According to the court filing, the plaintiffs made their case in part through the testimony of two anonymous witnesses who used to work for Zillow as a regional sales manager and a sales and operations trainer, respectively.

An amended shareholder lawsuit against Zillow Group is going forward after a federal court refused to dismiss the case, saying the plaintiffs had “plausibly alleged” that Zillow violated federal U.S. anti-kickback law through its agent-lender co-marketing program, and made misleading statements regarding its compliance.

The co-marketing program in question, launched in June 2013, allows the real estate agent customers of Zillow Premier Agent, who pay for advertising on Zillow Group’s apps and websites, to invite lenders to share marketing costs.

Participating lenders pay Zillow Group to appear as “Premier Lenders” in advertising alongside a particular agent who invited them. When Zillow users provide agents with their contact information, that information is also sent to co-marketing lenders, unless users choose to opt out.

Zillow CEO Spencer Rascoff

Former Zillow CEO Spencer Rascoff | Credit: Zillow Group

Two shareholders filed class-action lawsuits against Zillow, as well as its then-CEO Spencer Rascoff and then-chief financial officer Kathleen Philips, in August and September 2017 after the company admitted the Consumer Financial Protection Bureau had been investigating its co-marketing program for the previous two years for compliance with the Real Estate Settlement Procedures Act (RESPA).

The shareholder cases were consolidated in January 2018. The CFPB investigation ended in June 2018 with no action.

In October 2018, U.S. District Court Judge John Coughenour dismissed the consolidated lawsuit against Zillow, which alleged the real estate giant defrauded investors by failing to disclose that its co-marketing program allowed real estate agents to refer mortgage business to participating lenders in violation of RESPA, causing investors to purchase the company’s stock at artificially inflated prices.

Plaintiffs had the option to submit a revised complaint and did, prompting Zillow to file a motion to dismiss the suit in December. The complaint alleges Zillow Group, Rascoff and Philips violated the antifraud provision of The Securities Exchange Act — Section 10(b) and Rule 10b-5 — and that Rascoff and Philips violated a provision in the law — Section 20(a) — that makes them liable as “controlling persons” for aiding and abetting securities violations.

Kathleen Phillips photo hero

Kathleen Philips, former Zillow CFO | Credit: Zillow Group

Last week, on Friday, April 19, Coughenour denied that motion to dismiss, saying the plaintiffs had alleged “particularized facts” that show Zillow designed the co-marketing program to violate RESPA, that Zillow was instructing and encouraging agents and lenders to commit such violations, that the defendants made material misleading statements regarding the co-marketing program’s compliance with RESPA, that those statements were “deliberately reckless” and that the statements caused the loss alleged by the plaintiffs.

According to the court filing, the plaintiffs made their case in part through the testimony of two anonymous witnesses who used to work for Zillow as a regional sales manager and a sales and operations trainer, respectively.

The first anonymous witness alleged that co-marketing lenders received fewer leads than their co-marketing agents (a fact Zillow did not dispute) but continued to participate in the program because “lenders expected real estate agents to refer business” and recouped their advertising costs through those agent referrals rather than Zillow leads.

The witness also alleged that some agents provided co-marketing lenders with access to their Zillow accounts, so that lenders could obtain the agent’s leads in cases where prospective buyers had opted-out of providing their contact information to the lender.

The second anonymous witness said that “everyone knew that the lenders paid the agents for leads and referrals” and that Zillow trained its sales reps to “track the number of referrals lenders received from the co-marketing program.”

Moreover, Zillow sales reps contacted every agent customer quarterly to ask the agents “how much they did in lender referrals” and the witness was aware of at least one case where a lender had been paying 100 percent of the agent’s marketing costs on Zillow for about 2.5 years.

Whenever the witness spoke to Zillow about potential concerns with the co-marketing program, she was allegedly “reminded not to ask questions,” according to the court filing.

“Based on the anonymous witnesses’ statements, as well as the other allegations in the second amended complaint, the Court can draw a reasonable inference that Zillow designed the co-marketing program to allow agents to provide referrals to lenders in violation of RESPA, and that such referrals were occurring,” Coughenour wrote.

Later, Coughenour‘s decision states: “Further, the second amended complaint plausibly alleges that RESPA violations were occurring, based on the anonymous witnesses’ testimony regarding how participants were using the co-marketing program and the structure of the program itself. Defendants’ arguments to the contrary are unavailing.”

According to his order, the co-marketing program originally allowed a single lender to pay up to half of an agent’s advertising costs on Zillow and up to five lenders to pay up to 90 percent of an agent’s costs, but Zillow changed this policy at the beginning of 2017, allowing multiple lenders to collectively pay no more than half of an agent’s costs on Zillow. But according to the second anonymous witness, in practice, Zillow allowed lenders in the co-marketing program to evade that cap. When the witness reported to superiors that that practice might violate RESPA, the witness was allegedly told that the company had “bigger issues to deal with.”

Philips and Rascoff also failed to disclose that they had changed the co-marketing program in response to the CFPB’s investigation and the company hid this change from the public by not updating its website, the complaint said.

Rascoff was similarly misleading in saying “[w]e think the way we’ve constructed the program is completely compliant and allows agents and lenders to stay within the confines of the laws that govern this,” according to Coughenour.

“Viewing these allegations holistically, the Court can infer that Phillips and Rascoff were at least deliberately reckless in continuing to make statements that the co-marketing program was legally compliant,” he wrote.

RESPA includes a “safe harbor” provision that shields payments made at market value for services actually performed. But the second amended complaint alleges that Zillow’s co-marketing program was not protected by this provision “because it permitted lenders to pay a greater share of the marketing budget than is justified by the number of leads provided by the program.”

Asked for comment, a Zillow Group spokesperson told Inman in an emailed statement,”We are disappointed that the court, after a favorable ruling last fall, has allowed the suit to move forward. We believe the claims in the suit to be without merit and intend to vigorously defend ourselves against the lawsuit.”

The lawsuit seeks class-action status on behalf of Zillow Group investors who acquired or purchased Zillow securities from November 17, 2014 to August 8, 2017.

Email Andrea V. Brambila.

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