Demonstrating Value: How to Avoid Running Afoul of RESPA’s Anti-Kickback Provisions

August 10, 2017

By Jon P. Klerowski

Participants in the mortgage and real estate industries often struggle with making practical business decisions while simultaneously avoiding running afoul of Section 8(a) of the Real Estate Settlement Procedures Act’s (RESPA) prohibition on referral fees. Section 8(a) violations often involve sensitive valuation determinations associated with marketing and advertising services provided between mortgage industry participants.

Part one of this article provides an overview of the legal and compliance climate surrounding RESPA’s prohibitions against kickbacks and referral fees, and describes the types of arrangements between industry participants most susceptible to Section 8(a) scrutiny. Part two provides recommendations on how to support and document fair value determinations to avoid risk of non-compliance.

Section 8(a) of RESPA prohibits referral fees by making it illegal to give or receive any “thing of value” pursuant to an agreement or understanding to refer real estate settlement service business involving a RESPA-covered mortgage loan, as long as no RESPA exception is available. RESPA Section 8(b) also prohibits the splitting of any settlement service charge except as payment for actual services rendered. RESPA Section 8 applies to most residential real estate transactions that involve a “federally related mortgage loan” (e.g., purchase loans, assumptions, refinances, property improvement loans, and equity lines of credit that are secured by a mortgage on one-to-four family dwellings and issued by financial institutions either regulated by, or whose deposits are insured by any agency of the federal government). 

Any person who gives or accepts a fee, kickback, or thing of value (payments, commissions, gifts, tangible item or special privileges) for the referral of settlement business is potentially liable for a violation of Section 8(a) of RESPA. A real estate settlement service includes any service for which a consumer will pay fees in connection with the settlement of a residential home purchase (financed by a federally related mortgage loan), such as mortgage origination, title insurance, real estate brokerage, and closing services. Further, the other elements of a Section 8(a) violation (e.g., “thing of value” and “referral”) are defined and construed very broadly. For example, a “referral” includes any oral or written action directed to a person that has the effect of affirmatively influencing the person to use a particular settlement service provider when the person will pay a fee for the service.

Section 8(c) of RESPA provides certain exceptions to the broad reach of Section 8 liability.  In particular, RESPA Section 8(c)(2) provides that “nothing in this section shall be construed as prohibiting…the payment to any person…compensation…for services actually performed.” It is this Section 8(c)(2) upon which the traditional analysis of fees for advertising and promotional services is based, which generally viewed flat fee payments for such services rendered as exempt from Section 8(a) scrutiny if the value of those services was reasonably related to the payments made, without considering the value of any referrals that might occur. Various federal courts of appeal have held that “reasonable payments for goods, facilities or services actually furnished are not prohibited by RESPA.”

The U.S. Department of Housing and Urban Development (HUD) administered RESPA until 2011. In 2010, HUD issued an interpretative rule addressing how and under what circumstances home warranty companies could pay real estate brokers and agents for marketing services. HUD later acknowledged that its analysis in that rule also could apply to payments made by other kinds of settlement service providers. Under the general principle prohibiting payments for referrals, the HUD 2010 rule set out several factors in evaluating the permissibility of marketing payments. Services performed by real estate brokers and agents on behalf of home warranty companies were compensable at fair value if (i) the services were actual, necessary, and distinct from the primary services performed by the broker/agent, (ii) were not nominal, and (iii) were not duplicative of other services for which a charge was being made. Among other things, HUD also emphasized the importance of evaluating whether the payments were for compensable services only—as opposed to for referral activity—and ensuring that the payment was reasonably related to the value of those services.

In July 2011, the Consumer Financial Protection Bureau (CFPB), which was created as part of the Dodd-Frank Act in the wake of the financial crisis to supervise and enforce compliance with federal consumer financial laws, assumed responsibility for RESPA. The CFPB actively enforces RESPA, in conjunction with State Attorneys General and State Departments of Insurance. In addition, while they do not have formal authority to enforce RESPA, other state agencies such as real estate commissions also review and will seek to redress RESPA violations.

Advertising, Marketing and Related Service Provider Agreements

An area of focus for the CFPB under RESPA Section 8 relates to agreements to pay for marketing and advertising, or so-called marketing services agreements (MSAs).  The CFPB adopted HUD’s statements (including HUD’s 2010 rule on home warranty company payments to real estate brokers and agents) but the CFPB has taken the view that an MSA or other arrangement will not fall within the Section 8(c)(2) exception if the fees paid could be viewed as compensation for referrals, even if based upon the fair market value of marketing or advertising services (together, “marketing services”). The CFPB is concerned with MSAs and other arrangements between real estate settlement service providers to pay for goods, services, and facilities (herein after called “Service Agreements”) in ways that evade the requirements of RESPA. On October 8, 2015, the CFPB issued a compliance bulletin on the permissibility of MSAs, in which the CFPB stated that MSAs present “legal and regulatory” risk of running afoul of Section 8(a). The CFPB warned the industry to carefully consider the advisability of continuing any MSA arrangements and cautioned that MSAs would continue to receive intense regulatory attention and that “independently established market-rate compensation for marketing services, alone, does not suffice to ensure the legality of an MSA.”

In June 2015, in a RESPA enforcement action against mortgage lender PHH, CFPB Director Cordray issued a ruling on an appeal from CFPB administrative trial, stating that he regarded the Section 8(c) provisions as mere interpretative tools that can be relevant to evaluating Section 8 claims, and that such tools do not apply where there is evidence that the challenged payments were made for referrals. In other words, if an agreement can be construed as providing for the payment of things of value because referrals will be made, there is a per se Section 8(a) violation even if the payments are for the fair value of services, goods or facilities and permitted under Section 8(c)(2). On appeal to the D.C. Circuit Court of Appeals, the director’s decision was overturned by a three-judge panel, which held that Section 8(c) unquestionably exempts “bona fide” payments for goods or services actually provided, notwithstanding any referrals that may occur.  The panel held that under Section 8(c)(2) a “bona fide payment means a payment of reasonable market value.” However, in February 2017, the D.C. Circuit granted the CFPB’s petition for en banc review, vacating the panel’s decision. In connection with the en banc review, the CFPB has continued to maintain the Director’s view of RESPA Section 8(c)(2). The PHH case was argued on May 24, 2017, but a final decision in the case (which potentially could proceed to review by the U.S. Supreme Court) is not expected for several months. 

In this regulatory environment, companies are faced with a difficult decision regarding whether to shoulder the legal and compliance risk associated with Service Agreements. Some companies have announced that the costs and risks of entering into these agreements have far outweighed the benefits, leading to dissolutions of their existing agreements or inaction moving forward.  Others, however, take the view that there is room to permissibly receive compensation from another provider for the use of its marketing platforms (e.g., feature another provider’s ads or marketing material on its website, or placing that provider’s signage in its offices), or the receipt of other actual and necessary services, so long as the party being compensated receives no more than the fair market value of the goods or services actually rendered and refrains from extraneous activity that could be viewed as a referral. It is prudent to vet contemplated services with legal counsel who is familiar with the RESPA definition of a “referral.” Referral activity could include, for example: (i) incentivizing sales agents to promote, market, introduce, or otherwise refer the advertising party to consumers; (ii) endorsing the party being advertised; (iii) identifying the party being advertised as a “designated” or “preferred” partner; (iv) placing obligations in the agreement that appear to require exclusivity or an attempt to make referrals; and (v) setting or adjusting the payment level in whole or in part based on the number of actual or anticipated referrals.

The Acquisition or Formation of ABAs and Interests in ABAs

An affiliated business arrangement (ABA) under RESPA is a business arrangement in which a person who has a direct or indirect ownership position in a provider of real estate settlement services  directly or indirectly causes a referral of business to that provider and shares in the resulting profits.  However, Section 8 of RESPA has a special statutory exemption which permits ABAs to operate if the following conditions are met: (i) disclosure is made to the consumer prior to the referral, (ii) the consumer is not required to accept the referral to the recommended settlement service provider, and (iii) the loan originator only receives a return on the ownership interest (not the volume of referrals made) or other such payment permissible under Section 8. 

A joint venture is a common form of an ABA. For example, a real estate broker or property builder may partner with a mortgage lender or a title insurer to form a joint venture in which both partners have ownership interest. To ensure compliance with RESPA guidelines, the joint venture should have its own employees perform the core services of the business (i.e. certain core services associated with being a mortgage broker or a title agent). It is also common for one or both of the joint venture partners to provide the venture with “non-core” services (such as legal, accounting, tax, and administrative support) for efficiency and cost saving purposes. However, to avoid scrutiny under RESPA Section 8, if a joint venture partner who provides services to the venture may be making or receiving referrals from the venture, the services need to be priced at fair market value.

An ABA under RESPA may also be formed when one party is able to make referrals to or receive referrals from a real estate settlement service provider and buys an ownership interest in that provider. Here, too, the acquisition price for the ownership interest received must be at fair market value to comply with RESPA Section 8. The same is true in an established joint venture where a partner in a position to make referrals to or receive referrals from the joint venture wants to change its ownership position. 

Don’t miss part two of this article, which examines the importance of valuations and provides recommendations on how to support and document fair value determinations to avoid risk of non-compliance.

Jon P. Klerowski is a principal at PKF O'Connor Davies Advisory LLC, a firm that offers accounting, tax and advisory services. He has significant experience advising executive management, boards of directors, and their counsel on a wide array of accounting, financial reporting and modeling, business valuation and forensic accounting matters. Klerowski acknowledges Marcus B. Hemenway and Derek J. Miller for their contributions to this analysis.

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