A costly web of compliance.

Author:Morse, Neil J.

Proposed reforms of the Real Estate Settlement Procedures Act (RESPA) might bring welcome relief from a barrage of costly class-action suits over yield-spread premiums. That alone would make it a monumental step to many lenders. Yet other compliance burdens linger.

A GALVANIZING FEATURE IN THE DEBATE over the new Real Estate Settlement Procedures Act (RESPA) proposed rule is the yield-spread premium (YSP). A YSP is essentially a premium paid to an originator who originates a loan at a slightly higher rate, frequently to reduce out-of-pocket closing costs for borrowers. Because the mortgage is being originated with a higher-than-market rate, the lender funding the loan will pay a premium for it.

YSPs, a prime target of reformers and class-action attorneys, are greatly misunderstood, says Kris Wales, a broker and the president of River City Mortgage Corporation, Spokane, Washington, a 12-person shop.

"It's [just] a pricing mechanism," Wales says. And it is a legitimate way for brokers to be paid for their efforts, he adds.

"We're either going to take money upfront," with an outright charge for participation, "or [with] a yield spread," Wales says, explaining that "frequently" when brokers compete with banks on quoting rates, "ours are cheaper, [because] we have [less] overhead."

The yield-spread premium has become a cause celebre" for consumer activists and some elected officials who claim they are an open invitation to abuse.

Those ingredients alone would suffice to make YSPs a serious issue. But when you add to the fray a group of zealous attorneys eyeing big bucks, the whole matter escalates to a wave of class-action lawsuits, which have the potential to bankrupt significant numbers of mortgage-related businesses.

The premise of class-action lawsuits is that individually pursued claims against a company might not always be feasible. But the number of people who can make up a class can run into the millions.

"This species of cases represents the single largest threat to the viability of the wholesale mortgage lending industry from legal challenges," says attorney Michael Agoglia of Morrison & Foerster LLP, San Francisco. Agoglia, a consultant to the Mortgage Bankers Association of America (MBA), counted more than 200 class actions nationwide last spring, all of which center around the argument that yield-spread premiums "are simply devices to induce brokers to upcharge borrowers and avoid fully explaining what's going on," says Agoglia.

To address this threat of YSP lawsuits, since 1997 MBA has conducted a multifaceted litigation coordination effort using Morrison & Foerster. On the regulatory front, MBA also has aggressively pursued clarification of HUD policy on YSPs as well as comprehensive RESPA reform. In the last year alone, MBA filed amicus briefs in YSP cases before the Supreme Court and the Eighth and Ninth Circuit Courts of Appeal. And in recent months, with HUD's issuance of its Statement of Policy 2001-1 and recent wins in the Eighth and Ninth Circuits and in key federal district courts, lenders are starting to see some light in a very long tunnel.

The legal challenges are now rippling into the secondary market. In the last year, there has been a spike in class-action claims seeking to hold subsequent loan purchasers responsible for origination deficiencies, says Laurence Platt, an attorney with Kirkpatrick & Lockhart LLP, Washington, D.C.

However, Platt believes that the secondary market does not bear responsibility for any YSPs paid by lenders that make the loans in the...

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