Investing Excess Church Funds

A list of church investment do’s and don’ts.

Background. 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:

  • A church’s income may exceed expenses for a period of time.
  • A church creates a “designated fund” for a special purpose, such as a building fund. Such a fund may be sizable, and can last for several months or even years.
  • One or more donors contribute funds for a specific purpose that has not yet been implemented. For example, donors contribute to their church’s benevolence fund. The fund accumulates several thousand dollars during the year in excess of distributions.

In each of these cases church leaders must decide what to do with the accumulated funds. What legal responsibilities do church treasurers, and other 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 that are addressed in this article.

Key point. This article contains information of vital importance to members of your governing board. We recommend that it be reviewed by every board member.

The fiduciary duty of “due care.” 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.”

Key point. The fiduciary duty of care applies directly to church treasurers who serve on the governing board of their church. Church treasurers who do not serve on the governing board can play a vital role in informing board members of this fiduciary duty and its application to the board.

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:

A director shall discharge his or her duties as a director … (1) in good faith; (2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and (3) in a manner the director reasonably believes to be in the best interests of the corporation.

In discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by: (1) one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the matters presented; (2) legal counsel, public accountants or other persons as to matters the director reasonably believes are within the person’s professional or expert competence …. Revised Model Nonprofit Corporation Act § 8.30.

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:

[There is] a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. Absent an abuse of discretion, that judgment will be respected by the courts. The burden is on the party challenging the decision to establish facts rebutting the presumption.

Illustrative cases. 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 #1. 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:

Total abdication of [a director’s] supervisory role, however, is improper …. A director who fails to acquire the information necessary to supervise investment policy or consistently fails even to attend the meetings at which such policies are considered has violated his fiduciary duty to the corporation. While a director is, of course, permitted to rely upon the expertise of those to whom he has delegated investment responsibility, such reliance is a tool for interpreting the delegate’s reports, not an excuse for dispensing with or ignoring such reports. A director whose failure to supervise permits negligent mismanagement by others to go unchecked has committed an independent wrong against the corporation ….

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 #2. A court overseeing the bankruptcy of a prominent televangelist’s ministry concluded that the televangelist (as both an officer and director) had breached his legal duty of care to the corporation. The court emphasized that “trustees and corporate directors for not-for-profit organizations are liable for losses occasioned by their negligent mismanagement.”

Case #3. A court ruled that directors of a New York charitable trust could be sued for breaching their fiduciary duties. A child of the founder of the trust filed a lawsuit seeking to remove eight of the trust’s eleven directors. He asserted that the eight directors breached their fiduciary duties, mismanaged the trust’s investments, and negligently selected the trust’s investment advisor. Specifically, the lawsuit alleged that the eight 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 eight 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 #4. 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.

Application to church treasurers. What steps can church treasurers and church board members take to reduce the risk of violating the fiduciary duty of due care? Consider the following:

  • 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.
  • Check the church’s governing documents and minutes. The governing documents (i.e., articles of incorporation or bylaws) of some churches 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 familiar with these restrictions and to enforce them.
  • 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. After all, they were relying on the advice of experts.

Key point. The Model Revised Nonprofit Corporation Act (quoted above) specifies that “in discharging his or her duties, a director is entitled to rely on information, opinions, reports, or statements, including financial statements and other financial data, if prepared or presented by … persons as to matters the director reasonably believes are within the person’s professional or expert competence ….” This language provides directors with considerable protection when relying on the advice of experts on an investment committee.

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

Key point. Do not rely on the “expert opinion” of persons representing the promoter of an investment scheme. Investment schemes must be reviewed by independent and objective persons having financial and investment expertise. Ideally, these persons will be members of your church, or persons within your community who have a reputation of unquestioned integrity.

The United States Securities and Exchange Commission (SEC) lists four common investment scams that are perpetrated on religious organizations—pyramid schemes, Ponzi schemes, Nigerian investment scams, and prime bank scams. The SEC has provided the following warning signs of 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.

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.

Key point. Remember, you are investing donated funds. This is no time to be taking risks. Not only do officers and directors have a legal duty to exercise due care in the investment of church funds. Just as importantly, they have a moral duty to be prudent in their investment decisions. No officer or director wants to explain to church members at an annual business meeting how some of their contributions were lost due to poor investments.

Avoid investing in companies or programs in which a board member has a personal interest. The third case summarized above demonstrates the need to 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 higher degree of scrutiny.

Key point. A church’s investments should be reviewed at every board meeting. This ensures that all investments will be continuously monitored, and that necessary adjustments can be made.

  • 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 church board as the trustee of the fund. Trustees are held to an even higher degree of care in the investment of trust funds than 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.
  • Conclusion. Church officers and directors must take steps to inform themselves about any investment decision involving church funds. They can rely on a number of safeguards, including their own research, the recommendations of an investment committee, and common sense.

This article first appeared in Church Treasurer Alert, November 2006.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

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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