By Dennis H. Doss
There is nothing worse than looking up your name on the website of the California Bureau of Real Estate and seeing a disciplinary action listed there. It got there because you were audited by the BRE. It found that, although you did not lie, cheat or steal, your compliance with its many technical rules was less than perfect. So it filed a case against you called an Accusation.
On one hand, you have to see things from the BRE’s standpoint. Brokers can handle millions of dollars in broker-controlled escrows and loan servicing accounts with no minimum net worth, bonding or insurance. There is no other state where this is possible. Brokers are allowed to sell investments to private individuals and do a substantial loan volume, either as a lender or a broker, all without minimum net worth, bonding or insurance.
But, on the other hand, the BRE can be too aggressive. Case in point: we are currently defending an Accusation against a mortgage fund manager where the only mistakes he allegedly made was: (a) failing to have the company’s license number on business cards and business purpose loan applications, (b) failing to register as a dba his company without the ending “Corp.,” and (c) not giving a Lender/Purchaser Disclosure Statement to himself as the fund manager. That is major nitpicking. In contrast, if a lender operates under a California Finance Lender’s license, it can expect an audit by the Department of Business Oversight every three years. Every CFL lender must pay for the audit even if no errors are found. Unless something is seriously amiss, the DBO generates a report pointing out any errors. The licensee is then expected to write back saying it will correct things going forward and pay the audit bill. That is it. One big difference is that the BRE charges licensees for audits only as part of a settlement of an Accusation. In other words they only get paid if they file formal disciplinary charges. The current law gives them a financial incentive to file Accusations rather than issue constructive suggestions for correction like the DBO.
This article would become a book if we listed everything a mortgage broker could do wrong. So we decided to list the ten most common violations we have watched the BRE seize upon, in no particular order of notoriety:
- Trust Fund Violations. If you touch a borrower or an investor’s money, you are handling trust funds, even if you don’t deposit the money. You can only collect a credit report fee and appraisal fee before a loan is made. Advance fees are forbidden. If you can’t get the borrower to pay the appraiser directly, you must put the borrower’s money into a BRE trust account and pay the appraiser from that account. If you have prepaid the appraiser when the borrower’s check arrives, the money belongs to you so it has to go into your general account, not your trust account. If you service loans for your private investors, you better make sure that only BRE licensees can sign on the account and that monthly reconciliations are performed showing who the money belongs to. Don’t miss a quarterly trust fund report to the BRE or your annual CPA audit and report. If you sell a loan you own to a private investor, don’t put the money into your trust account. It is your money because you sold an asset you owned so the money should go into your operating account and not comingled with other client money in your trust account.
- Missing Borrower and Lender Disclosures. Every loan file should contain a borrower signed (ink) signed Mortgage Loan Disclosure Statement. If you sell loans to private investors or allow them to fund loans you have arranged, you should have a current Investor Questionnaire signed by the investor and a Lender/Purchaser Disclosure Statement (ink) signed by you and the investor.
Investor Questionnaire: http://www.dre.ca.gov/files/pdf/forms/re870.pdf
Lender/Purchaser Disclosure Statement: http://www.dre.ca.gov/files/pdf/forms/re851a.pdf
The BRE doesn’t have a form for it but you are required to obtain a statement from every investor that the particular trust deed investment does not exceed 10% of their net worth (excluding home). In addition, you have to disclose in writing the securities exemption your are relying up, e.g., Multi-Lender Rule in Business and Professions Code 10238.
- Threshold Reporting. It doesn’t take a lot of origination or servicing volume to become a threshold broker. When you hit that volume you are required to file with the BRE a Threshold Notification and commence quarterly trust fund reports (even if you don’t handle trust funds). You can see the volume figures and forms at the link below.
- Advertising. Advertising, in the eyes of the BRE, includes the usual things like TV, radio, newspapers, but also business cards, loan applications, emails, letterhead, flyers and websites. They are all required to have your license number and the BRE’s name and a descriptive word like “broker,” “agent,” “loan correspondent.” For more details on naming conventions, see the link below on the BRE’s website.
- Advance Fees. Forbidden. As mentioned above, you are only allowed to collect a credit report fee and appraisal fee before a loan is made.
- Unregistered DBAs. The BRE takes the position that any name you use that is not exactly the name you have registered with it, is a fictitious business name (DBA) that must be registered. So, if you tend to abbreviate your company name or drop the “Inc” or “Corp” you should file a DBA and register it with the BRE. Register a DBA at the link below after you have made your necessary county filings.
- Trust Account Overages, Shortages. Under BRE Regulation 2835 you are only allowed to have $200 of your own money in a trust account. If you deposit a check representing money partially owed to you, withdraw your portion immediately. Withdraw your servicing fees before the monthly statement date on your account. If a borrower’s check bounces after you have distributed the money it represents to an investor, replace it with your own money so you don’t have a shortage. When the check is good or replaced, pull your money out immediately. Better yet: avoid trust funds and hire a subservicer.
- Self Dealing. Becoming a borrower to one of your private investors is not against the law but is discouraged. Under Business and Professions Code 10231.2 you are required to write to the BRE and send them a completed and signed Lender/Purchaser Disclosure Statement and reference to 10231 at least 24 hours before taking money from the private investor. From experience, this kind of letter is likely to trigger an audit.
- Not Recording Trust Deeds. The BRE has no sense of humor when it comes to brokers who neglect to record trust deeds into the names of their private investors. Business and Professions Code Section 10234 requires that trust deeds be recorded before the investor’s funds are disbursed when making a new loan or within 10 working days when selling them an existing loan. However, if the broker owns the loan he or she is selling, the recordation of the assignment of the deed of trust must be immediate.
- Taking Money for Unspecified Investments. Mortgage brokers are not banks. They are prohibited by Section 10231 of the Business and Professions Code from taking or holding investor money until they have selected a trust deed loan and the investor has signed a Lender/Purchase Disclosure Statement disclosing the details of that particular loan.
It would be refreshing if the BRE adopted a more constructive approach to discipline following audits. As their budget tightens, they have tended to file more Accusations as a means of recouping audit costs. If the law were changed to simply pass the costs of all audits onto licensees, we think the pressure would lessen. We don’t see that happening soon so be diligent in your compliance. You can also hire a private compliance consultant to spend a day in your shop to give you a quick checkup.
This article is intended as educational material not legal advice. Consult a knowledgeable lawyer before implementing any of the ideas in this publication.