Loan Broker Compensation – Ethical And Legal Considerations

Mark SunshineBroker compensation is a hot topic for those in the financial services industry. Over the past few months, I’ve personally been asked about it numerous times, particularly in regard to finder’s fee arrangements. These agreements can be potential minefields of ethical and legal problems. While I want my firm, Veritas Financial Partners, to be a competitive lender, and compensating a network of brokers helps us get more loans, some of the fee arrangements seem to me to be not only unethical, but also illegal. At last month’s IFA conference, I learned that other CEOs were facing the same dilemma.

There are certainly situations where no ethical or legal issues exist in paying a loan broker a finder’s fee.  However, there are times when payment is more like a “back-alley” payoff. And I’ve been in the business long enough to know that if something has to be kept a secret, it usually means trouble.

After listening to my peers at the IFA conference, I decided to seek legal advice. I consulted Bijan Amini of Storch Amini & Munves PC, a seasoned commercial litigator who has counseled clients on this issue many times over the course of his career.

Bijan confirmed that the potential exists for civil and criminal liability when paying finder’s fees.  He mentioned some pretty frightening legal considerations: commercial bribery, commercial fraud, mail and wire fraud, and bank and lending fraud. The good news is that the standards for avoiding trouble are pretty simple: make sure that all interested parties know and understand the proposed finder/broker compensation arrangements.

Below are some specific examples of finder’s fee arrangements that Bijan and I discussed and our conclusions.

Finder/broker has a written agreement with lender. Borrower knows that the finder/broker is working for lender. This is an easy situation. Generally, there is no problem paying the finder/broker.  It’s still a good idea for the lender to obtain written closing representation from the borrower stating that the borrower doesn’t have a contractual relationship with the finder/broker and to confirm that the borrower knows the finder/broker is being paid by the lender.

Finder/broker is a loan broker or firm that contacts lender to discuss a prospective borrower.  Finder/broker requests no compensation from lender. This is also an easy one. The lender is in the clear to close the loan.

Finder/broker is a loan brokerage firm that contacts lender to discuss a prospective borrower.  Finder/broker requests compensation from lender. This fact pattern is fraught with risk.  Before even proceeding with a loan proposal, the lender must first clarify the finder/broker’s relationship with the borrower and must do so directly with the borrower.  It is possible that the finder/broker has no contractual relationship with, or fiduciary duty to, the borrower.  In such case, the lender can agree to pay the finder/broker. However, it may also be the case that finder/broker is “double dipping” on fees, without the borrower’s permission or knowledge, and is steering the loan to the lender willing to pay the most compensation to the broker/finder. The lender cannot proceed without first discussing the situation with the prospective borrower. If the borrower agrees, in writing, on the lender’s relationship with the finder/broker, the lender can proceed without concern.

Finder/broker is an individual and a full-time employee of another firm.  The individual asks for personal compensation. It is a very bad idea to compensate another firm’s employee without disclosure and written approval of both the employer and the borrower. If the lender pays an employee of another firm, or suggests that such compensation is possible, without prior written disclosure and approval, the lender is exposed to potentially serious civil and criminal liability.  In more than 30 states, the payment may be considered commercial bribery, and Federal mail and wire fraud are also implicated. The potential for disaster increases if the individual works for a bank or brokerage firm. And paying a designee, such as the individual’s wife or child, only makes things worse.

Finders and brokers are a great source of business, but only when compensation meets the highest legal and ethical standards. Knowledge of the above scenarios will help to avoid the potential legal and ethical pitfalls of finder’s fee agreements.

Author: Mark Sunshine is the Chairman and CEO of Veritas Financial Partners, a leading financial services firm providing senior secured loans to middle market businesses and comprehensive credit management services to banks and other financial institutions.

Prior to founding Veritas, Mr. Sunshine was the President of First Capital and the President and CEO of Siemens First Capital. Both companies were global commercial lenders.

For more information about Mark Sunshine, visit http://www.profnetconnect.com/mark_sunshine or http://www.vfpfinancial.com/

7 Comments

  1. This is very simple. As a life long Corporate Finance Consultant / Investment Banker. We never represent or are paid by the lender. We represent the borrower to obtain the best deal and best fit for our client. Our compensation comes strictly from our client / borrower.

    Dan Flick
    Managing Partner
    Infinity Financial Group
    Dallas, TX

  2. Mark..thanks for publishing this. In the small ticket arena this issue is even more prevalent (and abused accordingly). The ELFA Code of Conduct published addresses this as well. We need to have reform, some of which needs to come from some off of the MLFI-25 list.

  3. Great article. You must know what “master” is being served and you can never serve more than one. Business dealings should always be by the “golden rule” and self serving dealings is often a fraud flag.

  4. Great article!

    More information like this needs to be disseminated to the financial services
    industry, as their seems to be a gray area concerning broker fees/finders fees.

    It’s very simple if you have a fee agreement in place with the client, advise
    lender of this. If being compensated by lender advise client. Also if being
    compensated by the lender no need to hit the client, with huge “up-front fees”
    (processing, application, packaging etc).

    For Brokers it is in our best interests to be as ethical as possible,
    in order to not burn bridges with clients or lenders. After all they
    are the life-blood of our business.

    As Mark stated communication among all parties is key to staying out of trouble.

  5. Good overview of the potential pitfalls and abuses, Mark, and the critical need for transparency.
    On a related matter, it seems that regular old ABL deals or any kind of senior debt deals may fall under FINRA regulatory scrutiny, meaning loan brokers may be required to have a broker/dealer license –which is more likely to pose problems if the client is a public company or the deal is a large one. Thoughts?

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