QUESTION
We are the CEO and General Counsel of a regional mortgage banker. We decided to write you about an administrative
action that has been taken against us by our state banking department.
The issue involves employer-employee compensation. The banking department claims that we are engaged in “sham employment” in violation of RESPA. We do not want to describe the alleged violation here.
However, we would like to know some history and context related to “sham employment.” We have already contacted your firm to conduct a risk assessment of our employment practices.
What is “sham employment?”
ANSWER
To say this area of the Real Estate Settlement Procedures Act (RESPA) is
complicated would be an understatement. Thank you for contacting us to assist you. If you or anyone else would like to discuss this subject, please feel free to contact me HERE.
Right from the start, issues involving employer-employee compensation have proved to be one of the more controversial areas covered by RESPA.
You can go back to HUD’s decision in 1996 to withdraw the employer-employee exemption the Department had promulgated only four years earlier,[i] followed by HUD’s Congressionally mandated postponement of the effective date of the withdrawal.[ii]
As a result, the 1992 exemption, which states that Section 8 of RESPA does not prohibit an employer’s payment to its own employees for any referral services, remains in effect. That section of the RESPA statute specifically lists several practices that do not violate the statute.
The statute provides:
Nothing in this section shall be construed as prohibiting (1) the payment of a fee … (C) by a lender to its duly appointed agent for services actually performed in the making of a loan, (2) 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 …
The foregoing subsections support the payment of fees by employers to their employees.
In December 2011, when the CFPB republished Regulation X as its own regulation, it removed the unimplemented provisions of the 1996 rule that had remained part of HUD’s Regulation X. Accordingly, Regulation X, RESPA’s implementing regulation, currently allows an employer to pay its own employees for any referral activity. For the most part, this is all most mortgage professionals usually need to know about employer-employee compensation in the context of “sham employment.”
In place of the 1992 exemption, HUD adopted but then postponed the effective date, and then the CFPB permanently eliminated it, providing two additional limited exemptions for payments:
1. One for employer payments to managerial employees.[iii]
2. Another for payments to employees who do not perform settlement services.[iv]
The proposed 1996 revision also would have added a third exemption to clarify that payments made to an employer’s own bona fide employee for generating business for that employer are permissible.[v]
HUD’s May 9, 1997, proposal,[vi]
which the Department withdrew on February 13, 2001,[vii]
would have added a new “like-provider” exemption to RESPA’s Section 8
prohibition against kickbacks and unearned fees. (I
will not treat the 1996 amendments and the proposed “like-provider” exemption
in this response.)
HUD proposed amending Regulation X[viii]
to add an exemption that would allow payments by an employer to its own bona
fide employees for the referral of settlement service business to an
affiliated settlement service provider, provided that the referred settlement
service business is the same category of settlement service as provided by the
employer of the employee making the referral, the employee makes the affiliated
business arrangement disclosure[ix],
and the employee making the referral does not perform any other category of
settlement service in the same transaction.
Thus, here is the current
situation with respect to your question about “sham employment,” specifically,
the variety of developments regarding payments by an employer to its employees.
Under RESPA, an employer may pay its own employees for any settlement service,
including referrals to affiliates. A company may pay the employees of another
company only reasonable compensation for settlement services actually rendered.
HUD has made clear, both in its
regulatory guidance and its enforcement actions,[x]
that it regards “sham employment” or “bogus employee” arrangements as RESPA
violations. There is no reason to believe the CFPB takes a different position
on this issue.
Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group
________________________
[i] 12 CFR 1024.14(g)(1)(vii), originally adopted by 57 Fed. Reg. 49600 (November 2, 1996) and republished by the CFPB, 76 Fed. Reg. 78978 (December 20, 2011)[ii] Section 2103(b) of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (Title II of the Omnibus Consolidated Appropriations Act, 1997, Pub. L. 104-208), signed by President Clinton on September 30, 1996; 61 Fed. Reg. 58,472 (11/15/96)
[iii] Withdrawn Regulation X Section 3500.14(g)(1)(viii)
[iv] Withdrawn Regulation X Section 3500.14(g)(1)(ix)
[v] Withdrawn Regulation X Section 3500.14(g)(1)(vii)
[vi] 62 Fed. Reg. 25,740 (May 9, 1997)
[vii] 66 Fed. Reg. 25,478, at 25,497 (5/14/01). HUD withdrew the proposal following the January 20, 2001, issuance of a “Regulatory Review Plan” by the new Bush administration’s White House Chief of Staff, Andrew H. Card, Jr. HUD pointed out in its semiannual regulatory agenda that “Withdrawal of a rule does not necessarily mean that HUD will not proceed with the rulemaking. Withdrawal allows the new HUD Administration to further assess the subject matter and determine whether rulemaking for this subject matter is appropriate.”
[viii] Section 3500.14(g)(1)
[ix] As provided in 12 CFR 1024.15
[x] For instance, see the Znet Financial settlement (September 17, 2003). HUD found that Znet paid ReMax of Atlanta real estate agents as "employees" even though the agents performed little or no work for the lender. These agents were, therefore, sham “employees" who did little or no work for referral fees. Investigators found the agents performed little or no origination work other than filling out loan application forms.
