After crossing the $250 million asset threshold, your institution is subject to heightened requirements to avoid conflicts of interest when your institution’s employees perform or review property valuations. 12 CFR 1026.42(d)(2). Even though your institution’s valuations are produced by a third party, the employees who review those valuations are subject to Regulation Z’s conflict of interest rules. In addition, any employee that selects or contracts with the third party that performs valuations is subject to Regulation Z’s conflict of interest rules. 12 CFR 1026.42(b)(4). Generally, the rule provides a safe harbor if your institution separates functions related to obtaining and reviewing valuations from the “loan production function.” (The term “loan production function” includes any employee that generates or approves consumer loans secured by a consumer’s principal dwelling. 12 CFR 1026.42(b)(1).)

The rule provides a “safe harbor” from the conflict of interest rules if a creditor meets three requirements. If you meet all three requirements, your institution will qualify for the safe harbor, meaning that you will be deemed to be in compliance with Regulation Z’s conflict of interest rules. In essence, the three requirements ensure that your loan production employees (those who generate or approve loans subject to the rule) are separated from your valuation employees (those who prepare, oversee, or review valuations and those who select or contract with the company that prepares valuations for your institution).

Requirements for Valuation Employees

Two of the three requirements apply to your valuation employees. First, your institution cannot base a valuation employee’s compensation on the property value arrived at in the valuation. 12 CFR 1026.42(d)(2)(i). Second, a valuation employee must not report to a loan production employee — nor to any employee who receives compensation based on the closing of the particular loan to which the valuation relates. 12 CFR 1026.42(d)(2)(ii). According to the official staff comments, this requirement means that a valuation employee cannot be “directly supervised or managed by a loan officer or other person in the creditor’s loan production function, or by a person who is directly supervised or managed by a loan officer.” Official Interpretations, 12 CFR 1026, Paragraph 42(d)(2)(ii), Comment 1.

Requirements for Loan Production Employees

The third requirement applies to your loan production function employees, officers, and directors. No employee, officer, or director in the loan production function may select, retain, recommend, or influence the selection of your valuation employees or of a third party that performs valuations for your institution, whether directly or indirectly. 12 CFR 1026.42(d)(2)(iii). According to the official staff comments, this means that a valuation employee cannot have a supervisor or manager who also supervises or manages loan officers. Official Interpretations, 12 CFR 1026, Paragraph 42(d)(2)(iii), Comment 1.

Further Reading

Due to the complexity if these requirements, we recommend reviewing Paragraph (d)(2) in full, and we have attached a copy of the rule and the relevant official comments for your reference. Also, the Federal Reserve Bank of Philadelphia’s Consumer Compliance Outlook publication has released a helpful article that summarizes all of Regulation Z’s valuation requirements.

Paragraph 1026.42(d)(2) states that a valuation employee “does not have a conflict of interest in violation of paragraph (d)(1)(i) of this section based on the person’s employment or affiliate relationship with the creditor if:

“(i) The compensation of the person preparing a valuation or performing valuation management functions is not based on the value arrived at in any valuation;

“(ii) The person preparing a valuation or performing valuation management functions reports to a person who is not part of the creditor’s loan production function, as defined in paragraph (d)(5)(i) of this section, and whose compensation is not based on the closing of the transaction to which the valuation relates; and

“(iii) No employee, officer or director in the creditor’s loan production function, as defined in paragraph (d)(5)(i) of this section, is directly or indirectly involved in selecting, retaining, recommending or influencing the selection of the person to prepare a valuation or perform valuation management functions, or to be included in or excluded from a list of approved persons who prepare valuations or perform valuation management functions.”