Securities Regulator Expresses Concerns about Church Bonds

 

Church bonds, and broker sales practices involving them, have earned a spot on the list of examination and enforcement priorities of the Financial Industry Regulatory Authority (FINRA) for 2012. FINRA is concerned about sales of church bonds arising out of brokers’ inappropriate sales practices, unsuitable product offerings and misrepresentation.

Sales of church bonds are frequently associated with affinity fraud. Fraud that is facilitated by an appeal to a common interest ? a church or other group, religious beliefs, race, culture, et cetera ? is known as affinity fraud. Scam artists are often adept at exploiting this tendency to ascribe trustworthiness to one with whom we share a common interest. Church bond sales pitches often include appeals to support the mission of a church.

Church bond sellers have also tailored their sales pitches to capitalize on the low interest rate environment and the desire for relatively safe investment income on the part of retirees. In fact, however, church bonds are not safe investments. The impact of an increasing number of church bond defaults on retirees’ investment portfolios has been catastrophic.

Church bonds have a number of risks and problems. One notable feature of church bonds a lack of liquidity. This alone makes them unsuitable for investors who need liquidity. Church bonds are often small issues that involve $10 million or less. There is typically no secondary market for these bonds.

In addition, the true financial condition and creditworthiness of church bond issuers are often difficult to ascertain, since the source and nature of the underlying revenue streams that are required to service the bonds are often unclear. This lack of transparency is often exacerbated by the failure of a selling broker to perform proper due diligence.

The general economic decline has led to a decline in church donations and an inability of many churches to pay their debts as they come due. Foreclosures and bankruptcy filings by churches and church lending organizations, are now not uncommon. Consequently, church bonds carry substantial credit and market risk.

Despite these negative conditions and problems, some church bond underwriters reportedly lowered their underwriting standards in order to keep generating fees and mark-up compensation. Bond underwriters earn fees from church clients and compensation from mark-ups on sales to investors.

The law imposes a number of duties on brokerage firms and brokers that sell church bonds. They are required to have a reasonable basis for any investment recommendation they make. In that connection, they must perform a due diligence investigation to understand any risks and problems that may exist with respect to the investment. They must make a determination as to whether, based on their due diligence, the investment is suitable for any investor. They must make a determination as to whether the investment is suitable for a particular investor based on that investor’s investment objectives, risk tolerance and financial profile. Finally, brokers must disclose to potential investors, prior to any investment, all material facts and risks concerning the investment, making a fair and balanced presentation of the risks, and not just the potential benefits.

Unfortunately, these broker duties are often not fulfilled. Where that is the case, investors who have lost money may have compelling claims to recover their losses.

Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.