What is Net Branching?
Net branching was fairly common in the 1990’s into the early 2000’s until state and federal mortgage regulators put an end to this illegal mortgage practice. In its most basic form, net branching involved unlicensed, illegal mortgage company franchising of the mortgage business. Essentially, net branching mortgage companies were allowing unlicensed mortgage companies to illegally operate “under” their mortgage licenses.
Mortgage licensing laws throughout the country prohibit a legal entity from “using” the lending license held by another legal entity. Each legal entity must have its own mortgage license. Further, individuals conducting licensable mortgage activities must either have their own mortgage company license, or be an “employee” of a licensed mortgage company (Note: they must also be licensed as mortgage loan originator of that company under today’s laws).
How does Net Branching Work?
Although net branching can take many different forms, the most common factual scenario looked like this: a mortgage company looking to franchise its business would sign up “branch managers” who would form their own “marketing companies”. The licensed mortgage company would adopt an assumed name (e.g. ABC Financial, Inc. d/b/a “XYZ Financial”) that was very similar to the marketing company’s actual legal name (e.g.” XYZ Financial, Inc.”, and then add that assumed name to the mortgage company’s mortgage license. The licensed mortgage company would then enter into a net branching agreement with the net branch manager whereby the branch manager would be personally responsible for getting his/her own lease on office space, would be personally responsible for all branch expenses, and would be personally responsible for hiring branch employees who would be employed by the marketing company. Neither the marketing company, nor its employees were licensed. Instead, they pretended as if the branch, and the branch employees were actually part of the licensed mortgage company. The net branch operated under its own name, and loans were closed through the mortgage company (the sight different in the licensed mortgage company’s assumed name, and the marketing company’s legal name were almost never noticed). Payments from the mortgage company to the net branch manager (based on some type of profit-sharing formula for the branch operation’s production) were typically on a 1099 basis. In some instances, a branch manager would be paid by the mortgage company in the following manner: 10% on a W2 basis, and a 90% “marketing fee” on a 1099 basis to the branch manager or to the marketing company. Nevertheless, all branch employees were paid by the marketing company, as they were employees of that company, and not of the mortgage company.
The problem: under state licensing laws (and under FHA rules), in order for a person or company to conduct mortgage activities which require licensure, they must either be licensed, or be an employee of a licensee. In the scenario set forth above, the marketing company acted as an illegal, unlicensed mortgage company which solicited mortgage business, hired unlicensed mortgage loan originators, received compensation for mortgage-related activities, and which was responsible for all expenses of the branch operation. In every way, the branch acted as a mortgage company without a license. Further, all mortgage loan originators acted illegally as they were conducting mortgage business without being individually licensed, and without being employees of a licensed mortgage company.
Risks of Illegal mortgage net branching
Our law firm has encountered hundreds of illegal mortgage net branch arrangements over the years. Although net branching was virtually eradicated in the early 2000s through massive enforcement actions against industry violators, net branching continues to resurface over time. This cyclical net branch resurgence is due to the fact that new franchise marketing promoters are born every day, and they continue to target the consumer finance industry as a franchise opportunity. Franchising marketers jump into mortgage net branching (or net branching other forms of consumer lending) without any knowledge of state licensing laws, or of regulatory enforcement history.
Regardless of the facts, the story always ends the same way: both the net branching company and the net branch manager are subject to serious administrative enforcement actions by state licensing regulators. Violators may face large monetary sanctions, license revocations, cease and desist orders, denial of license applications, permanent exclusion from the finance industry, and/or potential misdemeanor or felony criminal prosecution.
Further, when a regulatory enforcement action is taken against the offending mortgage company, it usually ends in disaster for that mortgage company, either in the form of license revocation and/or massive fines. This usually led to the implosion of the mortgage company. The net branch manager and the marketing company were the next to feel the pain. The “marketing fees” to the net branch immediately stopped, and the net branch manager was left on the hook for all branch expenses with no income to pay for them: rent, employee payroll, office expenses, taxes, etc. As a result, often times the branch manager was forced to file for bankruptcy protection.