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REAL ESTATE SETTLEMENT PROCEDURES
ACT-CO NTROLLED BUSINESS
~2(~oi~49
HEARINGS
BEFORE THE
SUBCOMMITTEE ON
HOUSING AND COMMUNITY DEVELOPMENT
OF THE
COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-SEVENTH CONGRESS
FIRST SESSION
SEPTEMBER 15 AND 16, 1981
Serial No. 97-24
Printed for the use of the
Committee on Banking, Finance and Urban Affairs
U.S. GOVERNMENT. PRINTING OFFICE
85-396 0 WASHINGTON: 1981
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HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
FERNAND J. ST GERMAIN, Rhode Island, Chairman
HENRY S. REUSS, Wisconsin
HENRY B. GONZALEZ, Texas
JOSEPH G. MINISH, New Jersey
FRANK ANNUNZIO, Illinois
PARREN J. MITCHELL, Maryland
WALTER E. FAUNTROY, District of
Columbia
STEPHEN L. NEAL, North Carolina
JERRY M. PATTERSON, California
JAMES J. BLANCHARD, Michigan
CARROLL HUBBARD, JR., Kentucky
JOHN J. LAFALCE, New York
DAVID W. EVANS, Indiana
NORMAN E. D'AMOURS, New Hampshire
STANLEY N. LUNDINE, New York
MARY ROSE OAKAR, Ohio
JIM MArFOX, Texas
BRUCE F. VENTO, Minnesota
DOUG BARNARD, JR., Georgia
ROBERT GARCIA, New York
MIKE LOWRY, Washington
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland
FERNAND J. ST GERMAIN, Rhode Island
WALTER E. FAUNTROY, District of
Columbia
JERRY M. PATTERSON, California
JOHN J. LAFALCE, New York
JAMES J. BLANCHARD, Michigan
DAVID W. EVANS, Indiana
STANLEY N. LUNDINE, New York
MARY ROSE OAKAR, Ohio
BRUCE F. VENTO, Minnesota
ROBERT GARCIA, New York
MIKE LOWRY, Washington
PARREN J. MITCHELL, Maryland
CARROLL HUBBARD, JR., Kentucky
NORMAN E. D'AMOURS, New Hampshire
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland
J. WILLIAM STANTON, Ohio
CHALMERS P. WYLIE, Ohio
STEWART B. McKINNEY, Connecticut
GEORGE HANSEN, Idaho
JIM LEACH, Iowa
THOMAS B. EVANS, JR., Delaware
RON PAUL, Texas
ED BETHUNE, Arkansas
NORMAN D. SHUMWAY, California
STAN PARRIS, Virginia
ED WEBER, Ohio
BILL McCOLLUM, Florida
GREGORY W. CARMAN, New York
GEORGE C. WORTLEY, New York
MARGE ROUKEMA, New Jersey
BILL LOWERY, California
JAMES K. COYNE, Pennsylvania
DOUGLAS K. BEREUTER, Nebraska
DAVID DREIER, California
J. WILLIAM STANTON, Ohio
CHALMERS P. WYLIE, Ohio
STEWART B. McKINNEY, Connecticut
THOMAS B. EVANS, JR., Delaware
JIM LEACH, Iowa
ED BETHUNE, Arkansas
MARGE ROUKEMA, New Jersey
JAMES K. COYNE, Pennsylvania
GEORGE C. WORTLEY, New York
GREGORY W. CARMAN, New York
BILL McCOLLUM, Florida
BILL LOWERY, California
DOUGLAS K. BEREUTER, Nebraska
DAVID DREIER, California
PAUL NELSON, Clerk and Staff Director
MICHAEL P. FLAHERTY, General Counsel
JAMES C. SIv0N, Minority Staff Director
SUBCOMMITrEE ON HOUSING AND COMMUNITY DEVELOPMENT
HENRY B. GONZALEZ, Texas, Chairman
GERAU R. MCMURRAY, Staff Director
DIANE E. DoRIus, Counsel
FRANK T. DESTEFANO, Professional Staff Member
ANmoc~v VAI..kNzANo, Minority Counsel
(II)
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CONTENTS
Hearings held on: Page
September 15, 1981. 1
September 16, 1981 395
STATEMENTS
Boren, James L., Jr., president, Mid-South Title Insurance Corp., Memphis,
Tenn., president, American Land Title Association 152
Bossard, Richard C., president, The Title Co. of Billings, Inc., Billings, Mont .... 181
Collier, Thomas C., Jr., firm of Steptoe & Johnson, former Deputy Assistant
Secretary for Regulatory Functions, U.S. Department of Housing and
Urban Development 474
Daley, Stephen D., president, Intercounty Title Co. of Illinois, Chicago, Ill 193
Elliott, Robert Raymond, firm of Elliott & Bell, Washington, D.C 549
Ford, Dr. Deborah Ann, assistant professor of finance, University of Balti-
more 530
Guggenberger, Clyda, president, Valley Title Co., San Jose, Calif 145
Hilton, Charles R., senior vice president, Coldwell, Banker & Co., accompa-
nied by Stanley M. Gordon, vice president-general counsel 420
Levinson, Burton S., firm of Levinson &Lieberman, Inc., Beverly Hills, Calif.. 441
Peck, Gerald, president, Continental Abstract Corp., Carle Place, N.Y., chair-
man, Abstractors -and Title Insurance Agents Section, New York State
Land Title Association 169
Plotkin, Dr. Irving H., vice president, Arthur D. Little, Inc., Cambridge, Mass. 500
Savas, Dr. B. S., Assistant Secretary for Policy Development and Research,
U.S. Department of Housing and Urban Development 3
Stanton, Thomas H., Acting Director, Office of Policy Planning, Federal
Trade Commission; accompanied by John P. Brown, Assistant Director for
Consumer Protection, Bureau of Economics, Federal Trade Commission 64
Tate, Barry D., staff vice president, U.S. League of Savings Associations 405
Treadwell, Donald H., National Association of Realtors 395
Vartanian, Thomas P., General Counsel, Federal Home Loan Bank Board 45
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD
Boren, James L., prepared statement on behalf of the American Land Title
Association 156
Bossard, Richard C.:
Letter dated July 18, 1979, from Zane K. Sullivan, president and general
counsel, American Land Title Cos. of Missoula, Ravalli, Sanders, and
Mineral Counties, re aspects of controlled business in the title insur-
ance business in Montana 188
Newspaper articles submitted:
"Investigator Recommends Probe of Billings Title Firm," Great Falls
Tribune, October 10, 1979 187
"Title Insurance Dispute Still Unsettled," Billings Gazette, March 16,
1980 185
Collier, Thomas C., Jr., prepared statement 478
Daley, Stephen D.:
Prepared statement with attachments 196
Response to additional written question submitted by Chairman Henry B.
Gonzalez 390
Elliott, Robert Raymond:
Exhibit showing disposition of fees from a title insurance company 556
(III)
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Iv
Elliott, Robert Raymond-Continued Page
Federal disclosure statement form submitted at the request of Congress-
man Gregory W. Carman 623
Material referred to in oral presentation:
Agreement reached with three providers 581
"Review and Outlook," article from Insurance Stock Review, August
1981 584
Prepared statement 562
Ford, Dr. Deborah Ann:
"Controlled Business and the Title Insurance Industry," prepared state-
ment
Response to additional written questions 614, 615, 618, 619
"The Impact of Title Insurance and Controlled Business in the Savings
and Loan Industry," article from Federal Home Loan Bank Board
Journal, June 1981 544
Gordon, Stanley M.:
Prepared statement on behalf of the Coidwell, Banker & Co. Residential
Group 426
Response to additional written questions 473
Hilton, Charles R., response to additional written questions 471, 472
Levinson, Burton S., prepared statement 443
Peck, Gerald:
Prepared statement 174
Response to additional written questions submitted by-
Chairman Henry B. Gonzalez 388
Congressman David W. Evans 391
Plotkin, Dr. Irving H.:
Letters submitted:
Dated September 22, 1980, from C. J. McConville, Title Insurance Co.
of Minnesota, commenting on effects of controlled business in Hen-
nepin County 604
Dated December 19, 1980, from Lewis H. Goldfarb, Assistant Director
for Credit Practices and Carole L. Reynolds, attorney, Federal
Trade Commission, to Richard Patterson of the Department of
Housing and Urban Development, commenting on certain consum-
er protection issues related to the Real Estate Settlement Proce-
dures Act 523
Dated October 8, 1981, to Chairman Henry B. Gonzalez, commenting
on testimony of witness Charles R. Hilton 521
Response to additional written questions 615, 618, 619
"The Economic Consequences of Controlled Business in the Real Estate
Industry," prepared statement 510
Savas, Dr. E. S.:
Prepared statement on behalf of the Department of Housing and Urban
Development 10
Response to additional written questions submitted by:
Chairman Henry B. Gonzalez 143
Congressman Gregory W. Carman 144
Response to request for additional information from:
Chairman Henry B. Gonzalez 27
Congressman Jerry M. Patterson 45
Congressman Bruce F. Vento 37
Congressman James K. Coyne 45
Stanton, Thomas H.:
Prepared statement 68
"Tying Requirements With Imperfect Information-And Other Unfair
Contracts," staff paper 77
Tate, Barry D.:
Prepared statement on behalf of the U.S. League of Savings Associations.. 407
Response to additional written questions from:
Chairman Henry B. Gonzalez 470, 472
Congressman David W. Evans 473
Treadwell, Donald H.:
Prepared statement on behalf of the National Association of Realtors 399
Response to additional written questions 470, 471, 472
Vartanian, Thomas P.:
Prepared statement on behalf of the Federal Home Loan Bank Board 50
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Vartanian, Thomas P.-Continued
Response to request for additional information from: Page
Congressman David W. Evans 132
Congressman Bill Lowery 142, 143
APPENDIX
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD
American College of Mortgage Attorneys, Inc., letter dated September 29,
1981, from Robert H. Hodges, president 649
HALT-An Organization of Americans for Legal Reform, Inc., statement 631
Mortgage Bankers Association of America, Washington, D.C., letter dated
October 13, 1981, from William E. Cumberland, general counsel 668
Stevens, Joel W., senior vice president, Depositors Trust Co. of Augusta
(Maine), statement dated September 18, 1981 655
TransAmerica Title Insurance Co., Newtown Square, Pa., letter dated October
9, 1981, from J. Wm. Cotter, Jr 672
Walker, Hon. Robert S., letter dated September 28, 1981, on behalf of the
Conestoga Title Insurance Co., Lancaster, Pa., with enclosed statement of
the Conestoga Title Insurance Co 643
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REAL ESTATE SETTLEMENT PROCEDURES ACT-
CONTROLLED BUSINESS
TUESDAY, SEPTEMBER 15, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
SUBCOMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT,
Washington, D.C.
The subcommittee met at 10 a.m. in room 2222 of the Rayburn
House Office Building, Hon. Henry B. Gonzalez (chairman of the
subcommittee) presiding.
Present: Representatives Gonzalez, St Germain, Fauntroy, Pat-
terson, Evans of Indiana, Vento, D'Amours, W. Coyne, J. Coyne,
Carman, McCollum, and Lowery.
Chairman GONZALEZ. The subcommittee will please come to
order.
Mr. Coyne from Pennsylvania, once again I want to thank you
for your interest and your responsibility that you so well are
discharging. I might point out that under the rules, we couldn't
proceed until we had at least another member. Preferably we
would like to have members from both sides. But this is a rather
disorderly period in congressional development and it is my hope
that during today we will have more participation from the sub-
committee.
Last week we had very important hearings. We initiated what, I
trust, will be the most intensive array of hearings covering not
only the immediate crisis confronting us in housing, as well as in
urban problems and developments against a backdrop of very dis-
couraging factors.
Never before has the Nation faced the proportions of a housing
crisis with the attitudes of frozen indifference that reign in the
Congress and in the executive branch of the Government; we are
faced with a paralysis caused by a so-called economic crisis. The
fact is that a nation of this nature cannot and will not be strait-
jacketed into paralysis. It is a dynamic country. I don't know if any
Member of the Congress that hasn't been contacted by constitu-
ents, whether they be the mortgage bankers or the homebuilders,
or just the plain, average little businessmen, to communicate the
sense of crisis. But since January, resolving this crisis has been
relegated to a back burner until such time as the ERP, the econom-
ic recovery plan-whatever that turns out to be-is put in place.
Now, I think, as a personal belief, that those of us that serve in a
representative capacity cannot turn our backs on the reality of the
situation confronting us. We hope that before the year is out, we
will have covered pretty much not only this immediate realm and
some of the attendant factors, but also go into an oversight and
(1)
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2
review of all of the collateral programs that are associated with
either housing, construction, or urban or city problems.
Today and tomorrow the subcommittee meets in this room be-
cause we have been preempted from the full committee room.
However, on Thursday, the hearings will be held in the full com-
mittee room, 2128. But today and tomorrow we will review the
matter of real estate settlement practices, and in particular the so-
called controlled business problem. It was my hope when I sched-
uled these hearings that in the course of these 2 days we could
review the whole scope of the Real Estate Settlement Practices Act
and HUD's recommendations with respect to that act. However,
since the administration's report on RESPA was only released last
Friday and is not yet generally available, we must restrict the
focus of these hearings to the controlled business problem.
I might say parenthetically, that I believe that in the letter of
confirmation that was sent out to all the witnesses, particularly
the witnesses from HUD, we had indicated that under our rules it
was necessary to have a certain number of copies of the prepared
testimony in adequate time for not only the members of the sub-
committee but the staff to review. HUD has not complied with this
rule. It didn't comply last week for our manufactured housing
hearings and it did not comply for these hearings. I am very
disappointed and I must stress that we will insist upon compliance
with these rules in the future, and that we just certainly will not
introduce witnesses who have not complied with these rules.
Every witness, whether an administration official, a representa-
tive from an independent agency or a private citizen, should pro-
vide the subcommittee with the text or an outline of his statement
at least 48 hours-2 days ahead of his appearance. This is very
important. Last week, for instance, we had numerous witnesses
whose testimony was flatly contradicted by the testimony of others.
We can't recall the witnesses to cross-examine them a day later. By
reviewing the testimony 48 hours in advance, discrepancies and
conflicts may be noted and addressed when a witness appears. I
must express my disappointment that the HUD testimony was not
provided to the subcommittee until this morning.
The hearings on the HUD RESPA study and recommendations
will have to wait until there has been time for all of the interested
parties to digest the proposals put forward by HUD and to react to
them. Today and tomorrow we will study the controlled business
problems, which affects competition and therefore the cost of title
insurance.
As we all know, whenever a person buys a home there are a
number of essential steps involved for closing or settling the trans-
action. Among these essential steps is the procurement of title
insurance. Real estate professionals include brokers, mortgage
lenders, attorneys, and builders. These professionals are in a
unique position to influence the buyer's choice of title insurance
and other elements essential to real estate settlement. The typical
home buyer is not an attorney, broker, or otherwise acquainted
with the varied and complex details of real estate settlement. Like
the physician's patient, the buyer depends very heavily on the
recommendations of the professional. Buyers might not be aware
that title insurance companies can be controlled by the parties that
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3
recommend that title insurance be bought from a certain offeror.
Buyers might not even be aware that they have a choice in the
matter.
Whenever the buyer is faced with a situation in which a real
estate professional steers him into a title insurance in which that
professional has an interest, that buyer is faced with a controlled
business problem. The buyer probably will be unaware of the fact
that he is being steered into a~ controlled business. He has no way
of gaging the soundness of their business and probably will not be
aware that he might do better by shopping around. Therein is the
problem.
In the controlled business situation, the home buyer might end
up paying too much for too little and the closing costs might be
needlessly inflated. To the extent that controlled business discour-
ages competition there is a threat that exactly this kind of needless
cost inflation takes place. Clearly this is a problem that ought to be
examined.
A number of my colleagues both on and off this subcommittee
and the full committee have urged that these hearings be held. I
am glad to comply with their request, for as I have said many
times, this subcommittee intends to examine all things affecting
housing and to do everything in its power to insure that Americans
have safe, decent, and affordable housing.
Our first witness, representing the Department of Housing and
Urban Development, is the Honorable E. S. Savas, Assistant Secre-
tary for Policy Development and Research, and I don't know if my
colleague from the other side, Mr. Coyne in this case, wishes to
make a statement at the outset.
Mr. J. COYNE. No thank you, Mr. Chairman.
Chairman GONZALEZ. Again I want to emphasize how grateful I
am to Mr. Coyne. He made it possible to have the hearings last
week. We were very disappointed in the lack of presence of other
members of this subcommittee, but under the rules you will notice
that we couldn't proceed until we had one other member, at least,
present. So again I want to thank you, Mr. Coyne, for your extreme
interest and your sense of responsibility.
Dr. Savas, I think we now have a prepared text as of this
morning, and you may proceed, if you wish, by summarizing the
text of your statement, or you may wish to adhere to it. But it is
your choice, whichever way you see fit to proceed.
STATEMENT OF DR. E. S. SAVAS, ASSISTANT SECRETARY FOR
POLICY DEVELOPMENT AND RESEARCH, U.S. DEPARTMENT
OF HOUSING AND URBAN DEVELOPMENT
Dr. SAVAS. Thank you, Mr. Chairman and members of the com-
mittee. First, let me apologize for the delay in getting the complet-
ed draft to you. As the chairman noted in his opening remarks,
these are indeed busy and hectic times. However, I do appreciate
the opportunity to appear before the Subcommittee on Housing
and Community Develoment to present the Department of Housing
and Urban Development's findings concerning controlled business
arrangements and the Real Estate Settlement Procedures Act,
RESPA.
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4
As you are aware, HUD has administered RESPA since its enact-
ment in 1974 and amendment in 1975. During this time, the De-
partment has studied the compliance with and effectiveness of this
act. These studies form the basis of my remarks. Because the
Department's official report to Congress was delivered only last
week, my statement will refer only to general findings rather than
to specifics in the report.
The report was sent to Congress on September 10. It does not yet
represent the fully coordinated and cleared position of the adminis-
tration and may be subject to change.
Today, gentlemen, I will briefly outline the original objectives of
RESPA, present the primary findings of our study, and recommend
for your consideration possible changes to or replacement of the
existing legislation. Because these hearings are primarily con-
cerned with the issue of controlled business, I will highlight that
special problem within the general context of settlement services. I
must, however, address the whole issue because my recommenda-
tions on RESPA encompass my recommendation for the treatment
of controlled businesses.
The practice of owning or controlling an ancillary service compa-
ny has become controversial since the passage of RESPA. Section 8
of RESPA prohibits kickbacks and unearned fees. HUD issued an
interpretive rule in June 1980, indicating that a controlled business
arrangement may constitute a violation of section 8.
We have found, however, that a controlled business arrangement
may be the cheapest and most efficient provider of that service,
and referral to a controlled business saves the consumer time and
money in searching. Indeed, we would argue that referral fees may
lower the total package price to the consumer. It is equally true
that the controlled business also can be inefficient and costly, but
can remain in business because of referrals from its parent compa-
ny. In a settlement market, however, we have discovered that
consumer shopping and awareness are minimal; therefore, no natu-
ral market forces will ever correct this inefficiency.
The original objective of RESPA was to reduce the excessive cost
of real estate settlements. In the early 1970's, it was believed that
consumers were at the mercy of the mortgage lending and settle-
ment service industries. Borrowers appeared to have little knowl-
edge or understanding of either the settlement market or the re-
quired services.
Several government actions were considered, including direct
regulation of the charges. Instead, the option chosen by Congress
required disclosure of the information necessary for consumers to
compare the costs of settlement services. In theory, when equipped
with the necessary information about the need for various settle-
ment services, consumers would shop for the best or lowest cost
settlement services. This practice of shopping would, in turn, en-
courage lenders and other service providers to compete for busi-
ness, to lower prices to the most efficient, least-cost level, and to
eliminate unnecessary services. Referral fees or kickbacks, which
are undetectable even with consumer awareness, were legislatively
banned. Controlled business arrangements were not anticipated,
and thus, were not mentioned.
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Reflecting this consumer-disclosure approach, the purposes
stated in the act are to: One, give consumers advance information
about settlement costs; two, eliminate practices like referral fees or
kickbacks; three, reduce escrow amounts; and four, reform land
recordation systems.
Most of the regulatory provisions imlementing RESPA address
the first two points: Consumer information and kickback prohibi-
tion.
Under RESPA, the mechanisms for consumer information in-
clude a good-faith estimate of closing costs provided within 3 days
of loan application, a HUD-developed special information booklet
describing normal settlement services, and a uniform settlement
statement itemizing all settlement charges. In theory, armed with
this information, the consumer is able to compare and shop for
individual services before settlement. Lenders are responsible for
compliance with the advance disclosure provisions. All settlement
providers must abide by the antikickback section, although lenders,
attorneys, and real estate firms were the primary recipients prior
to RESPA.
I will now briefly summarize our finding about compliance with
RESPA and our evaluation of its achievement in minimizing real
estate settlement charges.
Our surveys report that compliance with RESPA is high. Most
consumers receive the booklet and forms within the specified time
frames. Although our contractor attempted to question the pres-
ence of kickbacks, the results were fairly inconclusive. The most
notable finding reveals the practice of what is known as "con-
trolled business," developed as a replacement for referral fees and
kickbacks.
These survey results, however, do not address the primary ques-
tions about RESPA's success or failure. The critical test is the
effectiveness of the regulation toward increasing consumer aware-
ness, fostering consumer shopping, and reducing settlement costs.
In order to analyze RESPA's effectiveness, we must look more
closely at settlement markets, consumer behavior, and industry
performance.
Real estate settlement is a means to an end-that is, the borrow-
er perceives settlement as a necessary evil in obtaining financing
and clear title for the purchase of his home, hopefully at the lowest
possible price. The intricacies of loan origination, capital market
requirements, and investor risk are not the primary concerns of
the consumer. Our effort, therefore, to educate consumers on the
complexities of and reasons for the process is an uphill struggle.
Compound this with the traditional practice whereby lenders and
real estate brokers select or recommend most of the providers of
ancillary services and we can easily see why the mechanisms
within RESPA have been less than successful.
By approaching settlement markets and services like any other
commodity, RESPA assumes that consumers can weigh the differ-
ence between two offers and decide which is the best value. Stand-
ard economic theory tells us that if all parties possess complete
information, no business can profit from inadequate knowledge and
all businesses will compete by lowering prices or increasing the
quantity or quality to the level that allows a normal profit.
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In most consumer markets, this premise holds true. In settle-
ment markets, however, the purchased services are not demanded
directly by the borrower. Consumers are not buying credit reports,
surveys, and appraisals. They are buying a house and financing.
The lender or ultimate investor demands these ancillary services
as assurance against risk. Hence, differences in the service levels,
in the quality of service, or in the companies are important to the
lender-not the consumer. In most cases, ever since RESPA's en-
actment, the consumer pays for these services on the advice of the
lender or broker.
With your indulgence, I will provide an analogy. RESPA ap-
proaches settlements as though they were new cars to be pur-
chased. Complete information equalizes the dealerships and con-
sumers can base their final decisions on real differences. If the
price of the car exceeds the value to the consumer, he simply will
not buy.
But in reality, the settlement market is more closely analogous
to the relationship between a physician and patient. Pharmaceuti-
cals are not the "end," but a means to the goal of well being.
Patients are not particularly interested in the prescription or
dosage, but rather the ultimate achievement of good health. The
physician, as an expert, makes the decisions; the patient relies on
this expertise. Likewise, the borrower wants clear title and a mort-
gage. He accepts the advice of the lender or other providers that so
much of each "ingredient"-that is, surveys, appraisals, et cetera-
is necessary to insure that his goal will be met.
Our studies indicate that less than 1 in 10 consumers shops for
services as a result of RESPA-required disclosures. So, even though
compliance with RESPA is high, the effect on shopping behavior
appears to be relatively insignificant.
We have, however, analyzed individual settlement industries, not
by comparing costs, but by reviewing performance and market
characteristics. The five major industries involved in most real
estate transfers are: lenders, title insurance companies, mortage
insurance companies, attorneys, and real estate brokers. We did
not find either overt, anticompetitive practices or ideal, perfectly
competitive markets. We did find practices which, at a minimum,
provide potential for inefficiency and higher consumer prices.
In particular, although the lending industry behaves the most
competitively of those studied, the home buyer often obtains the
relevant market information only after he has applied for a loan
and after prepayments for particular items dissuade him from
capitalizing on his knowledge and shopping further.
The attorney's position in residential real estate sales has
changed considerably over the past decade, as title insurance poli-
cies replace attorney title searches in the West and antitrust deci-
sions have reduced price uniformity. However, the cause of these
changes is unclear and could have occurred without RESPA.
Both the title and private mortgage insurance industries are
dominated by a few large companies. This domination tends to
indicate a lack of competition. On the other hand, however, inter-
views indicate that these companies compete aggressively for
lender business. Prices are uniform in these industries, which
would seem to indicate the existence of collusion. However, there is
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7
also reason to believe that the uniformly high prices are due, at
least in part, to similar production costs and comparable services.
What can be said unequivocally is that the potential exists for
market inefficiency. Specifically, the home buyer bears the direct
cost of purchasing title insurance and pays the premium for mort-
gage insurance, but is unable to calculate the benefit in terms of
reduced interest rate of reduced up-front lender charges.
Not knowing the benefits as well as the costs of title and mort-
gage insurance, the home buyer is in no position to decide whether
or not to purchase these items. The lender, on the other hand,
benefits from the risk reduction provided by insurance, but does
not bear the cost because it is charged directly to the borrower.
Even with RESPA, existing~ markets possess the potential for
abuse of the consumer. Borrowers are dependent upon advice from
parties who will benefit directly-even though these advisers bear
no costs. The selection criteria can include "rewards" or qualities
that affect only the advisor; the borrower, if given the choice,
might acquire the services differently.
The complexity of the services, the stress and emotion often
associated with the purchase of a home, the infrequency of such
transaction, and the up-front costs make settlement market infor-
mation expensive, time-consuming, and difficult for an individual
to obtain. Depending on experts who deal in these markets daily is
both logical and efficient-if the system is ideal.
Given the present operation of settlement markets and the estab-
lished procedures, any Government action should work within
these confines in order to take advantage of efficiencies within
existing operations. RESPA is misdirected because it increases the
amount of information going to the consumer in an effort to edu-
cate him to understand all the aspects of the somewhat arcane
process of settlement. Evidence, however, indicates that most con-
sumers, even when presented with the information, do not take the
time and effort to study the factors.
Our research and surveys suggest that a more efficient method of
facilitating information flow would be to reduce the amount of
necessary information to a minimum, an easily comprehendible
minimum. Further, because most of the services occurring at settle-
ment are lender-required, the choice about providers, amounts and
costs is more important to the lender and the ultimate investor
than to the borrower.
From our consumer and industry interviews, we can construct
the chronology of a typical settlement. The average borrower shops
for a lender using contract interest rate and origination points as a
comparison. Some borrowers turn to their real estate agents for
this search. Once the lender is selected, the borrower makes appli-
cation, pays the up-front charges, receives several forms and book-
lets from the lender, and goes~ home to wait for closing. A few
glance through the booklets and look at the bottom line of the good
faith estimates of closing costs. At settlement, the borrower again
receives a few forms and pays the bottom line of an accounting
sheet that lists all separate charges.
Collecting all the failings and drawbacks, we arrive at the con-
clusion that Congress should give careful consideration to a re-
placement of RESPA which we call "lender-packaging." We feel
PAGENO="0014"
8
that this approach may successfully address the problems and inef-
ficiencies perceived when RESPA was first proposed. Lender-pack-
aging involves the gathering of all lender-required settlement serv-
ices into one bundle with a prequoted price. A prospective borrower
or his agent would call for quotes from lenders and receive two
numbers: the contract interest rate and a fee for all lender-re-
quired services stated in dollars or percentages. The borrower need
not be concerned with the contents of the bundle, any more than
he need be concerned with locating the ultimate investors for the
loan. The settlement fees become a part of the cost of borrowing, as
they in fact are, and the borrower can compare these costs in
making his or her choice.
All services required by the lender would have to be included in
the package prices. Given existing practices, this would include
title search, the lender's title insurance policy, surveys, credit re-
ports, origination and commitment fees, attorney fees for lender
review of documents, and mortgage insurance. Lenders would then
have incentive to reduce or eliminate services at the margin where
the cost exceeds the benefit in order to remain competitive.
Lender-packaging would not preclude provision of additional
services desired by the borrower or arrangements negotiated be-
tween individual borrowers and lenders. For instance, owner's title
policy, borrower's attorney, and other services desired by the bor-
rower can still be a part of settlement at the borrower's discretion
and expense. Local and State government taxes and fees would not
be included in the package, because these fees are not lender-
required. Individuals may also wish to negotiate separate packages
to include or exclude specific services. The lender packaging con-
cept simply holds that all lender-required services can be pur-
chased for a single price that is known at the time of application.
Lender-packaging has the flexibility to adapt to the myriad re-
gional methods of real estate settlement. Lenders know local vari-
ations and can essemble the particular services necessary for that
area. Lenders can also choose different packages for different bor-
rowers or groups of borrowers. Lenders, for instance, may wish to
offer condominium buyers a different package than single-family
purchasers because title work is different. One lender may accept
purchasers in a new subdivision at a cheaper price because the
builder provides the closing services. Smaller lenders can purchase
the services from independent providers, as is done now, but the
price would be set and known at application instead of settlement.
The key is that lenders choose the services required and give the
price up front so that consumers can make logical comparisons.
The lender-packaging concept eliminates the concern about con-
trolled business and kickbacks or referral fees. While settlement
providers may wish to refer business to a particular company, the
ultimate decision will be based on the most efficient settlement
package because consumer choice will be based on that price. Con-
sequently, where a controlled business is an efficient arrangement
between two settlement providers, the practice can contribute to
lower consumer costs. Where the arrangement allows a lender, for
instance, to refer title work to a subsidiary that overcharges and
returns the excess profit, the total settlement package will have to
PAGENO="0015"
9
reflect this circular flow of payments or the lender will not be
competitive and normal market forces will correct the excess.
Therefore, with respect to controlled business, if lender-packag-
ing is adopted, we recommend that section 8 of RESPA be repealed.
If lender-packaging is not adopted, we recommend substituting an
antitrust statute without criminal penalties, which would allow
private rights of action. The new statute would expressly cover
controlled business arrangements as well as kickbacks and referral
fees. If competitors or consumers can prove a prohibited relation-
ship exists and is harmful, they may sue for damages and let the
courts decide the damage.
Before accepting any replacement for RESPA, Congress must
also decide whether any Government intervention is necessary.
Our assessment of the settlement market, as I have already indi-
cated, reveals a potential for abuse under current conditions.
Repeal of RESPA would increase that potential because the basis
for choosing providers could become more removed from the con-
sumer's interest.
The solution lies in a market where those who make the choice
base it on all the costs and benefits associated with that decision.
In terms of lender-packaging, that means lenders choose a quantity
of service, say appraisals, based on the cost associated with the
benefit-verifying the property value. Under present conditions,
consumers do not base their choice of lenders on the fee for ap-
praisal. The lender, in turn, has no incentive to reduce or eliminate
this service because the benefit of reduced risk occurs without a
cost. Under lender-packaging, consumers would choose lenders, in
part, based on the total settlement packages. Unnecessary or over-
used services would disappear as lenders competed for loans.
We are recommending that Congress consider lender-packaging
because it requires the minimum amount of Government interfer-
ence in a market that possesses potential for abuse of consumers.
Our report discusses several alternate forms whereby lenders offer
lender-packaging on a mandatory basis or as an option. The impor-
tant advantage to a mandatory provision, of course, lies in the
uniformity of operation. All lenders would play by the same rules,
thereby facilitating comparison shopping.
I have covered only briefly what is a large and detailed report on
our findings. I will be glad to answer any questions the subcommit-
tee has.
[Dr. Savas' prepared statement, on behalf of the Department of
Housing and Urban Development, follows:]
PAGENO="0016"
10
STATEMENT
BY
E. S. SAVAS
ASSISTANT SECRETARY FOR RJLICY [EVELOPT~ENT AND RESEARCH
U.S. DEPARTMENT OF HOUSING AND ~RBAN DEVELOP~NT
BEFORE
HOUSE COMMITTEE ON BANKINGJ FINANCE AND LRBAN AFFAIRS
SUBCOMMITTEE ON HOUSING AND COMMUNITY tEVELOP~'ENT
PAGENO="0017"
11
MR. CHAIRMAN AND MEMBERS OF THE, COMMITTEE:
1 APPRECIATE THE OPPORTUNITY TO APPEAR BEFORE THE
SUBCOMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT TO PRESENT THE
DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT'S FINDINGS CONCERNING
CONTROLLED BUSINESS ARRANGEMENTS AND THE REAL ESTATE SETTLEMENT
PROCEDURES ACT (RESPA).
As YOU ARE AWARE, HUD HAS ADMINISTERED RESPA SINCE ITS
ENACTMENT IN 19Th AND AMENDMENT IN 1975. DURING THIS TIME, THE
DEPARTMENT HAS STUDIED THE COMPLIANCE WITH AND EFFECTIVENESS OF
THIS ACT. THESE STUDIES FORM THE BASIS OF MY REMARKS. BECAUSE
THE DEPARTMENT'S OFFICIAL REPORT TO CONGRESS WAS DELIVERED ONLY
LAST WEEK, MY STATEMENT WILL REFER ONLY TO GENERAL FINDINGS
RATHER THAN TO SPECIFICS IN THE REPORT.
THE REPORT WAS SENT TO CONGRESS ON SEPTEMBER 10. IT DOES
NOT YET REPRESENT THE FULLY COORDINATED AND CLEARED POSITION OF
THE ADMINISTRATION AND MAY BE SUBJECT TO CHANGE.
TODAY, (]ENTLEMEN, I WILL BRIEFLY OUTLINE THE ORIGINAL
OBJECTIVES OF RESPA, PRESENT THE PRIMARY FINDINGS OF OUR STUDY,
AND RECOMMEND, FOR YOUR CONSIDERATION, POSSIBLE CHANGES TO OR
REPLACEMENT OF THE EXISTING LEGISLATION. BECAUSE THESE HEARINGS
ARE PRIMARILY CONCERNED WITH THE ISSUE OF CONTROLLED BUSINESS, I
WILL HIGHLIGHT THAT SPECIAL PROBLEM WITHIN THE GENERAL CONTEXT OF
SETTLEMENT SERVICES.. I MUST, HOWEVER, ADDRESS THE W1~OLE ISSUE
BECAUSE MY RECOMMENDATIONS ON RESPA ENCOMPASS MY RECOMMENDATION
FOR THE TREATMENT OF CONTROLLED BUSINESSES.
85-396 0 - 81 - 2
PAGENO="0018"
12
THE PRACTICE OF OWNING OR CONTROLLING AN ANCILLARY SERVICE COMPANY
HAS BECOME CONTROVERSIAL SINCE THE PASSAGE OF RESPA. SECTION 8 OF RESPA
PROHIBITS KICKBACKS AND UNEARNED FEES. HUD ISSUED AN INTERPRETIVE RULE
IN JUNE 1980, INDICATING THAT A CONTROLLED BUSINESS ARRANGEMENT MAY
CONSTITUTE A VIOLATION OF SECTION 8.
WE HAVE FOUND, HOWEVER, THAT A CONTROLLED BUSINESS ARRANGEMENT MAY
BE THE CHEAPEST AND MOST EFFICIENT PROVIDER OF THAT SERVICE, AND
REFERRAL TO A CONTROLLED BUSINESS SAVES THE CONSUMER TIME AND MONEY IN
SEARCHING. INDEED WE WOULD ARGUE THAT REFERRAL FEES MAY LOWER THE TOTAL
PACKAGE PRICE TO THE CONSUMER* IT IS EQUALLY. TRUE THAT THE CONTROLLED
BUSINESS ALSO CAN BE INEFFICIENT AND COSTLY, BUT CAN REMAIN IN BUSINESS
BECAUSE OF REFERRALS FROM ITS PARENT COMPANY* IN A SETTLEMENT MARKET,
HOWEVER, WE HAVE DISCOVERED THAT CONSUMER SHOPPING AND AWARENESS ARE
MINIMAL) THEREFORE NO NATURAL MARKET FORCES WILL EVER CORRECT THIS
INEFFICIENCY*
THE ORIGINAL OBJECTIVE OF RESPA WAS TO REDUCE THE EXCESSIVE COST
OF REAL ESTATE SETTLEMENTS' IN THE EARLY 1970's, IT WAS BELIEVED THAT
CONSUMERS WERE AT THE MERCY OF THE MORTGAGE LENDING AND SETTLEMENT
SERVICE INDUSTRIES' BORROWERS APPEARED TO HAVE LITTLE KNOWLEDGE OR
UNDERSTANDING OF EITHER THE SETTLEMENT MARKET OR THE REQUIRED SERVICES'
PAGENO="0019"
13
SEVERAL GOVERNMENT ACTIONS WERE CONSIDERED, INCLUDING DIRECT
REGULATION OF THE CHARGES. INSTEAD, THE OPTION CHOSEN BY CONGRESS
REQUIRED DISCLOSURE OF THE INFORMATION NECESSARY FOR CONSUMERS TO COMPARE
THE COSTS OF SETTLEMENT SERVICES. IN THEORY, WHEN EQUIPPED WITH THE
NECESSARY INFORMATION ABOUT THE NEED FOR VARIOUS SETTLEMENT SERVICES,
CONSUMERS WOULD SHOP FOR THE BEST OR LOWEST-COST SETTLEMENT SERVICES.
THIS PRACTICE OF SHOPPING WOULD, IN TURN, ENCOURAGE LENDERS AND OTHER
SERVICE PROVIDERS TO COMPETE FOR BUSINESS, TO LOWER PRICES TO THE MOST
EFFICIENT, LEAST-COST LEVEL, AND TO ELIMINATE UNNECESSARY SERVICES.
REFERRAL FEES OR KICKBACKS, WHICH ARE UNDETECTABLE EVEN WITH CONSUMER
AWARENESS, WERE LEGISLATIVELY BANNED. CONTROLLED BUSINESS ARRANGEMENTS
WERE NOT ANTICIPATED, AND THUS, WERE NOT MENTIONED.
REFLECTING THIS CONSUMERDI5CLO5URE APPROACH, THE PURPOSES STATED
IN THE ACT ARE TO: (1) GIVE CONSUMERS ADVANCE INFORMATION ABOUT SETTLE-
MENT COSTS~ (2) ELIMINATE PRACTICES LIKE REFERRAL FEES OR KICKBACKS~
(3) REDUCE ESCROW AMOUNTS~ AND, (4) REFORM LAND RECORDATION SYSTEMS.
MOST OF THE REGULATORY PROVISIONS IMPLEMENTING RESPA ADDRESS THE FIRST
TWO POINTS: CONSUMER INFORMATION AND KICKBACK PROHIBITION.
UNDER RESPA, THE MECHANISMS FOR CONSUMER INFORMATION INCLUDE A
GOODFAITH ESTIMATE OF CLOSING COSTS PROVIDED WITHIN THREE DAYS OF LOAN
APPLICATION, A HUD-DEVELOPED SPECIAL INFORMATION BOOKLET DESCRIBING
NORMAL SETTLEMENT SERVICES, AND A UNIFORM SETTLEMENT STATEMENT ITEMIZING
ALL SETTLEMENT CHARGES. IN THEORY, ARMED WITH THIS INFORMATION, THE
CONSUMER IS ABLE TO COMPARE AND SHOP FOR INDIVIDUAL SERVICES BEFORE
PAGENO="0020"
14
SETTLEMENT. LENDERS ARE RESPONSIBLE FOR COMPLIANCE WITH THE ADVANCE
DISCLOSURE PROVISIONS* ALL SETTLEMENT PROVIDERS MUST ABIDE BY THE ANTI
KICKBACK SECTION, ALTHOUGH LENDERS, ATTORNEYS, AND REAL ESTATE FII~1S
WERE THE PRIMARY RECIPIENTS PRIOR TO RESPA.
I WILL NOW BRIEFLY SUMMARIZE OUR FINDING ABOUT COMPLIANCE WITH
RESPA AND OUR EVALUATION OF ITS ACHIEVEMENT IN MINIMIZING REAL ESTATE
SETTLEMENT CHARGES'
OUR SURVEYS REPORT THAT COMPLIANCE WITH RESPA IS HIGH' MOST
CONSUMERS RECEIVE THE BOOKLET AND FOF~1S WITHIN THE SPECIFIED TIME
FRAMES' ALTHOUGH OUR CONTRACTOR ATTEMPTED TO QUESTION THE PRESENCE OF
KICKBACKS, THE RESULTS WERE FAIRLY INCONCLUSIVE THE MOST NOTABLE
FINDING REVEALS THE PRACTICE OF WrIAT IS KNOWN AS "CONTROLLED BUSINESS,"
DEVELOPED AS A REPLACEMENT FOR REFERRAL FEES AND KICKBACKS'
THESE SURVEY RESULTS, HOWEVER, DO NOT ADDRESS THE PRIMARY QUESTIONS
ABOUT RESPA's SUCCESS OR FAILURE' THE CRITICAL TEST IS THE EFFECTIVE
NESS OF THE REGULATION TOWARD INCREASING CONSUMER AWARENESS, FOSTERING
CONSUMER SHOPPING, AND REDUCING SETTLEMENT COSTS' IN ORDER TO ANALYZE
RESPA's EFFECTIVENESS, WE MUST LOOK MORE CLOSELY AT SETTLEMENT MARKETS,
CONSUMER BEHAVIOR, AND INDUSTRY PERFORMANCE.
PAGENO="0021"
15
REQ. ESTATE SETTLEMENT IS A MEANS TO AN END -- THAT IS, THE BORROWER
PERCEIVES SETTLEMENT AS A NECESSARY EVIL IN OBTAINING FINANCING AND CLEAR
TITLE FOR THE PURCHASE OF HIS HOME, HOPEFULLY AT THE LOWEST POSSIBLE
PRICE. THE INTRICACIES OF LOAN ORIGINATION, CAPITAL MARKET
REQUIREMENTS, AND INVESTOR RISK ARE NOT THE PRIMARY CONCERNS OF THE
CONSUMER. OUR EFFORT, THEREFORE, TO EDUCATE CONSUMERS ON THE COMPLEXI
TIES OF AND REASONS FOR THE PROCESS IS AN UP-HILL STRUGGLE. COMPOUND
THIS WITH THE TRADITIONAL PRACTICE WHEREBY LENDERS AND REQ. ESTATE
BROKERS SELECT OR RECOMMEND MOST OF THE PROVIDERS OF ANCILLARY SERVICES
AND WE CAN EASILY SEE WHY THE MECHANISMS WITHIN RESPA HAVE BEEN LESS
THAN SUCCESSFUL.
BY APPROACHING SETTLEMENT MARKETS AND SERVICES LIKE ANY OTHER
COMMODITY, RESPA ASSUMES THAT CONSUMERS CAN WEIGH THE DIFFERENCE BETWEEN
TWO OFFERS AND DECIDE WHICH IS THE BEST VALUE. STANDARD ECONOMIC THEORY
TELLS US THAT IF ALL PARTIES POSSESS COMPLETE INFORMATION, NO BUSINESS
CAN PROFIT FROM INADEQUATE KNOWLEDGE, AND ALL BUSINESSES WILL COMPETE BY
LOWERING PRICES OR INCREASING THE QUANTITY OR QUALITY TO THE LEVEL THAT
ALLOWS A NORMAL PROFIT.
IN MOST CONSUMER MARKETS, THIS PREMISE HOLDS TRUE. IN SETTLEMENT
MARKETS, HOWEVER, THE PURCHASED SERVICES ARE NOT DEMANDED DIRECTLY BY
THE BORROWER. CONSUMERS ARE NOT BUYING CREDIT REPORTS, SURVEYS, AND
APPRAISALS' THEY ARE BUYING A HOUSE AND FINANCING' THE LENDER OR
ULTIMATE INVESTOR DEMANDS THESE ANCILLARY SERVICES AS ASSURANCE AGAINST
RISK. HENCE, DIFFERENCES IN THE SERVICE LEVELS, IN THE QUALITY OF
PAGENO="0022"
16
SERVICE, OR IN THE COMPANIES ARE IMPORTANT TO THE LENDER -- NOT THE
CONSUMER. IN MOST CASES, EVEN SINCE RESPA'S ENACTMENT, THE CONSUMER
PAYS FOR THESE SERVICES ON THE ADVICE OF THE LENDER OR BROKER.
WITH YOUR INDULGENCE, I WILL PROVIDE AN ANALOGY* RESPA APPROACHES
SETTLEMENTS AS THOUGH THEY WERE NEW CARS TO BE PURCHASED. COMPLETE
INFORMATION EQUALIZES THE DEALERSHIPS AND CONSUMERS CAN BASE THEIR
FINAL DECISIONS ON REAL DIFFERENCES~ IF THE PRICE OF THE CAR EXCEEDS
THE VALUE TO THE CONSUMER, HE SIMPLY WILL NOT BUY.
Btrr IN REALITY, THE SETTLEMENT MARKET IS £~t)RE CLOSELY ANALOGOUS
TO THE RELATIONSHIP BETWEEN A PHYSICIAN AND PATIENT. PHARMACEUTICALS
ARE NOT THE "END," BUT A MEANS TO THE GOAL OF WELL BEINGS PATIENTS ARE
NOT PARTICULARLY INTERESTED IN THE PRESCRIPTION OR DOSAGE, BUT RATHER
THE ULTIMATE ACHIEVEMENT OF GOOD HEALTH. THE PHYSICIAN, AS AN EXPERT,
MAKES THE DECISIONS, THE PATIENT RELIES ON THIS EXPERTISE.
LIKEWISE, THE BORROWER WANTS CLEAR TITLE AND A MDRTGAGE. HE
ACCEPTS THE ADVICE OF THE LENDER OR OTHER PROVIDERS THAT SO MUCH OF EACH
"INGREDIENT" -- THAT IS, SURVEYS, APPRAISALS, ETC. -- ARE tIECESSARY TO
ASSURE THAT HIS GOAL WILL BE MET.
THE POTENTIAL FOR A CONFLICT OF INTEREST CAN EXIST IN BOTH MARKETS,
BUT SO DOES THE POTENTIAL FOR ECONOMIC EFFICIENCY AND CONSUMER BENEFIT.
THE OBJECTIVE IN EITHER MARKET IS TO MINIMIZE POTENTIAL CONFLICT AND
MAXIMIZE BENEFITS.
PAGENO="0023"
17
OUR STUDIES INDICATE THAT LESS THAN ONE IN TEN CONSUMERS SHOPS
FOR SERVICES AS A RESULT OF RESPA-REQUIRED DISCLOSURES. SO) EVEN THOUGH
COMPLIANCE WITH RESPA IS HIGH, THE EFFECT ON SHOPPING BEHAVIOR APPEARS
TO BE RELATIVELY INSIGNIFICANT.
WE HAVE NO MEANS OF DEFINITIVELY COMPARING SHOPPING BEHAVIOR BEFORE
AND AFTER RESPA. OUR COMMISSIONED SURVEYS IN 1979 SHOW THAT MOST HOME
BUYERS (60 PERCENT) DO NOT ENGAGE IN COMPARATIVE SHOPPING FOR ANY
PROVIDER. OF THE REMAINDER WHO REPORTED SOME SHOPPING, THREE QUARTERS
(75 PERCENT) SHOPPED FOR ONLY ONE PROVIDER. IF THE CONSUMER DID ANY
SHOPPING, IT WAS FOR LENDERS ABOUT HALF THE TIME, AND FOR ATTORNEYS
ABOUT A THIRD OF THE TIME. THESE FINDINGS ARE CRUCIAL TO ANY DECISION
ABOUT THE FUTURE OF RESPA BECAUSE, WITHOUT A SUFFICIENT AMOUNT OF
SHOPPING, NONE OF THE EFFICIENCY GAINS EXPECTED FROM A COMPETITIVE MARKET
CAN BE REALIZED.
IN ADDITION TO THE LESSTHANSATISFACTORY FINDINGS ABOUT SHOPPING
BEHAVIOR, THE INCREASING COST OF SETTLEMENTS APPEARS TO BE UNCHECKED BY
THE PROVISIONS OF RESPA. AGAIN, COMPARISONS ARE DIFFICULT DUE TO THE
LACK OF COMPARABLE PAST STUDIES AND fl~TA. BUT WHAT IS CREDIBLE AND
AVAILABLE INDICATES THAT FROM 1972 TO 1979 TOTAL SETTLEMENT COSTS
INCREASED BETWEEN 120-170 PERCENT, WHILE GENERAL PRICES INCREASED
65 PERCENT TO 75 PERCENT. IN OTHER WORDS, THE COST OF REAL ESTATE SETTLE
MENTS ROSE ABOUT TWICE AS FAST AS OTHER GOODS AND SERVICES~ WE CANNOT
CONFIDENTLY CALCULATE PRICE TRENDS FOR INDIVIDUAL SERVICES BECAUSE THE
1972 SURVEY WAS NOT SIMILAR ENOUGH TO THE 1979 STUDY.
PAGENO="0024"
18
WE HAVE, FOWEVER, ANALYZED INDIVIDUAL SETTLEMENT INDUSTRIES, NOT
BY COMPARING COSTS) BUT BY REVIEWING PERFORMANCE AND MARKET CHARACTER
ISTICS* THE FIVE MAJOR INDUSTRIES INVOLVED IN MOST REAL ESTATE TRANSFERS
ARE: LENDERS) TITLE INSURANCE COMPANIES, MORTGAGE INSURANCE COMPANIES,
ATTORNEYS, AND REAL ESTATE BROKERS*
WE DID NOT FIND EITHER OVERT, ANTI-COMPETITIVE PRACTICES OR IDEAL,
PERFECTLY COMPETITIVE MARKETS* WE DID FIND PRACTICES W-UCH, AT A
MINIMUM, PROVIDE POTENTIAL FOR INEFFICIENCY AND HIGHER CONSUMER PRICES.
IN PARTICULAR, ALTHOUGH THE LENDING INDUSTRY BEHAVES THE MOST
COMPETITIVELY OF THOSE STUDIED, THE HOMEBUYER OFTEN OBTAINS THE RELEVANT
MARKET INFORMATION ONLY .AEI~B. HE HAS APPLIED FOR A LOAN AND AEIE&
PREPAYMENTS FOR PARTICULAR ITEMS DISSUADE HIM FROM CAPITALIZING ON HIS
KNOWLEDGE AND SHOPPING FURTHER.
THE ATTORNEY'S POSITION IN RESIDENTIAL REAL ESTATE SALES HAS
CHANGED CONSIDERABLY OVER THE PAST DECADE, AS TITLE INSURANCE POLICIES
REPLACE ATTORNEY. TITLE SEARCHES IN THE WEST AND ANTI-TRUST DECISIONS
HAVE REDUCED PRICE UNIFORMITY* HOWEVER, THE CAUSE OF THESE CHANGES IS
UNCLEAR AND COULD HAVE OCCURRED WITHOUT RESPA.
BOTH THE TITLE AND PRIVATE MORTGAGE INSURANCE INDUSTRIES ARE
DOMINATED BY A FEW LARGE COMPANIES* THIS DOMINATION TENDS TO INDICATE
A LACK OF COMPETITION* ON THE OTHER HAND, HOWEVER, INTERVIEWS INDICATE
THAT THESE COMPANIES COMPETE AGGRESSIVELY FOR LENDER BUSINESS. PRICES
PAGENO="0025"
19
ARE UNIFORM IN THESE INDUSTRIES, WHICH WOULD SEEM TO INDICATE THE
EXISTENCE OF COLLUSION. HOWEVER, THERE IS ALSO REASON TO BELIEVE THAT
THE UNIFORMLY HIGH PRICES ARE DUE, AT LEAST IN PART, TO SIMILAR
PRODUCTION COSTS AND COMPARABLE SERVICES.
WHAT CAN BE SAID UNEQUIVOCALLY IS THAT THE POTENTIAL EXISTS FOR
MARKET INEFFICIENCY. SPECIFICALLY, THE HOMEBUYER BEARS THE DIRECT COST
OF PURCHASING TITLE INSURANCE AND PAYS THE PREMIUM FOR MORTGAGE
INSURANCE, BUT IS UNABLE TO CALCULATE THE BENEFIT IN TERMS OF REDUCED
INTEREST RATE OR REDUCED UPFRONT LENDER CHARGES.
NOT KNOWING THE BENEFITS AS WELL AS THE COSTS OF TITLE AND
MORTGAGE INSURANCE, THE HOMEBUYER IS IN NO POSITION TO DECIDE WHETHER
OR NOT TO PURCHASE THESE ITEMS. THE LENDERJ ON THE OTHER HAND, BENEFITS
FROM THE RISK REDUCTION PROVIDED BY INSURANCE, BUT DOES NOT BEAR THE
COST BECAUSE IT IS CHARGED DIRECTLY TO THE BORROWER.
ALTHOUGH PRICE COMPETITION IN THE REAL ESTATE BROKERAGE INDUSTRY
HAS INCREASED, PRICE UNIFORMITY REMAINS WITHIN ANY GIVEN LOCAL MARKET.
THIS PRICE UNIFORMITY IS NOT MAINTAINED BY VIRTUE OF REGULATORY OR LEGAL
MECHANISMS, BUT BY INFORMAL PATTERNS OF COOPERATION AND BY TRADITIONAL
PATTERNS OF COMMISSION SPLITS. HOWEVER, CONSUMER INTERVIEWS SHOW A
PREDOMINANT USE OF TRADITIONAL BROKERS AND GENERAL SATISFACTION WITH THE
SERVICE.
PAGENO="0026"
20
EVEN WITH RESPA, EXISTING MARKETS POSSESS THE POTENTIAL FOR ABUSE OF
THE CONSUMER' BORROWERS ARE DEPENDENT UPON ADVICE FROM PARTIES WHO WILL
BENEFIT DIRECTLY EVEN THOUGH THESE ADVISORS BEAR NO COSTS' THE
SELECTION CRITERIA CAN INCLUDE "REWARDS" OR QUALITIES THAT AFFECT ONLY
THE ADVISOR,' THE BORROWER, IF GIVEN THE CHOICE, MIGHT ACQUIRE THE
SERVICES DIFFERENTLY'
THE COMPLEXITY OF THE SERVICES, THE STRESS AND EMOTIONAL PITCH OF
A MOVE, THE INFREQUENCY OF A TRANSACTION, AND THE UPFRONT COSTS MAKE
SETTLEMENT MARKET INFOI~1ATION EXPENSIVE, TIME CONSUMING, AND DIFFICULT
TO OBTAIN' DEPENDING ON EXPERTS WHO DEAL IN THESE MARKETS DAILY IS BOTH
LOGICAL AND EFFICIENT -- IF THE SYSTEM IS IDEAL'
GIVEN THE PRESENT OPERATION OF SETTLEMENT MARKETS AND THE ESTABLISHED
PROCEDURES, ANY GOVERNMENT ACTION SHOULD WORK WITHIN THESE CONFINES IN
ORDER TO TAKE ADVANTAGE OF EFFICIENCIES WITHIN EXISTING OPERATIONS' RESPA
IS MISDIRECTED BECAUSE IT INCREASES THE AMOUNT OF INFOF~ATION GOING TO THE
CONSUMER IN AN EFFORT TO EDUCATE HIM TO UNDERTAND ALL THE ASPECTS OF THE
SOMEWHAT ARCANE PROCESS OF SETTLEMENT' EVIDENCE, HOWEVER, INDICATES
THAT MOST CONSUMERS, EVEN WHEN PRESENTED WITH THE INFORMATION, DO NOT
TAKE THE TIME AND EFFORT TO STUDY THE FACTORS' OUR RESEARCH AND SURVEYS
SUGGEST THAT A MORE EFFICIENT METHOD OF FACILITATING INFORMATION FLOW
WOULD BE TO REDUCE THE AMOUNT OF NECESSARY INFORMATION TO A MINIMUM'
FURTHER, BECAUSE MOST OF THE SERVICES OCCURRING AT SETTLEMENT ARE LENDER
REQUIRED, THE CHOICE ABOUT PROVIDERS, AMOUNTS AND COSTS IS MORE IMPORTANT
TO THE LENDER AND THE ULT.MATE INVESTOR THAN TO THE BORROWER'
PAGENO="0027"
21
FROM OUR CONSUMER AND INDUSTRY INTERVIEWS, WE CAN CONSTRUCT THE
CHRONOLOGY OF A TYPICAL SETTLEMENT. THE AVERAGE BORROWER SHOPS FOR A
LENDER USING CONTRACT INTEREST RATE AND ORIGINATION POINTS AS A
COMPARISON. SOME BORROWERS TURN TO THEIR REAL ESTATE AGENTS FOR THIS
SEARCH. ONCE THE LENDER IS SELECTED, THE BORROWER MAKES APPLICATION)
PAYS THE UPFRONT CHARGES) RECEIVES SEVERAL FORMS AND BOOKLETS FROM THE
LENDER) AND GOES HOME TO WAIT FOR CLOSING' A FEW GLANCE THROUGH THE
BOOKLETS AND LOOK AT THE BOTTOMLINE OF THE GOOD-FAITH ESTIMATES OF
CLOSING COSTS. Ai SETTLEMENT) THE BORROWER AGAIN RECEIVES A FEW FORMS
AND PAYS THE BOTTOM LINE OF AN ACCOUNTING SHEET THAT LISTS ALL SEPARATE
CHARGES.
RESPA REGULATES WHAT LENDERS MUST AND MUST NOT DO IN ORDER TO MAKE REAL
ESTATE LOANS. THE DISCLOSURE'RULES ARE SPECIFIC AND DO NOT ALLOW
REASONABLE VARIATION. THE RESTRICTION ON BUSINESS ACTIVITY BANS
BEHAVIOR THAT MAY BE AN EFFICIENT BUSINESS ARRANGEMENT.
COLLECTING ALL THE FAILINGS AND DRAWBACKS, WE ARRIVE AT A
RECOMMENDATION THAT CONGRESS GIVE SERIOUS CONSIDERATION TO A REPLACE
MENT OF RESPA WHICH WE CALL LENDERPACKAGING' WE FEEL THAT THIS
APPROACH WILL DIRECTLY ADDRESS THE PROBLEMS AND INEFFICIENCIES
PERCEIVED WHEN RESPA WAS FIRST PROPOSED. LENDER'PACKAGING INVOLVES
THE GATHERING OF ALL LENDERREQUIRED SETTLEMENT SERVICES INTO ONE BUNDLE
WITH A PREQUOTED PRICE. A PROSPECTIVE BORROWER OR HIS AGENT WOULD CALL
PAGENO="0028"
22
FOR QUOTES FROM LENDERS AND RECEIVE TWO NUMBERS: THE CONTRACT INTEREST
RATE AND A FEE FOR ALL LENDERREQUIRED SERVICES STATED IN DOLLARS OR
PERCENTAGES* THE BORROWER NEED NOT BE CONCERNED WITH THE CONTENTS OF
THE BUNDLE, ANY MORE THAN HE NEED BE CONCERNED WITH LOCATING THE ULTIMATE
INVESTORS FOR THE LOAN* THE SETTLEMENT FEES BECOME A PART OF THE COST
OF BORROWING, AS THEY IN FACT ARE, AND THE BORROWER CAN COMPARE THESE
COSTS IN MAKING HIS OR HER CHOICE.
ALL SERVICES REQUIRED BY THE LENDER WOULD HAVE TO BE INCLUDED IN
THE PACKAGE PRICES. GIVEN EXISTING PRACTICES, THIS WOULD INCLUDE
TITLE SEARCH, THE LENDER'S TITLE INSURANCE POLICY, SURVEYS, CREDIT
REPORTS, ORIGINATION AND COMMITMENT FEES, ATTORNEY FEES (FOR LENDER
REVIEW OF DOCUMENTS) AND MORTGAGE INSURANCE. LENDERS WOULD THEN HAVE
INCENTIVE TO REDUCE OR ELIMINATE SERVICES AT THE MARGIN WNERE THE COST
EXCEEDS THE BENEFIT IN ORDER TO REMAIN COMPETITIVE.
LENDER-PACKAGING WOULD NOT PRECLUDE PROVISION OF ADDITIONAL SERVICES
DESIRED BY THE BORROWER OR ARRANGEMENTS NEGOTIATED BETWEEN INDIVIDUAL
BORROWERS AND LENDERS* FOR INSTANCE, OWNER'S TITLE POLICY, BORROWER'S
ATTORNEY, AND OTHER SERVICES DESIRED BY THE BORROWER CAN STILL BE A PART
OF SETTLEMENT AT THE BORROWER'S DISCRETION AND EXPENSE* LOCAL AND STATE
GOVERNMENT TAXES AND FEES WOULD NOT BE INCLUDED IN THE PACKAGE, BECAUSE
THESE FEES ARE NOT LENDER-REQUIRED' INDIVIDUALS MAY ALSO WISH TO NEGOTIATE
SEPARATE PACKAGES TO INCLUDE OR EXCLUDE SPECIFIC SERVICES. THE LENDER
PACKAGING PROPOSAL SIMPLY HOLDS THAT ALL LENDER'REQUIRED SERVICES CAN
BE PURCHASED FOR A SINGLE PRICE THAT IS KNOWN .`T THE TIME OF APPLICATION
PAGENO="0029"
23
LENDER-PACKAGING HAS THE FLEXIBILITY TO ADAPT TO THE MYRIAD REGIONAL
METHODS OF REAL ESTATE SETTLEMENTS LENDERS KNOW LOCAL VARIATIONS AND CAN
ASSEMBLE THE PARTICULAR SERVICES NECESSARY FOR THAT AREA. LENDERS CAN
ALSO CHOOSE DIFFERENT PACKAGES FOR DIFFERENT BORROWERS OR GROUPS OF
BORROWERS* LENDERS1 FOR INSTANCE1 MAY WISH TO OFFER CONDOMINIUM BUYERS
A DIFFERENT PACKAGE THAN SINGLEFAMILY PURCHASERS BECAUSE TITLE WORK IS
DIFFERENT. ONE LENDER MAY ACCEPT PURCHASERS IN A NEW SUBDIVISION AT A
CHEAPER PRICE BECAUSE THE BUILDER PROVIDES THE CLOSING SERVICES~
SMALLER LENDERS CAN PURCHASE THE SERVICES FROM INDEPENDENT PROVIDERS1
AS IS DONE NOW1 BUT THE PRICE WOULD SE SET AND KNOWN AT APPLICATION
INSTEAD OF SETTLEMENTS THE KEY IS THAT LENDERS CHOOSE THE SERVICES
REQUIRED AND GIVE THE PRICE UPFRONT SO THAT CONSUMERS CAN MAKE LOGICAL
COMPARISONS.
THE LENDERPACKAGING PROPOSAL ELIMINATES THE CONCERN ABOUT CONTROLLED
BUSINESS AND KICKBACKS OR REFERRAL FEES. WHILE SETTLEMENT PROVIDERS MAY
WISH TO REFER BUSINESS TO A PARTICULAR COMPANY, THE ULTIMATE DECISION
WILL BE BASED ON THE MOST EFFICIENT SETTLEMENT PACKAGE BECAUSE CONSUMER
CHOICE WILL BE BASED ON THAT PRICES CONSEQUENTLY, WHERE A CONTROLLED
BUSINESS IS AN EFFICIENT ARRANGEMENT BETWEEN TWO SETTLEMENT PROVIDERS,
THE PRACTICE CAN CONTRIBUTE TO LOWER CONSUMER COSTS. WHERE THE ARRANGE
MENT ALLOWS A LENDER, FOR INSTANCE, TO REFER TITLE WORK TO A SUBSIDIARY
THAT OVERCHARGES AND RETURNS THE EXCESS PROFIT, THE TOTAL SETTLEMENT
PACKAGE WILL HAVE TO REFLECT THIS CIRCULAR FLOW OF PAYMENTS OR THE LENDER
WILL NOT BE COMPETITIVE AND NO~1AL MARKET FORCES WILL CORRECT THE EXCESS.
PAGENO="0030"
24
THEREFORE.. WITH RESPECT TO CONTROLLED BUSINESS.. IF LENDERPACKAGING
IS ADOPTED, WE RECOMMEND THAT SECTION 8 OF RESPA BE REPEALED* IF LENDER
PACKAGING IS NOT ADOPTED, WE RECOMMEND SUBSTITUTING AN ANTITRUST STATUTE
WITHOUT CRIMINAL PENALTIES, WHICH WOULD ALLOW PRIVATE RIGHTS OF ACTION.
THE NEW STATUTE WOULD EXPRESSLY COVER CONTROLLED BUSINESS ARRANGEMENTS
AS WELL AS KICKBACKS AND REFERRAL FEES. IF COMPETITORS OR CONSUMERS CAN
PROVE A PROHIBITED RELATIONSHIP EXISTS AND IS HARMFUL, THEY MAY SUE FOR
DAMAGES AND LET THE COURTS DECIDE THE DAMAGE.
BEFORE ACCEPTING ANY REPLACEMENT FOR RESPA, CONGRESS MUST ALSO
DECIDE WHETHER ANY GOVERNMENT INTERVENTION IS NECESSARY. OUR ASSESSMENT
OF THE SETTLEMENT MARKET, AS I HAVE ALREADY INDICATED, REVEALS A POTENTIAL
FOR ABUSE UNDER CURRENT CONDITIONS~ REPEAL OF RESPA WOULD INCREASE THAT
POTENTIAL BECAUSE THE BASIS FOR CHOOSING PROVIDERS COULD BECOME MORE
REMOVED FROM THE CONSUMER'S INTERESTS
THE SOLUTION LIES IN A MARKET WHERE THOSE WHO MAKE THE CHOICE BASE
IT ON ALL THE COSTS AND BENEFITS ASSOCIATED WITH THAT DECISION. IN
TERMS OF LENDERPACKAGING, THAT MEANS LENOERS CHOOSE A QUANTITY OF
SERVICE, SAY APPRA!SALS, BASED ON THE COST ASSOCIATED WITH THE BENEFIT --
VERIFYING THE PROPERTY VALUE. UNDER PRESENT CONDITIONS, CONSUMERS DO
NOT BASE THEIR CHOICE OF LENDERS ON THE FEE FOR APPRAISAL* THE LENDER,
IN TURN, HAS NO INCENTIVE TO REDUCE OR ELIMINATE THIS SERVICE BECAUSE
THE BENEFIT OF REDUCED RISK OCCURS WITHOUT A COSTS UNDER LENDER
PACKAGING, CONSUMERS WOULD CHOOSE LENDERS, IN PART, BASED ON THE TOTAL
SETTLEMENT PACKAGE. UNNECESSARY OR OVERUSED SERVICES WOULD DISAPFEAR
AS LENDERS COMPETED FOR LOANS.
PAGENO="0031"
25
WE ARE RECOMMENDING THAT CONGRESS CONSIDER LENDERPACKAGING
BECAUSE IT REQUIRES THE MINIMUM AMOUNT OF GOVERNMENT INTERFERENCE IN A
MARKET THAT POSSESSES POTENTIAL FOR ABUSE OF CONSUMERS. OUR REPORT
DISCUSSES SEVERAL ALTERNATE FO~1S N-IEREBY LENDERS OFFER LENDERPACKAGING
ON A MANDATORY BASIS OR AS AN OPTION. THE IMPORTANT ADVANTAGE TO A
MANDATORY PROVISION, OF COURSE, LIES IN THE UNIFOF~'HTY OF OPERATION.
ALL LENDERS WOULD PLAY BY THE SAME RULES THEREBY FACILITATING COMPARISON
SHOPPING.
I HAVE COVERED ONLY BRIEFLY, WHAT IS A LARGE AND DETAILED REPORT
ON OUR FINDINGS. I WILL BE GLAD TO ANSWER ANY QUESTIONS THE COMMITTEE
HAS.
Chairman GONZALEZ. Thank you very much, Dr. Savas.
We are honored with the presence of the full committee chair-
man, who also happens to be the ranking member of the subcom-
mittee. And we will ask him if he has any statement he wishes to
make at this time.
Mr. ST GERMAIN. Well, I would like to commend the chairman
and the subcommittee for holding the hearings. I apologize for
being tardy in my arrival, and, in fact, I am going to have to leave
early. It's great to be chairman of the full committee, but the
duties are unbelievable, and I don't think it would be fair for me to
interject into the questioning at this point in time. So I thank the
chairman and yield back.
Chairman GONZALEZ. Thank you, sir.
Dr. Savas, on page 4 of your statement, the second to the last
paragraph, you say that the issue of kickbacks in controlled busi-
nesses were examined in the Peat, Marwick & Mitchell study.
However, according to that contractor, their personnel were prohib-
ited by 0MB from going into that area. They were as much as
prohibited from not studying the extent to which referral fees were
kickbacks, have disappeared, and I don't see how, then, in the
absence of that consideration you can say that HUD can make the
recommendations it is making because they seem to be predicated
that on that study, but the contractors report that 0MB specifical-
ly refused them the opportunity to go into that aspect in the study.
Dr. SAVAS. The survey design and the survey instrument, of
course, required the approval of 0MB, and some questions dealing
directly with that issue were not included in the final question-
naire. However, the contractor was able, from the various inter-
views conducted, to obtain general information on this subject, and
that is what was revealed in our study.
PAGENO="0032"
26
Chairman GONZALEZ. Well, I don't believe that that answers the
question as to the specific refusal by 0MB and why-I'm quoting
here from the study:
The study conducted by Peat, Marwick, Mitchell & Co. was prevented from
investigating its sytems or the extent of controlled business. As with the issue of
direct kickbacks, the Office of Management and Budget severely limited the collec-
tion of information in that study, which would have provided hard data about
controlled business.
Now let me point out that this was not Mr. Stockman's 0MB.
This was Jimmy Carter's 0MB. Since Mr. Stockman is the present
demon, I didn't want to be unfair to that extent. 0MB always has
been onerous and sometimes, in my opinion, it has allowed admin-
istrations to exceed their proper authority and, in fact, invade the
congressional constitutional prerogative to hold the purse strings.
But in this case, there is no question, Mr. Savas, that 0MB ruled
out any consideration. So I question, then, the validity of the
assumptions upon which you base your recommendation.
Dr. SAVAS. Well, obviously, Mr. Chairman, I'm in no position to
try to analyze or interpret the decision made by 0MB last year.
However, try to look at it from the point of view of survey work,
survey research. I am inclined to believe that trying to ask ques-
tions about kickbacks and referrals in that kind of a collusive
environment would be futile. You don't receive information by
asking either the giver or the recipient, or the potential giver or
imputed giver or receiver, a kickback or referral fees. You can't get
information that way.
Instead, what the study focused on was the potential for abuse
and the fact that, basically, RESPA does not work. That is, to the
extent that RESPA was designed to increase consumer awareness
and to encourage shopping for services, the law has been unsuc-
cessful. It has been unsuccessful basically because it attempts to
educate consumers in a subject they do not need and do not or
apparently do not, wish to be educated upon. And so we offer an
alternative.
In other words, getting back to your principal point, Mr. Chair-
man, I don't think that the failure to ask questions, either to the~
potential giver or the potential recipient who derives kickbacks or
referral fees is disastrous to the study. The kind of information
that would be obtained by asking those questions is really of little
scientific value, in my judgment.
Chairman GONZALEZ. But the 0MB incursion went beyond pro-
hibiting the asking of questions. It specifically denied any ability of
the contractor to go into that area, either through questioning or
any other device. This is what I'm getting at.
But nevertheless, I realize that you are in no position to explain
why 0MB did what it did. All I'm saying is that in the absence of
that, the conclusions upon which you are basing some of your
recommendations would be open to question from a documentary
and factual standpoint.
In order to give the other members opportunity to question, I
will ask unanimous consent that I be permitted to submit other
questions in writing in time for Mr. Savas to answer for the tran-
script.
Wouldn't the requirement that lenders package settlement costs
tend to encourage the development of more controlled business
PAGENO="0033"
27
relationships between lenders and their wholly or partially owned
subsidiaries-leading eventually to an exclusion from the total set-
tlement process of independent title insurers, mortgage insurers,
and other subsidiary service providers?
[In response to the request Of Chairman Gonzalez, the following
additional information was submitted for inclusion in the record by
Dr. Savas:]
RESPONSE RECEIVED FROM MR. SAVAS
The requirement of a lender package may, indeed, lead to more ownership or
stock participation in ancillary service companies, but only to the extent that they
prove more efficient and less costly than using existing companies. That tendency,
however, need not and likely will not lead to the demise of independent providers.
Independents who provide their service more efficiently and less costly than a
lender-owned firm will remain in business on a contract or retainer basis supplying
lenders directly with the service needed. Your question holds the implication that
all lenders will choose to provide these ancillary services themselves and, once the
independents are eliminated, charge whatever they want for those services. No
evidence exists to suggest that occurring. Instead, consumers will shop for lenders
based on the mortgage rate as well as the closing costs. Lenders will not be able to
overcharge for closing services any more than they can overcharge for interest rate.
Chairman GONZALEZ. What I do want to point out or say and
really ask the question is that on page 10 where you are leading up
to your recommendation, you say that actually the lender has a
bigger stake in reducing costs. Well, it is actually the borrower
that is paying directly for those costs. So it would seem to me that
we can't relegate him to having less interest, less concern and less
at stake than the lender.
On page 14 you do get into your recommendations. I think there
is nothing in the act-and I stand to be corrected if your interpre-
tation of the present act is different-to prohibit the packaging
you've recommended, other than prohibiting a fee being attached
to the referral. I don't see why your recommendation isn't feasible,
even within the existing framework of the law without any amend-
ments. I don't find anything in the existing act that prohibits the
recommendation you're making on page 14.
Dr. SAVAS. Mr. Chairman, the recommendation we make is that
Congress give consideration to this admittedly rather novel con-
cept. And you are absolutely correct, of course, that there is no
prohibition in the current law regarding lender packaging.
However, unless everyone plays by the same rules, it's very easy
to see what would happen if one organization introduced lender
packaging and no one else did that.
One would simply be quoting a lower price because it would
include a different bundle of these arcane and hard-to-comprehend
services. For that reason, either everybody plays by the same rules,
or else we have the situation of a relatively inefficient market.
You are quite right in your observation, but I think that what it
leads one to is a conclusion that everybody has got to play by the
same rules, either within a State or nationally.
Chairman GONZALEZ. Thank you very much.
Mr. Coyne-and I say one of the two Coynes-they're both from
Pennsylvania, so we always have to say, it's J. Coyne.
Mr. J. COYNE. Thank you very much, Mr. Chairman.
I very much appreciated your testimony. In the past year, I've
participated in two settlements, and I have another one coming up
shortly. And as I've often said, going through a settlement proce-
85-396 0 - 81 -
PAGENO="0034"
28
dure is one of the most nervewracking activities for any average
consumer. Hopefully he doesn't have to do it too many times
during his lifetime. If he can get through it thinking he did about
half of it right, he is better than most.
Your idea of lender packaging seems to be very innovative to me.
Of course, I am concerned about what might happen as that gets
established and as the industry becomes accustomed to it. Lender
packaging, too, it seems to me, is vulnerable to abuses itself.
I can see a situation where during times of, perhaps, short credit,
the consumer goes into the lending office, and the package includes
one prequoted price. It is going to be $2,600 at settlement; this is
our bundle price, and take it or leave it. Included in that price is
an $1,100 appraisal fee which the consumer knows he could go out
and get for $250.
Unless we allow the package to be individually itemized and
allow the consumer to substitute within that package when he
knows he can get a better product, aren't we depriving him of some
of his choices?
For example, in one of my recent settlements, the savings society
instructed me that I had to get an appraisal, and I got quotes on
appraisals that ranged from $180 to more than $2,000 for the same
property. Now, of course, if there is that much range, because I
shopped, I guess I'd get a star in your book. I picked the $180, by
the way, and the savings society was perfectly happy with it, and
they didn't complain. They got the right number at the bottom, so
they were perfectly pleased with it.
Aren't we risking, under this package, giving the lenders an
excuse to disinform and to remove choices?
Dr. SAVAS. That's an excellent point, Mr. Coyne. I would say two
things.
One, would that all home buyers were as alert and aggressive as
you in shopping and comparing and so on. Unfortunately the facts
are that RESPA is responsible for less that 1 in 10 taking that
interest.
And second, it would certainly appear that with lender packag-
ing, if the prices were bloated because of a bloated appraisal price
or whatever, then the buyer would simply go somewhere else and
look for that. But he would have a simple means of comparison for
all of those complex settlement fees that a person would not get
into but once or twice in his life.
Mr. J. COYNE. What I'm saying is that at a time of a credit
crunch where the consumer doesn't have many choices, where he
might go to six or seven different banks and only one of them will
even let him make an application, then we are giving the lender a
vehicle for disguising a lot of padding of his price, and I think that
might be destructive to the consumer.
The other thing I have to say is, if we're going to give the lender
the right to put together this package, cannot we allow other
institutions or organizations to put together a package as well and
get even more competition in bringing together these different
services? Two-thirds of the settlement costs are nonlender-produced
services. They are produced by other individuals, attorneys, ap-
praisers, surveyors, whatever. Why can't we allow a separate in-
PAGENO="0035"
29
dustry to evolve and put these packages together more economical-
ly?
Dr. SAVAS. This is precisely why we offer this concept for consid-
eration by the Congress, because it requires that kind of very
careful probing analysis and attention.
I think one might argue that the basic thing that the purchaser
wants to buy is a mortgage. And it is the lender who decides what
he, the lender, needs in order to enable that loan to be made. And
the lender is who that package should be tailored for.
If the separate institutional organization is putting the package
together, then it's hard for the buyer of the house to figure what
packages he wants or does not want in there. Still it might work.
And if there were a lot of excess components in that package-now
I'm thinking out loud here-ultimately it's the lender who still has
to be satisfied with the ingredients of the package, and the buyer
would have to ask the lender whether he is satisfied with this
bundle, or is it missing something the lender needs.
Mr. J. COYNE. What I would hate to see is that Congress grant to
the lender the exclusive right to become the packager and thereby
give him a lever that other elements in the marketplace don't
have. I can tell by your testimony, you are, as I am, a strong
defender of free market supply and demand forces. But as you
know, when supply exceeds demand, the effects of regulation are
very different than when demand exceeds supply. We may develop
one set of regulations which, as you point out, will be very effective
in times of long supply. However, when demand gets short some of
these regulations could become counterproductive. I am apprehen-
sive about that.
Dr. SAVAS. I should add, of course, that there are lots of people
who can originate loans-that mortgage bankers, for example, can
originate loans-so they, too, could very well be in the packaging
business.
Mr. J. C0YNE. Thank you for your answers. And I want to also
submit a question, if I may, in writing.
Chairman GONZALEZ. Without objection, so ordered.
Mr. Coyne, Bill Coyne, that is?
Mr. W. COYNE. I have no questions, Mr. Chairman.
Chairman GONZALEZ. Thank you very much.
Mr. Patterson?
Mr. PATTERSON. Thank you, Mr. Chairman.
Dr. Savas, the mandatory feature you are committed to, appar-
ently, as I just heard it, is that the lender only be provided. Mr.
Coyne asked the question; you, I think, said less. And you feel the
lender-that is, because the lender has what-the greatest risk or
the only interest?
Dr. SAVAS. Mr. Patterson-it is basically because the lender is
the one who imposes these requirements.
Mr. PATTERSON. But I really find that hard to believe. I am going
out to buy a home, let's say. It seems to me that I have a greater
interest than the lender in whether or not I get a clear title and
whether or not the search has been done adequately and whether
or not the services have been rendered and whether or not I am
paying too high a price and virtually every other feature. And I
really doubt that the lender cares, other than that his security is
PAGENO="0036"
30
not impaired. And depending upon the amount of the downpay-
ment and depending upon a lot of other things, the lender doesn't
seem to me to have the totality of interest that the borrower would
have.
I think the chairman, as a matter of fact, made that point, and I
don't recall that you cleared it up, at least in my mind.
Dr. SAVAS. Let me identify part of the wonderous range of serv-
ices and fees that are provided here. In some of these, the consum-
er would have a more direct interest; others are really rather more
remote. And it is quite different to expound.
Let me read off a list of the fees and charges that appear typical-
ly in various settlements. Loan origination, credit report, appraisal,
survey, prepaid interest, mortgage insurance premium, inspection
fee, document preparation fee, attorney's fee, amortization sched-
ule fee, tax service fee, settlement or closing fee, escrow fee, title
search, abstract of title, examination of title, attorney's opinion
about title, and title insurance premium for the lender. Now, these
are not necessarily all found in any given settlement. This is an
example of the kinds of fees generally included.
And although you might single out one of these, like title insur-
ance-let's face it, most home buyers believe that the lenders title
insurance protects themselves, where as a matter of fact, it pro-
tects the lender. These various, quite obscure, and abstruse kinds of
things-evidence shows that people simply do not pay attention.
The theory and the idea behind RESPA, I guess you can argue
that it was an excellent idea. Its only shortcoming is that it didn't
work. That is, it failed to force purchasers of houses to educate
themselves and to become as knowledgeable as Congressman Coyne
was in his home settlement. That seems to be the basic issue.
Mr. PATTERSON. Well, at least that is what you are assuming. I
think that the Peat, Marwick Mitchell & Co. study didn't prove
that.
According to your own testimony, the data for 1972 isn't the
same as the study and the data for 1979. So I don't know how you
make that conclusion. It seems to me we spent $2 million on a
study that tells us what it was in 1979, and doesn't compare any-
thing with any earlier dates which would then give it some signifi-
cance.
Dr. SAVAS. That is a good point. But I think what does come out
quite clearly is that home purchasers do not in fact shop, and that
is the basic shortcoming.
Mr. PATTERSON. They don't shop, because they are interested in
buying a home, and they are interested in financing. And as you
stated-but they also have the biggest stake in everything else that
is wrapped up in that.
You also have situations, just changing it, and even if they're not
interested in the loan origination fee, they are going to pay the
price. The lender isn't going to pay it. So it would seem to me that
they would have an interest in virtually every item you mentioned,
because somebody is going to pay it.
What about those 32 States where the seller pays the fees? Now,
you are delegating-the seller is going to have to, I assume, under
your proposal, the seller is going to have to pay whatever the
lender puts in there that he requires for proving up, at least
PAGENO="0037"
31
adequately to the lender's satisfaction, the security in the home,
for him to make the loan; is that right?
In other words, that not only the buyer doesn't get protected, it
is the lender who gets protected, but if the seller is the one who
pays the bill, he doesn't get a chance to negotiate the price; he is
just going to pay whatever the package is? In other words, the
buyer goes out and finds the lender, and then after finding the
lender, they don't care what any of the fees are in there, because
they're not going to pay it, in 32 States. So in those 32 States, you
have got the seller walking into a transaction with maybe 1,000
dollars' worth of settlement fees, and where somewhere else it
might be $500.
And nobody is going to go to court, your antitrust thing. I mean,
who is going to sue for $500 difference? It is the multitude of cases,
time and time again, that is going to make huge profits for those
who have vested financial interest-and, frankly, squeeze out com-
petition.
I find a mandatory lender packaging system kind of obnoxious. It
seems to me it leads to less competition, instead of more.
Dr. SAVAS. Ultimately, it seems that these costs do get incorpo-
rated in the house price. Whether paid directly by the seller or
buyer, it gets incorporated in the home price, or someplace else. I
think that is the way the markets basically work. It appears to us
that the tendency would be to increase competition to lead to more
enlightened shopping without forcing the shopper to become an
expert in the settlement-closing process.
It seems the consumer would have a bundle to deal with-he
would have a price, and if he doesn't like the price, he could shop
around or compare, and particularly because there is competition
among lenders at various times, there may or may not be high
mortgage interest rates. But, the most competitive part of the
whole settlement process appears to be the lending part, and there
seems to be a logical opportunity to build upon that market force,
taking into consideration that we are wiser today than we were in
1974, we think. Taking this into consideration, and trying to devise
yet a better system, designed to achieve the ultimate objective.
Mr. PATTERSON. What if, instead of repealing section 8 of RESPA,
you just provided more information? In other words, instead of
saying, OK, it didn't work to our satisfaction, or we don't think it
did, we really don't know, but prices did go up, settlement costs did
go up, we're not sure whether it is inflation or lack of competi-
tion-but what about just providing more information at an earlier
time, rather than the booklet after an individual has already
signed a contract, and is really on a time frame of trying to find a
lender? How about having all lenders post what their settlement
charges are at every branch office?
It seems to me HUD ought to be interested in that and that adds
to the consumers' right to know in advance, rather than-and then
you can shop for everything-interest, you can look at it, and you
don't need a package. It seems to me that opens up a lot more
possibility for competition. They have to already do it in many
instances, where they have to publish things that they are doing.
Why not have them publish on a monthly basis, or whatever, what
their settlement charges are in each category, with a total-not in
PAGENO="0038"
32
any particular-in other words, you couldn't have it on this con-
tract case, but you could say, this is what it is per 1,000, or
whatever.
Dr. SAVAS. You used a crucial phrase in there just a moment ago.
You said "in total." What the settlement costs are, in total. And in
that case, I think that what you're suggesting is really precisely
the same as this, because you are defining a total kind of package.
You are itemizing the components of the package, and putting a
cost per item, but you didn't suggest a total package. Otherwise, we
come again to the basic point in the chairman's first question, that
you have got one organization describing a package, an itemized
and total cost, and then another organization with a different
package, which may or may not satisfy the lender's requirements.
It is that ability to compare packages which is important. The
lowest common denominator that we could find in our analysis was
that whatever it is that the lender requires, that is what the
package ought to consist of. Extraneous things need not be there.
The way to drive them out is with the competitive ability to pur-
chase competitively-instead of trying to change consumer behav-
ior, instead of trying to educate the consumer further, to under-
stand some of this enormous array of charges and fees that I read.
I am hard pressed, frankly, to define each of these, at the moment.
And, given the low frequency of occasions in which someone buys, I
think it is a problem.
Mr. PATTERSON. Well, I know my time has expired, Mr. Chair-
man, but if you posted all of those items, the person could take the
package, or take any individual-they might have their own attor-
neys, or someone might say, Hey, I am paying for this, let me
choose my own-and let everybody choose their own, and they're
all posted once a month, and everybody can see, and it seems to me
that the only package I'm talking about is let all lenders post that,
or realtors, or anyone who is putting it together. I don't care-
attorneys, whatever. And then let people pick and choose.
Now, you seem to say that, well, certain lenders want certain
title companies, or certain attorneys, to examine. And, you know,
you have your choice of going to a certain doctor. Well, I think that
right ought to go to the person who is paying the fee. If the lender
wants to pay the fee, fine.
Dr. SAVAS. Actually, your idea does indeed make sense. If the
notion is that the buyer, seeing that list, says, "What do I need this
for? If you drop that out, will the price drop?" The buyer could
challenge individual components of the package and arrive at a
lower price-you are quite right on that.
But as long as there is, at some point in the process, the lender
or whatever saying, "No, I need that," or "No, I need the satisfac-
tion of the clear title, and I need title insurance, and so on. And I
insist on that. And this is how much it is going to cost you."
But the notion of making those components explicit and letting
them open to challenge, like "Why do I need an inspection fee, if I
have already done such and such?"-that does indeed make sense,
and it can be considered as part of the lender package. In other
words, the lender packaging concept has flexibility and can be
made more or less open, instead of single priced, to show a range of
PAGENO="0039"
33
things. And then it is up to the individual to negotiate the smallest
package, both in cost and in extraneous elements.
Mr. PATTERSON. Thank you. Thank you, Mr. Chairman.
Chairman GONZALEZ. Mr. Lowery?
Mr. LOWERY. Thank you, Mr. Chairman.
Dr. Savas, let me play the devil's advocate for a moment, if I
may. From my own experience in shopping for title insurance, and
from every study that I have seen, my understanding is that very
few consumers shop for title insurance coverage. It strikes me that
they almost always rely upon their real estate broker or attorney.
If the consumers are dependent upon these real estate profession-
als, and the recommendations of these professionals regarding the
title companies, is not the request for the recommendation likely to
prejudice the professional in terms of their recommendation, par-
ticularly if they have a financial ownership in that company?
Dr. SAVAS. I'm sorry. I missed the thrust of your question.
Mr. LOWERY. If any attorney, lender, or broker, has an interest
in a title company, I would assume that there is a little market
shopping going on, and obviously that's going to influence someone
in terms of their recommendation, is it not?
Dr. SAVAS. That is certainly a plausible hypothesis, and is the
basic hypothesis upon which RESPA was predicated.
Mr. LOWERY. If that is sufficiently disclosed, why is there a
problem? Why should there be potential criminal penalties up to
$10,000 and the like?
Dr. SAVAS. What has emerged is controlled business, so that
kickbacks and referrals, in those pejorative terms, are in a sense
sanctified, and that is the basic thrust of the original legislation
and the concern of this hearing. What we have identified is poten-
tial market failure. We have identified the way the consumers
really behave in the marketplace, and consistent with the spirit of
the ultimate intent of the legislation, we have pointed out what is
really happening out there. The RESPA paperwork and disclosure
documents are, in fact, being given out, but that consumers are not
behaving differently; they are not buying this graduate course in
home settlement procedures.
And what we are doing is suggesting a possible alternative for
congressional consideration, with the kind of complexities and pos-
sible variations that Mr. Patterson, for example, suggested.
Mr. LOWERY. Is RESPA not working in terms of getting at tradi-
tional types of kickbacks? Are those practices substantially elimi-
nated? What I am talking about now is the interpretation as to
whether having an equity interest in a firm and a return on the
investment, if you will, necessarily-falls within that category.
Dr. SAVAS. The evidence is not very clear about the extent to
which kickbacks and referrals of the type that are prohibited by
RESPA are continuing to take place.
Mr. LOWERY. Let me read to you a provision from the Antitrust
Division of the Department of Justice analyzing the controlled
business problems. They said:
To sum up the major features of controlled title companies, where a real estate
settlement producer is able to direct the purchaser of a title policy, to a particular
title company, the purchaser is likely to end up with unreasonably high premiums,
[2] accepting less than usual service, or [3] accepting faulty title examinations from
the controlled title company.
PAGENO="0040"
34
How would you react to that statement? Do you agree with the
conclusions or not, and if so, why?
Dr. SAVAS. What is not known is the extent to which that prac-
tice continues to occur, and above all, the effect on total price. In
other words, there is ample evidence in other kinds of industries
and other situations where referral fees, and so on, have the net
effect of reducing the cost, and it makes it an efficient way of doing
business. Those practices have presumably emerged in this indus-
try because it is logical and it conforms to consumer behavior.
Mr. LOWERY. What evidence is there to support the conclusion of
the Justice Department from your own studies? Would you say the
problem has lessened since RESPA?
Dr. SAVAS. I'd have to say once again that there is no hard
evidence that there are currently kickbacks or referral fees in
violation of the law. But there is potential in the basic structure of
things. The industry response has been to develop controlled busi-
nesses.
Mr. LOWERY. Well, is there any evidence to suggest these conclu-
sions, high premiums, poor service, or faulty title examinations? I
mean, if we don't~ have a problem-if it is not broke, don't fix it.
You are suggesting a potential problem, but my questions relate
to what evidence we have to support these potential problems?
Dr. SAVAS. There is little or no direct evidence. It is a potential
problem, given the structure and nature of the industry and the
relationships, and the state of consumer awareness and consumer
behavior.
Mr. LOWERY. Thank you very much. I yield back the balance of
my time, Mr. Chairman.
Chairman GONZALEZ. Thank you, sir.
Mr. Vento?
Mr. VENTO. Mr. Chairman, on that last question, was that a
focus of the study or not? Was it a focus of the study, to look at
that? I thought that the chairman just said that the previous 0MB
restricted the character of the study; is that accurate?
Dr. SAVAS. As I answered previously, the 0MB review process
resulted in changing some questions and eliminating some ques-
tions-questions which are not likely to reveal information.
Mr. VENTO. Could you explain what direction the study took to
look at this, since it didn't utilize those questions? And the study
doesn't indicate that, but what did you do, or what was done,
within the context of this study, to review that question?
Dr. SAVAS. The question focused on compliance with various
aspects of the RESPA Act. It focused on the behavior of lenders in
increasing consumer awareness and delivering the right kinds of
brochures and information booklets.
Mr. VENTO. Well, I understand that. Did it focus on the question
of kickbacks, and collusion, between title companies and those
involved in providing settlement services or not?
I mean, I understand what I think the study said. At the same
time, I think we have to remain neutral on that particular ques-
tion, if the focus of the study didn't direct itself to that. You said
you did some things informally, that you had some informal re-
marks from consumers, that seemed to indicate that there was no
PAGENO="0041"
35
problem with regards to kickbacks. That is what you said previous-
ly.
Dr. SAVAS. Again, the potential problem is there. And despite the
absence of kickbacks, one would think that given the intent behind
RESPA, the emergence of controlled businesses represents an in-
dustry response to the new legislative climate.
With respect to the contractor and the contractor's work, directly
asking: "Have you given kickbacks?" or "Have you received kick-
backs?"-that was not done.
Mr. VENTO. I think that is probably right. I think they probably
made the right decision. I think that's a dumb question to ask,
because If I were participating in that, and someone asked, "Do you
give kickbacks?" I would be offended. And so I think that is right.
You said that there were some informal statements that were
made by consumers that seemed to indicate that that was not a
phenomenon. But were they really in a position to know or not?
I mean, you are the leading researcher over there, so you should
be able to judge whether or not a conclusion or statement that is
made-maybe it is just beyond the scope of the study, and you
can't say anything about it. If that's the case, I wish you would
state so for the record.
Dr. SAVAS. This kind of research was not intended to uncover
criminal behavior, and could not. Instead, we looked at trying to
understand the basic intent of the legislation, how effective was the
legislation in achieving its objective? That is what we focused on.
And we came to some significant conclusions about that, by asking
the right kinds of questions of the right kinds of people.
Mr. VENTO. I think that is very helpful. I think that clarifies
that point.
One of the conclusions that you pointed out, was providing com-
petitive type of environment. But one of the purposes, also, I think,
insofar as settlement charges, were that when the consumer, the
buyer, ends up in settlement, that they have no surprises at that
particular point; that they have had disclosure; that was one of the
major purposes, I thought, of the legislation. And it probably was
sold on that basis.
But did you find satisfactory conclusion, or did the study find
satisfactory conclusions, with regards to the fact that buyers ended
up being more knowledgeable about what their costs were going to
be at settlement, at closing, with respect to this, as compared to
what might have been the case since apparently we have no data
base at the inception of when this was passed? What was the
conclusion there? Did you make any conclusions?
Dr. SAVAS. Yes. There was general satisfaction with those esti-
mates, with the provision of the estimates, and that they were in
fact adequate, good faith estimates.
And to put it another way, people did arrive at the closing with
the right amount of money in their checking accounts.
Mr. VENTO. Well, I think that is a very important point. To me,
that was from a subjective standpoint, probably one of the more
important aspects or concerns that consumers have at that point.
Maybe just the fact that you reviewed it and the fact that disclo-
sure in and of itself might have resulted in less competition, that
is, there are less variables between the prices that might have
PAGENO="0042"
36
occurred in 1972 or before the act was in effect. Did evaluate if
there was less variability in terms of the settlement cost, as com-
pared to prior to the passage of or the implementation of RESPA?
Dr. SAVAS. I'm afraid that there was not good enough data before
to look into that issue.
Mr. VENTO. That is a very key question, in my mind's eye, as to
what the nature of the study is, but without data, of course, I
would not criticize that.
Did you review the possibility, or contemplate the possibility, of
the severability of settlement services from, for instance, all other
types of activities, such as loans? In other words, an absolute
separability. If an S. & L. wants to offer settlement services, is
there an absolute severability between the settlement services and
their loan programs?
Dr. SAVAS. We examined, in a sense, the whole process of settle-
ment, and looked at what it is that consumers are in fact buying,
and what it is they are being forced to pay for.
The separability issue was not examined separately and indepen-
dently, but simply as we formed the study. Gradually the conclu-
sions about how that market really operates-a way which, in a
sense, had not been contemplated in the original RESPA legisla-
tion.
Mr. VENTO. Did you consider that with respect to your recom-
mendations to us, with respect to changing of the law?
Dr. SAVAS. Yes, with the basic notion being that the more you
unbundle and the more you make these discrete services that a
purchaser has to shop for, given consumer behavior, that they will
not shop in that manner.
Mr. VENT0. Did you advocate severability? For instance your
package concept separate from other services that are not necessar-
ily related, such as the loan from the services offered? Would you
advocate that?
Dr. SAVAS. Yes, if I understand your question correctly. In other
words, what seems to make a great deal of sense is: What is it that
a lender absolutely requires and how much would that cost? And, if
other ancillary services are desired by the buyer, then let those be
priced separately.
Mr. VENTO. Well, of course, they offer the settlement services. I
think it is not altogether unusual-and probably very proper for
them to do so-but, for instance, if bank A offered the service for a
loan, could bank A offer the service for a loan that's going to bank
B? It is rather unusual I suggest, but not altogether unusual,
considering the circumstances.
One further question: Are you familiar with the problems of
buyer broker fees and the inclusion of such fees in the mortgage
amendment? An amendment was recently passed in the Reconcili-
ation Act that dealt with that. Do you think that buyers specifical-
ly need professional assistance in the process of the purchase of
homes?
Dr. SAVAS. Need professional assistance in terms of the services
of real estate brokers?
Mr. VENTO. That's right.
Dr. SAVAS. I don't have any very well-informed opinion on that
based on specific studies and the like now.
PAGENO="0043"
37
Mr. VENTO. Do you think they are adequately representatived as
far as the conclusions of the study are concerned? Were they
adequately served and represented in terms of their financial and
security interests with respect to the purchase of homes insofar as
the study is concerned?
Dr. SAVAS. This study, to the best of my knowledge, did not focus
on that end of the relationship. I could provide a more detailed
answer for the record.
Mr. VENTO. I would appreciate that. I just want to get through
these questions. I appreciate very much your effort to respond.
Thank you.
[At the request of Congressman Vento, the following additional
information was submitted for inclusion in the record by Dr.
Savas:]
RESPONSE RECEIVED FROM DR. SAVAS
Because HUD and PMM have been aware, and, in fact, have been involved in, the
Federal Trade Commission's study of real estate brokers, our RESPA studies de-
ferred the more specific issues about brokers to that study. Our consumer questions
on brokers concentrated on the services provided and general satisfaction. To that
extent, 83 percent of the sellers used a real estate broker, and 63 percent were very
satisfied with the agent. For buyers, 72 percent reported using a real estate agent
and 65 percent reported they were very satisfied with that agent. Of those reporting
any disappointment, the leading reasons were: agent did not provide enough help!
information at settlement, agent did not provide help with negotiation, and agent
did not provide enough information on which to base purchase of house. Half the
buyers said they did not pay the asking price and three-quarters of those said their
agent conducted the negotiations for the final price. Some inference could be ab-
stracted from these results about buyer satisfaction, but specific questions about the
buyer's financial and security interests were not posed.
Mr. VENTO. Thank you, Mr. Chairman.
Chairman GONZALEZ. Thank you, Mr. Vento.
Mr. Evans.
Mr. EVANS of Indiana. Thank you, Mr. Chairman.
I just wanted to try and understand one thing, and that is that
this lender packaging arrangement, could it not create a situation
that would lead to the development of further abuses in the ar-
rangement between the providers of the settlement services and
their efforts to curry favor with the lender? Is that not a possible
scenario that could be developed?
Dr. SAVAS. I always find it hard to answer "No" to a question
like that. In any system devised by man or by Congress it is
conceivable. Given man's infinite wisdom and ingenuity, I suppose
it can be perverted or subverted in some way. That is why we
recommend this as a concept, that appears to us, without the
benefit of having held hearings, that the lender addresses himself
to some of the fundamental desires of Congress in passing the
original legislation and conforms to the observed behavior of con-
sumers when they buy houses.
Mr. EVANS of Indiana. Well, let me just state that, in my own
way of thinking, that I think that the lender packaging that we are
discussing here could very well further problems that have existed
in the past in controlled business situations. That is a concern that
I have in your testimony that you presented this morning.
Thank you, Mr. Chairman.
Dr. SAVAS. You would think that what would happen is that the
force of competition would encourage, would force the packagers of
PAGENO="0044"
38
these various services to compete and to compete in a way that the
consumer can readily understand.
Mr. EVANS of Indiana. If that competition is present through the
various elements of the package, I would tend to understand and
agree with you.
Dr. SAVAS. But only the packager has to worry about that, and
the packager is competing with other packagers.
Mr. EVANS of Indiana. Right. I understand that. But it is that
packaging arrangement that does cause me some problems.
Chairman GONZALEZ. Mr. Lowery, do you have an additional
question?
Mr. LOWERY. Thank you, Mr. Chairman.
Dr. Savas, in reading through your testimony, I am baffled by
something. You talk about the potential for abuse and thus a need
for criminal penalties under this interpretive rule of RESPA, yet at
the same time recommend something that strikes me as being even
more restrictive and less competitive-lender prepackaging. How
do you justify those logically opposite conclusions?
Dr. SAVAS. Well, I guess I don't see that they are logically oppo-
site. We are proposing to sell something-namely settlement serv-
ices to a home buyer-in a form that the home buyer can readily
understand and price out, thereby making him a better shopper.
We propose not to educate him into the myriad intricacies of this
lengthy array of possible charges, but rather to simply have him
focus upon what, in fact, the buyers do focus on; namely, "What is
it going to cost me to get my mortgage?"
And by bundling the services in this manner, he focuses on a
simple number-whatever it was the lender requires, if he does not
require a title search, if he does not require title insurance for the
lender and so on and so forth, that is fine as far as the home buyer
is concerned. He has gotten what he needs and what he wants.
Mr. LOWERY. How is that going to help the consumer with the
competition? You're suggesting on the one hand that if the lender
were to recommend various service bureaus, such as title insur-
ance, that somehow that is a controlled activity and there is a
potential for abuse. What you're suggesting now is going to lend
itself to a totally noncompetitive environment and atmosphere.
Dr. SAVAS. Because lenders would compete, and packages with
these services would be expected to compete.
Mr. LOWERY. How about some of the concerns for cost and serv-
ice levels and for faulty title examinations and the rest of it? It
follows that somehow a lender is making a recommendation of a
particular company that results in those kinds of conclusions.
Then, are we not talking about having more of those same kinds of
situations if the lender has absolute total control?
Dr. SAVAS. Everything would be up front, the charges would be
up front. Whatever the lender needs for making the loan is includ-
ed in that package.
So, I don't understand where the possible abuse might come in.
Mr. LOWERY. That is my concern for your suggestion of a change
from the status quo: Where is the abuse? I have asked for studies,
for evidence, for examples; and you've responded by saying that
there's a potential for abuse. If there is a potential for abuse in
PAGENO="0045"
39
your status quo, why would there not be a potential for abuse in
what you're suggesting, a lender package?
Dr. SAVAS. Because the consumer awareness is brought to the
right position, and the consumer is able to shop for that.
Mr. LOWERY. I am not sure we, in this hearing room, can second-
guess what the level of consumer interest or sophistication is. It
strikes me the best place for that to be ironed out is in the market.
Chairman GONZALEZ. Mr. Coyne, do you have any questions?
Or Mr. Patterson?
Mr. PATTERSON. Just one, Mr. Chairman. The mandatory feature,
why not just make it voluntary? In other words, if you are going to
try something-and, in fact, can it be done now, couldn't a lender
now, on a voluntary basis, package? And if so, why aren't they?
Dr. SAVAS. Well, it seems to us that you're absolutely correct,
that that can be done today. There is no prohibition against that
whatsoever, but there is no incentive for lenders to package or to
show all the prices in that manner.
And if a lender did package services like that, it seems to me it
would be at a competitive disadvantage with the lender who adds
little pieces here and there and subsequently reveals the full bill.
Mr. PATTERSON. Well, it seems to me that consumer awareness is
built up by letting the consumer know what is going on, rather
than saying "Here's your package. And this is what it cost, but you
really don't know what's in it. Don't worry about it. Only the
lender needs to know, and the seller is going to pay for it."
It would seem to me that if more competition is what we want,
or if it is a good idea that they be doing it on a voluntary basis and
to mandate something that really builds in referral fees and kick-
backs, rather than locks them out, as we attempted to do in
RESPA, is going almost 180 degrees in the opposite direction of
congressional intent a few years ago.
Dr. SAVAS. I'm afraid that that is because the entire process is
counterintuitive. The basic intent behind those portions of RESPA
was that we would educate the consumer-that the consumer was
willing and able to be educated and he would become an informed
shopper of this myriad of services.
In fact, the evidence is that the consumers do not behave that
way. I guess I have long since given up trying to change the
behavior patterns of American consumers, and I am willing to stop
the education that way. Instead, go the other way, as I suggest.
Why multiply the amount of confusing information in a situation
where the buyer can seek out advice of experts, just as a person
who is sick goes to a doctor, and doesn't care whether he's getting
prescribed erythromycin A, B, C, or D as long as he gets cured.
That is the best analogy it seems to me.
And the notion of educating the consumer further, I agree with
that with most commodities. But in these kinds of situations, it
basically does not appear to work.
Mr. PATTERSON. Years ago, you know, the doctor wrote in Latin
and all of this sort of thing to make us think that he had a lot of
hocuspocus. And then I guess the awareness of people has come to
the point where now we want to know what kind of medicine we
are being given, and we want to be able to shop for generic medi-
cines and we want that opportunity.
PAGENO="0046"
40
And it seems to me that the direction of your recommendation is
counter to that whole goal of education of the American people.
And frankly, that-on top of that, that it doesn't really encour-
age any competition within the industry. You know, if you're
saying-well, your proposal seems to me that you're saying the
consumer doesn't care, they are only interested in this house and
what the monthly payment is and what it takes to get in. And I
think that is right.
But-so, if the competition is between lenders, realtors, what-
ever, why not have them pose well in advance so that people on the
very front end can see what they are getting and pick and choose,
because most States require the charges to be listed pretty well in
an area. And I think you could take a package where the seller
could pick or the buyer could pick; and as long as you added up to
the eight items of the settlement package, who cares whether one
lender offers it as a package or whether it is offered by a variety of
people. And the more variety, it seems to me, the more competi-
tion.
Dr. SAVAS. I guess the assumption behind that approach-I
mean, in the concept of showing what's included and even pricing
out of the mutual components, there is certainly nothing wrong
with that, and there is a lot of good in that.
The question is whether the end result is to increase the consum-
er's willingness and ability to shop. The evidence suggests that
people turn to the loan initiator for advice on who to buy mortgage
insurance premiums from and who to get their appraisal from and
who to do the survey. So that although, in principle, the knowledge
is there-you know, we say, "Who do we get these services from?"
And we may be right back where we were.
Mr. PATTERSON. It could be, but you are guaranteeing it by a
package, because if they walk in and it is sort of a one-stop service
and this is what they get and if you can't make-if you can't
educate the part-the buyer, the seller, whatever, maybe all of
them-you can educate only so many-why not increase the com-
petition among the industry by requiring that they list their prices,
that they be available for those who are the type that would look
for the price. They can find it. And those who wouldn't, the indus-
try will compete. Believe me, the one down the street is going to
say, "My gosh, do you see what their prices were? We had better
reexamine ours."
The whole thing here is not-you know, is to try to reduce the
cost-I mean, if you are saying the buyer doesn't want to be
educated or is only interested in certain things, well then part of
RESPA, too, is to make sure that the buyer and the seller are
treated fairly and that they don't pay excessive costs in settlement
charges.
Dr. SAVAS. That approach would appear to make sense, provided
that it is clearly understood that in that list of services, what is it
that is absolutely mandatory? What is it that the lender absolutely
insists upon as needed? The other services would rapidly drop out;
and one is left, in a sense, with the core. Then it is a question of
whether the buyer can shop around for that core. But I think the
buyer would be in a position of saying, "Well, you've said there are
the following five services which I must buy or I must get in order
PAGENO="0047"
41
for you to give me the loan. Where do you suggest that I get these
from?" And then we would be trapped in that situation, with the
referral process and so on that would be taking place.
Mr. PATTERSON. Thank you.
Chairman GONZALEZ. Mr. Carman.
Mr. CARMAN. Mr. Chairman, I was hoping you would ask me.
Dr. Savas, first of all, I would like to thank you for your testimo-
ny here this morning. I certainly agree with some of the state-
ments.
I understood the last part of your testimony to mean that the
RESPA Act has been a total disaster and a waste of money for the
public and a harassment of many of the lending institutions and
people involved who are working in this particular area.
It is my understanding, from talking to members of the staff
here and in scanning through your report, that you are contem-
plating and recommending a packaging kind of concept, so that one
particular institution or one particular lender would be responsible
for the overall services that would be granted to the borrower.
One of the things that occurred to me is that, if we had that kind
of result, wouldn't we run the very serious risk of specific compa-
nies or groups trying to take over control of a specific type of
service that would be granted; to the exclusion of others, without
giving them the opportunity for free and open competition?
It occurs to me, for example, that if I were to go into a lending
institution and found out that the person who was giving me the
commitment and promising me the commitment for the loan was
to say to me that the credit report, the appraisal fee, the title
report, the cost of the survey and so forth are all taken care of, and
I said, "Well, look, I would just as soon go over and see my friend
Charlie Brown for the survey, and I would like to work with
somebody else in regard to the title insurance," they may say,
"You can do whatever you want. But if you want to get the loan
over here, we have this thing all put together. That is the way it is
done here."
And as a result of that you would preclude the opportunity of the
individual to secure the appraisal-or not even necessarily the
appraisal, but certainly the cost of the survey and possibly the title
insurance from some other place.
It seems to me that that would embellish upon the mistakes with
the Real Estate Settlement Procedures Act in 1974.
And if I sound like I'm a little bit aggressive about it, I've waited
for years to be here to say that. [Laughter.]
Dr. SAVAS. Three points:
One, let me make clear that we are recommending consideration
of this concept of lender packaging. We do recognize that it is a
novel approach which requires careful examination, and some of
that has occurred this morning, I believe. That is one point.
A second point is that, to the extent that we recommend a
consideration of that kind of mandatory lender packaging, it would
not be a single price of the type that you suggest that might take
place, where here's one price for your mortgage and everything is
included, don't worry about it. We do recommend two prices: One,
the contract prices of the mortgage; second, a price for whatever in
PAGENO="0048"
42
the world it is that the lender requires before giving out a mort-
gage.
Mr. CARMAN. Mr. Savas, one of the problems we've got is the
person is going into a lending institution and doesn't even know
what a mortgage is. Most of them don't even know who owns the
house. They walk into a place and they say, "The bank owns the
place. What is my payment?"
You were very, very clear, I think, when you said that the
consumer sometimes is very affected in resisting education, the fact
that we have got the settlement procedures after the transaction is
a remarkable example of legislation to me the only thing that
really goes on top of it. I used to kid about it, saying that we
thought that the thing would be-when they had RESPA inspec-
tors, I didn't really think they would ever have them, but they
came by. I guess this is the product of that.
The point I'm trying to make with you is that I am very con-
cerned, coming from the real world-especially in this field-that
the abuses that can be visited upon what you seem to be proposing
be considered could be quite remarkable. I could literally see-in
fact, I do see, in my own perception, a tremendous power struggle
going on between different groups to control this industry, much to
the detriment the consumer.
In another area, we could say this would be considered. We
might be dealing with antitrust concepts, who is going to have the
monopoly over this particular industry? That becomes even more
difficult when you realize that the Federal Government has appar-
ently taken on the attitude that housing should have less of a
share of the gross national product. So it further exacerbates the
problems that we seem to be involved here in. And the more we
have open and fair competition and an opportunity for a borrower
to go to someone of his own choosing, the better off we are.
So, really, I would much rather have the person have the oppor:
tunity to choose his own surveyer, his own title insurance compa-
ny-indeed, his own lawyer, because just like we choose our own
doctor, hopefully, that gives us a better chance of getting better
services. And I wonder if you might just go further with that?
Dr. SAVAS. You raise a lot of good points, obviously.
Mr. CARMAN. That's only because I have been living with it for
20 years.
Dr. SAVAS. I guess one might argue that competition at the level
of the home buyer is rather illusory. That is, yes, there are a lot of
people out there who are offering these various services, but the
home buyer does not, in fact, take advantage of that competition.
Mr. CARMAN. Isn't that his choice?
Dr. SAVAS. Well, the market doesn't work that way. For those
who are concerned that the market doesn't work that way, I think
one could say that in order to have competition effectively, it could
be moved up one level, away from the individual home buyer, and
up to the packager of settlement services.
Mr. CARMAN. Mr. Savas, wait a minute. You're talking about
moving away from the man who is going to make the choice about
what he's going to pay. Why not let the man decide for himself
what he's going to pay?
PAGENO="0049"
43
If you're going to sell me a suit $150, $250, or $450, I'm going to
make that choice myself. If I don't care, that is my choice, but I
think the paternalistic approach that would seem to be a motivat-
ing force in regard to this act, would be certainly illusory at best.
What I am even more concerned about is that the individuals
involved here, the people we represent, the homeowners, aren't
going to get a fair shake at all. I think what's going to happen is
they're going to get crunched by very, very large competitors, very
strong commercial forces, and where they are not going to get a
choice at all. And I think we lose the individuality in the market-
place that, frankly, keeps it going.
And I don't care what the suit cost. You have got a super buyer
at your haberdashery store. But I want to tell you that it has been
my experience-in fact, we even found it recently with interest
rates, lo and behold, people go to different places to put their
money to get a higher rate of interest, whether it's a little old lady
or it's a very young person or whoever it happens to be.
So, I think that applies here. And I think what you are involved
in here is something that would seem to me, if Congress were even
to consider it at great length-and I don't want to certainly have a
closed mind to it-could not only bring on economic disaster to
certain elements of our economy, but more importantly, could
bring on a disaster of the ability for people to own their own
homes.
Dr. SAVAS. That is certainly a very plausible and eloquently
stated position. The main point I would make is simply that if any
legislation is considered, that the realities of that marketplace
should, in fact, be considered, that consumer behavior be taken
into consideration, and that we don't merely proceed on the blind
assumption that consumers are able to consume these arcane serv-
ices sensibly.
Mr. CARMAN. I certainly don't quarrel with your motivation; just
the result. That is a pragmatic aspect of it, and I think that if I
had my own way-I think probably what I would suggest is that
we take the RESPA forms and use them for wallpaper. I think that
the effect of them has been so-I mean, I can't tell you how many
loans that I have personally closed, or even taught people how to
fill out RESPA forms, to comply with the RESPA inspector's re-
quirements.
And I would have to tell you that these things are the subject of
laughter at real property closings. They have even mentioned the
name of some of the more well-known legislators down here in the
Congress who have been sponsoring them, and everybody says,
"This is another piece of ridiculous Government boondogglery that
is wasting your time and mine." I have yet to see more than five or
six lawyers try and explain what this thing means to a client,
much less what it means to another lawyer.
So that we have been very, very effective in confusing people.
Most people just bring out a closing sheet so people can know what
they spent and what was invOlved in it. Most people counseling
individuals tend to talk to them before the transaction as opposed
to afterward, because most people, believe it or not, do go in and
want to know what the cost of the loan is going to be. How much is
the payment going to be, is what they are interested in, and what
85-396 0 - 81 -
PAGENO="0050"
44
these other costs are. How much are points going to be, especially,
in this kind of a market.
But to put this kind of a burden on the consumer seems to me to
be something that is going to have some negative results, because I
don't think he is going to understand what's going on. And I think
you are right, in regard to that.
More especially, I think there are going to be elements in the
economy and in this whole field that are just going to simply take
control of it, and make sure the consumer really gets the hosing-
so we will end up having to have another study.
Chairman GONZALEZ. Let me just say, to sum up, Dr. Savas, that
though you are saying that you are presenting this by way of
observations and recommendations to the Congress, you are also
advocating a repeal of a key section. You want to repeal the
antikickback provision. You want to repeal section 9, you want to
repeal section 5, you want to repeal section 4. It just seems to me
that the lack of effectiveness which you assign to RESPA up until
now is predicated on very, very untenable and undocumented stud-
ies. You point out that in a critic2l area of consideration, the
contractors for the RESPA study were denied the opportunity of
reviewing some critical issues.
But I do think that my colleagues, especially on the subcommit-
tee, ought to realize that your testimony is very adamant in its
strong recommendations of the repeal of those sections. That goes
to the heart of the matter that the Congress went into exhaustively
a few years ago. But thank you very much for your testimony. Now
we must proceed.
We have two additional witnesses, and as we said before, the
subcommittee members will have the opportunity to submit any
questions that they did not have an opportunity to ask during the
hearing in writing, in time for the witness to answer for the
transcript.
Mr. J. COYNE. Mr. Savas, on pages IV (24) and (25) of your
RESPA report, it states:
We believe that a prohibition against kickbacks and unearned referral fees must
logically and legally include a prohibition against controlled business arrangements.
While I don't understand what you mean by "must logically and
legally include a prohibition against controlled business arrange-
ments," I do understand when you say it must "logically" do so. I
understand it, but I think you are wrong.
How can you argue that criminal sanctions should apply where
the provider of a settlement service is a wholly owned subsidiary,
when we all recognize that if the whole package of services is done
"in-house," there can be no referral or kickback and therefore no
violation of section 8? It would seem that even under antitrust law
a subsidiary is recognized as being the same as the parent and not
subject to various restrictions.
To me, "logic" would dictate that controlled business should not
be included under section 8. What the parent is receiving is a
return on investment or equity. After all, doesn't section 8(c) spe-
cifically state that:
Nothing in this section shall be construed as prohibiting * * * the payment to
any person of a bona fide salary or compensation or other payment for goods or
facilities actually furnished or for services actually performed * * *
PAGENO="0051"
45
One could logically argue that a return on equity not tied to the
level of referrals is a form of "other payment for goods." In this
case the "goods" would have been in the form of capital.
[At the request of Congressman James K. Coyne, the following
additional information was submitted for inclusion in the record by
Dr. Savas:],
RESPONSE RECEIVED FROM DR. SAVAS
I think the most important thing to remember about the report's statements on
controlled businesses and on kickbacks is that it is within the confines of settlement
markets and the traditions and practices evident in that market. Most areas of
consumer purchase do not require legislation and Section 8-type prohibitions be-
cause natural, competitive forces keep abuses from occurring. No prohibitions exist
to my knowledge, for instance, against, car dealers owning or "controlling" a service
department. But an active market of alternatives exists and the consumer can judge
for himself which price and service level to purchase without necessarily depending
on the dealer's advice. Settlements, on the other hand, do not conform to the
normal market as to standard consumer behavior. The dangers inherent in a system
where consumers depend heavily on other's advice and where free and equal infor-
mation is unavailable require explicit prohibitions like Section 8 of RESPA. Those
prohibitions must extend to arrangements that otherwise leave the consumer with
too little information to judge potential conflicts like financial interest in another
company. In-house provision is open and the consumer can judge for himself if a
conflict exists. The Department's recommendation for consideration focuses on
making the settlement market like all other competitive markets so that natural
forces instead of government regulations operate to protect consumers.
Chairman GONZALEZ. Mr. Patterson has a question.
Mr. PATTERSON. Does the Department contemplate any regula-
tory or enforcement action in connection with the controlled busi-
ness issue pending this period of congressional reexamination?
[At the request of Congressman Patterson, the following additional
information was submitted for inclusion in the record by Dr. Savas:]
RESPONSE RECEIVED FROM DR. SAVAS
The Department does not contemplate any further regulatory action while the
Congress reexamines the issues. However, the Department will continue to investi-
gate and report to the Justice Department any complaints or violations of the
regulations as they now stand.
Chairman GONZALEZ. We have Mr. Thomas P. Vartanian, Gener-
al Counsel of the Federal Home Loan Bank Board; and Mr.
Thomas H. Stanton, Acting Director, Office of Policy Planning,
Federal Trade Commission, accompanied by Mr. John P. Brown,
Assistant Director for Consumer Protection, Bureau of Economics
of the Federal Trade Commission. And we will ask you all to come
forward to the table. And we will recognize Mr. Vartanian first.
And as in the case of the other witnesses, you may wish to
summarize your statement, or present it for the record, as you read
it. If you wish to summarize it, without any objection, your full text
will be entered in the record at this point.
STATEMENT OF THOMAS P. VARTANIAN, GENERAL COUNSEL,
FEDERAL HOME LOAN BANK BOARD
Mr. VARTANIAN. Thank you, Mr. Chairman. I would like to
submit that full text.
Mr. Chairman, members of the subcommittee, thank you for
giving me this opportunity to testify today on behalf of the Federal
Home Loan Bank Board regarding our involvement in an interpre-
tive ruling issued by the Department of Housing and Urban Devel-
opment dealing with the legality: of lender referrals of settlement
service business to controlled businesses.
PAGENO="0052"
46
HUD recently reaffirmed the reasoning which was the basis for
the rule in its September 10, 1981, report to Congress on RESPA.
In that report, HUD's primary recommendation was the institution
of lender packaging and elimination of the current system of
RESPA regulation including section 8.
However, HUD also stated that unless section 8 was repealed
entirely, it should be amended to specifically preclude any referral
by one settlement service provider to a wholly or partially owned
subsidiary providing another settlement service.
At this date, only 5 days later, the staff of the Bank Board has
not had sufficient time thoroughly to study and evaluate the con-
clusions and the recommendations in the HUD report, something
which we would like to have a chance to do. Therefore, while we
urge Congress to give serious consideration to HUD's report, my
remarks will be directed primarily to the controlled business issue
as it exists under current law today.
In principal, the Bank Board supports the goal of the Real Estate
Settlement Procedures Act to protect consumers from unnecessar-
ily high settlement charges. In practice, however, we could not
support the HUD interpretive rule applying section 8 of the act to
the service corporations of savings and loan associations. Although
we acknowledge HUD's prerogative to interpret RESPA, we believe
that there are a number of legal and policy grounds which argue
strongly against retaining the rule, especially as applied to savings
and loan service corporations. In our opinion, HUD should with-
draw the rule. Should Congress reject HUD's lender packaging
recommendation and retain RESPA, I would recommend to the
Bank Board that it oppose HUD's alternative recommendation of a
statutory prohibition on referrals to controlled businesses.
Because of the high profitability of many required settlement
services, and due in part to RESPA's ban on kickbacks and com-
pensated referrals, service providers such as real estate brokers
and lenders have acquired an ownership interest in other settle-
ment providers and automatically make referrals to the controlled
entities. The American Land Title Association-ALTA-has argued
that these controlled businesses result in the same problems that
are caused by outright cash kickbacks and are in effect a means of
evading the section 8 prohibition on compensated referrals through
receipt of indirect compensation through dividends.
To address the perceived problem of controlled business relation-
ships under RESPA, HUD issued in July 1980 a final interpretive
ruling titled "Effect on the Real Estate Settlement Procedures Act
on Certain Practices Known as Controlled Business." The regula-
tion stated that the existence of a controlled business relationship
may be a violation of section 8 of RESPA.
This ruling was inconsistent with Bank Board regulations, which
authorize service corporations to provide settlement-related serv-
ices and to make referrals to service corporations with regard to
services such as escrow appraisal, title and hazard insurance. The
Board's staff also concluded that the ruling was not a correct
application of section 8.
Recognizing the need to reconcile the conflicting regulations,
then General Counsel of HUD, McGrew, and then Bank Board
Chairman Janis agreed that HUD would issue a clarifying regula-
PAGENO="0053"
47
tion excluding from its original rule referrals to service corpora-
tions made through a neutral list, including several unaffiliated
providers of a service, and exempting entirely hazard insurance
from application of the rule.
The Bank Board in turn agreed to amend its regulations to
prohibit referrals to service corporations, except through the use of
a neutral list. The Bank Board subsequently issued a proposed
regulation incorporating the substance of this understanding on
September 18, 1980. There are a number of legal and pragmatic
considerations which strongly support the conclusion that HUD's
interpretive ruling is inconsistent with RESPA and should be with-
drawn.
First, we have found no support in the legislative history to
indicate that Congress intended that payments other than those
directly related to the referral should be prohibited.
Additionally, had RESPA been intended to include dividends as a
fee, kickback, or thing of value, it would almost certainly have
addressed a number of issues raised by HUD's interpretation. For
example, dividends from a corporation are not contingent upon the
association's referral of business to the service corporation, but on
overall profitability of the service corporation as an entity.
It is therefore difficult, if not impossible, to determine the direct
contributions to dividends, if any, from settlement services where
service corporations also provide nonsettlement-related services, at-
tract other than referred business, or are referred customers from
various sources.
HUD's interpretive ruling also conflicts with RESPA's purpose of
protecting consumers from unnecessarily high settlement charges.
Both the act and HUD regulations implicitly assume that this
purpose is served by encouraging competition which will then
insure that prices paid by consumers will be kept as low as possi-
ble.
In our view, however, unnecessarily high costs may be more
likely to be eliminated if these functions are referred to the service
corporation, rather than performed by the association directly. This
is because a service corporation if a federally chartered association,
which is authorized to offer to the general public the escrow and
appraisal services that the association may offer only to its custom-
ers, can be expected to have economies of scale not available to the
association itself.
We are also disturbed by a number of other factors which argue
in favor of withdrawing the ruling. First, the existence of the HUD
interpretive ruling is likely to have a chilling effect on savings and
loans' use of service corporations due to the very vagueness of the
concept that controlled business relationships may be in violation
of section 8 of RESPA. This chilling effect could be especially
harmful at this time, because the performance of settlement serv-
ices by savings and loans' service corporations is a source of reve-
nue to some institutions. This is particularly true at present, when
profits on loan portfolios are generally low.
The practical problems of applying the HUD interpretive ruling
to service corporations performing appraisal services are also ex-
tremely troubling. Functionally, appraisals are internal tools for
determining loan-to-value relationships, and reaching sound lend-
PAGENO="0054"
48
ing decisions. It is therefore critical for a potentially long-term
underwriter such as a savings and loan association to be able to
specifically indicate the appraisers who will perform the necessary
underwriting appraisal services.
HUD's rule also would be unlikely to affect the problems alleged-
ly caused by controlled business relationships. To date, the title
insurance industry has been a chief proponent of a regulatory or
statutory prohibition of controlled business in performing title in-
surance services, on the grounds that such relationships lead to
poor quality work and higher prices.
However, a comprehensive study on the effect of RESPA by Peat,
Marwick, Mitchell & Co., completed in October of 1980, contradict-
ed both these arguments, and concluded that controlled business is
merely one aspect of reverse competition in the title insurance and
conveying markets, - and that a prohibition of controlled business
would be a band-aid solution and would not necessarily result in
lower title insurance charges.
As defined by the study, reverse competition occurs in the title
insurance business because title companies compete aggressively
for those in a position to refer business, rather than for the con-
sumer who actually pays the price for this service.
The final argument against retention of the HUD ruling or
adoption of legislation prohibiting controlled business referrals is
that both actions are inconsistent with HUD's own findings on
RESPA as reported to Congress on September 10 of this year. The
HUD report found that elimination of controlled business would
not necessarily benefit consumers and that there is reason to be-
lieve that such relationships are in fact economically efficient.
HUD's recommendation of statutory prohibition of controlled
business referrals makes little sense in view of these findings, and
is totally at odds with RESPA's express purpose of protecting con-
sumers from unnecessarily high settlement costs.
In view of the many problems raised by the July 1980 HUD
interpretive ruling on controlled business, the Bank Board is now
planning to withdraw its proposed regulation. Whether or not a
neutral list alternative is incorporated in later HUD interpreta-
tions, we could not support finalizing our proposed rule, which
would have endorsed HUD's interpretation of section 8 of RESPA.
The Bank Board acknowledges that the phenomenon of controlled
business in title insurance services is a symptom of the in-
dustrywide characteristic of reverse competition in the title insur-
ance and conveyancing service business; however, the HUD inter-
pretive ruling is inconsistent with the statutory intent and legisla-
tive history of RESPA.
Prohibiting controlled business will not by itself assure fair
prices nor high quality in title work, or other settlement services.
`fo the contrary, such a prohibition is likely to prove extremely
burdensome to the savings and loan industry, and may in fact
diminish existing competition in the business of providing settle-
ment services.
Accordingly, we recommend withdrawal of the HUD interpretive
ruling, and encourage Congress to develop alternative solutions to
address the problem of reverse competition as a whole.
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49
Thank you for this opportunity, and I welcome any questions you
may have.
[Mr. Vartanian's prepared statement, on behalf of the Federal
Home Loan Bank Board, follows:]
PAGENO="0056"
50
STATEMENT OF THOMAS P. VARTANIAN
GENERAL COUNSEL
OF THE
FEDERAL HOME LOAN BANK BOARD
~Mr. Chairman, thank you for giving me this opportunity to testify
today on behalf of the Federal Home Loan Bank Board regarding our
involvement in an interpretive ruling issued by the Department of
Housing and Urban Development (HUD) dealing with the legality of
lender referrals of settlement service business to "controlled
businesses." HUD recently reaffirmed the legal reasoning which
was the basis for the rule in its September 10, 1981 report to
Congress on RESPA. In that report, HUD's primary recommendation
was the institution of "lender-packaging" and elimination of the
current system of RESPA regulation, including Section 8. However,
HUD also stated that, unless Section 8 was repealed entirely,
it should be amended to preclude specifiCally any referral by
one settlement service provider to a wholly or partially owned
subsidiary providing another settlement service.
The Bank Board supports the goal of the Real Estate Settlement
Procedures Act ("RESPA") to protect consumers from unnecessarily
high settlement charges. However, we cannot support the HUD inter-
pretive rule applying Section 8 of RESPA to the service corporations
of sayings and loan associations. Although we acknowledge HUD's
prerogative to interpret RESPA, we believe that there are a number
of legal and policy grounds which argue strongly against retaining
the rule, especially as applied to savings and loan service corpora-
tions. In our opinion, HtJD should withdraw the rule. Moreover,
should Congress reject HUD's lender-packaging recommendation, the
same reasoning would compel the Board to oppose HOD's alternative
recommendation of a statutory prohibition on referrals to controlled
business.
PAGENO="0057"
51
Background of BUD "Controlled Business" Proposals
prior to the effective date of RESPA, June 20, 1975, settle-
ment service providers often formed "networks" which directed
potential mortgagors, by means of referral, through the various
servicers required to process and close a mortgage loan, such as
title insurers and escrow agents. In a typical pre-RESPA referral
situation, each time the homebuyer employed the referred service
provider, the referring entity received some type of compensation.
Section 8 of RESPA outlawed compensation for referrals based on
the theory that the unnecessary fee or kickback increased the
cost of settlement services without providing any benefit to the
homebuyer. Specifically, Section 8 expressly prohibits "any
fee, kickback, or thing of value" from being paid in return for
the referral of "business incident to or a part of a real estate
settlement service." A "thing of value" was in turn sweepingly
defined to include "any payment, advance, funds, loan, service,
or other consideration."
Because of the high profitability/low risk of many required
settlement services, and due in part to RESPA's ban on compensated
referrals, service providers such as real estate brokers and
lenders have acquired an ownership interest in other settle-
ment providers and automatically make referrals to the controlled
entities. It has been suggested by the American Land Title Association
(ALTA) and by BUD that these "controlled businesses" result in the
same problems that are caused by outright cash kickbacks and are in
effect, a means of evading the Section 8 prohibition on dompensated
referrals through receipt of indirect compensation through dividends.
PAGENO="0058"
52
To address the perceived problem of controlled business relation-
ships under RESPA, HUD issued in July, 1980 a final interpretive rule
entitled "Effect on the Real Estate Settlement Procedures Act on Certain
Practices Known as Controlled Business." The regulation, effective
Septerrüer 4, 1980, statefi that the "existence" of a controlled business
relationship "~~" be a violation of Section 8 of RESPA (12 U.S.C. §2607).
This ruling was inconsistent with Bank Board regulations, which
authorized (and continue to authorize) service corporations to provide
settlement-related services. Moreover, nothing in current Board
regulations prohibits referrals by insured institutions to service
corporations, with regard to services such as escrow, appraisal, title
and hazard insurance. Regarding insurance, Bank Board regulations
allow referrals to a service corporation offering insurance services,
but also require that a potential rrortgagor be informed in writing
of his or her right to select freely any insurance provider. The
following is an example of language for such a referral which the
Bank Board considers unobjectionable, but which would appear to be
impernissible under HUD's 1980 interpretive rule:
"You may select the title insurance and hazard
- insurance provider of your choice. We retain
the right to refuse insurance issued by the
company of your choice if we have good cause
for doing so. May we suggest the services
- of [service corporation] from whom we have
received especially good service."
The Bank Board believed that the July, 1980 MUD ruling was
inconsistent with Section 8 of RESPA as a matter of legal interpreta-
tion. However, it also recognized the need to reconcile two apparently
contradictory Federal regulations since, at the time the MUD regulation
was issued, approximately 660 service corporations provided insurance
services of some sort, 200 provided appraisal services and 50 provided
escrow services. Subsequently, then General Counsel of MUD McGrew and
PAGENO="0059"
53
then Bank Board Chairman Janis agreed that HUD would issue a clarify-
ing regulation excluding from its original rule referrals to service
corporations made through a `neutral list" including several un-
affiliated providers of a service, and exempting entirely hazard
insurance from application of the rule. The Bank Board in turn
agreed to amend its regulations tą prohibit referrals to service
corporations except through the use of a neutral list. The Bank
Board subsequently issued a proposed regulation incorporating the
substance of this understanding on September 18, 1980, with a comment
period running through November 18, 1980. Notwithstanding the Bank
Board's legal objections to HUD's interpretation of Section 8, the
Bank Board believed that this was a reasonable attempt at resolving
the inconsistent regulations and at the same time would serve the
useful purpose of solicting public and industry reaction to the
proposal. The vast majority of comments, including those of savings
and loan associations, the hazard trade insurance group and ALTA,
were negative.
BUD then published an interim regulation on December 22, 1980,
incorporating the concept that use of a neutral list by a parent associa-
tion would not constitute an illegal referral to a controlled business.
This regulation, which was to become effective on March 2, 1981, was
subject to the order freezing regulations of executive agencies issued
shortly after President Reagan took, office, and was later formally
withdrawn by HUD.
RESPA Not Applicable to Controlled Business
There are a number of legal and pragmatic considerations which
strongly support the conclusion that BUD's interpretive ruling is
inconsistent with RESPA and should be withdrawn. Alternatively,
we urge HUD to amend the ruling to specifically exclude the activities
of savings and loan service corporations from the scope of the ruling.
PAGENO="0060"
54
The Board's legal staff has carefully examined the issue and
concluded that RESPA was not intended to address payment of dividends
to parents by service corporations. RESPA was instead a response
to abuses in the real estate settlement industry involving the
"payment of referral fees, kickbacks, rebates and unearned commissions
as inducements to those persons who are in a position to refer
settlement business." (Senate Report No. 93-866, 93rd Cong., 2d
Sess. 6, reprinted in 1974 U.S. Code Cong. & Ad. News 6546, 6551).
To this end, RESPA prohibits payments for referrals of any `fee, kick-
back or thing of value" pursuant to "any agreement or understanding";
a thing of value is defined in the statute as "any payment, advance,
funds, loan, service or other consideration." It is HUD's contention
that the language of Section 8 clearly includes a prohibition of the
payment of dividends by a subsidiary to a parent where the latter
refers settlement business to the former.
In our view, the statutory language is ambiguous for several
reasons, as detailed below. Under well-settled precepts of
statutory construction, such ambiguity requires resorting to
legislative history and other rules of interpretation to determine
and effectuate legislative intent. First, I believe the statute is
ambiguous because it is unclear that "agreement or understanding"
includes the normal relationship between an association and its service
corporation. Generally, an "agreement" or understanding suggests
consent and bargaining. While it is unlikely that a service corporation
could refuse business directed to it by its parent, it is also unlikely
that business is sent under any explicit contract, oral or written.
Certainly elements of bargaining and consent are absent. Instead,
referrals can be made under a completely unilateral arrangement whereby
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55
an association directs all or some of its borrowers to its service
corporation at its option. No consent or return promise would be
required from the service corporation.
A second ambiguity arises from the connection in the statute
between the payment and the referral. Even if an agreement exists
between an association and its service corporation, it is unclear
that payment of a dividend would be made "pursuant to" such an agree-
ment. Presumably, the payment of the dividend would be required
under the arrangements creating the service corporation, and would
depend on general profitability rather than an agreement that business
would be referred.
Finally, it is unclear from the statute whether a dividend is a
"thing of value" contemplated by this legislation. Pursuant to
section 2(2) of RESPA,
the term "thing of value" includes any payment,
advance, funds, loan, service, or other con-
sideration .
While this list is not all-inclusive, it is nonetheless significant
that it contains no term that suggests anything other than direct
remuneration. Rather, it appears that this definition precludes
avoidance of the sanctions imposed by the statute by characterizing
a fee or kickback as an advance, funds or loan, or by making payment
in goods, services or concessions rather than money. At best, this
definition is one which gives rise to several different, reasonable
interpretations. It is not clear that dividends or returns of capital
are includable as "things of value."
Legislative history and other considerations provide extremely
strong evidence that the statutory ambiguity in Section 8 must be
resolved to exclude dividend payments from coverage. In particular,
PAGENO="0062"
56
there is no support in the legislative history to indicate that
Congress intended that payments other than those directly related
to the referral should be prohibited. Instead, the material suggests
that the prohibition is directed, exactly as stated, against unearned
direct payments rather than toward return of capital or shares of
profits. In particular, the reference to `other consideration"
appears to contemplate payment for referral services rather than
incidental compensation through dividends.
Had RESPA been intended to include dividends as a "fee, kickback
or thing of value," it would almost certainly have addressed a number
of issues raised by HOD's interpretation. For example, many service
corporations perform a multitude of functions in addition to settlement
services. Additionally, dividends from a corporation are not contingent
on the associations referral of business to the service corporation,
but on overall profitability of the service corporation as a entity.
Thus, it is difficult if not impossible to determine the contribution
to dividends, if any, from settlement services where service corpora-
tions also provide non-settlement related services. Despite this
problem, under HUD's rationale, any appreciation in value of service
corporation stock paid out as dividends rather than held as retained
earnings could be considered a kickback. Thus, HUD's rationale
would theoretically prevent any stockholder in a tiUe insurance
company from ever referring someone to that title company unless
* he wants to forfeit any dividend on his stock.
Moreover, at the time of the passage of RESPA, the service
corporations of Federally chartered associations had for several
* years been permitted to offer certain settlement services. The
Senate Report refers to certain service corporation activities as
objectionable, but does not indicate that referrals between an
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57
insured institution and its service corporation are a problem.
Id. Specifically, Senate Report 93-866 cited as objectionable
the payment of a commission by a title insurance company to a
service corporation wholly owned by one or more savings and loan
associations where the service corporation "performs no substantial
services on behalf of the title insurance company." This, of course,
is not the type of transaction we are trying to protect.
HUD's interpretive ruling is also inconsistent with RESPA
because payments by a wholly-owned subsidiary to its parent are
merely transfers of funds of which the parent institution is also the
owner because of its position as owner of the service corporation
and all its assets. Logically, therefore, dividends cannot be
considered payments for purposes of RESPA because they involve no
transfer of actual value. Similarly, it strains logic to classify
performance of services by a wholly-owned service corporation for
its parent as resulting from "referrals."
HUDs interpretive ruling also conflicts with RESPA's purposes.
Section 2 of RESPA cites one of the Act's purposes as protection
of consumers from "unnecessarily high settlement charges." Both the
Act and HUD regulations implicitly assume that this purpose is served
by encouraging competition, which will then insure that prices paid by
consumers will be kept as low as possible. In our view, however,
unnecessarily high costs are more likely to be eliminated if
these functions are referred to the service corporation rather than
performed by the association directly. This is because a service
corporation of a Federally-chartered association, which is authorized
to offer to the general public the escrow and appraisal services
that the association may offer only to its customers, can be expected
to have economies of scale not available to the association itself.
PAGENO="0064"
58
In addition, it should be noted that if the parent could not refer
business, in some cases the service corporations would have to be
disbanded since they would not be profitable in performing the services
only for the general public. Since Federal associations may not them-
selves offer settlement services- to the general public, the number
of providers of settlement services would decrease, lessening com-
petition and potentially having a detrimental effect on consumer
prices contrary to the purposes of RESPA.
In addition to our belief that the MUD interpretive ruling
is inconsistent with the legislative history and purposes of RESPA,
there are a number of other factors which, in the Board's opinion,
argue in favor of withdrawing the ruling. First, the existence
of the MUD interpretive ruling is likely to have a "chilling effect"
on savings and loans' use of service corporations due to the very
vagueness of the concept that controlled business referrals "may" be
in violation of Section 8 of RESPA. The uncertainty of the scope
and application of the rule could well encourage litigation under
RESPA's civil liability provisions, which could result in payment
of treble damages by both the parent and the service corporation.
Savings and loans may prefer to avoid altogether offering such
servic-es through their service corporations rather than risk
litigation. This chilling effect could in turn adversely affect
competition in certain types of settlement services. Moreover, a
number of savings and loans commenting on our proposed rule noted
that the performance of settlement services by their service corpora-
tions is an important source of revenue. This is particularly true
at present when profits on loan portfolios are generally low.
The practical problems of applying the MUD interpretive ruling
to service corporations performing appraisal services are also
PAGENO="0065"
59
extremely troubling. Functionally, appraisals are internal tools
for determining loan-to-value relationships and reaching sound
lending decisions. As such, appraisals are performed to protect the
interest of the lending institution, not the borrower. Unlike
escrow servicing or title insurance, the practice of appraisal is
not a uniformly developed profession, despite the existence of various
professional organizations, and there is a tremendous variance in
the actual level of practice. In view of this, it is critical for
a potentially long-term underwriter, such as a savings and loan,
to be able to specifically indicate the appraisers who will perform
the necessary underwriting appraisal services. Thus, nothing in Bank
Board regulations prohibits an association from conditioning loan
approval on the borrower's use of an appraiser selected by the
association. Accordingly, the Bank Board's supervisory staff has
in the past encouraged associations to form service corporations
to perform appraisals in an effort to ensure uniform, quality
service and to protect the institution.
In our view, application of the HUD interpretive rule to
prevent appraisal ?usiness referrals to service corporations is
of no value to the consumer, if the object is to prevent a parent
association from profiting from performance of appraisal services
for its borrower. Although the HUB rule precludes indirect profit
from receipt of dividends based in part on referral business, the
parent can make the same profits directly. Nothing in statutes or
regulations prohibits a parent from having its own staff appraisers
perform appraisals for its customers and charge a reasonable fee for
such service. This anomaly results because the RESPA violation
takes place only where there is payment for a referral. RESPA does
85-396 0 - 81. - 5
PAGENO="0066"
60
not prevent the lender from choosing the provider of settlement
services. Thus, when services are provided in-house, there is no
`referral", and no indirect dividend payment for the referral.
After having reviewed the comments submitted in response to the
Bank Board's proposed regulation of September 18, 1980, I believe
the alternative of avoiding a RESPA violation by providing mortgagors
with a neutral list containing the parent's service corporation,
as set forth in the Bank Board's proposed regulation and in HUD's
proposed interim rule of December 22, 1980, is undesirable for
several reasons. First, it would place associations in the difficult
posture of having to list some but not all competitors of their
service corporations. There is a possibility that such recommenda-
tions regarding providers of settlement services might expose
associations to law suits either on antitrust grounds or for damage
to reputation. While such suits would probably not be successful,
they could be expensive. They would also provide a further reason
for savings and loans to forego altogether the use of service
corporations to conduct settlement service business.
MUD's rule also would be unlikely to affect the problems
allegedly caused by controlled business relationships. To date,
the title insurance industry has been the chief proponent of a
regulatory or statutory prohibition of "controlled business" in
performing title assurance services on the grounds that such
relationships lead to poor quality work and higher prices.
Thus, it has been suggested that in the title insurance business,
controlled business, like the payment of direct kickbacks in exchange
for referrals, is simply another manifestation of reverse competition
in which referers seek to benefit from their own referrals. For
PAGENO="0067"
61
example, a lender or broker nay own an underwritten title company
and refer all or most custoners to the company. Such a controlled
title insurance company has an assured source of business and has
only marginal liabilities for losses since it is acting as the
agent for the insuring underwriter. Additionally, it has a com-
petitive advantage entirely unrelated to the service it provides
for the consumer. Arguably, the assurance of customers may reduce
or eliminate competitive incentives to provide quality service and
the relationship offers an opportunity to raise prices substantially
without losing customers.
However, a comprehensive study on the effect of RESPA by
Peat, Marwick and Mitchell (completed October, 1980) concluded
that controlled business is merely one aspect of "reverse competition"
in the title insurance and conveyancing markets, and that a prohibition
of controlled business would be a "bandaid solution and would not
necessarily result in lower title assurance charges." As defined
by the study, "reverse competition" occurs in the title insurance
business because title companies compete aggressively for those in
a position to refer business rather than for the consumer who
actually pays the price for this service. This phenomenon results
because most homebuyers do not understand title insurance, do not
comparison shop, and depend almost exclusively on referrals in
selecting a provider of service. The phenomenon of reverse competi-
tion creates an environment where service providers have little
incentive to keep prices low or be responsive to consumer concerns
generally because the consumer has no significant role in the
selection process.
The argument that controlled business leads to poorer quality title
work is also unpersuasive where lenders are the parent referrers to
PAGENO="0068"
62
controlled title agencies. In such a case, lenders have every incentive
to insist on a reliable title search and evaluation both to ensure
the security for loans and access to the secondary mortgage market.
An additional argument against retention of the HUD ruling
or adoption ofa Section 8 amendment prohibiting controlled business
referrals is that both actions are inconsistent with HUD's own
findings on RESPA as reported to Congress September 10. Specifically,
the MUD report, like the Peat, Marwick study, rejected as unpersuasive
ALTA's contentions that controlled business arrangements lead to
higher prices and poor quality title insurance work. Moreover,
the report found that elimination of controlled business would not
necessarily benefit consumers and that "there is reason to believe
such relationships are, in fact, economically efficient." MUD's
recommendation statutorily to prohibit controlled business referrals
makes little sense in view of these findings, and is totally at
odds with RESPA's express purpose of protecting consumers from
unnecessarily high settlement costs.
A final argument against application of the MUD interpretive
ruling to controlled business generally, and to savings and
loan associations in particular, is the de minimis participation
by savings and loan service corporations in the title insurance
business, which has provoked the most controversy. It has been
suggested that "controlled businesses" have had extremely adverse
effects on this aspect of real estate settlement services. However,
a recent survey by ALTA showed that only 83 savings and loan service
corporations are currently involved in the title insurance business.
By comparison, ALTA has approximately 2,200 members performing title
PAGENO="0069"
63
insurance services. Obviously, elimination of the controlled
business S&L service corporation competitors from the title insurance
marketplace would seem to hold far greater opportunities for reducing
competition than would maintenance of the status quo.
Bank Board's Future Plans
In view of the many problems raised by the July, 1980 HUD inter-
pretive ruling on controlled business, the Bank Board is now planning
to withdraw its proposed regulation. Whether or not a neutral list
alternative is incorporated in later r-SJD interpretations, we cannot
support finalizing our proposed rule, which would have endorsed HUD's
interpretation of Section 8 of RESPA.
Conclusion
The Bank Board acknowledges that the phenomenon of controlled
business" in title insurance services is a symptom of the industry-wide
characteristic of reverse competition in the title assurance and con-
veyancing service business. However, the HUD interpretive ruling is
inconsistent with the statutory intent and legislative history of RESPA.
Prohibiting controlled business will not by itself insure fair prices
nor high quality in title work or other settlement services. To the
contrary, such a prohibition is likely to prove extremely burdensome
to the savings and loan industry and may in fact diminish existing
competition in the business of providing settlement services.
Accordingly, we recommend withdrawal of the HUD interpretive ruling
and encourage Congress to develop alternative solutions to address
the problem of reverse competition as a whole.
PAGENO="0070"
64
Chairman GONZALEZ. Thank you, Mr. Vartanian. We will recog-
nize Mr. Stanton and his associate, Mr. Brown. And then we will
proceed with further questions.
STATEMENT OF THOMAS H. STANTON, ACTING DIRECTOR,
OFFICE OF POLICY PLANNING, FEDERAL TRADE COMMIS-
SION, ACCOMPANIED BY JOHN P. BROWN, ASSISTANT DIREC-
TOR, FOR CONSUMER PROTECTION, BUREAU OF ECONOMICS,
FEDERAL TRADE COMMISSION
Mr. STANTON. Thank you, Mr. Chairman. We would like to intro-
duce the full text of our statement plus a staff paper, "Tying
Requirements With Imperfect Information-And Other Unfair
Contracts," which is relevant to this issue.
Chairman GONZALEZ. Without objection, so ordered.
Mr. STANTON. Mr. Chairman, members of the subcommittee,
thank you for the invitation to testify today on the provision of
real estate settlement services by controlled businesses. Our re-
marks today represent our professional views rather than necessar-
ily those of the Federal Trade Commission or the FTC bureaus.
The controlled business issue can be divided into two separate
questions. One, is competition from controlled businesses likely to
increase or decrease settlement costs; two, what should be done
with section 8 of RESPA, which prohibits rebates for the referrals
of business to another provider.
These are difficult questions, but to anticipate our conclusions-
first, competition from controlled businesses is likely to decrease
settlement costs, and therefore should be encouraged. Two, section
8 of RESPA should be repealed. And three, the law should man-
date that consumers be informed by settlement providers of any
requirements that ancillary settlement services be purchased from
specific sources along with the price of those services. This infor-
mation should be provided while consumers are shopping, before
they are committed to use any services.
The analysis leading to these conclusions is as important as the
answers themselves. Real estate settlement services, as has been
said more than once today, are arcane and bewildering to the
average home buyer. They are infrequently purchased and they are
incidental to the purchase of a home, a far more important trans-
action. The major firms in the industry are simply unknown to the
consumer.
Under .such circumstances, we are pessimistic that most buyers
can do a thorough job of searching for the best combination of price
and services. We are inclined to believe that the market should be
allowed to develop structures which reduce the need for consumers
to shop carefully.
Consumers face the same problems in buying any number of
sophisticated goods and services, from burglar alarms to video cas-
settes. How do consumers overcome their shopping problems in
these markets? The answer is simple: Rather than do the shopping
themselves, they find other people to do their shopping for them. A
consumer facing heart surgery relies on his surgeon to arrange for
the anesthesiologist. Similarly, for many products, consumers can
rely on the reputation of an established retail firm to insure that
they get good quality for their money.
PAGENO="0071"
65
Any public policy that restricts the ways in which consumers can
delegate their shopping tasks is likely to do more harm than good.
In particular, artificial restrictions on the sensible bundling of
goods and services should be looked at with a jaundiced eye.
Department stores simplify shopping for many other goods and
services. Why can't people buy settlement services the same way
they buy in a department store? Late in the 19th century, the
retailing giants of America-Marshall Field, John Wanamaker, J.
C. Penney and Sears-revolutionized many markets by staking
their consumer reputations as retailers on the quality and price of
the broad range of goods that they sold. They deliberately made
themselves vulnerable to dissatisfied customers in order to con-
vince the world that customers would simply not be dissatisfied in
their store.
Today, when, for example, Sears sells a customer an Allstate
insurance policy, its reputation is at stake. If the policy is unsatis-
factory, either in price or in coverage, not only will the customer
not continue the policy, but Sears' overall reputation will be dam-
aged. That can hurt sales in every department, not just insurance.
So in addition to the normal incentives, the Allstate manager
has to serve customers well. There is the added pressure of the
children's apparel manager, the automotive manager, and others at
Sears whose reputation and sales depend to some extent on the
quality of service in the Allstate department. At the same time,
those other insurance firms who are competing with Sears in the
market now have added impetus to improve their reputation by a
variety of competitive methods. Thus, the benefits of the depart-
ment store accrue not only to the department store itself, but also
throughout the industry. Consumers can go to a large retailer, buy
a complicated product they may hardly understand, and be confi-
dent they are getting a quality product at a reasonable price.
By contrast, virtually none of the benefits of department store
shopping are available to the purchaser of real estate settlement
services today. How could they be introduced into the real estate
settlement business? Consumers could buy their settlement services
from sources offering a broad range of additional services as well.
Ideally, the consumer would be permitted to choose from among a
variety of such sellers, such as banks, stockbrokers, insurance com-
panies, and other possible competitors who may choose to enter the
market from entirely new directions.
A bank would have an incentive to provide a good combination of
quality and price of settlement services if that bank wants a con-
sumer reputation for other services, say, home improvement loans,
as well. Similarly, a stockbroker would seek to satisfy the settle-
ment service's customer in order to attract investment accounts.
The insurance company selling settlement services would hope to
get consumers of fire, life, and auto insurance policies as well.
By contrast, if the customer buys from a title company or escrow
service today, that company has less incentive to provide the opti-
mal combination of price and quality. If dissatisfied, all the con-
sumer can do in response is shift his title or escrow business the
next time he is in the market, and that will be infrequently-and,
if he moves, he may well be out of the firm's market area entirely.
If the customer buys from a real estate broker, he is only slightly
PAGENO="0072"
66
better off, because although the broker has more reputation at
stake, again, a customer uses brokers only infrequently.
The consumer's power is related to the number of return visits
he expects to make to a given seller in the market. At the moment,
the gain from purchasing multiple settlement services from the
same provider is probably small; however, permitting sales of a
bundle of settlement services together, provided, as we shall dis-
cuss, that this is accompanied by proper information disclosure, at
least allows the market forces to move firms in the right direction.
We are now ready to return to the first question, about the
impact of controlled businesses on the price of settlement services.
To limit the range of services that may be offered by any one
provider is to deprive the consumer of the clout he gets from facing
that same provider in any of a number of markets.
In short, the consumer has more market power when dealing
with a bank offering title or escrow services than when dealing
with a title or escrow company alone. On the other hand, it is clear
that consumers' power remains far less than in our earlier depart-
ment store example. We merely contend that the power is greater
when controlled companies are permitted.
Therefore, our answer to the first question is that the emergence
of controlled businesses should be permitted, and indeed encour-
aged, in order to increase the likelihood that settlement costs go
down.
The second question concerns the competitive impact of section 8
of RESPA, prohibiting rebates for settlement service referrals. Sec-
tion 8 is a response to the perceived problem called reverse compe-
tition. This issue has been alleged in conjunction with the sale of
title insurance, for example. The consumer pays directly for title
insurance, but is usually referred to the title company, for exam-
ple, by the lender. Under these conditions, the title company will
compete for the attention or favor of the lender or other referrer,
rather than for the attention or favor of the consumer.
If competition were directed to the consumer, it would tend to
come through lower prices. But competition for the referring party
results in higher title prices as title companies attempt to outbid
one another in higher referral fees, thereby allegedly increasing
the entire price of title policies. However, this argument is faulty.
It overlooks the need to look at two sets of prices: both the price
the customer pays for title insurance, plus the price paid for the
mortgage loan or other service provided by the referring party.
If the referring party operates in a vigorously competitive
market, such as the mortgage market may be at some point, all of
the profits from title insurance fees will be passed on to consumers.
Even in the worst hypothetical case, where you might allege the
referring party is a monopolist, economics argues it is still in the
monopolist's interest partially to reduce the price of services in
response to the referral profits.
Therefore, our answer to the second question is that section 8 of
the RESPA tends to increase rather to decrease settlement prices.
We would hasten to add to that to assure the consumer knows the
complete cost of the transaction, it is important that the settlement
providers disclose all requirements that the consumer also pur-
chase other services, and also disclose the price of those required
PAGENO="0073"
67
services. These are material facts of the transaction. The law
should mandate such disclosure while the consumer is still shop-
ping and before he is committed to a specific bank, broker, attor-
ney, or other referring party~ Indeed, consumers should be able to
obtain such information by telephone.
Such disclosure would not be expensive and should be considered
a cost of doing business that requires consumers to purchase a
combination of bundled services from specified sources.
Thank you.
[Mr. Stanton's prepared statement and the referred-to paper
"Tying Requirements With Imperfect Information-And Other
Unfair Contracts" follow:]
PAGENO="0074"
68
THESE REMARKS REPRESENT ONLY THE VIEWS OF MEMBERS OF THE
FEDERAL TRADE COMMISSION STAFF. THEY DO NOT NECESSARILY
REPRESENT THE VIEWS OF THE FEDERAL TRADE COMMISSION
OR FTC BUREAUS.
STATEMENT OF
Thomas H. Stanton
Acting Director
Office of Policy Planning
Federal Trade Commission
and
John P. Brown
Assistant Director
Bureau of Economics
Federal Trade Commission
BEFORE THE
Subcommittee on Housing and Community Development
Committee on Banking, Finance & Urban Affairs
United States House of Representatives
ON
Provision of Real Estate Settlement Services
By Controlled Businesses
September 15, 1981
PAGENO="0075"
69
Mr. Chairman, Members of the Committee:
Thank you for the invitation to testify today on the pro-
vision of real estate settlement services by controlled busi-
nesses.
Our remarks today represent our professional views rather
than necessarily those of the Federal Trade Commission or FTC
bureaus.
The controlled business issue can be divided into two
separate questions:
(1) Is competition from controlled businesses likely to
increase or decrease settlement costs?
(2) What should be done with Section 8 of RESPA [which
prohibits rebates for the referrals of business to another
provider]?
These are difficult questions. To telegraph our
conclusions:
(1) Competition from controlled businesses is likely to
decrease `settlement costs, and therefore should be encouraged.
(2) Section 8 of RESPA should be repealed.
(3) The law should mandate that consumers be informed by
settlement providers of any requirements that ancillary settle-
ment services be purchased from specific sources, along with
*/ The term "controlled business" was coined by the Iunerican
Land Title Association to describe a settlement service company
affiliated with a lender, broker, or real estate attorney.
PAGENO="0076"
70
the price of those services. This information should be pro-
vided while consumers are shopping, before they are committed
to use any services.
The analysis leading to these conclusions is as important
as the answers themselves.
Real estate settlement services are arcane and bewildering
to the average home buyer. They are infrequently purchased and
they are incidental to the purchase of a house, a far more
important transaction. The major firms in the industry are
unknown to the consumer. Under such circumstances we are
pessimistic that most buyers can do a thorough job of searching
for the best combination of price and services. We are in-
clined to believe that the market should be allowed to develop
structures which reduce the need for consumers to shop care-
fully. Careful shopping for complex and unusual goods or
service requires something rare and very valuable -- a combi-
nation of curiosity, technical ability, learning ability, and
market prowess -- that may be better put to use in shopping
for a house, earning a living, or raising a family.
Consumers face the same problems in buying any number of
sophisticated goods and services, from burglar alarms to video
cassettes. How do consumers overcome their shopping problems
in these markets? The answer is simple: rather than do their
shopping themselves, they find other people to do the shopping
for them. A consumer facing heart surgery relies on his
surgeon to arrange for an anesthesiologist. The consumer
PAGENO="0077"
71
looking for a digital watch delegates to the watch manufac-
turer the task of seeking out the most efficient supplier of
computer chips. Similarly, for many products consumers can
rely on the reputation of an established retail firm to ensure
that they get good quality for their money. This leaves the
retailer the difficult task of choosing which manufacturers'
products should be bought. Sellers are more than willing to
help consumers shop for the simple reason that consumers are
willing to pay them handsomely for this service. Any public
policy that restricts the ways in which consumers can delegate
their shopping tasks to others is likely to do more harm than
good. In particular, artificial restrictions on the sensible
bundling of goods and services should be looked at with a
jaundiced eye.
Department stores simplify shopping for many other goods
and services. Why can't people buy settlement services the
way they buy in a department store? Late in the 19th century
the retailing giants of America - Marshall Field, John Wanamaker,
J.C. Penney, and Sears - revolutionized many markets by staking
their reputations as retailers on the quality and price of the
broad range of goods that they sold. They deliberately made
themselves vulnerable to dissatisfied custprners in order to
convince the world that customers would not be dissatisfied in
their store. Today when, for example, Sears sells a customer
an Allstate insurance policy, its reputation is at stake. If
the policy is unsatisfactory to the consumer, not only will the
PAGENO="0078"
72
customer not renew the policy but Sears' reputation will suffer.
That can hurt sales in every department, not just insurance.
Thus, in addition to the nornal incentives the Allstate nanager
has to serve custoners well, there is the added pressure of the
children's apparel manager and the automotive nanager, and
others whose reputation and sales depend to some extent on the
quality of service in the Allstate Department.
At the same time, the insurance firms who compete with
Sears now have added impetus to improve their reputation by a
variety of methods; these methods include price competition,
warranties, extra services and so forth. Thus, the benefits
of the department store accrue not only to the department
store itself, but also thrcughout the industry.
Historically, the emergence of department stores had an
enormous beneficial effect on prices and on quality. The
simple fact that they sold a broad range of items made it pay
for retailers to go to great lengths to satisfy their custo-
mers. Their reputation with consumers was essential to their
commercial success and allowed them to guarantee the quality
and reasonable price of products-unfemi~iar to the consumer.
Customers can go to a large retailer, buy a complicated
product they nay hardly understand, and be confident that they
are getting a quality product at a reasonable price.
By contrast, virtually none of the benefits of department
store shopping are available to the purchaser of real estate
settlement services today. How could they be introduced into
the real estate settlement business?
PAGENO="0079"
73
Consumers could buy their settlement services from sources
offering a broad range of other services as well. Ideally, the
consumer could choose from among a variety of such sellers,
such as banks, stockbrokers, insurance companies or other
possible competitors.
A bank would have an incentive to provide a good combi-
nation of quality and price of settlement services if that bank
wants a consumer reputation for other services, say home improve-
ment loans, as well. sinilarly a stockbroker would seek to
satisfy the settlement services customer in order to attract
investment accounts. The insurance company selling settlement
services would hope to get consumers of fire, life, and auto
insurance policies as well.
By contrast, if the consumer buys from a title company or
escrow service, that company has less incentive to provide an
optimal combination of price and quality. If dissatisfied, all
the consumer can do is shift his title or escrow business the
next time he is in the market, and if he moves, he may well be
out of the firm's market area. If the consumer buys from a
real estate broker, he is only slightly better off because,
though the broker has more at stake, a consumer uses brokers
only infrequently. The consumer's power is related to the
number of return visits he expects to make to a given seller in
the market.
At the moment the gain from purchasing multiple settlement
services from the same provider is probably small. However,
permitting sales of a bundle of settlement services together
PAGENO="0080"
74
(provided this is accompanied by proper disclosure, as noted
below) at least allows market forces to move firms in the
right direction.
We are now ready to return to the first question about
the impact of controlled businesses on the price of settlement
services. To limit the range of services that may be offered
by any one provider is to deprive the, consumer of the clout he
gets from facing the same provider in a number of markets. In
short, the consumer has more market power when dealing with a
bank offering title or escrow services than when dealing with
a title or escrow company alone. Consumer access to that
market power will also improve his dealings with a title or
escrow company if he chose to go that route. On the other
hand, it is clear that consumers' power remains far less than
in the department store example; we merely contend that the
power is greater when controlled companies are permitted.
Therefore, our answer to the first question is that the
emergence of controlled businesses should be permitted, and
indeed encouraged, in order to increase the likelihood that
settlement costs go down. */
~/ A number of commentators have advocated that lenders be
required to provide more of the services than they presently
do and include the costs in their fee. This approach is
called lender pay.
We urge the committee to place a strong burden of proof on
those who advocate making lender pay mandatory rather than vol-
untary. A strong argument is necessary to explain why lenders
should be required to expand the list of services they provide
even if they do not view it as am attractive opportunity.
(Footnote cont'd on next page.)
PAGENO="0081"
75
The second question concerns the competitive inpact of
Section 8 of RESPA, prohibiting rebates for settlement service
referrals.
Section 8 is a response to the perceived problem called
`reverse competition." This issue has been alleged in con-
junction with the sale of title insurance, for example. The
consumer pays directly for title insurance but is usually
referred to the title company, for example, by the lender.
Under these conditions, the title company will compete for
the attention or favor of the lender (or other referrer)
rather than that of the customer. If competition were
directed to the consumer, it would come through lower prices;
but competition for the referring party would result in higher
title insurance prices as companies attempt to outbid one
another in higher referral fees, thereby increasing the price
of their title policies.
However, this argument is faulty; it overlooks the need
to look at both sets of prices: the price the customer pays
for title insurance plus the price paid for the mortgage loan
(or other service provided by the referring party). If the
referring party operates in a vigorously competitive market,
all of the profits from the title insurance referral fees
(Footnote cont'd from previous page.)
If lender pay is a good idea, and we are optimistic on
that score, then simply removing restrictions would help it
happen. However, if lender pay is not all it is cracked up to
be, .then lenders in the market will not find it attractive and
it would simply fade away.
85-396 0 - 81 - 6
PAGENO="0082"
76
will be passed on to consumers. Even in the worst case,
where the referring party is a monopolist, it is still in his
interest to reduce partially the price of his services in
response to his referral profits.
The fact of the matter is that referral is usually a very
valuable market service, and in most markets is amply and
properly rewarded.
For example, a real estate broker provides the service of
referring buyers to sellers; the senior partner of a law firm
"refers" clients to the working staff; indeed, a retailer
essentially refers customers to the particular manufacturers
whose products he stocks.
Therefore, our answer to the second question is that
Section 8 of the RESPA tends to increase rather than decrease
settlement prices.
To assure that the consumer knows the complete costs of
the transaction, it is important that settlement providers
disclose all requirements that the consumer also purchase
other services, along with the price of those services. These
are material facts of the transaction. The law should mandate
such disclosure while the consumer is still shopping, and
before he is committed to a specific bank, broker, attorney,
or other referring party. Indeed, consumers should be able to
receive such information by telephone. Such disclosure would
not be expensive and should be considered a cost of doing
business that requires consumers to purchase a combination of
services from specified sources.
PAGENO="0083"
77
TYING REQUIREMENTS WITH IMPERFECT
INFORMATION -- AND OTHER UNFAIR CONTRACTS
Richard Craswell *1
Tie-ins -- requirements that any buyer who wants to
purchase one good first agree to purchase some other good as
well -- have always been viewed with suspicion under the antitrust
laws. When imposed by a seller with some degree of monopoly power,
they have been regarded as an attempt to abuse that power by
extending it to a second product, and have been declared p~ se
illegal. However, the justifications for this rule have always
been somewhat unclear, and it is currently a matter of some
controversy as to whether this p~ se rule has any justification
at all.
One characteristic of this debate, however, is that it
has been limited to the case of tie-ins imposed by sellers with
monopoly power. This paper takes a slightly different approach,
analyzing the conditions under which sellers are able to insist
on a tie-in not because of monopoly power (in the traditional
sense) but because of inadequate consumer information. It can
be shown that certain patterns of imperfect information can
make tie-ins profitable even in a competitive market, and that
at least some litigated tie-in cases may well be examples of
this class of tie-ins rather than the result of monopoly power.
~/ Office of Policy Planning, Federal Trade Commission. The
author is grateful to Judith Gelman, Robert Lande, Richard Poole,
Steven Salop, and David Seide, among others, for helpful comments
on this and earlier versions. The views expressed are the author's
own, however, and do not constitute the views of the FTC or of any
of its Bureaus.
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This analysis can be generalized to treat tie-ins as simply one
form of non-price obligation imposed by sellers on buyers -- at
which point the same analysis can also be used to explain a number
of other unfairY contract provisions which have been traditional
consumer protection concerns.
The first section of the paper reviews the traditional
antitrust explanations of tie-ins and sets out the alternate
consumer information analysis. The second section generalizes
this analysis and applies it to unfair contract provisions and
various other consumer protection issues. The third section
surveys some possible beneficial effects, both of tie-ins and of
other contractual practices that might (otherwise) be viewed
as unfair. Finally, the last section discusses the costs and
benefits of various remedies, including some alternatives to
the traditional antitrust and consumer protection remedies
which flatly prohibit such contract terms.
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I. TYING REQUIREMENTS
A. Traditional Tie-In Theories
The traditional antitrust objection to tie-ins was based
on the belief that they weaken or destroy competition in the
market for the tied product. For example, suppose that a
computer monopolist will only sell to buyers who agree to buy
all their punch cards from that monopolist. 1/ This would
be viewed as giving the computer monopolist an unfair
advantage in the market for punch cards (the tied product). In
the extreme case, this might lead to the computer monopolist
acquiring a monopoly over punch cards as well, `leveraging the
monopoly power from one market to another. Even if the tie
did not lead to a second monopoly, it would still place competing
punch card manufacturers at a disadvantage that bore no relation
to their efficiency or performance in that market. As the
Supreme Court put it,
Where such conditions [tying arrangements]
are successfully exacted competition on the
merits with respect to the tied product is
inevitably curbed.... They deny competitors
free access to the market for the tied product
not because the party imposing the tying
requirements has a better product or a lower
price but because of his power or leverage in
another market. 2/
1/ This is a simplified version of the facts in International
Business Machines Corp. v. United States, 298 U.S. 131 (1936).
2/ Northern Pacific Ry v. United States, 356 U.S. 1, 6 (1958).
See also Fortner Enterprises v. United States Steel Corp., 394
U.S. 495, 508-09 (1969), and 512-13 (White, J., dissenting).
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Beginning in the 1950's, this traditional view of tie-ins
became the subject of much economic criticism. 3/ Put simply,
the economic objection was that the acquisition of a second
monopoly over the same customers would not necessarily benefit the
monopolist nor harm society. That is, the computer monopoly
by itself was sufficient to let the monopolist charge computer
users a monopoly price for the computers. Charging a monopolistic
price for the punch cards as well would increase the total cost
of computing services to users, thus reducing the demand for
computers (as well as for punch cards). But if the monopolist
had already been charging the most profitable monopolistic price,
it was not obvious that the monopolist would gain by raising
the cost of computing services still further and thus reducing
the total der~and. Indeed, in many circumstances the monopolist
would actually lose by such a course, unless the price of
computers were simultaneously reduced by enough to make up for
tne increased price of punch cards.
Thus, while the traditional view of tie-ins has continued to
prevail in the courts, 4/ most modern theories concerning tying
arrangements have taken somewhat different approaches. One
line of analysis has focused on the cases where a tie-in can
3/ The leading article was W. Bowman, "Tying Arrangements and
the Leverage Problem," 67 Yale L.J. 19 (1957). For modern
restatements of this position, see R. Bork, The Antitrust Paradox
380-81 (1978); R. Posner, Antitrust Law: An Economic Perspective
171-84 (1976)
4/ That is, tie-ins are still ~ se illegal, and the reasons
given for their prohibition are still by and large the same.
Whether the courts are still enforcing this rule with the
same severity is an issue beyond the scope of this paper.
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increase the monopolist's profits regardless of~ whether the
tie leads to a monopoly over the tied product. For example, the
monopolist might gain from raising the price of punch cards
and lowering the price of computers if the punch cards could be
used as a "metering" device to discriminate among users. That
is, the heavy users (who bought the most punch cards) would
end up paying disproportionately more for their total computing
needs, while lighter users (who might otherwise be driven away
by a higher price on computers) would end up paying less. 5/
Tie-ins may also be used as a substitute for some forms of
vertical integration, 6/ as an indirect method of raising
prices to evade maximum price controls, 7/ or as an indirect
method of lowering prices to inject competition in markets
where prices are fixed by minimum price controls or by some form
of horizontal collusion. 8/
5/ Bowman, supra note 3, at 23-24. For somewhat similar uses
~f tie-ins, see W. Adams & J. Yellen, "Commodity Bundling and
the Borden of Monopoly," 90 Q.J. Econ. 475 (1976); G. Stigler,
"United States v. Loew's, Inc.: A Note of Block Booking,"
1963 Sup. Ct. Rev. 152; M. Burstein, "The Economics of Tie-In
Sales," 42 Rev. Econ. & Stat. 68 (1960). As the Adams & Yellen
article demonstrates, however, in some cases these devices
may benefit the economy as a whole, by leading the monopolist
to increase his output. See also Posner, ~pra note 3, at 176-80.
6/ See Bowman, s~p~ note 3, at 24-26; R. Blair & D. Kaserman,
"Vertical Integration, Tying, and Antitrust Policy," 68 Am. Econ.
Rev. 397 (1978). This, too, may in some cases ben beneficial
rather than harmful.
7/ Bowman, supra note 3, at 21-23.
8/ It has also been suggested that certain tying requirements --
those which waived the tie if the seller could not match a
competitor's price for the tied product -- could be devices
for monitoring competitors' prices, thus facilitating tacit
collusion among oligopolists. J. Peterman, "The International
Salt Case," 22 J. L. & Econ. 351 (1979); F. Cummings &W. Ruhter,
"The Northern Pacific Cįi~7" 22 J. L. & Econ. 329 (1979).
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Other commentators have focused on the dynamic effects of
a second monopoly, either on the market for the tied product
or on the market for the tying product. For example, it has
been argued that a second monopoly over the tied product -- even
if it does not increase the monopolist's profits -- may still
reduce the competitive pressures for technical efficiency or
for innovation in that market, thus injuring the economy over the
long run. 9/ A second monopoly might also raise or reinforce
barriers to entry into the market for the tying product by
eliminating the independent producers of the tied product, if those
independent producers were the most likely potential entrants
into production of the tying product. Elimination of the
independent producers could also prevent anyone from entering
the tying market without simultaneously entering the tied market
as well (that is, producing both computers and punch cards) to
assure his customers a source of both goods. This could increase
the capital requirements of entry, thus aggravating any
disadvantage faced by the entrant in the capital market. 10/
9/ L. Sullivan, Handbook of the Law of Antitrust 447 (1977).
10/ 3 P. Areeda & D. Turner, Antitrust Law 259-60 (1978);
0. Williamson, Markets and Hierarchies: Analysis and Antitrust
Implications 11 (1975)
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This brief (and incomplete) summary hardly does justice
to the competing schools of thought on this issue. For purposes
of this paper, though, the key point about these arguments is
not their merit but their scope. All assume that buyers are
fully aware of the tying requirement, and of what that requirement
will eventually cost them, when they purchase the tying product.
It is always assumed, for example, that an increase in the
price of punch cards will in fact be perceived as an increase
in the total cost of computing services, and that buyers will
take this into account in determining their demand for computers.
In short, the entire debate has concerned markets in which buyers
are perfectly informed.
In the real world, of course, buyers are not always perfectly
aware of all of the costs of their agreements, nor is the extent
of their ignorance the same for all kinds of costs. The following
section abandons the assumption of perfect information, and
examines a class of tie-ins made profitable by high information
costs which would not have been profitable under the more
traditional assumptions.
B. Tie-ins with Imperfect Information
Consider the decisions a buyer must make in deciding whether
to accept a tying requirement -- for example, a buyer deciding
whether to purchase a computer from a seller who insists on
tying in punch cards as well. In a normal sale, the buyer
simply compares the value of the product with the price the
seller is asking for it, and decides accordingly. In a tie-in
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sale, however, there are really two prices the buyer must
consider. The buyer must not only decide whether the computer
is worth the up-front price charged for the computer itself,
but must also decide whether it is worth whatever net
inconvenience attaches to being locked into the accompanying
tying requirement. Considering the up-front price alone will
not be enough, for what appears to be a very good buy when
only the initial price is considered may be much less attractive
when viewed as part of an entire package.
Unfortunately, these two `prices" may not be equally easy
to observe. The price charged f or the computer (the tying
product) is usually fairly easy: It is a fixed amount, known
to both buyer and seller in advance, and usually stated in
dollars or some easily-convertible equivalent. However, the
"price' represented by the net cost of the tying requirement
is often much more difficult to calculate. In the computer
example, the buyer must figure out the number of punch cards
that will be needed over the course of the contract, and make
some guess (if it is not in the contract) as to how much the
seller will charge for them. More precisely, the buyer must
guess how much more he will have to pay under this contract
than if punch cards could be purchased on the open market --
which also requires some estimate of the future market price
for punch cards. The buyer must also consider the possibility
that the tied punch cards will be inferior, or that some other
punch card seller would be more convenient to deal with, or any
of a hundred other costs of being committed in advance to
dealing with one particular seller. In principle, all of these
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costs can be reduced to a single expected value, but the
calculation is not an easy one.
Moreover, none of these calculations can even begin unless
the buyer first discovers that there is in fact a tie-in
involved in this sale. In many cases this will be obvious
from the start; in others, it may require nothing more than
*a careful reading of the sales contract. In a number of cases,
however, buyers have alleged that they were forced to buy the
tied product not by amy clause in the contract but by coercion
introduced by the seller after the contract had already been
signed. 11/ This seems to have been mo~t common when the parties
were in a continuing relationship (such as franchisor-franchisee)
and the buyer would have faced significant costs in switching to
an alternate supplier, so that the seller's threat to terminate
relations if the tied product were not purchased carried some
weight. 12/ At any rate, from an information standpoint the
important fact is that such ties were not even in the contract,
and thus could not have been observed before the buyers.
entered into the initial transaction.
Thus, from the buyer's standpoint a tying requirement can
be viewed as a second, "hidden" price attached to the tying
product. Like an ordinary price, it represents something the
buyer must give up to obtain the tying product. Unlike an
11/ See, e.g., Atlantic Ref. Co. v. FTC, 381 U.S. 357 (1965);
TIre Sales Corp. v. Cities Service Oil Co., 637 F.2d 467 (7th
Cir. 1980), cert. denied, 49 U.S.L.W. 3789 (April 21, 1981);
Ungar V. Dunkin' Donuts, Inc., 531 F.2d 1211 (3d Cir. 1976).
12/ Economists have studied this as the problem of "opportunistic"
behavior. See, ~ B. Klein, R. Crawford & A. Alchian,
"Vertical Integration, Appropriable Rents, and the Competitive
Contracting Process," 21 J. L. & Ecori. 97 (1978); 0. Williamson,
"Transaction Cost Economics: The Governance of Contractual
Relations," 22 J. L. & Econ. 233 (1979); T. Muris, "Opportunistic
Behavior and the Law of Contracts," 65 Minn. L. Rev. 521 (1981).
PAGENO="0092"
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ordinary price, however, it will often be difficult to
identify and calculate in advance. It will not be impossible
for buyers to do this, of course, for they can always inquire
into the sellers reputation with past customers, estimate
their future demand for the tied product and its likely
market price, and so on. The point is simply that this
process is a difficult one, thus making it costly for consumers
to determine the entire price they will pay in advance of
their purchase.
The significance of these information costs is that they make
it possible for tying requirements to be imposed even in an
otherwise competitive market. For example, suppose that our
computer monopolist is now a perfect competitor, facing hundreds
of other sellers of identical computers. If such a seller
tried to raise the price of the computers, which is easily
observable, 13/ all the customers would switch to some other
seller who was still charging the competitive price. But the
same seller may be able to achieve an indirect price increase
without losing customers, by adding a tie that requires buyers
to return to that seller for their punch cards. Some
prospective buyers may not even realize that such a tie has
been imposed or that it will end up costing them something
by restricting their future choice. The tying seller clearly
will not lose any of these customers. Moreover, even those
prospective buyers who become aware of the tie will not switch
to some other seller unless they can be sure that the other
13/ There may be some markets in which even the up-front price
is difficult to observe -- for example, markets in which price
advertising has been banned. See, e.g., L. Benham, "The Effect
of Advertising on the Price of Eyeglasses," 15 J. L. & Econ.
337 (1972). That problem is beyond the scope of this paper.
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seller does not insist on a tying requirement that will end
up costing them even more. This is where the information
costs come in: As long as the first buyer's tie is not
expected to cost more than the cost of finding out what ties
are imposed by other sellers (and estimating their expected
costs) , prospective buyers will not even bother to search.
It will be cheaper for them simply to accept the first
seller's tie, knowing that they might be able to find a
better deal elsewhere but that the costs of finding it are
more than the gain is likely to be worth.
The story does not end here, however. As the last
sentence indicated, buyers' willingness to shop around depends
both on the costs of search and on the expected gains from
searching. 14/ The costs of search have already been discussed
-- i.e., the difficulty of finding out whether a seller imposes
a tying requirement, and (if so) of estimating how much that
requirement is likely to cost. The expected gains from
searching, however, will depend on how many other sellers
require a less-burdensome tie-in (or no tie-in at all) -- that
is, on the likelihood that the buyer will be able to find a
better offer. If it is.known that all sellers insist on the same
tie-in, for example, then no buyer will even bother to
search for a better offer, and no seller will lose business
because of the tie. 15/
14/ See generally G. Stigler, "The Economics of Information,"
69 J. Pol. Econ. 213 (1961), reprinted in G. Stigler, The
Organization of Industry 171 (1968).
15/ This is not quite true, for there will be some marginal
buyers who find the combined price (the up-front price plus the
tie) so high that they drop out of the market entirely. However,
this does not make the tie unprofitable in a competitive market.
While a monopolist would already~have be~i~ pricing so high that
it would have been unprofitable to raise the price higher and
exclude any more customers, this is generally not true of a
competitive equilibrium.
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The reason this is important is that, if the market for
the tying product is competitive, price competition may lead
all sellers to use the same (or similar) ties. If only one
seller tied punch cards to computers, for example, that
seller would then be earning additional profits (from the tied
sales) on every customer who purchased a computer. 16/ These
profits alone would give competing sellers an incentive to
copy the first seller, adopting a similar tie and earning
similar profits themselves. However, a competitive market
will not persist for long with some sellers earning higher-than-
normal profits from their customers. Competition for such
profitable customers will force sellers to lower the "up front"
price of the tying product, until all of the profits from
the tied sales have been competed away. The result will be
a new equilibrium, with all sellers charging a lower price
for computers and making up the lost revenue by obligating
buyers to buy some other product from them as well.
The problem, at bottom, is that sellers in such a market
have a strong incentive to compete on the basis of the "up front"
price and very little incentive to compete (because of buyers'
search costs) by using less-burdensome tying requirements.
The proposition that sellers will be less than competitive
in areas where buyers lack good information is hardly a novel one,
of course. For example, it is well known that sellers tend to
engage in less price competition in markets where price is
16/ These profits are of course greatest if the tied punch
~rds are later sold at a supracompetitive price. Even without
this bonus, though, the tied punch cards may represent a chance
to earn a normal competitive profit without all of the attendant
marketing costs, or (at the very least) an expected stream
of normal profits which is more certain than if the buyers
had not been committed by the ying requirement.
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difficult to observe. 17/ The problem is only slightly more
complex when consumers do have information about price but lack
information about some other product attribute, for then
sellers may make their products worse along the other dimension
(i.e., adopt more burdensome tie-ins) in order to compete more
favorably on price. The same analysis also applies to (and was
originally developed for) markets in which consumers have
good information about price but not about product quality,
in which case price competition may force all sellers to
offer products of inferior quality. 18/ If the number and
nature of tying requirements used by the seller is treated as
one more dimension of "product quality," 19/ the two issues
are formally identical.
A key question with respect to t~ing requirements, then,
is how many markets actually fit this analytic framework
of good information about price and poor information about
the costs of the tying requirement. Whatever the theoretical
17/ See T. Scitovsky, "Ignorance as a Source of Oligopoly Power,"
40 Am. Econ. Rev. 48 (1950) (papers & proceedings); G. Stigler,
supra note 14; L. Benham, p~ note 13. For a review of some
more technical economic modeli7 see S. Salop, "Information and
Monopolistic Competition," 66 Am. E.con. Rev. 240 (1976) (papers &
Proceedings. The courts and the FTC have accepted this principle as
a basis for striking down state laws forbidding price advertising.
Virg~inia State Bd. of Pharmacy v. Virginia Citizens Consumer
Council, Inc., 425 U.S. 748 (1976); Bates v. State Bar, 433 U.S. 350
(1977); American Optometric Ass'n v. FTC, 626 F.2d 896 (D.C. Cir.
1980)
18/ The seminal article is G. Akerlof, "The Market for Lemons:
Quality Uncertainty and the Market Mechanism," 84 Q.J. Econ.
488 (1970). See also H. Leland, "Quacks, Lemons and LicensTng:
A Theory of Minimum Quality Standards," 87 1. Pol. Econ. 1328
(1979); D. Smallwood & J. Conlisk, "Product Quality in Markets
Where Consumers are Imperfectly Informed," 93 Q.J. Econ. 1 (1979);
A. M. Spence, "Consumer Misperceptions, Product Failure, and
Producer Liability," 44 Rev. Econ. Stud. (1977); G. Heal,
"Do Bad Products Drive Out Good?" 90Q. J. Econ. 449 (1976).
19/ Cf. A. Leff, "The Contract as Thing," 19 Am. U.~ L. Rev.
131 (1970) .
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difficulties involved in estimating the net present value
of a tie-in, it is unlikely that those difficulties pose
any real problem in the case of sales to expert industrial
buyers (for example). The sane could be true of markets in
which the tying good is purchased repeatedly, so that buyers
can learn from experiene what tying requirements are imposed
and how much they typically cost. 20/
However, tie-ins are also imposed in markets which
come much closer to the conditions of imperfect information
analyzed here. Some tie-ins are imposed in connection with
consumer goods; often goods which are infrequently purchased. 21/
Others are imposed in contracts with small businessmen, who may
lack the expertise of more experienced purchasers. 22/ The
FTC's investigation of franchising practices, for example,
found that franchisees were often unware of the tying
20/ The economists' models of product quality and price
3~mpetition, discussed earlier, usually reach similar results
in markets where repeat purchases are important. See G. Heal,
note 18; B. Klein & K. Leffler, "The Role of Market
Forces in Assuring Contractual Performance," J. Pol. Econ.
(September 1981, forthcoming); C. Shapiro, "Premiums for
High Quality Products as Rents to Reputation," FTC Bureau
of Economics Working Paper No. 43 (August 1980). However,
if the purchaser does not learn about the tying requirement
until after incurring fixed costs committing himself to one
particular supplier (see text ~ at note 12), this may not
do any good.
21/ E.g., Ware V. Trailer Mart, Inc., 623 F.2d 1150 (6th Cir. 1980)
(mobile home sites); Moore v. Jas. H. Matthews & Co., 550 F.2d
-1207 (9th Cir. 1977) (cemetery lots); Miller v. Granados, 592 F.2d
393 (5th Cir. 1976) (condominiums); Forrest v. Capital Bldg~ & Loan
Ass'n., 385 F. Supp. 831 (M.D. La. 1973), aff'd per curiam, 504
F.2d 891 (5th Cir. 1974), cert. denied, 421 U.S. 978 (1975) (home
mortgage loans).
22/ ~ Yentsch v. Texaco, Inc., 630 F.2d (2d Cir. 1980)
Uocaliervl station operators); Ungar v. Dunkin' Donuts, Inc.,
531 F.2d 1211 (3d Cir. 1976) (local fast-food franchisees);
Crawford Transport Co. v. Chrysler Corp., 338 F.2d 934 (6th Cir.
I~64), cert. denied, 380 U.S. 954 (1965) (local automobile dealers).
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requirements imposed by their franchise agreements lacked
sufficient business experience of appreciate the requirements'
impact. 23/ Similar concerns have occasionally been expressed
by antitrust courts. 24/ Indeed, many of the markets involved
in these cases were highly unconcentrated in both the tying
and the tied products, so an explanation based on imperfect
information is at least more plausible than one based on an
attempt to abuse market power.
On the other hand, the fact that the market may be
characterized by imperfect information does not mean that
legal intervention is necessarily warranted, or even that the
information-based analysis given here necessarily describes
what is happening. Even in a market with imperfect information,
tie-ins may still be imposed for any of the traditional
reasons discussed in the first part of this section. Moreover,
tie-ins may also be imposed for any of several beneficial,
efficiency-increasing reasons to be discussed in Section III
below. This paper's analysis of markets with imperfect
information says simply that sellers in such a market may have
an incentive to adopt a tie-in regardless of whether it increases
efficiency or not. In a competitive market, any profits
23/ Trade Regulation Rule and Statement of Basis and Purpose,
Disclosure Requirements and Prohibitions Concerning Franchising
and Business Opportunity Ventures, 43 Fed. Rag. 59614, 59656-57
(1978)
24/ "The franchisees' apparen willingness to pay the ultimate
cost of the arrangement [by signing the franchise contract} is
clouded by the fact that they may well have been unware of
what that cost would come to in practice. Had the full amount
of the over-charge on the tied items been openly specified as
the cost of the tying items, agreement might not have been
forthcoming." Siegel v. Chicken Delight, Inc., 448 F.2d 43,
52-53 (9th Cir. 1971) , cert. denied, 405 U.S. 955 (1972)
85-396 0 - 81 - 7
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from the tie will be competed away and returned to the
buyers in the form of a reduced price for the tying product,
so if the tie increases efficiency (i.e., benefits the
seller by more than it costs the buyers) then the price-
reduction will be a large one and buyers should ultimately
benefit. Only if the sellers' profits (and the subsequent
price reduction) are less than the costs the tie imposes on
buyers has the market led to an inefficient result.
In short, the fact that the market may be marked by
imperfect information does not avoid the necessity of evaluating
the costs and benefits of the specific tying arrangement
being challenged. Before taking up that analysis in
Section III, however, Section II will consider other "unfair"
contractual arrangements usually thought of as unrelated
to tie-ins.
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II. OTHER UNFAIR CONTRACTS *
Tying requirements are notthe only contractual
arrangements which the law has viewed with suspicion. This
section will examine other contract clauses which have been
challenged under legal doctrines prohibiting "unfair" or
"unconscionable" contracts, or under various other legal rules.
As these legal doctrines are usually viewed as belonging to the
field of consumer protection rather than antitrust, the
similarities between such contracts and tying arrangements have
generally been overlooked. However, this section will
demonstrate that the issues raised by some classes of "unfair"
or "unconscionable" contracts are identical to those discussed
in the last section in connection with tie-ins.
A. Unconscionable Contract Clauses
At common law, as well as under the Uniform Commercial
Code, 25/ courts refuse to enforce contracts which impose
unconscionable risks or obligations on the buyer. For example,
courts have struck down contracts requiring consumers to
consent to be sued in distant jurisdictions, 26/ to allow the
seller to repossess all goods purchased on credit if the buyer
25/ Uniform Commercial Code § 2-302. The FTC has also struck
down some contract terms as "unfair or deceptive acts or practices
under §5 of the FTC Act. For a survey of those cases, see
R. Craswell, "The Identification of Unfair Acts and Practices
by the Federal Trade Commission," 1981 Wis. L. Rev. 107, 127-39
(1981) .
26/ E.g., Paragon Homes, Inc. v. Carter, 4 U.C.C. Rep. Serv. 1144
(N.Y. Sup. Ct. 1968). See also Spiegel, Inc. v. FTC, 540 F.2d 287
(7th Cir. 1976)
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defaults on any single purchase, 27/ or to waive the seller's
liability for personal injury or other consequential damages
caused by a defective product. 28/
Contracts such as these raise none of the antitrust
concerns traditionally associated with tie-ins. There is no "tied
product in these cases which the seller could even conceivably
be monopolizing, and no real likelihood that the unconscionable
clause is being used to effect a form of price discimination or
to raise barriers to entry. However, some of the criticisms of
unconscionable contract clauses sound very similar to the
traditional judicial criticisms of tying arrangements. In
particular, many courts and commentators have criticized
unconscionable contract terms as an abuse of the seller's
superior bargaining power vis-a-vis consumers. 29/ While
"superior bargaining power" (in the unconscionability sense)
may not be exactly the same as "market power" (in the antitrust
sense), the two concepts are at least somewhat related.
27/ E.g., Williams v. Walker-Thomas Furniture Co., 350 F.2d
~5 (D.C. CluE. 1971).
28/ ~ Henning~sen v. Bloomfield Motors, Inc., 32 N.J. 358,
161 A.2d 69 (1960).
29/ See Henningsen v. Bloomfield Motors, supra note 28; Uniform
~mmercial Code §2-302, Comment 4; Wilson, "Freedom of Contract
and Adhesion Contracts," 14 Int'l & Comp. L. Q. 172 (1965).
Though the term "unequal bargaining power" is often used loosely
to refer to a wide variety of situations, it appears to most
often refer to a combination of (a) the seller's "take ir or
leave it" bargaining posture, and (b) the weight given that
posture when each buyer needs the seller more than the seller
needs any individual buyer. At least two commentators have
treated this as reducing, ultimately, to some form of market
power in the traditional antitrust sense. See A. Schwartz,
"A Reexamination of Nonsubstantive Unconscionability," 63 Va.
L. Rev. 1053, 1971-75 (1977); R. Posner, Economic Analysis of
Law (2d ed. 1977) , at 84-88. See also A. Leff, "Uncomscionability
~ The Code -- The Emperor's New Clause," 115 U. Pa. L. Rev. 485 (1967)
PAGENO="0101"
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Perhaps as a result of this similarity, many objections to
prohibiting unconscionable contract clauses are virtually
identical to the objections economists raised to the judicial
view of tie-ins. 30/ Critics of the unconscionability doctrine
argue that, even with market power, it is not obvious that
sellers will have any incentive to force unconscionable
contract clauses on their customers. Insistence on a burdensome
contract, it is said, will make the total package less
attractive to buyers, just as if the seller had raised the
price of the product. If the seller was already charging the
maximum price that the market would bear, however, then the
seller would lose customers by raising the "price" even further
and should have no incentive to do so. Just as in the case
of tie-ins, the argument is that most sellers with market power
will exercise that power by raising the basic price rather than
by changing the other terms of the purchase agreement. 31/
This argument is correct to point out that "unconscionable"
contract clauses are in many ways similar to an increase in
price. A burdensome contract clause, like a tying requirement, is
an undesirable feature the buyer is forced to accept in order
to purchase the desired product. If the contract disclaims all
warranties, the buyer must accept the risk that the product
will be defective, including the risk of injury to himself or
others. If a lease requires the tenant to pay all attorneyst
30/ See text supra at note 3.
31/ See R. Epstein, "Unconscionability: A Critical Reappraisal,"
18 J. L. & Econ. 293 (1975); A. Schwartz, supra note 29;
R. Posner, supra note 29, at 84-88.
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fees in the event of a dispute, the tenant is accepting the
possibility of having to pay a large sum of money at some
point in time should a dispute ever arise. These risks increase
(by the amount of their expected present value) the total amount
the buyer can expect to pay as a result of his purchase; they
also increase the average profits the buyer can expect to make
on the sale. In this sense, the burdensome contract term is
exactly like,a second "pricet' for the product -- and is also
exactly like a tie-in.
However, a burdensome contract clause is also like a tie-in
in that this second price may be very difficult to estimate
in advance. The expected cost of a term which disclaims all
warranties depends on the likelihood that the product will
break down (which depends on how well it is made and what it is
used for) and the amount of damage likely to result if it
does. The cost of a term requiring the tenant to pay all
attorneys' fees depends on the likelihood of a legal dispute
arising (i.e., on how pugnacious the two parties are) and on the
size of the legal fees likely to be incurred if one does. Just
as in the case of tie-ins, these costs will often be very
difficult for buyers to estimate in advance of their purchase.
In fact, if the clauses in question are buried in fine print or
technical legal jargon, it may be difficult for buyers even to
discover their existence. 32/
32/ See, ~ J. Davis, "Protecting Consumers for Overdisclosure
~id Gobble~ook: An Empirical Look at the Simplication of
Consumer Credit Contracts," 63 Va. L. Rev. 841 (1977).
PAGENO="0103"
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Thus, the same information-'based analysis explaining the
existence of tying arrangements in competitive markets can also
be applied to unconscionable contract clauses. If price
competition prevents sellers from raising their prices directly
(that is, if consumers can easily observe the "up front" price),
a seller may still be able to raise prices indirectly by means of
a contract term which transfers some risk or liability to the
buyer. As long as the expected cost of that term is less than
it would cost buyers to find out whether other sellers' terms
are any more favorable (in terms of their expected present value),
buyers will not find it in their interest to shop around and
the seller will not lose any customers. In fact, sellers who
do offer non-burdensome contracts will probably have to charge
a higher price than those whose contracts shift many of the
risks and liabilities to the buyer, so markets which are
competitive on price alone may ultimately force all sellers
to adopt the unconscionable contract terms in order to
maintain a competitive price. And with all sellers using the
same or similar contract terms, no seller will lose customers
even among those who do take the time and trouble to compare
contract terms. 33/
33/ Compare the description of automobile contracts in
Henningsen Y. Bloomfield Motors, Inc., ~gpra note 28: "The
gross inequality of bargaining position occupied by the
consumer in the automobile industry is thus apparent. There
is no competition among the car makers in the area of the
express warranty. Where can the buyer go to negotiate for
better protection?" 161 A.2d at 87.
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Obviously, this does not mean that all burdensome contract
clauses are the result of such an information imperfection.
In some markets the information imperfection may not even
exist, if consumers can easily observe the terms of sellers'
contracts or if the product is purchased frequently enough
that sellers depend on the repeat business of satisfied
customers. 34/ Unconscionable contract terms may also be
imposed through more traditional means, such as fraud or
duress. 35/ At most, the analysis offered here explains only
one class of unconscionable contracts.
Moreover, the fact that an information imperfection is
observed to exist does not mean that all resulting contract
clauses are necessarily undesirable. As in the case of tie-ins,
if sellers are still competitive on price then any profits earned
from the burdensome contract clause will be competed back to
consumers in the form of lower up-front prices. The key question,
then is whether the amount sellers gain from the contract clause
(and give back in the form of lower prices) is greater or less than
the amount consumers lose from that clause. This question,
however, cannot be answered without a careful analysis of the
34/ Significantly, most unconscionability cases seem to
]5~volve major purchases which are not frequently repeated --
e.g., furniture, rental housing, automobiles, aluminum siding.
On products purchased frequently, consumers will come to
have a better idea of any hidden costs imposed by the purchase
agreement. See R. Reich, "Toward a New Consumer Protection,"
128 U. Pa. L. Rev. 1 (1979); see also note 20 supra.
35/ These traditional causes arise from problems within
the bargaining process between buyer and seller, rather than
from the institutional factors making it costly for buyers
to compare competing offers. For an excellent article contrasting
these two appraoches to unconscionability, see L. Kornhauser,
"Unconscionability in Standard Forms," 64 Cal. L. Rev. 1151 (1976).
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economic effects of each clause in question. 36/ Contract
clauses (including tie-ins) are unlike prices in that they do not
merely transfer meoney from buyers to sellers; they also transfer
various risks and obligations, which may be good or bad
depending on the net effects. All that this analysis has
suggested is that (given sufficient information costs) sellers
will have an incentive to adopt such clauses regardless of
whether their net effect is gobd or bad. In these markets,
the trade-off arrived at in equilibrium cannot be presumed to
reflect the most efficient result.
B. Other Consumer Protection Problems
The unconscionability doctrine is not the only way in which
the law restricts the enforceability of "unfair' contracts.
Other contract clauses have also been prohibited by specific state
statutes. For example, many state laws forbid contracts
containing disclaimers of certain kinds of warranties, 37/ or
assignments of wages, 38/ or prevent landlords from unfairly
retaining tenants' security deposits. 39/ Obviously, the fact
that such contract terms have been addressed under specific
statutes rather than under the general doctrine of unconscion-
ability does not change the applicable economic analysis.
36/ For some recent analyses of various contract clauses,
see J. Ordover & A. Weiss, "Information and the Law: Evaluating
Legal Restrictions on Competitive Contracts," 71 Am. Econ. Rev.
399 (1981) (Papers & Proceedings); B. Klein, "Transaction Cost
Determinants of `Unfair' Contractual Arrangements," 70 Am.
Econ. Rev. 356 (1980) (Papers & Proceedings); J. Brown, "Holder
in Due Course: Does the Consumer Pay?" 32 Bus. Law. 614 (1977);
R. Epstein, supra note 31.
37/ See Uniform Commercial Code §2-719(3).
38/ Uniform Consumer Credit Code § 3.305.
39/ Uniform Residential Landlord-Tenant Act §2.101.
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The information-based explanation of unconscionable contract
clauses given above may thus apply to these clauses as well.
However, a similar information-based analysis may also apply
to other consumer protection problems not involving the terms
of contracts. For example, many consumer complaints about
warranty performance are not complaints about limits in the
terms of the warranty; they are complaints about delays in the
seller's performance. The problem is that, while such delays
were not explicitly permitted by the contract, they were
not explicitly forbidden either. The time required for
warranty performance is often one of the issues on which the
contract is silent.
The contract's silence may not itself be objectionable,
of course. It will often be extremely difficult to specify
exact time limits in advance, especially as the length of time
required will often vary with the difficulty or the severity of
the repairs. 40/ As a result, however, consumers may have a
difficult time comparing different sellers to determine which
offers the promptest warranty performance. In that case,
even sellers who are perfectly competitive on price will have
little incentive to compete by improving their warranty
performance time. In fact, the pressures of price competition
may even force sellers to stop maintaining a high level of
warranty performance in order to reduce their costs and
maintain a competitive price. The problem, as in all the other
areas discussed here, is that the up-front price is very easy
to observe and compare but the level of warranty performance is not.
40/ That is, the transaction costs involved in writing a
complete contract will often be prohibitive. Cf. B. Klein,
supra note 36.
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A similar difficulty underlies the problem of fraudulent
diagnoses by providers of expert services. Such fraud is made
possible by the fact that a non-expert consumer usually finds it
very costly to check a mechanic's recommendation (or that of a
doctor, or a lawyer) that a particular course of repair or
treatment is needed. If the repair works (or the medical or
legal problem is avoided), it may have been because the treatment
was in fact successful, but it may also mean that the treatment
was never needed in the first place. 41/ The recommendation of
an unnecessary treatment thus is very similar to a tying
requirement. In addition to paying for the diagnosis itself,
the buyer will also end up paying for an unnecessary treatment
which (if the truth were known) the buyer would have preferred not
to purchase. The cost of the unnecessary treatment is a second
component of the total price the buyer will pay for having
patronized this particular diagnostician, but the likelihood
and likely magnitude of that price will be almost impossible for
the buyer to observe in advance.
As a result, even a competitive market may not provide any check
on the proliferation of such fraud. In fact, if diagnosticians do
compete on the basis of price (and if unnecessary treatments
or repairs yield more profits than necessary ones), price
competition may actually push the market to an equilibrium in which
every seller overprescribes. If there are enough fraudulent
sellers to be competitive, they will be unable to maintain an
equilibrium which brings them all excess profits, and eventually
price competition will force them to reduce prices until they
41/ See generally M. Darby & E. Karni, "Free Competition and
the Optimal Amount of Fraud," 16 J. L. & Econ. 67 (1973).
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earn only a normal rate of return. That is, there will still be
an excessive number of repairs being performed (as there is no
incentive to compete to reduce this number), but the price per
repair will have been forced down below what it would be in a
more honest market. This will leave the honest sellers with
a below-normal rate of return, forcing them to either begin
prescribing unnecessary repairs or to exit the market. 42/
In short, the problem of markets with an easily-observable
"up front' price and a more-difficult-to-observe hidden cost
is one which runs through many consumer protection problems. 43/
The focus of this paper has been (and will continue to be) on
tying requirements and other unfair contract terms, and area
of particular interest because antitrust analysis rarely if ever
takes such factors as inadequate buyer information into account.
However, this section should serve to demonstrate that the
underlying analysis may actually be of far wider applicability.
42/ The only check on this tendency would be something which
~akened price competition, such as advertising bans or a
consumer reluctance to patronize low-price providers (both of
which have often characterised the markets for the "learned
professions"). Darby and Karni (supra note 41) conclude in a
somewhat similar vein that the incentive to recommend unnecessary
repairs will be removed if prices are so high that no seller
will risk losing such profitable customers by making a
fraudulent recommendation. However, this depends crucially
on their assumption that a customer who discovers that some of
the repairs were unnecessary will in fact switch to another
provider -- an assumption which will not always be valid if the
customer has no way of telling whether other providers are
any more or less honest.
43/ Perhaps the most obvious instance, where the hidden
costs involve inferiorities in product quality, was alluded
to supra at notes 17-20.
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III. BENEFICIAL EFFECTS
The previous sections have demonstrated that tying
requirements and other unfair contract clauses nay be adopted
even in an apparently competitive marke-t. However, those sections
also pointed out that such contractual requirements did not
inevitably reduce consumer welfare. If sellers are still
competitive on price, then the sellers' profits from the contract
terms will eventually be competed away and returned to consumers
as lower up-front prices. Conversely, prohibiting such clauses
would take away some of the sellers' profits and leave them
temporarily earning below normal rates of return, thus
provoking a general increase in the up-front price. The
key question, then, is whether: the size of the reduction in
the up-front price is greater or less than the costs and
inconvenience the clause imposes on the buyers.
The costs that a tie-in imposes on buyers have already been
alluded to. A tie-in restricts the buyer to dealing with a
single seller of the tied product, possibly a seller whose product
is not as good or is less convenient to deal with. Even if that
seller's product and services are identical to other sellers,
his price may be higher, either because he is less efficient at
producing the tied product or because he is trying to earn
a higher profit on the tied sales. A more subtle cost may
arise if the tying and the tied product can be used together
PAGENO="0110"
104
in varying proportions, in which case the combination of a
reduced price on the tying product and an increased price on
the tied product may lead the buyer to combine them in a
less-than-efficient ratio. 44/ -
The costs of other burdensome contract clauses are more
difficult to generalize, but they are usually apparent from the
nature of the clause. The direct cost of a disclaimer of
warranty is the amount of damage that is done if the product
ever breaks down; the direct cost of a liability-for-attorneys-fees
provision is the amount of the attorneys fees if and when a
dispute ever arises. The present discounted value of those
provisions is thus the direct cost times the likelihood of the
relevant event ever arising, plus any adjustment required
for the degree of customers' risk aversion. The only more
subtle costs here are the effects of such clauses on the parties'
incentive to permit or prevent the triggering event from
ever taking place. For example, a clause making the tenant
liable for all legal fees in the event cf a dispute may
weaken the landlord's incentive to avoid getting into such a
dispute, thus increasing the probability that such a dispute
will actually arise. On the other hand, such a clause would
increase the tenant's incentive to avoid any dispute; this
might tend to lower that probability, and it is unclear what
the net effect would be.
44/ That is, the buyer will respond to these price signals
by using too much of the tying product and too little of the
tied product, as compared to the ratio that would be used if
both products were priced competitively. Note, though, that
if the seller had monopoly power over the tying product the
reduction of that product's price would have been a step toward
the competitive price and might have led to a more efficient
ratio of combination. Cf. Blair & Kaserman, supra note 6.
PAGENO="0111"
105
Since these clauses do not aa~ transfer wealth from buyers
to sellers, there is no reason to think that the costs discussed
above are necessarily equal to the buyer's gain. In the
case of tie-ins, for example, the price paid for the tied
product will be a pure transfer, but the inconvenience of
dealing with a less-preferred seller will be a loss to the
buyer which does not benefit the seller at all (and thus will
never be competed away as a price reduction) . 45/ If consumers
are generally more risk-aversethan sellers, the same could be true
of any contract clause which forced the consumer to bear majot risks
(e.g., the risk of injury caused by a defective product). There
would also be a net loss if the shifting of that risk increased
the probability that such a risk would actually come to pass --
e.g., if a disclaimer of warranty reduced the manufacturer's
incentive to produce a defect-free product by more than it
increased the consumer's incentive to use the product carefully.
However, before concluding that such clauses inevitably
reduce consumer welfare, one must also consider the possible net
benefits produced by those clauses. Tying arrangements, in
particular, may have benefits which are often overlooked in
45/ Even the price of the tied~ product will be a net loss if the
product is one the buyer would have preferred not to purchase,
because it had no value or was valued less than the seller's
cost of production. Interestingly, such tie-ins have been held
to be legal under the antitrust laws, on the theory that
competing sellers of the tied product have not been deprived of any
business. Yentsch v. Texaco, Inc., 630 F.2d 46, (2d Cir. 1980).
PAGENO="0112"
106
antitrust analysis, either because such clauses are nominally
se illegal or because of the frequent tendency in antitrust
to assume that all parties have perfect infornation. The
renainder of this section will examine sone of those potential
benefits.
Before proceding with that analysis, though, one difference
in perspective should be noted. The antitrust laws, even when
faced with the possible benefits of tying requirenents, have
often insisted that sellers look for less restrictive alternatives
which would achieve the same benefits without placing competing
sellers of the tied product at quite such a disadvantage.46/
When the reason for objecting to a tie-in is the injury it does
to competition or competitors, as discussed in Section I, this
approach may well be appropriate. In this paper, though, our
concern is with tie-ins that result from the market's response to
imperfect consumer information rather than from any attempt to
injure competition. There is no reason to assume that such tie-ins
improperly injure competitors as well as consumers; conversely, if
they are shown to benefit consumers, there is no a priori reason
46/ See, ~., Standard Oil Co. v. United States, 337 U.S. 293,
306 (1949); see also note 54 infra.
PAGENO="0113"
107
to insist on alternatives that would also benefit competitors.
Tie-ins which also cause competitive injury, and which
therefore would justify demands~ that their effect on competitors
be mitigated, are beyond the scope of this paper.
A. Efficiencies in Production
The most obvious beneficial effect of tying requirements
is found when two products are cheaper to produce or distribute
as a unit. It is almost certainly more efficient to sell
automobiles together with steering wheels and upholstery, for
example, even though this admittedly coerces buyers into
purchasing those items from a single source, and could foreclose
competition from independent sellers of steering wheels. The
antitrust courts have not treated such efficiencies as a formal
defense in tie-in cases, but have accomplished almost the same
result by considering these efficiencies in deciding whether
to characterize the arrangement as a `tie" or as the sale of a
single, integrated product. 47/
Similar efficiencies may explain why consumers continue
to purchase diagnoses and repair services from the same source, even
though this may give the seller an incentive to defraud buyers
by prescribing unnecessary repairs. Even taking into account
the incentive for fraud it is often much cheaper to have
the repafr performed at the same time and place as the original
diagnosis. For example, it may be costly to reassemble an
47/ See Siegel v. Chicken Delight, Inc., 448 F.2d 43, 48 (9th
Cir. 1971), cert. denied, 405 U.S. 955 (1972); Sullivan, ~
note 9, at 449.
85-396 0 - 81 - 8
PAGENO="0114"
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automobile and transport it to another shop to be repaired;
it may also be easier for the mechanic to perform the
repairs at the same time as the diagnosis (perhaps trying
several until one works) rather than trying to communicate
to an independent repairman the exact details of what needs
to be done. The principle is really the same as in the
automobile/steering wheel example: the most efficient
division of labor will often require integration of the
provision of several goods and-services. 48/
To be sure, these efficiencies will not always require that
the combined products be purchased from a single source. An
auto manufacturer could offer customized models (not necessarily
at a lower price) which came without steering wheels or upholstery,
or a mechanic could offer (for a fee) to try to write down
exactly what a customer's car needed so that the repairs could
be performed elsewhere. However, if the increased costs of these
options prevent many customers from taking advantage of
them, then at some point, especially where mass-produced
products are involved, the costs of customization become
prohibitive. This is most easily seen in the area of standard
form contracts, where the seller's refusal to even bargain over
a particular provision is often cited as evidence that the
contract is unconscionable. However, if the cost of negotiating
customized contracts is sufficiently high, and the number of
48/ The area of economic theory which deals with such issues
is usually referred to as the theory of the firm. See
generally R. Coase, `The Nature of the Firm," 4 Economica 386 (1937);
0. Williamson, supra n. 10, ch. 5.
PAGENO="0115"
109
customers who would want such contracts is sufficiently
low,, it could well be more efficient to "impose' the
same contract on every customer.49/
13. Efficiency in Product Selection
Another potential benefit of tying arrangements stemb
from their utilization of the seller as an agent for the
buyer in selecting the tied products. If information costs
or bther problems make it difficult for the Luyer to make:
`that choice, in some cases it ma~r be more efficient to shift*
that choice to the seller. This effic~ien9y thus depends on
~th~ chara~cteristic~ of t1~e sell~r's custoi~ers -- that is, the
demand side rather than on the characteristics of the
production process.
A common example of this involves products which require
high-quality components. Suppose, for example, that a salt
processing machine will only function properly with salt
of a given fineness and quality. If consumers have perfect
information -- that is, if they know what quality of salt the
machine requires, as well as the actual quality of the
different brands of salt available on the market -- then they
will presumably select a proper quality salt without any problem.
If we abandon the assumption of perfect information, though,
49/ See }ēqrnhauser, supra note 35, and the authorities cited
~ at note 31. Note, though, that this efficiency only
justifies the seller's refusal to bargain over the clause;
it does not necessarily justify the substantive terms of the
clause itself.
PAGENO="0116"
110
it may well be more efficient for the machine manufacturer
to choose the source of supply, thus preventing the
inadvertent use of inferior salt. The manufactuer will
probably be more familiar with the machine's requirements
(asymmetric information); also, the manufacturer need only
investigate the quality of various sources of supply once
rather than leaving it to each buyer to duplicate the same
investigation (economies of scale). This will be less
attractive if buyers have diverse demands -- e.g., if some
prefer to pay top dollar to reduce the chance of low-quality
supplies to a minimum, while others prefer to pay a little
less and take their chances. However, in industries where
the demand is sufficiently homogeneous, it would not be impossible
for buyers to prefer to have the seller arrange for a source
of supply and offer both products as a single package. 50/
In some cases, there may be similar economies in the
relationships between franchisors and local franchisees.
Franchisors typically sell far more than the right to use a
nationally known brand name. The franchise contract may also
specify the design of the local franchisor's building, the site
on which it is to be located, the sources from whom supplies
are to be purchased, the services to be provided at the location,
and so forth. 51/ To some extent, these restrictions may
50/ This is especially likely to be the case if buyers
cannot evaluate the tied products separately, as discussed
in the next section.
51/ For a survey of various franchise contracts, see
U. Ozanne & S. Hunt, The Economic Effects of Franchising, Select
Comm. on Small Business, U.S. Senate, 92d Cong., 1st Sess.
(Comm. Print 1971).
PAGENO="0117"
111
be designed to overcome the free rider problem that will be
discussed in the next section. They may also be designed to
redistribute the gains of *the operation between the franchisee
and franchisor. 52/ However, some requirements may simply
reflect the fact that the franchisor is often in a better
position to decide what method of operation will be most
profitable than is the local franchisee. The franchisee
is often a small investor with little or no experience in
making such decisions, while the franchisor may be al?le to
draw on the ei~perierrce of large numbers of similar operations
in varjous, pa.rts of the country. Under. these conditions, it
would not be surpri~ing if at least some franchisee~ preferred
to buy into a system in which many of the operating decisions
have already been made, even though this ties them into a fixed
method of doing business and forecloses them from independent
suppliers. ~j?~/
Again, many of these benefits may be obtainable without
actually requiring buyers to agree to a tying arrangement.
Sellers could make the selected products available and simply
recommend that buyers purchase them together, or even publish
the appropriate quality specifications (or a list of approved
suppliers) and recommend that buyers make their selection
52/ See text and notes infra at notes 59-60.
53/ For an analysis of the conditions under which franchisees
and franchisors would prefer such an arrangement to complete
vertical integration, where the franchisee was either an
employee or a passive investor, see P. Ruhin, "The Theory of the
Firm and the Structure of the Franchise Contract," 21 J.L. & Econ.
223 (1978); R. Caves & W. Murphy, "Franchising: Firms, Markets,
and Intangible Assets," 42 So. Econ. J. 572 (1976).
PAGENO="0118"
112
accordingly. 54/ In some cases, this may well be an efficient
method of giving buyers enough information to make an
informed choice while still leaving each buyer the freedom
to choose individually, thus accomodating differences in
preference. However, even this information is costly to
communicate, and may be of little use without additional
information as to ~ the seller recommended the brands he
did or what the consequences of using each one would be.
For example, some franchisees may prefer not to be handed
masses of data and told to make an independent decision
about each aspect of the design of the restaurant building
or the ingredients of each of the food items. In the production
and sale of any good or service, there will be some point at
which the customers will prefer to pay the seller to make
certain decisions for them.
C. Efficiency in Product Evaluation
The informational reasons for a tie identified in the preceding
subsection are particularly likely to be important if the
performance of various components can only (or can most easily)
be evaluated in combination. For example, if a consumer buys a
54/ In cases where tie-ins were believed to have injured
competition in addition to ensuring a tied product of adequate
quality, sellers have often been found liable for not having
used this `less restrictive" requirement. See, e.g.,
International Salt Co. v. United States, 332 U.S. 392, 397-98
(1947); International Business Machines Corp. v. United
States, 298 U.S. 131, 139-40 (1936); Siegel v. Chicken
Delight, Inc., 448 F.2d 43, 51 (9th Cir. 1971), cert. denied,
405 U.S. 955 (1972). However, the costs of these alternatives
have rarely been taken into account, perhaps because of the
tradition in antitrust analysis of assuming that buyers have
complete and costless information.
PAGENO="0119"
Hug..
salt processing machine from one source and salt from another,
if the machine fails it will be difficult for the customei~ to
know whether to blame the machine or to blame the salt. 55/
The general principle is that if consumers can evaluate the
adequacy of the combined good or service but not the adequacy
of individual couponents, then purchasing those components
from different sources will make it difficult for consumers
to assign responsibility for'any subsequent product failure.
This, in turn, weakens the incentive for those sellers to
produce components of the optimal quality, since blame for
an untraceable defect will be shared with the producers of
the other components. 56/ If one seller assumes responsibility
for production or selection of all of the components, though,
the market's check on product quality will be restored.
A related difficulty is often cited as a particular
concern in franchise operations. 57/ If a local
franchisee uses shoddy products, consumers may lower
55/ See Bowman, ~ note 3, at 27-28; Posner, supra note 3,
175-76.
56/ See Reich, ~ note, 34, at 16-17. In the terminology
employed by Darby & Karni; ~ note 41, eTen when product
systems as a whole are "experience goods" individual components
of that system are more likely to be "credence goods."
57/ See the authorities cited at note 53. See also
Kentucky Fried Chicken v. Diversified Packaging Corp.,
549 F.2d 368, 375, 38O~-8l (5th Cir. 1977) .
PAGENO="0120"
114
their estimation of the entire franchise operation without
realizing that the poor quality was limited to a single
franchisee. The decline in consumer demand would then be felt
by all franchisees, while the savings from using lower quality
products would accrue entirely to the franchisee who allows
the quality to decline. This externality reduces each
franchisee's inc.entive to invest in quality control, thus
leading to a general decline in quality throughout the
franchisor's sytem. Faced with these misincentives, franchisees
may well prefer to join a system which binds them to maintain
the same level of quality rather than leaving quality decisions
to each franchisee's discretion. ~iandating the purchase of
supplies fron a source selected by the franchisor is one method
of accomplishing this.
As a final point, it should be noted that the benefits
discussed in these last two subsections -- unlike efficiencies
arising out of the production process, discussed earlier -- do
not require that the tied products all be produced by the same
seller. The economies of' selection and evaluation result from
the seller's advantage in monitoring quality and selecting
an appropriate combination, not from any particular advantage
in producing that combination. Integration .would be required
only when the cost of monitoring the quality of independent firms'
output is so high that it is cheaper to control the quality of the
good or service by directly controlling its production.
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D. Efficiency in Allocating Risks
The final reason why customers might actually benefit from
some tying requirements has to do with the allocation of risks
between buyer and seller. This can be the case whenever the
buyer is unsure in advance about the value of the tying
product ~ a new salt processing machine), but the amount of
the tied product that is purchased will depend roughly on the
amount of use the tying product receives. In such a case,
both buyer and seller may prefer to offer the tying product at
an extremely low price, on condition that the buyer agree to
purchase the tied supplies (e.g., the salt) from the same seller
at a slightly above-market price. If the tying product turns
out to be useless, not many supplies, will be purchased, and
the buyer will not have paid as much as if he had paid the full
price for the tying product. Conversely, if the tying product
turns out to be extremely successful then the buyer will end
up purchasing lots of supplies, and will eventually pay the
seller a much larger total. Such an arrangement thus shifts
some of the risks as to the product's value from the buyer of
the product to the seller. 58/ -
58/ It has often been noted that tie-ins can also be used
L~this way even if consumers already know how much the tying
product is worth to them, if those to whom it is worth the most
are also those who will buy the largest amounts of the tied
product. This is the familiar `metering" case, in which there
is no risk to be spread and the tie is simply a method of
price discrimination. However, such a tie will not be desired
by many putchasers of the product (those who are heavy users)
and can only be imposed by a seller with some degree of monopoly
power. See text supra at note 5. Thus, this effect cannot
be analyzed without a full exploration of the use of tie-ins
to exploit monopoly power, a subject which remains beyond the
scope of this paper.
PAGENO="0122"
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Franchise operations may be an area where such risk-sharing
is often desired. For one thing, the franchisor will usually
have much better information about the expected profitability
of one of his franchises, and thus is in a better position
to decide how to valuethat risk. 59/ Even if this is not
the case, the franchisor is in a position to spread the risk
if it is likely that only some franchises will do poorly
and others will do well. A tie-in is not the only method of
spreading this risk, of course; a royalty or any other variable
fee which varied roughly with the franchisee's profitability
would accomplish the same thing. However, tie-ins may have
advantages in ease of application and enforcement -- since it
will always be to the successful franchisee's advantage to
disguise his profits and cheat on the arrangement -- which may
make them preferable to these alternate methods. 60/
59/ The franchi~or can of course attempt to communicate this
cnformation to prospective franchisees, but predictions of
profitability coming from the seller of the franchise will always
be suspect as self-serving puffery. The FTC recently prohibited
such predictions unless the franchisor possesses "material which
constitutes a reasonable basis for such representation" and
makes that material available to the prospective franchisee.
Disclosure Requirements and Prohibitions Concerning Franchising and
Business Opportunity Ventures, 16 CFR §436.1(b) (1980). However,
while this requirement may increase the accuracy and reliability
of such representations when they are made, it also increases
the cost of making them.
60/ For a more detailed analysis of alternate systems, see
Caves & Murphy, sup~a note 53, at 577-81.
PAGENO="0123"
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The allocation of risks, of course, is also involved in
most contract terns criticized as unconscionable. 61/
Disclaimers of warranties shift to consumers the risk that
the product will be defective; harsh default provisions
shift to borrowers some of the risk of loss if they default.
If the manufacturer has better information about those
risks, or is better able to spread them over a larger pool
(or is less risk-averse), then consumers may prefer to pay
the manufacturers to bear them.f or the same reasons that
franchisees preferred to have those risks borne by the
franchisor. However, in some cases the converse may be
true; e.g., if consumers know more about the likelihood of
their default than the lenders do. In addition, such clauses
may also affect the parties' incentives to reduce the relevant
risks, so the risks themselvesmay be larger or smaller
depending on which party is assigned to bear them. Thus,
limiting a warranty may decrease the manufacturer's incentive
to produce a safe product while increasing consumers'
incentives to use the product carefully; extending the warranty
61/ See text and notes supra at notes 44-45; see also the
authorities cited supra at note 36.
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118
may have the opposite effect. 62/ Variations in income may also
be relevant -- e.g., even if the incentive effects balance
out, poor consumers may prefer to be (in effect) self-insurers
rather than paying extra to have the manufacturer assume
certain risks.
In short, the allocation of risk produced by any given contract
clause may produce benefits as well as costs, and it will not
always be clear whether the net effect is good or bad. For
purposes of this section, the important point is that the benefits
as well as the costs must be considered in determining whether
the contractual allocation is in fact undesirable. The implications
this determination carries for the choice of the appropriate
remedy will be discussed in the following section.
62/ These issues are closely related to the issue of whether
strict liability or negligence (or some other standard) is the
most efficient standard in products liability law. For some
recent economic writings on this issue, see A.M. Polinsky,
"Strict Liability vs. Negligence in a Market Setting,
70 Am. Econ. Rev. 363 (1980) (Papers & Proceedings); S. Shavell,
"Strict Liability vs. Negligence," J. Leg. Stud. 1 (1980);
J. Ordover, "Products Liability in Markets with Heterogeneous
Consumers," 8 J. Leg. Stud. 505 (1979); D. Epple & A. Raviv,
"Product Safety: Liability Rules, Market Structure, and Imperfect
Information," 68 Am. Econ. Rev. 80 (1978); J. Brown, "Toward
an Economic Theory of Liability," 2 J. Leg. Stud. 323 (1973).
See also R. Posner, supra note 29, at 134-42; G. Calabresi, The
Cost of Accidents (1970Y~
PAGENO="0125"
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IV. REMEDIES
Just as the analysis of Section I and II was not meant
to imply that tying requirements and other burdensome contracts
are never justified, the analysis of Section III does not mean
that they are always justified. In some cases they may indeed
produce the benefits described in Section III, but in other cases
they may be inefficient behavior made possible only by the
high cost of comparative information'. In these latter cases,
there may still be a ju~tification for iome form of legal
intervention.
The traditional method of intervention has `been a flat
prohibition of the offending clause or practice. Under the
antitrust laws, tying requirements which meet the criteria for
an antitrust violation simply are no longer permitted to be
used, and the same is true of contractual provisions which are
found to be unconscionable. One implication of the analysis
presented here, however, is that it will often be difficult
to tell whether a challenged practice increases or decreases
consumer welfare. The benefits identified in Section III were
all sufficiently general that it will always be possible to
conceive of some efficiency-inc,reasing effect that might be
present. At the same time, consumers are never perfectly in-
formed about any product, so it will always be at least possible
that the contractual provision at issue is the product of this
PAGENO="0126"
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lack of information. 63/ It is conceptually possible to directly
measure all of the costs and benefits associated with a
particular clause or practice to determine whether fully-
informed consumers would prefer its elimination, but in
practice such measurements are so difficult and so subjective
that they rarely yield unequivocal conclusions. 64/ Thus, if
the only policy option is the all-or-nothing choice between
laissez-faire and a flat prohibition, that decision will
always be subject to a rather large cloud of uncertainty.
Another implication of this paper's analysis, though,
is that there may be alternatives to a direct prohibition that
present less of an all-or-nothing choice. In particular, if
the source of the suspected inefficiency is really an information
imperfection, then there may be information-oriented remedies
that would allow the market to correct those practices that
are indeed inefficient while avoiding the unintended disruption
of those that are not. This section of the paper will briefly
survey some of those alternative remedies.
63/ Cf. A. Schwartz & L. Wilde, "Intervening in Markets on the
Basis of Imperfect Information: A Legal and Economic Analysis,"
127 U. Pa'. L. Rev. 630 (1979). The authors there suggest a
methodology for determining when the market price is significantly
distorted from the price that would prevail in a perfect-in-
formation equilibrium. However, they acknowledge that the same
methodology cannot be applied to evaluate contractual provisions,
and simply suggest that legal intervention may be called for if
a "substantial portion" of consumers are not sufficiently "term
conscious." Id. at 661.
64/ See Reich, ~ note 34, at 12-14.
PAGENO="0127"
121
A. Disclosing the Existence of the Practice
The simplest remedy is one which requires sellers to
disclose the existence of the questionable practice. Sellers
who insist on a tying requirement could be required to disclose
that fact clearly and conspicuously in their promotional
materials. 65/ The same could be done for sellers who disclaim
~ll~ liability for physical injury resultin~ fi~om their
product, 66/'or make the customer liable for both sides'
attorneys' fees in the event of any dispute, or insist on any
other provision that might otherwise be banned as unconscionable.
These remhdi~s work (if at all) by reducing the cost
consumers of comparing competing offers. If consumers can
see at a glande which sellers insist on a tie-in and which
do not, then the seller who insists on an inefficient tie will
be much more likely to lose business to sellers with more
favorable contracts, even though the latter may be charging
a higher price. In effect, this remedy restores the market's
check on the terms of trade as well as on price, thus halting
the distorted competition that forced sellers to reduce price
while making up for the reduction with burdensome contract
terms. The obvious advantage of this remedy over an outright
65/ This was the remedy chosen by the FTC in its trade regulation
~le governing franchise relations, cited supra at note 23.
66/ Cf. Uniform Commercial Code §2-376(2) (modifications of
I~plied warranties must be "clear and conspicuous")
PAGENO="0128"
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ban on the burdensome terms is that, if the terms are in fact
efficient ones that cost more to give up than consumers are
willing to pay (i.e., if the legal system is mistaken in its
cost-benefit analysis) , a disclosure remedy would permit the
market to continue using that term while a prohibition would not.
A disclosure remedy also allows different consumers to make
different judgments depending on their individual tastes and
incomes, while a flat prohibition forces the same solution on
all consumers. 67/
However, this does not mean that disclosure of additional
information should always be required by the legal system.
Information is costly to disclose and costly for consumers to
process and use, so if the amount of harm being done by a
given clause or practice is not large then it may not even pay
to disclose the information. In particular, one must consider
the costs of overburdening consumers with too many disclosures,
thus reducing the attention that will be paid to any single
disclosure. 68/ There are, after all, a large number of
contractual requirements that consumers might be interested in.
It may well be true that the contracts are generally too long
and wordy to allow consumers to compare competing offers by
67/ For a more detailed analysis of the advantages of in-
formation remedies, H. Beales, R. Craswell & S. Salop, "The
Efficient Regulation of Consumer Information", Journal of Law &
Economics (October 1981, forthcoming) . See also Consumer
Information Remedies: Policy Session (Federal Trade Commission,
1979)
68/ See Davis, ~ note 32.
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123
reading the contracts -- but it is obviously self-defeating to
require that every provision be given "special" proninence.
Indeed, any conclusion that a given piece of information
is both important to consumers and capable of being effectively
disclosed at a low cost must first face the question of why,
if this is true, that information has not already been disclosed
by coppetitors. The seller who faces a loss of business to
rivals charginc~ lower pr~Lces but using one-sided contract terms
could in principle counteract this by pointing out to consumers
the disadvantages of his rivals' contracts, thus taking it upon
himself to reduce consumers information costs. Admittedly,
the failure of the market to generate such information does not
conclusively establish that the information costs more to produce
than the benefits it would provide. Disclosures about a given
seller's contract may be more efficiently communicated by that
seller than by his rivals, for example, or a government-mandated
disclosure may carry more credibility than an obviously self-
serving advertisement. 69/ However, the failure of the market
to generate such information should at least be taken as strong
evidence that the costs of making an effective disclosure are not
insignificant.
Finally, the disclosure's usefulness to consumers must also
be considered. Merely disclosing the existence of a tie-in
may not be enough if consumers lack sufficient information to
69/ For a more thorough analysis of the market's incentives
to generate information see Beales, Craswell & Salop, supra
note 67.
85-396 0 - 81 - 9
PAGENO="0130"
124
judge how much that requirement will cost them, and to compare
the contract to the offers of competing sellers on that basis.
To judge this, they will have to know how much of the tied
products they are likely to buy, how much they will have to
pay for it, what their alternate sources of the tied products
would have been, and so on. Thus, even though their information
with the disclosure will probably be better than it was without
it, it may still be insufficient for a meaningful comparison.
The same problem arises in dealing with unconscionable
contract provisions. For example, it may do little good to
inform consumers which sellers do not offer warranties, when
they lack the information to compare the likelihood of the
product failing and hence the value to be placed on the
warranty's absence. Similarly, disclosing diagnostician's
potential conflicts of interest may tell consumers little
about the extent to which each exploits that conflict by
prescribing unnecessary repairs. In these situations,
additional information may still be needed to restore the
market's check on seller behavior.
B. Disclosure of the Practice's Costs
A second possibility, then, is to disclose to consumers
the actual costs of the tying requirements or other conditions
imposed by the seller. For example, the Truth-in-Lending Act
requires a disclosure of a finance charge' (expressed as an
annual interest rate) which includes not onlythe interest
PAGENO="0131"
125
but also the cost of any other services the borrower is
required to purchase as a condition of obtaining the loan. 70/
Where such a disclosure is possible, `its advantages over
merely disclosing the existence of such requirements are
considerable. Not only is the, cost information more directly
relevant to consumers; it also has the advantage c~f being
able to be summarized in one or two numerical values rather
than requiring lengthy verbal descriptions of complex contractual
provisions. Numerical va]:ues are usua~.ly easier to communicate
to consumers, and much easief for consumers to Use' in
comp~riri cbmpeting qffers.
However, the costs of this form `of disclosure can also be
considerable. All of the costs discussed in the previous
subsection are relevant here, as is the question of why (if
the costs are low) competitors did not disclose this information~
voluntarily. Moreover, with this remedy the information to
be disclosed cannot be determined simply by examining the
contract. There will also have to be some form of accounting
to determine the actual costs imposed by each of the relevant
provisions, and this can add substantially to the costs of
the disclosure.
70/ 15 U.S.C. §1605 (1976). However, this requirement does
not include the cost of services.such as credit insurance which
are not explictly required but are strongly recommended by
lenders to borrowers who often lack sufficient information
to make an independent decision as to the need for those
services. See Statement of Lewis H. Goldfarb Before The Senate
Committee on Banking, Housing and Urban Affairs, June 14, 1979.
PAGENO="0132"
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In particular, most of the practices which this paper
has addressed involve costs which (a) are not known with
absolute certainty at the time of contracting, and (b) will
not be identical for every customer anyway. The costs of a
tying requirement will depend on the number of tied products
purchased and the price paid for them. The cost of a clause
exculpating a seller from his own negligence will depend on
whether he is negligent and how much damage results if he is;
the cost of a provision making the buyer liable for all
attorneys fees will depend on how many (and what kind of)
disputes arise between the parties. In each case, it is
impossible to know in advance exactly what the total costs of
the arrangement will be.
In some cases, it may still be possible to convey some
information by constructing an estimate of expected costs.
One could identify the characteristics of the average customer
and determine how much that customer would pay under various
contracts, or look to historical data to determine how much
each seller's customers had paid in the past. However, this
sort of measure suffers from the same problems as all
disclosures based on averages or index numbers, both in
terms of increased costs and reduced utility to consumers.
Obviously, not all consumers will experience the average
level of costs, and the identification of certain contracts
as superior for the average buyer may be useless or
even misleading to buyers with differing demands. Average
PAGENO="0133"
127
figures can also be misleading if some sellers have sold
heavily to non-representative groups of customers. For
example, a repair shop with a history of selling expensive
transmission repairs to almost every car it sees may be
engaging in fraudulent diagnoses -- but it may also have a
reputation as a transmission specialist, and thus be attracting
an unusual number of cars with transmission problems. This
does not mean that averages are never useful, of course, for
they may still be better than no information at all. But the
questions of just what sort of average will be the best
predictor of each customer's costs, and whether that prediction
is worth the costS of obtainingit, are very difficult
questions that can only be answered by reference to the facts
of each case.
C. Single-Price Disclosures
A third approach, which still permits sellers to retain
the tying requirement if they choose, is to require the seller
to charge a single price for the entire package of goods and
services. For example, computer sellers could still be
allowed to require that customers also buy their punch cards
from the same firm; they just would not be permitted to
charge a separate price for the punch cards. Instead, the
price for the tied goods would all be included in the price
of the computer -- or, more accurately, in the price of what
would then be called a "computing services package."
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128
* While it may be somewhat misleading to speak of this
approach as ~ "disclo~ur~ remedy, ` it does have some
similarities with the cost disclosures discussed in the
preceding subsection. In effect, this remedy requires the
seller to come up with his own estimate of the expected costs
of the tied goods and services, in order to figure how much
of a charge to add to the price of the tying product. The
result is that the buyer is presented with a single figure
representing the total Gost of th~ seller's cofltract, which
shouid greatly r~duc.e t~ie cost of comparing competing offe~s.
Assuiaing that sellers still compete `on the basis of price,
no seller will be able to add more of a charge than the
compptitive market will allow. At the same time, the seller
is still able to continue the tie-in if it `does in fact
produce net benefits -- ~ if there are quality control
problems which require the seller to select am appropriate
source of punch cards.
One the other hand, there are obvious disadvantages to
this remedy which could easily be prohibitive in many cases.
Paying a single up-front charge for the tied goods and services
means that, once that charge is paid, they become `free goods"
as far as the buyer is concerned. If the buyer is allowed
to control the amount or quality of the tied goods that are
used -- ~ the number of punch cards to be used -- there will
be no incentive for buyers to economize on their use, and they
will end up using larger amounts than would otherwise be
PAGENO="0135"
129
appropriate. In addition, the seller who makes such an offer
will probably attract a disproportionate number of customers
who want large quantities of the tied services, just as "all
you can eat" offers are most advantageous to people with large
appetites. The seller can of course adjust for this, by
raising the initial charge to take account of the. increased
use of the tied products -- but this ,fo~ces all customers to
pay for the higher level of use, thus pricing the package
out of the range of those who would prefer to payonly for
smaller quantities. In effect, this remedy requires the
seller to become a sort of insurer of each buyer's requirements
of the tied product, thus giving rise to the same moral
hazard and adver~e selection problems observed in traditional
insurance markets.
It should also be noted that this arrangement makes it
impossible to use tying requirements to let the seller bear
more of the risk as to the tying product's value. Section III-D
explained how a seller -- a frańchisor, for example -- might
set a low price for the tying product (the franchise itself)
and a high price on certain tied products (items used in the
franchise operation) to reduce the risk faced by the franchisee.
Buyers who did not find the franchise very valuable would
not be doing as much business and thus would not have to buy
as many of the overpriced tying products, and would therefore
pay a lower total amount than buyers whose franchises turned
out to be enormously successful. 71/ However, forcing the
franchisor to collect his entire payment in a s-ingle, up-front
71/ See text and notes at notes 58-60.
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130
charge would obviously prevent this method of risk-
spreading. 72/
Given these drawbacks, it might seem that this approach
to reducing consumer search costs would never be the optimal
one. However, before this remedy is completely discarded, it
should be observed that market institutions occasionally
adopt this approach voluntarily. Health Maintenance Organizations,
for example, usually collect their entire revenue through a
lump-sum price and do not charge separately for whatever
medical care their patients later require. Most warranties
also operate in this way, with buyers paying a single price
for the product plus whatever repair services they turn out
to need during the warranty period. Such arrangements
permit buyers to know in advance the total costs that will
be associated with patronizing each seller, thus facilitating
cost comparisons and providing a check on sellers' ability
to impose inefficient costs. When applied to diagnosis-and-
repair operations -- as in the case of both of the examples
given above -- they also eliminate the incentive to prescribe
unnecessary repairs, as well as strengthening the market's
check on any seller who still does.
72/ This "single-price' remedy is also inapplicable to
traditional unconscionable contract clauses, such as requirements
that tenants confess judgment and pay both sides! attorneys
fees in the event of any dispute. Because such a clause
forces the consumer to bear the risk of possible future costs,
the 6nly way to adopt a "single-price" approach would be
to force that risk back onto the seller and let the seller
raise the price by the appropriate amount. However, this is
precisely what happens when such clauses are banned. The
difference between the single price remedy and an outright
ban thus disappears in unconscionability cases.
PAGENO="0137"
131
In short, there is little that can be said in the abstract
about the general practicability or appropriateness of this remedy.
The particular drawbacks and advantages of such arrangements --
e.g., the extent to which the combined price distorts buyers
incentives -- will obviously vary from case to case, and will
have to be examined on that basis. One would al~o want to
know why sellers had not adopted subh arrangements voluntarily
if they were truly more efficient -- ~ if there were
legalbarriers preventing sellers from combinin9 services in
this way. For purposes of this paper, the most that can be
said is ±ha~ the possibility of such arrangements ought
at l~ast to be considered when evaluating the market's
performance and comparing possible remedies.
D. Prohi7bitions
Finally, having examined various information-oriented
remedies, it should be remarked that a flat prohibition of the
challenged practice may still be the superior remedy in
individual cases. There may be cases where no disclosure
remedy exists that would let consumers make effective
comparisons at a reasonable cost -- always a possibility
if the market is not already providing that information -- and
no practicable way to combine all of the costs associated
with a seller's offer into a single price. In such a case,
where the information imperfection cannot be addressed directly,
a ban would be the most efficient method of remedying the
problem. Certianly this possibility cannot be ruled out
a priori
PAGENO="0138"
132
However, it is worth repeating that a prohibition
only makes consumers better off if one is sure that the
clause being prohibited is in fact inefficient, and
fully informed consumers would willingly pay to be rid of it.
While an information remedy allows parties to continue using
clauses that produce net benefits, prohibiting the clause
forecloses that option. A prohibition is the most restrictive
of all the remedies considered here, and there are therefore
solid grounds for requiring stronger evidence that the practice
is on balance harmful before that remedy is imposed. At a
minimum, a flat prohibition should not be adopted without
first considering the other, less-restrictive options.
Chairman GONZALEZ. Thank you very much, Mr. Stanton.
The subcommittee will stand in recess, in order for the subcom-
mittee to answer the record vote on the floor, but we will allow Mr.
Evans to ask a question which you may answer for the record.
Mr. EVANS of Indiana. Mr. Vartanian, your statement mentions
Bank Board regulations prohibiting the requirement of a particular
title agency. Personally, I question if such a regulation is sufficient
in that the lender has such leverage under the perspective borrow-
er that the inference exists-perhaps through a mere wink of the
eye from the loan officer-that the lender's service corporation
title agency is the one that should be used by the perspective
borrower. Don't you sense any inherent conflict of interest prob-
lems through this type of controlled business arrangement?
[In response to the request of Congressman Evans for additional
information, the following response was received from Mr. Vartan-
ian for inclusion in the record:]
RESPONSE RECEIVED FROM MR. VARTANIAN
I would not contend that a lender in such a position has no potential conflict
between its desire to generate profits by referring business to its controlled title
insurance agency and the interest of a borrower in obtaining the services of a title
insurance agent which are the lowest cost and best value in terms of good service.
In a certain number of cases, those interests will converge; in others, they will not.
However, it is important to recognize that the lender and borrower have very
similar or identical interests in insuring that the provider does high quality work.
Thus, the lender has every incentive to insist on a reliable title search and evalua-
tion to ensure the security for its loans and access to the secondary mortgage
market. The lender also has an incentive to ensure that its controlled subsidiary
provides service which is a good value because a consumer dissatisfied with the
referral is less likely to return to the same lender for other financial services.
[Recess.]
Chairman GONZALEZ. The subcommittee will please come to
order.
I had one question for Mr. Vartanian. On page 9 of your state-
ment you say "Moreover a number of savings and loans comment-
ing on a proposed rule noted that the performance of settlement
PAGENO="0139"
133
services by their service corporations is an important source of
revenue. This is particularly true at present when profits on loan
portfolios are generally low." Given the obviously dire financial
straits of many savings and loans, wouldn't it be rather tempting
for a lender to refer a consumer to a subsidiary whose income will
raise the profitability of the savings and loan before he has re-
ferred a consumer to a competitor who provide better service?
Wouldn't that be a risk?
Mr. VARTANIAN. Well, if you're asking me if that temptation
exists, I can't deny that that temptation exists. What I would have
to say is that there is probably no industry in this country that is
more regulated than the savings and loan industry. The constant
perusal and constant examination that the savings and loan indus-
try goes through, I think, is incentive enough to make sure that
that does not occur on a basis that would be damaging to the
consumer.
Chairman GONZALEZ. Well, I think that depends on a couple of
factors. One, is such a thing as a title insurance all that important?
And, two, with the other things being recommended, such as the
repeal of the kickback section and all, then what seems to be a
temptation may become more than a reality.
There is also a question regarding the extent to which these
institutions will be regulated, given the present move toward de-
regulation. What will be considered overregulation and what isn't?
Where is the line of demarcation between the carrying out of the
congressional intent and the independence of the regulatory agen-
cies?
But in a time where you also have this tremendous chaotic
erosion of what up till now has been a traditional differentiation
between the various financial institutions, and especially* since the
enactment of the so-called "Bank Deregulatory Act," we are in the
midst of a real crisis. And some of this has been done in the name
of deregulation and has been brought about because, as always,
when you have competing interests, without regulatory control, the
law of the jungle will prevail.
It just seemed to me, though, that if the recommendations made
by the HUD official this morning were approved, the basic purpose
of RESPA would be threatened.
What opposition would you have to permitting savings and loans
and realtors to own service corporations such as title agencies, but
prohibiting them from referring their clients to such agencies, thus
avoiding conflict of interest, or what would appear to be conflict of
interest?
Mr. VARTANIAN. Mr. Chairman, I think that gets at the point of
my statement, that point basically being that there should be and
there is no assumption that the controlled business process that is
going on right now in the provision of settlement services, especial-
ly title insurance, is, in fact, not the best means for that process to
work under the circumstances it is now working under.
I think the Peat, Marwick & Mitchell study and the HUD study
both indicate that, in fact, it may be the cheapest way of providing
that service. And that is particularly because we are dealing in a
nonclassical mode of reverse competition. If, in fact, we were not
dealing in that nonclassical mode of reverse competition, there
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might be certain ways of dealing with the controlled business prob-
lem that would differentiate it from what we're doing right now.
But given the fact that the normal monopoly, oligopoly, and
other traditional standard antitrust provisions do not apply to the
situation we have currently facing us, we are dealing very much
with a quality service. Given those circumstances and given the
absence of any empirical evidence otherwise, I don't think it is fair
to assume that the controlled business structure that is currently
in place is a necessary evil.
Chairman GONZALEZ. Mr. Carman?
Mr. CARMAN. Thank you, Mr. Chairman.
I would like to make a couple of comments, if I can, Mr. Stanton,
just for the record. I appreciate your testimony and I mentioned to
you at the break two concerns and just two observations that I
would make from a pragmatic point of view, understanding from
the committee's vantage point certain items that I think are impor-
tant. On page 6 of your testimony you seem to allude that the
consumer has more power in dealing with a bank than perhaps
with the title company or lending institution.
It occurs to me that in many instances, at least in my own
experience as a private practitioner of law, that I found and still
find that a lawyer who the consumer has hired, if he hires a
lawyer or broker or someone else who is going to process a loan,
processes the real transaction on his behalf and presents it on his
behalf, will have a greater degree of leverage with the title compa-
ny, because that individual lawyer or agent or whoever he's going
to be will be dealing again and again with that title company. And
therefore, we have exceptions on the title policy that need to be
corrected, where we need special accommodations. In many cases,
the lawyer on behalf of the consumer will be in a position to have
greater effect in dealing with the title company.
The same individual agent or lawyer will have less, in my experi-
ence, of a practical impact in dealing with a lending institution,
unless he is controlling substantial sums of money coming into that
lending institution where, of course, he is able to effect a different
accommodation, such as their business, which is a reality that
exists in the market. But I would be inclined to think that as a
general proposition the consumer has, in many cases, not the kind
of economic impact that one would think in dealing with a large
lending institution.
Anybody can answer that, if they would like to.
Mr. STANTON. I guess, basically, I agree with what you are
saying; however, in a number of transactions, that attorney may
not be representing the consumer in the transaction and may be an
attorney representing the bank.
Mr. CARMAN. I would agree with that totally, if the lending
institution-presumably it does in many instances, certainly, in the
Northeast and Middle Atlantic States, as you properly pointed out,
and frankly, in some places elsewhere-is representing one client
with another; if he is representing the lending institution, he is
certainly not representing the individual consumer. Hopefully, de-
pending upon the nature of the transaction, the individual consum-
er would understand that he is caught not only in a transaction
with the lending institution, but in addition to that, a transaction
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with the person from whom he's buying the property, where he
could have a significant legal, as well as business considerations,
that he might want to take into account.
If a person chooses not to use a physician when he goes to the
hospital, I guess that is his prerogative. You can't do that for
everybody. If someone wants to operate on himself, as they say, I
guess he can. Certainly, after a certain amount of time he would
wise up and get someone who could help him in regard to that.
I mean, I don't think we disagree, but I'm just saying that I
think it is important to draw that particular distinction.
On page 8 of your testimony-and by the way, I think your
testimony was very explicit and proper in its presentation, and so
forth, but I do think something is extremely important to under-
stand. You indicate here, "Indeed, consumers should be able to
receive information by the telephone." And there's no question in
my mind that consumers should be able to receive information by
the telephone or by word of mouth.
The trouble with that in the marketplace is that everyone who is
dealing with a lender, be it a title company or anybody else,
because of business experience, which is one of the reasons why I
suspect we have some of the statutes on frauds, insist that these
types of things be placed in writing. Unhappily, we end up with a
lack of understanding sometimes or perhaps a clerk or someone
else does not convey the information properly, or the individual
who receives it may not be skilled in these transactions and does
not understand it properly. As a result of that, while we would like
to think that everybody could properly be informed of a transac-
tion, it's important to recognize that at least from my point of
view, I think we would not want to adopt this policy that we would
be giving people information in a controlled form, because I think
if we do, we will end up with very unhappy results which would
necessitate further studies.
Mr. STANTON. Thank you, sir. We appreciate that. The thrust of
our argument here was that if we are allowing a bundling of
services, we can't afford a provider to offer, say, an artificially low
mortgage rate to a consumer, without disclosing the fact that title
insurance will be required in the bundle of services and then
making it up through higher fees for the required title services
that the consumer might discover too late.
What we were getting at is, the need to disclose up front to the
consumer any requirements, the whole bundle of services and how
much that whole bundle will cost, so the consumer can still stop.
I appreciate completely your point that some of our discussions
of pragmatics may need refining.
Mr. CARMAN. Yes. And I think especially in light of the fact that
this is such a substantial transaction for the average family, that,
of course, that should be taken into account.
There was a question before that the chairman asked in regard
to title insurance, whether or not lending institutions should own
title policies on one side or title insurance companies and have
abstract companies, and so forth, and yet not use them in their
own lending institutions.
I would just make this comment myself on something that I
could foresee being a problem in that area which would be that you
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people send all of our title insurance over to my company, and I
will send all of my title insurance over to your lending institution.
And it occurs to me that it is possible that abuses could occur in
that kind of a situation. That is one of the reasons why we have
regulations precluding, for example, directors in various lending
institutions from referring business to their private insurance com-
panies and various other types of institutions.
I would think that probably as a general proposition we might
not want to contemplate that, as a general overall policy.
I am concerned about your recommendation, Mr. Stanton, that
the emergence of controlled businesses should be permitted. The
transaction involving the purchase of a single-family dwelling,
which is essentially speaking, I think what we are talking about
here. I'm not talking about a commercial transaction with someone
buying a two- or three- or four-family home, something of that
nature, but a transaction that an individual is involved in, perhaps
once in his lifetime and maybe two, three or four times in his
lifetime, depending upon whether or not we are able to, in the next
10 years provide any mortgage monies for anybody, I think we
should be very, very concerned about the problem I just alluded to
a few moments ago, if I own the one title insurance company, and
I'm a lending institution, and you own the other title company
with your lending institution, I could see all kinds of good current
going back and forth here with very rigged results in cost that
would be very undesirable, it seems to me, from a public policy
point of view.
I think that the more we are able to have open competition, the
better off we're going to be, and that's not to say we haven't had
abuses in the past, because we have, and we all know that. But the
implementation of the conflict of interest regulations, if you will
pardon the expression, in some of the places we've had them,
certainly have underlined the importance of avoiding those.
Virtually every single lending institution in this country is regu-
lated by the Federal Government, directly or indirectly, through
the use of the FDIC and the FSLIC and a multitude of other efforts
that we have, so that I am really very, very concerned about the
proposal that we somehow solve everybody's problems by having
just a smaller group of control, if I'm understanding you properly
here. A group of controlled businesses, if I'm understanding you,
and maybe I'm not.
Mr. STANTON. In contrast to the HUD recommendation at least
for consideration of the lender packaging, what we are saying is
that controlled businesses should be allowed. That does not say
that they should not face competition from service providers such
as title companies and others who do not offer a bundle of services.
That would be a fundamental distinction between our testimony
and that of HUD.
Mr. CARMAN. So that, for example, if I understand you, what
you're indicating is not that they have to be or that's the only way,
but what you're saying is that if a particular institution wishes to
provide these multitude of services as part of its overall present-
ment, it should be allowed to do it, if it wishes so to do.
Mr. STANTON. Yes, sir.
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Mr. CARMAN. I appreciate that clarification. Thank you very
much, Mr. Chairman.
Chairman GONZALEZ. Thank you, Mr. Carman. Mr. Patterson?
Mr. PATTERSON. Thank you, Mr. Chairman.
I would like to ask Mr. Vartanian if you have at the Bank Board
any statistics that would indicate the percentage or portion of title
insurance business which is now generated by lenders who own
title companies?
Mr. VARTANIAN. We don't, Mr. Patterson.
Mr. PATTERSON. Could you go back and get it?
Mr. VARTANIAN. If we could get it, I would be glad to give it to
you, but I don't think we could extrapolate that information from
our records.
Mr. PATTERSON. Do you know what percentage of institutions
that ~ou regulate have service corporations or who have title agen-
cies?
Mr. VARTANIAN. It is our impression that the number is 83.
Eighty-three savings and loan associations have service organiza-
tions that own title insurance agencies.
Mr. PATTERSON. By "own," do you mean wholly owned or partial-
ly, or would that indicate any ownership interest, or does that
mean that they actually own the whole title company?
Mr. VARTANIAN. That would be any ownership interest at all in a
service corporation.
Mr. PATTERSON. This packaging concept that was presented by
HUD this morning and upon which you commented seems to me to
be kind of a great thing to help bale out the savings and loans, in
terms of creating profit centers for them, if it is mandatory. If it is
voluntary, it seems to me it is a great opportunity for them to
continue to do what they may now do. And I would like to ask you
your opinion, assuming we moved in that direction. Do you think
mandatory is the way to go or voluntary?
Mr. VARTANIAN. Well, as I said, we've only had 5 days to think
about this concept of lender packaging that was proposed by the
Housing and Urban Development Department, but I think that if,
in fact, that was to be a consideration by Congress, it would seem
to be that a mandatory requirement would, in fact, lend itself more
to a position of equity among all people providing services rather
than leaving the question open as to who will advertise their
services and prices and who will not.
Mr. PATTERSON. I thought our testimony was, you would like to
see the imposition of the rule basically repealed by HUD; is that
correct or was that Mr. Stanton?
Mr. VARTANIAN. I think we're talking about two different rules.
What you just asked me, I thought, was a question dealing with the
proposal for lender packaging--
Mr. PATTERSON. Right.
Mr. VARTANIAN. Which has just been proposed September 10.
The rule that I was discussing in my testimony, which I was
requesting the repeal of, was an interpretative ruling issued by
HUD, indicating that the receipt of dividends from a wholly owned
or partially owned service corporation providing title insurance
work or other work for a settlement lender was a thing of value
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and, therefore, may-and the word "may" was used-may be a
violation of RESPA.
Mr. PATTERSON. So you would just as soon see that repealed and
forget the packaging; is that it? The mandatory packaging?
Mr. VARTANIAN. Well, yes, until we've had some time to think
about the packaging concept. I can envision, I guess, times when
the packaging concept would lend itself to abuses as much as
anything else, and I think at the Bank Board we are very much in
favor of getting at the root of the problem, and that is the reverse
competition problem. Consumers are not now being involved in the
process, either by choice or by the way the process has evolved
historically.
And I would point out once again that the controlled business
problem is not the result, but it is-excuse me, it is the result but
not the cause of the historic absence of price competition in the
title insurance business.
Mr. PATTERSON. And you feel what else should be done besides
HUD dropping its interpretative rule, in order to make sure that
the reverse competition-in order to make sure that there is com-
petition?
Mr. VARTANIAN. Well, I think we would prefer the kind of ap-
proach the Bank Board has taken in many other areas, for in-
stance, the adjustable mortgage loan, in trying to bridge the gap
between letting the market work by itself and giving the consumer
the adequate protection that he needs. And that is something that
is a difficult question to answer. How much disclosure do we give?
Thus we started with truth in lending, which ended up with
overdisclosure and people are now saying that RESPA is causing
the same problem, but if you are going to let the market work to
the extent that it can possibly work and still try to provide the
consumer with some sort of protection, it seems to me that disclo-
sure, some form of limited optimal disclosure, is the answer to that
question.
Mr. PATTERSON. I suggested that to the prior witness. More dis-
closure at an earlier opportunity. In other words, so that if some-
body may be buying a home in 6 months or so from now, can
obtain data that obviously will be somewhat out of date, but at
least shop around and look at who does what, in the practice over
time and perhaps conclude where they want to do their shopping
for the purpose of a home and the services that go along with that.
So you would generally think that might be a good idea?
Mr. VARTANIAN. I think that disclosure is. I think it would be of
benefit to the consumer and still allow the market to work in some
competitive fashion.
Mr. PATTERSON. Mr. Stanton, you talked about an interest in, I
think it was a watch. When you go buy a watch, you don't really
trust the retailer or somebody, the manufacturer, I'm not sure who,
rather than the chips involved. And I suppose that is true. It is
kind of a vertical integration. In other words, you're not going out
and buying the components and then take it to a watchmaker and
say, "OK, now build me a watch."
But I really wonder if it is the same thing. It seems to me, we
are comparing apples and oranges. When you buy a home, the
parties are not in a vertical line, at least not yet. You're talking
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about a buyer and a seller with arm's-length differences. And
you're talking about, perhaps, two realtors, one on the buyer's side
and one on the seller's side, so to speak, both of whom will gain if
they can close the deal between the buyer and the seller. And
you're talking about various lenders who may or may not offer
packages now and attorneys and others engaged in the business.
There is a lot of, it seems to me, opportunity for competition if
there aren't controlled businesses. And yet you compared what I
think is a more complex real estate transaction, that you do it less
often, and it is a much more important thing, and you don't have
any-the lender doesn't give any guarantees. Nobody gives you a
guarantee when you buy a house hardly these days or ever. So you
are basically buying what you feel you want, and if something goes
wrong, it isn't like you take the watch back. You've got the house,
and it's all yours.
How do you reason that out and say, "Let's just deregulate the
whole thing"?
Mr. BROWN. Mr. Patterson, if I could respond to that question,
certainly it is one that we have anticipated and are concerned
about because it is a very serious and difficult issue.
If we were to take something of a historical perspective and go
back to the beginnings of, for example, the high fidelity industry or
the digital watch industry, we would find a variety of suppliers
scattered around the world and having difficulties getting to the
consumer.
The fact of the matter is, though, that marketing devices,
modern marketing devices-department stores, name brands, have
gone a long way to solve those problems. I don't understand what
goes on inside a high fidelity amplifier, but I can go out and buy a
Pioneer at a local store, and I have a significant degree of confi-
dence that those products are going to meet my needs, even though
they are extraordinarily complicated and arcane.
Now a lot of that comes about from the fact that I can shop for a
variety of goods from those providers. They are terribly interested
in maintaining their reputations with me on a broad area of sales.
Mr. PATTERSON. But that is the very problem. You don't have a
broad competition. You know, you do with watches; you don't with
real estate. As a matter of fadt, if you want to buy that home, it is
that home, for whatever reason, and everything goes into how you
buy that home as cheaply as possible and the transactions that the
buyer and the seller in some cases can bring about to bring down
the price of the home.
Mr. STANTON. Congressman Patterson, the history of RESPA
demonstrates the dangers of underestimating the complexity of the
real estate industry. I guess our argument about competition is
simply to allow controlled companies, if they can do it cheaper and
offer a lower price for similar quality services to participate in that
range of competition to provide their services and not artifically,
without a very strong reason for it, to prohibit those controlled
companies from giving it their best shot.
Mr. PATTERSON. What do you think about the mandatory packag-
ing by lenders of all of these services?
Mr. BROWN. Well, as we said in our testimony on page 6 in a
footnote, our view is that there should be a strong burden of proof
85-396 0 - 81 - 10
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on those who advocate making it mandatory. We are optimistic
that it is `a good idea, but we may be wrong. And I think it is good
when you are wrong to allow mistakes to simply die quietly.
Mr. STANTON. One of the lynchpins of the mandatory approach is
that there is serious competition for interest rates. That issue must
be tested, particularly with the emergence of new kinds of mort-
gages, variable rate mortgages, and many other problems of infor-
mation overload in an area where it is already well documented
that consumers have difficulty utilizing the information available.
For that reason, I think we have to look very carefully at the
mandatory lender-pay concept to see whether, in fact, the real
benefits will emerge. We would be pleased to undertake that kind
of analysis. We were instructed for these hearings not to explore
lender-pay because the HUD report simply wasn't available to us.
Mr. PATTERSON. Maybe I would like to ask each of our panelists
what they think about disclosure of the lender's financial interest
in the settlement service that they provide. In other words, if they
are going to be the provider, do you believe that, in fact, the
lending institution should disclose their financial interest in a serv-
ice provider if they are in the business, if they are going to refer, if
they're going to make any referrals at all? Should they say, "We
have a financial interest" in X and Y service providers?
Mr. BROWN. Mr. Patterson, I will start. It seems to me that the
principles here are clear, and the practicalities are fabulously more
complex. The principles-when these people who make referrals
hold themselves out as giving honest referrals, it seems to me that
their fiduciary responsibility or something like fiduciary responsi-
bility would require them to disclose their relationships. How that
works out in practice is always going to be a very difficult problem.
How you disclose the fact that you have dinner with somebody
regularly, that you have some kind of close relationship and where
the line is, is almost going to be very difficult to do.
Chairman GONZALEZ. Will the gentleman yield at that point?
Mr. PATTERSON. Certainly.
Chairman GONZALEZ. Because our understanding is that the
HUD regulations presently provide for that. Where the lender
requires that a particular provider or affiliate group of providers
be used to provide such services, the consumer must be provided
with the name and address and telephone number of each provider
designated, the services which will be rendered by such provider, a
statement whether or not each such provider has a business rela-
tionship with the lender.
Mr. PATTERSON. Mr. Chairman, I understand that. I guess what
I'm trying to get at is, when should they disclose that? It is usually
disclosed after the deal is over.
Chairman GONZALEZ. I think the gentleman has hit the nail on
the head, like he did earlier, except he was saying, "Why not let
the lender issue the booklet?" The HUD official is talking about
the inconsequentiality of the information, the plethora of informa-
tion which was drowning the poor consumer. The truth is that
there is nothing wrong with that. It is the time at which the
purchaser is being offered the information that is critical.
And the question that I thought I would follow up with is, Why
not have, say, the realtor provide the information-not just the
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lender but the realtor-at a proper time, before the consummation
of the transaction and before the opportunity of the purchaser to
shop around had passed by?
Mr. PATTERSON. Mr. Chairman, I think that is exactly what I was
driving at.
Chairman GONZALEZ. You are absolutely correct. I think you've
hit the nail on the head.
Pardon the interruption, but I did think that Mr. Valanzano had
made a very valid point that the disclosure is already provided for
in HUD's rules.
Mr. PATTERSON. It is. The point at which it comes, there have
been a lot of analogies to doctors today and who operates on who
and whether you trust the operating physician, sur~eon, or wheth-
er you go get your own anesthesiologist, I suppose. I m not sure the
analogy is the same.
Chairman GONZALEZ. There, again, I think the analogies that
have been made here have been kind of atrocious. Let me tell you
that in the field of medical delivery and care, that has been a
scandal. I think the FTC ought to look into that, because the
anesthesiologists and the hospital boards were all on our necks just
2 or 3 years ago because of that abuse-controlled businesses lead-
ing to monopolisitic practices. Then the analogy to Sears is also
faulty.
Well, everybody knows that the Allstate Insurance Co. is Sears.
But this isn't true in the kind of business that we're talking about.
The purchaser doesn't know whether the lender or realtor whose
advice he is seeking is also part owner of the title insurance
company recommended by the lender or realtor.
Mr. STANTON. Mr. Chairman, if I might respond, as the sponsor
of one of those atrocious examples, the example of Sears is not
farfetched. They have already entered the real estate brokerage
industry. Merrill Lynch, which has a very big consumer reputation,
has also entered the real estate brokerage industry.
We are noting now with some anguish the entry of financial
institutions from other sectors, essentially competing against the
housing industry. We are in a process of watching entry from other
sectors of the economy to the real estate industry. We contend in
our statement that we should allow controlled businesses. We note
for the record that they are relatively few at this stage of the game
but they should be permitted simply because there may be efficien-
cies that should be utilized in competition.
I would anticipate that major gains along the department store
line that we were talking about would occur if department stores
were also to enter settlement services and not just real estate
brokerage.
Chairman GONZALEZ. Mr. Stanton-and again, I would ask if the
gentleman would further yield. There, again, Mr. Stanton, your
recommendations seem to be in contradiction with the antitrust
policy of the Attorney General of the United States. I quote from
"The Pricing and Marketing of Insurance-A Report of the Depart-
ment of Justice to the Task Group on Antitrust Immunities" which
Mr. Lowery referred to earlier. The study states:
To sum up the major evils of controlled title companies where a real estate
settlement producer is able to direct the purchaser of a title insurance policy to a
particular title company and at the same time that producer owns the title compa-
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fly, the purchaser is likely to end up, one, paying unreasonably high premiums; two,
accepting unusually poor service; or three, accepting faulty title examinations and
policies from the controlled title company.
How do you reconcile that?
Mr. STANTON. Let me start with the Justice Department study of
1977. I have read it carefully. We simply contend that one must
look not only at the price of, say, title insurance but also at the
total price of the total package, say, interest rates plus title insur-
ance. One must make a pragmatic examination, is that overall
price lower than, say, where an independent lender and an inde-
pendent title company offer the same services?
It is simply analytically not valid to look only at the price of title
services in both cases.
Chairman GONZALEZ. Gee, I wish you hadn't referred to interest
rates because, you know, the spiggot is wide open there. But I
thank you very much, and that does respond to my question.
Mr. PATTERSON. I would yield back the balance of my time.
Chairman GONZALEZ. Thank you, Mr. Patterson. And let me say
that we are deeply grateful for the time you have given us, and we
apologize for keeping you over the noon period. However, your
presentation and testimony is very valuable. And this is of great
value to us because what we are doing is reviewing the RESPA
law, and also HUD's evaluation and its interpretation.
And what we had from HUD this morning was what I consider
to be a rather strange interpretation of congressional intent. But
that is exactly what we need to know, and we are very grateful.
We do have some questions for the record.
Mr. LOWERY. Mr. Vartanian, in the June 1981 Federal Home
Loan Bank Board Journal an article appeared entitled, "The
Impact of Title Insurance and Controlled Business on the S. & L.
Industry." The article stated:
A controlled business relationship tends to create a situation in which one provid-
er has an assured source of business, regardless of its price or quality of its services.
In such a situation, it may be unrealistic to believe that consumers will get fair
value for their money.
Would you comment on that point?
COMMENT RECEIVED FROM Mn. VARTANIAN
We acknowledge that the controlled business relationship creates the potential for
a situation where a consumer does not get a hypothetical "best value." In reality,
however, there have been no empirical studies which support the conclusion that, as
a general matter, controlled agencies provide lower quality work at higher prices
than their independent counterparts. For example, the only documented instance of
higher settlement costs linked to a controlled business arrangement involved the
Coldwell Banker corporation.
According to the 1980 Peat, Marwick, Mitchell & Co. (PMM) study, Coldwell
Banker, a large brokerage firm in California, attempted to set up its own title
company, Guardian Title Company. Coldwell Banker already owned an escrow
company which, according to evidence presented at the Guardian application hear-
ing, charged 50 percent more than competitors. We do not dispute the finding that
the broker-owned escrow company in this case had higher prices than average in
the area. We also acknowledge the PMM study's conclusion that the possibility that
such market imperfections would continue to exist on a long-term basis is strong
because of the assured flow of business from the broker.
It should be pointed out, however, that the Coldwell Banker case was the only
documented instance of higher settlement costs linked to a controlled business
arrangement found by the PMM study or cited by ALTA's 1979 study of the
controlled business "problem" in the title insurance industry. Overall, the PMM
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study still concluded that there was insufficient empirical data to establish whether
or not controlled business arrangements have an adverse effect on settlement prices.
Additionally, HUD's report to Congress on RESPA explicitly labeled this argu-
ment unpersuasive and found that generally, the prices of title insurance have
remained constant at the same uniform percentage level, regardless of whether the
insurance was sold through an independent or "controlled" title company. HUD also
found that there was reason to believe that controlled business relationships are
economically efficient and could lead to reduced costs for consumers if freely al-
lowed. Finally, HUD noted that in at least one instance, an S&L service corporation
was performing private mortgage insurance services with lower costs than other
providers.
As to quality of service, as I pointed out in my full statement submitted to the
subcommittee, lenders have strong incentives to ensure high quality of work in
order to protect the security of their loans and access to the secondary market.
Moreover, there are no comprehensive studies indicating that controlled businesses
actually provide lesser quality title insurance work than independent service provid-
ers.
Mr. LOWERY. Section 8(c) of RESPA provides an exemption where
the payment is for "goods or facilities actually furnished."
Couldn't the term "goods" be read to cover capital contributions
and thus exempt wholly or even partially owned subsidiaries from
section 8's prohibitions?
RESPONSE RECEIVED FROM MR. VARTANIAN
There is nothing in the legislative history of section 8(c) which clearly indicates
that such "goods" include or exclude capital contributions. In other respects, the
legislative history of section 8(c) indicates that the exception is intended to permit
the payment by title insurance companies, attorneys, lenders and others for goods
furnished, so long as the payment bears a reasonable relationship to the value of
the goods or services received by the person or company making the payment. If the
payment is in excess of the reasonable value of the goods provided, the excess could
be considered a kickback or referral fee proscribed by section 8(a). S. Rep. No. 866,
93d Cong., 2d Sess. 6 (1974).
Thus, a reasonable interpretation would be that no illegal kickback occurs when
dividends generated by a controlled title agency bear a reasonable relation to the
capital contribution made by the parent corporation. However, this interpretation
would not protect controlled agency relationships if profits exceeded such capital
contributions and precluded a finding of a reasonable correlation between the two.
In view of this problem, the Bank Board would welcome a clarification of Congres-
sional intent as to the scope of section 8(a), which the Bank Board's legal staff has
concluded does not cover dividends or profits generated by a controlled business.
Our staffs reasoning is described in greater detail in my full statement to the
subcommittee.
[The following additional written questions were submitted to Dr.
Savas and appear with his answers:]
QUESTIONS SUBMITTED BY CHAIRMAN GONZALEZ
Question. During the 5 years RESPA has been in effect, the Department of justice
has yet to prosecute a for prosecution? Would you describe those cases and why
Justice declined to prosecute? Have any private causes of action been filed? Why?
Answer. You should be aware that, while the Department of Justice (DOJ) has
been largely inactive in the section 8 area, two U.S. attorneys' offices have prosecut-
ed five individuals and obtained convictions or pleas in all cases. However, four
cases involved payments recieved by title registrar clerks in Cook County, Illinois
and provide limited programmatic benefit either in the deterrent or the interpreta-
tion area. The other case involved credit and appraisal fees and total payments of
less than $120.
HUD has investigated and referred numerous cases to the Department of Justice
over the past six years. While precise records were not maintained in earlier years,
our review indicates that at least 60 complaint files have been established by our
Office of Inspector General (OIG) and more than 25 cases referred to DOJ for
prosecution. (HUD's OIG generally investigates section 8 complaints pursuant to an
agreement between HUD, DOJ, and the FBI.)
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Descriptions of each case would be voluminous. The cases involved almost every
settlement service provider. The most frequent alleged payors were title agencies!
underwriters. A number of controlled business complaints were recieved with most
involving title insurance.
We are aware of no case referred by JUD to DOJ which was declined because
DOJ disagreed with our determination that a violation was present. Nevertheless,
no case referred to DOJ by HUD has been accepted for prosecution. The stated
reasons for rejection are: lacks jury appeal; does not increase consumer costs;
coercion was not used to force consumers to choose the provider; administrative
sanctions were preferred by DOJ. It seems clear that there are at least four
important underlying reasons for a lack of a substantive prosecution: First, section 8
is a white collar crime with a misdemeanor sanction; second, it generally invloves a
complicated fact situation requiring extensive work; third, the offense is difficult for
a typical jury to relate to; further, a number of prosecutors, as the above stated
grounds indicate, don't understand the elements or the policy of the statute.
We are aware of only two or three private causes of action based in whole or in
part on section 8. These have been instigated by harmed real estage professionals
and only nominally involved consumers. The reason for the lack of consumer action
appears to be the result of consumers being unaware of their rights or the fact that
kickbacks were paid. Moreover, the amounts involved in individual cases do not
usually warrant instituting suit.
Question 2. Has any analysis been completed on the impact of a consumer's ability
to shop for settlement services if they were able to get relevant settlement service
cost information disclosed earlier than 24 hours before settlement or moment of
settlement itself'? Didn't the Peat, Marwick & Mitchell study recommend the best
point in time to provide consumers the HUD information booklet was when they
first contacted a realtor? Didn't the PPM study also recommend that the informa-
tion booklet would be more helpful to consumers if different versions were available
in different areas of the country where specific settlement practices vary? Why
didn't HUD propose those recommendations?
Answer. The Peat, Marwick, Mitchell and Company (PMM) recommendations
presume the continuation of RESPA and, consequently, concentrate on improving
the focus of that law. HUD's recommendation, on the other hand, starts at a zero
base as if no settlement market legislation exists and proceeds to develop the least
regulatory and most effective approach given present knowledge and understanding.
Even with that diverse beginning, the purposes of each recommendation aim at the
same point-consumer information gathering is too little and too late to provide
adequate assistance. PMM misses the mark, however, by asserting changes in
disclosure and increases in information will cure the problem. Without a guarantee
that various estimates for closing are, in fact, firm, disclosure at any advanced stage
still does not encourge shopping or a competitive market in ancillary services. The
key rests not simply on an earlier estimate but on the consumer's ability to use a
firm quote as a comparison and the lender's ability to compete based on information
available to all parties.
QUESTION SUBMITFED BY CONGRESSMAN CARMAN
Question. In response to a previous question, you indicated that HUD had found
evidence that controlled business relationships had the effect of actually reducing
closing costs. This statement appears to contradict actual case histories and testimo-
nies received by the Subcommittee from the Title Insurance witnesses.
I would greatly appreciate your submission for the hearing record of specific and
documented data and aggregates your studies have found to support your statement,
especially the variability and range of costs for required settlement services and
comparisons for such costs between controlled businesses and independent service
providers.
Answer. My previous statements have referred to the possibility that a controlled
business could reduce prices to the consumer. I stated, for instance, that where
controlled business is an efficient means of conducting settlements, it can contribute
to lower cost. We don't believe that the controlled business phenomena has surfaced
in all cases as a direct result of RESPA and Section 8. We believe that operation of
ancillary service companies can be efficient from the standpoint of the parent
company and the efficiencies can be passed to the consumer. At the same time, a
danger exists when purchase of these ancillary services is secondary to the immedi-
ate decision as in the case of a house purchase and the myriad services necessary.
HUD's position, therefore, that controlled businesses fall in the same category as
kickbacks rests on the potential danger in settlement markets for consumers to base
their choice on factors other than the price of a service from a controlled business.
Likewise, because these operations can be the result of efficient economies of size
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where several firms use the same "well" if you will, the Department feels they
should be allowed but with some sort of safety to prohibit the abuse of consumers.
The safety is a competitive market place with full and equal information available
to all parties. The Department recommends serious consideration of lender packag-
ing as satisfying these requirements.
As far as your request for hard evidence, we have no comparisons of costs
between controlled and independent service providers because the ownership and
stock division of ancillary companies is too expensive and too difficult to obtain. The
report's suppositions and conclusions about the settlement market depend on a basic
evaluation of the existing practices and our professional judgments as to what
makes this market different from all others.
I submit that the anecdotal evidence submitted by the title insurance industry to
the Committee does not prove that controlled business arrangements necessarily
raise consumer costs. A most important remark brought out in our report and by
Dr. Debra Ford in her testimony highlights the diversity of ways that title search
and insurance is conducted in this country. It is, therefore, improper, and moreover,
misleading to compare individual components of this service without addressing
what final settlement costs are.
Chairman GONZALEZ. The subcommittee will stand in recess until
2 p.m. And we do have some industry witnesses that will be very
important because it will give us a chance to hear from the people
that are the most directly involved.
The witnesses will include Mr. James L. Boren, Jr., who is presi-
dent of the Mid-South Title Insurance Corp. of Memphis, Tenn.;
Mr. Gerald Peck of Carle Plaōe, N.Y.; president of the Continental
Abstract Corp., Ms. Clyda Guggenberger, president of the Valley
Title Co., San Jose, Calif.; Mr. Richard Bossard, president of the
Title Co. of Billings, Mont.; and Mr. Stephen Daley, president of
the Intercounty Title Co. of Illinois, Chicago, Ill. So that is a wide
range of geographical representation of the industry, and we hope
everybody can come back.
Thank you very much.
[Whereupon, at 1 p.m., the hearing was recessed, to reconvene at
2 p.m. this same day.]
AFTERNOON SESSION
Chairman GONZALEZ. The subcommittee will come to order. We
will just consider this a continuation of the morning hearing.
Therefore, the usual rule of having to have at least one additional
member present doesn't have to be strictly followed under the
circumstances.
As we announced earlier in the day, we are delighted to have
you. We announced your identify earlier, and I think it is very
good that you come from all points of this country: North, East,
South, and West. We deeply appreciate the time and the sacrifice
coming here entailed. Particularly we wanted to thank you for
having prepared your testimony and provding the subcommittee at
least 48 hours' opportunity to examine your testimony.
So perhaps we will begin with the lady on the panel, Ms. Gug-
genberger, who is president Of the Valley Title Co. of San Jose,
Calif.
STATEMENT OF CLYDA GUGGENBERGER, PRESIDENT, VALLEY
TITLE Cth, SAN JOSE, CALIF.
Ms. GUGGENBERGER. Thank you, Mr. Chairman. My name is
Clyda Guggenberger, and I am president of Valley Title Co., in San
Jose, Calif. I would like to share with the subcommittee my first-
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hand experience with what happens when real estate brokers are
permitted to refer clients to a title company in which they have
ownership interests. The problems that independent title compa-
nies, such as my own, face and the damage to consumers that
results from this unfair method of competition demand a congres-
sional solution.
Here was our situation before the development of controlled
business arrangements in Santa Clara County. My former husband
and I started Valley Title in 1951 and sti].l own all the common
stock. My ex-husband went into politics and I am the acting chief
executive, solely responsible for managing the company. We were
the fourth title company in 1951 and grew to No. 1 within 5 years
by introducing the philosophy that Valley was everyone's title
company-particularly the buyers and sellers.
We provided well-trained technicians and fast, friendly service,
with no customer too small, no transaction too small to get a warm
welcome in our many convenient branch offices. The good will that
was built up brought us the highest repeat business; we had more
referrals from former buyers and sellers than any other company,
and brokers in our county reported to us that we were the title
company most requested by sellers who said they were treated so
well when they bought their property. That good will should still
be our greatest asset. In a moment I will tell you why we are no
longer able to reap the benefits of those productive 30 years.
Throughout the fifties and sixties our position was secure. Al-
though we were a local, independent company we handled 40 per-
cent of the business in our county with as many as 365 employees
in our 13 branch offices. At no time did we use rebates or kick-
backs to buy our real estate broker customers. On the contrary, the
brokers showered our efficient, friendly escrow officers with flow-
ers, candy and small gifts.
The only cloud on our horizon during this period was the "com-
pensating balance" era, when lenders tried to take advantage of
their leverage by restricting their loans to homebuilders who could
force their title companies to make large deposits with the lenders
until the building project was completed. Small, independent com-
panies like Valley had no massive deposits. Fortunately, the use of
compensatory balances was made illegal before we were harmed
too greatly.
There had always been a few brokers who tried to get a part of
the title fee returned to them as a reward for referring business.
There had even been a title entity that sold stock to brokers in the
fifties, but an average real estate broker in those days had three to
five salesmen and once the stock was distributed, it did not involve
many brokers.
The scenario changed drastically in the late sixties and early
seventies, however. Along with the incredible growth of the real
estate brokerage industry-a good broker might have 350 salespeo-
ple now-the rebate problem became gigantic in some areas of our
State. While brokers in the North asked for $15 for each referred
title transaction, in the South the brokers demanded Rolls-Royces,
free secretaries and office expenses, free mansions for themselves,
huge cash payments, et cetera. Our California State Legislature
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reponded with antirebate legislation intended to prohibit the
broker from sharing in the title fee.
Unfortunately, the brokers found a way around these laws,
which led to the creation of the most pernicious form of kickback
we have yet seen: The formation of broker-owned or broker-con-
trolled title companies. Stock ownership, where the stock is pri-
vately offered and sold only to substantial brokers who will commit
a large number of referrals to the tie-in title entity-has become
the new device whereby the real estate broker collects not only his
commission but a portion of the infinitely smaller title fee. Brokers
who did not participate have given me copies of the documents
making those commitments and have also described the interesting
manner by which the stock was frequently paid for-out of the
dividends of the title entity.
How has this innovative form of kickback affected my company?
In 1970, the three largest brokers, all my customers and who
together employ over 700 salespeople and account for most of the
listings of properties for sale in San Jose, formed their own con-
trolled title company along with several escrow companies. Within
months they had gone through the county and scooped up as
stockholders, always via privately offered stock exchanged for com-
mitments to send all transactions to the broker-controlled title
entity, the remaining top 50 real estate brokers in the area. In its
first month of operation, April 1971, this new broker-owned compa-
ny, Cal Land, took away almOst half of our company's business and
by 1976 it had passed Valley Title as the No. 1 title agency in the
county.
In 1976 the California Insurance Commission held hearings on
the application of a large brokerage house, Coldwell Banker, to
open a controlled title company, Guardian Title. At those hearings,
Robert Morton, president of Western Title Insurance Co., referred
to our specific situation when he described Valley Title as the
"dominant company in Santa Clara County for many years,"
adding "to beat that company in that county is something no one
else had done for 15 years." Mr. Morton put charts in evidence
showing the phenomenal growth of the broker-owned company as
well as the plunging fortunes of my company.
We had achieved the enviable position of being on top for 15
years, beating the large nationwide and statewide title insurance
companies solely on the basis of the competitive merits of our
company. We lost our customers overnight, not because Cal Land
offered better service or lower prices, but because real estate bro-
kers in an outrageous violation of the agency principle were steer-
ing their customers to their own escrow companies and title enti-
ties.
What was it like to slip from the top overnight through no fault
of your own? I cannot describe the humiliation, outrage, and de-
moralization as my employees asked their formerly loyal customers
for title orders, and received answers like the following: "Why,
Pam or Ruth or Jerry, I can't give you another order. I own stock
in Cal Land." Or as one broker said to one of my managers who
had been doing all of his title business for 15 years, "wouldn't it be
silly of me to give you business when I just purchased stock in Cal
Land?" Another broker told our whole branch office, "You all did a
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fantastic job getting this transaction closed. I thought it was going
to fall apart several times, but you saved my commission. Thank
you." As he got to the door he turned and added, "In all fairness, I
think I should tell you that is the last order you will ever get from
me, however. I have just purchased stock in Cal Land."
A second type of complaint was and still is more frequent. We
have heard it hundreds of times since April 1971. Syndication is
with us; brokers may now have 150 to 350 associate brokers, their
salespeople get listings and sell homes by depositing their own
license with the broker and working under his license. The broker
who owns a tie-in title entity invariably directs his salespeople to
take every transaction to his company. "Directs," we hear from
these salespeople, is too mild a word. Forces, orders, commands,
harasses, threatens, and even "fines" are more accurate descrip-
tions of the kind of pressure exerted by the brokers.
At a California Association of Realtors Convention, Associate
Realtors complained on the floor of the convention about being
forced to use the controlled title entities of their broker-bosses,
which they said were not only inefficient but charged more than
independent companies like Valley Title Co. The California Insur-
ance Department's own study revealed that where a real estate
brokerage company owned an escrow company and directed its
customers' business to that company, the consumer's cost for full
escrow services was significantly greater, in excess of 150 percent
more, than the consumer's cost for comparable services from inde-
pendent title companies in the same locality.
My figures 2 years ago proved the same excess charges for the
consumer in my county. As I attempted to update those figures for
this hearing a funny thing happened. Our messenger who was sent
to each broker-owned escrow company to request rate schedules,
without identifying herself as a Valley Title Co. employee, came
back empty handed from every one. Every broker-owned escrow
company refused to give out its rate schedules, explaining, "We get
our business from our owner's real estate office and we give our
title business to his title company. We don't have rate schedules for
the public," with some adding variations to that such as "we do not
want any other business," or "we do not even have a printed rate
schedule."
With all the coercion used by the brokers against their salespeo-
ple, we do manage to get a few transactions from them as they
"sneak" orders into us. "Sneak" is the word used over and over
again by the salespeople as they bring us an order and tell us how
difficult it is. Again and again we hear: "I hate going to my
broker's escrow company or my broker's title company. The service
is terrible. They are so inefficient over there. There have been five
different escrow officers working on my transaction. My buyers
and sellers had to come back four times because they always mess
things up at the boss' title company." Many salespeople are aware
they are breaking regulations and laws governing their behavior.
They tell us they know they are supposed to give the buyer or
seller a choice of title entities but say their real estate boss tells
them the transaction must go to his title entity. One salesperson
whose office was next to ours told our branch manager, "I was told
if I bring Valley another escrow I will have to come to my boss'
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office and pick up my license. I cannot afford to make a move now,
so I shall not be `sneaking' any more title orders in to you."
This same salesman was back in several months with a few large
orders. He explained, "Well, I had the most phenomenal year. I
sold $2 million worth of real estate. I am the number one salesper-
son in the office and I told them from now on that I am taking my
title orders where I get the best service, like it or not."
I complimented a broker who had been a good customer of ours
for 20 years, because he allowed his salespeople to bring us their
escrows, although he owned stock in Cal Land. But he surprised me
by saying, "Oh, I have cracked down on that, Clyda. It will not
happen again. You will never, get another order from our office."
When I asked, "Even if the seller demands it?", he turned away
angrily without answering me.
We are now hearing from a large broker's associates that the
broker is charging a "fine" for sale orders not taken to his escrow
company and new wholly owned tie-in title company. Three differ-
ent reports have come to us that this broker will take a "fine" out
of his salespeople's commission, the fine representing the profit the
broker would make if the transaction had gone to his tie-in compa-
nies.
If the broker is doing this to his salespeople, his own employees,
what does he do to the consumer when he gets him into that title
or escrow entity? We heard from ex-employees that the incidental
charges are unbelievable, huge amounts for "drawing documents,"
other fees and excess recording charges.
But, the third type of complaint we receive continually is even
more frightening to us: our loyal brokers who have no financial
interest in any title company are not coming in as often or are
cancelling escrow orders already opened with us because of threats
and harassments they report they are receiving from controlled
business brokers on the other side of the transaction. We have a
multiple listing service in our county, with a seller-pays-title-fee
tradition. When the broker for the seller has the option for his
seller of choosing the title entity, the participating broker for the
buyer will threaten that if the title does not go through his tie-in
company, the buyer just may not purchase the house. Or the
broker may have the buyer make out his deposit check to the
broker's own controlled title entity, not to our company where the
order has already been directed by the seller or his broker and a
preliminary title report issued.
Independent brokers, having to cancel the orders they placed
with us, are saying, "I'm sorry, this is terrible. You have already
done this work. I'm outraged. But what can I do, ask the buyer for
another deposit check? I am going to have to go through their title
company. I cannot risk losing this commission." Sellers have told
us themselves, "I thought I had my. choice of title companies. I
chose yours, but I was forced to go through the tie-in company
owned by the other broker. How is that? Why don't you people do
something about it?"
This is where we are not able to benefit from our 30 years' of
good service in Santa Clara County. Our brokers, our buyers and
sellers and borrowers of 30 years' standing, even sometimes our
own employees or their relatives are told they cannot come to our
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company because the real estate broker must have more than his
commission-he must have part of the title and escrow fee also on
every transaction.
Chairman GONZALEZ. Would you yield? Sometime before you
mentioned the seller. Now, that is presently prohibited by RESPA.
It is a violation of the law. Section 9(a): No seller of property that
shall be purchased with the assistance of a federally related mort-
gage loan shall require directly or indirectly, as a condition of
selling the property, that title insurance covering the property be
purchased by the buyer from any particular title company.
Ms. GUGGENBERGER. Yes, Mr. Chairman. I am not talking about
a deal where the buyer is getting a new loan. Quite often we have
so many loan assumptions these days, that we don't have as many
lender transactions right now. We are in a seller-pay county. The
tradition is that the listing broker, or the seller, chooses the title
company. Quite often a preliminary report is ordered before the
deal is even consummated, before the buyer buys the property.
In cases where there is a Federal loan or a loan that may be
sold, the buyer chooses the title company and his broker usually is
choosing it for him. But it is not done where it shouldn't be done.
We have many, many direct deals with the seller where the broker
tells him this is my choice, or do you have a choice, do you want to
pick a title company? And in our county the seller can say yes or
no, or I don't care, or what do you suggest, that sort of thing.
This guaranteed flow of business by brokers to their controlled
title entities brings unbelievably high profits to our competitors.
They have the finest equipment, fleets of delivery cars, quite often
the best employees they have stolen from us. One of their manag-
ers boasted to me 4 years after Cal Land started that in 1975-not
a good year for real estate-they had net profits after taxes of
$477,000 for only the first 9 months of their fiscal year. In all our
25 years of being No. 1, Valley had never seen a year with net
profits that high. We have had to watch the tie-in companies
burrowing into Fort Knox, carrying away the gold, with the seem-
ing approval of our State insurance commissioner and RESPA.
And here is the irony of it all: we are prohibited by our State
Insurance Department from taking a broker to lunch or dinner
more than once a month and the cost of that meal may not exceed
$7.50. While down the street, a tie-in title entity pays that same
broker quarterly dividends of $3,000 or $5,000 and provides him
with tie-in telephone lines, delivery services, directors fees, vaca-
tion trips-even suits of clothes-and many more opportunities to
benefit, along with the appreciation of his stock.
So, should we also sell our stock to brokers? And also be in
violation of State and Federal laws? Should we give up and sell
out? The president of Cal Land tried repeatedly to buy us, saying
"We're so successful, we have a second stock distribution coming
up. What brokers are left that have any sales volume will be swept
up this time. If you do not sell to us, Clyda, you are going to find
yourself without any business and you will have no title company
to sell to us."
As soon as RESPA was enacted, we had repeated offers to pur-
chase our company. They were very much afraid of what the
implications of RESPA would mean for them, and they said they
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needed to pick up some business here and they would like to buy
us. I was very much afraid of the liability that would go with that
stock. I felt they were in violation of the insurance laws of the
State of California and the antitrust laws, and I would not want to
have their stock, as a matter of fact.
Instead, I filed an antitrust suit against this company and its
broker stockholders. First, I must say that antitrust litigation is
not for everyone; it is extremely costly and time-consuming. Most
title companies that have been hurt by controlled business arrange-
ments are already suffering from loss of income, loss of reputation,
loss of good employees, and even good management at this point,
and will not have the money to pay for or the ability to sustain
such litigation. We thought we had an excellent case, but faced
with a 7-month trial in San Francisco, and promises that the
brokers involved would obey the laws and provide each buyer and
seller with a list of title entities from which to choose, we decided
to accept a settlement 1 week before trial. The settlement was
insufficient to compensate us for the losses we had already suf-
fered, and even more insufficient now that I see a few years later
that the brokers have not begun to keep their word to use fair
practices.
What is required, in my view, is comprehensive and effective
legislation to stop this form of unfair competition. When section 8
of RESPA was enacted, the kickback or rebate of cash or Rolls-
Royces, or whatever, was the manner in which brokers shared in
the title fee. Few brokers today would bother with that old-
fashioned $15 cash kickback. They can now obtain a part of the
title fees on all their customers' transactions by owning an interest
in a title company and steering all of their business and any other
business they can get hold of to that company. The financial bene-
fits to the broker are the same and should be proscribed to the
same extent. The public can only benefit from a stable insurance
industry. The brokers I have seen care nothing about the title
business, they only care about the short-term profits that can be
made from the business they control.
We hear from their exemployees of terrible defects in title that
are being passed on for the consumer to worry about in the future
because the broker-stockholder insists his deal must close; his com-
mission must be paid to him, right now.
Some say it is enough for the real estate broker to tell his client
he has a financial interest or to ask his client if he prefers another
title entity. Neither works; the only disclosure I have seen so far is
very small print at the bottom of an agreement to buy and sell real
property. No buyer or seller is concerned with that small print
when he is engaged in such an awesome procedure as purchasing
or selling a house. Asking the client is not working, as evidenced
by hundreds of complaints from real estate salesmen that the title
orders must be placed with their boss' title entity. It is a farce to
pretend the broker is giving his client a choice; it is destructive to
force a whole industry to live with lies, charades, and injustice.
If government thinks it's OK for a real estate broker to share in
the title fee, then let us all do it; let us all buy our customers. If
not, I respectfully request that this subcommittee enact compre-
hensive legislation that will insure that all title companies, regard-
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less of who owns their stock, have a fair opportunity to serve the
consumer, who deserves a better deal than he is getting now.
Chairman GONZALEZ. Thank you very much. We deeply appreci-
ate your testimony.
We are going to recognize Mr. Boren next, but let me first ask if
any one of you on the panel has any severe time restrictions such
as a plane to catch or anything like that.
[No response.]
Chairman GONZALEZ. OK, sir. If you would proceed.
STATEMENT OF JAMES L. BOREN, JR., PRESIDENT, MID-SOUTH
TITLE INSURANCE CORP., MEMPHIS, TENN., PRESIDENT,
AMERICAN LAND TITLE ASSOCIATION
Mr. BOREN. Ms. Guggenberger's statement is an excellent way to
start this afternoon, because that's a very good predicate, by pre-
cise example, to the statement of the American Land Title Associ-
ation. While I am president of Mid-South Title Insurance Corp., in
Memphis, I am also the president of the American Land Title
Association, and it is my function today to present the views of the
total group.
The subject of today's hearing is a problem of serious and grow-
ing dimensions in the title insurance industry. It is a problem that
not only affects the very survival of many independent abstracters,
title insurance agencies, and title insurance companies, but also is
one that is undermining the vitality of competition in our industry,
and jeopardizing the interests of consumers in obtaining high-qual-
ity title insurance services at reasonable prices. This problem,
which has come to be called the controlled business problem, is the
utilization by real estate professionals, as you well defined that
term this morning, Mr. Chairman, of their critical and often fidu-
ciary role in the real estate transaction to profit personally from
the selection of a provider of title insurance services.
For a variety of reasons, the consumer, who often does not have
either the ability or the willingness, as Mr. Coyne indicated this
morning, to shop for himself, almost invariably looks to and relies
upon the advice and guidance of his real estate broker, his lender,
or his attorney, in selecting a provider of title insurance services.
Such reliance on the advice of knowledgeable real estate profes-
sionals can have substantial positive benefits for the consumer,
since these real estate professionals are far more knowledgeable
than the consumer about the quality of services and the reason-
ableness of the prices offered by various providers of title insurance
services. Title insurance entities, in seeking the favorable recom-
mendations of these knowledgeable professionals-in a market in
which competition has not been foreclosed-have a very strong
incentive to compete on the merits for those recommendations.
Let me depart from my prepared text to say at this point that
there are a great many real estate brokers, there are a great many
lenders, and there are a great many attorneys who are steering
clear of the financial entanglements of controlled business, recog-
nizing and fulfilling the obligations which their particular relation-
ships with the customer impose upon them. But on the other hand,
the consumer and competitive benefits to which I have referred
will not be realized if the recommendation of the real estate profes-
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sional is based on considerations that serve his personal financial
interest, rather than the interests of the consumer.
The basic problem of insuring that the consumer will obtain the
disinterested advice of the real estate professional is a problem
that Congress already has addressed, at least in part, in section 8
of the Real Estate Settlement Procedures Act. Congress has deter-
mined that kickbacks or referral fees paid for the referral of busi-
ness should be proscribed because of their clear anticompetitive
and anticonsumer consequences. As a cosponsor of that original
RESPA bill, Mr. Chairman, I am sure you are well familiar with
the goals which it sought to achieve.
However, the receipt of direct kickbacks and referral fees consti-
tutes only one type of financial benefit that may prejudice the
recommendations of a real estate professional. Since the enactment
of RESPA in 1974, a wide variety of arrangements has developed,
whereby real estate brokers, mortgage lenders, builders, and attor-
neys have become title insurance agents or have established, ac-
quired, or purchased stock in title insurance agencies to which they
steer the title insurance business of their customers or clients.
The financial benefits to be derived from arrangements of this
type in many instances far exceed the benefits which might be
obtained by the direct kickback or the direct referral fee. Indeed,
because such controlled business arrangements have become more
widespread than the payment of kickbacks ever were, controlled
business arrangements will have a greater adverse impact on com-
petition than kickbacks ever had.
Our association has prepared an extensive paper on the con-
trolled business problem. It discusses these matters at great length,
and with your permission, Mr. Chairman, I would like to submit
this paper.'
I would like also at this point to summarize the major anticon-
sumer and anticompetitive consequences that the paper discusses.
First, when real estate professionals have a financial interest in
the selection of a provider of title insurance services, they invari-
ably steer their clients and customers to that provider, irrespective
of the competitive merits of the services and rates offered by other
title insurance providers.
Second, because a controlled title insurance agency does not have
to compete in the marketplace for its business, such an agency is
subject to little or no competitive pressures to maintain the quality
of its services or the reasonableness of its charges.
Third, title insurance companies or title insurance agencies that
have not provided stock or other financial interests to real estate
professionals are placed at very serious competitive disadvantage.
Indeed, the very survival of those companies may be threatened.
Fourth, permitting such professionals to have financial interests
in providers to which they refer business, inevitably channels com-
petition in a direction whereby title insurance entities seek to offer
such professionals ever-increasing financial benefits.
Fifth, the existence of controlled business arrangements acts as a
major deterrent to the entry of new title insurance companies and
new title insurance agencies into a market.
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154
Sixth, a title insurance agency composed of or owned by real
estate professionals is subject to serious conflicts between the inter-
ests of its owners, the interests of the consumer, and the interests
of the title insurance underwriter.
These adverse consumer and competitive consequences of con-
trolled business have been recognized by a great many Federal and
State agencies, industry commentators, and consumer advocates
who have examined the controlled business problem.
I would like to submit, Mr. Chairman, a review, a compendium of
excerpts from the various reports, studies, and comments.1
One of those to which you refer I have quoted in my complete
statement. This is the quotation read twice this morning, from the
report of the Justice Department's Antitrust Division, pointing out
the three basic problems which they found with controlled business
arrangements: Higher prices, poor service, and poor title examina-
tions. I quoted also in my full statement a statement from Public
Citizen Litigation Group, a public-interest law firm, which is much
along the same line. Both of those look at the problem from the
consumers' standpoint.
Additionally, I can assure you that the impact of these controlled
business arrangements on independent title insurance providers is
even more immediate and even more adverse. Those members of
the subcommittee with experience in the business world can appre-
ciate the sense of frustration and outrage of independent title
agencies-certainly something which came through in Mrs. Gug-
genberger's statement-when they find that after years of building
a successful business, their competitive opportunities are threat-
ened by companies who obtain business not by legitimate competi-
tive means, but by offering financial inducements to those who are
in a position to control the referral of the home buyers' business.
While section 8 of RESPA was a necessary first step in eliminat-
ing financial inducements, it is the belief of the American Land
Title Association that further clarifying legislation is needed to
prohibit the type of controlled business arrangements that have
become so widespread in recent years, arrangements which the
Department of Justice has referred to as "loopholes" in section 8.
Such clarifying legislation, I would emphasize, need not entail any
major Federal regulatory regime. On the contrary, various means
of enforcement could be provided, such as private rights of action
by competitors, that would obviate the need for Federal enforce-
ment or further regulations in this area.
Before concluding, and perhaps moving from the main subject
today, I would like to address briefly the notion that the problem of
controlled business can be eliminated, or in some way sanctified by
mandating that mortgage lenders pay for or package certain real
estate settlement services.
Our association believes that such a mandatory scheme would
aggravate the controlled business problem and, totally apart from
its effect on the controlled business problem, would not be desir-
able and would not be in the interest of consumers. First, unless
the mortgage lender is precluded from using a title insurance
service provider in which it has a financial interest, the adoption of
a lender-pay or lender-packaging scheme would place all title in-
1 At the time the hearing went to press, the referred to material had not been submitted.
PAGENO="0161"
155
surance agencies or title insurance companies that are not affili-
ated with a lender at an insuperable competitive disadvantage.
Second, if such a concept were workable or desirable, the market-
place would have developed it on its own. Third, the concept is
based on theoretical economiė concepts that may have very little
validity in the real world. In short, we see many serious drawbacks
and we see no real benefits from the lender-pay or the lender-
package proposal.
In conclusion, I would like to reiterate the position of the Ameri-
can Land Title Association on the issue of controlled business.
Under our private enterprise system, consumers are best served
when competitors are required to compete on the merits of their
prices and services, and when all competitors have a fair and equal
opportunity to compete. Because of the strategic role played by the
real estate professional in assisting the consumer in selecting a
provider of title insurance services, it is essential for all providers
to have a fair and equal opportunity to compete on the merits for
the favorable recommendation of these real estate professionals.
This opportunity is effectively foreclosed when the real estate pro-
fessional is permitted to benefit personally from his recommenda-
tion to the consumer. If such financial interests are permitted, fair
and effective competition on the merits will be lost. And the ulti-
mate loser will be the consumer.
Accordingly, on behalf of the American Loan Title Association, I
urge this subcommittee to introduce and to act favorably upon
legislation that would clearly and comprehensively prohibit real
estate professionals who are in a position to influence the consum-
er's selection of a provider from benefiting financially from that
selection.
[Mr. Boren's prepared statement, on behalf of the American
Loan Title Association, follows:]
85-396 0 - 81 - 11
PAGENO="0162"
156
STATEMENT OF MR. JAMES L. BOREN, JR.
PRESIDENT, AMERICAN LAND TITLE ASSOCIATION
My name is James L. Boren, Jr. and I am the President
of Mid-South Title Insurance Corporation in Memphis, Tennessee.
I currently am serving as President of the American Land
Title Association, the national trade association of the
land title industry, and I am appearing today to present the
views of our Association. Our Association comprises over
2,200 members located in all fifty states and in the District
of Columbia, including local and national title insurance
underwriters, as well as a great number of local title insur-
ance agents and abstracters.
The subject of today's hearings is a problem of serious
and growing dimensions in the title insurance industry. It
is a problem that not only affects the survival of many
independent abstracters, title insurance agencies, and title
insurers, but also is one that is undermining the vitality
of competition in our industry and jeopardizing the interests
of consumers in obtaining high quality title assurance ser-
vices at reasonable prices.
This problem, which has come to b~ referred to as the
"controlled business problem," is the utilization by real
estate professionals -- such as real estate brokers, mort-
gage lenders, builders, and attorneys -- of their critical
and often fiduciary role in the real estate transaction to
PAGENO="0163"
157
profit personally from the selection of a provider of title
insurance services. While this financial benefit may be
derived by becoming a commission agent for a titl~ insurance
company or acquiring an ownership interest in a title insur-
er, the controlled business problem more often manifests
itself in the form of a stock or other ownership interest by
the real estate professional in a title insurance agency to
which the professional refers the title insurance business
of his customers or clients and from which he receives
dividends or other financial benefits. To appreciate the
magnitude and implications for competition and consumers of
this problem, some background information is essential.
For a variety of reasons, the consumer, who purchases a
home only once or twice in his lifetime, almost invariably
looks to and relies upon the advice and guidance of his real
estate broker, lender, or attorney in selecting a provider
of title insurance services. The plain fact is that most
consumers do not have the time, knowledge, or incentive to
shop the market in order to select the provider of title
insurance services which offers the best combination of
price, service and policy coverage. While in recent years
our Association and its members have increased their efforts
to make consumers aware of the nature of title insurance
services and charges, because consumers purchase real estate
so infrequently and are generally more concerned with other
PAGENO="0164"
158
problems (such as obtaining mortgage financing, arranging to
move their household effects, locating schools for their
children, etc.) between the time they sign the purchase
contract and the time they go to closing, it is inevitable
that the great majority of consumers will continue to look
to the recommendations of their broker, lender, or attorney
in selecting a source of title protection. Such reliance on
the advice of a knowledgeable real estate professional can
have substantial positive benefits for the consumer, since
these real estate professionals are far more knowledgeable
than the consumer about the quality of services and the
reasonableness of the prices offered by various providers of
title insurance services in the community. Title insurance
entities, in seeking the favorable recommendations of these
knowledgeable professionals in a market in which competition
has not been foreclosed, have an incentive to compete for
those recommendations by bringing the merits of their services
and prices to the attention of these professionals. But
these consumer and competitive benefits will not be realized
if the recommendation of the real estate professional is
based_on considerations that serve his personal financial
interests rather than the consumer's interests.
The basic problem of ensuring that the consumer will
obtain the disinterested advice of the real estate profes-
sional in selecting a provider of title insurance services
is a problem that Congress has already addressed -- at least
PAGENO="0165"
159
in part. In Section 8 of the Real Estate Settlement Pro-
cedures Act -- or RESPA as it is more commonly known --
Congress has determined that kickbacks or referral fees paid
by title insurance service providers for the referral of
business should be proscribed because of their clear anti-
consumer and anti-competitive consequences. Such payments
were outlawed not only because they tend to inflate unneces-
sarily the cost of title insurance to the consumer and pre-
judice the kind of disinterested advice regarding the selec-
tion of a provider of title insurance services that the
consumer deserves, but because of Congress' belief that it
was deleterious to the healthy~ functioning of competition
for title insurance providers to compete for business by
offering kickbacks and referral fees to real estate pro-
fessionals who are in a position to recommend or refer busi-
ness. As a co-sponsor of the original RESPA bill introduced
in the 93rd Congress and as a member of the House-Senate
Conference Committee that produced the anti-kickback pro-
vision of RESPA, Mr. Chairman, I am certain that you are
quite familiar with the consumer goals sought to be achieved
by this provision.
But the receipt of direct kickbacks and referral fees
constitutes only one type of financial benefit that may pre-
judice the recommendations of a real estate professional.
Since the enactment of RESPA in 1974 -- perhaps in substan-
tial measure because of the uncertainties that surround the
PAGENO="0166"
160
scope of Section 8 of RESPA -- a wide variety of arrange-
ments has developed whereby real estate brokers, mortgage
lenders, builders, and attorneys have become title insurance
agents or have established, acquired, or purchased stock in
title insurance agencies to which they steer the title
insurance business of their customers or clients. While
such arrangements existed to a limited extent prior to the
enactment of RESPA -- particularly in smaller communities
where, of necessity, title insurance agencies may have been
owned by or affiliated with local real estate brokers, lenders,
or attorneys -- the proliferation of these arrangements in
major market areas has taken place primarily since the.
mid-l970's. The financial benefits to be derived from such
arrangements -- whether in the form of dividends from the
controlled entity, or in the form of capital appreciation of
the stock of a controlled entity that reflects retained
profits -- in many instances far exceed the benefits that
might be obtained from kickbacks and referral fees. In
terms of the impact on consumers and the impact on other
providers of title insurance services who do not offer such
financial inducements but who seek to obtain business on the
competitive merits of their products and services, these
controlled business arrangements are the functional and
economic equivalent of kickbacks, which you and your colleagues
sought to proscribe in Section 8 of RESPA. Indeed, because
PAGENO="0167"
161
such controlled business arrangements have become more wide-
spread than the payment of kickbacks ever was, controlled
business arrangements will have a greater adverse impact on
competition than kickbacks ever had.
It is impossible in the time I have today to catalog
the various types of controlled business arrangements or the
numerous anti-competitive or anti-consumer consequences of
the growth of such arrangements. Our Association has pre-
pared an extensive paper on the controlled business problem
that discusses these matters at great length and, with your
permission, Mr. Chairman, I would like to submit this
memorandum for inclusion in the record of these hearings.
While this memorandum will give the members of your Subcom-
mittee and your staff a complete understanding of the back-
ground, manifestations, and consequences of the growth of
controlled business arrangements in the title insurance
industry, I would like to summ~rize the major anti-consumer
and anti-competitive consequences that are discussed in this
paper:
When real estate professionals have a financial
interest in the selection of a provider of title
insurance services, they invariably steer their
clients or customers to that provider irrespective
of the competitive merits of the services and
rates offered by other title insurance providers
in that market.
Because a controlled title insurance agency does
not have to compete in the marketplace for its
business -- since it obtains its business by
virtue of the ability of its owners to control the
PAGENO="0168"
162
referrals of consumers -- such an agency is sub-
ject to little or no competitive pressure to
maintain the quality of its service or the rea-
sonableness of its charges.
Title insurance companies or title insurance
agencies that have not provided stock or other
financial interests to real estate professionals
who are in a position to make referrals or
recommendations of the consumer's business are
placed at a serious competitive disadvantage -- a
disadvantage that cannot be overcome by offering
the public better service or lower prices. Indeed,
the very survival of these companies may be
threatened.
Permitting such professionals to have financial or
ownership interests in providers of title insur-
ance services to which they refer business inevit-
ably channels competition in a direction whereby
title insurance entities seek to offer such pro-
fessionals ever increasing financial benefits;
while this form of competition may serve the
interests of real estate professionals, it clearly
does not serve the interests of consumers.
The existence of controlled business arrangements
in a particular market acts as a major deterrent
to the entry of new title insurance companies or
title insurance agencies into that market, since
such potential entrants realize that they cannot
expect to obtain business on the basis of the
merits of their products and services, and cannot
obtain business at all unless they are willing to
offer controllers of business greater financial
benefits than they are currently receiving.
A title insurance agency composed of or owned by
real estate professionals is subject to serious
conflicts between the interest of its owners
a real estate broker in seeing the trans-
action consummated so as to earn a real estate
brokerage fee), the interest of the consumer in
being informed of all potential title problems
that might threaten the use or enjoyment of the
property he is purchasing, and the interest of the
title insurance underwriter in insuring against
prudent title risks only.
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163
These adverse consumer and competitive consequences of
controlled business have been recognized by a great many
federal and state agencies, industry commentator~, and con-
sumer advocates who have examined the controlled business
problem. In this regard, I would also like to submit for
the record and for the Subcommittees review a compendium of
excerpts from these various reports, studies and comments.
Let me draw your attention to two of these documents
in particular.
In analyzing the impact of controlled business on com-
petition and consumers, the Antitrust Division of the
Department of Justice, in a 1977 Report entitled "The Pricing
and Marketing of Insurance," reached the following conclusions:
"To sum up the major evils of controlled
title companies, where a real estate
settlement producer is able to direct
the purchaser of a title insurance policy
to a particular company and at the same
time that producer owns the title company,
the purchaser is likely to end up (1) pay-
ing unreasonably high premiums, (2) accept-
ing unusually poor service, or (3) accept-
ing faulty title examinations and policies
from the controlled tille company."
Consumer groups have also expressed their concern about
the adverse impact of controlled business. In an October 29,
1980, letter to the Department of Housing and Urban Develop-
ment, Public Citizen Litigation Group, a public interest law
firm based in Washington, D.C., wrote:
PAGENO="0170"
164
"[w]here the real estate professional
has an interest in a title insurance
company there is a conflict of interest
between the responsibility of the lender,
broker or attorney to the client -- th~
buyer -- and his own financial interest
in the controlled title company. The
buyer will be deprived of unbiased ad-
vice if the real estate professional
steers him to a controlled company.
The effect of this practice is plain-
ly anti-competitive. There is no incen-
tive for the controlled title company to
improve policy coverage or service and
there is every incentive to increase
prices, because its business is steered
by owners and is free from competition
of the independent title companies.
Public Citizen urged HUD through enforcement of RESPA
and the request for supplemental legislation, to promptly
eliminate the steering of title insurance business to captive
companies."
While the views expressed by the Department of Justice
and Public Citizen reflect their concern over the impact of
controlled business on consumers, I can assure you that the
impact of such arrangements on independent title insurance
service providers is even more immediate and adverse.
I am certain that those members of the Subcommittee with
experience in the business world can appreciate the sense of
frustration and outrage of independent title agencies when
they find that, after years of building a successful business,
their competitive opportunities are threatened by companies
who obtain business not by legitimate competitive means, but
PAGENO="0171"
165
by offering stock or other financial inducements to those
real estate professionals who are in a position to control
the referral of the consumer's business. The other witnesses
on this panel today can address this point in greater
detail.
While Section 8 of RESPA~was a necessary first step in
eliminating financial inducements for the referral of title
insurance business, ALTA believes that further clarifying
legislation is needed to prohibit the type of controlled
business arrangements that have become so widespread in
recent years -- arrangements that the Department of Justice
has characterized as "loopholes" to RESPA Section 8. While
HUD has indicated in an Interpretive Rule that certain
controlled business arrangements "may be" violations of
RESPA Section 8, such an interpretive rule will not, without
further clarifying legislation, ensure that consumers are
adequately protected in seeking the impartial advice of real
estate professionals in selecting a provider of title insurance
services and that title insurance service providers will
compete for business solely on the basis of the competitive
merits of their prices and services, rather than on the
basis of how much stock or the size of the dividends or
commissions they can offer to persons who are in a position
to refer business. I would add that such clarifying legisla-
tion need not entail any major federal regulatory regime.
PAGENO="0172"
166
If clear rules are adopted in such legislation, various
means of enforcement could be provided, such as private
rights of action by competitors (similar to the private
rights of action available under the antitrust laws), that
would obviate the need for federal enforcement or further
regulation in this area.
Before concluding, I would like to address briefly the
notion that the problem of controlled business can be elimin-
ated by mandating that mortgage lenders pay for or package
certain real estate settlement services, such as title
insurance services. While the details of such a proposal
have not been spelled out, our Association believes that
such a mandatory lender-pay or lender-packaging scheme would
aggravate the controlled business problem and, totally apart
from its impact on the controlled business problem, would
not be desirable or in the interests of consumers. First,
unless limitations were placed on the ability of the mort-
gage lender to select for inclusion in the package a title
insurance service provider in which it had a financial
interest, the adoption of a lender-pay or lender-package
scheme would place all title insurance agencies or title
insurance companies that are not affiliated with mortgage
lenders at an insuperable competitive disadvantage. Indeed,
because of the economic incentive lenders would have to
establish captive title insurance entities to provide the
PAGENO="0173"
167
title insurance portion of the package, title insurance
entities that are not affiliated in one way or another with
a mortgage lender would probably be driven from the market.
Second, if such a concept were workable or desirable, there
would be no need for the federal government to mandate its
use, fot the marketplace would have developed the concept on
its own. Third, the concept is based on theoretical eco-
nomic concepts that may have little validity in the real
world and, if implemented on a nationwide basis, could have
serious adverse and unanticipated consequences on the
mortgage lending industry. Moreover, to my knowledge there
is no real evidence to demonstrate that consumers would in
any way benefit from such a radical proposal. In short, we
see many serious drawbacks and no real benefits from the
lender-pay or lender-package proposals.
In conclusion, Mr. Chairman, I would like to reiterate
the position of the American Land Title Association on the
controlled business issue in the clearest terms possible.
Under our private enterprise system, consumers are best
served when competitors are required to compete on the
merits of their prices and services for the consumer's
patronage and when all competitors have a fair and equal
opportunity to compete for that patronage. Because of the
strategic role played by the real estate professional in
assisting the consumer in selecting a provider of title
PAGENO="0174"
168
insurance services, it is essential, if a competitive market
for title insurance services is to be preserved and the
interests of consumers are to be served, for all providers
to have a fair an~ equal opportunity to compete on the
merits of their products and services for the favorable
recommendation of these real estate professionals. This
opportunity is effectively foreclosed when the real estate
professional is permitted to receive a kickback or otherwise
to benefit personally from his recommendation to the
consumer, as he does when he has a financial or ownership
interest in the provider of title insurance services ~to
which he refers business. If such financial interests are
permitted, fair and effective competition on the merits will
be lost, and the ultimate loser will be the consumer.
Accordingly, I urge this Subcommittee to introduce and
act favorably upon legislation that would clearly and com-
prehensively prohibit real estate professionals who are in a
position to influence the consumer's selection of a provider
of title insurance services from benefiting financially,
whether in the form of a kickback, referral fee, commission,
stock ownership, dividend, or otherwise, from that selec-
tion.
PAGENO="0175"
169
Chairman GONZALEZ. Thank YOU again, Mr. Boren. I again thank
~OU for letting me recognize Ms. GUggenberger first, as a matter of
just plain, old-fashioned chivalry, southern chivalry.
Mr. BOREN. We from Tennessee understand. [Laughter.]
Ms. GUGGENBERGER. A lady who is from Florida naturally appre-
ciates and expected that. [Laughter.]
Chairman GONZALEZ. Well, in view of the fact that you are the
president of the national association, ordinarily, you would have
been recognized first. We will next hear from Mr. Gerald Peck,
president of the Continental Abstract Corp., Carle Place, N.Y.
STATEMENT OF GERALD PECK, PRESIDENT, CONTINENTAL AB-
STRACT CORP., CARLE PLACE, N.Y., CHAIRMAN, ABSTRAC-
TORS AND TITLE INSURANCE AGENTS SECTION, NEW YORK
STATE LAND TITLE ASSOCIATION
Mr. PECK. Mr. Chairman, members of the subommittee, ladies
and gentlemen of the real estate industry, my name is Gerald
Peck, and my place of business is in Cane Place, N.Y., a New York
City suburb. And although I am serving my third term as chair-
man of the Abstractors and Title Insurance Agents Section of the
New York State Land Title Association, I appear today in my
personal capacity as an independent title insurance agent with
almost 25 years' experience in the title insurance industry.
I am a coowner and officer in two full service title insurance
agencies, Continental Abstract Corp. and County Abstract Co., Inc.,
representing four title insurance carriers. We serve a 10-county
area in and around the Metropolitan New York area.
I would like briefly to discuss today some of the issues of con-
trolled business, and I would like to focus your attention on one of
the more critical, but frequently poorly appreciated, problems that
is created when the person or entity that acts as a title insurance
agent is controlled by or has a financial affiliation with the broker
or lender in the real estate transaction.
The essential purpose served by those of us who are engaged in
the title insurance business is to guarantee the security of invest-
ments made in real estate by home buyers, mortgage lenders,
investors and others. Of course, financial indemnity in the event of
a title loss is a significant aspect of the financial production and
security we provide.
But title insurance, which1 guarantees that a certain state of
facts, that is, the nature of the rights being acquired in the trans-
action, exists at the time the policy is issued, is so fundamentally
different from life or casualty insurance, which provides for finan-
cial indemnity for losses suffered as a result of unforeseen future
events, the foundation of our industry's services is the rendering of
a thorough and accurate determination of the nature of the bundle
of rights and limitations on those rights that is the state of the
title-the history of what makes that title what it is and that the
parties will be acquiring in the transaction-prior to the issuance
of the title insurance policy.
Once those rights and limitations have been determined and
communicated to all the parties involved, the buyer or lender is in
a position then to determine whether to proceed with the transac-
tion, in light of that bundle of title information we've disclosed.
PAGENO="0176"
170
And the title insurance agent or insurer can determine what liens,
claims or encumbrances may be insured against or what steps
must be taken to correct or eliminate any defects or problems in
the title prior to the consummation of the transaction.
Thus the vast majority of the revenues received by the title
insurance industry are utilized for these very important purposes
of determining the state of the title, resolving, where possible,
those title problems that are discovered, and determining whether
certains liens, claims or encumbrances can properly be insured
against or must be noted as exceptions to the policy's coverage.
Accordingly, in contrast to a life insurance agent whose commis-
sion is designed to compensate him for performing a sales function,
and where the premium is received for unknown risks that may
arise in the future, the portion of the title insurance premium
retained by the legitimate independent title insurance agent is
intended to compensate it for performing those services I have just
discussed-the work package-that are essential to the issuance of
a title insurance policy.
The title examination, the proper clearance of liens, claims, or
encumbrances, and the determination of the risks to be insured are
very time consuming, but are essential to the proper issuance of a
correct title insurance policy. These risk elimination functions
serve the interests of all investors in real estate, because they
inform the parties not only of the precise nature of the title they
are getting and the nature of the property that is subject to the
transaction, but they insure that title insurance losses are kept low
and hence that rates are kept to the lowest level possible. In other
words, we spend an awful lot of time and money prior to the
issuance of the title report for the purpose of claims avoidance.
Our claims are based on our ability to accurately determine the
history and state of the title, rather than some future eventuality
or casualty. These risk elimination functions, in other words a
thorough and careful search and examination of the title, combined
with sound underwriting of risks, constitute the foundation of our
industry's services and are provided in the context of a real estate
transaction where there are frequently conflicting interests among
the parties. We have the buyer, the seller, and the lender. We have
the attorney for the lender. We have the attorney for the buyer,
the attorney for the seller, and the attorney for the title insurance
company.
So in effect, there are three very different interests involved,
possibly four. Therefore, it is essential to the healthy functioning of
the title insurance industry and to providing proper service to the
various parties who are involved in the real estate transaction that
these services be performed by competent, independent title insur-
ance professionals, who are not subject to the conflicts of interest
that can arise when the provider of the services is owned or con-
trolled by one of the parties to the transaction.
In effect, if you think about it for a moment, you have the seller,
the buyer, and the lender. There is a strong dichotomy in the
interests of these parties. There is almost a conflict as between the
parties as to who is getting what. If you take all of this and put
this into one ball, we have a very, very serious question as to who
is representing whom and for what.
PAGENO="0177"
171
One of the most insidious aspects of the growth of the controlled
business arrangements, is that such arrangements tend strongly to
undermine this very foundation-the independence of title insur-
ance service providers. An independent agent must offer first-rate,
efficient thorough service. All of the buyers, sellers, brokers, lend-
ers or attorneys who deal with my company know that as a result
of the quality of our professional employees and our independ-
ence-we are not owned by anybody participating in the transac-
tion-that the title work will be handled in a highly competent
manner, and that we will use our best efforts in the best interests
of all the parties to the transaction to identify and assist in the
resolution of any title problems.
Similarly, the title insurance underwriters on whose behalf we
issue title insurance policies know that while we will endeavor to
provide the best title protection we can for our customers, we will
be exercising sound and independent underwriting judgment in
determining the coverage of the policies we issue on their behalf.
Whereas, a controlled title insurance agent, which may be nothing
more than a small shop, a one- or two-man operation, can be
pressured to close and ignore title problems because of the econom-
ic pressure brought to bear by the person controlling that company
who is a party in the transaction. His boss, for all intents and
purposes, is the broker who is anxious to get his deal closed and
will oftentimes press inordinately to have title questions passed
over.
Unlike controlled title insurance agencies which are assured of
their business, because their owners are in a position to steer their
clients or customers to that agency, our success is totally depend-
ent on the quality and integrity of the services we offer.
I suggest to you that the interests of competition and consumers
are far better served when the success of the provider of title
insurance services is determined by how well it has served the
interests of all the parties to the real estate transaction rather
than how effectively the stockholders of that company can direct
the business of their customers or clients to that company.
Let me make reference to an example of some of the pressures
we are placed under. We did work for a number of years for a
particular law firm, where the senior partner represented a sav-
ings and loan institution. We had a good relationship with that
firm, although the senior partner was a very difficult man to do
business with, because he didn't want to hear about title excep-
tions, or problems. He only wanted to close.
Following the enactment of section 8 of RESPA, the senior part-
ner requested that since RESPA had been enacted, we should set
him up as a subagent so that he could write the title insurance
business for the savings and loan he represented, and therefore, we
should split the premium with him on a 50-50 basis.
Since he was one of the most difficult of our 200 or 300 custom-
ers, he gave us quite a time on this thing. We refused, and so he
contacted a title insurance company and became an agent for his
own controlled business, and then hired somebody on a part-time
basis to operate the title insurance agency he established. The
upshot of this, interestingly, is that one of the partners in his law
firm, 1 year or 2 after that, called us up with an apology and asked
85-396 0 - 81. - 12
PAGENO="0178"
172
whether we would be willing to accept his work again, because he
preferred to do business with a professional, independent title
agency.
The fact is that with our customers, and we have hundreds of
them, I can afford to say no to a customer on a title problem. I can
afford to say no, if I know the title is not what it should be. But if I
was an employee of an agency owned by a broker or lender that
was directing the business to my company, I would be constantly
under a threat of job loss or economic coercion, or whatever, not to
let title problems prevent their deals from closing.
In contrast to the constant competitive pressures I am under to
maintain the quality and efficiency of the services we provide, title
insurance agencies that are owned or controlled by brokers or
lenders or attorneys operate under a totally different set of rules.
They don't have to worry about losing business because of the poor
quality of their service. Their business is virtually guaranteed by
those controllers of the business who are financially affiliated with
them.
Moreover, I have seen the effects of this in numerous controlled
business situations. Agencies controlled by savings and loans or a
real estate broker, for example, are inherently subject to pressure
to short cut their search and examination operations or to ignore
title problems that if disclosed might jeopardize or slow down the
consummation of the transaction.
Occasionally, this conflict of interest situation may result in even
greater disaster. For example, several years ago, a mortgage lend-
ing company which had obtained control of a title insurance
agency, ran into financial problems. In order to solve its cash flow
problems, the lending company sought to utilize the cash handled
by its controlled agency. Although the agency continued to issue
new title policies, it failed to pay off prior mortgage loans on the
properties involved. When this house of cards finally came tum-
bling down, hundreds of thousands of dollars in title losses were
suffered, losses that ultimately must be reflected in the premiums
paid by consumers.
As a matter of note, we have seen the claims ratio in our indus-
try constantly climbing. Our reserves are predicated on 100 years
of title experience, but 100 years of title experience where there
was independence on the part of title agents. I seriously wonder
what will happen in the future if controlled business arrangements
continue and title problems which are pushed to the side or
brought up as a very secondary thing by these controlled agencies,
finally come home to roost.
While the example I have just given may be a rather dramatic
one, it tends to highlight my point that all the parties to a real
estate transaction-the buyer, seller and lender, and the title in-
surer who ultimately stands behind the policy-have an essential
interest in the quality and independence of the person or entity
that performs the essential function in the issuance of that title
insurance policy.
If controlled business is allowed to continue, it is inevitable, and
we've seen this in a number of States, that real estate brokers or
mortgage lenders will end up dominating, gobbling up the title
PAGENO="0179"
173
insurance industry and the valuable role played by the independ-
ents, such as myself, will be lost.
The adverse impact on the integrity of real estate titles, on the
losses that will inevitably be suffered by title insurers, and on the
quality of the services provided to consumers will be clear. And
then everybody will ask how did we let this happen?
Before closing, I would like to make one additional point. I
believe that the prohibition of kickbacks and referral fees con-
tained in section 8 of RESPA was quite desirable and when enacted
had the effect of stopping many undesirable arrangements. The
lack of any meaningful enforcement of this section, however, has
greatly reduced its usefulness in prohibiting such arrangements. It
seems clear that criminal prosecutions, which are provided for
under section 8, are not the answer.
I believe the Justice Department has only acted in one or two
cases involving RESPA violations. And I believe it does not have
the resources to enforce this nationally. Therefore, I would like to
urge the subcommittee to consider alternate means of enforcing
section 8, including any amendments to be made to deal with the
broad problem of controlled business, by providing, for example, for
private rights of action by competitors. Rather than have to go
through an antitrust action as Clyda did, allow competitors to
enforce the Federal prohibitions contained in section 8. The legisla-
tion might also provide for administrative or regulatory actions by
State insurance departments and might encourage the use of indus-
try self-enforcement mechanisms.
I would like to digress for just one moment. We had a situation
in the State of New York, wherein part of our rate structure as
title insurance carriers provided for a 15 percent procurement
payment to be paid to an attorney or real estate broker. Prior to
1974, this was the standard way of doing business. RESPA was
enacted and declared that this was illegal. Section 440 of the New
York State insurance law also declared that this was illegal. The
title companies then reduced their rates by 15 percent, which
became from a consumer standpoint a bonanza. The consumers just
saved the money that was going into the lawyer's pockets.
Just one further small comment. This morning I heard the com-
ment made that kickbacks and controlled business are an efficient
way of doing business. I heard this from an officer of an agency of
the U.S. Government. I might think that kickbacks and controlled
business might be an appropriate way to do business in an Iranian
bazaar, but not as a part of the industry that I love and have great
feeling for and deeply respect.
I thank you for your indulgence.
[Mr. Peck's prepared statement follows:]
PAGENO="0180"
174
Statement of Gerald Peck
Before House Subcommittee on
Housing and Community Development
My name is Gerald Peck and I work in Carle Place, New
York. Although I have been serving for the last two years
as the Chairman of the Abstractors and Title Insurance
Agents Section of the New York State Land Title Association,
I am appearing today in my personal capacity as an inde-
pendent title insurance agent with almost 25 years' experience
in the title insurance business. lam a co-owner and officer
in two independent, full-service title insurance agencies
(Continental Abstract Corporation and County Abstract Co.)
that serve a ten county area in and around metropolitan New
York.
In the brief time I have today, I will not attempt to
cover all of the many aspects of the controlled business
problem that are discussed at great length in the ALTA white
paper. Rather, I would like to focus your attention on one
of the more critical, but frequently poorly appreciated,
problems that are created when the person or entity that
acts as a title insurance agent is controlled by or has a
financial affiliation with the broker or lender in the real
estate transaction.
The essential purpose served by those of us who are
engaged in the title insurance business is to guarantee the
PAGENO="0181"
175
security of investments made in real estate by home buyers,
mortgage lenders, investors and others. Of course, financial
indemnity in the event of a title loss is a significant
aspect of the financial proteótion and security we provide.
But because title insurance, which guarantees that a certain
state of facts (i.e., the nature of the rights being acquired
in the transaction) exists at the time the policy is issued,
is so fundamentally different from life or casualty insurance
(which provides for financial indemnity for losses suffered
as a result unforeseen future events), the foundation of our
industry's services is the rendering of a thorough and accurate
determination of the nature of the bundle of rights and
limitations on those rights -- that is the state of the
title -- that the parties will be acquiring in the trans-
action prior to the issuance of the title insurance policy.
Once those rights and limitations have been determined and
communicated to the parties involved, the buyer or lender is
in a position to determine whether to proceed with the
transaction in light of the title information disclosed, and
title insurance agents or insurers can determine what liens,
claims, or encumbrances may be insured against or what steps
must be taken to correct or eliminate any defects or
problems in the title prior to the consummation of the
transaction. Thus, the vast majority of the revenues
received by the title insurance industry are utilized for
these very important purposes of determining the state of
PAGENO="0182"
176
the title, resolving, where possible, those title problems
that are discovered, and determining whether certain liens,
claims or encumbrances can properly be insured against or
must be noted as exceptions to the policy's coverage. Accord-
ingly, in contrast to a life insurance agent, whose commission
is designed to compensate him for performing a sales function,
the portion of the title insurance premium retained by the
legitimate independent title insurance agent is intended to
compensate it for performing these very essential and time-
consuming functions in the issuance of the title insurance
policy.
These `risk-elimination" functions serve the interests
of all investors in real estate since they not only serve to
inform the parties about the precise nature of the title to
the property that is the subject of the transaction, but
they ensure that title insurance losses -- and hence title
*/
insurance rates -- are kept to the lowest level possible.-
These risk-elimination functions (i.e., a thorough and careful
*/ If those who are responsible for making the underwriting
judgments in the insuance of a title insurance policy have
done their jobs properly in searching and examining the
title and in making prudent underwriting judgments on the
risks that may be assumed, title losses should be kept to a
minimum. As New York Superintendent of Insurance Thomas A.
Harnett pointed out in a 1975 letter sent to several title
companies in New York:
"It is noted that title insurance theo-
retically should be loss free, since the
insured is not protected for defects in
title occuring after the date of the
policy. In developing a title insurance
rate, it is a generally accepted fact
that title losses will not exceed five
percent of premium income."
PAGENO="0183"
177
search and examination of the title combined with sound
underwriting of risks) constitute the foundation of our
industry's services and are provided in the context of a
real estate transaction where there are frequently con-
flicting interests among the parties (the buyer, the seller,
the lender, or their counsel)~ who are the beneficiaries of
these services. Thus, it is essential to the healthy
functioning of the title insurance industry -- and to the
various parties who are involved in a real estate trans-
action -- that these services be performed by competent,
independent, title insurance professionals who are not
subject to the conflicts-of-interest that can arise when the
provider of these services is owned or controlled by one of
the parties in the transaction. One of the most invidious
aspects of the growth of controlled business arrangements is
that such arrangements tend strongly to undermine this very
foundation of our industry's services.
The success I have been able to achieve in building my
own business has come not frOm offering kickbacks, stock in
my business, or other financial inducements to those
lenders, brokers or attorneys who utilize my companies'
services, but by offering first rate, efficient and thorough
service. All of the buyers, sellers, brokers, lenders or
attorneys who deal with my company know that, as a result of
the quality of our professional employees and our independence,
the title work will be handled in a highly competent manner,
PAGENO="0184"
178
and that we will always use our best efforts -- in the in-
terests of all the parties in the transaction -- to identify
and assist in the resolution of any title problems. Similarly,
the title insurance underwriters on whose behalf we issue
title insurance policies know that, while we will endeavor
to provide the best title protection we can for our cus-
tomers, we will be exercising sound and independent under-
writing judgment in determining the coverage of the policies
we issue on their behalf. Unlike controlled title insurance
agencies, which are assured of business because their owners
are in a position to steer their clients or customers to
that agency, our success is totally dependent on the quality
and integrity of the services we offer. I suggest to you
that the interests of competition and consumers are far
better served when the success of a provider of title
insurance services is determined by how well it has served
the interests of all the parties in the real estate trans-
action, rather than how effectively the stockholders of that
company can direct the business of their customers or clients
to that company.
In contrast to the constant competitive pressures I am
under to maintain the quality and efficiency of the services
we provide, title insurance agencies that are owned or con-
trolled by brokers or lenders or attorneys operate under a
very different set of rules. They don't have to worry about
losing business because of the poor quality of their service.
PAGENO="0185"
179
Their business is virtually guaranteed by those controllers
of business who are financially affiliated with them. More-
over, and I have seen the effects of this in numerous con-
trolled business situations, agencies controlled by a savings
and loan association or a real estate broker, for example,
are inherently subject to pressure to short-cut their search
and examination operations or to ignore title problems that,
if disclosed, might jeopardize or slow down the consummation
of the transaction. Occasionally, this conflict-of-interest
situation may result in even greater disaster. For example,
several years ago a mortgage lending company, which had
obtained control of a title insurance agency, ran into
financial problems and, in order to solve its cash flow
problems, sought to utilize the cash handled by its con-
trolled title insurance agency. Although the agency con-
tinued to issue new title insurance policies, it failed to
pay off prior mortgage loans on the properties involved.
When this house of cards finally came tumbling down,
hundreds of thousands of dollars in title losses were
suffered --. losses that ultimately must be reflected in the
premiums paid by consumers.
While this may be a rather dramatic example, it tends
to highlight my point that all the parties in a real estate
transaction -- the buyer, the seller, the lender and the
title insurer who ultimately stands behind the policy --
have an essential interest in the quality and independence
PAGENO="0186"
180
of the person or entity that performs the essential func-
tions in the issuance of the title insurance policy.
If controlled business is allowed to continue to grow,
it is inevitable that real estate brokers or mortgage
lenders will end up dominating the title insurance industry
and that the valuable role played by independent title
insurance service providers in the real estate settlement
process will be lost. As in the case of any disease that
strikes at the foundations of a structure, the consequences
may not be visible immediately. But over time the adverse
impact on the integrity of real estate titles, on the losses
that will inevitably be suffered by title insures, and on
the quality of the services provided to consumers will be
clear. And then everyone will ask, how did we let this
happen?
Before closing, let me make one additional point. While
I believe that the prohibition of kickbacks and referral
fees contained in Section 8 of RESPA was quite desirable,
and when enacted had the effect of stopping many undesirable
arrangements that had existed, the lack of any meaningful
enforcement of the section has greatly reduced its usefulness
in prohibiting such arrangements. It seems clear that
criminal prosecutions, which are provided for under Section
8, are not the answer, since it is impossible to expect the
PAGENO="0187"
181
Department of Justice or United States Attorneys to devote
significant resources to the enforcement of the prohibition.
Accordingly, I would urge the Subcommittee to consider
alternative means of enforcing Section 8 and any amendments
that may be made to deal with the broad problem of controlled
business by, for example, providing for private rights of
actions by competitors, for enforcement of the federal
prohibitions through administrative or regulatory actions by
state insurance departments, and perhaps, by encouraging the
use of industry self-enforcement mechanisms. I feel these
measures would have far greater deterrent effects than the
threat of criminal prosecutions.
Thank you and I am prepared to respond to any questions
the members of the Subcommittee may have.
Chairman GONZALEZ. Thank you very much, Mr. Peck. We
deeply appreciate your testimony.
We will proceed with Mr. Richard Bossard, president of the Title
Co. of Billings, Inc., Billings, Mont.
STATEMENT OF RICHARD C. BOSSARD, PRESIDENT, THE TITLE
CO. OF BILLINGS, INC., BILLINGS, MONT.
Mr. BOSSARD. Mr. Chairman, members of the subcommittee, my
name is Richard Bossard and I am a businessman from Missoula,
Mont. Together with several other investors, I own four successful
title companies serving Missoula, Ravalli, Sanders, and Mineral
Counties in Montana. We also own a fifth title company that was
forced to close its doors when it could not survive in a market
dominated by controlled business arrangements.
I would like to share with you today our experience when we
entered the Billings, Mont. market and competed with a broker-
owned title company there.
In early 1978 we began to investigate the possibility of establish-
ing a title company to compete in the Billings market. Then, as
now, only three companies, including First American Title &
Escrow of Billings-or "Fatebill" as it is called-were active in the
Billings area.
Our experience and market research indicated that the Billings
market provided excellent prospects for a new entrant. According-
ly, on August 15, 1978, we~ incorporated the Title Co. of Billings,
Inc., and a few months later began our operations.
Unfortunately, we failed to appreciate fully the effect that con-
trolled business would have on our ability to compete for business
in Billings. Fatebill, a title insurance agency organized as a cooper-
ative and all of whose members are real estate brokers in the
Billings area, was originally organized in 1974. While it initially
PAGENO="0188"
182
had oniy 11 percent of the market, a 1979 report on title insurance
and controlled business in Montana prepared for the Montana
Commissioner of Insurance found that by 1978 Fatebill controlled
more than 50 percent of the market in Billings. In fact, our own
employees in Billings at that time estimated that its market share
was closer to 70 percent.
Fatebill was able to capture such a large market share not
because it offered lower prices or better service, but because its
real estate broker-owners were able to exercise very effective con-
trol in steering the title-related business of their buyers and sellers
to it.
The hearing officer who prepared the report found-
* * * although given ample opportunity at the hearing to rebut that fact, Fatebill
presented no testimony or subsequent statement for the record setting forth reasons
for its phenomenal growth-such as better service-other than broker control.
Fatebill's broker-owners had a strong incentive to steer title
business to the controlled agency because Fatebill's bylaws pro-
vided that only real estate brokers could be members of the cooper-
ative and that "patronage refunds" were to be paid to members
based on the amount of business referred to the cooperative.
In plain English, each real estate broker received a cash
"refund" of a portion of the charge for title services paid by the
consumer whose business the broker had steered to Fatebill. Some
brokers were rumored to have received refunds totaling as much as
$50,000 in a single year.
We soon discovered the stifling effect that controlled business
has on competition when we attempted to solicit business for our
company. Some brokers informed us that due to the financial bene-
fit that they received from directing business to Fatebill they had
no intention of referring business to our company and we should
not bother to contact them again.
Other brokers were more polite and advised us that although
they recognized that we could provide faster and better service
than Fatebill, they still would not refer any business to us because
of their financial relationship with the cooperative.
In any case, the result was the same-we could not compete for
business because the controlled business tie was too strong. The
control that the brokers who were affiliated with Fatebill exercised
over the decisions of their customers was so strong that even the
lending institutions in Billings who believed we could provide supe-
rior service were unable to recommend business to us. Several of
these lenders told us that brokers threatend to refuse to refer loan
applicants to them if they did not permit the brokers to direct the
title business to Fatebill.
Of course, we were not the only one hurt by this controlled
business situation. Consumers and other purchasers of real estate,
who depend on a title company's independent assessment of the
rights they will be acquiring in real estate transactions, were also
hurt.
One example that we brought to the attention of the hearing
officer who prepared the 1979 report to the Montana Commissioner
of Insurance demonstrates this point. In a transaction that had
been brought to our company, the preliminary title insurance com-
mitment set forth, as an exception to the title, certain covenants
PAGENO="0189"
183
and restrictions that had the effect of prohibiting the type of
commercial activity that the buyer of the property intended to
engage in.
When the real estate agent, who we understood was a member of
the Fatebill group, saw this preliminary commitment, he said that
if his title company had been used the restrictions would never
have been shown and the transaction could have been completed,
rather than failing as it did, because the buyer appreciated the
significance of the disclosure.
Clearly, anyone who buys, invests in, or lends money on real
estate is ill-served when the title company, which is supposed to
provide the parties with an independent assessment of the nature
of the title that can be insured, is subject to conflicting pressures
by its owners to "bury" any "problems" that are discovered.
We tried to hang on in the face of this controlled business
activity while we waited for government agencies to take some
action against what appeared to us to be clearly anticompetitive
and anticonsumer arrangements.
Our views on the unfair nature of the financial relationships
between the brokers in Billings and Fatebill were confirmed in the
1979 report to the Montana Commissioner of Insurance that I
mentioned earlier.
The conclusion in that report attracted considerable press atten-
tion, and I would like to submit for the record two of the newspa-
per clippings discussing that report and the impact of controlled
buiness, in Billings.
Chairman GONZALEZ. Without objection, so ordered.
Mr. BOSSARD. Despite the recommendation of the hearing officer,
however, the State commissioner of insurance declined to take any
action against Fatebill. Similarly, investigations of Fatebill by the
FBI and by HUD have failed to produce any action.
At the time of the Montana Department of Insurance hearings in
1979, our company submitted a letter, which I would also like to
include in the record of this hearing, describing the effect that
controlled business would have on the interests of consumers. We
said then:
Another consequence of controlled business activity * * * [is] that the consumers
in Yellowstone County will in the long run suffer by the lack of competing title
service. The only competition which exists in Yellowstone County at the present
time is between the other title companies for the remaining 30 percent of the
market not totally controlled by First American. That 30 percent is not sufficiently
large enough, in my opinion, to maintain or justify the continued existence of three
other independent agents. As a consequence, one or more of those agents will
probably go out of business if the controlled business situation continues in its
present form. Further, it is my belief that if allowed to continue, First American's
percentage of the Billing market will probably increase making even smaller the
market share available to the remaining agents.
Our prediction proved tragically correct for our own company.
On October 15, 1980, approximately 2 years after we began to do
business in Billings, we were forced to close our doors.
Today, Fatebill continues to control the overwhelming portion of
the market for title services in the Billings area and continues to
recruit additional real estate brokers. Approximately 65 brokers in
the Billings area are currently members of Fatebill, comprising
approximately 75 percent of all real estate brokers active in the
Billings area. The two remaining noncontrolled title companies in
PAGENO="0190"
184
Billings are left to compete for the ever-shrinking share of the
market not controlled by real estate brokers affiliated with Fate-
bill.
Obviously, had we been aware, when we entered the Billings
market, of the number of brokers who were financially tied to
Fatebill and the strength of that financial relationship, we would
never have invested the several hundred thousand dollars that we
spent trying to break into the market.
Perhaps more to the point, had it been clear that Congress, the
Department of Housing and Urban Development, the Department
of Justice, and the Montana Insurance Commission would permit
this kind of controlled business activity to continue without inter-
ference, we would have realized that our efforts to bring more
competition to the Billings market would inevitably prove futile.
I simply cannot understand how our Government can permit
these kinds of arrangements to continue, particularly in the face of
mounting evidence that the problem is one of nationwide propor-
tions.
I now fully appreciate the wisdom of the hearing officer for the
Montana Department of Insurance, who was a former deputy com-
missioner of insurance in California and who had seen the abuses
caused by controlled business in that State, when he concluded in
his 1979 report:
"The question of licensing persons who control the flow of title
insurance as title agents is a major national issue and one which
cannot, and should not, be ignored."
Something must be done about this problem, and only Congress
has the ability to take the necessary action before all independent
title companies are driven out of business and the public is de-
prived of the benefits of the competition they provide.
[The newspaper articles referred to by Mr. Bossard and a letter,
dated July 18, 1979, from Zane K. Sullivan, president and general
counsel, American Land Title Companies of Missoula, Ravalli,
Sanders, and Mineral Counties, submitting testimony on aspects of
controlled business in the title insurance industry in Montana,
follow:]
PAGENO="0191"
Dy MIKE ARCHBOLD
Of The Gazette Staff
Billings Real Estate Broker Stu
Henkel calls it "immoral and illegal."
Otarles Gamble, a fellow Billings
real estate broker, says, "I don't see
anything ~ong with it. There are some
sharp legal minds that agree."
"It" is American Title and Escrow
of Billings, more precisely its organiza-
tion as a cooperative owned by the ma-
jority of local real estate brokers who
share in the annual profits, if any.
Henkel, not a member of the
cooperative, and Gamble, a co-op mem-
ber and board director, represent the
two viewpoints that have developed in
Montana and elsewhere in the nation
over the issue of real estate agent-con-
trolled title insurance companies - a
legal,,and ethical gray area that is worry-
ing state insurance commissioners and
the U.S. Department of Justice.
In its simplest form~ title insurance
is a method to protect the public against
uncertainties, such as liens against prop-
erty or disputes over ownership, inher-
ent In almost all real estate transac-
tions. A policy on a $50,000 home costs
about $230 and Is paid for in a lump
sum, generally at the time the transac-~
tion Is closed.
What is legal profit-sharing to sup-
porters is an illegal rebate or kickback
to opponents.
What is nothing more than the
free.enterprise system to supporters is
unfair competition and a violation of
anti-trust laws to opponents.
Complaints from other Billings
area title companies about American
Title and Escrow (formerly First Arner-
ican Title and Escrow) prompted an
"extensive" FBI investigation last fall
of the Billings co-op.
That investigation is completed and
in the hands of the U.S. Justice Depart-
ment in Washington, D.C., for review,
according to Jay E. Bailey, special
agent in charge of the Montana-Idaho
Division of the FBI.
Neither the Justice Department
nor Deputy U.S. Attorney Robert Zim-
merrnan in Billings would comment on
the investigation or whether it will re-
sult in any legal action, A federal grand
jury will be convened in Butte on
March 25 but it is unknown whether
American Title and Escrow will be on
the agenda.
Complaints also launched an inves-
tigation last summer of title insurance
companies statewide by state Auditor
and Insurance Commissioner E.V. Om-
holt. Hearings were held, testimony
taken and a report issued.
The report, done by Roger McNitt,
then a deputy insurance commissioner
in California and now in private law
practice in San Diego, was critical of
American Title and Escrow's real estate
broker ownership and recommended
that Omholt investigate the company
further for possible violation of federal
and state laws.
It was McNitt's opinion that the
profit sharing or `patronage refunds"
from American Title and Escrow to Its
membership brokers amounted to a
kickback and therefore were illegal
under federal law, and possthly under
state rebate laws. He urged "harsh and
swift" action against any title insurance
companies where rebating is detected.
McNitt said last week in a tel-
ephone interview that the issue is le-
gally a fuzzy one and there are ques-
tions about how far a state can go to en-
force anti-trust laws.
Contacted last week, Omholt said
the report has been referred to a Na-
tional Association of Insurance Comrnis-
sioners' task force on real estate agent-
controlled title insurance companies, of
which Montana is a member.
"We are putting it under a tremen-
dous amount of study," said Omholt.
"We want to be sure our feet are plant-
ed in the right direction. There are two
sides to any argument and I don't want
to go off half-baked, particularly when
you have something like this of national
significance."
185
(The Billings Gazette, March 16, 1980)
Title insurance . dispu te
still unsettled
PAGENO="0192"
186
Omholt said the report was only
the beginning of an investigation, add-
ing that the task force may come up
with proposed regulations this summer
and legislative regulations which could
be presented to the Montana Legisla-
ture in January.
State Deputy Insurance Cornrnis-
sioner Josephine Driscoll said she didn't
think the Billings co-op was adverse to
the public interest, nor did she think the
co-op could be construed as having a
monopoly in Yellowstone County.
However, she did indicate that
most people agree such `controlled bu-
sinesses could lead to problems,' add-
ing that something should be done to
protect against them.
Zane Sullivan, owner of Insured
Titles Inc. in Missoula and formerly
with American Land Title Companies,
was extremely critical of the Billings co-
op at the hearings. He explained at the
hearing that an attempt by American
Land Title to open an office in Bithngs
was defeated by the broker-controlled
co-op.
Though no longer involved In thE
Billings area, Sullivan said the co-op i~
an immediate threat to the free-enter
prLse system of competition and a long
term threat to quality service as the co
op garners an ever larger share of thi
title insurance market in the area.
Managers of the three other 11th
insurance companies in Billings toll
The Gazette that they agree.
"I feel it is wrong, at the very leas
a conflict of interest," said Robert T
Brown of The Title Company of Bil
lings. "Believe me, if I thought it wa~
right, I would be doing it."
Despite the co-op's claim that it I
simply returning profits to its member~
Brown said it is as simple as a real:es
tate agent collecting $200 from a den
for title insurance, taking the roone:
down to American Title and Esci:cw
and then pocketing $50 of his ciei~t'
money as his share of the business. -
Brown said that Is unfair
competition because the pub-
lic rarely shops around for
title insurance and relies on
the real estate agent's recom-
mendation.
"Maybe I'm dumb and
naive but there's got to be
some Justice," he sald,ad-
ding he would like to see a
legal determination one way
or the other, -
"We'd all like to see a de-
termination," said Richard
Brown of Safeco Title Insur-
ance Co.
Allen Leppink of First
Montana Co. of Billings said
if the case isn't presented to
the Butte grand Jury, he
thinks it will die. If that hap-
pens, he said, an attempt will
be made to get hold of the
FBI investigation.
Gamble, however, dc-
fends the arrangement, ex-
plaining that the co-op gives
quality service and none of
the "stockholders" are in-
volved in running the busi-
ness itself.
He said that he advises
clients about his interest in
the coop, adding that he also-
sends title insurance policies
through other companies in
town.
Don Fioberg of Floberg
Realtors, a co-op member
and board member, said both
state and federal officials ap-
proved the organization when
it was first set up. "If some-
one proves it Isn't legal now,
my resignation would be in
the mall," be said:
* ~Hé said both the profits
* and the losses of the eons-
pany are distributed tothe
members. - - - -
* Though he agreed the
company has nearly a 50 per-
cent share of the Utle Insur-
ance market locally, Floberg
said that Is a matter of ggēd
service. "if we have a geod
company, should we fold~p
because our competitors are
upset?" he asked.
He said information about
the distribution of co-op prof-
its is confidential but said it
"was substantial enough to
make it worth t~ hassle of
going to co-op meetings."
Non-member real estate
agents report that some of
the co-op's large brokers
have received more than
$20,000 to $50,000 a year.
Asked about those figures,
Gamble said he wasn't aware
of the total profit picture but
said the amounts seemed
very high..
PAGENO="0193"
187
(Great Falls Tribune, October 10, 1979)
Investigator recommends
probe of Billings title firm
Thbuae Capital Bureau Evidence at a June hearing mdi- `quality When the title company iioeo.'
HELENA An investigation di- cites that First American grew from trolled by real estate agents who may
tected by State Auditor Sonny Omholt 11 percent of the Yellowstone County be more concerned, with closin$ th.
concludes that a cozy, but illegal, ar- market in :1974 to 52 percent in -1978. deal than the quality of the title.
4ringement may exist between reaJ ea- `Competitors complained at the hear- `,, He said his ėompany had Issi4d'Q
sate brokers and a Billings title com- ing that the substantial growth Was preliminary commitment setting forth'
patsy, Including boycotting of other due to broker control. And First covenants and restrictions on a piece
cempaflies and kickbacks to the brok- American presented nothing to rebut of property that had the ~ffect iI pro-"
era. that claim, although given ample op-. hibiting the typo of commercial lefty-
- Roger McNitt, a San `Diego atter `portunity, McNitt says. - ity intended by the buyer. The real is-
y retained by Oniholt. recommends Zane Sullivan of Miasoula, presi. tate broker involved said had he base
fo a report released Tuesday that Om' dent of the competing American Land allowed to use his title company, tba.
bolt investigate the alleged antitrust Title Companies, contended in a sub- covenants, though a matter of pdbtie
~aspects of First American Title & Es- sequent letter that First American's record, would never have been shown
crow of Billings and take stops to re- dominance of the Billings market, and the deal would have beep ~-`,
verse any kickbacks. -Which he puts at 70 percent, has all pleted, Sullivan says. `
McNitt also recommends that Om- - but frozen his company out of Bil- ` Kickbacks are prohibited by kd-
bolt take a close look at all the big lings. eral law, McNitt notes, and he says
title companies in the state and in- He says brokers told his employees any "patronage refund" from the title
,`veke "harsh and swift" disciplinary not to bother because they receive an company to its member-brokers
action on any found to be giving se- `annual dividend from First American amounts to a kickback.
bates to real estate brokers, lawyers, based on how well First American is
* developers, lenders or others sending doing. Had he known that, his corn-
business to them. Suspension of ii- pany wouldn't have committed sev-
censes would be appropriate for the - end hundred thousand dollars in an
slow learners, McNltt ~, attempt to enter the Billings marjtet,
McNitt says First American is dif- Sullivan says.
- ferent from other title companies in Sullivan cited an example of the
that it W55 organized as a cooperative theory that title insurance record
in 1977. Its membership is limited to keeping and reports may suffer in
real estate brokers, who receive a dis-
tribution of the entire net earnings of
the business each year.
First American previously oper-
ated as a partnership and distributed
earnings based not on partnership
contributions but on business directed
to the company by each partner, Mc-
Nitt says.
85-396 0 - 81 - 13
PAGENO="0194"
188
~fljE.'~iaC~ J1aizcIEfitL~ eor~~
MISSOULA o RA VALLI e SANDERS ° MINERAL
COUP~TIES.
July 18, 1979
Mr. Roger L. ~Nitt
~edrrnn, Sohlberg & Lewis, Inc.
3252 5th Avenue
San Diego, California 92103
RE: Public Investigative Hearing on Title Insurance
~partrr~nt of Insurance, State of M~ntana
Mr. Hearings Officer:
The following iiaterial is su]~ttth as written testi~ny on
the aspects of `con~ol1ed business in the title insurance industry
within the State of Mmtana. The undersigned, as president arid
general counsel of the following corporations, P~rican Land. Title
Co. of Missoula, ~ii~rican Land Title Co. of Sanders County, knerican
Land Title Co. of Ravalli.County, Pmerican tend Title Co. of Nineral*
County, and The Title~Cy~of Billings,.wishes to~ su~t the
following responses hec.SSioner~of~flsuranc~s irēuiry
concerning con o1led.,~siness `~
- ` -
*l~ .~D~es 11ed:bisinass"~ constitute ~t undefined. uzifair
trade practice (33-18-1003 M~) boycotting (~3-l8-303 1~I~A)
rebating (33-18-210, MA) ,~i±npropersbar~ng of..c~cissicn (33-17-1103,
I'~A), or any other act or practice.~ic1tLis..r1Ot~ in the best interest
of thepublic?
"C~troUed. business" certainly does ~d.st at the present
in the State of M~ntaria and within the title; Lnsurallcein.stry--speCi-
ficaily within Yellowstone: County, Y~nt a:~-~~
Within the last sixi~nths ~fiave been att~ting to establish
a new title insurance agency in Billings, Yellowstone County, 1~ntana.
It has been our experience in this ven~e that al]. of the things
mentioned by the econ~.st testifying orally during the June 26th
and 27th sessions of the hearings have been found to be true. The
Yellowstone County mericet area contains a population of appro~dmetely
125,000 arid at the time of our att~ted entry into that naxhet there
were three e~cLstirig title ccxapanies. Under all other circu.nistancas
r~rmal to the title business within the State of ~bntana, such a
ratio of title agencies to population w~uld indicate a conducive
a~rnsphere to the establishnent of a new agency. Hc~ver, the
experience we have had in that ccnnarnity in carpetition with the
First American Title & Escrow Agency has certa1i~1y evidenced the
"chilling effect" referred to by Mr. Plotkin during his testitxuny.
As previous testinxny has evidenced, the First American
Title & Escrow Agency in Billings, M~ntana~ is a ]~`L)r1tana cooperative
corporation organized under the laws of the State of M'ntaria and
isoula, Mootono 89807 Ramflton. Montxao 59840 Tho,~p,oo Faflo. Montono 59873 Sopsz~or. Moulo'ao 598
~t Spruce - P.O. Box 7546 223 South lit Street -Drowor 860 406 Mob Street - P.O. Box 850 P.O. Box 788
(406) 728-4443 (406) 363.2340 (406) 827.3391 (406) 8223391
PAGENO="0195"
189
has as shareholders a large percentage of the real. estate brokers
residing and doing business in Yellowstone County. Con~ary to
the tescix~ny of one wthiess during the recent hearings in Helena,
it is my belief and understanding that the First ~Azrerican Title &
Escrow Caipany in Billings holds closer to a 7O7~ share of the
Existing title insurance market in that locale rather than 5O'/~
of the merket as was alluded to.
The "chilling effect" referred to has becar~ evident to our
organization through ~periences in att~tirig to ccxI~ete in the.
cocniunity. Specifically, ~loyees of the corporation, in att~ting
to obtain title insurance orders within that coaizi.mity, have
contacted a rn.niber of real estate brokers, salespersons, etc. to
advise than that we were engaging in title services in that cctia~iity
arid were interested in providing fast quality service for their
title insurance needs. In s~ instances, our personnel were
advised that the broker and the agency received a dividend pay~lt
frczn a First American Caopany on an ~~ial basis in an ~xtt
reflective of the a~unt of business directed to the First American
office during the course of the preceeding year and due to the
financial benefit being received by the broker we. should riot
bother to contact the office again because they had no intention
of doing business with anyone other than First American. In
other instances, our personnel were received in a mare friendly
manner and were advised that although they ~p1d appreciate the
faster service that we might offer and the mare personal form of
contact, they ~uld riot be doing any business with us because of
the financial c~mit~nt with the First American office.
Suffice it to say that had we known at the outset the
percentage of the local real estate agents who were financially
tied to the First American office and the strength of that financial
caiim~~nt we. certainly ~uld not have invested the several hundred
thousands of dollars that we presently have conmitted in an att~t
to enter the Billings market.
Another consequence of controlled business activity as stated
by Mr. Plotkin convinced me that the consuners in Yellowstone County
will in the long run suffer by the lack of carpeting title service.
The only coupetition which exists in Yellowstone County at the
present tine is between the other title caipanies for the ranaining
307, of the market not totally controlled by First American. That
307, is not sufficiently large enough, in my opinion, to maintain
or justify the continued existence of three other independent
agents. As a consequence, one or mare of those agents will probably
go out of business if the controlled business situa~icn continues
in its present form. Further, it is my belief that if allowed to
continue, First American's percentage of the Billings market will
probably increase making even m~aller the market share available
to the rare.ining agents.
In light of the foregoing cixrrnents, it is my opinion that
"controlled business" as it exists in Yellowstone County, certainly
constitutes an undefined, unfair trade practice described in Section
33-18-103 of the ~bntana Code Annotated and is mast definitely riot
in the best interest of the public.
PAGENO="0196"
190
I wish to fi. ~ner point out another itan ft our experience
in Yellowstone County which supports the position taken by Mr. Plotkin
as to the effect of controlled business upon a title insurance indestry
within a given area. Mr. Plotkin's testimeny describes that if the
title insurance business of an agent in a given locale is controlled in
w1-~le or in part by a real estate group w1~se prinary concern ray be to
collect cath~ssions rather than to insure that quality real estate
trarisactions~are conducted, the quality of the title insurance
recordkeeping and report aspects of the business ray tend to deteriorate.
I believe evidence of this situation is already apparent and
existing in Yellowstone County. In one transaction which was directed
to our Yellowstone County office, the title insurance preliairiary
c~initoent set forth as an exception the covenants and restrictions
applicable to the property, the effect of which seens to prohibit the
type of ccxrrnercia]. activity in which the buyer intended to engage.
Upon seeing the report and exani.ning its content, the Yellowstone County
real estate agent, who is understood to be a menber of. the First American
group, rade the c~nt that bad he been allowed to use his title ccxrpany
the covenant never ~culd have been shown and the transaction could have
been c~leted rather than failing as it did due to this disclosure.
If the real estate agent can control the content of the title
cc~imitr~nts, certainly it wauld seen to follow that the r~inder
of service and quality of product wauld otherwise deteriorate the longer
the controlled entity continues to operate in its present form.
2. - Should the cotrmissibner praalgate rules restricting controlled
business in the area of title insurance?
The Ccximnissioner should pr~ii].gate rules restricting controlled
business in the area of title insurance. The ccnniissioner has the
authority to pron.ilgate such rules and regulations as ray be necessary
pursuant to the authority granted by Section 33-1-313 of the M~ntena Code
Annotated. The pro~ailgation of the rules and regulations ~uld be
preferable to att~pting to enact specific legislation to counter controlled
business.
This belief stons frcxa the ~erience testified to by the
respresentative frcxi the Oregon Insurance Ccuinissioner' s Office. It
is recalled fran that gentlenen's testimeny that although they considered
establishing rules to restrict controlled business activities due to the
political climate of their state, they chose to seek legislation to
control the s~ activity. However, the insurance cc~iinissioner' s office
~s apparently unsucce.ssful in its att~t to have the legislation passed
due to the tr~ndous opposition generated by the controlled business
entity.
I certainly believe the sane result ~uld prevail in Mnntana
if the insurance connissioner's office attampted to go the legislative
route rather than the rule making alternative.
3. - Is there c~etition for the consuner's title insurance dollar?
At the present time in Yellowstone County, Montana, there is
little carpetition for the consure.rs' title insurance dollar. Th.~e to
PAGENO="0197"
191
the circunstances reL 3 above, the three title Inst ice agencies
operating in that county which are not cooperatives c~ete strongly
for roughly 3C170 of the available title insirrance market. AmDng those
entities, there appears to be the normal caTpetition which is
typically found in mast areas of the state where controlled enterprises
do not exist. However, in approximately 7O7~ of the market there is
virtually no ccnipetition for the consumers' title insurance dollar
since as previously stated the real estate brokers who are participants
in the First American Title & Escrow Agency direct their business to
their organization to the total exclusion of the other companies.
4. - How does the consuner make his choiae?
In the Yellowstone County market area, the cons~r epparently
does not have a cboice as to the title c~any to be utilized in the
tran.~action. The methed of placing the title order appears ~t:o be
different depending upon whether the real estate agent is a member of
the controlled business entity, First American Title & Escrow, or is
an independent in all senses of the ~vrd and utilitizes the other three
title companies within that ccxniunity. In the first instance, the
constzne.r is in some manner directed to First American. It is unknown
whether or not a discussion is had between the broker, salesperson, and
client or whether the order is merely placed with First American Title
& Escrow without the buyer or seller being consulted in any manner. I
do know from conversations with area lenders that no discretion is left
to the lending institution where a broker involved in First American is
concerned.
In MLssoula County, if the real estate agent, seller, or buyer
e~qresses no preference where the title insurance order is to be placed,
the lender will frequently place the order where they have received the
best service, quality of product, etc.
In Yellowstone County, the lenders indicate that if they att~t
to place the title orders with any of the three independent companies and
not the First American Title & Escrow Company, the broker involved, if a
First American participant, will almost always adanantly reject the
overture to any other company and denand that the order be cancelled and
the order replaced with First American. The strength of the derund made
by the broker placing the order with First American and directing that
the lender comply with this request is so strong that the lenders have
indicated the application was terminated at the request of the broker
* and the customer taken to a different lender if the lender refused to
comply with the plac~nent of the title order to First American.
5. - What is an acceptable percentage, if any, for ownership or
control of a title insurance plant by a producer(s) of title business?
AND
6. - What is an acceptable percentage, if any, for business of
a title insurance plant referred by producers of title business having
a financial interest in the plant?,
I do not feel that ownership of a title insurance plant by a
producer of title insurance is necessarily bad, per se. I do believe,
however, that the utilization of that facility by the producer and the
direction of title business generated by the producer to that entity
is a tromendous evil in and of itself.
PAGENO="0198"
192
The test m~n1 .,f Dr. Plotkin described the mitial harm to
the connaner and to the title inst~ance industry fron buch a situation
and I conc~ with his c~cnents totally. If a producer is allowed to
refer title business to a c~any in which financial interest is
maintained, I do believe that in any event it should not ~ceed 107, of
that producer's total business including the business generated by associates
of that producer. Dr. Plotkin made reference to IL~fl~jng the cow fran
the wrong end' and I certainly c~r~ot argue with his position but I en
exceedingly concerned that specific attention needs to be given to the
`total end result of the controlled business activity and not to just
the ownership aspect.
* For example, it is my ucderstanding that the M~ntama Insurance
Ccximissioner' s Office has cont~1ated placing a restriction upon the
~unt of business a producer who is an owner of a title c~any could
* do with that title ccmpany. It f~ther is my umderstanding. that no
restriction ~uld be placed on the ~umt of business that the associates
of that producer could do with that ccmpany. I en ~avely concerned that
this, if coi-rect, ~vuld lead to a tr~idous injustice to the other
independent c mariies operating in the area of that controlled business
entity. The reason for my concern steas fran the iciowledge that producers
~ho are associated with the controlled business entity are frequently
the broker-owners and that the several salespeople wnrldng in that
office, who are termed in nnst instances to be "independent contractors",
generate far mere business for the controlled entity than what the
producer/broker ever does. For this reason, I en concerned that
controlling the activities of the broker and not the salespeople in the
office as well would result in minimal regulation.
In summation, Dr. Plotldn nmst vividly detailed before those
present at the hearing the circumstances in which a controlled business
entity thrives mid the detrimental harm which probably will result fran
the continued activities of such an entity if allowed to persist. I
have had a first hand opportunity to view the very things of which he
spoke and believe that the potential evils described are presently
e~cLsting and ~owing in Yellowstone County, Montana.
I urge that the Ccenissioner of Insurance take irrmediate action
to pron.ilgate such rules and regulations as may be necessary to curtail
the activities of controlled business entities throughout the State of
M~ntana, to prevent their spread, and to insure the quality of product
and business afforded by title insurance agents throughout the state to
the consuming public.
~
SULLIVAN
and General Counsel
PAGENO="0199"
193
Chairman GONZALEZ. Thank you, Mr. Bossard.
That is precisely why we have insisted on these hearings this
early in September and from the very beginning set this as one of
the areas of priority concern for the committee.
Next we have Mr. Stephen Daley, the president of the Inter-
county Title Co., of Illinois, from the great city of Chicago, Ill.
STATEMENT OF STEPHEN D. DALEY, PRESIDENT,
INTERCOUNTY TITLE CO., OF ILLINOIS, CHICAGO, ILL.
Mr. DALEY. My name is Steve Daley, and I am from the Chicago
area. I am also the author-compiler of the buff-colored book distrib-
uted to the subcommittee.
My fellow panel members have accurately described most of the
real world problems of controlled business, but I would like to
point out another inevitable result of controlled business and that
is, in my opinion, the bankruptcy of the national title insurance
industry or, at the very least, of most of the national title insur-
ance companies.
In addition to the resulting harm to the insureds, the homeown-
ers, the investors, and the lenders who have no place to turn
except to the trustee in bankruptcy, the certain result will be the
elimination of the marketability of real estate in the United States.
I will have more to say about this frightening conclusion a little
later.
With Chairman Gonzalez' concurrence, I would like to summa-
rize my written testimony.
Chairman GONZALEZ. Certainly, sir.
In fact, if all of that information is available to include in the
permanent record, your presentation shall be incorporated, as you
presented it to~ us, into the record.
Mr. DALEY. Thank you, sir.,
For those of you that are following my written testimony, I am
now on page 9.
Controlled business has really just begun to grow in our market-
place. The most devastating such entry has been Coldwell Banker
Title Services, which is a realtor-owned title agent in Du Page
County, Ill. Du Page County is Illinois' second most populous
county, with a population in excess of 650,000 persons. Coldwell
Banker Realty Co., is thought to have about a 20-percent share of
the residential marketplace in Du Page County or, to look at the
numbers another way, is involved in one in five residential transac-
tions in Du Page County.
According to a local Coldwell executive, their success rate in
obtaining the title orders on the transactions in which they are
involved as broker is about 55 percent, which converts to an 11-
percent share of the Du Page County title marketplace.
Their method of marketing the title product depends upon
whether Coldwell is the listing broker or the selling broker. If they
are the former, the listing agent, the title is placed with their title
agency at the listing stage. If they are the latter, the selling
broker, a title order is placed with their title agency shortly after
the contract between seller and buyer is signed. In either case,
shortly after the contract between seller and buyer is signed, the
SOP, the standard operating procedure, is that a Coldwell title
PAGENO="0200"
194
commitment is sent to the lender, the attorneys, and even to the
other broker if there is one.
Included within the broker's network of companies is a mortgage
banking company, and that company sends almost all of its busi-
ness in Du Page County to the captive title agency.
While the policymaking officers of Coldwell may not be forcing
their employees to steer every deal to their title agency, we can tell
you that many of the Coldwell personnel feel the pressure to do so
and are unhappy with, to use their words, "being forced to use the
Coldwell Banker Title Co." Many would prefer to do business with
other companies, but feel their job is on the line if they don't
cooperate in steering their customers to the Coldwell Banker Title
Agency.
We have had the same responses from lenders who rely on the
Coldwell brokers for referrals. They would prefer not to accept the
Coldwell title product, but feel that their refusal may jeopardize
their relationship with this volume producer of real estate deals.
Coldwell claims this is competition, but I say it is just the oppo-
site. Neither my company nor any of my competitors can sell our
product to the customers of Coldwell Banker brokers, even if our
product is better or cheaper than that of Coldwell Banker Title
Services.
The second instance of controlled business involves one of those
83 title agencies that was mentioned this morning, one owned by a
savings and loan service corporation. This particular savings and
loan steers the title business generated by its loan activity to its
title agency. The steering became very evident to us when the
savings and loan acquired a lender who was a regular customer of
ours.
Prior to its acquisition, we received most of the business of First
Calumet Savings and Loan Association. In 1978, that amounted to
101 orders. In 1979, there was 145 orders. The acquisition occurred
in the first quarter of 1980, and since then we have received only
14 orders. Since the acquisition, we have been shut out of that
market for all practical purposes, as have been our competitors.
While one title policy does not conclusively prove the invalidity
of this agent's product, we have seen one policy, and that one
reflects an incorrect status of title.
We were subsequently asked to bring down title on the same
parcel of land and found that the agent had missed the recorded
restrictions which affected the land. While we suppose the omitted
title exceptions are not that crucial-unless, of course, the insured
wants to build a garage or addition-this product of the savings
and loan's title agency is certainly an indication of faulty title
work. Copies of both work products are included in the book.
A third such incident involves American/Invsco or a subsidiary
thereof. Apparently this condOminium investor is now in the title
insurance business and is guaranteeing the titles on the projects in
which it is also the seller. The only way that such a deal makes
any dollar sense is that American/Invsco is writing its sales con-
tracts to require its buyers to pay for title costs which would
normally be paid by American/Invsco in our area.
A fourth such instance involves a nonrecurring problem of con-
trolled business because the main participant is currently under
PAGENO="0201"
195
Federal indictment. This scam involved an individual who owned a
small title insurance agent ąf USLife Title Co. of New York and
who operated in one of our suburban counties. The agent also
owned an interest in a small builder.
As many builders do, the small builder ran into cashflow prob-
lems, which were resolved in part by the title agent who closed two
transactions at his company without paying off the construction
mortgages. Of course, clear title policies were issued to the insured
and USLife Title paid $280,000 because of the conflicting interest of
its agent.
At the beginning of my testimqny, I concluded that an inevitable
result of controlled business would be the bankruptcy of the title
insurance industry.
The committee may be interested in knowing that the total
statutory reserves of the top 13 title insurance companies in the
United States were, as of December 31, 1980, only some $293 mil-
lion. These reserves were established on the basis of historical
experience, which, in turn, is based upon an underwriting posture
of sound and independent underwriting and prudent assumption of
risks; $293 million is probably adequate if sound underwriting and
risk avoidance are the goals of the producer of the title product.
It is reasonable to assume, however, that the usual controlled
business agent is not interested in risk avoidance. And now that he
has effectively eliminated the traditional policeman, the independ-
ent title company, almost all deals will end up closing.
To put my fears in better perspective for you, my company alone
will annually write title policies with a face value of around $1
billion in a down market like we now have, or $2 billion in a
normal market.
If our underwriting posture switched from risk avoidance to
"close every deal"-and we have the power to do that-we could
bankrupt our underwriter in less than a week in either kind of
market, and it would take us only a little longer to bankrupt the
whole industry. And my company is only one of literally tens of
thousands of title agents.
The title insurance companies will argue that they will make up
their increased claims losses by increasing prices, but there may
not be enough time for them to do so.
When the crunch hits-and it may already be in transit-we all
may be facing a financial debacle that could drive this country into
its worst depression ever.
It has been my purpose to outline for the subcommittee a prob-
lem which most knowledgeable commentators consider a most seri-
ous one. It is one which transcends the kickback problems found to
exist in the title insurance industry by the U.S. Congress and
which resulted in the passage of RESPA.
If allowed to continue, controlled business will eliminate perhaps
the industry itself, but certainly those forms of competition in the
industry which are beneficial to the consumer, and the consumer
will end up with an overall inferior product at a greater cost.
Allowing controlled business to continue is a little like putting
the goat in charge of the cabbage patch.
Thank you.
[Mr. Daley's prepared statement, with attachments, follows:]
PAGENO="0202"
196
A
TESTIMONY OF STEPHEN D. DALEY ON CONTROLLED BUSINESS
IN TITLE INSURANCE INDUSTRY BEFORE THE SUBCOMMITTEE ON
HOUSING AND COMMUNITY DEVELOPMENT OF U. S. HOUSE OF
REPRESENTATIVES COMMITTEE ON BANKING, FINANCE AND URBAN
AFFAIRS.
TABLE OF CONTENTS
Written Testimony of Stephen D. Daley A
U. S. Justice Department Report on
"the Pricing and Marketing of Insurance"
(Title Insurance Portion) B
Specimen ITI Title Commitment C
Transcript of Testimony of
Clyda Guggenberger D
Transcript, Guardian Title Case E
TIM Title Policy F
Copy of ITI Schedule B G
Biographical Information on Stephen D. Daley H
PAGENO="0203"
197
I wish to submit the following written testimony in conjunction
with the September 15-16th hearings on controlled business in the
title insurance industry.
My position on controlled business is that it represents a prac-
tice which will result in the consumer (1) paying unreasonably high
costs for title insurance, (2) accepting unusually poor service, and
(3) accepting faulty, and in some cases doctored, title examinations
and title policies. The same basic conclusions as these were also
reached by the U. S. Justice Department and were published by them in
their 1977 report on "The Pricing and Marketing of Insurance." (A
copy of the appliable portion of that report is attached as Exhibit
B.)
A fourth result of controlled business is, in my opinion,
inevitable, and that result is the bankruptcy of the reserve-light
title insurance industry (or at the very least, of most of the national
title insurance companies). In addition to the resulting harm of
insureds (homeowners, lenders and institutional investors) who will
have no place to turn (except a trustee in bankruptcy) , a certain
result will be the elimination of the marketability of real estate in
the United States.
But rather than continue on with more broad generalizations or
rather than to attempt to chronicle what is currently known aEout this
anti-competitive and anti-consumer practice, I feel that the committee
may benefit from an explanation of how the title industry actually does
business. I will use the framework of the workings of the Northern
Illinois marketplace and of my company for that explanation.
PAGENO="0204"
198
The Northern Illinois residential title insurance marketplace
is generally considered to be the second largest such marketplace in
the United States (behind Los Angeles), although we may have lost our
number two position to Houston, Texas. In general, in our marketplace:
1. There is very little regulation of the title insurance industry
by the State of Illinois. Our rates and charges are not fixed by the
State nor do we have to file our rates with the State nor does the
State impose any restrictions on the coverage that we can provide. In
fact, the only requirements (other than those imposed on other cor-
porations) of the State of Illinois are (a) a title insurance company
must qualify as much with the State of Illinois, which entails sub-
mitting an application accompanied by certified financial statements,
depositing within the State the dollars required by statute for the
benefit of the Illinois creditors and obtaining a certificate of auth-
ority and (b) annually updating the financial paperwork.
2. Homesellers are almost always represented by an attorney of their
own choice, and the majority of homebuyers are also represented by an
attorney of their choice. Lenders are not represented by an attorney
in residential transactions. That has been the way that our "title
and conveyancing industry" (as it is characterized by Peat, Marwick
~ind Mitchell in their report to HUD on RESPA) has evolved. As a
result, the title companies do not provide many of the services that
are routinely provided in other areas of the U.S.A. Unlike california
where escrow or title companies prepare de'eds, affidavits of title,
PAGENO="0205"
199
bills of sale, etc. , all of these functions are normally performed by
the homesellers' attorney. (While it is not particular germane to
the question of controlled business, the above real-world situation was
completely missed by Peat, Marwick and Mitchell in their report to
DHUD on RESPA, with the result that their findings and conclusions re-
lating to attorney representation are absolutely false insofar as the
second, or third, largest residential marketplace is concerned.)
3. The homeseller normally pays most of the cost for the issuance of
an owner's title policy insuring his buyer. In a cash or assumption
transactions, the homebuyer's title costs would not normally exceed
$20.00 (for a datedown of title to cover the recordation of a deed).
In the case of a transaction involving mortgage financing, the buyer
would normally be expected to pay only for the cost of issuing a
mortgage title policy, or $60.00.
My company, Intercounty Title Company of Illinois (ITI) is a title
insurance agent of Stewart Title Guaranty Company (STGC), with auth-
ority to issue STGC title commitments and title policies in several
Illinois counties, including Cook County (in which Chicago is located)
and the collar counties which comprise the geographical area generally
known as Northern Illinois.
ITI is the largest title insurance agent in the State of Illinois,
is STGC's largest independent agent and is generally acknowledged as
the largest independently owned title insurance agent in the United
States. (By independently owned, we mean that ITI is privately owned
by myself, my spouse and three key corporate executives, and none of
us has a financial interest in any other real estate-related
activity.)
PAGENO="0206"
200
Within the terminology currently being used by the Department of
Housing and Urban development (DHUD), ITI is an "UTC" (underwritten
title company) which means that we:
1. Market our own product, almost totally at our expense, to lenders,
real estate brokers, attorneys and builders. While we are proud of
the STGC name, we are really selling ITI, and its services, its prices
and in some cases, greater consumer and/or lender protection. This
practice of selling our product to intermediaries rather than directly
to the consumer has been characterized by the term "reverse
competition," and some commentators (notably Peat, Marwick and Mitchell
in their report for (DHUD on RESPA) have critiized this practice as
being somewhat less than desirable. But, in the real world, these
professionals are in the absolute best position to advise their clients
or customers of where the best deal can be obtained. Hot only do
these professionals have the requisite background and knowledge to be
able to evaluate what title company has the best deal, but they are in
fact measuring the performance and reputation of the sundry providers
of these services on a day-to-day basis. At least that's true when the
professional is making his or her evaluation with only the interests of
the consumer in mind.
2. Run our own searches of the public records, or where those are
unusable, purchase search work from a title company which maintains an
adequate title plant.
PAGENO="0207"
201
3. Make our own evaluations of the proper status of title from that
search work, and issue STGC title commitments to the parties involved.
(A title commitment, or as it sometimes phrased, a title report, is
normally the first document that our customer receives as a result of
a title order being placed with us. The title commitment shows the
present status of title and our requirements for the issuance of a
final title policy. The professionals involved, and in our marketplace
it's usually the sellers' and buyers' attorneys, acquire the necessary
documentation to bring the status of title to that permitted by the
contract between seller and buyer. A specimen copy of an ITI title
commitment is attached as Exhibit C.
4. As title clearance documentation is presented to us, evaluate same
for the purpose of amending our initial evaluation of the status of
title
5. In a large number of the transactions upon which we write title
insurance, close the transaction~through the vehicle of an escrow.
6. When title is acceptable to the insureds, issue STGC title policies
to those insureds, Sand concurrently therewith pay STGC the remitt-
ance agreed upon between our two companies.
7~ perform those other tasks that sound management principles require
of any privately or publically owned qompany (i.e., the accounting and
general management functions).
PAGENO="0208"
202
8. Are legally and financially responsible to STGC should claims
arise because of our actions, or in some cases (such as claims arising
out of escrow closings) are totally responsible for any claims. Should
a claim arise, if it is one that is our responsibility to pay, we pay
the claim and concurrently notify STGC (depending on dollar amount).
Should a particular claim be one that STGC is responsible for (like
defending a spurious law suit attacking a properly insured title) , we
work very closely with STGC legal staff to ensure that the traumas
being suffered by our insured are kept to a minimum. The area of
claims is one that is generally misunderstood, and a big part of that
misunderstanding results from the (mis)use of the word "insurance".
"Title insurance" is really a misnomer, and more descriptive term-
inology would be "title assurance" or "title guaranty." A title policy
is not the typical insurance policy which normally provides dollar
coverage against the occurrence of a risk that is either certain to
happen (as in the case of life, or as it might be more accurately des-
cribed, death insurance) or is likely to happen in an acturially
determinable number of instances (as in the case of health or as it
might be more accurately described, sickness insurance) . Sut when a
title company writes its product, th.ere is normally an attempt to
eliminate all possible risks prior to the issuance of the final title
policy, and when claims do occur there are usually a result of
inad~quate records; or inaccurate searching; or errors in underwriting,
and/or examinations. The- acturial type of coverage which is a part of
every ALTA form title policy, while important to the insureds, is a
long-shot risk. We make this point becuase some commentators on the
title insurance industry criticize it because claims paid represent
such a small percentage of premiums charged, whereas in fact the
smaller the percentage of claims paid the better job that particular
title company is doing.
PAGENO="0209"
203
There are two key points to be understood from the above description of
how ITI functions in its marketplace, these being:
1. There should be little sustantive difference in the method of
operations of an underwriter engaged in direct operations and an agent.
In fact, the only real difference is in the area of claims. The under-
writer pays all claims whereas the agent will generally pay a lesser
sum than 100% of claims. In general, the higher the remittance paid
the fewer claims the agent will pay. In any case, the underwriter
will have the contingent liability to pay all claims to its insured
should the agent be unable to pay. (In the case of ITI, we and STGC
have agreed upon a lower than average remittance to STGC in exchange
for higher that average claims exposure to ITI.)
2. Payments or remittances by an agent to its underwriter when a title
policy is issued should be viewed as just another cost of doing busi-
ness of the agent rather than as a `commission" paid by the underwriter
to the agent. We make this point because some commentators give a lot
of credence to the fact that underwriters are splitting so-called
insurance premiums with an agent who does little or nothing to earn the
premiums, and that these premiums are inflated because of the need to
pay the "commissions." The actual facts are that agents such as ITI
are doing all of the work, which is a substantial part of the costs
incurred in the production of the title product, and in fact, the
typical full-service agent who competes against an underwriter must
have a more efficient operation because of the payments made to the
agents' underwriter.
85-396 0 - 81 - 14
PAGENO="0210"
204
As touched on previously, we don't feel that the average homeseller or
homebuyer is either equipped with the knowledge to make an intelligent
choice on the provider of title services or has the inclination to
become knowledgeable. That conclusion is also made by Peat, Marwick
and Mitchell in their report to BUD on RESPA. We have some empirical
data to support the consumer indifference on what should be one of the
most important elements of that selection process--price. Between
December of 1978 and February of 1979, my company conducted a direct
mail campaign aimed at potential homesellers. Using primarily news-
paper advertisements of homes currently for sale, we sent 2,000 letters
to homesellers, offering to each a significant reduction in their
upcoming title bill. About 1,500 of these letters were sent through
the listing broker and about 500 were sent directly to the homeseller.
The cost savings were in an average range of 15-20%. A total of four
homesellers elected to initially accept our offer, with only one such
seller contacting us to see if we would extend the offer after its
expiration date. Those numbers are more significant when you realize
that we probably received the title orders anyway on 400 of the trans-
actions.
With this `general overview of how the title industry does operate,
we now like to introduce the element of controlled title business into
the marketplace. The term "controlled business" means that the
provider of some settlement services (i.e. , our middleperson attorney,
lender, broker or builder) uses his or her influence with the consumer
to steer the title order to a title agency owned in whole or in part
by that provider.
PAGENO="0211"
205
Controlled business has not affected our marketplace as severely
as it has some other geographical areas. That it has not can
be attributed to two factors, these being (1) intensive competition
has kept the costs of title insurance very low, and (2) the profes-
sionals (i.e., the attorneys, brokers and lenders) are just that,
and are dedicated to protecting the best interests of their respec-
tive clients or customers.
But we've begun to see it grow in our markplace, and while the
details of the individual deals that have been made are not known to
us, it is possible to tell the committee a bit about what we've seen
and heard.
The most devasting such entry has been Coldwell Banker Title Ser-
vices, which is an agent in Du Page County, Illinois, of Safeco Title
(and apparently the Safeco-Coldwell relationship is somewhat of a
national trend). Du Page County is Illinois' second most populous
county with a population of 658,177persons according the 1980 Census.
It is geographical area in which are located a large number of very
high priced homes. (ITI's average policy amount, company-~~ide is about
$47,000.00, but our average policy in Du Page County is around
$100,000.00.) Coldwell Banker Realtor Company is thought to have about
a 20% share of the residential marketplace in Du Page County, or to
look at the numbers another way, Coldwell Banker Realtors is i~nvolved
in one in five residential transactions in Du Page County. Per
statements made to me by a senior executive of Coldwell Banker, their
success rate in obtaining the title order on the transactions in which
they are involved is about 55% which converts to an 11% share of the
Du Page County title marketplace.
PAGENO="0212"
206
it appears that their method of marketing their product depends
on whether Coidwell Banker Realtors is the listing agent or selling
agent. If they are the former, a title order is placed with their
title agency at the listing stage. If they are the latter, a title
order is placed with their title agency shortly after the contract
between seller and buyer is signed. In either case shortly after the
contract between seller and buyer is signed, Coldwell Banker sends its
existing title commitment to the lender, the attorneys and even to the
other broker (if there is one). included within the Coidwell Banker
network of companies is a mortgage banking company, and that company
sends almost all of its business in Du Page County to the Coldwell
Banker title company. While we certain that the policy-making officers
of Coidwell banker would not be so foolish as to attempt to force their
broker and salespeople employees to steer every deal to the Coldwell
Banker title company, we can tell you that many of such brokers, sales-
persons and branch managers feel the pressure to do so, and are unhappy
with "being forced to use the Coldwell Banker Title Company." Many
would prefer to do business with iTi or with one of our competitors,
but feel that their job is probably on the line if they don't co-
operate in steering their customers to the Coidwell Banker title
company. It would be fair to say that we're feeling the same press-
ures as Clyda Guggenberger of Valley Title, who testified on September
23, 1980 at the RESPA public hearings held by DHUD. A copy of that
testimony is attached as exhibit D. We have the same responses from
lenders who rely on Coldwell Banker Realtors for referrals. They
would prefer not to accept the Coldwell Banker title product, but
feel that their refusal may jeopardize their relationship with this
volume producer of real estate deals.
PAGENO="0213"
207
We, of course, are not privy to the deal made between Coidwell
Banker title company and Safeco Title. We assume it's not the same
one that was found to exist in California, in which Guardian Title
(a Coldwell subsidiary) became an agent of one of the Safeco companies,
with almost no functions to perform. A copy of the California Appel-
late Court decision is attached as exhibit E. The deal may be the
same one that was offered to ITI by Safeco, and that was that Safeco
would produce for our use a complete search package free of charge, and
take the same remittance fee we were currently paying our then under-
writer. ITI rejected that deal because we knew the average cost of
producing a proper search package was greater than the average remitt-
ance, in real dollar terms, and to our way of thinking the deal didn't
make any sense. We do know that Safeco Title is closing transactions
upon behalf of The Coldwell Banker title company, as Safeco Title
has been listed as the payee for the closing fee on several RESPA
statements that we have seen.
But, in any case, this controlled business title agency has managed
to obtain an 11% share of the DuPage County marketplace in less than
a two years, and we expect that share to grow to the same figure as
their share of the residential marketplace. Coldwell Banker claims
that this is competition, but we say that this is misusing their in-
fluence with the consumer, to steer the consumer. In any case, neither
my company nor any of my competitors can sell its product, even if
better or cheaper, to Coldwell Banker Realtors in Du Page County. We
do known from the comments from Coldwell Bankers empolyees and of
employees of some of their vendors that the service of the Coldwell
Banker title company is inferior to that available elsewhere in the
marketplace.
PAGENO="0214"
208
The second instance of controlled business is a bit more complex,
but the players are:
1. Title Insurance Company of Minnesota (TIM), the underwriter.
2. Land Title Company of America Inc., an agent (such as ITI) of TIM.
3. Home Title, a subsidiary of the service corporation of Land of
Lincoln Association, an Illinois chartered- savings and loan associa-
tion. Home Title was incorporated in the latter part of 1979. We
don't known whether Home Title is an agent of TIM or Land Title.
The scheme is that the Land of Lincoln's loan department personnel
"suggest" to prospective borrowers that they would like the borrowers'
concurrence in using Home Title. Of course, the average borrower is
interested in getting his or her loan approved, and is willing to agree
to almost anything. Land of Lincoln then sends the title order to Home
Title who in turn gives the order to Land Title. One version of the
scheme told to me by a senior office of Land Title, was that his
company received $185.00 for processing the search work and preparing
the title commitment for Home Title, and that Home Title wrote the
title policy and paid the remittance to TIM, keeping the excess. In
any case, almost all of Land of Lincoln's transactions are now handled
by either Home Title or Land Title, and my company and our competition
has no way to obtain any business from this savings and loan assoc-
iation. In fact, even when dealing with builders, Land of Lincoln
notifies an officer of Land Title to make a sales call, and the in-
fluence of Land of Lincoln is used to try to convince the builder to
switch the builder from the title company selected by him. Prior to
the formation of Home Title, Land of Lincoln split its title business,
with my company receiving a small share and two o.ther competitors
receiving the bulk. Since the formation, it appears that Home Title or
Land Title receives almost all of it.
PAGENO="0215"
209
In-early 1980, Land of Lincoln acquired another association, called
First Calumet Savings Association, and merged that institution into
Land of Lincoln. In 1978 my company received 101 title orders from
First Calumet Savings; in 1979 we received 145 transactions, and in
all of 1980 we received 14 deals. In 1981, to date we've received
3 orders. While one title policy does not conclusively prove the
validity of the Home Title or Land~Title product, we've only seen one
such policy, and a copy of that policy is attached as exhibit F. We
were subsequently asked to bring title down on the same tract of land
(when the Home Title-Land Title-TIM policy was turned into us), and
we direct your attention to exceptions 4 and 6 on Schedule B of our
title commitment (attached as Exhibit G). While we suppose that these
omitted title exceptions are not that important (unless the insured
wants to build an addition or a garage), their omission is certainly an
indication of the "faulty title work" done by a controlled business
agent. Incidentally, if you call 312-323-9870 (the telephone number of
Land Title listed in the left corner of exhibit F),. the telephone will
be answered "TitleCompany" and ifyou ask is this "Home Title", the
answer will be "yes". If you ask if this is "Land Title," the
answer will again be "yes".
The third such instance involves the two of the same players as
above (TIM and Land Title) and American/Invesco, or a subsidiary there-
of. Apparently this condominium developer is also in the title insur-
ance business, and is "guaranteeing" the titles on the projects in
which it is also the seller. The only way that such a deal makes any
sense is that American/Invesco is writing its sales contracts to
require its buyers to pay for title costs (which would normally be
paid by American/Invesco).
PAGENO="0216"
210
The fourth such instance involves a non-recurring problem of
controlled business because the main participant is currently under
Federal indicment (we understand) for embezzlement or mail fraud. This
scam involved an individual who owned a small title insurance agent of
USLife Title Company of New York, and who operated in one of our
suburban counties. The agent also owned an interest in a small builder
As many builders did, this small builder ran into cash flow problems,
which were resolved in part by the title agent who closed two trans-
actions at his company, without paying off the construction mortgages.
Of course, clear title policies were issued to the insured, And
USLife paid $280,000 because of the conflicting interest of its agent.
At the beginning of my testimony, I included that an inevitable
result of controlled business would be the bankruptcy of the reserve-
light title insurance industry. The committee may be interested in
knowing that the total unearned premium reserves of the top 13 title
insurance companies in the United States totalled, as of December
31, 1980, only $293,622,000. These reserves are for anticipated
losses, and they have been established on historical experience, which
in turn, is based upon an underwriting posture of risk-avoidance. It
is reasonable to assume that the usual controlled business agent is
not interested in- risk-avoidance, and now that he has effectively
eliminated the traditional policeman (the independent title company),
almost all deals will end up closing. And, on a case by case basis,
the decision to close may not be a bad business decision. Consider
the scenario of a broker-controlled title agency which discloses an
$8,000 possible title problem, and a sales commission of $10,000.00
that will be lost if the deal dosen't close. It may be a good
business decision to close, with the broker agreeing to ante-up
$8,000.00 if needed.
PAGENO="0217"
211
Depending on the number of times that such a situation arose, the
cumulative effect could be catastrophic, as it was in 1975 when one
underwriter suffered a loss of some $9,000,000 because of one control-
led business builder agent. To putmy fear in more perspective for you
-my company alone will annually write title policies with a face value
of around one billion dollars (in a down market like we now have)
or two billion dollars (in a normal market). If our underwriting
switched from risk-avoidance to close every deal and we have the power
to so switch, we could bankrupt STGC in less than a week (in either
kind of market) and it would take us less than three months to bank-
rupt the whole industry. And ITI is only one of literally tens of
thousands of title agents. The title insurance companies will argue
that they will make up their increased claims losses by increasing
prices, but there may not be enough time for them to do so. When the
crunch hits, and it may already be in transit, we all will be facing
a financial debacle that could drive this country into its worst
depression, ever!
It has been my purpose to outline for the committee a problem
which most knowledgeable commentators consider a most serious one. It
is one which transcends the kickback problems found to exist in the
title insurance industry by the Cdngress in 1974 and which resulted in
the passage of RESPA. If allowed to continue, controlled business will -
eliminate those forms of competition in the title insurance industry
which are beneficial to the consumer, who will end up with an overall
inferior product at a greater cost.
Allowing controlled business to continue is a little like putting
the goat in charge of the cabbage patch. -
PAGENO="0218"
212
B
THE PRICING AND 1~PJ(ETING OF INSU~NCE
A REPORT OF THE DEPART~NT OF JUSTICE
TOTHE
TASK GROUP ON ANTITRUST I~RJNITIES
JANUARY 1977
PAGENO="0219"
213
FOREWORD
For approximately 18 months, the Department of Justice,
on behalf of and at the request of the Task Group on
Antitrust Immunities, has conducted a study of the business
of insurance. Focusing primarily on property-liability
lines, the Department gathered information on the question
of whether the present sche~rneof state regulation and
federal antitrust immunity attending the pricing and
marketing of insurance is in the public interest. Obviously,
the matter is deserving of the closest consideration,
particularly in view of the fact that many forms of in-
surance are widely viewed as a necessity in America today.
The Department's early appreciation of the complexity of the
issues involved has been repeatedly confirmed; regulation of
the business of insurance has been found to entail diverse
and sometimes conflicting economic and social goals.
Furthermore, knowledgeable opinion differs substantially on
the weight to be assigned to each such goal and on the best
methods for their realization.
The following report and, recommendations represent the
Department's best efforts to identify and examine the
PAGENO="0220"
214
particular issues presented by the overall question of
insurance regulation, reach tentative conclusions as to
their resolution, and to outline a proposal which would
allow for greater competition among ~~su.r~cswithout direct
interference with insurance regulation as now practiced. In
essence, our proposal would allow insurers that wish to
adopt a more entrepreneurial approach to choose a less
regulated national system under which they would enjoy no
special antitrust immunity. Other insurers, who continue to
,ppt for state regulation, would still enjoy the protection
of the NcCarran-Ferguson Act.
We believe that our proposal is sound and workable. In
framing it, we have made a substantial effort to ascertain
and consider the views of those with expertise in the
industry and its regulation. However, we realize that we
have not been able to consult with all who may be interested,
and we have not had a detailed document to offer those with
whom we have consulted. Therefore, we believe that we
should offer the Department's tentative views at this time
to stimulate comment by all interested parties and con-
sideration of the issues by regulatory and legislative
bodies at both the state and federal levels.
PAGENO="0221"
215
PROJECT STAFF
The Report was prepared in the Department of Justice by
Antitrust Division attorney Guy B. Maseritz, now Chief of
the Division's Legislative Unit, subject to the immediate
supervision of Neil E. Roberts, Chief of the Division's
Evaluation Section and the overall guidance of Jonathan C.
Rose, Deputy Assistant Attorney General. Also contributing
to the preparation and analysis of the Report were Antitrust
Division attorneys Daniel J. Pearlman, Ilene G. Block,
Howard .M. Blumenthal, and Gordon L. Lang, and economist
Richard A. Ippolito of the Division's Economic Policy
Office, under the direction of Dr. George Hay.
Final approval of the Report was given by Donald I.
Baker, Assistant Attorney General of the Antitrust Division.
PAGENO="0222"
216
SUMNARY
This is a summary of the Justice Department's report to
the Task Group on Antitrust Immunities on the effects of
state regulation on the pricing and distribution of in-
surance since the enactment of the McCarran-FergusOfl Act in
1945.
1. ~~ground.
Traditionally, the regulation of insurance had been
ceded to the states by the federal government. However, in
1944, the Supreme Court held that the sale of property-
liability insurance was in interstate commerce and subject
to the provisions of the federalantitrust laws. United
States v. South-Eastern Underwriters Association, 322 U.s.
533, That decision made illegal the numerous private cartel
rate-fixing agreements which had determined prices in the
property-liability field and raised questions as to the
validity of the various types of state regulation of insurance.
The next year Congress enacted the McCarran-FergUsOn
Act which ratified the states' power to regulate insurance
absent specific federal insurance legislation' and provided
an antitrust exemption for private concerted price-fixing
activities which were subject to state regulation. The
antitrust exemption was justified on the ground that com-~
(ii.i)
PAGENO="0223"
217
petitive pricing in the insurance field would lead to
ruinous competition and the demise of many insurance
companies, thereby denying the public the benefit of a
reliable insurance mechanism. All of the states adopted
regulatory schemes relating to property-liability insurance
rates. Some states set the rates themselves. Most adopted
`prior approval' systems which feature private rate bureaus
as the moving force in the determination of rates. Still
other states adopted "open competition" systems which allow
cartel rate setting but enable insurers to price indepen-
dently with relative ease.
In life insurance and most group health insurance there
is virtually no direct state regulation of rates, but
individual health insurance and Blue Cross/Blue Shield
services are subject to varying degrees of state rate
regulation.
The basic question under study was whether continuation
of the present exemption of the business of insurance from
the federal antitrust laws, by virtue of the McCarran Act
and state regulation, is in the public interest. Essentially,
it was necessary to determine whether thirty. years of state
regulation had provided the public with the benefits normally
attributed to competition, i.e., reasonztble prices based on
the cost of rendering the services; efficient services
(iv)
PAGENO="0224"
218
rendered at the lowest possible cost; and innovation -- the
utilization of new or improved products or services and
methods of distribution. The underlying premise of the
study was that, if regulation had not provided these benefits,
or if it now appeared that the application of the federal
antitrust laws would not interfere with the basic policy
objectives of insurance regulation, then legislation should
be introduced to modify the statutory antitrust exemption.
2. Findinqs
The Department observed that over the past ten years
there have been a number of states that have adopted an
"open competition" system of rate regulation after attempt-
ing to administer a highly regulated system.. The experimenta-
tion with competitive controls as a substitute for concerted
ratemaking is evidence of the inadequacies of state rate
regulation. Moreover, the emergence of independent pricing
in segments of the property-liability industry, despite
restrictive state laws, may be attributea to an industry
structure that favors competition, to certain inherent
weaknesses in rate regulation, to the successful experimen-
tation with deregulation in a number of states, and to the
(v)
PAGENO="0225"
219
continuing Congressional investigation into insurance
industry practices.
In addition, the evidence compiled by the Department on
the effects of rigid rate regulation in automobile insurance
indicates, that such regulation has fostered greater adherence
to bureau rates, discouraged rate reductions, contributed to
instability in insurance company operations, established
varjous forms of cross-subsidization between good and bad
drivers, imposed unnecessary restrictions on the collective
merchandising and the direct writing of insurance, and
aggravated the availability problem in which marginal or
high risk drivers have difficulty obtaining covera~e in the
open market at the prevailing rates.
On the other hand, the long-run experience of at least
one major insurance state under an open competition system,
in which the state has relied on market forces to control
prices, suggests that unrestricted price competition can
provide an effective substitute for rate regulation as a
means of achieving reasonable prices and maximum efficiency
in the sale and distribution of insurance.~ A comparison of
the experience of the same insurers under certain open
competition and prior approval systems suggests that
(vi)
85-396 0 - 81 - 15
PAGENO="0226"
220
competition fosters independent pricing, operating stability,
and flexibility in the pricing structure. The relatively
favorable performance of the insurance companies under the
highly competitive system suggests that it provides a more
effective mechanism for accomplishing the basic insurance
goals-of providing a reliable insurance mechanism and
generally available coverage at a price reasonably related
to cost.
In the commercial lines, the findings of the Department
indicate that state regulatory schemes are largely illusory
and that insurers are generally free to set their own prices,
owing to the availability of state-authorized rating plans
which permit insurers to individually price risks based
essentiaUy on their business judgment and competitive
pressures. The prevalance of these plans in the commercial
lines raises a fundamental question as to the purpose and
need for the ostensible state rate regulation in these lines
of insurance.
Finally, it appears that the industry should be able to
conduct its business without any special exemption from the
federal antitrust laws. Antitrust precedent indicates that
insurance companies could pool their loss experience through
(vii)
PAGENO="0227"
221
a statistical bureau consistent .with federal antitrust
standards. Moreover, the federal antitrust laws would not
prohibit any necessary trending of future losses on a com-
posite basis by advisory organizations that were independent
of. the companies they were serving. Likewise, the antitrust
laws would not prohibit those voluntary risk-sharing arrange-
ments, such as insurance pools and reinsurance agreements,
that were either necessary to the conduct of business or
served some other legitimate business purpose without sub-
stantially lessening competition.
3. Pro~ose~ls
In view of the findings of the Department on the
adverse effects of regulation and the ability of the in-
dustry to function effectively in a fully competitive
environment, the Department believes that an alternative
scheme of regulation, without McCarran Act antitrust pro-
tection, would be in the public interest. This alternative
would consist of a system of regulation of insurance com-
panies similar to that applicable to other federally-
chartered financial ii~istitutiąns. Insurance companies would
have the option of seeking a federal charter and thereby
losing McCarran Act protection, or retaining that protection
(viii)
PAGENO="0228"
222
under a state charter. Insurers operating under federal
auspices (and perhaps others) would participate in a federal
guaranty system. Insurance companies meeting minimum
financial standards of eligibility could qualify for a
federal charter, although those writing certain lines of
insurance in such fashion as to raise problems of "reverse
competition" (that is, com~etitiofl for the services of the
agent rather than the ultimate consumer) might have to
remain subject to state regulation.
Federally-chartered companies would be exempt from
state rate regulation, state restrictions on collective
merchandising and direct writing of insurance, state guaranty
funds, and state solvency regulation. A federal agency,
such as the Federal Insurance Administration, could develop
a uniform system of solvency regulation in which the emphasis
was on the early detection and swift removal of failing
companies from the marketplace, rather than the traditional
state approach to solvency regulation of "keeping every
insurer afloat." A guaranty fund, much like the FDIC, could
operate on a preassessment basis to provide reserves in the
event that a weak company goes undetected.
Federally- chartered companies would be required to
participate in a federal guaranty fund, and the insurerS
(ix)
PAGENO="0229"
223
(and their agents to the extcnt.relevant) would be subject
to the following federal controls: federal solvency and
investment standards; federal laws against invidious dis-
crimination in the selection and classification of risks
based on race, age, and sex; and federal standards on dis-
closure of price information and underwriting experience.
The federal antitrust laws would also fully apply, without
any special exemptions.
The state would continue to play an affirmative role in
the regulation of federally-chartered companies. Taxes
could be imposed on companies doing business within the
state, although further study is recommended on the com-
petitive effects of retaliatory state taxes. The state
could require these companies to participate in a residual
market plan so as to ~service drivers unable to obtain
protection in the voluntary market. The state could regulate
the rates charged by the plans, provided that they were
administered on a self-sustaining basis. In lieu of cross-
subsidization between high and low risk drivers, the state
could furnish a direct "external" subsidy to individuals who
could not afford insurance protection.
Finally, the state would continue to play a dominant
role in regulatory matters pertaining to the insurance con-
tract, such as minimum coverage requirements, cancellation
(x)
PAGENO="0230"
224
and renewal of policies, financial responsibility laws, corn-
pul5ory insurance, policy forms, licensing of agents, and
systems of liability (fault vs. no-fault).
Insurance companies electing to remain state-chartered
would be subject to the full scope of state insurance regu-
lation, as well as NcCarran Act protection.
The dual system of regulation, either with respect to
federally-chartered companies or state-chartered companies
participating in the federal guaranty fund, wouldrequire
i~he reconciliation of federal and state regulation. In this
regard, the experience of the banking laws may provide some
guidance so that all insurance companies would be subject to
state law, unless they are expressly exempt by federal law
or unless the state laws interfere or conflict with the
purposes of the federal scheme.
In summary, a predominant segment of the property-
`liability insurance industry is favorably structured for
competition, with a large number of competitors, relatively
moderate concentration, ease of entry, a standardized
service, a relatively simple and short-term contract, and an
increasingly price-sensitive consumer market. The available
evidence suggests that unrestricted price competition would
be an effective alternative to state rate regulation and
(xi)
PAGENO="0231"
225
compatible with regulatory objectives for a reliable insur-
ance mechanism. It is the opinion of this Study that all of
the major lines of property-liability insurance should have
the option of operating in a fully competitive environment
under a dual system of regulation. Other lines, including
life insurance, are probable candidates, subject only
to state regulation designed to limit compensation to
intermediaries and thus counter the phenomenon of reverse
competition. Further study appears necessary to reach
definitive conclusions in health insurance and medical
malpractice. As one industry-sponsored study recently con-
cluded, `tthis may be the time for the insurance industry to
surrender the cloak and face the antitrust elements ungarbed
because only then can it be treated equally with other
segments of interstate commerce.'
(xii)
PAGENO="0232"
226
D. Special Problem Lines
The primary focus of this Report has been on P-L lines
of insurance. Our less extensive consideration of some
other lines, however, has revealed some special problems,
which may call for different conclusions on whether these
lines may be written on a fully competitive basis without
any regulatory oversight. We discuss below some particular
problems presented, including the phenomenon of "reverse
competition."
1. Title Insurance
a. Services of the Title Insurer
Title insurance policies generally provide for the
indemnification of the owners of real property, persons
having liens thereon, or other parties having an insurable
interest in the land, against loss or injury caused by
defective title or by certain encumbrances on the property
insured. Prior to the turn of the century the purchase of
title insurance was relatively rare -- the. st~ndard method
of title proof was the preparation of an abstract of the
official land records concerning a land parcel by a layman
coupled with an attorney's opinion letter as to the state of
the title to the parcel based on that abstract. As America
has become more urban and more mobile, however, the
abstract-opinion letter method of title proof has been
largely displaced or supplemented by title insurance. Land
PAGENO="0233"
227
records have become more voluminous and complex as popula-
tion density and mobility have increased.
In urban areas, intensive improvement of land and the
use of real estate as security for the investment of insur-
ance company reserves has necessitated graater concern for
the protection of underlying title. 499/ Iii addition, title
insurance indemnifies the policyholder for defects or errors
in the land record or search thereof as well as for certain
defects such as liens, fraud, forgery, and lack of competency,
which cannot be discovered by: a search of the official land
records; something an attorney's opinion letter cannot do.
For all these reasons title insurance has become, and is
likely to remain, a major component of title proof in most
real estate transactions.
There are three basic participants in the chain of
distribution of a title insurance policy: 500/ (1) the real
estate settlement producer, (2) the title company which does
the ~ork of searching and examining the title to the property
and issues the title insurance polIcy as the agent of a title
insurer, and (3) the title insurer or underwriter whose policy
is issued. The real estate settlement producer is a person
499/ J. Brown Jr., An Analysis of Competition in the Title
Insurance Industry, June 1964 (Ph.D. dissertation, Univer-
iity of Southern California, University Microfilm No. 64-
13,488), at 69.
500/ See A. Hoff lander and D. Shulman, The Distribution of
Title Insurance in California: Analysis of a Potential
Problem, March 1976, at 410.
PAGENO="0234"
228
whose knowledge, experience, and business relationships give
him a potential to control, through domination of the
settlement process, the placement of orders for a whole
array of ancillary services such as title insurance.
Title insurance involves two separate services: the
determination of the state of title to a parcel of land, and
a contract to make the determination good should it prove to
have been mistaken and loss result. ~l/ These separate
services need not be performed by the same people. A title
insurer may insure a title opinion given by a lawyer on the
basis of a personal search or upon an abstract, thus supple-
menting this established form of title proof. On the other
hand, the title insurer may perform all functions itself,
commonly maintaining a title plant to facilitate search-
ing. 502/ An increasingly common situation, which will be
discussed at some length infra, is where a group, typically
of real estate brokers, forms an affiliated title company
which maintains a title plant and does all the preliminary
work of searching and abstracting a title and actually
issues the insurance policy but as agent to a title insur-
501/ HUD/VA, Report on Mortgage Settlement Costs (1972), at
43.
502/ A title plant `consists principally of duplicate
copies of public records pertaining to all land parcels in a
particular county arranged and indexed to nable accurate
and speedy searching of titles for individial parcels. Most
highly developed plants are in counties with large popula-
tions." Axelrod, Berger, and Johnstone, Lnnd Transfer
and Finance, at 598.
PAGENO="0235"
229
ance company which underwrites the risk. The premium rece-
ived from the policy is then split between the title insur-
ance company that assumes the risk and the title company
that sold the policy and did most of the work.
Title insurance is unlike most other forms of insurance
one can buy. It is much closer to a risk avoidance service
than to risk Indemnification. The primary emphasis of a
title insurer in issuing a policy is on an accurate search
of the title records and the discovery of any possible
defects. Those defects which are discovered prior to the
issuance of the title policy are excluded from coverage. If
there is a likelihood that litigation will be required to
provide clear title the policy will probably not be issued
at all. 5O3/~ At the same time, the prospective buyer or
mortgagee is made aware of the title defects and can decide
not to proceed with the transaction or can attempt to cure
the defects before proceeding.
What this means for the title insurer is that only a
small percentage, between five and ten percent, of its gross
income is used to pay losses on title insur~rxce policies
while approximately eighty percent. of its income is absorbed
by operating expenses such as employee salaries
503/ B. Owen, "Licensing of Real Estate Bro~:ers as Under-
written Title Agents" at 18, May 1976, (Stuc.lles in Industry
Economics No. 64, Department of Economics, Stanford Uni-
versity).
PAGENO="0236"
230
and the cost of maintaining its title plant. ~9~/ As one
scholar states: 505/
* . . title insurance has less "cas-
ualty" exposure in its policy than
life and fire insurance. Most of the
operating costs of a title office are
personnel costs for searching and
examining the title, and not for losses
paid and anticipated from actuarial
calculations.
In contrast to the five to ten percent loss ratio for title
insurance, the average loss ratio for homeowners multiple
peril insurance is approximately sixty-five percent. ~/
b. Reverse Competition
The market demand in the title insurance industry also
differs from that of most other forms of insurance. Title
insurance is ancilliary to the principal tansaction, which
is the purchase of an interest in land. As part of the
process of acquiring an interest in land, the buyer either
desires or is required to obtain evidence that his interest
is as represented by the seller.
504/ P. Smith, Title Insurance Companies (~evised Ed.,
1971), at 22.
505./ Analysis of Competition, supra, n. 49~ at 76.
506/ Best's Aggregates & Averages, Properti-Liability
(1975), at 30.
PAGENO="0237"
231
Under these circumstances, the demand for title insur-
ance is highly inelastic. That is, within reasonable limits
the number of policies demanded will not change signifi-
cantly with changes in policy prices or with changes in the
income of buyers. Title proof is simply part of the pro-
cedure for transferring interests in land, 507/ and, as a
result, title insurance has become an ancillary service of
the real estate market.
The effects of this phenomenon are described as fol-
lows;
Perhaps nowhere in the economy
is there such a rnaldistributiOn of
economic knowledge and power than in
the financial and real estate markets. 508/
Sellers in particular and those
choosing the source of title insurance
for the ultimate buyer are generally
quite well informed as to what i5 offered
in the market. Those who actually pay
for policies are as a rule notoriously
uninformed as to the sellers and the
services they offer. 509/
Due to lack of knowledge, lack of time, and lack of interest
the purchaser of a title insurance policy frequently exerts
507/ ~p~ysis of Cornpetit , ~ n. 499 at 70-71.
508/ Distribution of TitleInSuraflce, ~ fl. 500.
509/ Analysis of Competition, suora, n. 499 at 238.
255
PAGENO="0238"
232
little, if any, influence on the selection of sellers.
Although the person who pays for the title insurance policy
could determine the seller, he usually does not, relying,
instead, on his real estate broker, mortgage banker, or
attorney to direct the business to the most suitable insurer. 510/
In other words, competition in the title insurance
business is directed at the producer of business rather than
the consumer. A title company wishing to increase its share
of the market would not necessarily try to reduce prices or
improve coverage in order to attract retail purchasers of
~title insurance. Rather, the company would seek to influence
those brokers, bankers, and attorneys who are in a position
to direct title insurance business to it. The most direct
manner of influencing this business is to grant the producer
of the business a fee, commission, rebate, or kickback -- to
the detriment of the title insurance purchaser. This is the
phenomenon of reverse competition.
The presence of reverse competition in the title insur-
ance industry has resulted in "a long history of such anti-
5l0,~ Id., at 74.
PAGENO="0239"
233
competitive practices as fixed fees, forced (tied) sales,
and kickbacks." 51]~, Reverse competition has the effect of
raising the cost of title insurance, for the higher the cost
of the insurance, the larger the referral commission or
kickback to the business producer and the more business a
title insurer is likely to. have. There is little incentive
to increase efficiency of title search ēr expand coverage.
The presence of reverse competition requires unique
structural so3.utions separate and apart from those required
to encourage competition, and unless reverse competition can
be effectively controlled, rate regulation in the title
insurance industry cannot be wholly eliminated.
it is the conclusion of this Report that the problems
of reverse competition in title insurance as presently
in&rketed preclude a total reliance on market forces to
control the level of rates. T~herefore, absent new marketing
~techniques which would eliminate the problem, title ~
rates and distribution should remain subject to state regula-
511/ Distribution of Title Insurance, supra, n.500 at 3.
See also Licensing of Real Estate Brokers, ~uora, n.503 at
38.
PAGENO="0240"
234
tion. However, we believe that steps may be taken at th~~
state level to minimize or overcome the problems of reverse
competition. These matters are discussed below.
C. State Regulation
(1) Consumer Knowledge
(a) Shopper's Guide
We have indicated that reverse competition in the title
insurance industry is brought about because of a lack of
knowledge, lack of time, and lack of interest on the part of
the purchasers of title insurance policies. No amount of
legislation can increase consumer interest in title insur-
ance, but there are two methods by which the knowledge and
time deficimncies of the title insurance purchaser can be
overcome. pne is the direct m~,~iod of requiring the lender
or broker to furnish the purchaser, early in the settlement
process, with sufficient knowledge to enable him to make an
informed decision on his own. The other method is more
indirect -- having the lender purchase a title policy on
behalf of the individual buyer.
We believe that the most effective method is to inform
the title insurance purchaser and allow him to make the
ultimate decision on what policy to buy. The nature of such
PAGENO="0241"
235
an informational scheme could be simple. At the very
beginning of every mortgage procurement discussion, the
mortgage lender would be required to give the mortgage
seeker a pamphlet which would provide: (1) a brief account
of the nature and purpose of title insurance in the transaction;
(2) whether or not title insurance would be required by the
mortgage lender, and if required, a statement of the mortgage
seeker's right under section 9 of the Real Estate Settlement
Procedures Act of 1974 (RESPA) 512/ to choose his own title
insi.~rance company; (3) a statement in bold faced type that
the mortgage lender was making no recommendation about whom
to buy title insurance from but rather encouraged the
mortgage seeker to shop for the most attractive package; and
(4) a list of all the title insurance companies writing
policies in the lócality in -which the property being purchased
was situated and their addresses and phone numbers. This
~iopper's guide" could be brief and inexpensive to produce;
at the sane time it might be enough to encourage the
prospective home buyer to sample title insurance companies
in order to save some money on mortgage settlement costs.
It might be prudent, if such an informational scheme
were adopted, to broaden the number of people required to
512/ 12 U.S.C. §S 2601-16.
85-396 0 - 81 - 16
PAGENO="0242"
236
distribute the pamphlets. Currently, other real estate
settlement producers, such as real estate brokers or escrow
agents, may direct prospective real estate purchasers to
title companies. Perhaps all real estate settlement producers
should be limited in their ability to influence the placement
of title insurance business to the distribution of such
informational pamphlets.
(b) The Lender as Purchaser
The second method is not a new idea in the title insur-
ance area. Over five years ago Senator Proxmire introduced
a bill called the Title Charge Reduction Act, 513/ which
would have required any mortgage lender who required title
insurance before making a home mortgage loan to purchase the
title insurance itself and forbade the lender from passing
the cost on to the buyer or seller of the home. The issue
of whether or not the home buyer or seller ought to pay for
title insuance which primarily benefits the mortgagee is
purely legislative. From a competitive perspective, however,
the mortgage lender clearly is in a better position than the
purchaser to acquire title insurance at the lowest possible
513, S. 2775, 92d Cong., 1st Sess. (1971).
PAGENO="0243"
237
cost. The lender has the business knowledge and time to
shop for the lowest rates and best coverage available plus
the added advantage that it will constantly be in the market
for title insurance as opposed to a home buyer who may not
purchase another title policy for the rest of his life. The
mortgage lender is thus theoretically the best buyer of
title insurance whether or not it is allowed to charge the
home buyer or seller for the ąost.
Those testifying on the bill's merits generally felt
that banks, being in business~to make money, would be unwilling
to provide such a service for the mortgagor without in some
way extracting a profit from it and in the process driving
the cost to the mortgagor at least as high, if not higher,
than it would have been before. 514/
(2) Elimination of Private Cartels
Competition within the title insurance industry is stifled
at times by state laws which are anticornpetitive to no
purpose. Chief among these are laws which allow private
514/ See, e.q., testimony of HUD Secretary ~omney, Hearincs
~ 2775 Before the Subcomrrt~ on Housinc aid Urban Affairs
of the Senate Comm. on Bankina, Housinc, and Urban Affairs,
92d Cong., 2d Sass., at 21-23 (1972).
PAGENO="0244"
238
cartel ratemaking via membership in state-sanctioned rating
bureaus. --
The primary raison d'etre of the rate bureaus is to
gather industrywide loss data from which accurate, statewide
title insurance premium rates can be calculated. But corn
ppsite loss data is almost irrelevant in the title insu~ce
ind~~y. 515/ It was noted earlier in this Report that the
title insurance industry paid out only between five and ten
percent of its gross income in losses to policyholders while
over eighty percent of its income was absorbed by the
expenses of searching title, such as employee salaries and
title plant maintenance. Since by far the largest component
of the cost of a title insurance policy is the title search
expense the bureau could presumably serve a very limited
function in this line of insurance. ~rgu~bly, expenses are
unique for each title insurer, depending t~~n the efficiency
of operations, and should be determined on an individual
company basis. Even conceding that industry loss data would
be useful in enabling a title insurer to ~ccurately calculate
its own title premium rates, the rating b~:eau could compile
and disseminate statistical data, and independent
515/ The absence of a need for pooling loss experience is
evidenced in part by the limited bureau mcnbership. One
respondent, conducting business in all but one of the states,
indicated membership in a rating bureau in only 15 states.
PAGENO="0245"
239
advisory organizations could trend losses, as we recommended
for automobile and fire insurance.
Another possible reason for state-sanctioned rating
bureaus is that the state insurance departments have only to
deal with one entity when rate changes are proposed rather
than with each individual insurance company. This reason
lacks much force in the title insurance industry due to the
small number ofoperating companies. ~~total number_of
title insurers operating in the nation has been shrinking
s~teadily in recent years, due in part to mergers and con-
solidations, down to an estimated 90 insurers in 1972 516/
and the number in any one state was considerably less than
that. In California, for example, only 16 companies are
actively writing title insurance policies. Thus, reviewing
proposed individual rate adjustments would not be an onerous
burden, especially since the states can require an insurer
to submit detailed supportive evidence with each request for
new rates. Coupled with the fact that industrywide rates
make little sense in the title insurance area and that
bureau rate setting supplies an anticompetitive nexus for
the title insurance industry, the evidence is very strong
that private cartel ratemaking ought to be curtailed.
516/ Barron's, Nov. 13, 1972, at 3.
PAGENO="0246"
240
(3) Rate Regulation
Title rates vary on a state and countywide basis de-
pending on, among other things, the urban or rural character
of the area, the number of sources that must be examined to
do a thorough title search, and state and local regulations
regarding who can conduct a title search. That the states
ake the p~pper bodies to regulate such intricate rates -- so
-~
long as regulation remains necessary -- is well shown by the
*attempt of the Department of Housing and Urban Development
and the Veterans Administration to implenent their authority,
under section 701(a) of the Emergency Hone Finance Act of
1970, "to prescribe standards governing the amounts of settle-
ment costs allowable in connection with the financing of
PAGENO="0247"
241
[HUD-insured and VA-guaranteed loans) housing" in any geo-
graphic area. BUD and VA first attempted to set maximum
settlement cost rates for six major metropolitan areas
only. After the rates were proposed, HUD received more
public corn~nent in response than they had ever received
before on a single subject -- most of it negative. 517/
After a thorough reevaluation of the processes and pro-
cedures necessary to properly establish nationwide regional
settlement cost standards, BUD determined that."even if it
could be concluded that Federal regulation of settlement
costs was workable at all, such regulation could be achieved
only at a very high administrative cost, widely out of
proportion to the benefits that would be received by con-
sumers." 518/
As a good example of such criticism see, Arthur D.
Little, Inc., ~~ysis of BUD/VA Report on ~!ortgage
Settlement Costs (January 1972), reprinted February 1975.
~j~/ Testimony of Sheldon B. Lubas, Assistant Secretary -
Commissioner for Housing Production and Mortgage Credit of
the Department of Housing and Urban Development before the
Subcommittee on Housing of the House Committee on Banking
and Currency, December 4, 1973.
PAGENO="0248"
242
There are two major social objectives in the area of
title insurance which can be achieved through state rate
regulation. One is to control the price inflating tendency
of reverse competition. As indicated at the outset, lack of
purchaser knowledge causes competition in the title insurance
industry to focus on market outlets. Instead of price
competition to reduce costs and attract ultimate consumers,
reverse competition drives up title costs as insurers strive
to pay higher commissions and kickbacks to real estate
settlement producers. This is the'~primary reasor~'that rate
regulation is needed in the title insurance ind~~y at all.
The establishment of maximum rates should be sufficient to
enable the states to control this problem. To the extent
that competitive pressures might be able to force down
prices, the consumer could only benefit.
The other major social objective in t~e title insurance
field is subsidization of low~cost home purchasers in their
title insurance rates bycornrnercial property and high-cost
home purchasers. Because title search expenses do .not
necessarily increase as the value of the p:operty being pur-
chased increases, it might be expected that the percentage
that the cost of the title insurance policy bears to the
PAGENO="0249"
243
overall cost of the property being purchased would fall as
the cost of the property rose. This is not the case. The
cost of title insurance as a percentage of purchase price
tends to remain constant at all price levels. Low-cost
property purchasers get title insurance policies at below
cost while higher priced property purchasers must make up
the difference. The result is "an excessive degree of
progressivity in the price structure which requires the
industry to depend on the few purchasers of large policies
to provide both a large cross-subsidy to smaller consumers
and an underwriting prof it." 519/
While this rate structure has the effect of making the
title insurance industry's profits excessively sensitive to
swings in the market for expensive private and commercial
property, it does make title insurance available at a reason-
able cost to purchasers of lower priced residential property.
The subsidy can be explained by the importance of the home-
buyers market to the title insurance ~.ndustry as a stabilizing
factor in a highly seasonable business. Whether this subsidi-
zation is desirable should be a matter of economic and state
519/ Arthur D. Little, Inc., Economic Considerations in the
Establishment of Title Insurance Rates in Pennsylvania
June 17, 1973 (Report to the Pennsylvania Land Title Insurance
Rating Bureau, Case 75550), at 20.
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244
policy. The state regulators, at the very least, should be
able to identify and measure the subsidy. Moreover, it
would appear that, to the extent that a state chooses to
foster this subsidization, maximum rate setting power is all
that would be needed.
As we discuss in greater detail in Part VII of this
Report, rate regulation has not been a relevant factor in
preventing insolvency. State solvency regulation, and
perhaps complementary federal solvency regulation for title
insurers eligible to participate in a federal guaranty
program, should be the process for achieving a reliable
title insurance mechanism.
(4) Title Companies Affiliated with
Producer
There is at least one major area in which state action
(and perhaps amendments to existing federal law) might
reduce or eliminate the problem-of reverse competition in
title insurance.
Congress attempted to deal with the problem of kickbacks
and unearned fees in the real estate settlcment services
area by passing RESPA. Section 8 of the Act makes it
illegal to give or receive anything of value for mere
referral of business in connection with a federally-related
PAGENO="0251"
245
real estate mortgage settlement service such as title
insurance, nor may any party to such a transaction take
any part of a fee paid for a mortgage settlement service
other than for services actually performed. While this
law is designed to close the front door to rebates and
kickbacks in the title insurance business, a loophole has
appeared which may ultimately cause a problem worse than
outright kickbacks. This loophole is the title company
affiliate of a real estate agency, which ~e will refer to
herein as the "producer's affiliate" or "controlled title
company."
The tii~le insurance company has a very passive role in
the distribution process, in that it does not seek out the
consumer and deal directly with him. It only underwrites
the risk for the policy issued by its agent. When the
producer has an affiliate that issues the policy, naturally
the producer will direct all of its title insurance business
to its affiliate. Title insurers, who genc~rally need a
large volume of business to cover the costs of creating and
maintaining their title plants, will bargain with the pro-
ducer's affiliate in order to get a guaranteed source of
PAGENO="0252"
246
title underwriting business; that is, the producer's affil-
iate will contract with whatever title insurer offers the
best deal to have all of its policies underwritten by that
one insurer.
~itle companies controlled by producers have been
s~eadily increasing in number since the passage of RESPA.
They possess several anticompetitive features. One is that
they encourage, on a new level, the type of activity sought
to be eliminated by RESPA. As the producer's affiliate
becomes established, competitive pressures will pusn title
insurance rates higher. The only way a title insurer can
guarantee itself adequate business is to outbid its competi-
tion in negotiating the percentage of the premium for the
title policy that it is willing to accept as an underwriting
fee or to outbid them in providing the work product and
services normally assumed by the producer's affiliated title
company (i.e., providing a search package requiring the
title company to do little other than deliver the policy and
collect the fee). Naturally, as the title insurer's profits
decline due to reduced underwriting fees or because of
increased costs due to commitments to assume more of the
PAGENO="0253"
247
duties normally provided by a title company, the cost of
title insurance will inevitably rise. 520/
These practices, if they could be proved to be payments
other than for services actually performed, may violate
RESPA. 521/ However, proving these violations would be
difficult and their elimination would not be wholly curative
of the situation for the presence of the controlled title
company creates other anticompetitive problems. Real estate
brokers and others will have no desire to direct business to
the best title company; rather, they will direct business to
/~
their own companies. Instead of receiving a kickbQck for
this service, they will r~ceivė corporate dividends, and the
receipt of corporate dividends from a producer's affiliate
is outside the prohibition of RESPA as currently interpreted
by ~JD. The amounts paid, their purpose, and the parties
receiving them, could be the same as under the kickback
system, but they would be exempt from RESPA. Reverse
competition would be strengthenedsince the affiliate's
~/ State of California, Department of Insurance, Findings
of Fact, Conclusions of Law, and Recommendation In the
Matter of Application of Guardian Title Company, a California
corporation, for Organixational Securities Permit, File No.
L-67, UTC LA-70, October 27, 1976.
521/ HUD Regulations, Title 25, Chapter XX, Part 3500,
Section 3500.14 and Appendix B, example 9, 41 Fed. Reg.
22702 (1976)
PAGENO="0254"
248
decision as to whom it chooses to underwrite its policies
would be based on how much it would receive as compensation,
not ho~; much the policy will cost the purchaser; and the
producer, who profits as the controlled title company
profits, will continue to direct business to its own
affiliate.
This controlled placing of settlement services has a
definite tendency to increase the price paid by the con-
sumer. In recent hearings conducted by the California State
Department of Insurance into the licensing of controlled
title companies in that state, the Department uncovered
evidence that where a real estate company applying for a
license to operate an affiliate had formed a controlled
escrow business and channeled all of its real estate business
through that escrow company, consumer's costs for full
escrow services from that company were significantly greater
(in excess of 150% more) than the consumer's cost for the
same or substantially similar escrow services from title
insurers providing escrow services in the same locality, and
the Insurance Department concluded that the same result
could be expected if controlled title companies became
licensed. 522/ The Insurance Department also concluded that
by combining a parent real estate company's financial data
522/ Application of Guardian Title Company, supra note
at 10-11.
PAGENO="0255"
249
with the financial data of a controlled title company, many
of the statistics necessary to properly regulate title
insurance rates would be lost. 523/
To sum up the major evils of controlled title companies,
*where a real estate settlement producer is able to direct
the purchaser of a title insurance policy to a particular
title company and at the same time that producer owns the
title company, the purchaser is likely to end up (1) paying
unreasonably high premiums, (2) accepting unusually poor
service, or (3) accepting faulty title examinations and
policies from the controlledtitle company. 524/
We believe that the problems raised by the controlled
title companies could be handled at the state level.
Clearly, there is a need for state supervision of real
estate settlement producers with affiliated title companies.
At the very least, stringent disclosure requirements should
be imposed on these producers, as discussed earlier in this
Section. The states may also seek to prohibit tie-in
arrangements between real estate settlement and title
insurance services.525/ Of course, the mcst drastic remedy
would be the prohibition against a real estate broker or
523/ Id., at 11-12.
524/ Analysis of Competition, supra, note 499 at 95.
525/ Compare Section 106 of the Bank Holding Company Act
Amendments of 1970, 12 U.S.C. S 1q71 et ~
PAGENO="0256"
250
escrow agency from owning any boneficial iiterczt in a title
company or title insurance Company because of the potential
problems of reverse competition.
In conclusion, tha title insurance industry suffers
from a number of competitive problems. Chief among these is
reverie competition brought about by an imbalance of knowledge
on t1~e part of r~a~ property purchasers. Reverse competition
*prcsently overwhelms most fo~is of competitive pressure in
its tendency to drive title insurance rates up. Unless this
~roblem can bc solved, o~ unless title insurance, is marketcd
in new, direct ways which eliminate reverse competition,
competitive controls cannot be relied upon to prevent exces-
sive rates. .
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251
VII. CONCLUSIONS AND RECOMNEND7~TIONS
A. conclusions
1. Rigid State Rate Regulation Has
Had Adverse Effects
Rigid state rate regulation in insurance -- charact-
eristic of a number of state systems -- has fostered greater
adherence to bureau rates, discouraged rate reductions,
contributed to instability in insurance company operations,
es~ab1ished various forms of cross-subsidization between
good and bad risks imposed unnecessary restrictions on the
collective merchandising and the direct writing of insur-
ance, and aggravated the availability problem in which
marginal or high risks have difficulty obtaining coverage in
the open market at the prevailing rates.
2. Vigorous Competition is Consistent
With the Goal of Reasonable Prices
The long-run experience of at least one major insurance
state under an open competition system, in which the state
* has relied on market forces to control.prices, suggests that
essentially unrestricted price competition can provide an
effective substitute for rate regulation as a means of
achieving reasonable prices and maximum efficiency in the
sale and distribution of insurance. A comparison of the
* experience of the same insurers under certain open corn-
85-396 0 - 81 - 17
PAGENO="0258"
252
petition and prior approval systems suggests that competition
fosters greater independent pricing, operating stability,
and flexibility in the pricing structure. The relatively
favorable performance of the insurance companies under the
highly competitive system suggests that it provides a more
effective mechanism for accomplishing one of the basic
insurance goals.-- generally available coverage at a price
reasonably related to cost. 598/
In the commercial lines, the study indicates that state
regulatory schemes are largely illusory and that insurers
are generally free to set their own prices, owing to the
availability of state-authorized rating plans which permit
insurers to individually price risks based essentially on
their business judg~nent and competitive pressures. The
prevalence of these plans in the commercial lines raises a
fundamental question as to the purpose and need for the
ostensible state rate regulation in theoe lines of insurance.
3. The Insurance Industry Could
* Function Effectively in a Manner
Consistent with the Federal Anti-
trust Laws
The insurance industry should be able to conduct its
business within the federal antitrust laws without any
special exemption. Antitrust precedent indicates that
598/ See Casualty Insurance., supra note 317 , at 776;
NAIC, supra note 25 , at 95-96.
PAGENO="0259"
253
insurance companies could pool their loss experience con-
sistent with federal antitrust standards. Moreover, the
federal antitrust laws would not prohibit the trending of
future losses on a composite basis by advisory organizations
that were independent of the companies they were serving.
Likewise, the antitrust laws would not prohibit those voluntary
risk-sharing arrangements, such as insurance pools and rein-
surance agreements, that were either necessary to the con-
duct of business or served some other legitimate business
purpose without substantially lessening competition.
4. Vigorous Competition is Consistent
with the Goal of. a Reliable
Insurance Mechanism
One of the principal concerns of Congress in enacting
the X'lcCarran-Ferguson Act was that unrestricted competition
would result in price wars and mass bankruptcies. The long-
run experience in California (and published opinions on the
more recent experience of a major insurer of private passen-
ger automobiles) suggest that insolvency is essentially a
function of mismanagement. 599/ Even in a highly regulated
environment, insurers may adopt inadequate prices, fail to
59W See reference to California experience in 1969 New York
Report, supra note 87 , at 129. See also discussion of
GEICO problems in Fortune, June 1976, at 128.
PAGENO="0260"
254
identify marginal or high risks or underestimate loss
development factors. Ironically, rigid rate regulation,
rather than unbridled competition, appears to have had an
adverse effect on the stability and solvency of insurers
because "it makes rates unresponsive to changing market
circumstances' and thereby exacerbates a company's financial
difficulties. 600/
5. Competition Suggests a Need For
a Nore Efficient System of Sol-
y~p~y Regulation
It is very possible that under a fully competitive
system on a national scale, inefficient insurers may be
forced out of the market. A transition to a highly com-
petitive system may require a major shift in regulatory
policy, from that of "keeping every insurer afloat" to that
of "swift detection and swift removal of a failing company
from the insurance marketplace." 601/ The New York Insurance
Department recognized the need for a new approach to solvency
regulation in concluding that: 602/
600~ 1969 New York Report, sup~a note 87, at 130.
60]! New York Insurance Department Report on "Regulation of
Financial Condition of Insurance Companies" (1974) (referred
to herein as "1974 New York Report"), at 59, 80.
(,02j Id., at 74. Bracketed letter added for clarification.
PAGENO="0261"
255
The legitimate need for improved market
performance by insurers also make[s) it
increasingly less appropriate to regard
preservation of strong financial con-
dition and prevention of insolvency
as absolute goals of insurance
regulation. Instead, our objectives
with respect to financial condition
must increasingly be balanced against
their impact on other goals of
insurance regulation.
The National Association of Insurance Commissioners
appears to have recognized the need for a uniform early
warning system to monitor the financial condition of pro-
perty-liability companies. 603/ However, the ability to
detect potential solvency problems depends on the quality
and quantity of the resources of both the domiciliary state
and the state where the company is licensed to do business. 604/
The domiciliary state must periodically examine in depth the
insurer's financial .condition. The licensing state must
monitor the condition of the company, relying in part on the
domiciliary state and on its own early warning system.
Most important, effective solvency regulation in a
competitive environment depends on the acceptance of market
603/ NAIC Audit Ratios for Property and Liability Companies
(1975).
604/ For example, in New York about 65 percent of the fire
and casualty companies doing business in the state,
representing about 87 percent of total assets, are nondom-
iciliary companies. New York Insurance Department, Statis-
tical Tables from Annual Statements (1975), at Table 18.
PAGENO="0262"
256
forces as a mechanism for weeding out weak and inefficient
companies and on the willingness to remove, in a timely
manner, a company from the marketplace where there is a
substantial danger of insolvency. There must also be
available an established guaranty fund in the event that the
regulatory controls fail to detect a financially unsound
company in time.
The adaptability of traditional state methods of sol-
vency regulation to a competitive environment is doubtful.
The states vary substantially in the amount of resources
devoted to regulatory oversight. Very few states administer
their solvency regulation in a fully competitive system.
New York, for example, was in the vanguard of regulatory
reform, at least in recognizing the benefits of rate deregu-
lation and the need for a drastic change in s~ate solvency
regulation under such a system. 605/ At the same time,
New York has retreated from a truly open competition system
in the process of introducing no-f thilt ihsurance, and the
state has used its preassessment security (guaranty) fund to
purchase $200 million of state obligations, adversely affect-
ing the liquidity of the fund. 6o&/
605/ 1975 New York Report, supra note 87 , at 88-89; 1974
New York Report, supra note 601 , at 74; New York Insurance
Department Report, Competition in Property and Liability
Insurance in New York State (1973) , at 113-14; 1969 New York
Report, supra note 37 , at 149.
60V Congressional Record, October 1, 1976, at S. 17836.
PAGENO="0263"
257
We recognize that there are a few exceptional states
like California, whose regulators have approached the sol-
vency issue with minimum interference to the free market
mechanism. However, there are also few open competition
systems today that are politically secure. The regulators
from California, Hawaii, New York, Illinois, and Virginia
all inform us that the future of rate deregulation in their
states is uncertain.
6. Competition is Consistent With the
Goal of Preventing Unfair Discrim-
ination
Competitive forces can generally serve to protect
consumers against unfairly discriminatory prices, provided
that there is adequate disclosure and regulatory effort to
make consumers aware of alternative sources and prices of
insurance. The relatively simple and short-term nature of
the contract in the personal lines of property-liability
insurance should facilitate consumer price shopping. 607/
Consequently, we believe that competitive pressures can
adequately regulate the method by which insurers distribute
their services, whether it be through collective merchandising,
direct writing, independent agents, or some combination
607' However, a different situation exists in the life
insurance field. In view of the various forms of protection
and the long-term nature of the contract, there is a need
for improved disclosure of cost information so as to enable
the individual buyer to shop for price.
PAGENO="0264"
258
thereof. Market forces should also generally be able to
regulate the method by which insurers assess and select
risks and the process by which agents price their services.
7. Special Consideration is Necessary
With Respect to Invidious Discrim-
ination and the Affordability
Problem
It is possible that competitive forces may not neces-
sarily rectify problems of social fairness in the sale of
insurance, particularly in dealing with invidious discrim-
ination and affordability problems. We believe that there
should be federal standards prohibiting federally-chartered
companies from refusing to service individuals, or charging
them disproportionately higher rates, because of their race
(e.~., territorial redlining), age or sex.
The affordability problem obviously will not be resol-
ved by unrestricted -competition, in which prices are reason~-
ably related to costs. We believe that each state should
decide whether and how it will provide a direct subsidy to
drivers who are unduly burdened by the cost of insurance.
8. Residual Market Mechanisms
Are Appropriate
While competitive ratemaking may ease the availability
problem, some form of mandatory pooling mechanism seems
likely to remain necessary in order to provide coverage to
all drivers who seek protection. The form and regulation of
that mechanism should be left exclusively to the states.
PAGENO="0265"
259
9. A Competitive Alternative to Present
Restraints in the Pricing and Marketing
of Insurance Would be Utilized
Our earlier conclusions as to the consistency of
competition with the traditional public interest goals of
insurance regulation - reasonable prices, a reliable insur-
ance mechanism, and economic and social fairness - do not
fully answer the question of how the industry would react in
the event that a freely competitive mode of pricing and
marketing were available. The~ evidence is that it would
take advantage of such an alternative.
(a) The Industry is Generally Structured in
a Manner Conducive to Competition
The property-liability segment of the industry is only
moderately concentrated, with the twenty largest insurance
groups accounting for just over half of the industry premiums.
No single group accounts for a major share of the overall
market. Entry restrictions do not appear substantial, and
competition does not appear inhibited by significant econo-
mies of scale. In short, this segment of the industry is
structured in a manner conducive to competition. 603/
608/ See discussion on pages 7-11, of this Report.
PAGENO="0266"
260
The life insurance industry is more concentrated, but
there is evidence that this concentration has been eroding.
At present, however, although sophisticated purchasers of
mass merchandised life insurance demand vigorous competi-
tion, competition for the business of individual consumers
nay be inhibited by the complexity of the product and the
phenomenon of `reverse competition" wherein the companies
compete for the allegiance of agents rather than consumers.
It is unclear whether safeguards against these two problems
are necessary to lead the industry along the competitive
paths its overall structure would suggest. 609/
609/ See discussion on pages 11-14 and 277-282 of this
Report. See pages 239-286 of this Report for a dis-
cussion of the relative competitive inducements in other
lines of insurance.
PAGENO="0267"
261
(b) The Industry's Demonstrated
Competitive Prqpensity
For a number of years, the concept of competitive
controls as a substitute for direct regulation has become
increasingly popular among regulators. The industry has
similar inclinations: it is advocating enactment of open
competition laws, and abandoning its long-standing position
that rates should be made in concert rather than in the
marketplace. Experimentation with competition has been
substantial, as has the emergence of independent pricing in
segments of the property-liability industry. ~j~/
Opposition to prior approval laws has been grbwing
within the industry, initially from the direct writers who
market their product through their own employees or agents
and who have gained a significant share of the business in a
relatively short time. Their, growth has been attributed in
substantial part to a more efficient marketing technique and
the availability of independent pricing. Finally, insurers
have sought a rate structure more responsive to changes in
loss experience and other cost factors, an interest consis-
tent with that of consumers over the long, run. 611/
610/ See discussion on pages 27-28 of this Report.
6j3j See discussion on p~ges 28-30 of this Report.
PAGENO="0268"
262
Perhaps the best d~rnonstration of the industry's
propensity for competition, however, is its performance
where competition is the rule rather than the exception.
Our study indicates that in California, where open com-
petition has long been a fact of life in the industry, a
substantially larger proportion of insurance is independ-
ently priced than in other, more restrictive states. 612/
Thus, we conclude that given the opportunity, a signifi-
cant segment of the industry would adbpt an alternative,
fully competitive mode of pricing and-marketing insurance in
those many lines conducive to it.
B. The Comoetitive Alternative
Our conclusions as to the consistency of competition
with the traditional goals of insurance regulation and the
probabilityof its adoption by the industry lead to the
question of how an outlet for competition can be created.
We believe that serious consideration should be given to a
proposal that would give insurance companies the option of
doing business under federal auspices, in a manner
612/ See discussion on pages 36-50 of this Report.
PAGENO="0269"
263
similar in some respects to the option presently available
to-other financial institutions -- banks, savings and loan
associations and credit unions. Such an alternative is
suggested by the parallel between depository financial
services and insurance services, and between the need to
assure the solvency of the overall insurance mechanism and
the need to assure that of the banking system, which has led
to the concept of federal deposit insurance. It is also
suggested by the positive effects that the present dual
regulatory scheme pertaining to depository financial in-
stitutions has had on unnecessary restraints on competition.
Extensive discussion of the particular features of
today's "dual banking system" 613/ i~ beyond the scope of
this report. Moreover, we do not wish to suggest that every
aspect of that system would be appropriate for a parallel
system covering insurance, or indeed that every aspect of
that system as it now exists is consistent with
613/ The term i~; as indicated above, not sufficiently
T~iusive.
PAGENO="0270"
264
the contemporary public interest. 614/ However, the dual
banking system provides a workable model from which to
start, and is generally viewed as allowing a proper accom-
modation of state and federal interests in interstate
commerce.
1. Solvency Assurance at the Federal Level
As indicated in our conclusion on the consistency of
competition with the goal of a reliable insurance mechanism,
we recognize the legitimate governmental interest in seeing
to it that those who acquire insurance protection will have
someone to turn to if and when claims arise. Insurance,
like other financial services, involves very substantial
interests of businesses and individuals, interests often
determinative of their ability to survive in the financial
614/ Extensive examination of the operation of the "dual
banking system" has been under way for some time, most
recently culminating in passage by the Senate of S. 1267
(94th Cong., 1st Sess.), the "Financial Institutions Act of
1975." The Department of Justice has criticized certain
aspects of the regulation of financial institutions, see,
e.g., Testimony of Thomas E. Kauper, Assistant Attorney
General, Antitrust Division before the Subcommittee on
Financial Institutions, Regulation and Insurance, Committee
on Banking, Currency, and Housing, House of Reoresentatives,
concerning The Financial Reform Act of 1976, March 17, 1976.
We are not aware, however, of any -substantial fundan~enta1
criticism of the dual regulation concept itself.
PAGENO="0271"
265
if not literal sense. This parallel suggests that insurance
companies doing business under federal auspices should be
subject to some form of review of their operations, not
entailing rate regulation, at the federal level. It also
suggests the probable necessity for a federally-established
guaranty fund in the event of the sudden, unpredicted demise
of such a company.
The rationales underlying federal solvency regulation
and a federal guaranty fund are set out infra, in the
~discussion.of the specifics of a dual regulatory system
proposal. At this point, however, it is, interesting to
again note a parallel between the type of solvency regu-
lation we see as appropriate at the federal level for
insurance and the type of solvency regulation we believe
proper for depository financial institutions.
The discussion above indicates our belief that
the transition to a highly competitive marketplace may
require a shift in policy from preserving at all costs
the viability of each individual insurer to the swift
detection and removal of a failing company from the
marketplace, and the meeting of its reponsibilities by
absorption of its business by the industry at large (e.q.,
throuē~h merger or policy transfers) or by a last resort
guaranty fund. After all, the important consideration
PAGENO="0272"
266
from the public'sstandpoint is not the preservation of any
one company, but rather the preservation of a reliable
insurance mechanism.
In like manner, the Department has questioned what is
apparently a common premise -- that individual depository
institutions must be preserved at all cost in the interest
of systernwide stability. The Department has recognized that
the effects of sudden and catastrophic failure must be
avoided; however, it has noted that other forms of market
ttexitu are available, and has urged that such alternatives
are superior to universally over-restrictive regulations
which tinnecessarily inhibit competition. 615/
These consistent views of the proper scope of federal
solvency regulation reinforce our view that the dual banking
system provides a workable preliminary model for a competitive
alternative in the pricing and marketin~ of insurance.
.615/ See Testimony of Thomas E. Kauper, Assistant Attorney
~~cral, Antitrust Division, before the subcommittee on
Financial Institutions, Regulation and Insurance, Committee
on Banking, Currency and Housing, House of Representatives,
concerning Proposals for Reform of the Regulation of Financial
Institutions, December 4, 1975.
PAGENO="0273"
267
2. Positive Benefits of a Federal Regulatory
Alternative
A search for possible outlets for the competitive
propensities of a large segment of the insurance industry
leads to consideration of an alternative federal system for
another reason -- under the present dual banking system, the
two basic alternatives for doing business in a particular
state serve as a check upon one another. Where a federal or
state alternative exists, regulation is kept in check, since
undue restraints may induce individual institutiOns to move
from one system to another.
That alternative regulatory schemes may actually serve
as a check upon one another can be demonstrated by recalling
a few events occasidned by what was seen as overly restrictive
regulation of depository financial institutions. For example,
in the 1920s, the decline of the national banking system was
traced to narrow charter powers and an unequal competitive
position vis-a-vis state chartered institutions. Congress
responded in the McFadden Act of 1927. 616/
616/ See Fischer and Golembe, "The Branch Banking Provisions
6Uthe McFadden Act as Amended," (Golembe Associates, Inc.),
in Comoendiurn of Issues RclatincT to Branchinq by_Financial
Institutions, prepared by the Subcommittee on Financial
Instituti~i of the Committee on Banking, Housing and Urban
Affairs, United States Senate, 94th Cong., 2d Sess., October
1976.
85-396 0 - 81 - 18
PAGENO="0274"
268
In 1963, controversy arose over the liberal policies,
particularly national bank chartering and branching deci-~
sions,of then Comptroller of the Currency Saxon. 617/ The
merits of Mr. Saxon's policies may be debated, but it is
undeniable that alternative regulation prompted or at least
permitted, in those times, an butlet for competitive pres-
sures. In testimony before the House Banking Committee, Mr.
Saxon put forth his view of the proper concept of dual
regulation: 618/
What meaning should be attached to
the dual banking system, and how should
it function?
We see no way that a dual banking system
cam function if either segment, State or
National, is held in check for the purpose
617/ See generally, "Conflict of Federal and State Banking
Laws," Hearings before the Committee on Banking and Currency,
House of Representatives (8Sth Cong., 1st Seas.), April 30,
Nay 1, 2, 3, and 6, 1963.
~j~/ Id., at 280.
PAGENO="0275"
269
of safeguarding the other. Such an approach
would subordinate one system to the other,
and there could be no true duality.
Where there is only one regulatory structure available,
or where one system is subordinated to another, policies are
more likely to develop which dampen if not douse innovation
and the search for efficiencies. We believe that such has
occurred in insurance under the present monolithic regula-
tion pertaining in each state.
Lest there be any misunderstanding, it should be added
that we by no means endorse what has been called "cornpeti-
tion in laxity" in the regulation of financial institutions.
Assurance of the reliability ąf the insurance mechanism is
of primary importance, although as we have noted, this does
not mean that even poorly run, inefficient companies should
be artificially supported. In any event, we see no necessary
inconsistency between the concept of a dual regulatory
system and sufficient governmental ~uarantees of insurance
reliability.
PAGENO="0276"
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C. ~~gJ~osal
We envision a dual system of regulation of insurance
companies in many ways similar to those which pertain to
depository financial institutions, involving federal chart-
ering and a related guaranty system. A federal agency, such
as the Federal Insurance Administration, could administer
the federal system. Insurance companies would have the
option of seeking a federal charter and thereby losing
NcCarran Act protection, or retaining that protection under
a state charter and remaining subject to the full scope of
state regulation.
We do not attempt in this Report to advance a definit-
ive proposal for such a dual system of insurance regulation.
Rather, we look to the federal banking system f or guidance
as to a general scheme of dual regulation suitable for the
insurance industry. We examine below the rationale for
certain specific concepts in the proposed dual system, in
light of our findings on the insurance industry.
1. Eligibil~~
All insurance companies meeting minimum standards of
financial responsibility (e.~., minimum capital and reserve
requirements) should qualify for a federal charter.
PAGENO="0277"
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In the case of a group of insurers under common manage-
ment or control, it is recommended that no one or more of
the insurers in the group be federally-chartered unless all
of the companies are so chartered. Otherwise, insurance
groups could conceivably use competitive, federally-chartered
companies in some states or lines, and state-chartered
companies in others, possibly' resulting, among other things,
in artificial carry-over effects. Further, effective sol-
vency oversight may require supervision of an entire group
a single regulator. Because of the significance of
insurance groups, a workable system. seems to require that an
all-or-nothing approach be adopted in offering an alterna-
tive to state rate regulation.
2. Federal Regulation of Federally-
Chartered Companies
We recommend that federally-chartered insurance
companies be exempt from state rate regulation (includ-
ing regulation of risk classifications), state restrict-
ions on collective merchandising and direct writing of
insurance, state guaranty funds, and state solvency regu-
lation. As a substitute for state regulation in these
areas, we propose that federally-chartered companies
PAGENO="0278"
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be required to participate in a federal guaranty fund, and
that these insurers (and their agents to the extent rele-
vant) be subject to the following federal controls: federal
solvency and investment standards; federal laws against
invidious discrimination in the selection and
classification of risks based on race, age,, and sex; and
federal standards on disclosure of price information and
underwriting experience. The federal antitrust laws, without
any special exemption, would also be fully applicable to the
operations of federally-chartered companies. We examine
below the rationale for these recommendations.
a. Market Controls as a Substitute for
State Rate Regulation
We have examined in some detail the relative perfor-
inance of private passenger auto insurers under a true "open
competition".system and two "prior approval" systems
involving extensive state involvement in the pricing
process. 619/ The evidence strongly suggests that
unrestricted price competition is superior to rigid rate
regulation as a way of achieving reasonable prices, a
619/ See Part III of this Report at pages 36-90.
PAGENO="0279"
273
reliable insurance mechanism, an1 economically fair
prices which are based on an accurate assessment of the risk
presented. 620/ This evidence on personal line insurance is
buttressed by the experience in the commercial lines of P-L
insurance in which there has not been (and is not likely to
be) meaningful rate regulation. 621/ Moreover, it appears
that federally-chartered companies would be able to conduct
essential collective activities -- including the pooling of
loss statistics, loss projections, and voluntary risk-
sharing -- within the existing federal antitrust laws.
Consequently, we recommend that the price of insurance
sold by federally-chartered companies be controlled ex-
clusively by market forces (with the federal antitrust laws
fully applicable) as a substitute for state rate regulation.
b. Federal Solvency Regulation and
Guaranty Fund as a Substitute for
Comparable State Requlation
There are several considerations that lead us to the
conclusion that federal ~olvency regulation and a federal
620/ See discussion on pages 36-75 of this Report.
621/ See discussion on pages 198-200, 203-204, 220 and 245
of this Report.
PAGENO="0280"
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guaranty fund would serve to -complement a fully competitive
system.
Solvency regulation may be used by the states as an
indirect means of regulating insurance rates. Thus, in life
insurance we are informed that the expense limitation laws,
together with minimum reserve standards, minimum and maximum
surplus limitations, and dividend distribution requirements,
serve as an alternative to rate regulation. 622/' While these
various forms of solvency regulation may be perfectly compa-
tible with a fully competitive scheme, they must be adminis-
tered in a manner in which there is an acceptance of competi-
tive forces as the mechanism for setting prices, and a
willingness to regulate for solvency in a manner consistent
with those objectives. -
Similarly, reliance on market controls to regulate
prices appears to necessitate a new approach to solvency -
regulation as outlined by the New York Insurance Department
in its 1974 report. 623/ State insurance regulators (with
exceptions) have traditionally sought to `keep every
622/ See discussion on page 279 of this Report.
623/ See discussion on pages 343-344 of this
Report.
PAGENO="0281"
275
I
insurer afloat" rather than achieve early detection of
failing companies and their swift removal from the market-
place if necessary.
Finally, it should be recognized that under a fully
competitive system on a national scale, inefficient insurers
may be forced out of the marketplace. There must be avail-
able an established guaranty fund, comparable to the FDIC,
in the event that the regulatory controls fail to detect a
financially unsound company in time to permit an orderly
dissolution. Even the most proficient of regulators may not
be able to identify a company that borders on insolvency
because of a poor book of business or underestimated loss
development factors. 624/
We believe that those companies electing to participate
in a fully competitive system -- as distinguished from
insurers remaining fully subject to state reguiation --
should bear the burden of such a system. Federally-chartered
companies would be required to participate in the federal
guaranty fund as an alternative to participation in the
state funds where they conduct their busin~ss.
624/ See note 355 on page 160 of this Report.
PAGENO="0282"
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c. Federal Preemption .of State Regulation
Against Unfair Price Cornpetition
We indicated above the rationale for substituting
market controls for state rate regulation, including regu-
lation against inadequate, excessive, or unfairly discrim-
inatory prices. We have concluded that competitive pressures
can adequately control unfair price discrimination that may
arise in the distribution of insurance. Consequently, we
believe that federally-chartered insurers should be free to
utilize collective merchandising, direct writing, independent
agents, or any combination thereof, subject only to federal
(and state) disclosure requirements and federal antitrust
constraints. 625/ Likewise, we believe that the agents of
such insurers should be free to use a fixed graded commis-
sion scale, rebating; net pricing, or some other process for
pricing their services, subject to federal (and state)
~disclosure requirements and antitrust constraints. 626/
625/ See discussion on pag~s 327-330 of this Report.
626/ See discussion on pages 302-303. of this Report.
PAGENO="0283"
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It is possible, however, that competitive restraints
may not prevent invidious discrimination in which individuals
are denied coverage or are charged disproportionately high
rates based on their age, sex, and race ~ territorial
redlining). Consequently, we recommend federal legislation
that would prohibit invidious discrimination in the sale of
insurance and that would require validation of risk classes
based on age, sex, and race and provide relief against risk
classifications that are, among other things, arbitrary or.
illogical. 627/
We believe that federal (and state) disclosure require-
ments with respect to pricing and underwriting experience
are not only an important complement to these anti-discrim-
ination measures, but are essential to the full and fair
exchange of information in a competitive environment.
3. State Regulation of Federally-
Chartered Companies
We envision an affirmative but limited role for the
states in the regulation of federally-chartered companies.
627/ See discussion on pages 337-339 of
this Report.
PAGENO="0284"
278
The states could continue to impose taxes on all corn-
panics doing business within their jurisdiction. 628/
The states could require all companies doing business
within their jurisdiction to participate in a pooling mecha-
nism to serve individual drivers who are unable to obtain
insurance protection in the open market. We recognize that
while a flexible price structure for federally-chartered
companies may ease the availability problem, some form of
mandatory pooling mechanism may be necessary in order to
provide coverage to all drivers who seek protection. The
form and regulation of that mechanism should. be left exclu-
sively to the states, since to some extent the magnitude of
* the residual market depends on the state requirements for
insurance coverage. Some states have compulsory insurance
laws and other states have financial responsibility laws
administered with varying degrees of stringency.
628/ There is some question as to -the competitive effects
of `retaliatory" and "discriminatory' state taxes imposed on
foreign and alien insurers. See Pyle, "The Metamorphic
Retaliatory Tax Law (What Lies Ahoad?)", in a paper presented
to The Association of Life Insurance Counsel (May 1972).
We have not examined this issue, but recommend further
study to determine the existing and potential competitive
ramifications of these state laws.
PAGENO="0285"
279
The states could regulate the rates and risk classi-
fications used by these residual market plans. However, it
is strongly recommended that federally-chartered companies
only be required to participate in plans which operate on a
self-sustaining (cost-related) basis. Otherwise, the states
could continue to use such plans as a means of involving
federally-chartered companies in cross-subsidization, 629/
perhaps indirectly regulating~ all of their rates and poten-
tially undermining the viability of the federal competitive
alternative.
In lieu of cross-subsidization between high and low
risk drivers, the state could furnish a direct `external"
subsidy to individuals who cannot afford insurance pro-
tection. 630/
629/ New York's assigned risk plan -- even during the
~period when the State was under a full "open competition"
system -- provided for a substantial subsidy from the vol-
untary market. New York Insurance Department, Preliminary
Report on "The Automobile Assigned Risk Plan in New York
State" (undated), at 12.
Under the New York formula, "plan rates for compulsory
coverage are established at a point midway between (1) the
rates computed on the basis of assigned risk loss and expense
experience of all companies, and (2) the average rates that
would result if computed on the basis of the voluntary risk
loss and expense experience of all companies, reduced by
probable policyholder dividends."
630/ See discussion on pages 71-74 of this
Report.
PAGENO="0286"
280
Finally, the states could continue their dominant role
in regulatory `matters pertaining to the insurance contract,
such as minimum coverage requirements, cancellation and
renewal of policies, financial responsibility laws, compulsory
insurance, policy forms, licensing of agents, and systems of
liability (fault vs. no-fault). We believe that all of these
activities depend on the underlying system of insurance
protection; that varies from state to state. None of these
activities would appear to conflict with the competitive
goals of the federal alternative, provided the residual mar-
ket was administered on a self-sustaining basis and federally-
chartered insurers in the voluntary market had pricing,
classification, and initial underwriting discretion. 631/
Nevertheless, a dual system of regulation would require
the reconciliation of federal and state regulation. In this
regard, the experience of the banking laws may provide some
guidance so that all insurance companies would be subject to
state law, unless they are expressly exempt by federal law
or unless the state laws interfere or conflict with the
purposes of the federal scheme. 632/ .
631/ See discussion on page 319 of this Report.
632/ See Franklin National Bank of Franklin Square v.
New York, 347 U.S. 373 (1954); Lewis v. Fidelity~ Deposit
Co. of Maryland, 292 U.S. 559 (1934); First National Bank
in St. Louis v. State of Missouri, 263 U.S. 640 (1924).
PAGENO="0287"
281
4. Dealing with "Reverse Competition"
ma Dual Regulatory System
We have examined in some detail the problems of "reverse
competition" in title insurance and, to a lesser extent, in
credit life and health insurance and life insurance generally.
The problem essentially is that consumers are either
"captive" buyers, uninformed buyers, or simply buyers in-
different to price variations among sellers. Consequently,
insurers compete for the producers' business rather than
directly for the business of the ultimate consumer, result-
ing in excessive commissions and prices.
In title_insurance, the ōonsumer is captive because
the service is ancillary to the principal transaction,
which is the purchase of real estate. 633/ In credit
health and life insurance, reverse competition stems
from the inferior bargaining position of the buyer
who, again, may view the insi.irance service as ancillary
to the principal transaction, which is the purchase of
credit. ~ In life insurance, the dependence of the
insurer on the agent to initiate buyer interest in tile
service and the lack of consumer knowledge. may contribute
633/ See discussion on pages 255-256 of this Report..
634/ See discussion On pages, 276-277 of this Report.
PAGENO="0288"
282
to excessive commissions. t~t least this appears to be the
rationale for Section 213 of the New York Insurancc Law. 635/
However, the problem may not exist for all life insurers,
where for example direct writers have control over the level
of commission rates ~nd compete on the basis of price.
Likewise, the problem may not be universal for all title
insurers or all credit life and health insurer companies.
consequently, we believe that further study of the reverse
competition problem is required, particularly in life
insurance.
There may be several alternatives to dealing with the
problem of reverse competition in such a manner as to be
consistent with the objectives of a dual regulatory system
in which the federal alternative is fundamentally a com-
petitive one. We. believe t1~e best approach would be to
p~rmit companies engaged in ~ problem lines to qualify
for federal chartering but remain subject to selective forms
q~state regulation designed to set limits on cdmpensation
to intermediaries and thus counter the reverse competition
phenomenon.
See discussion on pages 280-281 of this
Report.
PAGENO="0289"
283
* ~* *
In summary, a predominant segment of the property-
liability insurance industry is favorably structured for
competition, with a large number of competitors, relatively
moderate concentration, ease of entry, a standardized
service, a relatively simple and short-term contract, and an
increasingly price-sensitive consumer market. The available
evidence suggests that unrestricted price competition would
be an effective alternative to state rate regulation and
compatible with regulatory objectives for a reliable in-
surance mechanism. It is the opinion of this study that all
of the major lines of property-liability insurance should
have the option of operating in a fully competitive environ-
ment under a dual system of regulation. Other lines, including
life insurance, are probable candidates, subject only to
possible regulation countering the phenomenon of reverse
competition. Further study appears necessary to reach
definitive conclusions in health insurance and medical
malpractice. As one industry-sponsored study recently
concluded, "this may be the time for the insurance industry
to surrender the cloak and face the antitrust elements
ungarbed because only then can it be treated equally with
other segments of interstate commerce." 636/
636/ The College of Insurance 1~csearch Institute, "Insur-
ance Regulation at the Crossroads" (1976) , at 56.
85-396 0 - 81 - 19
PAGENO="0290"
284
A~69~ L~~d T~ A,s 9t'9~ C0~~:1~95 1966
COMMITMENT FOR TITLE INSURANCE
Issued by
STEWART TITLE
GUARANTY COMPANY
Stewart Title Guaranty Company, a Texas corporation, herein called the Company, for a valuable
consideration, hereby commits to issue its policy or policies of title insurance, as identified in Schedule
A, in favor of the proposed Insured named in Schedule A, as owner or mortgagee of the estate or
interest covered hereby in the land described or referred to in Schedule A, upon payment of the
premiums and charges therefor; all subject to the provisions of Schedules A and B and to the
Conditions and Stipulations hereof.
This Commitment shall be effective only when the identity of the proposed Insured and the
amount of the policy or policies committed for have been inserted in Schedule A hereof by the
Company, either at the time of the issuance of this Commitment or by subsequent endorsement.
This Commitment is preliminary to the issuance of such policy or policies of title insurance and
all liability and obligations hereunder shall cease and terminate six months after the effective date
hereof or when the policy or policies committed for shall issue, whichever first occurs, provided that
the failure to issue such policy or policies is not the fault of the Company.
This Commitment shall not be valid or binding until Schedule B is countersigned by an authorized
signatory.
IN `WITNESS WHEREOF, Stewart Title Guaranty Company has caused its corporate name and
seal to be hereunto affixed by its duly authorized officers as of the date shown in Schedule A.
~TEWAR'~,i(~I
Co/ffper~e3~ 06' kiietiu c rn'f
312) 977-2626 President
c076gh!. 1966. A~9~63~ L2~d T6~ A1199:3~ 9'~ TI FollIl 400(M3980)
PAGENO="0291"
285
Standard Conditions, Requirements and
Exceptions of this Commitment
CONDITIONS:
1. The term "mortgage," when used herein, shall include deed of trust, trust deed, or other security instrument.
2. If the proposed Insured has or acquires actual knowledge of any defect, lien, encumbrance, adverse claim or other matter
affecting the estate or interest or mortgage there on covered by this Commitment other than those shown in Schedule B hereof, and
shall fail to disclose such knowledge to the Company in writing, the Company shall be relieved from liability for any loss or damage
resulting from any act of reliance hereon to the eotent the Company is prejudiced by failure to so disclose such knowledge. If the
- proposed Insured shall disclose such knowledge to the Company, or if the Company otherwise acquires actual knowledge of any such
defect, lien, encumbrance, adverse claim or other matter, theCompany at its option may amend Schedule B of this Commitment
accordingly, but such amendment shall not relieve the Company from liability previously incurred pursuant to paragraph 3 of these
Conditions and Stipulations.
3. Liability of the Company under this Commitment shall be only to the named proposed Insured and such parties included under
the definition of Insured in the form of policy or policies committed for and only for actual loss incurred in reliance hereon in
undertaking in good faith (a) to comply with the requirements hereof, or (b) to eliminate exceptions shown in Schedule B, or Ic) to
acquire or create the estate or interest or mortgage thereon covered by this Commitment. In no event shall such liability enceed the
amount stated in Schedule A for the policy or policies committed for and such liability is subject to the insuring provisions, the
Exclusions from Coverage and the Conditions and Stipulations of the form of policy or policies committed for in favor of the
proposed Insured which are hereby incorporated by reference and are made a part of this Commitment except as expressly modified
4. Any action or actions or rights of action that the proposed Insured may have or may bring against the Company arising out of
the status of the title no the estate or interest or the status of the mortgage thereon covered by this Commitment most be based on
and are subject to the provisions of this Commitment.
REQUIREMENTS:
1. Priortotheissuanceog:
A. Any owners title insurance policy hereunder, there shall be of record a valid conveyance to the proposed insured.
B. Any lenders title insurance policy hereunder, there shall be of record:
(11 A mortgage running to the proposed insured.
(21 A valid conveyance of fee simple title to the mortgagors therein, which conveyance must be dated on or before the date
of the mortgage.
EXCEPTIONS:
1. The policy or policies to be issued will contain exceptions to the following matters unless the same are disposed of to the
satisfaction of the Company.
A. Defects, liens, encumbrances, adverse claims or other matters, if any, created, first appearing in the public records or
attaching subsequent to the effective date hereof but prior to the date the propused insured acquires for value of record the
estate or interest or mortgage thereon covered by this Commitment.
B. Unless the ALTA Loan Policy Requirement appearing on the inside front cove are met, the lender's policy will be vubject to the following
exceptions Ill and 121:
(1) Any lien, or right to a lien, for services, labor, or material heretofore or hereafter furnished, imposed by law and not
shown by the public records.
(2) Consequences of the failure of the lender to pay out properly the whole or any part of the loan secured by the
mortgage described in Schedule A, as affecting: (A) the validity of the lien of said mortgage; and (B) the priority of the
lien over any other right, claim, lien or encumbrance which has or may become superior to the lien of said mortgage
before the disbursement of the entire proceeds of the loan.
C. Standard Exceptions for the owners policy:
It) Rights or claims of parties in possession not shown by the public records.
121 Easements, or claims of easements, not shown by the public records.
(3) Encroachments, overlaps, boundary line disputes, or other matters which would be disclosed by an accurate survey or
inspection of the premises.
14) Any lien, or right to a lien, for services, labor, or material heretofore or hereafter furnished, imposed by lvw and not
shown by the public records.
(5) Taxes, or special assessments which are not shown as existing liens by the public records.
GAP PROTECTION LIMITATIONS AND REQUIREMENTS:
If GAP protection `s approved in Schedule B of thix title commitment, the following limitations and requiremeots apply:
1. The coverage is automatically in effect for thirty 1301 calendar days, from the date on our title commitment. Should a closing be
scheduled for a later date, then bringdown of title must be ordered from us, and upon our covering of the later date, the coverage
V will be in effect for an added thirty (301 days. There mill be no added charge for this first later date if needed).
2. The coverage does not include:
A. Matters that the parties are aware of, otto which in the case of the buyers they have contractually agreed to take subject to.
B. The failure to promptly deliver title documents to us.
C. Defective title documents.
3. The title bill, including the extra premium for the GAP protection, must be paid.
4. We must be furnished the original of the sellers affidavit of title and that document must run to our benefit and be deposited
with us with the title documents.
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286
A.L.T.A. COMMITMENT FORM S
SCHEDULE A
Number Specimen Effective Date Specimen
Policy or Policies to be issued:
Owner's: (1970 Alta) AMOUNT: $45,000.00
Proposed Insured:
Robert K. Nobody and Ruth A. Nobody, His Wife
Loan: (1970 Alta)
Proposed Insured: AMOUNT: $35,000.00
XYZ Lender, A corporation of Illinois
2. The estate or interest in the land described or referred to in this commitment and covered herein is
fee simple, and title thereto is at the effective date hereof vested in:
Heirs at law or devisees of Peter Somebody
3. The land referred to in the Commitment is described as follows:
Lot 1 and west 5 feet of lot 2 in Blackacre, a subdivision in the south ½ of
Section 37, Township 40 North, Range 22, east of the third principal meridian,
in Cook County, Illinois.
This Commitment is valid only if Schedule B is attached.
PAGENO="0293"
287
ALTA COMMITMENT FORM S. SM and E
SCHEDULE B
Schedule B of the policy or policies to be issued will contain the exceptions shown on inside front cover of
this Commitment and the following exceptions, unless same are disposed of to the satisfaction of the
Company:
1. General real estate taxes for the years 1980 and 1981. Tax nos. 01-01-503-420
(Lot 1) and 01-01-503-421 (all of Lot 2).
NOTE: The amount of the 1980 taxes were $33.00 (L~.t 1) and $1,000 (all of Lot 2).
NOTE: The first estimated installment of the 1980 taxes is paid
(Lot 1:$16.67; Lot 2: $500.00)
NOTE: The second installment of the 1980 taxes and the 1981 taxes are not yet
due and payable.
2. An application for tax division/consolidation must be filed to remove west 5 feet
of Lot 2 from the remainder of said lot.
3. As the foregoing tax division will hot be effective until the 1982 bills come~Gut
in 1983, the lender will require that we insure against loss or damage by reason
of nonpayment of said taxes for second installment of 1980 taxes and 1981 taxes.
To accomplish same, we will require a title indemnity agreement, secured by a
deposit of $2,000.00.
4. Possible back tax for the years 1979 and prior as it appears subject land is
being assessed on an unimproved basis. To clear this exception, a back tax
letter should be obtained from the Cook County Assessor, and presented to us so
that we may establish a title indenaiity.
5. Annual Benefits for the maintenance of the Calumet Union Drainage District,
Warrant No. 8. Benefits payable in 1976 and prior years are paid.
NOTE: Paid receipts for the years 1977, 1978, 1979, 1980 and 1981 must be
brought to closing.
6. Special assessment, Village of Someplace, Warrant 189, for storm sewers, payable
in five annual installments, in the total amount of $600.00. Installments 1-3,
due in 1978-80 are paid, and installments 4 and 5 (due in 1981-1982) are not paid.
NOTE: Bills for unpaid installments, including interest for at least 5 calendar
days after closing, must be presented for payment at closing.
Countersigned:
SPECIMEN
AUThORIZED SIGNATORY
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288
7. Trust Deed dated November 1, 1971 and recorded November 2, 1971, as document
21212121, made by Peter Somebody and Maria Somebody, his wife, to Chicago Title
and Trust Company, as Trustee, to secure an indebtedness of $55,000.00.
NOTE: It appears from the terms of said Trust Deed that payments are to be
made to XYZ Bank.
8. Trust deed dated December 1, 1973, and recorded December 10, 1973, made by
Peter Somebody, a widow, to Chicago Title and Trust Company, as Trustee, to
secure an indebtedness of $4,500.00.
NOTE: It appears from the terms of said Trust Deed that payments are to be
made to the Easy. Loan Credit Company.
NOTE: The cancelled note and trust deed must be physically present at the
closing.
9. We should be furnished our deceased joint tenancy affidavit and a copy of the
death certificate (Form 107 enclosed) for Maria Somebody.
10. Building setback line of 30 feet (from the North lot line) as shown on the
plat of subdivision and as contained in the declaration recorded as
document 12121212.
11. Violation of aforesaid building line as improvement located on subject land is
located less than 30 feet from the north lot line.
12. Restriction that garage may not be erected nearer than 80 feet from the north
lot line, as contained in Declaration recorded as document 12121212.
13. Easements for public utilities and drainage over, upon and under the south 10
feet and the west 5 feet of subject land, as shown on plat of subdivision and
as reserved in the declaration recorded as document 12121212.
14. Encroachment of garage located mainly on subject land over and onto land east
and adjoining by about 7 inc~hes more or less.
15. Our title finding is based upon the assumption that title will be derived by
an executor's deed executed by Peter Somebody, Jr., pursuant to decree of sale
entered in Case 80 P 1234. Relative thereto, we should be:.
1. Furnished aforesaid deed.
2. State Inheritance and Federal Estate Tax clearance.
16. Judgement entered January 12, 1976, in Case 76 MI 22222, in favor of John Johns
and.vs. Peter Somebody, in the amount of $3,000.00.
NOTE: Attorney of record for judgement creditor is Donald Barrister,
135 South LaSalle Street, Chicago, Illinois
Schedule B is continued on following page.
PAGENO="0295"
289
17. Revenue lien recorded as document 24242424 in favor of United States of
America and vs. Robert K. Nobody and Ruth A. Nobody, his wife, in the
amount of $127.50.
NOTE: We are willing to insure that the mortgage described in Schedule B
is a prior lien to aforesaid revenue lien.
The mortgage title policy to issue will contain our Comprehensive
Endorsement No. 1A, excepting paragraph 3 thereof as same relates to
exceptions 11 and 14.
The owners and mortgage title policies to issue will contain the following
two endonsements:
1. The Company hereby insures the insured against loss or damage which
the insured shall sustain by reason of the entry of any court order
or judgement which constitutes a final determination and denies the
right to maintain the existing improvements on the land because of
the violation of the building line specifically set forth in
Schedule B.
2. The Company hereby insures the insured against loss or damage which
the insured shall sustain by reason of the entry of any court order
or judgement which constitutes a final determination and denies the
right to maintain the existing improvements on the land because of
the encroachment or encroachments thereof specifically set forth in
Schedule B.
PAGENO="0296"
290
I. We should bt forninheif on ~ALTA Loan ood Estended Conerage
On-nets Palioy Siateerant" (Porte 109, Renintd, Joly, 1974) ecuted
bythe tnae:gtgaen andall otherpaciiesholdiagtiile tathe boddoniag
the sin mouthu preceding the dote of the oonantittneut foi'laan policy,
nihich statement should octet the date of dinbutnnniest ot-the dote of
* thsComnoitment,nihichenteitliaet.
NOTE I: Sooh statement should he esecuiad in doplioote. The
crigioul copy should be aftoohed fothe moelgage oote; fhe
duplicate copyshauldbefio'ni.nhed to theCciopooy.
NOTE 2: In lieo of suid stutemeet being esecuted by the Sellet, an
esecated copy at the origioal of an "Atfidanif of Title" (0
accep:tble loam may be fotetinhed totheCotopooy.
2. If aoy impronemeots hate beee mode oo the loud n-ithio tin mootht
of the dole of the oommitmeot fat laao policy, satiufactoty entdeoce
should be tot'oiuhed the Componyollhe paytneo in fidlof the cost of
tutniuhing luboe aod moteeitl iu 0000ectico n'ith said improuemeotn.
See teqoiremeotsfaeMechtaicLitnclaim conetage beluu.
(NOTE: Thefotegoiugeequirementnillben.oia-edofthel000pclicy
a to mute subject to "Any lieu, oe eight too lieu, tot seen'
ices, oboe, oe mateeiol heeetofoee ut heeultee foto'ohed,
innpouedbyluu-ond oat shot-a by :hepubliceecoedn"(
3. tofcrenation should be tueninhed the Company at to n-hethet ct-not
the nihole ot'ony putt of the indeb:ednesn scooted by the mortgage to
be intoned in to be oned to pay foe any future impeonements on the
loud.
4. lIthe loon policy it to innate the assignee of the mortgage, a "date'
dan-n" of thin Commitment should be ordeeed to octet the tecording
of the ansignment, and thin Commitment in subject to such additional
esceptions, ilany, as maybe deemed necessaty.
NOTE A: lIthe peoposed insured is asecondaey int-estat, ut should
be futoinhed a cettificaf ion by the original lender that the
otiginol copy of the ALTA Loan and Eatended Coueeage
Ounces Policy Statement has been at na-ill be delia-teed to
thepiarcha.neeotosnignteoffhe maegagtpapees.
NOTEB: Whtee the amount of the loon in mote than $50,000.00, on
n-heee, tegardleun of amount, if mote than 60 day: hunt
elapsed beta-ten the date of the Commitment and the dote
of di.nbutuement, a "dote-dunn" of the Commitment must
be ordered to conte date of disbursement.
REQUIREMENTS FOR ALTA EXTENDED COVERAGE - OWNER'S POLICY
Genetal enceptions I nheough 5 (see paragraph IC. of Euceptions on in- seller(sl that no change: hate been mode to the subject land since the
side ft ant coter heeein( ta-ill be deleted on all onner's policies na-hich coiee date of the surcey.
a completed single-family ee:idence, including a condominium anit or
apanmen: building containing no mote than four units, prociding that me 2. The documentation called foe by patagtaphs 1 and 2 andee nbc abate
ant famished the follnuing: ALTA Loan Policy Reqaitements.
1. A caeeent, spatted sattey of the subject land. If the nurney is mote NOTE: The tight is etnerned so specifically taint any adietse eights
than sin month: old, ne shaald be faeoi:hed an affidavit feom the di:cloned by the aforesaad documentation,
REQUIREMENTS FOR MECHANIC LIEN CLAIM COVERAGE
Should theee hun-c been imptcntmentn made on the loud nithin sin
manths of the date of thin ccmmiimtnt, nor rtqoirtmtuia far giniug
MtchaaicLita canteage ate anfcllann:
1. AnOn-ntr'sS:attment,aodtroath,st::ioglarnhla(:henomtnotall
put-rita n-ith n-hem the onner canteacted far thr furoithiug ollabar
and material in counectian n-ith the impeoutments. and (6) :ht
nataee of each conttacf and theamaou: paid otfohe paid there-
2. A Geneeal Contractat's S:a:emnn: team each of the parties named
in:heOu-nte'sS:a:emto:,nhichshculd-
(a) net forth the fall name of the genetal contractor aud the name
of the putty n-i:h n-hem the canitactoeagteed Ia taroish
labueandma:eeialiacanotctiaun-iththt impeanement;
(hi iden:ify :htland by i:slegal dtscripiian otstttet addteau;
(c) desceibt the impeonemen:s;
(d( stt forth the named and the actaal amaout (not he estimated
amoaot) due to each siibcontractcraod materialman, :ht
fatal amOunt paid ta each a: :ht dott of the statemtut
aud tht balance dot, if any;
(e) bearacaircul dale;
(I) be propttlysigutdby:he gtntrai couttactcr; cud
(gi beoatari.ttd
3. A Subcon:rac:ot's S:u:emeu: feom each siiboauteac:or named on
:heO totralCou:rnctot'sStatemtnt,nhichshould-
set fctnh the loll name of the nubcantractoe and the name of
he patty n-ith n-ham the subcontractat ageetdtc furnish
labatanil material ina-annectionnith the impeourmeuts;
(hi identity :htlandbyi:nlegal dtuctipiion otitu steed addtetu;
(ci dtscribe the oataee of the n-ark cc material a be lurnithed by
the sobcan:tactat;
(di set laeth the namtu of theie sab-ncbcouttactaes and
materialmen; denceibt the type and amncoi of n-ark or
maitrial furnished oe a be tutoi.nhtd by each; and set
teeth the total amount paid ta each at the date sf the
statement and :hebalanct due thtm, if any;
(ci beat scaeeeot date an the date of completian of the sub'
(Ii be peopeely signed by the nabcantractot makiag the
igi be natutiotd.
NOTE: In the cone ala single family duelling (not lunacy, type),
Subconttactiit's Statements need be obtained fram the
tallcu-ing trades only: (a) Concrete, (hi Masoney, (ci Car-
pentry, (di Plastering at Dryn-all, ti Plumbing, if) Septic
and Well System, (gi Heating, jh) Aie Canditioning, and
(ii Electrical
NOTE: It all on a part at the subcontroctae'n material a frcm his
stack, bin sltldants (oat u-oia-tt( nhaiild recite `All (at all
othet( material nas laken from my open stock and
deliaernd Ia the job site by my cnn track and the
gel cuing are the names of thase paritra n-ha faroiahed
said material': Noeten . , . Mateelol lnenlnhed.. ,Asosnnnt
...Bolaaredse,ifany.
Final n-am-em from the general couteactor and all the sub
cou:ractamn,nub-nubcootrac:orsand euaterialmen,nhich should -
(a) Identify the person niih n-hem the couteacf n-as made to sup-
ply the noek or uateeial furnished:
(hi dencribn:htn-orkoematetialfarnished;
(ci identify the land fat n-hich the moth at material n-au faeniuhed
by iisltgaldtscrip:iou oritn addtess;
(di recite he tall cannideratian foe the n-ainee ($1.00 n-ainetn oat
bring accepioble); and
(ci bepecprtlyeetcetrdbythtpertanfornishing:hen-ait-er
PAGENO="0297"
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D~
50
7 PRESENTATION BY:
CLYDA GUGGENBERGER,
8 VALLEY TITLE CO!~P1~.NY
9 MR. PATTERSON: Would you please state your full
10 name and address for the record?
11 MS. GUGGENBERGER: Yes. I'm Clyda Guggenberger.
12 ?.ly address is 300 South First Street, San Jose, California
13 MR. PATTERSON: Would you please state your
14 Occupation? .
15 ~ MS. GUGGENBERGER: Yes. I am the President of
16 Valley Title Company, an underwritten title company in
17 Santa Clara County.
18 . MR. PATTERSON: Are you representing any organi-
19 zation today? And if so would you please identify it?
20 MS. GUGGENBERGER: Yes, my own title company.
21 MR. PATTERSON: Please proceed.
.`22 MS. GUGGENBERGER: Don Edwards and I started the
23 ~orn~any in 1951 and we still own all of our common stock.
24 Don is retired from the title business, having been elec-
25 ted to Congress in 1962, and I an the acting manager.
NEAL R. GROSS
* * COURT REPORTERS AND TRANSCRIBERS
* 1330 VERMONT AVENUE NW
PAGENO="0298"
292
SI
1 We were the fourth title company in Santa Clara
2 County. And within five years, we became number one by
3 introducing the philosophy that we were everyone's title
4 company, but most of all the buyers' and sellers! title
5 *company. No customer was too small, no transaction was
6 too small, no problem that could not be solved. We spe-
7 cialized in well-trained technicians and friendly cooper-
8 ation.
9 When statewide and nationwide title insurers
10 opened companies during the 50's and 60's, Valley remained
11 the most popular, even though it was a small, local iride-
12 pendent, handling 40 percent of the business, at times
13 hiring as many as 365 employees, and having 13 branch
* 14 offices.
15 Valley had the highest repeat business and
16 ha~ndled more direct sales made without a real estate
17 broker than any other title company, which showed that our
* 18 policy of treating buyers and sellers as the most impor-
19. * tant customers was paying off.
20 Only once in those years, when compensating bal-
21 ances invaded the late 1960's, did we fear that the end
22 of small independent companies like ours was very closely
.1t
23 corning. Lenders tried to take advantage of their lever-
24 age by making preferential loans to developers who could
*. 25 force their title company to put massive amounts of money
(202) 234.4433
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52
on deposit with a commitment not to remove the noney from
2 the lending institt~tion until the developer's projects
~ were completed.
4 Small independent companies like Valley had no
5 PnassiVe amounts to deposit at various banks. And it
6 seemed that only the larger insurance companies would be
~ able to stay in business. Fortunately, that was made
8 illegal before too much harm was done to us.
9 In the 60's, kickback and anti-rebate laws were
10 passed at the state level, and they did not affect us at
~ aLl. Valley had never bought its customers. In fact, we
12 received thank-you gifts continually from our brokers and
13 builde~s, and we gave nothing but expert service to them.
There have always been brokers, since I started
15 in ~he title business in 1951, who tried to get something
1~
* 16 out of the title company for giving us the business. They
17 ~isually went to the newest one in town that had to take
18 whatever business it could scrounge around for. We had
19~ our turn when we started our company.
20: Nost brokers and their salespeople are fine
21 people. They are working hard to make a few deals. They
22 * have always appreciated the help they got from their
~ ,ti~le.ēompany. Our desks, in the old days particularly,
24 were covered with candy, flowers and other gifts whereby
the brokers expressed their appreciation for their
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
* 1330 VERMONT AVENUE. NW
` (202) 234.4433 WASHINGTON. D.C. 20005
PAGENO="0300"
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4 I * * 53
1 particular escrow people at a job well done.
2 We knew that a title company out of county had
3 sold stock to brokers in the 1950's, that had not amounted
4 to much. A large real estate office in those days con-
~ sisted of maybe one b~rokerand two salespersons, or maybe
6 *fjve salespersons.
7 Now, a lot of these things had changed by 1971
8 when the anti-rebate laws seemed to provoke a new scenario
9 Many brokers were getting bigger. Offices were expanding,
10 along with our incredible real estate market, to 200 to
~ 30!) salespeople each. Syndication was with us, and
12 brokers: were forming their own escrow companies, their
13 termite companies, mortgage loan companies.
In our county, our three top brokers, all good
15 ValLey customers for years and years, together employed
16 600 salespeople. And they almost cornered the market in
17 listings. Santa Clara County is a seller pay county.
18 Control of listings is in the control of sellers, and it
19 is the seller's broker who has the prerogative of picking
20 the title company.
21 Those three brokers in 1971, joined by several
22 others in conjunction with a chain of state~ide broker-
`I .
23 pwn~d .t.itle companies, started a new tie-in company in
.24 Santa Clara County in 1971. The market rise, market share
rise of this company, was sensational. 13y 1976 it had
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330 VERMONT AVENUE NW
PAGENO="0301"
295
1 passed Valley, my company, taking almost half of Valley's
2 business. At its inception in the month of April 1971
3 we lost half our business.
4 By their issuance of stock to a final total of
5 *almost 50 real estate persons within the ne>~t two or three
6 years, they had taken even more business, During the
7 Guardian ~ritle hearings in 1976, Robert,Morton, President
8 of Western Title Company, referred to our specific situa-
9 tion when he described Valley as "the dominant company in
10 that county for many years," I quote him, and went on to
11 say, quote, "To beat that company in that county is some-
12 thing that no one else has done for 15 years." And with
13 this he put charts in, and. I would repeat that we had
14 achieved this enviable position for 15 years of being the
15 top one there, competing with nationwide and statewide
16 chains solely on the basis of the competit~.ve merits of
`17 oui~ company, giving good services, having reasonable
.18 rates.
19 Mr. Morton attached these charts, which showed a
20 phenomenal rise of the tie-in broker company of Cal Land
21 concomitant with the plunging fortunes of Valley Title
22 Company. .
23 Now, experts in antitrust cases tell me that what
24 happened to Valley after this tie-in broker company was
25 * formed was typical. The ensuing breakdown in morale of ow
202) 234.4433
PAGENO="0302"
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1 employees, the humiliation, rage, shock, often culminating
2 in schism or breakup in the business itself, are the
3 usual symptoms of the disease called unfair competition.
4 *And they are usually more prevalent with the front-runner
5 t1~an with lesser competitors. The higher you are, it
6 seeins,.the harder you fall from your position.
7 When brokers control the title entity, they skin
8 the cream 6ff the. top of the title business. The single
9 family or multi-family residential is the top money-
10 maker. There are rarely major title problems with this
11 type of business. And the losses that may be incurred in
12 any sin9le transaction are within manageable limits.
13 Usually this property has changed hands many, many times
i~ and been insured many times.
15 * The rest of us, however, when this business is
16 gone~ are left to scrounge for the kind of business that
costs more to service and exposes us to inultirnillion
.18 dollar risks. We may have to spend three weeks searching
19 a right-of-way that's going to be seven feet wide, for
20 the City. As a matter of fact, our company has almost
21 all of the right-of-way business now, which has maybe
22 $100 as the fee that we get out of it.
23 * Our branch manager meetings were like wakes,
24 as managers and escrow officers described their set-backs,
25. arid the refusals they received when they asked for busines
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
~33O VERMONT AVENUE. NW
(202) 234.4433 WASHINGTON. D.C. 20005
PAGENO="0303"
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56
I Over and over, we heard from our managers and escrow
2. officers, ~I asked my good customer of ten years' standing
3 or eight years' standing for his next house sale, and he
4 said, `Why, I couldn't give you a deal, Jerry, I own stock
5 in Cal Land.'' Quite.ofteri it was said in an increduluous
6 ~tone.
7 One broker said, "It would be silly under the
8 circumstances to bring business to you." Another told our
9 branch office, "You dida fantastic job closing this diffi
10 cult sale. Thank you very much. I should warn you in
11 all fairness, however, you will never get another deal
12 from me. .1 have just purchased stock in Cal Land."
13 ~ second type of complaint was more numerous.
14 Salespeople complained that they were no longer able to
15 bring their deals to Valley. Their broker-bosses, who
* 16. might have as many as 200 or 300 of these salespeople, if
17 the broker-boss was the owner of a tie-in escrow company
18 or tie-in title company, forced them to take their deals
19 where the broker could make money on the transactIon,
20 . Many salespeople brought us orders which they
* 21 said they were sneaking to us, pretending the seller had
22 ir~sisted they go to Valley. This was rather reasonable
4'
23 because V~1ley was known to be a buyer and seller title
24 * company. We had.tremendous exposure. People liked to go
*25 * to Valley.
* . NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330 VERMONT AVENUE. NW
(2~2) 234*4433 WASNINGTON. D.C. 20005
PAGENO="0304"
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5~1
.1 They pointed out that that wasn't something
2 they could claim too often, as the county got larger, and
3 there couldn't be that many people who insisted on going
4 to Valley Title. We understand that at a California
5 Association of Realtors annual convention, associate
6 realtors complained on the floor that although they were
* 7 ir~dependent contractors, they were forced to use the tie-
8 in companies of their broker-bosses, and that the tie-ins.
9 werenot efficient, thattherewas a higher cost to their
10 clients because the broker escrow company almost -- in
~ fact, invariably charges a higher escrow fee than the
.12 title company would charge, did it handle the escrow and
13 title service together.
14 One salesperson told one of our branches, and I
15 . could go on with hundreds of stories, just unbelievable
16 stores, he .told our branch, "1 was told if I bring you
vi i~ another deal to Valley Title, I will have to come pick
*. 18 up my license." If you're familiar with the system,
19 whereby associate realtors come in and they put their
20 license down with the broker, and then they're operating
21 under his license. This man said, "I hate dealing with
22 the boss' escrow company. I detest going over there. But
23 .~I. cannot afford to make a move now. I can't ~f ford to
24 change brokers. So I shall not be sneaking any more deals
25 in to you."
NEAL IL GROSS
COURT REPORTERS AND TRANSCRIBERS
~33D VERMONT AVENUE. NW
WASHINGTON. D.C. 20005
(202) 234.4433
PAGENO="0305"
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58
.1 In fact, a little later on, he came back about
2 a year later, gave us two orders, and the same manager
3 said, "Gosh, how can you bring us orders now?" And he
4 said, "Well, I had the most phenomenal year. I sold
5 $2 million worth of real estate. I'm the number one sales
6~ man in the office. Arid now I just am saying, "I'm going
7 to Valley whether you Like it or not. No one dares to
8 fire me."
9 When I complimented a broker, who had been a good
.10 customer for years of Valley's, a customer of 20 years,
11 because he was still allowing his salespeople to bring
12 deals in, although he owned stock in Cal Land and I knew
13 that, and he had always taken pride in his very .high
14 ethical and moral reputation and had worked very hard to
15 make "real estate broker" a very respectable word in
16 `~čalifornia,.and I said to him, "Fred, I think it's really
17 nice of you that, owning stock in Cal Land, you have been
:18 fair and you've always let your salespeople cone in to
.19 our company if they would like to." He said, "Oh, I've
20 stopped that, Clyda. That will never happen again. You
21 will never get an order from our office again."
22 Now, I ask you, how could he be so sure he would
"23 never send us an order, if he were complying with laws
~4 that prohibit him from coercing people into a particular
25 escrow or title company? He was ruling out even a seller
* * * * NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
* . 1330 VERMONT AVENUE. NW
85-396 0 - 81 - 20
PAGENO="0306"
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59
1 * preferring to come to our company.
2 Now, the third type of complaint I received con-
3 tinually from my escrow personnel was even more frighten-
4 ing. Our own non-tie-in brokers were not coming in as
5 often. And they began to drop out of our company. They
were describing the harassments they were suffering when
7 ~they had the listing and they had the prerogative of ordex
8 ing the title search, but there was a tie-in broker on ti-ic
9 other side. The tie-in salesman or broker on the other
10 side, who did not supposedly have this choice, would mdi-
11 cate that the deal had to go through the tie-in company
12 or the buyers just might not make an offer to the sellers
.13 `on tI-ie house.
14 Or when the buyer's deposit check came in, it
15 was invariably made out to the tie-in title company, nt
16 rr*,~1e out to-the title company where theorder had already
17 been placed, the preliminary report had been issued.
18 Many, many times we were having to cancel orders, get no
19 fee, because the brokerwould say to us, "I'm sorry, this
20. is terrible, I'm outragod by what they did. But what am
21 I going to do? Go to the buyer and say, `Give me another
22 deposit check'? I'm going to have to go through their
* ~3 title company. I'm not in a position to risk losing that
24 deal."
- 25 - The sudden rise to prosperity, the unbelievably
- NEAL R. GROSS
Cou~ ~EP0RTIRS AND TRANSCRIBERS
* 1330 VERMONT AVENUE. NW
PAGENO="0307"
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60
1 high profits which are generated by skimming off the
2 cream of the business and the momentum gained kept our
3 controlled business competitors just sparkling and dancing
4 *wher. they walked. They were so thrilled. They had the
5 finest of everything*, the best equipment. Employees
6 stolen from all of us. Fleets of delivery cars.
7 One of their own managers boasted to me that in
8 the first nine months of 1975, four years after they had
9 started, they had net profits of $477,000. In all of the
10 years that Valley had been in operation, 20 years, we had
11 never seen a year with net profits of $477,000.
12 He said, "Morale is fantastic at our company,
13 Clydį." I responded, "Why not? We would whistle while
14 we worked also if we were burrowing into Fort Knox and
15 egrrying away the gold with full approval of all governing
16 bodies, like the Insurance Commissioner, BESPA.and every-
17 body."
.18 Meanwhile, we were not allowed to buy a broker
1.9 friend a' lunch at that particular time, after 74~-2 came
20 out. We were not allowed to keep matches on the' counter
21 for fear a broker would pick them up. We couldn't keep a
22 scratch pad on the counter or pencils because that would
4'
23 `be a.gift for the broker.
24 Meanwhile, across the street, they could give
25 this broker thousands of dollars in dividends twice a
NEAL' R. GROSS
COURT RIPORTIRS AND TRANSCRIBERS
1330 VERMONT AVENUE. NW
.,..,. (202) 234.4433 WASHINGTON. D.C. 20005
PAGENO="0308"
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61
1 year ox three or four times a year. It seemed very unfair
2 tous.
$ The broker-owned company, by the way, this
~ particular company made repeated attempts to buy Valley.
~ Particularly, by the way, they made attempts right as 74-2
6 `came out, which was a California bulletin against rebates.
~ And then they really called me on a daily basis almost for
8 about three weeks because they were afraid this spelled th
end of their title companies.
10 They warned me of the urgency to sell. The
~ President would call up and say, "We're so successful, we
* 12 `have ~ second stockdistribution to brokers coming up.
13 And, Clycia, what brokers are left, we're going to sweep
14 in this time with a second stock distribution. Soon you'r~
15 gci~ng to have nothing to sell to us. You better hurry and
16 make up your mind because you're not even going to have a
17; title company left to sell to us."
18 Their antitrust attorney, l~ater, after I sued
19 them, during a deposition, asked me why, if I was so con-
20 cerned about this loss of business due to unfair competi-
21 tion, why didn't I in fact sell to Cal Land? I answered,
2~ "If for no other reason, the sale would have required me
* 23 ~t~o accept Cal Land stock, and I would not accept stock
- 24 that carried with it such a tremendous liability." I
25 believed then, and I believe now, that the broker-owned
PAGENO="0309"
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62
1 title companies are already operating against the laws of
2 the state of California and of the Federal Government.
3 Proof of that lies in the: success of my own antitrust
4 `litigation, which managed to hang in the courts through
5 dozens of motions for all defendants for three years until
~ne week before trial, and the substantial settlement
7 offer we finally accepted to drop the suit.
8 The amount and details of the tie-it arrangements
9 are under a protective order, which they received. For
10 my part, I am willing to, release them if the Insurance
11 Commissioner or the Justice Department or any governing
12 body wants to see how such an arrangement works.
13 I had already received certain documents passed
14 on to me by brokers which showed the commitment of orders
15 th~ty had to make to be allowed to purchase stock. Brokers
16 who did not finally purchase stock had brought in some of
17 ` .these documents which showed that they had to make a
18' commitment, they had to say, "I will give to you, Cal
19" Land, so many orders. I have so many now. I will give
20 you so many if I'm allowed to buy stock." They had to
21 sign these and fill them out. And all of them seemed to
22 be in violation of the kickback statutes, particularly
.4
23 ,}~ESP1t.',s, even at that particular time.
24 As we know, Section 8 of RESPA is already law on
-25 the books. It is up to HUD and to Congress to make it
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330 VERMONT AVENUE. NW
PAGENO="0310"
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63,
~ meaningful and to make it work. Do you intend to stop
2 brokers from participating in, from sharing in the title
3 fee in whatever form they think of next? Are you going to
4 clarify the ambiguities? If not, you're going to place
5 coIi~panies like mine in a position where we cannot survive
6 as,independent businesses.
7 I own my owr~ stock. Don Edwards and I own it.
8 He's xny ex-husband. And if the industry is allowed to go
9 in the direction of controlled business, onwership by
10 real estate brokers, we too can sell stock to brokers and
11 bui~ders and stay in business. But don't make inc expose
12 myself t~ the same type of antitrust litigation I brought
13 in 1976 against this one tie-in company and its broker-
14. stockholders.
15 A word on antitrust litigation. It's not possi-
16 ble for everyone, although I recommend it if that is the
17 or~ly way to stop this wave of unfair competition brought
18 on us by the effort of the brokers to get around the cash
19 kickback and referral system, which is now turning into
20 stockholders. I must warn, antitrust litigation is very
21 painful. In most cases it would be prohibitively cxpen-
22 sive if you can't get an attorney to take it on a contin-
23 ~ency basis. It's almost impossible. And a company is
24 already suffering anyway. It can't come up with attorney'
25 fees for this type of litigation. And in many cases it
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330 VERMONT AVENUE. NW
r~u~ir~w r~r ,noos
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I wouldn't even be available. If you're in an area where
2 you don't have a good antitrust attorney, you wouldn't
3 even be able to do it.
4 . Before suing, I made numerous attempts to inter-
5 estthe Insurance Commissioner, the Governor's office and
6 the Attorney General, by correspondence and personal calls
7 Threatened with a seven-month trial, during which time my
8 poor company would necessarily be so poorly managed with-
9 out its President that i would risk losing what business
10 and employees I had left, I accepted a settlement offer
11 that was substantial by some standards, but infinitesimal
12 compared to the losses suffered by my company over the
13 last eight years,
14 The meanE by which controllers of business, such
15 ~s brokers, seek to benefit from the ability to control
16 the consumer's business has changed dramatically from the
old forms of kickbacks. No tie-in broker today would
18 bother with, the old fashioned $15 cash kickback. He now
19 gets a part of the title fee on all his tie-in colleagues'
20 deals as a bonus for his conspiracy, it seems.
21 He has complex direct telephone trunk lines and
22 messenger services running back and forth among his. tie-in
23 offices and entities, doing all their err~inds for them.
24 He uses all their supplies. He gets directors' fees,
25 trips, gifts as a stockholder. On top of that he gets
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
- * - 11~fl V~'ufl~JT £V~ r w~./
PAGENO="0312"
306
65
1 dividends, huge cash dividends several tines a year.
2 Most likely, he purchased his stock by putting up
3 no money, just executing a note that was repaid as his
4. dividends were credited against the note. He is building
S a lifetime annuity for himself. He pays no tax as he
6 would on cash rebates. He will sell his stock someday or
7 trade it with a capital gains tax advantage.
8 He is making in some cases thousands, even
9 hundreds of thousands of dollars, from sharing in those
10 title fees which numerous laws say are forbidden to him.
11 The stock purchase is far more pernicious a form of rebate
12 than we knew before the legislation that was brought about
* 13 to stop rebates.
14 The owner of a title company, which has since
15 go'~ie out of business in our county, that paid $500 per
16 month to each of five brokers -- by the way, these were
17..' the same five brokers that left Valley -- although it was
18. illegal as a rebate even then, said he complained con-
19 stant~y to him that he was not getting all of the tie-in
20 broker's business, back in the days when he paid $500 a
21 month to each one of.the brokers.
2~ The broker said, "Oh, we have no control over our
23. salespeople." The sane broker today, one of these same
`24 brokers today told his salesperson, in.orie office all the
25 * salespeople, "If you give another deal to Valley, you can
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
- - 1330 VERMONT AVENUE. NW
PAGENO="0313"
307
66
$ ~ pick up your license and leave our office."
3 One more note on the tragedies of competing with
t s tie-in company. The extra profits attract ambitious
O ..enployees. Often our best employees who were most indig-
S nant succumbed to the, "If you can't lick `em, join `em"
* philosophy. One of my best technicians and business-
I getters told me, "I want to work for number one. I cannot
O stand being number t'~io. And I cannot stand all the
* sadness and defeat around .here as we lose customer after
~j customer to them. I know it is not Valley's fault.
~i ~eaven knows, I've worked hard to keep what remaining
U busiii~ss we have. I believe they're operating against the
~ law. I am stunned by. the. hypocrisy of the whole thing,
~. the. fact that we have these laws., and yet we have more
i~ ptéblems.with.the brokers.than.before. Still I'm going
16 to go to ~ork for. Cal. Land. because. I want to know what
17 it's like again, to be. with. a number. one company."
IS The employee cane. back. to. us a year later and
19' is still with. us saying,. "I did not believe it was possi-
20 ble to collect so many greedy, r~oney-oriented people in
21 one building. It was "Sock it to the customer." I was
22 ashamed. I could not stand it."
4'
23 ... An example of the high fees charged the customer
24 when he's caught by a broker who refers him to a tie-in
*25 . escrow company, and then a tie-in title company, follows.
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330VERMONT AVENUE. .NW
~ (202) 234:4433 WASHINGTON. D.C. 2000$
PAGENO="0314"
308
67
.1 For instance, we have many escrow companies, all seven of
2 these top brokers started escrow companies of their own.
We have their rate schedules. If you take any one of
*their rate schedules, and take a schedule fee of Valley~
~ritleor Transanerica or Title Insurance, you will find
6 ~xactly the sane thing happens.
7 On a $50,000 policy, which we alr~st do~i't have
8 any rr~re, a broker-owned escrow company charges as the
escrow fee alone $164.'50. Our escrow fee is $104.90.
10 Now, that's a difference of $59.60. That's on a $50,000
11 deal, there's a $59.60 difference.
12 On a $100,000 policy, the broker-owned escrow
13 company's fee is $239.50. Our Valley Title escrow fee is
* 14 $156.90. The difference is $82.60 higher that the buyer
15 he~ to pay just because he bought a house from a broker
16 who owned a tie-in escrow company.
17 On $120,000, the broker-owned escrow fee is
18 $261.50. Ours is $169.90. The difference is $91.60.
19 On a $150,000 policy, broker-owned escrow company charges
* 20 $294.50. Valley charges $188.40. The difference is
21 $106.10.
2~ From $100,000 going up to $300,000, we charge
* 23 65 ceiits at Valley for every $1,000 up to $300,000. The
* 24 broker-owned escrow company charges $1 per $1,000, which
25 brings us to an interesting point. I have heard it
NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
1330 VERMONT AVENUE. NW
12021 234.4433 WASHINGTON. D.C. 20005
PAGENO="0315"
309
68
1 suggested that brokers should be allowed to run all the
2 title companies they want, that perhaps the proliferation
3 might bring lower prices., I night say in a cynical aside,
4 ~like it has brought us lower real estate commissions.
5 * It seems naive to me, considering the realtors'
6 track record. Not only have the brokers been receiving
7 for the last 30 years that I know of commissions suspi-
8 c~ously close to a fixed nationwide percentage, but in
9 every case when the broker owfls an escrow company of his
10 own, a substantially higher combined fee has to be paid by
11 *~iis unsuspecting clients.
12 : Now, he doesn't tell this to his buyer, "You are
13 going to pay an extra fee coming to my company." He may
* 14 say in small print on the deposit receipt, "This may be
15 r~1ferred to a company in which we have a financial inter-
16 est." lie never says, "But you've got to pay more besides
17. for the privilege of going to my company."
18 All surveys I have seen -~ some of them have been
i9~ mentioned here -- indicate that the consumer is paying a
* 20 higher fee everywhere for the privilege of falling into
21 the hands of. a broker who owns his own escrow company.
22 And I think the brokers are already showing us
23 how trustworthy the fox is when put in charge of the
* 24 chickencoop.. And what an outrageous violation of the
25 agency principle.
cot,
PAGENO="0316"
310
69
I I filed an antitrust suit after making several
2 attempts to interst the governing bocies in stopping or at
3. least. investigating what I could see would be a flood of
4 new tie-in companies. Today there are literally hundreds
5 o~f new tie-in entities, and the nature of the title
6 i~ndustry is changing daily. Is this the way our industry
7 best serves its needs, as well as the needs of the house-
8 buying public?
9 In these days of incredibly high housing costs,
10 high interest rates, other taxes, closing costs, termite
11 c~tts, new solar energy ordinances which have just come to
12 our cou~ity and will be coming all over the country, higher
13 fire insa.irance, inflation at every step, when our buyers
N come in angrier and angrier with the commitments expiring
15 an~:the interest rates going up on Tuesday or Thursday,
16 can we in good conscience plan a future for these buyers
17 and sellers which envisions a handful of large syndicated
18 real estate companies, like Red Carpet, Value, Century 21,
19 Allstate Realtors, Berg Enterprises, Cóldwcll, Banker,
20 owning large syndicated escrow companies which already
21 we know sock it to the public, and large syndicated title
22~ or title insurance companies, resulting in one profession,
23 ~the re'al estate profession, gaining a monopoly over the
-24 transfer of real property in the United States?
25 In 1977, Kenneth Berg, President of Berg
- NEAL R. GROSS
COURT REPORTERS AND TRANSCRIBERS
~33O VERMONT AVENUE. NW
1~O~l 234.4d33 WASHINGTON. D.C. 20005
PAGENO="0317"
311
* 70
1 Enterprises, based in New Jersey, nade a shocking predic-
2 tion. He said, "By 1980," which is already here, "instead
3 of 240,000 real estate companies, there will be only 10
4 left in the United States." Isn't that a frightening
5 thought? He may be a little off in his prediction, but
6 ~ou can read similar figures, similar predictions every
7 weekend in. the housing section of the newspaper, as you
8 see what Century 21 įays and Cal D Op (phonetic) says
9 about what is happening, and how many franchises they are
10 opening on a weekly basis, thousands all over the country.
11 There is one, other pressing reason, I believe,
12 why real estate brokers should not be in the title busi-
13 ness. We have had several smaller broker-owned companies
14 come and go in our county in the last seven years. They
15 are snot all successful. Some have folded. Stability in
16 the insurance industry is important. The public benefits.
17 - The brokers, however -- and God knows I love a
18 lot of them, all the ones that stayed at Valley, anyway --
19 have no long-term interest in the title business except
20. to make short-term profits from them. I have never seen
21 a broker in the title business who cares anything about
22 that business at all.
di .
23 . .,. . Rarely do they ever understand our obligation to
*24 honestly examine the records and their own tendency is to
~ see a title defect as an unnecessary hindrance to their
NEAL R. GROSS
COURT REPORTERS AP~D TRANSCRIBERS
1330 VERMONT AVENUE. NW
,,r~.% "." . *.*. .
PAGENO="0318"
312
73H
I receiving a commission check. - -
2 - Brokers have shown no love for title examining
for its own sake. And there are many of us in the escrow
~: `and title business who really are in love with this whacky
~ profession we have, but again, I'm talking about some
6 real estate persons. We have found a lot of then wise
`~ enough to stay in their own professions and do a good job
8 there. There is ample money for them to make in their own
~ business.
10 We in the title business do not start real estate
~ c~ipanics. The public would suffer if we did. Brokers,
12 lenders and developers should not be in the escrow and
13 title business. The public is suffering for their oppor-
14 * tunism right now all over the land.
15 Thank you.
16 MR.. COLLIER: I ~~ould like to ask you one ques-
17 ~ion, if you would be interested in submitting it. I'd
18 be very interost~d in socing a list of the contacts you
19 : made, the efforts ycu ra~ic to involve both state and/or
20. federal acencics in thc inv~zti~:~tic~, r~nccutjor. ~.`h~t-
21 ever, of the situatio:~ that you'vc de~criLcd in your testi
22~ mony.
23 ` * i~is. cuGc:::I.~n: I ~.avo ~ lcttcr th.~t I t.:
24 to the Governor's OL~cto or~ s~y ~eb.. ~ ictt~ ~
* I wrote to the ~ttorncy ~ t~ 11~ Ir~LJr;hcc.
~~`** (202) 234.4433
PAGENO="0319"
313
72
1 Corrimissioner, I believe, several different contacts that
2 ~ made.
MR. COLLIER: I'd be interested in seeing those.
4 145. GUC-GENBERGER: All right. Pine, thank you.
5 MR. PATTERSON: Thank you ve±y much.
6 I'd like to take a short break at this point for
everyone to have an opportunity to stretch their legs and
8 get some coffee or something. Ue'd ask you to be back in
about 10 minutes so we can get started with our next
10 statement.
11 (Brief recess.)
12 MR. COLLIER: I'd like to get started again. I
13 think some people will trickle in from outside as we
14 start.
15 ~ During the break I stepped outside and got my
.16 first taste of sunny southern California. And it's about
17 15 years since the last time I was out here. And I couldn t
18 resist taking off my coat. and rolling t~p my sleeves.
19 Please feel free, if you would like to get similarly
20 comfortable. i would like for this to be as informal a
21 proceeding as possible.
.22 We can move directly into the next presentation.
23 ~ would ask everyone to attempt to stay within the 20
24 rnintues that we've set aside for each person so that we ca
25 stay on schedule for the rest of the afternoon.
IO2~ 234-4433 -
PAGENO="0320"
314
EXHIBIT C
CERTIFIED FOR PUBLICATION
IN THE COURT OF APPEAL OF TI-lB STATE OF CALIFORNIA
SECOND APPELLATE DISTRICT
DIVISiON FOUR
COLDWELL BANKER & COMPANY, a ) 2 CIV. NO. 55067
California corporation; GUARDIAN )
TITLE COMPANY, a California ) (Super.Ct.No. C 159 518)
corporation,
Petitioners and
Respondents, )
DEPARTMENT OF iNSURANCE OF THE
STATE OF CALIFORNIA, WESLEY .3.
}CINDER, INSURANCE COMMISSIONER
OF THE DEPARTMENT OF INSURANCE )
OF THE STATE OF CALIFORNIA, )
Respondents and. )
Appellants. )
APPEAL from a ~udgrnent of the Superior Court,
Los Angeles County. Campbell N. Lucas, Judge. Reversed.
George Deuki~ejian, Attorney General, Arthur C.
de Goede, Assistant Attorney General, and Susan E.
Hc-nrichscn, Deputy Attorney General, for Respondents and
Appellants.
PAGENO="0321"
315
Tuohey, Barton & McDermott and Conrad C.
Tuohey; Gibson, Dunn & Crutcher and John J. Hanson and
Robert H. Fairbank; and Stanley H. Gordon, for Peti-
tioners and Respondents.
AdamS, Duque &Bazeltine and John H. Brinsley
arid Jeffrey P. Smith; Bell, Boyd, Lloyd. Haddad & Burns
and John C. Christie, Jr., James I. Serota and Lucinda
0. NcConathy; and Orrick, Herrington, Rowley & Sutcliffe
and James H. Benney and John F. Seegal; and Levinson &
Liebermari, Inc. and Burton S.: Levinson, Lawrence R.
Lieberman and Christopher J. Tesar, as amici curiae in
support of Respondents and Appellants.
Petitioners Coldwell Banker & Company, a
California corporation, and Guardian Title Company, a
California corporation, sought ~ writ .of mandate and -
declaratory relief to compel the respondents, the Depart-
pent of Insurance of the State of California and Wesley
3. Xinder, Insurance Commissioner, to issue to Guardian
Title an organizational permit (a permit to sell stock)
and a licelise to do business. The permit and the license
would enable Guardian Title to conduct business as an
1/
underwritten title company.~
17
Please see following page.
85-396 0 - 81 - 21
PAGENO="0322"
316
I
The Factual Back round and
Pro~i~u sto
We set forth the facts and procedural history
relevant to this dispute. On Hay 16, 1975, Coidwell Banker,
a real estate broker, caused the formation and incorpora-
tion of Guardian Title to conduct the business of an
-underwritten title company as defined in section 12340.5
2/
of the Insurance Code.
On June 4, 1975, Guardian Title submitted to
the Department of Insurance applications for an organiza-
3/ 4/
tional permit and for a license. Specifically, Guardian
In our discussion, petitioners will sometimes be
referred to as Coidwell Banker and Guardian Title;
respondents will sometimes be referred to as the Depart-
ment and the Commissioner. All references to code sec-
tions will refer to the Insurance Code, unless otherwise
indicated.
2/
- "Underwritten t~t1e company" is defined therein as
"any corporation engaged in the business of preparing
title searches, title examinations, title reports,
certificates or abstracts of title upon the basis of
which a title insurer writes title policies."
3/
Insurance Code section 827 requires the issuance of
a permit by providing: "An insurer shall not sell in this
state,. . . or offer for sale, negotiate for the sale of,
or take subscriptions for any security of its own Issue
until it shall have first applied for and secured from the
commissioner a permit authorizing it so to do."
4'
- Please see following page.
PAGENO="0323"
317
Title sought authorization to sell and issue 4,000 shares
of its $50 par value common stock at a price of $50 per
share to Colduell Banker; it was contemplated that Coldwell
Banker would be the sore shareholder. The license applica-
tion, as it was originally submitted, proposed that
Guardian Title engage in the undeniritten title business
in 19 California counties.
On January 12, 1976, petitioner Guardian Title
filed formal amendments to both applications, requesting
authorization to do business in only the four counties
of Los Angeles, Ventura, Orange and San Diego; in addi-
tion, Guardian Title then proposed to issue 7,000 shares
of common stock to Coidwell Banker alone. The Department
of Insurance was also informed of Guardian Title's inten-
tion to enter into an underwriting title agreement with
Security Title Insurance Company, a California corporation
and a wholly-huned subsidiary of Safeco Insurance Company,
engaged in the business of issuing title insurance policies.
- The license requirement is set forth in In~urance
Code section 12389, subdivision (a)(3), which provides,
in part pertinent to the issue before Us: "Such an
underwritten title company shall obtain from the com-
missioner a license to transact its business. Such
license shall not be granted until the applicant conforms
to the requirements of this section and all other provir
sions of this code specifically applicable to applicant."
PAGENO="0324"
318
Despite nuz~erous requests, both telephonic and
written, the Department failed to act upon the applica-
tion for the stock permit; it also failed to issue the
license, taking the position that the authorization to
sell stock was a condition precedent to the Department's
consideration of the license application. ~On January 30,
1976, Guardian Title made formal demand on the Department
for the approval of both applications.
On Narch 3, .1976, Coidwell Banker and Guardian
Title filed a petition for a writ of mandate and declara-
tory relief in the Superior Court of Orange County. The
Department and the Commissioner appeared and made a
motion for change of venue to the Superior Court of
Los Angeles County; the motion was granted. At this
point the Department and the Commissioner advised Coidwell
Banker and Guardian Title of the fact that an administra-
tive hearing would be conducted concerning the applications.
It was stated that the hearing would be held pursuant to
5/
Insurance Code section l2924 and that the principal issues
for determination were to be the proper interpretation
This section confers broad investigative powers on
the Commissioner, enabling the production of evidence
"on any subject touching insurance business."
PAGENO="0325"
319
and application of Insurance Code sections 839 and 839.1
to the applications of Guardian Tit1e.~
61
- insurance Code section 839 provides: "The commissioner
shall issue a [stock) permit if he finds that: [~) (a) The
proposed plan of business of the applicant and the proposed
issuance of securities are fair, just, and equitable. [`fl
(b) The applicant intends fairly and honestly to transact
its business, and [1) (c) The securities the applicant
proposes to issue and the methods to be used by it in
issuing or disposing of them are such as, in his opinion,
will not work a fraud upon the purchasers thereof, or
upon policyholders or other security holders of applicant.
[j] Otherwise, he sha~.l deny the application and notify
the applicant in writing of his decision."
insurance Code section 839.1 provides: "(a) In any
case where a domestic insurer~ is directly affected by
the total transaction for some part of which the permit
applied for is needed, and the commissioner in his dis-
cretion determines that reasonable grounds exist for
contentions that such total transaction or any part
thereof: [~) (1) is a combination of capital, skill,
or acts to create or carry out restrictions on or to
prevent competition in the insurance business; or [~J
(2) is a combination (in the form of a trust or other-
wise) in restraint of the insurance business; or (fl
(3) is an attempt to monopolize the insurance business;
or [`1) (4) Is a conspiracy to create any of the fore-
going; or [~) (5) That such total transaction, or any
part thereof, if consummated will create or result in any
of the foregoing or will substantially lessen ccmpetition
in the insurance business. [`1) Then, in such event,
the Insurance Commissioner may make findings with respect
to whether such total transaction, or any part thereof,
would or would not do or be arty of the foregoing. [1)
(b) In the event the Insurance Commissioner makes
affirmative findings as provided in subdivision (a) of
this section, he may deny the permit applied for."
PAGENO="0326"
320
From May 12, 1976, through May 24, 1976, the
Departmerkt conducted hearings periodically on this
71
matter. As constituted, the hearings were concerned
with the economic effect of permitting real estate
brokers, through wholly-owned subsidiary title companies
(this being the relationahip between Coidwell Banker and
Guardian Title), to enter the title underwriting business,
with particular emphasis on the impact such entries into
the title underwriting business would have upon competi-~
tion. The Department of Insurance hearing officer noted
that, in addition to the Coldwell Banker-Guardian Title
applications, there were ten other similar applications
under review by the Department.
Seventeen witnesses testified. Two expert
economists, familiar with the title insurance business,
were presented; they were Dr. Irving H. Plotkin, Senior
Economist for Arthur D. Little, Inc., appearing on behalf
of California Land Title Association, and Dr. Alfred B.
Bofflander, Professor of Finance and Insurance, U.C.L.A.
Graduate School of Management, appearing on behalf of
7/
The administrative record, consisting of four volumes
of reporter's trar~script and 65 exhibits. was lodged in
the Superior Court file as an exhibit. This record is
before us and we have reviewed it.
PAGENO="0327"
321
Transamerica Title Insurance Company. Guardian Title
and Coidwell Banker attended these hearings and were
represented by counsel, who had the opportunity to
present such evidence as they wished, and the opportunity
to cross-examine all witnesses who testified. They did
present the testimony of Guardian Title President Charles
R. Hilton; the 1974 Annual Report of Coidwell Banker was
received in evidence.
~i~tJ~4.p testified that he had been gathering
statistical data for the preceding five years in an
attempt to determine the impact on the industry by the
entrance into the market of broker-controlled underwritten
title companies. He asserted that "a decision made here,
which can be shown to be not in the long run best interests
of the consumer, will have a fairly direct and iuanediate
impact on the availability of the states to defend their
regulatory system." He noted that the outstanding
characteristic of the industry is the fact that the real
estate broker controls the placement of title insurance
in almost every property transfer transaction. He
characterized the industry as an "oligopoly."
81 -- --
Webster's Third International Dictionary, 1966
Unabridged edition, defines "oligopoly" as "a market
situation in which each of a limited number of producers
is strong enough to influencethe market but not strong
enough to disregard the reaction of his competitors . . .
PAGENO="0328"
322
Plotkin found that the average profit annually
was ?..4 percent, although it was extremely volatile,
ranging from 2 to 15 percent in any given year. The
profit realized was below the ordinary rate of business
return. He stated that an operation characterized by
high fixed costs -- such as the title industry - - assigns
a great deal of value to every marginal bit of business.
He emphasized that a sure source of supply of business
is extremely valuable in such an industry. Analyzing the
financial data submitted by Guardian Title in connection
with its application. Plotkin thought the rate of return
(profit) expected was abnormally high, based as it was on
significantly lower expenditures by Guardian Title. He
made reference to the ex-perience in northern California
where entrants to the market that ~iere broker-controlled
not only garnered an astonishing percentage of the
business from the very beginning, but continued to grow
at the expense of the independent title companies who
could statistically chart the fact that they were losing
ground by the month. The primary example of this phenomena
was a group called Founders, broker-controlled 2nd operating
in counties, of northern California.
Bofflarider, who testified at the administrative
hearing, was the coauthor of a report entitled "The
PAGENO="0329"
323
DistributiOfl of Title Insurance in California,' l4arch
1976. He agreed with Plotkin that the main characteristic
of the industry is broker control of the basic real estate
transaction. lie fcnd an analogy in the sale of credit
life insurance ai-id concluded that, as in that industry,
broker-controlled underwritten title companies would
eventually drive prices up while decreasing the quality
of the product, ~ title insurance. He was opposed to
the licensing of Guardian Title - - not only for the
anti-competitive impact generated by any broker-controlled
underwritten title companies -- but because his analysis
of Guardian Title's financial data, submitted with the
application, led him to the conclusion that Guardian Title
had been set up primarily as,a conduit between Safeco
insurance Company and Coldwell Banker to enable Safeco to
pay rebates for insurance business in violation of 1n~urance
Code section 12404. Evidence supporting this view was
contained in the underwriting contract between Guardian
Title and Safeco, which disclosed that Guardian Title
would be collecting fees in some situations without doing
any work and would be collecting fees the rest of the time
for performing very little work.
From such evidence the Insurance Comi~issiOner
could reasonably concludc that a license to Guardian
PAGENO="0330"
324
Title would provide the opportunity to Safeco Insurance
Company to offer rebates to Coldwell ~3anker, funneled
through Guardian Title, in return for Coidwell Banker's
sending all, of its title insurance business to Safeco.
Findings of fact and concipsions of law were
made and issued by the Department hearing~officer on
August 16, 1976. The findings tel]. us that Colduell
Banker was not only a real estate broker, but, through
its subsidiaries, was engaged in all facets of real estate
9/
and related endeavors. Particular emphasis was placed
upon Coidwell Banker's relationship with its wholly-owned
subsidiary, LandmarkEscrow Services, Inc. , which derived
100 percent of its business from Coldwell Banker and whose
escrow charges to customers were 150 percent higher than
those of other escrow companies operating In the same
area. The Department concluded that Colciwell Banker, as
a real estate broker, would strive to direct title business
to Guardian Title in the same manner as it directed to
Landmark Escrow the handling of escrows which are neces-
PAGENO="0331"
325
Finding I~o. B declared that, "tw]ith rare
exception, buyers and sellers of residential property
either express no preference or look to the real estate
broker or salesman (real estate producer) for advice in
choosing an escrow holder, a title insurer or other
supplier of services ancillary to the transfer of real
property. Accordingly, the real estate producer not
only has the potential to control, but generally does
control, the placement of orders for such ancillary
services, . .
It was found that competitive efforts by the
title companies are ordinarily directed toward the rEal
estate broker rather than the ultimate seller and
purchaser, the consumers, and that the broker involved
may select the entities to perform the ancillary fume-.
tions for reasons other than the welfare of the consumer -~
a phenomenon known as "reverse competition." There was
a strong inference that petitioner Coldwell Banker, as a
real estate broker, would be in a position to steer its
customers needing ancillary real estate services in the
direction of the providers of such services selected by
10/
Coldwell Banker.
10/
- An analogy was found inthe sale of credit life and
disability insurance, where the demand is "derived" in the
sense that it would not exist except for the underlying
transaction, and the cost represents a small percentage
(one-half of 1 percent) of the total transaction rice.
(See Credit Ins. Gen.A~nt~Assn. v. ~ (1976 16
PAGENO="0332"
326
it was revealed that 20 title insurers currently
held certificates of authority in California to issue
title insurance policies, and that 14 of this group
utilized underwritten title companies in the process.
One hundred and twelve underwritten title companies were
currently licensed in California, many of which also
ill
offered escrow services.
The Department made an analysis of the economic
factors present in the title underwriting business with
particular reference to the situation of Guardian Title.
in most counties in California, recordings of land
transactions are maintained on a grantor-grantee listing
basis. A "title plant" of a private corporation is
essentially a duplicate o.f county land records, but
reorganized to indicate relevant data on a geographic
or parcel-by-parcel basis. Most of the underwritten
title companies (90 percent) either own their own title
plant or pay a fixed share of the cost of maintaining a
jointly owned title plant. The remainder either use
county records, have access to a title plant, or have a
UI
- It was noted that Guardian Title had no intention
of offering escrow services, because of the existence
of Coidwell Banker's wholly-owned escrow service corpora-
tion, Landmark.
PAGENO="0333"
327
"search package" arrangement whereby the ~requisite informa-
tion is secured by others. Particularly in densely
populated areas, the task of creating. maintaining and
using a title plant is costly and time-consuming. Since
entry into the title insurance business is dependent
upon such an expense, success depends upon the ability
to attract a substantial volume of business in a reason-
ably short period of time.
Obviously, an entrant such as Guardian Title,
assured from the outset of referrals from the real estate
broker, Coldwell Banker, would have a substantial economic
advantage over those title companies without a ready-made
source of business. Guardian Title, the findings stated,
due to its contract with Security Title and Insurance
Company, would have the additional advantage of not being
required to make other than a minimal capital investment
in title plant acquisitioi~ or maintenance in the four
counties in which it proposed to do business, since
Security would, pursuant to the agreement, provide
Guardian Title with plant access in Los Angeles and
Orange Counties, and with a search package in San Diego
and Ventura Counties (the result in the latter counties
being that Guardian Title would have almost nothing to
do in those two counties).
PAGENO="0334"
328
The findings froto the administrative hearings
set forth that dramatic growth in the real estate market
has enabled some of the new underwritten title companies
to compete successfully with existing companies, but
foresaw that "Ifloreclosure of the market or an appreciable
part of the market to entrants by tie-in sales or comparable
arrangements, could pose an insurmountable barrier to
entry. . . ." The Coldwel], Banker-Guardian Title arrange-
ment was seen as a potential threat in the future because
potential new entrants without a ready-made'source of
business might well decide not to enter the market for
fear of being at a competitive disadvantage that could
not be overcome, even by "offering lower prices, better
coverage, or higher quality service."
The Department of Insurance determined that, the
proliferation of broker-owned undaruritten title companies
would result eventually in dimin~shing.competition and
lack of incentive to lower prices. Since the margin of
profit in the business is small, the market volatile,
and fixed expenses very high, there would be.continuous
pressure to increase the cost of services to the consumer.
It was further found that, although "relatively
few" underwritten title companies were presently owned or
controlled by real estate producers, the evidence showed
PAGENO="0335"
329
that those that were so owned or controll~d, "have generally
enjoyed success in terms of market penetration and profit-
ability that is unmatched by Itheir competitors]. No reason
has been shown for the extraordinary success of such under~
written title companies other than their ownership or
~12/
control by real estate producers."
Another significant finding was Findthg No. 29,
to the effect that the licensing of Guardian Title would
"serve as a significant deterrent to entry and, therefore,
would serve to substantially lessen competition in the
title insurance business."
Therefore, the conclusion was reached that Guardian
Title was not entitled to a stock permit because it would be
in violation of Insurance Code sections 839. subdivision (b),
and 839.1, subdivision (a)(5). We need not consider the
applicability of Insurance Code section 839 -- the general
section -- because the record demonstrates that the permit
was properly denied under the more specific provisions of
Insurance Code section 839.1. Other findings and conclusions
concerned the illegality per se of the Guardian Title-Coldwell
l~2J
The evidence upon whichthe Department relied in
making this finding concerned experience in northern
California rather than any figures relative to market
share, market penetration or growth of realtor-owned
underwritten title companies in the four southern California
counties in which Guardian Title proposed to operate. The
northern California experience, however, led the Department
to conclude that the market share of wholly-owned under-
written title companies would be closely aligned to the
share of the market controlled by the parent.
PAGENO="0336"
330
Banker arrangement as a fox-rn of. "tie~in sa1e,~' the~
possible violat~on of Insurance Code section~ 124~4 and
12412, which prohibit rebates) and the inapplicabIlity
of Insurance Code sections 790 et seq., which enumerate
certain unfair business practices by insurers.
With respect to the language of Insurance Code
section 839.1, the Department declared that "every domestic
insurer" would be "directly affected by the total trans~
action fin which Guardian Title would be engaged) to the
extent that the granting of this permit . . . portends the
end of competition as it is presently known in the title
insurance industryinCa1ifo~mia, . . .".And, it was con-
cluded, that "[t)he provisions of § 839.1, although patterned
after the [federal) Clayton Act and in part the regulations
of the Federal Trade Commission, are unique to the Insurance
Code in California law. The Legislature clearly intended
the section to be applied prospectively to enable the
Commissioner to deny securities permits to insurers,
foreign and domestic, in any situation where the Commis-
sioner finds that the total transaction, or any part
thereof for which a securities permit is required, will
result in any of the anti-trust type violations enumerated
in the section."
With the exception of two findings iun~ateria1
here, the Department's findings and conclusions were
PAGENO="0337"
331
adopted by the Commissioner, and, on October 27, 1976,
the application of petitioners for a stock permit was
formally denied upon the grounds that issuance would
violate Insurance Code sections 839, subdivision (b),
and 839.1, subdivision (a)(5).
Coidwell Banker and Guardian Title then resumed
litigation in the superior court, filing ~ second supple-
mental and amended petition for mandate and declaratory
relief. In it they alleged that, pursuant to the Insurance
Code, the issuance of the permit and the license were
ministerial rather than discretionary duties of the
respondents Department of Insurance and the Commissioner;
but that if discretion could be exercised by respondents
in connection with issuance, it had been abused; and that
denial of the applications constituted a denial of due
process and equal protection of the laws. The matter
came to trial in 1977.
11
The Pindin s, Conclusions and
o ~t čTrial Court
As a preliminary matter, all the parties to the.
litigation agreed that the petition for mandate was sought
pursuant to Code of Civil Procedure section l085.
page. -
13/
Please see following
85-396 0 - 81 - 22
PAGENO="0338"
332
Coidwell Banker and Guardian Title again offered the
testimony of Charles R. Hilton, a California attorney,
who identified himself as an employee of Coldwell Banker
and president of Guardian Title. Hilton tes~ti~fied that
the percentage of the real estate market enjoyed by
Coidwell Banker in the four California counties in which
Guardian Title wished to do business constituted 2 percent
of the total market, and that Coldwell Banker was able to
influence the choice of title insurance companies by its
customers in about 50 percent of the sales consununated,
with the result that the title insurance business which
would flow to Coldwell Banker's subsidiary, Guardian Title,
would be in the nature of 1 percent of the real estate
14/
market in the four counties.
At one point, the trial court announced that, it
137
That section provides, in pertinent part for our
purposes, that a writ of mandate "may be issued by any
court, except a municipal or justice court, to any
inferior tribunal, corporation, board, or person, to
compel the performance of an act which the law specially
enjoins, . . . ; or to compel the admission of a party to
the use and enjoyment of a right or office to which he
is entitled, . .
.14/
Prior to this testimony, the Department and the
Commissioner objected to it on the ground that Hilton
had already testified at the administrative hearing, but
then withdrew the objection, raised no further objection
to his testifying, and conducted a cross-examination.
PAGENO="0339"
333
would apply the substantial evidence rule in reviewing
the administrative decision, i.e., that it would deter-.
mine whether or not the administrative findings, con-.
clusions and decision were supported by substantial
evidence presented at the administrative hearings. But
at another point, the trial court declared that, since
Insurance Code sections 839 and 839.1 did not require
that a hearing be held before an administrative deter-.
mination was made of their applicability to petitioners
Guardian Title and Coidwell Banker, the petition for
mandate was before the trial court pursuant to Code of
Civil Procedure section 1085. }~ence, the trial court,
in considering the petition, was entitled to Exercise
independent judgment regarding the substantiality of the
evidence in assessing the factual determinations made at
the administrative level and~ in assessing the "fairness"
of the administrative hearing.
The trial court decided in favor of Guardian
Title and Coidwell Banker and thus overturned the
administrative decision denying the applications for a
stock permit and license to do business.
Some of the findings of fact and conclusions
of law made by the trial court concerned the administra-
tive hearing held by respondents. Thus, the trial court
PAGENO="0340"
334
found that "tr)espondentS' administrative hearing,
although excessive in scope, was a full and complete
consideration by Respondent of all facts and issues
pertinent to the ORGANIZATIONAL APPLICATION and the
LICENSE APPLICATION." (Finding No. 55.) The trial
court also found that Guardian Title and Coldwefl. Banker
had been represented at the hearing by counsel and had
been afforded every opportunity to present their case;
the findings characterized the administrative hearing as
general in nature, concerned with issues which affected
not only petitioners but ten other broker-applicants.
Virtually all of the findings of the administra-
tive decision concerning the nature of the underwritten
title insurance business in California and the economic
factors which determine entry into the business, were
disposed of by the trial court in Finding No. 25, which
stated: "It is not necessary for the Court to determine
[15!]
whether or not these Administrative Findings of Fact -
are supported by substantial evidence or the weight of
the evidence, since the Court has determined that, asa
matter of law GUARDIAN'S share of the relevant market
Specifically, administrative findings No. 2 through
26 (with the exception of No. 19, not adopted by the
Commissioner and the first sentence of No. 26).
PAGENO="0341"
335
is too small to substantially lessen competition."
(Emphasis added.) The trial court also found it unneces-
sary to make findings concerning the large body of evi-
dence introduced at the administrative hearings because
the hearing afforded Guardian Title really concerned a
"public policy" question rather than the applications of
Guardian Title for a permit and license. The finding
that Guardian Title's share of the relevant market was
demin±mus in terms~of substantially lessening coTrpeti-
tion was the key finding made by the trial court.
Also crucial to the trial court's judgment
granting the petition of Guardian Title and Coidwell
Banker for a peremptory writ of mandate, was the inter~'
pretation made of the anti-trust provisions of Insurance
Code section 839.1, subdivision (a)(5). Declaring that
the section contained anti-trust provisions analogous to
the federal anti-trust provisions set forth in the federal
Clayton Act (15 U.S.C. § 12 through § 27), the court found
the language of the California statute more restrictive
than that of the federal law, and noted that such
"veitical integration" arrangements as that of Coldwell
Banker and Guardian Title were not illegal per Se, citir~g
tice California Supreme Court case of Chicago Title 1ns~
Co. v. Great Western Financial Co~. (1968) 69 Cal.2d
305, 324.
PAGENO="0342"
336
~ . Thetriai:court:placedgreat empIii~uis:on ths
iinpropriety~: pft1ie-:~rOCeS$~by whith~the'~ administrati\'e
ageucyhad::~eached~t1~. conclusion that .. Cuardia±i Title
shöuldThot.be:issued~: stockpermit a~d:lice~se
specif~ąl1ythąt~pait-Of-the prpce~ which involved
consideratibn of~ the. peridthg app1ications.~ of; ten other
similarly . s1tuatedbrokez~awr~ed iinder~titten title
COt~~P~Y.:. .appIicant~~;Other~firn3iflgS:~afld conclusions
~ ~ ~,1moi~ rc~-~fl~1 ~rdMi o~ ~ ~
~e
~ ~-
~4 ~ ~ ~ ~ ~rC 2~t~ -~ ~:; ~ ~ ~ ~L ~ ~. ~ -~
~ to ~uarMi~n i~L~ ~in~c~
~ ~ ~ _~_ -~ -~:;~: ~ <`~~ i;~_ __~ ~ j~?~ ~. ~#~2~Z
~ ~&tb1i~én~, ~ ~a
__c~~ ~ ~ ~ ~ ~-`~ *_ ~ ~ ~ &r -~ "~
~ t&tie ~
J -,~ ~ ~ __:~ - ~ ~--~--~, ~:-;:C ~ -~ ~~-~-: £~ ~ ~ ~ ,~ ~ ~ ~ -`
~ t~~oti~h~ C~4d~efl'i ~
?~ ~`4 t~%~r;~ ~ ~j ~ ~ ~ ~ ~
~
~ ~; ~ ~ ~ ~ .: -~ ~ ~ ~`-~r ~ -"~~- ~ ~-:~ ~ :`- :~1- ~ ~- ~
~ ~ ~ ~ ~
`~__,;` ~ ~ ~ ~ rct~L~: ~ ~ ~ `- ~ \~A ~
the pere'r~pj~t7 ~Ut ~ ~gndat~e _ -`-- ~ -,~ - ~ ~ ~1 ~
~ ~ ~ ~ ~ -:-~~~ ~
~ ~ ~ ~ ~ 1~r~~r~i
PAGENO="0343"
337
~ ~ ~.- -~- ~` { ~ ¶~ (~` ~ _t~_,~~J
~ :_- ~ -.~ ~ ~ ~: ~. ~ ~ ~ ~: ~- _ ~ ~ ~ -`~;: ~ ~
j; ?-~E~ ~ ;~ -L'~c~ ~ ~ `- ~` I ~? ~ ~ ~ ~ ~ f ~
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-a. ~ ~ ~r
~- _~_1_. 1'~m:~Jby~ ~ c11~~ ` -
zi4~ b~~ii viat~ie ~ 4i~-~2~1g~ ~
£ ~ o et e~Th~bj~itii~nv a~di ~hii~rice~ ~-
-~- ~Ei~t~ss1Qner H~ e Exceedé~~theur s~I~ i ~
J ~ ~ ~
-~-.`~ ~ r~ ~ ~ ~ ~ ~ ~ ~ ~ ~, ~
-~- ~ ~T~?j;: ~ aug~t~t~it~on ~ r~cord~~
~ ~ ~ : ~ ~
puisuant~tO~tu1e,12'~ ~ (~)i~ of~he CfLa
~ ~ ~ .~ ~ ~ _;~-1 ~ ~ ~ ~ - ~-i ~-~` k ~ d~ ~ `~ ~ ~ ~ ~ ~ -~ ~
~ ~ . f - -~::~:L (- y-~~:;;:k~;;~ ~- ~ ~ ~:: -~--r-~r ~ *-~~ ~
3UdgtM~flt~ 4~fl ~Pz~(~ ~ 4cu~tan~~ji~;
`J ~ `~ i~r~ ~
have r~dere&ThD~t ~ ~a~p~?F uE t1i~ ~ ~
- ~-~.-- -~-~ ~;=~--- -- - _j*__ ;~ ~k ~ ~ (~5_~ ~ ~ ~ ~ ~
- ~ -~` -;~. -~ ~ -t.L -c.T ~ -~`~ ~ - ~- ~ )~- ~ ~ ~
Iisu~nce s~~c~~he ~~n~p~jt
-~-`~-~( ,`__t~ .`* - )~___~ ~-~- -r - ~ ~"1~.w
~ !WZ~ Of pe~p't6~y ~dat~ ~ ~
~ ~- L -- - ~ ~, - :~ :~ ~ L~ ~ ~ ~ ~-_ ~. ~ `t ~ ~ ~ ~. ~i ~ ~
L~a~ ~:t~ry~~ ~ ~:
- f;-~-- .-~_;- ~ -~ - ~ _~_~,7~_ ~ ~ -~` ~ .~ ~- -~L 2 J~' ~
~ the~ ~ ~ilt ~adi~ctaj r~!L?P
::- ~ ;~ ~ ~ `~~_ -` ~` ~ v~ ~-` `-~ _-~ ~ _ - _ -~ ~ ~__~)~_ c-
-t~_1~ ~ t~es~~p~tc: ~ ~ ~ ~ ~
~- ~ -~ ~ ~ I ~ ~ ~ -;;? ~ ~ ~ ~ ~ 2~- ~. ~ ~ *- ~ ¼ ~
~ ~i~d (~I)1~- ~sq `~-r- ~ ~. ~ij~ ~ ~ ,t .-~ ~ ~ ~- ~~`g~-s' -~V~ ~-
PAGENO="0344"
338
The judgment granting a peremptory writ of
mandate was executed and entered on November 14. 1977.
The Department and the Insurance Commissioner filed a
notice of appeal on January 13, 1978. The appeal had
the effect of staying proceedings on the judgment and
the peremptOry writ of mandate issued pursuant thereto.
(Code Civ. Proc., § 916; Environme~talCo21it1_2~
Orange County, Inc. v. AVCO Community .DeveloPerS_Iflc.
(1974) 40 Cal.App.3d 513, 525.) On June 20, 1978, the
trial court issued an order setting aside the aut~matic
stay. The order was issued pursuant to Code of Civil
Procedure section illOb which provides: "If an appeal be
taken from an order or judgment granting a writ of
mandate the court granting the writ, or the appellate
court, may direct that the appeal shall not operate as
a stay of execution if it is satisfied upon the showing
made by.the petitioner that he will suffer irreparable
damage in his business or profession if the execution is
stayed."
The June 20, 1978 order provided, in part
pertinent to the issues before us, that. "[r)espondents
[the Department and the CommissionerJ are hereby ordered
to comply with that Writ of Handate. This order is hereby
stayed until July 6, 1978, to allow Respondents the
PAGENO="0345"
339
opportunity to act as hereinafter provided or to seek such
further judicial relief as they desire. [fl IT IS
FURTHER ORDERED that Respondents may, as ~n alternative
election to the foregoing order, do all of the following:
no later than June 30, 1978, approve the ORGANIZATIONAL
APPLICATiON of Petitioner GUARDIAN TITLE CONPANY; upon
receipt of written notification by Petitioners that
Petitioner COLDUELL BANKER & COlIPANY has purchased the.
securities of GUARDIAN TITLE COMPANY pursuant to the
organizational permit. immediately issue a conditional
license to Petitioner GUARDIAN TITLE COMPANY, which
license _sha)~1 remain in effect even if Respondents p~
~~uon~ppeal and be revocable only_in accordance with
California 1w and upon the terms and conditions set fo~
in the license described hereinef~. The conditions on
this license shall be the same as those set forth and
imposed upon those other conditionally licensed under-
written title companies as set forth by way of exhibits
to Respondents' Points and Authorities in opposition to
the motion herein, via., that of United Title Company,
a conditionally licensed licensee approved by Respondents
subsequent to the trial of this action, which are incor-
porated herein by reference. [fl IT IS FURTHER ORDERED
that, in the event Respondents elect to conditionally
PAGENO="0346"
340
license Petitioner GUARDIAN TITLE COMPANY as hereinabove
set forth, such conditional license shall also be with-
out prejudice to Petitioners' entitlement to an uncondi-
tional license as may be finally affirmed in the appeal
of the judgment entered by this Court." (Emphasis added.)
The permit to Guardian Title authorized it to
issue and sell 7,000 shares of common stock at $50 per
share to Coidwell Banker in order for the latter to be
qualified financially for the issuance of a license to
Guardian Title to act as an underwritten title company..
The permit to Guardian Title was followed by a license
to it to transact business as an underwritten title
company. The permit imposed certain conditions. Included
was a condition that Guardian Title seek outside referrals
(other than from Coldwell Banker) in an amount constituting
10 percent of its business the first year, with an
objective of adding 10 percent each year thereafter
until, at the end of five years, the share of outside
business would constitute 50 percent. of G~~rdian Title's
total business.
We now deal with the-contention of Coldwell
Banker and Guardian Title that the appeal of the Depart-
ment and the Insurance Commissioner is now moot and that
the only issue legitimately before us is whether the
PAGENO="0347"
341
imposition of conditions on the permit and license
exceeded the powers of the Department and the Cominis-
sioner. No party to this litigation has supplied us
with a record which explains the nature of the showing
made below by petitioners Coidwell Banker and Cuardian
Title to obtain the order vacating the automatic stay
on appeal.
At the outset we take note of the fact that
thetrial judge's order, made after judgment, recites
that the conditional license tobe issued to Curadian
Title pursuant to the trial court's order "shall remain
in effect even if RespondentspreV~ E2..~22~1 and
be revocable only in accordance with California law and
upon the terms and conditions set forth in the license
described hereinafter. . . *" (Emphasis added,)
It is undisputed that the Department of
Insurance and the Insurance Commissioner complied with
this singular order made belOw. It is equally manifest
that no appeal was taken by the Department or the Com-
missioner from it. However,~in view of the disposition
PAGENO="0348"
342
we make of this matter before us, we need not consider
whether such an order is appealable.
it is crystal clear that nothing contained in
Code of Civil Procedure section lilOb empowers the trial
court to insulate its previ~us judgment from judicial
review by issuing an order after judgment that.purports
to render appeal from the judgment meaningless. Such
"bootstrapping" is not cognizable under any recognized
principle of statutory or decisional law pertaining to
appellate review.
It may readily be seen that a reversa~, of the
trial court's judgment requires that the parties be
returned as close as is possible to that position they
occupied prior to the rendering of the erroneous judg~.
ment. - (See Code Civ. Proc., § 908.) If the judgment is
affirmed, it is enforceable according to its terms. In
other words, our determination here will either result
in Guardian Title's entitlement to a stock permit issued
~~ut conditions, or, it will result in Guardian Title's
entitlement to no permit, at all. (See Santa Clara Co~,~i
Dist. Attorney investigators A. v. County.of Santa
Clara (1975) 51 Cal.App.3d 255; puller v., San Bernardinq
Valley Hun. Wat. Dist. (1966) 242 Cal.App.2d 66.)
PAGENO="0349"
343
The relief ordered by the superior court
under Code of Civil Procedure section lilOb was purely
interim relief, effective during the pendency of this
appeal. The superior court had no jurisdiction to do
more than that while this appeal is pending. Although
the effect of the interim order of the superior court
was to authorize Curadian Title to do business under a
court-ordered license, that license will expire when the
remittitur of the reviewing court goes down. (See
~yRealty~. v. O'Bannon (1969) 2 Cal.App.3d 917, 923.)
As for inootness, the general rule is that a
party waives the right to appeal if he vo1untari~y com-
plies with the terms of the lower court's judgment. A
waiver is implied "only if the satisfaction or compliance
is by way of compromise, or is coupled with an agreement
not to appeal. Where it is compelled orcoerced, e.g.,
by the threat of forfeiture or seizure of property under
execution, there is no waiver." (6 Witkin, Cal. Proce-
dure (2nd ed. 1971) Appeal, § 135, p. 4129; see, also,
Reitano V. Yankwich (1951) 38 Cal.2dl, 3; Lee v. Brown
(1976) 18 Cal.3d 110, 116; Sé1byConstructors,j~. `V.
l~cCart~y (1979) 91 Cal.App.3d 517, 521; Signal Hill
Aviation Co. v. Stropp~ (1979) 96 Cal.App.3d 627.)
PAGENO="0350"
344
The burden here is on Coldwell Ranker and -
Guardian Title to demonstrate that the Department ai~d
the Insurance Commissioner entered into some type of
compromise agreement with Coldwell Banker and Guardian
Title which was intended to terminate thi~ litigation
pending the appeal. No showing has been made here that
such was the case.
It seems clear that once the trial court had
vacated the automatic stay of the judgment and made its
order directing the issuance of the permit and the license
by the Department and the Commissioner, they were corn-
pelled to fdllow the order or face a citation for contempt.
Under these circumstances, the decision to comply cannot
be regarded as the voluntary act which constitutes waiver
of appeal rights. The instant case is not unlike English
v. City of Lon~g leach (1950) 35 Cal.2d 155. in which
English sought a writ or mandate to compel the city to
vacate its order of discharge and reinstate him as a
police officer. In rejecting the contention that the
appeal had been rendered moot because English had been
reinstated during the appeal, the court observed: "The
continued employment of English by the city resulted
from the fact that he obtained a court order directing
that this appeal should not operate as a stay of
PAGENO="0351"
P345
execution of the judgment granting the writ of mandate
(Code Civ. Proc., § illOb), and the city's inability or
failure to resist the application for that order was
not such a voluntary compliance with the writ as to
render the issues moot." (Id. at p. 160.) (Emphasis
added.) We conclude, therefore, that the appeal before
us is riot moot.
Furthermore, we decline to review on this
appeal the propriety of the conditions imposed by the
Department and the Insurance Couiinissioner on the issuance
of the permit and license to Guardian Title. Not only
did these matters occur afterjiIdgmenti but, pursuant
to our analysis of the impact~of our decision on the
judgment, the fact that conditions were imposed upon the
issuance of the permit and the license pending appellate
determination of the correctness of the judgment will
prove nonconsequential when the remittitur is received
by the trial court.
Iv
The Standard for the Trial Court's Review
- of theAdrninTstrative Decision
The Department and the Commissioner contend on
this appeal that the trial court erred In conducting an
PAGENO="0352"
346
independent, de novo review of the administrative deci~
sion to deny Cuardian..Title the stock permit it sought.
As pointed out previously, it appears from the re~o~d
that the trial court, although announcing at one point
that it was applying the test of substantial evidence
before the administrative tribunal, subsequently declared
~
~
the evidence -- that adduced both at the administrative
hearings and in th~ trial court.
We are not dealing here with a statewide
administrative agency exercising quasi-judicial power
conferred upon it by the California Constitution, but,
rather, with a statewide administrative agency exercising
power to make certain determinations - - a power conferred
upon it by the Legislature. Of some importance is the
fact that the Insurance Code provisions (commencing with
section 820) concerning the issuance of stock permits by
the Commissioner do not provide, as a matter of right,
for a hearing upon a permit application.. In this
instance, however, the Department and the Commissioner
chose to afford a hearing to Guardian Title.
Although a hearing was held, it was not "required
PAGENO="0353"
347
by law" in the sense that would trigger the judicial
review contemplated by Code of Civil Procedure section
1.094.5, i.e., the administrative mandamus section. It
was agreed by the parties herein, and correctly so, that
the petition for mandate was b~efore the trial court
pursuant to the traditional mandamus statute - Code of
Civil Procedure section 1085. The question presented is
that of the applicable standard of review. Was the -r
trial court limited to rev~iewing the substantiality of
the evidence introduced before the administrative agency
to support the administrative determination, or, was it
empowered to reassess all theevidence before the court
independently - the more intnjsive standard of review.
Two older California Supreme Court decisions
have considered the issue. In NcDonoug~ v. Goodcell
(1939) 13 Cal.2d 741, the factual background of the dis-
pute was that the California Legislature had, by statute,
conferred upon the Insurance Commissioner the duty to
-\ ascertain and determine the qualifications of an applicant
for a permit to conduct a bail bond business; the statute
in question was a newly enacted licensing law. Peti-
tioners, long in the bail bond business, made application
for a permit, and public heariDgs were held. The permit
was denied, and petitioners sought judicial review.
85-396 0 - 81 - 23
PAGENO="0354"
348
In affirming the administrative action, the
California Supreme Court stated that "it is the settled
general rule of law in this state that where the legis.~
lature has by statute clothed an administrative officer
with power to ascertain the facts with reference to the
fitness of an applicant for a permit to engage in a
business subject to regulation under the police power
and has vested in such officer the discretion, based on
the facts ascertained, to grant or deny a permitto
engage in such business the courts will not interfere with
the exercise of such discretion except in the case of an
abuse thereof.'~ (Id. at p. 74B.) The McDonougj~ court
proceeds to state that one form of discretionary abuse -~
arbitrary action -- would occur "in the event there was
no sufficient factual basis for [the administrative)
conclusions." (Id. at p. 749.) Applying the rule that
j~idicia1 review was concerned with the existence of
substantial evidence before the administrative agency,
whether there were conflicts in that evidence or not,
the 11cDono~gh court upheld the determination made by
the Insurance Commissioner.
In Drun~p~y v. State Bd. of Funeral Directors
(1939) 13 Cal.2d 75, the petitioners were duly licensed
embalmers, charged with certain violations of the Funeral
PAGENO="0355"
349
Directors and Embalmers Law: That law provided for
notice and hearing prior to revocation of a license.
After hearing1 the Board suspended petitioners; the
petitioners sought judicial review; the trial court
determined the issue "on the evidence produced before
the board." (Id. at p. 78.) It then ordered the Board
to reinstate the petitioners. The Board appealed.
The ~ court, after deciding that mandamus
was the appropriate method of obtaining judicial review,
posed the question in this fashion: "[W)hat weight the
courts should give to the find5.ngs of the board -~ or,
stated another way, are the findings of the board, if
based on substantial although conflicting evidence,
binding on the courts . . . . ?" (Id. at p. 84.) Reasoning
that to hold otherwise would confer quasi-judicial power
upon an administrative agency not designated by the
California Constitution as an agency so empowered, the
Drunmey court declared that "the court to which applica-
tion for mandate is made must weightbe ~
exercise its independent judgment on the facts, as well as
on_th~1aw~ i~J1~ complaining party is to be accorded
his constitutional rights under the state and federal
Constitutions. . . . for a purely administrative board to
deprive a person of an existing valuable privilege withou~t
PAGENO="0356"
350
i~bra ~
the due process clause of the federal Constitution."
~
Both Nc~ono~~ and Drumn~ were decided in 1939
and have not been overruled or .questioned. McDonough,
adhering to the substantial evidence.rule, distinguished
the ~ holding on the ground that Dr~inm~ had
formulated an exception to the general rule. which applied
only where it was determined that a party was being deprived
of a "constitutional right." More recent case law has
recogn~edthat this distinction betveer~ the two approaches.
is dependent upon whether the right involved is "vested"
or not. (Merrili~ v. ~t~nto~j~otOr Vehicles (1969)
71 Cal.2d 907, 914-915.) The denial of a permit to an
applicant (the McDonough situation) has traditionally
been regarded as involving a non-vested ri'ght, while
revocation of a permit or license already granted (the
~ situation) has been regarded as involving a vested
right of the permittee or licensee. In the latter caseS
the trial-court review is conducted on the independent-
judgment-on-the-facts basis.
Both NcDonough and Druntmey were decided before
the enactment of the Administrative Procedure Act and
PAGENO="0357"
351
section 1094.5 of the Code of Civil Procedure providing
for administrative mandamus. Nevertheless, the distinc-
tion between vested and nonvested rights continues to be
of controlling significance not .only in cases governed by
administrative-mandamus principles but those which are
not.
The McDonoug~ court's adoption of the substan-
tive evidence rule in vested rights cases has been relied
upon in such subsequent decisions as So. Cal. J~cj~e1
~ ē~Iifornia etc. Racin~B~. (1950) 36 Cal.2d 167,
and Crestlawn HeTnorial Park Assa. v. Sobieski (1962) 210
Cal.App.2d 43; the i~eD6nou~h-Druimnē)~ distinction has been
discussed recently in Tex-Cal~Land Management, Inc. V.
~g~u1tura1 Labor Relations Bd. (1979) 24 Cal.3d 335
343. No case has been brought to our attention which
specifically considers the power of the Insurance
Commissioner to deny a stock permit, and the scope of
subsequent judicial review of this administrative decision.
The case of Blood Service Plan Ins. Co. v. Roddis (1968)
259 Cal.App.2d 807, strenuously relied upon by Coldwell
Banker and Guardian Title both in the trial court and on
this appeal, did not address the issue of the standard
of review; in that context, it is not helpfuL. in any
event, the Roddis decision is readily distinguishable
PAGENO="0358"
352
from the case at bench. It involved the propriety:of
administrative denial of a certificate to do business --
a case in i~,hich the administrator had conceded that
petitioner insurance company had complied with all the
applicable criteria for obtaining the certificate. Under
those circwsstanCes, the appellate court found that it
was an abuse of discretion on the part of the Insurance
Coimnissioner to refuse to issue the certificate.
Host of the decisional law on j~.idicial review
has evolved in recent years from administrative proceedings
reviewable pursuant to Code of Civil Procedure section
1094.5, but it has recognized the relevance of the
distinction between vested and nonvested rights. In the
landmark case of Bixbyv. Pierno(l9ll) 4 Cal.3d 130,the
California Supreme Court held that section 1094.5 empowered
the Supreme Court to establish standards for determining
which c~ses require an independent_judgment review and
which call for only a substantia1~evidence review of the
entire administrative record. The ~ court makes clear
that when the right involved is a fund toental.v~!~!4 right,
the standard of judicial review is the independent-judgment
review. Agreeing with ~ was Stru~ms~y v. San Diē~q
County Employees Retirement Assn. (1974) 11 Cal.3d 28.
The Bixby-Strumslēy rule of judicial review was
PAGENO="0359"
353
explained by Anton v. San_~ntonio_Commtmi~yHp~. (1977)
19 Cal.3d 802, 822, in the following fashion: "That
rule, as stated by us in Strumsky, provides that if the
subject or decision `substantially affects a fundamental
vested right, the court, in determining under section
1094.5 of the Code of Civil Procedure whether there has
been an abuse of discretion because the findings are not
supported by the evidence, must exercise its independent
judgment on the evidence arid find an abuse of discretion
if the findings are not supported by the weight of the
evidence. If, on the other hand, the order or decision
does riot substantially affect a fundamental vested right,
the trial court's inquiry will be limited to a deter-
inination of whether br not the~ findings are supported by
substantial evidence' in light of the ~Tho1e record." It
is manifest that the difference between the tvo standards
of judicial review is of ~ubstantia1 significance.
Since, in the case at bench, the trial judge
applied the independent.judgment-on-the-e'~iidence standard,
the issue before us is "whether or not the administrative
decision here in question ~`ubstantia1ly affectsaT~~
fundamental vested right `` (Anton supra 19 Cal 3d 802
823 ) The question presented is twofold Was the right
or interest of Coldwefl Banker, a real estate broker, to
PAGENO="0360"
354
form Guardian Title and have the latter apply for a
permit to issue stock and a license~to engage in the
under~'ritten title company business a right or interest
which is "fundamental1t? But even assuming that the
interest or right involved is "fundamental," the second
aspect of the quescion.is whether the right or interest
is a "vested" interest or right.
* The concept of a "fundamental" right has not
been precisely defined. The ~ court used language -
that "[i)n determining whether the~ right is fundamental
the courts do not alone weigh the economic aspect of it,
but~ the effect of it in human terms a-nd the importance of
it to the individual in the life situation." (Bix~y,
!~pra, 4 Cal.3d 130, `144.) Similarly, a "vested" right
has not been defined with complete precision. The ~
court defined the "vested" fundamental right in terms of
a- contrast between a right possessed and one'that is
merely soug~: "rAind, if it is such a fundamental
right, whether it is possessed by, and vested in, the
individual or merely sought by him. In the~ latter case,
since the administrative agency must engage in the
delicate task of determining whether the individual
qualifies for the sought right, the courts have deferred
to the administrative expertise of the agency.. If,
PAGENO="0361"
355
however, the right has been acquired by the individual,
and if the right is fundamental, the courts have held the
loss of it is sufficiently vital to the individual to
compel a full and independent review." (Bixb2, supr,
4 Cal.3d 130, 144.)
In Anton, the court applied the Bixby-Strumski
definitions and concluded that a physician's right to
renewal of hospital and staff privileges which had been
renewed annually for a number of years before, and which
was now denied by a decision of the hospital's board of
directors, was "both fundamental and vested within the
meaning of ~ and Stru~~." . (Anton, supra, 19 Cal.3d
802, 825.) The Anton court thus continues the traditional
distinction made between an application for a license (a
"privilege") and the revocation of a license (a "vested
right").
We conclude, therefore, that, under Bixby, /
Strutns1~ and Anton, the right or interest of Coidwell
Ban1~er and Guardian Title; which was affected by the
decision of the Department and the Insurance Commissioner,
was neither a "fundamental" right nor a "vested" right.
The appropriate standard of judicial review by the trial
court below was thus the substantial-evidence test and
PAGENO="0362"
356
not the independent-judgment test.. It was thus error
for the trial court to a~ply the independent-judgment
test in the case before us. The trial court should not.
have admitted additional.ev~dence.~and then relied upon
it threachingits decision. Basically the trial court
reached its dec~.sion by holding that the Department and
the Insurance Commissioner had misinterpreted and mis-
applied Insurance Code sections .839 and 839.l.of the.
Insurance Code and in so doing had denied to cuardian
Title and Co1d~ellBanker their constitutiona' due process..
rights. -
Since the trial court employed the wrong standard:
of judicial review, its findings of fact become irrelevant
to a consideration of the issue of whether the administra-.
dye decision in question. is supported by substantial
evidence on the whole record before the administrative
agency. But even when the substantial-evidence standard
is applicable, the trial court siust look to the entire
administrative record not only to determine, whether the
findings are supported by substantial .evider'ne~, but also
* `to determine "whether the agency couzizzitted any errors of
law." (Bixby, ~ 4 Cal.3d 130, 144.)
We next consider ~hether the trial court was
PAGENO="0363"
357
correct in~ holding that the Department and the Insurance
Cotm~issioner had committed errors of law in interpreting
their powers under the relevant Insurance Code section.
We also consider, in view of the trial court's failure
to do so, whether a review of the entire administrative
record establishes that the findings and decision are
supported by. substantial evidence.: *..* .. ** .. .~
The Administrative Decision Does I~o~_Invol~
~i~rrors of Law and ~he 1~dmthistrative~
in in a of1~įct ancFD~ision are Su orted
y u stąntial Evidence~ń t1~e1'ho eecor
Of.crucial importance in this litigation is
the meaning to be attributed to section 839.1 of :
the Insurance Code. It is true that, insofar as we
have been able to discover, no legislative guidance ~n
the forts ofcommittee reports or other materials exists
-. . *. 161
withrespeet to this. 1965 enactment of the Legislature.
* Thus, we must turn elsewhere for aids to appropriate
* interpretation. : .
A review of Article 8 of the Insurance Code
.16/
* Section 839~I was enacted into law as set forth
in Senate Bill No. 559, introduced by Senator Doiwig on..
February 18, 1965. The Legislative Counsel's Digest
merely summarizes its content.
PAGENO="0364"
358
commencing w~.th section 820 ano concerned with the
issuance.of securIties by insurers, reveals that the
Department and the Insurance Commissioner hįvč. been
charged with the duty and responsibility of monitoring
the issuance of such securities in broad terms, rather
than in terms of limitation The legislative objective
appears to be not only to safeguard the rights of share-S
holders but other important members of the public -~ the
consumers.
The.Legislature,, as it is entitled to do,1~s
delegated broad powers ~o the Department and th~ Insurance
Corrmiss~oner powers which include the power to deter- -.
mine not only the present danger but potential danger
to competition in the insurance industry presented by-
~ar1ous business combinations and arrangements The -
language of Insurance Code section 839.1 does not sug-
gest that the section was intended to deal only with
mergers but rather with any business combination
likely to have damaging economic consequences; there i~
PAGENO="0365"
359
no language in the ~section which supports the view that
on1y..~zoi~~ arrangements were to be subjectto
administrative scrutiny.
Among the distinguishing features of section -
839.1-is the fact that administrative anti-trust inquiry
may commence at the critical stage pri~~ to the issuance
of a stock permit to an insurer applicant. }!uch was made
below of the purportedly erroneous process employed by
the Department and the Couir4ssioner at the administrative -
level of taking into account the existence of a number of
applications pending which were similar to those of
Guardian Title in assessing the impact of the business
arrangement involved on competition in the title insurance
industry. Under Insurance Code section 839.1, we deem
it appropriate - and indeed1 necessary -- for the
Department and the Commissioner to make the scope of
their inquiry include the factor o~ similar pending
applications. To hold otherwise and to limit the
administrative decision-making power to consideration
of each application in a vacuum, requiring the administra~
tive agency to ignore that applieation's s-ignificance as-
part of a trend toward an unhealthy concentration of
economic power, would-rob section 839~.l of much of its
effectiveness. -
PAGENO="0366"
360
The narrow construction of Insurance Code
section 839.1, favored by the trial court on this issue,
led, in turn, to a misguided search for anti-trust
principles applicable to single entities rather than a
consideration of the many elements which attain signifi'-
cance with respect to an entire industry.
AU. of the parties to this litigation r~cog-
nized, and quite reasonably so, that the language of
Insurance Code section 839.1, subdivision (5), referring
to a denial of a permit in the case of those business
arrangements which "will substantially lessen competi-
tion in the insurance :bt~s1~55" was similar to that
employed in the federal anti-trust legislation, i.e.,
the Sherman Act (15 U.S.C. §~ 1-7) and the Clayton Act
(15 U.S.C. §~ 12-27), and that the case law interpreting
federal anti-trust legislation would offer some assistance
to the task of interpreting section 839.1.
~hi1e Guardian Title and Coldwell Banker have
characterized section 839.1 as a "little Clayton Act,"
~ ~ .~
such a description is óvérly sin~1T~tic. "A~i ~T1m~~'°'~
matter, it is to be noted that our statute is unliTce the
federal Sherman and Clayton Acts beöause it operates.: in
the context of permit issuance; the burden of compliance
PAGENO="0367"
361
with its terms is on the applicant, rather than on the
government or a complaining party to establish anti-
trust violation pursuant to federal law.
Nor do we accept the interpretation. urged
below by Guardian Title and Coidwell Banker, that section
839.1 is more restrictive in its language than the
federal legislation because of the section's use of the.
word "will"; that usage merely portends that the Depart-
ment arid the Commissioner have the power and the duty to -
consider potential threat to competition in addition to
current danger.
In pursuit of analogies, Guardian Title and
Coidwell Banker urge that the most appropriate reference
in-federa1.~lawis. that containe.d in Section 3 of the
17/
Claytpn Act (15 U.S.C. § 14)~ and concerned with the
~~1~..__~
"It shall be unlawful for any person engaged in
commerce, in the course-of such commerce, to lease or
make a sale or contract for sale of goods, wares, ` -
merchandise, machinery,., supplies1, or other commodities,
whether patented or tinpateritad, for' use * consunpt~on~
orresa1e~. .:~, or- fix.i price charged therefor, or
discount"from,:or rebate upon, such price, on the cOndi-.'.:-'
tion, agreement, cr understanding that the lessee or
purchaser thereof shall not use or deal in the goods,
wares, xserchandise,.roachinery, supplies, or other com-
modities `of a-competitor' or. competitors of the' lessor or -`
`sellewi'iere"the-effect' of such lease', sale, :or contract
for sale or such condition, agreement, or understanding
inaybetosubstantially lessen competition or tend to'
create a monopoly.in any line of commerce."
PAGENO="0368"
362
monopolistic effect of exch~sive dealing contracts. We
are urged to view the Coidwell Banker~~Guardian Title
arrangement as such a contract, and invited to accept
the holding of Tampa Electric Co. v. Nashville_ē~
(1961) 365 U.S. 320. as dispositive of the case at bench.
The ~ case was concerned with the anti-trust.
implications of a requirenents contract entered into between
a public utility and a coal producer. ~ is particularly
helpful here in that it discussed the type of evidence
necessary in anti-trust litigation to assist a court in
determining what constitutes "substantial" lessening of
competition. That evidence was described in Taxnp~ in the
following terms: :"First, the line of commerce, i.e., the- .
-- type of goods, ~wares;-or marchandise; etc.,:involved ustbe~:
detened,.~here:it.isin controversy, on the basis-of ...~-
the-facts peculiar-to the case.- Secon4, the area of
effective competition in the known line of commerce must -
be charted by careful selection of the market area in
which the seller operates,- arzd.to which the purchasercan
practically turn for supplies. In short~ the threatened
foreclosixre of competition must be in relation to the . -
market. . . . [~].Third, and la~st,.the competition foreclosed
by the contract must be. found to constitute a substantial
share of the market. . - `That is to say, the opportunities - - -
PAGENO="0369"
363
for other traders to enter into or remain in that market
must be significantly limited . . . *" (Tamp~, ~pra,
365 U.S. 320, 327~328; fn. omitted.)
The Tampa court, proceeds to state that "[t]o
determine substantiality in a given case, it is neces~
sary to weigh the p1robab~ effect of the contract on the
relevant area of effective competition, taking into
account the relative strengthof the parties~ the prppor~~..
tionate volume of co=erce involved in relation to the
total volumeof cotonerce in the relevant market area,
and the p~bable immediate and future effects which pre~
emption of that share of the market might have on effective-'--
competition. therein. It follows that a mere showing that~ the
contract itself involves a substantial number of dollars
isordinarilyof little consequence." (Id. at p. 329.) -.
(Emphasis added:) In ~ itwasheld that-evidence ~- --
establishimg that the contract when performed would only..:;~
constitute 1 percent of the. total volume of business in
the relevant market area precluded" the conclusion of. anti~~.
trust: violation;'bčóause-thč l.percant'was- consider~d'~~F~:
de minitrius as a matter of law in terms of cotnpeti~ive -
effect -
In.the case-at bench,-the ~
as a matter of law - that 1 percent of the market was also
85-396 0 - 81. - 24
PAGENO="0370"
~64
dem5nim~and. as a consequence, refused toweighthé-.
large body of.adxainistratively-addUCed evidence emphasiz~.ng::~
the econcm~c factors extant in the title insurance
industry in California which led to the administrative
conclusion that the Cold~elI Banker'Cuarth.en Title arrange~
ment;would .eventually: foreclose a substantja1. ptp~ of
the market to competition not similarly situated
**Weconcl'ude~ that neither the trial court's
hctual determination with ~spect to the purported
1 percent i~hich was beyond the scope of its review
poker -- nor the legal conclusion of de riinimus can be
supported on the record before us
* As~ to the factual determination, it. rests on
the~i court-..testimony of charles R. Hilton, president
of 1 Guardian Title , whi~h was substantially the same as
that presented at the administrative bearing At the
admthistrative~hearthg~ Hilton was asked:.~ "In Los Angeles~"~
County do you have any idea ~hat percentage of the real
estate market that Forest E Olson fa subsidiary3 and
Coidwell Bankerthid~itsother'SUbSidiarieShaVe?" Hilton-~
* * *
follows:"A lean answer that this way:
it would `take a lot of extrapolation It would be -
conjecture on my part I can go back to 1969 when
PAGENO="0371"
365
Forest~E..: Olson was'acquired by Coidwell Banker.: We had'~~
a Justice Department inquiry at that time because of the
merger of tw~ leading real estate firing and wehireda
fello~.don'.t~tėCall' his name to. do a survey to sea
what' ~ercantage of the reported real estate activities
there was.. *He~reported to the Justice Department that.~~:~
that was somewhere in the area of 1 percent [i] Q
Total? - [~] A Total 113 Q -In Los Angeles? [1]
A I thini~ that was for the whole state - I believe it.
was for the whole state because the inqu~ry ~,as related
to the state.. CoidwelI Banker has offices, in the North
and the South. . [1) Q .Right~:Ppn't you as some sort-:~:-
of business practice try to get `some' ball' park figure as
to the percentage of the business you are getting? [`i]
A "No,'because it isa very bifurcated business because - -
we don't do so much work in Los Angeles County. - The county,~-
figures would-be meaningless."-' ...
We note that trial took place in 1977; in the
Annual Report of 1974 Coidwell declared that,' since the
acquisition of Forest E. Olson Company, ~t was-the largest2-:
residential brokerage firm in Los Angeles County The
problem which is presented, however, is not necessarily':.~':
that `of the credibility of the witness." The problem is.
that ~
PAGENO="0372"
366
"the market" is not identified in terms of whether the
percentage reference is to the ~ of sales transactions
or to the dollar volume of those transactions. The testi-
mony appears to be limited to the number of sales, rather
than to all facets of real estate transactions such as the
dollar voltmie and the size and character of the real estate
involved in each transaction. Testimony based upon a
"survey" done by some unna.eed party in 1969 has little,
if any, relevance to the business position enjoyed by
Colduell tanker in 1977. Certain minimal requirements of
precision must prevail in the quality ofevidei~ce which
supports a factual finding. It must be evidence which
possesses "solid value." The Hilton testimony did not
meet this standard. The Insurance Commissioner was not
required to accept and give substantial weight to this
kind of flimsy, conjectural and insubstantial evidence.
In addition, the trial court's legal conclusion
that "17~" was de u,inimus as a matter of law was erroneous
in the context of the present case. A more appropriate
analogy in federal anti-trust law is found in Section 7
18/
of the Clayton Act (15 U.S.C. § 18) ,~ and the case law
I8T~
- That section provides, in pertinent part, that
"[njo corporation engaged in commerce shall acquire,
directly or indirectly, the whole or any part of the
(Continued)
PAGENO="0373"
367
which interprets it. In Bra Sho .v. United States
(1962) 370 U.S. 294, it is made perfectly clear that no
one definition, of "substantially," insofar as lessening
competition is concerned, was intended by the Congress
to control the assessment of in~rgers, "whether in
quantitative terms of sales or assets or market shares
or in designated qualitative terms, by.which a merger's
effectson competition were tobe measured." (~. at
p. 321.) One very important element perceived in ~p~qj~
wasthe special situation that prevailed in the particular
industry involved. The special situation would take into
account factors such as the economic motivation behind
the arrangement, its "nature and purpose," and "the trend
toward concentration in the industry.'~
To the extent which the Coidwell Banker-Guardian
Title arrangement can be ~egarded as "vertical," Brown
aptly points out that "[e3very extended vertical arrange-
ment by its very nature, for, at least a time, denies to
Tg~/ (c6nt~)
stock or other share capital and no' corporation subject
to the jurisdiction of the Federal Trade Commission shall
acquire the whole or any part of the assets of another
corporation engaged also in commerce, where in any line
of commerce in any section of the country, the effect of
such acquisition may be substantially to lessen coTnpeti-
tion, or tend to create a monopoly." (Emphasis added.)
PAGENO="0374"
368
competitors of the supplier the opportunity to compete
for part or all of the trade of the customer~party to
the vertical arrangement. However, the Clayton Act does
not render unlawful a11 such vertical arrangements, but
forbids only those whose effect `may be substantially
to lessen. competition, or to tend to create a monopoly,
." (Brown. supra, 370 U.S. 294, 324.)
Guardian Title and Coidwell Banker also relied
below on a single statement contained.in Chicago Title
Ins. Co. v. Great Western Financial Co~. (1968) 69 Cal.2d
305, 324, a pleading case. The statement sets forth that
"[n)ot only are vertical distribution agreements in this
instance contemplated by the Insurance Code, but `fi]t
seems clear to us that vertical integration, as such
without more, cannot be held violative of the Sherman.
Act." But the Chicago Title case was not concerned with
vertical business arrangements and pot~entia1 application
of lnsurance Code section 839.1. In addition, we agree
that a vertical business arrangement ~ ~ connotes
nothing unlawful, but the contrary may be.true when the
arrangement is assessed in relation to a particular set
of facts in a particular industry.
The Brown court emphasizes the multiplicity of
PAGENO="0375"
369
f~o;~; ~ in ~ dėter~nati~n~ ~ ~act~orsr~l-
lof the ~ ~incIuding experts ~-
at the ~dtrt1ui~t~:ive hearingsiieldiii the case at_b~ch-~_
~e hold t1~at theIü~u~ance Coa~ru~ssioner ~as~ not i~quired ~
tp_n~~ ~üt oi:l~ ~ ~nd ~ of?1~L~~
other factors in arrwlng at his conclusion _?~uch of
~the ~ was ~
trovarted and there is no basis ii~ the adrranistrativa
~ court ~hahe~7-
~id~e.~nistratiV~ desiv~ot~suppor~Q~Lby substant1~I$~'
~evenc&oD th hoIei~čcordr ~~-~--
- _-_ ---- --
- As our discusshrk indicates ~e have a3~so -~-`~-
concluded ~~that the trial court B error -in appIy~ing the~
ong~t~dar4ō~ v~as conpo~ded by ~iain~erc. ~
pre~ and ~isappU~at~*fl-of section-839' L Of the
Ths~ance ~ se~ti~ri ~ ard5~a'~ ~-
t~1edT~i~ker'~s ~barictzat1i~~
~
1~tI'v4~ intent ~orc~nEe upon the P~partn~ent and ~the ~
~ ~
~-~ate potenv~1yT~thm~er~us businesS
arran~e~rentS LW~tiCh thrcu~en healthy ce~xpeti n.~
;~;~ tr ~ lan~~;t~agų- O~ ~jh~ ~;;Z4J~ ~
PAGENO="0376"
370
coitewp1at~the exorcis&of di~sczet~O~ by-the ~
~ involvcd -~-Thac di cretilon ~as ~xupIoy~d ~
tO cons~e~ that~tb otattraflSaCtiQTJ~01T0d to j~
~ D!~surance cdeLsec~t~ofl 839 11kic1~ ~
o~aCU c~ųi'~~-pO~r prtened~r~-
by ~ ~ic1~.~ig appUcatio~S. _~1~ii1~ ds~reti~fl~T~
~ ii not wi~h1at1 17 ~ioId that it ~as properly~~r
exerci~d by ~the Dcpartmei~t and the~Co~is9~~Oner ~n~the~~
~
! app11~t~S~fOr ~ &~cen~
~ an w~derwr~ttefl titico~any~~
The dec~st~n ~ ~mpIy supported by substantial evidence --
~: ~ 1ight~ ~
~ -
CERTIFIED;:IOR~FLTBLICA-;~. :
JEYFERSOI ~(Bernard)~J..T~:
We. concur:-.
~
* KINGSLEY
PAGENO="0377"
371
AMERICAN LAND TITLE ASSOCIATION OWNER'S POLICY
FORM B - 1970 (Amended 10-1770)
TITLE INSURANCE COMPANY OF MINNESOTA
A Slock Company, of MInnapoIIs, MInnesota
SUBJECT TO THE EXCLUSIONS FROM COVERAGE, THE GENERAL EXCEPTIONS AND THE EXCEPTIONS
CONTAINED IN SCHEDULE B AND THE PROVISIONS OF THE CONDITIONS AND STIPULATIONS HEREOF,
TITLE INSURANCE COMPANY OF MINNESOTA, herein called the Company, insures, as of Dale of Policy shoven in
Schedute A, against toss or damage, not exceeding the amount of insurance stated in Schedute A, and costs, attorneys' fees
and expenses which the Company may hecome obligated to pay hereunder, sustained or incurred by the tnsured by reason of:
I. Titte to sheestate or interest described in Schedute A being vested otherwise than as Stated therein;
2. Any defect in or lien or encumbranceon such title;
3. Lack of a right of access toand from the land; or
4. Unmarketabitityof such title.
IN WITNESS WHEREOF, the said Title Insurance Company of Minnesota has caused its corporate name and seal to
be hereunto affned by its duly authorized officers ax of the dale shown in Schedule A, the policy to be valid when counterstgned
by an authorized officer or agent of the Company.
TITLE INSURANCE COMPANY OF MINNESOTA
Secretary
LAND TITLE COMPANY OF AMERICA, INC.
SUITE312 * 1SSPINNINGWHEELROAD
HINSDALE. ILLINOIS 60521
(312)323.9670
CHICAGO OFFICE
SUITE214O * ONENORTHLASALLESTREET
CHICAGO, ILLINOIS 606Q2
(312)236.7610
~v~vxxcxvnavycvaexvss xv.
PAGENO="0378"
372
EXCLUSIONS FROM COVERAGE
The following matters are expressly excluded from the coverage of this policy:
1. Any law, ordinance or governmental regulation (including but not limited to building and zoning ordinances)
restricting or regulating or prohibiting the occupancy, use or enjoyment of the land, or regulating the character,
dimensions or location of any improvement now or hereafter erected on the land, or prohibiting a separation in
ownership or a reduction in the dimensions or area of the land, or the effect of any violation of any such law,
ordinance or governmental regulation.
2. Rights of eminent domain or governmental rights of police power unless notice of the exercise of such rights
appears in the public records at Date of Policy.
3. Defects, liens, encumbrances, adverse claims, or other matters (a) created, suffered, assumed or agreed to by the
insured claimant; (b) not known to the Company and not shown by the public records but known to the insured
claimant either at Date of Policy or at thedate such claimant acquired an estate or interest insured by this policy
and not disclosed in writing by the insured claimant to the Company prior to the date such insured claimant
became an insured hereunder; (c) resulting in no loss or damage to the insured claimant; (d) attaching or created
subsequent to Date of Policy; or (e) resulting in loss or damage which would not have been sustained if the insured
claimant had paid value for the estate or interest insured by this policy.
GENERAL EXCEPTIONS REFERRED TO UNDER SCHEDULE B-Item No. 1
I. Rights or claims of parties in possession not shown by the public records.
2. Easements, or claims of easements, not shown by the public records.
3. Encroachments, overlaps, boundary line disputes, or other matters which would be disclosed by an accurate
survey or inspection of the premises.
4. Any lien, or right to a lien, for services, labor, or material, heretofore or hereafter furnished, imposed by
law and not shown by the public records.
5. Taxes, or special assessments which are not shown as existing liens by the public records.
SPECIAL PROVISIONS
All clauses, if any, which indicate any preference, limitation or discrimination based on race, color, religion or
national origin are omitted from all building and use restrictions, covenants and conditions, if any, shown herein.
CONDITIONS AND STIPULATIONS
1. Dafinitianof Terms
The following terms when used in this policy mean:
* (a) `insured": the insured nnmed in Sehedute A, and, subject
to any eights or defenses the Company may have had against the
named issueed. those who succeed to the interest of such insured by
operation of law as distinguished from purchase including, but not
limited to, heirs, distribulees, devisees, survivors, personal
representatives, next of kin, or corporate or fiduciary successors.
(b)"insured claimant": an insured claiming loss or damage
hereunder.
(c) "knowledge": actual knowledge. not constructive
knowledge or notice which may be imputed to an insured ty censors
of any public records.
(d) "land": the land described, specifically or by reference in
Schedule A, and improvements affixed thereto which by law
coestitule real properly; provided, however, the term "land" does
not include any property beyond the lines of the ares specifically
described or referred to in Schedule A, nor any right, title, interest,
estate or easement in abutting streets, roads, avenues, alleys, lanes,
ways or waterways, hut nothing herein shall modify or limit the
extent to which a eight of access to and from the land is insured by
this policy.
(e) "mortgage": mnrtgnge, dēd of trust, trust deed, Sr other
security instrument.
(f) "public records": tifose
constructive notice of matters relalir
dswhidt by tuw'insport
2. Continaation of Insurance after Canveyance of Title
Tb ecoverage of this policy shall continue in force as of Dale of
Policy in favor of an insured so lung as such insured retains an eslale
or interest in the land, or holds an indebtedness secured by a
purchase money mortgage given by a purchaser from such insured,
or so long as such insured shall have liability by reason of govenanla
of warranty made by such insured in any transfer or conveyance of
such estate or interest; provided, however, Ibis policy shall not
continue in force in favor of any purchaser from such insured of
either said estate or interest or the indebtedness secured by a
purchase money mortgage given to such insured.
3. Defense and Prosecution of Actions - Notice of Claim to be
given by an Insured Claimant
(a) The Company, at its own cost and without undue delay,
shall provide for the defense of an insured in all litigation consisting
of actions or proceedings commenced against such insured, or a
defense interposed against as insured in an action to enforce a
contract for a sale of the estate or interest in said lund, to the extent
that such litigation is founded upon an alleged defect, lien,
encumbrance, or other matter insured against by this policy.
(b) The insured shall notify the Company promptly in svriling
(i) in case any action or proceeding is begun or defense is interposed
as set forth in (a) above, (ii) in cane knowledge shall come to as
insured hereunder of any claim of title or interest which is adverse
to the title to the estate or interest, as insured, and which might
cause toss or damage for which the Company may be liable by
virtue of this policy, or (iii) if title to the estate or interest, as
insured, is rejected as unmnrketable. If such prompt notice shalt
not be given to the Company, then as to such insured all liaciility
(Continued on inside lrsck flap)
PAGENO="0379"
373
ALTA OWNER'S FORM
SCHEDULE A
Number Date of Policy Amount of insurance
4164 C 4 March 31, 1980 $50,000.00
1. Name of Insured:
Virgil C. Broussard, di~rced and not since renarried
2. The estate or interest in the land covered by this policy is a fee simple.
3. Title to the estate or interest covered by this policy Is, at the date of policy, vested in the Insured.
4. The land covered by this policy is described as follows:
Lot 5032 in Woodland Heights Unit 12, being a subdivision in Sections
25, 26 and 35, Township 41 North, Range 9, East of the Third Principal
Meridian in the Village of Streamwood, Cook County, Illinois, recorded
in the recorder's office March 6, 1970 as document 21099951, in
Cook County, Illinois.
Countersigned:
~
gtL~I'VORIZED SIGNATORY
This policy valid only If Schedule B Is ettached.
PAGENO="0380"
374
QWNE~'SILENDER'S FORM
SCHEDULE B
This policy does not insure against loss or damage by reason of the following:
1. General Real Estate Taxes for the years 1979 and 1980.
Tax Ntzber 06-26-414-013 Vo1t~ 61
The first instalmEnt of the 1979 taxes is paid.
2. Martgage dated March 7, 1980 and recorded March 12, 1980 as
dnc~m~nt 25389430 cEde by Virgil C. Broussard, divorced and
not since ranarried to Land of Lincoln Savings and Loan, a
Corporation of illinois to seci~e an indebtedness of $40,000.00.
3. Assigsrrent of rents dated March 7, 1980 and r~cordéd March 12,
1980 as docurrent 25389430 to Land of Lincoln Savings and Loan.
4. Easerr~nt for public utilities and drainage over, upon and
under the Westerly 5 feet of the land, Northerly 4 feet of
the land, and Southerly 4 feet of the land, as sh~n on the
plat of subdivision.
Countersigned:
~~I4'ORIZED SIGNATO~Y
Fo,m 212
PAGENO="0381"
375
Title Insurance Cc ~ny
of Minnesot
EXTENDED COVERAGE ENDORSEMENT
General Exceptions Number(s) 1 thii.i 5 of this policy are hereby deleted.
This endorsement is made a part of the commitment or policy and is subject to all the terms and
provisions thereof and of any prior endorsements thereto. Except to the extent expressly stated;
it neither modifies any of the terms and provisions of the commitment or policy and prior
endorsements or increase the face amount thereof.
By: ~
FORM 218
PAGENO="0382"
376
HOIVIBOWffBRS fflFh~TIO~ ~I~!fflIflTM
ENDORSEMENT
Title Insurance Company of Minnesota does hereby voluntarily agree that,
without any additional premium paid or to be paid by the Insured, the Policy
Amount stated in Schedule A of the policy to which this Endorsement is
attached is subject to automatic upward adjustments in the following manner
and extent:
THE AMOUNT OF INSURANCE IN FORCE AT ANY TIME
UNDER SAID POLICY SHALL BE CONSIDERED THE POLICY
AMOUNT SHOWN IN SCHEDULE A PLUS THE PERCEN-
TAGE BY WHICH THE UNITED STATES DEPARTMENT OF
COMMERCE COMPOSITE CONSTRUCTION COST INDEX
MAY HAVE INCREASED SINCE THE POLICY DATE, PRO-
VIDED HOWEVER, THEAMOUNTOFINSURANCE IN FORCE
FOR A PARTICULAR CLAIM SHALL BE DETERMINED AS OF
THE DATE THE CLAIM IS DISCOVERED, AND FURTHER
PROVIDED THE MAXIMUM AMOUNT OF INSURANCE IN
FORCE AT ANY TIME SHALL NOT EXCEED 180 PERCENT
OF THE FACE AMOUNT OF THE POLICY, LESS AMOUNTS
PAID FOR CLAIMS HEREUNDER.
The provisions of this Endorsement apply only to an owner's policy covering a single
family residence (including a townhouse or condominium unit).
This Endorsement is made a part of said Policy and is subject to the schedules, Exclu-
sions from Coverage and Conditions and Stipulations therein, except as modified by
the provisions hereof.
TITLE INSURANCE COMPANY OF MINNESOTA
By
Attest: ~ ~
Secretary
©Title Insurance Company of Minnesota 1975
T1M HIS 2355 * 2/1/75
PAGENO="0383"
377
(Continued from inside front flap)
of the Cosspssy shsllaease ord'tsso ,e is regard.tothe snattter or
toasters for nchich such prompt to; is'rrqcorsd; pron'ided, host.
roes, thst faiurs to notify shalt is no oasr prejudice the rights of
any such insured cndrr this polioy unless the Company shall be
prejodiord by sooh failure and then only to the sutsstt of such
(o) Thr Company shall hats hr right at its ons cost to
ioatitutr and nithoot undue drlty prossoute any action or
proorediog or to do any othrr act ,ohich in its opinion nay hr
oscrasary or desirablr to rstablisb tbr tilir In thr estatr or
asissurrd,andsbrCosnpany stay taks any appropriate action undrr
lbs lsrtna of this policy, tohrlhsr or rot it shall hr liablr lhrrruodrr,
and shall not thrrsby oonordr liability or mains any pronitios of this
polity.
(d)Whsnetsr hr Company shall hats brought any action or
iotsrpossd a defrost as required or prrthillsd by abs prooiniooa of
this policy, lhs Compaoy may posaur any such litigation to float
delsrminalion by a coors of oompelsnt jurisdiction and euprsssly
srssrosa abs right, in its sole disorstion, so appeal fmm any adosras
judgment or otdsr.
(r) to all olsen oohsts this policy premila or rsqalrsa lbs
Company to psossouss or pronids for abs drfsoas of any action or
psocerdiog, abs iosurrd hrrson dsr shall arours to the Company abs
right so so p50550015 or protids dsfsnns in suoh action or
psoorrdlog, and all appeals thrrsio, god permit abs Company to car,
alias option, abs name of souh inaossd for such purpose. Whsnever
reqasalrd by abs Company, such insured shall ghs lbs Company alt
reasonthlr aid 10 any aooh action or procssding, is sffsoling
arousing soidrocs, obtaining oilsssses, or prossoutiog or
dsfssding auoh action or proosrdiog, and abs Company shall
rsimbusnssuchinaossdforanysnpsnasaoincorssd.
4. Nation of Loss - Llssisatlos at Aaslas
In addition to lbs nolioss required undse paragraph 3(b) of shear
Conditions and Slipalatloss, a statement is osillog of any loss or
damage for ohich it is ctoimsd lbs Company Is liabls coder this
polity shall bs foroishsd to the Company n.ilhls 90 days aftsr auoh
loss or damags shall hat's hers dstermised and no right of action
* shall accrue to an insoesd clainqant until 30 days afIre such
slalsesent shall ham bssn funnlshsd. Failurs to famish suoh
stalemsnt of loss or damage shall lssmioals any liability of lbs
Cost pany ondsr this policy nato such loss or damage.
* 5. Optiaea as Pay as Osbeestlaa Stalls Claisna
Thr Compsoy shall hats lbs option to pay or otheestise sellIe
for or in lbs sams of so Insured claimant any claim lnaored against
or to terminate all liability and obligations of lbs Company
hsesus dsr by paying or lendsslng paymsst of lbs amount of
~sorants under this polloy logslhss ninth any costs, attorneys' fees
and ecpsnsss loocesed up to lbs liens of soch payment or tender of
payment, by the Insured olaimast and aulborised by the Company.
6. Desetesisatlns and Payesess at Loss
(a) Thr liability of the Cost pany andes this policy shall in no
(i) the actual baa of lbs Isnore d olainsass; or
* (ii) the sm000l of insurance slated In Schedule A; or
(b)Ths Company mill pay, Is addition to any loss insured
against by Ibis polloy, all costs imposed upon as lssccrsd In litigation
carried on by the Company foe such `osused, and all costs,
atsororys' feet and enpenses in htlgalios carried on by such insured
* soilh the nonittsn authositation of the Company.
(c) When liability has bees definitely fined In accordance
,oilh the conditions of this policy, the lose or damage shall be
* payable toithio.30 days thereafter.
7. Lie,itasios of Liability
No claim ahall asiss or be maintainable coder this policy (a) If
lbs Company, after htoittg eros lord notice of an alleged defeol, lien
or st,combtancr insured against hereunder, by litigation or
otheenoice, eemoors such defect, lien or encumbrance or sslablishss
the title, at insured, n.ithinarrtaonabls time after receipt of such
- noliue; (hi in the enrol of liticollon until there baa been a final
determination by a court of oumpsssos iueisdiction, and disposition
of all appeals shesefrom, adosess to the title, as insured, as psnoided
in paragraph 3 hereof; or (0) foe liability ooluotaeily asoumed by an
losured In settling any claim or suit oithnut prior n.rltten consent of
- IheCompany.
Note: This policy valid only if Schedutes A aod B are attuched.
REMITTANCE N? CZ02390
8. Radactias of Liability
All payments under Ibis polioy, ecoept payments toads foe uosts,
astososys' fees and eupenses, shall reduos the ant000t of the
iosuranue pro tanto. No payment shall be made nithoot producing
Ibis policy for endorsement of such payment unless the policy be
lost or destroyed, in nohich case psoof of soub loss us desleuclion
shall be fuenished to the satisfaction of lbs Company.
8. Liobltisy Narnoteulatina
It is rnptesoly understood that the atn000t of insurance ooder
this policy shall hr seduced by any aenouot the Comptny may pay
under any policy inausing either (a) a moelgage sho,cn or referred to
in Sohedolr 0 hereof tuhich is alienor the estate or interest coosred
by this polioy, or (b) a mortgage hereafter eoeoutsd by an insured
nchiuh Is a ohasge or lien on the estate on interest desusibed or
eefrreed loin Schedule A, and the amount so paid shall be deemed
payment under this policy. The Company shall ham the option to
apply to the payment of any such motlgagre any amount that
othernoite mould be payable hereunder to the insuerd otoors of the
estate or mIstral comeed by this policy ond the om000t so paid
shall be deemed a payment undes this poliuy to said insured otonre.
1g. Apposliarmest
If the land desceibed in Suhedule A consists of Inc or more
p.crcels n'hich are not used attaingle site, and a lots is established
affecting one or more of suid parcels but not all, the toss shall be
computed and settled on a peo stat basil as if the amount of
Insurance under this policy snot dioidsd pen tall cs so the talus on
Date of Polloy of each asposate paecet to the tohols, enclusits of any
Impeonements mode subsequent to Date of Policy, unless a liability
or nalue ban othet-nite been ogered opus oa to eauh sooh paeosl by
the Company and the insured at the time of the issuance of this
policy snd ahoton by ansnpeesa statement herein us by an
endorsement attached hereto.
11. Sobeagsnios Urns Payment or Satstsmast
Whensoer the Company shall ham settled a damn under this
policy, all right of subeogslioo shall nest in the Com pony unaffeoted
by any lot of the insored oltistant. The Company shall be
subrogated to and be entitled to all rights and temedirs tohich such
iosored claiotaot mould hate had against any person or peopetly in
respect to suoh ulaitm had this polioy nut been issued, and if
esqoested by theContpany,such insured cbaimoot shall Itunsferto
the Company all rights and remedies against any petsun or plopetty
necessary In otdrr to peefeut suuh eight of aubsogation and shall
permit the Company to use the name of aooh iosured olaimant is
any leonsaclion or litigation Inooboing such eights or remedies. If the
payment dues not come the tots of such insured oloimant, the
Comptoy shalt be subrogutrd to suoh eights and esmedies in the
proportion nohich said payment bears In the am000t of said loss. If
lost should result from any tot of soch insoted olnimant, such aol
aholl not told this polioy, but the Company. io that stent. ahalt be
seqoised to pay only that part of any losses intoned agaiost
heteunder nohich shall scored hr am000t, if any, lost to the
Cotnpany by reason of the imptientrol of the ticht of subrogation.
12. Liability LImited so this Poliny
This ioslronnsnt together nith all endorsements and other
policy and contract beluosen the insured and Ihe Company.
Any claim of loan or damage. ohether or not based ott
negligence, and nhioh arites out of the status of the silts to the
estate or internal cooeesd heesby or any oution assenting such ctoim,
shall be testricted to the plonitions and uosditions and stipolations
of this policy.
No amendment of or endorsement 10 this polity can be made
eccept hy noriling endoesed ttereon or atlaohed hereto honed by
either abe President, a Vice Pecaideol, the Secestaty, an Antistont
Sectelory, or talidating officer or aulhosieed tigoatusy of lbs
Company.
13. Naelcas, Where Sent
All colices required lobs giorn the Cues pany cod ony statement
is coiling requited lobe furnished the Company shall be addeessed
toils Hosts Office, Minneapolis, Mionesota 504db.
PAGENO="0384"
378
C
ALIACOMMITMENT FORM S SM ~MdE
SCHEDULE B
Schedule B of the poiicy or policies to be issued will contain the exceptions shown on inside front cover of
this Commitment and the following exceptions, unless same are disposed of to the satisfaction of the
Company:
1. GENERAL REAL ESTATE TAXES FOR THE YEARS 1980 AND 1981.
TAX NUMBER: 06-26-414-013, VOLUME 61.
NOTE: THE AMOUNT OF THE 1979 TAXES WAS $752.16.
NOTE: THE FIRST INSTALLMENT OF THE 1980 TAXES HAS BEEN PAID, ($376.08)
NOTE: THE SECOND INSTALIJRDtT OF THE 1980 TAXES AND THE 1981 TAXES ARE
NOT YET DUE AND PAYABLE.
2. MORTGAGE DATED MARCH 7, 1980 AND RECORDED MARCR 12, 1980 AS DOCUMENT NUMBER
25389430 MADE BY VIRGIL C. BROUSSAPD, DIVORCED AND NOT SINCE REMARRIED, TO V
LINCOLN FEDERAL SAVINGS AND LOAN ASSOCIATION OF BERWYN, TO SECURE AN INDEBT-
EDNESS OF $40,000.00.
3. ASSIGNMENT OF RENTS DATED MARCH 7, 1980 AND RECORDED MARCh 12, 1980 AS DOCUMENT
NUMBER 25389431 MADE. BE VIRGIL C. BROUSSARD, DIVORCED AND NOT SINCE REMARRIED,
TO LINCOLN FEDERAL SAVINGS AND LOAN ASSOCIATION OF BERWYN.
4. BUILDING SETBACK LINE OF 25 FEET (FROM THE EAST AND WEST LOT LINES) AND 5 FEET
(FROM THE NORTH AND SOUTH LOT LINES) AS CONTAINED IN THE DECLARATION RECORDED
AS DOCUMENT NUMBER 21154331.
5. EASEMENTS FOR PUBLIC UTILITIES AND DRAINAGE OVER, UPON AND UNDER THE WEST 5 FEET
AND THE NORTH AND SOUTh 4 FEET OF THE LAND, AS SHOWN ON THE PLAT OF SUBDIVISION.
6. COVENANTS AND RESTRICTIONS AS CONTAINED IN THE DECLARATION RECORDED AS DOCUMENT
NUMBER 21154331, RELATING TO USE, COST, TYPE, AREA AND WIDTH, NUISANCES, FENCES,
TEMPORARY STRUCTURES, ANIMALS, OIL AND MINING OPERATIONS, WATER SUPPLY AND SEWAGE
DISPOSAL SYSTEMS, SIGNS, LAND NEAR PARKS AND WATER COURSES, GARBAGE DISPOSAL,
SIGHT DISTANCE AT INTERSECTIONS AND ARCHITECTURAL CONTROL.
7. THE SPOUSE, IF ANY, OF THE PERSON NAMED IN SCHEDULE A MUST JOIN IN THEIR RESPECTIVE
DEED TO COME IN ORDER TO PROPERLY RELEASE ANY HOMESTEAD ESTATE.
THE OWNER' S TITLE POLICY WHEN ISSUED WILL CONTAIN OUR COMPREHENSIVE ENDORSEMENT NUMBER
1 (WITHOUT EXCEPTIONS).
Countersigned:
AUTHORIZED SIGNATORY
PAGENO="0385"
379
H
HISTORICAL INFORMATION ABOUT STEPHEN D. DALEY
Stephen D. Daley is president and chief executive officer of ITT,
which is a policy-issuing agent of Stewart Title Guaranty Company in
northern Illinois.
During his career in the title insurance business, Daley has worked for
Chicago Title and Trust Company and Chicago Title Insurance Company in Illinois
and New Jersey, and has been responsible for closing-escrow operations which
have handled in excess of 500,000 residential real estate transactions.
Daley is a licensed Illinois attorney, and a member of the American,
Illinois and Chicago Bar Associations (CBA). He is also a member of the CBA's
real property committee and its residential closing and conveyancing subcommittees.
During 1974-75, he was a member of the teaching facility of the Illinois Institute
for Continuing Legal Education, and "taught" RESPA to those members of the Illinois
Bar who participated in that Institute's RESPA programs.
Daley is a member of the National Association of Realtors, the Illinois
Association of Realtors, the Chicago Real Estate Board (CREB), the South Side-
Suburban Board of Realtors (SSSBR) the Natiqnal Association of Real Estate Brokers
and the Dearborn Real Estate Board (DREB). He is a member of CREB's FHA-VA
Committee and is legislative chairman of the SSSBR. In 1975 he was given DREB's
Special Recognition Award for his efforts in educating that realtor board on RESPA.
Daley is a member of the Illinois Mortgage Bankers Association (INBA), and is
a past trustee of that association as well as past chairman of IRMA's single-
family loan committee. He was named Residential Mortgage Banker of the Year, in
1979, by IMBA.
Daley is a member of the Illinois Land Title Association, and a member
of that Association's board of directors.
Daley's series of articles in 1974-75 in "Chicagoland's Real Estate
Advertiser" (a state-wide real estate news publication that claims the title of
"America's largest circulation real estate newsweekly") were submitted by that
newspaper to the National Association of Realtors for its award as "best series."
He lost.
Daley is generally acknowledged in northern Illinois as an expert on residential
real estate closings and on RESPA.
85-396 0 - 81 - 25
PAGENO="0386"
380
Chairman GONZALEZ. Thank you, Mr. Daley.
In the very beginning, I asked the indulgence of the panel for a
technical definition, if you could help us with on the subcommittee.
Would you please explain the difference between a mortgagee's
title insurance policy, an owner's title insurance policy, and a
unified policy providing joint protection for the mortgagee and
owner?
One of the recommendations of the HUD study was that unified
policy purchases should be stimulated as one way to reduce the
cost of unnecessary services. Would you comment on this recom-
mendation?
Mr. BOREN. Yes, Mr. Chairman. The mortgagee's policy, some-
times referred to as the lender's policy or the loan policy, is written
to insure the holder of the mortgage lien upon the property against
losses covered by the policy. It is a policy which normally gradually
reduces in coverage as the mortgage is paid down and expires when
the mortgage is paid off or otherwise is disposed of.
The owner's policy, as the term indicates, protects the owner of
the property. There are variations of it. One such variation is the
leaseholder's policy to protect the leaseholder, but that is more
commonly used in commercial transactions. And the owner's policy
does protect the owner. It continues to protect the owner as long as
he or his heirs have any interest in the property or any liability
upon warranties after sale of the property.
The so-called unified policy approaches a situation which effec-
tively, I think, is taken care of in the industry today by the
simultaneous issuance of policies both to the lender and the owner.
Normally, when an owner's policy and a mortgagee's policy are
written at the same time, the second policy is written for a more or
less nominal charge. That is not universally true, but nothing is
universally true about our industry today, except the problem of
controlled business.
The only possibility that I could see that would be a beneficial
result of the use of a single piece of paper instead of two is that
someone may think it is simpler to have only one rather than two.
But by and large, the lender is holding its policy, and the owner is
holding his policy, and it's not a copy of somebody else's.
There is an additional problem which is arising today because of
the requirements in a great many States that contracts of insur-
ance sold to consumers be written in so-called plain English. Our
owner's policy, the most recent version of the ALTA's policy, is
written in plain English, but frankly attorneys for lenders don't
want plain English policies. They want policies written in the
language that you and I have understood since we were in law
school.
So, while on the surface there may seem to be some benefit to a
unified policy, and our association certainly is willing to cooperate
on further exploration of this, there are good reasons for two
policies from the standpoint of satisfying the parties insured, and
by and large the question of the price has been taken care of
through the simultaneous issue rate available in most jurisdictions.
I would defer to any additional comments the panel might wish
to make.
PAGENO="0387"
381
Mr. PECK. While there is a certain identity of interests between
the mortgagee and the borrower, we think there is a strong desire
for separate insurance policies-but of course presented, as Jim
said, on a simultaneous issue rate.
Chairman GONZALEZ. You answered my question, but is there a
differential in rate or cost in the owner's or the lender's policy as
distinguished from the buyer's policy?
Mr. BOREN. That differs frOm jurisdiction to jurisdiction, sir.
Probably in most, there is a larger premium charged for the
owner's coverage than for the lender's policy. In many other juris-
dictions, primarily in the interests of simplicity in presenting the
cost to the public, the rates are the same, taking into account more
or less an averaging of costs. Many of these instances, the rates are
paid by the same person anyway under the simultaneous issue
rate.
Chairman GONZALEZ. Coming from Texas, I have always appreci-
ated the fact that Texas all along for years and years has had a
very good system. As a matter of fact, when we first went into this
RESPA legislation some 5 or 6 years ago, there were only two
States that had any kind of standards, and Texas was one. I guess
it goes back to the roots of Texas populism.
But the State legislature, through the years, provided a very
wonderful system. And ever since I came up to Washington, I have
appreciated the tremendous difference and the simplicity of the
law and the requirements and the procedures involving and entail-
ing closing costs. And it was my hope that we could get some
similar standards. But there was a resistance to an amendment I
offered whereby we would recognize and not preempt States alto-
gether, by recognizing that those States that had stronger or just
as strong provisons and systems would be exempt from the Federal
regulatory attempt as finally reflected in RESPA.
However, I am concerned about the descriptions we have re-
ceived today of what could be a dangerous and pernicious practice.
While a lender may have a concern that is almost as great as that
of a purchaser in assuring that the purchaser has received clear
and unencumbered title to his property, a realtor has less stake in
assuring a valid title than either a lender or purchaser.
The relationship between : realtors and controlled business title
insurers is disturbing. Not that I ascribe any bad motives necessar-
ily to realtors, but it is just in the nature of things that a lender
will have a continuing stake in the adequacy and the integrity of
the title. The homeowner or purchaser would also be much more
apt to have that continuing concern than a person such as a
realtor who is involved transitorily in the disposal of the property
or as an agent in the process of acquisition and disposal.
So this is very, very disturbing. And the reports that you have
presented from all corners of the country clearly indicates that
there is a problem. And I agree with the assessment that it has
national aspects because of the myriad of State diversities and
practices in this respect.
It is just one of the things that I think you have really brought
out very eloquently and disturbingly.
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382
Now the concern is being expressed with regard to the cost of
title insurance to the consumer. That leads to the basic question of
why the consumer must purchase title insurance.
Wouldn't it be more logical for the companies to insure their
work similar to the liability insurance that doctors use?
Incidentally, we will have the realtors, the real estate repre-
sentatives, tomorrow, and we will also have in the afternoon repre-
sentatives from the general public or the legal profession. But
regarding this question here, why should the cost of title insurance
all be on the consumer? Is that a legitimate question to ask?
Mr. BOREN. I think it is a very key question, Mr. Chairman. I
think someone made the statement this morning that in 40 percent
of the jurisdictions, most if not all of the title charges are paid by
the seller. Someone else picked up on the fact that eventually the
buyer pays it all anyway, and in no instance is that any truer than
if the lender supposedly pays for it. The cost will eventually fall on
the buyer in any case.
Am I responding to your question?
Chairman GONZALEZ. Somewhat. However, the basic question is
why should the burden of the purchase of insurance be assumed
100 percent by the consumer and not be handled by the title
insurer just as a physician must buy malpractice insurance.
Mr. BOREN. Well, I think we could approach that in part histori-
cally. Prior to the development of the title insurance industry,
there were conveyances in parts of the country, abstracts were
utilized in other parts of the country, and attorneys examined the
public records in still other places. If they made a mistake, they
were liable, and perhaps they carried some sort of liability cover-
age. But that was a very poor and very limited form of protection
for the buyer, because if the party doing the work was not negli-
gent, there was no liability. So the market determined that greater
coverage was needed-and this was the reason for the growth of
title insurance.
As to why the cost must fall upon the buyer, there are certain
parties to the transaction among whom costs have to be appor-
tioned-the seller and the buyer. The lender can't pay it without
passing it through, and the title company should get paid for its
work, although sometimes we wonder if we do. You know, that
really only leaves one other party. That party is the taxpayer, and
that is probably the most costly way for any of us to wind up
having our title protection provided.
Chairman GONZALEZ. I know that we have had some very specific
testimony from the various localities and districts which the wit-
nesses' business takes place in. But do we have any statistics
showing how many mortgage lenders or real estate brokers own
substantial interest in a title insurance company, what percentage
of these controlled businesses were created after the passage of
RESPA?
If you have any kind of statistics that you feel you either have or
you could procure for us, it would be very helpful to have for the
record.
Mr. BOREN. Well, I think the initial reaction to that is that there
are thousands of cases-this is the way title people like to scare
each other when they meet today, talking about the latest develop-
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383
ments of controlled business. But as was pointed out this morning,
it is very difficult to get these statistics. In many instances, certain-
ly since the passage of section 8 and with the HUD interpretive
rule, you are in effect asking someone to declare that they may be
in violation of a Federal criminal statute.
On the other hand, you may be asking someone who is 99 per-
cent certain as to who owns a particular agency, but who can't
prove it, perhaps to subject himself to a defamation action for
saying that there is a violation of the statute.
We tried very hard, and we have come up with some rough
figures which we know are insufficient and inaccurate. The figure
of 83 which you heard this mOrning was, I think, the first figure
that we came up with. I think we have a little over 100, but this
includes other lenders as well as S. & L.'s. We had hardly gotten
that figure together when somebody pointed out to us that in one
city there were three S. & L. agencies that nobody had been willing
to admit existed. So we know there are a lot more out there than
we have been able to come up with.
Certainly if we come up with anything, the subcommittee will be
among the first to know.
Chairman GONZALEZ. The number we heard, I believe, was from
the S. & L. standpoint.
Mr. BOREN. It was. It's interesting to note that in an industry
which, as Mr. Vartanian said, is one of the most heavily regulated
that we have, the regulators don't know how many controlled
business agencies there are. And it's unfortunate that Peat, Mar-
wick was not permitted to look into that. Very possibly, we would
have had some statistics now, but we have not been able to come
up with them.
Ms. GUGGENBERGER. Can I add something to this?
Chairman GONZALEZ. Certainly.
Ms. GUGGENBERGER. Mr. Chairman, it is very difficult to find out
as to real estate brokers, for instance, which brokers own stock in
title companies. When I filed an antitrust suit against 25 real
estate brokers, and the title entity and its holding companies, with
our subpena powers, with a complaint on file, with our power to
issue interrogatories, it took us 4 years and numerous appearances
before judges who kept ordering the title entity to give us a list of
the real estate broker stockholders-it took us 4 years to finally get
a list.
I wasn't even sure if I had sued the right people up until that
point. It is almost impossible to find out if a broker owns stock in a
company. As I say, with our subpena powers, we had to go back
and forth to the judge to get him to order it, again and again, and
they would just refuse to disclose.
Today we have three or four companies in our county, and we
don't know who owns the stock, how many brokers or developers
own the stock. We hear rumors that so-and-so developer owns it,
but we really don't know how they are constituted.
Chairman GONZALEZ. I think that underlines a point I was trying
to make earlier today abOut the rather inadequate analogy be-
tween controlled business, and Sears and Roebuck's insurance com-
pany. If you as a concerned professional don't even know, and
nobody can ascertain, exactly who is behind the controlled busi-
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384
ness, how in the world can we expect consumers to have any kind
of knowledge as to who actually is servicing their title?
But you also heard the witnesses earlier this morning-and you
may or may not have been here earlier today--
Mr. BOSSARD. I was.
Chairman GONZALEZ. Well, testimony was endorsing or approv-
ing the controlled business approach. The HUD official stated cate-
gorically that their study demonstrated that there was nothing to
indicate that controlled business resulted in higher costs, but
rather, the other way around. However, from my perspective in the
absence of documentation of the first and no documentation with
respect to the second contention, it seems like a preconceived
desire to make a recommendation, without any factual informa-
tion.
But from your standpoint-I am asking the panel here-is there
any evidence that you are aware of that controlled business ar-
rangements lead to higher title insurance rates?
Mr. BOSSARD. I would like to answer first.
Chairman GONZALEZ. Certainly.
Mr. BOSSARD. Specifically, they very definitely do. An example is
that our closing rate, our escrow rate when someone is going to
buy out another individual's equity for cash and take over the
existing mortgage, would be $25. Our controlled business competi-
tor, however, charges a minimum of $150 for any type of closing.
Of course, these are our minimum fees. For transactions that
require more work, such as trades or carry-back financing by the
seller, then of course the charge would be higher. But I am compar-
ing our basic fee, as opposed to, as I say, our competitor's minimum
fee of $150. That is one way in which the controlled business
problem affects consumers.
Chairman GONZALEZ. You heard our colleague, Mr. Coyne, de-
scribe his personal experience, and what I don't recall was whether
that was back home in Pennsylvania or here in the District. Of
course, here in the District-and it's no reflection upon my distin-
guished colleague, but--
Mr. DALEY. The best documented case is the Guardian Title case,
which is in California. There is a copy of the court decision in that
buff-colored book. And there, the finding was that the controlled
escrow company routinely charged 150 percent more for escrow
fees than their competition for the same services.
Chairman GONZALEZ. I saw that. You see, the thing is that
nationally we don't have anything on record, and hopefully we
have thought that perhaps the HUD people would have document-
ed something in furtherance of their presentation. But since we
were not given a copy of their testimony until today, there was no
real chance to evaluate this.
But, it seems to me that one of your recommendations for
strengthening RESPA included permitting filing a civil suit. Actu-
ally, I would like to point out a little history on that idea. I had a
little bit to do with it, coincidental with the Subcommittee on
Housing's considering the then-suggested course of action on real
estate settlement cost practices.
I was appointed chairman of an ad hoc subcommittee on the
Robinson-Patman Act, and so, if you will look at the wording here,
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385
where if you are successful in a suit you can recover three times
over-that three times figure, that is where we got it. We got it
from the Robinson-Patman Act, and I think that one of the things
that I have hoped for in this area is a Robinson-Patman Act or
version in this type of business, for real estate settlement costs or
practices or title insurance.
I think that is the best, because the one great virtue of the
Robinson-Patman Act, which is considered the Magna Carta of the
little businessman, is not that aspect that is subject to the regula-
tory authorities' enforcement, but that which is amenable to the
private citizen-except that our judiciary system being what it is, it
has almost become prohibitive to institute a suit under that sec-
tion. It is in fact an impediment to carrying out the intent of the
Congress in the 1930's when it enacted the Robinson-Patman Act.
But actually, it is the only act that I know of that gives the right
to the individual that we ordinarily provide to the regulatory agen-
cies. I think something of this kind, if we are fortunate enough to
have the wit and the ability tO think it out, would go a long way in
resolving what is obviously an insidious incursion of monopolistic
practices into an otherwise competitive area.
Mr. PECK. Mr. Chairman, I would like to reiterate in the history
of mankind I find it very hard to comprehend how giving a kick-
back can bring a rate down. I know, to go back to my comment
before, and to Congressman Carman's--
Chairman GONZALEZ. Well,' we are in 1981, and the famous Eng-
lishman Orwell said it would be 1984. You know, more is less.
[Laughter.]
A kickback doesn't cost anything.
Mr. PECK. Reiterating a point I made before, sir, is that when the
commission, the so-called legitimate kickback, that was part of our
rate structure in the State Of New York, when that commission
was finally outlawed by section 8 of RESPA and by section 440 of
the New York insurance law, it brought our rates down 15 percent
in the State of New York.
Chairman GONZALEZ. Well, of course, the favored process today,
which was reflected in the statement by Mr. Savas, is that any-
thing that you do that will `remove or lessen the presence of this
nasty thing called the Gove'rnment can be justified. That is what
we are confronting at this time.
Now, your statement states clearly that governmental action in
the proper area is the only recourse a citizen has who is defenseless
against forces that he singlehandedly cannot control.
This has always been the credo or the faith behind the American
approach, which is unique, which still maintains that effective
decisionmaking is with the people. I don't think we appreciate this.
But we are in a day and time when national leaders are saying:
Oh, no, everything in this respect has been wrong. You have had
oppressive governmental presence, and what we want to do is take
the government off the back of individuals-even if that means
allowing other people on their backs.
But with that concept, which is fine, I think that no freeborn
American wants uncontrollable Government or oppressive Govern-
ment. In fact, that is what America is all about.
PAGENO="0392"
386
The question is whether that is an accurate appraisal of what
has happened with the Federal governmental level. Obviously, in
New York, in an enactment by the State legislature, if that is
directly attributable to the reduction in an otherwise unconscion-
able cost, that is salutary government, and this is what we are
trying to ascertain.
But I share your bewilderment when, less than 5 years after the
effective date of a congressional act stating that kickbacks are
wrong, and unlawful, we have governmental officials saying that
we should repeal that prohibution, and that kickbacks apparently
are not that bad. So that this is what the issue is all about.
What you are reporting to date from the grassroots is what some
of us up here have been reporting-let me admit, without too much
success. And so this is why I am so grateful and was compliment-
ing you on your testimony.
Now, I have about three or four other questions, but because of
the time-and I have exceeded it-I would like to ask unanimous
consent that I may submit these for the record in time for you to
reply in the transcript.
Mr. Carman?
Mr. CARMAN. Mr. Chairman, I would be delighted, from my point
of view, to give you unanimous consent.
Mr. FAUNTROY. I will make it unanimous. [Laughter.]
Chairman GONZALEZ. I was going to recognize you, Mr. Carman,
because under the rules of courtesy, actually the one that I should
recognize is Mr. Fauntroy first, but I just had to get this off of my
chest, too, and I felt that it was in line with the statements and
some of the things that the witnesses have reported.
But, Mr. Carman, I will recognize you at this time.
Mr. CARMAN. The only thing that I would like to say and com-
ment on at this hour, which I notice is late, is, first of all, I'm sorry
I have not been here to hear all of your testimony. I personally
came here so I could examine the statements that have been sub-
mitted.
I would like to point out something that I had read in Mr. Peck's
statement that I find to be rather accurate, and that is that if we
are in a situation where mortgage lenders or real estate brokers
are in a position of control, there is no question that they would
steer the business and control the business that is going to title
companies or to anybody else that they are in a controlled business
with.
I think the more that we have an understanding of that practical
business aspect, the more we will be able to understand how this
business called real estate closings should be regulated or more
especially should not be regulated. I think that is an important
aspect for us to take into account, especially in light of the reason
why we are here, and that is to serve the public. And to use the
chairman's word, I believe that would be salutary, quite beneficial
for everyone.
I would like to thank you on my behalf for coming here. I have
long maintained that Washington is not the real world, that the
real world is where you people come from. We need this kind of
business-oriented experience to let us know what is happening in
the field of endeavor that each one of you represents, specifically in
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387
the title company areas, and you come and you offer a great deal of
insight.
I will close by just saying to you that, to me, when I left the
hearing this morning, someone asked me some comments about
just RESPA in general, and I said I thought it was remarkable that
we ended up having to have someone study a program that people
noticed after the event took place to know what the cost would be
as opposed to study that went on for some period of time so that we
could be informed as to what happened when we were informed
after the event.
I don't know that we should have to always have that kind of
study necessarily implemented, but I do know that we need to have
the insights that each and every one of you can give to us when
you come to a hearing of this kind.
What we are about here is very important. I believe the housing
industry-I believe the construction industry in large measure is
hurting as badly as it is because Government has not been salu-
tary-in fact, I think Government has been rather harmful to the
housing industry in this country in the last several years for many
reasons which I'm not interested in going into right at this moment
but will in more elaborate detail as time unfolds.
I think that can be turned around. I think we can be a valuable
service. And let me just say that I will feel free and I hope all of
you will be willing to do this, and I'm sure you will be, that if there
are any further inquiries from me or any members of the commit-
tee, I'm sure that you will be most cooperative in furnishing us
with any additional information that we desire.
Mr. BOREN. Certainly we will be happy to.
Mr Chairman might I comment upon one point which relates to
something you said and something Mr. Carman said also. 1 men-
tioned it in my prepared statement, but I may have passed over it
somewhat
We understand to some extent where we are today on the ques
tion of Government involvement and Government regulation. It is
the position of the American Land Title Association that the most
effective role that the Federal Government can play in solving the
controlled business problem is to come up with some very clear and
comprehensive guidelines, rules of the game which all can follow,
which will make possible the operation of a competitive system and
an open market.
That, coupled with some well-thought-out methods of enforce-
ment, primarily private action by consumers, as you point out, Mr.
Chairman, by competitors who know what is going on, and to have
the incentive to enforce the law, given the rights to seek injunctive
relief and seek damages possibly some rights in the State insur
ance departments to use these standards as they enforce and regu-
late our industry would be a very good melding of Federal, State,
and private effort to cure a problem which is bothering us all
There is no effort, although I am sure it is sometimes made on
the part of our industry, to discourage competition, to say "Let
anybody come in." I think, Mr. Carman, as you pointed out, we
would let anybody come in so long as they are not going to use the
particular powers which they have by virtue of their relationship
to the real estate transaction to foreclose competition.
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Competition in the title industry is not based upon the number
of nominal agents. It is based upon the number of transactions
which are open to the best provider of title insurance services.
Chairman GONZALEZ. Mr. Fauntroy, excuse my having delayed
you here, but I wish to recognize the presence of Mr. Fauntroy,
who is a representative of the District of Columbia and has a big
stake in all of this.
You don't have a title insurance company, though, do you?
[Laughter.]
Mr. FAUNTROY. Thank you, Mr. Chairman.
Mr. Chairman, the industry witnesses here-and let me thank
you for holding these hearings, and I express my regret that I was
not here this morning for the Government witnesses, and express
my gratitude for the quality of the testimony given this afternoon,
portions of which I have been able to glance at while I have been
intrigued by your series of questions and answers, and I look
forward to the continuation of the hearings tomorrow.
Now is there additional business-are there additional witnesses
to be heard at this time?
Chairman GONZALEZ. No.
Mr. FAUNTROY. Well, I will yield back to you the balance of the
time you gave me.
Chairman GONZALEZ. Thank you very much, Congressman.
[The following additional written questions were submitted to the
industry witnesses and appear along with their responses:]
QUESTIONS SUBMITFED BY CHAIRMAN GONZALEZ TO MR. PECK
Question 1. Has there been a decrease in the average cost of title insurance
between 1975 and 1979? Can that be attributed to enactment of section 8 of RESPA,
to increased competition, or to increases in real estate prices that could result in
lower average insurance rates per $1,000 value?
Answer. While ALTA has no independent information on changes in the cost of
title insurance between 1975 and 1979, the Department of Housing and Urban
Development's recently published report under Section 14 of RESPA states (on page
11-28) that: "there has been a decrease in the real cost of title insurance between
1975 and 1979 which is probably attributable in part to the enactment of Section 8.
although the connection cannot be clearly established."
This statement in the HUD report is based on the findings contained in Volume II
of the Peat, Marwick, Mitchell & Co. study (at pages XV.30 to XV.32) that between
1975 and 1979, average title assurance charges (which include associated legal and
conveyancing charges) increased only 11 percent, in comparison with a 45 percent
increase in housing costs during this period and a 24 percent increase in the
Consumer Price Index (CPI). Because the increase in title assurance costs was less
than half of the increase in the CPI, title assurance costs actually declined in real
terms.
While it is impossible to determine precisely what accounted for the fact that title
assurance charges increased at a much less rapid rate than housing prices or
inflation in general, two factors can clearly be identified:
The enactment of Section 8 of RESPA (for example, as pointed out by Mr. Peck in
his statement, following the enactment of RESPA and the elinination of the 15
percent procurement commission that had been paid in New York to lawyers and
brokers, title insurance rates in New York were reduced by 15 percent); and
The fact that the title insurance industry's rate structure (which provides for a
flat minimum charge for policies of an initial amount of liability and a rate per
thousand multiplied by the amount of liability in excess of the amount covered by
the minimum charge) is suchthat the rates for title insurance policies necessarily
rise more slowly than increases in the prices of real estate insured (although it
should be noted that the costs incurred by title insurance service providers general-
ly do increase at least as fast as the inflation rate).
Question 2. How are title insurance rates set and what efforts are being made
within the industry to increase competition and lower these rates?
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Answer. The ways in which title insurance rates are set vary greatly across the
country. In Texas, for example, the State Board of Insurance, after hearings and
appropriate review of relevant information and data, determines the title insurance
rates that must be charged on an "all-inclusive" basis, which includes the search
and examination of title, the issuance of the title insurance policy and the handling
of the settlement. In contrast, there is no regulation of rates in Illinois and each
company in that state is free to set its own rates and charges. The majority of states
that regulate title insurance rates provide for a "file and use" system, whereunder
title insurance companies must file the rate schedules that they will use, with such
rates subject to disapproval by the appropriate state regulatory authority.
Irrespective of the method by which the various states seek to regulate title
insurance rates, the basic goal sought in the establishment of title insurance rates is
to provide an aggregate level of revenue that will cover the reasonable costs of
providing title insurance services (such as the costs of the title search and examina-
tion, the establishment of reasonable reserves, federal and state taxes, and a fair
return on investment) and then to determine a rate schedule for the various
categories and levels of insurance that will provide the needed level of revenues and
that will be fair and equitable to all purchasers and sellers of real estate.
As discussed in response to the previous question, the rate schedules generally
utilized throughout the country provide for a flat minimum charge for an initial
amount of policy liability and a rate per thousand multiplied by the amount of
liability in excess of the amount covered by the minimum charge. As a result of this
type of rate schedule, the title insurance charges in transactions involving lower
priced real estate (such as in the purchase of residential real estate by low and
middle-class families) are proportionately lower than the charges in transactions
involving high-priced residential property or in commercial transactions. The mem-
bers of ALTA and state insurance~ regulators believe that such a rate structure
provides many benefits to low and moderate income families that purchase or sell
residential real estate because:
It ensures that the consumers will know at the outset what the charges for title
insurance services will be (this would not be the case if the charge were determined
on the basis of the work actually performed in the particular transaction-since the
total charges would not be known until after the work was completed);
It ensures that virtually all lower-priced real estate can be insured even though
the title work involved in a particular transaction may be quite extensive (if
charges in a particular transaction were based on work performed in that transac-
tion, a transaction involving a parįel of real estate with a particularly complex set
of title problems might necessitate a charge that was disproportionately high in
relation to the value of the real estate and might make many lower-priced parcels
unmarketable); and
It provides a measure of beneficial cross-subsidization between transactions in-
volving higher-priced real estate and transactions involving low-priced real estate
(i.e., the charges in transactions involving more expensive property will exceed the
average cost of handling all transactions whereas the charges in transactions involv-
ing lower and moderate cost housing will be below the average cost of handling all
transactions.) i
With regard to the question of what the industry is doing to increase competition
and to ensure that rates are kept to reasonable levels, the single most important
endeavor in this regard is the industry's efforts to ensure that competition will be
kept open to all companies that seek the consumer's patronage by obtaining reason-
able and effective limitations on the ability of real estate professionals (such as real
estate brokers and mortgage lenders) to foreclose such competition by steering their
clients' or customers' title insurance business to companies in which they have
financial interests. As was repeatedly pointed out by all the witnesses at the
Subcommittee's hearings, including the witnesses representing various governmen-
tal agencies, in the vast majority of real estate transactions involving consumers
these real estate professionals have the ability, through recommendations or refer-
rals, to influence the consumer's selection of a provider of title insurance services.
In light of this fact, the maximum degree of competition will exist only if all title
insurance service providers in the market have a fair and equal opportunity to
compete for those recommendations and referrals on the basis of the merits of their
prices and services. If all real estate brokers and mortgage lenders in a particular
market are permitted to have financial interests in title insurance service providers,
1 Several state statutes specifically recognize the benefits of this cross-subsidization. For
example, Section 739(d) of the Pennsylvania Insurance Code provides: "Rates may, in the
discretion of any title insurance company, be less than the cost of performing the work in the
case of smaller insurances, and the excess may be charged against the larger insurances without
rendering the rates unfairly discriminatory."
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390
and to receive dividends, referral fees, or other financial benefits from those compa-
nies, it is both naive and illogical to believe that such professionals will not favor
their controlled companies to the exclusion of all others. In such a market there will
be no real or effective consumer-oriented competition between title insurance serv-
ice providers.
In addition to seeking legislation that would eliminate the anti-competitive conse-
quences of controlled business, the industry, through various committees of ALTA
that are working with state insurance commissioners, has been seeking to strength-
en and to enhance the effectiveness of state regulation of title insurance. Of course,
as is true of almost all industries that have been ravaged by the impact of inflation
(as noted in response to the previous question, title insurance revenues increase
more slowly than the industry's costs of doing business), the members of the indus-
try are constantly seeking ways to minimize their costs of operation and to increase
productivity-efforts that ultimately are reflected in the rates charged to insureds.
Question 3. What opposition would you have to permitting S&Ls and realty
companies to own service corporations, such as title agencies, but prohibiting these
from referring their clients to such agencies?
Answer. The American Land Title Association does not oppose permitting savings
and loan associations or real estate brokerage companies (or anyone else for that
matter) to own title insurance agencies or otherwise to enter the title insurance
business-so long as such associations or brokerage companies are not able to
bestow an unfair competitive advantage on their controlled agencies by referring or
steering the business of their clients or customers to them. If a mortgage lender or
real estate broker believes that it can establish a title insurance agency that will
provide efficient services at reasonable prices-and thereby attract uncontrolled
business solely on the basis of the merits of the agency's products and services-
there is no reason to prohibit such entry. If a broker-owned or lender-owned title
insurance agency can compete on equal terms with existing independent title agen-
cies and title insurance companies, and attract business from uncontrolled sources,
it should certainly be permitted to do so.
The fact of the matter is that the great number of controlled title insurace
agencies that have been established in recent years do not attempt to obtain
business from independent sources or would have a difficult time surviving if they
were dependent on their ability to attract independent business. They have been
established as a means of enabling the real estate professionals who own them to
capitalize on thes professionals' power and ability to direct the business of their
clients or customers. If these controlled agencies are as efficient and competitive as
their owners frequently claim, they should have no trouble in competing successful-
ly with other title insurance agencies for the vast number of transactions that are
not controlled by the real estate professionals who have financial or ownership
interests in them.
Of course, any legislation that permits these real estate professionals to own title
insurance entities, but prohibits such professionals from referring the business of
their clients or customers to such entities, must ensure that such professionals
cannot do indirectly what they are prohibited from doing directly. For example, as
Rep. Carman pointed out in his questioning of Mr. Stanton, two mortgage lenders
should not be permitted to engage in a mutual swapping of referrals, so that Lender
X steers all of his borrowers' title insurance transactions to the title agency owned
by Lender Y in return for Lender Y's agreement to refer all his borrowers' title
insurance business to the agency owned by Lender X.
QUESTION SUBMIrFED BY CHAIRMAN GONZALEZ TO MR. DALEY
Question. You mentioned in your testimony that the average home buyer is not
inclined to shop around for title services. In fact, you cite your own experience
where home buyers were indifferent to shopping around for title service, even when
offered substantial price discounts.
If the consumer is so indifferent, why should the Congress or HUD be addressing
this issue at all? How can it be justified that we are benefiting the consumer if the
consumer doesn't care?
Answer. I believe that it is beyond dispute that the average homer buyer-on his
own-will not and cannot effectively shop for title services. The reason for this is
not because he is necessarily indifferent to the price he may be charged of the
service he may receive, but because, as all of the witnesses at the hearing agreed,
the average consumer purchases real estate only once or twice in a lifetime and,
given all of the other concerns that the consumer has at the time (i.e., obtaining
mortgage financing, arranging to move, selling his present home if he owns one,
etc.), he is simply not in a good position to acquire the knowledge necessary to
PAGENO="0397"
391
evaluate the prices and services offered by various providers of title services. On
this point, I am in total agreement with Mr. Savas, the representative of HUD.
On the other hand, the consumer does deal with real estate professionals (such as
his broker, attorney or mortgage lender) who have acquired initimate knowledge
about the various providers of title services in the market and who are in an
excellent position to provide independent, professional advice and guidance to the
consumer that will save the consumer the time and cost of becoming an expert
himself. In many if not most transactions, the consumer probably believes that his
broker or lender is providing such advice to him today. And, indeed, in many
transactions brokers and lenders do provide this type of disinterested professional
advice-advice that consumers clearly should be entitled to.
If this were universally the case-if all real estate professionals provided such
advice and assistance to the consumer-there would be no need for federal action in
this area. While consumers would not be shopping themselves for title services, they
would be getting the benefit of the shopping that is done by the sophisticated
professionals on whose advice they rely. On the other hand, when the advice of
these professionals is affected by their ability to profit personally from their advice,
and where mere disclosure of such a financial interest cannot cure the problem
(since, as all the witnesses agreed, even if the consumer found out that the real
estate professional had a financial interest in the title company he is recommend-
ing, the consumer is not in a position to effectively shop for title services on his
own), I believe a competitive and consumer issue of serious dimensions is created
that deserves the attention of HUD and the Congress.
The fact that there has not been an outcry to date from consumers about the
controlled business problem should not be surprising. The adverse effects of con-
trolled business-the impact on competition, the foreclosure of markets to independ-
ent competitors, the degradation in the quality of title insurance underwriting and
in other services that are provided-are not necessarily apparent to the consumer in
the immediate transaction. If I were a consumer whose title business had been
steered by my broker to a title company he owned, the chances are I would never
find out that other companies in the market could have provided those services
more efficiently or at less cost, or that certain title problems might have been
identified that were overlooked. More importantly, I would never know which title
company my broker would have selected if he had no financial interest in any title
company and instead selected the one he knew could provide the best service at the
best price.
While it may be difficult to identify that any particular consumer has been
harmed in any particular transaction, the development of a market structure in
which all brokers, lenders, and other real estate professionals are allowed to profit
personally from their recommendations of title companies to consumers must inevi-
tably result in a market in which no consumer will obtain disinterested assistance
and advice in selecting a title company. In such a market the interests of the real
estate professionals, not the interest of consumers, will be served. Perhaps when all
title companies are owned or controlled by brokers or lenders the problems of
controlled business will become so apparent to such a vast number of consumers
that their outcry will be heard in Washington. But by that time, it may be impossi-
ble for Congress to take action-action that can still be taken today-to ensure that
the interests of competition and consumers are protected.
QUESTIONS SUBMITTED BY MR. EVANS OF INDIANA TO MR. PECK
Question 1. Is there any evidence that controlled business arrangements lead to
higher title insurance rates?
Answer. While it is difficult to ascertain the extent to which controlled business
arrangements have already resulted in higher rates and charges to consumers, all
available evidence, as well as economic and antitrust theory, clearly point to the
conclusion that such arrangements will inevitably lead to higher rates and charges
in the future.
There are several reasons why it is difficult to quantify the extent to which
controlled business arrangements may already have resulted in higher charges for
title insurance services. First, while it was anticipated that the study of real estate
settlement costs conducted by Peat, Marwick, Mitchell & Co. (the contractor selected
by the Department of Housing and Urban Development to assist it in preparing the
report called for by Section 14 of RESPA) would develop information on the extent
and impact of controlled business in the title insurance industry, as was noted
during the hearings Peat, Marwick was prevented by the Office of Management and
Budget from exploring the contrOlled business problem in sufficient depth to obtain
any meaningful data.
PAGENO="0398"
392
Second, the controlled business problem primarily involves the steering of busi-
ness by real estate professionals to title insurance agencies in which they have
financial interests. Because the basic title insurance rates charged by an agency are
those that have been established by the title insurance underwriter for which it is
an agent-and, to avoid problems of discrimination, such rates cannot vary depend-
ing on the source from which the underwriter's policies are obtained-at any
moment in time and in any particular market the title insurance rates charged by a
controlled business agency will be no different from the rates charges by other
agents of that underwriter. (To the extent that the agent is permitted to make
separate charges for certain services, such as for the handling of the closing or the
preparation of documents, that are not embraced within the rates filed by the
underwriter, as discussed below there is evidence that the charges imposed by
controlled business agencies are higher than those charged by independent agencies
who do not have guaranteed sources of business.)
Finally, as is frequently the case with regard to other types of arrangements (such
as tie-ins) that foreclose markets to independent competitors, there may be no
evidence of higher charges in the short-run. As in the case of tie-ins, the anti-
competitive and anit-consumer evil of controlled business is, as one federal district
court judge has phrased it, that such arrangements harm "competing sellers of the
tied product by foreclosing them from access to the market for reasons having
nothing to do with the merits of the tying seller's product, and [harm] buyers by
restricting their range of choice in the tied product market." [Anderson Foreign
Motors v. New England Toyota Distributors, 475 F. Supp. 973, 980 (D.Mass. 1979).]
Although a particular consumer who has been subjected to a tie-in or who has been
steered to a controlled title insurance agency may not necessarily be charged more
for the product or service than if he purchased that product or service from other
suppliers, in the long run, as the forces of competition are eliminated by such
market-foreclosure arrangements, there will inevitably be an adverse impact on
consumers.
Notwithstanding the foregoing, there is evidence as to the inevitable impact of
controlled business arrangements on prices to the consumer. First, as the Antitrust
Division of the Department of Justice found in its extensive analysis of the problems
of controlled business and reverse competition in the title insurance industry con-
tained in pages 268-274 of its January 1977 report entitled "The Pricing and
Marketing of Insurance," controlled business arrangements have been "steadily
increasing in number since the passage of RESPA [and] possess several anticompeti-
tive features." The Antitrust Division concluded that this "controlled placing of
settlement services has a definite tendency to increase the price paid by the con-
sumer."
Second, as Mrs. Guggenberger and Mr. Bossard pointed out in their statements,
with respect to services that are not included in the rates filed by title insurance
underwriters, controlled business entities charge more than do independent title
agencies in the same market. This point is confirmed by the Findings of Fact made
by the California Department of Insurance in connection with the application of
Coldwell Banker & Co. to establish a controlled title insurance agency. The Depart-
ment found that with respect to the charges for escrow services made by Landmark
Escrow Services, a wholly-owned subsidiary of Coldwell Banker that obtained all of
its business from Coldwell Banker brokers, "the consumer's cost for regular full
escrow services from Landmark is significantly greater (in excess of 150 percent
more) than the consumer's cost for the same or substantially similar escrow services
from title insurers and independent title companies providing escrow services in the
same locality." (Finding of Fact No. 21.)
I would note that other state insurance departments have reached similar conclu-
sions about the effects of controlled business. For example, in a 1977 Bulletin, the
Michigan Commissioner of Insurance concluded as follows:
"The findings and conclusions by various executive, legislative and judicial
branches of federal and state governments and the results of the Insurance Bu-
reau's investigation have caused me to recognize that permitting real estate brokers
to own or control a licensed title insurance agency for the purpose of channeling
title insurance business is detrimental both to the consumer of title insurance and
to actual and potential competition in the title insurance market. . . . The anti-
competitive nature of such an arrangement is obvious and widely acknowledged. Its
effect on the title insurance industry and consumers can only be harmful."
Third, a recent rate filing made by an independent title insurance company in
Pennsylvania points up the adverse price impact of controlled business. In a Sep-
tember 26, 1980, rate filing made with the Insurance Department of the Common-
wealth of Pennsylvania, T.A. Title Insurance Company indicated that, contrary to
the requests for rate increases that were being made by other title insurance
PAGENO="0399"
393
companies in Pennsylvania, it intended to maintain the rates it had filed in August
1977. The company stated that the higher rates sought by its competitors "are more
necessitated by the influence of `Controlled Business' agencies than by the impact of
inflation. Since our company has no `Controlled Business' agencies to subsidize, we
are able to maintain the August 1977 rates for the consumer at this time.
In conclusion, ALTA believes that focusing on whether any particular controlled
title insurance agency is currently charging more-or even less-than other title
insurance agencies may cause members of the Subcommittee to fail to focus on the
primary, long-term issues that should be of concern to the Congress: whether the
interests of consumers will be served if markets are allowed to develop in which
real estate brokers or mortgage lenders refer the consumer's business to captive
title insurance agencies and where independent title companies are effectively
foreclosed from competing for the recommendations of those real estate profession-
als, or whether, in contrast, the interests of consumers will be served if markets are
allowed to develop in which the real estate professional has no conflicting financial
self-interest in making recommendations to the consumer regarding the title insur-
ance service provider that offers the best combination of price and service.
Question 2. Won't a fairly extensive federal regulatory regime have to be estab-
lished to enforce federal controlled business legislation?
Answer. We do not believe an extensive federal regulatory regime would have to
be established if Congress enacted a clear prohibition on real estate professionals
referring business to title insurance entitles in which they have financial or owner-
ship interests.
For example, enforcement of the controlled business prohibitions would not neces-
sarily have to be undertaken by a federal agency or by federal enforcement authori-
ties. By providing for rights of action (in the form of injunctive relief and damages)
to competitors of entities that are engaged in violations of the controlled business
legislation, those competitors who know what is going on in the real world and who
have a financial incentive to see the violations stopped will be able to provide much
more effective enforcement than would be the case if enforcement actions were
brought by federal agencies. Thus, effective enforcment can be obtained, in our
view, without any significant involvement by the federal government. If the "rules
of the game" are clear, the marketplace, and competitors in that marketplace, will
effectively enforce them.
An additional approach that might be utilized is to encourage state insurance
regulators to enforce the federal controlled business prohibitions through various
administrative and regulatory mechanisms available under state law..
Question 3. What would you propose that Congress do about the controlled busi-
ness problem?
Answer. ALTA believes that Congress should enact legislation, perhaps as a
clarifying amendment to Section 8 of RESPA, that would provide that no real estate
professional can act as a title insurance agent with respect to business he controls
(i.e., transactions involving his clients or customers) or refer such business to title
insurance service providers (i.e., title insurance agencies or undrwriters) in which he
has a financial or ownership interest. (Obviously, such prohibitions should not apply
to a de minimis financial interest, such as the ownership of a few shares of stock in
a publicly-owned company.) If such legislation were adopted, real estate profession-
als, such as mortgage lenders arid real estate brokers, would be in a position to
make disinterested referrals of their clients' or customers' title insurance business
based on their expert knowledge as to which title insurance service provider can
best provide the service needed by the consumer at the most reasonable charge.
Such legislation should be coupled with reasonable enforcement mechanisms,
such as those discussed in response to the previous question, that need not involve
the federal government in any significant way.
Chairman GONZALEZ. And as I said earlier, tomorrow it is our
hope to have witnesses from the real estate professional area and
the public witnesses at 10 a.m. in this same room, 2222 of the
Rayburn House Office Building.
We will have Mr. Donald H. Treadwell, who is first vice presi-
dent of the National Association of Realtors; Mr. Barry D. Tate,
staff vice president of the, U.S. League of Savings Associations; Mr.
Charles R. Hilton, the senior vice president, and Mr. Stanley M.
Gordon, vice president and general counsel of Coldwell Banker &
Co., of Newport Beach, Calif.; and Mr. Burton S. Levinson of Levin-
son & Lieberman, Inc., Beverly Hills, Calif.
PAGENO="0400"
394
And at 2 o'clock, we have public witnesses listed as Mr. Tom
Collier, the former HUD Deputy Assistant Secretary; Dr. Try Plot-
kin, vice president of Arthur D. Little, Inc., of Cambridge, Mass.;
Dr. Deborah Ford, assistant professor of finance, University of
Baltimore; and Mr. Robert R. Elliott, an attorney.
But again, we thank each and everyone of you for having trav-
eled here, in some cases the width of the continent, to give us the
benefit of your testimony, which is, as I said and repeat, very
valuable. Thank you, indeed, and have a safe and happy return to
your homes.
[Whereupon, at 4:15 p.m., the hearing was adjourned, to recon-
vene at 10 a.m. on Wednesday, September 16, 1981.]
PAGENO="0401"
REAL ESTATE SETTLEMENT PROCEDURES ACT-
CONTROLLED BUSINESS
WEDNESDAY, SEPTEMBER 16, 1981
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS,
SUBCOMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT,
Washington, D.C.
The subcommittee met at 10:10 a.m. in room 2222 of the Rayburn
House Office Building; Hon. Henry B. Gonzalez (chairman of the
subcommittee) presiding.
Present: Representatives Gonzalez, Vento, Carman, McCollum,
and Lowery.
Chairman GONZALEZ. The subcommittee will come to order.
We will consider this morning a continuation of yesterday's hear-
ing, and thus a recess instead of an adjournment.
We will continue tomorrow on the subject matter of migrant
labor housing. And this morning we have witnesses representing
the real estate professional sector. We have Mr. Donald H. Tread-
well, the 1982 first vice president of the National Association of
Realtors; Mr. Barry D. Tate, staff vice president of the U.S. League
of Savings Associations; Mr. Charles R. Hilton, senior vice presi-
dent, and Mr. Stanley M. Gordon, vice president-general counsel, of
Coldwell, Banker & Co., from California; and Mr. Burton S. Levin-
son of Levinson & Lieberman, Inc., of Beverly Hills, Calif.
In the afternoon we will have public witnesses. Mr. Tom Collier,
former HUD Deputy Assistant Secretary, now presently with a law
firm here; Dr. Try Plotkin, vice president of Arthur D. Little, Inc.,
Cambridge, Mass.; Dr. Deborah Ford, assistant professor of finance
of the University of Baltimore; and Robert R. Elliott, an attorney.
Unless there is some reason or objection we will start with Mr.
Treadwell, who is the next first vice president of the National
Association of Realtors.
STATEMENT OF DONALD H. TREADWELL, NATIONAL ASSOCI-
ATION OF REALTORS
Mr. TREADWELL. Thank you, Mr. Chairman. We will submit a
copy-in fact, I already have submitted a copy for the record. The
statement is relatively brief and I would like to read it at this
point.
My name is Donald Treadwell. I am a realtor from Southgate,
Mich., and will be the first vice president of the National Associ-
ation of Realtors in 1982. I appear today to present the associ-
ation's views concerning the controlled business issue which is the
subject of these hearings. Like most realtors, I have daily contact
with the requirements of the Real Estate Settlement Procedures
(395)
85-396 0 - 81 - 26
PAGENO="0402"
396
Act, RESPA, its usefulness and its shortcomings. We urge the
subcommittee to hold additional hearings regarding the broader
issue of RESPA's future, at which time the association can provide
more detail to support its view that the cost and burden of this law
far exceeds its usefulness to consumers. I will return to this subject
later in my statement.
As to the controlled business issue, I believe the association's
views may assist the subcommittee in better understanding the
business relationships that have given rise to the occasionally in-
tense discussions that have taken place recently.
It is inaccurate, however, to assume that these business relation-
ships are necessarily new to the residential real estate transaction
or that they have arisen in direct response to the passage of the
Real Estate Settlement Procedures Act in 1974 and are designed
only to circumvent that statute's prohibition against kickbacks and
unearned fees. Within my own knowledge, such settlement service
referrals have existed for over 20 years. They were not entirely
proscribed by the passage of the 1974 legislation. We believe it is
simplistic to assume that all types of settlement service referrals
are inherently bad and, therefore, should be prohibited by RESPA.
If that were the case, we believe the statute would have more
specifically addressed the matter in its language and regulatory
application would be more precise.
The principal concern of the National Association of Realtors in
this regard is to increase the ease and economy of transfer of
interests in real property. Obviously, an important element is the
assurance that the title to the property is free from defects. The
issue under discussion today is whether the actions of corporations
controlled by some of the providers of other services, in the issu-
ance of documents assuring quality of title, have resulted in either
diminished service or increased costs to the consumer.
From a recent survey of the membership of the National Associ-
ation of Realtors, it appears that less than 1 percent of our mem-
bers are involved in controlled corporations as they have been
defined today. It is recognized that a potential for abuse may exist..
As a practical matter, the realtor is particularly sensitive to the
RESPA section 8 prohibition against kickbacks and unearned fees.
The position of the national association is clearly set forth in
Standard of Practice No. 16-1 under article 16 of the Code of Ethics
in which it is stated:
The realtor should not recommend or suggest to a principal or a customer the use
of services of another organization or business entity in which he has a direct
interest without disclosing such interest at the time of the recommendation or
suggestion.
We are not aware of complaints from either the buyers or sellers
of property of unreasonable charges for title insurance. It is recog-
nized that the consumer is more concerned with the speed and
efficiency of title evidence service than the cost within the general
limits of the charges which in many cases are set by the State
regulatory agencies.
We consider it the obligation of the brokers to make recommen-
dations which are in the best interests of their clients. In the event
a broker has any interest, direct or indirect, in any entity furnish-
ing a service to which he has directed the client, he has a duty to
PAGENO="0403"
397
disclose such interest. The client in this event, is on notice and if
the charges do not appear reasonable, would have adequate oppor-
tunity to obtain reassurance of the reasonableness of the charge.
The existence of owned or controlled settlement service providers
has recently been a source of concern, not only to the title insur-
ance industry, but also the Department of Housing and Urban
Development, the Department of Justice, and State insurance regu-
lators. In Michigan, the commissioner of insurance is currently
conducting extensive hearings on this matter. I understand that
investigations in other States are also taking place. However, there
has been little agreement as to just how menacing the control of
settlement service providers really is.
The National Association of Realtors sees a distinct conflict in
the attitude exhibited by controlled business critics that accept a
settlement service provider within a corporate framework, yet
oppose a provider that is outside the corporate structure but con-
trolled by means of majority stock ownership or similar ownership
mechanisms. Variations in the degree of control are many. In the
opinion of the association, it is unlikely that one can be "a little bit
pregnant" regarding the degree of control-a settlement service
provider is either controlled or it is not. It can either be referred
through a wide variety of relationships or it cannot. It is this
uncertainty that caused the generally negative reaction to the
"interpretative rule" which the Department of Housing and Urban
Development issued on July 24, 1980, regarding section 8 of
RESPA. To advise an industry as diverse as the real estate busi-
ness that "the existence of a `controlled business' relationship may
be a violation of section 8," and fail to provide any criteria by
which to determine when and under what circumstances such vio-
lation might occur was, in the opinion of the National Association
of Realtors, the worst possible approach that could have been taken
to determine when a business might be deemed a "controlled busi-
ness." In our view, the interpretative rule is inconsistent with
existing RESPA regulations.
In any discussion of this issue, it is important to keep in mind
that many of the criticized broker-title insurance relationships
exist because the title insurors themselves initiated them. Typical-
ly, such arrangements have been developed for the purposes of
efficiency rather than profit. A key element in the residential real
estate transaction is timing. The length of time it takes to search a
title and issue a policy assuring its quality is often critical to the
closing of a residential real estate transaction. Members of our
association uniformly agree that, regarding the controlled business
issue, the title insurance business will go to the individual or
company that provides the best and fastest service.
Both RESPA and the Truth-in-Lending Act were designed to
heighten consumer awareness of the cost components involved in
home purchases. The duplication of intent, and to a degree content,
presents an example of excessive regulation with little or no bene-
fit to the consumer. For over 6 years, RESPA has been in effect-
during that time there have been no meaningful prosecutions for
violations of its provisions. The reason seems clear enough-during
that time there have been no significant consumer or regulatory
complaints alleging violations of RESPA.
PAGENO="0404"
398
The considerable number of providers of various settlement serv-
ices have given consumers alternative sources for these services.
We believe this competition is a better guarantee of reasonable cost
and good service than any artificial regulation. It has been said
that consumers of these services have little background to make
informed decisions. In most instances, the consumer is aided by
knowledgeable brokers and lending officers. As long as the stand-
ard endorsed by the National Association of Realtors, that is, full
disclosure of any possible conflict of interest is followed, experience
has shown that buyers and sellers have been well served.
It is our opinion that in this matter, RESPA has not proved of
significant enough benefit to warrant modification and should be
repealed. The circumstances giving rise to its creation were of
limited scope. The considerable cost of its past implementation
could have been spent to greater public advantage elsewhere. Fur-
ther wasted time and effort of Government and industry to modify
the RESPA statute should be halted and that effort redirected.
We will be happy to respond to any questions which you might
have.
[Mr. Treadwell's prepared statement, on behalf of the National
Association of Realtors, follows:]
PAGENO="0405"
399
~N 7N ~N
_.______.-1____
Statement of the
NATiONAL ASSOCIATION OF REALTORS®
THE WORLD'S LARGEST TRADE ASSOCIATION
-~--~-~ -~-----
~I1
L
TO THE~ Subcommittee on Housing and Community Development
of the
House Committee Banking, Finance and Urban Affairs
ON: "Controlled Business"
BY: Donald H. Treadwéll
DATE: September 16, 1981
PAGENO="0406"
400
CONTROLLED BUSINESS
My name is Donald Treadwell. I am a Realtor® from Southgate,
Michigan, and will be the first Vice President of the NATIONAL
ASSOCIATION OF REALTORS® in 1982. I appear today to present the
Association's views concerning the "controlled business" issue which
i'~ the subject of these hearings. Like most Realtors®, I have daily
contact with the reguirements of the Real Estate Settlement Proce-
~ures Act (RESPA), its usefulness and its shortcomings. We urge the
Subcommittee to hold additional hearings regarding the broader issue
of RESPA's future, at which time the Association can provide more
detail to support its view that the cost and burden of this law far
exceeds its usefulness to the consumers. I will return to this
subject later in my statement.
As to the "controlled business" issue, I believe the Association's
views may assist the Committee in better understanding the business
relationships that have given rise to the occasionally intense
discussions that have taken place since the publication of the Ameri-
can Land Title Association's (ALTA) white paper entitled: "The Con-
trolled Business Problem in the Title Insurance Industry," published
in November of 1979.
Attention has been focused on this issue since the publication
of the white paper. It is inaccurate, however, to assume that the
business relationships that the report criticizes are necessarily
new to the residential real estate transaction or that they have
arisen in direct response to the passage of the Real Estate ~Settle-
ment Procedures Act in 1974 and are designed only to circumvent that
statute's prohibition against kickbacks and unearned fees. Within
my own knowledge such settlement service referrals have existed for
over 20 years. They were not entirely proscribed by the passage of
the 1974 legislation. We believe it is simplistic to assume that all
types of settlement service referrals are inherently bad and, there-
PAGENO="0407"
401
-2-
fore, should be prohibited by RESPA. If that were the case, we
believe the statute would have more specifically addressed the
matter in its language, and regulatory application would be more
precise.
The principal concern of the NATIONAL ASSOCIATION OF REALTORS®
in this regard is to increase the ease and economy of transfer of
interests in real property. Obviously, an important element is the
assurance that the title to the property is free from defects. The
issue under discussion today is whether the actions of corporations
controlled by some of the providers of other services, in the issuance
of documents assuring quality of title, have resulted in either
diminished service or increased costs to the consumer.
From a recent survey of the membership of the NATIONAL ASSOCIATION
OF REALTORS® it appears that less than one percent of our members are
involved in controlled corporations as they have been defined today.
It is recognized that a potential for abuse may exist. As a practical
matter, the Realtor® is particularly sensitive to the RESPA Section 8
prohibition against kickbacks and unearned fees. The position of
the National Association is clearly set forth in Standard of Practice
#16-1 under Article 16 of the Code of Ethics in which it is stated:
"The REALTOR" should not recommend or suggest to a principal
or a customer the use of services of another organization
or business entity in which he has a direct interest without
disclosing such interest at ~he time of the recommendation or
suggestion."
We are not aware of complaints from either the buyers or sellers
of property of unreasonable charges for title insurance. It is
recognized that the consumer is more concerned with the speed and
efficiency of title evidence service than the cost within the general
limits of the charges which in many cases are set by the state regula-
tory agencies.
PAGENO="0408"
402
We consider it the obligation of the brokers to make recommenda-
tions which are in the best interests of their clients. In the event
a broker has any interest, direct or indirect, in any entity furnishing
a service to which he has directed the client, he has a duty to
disclose such interest. The client in this event, is on notice and
if the charges do not appear reasonable, would have adequate oppor-
tunity to obtain reassurance of the reasonableness of the charge.
The existence of owned or controlled settlement service providers
has recently been a source of concern, not only to the title insurance
industry, but also the Department of Housing and Urban Development,
the Department of Justice, and state insurance regulators. In Michi-
gan, the Commissioner of Insurance is currently conducting extensive
hearings on this matter. I understand that investigations in other
states are also taking place. The Department of Housing and Urban
Development's concern was initially evidenced by an internal memo-
randum dated August 8, 1979. However, there has been little agreement
as to just how menacing the control of settlement service providers
really is. We hope that these Congressional hearings will provide
a clearer picture of these corporate relationships.
The NATIONAL ASSOCIATION OF REALTORS® sees a distinct conflict
in the attitude exhibited by "controlled business' critics that accept
a settlement service provider within a corporate framework, yet oppose
a provider that is outside the corporate structure but controlled by
means of majority stock ownership or similar ownership mechanisms.
Variations in the degree of control are many. In the opinion of the
Association, it is unlikely that one can be "a little bit pregnant"
regarding the degree of contro] -- a settlement service provider
PAGENO="0409"
403
-4-
is either controlled or it is not. Business can either be referred
through a wide variety of relationships or it cannot. It is this
uncertainty that caused the generally negative reaction to the
"interpretative rule" which the Department of Housing and Urban
Development issued on July 24, 1980, regarding Section 8 of RESPA.
To advise an industry as diverse as the real estate business that
"the existence of the `controlled business' relationship ~ be a
violation of Section 8 ...," and fail to provide any criteria by
which to determine when and under what circumstances such violation
might occur was, in the opinion of the NATIONAL ASSOCIATION OF
REALTORS®, the worst possible approach that could have been taken to
determine when a business might be deemed a "controlled business."
In our view, the interpretative rule is inconsistent with existing
RESPA regulations.
In any discussion of this issue, it is important to keep in
mind that many of the criticized broker-title insurance relationships
exist because the title insurors themselves initiated them. Typically,
such arrangements have been developed for the purposes of efficiency
rather than profit. A key element in the residential real estate
transaction is timing. The length of time it takes to search a title
and issue a policy assuring its quality is often critical to the
closing of a residential real estate transaction. Members of our
Association uniformly agree that, regarding the "controlled business"
issue, the title insurance business will go to the individual or
company that provides the best and fastest service.
Both RESPA and Truth in Lending were designed to heighten
consumer awareness of the cost components involved in home purchases.
The duplication of intent, and to a degree content, presents an
PAGENO="0410"
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-5-
example of excessive regulation with little or no benefit to the
consumer. For over six years RESPA has been in effect -- during
that time there hai~e been no meaningful prosecutions for violations
of its provisions. The reason seems clear enough -- during that
time there have been no significant consumer or regulatory complaints
alleging violations of RESPA.
The considerable number of providers of various settlement
services have given consumers alternative sources for these services.
We believe this competition is a better guarantee of reasonable cost
and good service than any artifical regulation. It has been said
that consumers of these services have little background to make
informed decisions. In most instances the consumer is aided by
knowledgeable brokers and lending officers. As long as the standard
endorsed by the NATIONAL ASSOCIATION OF REALTORS®, that is, full
disclosure of any possible conflict of interest is followed, experience
has shown that buyers and sellers have been well served.
It is our opinion that in this matter, RESPA has not proved of
significant enough benefit to warrant modificatioi and should be
repealed. The circumstances giving rise to its creation were of
limited scope. The considerable cost of its past implementation could
have been spent to greater oublic advantage elsewhere. Further
wasted time and effort of government and industry to modify the RESPA
statute should be halted and that effort redirected.
We will be happy to respond to any questions which you might
have.
PAGENO="0411"
405
Chairman GONZALEZ. Thank you very much. We will proceed and
recognize Mr. Tate, who is the staff vice president of the U.S.
League of Savings Associations.
STATEMENT OF BARRY D. TATE, STAFF VICE PRESIDENT, U.S.
LEAGUE OF SAVINGS ASSOCIATIONS
Mr. TATE. Thank you, Mr. Chairman.
I do have a short oral summary of the full statement, which is in
the back of the room, and I would like the full statement to be
made a part of the record.
Chairman GONZALEZ. Without objection, that will be done.
Mr. TATE. I am Barry Tate of Chicago, and I appear today on
behalf of the U.S. League of Savings Associations, of which I am a
staff vice president.
The testimony you have received on controlled business relation-
ships under section 8 of RESPA has been quite extensive and I will
be brief. Federal Home Loan Bank Board rules today contain
strong provisions preventing a savings and loan association from
conditioning the making of a loan on the borrower's purchase of
hazard insurance, title insurance or other services from the parent
association service corporations. No insured institution may grant
credit with the prior agreement, condition, or understanding that
the borrower must contract with any specific person for insurance.
Violation is a serious matter and could result in a monetary penal-
ty or cease-and-desist order. These prohibitions also apply under
the general antitrust laws.
A second rule requires a written notice to borrowers informing
them of their free choice in connection with insurance services. To
say that referral of settlement business by a parent savings and
loan to its wholly owned service corporation is a violation of a
criminal statute, whereas the same settlement service provided
directly by a parent would not violate the statute, makes absolute-
ly no sense and in our opinion goes far beyond the intent of
Congress in enacting section 8 of RESPA.
The Department of Justice, in issuing guidelines under the anti-
trust laws, has taken the formal position that a parent and its
controlled subsidiary are to be treated as a single entity. If, howev-
er, section 8 were now to be expanded as sought in HUD's August
1980 attempt, to police transactions involving subsidiaries, we
would recommend an exemption for regulated financial institu-
tions.
Existing Bank Board and banking agency regulation and exemp-
tion and examination are best suited to monitor and protect
against such abusive practices. These institutions are already sub-
ject to too much regulatory overlap. Every effort should be made to
reduce the number of agencies with which institutions must deal.
Also, Congress should encourage a lending institution making
long-term portfolio investments for their savings customers, to pro-
vide incidental services, not to restrict them. Furthermore, we
would urge this subcommittee to consider controlled business in
the context of our Nation's antitrust laws.
While the conditioning of the sale of one product on the sale of a
second product is prohibited as a "tie-in," there is no limitation on
a seller promoting the voluntary purchase of a second product.
PAGENO="0412"
406
Such promotion enhances competition and promises convenience
and lower costs to consumers. If general antitrust principles are
not offended, we certainly see no proper justification for a special
antitrust law in the real estate settlement services area, any more
than one would prohibit Sears, Roebuck from servicing its washing
machines in order to asssure business for independent repair shops.
In conclusion, we believe that proposals to frustrate competition
among providers for settlement services must be considered very
drastic, and appropriate only where a very serious problem exists
and all lesser remedies have failed. That is certainly not the case
with title insurance services and other ancillary activities engaged
in by service corporations subsidiaries of savings and loan associ-
ations.
The U.S. League of Savings Associations appreciates this oppor-
tunity to present its views and I look forward to your questions.
[Mr. Tate's prepared statement, on behalf of the U.S. League of
Savings Associations, follows:]
PAGENO="0413"
`407
STATEMENT OF BARRY TATE
ON BEHALF OF THE U.S. LEAGUE OF SAVINGS ASSOCIATIONS
TO THE SUBCOMMITTEE ON HOUSNG AND COMMUNITY DEVELOPMENT
HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
MR. CHAIRMAN:
The U.S. League of Savings AssociatiOnS* is very
~1eased to have this opportunity to testify before your
Subcommittee.
We are concerned about attempts to expand Section 8 in such a
way that it would be a statute governing parent subsidiary
relationships, and we appreciate the opportunity to present our
views on this subject.
I am Barry D. Tate, and I am staff Vice President of
the League. I have with me Ray Gustini, U.S. League Associate
Washington Counsel.
*The U.S. League of Savings Associations has a membership of
4,400 savings and loan associations representing over 99% of
the assets of the $625 billion savings and loan business.
League membership includes all types of associations --
Federal, and state-chartered, stock and mutual. The principal
officers are: Rollin Barnard, President, Denver, Cob; Roy
Green, Vice Pres., Jacksonville, FL; Stuart Davis, Legislative
Chairman, Beverly Hills, CA'; William B. O'Connell, Executive
Vice Pres., Chicago, IL; Arthur Edgeworth, Director, Washington
Operations; and Glen Troop,' Legislative Director. League
headquarters are at 111 E. Wacker Drive, Chicago, IL 60601.
The Washington office is located at 1709 New York Avenue, N.W.,
Washington, D.C. 20006. Telephone 202-637-8900.
PAGENO="0414"
408
-2-
RESP~ Section 8 was originally intended to prohibit
the payment of kickbacks for referral of settlement business.
The provision was designed to cure a practice which was
highlighted in a series of articles in the Washington Post.
The articles exposed a practice by title companies in the
Washington D.C. area of making payment in cash to attorneys and
others who sent title business to title agencies. The original
regultaions under Section 8 prohibited such cash payments.
They also prohibited utilizing any indirect methods as a
subterfuge to make such payments indirectly. Those original
regulations are still in effect today. They remain unchanged.
However, until recently, HUD did not attempt to apply
Section 8 to the normal and legitimate subsidiaries of
financial institutions. Nor do we believe that Congress
intended in enacting Section 8 to apply it to such
parent-subsidiary relationships.
With respect to savings and loan associations and
other financial institutions, those relationships are already
governed by extensive Federal and state regulation, as well as
the Federal and State antitrust laws.
PAGENO="0415"
~4o9
-3-
If I may, Mr. Chairman, I would like to briefly
describe the Regulatory framework within which savings and
loans operate. YoCi, as a long standing member of this
Committee, are well aware of the detailed nature of federal
regulation of the savings andloans business. In fact, the
operating rules for savings and loans have been described
without a great deal of exageration as "cradle to grave"
regulation. Savings and loans were-, of course, initially
chartered to serve specialized credit needs i.e., the providing
of home mortgage credit. Tax laws and investment restrictions
channelled virtually all of our lending into housing or housing
related areas.
I will not take the time to describe the full panoply
of regulatory requirements for savings and loan associations
but I will mention by way of example that Federal Home Loan
Bank Board regulations touch~ on such widely divergent areas as
employment contracts for managers, square footage of offices,
exclusive leases, accurate advertising, and payment of interest
in gold. In other words the Board has pervasive jurisdiction
over all aspects of savings and loan operations.
In addition, detailed rules govern the establishment
and operation of service corporations for federally chartered
PAGENO="0416"
410
-4-
savings and loan associations. The rules in addition contain
specific prohibitions against 1) kickbacks and 2) tie ins or
referrals of borrowers to service corporatons. I will describe
those operations in more detail simply to demonstrate,
Mr. Chairman, that Federal Home Loan Bank Board has shown
considerable concern for preventing savings and loans from
using their unique position as lender to unfairly provide
business for service corporations. I would emphasize, however,
Mr. Chairman, the word "unfair' because we do not believe that
savings and loan customers should be prevented automatically,
from using any services provided by a subsidiary if the
institution has complied with detailed rules which assure such
fairness.
Before describing these rules let me briefly sketch
the background of service corporations. Service corporations
were created as part of Housing Act of 1964. They were
designed to permit savings and loans to pursue activities not
legally permitted for the associations themselves. The scope
of these activities is broad--real estate acquisition and
development, appraisals, insurance and real estate brokerage
and numerous other savings and loan related activities.
Savings and loans service corporations have permitted their
parent associations to diversify their operations but only on a
limited basis i.e., investment is limited to an amount not to
exceed 3% of assets.
PAGENO="0417"
411
-5-
Service corporations have a broad customer base whicfl
includes those who do business with the association. The
relationships with such customers and the manner in which
savings and loan customers may purchase services of a savings
and loan subsidiary are tightly controlled.
FHLBB rules contain strong provisions preventing a
savings and loan association from conditioning the making of a
loan on the borrowers purchase of hazard insurance, title
insurance or other services from the savings and loants
subsidiary. The rule specifically provides that no insured
savings and loan may grant credit with the prior
agreement,condition or understanding that the borrower contract
with any specific person for insurance. Similar restrictions
apply to the customers use of a lawyer or a real estate agent
or broker. Violation of a prohibition of this type is a
serious matter and could result in a monetary penalty or
issuance of a cease and desist order by the Federal Home Loan
Bank Board. These prohibitions apply under the antitrust laws
as well.
A second rule requires that an insured association
provide a written notice to, a borrower outlining his free
choice in connection with insurance services. This notice is
designed to assure a borrower that selection of h.is insurer is
within his sole discretion and not that of the lender.
85-396 0 - 81 - 27
PAGENO="0418"
412
-6-
Accordingly, whenever services such as insurance are
available customers are notified that they have a free choice
in selecting the provider and associations are specifically
prohibited from using the credit decision to coerce customers
to accept such customers into using the services.
The issue upon which are asked to comment today
involves alleged wrong doing or unfairness which is said to
occur when providers of settlement services "refer' business to
wholly or partially owned subsidiaries such as a savings and
loan service corporation. Our view is that such conduct is
entirely appropriate and in fact consistent with the purpose
for which service corporations were created. We would note
that the Department of Justice has taken the formal position in
issuing guidelines under the antitrust laws, that a parent and
its controlled subsidiary are to be treated as one. Thus the
parent can establish or "fix" the prices of the subsidiary and
allocate territories to the subsidiary, both of which would
otherwise be per se antitrust violations.
Of the approximately 2700 savings and loan service
corporations currently in existence, about 95 percent are 100%
owned by a single parent savings and loan association. There
PAGENO="0419"
413
-7-
is no question under Section 8 that a single entity cannot
"refer" business to itself. Thus, a savings and loan
association would be permitted under Section 8 to provide two
or more settlement services, such as appraisal and document
preparation, to a borrower. A wholly owned subsidiary of a
savings and loan association ought to be treated as part of the
parent for purposes of Section 8. To say that referral of
settlement business by the parent to the wholly owned service
corporation, and receipt of dividends generated by such
business, is a violation of a criminal statute, whereas the
same settlement services if all provided by the parent would
not violate the statute, makes no sense, and goes far beyond
the intent of Congress in enacting Section 8.
We believe that if Secti~on 8 were to be expanded by
Congress, consistent with the HUD August 1980 attempt to police
transactions involving subsidiaries, regulated financial
insitutions and their service corporations should be exempted.
The reasons are several:
--First, and most important, as to regulated financial
institutions, the Federal Government already has available a far
more effective and efficient method of imposing protections and
limitations, namely, the regulation and examination of the
savings and loan and bank regulatory agencies.
PAGENO="0420"
414
-8-
--Second, the policies and regulations of the savings
and loan and bank regulatory agencies can be fine tuned to
accomplish any necessary objective, thereby avoiding
unnecessary restriction of competition and assuring fairness of
competition and protection of the public interest
--Third, unlike builders, realtors and attorneys,
financial institutions have long-term involvement as portfolio
lenders. They should be permitted to offer as many of the
services incident to the loans as they wish, provided, of
course that they do not engage in impermissible tying of one
product to another. Incidentally, we do not understand the
argument that quality of title insurance would suffer if
provided by the lender, since the lender has a strong interest
in a high quality title insurance policy. The lender relies on
that policy in making a very substantial cash investment. He
wants to make a good loan, not buy a lawsuit.
--Fourth, regulated financial institutions are already
subject to too many sets of regulations from a variety of
Federal agencies in addition to the agency which is the
principal regulator. Every effort should be made to reduce the
number of agencies with which a regulated financial institution
must deal. Each additional set of regulations and additional
PAGENO="0421"
415
-9-
agency with which the institution must deal imposes further
overhead- -costs which eventually are borne by the public in one
form or another.
- -Fifth, there is persuasive precedent for the
exemption we propose. Both banks and savings and loans are
exempt from the jurisdiction of the FTC with respect to unfair
trade practices. Sectin 5 of the FTC Act specifically provides
that certain closely regulated entities or businesses such as
financial institutions are exempted from FTC jurisdiction over
unfair or anti-competitive trade practices. In that
connection, a House Commerce Committee succinctly described the
extensive authority of the Board in the area of consumer
matters, it said:
"Savings and loans should be exempt from
FTC jurisdiction. The Federal Home Loan Bank
Board would regulate savings and loans
institutions with respect to consumer protection
matters and most areas of antitrust with the
Justice Department enforcing the Clayton Act.
against such institutions... The committee is
satisfied that: the Bank Board has the necessary
regulatory toois to protect consumers from unfair
or deceptive acts or practices by savings and
loan associatiOns'.
PAGENO="0422"
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-10-
We agree with the committee and so did the Congress
since in 1979 it enacted into law a provision which gave
savings and loans an exemption from FTC jurisdiction because
they were really regulated very closely by the FHLBB
Let me make clear that we do not suggest an exemption
from the general kickback and unearned fee provisions of
Section 8. We are of the opinion that the Real Estate
Settlement Procedures Act in general may have outlived its
usefuilness; our purpose today however, is to discuss the
subject matter of this hearing. We only propose, therefore,
that any extension of Section 8 into the governing of normal
relationships of parents and subsidiaries should not apply to
regulated financial institutions. Any corresponding
limitations for financial institutions should, instead, be
carried out by the Federal Home Loan Bank Board and the bank
regulatory ag~ncies under the general laws creating their
regulatory authority.
We would also urge the Subcommittee to consider the
entire issue of so-called `controlled business" in the context
of the nation's general antitrust laws. The antitrust laws
contain long standing and well understood restrictions
regarding monopolization, conspiracy to monopolize, attempts to
PAGENO="0423"
417
-11-
monopolize, and so on. In addition, the specific prohibitions
against "tie ins" are essentially the sane as those imposed by
FHLBB regulations. We would also point out that with respect
to the antitrust laws regarding "tie ins", while the
conditioning of sale of one product on the sale of a second is
prohibited, there is no limitation on the seller promoting the
voluntary purchase of the second product. Such promotion
enhances competition.
Any proposal to prohibit savings and loan
associations, or any other industry group for that matter, from
having subsidiaries sell services to the public would
constitute a special antitrust law. We see no proper
justification for such a special antitrust law in the real
estate settlement service area -- and we would note that the
principal proponents such a special antitrust law are insurers
which are favored by the McCarren-Ferguson Act exemption from
certain aspects of the antitrust laws.
Any number of industry groups in the nation could make
the same "controlled business" arguments in support of stamping
out competition from other groups.
PAGENO="0424"
418
-12-
Independent appliance repair companies could argue
that major retailers should be prohibited from selling service
contracts with appliances to their "controlled' customers.
Independent automobile garages could argue that
automobile dealers should be prohibited from referring their
new car purchasers to their own service repair shop for repairs
paid for by the consumer.
Independent medical clinics could argue that Congress
should prohibit hospitals from referring their "controlled"
business to affiliated medical doctors.
Independent pharmacies could argue that hospitals
should be prohibited from referring their "controlled" patients
to their own phrmacies.
Independent mutual funds could argue that major
brokers should not be permitted to steer their "controlled"
customers to their own mutual funds.
Settlement services are not distinguishable from any
of these examples. To the extent that title insurers argue
that they are different because the consumer has little
PAGENO="0425"
419
-13-
interest in or knowledge of them, there is an admission that
title insurers are doing little or nothing to compete for the
consumer's business, and instead are expending extraordinary
sums in `purchasing' title business (as their own 1979 White
Paper indicates*). Some title insurance carriers are paying as
much as 70 per cent, 80 per cent, or even more of the title
insurance premium to the independent title agency or attorney
title agency or attorney who refers them the business. We
would suggest that they review this practice and attempt to
compete in a traditional manner through price and advertising.
A title insurer or independent title agency could, in our
opinion,attract business directly from the consumer if it
advertised in the Real Estate Sections of newspapers
particularly if it offered to conduct settlements at lower
costs than competitors.
the only way a title insurer can .guarantee itself adequate
business is to outbid its competition in negotiating the
percentage of the premium for the title policy that it is
willing to accept as an underwriting fee or to outbid them in
providing the work product and services normally assumed by the
producez~'s (i.e., the controller of business') affiliated title
company.
PAGENO="0426"
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-14-
In conclusion, we would stress that we favor
competition, and we believe that any proposals to prohibit
competition must be considered as very drastic and only
appropriate where a very serious problem exists and all lesser
remedies have failed. That is certainly not the case in the
area we have been discussing.
We would be pleased to answer any questions you may
have.
Chairman GONZALEZ. Thank you very much, Mr. Tate. We deeply
appreciate your presentation.
We will now recognize Mr. Hilton.
STATEMENT OF CHARLES R. HILTON, SENIOR VICE PRESI-
DENT, COLDWELL, BANKER & CO., ACCOMPANIED BY STAN-
LEY M. GORDON, VICE PRESIDENT.GENERAL COUNSEL
Mr. HILTON. Thank you, Mr. Chairman.
With your permission, Mr. Chairman, we would like to submit
our written statement, and then I would like Mr. Gordon to be
permitted, if possible, to paraphrase it in a short fashion. Then I
would like to make some comments following that.
Chairman. GONZALEZ. Without objection, we will proceed in that
manner.
Mr. GORDON. Thank you, Mr. Chairman. I will make a brief
summary of our statement and hopefully point out some of the
facts that the subcommittee has been asking for.
Let me first observe that the controlled business issue appears to
be a title insurance matter. It really does not impact the lending or
escrow industry as there has been no objection that we are aware
of from the lenders or the escrow industry as to our having these
ancillary services.
The first issue which I think the American Land Title Associ-
ation raises in its presentation concerns broker control. We have
established several title agencies and have found that it is very
difficult to obtain business from our agents. As you are aware, in
most cases our agents are independent contractors and they are
most concerned with obtaining the best service possible. They are
unimpressed by the fact that we have a title agency and we only
obtain business from them after demonstrating good service. Obvi-
ously, there is no requirement that the agents use our services and
there is a full disclosure made to the public of our ownership
interest.
We have gathered some statistics concerning the amount of busi-
ness that we obtain from our broker companies on an overall
average. It is approximately 50 percent. This is true in southern
PAGENO="0427"
421
California for Guardian Title Co. In the Chicago area our figure is
19 percent; for Kansas it is 16 percent; and for northern Virginia it
is 22 percent. These are the percentages of title orders from our
own real estate brokers out of all orders possible to obtain from
them.
Our title agencies have not been profitable, except in southern
California, last year. Our experience with our escrow company
which has existed for several years also is that we obtain approxi-
mately 50 percent of the escrow business available from our own
broker.
From an industry point of view, there are relatively few real
estate broker-owned title agencies and their impact on the overall
title insurance market is minimal. In Los Angeles and Orange
Counties, which are the major markets in southern California, our
company has approximately 1.4 percent of the title order market.
There are five broker-owned: title agencies in southern California.
On a combined basis, they have about 10 percent of the market.
But you must recognize, a percentage of the market share that
they have is from outside business by virtue of a license require-
ment from the California Department of Insurance.
In the Chicago area we have approximately 0.7 percent of the
market. There was a comment yesterday on Du Page County. Our
preliminary check indicates :we have 4 percent of the market, not
11 percent, in that area. We have the only broker-owned title
agencies in the Chicago, in Kansas City, and northern Virginia
areas. Certainly we have a de minimus impact on the overall title
insurance industry in those areas. I think this again confirms the
fact that there are few real estate brokers that have such agencies,
and their impact on an overall basis is just not significant.
We have facts on title insurance fees which I think are also
noteworthy and which contradict any contention that real estate
broker-owned title agencies, charge higher fees. Prof. Bruce Owen
of Stanford University was commissioned by the Departments of
Insurance and Real Estate in California during the consideration
and licensing of such companies a few years ago. He did a report
indicating that: First, real estate broker and business influencer
ownership of title agencies had existed for years, and second, there
was no evidence of higher~ charges being made by such agencies.
The Peat, Marwick report done for HUD also confirms this find-
ing; specifically, our rates in southern California are the same as
our underwriters. The rates of the other broker-owned agencies in
that area are virtually the same as their underwriters, and the fact
of the matter is, everybody's rates are within 1 or 2 percent in the
entire area. In Chicago, we are 25 percent below the market. We
have done the best we can to bring that across to people, but it
really hasn't been meaningful. In Kansas City we are at the mid-
range of the rates, and in Virginia we are also at the midrange.
We have heard numerous references to the rates of Landmark
Escrow Co., which is owned and operated by us in the southern
California area, now doing business as Coldwell Banker Escrow
Services. The example cited on Landmark's rates is that these
rates have been 50 percent higher than the escrow rates of title
insurance escrow departments. What is not observed is that the
Landmark rates have been midrange for the escrow market and
PAGENO="0428"
422
currently its escrow rates are below the middle of the market. As
Professor Owen observed, the rates of broker-owned escrow compa-
nies are actually lower than those of the independent escrow com-
panies; and, there are a lot of independent escrow companies out
there. So I do not think the Landmark example should be cited to
infer that our title agency rates are higher then normal. This is
particularly so because the evidence is that the rates for our title
agency generally are in the middle of the market and are the same
charged by our underwriters in southern California. So the direct
example of what we charge is what should be referred to.
There have been inferences that the quality of our service is not
adequate and we have no incentive to perform quality service. This
ignores the fact that by law we have indemnification responsibility
to the title insuror. In southern California we are automatically
liable to our underwriter on the first $25,000 of risk. In many of
our transactions our mortgage banking subsidiary is involved and
it has direct interest as a lender that a defective search not be
done.
I have personally worked very closely with the title agency in
our area. They people there check with me, and with Safeco's
counsel on any problems that arise. They are very astute and very
concerned about the quality of their service. So I haven't seen any
evidence of poor service in that regard.
I think that the best thing that can be done by the ALTA to
evaluate quality of service is to do a survey of all broker-owned
title agencies and look at their loss experience. That can't be hard
to do. And I think it should be done before one concludes that
broker-owned title agencies have provided poor quality of service.
There should be some statistical information presented showing
that claims, losses, and a comparison to other underwritten agen-
cies and to the title insurors themselves. I did the best I could to
check with all of our people on our claims and losses and found
that they were virtually negligible. There are one or two small
claims here or there, but certainly nothing to- indicate a pattern of
writing around title defects. We just don't have obvious deficiencies
in the title searches we are doing.
Lastly, we are attempting to provide full service to our clients.
We feel the vertical integration of all services is the best way to
serve their needs.
Mr. Hilton has some additional comments.
Mr. HILTON. Thank you, Mr. Chairman.
My name is Charles R. Hilton and I am a senior vice president of
Coidwell, Banker Residential Group; and among my other creden-
tials, I happen to be a native of the great State of Texas, although I
have been adopted by California at the present time.
In conjunction with my position, I have been counsel for the
firm, and in the last several years, I am responsible for what we
call ancillary services, which are trying to be put out of business by
proposed legislation on the Federal level and in several of the
States. I have been at this for 28 years, since 1953, and I have been
involved in the drafting of all kinds of legal instruments for the
real estate profession. I feel I have a fairly good understanding of
it.
PAGENO="0429"
423
Incidentally, I do admire immensely the regulation of the title
insurance business in the State of Texas, but in Texas specifically,
they do not have any problem with the people that are in the so-
called controlled title insurance business, and there are several
controlled business operations in the State of Texas.
In my observation of the meeting yesterday, one thing was said
which struck a chord to me, which would be to the benefit of the
consumer. And, Chairman Gonzalez, that was said by yourself in
conversation with Mr. Patterson, when you referred to the fact
that maybe we could give notice to the buyer of all of his estimated
closing costs, prior to the time that he was bound by the contract.
This would obviously have to be at the broker level, rather than
later on, after the contract is entered into. I think that is a marvel-
ous idea and a good one, and maybe that should be advanced.
Now, we are against kickbacks. But, Mr. Chairman, using your
word yesterday, a "kickback," in my understanding, is exactly
apparently the same as yours. That is, it is a freebe, and a freebe
you get for doing nothing.
In our operation, all of our ancillary services are operated as a
full line service company. We do our title searches; we do the
examinations; we share in the risk; we take all of the risk, in some
cases. And that doesn't sound exactly like a freebe to me.
The Sears example, in our judgment, applies exactly to us. We
work very hard, and we have a lot of stake with each of our clients
because we want them to reuse our services. And they do.
Now, you may think that a real estate purchaser of residential
property would only buy once, or maybe three or four times, during
their lifetime. But they influence an awful lot of other people. And
it would be a shame, in our opinion, if we were to do a lousy
service job on a residential property and wind up losing a shopping
center in some other jurisdiction because this person was employed
by a company in that business.
Mr. Chairman, you asked Mr. Boren yesterday for facts. I have
been asking for facts at hearings for 5 years. And you know, Mr.
Boren said they are very difficult to obtain.
In the underwritten title business, all of these agents are under-
written by title insurance companies, and to the best of my knowl-
edge, they are all members of the American Land Title Associ-
ation. It would seem to me to be relatively simple to prepare a
questionnaire to all the members of the American Land Title Asso-
ciation, asking them: how many agents they underwrite; whether
they are brokers, attorneys, savings and loans, lenders, et cetera.
And I have asked for that information at HUD hearings; I asked
for that at Guardian Title hearings in California; and it is really
very difficult to obtain.
We have been fighting against nonfacts for 5 years, regarding
title hearings, kangaroo court-type hearings. We fought nonfacts
and found findings of facts where there were no facts. I haven't
heard any facts at this hearing that would lead anybody to the
conclusions that real estate brokers who have a controlled ancil-
lary service charge higher fees-maybe I missed it-or that they
offer poor service, or that they write defective policies. That is the
most ludicrous thing that I think anyone could ever say: that a real
estate broker, for a small : or large commission, would write around
PAGENO="0430"
424
a defect in the title, which would cost them many times over the
amount of their commission. That is just-they'd have to search for
something.
I think there is a benefit for the real estate broker's being in
ancillary services, and I will give you a couple of them:
In 1967 we formed an FHA/VA-approved mortgage banker, and
we have operated it continuously ever since. The reason we formed
that mortgage banker was so that we could guarantee the loan
discount points to our buyer and seller, at the point of sale. Prior
to that time, where you had a contract with two or three loan
discount points, they frequently changed before the closing, and
some 60 days later the points might have changed to 10 or 12 loan
discount points.
Well, I tried to get the industry to get involved in guaranteeing
at the point of sale, and we weren't successful. We successfully
guaranteed loan discount points from 1967 until 60 days ago; and
60 days ago, unfortunately, FNMA made it too difficult, because of
their problems, for us to continue in that operation, so we can no
longer guarantee it. But we will be back in there.
The second benefit that I would observe from our participation in
the controlled business is that when we come into different juris-
dictions-and the Chair had some questions yesterday about
owner's policies-there are some States which, by custom, do not
encourage buyers to obtain ownership title insurance. And as a
matter of fact, I have heard the story: Well, why should the buyer
buy an owner's policy? The lender has bought a policy, and the
lender is covered.
And my response to counsel and settlement agents and title
companies across that country, in that type of jurisdiction-and by
the way, that is Georgia, Minneapolis, northern Virginia-they
have a custom where they say, "Why buy that?" And I say, "If the
lender has fire insurance, why should the buyer have fire insur-
ance?" We have been encouraging homeowner title insurance for
the owner-buyer, rather than just for the lender.
Now, I have a suggested benefit possibly to the consumer. You
will hear later on, by the way, testimony this afternoon from Dr.
Irving Plotkin. He is listed as a public witness, and if that lends
objectivity to his testimony, I would like to be so listed. Dr. Plotkin
has been testifying at all of the hearings that I have attended, paid
by a member of the American Land Title Association; I assume
that is what he is doing here today, but I don't really know.
You will hear testimony from Dr. Plotkin about the high cost of
entry into the title insurance insurance, the high capital cost. I
always thought of it as a labor-intensive business. But, like an
attorney-if an attorney made $1,000 on his first day, he might
have a 500- or 600-percent return on his capital investment, if you
excluded his education.
But at any rate, the capital investment that Dr. Plotkin will talk
about relates to title plants-records-both the acquisition and the
maintenance of them.
Now here's the problem: We have several jurisdictions that abso-
lutely require a title agent or a title insurance company to own the
title plant. This is a duplication of public records. They duplicate
the public records, and then index it so it is more easily retrieved.
PAGENO="0431"
425
But I would suggest some legislation might be advanced, that
would require the sharing and computerizing of all of these title
records in the various counties of this Nation. We could really
reduce the cost to the consumer.
Now, I've run into situations, of course, where I can't lease a
plant because the three or four title companies that are already
doing this have contractual arrangements which prohibits us, or
somebody else, from sharing in the use of that facility.
I suggest to you that ALTA is asking for protectionist legislation
based upon a potential evil. And they can't say it's anything but
potential. But the potential exists, with or without controlled busi-
ness.
For example, you might ask anybody from the title insurance
industry, who gets the title orders from their escrow department?
That is a 100-percent referral. The settlement department refers
100 percent of their title orders to their title company. That is
understandable and natural.
Now, the surveys that I have observed in-questions to clients
indicate that the real estate broker, who is the direct point of
contact in normal situations with the buyer and seller-they
expect the real estate broker to walk this transaction through to
conclusion, which means that the real estate broker is put in a
position of some responsibility in connection with each of the serv-
ices offered-be it survey, or title, or loan; whatever-and to help
that buyer and seller through the maze that they are confronted
with.
I suggest to you, Mr. Chairman, that if the real estate broker has
responsibility for those services, they should be entitled to then be
involved where they can offer the finest service available.
I thank you for your attention. When we get to the questions, we
will be happy to respond.
[Mr. Gordon's prepared statement, on behalf of the Coldwell,
Banker & Co. Residential Group, follows:]
PAGENO="0432"
426
STATEMENT OF COLDWELL, BANKER ~ COMPANY
ON CONTROLLED BUSINESS
presented to
HOUSING ~ COMMUNITY DEVELOPMENT SUBCOMMITTEE
OFTHE
HOUSE OF REPRESENTATIVES
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
September 16, 1981
PAGENO="0433"
427
INTRODUCTION
My name is Stanley M. Gordon, Vice President and General
Counsel for the residential group of Coldwell, Banker &
Company. With me is Mr. Charles R. Hilton, a director of the
Company and a Senior Vice President of the residential group
responsible for ancillary services which includes Title and
Settlement services in several states. Coldwell, Banker &
Company is publicly owned and listed on the New York Stock
Exchange. It does business in all areas of real estate brokerage
throughout the United States.
The residential group includes nine residential brokerage
c9mpanies, as well as title, escrow, mortgage banking, relocation
and referral, and insurance brokerage services. We have
developed our operations with the goal of providing our clients
with real estate and real estate related services of the highest
quality.
Our purpose in being here is to assist this subcommittee in
its efforts to understand that aspect of the real estate service
industry which has been characterized as "controlled business".
It is the position of our company that the relationship of real
estate brokers to their wholly owned service companies is
entirely proper. The ownership and utilization of such companies
is legal, and is neither detrimental to consumers, nor to the
other participants in the particular service areas. These are
legitimate business operations which should not be proscribed
unless there are compelling reasons to do so. The mere fact that
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85-396 0 - 81 - 28
PAGENO="0434"
428
they are an alternative method of delivery of such services is
not a basis for their elimination or restriction. Our discussion
will focus primarily on real estate broker owned title companies,
as the impetus for this inquiry on controlled business arises
from the title insurance industry. We are unaware of any conten-
tions that pertain to this issue being made as to other broker
owned services such as escrow or mortgage banking.
REAL ESTATE SETTLEMENT PROCEDURES ACT
The current vehicle for the title industry's challenge to
real estate broker owned title agencies is to contend that the
business relationship of the broker to its title agency is a
violation of the anti-kickback and rebate provisions set forth in
Section 8 of the Real Estate Settlement Procedures Act ("RESPA").
We have reviewed thoroughly the Congressional Record,
including all prior hearings and correspondence that accumulated
in the gradual development of PESPA. It is obvious that the
basic purpose of RESPA at the time of its enactment was to spur
the consumer into shopping for settlement services, with the
expected consequence of reducing settlement costs and improving
competition among these services. The effect of Section 8 of
RESPA was to prohibit kickbacks and other payments made by a
settlement service provider, such as a title insurance company,
to one who merely referred a customer and who did not provide any
service for a reasonable compensation. There was virtually no
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PAGENO="0435"
429
mention in this legislative history of an alleged controlled real
estate business problem, notwithstanding the fact that business
influencers, such as real estate brokers, have had ownership
interests in title agencies for years prior to the enactment of
RESPA.
Nevertheless, it is asserted that business influencer owned,
particularly real estate broker owned, title agencies arose in
response to Section 8 of RESPA. Although some title agencies may
have been formed to circumvent Section 8, it cannot be presumed
that all real estate broker owned title agencies founded after
the adoption of RESPA are merely devices to circumvent Section
8. This certainly was not the intent in forming our title
agencies, nor do they function in any manner which can be deemed
to be a circumvention of Section 8. Such an assertion assumes
that the real estate broker owner has agreed with a title insurer
to funnel kickbacks through a sham title agency for the referral
of title orders.
The most common examples of circumvention are those agencies
which provide little or no service to their customers. They do
not perform a search of the title records, and have few of the
other characteristics of an ongoing business, such as a staff of
employees and related operating expenses. Such agencies, in our
opinion, come within the prohibition of Section 8. The rule
issued by the Department of Housing and Urban Development ("HUD'~)
in 1980, on the distribution of profit; which is generally a
dividend, by the service company to its broker owner possibly
being such a violation is consistent with this. We do not feel
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PAGENO="0436"
430
that this interpretative rule was intended to reach legitimate
business operations. The rule merely encompasses the device of a
kickback from a title insurer being paid as a dividend through a
shell corporation as a means to circumvent RESPA. It is
unfortunate, however, that this rule, being addressed to the
ownership of settlement service providers generally, can be
interpreted to put in question a real estate broker's business
relationship with its wholly owned escrow, mortgage banking, and
other companies, which come within the scope of being settlement
service providers. This is clearly an unintended consequence.
Our title agencies do their own title searches; have staffs,
offices, overhead expenses; and provide other legitimate
services. They are not shell corporations or shams through which
the underwriting title insurer is funneling a kickback to our
real estate brokers. Any presumption that such title agencies
are a device to circumvent Section 8 of RESPA is unsupportable.
Section 8 should not be construed to mean that the mere
dealing of a real estate broker with its title agency, which
results in a dividend or other value to the broker, is in itself
a violation of Section 8. The real estate broker and its wholly
owned subsidiary title agency are really one and the same. The
fact that some states require the title agency to be a separate
corporation does not break the identity between the title agency
and the broker for purposes of Section 8. A title order arising
from the broker's customer in this context has not been referred
anywhere. It is merely another aspect of the sales transaction
being dealt with by another division of the broker. A company
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PAGENO="0437"
431
cannot agree to refer business to itself or pay a kickback to
itself.
There must be, for a violation of Section 8, the involvement
of a third party, such as the title insurance underwriter of a
title agency, that has agreed to make a kickback to the broker.
This arrangement is best established by the absence of reasonable
compensation from the underwriter to the title agency for the
services actually rendered by the title agency. The kickback is
the payment by the title insurer to the title agency (which is
then passed through to the broker owner) where there is no
service being rendered which reasonably corresponds to the
payment. If the title insurer's payment to the title agency is
reasonable, in light of the services being rendered, then Section
8 of RESPA has not been violated. The further tracing of the
title agency's profit, including any dividend to the broker owner
after the agency's operations are financially sound, goes beyond
any apparent purpose of section 8.
We submit that a title agency owned by a real estate broker
which provides legitimate business services and receives
reasonable compensation for these services from its underwriter
is not a business arrangement which circumvents Section 8 of
RESPA.
PAGENO="0438"
432
REAL ESTATE BROKER OWNED TITLE AGENCIES IN GENERAL
On a broader spectrum, several arguments have been advanced
by title insurance trade associations that real estate broker
owned title agencies are detrimental to the consumer and the
industry and should be prohibited by law. This position is self
serving and made only to preserve industry member positions, with
absolutely no regard for the public nor for improvement of the
real estate settlement process. This proposed ban leaves no room
for legitimate full service agencies such as ours, which provide
excellent service to the public and which do not act to the
detriment of the consumer nor the industry.
There are a few basic arguments cited in opposition to real
estate broker ownership of title agencies. They may be
summarized~as follows:
(1) Real estate brokers control the placement of title
orders and such control leads to unfair competition.
(2) Real estate broker owned title agencies charge higher
prices.
(3) Real estate broker owned title agencies render poor
quality service and are prone to write around title
defects.
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PAGENO="0439"
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BROKER CONTROL
The assertion that real estate brokers control the placement
of title orders is simplistic. There are several parties
involved in the real estate settlement process, all of which
exert influence and give advice on where a title order should be
placed, as well as on the utilization of other settlement
services. This influence factor is something that cannot be
eliminated through legislation. Furthermore, it is not
necessarily wrong to exert influence over which services should
be used. The broker control argument fails to recognize the
independent nature of the real estate salesperson. The real
estate salesperson will go to whomever he chooses to provide
settlement services. It is our experience that the salesperson
is totally disinterested and unimpressed by the fact that his
real estate broker has a title agency. The only way our title
agencies have been able to ąbtain business from their affiliated
real estate broker companies is through the performance of
excellent services and the building of a reputation for these
services.
We do not require our, salespersons or clients to use our
title agencies. There is absolutely no tie-in arrangement or
anything close to a tie-in~ arrangement with these services. A
disclosure of ownership of our settlement service providers is
made in writing to our clients.
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Our title agencies generally obtain no more than 50% of the
title orders from their related real estate brokers. In Southern
California, Guardian Title receives approximately 50% of the
title orders from the two residential companies owned by Coldwell
Banker in that region. In the Chicago area, the figure is only
31%; for Kansas, it is 60%; and for northern Virginia, it is
22%. These percentages have been achieved with great difficulty,
only after the establishment of a reputation for service. Our
title agencies have not been profitable, except in Southern
California last year. Our escrow company in Southern California,
which has operated for many years, also obtains a maximum of 50%
of the escrow orders from our real estate brokerage companies in
that area.
From an industry point of view, there are relatively few
real estate broker owned title agencies. Their impact on the
title insurance market is minimal. In Los Angeles and Orange
Counties, the major markets of Southern California, our company
has approximately 1.4% of the title order market. The entire
group of broker owned agencies in these counties, five companies,
have about 10% of the market. The market share for broker owned
agencies on a combined basis for all of Southern California is
approximately 6.5%. A portion of all of these market shares is
business from sources other than the respective real estate
broker owners. In Chicago, Kansas City, and Northern Virginia we
are not aware of any other real estate broker owned title
agencies; the market share of these agencies is de minimus. The
presence of these title agencies is not material to the title
PAGENO="0441"
435
insurance industry or the competitive environment of the
individual members.
Real estate brokerage is such a fragmented industry that
concentrated blocks of business in classic anti-trust terms
simply do not exist. If one looks at the few real estate brokers
that have such title agencies, the number of title orders being
handled by them does not impact the title insurance industry
significantly. Additionally, if the combined operations of all
of these real estate broker owned title agencies did
significantly impact this industry, the ultimate question would
remain whether or not this method of business is detrimental to
th~ industry. The fact that there is another method of business
creating competition and allegedly erroding the market share of
existing entities does not lead to the conclusion that this
method should be prohibited.~ The title insurance industry, is
fraught with basic problems that will not be solved by the
elimination of real estate broker owned title agencies.
TITLE FEES
The most significant consumer oriented argument asserted by
those that seek to ban real estate broker owned title agencies is
that such agencies charge higher fees. This is simply false, as
has been observed over the past several years. Professor Bruce
Owen, in doing a study on such agencies for the California
Departments of Insurance and Real Estate (Licensing of Real
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PAGENO="0442"
436
Estate Brokers as Underwritten Title Insurance Agents), noted
that (a) real estate broker and other business influencer
ownership of title agencies has existed for years in California
(Owen report, page 40); and, (b) that there is no evidence of
higher charges being made by such agencies. (Owen report, pages
82-86). Peat, Marwick, Mitchell & Co. reported to MUD "We did
not find that where the title assurance services are provided by
a `controlled business', the charges for title assurance services
were either higher or lower than the charges in markets where
attorneys or title insurance companies provided the service."
(REAL ESTATE CLOSING COSTS VOLUME 1: EXECUTIVE SUMMARY, page
111.10)
Our rates in Southern California are the same as those of
our underwriter. Virtually all the rates of broker owned
agencies, non broker owned agencies, and title insurers in that
area are the same. In Chicago we are 25% below the market; in
Kansas City we are at mid range and below several of the major
companies; in Virginia our rates are negotiated and are equal to
or lower than competitors. We will supply our rate schedules to
this subcommittee upon request.
The example most often cited by those opposed to our title
agencies is that of Landmark Escrow Company, operated by us in
California. It is cited that Landmark's escrow rates were 50%
higher than the escrow rates of title agencies and title insurers
in the same locality. What is not stated is the fact that
Landmark's rates were mid-range for the escrow market in the
area. Professor Owen observed that broker owned escrow
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137
companies' rates were found to, be generally lower than the rates
of independent escrow companies (Owen report, pages 72-73, tables
14 and 15). It must be recognized that low rates do not
necessarily indicate that the best services are being rendered.
In California, the escrow operations of the title insurance
companies do not have a good reputation for quality or service.
A related argument on the issue of costs is that broker
owned title agencies will drive a hard bargain with their under-
writers, causing the underwriters to charge higher rates to the
public. There is no authority cited for this and we submit that
this is speculation. We choose our underwriters on the basis of
the quality of their plant facilities, the overall quality of the
services available to us and a variety of other business
factors. Their rates are not the most important criterion.
Frankly, if we drove too hard a bargain, our underwriters could
cease to do business with us and open their own agencies. It is
interesting that Peat, Marwick, in commenting on title assurance
charges from 1975 to 1979 in four sites studied, observed that
".... this data, although limited, indicates that average total
title insurance charges declined in real terms over this three
and one-half (year) period.'t 7 (REAL ESTATE CLOSING COSTS VOLUME
1: EXECUTIVE SUMMARY, page 111.3) This is the same period when
the alleged rise of real estate broker owned title agencies
occurred.
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438
QUALITY OF SERVICE
The assertion that broker owned title agencies will provide
poor service and do faulty examinations to close a sale is
unsupported by fact and ignores reality. Title agencies, real
estate broker owned or otherwise, are responsible to their
underwriter for their negligent searches or actions. They are
also legally responsible to their customers in civil liability on
grounds other than the title policy itself, most often on the
basis of negligence in their searches. No business can succeed
if it provides poor service or poor quality. A few bad title
searches, with resultant litigation and damages, can drastically
reduce the profitability of an agency and its value to an
underwriter. A pattern of erroneous searches would result in
financial risk and losses that would deter any underwriter from
continuing to do business with the agency.
The contention that a broker owned agency will write around
a deal, killing title problems so that the broker can realize a
commission at closing, is also economically unsound. The
commission the broker receives from a sales transaction is simply
too small in comparison to the risk of loss ultimately faced by
its agency from writing around a known title defect. Further, it
is too much to assume that broker owned title agencies,
particularly full service entities such as ours, are going to
systematically respond to pressure from salespersons to take on
such risks. Whenever there is a significant title question, our
title agency personnel check with the underwriter, and legal
counsel, if appropriate, before issuing the policy.
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439
It would be interesting to do a study among the underwriters
of broker owned title agencies to see what their loss experience
has been from these agencies, compared to other sources of busi-
ness. This would appear to be the most elementary factual
analysis that should be made before one asserts the existence of
poor quality in these business operations. The loss experience
of our own agencies is de minimis and is probably better than
that of most title insurance companies. The record of our
agencies, which is available upon request, contradicts the
blanket conclusion that such agencies render poor quality
service.
CONCLUS ION
The operation of real estate broker owned title agencies as
legitimate business operations does not pose a valid problem
under Section 8 of RESPA. This provision of RESPA was never
intended to delve into such relationships as long as there has
been a reasonable fee paid for actual services rendered between
the title insurance underwriter and the broker's title agency.
The concentration on this issue has merely been a means by which
the title insurance industry has attempted to bring attention to
its concern over real estate broker owned title agencies.
Although there have been many arguments presented about the
impact of such title agencies, the facts do not support this
speculation. The operation of real estate broker owned title
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PAGENO="0446"
440
agencies has been shown to have no adverse effect on the consumer
with respect to rates and quality of service. Additionally, the
small number of such title agencies and the relativ2ly minimal
amount of business obtained by them is not significant for the
title insurance industry. The title insurance industry has had
limited profitability over the past several years and must
address its internal operational problems without seeking to
preclude the entry of other service providers into their
business.
It is the desire of Coldwell, Banker & Company to provide
all services required for a real estate transaction to its
clients. This is in accordance with the current trend of
vertical integration in the real estate and financial services
industries. This interrelationship of companies may prove to be
the most economical and efficient means to serve the needs of the
consumer in dealing with real estate. Our industry and all
aspects of the housing industry are undergoing significant
change, which will continue for the next few years. The best
course of action, in our opinion, is to allow the real estate and
housing industry to stabilize before any further review on the
subject matter of today's hearings is considered.
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441
Chairman GONZALEZ. Thank you very much, Mr. Hilton.
We will proceed with Mr. Levinson, from Beverly Hills, Calif.
STATEMENT OF BURTON S. LEVINSON, FIRM OF LEVINSON &
LIEBERMAN, INC., BEVERLY HILLS, CALIF.
Mr. LEVINSON. Thank you, Mr. Chairman. It is a pleasure to be
with you this morning.
My name is Mr. Levinson, and although I appear on this particu-
lar panel which seems to be made up of people who are involved as
employees, or connected with the real estate industry, I am appear-
ing as a public witness.
I would first of all ask Chairman Gonzalez that the prepared
remarks that I have previously presented be submitted for the
record.
Chairman GONZALEZ. Without objection, so ordered.
Mr. LEVINSON. Thank you.
I think that, based on the statements that Mr. Hilton just said,
that I should clarify for the record that I do not appear here on
behalf of any client, any title company, any real estate brokers, or
any group of such people; but entirely on my own, at my own
expense, because I feel that these hearings that you are having are
important and deserve the attention of people who are involved in
general in this industry.
As the first paragraph of my comments points out, in our partic-
ular law firm, we are privileged to represent real estate brokers,
buyers and sellers of property, and title insurance companies. We
feel that has given us an opportunity to survey the concerns that
are now before this subcommittee. It is in that regard, Chairman
Gonzalez, that I appear here today.
I agree with many members of the panel, in that our concern
ought to be the question of what is best for the consumer. And to
be candid, I am a little bit confused that we have not been more
oriented in these discussions here this morning with the concerns
of the consumer. Let me tell you about that, as I see it.
Quite frequently, we observe that buyers or sellers of real proper-
ty, represented by real estate brokers, are led automatically by
those brokers to certain title insurance companies. It has been the
practice of our law firm to inquire, to ask that particular broker or
sales person, "Why have you selected that title insurance compa-
ny?" We do that almost as a matter of curiosity.
I can remember, 5 or 6 years ago, when the real estate broker
and sales people industry decided that it would be best for them to
develop the use of the term professional. I think that that was a
conscious decision on the part of the industry, to use the term
professional to make the public feel that they could have more
confidence in dealing with real estate people.
As an attorney, I have often thought the word professional car-
ried with it connotations of a fiduciary responsibility. It is for that
reason that I am puzzled in part by the comments of some of the
previous speakers, because it appears to me that there is a question
of a potential conflict of interest in the things that we, as attor-
neys, are continually concerned about.
When we ask people, "Why are you turning to a certain title
insurance company?" and they inform us that they are doing so
PAGENO="0448"
442
because they have a financial interest in that company, we, as
attorneys, wonder if in fact the interests of that particular buyer or
seller are being carefully represented; or whether the motivation-
be it immediate financial reward or potential reward-is the
reason that that title company has been selected.
There seems to be here, Chairman Gonzalez, a misunderstanding
about the actual day-to-day practice of the real estate industry, as
at least we understand it in southern California. Most often, the
consumer really doesn't know too much about title insurance. It is
true that the real estate brokers know a great deal more about it.
We find, in representing various title insurance companies, that
there is a tremendous difference in the quality of the work that
they turn out. I don't suggest-and I agree with Mr. Hilton that
any title company intentionally turns out a defective policy, or a
defective preliminary report-but I agree totally with Mr. Tread-
well, when he says that the most important element-and he said,
Congressman Gonzalez, the key element is timing. Like every other
industry, various title companies flux, they change, the quality and
timing of their product changes from week to week and from
month to month.
The point that I believe that this panel overlooked is the fact
that when a real estate broker owns a part of a company, that his
motivation is to forward work to that company because he has a
potential or immediate financial return, not to check on a week-to-
week basis, to see what company is providing the best service then.
I know of situations where title company representatives have
tried to talk to people connected with the firms represented here
today by my colleagues from California, Mr. Gordon and Mr.
Hilton, and have been turned away because of the fact that the
position is: We don't need to know about the services that your
title company performs or provides because we have our own title
company. Mr. Hilton is correct-or was it Mr. Gordon-who stated
that many of the people who work for them are independent con-
tractors and are, to use his term, unimpressed by the fact that
their company has their own in-house title company.
The reason they are unimpressed, I suggest to you, is because
they recognize that in the day-to-day market, that other title insur-
ers are able to provide a service which is as good or better.
And I think that what this committee-and I suggest this re-
spectfully, Congressman Gonzalez-ought to take into account is:
What is truly in the best interest of the consumer? Should a real
estate broker or sales person be in the potential or real conflict of
interest of having to say:
Should I refer this matter to this particular title company because I own an
interest in it, or should I continue to survey, day-to-day, week-to-week, what serv-
ices, what timing, what fees are available by other title insurance companies?
Where lies the greater duty? The duty to protect one's own
financial interest or the duty of the one who represents the client,
the fiduciary, the tie-in with that professional responsibility which
the real estate professional sees?
Thank you.
[Mr. Levinson's prepared statement follows:]
PAGENO="0449"
443
STATEMENT OF BURTON S. LEVINSON, ESQ.
LEVINSON & LIEBERM~N, INC.
BEVERLY HILLS, CALIFORNIA
BEFORE THE
HOUSE SUBCOMMITTEE ON HOUSING & COMMUNITY DEVELOPMENT
SEPTEMBER 15 AND 16, 1981
CONTROLLED BUSINESS HEARINGS
Mr. Chairman and members of the Subcommittee, my name is
Burton S. Levinson and I am a senior partner of the law firm,
Levinson & Lieberman located in Beverly Hills, California.
Our firm has a number of real estate clients including title
insurance underwriting companies. I am a frequent contributor
to real estate publications, including, contributing editor,
on the subject of escrow and title insurance matters in Stan-
dard & Poor's Real Estate Handbook and such national publica-
tions as the July 1981 edition: of "Real Estate Today." I am
also a member of the Practicing Law Institute facu1t~y on title
insurance matters.
Controlled business is a growing phenomenon. In many
respects it touches on a number of providers of ancillary
services. However, my remarks will address the problems with
controlled business arrangements vis-a-vis the title insurance
industry.
85-396 0 - 81 - 29
PAGENO="0450"
444
INTRODUCTION
I am pleased to appear before the Subcommittee on a mat-
ter that I consider both anti-consumer and anti-competitive
in nature. From the outset, I wish to applaud the efforts of
Chairman Gonzalez for scheduling these hearings and bringing
the controlled business problem to the attention of Congress
and the public. In announcing these hearings, Chariman Gon-
zalez stated that controlled business is "an anti-competi-
tive device that threatens needless inflation of real estate
settlement costs." I am in complete agreement with the Chair-
man, and I would like to take this opportunity to articulate
my concerns.
In a recent article in the Winter, 1980 edition of The
Antitrust Bulletin, Professor W. David Slawson, in discussing
economic harm caused by tie-in arrangements, defined competi-
tion as the existence of buyer's alternatives." This is a
most appropriate definition, particularly when viewed in the
context of controlled business. Moreover, from my perspec-
tive, it explains in a most concise way the primary reason
why this Subcommittee and members of Congress must be con-
cerned about controlled business. If we wish to preserve
the benefits of competition for consumers, we must preserve
the existence of buyer's alternatives. Any practice or ar-
rangement that has a practical effect of reducing or elimi-
nating the alternatives available to buyers adversely affects
competition and consequently adversely affects the range of
prices and services that will be available to consumers.
2.
PAGENO="0451"
445
FUNCTION OF REAL ESTATE PROFESSIONALS
I am sure that members of the Subcommittee are cognizant
of the fact that homebuyers and sellers have little under-
standing of, or knowledge about, the real estate settlement
process. Most consumers rely on the guidance of their real
estate broker, mortgage lender, or attorney in selecting a
title company. These real estate professionals, because of
their expertise and intimate knowledge of the real estate
settlement process, are in a position to assess the range of
alternatives available to consumers in obtaining the protec-
tion afforded by title insurance and to assist the consumer
~n selecting a title company that will best serve the con-
sumer's interest. Thus, the guidance afforded by real estate
professionals - if they have no financial interest in the
selection - actually enhances the alternatives to buyers.
However, when the real estate professional has a finan-
cial interest in a particular title company, he will invari-
ably recommend that title company t~ the consumer irrespective
of the merits of the prices or services offered by other com-
panies. Therefore, the practical result is that alternatives
available to consumers will be effectively reduced or even
eliminated since, in many instances, consumers rely exclusive-
ly on the recommendations of the real estate professionals
in making their decisions on the selection. of a title com-
pany.
3.
PAGENO="0452"
446
CONTROLLED BUSINESS - STATE OF CALIFORNIA
The problems created by controlled businesses are not
simply theoretical ones. Evidence has been developed in my
own State of California that indicates the real world impact
of controlled business arrangements.
In 1977, Coldwell Banker and Co., a large real estate
broker, applied to the California Department of Insurance to
obtain an organizational permit and license for its wholly
owned subsidiary, Guardian Title Company, which would act as
a title insurance agent for real estate transactions handled
by the parent broker. The Insurance Commissioner denied the
application and concluded that the granting of such a license
would enable Coldwell Banker "to carry out a restriction on,
or to prevent competition in, the title insurance business."
The decision was affirmed in the California Court of Appeal
(Coldwell Banker v. Dept. of Insurance, 102 Cal.App.3d 281,
1980). One of the facts that the Commissioner found persua-
sive in reaching the conclusion to deny the application was
that Coldwell Banker already had a controlled business rela-
tionship with an escrow company to which Coidwell Banker's
clients were referred and whose charges the Commissioner found
to be in excess of 150% greater than the charges for similar
escrow services made by independent title insurers and under-
written title companies in the localities involved.
The California Insurance Commissioner also found that
those underwritten title companies owned or controlled by
4.
PAGENO="0453"
447
real estate producers have generally enjoyed success in terms
of market penetration and profitability that was unmatched by
other underwritten title companies and title insurance compa-
nies operating in the same geographic area. According to the
Commissioner's findings, no reason for the extraordinary suc-
cess of such underwritten title companies has been shown other
than their ownership or control by real estate producers.
ANTI-COHPETITIVE IMPLICATIONS
OF CONTROLLED BUSINESS
I think it is fair to say that entry into an form of busi-
ness and, in this particular situation, the title insurance
industry - should be open to anyone who is willing to com-
pete on the merits of his services and prices for the con-
sumer's business. However, with the proliferation in con-
trolled business title companies - where the primary purpose
of the new title company is to handle the captive business
of its stockholders rather than to compete on the merits for
the business - does not, in any sense, result in increased
competition. A title company whose success depends on the
nature of the real estate professional's financial interest -
and not on the merits of its service or prices - is not bring-
ing new competition to the market. Rather, the controlled
company is diminishing competition by removing a block of
transactions from the competitive arena since no other service
5.
PAGENO="0454"
448
provider can, as a practical matter, vie for the business that
is steered to the controlled entity.
I wish to make it perfectly clear that I personally am
not opposed to real estate professionals having an ownership
interest or owning outright a title company. If a broker-
owned, lender-owned, or attorney-owned title company wishes
to compete on the merits for business it did not control,
there could be no legitimate objection since all title com-
panies, regardless of their ownership, would have an equal
ability to compete for the title insurance business in that
particular market. But, where one class of title companie~ -
comprised of companies owned by real estate professionals who
are in a position to influence the consumer's selection of a
title company - has a virtually insurmountable advantage in
obtaining business, I believe a legitimate and meritorious
objection can be raised. Simply put, competition for the
consumer's business should be based on the title company's
services and prices - and not on the financial interest of
the real estate professionals steering business to a particu-
lar title company in which they have an ownership interest.
CONCLUSION
Mr. Chairman, it is my position that Congress should
adopt legislation that would prohibit controlled business
arrangements. The burgeoning problem of controlled business
has very, very serious implications for the consumer. As
6.
PAGENO="0455"
449
the issuance of title insurance is stratified through con-
trolled business entities, pricing of the product will become
less and less sensitive in a market that lacks vigorous com-
petition. Who gets hurt when the competition is stripped
from the market - the consumer~!
Controllers of business realize that they do not have
to be price sensitive since they have a "lock" on a certain
portion of business funneled through their controlled title
company. The steering of business based on ownership inter-
est by real estate professionals should be prohibited. When
title companies that are willing to compete on the merits are
foreclosed from a portion of the market by companies whose
business is derived from the strategic ownership interest of
real estate professionals - this is wrong.
I urge the Subcommittee to introduce legislation that
would amend the present Real Estate Settlement Procedures
Act to include a prohibition on controlled business arrange-
ments.
Thank you for this opporthnity to present my views on
this very ithportant matter.
7.
PAGENO="0456"
450
Chairman GONZALEZ. Thank you very much, Mr. Levinson. That
was a very excellently stated and succinctly presented statement.
And we appreciate it. The written testimony, of course, has been
offered for the record.
As some of the witnesses stated yesterday that coercive tactics
were used by real estate brokers who owned title insurance compa-
nies to assure that their agents referred customers to their con-
trolled title insurance companies.
What is your experience with those practices, Mr. Hilton? Was
that factual? And is that desirable? And is it consistent with a true
competitive environment that would inure to the benefit of the
consumer?
Mr. HILTON. No, Chairman Gonzalez.
I have worked very hard for 28 years, to get every single title
order, every single escrow, every single mortgage that we could get.
In my judgment, with a real strong effort and an absolute quality
of service, I would lose title orders to some of Mr. Levinson's clients
because they got a bottle of whisky. And that is just a practice that
happens-a lunch or that type of thing.
But in our company, the salesmen, by the way, don't have any
ownership interest in any of our ancillary services, unless they own
some of our parent company stock-we are a publicly held compa-
ny-and to my knowledge, that is almost a nonexistent quality.
We have no requirement that a salesman use any of our services.
They do not become unemployed or are required to go across the
street, as independent contractors. Our percentages would tell
anyone who would look at it-if we can only get to 20 and 30
percent in some areas, because someone else has done a better
public relations job with our own salesmen-that we are not coer-
cive or using coercive tactics to get their business.
Now, to encourage our salesmen in the strongest fashion that we
čan-because we have a responsibility to the client, overall respon-
sibility, legal liability to the client-is, in my judgment, a sound
way for us to proceed. If we have responsibility for all the spokes in
the wheel and we can only control one of those spokes, we are in a
terrible position, and we have been in that position in many, many
cases.
At one time, when I was kind of the problem solver in the
company, trying to straighten a transaction out so it could go
forward, we were dealing with 70 different settlement agents. And
if you can imagine my phone calls, with a lot of competent people
and some incompetent people, some with an understanding of the
transaction and some without it, in trying to solve problems. It just
gets to be horrendous.
Now, you asked about harassment. Absolutely none. Some of our
finest salesmen use our ancillary services; some of our finest sales-
men do not use our ancillary services. The amount of money that
they make doesn't have anything to do with it. The turnover in
real estate itself would tell you that the real estate broker or
independent contractor doesn't have real control. I would suggest
the real estate broker who tried that type of control would lose all
of his sales people.
Chairman GONZALEZ. Did you hear, or were you present, when
the gentleman from Montana, Mr. Bossard, testified about his par-
PAGENO="0457"
451
ticular experience, and the demise of one or two of his ventures
which he attributed to the controlled business situation?
He was picturing a situation there where the nature of the
association was so anticompetitive that his investment in his ven-
ture as a competitor was not feasible. And it ended in failure.
Is that reflective of the basic reason for the traditional title
insurance companies' feeling of injustice or impropriety? I don't
know if I am asking a fair question, because you may or may not
have been present.
Mr. HILTON. I was present.
Chairman GONZALEZ. Or you may not recall his particular testi-
mony.
Mr. HILTON. His was a cooperative, I believe, was it not?
Chairman GONZALEZ. I believe that it was. I believe he referred
to it as being a cooperative.
Mr. HILTON. As I recall, that was in the state of Michigan, or was
it Montana?
Chairman GONZALEZ. That was Montana.
Mr. HILTON. That is an isolated example, of course, and it would
cause anyone in the title insurance industry, or a title agent, to be
quite chagrined if all of the real estate brokers in a small commu-
nity were to form a cooperative, and do that work themselves. That
is obvious. That does have some, I think, legal possibilities, as an
attorney, but that would cause a great deal of chagrin.
And I would be opposed to that type of thing, also. That has
happened rarely. There have been some lawyer cooperatives in
various jurisdictions that have done that same thing-the settle-
ment attorneys have gotten together and formed a title agency as a
cooperative. But one of the answers, I believe, is under section 8,
the kickback which is prohibited. If you are required as a title
agent to do the work, if you have to do the title search and
examination and write the policy and take some risk in conjunc-
tion with it, and put your reputation on the line, just not some
other-just not the underwriter-I think it goes in the direction of
solving that problem.
As an example, we are probably-and I think we are, to the best
of our knowledge, the largest real estate broker in the United
States, in terms of gross commissions and things of that type. And
we are nationally. And yet we get in Los Angeles County, I believe
the figure-Los Angeles and Orange County is 1.1, or 1.4 percent of
the total business. That is de minimus.
Now, most real estate brokers have one office, or two offices, and
could never hire the staff to do the searches and the abstracting
and issue the policies. Most-and 1 would say somewhere in the 90
percentile-could not be in there. So you wouldn't find that. I
think the cooperative is in a unique position, and I sympathize
with the gentleman, but I also would recommend that he seek
counsel.
Chairman GONZALEZ. Well, with respect to the basic reason for
these hearings, and the overview of RESPA, you may be very right,
that in that particular situation it would be in the nature of an
antitrust violation-and the other aspects of the law-particularly
reflected in the report by the Justice Department, in that particu-
lar area of concern.
PAGENO="0458"
452
And as I see it, and what the testimony has brought out in case
after case, is that in view of HUD's position and the fact that we
are really finding that it isn't so much the actual statute as reflect-
ed in RESPA, but the interpretive rulings by HUD, that have given
rise to some of these more disparate situations.
But do you find, or is it your opinion, that we have had a growth
in this type of controlled business relationship, between realtors or
any other type of venture and title insurance, since the enactment
of RESPA?
Mr. HILTON. Chairman Gonzalez, I can only respond to that from
my own personal observation, but I have been at this since 1953.
Prior the enactment of RESPA, there were 26 underwritten title
companies, 26 underwritten title agencies, that had perhaps control
features involved. The word "control," by the way, is just used-
but it doesn't really exist. And I would suspect if you checked with
the Insurance Commission in the State of California today, you
would probably have 26, 25, in that range.
Now, we have run into some interesting things. In Kansas City,
we are the only broker-owned title company, and yet the legislation
has been proposing a prohibition on broker-owned title companies,
and the perceived notion that all of this is being taken away from
the title companies-we are the only ones over here ~n northern
Virginia.
And incidentally, the Attorney General, on the unauthorized
practice of law questions, highly complimented our lay settlement
agency and title operation over there, because we have reduced the
costs substantially. So I would say we are the only one in Chicago
we know of. We are the only one in northern Virginia we know of.
Chairman GONZALEZ. How long have you been in business in
northern Virginia?
Mr. HILTON. We have been in the business in northern Virginia,
I believe, approximately 2 years. We bought an existing title
agency.
Chairman GONZALEZ. Mr. Treadwell, I believe you wanted to
make a comment?
Mr. TREADWELL. I would simply comment and reiterate what I
indicated in my previous remarks, that from my own information,
this type of arrangement has existed for in excess of 20 years-in
the Detroit area at least 25. Lawyers Title started as a similar type
of controlled or semicontrolled type of business, initially.
I think that there has been a big acceleration during the last 5
or 6 years, but I think it has been in spite of RESPA, and not
because of it. I think you mentioned the explosion in electronic
communications, and the changes in the structure of the industry
which is moving to larger companies. The growth of Coldwell
Banker, for one example and only one of many examples, and the
resources they have and their need for having quality control and
being able to assure an evenness of the product has resulted in
their expansion more so than the RESPA features.
Chairman GONZALEZ. Mr. Tate, did you want to comment?
Mr. TATE. Concerning your request for numbers, Mr. Chairman,
the League did a survey of service corporation title insurance
agencies in October 1976, which is roughly at the time RESPA
began. There were 36 out of some 2,050 service corporations that
PAGENO="0459"
453
had title agencies, and another 10 were abstract companies at that
time. Interestingly enough, the American Land Title Association
has just recently completed a~ survey in 1981 which, I believe shows
that that number has only grown to about 73. So I don't think
there has been a huge growth, and it is a very modest occurrence.
Chairman GONZALEZ. I believe 73 is the figure that was given to
us yesterday by Mr. Vartanian.
Because I have exceeded the normal time allotment, we will
proceed with the other members after I ask one further question. I
will ask unanimous consent to submit additional questions in writ-
ing to the panelists in adequate time to answer for the transcript.
Couldn't requiring or encouraging lender packaging, as recom-
mended by the Department yesterday, hasten the demise of inde-
pendent competitive settlement service providers? Are those inde-
pendent service providers an inefficient anachronism that should
gradually be replaced by controlled business relationships? Or is
there some value in taking steps to assure that those independent
service providers do not disappear?
Mr. Treadwell?
Mr. TREADWELL. This is a matter which has not been given-we
haven't had an opportunity for detailed study. But our preliminary
analysis of it is that we are faced with 50 States-many of the
States have anywhere from a few to as few as 3 or 4 to as many as
100 counties. Title work historically in most of the United States
has been based upon examination of records which are kept at
county levels.
What I am suggesting is there is a tremendous diversity of
problems from these small rural counties with occasional transac-
tions, and complex descriptions, and things of this nature, to the
more sophisticated counties, where there is a very high volume of
transactions and legal descriptions have been pretty well refined in
recorded plats and things of this nature.
And because of this tremendous diversity, we feel that we should
respect that. We feel that a general rule of a nationwide applica-
tion is inapplicable and inappropriate. We feel that a compulsory
requirement for lender packaging at this point would be inappro-
priate. We feel that a voluntary system of encouragement, of regu-
lations which permit this, might very well let us know within the
next 5 or 10 years what is the mOst efficient method.
The National Association of Realtors represents primarily the
brokers who are in turn representing the homeowners, and our
principal concern is that the means and methods of transfer of
their interest in real property should be facilitated. If that can
happen, we think the consumer is bettter served. And if the con-
sumer is better served, we think that we will be better served as an
industry.
Chairman GONZALEZ. Thank yoU very much. Just one final thing.
Mr. Hilton, I was very much impressed by your endorsement of
this idea that the consumer be given information before he is
bound by the contract. As you know, the present requirement in
the law is that an information booklet and a good faith estimate of
settlement costs be provided to a ōustomer when a written applica-
tion for a mortgage is submitted. However, HUD and the National
Association of Realtors have advocated repealing that provision.
PAGENO="0460"
454
I think Mr. Patterson was referring to that issue. HUD com-
ments on the overwhelming amount of information they claim is
needless. It appears that it is not so much the fact that the infor-
mation is needless, or that the consumer doesn't want it, but the
information is not provided at the right time, I thought, why not
have the realtor be the one to disseminate that information at the
point before the customer has a binding contract?
Mr. HILTON. Chairman Gonzalez, when I first studied RESPA
and its effects, after a couple of days of seminars I started laugh-
ing, because it was obvious that the notice was given after the fact,
and that has been my judgment ever since its enactment. And it is
nice to give notice, but they are still bound to the seller, and the
seller has rights also.
And I don't care what objection they had after they received the
notice. They were still bound. And if we could find some way to
give them advance notice, prior to being contractually obligated, I
can't speak for the real estate industry, but I know that our compa-
nies across this company would be thrilled.
Most brokers, I believe, and I don't know all of the brokers, but
most brokers, I believe, before they prepare an offer on a property,
presently do a cost estimate of everything. I know that our compa-
nies do. The sheet goes to everything from the title services, to the
escrow services, to the termite costs, to the loan discount points, to
your monthly payment, and interest rate, and all of those things.
It would be very easy to adapt that and have that as a prior
notice condition. And I can't speak for the industry, but our compa-
ny would be delighted with that type of notice.
Chairman GONZALEZ. That seems to me most reasonable and
very advantageous, from the consumer standpoint.
Mr. Tate?
Mr. TATE. Part of the difficulty of the good faith estimate is it
has to be a contractually known number. If we could get with an
estimate that could be delivered up front, where it would do some
good, it would be very useful to the consumer. The difficulty is the
rules now require that we give them hard numbers, and we don't
know hard numbers until we are about ready to close. You can get
very close.
Mr. HILTON. You can get very close, though. Really, there is no
question about that. Once you determine the sale price, you can get
very, very close to actual numbers, within $100 or $200, generally
speaking.
Chairman GONZALEZ. Mr. Treadwell, did you have any comment
on that?
Mr. TREADWELL. Yes. I think when we talk about the settlement
cost, that this is a figure about which we have certain understand-
ing. The consumer in my experience isn't interested in that figure.
He is interested in two other figures. The basic one, of course, is
the price of the property, and the second one is his total downpay-
ment. He looks at the downpayment as being the amount of actual
legal downpayment, plus all of the associated costs. And I would
follow the comment of Mr. Tate by saying that it is impossible to
get a hard number early on, because we have proration of taxes,
we have proration of interest. Frequently when a new loan is going
to be put out, there are a number of variables which depend upon
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the date on which the transaōtion will actually be closed. And this
of course is not always known, because the closing may take place
in a week, it may take place in 2 or 3 months subsequent to the
date.
So I think my own experience is that all of the good salesmen
disclose as accurate figures as they can, because the worst thing
that can happen in a transaction at closing is to have surprises
come up in the amount of the total settlement costs. So I agree
that this is done as a matter of practice. We find that the problems
that we have had, personally, in our office, are with new salesmen.
And we have learned the first thing we must do is to educate them
to avoid any surprises at the time of closing. I think that most
offices do this as a matter of good business practice.
As long as no hard figures are required, that is precisely accu-
rate figures because these are impossible to determine, but rather
reasonable estimates with reasonable degrees of variation, this
kind of estimate is certainly appropriate, and I think this is the
general practice in the industry.
Chairman GONZALEZ. Thank you.
Mr. Lowery?
Mr. LOWERY. Thank you, Mr. Chairman. I would like to follow up
on your question regarding the HUD proposal for lender packag-
ing. It occurs to me that should we proceed in this regard, I don't
know why it should be limited merely to lenders. I don't know why
others could not put together a package, the broker or whomever,
and that sounds like we're getting dangerously close to this evil or
alleged evil, that we are trying to define and deal with today. That
seems to be one point to make.
Mr. Treadwell, we have heard your comments on the HUD
lender packaging, but I would appreciate it if the other members of
the panel would comment, as well. Just as briefly as you can, and
particularly along the lines of the expanded concept of allowing
others to package.
Mr. HILTON. Well, I would respond in the sense that if we have a
prepackaging, which we have today, really-if you have prepackag-
ing, I think anybody should be permitted to prepackage, as part of
our American system, and our American ideals. I think anybody
can be in any business, unless it is substantially to the detriment of
the public. If you had lender prepackaging, I would be concerned
that we would just be shifting the responsibility to some who would
want it and some who would not want it. And I don't think that
their interest would be in protecting the consumer when they were
shopping for these other services. As a matter of fact, you're going
to create a heck of a lot of new service companies, I would think.
If I were in the lending business, and had the responsibility-
which is kind of like the broker today, who starts with a fiduciary
duty-and by the way, out of the whole spectrum of services of-
fered in real estate, to my best knowledge the only person that
ever has the fiduciary duty is the real estate broker.
Now, I don't know all of the laws in all of the jurisdictions, but
generally speaking, the real estate broker has a fiduciary duty to
one of the parties, and I have always contended that everything
that we do in conjunction with that process gets us more and more
PAGENO="0462"
456
and more responsible to the consumer-which, in my judgment, is
good.
But lender packaging, I would be willing to shift the responsibili-
ty, and either commence the service to the corporations where they
are not really protecting the consumer by really shopping around.
It is still going to be doing business, and that sort of thing happens
because you have some reliance on people who you go to.
Mr. TATE. Mr. Chairman, the lender packaging concept only
came out last week, and the U.S. League of Savings Associations
has not had an opportunity to get the views of its membership;
however, I would offer my views. As I have indicated, there are
relatively few service corporations that voluntarily engage in the
packaging service now. I think the question to be asked is why.
And basically, I think the existing system, without packaging,
has been working rather well. Those that are doing it, I know,
would like to continue doing it. But I think mandatory lender
packaging may not be possible in all jurisdictions of the country. I
am very mindful of what Mr. Treadwell said about the variation,
one State and one county to the next. I am also mindful of the fact
that the service corporation and the lender are very interested in
good title. They have perhaps the largest stake in quality title
services.
Voluntary lender packaging seems to be the way to go. The
reason HUD recommended mandatory lender packaging would be
that the consumer would have a uniform basis of comparison. And
I think that if we go with reasonable estimates up front, available
from the realtor, those not offering a packaging service, the con-
sumer would be able to use the estimate to determine a meaningful
basis of comparison.
Mr. LEVINSON. Mr. Lowery, I believe that the concept of the
lender package may have originated in the Peat, Marwick report.
The concluding volume, the third volume I believe, suggests that
there might be three possibilities as Peat, Marwick saw it, in terms
of RESPA: to repeal it; to get into lender packaging, which I will
discuss in just a moment; or to perhaps try to strengthen certain
portions of the existing law.
The concept advanced by Peat, Marwick, Mitchell & Co., in
terms of lender packaging was based upon the idea that lenders
would have a little bit more leverage in dealing with title insur-
ance companies than would an individual consumer, so that they
felt that as a result, lenders having more bargaining position, being
able to talk about not one deal but thousands of deals, might be
able to have some effect upon lowering the ultimate cost in terms
of the title policy. I think it is kind of naive.
One of the reasons for that is that I believe that lenders would
find title insurance premiums, in terms of the total package, to be
rather insignificant. Lenders, in putting together the package, are
concerned, naturally, with not only mortgage rates, points that are
going to be derived and things of that sort, and the question of
whether or not they could be able to seek to be able to get a benefit
of $25 or $50-and, Mr. Lowery, it seems to me the most important
aspect-and then pass that on to the consumer who is totally
overlooked. Now, I think this idea of the lender package is frankly
just an attempt by HUD, in a way, to say we don't know how to
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deal with this situation; let's hand it over to the lenders and see if
they can't do it.
Mr. LOWERY. Why don't we turn it back over to the market?
Mr. LEVINSON. That was the conclusion. I think that is where it
belongs in the field of competition.
Mr. LOWERY. Let me ask a few more questions. What is the
current practice on disclosure to a client of financial interests,
whether it be the brokerage firm or a lender's service bureau, a
title company to an escrow service or whatever?
Mr. HILTON. Speaking on behalf of Coldwell, Banker & Co., all of
our documents, the originating documents, the original contract
makes full disclosure of our ownership of the mortgage company,
the settlement company and the title company. There is no re-
quirement that they be used.
Mr. LOWERY. Is this buried within some document or is it dis-
closed up front?
Mr. HILTON. Let me put it this way: it is eight-point, boldface
type on the front sheet of a one-page sales contract. It is the most
prominent portion of that document except for the title. As you
glance at it, it stands out; and I can assure you we believe in
notice. We will get our clients-I don't know of a title company
that has a notice in their escrow agreement that they are going
to-that they own the title company or vice versa, because they say
it is all one and the same. Settlement and title to them is the same.
To us, the real estate process is the same. It is all just little
component parts.
Mr. LOWERY. You define your own market.
Mr. GORDON. I might add that in California, all the broker-owned
title companies are making large disclosure by requirement of the
Department of Insurance.
Mr. LOWERY. Mr. Levinson, what has your experience been?
Mr. LEVINSON. Thank you. Mr. Gordon and Mr. Hilton are cor-
rect. My belief is that that statement appears about two-thirds of
the way down in printed form, and says roughly that the consum-
er-that is to say, there is acknowledgment or advice given that
the real estate broker has a financial interest in the escrow compa-
ny or in a brokerage company in--
Mr. LOWERY. Is that standard in your dealings?
Mr. LEVINSON. That is standard in the dealings. There is not,
beyond that, a statement to the effect of whether that interest
changes anything. Just like, please be aware that we may have or
do have a financial interest.
Mr. LOWERY. You commented that on any given day, the service
level is different internally within a title company. My question is,
Other than the timeliness of how quickly you were going to get the
policy back, how do you make that determination?
Mr. LEvIN50N. Well, that is an interesting thing, how these
things get down to common problems. I consider our firm privi-
leged to represent Guardian's underwriter, Safeco, whom I consider
to be one of the most reputable and finest title insurance compa-
nies in the Nation. So there is nothing I'm going to say which is
related to Safeco.
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Talking in general, title officers, who are the on-line people in
title companies who turn out information, have their good days
and their bad days after times.
Mr. LOWERY. I understand that. But say you are a realtor, and
you make a recommendation; how do you know whether somebody
is having a good day or a bad day, or whether they've had a fight
with their wife, or whether they got up on the right side of the bed,
or whether they are on a diet and have a headache, or whether
they have marital problems or whatever?
Mr. LEvIN50N. Because oftentimes--
Mr. LOWERY. You can't make that determination, and so my
question is: How do you determine, other than an objective stand-
ard of how quickly you are going to get a policy back, the level of
service?
Mr. LEVINSON. Those are the most significant things, you've just
touched upon them. In addition to that, you will find on many
occasions that the preliminary report that has been issued will
contain certain items in it that a consumer might find either
objectionable or even the consumer's broker, or items they really
want to have explained. The response time, Mr. Lowery, of various
title companies to those inquiries varies.
Mr. LOWERY. Well, it strikes me if the broker is faced with the
decision of losing the 3- or 6-percent commission, because of an
untimely delay, they are immediately going to switch to a title
company that is more responsive whether they have a financial
interest or not. I think to suggest that for the miniscule amount of
money that they can earn off from the referral, the broker will
accept less-than-adequate service flies in the face of reality.
Mr. LEVINSON. I'm on the same wavelength you are. The point
that I .had hoped to make in my testimony was one of the features
I find objectionable of the Guardian title philosophy, is rather than
inviting representatives from other title insurance companies to go
before their people and say on a regular basis, these people go right
out in the field. They want to go into the office, they want to say
use our title company because we can provide faster service.
Mr. LOWERY. If they meet the terms of the requirement, in
getting the deal closed, who cares? In the argument that has been
advanced before, on which Mr. Hilton and I agree-we have heard
nothing in the way of facts from anybody in terms of poor service
or sloppy searches resulting in more claims and greater losses at
greater costs. Where is the evidence to suggest that? We are talk-
ing about a potential problem. if there is full disclosure to the
consumer up front, where is the problem?
Let me ask you a further question.
Mr. CARMAN. Would you yield for just a moment?
Mr. LOWERY. In just one moment.
Have you ever advised clients, because of your concerns with
title companies that were involved, to switch title companies?
Mr. LEVINSON. Yes.
Mr. LOWERY. Under what circumstances?
Mr. LEVINSON. There have been several circumstances. In some
instances, it has been-and these haven't applied often to residen-
tial. It has been because the amount of the title policy was so
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significant that I felt that the company with greater financial
assets might be better for that particular client.
Mr. LOWERY. These were not residential sales?
Mr. LEVINSON. Yes, because of the dollars. All title companies in
California--
Mr. LOWERY. You said they were not residential?
Mr. LEVINSON. Yes.
Mr. LOWERY. These were large-scale commercial deals, where
often the fees are negotiated?
Mr. LEVINSON. No.
Mr. LOWERY. With very sophisticated parties involved and a
battery of lawyers on both sides?
Mr. LEVINSON. Yes, to some of your questions, and no to others.
[Laughter.]
Mr. LOWERY. I'm concerned, because you say you have not sug-
gested another company in the case of an unsophisticated, unsu-
specting residential buyer, because the fees are so low. In those
rare instances where we are talking about megabucks, where the
fees are often negotiated aėross the board, sure it makes some
sense to shop under those circumstances. My concern is the ration-
ale behind the Federal Government initiating legislation to be
binding across the entire land, in a situation that you, with a
fiduciary obligation to your clients, do not feel sufficiently signfi-
cant, for you to have felt an obligation to advise your client to
switch. I don't understand the need.
Mr. LEVINSON. If your conclusion is that we should abandon
RESPA, I would go with that. I feel there is a danger--
Mr. LOWERY. Then we're very much on the same wavelength.
Mr. LEVINSON. That is why I've been wondering where we've
been going from. I do believe that there is a concern that we all
share, that brokers not abuse the privilege or relationship that
they may establish with a consumer to their own financial benefit.
Mr. LOWERY. Well, I would like some facts to suggest when that
relationship has, in fact, been abused.
Mr. LEVINSON. May I answer? I want to answer just for a second,
another portion of your question. All title companies do not resolve
claims the same way that others do. To those of us in the field, we
observe that there are variances in the response to claims. A
person who buys a title insurance policy, Mr. Lowery, hopes to
never have to use it. It is when the claim arises that they suddenly
say what the heck is a title policy and what does it mean? It is at
that time that we have observed that, and that is the reason for
having purchased the policy, that various title companies have
different attitudes as to the handling of claims.
Mr. LOWERY. Are there not procedures set up within State juris-
dictions for an inordinate amount of these types of abuses, for the
state licensing agency to come down and come down hard?
Mr. LEVINSON. The insurance code in California, to the best of
my knowledge, only requires the insuror to act in good faith. I
think it would be--
Mr. LOWERY. The State insurance commissioner is well aware if
there are abuses of title companies that continually have faulty
searches and are continually having problems. It affects their
whole financial status and well-being.
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460
Mr. LEVINSON. But I want to be able to make the point that to
the consumer who only buys a house or gets involved maybe once
or twice in a lifetime, and probably never looks to the title policy, a
real estate broker who is a professional is involved in thousands of
the activities and will become acquainted with the occasional
claim. I want that real estate broker, who is able to then evaluate
the performance of a title company, to say if the person that I
represent, this person who is buying the house does have a title
claim, are they going to be dealing with the title company who is
going to take care of the claim quickly? Is that going to be the best
company?
Mr. LOWERY. Mr. Levinson, I would agree. As an attorney deal-
ing in the field, have you ever entered a situation where you have
recommended against a particular title company because you felt
their work was consistently sloppy and it jeopardized the interest
of your clients?
Mr. LEVINSON. Yes.
Mr. LOWERY. In residential?
Mr. LEvIN50N. Several years ago, yes.
Mr. LOWERY. You said earlier that your concern is with instances
where the fee was too high, not that the quality of the work was
deficient.
Mr. LEvIN50N. That wasn't my answer to your previous question.
You had asked whether or not, because of the financial aspects,
and I said in large, commercial transactions we have sometimes
suggested a particular title company or companies had better fi-
nancial resources than others.
Mr. LOWERY. But you have advised a client to change companies
in one instance, at least, because of the poor work of the title
company?
Mr. LEvIN50N. Yes.
Mr. LOWERY. Have you advised the other parties that were in-
volved, the broker and the lender, of your concerns?
Mr. LEvIN50N. I don't know if I did, and I apologize. I really
don't know. I don't have a recollection.
Mr. LOWERY. In what percent of your cases would you say that
occurs?
Mr. LEvIN50N. There are, Mr. Lowery, right now, quite a few
title insurance companies in California that the department of
insurance is concerned with.
Mr. LOWERY. Well, then, there is an appropriate agency to deal
with those kinds of abuses. I'm still wondering why the Federal
Government should be involved?
Mr. LEvIN50N. I don't want the Federal Government involved in
it. But my response to your question is that if I found a person
buying a residence who came into us and said my real estate
broker suggests using a particular title insurance company and I
knew that that title company was having problems in the State or
appeared to be undercapitalized or was not really responding to
claims on time, I would suggest to that client, "Pick another title
company."
Mr. LOWERY. But you've only done it once? And I assume the
broker would give the same advice to their clients. I would like to
know some instances where that has happened and there has been
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an ongoing or continuing pattern. I have yet to see any evidence of
that.
Mr. Chairman, I appreciate the time.
Mr. VENT0. Mr. Chairman, I've been waiting and we're well
beyond the 5 minutes. I don't want to object, but we've all been
very patient.
Chariman GONZALEZ. We will distribute the time liberally.
Mr. LOWERY. Thank you, Mr. Chairman.
Escrow referrals and referrals for title insurance from title com-
panies; do you know, is there full disclosure in those instances? Is
there not a fiduciary obligation to so disclose for a possible finan-
cial interest, and what is the law in that regard? The title company
handling the escrow; is that not along the same lines of the things
we're talking about?
Mr. LEVINSON. It is along the same lines, Mr. Lowery. I don't
know of any law--
Mr. LOWERY. That requires disclosure?
Mr. LEvIN5ON. I know of none. When title companies handle
escrows, as they often do, they have independent escrow instruc-
tions, that is to say, the instructions are on their standard form. It
will say that the title policy would be issued by, and their name
would be printed. If your answer is does then Blank Title Co., who
is handling the escrow, say that the title policy that will be issued
will be by our company and we are one and the same, no, I don't
know of any companies that disclose that.
Mr. LOWERY. Well, I have trouble distinguishing between that
and what we are talking about in terms of potential abuse. It
strikes me we are talking about marketing techniques and vertical
integrated services. And unless there are definite abuses, I have
some concerns as to why we're getting involved in the first place.
Mr. Chairman, I thank you very much.
Chairman GONZALEZ. Thank you, Mr. Lowery.
Mr. Vento?
Mr. VENTO. The question, that is replete through your testimony,
is whether or not there is competition or, at least, buyer search for
title insurance and other types of settlement services fees. And it's
your judgment that that does not occur by virtue of the require-
ments of RESPA.
Mr. HILTON. Is that directed tO me?
Mr. VENTO. Well, to anyone who wants to answer it, Mr. Hilton.
If you'd like to answer it, that's fine.
Mr. HILTON. Well, to take that in parts, I'm realistic enough to
understand that residential purchasers and sellers do not shop for
any of those services. It just does not happen.
Mr. VENTO. Mr. Treadwell, as someone representing the realtors,
do your members try and point out the differences in cost or prices
of any of these services to consumers? I mean, if disclosure by itself
isn't doing it, do the realtors take an active role in terms of looking
or shopping around and advising consumers with regards to settle-
ment services?
Mr. TREADWELL. Initially, when the transaction is written up, the
general practice-and it's not universal, but the general practice is
that an estimate would be made of what the total selling cost will
be, and that is usually broken down in front of the customer or the
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client. Strictly from the standpoint of good business we want, as a
salesman, to let the customer know that someone else is charging
for these services. This isn't something that is being charged by our
particular company. In other words, there's a survey required, an
appraisal, of whatever the other cost factors might be. I think this
is the general practice.
Now, in most cases the actual cost of a title policy on a residence
is, at least in Michigan, standard. The maximum rates have been
set by the State insurance commissioner and are controlled by the
commissioner, and there is no negotiation that I've ever been
aware of in the 40 years that I've been in the business. On larger
policies, major commercial policies, there is negotiation.
Mr. VENTO. What about the other services that might be re-
quired? A survey and certain other fees, are they negotiable? Is
there any reason to shop around for those particular fees, in your
judgment?
Mr. TREADWELL. Yes. Generally these-in fact, surveys and ap-
praisals specifically are supervised by the lending institution. I'm
also on a bank board of directors and have been for 25 years, and
periodically we do shop for quality of service and fee. And of
course, during the last 7 or 8 years, that has been a constant
problem.
Mr. VENTO. Is that a practice of outlining the cost at the time of
a sale or at the time of the first contract? Because I guess the
escrow contract is that duplicitous, in the sense that RESPA also
requires something of this nature?
Mr. TREADWELL. Yes. I think that, generally speaking, this type
of information has been supplied by most brokers as a matter of
course.
Mr. VENTO. But the difference is the legal requirements with
regards to whether or not there is a standard in essence, other
than that of your own professional association or of your own firm;
is that correct?
Mr. TREADWELL. Yes, that is correct, whether or not it is a policy,
it's done because it's good business, not because it's required by
some law.
Mr. VENTO. With regards to the settlement package, What is the
position of the National Association of Realtors concerning the
severability of the elements of the package? Do you feel that con-
sumers should be able to shop around for each separate element?
You would not disagree that there should exist an opportunity for
the purchaser to obtain these services from a company not associat-
ed with the lending institution.
Mr. TREADWELL. That is a personal opinion, but I would say that
it does not make any particular difference because I think competi-
tion will take care of that. Right now, of course, we are at a time
when there is very little competition for clients by mortgage com-
panies and banks and savings and loans. But under normal condi-
tions, there is competition to place these funds at the highest price
that they can be placed in terms of interest and all the other
charges. So I think these things will be regulated by competition in
normal markets.
Mr. VENTO. One element that has been talked about here a lot, is
the kickback scheme and the competition for settlement services.
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And I don't know what they were thinking in 1974, but I would
guess one of the primary considerations was that at the time of
closing, that Congress wanted to eliminate the surprise element. In
the past, many individuals had a very large bill for which they had
to write a check at that moment that they did not expect. Isn't that
a significant factor in the creation of this legislation?
Mr. TREADWELL. I think it was, and I believe the record would
show that the primary concern was the large attorney's fees that
were charged by lenders in connection with closings. That wasn't
the sole concern, but it was certainly one of the primary concerns.
And all of these other ancillary matters then got into it.
Mr. VENTO. Well, I think that that is very correct. How would
you characterize changes, within your profession? Recently we had
a problem that arose with regards to buyer-broker fees in FHA and
VA insurance in certain jurisdictions. With regards to that, do you
think that the growth or use of buyer-broker will be a significant
help to purchasers?
Mr. TREADWELL. Do you mean by this that there will be a broker
representing the buyer as well as the seller?
Mr. VENTO. Yes.
Mr. TREADWELL. In our own office and in the industrial/commer-
cial areas, we operate about 40 to 50 percent of the time as a
representative of the buyer now. I think as a practical matter, the
public hasn't been educated to the necessity or advisability of
hiring brokers to represent them in the purchase of a house. I
think that is a long ways away.
Historically, the National Association of Realtors has been pro-
moting the position that they would represent as the agent the
principal who normally would be the seller, because he's the one
that pays the commission. This position goes back to 1908 when the
association was formed. One of the problems at that time was that
the broker, or the people who functioned as brokers, were acting on
their own behalf and not representing the sellers and were taking
whatever they could get in the way of commission, buying proper-
ties and acting almost as an independent business, using other
people's property as the merchandise. This, I think, has been
stopped, and it's been clearly established that there is a fiduciary
relationship which is generally well regarded.
I think most of the established offices jealously guard their repu-
tation because there is a tremendous amount of repeat and referral
business. So while there have been-I'm sure there have been some
abuses, generally speaking, we have established this pattern.
Specifically, I don't think this pattern of our representing the
seller will change in the immediate future in residential properties.
I think in the long run it may very well develop that way.
Mr. VENTO. Thank you, Mr. Chairman.
Mr. Hilton, did you have a response?
Mr. HILTON. Mr. Vento, as I hear your question on the severabil-
ity-the question, if it related to mandatory severability-I think
we have to have that, or you are going to have an illegal tie-in. It
has to be severable in some fashion, in my opinion.
Mr. VENTO. Well, I think that is the problem, and I think-
irrespective of what the law is and what is right and proper-or we
have a very hard time I think under the current RESPA under the
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proposal from the administration establishing that severability in-
deed exists. That was indicated in your previous testimony. And so I
don't know what good ideas we can come up with to maintain that
but it is essential that there be severability from the standpoint of
maintaining competitive prices and service and quality.
Thank you, Mr. Chairman.
Chairman GONZALEZ. Thank you, Mr. Vento.
Mr. Carman.
Mr. CARMAN. Mr. Chairman, I would like to follow up on a point
with Mr. Levinson and the other members of the panel that was
raised before, specifically referring to the fiduciary relationship of
broker-owned title insurance companies.
Certainly, if you have a mandatory situation-I am very, very
concerned about that, obviously-and even in a voluntary situa-
tion, which obviously you've had the experience with out in Califor-
nia, as you've described here today-I see particular problems of a
conflict of interest that potentially are very, very substantial.
For example, let us say that we have a particular builder who is
about to become involved in a tract development, and the particu-
lar builder is interested in developing a particular parcel and is
going to a lending institution and looking to secure a substantial
loan. The broker, obviously, is interested in securing, hopefully, a
substantial commission. He goes to his own title company and says:
We have a very, very difficult title exception in this matter, and we are concerned
about the proper passage or the proper omitting or the appropriate disregarding of
that title exception in order to satisfy the lawyers representing the lending institu-
tion that are going to be looking to this property as the security for the loan.
And it occurs to me that the broker, especially because he is
interested in securing a very substantial commission in this trans-
action and doesn't want to do anybody in but nevertheless doesn't
want to lose his commission, may very well exercise a substantial
amount of leverage on the title company, whether he owns it or
not but especially if he owns it, to secure the passage of that
exception. An example is where we might have the right of rever-
sion of that real property to some third party because some restric-
tive covenant has been placed upon the property, a reversion that
might not be regarded necessarily as a forfeiture and therefore
might be subject to proper passage.
Under those circumstances-No. 1, the consumer who buys one
of these houses is going to be hurting. No. 2, the lender is going to
be hurting, who, by the way, wasn't even made privy to this
conversation that went on between the broker and his own title
company or this title company with whom he has a rather substan-
tial business relationship. And of course if the Federal Government
happens to be involved in regard to this transaction, insuring it
through the FHA or the VA or some other particular governmen-
tal agency, they may also feel bad about this particular transaction
they didn't know anything about.
So when we bandy about this term "fiduciary", I think it is
something that is very important. I'm not trying to impugn any-
body, but I'm suggesting that there is a built-in conflict of interest
there that I don't think we've discussed, and I think you know
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what I'm referring to. I would submit that you don't have any
special quarrel with what I'm raising here.
Mr. LEvIN50N. That is exactly true. I concur completely. I feel
somewhat in a difficult position here, because I cannot breach a
confidential relationship in terms of the attorney/client, but I
know of a case that is so parallel to that in Los Angeles where a
major real estate broker in a large residential transaction of sever-
al million dollars pressured the broker-controlled company that he
was involved in to issue a policy, even though the title insurer,
when the search was originally made, said they were not going to
insure the title.
Mr. CARMAN. Mr. Levinson, I will go further and indicate to you
that I am aware myself of instances, not where brokers have done
it, but where the developer himself has done it, because he is
channeling so much business toward the title company that he
says, "Hey, look, you people don't want to write my business;
there's no problem. The one down the block will." And depending
upon the economic viability and stability of the company you could
end up having any kind of strange aberration of the title report
coming to the fore.
And I just think it is important to make sure that is clear,
because when we talk about mandatory controlled business, we've
got tremendous problems. And even in these other areas where
we've got built-in conflicts of interest, I think we've got some
problems.
Mr. LEvIN50N. Congressman, might I just point out that I agree
with you completely and the statements that have been previously
made here-that by putting a disclaimer on escrow instructions or
on listing agreements or a contract that says that the broker has
an interest in a title company, that in no way covers the situation
that you are describing.
Mr. CARMAN. I totally agree with you, especially when you con-
sider that some people think that "escrow" is "escarole" which you
make salad from. [Laughter.]
Now the other thing I would like to comment on is a statement
made or some of the comments made here by Mr. Tate. He com-
ments on page 8 of his testimony, that regulated financial institu-
tions are already subject to too many sets of regulations from a
variety of Federal agencies, in addition to the agency which is the
principal regulator.
I'm inclined to think, with all due respect, Mr. Tate, that may be
an understatement, and that is a strong statement that you have
made. But certainly insofar as the Federal institutions are con-
cerned, I think virtually every single Federal institution or virtual-
ly every single lender in this country is certainly regulated, if you
want to consider that-virtually all of them are tied in with the
FSLIC or the FDIC, so you've got a tremendous involvement with
the Federal Government there anyway.
But I do raise this question, forgetting for a moment about
mandatory controlled businesses, which frankly I think I don't tend
to favor, which is probably clear from what I'm saying here, but
even in other areas where we have voluntary tie-ins, it seems to
me that somewhere along the line, whether it is done at the
Federal level or the State level, we need to be aware of these
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potential conflicts that are not cured, as Mr. Levinson has pointed
out, simply by someone placing a stamp on a RESPA form, a truth-
in-lending form, or some other defined form of disclosure, saying
that somehow there are conflicts here.
I think that is an area where we have got a conflict, as I've
described here, between the broker and the title company without
the lender, in the example I raised before, even being consulted,
much less the consumer who has no idea what is going on or the
Federal Government or a State agency that might be insuring
these loans, depending upon how the thing is set up.
And if anybody would comment on that, I would appreciate it.
Mr. TATE. Well, Mr. Carman, I think your earlier example of the
broker and the title company conspiring to slip the lender a bad
title happens just about once. The lender would not continue to do
business with that particular--
Mr. CARMAN. Mr. Tate, when that happens, for those who have
been very experienced in this field, keep in mind that the claim is
not really that often presented in the title area. So you are talking
about questions of the technical concept of marketability of the
title, and I'm suggesting to you that the lender, the Federal Gov-
ernment, and the consumer may not even be aware of these partic-
ular areas. And ultimately a tremendous amount of money is
earned here. And there is more than just one deal. The first deal
that he finds out about, he may say, "How could you do this to
me?" and all of a sudden turn around and find out his mortgage
portfolio is sitting there with, say, $10 to $20 million worth of
deals, and-surprise, surprise-then he really finds out about the
latent difficulties he's got in the transaction. He also takes a look
at the title company and finds out that notwithstanding all of their
reserves, he doesn't feel so comfortable about their ability to meet
these potential claims that they might have.
Mr. TATE. I am mindful of the potential of this problem. T am not
aware of any practical experience in this area.
As far as your other question, savings and loans are not only
required by insurance regulations to disclose their own interest in
title agencies; they must also inform the customer in writing that
he may obtain his insurance services anywhere. So we think that
the insurance of accounts regulations adequately cover this area,
and additional regulations, whether it be Federal Reserve or
escrow or truth in lending or what have you, may be excessive.
Mr. CARMAN. Well, I don't quarrel on that with you. I think the
lending institution is covered.
My question to you is, Do you think that the insurance regula-
tions at the present time extend far enough? Do you think that
there should be some area where there should be an examination
or some further step in regard to auxiliary business, just to the
lending institution, such as brokers and title companies and so on?
Or should it be allowed to stay the way it is?
Mr. TATE. I think it should be allowed to stay the way it is. It is
my judgment that the lender-controlled agencies are actually the
innovators in price and service.
Mr. HILTON. Mr. Carman, I would like to respond a little bit. I do
agree with you, when you have the bad actor who passes on a title
defect and he doesn't make a disclosure.
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467
I suggest to you, however, that even in your own example, this is
not really logically, percentagewise, connected or related to the
controlled business aspect that I came prepared on. I think for
every example of someone who you express in terms of a broker-
owned situation, I can give you 20 where the person that asked the
title company to pass on the defect had leverage for other reasons.
So if we were to prohibit the controlled activity on that basis, I
would say that would be logical in our situation, and I have diffi-
culty talking about the industry. Our salesmen really don't have
leverage. I mean, someone who has two or three transactions a
month, for heavens sake, doesn't have leverage over the ownership
of and management of our company to the point where we're going
to write around it and take a big future loss at some date.
I have seen leverage. I have been asked to go around transac-
tions. I have been asked by the insurance commissioner my partic-
ular philosophies on writing~ around the defect with knowledge of
some of the people involved. And some of the title insurance com-
panies-some of the national insurance title insurance companies
have a different attitude than I do.
If a home buyer were to buy a policy and there was a potential
defect or break in the chain of title, as an example, so that they
could completely be removed, I would say we will not write the
policy, even with all kinds of notices. And so there are some
differences there. But notice that we give of our ownership doesn't
cure anybody's crooked operation-the potential.
It's very difficult to say that, because it is potentially a risk.
However, there are press accounts. Whenever you place your funds
in a stockbroker's or attorney's office, they could steal it.
Mr. CARMAN. I am less uptight about the voluntary aspects of it,
frankly, than the mandatory aspects of it. But I am raising it even
in the voluntary aspects. You have a potential for it. Certainly in
the mandatory, I think you can get very strange aberrations and
results.
Thank you, Mr. Chairman.
Chairman GONZALEZ. Thank you very much, Mr. Carman. I
think you followed right through on a point that was kind of left
suspended somewhat by Mr. Lowery. The key question is, whether
or not, in a controlled situation, you wouldn't have reluctance on
the part of the parties involved to disclose their interest.
Now as I was listening to you, the complexity of the problem
confronting us I think was very much illustrated. However, the
example you mentioned, seemed to me to fall within the jurisdic-
tion of a fraudulent preparation of title search.
Mr. CARMAN. Well, not necessarily, Mr. Chairman, because you
are dealing in many cases with a question of discretion. It does not
necessarily connote the idea of fraud, but whether or not within
the framework of a business transaction less than fraud, you might
have an overreaching-which is certainly not even the equivalent
of a civil or a criminal fraud-that might possibly be taken into
account by the state that you are dealing with.
And what is interesting in that is that the people who are going
to be substantially affected by it are not even consulted or made
aware of it. And it goes on every single day.
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Chairman GONZALEZ. True, but if there is an omission of such a
vital thing as a reversionary clause or a restrictive covenant, the
title searcher would, in my opinion, not only be negligent, but
could be guilty of fraud or conspiracy.
Mr. CARMAN. Well, the problem with it is, sir, they would not
necessarily disregard it. But under some circumstances they might
give something called affirmative insurance against its implemen-
tation. In other words, they may acknowledge that the reversion
exists there but under some circumstances offer various types of
positive insurance against its implementation.
Now that might be more satisfactory to the lender involved. But
what happens in practice, I believe, is that sometimes lenders rely
too much upon the title insurance companies and don't go behind
some of these exceptions and look at them independently, which
means that if you have extensive practice in this area, you could
end up with very difficult results. And I think if we ended up with
mandatory controls, it would appear to me that we might end up
with a result which would tend to exacerbate this kind of practice
which simply exists in the marketplace anyway.
Chairman GONZALEZ. It's true. But the complexity of the situa-
tion confronting us is that if we are attempting to legislate on a
national level with a myriad of differences in practices and cus-
toms and laws in the various States, other-I think there is diffi-
culty there.
Mr. CARMAN. Well, what I suggest, sir, is that the very point you
make about the Federal Government trying to legislate on a na-
tional level to solve all of the problems in the several 50 States
becomes a very, very difficult one indeed.
We have even within individual States tremendous, as I under-
stand it, variations in practices. In some places, we rely upon only
abstracts of titles to see what the title looks like, and we don't use
title insurance in individual States. For example, that happens in
the State of New York. In other portions of New York where I
come from, of course, we use title insurance policies.
I think what is important to understand is that by trying to
enforce a broad brush of mandatory requirements, we end up with
rather strange results, and T believe the result of the RESPA
legislation is emblematic of that particular difficulty which you so
eloquently have elucidated upon.
Chairman GONZALEZ. That's true. But nevertheless, the fact is
that we have had national legislation since 1974, which was intend-
ed to curb widespread abuses that were not being adequately ad-
dressed at the State or local level.
Now there was one other thing in your presentation there--
Mr. CARMAN. I was only asking questions, sir. [Laughter.]
Chairman GONZALEZ. But in such a large transaction as you
described, it is unthinkable to me that in any jurisdiction that the
lender wouldn't do his own checking on the title.
Mr. CARMAN. The practice is not that way, Mr. Chairman, as I
understand it, throughout the various States. That is why we have
title insurance companies. That is why we have abstract compa-
nies. And lenders as well as consumers look to the title companies
to effect the search.
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469
Happily, in some of the situations, as I understand it, through
the country-and it is one of the reasons why I suspect that lend-
ers generally speaking, institutional as well as others, are extreme-
ly anxious to have their own lawyers examine what is going on is
because they are able to go back and check independently and
make sure that the title company is doing its job or the abstract
company is doing its job, and therefore we get a higher quality of
performance.
But if we were, to say in the interest of protecting everybody, we
are going to require mandatory controlled practices, we are going
to require lending institutions to either hire lawyers off a list, or
people who are going to be protecting these loan obligations, we
may very well end up getting exactly the opposite result that we
are looking for in trying to make sure the consumer is protected.
The lender is protected, and indeed the Federal Government, when
it is involved with FHA or VA practices.
Chairman GONZALEZ. Mr. Tate.
Mr. TATE. Let me assure Mr. Carman that the right to counsel is
very basic in this country, and I hope we're not going to be having
to hire attorneys off of a list.
Mr. CARMAN. I hope not, too.
Mr. TATE. In a large transaction as you describe, the lender
typically would retain its own counsel as well in the review of the
title.
Chairman GONZALEZ. There was also one point that I wanted to
make, Mr. Tate, before we close in connection with the statement
of overregulation, particularly in the area of the savings institu-
tions.
Yesterday, in the statement prepared by Mr. Vartanian, on page
3, he said, regarding insurance, Bank Board regulations allow re-
ferrals to a service corporation offering insurance services, but also
require that a potential mortgagor be informed of his or her right
to select freely any insurance provider.
The following is an example of language for such a referral
which the Bank Board considers unobjectionable, but which would
appear to be impermissible under HUD's 1980 interpretive rules.
And I quote, as he quotes:
You may select the title insurance and hazard insurance provider of your choice.
We retain the right to refuse insurance issued by the company of your choice if we
have good cause for doing so. May we suggest the services of the service corporation
from whom we have received especially good services.
Now, it seems to me this does nOt require disclosure of ownership
interest. Are there any regulations that do so?
Mr. TATE. Yes, sir, it is my understanding that he RESPA regu-
lations require disclosure of ownership. And the insurance of ac-
counts regulations also require disclosure of ownership in a conflict
of interest situation.
Chairman GONZALEZ. The point with respect to the RESPA rules
and legislation is that only if the service is mandated or required,
not just recommended, is the disclosure of an ownership interest
mandated.
Mr. TATE. In States called for title insurance, that is required by
the lender.
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470
Chairman GONZALEZ. As my counsel says, only if the S. & L.
requires that specific use does RESPA then require the disclosure.
At least that is our interpretation of the present rules and regula-
tions.
Mr. TATE. I will be glad to prepare a statement for you on that.
Chairman GONZALEZ. We will be grateful for that.
Mr. TATE. It's my understanding that the general practice is to
disclose and we actually prefer to disclose for several reasons, not
the least of which is we think the consumer needs the best service
possible.
Chairman GONZALEZ. We will have some questions in writing
that we will submit in ample time for you to address yourself to
them in time for the preparation of the transcript.
[The following additional written questions were submitted to the
panel of real estate professionals and appear with their responses:]
QUESTIONS SUBMITTED TO Ma. TREADWELL AND MR. TATE
Question 1. Given the financial difficulties in the mortgage and realty industries,
is it likely that any cost-saving efficiencies that might be related to a controlled
business relationship will be passed through to consumers?
RESPONSE RECEIVED FROM Ma. TREADWELL
As a practical matter, the competitive nature of the real estate business normally
provides the impetus to pass cost-saving efficiencies resulting from such relation-
ships through to consumers. In difficult economic periods, such as are now being
experienced, competition for real estate sales probably makes this even more likely.
Question 2. What opposition would your associations have to permitting S. & L's
and realty companies to own service corporations, such as title agencies, but prohib-
iting these from referring their clients to such agencies? Wouldn't such a require-
ment enhance competition by permitting new entrants into the real estate settle-
ment process but avoid any potential conflicts of interest that could harm the
unsophisticated purchaser?
RESPONSE RECEIVED FROM MR. TREADWELL
The National Association of Realtors favors competition in the offering of all
services. "Controlled business" relationships should be viewed with three basic
principles in mind. First, the integrity of the fiduciary should be preserved. Second,
funds deposited in a fiduciary should not be utilized to compete with businesses that
are not so funded. And third, full and timely disclosure of potential conflicts of
interest should be made.
Our principal opposition to permitting savings and loan associations to own title
agencies directly or indirectly is based on their character as financial institutions.
As such they have a fiduciary relationship well recognized in the controls and
guarantees imposed by their regulators, including, but not limited to, insurance of
their deposits by their regulators, special provisions that assure their solvency. We
consider it highly inappropriate to utilize assets of profits from such assets to
support business enterprises subject to normal commercial risks. For example, evi-
dence indicates that a significant amount of the losses and lack of liquidity suffered
by savings and loans recently has been due to their involvement in land develop-
ment and similar activities. Such activities expose them to conflict of interest in
that decisions are sometimes made to assist the anciliary activity by providing funds
at rates and terms not generally offered to their other customers.
The Association would have no objection to a realty company owning a service
corporation providing there is full and timely disclosure so that prospective users of
its services might obtain competitive bids if they consider it in their best interests.
Obviously in this prohibiting those realty companies from referring clients to such
agencies would obviate the need for disclosure although it would reduce competition
slightly so far as their clients are concerned.
RESPONSE RECEIVED FROM MR. TATE
Insofar as Federal and most state S&L associations are concerned, service corpora-
tions have been created by law to provide a number of customer services such as
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title insurance, hazard insurance, appraisals, escrow services, tax return prepara-
tion, etc. It would be inconsistent with the intent of Congress in authorizing service
corporations, in the Housing Act of 1964, were associations only permitted to serve
non-mortgage customers with their subsidiary service corporations. In many mar-
kets it would be difficult, if not impossible, to serve just non-mortgage customers
since associations are the main source of home financing in these markets. Elabo-
rate cross-check systems would need to be developed to meet any "non-mortgage
customer only" requirement. Many existing service corporations would find their
remaining market for non-association mortgage customers so hard to determine that
they would probably drop out of the settlement service business. This would reduce
rather than enhance competition.
QUESTIONS SUBMITTED TO PANEL
Question 1. It seems to me that in addition to the issue of whether or not
controlled business practices add to settlement costs of homeowners, another crucial
issue that must be addressed is how to better educate and inform the consumer, so
that he or she will be more inclined to shop around for these services.
Do you have any suggestions as to how consumers can be made better informed as
to how title insurance operates and how to evaluate the services it provides?
RESPONSE RECEIVED FROM MR. TREADWELL
The National Association of Realtors has heard little complaint from consumers
relative to their desire to know more or have more information concerning title
insurance. This line of insurance renders generally trouble free service and the
consumer has expressed little desire to know in detail how to evaluate this service.
Since title insurance is state regulated, we suggest that consumer education
efforts be developed at that level, rather than a national level which may create
more problems than it solves.
The secondary market will provide sufficient standardization in title insurance,
much as it already has with private mortgage insurance. The marketplace will
dictate standards of quality which will benefit the consumer as well as other
participants in the transaction.
RESPONSE RECEIVED FROM MR. HILTON
It is my opinion that the consumer will not shop for title services no matter what
legislation is passed or proposed. The consumers will continue to rely upon their
attorney, their real estate broker, or the lender who makes use of these services on
a daily basis. Since the rates are almost identical in the comparable market area,
the consumer would be theoretically shopping only for the title entity that provides
the best service. Since the service consists of abstracting the title and then writing
an insurance policy, the evaluation of these services is extremely subjective and
simply could not be evaluated by the normal consumer. Perhaps instead of empha-
sizing the consumer shopping in this impossible situation, the emphasis should be
placed on increasing the duty and liability of the service provider. Perhaps the title
insurance industry would be willing to accept a fiduciary duty to the ultimate
consumer in lieu of a bare contractual insurance relationship. This could reduce
some shoddy practices in the title insurance industry and create an emphasis on
real quality of service.
Question 2. Is there any evidence that when a lender or realtor "ties" their
service to additional settlement services that efficiencies are created and that any of
the resulting savings are passed through to consumers?
RESPONSE RECEIVED FROM MR. TREADWELL
The need to increase the ease and economy of transfer of interests in real
property provides the incentive to refer business to known providers, some of whom
are corporately related to the referrer. The efficiencies of these relationships are
savings in time and therefore, in a sense, money. That they are passed on to the
consumer is inherent in their operation.
RESPONSE RECEIVED FROM MR. HILTON
It should be understood that the few realtors that provide additional settlement
services do not tie or require the use of those services. At the present time, I don't
believe that there is any hard evidence available to prove or disprove that the use of
these ancillary services results in significant cost differences. In my 28 years of
experiences, I have been convinced that the consumer wants and expects, to the
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extent possible, a one-stop real estate settlement transaction. Shopping for a home
can be a harrowing experience as many of us know. If, after having found our home
to be purchased, we were required to individually shop for a surveyor, title compa-
ny, settlement agent, leader, it would be extremely onerous. Since I don't believe
the consumer would do this shopping and would ask the attorney, realtor, or lender
their best opinion, the shopping would still be through a single source. This is the
real consumer benefit in the realtor providing these ancillary services. There are
efficiencies to the counsmer in terms of saving time, effort and energy in completing
his transaction by having one of the professionals request the necessary services to
be performed in conjunction with a closing. A professional would distribute the
paperwork to the proper places at the right time and generally do the running for
the consumer. In addition, where the professional is directly involved in all the
settlement services, solutions to problems are more easily identifiable and deter-
mined in order that the transaction can close satisfactorily or can be terminated if
the problem is insurmoutable. In many real estate transactions, the problem is that
there are too many fingers in the pie and the left hand has no idea what the right
hand is doing. Obviously consumers who desire to do all of their own negotiations
with additional service providers should not be inhibited from doing so. If they
think a particular title policy from one company is better than a title policy from
another company, that should be their choice. We must, however, recognize objec-
tively that most of the endorsements used by the title insurance industry are the
same or so similar as to be indistinguishable. A new endorsement by one insurance
company is almost immediately followed by the industry.
Question 3. Given the dire financial straits or many S. & L's, wouldn't it be rather
tempting for a lender to refer a consumer to a subsidiary whose income will raise
the profitability of the S. & L. before he referred a consumer to a competitor who
might provide better service?
RESPONSE RECEIVED FROM MR. TATE
Our condition as an industry is a matter of great concern to us and to those who
have come to depend on savings and loans to supply home mortgage credit. Never-
theless, our understanding of the antitrust laws is that there is no limitation on a
seller of one product, promoting or encouraging the voluntary purchase of a second
product by this customers. We consider it appropriate and rational economic behav-
ior, therefore, for a lender to cross sell customer services. The HUD/RESPA study
shows settlement service costs provided by service costs provided by service corpora-
tions to be competitive. Also, the consumer is free to select any competitor that
might provide better service or a less costly product. Detailed Insuramce of Ac-
counts regulations also require the lender to inform the borrower of his right to
obtain insurance services anywhere without affecting the outcome of his loan appli-
cation.
RESPONSE RECEIVED FROM MR. TREADWELL
Human nature being what it is, the concern expressed in this question could be
legitimate. If such referrals are necessary to permit profitable operation of such
subsidiaries, this reemphasizes the inappropriateness of permitting fiduciary institu-
tions to indulge in ancillary activities such as service corporations.
RESPONSE RECEIVED FROM MR. HILTON
At the working level of the settlement providers, the question of better service is
100 percent subjective. It would seem to me if a S & L believed that is subsidiary
gave poor service that they would make every effort to train or hire individuals who
would provide the service in a satisfactory manner. Generally speaking, in the
settlement provider area we are not talking about a highly sophisticated profession-
al activity. While the intelligence and skill levels can be high, the service can be
provided by a large segment of our population with minimal training. In short, if a
title company had a searcher who demonstrated a lack of ability to consistently
search the public records or its own title records, that person can be replaced and
frequently is. It is true that over the course of years there may be a discernible
difference in the service provided by various individuals. I suggest, however, "better
service" is generally the result of frequent contacts with the real estate professional,
an understanding of how to cooperate with each other, a realization of the respec-
tive roles that each plays in the real estate transaction so that their "timing"
becomes similar to that of a quarterback and a wide receiver. If this relationship
does not develop, the individual service providers generally move on to some other
field of activity.
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RESPONSE RECEIVED FROM MR. GORDON
In the real estate business, the salesperson, who in most cases is an independent
contractor, is vitally concerned that he use the best and most efficient settlement
services for a transaction. There is no loyalty to company-owned ancillary services.
The biggest barrier to the utilization of company-owned ancillary services is to
convince the salesperson that ours provide service which is as good or better than
those he is presently using. Whenever this is not the case, competitor services will
be selected over ours by the salespeople.
QUESTION SUBMITTED BY CONGRESSMAN EVANS OF INDIANA TO MR. TATE
Question. Isn't it clear that if you are a real estate broker or mortgage lender and
stand to benefit personally from steering your customers or borrowers to a title
company you own, that you will have a strong incentive to direct business to that
company even if other independent companies in the area provide better service or
rates?
Answer. Most Federal and many state associations are mutual institutions. Thus,
in the case of such institutions, an individual may not personally benefit from
services provided by a subsidiary service corporation owned by a savings and loan.
Under RESPA the lender may provide any number of settlement services directly
within the association. We see no distinction when a subsidiary service corporation
is used.
Borrowers do shop for alternatives and are influenced by lower costs or better
services. Many consumers find the settlement package to be such a nominal part of
the entire loan transaction that they select the lender's subsidiary service corpora-
tion, when it offers these services, because of more timely service that is either less
expensive or not any more expensive than alternative providers. The main interest
of the lender is to assure timely service in originating mortgages. Also whether
mutual or stock institutions are involved out of 2700 service corporations under 100
engage in the title agency business. The few service corporations that engage in the
title agency business do so primarily out of a customer service motivation.
Chairman GONZALEZ. We are grateful for your time and your
presence here this morning. Your testimony was very valuable to
the subcommittee.
This afternoon we will proceed with the witnesses labeled public
witnesses. And Mr. Levinson, incidentally, was one of those; but
* because of the urgency of his having to get back to California this
afternoon, we squeezed him in this morning. And we deeply appre-
ciate his presence.
And we know that those of you who have come clear across the
country from California and others from distant points did under-
take a sacrifice, and we deeply appreciate it. And we hope we will
have a continuing relationship here, because the subcommittee will
proceed into further and extensive hearings, and even on this
matter.
Mr. TATE. Counsel advises me that there is a Bank Board Gener-
al Counsel's opinion clarifying the insurance of accounts regula-
tions and which requires the disclosure of the ownership.
Chairman GONZALEZ. Well, thank you very much, sir.
And thank you, gentlemen.
The subcommittee will stand at recess until 2 p.m., in this same
meeting room.
[Whereupon, at 12:15 p.m., the hearing was recessed, to recon-
vene at 2 p.m., this same day.]
AFTERNOON SESSION
Chairman GONZALEZ. The subcommittee will please come to
order. And we continue the hearing. We are pleased to recognize at
this time, Mr. Tom Collier, who is a former HUD colleague, as
Deputy Assistant Secretary, and we deeply appreciate your pres-
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ence here. Yu are one of the administrators that was here at the
time the section 14 RESPA report was under development. So
thank you, indeed, Mr. Collier, and you may proceed.
What we can do is incorporate into the record at this point the
text as prepared by you. You may proceed either by reading it or
summarizing it.
STATEMENT OF THOMAS C. COLLIER, JR., FIRM OF STEPTOE &
JOHNSON, FORMER DEPUTY ASSISTANT SECRETARY FOR
REGULATORY FUNCTIONS, U.S. DEPARTMENT OF HOUSING
AND URBAN DEVELOPMENT
Mr. COLLIER. Mr. Chairman, I would like to summarize it, and
thank you for inviting me to testify on this issue. I am now in the
private practice of law, but formerly I served as Deputy Assistant
Secretary for Regulatory Functions at HUD. In that capacity, until
January 20th of this past year, I was responsible for preparing the
section 14 report on RESPA. The views that I express today, how-
ever, I would like to emphasize, are entirely my personal views.
To summarize those views, let me first say that in my opinion,
controlled business arrangements provide a sophisticated camou-
flage for the payment of kickbacks, solely for the referral of settle-
ment service business. I read the enactment of RESPA and section
8, in particular, as outlawing the payment of such kickbacks, re-
gardless of the scheme devised to obscure the real nature of those
payments.
It is for this reason that I believe it is imperative for Congress to
speak again on this issue and definitively to prohibit the predatory
and anticompetitive activity referred to generally as controlled
business. Controlled business arrangements may involve any of the
variety of real service providers, in their most common form they
involve the ownership by a real estate broker (or possibly a lender)
of a title insurance agency. The right of a lender to designate his
own attorney, however, in my opinion, does not involve a con-
trolled business arrangement. In addition, the type of title insur-
ance agency-attorney-agent, independent-agent, or underwriter
branch office-is irrelevent to the controlled business question. It is
the ownership of the agency by another real estate service provides
(such as a broker or lender) which causes a controlled business
problem.
The use of controlled business arrangements is increasing. Peat,
Marwick, Mitchell, & Co., an accounting firm that was retained by
the Department of Housing and Urban Development to do study on
RESPA, found that 37 percent of the title company personnel
which it interviewed, indicated that there was a trend to controlled
business. This opinion was shared by 100 percent of those inter-
viewed in Los Angeles, which is often a trend setter in real estate
matters.
The increased incidence of controlled business, however, is not
the result of some market abberation. Instead the development of
controlled businesses, like the payment of kickbacks, is a natural
consequence of the economic phenomenon which pervades the real
estate settlement service market known as reverse competition.
This simply means that home buyers do not shop for settlement
services. Instead they rely entirely upon the recommendations of
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the real estate broker, lender or attorney. Therefore, title insur-
ance agents compete against one another, not for the home buyer's
attention, but for the real estate broker's referral.
Since the broker neither pays for the title insurance nor is
harmed if the title search isn't adequate, he may not be concerned
about the cost or quality of the service provided. Moreover, if the
broker receives a financial reward such as a direct kickback or
corporate dividend, for steering a home buyer to a particular title
insurance agent, it is doubtful that the broker will put the home
buyer's interest first, when making a referral.
The potential for serious consumer abuse in these circumstances
seems obvious.
I know that the chairman yesterday criticized several of the
analogies that were used to describe this market; however, I think
Assistant Secretary Savas chose a particularly appropriate one
when he referred to the physician-patient relationship, particularly
concerning the possibility of doctors owning pharmacies. The
reason I think this is an appropriate analogy, Mr. Chairman, is
that it involves the same type of trusting or fiduciary relationship
as we're talking about here. It also involves the unusual power of a
very special kind of referral, a doctor referring a patient to an
owned pharmacy. In addition, it involves a similar controversy that
has developed concerning controlled business arrangements.
I only had a short time to look into this, but it appears that
about seven States have outlawed controlled business arrange-
ments concerning a doctor referring patients to pharmacies, and at
least seven other States have taken action to eliminate some of the
harmful effects which may arise from such referrals.
In addition, there have been several sets of congressional hear-
ings on this issue, and at the outset of one of them, Senator Hart
stated that:
The subject of our hearing today is doctor ownership of pharmacies. The unfair
trade practices and restraints of trade possible in these situations to me seem
obvious.
Now I'm not certain that Assistant Secretary Savas intended to
carry his analogy to this logical conclusion, but my concern in the
market that we are talking about today, and I believe Senator
Hart's concern, when he was talking about the physician-pharmacy
controlled business situation is that the significance of referrals in
these markets can simply not be underestimated.
Home buyers-even educated home buyers-do not search or
bargain for the best of least expensive settlement service. Peat,
Marwick, Mitchell & Co. found that only 11 percent of the home
buyers interviewed indicated that they had spoken with more than
one title insurance agency. I think most real estate professionals
would consider that percentage exaggerated. I know that 5 years
ago when I bought my home, I ±id not search for title insurance,
and I suspect that most of the folks in this room didn't shop either.
Since the home buyer does not shop, the selection of the title
insurance agent is effectively tied to the selection of the real estate
broker or the lender. In my opinion, controlled business arrange-
ments have been created to take advantage of this tied relation-
ship, so that brokers can profit, not upon the wise investment of
85-396 0 - 81 - 31~
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476
their capital or their skill, but on the power that their referrals
have over unsuspecting home buyers.
Now I want to be clear that I am not stating or implying that
savings and loan institutions through their service corporations or
Coidwell Banker are engaging in some kind of evil activity. The
savings and loan institutions especially have been encouraged to
engage in this activity by the Federal Home Loan Bank Board.
But the point that I want to suggest to you and the one that I
think you should focus upon, is the power that the referrals which
we are talking about have in this particular market, because it is
this power which creates the potential for abuse that I think de-
serves to be addressed in legislation.
Before I discuss several proposed modifications to section 8, I
want to suggest two overriding principles that might guide your
consideration of this issue.
First, I think Congress must speak to this issue promptly and
definitively. I think more harm will be done by allowing the pres-
ent situation to continue than will be done either by allowing or
prohibiting controlled business arrangements. At the present time
legitimate companies that might otherwise engage in controlled
business arrangements are losing customers to controlled business-
es. It is extremely important that the rules of the game be clearly
defined, so that the entire industry plays by the same rules.
Second, I suggest to you that there is no logical basis whatsoever
for distinguishing between kickbacks and controlled business ar-
rangements. Every harm that is intended to be prevented by the
enactment of the section 8 prohibition against kickbacks, would
also result from a controlled business arrangement. Should Con-
gress desire to allow controlled business arrangements, the only
sensible approach would be to repeal section 8 entirely.
My personal recommendation, however, is that section 8 should
be retained and amended specifically to prohibit controlled busi-
ness arrangements. In addition, I believe the enforcement mecha-
nism in section 8 should be changed substantially. First, the crimi-
nal prohibition should be eliminated. In its place, competitors
should be allowed to sue alleged violators of section 8 for injunctive
relief and for statutorily determined damages and attorneys' fees.
Also the self-enforcing statute should be removed entirely from
HUD's jurisdiction, since there would no longer be any need to
expend HUD's limited resources for enforcement.
Although I have not had an opportunity to review the new
administration's section 14 RESPA report submitted to Congress
just last week, I understand that with a few major exceptions, its
controlled business-related recommendations are similar to those
that I have suggested today. I disagree, however, with that report's
major recommendation, mandatory lender packaging and repeal of
section 8. I must admit that I find the economic theory upon which
the lender packaging concept is based extremely attractive. It is
the only approach which deals not with the deleterious effects of
reverse competition, such as the payment of kickbacks and con-
trolled business arrangements, but instead attempts to modify re-
verse competition itself.
The success of lender packing, however, depends upon the valid-
ity of the assumption that the hor1ie buyer will shop for the most
PAGENO="0483"
477
attractive interest rate and a bundled package cost, thus forcing
the lender to be price conscious in the selection of the providers of
the services included within that bundle.
Although this assumption appears reasonable, there is absolutely
no evidence whatsoever to indicate that it will work. In fact, Peat,
Marwick, Mitchell & Co. concluded that it "cannot be determined"
from existing information, whether competition is "sufficiently
robust" to create the "intense" competitive "pressure" necessary to
force lenders to arrange settlement services at lower than prevail-
ing costs and to pass any savings through to consumers.
I feel a lender packaging demonstration program of some type
which would put the attractive economic theory to a practical test
is in order. A Federal statute, however, which mandates that every
real estate lender completely rearrange existing business practices
is questionable, especially in this era of deregulation. Moreover, it
appears particularly unwise to aim such a mandatory provision at
a market as fragile as real estate lending is today, without a firm
base in practical experience, indicating that the theory is workable.
In conclusion, let me reiterate the need for a prompt clarification
of whether controlled business arrangements are prohibited. It ap-
pears to me that it will be sometime before Congress will be able to
take definitive action on the controversial mandatory lending pack-
ing proposal presented by HUD. Since this proposal contemplates
allowing controlled business arrangements, I fear that the proposal
itself will encourage the increased development of controlled busi-
ness arrangements, as title insurance companies attempt to lock up
portions of markets as quickly as possible by selling stock to area
lenders.
This new pressure to create controlled arrangements while Con-
gress considers the mandatory lender packaging proposal, will pre-
sent a particularly unfair Hobson's choice for reputable title insur-
ance companies which must choose between creating controlled
business arrangements, possibly in violation of existing law or
losing business which they have carefully developed and nurtured
over a number of years.
Mr. Chairman, I want to thank you again for giving me this
opportunity to express my views, and I'm more than happy to
answer any questions which you might have.
[Mr. Collier's prepared statement follows:]
PAGENO="0484"
478
STATEMENT OF
THOMAS C COLLIER, JR1 ESQUIRE
STEPTOE & JOHNSON
[FORMER DEPUTY ASSISTANT SECRETARY FOR
REGULATORY FUNCTIONSJ DEPARTMENT
OF HOUSING AND URBAN DEVELOPMENT]
BEFORE THE
SUBCOMMITTEE ON HOUSING AND COMM'NITY DEVELOPMENT
OF THE
HOUSE COMMITTEE ON BANKINGJ FINANCL AND URBAN AFFAIRS
SEPTEMBER 16~ 1981
PAGENO="0485"
479
STATEMENT OF THOMAS C. COLLIER, JR.
MR. CHAIRMAN AND MEMBERS OF THE SUBCOMMITTEE, THANK
YOU FOR INVITING ME TO TESTIFY ON THE ISSUE OF CONTROLLED
BUSINESS.
INITIALLY, I WOULD LIKE TO EXPLAIN TO THE COMMITTEE
THAT I BECAME INVOLVED IN THIS ISSUE LAST YEAR AS A
SPECIAL ASSISTANT TO THE GENERAL COUNSEL AND LATER AS THE DEPUTY
ASSISTANT SECRETARY FOR REGULATORY FUNCTIONS AT THE DEPARTMENT
OF HOUSING AND URBAN DEVELOPMENT. AS THE DEPUTY ASSISTANT
SECRETARY I WAS RESPONSIBLE FOR THE PREPARATION OF THE REAL
ESTATE SETTLEMENT PROCEDURES ACT (RESPA) REPORT TO CONGRESS AS
REQUIRED BY SECTION 1~4. IN ORDER TO PREPARE THAT REPORT I HELD
PUBLIC HEARINGS, PUBLIC MEETINGS AND COUNTLESS DISCUSSIONS WITH
REPRESENTATIVES OF MANY SETTLEMENT SERVICE PROVIDERS, IN ADDITION,
PAGENO="0486"
480
-2-
I REVIEWED A VARIETY OF MATERIALS INCLUDING THOSE SUBMITTED AS
PART OF THE PUBLIC RECORD AND THE PEAT, MARWICK AND MITCHELL
REPORT ON RESPA WHICH HAD BEEN COMMISSIONED BY THE DEPARTMENT,
MY EFFORT TO LEARN AS MUCH AS POSSIBLE ABOUT THESE
ISSUES WAS AIDED SUBSTANTIALLY BY AN EXTREMELY DEDICATED AND
COMPETENT STAFF, THE SECTION 114 REPORT TO CONGRESS WAS DUE ON
JANUARY 30, 1981, ON JANUARY 20, 1981, MY LAST DAY AT HUD, I
LEFT A DRAFT REPORT FOR THE NEW ADMINISTRATION TO CONSIDER,
THAT REPORT CONTAINED RECOMMENDATIONS WHICH, IN MY OPINION, WERE
SOUND, ALTHOUGH SOME OF THEM -- REFLECTING AN ATTEMPT AT
COMPROMISE IN ORDER TO CONSTRUCT A DEPARTMENTAL CONSENSUS --
WERE MODIFICATIONS OF MY PERSONAL CONCLUSIONS, IT IS MY
PERSONAL VIEWPOINT WHICH IS THE FOCUS OF MY TESTIMONY TODAY,
PAGENO="0487"
481
-P3-
IN MY OPINION, CONTROLLED BUSINESS ARRANGEMENTS PROVIDE
A SOPHISTICATED CAMOUFLAGE FOR THE PAYMENT OF KICK-BACKS SIMPLY
FOR THE REFERRAL OF SETTLEMENT~ SERVICE BUSINESS I READ THE
ENACTMENT OF RESPA, AND SECTION 8 IN PARTICULAR) AS OUTLAWING
THE PAYMENT OF SUCH KICK-BACKS REGARDLESS OF THE SCHEME DEVISED
TO OBSCURE THE REAL NATURE OF THE PAYMENTS. FOR THIS REASON,
I BELIEVE IT IS IMPERATIVE FOR CONGRESS TO SPEAK AGAIN ON THIS
ISSUE AND DEFINITIVELY TO PROHIBIT THE PREDATORY AND ANTI-
COMPETITIVE ACTIVITY REFERRED TO GENERALLY AS CONTROLLED BUSINESS.
I. THE NATURE AND EXTENT OF THE CONTROLLED BUSINESS PROBLEM
"CONTROLLED BUSINESS" REFERS TO THE OWNERSHIP OF ONE
REAL ESTATE SERVICE PROVIDER BY ANOTHER, THE REFERRAL OF BUSINESS
BY THE OWNER TO THE OWNED ENTITY AND THE RETURN TO THE OWNER OF
A PORTION OF THE OWNED ENTITY'S PROFIT, USUALLY IN THE FORM
PAGENO="0488"
482
OF A CORPORATE DIVIDEND, CONTROLLED BUSINESS ARRANGEMENTS MAY
INVOLVE ANY OF THE VARIETY OF REAL ESTATE SERVICE PROVIDERS~
HOWEVER, IN THEIR MOST COMMON FORM THEY INVOLVE THE OWNERSHIP
BY A REAL ESTATE BROKER (OR POSSIBLY A LENDER) OF A TITLE
INSURANCE AGENCY,
THE USE OF CONTROLLED BUSINESS ARRANGEMENTS IS INCREASING,
PEAT, MARWICK AND MITCHELL FOUND THAT 37% OF THE TITLE COMPANY
PERSONNEL WHICH IT INTERVIEWED INDICA',ED THAT THERE WAS A TREND
TO CONTROLLED BUSINESS, THIS OPINION WAS SHARED BY 100% OF
THOSE INTERVIEWED IN LOS ANGELES WHICH OFTEN IS A TREND SETTER
IN REAL ESTATE MATTERS,
THE INCREASED INCIDENCE OF CONTROLLED BUSINESS IS NOT
THE RESULT OF SOME MARKET ABERATION INSTEAD, THE DEVELOPMENT
OF CONTROLLED BUSINESSES, LIKE THE PMYMENT OF KICK-BACKS, IS A
PAGENO="0489"
483
-5-
NATURAL CONSEQUENCE OF THE ECONOMIC PHENOMENON WHICH PERVADES
THE REAL ESTATE SETTLEMENT SERVICE MARKET: "REVERSE COMPETITION."
THIS SIMPLY MEANS THAT HOMEBUYERS DO NOT SHOP FOR SETTLEMENT
SERVICES. INSTEAD, THEY RELY ENTIRELY UPON THE RECOMMENDATIONS
OF THEIR REAL ESTATE BROKER~ LENDER OR ATTORNEY. THEREFORE,
TITLE INSURANCE AGENTS COMPETE AGAINST ONE ANOTHER, NOT FOR THE
HOMEBUYER'S ATTENTION, BUT FOR THE REAL ESTATE BROKER'S REFERRAL.
SINCE THE BROKER NEITHER PAYS FOR THE TITLE INSURANCE NOR IS
HARMED IF THE TITLE SEARCH IS INADEQUATE1 HE NAY NOT BE CON-
CERNED ABOUT THE COST OR QUALITY~ OF THE SERVICE PROVIDED.
MOREOVER, IF THE BROKER RECEIVES A FINANCIAL REWARD, SUCH AS A
DIRECT KICK-BACK OR A CORPORATE DIVIDEND, FOR STEERING THE
HOMEBUYER TO A PARTICULAR TITLE INSURANCE AGENT.. IT IS DOUBTFUL
THAT THE BROKER WILL PUT THE HOMEBUYER'S INTEREST FIRST WHEN
PAGENO="0490"
484
-6-
MAKING A REFERRAL. THE POTENTIAL FOR SERIOUS CONSUMER ABUSE IN
THESE CIRCUMSTANCES SEEMS OBVIOUS.
THE SIGNIFICANCE OF REFERRALS IN THIS MARKET SHOULD
NOT BE UNDERESTIMATED. HOMEBUYERS -- EVEN EDUCATED HOMEBUYERS --
DO NOT SEARCH OR BARGAIN FOR THE BEST OR LEAST EXPENSIVE SETTLE-
MENT SERVICE. PEAT MARWICK AND MITCHELL FOUND THAT ONLY 11% OF
THE HOMEBUYERS INTERVIEWED INDICATED THAT THEY HAD SPOKEN WITH
MORE THAN ONE TITLE INSURANCE AGENCY, MOST REAL ESTATE
PROFESSIONALS WOULD CONSIDER THAT PERCENTAGE EXAGGERATED, FIVE
YEARS AGO WHEN I BOUGHT MY HOME I DID NOT SHOP FOR TITLE INSURANCE,
AND I IMAGINE MOST OF THE PEOPLE IN THIS ROOM DIDN'T EITHER,
SINCE THE HOMEBUYER DOES NOT SHOP, THE SELECTION OF THE TITLE
INSURANCE AGENT IS EFFECTIVELY "TIED" TO THE SELECTION OF THE
BROKER. IN MY OPINION, CONTROLLED BUSINESS ARRANGEMENTS HAVE
PAGENO="0491"
485
-7-
BEEN CREATED TO TAKE ADVANTAGE OF THIS "TIED" RELATIONSHIP SO
THAT BROKERS CAN PROFIT, NOT UPON THE WISE INVESTMENT OF THEIR
CAPITAL OR SKILL, BUT ON THE POWER THEIR REFERRALS HAVE OVER
UNSUSPECTING HOMEBUYERS.
IN ATTEMPTING TO DETERMINE WHETHER CONTROLLED BUSINESS
ARRANGEMENTS HAVE CAUSED A SPECIFIC HARM WHICH JUSTIFIES THEIR
PROHIBITION, MUCH OF THE FOCUS HAS BEEN ON THE QUESTION OF WHETHER
SUCH ARRANGEMENTS HAVE INCREASED THE COST OF TITLE INSURANCE FOR
CONSUMERS. ALONG THESE LINES, PEAT, MARWICK AND MITCHELL CON-
CLUDED THAT "NO PROOF EXISTS THAT CONTROLLED BUSINESS HAS
RAISED [CONSUMER TITLE INSURANCE] PRICES TO DATE." ALTHOUGH I
AGREE WITH THAT GENERAL CONCLUSION, THERE ARE TWO MAJOR CAVEATS.
FIRST, ALTHOUGH "PROOF"MAY NOT EXIST, ANECDOTAL
EVIDENCE OF INCREASED PRICES CERTAINLY DOES. FOR EXAMPLE, IN THE
PAGENO="0492"
486
-8-
COLDWELL BANKER DECISION IN CALIFORNIA, THE COURT UPHELD AN
ADMINISTRATIVE DENIAL OF A LICENSE APPLICATION FOR A BROKER
CONTROLLED TITLE INSURA"C. AGENCY, THE ADMINISTRATIVE RECORD
INCLUDED A NUMBER OF RELEVANT COST FINDINGS INCLUDING THE FACT
THAT A COLDWELL CONTROLLED BUSINESS ESCROW SERVICE CHARGED
SIGNIFICANTLY MORE (IN EXCESS OF 150%) THAN OTHER ESCROW
COMPANIES OPERATING IN THE SAME AREA. IN ADDITION, IT APPEARS
THAT A RECENT REQUEST FOR AN INCREASE IN THE TITLE INSURANCE
RATE SCHEDULE IN PENNSYLVANIA WAS MOTIVATED IN PART BY THE
LARGE COMMISSION SPLITS DEMANDED BY CONTROLLED TITLE AGENCIES.
THE SECOND CAVEAT CONCERNS THE DANGEROUS SHORT SIGHTEDNESS
OF FOCJSING ONLY ON EXISTING PRICES. HISTORICALLY CONGRESS HAS
PROHIBITED SIMILAR ANTICOMPETITIVE PRACTICES IN ORDER TO PREVENT
PAGENO="0493"
487
-9-
THE ACCUMULATION OF MARKET POWER SUFFICIENT TO FORCE ARTIFICIAL
PRICE INFLATION OR ALLOW DETERIORATION IN THE QUALITY OF SERVICE.
FOR THE SETTLEMENT SERVICES INDUSTRY, THE EXPANSION OF CONTROLLED
BUSINESS MAY WELL PRODUCE AN OLIGOPOLY OR MONOPOLY IN A LOCAL
MARKET, DRIVING OUT EXISTING COMPETITION. A TELLING EXAMPLE OF
THIS WAS PRESENTED AT A HEARING I HELD IN Los ANGELES BY A VICTIM
OF SUCH PREDATORY PRACTICES, MRS. CLYDA GUGGENBERGER, WHO I
BELIEVE WILL ALSO TESTIFY BEFORE YOU. ONCE COMPETITION IS
ELIMINATED, PRICES MAY ESCALATE SIGNIFICANTLY. MARKET ENTRY
BECOMES IMPOSSIBLE UNLESS HIGHER KICK-BACKS ARE OFFERED FOR
REFERRALS -- PUSHING PRICES STILL HIGHER. IN ADDITION, BY
LOCKING UP A SIGNIFICANT PORTION OF A LOCAL MARKET, THE TITLE
INSURANCE AGENT GAINS EXTRAORDINARY POWER OVER THE UNDERWRITERS
WITH WHOM THE AGENT PLACES POLICIES. THE AGENT IS THEN IN A
PAGENO="0494"
488
- 10 -
POSITION TO DEMAND AN EXCESSIVE COMMISSION, AGAIN CAUSING HIGHER
CONSUMER PRICES. FINALLY, WITH THE REDUCTION IN COMPETITION
THE AGENT'S INCENTIVE TO PROVIDE HIGH QUALITY SERVICES MAY
DIMINISH. ALL OF THESE ARE SERIOUS PROBLEMS WHICH MAY DEVELOP
IF CONTROLLED BUSINESS COMES TO DOMINATE THE INDUSTRY.
II. ThE~SCOPE OF EXISTING CONTROLLED BUSINESS PROHIBITIONS
IN MY OPINION, IT WAS THE INTENT OF SECTION 8 TO PREVENT
THE POTENTIAL CONSUMER ABUSE THAT INHERES IN SUCH SCHEMES BY
OUTLAWING ANY FORM OF PAID REFERRALS, IN 1980, THE DEPARTMENT
RECEIVED SEVERAL INQUIRIES REQUESTING AN OPINION AS TO WHETHER
CONTROLLED BUSINESS ARRANGEMENTS WERE PROHIBITED BY SECTION 8.
THE DEPARTMENT WAS RELUCTANT TO ISSUE SUCH AN OPINION INASMUCH
AS IT WAS CONSIDERING WHETHER CONTROLLED BUSINESS ARRANGEMENTS
SHOULD BE PROHIBITED AS PART OF A COMPREHENSIVE SECTION 114 REPORT.
PAGENO="0495"
489
- 11 -
HOWEVER, SINCE IT APPEARED THAT THE INCIDENCE OF CONTROLLED
BUSINESS ARRANGEMENTS WAS INCREASING, A DECISION WAS MADE TO
REVIEW THE RESPA PROGRAM OFFICE'S EXISTING DETERMINATION THAT
CONTROLLED BUSINESS ARRANGEMENTS VIOLATE RESPA AND TO ISSUE THE
DEPARTMENT'S LEGAL INTERPRETATION OF SECTION 8~
THUS THE DEPARTMENT RELEASED ITS MUCH, AND I BELIEVE
UNFAIRLY, MALIGNED INTERPRETIVE RULING STATING THAT CONTROLLED
BUSINESS ARRANGEMENTS MAY VIOLATE SECTION 8 IN THE INTER-
PRETATION, THE DEPARTMENT RESTATED THE PROHIBITION AGAINST KICK-
BACKS FOR BUSINESS REFERRALS AND CAUTIONED THAT IT WAS APPLICABLE
"NOTWITHSTANDING (1) THAT THE PERSON REFERRING THE BUSINESS HAS
AN OWNERSHIP INTEREST IN THE PROVIDER OF THE SERVICE, OR (2) THAT
THE PAYMENT OF THE `FEE, KICK-BACK OR THING OF VALUE' IS
CHARACTERIZED AS A RETURN ON CAPITAL INVESTED" IN OTHER WORDS,
PAGENO="0496"
490
- 12 -
REAL ESTATE SERVICE PROVIDERS WERE SPECIFICALLY INFORMED THAT,
IF ALL OF THE ELEMENTS OF A SECTION 8 VIOLATION ARE PRESENT, A
SECTION 8 VIOLATION WILL BE FOUND REGARDLESS OF THE ATTEMPT TO
PORTRAY THE ARRANGEMENT AS AN ORDINARY CAPITAL INVESTMENT AND
RETURN THIS OPINION DID NOT ALTER OR EXTEND THE STATUTE ONE
IOTA, THOUGH IT DID NOT PROVIDE THE DEFINITIVE CLASSIFICATION
SOME HAD SOUGHT,
UNDER THE CURRENT LAW, IT IS INHERENTLY DIFFICULT TO
PROVIDE A RULING THAT IS DISPOSITIVE OF ALL ARRANGEMENTS, THE
MOST DIFFICULT ELEMENT OF PROVING A SECTION 8 CRIMINAL OFFENSE
IS WHETHER THE PAYMENT OF THE DIVIDEND HAS BEEN MADE PURSUANT
TO "ANY AGREEMENT OR UNDERSTANDING ORAL OR OTHERWISE" TO REFER
THE BUSINESS, IF THE DIVIDEND PAYMENT IS A LEGITIMATE RETURN
ON CAPITAL INVESTED, IN MY OPINION, THERE WOUJ~ NOT BE A VIOLATION
PAGENO="0497"
491
-~ 13 -
OF SECTION 8. FOR EXAMPLE, IF A REAL ESTATE BROKER MADE A
SIGNIFICANT CAPITAL INVESTMENT IN A TITLE INSURANCE AGENCY,
REFERRED BUSINESS TO MANY DIFFERENT AGENCIES AND RECEIVED A
REASONABLE DIVIDEND RELATIVE TO THE AMOUNT OF CAPITAL INVESTED,
THERE WOULD NOT BE A VIOLATION OF SECTION 8 PROOF OF A
VIOLATION WOULD BE EVEN ~iO~ DIFFICULT IF, IN ADDITION, ONLY A
SMALL PORTION OF THE AGENCY'S BUSINESS WAS ATTRIBUTED TO THE
OWNER'S REFERRALS. ON THE OTHER HAND, IF THE CAPITAL INVESTMENT
WAS SMALL, THE DIVIDENDS LARGE AND THE MAJOR PORTION OF BUSINESS
OF THE OWNER OR OF THE AGENCY WAS RELATED TO REFERRALS FROM THE
OWNER, THERE WOULD BE A VIOLATION OF SECTION 8. IN THE FACE OF
THESE AND OTHER PROOF PROBLEMS, BOTH SECTION 8 AND THE INTER-
PRETIVE RULING ARE LIKELY TO FAIL TO DETER THE CONTINUED
DEVELOPMENT OF CONTROLLED BUSINESS,
85-396 0 - 81 - 32
PAGENO="0498"
492
- iLl -
IN MY OPINION THE DEPARTMENT COULD HAVE AVOIDED AND
COULD STILL AVOID THESE PROOF PROBLEMS CONSISTENT WITH THE
CONGRESSIONAL INTENT OF SECTION 8, BY PROHIBITING CONTROLLED
BUSINESS ARRANGEMENTS ENTIRELY FOR EXAMPLE, TITLE INSURANCE
AGENTS COULD BE PROHIBITED FROM ACCEPTING CUSTOMERS WHO ARE ALSO
CUSTOMERS OF OWNER-BROKERS. SUCH AN EXPANSION OF THE LITERAL
PROHIBITIONS OF SECTION 8, HOWEVER, APPEARED UNWISE SIX MONTHS
BEFORE RECOMMENDING TO CONGRESS PROPOSED RESPA MODIFICATIONS.
MOREOVER, IT MAY BE BROADER THAN NECESSARY. IN ANY EVENT, THE
INTERPRETIVE REGULATION WAS NOT INTENDED TO BROADEN OR NARROW THE
LITERAL MEANING OF SECTION 8, BUT ONLY TO ARTICULATE THE DEPARTMENT'S
INTERPRETATION OF THE STATUTE TO ENCOURAGE PERSONS CONTEMPLATING
CONTROLLED BUSINESS ARRANGEMENTS TO TAKE INTO ACCOUNT THE
PROSCRIPTIONS OF SECTION 8.
PAGENO="0499"
493
- 15 -
III. PROPOSED MODIFICATIONS OF SECTION 8
THE STATUTE'S UNCERTAINTY, HOWEVER, SHOULD NOW BE
ELIMINATED, BEFORE I DISCUSSSEVERAL PROPOSED MODIFICATIONS TO
SECTION 8, I WOULD LIKE TO SUGGEST TWO OVERRIDING PRINCIPLES
AS GUIDES FOR YOUR CONSIDERATION
FIRST, CONGRESS MUST SPEAK TO THIS ISSUE PROMPTLY AND
DEFINITIVELY, MORE HARM WILL BE DONE BY ALLOWING THE PRESENT
SITUATION TO CONTINUE, THAN WILL BE DONE BY EITHER ALLOWING OR
PROHIBITING CONTROLLED BUSINESS. AT THE PRESENT TIME LEGITIMATE
COMPANIES THAT MIGHT OTHERWISE ENGAGE IN CONTROLLED BUSINESS
ARRANGEMENTS ARE LOSING CUSTOMERS TO CONTROLLED BUSINESSES. IT
IS EXTREMELY IMPORTANT THAT THE RULES OF THE GAME BE CLEARLY
DEFINED, SO THAT THE ENTIRE INDUSTRY PLAYS BY THE SAME RULES,
PAGENO="0500"
494
- 16 -
SECOND, I SUGGEST TO YOU THAT THERE IS NO LOGICAL BASIS
WHATSOEVER FOR DISTINGUISHING BETWEEN KICK-BACKS AND CONTROLLED
BUSINESS ARRANGEMENTS. EVERY HARM INTENDED TO BE PREVENTED BY
THE ENACTMENT OF THE SECTION 8 PROHIBITION AGAINST KICK-BACKS
MILL ALSO RESULT FROM CONTROLLED BUSINESSES, SHOULD CONGRESS
DESIRE TO ALLOW CONTROLLED BUSINESS ARRANGEMENTS, THE ONLY
SENSIBLE APPROACH MOULD BE TO REPEAL SECTION 8 ENTIRELY.
MY PERSONAL RECOMMENDATION, HOWEVER, FOR ALL OF THE
REASONS DISCUSSED EARLIER IN MY TESTIMONY, IS THAT SECTION 8 BE
RETAINED BUT AMENDED SPECIFICALLY TO PROHIBIT CONTROLLED
BUSINESS ARRANGEMENTS. IN ADDITION, I BELIEVE THE ENFORCEMENT
MECHANISM IN SECTION 8 SHOULD BE CHANGED SUBSTANTIALLY. FIRST,
THE CRIMINAL PROHIBITION SHOULD BE ELIMINATED. IT HAS FAILED
MISERABLY AS A DETERRENT IN LARGE PART BECAUSE THE JUSTICE
PAGENO="0501"
495
- 17 -
DEPARTMENT DOES NOT HAVE THE CAPACITY TO PROSECUTE MISDEMEANOR
WHITE COLLAR CRIMES IN ITS PLACEJ COMPETITORS SHOULD BE
ALLOWED TO SUE ALLEGED VIOLATORS OF SECTION 8 FOR INJUN
RELIEF AND FOR STATUTORILY DETER
NEW
JUST L~
ITS CONT,
IDENTICAL
WITH THE REP
PACKAGING AND
Ic.
uST ADMIT THAT I FIND THE
PAGENO="0502"
496
- 18 -
ECONOMIC THEORY UPON WHICH THE LENDER-PACKAGING CONCEPT IS
BASED EXTREMELY ATTRACTIVE IT IS THE ONLY APPROACH WHICH
DEALS, NOT WITH THE DELETERIOUS EFFECTS OF REVERSE COMPETITION
SUCH AS THE PAYMENT OF KICK-BACKS AND CONTROLLED BUSINESS
ARRANGEMENTS, BUT INSTEAD ATTEMPTS TO MODIFY REVERSE COMPETITION
ITSELF
A LENDER ENGAGED IN LENDER-PACKAGING WOULD BUNDLE ALL
OF THE SERVICES INCLUDING TITLE INSURANCE, WHICH IT REQUIRES AS
A PREREQUISITE TO CLOSING A LOAN, AND WOULD MARKET THE COSTS OF
THIS PACKAGE ALONG WITH ITS INTEREST RATE THE SUCCESS OF
LENDER-PACKAGING DEPENDS UPON THE VALIDITY OF THE ASSUMPTION
THAT THE HOMEBUYER WILL SHOP FOR THE MOST ATTRACTIVE INTEREST
RATE AND BUNDLED PACKAGE COST, THUS FORCING THE LENDER TO BE
PRICE CONSCIOUS IN THE SELECTION OF THE PROVIDERS OF THE SERVICES
PAGENO="0503"
497
- 19 -
INCLUDED WITHIN THE BUNDLE, ALTHOUGH THIS ASSUMPTION APPEARS
REASONABLE, THERE IS ABSOLUTELY NO EVIDENCE WHATSOEVER TO
INDICATE THAT IT WILL WORK, IN FACT, PEAT, MARWICK AND
MITCHELL CONCLUDED THAT IT "CANNOT BE DETERMINED" FROM EXISTING
INFORMATION WHETHER COMPETITION IS "SUFFICIENTLY ROBUST" TO
CREATE THE "INTENSE" COMPETITIVE, "PRESSURE" NECESSARY TO FORCE
LENDERS TO ARRANGE SETTLEMENT SERVICES AT LOWER THAN PREVAILING
COSTS AND TO PASS ANY SAVINGS THROUGH TO CONSUMERS,
A LENDER-PACKAGING DEMONSTRATION PROGRAM OF SOME TYPE
WHICH WOULD PUT THE ATTRACTIVE ECONOMIC THEORY TO A PRACTICAL
TEST IS IN ORDER. A FEDERAL STATUTE, HOWEVER, WHICH MANDATES
THAT EVERY REAL ESTATE LENDER COMPLETELY REARRANGE EXISTING
BUSINESS PRACTICES IS QUESTIONABLE, ESPECIALLY IN THIS ERA OF
DEREGULATION. MOREOVER, IT APPEARS PARTICULARLY UNWISE TO AIM
PAGENO="0504"
498
- 20 -
SUCH A MANDATORY PROVISION AT A MARKET AS FRAGILE AS RESIDENTIAL
REAL ESTATE LENDING IS TODAY WITHOUT A FIRM BASE IN PRACTICAL
EXPERIENCE INDICATING THAT THE THEORY IS WORKABLE
CON CLUS I ON
IN CONCLUSION, LET ME REITERATE THE NEED FOR A PROMPT
CLARIFICATION OF WHETHER CONTROLLED BUSINESS ARRANGEMENTS ARE
PROHIBITED IT APPEARS TO ME THAT IT WILL BE SOME TIME BEFORE
CONGRESS WILL BE ABLE TO TAKE DEFINITIVE ACTION ON THE
CONTROVERSIAL MANDATORY LENDER-PACKAGING PROPOSAL PRESENTED BY
HUD SINCE THIS PROPOSAL CONTEMPLATES ALLOWING CONTROLLED
BUSINESS ARRANGEMENTS, I FEAR THAT THE PROPOSAL ITSELF WILL
ENCOURAGE THE INCREASED DEVELOPMENT OF THEM AS TITLE INSURANCE
COMPANIES ATTEMPT TO LOCK-UP PORTIONS OF MARKETS AS QUICKLY AS
POSSIBLE BY SELLING STOCK TO AREA LENDERS
PAGENO="0505"
499
- 21 -
THIS NEW PRESSURE TO CREATE CONTROLLED BUSINESS
ARRANGEMENTS WHILE CONGRESS CONSIDERS THE MANDATORY LENDER-
PACKAGING PROPOSAL, WILL PRESENT A PARTICULARLY UNFAIR H0BS0N'S
CHOICE FOR REPUTABLE TITLE INSURANCE COMPANIES WHICH MUST
CHOOSE BETWEEN CREATING CONTROLLED BUSINESS ARRANGEMENTS,
POSSIBLY IN VIOLATION OF E~I~', ~NG LAW, (iR LOSING BUSINESS WHICH
THEY HAVE CAREFULLY DEVELOPED AND NURTURED OVER A NUMBER OF
YEARS. IN ORDER TO ALLEVIATE THIS PRESSURE, I SUGGEST THAT YOU
CONSIDER SEVERING THE SHORT-TERM ISSUE OF CLARIFYING WHETHER
SECTION 8 PROHIBITS CONTROLLED BUSINESS ARRANGEMENTS FROM THE
LONG-TERM ISSUE OF MANDATORY LENDER-PACKAGING. OTHERWISE, I
PREDICT THAT AT THE NEXT RESPA HEARINGS YOU WILL HEAR FROM
REPRESENTATIVES OF COUNTLESS TITLE COMPANIES WHO, LIKE
PAGENO="0506"
500
- 22 -
MRS GUGGENBERGERJ WILL HAVE BEEN NEARLY FORCED OUT OF BUSINESS
BY THE RECENT DEVELOPMENT OF NEW CONTROLLED COMPANIES,
THANK YOU FOR ALLOWING ME THE OPPORTUNITY TO PRESENT
MY VIEWS ON THIS SUBJECTS I WOULD BE HAPPY TO RESPOND TO ANY
QUESTIONS WHICH THE CHAIRMAN OR MEMBERS OF THE COMMITTEE MIGHT
HAVE
Chairman GONZALEZ. Thank you very much, Mr. Collier. We
deeply appreciate your presence and your contribution. We will
proceed with Dr. Try Plotkin, the vice president of Arthur D. Little,
Inc.
STATEMENT OF DR. IRVING H. PLOTKIN, VICE PRESIDENT,
ARTHUR D. LITTLE, INC., CAMBRIDGE, MASS.
Dr. PLOTKIN. Thank you, Mr. Chairman. Thank you very much
for inviting me to appear before this very important hearing.
My research experience and professional qualifications as a mi-
croeconomist are recorded in my résumé which I have submitted.
My research into title insurance began in the early seventies
with studies with HUD staff members concerning the HUD/VA
study of real estate settlement costs. Since then, I have consulted
with the American Land Title Association, the National Associ-
ation of Insurance Commissioners, individual State title insurance
associations, and have extended my research into many aspects of
the industry's economics and regulation. I have presented numer-
ous papers about the industry and have submitted for the record a
monograph I published dealing with the economics of the title
insurance industi'y. Your staff received those earlier this week.
While I have consulted with and for numerous segments of the
real estate settlement industry and its regulators, I appear here
solely to present my own views and do not purport to represent the
views of any other person or group.
Because I was contacted only recently by the staff and because
my role is to comment on the statements and evidence of other
witnesses, I have no prepared statement. I have just given the
subcommittee the typed up draft material I have prepared during
the past 2 days and nights to assist you in following my remarks.
I do not submit this paper for the record, only because I have not
had a chance to edit it. With your permission, I will do so soon
after the hearings and submit it as a formal statement in addition
to the presentation I'm making now, sir.
Chairman GONZALEZ. Without objection, that will be done.
PAGENO="0507"
501
I should say this, and I think it properly should be said in the
name of fair play, that after you have studied the transcript, you
will be provided the opportunity to add your comments if you deem
that necessary for the transcript, since reference was made to you
individually in a critical sense, I thought that that would be proper
to advise you of that opportunity.
Dr. PLOTKIN. Thank you, sir. Thank you for that courtesy. I did
hear it this morning. I would hope that the full nature of my
testimony, and most particularly the sources I will point to, includ-
ing court documents and decisions by administrative officials deal-
ing with the same facts that were being discussed this morning,
Mr. Chairman, I think-and I will permit myself only this ad
hominem response-will illustrate that the witness' ability to fore-
cast what I am going to say is about at a par with his ability to
relate historic facts.
[Further comments are contained in a letter to Chairman Gonza-
lez dated October 8, 1981, and follows Dr. Plotkin's prepared state-
ment.]
Dr. PLOTKIN. Referral fees and kickbacks are generally outlawed
as business practices not only because they tend to inflate prices to
consumers but also because such trade practices are at fundamen-
tal variance from the basic methods of competition upon which the
American economic system is based. Such trade practices are even
more deleterious to the functioning of a healthy marketplace than
many structural arrangements proscribed by the antitrust laws.
Human nature and actual economic practice is such that kick-
backs of all kinds seldom if ever flow down to benefit the consum-
ing public. Mr. Savas' assertions that there exists "ample evidence
of referral fees reducing costs" was not supported by even a single
example. I understand he will be asked to give specific examples in
support of that assertion. All available evidence of which I am
aware in the title insurance and related industries demonstrates
just the reverse: those who received kickbacks were enriched great-
ly; no benefit flowed to the public.
I believe one thing is abundantly clear. It is completely contra-
dictory for RESPA section 8 to outlaw kickbacks and referral fees
while, in 1981, not directly proscribing controlled business arrange-
ments. As HUD and others have stated, forthrightness now de-
mands that either kickbacks in all their various forms controlled
business, under-the-table payments, lavish entertainment, what
have you-be declared contrary to the public good or be declared
harmless and all prohibitions against them be uniformly removed.
Not to do one or the other is to try to have one's cake and eat it
and serves the public and the industry-the total real real estate
settlement industry-very ill.
Controlled business is not only the functional equivalent of kick-
backs and referral fees from an economic point of view-as all who
have written on this topic, including HUD, the Department of
Justice, the FTC, and academic economists have stated-but con-
trolled business arrangements also aggravate the consumer harm
produced by kickbacks by erecting serious barriers to competition,
by foreclosing the market to existing competitors, diminishing the
prospects of new entry, leading to the demise of independent title
insurance agencies, and lowering product quality.
PAGENO="0508"
502
These results have been demonstrated again and again through-
out the country since 1975. In addition to the testimony of yester-
day's witnesses, which the chairman rightly pointed out, came
from the four corners of our country, I would respectfully call your
attention to the recent hearing by the Texas Board of Insurance
dealing specifically with the problems which can emerge and, in
fact, have emerged under conditions of controlled business. In that
hearing, numerous witnesses documented experiences in Texas pre-
cisely similar to-in some cases, identical to-the testimony of
yesterday's witnesses.
The establishment of a new title insurance agency by controllers
of business or the conversion of an independent agency into one
owned by real estate professonals should never be thought of as
new entry or new competiton in a given market for title insurance.
Rather, such "entry" produces just the opposite effect. Such entry
cartelizes the market, forecloses competition, and in the short and
long run is harmful to consumer interests.
Controlled business agencies are not pro-competitive. Rather, by
their very nature they kill off all possible competition from inde-
pendent title companies for a segment of the market-namely, the
business which the broker or lender owning the agency can direct
to its subsidiary.
Mr. Chairman, because this point seems to be escaping some
attention, may I use my pad to illustrate the economic point?
If we take the circle that I have drawn-and I hope it can be
seen-as the totality of the orders in a given market for title
insurance, let us say in a city or a county, and we represent by a
piece of the circle-labeled A-those orders that a real estate pro-
fessional can effectively direct, steer, control, or channel to one or
another provider of title insurance, as all witnesses have said, that
controller of business will be the object of competitive pressures by
various title providers saying, "Give me part of your orders"; "Give
me part of your orders"; "No, give it to me." He will be the object
of competition.
But if he takes that segment of orders-let's say 10 percent of
the market-and creates his own title insurance agency, there will
no longer be any competition by any of the other independent
agencies or the direct operations of any underwriter's branch to
that controller of business for his orders, for such competition
would be futile.
Once that controller of business has established a financial link
in between himself and a title agency, his ability to place the
orders into his own agency and the rewards that agency is able to
give him causes competition to fall away.
This is not merely a theory, sir, but has been demonstrated in
many States in the country under exhaustive hearings-witnesses
under oath, cross-examined, with documentation. Many of them
have been referred to before in these proceedings, and I will refer
to some more.
One might say, "Well, that is only 10 percent or even 2 percent
of the market-so what does it matter?" Then consider another
real estate professional or maybe a group of two or three real
estate professionals, such as happened-a number of real estate
brokers, a number of lenders, a number of attorneys formed togeth-
PAGENO="0509"
503
er and pooled their business-that might represent only another 5
percent. What is happening in classic antitrust terms?
More and more of the market is being foreclosed from competi-
tion. It is indeed most misleading to view the creation of a con-
trolled business entity as producing additional competition. It does
just the reverse. It forecloses from any meaningful competition the
business which the owner of that entity can steer to his own
affiliate.
This was the thrust of the testimony of yesterday's witnesses.
This was also the thrust of the testimony and the finding in the
California, Montana, Texas, and NAIC hearings.
Likewise the establishment of controlled business agencies by
real estate professionals cannot instructively be analogized with
vertical integration. In many instances, vertical integration can
produce consumer benefits by increasing efficiency. Hence, I fully
agree with the current Department of Justice policies in that
regard with respect to the economy at large.
However, vertical integration without economies of production or
coupled with the ability to effectively compel consumer acceptance
of your ancillary product is not the kind of antitrust reform the
Department of Justice is pursuing. Controlled business is not an
example of productive vertical integration, but rather is an illus-
tration of full line forcing, an exercise of market power without
redeeming social value.
I would respectfully submit that the subcommittee give full at-
tention to the decision of the California Appellate Court in the
matter of Guardian Title, for, it reviews all of the theories and
evidence we have been discussing. In the volume submitted by Mr.
Daley, it is included under tab E.
The Chairman indicated that if a ~ill possible certain portions of
Mr. Daley's material would be ir cuded in the record. I would
recommend that this decision, wh~ i distills a great deal of evi-
dence and reviews an administrativ hearing on this very topic, is
most insightful.
Let me now read but one senten : of the court in reviewing the
evidence. Talking about whether a ccntrolled entity leads to fair or
unfair competition-Guardian T. ~ in this case, would be the
controlled entity. The court state
Obviously an entrant such as Guardir `i~ l~ --assured from the outset of referrals
from the real estate broker, Coldwell ~-wou1d have a substantial economic
advantage over those title companies `~ ~iout a ready-made source of business.
This is the a: ~itrust problem hat is at the heart of the con-
trolled business argument. Too ~ften, nonrelevant or tangential
issues have gotten in the way of oLserving this phenomenon.
I should add, as I responded to the chairman's permission to
respond to the previous witness, ~f the findings of the urt-and
especially as the court reviews the findings of the Califo ;ia Insur-
ance Department-are scrutinized, I believe you wil1 substan-
tial variance about historical facts, as determined bot~ I he court
and the California Insurance Dep~rtment, from the ~ mony pre-
sented this morning by the witne~es from Coldwell Lanker, rest
my credibility on an evaluation ` the court's and tli~ Cah ornia
Insurance Department's findings with respect to tho~c facts and
the quality of Mr. Hilton's testimony.
PAGENO="0510"
504
It may be tempting to argue that because controlled business-or
kickbacks, for that matter-do not increase the price of any partic-
ular transaction, there can be no harm to consumers. Such reason-
ing ignores the findings of economics and the courts:
As in most anticompetitive structural arrangements, the harm
and price effects are long run and systemic in nature. They may
take a long time to be revealed.
It is just such reasoning that has led the courts to declare certain
practices per se illegal, even if the immediate result may be to
lower prices. For example, to paraphrase a question asked of a
witness this morning: "What is the harm as long as the price is no
higher and the service is as good?" A paraphrase could be: "What
is the harm of a number of manufacturers conspiring together to
lower the price of a good or service to the consumer?" Anyone even
passingly familiar with antitrust law and court decisions or the
teachings of economics understands that the harm to the long-run
market and consumer interest in such conspiracies is manifest and
generally well recognized. Accordingly, such a conspiracy, even one
to lower prices, is per se illegal.
Economics teaches that whenever markets are foreclosed, free-
dom to compete diminished, or access to customers denied, consum-
er prices inevitably must be harmed. And controlled business, as
this pie diagram illustrates, is nothing more or less than a foreclo-
sure of a portion of the market to free, fair, and equal competition.
While it is rare to be able to observe these phenomena directly,
since 1975 a number of these results have been documented around
the country. These results include the facts that: Lenders and real
estate brokers have prevented independent title agencies from even
soliciting title business once they established controlled entities;
brckers and lenders have been able to direct virtually 100 percent
of their consumers' title business to their newly created controlled
agencies; controlled agencies have gained large shares of the
market with incredible rapidity; real estate professionals owning
interests in controlled agencies have made unprecedented and huge
profits; clients of real estate professionals have been sold closing
services at much higher than existing prices; and product quality
has suffered.
Hence, one must conclude on the basis of theory and factual
observation that controlled business produces not only the higher
prices associated with kickbacks but an additional assortment of
anticompetitive and highly undesirable economic consequences.
However, even if one does not believe that the empirical case is
conclusive, logic dictates that laws should push in the direction of
stopping market foreclosure, rather than legitimizing kickbacks
and monopolies of any sort.
In that regard, I strongly commend to your attention the article
by Professor Hofflander of UCLA, who urged the California Insur-
ance Department to make decisions which maximize the ability of
competitive forces to work on a free and even basis and minimize
conflicts of interest, especially when dealing with an ancillary
product over which the customer really has very little freedom of
choice.
I think it is important to view the suggestions made by HUD as
an attempt to solve the problem other than by including in section
PAGENO="0511"
505
8 of RESPA a prohibition against controlled business. HUD specifi-
cally asked that the full logic of its views on RESPA be considered
in order to understand its recommendation with regard to con-
trolled business, and I agree it should.
The HUD report and statement and the personal views of the
FTC official begin with the remarkable observation that according
to one economic model, kickbacks can be good things-not merely
harmless but useful. HUD's acceptance of the validity of this model
underlies its recommendation with respect to the appropriate
public policy treatment of all kinds of kickbacks, including con-
trolled business, and section 8 in its entirety.
If one could place even a modicum of faith in the HUD or FTC
analysis, I too would urge the repeal of section 8 and be glad to see
yet one more governmental regulation bite the dust. However, the
actions HUD and the FTC recommend would be detrimental to the
fabric of healthy competition in the American economy. If Con-
gress follows their suggestions, it would in effect be signifying its
agreement that kickbacks are~ a legitimate tool of competition in
the American economy.
I think it's very important to note that the witness from the FTC
made it abundantly clear that he was presenting his personal
views. The Federal Trade Commission has spoken only once that I
know of in a formal sense on the matter of controlled business and
kickbacks. It did so in a letter sent to HUD by the Bureau of
Consumer Protection setting forth the official position of the
Bureau of Consumer Protection, but not the position of the full
Commission, which had not issued an opinion on this.
In that letter it says:
The Peat, Marwick study raised the possibility of prohibiting ownership of under-
written title companies by referrors as another means of advancing competition in
this area. We believe this constitutes an important alternative remedy which should
be considered.
That is the only official statement by the Federal Trade Commis-
sion. So when I mention the Federal Trade Commission in my
testimony, I am referring to the personal views of the FTC official
and not to an official position of even an FTC bureau.
Chairman GONZALEZ. Dr. Plotkin, if you have no objection, might
we not include the copy of the letter in the record?
Dr. PLOTKIN. I certainly have no objection, and we will supply
that to your staff.
[The letter referred to follows Dr. Plotkin's prepared statement.]
Dr. PLOTKIN. HUD and the FTC official argue that our economy,
in general and specifically in credit granting-in spite of the un-
equal positions of would-be borrowers and lenders-behaves in such
a way that any form of graft will be filtered down to the consum-
ing public at large by the forces of competition and hence are of no
concern.
They base this belief on a theoretical model of how mortgage
lenders and real estate brokers actually compete. They offer not
one scrap of empirical evidence in support of these novel conten-
tions, and turn their backs on literally mountains of data and
evidence which refute their theories.
One must understand something about ecoiiomic models-some-
thing which even economists may forget. All models are merely
PAGENO="0512"
506
logical possibilities. The job of the economist and the Congressman,
on the basis of their education, experience, and research, is to
judge the degree to which a logical model is realistic-the degree to
which it reflects reality and is likely to accurately predict what
will happen in the real world if certain actions are taken.
As we shall see, HUD does none of this. Rather, it and the FTC
official offered proof by analogy of such poor quality as to be
almost insulting, at least in my opinion as an economist.
For example, the HUD and FTC witnesses primarily pointed to
department stores and physicians as analogies. Witnesses this
morning also pointed to Sears Roebuck asking what is wrong with
selling insurance and refrigerators in the same store.
Their use of the department store analogy reveals ignorance of a
fundamental aspect of the mortgage lending/title insurance tie-in
and the true problem of controlled business. Namely, for all practi-
cal purposes, a person seeking a loan will do all he can to motivate
the lender to grant him credit, including volunteering to use
whichever provider of ancillary services the borrower believes the
lender really wants, even if the lender makes no explicit or even
implicit suggestion.
While that might sound like quite an assertion on my part, I
respectfully commend your attention to the hearing record given
under oath before the Texas Department of Insurance where lend-
ers said outright that they do, in fact, have that ability, and real
estate agents said they will always designate the lenders' con-
trolled interests when making a loan application-"Like chicken
soup to the dead, it certainly can't hurt in causing the lender to
look with favor on your application."
Contrast this with buying a refrigerator at Sears. No appliance
salesman would ever think to suggest that I also get an Allstate
policy in order to maximize the chance of his selling me the refrig-
erator. To suggest that such an analogy is instructive must be
either foolish or insulting.
Generalizations about corporate reputation are wholly without
real world relevance to the kickback issue. Controlled business
kickbacks are only important when the person who is doing the
steering is in a position of power over the person whom he is
steering. The Sears Roebuck refrigerator salesman has no power
over me, no power to effectively force me to buy an Allstate insur-
ance policy. I cannot but commend the John Wanamakers and
Sears, Roebucks of the world. However, these organizations have
none of the power of a lender with respect to his would-be borrow-
er, of a doctor with respect to his patient, of a real estate broker
with respect to his client. Such professionals have an almost abso-
lute monopoly of information and are regarded by their clients as
fiduciaries. Such professionals can steer their clients to buy a
needed ancillary service from the provider paying them the great-
est kickback-no matter what form it may take. There is simply no
analogy with a department store selling many, often unrelated,
items.
However, the HUD and FTC physician analogy is instructive and
must be fully considered. I-and I suspect from your remarks of
yesterday, you, too, Mr. Chairman, and most people-would be very
concerned if I felt my doctor's prescribing drugs or a particular
PAGENO="0513"
507
drug was even potentially influenced by his interest in a pharmacy
to which he might steer me, or his ordering medical tests was
influenced by his interest in the lab to which he sends both my
blood and money, and gets back both my results and a dividend or
a kickback.
Applying the FTC and HUD economic model to their own anal-
ogy would tell you there is no reason for concern, for those divi-
dends keep down doctors' fees.
Chairman GONZALEZ. Would you yield, Dr. Plotkin, because I
must say there is a recorded vote going on on the House floor and I
must go record my presence and vote. It is an important appropri-
ation matter, and therefore I am going to ask that we recess for
about 5 minutes in order to vote and return.
But with respect to the analogy-well, one reason is, I am sur-
rounded by physicians. I have a brother, uncle, two cousins, three
nephews-they're all doctors, and I know some of the practical
aspects. But I thought that was a rather poorly selected analogy.
[Laughter.]
[Recess.]
Chairman GONZALEZ. The subcommittee will pick up where we
left off. I tried to do some trolling for some of the members of the
subcommittee but I wasn't successful. Every one of those that I was
able to contact has conflicts and each one of them stated he was at
a critical juncture in their other hearings. But it ranges from
immigration to, antitrust activities in the small business chemical
industry. Anyway, some of the members indicated that as soon as
they could disengage themselves from their other conflicts, they
would be present. So we will pick up, Dr. Plotkin, and pardon the
interruption.
Dr. PLOTKIN. We had just finished discussing the analogy offered
by the FTC and HUD to medical care providers who choose on
behalf of their patients the providers of ancillary medical services
in which they have a vested interest. I would note that our Govern-
ment has clearly stated, in direct contravention to the theory of
HUD and the FTC officials, that it does not want the alleged
benefits associated with rebates, kickbacks, or referral fees, when it
is spending its own, or should I say, our money. And I refer here
specifically to the Medicare/Medicaid Act, 42 U.S.C., section 1396
h(b)(1).
If Mr. Collier can practice economics I will practice law a little
bit, without a license. More revealing is the discussion in an appel-
late court's decision quoting the legislative history. The committee
report stated that:
Existing law provides specific penalties under the medicare and medicaid pro-
grams for certain practices that long have been regarded by professional organiza-
tions as unethical, which are unlawful in some jurisdictions, and which contribute
significantly to the cost of the programs. Such practices as the submission of false
claims, or the soliciting, offering or acceptance of kickbacks or bribes, including
rebates or a portion of fees or charges for patient referrals, are misdemeanors under
present law.
Our Government has stated clearly that it does not want any
part of these alleged benefits that come from kickbacks through
the magic operation of competition when it is the payor under
medicare and medicaid.
85-396 0 - 81 - 33
PAGENO="0514"
508
In addition to its belief that kickbacks can be a force for good,
HUD advances a grin-without-the-cat version of the lender-pay
model put forward a number of years ago. HUD calls its proposal
lender package, for lenders would not pay for the services they
demand out of the interest rate, as was originally proposed, but
rather would levy an up-front charge as they now do.
Whatever merit this proposal may have it has none as long as
controlled business is a part of it. For as a cure for the evils of
kickbacks and controlled business, which HUD claims it is, the
lender-package scheme must be considered a cruel hoax at best and
an engine which would aggrevate the current problems at worst.
Lender packaging has also become a bit of a red herring in this
hearing for it has diverted attention away from the clear need to
address the controlled business version of kickbacks in revisions of
RESPA, section 8. I hope it is clear that I believe that anyone
should have the right to establish a title agency or a title insurance
underwriter. Just because that person is a real estate professional,
be he a lender or a real estate broker, he should not be proscribed
from entering and competing in the business for title insurance.
However, he should not write himself a competitive advantage so
that he can channel his own business to his own entity, and,
thereby, compete on an unequal basis with all other title providers.
That is what goes against the entire grain and thrust of fair trade
practices and abuses the basis logic and reasoning of antitrust.
I base this strong statement not merely on theoretical reasoning,
but on a massive amount of empirical information dealing with the
results of lenders packaging an insurance product together with
the granting of credit. Results which are or should be well known
to all the Government agencies testifying in this hearing, yet about
which they appear to be completely ignorant. Specifically, a review
of the well-documented and sorry history of lenders' profiting from
the sale of credit life insurance should end any speculation about
what would likely happen if the lender could both package and
benefit financially from the sale of title insurance as an effective
condition to granting mortgage loans.
As Congress knows from its numerous major studies of credit life
insurance dating back to 1955 and as recent as 1979, this product is
generally packaged by lenders and sellers of consumer durables
purchased on credit-cars, appliances, et cetera. Further, these
lenders or merchants have used numerous devices to insure that
they capture a very large portion of the $1.8 billion paid by con-
sumers in 1979 for such insurance without passing any of these
profits back to their captive customers in the form of lower prices
elsewhere.
The well-documented use of kickbacks, commissions, rebates and
now controlled agencies and reinsurance subsidiaries by lenders
selling credit life insurance bears a striking parallel to the evolu-
tion of title insurance arrangements benefiting real estate brokers
and lenders. The striking parallel is also present with respect to
the ancillary nature of the two insurance products, the usual envi-
ronment surrounding their sale, the unequal status and knowledge
of the would-be borrower and the lender, the up-front premium
payment, and many other items of important similarity.
PAGENO="0515"
509
To me, one of the most outstanding features of the HUD state-
ment and its report proper is its studied neglect of the experience
from credit life. This is especially remarkable in the face of the fact
that so many of the sources HUD reviewed-including the Depart-
ment of Justice, the decision by the California Insurance Depart-
ment, and the appellate court in California-have specifically and
prominently drawn attention to the analogy between credit life
insurance and title insurance and its important lessons for compe-
tition.
Finally, when without one shred of empirical evidence to offer in
support of its remarkable theory and in the face of much contradic-
tory evidence, HUD asserts that lender-packaging will "eliminate
the concern about controlled business and kickback or referral
fees," I must conclude I am reading "Candide," and this is truly
the best of all possible worlds. In the alternative, my teacher,
Professor Samuelson, was Don Quixote, and all the antitrust law
was written by Sancho Panza.
Economic analysis is far from perfect. Yet I assure you, Mr.
Chairman, it has much better reasoning to offer than the HUD/
FTC panacea. Only someone who was unconcerned about kickbacks
in the first place-perhaps because he thought they were good
things-or someone dedicated to reducing the role of Government
at any cost, could take comfort from the lender-package scheme,
urge the repeal of section 8, or urge the noninclusion of a very
broad ban on controlled business within a revised section 8.
Given the evidence before you from throughout the country, the
repeal of section 8 or the failure to explicitly include controlled
business within it, would constitute a grave error. For either action
would announce to the American public that Congress condones
kickbacks as a legitimate basis of competition in American indus-
try. This would be a monumental step backward.
Thank you very much, especially for your patience. I realize I
have run on more than the usual time.
[Dr. Plotkin's prepared statement, "The Economic Consequences
of Controlled Business in the Real Estate Industry," and the mate-
rial referred to in his oral presentation-the letter to Chairman
Gonzalez commenting on the testimony of witness Charles R.
Hilton of Coldwell, Banker, and the Federal Trade Commission
letter to the Department of Housing and Urban Development
follow:]
PAGENO="0516"
510
THE ECONOMIC CONSEQUENCES OF CONTROLLED
BUSINESS IN THE REAL ESTATE INDUSTRY
STATEMENT OF
DR. IRVING H. PLOTKIN
BEFORE THE
SUBCO~'T1ITTEE ON HOUSING AND COMMIJ4ITY DEVELOPMENT
OF THE
HOUSE C*?IITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
SEPTEMBER 16, 1981
Arthur DLitfle,Inc
PAGENO="0517"
511
THE ECONOMIC CONSEQUENCES OF CONTROLLED
BUSINESS IN THE REAL ESTATE INDUSTRY
I. Introduction
Mr. Chairman, members of the Subcommittee, thank you very much for
inviting me to appear before this important hearing.
My research experience and professional oualifications as a micro-
economist are recorded in my resume (which I have attached to this
statement). My research into the title insurance industry began in the
early 1970s when I met with HUP staff members following the publication of
the HUD/VA study of real estate settlement costs. Since then, I have
consulted with ALTA. the National Association of Insurance Commissioners,
and individual state title insurance associations, and have extended my
research into many aspects of the economics and regulation of the industry.
I have presented numerous paPers on the title insurance industry and have
submitted, for the record, a monograoh I published dealing with the
economics of this industry.*
While I have consulted with and for numerous segments of the real
estate settlement industry and its federal and state regulators, I appear
here solely to present my own views and do not purport to represent the views
of any other person or group.
II. Kickbacks and Controlled Business
In my opinion, referral fees and kickbacks are generally outlawed as
business practices, not only because they tend to inflate prices to
consumers, but because such trade practices are fundamentally at variance
with the basic methods of competition upon which the American economic
system is based. Such trade practices are even more deleterious to the
functioning of a healthy marketolace than are many structural arrangements
proscribed by the antitrust laws.
Human nature and actual economic practice are such that kickbacks of
all kinds seldom, if ever, flow down to benefit the consuming public. Mr.
Savas' (HUD) assertion that there exists "ample evidence of referral fees
reducing costs," was not supported by even a single example, although I
understand he will be asked to provide some support for this assertion. All
available evidence of which I am aware in the title insurance and related
industries demonstrates just the reverse: those who received kickbacks
were greatly enriched--no benefit flowed down to the public.
*plotkin, Irving H., On the Theory and Practice of Rate Review and Profit
Measurement in Title Insurance, Cambridge, Massachusetts, 1978.
PAGENO="0518"
512
One thing is abundantly clear. It is completely contradictory for
Section 8 of RESPA to outlaw kickbacks and referral fees while, in 1981,
failing to directly proscribe controlled business arrangements. As HUD and
others have stated, forthrightness now demands that kickbacks in all their
various forms,e.g., controlled business, under-the-table payments, lavish
entertainment, be held either to be contrary to the public good or to be
harmless.
Controlled business is not only the functional equivalent of kick-
backs and referral fees--as all who have written on this topic, including
HUD, the Department of Justice, and academic economists have stated--but
controlled business also aggravates the consumer harm produced by kick-
backs. Controlled business harms competition by:
* foreclosing the market to existing competitors;
* raising barriers to new entry;
* causing the demise of independent title insurance agen-
cies; and
* lowering product quality.
These results have been demonstrated again and again throughout the
country since 1975. I call your attention to the testimony of yesterdays
witnesses and also to the recent hearing by the Texas Board of Insurance,
where numerous witnesses documented similar experiences.
III. New Competition or Foreclosure
The establishment of a new title insurance agency by controllers of
business, or the conversion of an independent agency into one owned by real
estate professionals, should never be thought of as new entry or new
competition in a given market for title insurance. Rather, such "entry'
produces just the opposite effect through its cartelization of the market,
its foreclosure of competition, and its damaging effect on the interests of
consumers in both the short and long run.
Controlled business agencies are not pro-competitive. Rather, by
their very nature, they kill off all possible competition from independent
title agencies for a segment of the market, namely that business which the
broker, attorney, or lender owning the controlled business agency can
direct to its subsidiary selling title insurance.
For example, one can draw a circle to represent all of the orders in
a given market for title insurance with a piece of the circle representing
those orders that real estate professional A can effectively control, say,
10% of the market. This professional would normally be the object of
competition among various providers of title insurance seeking to get a part
of his orders. However, if A creates his own title insurance agency to which
2
PAGENO="0519"
513
he steers his clients, competition for this part of the market will have
been foreclosed. Likewise, real estate professionals B and C with, say, 5%
of the market, could jointly set up their own controlled entity. In the
diagram below, 15% of the market has thus been removed from competition by
the creation of controlled business agencies.
SEGMENT OF
MARKET X
CLOSED TO
COMPETI TION
ORDERS FOR TITLE INSURANCE IN MARKET X
Thus, the establishment of a controlled business agency does not
increase the number of competitors; it does just the opposite. Claims to
the contrary reveal a lack of understanding of economic theory in general or
the specific nature of the title insurance industry. The establishment of
controlled business agencies has foreclosed increasingly larger shares of
numerous title insurance markets from competition.
IV. Vertical Inteoration
The establishment of controlled business agencies by real estate pro-
fessionals is not analogous to vertical integration. It is true that
vertical integration can produce consumer benefits in many instances by
increasing efficiency; I agree with current Department of Justice policies
in this regard. However, vertical integration that compels consumer
3
PAGENO="0520"
514
acceptance of ancillary products and does not exhibit economies of
production is not `the kind of antitrust reform being pursued by the
Department of Justice. Controlled business is not an example of productive
vertical integration but, instead, is an example of full line forcing, an
exercise of market power without redeeming social value.
The harm to competition described above can be observed in the
discussion of the California Appellate Court in the matter of Guardian
Title. The Court took up the issue of whether Guardian Title, considered to
be a controlled entity, was causing fair or unfair competition to take place
in the market for title insurance. The Court stated, in part: "Obviously
an entrant such as Guardian Title--assured from the outset of referrals from
the real estate broker, Coldwell Banker--would have a substantial economic
advantage over those title companies without a ready-made source of
business."
I agree with the California Appellate Court that a controlled entity
has a substantial and unfair economic advantage over uncontrolled title
insurance companies. The existence of unfair competition is the antitrust
problem that lies at the heart of the controlled business controversy,
although it has often been clouded by tangential or irrelevant issues.
V. Prices
It may be tempting to argue that because controlled business dealings
or kickbacks do not increase the price of any particular transaction, no
harm to consumers will result. Such reasoning ignores the findings of
economics and the courts:
* As in most anticompetitive structural arrangements, the
harm to consumers and deleterious price effects are long
run and systematic in nature. They may, therefore, take
a long time to be revealed.
* Recognition of this effect has led the courts to declare
certain practices perse illegal, even if the immediate
result may be a reduction in prices. Such a reduction, if
caused by non-market forces, e.g., an economic con-
spiracy, has an anticompetitive effect and is, thus, not
in the interests of consumers.
* Economics teaches us that whenever markets are fore-
closed, freeoom to compete diminished, or access to
customers denied, consumer welfare inevitably must be
harmed. Controlled business is equivalent to a fore-
closure of part of the market.
4
PAGENO="0521"
515
While it is rare to be able to observe the above results directly, a number
of them have been documented around the country since 1975:
* Lenders and real estate brokers have prevented inde-
pendent title agencies from even soliciting title busi-
ness once they established controlled agencies.
* Lenders and brokers have been able to direct virtually
100% of their customers title business to the newly-
created controlled agencies.
* Controlled agencies have gained relatively large shares
of the market with incredible rapidity.
* Real estate professionals owning interests in controlled
agencies have made unprecedented and huge profits.
* Clients of real estate professionals have been sold
closing services at prices much higher than those exist-
ing elsewhere.
* Product quality has suffered.
One must thus conclude, on the basis of theory and factual observation, that
controlled business produces not only the higher prices associated with
kickbacks but an additional assortment of anticompetitive and highly
undesirable economic consequences.
Even if one does not believe that the empirical case is conclusive,
logic dictates that the laws should go against market foreclosure, rather
than legitimizing kickbacks or monopolies of any sort. Professor
Hofflander of UCLA has written a pertinent article urging that regulators
make decisions that maximize the ability of competitive forces to work on a
free and even basis and minimize conflicts of interest, especially in regard
to ancillary products over which customers have very little real freedom of
choice.
VI. HUD Suggestions
The suggestion made by HUD amounts to an attempt at solving the
acknowledged problem other than by the most obvious way--inclusion in
Section 8 of RESPA of a prohibition against controlled business. (However,
HUD specifically states that unless Congress is prepared to make lender-
package mandatory, Section 8 must be amended to prohibit controlled
business.) HUD specifically asked that the full logic of its views on RESPA
be considered in order to understand its recommendation with regard to
controlled business, and I agree.
5~
PAGENO="0522"
516
The HUD report and statement and the personal views of the FTC
witness* begin with the observation that, according to one economic model,
kickbacks can be good things--not merely harmless but useful. HUD's
acceptance of the validity of this model underlies its recommendations with
respect to the appropriate public policy treatment concerning all kinds of
kickbacks, including controlled business and Section 8 in its entirety.
If one could place even a modicum of faith in the HUD or FTC analysis,
I too would urge the repeal of Section 8 and be glad to see yet one more
governmental regulation bite the dust. However, the actions HUD and the FTC
recommend would be detrimental to the fabric of healthy competition in the
American economy. If Congress follows their suggestions, it would in effect
be signifying its agreement that kickbacks are legitimate tools of
competition in the American economy.
HUD and the FTC argue that our economy, in general and specifically in
regard to credit granting (in spite of the unequal positions of would-be
borrowers and lenders), behaves in such a way that any form of graft will be
filtered down to the consuming public at large by the forces of competition
and, hence, is of no concern. HUD and the FTC base this belief on a
theoretical model of how mortgage lenders and real estate brokers actually
compete. They offer not one scrap of empirical evidence in support of this
novel contention, and turn their backs on mountains of data and evidence
that refute their theory.
One must understand something about economic models--something which
even economists may at times forget: All economic models are merely logical
possibilities. The job of the economist and (in this case) the Congressman,
on the basis of their education, experience, and research, is to judge the
degree to which a logical model is realistic and can be relied upon to
predict accurately what will happen in the real world if certain actions are
* The FTC witness made it very clear that he was presenting his personal
views and not those of the Commission. He suggested the outright repeal of
Section 8, trusting to competition the job of returning the kickbacks to the
consuming public. The Bureau of Consumer Protection of the FTC set forth
its official position on controlled business and kickbacks in a letter to
HUD. This letter has been submitted for the record. It says in part, "The
Peat, Marwick study raised the possibility of prohibiting ownership of
underwritten title companies by referrors as another means of advancing
competition in this area. We believe this constitutes an important
alternative remedy which should be considered." (Letter of December 19,
1980, signed by Mr. Lewis H. Goldfarb, Assistant Director for Credit
Practices, and Ms. Carole L. Reynolds, Attorney, Division of Credit
Practices, Bureau of Consumer Protection, Federal Trade Commission, to
Mr. Richard Patterson, Acting Director, Real Estate Division, Office of the
Assistant Secretary for Neighborhoods, Voluntary Associations and Consumer
Protection, Department of Housing and Urban Development.) For the
remainder of this statement, reference to the FTC will be to personal views
of this FTC witness only.
6
PAGENO="0523"
517
taken. As we shall see, HUD failed to do this. Rather, HUD and the FTC
offered proof-by-analogy of such poor quality as to be almost insulting, at
least in my opinion as an economist.
VII. Analogies
The proof-by-analogy offered by the HUD and FTC witnesses was based
primarily on the activities of department stores and physicians. Use of the
department store analogy reveals their ignorance of a fundamental aspect of
the mortgage lending/title insurance tie-in and the true problem of
controlled business. Namely, for all practical purposes, a person seeking
a loan will do all he can to motivate the lender to grant him credit, which
includes volunteering to use whichever provider of ancillary services the
borrower believes is the lenders preference, even if the lender makes no
explicit or even implicit suggestion in this regard.* Contrast this with
the purchase of a refrigerator atSears. No appliance salesman would ever
think to suggest that I should also get an Allstate policy in order to
maximize the chance of his selling me the refrigerator. This analogy sheds
no light on the economic consequencies of kickbacks in real estate financing
or brokerage. In fact, controlled business kickbacks are only important
when the person who is steering theconsumer to a particular ancillary good
or service provider is in a position of power over the consumer.
On the other hand, the physician analogy used by HUD and the FTC is
instructive and should be fully considered. I, for one, would be very
concerned if I felt that prescriptions written by my doctor were even
potentially influenced by his interest in a particular pharmacy to which he
might steer me, or if medical tests ordered by him were influenced by his
interest in the lab to which he sends both my blood and money, and from which
he gets back both my results and a dividend (kickback). Applying the FTC and
HUD economic model to their own physician analogy tells you tha.t there is no
reason for concern, for the dividends keep down doctors' fees. Federal law
and the courts, not to mention comon sense, tell you quite the opposite.
It should be noted that our government has made clear, contrary to the
theory of HUD and the FTC, that it wants none of the alleged benefits
associated with rebates, kickbacks, or referral fees when it is spending
public money. This has been stated directly in the case of Medicare and
Medicaid.** A discussion by the Sixth Circuit Court of Appeals on the
legislative history sets forth Congress' reasoning:
*Cf. the record of testimony given under oath before the Department of
Insurance in Texas where lenders admitted to having this power over
borrowers and real estate agents said that they designate the lenders'
controlled interests when making a loan application.
**f~1edicare/Medjcajd Act, 42, USC section 1396 h(b)(1)
7
PAGENO="0524"
518
"The report of the House Committee on Ways and Means contains
the following statement on the purpose of the 1977 amendment:
`The committee bill would modify the penalty provisions in
existing law which relate to those persons providing services
under Medicare and Medicaid. Existing law provides specific
penalties under the Medicare and Medicaid programs for certain
practices that long have been regarded by professional organ-
izations as unethical, which are unlawful in some juris-
dictions, and which contribute significantly to the cost of
the programs. Such practices as the submission of false
claims, or the soliciting, offering, or acceptance of kick-
backs or bribes, including rebates or [sic] a portion of fees
or charges for patient referrals, are misdemeanors under
present law . . .`
VIII. Lender-Package
In addition to its belief that kickbacks can be a force for good, HUD
advances a grin-without-the-cat version of the lender-pay model put forward
a number of years ago. HUD calls its proposal "lender-package" for under it
lenders would not pay for the services they demand out of the interest rate
as originally proposed, but rather would levy an up-front charge as they do
at present. As a cure for the evils of kickbacks and controlled business-
-which HUD claims it is--the lender-package scheme must be considered to be
a cruel hoax at best and an engine which would aggravate the current problem
at worst.
The lender-package proposal has become a red herring in this hearing
for it has diverted attention away from the clear need to *address the
controlled business version of kickbacks by revising Section 8 of RESPA. I
believe that anyone should have the right to establish a title insurance
agency, regardless of whether he is a real estate broker or lender.
However, this person should not be able to gain a competitive advantage by
channeling controlled business to his own entity and, thereby, compete on an
unequal basis with all other providers of title insurance. This is what
goes against the entire grain and thrust of fair trade practices and abuses
the basic logic and reasoning of antitrust principles.
TX. Credit Life Insurance
I base the above statement not merely on theoretical'reasoning, but
also on a massive amount of empirical information concerning the results of
the granting of credit with the packaging of an insurance product by
lenders. All the government agencies testifying in this hearing should be
well aware of these results, but apparently they are not. Specifically, a
*United States v. Tapert, 625 F.2d 111 (1980)
8
PAGENO="0525"
519
review of the well-documented and sorry history of lenders profiting from
the sale of credit life insurance should end any speculation about what
would be likely to happen if lenders could both package and benefit
financially from the sale of title insurance as an effective condition to
the granting of mortgage loans.
As Congress knows from its numerous major studies of credit life
insurance dating back to 1955 and produced as recently as 1979,* this
product is generally packaged by lenders and sellers of consumer durables
purchased on credit (cars, appliances, etc.). Furthermore, these lenders
or merchants have used numerous devices to ensure that they capture almost
half of the $1.8 billion paid by consumers in 1979 for such insurance
without passing any of these profits hack to their captive customers.
In contrast, credit unions generally do not gain from the dis-
tribution of credit life insurance to their borrowing members.** In
consequence, many credit unions do not impose a separate charge for the
coverage. This, and the legislative and regulatory history of credit
insurance show, that if, hut only if, the financial benefit is denied the
lender who controls the sale of credit life, the notential for overcharge
and other abuse of the consumer is eliminated.
The well-documented use of kickbacks, commissions, rebates, and now
controlled agencies and reinsurance subsidiaries by lenders selling credit
life insurance, bears a striking parallel to the evolution of title
insurance arrangements benefiting real estate brokers and lenders. The
striking parallel is also present with respect to the ancillary nature of
the two insurance products, the usual environment surrounding their sale,
the unequal status and knowledge of the would-be borrower and lender, the
up-front premium payment, and many other important items.
*The Tie-in Sale of Credit Insurance in Connection with Small Loans and
Other Transactions, Report of the Subcommittee on Anti-Trust and Monopoly
Legislation of the Committee on the Judiciary, U.S. Senate, Eighty-third
Congress, Second Session (1955); Consumer Credit Industry (Credit Insur
ance), Hearings before the Subcommittee on Anti-Trust and Monopoly of the
Committee on the Judiciary, U.S. Senate, Ninetieth Congress, First Session
(4 vols. 1967); Consumer Credit Insurance Act of 1969, Hearings on S. 1754
before the Subcommittee on Financial Institutions of the Committee on
Banking and Currency, U.S. Senate, Ninety-first Congress, First Session
(1969); Tie-ins of the Sale of Insurance by Banks and Bank Holding
Companies, Hearing before the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, Ninety-sixth Congress, First Session (1979); Credit
Life Insurance, Hearings before the Subcommittee on Anti-Trust, Monopoly
and Business Rights of the Committee on the Judiciary, U.S. Senate, Ninety-
sixth Congress, First Session (1979).
**Federally chartered credit unions are prohibited from being compensated
for the sale of credit-related insurance beyond reimbursement for actual
costs incurred. See 12 C.F.R. SectiOn 721.1(M) (1981).
9~
PAGENO="0526"
520
To me, one of the most surprising features of the HUD statement and
its report is its studied neglect of the experience with credit life
insurance. This is especially remarkable in the face of the fact that so
many of the sources HUD reviewed, including the Department of Justice, the
California Insurance Department, and the Appellate Court in California,
have prominently drawn specific attention to the analogy between credit
life and title insurance and the important lessons it holds for competition.
X. Conclusion
Finally, when without one shred of empirical evidence to offer in
support of its remarkable theory and in the face of much contradictory
evidence, HUD asserts that its mandatory lender-package scheme will
"eliminate the concern about controlled business and kickback or referral
fees" and the FTC witness urges the outright repeal of Section 8 without any
other actions, I must conclude that I am reading Candide, and this is truly
the best of all possible worlds.
Economic analysis is far from perfect. Yet I assure you, Mr.
Chairman, it has much better reasoning to offer than the HUD/FTC panacea.
Only someone who was unconcerned about kickbacks in the first place--
perhaps because he thought they were good things--or someone dedicated to
reducing the role of government at any cost, could take comfort in the
lender-package scheme, urge the repeal of Section 8, or oppose the inclusion
of a very broad ban on controlled business within a revised Section 8.
Given the evidence before you from throughout the country, the repeal
of Section 8 or the failure to explicitly include controlled business within
it, would constitute a grave error. Either action would announce to the
American public that Congress condones kickbacks as a legitimate basis for
competition in American industry. This would be a monumental step backward.
10
PAGENO="0527"
521
ArthurD Little,Inc. ACORN PARK CAMBRIDGEMA 02140(617) 864-5770TELEX 921436
October 8, 1981
The Honorable Henry B. Gonzalez
Chairman
Subcommittee on Housing and Community
Development of the
Committee on Banking, Finance
and Urban Affairs
U. S. House of Representatives
2129 Rayburn House Office Building
Washington, D. C. 20515
Dear Mr. Chairman:
As you kindly invited me to do, I have reviewed the testimony of Mr.
Charles R. Hilton, Senior Vice President of Coldwell, Banker. I supply for the
record, as you requested, the following responses:
Mr. Hilton's forecast of what I would say before your subcommittee proved
to be completely erroneous. In fact, I have never claimed that the title insurance
industry is capital intensive. I have, however, observed that the nature of its
operations generally produces significant fixed costs albeit in payroll expense.
(See, for instance, my monograph On the Theory and Practice of Rate Review
and Profit Measurement in Title Insurance, Cambridge, Massachusetts, 1978, as
well as studies by numerous researchers, such as Professors Alfred Hofflander
and Kevin E. Villani.)
Mr. Hilton's remarks appear to suggest that my testimony about the
economic harm caused by controlled business should not be credited. I think it
is fair to note that Mr. Hilton presented testimony similar to his testimony
before you both to the California Insurance Department and before a California
superior court as a part of Coldwell, Banker's appeal of the Insurance
Department's decision regarding the economic consequences of controlled
business. The California Court of Appeals, in reviewing both decisions and Mr.
Hilton's testimony in both proceedings, made the following observations:
"As to the factual determination [made by the lower court], it rests
on the in-court testimony of Charles R. Hilton, president of
Guardian Title, which was substantially the same as that presented
at the administrative hearing.' [The Court then quotes, at some
length, Mr. Hilton's testimony to the effect that Coldwell, Banker's
PAGENO="0528"
522
October 8, 1981
Page 2.
The Honorable Henry B. Gonzalez
Chairman
Subcommittee on Housing and Community
Development of the
Committee on Banking, Finance
and Urban Affairs
U. S. House of Representatives
real estate business was de minirnus in Southern California. The
Court then states,] "We note that trial took place in 1977; in the
Annual Report of 1974 Coldwell declared that, since the acquisition
of Forest E. Olson Company, it was the largest residential
brokerage firm in Los Angeles County. The problem which is
presented, hoviever, is not necessarily that of the credibility of the
witness." [In sustaining the Insurance Commissioner's findings, the
Court further says,] "Certain minimal requirements of precision
must prevail in the quality of evidence which supports a factual
finding. It must be evidence which possesses solid value.' The
Hilton testimony did not meet this standard. The Insurance
Commissioner was not required to accept and give substantial
weight to this kind of flimsy, conjectural and insubstantial
evidence.'
Mr. Hilton appears to ne attempting to discreoit my testimony, in advance,
by suggesting that I should not be called a "public witness." When I was first
contacted oy your staff, 1 understood that I would be on an "economist panel." It
was riot until I arriveo at the healing tnat I learned tnat my panel had been styled
a "public panel." I think the style was accurate in that it distiriguisned the panel
I appeared on from other panels which represented specific interests in the real
estate industry ano witnesses wno spoke as policy representatives of their firms,
trade associations, or government agencies. Like all otner members on the
`public panel, my research in the real estate inoustry has been commissioned by
a large mix of government regulators, government participants, and private
participants. However, as my testimony stated, I represented no party, no
former or existing client, at the hearing. Ratner, I presented solely my own
views, with which the sponsors of my current research, the American Land Title
Association, may not agree.
I appreciate your giving me the opportunity to review and comment on the
testimony of Mr. Charles Hilton.
Respectfully yours,
s/
Irving H. Plotkin
Vice President
/psf
PAGENO="0529"
523
FEDERAL TRADE COMMISSION
WASHINGTON. D. C. 20580
IJUREAU OF
~ONSU5IE[t PP.O1WFION
December 19, 1980
Mr. Richard Patterson
Acting Director
Real Estate Division
Office of the Assistant Secretary
for Neighborhoods, Voluntary
Associations and Consumer Protection
Deportment of Housing and
Urban Development
Washington, D.C. 20410
RE: BUD Report to Congress on
Real Estate Settlement
Procedures Act
Dear Mr. Patterson:
This is in response to your request for comment with respect
to the Peat, Ilarwick, Mitchell and Co.. (`Peat, Marwick") draft
final report to BUD in connection with your evaluation of the
Real Estate Settlement Procedures Act of 1974 (RESPA). You have
also asked fur other information concerning the impact of BESP1~
and potential policy alternatives which may be included in BUD's
report to Congress concerning RESPA and the possible necessity
for further legislation in the area of real estate settlement
costs. At this time your target dote for submission for the
final BUD report to Congress is January 30, 1981.
Our comments address certain consumer protection issues
related to RESPA and focus particularly on the goal of achieviiiēj
active price competition in settlement service markets. The
comments include some discussion of findings in the Peat,
Marwick report, as well as other areas of concern. Our com~nents
represent the views of the Division of Cre'di Practices and do
not necessarily reflect the views of the Commission or of an~'
particular Commissioner.
I. PROBLEM AREAS
A. Settlement Service Markets Generally
Consistent with the findings of the Peat, Marwick study, our
experience indicates that consumers lack adequate, and in some
cases accurate, information with regard to settlement services
in connection with residential mortgage transactions. The
settlement service area, as well as mortgage finance, is
unfamiliar to most consumers and some technical knowledge is
necessary to facilitate inforir~:d choices. Although RESPA seeko
to provide consumers with increased and relevant material in
this area, many consumers have difficulty understanding
information provided due to its technical nature. While
85-396 0 - 81 - 3~4
PAGENO="0530"
524
;ir. 1-~ichard Patterson Page 2
additional sources of information may be available- through trade
associations or other sources, many consumers are not aware of
these possibilities.
Another general problem area (discussed below) which merits
consideration in evaluation of RCSP1~'s effectiyeness is the
problem of lawyer tie-ins in the performance-of settlement
services. For example, the Federal Iloae Loan Bank Board's
efforts a few years back to clarify when the lending institution
may require the use of its attorney may, in our view, have
inadvertently exacerbated rather than alleviated this problem.
Tnis is an area of consider-able concern to the Division and one
which has generated inquiries from consumers over the years.
%ce also hops the report will explore the practice by
some lenders of charging for whet are apparently unnecessary
or duplicative settlement services. As alternative mortqa;e
instrument programs increase, the potential e~:ists that
appraisals, title searches and other settlement services may be
required by the same or different lenders with respect to
refinancings and loan renewals.
B. Brokerage Industry
The Peat, flarwick finding of a lack of active price
competition in the brokerage industry is emtremely important to
consumers. This is especially significant in view of. the lack
of significant barriers to cntry, the large number of providers
and the competitive nature of tho real estate brokerage
concern. -
The result of this absence of competition is high prices for
the consumer in the form of real estate commissions despite
differing market conditions. he encourage HUB to analyze this
problem closely to further evaluate the possibility of collusive
practices, ~ price fixing. ho have seen instances in the
Fashington, D.C. market of retaliatory action taken against
discount brokers by the major firms in the area. tihilc- consumer
inquiries to the Division do not indicate widespread.
dissatisfaction with performance of services provided by
brokers, greater price competition should be encouraged to
produce a more efficient service.
C. Mortgage Lending
Certain practices exist in the mortgage lending industry
which may impact only indirectly on the question of price
competition, but which may involve other undesirable economic
effects. For example, it appears to be fairly commdn in the
industry for le-nders to require their- own attorney to
PAGENO="0531"
525
Mr. Richard Patterson Page 3
review settlement documents which were previously prepared by an
attorney retained by the buyer. While this may satisfy lenders
that the loans involved will meet the necessary standards of the
secondary market, the result of this process is that at least
two attorneys perform the same or similar teaks and excessive
and unnecessary costs are imposed on the consomer. In addition,
designation by the lender of a particular attorney for this
purpose creates a noncompetitive pricing situation for the
consumer. Even where the lender doe not require use of its
attorney, the practice of requiring the borrower to choose from
among a limited number of attorneys produces substantially the
same anticompetitive effects~
The Division has also received complaints end inquiries over
recent months with respect to lenders requiring excessive escrow
of funds at settlement. While IlUD regulations currently specify
procedures and formulas to be applied in computing escrow funds,
there appears to he some evidence of noncompl iance with these
requirements. This problem is not treated in thePeat, Warwick
study and merits further consideration and possibly new
remedies.
Some fixed rate mortgage lenders also appear to be p~oviding
an initial commitment to the borrower and subsequently reneging
on that rate. In volatile market situations, it may be
difficult for a lender to predict the exact rate of interest
upon closing, however, additional protections are necessary to
insure that lenders do not shift a disadvantageous market
position to the consumer by holding berroweri~ to their
commitments when rates drop and reneging on commitments when
rates soar.
At present, federal law does not require mortgage lenders to
provide the borrower with.a copy of the appraisal of their
property nor with a copy of ether documents of interest to
consumers which are included in the borrower's file and
accessible to the lender. Some lenders appear reluctant to
provide these documents to consumers. It is unclear whether
this problem is related to the cost associated with provision of
the document or, in some cases, reflects upon the quality of the
service provided. As mentioned ahove, we are particularly
concerned wih the possibility that certain flexible rate
mortgage lenders may require spurious services which will.impose
unnecessary costs on consumers. Failure to provide consumers
with a copy of the appraisal makes it difficult to determine
whether the appraisal was poorly done or done a~ all. Borrowers
are also entitled to a copy of the appraisal since they paid for
the service.
PAGENO="0532"
526
Mr. Richard Patterson Page 4
D. I*lortgage Insurance
Many consumers are unfamiliar with the product or manner of
purchase of mortgage insurance. In large part, this is because
in most mortgage transactions where mortgage insurance is
required, the lender acts as the buyer of the service. Thus,
the mortgage insurer and borrower do not have ~he opportunity to
discuss cost, payment options or other features of the service.
Most lenders also do not discuss these matters with the
consumer, despite the fact that mortgage insurance may add
thousands of dollars in cost to the mortgage transaction.
In our experience, consumers are concerned about the cost,
the terms of the mortgage insurance policy and other aspects of
the mortgage insurance industry. However, their first and only
contact with information on this subject is at the point of
consummation of the transaction, a time when they ore presented
with various documents and nave insufficient time to consider
mortgage insurance issues. Additional provision is necessary to
improve consumer input in this asoect of the transaction.
E. Title Insurance and Conveyoncing Services
The many conveyancing services provided at settlement or
closing are usually performed by an attorney or a title
insurance company. be are particularly concerned with the
interlocking relationships between referors and title insurance
companies in this industry, especially those between attorneys,
lenders and title insurance companios. These areas are
unfamiliar to consumers and consumers lack meaningful
information sufficient to shop and compare the services provided
as well as their cost. In general, our experience is that a
substantial consumer education effort may be necessary to
overcome some of these problems.
II. ALTERNATIVES
We recommend the following alternatives to he used in
conjunction with continuation of HESPA, with certain amendments.
A. Earlier Delivery of the Good Faith Estimate (GFE)
The good faith estimate is presently provided to the home
buyer after the loon application is made and provides the
consumer with some information regarding the potential
settlement related costs. Unfortunately however, this point in
PAGENO="0533"
527
(Ir. Richard Patterson Page 5
time is generally too late to assist the connuocr in certain
credit shopping decisions cohcerning a mortgage loan. Requiring
provision of the GEE prior to the application process would
provide prospective borrowers eth more infnrrnation with which
to evaluate their ability and tneir willingness to incur debt.
B. Loan Commitments
We recommend that lenders be required to provide a 21 day
commitment at a stated interest rate for a minimum time period,
~i.ge' 21 days. This would permit consumers time to shop for tOe
best credit buy and to rely on ttie rate quoted by the lender
upon commitment. It would remedy to some extent the current
problem of lenders reneging on commitments. While it is
possible that this prejooal could result in lenders quoting
higher interest rates initially, it would nonetheless give the
consumer a rate they could employ in the credit shopping
process. Thus this approach could provide borrowers with
greater certainty of terms and not significantly increase toe
lender's risk.
C. Interest Rates and Points
To facilitate comparison credit shopping by consumers, iic
recommend that lenders he provided the option of increasing
their interest rate and reducing paints. Creditor use of
discount points tends to moPe it difficult for the borrower to
compare loan costs bdtween lenders in the early shopping stage..
Although the Truth in Lending Act requires lenders to utilize
the Annual Percentage Rate (APR) in oral quotations am wall as
disclosure statements, in the early stage of credit shopping,
the interest rate may be sore important to the consumer. At
that time, the total cost of credit may be unknown end ths APR
undeterminable. Further, the largest portion of credit cost
will be the interest rate and that figure may fe ascertainehlc.
in addition, points have traditionally been imposed to increase
creditor yield where interest rate ceilings prevented charging
reasonable rates. The Depository Institutions Deregulation and
Nonetery Control Act of 1980 lifted ceilingi; on mortgage
interest rates and thus has minimized some of the necessity for
lenders to utilize alternative mechanisms to increase this
yield.
D. Publication of Mortgage Finance Costs
Me support increased publication of rates and costs
associated with mortgage financing and other iiiforniation
concerning terms of the mortgage transaction to consumers. Tons
PAGENO="0534"
528
Mr. Ric~ard Patterson Page 6
information could bc provided triough fcdercjl, statc era local
agencies as well as through lendocs and trade associations,
chambers of commerce and civic groups. Mc also recommend a
substantially increased consuser education program which maw
include utilization of public education institutions.
C. Mortgage Insurance
We strongly recommend that consumers be provided more and
varied information concerning mortgage insurance, policies,
forms and premiums. This could be included in the revised
special information booklet provided consumers early in the
credit shopping process. We believe it is especially important
that consumers have, and be aware that they have, an option to
chose the mortgage insuronce provider. They should also ho
informed as to how long they must pay mortgage insurance.
Payment options should be provided in ii :u of the sinqle prepeid
policy. This would erahie consumers to select paymcnt options
which are more tailored to their needs and eould provide for
greater competition in the industry.
It is especially important that consumers he mode aware that
they have a choice of potential mortgage insurers. While we
believe tnat the lender may provide the consumer with a
potential group of insurers, we recommend that this group he
nonexclusive, i.e., that the consu:rer be permitted to select any
cospetent mortgage insurer of the consumer's choice.
We would also encourage state insurance commissions to
evaluate the extent to which premiums currently being charged
are excessive. flowever, we would not encourage state regulation
of the industry, and we believe that more direct and open
competition will alleviate the necessity for an ongoing
investigation in this area.
F. Title Insurance
With respect to the title insurance and conveyancing
industries, the primary problem for consumers is lack of
information and lack of choice of alternative providers of these
services. Most consumers purchase a house and obtain a mortgage
only once or a few times ever their lifetime and are unfamiliar
with conveyancing problems. Information which is provided
consumers on these matters is often technical and confusing.
Consumers need to be gradually provided information which will
contribute to a meaningful credit choice. Providing additional
information in the mpecial information booklet would be helpful,
however a program of consumer education as discussed above,
through civic groups, cnambcrs of commerce and even the public
education system would also be helpful..
PAGENO="0535"
529
Title insurance ratea are currently protected from antitrust.
actions under the McCarran-Ferguson T~ct. %e also recommand
state deregulation to encourage open compc:tition and reasonable
rates.
The Post, tiarwick study raised the possibility of
prohibiting ownership of underwritten title companies by
referers as another means of advancing conpetilion in this
area. We believe this constitutes en important alternative
remedy which should be considered.
We oppose requiring lenders to provide a list of acceptable
attorneys for title insurance firms to be provided consumers by
lenders and real estate brokers. In our exper ioncs consumers
may be intimidated by the suggestion from the lender who will
ultimately approve the mortgage application that a particular
attorney be retained. However, we would not oppose lender
provision of a list of potential attorneys to the consurar
provided that the consurarr was clearly notified that salection
from this list was not mandatory. T~n additional approach to the
title insurance problem would be- to enact a Federal Land
Recordation Act as an amendment -to RESP~. This would require
states to utilize uniform procedures in recording title to land
and thus minimize the necossiLy for title insurance.
G. Brokerage Services
The lack of pri-ce competition and the presence of
substantial price uniformity in the provision of brokerage
services indicates some remedies are necessery in this area. -
i~gain, we support alternatives focused upon deregulation,
howaver, and believe that publicising to consumers that these
commission rates are nonfixed is an importont initial step.
Increased consumer awareness of- the terms of the listing
agreement is important and could be accomplished through
revision of this special information booklet. We do riot believe
this would substantially increase seller or lender cost, and it
would contribute to increased price competition.
H. General Remedies - -
We also recommend amendment of RESP~I to provide for
administrative remedies in the form of injunctive relief and.
- - civil -penalties for violations of-the Act and any implementing -
regulat ions. This would permit IJUD to actively enforce these
important requirements and would encourage industry-wide
compliance. - -
We urge BUD to consider these issues in drafting its report
on RESPA to Congress. We mppreįiate this opportunity to present
our views to BUD on this matter.
Si erely,
~4~I1
- ewis H. Goldfarb,.
~ssistan1 Director -
- for Credit Practices - -
~ (.4~c
Car ole L. Reynolds
Attorney
Division of Credit Practices
PAGENO="0536"
530
Chairman GONZALEZ. Well, thank you very much. I am not
aware that you went over the average. [Laughter.]
I, for one, I guess, have been criticized because I indulge in a
very liberal way, not only with witnesses but with members, be-
cause I think that is one of the handicaps of a body such as the
House, where you have very definite time constraints. But I think
it is best, to the maximum point possible, to give the opportunity to
the witness who, in most instances, has traveled many miles and
will not likely have a chance to reappear. [Laughter.]
But we will continue with Dr. Deborah Ford who is assistant
professor of finance at the University of Baltimore.
STATEMENT OF DR. DEBORAH ANN FORD, ASSISTANT
PROFESSOR OF FINANCE, UNIVERSITY OF BALTIMORE
Dr. FORD. Thank you very much, Mr. Chairman.
I have been asked to speak briefly this afternoon as an independ-
ent observer of the title insurance industry. By way of background,
I participated in a 2-year study of the effects of RESPA when I was
with Peat, Marwick, Mitchell & Co. That study had been author-
ized by HUD. I would like to make clear, though, that I am no
longer with Peat, Marwick & Mitchell and that the views that I am
expressing this afternoon are my own and not necessarily those of
that firm, or for that matter, the Peat, Marwick study that came
out last year.
Since I left Peat, Marwick, I have been teaching finance full-
time. However, I have retained an interest in title insurance, par-
ticularly the methods and channels through which it is provided to
consumers. It is this issue in its broadest context which I would
like to address this afternoon.
Despite the fact that reverse competition was discussed at great
length yesterday, I would like to add a few words on that subject
since I believe that this is, in fact, the basic problem of which
controlled business is a result, and not a problem in itself. Title
insurance, or an attorney's opinion in some places, is not an ordi-
nary economic good. It is purchased only at a time of a real estate
transaction and it is a true ancillary good to a much more impor-
tant transaction.
Second, while real estate professionals might understand the
need for and provision of title insurance, the vast majority of
homebuyers do not. They may purchase homes on only a few
occasions over a lifetime. Therefore, the necessity of learning how
to purchase title insurance may seem unimportant.
Further, if the real estate transactions are in different locales,
the methods of purchasing title information and insurance may not
be comparable. Therefore, the consumer's own past experience may
seem irrelevant. The result of a lack of information and infrequent
occurrences is that most consumers depend upon real estate profes-
sionals to provide recommendations and guidance for all settlement
services, including the purchase of title insurance.
In the RESPA study, Peat, Marwick, Mitchell & Co. asked a
number of title insurance personnel in different locations how they
believed that they obtained customers. While the answers reflect
estimates and not actual data, they are nevertheless revealing. A
summary of their responses appears in exhibit 1.
PAGENO="0537"
531
According to industry personnel themselves, less than 20 percent
of their customers come to, them directly. Over 80 percent are
referred by lenders, attorneys, and brokers. These figures are a
national average and do not reflect different local patterns. For
example, in some areas, attorneys' recommendations may be
almost zero while broker recommendations alone are well over 80
percent.
This pattern of obtaining business has led to what is commonly
called reverse competition. Providers of title insurance have an
incentive to compete for referrals, not customers. This type of
competition has taken a number of forms in the settlement indus-
try. RESPA was enacted to prohibit the most obvious forms, such
as direct kickbacks and payoffs. Other forms include high commis-
sion rates for both attorney agents and nonattorney agents, large
expense accounts, and the subject of today's hearing, the ownership
of title insurance agencies by referrers.
The process is characterized by reverse competition because the
incentives interact to increase, operating cost and consumer prices.
Under competitive incentives, cost and consumer prices are as-
sumed to be at or approaching the lowest possible level. Under
reverse competition there is no incentive to lower prices because
the consumer, that is, the home buyer who is actually paying the
bill, does not choose the provider. He chooses a referrer.
Now, in light of that, there are two key areas which I believe
have not been addressed adequately at these hearings in light of
the nature of the provision of title insurance. One is the price of
the product in general, and the second is those situations which are
directly comparable to agency ownership but which would, never-
theless, not be covered under the definition of controlled business
presented up until this point.
Unlike other lines of insurance, payment to title insurance com-
panies may or may not cover the total charges to the consumer for
the services provided. These services can be broadly categorized
into three groups; title insurance, title search and examination,
and settlement and document preparation. The last of these is also
frequently referred to as escrow.
Title insurance, in this situation, refers to what the industry
usually calls the risk premium. This is the insurance policy itself.
However, title insurance is not sold unless a search and examina-
tion of the existing public records is conducted. This involves a
separate fee.
Last is the cost of settlement itself. This procedure has nothing
necessarily to do with the title insurance. However, the service is
usually provided in those cases that I have known about. The
service is usually provided by the same entity that provides for
title search and insurance. While lenders and even brokers may at
times provide settlement services, usually it is the title insurance
provider. Thus it is a mistake to discuss pricing in this industry
without combining all three services. The price for one service may
seem low, but is often offset by very high charges for other serv-
ices.
Exhibit 2 graphically depicts the entities that provide the serv-
ices to consumers. In some cases, it is the underwriter or title
insurance company itself However, in many cases it is either an
PAGENO="0538"
532
underwritten title company or an attorney. Referrer owned title
companies are one variation of the underwritten title company. An
independently owned agency is another variation, and some compa-
nies are owned by individuals who are not referrers.
One argument against controlled business is that these providers
are in a position to sustain higher charges than other providers. In
fact, there may be specific instances of this happening. However,
there are no sources of independent data which separate out con-
trolled businesses from other providers. Thus, there is no really
scientific or statistical conclusions that can be drawn in any signifi-
cant way with regard to whether or not the prices of one group of
agencies is higher than another group of agencies.
I would also like to add at this point that there was quite a bit of
discussion yesterday afternoon about the poor quality of work that
would be done or that is done by controlled businesses. I have no
way of knowing whether they provide poor searches or are writing
over known defects, but I would like to say that if they are doing
as poor a job as was brought out yesterday, that is, that they may
in fact be threatening bankruptcy to the underwriters, perhaps
some questions are in line for some of these underwriters with
regard to the type of quality control they have over their own
agents in the field.
A more important question, however, may be whether charges
are uniformly higher than necessary in noncontrolled business sit-
uations. This is a very difficult question to answer. The title insur-
ance underwriters are in a position to discuss only the premiums
that they collect on a State or nationwide basis. Referring to exhib-
it 2 again, that payment will cover all three service categories in
those cases where a branch of the underwriter is the primary
provider. But in cases where agents are used, it will not.
The amount collected will cover only that portion of the charges
actually turned over to the company by the agent. The financial
incentives for being an agent, either an attorney or nonattorney,
have always been very high if the agent could generate large
volumes of business. The abusive situations which RESPA was
designed to eliminate occurred as a result of agents' activities, not
controlled businesses in most situations. It is my feeling that that
incentive remains.
It is very difficult to define a high price in this industry. Howev-
er, in economics we usually talk about relating the pricing mecha-
nism to the cost of producing the goods. The provision of the
services necessary for title insurance and settlement is extremely
labor-intensive; therefore, the predominant cost tends to be in
wages, except in some cases such as California where computerized
title plants have been established. However, pricing is not based,
even on average time spent producing the service. Instead, tradi-
tionally, it has been based on house price or mortgage amount.
Even a brief review of title services indicates that no single indus-
try cost, not even the losses, are related to house prices.
It also indicates that in a period such as the seventies which
were characterized by rising house prices and increased turnover,
revenues in this industry would increase more rapidly than operat-
ing costs. While it is impossible to prove, the indications are that
this phenomena of rising house prices and turnover was as much
PAGENO="0539"
533
responsible for the increase in controlled business in the last
decade as the existence of section 8 prohibitions.
Now, I would also like to say, to digress for a few minutes, to
discuss some of the noncontrolled business relationships. Almost a
year ago HUD published an interpretive ruling of what controlled
business was, and I would like to read their definition at that time
of what a controlled business was:
This term, controlled business, describes an arrangement whereby a person in a
position to refer settlement business, typically a real estate broker, mortgage lender,
attorney, et cetera, has an ownership interest in a settlement service provider,
refers business to that provider and shares in the profits of that provider through
direct or indirect distributions.
That concept, at that time, was interpreted to cover the following
situations: S. & L. service corporations; possibly bank subsidiaries,
if they existed, but I have never heard of that particular case
existing; broker-owned title companies; and borrower-related title
insurance companies, which are attorney co-ops. Dr. Plotkin today
has expanded that definition, as I believe is correct, but at this
hearing I have heard no testimony with regard to any relationships
except the S. & L. service corporations and the broker-owned title
companies.
In fact, the extension should be, and has not been, to my knowl-
edge, extended to individuals within the institutions having an
interest in title work or title agencies. These types of situations
involve relationships between officers and directors of lending insti-
tutions, and their own personal ownership of title insurance corpo-
rations, law firms, brokers, and attorneys, the types of personal
ownership and personal relationships which are not going to be
covered by a definition which only refers to institutional owner-
ship.
The problem in providing settlement services of all kinds is
reverse competition and the fact that in some cases lenders can set
the requirements not only for the type of services necessary, but
for the provider of those services itself. Title and legal work is only
one type of service that falls into this category. Others are mort-
gage insurance, appraisers, and surveyors. In all of these cases, the
consumer has little understanding and less say in who will perform
these services and how much the cost should be.
The result has been high charges, which I believe could have
been lowered in many cases. The prohibition of controlled business
with no other changes in the procedure for requiring services or
providers is a Band-Aid solution to what is a real problem. There is
no reason to believe that pricing would be more competitive with-
out controlled business.
I would like to point out that with all of the discussion on the
problems of controlled business, there has never been any real
indication of how widespread the phenomenon is, or that prices
under a controlled business situation are uniformly higher than
other provider prices. There simply is too little known at the
present time to write any new legislation on this narrow issue.
Instead, the whole concept of provider relationships with refer-
rers and lender-required services should be studied. RESPA was
aimed at one aspect of what is now known as a very complex
problem, and thus, in my estimation, has little overall effect. I
PAGENO="0540"
534
believe that legislation prohibiting controlled business would suffer
the same result.
[Dr. Ford submitted the following for inclusion in the record: A
prepared statement "Controlled Business and the Title Insurance
Industry," and an article from the Federal Home Loan Bank Board
Journal of June 1981 entitled "The Impact of Title Insurance and
Controlled Business on the Savings and Loan Industry." The mate-
rial follows:]
PAGENO="0541"
535
Testimony of
Deborah Ann Ford, Ph.D.
of the
University of Baltimore
before the
Committee on Banking, Finance and Urban Affairs
Subcommittee on Housing and Community Development
September 16, 1981
PAGENO="0542"
536
CONTROLLED BUSINESS
AND
THE TITLE INSURANCE INDUSTRY
Good afternoon. Mv name is Deborah Ann Ford. I have
been asked to speak briefly this afternoon as an independent
observer of the title insurance industry. By way of
background, I participated in a two year study of the effects
of RESPA, when I was with Peat, Marwick, Mitchell. That
study was authorized by BUD. Since then I have been teaching
finance full time. However, I have retained an interest in
title insurance, particularly the methods and channels thiough
which it is provided to consumers. It is this issue, in its
broadest context, which I would like to address this afternoon.
REVERSE COMPETITION
Title insurance, or an attorney's opinion in some places,
is not an ordinary economic good. First, it is purchased
only at the time of a real estate transaction. It is a
true ancillary good, to a much more important transaction.
Second, while real estate professionals may understand the
need for and provision of title insurance, the vast majority
of homebuyers do not. They may purchase homes on only a
few occasions over a lifetime, therefore, the necessity
of learning how to purchase title insurance may seem
unimportant. Further, if the real estate transactions
are in different locales, the methods of purchasing title
information and insurance may not ~ comparable. Therefore,
the consumer's past experience may be irrelevant.
The result of the lack of information and infrequent
occurances is that most consumers depend on real estate
professionals to provide recommendations and guidance in
PAGENO="0543"
537
all settlement services, including the purchase of title
insurance. In the RESPA study, Peat, Marwick, Mitchell,
asked a number of title insurance personnel, in different
locations, how they believed they obtained customers.
While the answers reflect estimates and not actual data,
they are revealing. A summary of the responses appears in
Exhibit 1.
Exhibit 1
SOURCES OF TITLE INSURANCE REFERRALS
-2-
PAGENO="0544"
538
According to industry personnel, less than twenty (2O7~) percent
of their customers come to them directly. Over eighty (8O7~)
percent are referred by lenders, attorneys, and brokers.
These figures are a national average and do not reflect
different local patterns. For example, in some areas, attorneys
recommendations may be almost zero, while broker recommendations
alone are well over eighty (8O7~) percent.
This pattern of obtaining business has led to what is
commonly called reverse competition. Providers of title
insurance have an incentive to compete for referrals not
customers. This type of competition has taken a number of forms
in the settlement industries. RESPA was enacted to prohibit
the most obvious forms, such as direct kickbacks and payoffs.
Other forms include high commission races for both attorney
agents and non-attorney agents, large expense accounts and,
the subject of today's hearing, the ownership of title insurance
agencies by referrers. The process is characterized by reverse
competition because the incentives interact to increase operating
costs and consumer prices. Under competitive incentives,
costs and consumer prices are assumed to be at - or approaching -
the lowest possible level. Under reverse compefition, there
is no incentive to lower prices because the consumer - i.e.,
the homeowner who is actually paying the bill - does not
choose the provider; he chooses a referrer.
There are two key areas which I believe have not been
addressed adequately at these hearings, in light of the
nature of the provision of title insurance. (1) The price
of the product in general and (2) the situations which are
directly comparable to agency ownership but which would not
be covered under the definition of controlled business
presented at this hearing.
-3-
PAGENO="0545"
539
THE PRICING OF TITLE INFORMATION
AND INSURANCE SERVICES
Unlike other lines of insurance, payment to title
insurance companies may or may not cover the total charges
to the consumer for the services provided. These services
can be broadly categorized into three groups.
1. Title Insurance
2. Title Search and Examination
3. Settlement and Document Preparation
Title insurance, in this case, refers to what the industry
calls the risk premium. This is the insurance policy itself.
However, title insurance is not sold unless a search and
examination of the existing records is conducted. This
involves a separate fee. Last is the cost of settlement
itself. This procedure has nothing to do with the title
insurance; however, the service is usually provided by the
same entity that provides the title search and insurance.
While lenders and even brokers may at times provide settle-
ment services, usually it is the title insurance provider.
Thus, it is a mistake to discuss pricing in this industry
without combining all three services. The price for one
service may seem low, but is often offset by very high
charges for other services.
Exhibit 2 graphically depicts the entities that provide
these services. In some cases, it is the underwriter or title
insurance company itself. However, in many cases it is
either an underwritten company or attorney. Referrer owned
title companies are one variation of an underwritten title
company. An independent owned agency is another variation
and some companies are owned by individuals who are not
referrers.
-4.-
85-396 0 - 81 - 35
PAGENO="0546"
540
Exhibit 2
CONSUMER FUNDS PAID FOR TITLE INSURANCE
One argument against controlled business is that these
providers are in a position to sustain higher charges than
other providers. In fact, there may be specific instances
of this happening. However, there are no sources of indepen-
dent data which separate out controlled businesses from other
providers. Thus, no conclusions can be drawn in any statis-
tically significant way.
A more important question may be whether charges are
uniformly higher than necessary in non-controlled business
situations. This is a very difficult question to answer.
-
U, s,h~U,d U, pUU1.I by
-5-
PAGENO="0547"
541
The title insurance underwriters are in a position to discuss
only the premiums that they collect on a state or nationwide
basis. Referring to Exhibit 2 again, that payment will cover
all three service categories in those cases where a branch of
the underwriter is the primary provider. But in cases where
agents are used, it will not. It will cover only that portion
of the charges actually turned over to the company by the agent.
The financial incentives for being an agent - attorney or
non-attorney - have always been very high, if the agent could
generate large volumes of business. The abusive situations
which RESPA was designed to eliminate occurred as a result of
agents' activities, not controlled businesses in most situations.
That incentive remains.
It is very difficult to define a high price. However, in
economics we usually talk about relating the pricing mechanism
to the cost of producing the goods. The provision of the
services necessary for title insurance and settlement is
extremely labor intensive; therefore, the predominate cost tends
to be in wages.
However, pricing is not based even on average time spent
producing the service. Instead, traditionally, it has been
based on house price or mortgage amount. Even a brief review
of title services indicates that no industry cost, not even
losses, are related to house prices. It also indicates that in
a period such as the 1970's which were characterized by rising
house prices and increased turnover, revenues in this industry
would increase more rapidly than operating costs. While it is
impossible to prove, the indications are that this phenonema
was as much responsible for the increase in controlled business
in the last decade as the existence of Section 8 prohibitions.
-6-
PAGENO="0548"
542
NON CONTROLLED BUSINESS
RELATIONSHIPS
The concept of controlled business is one of ownership.
But there are many non-ownership situations, sanctioned
explicitly or implicitly by the Federal Government, which can
lead to the same possibility of high prices. The clearest
example of this myopia is the case of lender owned title
agencies. The proposed definition would prohibit Savings and
Loan Service Corporations from providing title services. How-
ever, it does not prohibit a Savings and Loan from virtually
requiring a potential mortgagor to use an attorney agent of
the lender's choice. I say `virtually' because what the
Federal Home Loan Bank Board specifically allows is the cost
of a review fee by the attorney of the lender's choice if the
mortgagor has used an attorney - or title compay - of his own
choice. There is no maximum set on this review fee. I
believe such practices can and do lead to higher than
necessary prices in many cases. Certainly the potential is no
different from that of a controlled business.
There is every incentive for an attorney to arrange such
a relationship. Inevitably, the attorney is an agent for an
underwriter. As a result, he will often be able to charge for
the title search and settlement and also receive a portion of
the risk premium. Depending on the size of the lending institu-
tion, the income can be large. There is no economic incentive
for keeping fees low in this type of siLuation, because the
source of referrals is assured. This may not always happen,
but it can and, at times, does.
I have outlined this particular situation not because I
believe it is better or worse than controlled business, but
only to illustrate the complexity of the inter-relationships
of which controlled business is only one.
-7-
PAGENO="0549"
543
The problem in providing settlement services of all
kinds is reverse competition and the fact that in some cases
lenders can set the requirements not only for the type of
services necessary but for the provider of those services.
Title and legal work is only one type of service that falls
into this category. Others are mortgage insurance, appraisers
and surveyors. In all of these cases the consumer has little
understanding, and less say in who will perform the service
and how much the cost should be. The result has been high
charges which I believe could have been lowered in many cases.
CONCLUSION
The prohibition of controlled business with no other
changes in the procedure for requiring services or providers
is a band-aid solution to what is a real problem. There is no
reason to believe that pricing would be more competitive with-
out controlled business. I would like to point out that with
all the discussion on the problems of controlled business,
there has never been any real indication of how widespread the
phenomenon is or that prices under a controlled business
situation are uniformly higher than other provider prices.
There simply is too little known at the present time to write
any new legislation on this narrow issue.
Instead the whole concept of provider relationships
with referrers and lender required services should be studied.
RESPA was aimed at one aspect o~ the complex problem and, thus,
in my estimation, had little overall effect. I believe that
legislation prohibiting controlled business would suffer the
same result.
-8-
PAGENO="0550"
FHLBB Journa~ Jiu~e 1981
by Dr. Deborah A. Ford, Assistant
Professor of Finance, University of
Baltimore, and 0. Burgess Allison,
Consultant and Attorney,
Washington, D.C.
Overview
In June 1980, the U.S. Depart-
ment of Housing and Urban Devel-
opment (HUD) passed an inter-
pretive ruling on a section of the
Real Estate Settlement Procedures
Act. The ruling stated that referral
of settlement business to a wholly or
partially owned subsidiary "may"
constitute a violation of the kick-
back provisions of the Act. The rul-
ing would have covered referrals by
S&Ls to their service corporations
which operate title insurance
agencies.
The response by the Federal Home
Loan Bank Board was to suggest
that their members be allowed to
give mortgage customers an alpha-
betically arranged list of title in-
surance providers in their lending
area. The S&L's title insurance serv-
ice corporation could be included in
this "neutral list."
While all regulations, including
the HUB Controlled Business rul-
ing, are being held in temporary
abeyance by the Reagan Administra-
tion, a congressional review of the
Act is scheduled in the near future.
The Real Estate Settlement
Procedures Act
In 1974, the Real Estate Settle-
ment Procedures Act (RESPA) was
passed by Congress to provide a
degree of consumer protection to
homebuyers in the real estate settle-
ment process. One of the stated ob-
jectives of the law was to eliminate
what Congress found to be "unnec-
essarily high settlement charges
Fctteeal Ftooae Loan Bank Boned Resolootion
Na. 80-592. Peoposod Change to t2 CFR Sohohop-
tee D-tosoeaooo of Aooaaott 1563.35 Rttttiotioo,
ioools'iog loan teeniaes.
caused by certain abusive prac-
tices." In particular, Section 8 of
the Act was designed to prevent
kickbacks and other such payments
made for referrals between the
various settlement service industries.
As the date for a congressional
review of RESPA draws near, the
interpretation of Section 8 is receiv-
ing special attention from regula-
tors, settlement industry represent-
atives, and consumer advocates.
Section 8 of RESPA is entitled
"Prohibition Against Kickbacks and
Unearned Fees." It expressly pro-
hibits "any fee, kickback, or thing
of value" from being paid in return
for the referral of "business incident
to or a part of a real estate settle-
ment service." ` This broad lan-
guage was originally adopted in an
attempt to cover any possible form
of kickback. Unfortunately, the very
breadth of the language has given
rise to a lawyer's nightmare of try-
ing to determine what type of refer-
rals are not prohibited. Clearly, an
outright cash payment for referrals
is illegal, but the problem of inter-
pretation arises when the payment is
made in connection with a service or
is paid as a "dividend."
Lending institutions, as welt as
Real Eotata Seotleoteat Peooodneoo Ast of 1974,
an aoteoded in 1975. t2(a).
Rent E,tate Satoteoteot Ptoaodootos Aol of 1974.
an ototodod in 1975, tNt).
real estate brokers' and attorneys,
are in an excellent position to refer
customers to providers of various
settlement services. The question of
a possible Section 8 violation arises
when one of these individuals or in-
stitutions establishes their own set-
tlement service company and are
able to profit, thereby, from their
own referrals. The American Land
Title Association' has coined the
phrase "controlled business" to
describe such a relationship. ALTA
argues that controlled business
results in the same problems that are
caused by outright cash kickbacks,
even if the profits represent a return
on investment.'
Typically, when a statute gives
rise to such questions of definition
and interpretation, the issues are
brought before the courts and the
judiciary nsakes the final decision.
However, during the five years
RESPA has been in effect, the De-
partment of Justice has yetto bring
a test-case prosecution under Section
8. Thus, the traditional case law
precedents which would normally
act as legal guidelines to industry
participants are absent.
The interpretive ruling which was.
proposed by HUD on July 24, 1980,
did little to sIted any light on the ap-
plicability of Section 8~to controlled
business. The key provision of the
ruling concluded only that a con-
trolled business relationship "may"
constitute a violation of Section 8.
The ruling did, however, offer a
specific definition of controlled
business. Such a relationship exists,
HUD concluded, if "a person in
position to refer settlement business
(typically a real estate broker, mort-
- The leant "teal estate btohee" in osad ttoooglt-
not this aetiolo in itt geooeio tonst, to inatoode toot
estate agent,. btokoet. tnletpeople nod theta
`The Aaneeiaoo Land Title Atnanintion (ALTA)
is the national tnadc atsooistino of title
ondetn'eitttt, and agooaiet.
It is intpnt100t so point oat that ALTA is lobby-
ing foe a poohihioioo of oooteottod bosinet,. etgsnd-
less of sohoohee she panhibition is iooladod ssapoeo
of Seotion 8 nt added as ott eatitoly too rngolotioe.
544
The Impact of Title Insuranceand Controlled
Business on the S&L Industry
PAGENO="0551"
gage lender, attorney, etc.) has an
ownership interest in a settlement
service provider, refers business to
that provider, and shares in the
profits of that provider through
direct or indirect distribution."
Clearly, every savings and loan serv-
ice corporation which provides set-
tlement services falls within this
definition.
The most important effect of
HUD's ruling was that it raised the
possibility that controlled busi-
nesses-including service corpo-
rations with Bank Board approval-
would be treated by HUD as a
violation of RESPA. In order to
avoid suds an apparent inconsist-
ency between Federal regulators, the
Bank Board's rule change would
prohibit referrals to service corpora-
tions, except indirectly, through a
"neutral list."
The problem of institutions bene-
fitting from their o.~n referrals-
a problem Congress or HUD must
eventually address directly--is that a
controlled business relationship
tends to create a situation in svhich
one provider has an assured source
of business, regardless of its prices
or the quality of its services. In such
a situation, it may be unrealistic to
believe that consumers will get fair
value for their money. The problem
of assured referrals is particularly
acute in the sale of title insurance,
escrow and conveyancing services,
- -----
:~iE-i-:' ~
11.5. D~patm~ttt t.f Iyaktg ad Ud-a Dytd-
apmmt. P,opayd I,:tmJ)!ylitt Rahttg (yilittila
b~sttpp1iyd).
because of the nature of the market
for those services and the complex-
ity of the product.
The Provision of Title Assurance
and Conveyance Services
The assurance to both lenders and
purchasers that a particular piece of
property is free and clear of encum-
brances (and is legally transferable)
is an essential part of the real estate
settlement process. In many parts of
the country, such assurances are
provided by an attorney's opinion
of title, and in other areas by title
insurance. With the growth of a na-
tionwide secondary market for the
saleand purchase of mortgages, the
need for consistent and uncondi-
tional title assurance for lenders has
led to an extensive use of title in-
surance, with its fairly standardized
forms and regulated financial
backing.
Title insurance is sold to con-
sumers by different types of pro-
viders, eachwith its own distinct
relationship to the underwriting title
insurance company. Branch offices
(and in some cases the Isome office)
of the undersvriters sell a substantial
number of title insurance policies
directly to consunsers.' However,
the largest portion of title insurance
business is sold by agents for the in-
surance companies. -
One type of agent is the under-
written title company, which is inde-
pendently owned but is generally
affiliated with just one underwriter.
An attorney-agent (the other type of
agent) is an attorney or law firm
which may sell title policies from a
number of different underwriters to
its settlement clients. Figure 1 iden.
tifies the different types of providers
of title insurance, and shows the
Th, mm aymmyt mill b~ tad thmttghmtt
hit anidy a atm tat that homatatatatatat atho am pay.
iatg tm that hilt at aa000. Lao thoaeh ho hilly
myatoytoyatogat may batiatfit thy moytgaet Itiodatat.
md tyay tiot 000ty thepatiohatitti at all. hit
homeoamey toha mat pay the bilk fat tidy
flow of funds paid by the consumer
for that insurance.'
Regardless of the form of title
assurance used in a particular trans-
action-whether title insurance or
attorney's opinion-the key issue
raised to Congress is the price of
that assurance. Most forms of title
assurance are popularly believed to
be considerably overpriced.
Reverse Competition
In December 1978, HUD commis-
sioned Peat, Marwick, Mitclsell &
Co. (PMM & Co.) to conduct a
study of the effect of RESPA in the
settlement service industries. The
study revealed what professionals in
the real estate industry have long
known: that nsost homebuyers do
ti~_
-~.(.i-j.*1
not understand title insurance nor
do they shop for it. They depend
almost exclusively on referrals from
real estate professionals in the local
area. Figure 2 shows what Peat,
Marwiek, Mitchell & Co. found to be
the average amount of business local
title companies said they receive from
different sources.° Title company
representatives reported more than
80 percent of title insurance business
is obtained through direct referrals
from lenders, brokers, and attorneys.
These real estate professionals work
545
Figaro I toot mad itt the stady of settlemeot
,etoioatt peapayydtortheDtpaetmetttotHmltiog
ad Utboo Ooaelopmeot by Foot. Marmiok. Mitohett
& Cat.. That RtalEatalt Syarlemmrt P,ocyd:tma .4a1.
Saotiato 14a. That 1979-SO Etal:ttoiao (1980) vot. II.,
p. XII. 4.
Ibid. Vat. II. p. Y. 20.
PAGENO="0552"
with title companies on a regular
basis and are in the best position to
effectively evaluate their perform-
ance. Homebuyers simply do not
have the time or resources to
develop this expertise. The result of
such a dependence on referrals is
that title companies compete aggres-
sively for those in a position to refer
business, rather than for the con-
sumers who will actually pay the
bill.
This fundamental characteristic,
generally referred to as reverse com-
petition, serves to create a market in
which traditional economic prin-
ciples of a competitive market do
not apply. Since the consumer has
no significant role in the selection
process, there is little incentive to
keep prices low or otherwise be con-
cerned about the consumer. Some of
the things done to compete for
referrers may prove beneficial to the
consumer and referrer, but not
always. Regardless of who bene-
Foe esusople. it iso the beet ioteeettt of toony
refeteest to hone the title eotk nootpteted quickly.
This seesice often tooths to the hotteSt of both coo-
and refeores.
fits, it is the homebuyer who pays.
As long as consumers continue to
rely on referrals for title insurance,
reverse competition will exist in this
market. The PMM & Co. study
made it quite clear that increased
consumer education does not have a
realistic potential to change this fun-
damental market characteristic. In-
stead, the economic dysfunctions of
reverse competition must be ad-
dressed in another way.
Symptoms of Reverse Competition
Reverse competition in the title in-
surance industry has taken one of
several different forms in providing
benefits to referrers. D~rect kick-
backs are the most obvious form of
benefit, and prior to RESPA they
appear to have been a standard
operating practice in many areas of
the country. Following the enact-
ment of RESPA, however, the open
payment of such kickbacks appears
to have diminished.'
This conclusion is dtoscs ftoos intetnienos by the
outhots sith title itsutess and eec! estote ptofes.
siotols cooducted ucooss the nouotny dutiog she
cousse of the PMM & Co. study. PM.'.! & Co. soon
There are other manifestations of
reverse competition which have been
unaffected by the passage Of
RESPA. One of these is found in
the attorney-agent relationship. In
many areas of the country, the set-
tlement attorney does the title work
and then, acting as agent for a title
company, sells the policy of title in-
surance. Thus, the attorney-agent is
in a position to generate substantial
amounts of title insurance business
and to choose a title role in the
selection process. There is little in-
centive to keep prices low or to
choose which company will be used.
The result is that the underwriters
compete for attorney-agents by pay-
ing a "commission" out of the title
insurance premium. Sometimes this
commission is used to offset the
price of the title search, but fre-
quently the attorney charges the
enable so study the ,ffectinesess of RESPA en this
ctitical issue. hosceore, because questions related to
this issue `eeoc stsack feom the sotsey instruttteot.t
ehen they soese eecsetced by the Oftiue of Maouge-
,netct and Budget (0MB)." Peat, Maesaiok. Mitobell
& Co., The Rea!E.stote Settkmeot PtocedatooAai.
Section I-Os. The 1979-80 Ea-otuotioot (t9)5) Vol. II,
p. XIII. 2.
546
Figure 1.-Consumer Funds
Paid for Title Insurance
Figure 2.-Sources of
Title Insurance Referrals
- ~t~~~scoth
-~>.- rotc, pod enthe stTecoed fOe tosecce peostdet by
----p.- Pteoios. toss cOtte~tones. pad en ~ ty One
PAGENO="0553"
547
hornebuyer separately for the itself affects the price of title assur- Angeles, a difference of more than
search, in addition to other services. ance is particularly difficult. One 100 percent. There was no evidence
The commissions often amount to problem is that controlled businesses of corresponding differences in
50 or 65 percent of the title in- are not separately identified on any operating costs or losses for corn-
surance premium. sources of data. Another problem is panics in the different regions.
Another form of reverse competi- that settlement fees are structured in These findings indicate that charges
tion is found in the review fee sys- such a way that individual service are at least somewhat arbitrary, and
tern used by some lenders. While the prices cannot be broken down and not necessarily related to either costs
lender does not actually require the compared. Title and conveyancing or losses."
use of a particular attorney or title charges, as identified on the stan-
company, the lender charges a sub- dard HUD-l settlement sheet, are as Controlled Businesses and Prices
stantial "review fee" if the bor- follosvs: An unresolved issue, hosvever, is
rower uses someone else. Sometimes the relationship betss'een controlled
this reviesv fee is nominal, but it settlement or closing fee business and prices. A controlled
often amounts to hundreds of dot- title company with an assured flow
lars. For many homebuyers, such a abstract of title search of business does not need to incur
fee effectively prevents them from title examination high marketing costs. If traditional,
seeking independent counsel or from title insurance binder competitive principles were applied,
using a title company of their own document preparation these savings would be passed on to
selection, consumers. However, given the
Controlled business is another notary fees nature of reverse competition, it is
manifestation of reverse competition attorney's fees doubtful that any coat savings de-
in which referrers seek to benefit title insurance rived by a title company from a
from their own referrals. In a con- controlled business relationship
trolled business situation, a broker other would be passed on to consumers.
or lender osvns an underwritten title In fact, it appears quite likely that
company, and refers all (or most) of Some providers include all of the such a relationship helps to maintain
its customers to its own title corn- above services in one fee, while high prices and provides the capa-
pany." The controlled title company others specify each individual bility of raising prices without losing
has an assured source of business charge. Some providers combine a customers." Given the financial in-
and has only marginal liabilities for partial package of services and item- centives involved, there is every
losses since it in acting as the agent ize the remainder. The packages and reason to believe that a controlled
for the insuring undersvriter. It terminology used are not consistent business would take full advantage
clearly has a competitive advantage between different areas, nor between of its relationship.
entirely unrelated to the service it different providers in thesaine
provides for the consumer, area." Developments to Date
The advantage in a controlled The PMM & Co. study compared In 1979, the American Land Title
business, review fee, or other tied prices by looking at the entire pack- Association, in collaboration with
relationship is important because of age of title and conveyancing Dr. Irving Plotkin of Arlhur D. Lit-
its effect on the service eventually charges. They collected pricing data tIe, Inc., published a "while paper"
provided to the consumer. This from individual HUD-l settlenient report svhich identified, for the first
assurance of customers virtually sheets in eight metropolitan areas. time, the practice of controlled busi-
eliminates any compelitive incentives The average cost of all title assur- ness within their industry and called
to provide quality service. Further, ance services on a $60,000 house"
the relationship offers an opportu- ranged from a low of $229 in
nity to raise prices substantially Denver to a high of $559 in Los "This ob,oooal,oo is ,oppaeted each,, by she
without losing customers f h a d d 5 ~ A los 5 m
plc, the aserage chaege ioos S559, bat iii a sigoiitcaets
The Price of Title Assurance and ____________ ,saeohoo of ,etltesieots (it parve,') ho total ohaoees
Conveyanctng Services ` Fot esatople, "aft iscfa,ivo" sills iosaeaeve soeoe ie,s baa 5350. The ,iaiidaod dos-ialioo of
Arriving at a definitive conclusion chaego ii, oo~,laly irigiade, th~ title osaech title poko, is Lo, Ailgeleoloas 5214. bitt oofy 566 is
as to svhethser controlled business ~ ~ iol~e~al~a at ~`~lh she osittiag peivesloivlaee faa sub
fee,orid doaaaie,t plopoeatiaa sac irittaded oaao cod oaa,oyaaaiag soovive,, a coateolbed title
bat sheic is at catea ehstge fat cettklaeat. oaapaay oat ioteoaao is tatat ohaogoa isilitaist
Coittealfed sill, oaolpasies hate alto hoe, `" Hun-i fooai, sates seloated too,, Bostoa, jog rho prke of its title iasaaattve poeaiiiieo-sohivh it
ettablithed by baildeos arid deaobapess of cesideatiof Dosseo, \Vashiagloo 5D.C.5, Jagkroosille (Fits, Los oogsfsted it, oiaay ,ltles. The ohaago foe sho total
,ahdiairioas. This glaap. aesy etach like hiokets, Aogofes, St. Levis, Sits Atitasia, arid Soaltfe fao paakage cart ho iavoeased sabslaaiiaffy by caisiag the
ace is a pasilias to ,efcs sills iotaraove gactoolees oil setltettleills iaaaftiog she safe of gases south peices eec of aoaihoe, ooeegtifaied coalposeltl of the
a f,eqaest sad 000tiesiog baci,. brtaeao $55,000 arid $65,000. paokago-sach as the reitleretool Or eaceais foe.
PAGENO="0554"
548
for governmental regulation. This broader perspective must be taken in issue of controlled business will be
while paper marked the start of a order to address the problem as a raised as a part of that review.
concentrated lobbying effort to have whole. Case-specific regulations Controlled business, however, is
Congress or other regulators address which do not affect the basic incen- merely one symptom of the indus-
the situation, lives have a tendency to merely trywide characteristic of reverse
The study completed for HUD in channel those incentives through a competition. A prohibition of con-
the fall of 1980, however, concluded different route. trotted business will not, by itself,
that controlled business is merely ensure fair prices nor high quality Ii-
one aspect of reverse competition in Summai~y tIe work. One more layer of regula-
the title insurance and conveyancing The different approaches to these lion wilt not resolve the problem of
markets, and that a prohibition of issues taken by the Bank Board and tied relationships--of svhich con-
controlled business "would be a HUD are quite likely attributable to trolted business is only one example.
bandaid solution and would not their fundamental roles. The Reverse competition will continue to
necessarily result in lower title Department of Housing and Urban work against consumers' best inter-
assurance charges." " Development has been charged with ests, unless this fundamental prob-
The major problem with concen- a consumer protection responsibility 1cm is addressed as a whole.
trating on limited issues, such as under RESPA, while the Federal As deregulation gains popular and
controlled business or neutral lists, Home Loan Bank Board's responsi- political support, proposed legisla-
is that the larger problem of reverse bullies are limited to the operation lion will have to be well thought out
competition is not addressed. Thus, of savings and loan associations as and directly responsive to identi-
there is a danger of overlooking the an industry. Ultimately, when Con- fiable problems. It will be essential
lack of consumer protection against gress re-examines the Real Estate that Congress and the various regu-
tied relationships between lending Settlement Procedures Act later this latory agencies have a realistic
institutions and specific attorneys, year, the determination will be made understanding of the settlement n-
or the effect of title companies com- as to whether new or different legis- dustries involved and existing
peling for agents with higher and lative remedies to high settlement market conditions' before attempt-
higher commissions. A much costs are needed. Undoubtedly, the ing to make substantive regulatory
changes. J
Poot, Motoick. Mitchtlf & Co., Tho Roof
£ttoto &ttfotttcttt P,occdctotAot. Scdioo 14o. Tho
1979-dOEcolcotiott. ((9501 Vot. t, p. iv. it.
Atotooticood ootfiot, ho ttody oottdcctod by
Poot. ototccick .Mitholl & Co. toot ptooootod ftottt
ttooctigotctg tho ocktooco ot ottoct of octtttoflod
bctioo~. At toith ho icsoo of ditcot kichbo.ko, tho
Offico of fitocogoot tot cod Oodgot tooototy tiottitod
ho ~yfoctitttt of itofotototitto itt hot ttcdyohich
tooofd hooc ptottdtd hood dotoohoot~o~tf~otf~
PAGENO="0555"
549
Chairman GONZALEZ. Thank you very much. We will proceed
with Mr. Robert R. Elliott, an attorney, and the former General
Counsel of the Department of Housing and Urban Development.
STATEMENT OF ROBERT RAYMOND ELLIOTT, FIRM OF
ELLIOTT & BELL, WASHINGTON, D.C.
Mr. ELLIOTT. Thank you, Mr. Chairman. I am pleased to be
invited by you to present my views regarding RESPA. I would like
to submit my written statement for the record, and summarize it.
Mr. GONZALEZ. Without objection, so ordered.
Mr. ELLIOTT. I am Robert Elliott of the law firm of Elliott & Bell
in Washington, D.C. I served as General Counsel of HUD from 1974
to 1977, when RESPA was originally enacted and implemented. I
have more recently reviewed RESPA for the U.S. League of Sav-
ings Associations, but I wish to clarify that I am not appearing this
afternoon as a representative of the U.S. League of Savings Associ-
ations or any other client. The views I present are strictly my own
views, and not the views of any client.
Let ~me first turn to lender-packaging. The HUD report to Con-
gress proposes legislation requiring lenders to offer so-called
lender-packaging of home purchase closing costs.
In my view, there is no objection to voluntary "lender-packag-
ing," and in fact some lenders on occasion currently engage in
"lender-packaging." For example, I recently arranged for "lender-
packaging" of closing costs for a large mortgage lender which
invited its existing borrowers in the Washington area to refinance
low rate loans with below-market loans. The lender offered to pay
all closing costs as part of the program. You might even call that
"lender-pay," rather than "lender-packaging." There was no inten-
tion to pass that cost along.
I brought with me the text of a short agreement which was
reached with three providers, and perhaps that would be useful in
the record, since it is an example of actual "lender-packaging."
Mr. GONZALEZ. If you would be kind enough to provide that for
the record, then without any objection, we will make it a part of
the record at this point.
[The referred-to agreement appears following Mr. Elliott's pre-
pared statement.]
Mr. ELLIOTT. Let me also mention that I negotiated the same
letter of agreement with three title providers, and each one was of
a different type: One was an attorney in Virginia, who was not a
title agent; one was an attorney-title agent in Maryland; and the
third was a title insurance carrier in the District of Columbia.
Each of them agreed to a price of $175 per closing, which included
title search, a variety of services, although not all of the document
preparation, which would have been probably another $25.
We did not use title insurance. We have a quotation there of the
cost of providing all of the settlement services, without title insur-
ance. Each one agreed that if my client later wanted title insur-
ance, they would provide it effective back to the date of closing.
That $175 quotation, by the way, was with respect to refinancing.
There was no transfer of the title of the property from seller to
purchaser involved there.
PAGENO="0556"
550
Developers such as condominium conversion developers often
offer to pay most or all title-related settlement costs as a market-
ing tool. Such a practice is similar to "lender-packaging" and might
be called "builder-packaging."
Lender-packaging or builder-packaging is unobjectionable. What
is questionable, however, is the idea of new legislation to dictate
the use of "lender-packaging." In this era of deregulation and
reduced Federal intervention in the private sector, I would be
surprised if Congress were to enact a law imposing entirely new
requirements on 5 or 6 million private transactions per year.
Under HUD's proposal, the lender would be permitted to pass
the closing costs along to the borrower and possibly the seller in
any form, including discount points, fees and interest rate, or any
combination. However, I wonder whether HUD has in mind at
least some limitations. For instance, would HUD's proposal allow a
lender to tell the borrower that the borrower will have to pay a
"closing fee" equaling to the penny the total of the precise costs
the lender pays for a series of services, and then tell the borrower
what they will be? That would appear simply to allow the lender to
select the providers for the borrower, with the borrower paying the
precise charges of those providers.
I believe the basic problem with the HUD recommendation for
legislation is the one I mentioned earlier. The legislation proposed
by HUD would tell the three parties-the lender, borrower, and
seller-in about 5 or 6 million private transactions per year how to
handle a portion of those transactions.
The public has indicated to Congress in various ways recently
that the public wants less government, less regulation, and less
Federal intervention in the private sector. We are in a period in
our history when enactment of far-reaching new laws dictating to
private parties how to conduct their affairs will not be acceptable
except in the most urgent situations such as those involving
human safety.
Let me mention several other reservations I have regarding the
HUD recommendation to require "lender-packaging" by Federal
statute.
First, the recommendation proposes legislation that would take
effect nationwide and govern millions of transactions annually. Yet
there is no assurance that the "lender-packaging" system will work
to benefit consumers in the way the report contemplates. The
legislation in question might prove to be a very costly and damag-
ing nationwide experiment-much as the original version of
RESPA proved to be. This is social engineering on a grand scale.
I think the danger is that every lender would be required to gear
up to procure the various settlement services by a given date.
Should the system then prove not to be in the public interest, the
law could then be repealed and its implementation dismantled. Of
course, in the interim many providers of services may have gone
out of business because they were unsuccessful in attempting to be
hired by lenders.
Second, an alternative approach would be to leave the proposal
to State legislatures, but to enable States to implement it without
exception within their boundaries, the Federal Home Loan Bank
Board and bank regulatory agencies could issue regulations requir-
PAGENO="0557"
551
ing Federal savings and loan associations, and national banks, to
offer "lender-packaging" in any State where the State legislature
requires it.
In that fashion, we would have the benefit of an experiment in a
State rather than having Congress implement a nationwide experi-
ment. On the other hand,, if it turns out that no State adopts
HUD's proposal, that should tell us something about whether the
HUD proposal is worthy of enactment.
Third, I have reservations as to whether the consumer would in
fact save money. In some cases, costs may actually be increased by
implementing "lender-packaging." For instance, in given local situ-
ations, some lenders may conclude that any possible savings in the
settlement costs in question-principally, title insurance, title
search, preparation of documents, survey, private mortgage insur-
ance and closing fee-are such a small part of the cost of the
transaction that obtaining those savings will not affect the lender's
competitive position. In such a situation, settlement services that
are contracted out might be viewed more as plums to be handed
out than items to be made the subject of hardnosed negotiation.
Fourth, if "lender-packaging" is found to be highly desirable, as
an alternative to HUD's proposal to enact nationwide require-
ments, Congress could instead create a strong incentive for lenders
to offer it.
Now, the incentive I would suggest be considered is this: Mr.
Carman mentioned the somewhat humorous reaction of some
people to RESPA and other requirements. I have personally wit-
nessed that myself. The RESPA booklet and cost disclosures, I
think, might be a little more useful than has been indicated at
times in the hearings, but they are only of moderate value. The
Truth-in-Lending Act, in my experience, is even worse in terms of
being of very marginal value.
Let me digress to say that the truth-in-lending law reaches ex-
tremes. I recently prepared a 36-inch-long form, which was sent by
a client through the mail. The client did not know whether to roll
it up or fold it. Why is it 36 inches long? Because the truth-in-
lending law requires that the entire disclosure form be on one side
of one sheet of paper.
Let me say in fairness that the recent simplification act now
provides a shorter, simpler form. But still, this is the sort of thing
one contends with. And I think that a proper incentive to "lender-
packaging" might be to say that if a lender opted for "lender-
packaging," he could be totally exempt from most or all of the
provisions of Truth in Lending and RESPA. Perhaps that would be
a sufficient incentive that lenders would offer it.
In that connection, I would note that the HUD report finds that
the RESPA booklet and the RESPA good faith estimates come to
the consumer too late, since they are provided by the lender.
The solution would be to have the realtor provide them instead
of the lender. The realtor could be required to do so at the time the
purchaser/borrower first makes a written offer to purchase a
home. A Federal basis could be found for such a requirement under
the Commerce Clause of the Constitution. For instance, the re-
quirement could apply to every buyer expected to seek a federally
related mortgage loan of the type currently covered by RESPA. I
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552
would add that use of the mails for interstate commerce ought to
be adequate.
Another question that has been raised in the past regarding that
proposal has been, What about the transaction where there is no
realtor? And I think the answer there is simple: The lender always
knows from the sale contract whether or not there is a realtor. In
those cases where there isn't one, the lender could then give out
the good faith estimate and booklet. But where there is a realtor, I
think the responsibility should be transferred to the realtor. And I
was heartened to hear the realtors on the earlier panel indicate
that they have no objection to that.
Let me turn to the subject of so-called "controlled business." I
note that a bit of new confusion has been introduced in this subject
by reason of the fact that the American Land Title Association, or
ALTA, has generally referred to the settlement business as the
"business" which is controlled, whereas the HUD report refers to
the subsidiary of a lender or other entity as a "controlled busi-
ness." I think the ALTA's position on this is very clear and well
understood.
I think HUD and ALTA are essentially talking about the same
thing. However, I would note in passing that the HUD report
generally fails to make needed distinctions between parent-subsidi-
ary situations as opposed to situations where the referring party
owns a minority equity interest in a settlement service provider.
The HUD report makes a number of interesting observations
regarding so-called "controlled business." First, it says:
RESPA's prohibition against such potential industry abuses as kickbacks and
referral fees appears to have been largely circumvented by increased controlled
business relationships.
I don't think that is generally true nationwide, although I be-
lieve that those on the side of extending the prohibitions are con-
cerned that would happen in the future. In the Washington area
with which I am familiar, I do not think there has been any such
development of so-called "controlled business."
The primary kickback and unearned fee problem that we have in
the Washington area is the same one that still exists nationally,
and the one which is causing the title insurance carriers to operate
in the red, namely, the payment by title insurance carriers to title
agencies and approved attorneys of 50 percent to over 80 percent of
the title insurance premium for services worth at best 30 percent
of the premium-and I will come back to that in a moment.
Second, the HUD report states that there is reason to believe
that "controlled business relationships" are "in fact, economically
efficient." We also heard testimony from the FTC with respect to
whether indeed controlled business relationships are economically
efficient or desirable.
Probably, a subsidiary of a lender could very efficiently provide
settlement services. As but one example, a lender or its subsidiary
can prepare promissory notes, mortgages, and other legal docu-
ments by computer using primarily information already placed on
the computer for loan processing.
What happens is this: When someone applies for a loan, a lot of
information goes on a computer-the name of the borrower, a lot of
information about the borrower, the terms of the loan. You may
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553
have to add a few things to crank out all the legal documents, the
legal description in particular. Having all of it on the computer in
order to do the loan processing and, if the loan is eventually made,
to service the loan, you can then press a button and have it print
out and fill in all of the blanks in the standard FNMA and FHLMC
note. You can press another button and have it fill out a mortgage
or deed of trust. You can press another button and have it fill out a
truth-in-lending statement. So there is, I think, some efficiency
there.
I would add also that some lenders prefer to prepare these docu-
ments regardless of who handles closing, because of the constant
minor errors that occur when the documents are prepared by
others. And I will give you an example of how difficult this be-
comes. Many participation loan purchasers now require that notes
be notarized. They may have a checklist with 50 or 100 things they
want.
One of them may be that the promissory note be notarized. In
most jurisdictions, that wouldn't otherwise be done. So, a lender
active in the secondary market may say to the various people
closing loans that he wants in his loan portfolio a lot of loans that
he can eventually sell to that type of purchaser. Therefore, he
wants all of the notes notarized.
What happens? If the lender doesn't prepare the note and put a
notarization form at the bottom, half of these cases come back from
all of the independent title agencies and attorneys, and they do not
notarize the note because they think it is silly. It probably is silly,
except that it is needed to sell a participation 2 years later. The
note then goes back.
The title company calls in the borrower, or just has it notarized,
perhaps. In some cases, this leads, actually, because of similar
requirements, to re-recordation of the mortgage or deed of trust.
Sometimes the borrower has to come back in and sign or intial. So
lenders are tending more in the direction of pressing a button and
getting these documents printed out.
Now, let me address again the subject of controlled business.
While independent title agencies should not be forced out of busi-
ness by unfair and coercive tactics such as unlawful "tie-ins,"
neither should those that cannot operate efficiently be propped up
in business by Federal laws eliminating competition. There is no
doubt that our Nation is suffering a severe shortfall in the rate of
increase in productivity-a major cause of inflation. We should
recognize that inefficient independent title agencies may meet the
same fate as many independent grocery stores of an earlier era
unable to compete with Safeway and other large and efficient
competitors. However, I do not believe that will generally happen
in the real estate closing business.
Another point in the HUD Report is to question whether the
outright kickbacks are necessarily a bad thing, since they might
result in different prices. I personally believe that outright kick-
backs should be prohibited. Apart from severe ethical questions, in
many cases there would be no passthrough to the consumer. For
instance, I believe that were kickbacks to be paid to a realtor,
there is little chance that the resulting income to the realtor would
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554
be passed on to the public in lower real estate commissions as a
result of competition among realtors.
Moreover, in the case of title insurance premiums, if the kick-
backs are passed through to the consumer in the form of free
services or artificially reduced fees for services, criminal insurance
"rebates" may be involved under State insurance codes. You may
know that basically the purpose of those State laws is to maintain
the integrity of rate regulation by avoiding the companies' giving
away resources they should have to respond to their policies. In
addition, those laws are intended to prevent inequities.
The evils of outright kickbacks are at present concentrated in
the area of premium-splitting by title insurance companies, which
typically pay title agencies a portion of the premium far in excess
of anything that could be justified by the title insurance policy
issuance work done by the agent. Larger amounts might be justi-
fied by preparing the search of title and examining title, by prepar-
ing documents-but 50 to 70 or even 80 percent is never justified
by the work involved in pulling a form of binder off of a shelf;
filling in a few blanks-having the secretary fill in a few blanks;
pulling a blank form of policy off the shelf, and having somewhat
greater information filled in; and logging in the policy. Those
things don't justify a 50 to even more than 80 percent portion of
the premium.
Apparently, the title insurers and their agents think that even a
minuscule amount of actual services exempts their arrangements
from section 8, under the exceptions stated in RESPA, section 8(c).
This exempts payment of a fee by a title company to its agent for
services actually performed. Let me come back to that in a
moment. I called several of the major title insurance companies a
few days ago and asked about their standard premium-splitting
practices.
All engaged in similar practices. One even specifically told me
that the title insurance company would do everything for the agent
including the typing of the title policy or the title binder, but not
both. He said that the insurance company was concerned that if it
typed both, there would be no services at all left for the agent to
perform, and the premium sharing could then be a kickback. I
think it is a kickback anyway, even if a few documents are pre-
pared, because I think 50, 70, or 80 percent is excessive.
And at page 12 of my written statement, in the footnote, I quote
the 1974 House and Senate reports which expressly stated:
To the extent the payment is in excess of the reasonable value of the goods
provided or services performed, the excess may be considered a kickback or referral
fee proscribed by section 8.
As I say, I think there is little doubt that 50 to 70 percent or
more being paid to title agencies is in fact excessive. The work
involved with preparing a binder is a few minutes of clerical work.
The issuance of the policy is a bit more work. And aside from
logging in the policy, there are virtually no other duties.
Probably half of the 50 to 70 percent share of premium is in fact,
in my view, a kickback in the sense that it is an exchange of
money for the referral of business to the title insurance company.
In fact, almost the entire share is gravy, in cases where the title
agency charges the cost of the title search separately to the borrow-
PAGENO="0561"
555
er, and imposes enough other charges to cover his cost and produce
a profit without the kickback in the form of the agent's 50 to 80
percent share of premium.
Overnight, Mr. Chairman, I prepared this exhibit. Mr. Warfield,
perhaps you could give Mr. Carman a copy-which illustrates this
point. And, Mr. Chairman, I gave you a copy earlier. I believe you
have it there.
[The referred-to exhibit follows:]
85-396 0 - 81 - 36
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556
EXHIBIT TO
TESTMONY OF ROBERT RAYMOND ELLIOTT
Example
CLOSING AGENT'S FEES
CLOSING OR LEGAL FEE $250
MESSENGER 10
NOTARY 2
Misc. Fees 10
SUBTOTAL $~T~
TITLE SEARCH 75 (Paid to third party)
SURVEY 70 (Paid to third party)
GROSS. INCOME TO CLOSING AGENT FROM FEES OTHER
THAN ANY COMMISSION ON TITLE INSURANCE: $272.00
TITLE INSURANCE TOTAL PREMIUM (Home owner's and mortgagee policy)*
$100,000 House $150,000 House $200,000 House
$332.50 $432.50 $532.50
TITLE AGENT'S COMMISSION:
AT 50% $166.25 $216.50 $266.25
AT 80% $266.00 $346.00 $426.00
CLOSING AGENT'S GROSS INCOME FROM TRANSACTION
No Commission $272.00 $272.00 $272.00
AT 50% $438.25 $488.50 $538.25
AT 80% $538.00 $618.00 $698.00
* "National Rates" - that is: $3.50 per thousand first $50,000,
$3.00 per thousand next $50,000 and $2.00 per thousand above.
In addition, $7.50 for mortgagee policy.
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Mr. ELLIOTT. Now, to start with the fees that in this case an
attorney might charge, let's take the example of Benny Kass, who
is a very well known Washington real estate attorney and consum-
er advocate, and publishes an excellent weekly column in the Sat-
urday real estate section of the Washington Post. When I called his
office, his office advised me that he imposes a $250 legal fee to do
all of the work involved, and there is a separate fee for the title
search, of $75, and a few other fees for notary and messenger,
which I think are on the order of perhaps $20. At the top of this
exhibit, Mr. Chairman, you will see that I have listed fees along
those lines, not with specific reference to Mr. Kass, but just to take
an example.
So I have there a legal fee or closing fee, in the case of a
nonattorney, of $250, with some other minor fees, for a total of
$272. Then I have a fee for title search of $75. Now, all of the
major title companies I called last week said that they could pro-
vide me, if I were a title agent, with a title search for $75 or $80.
And they would use their plants, crank out the search, and give it
to me for that price. I have also put here $70 for a survey. That
would be paid to the surveyor and that would come into the attor-
ney's office, but go right back out.
Now, look at the premiums-$100,000 house, $150,000 and
$200,000-and these, I believe, are based on the actual premiums in
effect in the Washington area. The title insurance premium is $332
for the $100,000 house, going up to $532 for the $200,000 house. At
a 50-percent commission-I have the commissions across there on
the title insurance. And ranging in the 50-percent case, from half
of the premium, or $166 up to $266, and at 80 percent, which is not
uncommon anymore, although 60 and 70 percent are more
common, I would have the share of the premium to the agent going
from $266 to $426.
So, at the bottom, you can see how the agent comes out. If there
is no title insurance, or if he doesn't get a commission, he receives
whatever fees he imposes. And those fees should be adequate. But I
would digress to say that perhaps those fees are smaller because
the commission may be more than necessary, and might be passed
through to the consumer in that form.
I will digress further to say that I recently represented a
Member of Congress in the purchase of a house, and he was one of
those very unusual people who said, "Why don't you check around
and see where you can get the settlement done." And so I shopped
for him, and I called a few companies. It was not long before I
found one that said:
Well, we will do everything for nothing, because the title insurance commission
on that house is a little more than $200,000. If you would just pay us the full title
insurance premium, that will be sufficient. We won't charge anything for search or
anything else.
So on occasion, I think it is true that some of this commission is
passed through to the consumer; however, I did hear Mr. Treadwell
say this morning that in 40 years of experience he doesn't find
anyone coming in negotiating about that premium. It is on the
sheet as an insurance premium. Who is going to say, "Well, could I
have a lower insurance premium?" And if they ask, they couldn't
have it, anyway
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558
Now, such fees as $272-or maybe it should be $350, maybe it
should be $150, but those fees should be proper and should be
adequate compensation, and there should be competition between
providers at that fee level.
I have a number of suggestions:
First, State insurance regulators ought to limit those fees. And
as I say in my statement, I think they ought to limited to 30
percent if it is an insurance-issuing agent, one who pulls these
blank insurance forms off the shelf, fills them in on behalf of the
company and issues them. If he doesn't even do that, I think it
ought to be 20 percent or less, because all he is doing is tacking the
summary of title report to a binder form, to my knowledge.
Now, interestingly, 2 days ago I called the State insurance com-
missioner of Maryland to see what he thought of that, Edward G.
Birrane, Jr. It turns out he prepared a State statute. And in fact,
he mailed me a copy of it and I have it in my pocket, but I wasn't
able to actually read it, to be frank, because I just got it this
morning on my way over here. But the statute would have regulat-
ed the amount of commissions to agents. It would have done some
other things, including requiring mandatory refilings, which would
have given him an opportunity to review the proper level of title
premiums.
He told me, as I understood it, that if they don't file, the insur-
ance commissioner in Maryland can't just come in affirmatively
and say those rates are too high or, for that matter, too low.
I asked Mr. Birrane what the reaction of title agencies and
others, including title insurance companies, was to the proposal to
limit the title insurance commissions to agents. He described their
reaction in one word, "apoplectic." He said they were totally op-
posed to the imposition of maximum limits on the portion of premi-
um which is split with the title agency.
Now, one can readily understand why the title agencies and
attorneys would not like to see such a limitation because they are
receiving these commissions-although there are always enlight-
ened members of every profession, and I have spoken to a few who
would be very much in favor of that kind of limitation. But I
believe the title insurance companies would be very ill-advised to
oppose such limits, and I'm not sure, nationwide, that they would.
The limits would provide a direct solution to the fundamental
problem they face, namely, that while title insurance premiums
are high enough-probably too high-the title insurers outbid each
other in increasing what are, in effect, kickbacks they are paying
to title agencies to purchase title business, kickbacks so large that
the title insurance companies are deliberately taking on loss busi-
ness.
And if I had any doubt about that, I was looking this morning at
something called the Philo Smith & Company Report of August
1981, and they state in there, at page 15:
In recent years commission rates have increased with the portion of premium
retained by agents reaching 90 percent or more in California.
Now, I'm sure that it won't reach 100 percent-at least I don't
think so-but I think that 90 percent is an embarrassment.
And I spoke to a very qualified title person earlier this morning,
one who ran the whole Washington area for one of the major title
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559
companies, and he said he agreed that these percentage commis-
sions are embarrassing, they are bad for everybody concerned, and
that what should happen is that those other services should be
compensated by separate fees.
Chairman GONZALEZ. Mr. Elliott, would it be possible to obtain
for the record a copy of that report?
Mr. ELLIOTT. I'm a little reluctant about that, Mr. Chairman, in
that there is a warning on the front about anyone reproducing it.
But what I would do is give you my copy, and then I'm sure
when the subcomriiittee contacts Philo Smith & Co., they could
authorize that. I would be happy to do that.
[The referred-to report follows Mr. Elliot's prepared statement.]
Mr. ELLIOTT. Second, if title insurance premiums are not to be
deregulated, I believe State insurance regulators should allow no
increases. And I would say, parenthetically, that the Philo Smith
report says that a major effort by title insurance companies to get
higher premiums is in the offing.
I think, if anything, premiums should be reduced. The premium
per policy has risen drastically. As Dr. Ford just said, the risk isn't
related to the home prices, but the premium sure is. It is per
thousand. Since the insurance isn't primarily related to risk, the
dollar volume is all but irrelevant. And because the price of hous-
ing has gone up faster than inflation, the premium amounts have
gone up faster than inflation on premium-per-policy basis.
The companies have sustained $60 to $70 million loss last year.
They had profits in 1975 to 1979, according to the Philo Smith
report, but the the $60 or $70 million should be compared to total
insurance of $1.1 billion. In one case, I saw a figure of $1.4 billion,
and another in 1980. Of that, 60 or 70 percent is residential.
And I think that the kinds of kickbacks I'm talking about totaled
at least $200 million a year paid by the American public, and
perhaps $300 million. So I think that is what is causing the $60 or
$70 million losses. The downturn in the economic situation is also a
cause.
If kickbacks were eliminated and the commissions to agents re-
duced to something reasonable, I believe that the profit situation
would be turned around. And the American public undoubtedly is
bearing the cost of those kickbacks, except to the extent they are
passed through and reducing the, cost of other services.
That leads me to a third point~ I think HUD should immediately
revise the settlement statement requirements to prohibit the
person conducting settlement, who is the person that must fill out
the settlement statement, from stating as a title insurance premi-
um more than the net amount paid to the title insurer.
He should separately show his retained share, which if it is 50
percent to 90 percent, he should show that as a "referral and title
agent fee" or something similar, because it is a shame to have
someone go to settlement and never know that that is happening.
He sees that title insurance premium as a lump sum on that sheet
and thinks there is nothing to be discussed there. If the consumer
knew that $600 of the $700 premium was going to the agent, he
might at least say, "Well, why don't you waive these other fees?
You're getting enough from the title insurer."
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560
My final recommendation is that HUD should issue regulations
for comment and then for effect, determining that fees to title
agencies in excess of the amounts that I suggested, a maximum of
about 30 percent, constitute kickbacks under section 8. I think that
that would be a reasonably effective step to take.
Now, let me clarify something. I'm not saying that everything
the title agent does in closing the loan can adequately be paid for
out of 20 or 30 percent of the premium. What I am saying is that
that is enough to pay for the insurance function. If he needs more
income than that-and he probably does-he should charge fees for
it. And those two things should be distinct.
There actually are cases, as I mentioned, in the Washington area
where that extra income is being passed through in the form of no
charge or a low charge for other services. I think that that would
support what Mr. Stanton of the FTC was saying about the possi-
bility that kickbacks essentially could be passed on to the consum-
er. I think that some of these kickbacks are indeed being passed on
to the consumer in that form.
I will skip the rest of my statement, which analyzes the HUD
report's recommendations with respect to controlled business,
except to point out one thing. To the extent that HUD proposes to
amend section 8, to make it either cover parent-subsidiary relation-
ships or make it an antitrust statute, I think those suggestions
overlook the well-established antitrust policy of the country, which
I point out in a footnote at page 17 in my statement. The Justice
Department says, as recently as January 26, 1977, in the "Anti-
trust Guide for International Operations":
The Department of Justice has consistently accepted the views stated in 1955 that
a parent corporation may allocate territories or set prices for the subsidiaries that it
fully controls.
Now, those are otherwise per se violations. I don't think the
proposal coming from HUD to have an antitrust statute dealing
with parent-subsidiary relationships would be consistent with the
general application of the antitrust laws in the country.
One other comment if I could make it, Mr. Chairman, I would
point out that the horror story recounted by Mrs. Guggenberger is
not a parent-subsidiary situation. It is a case, as she describes it-
of course, we haven't heard the other side, but as she describes it,
it is a case involving numerous noncontrolling shareholders who
have a minority equity interest. And as she described it, the com-
petitor is a single entity, used as a mechanism to implement a
classic conspiracy in restraint of trade to monopolize the settle-
ment business in an entire county. It is a shame that the Antitrust
Division didn't, in fact, take up the burden of that one.
If her facts are correct, she did the right thing. She filed an
antitrust suit. And she won it. Nothing I have said would condone
such reprehensible activity as to go out and monopolize an entire
county in that fashion.
But it is to compare apples and oranges to say that that case is
therefore evidence that no savings and loan or other entity should
h~. ~ a subsidiary offering services. I think that those two situa-
tions are entirely different.
I would conclude my statement at that point, Mr. Chairman.
Thank you very much.
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[Mr. Elliott submitted the following for inclusion in the record: A
prepared statement; the referred-to agreement reached with three
providers; and the referred-to article from the August 1981 issue of
the Insurance Stock Review entitled "Review and Outlook: Title
Insurance." The material follows:]
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STATEMENT
OF
ROBERT RAYMOND ELLIOTT
BEFORE
SUBCOMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT
September 16, 1981
Mr. Chairman and members of the Subcommittee, I
am pleased to be invited by you to present my views regarding
RESPA.
I am Robert Elliott of the law firm, Elliott & Bell,
in Washington, D. C. I served as General Counsel of MUD from
1974 to 1977, when RESPA was originally enacted and implemented.
I have more recently reviewed RESPA for the United States
League of Savings Associations, but I wish to clarify that I am
not appearing this afternoon as a representative of the U. S.
League or any other client. The views I present are strictly
my own views, and not the views of any client.
I. Lender-Packaging
The MUD Report to Congress on RESPA proposes
legislation requiring lenders to offer so-called "lender-
packaging" of home purchase closing costs. "Lender-packaging"
in a nutshell means that the lender would procure and pay for
the title search, title insurance, closing and other services,
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but would be free to recover the costs in loan charges of
various types.
In my view, there is no objection to voluntary
"lender-packaging," and in fact some lenders on occasion
currently engage in "lender-packaging." For example, I
recently arranged for "lender-packaging" of closing
costs for a large mortgage lender which invited its
existing borrowers in the Washington area to refinance
low rate loans with below-market loans. The lender
offered to pay all closing costs as part of the program.
In addition, developers such as condominium conwersion
developers often offer to pay most or all title related
settlement costs as a marketing tool. Such a practice
is similar to "lender-packaging" and might be called
"builder-packaging. 7
Lender-packaging or builder-packaging is
unobjectionable. What is questionable, however, is the
idea of new legislation to dictate use of "lender-packaging."
In this era of deregulation and reduced Federal intervention
in the private sector, I would be surprised if Congress
were to enact a law imposing entirely new requirements
on five or six million private transactions per year.
HUD is mindful of the general philosophy of the
Reagan Administration. I believe HUD somewhat reluctantly
came to the conclusion that such far-reaching legislation
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should be proposed, and I note that HUD stops just short
of urging enactment of such legislation, and instead urges
Congressional "consideration of such legislation.
While the proposal is presented by HUD as a
trade-off for relaxation or removal of some existing RESPA
and Truth in Lending requirements, in fact if those require-
ments are not worthwhile they could simply be removed.
HUD proposes two alternative types of legislation
One type of law would require the lender to purchase the
closing costs in every transaction. I suppose that under
this approach, borrowers would actually be precluded from
selecting their own settlement service providers.
The other type of law proposed would require the lender
to offer to purchase the settlement services, but would permit
the lender, in addition, to quote other terms for the loan if
the borrower opted to obtain (and pay for) his own closing costs.
Under either approach, the lender would be permitted
to pass the closing costs along to the borrower and possibly
the seller in any form, including discount points, fees and
interest rate or any combination. However, I wonder whether HUD
has in mind at least some limitations. For instance, would
HUDs proposal allow a lender to tell the borrower that the borrower
will have to pay a "closing fee" equalling to the penny the total
of the precise costs the lender pays for a series of services,
and then tell the borrower what they be?
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That would appear simply to allow the lender to select the
providers for the borrower, with the borrower paying the
precise charges of those providers.
I believe HUD was reluctant about the second
alternative for fear that lenders who did not like "lender-
packaging" would quote very unfavorable terms for loans
including lender-packaged closing costs, and then would
quote normal terms for loans where the borrower opted to
pay the closing costs.
However, it may be that 0MB insisted that HUD
should be neutral between the two. The Report is neutral.
I believe the basic problem with the HUD recom-
mendation for legislation is the one I mentioned earlier.
The legislation proposed by HUD would tell the three parties
(lender, borrower, seller) in about five or six million
private transactions per year how to handle a portion of
those transactions. The public has indicated to Congress in
various ways recently that the public wants less govern-
ment, less regulation and less Federal intervention in the
private sector. We are in a period in our history when
enactment of far-reaching new laws dictating to private
parties how to conduct their affairs will not be acceptable
except in the most urgent situations such as those involving
human safety.
The lagislation proposed differs in kind from
PAGENO="0572"
566
existing RESPA which is primarily a disclosure law. While
RESPA contains a few substantive rules such as Section 8
regarding kickbacks and unearned fees, RESPA generally
allows private parties to determine by contract which party
pays for what.
Let me mention several other reservations I
have regarding the HUD recommendation to require "lender-
packaging' by Federal statute.
1. First, the recommendation proposes legislation
that would take effect nationwide and govern millions
of transactions annually. Yet there is no assurance that
the "lender-packaging" system will work to benefit consumers
in the way the Report contemplates. The legislation in
question might prove to be a very costly and damaging
nationwide experiment -- much as the original version of
RESPA proved to be. This is social engineering on a grand
scale.
I think the danger is that every lender would
be required to gear up to procure the various settlement
services by a given date. Should the system then prove
not to be in the public interest, the law could then be
repealed and its implementation dismantled. Of course,
in the interim many providers of services may have gone
out of business because they were unsuccessful in attempting
to be hired by lenders.
PAGENO="0573"
567
2. Second, an alternative approach would be to
leave the proposal to state legislatures, but to enable states
to implement it without exception within their boundaries,
the Federal Home Loan Bank Board and bank regulatory
agencies could issue regulations requiring Federal savings
and loan associations and natiohal banks to offer "lender-
packaging in any state where the state legislature requires
it.
In that fashion, we would have the benefit of an
experiment in a state rather than having Congress implement
a nationwide experiment. On the other hand, if it turns
out that no state adopts HUD's proposal, that should tell -.
us something about whether the HUD proposal is worthy of
enactment.
3. Third, I have reservations as to whether
the consumer would in fact save money. In some cases, costs
may actually be increased by implementing "lender-packaging."
For instance, in given local situations, some lenders may
conclude that any possible savings in the settlement costs
in question -- principally, title insurance, title search,
preparation of documents, survey, private mortgage insurance
and closing fee -- are such a small part of the
cost of the transaction that obtaining those savings will
not affect the lender's competitive position. In such a
PAGENO="0574"
568
situation, settlement services that are contracted out might
be viewed more as plums to be handed out than items to be
made the subject of hard nosed negotiation.
4. Fourth, if "lender-packaging" is found to be
highly desirable, as an alternative to BUD's proposal to
enact nationwide requirements, Congress could instead create
a strong incentive for lenders to offer it.
The Truth in Lending Act, even as revised, is of
only marginal value to the consumer in home mortgage financings,
as the BUD Report indicates. Similarly, the RESPA booklet
and cost disclosures seem to be of only moderate value.
Therefore, the incentive I would suggest would
be a total exemption from all requirements of RESPA and
Truth in Lending for first mortgage transactions as to
which the lender voluntarily adopted "lender-packaging.
Realtor Distribution of Booklet
and Good Faith Disclosures
In that connection, I would note that the BUD
Report finds that the RESPA booklet and the RESPA good
faith estimates come to the consumer too late, since they
are provided by the lender.
The solution would be to have the realtor
provide them instead of the lender. The realtor could
PAGENO="0575"
569
be required to do so at the time the purchaser/borrower
first makes a written offer to purchase a home. A Federal
basis could be found for such a requirement under the
Commerce Clause of the Constitution. For instance,
the requirement could apply to every buyer expected to
seek a mortgage loan of the type currently covered
by RESPA.
As a backstop, lenders could be required to
provide the good faith estimate and the settlement
booklet in cases where a realtor does not appear on
the sale contract.
II. `Controlled Business"
Let me turn to the subject of so-called
"controlled business." I note that a bit of new confusion
has been introduced in this subject by reason of the
fact that the American Land Title Association (ALTA) has
generally referred to settlement business as the "business"
which is controlled, whereas the HUD Report refers to the
subsidiary of a lender or other entity as a "controlled
business."
HUD and ALTA are essentially talking about
the same thing. However, I would note in passing that the
HUD Report generally fails to make needed distinctions
between parent-subsidiary situations as opposed to situations
PAGENO="0576"
570
where the referring party owns a minority equity interest
in a settlement service provider.
The HUD Report makes a number of interesting
observations regarding so-called "controlled business."
-- First: "RESPA's prohibition against
such potential industry abuses as
kickbacks and referral fees appears
to have been largely circumvented
by increased controlled business
relationships." (Summary, Page ii)
In the Washington area with which I am familiar, I
do not think there has been any such development of so-
called "controlled business."
The primary kickback and unearned fee problem
that we have in the Washington area is the same one that
still exists nationally, and the one which is causing the
title insurance carriers to operate in the red, namely, the
payment by title insurance carriers to title agencies and
approved attorneys of 50% to over 80% of the title insurance
premium for services worth at best 30% of the premium
-- and I will come back to that in a moment.
-- Second, the HUD Report states that there
is reason to believe that "controlled
business relationships" are, "in fact,
* economically efficient." (Summary, page ii)
Probably, a subsidiary of a lender could very efficiently
provide settlement services. As but one example, a lender
or its subsidiary can prepare promissory notes, mortgages
and other legal documents by computer using primarily
PAGENO="0577"
571
information already placed on the computer for loan processing.
While independent title agencies should not be forced out of
business by unfair and coercive tactics such as unlawful "tie
ins," neither should those that cannot operate effeciently
be propped up in business by Federal laws eliminating
competition. There is no doubt that our nation is suffering
a severe shortfall in the rate of increase in productivity
-- a major cause of inflation. We should recognize that
inefficient independent title agencies may meet the same
fate as many independent grocery stores of an earlier era
unable to compete with Safeway and other large, and efficient
competitors. However, I do not believe that will generall~/
happen in the real estate closing business.
-- Third, the HUD Report also questions whether
outright kickbacks are necessarily a bad thing,
since they may result in different prices than
would otherwise exist.
I personally believe that outright kickbacks
should be prohibited. Apart from severe ethical questions,
in many cases there would be no pass through to the consumer.
For instance, I believe that were kickbacks to be paid to a
realtor, there is little chance that the resulting income to
the realtor would be passed on to the public in lower real
estate commissions as a result of competition among realtors.
Moreover, in the case of title insurance premiums, if
the kickbacks are passed through to the consumer in the form of
85-396 0 - 81 - 37
PAGENO="0578"
572
free services or artificially reduced fees for services,
criminal insurance "rebates" may be involved under state
insurance codes.
The evils of outright kickbacks are at present
concentrated in the area of premium-splitting by title
insurance companies, which typically pay title agencies a
portion of the premium far in excess of anything that could
be justified by the work title insurance policy issuance work
done by the agent. The title agent typically receives 50% to
70% of the title insurance premium, and sometimes 80% or more.
Apparently, the title insurers and their agents
think that even a miniscule amount of actual services
exempts their arrangements from Section 8, under the exceptions
stated in RESPA Section 8(c).* I called several of the
major title insurance companies a few days ago and asked
about their standard premium-splitting practices. All engaged
in similar practices. One even specifically told me that the
title insurance company would do everything for the agent
including the typing of the title policy or the title binder,
but not both. He said that the insurance company was
concerned that if it typed both, there would be no services
at all left for the agent to perform, and the premium
* Section 8(c) provides in part: `Nothing in this section shall
be construed as prohibiting (1) the payment of a fee . .
(B) by a title company to its duly appointed agent for
services actually performed in the making of a loan. . . ."
PAGENO="0579"
573
sharing could then be a kickback.
I would refer the Committee to the identical
language in the 1974 House and Senate Reports regarding the
original RESPA Section 8, whichmade clear that excessive
fees violate Section 8.*
There can be no doubt that the 50% to 70% or
more being paid by the title insurance companies to the
title agencies is excessive. The work involved in preparing
a binder is a few minutes of clerical work. The title insurance
policy is a bit more clerical work, primarily typing, and a
* slight amount of professional work. The agent also maintains
a log of the insurance policies issued. There are virtually
no other duties.
Probably half or more of the 50% to 70% share
of the title insurance premium is, in fact, a "kickback" in
* The House and Senate Reports in 1974 regarding RESPA
both contain the following identical discussion:
"Subsection [8] Cc) makes clear that section
[8] is not intended to prohibit the payment
of title insurance companies, attorneys,
lenders and others for goods furnished or
services actually rendered, so long as the
payment bears a reasonable relationship
to the value of the goods or services
received by the person or company making
the payment. To the extent the payment
is in excess of the reasonable value of
the goods provided or services performed,
the excess may be considered a kickback
or referral fee proscribed by Section [8]."
[Emphasis added.)
PAGENO="0580"
574
exchange for the referral of the business to the title
insurance company. In fact, almost the entire share is gravy
since the title agent typically charges the cost of the
title search separately to the borrower and imposes enough
other charges to cover his costs and produce a profit
without the kickback in the form of the agent's 50% to 80%
share of the title insurance premium.
As an example, Benny Kass, is a well-known real
estate attorney and consumer advocate in Washington, D.C.
who publishes a weekly column in the Saturday Real Estate
Section of the Washington Post. His office advised me that
he imposes a $250 legal fee to close home purchase
transactions, as well as the cost of a title search (about
$75) and a few lesser fees.
Such fees ought to be sufficient compensation
without receiving any additional compensation in the form
of premium-splitting with the title insurance company.
I have a number of suggestions to remedy this
problem.
1. First, state insurance regulators should limit
fees permitted to be paid by title insurance companies to
title agencies and approved attorneys.
PAGENO="0581"
575
I believe appropriate limits would be approximately:
20 percent of the premium in the case
of those agents or approved attorneys
who only issue title binders.
30 percent in the case of agents issuing
the binder and title policy.
On Monday, September 14, I spoke with the insurance
commissioner of the State of Maryland, Edward G. Birrane, Jr.,
who had prepared a state statute which would have required title
insurance premiums to cover only the title insurance, not any
services, and would have put into effect state insurance regulation
of the share paid to a title agent as a commission. I asked Mr.
Birrane what the reaction of title agents and the title insurance
companies was. He described their reaction in one word: "Apoplectic."
The were totally opposed to the imposition of maximum limits on
the portion of premium permitted to paid to the title agency.
One can readily understand why the title agencies and
attorneys would not like to see such a limitation. But I believe
the title insurance companies are very ill-advised to oppose such
limits. Those limits would provide a direct solution to the
fundamental problem faced by those companies, namely, that
while title insurance premiums are high enough, probably too
high, the title insurers out bid each other in increasing
what are, in effect, kickbacks they are paying title agencies
to purchase title insurance business -- kickbacks so large
that the title insurance companies are deliberately taking
on loss business.
PAGENO="0582"
576
State regulation limiting the level of agent
commissions is both in the insurance companies' best interests
and in the public interest.
While I recommend that state insurance commissioners
limit these referral fees, the strong vested interests of
agencies andattorneys handling settlements -- and their
political clout at the state level -- leave me with little
optimism that such reforms will occur at the state level.
2. Second, assuming title insurance premiums are
not deregulated, state insurance regulators should allow
no increases in title insurance premiums for properties
covering one to four family properties. If anything, the
premiums should be reduced. The premium per policy has
risen drastically -- well in excess of general inflation
-- due to increases in home prices. Since the insurance
is not primarily insurance against risk, the larger dollar
amount of coverage per policy is all but irrelevant.
The title insurance carriers did about $1.1 billion
of title insurance business in 1980, about 70% of which was
residential. In the process, they sustained losses of about
$60 to $70 million, while paying at least $200 million, and
probably more, in kickbacks of the type I have described.
If the kickbacks were eliminated and commissions accordingly
were reduced to a level which represented reasonable compensation
to the title agency, premiums could be cut substantially.
PAGENO="0583"
577
The American public is bearing the cost of these
kickbacks. And the kickbacks are generally not disclosed
to the consumer, a point which leads me to my next recommendation.
3. HUD should immediately revise the settle-
ment statement requirements to prohibit the person conducting
settlement (who is the person that must fill out the settlement
statement) from stating as a title insurance premium more
than the net amount paid to the title insurer after that person
deducts his referral fee. He should separately show his retained
share of the premium and designated it a"REFERRAL AND TITLE AGENT
FEE', or something similar.
4. Finally, HUD should issue regulations for comment
and then for effect determining that fees to title agencies
in excess of amounts such as those I have suggested (20%
maximum for agents issuing binders only, and 30% for other
agents) constitute kickbacks under Section 8. No other
single, immediate step would do more to solve the earnings
problems of the title insurance companies and stamp out
kickbacks to the benefit of the consumer.
Let me turn to the HUD recommendation regarding
"controlled business." The HUD Report states at page IV-24
that the Department is not prepared to recommend retention
of Section 8 nor to recommend repeal.
PAGENO="0584"
578
DUD then states:
"We believe that a prohibition against
kickbacks and unearned referral fees must
logically and legally include a prohibition
against controlled business business arrange-
ments. Therefore, this Department recommends
that, unless Section is repealed entirely,
it should logically be amended to specifically
preclude any referral by one settlement
service provider to a wholly or partially
owned subsidiary providing another settlement
service. This, however, we view as virtually
unenforceable. (Emphasis added.)
I really do not understand quite what DUD is recommending,
in view of the final statement that the prohibition proposed
is considered "virtually unenforceable.' Nor do I understand
why DUD thinks such a prohibition would be unenforceable.
The problem with such a prohibition is not a
practical problem of enforcing it. As to regulated financial
institutions, it would be a simple matter to enforce it.
The problem is that the prohibition flies in the face of
established antitrust policy which treats a parent and
controlled subsidiary as one.* Further, it would make
* United States Department of Justice, Antitrust Division,
"Antitrust Guide for International Operations," January 26,
1977, pages 12-13:
"The Department of Justice has consistently accepted
the view stated in the 1955 Report of the Attorney
General's National Committee to Study the Antitrust
Laws: a parent corporation may allocate territories
or set prices for the subsidiaries that it fully
controls. The Department's test has generally been
formulated in terms of whether the parent controls a
majority of the voting stock of the subsidiary.
However, the same reasoning may apply to a minority
position where the U. S. firm maintains effective
working control."
PAGENO="0585"
579
little sense since it would prohibit in the parent-
subsidiary context what would still be permitted in the
context of a single corporate entity. Thus, such a prohibition
as to a parent providing a loan where a subsidiary provides
appraisal, fire insurance and title insurance, would have
no effect on a single corporation which provides the loan,
the appraisal, fire insurance and title insurance.
Whatever might be said for the situation in
which the referring party has an equity interest but not
a controlling interest in a settlement service provider,
and that is a different case, the parent-subsidiary situation
is entirely distinguishable. HUD apparently draws no
distinction.
It would appear that if HUD does not think two
settlement services should be provided by a parent-
subsidiary combination, it follows that HUD should also
be opposed to having the parent itself provide two services.
HUD at page IV-25 suggests recasting Section 8
as an "anti-trust type statute without criminal penalties"
to prevent "controlled business arrangements." But as I
mentioned earlier, the Department of Justice has
specifically rejected restrictions on parent-subsidiary
relationships in administering the Sherman Antitrust Act
and related legislation. It would be most unlikely that
PAGENO="0586"
580
the Congress and the Justice Department would take such
an unusual antitrust approach to parent-subsidiary relation-
ships in the one to four family real estate settlement
area.
The existing antitrust laws are preferable. The
primary antitrust prohibition which is applicable to the
parent-subsidiary -- and is equally applicable to the
parent alone in offering to products to the public --
is the prohibition against tying.
The tying prohibition prohibits a party from
conditioning the sale of one product on the sale of another
(by a subsidiary, or by the parent for that matter). The
proponents of a so-called "controlled business" prohibition
wish to go a step further and stamp out all competition
from such subsidiaries even where they refrain from such
tying. I cannot agree that such an anticompetitive step is
desirable, when alternatives are available which will
increase competition.
This concludes my testimony, and I would be
pleased to answer any questions.
PAGENO="0587"
581
[TEXT OF LETTER OF AGREEMENT WITH MARYLAND ATTORNEY AGREEING
TO PROVIDE COMPLETE SETTLEMENT SERVICES IN CONNECTION WITH
"LENDER-PACKAGING" OF SERVICES FOR REFINANCING PROGRAM -
FOR $175 PER CLOSING - AND TITLE INSURANCE ONLY IF REQUESTED]
April 6, 1981
[Maryland attorney]
Dear
This will confirm your agreement with us regarding
the provision of settlement services in connection with
closings under [Lender's] refinance program.
[Lender] intends to offer to certain
borrowers the refinancing of their existing mortgage
loans at a below market rate. The purpose of the program
is to obtain a higher yield to [Lender] than
is being received on existing loans to these customers.
The rate of interest on each new loan will be determined
based upon the rate of interest on the existing loan,
the amount of increase in loan amount and possibly other
considerations such as remaining term under the existing
loan.
In connection with these refinancings, [LenderJ
intends to charge points, but to pay the closing
costs (other than owner's title insurance premium and
possibly certain other expenses as stated below).
You have agreed with us to provide all services
in connection with the closing Of any such loans, including
but not limited to the following:
1. Examination of title;
2. Preparation of all instruments, other than
the note, deed of trust and Truth in Lending statement, if
any, in the event such documents are prepared by us as
we anticipate;
3. The holding of settlement in your offices;
4. Notarization;
PAGENO="0588"
582
April 6, 1981
Page 2
5. Administration of any required pay-off S in
connection with the loan, including release of existing
deed(s) of trust and other liens (but you will not be
expected to absorb any out-of-pocket expenses involved
in such pay-off s such as trustee release charges); also
collection and disbursement of prepaid items;
6. All other services customarily provided in
connection with such settlements.
You have agreed to provide the above services
for a fixed fee per case of $175, and you will not charge
any "settlement fee" or other charges to us or to the
borrower except for the fixed fee which will be paid by
us.
Except as set forth below regarding owner's
title insurance, and except with respect to any other charges
which we may designate from time to time such as the fees and
expenses that may be involved in release of junior deeds of
trust, the borrower will not pay any charges or expenses
in connection with the settlement, other than the payment
of points to us and any prepaid items. [Lender)
will pay the applicable recording fees and charges, stamp
taxes, release of first deed of trust charges and other
expenses and governmental charges in connection with
the closing, as well as the cost of survey and of an
appraisal. We reserve the right to select the surveyor
and the appraiser.
If we so request, you agree to furnish us a
mortgagee title insurance policy. However, in the event
that we so advise you in advance of settlement, we will
not purchase a mortgagee title policy at settlement in
which case you agree to certify title from the date the
property was acquired by our borrower, and you agree
at any future date as we may determine, to provide us
with a mortgagee title policy with respect to title as
of the date of settlement. -
You agree to cause any mortgagee title~ insurance
policy to be issued by a title insurance company of known
reputation and quality, acceptable to us, and one which
PAGENO="0589"
583
April 6, 1981
Page 3
will provide a reissue rate in the event that any other
known title insurer has issued a mortgagee title policy
within the previous ten years. You also agree to obtain a
replacement rate from the insurer which issued the previous
mortgagee title policy, if such a rate is available and is
less expensive than the reissue rate. All of the foregoing
shall be subject to the right of [Lender) to
select the title insurer.
You agree not to urge the borrower to purchase
owner's title insurance. In the event the borrower deter-
mines to purchase an owner's title insurance policy,
[Lender) will not pay for such insurance.
It is our intentio.n to send you settlement
cases with respect to properties in Maryland, but you
understand that we are under no obligation to send you any
such cases, and are free to send them to other settlement
service providers should we determine to do so.
Please indicate your agreement with the above
by signing and returning one, copy of this letter.
Sincerely,
Agreed: -
Date:
PAGENO="0590"
584
* THE INSURANCE STOCK REVIEW
August 1981
REVIEW AND OUTLOOK
TITLE INSURANCE
This special issue of The Insurance Stock Review surveys the
title insurance industry in one of its worst operating environments
since World War II. Leading national carriers are attempting to
hold market share and operating margins through increased com-
mercial volume, expense controls and expanded ancillary services.
While corporate consolidations will occur, most carriers will re-
main status quo and await the time when the unprecedented pent-up
demand for housing can be fulfilled. The first article in this
issue will discuss the macro-economic outlook for the industry in
the context of the real estate cycle, while the micro-economic
picture will appear through descriptions of the twelve industry
leaders in the section that follows.
-1-
PAGENO="0591"
585
* Insurance by definition is the elimination of risk - life in-
surance and property and casualty coverages indemnify after the
loss is incurred, while title insurance seeks to avoid the risk in
the first place. Title insurance is a uniquely L~merican product;
it was invented to help assure property ownership as the need for
indemnification against losses arising in the future on title prob-
lems occurring prior to ownership intensified as this country grew
geographically and became more populated. The use of title insur-
ance continues to broaden today, as carriers provide efficient, low
cost and speedy (as rapid as twenty four hours) real estate closings
along with the needed title indemnification. The viability of the
product has been proven, and has become even more evident recently
as we export the product overseas, in marked contrast to the develop-
ment of our other insurance forms, which accompanied our early
colonists here from abroad.
The economic difference between risk assumption and risk
avoidance is very significant. In title insurance, about 90 per-
cent of the premium dollar is committed to avoiding risk and ~Ls
devoted to the procurement of the business, its underwriting, and
maintenance of the industry's research centers: the title plants.
Such efforts necessitate large staffs and fixed assets, making the
title area both labor and capital intensive. These factors make
the industry completely dependent upon continued volume gains to
cover high fixed operating expenses and major capital commitments,
and have made it vulnerable to wide cyclical swings.
Life insurance and property and casualty products require the
major portion of the premium dollar to be allocated for claim pur-
poses. This longer-term risk assumption posture results in a sub-
stantial claim reserve build-up, with such reserves invested in
income-bearing assets. The title industry, on the other hand,
allocates only between 5 percent and 10 percent of its premium
dollars for claim purposes, and loss reserves are not large in re-
lation to the premium charged. With its service orientation,
almost 30 percent of title assets are placed in non-income-bearing
assets, including real estate and premium receivables, compared
with 5 to 10 percent for other insurance segments, as shown in the
table on the next page:
-2-
PAGENO="0592"
586
Insurance Industry Asset Distribution
Percent of Assets
Industry Segment Life Property/Casualty Title
Cash and Government Bonds 7 10 11
Corporate Securities:
Bonds 39 54 31
Stocks 9 19 23
Mortgages 27 2
Real Estate 3 1 22
Other Assets Including Policy
Loans and Premium Receivables 15 16 11
100% 100% 100%
Investment Income as Esti-
mated Percent of Total
Revenues 25% 12-13% 6%
Source: Life Insurance - American Council of Life Insurance
Property and Casualty - A. N Best Company
Title - NAIC Forms i!9 for 12 industry leaders re-
viewed individually in this issue
For the life and property and casualty carrier, the large in-
vested asset position provides an increasingly important source of
stable and growing income to bolster underwriting results. Last
year, for example, investment income for the property and casualty
industry more than offset a three percent underwriting loss, en-
abling this industry to achieve a 17 percent return on equity
despite operating in a cyclical trough. In contrast, the title
industry also functioned in a depressed environment, but did not
benefit operationally from such an underwriting offset and showed a
return on equity of only about four percent. Thus to remain prof-
itable when an unfavorable residential real estate market develops,
the title industry must tighten operations and seek alternative
revenue streams, both within the real estate field and through
diversification.
-3-
PAGENO="0593"
587
The over 100 companies comprising the title insurance industry
are called upon to insure title to a large part of the privately-
owned property in this country's 3.6 million square miles and yet
remains relatively small, with total revenues of about $1.4 bil-
lion. If viewed as a single company, the title industry would rank
about number 235 in terms of revenue, and would be about the size
of Polaroid Corporation.
With the industry constantly faced with the problem of cover-
ing both high fixed labor expenses as well as making the major
capital commitments required for geographic expansion and increased
market penetration, it is not surprising that industry consolida-
tion has been a major growth method. Large title carriers have
acquired smaller companies and agencies, with large corporate enti-
ties, often industrials, acquiring major carriers. Also, large
agency companies have been acquired by or affiliated with national
carriers, as they too have felt inflationary pressures on costs.
In 1980 two of the nation's largest agency companies were acquired,
California-World Financial by Lawyers Title, and Oceanic Finar~Eial
Corporation by Old Republic International Corporation, which also
owns Minnesota Title. Also, Stewart Title has a ten-year exclusive
underwriting contract with Intercounty Title Assurance Company of
Illinois, the largest independent agency at present.
This scenario of growth by acquisition has been an integral
part of the title industry's development. Local companies became
regional in scope, and regional companies expanded to operate
nationally. The first company to operate nationwide was Lawyers
Title Insurance Corporation of Richmond, which was acquired by
Richmond Corporation, a company which in turn is now a renamed
subsidiary of Continental Group. It. originally extended its oper-
ations primarily by insuring lawyers' title opinions. Today there
are about a dozen companies which, in varying degree, operate
nationally.
The national companies which have evolved in this manner have
become strong, effective business organizations, and are now
competing agressively to maintain or increase market share. So-
phisticated marketing and distribution techniques have been devel-
oped by these companies, and because of their financial strength
and broad facilities, these companies have an advantage over local
title insurers in competing for the business of large mortgage
lenders and major commercial real estate developers and investors.
With the scope of their operations, the national companies also
have the potential to develop ancillary insurance services. The
twelve largest title insurers write amajor portion of the nation's
business and they are listed below, ranked by gross revenues, with
parent company indicated where applicable.
-4-,
85-396 0 - 81 - 38
PAGENO="0594"
588
Gross Revenues from Title Insurance
and Related Services
(GAAP Basis)
Compounded
Annual Primary
1980 Growth Rate Growth Source
Title Insurer Amount Past 5 Years Since 1970
(000, 000)
Chicago Title and Trust Company
(Lincoln National Corporation) $260 17.1% Internal
(Southern Pacific Company) 248 11.8 Internal
Continental Financial Services
(Lawyer's Title Insurance Corporation -
primary title subsidiary) 133 12.3 Acquisition
(Lawyers Title
only)
First American Financial Corporation 121 20.8 Acquisition
Old Republic Title Insurance Group
(Title Insurance Company of Minnesota -
primary subsidiary) 98 15.1 Acquisition
(Title Insurance
Co. of Minnesota
only)
Transamerica Title Insurance Company
(Transamerica Corporation) 93 9.2 Acquisition
SAFECO Title Insurance Company
(SAFECO Corporation) 92 18.1 Acquisition
Commonwealth Companies - -
(Reliance Group, Incorporated) ~ .82.. 18.6 Acquisition
~I \`~*i
Stewart Information Services Corporation 69 16.6 Internal
American Title Insurance Company
(The Continental Corporation) 34 6.4* Internal
St. Paul Title Insurance Corporation
(The St~. Paul Companies, Inc.) 27** 11.0 Acquisition
Western Title Insurance Company 25 3.2* Internal
°Four years only.
**Statutory only per 1980 NAIC Form A9.
PAGENO="0595"
589
History and Background
Before turning to an analysis of the numerous factors, both
internal and external to the industry, that affect volume growth
and profitability a recapitulation of the industry's development
follows. In the latter part of the 19th century, the "Go West"
movement plus the development of the United States as a complex
industrial society led to tremendous increases in real estate
activity. The records of title transfers and encumbrances entering
the public land offices grew faster than the techniques for control-
ling this data. The simultaneous development of metropolitan
centers required large capital investments secured by real estate
mortgages. When the Supreme Court of Pennsylvania, in an 1868
case, absolved a lawyer from liability for an erroneous title
opinion on the ground that he had not been negligent, legal asso-
ciations in Philadelphia set out to find a means of protection
against such losses. As a result of these efforts, the first title
insurance company was formed and the first policy was written in
1876.
majority of the early ventures into title insurance were
/ made by banks and trust companies which combined the title insur-
ance function with the lending of mortgage money. Title insurance
was to remain an integral part of the banking industry for the next
~fifty years. Following the First World War, a number of indepen-
dent companies were formed and seemed to prosper. However, most of
those companies were primarily mortgage guarantee companies and
their participation in real estate financing proved fatal when the
Depression struck. Because of losses incurred on mortgage guaran-
tees, more than three out of every four companies insuring titles
failed. Following the Depression, title insurance companies no
longer guaranteed that the obligor would pay the debt secured by
his mortgage. They guarantee only the validity of the title to the
land used as security for the payment of the debt. With this, the
title insurance industry came into its own and began a period of
accelerated growth that has continued to the present time. Because
the title insurance business is dependent upon real estate activity
and the volume of land transfers, it has exhibited a cyclical
growth pattern in line with the expansion of the economy as a whole
and the rise in real estate values in particular. Although not
standard in policy form, title insurance indemnifies property
owners, lien holders, or other lawfully interested parties against
loss or injury due to defective title or unknown encumbrances on
the insured property. Policies stipulate that the insurer will
defend the title at its own expense. There are two basic types of
titleinsurance: the owner's policyprotects up to the face amount
of the policy, usually the cost of the property insured. This
coverage continues until the owner transfers title to a new owner.
-6-
PAGENO="0596"
590
The mortgagee's policy is designed to protect the lender and is
usually equal to the amount of the loan. Coverage is reduced as
the debt is amortized and terminates when repaid. Because there is
no way to determine how much title protection has ceased or has
diminished, the total insurance-in-force as well as the total
possible liability cannot be measured precisely.
As noted previously, title insurance is based on avoiding
risk, rather than on risk assumption and distribution. The non-
insurance service provided is considerably greater than that pro-
vided by other insurers, and as far as cost, outweighs pure insur-
ance. Most insurers update title plants daily. The maintenance of
a plant requires skill and great expense, but this plant represents
the `backbone" of the industry. County land volume changes can run
as high as 30,000 to 40,000 a month. In certain areas, title
records can go back 100 years or more, before the county existed.
Although new title plants can be built with microfilm and automatic
data processing, plants built in this way may not provide as strong
a base for title insurance as the established title plant does.
The newer the title plant and the smaller the amount of information
in the insurer's files, the greater the amount of search work which
must be done to minimize the degree of underwriting risk assumed.
Thus the title plan developed over a long period of years usually
provides the most comprehensive basis for title insurance. In
recent years, the industry hasn't had to build many new plants as
carriers have realized that they can operate jointly and share the
information-gathering part of the business. The current trend is
flto purchase a share of a plant. For instance, Chicago Title and
Lawyers Title bought shares in an Orange County, California, plant.
This provides them access to that market while saving First Anieri-
can Title, the plant's originator, over $100,000 a month in main-
[Jenance costs.
If the preliminary title search work is done properly, the
insurance involves little risk exposure for the insurer. Also,
title insurance requires only one premium paid in full when the
policy is issued, again contrasting with casualty or life insurance
which requite peiodic premium payments. The title policy covers
existing and usually unknown prior risks for an indefinite period,
whereas other insurance forms normally exclude pre-existing prob-
lems.
The method and extent of loss indemnification varies by region
and still depends upon local real estate customs. However, greater
population mobility, the need for title insurance in complex com-
mercial and secondary mortgage transactions, and the title insur-
ance req'uirements of lending institutions have combined to increase
demand for the product. Volume on the West Coast and in the South-
PAGENO="0597"
591
west, where title insurance is generally accepted as part of the
transfer procedure, accounts for about one-third of business
written in the United States. Title insurance companies were
originally organized within particular counties, and each company
utilized its own title plant to search titles in that county. In
some parts of the country, abstracters maintain title plants, make
title searches, and provide owners and nortgagees with a certif i-
cate that states the nature and scope of the abstracter's title
search. This abstract may in turn be insured by a correspondent
title insurance company. In other parts of the country, lawyers
who specialize in the transfer of land examine the public records,
weigh the evidence contained in them, and provide clients with an
opinion as to the validity of the title. As with the abstract,
lawyers' opinions may in turn be insured by correspondent title
insurance companies. As already noted, title insurance is widely
accepted in the western states and certain urban areas of the East
and Midwest. In many other parts of the country, title insurance
has not been as generally used, particularly in transactions
involving residential real estate. Lawyers' opinions are still
widely used in New England, along the Atlantic Seaboard, and in
the South. Abstracting is also still widely used in many parts of
the country, but particularly in the Middle West.
However, regional differences are lessening and title insur-
ance is becoming more widely accepted both voluntarily and as
required by mortgage lenders. Penetration will continue to in-
crease as consumers realize that a title insurance closing can
cost 50-75 percent less than other methods and, with computerized
closings, be as speedy as overnight. Illustrating the market
changes and greater use of title insurance east of the Mississippi,
premium volume of the twelve national title carriers breaks down
in 1980 as follows versus five years ago.
-8-
PAGENO="0598"
592
Distribution of Direct Premiums Written by Region
Percent of Total
1980 1975
West Coast and Nountain States 41.0% 46.1%
Middle Atlantic and New England 16.9 15.8
Southwest 16.9 10.7
Midwest 13.5 17.7
Southeast 11.7 9.7
Total 100.0% 100.0%
To take advantage of changing consumer attitudes, population
relocation and the greater acceptance of the title insurance pro-
duct, almost all national carriers have expanded territorially.
The primary or general direction taken by each of the carriers
listed on page 5 of this report is illustrated on the map on the
next page.
Rates and Regulation
The premiums charged for the issuance of title insurance vary
with the policy amount and the type of policy issued. The premium
is collected in full when the real estate transaction is closed.
In many areas, premiums charged on subsequent policies on the same
land may be reduced, depending generally on the elapsed time be-
tween the issuance of policies on the same property and the nature
of the transactions in connection with which the policies are
(`issued. Most of the charge to the consumer relates to title
/ search and examination rather than the assumption of underwriting
L risk. The premium rates are higher for the owner's policy because
it covers the duration of ownership, whereas the loan policy
covers only the duration of the mortgage. Rates generally become
progressively lower per thousand dollars of insurance as policy
amounts increase. The limit of liability is the policy amount
plus the cost of defending the insured title against attack.
Like other types of insurance, title insurance in most states
is regulated by the state insurance department, but in some states
another department of the executive branch may have jurisdiction.
-9-
PAGENO="0599"
- - I
NATIONAL EXPANSION OF THE 12 LEADING TITLE INSURERS 1970 - 1981
~~st~t~s ~ thc1~dthg A1~~k~ ~ H~~ii; cI~d~ t~-t~ ~d f~i
c;1
PAGENO="0600"
594
Since 1970, increasing regulatory attention has been focused on
title insurance, whereas previously the line had been much more
loosely regulated than the property and casualty insurance busi-
ness or life insurance. In general, the thrust of numerous in-
vestigatory and ratemaking hearings has been to satisfy insurance
commissioners that title insurance rates are not unreasonable or
excessive. In a number of cases, however, it has been demonstrated
that rates were actually providing an inadequate return to title
insurers. Arthur D. Little, Inc. was retained in 1978 by the
American Land Title Insurance Association to advise on title rates
and, for instance, reported that, in order to obtain a fair return
on equity, rates should be increased by 37 percent in New York.
Many states now have in place a good framework for providing
regulation equitable to both the consumer and carriers. Such
states include New York, Pennsylvania, Texas, Washington, Oregon,
and California. In Texas, rates are reviewed annually in November,
with changes initiated the following year. That state's rating
history has included an increase in 1976, no change through 1978,
and a slight reduction in 1979, followed by increases of 3.1
percent last year and 9 percent this year. While most carriers
have sought rate relief to compensate for rising costs and shrink-
ing margins, this movement has not been universal. In some cases
where administrative relief has been given, competitive forces
keep the increase from taking effect. Now, with the industry
unprofitable, the carriers have become m~ TRi 6utTriiTRIr desire
L ~
While rate consideration procedures are not being speeded up, re-
cent actions taken have been positive.
The Real Estate Market
Premium volume changes for the title industry correlate
directly with the level of real estate transactions, and opera-
tional margins are influenced by transaction volume and inflationary
trends. The bulk of the industry's revenues are derived from
residential transactions, which require the availability of sub-
stantial credit. In the past, low cost financing was available to
the homebuyer and was subsidized through passbook savings accounts
at thrift institutions. In order to finance housing, the govern-
ment allowed such institutions to pay a 1/4 percent higher interest
rate than that allowed at commercial banks. The average American
had the opportunity to leverage his real estate investment through
first and second mortgages. He could purchase a first home with a
small down payment coupled with affordable monthly mortgage pay-
ments at low interest rates; he could move frequently or trade up.
This scenario resulted in a doubling of occupied housing from
- 11 -
PAGENO="0601"
595
about 35 million units in 1940 to over 70 million last year, with
mortgage credit exceeding $1.4 trillion, almost double the amount
five years earlier.
However, in the late 1970's as int~rest rates soared, the flow
of funds from savings and loans into money market funds, Treasury
bills and other investments providing significantly higher yields
started and continues today. With their source of low cost mortgage
money drying up, savings and loans became unable to support the
needed housing development. During the 1960's, over 90 percent of
mortgages were financed through passbook savings. The present level
is less than 25 percent. The 1980's will be a period of capital
shortage and it appears that the homebuyer will have to compete,
unsubsidized and on an equal footing, for available capital with
commercial and industrial buyers.
Heretofore, the Federal Government had fostered home develop-
ment. At present, the Administration appears more concerned with
improving productivity in the country through new technology and
modernized plant and equipment, and has adopted a somewhat neutral
attitude toward residential construction. On the one hand, the
removal of the differential between thrift company and commercial
banks savings interest rates has been proposed, while at the same
time, proposed tax legislation would allow an individual to exclude
up to $1,000 of interest from taxable income on savings certificates
which would carry an interest rate equivalent to 70 percent of the
one-year Treasury bill rate. It appears that during the 1980's, the
residential housing and financing industries will have to rely
almost completely on their own ingenuity to meet changing consumer
and capital demands with relatively little legislated subsidization.
To date, the inverse relationship between interest rate trends and
residential housing activity has correlated directly with the title
insurance industry's operating margins and return on capital as
illustrated in the graph on the next page.
To fulfill anticipated consumer demand, estimates indicate that
two million now housing units must be added per annum during this
decade. However, with housing prices expected to continue to rise,
with carrying charges higher as interest rates surpass previous
levels, and with households smaller in size and more energy-
conscious, the shape of the market will change radically. While the
sale of new detached" single family homes continues to fuel the
pressure of high interest rates, brokers indicate that sales of
multifamily units offering concessions and/or lower interest rates
like the one described below are gaining in popularity.
- 12 -
PAGENO="0602"
596
TITLE INDUSTRY OPERATING MARGIN
AND RETURN ON EQUITY
CORRELATED WITH INTEREST RATES
AND ROUSING ACTIUITY PATTERNS
1971 - 1980
20 ~j~Hft~4~[ ~ H-~1 ft~Tfl*r~
18 =
16 -~H_--- - - I
14 -~ -
_______ E I IgI Rd
PIRA 8 ____ p p~ PAl
: _________________________ ___________ ~11 L~~:1~1 A A
~ -~~~--H ---~
2 ___
________ RI11R~f U~Rt~
10
~: ~ ~ ~jRj8gS~
12 ~ ~ 6 S Sd
__ 5
1L2
8 ~ ~ ~9~T-~ ~
TSR Id pP I ~ ITT2 jj,VH-.~--4~ I_~L-4 `5\Jf~~
Op I 6 ~ 3
~ ~
AR i~ ~1i / -
(A d RI 8 ~ - I - -
.L.~, ~
L L -L 1
2 1 1 fl
t4-=~ ~i~Iti ~ ~J =LtL~ Eti~ :
8 Hf iiiJLLIJL~f LLL'tI.7
1971 1972 1973 1974 1975 1976 1977 1978 1979 1980
- 13 -
PAGENO="0603"
597
52 UNITS
$37,500 902 Financing Available
FOR EARLY BUYERS
1) 13% mortgage guaranteed for first year
(savings $1,200).
2) Free common charge (includes heat & hot
water) for first year (savings $1,200).
3) We guarantee to purchase your unit back
at end of 1 year.
The industry, in addition to adjusting the design of its
housing, will also have to adjust its financing method. The
problem, of course, becomes one of how to structure a mortgage
that allows the lenders an adequate return and is still withIn the
means of the consumer. Such forms include the shared appreciation
mortgage, which would allow maintenance of a fixed rate and payment;
variable rate mortgages; seller-backed first mortgages; and wrap-
around mortgages. Some industry spokesmen estimate that interest
rates will range between 10 percent and 15 percent during the rest
of this decade, that the demographic bias will remain with the
Sunbelt and that housing prices will continue to increase, pos-
sibly doubling by 1990. In such an environment, housing starts
may only average 1.5 million annually, with the unsatisfied demand
resulting in added pressures on rental markets and a change in
living patterns.
While a recent article in the Wall Street Journal reported
the continued slump in new home sales, an adjacent article indicated
a rise in non-residential building awards. If one drives through
most major urban or suburban areas, one cannot help noticing the
dearth of new home building contrasted with continued commercial
development. New housing starts are now running at a seasonally
adjusted level of only 1.0 million, and sales of existing homes at
an annual rate of 2.7 niillion units. Non-residential construction,
propelled by new public works and power plant facilities, exceeds
1980 levels. Excluding these propellants, non-residential con-
struction Is about even with last year. Indicative of the environ-
ment, The New York Times recently published an article headed
"Boom Times For the Builders of New York', citing that 72 now
office buildings or complexes were Planned to be constructed over
the next three to four years.
About 15 percent of the title industry's current volume
represents projects of a $1 million-or-greater value - i.e.,
almost solely commercial. Commercial transactions, while incurring
- 14 -
PAGENO="0604"
598
a lower-per-thousand--dollar premium rate than smaller residential
properties, obviously provide a higher premium per transaction. The
continued industrial expansion plus developments of multifamily
units and shopping centers is helping to sustain the title industry
this year as residential turnover remains depressed. Commercial
ventures require substantial reinsurance, which at present appears
available. With the commercial market expected to grow more rapidly
than the residential during this decade, the relative importance and
quest for industrial coverages will intensify among national title
insurance competitors. While increased commercial business will
take up some of the residential slack, the best medicine for the
industry would be the current administration's success in bringing
down both inflation and interest rates.
pp~~~tions and Outlook
As has been previously noted, the service of the title plant
represents the title insurer's principal cost. With one-third or
more of a carrier's personnel highly skilled, it is difficult to
contain and control expense. For most companies operating on a
national scale the next most important expense is commissions paid
to agents, abstracters, and lawyers. Because the title agent has
been squeezed by inflationary pressures, he has sought an increased
portion of the premium dollar, and in recent ~
have increased, with hen tionof the premium ained~ by agents~
~ ~ compared with 50 percent
in other areas of the country. Last year, expenses excluding
losses cost the industry over 95 percent of its operating revenues,
excluding investment income. The cost of claims ranges from 5
percent to 10 percent of premiums earned for most companies.
Because of the proliferation of new title plants, the lack of price
increases, and intensified competition, loss ratios are higher now
than those which prevailed prior to the 1970's, when loss ratios
rarely exceeded 5 percent. While the lowest cost title insurance
operation is often the one based on an established, well-maintained
title plant, companies which derive the bulk of their revenues from
underwriting policies issued by agents and abstracters in theory
have more stable margins. That is so because those companies do not
have such a large burden of fixed cost to carry when volume de-
clines.
Subject to the limitations on the usefulness of gross reve-
nue figures, which are dependent upon the form of service each car-
rier renders, the distribution mechanism it uses, and its own
accounting conventions, the table below ranks the companies reported
on individually in the next section by average statutory under-
writing margin over the past five years.
- 15 -
PAGENO="0605"
599
Leading Title Insurers
Ranked by Operating Ratios (Average)
Underwriting Margins
Company 1975-80 Average 1980 1979
1) Transamerica Title 10.9% -7.1% 10.4%
2) Western Title 10.0 -2.8 4.5
3) SAFECO Title 7.3 -1.6 5.8
4) First American Title 6.5 2.0 5.7
5) Stewart Title 4.5 -0.3 6.6
6) Commonwealth Land Title 4.1 0.1 2.4
7) Ticor 1.3 -12.6 2.9
8) Title Insurance of Minnesota 0.8 -~7.3 -0.1
9) Lawyers Title 0.7 -4.6 3.1
10) St. Paul Title -0.8 -12.0 2.4
11) Chicago Title -1.5 -15.7 -4.8
12) American Ti tle -4.4 -14.5 -0.4
Twelve Company Average 3.3% -6.3% 3.2%
Source: NAIC Forms $9.
A composite for the 63 title insurers listed starting on page
109 of this issue and representing the bulk of industry writings,
showed a statutory loss of over $50 million last year versus a
profit of about $50 million in 1979. Revenue results are further
summarized as follows:
63 Title Insurers
1980 vs 1979 Statutory Results
% Change
Premiums earned -9.3
Total revenues including
investment income -8.3
- 16 -
PAGENO="0606"
600
Most. carriers tried to bring expenses in line with lowered revenues
by reducing workforces, some by as much as 30 percent, closing
marginal offices, and delaying, at least temporarily, expansion
plans. Despite these efforts, operations were generally unprof it-
able, with the industry providing a net return on capital of only
about 3.7 percent.
While very few of the major carriers reported operational ia-
provement, the degree of operating deterioration reflects geographic
volume bias and operating method. Last year, the West Coast.,
Midwest and Nountain States fared worse than the Southeast and
Southwest. Also, carriers that operate on a direct basis rather
than through agents found it more difficult to reduce overall
expenses. Thus, carriers like Ticor, Transamerica, and Chicago
Title, which operate primarily on a direct basis and had a western
or midwestern orientation, showed the widest margin swings. This
year the trend has partially reversed itself, with the West Coast
recovering somewhat but the midwest and north central states re-
maining under pressure.
Volume this year is being bolstered by heavier commercial
activity, and at present it appears that premium volume will ap-
proach last year's with at most a 1-2 percent reduction. For full
year 1981, housing starts are expected to be about 1.2 million,
versus 1.3 and 1.8 million in 1980 and 1979, respectively. Sales of
existing homes are expected to remain at 1980's level of 2.9 mil-
lion, and rise to 3.5 million next year. While carriers continue to
attempt to hold staffs to minimal levels, inflationary pressures are
resulting in overall expense increases of 10 percent or more. Thus,
despite improved profitability from increased commercial business,
overall operational results are expected to deteriorate further in
1981.
Reflectin the current low rate . rovided by the title
~ many co pora~p~j~agagdop~atiomal
managements and one major carrier - from the field.
- s expected to seek increased mar et share
and greater economy of scale plus the realization by some holding
companies that title operations may not be syergistic with their
other activities, the industry's consolidation will continue and may
accelerate.
The reports which follow are based on management contacts with
the subject companies. Every effort is made to be sure that these
reports are reliable, but they caniiot he guaranteed as to accuracy,
Any opinions expressed are those of Philo Smith & Co. and are not
the responsibility of the companies' management.
- 17 -
PAGENO="0607"
601
Chairman GONZALEZ. Thank you, Mr. Elliott.
And if there is no objection, the exhibit that you provided on the
rate fees, closing agents, and so forth will be incorporated following
your prepared statement.
Well, I guess trying to get to the main thing here on the con-
trolled business-and this is for the panel-what opposition would
any or all of you have to permitting the savings and loans, for
example, and the reality companies to own service corporations
such as title agencies, but prohibiting these from referring their
clients to such agencies? Wouldn't such a requirement enhance
competition by permitting new entrants into the real estate settle-
ment process and perhaps avoid any potential conflict of interest
that there might be?
Mr. ELLIOTT. Mr. Chairman, I will take a crack at that first. I
think that the Congress has encouraged savings and loans to oper-
ate through service corporations. They, in fact, wanted the savings
and loans to acquire the profit opportunities that were going other-
wise to affiliated but not owned law firms, hazard insurance agen-
cies, and so forth. Congress enabled savings and loans to create
service corporations, and many of those were created by purchas-
ing from other entities.
I think that the appropriate solution with respect to regulating
financial institutions is not to have a blanket prohibition that they
can never sell anything to a customer of the parent. What should
happen is that they should never be permitted to tie in. There
should be adequate notice, and any coercion or unfairness should
be eliminated in the form of regulation of those institutions.
Dr. PLOTKIN. I think your question is an opportunity-at least on
my part-to make abundantly clear that I am much in favor of all
possible entry and competition within the insurance industry. And
to the extent that a savings and loan corporation, through its
service corp or a real estate broker, could become a competitive
force in the title industry, I think that would be definitely procom-
petitive and proconsumer.
However, if that operation is allowed to have an unfair advan-
tage in competition in terms of having, as the court in California
ruled, a secure source of business, namely the titles order that it
could direct to itself, it will have a deleterious effect on the supply
side of the market, its other competitors, as well as raise all of the
serious questions, ethical and conflict of interest that all of the
witnesses have been talking about.
Therefore, the essential element in preserving competition is not
to prohibit any participant in the real estate market from offering
a title insurance agency service or even title insurance underwriter
service, but only prohibit such a real estate professional from exer-
cising what, as a practical matter, is its inevitable power-very
fully documented-inevitable power to direct the business that
comes to it, as a real estate professional, into its own subsidiary.
So, if the law were amended as you state, I think that it would
be procompetitive without any problem. However, if the law were
amended so that it could direct its own controlled business into this
newly created subsidiary, it would be anticompetitive in every
dimension that has been considered here and also in every dimen-
PAGENO="0608"
602
sion that is generally discussed when the antitrust rules are looked
at.
Mr. CARMAN. Mr. Chairman, would you yield for just a moment?
Chairman GONZALEZ. Certainly.
Mr. CARMAN. Don't we find, Dr. Plotkin, that the regulations-
and I'm specifically thinking of the regulations promulgated by the
Federal Home Loan Bank Board dealing with conflicts of interest
at the present time-and off the top of my head, I would think,
also, the regulations coming out from the Federal Reserve, but I'm
not sure, because I'm not immediately familiar with those-would
tend to discourage this kind of tie-in, as it has been alluded to at
this point, because of the tremendous amount of leverage that the
various institutions have in controlling business and so forth,
either directly or indirectly?
And does it really necessitate further legislation when you real-
ize the tremendous amount of supervision that virtually every
financial institution in this country has with these various regula-
tory agencies? I mean, do we have to legislate more? Or don't we
have enough with the regulatory agencies now?
And we have an established public policy-but I think it extends
probably for the last 20 years anyway-that has discouraged this
kind of thing. In fact, we deal with members of the boards of
directors of these various institutions. And we have said we are
even concerned about them.
If you think back to just about 4 or 5 years ago anyway, when we
defined the so-called conflict of interest regulations, some of which
perhaps were well thought out and some of which perhaps were
not so well thought out, we made great efforts to avoid having
members of the boards of directors, for example, be in a position
where they might tie in with a person, for example, who might
have a lumberyard, trying to run some sort of tie-in with his
lumberyard and his activities as a member of the board of directors
of one of these institutions of a person who is a real estate broker.
And we have our examiners coming before these various institu-
tions and asking about and inquiring about the various examina-
tions they've done, what the affiliation is there, and so to promote
channels in how business is being unfairly treated.
Goodness knows, we have had enough experience with institu-
tions where this kind of thing has happened. And I'm thinking
back probably several years, to some instances we had out in the
California area, where we were concerned with some organized
crime elements involved in some of the problems that we have
there.
We're talking about reversing a trend, not being against competi-
tion because, goodness knows, I think all of us here are interested
in competition. But aren't there some inevitable problems that we
have been trying to avoid for at least 20 years that we should be
concerned about here?
Dr. PLOTKIN. If I understand the thrust of your question, the
answer is, yes, sir. The laws and regulations that you referred to,
issued by the Comptroller of the Currency or the Home Loan Bank
Board or the Fed, as they regulate various segments of the lending
industry, I think make it abundantly clear that no one may explic-
itly tie the granting of a loan to the acceptance of any particular
PAGENO="0609"
603
ancillary service from a particular provider, whether that particu-
lar provider is someone in whom the lender has an interest or not.
Mr. CARMAN. In fact, there might even be implicit as well as
explicit ties.
Dr. PLOTKIN. Indeed. However, it is not at all necessary for any
lender to make any explicit linkage or requirement to its granting
of credit to get almost complete acceptance of its ancillary service
provider by all the people applying to it. And earlier today, my
testimony pointed to extensive testimony in the State of Texas
where the lender seeking to create such an entity admitted by its
attorney, who not only represented it in the hearing but was it's
general counsel, admitted that should the lender desire to direct, to
steer, to control its borrowers to a particular vested interest provid-
er of ancillary services, it could do so in so numerous and subtle
ways as to deny or avoid any possible detection, it does not have to
link it explicitly.
Real estate broker after real estate broker testified that, as long
as they know a lender has a financial interest in a particular
ancillary service provider, they will always indicate voluntarily
and right up front on the loan application that they will select that
particular provider for that particular service so as to maximize
the chance of getting the loan.
Mr. CARMAN. You don't have to convince me; I believe it.
Dr. PLOTKIN. One of the best pieces of empirical evidence con-
cerns the city of Minneapolis, the headquarters of the Minnesota
Title Insurance Co., one of the largest underwriters in the country
and was the largest underwriter in Minneapolis. It, as might be
expected, got the lion's share of the business of the largest S. & L.
in Minneapolis. That would be the natural consequence of normal
business relationships. That S. & L. at one point obtained an own-
ership interest-whether it was 49 percent or 51 percent, I forget-
in a title agency. Within the course of a year-and you can see
these statistics month by month as the commitments ran out-the
vast bulk of the business of the, S. & L. was shifted from Minnesota
Title to this newly interested agency, who heretofore had only
gotten the most minor part of that S. & L.'s business.
I will find for you and present a letter from the president of
Minnesota Title detailing the statistics on a month-by-month basis.
I do not believe that in any particular case that a very large S. &
L. specifically tied its granting of a loan to acceptance by the other
party.
[The referred-to letter follows:]
85-396 0 - 81 - 39
PAGENO="0610"
604
i4~. TITLE INSURANCE COMPANY OF MINNESOTA
C. J. McCONVILL~ September 22, 1980
Dr. Irving Plotkin
Arthur D. Little Inc.
25 Acorn Park
Cambridge, Massachusetts 02140
Dear Mr. Plotkin:
You and I were discussing the effects of controlled business
recently and I mentioned what our recent experience had been
in Hennepin County of which Minneapolis is the county seat.
The largest savings and loan in the state is Twin City Federal
Savings and Loan Association (TCF) with over $2,000,000,000 in
assets. Approximately in March of 1979, TCF acquired a 52 per-
cent interest in a local title company, Northstar Abstract and
Title Company. Enclosed is an exhibit which shows the number
of mortgages that were recorded by TCF and the dramatic shift
in the business from ourselves to the controlled agent.
In April, 1979, we handled over 80 percent of this savings and
loan's mortgage business--either through abstracts or title in-
surance; Northstar had 12 percent. In the month of August, 1980,
those figures were more than reversed.. .Northstar had 83.3 per-
cent of their business while we had 9.8 percent.
I believe that this graphically illustrates how the ownership of
a title company by a savings and loan service company can have a
significant impact on the marketplace.
Best regards,
~
President
400 SECOND AVENUE SOUTH * MINNEAPOLIS, MINNESOTA 55401 * (612) 371~1 111
PAGENO="0611"
605
HENNEPIN COUNTY
TWIN CITY FEDERAL MORTGAGES RECORDED
Minn. Title Northstar
Minn. Title Northstar Total* Percentage* Percen~pgg~
April 1979 220 33 271 81.1 12.1
May 1979 193 81 294 65.6 27.5
June 1979 166 148 331 50.1 44.7
July 1979 175 208 399 43.8 52.1
August 1979 134 128 277 48.3 46.2
September 1979 82 101 198 41.4 51.0
October 1979 58 107 180 32.2 59.4
November 1979 76 168 250 30.4 67.2
December 1979 80 192 293 27.3 65.5
January 1980 65 173 263 24.7 65.7
February 1980 41 60 104 39.4 57.6
March 1980 15 65 83 18.0 78.3
April 1980 23 96 125 18.4 76.8
May 1980 13 80 98 13.2 81.6
June 1980 13 38 58 22.4 65.5
July 1980 10 24 37 27.0 64.8
August 1980 13 110 132 9.8 83.3
*These do not total 100 percent because a small percentage of the
business is handled by some of the other compeitors--there are a
total of 8 title companies doing business in Hennepin County.
Mr. CARMAN. You're absolutely right. And I don't think any-
body's going to quarrel with that.
Chairman GONZALEZ. Mr. Carman, if I could reclaim my time, I
do want to give an opportunity for the other panelists, since I also
directed the question to the other panelists.
Mr. CARMAN. Yes, sir.
Mr. COLLIER. Mr. Chairman, I think your suggestion is a fine one,
but I would caution you on two points-your suggestion being
simply outlawing the referrals to these entities.
Chairman GONZALEZ. I was just raising the question. I'm not
advancing the suggestion.
Mr. COLLIER. Your question presenting this as one possible way
of dealing with this problem.
My first point concerns the problem of proving that a referral
has occurred in this situation. It is important that some specific
indication be made, either in the statute or regulation, that set out
exactly what facts would give rise to a presumption that a referral
has occurred.
For example, if 30 or 40 percent of the business of the lender or
broker which owns the particular title insurance agency is handled
by that agency, is it fair, then, to presume that your referrals have
occurred, even if you can't prove that there has actually been a
direction by an employee to use this particular agency?
Chairman GONZALEZ. So it is reasonable to infer that what you
are saying to us is that the exclusionary power that Dr. Plotkin
refers to, would be legally difficult, to establish.
Mr. COLLIER. Yes; Mr. Chairman, referrals can be so subtle that
they are very difficult to prove in order to establish a violation.
Therefore, if you are going to consider that method of dealing with
this problem, I think you should specify when a presumption that a
referral has occurred would arise.
PAGENO="0612"
606
A second problem I would point out to you, as one who ran a
program for a short while where there were 40 or 50 violations or
potential violations of section 8 which were investigated in detail
by the Inspector General, many of those being referred to the
Justice Department that then decided that, although violations
were present, they would not be prosecuted because they did not
present, in the Justice Department's opinion, an issue with jury
appeal, is that you also need to create some kind of penalty that
would actually be a deterrent. The criminal penalty will not be a
deterrent to violations.
Chairman GONZALEZ. What about a suggestion that I have ad-
vanced for a son of Robinson-Patman Act? It would give the com-
petitors the civil capacity to sue and obtain redress and compensa-
tion for the disruptive competition.
I agree with you. I think the inadequacy and, up to now, the
failure of the criminal provisions make it clear that a self-regula-
tory type civil suit by a competitor would be perhaps a realistic
and justifiable measure.
Mr. COLLIER. Mr. Chairman, I think not only would that provide
a more effective deterrent, but I think it would also get the Justice
Department and MUD out of a situation which they shouldn't be
involved in in the first place.
Chairman GONZALEZ. Absolutely, and I would say, if the Con-
gress were to see fit to legislate along those lines, that it would
make it clear that MUD would be completely out of the picture.
Mr. COLLIER. I think they would appreciate that, Mr. Chairman.
Mr. CARMAN. Mr. Chairman, could I just make a comment in
regard to that?
Chairman GONZALEZ. Please proceed.
Mr. CARMAN. One of the problems that I think has happened
with that kind of approach is that it sometimes becomes a Fair
Employment Act for lawyers, and I would just allude to the fact
that Mr. Elliott showed us a form a few moments ago that looked
like a bill of lading, which he alluded to as being the truth-in-
lending form, to make sure that he complied with everything that
helps avoid class actions and other kinds of good things like that.
And I would point out that no matter how the thing is resolved,
that in the examination of these institutions, one of the probative
bits of information that examiners pick up is what percentage of
business has been going in a particular direction as information as
to what is happening and helping with the burden of proof in those
areas.
So I think it is certainly a comment that needs to be at least
thought of by the committee.
Chairman GONZALEZ. Certainly, it has to be.
Dr. Ford, do you have any comments.
Dr. FORD. As I remember, the question was, would we have any
problem, or do we have any problem with S. & L.'s and brokers
referring customers to their own agencies?
Chairman GONZALEZ. Not exactly, but what about a prohibition
against a company or agency referring its customers to its own
service subsidiary?
Dr. FORD. My own feeling is that as far as the consumers are
concerned, the issue is the price that they are paying for settle-
PAGENO="0613"
607
ment services. If controlled businesses are actually leading to
higher prices than noncontrolled business situations, then the con-
sumer is obviously in a worse situation than he would be if he were
not sent to a controlled business.
If, as both Mr. Elliott and I discussed, prices are high and high
enough to lead to excessive profits anyway at the agency level,
then in fact the controlled businesses don't really need to raise the
prices. And in that case, whether or not consumers are sent to
controlled businesses or to noncontrolled businesses becomes not an
issue of how well or badly they do, but in fact who ends up doing
the business. And then it just becomes a matter of who gets their
share of the pie, so to speak-the independents or the controlled
businesses.
Chairman GONZALEZ. Well, the thrust of the consideration of this
matter is whether or not there is an unneeded and unjustified
inflation factor, in the cost to the consumer and whether or not a
monopoly which might result from a controlled business arrange-
ment would eventually lead to unnecessarily high cost to the con-
sumer.
Doctor, you are the coauthor of an article that appeared in the
Federal Home Loan Bank Board Journal in June, and in it, you
have a statement saying, I quote now:
It may be unrealistic to believe that consumers will get fair value for their money
with respect to the tie-in business.
Now this seems contradictory to the statement you have given us
today.
Could you explain and also, if possible, provide some recommen-
dations on what is needed to overcome this problem of what you
referred to as reverse competition in the real estate settlement
market?
But am I correct that there is a conflict in the written article
and your statement?
Dr. FORD. I don't think so. And to be honest with you, I can't
remember what context that sentence came out of.
Chairman GONZALEZ. Well, I know that you were the coauthor,
and I know how those things are, and it may be that particular
section that you didn't coauthor.
Dr. FORD. I don't want to disclaim any responsibility yet.
Chairman GONZALEZ. Well, on page 3--
Dr. FORD. I'm sorry, I don't have a copy of it.
Chairman GONZALEZ. Well, our counsel here has his. It says:
The problem of institutions benefiting from their own referrals, a problem Con-
gress or HUD must eventually address directly, is that a controlled business rela-
tionship tends to create a situation in which one provider has an assured source of
business, regardless of the price or the quality of its services.
In such a situation, it may be unrealistic to believe that the consumers will get
fair value for their money. The problem of assured referrals is particularly acute in
the sale of title insurance, escrow, and cdnveyancing services because of the nature
of the market for those services and the complexity of the product.
Dr. FORD. I'm not sure that that is at odds with anything that
I've said today. I would like to make clear that I am not justifying
controlled business. I think that has become a narrowing of the
scope of these hearings down to simply the issue of controlled
business, especially when some of, us are not even sure how we are
defining controlled business.
PAGENO="0614"
608
This has taken the spotlight off of some broader things that
should be looked at. I am not sure that in these situations that a
consumer's interest would necessarily be looked at or that they
would be getting fair value for their money. But I am not sure that
they get it in noncontrolled situations either.
Now the issue of what should be done with regard to this is a
very complex problem, the whole issue of title agencies and title
attorney agents of controlled and noncontrolled business and that
type of thing.
My own feeling is that while I'm not sure that Mr. Elliott's
suggestion of the 30-percent commission limitation is the exact
number-and in the Peat, Marwick report, what we recommended
with regard to title insurance and conveyancing services was that
the State insurance commissions, who do have the responsibility
for regulating title insurance agents and the business, develop
some sort of a uniform title insurance regulatory act which would
help them set prices at some sort of realistic rate for this service.
And the idea was that since they have not taken an interest in
that up until this point, perhaps the Federal Government or HUD
could cause an interest in a uniform act and help them develop
one; let me put it that way.
Chairman GONZALEZ. That brings us back to something Mr. El-
liott referred to, when he quoted the language on page 12 of his
statement, referring to the House and Senate reports in 1974, with
respect to RESPA. And that particular underlined section: "To the
extent the payment is in excess of the reasonable value."
Well, the problem there is that there has been until now inter-
pretation of what should be considered no legal reasonable value.
This is the difficulty. And of course, as was well pointed out also by
Mr. Elliott, even if there was a willingness on the part of the
legislature to look at this problem, the idea that we would, on a
congressional level, attempt to regulate through price determina-
tions what is reasonable would, I think, be absolutely unrealistic.
Dr. FORD. That may well be. But that is, of course, the job of the
state insurance commissioners. That is their responsibility.
Chairman GONZALEZ. That's right. Which leads me to the ques-
tion I was going to ask Mr. Elliott.
As I understand, you recommend that, as an incentive for lend-
ers to package settlement services, they be exempt from the disclo-
sure requirements of RESPA. Now, while those requirements may
seem burdensome, of course, to the regulated parties, according to
the HUD study, 85 percent of the purchasers found the settlement
form useful; and 75 percent of purchasers who received the book
felt the information booklet to be helpful.
Now, given the complexity of the process, of the services and
costs, how do you justify eliminating disclosure requirements that,
according to this study, the consumers found it to be helpful?
Mr. ELLIOTT. Mr. Chairman, I think you raise a very good point. I
feel, throughout this hearing, that inadequate respect for the intel-
ligence and ability of the average consumer has been evidenced by
many witnesses. I think that that information given to the consum-
er is useful. I have heard people tell me it's useful. Since I original-
ly designed that form and wrote that booklet, I thought it was a
pretty good job, as well.
PAGENO="0615"
609
And I think those are useful requirements. I put forward the
idea of an exemption as an alternative to mandating lender pack-
aging throughout the country, and I suggested that some provisions
could be exempted. I think you could get by quite well without
truth in Lending. I'm not really in favor of eliminating the booklet.
I notice in the HUD report, if I remember correctly, that one of
the tables showed that even as to title insurance, 18 percent of
those surveyed shopped.
Now I think there is a great deal of validity as to what the
ALTA and Dr. Plotkin say, regarding the lack of shopping; but that
is not a 100-percent situation. And let's bear in mind this: The title
companies and title agencies are doing nothing to contact the
consumer directly. Why don't they run some ads in the real estate
sections? Well, one of the reasons they don't try to compete for the
consumer is they are unwilling to compete on price. And so, what
would you put in the ad? "We're good," I guess, "but we won't save
you any money."
I think that there is more ability to compete for the consumer's
attention than has been recognized by most of the witnesses and by
HUD and by the studies. One out of five is looking for title insur-
ance on his own-I think that was the number, 18 percent. That is
fairly high, given the fact that no one is approaching the consumer
and advertising for his attention.
But let me also say that in hazard insurance, if you were buying
a home and either the realtor~ or the lender said, "By the way, use
First Federal's service corporation. They've got a service corpora-
tion that sells fire insurance, so why don't you buy it there on your
new home," you can't seriously believe that 99 percent of the
American public would simply say "yes." I think half of them, at
least, would say, "Gee, I've got my own agent and I like their
service. I will provide my own policy."
So I think the degree of ability to compete varies with the
product. I think it is lower for title insurance; it's higher for hazard
insurance. But to lump these all together and say that the consum-
er never expresses any interest, and therefore the realtor, the
lender, or the attorney picks everything-I do not believe that,
based on my own personal experience.
Chairman GONZALEZ. Mr. Collier?
Mr. CARMAN. Mr. Chairman, could I just interject one thing?
Chairman GONZALEZ. Certainly.
Mr. CARMAN. It does occur to me, Mr. Elliott, in regard to your
commentary, that I think you are correct when you say that there
are places where the consumer has an interest. I don't think any-
body who has an awareness is going to quarrel with that, or say
100 percent of anything exists in~ this area.
But I would like to suggest to you that I don't believe-certainly
in the area of competition here-that many of the consumers un-
derstand the distinction between a mortgage title insurance policy
and a fee title insurance policy. So that, not withstanding the price
commentary which you made-which I think is appropriate-since
they don't understand the difference between the two of them,
perhaps it would be an illusory kind of an effort to advertise,
specifically, for that in the newspaper. And that may be one of the
major reasons we don't have any advertising.
PAGENO="0616"
610
Thank you, Mr. Chairman.
Mr. ELLIorr. Let me mention, Mr. Carman, that I'm not sure
that the differentiation in rates between mortgagee policies and
owner policies is justified, either.
Mr. CARMAN. That is something I will try to go into when the
chairman is done.
Chairman GONZALEZ. Well, I want to thank you again, and say
that we are particularly grateful to you two gentlemen, Mr. Collier
and Mr. Elliott, because you have served in an administrative
capacity at the time that the legislation was initiated and was
being implemented. I have always considered the Congress at fault,
in not doing more of this summoning back past administrators and
past Presidents, even Jimmy Carter, and benefiting from their
experience.
Mr. Collier, my question there is: Is there any evidence that
controlled business arrangements lead to higher or lower title in-
surance rates or property appraisal costs?
Any hard facts or studies that you might be aware of?
Mr. COLLIER. I would join in the frustration of a number of other
witnesses, in telling you that when I was trying to collect together
information in order to write the RESPA report, that I was unable
to find hard facts on the number of controlled business arrange-
ments, and hard facts on cost increases that may have been
brought about as a result of controlled business arrangements,
particularly in the title insurance area.
Having said that, though, I did receive some information. There
is-the subcommittee staff, in particular, ought to be aware of it-
there is a marvelous public record at HUD, in terms of submissions
that were made, public hearings that were held, and so forth,
where a lot of this information, I think, is lodged. I am at some-
what of a disadvantage because all I took with me when I left the
Department were my personal notes, Mr. Chairman. Thus, I will
give you my best recollections. But I'm not sure, and would suggest
that the staff please check the public record at HUD.
One situation I think has been referred to several times, al-
though it doesn't directly involve title insurance, it is the Coldwell,
Banker findings of fact by the administrative law judge from the
insurance commission in the State of California. These findings
include a review of the possibility of cost-related increases that
would arise because of controlled business arrangements, and make
some very specific findings, and some helpful findings in this area.
The only finding of actual cost increase, however, is the one that
deals with the escrow services. It is a finding that there has been a
significant increase over the sorts of other escrow service providers
in the area, by the Coldwell, Banker-controlled business escrow
service; and that the increase was to the extent of 150 percent.
Another situation that I am aware of deals with the State of
Pennsylvania, where there was a recent request for an increase in
the State title insurance rate, to be approved by the State commis-
sion. That increase several of the title insurance underwriters at-
tribute, in part, to the large increase of commission splits. I am
again referring to a similar problem, I think, that Mr. Elliott has
been referring to; and that is the amount of the commission premi-
um that is retained by the agent.
PAGENO="0617"
611
One of the harmful effects of controlled business arrangements is
that they give the local company, the agent, a large degree of
leverage in negotiating its premium with the title underwriters. If
he is able to negotiate a 60-percent or an 80-percent or a 90-percent
commission because he has tied up all of this business, then the
underwriter may, in turn, go to the insurance commission and
request a higher rate.
I understand that is the situation that at least some of the
underwriters in Pennsylvania believe is the cause of the recent
increase in rates in Pennsylvania.
Those are the only two specifics that I can recall, although I
believe that there are several others in the record of the Depart-
ment.
Chairman GONZALEZ. Thank you very much.
Dr. Plotkin, did you have a comment?
Dr. PLOTKIN. There was one other example that is precisely on
point, that the witness from New York State brought to the sub-
committee's attention yesterday. As a person involved in the actual
calculations set before the insurance department, I think I could
lend more specificity to his example.
There was a practice in New York State, which was only put an
end to by the Federal passage of section 8 of RESPA, of giving to
attorneys what has been styled by that witness as a 15-percent
procurement commission. The insurance department took great
umbrage at that, and refused to give the insurance industry any
rate increases as long as they paid that commission.
On the other hand, the legislature-which some say was con-
trolled by attorneys-I no longer live in Brooklyn, so I can't attest
to the truth or fallacy of that-but they refused to remoye the laws
until the day before RESPA became effective. And as soon as that
happened, papers were filed with the insurance department, as the
witness testified, lowering the rate by that 15-percent procurement
commission.
So, sometimes you can observe a phenomenon by observing the
reverse, where a controlled business situation or a kickback that is
analagous is removed. But, as the courts know, in antitrust work,
especially dealing with things of structural relations that tend to
impact price, it is the very rare exception that you will have
economic evidence directly on it.
But, looking at the evidence in a large number of States, the four
corners of the country, there is no evidence of controlled business
ever leading to a lower price; and there is both theoretical reason-
ing to suppose, as Dr. Ford's article clearly stated, as well as
anecdotal evidence to support the supposition, that controlled busi-
ness leads to a higher price.
Chairman GONZALEZ. Thank you very much.
Mr. Valanzano has reminded us that Coldwell, Banker explained
that the 150-percent comparison was against the lowest-cost provid-
er of the escrow service. And, according to Coidwell, Banker, their
prices were at the median level, in their explanation of that admin-
istrative law judge decision.
Mr. COLLIER. Mr. Chairman, that is not my recollection of the
reading of the opinion of the California court. I think I have it in
my briefcase. We could look it up and examine the exact language.
PAGENO="0618"
612
Chairman GONZALEZ. If I remember correctly, we had a copy of
that provided yesterday.
Well, what we're saying is that this was Coidwell, Banker's ex-
planation.
Mr. Elliott, I shut you off, I believe, in giving you an opportunity
to respond to that first question I asked of the entire panel, about
the controlled business.
Mr. ELLIOTT. The question was: What would be wrong with a
Federal law prohibiting the referral of customers to one's own
subsidiary?
And I started to say that, with respect to financial institutions
which are regulated, I thought there was a better conduit to avoid
any coersion or unfairness, namely, regulation. Well, I think there
are quite a number of other problems with it, as well.
For one thing, if Congress were to say that, for instance, the
savings and loan association could provide the loan-but not the
appraisal, and not the title insurance, and not the hazard insur-
ance, and not the notary, and not the preparation of the documents
all from the subsidiary-I guess it follows that the savings and loan
shouldn't have the parent do any of those things either.
In other words, what you're getting into is the federal law that
regulates the relationship between a parent and a subsidiary. And
most of those are wholly owned subsidiaries. And that is what I
pointed out in my testimony: That the antitrust division's policy is
very clear, that even price fixing is permitted between a parent
and a subsidiary. I think it is very hard to regulate there.
And it would follow that you ought to also say that a lender
shouldn't do itself what it can't do through a subsidiary, because
most of these financial institutions have accounting and tax on a
consolidated basis. The subsidiary is merely a corporate entity, and
whatever is done through the subsidiary is the same as though the
parent did it itself.
Another point in that regard is, I think that one should recognize
that there is a return on capital. Capital is invested in setting up
that subsidiary. Now, one shouldn't really say that an arrangement
where a subsidiary is providing appraisals, hazard insurance, and
whatever, earning a profit, that that is a kickback in the sense that
passing $100 under the table to someone who refers business to you
is a kickback.
So, I think that the parent-subsidiary situation is a very difficult
one in which to impose that kind of a prohibition.
I think the more appropriate congressional policy and govern-
mental policy is to prohibit tying-to prohibit coercion. It may be
that there is a market position of the referring entity, and a
considerable efficiency. It may be that they are a strong competi-
tor.
And let me make this final comment: I don't know what empiri-
cal evidence there is that controlled businesses might actually
bring down charges, but I would say that the realtors' commissions
are, by far and away, the largest charge in these transactions. If
you take 7 percent of a $200,000 house, a $14,000 commission is
quite a bit more than all of these items we're talking about.
I have the impression that if there is ever going to actually be
some competitive pressure on those commissions, it will come from
PAGENO="0619"
613
controlled businesses. It will come when a conglomerate sets up or
acquires a subsidiary to be a realtor, and then finds that, somehow
or another, they might do better with a 5-percent commission. And
I think there is the potential there to bring down some of these
fees.
Chairman GONZALEZ. Dr. Plotkin, has there been, to your knowl-
edge, a decrease in the average cost of title insurance between 1975
and 1979? And can that be attributed to the enactment of section 8
of RESPA, to increased competition, or to increases in real estate
prices that could result in lower average insurance rates per $1,000
of value?
Dr. PLOTKIN. I believe the most comprehensive finding in that
area was the one supplied by HUD, by some of the research done
by Peat, Marwick, Mitchell & Co. And while I may be wrong,
because I read this only over this weekend-that was the first
opportunity I had to see the HUD statement and the FIUD execu-
tive summary of its report-the report repeats what I believe was a
valid finding of Peat, Marwick, Mitchell & Co.-that title costs,
whether per transaction or in total, have gone down in real terms
since the passage of RESPA.
I believe the filed statement of the HUD witness said just the
reverse. But I further believe that its actual report, HUD's report,
as opposed to its statement, is in accord with the findings of Peat,
Marwick, Mitchell & Co.
I think under a situation of such massive inflation as we have
had since 1974, one has to talk about the real cost and not the
nominal cost. This does give me an opportunity, however, to com-
ment on a statement that has been made by two witnesses that
could be very badly misinterpreted.
It is quite true that the price of title insurance, as you stated, sir,
was related to the per $1,000 of house value or of mortgage in-
sured. However, unlike a realtor's commission, it is not a flat
percentage as there is a large fixed component in determining the
price of the title insurance product. So, in general, the price of title
insurance rises only 50 or 60 percent as fast as the inflation in
home prices or in the amount mOrtgaged.
And in the data that was referred to by Mr. Elliott from Philo
Smith, the data that Dr. Ford referred to, and the data that I have
been compiling for the last 8 or 9 years, it definitely shows that the
revenues of the title insurance underwriters have not kept pace
with the growth in their costs, so that many of them are experienc-
ing losses and financial difficulty.
I think in real terms that is correct. And that is what the HUD
study-not their statement, but the HUD report, as backed up by
the Peat, Marwick, Mitchell & Co. study-showed. But I don't want
to make that an absolute statement unless I can go back and check
my sources.
But further, it is very important to understand that title insur-
ance underwriters' or even agents' revenues do not rise as do real
estate commissions proportional to the increase in housing prices.
And the net result of the rise in their revenues versus the rise in
their costs has been to produce large losses in the latter half of the
seventies, not to increase profits.
Chairman GONZALEZ. Mr. Elliott, did you want to respond?
PAGENO="0620"
614
Mr. ELLIOTT. Mr. Chairman, on page 16 of the Philo Smith
report, it is interesting that it shows a decline in underwriting
margins, as they define them. And certainly Dr. Plotkin is correct
that they have moved toward losses, but I think that what is
missed here is the fact that in the period, say, 1975 to 1980, we've
gone from a very active housing economy to a very inactive one,
and this is a cyclical situation.
And the other thing is that in the cyclical situation, the title
insurance carriers have bid up these commissions and have moved
more and more in the direction of taking on loss business. The
Philo Smith report, in fact, says that we should expect that the
title insurance companies will now come into the State administra-
tors or regulators for higher commissions. It says now, with the
industry unprofitable, the carriers have become more united in
their desire for price adjustments and are more aggressively seek-
ing the same.
It also points out that there is some consolidation in the indus-
try. And it points out that some of the major title insurance
carriers are buying up some of the very large title agencies, the
independent agencies. So I think that what they are doing essen-
tially is getting ready for a better day. They would like to hit that
better market when pent-up demand is unleashed, with higher
premiums and with each of them maintaining their market posi-
tion.
I think that their earning situation should be considered in the
context of those factors.
Chairman GONZALEZ. Thank you very much.
I have additional questions that I will submit in writing for the
record, which you may answer later.
[The following additional written questions were submitted by
Chairman Gonzalez to the public witnesses, and appear with their
responses:]
QUESTION SUBMIrrED TO DR. FORD
Question. Yesterday there was extensive discussion about the extent to which the
Peat, Marwick & Mitchell study addressed the problems of the existence of referral
fees or gifts and of controlled businesses. As a member of the Peat, Marwick,
Mitchell & Co. team that worked on that study, would you clarify what restrictions
were placed on the study and what conclusions regarding these issues can reason-
ably be drawn from the data reviewed in the study?
Answer. The Peat, Marwick & Mitchell Company study had the use of two sets of
data-or information-on which the analysis and conclusions were based. One was
an extensive collection of settlement forms from across the nation that gave an
indication of varying charges nationwide, but, no information on industry practices.
The other information set was answers to questions which were posed to partici-
pants in the settlement industries in eight different settlement locations across the
nation.
The questionaire used for each industry group had to be cleared by the Office of
Management and Budget. They struck all questions which they believed did not
pertain directly to RESPA. Questions developed to determine ownership groups, tie-
ins, referral relationships and controlled business were never asked specifically of
each interviewer. The PMM & Co. study concluded that more information was
needed before controlled business should be prohibited. Further, it concluded that
such a prohibition would be a "band-aid solution" since so many tied relationships,
not involving ownership, would not be covered.
In no case should PMM & Co. study be used to either justify or condemn con-
trolled business. The information gathered gave no clue to the prices and quality of
service provided by controlled businesses versus independently owned agencies or
firms.
PAGENO="0621"
615
QUESTIONS SUBMITTED TO DR. FORD AND DR. PLOTKIN
Question 1. Yesterday the FTC submitted a report for the record that claims that
in a market characterized by imperfect consumer knowledge, tying arrangements,
contrary to traditional antitrust theories, may actually benefit consumers. Do you
agree that potential economic benefits resulting from tying arrangements could
apply to real estate settlement markets?
RESPONSE RECEIVED FROM DR. FORD
I do not believe that tied relationships benefit the consumer in real estate trans-
actions. Vertical integration has led to lower prices for consumers in some indus-
tries where the producer of a product acquires ownership of input materials. This is
not the case in real estate transfers where many services purchased are ancillary,
but not necessary, to the actual transaction. The ancillary nature of the services
combined with consumer ignorance has meant high, not low, charges in the past. I
see nothing to indicate this would change if controlled business became more
extensive.
RESPONSE RECEIVED FROM DR. PLOTKIN
No; not only do I not believe that there would be any potential economic benefits
resulting from tying arrangements (or their functional equivalent-controlled busi-
ness arrangements) in the real estate settlement market, but, as discussed below, I
do not believe that a fair reading Of the report submitted by the FTC witnesses
supports the position taken by the FTC witnesses at the hearing that such arrange-
ments may actually benefit consumers and should not be prohibited.'
The report submitted by the FTC witnesses, "Tying Requirements with Imperfect
Information-and Other Unfair Contracts" (Policy Planning Issues Paper, Septem-
ber 1981) was prepared by Richard Craswell and contains a specific disclaimer that
the views presented do not necessarily reflect the views of the FTC or the FTC
Bureaus. Nevertheless, by introducing the Craswell paper into the record, the FTC
witnesses presumably believe that the paper supports their position that the pay-
ment of kickbacks or the existence of controlled business arrangements in the
provision of real estate settlement services (such as title insurance) should not be
prohibited. After carefully studying the Craswell paper, I believe that its major
thrust and analysis argues strongly against the FTC position.2
The basic thrust of the Craswell paper is not to demonstrate that tying arrange-
ments in markets characterized by imperfect consumer knowledge may benefit
consumers. Rather, the purpose of the paper is to suggest that: (1) While the courts
have generally looked for the presenōe of classical antitrust monopoly or market
power in the tying product market before finding that a tie could be harmful,
certain tying arrangements may exist because the seller has "leverage" over the
buyer as a consequence of the buyer's imperfect knowledge (in other words, imper-
fect consumer knowledge may be a substitute for market power); and (2) if certain
essential conditions exist (i.e., the seller is operating in a vigorously competitive
market and the tie increases efficiency), in certain of these cases-but not even in
all of these cases-information-based remedies may be a better way to deal with
tying arrangements* resulting from imperfect consumer knowledge than a total
prohibition on such arrangements.
Whatever validity this analysis may have in general, the question is how this
analysis should be applied in the context of tie-ins, controlled business arrange-
ments, and kickbacks in the real estate settlement market.
With regard to the view expressed by Mr. Craswell that imperfect consumer
knowledge can provide sellers with the same kind of "leverage" over consumers as
is provided when the seller has monopoly or market power in the tying product, I
am in complete agreement. But that is only the first part of the analysis. Mr.
Craswell emphasized repeatedly throughout his paper that tie-ins involving imper-
`It is important to note that the position of the FTC witnesses was significantly different
from that advanced by the HUD witness. The HUD witness stated that if lender packaging was
not adopted, then RESPA Section 8 should be expanded to include all forms of controlled
business. The thrust of the FTC staff presentation was that Section 8 should be repealed in its
entirety.
2 Because I found the Craswell paper contradictory to the position expressed by the FTC
witnesses at the hearing, I checked with the Subcommittee staff to be certain that the Craswell
paper was in fact the report submitted by the FTC witnesses. In addition, I discussed my
understanding of this paper (as it related to the subject of the Subcommittee's hearing) with Mr.
Craswell, and I am sending Mr. Craswell a copy of this response.
PAGENO="0622"
616
fect consumer knowledge may not be harmful to consumers only if two conditions
apply:
"First, the seller (in our context the real estate broker, mortgage lender, or other
real estate professional participating in the controlled business arrangement) must
be in a vigorously competitive market so that `any profits from the tie will be
competed away and returned to the buyers in the form of a reduced price for the
tying product' (pp. 15-16 of the Craswell paper).
"Second, the tie must increase the efficiency of providing the various services so
that the seller realizes greater benefits than the costs borne by the buyer so `the
price-reduction will be a large one" (p. 16).
Craswell notes that "the fact that the market may be marked by imperfect
information does not avoid the necessity of evaluating the costs and benefits of the
specific tying arrangement being challenged" (p. 16). Later in the paper Craswell
reminds the reader "[t]he key question then is whether the amount sellers gain
from the contract clause [sale of the tied product] (and give back in the form of
lower prices) is greater or less than the amount consumers lose from that clause
[purchase of the tied product]" (p. 22). Craswell further warns, "[a]ll that the
analysis has suggested is that (given sufficient information costs) sellers will have
an incentive to adopt such clauses [tie-ins] regardless of whether their net effect is
good or bad. In these markets, the trade-off arrived at in equilibrium cannot be
presumed to reflect the most efficient result" (p. 23).
Finally, in discussing possible remedies to tying arrangements based on imperfect
information (pp. 43-56), Mr. Craswell does suggest that disclosure-type remedies
may be more desirable than a total prohibition in certain cases (i.e., where greater
disclosure can correct the information imbalance). But he does not suggest that
these remedies are the exclusive means of dealing with such tie-ins, even in markets
characterized by intense price competition: "Finally, having examined various infor-
mation-oriented remedies, it should be remarked that a flat prohibition of the
challenged practice may still be the superior remedy in individual cases" (p. 55).
In light of the above discussion, for the FTC witnesses to utilize Mr. Craswell's
paper in support of their position, they would have to demonstrate: (1) That those
who would impose tie-ins (or controlled business arrangements) in connection with
title insurance services-real estate brokers, mortgage lenders, and other real estate
professionals who have the ability to control the placement of title insurance
orders-operate in a vigorously competitive market and will compete away in the
price of their own services any profits they realize from such tie-ins; (2) that the
utilization of tie-ins (or controlled business arrangements) by such real estate profes-
sionals results in efficiencies of sufficient magnitude that the "price reduction [on
these professionals' own services] will be a large one and buyers should ultimately
benefit" (p. 16); and (3) that information-oriented remedies (i.e., providing greater
information to consumers about the tying arrangements) can effectively remedy the
information imbalance.
Not only have the FTC witnesses (or any other witnesses) been unable to demon-
strate that these three conditions are met with regard to tie-ins or controlled
business arrangements in the sale of title insurance, but the evidence adduced at
the hearings is quite to the contrary: (1) The evidence contained in the HUD Section
14 report and in the Peat, Marwick, Mitchell and Co. study is that such vigorous
competition does not exist in the markets in which such real estate professionals
operate. While the mortgage lending market may be relatively more competitive
than the market in which the other real estate professionals operate, Peat, Marwick
concluded that it "cannot now be determined" whether mortgage lenders are suffi-
ciently competitive as to ensure that they will pass on any savings to consumers (see
p. 111.12 of the PMM Revised Executive Summary); (2) there is no evidence that
real estate professionals (such as mortgage lenders or real estate brokers) can
realize any inherent efficiencies in providing title insurance services. Indeed, given
the differences in the nature of the capital resources and expertise required in
providing the different services, it is difficult to perceive how there can be any
inherent efficiencies; (3) the thrust of HUD's Section 14 report and the position of
the FTC witnesses is that the information imbalance consumers face with regard to
the purchase of settlement services cannot be overcome by information-oriented
remedies.
In sum, while the Craswell paper does conclude that remedies short of a total
prohibition may be desirable when dealing with certain tie-ins that result from
~ discussion of credit insurance abuses in the lending industry contained in my prepared
statement and in the numerous congressional hearings held on the topic referenced at p. 9 of
my statement is also relevant to the issue of whether lenders pass on the benefits they realize
from the sale of ancillary insurance products.
PAGENO="0623"
617
information imbalances (and in general I agree), the use of tie-ins or controlled
busEness arrangements in connection with the provision of title insurance services
are not the type of arrangements that would fall within the Craswell analysis.
Finally, two other important points should be noted about the Craswell paper.
First, the Craswell paper carefully notes that if the tying arrangement, even inad-
vertently, also produces an anticompetitive effect in the supply market for the tied
product (e.g., the market for title insurance services), then such cases are outside
the scope of the paper: "Tie-ins which also cause competitive injury, and which
therefore would justify demands that their effect on competitors be mitigated, are
beyond the scope of this paper" (p. 31). He agrees that such competitive injury may,
for instance, "reduce the competitive pressures for technical efficiency or for innova-
tion in that market, thus injuring the economy over the long run" (p. 6). However, it
is precisely this problem-the long-run competitive injury caused by the market
foreclosure inevitably produced by controlled business arrangements-that was the
focus of the hearings and that is the source of consumer harm emanating from
controlled business arrangments.
Second, in two subsections of his paper ("Efficiency in Product Selection" and
"Efficiency in Product Evaluation" on pp. 33 through 38), Craswell points out that
certain ties emanating from imperfect information may be beneficial to consumers
in that the seller is in a better position than the buyer to evaluate the appropriate-
ness or availability of an ancillary product and to determine the most cost-effective
producer of that product. Craswell carefully notes in two places, however, that there
is no need for tying, packaging or integrating this ancillary product with the seller's
principal product in order for the buyer to obtain the benefits of the seller's
knowledge and expertise. Rather, such tying is likely to have an unnecessarily
adverse competitive impact on the ancillary product market: "[a]gain, many of these
[product selection] benefits may be obtainable without actually requiring buyers to
agree to a tying arrangement" (p. 35). In footnote 54 at page 36, Craswell notes:
"In cases where tie-ins were believed to have injured competition in addition to
ensuring a tied product of adequate quality, sellers have often been found liable for
not having used this `less restrictive' requirement."
In summarizing his discussion on this point, Craswell states:
"As a final point, it should be noted that the benefits discussed in these last two
subsections-unlike effeciencies arising out of the production process, discussed
earlier-do not require that the tied products all be produced by the same seller.
The economies of selection and evaluation result from the seller's advantage in
monitoring quality and selecting an appropriate combination, not from any particu-
lar advantage in producing that combination. Integration would be required only
when the cost of monitoring the quality of independent firms' output is so high that
it is cheaper to control the quality ofthe good or service by directly controlling its
production" (p. 38, emphasis added).
The relevance of Craswell's observations on this point to the role of the real estate
professional in assisting the consumer in selecting a provider of title insurance
services is obvious. In the case of title insurance, real estate professionals have a
great information advantage over the consumer and are in an excellent position to
evaluate the prices and services of various title insurance service providers. Because
the cost incurred by these real estate professionals in monitoring the cost and
quality of services provided by independent title firms is so low, under Craswell's
analysis there would be no reason for the real estate professional to have to control
the production of title insurance in order to provide this service to the consumer.
In obtaining the disinterested advice of the real estate professional regarding
selection of a title insurance service provider, the consumer would be obtaining all
of the benefits cited by Craswell with none of the burdens or risks that his analysis
points out will be attendant upon the existence of a tying or controlled business
relationship between real estate professionals and title insurance service providers.
However, if allowed to profit from the consumers' ignorance, real estate profes-
sionals will fail to provide the real consumer benefits of a disinterested but highly
informed selector of title insurance. In addition, as Craswell's analysis also suggests,
by foreclosing any meaningful competition within the title insurance industry,
controlled business arrangements will lead to a long-run diminution of consumer
welfare.
The Craswell paper supports the analysis articulated above and not the position
advocated by the FTC witnesses. Finally, I would note that if it is taken to support
the position advanced by the FTC witness (which extended not only to controlled
business, but also to kickbacks, and not only to lenders, but to all participants in
the real estate market, including brokers and attorneys), the analysis then would
have to support the practice of physicians' getting kickbacks from medical laborato-
PAGENO="0624"
618
ries and other such manifestly antisocial arrangements. Such conclusions are not
supported by good economic analysis.
Question 2. If the key source of competition in the real estate settlement market
as it presently exists is between the subsidiary service providers competing for
business referred by real estate agents and lenders, will encouraging controlled
business relastionships or lender packaging enhance or reduce competition?
RESPONSE RECEIVED FROM DR. FORD
I do not believe that controlled business, whether it is owned by real estate agents
or lenders, will lead to lower prices or better service for consumers. There is no
doubt that lender packaging will lead to lender owned service providers. However,
prices of services may be used to supplement profits rather than lower consumer
costs.
RESPONSE RECEIVED FROM DR. PLOTKIN
It will reduce competition.
Owing to imperfect information and the cost and difficulty of obtaining complete
information, residential home buyers and sellers generally rely on real estate pro-
fessionals (brokers, attorneys, or lenders) to select for them providers of ancillary
services, including title insurance. Hence, competition in the provision of title
insurance is, indeed, frequently focused on obtaining the business referred by real
estate professionals. For all practical purposes (and this has been documented on
numerous occasions, including the testimony of witnesses at the hearing and the
data presented in my testimony), as soon as a real estate professional establishes a
controlled business entity, all competition by independent title agents or underwrit-
ers' branch operations for the business controlled by that professional ceases. These
competitors know better than to waste their time knocking their heads against a
stone wall. Hence, there can be no dispute that, once a controlled business relation-
ship is established, that segment of the market is foreclosed from competition by
individual title agents or underwriters' branch operations. While the business con-
trolled by a single real estate professional may not represent a significant part of
the market, as more and more real estate professionals establish controlled business
arrangements, an even greater portion of the market is foreclosed from competition.
The same is true under a lender packaging scheme if that scheme permits the
establishment of a controlled business agency by the lender. Lender packaging,
however, which forbids the creation of a controlled business entity may not have
this deleterious effect on competition. Economic reasoning does not suggest the
likelihood of this deleterious effect in the absence of controlled business. There is no
real world experience, however, on which to confirm or deny this economic reason-
ing. It is appropriate, also, to note that the general case for the efficacy of lender
packaging has not been made. As I noted in my answer to the previous question, the
Craswell paper clearly indicates that when the seller is merely providing his exper-
tise in terms of selecting the best suppliers of an ancillary product, there is no
justification for packaging, especially if such packaging might have an adverse
competitive impact on the ancillary product market.
Accordingly, my answer to your question is yes. Because the question's premise is
correct with respect to the key source of competition, controlled business on its own
or lender packaging including controlled business will foreclose all hope of meaning-
ful competition, ultimately leading to a lack of competitive vitality in the supply
market for title insurance. I would again reiterate that my position is not based
solely on economic reasoning. The question could be easily rephrased with respect to
credit insurance rather than settlement services. I believe the record is abundantly
clear that the ability of lenders to package credit insurance and, also, to establish
controlled entities, which allow them to profit from the sale of credit insurance, has
been severely detrimental to competition in that ancillary product. At the same
time, I believe, there has been no showing at all that consumers have benefitted
from the remarkable profts that lenders have been able to earn on credit insurance.
All the evidence presented to the numerous congressional hearings strongly argues
the reverse.
Question 3. Wouldn't the requirement that lenders package settlement costs tend
to encourage the development of more controlled business relationships between
lenders and their wholly or partially-owned subsidiaries, leading eventually to an
exclusion from the total settlement process of independent title insurers, mortgage
insurers, and other subsidiary service providers?
PAGENO="0625"
619
RESPONSE RECEIVED FROM DR. FORD
Whether a lender or a group of lenders would establish settlement service provid-
ers, would depend on the loan volume available for referrals. Undoubtedly some
lenders would establish subsidiaries. To the extent that occurs, independent agents
and underwriter branches would be affected adversely. Whether or not such an
effect should be viewed as undesirable depends on the ultimate effect on the con-
sumer. If prices are already high, this effect may be negligible.
RESPONSE RECEIVED FROM DR. PLOTKIN
Yes; as put forwared by HUD, the lender packaging scheme would permit them as
a matter of law to establish controlled business entities. Further, the scheme would
be a very strong motivating force that would ensure the rapid spread of controlled
business entities throughout the lending market. This would inevitably lead to the
exclusion of independent title insurance agencies, direct branch operations of title
underwriters, and similar independent providers of other ancillary services from the
entire market.
As I recall from the two days of hearings, a number of your Subcommittee
members, based on their own business experience, suggested that lender packaging
would ultimately lead to the death of independent providers. It defies all common
sense to suggest that independent providers of ancillary services would have a fair
or equal opportunity to compete for business generated and directed by the lenders.
One lesson from all the data is clear. When a real estate professional, can benefit
financially from his (almost inevitable) selection of the provider of an ancillary
product, competition and its benefits for consumers will be harmed.
Chairman GONZALEZ. Mr. Carman?
Mr. CARMAN. Thank you, Mr. Chairman.
First of all, I would like to thank each one of the members of the
panel for being so patient and staying here and listening to these
questions. But I think the chairman has raised some very, very
good points.
I would like to specifically compliment Dr. Plotkin for some of
the comments he's made, specifically in regard to rate structures
and how they work.
I think you, Dr. Ford, pointed out that really this is the responsi-
bility, as a general proposition, of the insurance departments in the
various States. We all know that, I think, from a national point of
view, some of the insurance departments are weaker; some of them
are stronger. That is something that will continue, I suspect, for as
long as we have human beings running them.
I would comment in regard to a couple of things.
Mr. Elliott, I do have grave concern as to whether we should as a
general proposition decide upon 30 percent, 40 percent, or any
particular number, as I understood you to say, pertaining to what
increases should be or not. I think really that has to be defined, if
you will, by actuarial approaches run through the various insur-
ance departments as opposed to what I would consider to be trying
to legislate an economic result.
I suspect that perhaps even you do not disagree with that ap-
proach, and it really is something that has to be done actuarially,
but I would be extremely reluctant to see the Federal Government
or a State government without that kind of actuarial approach to
go after-and that is notwithstanding that in many cases there are
those, including myself, certainly in this area, who would maintain
that perhaps the rate structure could effectively be lowered, but I
don't think it should be done legislative fiat, by a legislative body. I
think it is an administrative problem. That has to be done. And I
presume you don't disagree with that.
85-396 0 - 81 -
PAGENO="0626"
620
Mr. ELLIOTT. I would under no circumstance suggest that the
U.S. Congress get into the issue of what those rate levels should be.
They should be regulated by the States. Nor am I saying that the
premiums themselves should be reduced to 30 percent of where
they are.
What I am saying is this: I think those State insurance commis-
sioners should determine that whatever the rates are, even if they
are kept where they are, that approximately 30 percent or less is a
sufficient commission to the title agent.
And as far as actuarial analysis, I don't think that is relevant to
that commission because the agent bears no actuarial risk. He fills
out the forms. The carrier bears the risk.
Mr. CARMAN. Mr. Elliott, I would suggest to you that I under-
stand your position in regard to that. I think again we are dealing
with something that is involved with economics, and maybe it
should be 30 percent; maybe it should be 10 percent; maybe it
should be 50 percent. But I think that from my vantage point
anyway, I get very, very concerned-and I realize we are dealing
with a regulated industry-but I get very concerned whenever
government is regulating anything to do with economics, as long as
we have a fair economic situation.
Mr. ELLIOTT. Perhaps the rates should be deregulated. As long as
they are regulated--
Mr. CARMAN. Well, that's a whole `nother proposition.
I would like to comment in regard to something else. I under-
stood you to say, sir-and that pertains to whether or not we could
effect a reduction in the cost to the consumers by having controlled
business deal in that area. I understood you to say that-I believe
you used Merrill Lynch as your example-but regardless of what
company or what corporation or what particular area you are
dealing with, if they were to move into the market and controlled
services, it occurs to me, if we had more and more controlled
services, we might lower real estate commissions or other costs and
so forth.
It occurs to me that indeed you may be correct in indicating that
if we had a number of businesses or smaller numbers of groups in
here that would be able to come into a given area, that you could
secure a control as we squeezed out competition in other areas. But
it occurs to me, that would only be a short-run type of thing, and
in the long run, after they had gotten control of these businesses
and they had run the whole show in there-and the competition
was totally squeezed out, that in the long run, ultimately because
they have control, we might end up increasing things, and you
would almost end up with a monopolistic approach, which I don't
think would be something that would be a desirable result.
Mr. ELLIOTT. That would be a classic monopoly scenario where
the prices are pushed down by someone with a deep pocket who
pushes everyone else out of the business, and then they are pushed
up to monopolistic levels.
Now again, it is very hard to apply any model to every county in
every State in this country. A lot of different things can happen.
I do think that there is potential for increased competition in the
controlled business setting. I recognize objectively that there are
other settings where the horror stories could occur of monopoliza-
PAGENO="0627"
621
tion and people being squeezed out. Here, again, I think our anti-
trust laws deal best with this, not a revision of section 8 of RESPA.
Mr. CARMAN. I would suggest to you that, again looking at espe-
cially this particular field, which is, notwithstanding anything else
anybody else says, a specialized field where a certain degree of
sophistication and understanding obviously has to and is something
that exists, that as long as the consumer, as we referred to before,
has difficulty understanding what a mortgage is, as you well know,
or what even a bond or a note is, much less a contract-and that's
the reason, I guess, they send people to law school to master those
things, as you well know, sinėe you are a lawyer-I'm suggesting
that since we are dealing in a technical field, that there is certain-
ly a place for government to be aware of abuses that exist and that
those things should be corrected.
On the other hand, I think that the Federal Government and,
indeed, the State governments have to be extremely chary as to the
involvement as it is worked out here. I think that that bill of
lading that you showed us, referred to as the truth-in-lending form
which extended for three sheets, is a remarkable example of what
kind of anomalies can result by overregulation that sometimes
causes remarkably peculiar results and unhappy results for the
consumers and for the industry, as well as for government.
I was interested in a comment also that you made, Mr. Elliott,
pertaining to perhaps exempting, if I understood you properly, the
various institutions from truth-in-lending requirements and
RESPA requirements.
Mr. ELLIOTT. If they implemented HUD's proposal without being
told by the Congress to do so. That was a thought that I had.
Mr. CARMAN. First of all, I would presume that you would
gather, from my vantage point anyway, that RESPA could go the
way of the past historical event, insofar as I am concerned. But I
would be inclined to think that there were certain parts of the
truth-in-lending legislation that have been beneficial-not what
you showed us, because I think what you showed us is a remark-
able example of a document calculated not to give disclosure to
anything or anybody except possibly how lawyers could start class
actions against you in case you had it in the wrong form or the
wrong pica of print.
But that is a special type of abuse that exists, that you know
about and I think that the various members of the panel know
about. But I would point out, there have been certain ideas or
certain things that have come out of the truth-in-lending law per-
taining to real estate transactions. If nothing else, it lets people
know the total amount of interest they're going to pay over the 25
or 30-year period of the loan, which, indeed, is more than the
original amount of the loan that they have worked out. In other
words, they would pay well in excess of the principal amount of the
loan over the 25-year period, which came to many, many people as
a great shock, including, believe it or not, in my humble opinion,
some of the people who actually closed the loans.
Mr. ELLIOTT. Why not combine the two forms? Why not have in
the same 3 days after the loan application, the truth-in-lending
form and the loan disclosure on two separate pieces of paper? It
doesn't make any sense.
PAGENO="0628"
622
Mr. CARMAN. Mr. Elliott, you have no quarrel with me. I'm
brand new here, and it took me awhile to get here. That is why I
wasn't here when they put the RESPA thing together. I was one of
those guys who was the victim of it and some of these other things,
from another vantage point.
But what I'm suggesting to you at this point is that, as we
embark upon these new proposals, these new suggestions, I am
inclined to think that at the present time, not only have these
regulations-and not only these pieces of legislation that have been
implemented here-caused tremendous havoc in the industry, but I
believe that we are embarking upon a period of time right now
which is even more difficult, because I perceive that there are
those in the Federal Government, in and out of this field, who will
think that housing perhaps has had too much of a share of the
gross national product. And now, unless we are very careful from a
governmental point of view, we will be more effective in having a
greater deemphasis on the ability of housing to develop in this
Nation-a happenstance which I regard to be extremely unfortu-
nate and something that I am very, very concerned about. In fact, I
would suggest to you, at this point I regard our housing problems
to be in a crisis state, and I think with a little bit of effort, we
could bring it into a castrophic state within about 4 years.
Mr. ELLIOTT. I agree with you on that.
Mr. CARMAN. I bet you do. And I am saying as far as much of
this legislation is concerned, all we have done really effectively is
we have developed through RESPA a form that is designed to tell
people, perhaps, if they could understand it, on both sheets, what
happened to them after the fact-which is incredible. And we have
done the same through the truth-in-lending form. And I am going
to ask you if you would, if you would be willing to, to submit that
form that you just showed us for the record.
Mr. ELLIOTT. I will delete the name of the client and submit it.
[The referred-to form follows:]
PAGENO="0629"
623
~~,.-Mortgage Company
Purchase Loan
Secured by First
Lien on Dwelling
Federal Disclosure Statement
for Loan Secured by Real Property
Date of Disclosure: July 1, 1981
Borrowers: :11:11;-
Address: 5301 1~thsrd ~zcle 4239
~, ~xyIa~1 20016
The FINANCE CHARGE* will begin to accrue on J~y 10, 1981
Principal Amount of Mortgage Loan $ 35,000.00
Items Included in Prepaid FINANCE CHARGE*:
(1) Loan Origination Fee (Buyer) $ 350.00
(2) Loan Discount Fee (Seller) $ 350.00
(3) Mortgage Insurance Premium $
(4) FNMA Review Fee $
(5) Advance Daily Interest (from date of
settlement to 30 clay estiirate
at a per diem rate of $ ) $
(6) $
Prepaid FINANCE CHARGE* $ 1064.58
Amount Financed $ 33,935.42
ANNUAL PERCENTAGE RATE* 12.930
Items Included in FINANCE CHARGE*:
(1) Total Prepaid FINANCE CHARGE* $ 1064.50
(2) Mortgage Insurance Premiums Not Prepaid $
(3) Interest Not Prepaid $ ~~474.40
(4) $
FINANCE CHARGE* $ 100,538.98
Charges Not Included in FINANCE CNARGE*:
(1) Appraisal Fee ( 50.00
(2) Credit Report 21.00
(3) Settlement Fee $ 50.00
(4) Title Examination $ ns.oo (e)
(5) Title Binder $ 7.50 (e)
(6) Document Preparation 5 35.00
(7) Notary Fees $ 4.00 (e)
(8) Title Insurance $ 3~O0 (e)
(9) Recording of Deed $ 14.00 (e)
(10) Recording of Deed of Trust $ 9.00 (~)
(11) Recordation Tax $ (e)
(12) State Transfer Tax $262.30 (e)
(13) County Transfer Tax $ 524.60 (e)
(14) State Tax Stamps $~o.B2 (e)
(15) Survey $ (e)
(16) $
(17) $
(18) $
(19) $
(20) $
Note: Those charges which are estimated in amount
are followed by the letter "e" in parenthesis.
PAGENO="0630"
624
Mortgage Insurance:
The loan [~i~ [is not] to be insured by private mortgage insurance.
Payment Terms:
Borrowers obligate themselves to pay the principal plus interest in333
monthly installments. The monthly installments of principal and interest
will initially be $ ~73.~4 . The first monthly installment will be
due on August 1, 1981, with subsequent installments due on the first day
of each month thereafter.
If it is stated above that the loan is to be insured by private mortgage
insurance, also due with the first monthly installments
are additional amounts of mortgage insurance premiums. These additional
amounts will range from an estimated ~/A payable with the first
monthly installment to an estimated $ N/A payable with the
installment. The Total of Payments will be $ (the sum of the
principal, the interest and the mortgage insurance premiums).
Variable Interest Rate:
The interest rate on this loan may change, resulting in a change in the
ANNUAL PERCENTAGE RATE*. The interest rate may only be changed on the
"Change Dates" which occur every three years commencing July 1, 1984.
Any increase in the interest rate will result in an increased payment amount.
Hypothetically, if the interest rate were 1/4 of 1% higher as of the date
the loan is made, your regular monthly payment would be increased commencing
~ Sc~mbmr1 , by $ 6.'O so that the payment would be $ 380.34.
A change in interest rate will occur if there is a change in a specified
index (the "Index"). The Index is the weighted average rate (rounded to
the nearest one-eighth of one percent) announced by the Federal Home Loan
Mortgage Corporation (or any successor to it) for its whole loan auction
to purchase conventional one to four family mortgages with delivery in 60
days, or the shortest other period for such an auction if the 60 day period
is altered ("FHLMC Auction"). However, as to any Change Date, if no FHLMC
Auction is held during the thirty (30) days preceding the twentieth day of
April before that Change Date, the Index for that Change Date only shall be
the "Contract Interest Rate, Purchase of Previously Occupied Homes, National
Average for all Major Types of Lenders" (rounded to the nearest one-eighth
of one percent) published by the Federal Home Loan Bank Board (or any
successor to it), provided that such figure is published for the month of
March preceding the Change Date not later than the twentieth day of April
preceding the Change Date, and if such publication is not made for the
previous month on or before the twentieth day of April preceding the
Change Date, then the Note Holder will set the Note interest rate by using a
comparable national index (rounded to the nearest one-eighth of one percent).
IX~ I~3\SE OR DI tERSE t~L ~ 3% CS' PDIVIDI~ R1~IE ~ 5% (F D~TThL PR~IE.
Lender's Security Interest:
Lender's security interest is a first lien on the property located at
5301 Westbard Circle, The Kenwood Condominium, Apartment Nurnber239
Bethesda, Maryland 20016, and covers after-acquired property and future
advances as set forth in the security agreement.
Delinquency Charges:
Borrowers shall pay to Lender a late charge of five (5) percent of any
monthly installment of principal and interest not received by Lender within
fifteen (15) days after the installment is due.
Prepayment Conditions:
There is no penalty for prepayment, and the borrowers may repay the loan
in whole or in part at any time. A partial prepayment will not delay due
dates of monthly payments, but will reduce the~amount of monthly payments
after the next "Change Date."
PAGENO="0631"
625
Rebate of Unearned FINANCE CHARGE*: -
If it~ is stated above that the loan is to be insured by a private mortgage
insurer, then in the event this loan is prepaid in full, Borrowers will
receive a rebate of unearned FINANCE CHARGE* computed according to the
private mortgage insurance company's short rate cancellation schedule. If
the loan is not to be insured by a private mortgage insurer, then there
shall be no rebate of any finance charge in the event of prepayment in full.
In the event that this loan is accelerated upon default, Borrowers will
not receive any rebate of unearned FINANCE CHARGE*.
Property Insurance:
Because Borrowers are purchasing a condominium unit, Borrower's share of the
condominium master hazard insurance policy is reflected in the Declaration,
Bylaws and other documents relating to the condominium. No additional
property insurance is required.
Other Insurance:
Credit life, mortgage life, or accident, health or loss of income insurance
is not *equired to obtain this loan.
The undersigned Borrowers hereby acknowledge that this loan is to finance
the purchase of real property which Borrowers intend to use as their principal
residence. They further acknowledge receipt of this Disclosure Statement on
the date hereof.
_________________________________________ July 13, l9Fl
Date
Signature of Borrower~-j~ -~
Signature of Borrower
Date
This Disclosure Statement must be properly signed, dated and returned to
Lender's office.
* Note: The use of the "*" in this Disclosure Statement is solely to
make the underlined words before the ~*" conspicuous.
Chairman GONZALEZ. But that form has been discontinued.
Mr. ELLIOTT. I found I couldn't even use the new short form after
the new law, because my client wasn't able to get the form out 3
days after the loan application, and once you don't do that, you are
under the old law, because there is no way to comply with the new
law.
Mr. CARMAN. And what is interesting in regard to it-and let the
record reflect that there is a note of laughter in regard to this.
Even though there is a sense of humor in these matters, it really
borders upon the tragic, the tragedy side of it, and it is understand-
able how we could all laugh with frustration. And I join in that
laughter of frustration.
But I also join in the very real concerns, in this way, and that is
that it inhibits lenders from becoming involved in real property
transactions, when we are now witnessing a whole changeover in
our financial establishment, moving from the traditional lenders
who have been involved in real property transactions toward an
integrated banking system; this system contemplates, I believe,
that savings and loan associations and savings banks and those
lenders who have been traditionally involved in the real property
mortgage area, will be shifting their emphasis more and more so
that ultimately the portfolios of these institutions will be about 40
to 45 percent, maybe, in the real estate area, and the commercial
institutions may be coming into that area, too.
PAGENO="0632"
626
They will also be dealing with, maybe, the balance of them, in
commercial types of transactions, and perhaps if we really work at
it hard enough by making it difficult to lend in the real estate
field, with the various regulations and so forth that we are talking
about here, we might even be successful in deemphasizing further,
which would be a very unhappy result, the amount of money that
is available for real estate, for single-family dwellings as well as
multiple dwellings.
And the reason I am mentioning these things is because, certain-
ly, as the chairman has so properly pointed out, it is a good thing
for us, I believe, in this committee and this subcommittee, to hear
from those of you who have been involved in preparing some of
these regulations that have had some good results in some cases,
and I believe dismal results in others.
And I think now it is very, very important that this area have its
house properly put in order as quickly as possible. I think some-
thing else that needs to be discussed, and I think it is a very
important concept-it is the term "kickback." "Kickback" immedi-
ately connotes some sort of a nefarious type of a fee, which can be
criminal in nature, but certainly under-the-table, bad news type of
a thing.
I am not against at all, under any circumstances, disclosure so
people know what is going on. In fact, I am in favor of full disclo-
sure. But I do believe that somewhere there are economic services
that are rendered, and where those economic services are valid and
are rendered, and without a fee attached to them they will not be
rendered, that sometimes the public doesn't always come out even;
in other words, sometimes we just always end up with a very bad
result, and ultimately maybe sometimes with bad producers.
And I think that extends-although, to the best of my recollec-
tion, section 8 avoids referral to this-but I even referred to a
finder's fee in a commercial transaction, which could be perceived
as, in the context of these overall items here, as a kickback. And I
think that is something that, even though I believe it is exempt,
from my recollection of it off the top of my head, I think that is
something that we also have to look to very carefully before we
finally determine what legislation ultimately we will work on.
Mr. ELLIOTT. I think the specific section 8 was intended to cover
a $100 payment from someone to someone. I don't think, frankly,
that Congress had in mind attacking dividends and return on
capital, subsidiaries, et cetera. I think Mr. Collier and Dr. Plotkin
might disagree with me. And we will allow Dr. Plotkin to be a
lawyer for that purpose. Maybe Dr. Ford would also disagree with
me. But I do not think that it was intended to cover the parent-
subsidiary situation. I think that would require legislation.
I agree with you in general that I am very worried about what is
going to happen in the next few years. I think the predominant
thinking of many of the outstanding economists influencing the
administration is that housing is consumption, and that too much
of our resources have gone into it, and that we need to reindustria-
lize.
Mr. CARMAN. Let me just say, Mr. Elliott, that I don't think this
applies to just the present administration-it is the last adminis-
tration as well-I mean, it is not something that is new. That's
PAGENO="0633"
627
when the last legislation got passed, and I think that is when this
whole thing, following it historically, at least, from the Hunt Com-
mission report going back to 1970-found its implementation not in
this Congress but in the last Congress, and we are just following
the natural flow.
Mr. ELLIOTT. I think there is also some considerable validity to
the view of Anthony Downes and others on this, that we are a
country that is getting behind industrially, but what are we going
to do?
Now, let me bring it down to your specific comment, Mr.
Carman. You mentioned two areas that concern me right now. You
were saying essentially that if we also make mortgage lending for
the average family unattractive, then we free all these institutions
to be bankers. What is going to become of the supply of money to
housing? I think that is a very valid consideration.
Now, I do think that most of these consumer laws have gotten
down to the level not of chaos, but of mild pain, and mild cost. And
most lenders will tell you that-
We can deal with that; it's not really a problem anymore. TIL is more of a
problem, but still, we know how to deal with that, too.
But you ;arč adding layers of cost that are passed on to the
consumer, and I do think there are problems in terms of two areas
right now that deserve focus.
Mr. CARMAN. Before you do that, I want to just take issue with
something that I just understood you to say. First of all, the cost
element, in the sense of typing up a form, in many cases, can be
absorbed by the institution. The class actions that we alluded to
before because of what you did in regard to your truth-in-lending
form, which you are going to submit to us, show a tremendous
burden where an institution can actually be devastated in regard
to it. They are not de minimus costs. They actually add to the time
of a closing.
Mr. ELLIOTT. I don't think they are de minimus. I think they are
now within control, but they are not de minimus.
Mr. CARMAN. It depends upon your point of view, because who is
making the payment for that? Right now we have-is it the con-
sumer or the institution who is paying for it? And therefore, the
consumer is paying for it, directly or indirectly, for a form, for
example, in regard to RESPA, to tell him, maybe, what happened
to him-assuming he is smart enough or his lawyer is smart
enough to figure out what that form is all about. And I think that
is a ludicrous example of how not to regulate.
Mr. ELLIOTT. I agree with you. I have been involved in this ever
since 1969, when I started designing the FHLMC standard form of
mortgage. And yet, the last time I bought a house, I found the
closing to be very confusing. I agree with you; there are just too
many forms and too many local and Federal requirements.
Let me just note these two questions for you. One, I am con-
cerned about commitment practices in this country. I am concerned
that people are getting hurt between the time of contract and the
time of closing.
Two, I am concerned about variable rate loans. I think they are
basically a good idea, but I am very concerned about how the
consumer figures out what he is getting. And I don't think Federal
PAGENO="0634"
628
forms of notice help very much. I have tried to apply them to
specific situations. And it is hard to take, for instance, the Federal
Home Loan Bank Board form of notice that you have to give, adopt
it to your case, and think you can come up with something the
consumer is going to understand.
I think that commitment area and the explanation of what an
adjustable rate loan is are two areas that need a lot of further
attention.
Mr. CARMAN. First of all, I agree with you, obviously, and I
would indicate to you that this is another reason why I think it is
necessary for this committee and for the Congress to recognize that
there is a limit as to how much we can do in regulating this whole
area.
There is no question in my mind that renegotiable rate mortgage
type documents, variable rate mortgage type documents, as well as
others that have not even been discussed here, and aren't maybe
even thought up yet, at the present time, are going to be in the
field, and that if you're going to have any kind of mortgage lending
for real estate mortgage, I think that is just going to be something
that is going to be, especially in light of what is happening eco-
nomically. Jt is incredible to me that we can deal with the Federal
Home Loan Bank Board, the Federal Reserve, the Comptroller of
the Currency, and anybody else you can think of out there-the
FHA, the VA-all requiring various types of closing forms and
then superimposed on top of all of this additional forms through
the RESPA legislation.
I guess what I would like to close with, and especially in light of
the hour, is this: That insofar as I am concerned, the more I listen
to the testimony, I am really persuaded that certainly mandatory
control would be a total and complete disaster, an absolute disas-
ter. And I think we have to be very much aware that in many,
many instances, conflicts of interest can exist that have to be
looked at very, very carefully by the regulatory agencies.
And the last comment, I guess, I would make is that there is no
question, Mr. Elliott, that in your commentary about all of the
forms going back and forth to the people-the so-called simple
truth-in-lending form, the so-called simple concept of an annual
percentage rate being different from what interest is, the simple
concepts of how are we going to compute what taxes are going to
be in future-emphasize to me how significant it is and how impor-
tant it is that we emphasize more and more the significance of
having the marketplace run a good bit of this business-as opposed
to the Government running the business-because the Government
running it has done as effective a job in this area as it has in so
many areas: It has really messed it up. And if we continue to mess
it up more, we will even have less money, in my opinion, commit-
ted to housing. And I think that would be a really terrible, terrible
situation.
Dr. PLOTKIN. There was a comment Mr. Elliott made to you
concerning my testimony which leads me to believe I must have
misspoken, or he misheard me. I did not claim-in fact, I made no
statement whatsoever-as to whether or not it was the intent of
Congress in passing RESPA to include dividends received on con-
trolled entities.
PAGENO="0635"
629
What I did say, and tried to say as clearly as I could, is that
every single economist who has written on the subject has conclud-
ed that the competitive effect of controlled entities is identical to
and perhaps even worse than, the competitive effect of the illicit
type of kickbacks that you, Mr. Carman, distinguished from find-
er's fees. And my statement was that in 1981-and I think I
remember saying "not 1974, but in 1981"-the choices that are
before you are either repeal RESPA, because you don't care about
those types of competitive effects, you don't believe they are bad, or
amend RESPA to include controlled business as an equally pro-
scribed practice as kickbacks of the illicit type.
Mr. CARMAN. Except for this, Dr. Plotkin, in other words, you
seem to suggest that we have a choice of one or the other, pertain-
ing to RESPA. I would suggest to you that we don't necessarily
have that choice one way or the other that way; that perhaps it is
already covered by the regulatory agencies that are in charge of
these practices through the various regulations we just talked
about a few moments ago, dealing with conflicts of interest. I think
there is an awful lot of concern in that area.
Perhaps that part of it needs to have some expansion, but it
would seem to me, based upon what I have listened to in these
various hearings and what I understand to be the thrust of what
RESPA has done, that perhaps RESPA should be thought of as an
archaic bronchial disease, and gotten rid of.
Thank you, Mr. Chairman. I yield back the balance of my time.
Chairman GONZALEZ. Well, thank you very much, Mr. Carman.
We deeply appreciate your participation and your very valuable
contribution.
I should say that we are extremely grateful to the panelists for
your patience. This has been a lengthy session this afternoon. We
are past the usual closing time of the work day, but I must also
express our appreciation for the importance of your testimony, and
your presence. We are deeply grateful.
The subcommittee will meet again in the morning, at 9 o'clock,
in the main committee hearing room, room 2128, in order to go
into the hearings on migratory labor housing.
[Whereupon, at 5:20 p.m., the hearing was adjourned.]
PAGENO="0636"
PAGENO="0637"
APPENDIX
ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN THE RECORD
STATEMENT
OF
HALT--AN ORGANIZATION OF AMERICANS FOR LEGAL REFOPJd, INC.
PREPARED FOR
SUBCOMMITTEE ON HOUSING AND COMMUNITY DEVELOPMENT
September 25, 1981
In the Subcommittee on Housing and Community Development
hearings on RESPA and controlled business practices, representatives
from both HUD and various industry groups spoke at length about the
perceived needs and interests of consumers. Because these hypotheses
about consumers' needs appear to have been based upon conjecture rather
than experience, HALT--An Organization of Americans For Legal Reform--
welcomes the opportunity to present the subcommittee with an analysis
of real estate settlement practices and the controlled business problem
from the consumers' perspective.
HALT is a non-profit public interest consumers' organiza-
tion with approximately 75,000 members across the country. Our goal
is to make the legal system more responsive to the needs of the average
citizen by working to reduce the cost and improve the quality of legal
services. HALT publishes educational manuals for consumers on subjects
such as "Shopping For A Lawyer," "Small Claims Court," "Probate," etc.
One of our manuals, "Real Estate," is a thorough guide to residential
real estate sales contracts, mortgages, conveyancing, title insurance,
the closing process, etc. In short, it is about the settlement process.
This report was presented to the Subcommittee on Housing and Community
Development by Paul Hasse, Chairman of Halt, Inc.
(631)
PAGENO="0638"
632
-2-
Over 60,000 copies have been distributed to date and the response
from consumers and experts has been extremely positive. In the words
of Richard V. Weliman, Professor of Law at the University of Georgia
and author of the Uniform Probate Code, the manual is "clear, accurate,
and quite responsive to typical consumer questions."
Through our research for the manual, communication with
our thousands of consumer members, and consultation with academics and
industry professionals, we've learned quite a lot about how the settle-
ment process affects consumers. We know that consumers find the process
of transferring real estate complicated, expensive, and intimidating.
One major study has shown that, for most Americans, the purchase of a
home is one of the most traumatic experiences in life. It is second
only to the grief suffered upon the death of a loved one.
The purchase of a home is the largest investment that most
consumers will make in their lifetime. They are understandably concerned
that the transfer and settlement process be accomplished smoothly and
inexpensively. The demand for our manual on real estate has demonstrated
that homebuyers want to reduce settlement costs by shopping carefully
for settlement services. They are interested in saving money, but they
are also interested in understanding the settlement process so they can
rest assured that all necessary tasks have been performed properly. The
response we have received from people who have used the manual clearly
indicates that they felt the time invested in educating themselves was
worthwhile.
If we've learned anything as a consumer organization interested
PAGENO="0639"
633
-3-
in settlement practices, it is that consumers are interested in compara-
tive shopping to reduce the costs of the various components of the pres-
ent settlement process. Our experience is cOntrary to HUD's central
presumption that consumers are not interested in shopping. The fact is
that many consumers do shop. The Peat, Marwick, Mitchell ~, Co. study
conceded that at least 4 out of 10 homebuyers engage in comparison
shopping for settlement services. We're confident that the actual per-
centage is higher than this and would be higher still if Congress can
improve consumers' ability to shop by eliminating controlled business
practices.
Both this subcommittee and HUD are interested in reducing
the costs of buying a home. The focus of this particular hearing is
on settlement costs. It is apparently agreed by both the members of
this subcommittee and I-HiD that the way to reduce these costs is through
increasing competition among providers of settlement services. I-HiD's
lender packaging recommendation would restrict the point of price com-
petition to lenders. The present system,on the other hand, supposedly
allows competition among providers at each step in the settlement process.
It is essential to realize that competition is significant
only when a consumer can make an informed choice among competitors. For
this choice to be meaningful, there must exist:
(1) consumers who are knowledgeable enough to make an informed
choice;
(2) consumers who are truly free to choose among providers; and
(3) an open, truly competitive market.
PAGENO="0640"
634
-4-
Consumers must have access to information that will enable
them to choose wisely between available options. No settlement system
in a free market can preclude the necessity of consumers making decisions
that are perceived to be in their best interest. Whether choosing be-
tween the services offered by various settlement providers, or between
different lender packages offered at different prices, consumers must
make a decision based on an understanding of their needs and of settle-
ment process. Therefore, regardless of the type of settlement system
that is available, the option--and the availability--of educational
materials must remain.
Communication with our members indicates that they believe
the consumer educational materials required by RESPA and produced by HIJD
are not provided early enough, and are merely descriptive when they should
be normative (that is, they describe the process, but offer no suggestions
on how to avoid the pitfalls).
A Uniform Settlement Statement provided 24 hours before
closing is virtually worthless. The closing process has its own momentum
by this point and few people are willing to jeopardize the settlement at
the last minute by objecting to a few hundred dollars (or even more) that
are charged for inflated or unforeseen closing costs. The same is.true
of the Good Faith Estimate (GFE) which is provided 3 days before closing.
And because the GFE is only an estimate, people tend to pay little atten-
tion to it. HUD's Special Information Booklet is provided by lenders, but
this is also relatively late in the process. By this stage, real estate
PAGENO="0641"
635
-5-
brokers may have been contacted, the home selected, earnest money paid,
a takeback or second mortgage offered, etc.
The present settlement system is inherently confusing and
intimidating, particularly for persons who are buying a home for the
first time. The success of our real estate manual shows that given the
amount of money involved, people will take the time to read 40 pages
about the settlement process. They do, however, need time to digest
that information and to understand the entire process. It is not easy
to accomplish this while sitting at a banker's desk and trying to nego-
tiate a mortgage.
1~e would suggest that a consumer booklet discussing the
entire process (sales contracts, mortgages, lenders, title insurance,
closing, etc.) be made available to buyers at the earliest possible
moment. Ideally, this would occur in the real estate agent's office.
The second problem with the RESPA-required educational ma-
terials is that they describe the settlement process but they do not
take an agresaive consumerist stance. They do not always advise when
fees may be negotiable, which services may be inessential padding, etc.
Understanding the process of settlement is only important
as the first step in understanding where abuses may occur and how they
may be prevented. Useful consumer information must analyze the entire
settlement process and make recommendations and candid observations that
truly benefit consumers. HUD's materials fail to do this. Consumers
who have read HUD's materials tell us that their initial response is,
"O.K., that's what happens. Now what am I supposed to do about it?"
85-396 0 - 81 - 141
PAGENO="0642"
636
-6-
HUD's materials should be provided earlier and be more
actively pro-consumer. But even if its materials were as useful as
HALT's, there are many situations where specific advice about decision
making is pointless because the consumer is offered no real choice.
This is the issue addressed by requirement (2) above. It is the problem
of controlled bisiness.
Peat, Marwick, Mitchell ~ Co. was not allowed to look
into specific abuses, and the lack of solid evidence about the harm
to consumers made much of the discussion before the subcommittee purely
conjectural. But although the Peat, Marwick study contains little
information about controlled business abuses, the fact is that these
practices are common, evidence of them is easy to obtain, and their
effect upon consumers is pernicious.
One can, for example, look at the series of articles on
this subject published in the Washington Post in November of 1979.
These articles describe in great detail the abuse of the settlement
system found in Maryland, Virginia, and the District of Columbia.
Reporter Mike Weisskopf learned that before RESPA was passed, settlement
lawyers collected 25 percent of the title insurance premium cost in
kickbacks for every customer referred to a title insurance company.
Now, after RESPA, the same lawyers are collecting an average of 60
percent (and as much as 70 percent) of the title insurance fee in sales
commissions from the title insurance company.
These "commissions" are legal because the lawyer is now
PAGENO="0643"
637
-7-
acting as an agent of the insurance company. Being an agent requires that
the lawyer must issue two sets of insurance documents to the lender
and the buyer. This task, which takes a secretary 15 minutes to one
hour to perform, earns the lawyer a commission which can amount to as
much as $233 of the $333 that a homebuyer pays for title insurance on a
$100,000 house.
Title insurers argue that distributing money to these agents
is part of doing business and that the rates would not drop if the com-
mission were eliminated. However, North Carolina passed a law in 1973
that prohibited the payment of commissions to lawyers, lenders, and
real estate agents. Title insurance premiums dropped 40 percent.
Another common abuse discovered by Weisskopf was the prac-
tice of lenders inducing borrowers to use specific law firms to handle
settlement procedures. Members of these recommended firms often serve
as directors of the bank and the firms almost invariably keep large,
interest-free accounts at the bank.
The borrower is steered into using the bank's preferred
lawyer by means of an extra "review fee" for borrowers who choose
their own settlement attorney. This review fee, which runs as high
as $150, is an economic disincentive that is usually sufficient to
keep borrowers from using anyone other than the recommended lawyer.
As one home buyer remarked, "I didn't have much choice. You don't want
to jeopardize your chances for amortgage.. .and I know the bank's policy."
The relationship between title insurance companies and lenders
is similar to the relationship between lawyers and lenders. Weisskopf
found that on December 31, 1978, Lawyers Title Insurance Co., the largest
PAGENO="0644"
638
-8-
insurer in Virginia, was keeping $3.7 million in about 60 interest-
free accounts. More than Si million was kept in United Virginia Bank.
The chairman of the board of United Virginia Bank, Richard H. Dilworth,
was also a director of Lawyers Title.
On the same day, Title Guarantee Co., the largest insurer
in Maryland, had $1.4 million in interest-free deposits at five Mary-
land banks. The chief officer of each bank served as a director of
Title Guarantee. The high number of clients shared by these title
insurers and lenders with interlocking directorates is supposedly coin-
cidental.
There are three ways of preventing the abuses outlined
above: (1) reform the present system; (2) implement a "lender packaging"
system; or (3) implement a combination of (1) and (2).
Two approaches would have to be taken if the present system
is to be effectively improved. The first would be to simplify the
closing process to reduce the number of unnecessary, arcane, and expen-
sive service charges which accompany the securing of a mortgage and the
transfer of title.
Reform of the settlement process would probably have to
come through from -sources other than the RESPA legislation. For example,
many lenders' requirements are based on their concern to make their
mortgages marketable in the secondary mortgage market. The federal govern-
ment both regulates and participates in this market. By making its
requirements simpler--and perhaps less demanding--primary mortgmgees
could do likewise. Conveyancing costs could also be dramatically re-
duced if HUD was to actively encourage states to implement computerized
PAGENO="0645"
639
-9-
land parcel recordation systems. Several communities are now appending
parcel tit'e information to computerized county tax records. This re-
duces the need for expensive title searches and title insurance.
The second approach to reforming the present settlement
system would have to be the prohibition of controlled business prac-
tices. This would require amendment of the 1974 RESPA legislation.
As described above, the growth of controlled business practices have
subverted the intent of RESPA. Prohibiting `kickbacks" is not suffi-
cient. The wording of any amendment to RESPA should specifically pro-
scribe the controlled business arrangements that are now common.
The amendment must also consider a special problem that
has been mentioned above but was largely ignored in the discussions
before the subcommittee. Lenders often provide a list of "recommended"
providers, adding that the borrower is free to shop around for other
service providers. The catch is, however, that the lender will charge
the borrower a considerable fee to "double check" the accuracy of any
outside providers' work. Finding an attorney who will provide an in-
expensive title search is pointless if the lender will add a large fee
to check that attorney's work. It becomes cheaper for the consumer to
unwillingly pay the higher fee of the lender's preferred provider.
Requiring full disclosure of all business relationships (or
even prohibiting most of the common controlled business arrangements)
will have no impact as long as lenders can make consumer comparison
shopping uneconomical by charging to verify all "outside" work. Pre-
ferred providers will continue to receive a steady flow of referrals.
PAGENO="0646"
640
- 10 -
Of course, prohibiting controlled business arrangements such as inter-
locking directorates will reduce the grounds for preference, but unless
these sort of additional lender fees are contained the consumer will
not be free to choose among services that are available in the open
market.
An alternative to reforming the byzantine structure of the
present settlement system is the implementation of a "lender packaging"
system. In theory, the system has certain attractions: lenders put
together loan packages that include all settlement services and costs.
Consumers may then choose between the packages rather than a half dozen
different services. Most significantly, all final settlement costs
are apparent from the outset. Lenders in competition would strive
to reduce the settlement costs--in some cases by eliminating certain
settlement requirements--in their effort to attract borrowers.
As usual, there is a considerable gap between theory and
practice. H1JD's support for lender packaging is predicated on the as-
sumption that consumers are not interested in shopping and that lender
packaging eliminates the need to shop. Neither of these assumptions
are true. HALT's experience with its 75,000 members clearly indicates
that people want to shop because of the amount of money at stake, and
they will shop when presented with timely consumer information and when
the system permits genuine purchasing options.
Lender packaging certainly does not eliminate the need to
shop. If lender packaging really works, settlement costs will start to
drop as lenders eliminate unnecessary services. But once this happens,
PAGENO="0647"
641
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shopping cannot be based solely on cost comparison. Cost will be one
factor, but the services to be provided will be another. For consumers
to decide which services are essential for their needs, they must know
something about the nature of those services. The need for adequate
consumer education is inescapable.
Acceptance of the necessity of consumer education and choice
negates HUD's second assumption: that lender packaging and the present
settlement practices would not co-exist in a community. HUD believes
that lender packaging would be ala disadvantage in the present market
because consumers would not (or could not) understand the difference
between the two systems.
But if consumers have to understand the essentials of
either system to make informed decisions, why can't they grasp the es-
sentials of both? The concept of lender packaging is easy enough to
explain. In fact, it looks pretty attractive to many consumers once
it is explained because it eliminates unforeseen expenses at settlement.
In this respect, lender packaging is more attractive than the present
system. It would be attractive whether or not--or even if--examples
of the present system happen to co-exist in the same community.
HUD's recommendation that lender packaging be implemented
to the exclusion of the present system seems to present a real danger
to the interests of consumers. Lender packaging would almost certainly
lead to the centralization of settlement services. Independent title
agents, real estate attorneys, etc., would be forced to work through
lenders. Those providers who are "outside" the lenders' network could
PAGENO="0648"
642
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probably not survive. Lenders may even find it more cost-effective
to develop all-inclusive, in-house provider services.
The question is whether or not intense lender competition
is common, or even likely to occur with soae regularity. This, of
course, primarily depends on the available money supply. When interest
rates and borrower demand were low, lender packaging legislation might
be a boon to consumers. At other times (such as now) it would probably
lead to a "take it or leave it" attitude among lenders.
The existence of lender competition would also depend on
lenders' willingness to compete. As long as no lender began price-cutting,
lenders in a community (especially lenders in a small community) would
profit by maintaining unnecessary and inflated settlement requirements
and costs. And, if lender ~ was the only available settlement
system, consumers would have no real choice.
In the interest of maintaining a competitive environment among
providers of settl~ent services, a combination of the present settlement
system and the lender packaging system would be preferable. The "mixed"
systems would satisfy the first requirement mentioned above. It would
promote an open and truly competitive market situation. If consumers
are then provided with timely educational information and are free
to choose among providers in a competitive market, settlement costs are
certain to drop from their present levels.
On behalf of its members and other consumers, HALT strongly
urges the subcommittee to recommend legislation that will eliminate con-
trolled business practices, encourage the early presentation of adequate
consumer information to homebuyers, and promote the use of lender packag-
ing in addition to the traditional methods of offering settlement services.
PAGENO="0649"
643
RODERT S. W3L.KER
1OTHD~S,. P~%~A~~S M~R~NA ~. ~O~RtSON
ON ~ of tbe ~tuteb ~`tatt~
~ou~e of ptt~tntatibe~
~&a~bfngton~ ~. 20515
September 28, 1981
The Honorable Henry B. Gonzalez
Chairman
Subcommittee on Housing and
Community Development
Committee on Banking, Finance
and Urban Affairs
U.S. House of Representatives
2129 Rayburn House Office Building
Washington, 0. . 20515
Dear Mr. C irman:
I am writing to you on behalf of my constituents, the Conestoga
Title Insurance Company, Lancaster, Pennsylvania. Unfortunately,
Conestoga Title was not afforded an opportunity to testify at
the hearings held earlier this month by your Subcommittee on
the subject of controlled business due to the lengthy list of
witnesses. However, they have compiled a written statement
which I believe merits your consideration.
Conestoga Title has been actively involved with the controlled
business question for several years and has developed an im-
pressive expertise on the subject. Accordingly, I would be
grateful for the inclusion of Conestoga Title's statement in
the permanent hearing record. Your assistance will be greatly
appreciated and I look forward to hearing from you in this
regard at your earliest convenience.
C ially,
End Robert S. Walker
cc: Hon. J. William Stanton
85-396 0 - 81 -
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644
STATEMENT OF CONESTOGA
TITLE INSURANCE COMPANY
HEARINGS OF SEPTEMBER 15 AND 16
BEFORE HOUSE SUBCOMMITTEE ON
HOUSING AND COMMUNITY DEVELOPMENT
RE: RESPA AND
CONTROLLED BUSINESS
Conestoga Title Insurance Company ("Conestoga") of
Lancaster, Pennsylvania has been involved in the controlled
business question for the past six years, in proceedings on
both the national and state level, and wishes to present the
following points for consideration by this Committee.
1. Conestoga was formed in 1975, and is the only title
insurance company in Pennsylvania which is not a member of
the state's Title Insurance Rating Bureau, which fixes
uniform rates for all title insurance companies except
Conestoga in the state.
2. Conestoga files its own rates, offers its customers
rates as much as 17% below those of the Rating Bureau, and
is thus responsible for the first price competition which
the present generation of title insurance consumers in
Pennsylvania have enjoyed.
3. While having been accused by some quarters of
engaging in controlled business because of its affiliation
with a title insurance agency owned by realtors, Conestoga
is thus living proof of the fallacy in the argument that
PAGENO="0651"
645
"controlled business" necessarily leads to higher title
insurance rates. In Pennsylvania, at least, exactly the
opposite holds true. The highest rates lie with those who
advocate the flat prohibition, without further inquiry, of
ownership in title insurance companies or agencies by real-
tors, attorneys or lenders, while Conestoga offers the
substantially lower rates.
4. While Conestoga is affiliated with an agency owned
by realtors, this agency is a full service agency, and is
paid commissions for services actually performed. Customers
of that agency are advised that the agency is owned by
realtors, and those consumers are advised that they are
under no obligation to obtain their title insurance through
that agency. Moreover, the agency makes no payment, nor
gives anything of value to its realtor-owners for the refer-
ral of clients. The only compensation which the owners
receive is in the form of ordinary dividends or profit
distributions, which may or may not be paid in any given
year, and which are totally unrelated to any particular
policy, premium or commission.
5. Conestoga does not oppose the prohibition of pay-
ments to "sham" agencies, which exist only to refer business
and which perform no services for the customer whose policy
they handle. Conestoga does not operate this way, and does
not condone such operation by others. The prohibition of
-2-
PAGENO="0652"
646
such sham agencies can be accomplished under the existing
provisions of the United States Real Estate Settlement
Procedures Act (`RESPA'), specifically §8, 12 U.S.C. §1207,
which expressly prohibits payments other than for services
actually performed.
6. Such sham agencies should and must not, however, be
confused with legitimate agencies such as Conestoga's.
Affiliation with independently owned agencies is the only
method through which smaller title insurance companies, like
Conestoga, can expand beyond their home office. Unlike the
few industry giants, the small companies do not have the
capital for expansion through branch offices, which require
substantial capital outlays. If the agency system were
abolished or impaired, the ability of the smaller companies
in the industry to compete would be effectively eliminated.
It should come as no surprise, accordingly, that the strongest
advocates of prohibiting so-called controlled business are
the industry giants, like Commonwealth Land Title Insurance
Company, which lists annual revenues of more than $75,000,000
and a national network of 185 branch offices.
7. The blanket prohibition of realtors, attorneys and
lenders from ownership interests in title insurance companies
or agencies, regardless of the legitimate nature of the
company or agency in question, would serve effectively to
destroy the agency system. Attorneys, realtors and lenders
-3-
PAGENO="0653"
647
have traditionally been the sources of capital for title
insurance agencies, simply because of their daily contact
with real estate transactions. To prohibit them from owning
agencies would be to eliminate the only persons who are most
likely to undertake this type of investment.
8. Impairing the ability of smaller companies to
compete would only increase the already serious concentra-
tion in the title insurance industry. In 1974, the Federal
Trade Commission began an investigation of the title insur-
ance industry, and.completed its study in 1978. The FTC
found that while the industry had grown substantially over
the years, it was becoming increasingly concentrated in a
handful of industry giants, who were themselves part of even
larger conglomerates. (Exhibit "A" hereto.) According to
the FTC, eight companies controlled 85% of the business in
the United States as of 1969, these eight companies had
accounted for at least 134 acquisitions in the period between
1950 and 1973, and four-fifths of these acquisitions had
taken place after 1960.
9. If the focus is to be one, as it should, truly of
concern for consumer prices, then attention must be given
not only to ownership by realtors, attorneys and lenders in
title insurance companies and agencies, but also to the
following practices, which, are the prerogative of the larger
companies in the industry:
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PAGENO="0654"
648
(a) affiliation of major title insurance compa-
nies with major mortgage lenders through parent subsidiary
relationships, or as siblings of a common parent;
(b) the creation by major title insurance compa-
nies of mortgage insurance companies, through which custom-
ers for title insurance business can be attracted;
(c) loans by major title insurance companies to
real estate agencies and real estate chains; and
(d) the acquisitions of smaller title insurance
companies by larger ones, as already noted above.
CONCLUS ION
Conestoga is grateful for the opportunity to have the
above facts presented and considered, and is prepared to
supplement this presentation with further facts at this
CommitteeT s request.
Respectfully submitted,
301 Cipher Building
36 East King Street
Lancaster, PA 17602
(717) 397-3791
Attorney for Conestoga
Title Insurance Company
-5-
PAGENO="0655"
Hon. Henry B. Gonzales
Chairman
Sub-Committee on Housing &
Community Development of
the Committee on Banking,
Finance and Urban Affairs
2129 Rayburn House Office Building
Washington, D.C. 20515
RE: HEARINGS ON CONTROLLED BUSINESS
September 15th and 16th, 1981
Dear Chairman Gonzalez:
The American College of Mortgage Attorneys is most interested
in the above hearings and had representatives present to monitor
the testimony and to analyze the written statement of the
witnesses. We note that the testimony was diverse and often
contradictory and inconclusive. The main advocates of legislation
concerning controlled business' were, of course, the members
of the American Land Title Association (ALTA) panel. Yet even
their testimony contained no factual evidence that alleged
"controlled business" was in fact detrimental, but they instead
alluded primarily to the potential effects of a controlled
situation.
We also note that the anecdotal testimony of the ALTA panel
related entirely to insi-ances concerning real estate brokers
who also were providers of title insurance, usually through
a corporate agency in which the broker had an equity interest.
There was no direct reference to attorneys who are also agents
for a national underwriting title company, but attorneys
were obliquely included in the broad definition of "real estate
professionals" together with real estate brokers, mortgage
lenders and builders (see Page 1 of the testimony by James
L. Boren, Jr., the President of ALTA). It is our opinion that
the inclusion of attorneys in that definition was incorrect
and in fact raises a false issue. We know that you, as Chairman,
the other members of the committee, the staff and the Congress
have a most difficult burden in considering possible national
legislation that can be effectively and equitably applied to
real estate and title insurance transactions, particularly
in light of the great diversity of local laws and customs and
real property records and procedures at the local court houses.
649
AMERICAN COLLEGE
OF
MORTGAGE ATTORNEYS, INC.
September 29, 1981
PAGENO="0656"
650
As our membership is composed of attorneys specializing in real estate law
and practicing in 32 states and the District of Columbia, we feel qualified
to bring to the attention of the co=ittee various facts and insights into
the daily practice which nay be helpful in your deliberations. We firmly
believe that attorney-agents are not involved in any sense in anticoapetitive
"controlled business" which has even a potential for adverse consumer
consequences and submit for the consideration of the coaunittee the following:
I. HISTORICAL RELATIONSHIP OP ATTORNEYS AND TITLE INSURANCE
Title insurance, since it is a guarantee that there are no errors,
omissions or deficiencies in the past chain of title, must of necessity be
based upon an examination of past title history by a competent and experienced
attorney who is well versed in real estate law. Since the title to real
estate often passes through many links of different and diverse nature, such
as credit sales, partitions between co-owners, heirs or divorced spouses,
probate matters either testate or intestate, corporate liquidations and
mergers, exchanges and foreclosures, bankruptcy, tax sales, etc., the
attorney must have a significant knowledge both in depth and breadth of
state and federal substantive and procedural laws. Title insurance
historically is in addition to and ancillary to the basic title certification
by licensed attorneys and is generally obtained to protect against abstruse
deficiencies dehors the public records, such as forgery, incapacity, etc.
In many states, a policy of title insurance by law must be based upon
certification by a licensed attorney. In order to comply with the requirements
of state law, and with prudent business practice, there are several procedures
whereby title companies can obtain the required certification. Often national
underwriting title companies will rely upon the certification by an attorney
on their approved list. Some underwriters will open a local office which
is an agency or branch of the national company and will then use salaried
in-house counsel. In many instances, particularly in the Southeast and along
the Atlantic seaboard and into the Northeast, companies enter into an agency
contract with an individual attorney in whose ability they have confidence,
and the attorney-agent is given all of the necessary forms, includ±ng the
initial commitment and the final policy forms with all of the endorsements.
The attorney handles all of the work, collects all of the fees including
his fee as attorney and the insurance premium as agent, and ultimately remits
to the company a copy of the final policy and the company's share of the
premium.
In this last method of operation, the policy holder is generally the
personal client of the attorney and can be either a lender-client or am
individual-client. If the attorney merely renders his individual written
certification of merchantability of title based upon his opinion, then the
client is protected by the net worth of the individual attorney and his
partners, and by their errors and omissions or malpractice insurer. The
attorney's client for a number of reasons, such as protection against title
deficiencies dehors the record, or because the client may be dealing with
a national lender who requires it, may request title insurance in addition
PAGENO="0657"
651
to the attorney's personal certification. Lenders nay require such additional
evidence of title security to enable them to participate in the national
secondary market. In such instances, it is often expeditious and economical
for the attorney, as a natural adjunct to his practice, to issue the title
policy of the underwriting company which he represents directly from his
office as an attorney-agent.
This procedure is most advantageous to the lender or individual client
who is the consumer, because he can exercise his right to have his own attorney
with whom he is familiar and in whom he has confidence with regard to the
quality of work .and integrity, handle the title certification and the issuance
of insurance.
II. THE RESTRAINT ON "CONTROLLED BUSINESS" AS ADVOCATED BY ALTA WOULD
ALTER THIS HISTORIC* RELATIONSHIP TO THE DETRIMENT OF THE CONSUMER
ALTA's position as to attorneys, as set forth in their "White Paper"
of November 1979, pages 23, 33 and 43-45, and in the testimony of Mr. James
Boren, apparently is based upon the following reasoning. When an attorney
is representing his personal client, whether an individual purchaser or a
corporate lender, and the client requests title insurance and will certainly
rely upon the attorney's advice, an attorney can "control" who issues title
insurance. ALTA strains to interpret this most ominously even though the
attorney in this and all matters is ethically mnd legally obligated to
represent the best interests of his client, and is also subject to the
competition of his peers in the market place. It is ALTA's position that
the attorney, when requested by his client to issue title insurance, should
be prohibited from issuing it, either as an individual attorney-agent or
through a corporate agency of which he is the owner; rather the attorney
must in fact require that the client seek out and go to an "independent title
agency," i.e., a branch office of a national title underwriting company,
that the client chooses by chance or through the yellow pages or in some
other nysterious manner. If pursued to its ultimate conclusion this reasoning
would also prohibit an attorney from ever providing a service to his client
in areas in which he is skilled, if in fact another business or professional
also offers the same services. For example, an attorney with expertise in
taxation law would also be prohibited from advising his own client on tax
matters, and would be required to force his client to seek the services of
another "independent" attorney or accountant, or Certified Financial Planner.
Certainly an attorney can render advice and service in tax matters to his
own client without a conflict and also should certainly be able to issue
title insurance as an adjunct to his representation of his client. This
example should illuminate the illogical and counter-productive effect of
the ALTA "controlled business" position which is without merit, erroneous
and will be to the ultimate detriment of the client-consumer, because thereby
a competent real estate attorney who has been employed by his client, with
knowledge of his local reputation, ability and integrity will not be allowed
as a natural adjunct to his practice to issue a title policy based upon his
title certification. This results in attorneys being deprived of the right
to represent and serve their clients. ALTA seeks in fact to remove attorneys
as attorney-agents, yet at the same time allow title insurance companies
not only to issue title policies but also to practice law by having the basic
PAGENO="0658"
652
title certification performed through house counsel. To the extent that
the use of title insurance may escalate because of the increased sale of
mortgages in secondary markets, or for other reasons, ALTA's position would
result in the removal of tens of thousands of individual local attorneys
from the practice of real estate law and would leave the practice of real
estate law and the issuance of title insurance toa small number of national
companies resulting in an oligopoly, if not a monopoly.
It is also submitted that this will be to the ultimate detrinrant of
the consumer in that some national title companies have on occasion evidenced
a willingness to accept titles on an undarwriting or casualty basis, as opposed
to the traditional method of proper abstracting, examination, requiring that
deficiencies be cleared and proper approval and execution of curative work
prior to certification of the title and closing. Proper certification of
title by an ethical and diligent professional practitioner, as opposed to
the issuance of title insurance on an underwriting basis by a company, is
critical because title insurance is not protection against future unknown
casualties. It is in fact a guarantee that there are no undiscovered or
unresolved errors or omissions back in the chain of title.
Contrary to popular forklore, title insuranca does not make a bad
title ~ and the basis of all of the benefits and protection to the
consumer is the underlying title opinion by the attorney. If a consumer
has contracted to sell his existing home which was purchased with title
insurance based upon an improper examination and, relying upon that
anticipated sale he has purchased a new home, but the sale of his former
residence is delayed because of title requirements resulting from a mew and
proper title examination, it is of little consolation to the "two-hone owner"
that the title company ultimately and perhaps after extended litigation nay
reimburse him for damages ~ ~ to the amount originally stated in the
policy, Because the amount of coverage is limited to the purchase price
paid, the insurance protection afforded is often less than the market value
of the property at the time the error is discovered, usually when the property
is up for re-sale. The best interest of the consumer is served by his
acquisition of the property free from any title deficiencies ab initio rather
than have to rely upon ultimate and inadequate reimbursement in the event
of error and loss.
In pursuing the guarantee of the title, regardless of whether the
client is an untutored individual who is purchasing his first residence or
a lender-client who is providing the funds for the transaction, the client
must be allowed to exercise his basic right to select his own attorney with
whose skills and abilities he is familiar, as opposed to some unknown house
counsel, who may be very competent or may be of limited ability and experience,
and who may be encouraged by the company to perform in a less diligent manner
solely to promote the collection of premiums without regard to the ultimate
integrity of the title and interest of the consumer. The client-consunjer
is best served by the personal selection of the individual attorney-agent.
PAGENO="0659"
653
III. AN ATTORNEY-AGENT IS SO CLOSELY AND INTIMATELY INVOLVED
WITH THE ENTIRE PROCESS THAT THE ATTORNEY-AGENT CAN BE
READILY DISTINGUISHED FROM BROKERS, DEVELOPERS AND LENDERS
ALTA, in its attempt to monopolize the practice of real estate
law and in pursuit of the issuance of title insurance by a small number of
national underwriters, is also attacking real. estate broker-titl3 agents
and developer-title agents and lender-title agents. It is obvious that the
concept of attorney-agent can be distinguished from these and defended because
of the following:
1. The attorney's title opinion or certification must be the basis
of the supplemental title insurance and is in fact required by
law in many states.
2. If a client requests title insurance as a supplement
to his attorney's title certification, thn insurance can
be issued as a normal adjunct to the attorney's practice.
3. The attorney, by virtue of his exanination and. certification
of title, has a continuing and joint obligation with the
underwriters for any errors and omissions. But, real estate
brokers after the sale have no further obligation with regard
to the title. Thi$~ may create a conflict of interest as
some broker-agents may be tempted to urge the issuance of
a clear title policy regardless of the title history so as
to assure the collection of their real estate commission.
The attorney has no such conflict because he, and in many
states his estate and heirs, has an on-going financial
responsibility which significantly exceeds the small title
commission collected.
4. The attorney-agent, because he in fact does all of the
.work both as the attorney and as the agent for the title
insurance company, is certainly not in violation of the
"kickback" provision of Paragraph a of Section 8 of RESPA.
For the same reason it can not be alleged that he is
receiving an "unearned fee" in violation of Paragraph b of
Section 8 of RESPA. All of the work is done by the attorney-
agent and the national underwriting company is merely receiving
a part of the premium for their joint risk-taking, just as
in other types of insurance company and agency relationships.
This was recognized in the original RESPA legislation and
the attorney-agent was expressly excluded in the exceptions
of Paragraph a, Section 8.
5. It must be noted that attorney-agents were in exist~nce
for many years prior to RESPA while broker-agents, etc.,
are a recent phenomenon.
6. All of the above are peculiar to the attorney-agent
situation, which can certainly be distinguished from the
realtor- or developer-agent.
PAGENO="0660"
654
IV. THE NATIONAL UNDERWRITING COMPANIES HAVE THE ABILITY TO
CONTROL ANY PERCEIVED ABUSES WITHOUT THE NECESSITY OF
INPRECISE AND FAR-REACHING LEGISLATION FROM WASHINGTON
There is certainly no naed for any additional legislation in this
area. All agents for title companies, whether they be an independent agent,
real estate broker-agent, developer-agent or attorney-agent, have executed
agency contracts with the national underwriting companies, all of which agency
contracts have termination clauses. If ALTA genuinely feels that there is
a controlled situation which is detrimental to the consumer, or more realistically
to the economic self-interest of national title companies, then the members
of ALTA, i.e., the national underwriters, have the ability at this time to
alleviate any alleged abuses by terminating all agents pursuant to the clauses
in the agency agreement. In fact, since the national companies sought out,
encouraged and. contracted with every agent, then any alleged problems can
be said to be of their own making. The companies allege that they are incapable
of acting in unison in terminating detrimental agency contracts and each
is afraid to act individually. Such timidity cannot be the justification
for additional and burdensome legislation.
In conclusion, Mr. Chairman, we assert that there is in fact no
national problem with regard to attorney-agents. This is substantiated by
the Peat, Narwick, Mitchell & Company report on RESPA prepared in October
of 1980 for the Department of Housing and Urban Development which report,
in volume 1, Executive Summary, page 111.10, states as follows:
"We did not find that where the title assurance services
are provided by a `controlled business,' the charges for
title assurance services were either higher or lower than
the charges in markets where attorney agents or titla in-
surance companies provided the service. Nor were we able
to ascertain whether the presence of attorneys in the
settlement process resulted in higher or lower overall
charges.
"As noted earlier, we did find that, between 1975 and
1979, the combined price of title assurance and conveyancing
services declined in real terms in four localities studied.
This may or nay not, however, reflect the national experience."
A similar statement was also included in the revised report entitled "Executive
Summary and Final Report dated January, 1981, Page 111.14."
However, if in fact there is a problem, thm as stated above the
national title underwriting companies currently have the ability to rectify
any real abuses by merely cancelling agency contracts. In any event there
is certainly no need for additional legislation with regard to attorney-
agents who ha'~e served their community and clients so well for so many years.
It is possible that attorney-agents were not intended to be the
focus of these hearings or to be included in any proposed legislation, but
were in fact to be rightfully excluded as in the existing RESPA legislation.
However, we were concerned by the broad and ambiguous language used by the
ALTA witnesses and felt a duty to bring the above matters to the attention
of the committee. We were advised that written briefs could be submitted
subsequent to the hearings and we request that this be filed as part of the
record on behalf of the College.
tted,
OF MORTGAGE ATTORNEYS,
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655
STATEMENT OF
JOELW. STEVENS
SENIOR VICE PRESIDENT
DEPOSiTORS TRUST COMPANY OF AUGUSTA
AUGUSTA, MAINE
BEFORE THE, SUBCOMMITTEE ON
HOUSING AND COMMUNITY DEVELOPMENT
OF THE
HOUSE COMMiTTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
September 18, 1981
PAGENO="0662"
656.
STATEMENT OF JOEL W. STEVENS
SENIOR VICE PRESIDENT
DEPOSITORS TRUST COMPANY OF AUGUSTA, AUGUSTA, MAINE
MR. CHAIRMAN AND MEMBERS OF THE SUBCOMMITTEE:
My name is Joel W. Stevens and I am Senior Vice President of
Depositors Trust Company of Augusta, a commercial bank located in
Augusta, Maine. I regret being unable to testify in person before you,
but unfortunately, I became aware of the RESPA hearings at a late date,
and my counsel was told by the Subcommittee Staff that there would be
no room on your busy schedule to accommodate an additional speaker. I
am, therefore, submitting this statement for the record and hope that you
will carefully consider, in your deliberations, the information I am
providing.
Fortunately, I was able to have the head of my bank's Mortgage
Department, Mr. Bradley Snow, and an attorney representing our bank,
Mr. Gordon Grimes, of Bernstein, Shur, Sawyer and Nelson of Portland,
Maine, attend the first day of your hearings, and I have had an
opportunity to review the testimony presented on that day, as well as the
written testimony submitted on the following day. I have certainly
benefited from this testimony and I applaud the initiative of your
Chairman, Representative Gonzalez, in holding these hearings.
The Committee has received much information from government
agencies, title insurance companies, real estate brokers, and others,
about the impact of Section 8 of RESPA upon their operations. As was
pointed out by Chairman Gonzalez during the first day of the Committee
hearings, this information was "grass roots" data from people who are
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most aware of the impact which Section 8 has upon home loan closings. I
would like to add some further information about Section 8's impact upon
an area which has not, to my knowledge, been addressed by the
witnesses or Committee investigation. My purpose is to point out to the
Committee some of the dangers of, passing legislation which attempts to
establish a uniform national policy and which in doing so, scoops into its
regulatory net numerous legitimate and beneficial transactions of which
there is no evidence of abuse, and for which there is no need of
governmental interference and regulation. I also would like to
demonstrate that sonic of the interpretations given to Section 8 of RESPA
by HUD cause the statute to sweep too broadly and interfere with many
useful business ventures.
In order to demonstrate my point, I will need to review briefly for
the Committee some of the aspects of the residential housing market in the
section of the country in which my bank operates: Northern New
England.
Historically in Northern New England, consumers have financed their
home purchases by the use of mortgages obtained from savings banks,
and savings and loans institutions. In recent years, however, the
interest rates which these institutions offered to their depositors were not
competitive with interest rates obtainable in other forms of investment,
particularly money market certificates. The funds which savings banks,
and savings and loans previously used to lend to home purchasers
disappeared as savers withdrew money from their accounts and put it
elsewhere. Additionally, the interest rates which banks had to charge on
coventional home loans skyrocketed to unacceptable levels. With this
decline in local funds and rise in rates for home mortgages, home starts
and purchases are down in Maine, New Hampshire and Vermont and a
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-3-
depression in the construction industry and all related trades and fields
exists. Fortunately, Congress has created a mechanism which is able to
channel capital into the home mortgage markets of Northern New England
at lower than conventional rates. Through the Veteran's Administration
Loan Program (VA) and Federal Housing Administration Loan Program
(FHA) (and the eventual sale of such loans on the secondary mortgage
market to the Government National Mortgage Association ("Ginnie Mae"),
and Federal National Mortgage Association ("Fannie Mae")), money for
home purchases can be made available to consumers in Northern New
England. However, the existing banking institutions in the area have
been slow to use these programs and have not, by and large, offered
such loans. Additionally, institutions which did attempt to handle such
financing programs found that connections in the secondary mortgage
market were essential in handling a large portfolio of home mortgages, yet
these connections were difficult and time consuming to establish.
Depositors of Augusta was one of the first and is still one of the few
banks in Maine to move into the VA and FHA mortgage market.
Depositors of Augusta has developed an excellent reputation in the
secondary mortgage market, and through its connections, has been able
during the last year to process many millions of dollars of VA and FHA
loans. Such loans, at interest rates two or three percentage points below
conventional rates, have been the only possible financing option to many
consumers wishing to purchase their own home.
As many members of the Committee know, sections of Northern New
England are rapidly changing. Many towns and villages which, only ten
to fifteen years ago were largely rural and agricultural in nature, have
become bedroom communities to the large metropolitan areas of Boston,
Manchester, and Portland. Also as new industry has moved into Maine
PAGENO="0665"
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-4-
and New Hampshire, the need for new workers has arisen. In addition, a
higher standard of living generated by this economic development has
occurred among native residents of these areas. Consequently, the
demand for homes, especially in southern New Hampshire and Maine, has
increased dramatically. However, builders have been reluctant to
undertake construction of subdivisions because of high borrowing costs
and also because potential buyers of such "spec. homes" might be unable
to secure home mortgage money. A number of years ago a group of home
builders in this area began to realize this problem. They sought a way
to bring FHA and VA financing to their customers. Existing institutions
such as commercial banks and savings banks had not developed such
secondary market programs and this group of contractors wished to set
up a company which would fill the need which clearly existed. Despite
their best intentions, this group was unable to establish a successful
program because of their lack of sophistication, expertise and connections
in the secondary mortgage market.
These builders were friendly, however, wIth an employee of
Depositors of Augusta, Mr. Bradley Snow, who formerly worked for a
New Hampshire bank. These builders knew that Mr. Snow was familiar
with the secondary mortgage industry and that he had been instrumental
in developing Depositors of Augusta's strong VA and FHA mortgage
program. A marriage of Mr. Snow's knowledge and abilities and
Depositor's strong connections, with the need of these builders was
natural, and discussions began in the early summer of 1981 to put
together some form of organization which could effectively deliver badly
needed home mortgage money to consumers.
After initial discussions, it was envisioned that Depositors and a
corporation owned by these builders would jointly form a new corporation
85-396 0 - 81 -
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called Homeowners Mortgage Co. which would supply financing to
consumers seeking VA and FHA mortgages. Both the builders' company
and Depositors Trust would contribute 550,000 as initial start-up capital
in exchange for a 50% ownership interest. Capital was needed from these
two investors to rent an office location, hire staff, buy furnishings and
so forth. Homeowners Mortgage would make VA and FHA loans to home
buyers, some of which might be purchasing homes from shareholder
builders. Referrals were to take place since getting financing for a home
buyer was the primary motiviation for these builders' involvement in the
new enterprise. Homeowners' Mortgage Company would earn money from
origination fees charged to the consumer/buyer and the interest received
on the loan prior to the time the mortgage was sold on the secondary
market. If profits remained at the end of the year, they would be
distributed to Depositors of Augusta and the builders' company on an
equal basis consistent with the 50/50 share ownership involved.
As this new entity was taking shape, lawyers working for Depositors
of Augusta uncovered what they believed was a possible problem with the
arrangement. Section 8 of RESPA had recently been interpreted by HUD
to prevent ownership by builders in any entity which supplied "settlement
services" to consumers where the builders referred buyers to that entity.
HUD interpreted Section 8 to prohibit ~y form of controlled business.
This interpretive rule indicated that payment of dividends to those
holding an ownership interest in a provider of settlement services, would
be prohibited if any referral had occurred, even though these dividends
were "characterized as a return on capital invested." An attorney for
HUD's Consumer Protection Division, Mr. James rvlaher, advised attorneys
for Depositors of Augusta that the proposed arrangement would violate
RESPA no matter how it was structured, so long as home builders were
PAGENO="0667"
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-6-
shareholders of the mortgage company and any referrals by the builders
of home buyers to that company occu red.
At present, the entire New Hampshire venture has been put on hold
pending a determination of the legality of the transaction. Depositors
became aware that this Committee was holding a hearing on the controlled
business issue and thought that the Committee should be apprised of the
problems which HUD's interpretation has caused for this proposed
enterprise.
Throughout the hearings, the Committee has been primarily
concerned about "kickbacks" which could unnecessarily raise the cost of
settlement services to the consumer. For instance, the testimony of the
title insurance industry indicated that when real estate brokers owned
title insurance companies, charges for title services increased and the
quality of title work went down. For this reason, the title companies
argue that it is not in the interest of the consumers for Congress to allow
controlled businesses. The real estate industry disputes this.
Depositors does not believe enough information exists to tell who is
correct. But assuming that the title companies are right, perhaps for
controlled title companies Section 8 is a good thing. However, the
Committee should be aware that the same law that perhaps rightly
restricts controlled businesses involving title insurance, wrongly restricts
the partial ownership by builders in a mortgage company designed to
make VA and FHA loans available. The reason that I say "wrongly" is
because no matter what the financial interest of referring builders might
be in a loan company, they are already prohibited by VA and FHA
regulations from charging for the loans any more than the government
allowed interest rate. Both the "origination fee" and loan interest rate
are set by VA and FHA and the loan will not qualify for government
PAGENO="0668"
662
-7-
insurance or guarantee unless these rates are as allowed. The consumer
cannot under FHA and VA regulations, be charged any more for his loan
even if the builder/owners of Homeowner's Mortgage Comapny wished to
increase the fees. Additionally, any individual VA and FHA loan cannot
even be made without the prior approval of a VA or FHA representative.
Thus, all charges and costs and interest rates which the controlled
business mortgage company will itself impose on the consumer are already
limited and reviewed under existing Federal law. The amount of interest
being charged by a mortgage company or bank for VA or FHA loans
cannot vary from institution to institution since that interest rate is
already established by the United States Government. It makes no
difference whether a consumer secures his loan from a controlled business
mortgage company or an independent bank since the interest rate and
origination fee to be charged will be the same. (Banks could choose to
make loans at below the VA or FHA rate if they wished to, but then they
would not be able to resell the loan on the secondary market since buyers
there seek loans of the highest permissible rate. Thus VA and FHA rates
are standard everywhere and are almost always the maximum allowable
rate.)
As the Committee can recognize, in this type of situation, the evils
of the controlled business do not and cannot exist. Even though in
theory a referring builder might be induced to have its controlled
mortgage company raise the interest charged to a consumer so that it
might profit through dividends, in fact the builders cannot do this
because of their participation in a government thortgage program which
sets maximum allowable rates. Additionally, the builders primary interest
is to sell his house. Increasing the cost of financing to his purchaser
may well defeat his basic goal. His primary motivation and participation
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-8-
in the mortgage company is to obtain the profit on the sale of his house,
and not to secure money from the financing, although certainly that is a
legitimate goal of ownership if the company is able to earn a profit.
Depositors Trust Company of Augusta does not believe that Section 8
of RESPA was intended to prevent ownership interests in mortgage
companies by builders where VA and FHA loans were at issue. First of
all, Depositors questions whether the loan itself is a "settlement service"
within the meaning of RESPA. HUD has taken such a position in
rendering its opinion to us on this fact situation. Yet 12 U.S.C. §2602
defines settlement services to include,
Any service provided in connection with a real estate
settlement including, but not limited to, . . . title
searches, title examinations, . . . title insurance, .
preparation of documents . . . property surveys .
credit reports or appraisals . . . pest and fungus
inspections, services rendered by a real estate agent, or
broker and the handling of the processing and closing or
settlement.
It is interesting that nowhere in this definition is the loan itself
mentioned. Depositors believes that HUD's interpretation of RESPA to
include loans themselves as part of "settlement services" misconceives the
entire concept of the law. The definition clearly indicates that settlement
services includes service in connection with "a real estate settlement."
The real estate settlement is the sale of the house and issuance of the
loan taken together. The loan can't be connected with itself. Subsidiary
services such as title insurance, appraisals and so forth are the types of
connecting services which Congress meant to cover. We would hope that
the Committee could clarify the intent of Congress to indicate that the
loan itself is not covered by Section 8.
However, even if a loan is a service covered by Section 8,
Depositors cannot understand HUD's position that this proposal would be
a violation of the law. 12 U.S.C. §2607 (Section 8C of RESPA) clearly
PAGENO="0670"
664
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indicates that nothing in Section 8 prevents payment to any person of
"compensation or other payment for goods or facilities actually furnished
or for services actually performed." Depositors believes that any
dividends paid to shareholders of Homeowner's Mortgage Company,
whether they be to Depositors or the home builders, would merely be a
return on their invested capital and would serve only as compensation for
the service of making the loan. Since, as indicated earlier, the charges
to the consumer, in the form of interest on the loan and origination fee,
are already regulated by the Federal Government, it is impossible to see
any amount of these charges as payment for a referral. In all VA and
FHA loans, whether they be by a controlled business or otherwise, the
Federal Government has determined that a certain amount of interest is
allowed for compensation for lending the money and a certain amount is
allowed for orginating the loan. It flies in the face of this determination
when HUD says that in a controlled business situation some amount of
that interest rate or orgination fee could be inferred to be compensation
for a referral, thereby running afoul of Section 8. Why does the interest
charge include a "fee for referral" when made by a builder controlled
mortgage company, yet that identical charge only be interest for the loan
of money when made by a bank? HUD is clearly wrong and we would
hope that the Committee would clarify the law in this regard.
Finally, I would like to point out that all of the testimony presented
to the Committee, as well as the experience of many of its members,
would indicate that consumers do not shop for settlement services, but do
shop around for the lowest possible mortgage rate. Since mortgage rates
are in fact what are at issue in the Homeowner's Mortgage project, it is
clear that even if inflated charges were able to be included in the loans
in violation of FHA and VA regulations, and if such charges got through
PAGENO="0671"
665
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the loan review by HOD or VA staff, consumers themselves would identify
such inflated charges and choose to go elsewhere for their loans. Thus,
the competitive market forces, outlined by the Federal Trade Commission
staff to the Committee, would serve to prevent the financial interest of a
shareholder in a controlled business from increasing rates above what had
been established in the market.
A number of analogies were suggested during testimony before the
Committee. Although Chairman Gonzalez rightly indicates that many of
these analogies were "atrocious," there is one analogy which I believe is
sound in this particular situation. As the Committee Members well know,
many manufacturers in our country provide financing for the purchase of
their products. Ford Motor Company, for instance, has established Ford
Motor Credit which will supply auto loans to customers buying a Ford
automobile. Ford obviously has an interest in selling its cars and if it can
provide low cost financing to purchasers, more of its cars will be sold.
No one would question this type of arrangement which is an important
part of our national economy.
This is exactly the concept which Depositors and the New Hampshire
home builders group wish to bring to the New England home mortgage
industry. Builders have constructed homes in a subdivision just as Ford
constructs automobiles. These builders wish to provide financing
alternatives to their customers which will generate sales of homes. They
wish to create a financing agency which will provide VA and FHA loans to
customers in an area where such loans are now not readily available.
Their own interest in selling the home, and Federal regulations governing
these loans and their rates, protect the consumer entirely in such
transactions. The same market forces which govern Ford Motor Credit
govern the proposed Homeowners Mortgage Company.
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The return which builders may get as shareholders of Homerowners
Mortgage Company is based merely upon charges received for loans at
rates already established and limited by the Federal Government. The
opportunity for inflated charges does not exist. Even if it did, shopping
by consumers for mortgage rates would make inflated loans
non-competitive in the market. In this situation allowing a return on
capital to builders who own part of a mortgage company is not
unreasonable or damaging to consumers. This is surely the type of
legitimate return which Mr. Thomas Collier, former Deputy Assistant
Secretary for Regulatory Functions of HUD argues should be allowed on
page 12 of his testimony to you.
Depositors Trust of Augusta urges the Committee to consider the
situation I have just described when studying revisions to Section 8.
The Committee must remember that the laws in our 50 states differ
markedly, and additionally the Federal Government has established
numerous programs which deal with home loans. There may be a number
of legitimate transactions which Section 8 will inhibit unless the HOD rule
is narrowed. If title companies are a problem, then limit any prohibition
on controlled businesses to them. But don't allow a broadly drawn and
interpreted law inhibit arrangements beneficial to consumers. I believe
that the subcommittee should at a minimum recommend changes in Section
8 to account for situations where a controlled business does not and
cannot result in inflated charges. The law should allow builders, or
perhaps others such as brokers, to invest in mortgage companies and
receive a return on their capital. So long as the charges made by the
mortgage company are fair and reasonable, or in amounts allowed by
existing Federal loan programs, there is no danger that the financial
interest involved will hurt the consumer. As I have indicated above, I
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do not think that a financial interest in such a situation in any way
harms the consumer and in fact that financial interest is a prime
motivation in ensuring that low cost, prompt and efficient service be
provided to consumers who wish to purchase their own home.
Congress can clearly exempt loans from the definition of "settlement
services," or clarify Section 8C of RESPA to allow compensation in the
form of fees already regulated by Federal law. Or they can make clear
that controlled businesses are permissible where it can be shown .that no
referral fee is being paid as part of a dividend distribution. Congress
could also allow controlled businesses but require disclosure of any
interest the referrer has, as is already required under Article 16 of the
Code of Ethics of the National Association of Realtors. (See Donald
Treadwell testimony, p. 2). But Congress must do something to prevent
an injustice from being done to citizens who wish to engage in legitimate
business transactions. I urge the Committee to explore ways to open up
the home mortgage industry to an influx of capital from home builders, as
my bank wishes to do.
I hope that this insight into the problems which we have encountered
with HUD's interpretive rule will be of value in revising Section 8. I
appreciate the Committee's time in reviewing my testimony and would be
happy to answer questions or provide further information about our
concerns to you.
Joel W. Stevens
Senior Vice President
Depositors Trust Company of Augusta
268 Water Street
Augusta, Maine 04330
Tel. 1-207-623-4721
0910a
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1125 Ff,eoo,h Seer,, N.W.
Wsshiogeo, D.C. 20005
Mortgage Bankers Association of Aenerica `,XHSa,o P. Coesberland
GeoxalCaaa,I
(202) 861-6516
October 13, 1981
Honorable Henry B. Gonzalez
Chairman
Subcommittee on Housing and
Community Development
U.S. House of Representatives
Washington, D.C. 20515
Dear Mr. Chairman:
The Mortgage Bankers Association of America appreciates this opportunity to
comment upon the application of the Real Estate Settlement Procedures Act
(RESPA) to "controlled business" in the real estate settlement market,
that is, where a business providing one settlement service is owner or con-
trolled by a person providing another settlement service and a customer
referral taken place between them. The September 15 and 16, 1981 hearings
chaired by you on this subject carefully brought out the facts, to the extent
they are now available, about the extent and nature of "controlled business."
MBA would like to express its view on these facts.
MBA is a nationwide organization devoted exclusively to the field of mortgage
and real estate finance. Its membership comprises originators, mortgage
investors, and a variety of industry-related firms. Mortgage banking firms
which make up the largest portion of the total membership, engage directly in
originating, financing, selling, and servicing real estate investment portfolios.
We have long been interested in the prohibition of kickbacks and unearned fees.
In testinony before the House Committee on Banking and Currency, on June 8, 1972,
MBA President Philip C. Jackson, Jr., commenting on a legislative effort that
ultimately led PESPA, said "we support the interest of the committee in pro-
tecting borrowers and home purchasers in establishing a code of conduct
between borrowers and lenders in connection with the purchase of homes." That
same year, MBA worked with the Federal Housing Administration (FaA) in the
formulation and dissemination of clarifying Regulation, 24CFR203.7(a)(6), that
prohibited the payment of kickbacks in connection with FHA insured loans.
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On December 5, 1973, Kennon V. Rothchild, Chairman of MBA's Washington Com-
mittee, addressed the Housing Subcommittee regarding the legislation that
became RESPA. Focusing on the section that became Section 8 of RESPA, he said,
"we like the language in (the section) and hope it remains in any language
which is enacted into law." The testimony explained that MBA's support was
based on an understanding that the language in the section was to the same
effect as the language which MBA had worked with the Department of Housing and
Urban Development (HUB) in developing as the FHA "anti-kickback" regulation.
The slightly different language of the Regulation, developed at the same time
as Section 8 of RESPA is an aid in appreciating the meaning and scope of
Section 8. The FHA regulation provides:
The payment by the mortgagee of any fee, kickback, or other con-
sideration, directly or indirectly, in connection with any insured
mortgage transaction or transactions to any person including an
attorney, escrow agent, title company, consultant, mortgage broker,
seller, builder, or real estate agent if such person has received
any other payment or other consideration from the mortgagor, the
seller, the builder, or any other person for services related to
such transaction or transactions or from or related to the purchase
or sale of the mortgaged property, except that compensation ~
paid for the actual performance of such services as may be approved
]~y the commissioner. 24CFR203.7(a)(6) (Emphasis supplied)
Section 8 of RESPA does not contain the words "directly or indirectly" and
thus, some have said, it does not adequately prohibit the indirect payment of
a referral fee that takes the form of profits from a business entity owned by
the referring party. The recent hearings focused on title insurance agencies,
but the analysis would apply to any situation where the business entity re-
ceiving the referral was owned by the referring party, or where both had a
common owner.
As reflected in its 1973 testimony, MBA believed that Section 8 was intended to
haveas broad an application as the FHA Regulation developed at the same time.
Therefore, the proper interpretation of~Section 8 would apply its prohibitions
to referral fees no matter what form the payment takes, whether directly or
indirectly, as is explicitly recited in the PItA Regulation.
In 1976, HUB promulgated Regulation X pursuant to RESPA. Regulation X supports
and adopts the interpretation that HESPA applies to all forms of referral fees.
The regulation defines the prohibited payment of a "thing of value" to include
a payment "provided either directly or indirectly to the person referring
settlement business and can take many forms." 24CFR3500.14(b). Regulation X
continues on to enumerate some of the forms in which such an indirect, illegal
payment could be structured.
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From these observations, MBA concludes that RESPA is adequately broad in its
coverage to prohibit referral fees transmitted through a controlled business
and that no amendment to the Act is necessary. However, if the committee
feels that RESPA should be explicit in its coverage, it also follows from
these observations that MBA would have no objections to amending Section 8
by inserting "directly or indirectly" following "accept" in both subsection
(a) and (b).
To say that referral fees passed back through a controlled business are pro-
hibited by RESPA is not, however, the same as saying that RESPA should be
interpreted as prohibiting all businesses under a common ownership from pro-
viding more than one settlement service. While subsection (a) of Section 8
does not explicitly state that some payments between providers of settlement
services are permitted, both subsection (b) of Section 8 and the FHA Regulation
reflect such permission and set the standard. Payment for services actually U
performed are permitted, regardless of who receives them. Regulation X,
Section 3500.14(d) elaborates this standard.
That a contrary interpretation would appear to be open is occasioned by the
narrow context in which the question has arised. The evidence is that there
has been an increase in the incidence of owners of one type of settlement
service provider, real estate brokers and savings and loan service corpora-
tions, acquiring or opening another type, title agencies, subsequent to
enactment of RESPA. This evidence leads to the suggestion that common owner-
ship is an attempt to avoid RESPA, and therefore RESPA should be interpreted to
prohibit multi-facet service by controlled businesses. It has been argued
that controlled business was not specifically addressed by RESPA because it
was unknown when RESPA was enacted.
However, when the real estate settlement market is examined beyond the narrow
confines of the title business, a different conclusion regarding RESPA and
controlled business emerges.
While in 1972 "controlled business" was not prevalent in the title agency part
of the real estate market, it was widespread and known in the larger real
estate industries of sales and finance. Then, as today, many real estate
brokerage companies are also in the mortgage banking business. Many homebuilders
provide orarrangefinancing for homebuyers. These complementary businesses
were and are conducted by different departments or subsidiaries of single or-
ganizations. They work, and worked at the time of the enactment of RESPA, in
an efficient manner to provide the buyer and seller of a home with the ability
to complete the transaction.
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In enacting RESPA less than 10 years ago, Congress was aware that some settle-
ment service businesses were owned, controlled or otherwise related to each
other in a way that was not arms length. Congress addressed the matter then
by outlawing unearned fees, no matter how structured, and permitting earned
fees, no matter who earned then.
This approach provides a prohibition against the "shell" or inactive title
agency about which the committee heard during the hearings, and it allows
title agencies whose service earns a fee to receive the fee.
Neither the evidence presented by BUD, based upon the study performed at the
direction of Congress, nor any other testimony during the hearings established
that the former was widespread, requiring additional Federal legislation as
a remedy, or that the latter was harmful.
In conclusion, with regard to "controlled business," MBA believes that, prop-
erly interpreted, the Congress distinguished between types of conduct rather
than types of ownership, that this distinction was proper then and is proper
now, and that no adequate demonstration has been made to change the distinction.
NBA appreciates the opportunity to set forth its views on the subject of RESPA
and controfled business. Should the Subcommittee consider RESPA further, MBA
would be pleased to have the opportunity to testify.
We shall be happy to furnish additional information, if needed.
Sincerely,
/ /
WilliamE. Cumberland
General Counsel
WEC/ej c
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TI1LE iNSURANCE COMPANY
3740 WEST CHESTER PIKE
P.O. BOX 1
NEWTOWN SQUARE, PA. 19073 - (2151 3533900
J. WM. COTTER, JR., President
October 9, 1981
Rep. Henry.B. Gonzlez
Chairman
House Subcommittee on Housing
and Community Development
2129 Rayburn House Office Building
Washington, D.C. 20515
Dear Mr. Chairman:
I attended the hearings on controlled business held September 15
and 16 by the Subcommittee on Housing and Community Development.
I want to congratulate you and the other members of the Subcommittee
for taking time.frorn your busy schedules to hold hearings on the
significant abuses caused by controlled business. I admire your
patience, and I was exceptionally impressed by the depth of under-
standing that you and the members of the Subcommittee brought to
the hearing.
After listening *to the testimony of several of the witnesses at
the hearing who described the adverse impact of controlled business
on their companies and on their communities, I feel compelled to
*add my voice to theirs and describe my own experiences with controlled
business in my area of P~nnsylvania.
My company, a very small title insurer in Pennsylvania, is, like
the great majority of title insurance providers in the country,.
extremely localized. We operate in only a few counties, primarily
*in Delaware County, Pennsylvania. Our company began its operations
in Delaware County in 1948: we have since, grown to be t~e largest
title insurance agency in the county and employ over 40 people in
the county.
Although T. A. Title Insurance Company offers a 10% to 12% lower
rate for title insurance than our controlled business ccmpetitorr
since 1976 over 20% of the market for title insurance services i
REINSURANCE EXCLUSIVELY CV
TRSPIUAMERICA TITLE INSURANCE COMPANY
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673
`LA TITLE INSURANCE COMPANY
Delaware County has h~en captured by real estate broker-owned title
insurance agencies.
It is clear that if the brokers who own these controlled business
agencies had no financial interest in any title company, a great
many of the transactions that were steered to the controlled agencies
would have been referred to my company becuase of the attractiveness
of our rates. and our well-known reputation for quality service.
For example; one broker, who in past years recommended our company
in over 100 transactions per year, joined with a number of other
brokers about 2 years ago in a controlled title agency. Since
that time our company has not handled a sinole transaction in
which that broker has been involved. My own sister sold a home
through that broker and, when she tried to have the transaction
handled by our company, was advised that the transaction would
instead be handled by the controlled business agency, supposedly
because "the buyers requested that agency." Our branch office in
the part of the county where that controlled business agency is
operating saw its business decline from 1600 applications in one
year to slightly more than 500 applications the next year -- a
loss of almost 66% of its business in a single year.
If this astonishing shift in business was the result of a competitor's
offering better service or lower rates, I could accept the loss of
business as a natural result of competition. But, make no mistake
about it, this shift Is not the result of normal competitive factors.
The controlled business agency is not "competing" for its business;
it has not been able td obtain this incredible volume of business
because it offers better prices or services than my company. Rather,
the brokers involved have decidedthat it is in their financial interest
to steer their customers to the company they own, rather than, as
they have in the past, selecting the company they know can do the
best job for the consumer'.
Real estate brokers, mortgage lenders, builders and other real estate
professionals are able to control the business of their clients
because consumers are so reliant on these professionals for assistance
in selecting a title company. It is easy to understand this reliance
when you recall the situation at the time you bought your~ first home
and remember the tremedous pressures that you may have felt in dealing
with `a host of problems and decisions that you may never have en-
countered before that time. For example, even my wife's cousin;
who asked me several dozen questions about his particular real estate
transaction while it was developing, advised me that the real estate
broker involved in his transaction told him to go to a particular
title company (one that the broker owned) and he did, simply because
he was afraid that the broker would not sell him the house if he
did not follow the broker's direction. The complexities of the
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674
entire homebuying process are such that the vast majority of
purchasers are likely to take, the path of least resistance. The
idea that homebuyers will `buck' the real estate broker or mortgage
lender when he recomrr~ends a particular title company is utter nonsense..
During the hearings the question was asked whether there was "hard
evidence" of increased costs due to controlled business. In addition
to the evidence.that was brought to the Subcommittee's attention
by the various title company representations, I would like to add
my own evidence. In 1979 I made a survey of the charges being made
by controlled agencies in my area of Pennsylvania and compared them
with the prices charged by our company. I found that in many. instances
the controlled agencies were not utilizing the lower rates prescribed
in the case of reissue policies and transactions involving subdivisions,
whereas independent agents, such as my company, who had to compete
for business, were providing those discounts.
During the hearings several witnesses also stated in response to
question~ that there was no "hard evidence' that the title evidence
prepared by controlled agencies is inferior to the work done by
independent agencies. Again, I know of one case where there is
likely to be a complete failure of title on a development of about
50 homes in which the builder of the development controlled the title
agency that issued title insurance policies on those homes. (We
discovered that title problem when we searched the title on a resale
of a home in the development.) I have no way of knowing whether
the failure of the controlled agency to identify., the title defect
was the result.of incompetence or was the product of a deliberate
decision to bury the defect. In any event, if an independent title
company, such as my own, had done the title work, the problem certainly
would have been discovered before the homes were sold.
Mr. Chairman, all too often the government is faced with crisis
situations on problems that could have been avoided if action had
been taken before the problem reached crisis proportions. That is
`the situation you face with the growth o~ controlled business. If
action is takennow, you `will be able to preserve the independence
and integrity of an industry -- the title insurance industry -- that
`~ has played an essential role in establishing the safety and marketability
of investments inreal estate. If you fail to take action, and.
permit real estate brokers, mortgage lenders, builders and other
participants in the real estate settlement process toown and control
the title insurance industry, independent title companie~ that are
not owned by a broker, lender or builder will not survive. In such
a market, there will be no competition, since each title company
will know that it can count on the business sent to it by its owners.
I cannot understand how anyone can believe that such a result serves
the best interests of consumers.
The hearings were, indeed, an excellent first step. Hopefully you
now grasp the problem, an~d understand its potential magnitude and
impact on competition and consumers..' I urge you to take appropriate
action. .
Very truly yours,