Co-marketing Program May Violate RESPA, Court Rules

Financial Services Law

Ruling on an amended complaint, a Washington federal court refused to dismiss a securities class action alleging that Zillow’s co-marketing program violated the Real Estate Settlement Procedures Act (RESPA).

The order was something of a surprise, given that the court had previously granted Zillow’s motion to dismiss based on a prior version of the complaint.

What happened

A group of plaintiffs filed suit against Zillow, asserting violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 as well as a violation of Securities and Exchange Commission Rule 10b-5. The suit also named the company’s chief executive officer (CEO) and chief financial officer/chief legal officer (CFO) as defendants.

The plaintiffs alleged that Zillow’s co-marketing program was designed to allow participating real estate agents to refer mortgage business to participating lenders in violation of Section 8(a) of RESPA. In addition, the defendants made a series of misleading statements about the company’s legal compliance by failing to disclose the co-marketing program’s alleged illegality, particularly after the Consumer Financial Protection Bureau (CFPB) launched an investigation into the program, according to the complaint.

As a result of the defendant’s misrepresentations about the company’s legal compliance, the plaintiffs purchased Zillow stock at artificially inflated prices, they told the court.

The defendants moved to dismiss the case, and the Washington federal court granted the motion—albeit without prejudice and with leave to amend.

In response, the plaintiffs amended their complaint, adding new allegations to back up their theories of RESPA liability and including statements from two anonymous witnesses (AW1 and AW2), both of whom worked for Zillow during the relevant time period, to support their allegations.

AW1 was a regional sales manager who was responsible for overseeing a team of sales representatives tasked with upselling and cross-selling to existing co-marketing customers. In her affidavit, she stated that co-marketing lenders received fewer leads than their co-marketing agents but continued to participate in the program because “lenders expected real estate agents to refer business.” She also stated that she did not believe “lenders recoup[ed] advertising costs through leads from the Zillow site but through the referral relationship forged with the real estate agent.”

She stated that she was personally aware of real estate agents providing their co-marketing lenders with access to their Zillow accounts so that the lender could obtain the agent’s leads in cases where prospective homebuyers had opted out of giving their contact information to the lender.

A sales and operations trainer, AW2 stated that “[e]very agent and lender knew that the co-marketing program was for the lender to get leads and referrals” and that “everyone knew that the lenders paid the agents for leads and referrals,” emphasizing that “it was understood that lenders were paying for referrals.”

The statements of the AWs, coupled with adequate corroborating details (such as how Zillow made changes to the co-marketing program in the beginning of 2017 during the CFPB’s investigation, the information contained in a consent judgment with the CFPB that allowed a reasonable inference that it was Zillow, and the design of the co-marketing program) and the allegations of the second amended complaint, were sufficient to survive the motion to dismiss.

“Based on the anonymous witnesses’ statements, as well as the other allegations in the second amended complaint, the Court can draw a reasonable inference that Zillow designed the co-marketing program to allow agents to provide referrals to lenders in violation of RESPA, and that such referrals were occurring,” U.S. District Judge John C. Coughenour wrote.

“The second amended complaint contains particularized facts alleging that there was an understanding between Zillow and the co-marketing participants, that in exchange for lenders paying a portion of agents’ advertising costs, lenders would receive mortgage referrals from their partnering agents. That arrangement – although not ostensibly based on an oral or written agreement – is evinced by participating agents allegedly providing, and Zillow allegedly tracking, referrals to participating lenders.”

These allegations were sufficient to support an “agreement or understanding for the referral of business” based on a “pattern or course of conduct” in violation of RESPA, the court said, with occurring violations based on the testimony of AW1 and AW2 regarding how participants were using the co-marketing program and the structure of the program itself.

The defendants’ arguments to the contrary were unavailing, the court found, refusing to ignore or minimize the statements of the AWs. Further, the second amended complaint sufficiently alleged that the co-marketing program was not protected by RESPA’s safe harbor because it permitted lenders to pay a greater share of the marketing budget than was justified by the number of leads provided by the program, the court said.

According to the plaintiffs, Zillow charged agents each time a user viewed a listing and not when a customer generated a lead, meaning that lenders were paying more than fair market value for co-marketing advertising. In addition to the statements of AW1 and AW2 to back up these allegations, the court noted the claims found in a 2015 wrongful termination lawsuit filed against Zillow, where two former employees alleged they were fired after reporting similar RESPA violations to upper management.

“Based on the … allegations, the court can draw a reasonable inference that Zillow designed the co-marketing program to allow lenders to pay more than fair market value for the advertising they received and therefore fell outside RESPA’s safe harbor provision,” Judge Coughenour wrote.

The plaintiffs alleged not only that lenders were paying more than 50 percent of an agent’s advertising costs but that Zillow, through its design of the program and inaction in enforcing the spending cap, was allowing the practice to occur, the court said.

Turning to the issue of misleading statements, the court found that the company’s filings with the SEC, where it stated that it was in compliance with governing laws and regulations, were materially misleading based on the allegations in the second amended complaint.

“Defendants’ omission of such facts – for example, Zillow inquiring about and tracking agent’s referrals, or that the co-marketing program allowed lenders to pay more than the fair market value for advertising – make their opinion about its general legal compliance materially misleading,” the court wrote.

As for the challenged statements about legal compliance made by the CEO and CFO (for example, “We think the way we’ve constructed the program is completely compliant and allows agents and lenders to stay within the confines of the laws that govern this,” during a television interview), Judge Coughenour determined that they could also be materially misleading and satisfied the scienter requirement when the allegations in the second amended complaint were viewed holistically.

Both the CEO and CFO “made numerous statements displaying their familiarity with how the co-marketing program was designed and operated,” the court said, meaning it could “reasonably infer that they would have been aware of those aspects of the co-marketing program that plaintiffs have plausibly alleged violated RESPA.”

Considering the new allegations contained in the plaintiffs’ second amended complaint, the court denied the defendants’ motion to dismiss the Securities Act claims. The decision wasn’t a total victory for the plaintiffs, however, as the court granted the defendants’ motion to dismiss claims brought under the Consumer Financial Protection Act.

To read the order in In re Zillow Group, Inc. Securities Litigation, click here.

Why it matters

The decision is particularly problematic for Zillow. After Zillow won its first motion to dismiss the class action—and dodged a CFPB investigation over similar allegations—the new order not only allows the suit to move forward against the company, but also opens the door to liability both for the company itself as well as for two executives, the CEO and the CFO.



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