Has RESPA Run Amok?

Here at ComplianceAction, we are getting a lot of questions about RESPA enforcement. Some of these questions seem pretty wild to those of us who were around at the creation of RESPA.

Back when RESPA was invented, the idea was two-fold: to eliminate (or at least mitigate) settlement shock by telling customers in advance of closing what size check they should bring to closing, and by making illegal any relationships or business arrangements that added unnecessary costs to closing.

A lot has changed since RESPA was first enacted, but RESPA hasn't moved with the changes, even when they bring advantages to the customer. Here's one of the current problems. The Flood Hazard Insurance Act requires lenders to determine whether improved real property that will secure a loan is located in a flood hazard area. To do this, the Act and FEMA encourage lenders to use vendors - third party companies that are proficient at this work and who stand behind their work and guarantee it.

Now, when a bank identifies property that needs to be reviewed for flood hazard location, it isn't going to go out and shop for a vendor for each loan. The only way to manage this efficiently is to identify a company that suits the bank's needs, taking into account proven performance, cost, efficiency and speed for turn-around. When the bank finds such a vendor, it usually enters an agreement that includes negotiating for a good price and service.

When the Flood Hazard Insurance Act was revised, it generated a business opportunity for vendors. Companies sprang up out of the primal swamp and went into business. Suddenly, flood hazard certification was wildly competitive.

Flood vendors came knocking at banks' doors offering services and deals. Bottom line: costs went down for consumers, flood certification was working, and things seemed pretty good.

Enter the Ambitious Examiner. An Ambitious Examiner is one who is looking for a way to be noticed by the powers that be (in his or her agency) and believes - probably correctly - that the way to get noticed is to find violations. And when you are looking for new and interesting violations, RESPA has some fertile ground to work with.

Here's what is happening. Examiners are finding fault with flood certifications in two primary ways. First and least important, they are raising concerns about the fact that the flood vendor is a required service provider. You can deal with this one by including the required service provider notice on the Good Faith Estimate.

Second, and pretty lethal, is the position that any benefit offered to the bank by the flood vendor, such as a free or low-cost review of the bank's existing portfolio, is a kickback - a pay-a-criminal-fine-or-go-straight-to-jail kind of violation. According to these examiners, the arrangement is illegal because the bank is receiving a free service from a settlement service provider. And RESPA says you can't do that!

Wait a minute - what is happening here? All the bank did was shop for a good deal. Moreover, the primary beneficiary of the good deal was the customer - the borrower. However, these examiners don't seem to have consumer benefits in their sights. They are looking only at and for violations.

Let's go back to the beginning for a moment. What RESPA was designed to do was protect consumers from deals that were made by settlement service providers and essentially concealed from the consumer. They were arrangements that lined the pockets of the parties involved by taking the money out of the consumer's pocket.

Now, with that bit of history and perspective, let's look at what is going on in today's compliance nightmare. The bank must obtain a flood hazard certification on improved real property that will secure a loan. Congress designed this process to improve the insurance levels and to reduce the strain on disaster relief funds. Given the recent consequences of Hurricane Floyd, there are lots of consumers - and banks - who should be grateful for their insurance.

In the same legislative move, Congress added warnings to lenders about the existing portfolio but did not take as broad-reaching a solution. Essentially, Congress left the bank to decide whether to review the portfolio. But, because certification of loans in portfolio is not mandatory - or for some other reason we cannot discern - the lender may not generally pass on the cost of a portfolio certification to the customer. The bank has a choice of eating the cost or taking the risk.

Enter the flood vendor eager for business who offers to review the portfolio for free. An answer from heaven!

This is a situation in which everyone benefits - the bank, the vendor, and the consumer. But that makes no difference to the ambitious examiner who sees an opportunity to write up an interesting and even esoteric compliance violation. Better yet, it involves possible criminal sanctions! What more could an ambitious bureaucrat ask for? The fact that the bank negotiated a favorable or even below-market rate is irrelevant. The fact that the law requires this service and creates new risk in the bank's portfolio is irrelevant. The law is the law.

Now let's look at the remedy. These imaginative and ambitious examiners have produced the ultimate in absurdity: the bank has to pay for the portfolio certification. Never mind that the bank might not have chosen to purchase a portfolio certification if they had to pay for it. Never mind that this makes absolutely no difference to the immediate customer. Never mind that this raises, not lowers, the bank's cost of doing business and that cost may be passed on to future consumers.

Have we gone nuts???

Copyright © 1999 Compliance Action. Originally appeared in Compliance Action, Vol. 4, No. 11, 10/99