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FEDERAL RESERVE BANK OF NEW YORK [ Circular No. 9173 "1 October 27, 1981 PROPOSED AMENDMENT TO REGULATION Z Definition of Arranger of Credit To All Depository Institutions, and Others Concerned, in the Second Federal Reserve District: The Board of Governors of the Federal Reserve System has requested comment on a proposal to amend the definition of “ arranger” of credit in its Regulation Z, “ Truth in Lending.” The following is quoted from the text of the Board’s announcement: The proposed amendment would assist persons who help arrange consumer credit — including home sales where the seller participates in the financing — to determine if they are subject to Truth in Lending disclosure requirements. The proposal would amend Regulation Z as revised under the Truth in Lending Simplification and Reform Act. The amendment would attempt to describe more precisely what actions constitute arranging for credit. Revised Regulation Z defines an arranger of credit as a person who regularly arranges for the extension of consumer credit by another who is not a creditor (with “ regularly’ ’ meaning 25 times in the past year or 5 times where the transaction is secured by a home), if a finance charge may be imposed for the credit or the credit is to be repaid (excluding the down payment) in more than four installments. To clarify the meaning of the word “ arrange,” the proposed amendment would add two factors to this definition. The arranger would be one who is involved: — in developing or negotiating credit terms, and — in helping to complete credit documents. Enclosed is the text of the proposed amendment to Regulation Z. Comments thereon should be submitted by December 7, 1981, and may be sent to our Consumer Affairs and Bank Regulations Department. Questions on this matter may also be directed to that Department (Tel. No. 212-791-5914). A nthony M. S olomon, President. FEDERAL RESERVE SYSTEM 12 CFR PART 226 [Reg. Z; Docket No. R-0368] Definition of Arranger of Credit AGENCY: Board of Governors of the Federal Reserva System. ACTION: Proposed rule. SUMMARY: The Board is publishing for comment a proposal to amend the definition of "arranger of credit" in revised Regulation Z. The amendment would revise the definition to describe more clearly an arranger of credit. If adopted, the proposed definition would cover many real estate brokers who arrange sellerfinanced transactions. DATE: Comments must be received on or before December 7, 1981. ADDRESS: Comments should refer to Docket No. R-0368 and should be mailed to the Secretary, Board of Governors of the Federal Reserve System, Washington, D.C. 20551, or delivered to Room B-2223, 20th and Constitution Avenue, N.W., Washington, D.C., between 8:45 a.m. and 5:15 p.m. Comments may be inspected weekdays in Room B-1122 between 8:45 a.m. and 5:15 p.m. FOR FURTHER INFORMATION CONTACT: Regarding the regulation: Susan Werthan or Steven Zeisel, Staff Attorneys, Division of Consumer and Community Affairs, Board of Governors of the Federal Reserve System, Washington, D.C. 20551 (202) 452-3867. Regarding the regulatory analysis: Fred B. Ruckdeschel , Econo mist, Regulatory Improvement Project, Board of Governors of the Federal Reserve System, Washington, D.C. 20551 (202) 452-2579. SUPPLEMENTARY INFORMATION: (1) Introduction. Effective April 1, 1981, the Board substantially revised Regulation Z, which implements the Truth in Lending Act (46 FR 20848, April 7, 1981). The revisions reflected amendments made by the Truth in Lending Simplification and Reform Act (Title VI of the Depository Institutions Deregulation and Monetary Control Act of 1980, Pub. L. 96-221). Creditors may begin complying with the revised regulation immediately, but compliance does not become mandatory until April 1, 1982. The Board is now publishing for comment a proposed amendment to the definition of arranger of credit in the revised regulation; unless otherwise indicated, all references to Regulation Z are to the revised regulation. The Truth in Lending Act requires that "creditors" give Truth in Lending disclosures to consumers. A creditor is defined as a person who regularly extends consumer credit, or a person who is an "arranger of credit." Under the previous Truth in Lending Act, an arranger of credit was considered a creditor only ff the person actually extending the credit was also a creditor (one who in the ordinary course of business regularly extends consumer credit). The Truth in Lending Simplification and Reform Act changed [Enc. Cir. No. 9173] - 2 - the definition of "creditor" to cover instead those arrangers who regularly arrange for credit to be extended by persons who do not meet the creditor definition. This change eliminated coverage of those who arrange credit on behalf of creditors but for the first time covered those who arrange credit for non-creditors. The simplification act does not make clear, however, what activities constitute arranging credit, and Regulation Z does not significantly expand the statutory definition. The Board believes that more specificity is needed to make the defini tion easier to apply to individual cases and to assist persons, such as real estate brokers, to determine whether they must comply with Regulation Z. Therefore, the proposed definition attempts to describe more precisely what actions constitute arranging for credit. Regulation Z presently defines an arranger of credit as follows: "Arranger of credit" means a person who regularly arranges for the extension of consumer credit!./ by another person if: (i) A finance charge may be imposed for that credit, or the credit is payable by written agreement in more than four installments (not including a downpayment); and (ii) The person extending the credit is not a creditor. The footnote explains that a person regularly arranges for the extension of consumer credit only if it arranged credit more than 25 times (or more than 5 times for transactions secured by a dwelling) in the preceding calendar year. The proposal would retain the substance of the present definition but it would add 2 factors to clarify the meaning of the word "arrange." To fall within the proposed definition, a person must be involved in (1) developing or negotiating credit terms and (2) helping to complete the credit documents (the sale contract would be a credit document for this purpose if it spells out terms upon which the seller agrees to provide financing for the buyer). The definition would cover most mortgage loan brokers, as well as real estate brokers arranging seller-financed transactions. The mortgage loan broker typically advertises the availability of loans and is approached by a potential borrower. The borrower completes an application, and a mortgage or deed of trust is drafted based on the terms offered by the broker and the particular needs ,of the borrower. The broker then obtains a lender — often a private individual who desires to invest funds in the mortgage market. Since the mortgage loan broker typically develops the credit terms and assists in completing the relevant credit documents, the broker would be an arranger of credit under the proposed definition (assuming the arranger definition is met in other respects). The proposed definition would also cover most real estate brokers who arrange sales involving seller financing. In this increasingly common situation, the buyer often assumes an existing mortgage and the seller finances a second mortgage loan for the difference between the sale price and the existing ▲ mortgage (less any downpayment). Alternatively, the owner may take back a first mortgage for the entire sale price (less any downpayment). The real estate broker or salesperson typically acts as an intermediary, suggesting or proposing the terms that the owner may be willing to accept and the terms that the buyer is willing to offer. The terms are usually drafted on a purchase agreement form supplied by the broker and prepared with the broker's aid. In such a situation, the broker would be an arranger of credit (if the proposed definition is otherwise met) since the broker negotiates the credit terms and assists in completing credit documents. If the real estate broker or salesperson does no more than suggest that the seller supply a portion of the financing, the broker would not be an arranger of credit. Likewise, if the broker assists in completing the contract documents, but does not develop or negotiate the terms, the broker would not be an arranger. While the Board believes that the proposed language sufficiently describes what it means to arrange credit, various interpretations of the pro posed language are possible. The Board solicits comment on the following points: o What activities should constitute developing or negotiating the credit terms? o Should "credit documents" refer only to those documents that contractually obligate the consumer? o How should real estate brokers be counted for purposes of the numerical test of coverage -- by salesperson, broker or broker age firm? An entirely different definition than the proposal may be preferred. Some alternative ways of describing what it means to arrange credit are con tained in the following list. They could be added to the proposed definition, or they could substitute for it. They all assume that the "arranger" regularly arranges consumer credit to be extended by a person who is not a creditor and that the credit involves a finance charge or is payable by written agreement in more than 4 installments. Arranging credit might include: o Transmitting or conveying the terms of the offer. ° Bringing together the parties in regard to the financing. o Advising the credit extender or consumer regarding the financing terms. o Procuring or soliciting an extender of credit. o Acting as an Intermediary between the credit extender and the consumer. - A - The Board solicits com m ent on the usefulness of any or all of the c h a ra c te ristic s listed as possible additions or a lte rn a tiv e s to the definition. F urtherm ore, an arranger of cred it may or may not receive a fee for the service. The Board solicits com m ent on w hether receip t of a fee should be p art of the definition of an arranger of c re d it. Real e sta te brokers, who obtain a com m is sion for selling but not an explicit fee for obtaining financing, would be excluded from Truth in Lending requirem ents by such a te s t. Finally, the Board solicits com m ent on the question of w hether real e sta te brokers who assist in seller financing should be considered arrangers of cre d it, and thereby have responsibilities for making Truth in Lending disclosures. The Board is allowing less than the ususal 60 days for com m ent because it believes th a t prom pt resolution of the m a tte r is in the public in te re st in view of the impending date for m andatory com pliance with the revised regulation. (2) Initial R egulatory Flexibility Analysis. The Board requests com m ent on a proposed clarificatio n of the word "arrange," as in "arrange c re d it," which is undefined in the Truth in Lending Sim plification and Reform Act and is employed in the Board’s revised R egulation Z, which im plem ents th e a c t. The clarificatio n is necessary to im plem ent the a c t as it applies to persons who arrange a cre d it tran sactio n betw een a borrowing consum er and a nonprofessional extender of cred it, who does not conform to th e definition of "creditor" in Regulation Z and is thus not subject to the disclosure requirem ents of the Truth in Lending A ct. Anyone who, by the regulatory definition, regularly arranges cred it would be required to provide a consum er with th e standard disclosures required for the type of cred it being provided.J_/ O bjective of the proposed d efinition. The purposes of the Truth in Lending A ct and R egulation Z are to assure a m eaningful disclosure of cre d it term s so th a t the consum ers will be able to (1) com pare more readily the various cred it term s available to them and (2) avoid the uninformed use of c re d it. The prim ary objective of the proposed definition is to assure th a t all m eaningful term s of cred it are disclosed to buyers of dwellings when a real e sta te salesperson or broker arranges financing from a nonprofessional c red ito r, most notably individuals selling their hom es.2/ 17 An extender or arranger of cred it is not required to provide disclosures if he or she extends cre d it no more than 5 tim es during the preceding or cu rren t calendar year when transactions are secured by a dwelling or more than 25 tim es in other instances. 2 / The Board believes th a t consum ers very rarely obtain cred it from nonprofessional c re d ito rs through the services of an arranger of cred it unless the cred it is secured by a dw elling. M oreover, under the regulation an arranger is required to provide disclosures only when he or she arranges cre d it from nonprofessional lenders more than 25 tim es per year. The Board seeks inform ation on w hether nonprofessional lenders provide, through arrangers, any significant volume of cred it th a t is not secured by a dw elling. Small en titie s to which the rule would apply. Although d ata on the number of firm s, brokers, and salespersons in re a l-e sta te brokerage are scanty, th e proposed definition would directly or indirectly apply to a large number of sm all e n titie s, including individuals. Salespersons, who are o ften technically independent c o n tra c to rs associated with a broker, would present the disclosures to buyers and in many cases calcu late the required figures. They number in the hundreds of thousands and perhaps considerably more than one million. Brokers, who would be liable under R egulation Z if a disclosure was not made or was erroneous, number in th e tens of thousands. There is also a large number of brokerage firms th a t would in most cases be classed as sm all businesses. There are, how ever, some real e s ta te brokerage firm s th a t could be considered large by standards of th a t industry.3/ Under the proposed definition of arranging, real e sta te brokers who "regu larly" arranged credit would be required through th eir salespersons to provide T ruthin-Lending disclosures when consum ers financed th e purchase of a dwelling with funds secured by the dwelling and obtained from a lender who was not required to provide the disclosures. The lender could thus be e ith e r th e seller of th e dwelling, a relativ e of the seller or other person brought in by the seller, or an outside th ird party brought in by the broker or salesperson. R egulation Z, as revised, defines "regu larly" as meaning arranging cred it more than five tim es in a calendar year when th e cre d it is secured by a dwelling. R equirem ents for com pliance. Regulation Z requires, among o ther things, disclosure of (1) the annual p ercentag e ra te ; (2) the finance charge (to tal in te re st paym ents); (3) the am ount financed (the loan); (4) to ta l paym ents (in terest and princi pal); (5) the to ta l sale price, which includes th e am ount financed, the finance charge, and the downpaym ent; and (6) the paym ent schedule, which shows the monthly pay m ents and any unpaid balance a t m atu rity . N ecessary professional skills. The Board believes th a t the skills required for calculating figures to be disclosed in simple cases of seller financing are com par able to those needed for calculations provided by many agents when assisting buyers understand the im plications of financing through financial in stitu tio n s. In complex cases of seller financing the selling agent may need to rely on a person more e x p eri enced in real e s ta te financing, such as the salesperson's supervising broker. Significant econom ic im pacts on small e n titie s . The Board recognizes th a t costs are incurred when Truth-in-Lending disclosures are required. They include the costs of training of salespersons and brokers to make necessary calculations or th e outlays for training, equipm ent, and com m unications when a cen tralized service provides an agent with the required figures. Costs of disclosure will likely be a c c e n tu ated because of brokers' e ffo rts to avoid th e p o ten tial liability of erroneous disclosure statem e n ts. It also recognizes th a t th ere will be costs th a t are not directly m onetary such as th e agent's tim e and e ffo rt and the increased com plications during th e n e g o tia t ing process. 57 Locally-owned franchises of a nationw ide system are considered here to be indivi dual en titie s and not to be integral p arts of a single large e n tity . Another im pact of the proposal would be an increase in the risk, incurred by a broker, of a sales agent providing a disclosure th a t is in co rrect in any of its te rm s. Although brokers would not be liable for erro rs if they could show "by a prepon derance of evidence th a t the violation was not intentional and resulted from a bona fide e rro r notw ithstanding the m aintenance of procedures reasonably adopted to avoid any such erro r," they could incur the legal and other expenses necessary to c o n test actions of buyers. The s ta tu te normally would provide a buyer 1 year in which to bring an action against a broker for an erroneous disclosure. The Board seeks inform ation w hether a broker would also be a t risk beyond the one-year period if a buyer la te r raised a Truth-in-Lending violation as a defense in a collection action brought against the buyer by the seller. The Board likewise seeks inform ation on the e x ten t to which sellers might also be a t risk. Buyers might a sse rt, for exam ple, a violation of the act as a defense for not m eeting the term s of debt instrum ents. A ccordingly, a defaulting debtor could, at minimum, increase the p o ten tial or actu al legal expenses of a seller in a d efau lt action and conceivably could cause the seller a more extensive loss owing to an erro r by a salesperson or broker.4/ The buyer might use the th re a t of a legal action to e x tra c t from the seller a ren eg o tiated or refinanced loan on term s more favorable than he could obtain w ithout the th re a t. Is th e re any evidence suggesting th a t buyers m ight be able (1) to use violations by a real e sta te broker to avoid their full obligations to sellers or (2) to unfairly abuse good-faith sellers? Significant alte rn ativ es to the proposed ru le. Since the proposal may be regarded as having a significant econom ic im pact on a substantial number of small e n titie s, the Board invites com m ent on significant a lte rn a tiv e s, such as the following: (1) Application of the num erical te s ts : The Board believes th a t if the num erical te st of 5 tran sactio n s involving financing secured by a dwelling is applied to the broker in each real e s ta te o ffice, a large proportion of sales with seller financ ing would require R egulation Z disclosures. A lternatively, a sm aller proportion of tran sactio n s would require disclosures if the definition of arranger is applied individu ally to the broker and each asso ciate broker in an o ffice; and many few er would require disclosures if the definition is applied individually to salespersons and to brokers when they are selling. (2) Exemption of real e sta te brokers from coverage under Regulation Z: Brokers could be exem pt on 2 grounds from providing disclosures for seller financing. (a) Tem porary nature of seller financing. The recen t increase in and continued use of seller financing is p redicated on the economic and financial conditions in the United S tates during the past 12-24 months. Accordingly, the present cyclically high volume of seller financing is likely to diminish. For this reason, seller financing m ight be excluded from the definition of arranging a t the present tim e because th e cu rren t prom inence of seller financing may be deem ed tem porary. £7 Subsequent recovery by the seller from the broker m ight not be easy, especially For a seller who subsequently moved or re tire d to another s ta te . (b) R eliance on standard docum ents for conveying; in fo rm atio n . Standard docum ents used in seller financing (such as the sales agreem ent, the note, and the deed of tru st) typically show the in te re st ra te , the am ount financed, the monthly paym ent, and the m aturity, all of which th e required Truth-in-Lending disclo sures would duplicate. The docum ents also typically indicate the fa c t of an unpaid balance at m aturity. They typically do not show the finance charge, th e to ta l pay m ents, "total sale price," and notably, the am ount of any unpaid balance a t m atu rity , the balloon paym ent. Of the 4 disclosure elem ents not typically shown in the standard docu m ents, the am ount of the balloon paym ent, which is a prom inent elem en t in seller financing, is potentially most im portant to the decision of purchasing a home. A ccord ingly, requiring disclosure of the balloon paym ent, in p a rticu lar, in seller financing would allow for a more informed use of cred it if the buyer would not otherw ise have learned the am ount of unpaid balance and considered th a t am ount in his decision w hether to purchase a dwelling. Stating the am ount of an unpaid balance to be paid or refinanced a t m atu rity , however, provides no d ire c t warning of the perceived prim ary problem in sh o rt-term seller financing. Specifically, it does not warn th e buyer th a t econom ic and financial conditions at m aturity could prevent refinancing or could increase its cost above th a t of the original seller financing to such an ex ten t th a t the buyer could not afford the monthly paym ents owed on refinancing. The Board is seeking evidence to indicate w hether requiring disclosure of the am ount of the balloon paym ent will be an e ffe c tiv e method of alertin g a consum er to th e kind of financial risk inherent in a balloon paym ent. For exam ple, is th ere evidence th a t Truth-in-Lending disclosures provided by financial institutions have e ffectiv ely a le rte d buyers in th e past to the cu rren t problems with balloon paym ents? (3) Establishm ent of d ifferen t disclosure req u irem en ts: In view of the d ifficulties faced by small e n titie s, only those disclosures considered vitally im portant m ight be required of real e sta te brokers ra th e r than making coverage under Regulation Z an all or nothing proposition for brokers. On the o ther hand, the prim ary burdens may arise from the requirem ent to disclose a t all ra th e r than from the number of item s th a t must be disclosed. (U) Provision for a differen t e ffe c tiv e d a te : The requirem ents of the a c t could be delayed from April 1, 1982, until O ctober 1, 1982, for real e s ta te b ro k er age firm s. Most of the firms are small and would be subject to the disclosure req u ire m ents of Regulation Z for the first tim e. The delay m ight allow th e real e sta te industry tim e to fully investigate and resolve p o ten tial problem s associated with the "arranger" issue. M oreover, a delay might allow the industry to adjust more easily to the regulatory burden while the d ifficu lt conditions in the real e s ta te m arket p ersist. On the other hand, a d ifferen t e ffe c tiv e d ate would delay full im plem entation of the sim plification a c t more than 2 yeacs a fte r its passage. - 8 - (3) Authority. In consideration of the foregoing and pursuant to the authority granted in § 105 of the Truth in Lending Act (15 U.S.C. 1604, as amended), the Board proposes to amend Regulation Z, 46 FR 20848, by revising § 226.2(a)(3) and footnote 2 to read as follows: SECTION 226.2 -- Definitions and Rules of Construction (a) Definitions. (3) "Arranger of credit11 means a person who regularly?/ (i) develops or negotiates the credit terms, and (ii) * * * assists in completing credit documents containing the binding credit terms, such as the contract of sale or note. The credit involved must be extended by person who is not a creditor; and it must be subject to a finance charge or payable by written agreement in more than four installments (not including a downpayment). Board of Governors of the Federal Reserve System, October 19, 1981. (signed) William W. Wiles ----- WilTi am "W.""Wile's----Secretary of the Board [SEAL] 2/ Regularly means more than 25 times (or more than 5 times for Transactions secured by a dwelling) in the preceding calendar year. If a person did not meet these numerical standards in the preceding calendar year, the numerical standards shall be applied to the cur rent calendar year.
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