A Christian Ministry’s Fundraising Violated Federal Securities Laws

Churches should never assume they are automatically exempt from federal regulations when raising funds by selling securities.

Richard R. Hammar, Attorney, CPA

Bio

State: Maine
Categories: Fraud

Key point 9-04. Federal and state laws regulate the offer and sale of securities for the protection of the investing public. In general, an organization that issues securities must register the securities, and the persons who will be selling the securities, with state and federal agencies. In addition, federal and state laws contain a broad prohibition on fraudulent activities in the sale of securities. Churches are exempt from some of these requirements in some states. However, they remain subject to the prohibition of securities fraud in all 50 states, and under federal law.

A federal court in Maine found that a promoter of Christian concerts had violated federal securities laws as a result of his offer and sale of unregistered securities and fraudulent statements made to prospective investors.

Ministry seeks investors to repay debt

A Christian ministry (the “defendant”) promoted, organized, and hosted Christian music concerts and festivals. In order to host a music concert or festival, the defendant paid certain expenses upfront, such as deposits for artists and venues, radio promotions, and other production-related costs. Its primary source of revenue was ticket sales, which included advance sales on its website as well as direct sales at the music venue.

As early as 2014, the defendant began borrowing money from companies that provide short-term cash advances to small businesses in need of immediate cash flow. It borrowed approximately $700,000 from more than one dozen cash-advance companies.

The defendant was unable to repay on schedule all of the debt incurred from cash advances. To raise needed funds, the defendant began offering investments in promissory notes. From January 2014 through October 2018, the defendant raised more than $3.1 million from 149 investors.

The defendant solicited promissory-note investors through a number of different in-person and electronic means, including email blasts to solicit investors, using the email addresses obtained through online ticket sales and through the entry of email addresses by those who visited the defendant’s website to indicate interest in becoming “financial partners.”

A typical mass solicitation email stated: “Become a financial partner with our summer festivals. Help us spread the message of Christ plus earn 20% on your investment. To learn more please e-mail [us].”

The defendant did not have any information about these individuals’ finances or level of sophistication in making investments at the time it sent these email blasts. Similarly, prior to accepting investor money and executing promissory notes, it did not ask investors about their finances or investment experience.

The defendant contacted potential investors who showed interest in learning more about the specific terms of the offered investment by email and phone. The defendant falsely represented that investor money would be used exclusively for costs associated with its music concerts and festivals.

Some promissory notes specified the particular concert or festival for which the investor’s funds would exclusively be used, while others were more general. The defendant never implemented any mechanism to track the use of investor funds to ensure that they were used exclusively for the stated purpose.

The defendant “guaranteed” the repayment of the promissory notes in monthly installments with a fixed annual return ranging from 10 percent to 25 percent. It told prospective investors that the promissory notes were “secured,” explicitly stating to some investors that repayment of principal plus interest was not dependent on the success of any concert or music festival. And it claimed that all prior investors had been paid back 100 percent of the money invested. However, by at least 2016, the defendant had failed to fully repay some investors and had failed to pay a single installment to others.

The defendant did not disclose to investors its deteriorating financial condition from declining ticket sales, its growing debt to other individual investors and commercial lenders, or that the only way it could repay potential investors was if the concerts and festivals were profitable. It obtained investor funds as a result of these misstatements and omissions.

The defendant did not register the promissory notes with the Securities and Exchange Commission (SEC).

The SEC claims the defendant committed fraud

The SEC sued the defendant claiming that it had committed fraud in the offer or sale of securities and sold unregistered securities in violation of the federal Securities Act. A federal court ruled summarily in favor of the SEC. The court permanently enjoined the defendant from the sale of securities and ordered it to pay damages of $1,800,000 in gains it realized from its fraudulent conduct.

A federal appeals court affirmed the SEC position. It noted that the federal Securities Act prohibits “fraud and other deceptive practices” in connection with the purchase and sale of securities.

To prove securities fraud, the SEC must demonstrate that a defendant: “(1) made a material misrepresentation or a material omission as to which it had a duty to speak . . . (2) with scienter (i.e., a conscious intent to defraud); (3) in connection with the purchase or sale of securities.”

The court concluded that the SEC’s evidence “suffices to establish that [the defendant] made material misstatements and omissions with scienter in connection with the purchase and sale of securities . . . in violation of . . . the Securities Act.” It noted:

First, the SEC demonstrates that [the defendant] solicited investors through multiple, repeated, brazen misrepresentations about the offered promissory notes, including the use to which [it] would put investors’ money, the guarantee of a profit of between 10 and 25 percent, the claim that the investments were “secured,” and the assertion that prior investors had been paid back in full . . . while simultaneously omitting to disclose its deteriorating financial condition, growing debt, and inability to fully repay investors. . . .

Second, the SEC establishes that the misrepresentations and omissions were material, that is, that there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. . . . In this case, as the SEC argues, a reasonable investor would want to know that (i) his or her investments were not “secured,” (ii) the promised return was not “guaranteed,” (iii) the defendant had implemented no mechanism to track investors’ funds to ensure they were used for the stated purposes and had used investor funds to pay personal expenses, (iv) the defendant’s financial condition had been deteriorating, and (v) the defendant did not in fact repay 100 percent of prior investors. . . .

[Third] the SEC demonstrates that the defendant acted with scienter. It made repeated false representations about the safety and security of the investments at issue, including that repayment was “guaranteed,” the investments were “secured,” and all prior investors had been paid back 100 percent, while using invested funds to repay high-interest debt and other personal expenses as well as to repay prior investors and failing to disclose the defendant’s deteriorating financial condition.

What this means for churches

Laws regulating the sale of securities have been enacted by the federal government and by all 50 states. The term security is defined very broadly by such laws to include many instruments utilized in church fundraising efforts, including bonds, notes, and trust agreements.

Securities laws were enacted to protect the public against fraudulent and deceptive practices in the sale of securities and to provide full and fair disclosure to prospective investors. To achieve these purposes, most securities laws impose the following conditions on the sale of securities:

registration of proposed securities with the federal or state government in advance of sale

filing of sales and advertising literature with the federal or state government

registration of agents and broker‑dealers who will be selling the securities

prohibition of fraudulent practices

Although the federal government and most states exempt securities offered by any organization “organized and operated not for private profit but exclusively for a religious . . . purpose” from registration, it is important to note that some states do not exempt the securities of religious organizations from registration. Other states impose conditions on the exemption. Many require that an application for exemption (or “notice” of exemption) be submitted and approved before a claim of exemption will be recognized. A few states require churches and religious denominations that “issue” their own securities to register as issuers or issuer-dealers. Further, all securities laws subject churches and other religious organizations to the antifraud requirements.

Churches therefore must not assume that any securities that they may offer are automatically exempt from registration or regulation. Put another way, all churches that offer or sell securities will be subject to state and federal securities laws—the only question is to what extent.

It is important to note that the antifraud provisions of federal and state securities laws are very broad, and some churches have violated them without knowing it. For example, the following activities have been deemed to be fraudulent:

making false or misleading statements about church securities

failing to disclose material risks associated with securities

manipulating the church’s financial records in order to facilitate the sale of securities

failing to establish a debt service or sinking fund reserve out of which church securities will be retired

making false predictions

recommending the sale of securities to investors without regard to their financial condition

inducing transactions that are excessive in view of an investor’s financial resources

borrowing money from an investor

commingling investors’ funds with the personal funds of another, such as a salesman

deliberately failing to follow an investor’s instructions

making unfounded guarantees

misrepresenting to investors the true status of their funds

representing that funds of investors are insured or “secure” when in fact they are not

representing that investments are as safe as if they had been made in a bank, when this is not the case

representing that securities have been approved of or recommended by the state securities commission or that the commission has passed in any way on the merits or qualifications of the securities or of any agent or salesman

Bottom line: Churches should never consider using securities to raise funds without the counsel of an experienced securities attorney. SEC v. Wall, 2020 U.S. Dist. LEXIS 56152 (D. Me. 2020).

Legal Developments

A Murder Confession to a Pastor Not Considered Privileged

The defendant waived clergy-penitent privilege by sharing substantial statements with others.

Richard R. Hammar

State: Maine
Categories: Confidential and Privileged Communications

Key point 3-08.05. In most states a counselee can waive the clergy-penitent privilege by disclosing the privileged communication to someone other than the minister. In some states the minister also may waive the privilege.

The Supreme Judicial Court of Maine ruled that a murder suspect’s confession to a pastor was not protected from disclosure at his trial by the clergy-penitent privilege because the privilege had been waived.

Background

In 1980, a 16-year-old girl was abducted and murdered by a teenage boy (the “defendant”) while jogging in her neighborhood. The body was found the next day in a wooded area near a public high school. Although the defendant was identified as a suspect in the victim’s death early on in the investigation, he was not questioned during the first months of the investigation because of injuries he suffered in a car accident.

A year after the murder, the defendant had his stepfather drive him to a local parsonage so that he could meet with a pastor.

During that meeting, the defendant revealed to the pastor that he had killed the victim by hitting her with a pole with a knob on it, but stated that he did not sexually assault her. The pastor told the defendant that he did not believe his statement that he had killed the victim and that he would only believe him if he told his mother and stepfather what he had done.

The defendant’s mother and stepfather arrived at the parsonage at the pastor’s request, and the defendant told them that he had killed the victim. Afterward, the pastor drove the defendant to the local police department, where he met with two detectives.

During the interview with the detectives, the defendant stated that the victim had been tied with a rope, and that he “had a feeling” that three adolescent males had sexually assaulted her. The defendant added that the victim had kicked him in the leg and that he hit her once with an insulator he found on the ground. The defendant was not arrested after the interview.

In June 1989, eight years later, the defendant began working at a community college as a janitor. During his first night on the job, he met with his supervisor, who asked him some questions to get to know him. After learning that he was from the town where the victim had been murdered, the supervisor asked if he knew about the case. The defendant responded that he knew about the murder because he was the one who had killed the victim with a glass insulator. The supervisor later asked why he had not been arrested, and the defendant proclaimed that he had “beat” all of the interviews.

Trial court: pastor could testify

In March 2016, 27 years later, the defendant was indicted for the victim’s murder.

A critical piece of evidence was the defendant’s confession to the pastor. The trial judge ruled that the pastor could testify about the confession because the defendant had “waived” the clergy-penitent privilege. The court found the defendant guilty of murder and imposed a 45-year sentence of incarceration.

Disclosing “a significant part of the privileged matter” to others

The defendant appealed to the state supreme court, claiming that the trial court erred when it found that the defendant had voluntarily waived the clergy privilege by repeating to his mother, stepfather, and law enforcement officers substantial portions of the statements that he had made to the pastor.

The supreme court agreed that the defendant had waived the clergy privilege and, therefore, the pastor could testify at his trial concerning the confession. It quoted the Maine clergy-penitent privilege statute: “A person has a privilege to refuse to disclose, and to prevent any other person from disclosing, a confidential communication made to a member of the clergy who was acting as a spiritual adviser at the time of the communication.” However, the statute goes on to provide that a person waives the privilege “if the person . . . voluntarily discloses or consents to the disclosure of any significant part of the privileged matter.”

The court concluded:

[T]here is competent evidence in the record that the defendant disclosed to his mother and stepfather a significant part of the confidential communication he made to the pastor. Although the defendant did not disclose to his mother and stepfather every detail of the information that he had disclosed to the pastor, he disclosed a significant part of the privileged matter, namely, that he had killed the victim. . . . Therefore, the trial court did not err in determining that the defendant had waived the religious privilege.

What this means for churches

Not all conversations with a pastor are protected against future disclosure in court by the clergy-penitent privilege. While the definition of this privilege varies slightly from state to state, it is generally acknowledged that only confidential communications made to a pastor acting as a spiritual adviser can be privileged.

As this case illustrates, pastors may be compelled to testify regarding confessions shared with them in confidence if the counselee waived the privilege by communicating substantial portions of what he or she shared with a pastor to others. State v. Fournier, 203 A.3d 801 (Me. 2019).

Legal Developments

Sexual Misconduct by Clergy, Lay Employees, and Volunteers

The Maine Supreme Court ruled that a Catholic diocese could be sued on the basis of negligent supervision and breach of a fiduciary duty for a priest’s molestation of an adolescent male.

Richard R. Hammar, Attorney, CPA

Bio

State: Maine

Key point 4-08
. Every state has a child abuse reporting law that requires persons designated as mandatory reporters to report known or reasonably suspected incidents of child abuse. Ministers are mandatory reporters in many states. Some states exempt ministers from reporting child abuse if they learned of the abuse in the course of a conversation protected by the clergy-penitent privilege. Ministers may face criminal and civil liability for failing to report child abuse.

Key point 10-09.1
. Some courts have found churches liable on the basis of negligent supervision for a worker's acts of child molestation on the ground that the church failed to exercise reasonable care in the supervision of the victim or of its own programs and activities.

Key point 10-13.1
. A few courts have found churches and denominational agencies liable on the basis of a breach of a fiduciary duty for the sexual misconduct of a minister. In some cases, the church or agency is found to be vicariously liable for the minister's breach of a fiduciary duty, but in others the church or agency is found to have breached a fiduciary duty that it had with the victim.

The Maine Supreme Court ruled that a Catholic diocese could be sued on the basis of negligent supervision and breach of a fiduciary duty for a priest's molestation of an adolescent male who served as an altar boy and attended a church school, and whose parents were partially incapacitated and unable to fully oversee his upbringing.

An adult male (Michael) sued a priest who allegedly molested him when he was a minor, and a Catholic diocese. The lawsuit alleged several theories of liability, including negligent supervision and breach of a fiduciary duty. A trial court dismissed all claims, and Michael appealed to the state supreme court.

Negligent supervision

Michael claimed that the diocese was responsible for his injuries on the basis of its "negligent supervision" of the priest after learning of his propensity to sexually abuse boys and its failure to report him to the police and notify members of the parish. The court stressed that "the constitutional guarantee of religious freedom mandates that we carefully balance the relevant societal interests and the potential interference with religious freedom when assessing claims against religious organizations based on allegations of abusive conduct by members of the clergy."

It concluded that a "special relationship" between a church and a victim of clergy sexual abuse "may give rise to a duty on the part of the church to prevent harm caused by the intentional acts of its clergy."

Fiduciary relationship

Michael's claim of a fiduciary relationship was based on the fact that throughout the seven-year period that he was abused by the priest, he was both a parochial school student and an altar boy at the church. In addition, his lawsuit alleged that the priest and diocese knew that his parents suffered from illnesses that limited their involvement in raising their son, and this gave rise to a special relationship in terms of the religious training and education of their son.

The court agreed that Michael's special involvement in the activities of the church as both a parochial school student and an altar boy "distinguished his status from that of a general member of the church." For example, his involvement required "that he be physically present at the church more often than a general member and that he have substantially greater day-to-day contact with members of the clergy and faculty than would a general member." The court concluded that a special relationship did exist between Michael and his church and diocese that supported claims of both negligent supervision and breach of a fiduciary duty:

Michael has asserted the existence of a special relationship that ineluctably involved the actual placement of trust, as well as a substantial disparity of power and influence between him and the diocese. By its very nature, such a special relationship renders a child vulnerable to the possibility of abuse at the hands of a miscreant employee. An established and close connection between a child and an organization, whether religious, academic, or otherwise, is a reasonable basis, informed by both common sense and common experience, to impose a duty on the organization to prevent harm to the child.

When viewed in the most positive light, Michael's allegations establish a special relationship between him and the diocese as his fiduciary. Such a relationship gave rise to a duty to protect on the part of the diocese if the diocese had reason to believe that a priest posed a substantial risk of harm to a child in Michael's circumstances. The duty does not exist simply because of Michael's status as a student and altar boy, but because of the added assertion that the diocese knew or should have known of the risk of harm posed by the priest who abused him.

First Amendment defense

The diocese asserted that the First Amendment religion clauses prohibited a civil court from imposing a duty upon a religious organization to supervise its clergy. The court rejected this defense, noting that the First Amendment "is violated only when laws actually conflict with a religion's specific doctrines and therefore impose penalties either for engaging in religiously motivated conduct or for refusing to engage in religiously prohibited conduct." It concluded that "we cannot infer from the diocese's generalized assertions that there is, in fact, an actual doctrine or practice that will be substantially burdened by the resolution of Michael's claim."

The diocese claimed that "the intrinsic logic of any judicial declaration and administration of a standard of care for church oversight of clergy necessarily will involve the court deeply in matters of theology and governance." The court disagreed: "It is not self-evident in this case that the application of a duty of due care will cause the court to probe deeply into the allocation of power within an hierarchical church so as to decide religious law governing church polity in violation of the First Amendment." The court did concede that the diocese could present evidence to the trial court that a resolution of Michael's claim would compel the court to "decide religious law governing church polity" in violation of the First Amendment. However, it cautioned that "the diocese's right to the free exercise of religion will not be infringed in the present case if the employment decisions it made do not implicate religious beliefs, procedures, or law."

The court concluded, "If a religious organization knows or has reason to know that a member of its clergy has a propensity to sexually abuse children, the First Amendment is not necessarily violated if the civil law imposes on the organization a duty to exercise due care to protect children with whom the organization has a fiduciary relationship …. Michael's claim that the diocese learned of the priest's propensity to sexually exploit and abuse young boys, but failed to report him to law enforcement officials and then concealed the information from the parishioners, and the public, stated a claim upon which relief can be granted."

Application
. There are two significant points to note. First, the court recognized a "fiduciary duty" giving rise to liability on the part of the diocese for both negligent supervision and breach of a fiduciary duty. However, the court defined a fiduciary or "special" relationship narrowly. Such a relationship requires more than church attendance or membership. In this case, Michael had a special relationship with the diocese because he was a minor; his parents were unable, due to their physical infirmity, to properly raise him, and this fact was known to the diocese; Michael served as an altar boy at the church and attended the church's parochial school.

Second, the court concluded that the diocese's failure to report the priest's prior acts of child molestation to law enforcement, and to the church congregation, could support liability based on both negligent supervision and breach of a fiduciary duty. Fortin v. Roman Catholic Bishop of Portland, 871 A.2d 1208 (Me. 2005).

Legal Developments

Can a State Demand an Accounting of Church Trust Funds?

Yes, rules a court.

Richard R. Hammar, Attorney, CPA

Bio

State: Maine

Church Law and Tax 1992-07-01 Recent Developments

Wills, Trusts, and Estates

Richard R. Hammar, J.D., LL.M., CPA

• Does a state have the authority to demand an accounting of church trust funds? Yes, concluded the Supreme Judicial Court of Maine. In 1939, a wealthy individual made a gift of a substantial amount of stock to a church, subject to the following two conditions: (1) the church was to use the trust fund for “charitable uses and purposes,” and (2) the church was not to sell or transfer the stock for a period of fifty years. In 1983, after faithfully observing the terms of the trust for forty-four years, the church sought court permission to sell the stock. It noted that the value of the stock had fallen sharply and the rate of return was substantially less than could be achieved with other investments. The court permitted the church to sell the stock (then valued at $733,000) in order to protect the trust fund. In 1987, the state attorney general received information suggesting that the church was not carrying out the terms of the trust. The attorney general asked the church for an accounting of the trust fund. When the church refused to comply, the attorney general sought a court order compelling the church to provide an accounting. The church argued that expiration of the fifty-year restriction on sale of stock expired in 1989, and this gave the church full legal title to the trust. The church also argued that the first amendment guaranty of religious freedom protected the church from complying with the demand for an accounting. The trial court rejected the church’s arguments, and ordered the church to provide the attorney general with an accounting. The church appealed, and a state appeals court agreed with the trial court’s ruling. The appeals court noted that the fundamental purpose of the trust continued to be for “charitable uses and purposes.” This purpose was not affected by the expiration of the fifty-year ban on sales of stock. The court then observed: “Where property is given to a charitable corporation and it is directed by the terms of the gift to devote the property to a particular one of its purposes, it is under a duty, enforceable by the attorney general, to devote the property to that purpose.” Accordingly, the church was not free to spend trust funds in any manner it chose. It had to spend them consistently with the trust purpose (“charitable uses and purposes”). And, the attorney general had the legal authority to ensure that the church was complying with the trust purpose, and this authority included the right to demand an accounting of trust funds. The court also rejected the church’s claim that requiring it to prepare an accounting would violate the constitutional guaranty of religious freedom. It observed: “Civil courts can constitutionally adjudicate property disputes involving religious organizations if they can be resolved in accordance with neutral principles of law and without interpretation of, or reference to, religious doctrine. We have held that a suit for an accounting of church funds is a property dispute capable of resolution by application of neutral principles of law …. The attorney general is not attempting to inquire into the financial affairs of the church, or impose a regulatory scheme, but only to obtain the information necessary for him to fulfill his statutory obligation to the public. Because we find that the trust is a public trust, separate and distinct from the church, the court ordered accounting can be accomplished by application of neutral principles of law and therefore, does not impinge upon the church’s first amendment freedoms.” Attorney General v. First United Baptist Church, 601 A.2d 96 (Me. 1992).

Schools

Church Law and Tax 1989-07-01 Recent Developments Schools Richard R. Hammar, J.D., LL.M., CPA •

Richard R. Hammar, Attorney, CPA

Bio

State: Maine
Categories: Schools

Church Law and Tax 1989-07-01 Recent Developments

Schools

Richard R. Hammar, J.D., LL.M., CPA

• The Supreme Judicial Court of Maine ruled that a state law regulating homeschooling did not violate the constitutional guaranty of religious freedom. The Maine “compulsory education” law requires that children attend either a public school or “obtain equivalent instruction that is approved by the commissioner [of education].” Parents who homeschooled their children argued that “any judgment by government officials of the merits of parents’ educational choices is a usurpation by the state of the God-given, constitutionally protected religious autonomy of the family.” They directly challenged the legality of the Maine law. The court, citing Supreme Court rulings, stated that the constitutional guaranty of religious freedom is not violated unless the alleged victims can demonstrate that the exercise of their sincerely-held religious beliefs is restrained by the challenged governmental action, and that the challenged action is not based on a “compelling public interest.” The court acknowledged that the Maine law imposed a significant restraint on the exercise of the parents’ sincerely-held religious beliefs. But, it concluded that the state law was supported by a compelling interest that outweighed the parents’ constitutional rights, since “it is settled beyond dispute, as a legal matter, that the state has a compelling interest in ensuring that all its citizens are being adequately educated.” Blount v. Department of Educational and Cultural Development, 551 A.2d 1377 (Me. 1988).

© Copyright 1989, 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m65 m47 c0489