HUD's Office of Inspector General (OIG) recently completed audit reports with respect to marketing, noncompetition and volume-based incentive arrangements entered into by First Magnus Financial Corporation, and concluded that these arrangements violated the Real Estate Settlement Procedures Act ("RESPA").
According to the report, the incentives took two forms. Under a percentage point system, First Magnus paid its brokers a certain percentage (typically .25%) of the loan volume it originated. Under a tiered bonus system, First Magnus paid its mortgage brokers incentives for loan volume that exceeded $1 million and reached $10 million with the amount of the incentive increasing from $500 at the low end and peaking at $8,000 at the high end. OIG concluded that First Magnus violated RESPA by issuing volume-based incentive payments to brokers in exchange for originating and processing federally related mortgage loans, including FHA-insured loans, since the payment of volume-based incentives constitutes a payment for referral of business.
During the years 2003-2005, First Magnus paid more than $753,000 in marketing fees and non-competition fees to builders and real estate companies in exchange for what OIG characterized as exclusive referrals of more than $937 million in federally related mortgage loans. Of those fees, OIG particularly focused on approximately $32,000 in marketing fees and noncompetition fees that were paid in exchange for the exclusive referral of 236 FHA-insured mortgages totaling more than $30 million. First Magnus paid the $32,000 in fees in exchange for exclusive promotion of its mortgage products and programs. First Magnus loan officers were on site at builders' and real estate companies' offices, and borrowers were directed to these First Magnus loan officers by the homebuilder sales agents and real estate agents. OIG concluded that these arrangements effectively limited affected borrowers' ability to comparison shop with other lenders and violated RESPA.
As part of the arrangement, homebuilders and real estate companies were required to exclusively distribute and display various First Magnus promotional and marketing materials, as well as provide First Magnus employees with exclusive access to their sales offices. Among the promotional and marketing materials homebuilders and real estate companies were required to distribute and display at their sales offices were business cards, flyers, and brochures covering various First Magnus mortgage products and services. First Magnus was also permitted to provide training presentations to builder sales staff, distribute its business cards to customers and display its signage and marketing materials in customer newsletters. First Magnus was supposed to pay a flat monthly fee for the marketing services, but there was evidence with respect to at least one homebuilder that the monthly fee was reduced due to (according to OIG) slower volume during the period. The agreements also stated that the fees paid to the homebuilder would be reviewed semi-annually to evaluate the mutual effectiveness of the agreement. OIG stated that these terms allowed First Magnus to terminate the arrangement if the volume of mortgages being referred by the builder did not justify the monthly referral payment, since either party was able to terminate the arrangement on 30 days notice.
First Magnus closed its doors in the summer of 2007, and filed for bankruptcy protection shortly thereafter. Therefore, First Magnus was unable to respond to HUD's charges.
Section 3500.14(b) of Regulation X (the RESPA regulations) states that "no person shall give and no person shall accept any fee, kickback, or thing of value pursuant to any agreement or understanding, oral or otherwise, that business incident to or part of a settlement service involving a federally related mortgage loan shall be referred to any person." Section 3500.14(g)(iv) states that RESPA permits "a payment to any person of a bona fide...compensation or other payment for goods or facilities actually furnished or for services actually performed."
It has generally been the view in the mortgage lending community that marketing arrangements are permissible if the value of the services provided by the service provider are reasonably related to the amount paid for those services by the lender. In fact, the provision from the First Magnus marketing agreement that permits a semi-annual review of the fees paid to the service provider is typically intended to enable the lender to adjust a marketing arrangement where the lender determines that it has been paying more in fees than the value of the services being provided.
OIG did not focus on the value of the services at all, but concluded that the exclusive nature of the arrangement resulted in the fees being for referrals of business. While OIG's conclusion related only to FHA-insured loans (since the purpose of the audit appeared to be to focus only on those loans), there is certainly reason to be concerned that HUD would reach the same conclusion on any similar arrangements with respect to all federally related mortgage loans. Therefore, it would seem prudent for lenders to make sure that their marketing arrangements are not exclusive in nature.
In addition to marketing payments, OIG also determined that payments totaling $150,000 were made to Long Realty in connection with an operating agreement involving a First Magnus affiliate, FMLC LLC, an entity that was owned 50.1% by First Magnus and 49.9% by Home Services America, the parent company of Long Realty. As part of this agreement, First Magnus paid Home/Long a noncompete fee of $50,000 per year in exchange for Home not entering into any similar agreement in three Arizona counties. Further, Home/Long would not let any other lender have access without appointment to Long Realty offices or its employees. This noncompete fee ensured an exclusive relationship between First Magnus and Home/Long in those counties and further prohibited Home from providing competitive lending services in the same counties. As a result, uninformed borrowers were directed to First Magnus, when better FHA mortgage terms may have been available from other lenders. OIG found this practice to be a violation of RESPA's prohibition against referral fees in exchange for FHA mortgage business.
Finally, in a separate audit, OIG found that from 2003 through 2005, First Magnus issued $102,840 in volume-based incentives or bonuses to brokers for originating and processing 326 federally related mortgage loans (FHA-insured and non-FHA-insured). Of the payments made to brokers, $58,571 in volume-based incentives was paid for originating and processing 169 FHA-insured mortgage loans.
This action relates to how volume compensation programs may get treated under HUD's RESPA Policy Statements on yield spread premiums and core title services. Each of the Policy Statements contain provisions that exempt compensation that is reasonably related to the value of services provided, but each also states that payments cannot be made for referrals of business and that when the payment is based on the volume of business, it is evidence of an agreement for the referral of business unless it is shown that the payments are for legitimate business reasons unrelated to the value of the referrals.
Again, First Magnus was unable to respond to the audit. Thus, it is unknown whether it would have tried to justify the volume payments under Section 8(c) of RESPA. This audit report would seem to indicate that HUD will regard payments for volume referrals as presumptively illegal under RESPA and will place the burden (which may well be a formidable one) on the persons engaging in this practice.