Bank Lawyer's Blog

RESPA: A Referral By Any Other Name...

Any mortgage originator understands that Section 8 of the Real Estate Settlement Procedures Act (12 USC 2607) clearly prohibits the payment of fees for the referral of a “settlement service” involving a federally related mortgage loan.  It seems simple enough, but, of course, where consumer protection laws, lawyers and bureaucrats intersect, the issue becomes much more complicated.

Over the past several years, clients have pointed us to numerous sites sponsored by mortgage loan originators who offer to establish online “affiliate” relationships with the owners of third party web sites. The affiliate posts a link on its web site to the loan originator’s web site, and is paid a fee for each potential borrower who “clicks through” the link to the loan originator’s site. The affiliate performs no other service in connection with the loan. Some originators pay a fixed fee for each click through. Informal discussion with HUD consumer compliance specialists, and guidance issued by HUD, indicate that such fees should be acceptable “advertising” rather than “referral” fees, assuming that the “affiliate” does nothing, directly or indirectly (for example, through the design, content or placement of the link itself) to “recommend” or “refer” potential borrowers to the specific loan originator. Payment of fees on a “per click-through” basis is common in the online advertising world (although this form of commission payment is becoming less popular). Also, HUD has stated that a web site operator can sell information about potential customers to various entities for marketing purposes and be compensated for selling these “leads.”

The risk of having the fee classified as a “referral fee” increases as modifications are made to these practices. For example, if an “affiliate” is compensated only when a loan closes, this more clearly appears to be compensation solely for the referral of business under long-standing HUD analysis, especially when the affiliate performs no other specific services in connection with the loan. How about payments only when the “click through” potential borrower submits a loan application? When the potential borrower gives personal contact information to the loan originator? The analysis becomes more complicated, and pat answers are beyond the scope of a blog entry. No loan originator, or “affiliate,” should enter into these arrangements without expert advice. RESPA provides potentially stiff penalties for both the “giver” and the “receiver” of illegal “referral fees.”

What truly amazes us is the continued use by some loan originators in the material that promotes their affiliate programs, of words that seem guaranteed to push HUD’s “hot button.” Typical is the following:

• “You refer customers to us through your unique affiliate links to our site.”
• “Lifetime commissions from your referrals.”

All the time, money and effort you spend to structure a RESPA-compliant affiliate program can be undermined through the use of such terms.  Dodging bullets from HUD is hard enough. Why have to dodge your own?
--- Kevin Funnell

A Fact About FACTA: Risk-Based Pricing Notices

The Fair and Accurate Credit Transactions Act of 2003 (“FACTA”), signed into law on December 9, 2003 by President Bush, made major changes to the Fair Credit Reporting Act (the “FCRA”). One of the changes that has received less publicity than other changes is the risk-based pricing disclosure requirement of Section 311 of FACTA.

Effective December 1, 2004, Lenders who use a “consumer report” (as defined under the FCRA) in connection with a loan to, or loan application from, a consumer, and, based in whole or in part on that consumer report, vary the “material” terms of credit to that consumer in a materially adverse manner from “the most favorable terms available to a substantial portion” of that lender’s consumers, must provide a notice to the consumer. The notice must inform the consumer that the terms offered are set based on information from a consumer report; identify the consumer reporting agency furnishing the report; inform the consumer that the consumer may obtain a copy of the report from a consumer reporting agency; and include contact information for the consumer reporting agency (including a toll-free number for the agency).

The “risk-based pricing” notice is intended to address cases where lenders vary the pricing terms of credit to consumers after the consumer applies for a loan, based on consumer credit reports. As noted below, it does not replace the “adverse action” notices already required by the FCRA in cases where a lender either denies credit or makes a counteroffer that is rejected by the consumer, based upon a consumer report.

The Federal Trade Commission and the Federal Reserve Board will jointly prescribe regulations concerning this notice that will address the form, content, time and manner of delivery of the notice; define such terms as “material credit terms” and “materially less favorable” credit terms; and adopt a model form of notice. Those regulations have not yet been proposed, although Section 311 of FACTA requires the adoption of the model form of notice by the FTC and the FRB no later than 6 months following the date of enactment of FACTA. Therefore, we should see this form prior to the second week of June.

With respect to timing of the notice, Section 311 of FACTA does provide that, except as provided in the FTC/FRB regulations, the lender will have the option of providing the notice at the time of the application or at the time of approval. Because of the uncertainty of determining precisely what are “material” loan terms and what loan terms are “materially less favorable,” many lenders may opt to “playing it safe” by giving the notice in connection with all loan applications, or, at least with all approval letters.

Lenders are familiar with the existing provisions of Section 615 of the FCRA, which require specific disclosures in connection with “adverse action” notices whenever a lender uses a credit report to either deny credit, or to make a counteroffer to the credit applicant that is rejected. The notice required by Section 311 of FACTA cannot be used to satisfy the requirement with respect to an “adverse action” notice. On the other hand, a lender is not required to send the Section 311 notice if it has or will send the required adverse action notice.

The notice would also not have to be sent if a consumer applies for specific material terms and is granted those specific terms (for example, in connection with a pre-screened credit offer that is accepted), except where those material terms were initially specified by the lender after the consumer “initiates the transaction” (applies for the loan or responds to a pre-screened credit offer) and after the lender obtained a credit report.

The dark cloud of additional consumer regulation does have its silver lining. Only administrative enforcement by the appropriate federal banking agency will be permitted. No civil liability action is otherwise applicable. A lender will not be liable for failure to give the notice if it “maintained reasonable policies and procedures to comply” with this requirement, or the lender “reasonably believed” that it is prohibited by law from contacting the consumer. Finally, this federal law pre-empts any state law attempting to regulate the same subject matter.
---Kevin Funnell

The Good (Bad) Old Days

We've noticed over the last couple of years that there has been a "hardening" of the attitudes of the federal banking regulators toward some banks and thrifts that are operating in a manner other than a traditional "mom and pop," "plain vanilla" commercial bank or savings and loan. In some cases, profitable banks and thrifts (in a couple of instances, very profitable institutions), with excellent capital levels and earnings, and with no serious regulatory concerns raised in previous examinations, have suddenly, and without warning, been confronted with hostile and overbearing directives from federal banking regulators that seriously impede their ability to conduct their business in the normal course. In some cases, specific regulations have been cited as the basis for supervisory directives; however, in most instances the regulators have initially relied upon, or eventually fallen back upon, general, and vague, "safety and soundness" concerns. As any banker knows, trying to discuss in a logical fashion, using sound business analysis, "safety and soundness" issues with regulators can be a trip with Alice through the looking glass. The owner of one very successful institution became so exasperated with the lack of rational explanation for the regulatory concern that he decided to liquidate his institution, take his considerable millions of dollars in capital, and conduct his future business endeavors in a rational environment.

What's going on? Conversations with sources within some of the regulatory agencies confirm that the attitude of the agencies is in many important respects akin to the late 1980's and early 1990's, when they were coping with the savings and loan and commercial banking failures of massive proportions. Perhaps it has to do with the corporate scandals of recent years and the desire to avoid the same outbreak. For example, examiners of some institutions have been examining the board of directors' minutes to make certain that all meetings required by the bank's bylaws are being held as often as required by, and in compliance with, the bylaws. Holding companies, even those that are simply "shells" that own only one bank or thrift and conduct no other activities, are being criticized for transactions that impair the holding company's capital (not the bank's capital). This is particularly curious with respect to thrift holding companies regulated by the Office of Thrift Supervision, which, unlike bank holding companies, do not have a regulatory-mandated capital requirement. In addition, business plans that are out of the ordinary in any respect, even those that have been previously approved and have been successfully implemented for years, are being challenged.

We can all speculate on where this will lead. Our bet, based upon our personal experiences, is that intelligent capital, particularly capital deployed by those with an entrepreneurial bent, will avoid the national thrift or bank charter as long as this regulatory attitude persists. Others, who wish to continue to play the game, will do what smart financial institution managers always do when confronted with these bouts of irrationality: remain calm, act humble, accommodate what they can and take a stand where they reasonably cannot, and ride the top of the wave until it washes against the shore. This is just another cycle to be played out until it comes around again.
--- Kevin Funnell