Investment Fraud – Safeguarding the Funds of Churches and Church Members

Article summary. Unscrupulous individuals are targeting churches and church members in fraudulent investment schemes. Church leaders must be aware of this risk and take steps to protect church assets as well as the assets of church members. This article will help church leaders accomplish these vital tasks.

Many churches, and church members, have been victimized by investment fraud. This article will assist church leaders in protecting church assets, and the assets of church members, from such scams.

Sound unbelievable? It shouldn’t. Investment scams have victimized many churches and church members, and no church is immune. This article will explain the most common forms of securities fraud, provide several examples from real life, address the fiduciary duty of church leaders to invest church funds prudently, and provide practical steps that church leaders can take to minimize if not eliminate this risk.

Investment fraud is a risk not only to churches, but also to church members. Church leaders who familiarize themselves with the information in this article not only will be protecting their church, but they also will be protecting members from scams. As a result, we recommend that every church leader be asked to review this information.

Let’s begin with a simple principle that will protect churches and church members against most investment scams-if it sounds too good to be true, it is.” In the pages that follow you will be introduced to several tragic cases of securities fraud involving churches and church members. In every one of these cases, the tragedy could have been avoided through heeding this simple principle.

This article contains the following sections:

The kinds of investment scams that have victimized churches and church members are too numerous to mention. Here are some common and recurring ones.

(1) pyramid schemes

In the classic “pyramid” scheme, participants attempt to make money solely by recruiting new participants into the program. The hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.

The promoters behind a pyramid scheme may go to great lengths to make the program look like a legitimate multi-level marketing program. But despite their claims to have legitimate products or services to sell, the promoters simply use money coming in from new recruits to pay off early stage investors. But eventually the pyramid will collapse. At some point the schemes get too big, the promoter cannot raise enough money from new investors to pay earlier investors, and many people lose their money.

The Federal Trade Commission offers the following advice about pyramid schemes:

(2) ponzi schemes

Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period. Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.

A Ponzi scheme is closely related to a pyramid because it revolves around continuous recruiting, but in a Ponzi scheme the promoter generally has no product to sell and pays no commission to investors who recruit new “members.” Instead, the promoter collects payments from a stream of people, promising them all the same high rate of return on a short-term investment. In the typical Ponzi scheme there is no real investment opportunity, and the promoter just uses the money from new recruits to pay obligations owed to longer-standing members of the program. This is often called “stealing from Peter to pay Paul.” In fact some law enforcement officers call Ponzi schemes “Peter-Paul” scams.

Both Ponzi schemes and pyramids are quite seductive because they may be able to deliver a high rate of return to a few early investors for a short period of time. Yet, both pyramid and Ponzi schemes are illegal because they inevitably must fall apart. No program can recruit new members forever. Every pyramid or Ponzi scheme collapses because it cannot expand long enough to satisfy current and new investors. When the scheme collapses, most investors find themselves at the bottom, unable to recoup their losses.

Ponzi schemes continue to work on the “rob-Peter-to-pay-Paul” principle, as money from new investors is used to pay off earlier investors until the whole scheme collapses. Many churches and church members have been defrauded out of funds by investing in such schemes.

Another definition of a ponzi scheme is “a fraudulent investment scheme in which money contributed by later investors generates artificially high dividends for the original investors, whose example attracts even larger investments.” Black’s Law Dictionary 1180 (7th ed.1999).

(3) Nigerian investment scams

Nigerian advance-fee fraud has been around for decades, but now seems to have reached epidemic proportions. According to the Federal Trade Commission (FTC) some citizens are receiving dozens of offers a day from supposed Nigerians politely promising big profits in exchange for help moving large sums of money out of their country. And apparently, many compassionate consumers are continuing to fall for the convincing sob stories, the unfailingly polite language, and the unequivocal promises of money. These advance-fee solicitations are scams, according to the FTC.

Here is a typical scenario. Claiming to be Nigerian officials, businesspeople or the surviving spouses of former government officials, con artists offer to transfer millions of dollars into your bank account in exchange for a small fee. If you respond to the initial offer, you may receive “official looking” documents. Typically, you’re then asked to provide blank letterhead and your bank account numbers, as well as some money to cover transaction and transfer costs and attorney’s fees. You may even be encouraged to travel to Nigeria or a border country to complete the transaction. Sometimes, the scam promoters will produce trunks of dyed or stamped money to verify their claims. Inevitably, though, emergencies come up, requiring more of your money and delaying the “transfer” of funds to your account; in the end, there aren’t any profits for you to share, and the promoter has vanished with your money.

Incredibly, many church members, and some churches, have fallen victim to Nigerian investment scams. If you’re tempted to respond to an offer, the FTC suggests you stop and ask yourself two important questions:

The U.S. State Department cautions against traveling to the destination mentioned in the letters. According to State Department reports, people who have responded to these “advance-fee” solicitations have been beaten, subjected to threats and extortion, and in some cases, murdered.

(4) prime bank scams

Prime bank scams are yet another investment scam that has been perpetrated against churches and church members. Here is how the SEC describes these scams:

The SEC warns that nonprofit organizations are often targeted by the promoters of these scams, and that promoters have demonstrated “remarkable audacity, advertising in national newspapers, such as USA Today and the Wall Street Journal.” Some promoters avoid using the term “Prime Bank note,” and tell prospective investors that their programs do not involve prime bank instruments in an effort to demonstrate that their programs are not fraudulent. Regardless of the terminology, the basic pitch, that the program involves trading in international financial instruments, remains the same, and investors should continue to be vigilant against such fraud.

The SEC has provided the following warning signs of prime bank or other fraudulent bank-related investment schemes.

You should be especially watchful for prime-bank related schemes promoted over the Internet.

Summarized below are several actual cases of investment scams that have victimized churches and church members. Many involve variations of Ponzi or pyramid schemes.

Case 1. Tom was a registered agent for a broker-dealer that specialized in the sale of church-related securities. Tom purported to sell an “interim church loan fund” through his personal company. In fact, there was no interim church loan fund. Tom placed the client funds in his checking account and used the majority of the funds to pay personal expenses. In all, he defrauded investors (both church members and churches) in the interim church loan fund of over $1.7 million. Barnes v. SWS Financial Services, Inc., 97 S.W.3d 759 (Tex. App. Dallas 2003).

Case 2. A promoter (Jerry) of a “Ponzi” style investment scheme pled guilty to 17 counts of securities fraud and mail fraud in connection with the fraudulent sale of securities to several church members. Jerry’s leadership position in the church caused some victims to trust him. A number of his victims commented that he manipulated their faith to gain access to their money. For example, one victim testified that “the church out there where we went, where Jerry went, endorsed him highly, the pastor did. I trusted the pastor, and thus, we trusted Jerry.” Another victim described how Jerry prayed with her just before he showed her fraudulent layouts for his purported developments. A letter from a former church member contained the following description of Jerry’s activities,

Jerry used his victims’ faith to target investors. A brochure printed by the church invited parishioners to invest with Jerry, announcing that “in almost every case, our plan will be able to at least match or out perform your current yields, and at the same time earn dividends for our church and its future. These funds will become the backbone of our plan to build the church campus and retire all debt within five years.” In soliciting parishioners’ investments, Jerry announced:

A federal appeals court affirmed Jerry’s guilt, but ordered a trial court to reconsider the length of his prison sentence. United States v. Luca, 183 F.3d 1018 (9th Cir. 1999).

Case 3. A business representing itself as a nondenominational, non sectarian international Christian ministry (formed in the Dutch Antilles Island of Aruba) placed the following advertisement in an entrepreneur magazine with a nationwide circulation: “Need extra income? [We] would like to show Christian families how working together they can become debt free. Call [a toll-free telephone number] and request the Christian program.” Persons who responded to the ad were mailed literature that offered financial assistance through participation in a monthly fund-raising project. By providing others with “love gifts” in the amount of $30, $60, or $100 per month, a participant became eligible to receive monetary “gifts of love” from a “3 wide x 7 level deep network.” Of the monthly payments, 30% went to the ministry and 70% was for “love gifts” to be forwarded to earlier participants in the program. New participants recruited and sponsored other participants, creating an upline of up to seven levels. A participant received a portion of the monthly “love gift” payments made by those in one’s upline. A participant became eligible to receive “love gifts” from others by making monthly payments and by sponsoring others to join the program. The literature represented that it was possible for a participant to receive $10,800 per month from this program. The program was also promoted through radio ads to Kansas residents who needed extra income through a “Christian program.” In response to these advertisements, approximately 30 Kansas residents sent for information about the program. The Kansas securities commission concluded that the program was a security, and that it violated securities law in the following ways: (1) neither the securities nor those selling them had been registered; and (2) investors were not informed that the ministry had been issued a cease and desist order by the state securities commission a few years earlier. The commissioner ordered the ministry to discontinue any further offers or sales of its program to residents of Kansas unless the securities are registered in advance. In the Matter of Agape International Ministries, 1995 WL 582034 (Kan. Sec. Com. 1995).

Case 4. The Virginia Division of Securities investigated a church’s securities program, and concluded that the church violated state securities law by selling unregistered securities in the form of bonds called “Certificates of Faith,” and using unregistered agents in the sale of the securities. The church entered into a settlement offer with the Division, which required it to make a rescission offer to all bondholders including an explanation for the reason for the rescission offer. The church also agreed to offer only securities that are registered under the Virginia Securities Act or are exempted from registration, and to offer and sell such securities only through agents who are registered under the Virginia Securities Act or who are exempted from registration. Commonwealth of Virginia v. Unity Christ Church, 1996 WL 392586 (Va. Corp. Com. 1996).

Case 5. 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: (1) He “converted approximately $900,000 of certificate funds to the personal benefit of himself and family members.” (2) 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). (3) He promised that when the certificate matured, the investor would be entitled to repayment of the principal plus the balance of any outstanding interest. (4) He told investors that they would not have to pay income taxes on the interest payments they received from the church. (5) He told investors that their investments were safe because they were backed by the assets of the church. (6) 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 prison.

A federal appeals court affirmed the pastor’s conviction, and an increase in his sentence to the “aggravating” circumstance that he breached a position of trust. The court concluded, “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 he was the church’s pastor and spiritual leader, his congregation undoubtedly trusted him to further the church’s religious mission. His 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.” United States v. Lilly, 37 F.3d 1222 (7th Cir. 1994).

Case 6. A church hired a treasurer (Steve) as a compensated employee. Steve was responsible for the church’s bookkeeping, payment of bills, and a general responsibility for the church’s financial accounting. At the time he became treasurer, he was employed as a loan officer by a local bank. Steve invested a large amount of the church’s funds with an investment firm. He later testified that he wanted to become a “hero” by investing the church’s money in stocks and securities and thereby increasing the church’s funds. Steve urged the investment firm to invest the church’s funds in speculative stock. Over the next few years, the value of the church’s portfolio plummeted, creating a financial crisis for the church. Steve confessed that he had invested the church’s funds in speculative investments, and that most of the investments had “failed.” Church board members occasionally signed “authorization” forms giving Steve the authority to invest the church’s funds. But the board exercised insufficient oversight over Steve’s activities to ascertain the true status of church funds. The church later sued the investment firm for malpractice and securities fraud. Yellowstone Conference of the United Methodist Church v. Davidson, 741 P.2d 794 (Mont. 1987).

Case 7. An investment advisor (Jerry) derived his income through various social contacts, including his church. He lured several church members into investing in commodities and a gold mine. Jerry received 5% of each person’s investment to cover “personal expenses,” plus 25% of all profits. As an inducement to investing with him, Jerry “personally guaranteed” a 25% return over the first year. If an account failed to perform sufficiently, he would pay the guaranteed return from his personal assets. No risks were explained to the investors, who were generally unsophisticated. Rather than receive any return after the first year, the investors were informed that Jerry’s practices had caused the loss of “a substantial portion of their investment.” No guarantee was forthcoming from Jerry at that time but he assured investors that he was withdrawing their funds and transferring them to another commodities broker who would “recover” their original investment plus the guaranteed amount within a “relatively short period of time.” Other than a partial return of funds to a select few, the investors received nothing, but were convinced by Jerry to leave their remaining funds in his control with the promise that he would recover their original investment plus much more by investing their funds in a gold mine in Arizona. Jerry informed all the investors there was “the possibility of becoming as financially independent as you want” and that he “had spent years and thousands of dollars acquiring financial information.” In fact, the investors lost virtually all of their investments. Stokes v. Henson, 265 Cal. Rptr. 836 (Cal. App. 1990).

Case 8. A religious ministry operated and marketed a “double-your-money” scheme called the “Faith Promises Program.” The ministry used a bank as a major depository and source of financial services while operating the Ponzi scheme. Eventually, the Ponzi scheme swindled more than fifteen thousand victims out of an estimated five hundred million dollars. Many of the founders of the scheme were convicted for a variety of federal offenses. The ministry filed for bankruptcy protection. Several investors later sued the ministry’s bank, claiming that it was responsible for the ministry’s fraud on the basis of negligence and breach of fiduciary duty. A court ruled that the relationship of the ministry to the bank was a fiduciary one, but not the relationship between individual investors and the bank and therefore the bank was not liable to the investors for the ministry’s fraud. The court concluded, “To hold the bank liable in this situation, essentially, would be to instill on banking institutions the power to regulate what their customers do with their money, a power this court cannot and will not establish. As such, the bank had no duty to disclose any material facts to the investors, even if it had knowledge of such facts.” O’Halloran v. First Union National Bank, 205 F.Supp.2d 1296 (M.D. Fla. 2002).

Case 9. A man (Walt) spent six months each year in Massachusetts and the other six months in Florida. While living in Florida, Walt met Pastor Jim, the pastor of a local church. Pastor Jim told Walt about the plans to build a new sanctuary, and he suggested that Walt purchase mortgage-backed bonds to help finance the building. The church had issued bonds valued at $1.7 million. A prospectus given to prospective investors stated that the property owned by the church was more than sufficient to cover the value of the bonds. A securities salesman later met with Walt, and informed him that the bonds were a good investment in that they had a high interest rate, that Pastor Jim was a good, young pastor who planned to get his Ph.D. and that the bonds were secure because of the value of the church property. The salesman also told Walt that if he invested $300,000 in the bonds, he would be repaid within six months. A few weeks later Walt purchased the bonds. Over the next several months, when Walt was back in Massachusetts, Pastor Jim called him several times asking him to purchase additional bonds. The pastor assured Walt that the value of the church property exceeded the value of the bonds, and that Walt would be repaid in a few months. Pastor Jim and two other church officers traveled to Massachusetts to meet personally with Walt. However, Walt refused to purchase any more bonds. The church paid Walt interest on the bonds for the next two years, until Pastor Jim informed him that the church was no longer able to meets its obligations. Walt sued the church for securities fraud. Bearse v. Main Street Investments, 170 F.Supp.2d 107 (D. Mass. 2001).

The United States Securities and Exchange Commission (SEC) has launched prosecutions of several investment scams targeting churches and church members. These cases involve alleged violations of federal securities laws, and typically seek injunctions, restraining orders, monetary damages, and rescission offers. A rescission offer is an offer made by the issuer of a security to investors giving them the opportunity to “rescind” (revoke) their investment and recover some or all of their original investment.

Sumarizing every enforcement action taken by the SEC against persons and organizations that have perpetrated securities fraud against churches and church members would require a full-length book. Some illustrative cases are summarized below.

Case 10. In 2002 the United States Securities and Exchange Commission (SEC) filed a civil enforcement action alleging that from at least 1996 though at least 2002 a “loan fund” operated by a religious denomination (the “church”) fraudulently raised $85 million from the sale of investment notes to thousands of investors nationwide. The loan fund was formed by the church in 1921 for the primary purpose of raising funds to loan to churches for the construction of new churches and to fund renovations of existing churches of the denomination.

The SEC claimed that, in connection with the offer and sale of the investment notes, the loan fund repeatedly made material misrepresentations and omitted to state material facts in its “solicitation materials” and offering circulars concerning the financial condition of the loan fund, and the primary use of investment note proceeds and the safety and risks associated with the investment notes. Each of the loan fund’s offering circulars included an unqualified, independent auditor’s report and a consolidated statement of financial condition.

Specifically, the SEC lawsuit alleged that the loan fund embarked upon a fraudulent scheme to conceal from investors the severe financial difficulties it had suffered. For example, the loan fund improperly used a provision of the tax code as a vehicle to generate non-existent income. This income was recognized by the loan fund on its consolidated statement of financial condition and was used to offset its losses. As a result, for several years the loan fund improperly recognized nearly $25 million in non-existent income that was used to offset other losses and thereby avoided recording at least $26 million in losses.

The SEC lawsuit further alleged that instead of using investment proceeds primarily to fund church loans (as promised in its advertising literature and offering circulars) the loan fund used the proceeds to fund speculative real estate transactions; fund losses at these failing properties; and make interest and principal payments to prior investors. The SEC lawsuit also claimed that as a result of the loan fund’s deteriorating financial condition, it was unable to maintain the promised cash reserves stated in its offering circulars, which were distributed to investors nationwide.

In 2003 a federal judge in Indiana approved a plan for repayment of investors. The plan had been developed by the SEC, investors representatives, and loan fund, and submitted to the court for approval. The plan called for the liquidation of all loan fund assets for the benefit of the investors (most of whom were unsecured noteholders). This plan is still being implemented, but church officials are advising thousands of noteholders nationwide that they should not expect to receive more than “35% to 60%” of their investments.

Case 11. In 2002 the SEC filed charges against a company for perpetrating an “affinity fraud” in a Ponzi-like investment scheme. Affinity fraud refers to investment scams that prey on members of identifiable groups such as religious, ethnic and racial groups. The promoters of these scams are group members or claim to be group members. The SEC alleged that from 1998 through 2000 the company targeted religious individuals and raised approximately $4 million through the unregistered and fraudulent sale of its stock. The SEC claimed that the company’s president solicited religious individuals whom he had met through his work as a pastor and investment adviser, by making false and misleading statements about his company’s financial status, projected earnings and investment returns, and use of investor funds. The SEC further alleged that some investors were promised and paid a guaranteed return of 12% per year on their investment. However, the company (without investors’ knowledge) used the proceeds from the sales of stock to new investors to pay the inflated investment returns to existing investors. Company representatives fraudulently assured investors that it was a profitable business and a “safe investment” when in fact it consistently operated at a loss and did not have enough assets to cover its expenses and liabilities. The SEC charged several company officers of violating the antifraud provisions of federal securities law. The FBI assisted the SEC in the investigation of these charges. The case is pending.

Case 12. In 2001 the SEC Securities and Exchange Commission filed charges against two companies relating to a fraudulent trading scheme that raised approximately $22 million from at least 50 investors, many of whom were members of the same religious denomination. According to the SEC, the defendants fraudulently offered and sold unregistered securities in an “international bank-related financial instrument trading program” that was completely fictitious. The defendants promoted their trading program under various names, including Swiss Asset Management, Wall Street South, and Resource F. The SEC claimed that the companies’ agents solicited investors using misrepresentations that the investment involved high-quality debt instruments of very large international banks, that the investors’ principal was never at risk and could be returned after one year, and that investors would receive profits of approximately 4-5% every month (or 48-60% annually).

During the initial stages of the fraud, investors received monthly payments that the defendants represented were “profits” on their investment. However, monthly payments to investors eventually stopped. Despite numerous requests, no investors received the return of their investment. Further, since the cessation of monthly payments, promoters regularly sent letters to investors making excuses for the cessation of payments, and making the false statements that trading and monthly payments would resume soon. These letters included a request that investors contribute money to purported “legal efforts” to obtain the return of investors’ funds.

A federal court entered an order barring certain officers of the defendants from engaging in further fraudulent activity and freezing their assets to ensure that assets were preserved to pay investors their lost principal.

Case 13. The SEC filed a lawsuit in federal court seeking to halt an ongoing nationwide affinity fraud, primarily targeting African-American churches, conducted by an individual (the defendant) through a bogus company. The SEC alleged that the defendant engaged in a deliberate scheme to defraud investors by making false and misleading statements in connection with the unregistered offer and sale of securities in the form of investment contracts in a “church funding project.” The defendant raised at least $3 million from over 1000 investing churches located throughout the United States. The SEC claimed that through various promotional means, including a website, the defendant’s presentations at group meetings and religious conferences, telephone solicitations, mailings and a commissioned sales force, the defendant solicited churches to invest in the church funding project by falsely promising huge financial returns. Specifically, for each investment of $3,000, the defendant promised to pay a return of $500,000! He told investors that his company would fund the promised returns from a pool of money it received for this purpose from four sources—profit-making corporations; federal government grants; other Christian institutions; and profits from a series of world-wide Christian-based resorts to be built and run by a “sister corporation.” In fact, the defendant did not have any commitments from profit-making corporations or other institutions to fund this project, and he built no resorts. As a result of this scam, the defendant has outstanding commitments to investors of at least $500 million. The SEC asked the court to permanently enjoin the defendant from selling securities, and also sought an asset frieze, disgorgement of profits, civil penalties, and an order preventing the destruction of documents.

Case 14. In 2001 the SEC sued an individual (the defendant) alleging that he defrauded a church out of $900,000. The SEC claimed that the defendant used his investment advisory firm to misappropriate hundreds of thousands of dollars in “soft dollar credits” generated by securities transactions made on the church’s behalf in an account that the defendant created with a broker-dealer. Soft dollar credits are created when an investment adviser and a broker-dealer enter into an arrangement in which a percentage of commissions are used to pay for products and services, such as research, that help the adviser in making investment decisions. Because soft dollar credits are generated by commissions paid by the advisory client, they are assets of the client. Soft dollar arrangements are permissible under the securities laws if there is appropriate disclosure to the client about the products and services for which the soft dollars will be used, as well as disclosure that the client may pay higher commission rates as a result of the soft dollar arrangement.

The SEC alleged that as part of the scheme to misappropriate soft dollar credits, the defendant submitted over a hundred invoices to the broker-dealer for payments with soft dollars that had been generated by trading in the church’s account. Many of the invoices were in the name of a “shell entity” the defendant controlled, and falsely indicated that it had provided services that were payable with soft dollars. The broker-dealer paid hundreds of thousands of dollars to this shell company based on these false invoices. The defendant personally picked up these payments from the broker-dealer and deposited them into bank accounts that he controlled. He then withdrew the majority of the funds for his personal use.

The SEC claimed that the church was not informed that its soft dollars were being used for the defendant’s personal benefit, and that the defendant violated his fiduciary duty of “best execution” for his client’s securities trades by fraudulently setting the commissions paid by the church at a rate that was approximately five times higher than the average rate charged for soft dollar transactions at the time. The SEC also charged that the defendant “churned” the church’s endowment account, frequently causing the church to accumulate large positions of stock in a company only to sell the entire position weeks later at a similar price. These actions were taken to generate additional soft dollar credits, which the defendant then misappropriated.

The SEC asked a federal court to grant injunctive relief, disgorgement of improperly-obtained benefits, plus civil penalties. This case was settled by the parties, with the defendant agreeing to pay back $1.2 million (all but $300,000 was waived based on his financial inability to pay).

Case 15. In 1999 the SEC filed a lawsuit in federal court in Texas, seeking a court order barring an individual (the defendant) from future violations of the anti-fraud provisions of the federal securities laws. The SEC alleged that the defendant raised and misappropriated at least $1.2 million from victims, including elderly church members, through sales of fictitious church bonds and interests in a fictitious “Interim Church Loan Fund” (the Church Fund). The defendant, a 64-year-old part-time education minister and Bible study teacher solicited retired brokerage clients and attendees of religiously-oriented seminars he conducted. Prospective investors were encouraged to liquidate conservative investments, such as government bonds or federally guaranteed certificates of deposit, to invest in the Church Fund. Investors were told that the Church Fund would invest in various church-issued and secured notes or other debt obligations that would provide safe annual returns of 11% or more. The SEC alleged that none of the money raised was used to purchase church-issued debt instruments or any other form of investment. Instead, investors’ monies were used for operating expenses, to make “interest” payments to other investors in an obvious Ponzi scheme, and to support the defendant’s extravagant lifestyle, which included gambling trips, vacations, and lavish gifts to female acquaintances. The SEC claimed that the defendant had engaged in numerous acts of securities fraud, and sought a court order requiring disgorgement of all wrongfully obtained profits and civil penalties.

Case 16. The SEC filed a lawsuit in a federal court in New York charging the pastor of a church (the defendant) with fraudulently offering and selling securities to members of his church and followers of his radio ministry, among others. The complaint also alleges that the defendant diverted more than $200,000 to his own personal benefit. Specifically, the SEC claimed that over the course of two years the defendant, through “success seminars” promoted by him at church services and on his radio program, fraudulently induced at least 145 people to invest a total of more than $300,000 in a company he created. He claimed to prospective investors that God advised him to gather a group of 1,000 people and have each one of them make a “commitment” of $1,000. He falsely promised prospective investors that his company would use their funds to buy real estate, and that investors would earn returns of up to 60% per year.

The SEC claimed that instead of purchasing real estate, the defendant misappropriated and diverted in excess of $200,000 of investor funds to pay personal expenses and the expenses of his church, and to invest in businesses he owned or controlled. The SEC asked the court to order the defendant to account for, and to disgorge, all ill-gotten gains and pay civil penalties.

Case 17. Over the course of several years a youth pastor (the defendant) raised more than $20 million from approximately 150 persons in his church through an unregistered offering and selling of securities in the form of notes that he issued under the name of a company. In selling these notes, the defendant fraudulently guaranteed extraordinary annual returns of 15% to 20% to investors and told investors that they would receive their returns in the form of monthly interest payments. He assured investors that he would send their money to a wealthy childhood friend who lived in Canada and who was supposed to use his expertise in options trading to generate the guaranteed returns.

The SEC sued the defendant in federal court, and charged him with multiple acts of securities fraud. The SEC made the following allegations: (1) The “company” that issued the securities sold by the defendant did not exist. (2) In order to fund their investment, investors have refinanced their homes and have withdrawn substantial retirement savings. (3) Investors are provided with a one-page note. Investors receive no other written information regarding their investment. The notes do not state any risk associated with the company or information about the defendant. (4) The defendant used funds received from investors to pay personal expenses such as luxury automobiles, a boat, motor home and credit card purchases. (5) None of the investors ever received a written statement reflecting the location of their money, the returns their investment earned or how the returns were generated. (6) Prior to investing, the defendant never asked investors to provide any personal financial or investment experience information. (7) The defendant assured investors that their investments would earn a guaranteed 15% annual interest rate, but investors who were pastors were told they will earn a guaranteed 20% annual interest rate. (8) The defendant told investors that for a limited time his company was offering higher interest rates of 40% for six months. He also told one investor that he would earn a guaranteed 10% return over three months on a $50,000 investment. (9) The defendant told investors that their principal investment was guaranteed by his company.

Investors eventually stopped receiving their monthly interest payments when the Ponzi scheme was unable to attract new investors.

The SEC charged that the defendant had no reasonable basis for guaranteeing investors a 15% to 20% annual return on their principal investment because he lacked the resources to fulfill such guarantees and played no role in generating the returns payable to investors each month. When given the opportunity to explain in testimony before the SEC how he was able to guarantee an annual return of 15% to 20% to investors, the defendant asserted his Fifth Amendment right against self-incrimination.

The SEC asked a federal court to freeze the defendant’s assets, ban him from selling securities in the future, assess penalties, and order him to disgorge any profits.

Case 18. The SEC filed charges against two ministers (the defendants) for allegedly misrepresenting or omitting material facts when they sold securities to members of their respective churches, to members of churches of the same denomination, and to friends and relatives of the church members. The defendants promised exorbitant returns on investments along with the return of the investors’ principal when, in fact, the defendants were operating a Ponzi scheme. More than $3.5 million worth of unregistered securities were issued to over 200 individuals in at least 16 states during the scheme. A federal court ordered the defendants to pay damages of $4 million, plus civil penalties.

Case 19. The SEC sued two persons (the defendants) as a result of an investment scam that defrauded at least 1,000 persons out of more than $1.3 million. The SEC claimed that the defendants engaged in a scheme to defraud primarily African-American investors through the exploitation of their religious faith and their ethnic pride. The defendants sought prospective investors through presentations at small churches and through meetings arranged through pastors of those churches. These presentations were open to the general public and frequently were advertised to the congregation during church services on the preceding Sunday. The defendants offered and sold unregistered securities to these prospective investors, inducing investments by misstating and omitting facts important to the prospective investors’ investment decisions. The presentations were replete with prayers and quotes from the Bible. The crux of the presentations was twofold: (1) that investing in a company prior to the public offering of its stock was the key to becoming wealthy; and (2) that African-Americans traditionally had been unable to take advantage of such opportunities, in part because of SEC “regulations” that limited the purchase of pre-IPO (initial public offering) shares to investors earning at least $200,000 a year. The defendants offered their audiences what they presented as the chance to make such lucrative investments by purchasing “memberships” that would provide to them gifts of stock in African-American controlled companies.

The defendants offered three levels of “memberships” in their investment program. “Founders” membership entitled the purchaser to three “financial literacy” courses and 2,000 shares of stock in each of three companies in return for an initial payment of $2,500 and an annual fee of $50. “Warriors” membership entitled the purchaser to two financial literacy courses and 500 shares of stock in each of three companies for an initial payment of $1,000 and an annual fee of $50. “Believers” membership entitled purchasers to one financial literacy course and 250 shares of stock in each of three companies for an initial payment of $500 and an annual fee of $50. All of the stock shares were unregistered securities.

In offering the memberships and unregistered securities, the defendants knowingly or recklessly made several misrepresentations of material facts to prospective investors, including the following: (1) Churches in the Washington, D.C. area who had invested in the program had made $50,000 in “a couple of months.” In fact, this was not true. (2) Two individual congregation members that invested had made $250,000 in five months and had used their profits to buy matching Porsches. In fact, this was not true. (3) The companies allegedly issuing the unregistered securities were in a position to undertake initial public offerings within a few months at prices far higher than what investors paid for their shares. (4) The defendants failed to inform investors of potential risks, including their multiple bankruptcy filings.

Pastors repeatedly introduced the defendants at presentations as successful African-American businessmen who wanted to “give something back to the community” by helping African-American churches. In fact, the defendants were deliberately defrauding African-American churches and the members of their congregations. Investor money did not enable the investors to obtain stock or otherwise benefit members. Rather, much of the money that the defendants collected from investors went to the benefit of the defendants, including $300,000 in salary or payments; $42,000 in payments to hotels, including payments to a luxury hotel located within 15 miles of where the defendants lived; and more than $92,000 in cash withdrawals.

Case 20. A financial advisor (the defendant) was sentenced to 29 years in prison as a result of 93 counts of securities fraud, mail fraud, wire fraud, money laundering, and tax evasion as a result of a fraudulent scheme involving the sale of $35 million of corporate notes to hundreds of investors located throughout the nation. In addition to the prison sentence, the defendant was ordered to forfeit $34 million in cash, his house, and shares of stock that he acquired with ill-gotten gains. One of the victims was a church organization that purchased $2.5 million of securities. The defendant falsely represented to a church representative that the securities were insured by performance bonds and that an affiliated company had entered into a contract to provide regional air service for a major air carrier. In fact, the securities were uninsured and the airline had terminated all negotiations with the company after discovering the defendant’s prior criminal convictions.

Case 21. A federal court in Maine entered a judgment against two individuals (the defendants) for securities fraud and acting as unlicensed brokers in an investment scheme involving deposits into a Mexican bank. The court permanently enjoined the defendants from future violations of the securities laws, assessed penalties, and ordered them to return profits from their scheme. The defendants obtained money from investors by promising to pay them virtually risk-free returns of 15% to 25% per month. Defendants misrepresented to investors that these extraordinary rates of return would come from placing their investments in a special Mexican bank account not available to the general public that paid 85% per month. To explain how the bank could generate such a return, the defendants misrepresented that it was “supported by 25 top Prime Banks.” Defendants also misrepresented that other investors already had or were about to place $500 million or $1 billion in the account. The court found that the Mexican bank account earned only standard rates of interest and there were no investors depositing $500 million or $1 billion; and that the “Prime Bank” programs promoted by the defendants are nothing more than fraudulent schemes.

According to the court, the defendants’ fraud was especially egregious because they exploited investors’ sincere religious beliefs. Defendants told investors that the Mexican program had been started by Christian men and would help church-related programs. The court stated that one of the defendants exploited his position as minister of his church to convince unsuspecting people to give their money to a program that he “recklessly endorsed.”

Case 22. The SEC brought charges in federal court against a company (the defendant) that committed securities fraud against church members. The defendant made a sales presentation to a national church conference attended by approximately 30,000 individuals. The SEC claimed that the defendant attempted to raise $60 million from 5,000 investors over a ten-year period. Investors signed option agreements obligating them to purchase a fixed amount of stock for $1.25 per share by making an initial $98 payment and then monthly minimum payments of $99 for ten years, representing a total investment of $11,978 per investor.

Resource. Investors are again advised to read the SEC’s “Cyberspace” Alert before purchasing any investment promoted on the internet. The free publication, which alerts investors to the telltale signs of online investment fraud, is available on the Investor Assistance and Complaints link of the SEC’s website www.sec.gov. It can also be obtained by calling 800-SEC-0330.

Case 23. Several individuals (the defendants) were charged with securities fraud and money laundering in a $160 million scam that targeted churches and their pastors, leaders and members. The chief defendant is a self-proclaimed former minister who exploited his connection to highly visible members of the evangelical Christian community to meet potential investors, legitimize his operations and sell securities in a sham company having no legitimate operations. The defendants represented to investors that their company and its affiliated companies operated a highly successful “import/export” business in which investors could participate by purchasing securities. They falsely represented that the investment programs involved importing merchandise for resale in the United States from which the company would pay 50% of the profits from sales to investors. As part of their scheme, they established a website on the Internet to solicit investors. They falsely promised investors that their money was at minimal risk and that they would earn a 25% to 50% return on their investment in a three to six-month period. They falsely represented that some of their investment programs were selling merchandise to major retailers including Hobby Lobby Stores, JC Penney Stores, and Pier One Imports. The defendants even falsely represented to investors that the SEC had several lawyers inspect its business operations in Ontario and that the SEC had given it a “clean bill of health.”

The government claimed that the defendant’s company was formed and operated to carry out their fraudulent scheme and the primary source of the company’s income was investor funds. Payments made to some investors were not returns on their investments but were from funds invested by other persons. Most of the invested funds were converted to the defendants’ personal use.

Most churches, at least occasionally, accumulate funds in excess of current expenses, and church leaders must decide what to do with these funds. This can happen in a number of ways, including the following:

In each of these cases church leaders must decide what to do with the accumulated funds. What legal responsibilities do church leaders have when it comes to investing church funds? Can they be legally accountable for bad investments? How can they minimize their risk of liability? These are important questions.

Those who serve on a board of directors, whether for a church or any other organization, have a legal duty to perform their duties “in good faith, in a manner they reasonably believe to be in the best interests of the corporation, and with such care as an ordinarily prudent person in a like position would use under similar circumstances.” This duty commonly is referred to as the “prudent person rule” or the “duty of due care.”

The fiduciary duty of due care often is set forth in a state’s nonprofit corporation law. To illustrate, the Revised Model Nonprofit Corporation Act, which has been enacted in a small but growing number of states, contains the following language:

This duty of due care applies to the investment of corporate funds. However, directors are not accountable for every bad investment they authorize. They are not held to a standard of perfection. Rather, they are accountable only if an investment decision was not based on “the care an ordinarily prudent person in a like position would exercise under similar circumstances.” The courts have been reluctant to impose liability on directors for an exercise of poor judgment. One state supreme court, in language that has been quoted by several other courts, observed:

Summarized below are a few cases that illustrate the application of the “duty of due care” to the directors of religious and other charitable organizations:

Case 24. A court ruled that the directors of a nonprofit corporation breached their fiduciary duty of care in managing the corporation’s investments. For nearly 20 years, management of the corporation had been dominated almost exclusively by two officers, whose decisions and recommendations were routinely adopted by the board. The corporation’s finance committee had not convened in more than 11 years. Under these facts, the court concluded:

The court concluded that officers or directors of a nonprofit organization breach their fiduciary duty of care with regard to the investment of the organization’s funds in any of the following situations: (1) they fail to use due diligence in supervising the actions of employees or outside experts “to whom the responsibility for making day-to-day financial or investment decision has been delegated”; or (2) they knowingly permit the organization to enter into an investment with another organization in which one or more officers or directors has a substantial interest—unless the conflict of interest is fully disclosed to the board, is approved by a disinterested majority of the board, and is fair to the organization; or (3) they “otherwise failed to perform [their] duties honestly, in good faith, and with a reasonable amount of diligence and care.”

Case 25. A court overseeing the bankruptcy of the PTL ministry concluded that Jim Bakker (as both an officer and director) had breached his legal duty of care to PTL. The court emphasized that “trustees and corporate directors for not-for-profit organizations are liable for losses occasioned by their negligent mismanagement.”

Case 26. A court ruled that directors of a charitable trust could be sued for breaching their fiduciary duties. A child of the founder of the trust filed a lawsuit seeking to remove 8 of the trust’s 11 directors. He asserted that the 8 directors breached their fiduciary duties, mismanaged the trust’s investments, and negligently selected the trust’s investment advisor. Specifically, the lawsuit alleged that the 8 directors mismanaged the trust’s investments by authorizing the investment of a substantial portion of the trust’s assets in speculative securities and in the stock of a company with direct ties to the directors, and authorized excessive trading in securities, thereby incurring substantial commissions. A court ruled that the 8 directors could be sued. It noted that the New York Not-For-Profit Corporation Law requires that the officers and directors of a nonprofit corporation “discharge the duties of their respective positions in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions.” The court concluded that the directors in this case may have violated this standard, and allowed the case to proceed to trial.

Case 27. A court ruled that the officers and directors of a nonprofit organization could be sued on the basis of their gross negligence in the management of the affairs and finances of the organization. The officers and directors were not sued for breach of any fiduciary duty, but rather in a “quo warranto” proceeding under state law. Such a proceeding allows officers and directors to be sued to prevent a diversion, loss, or waste of corporate funds or property. The court also ruled that a state law protecting uncompensated officers and directors of nonprofit organizations from liability did not apply in this case since the officers and directors were accused of gross negligence.

How can church leaders responsibly discharge their fiduciary duties and protect the assets of the church and church members from fraudulent investments? Consider the following:

(1) check state law

If your church is incorporated under state law, be sure to check your state nonprofit corporation law for any provisions that address the duties of officers and directors. This information should be made available to all of the church’s officers and directors.

(2) check the church’s bylaws and minutes

Some church bylaws contain restrictions on investments. Such restrictions may also appear in the minutes of congregational or board meetings. It is essential for board members to be aware of these restrictions and to honor them.

(3) use an investment committee

Many nonprofit organizations use an investment committee to make recommendations regarding the investment of funds. This can be an excellent way to reduce the liability of board members for poor investment decisions. Rather than make decisions themselves, the board appoints an investment committee that includes individuals with proven investment or financial expertise. Committee members may include stock brokers, CPAs, attorneys, bankers, financial planners, and business leaders. Of course, the committee’s recommendations ordinarily must be approved by the governing board, but by relying on the advice of experts the board is greatly reducing the risk of being liable for poor investment decisions. They were relying on the advice of experts.

(4) investment policy

A church congregation or board can create an investment policy to direct investment decisions. A policy can prohibit investments in specified instruments or programs.

(5) avoid speculative or risky investments

If a proposal sounds “too good to be true,” it probably is. Any scheme that promises to “double your money” in a short period of time should be viewed with extreme skepticism. It is absolutely essential that such schemes not be pursued without the thorough evaluation and recommendation of persons with financial and investment expertise.

Here are some examples of investments to avoid: uninsured bank accounts, high-risk bonds, gold or other precious metals, unsecured loans, and limited partnerships. It is also best to avoid investing all or a significant portion of available funds in the stock of one company, since the lack of “diversification” creates added risk. Investing in stock generally should be avoided unless investments are sufficiently diversified (for example, through conservative mutual funds) and recommended by a knowledgeable investment committee.

(6) avoid investing in companies or programs in which a board member has a personal interest

Avoid investing in companies or programs with direct ties to a member of your board. Such investments are not always inappropriate, but they demand a much higher degree of scrutiny.

(7) trustees have a higher duty

Sometimes church board members are designated as the trustees of a charitable trust. For example, a member dies leaving a large sum to the church for a specific purpose and designates the pastor or church board as trustees of the fund. Trustees are held to an even higher degree of care in the investment of trust funds than are officers or directors of a corporation. However, the Revised Model Nonprofit Corporation Act specifies that “[a] director shall not be deemed to be a trustee with respect to the corporation or with respect to any property held or administered by the corporation, including without limit, property that may be subject to restrictions imposed by the donor or transferor of such property.” In other words, a church officer or director is not automatically deemed to be a “trustee” of church funds. Officers and directors generally are held to the higher legal standard applicable to trustees only if they are designated as trustees in a legal instrument that creates a trust fund.

(8) SEC recommendations

Review and apply the recommendations published by the United States Securities and Exchange Commission.

© Copyright 2004 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: m85 m46 m18 c0204