PAGENO="0001" 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 PAGENO="0002" 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) PAGENO="0003" 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) PAGENO="0004" 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 PAGENO="0005" 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 PAGENO="0006" PAGENO="0007" 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) PAGENO="0008" 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 PAGENO="0009" 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. PAGENO="0010" 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. PAGENO="0011" 5 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. PAGENO="0012" 6 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 PAGENO="0013" 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. PAGENO="0055" 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 PAGENO="0061" 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 PAGENO="0063" 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. PAGENO="0084" 78 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. PAGENO="0085" 79 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). PAGENO="0086" 80 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. PAGENO="0087" 81 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). PAGENO="0088" 82 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) PAGENO="0089" 83 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 PAGENO="0090" 84 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 PAGENO="0091" 85 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" 86 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. PAGENO="0093" 87 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. PAGENO="0094" 88 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. PAGENO="0095" 89 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) . PAGENO="0096" 90 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). PAGENO="0097" 91 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 PAGENO="0098" 92 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. PAGENO="0099" 93 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) PAGENO="0100" 94 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" 95 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. PAGENO="0102" 96 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" 97 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. PAGENO="0104" 98 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). PAGENO="0105" 99 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. PAGENO="0106" 100 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. PAGENO="0107" 101 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). PAGENO="0108" 102 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. PAGENO="0109" 103 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" 108 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. PAGENO="0121" 115 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" 116 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" 117 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. PAGENO="0124" 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" 119 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" 120 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" 122 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. PAGENO="0129" 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" 126 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." PAGENO="0134" 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. PAGENO="0136" 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 PAGENO="0140" 134 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 PAGENO="0141" 135 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 PAGENO="0142" 136 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. PAGENO="0143" 137 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 PAGENO="0144" 138 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 PAGENO="0145" 139 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 PAGENO="0146" 140 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 PAGENO="0147" 141 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- PAGENO="0148" 142 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 PAGENO="0149" 143 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.) PAGENO="0150" 144 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 PAGENO="0151" 145 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- PAGENO="0152" 146 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 PAGENO="0153" 147 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 PAGENO="0154" 148 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' PAGENO="0155" 149 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 PAGENO="0156" 150 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 PAGENO="0157" 151 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- PAGENO="0158" 152 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- PAGENO="0159" 153 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. PAGENO="0160" 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. PAGENO="0169" 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. PAGENO="0250" 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. . PAGENO="0257" 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" 270 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" 271 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" 272 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" 274 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" 276 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" 277 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. PAGENO="0292" 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 PAGENO="0294" 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" 291 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 PAGENO="0299" 293 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" 294 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" 296 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" 297 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" 298 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" 299 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" 300 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" 301 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" 302 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" 303 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" 304 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 PAGENO="0311" * ~3o5 64 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 ~ ~ ~ -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. PAGENO="0388" 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- PAGENO="0389" 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- PAGENO="0390" 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, PAGENO="0391" 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 PAGENO="0393" 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. PAGENO="0394" 388 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? PAGENO="0395" 389 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." PAGENO="0396" 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" 404 -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" 416 -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" 420 -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 -1- 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 -2- 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 -3- 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 -4- 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. -6- PAGENO="0439" 433 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. -7- PAGENO="0440" 434 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 -9- 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 -10- PAGENO="0443" 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. -11- PAGENO="0444" 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. -12- PAGENO="0445" 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 -13- 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. PAGENO="0447" 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 PAGENO="0461" 455 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 PAGENO="0463" 457 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. PAGENO="0464" 458 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 PAGENO="0465" 459 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. PAGENO="0466" 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 PAGENO="0467" 461 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 PAGENO="0468" 462 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. PAGENO="0469" 463 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 PAGENO="0470" 464 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 PAGENO="0471" 465 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 PAGENO="0472" 466 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. PAGENO="0473" 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. PAGENO="0474" 468 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. PAGENO="0475" 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. PAGENO="0476" 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 PAGENO="0477" 471 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 PAGENO="0478" 472 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. PAGENO="0479" 473 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- PAGENO="0480" 474 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 PAGENO="0481" 475 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~ PAGENO="0482" 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 PAGENO="0558" 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 PAGENO="0559" 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 PAGENO="0560" 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 PAGENO="0562" 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. PAGENO="0563" 557 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 PAGENO="0564" 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 PAGENO="0565" 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." PAGENO="0566" 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. PAGENO="0567" 561 [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:] PAGENO="0568" 562 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, PAGENO="0569" 563 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 PAGENO="0570" 564 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? PAGENO="0571" 565 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 - 11 - 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 - 12 - 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 - PAGENO="0650" 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: -4- 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, PAGENO="0661" 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 PAGENO="0663" 657 -2- 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 PAGENO="0664" 658 -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" 659 -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 - PAGENO="0666" 660 - -5- 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" 661 -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 PAGENO="0669" 663 -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 -9- 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 -10- 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. PAGENO="0672" 666 -11- 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 PAGENO="0673" 667 -12- 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 PAGENO="0674" 668 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. PAGENO="0675" 669 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. PAGENO="0676" 670 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. PAGENO="0677" 671 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 PAGENO="0678" 672 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 PAGENO="0679" 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 PAGENO="0680" 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,