Securities Law Violations
Key point 4-07. Clergy may violate state securities laws in a number of ways, including the sale of securities without registering as an agent, and the commission of fraudulent practices.
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. The Uniform Securities Act, which has been adopted by a majority of the 50 states, defines a security as
any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; voting trust certificate; certificate of deposit for a security; certificate of interest or participation in an oil, gas, or mining title or lease or in payments out of production under such a title or lease; or in general any interest or instrument commonly known as a "security". …
This definition is broad enough to include many instruments used in church fundraising efforts.
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
Ministers may be directly impacted by their state's securities law in at least two ways. First, if they are engaged in selling their church's securities (or offering them for sale), they may be required to register as an "agent" or "salesperson." Second, they are prohibited from engaging in any form of fraudulent practice in connection with the offer or sale of securities.
The Uniform Securities Act, which has been adopted by a majority of states, provides that "it is unlawful for any person to transact business in this state as a broker-dealer or agent unless he is registered under this act." Registration generally involves the filing of a detailed application with the state securities commission, payment of the prescribed fee, and, in many states, the successful completion of a securities law examination. The "Church Bond Guidelines," prepared by the North American Securities Administrators Association (NASAA) and adopted by several states, specify that the Uniform Securities Act requires that
any person, including an officer or director of the issuer, who wishes to offer or sell church bonds must either be a registered representative of a licensed securities broker-dealer, or alternatively must file for registration as an agent with the administrators of the states in which he intends to sell securities pursuant to section 201 of the Act. This is true even if the church bonds themselves are exempt from registration under … the Act. Any person who sells church bonds without compliance with the agent registration provisions of the Act could also be liable under both the civil and criminal sections of the Act.
Some states exempt the sellers of church securities from the agent registration requirements. The majority, however, require registration—and only a few of these states waive the examination requirement. The NASAA church bond guidelines specify that "an administrator may waive the testing requirements for a securities agent's license, provided, however, that the offering is substantially in compliance with" the church bond guidelines.
Key point. Ministers who contemplate making offers or sales of securities should assume that they must register as an agent until they receive adequate assurance that they are exempt. Even those ministers who do not plan on offering or selling securities directly should note that virtually any promotion of church securities, no matter how indirect, may trigger the agent registration requirements.
Section 410 of the Uniform Securities Act provides that any person who offers or sells a security in violation of the agent registration requirement is
liable to the person buying the security from him, who may sue either at law or in equity to recover the consideration paid for the security, together with interest at the rate of six percent per year from the date of payment, costs, and reasonable attorneys' fees, less the amount of any income received on the security, upon the tender of the security, or for damages if he no longer owns the security.
Section 410 further provides that the employer of an unregistered agent is also liable. Thus, both a minister and his or her employing church will be liable under this section if the minister sells church securities in violation of an agent registration provision.
2. THE PROHIBITION OF FRAUDULENT ACTIVITIES
The term fraud is defined above. Neither federal nor state securities laws exempt ministers from the prohibition of fraudulent activities in the offer or sale of securities. As noted above, the term "fraud" is defined broadly, and this can result in unexpected liability for securities fraud.
Case study. A minister was found guilty of engaging in fraudulent practices through failing to disclose to investors of church securities that he had $116,000 in unsatisfied debts, that he had incurred $700,000 in unsatisfied debts on behalf of a previous church through the sale of securities, and that the church's financial statements were in error. Order of Florida Comptroller No. 78 1 DOS (February 17, 1978).
In a leading case, a federal appeals court upheld the conviction of a pastor for securities fraud. A church began selling to investors what it called "certificates of deposit." The pastor allegedly told potential purchasers that the certificates of deposit would be used to finance the improvement or expansion of the church and to build a retirement complex. He represented or caused others to represent that the church would pay certificate holders between 12 and 16 percent interest on a quarterly basis and that interest payments would continue until the maturity of the certificate (5 years after the date of issuance). He further promised that, when the certificate matured, the investor would be entitled to repayment of the principal plus the balance of any outstanding interest. The pastor further informed investors that they would not have to pay income taxes on the interest payments they received from the church and that the investment was safe because it was backed by the assets of the church.
The church raised over $1.6 million dollars from the sale of the certificates to 90 investors, 27 of whom were church members. The pastor took a significant portion of the certificate proceeds for his personal use. Among other things, he purchased 4 airplanes, a house for his mother, sports cars and passenger trucks, and made a down payment on his daughter's house. The pastor resigned when his actions were uncovered, and the church filed for bankruptcy protection.
The pastor was later prosecuted for 12 counts of securities fraud under federal law, including the following:
- The pastor made "false and fraudulent representations and material omissions" in the sale of the certificates of deposit.
- The pastor "converted approximately $900,000 of [certificate] funds to the personal benefit of himself and family members."
- The pastor told potential purchasers that the certificates of deposit would be used to finance the improvement or expansion of the church and to build a retirement complex.
- The pastor represented or caused others to represent that the church would pay certificate holders between 12 and 16 percent interest on a quarterly basis and that interest payments would continue until the maturity of the certificate (5 years after the date of issuance).
- The pastor further promised that when the certificate matured, the investor would be entitled to repayment of the principal plus the balance of any outstanding interest.
- The pastor told investors that they would not have to pay income taxes on the interest payments they received from the church.
- The pastor told investors that their investments were safe because they were backed by the assets of the church.
- At no time did the pastor tell investors that the money from the sale of certificates was to be used for the personal expenses of the pastor and his family.
The pastor was convicted on all counts and sentenced to five years in prison. He appealed his conviction to a federal appeals court on the ground that the government's investigation and prosecution violated his First Amendment right to the free exercise of religion. The federal appeals court rejected the pastor's defense and affirmed his conviction. It began its opinion by noting that
[the pastor] does not maintain that the tenets of his religion require him to undertake securities fraud [or] that by outlawing securities fraud [the federal securities law] impermissibly burdened his First Amendment right to practice his religion freely. Instead, he asserts that "[t]he ability to determine what is an appropriate use of church money is at the heart of the charges brought against" him, and that "[a]llowing the Court, or a branch of the United States Government, to make that determination violated [his] constitutionally protected free exercise of religion."
The pastor insisted that the First Amendment guaranty of religious freedom assured pastors of the right to determine the appropriate use of church money without government interference. The court disagreed. The court stressed that the trial court's conviction of the pastor for securities fraud
had absolutely nothing to do with reviewing the church's internal allocation of funds, nor did it implicate any issue of religious polity. Instead, [the pastor's] offense pertained solely to the way in which he procured the "church" funds in the first place. [The pastor] obtained the money by, among other things, making fraudulent misrepresentations and omissions of material fact in the sale of the certificates of deposit. Those misrepresentations and omissions are objectively demonstrable actions the pastor undertook as an individual. [He] was convicted not because the government or the court decided that the church had spent its money unwisely, but because [the pastor] did not spend the certificate money in the way that he promised the investors he would, and because he lied to the investors about their ability to recover their investment principal upon certificate maturity.
Hence, neither the [government's] investigation into the pastor's conduct, nor the [trial court's] adjudication of his guilt, required any governmental foray into the realm of religious law or any repudiation of an ecclesiastical tribunal's decision. [The pastor's] First Amendment challenge to his conviction is without merit.
The pastor also claimed that his prison sentence had been improperly increased by the court. Under federal sentencing guidelines a court may increase a prison sentence for "breach of a position of trust." In order for a court to increase a prison term on this basis, it must find that (1) the defendant occupied a position of trust, and (2) the defendant abused his position in a manner that significantly facilitated the commission or concealment of the offense. The sentencing guidelines state that "[t]he position of trust must have contributed in some substantial way to facilitating the crime and not merely have provided an opportunity that could as easily have been afforded to other persons. This adjustment, for example, would not apply to an embezzlement by an ordinary bank teller." The appeals court concluded that the pastor had abused a position of trust and therefore the increase in his prison sentence was warranted. It observed:
Because [the pastor] was the church's financial decisionmaker, church-member investors and church personnel trusted him to be the sole, unsupervised manager of the church's finances. This position of trust allowed the pastor to control the church's bank accounts and misapply the certificate funds clandestinely. Because [the pastor] was the church's pastor and spiritual leader, his congregation undoubtedly trusted him to further the church's religious mission. [The pastor's] position of trust allowed him to use his authority to mislead church-member investors into believing that the church needed the certificate funds for building projects and to persuade them to invest their money for the good of the church and its endeavors. The [trial court] therefore correctly determined that [the pastor] occupied and abused a position of trust.
Key point. An unexpected consequence of the pastor's securities fraud was that he was also guilty of income tax invasion. He failed to realize that by treating the investors' monies as his own personal funds he was in effect receiving taxable income that he failed to report.
The subject of church liability for securities law violations is addressed in another chapter. See § 9-04, infra.