of business and do not involve the

defraying of expenses that otherwise would be incurred by persons in a

position to refer settlement services or business incident thereto;

(vii) A payment by an employer to its own bona fide employee for

generating business for that employer;

(viii) In a controlled business arrangement, a payment by an

employer of a bonus to a managerial employee based on criteria relating

to performance (such as profitability, capture rate, or other

thresholds) of a business entity in the controlled business

arrangement. However, the amount of such bonus may not be calculated as

a multiple of the number or value of referrals of settlement service

business to a business entity in a controlled business arrangement; and

(ix)(A) A payment by an employer to its bona fide employee for the

referral of settlement service business to a settlement service

provider that has an affiliate relationship with the employer or in

which the employer has a direct or beneficial ownership interest of

more than 1 percent, if the following conditions are met:

(1) The employee does not perform settlement services in any

transaction; and

(2) Before the referral, the employee provides to the person being

referred a written disclosure in the format of the Controlled Business

Arrangement Disclosure Statement, set forth in Appendix D to this part.

(B) For purposes of this paragraph (g)(1)(ix), the marketing of a

settlement service or product of an affiliated entity, including the

collection and conveyance of information or the taking of an

application or order for an affiliated entity, does not constitute the

performance of a settlement service. Under this paragraph (g)(1)(ix),

marketing of a settlement service or product may include incidental

communications with the consumer after the application or order, such

as providing the consumer with information about the status of an

application or order; marketing shall not include serving as the

ongoing point of contact for coordinating the delivery and provision of

settlement services.

* * * * *

5. Section 3500.15 is amended by revising the introductory text of

paragraph (b)(1), to read as follows:

Sec. 3500.15 Controlled business arrangements.

* * * * *

(b) * * *

(1) Prior to the referral, the person making a referral has

provided 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 person performing

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 no later than the time of each referral or, if

the lender requires the use of a particular provider, the time of loan

application, except that:

* * * * *

Sec. 350017 [Amended]

6. Section 3500.17 is amended as follows:

a. In paragraph (b), in the definitions of ``Aggregate (or)

composite analysis'' and ``Single-item analysis'', by removing the

reference ``Appendix F'' in the last sentence of each definition and

adding in its place the reference ``Appendix E''.

b. In paragraph (c)(1)(i), in the second sentence, by removing the

reference ``Appendix F'' and adding in its place the reference

``Appendix E''.

c. In paragraph (d)(1)(ii), in the last sentence, by removing the

reference ``Appendix F'' and adding in its place the reference

``Appendix E''.

7. Appendix B is amended by revising Illustration 11, redesignating

Illustrations 12 and 13 as Illustrations

[[Page 29253]]

13 and 14 respectively, and adding a new Illustration 12, to read as

follows:

Appendix B to Part 3500--Illustrations 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. A, B,

and C are subsidiaries of H, a holding company, which also controls

a retail stock brokerage firm, D. None of A, B, or C requires

consumers to purchase the services of its sister companies, and each

company sells such services separately and as part of the package. A

also pays an employee T, a full-time bank teller who does not

perform settlement services, a bonus for each loan, title insurance

binder, or closing that T generates for A, B, or C. A pays T these

bonuses out of A's own funds and receives no reimbursements for

these bonuses from B, C, or H. At the time that T refers customers

to B and C, T provides the customers with a disclosure using the

controlled business arrangement disclosure format. Also, Z, a

stockbroker employee of D, occasionally refers her customers to A,

B, or C; gives a statement in the controlled business disclosure

format; and receives a payment from D for each referral.

Comments: Selling a package of settlement services at a discount

is not prohibited by RESPA, consistent with the definition of

``required use'' in 24 CFR 3500.2. Also, A is always allowed to

compensate its own employees for business generated for A's company.

Here, A may also compensate T, an employee who does not perform

settlement services in this or any transaction, for referring

business to a business entity in an affiliate relationship with A.

Z, who does not perform settlement services in this or any

transaction, can also be compensated by D, but not by anyone else.

Employees who perform settlement services cannot be compensated for

referrals to other settlement service providers. None of the

entities in an affiliated relationship with each other may pay for

referrals received from an affiliate's employees. Sections

3500.15(b)(3)(i)(A) and (B) set forth the permissible exchanges of

funds between controlled business entities. In all circumstances

described a statement in the controlled business disclosure format

must be provided to a potential consumer at or before the time that

the referral is made.

12. Facts: A, a real estate broker, is affiliated with B, a

mortgage lender, and C, a title agency. A employs F to advise and

assist any customers of A who have executed sales contracts

regarding mortgage loans and title insurance. F collects and

transmits (by computer, fax, mail, or other means) loan applications

or other information to B and C for processing. A pays F a small

salary and a bonus for every loan closed with B or title insurance

issued with C. F furnishes the controlled business disclosure to

consumers at the time of each referral. F receives no other

compensation from the real estate or mortgage transaction and

performs no settlement services in any transaction. At the end of

each of A's fiscal years, M, a managerial employee of A, receives a

$1,000 bonus if 20% of the consumers who purchase a home through A

close a loan on the home with B and have the title issued by C.

During the year, M acted as a real estate agent for his neighbor and

received a real estate sales commission for selling his neighbor's

home.

Comments: Under Sec. 3500.14(g)(1), employers may pay their own

bona fide employees for generating business for their employer

(Sec. 3500.14(g)(1)(vii)). Employers may also pay their own bona

fide employees for generating business for their affiliate business

entities (Sec. 3500.14(g)(1)(ix)), as long as the employees do not

perform settlement services in any transaction and disclosure is

made. This permits a company to employ a person whose primary

function is to market the employer's or its affiliate's settlement

services (frequently referred to as a Financial Services

Representative, or ``FSR''). An FSR may not perform any settlement

services including, for example, those services of a real estate

agent, loan processor, settlement agent, attorney, or mortgage

broker. In accordance with the terms of the exemption at

Sec. 3500.14(g)(1)(ix), the marketing of a settlement service or

product of an affiliated entity, including the collection and

conveyance of information or the taking of an application or order

for the services of an affiliated entity, does not constitute the

performance of a settlement service. Under the exemption, marketing

of a settlement service or product also may include incidental

communications with the consumer after the application or order,

such as providing the consumer with information about the status of

an application or order; marketing may not include serving as the

ongoing point of contact for coordinating the delivery and provision

of settlement services.

Thus, in the circumstances described, F and M may receive the

additional compensation without violating RESPA.

Also, employers may pay managerial employees compensation in the

form of bonuses based on a percentage of transactions completed by

an affiliated company (frequently called a ``capture rate''), as

long as the payment is not directly calculated as a multiple of the

number or value of the referrals. 24 CFR 3500.14(g)(1)(viii). A

managerial employee who receives compensation for performing

settlement services in three or fewer transactions in any calendar

year ``does not routinely'' deal directly with the consumer and is

not precluded from receiving managerial compensation.

* * * * *

8. Appendix D is revised to read as follows:

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[GRAPHIC] [TIFF OMITTED] TR07JN96.001

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9. Appendix E is removed and Appendix F is redesignated as Appendix

E.

Dated: May 31, 1996.

Nicolas P. Retsinas,

Assistant Secretary for Housing-Federal Housing Commissioner.

[FR Doc. 96-14329 Filed 6-6-96; 8:45 am]

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