Article Archives >> Lead Stories >> July 16-31, 2009

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Sale of Gift Annuities
Subject to Securities Fraud Rules
Philanthropy Protection Act does not exempt
commissioned sellers from registration requirements

The sale of charitable gift annuities in a Ponzi scheme violated federal and state securities rules, the 9th Circuit Court of Appeals has held, and individuals selling them on commission were not exempted from registration requirements by the Philanthropy Protection Act of 1995.  It has affirmed a District Court order for the sales reps to pay damages ranging from $31,900 to $109,900 per person.  (Warfield v. Alaniz, No. 07-15586, 6/24/09.)

The scheme was promoted from 1996 to 2001 by the Mid-America Foundation controlled by Robert Dillie.  Dillie and his commissioned sales force promised “a gift for your lifetime and beyond,” and pledged to preserve the American way of life.  They sold more than 400 gift annuities for about $55 million, but never invested the funds.  They used new sales to make annuity payments to previous purchasers, and paid expenses, including coverage of some of Dillie’s gambling expenses.  Virtually nothing went to charity.  Dillie was convicted and sentenced to more than 10 years in prison.

A receiver appointed to protect the funds of annuitants sued the sales reps to recover commissions paid and claimed violation of state and federal securities laws, constructive fraud and unjust enrichment, among other things.

The sales reps first argued that the gift annuities were not securities.  The Court of Appeals, following a long line of cases stemming from the U.S. Supreme Court’s 1946 decision in SEC v. W.J. Howey Co., held that they were investment contracts in which the annuitants invested money in a common pool with an expectation of profit from the efforts of others.

The Court said it did not have to decide whether they were “exempted securities” under the Philanthropy Protection Act because even securities issued by charitable organizations that are exempt from registration requirements are subject to the anti-fraud provisions of the securities law.

The sales reps also argued that they were exempt from broker-dealer registration requirements because of the Philanthropy Protection Act. 

The Philanthropy Protection Act had been passed by Congress to assure charities that they could issue gift annuities and other pooled investment vehicles without having to register the securities or their development officers as broker dealers.  It was enacted to ward off a series of suits challenging gift annuities and the rate setting procedures.

While sales reps are generally exempt under the PPA, the Court said, Congress included a specific provision stating that the exemption shall not apply to any charitable organization, or any trustee, director, officer, employee or volunteer unless such person “is either a volunteer or is engaged in the overall fundraising activities of a charitable organization and receives no commission or other special compensation based on the number of donations collected for the fund.”

Since the sales reps were paid on commission, the Court said, they were not exempted from the general securities requirements.

YOU NEED TO KNOW

Many current development officers may not have been active during the turbulent times of the 1990's when gift annuities were subject to challenge from a number of quarters, and many of those who were active may have forgotten the issues.  It is easy in the current environment to forget that even though gift annuities are not subject to full securities scrutiny, they are also not totally exempt.  As this case so clearly holds, they are subject to the anti-fraud rules, and individual development officers or other sales reps are not exempt from registration requirements if they are paid on commission.

 

Article Archives >> Lead Stories >> July 16-31, 2009