Avoid the "Domino Effect" of Non-Compliance in Real Estate
Updated: May 3
We are almost halfway through 2023 and given the regulatory landscape that I find myself working in, there are too many pressing issues and topics that I would like to write about, ranging from friendly tips to stern warnings. Due to the nature and volume of my compliance work at the moment, I have no choice but to put forth a hybrid piece which aims to check off both boxes.
Lately, I have been thinking about when I first started my consulting business. Back in 2016, having formerly worked as a Special Investigator for the California Department of Real Estate (DRE), I knew I had something special to offer and that there was a compliance-minded audience out there who needed it. Admittedly though, when I first started working in this field, I sometimes felt like compliance was more an afterthought than an actual priority, or even a luxury item that only some brokers could afford. Some real estate licensees recognized its worth and invested in it, while others simply ignored it or couldn't justify the expense. Interestingly though, over the last seven years, I believe real estate compliance has significantly increased in value. It seems that more and more real estate licensees are learning, and some in a harsher fashion than others, that without regulatory compliance, serious consequences may be incurred.
Our current regulatory climate has definitely played a part in changing this mindset about compliance. Put another way, the DRE, our state regulator in California, is actively enforcing the law and holding real estate licensees fully accountable for their actions. By the way, it's worth noting, a diligent regulator is not a bad thing! In fact, we want our regulators alert and paying attention to the activities of real estate practitioners as consumer protection should always be top of mind. In fact, even real estate agents and brokers want to know that when they witness wrongdoings committed by other licensees in the industry, that these actions and practices will not go unnoticed or unchecked, and that the DRE will appropriately enforce the law.
But the reality is, an active regulator also means that all real estate brokers and agents must stay on point and be vigilant. Even the "good" licensees have something to lose here and can be subject to discipline. This means that every advertisement, representation, claim, practice, client interaction, disclosure, electronic communication and transaction counts. Collectively, these outputs represent an agent's reputation, conduct, compliance and real estate license. Quite frankly, everything that an agent does, and puts out into the real estate universe, are on display for the public, and DRE, to evaluate.
So, these days, when I get asked a simple question about compliance, it seems that there is never a simple answer to provide. I instantly want to educate licensees about what I am seeing, advise them to be thoughtful and cautious, and of course warn them about potential license discipline. I suppose the curse of being a compliance consultant is that I can't help but see 50 feet down the road. In my line of work, I have witnessed, and continue to watch, the impact of irreversible mistakes and missteps, and how they can land a real estate licensee in a very bad spot.
The Domino Effect
Enough (uncorrected) failures or errors could naturally become, or be deemed by the DRE as, a pattern of misconduct. When you couple this pattern of unlawful activity with the general mismanagement of risk, non-compliance, and lack of broker supervision, well now you have something that looks more like falling dominos, or the "domino effect."
While the domino effect is entertaining to watch, it's not when we think about it in terms of real estate and non-compliance. One way to think about it would be, one bad act, by one single agent, conducted under one absentee broker, could actually subject the agent and/or broker to a variety of serious and costly outcomes, including disciplinary action against their license, civil liability, and/or monetary penalties.
Yet another way might be, one misrepresentation by one agent, one misleading advertisement by another agent, both working for the same brokerage, cause two complaints to be filed against the respective agents and their responsible broker at the same time. The DRE audits the brokerage and discovers lack of broker supervision along with multiple violations of law (and to a degree that far exceed the issues or concerns that gave rise to the initial complaints). While this domino effect could have possibly been prevented or mitigated through smart risk management, higher standards of compliance and real estate practice, and broker supervision, regrettably, by this point, it's momentum can't be stopped and the aftermath will likely result in some kind of regulatory action or discipline against the licensees involved.
Moreover, if you lose your balance in this regulatory environment, even just for a brief moment, there may be repercussions that you can't avoid or reverse. As it turns out, risk management is not just a real estate course, it needs to be a state of mind for all real estate licensees otherwise consider yourself fair game for regulators. Given the regulatory scrutiny and stakes, let's review a few relevant tips and warnings to stay focused on, and driven towards, compliance and best practices in the real estate industry.
Tip #1 - Document everything
Being a real estate licensee can be tough. An agent must constantly juggle, consider and adhere to ethical obligations, the standard of care of real estate professionals, and of course the Real Estate law. Frankly, even when an agent does everything right, they could still be named in a civil lawsuit, DRE complaint or both! That's right, even when a real estate licensee has lawfully abided by the letter of the law, they could find themselves in a situation where they have to defend their actions. So how does a real estate licensee protect themself? Well, the right answer requires a comprehensive and versatile set of actions, including compliance with myriad statutory duties and the performance of best practices. One fundamental practice that I would like to focus on is documenting everything in a real estate transaction.
By law, a real estate broker is required to retain all electronic communications in connection with licensed activity, except for those communications of an ephemeral nature [California Business and Professions Code (B&P) 10148]. This means that the broker must retain all of their agents' electronic communications in connection with a real estate transaction. The benefit of relying upon and retaining electronic communications is that it organically replaces the need for keeping a transaction or conversation log. It is precisely the electronic messages that often tell the story of a real estate transaction. For example, an agent's emails may evidence when they delivered pertinent information to their principal, provided material disclosure and reports to the parties, and/or followed their client's written instructions.
The act of using and retaining all electronic communications, in order to document all events, details and activities in a transaction, has become increasingly helpful to licensees, so much so that even if an agent and client are discussing an issue in person, it would be prudent for the agent to send a post-discussion summary email to their client. The purpose of which would be to confirm their understanding of the discussion with their client. This practice helps ensure that all parties are on the same page and agreeable to any terms or conditions discussed, while any misunderstandings or needed corrections between the parties can be quickly identified and addressed.
Notably, what some licensees fail to recognize is that complying with this requirement doesn't just make you compliant; it can actually help keep your real estate license safe by potentially dismissing false claims and accusations. To illustrate the power of electronic communications, imagine a displeased client who claims that their agent failed to disclose a material fact to them during a real estate transaction. They file a complaint with the DRE. In response to the DRE's investigative inquiry and request for documents, the broker produces a text exchange between their agent and client which specifically disproves the client's allegation. In turn, the DRE finds no evidence of unlawful activity against the licensees and close their case. As a former DRE Investigator, I encountered several cases like this where electronic communications specifically refuted allegations of unlawful activity and freed the broker and/or agent from further investigation.
Bottom line, if you are an agent, please make sure that you retain and submit all electronic communications in connection with licensed activity to your responsible broker. If you are broker, you are required to have established policy and procedures in place to ensure that all electronic communications in connection with licensed real estate activity are submitted by your licensees and retained by the brokerage.
As a motivating side note, keep in mind that when a consumer files a complaint against an agent, they normally have, and submit, every email or text communication they had with the agent to the Department. However, if the broker is unable to do the same, it could be a problem depending on the nature of the communication and complaint.
Tip #2 - Delivery of Termite Reports
A real estate licensee has a duty and responsibility to disclose any and all material information which they are aware of affecting the value or desirability of real property. With this duty comes the disclosure and delivery of any and all property reports. Specifically, when it comes to the delivery of termite inspection and completion reports, the DRE is authorized to enforce compliance in this area [Commissioner's Regulation (Reg.) 2905].
This requirement is certainly not new, but warrants a reminder and tip. When acting as an agent for the seller, please be sure that you deliver all termite reports, including, but not limited to, inspections, re-inspections, supplementals and completion reports, to the buyer's agent and/or buyer. For example, if two termite inspection reports exist, that were issued by two different companies, both reports must be disclosed and provided. An agent is not allowed to pick and choose which termite report that they provide to a buyer.
As a former Investigator for the DRE, I have investigated these types of cases where an agent is guilty of intentionally withholding, or failing to disclose, all termite reports to the buyer, including reports which evidence more termite issues with the property. As you might suspect, these complaints are easier to investigate since there is no excuse that the agent can provide to justify their unlawful conduct. The name of the game is disclosure, and the proper delivery of all material information to the parties is integral to the success of a compliant real estate transaction.
Equally important to the disclosure of such reports is retaining the buyer's written receipt of the same. Without the buyer's written receipt of any and all termite inspection and completion reports, which is tantamount in my opinion, a broker does not have the proper evidence to prove that they abided by the law. By the way, I hate to say it, but accidental mishaps in this area are not taken lightly. By example, an agent who thinks they provided a termite report to their principal, but later discovers that they made an error and/or they have no evidence to prove that they did, may still be held liable.
Unfortunately, an agent's unintentional mistake does not preclude the broker from regulatory evaluation. In fact, if you are the broker supervising the agent in this situation, your supervision of that agent (as well as your entire brokerage) will have to answer to this claim and other general questions about how the disclosure and delivery of termite reports are handled, supervised and monitored.
The brass tax: if you are an agent, it's your responsibility to disclose all reports, including termite reports, and obtain written receipt of delivery. If you are a broker, it's your duty to make sure that all agents are knowledgeable about, and comply with, this requirement and that all reports, and evidence of written receipt regarding the same, are retained by the brokerage.
Tip # 3 - Clear and Unambiguous Terms and Disclosure
Working as both a real estate compliance consultant and expert witness, I often see first-hand how badly worded disclosure or contracts can lead to a real estate dispute, or worse, a regulatory or civil complaint. When you work in real estate, it is absolutely paramount that brokers and agents prepare clear and unambiguous real estate contracts and disclosure. When the real estate paperwork lacks clarity, a real estate licensee put their clients, and own license, in jeopardy.
The good news is, before material documents are signed by the parties, there is time, or a golden opportunity if you will, to prevent potential issues. If you are an agent, you should be reviewing material documents with your broker or designated licensed supervisor before presenting them to principals, especially when you encounter situations or transactional events that are outside of your experience level or expertise.
If you are a broker, you are required to have an appropriate system in place to review, supervise and monitor material documents that are being prepared by your licensees and executed by principals [B&P 10159.2 and Reg. 2725]. Take dangerous guesswork and misleading wording out of the equation through the establishment of policy or rules, along with adequate training, that help agents prepare clear and unambiguous real estate documents. If your agents have questions or concerns, a responsible broker should make sure that their licensees have access to leadership, resources and guidance.
Something to think about, if an agent submits real estate paperwork to their broker, mid-transaction or before the closing, and they are problematic or deficient, it is part of the broker's responsibility to monitor this activity and make sure that issues are identified, addressed and/or corrected in a timely manner. Coincidentally, a lot of badly written contracts or disclosure that give rise to real estate disputes or claims, are not supervised by responsible brokers, and are only discovered by these brokers once they become a legal or regulatory problem.
Tip # 4 - Conflicts of Interest
If you asked me what types of real estate transactions or activities typically garner issues or regulatory review, I would say any licensed activity involving a conflict of interest. If an agent or broker is acting in more than one capacity, or "wearing more than one hat" in a real estate transaction, then clear and timely written disclosure is required.
For example, if an agent is acting as both a principal and real estate licensee, then that should be clearly disclosed in writing to all parties as soon as the agent becomes aware of this conflict of interest. Another example is when a real estate broker acts as both a broker and escrow holder in a real estate transaction. Broker-controlled escrow transactions come under the DRE's purview and among other requirements, the relationship between the brokerage and its in-house escrow division must be fully disclosed. Finally, another situation that comes to mind, is if a broker or agent, acting as a licensee on behalf of the buyer, has ownership in the property that is being sold. These scenarios present conflicts of interest which need to be identified, addressed and disclosed to the parties at the outset of the transaction.
Essentially, if you are an agent, it is best to tread carefully here. If you fail to fully disclose your role(s), or any conflicts of interest, to the parties in a real estate transaction, then you could find yourself in serious hot water if a complaint is filed with the DRE or you are sued. Additionally, if you fail to disclose any conflicts of interest that you are aware of to your responsible broker, you could find yourself in violation of your broker's rules too. When this happens, you will likely not have any ally to lean on for support in the event of a DRE investigation. Please check out an article that I wrote on rogue real estate agents as it captures the problems of operating in this regard.
If you are a broker, then you should have established policy and procedures in place which adequately cover the definition and identification, as well as reporting and disclosure, of conflicts of interest. It would be best to employ a policy where agents must report or notify the broker of any conflicts that they have up-front and prior to commencing in any related licensed activity. By doing so, the broker and agent can work together to ensure that no activities run afoul of the law.
Tip # 5 - Supervision
So, how do you prevent all of the dominos of compliance from falling down and wreaking regulatory havoc? Well, one way to prevent non-compliance is through reasonable and effective broker supervision. A real estate broker is actually required to perform reasonable supervision over their firms, agents and licensed activities [B&P 10159.2 and Reg. 2725]. While supervision is mandated by law and real estate brokers are required to comply, the truth is, if you are a responsible broker with a salesforce of agents to oversee, then effective supervision is your only way to survive (and protect your real estate license) in this industry.
As you might recall, I started this piece by telling you that even good agents or brokers can get in trouble. These days you don't have to commit fraud, or intentionally violate the law, to be investigated and prosecuted by the DRE. So, what does this mean for licensed real estate professionals? Well, as I always preach, broker supervision is everything. A firm's compliance with the law is only as good as their agents' compliance with the law. Therefore, the only way for a broker to ensure the right outcomes and consistently stay compliant is through risk management together with the establishment of policy, procedures, rules and systems that review and oversee all licensed activity and practices.
It should be noted that if you are a broker reading this article, and do not have any established policy and procedures in place, please consider this your wake-up call. At a minimum, and as I mentioned before, a broker is required to establish policy and procedures to ensure compliance with the Real Estate law. However, the real task at hand, is the creation of an appropriate system to ensure that your policy and procedures are properly adhered to by all of your agents, and that real compliance is actually being achieved through every advertisement, client interaction, email communication, disclosure and transaction.
Now if you are a real estate agent, you want to be properly supervised. You want to be guided by your responsible broker on what to do and what not to do. To be able to ask questions and obtain reliable answers and guidance. Conversely, if you work for a brokerage where there is no leadership, established policy and procedures, reliable transaction checklists to refer to, and/or access to quality assistance when you need it, then lack of brokerage supervision becomes your problem too.
In my opinion, effective broker supervision makes the real estate world go around, and both brokers and agents play a part, and have an interest, in its success. Namely, it is imperative for brokers to abide by the law and set up proper controls and policy that will be diligently supervised, monitored and enforced to ensure compliance, and for agents to faithfully and continually abide by their broker's rules, and be compliance-minded in all aspects of their real estate business from their advertising to professional conduct and transactions.
When it comes to real estate contracts, we all know that time is of the essence, I believe the same could be said of achieving regulatory compliance in real estate. Based upon what I am seeing in the industry, and the DRE's enforcement activity, the time to get compliant is now. Evaluate your real estate compliance, and if changes are necessary, take the appropriate corrective actions as swiftly as possible and hopefully before you have to potentially answer to the DRE.
NOTE: Summer Goralik is a real estate compliance consultant. Any opinions, suggestions or recommendations contained in this article are based on her experience working for, and knowledge of the laws enforced by, the Department of Real Estate, and must not be considered legal advice. Please contact a licensed real estate attorney for legal support.
About the Author
Summer Goralik is a Real Estate Compliance Consultant and licensed Real Estate Broker (#02022805). Summer offers real estate brokers a variety of consulting services including assistance with California Department of Real Estate investigations and audit preparation, mock audits, brokerage compliance guidance, advertising review, and training. She helps licensees evaluate their regulatory compliance and correct any non-compliant activities. Summer has an extensive background in real estate which includes private sector, regulatory and law enforcement experience. Prior to opening her consulting business in 2016, she worked for the Orange County District Attorney's Office as a Civilian Economic Crimes Investigator in their Real Estate Fraud Unit. Before that, Summer was employed as a Special Investigator for the DRE for six years. Among many achievements, she wrote several articles for the DRE, four of which were co-authored with former Real Estate Commissioner Wayne Bell. Prior to her career in government and law enforcement, Summer also worked in the escrow industry for nearly five years. For more information about Summer's background and services, please visit her website, www.expertdrecompliance.com