Office of the Assistant Secretary for Housing-Federal Housing Commissioner; Real Estate Settlement Procedures Act (RESPA); Statement of Policy 1996-1, Regarding Computer Loan Origination Systems (CLOs)

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

24 CFR Part 3500

[Docket No. FR-3638-N-03]

Office of the Assistant Secretary for Housing-Federal Housing

Commissioner; Real Estate Settlement Procedures Act (RESPA); Statement

of Policy 1996-1, Regarding Computer Loan Origination Systems (CLOs)

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

Commissioner, HUD.

ACTION: Statement of Policy 1996-1: Computer Loan Origination Systems

(CLOs).

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SUMMARY: This Statement of Policy sets forth the Department's

interpretation of Section 8 of the Real Estate Settlement Procedures

Act (RESPA) and its implementing regulations with regard to the

applicability of RESPA to payments for services from certain computer

systems, frequently called CLOs, used by settlement service providers

in connection with the origination of mortgage loans or the provision

of other settlement services covered by RESPA. This statement explains

the statutory and regulatory framework for HUD's treatment of payments

to CLOs.

In reading this policy statement, the reader should be aware that

HUD's RESPA rule was recently streamlined through a separate

rulemaking. 61 FR 13232 (Mar. 26, 1996). This streamlining caused

several provisions of the RESPA rule to be renumbered. Except as is

otherwise indicated in the context of the policy statement, this policy

statement refers to provisions by their current section number,

incorporating all revisions to date as a result of the streamlining and

today's rulemaking, published elsewhere in the Federal Register.

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: Individuals and firms have developed and are

developing various systems that employ computer technology to assist

consumers in finding a lender, selecting a mortgage product,

originating a mortgage, or choosing among other settlement service

providers and products. These systems are sometimes called computer

loan origination systems (hereafter ``CLOs''), although other

terminology may be used, such as computer loan information systems.

These systems differ in the way they interact with consumers, in the

way they collect and display information on mortgage options, in the

range of choices of products and services they provide to consumers,

and in the extent to which they share work with other providers in the

settlement service process. HUD expects product diversity to increase

as technology evolves and new telecommunication options become

available.

The following exemption was set forth in the November 2, 1992 final

rule, effective December 2, 1992: Section 8 of RESPA does not prohibit

* * * any payment by a borrower for computer loan origination services,

so long as the disclosure set forth in Appendix E of this part is

provided to the borrower. 24 CFR 3500.14(g)(2)(iii).

This exemption from Section 8 was for ``any payment by a borrower

for computer loan origination services,'' as long as certain

disclosures were provided. This rule did not address payments made by

lenders, thus leaving such payments subject to Section 8 scrutiny.

Although the term ``CLO exemption'' is frequently used, including in

the preamble of the 1992 final rule, the exemption was not for the CLO

itself, but only for payments made for CLO services by borrowers. The

1992 final rule did not speak to other issues; notably it did not

define a CLO or explain how RESPA applies to payments by lenders to

CLOs for CLO services. The November 2, 1992 rule also withdrew all

previous informal legal opinions, including those stating the

Department's views on various CLO issues.

In response to numerous expressions of concern about the new

exemption and other aspects of the revised regulations, HUD requested

public comments in a Federal Register Notice on July 6, 1993, and held

public hearings on August 6, 1993.

On July 21, 1994, HUD issued proposed regulations that would repeal

the general CLO exemption for borrower payments and, in its place,

establish an exemption for borrower payments to certain ``qualified

CLOs'', that is, CLOs having characteristics that HUD considered

beneficial to consumers. The proposed exemption would apply only to

payments by borrowers, but HUD did solicit public comments on whether

to provide a similar exemption for payments by lenders to qualified

CLOs. Under the proposed rule, payments by borrowers to CLO systems

that did not qualify for the exemption were subject to scrutiny under

section 8 of RESPA. HUD also invited those with active CLOs or those

developing CLOs to demonstrate their systems at a Technology

Demonstration Fair on September 30, 1994. Twenty-one CLO operators

accepted the invitation and participated in this all-day demonstration

in Washington, D.C.

The public comments in response to the proposed rule raised a

number of specific questions about the proposed exemption for payments

to qualified CLOs, and generally displayed skepticism or uncertainty

about the usefulness of the proposal. Concerned that the comments did

not adequately address all the issues, HUD held two informal meetings

with industry and consumer groups to seek additional individual input

on the likely future development of CLOs. These meetings were held on

August 11, 1995, and September 21, 1995. While HUD learned many things

from the public comments and the meetings with industry and consumer

groups, one message seemed to predominate. All parties wanted clearer

guidance from HUD on how RESPA's disclosure and anti-kickback

provisions apply to borrower and lender payments for CLO services.

Both the 1992 and the proposed 1994 exemptions for borrower

payments to CLOs were offered because of concern that uncertainty about

how RESPA applied to payments to CLOs might be impeding the development

or use of potentially beneficial technology. However, by limiting the

exemptions to borrower payments, in both cases, HUD did not address the

primary issue of how RESPA's anti-kickback provisions applied to lender

payments to CLOs.

Many participants in the informal meetings urged that it was

impossible to

[[Page 29256]]

create a useful safe harbor or exemption for ``qualified CLOs'',

because changes in technology and in its use in the market would

repeatedly make that safe harbor obsolete. CLO service providers would

take their chances of running afoul of RESPA, rather than develop

systems to meet the ``qualified CLO'' criteria. More helpful, many

participants argued, would be if HUD explained clearly how RESPA's

anti-kickback prohibitions and disclosure requirements applied to

various sorts of CLO payments.

After considering the public comments and informal meetings, HUD

has decided: (1) To eliminate the exemption for borrower payments to

CLOs and the associated disclosure; (2) to abandon the idea of

establishing a similar or broader exemption for qualified CLOs; and (3)

to issue this policy statement to help those developing and using CLOs

to understand better how RESPA applies to their activities.

HUD does not think it is useful to continue a modest exemption or

to develop a separate and elaborate regulatory structure for a still

emerging industry. However, clarification of certain matters in the

form of a policy statement would be useful to the industry and

consumers. The effect of this action is to subject payments to CLOs to

the same RESPA provisions as payments for any other service; however,

HUD is providing specific guidance on how HUD will apply these

provisions in the CLO context.

Today HUD is simultaneously issuing a revision to the 1992 rule.

The preamble to this new final rule contains a fuller discussion of the

decision- making process leading from the November 2, 1992 rule to the

withdrawal of the exemption and the issuance of this guidance.

To the extent this guidance interprets rules that become effective

120 days from the date of this publication, then this guidance will be

applicable as of the effective date of such rules.

Statement of Policy--1996-1

To give guidance to interested members of the public on the

application of RESPA and its implementing regulations to these issues,

the Secretary, pursuant to Section 19(a) of RESPA (12 U.S.C. 2617(a))

and 24 CFR 3500.4(a)(1)(ii), hereby issues the following statement of

policy.

For purposes of this statement of policy, a CLO is a computer

system that is used by or on behalf of a consumer to facilitate a

consumer's choice among alternative products or settlement service

providers in connection with a particular RESPA-covered real estate

transaction. Such a computer system: (1) may provide information

concerning products or services; (2) may pre-qualify a prospective

borrower; (3) may provide consumers with an opportunity to select

ancillary settlement services; (4) may provide prospective borrowers

with information regarding the rates and terms of loan products for a

particular property in order for the borrower to choose a loan product;

(5) may collect and transmit information concerning the borrower, the

property, and other information on a mortgage loan application for

evaluation by a lender or lenders; (6) may provide loan origination,

processing, and underwriting services, including but not limited to,

the taking of loan applications, obtaining verifications and

appraisals, and communicating with the borrower and lender; and (7) may

make a funding decision.

This definition is not meant to be restrictive or exhaustive; it

merely attempts to describe existing practices of service providers.

With the use of technology evolving so rapidly, however, it is

difficult for the Department to provide guidance on future unspecified

practices in the abstract.

This statement of policy provides guidance on how RESPA applies to

service providers and interprets existing law. It does not add any new

restrictions on business practices.

Section 3 of RESPA defines ``settlement services'' to include:

[A]ny service provided in connection with a real estate

settlement including, but not limited to * * * the origination of a

federally related mortgage loan (including, but not limited to, the

taking of loan applications, loan processing, and the underwriting

and funding of loans), and the handling of the processing, and

closing or settlement. 12 U.S.C. 2602(3).

The regulations define a ``settlement service'' to mean ``any

service provided in connection with a prospective or actual

settlement.'' 24 CFR 3500.2. This definition specifically includes the

providing of any services related to the origination, processing, or

funding of a federally-related mortgage loan. 24 CFR 3500.2. To the

extent that a CLO performs ``settlement services'', it is a settlement

service provider. Conversely, if a CLO does not perform settlement

services, it is not a settlement service provider.

NOTHING IN THIS POLICY STATEMENT SHOULD BE READ AS A HUD

ENDORSEMENT OF ANY CHARGE TO CONSUMERS OR AS A REQUIREMENT FOR ANY

CHARGE TO CONSUMERS.

1. Payments by Consumers to CLOs

CLOs that provide services to consumers may charge consumers for

services performed. 12 U.S.C. 2607(c)(2). RESPA requires that all

charges for settlement services be reported on the Good Faith Estimate

and the HUD-1 or HUD-1A; however, the regulations do not address the

exact timing of the payment. 12 U.S.C. 2603(a) and 2604(c). Similarly,

any payment for CLO services that is paid outside of closing must be so

identified on the HUD-1 or HUD-1A settlement statement. 24 CFR 3500,

App. A, General Instructions. In addition, settlement service providers

whose products are made available on CLOs may reimburse consumers for

any fee charged them by the CLO.

2. Payments by Settlement Service Providers to CLOs

Section 8(a) of RESPA prohibits payments for the referral of a

consumer to a settlement service provider; however, Section 8(c)(2)

permits payments for goods or facilities actually furnished or for

services actually performed. 12 U.S.C. 2607(c)(2).

The definition used in this policy statement encompasses various

types of CLOs. Regardless of the type of CLO, compensable goods,

facilities, or services must be provided by the CLO in return for

payments by settlement service providers. Any such payment must bear a

reasonable relationship to the value of the goods, facilities, or

services provided. 24 CFR 3500.14(g)(2). A charge for which no or

nominal services are performed or for which duplicative fees are

charged is an unearned fee. 24 CFR 3500.14(c). For example, if a CLO

lists only one settlement service provider and only presents basic

information to the consumer on the provider's products, then there

would appear to be no or nominal compensable services provided by the

CLO to either the settlement service provider or the consumer, only a

referral; and any payment by the settlement service provider for the

CLO listing could be considered a referral fee in violation of section

8 of RESPA. Note, however, that a new provision of HUD's RESPA rules at

24 CFR 3500.14(g)(1)(ix), discussed at Section 4 below, allows

employees who do not perform settlement services to market settlement

services or products of an affiliated entity and to receive employer

payments for these referrals. A company may not pay any other company

for the

[[Page 29257]]

referral of settlement service business. 24 CFR 3500.14(b).

RESPA places no restrictions on the pricing structure of CLOs as

long as the payments are not referral fees and are reasonably related

to the value of the services provided. However, the value of a referral

is not to be taken into account in determining whether the payment

exceeds the reasonable value of the goods, facilities, or services. 24

CFR 3500.14(g)(2). If these requirements are met, CLOs may charge

settlement service providers a fixed or periodic fee or a fee for each

closed transaction arising from the use of the CLO. However, if a CLO

charges different fees to different settlement service providers in

similar situations, an incentive may exist for the CLO to steer the

consumer to the settlement service provider paying the highest fees.

HUD may scrutinize these circumstances to determine if the

differentials constitute referral fees.1

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\1\ Depending upon the circumstances of the referrals and the

design of the CLO system, this steering of consumers may violate the

Fair Housing Act, as may selective marketing of CLO systems.

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Settlement service providers may pay CLOs a reasonable fee for

services provided by the CLO to the settlement service provider, such

as, having information about the provider's products made available to

consumers for comparison with the products of other settlement service

providers. If a CLO elects to act as a mortgage broker, as that term is

defined in 24 CFR 3500.2, then all RESPA rules related to compensation

of mortgage brokerage services apply to the CLO. On December 13, 1995,

HUD convened a negotiated rulemaking that could result in changes to

these RESPA rules. CLOs should review carefully any changes in the

regulations applicable to mortgage brokers and others that result from

this rulemaking.

3. CLOs in a Controlled Business Context

When a CLO is used in a controlled business arrangement, the RESPA

regulations relating to controlled business arrangements apply. Section

3(7) of RESPA (12 U.S.C. 2602(7)) defines a controlled business

arrangement in terms of an affiliate relationship or a direct or

beneficial ownership. The regulations provide definitions of affiliate

relationship, beneficial ownership, and direct ownership. 24 CFR

3500.15(c). Separate entities are a necessary component of the

controlled business arrangement definitions. For example, if a real

estate brokerage firm uses a CLO within its own business structure and

there is no separate affiliated business entity involved, then the CLO

is not being used in a controlled business arrangement with the real

estate brokerage firm.

A controlled business arrangement does not violate RESPA if three

conditions are met. 12 U.S.C. 2607(c)(4)(A)-(C). Section 3500.15(b) of

the regulations elaborates on the three requirements. First, when

consumers are referred from one business entity to an affiliated

business entity, a written disclosure of the affiliate relationship

must be provided. For example, if a real estate firm has an affiliate

relationship with a company providing CLO services and an agent of the

real estate firm refers a customer to the CLO company, then the real

estate agent must provide the required disclosure to the customer at

the time of the referral. Similarly, if the CLO company has an

affiliate relationship with one of the settlement service providers

listed on the CLO, then the CLO operator must provide the customer with

the required disclosure before the consumer uses the CLO. Second there

can be no required use, i.e., the referring entity cannot require the

consumer to use the CLO and the CLO cannot require the consumer to use

an affiliated company listed on the CLO. Thirdly, the only thing of

value that is received by one business entity from other business

entities in the controlled business arrangement, other than payments

permitted under 24 CFR 3500.14(g) for services actually performed, is a

return on an ownership interest or franchise relationship.

4. Payments of Commissions or Bonuses to Employees

CLOs are subject to the same RESPA provisions regarding employee

compensation as any service provider. For example, a settlement service

provider listed on the CLO may not pay a CLO employee a referral fee or

commission if the consumer selects that settlement service provider. 24

CFR 3500.14(b). Employees of a CLO may receive a bona fide salary or

compensation from the CLO--their employer. 24 CFR 3500.14(g)(1)(iv).

Compensation from CLOs to their employees may include commissions for

transactions closed on the system. 24 CFR 3500.14(g)(1)(vii). However,

if a CLO pays commissions for transactions closed with some settlement

service providers but not for transactions closed with other settlement

service providers, HUD may scrutinize these payments to determine if

the commissions constitute referral fees or are exempt under other

provisions (see below).

HUD established two new exemptions related to compensation of

employees in a final rule published today and effective 120 days from

their publication. The first exemption (24 CFR 3500.14(g)(1)(viii))

allows an employer to pay managerial employees who do not routinely

deal with the public bonuses related to the referral of settlement

service business to a business entity in a controlled business

arrangement. The CLO employee who routinely deals with customers is not

considered a managerial employee within the meaning of 24 CFR 3500.2. A

CLO may have managerial employees within the meaning of 24 CFR 3500.2,

such as a district manager who oversees several CLO operators who work

in different locations. Such a managerial employee may receive bonuses

based on criteria related to the performance of a business entity in an

affiliate relationship, such as profitability, capture rate, or other

thresholds. However, the amount of such bonus may not be calculated as

a multiple of the number or value of referrals of settlement services

business to a business entity in a controlled business arrangement. 24

CFR 3500.14(g)(1)(viii).

The second exemption (24 CFR 3500.14(g)(1)(ix)) allows employer

payments to their own bona fide employees for referrals of business to

affiliated entities if the employee does not perform settlement

services in any transaction and provides the consumer with a written

disclosure in the format of the Controlled Business Arrangement

Disclosure Statement. Employer payments to a CLO employee who does not

perform settlement services may qualify for this exemption. This

exemption permits employer payments to employees who do not perform

settlement services for referrals to affiliates. Under this exemption,

the employee may market a settlement service or product of an

affiliated entity, including collecting and conveying information and

taking an application or order for the services of an affiliated

entity. Marketing 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. Under

the exemption, a CLO employee who takes an application and collects

information for an affiliate but performs no other settlement services,

may receive a payment from his or her

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employer for a referral to an affiliated entity.

5. Neutral Display of Information on Settlement Service Providers and

Their Products

Section 8(a) of RESPA prohibits compensated referrals. HUD may

scrutinize non-neutral displays of information on settlement service

providers and their products because favoring one settlement service

provider over others may be affirmatively influencing the selection of

a settlement service provider which could constitute a referral under

RESPA. 24 CFR 3500.14(f). An agreement or understanding for the

referral of business incident to or part of a settlement service may be

established by a practice, pattern, or course of conduct. 24 CFR

3500.14(e). For example, if one lender always appears at the top of any

listing of mortgage products and there is no real difference in

interest rates and charges between the products of that lender and

other lenders on a particular listing, then this may be a non-neutral

presentation of information which affirmatively influences the

selection of a settlement service provider. Furthermore, if there is an

affiliate relationship between the CLO and a favored settlement service

provider, the non-neutral presentation of information under certain

circumstances could constitute a required use in violation of

3500.15(b)(2). This guidance on neutral displays should not be read to

discourage CLOs from assisting consumers in determining which products

are most advantageous to them. For example, if a CLO consistently ranks

lenders and their mortgage products on the basis of some factor

relevant to the borrower's choice of product, such as APR calculated to

include all charges and to account for the expected tenure of the

buyer, HUD would consider this practice as a neutral display of

information.

Authority: 12 U.S.C. 2617; 42 U.S.C. 3535(d).

Dated: May 31, 1996.

Nicolas P. Retsinas,

Assistant Secretary for Housing-Federal Housing Commissioner.

[FR Doc. 96-14330 Filed 6-6-96; 8:45 am]

BILLING CODE 4210-27-P