From the March 2004 issue of Investment Advisor • Subscribe!

Mortgage Mess

Are you helping clients obtain mortgages? That's great--but you'd better be aware of some tough federal rules

Over the past few years, numerous advisors, independent broker/dealers, and brokers have formed relationships with mortgage lenders to help serve their clients better and pull in some extra cash. But not all of these relationships are on the up and up. As a result, some advisors may be violating Section 8 of the federal Real Estate Settlement Procedures Act (RESPA), exposing themselves to large fines and even imprisonment.

John Jacobs, an attorney with Maddin, Houser, Wartell, Roth & Heller, P.C. in Southfield, Michigan, has been representing mortgage companies for 30 years. He says he knows of quite a few cases where mortgage lenders and advisors are walking a thin line in complying with the law. Mortgage lenders pay fees to some advisors in return for referring clients, he says. Under RESPA, that's a no-no. Jacobs says he's gotten numerous phone calls from mortgage companies asking him how to go about compensating advisors for referrals, "and each time, the [lender's current referral] structure poses significant problems."

RESPA is enforced by the U.S. Department of Housing and Urban Development (HUD). It is a consumer protection statute that "requires that consumers receive disclosures at various times in the transaction and outlaws kickbacks that increase the cost of settlement services," according to an explanation provided on the RESPA home page (www.hud.gov:80/offices/hsg/sfh/res/respa_hm.cfm).

Indeed, Section 8 of RESPA "prohibits the payment of a referral fee kickback, or 'thing of value', for the referral of the mortgage loan," Jacobs says. "Thing of value" is broadly defined, he says, but usually means trips and gifts other than money. The two exceptions to this prohibition, Jacobs says, are that the mortgage company can pay commissions to its employees, and that the mortgage company "can pay reasonable compensation for substantial services provided."

Jacobs says HUD has never issued a statement on "what it takes to be an employee" in these types of arrangements. The only decree related to this issue that it has made, he says, is that HUD "is not going to accept a sham."

What's a Fee?

"For example, say there's an arrangement where a mortgage company leases space in a realtor's office; [HUD] has said, 'if it's a real lease, that's fine.' But if you're paying substantially above market value for rent, then you're paying a referral fee." Another instance would be "simply referring one mortgage loan a year and being paid a payroll check for it and getting a W-2," he says. "Without having any other contact with the [mortgage] company, I don't believe that qualifies as an employee."

David Peskin, CEO of Vertical Lend, a mortgage lender in Melville, New York, says he knows there are "kickbacks going on" among mortgage lenders and advisors. And not only are advisors and brokers being illegally compensated, he says, but mortgage lenders are sometimes paying "a marketing fee" to the company that the advisor or broker works for. "A mortgage company cannot pay a company to do a loan; they have to pay an individual to act as a loan officer," Peskin says. It's legal to pay a "marketing fee" to an advisor or broker "as long it's not based on the outcome of the loan," Peskin says. But "a lot of mortgage companies are basing the fee on the outcome."

An advisor or broker must be an employee of the mortgage company--either full- or part-time--to receive compensation for a referral, Peskin says. That is the way his firm's program is set up. And the advisor can only do business with one mortgage company at a time.

But another common setup would be illegal: A planner calls a mortgage company and says he's going to have a client call the lender about a loan. After receiving the call, the lender then goes ahead and processes the loan and sends the advisor a check. "That's a complete violation of RESPA," Peskin says. Why? Because "RESPA states that the planner has to participate in the mortgage origination," adds Jeff Tubbs, a planner with Wealth Management Group in South Lion, Michigan.

Section 8 of RESPA identifies 14 different activities that take place in a mortgage origination; of those 14, the advisor must participate in five. "If there is a [mortgage lending] program in which [an advisor] is getting paid for doing little or nothing, that's a cause for concern," says Robert Foregger, COO of Everbank in Jacksonville, Florida, which has a mortgage lending program for advisors. And that includes providing "consulting-type activities," says planner Tubbs, in which the advisor merely says: "I told my client what a 15-year or 30-year mortgage is," and that's it. An advisor or broker must take the client's mortgage application, fill it out, decide which loan program is best for the client--typical tasks that are performed by a loan officer. However, attorney Jacobs adds that many states, including Michigan, require an advisor or individual broker to be a licensed mortgage broker before performing any of these tasks. "If all you do is take the application and perform the services and you're paid a fee when you refer that application to the mortgage lender, you must be a licensed mortgage broker under [many] state laws."

Background Checks

Peskin says advisors performing loan services don't have to go it alone, because Vertical Lend assigns an account executive to each advisor to help walk them through the loan process. Advisors who participate in Everbank's mortgage program, meanwhile, become part-time employees of the bank, Foregger says, and must go through a training process. "We do background checks and credit checks," Foregger says. "Once [the advisors] are trained and ready to go, we provide them with access to our automated compliance system, which is a full-service software module that ensures they do all of the required steps in the mortgage origination process. That's critical." Since starting its banking and mortgage programs nine months ago, 1,000 advisors have signed up. "We have built a rigid program that ensures compliance with RESPA," Foregger says. "There are mortgage companies that are 'riding the fine line' when it comes to complying with RESPA. "But I don't think it's an advisor issue; I think it's a broad mortgage issue."

But Larry Papike, president of Cross-Search, a broker/dealer recruiting firm in San Diego, says he wouldn't be surprised if brokers are violating RESPA. He notes that brokerage firms have no way to regulate the mortgage activity performed by brokers because it's considered an outside business activity. Brokers have been "looking for avenues to make money, and tons of them jumped into this mortgage business" over the past few years, Papike says. "There's no telling what the heck [the brokers] are doing."

The bottom line for advisors and brokers when referring clients to a mortgage broker is to "be aware of Section 8 of RESPA," Jacobs says. If the advisor violated Section 8, there could be stiff penalties. For each violation, Jacobs says, the advisor can be "fined up to $10,000 or imprisoned for one year, or both," he says. In addition, "for receiving the fee, the advisor can be liable for the return of the fee together with attorneys' fees."

Ready for a Class Action Suit?

The advisor could even face a class action lawsuit, in which a borrower sues on behalf of himself and everyone else who was referred by him. More importantly, Jacobs says, the "[borrowers] can recover their actual attorney fees." And the mortgage company can actually lose their license, adds Vertical Lend's Peskin.

It's imperative that advisors wishing to get involved with mortgages "make sure the company has really identified and understands the rules and regulations," Peskin says. If the company is "looking for ways to get around" the rules, he says--"meaning they haven't put any attorneys behind" their program--"then it's bad for everybody." Advisors must "consult with legal counsel that specializes in RESPA to ensure that their arrangement is not known as a sham as defined by RESPA," adds planner Tubbs. Another piece of advice: "Make sure you're getting compensated on [the services you performed] on the loan." And if the mortgage company allows the advisor to charge any fee that they want to the client, "there's a good chance [the advisor will] end up violating RESPA, especially if [he's] not doing any work," Peskin says. "Charging a higher rate in the end doesn't benefit the client. That's where a lot of the high-cost loans come in." Vertical Lend's program gives advisors a set referral fee no matter what rate they charge the client, Peskin says.

HUD Gets Involved

You may be wondering how HUD would know that the advisor didn't do any work on a loan. Peskin says HUD could investigate a mortgage company and "look at who signed all of the disclosures, meaning the loan officer," he says. And HUD could also "contact the clients and ask who represented them."

Adding mortgages to your stable of services can significantly enhance your bottom line, as well as provide a valuable service to your clients. And from a competitive standpoint, with accounting firms and banks having already jumped on the mortgage bandwagon, advisors can't afford to let the opportunity to originate mortgages pass them by. But take special care in making sure the mortgage program you join up with is legitimate.

Washington Bureau Chief Melanie Waddell can be reached at mwaddell@ia-mag.com.

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