By Janet B. Thoren, Legal Counsel
The License Law has always required brokers to disclose known conflicts of interest, and to avoid working on behalf of one party in a transaction without the knowledge of each party for whom the broker acts. Listing agents are required to set their compensation with their clients in the written listing agreement. Buyer agents must do the same in the Buyer Agency Agreement. From time to time, however, issues have arisen related to compensation and the appearance of impropriety in the manner in which licensees are often compensated.
In 2007, a newspaper article reported that certain buyer agents were receiving large bonuses from homebuilders/sellers as incentives to steer buyer clients to particular builders’ properties. The brokers involved failed to disclose these bonuses to their buyer clients. This raised a concern that seller-paid incentives could cause brokers to direct their buyer clients to certain properties where the agent might receive extra compensation without the buyer’s knowledge, rather than showing the buyer other properties that might also have suited the buyer’s needs, perhaps at a lower price.
• 2007 INCENTIVE DISCLOSURE ADVISORY COMMITTEE
In response, the Commission formed an Incentive Disclosure Advisory Committee and charged it with determining whether changes in the Real Estate Commission’s rules were needed to reasonably assure that real estate purchasers and sellers are properly informed of any compensation received by or offered to their brokers from another party to the transaction. The committee, which consisted of brokers, educators, attorneys, and a representative from the Consumer Protection Division of the Attorney General’s office, found that there were promotions by builders and developers offering bonuses or special incentives to certain real estate brokers representing buyers without adequate disclosure to those buyers. These incentives ranged anywhere from $2,000 – $10,000 in cash, trips, or other prizes for selling particular properties. In most cases, the prices of the homes were increased to cover the cost of the bonus or incentive, meaning the buyers unknowingly paid the bonuses. Sometimes the incentives were disclosed to the buyer, but in other instances, they were not. The committee recommended that the Commission’s disclosure rule should be amended to clarify that:
• Disclosure of all compensation, including bonuses and incentives, should be made to the broker’s client in writing, should be prominent, and should be acknowledged by the client;
• The value of any incentive should be disclosed and, if other than cash, described; and
• Disclosure should be timely (preferably while showing properties for which incentives are offered) but in no event not later than the time of offer.
After an investigation into the transactions that were the subject of the newspaper article, the Commission took disciplinary action against the brokers and firms involved for which sufficient evidence was discovered. The compensation disclosure rule, A .0109, was amended as a result of the committee’s recommendations. The rule as amended requires agents to do the following:
1. A broker in a sales transaction cannot be compensated by his client unless that compensation is provided for in a written agency contract meeting the requirements of Commission rule A.0104. Buyer agents and listing agents need written agency agreements in every transaction that provide for compensation.
2. A broker in a sales transaction cannot receive any compensation, incentive, or bonus of more than nominal value from any other party unless the broker provides full and timely disclosure of the payment or incentive, or the promise or expectation of such payment or incentive, to the broker’s principal. This disclosure can be oral, but must be confirmed in writing before an offer is made or accepted by the principal.
3. Full disclosure requires a description of the compensation, incentive, or bonus, including its value and the identity of the party by whom it will or may be paid. The value can be expressed using a specific dollar figure, percentage or other mathematical formula. It is not sufficient to describe compensation as being any amount “up to” a certain amount, or “between” two figures. Disclosure is timely if it is made in sufficient time to aid a reasonable person’s decision-making. To be timely to a buyer, the disclosure should be made at the time of showing if at all possible, but if not, at least prior to the submission of an offer.
The rule does not require a broker to disclose to a person who is not the broker’s principal the compensation the broker expects to receive from the principal. It also does not require a broker-associate, for example, to disclose to his or her principal the portion of compensation the broker-associate might receive from his employing brokerage firm.
The rule serves two policies. First, a consumer is entitled to know what the consumer will owe his own broker in connection with the consumer’s real estate transaction. In addition, a consumer is entitled to know when his own broker is being paid by someone else in the transaction, and how much the broker is to receive if the consumer completes the transaction. If a broker stands to make a bonus if he sells a property in a particular subdivision, the buyer has a right to know and to decide whether or not the buyer wants to see homes outside the subdivision that might not offer the same bonus, but might be comparable and may be listed at a lower price.
• HOW DO BROKERS DISCLOSE COMPENSATION?
Whether the principal is a buyer or seller, compensation should be provided for in the required written agency agreement. If a buyer agent discovers a bonus or incentive is being offered on a property after the agency agreement has been executed, the disclosure can be made by any written means including email or subsequent written note.
• LISTING AGENT DISCLOSURE
Listing agents are required to have written agency agreements with their seller clients. The NCAR standard form listing agreement provides a place to disclose to the seller principal the listing broker’s (firm’s) compensation.
• BUYER AGENT DISCLOSURE
The same is true for buyer agents. They are required to have written agency agreements with their buyer clients, and compensation can be disclosed in that agreement. NCAR has a standard exclusive buyer agency agreement that provides a place for disclosure of compensation. The form also indicates that the buyer agent may be offered additional compensation in the form of a bonus or incentive. The buyer agent or firm must still disclose the details of any bonus or incentive in writing prior to the time of the offer. NCAR has provided a new form for the disclosure of incentives or bonuses discovered after the agency agreement has been executed.
• SUBAGENTS AND DISCLOSURE
What if you are handling the transaction for the buyer, but you are not a buyer agent, you are a subagent of the seller? No disclosure is necessary. Your principal is the seller, and he or she should have already received disclosure through the listing agent. If you have thoroughly discussed agency with the buyer, and the buyer has signed the Working With Real Estate Agents brochure which indicates you are a subagent of the seller, the buyer should understand that you do not represent him or her.
• DUAL AGENCY/DESIGNATED AGENCY
What compensation must a dual agent disclose? Remember that in most cases, the firm owns the listing and the buyer agency agreement, not the individual agents working the transaction. Disclosure to the seller is not an issue if it is done as part of the written listing agreement. Since the firm represents both the buyer and the seller, however, and since the firm is being paid by the seller, it must make a full compensation disclosure to its buyer client. This means the full amount of compensation or bonuses the firm is receiving from the seller.
EXAMPLE: An agent working with a buyer may not know at the time of showing or at the time an agency agreement is signed with the buyer the full amount of commission on each property listed by the firm, plus any other incentives. Firms must make this information available to their brokers so disclosure can be made at the time of showing. If the information is not available at the time of the showing, the agent should make a good faith estimate of the firm’s compensation and then follow up with full disclosure before an offer is made. If a broker assisting the buyer discovers a bonus is being offered at some point after the initial disclosure, the broker must disclose the bonus to the buyer immediately in writing. Emailing the buyer is a sufficient means of disclosure.
• WHAT ABOUT SPECIAL TYPES OF FEES?
EXAMPLE: A builder offers brokers incentives based on the number of properties sold. For example, when the individual broker sells 5 properties belonging to the builder, he receives a bonus of $5,000.00. The broker must disclose to his buyer client that the builder offers such an incentive, the amount of the incentive, and the fact that if the buyer purchases the property in question, the broker will either receive the bonus or have a future chance at receiving the bonus.
EXAMPLE: A builder offers a firm incentives based on the number of properties sold. For example, when brokers with a certain firm sells 10 properties belonging to the builder, the firm receives a bonus of $10,000.00. If the firm represents the buyer either exclusively or in a dual agency situation, the firm must disclose the incentive arrangement with the buyer. An individual broker with the firm who knows or should know about the bonus is also required to disclose.
EXAMPLE: A builder may pay a brokerage firm a fee for marketing a subdivision. These types of fees are sometimes paid to the brokerage firm at closing as each property sells. In such situations, a broker must disclose to his or her client that the firm receives fees for marketing the subdivision and that the fees are paid upon the closing of each property, and the amount to be paid based on the sale of the subject property.
• WHY CAN’T BROKERS JUST DISCLOSE “EXTRA” COMPENSATION IN ADDITION TO THEIR COMMISSION?
In order to require only disclosure of “extra” compensation, the Commission would first have to establish what constitutes a base-rate of compensation. Since the Commission cannot set commission rates, nor can brokers lawfully agree among themselves as to a base-rate (because of federal anti-trust laws), it is impossible to require brokers to disclose only “extra” compensation. A broker could simply add the incentive to the base-rate in the transaction, call it all commission, and disclose nothing to the buyer.
• 2010 INCENTIVE DISCLOSURE IMPLEMENTATION ADVISORY COMMITTEE
In 2010, the Commission convened an Incentive Disclosure Implementation Advisory Committee to evaluate complaints and criticisms of the incentive disclosure rule and to recommend changes, if necessary, to disclosure requirements in dual agency transactions. The committee concluded that many brokers misunderstand the current disclosure rule and believe the rule is limited to a disclosure of additional or incentive compensation, and do not understand that in a dual agency situation, the firm must disclose total compensation to the buyer client. A majority of the committee concurred that full disclosure should remain the rule, including dual agency transactions, where the greater risks to the buyer also arise.
As with everything else, the amount of any incentive or bonus, whether cash or a non-cash item such as a trip, must be disclosed on the HUD-1 closing statement.
• POTENTIAL FOR DISCIPLINARY ACTION FOR FAILURE TO DISCLOSE COMPENSATION
With all the disclosure requirements, the Commission will look at all the facts and circumstances surrounding a particular transaction before making a decision as to whether a broker acted inappropriately in disclosing compensation. Some of the factors that would be considered in connection with a complaint that a consumer was not given full and timely disclosure of the firm’s compensation as required by the rule include:
• whether the broker gave the consumer a good faith estimate and how close the estimate was to the actual compensation paid;
• whether the broker had any reason to suspect the compensation might be different than disclosed;
• whether the compensation received was more, or less, than the amount disclosed;
• what systems were in place by the firm to make the information available;
• whether the broker utilized the firm’s systems but, because of unusual circumstances, was unable to obtain the necessary information;
• whether the failure to disclose was exceptional, or the standard operating procedure of either the broker or the firm; and
• all other relevant facts and circumstances concerning the particular transaction.
The Commission will not generally impose discipline against a licensee who has made an error acting in good faith, particularly when the licensee has taken reasonable steps to obtain and disclose the correct information, and when any error was corrected without harm or significant risk to a member of the public.
This article came from the March 2011-Vol41-3 edition of the bulletin.