Will these changes provide opportunities — or challenges — to those selling interests in notes secured by deeds of trust and similar investments?

Over the past 25 years, many new forms of securities offerings of interests in notes secured by deeds of trusts or “pool” arrangements for notes secured by deeds of trust have been created, some of which rely on rules that exempt the seller of the security from the necessity of obtaining qualification from state or federal authorities.

The changes effected by the JOBS Act relate to two types of exemptions, the exemption under Rule 506, commonly known as “Reg D,” and the less familiar “Reg A.”

First, let’s establish what the new rules DO NOT do. They DO NOT present an opportunity for new business models. The rules may best be summarized as providing some opportunity, but only with new and additional restrictions.

For more information, please read this summary, prepared by Bruce Methven, Esq. (His web site: http://www.methvenlaw.com)

Here are a few key issues to consider:

1. Will I be able to publicly advertise my security offered under a Rule 506 exemption?

While it is true that some form of advertising will be allowed under the yet unpublished rule, the new rule also changes how sellers of securities who use advertising will assure that the investors meet the threshold of being an “accredited investor” (that is, someone with a net worth of more than $1,000,000 exclusive of home and furnishings, or income over $300,000—per couple—for at least the past two years). The Act requires the SEC to issue regulations that “require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors” when advertising is used.  Instead of relying on statements signed by the investor, the seller of the security who uses advertising will have to verify the net worth and income, although it’s not known yet what will be required in the way of verification. Failure to accurately verify will, of course, result in possible liability for securities fraud.

For Rule 506 offerings that use advertising, this means that the level of due diligence will be increased to certify that investors are exempt. Self-certification, which is the case now, will not be allowed if the offering is advertised.

Also, until the SEC issues new regulations, the old regulations remain in place and no advertising can be done.  In addition, the new regulations may well limit advertising to ONLY “public tombstone” ads, which are standard in the industry.

Of course, no one yet knows what the regulations that the SEC will adopt will look like.

These regulations may have a substantial effect on the public advertising and “Affiliates” provisions.

Our advice: DO NOT to take any sudden action now—such as hiring counsel and starting up a new business model—but rather wait to see what the rules actually state.

2. Can I sell my security offered under Regulation D (Rule 506) to more investors?

While the new rules MAY allow a company to have more than 500 investors, the raising of this limit does not in any way impact the question of what the minimum investment should be by each investor. This is a much more complicated issue relating to suitability, which is the impetus for our counseling caution, and represents another fine point that some attorneys may choose to ignore in order to generate business during this period wherein the rules are not clearly defined.

3. Can I use Regulation A+ to offer securities on a national basis?

It is likely that Regulation A+ will be of limited or no use to real estate brokers. The old Regulation A allowed companies to raise $5,000,000 with less disclosure and compliance than a full SEC registration, although most states have not adopted exemptions that fit well with Regulation A. The limit has been raised to $50,000,000, but most, if not all, competent securities lawyers would advise that the Regulation A procedure is inappropriate for real estate brokers or CFLs. Simply put, the purpose of Regulation A is NOT to allow brokers (who may not meet the SEC’s requirements) to find lenders (who may not meet the SEC’s requirements) to fund pools of loans nationally.

The problem is, unlike with crowdfunding and the public advertising of Rule 506 offerings, this “Small Issues” (Section 401) exemption only preempts state law if either the securities are 1) offered or sold on a national securities exchange—which means going public; or 2) are sold only to “qualified purchasers.”

A “qualified purchaser” is defined as:

• a person with more than $5 million in investment;
• a company with more than $5 million in investments owned by close family members;
• a trust, not formed for the investment, with more than $5 million in investments;
• an investment manager with more than $25 million under management; or
• a company with more than $25 million of investments.

That’s a much higher standard than “accredited investor,” which requires only $1 million in net assets or $200,000 in annual income (or $300,000 in annual income with a spouse).

We are exhorting our readers and our clients to read this article and then make up your own minds about what tools are available now and what tools may be available in the future.

Before you decide this may be the time for a new business model, we recommend that you consult with competent securities counsel.

If you would like assistance with finding and selecting counsel, please e-mail us at info@the3wisemen.

An analysis of new legislation that will require brokers to qualify their investors before taking their money.

Read on to learn more about what changes to expect and how you can access new tools to protect yourself and your business now. Please be sure to take advantage of the free offer located at the bottom of this message.

For at least ten years I have been preaching to the mortgage brokerage industry that every day the members were acting less like real estate brokers and more like securities dealers.  My diatribe goes back to my being a member of the committee—appointed by then-Governor Jerry Brown (in his first iteration)—that wrote the original multi-lender rule.  The Department of Corporations (“DOC”) made clear that the sale or brokerage of a note secured by a deed of trust was and is the sale of a security.

In California, all securities have to be registered with the Department of Corporations (so called public offerings) or sold pursuant to one of several exemptions, including but not limited to the so-called private placement exemption found in Corporations Code Section 25101(f).

Of course the multi-lender rule (which was subsequently codified in Business and Professions Code Section 10237 et. seq. provided an exemption from the necessity of registering or qualifying the sale of the security, the note secured by deed of trust, if the sale was limited to ten or less investors and all of the other requirements of disclosure and reporting were followed.

In the last 10 years, many real estate brokers have decided to use the securities qualification or exemption to allow the sale of notes to more than ten investors and to carry out so called “business plans” that were beyond those allowed under the multi-lender rule.  Some of these securities allowed the division of the note into unlimited shares, allowing the sale to as many as 250 investors in a single loan, allowed construction and entitlement loans that exceeded the $2,500.000 limit, and in other ways sought to provide for business plans that were beyond what was authorized by the statutory exemption.

I am sure that the purveyors of these designed-business-plan programs were well intentioned, but the recent times have found that a number of the companies using such exemptions have not performed as intended, resulting in losses to investors.   These issues have come to the attention of the Department of Corporations and the Department of Real Estate based on complaints from investors, news stories, and other venues.

The result is that the DOC is proposing legislation that they believe will deter the sort of conduct that caused the problem.  In analyzing the problem, the Department found three key areas to address:

1.     That brokers need to understand that because they are selling a security, they have the same duty as a stock broker: the “know your customer rule.”   This rule is a foundation of the regulation of the securities industry.  Too often brokers have been told that all they need to do is make sure that a lender checks the box on the Lender/Purchaser Disclosure statement averring that the loan being purchased does not exceed 10% of the investors net worth or in the case of a public or private offering, simply sign the subscription agreement attesting to meeting whatever income or net worth requirements are set forth in the offering.

The DOC asserts, and I believe correctly, that this far understates the duty of one selling an investment.   The seller has duties, which include verifying that the proposed investment is suitable for the risk profile of the investor, and that the financial condition of the prospective investor is appropriate for the risk to be undertaken.

A brief example:  A widow whose entire net worth, other than the equity in her house is $1,000,000 from a life insurance policy.    Assume she purchases 10 interests in 10 notes each of $100,000.  The widow can correctly check the box that each investment does not exceed 10% of her net worth, but such an allocation of risk is completely inappropriate.   If the real estate market goes down, as it did, the widow’s entire net worth could be in jeopardy.
Another simple example: An investor purchases an interest in a large second trust deed, behind a large first trust deed on a commercial property.  The investor lives off the income of trust deed investments and has only limited liquid assets.  Without any investigation of the ability of the investor to meet cash calls to protect his investment, such as advances to prior encumbrances or taxes, the seller has placed this investor and perhaps all others in the transaction at risk, for the failure to assess the ability to meet calls for advances.

See Senate Bill 978 as amended March 15, 2012.  The bill adds the following requirements to a broker selling or brokering any interest in a note secured by deed of trust:

a.     Assure that the purchaser can bear the economic risk of the investment
b.     That the investment is suitable, given the purchaser’s investment objectives, portfolio, and financial situation
c.     The broker must obtain information about the investor that includes at least the age, investment objective, investment experience, income, net worth, financial situation and must maintain a record of this information for four years.

The DOC envisions the use of a questionnaire to gather the information that is described.  Such a form has been in use by the general securities industry for many years.

See important note at the end of this article regarding tools to use today to meet your duties and protect yourself from lender lawsuits.

2.     That whatever rules and limitations that applies to a loan sold to two or more investors should also apply to a loan sold to a single investor.  Under their view, the sale of single note to a single investor is no less a security than one sold to multiple investors, and therefore, there is no logic to support having one set of rules for multiple investor loans and a different, more lenient set, for loans sold to a single investor.

3.     In order to regulate the use of the private placement exemption, which the DOC feels has been abused, a new requirement is made that those intending to use an exemption for the sale of interests in notes must file the notice within 15 days of the first sale.  Under the old law there was no penalty for filing of a late notice, even after the sale of all interests was complete.  The failure to timely file is to pay the same fee that would have been due if an offering for a public sale were made, a not insubstantial amount.

The primary purpose for this change is to allow the DOC to collect the names of those filing and to track the volume of these offerings.  No doubt these offerings will be subject to greater scrutiny and audit than in the past.

WHAT CAN I DO?  WILL THESE CHANGES PUT ME OUT OF BUSINESS?

My answer is: no.

When I was a principal in my own mortgage company, under my direction we instituted procedures to gather the information that the DOC is now seeking to require by statute.   While I am confident this bill will pass, it is my opinion that this statue is merely a statement of EXISTING law and not something new.  I believe that every broker has the duty to “know his customer” and to obtain enough information to assess whether or not the investment he is offering is appropriate for the investor.

Perhaps more importantly, the use of this procedure will also help limit liability, especially from those investors who would choose to sue a broker for a bad loan rather than accepting the responsibility for their own decision to invest, and the greed that drives it.   More than one of the brokers I know who have been sued, who used the methods I recommend, report that these procedures have fended off many of the most avaricious and persistent investors and their lawyers.

If you would like to receive a FREE copy of my general advice document, “How to Protect Yourself and Your Investor” — including a FREE draft form of an Investor Questionnaire that meets the requirements envisioned by this statute, please e-mail me at mfeinsteinesq@feinsteinoffice.com.

Asset Seizure

Click this link to view the text of Penal Code Sections 186.11 and 186.12 apparently pursued by the AG and County DAs. AB 1293 was Chaptered on September 30th, 2011. The seizing of assets of white-collar criminals as an enhancement in aggravated fact situations, as defined, may be dangerous for real estate and mortgage brokers, escrow holders, appraisers, developers, and principals of small to moderate sized hedge funds, among others.  Three to four potential felonies are low hanging fruit relatively easy to prove up and establish, e.g., comingling and conversion (even in the context of forming an entity with private parties to acquire interests in real property – equitable, fee, or mortgage and obtaining funds from the public not deposited in trust accounts as the licensee inappropriately claimed to be a principal when the licensee is acting as an agent within the course and scope of the real estate license); recording false documents (which occurs in various forms and fact situations); receiving advance fees (either when expressly prohibited under applicable law or not placed in trust accounts and handled in accordance with the requirements of the Real Estate Law); or issuing securities that have not been properly qualified by exemption or through application and permit. It is my understanding the consumer fraud units of County DAs and of the AG are actively pursuing real estate and mortgage fraud at this time.

Duties to Buyers by Sellers and their Agents

The law is settled in California that Sellers do have duties of disclosure of material facts to Buyers, particularly latent property defects.  The seminal cases include Lingsch v. Savage (1963) 213 Cal.App.2d 729 and Easton v. Strassburger (1984) 152 Cal. App. 3d 90, which gave rise to Civil Code Sections 1102 et seq. and 2079 et seq. Further, the DRE imposes standards on real estate licensees pursuant to B & P Code Sections 10176 and 10177 regardless of whether the licensee represents the principal to the transaction to whom the disclosures are made.  For example, a real estate broker may be the exclusive agent of the Seller but would owe disclosure duties to the Seller and to the Buyer and fiduciary duties in addition to the disclosure duties to the Seller.

Click this link to view a brief overview of the Realtors Code of Ethics. The Code of Ethics obligates Realtors to disclose material facts to both clients and customers. Realtors describe clients as those principals to whom fiduciary duties are owed and customers as those principals to whom disclosure duties are required but to whom fiduciary duties are not owed. The Code of Ethics also includes a section entitled “Duties to the Public”.  This section is intended to apply to any party to a real property or a real property secured transaction in which the real estate licensee is acting within the course and scope of the license. The expanded Code of Ethics and Standards of Practices as promulgated by the National Association of Realtors and should be reviewed to understand adequately the duties and obligations owed by Realtors in real property and in real property secured transactions. The Code of Ethics are instructive for all real estate licensees, whether or not they are a member of the National Association of Realtors.

The mortgage loan servicers identified are required to dedicate at least $20 billion in various forms of relief to homeowners and an approximate additional $5 billion in cash payments to several states and to the federal government. Apparently, the federal government prefers the major banks listed within the settlement to extend directly financial relief to homeowners and at the same time compensate governments at the state and federal level for some of the alleged losses suffered. The settlement does not include Fannie Mae, Freddy Mac, FHA, VA, or Ginnie Mae, as the federal government and its agencies do not wish to contribute taxpayers’ funds to this settlement (which would require Congressional approval).

Equally, the settlement excludes the investors holding the participation certificates evidencing investments in senior and subordinate traunches created when pools of residential mortgage loans were securitized and then sliced and diced with interests therein sold to investors, whether foreign or domestic. While the settlement does not include all mortgage loan servicers, it is apparently expected the procedural requirements will become the standard of or at least an example for the rest of the mortgage loan servicing industry.

A Release of Claims is included within the National Mortgage Settlement.  The following represents the Release language included within the Executive Summary:

“The proposed Release contains a broad release of the banks’ conduct related to mortgage loan servicing, foreclosure preparation, and mortgage loan origination services.  Claims based on these areas of past conduct by the banks cannot be brought by state attorneys general or banking regulators.

“The Release applies only to the named bank parties. It does not extend to third parties who may have provided default or foreclosure services for the banks.  Notably, claims against MERSCORP, Inc. or Mortgage Electronic Registration Systems, Inc. (MERS) are not released.

“Securitization claims, including claims of state and local pension funds, and including investor claims related to the formation, marketing or offering of securities, are fully preserved.  Other claims that are not released include violations of state fair lending laws, criminal law enforcement, claims of state agencies having independent regulatory jurisdiction, claims of county recorders for fees, and actions to quiet title to foreclosed properties.  Of course, the Release does not affect the rights of any individuals or entities to pursue their own claims for relief.”

The provisions within the National Mortgage Settlement designed to assist homeowners should be reviewed for their application to each fact situation.

In his most recent Budget Proposal, Governor Brown has included plans to consolidate all businesses in the financial industry under one head. He proposes the elimination of the Department of Real Estate and the Office of Real Estate Appraisers and placing jurisdiction of these licensees under the Department of Consumer Affairs. At the same time the Department of Corporations and the Department of Financial Institutions will be merged into one new entity called the Department of Business Oversight.

It seems that the Governor wants the consumer groups to limit the operations of the mortgage brokers, and the regulators of the big banks to regulate all the lenders and securities dealers.

These changes may well result in the elimination of the opportunity for real estate brokers to arrange loans for private investors.

Please see the analysis, by Guy Puccio, below.

We welcome your comments on this issue.

As you may know, Governor Brown is proposing to shut down a number of offices and the consolidation of a number of departments and agencies in the Executive Branch of state government.  Included is the apparent restructuring of BT&H into a new Department of Business and Consumer Services. Consolidation of DFI and DOC will likely shift most of the control of the industries and the services previously regulated by the DOC to the large banks, savings banks, and thrifts.

I am concerned about the proposal to eliminate the DRE and the OREA and to transfer their licensing function to Bureaus within the Department of Consumer Affairs (“DCA”). The better option would be to consolidate DRE and OREA and leave the DRE as an independent department under the proposed Department of Business and Consumer Services. The second option is to create a separate division within the proposed consolidation of the DFI and DOC consistent with the proposal for consolidation submitted to the previous administration.

A subsequent clarification has been issued regarding mortgage brokers who would be separated from the DRE and restructured within the consolidated entity, i.e., the proposed Department of Business and Consumer Services. The remaining licensing functions of the DRE would be transferred to a bureau within the DCA.

In my opinion, the regulation of the real estate and mortgage brokerage industries is a complex endeavor and not an activity with which the DCA has any recognized experience.

Will this consolidation plan shift most of the enforcement to the feds and to the California AG removing the legal section of the DRE that is currently responsible for the enforcement of the Real Estate Law? This is similar to a proposal advanced by Governor Brown when he was Attorney General.

The following are excerpts from the recently-released Governor’s Budget Proposal:

Consolidate Oversight of Financial Businesses into a Single Department —

The Department of Corporations regulates a variety of entities involved in the financial industry including securities brokers and dealers, mortgage lenders that are not affiliated with banks, and financial planners. The Department of Financial Institutions regulates state‑chartered banks, credit unions, and money transmitters.  This proposal eliminates the Department of Financial Institutions and the Department of Corporations and consolidates their functions into a new Department of Business Oversight because both of these departments perform the same fundamental mission (i.e. the licensing and regulation of business entities). The new Department will be part of the Business and Consumer Services Agency.

Consolidate Professional Licensing Functions within the Department of Consumer Affairs —

The Department of Real Estate and the Office of Real Estate Appraisers license and oversee professionals, which is the core function of most of the bureaus in the Department of Consumer Affairs (DCA). This proposal eliminates the Department of Real Estate and the Office of Real Estate Appraisers and places them as bureaus under the DCA in order to achieve administrative savings and efficiencies. Similarly, the Structural Pest Control Board and the Board of Chiropractic Examiners will be placed under the DCA.

I: The Appraiser Qualifications Board (AQB) has issued the following Exposure Draft:

Fifth Exposure Draft of Proposed Revisions to the Real Property Appraiser Qualification Criteria

Link: https://appraisalfoundation.sharefile.com/d/s37bad6cf5694643b

Written comments requested by December 5, 2011

Send Comments to AQBComments@appraisalfoundation.org

II: The Appraisal Practices Board (APB) has issued the following Exposure Draft:

First Exposure Draft: Residential Appraising in a Declining Market

Link: https://appraisalfoundation.sharefile.com/d/sbdb218d49bc48c6a

Written comments requested by December 5, 2011

Send Comments to APBcomments@appraisalfoundation.org

The Appraisal Foundation

The 3 Wise Men invite you to post your comments here so that we may engage in a discussion with you here. We will also collect and submit your thoughts to TAF along with our commentary.

Link to the document under consideration:

Communication and Reporting Discussion Draft

Email address for sending comments directly:

ASBComments@appraisalfoundation.org

Details (from The Appraisal Foundation):

Those who have followed the work of the Appraisal Standards Board (ASB) over the last several years are aware of the Board’s continued efforts to properly address the topic of communication and reporting in appraisal practice.  This includes, most recently, proposed revisions for the 2012-13 edition of USPAP that appeared in the first two exposure drafts during the last publication cycle, but ultimately were not adopted because the ASB believed additional information was needed to properly address public trust and avoid any significant unintended consequences.

Nevertheless, the Board continues to believe this is an important issue as there is a demonstrated need for a clearer understanding of an appraiser’s responsibilities when communicating within appraisal practice…. When commenting on various aspects of this discussion draft, it is very helpful to reference the line numbers, fully explain the reasons for concern or support, provide examples or illustrations, and suggest any alternatives or additional issues that the ASB should consider.

Click the bill titles to download the full text PDFs.

As of today, the following measures have been Chaptered:

SB 4 (Calderon and Vargas) Mortgages.

Requires the notice of sale, given pursuant to a deed of trust or mortgage secured by real property containing from 1 to 4 single-family residences, contain language notifying potential bidders of specified risks involved in bidding on property at a trustee’s sale, and a notice to the property owner informing the owner about how to obtain information regarding any postponement of the sale. Requires a good faith effort to be made to provide current information regarding sale dates and postponements and that the information be available free of charge.

SB 6 (Calderon and Vargas) Real Estate: appraisal and valuation.

Prohibits a licensee from knowingly or intentionally misrepresenting the value of real property. Prohibits a licensee who offers or provides an opinion of value (BPO) of residential real property (as defined) when originating mortgage loans from having an interest in the property (as defined). Prohibits influencing an appraiser to report a minimum or maximum value for specified property, implying to an appraiser that his or her retention depends on his or her estimate of the real property value, excluding an appraiser from future engagement because he or she reported a value that does not meet or exceed a certain threshold, and conditioning compensation paid to an appraiser on consummation of the real estate transaction.

SB 53 (Calderon and Vargas) Real Estate Licensees.

This is an omnibus bill authorizing (among others) the Real Estate Commissioner to issue citations to unlicensed persons believed to be engaging in activities for which a real estate license is required or to licensees who are in violation of any provision of the Real Estate Law or any rule or order thereunder. The Commissioner may include an order to correct the violation or to include an administrative penalty of up to $2,500 per citation. This bill authorizes the Commissioner to apply to the Superior Court for an order requiring a licensee to appear before the Commissioner or to produce evidence (as defined). Authorizes the Court to punish as contempt the failure of a licensee to comply with such an order, and authorizes the Commissioner to make information public confirming an investigation or proceeding against an unlicensed person or licensee, as specified.

Requires a real estate broker who is exempt from the Escrow Law and who engages in escrow activities for 5 or more transactions in a calendar year or whose escrow activities equal or exceed $1,000,000 in a calendar year to file a specified report with the DRE within 60 days following the completion of the calendar year. The Commissioner is authorized to assess specified penalties upon a licensee who fails to provide the report to the DRE, and the Commissioner may suspend or revoke the license of a real estate broker for failure to pay those penalties. This bill authorizes the Commissioner to suspend or revoke a real estate license if the licensee has violated any provision of law that constitutes a violation of the licensing law applicable to the licensee, as specified.

Requires a real estate broker to submit a copy of the information in the real estate broker’s transaction file relative to qualification or exemption from qualification under the Securities Law for a transaction to any investor from whom the real estate broker obtains funds in connection with the transaction. The bill also recasts specified provisions relative to the requirements that apply to transactions exempt from qualification. This bill provides the Commissioner with access to those (DMV) records for purposes of enforcing specified provisions of the Real Estate Law or the Subdivided Lands Law.

SB 217 (Vargas) Mortgage Loan Originators: licensure.

Provides that an expunged or pardoned felony conviction does not require denial of a license or license endorsement but would authorize the consideration of the underlying crime, facts, or circumstances of the expunged or pardoned felony conviction when determining whether to issue a license or license endorsement, as specified. Existing law exempts from the provisions of the California Finance Lenders Law specified persons and entities, including any person doing business under any law of any state or of the United States relating to banks, trust companies, savings and loan associations, and insurance premium finance agencies. Authorizes a person exempt from the provisions of the California Finance Lenders Law to apply to the Commissioner of Corporations for an exempt company registration to allow sponsoring one or more individuals required to be licensed as mortgage loan originators who originate mortgage loans solely on behalf of the exempt person.

Requires an exempt person to comply with all rules and orders that the Commissioner deems necessary to ensure compliance with the federal SAFE Act and would require an exempt person to pay an annual registration fee. Authorizes a licensed mortgage loan originator who is an insurance producer to originate loans on behalf of an exempt person or on behalf of a licensed finance lender that originates loans for an exempt person, as specified.

SB 458 (Corbett) Mortgages: deficiency judgments.

Expands those provisions to prohibit a deficiency judgment upon a note secured solely by a deed of trust or mortgage for a dwelling of not more than 4 units in any case in which the trustor or mortgagor sells the dwelling for a sale price less than the remaining amount of the indebtedness outstanding at the time of sale, in accordance with the written consent of the holder of the deed of trust or mortgage if the title has been voluntarily transferred to a buyer by grant deed or by other document that has been recorded and the proceeds of the sale are tendered as agreed.

Provides, following the sale, in accordance with the written consent, the voluntary transfer of title to a buyer, as specified, and the tender of the sale proceeds, the rights, remedies, and obligations of any holder, beneficiary, mortgagee, trustor, mortgagor, obligor, obligee, or guarantor of the note, deed of trust, or mortgage, and with respect to any other property that secures the note, shall be treated and determined as if the dwelling had been sold through foreclosure under a power of sale, as specified. Prohibits the holder of a note from requiring the trustor, mortgagor, or maker of the note to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale.

Provides that the limitations on a deficiency judgment are inapplicable if the trustor or mortgagor is a corporation, limited liability company, limited partnership, or political subdivision of the state. The provisions would also be inapplicable to any deed of trust, mortgage, or other lien given to secure the payment of bonds or other evidence of indebtedness authorized, or permitted to be issued, by the Commissioner of Corporations, or that is made by a public utility subject to the Public Utilities Act.

SB 510 (Correa) Real Estate Brokers: corporate officers: designating branch managers.

Authorizes an employing broker or corporate designated broker officer appointed by an employing broker to appoint a manager of a branch office or division of the employing broker’s real estate business and delegate to that manager responsibility to oversee and supervise operations and activities, as specified. Requires the appointment be made by means of a written contract and the employing broker or corporate designated broker officer send a notice to the DRE identifying the appointed manager and branch office or division, as specified. Requires the employing broker or corporate designated broker officer to notify the Commissioner whenever a branch manager is terminated or changed.

Specifies that an appointee shall not hold a restricted license, be subject to debarment, or have less than 2 years of full-time real estate experience within 5 years preceding the appointment. Authorizes the Commissioner to suspend or revoke the license of an appointed licensee for failure to properly oversee and supervise operations, as specified.

SB 706 (Price) Business and Professions.

Authorizes the DRE to enter into a settlement with a real estate licensee or applicant instead of the issuance of an accusation or statement of issues against the licensee or applicant and requires the settlement to identify the factual basis for the action being taken and the statutes or regulations that have been violated. Authorizes an administrative law judge to order a licensee in a disciplinary proceeding to pay, upon request of the Commissioner, the reasonable costs of investigating and prosecuting the disciplinary case against the licensee.

Two measures regarding independent contractor relationships were just enacted into law by the California Legislature. These legislative measures signed by Governor Brown are AB 1396 (Committee on Labor and Employment) and SB 459 (Corbett). Effective January 1, 2013, AB 1396 requires whenever an employer enters into a contract of employment for services to be rendered within this state and the contemplated method of payment involves commissions (as defined), the contract is to be in writing and is to include the method by which the commissions are to be computed and paid. This measure amends Section 2751 and repeals 2752 of the Labor Code. The term “commissions” is apparently defined in 204.1 of the Labor Code.

SB 459 adds Sections 226.8 and 2753 to the Labor Code, effective January 1, 2012. Section 226.8 makes it unlawful to willfully misclassify an individual as an independent contractor or to make deductions from compensation for any purpose, including (but not limited to) goods, materials, space rental, services, government licenses, repairs, equipment maintenance, or imposing fines which would have been unlawful if the individual had been properly classified as an employee. Employers who misclassify employees will be subject to civil penalties of not less than $5,000 or more than $15,000 for each violation (or not less than $10,000 or more than $25,000 for each violation, if engaged in a pattern or practice of such mischaracterization), plus additional penalties or fines and other remedies as authorized by law.

Employers are required to post a notice informing workers who believe that they are being misclassified of the right to contact the Labor and Workforce Development Agency presumably to file a complaint. The contact information is to be included in the notice. Further, Section 2753 provides any person who for money or other valuable consideration knowingly advises an employer to treat an individual as an independent contractor to be jointly and severally liable with the employer, if the individual is found not to be an independent contractor.

Apparently, this is to apply to accounting, bookkeeping, and tax professionals.

It has been reported, the joint and several liability includes the payment of income taxes, interest, and penalties resulting from the mischaracterization, but the statute does not specifically say that. Rather, it may be limited to the civil penalties and fines for which the professionals are jointly and severally liable. Unless regulations or public policy statements are issued, a legal opinion may be required to clarify this issue. A lawyer who provides legal advice in the course and scope of the practice of law is exempt from the provisions of Labor Code Section 2753.

IRS is also pursuing employers who utilize independent contractors in an apparent effort to reduce such relationships and to increase the number of individuals who are W-2 employees.

Reportedly, the U. S. Labor Department and IRS are now sharing leads along with a number of states on misclassified workers. IRS expects the pressure they are bringing to bear to encourage firms misclassifying workers to correct voluntarily the status of these individuals to employees.

This requires employers to agree to treat the workers as W-2 employees for future tax periods subject to a maximum penalty of 1.086% of the compensation paid to the workers for the previous year plus all taxes that would be due because of the mischaracterization. IRS describes in its announcement 2011-64 how to comply with the voluntary program. Each employer should discuss the independent contractor issue with its accounting, bookkeeping, or tax professionals (assuming these professionals will provide such advice), or this issue should be discussed with legal counsel representing the employer.

Remember, the FRB’s regulations on the payment of compensation to loan originators performing as salesperson or broker associates in federally related residential mortgage transactions require a W-2 employee relationship.

Contact us if you need assistance understanding and/or complying with the new laws.

By Guy Puccio

Business and Professions Code Section 10240(c) purportedly extends an exemption to mortgage brokers when arranging “federally regulated residential mortgage loans.” However, this exemption is inapplicable to most loan transactions conducted by mortgage brokers registered with the NMLS as an LO (MLB/MLO) and even when arranging transactions where the loan proceeds are used for personal, family, or household purposes.

The phrase “federally regulated” is substantially narrower than “federally related.” Under current law, “federally regulated” loan transactions are loans made by nationally chartered or licensed banks, savings and loans, savings banks, thrifts, and credit unions; or if state chartered or licensed, those financial institutions that have opted for FDIC insurance coverage. The phrase “federal regulation” is operative with financial institutions and licensed lenders where oversight by the federal government extends to underwriting and funding loans, i.e., to ensure the “safety and soundness” of the financial institution.

Pursuant to the Truth in Lending Act (TILA), MLBs/MLOs are not “creditors” and, therefore, the completion and delivery of TILA required disclosure statements and notice of rights by brokers as third party originators is ineffective.

This issue was discussed in a case where a car dealer completed and delivered a TILA disclosure statement to a consumer/borrower when the loan was funded by a commercial bank. Similar to a mortgage broker, the car dealer was acting as a third party originator and not acting as the actual lender/creditor. The court held that the completion and delivering of a TILA disclosure statement by other than the actual lender/creditor is ineffective. See 15 USC Section 1601 et seq. and 12 CFR 226 et seq.; Vallies v. Sky Bank, Third Circuit No. 08-4160, 591 F.3d 152 (2009).1

California mortgage brokers may not characterize themselves as a lender/creditor unless the loan is made with the broker’s “own funds,” as defined. Except when subject to a specific exemption authorized by the Real Estate Law for commercial loans being delivered to a financial institution (as defined), mortgage brokers may not concurrent or table fund loans in California transactions. Further, neither California finance lenders acting under the Finance Lender Law nor mortgage bankers acting under the Residential Mortgage Lending Act may engage in concurrent or table funding, except when the mortgage banker is relying on funds advanced by a financial institution with whom the mortgage banker is affiliated or is a subsidiary. See Business and Professions Code Section 10234 et seq.; 10 CCR, Chapter 3, Section 1460; and, Financial Code Section 50003(t).2

Mortgage brokers typically act in an agency capacity. To fit the definition of a lender and creditor, the mortgage broker is required to make the loan from his, her, or its own capital or with funds obtained from an independent credit line that appears as a debt on the broker’s financial statement and the lender extending the line neither is committed to nor engages in the purchase of the loans funded off the line. In addition, the mortgage broker must approve of the loan and the loan may not be prior approved by the extender of the credit line. While it is possible to delegate loan underwriting, it is inappropriate to delegate loan approval. Unless the entity making the loan is a federally regulated financial institution or a federally approved mortgagee or seller/servicer (holds a “federal eagle”), the person or entity qualifying as a lender/creditor must regularly make loans with their or its name appearing as the payee on the promissory note and the beneficiary on the deed of trust, must approve of each loan, and must rely on their or its own capital or independent credit lines, as previously defined.2ibid Also, See 12 USC Section 2601 et seq. and 24 CFR Parts 3500 et seq.; and 15 USC Section 1601 et seq. and 12 CFR Section 226 et seq.

Even if a mortgage broker could fit the lender/creditor definition as outlined above, such loans would not be “federally regulated” under current law when funded by a mortgage broker. This may change if regulations under the “Dodd-Frank…Act” are promulgated as the Obama Administration would like control over all mortgages, including loans made by “non-banks,” e.g., mortgage brokers, mortgage bankers, hedge funds, etc. and whether such loans are secured by one to four units or otherwise secured.

In the meantime, TILA disclosures to have any effect or validity must be completed and delivered by the lender/creditor and not by a third party. However, a mortgage broker may act as the exclusive agent of the lender/creditor or as an authorized subsidiary of the lender/creditor (as defined) and, in such capacity, complete and deliver the TILA disclosures and notices of rights to the intended borrower. Few institutional or licensed lenders/creditors will authorize a mortgage broker to act as their exclusive agent or as a subsidiary. Thus, when the mortgage broker is acting as an agent of the borrower, the broker cannot comply with Section 10240(c). Accordingly, this statutory exemption from completing and delivering the mortgage loan disclosure statement would be inoperative and without efficacy.1ibid. In my opinion, Business and Professions Code Section 10240(c) should be repealed, as its application is too limited to have any significant effect.