Minnesota and federal housing officials have launched a crackdown on affiliated business arrangements in which real estate brokerages, lenders or builders own a share of companies that provide title insurance.
Affiliated business arrangements, or ABAs, are legal in many states unless they are determined to be sham businesses created to generate illegal payments and kickbacks in exchange for referrals.
That’s how the Minnesota Commissioner of Commerce and the U.S. Department of Housing and Urban Development have characterized Five Star Title, a partnership between a mortgage lender and title company.
In a consent order, St. Paul-based lender Five Star Mortgage agreed to pay $9,812 in restitution and a civil penalty of $10,000 to settle charges that the company “accepted kickbacks or other things of value” for referring more than 750 loan customers to Five Star Title, “a sham affiliated business arrangement.”
The settlement with Five Star Mortgage is part of an ongoing investigation into affiliated business arrangements by the state Commerce Department and HUD, said Commerce spokesman Bill Walsh.
Under the provisions of the federal Real Estate Settlement Procedures Act, or RESPA, anyone making a referral to an affiliated business must disclose any financial interest they have in the business.
In most cases, state and federal regulators said, Five Star Mortgage did not adequately disclose its relationship to Five Star Title to its customers or the cost of services it was providing.
Five Star Mortgage owners David Boogren and Josh McCarthy told Inman News they don’t dispute that the required signed affiliated business disclosures were not always completed. But they disagree with the allegation that Five Star Title was a sham affiliated business.
When approached by Excel Title Holdings LLC about forming an affiliated business, lawyers familiar with RESPA advised Five Star Mortgage that the arrangement would comply with the law, McCarthy said.
Five Star Mortgage agreed to settle the charges because it was less costly than fighting them, he said, and because the state was prepared to launch proceedings against the company’s license to originate mortgage loans.
“They were nice to work with, but we would ask them very specific questions about how we could have done it differently, and it seemed we couldn’t get the right answer,” McCarthy said of the negotiations that led to the settlement.
Under the eyes of RESPA, an affiliated business may be determined to be a sham if it does not have its own employees, separate offices, phones and capital.
According to an affidavit signed by Five Star Mortgage’s owners, the company did not contribute any capital when Five Star Title was created in May 2004. Boogren and McCarthy were each granted a 13.3 percent ownership stake in Five Star Title in exchange for part of their share of future profits, the affidavit said.
In their affidavit, Boogren and McCarthy also said Five Star Title’s operations were managed by Excel Title LLC, which paid its employees and provided health, dental and 401K benefits. Five Star Title contracted with Excel Title LLC for production services, including title search and abstract, examination of title, issuance of title policy, recording of documents, and storage and maintenance of files, the affidavit said.
Investigators also alleged that Five Star Mortgage sent e-mails promising real estate agents $600 to $1,000 for every loan customer they brought to the company who also closed a sale using Five Star Title. Boogren and McCarthy said the e-mail was an unauthorized action by one employee, and that the offer was retracted and never acted upon.
Walsh, the spokesman for the Commerce Department, said Five Star Mortgage was profiting from the arrangement without providing any service other than referrals.
“I think the key is whether or not you add value in the course of the transaction,” Walsh said. “I don’t think they proved their agents were doing anything besides providing referrals.”
McCarthy said that the motivation to enter into an affiliated business arrangement with Excel Title was to provide better service and lower fees for Five Star Mortgage’s customers.
Creating Five Star Title made it convenient for clients to close at Five Star Mortgage’s office, and Five Star Mortgage was able to negotiate lower fees with Excel, McCarthy said.
“We said we didn’t want to get rich, we want to control fees,” McCarthy said.
All told, McCarthy estimated Five Star Mortgage made less than $20,000 from its share of ownership in Five Star Title.
For a company that depends on repeat and referral business, “We got the short end of the stick here,” McCarthy said, adding that affiliated business arrangements are common in Minnesota’s title insurance industry.
Walsh agreed, and said the settlement with Five Star Mortgage is only the first result of a broader investigation into affiliated business arrangements. Walsh would not say if Excel Title is one of the companies being investigated.
“I can’t speak of specific investigations, but we’re making this (ABAs) a focus,” Walsh said. Five Star Mortgage, he said, is “in a marketplace where a lot of people are behaving this way. It doesn’t get around the fact they are in violation of RESPA.”
Calls to two Excel Title executives for comment were not immediately returned.
Critics of affiliated business arrangements say many consumers don’t know much about buying title insurance and aren’t likely to shop around. That creates opportunities for real estate agents and brokers, lenders and home builders to steer their clients to companies they have an ownership interest in, where they will be charged more, critics say.
A recent industry-sponsored study of affiliated business arrangements in nine states — including Minnesota — concluded that ABAs do not charge more than nonaffiliated title insurers. During the course of the study, affiliated businesses increased their market share from 22.3 percent in 2003 to 26.3 percent in 2005.
According to an industry group, The Real Estate Services Providers Council Inc., 19 states have “highly restrictive” laws governing affiliated business arrangements, and 12 others have lesser restrictions. Some states have imposed caps limiting the stake real estate firms can own in an affiliated business to as little as 10 percent.
Ohio regulators recently pulled back from a proposal to reduce the state’s ownership cap from 50 percent to 10 percent after RESPRO objected.