It s Time for a RESPA Checkup:

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1 July 2008 Authors: Phillip L. Schulman Holly Spencer Bunting K&L Gates comprises approximately 1,700 lawyers in 28 offices located in North America, Europe and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations and public sector entities. For more information, visit It s Time for a RESPA Checkup: Federal and State Regulators Begin to Scrutinize Marketing Agreements In March of this year, the Colorado Division of Real Estate ( Division ) initiated an investigation into a $600,000-per-year marketing arrangement between a national title insurance underwriter and one of the country s largest real estate brokerage franchisors. In exchange for an annual fee, the franchisor agreed to exclusively market and promote the title underwriter s products and services to the broker s nationwide franchisees. The Division, however, questioned whether the agreement was for services rendered or a disguised arrangement to pay referral fees. As a result, the Division has subpoenaed documents and records from the broker s franchisees and at least nine other real estate companies that maintain marketing agreements with mortgage lenders and other settlement service providers. The U.S. Department of Housing and Urban Development ( HUD or Department ) also has agreed to assist the Division in its investigation by reviewing the marketing agreements obtained by the Division for violations of the Real Estate Settlement Procedures Act ( RESPA ). Accordingly, for the first time in RESPA enforcement history, HUD is poised to target the permissibility of marketing agreements under RESPA. If you are a settlement service provider and a party to a marketing agreement, now is the time for a RESPA checkup. If structured properly, marketing agreements are legal under Section 8(c)(2) of RESPA. I. RESPA Requirements Section 8(a) of RESPA prohibits any person from giving or receiving a thing of value in exchange for the referral of settlement service business. The statute, however, provides a number of exceptions to this prohibition, including an exception for goods or facilities actually provided and services actually performed. Section 8(c)(2) states that the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed does not violate Section 8 of RESPA. 1 Presumably, therefore, a marketing agreement will qualify for a Section 8(c)(2) exception from RESPA if it satisfies the following two conditions: (1) The payment recipient performs real marketing services; and (2) The marketing fee is commensurate with the fair market value of the services performed and not paid on a per-transaction basis. 2 A marketing agreement will not comply with RESPA if it merely disguises the payment of referral fees to providers in a position to refer settlement service business. To create a marketing agreement that is legal under Section 8 of RESPA, settlement service providers should keep the following guidelines in mind.

2 II. Actual Marketing and Advertising Services First, one party to the agreement (usually a real estate broker or home builder) must perform actual marketing and advertising services that are general in nature and that are unrelated to any specific transaction. Marketing agreements should be written and should contain a list of these actual services. For instance, a settlement service provider could distribute the other provider s brochures and promotional materials in its office locations and at special events, allow the other provider s representatives to attend a certain number of sales meetings per month or year to make sales and product presentations, provide a website link to the other provider s webpage, and create and manage opportunities for the other provider to promote its products to the public (e.g., speaking engagements). These are only a few examples of the types of actual marketing services a settlement service provider could perform under a marketing agreement. The greater the number of services performed, the easier it will be to justify a marketing fee. Be advised that it is not enough to merely list these types of services in a marketing agreement; one party to the agreement must actually perform the services. We recommend that the parties to a marketing agreement create a reporting system under the agreement to ensure all services are performed and measure the level of performance. As an example, if a home builder agrees to distribute a title insurance agency s brochures under a marketing agreement, the home builder should prepare a monthly report for the title agency that identifies the number of brochures printed in the previous month and distributed in each of the builder s sales offices. If HUD or state regulators were to later question the legitimacy of the marketing agreement under RESPA, both the builder and title agency could demonstrate that actual marketing services were performed in accordance with Section 8(c)(2) of RESPA. III. Fair Market Value Marketing Fees Second, the marketing fee paid under the agreement must be commensurate with the fair market value of the marketing and advertising services actually performed. While HUD has not provided any meaningful guidance regarding how to determine the reasonableness of a particular fee, it has emphasized that transactionally based compensation is not permissible. Thus, a marketing agreement should require a flat fee (whether paid monthly, quarterly, semi-annually or otherwise) that reflects the fair market value of the actual services performed and is not tied in any way to closed transactions or to the success of the marketing arrangement. If an adjustment is made to the amount of a marketing fee, that adjustment should correlate only to an adjustment in the marketing services performed. It is not acceptable, for example, to reduce a marketing fee merely because the marketing services performed by one party have not resulted in increased settlement service business. The ultimate question, therefore, is how to determine a fair market value fee. Unfortunately, there is no onesize-fits-all approach, and settlement service providers must make this business decision for each marketing agreement. That being said, one important factor to consider when determining fair market value is the size of the settlement service provider performing the services. For example, a real estate broker with 20 offices and 1,000 real estate agents would be able to market a title insurance agency s services to more potential home buyers than a broker with one office and 15 agents. In other words, a larger real estate broker will be able to distribute more of the title agency s brochures and flyers, will produce more hits or impressions on a website, and will generate more combined customer traffic at broker events or open-houses than the smaller real estate broker. As the larger broker will produce more marketing materials to reach their larger customer bases and expose the title agency to more potential customers, it follows that marketing services performed by the larger brokers have a higher fair market value. Thus, to gauge fair market value, settlement service providers may want to retain the services of a third-party public relations firm or advertising professional to evaluate the fair market value of the agreed-upon services. In the end, both the settlement service provider paying the marketing fee and the provider performing the marketing services should be able to document and justify fair market value. July

3 Given HUD s and the Division s recent focus on marketing agreements, it is possible that regulators could target any settlement service provider that performs marketing services or pays marketing fees under the agreements. As a result, given the civil and criminal implications of non-compliance with RESPA, settlement service providers must be ready to answer HUD and state inquiries and defend their business practices. If you have questions or concerns about your own practices and marketing agreements under RESPA, please contact Phillip L. Schulman ( / [email protected]) or Holly Spencer Bunting ( / [email protected]). Endnotes 1 12 U.S.C. 2607(c)(2). 2 See HUD Informal Advisory Opinions, dated April 11 and 24, 1986, and May 31, 1985, by John J. Knapp and Grant E. Mitchell, respectively. July

4 K&L Gates Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance. For more information, please contact one of the professionals listed below. LAWYERS Boston R. Bruce Allensworth [email protected] Irene C. Freidel [email protected] Stephen E. Moore [email protected] Stanley V. Ragalevsky [email protected] Nadya N. Fitisenko [email protected] Brian M. Forbes [email protected] Andrew Glass [email protected] Phoebe Winder [email protected] Los Angeles Thomas J. Poletti [email protected] Miami Paul F. Hancock [email protected] New York Elwood F. Collins [email protected] Phillip M. Cedar [email protected] Steve H. Epstein [email protected] Drew A. Malakoff [email protected] San Francisco Jonathan Jaffe [email protected] Erin Murphy [email protected] Seattle Holly K. Towle [email protected] Costas A. Avrakotos [email protected] Melanie Hibbs Brody [email protected] Eric J. Edwardson [email protected] Anthony C. Green [email protected] Steven M. Kaplan [email protected] Phillip John Kardis II [email protected] Rebecca H. Laird [email protected] Laurence E. Platt [email protected] Phillip L. Schulman [email protected] H. John Steele [email protected] July

5 Ira L. Tannenbaum Nanci L. Weissgold Kris D. Kully Morey E. Barnes David L. Beam Emily J. Booth Holly Spencer Bunting Krista Cooley Elena Grigera David G. McDonough, Jr Lorna M. Neill Staci P. Newman Stephanie C. Robinson Melissa Sanchez Kerri M. Smith Director of Licensing Stacey L. Riggin gulatory Compliance Analysts Dameian L. Buncum Teresa Diaz Jennifer Early Marguerite T. Frampton Robin L. Gieseke Allison Hamad Joann Kim Brenda R. Kittrell Dana L. Lopez Patricia E. Mesa Jeffrey Prost K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining offices throughout the U.S., in Berlin, in Beijing (K&L Gates LLP Beijing Representative Office), and in Shanghai (K&L Gates LLP Shanghai Representative Office); a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining our London and Paris offices; a Taiwan general partnership (K&L Gates) which practices from our Taipei office; and a Hong Kong general partnership (K&L Gates, Solicitors) which practices from our Hong Kong office. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is available for inspection at any K&L Gates office. This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Data Protection Act 1998 We may contact you from time to time with information on K&L Gates LLP seminars and with our regular newsletters, which may be of interest to you. We will not provide your details to any third parties. Please [email protected] if you would prefer not to receive this information K&L Gates LLP. All Rights Reserved. July