Avoid Co-Brokering
An edited version of this article appeared in the March 2001 issue of the
Origination News.
By William P. Vestevich, Esq.
"I don’t need to get a mortgage license, I’ll just co-broker the loan”. I
hear this matter-of-fact statement every day from potential clients in my
mortgage licensing law practice. When I ask these individuals if they are
aware that co-brokering in the residential mortgage loan industry is almost
uniformly illegal throughout the country, I consistently receive two
reactions from them. The first is a combination of disbelief and defensive
posturing: “My lender lets me co-broker all the time, so I’m sure it’s
legal. Anyway, the loan closes in my lender’s name so I don’t have to be
licensed.” Then, after explaining the law in detail, I receive the second
reaction – justification: “Well . . . I only co-broker once in a while”. For
purposes of this article, the term “co-brokering” is used generally to
describe a situation where a residential mortgage broker or lender, who is
unlicensed in any given state to conduct mortgage brokering, teams up with a
second, licensed, mortgage broker, or lender, in order to originate a
mortgage loan. As part of the co-brokering arrangement, the unlicensed
referring mortgage broker usually receives a fee from the licensed mortgage
company for the referral of the mortgage loan business. This article will
explain the reasons why, as a general rule, co-brokering should never be
used as a “license substitute” on any mortgage loan transaction.
CO-BROKERING: THE MYTH
The problem with co-brokering is that many, many mortgage professionals
mistakenly believe that, just because co-brokering is conducted in other
“brokering” professions (e.g. the real estate brokerage industry), that it
is also permissible in the residential mortgage loan industry. Nothing could
be further from the truth. As a general rule, to engage in the mortgage
business in any given state, a mortgage company must either be licensed, or
exempt from licensing, and all loan officers must either be individually
licensed, or employed by a licensed mortgage company.
The co-brokering problem has escalated dramatically due to the proliferation
of the Internet in the mortgage business. Prior to the Internet, mortgage
companies did business in their own back yards, and obtained the proper
licensing to conduct mortgage business in their home states. With the
Internet, mortgage companies are being presented, and tempted, for the first
time with the possibility of doing business with borrowers across the
country. Not wanting to be bothered by state and federal mortgage lending
and licensing laws, many mortgage professionals erroneously believe that
they can avoid regulatory “hassles” of licensure, and compliance with
federal laws, simply by closing loans in the name of a mortgage company
which is properly licensed in the states in which their borrowers reside.
DOWNSIDE RISKS
The frightening reality is that many mortgage companies either don’t know,
or don’t care, that in almost every state they must first be licensed in
order to conduct any mortgage brokerage, or mortgage banking, activities. It
is important to note that even the solicitation of mortgage business,
without anything more, is illegal in a number of states. Unfortunately,
co-brokering has caused many, many mortgage professionals, and their
companies, to become unwittingly exposed to potential criminal liability
(misdemeanors and even felonies - that’s right – felonies!), and for huge
civil fines.
TWO TYPES OF LAWS - TWO TYPES OF PENALTIES
As I explain to my clients, the reason that some lenders will do business
with them, even though they are not licensed, is due to the fact that two
different types of state licensing laws exist. In the first category of
states, it is illegal to conduct mortgage business (solicitation,
negotiation, origination, funding, etc.) without first being properly
licensed. In these states, only the unlicensed mortgage company places
itself at risk in a co-brokered transaction. This is due to the one-sided
nature of the penalties, which punish only unlicensed mortgage companies.
Since only the unlicensed mortgage company is exposed to risk, licensed
mortgage companies are willing to take co-brokered deals.
However, in the second category of states, not only is it illegal to conduct
the mortgage business without being properly licensed, but it is also
illegal to transact mortgage business with unlicensed mortgage companies. In
these states, penalties are dual in nature: both the licensed
and the
unlicensed mortgage companies are placed at risk. It is highly unlikely that
licensed/exempt mortgage companies will do business with unlicensed
companies in these states due to the dual nature of the penalties.
ANTI-KICKBACK RULES
Under the Real Estate Settlement Procedures Act, “RESPA” (12 USCS 2601, et
seq.), it is illegal to give anything of value for the referral of
settlement services. Referral fees, no matter the name by which they are
called, are not permitted between separate, unrelated mortgage companies.
Violations of RESPA’s anti-kickback rules subject both the mortgage company
paying referral fees, and the mortgage company receiving referral fees, to
federal penalties of up to $5,000 per transaction.
In an attempt to circumvent RESPA’s anti-kickback rules, co-brokering
mortgage companies usually try to justify their actions under one of two
erroneous lines of reasoning. First, some co-brokering/referring mortgage
companies perform the entire origination process up to the point of closing,
at which time the loan closes in the licensed lender’s name. Under this
scenario, the co-brokering mortgage company has actually done the work and
has provided settlement services, so the fees they receive are not “referral
fees” – they are actually earned as compensation for performing the
origination process. RESPA does provide that a settlement service provider
may receive compensation for settlement services actually provided (i.e. you
must do work on the file to get paid for it). However, even though
settlement services are being provided pursuant to RESPA, the fundamental
problem of illegal, and unlicensed, state mortgage activity still remains.
The second erroneous methodology utilized in attempting to circumvent RESPA
is for an unlicensed mortgage company to simply refer a mortgage loan deal
to a licensee without doing any origination work, and re-label referral fees
as something seemingly harmless, such as “marketing fees”. However, changing
the name of the fees doesn’t change the nature of the fees. It is safe to
assume that any regulator reviewing a mortgage loan transaction will look to
substance over form, and will easily see through thinly-veiled attempts at
disguising referral fees. It is also important to know that the regulators
who drafted RESPA, and its supporting Regulation Z, have pretty much thought
of every obvious, and not-so-obvious, scheme under which referral fees might
be disguised. The best advice in this area is to avoid referral fees and
co-brokering altogether.
SUMMARY
The best and smartest course of action for any mortgage company is to obtain the
proper mortgage licensing in all states in which the company intends to conduct
mortgage business. While it may be tempting to make a quick referral fee in an
isolated co-brokered mortgage loan deal, the downside risks to the unlicensed
co-brokering/referring company, and in some states also to the licensed
co-brokering lender or broker, far outweigh the minimal benefit. Finally, and
perhaps most importantly, in all cases where there may be any doubt concerning
the proper course of action, it is best to consult with your licensing counsel
or regulatory compliance counsel to ensure compliance with the law.
© 2001-2008 Vestevich & Associates, P.C.
William P. Vestevich, Esq. is founder of Vestevich & Associates, P.C.,
Bloomfield Hills, Mich., a nationwide mortgage licensing law firm, with
additional practice areas in business and corporate law. Toll-free: (877)
454-2367.
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