Pastor, Church & Law

Federal and State Securities Law

§ 9.04

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 fifty states, and under federal law.

1. In General

Laws regulating the sale of securities have been enacted by the federal government 50 Securities Act of 1933, 15 U.S.C. §§ 77a-77aa. and by all 50 states. 51 Nearly 40 states have enacted all or significant portions of the Uniform Securities Act.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

a note; stock; treasury stock; security future; bond; debenture; evidence of indebtedness; certificate of interest or participation in a profit-sharing agreement; collateral trust certificate; preorganization certificate or subscription; transferable share; investment contract; voting trust certificate; certificate of deposit for a security; fractional undivided interest in oil, gas, or other mineral rights; put, call, straddle, option, or privilege on a security, certificate of deposit, or group or index of securities, including an interest therein or based on the value thereof; put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency; or, in general, an interest or instrument commonly known as a “security”; or a certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. The term:

(A) includes both a certificated and an uncertificated security;

(B) does not include an insurance or endowment policy or annuity contract under which an insurance company promises to pay a fixed [or variable] sum of money either in a lump sum or periodically for life or other specified period;

(C) does not include an interest in a contributory or noncontributory pension or welfare plan subject to the Employee Retirement Income Security Act of 1974;

(D) includes as an “investment contract” an investment in a common enterprise with the expectation of profits to be derived primarily from the efforts of a person other than the investor and a “common enterprise” means an enterprise in which the fortunes of the investor are interwoven with those of either the person offering the investment, a third party, or other investors; and

(E)includes as an “investment contract,” among other contracts, an interest in a limited partnership and a limited liability company and an investment in a viatical settlement or similar agreement. 52 Uniform Securities Act § 102(28).

This definition is broad enough to include many instruments utilized in church fundraising efforts. Securities laws were enacted to protect the public against fraudulent and deceptive practices in the offer and 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 offer and sale of securities:

  1. registration of proposed securities with the federal or state government in advance of sale
  2. filing of sales and advertising literature with the federal or state government
  3. registration of agents and broker-dealers who will be selling the securities
  4. prohibition of fraudulent practices

The federal Securities Act of 1933 exempts “any security issued by a person organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes and not for pecuniary profit, and no part of the net earnings of which inures to the benefit of any person, private stockholder, or individual.” 53 Section 3(a)(4).

Similarly, the Uniform Securities Act, which has been adopted by most states, exempts from registration:

[A] security issued by a person organized and operated exclusively for religious, educational, benevolent, fraternal, charitable, social, athletic, or reformatory purposes, or as a chamber of commerce, and not for pecuniary profit, no part of the net earnings of which inures to the benefit of a private stockholder or other person, or a security of a company that is excluded from the definition of an investment company under Section 3(c)(10)(B) of the Investment Company Act of 1940; except that with respect to the offer or sale of a note, bond, debenture, or other evidence of indebtedness issued by such a person, a rule may be adopted under this [Act] limiting the availability of this exemption by classifying securities, persons, and transactions, imposing different requirements for different classes, specifying with respect to paragraph (B) the scope of the exemption and the grounds for denial or suspension, and requiring an issuer:

(A) to file a notice specifying the material terms of the proposed offer or sale and copies of any proposed sales and advertising literature to be used and provide that the exemption becomes effective if the administrator does not disallow the exemption within the period established by the rule;

(B) to file a request for exemption authorization for which a rule under this [Act] may specify the scope of the exemption, the requirement of an offering statement, the filing of sales and advertising literature, the filing of consent to service of process complying with Section 611, and grounds for denial or suspension of the exemption; or

(C) to register under Section 304 [pertaining to registration by qualification]. 54 Id. at 201(7). See generally Horner & Makens, Securities Regulation of Religious and Other Nonprofit Organizations, 27 Stetson L. Rev. 473 (1997).

Note that this language gives state legislatures some flexibility in crafting a religious exemption. States may require religious organizations to file a notice with the state securities commission describing a proposed offer of securities, with the exemption becoming effective within a specified time if the securities commission does not object to the offer. Or, states may require religious organizations to file a more formal request for recognition of exemption, subject to such terms as the state legislature chooses to impose. States are also free to make their exemption of religious organizations automatic, or to provide no exemption of any kind (and thereby require religious organizations to pursue registration of their securities offerings).

An official comment by the drafters of the Uniform Securities Act states:

Section 201(7) provides statutory authority for the states to adopt rules with respect to notes, bonds, debentures and other evidences of indebtedness issued by nonprofit organizations. Each state may adopt different rules tailored for various types of nonprofit debt offerings, (e.g., local church bond offerings, national church bond offerings, church extension funds, charitable gift annuities). For states that do not wish to provide an automatic exemption from registration for a particular type of nonprofit debt instrument or offering, Section 201(7) creates three categories of regulatory review that may be required by rule: (a) exemption by notice filing, (b) exemption by state authorization, and (c) registration by qualification. These categories are consistent with the manner in which many states currently review different types of nonprofit debt securities.

Key point. 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. Church securities always will be subject to some degree of regulation. The question in each case is how much.

In the minority of jurisdictions in which a church must register its securities, registration ordinarily is accomplished by filing a registration statement with the state securities commission setting forth the following information:

  • the issuer’s name, address, and form of organization;
  • the state or foreign jurisdiction and date of its organization;
  • the general character and location of its business;
  • a description of its physical properties and equipment;
  • the name, address, and principal occupation of each officer and director for the previous five years;
  • the amount of securities of the issuer held by each officer and director;
  • the remuneration paid to each officer and director during the previous 12 months and estimated to be paid during the next 12 months, directly or indirectly, by the issuer;
  • the capitalization and long term debt of the issuer;
  • the kind and amount of securities to be offered;
  • the proposed offering price or the method by which it is to be computed;
  • the estimated aggregate underwriting and selling discounts or commissions and finders’ fees, or anything else of value to accrue to the underwriters or finders in connection with the offering;
  • the estimated amounts of other selling expenses, including legal, engineering, and accounting charges;
  • the estimated monetary proceeds to be received by the issuer from the offering; the purposes for which the proceeds are to be used by the issuer;
  • the estimated amount to be used for each purpose;
  • the order or priority in which the proceeds will be used for the purposes stated; the amounts of any funds to be raised from other sources to achieve the purposes stated;
  • the sources of the funds;
  • a description of any pending litigation, action, or proceeding to which the issuer is a party and that materially affects its business or assets, and any litigation, action, or proceeding known to be contemplated by governmental authorities;
  • a copy of any prospectus, pamphlet, circular, form letter, advertisement, or other sales literature intended as of the effective date to be used in connection with the offering;
  • a specimen or copy of the security being registered, unless the security is uncertificated;
  • a copy of the issuer’s articles of incorporation and bylaws or their substantial equivalents;
  • a signed or conformed copy of an opinion of counsel concerning the legality of the security being registered, which states whether the security when sold will be validly issued, fully paid, and nonassessable and, if a debt security, a binding obligation of the issuer;
  • a balance sheet of the issuer as of a date within four months before the filing of the registration statement;
  • a statement of income and changes in financial position for each of the three fiscal years preceding the date of the balance sheet and for any period between the close of the immediately previous fiscal year and the date of the balance sheet, or for the period of the issuer’s and any predecessor’s existence if less than three years; and
  • any additional information or records required by rule adopted or order issued under state law.55 Uniform Securities Act § 304.

The method of registration described above is referred to as registration by qualification. Most states also provide for registration by coordination. Churches will rarely if ever utilize registration by coordination, since this method assumes registration of an issuer’s securities under the federal Securities Act of 1933 and churches are exempt from registration under this Act.

The registration statement ordinarily is prepared on a form provided by the state securities commission. Considerable effort has been expended to standardize securities laws and related forms among the 50 states. Most states now permit issuers to register their securities on a uniform application developed by the American Bar Association. This uniform application is called Form U-1 (the current edition was approved in 2016).

Generally, the filing of a registration statement with a state securities commission constitutes registration of the security unless the commission objects to the registration statement within a prescribed period. A state securities commission retains the authority to suspend or revoke a registration of securities on the basis of a variety of grounds, including fraud, unreasonable commissions, illegality, omission of a material fact in the registration statement, and willful violation of any rule, order, or condition imposed by the securities commission.56 Id. at § 306.

Registration of securities generally is effective for one year, although some state laws stipulate that a registration will expire when the securities described in the registration statement have been sold.

Most securities laws that exempt church securities from registration also exempt churches from the requirement of filing sales and advertising literature with the securities commission. Again, churches must not assume that they are exempt from the filing requirement, since some state securities laws contain no such exemption. Furthermore, even if a church is exempt from the requirement of filing its sales and advertising literature with a state securities commission, it may be deemed to have entered into fraudulent transactions with investors if at or before the time of a sale or an offer to sell it does not provide each investor with a prospectus or offering circular containing sufficient information about the securities to enable an investor to make an informed investment decision.

The North American Securities Administrators Association (NASAA) has issued the following three guidelines pertaining to securities issued by religious organizations 57 The guidelines are available on the NASAA website (

(1) Church Bonds

In general, these guidelines require certain basic information on the cover page, and in addition require a full description of the history and operations of the church; the church’s prior borrowing experience; risk factors associated with investment in the church’s securities; how funds will be held during the offering period; anticipated use of proceeds; current financial condition of the church, accompanied by financial statements for the past three years; the church’s properties; the type and amount of the securities to be offered, including interest rates, maturity dates, payment dates, and paying agent; the plan of distribution; pending or threatened legal proceedings against the church; tax aspects of ownership of the church’s securities; and the church’s leadership.

(2) Guidelines for General Obligation Financing by Religious Denominations

These guidelines address debt securities offered by denominational agencies that are used to provide resources to affiliated churches and institutions in the form of grants or loans. In general, these guidelines incorporate many of the same standards that are contained in the guidelines for local church securities offerings. They also contain guidelines for evaluating the strength of a loan fund.

(3) Church Extension Fund Securities

These guidelines define a church extension fund (CEF) as follows: “A not-for-profit organization affiliated or associated with a denomination, or a fund that is accounted for separately by a denomination organized as a not-for-profit organization, that offers and sells notes primarily to provide funding for loans to various affiliated churches and related religious organizations of the denomination for the acquisition of property, construction or acquisition of buildings and other related capital expenditures or operating needs.”

An official comment accompanying the guidelines provides the following clarification:

General obligation financing by a CEF is different in its purposes and operation than the one-time offering of Church Bonds by an individual church or congregation to finance the construction of a single, specific church building or other related capital improvements, in which all of the securities are repaid within a set period of time. CEF NOTES are sold for various terms and at varying interest rates and the offerings are normally continuous in nature to provide an ongoing source of financing to the various affiliated churches and related organizations. In order to maintain the CEF as a permanent resource for the affiliated churches and related organizations, repayments of principal on loans made by the CEF are continuously reinvested in new loans to affiliated churches and related organizations. A CEF normally is a single purpose organization and has no significant operating activities other than raising funds and making capital loans to its affiliated churches and related organizations. Since the CEF is generally incorporated and operated separately from the DENOMINATION and its affiliated churches and related organizations, assets of the CEF are used primarily for the purpose of financing building projects for affiliated churches and related organizations. To the extent the CEF is a separately incorporated entity, it normally is not liable for any debts arising from other unrelated activities or programs of the DENOMINATION or its affiliated churches and related organizations. The history of most CEFs reflects an absence of delinquency or default in payments on amounts owed under their NOTES. The primary indebtedness of most CEFs consists of the outstanding NOTES. A significant number of INVESTORS reinvest with the CEF when their NOTES mature. Therefore, the establishment of any special repayment provisions, including a sinking fund or trust indenture, for the purpose of making payments on principal or interest due on NOTES, is normally unnecessary and inappropriate in view of the continuous nature of the offerings and the fact that the funds are not designated for specific capital projects.

It is important to observe that most states require that persons who sell or offer to sell securities be registered with the state securities commission. Registration involves submitting a detailed application58 Most states accept the uniform Form U-4 prepared by the National Association of Securities Dealers. See generally § 4-07, supra.and, in most cases, the successful completion of a securities law examination. A few states that exempt the securities of religious organizations from registration do not exempt persons selling or offering to sell such securities from the salesman registration requirements.

2. Securities Fraud

No state securities law exempts religious organizations from the antifraud provisions. The antifraud provisions of the Uniform Securities Act are set forth in section 501:

It is unlawful for a person, in connection with the offer, sale, or purchase of a security, directly or indirectly:

(1) to employ a device, scheme, or artifice to defraud;

(2) to make an untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which it is made, not misleading; or

(3) to engage in an act, practice, or course of business that operates or would operate as a fraud or deceit upon another person.

This section is substantially the same as section 17(a) of the federal Securities Act of 1933. Section 17 states that the Act’s exemption of nonprofit organizations from the registration requirements does not apply to the antifraud provisions.

The antifraud provisions of federal and state securities laws are very broad. They have been construed to prohibit a wide variety of activities, including the following:

  • 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

Key point. There are two additional considerations that churches should consider before offering securities. First, some securities may be regulated under state and federal banking law. For example, it is possible that the issuance of “demand notes” (notes redeemable by investors “on demand”) would violate state and federal banking laws. Demand notes are basically deposit arrangements which may trigger banking regulation. Second, complex accounting principles apply to some securities programs. It is essential for churches to work with a CPA firm with experience in representing nonprofit organizations that issue securities.

In a leading case, the federal Securities and Exchange Commission brought an action in federal court seeking to enjoin a church and its leader from violating the antifraud provisions of the Securities Act of 1933.59 Securities and Exchange Commission v. World Radio Mission, Inc., 544 F.2d 535 (1st Cir. 1976).The church had solicited funds through investment plans consisting essentially of the sale of interest-bearing notes to the general public. The notes were promoted through advertising literature extolling the security of the investment. For example, one advertisement stated in part:

You may be a Christian who has committed his life into the hands of God, but left his funds in the hands of a floundering world economy. Financial experts everywhere are predicting a disaster in the economy. They say it is only a matter of time. … God’s economy does not sink when the world’s economy hits a reef and submerges! Wouldn’t it be wise to invest in His economy?

The Securities and Exchange Commission argued that the church had defrauded investors by such representations when in fact it had a substantially increasing operating deficit that had jumped from $42,349 to $203,776 in the preceding three years. This fact was not disclosed to investors.

The church argued that religious organizations are protected by the First Amendment from the reach of securities laws. In rejecting this contention, the court observed: “Defendants constantly emphasize that they are engaged in ‘God’s work.’ No court has ever found that conduct, by being so described, is automatically immunized from all regulation in the public interest.” 60 Id. at 539 n.7.The court quoted with approval the United States Supreme Court’s earlier observation that “[n]othing we have said is intended even remotely to imply that, under the cloak of religion, persons may, with impunity, commit frauds upon the public.” 61 Id. at 537 n.3, quoting Cantwell v. Connecticut, 310 U.S. 296, 306 (1940). The court was “surprised … by defendants’ recitation of the parable of the servants entrusted with their master’s talents. We do not question the parable, but insofar as it indicates a duty to make loans, it is to make profitable ones. A servant contemplating lending to a possibly shaky enterprise would do well to note the final verse.” Id. at 538 n.6.The court found it irrelevant that investors had a “religious” motivation, that most investors were “believers,” and that the church did not intend to defraud or deceive anyone.

A number of churches and other religious organizations have been investigated by the federal Securities and Exchange Commission and by state securities commissions. In most cases, the investigation was prompted by the complaint of an investor.62 See, e.g., In the Matter of Keep the Faith, Inc., Ariz. Corp. Com., Dec. 54503 (April 25, 1985) (issuer incorrectly stated that its securities program did not involve a donation and did not disclose material information to investors, including the interest rate and term of the securities, and the background and financial condition of the issuer); In the Matter of Johnson Financial Services, Inc., Ga. Securities Div., No. 50-84-9500 (August 6, 1984) (salesperson falsely represented that he was working with a Presbyterian church to help sell its bonds, that he was a licensed salesperson, and that the church bonds he was offering earned 18 percent “tax free” for years); In the Matter of Tri-County Baptist Church, Mich. Corp. and Secs. Bureau, No. 84-32-S (June 11, 1984) (church failed to maintain an escrow account for proceeds of bond sales and did not apply proceeds as described in prospectus).

Churches that violate state securities laws face a variety of potential consequences under state and federal securities laws. These include investigations, hearings, subpoenas, injunctions, criminal actions, cancellation of sales, suits for monetary damages by aggrieved investors, monetary fines, and revocation of an exemption, or registration, of securities.

Key point. It is important to recognize that “good faith” (a lack of an intention to deceive, or lack of knowledge that a particular transaction is either fraudulent or otherwise in violation of securities law) does not necessarily protect against liability. To illustrate, some courts have ruled that the sale of unregistered securities in violation of state securities law is punishable despite the innocent intentions of the seller. 63 Moerman v. Zipco, Inc., 302 F. Supp. 439 (E.D.N.Y. 1969), aff’d, 422 F.2d 871 (2nd Cir. 1970); Trump v. Badet, 327 P.2d 1001 (Ariz. 1958).However, civil lawsuits by investors alleging fraud in the sale of securities must demonstrate an actual intent to deceive or defraud.64 The United States Supreme Court so held in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). While the Ernst decision dealt only with proof of an intent to deceive under the antifraud provisions of federal securities law, the decision has been held to apply by implication to private actions under the antifraud provisions of state securities laws. See, e.g., Greenfield v. Cheek, 593 P.2d 293 (Ariz. 1978).

Case studies

  • 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.65 Commonwealth of Virginia v. Unity Christ Church, 1996 WL 392586 (Va. Corp. Com. 1996).
  • A state corporation commission launched an investigation into a church’s bond program as a result of the following allegations: (1) the church’s prospectus omitted disclosure of defaults by the church on bonds it issued in 1984 and 1987; (2) the financial statements included with the church’s prospectus failed to properly reflect the total accrued interest on outstanding bonds; and (3) the prospectus issued to investors falsely represented that the church was current in its sinking fund payments for prior bond offerings. The commission entered into a settlement with the church which contained a number of terms, including the following: (1) payment of a fine; (2) an assurance that the church would not engage in any further practices in violation of state securities law; (3) an audit of the church’s financial records; (4) the formulation of a financial plan by which all holders of outstanding bonds will be paid full principal and interest in accordance with the terms of their bond agreements; and (5) distribute to all bondholders a disclosure document, approved by the commission, disclosing all previous omissions, the church’s current financial status, and its plan for the full repayment of all outstanding bonds.66 Commonwealth of Virginia v. Zion Apostolic Christian Memorial Church, 1998 WL 514271 (Va. Corp. Com. 1998).
  • 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 decision maker, 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.”67 United States v. Lilly, 37 F.3d 1222 (7th Cir. 1994).

  • 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.

3. The Sarbanes-Oxley Act

The Sarbanes-Oxley Act amends federal law to permit private lawsuits for securities fraud violations to be brought not later than two years after its discovery, or five years after the date of the violation, whichever is earlier.

Case studies

  • To raise funds for a new building, a church sells bonds through its minister and board to church members. The church board assumes that the church is exempt from any legal restrictions, and so does not comply with the provisions of the state securities law. No “offering circular” (prospectus) is provided to prospective investors describing the securities and various risks, no one who sells the securities complies with agent registration requirements mandated by state law, and the church fails to create a “sinking fund” with a portion of the proceeds received from the sale of the securities. Within one year the church sells $400,000 of its promissory notes, but eventually defaults on all of them. Four years after the notes were sold, several investors sued the church in federal court alleging various counts of securities fraud under federal law. The church is not a public company and therefore is not subject to most of the provisions of the Sarbanes-Oxley Act. However, the Act extends the statute of limitations for securities fraud claims under federal law to not later than two years after discovering the fraud, or five years after the date of the violation, whichever is earlier. This extended statute of limitations for federal securities fraud claim applies to lawsuits brought against churches.
  • A church issues $1,000,000 in promissory notes for the construction of a new educational facility. It prepares a prospectus describing the securities, the history of the church, and the church’s financial condition. However, the prospectus fails to mention that the church has run budget deficits for each of the past 3 years, and that attendance has declined by 25 percent over that same period. The church board decided that this information was too negative to be put in the prospectus and would make the church’s notes too unattractive to investors. Several years later, the church defaults on the notes, and some investors sue the church for securities fraud under federal law on the basis of the church’s decision to omit information in the prospectus regarding deficits and attendance declines. The church is not a public company and therefore is not subject to most of the provisions of the Sarbanes-Oxley Act. However, the Act extends the statute of limitations for securities fraud claims under federal law to not later than two years after discovering the fraud, or five years after the date of the violation, whichever is earlier. This extended statute of limitations for federal securities fraud claim applies to lawsuits brought against churches.

4. Protecting Churches and Church Members from Investment Fraud

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

Consider the following scenario. A church raises $250,000 for its building fund but is still years away from reaching the goal specified by the congregation before construction can begin. This year the pastor meets Jon, an “investment expert,” who seems very knowledgeable about investment opportunities. Jon claims that he can turn the 1 percent return the church is earning on its building fund in a local bank to 30 percent or even 50 percent. The pastor is skeptical at first, but begins to see Jon as an answer to prayer. “Within just a few years, we will be able to begin construction on our new sanctuary,” he muses. The pastor is also impressed by Jon’s description of a “high yield investment program” involving international banks. The pastor invites Jon to make a presentation to the church board. Jon assures the board that the investment program only involves the “top ten world banks.” The board is impressed, and votes to turn over the investment of the church’s building fund to Jon. Within a few months, Jon suggests that the pastor promote the investment program to members of the congregation. With the pastor’s encouragement, many church members invest their own funds in Jon’s program. After several months, the pastor, board, and individual investors begin to wonder when they will receive their 50 percent return on their investments. Jon assures them that it is only a matter of time. A year passes, and still no earnings have been reported. Federal investigators contact the pastor and explain that Jon was engaged in a multi-million dollar securities scam, and that there is little chance that the church, or the individual investors, will ever receive back their invested funds much less any earnings. The pastor is devastated, as is the church board. Some church members invested their life savings in what they believed was a blessing from God. Several members begin blaming the pastor and board.

Sound unbelievable? It shouldn’t. Investment scams have victimized many churches and church members, and no church is immune. This section 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 section 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 section addresses the following topics:

  • common investment scams
  • illustrative cases
  • SEC enforcement actions
  • liability of church leaders
  • reducing the risk of investment fraud
  • Common investment scams

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:

Steer clear of multilevel marketing plans that pay commissions for recruiting new distributors. They’re actually illegal pyramid schemes. Why is pyramiding dangerous? Because plans that pay commissions for recruiting new distributors inevitably collapse when no new distributors can be recruited. And when a plan collapses, most people (except perhaps those at the very top of the pyramid) end up empty-handed.

If you’re thinking about joining what appears to be a legitimate multilevel marketing plan, take time to learn about the plan before signing on.

What’s the company’s track record? What products does it sell? How does it back up claims it makes about its product? Is the product competitively priced? Is it likely to appeal to a large customer base? What up-front investment do you have to make to join the plan? Are you committed to making a minimum level of sales each month? Will you be required to recruit new distributors to be successful in the plan?

Use caution if a distributor tells you that for the price of a “start-up kit” of inventory and sales literature—and sometimes a commitment to sell a specific amount of the product or service each month—you’ll be on the road to riches. No matter how good a product and how solid a multilevel marketing plan may be, expect to invest sweat equity as well as dollars for your investment to pay off.

(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 percent return in just 90 days compared with five percent 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.

Key point. Here’s a good common sense rule to follow when evaluating investment options, “If it looks too good to be true, don’t touch it.”

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.”68 Black’s Law Dictionary (10th ed.2014).

(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:

  • Why would a perfect stranger pick you, also a perfect stranger, to share a fortune with?
  • Why would you share your personal or business information, including your bank account numbers or your company letterhead, with someone you don’t know?

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:

Lured by the promise of astronomical profits and the chance to be part of an exclusive, international investing program, many investors have fallen prey to bogus “prime bank” scams. These fraudulent schemes involve the use of so-called “prime” bank, “prime” European bank or “prime” world bank financial instruments, or other “high yield investment programs” (“HYIP”s). Persons who promote these schemes often use the word “prime” (or a synonymous phrase, such as “top fifty world banks”) to cloak their programs with an air of legitimacy. They seek to mislead investors by suggesting that well regarded and financially sound institutions participate in these bogus programs. But prime bank and other related schemes have no connection whatsoever to the world’s leading financial institutions or to banks with the word “prime” in their names.

How do prime bank scams work? Here is the SEC explanation:

Prime bank programs often claim investors’ funds will be used to purchase and trade “prime bank” financial instruments on clandestine overseas markets in order to generate huge returns in which the investor will share. However, neither these instruments, nor the markets on which they allegedly trade, exist. To give the scheme an air of legitimacy, the promoters distribute documents that appear complex, sophisticated and official. The sellers frequently tell potential investors that they have special access to programs that otherwise would be reserved for top financiers on Wall Street, or in London, Geneva or other world financial centers. Investors are also told that profits of 100% or more are possible with little risk.

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.

  • Excessive guaranteed returns. These schemes typically offer or guarantee spectacular returns of 20 to 200 percent monthly, absolutely risk free! Promises of unrealistic returns at no risk “are hallmarks of prime bank fraud.”
  • Fictitious financial instrument. Despite having credible-sounding names, the supposed “financial instruments” at the heart of any prime bank scheme simply do not exist. Exercise caution if you’ve been asked to invest in a debt obligation of the top 100 world banks, Medium Term Bank Notes or Debentures, Standby Letters of Credit, Bank Guarantees, an offshore trading program, a roll program, bank-issued debentures, a high yield investment program, or some variation on these descriptions. Promoters frequently claim that the offered financial instrument is issued, traded, guaranteed, or endorsed by the World Bank or an international central bank.
  • Extreme secrecy. Promoters claim that transactions must be kept strictly confidential by all parties, making client references unavailable. They may characterize the transactions as the best-kept secret in the banking industry, and assert that, if asked, bank and regulatory officials would deny knowledge of such instruments. Investors may be asked to sign nondisclosure agreements.
  • Exclusive opportunity. Promoters frequently claim that investment opportunities of this type are by invitation only, available to only a handful of special customers, and historically reserved for the wealthy elite.
  • Claims of inordinate complexity. Investment pitches frequently are vague about who is involved in the transaction or where the money is going. Promoters may try to explain away this lack of specificity by stating that the financial instruments are too technical or complex for “non-experts” to understand.

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

Reducing the Risk of Investment Fraud—SEC Recommendations

As you read through the cases summarized above, you may be amazed that anyone could have fallen for these scams. But the truth is that in each case church members and leaders found the investment scheme to be legitimate, and did not realize that they were being victimized. Are there specific steps that church members and leaders can take to reduce the risk of financial fraud? Fortunately, the answer is yes. A first step is to be familiar with the four specific kinds of investment fraud described above (pyramid schemes, Ponzi schemes, Nigerian investments, and prime bank investments). A second step is to review the actual cases summarized above. Third, review the following recommendations from the United States Securities and Exchange Commission.

(1) if it sounds too good to be true, it is

High-yield investments tend to involve extremely high risk. Never invest in an opportunity that promises “guaranteed” or “risk-free” returns. Words like “guarantee,” “high return,” “limited offer,” or “as safe as a C.D.” may be a red flag. No financial investment is “risk free” and a high rate of return means greater risk. Watch out for claims of astronomical yields in a short period of time. Be skeptical of “off-shore” or foreign investments. And beware of exotic or unusual sounding investments, especially those involving so-called “prime bank” securities. Compare promised yields with current returns on well-known stock indexes. Any investment opportunity that claims you’ll get substantially more could be highly risky. And that means you might lose money.

(2) “guaranteed returns” aren’t

Every investment carries some degree of risk, and the level of risk typically correlates with the return you can expect to receive. Low risk generally means low yields, and high yields typically involve high risk. If your money is perfectly safe, you’ll most likely get a low return. High returns represent potential rewards for folks who are willing to take big risks. Most fraudsters spend a lot of time trying to convince investors that extremely high returns are “guaranteed” or “can’t miss.” Don’t believe it.

(3) check out the company before you invest

If you’ve never heard of a company, broker, or adviser, spend some time checking them out before you invest. Most public companies make electronic filings with the SEC that can be inspected on the SEC website. Some smaller companies don’t have to register their securities offerings with the SEC, so always check with your state securities regulator. You’ll find that telephone number in the government section of your phone book. Or call the North American Securities Administrators Association (NASAA) at (202) 737-0900. Many online investment scams involve unregistered securities. One simple phone call can make the difference between investing in a legitimate business or squandering your money on a scam.

Your state securities department can tell you whether the person pushing the investment opportunity has a disciplinary history by checking the Central Registration Depository (CRD). You can also obtain a partial disciplinary history by contacting NASD’s toll-free public disclosure hot-line at (800) 289-9999 or visiting their website at

If a promoter only lists a P.O. box, you’ll want to do a lot of work before investing your money.

(4) if it is that good, it will wait

Scam artists usually try to create a sense of urgency, implying that if you don’t act now you’ll miss out on a fabulous opportunity. But savvy investors take time to do their homework before investing. If you’re being pressured to invest, especially if it is a once-in-a-lifetime, too-good-to-be-true opportunity that “just can’t miss,” just say “no.” Your wallet will thank you.

(5) understand your investments

Scam artists frequently use a lot of big words and technical-sounding phrases to impress you. But have faith in yourself! If you don’t understand an investment, don’t buy it. If a salesman isn’t able to explain a concept clearly enough for you to understand, it isn’t your fault. Don’t make it your problem by buying!

(6) beauty isn’t everything

Don’t be fooled by a pretty website—they are remarkably easy to create.

(7) is the person offering the securities licensed?

Find out if the person or firm selling the investment needs to be licensed. Call your state securities regulator and ask whether the person or firm is licensed to do business in your state and whether they have a record of complaints or fraud.

(8) be especially skeptical of investing via the Internet

You should be skeptical of investment opportunities you learn about through the Internet. When you see an offering on the Internet (whether it’s on a company’s website, in an online newsletter, on a message board, or in a chat room) you should assume it’s a scam until you’ve done your homework and proven otherwise. Get the facts before you invest, and only invest money you can afford to lose.

(9) be skeptical of offshore investment opportunities

Watch out for offshore scams and investment opportunities in other countries. When you send your money abroad, and something goes wrong, it’s more difficult to find out what happened and to locate your money.

(10) call the SEC

If you have any doubts about an investment opportunity, call the SEC or your state securities department. You can get the telephone numbers by visiting their websites.

10 Questions to Ask Before You Invest

The SEC suggests that prospective investors ask the following 10 questions before investing funds:

  1. Is the investment registered with the SEC and the state where I live?
  2. Is the person recommending this investment licensed with my state securities agency? Is there a record of any complaints about this person or the firm he or she works for?
  3. How does this investment match my investment objectives?
  4. Will the sales representative send me the latest reports that have been filed on this company?
  5. What are the costs to buy, hold, and sell this investment? How easily can I sell?
  6. Who is managing the investment? What experience do they have? Have they made money for investors before?
  7. What is the risk that I could lose the money I invest?
  8. What return can I expect on my money? When?
  9. How long has the company been in business? Is it making money, and if so, how? What is their product or service? What other companies are in this business?
  10. How can I get more information about this investment, such as audited financial statements, annual and quarterly reports, and a prospectus?

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold 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. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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