Self-directed IRAs are a type of financial instrument which allows a person to invest in a larger range of assets than a traditional IRA. Many of us are familiar with IRAs that invest in stocks, bonds, mutual funds, and certificates of deposit, but self-directed IRAs expand from these more traditional investing avenues, and also allow someone to invest in promissory notes, real estate, precious metals, private placement securities, tax lien certificates, and other investments which may not be registered.
This type of IRA is becoming increasingly popular in the United States, with about $94 billion of retirement funds invested in them. They are completely legal, when used correctly. However, some of the inherent characteristics of this financial instrument have not only attracted legitimate investments, but in addition scammers and fraudsters who use the patina of the self-directed IRAs legality to defraud investors of their life savings.
Why are Self-Directed IRAs so susceptible to fraud?
As with all IRAs, a self-directed IRA must be held by a trustee or custodian. However, with the more traditional IRAs the custodians are typically banks and broker-dealers who only allow investment in firm approved stocks, bonds, mutual funds and CDs. However, with a self-directed IRA the trustee or custodian’s duties may be more lax.
The fact that this type of IRA allows investment in a broader range of assets can increase the likelihood of fraudulent behavior. For example, unregistered securities are permitted in this type of IRA. There is typically less investigation into this type of security, with less information easily available, and further there is no guarantee that any information provided has been audited. Therefore, in a situation in which more due diligence is typically required there is less opportunity to review accurate information to perform that due diligence.
In addition, the broader range of assets allowed for self-directed IRAs can create unique risks for investors that should be considered, such as lack of liquidity and difficulty in valuing assets. The result of the characteristics of these assets means that the self-directed IRA custodians will often list the value of the assets as the original purchase price, plus any gains as determined arbitrarily by the promoter. These values that are told to investors may not reflect the true value of the investment if sold on the open market. Further, these self-promoting statements may go unchecked and unquestioned.
Finally, the fact that self-directed IRAs are a tax-deferred account can impact psychologically how much oversight an investor has over this type of investment instrument. The fact that there is a financial penalty for early withdrawal means people tend to invest in these types of accounts for the long term, when more prudent investors in these types of investments may more actively manage such accounts. This same mind set may also allow the person committing the Ponzi type scheme or other fraud to conduct their fraud longer before their misdeeds are detected.
Scott Starr, a partner in this firm, has stated, “Some of these investment advisors and stockbrokers are clearly committing malpractice and breaching their fiduciary duties” when directing individuals to invest in these self-directed IRAs. Further, he states that “It is not uncommon for these individuals to place their clients in investments that are either too high risk, carry a time horizon that is too far in the future, or fail to properly diversify these portfolios.”
See if you have a case
If you believe you have been taken advantage of, contact us right away. We can help you know if you have a legitimate case.
[Sources: SEC office of Investor Education and Advocacy, Investor Alert: Self-
Directed IRAs and the Risk of Fraud, found at www.investor.gov; Indiana Secretary
of State Announces Guilty Plea and Sentencing in Retirement Scam dated 11/10/
11; Indiana Securities Fraud Case Highlights Risks of Self-Directed IRAs, from the
wallstreetfraudblog.com; and Self-Directed IRAs’ pitfalls highlighted in fraud case,
written by Rebecca S. Green, in The Journal Gazette]