Risk Management for Your Brokerage

Your associate broke the law!

October 1, 2006

You’ve always given your top sales associates a lot of leeway in their dealings. They’re experienced veterans and make a lot of money for your brokerage, but lately you suspect that one of your associates is walking a fine line between aggressively courting deals and skirting the letter of the law on matters such as disclosures.

Another one of your go-getters has always been a bit sloppy when it comes to delving into deal details that don’t quite add up, such as unexpectedly high appraisals.

If you let your associates continue these behaviors, you’re courting trouble, say two attorneys who work with brokers on liability matters. Whatever the matter involves, you bear ultimate responsibility for your associates’ actions.

Rather than hoping your sales associates—and you—don’t get hit with a lawsuit, be proactive by maintaining and updating a policies-and-procedures manual (see “Start with the right procedures,” page FB4), monitoring paperwork, confronting problematic actions immediately, and letting associates go if they don’t change their ways. Failure to address illegal actions by your associates, whether they’re committed knowingly or unknowingly, can expose you to liability and put your brokerage at risk. No amount of business that associates generate is worth that.

Where risk lies

For sales associates, the majority of legal risks involve agency or property condition disclosures. But associates can also get caught up in fraud, especially as the sophistication of mortgage scams grows.

“Associates aren’t as exposed to mortgage fraud liability as other parties, like appraisers and mortgage brokers, but because it’s a growing trend, the risk to them is increasing,” says Newton Marshall, an attorney in Chicago.

When it comes to wrongdoing, mortgage deals can be especially ambiguous. It’s possible to have two deals structured in ways that aren’t too different from each other, with fraud occurring in one instance but not in the other. The difference is whether there was intent by one party to mislead another, attorneys say.

A good example involves deals in which the contract price is inflated to generate pocket money for the buyer. There are legitimate cases in which borrowers apply for mortgage financing for an amount greater than the contract price to cover acquisition and renovation (say $170,000 for acquisition and $30,000 for rehab). In a fraudulent version of those deals, though, the buyer concocts a story to win the cooperation of the seller and possibly the seller’s agent to alter the contract to show an inflated purchase price of, say $200,000 on a $170,000 home. Then possibly with the complicity of a mortgage broker, an appraiser, or both, the buyer obtains a purchase money loan for the inflated purchase price, giving the seller proceeds equivalent to the real price ($170,000). The buyer keeps the $30,000. Sellers and their agents can sometimes be lulled into cooperating with such a scheme because they are getting a price they might not otherwise obtain and don’t realize that by cooperating in deceiving a lender, they’re breaking the law.

Scenarios are also possible in which real estate salespeople collude, perhaps to create a $30,000 incentive to attract buyers who intend to flip the property and pocket the cash.

What do you already know?

When you encounter fraudulent activity, you need to know whether your associate is engaging in fraud or is an innocent party. “Consider the salesperson’s history and your relationship with the person,” says Brad Boyd, an attorney in Minneapolis. “Does this person simply misunderstand what she’s doing? After all, realistically, transactions can become complex, and if a salesperson isn’t involved in a lot of deals, she may actually be unfamiliar with what’s going on.”

If the associate participated in ignorance and the deal hasn’t closed yet, the person should be directed to stop the transaction immediately and turn the matter over to the FBI, since these cases are typically a federal issue. Also alert the real estate commission. “If the person’s truly innocent, she shouldn’t have any problem keeping the deal from occurring,” says Boyd. An associate who refuses to act should be let go immediately and the matter turned over to the real estate commission.

“The worst thing you can do is turn a blind eye and pretend you didn’t know about it,” says Boyd.

Pattern of Laxity

Failures to disclose an agency relationship or property condition are far more likely than fraud to trip up your associates, so expect to deal with those at some point, say attorneys. Whether the failure is intentional or inadvertent, the potential for liability is the same.

As with cases of suspected fraud, you want to confront associates with your concerns and give them a chance to correct their actions if their involvement stems from a mistake.

For example, if an associate has sold several similar houses in a neighborhood, each with a history of basement flooding, the associate should disclose that to buyers even if the house they’re looking at in that neighborhood doesn’t show signs of flooding. As an extra precaution, the associate should talk with the seller before meeting with the buyers to obtain the seller’s views on why this one house doesn’t flood.

Disclosure laws differ by state, but generally salespeople aren’t required to disclose issues such as neighborhood flooding. However, that won’t stop buyers from suing you and the associate if their basement proves prone to flooding and they learn your associate’s other listings in that neighborhood had the same problem.

Associates who have a pattern of omitting inconvenient property conditions or committing other disclosure sins and don’t respond to your warnings should be let go, Marshall says. In addition, the broker doesn’t have to wait for a pattern to develop, particularly where the omission wasn’t inadvertent.

Beware of defamation

You don’t want to publicly discuss your reasons for parting ways with an associate; otherwise, you can set yourself up for a defamation lawsuit. “If you mention something publicly that you’re just suspicious of when you let an associate go, you’re jeopardizing the person’s future employability,” says Boyd.

Staying mum is easier for brokers than regular employers because of independent contractor laws. With most standardized independent contractor agreements, you can let associates go without having to give a reason. That protects you from the kind of wrongful dismissal or other types of complaints that employers face from disgruntled former employees, says Marshall.

What your associates’ independent contractor status won’t protect you from, though, are liability lawsuits, making it of utmost importance that you not let bad behavior continue. Keep policies and procedures in place, backed up by regular communication on legal matters. Then, when you suspect bad behavior, tell your associates it’s shape up or ship out.

“Generally, you can’t hide behind your independent contractor agreement” when your associates act badly, says Marshall.

Recognize the signs

Your associates won’t come out and tell you they’re committing fraud. If they’ve stumbled into a fraudulent transaction unknowingly, they can’t tell you. So how can you spot a problem early on?

Review paperwork your associates complete. If your operation is large enough to have an in-house attorney or one on retainer, have the lawyer conduct spot checks.

You want to look for accuracy and completeness, says Brad Boyd, an attorney in Minneapolis. Although signs of inaccurate or incomplete paperwork by themselves don’t mean fraud, they could point to trouble in a deal or at least expose an associate’s inexperience, warranting more attention from you.

Sloppy paperwork can also alert you to other types of problems, such as laxity in making disclosures. Although the associate isn’t intending to act illegally, the person’s negligence can get you in trouble, says Boyd.

Brokers in other companies and customers who complain can be a source for learning whether an associate is acting wrongly, says Newton Marshall, an attorney in Chicago. “Typically, tips come from the public or another broker,” Marshall says. The problem with those sources, though, is that by the time you hear of the problem, it’s too late to act proactively to stop it, he says.

If you receive a tip, monitor the associate closely to see whether there’s a pattern of sloppiness or deliberate omissions. “If an associate is purposely not disclosing mold or a wet basement,” says Marshall, “you should confront the person as soon as possible.”

Start with the right procedures

Real estate law has evolved extensively over the last decade, so even if you have a policies-and-procedures manual in place, you need to revisit it regularly to keep it current.

“The broker can be held responsible if agents claim they were never educated about what’s right and what’s wrong,” says Brad Boyd, an attorney in Minneapolis.

Illinois, for example, up until about a half dozen years ago didn’t allow a private right of action against licensees for violations of license law, such as a failure to exercise proper supervision over salespeople, because licensing law imposes a duty on brokers to supervise salespeople. So any enforcement against sales associates or the broker had to come from the real estate commission or other public body, says Newton Marshall, an attorney in Chicago. Today, consumers can sue practitioners directly, a recipe for increased exposure. “There’s a lot more statutory law today than 10 years ago, and your manual must reflect that,” says Marshall.

Once you update your manual, make sure your associates receive a copy and know about any new material. To be on the safe side, require them to sign a statement saying they’ve read it. “Put the burden on them,” says Marshall.

Follow up with regular risk management education, too, even if it’s just monthly or quarterly e-mail reminders to associates or conference calls about what to do in certain situations. The beauty of e-mails and conference calls is that you don’t have to devote valuable sales meeting time to the topic.

“A lot of associates don’t like to get hit with these topics at meetings because they view themselves as independent. But they must be reminded what they can and can’t do,” says Marshall.

What you’re trying to create with this risk management approach is an environment that’s unambiguous about abiding by the law. But you’re also establishing a paper trail demonstrating your commitment to education about the law. That way, associates can point fingers at you and say you’re lackadaisical about keeping up with changes in the law.

“If I see [risky behaviors] happening routinely in my brokerage, involving more than one salesperson, than am I as a broker not doing a good job educating associates?” asks Boyd.

With the paper trail, you demonstrate that you are, says Marshall. “No one can say you’re not watching the shop.”

Robert Freedman

Robert Freedman is the former director of multimedia communications at NAR.