The Clock Is Ticking:

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1 January Authors: Phillip L. Schulman Holly Spencer Bunting K&L Gates comprises approximately 1,700 lawyers in 28 offices located in North America, Europe and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations and public sector entities. For more information, visit The Clock Is Ticking: Two Lawsuits Seek to Enjoin Final RESPA Rule After the U.S. Department of Housing and Urban Development ( HUD or Department ) issued its final rule on November 17, 2008 to reform the Real Estate Settlement Procedures Act ( RESPA ), two groups appeared to fare the worst based on the Department s RESPA changes mortgage brokers and home builders. More specifically, despite strong objection from mortgage brokers, HUD finalized its plan to require broker fees, or yield spread premiums, to be separately disclosed on the Good Faith Estimate ( GFE ) as a credit to the total origination charges. In addition, HUD amended the definition of required use as applicable to affiliated business arrangements to prohibit only home builders from offering customer incentives and linking those incentives to the consumer s use of affiliated companies. In both instances, the Department appeared unwilling to compromise, which many viewed as a direct attack against mortgage brokers and home builders. Thus, rather than wait for future congressional or regulatory amendments to the RESPA rule, both mortgage brokers and home builders have turned to the courts for immediate intervention. On December 19, 2008, the National Association of Mortgage Brokers ( NAMB ) filed suit against HUD in the U.S. District Court for the District of Columbia for permanent injunctive relief to prevent the Department from enforcing the final RESPA rule. 1 Three days later, on December 22, 2008, the National Association of Home Builders ( NAHB ) sued HUD in the U.S. District Court for the Eastern District of Virginia in search of both a preliminary and permanent injunction against the Department s enforcement of the required use provision. 2 While the NAMB and the NAHB have different reasons to block the final RESPA rule, both have similar arguments that is, the Department acted arbitrarily and capriciously in its decision making and failed to state adequate reasons for the restrictions it created in the rule. The NAHB suit, at least, has HUD s attention since the Department agreed on January 7, 2009 to extend the effective date of the required use provision until April 16, 2009 This Client Alert summarizes the arguments made in these two lawsuits, as well as the effects these suits may have on the future of the final RESPA rule. I. NAMB Disclosure of Broker Compensation Despite the January 1, 2010 effective date for the revised GFE and accompanying disclosure of yield spread premiums, the NAMB wasted no time in challenging the Department s authority to target mortgage brokers compensation and require its disclosure in a manner different from that required of mortgage bankers. In its lawsuit filed on December 19, 2008, the NAMB has asked the court to permanently enjoin HUD from enforcing all provisions of the final rule based on a number of legal grounds. The NAMB claims the final RESPA rule singles out mortgage brokers and is arbitrary and capricious, is not reasonably supported by HUD s explanations and justifications, is contrary to RESPA s interpretations and judicial precedent, and will result in irreparable harm to the NAMB and its members. 3 These arguments surround the perceived differences in mortgage broker and mortgage lender origination charges. However, as the NAMB explains in its complaint, the

2 differences result from the same calculation against the par interest rate, which should result in consistent disclosures. Notably, just as brokers are paid through yield spread premiums, which represent the premium a lender is willing to pay to purchase a loan with an interest rate that is above the lender s par rate, 4 the NAMB emphasizes in its complaint that lenders similarly recoup the cost of fronting settlement costs by selling mortgage loans on the secondary market for a price that represents the difference between the interest rate on the lender-originated loan and the purchaser s par rate. In fact, the NAMB states that HUD has explicitly recognized that the sale of lender-originated loans on the secondary market achieves the same purpose as lender payments to mortgage brokers, or YSPs; the payments are functionally equivalent. 5 Accordingly, by requiring the separate disclosure of broker compensation under the final rule, the NAMB claims that the final rule does not satisfy RESPA s purpose, which is to provide consumers with more effective disclosures of settlement costs and protect them from unnecessarily high settlement charges. Without a rational basis for the Department s decisions, the NAMB requests that the court block the final RESPA rule. Although the NAMB notes in its complaint that certain aspects of the final rule become effective January 16, 2009, the applicable GFE and HUD-1 Settlement Statement ( HUD-1 ) disclosure provisions will not be effective until The NAMB, therefore, does not ask the court to grant it any immediate relief from the rule (despite the fact that it seeks an injunction applicable to the entire RESPA rule). The NAMB s arguments also appear to be repetitive of the arguments it has been making since HUD first proposed the separate disclosure of broker compensation in its 2002 attempt at RESPA reform. While the Department may actually favor full disclosure of mortgage broker and mortgage banker compensation on the GFE and HUD-1, HUD recognizes it is limited by the secondary market exemption to RESPA. In other words, any fees that a lender receives in connection with the sale of a loan in the secondary market are exempt from RESPA s Section 8 requirements. Accordingly, HUD is likely to claim there is no legal basis to require a mortgage banker s secondary market fees to be disclosed on the GFE or HUD-1, and the Department is unlikely to back away from its position on the disclosure of broker fees. With no expedited timeline for this litigation, it remains to be seen whether a court will find the NAMB s arguments persuasive or enjoin enforcement of the entire final rule based on objections to the disclosure of mortgage broker compensation. II. NAHB Required Use In a race against the clock, the NAHB, as well as a number of home builders and their affiliated mortgage and title companies, filed suit against HUD on December 22, 2008 to ask the court to both preliminarily and permanently enjoin the Department s enforcement of the required use provision in the final rule, which becomes effective January 16, Like the NAMB, the NAHB claims the Department acted contrary to RESPA s statutory requirements and in an arbitrary and capricious manner without rationale, reasoning, or explanation to justify the final rule. 6 Unlike the NAMB, however, the NAHB focuses solely on the final rule s required use provision. The NAHB complaint is based upon one aspect of the revised required use definition namely, that home builders are prohibited from offering customer incentives linked to the consumer s use of affiliate companies. As settlement service providers are not similarly restricted, the NAHB emphasizes in its complaint that HUD singles out home builders, who have long created affiliated companies in reliance on the ability under RESPA to offer bona fide incentives to encourage consumers to use affiliated companies. 7 The NAHB makes five primary arguments as to why the court should enjoin enforcement of the final rule s required use provision. First, the NAHB cites to the time and cost savings affiliated companies afford builders and their customers when consumers elect builder incentives and the use of affiliate companies. 8 Second, the complaint details the Department s long-standing acceptance of builder-affiliate incentive arrangements and their compliance with the affiliated business arrangement requirements of RESPA. 9 Third, NAHB claims that the Department s explanations for changing the definition of required use are not supported by the administrative record. For instance, the NAHB January

3 cites to HUD s quotation of the NAMB to suggest that builders affiliated mortgage lenders offer higher interest rates. Yet, the NAHB also indicates that HUD has conceded that there are consumer-realized efficiencies in affiliated business arrangements. 10 Fourth, NAHB s complaint details various examples of the ways in which the Department failed to respond to public comments, including comments from another federal agency that suggested HUD should reconsider its proposed revision to required use. The complaint details a number of studies that were discussed in the public comments that the NAHB suggests support the allowance of builderaffiliate incentive arrangements. 11 Finally, the NAHB suggests that HUD itself is unsure of the true effects of the final rule, as it has informally provided guidance to builders on how to comply with the required use provision and subsequently withdrawn that guidance. 12 With these arguments as a foundation, NAHB asks the court to take immediate action to stop the required use provision from taking effect on January 16, Given the short period of time before the rule becomes effective, and the substantial changes home builders will be forced to make to their standard business models to comply with the rule, the U.S. District Court for the Eastern District of Virginia is likely to pay close attention to this case. Moreover, with two lawsuits filed against the Department in three days regarding the final rule, HUD may be taking a few steps in retreat. In fact, in response to the NAHB s request for a preliminary injunction, the Department has agreed to delay implementation of the final rule s required use provision until April 16, This is an immediate victory for home builders, who may continue to offer customer incentives linked to the use of affiliate companies until April. But, what happens next is anyone s guess. By agreeing to postpone implementation of the required use provision, the Bush Administration has tossed this hot potato to the incoming Obama Administration and, at the same time, avoided any embarrassment of a preliminarily enjoined rule. At this point, the Department could take one of several approaches. The new Administration could decide to revise the final rule, which would require a new notice and comment period under the Administrative Procedure Act to make any changes to the regulations. The new Administration also could opt for withdrawing the required use provision of the final rule, which would leave the current definition of required use in place. This course of action avoids the need for further public notice and comment. Or, HUD may be prepared to spend the next 90 days marshaling their defenses in support of the positions it took in the final rule. In any case, the RESPA rule is not likely to be a top priority for the new Administration, and, much like the NAMB s lawsuit, it remains to be seen whether the court will agree with the NAHB. If you have any questions about the final RESPA rule or the lawsuits discussed herein, or you would like a more detailed explanation of the final RESPA rule s changes, please contact Phillip L. Schulman (202) / phil.schulman@klgates.com or Holly Spencer Bunting (202) / holly.bunting@klgates.com. Endnotes 1 See National Association of Mortgage Brokers, Inc. v. Preston, No. 08-cv (D.D.C. filed Dec. 19, 2008) (hereinafter NAMB v. Preston ). 2 See National Association of Home Builders, et al. v. Preston, No. 08-cv-1324 (E.D. Va. filed Dec. 22, 2008) (hereinafter NAHB v. Preston ). 3 See NAMB v. Preston, No 08-cv-02208, Compl Id., Compl. 19, Id., Compl See NAHB v. Preston, No. 08-cv-1324, Compl See id., Compl See id., Compl See id., Compl See NAHB v. Preston, No. 08-cv-1324, Compl See id., Compl See id., Compl January

4 K&L Gates Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance. For more information, please contact one of the professionals listed below. LAWYERS Boston R. Bruce Allensworth bruce.allensworth@klgates.com Irene C. Freidel irene.freidel@klgates.com Stephen E. Moore stephen.moore@klgates.com Stanley V. Ragalevsky stan.ragalevsky@klgates.com Nadya N. Fitisenko nadya.fitisenko@klgates.com Brian M. Forbes brian.forbes@klgates.com Andrew Glass andrew.glass@klgates.com Phoebe Winder phoebe.winder@klgates.com Charlotte John H. Culver III john.culver@klgates.com Los Angeles Thomas J. Poletti thomas.poletti@klgates.com Miami Paul F. Hancock paul.hancock@klgates.com New York Philip M. Cedar phil.cedar@klgates.com Elwood F. Collins elwood.collins@klgates.com Steve H. Epstein steve.epstein@klgates.com Drew A. Malakoff drew.malakoff@klgates.com San Francisco Jonathan Jaffe jonathan.jaffe@klgates.com Erin Murphy erin.murphy@klgates.com Seattle Holly K. Towle holly.towle@klgates.com Costas A. Avrakotos costas.avrakotos@klgates.com Melanie Hibbs Brody melanie.brody@klgates.com Daniel F. C. Crowley dan.crowley@klgates.com Eric J. Edwardson eric.edwardson@klgates.com Anthony C. Green anthony.green@klgates.com Steven M. Kaplan steven.kaplan@klgates.com Phillip John Kardis II phillip.kardis@klgates.com Rebecca H. Laird rebecca.laird@klgates.com January

5 Laurence E. Platt Phillip L. Schulman H. John Steele Ira L. Tannenbaum Nanci L. Weissgold Kris D. Kully Morey E. Barnes David L. Beam Emily J. Booth Holly Spencer Bunting Krista Cooley Elena Grigera Melissa S. Malpass David G. McDonough, Jr Stephanie C. Robinson Kerri M. Smith David Tallman Director of Licensing Stacey L. Riggin Regulatory Compliance Analysts Dameian L. Buncum Teresa Diaz Jennifer Early Robin L. Gieseke Allison Hamad Joann Kim Brenda R. Kittrell Dana L. Lopez Patricia E. Mesa Jeffrey Prost K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and maintaining offices throughout the U.S., in Berlin, in Beijing (K&L Gates LLP Beijing Representative Office), and in Shanghai (K&L Gates LLP Shanghai Representative Office); a limited liability partnership (also named K&L Gates LLP) incorporated in England and maintaining our London and Paris offices; a Taiwan general partnership (K&L Gates) which practices from our Taipei office; and a Hong Kong general partnership (K&L Gates, Solicitors) which practices from our Hong Kong office. K&L Gates maintains appropriate registrations in the jurisdictions in which its offices are located. A list of the partners in each entity is available for inspection at any K&L Gates office. This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved. January