The Consumer Financial Protection Bureau (CFPB) filed a complaint against the Kentucky-based law firm of Borders & Borders PLC in October 2013, alleging that the firm violated RESPA by using a network of sham affiliated business arrangements (AfBA) to pay kickbacks for referrals of real estate settlement business. The law firm recently asked the court to dismiss the case, arguing that the CFPB’s complaint relied on the Department of Housing and Urban Development’s (HUD) 10-factor test, which the 6th U.S. Circuit Court of Appeals found unconstitutional. In a reply to the court, the bureau said it can show that Borders violated RESPA without using the controversial test.
In its complaint, the CFPB alleged that Borders & Borders violated RESPA by paying kickbacks to real estate and mortgage brokerage companies that referred business to the firm. The kickbacks, the bureau claimed, were disguised as profit distributions made by nine joint ventures that were created and operated by Borders. According to the bureau, the firm also failed to provide adequate AfBA disclosures to its customers, which are required under RESPA and Regulation X.
Borders filed a motion for judgment on the pleadings on May 1, arguing that the bureau should not rely on HUD’s 10-factor test because the 6th Circuit shot down the test in the case of Carter v. Welles-Bowen Realty Inc. The test was contained in HUD’s statement of policy 1996-2, and set forth 10 factors that HUD would weigh in determining whether an entity is bona fide. With the test deemed invalid, Borders asked the court to dismiss the case.
In its reply to Borders’ request, the CFPB said it did not rely on HUD’s 10-factor test in its complaint and argued that the test isn’t necessary to prove that the firm violated RESPA.
“Unlike the plaintiff in Carter, the bureau has not cited the statement of policy in its complaint in this matter, nor does its claim against the defendants depend on the statement of policy’s validity,” the CFPB wrote in its May 27 memorandum to the court. “Rather, the bureau’s cause of action relies on the authority of the RESPA statute itself and Regulation X.”
The bureau argued that the complaint adequately alleged facts illustrating that Borders violated RESPA Section 8(a). In addition, the CFPB told the court that Borders cannot rely on the AfBA safe harbor contained in Section 8(c) because the law firm failed to provide proper disclosures and the payments the defendants received were not bona fide returns on ownership.
Section 8(a) prohibits the giving or accepting of a thing of value pursuant to an agreement or understanding that real estate settlement service business will be referred.
According to the bureau, all of these elements are met in the complaint against Borders. First, the agency says it can show there was an agreement that the joint venture partners referred customers to Borders for settlement services.
Second, the bureau said that it can show a thing of value was provided in the form of purported returns on ownership interests in the joint ventures.
Under Section 8(c)(4) of RESPA, an AfBA qualifies for a safe harbor if it meets three conditions: 1) the person making the referral must disclose the arrangement to the client; 2) the client must remain free to reject the referral; and 3) the person making the referral cannot receive any thing of value from the arrangement other than a return on the ownership interest.
The bureau alleged that the defendants did not qualify for the safe harbor because the payment claimed to be a return on the ownership interest of the AfBA was not bona fide.
“The bureau intends to prove that the defendants created and operated a well-oiled payment-for-referral machine easily understood and frequently utilized by numerous real estate and mortgage brokerage companies,” the CFPB said. “The operating instructions for the machine provided that when those companies referred customers to the defendants for closing and other real estate settlement services, the defendants paid the referring parties with money disguised in accounting ledgers to look like profits generated by title insurance companies co-owned by the referring parties.”
According to the bureau, in order to qualify for the safe harbor in Section 8(c), the payment claimed to be a return on ownership interests in an AfBA must be bona fide.
Regulation X states: “Neither the mere labeling of a thing of value, nor the fact that it may be calculated pursuant to a … partnership organizational document … will determine whether it is a bona fide return on an ownership interest ... Whether a thing of value is such a return will be determined by analyzing facts and circumstances on a case by case basis.”
Instead of paying bona fide returns on ownership interests, the bureau said defendants and joint venture partners created the AfBAs as accounting tricks to keep track of referrals and make illegal kickbacks to the referring parties.
In its complaint, the bureau alleged that the joint ventures: “each had only one staffer” who was concurrently employed by Borders; “did not have their own office spaces, email addresses or phone numbers;” “did not advertise themselves to the public;” and “did not perform substantive title work.” The agency also alleged that the employees of Borders managed the business affairs of the joint ventures and said the offices could not function independently from Borders.
These allegations appear to be closely associated with HUD’s 10-factor test; however, the bureau said the claims were not related to the test.
“The clearly implied inferences of these and other allegations in the complaint are that assignment of the title insurance work from Borders & Borders to [an AfBA] involved little more than changing names on paperwork and switching accounting entries in the companies’ books and that the services provided to customers under the names of those different entities were wholly indistinguishable,” the CFPB said.
In its motion, Borders relied heavily on the fact that the 6th Circuit found HUD’s test unconstitutional. The bureau said the defendants misinterpreted the Carter case.
“In fact, the defendants appear to contend that Carter did away with the bona fide inquiry and that sham affiliated businesses are somehow legal under RESPA.”
The Borders case is distinguished from Carter, the bureau said, because in this case, the CFPB is disputing that the defendants satisfied the three elements necessary for the safe harbor to apply.
“As an initial matter, the Carter decision focused on whether a statement of policy issued by HUD validly imposed an additional condition for invoking the affiliated business safe harbor beyond those contained in RESPA and Regulation X,” the bureau wrote. “The Carter opinion makes this limitation of its holding clear in its very first paragraph by acknowledging that RESPA establishes three prerequisites for the affiliated business safe harbor and that both the plaintiffs and defendants in that case agreed that the defendants satisfied all three of them.”
Because the CFPB says the defendants received something other than a return on the ownership interest of the AfBAS, the safe harbor would not apply.
In addition, the bureau claimed that the safe harbor does not apply for another reason — the defendants failed to provide adequate disclosures because the disclosures were not always provided to consumers and they were provided at closing rather than at the time the referral was made. The bureau also alleged the disclosures failed to disclose ownership percentages, did not have a customer acknowledgment section and modified the language and font contained in the standard AfBA disclosure form.
The court has not yet made a decision on Borders’ motion for judgment on the pleadings. RESPA News will continue to provide updates on this case as they develop.
To get more information on this case and HUD’s 10-factor test read:
Law firm says CFPB is wrong about alleged RESPA violations
Have an AfBA? HUD’s 10-factor test is important
HUD’s 10-factor AfBA test deemed invalid by federal appeals court
Borders & Borders court battle over alleged sham AfBAs continues