Real estate brokers, agents and title companies not only have to deal with a slow market, but now must defend their affiliated business relationships. These affiliated business arrangements are under attack by HUD, the state of Minnesota and in a lawsuit brought in Hennepin County district court. In the last month Coldwell Banker Burnet has been targeted in a class action lawsuit for its business practices with respect to their agents and their affiliated title services and First American Title Insurance Co. agreed to pay a $500,000.00 civil penalty to the state of Minnesota to settle the allegations brought by the state that First American created 35 sham businesses that generated title referrals.

In both cases the targets of the allegations denied any wrongdoing, are large corporations and the allegations involved the relationships between related real estate entities and the referral of business. There are, however, some key differences.

In the First American case, the allegations were brought by the state of Minnesota. In the Burnet case, the allegations were brought in a civil lawsuit. While both have denied wrongdoing, First American entered into a consent order where they agreed to shut the targeted affiliated businesses down, pay a monetary penalty and create educational material for consumers to be posted on the Minnesota Department of Commerce’s web site whereas the Burnet case is in the early stages and is still contested.

Both cases are significant and should be studied by real estate professionals who have affiliated businesses. Real estate brokers have to be concerned on two levels – first, with respect to their own affiliations, and, two, with respect to its agents affiliated relationships (Real estate brokers have supervisory responsibility over the actions of its agents). While these two cases specifically focus on referrals to title companies by affiliated real estate professionals, including real estate agents, the same theories could be used to attack other affiliated relationships such as referrals to lenders.

First American began creating affiliated business groups in Minnesota in 1995. Each business entity was owned by First American through a subsidiary, Universal Partnerships Inc., along with a number of real estate professionals that were in the position to refer title work to the affiliated title business entity. Universal held 20 percent of the affiliated business entity and the real estate professionals held the remaining 80 percent of the ownership of the affiliated business. The various real estate professionals (real estate agents and brokers, builders, mortgage loan officers and land developers) each paid $500 for their interest in the affiliated business entity. As owners they all received profit distributions based on their ownership, not on the amount of referrals they made. According to the consent order First American hired, trained and supervised the employees of the business and managed the business for free. In some cases, the affiliated businesses shared employees, office space and equipment.

RESPA prohibits illegal kickbacks for referrals but does allow affiliated businesses provided that they are not used as a conduit for illegal kickbacks and that meet certain requirements (i.e., they maintain their own offices, employees, phones and capital).
First American has long taken the position that their affiliate businesses complied with RESPA in that the owners were required to disclose to their clients their financial interest in the affiliated business, the owners were paid pursuant to their ownership interests and not based upon the number of their referrals and each affiliated business had its own employees, offices and capital. HUD and the Minnesota regulators took the position that the affiliated businesses violated state and federal law as follows: first, they were not “settlement service providers” under RESPA so that the payment of profits to the affiliate owners constituted a RESPA violation. Second, the employees who were paid commissions or other compensation for title insurance that were sold did not hold Minnesota insurance producer licenses as required by statute. Third, they failed to “completely or accurately disclose” their affiliated business arrangement.

Pursuant to the Consent Order, First American agreed to the following:

1. to pay a $500,000.00 civil penalty to the state of Minnesota;
2. to close down its 35 affiliated businesses;
3. to provide educational material regarding title insurance for the Department of Commerce web site.

The Minnesota Department of Commerce also announced that Gibraltar Title Agency of Edina signed a Consent Order agreeing to the following:

1. to pay a $10,000.00 civil penalty to the state of Minnesota;
2. to reimburse to customers $100,000.00;
3. to close down its 4 affiliated businesses.

In November of 2006 the Minnesota Department of Commerce and HUD declared a crackdown on affiliated businesses and issued a Consent Order against Five Star Mortgage alleging that Five Star had established sham affiliated businesses. Since that action the industry has been waiting to see how serious the state and HUD was with respect to the crackdown. Judging by its recent actions the answer is very serious.

In February of 2007 a class action lawsuit was commenced against Burnet Realty (doing business as Coldwell Banker Burnet) alleging that Burnett used “deceptive and misleading conduct steering consumers, to which it owed fiduciary duties, to an affiliated title company [Burnet Title] that it knew or should have known had some of the most expensive insurance rates and settlement fees in the marketplace, without full and adequate disclosure of all material facts related to the practice”.

The most interesting thing about his lawsuit is that it is not based upon claims that their affiliated business arrangement violated RESPA, instead, it alleges that Burnet violated its statutory and common law fiduciary duties to its clients by steering them to Burnet Title.

The lawsuit alleges that agents of Burnet are pressured and enticed to steer their clients to Burnet Title even though their rates are higher than many other title companies. The lawsuit alleges that Burnet engages in the following activities to encourage the steering of business to Burnet Title:

1. pressures its sales associates to steer clients to Burnet Title;

2. trains its agents to steer clients to Burnet Title;

3. creates internal barriers to make it more difficult for an agent to recommend a title
company other than Burnet Title;

4. creates barriers to prevent other title companies to market their title services to Burnet agents while assisting Burnet Title in marketing its services;

5. offers financial incentives to agents and managers for steering clients to Burnet Title:

a. Burnet agents are paid their commission check at closing only if Burnet Title is used as the settlement agent;

b. payment of retirement plan contributions;

c. payment of marketing and/or other expenses;

d. the ability to participate in bonus pools

While Burnet provides to clients an Affiliated Business Disclosure, the lawsuit alleges the disclosure does not fully disclose all material facts known to Burnet that might affect the clients’ rights or interests. Specifically, Burnet does not disclose that there are other title companies that charge less than Burnet Title and does not disclose the pressure applied to the agents and the financial inducements offered the agents to refer clients to Burnet Title. While the disclosure does state that there are other settlement service providers available and that the client is free to shop around, the lawsuit states that this does not negate Burnets’ obligation to act in the best interests of the client and to disclose all material facts it possesses. Further the lawsuit alleges that while the disclosure does state that “the referral of business to these companies may provide us or other related parties noted herein a financial or other benefit”, it does not disclose the specific pressure and financial incentives and rewards offered for such referrals.

I will monitor the progress of this lawsuit it that it has a significant potential impact on all real estate brokers and agents who have affiliated business arrangements. Real estate brokers cannot only be concerned with their own affiliated business relationships but also the affiliated business arrangements of its agents since the real estate broker is liable for the acts of its agents.

Many, if not most, real estate brokers/agents have affiliated business relationships (title, mortgage, etc.) to whom they refer clients to. For years brokers/agents have felt comfortable with these relationships because the companies who set them up have assured them that the arrangements complied with RESPA and there were few actions taken against affiliated business arrangements.

Even when HUD and the state of Minnesota announced last November that they were going to crack down on affiliated businesses most brokers/agents were unaware or took a wait and see attitude. No longer can brokers/agents afford to blindly go forward with their affiliated business arrangements.

The First American case illustrates that even though you are dealing with a national company that has spent a great deal of time and money setting up a system to comply with RESPA, there is no guarantee that the state or HUD will agree. All of the systems that have been set-up as clones of the First American model are now immediately at risk – what are you doing differently that makes your system comply?

As an individual agent or broker you may be asking yourself why you should care, after all the action was brought against the company who set it up not the individual agents who were owners in these companies. The fact is that while the state has not yet gone after individual agents and/or brokers, there is nothing to stop them from doing so. If they do, will they go after just current owners all owners including past ones? Will they stop now or will they go after other affiliated business arrangements? Nobody knows but I would not bet against it.

The Burnet case adds another element to the mix – even if your affiliated arrangement meets RESPA requirements are you violating your fiduciary duties to your client by how you refer them to the affiliated business. We don’t know how this case is going to turn out but you should be asking yourself does my referral to an affiliated business further the best interests of my client? It will be hard to defend yourself if you are aware of facts that are not disclosed to your client that indicate that using the affiliated business is not in their best interests.

Brokers in particular should be on alert. First, you probably have your own affiliated business arrangements that may come under attack. What methods are you using to promote that affiliation to your agents? You better make sure that you have a clear, thought out plan that you are willing to defend. Second, you probably have agents that have their own affiliations. Since you are responsible for their actions do you know whether their affiliation complies with RESPA? Do you know whether referrals to that affiliated business is done in a way that complies with the agents’ fiduciary duty to their client? Do you have policies in place that require your agents to disclose to you all of their affiliated business arrangements? Do you have policies in place to supervise or control and/or terminate these affiliations? Up to now you have probably ignored the issue to avoid upsetting your agents. Given recent developments you can no longer afford to ignore the issue.