QUESTION
Can we deduct from our loan officers’ compensation the cost
of marketing materials, such as the per- account fees of an outside customer
relationship manager (CRM) to stay in touch with past clients and referral
partners?
ANSWER
While it is theoretically possible to deduct marketing
expenses from loan officer compensation in certain limited circumstances,
attempting to do that in practice is fraught with legal and compliance risk.
As a starting point, because loan officer compensation rules
consist primarily of various prohibitions, determination of whether any loan
officer compensation plan is "compliant" is a fact-specific and
“situationally dependent” exercise that requires evaluation of the plan as a
whole.
Secondly, there are many federal and state labor law requirements
that must be considered. For example,
the federal Fair Labor Standards Act (FLSA), and most state labor laws,
prohibit any deduction from the pay of non-exempt employees (most mortgage loan
officers) that is not specifically authorized by statute or regulation and that
reduces the employee’s compensation below the applicable statutory minimum wage[i]
or reduces the non-exempt employee’s overtime compensation in any amount. An employee must always receive at least the
minimum wage and must be paid any earned overtime. Whether and how the
deduction arrangement is documented in the LO's compensation agreement is also
critical. Under most state laws, if the employee’s consent to the deduction is
not specifically documented in advance in a written agreement, the deduction
normally cannot occur. And if not structured properly, even authorization for
such deductions in a written employment agreement can be problematic because
employee compensation, once paid, normally cannot be reduced.
Thirdly, any such deduction would have to "pass
muster" under both the Loan Officer Compensation Rules of Regulation Z of
the Truth in Lending Act (TILA), and the Fair Lending laws. In that regard,
Regulation Z prohibits basing a loan originator's compensation on "any of
the transaction's terms or conditions" or the “terms of multiple
transactions,” or on a “proxy” for such terms. The Dodd-Frank Act codifies that
prohibition. Under Reg. Z, a "term of a transaction" is defined as
"any right or obligation of the parties to a credit transaction."
This means, for example, that a mortgage loan originator employee (LO) cannot
receive compensation based on the interest rate of the loan or on the fact that
the LO "steered" the customer to use a particular vendor in the
transaction.
The key language is found in Section 1026.36(d) of Reg. Z, as
follows:
(d)
Prohibited payments to loan originators.
(1) Payments based on a term of a transaction.
(i) Except as provided in paragraph (d)(1)(iii) or (iv) of
this section, in connection with a consumer credit transaction secured by a
dwelling, no loan originator shall receive and no person shall pay to a loan
originator, directly or indirectly, compensation in an amount that is based on
a term of a transaction, the terms of multiple transactions by an
individual loan originator, or the terms
of multiple transactions by multiple individual loan originators. If a loan
originator's compensation is based in whole or in part on a factor that is a proxy for a term of a transaction, the
loan originator's compensation is based on a term of a transaction. A factor that is not itself a term of a
transaction is a proxy for a term of the transaction if the factor consistently
varies with that term over a significant number of transactions, and the loan
originator has the ability, directly or indirectly, to add, drop, or change the
factor in originating the transaction. (Emphasis added.)
Based on the emboldened definition above, a “proxy analysis”
is required to evaluate whether deductions for marketing expenses (or other
expenses) amount to a “factor” that “consistently varies with [a] term of the
transaction (or series of transactions) over a “significant number of
transactions” where the originator “has the ability, directly or indirectly, to
add, drop, or change the factor in originating the transaction.” This, in turn,
could necessitate evaluation of whether the marketing expenses deducted are the
same for every transaction and every loan type and interest rate, or vary
statistically depending on the terms of the loan. If the deduction in any
way incentivizes the loan officer (qualitatively or statistically) to “steer”
consumers into or away from loans with certain terms, there is a potential TILA LO
Comp issue. And, in the same manner, there could also be a Fair
Lending” issue if application of the deduction results in a pattern of loan
origination that has a disparate impact on a protected class of borrowers.[ii]
Finally, if your company originates FHA loans, the proposed deduction
might constitute a violation of HUD rules requiring that all operating expenses
be paid by the mortgagee.
HUD Handbook 4001.1(I)(A)(6)(g)(ii) provides that:
“The Mortgagee must pay all of its own operating expenses, including the
expenses of its home office and any branch offices where it conducts FHA
business. The Mortgagee must maintain all accounts for operating expenses in
its name.” (Emphasis added.) Section
4001.1(I)(A)(4)(d)(i) of the HUD Handbook also provides: “The Mortgagee must
not engage an existing, legally separate mortgage company or broker to function
as the Mortgagee’s branch office or DBA name or to conduct FHA activities using
the Mortgagee’s FHA approval.”
While there appears to be no HUD prohibition on
employees voluntarily reducing their basic rate of compensation across the
board because management’s expenses have increased, that would need to be
documented in the LO’s employment agreement and, again, could not result in the
compensation dropping below applicable minimum wage and overtime pay
requirements.
Michael Pfeifer
Director/Legal & Regulatory Compliance
Lenders Compliance Group
[i] The
federal minimum wage is currently $7.25 per hour. Some state minimum wage requirements
are higher.
[ii] Under
the 2018 revisions to the Official Staff Interpretations of Reg. Z §1026.36(d)(1),
a loan originator is permitted to
decrease its compensation under very limited circumstances involving unforeseen
increases in settlement costs. But those circumstances do not apply here. The
applicable commentary reads: “Permitted decreases in loan originator
compensation. Notwithstanding comment 36(d)(1)-5, §1026.36(d)(1)
does not prohibit a loan originator from decreasing its compensation to defray
the cost, in whole or part, of an unforeseen increase in an actual settlement
cost over an estimated settlement cost disclosed to the consumer pursuant to
section 5(c) of RESPA or an unforeseen actual settlement cost not disclosed to
the consumer pursuant to section 5(c) of RESPA. For purposes of comment
36(d)(1)-7, an increase in an actual settlement cost over an estimated
settlement cost or a cost not disclosed is unforeseen if the increase occurs
even though the estimate provided to the consumer is consistent with the best
information reasonably available to the disclosing person at the time of the
estimate.”
