POSITIVE DEVELOPMENTS FOR AFFILIATED BUSINESS ARRANGEMENTS

BY STANLEY M. GORDON OF GORDON & ASSOCIATES Stan@SGordonlegal.com February 19, 2014

The Dodd Frank Act, still in the process of being implemented through the regulations of the Consumer Finance Protection Bureau (CFPB), has dramatically reshaped the business model and practices of the mortgage banking and brokerage industry. Most of the attention has been on Qualified Mortgages (QM), Qualified Residential Mortgages (QRM), loan officer compensation rules, effective as of January 2014, and the new integrated mortgage disclosures, effective in August of 2015. However, little notice has given to the fact that Dodd Frank indirectly, and without debate or analysis, put the continued viability of Affiliated Business Arrangements (AFBAs) at risk. Nevertheless, the CFPB is moving in the direction of minimizing this risk while it considers the arguments of interested parties on whether AFBAs should be in the disadvantaged position that they are under Dodd Frank. At the same time, efforts still continue to remedy this through proposed amendments to Dodd Frank. These Congressional efforts will extend well into 2014, whereas the problem for AFBAs under Dodd Frank became operational in January of 2014. On the litigation front, in November of 2013 there was a recent litigation development in federal court which may signal a reversal to the trend of class action challenges to the legitimacy of an AFBA. The Court of Appeals for the Sixth Circuit determined that HUDs 10 point Policy Statement on what it considers in determining if an AFBA is legitimate, was an impermissible regulatory action. This ruling was based on the fact that RESPA (the Real Estate Settlement Procedures Act, 12 USC 2601 et. seq.) creates criminal liability; and, therefore, the Policy Statement is not valid as it adds requirements beyond the specified safe harbor provisions in RESPA for AFBAs. Some brief background on AFBAs is in order to fully appreciate the meaning of the developments mentioned above. AFBAs primarily exist in the context of a large real estate brokerage company or a major home builder. The AFBA is usually a mortgage banker or broker, and there is often a title insurance agency and a homeowners insurance agency as part of the affiliated group of companies. AFBAs have been an essential source of income for the larger real estate brokerage companies because of the shrinking company dollar from real estate sales commissions alone. During the course of various state and federal legislative and regulatory skirmishes between the interested parties over the years, there has been no credible evidence of any lesser quality of service or higher costs to the consumer arising from the use of AFBAs. There is,

however, an issue of reverse competition wherein the real estate sales agent is the focus of marketing and competition to have them select these services. Since the homebuyer engages in few and infrequent real estate purchases, they have little knowledge in this area and frequently rely on their real estate sales agent to direct them to these service providers. Notwithstanding the reverse competition issue and claims by detractors of higher prices and a lesser quality of service, a large number of consumers have expressed their satisfaction with using AFBAs and prefer the one stop shopping experience in their real estate transaction. With regards to Dodd Frank, when it was being adopted there was no focus on whether the law on AFBAs should be changed or whether there was any problem with them in terms of mortgage originations. However, in defining what was included in calculating the three percent points and fees limit for a QM, Dodd Frank utilized the concept from the high cost loan provisions of Truth in Lending (TIL) which adds in the fees and charges retained by affiliates of the lender for its APR calculations. Historically this inclusion was not material since the tolerances before a mortgage was deemed to be high cost were fairly high. However, the inclusion of the fees and charges of the lenders affiliates involved with the origination of a QM, particularly the title fees of the buyer and the seller, can cause the three percent points and fees limit to be exceeded for many loans up to $250,000 (although there are adjustments in Dodd Frank for loans under $100,000). As a result of the inclusion of the affiliate fees for QM loans, lenders with affiliated title companies were facing the prospect, as of January 2014, of having to close or otherwise divest their title agency. The problem is more severe for the real estate brokerage organization which owns a mortgage company and a title agency, and possibly an insurance agency, since they rely on that additional income as well as the efficiencies that arguably exist from AFBAs. The same issues exist as to the homebuilders which have AFBAs, although the sale of homes is more profitable than real estate brokerage. There has been a concerted effort by the National Association of Realtors, the Mortgage Bankers Association, the National Home Builders Association, the Real Estate Settlement Providers Organization and other groups to remedy this AFBA problem through proposed amendments to Dodd Frank. The approach is to amend the points and fees definition in QM to exclude title fees and costs from inclusion from the three percent points and fees limit. However, there is political opposition to this proposal, which is complicated by the fact that efforts to amend Dodd Frank in any respect, to date, have been resisted by the Democrats and consumer groups. Nevertheless, there is a reasonable expectation that both houses of Congress will favorably act on the AFBA proposals in 2014. Key to progress on preserving AFBAs related to mortgage originations is the recent interest expressed by the CFPB to learn more about this issue. After repeatedly stating that it could not regulate around the specific provisions of Dodd Frank regarding AFBAs fees and QM loans, the CFPB appears to be willing to consider the merits of this issue. A significant step that the CFPB has taken on this is to clarify that only the fees retained by the lenders AFBA, as opposed to those passed on to the underwriter in the case of title insurance, need to be included in the three percent calculation for QM loans. 2

This is an interim and partial relief for those affected by the AFBA problem. Counting only the fees retained by the AFBA for QM purposes may enable more of them to participate in QM loans originated by their owner or affiliate; hence, the existence of these AFBAs and their current ownership relationships have a better chance of continuing pending further Congressional action in this area. In this regard, the CFPB has also asked for more data and information on AFBAs. It is the hope of the advocates for an amendment to Dodd Frank on this issue that the CFPB will be favorable, or at least neutral, to the proposed amendment of Dodd Frank when asked by Congress for its opinion. The other positive development for AFBAs is the above mentioned decision by the Sixth Circuit of the Federal Court to set aside HUDs Policy Statement on sham AFBAs. Although this decision is not binding on other parts of the country, it is a clear indication that HUDs Policy Statement, and similar regulations or interpretations forthcoming by the CFPB on AFBAs, as HUDs successor on RESPA enforcement, should not be utilized by plaintiffs challenging the validity of an AFBA. From the courts point of view, as long as the AFBA at issue was providing some settlement services, and the other AFBA requirements were being followed, such as giving the disclosure, then it was not proper to inquire further into the validity of the AFBA, as is done by the HUD Policy Statement. The court found that since RESPA has criminal penalties that its AFBA requirements should be interpreted narrowly. Hence, the court noted that the deference normally accorded to the regulators interpretation of a statute is not applicable, as such regulations can expand upon the definition of the criminal conduct set forth in the statute itself. This decision is a favorable development for those defending challenges to AFBAs, which are more likely to occur in a class action context. Nevertheless, it is doubtful that the CFPB will refrain from taking action against what it considers to be sham AFBAs that provide minimal services for which they are clearly overpaid. Additionally, the CFPB has additional authority beyond RESPA for unfair or deceptive practices which it may use to address such business operations. In conclusion, the actions of the CFPB on the three percent QM points and fees issue, as well as the federal court decision narrowing challenges to the viability of an AFBA, give some hope that AFBAs related to mortgage companies can remain as a viable business methodology. The decision limiting regulatory expansion of the requirements for AFBA compliance, although not binding on federal district courts outside of the Sixth Circuit, is a welcome development that defenders of AFBAs can cite in resisting legal challenges.